Utstarcom, Inc. Securities Litigation 04-CV-04908-Appendix Of

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GREGORY A. MARKEL (pro hac vice) ([email protected]) 1 RONIT SETTON (pro hac vice) ([email protected]) AMANDA KOSOWSKY (SB # 214282) ([email protected]) 2 CADWALADER, WICKERSHAM & TAFT LLP One World Financial Center 3 New York, NY 10281 Telephone: (212) 504-6000 4 Facsimile: (212) 504-6666

5 and

6 MORGAN LEWIS & BOCKIUS, LLP MICHAEL J. LAWSON (SB # 66547) ([email protected]) 7 VINCENT P. FINIGAN, JR. (SB # 053517) ([email protected]) One Market 8 Spear Street Tower San Francisco, CA 94105-1126 9 Telephone: (415) 442-1000 Facsimile: (415) 442-1001 10 Attorneys for Defendant Banc of America 11 Securities LLC 12

13 UNITED STATES DISTRICT COURT 14 NORTHERN DISTRICT OF CALIFORNIA 15 SAN JOSE DIVISION 16

17 Case No. C-04-4908 –JW(PVT) In re UTSTARCOM, INC. SECURITIES 18 LITIGATION APPENDIX OF UNPUBLISHED AUTHORITIES IN SUPPORT OF 19 BANC OF AMERICA LLC’S MOTION TO DISMISS 20

Date: September 11, 2006 21 Time: 9:00 a.m. Dept: 8, 4th Floor 22 Judge: Hon. James Ware

23 Date Comp. Filed: April 13, 2006

24 Trial Date: None set 25 26 27 28

APPENDIX OF UNPUBLISHED AUTHORITIES; CASE NO.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

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Table of Contents 1 1. Abbell Credit Corp. v. Bank of America Corp., 2 No. 01 C 2227, 2002 WL 335320 (N.D. Ill. Mar. 1, 2002) 3 2. In re Exodus Communications, Inc. Securities Litigation, No. C 01-2661 MMC, 160, 163, 2005 WL 1869289 (N.D. Cal. Aug. 5, 2005) 4 3. In re Netopia, Inc. Sec. Litig., 5 No. C-04-03364 RMW, 2005 WL 3445631 (N.D. Cal. Dec. 15, 2005) 6 4. In re Oak Technology Securities Litigation, No. 96-20552SW, 1997 WL 448168 (N.D. Cal. Aug. 1, 1997) 7 5. In re Portal Software, Inc. Sec. Litig., 8 No. C-03-5138 VRW, 2005 WL 1910923 (N.D. Cal. Aug. 10, 2005) 9 6. In re Silicon Storage Tech., Inc. Sec. Litig., No. C 05-0295-PJH, 2006 WL 648683 (N.D. Cal. Mar. 10, 2006) 10 7. In re TyCom Ltd. Securities Litigation, 11 No. 03-CV-1352-PB, 02-MDL-1335-PB, 2005 WL 212767 (D. N.H. Sept. 2, 2005) 12 8. In re Valence Tech. Sec. Litig., No. C 94-1542-SC, 1995 WL 274343 (N.D. Cal. May 8, 1995) 13 9. In re Valence Tech. Sec. Litig., 14 No. C 95-20459 JW, 1996 WL 37788 (N.D. Cal. Jan. 23, 1996) 15 10. In re WRT Energy Sec. Litig., Nos. 96 CIV. 3610 and 96 CIV. 3611 (JFK), 1999 WL 178749 (S.D.N.Y. Mar. 31, 1999) 16 11. Stack v. Lobo, 17 Civ. No. 95-20049 SW, 1995 WL 241448 (N.D. Cal. Apr. 20, 1995) 18 12. Zishka v. American Pad & Paper Co., No. 3:98-CV-0660-M, 2000 WL 1310529 (N.D. Tex. Sept. 13, 2000) 19 20 21 22 23 24 25 26 27

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

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

Briefs and Other Related Documents Since 1940, Abbell has maintained a banking and investment relationship with BAC and its United States District Court, N.D. Illinois, Eastern predecessors. Merle Hay and Westgate maintain a Division. banking relationship and accounts with BAC and ABBELL CREDIT CORP., an Illinois corporation, BAS. Among its other duties, Abbell is responsible Merle Hay Mall, an Iowa limited partnership, for investing excess cash balances generated by Westgate Village Shopping Center, an Illinois limited Merle Hay and Westgate. Abbell effectuated these partnership, and J. William Holland, an individual, investments through BAS or its predecessor entity. Plaintiffs, Since 1984, Abbell has invested the excess cash v. balances by purchasing commercial paper with a BANK OF AMERICA CORPORATION, a maturity date of less than sixty days. For each such Delaware corporation, Banc of America Securities, transaction, Abbell only purchased short-term L.L.C., a Delaware corporation, and Matt Williams, commercial paper recommended by BAS as an individual, Defendants. creditworthy and having the highest quality rating of No. 01 C 2227. A1/P1. Plaintiffs' investment criteria and strategies have not varied since 1984. March 1, 2002. On at least one occasion, Abbell has requested that BAS prepay a piece of commercial paper prior to MEMORANDUM OPINION AND ORDER maturity. At that time, BAS prepaid to Abbell the LINDBERG, Senior District J. principal amount of its investment at the discount rate *1 Defendants Bank of America Corporation, Banc available on the trade date for the number of days of America Securities, and Matt Williams have from the date of purchase to the refund date. BAS moved to dismiss plaintiffs' second amended charged Abbell a nominal fee for the prepayment. complaint. For the reasons stated below, Bank of America Corporation's motion is granted, and Banc BAC has been the dealer of Pacific Gas & Electric of America Securities' and Williams' motion is (“PG & E”) commercial paper since 1985. In October granted in part and denied in part. 2000, BAC provided a $1 billion credit facility to underwrite PG & E's commercial paper program. In November 2000, PG & E authorized the public I. Factual Background issuance of commercial paper in the total amount of $1.85 billion. In considering a motion to dismiss, the court must accept as true all well-pleaded facts and must draw On November 28, 2000, Williams telephoned all reasonable inferences from those allegations in Abbell's controller, and recommended that Abbell plaintiff's favor. MCM Partners, Inc. v. Andrews- purchase PG & E commercial paper for Merle Hay Bartlett & Assoc., Inc., 62 F.3d 967, 972 (7th and Westgate. Williams stated that PG & E offered a Cir.1995). According to the allegations in the second sixty-day commercial paper at a discount rate of amended complaint, plaintiff Abbell Credit 6.4%, with a maturity date of January 29, 2001. Corporation (“Abbell”) is the managing agent for Williams further stated that “the PG & E commercial plaintiffs Merle Hay Mall (“Merle Hay”) and paper was rated A1/P1, that PG & E just basically Westgate Village Shopping Center (“Westgate”). supplies the West Coast with electricity and that Plaintiff J. William Holland (“Holland”) is the California would never turn out the lights on PG & managing general partner of Merle Hay and E.” Westgate, and is the chairman of Abbell's board of directors. Defendant Banc of America Securities *2 Based on the information provided by Williams, (“BAS”) is a securities brokerage enterprise, and a and his recommendation, Abbell purchased two wholly-owned subsidiary of defendant Bank of pieces of PG & E commercial paper on behalf of America Corporation (“BAC”). Matt Williams is a Merle Hay and Westgate, for a total of approximately registered securities broker employed by BAS. $1 .95 million. Following the purchase, BAS did not

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 4 of 163 Not Reported in F.Supp.2d Page 2 Not Reported in F.Supp.2d, 2002 WL 335320 (N.D.Ill.), Fed. Sec. L. Rep. P 91,734 (Cite as: Not Reported in F.Supp.2d) send Abbell a commercial paper memorandum, claim.” Id. which would have confirmed the terms of the agreement and included a general description of financial credit available to the issuer. Abbell would A. Existence of a Duty typically receive such a commercial paper memorandum seven to ten days after a purchase of Plaintiffs seek to hold defendants liable for failing to commercial paper. disclose that BAC provided a credit facility to PG & E, that BAC was the underwriter dealer of the PG & PG & E's financial condition deteriorated in E commercial paper, and that BAC would profit from December 2000 and early January 2001. On sales of PG & E commercial paper. According to December 14, 2000, BAS's energy analysts stopped plaintiffs, these omissions led plaintiffs to believe recommending PG & E commercial paper as that PG & E was in sound financial condition when it creditworthy. In early January 2001, Abbell learned was not. BAS and Williams argue that all claims of BAC's $1 billion credit facility, and that that credit against them should be dismissed because the second facility formed the primary reason for PG & E's amended complaint does not allege that they had a commercial paper's A1/P1 rating. Between January 8 duty to disclose the information. BAC also argues and January 12, 2001, Abbell sought the prepayment that it had neither a direct duty to disclose the of the PG & E commercial paper from Williams, who information to plaintiffs, nor a duty to ensure that declined. On January 15, 2001, Williams advised BAS disclosed the information. Abbell that the commercial paper could not be prepaid, and that the market price was $0.75 per *3 Several of plaintiffs' claims in the second purchase dollar. On January 17, 2001, the PG & E amended complaint require proof of a duty. An commercial paper was downgraded to junk status, omission of a material fact is actionable under and PG & E defaulted on the commercial paper set to Section 10(b) and Rule 10b-5 only if the defendant mature on that date. Eventually, on January 22, 2001, has a duty to disclose that fact. Chiarella v. United Abbell sold the PG & E commercial paper to BAS States, 445 U.S. 222, 230 (1980); Congregation of for $0.50 per purchase dollar. the Passion v. Kidder Peabody & Co., 800 F.2d 177, 182 (7th Cir.1986). In addition, a common law fraud This lawsuit followed. Plaintiffs' second amended claim based on an omission or concealment of a complaint alleges claims under Section 10(b) of the material fact requires there to have been a duty to Securities Exchange Act of 1934 against all speak. Lidecker v. Kendall College, 550 N.E.2d 1121, defendants, and alleges claims under Section 12(1) of 1124 (Ill.App.Ct.1990); Warner v. Lucas, 541 N.E.2d the Securities Act of 1933, the Illinois Securities 705, 706 (Ill.App.Ct.1989). Finally, duty is an Law, and claims of fraud, negligence, and breach of element of any negligence claim. See Advincula v. contract against BAS and Williams. United Blood Servs., 678 N.E.2d 1009, 1015 (Ill.1996).

II. Discussion A fiduciary duty arises between a broker and a customer only when the dealings between them When ruling on a motion to dismiss under “presuppose a special trust or confidence .” Fed.R.Civ.P. 12(b)(6), the court must consider Congregation of the Passion, 800 F.2d at 182. Thus, “whether relief is possible under any set of facts a broker generally is not the fiduciary of his customer consistent with the allegations of the plaintiff's unless the customer entrusts the broker with complaint.” Pokuta v. Trans World Airlines, Inc., 191 discretion to select the customer's investments. Carr F.3d 834, 839 (7th Cir.1999). That is, if it is possible v. CIGNA Securities, Inc., 95 F.3d 544, 547 (7th to hypothesize a set of facts that would entitle the Cir.1996). The second amended complaint alleges plaintiff to relief, consistent with the allegations in that Abbell had been investing in commercial paper the complaint, dismissal under Rule 12(b)(6) is through BAS or its predecessor since 1984, and that inappropriate. See Graehling v. Village of Lombard, Abbell relied upon BAS and the BAS representative Ill., 58 F.3d 295, 297 (7th Cir.1995). “[A]lthough exclusively for information and recommendations plaintiffs can plead conclusions, the conclusions must relating to investments in commercial paper. At this provide the defendant with at least minimal notice of stage in the proceedings, the court cannot say that it the claim.” Jackson v. Marion County, 66 F.3d 151, appears beyond doubt that plaintiffs can prove no set 154 (7th Cir.1995). A plaintiff can “plead himself out of facts in support of their claims against BAS and of court by alleging facts which show that he has no Williams that would entitle them to relief. These

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 5 of 163 Not Reported in F.Supp.2d Page 3 Not Reported in F.Supp.2d, 2002 WL 335320 (N.D.Ill.), Fed. Sec. L. Rep. P 91,734 (Cite as: Not Reported in F.Supp.2d) allegations are sufficient to withstand a motion to dismiss based on a lack of duty as to the claims BAS and Williams contend that Count II should be against BAS and Williams. dismissed because plaintiffs fail to satisfactorily explain why Williams' statement that the PG & E The court's conclusion is different as to plaintiffs' commercial paper had an A1/P1 rating was claim against BAC. The court disagrees with misleading, as required by the Private Securities plaintiffs' claim that BAC owed them a direct duty to Litigation Reform Act (“PSLRA”). See 15 U.S.C. § disclose information regarding its role as underwriter 78u-4(b)(1). Plaintiffs respond that the second and dealer of the PG & E commercial paper, and PG amended complaint alleges that Williams' & E's financial problems. While plaintiffs may have representation that the PG & E commercial paper was maintained a banking and investment relationship rated A1/P1 was misleading because Williams failed with BAC dating from 1940, they do not allege that to disclose that this rating was based on BAC's credit they had any contact with BAC relating to the facility rather than on PG & E's financial stability, transaction at issue, other than that payment for the that BAC was the underwriter and dealer of the PG & commercial paper was made from plaintiffs' BAC E commercial paper, and that BAC would profit from bank accounts and that the commercial paper then sales of PG & E commercial paper. This explanation was “delivered to Bank of America safekeeping .” FN1 is sufficient to withstand a motion to dismiss. BAS Plaintiffs do not allege that BAC solicited them to and Williams may find plaintiffs' explanation buy the PG & E commercial paper, or that plaintiffs unconvincing, but the issue of whether a statement or sought BAC's advice on the transaction. The court is omission is material requires a “highly fact- not aware of any duty of a bank to monitor how its dependent analysis” that in this case is unsuitable for customers use funds on deposit with the bank, or to decision at this early stage of litigation. See Searls v. monitor the types of instruments it stores for Glasser, 64 F.3d 1061, 1066 (7th Cir.1995). customers. Plaintiffs' use of BAC's banking services in processing their purchase of PG & E commercial BAS and Williams also challenge Count II on the paper is not a contact sufficient to impose on BAC a basis that plaintiffs fail to sufficiently allege that duty to review plaintiffs' investment decision and defendants acted with scienter. The PSLRA requires make disclosures relating to that decision. plaintiffs in securities fraud cases to “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of FN1. This information is contained in mind.” 15 U.S.C. § 78u-4(b)(2). The Seventh Circuit confirmation documents attached as exhibits has yet to address just how rigorous this pleading to the second amended complaint, and is standard is. Cases in the Northern District of Illinois therefore part of the complaint. See have generally followed the Second Circuit's Fed.R.Civ.P. 10(c). pleading standard, which requires plaintiffs to allege facts either (1) showing that the defendant had both *4 Nor did BAC have a duty to ensure that its motive and opportunity to commit fraud; or (2) subsidiary, BAS, disclosed information to plaintiffs. constituting strong circumstantial evidence of As a general rule, a parent corporation is not liable conscious misbehavior or recklessness. See, e.g., In for the acts or omissions of its subsidiary. See United re Westell Techs., Inc., No. 00 C 6735, 2001 WL States v. Bestfoods, 524 U.S. 51, 61 (1998). Although 1313785, at *10 (N.D.Ill. Oct. 26, 2001); Danis v. a parent corporation has the power to control its USN Communications, Inc., 73 F.Supp.2d 923, 937 subsidiary, see Esmark, Inc. v. N.L.R.B., 887 F.2d (N.D.Ill.1999); Rehm v. Eagle Fin. Corp., 954 739, 757 (7th Cir.1989), that power does not translate F.Supp. 1246, 1253 (N.D.Ill.1997). into a duty to control. The second amended complaint does not allege, and plaintiffs do not argue, that *5 To show strong circumstantial evidence of corporate formalities should be disregarded in this recklessness, a plaintiff must point to “highly case. Because Count VIII does not allege an omission unreasonable” conduct: “an extreme departure from of a material fact that BAC was obligated to disclose, the standards of ordinary care...to the extent that the it does not state a claim against BAC under Section danger was either known to the defendant or so 10(b) and Rule 10b-5 that could be granted. obvious that the defendant must have been aware of Accordingly, Count VIII is dismissed. it.” Rehm, 954 F.Supp. at 1255. Plaintiffs argue that the complaint alleges strong circumstantial evidence of recklessness against BAS and Williams in that PG B. Section 10(b) and Rule 10b-5 (Counts II and VIII) & E's financial instability was an objectively obvious

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 6 of 163 Not Reported in F.Supp.2d Page 4 Not Reported in F.Supp.2d, 2002 WL 335320 (N.D.Ill.), Fed. Sec. L. Rep. P 91,734 (Cite as: Not Reported in F.Supp.2d) danger that BAS and Williams knew about or should common design.” ’). However, plaintiffs' argument have known about through their close relationship on this point requires the court to assume the very with PG & E. The second amended complaint also fact that plaintiffs are trying to establish: plaintiffs alleges that BAS knew or should have known about seek to show that BAS and Williams knew of PG & PG & E's financial instability “[b]ased on Bank of E's financial instability by arguing that BAS and America's position as the lead underwriter dealer of Williams were trying to help BAC avoid financial the commercial paper program and BAS's position as exposure due to PG & E's financial instability. seller of the commercial paper.” These allegations are Although BAS and Williams undoubtedly had the insufficient to establish strong circumstantial opportunity to defraud plaintiffs, given the evidence of recklessness on the part of Williams and longstanding investment relationship that plaintiffs BAS. Contrary to plaintiffs' argument, the second allege, the motives plaintiffs allege do not rise to the amended complaint does not allege that BAS and level that permits a strong inference of scienter. Williams had any relationship with PG & E. More Therefore, Count II must be dismissed. importantly, the second amended complaint imputes BAC's knowledge to its subsidiary without providing any concrete factual basis for doing so. C. Securities Act of 1933, Section 12(1) (Count III)

Nor do plaintiffs sufficiently allege scienter by *6 BAS and Williams next seek the dismissal of showing that BAS and Williams had a motive and Count III of the second amended complaint, which opportunity to defraud. Simply alleging a motive and alleges that BAS and Williams offered and sold opportunity is not enough to satisfy the scienter unregistered securities in violation of Section 12(1) requirement of the PSLRA; the facts alleged still of the Securities Act of 1933, 15 U.S.C. § 771(a)(1). must give rise to a strong inference of scienter. See BAS and Williams argue that plaintiffs' earlier 15 U.S.C. § 78u-4(b)(2); see also Chu v. Sabratek statements in this case that the commercial paper was Corp., 100 F.Supp.2d 815, 823 (N.D.Ill.2000). exempt from the registration requirement constitute a Plaintiffs contend that Williams and BAS were judicial admission on the issue, and that in any event, motivated to conceal material facts by the profits they the PG & E commercial paper was not required to be and BAC would earn in selling PG & E commercial registered. FN2 BAS and Williams contend that the paper. However, a plaintiff cannot allege scienter following of plaintiffs' statements, made in plaintiffs' based merely on motivating factors that would be motion to reconsider this court's order dismissing a true for nearly all companies; it is presumed that portion of their first amended complaint, constitute defendants act in their economic self-interest. Rehm, judicial admissions: “The PG & E Commercial Paper 954 F.Supp. at 1253; see also, e.g., Phillips v. LCI was exempt from the registration requirements under Int'l, Inc., 190 F.3d 609, 621-23 (4th Cir.1999) Section3(a)(3) and therefore exempt from the (desire to retain position on corporation's board and prospectus requirement,” and “The reason why a obtain higher stock price constituted insufficient formal prospectus was not issued is because the motive); In re Brightpoint, Inc. Secs. Litig., No. IP99- commercial paper was and is exempt from the 0870-C-H/G, 2001 WL 395752, at *14 (S.D. Ind. registration requirements of the statute under Section Mar. 29, 2001 (desire to gain reputational and 3(a)(3).” BAS and Williams argue that these monetary benefits from positive public perception of statements prevent plaintiffs from now claiming that company constituted insufficient motive); In re Next the PG & E commercial paper was subject to the Level Sys., Inc., No. 97 C 7362, 1999 WL 387446, at registration requirements. *9 (N.D.Ill. Mar. 31, 1999) (desire to maintain reputation in capital markets and retain access to financing constituted insufficient motive). FN2. BAS and Williams also take issue with the allegation in Count III that they offered Plaintiffs also argue that Williams and BAS were and sold unregistered securities by offering motivated to defraud by their desire to avoid financial to “prepay” the PG & E commercial paper exposure caused by PG & E's deteriorating financial on January 15, 2001. Plaintiffs appear to condition. A subsidiary's desire to benefit its parent have abandoned this portion of their claim, could constitute a valid motivation. See Copperweld since they do not respond to defendants' Corp. v. Independence Tube Corp., 467 U.S. 752, argument that defendants' offer to buy the 771-72 (1984) (“the subsidiary acts for the benefit of commercial paper from plaintiffs prior to the parent...[I]n reality a parent and a wholly owned maturity would make defendants purchasers subsidiary always have a ‘unity of purpose or a in that transaction, rather than sellers.

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The court disagrees that plaintiffs' statements D. Illinois Securities Act (Count IV) constitute judicial admissions. Counsel's legal conclusions do not constitute judicial admissions. See BAS and Williams next argue that plaintiffs' claim Dabertin v. HCR Manor Care, Inc., 68 F.Supp.2d under the Illinois Securities Law should be dismissed 998, 1000 (N.D.Ill.1999). In addition, Federal Rule of because it is not pled with particularity, as required Civil Procedure 8(e)(2) allows plaintiffs to pursue by Federal Rule of Civil Procedure 9(b). The inconsistent theories of recovery in the same lawsuit. allegation in the second amended complaint that Thus, a claim made early in a lawsuit that is later defendants “engaged in deceptive practices” in superceded by an inconsistent one is not a judicial violation of the Illinois Securities Law is identical to admission. Moriarty v. Larry G. Lewis Funeral Dirs., plaintiffs' claim in their first amended complaint, a Ltd., 150 F.3d 773, 777-78 (7th Cir.1998). Plaintiffs' claim that BAS and Williams did not challenge in argument supporting their claim of a violation of their first motion to dismiss. BAS and Williams Section 12(2) of the Securities Act of 1933 does not nevertheless contend in their reply brief that they prevent them from now claiming a violation of have not waived this challenge. According to BAS Section 12(1). and Williams, the second amended complaint removes an allegation that Williams represented the BAS and Williams also argue that the second PG & E commercial paper to be creditworthy from amended complaint does not contain allegations that the factual background section of the first amended the PG & E commercial paper was required to be complaint, a change which in turn impacts the registered, and argue that plaintiffs must rebut a deceptive practice allegation in the Illinois Securities presumption that commercial paper with a maturity Law claim. under nine months is exempt from the registration requirements. Section 3(a)(3) of the 1933 Securities In their motion to dismiss the second amended Act exempts from registration “[a]ny note...which complaint, however, BAS and Williams did not arises out of a current transaction or the proceeds of challenge plaintiffs' new characterization of which have been or are to be used for current Williams' statements as applied to the Illinois transactions, and which has a maturity at the time of Securities Law claim, but rather confined their issuance of not exceeding nine months...” 15 U.S.C. challenge to the vagueness of the allegation of § 77c(a)(3). This exemption has been interpreted to “deceptive practice.” This argument should have apply only to short-term, prime quality negotiable been brought in the motion to dismiss the first commercial paper that is of a type not ordinarily amended complaint; since it was not, it is waived. See purchased by the general public. See Sanders v. John Fed.R.Civ.P. 12(g). BAS' and Williams' argument Nuveen & Co., 463 F.2d 1075, 1079-80 (7th regarding the effect of the changed factual Cir.1972). The burden of establishing an exemption background section, appearing for the first time in is on the party that claims it. Securities and Exch. their reply brief, is also waived. See Estate of Phillips Comm'n v. Ralston Purina Co., 346 U.S. 119, 126 v. City of Milwaukee, 123 F.3d 586, 597 (7th (1953). Cir.1997); Petri v. Gatlin, 997 F.Supp. 956, 977 (N.D.Ill.1997). *7 At this stage, reading the second amended complaint in the generous light that it must, the court finds that the allegations in the second amended E. Fraud (Count V) complaint could support plaintiffs' position that the PG & E commercial paper was subject to the BAS and Williams contend that Count V, alleging registration requirement. Plaintiffs allege that BAS fraud, is fatally deficient under Rule 9(b) because it and Williams sold PG & E commercial paper, an does not specify the content of the alleged failure to unregistered security, and that that sale violated the disclose material facts or misrepresentation. The prohibition against sales of unregistered securities. court disagrees. Rule 9(b)'s particularity requirement Since a security with a maturity of less than nine means supplying the “who, what, when, where, and months is not necessarily exempt from the how: the first paragraph of any newspaper story.” registration requirement, plaintiffs do not plead DiLeo v. Ernst & Young, 901 F.2d 624, 627 (7th themselves out of court by alleging the short-term Cir.1990). Essentially, a plaintiff must specify which nature of the PG & E commercial paper. BAS' and defendant “said what to whom and when.” Ackerman Williams' motion to dismiss Count III is denied. v. Northwestern Mut. Life Ins. Co., 172 F.3d 467, 471 (7th Cir.1999). The second amended complaint

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 8 of 163 Not Reported in F.Supp.2d Page 6 Not Reported in F.Supp.2d, 2002 WL 335320 (N.D.Ill.), Fed. Sec. L. Rep. P 91,734 (Cite as: Not Reported in F.Supp.2d) alleges that in recommending that plaintiffs purchase PG & E commercial paper, Williams failed to inform ORDERED: BAS' and Williams' motion to dismiss is plaintiffs that BAC's credit facility formed the granted in part and denied in part: the motion is primary reason for the commercial paper's A1/P1 granted as to Count II, and denied as to Counts III rating, a fact that plaintiffs claim would have been through VII. BAS' and Williams' motion for material to an assessment of whether the commercial judgment on the pleadings is denied, as the pleadings paper was creditworthy. This allegation adequately are not yet closed. See Fed.R.Civ.P. 12(c). BAS' and supplies the “what,” as required by Rule 9(b). Williams' motion to strike Count I is granted. BAC's motion to dismiss is granted. BAC's motion to strike *8 BAS and Williams also argue that Count V fails to is denied as moot. allege the elements of a common law fraud claim. To establish common law fraud under Illinois law, a N.D.Ill.,2002. plaintiff must show that: (1) the defendant made a Abbell Credit Corp. v. Bank of America Corp. false statement of material fact, (2) the defendant Not Reported in F.Supp.2d, 2002 WL 335320 knew that the statement was false, (3) the defendant (N.D.Ill.), Fed. Sec. L. Rep. P 91,734 made the statement intending to induce the plaintiff to act, (4) the plaintiff relied on the truth of the Briefs and Other Related Documents (Back to top) statement, and (5) the plaintiff's damages resulted from that reliance. Connick v. Suzuki Motor Co., 675 • 2002 WL 32677293 (Trial Motion, Memorandum N.E.2d 584, 591 (Ill.1996). BAS and Williams and Affidavit) Plaintiffs' Response to Defendants' contend that the second amended complaint does not Motion to Formulate and Simplify Certain Issues allege facts that Williams knew to be false or that he Pursuant to Rule 16(c) of the Federal Rules of Civil intended to induce plaintiffs to act on his false Procedure (May 29, 2002) statement. The second amended complaint alleges • 2002 WL 32677297 (Trial Motion, Memorandum that Williams called Abbell's controller to solicit and Affidavit) Plaintiffs' Response to Defendants' Abbell's business, and in making his recommendation First Request for Admission of Facts and that Abbell purchase PG & E commercial paper: Genuineness of Documents (May 29, 2002) knowingly failed to inform [Abbell's controller] of • 2002 WL 32677287 (Trial Pleading) Amended material facts and misrepresented the material facts Answer to Second Amended Complaint (May 23, regarding Bank of America and BAS's due diligence 2002) investigation of PG & E, PG & E's creditworthiness • 2002 WL 32677282 (Trial Pleading) Answer to and the basis for the A1/P1 rating assigned to PG & Second Amended Complaint (Mar. 18, 2002) E's Commercial Paper. • 2002 WL 32677269 (Trial Motion, Memorandum and Affidavit) Reply of Bac in Support of Its Motion These allegations are sufficient to withstand a motion to Dismiss and/or Strike (Feb. 4, 2002) to dismiss. • 2002 WL 32677277 (Trial Motion, Memorandum and Affidavit) Reply of Bas and Williams in Support of Their Motion to Dismiss and/or Strike and/or for F. Breach of Contract (Count VII) Judgment on the Pleadings (Feb. 4, 2002) • 2002 WL 32677257 (Trial Motion, Memorandum Finally, BAS and Williams argue that Count VII, and Affidavit) Plaintiffs' Response to the Motion of alleging breach of contract, should be dismissed Bank of America Corporation to Dismiss and/or because plaintiffs fail to allege that they performed Strike (Jan. 25, 2002) their obligations under the contract. Defendants • 2002 WL 32677263 (Trial Motion, Memorandum presented this argument in their initial motion to and Affidavit) Plaintiffs' Response to Defendants' dismiss, albeit obliquely, in the context of arguing Motion to Dismiss and/or Strike and/or for Judgment that plaintiffs had not alleged the existence of a on the Pleadings (Jan. 25, 2002) contract. As this court previously ruled, under liberal • 2001 WL 34666671 (Trial Pleading) Second federal notice pleading rules, plaintiffs have Amended Complaint (Nov. 16, 2001) sufficiently alleged the elements of a breach of • 2001 WL 34666664 (Trial Pleading) Amended contract claim at this stage. See Petri, 997 F.Supp. at Complaint (May 25, 2001) 965-66 (finding that hypothesis that plaintiffs had • 1:01CV02227 (Docket) (Mar. 29, 2001) fulfilled their contractual obligations was consistent • 2001 WL 34666661 (Trial Pleading) Complaint with allegations in complaint). The motion to dismiss (2001) Count VII is denied.

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Adam W. Wegner (“Wegner”), Beverly Brown Briefs and Other Related Documents (“Brown”), and William Yeack (“Yeack”) (collectively, “Individual Defendants”), each of United States District Court,N.D. California. whom is a former officer of Exodus FN1 In re EXODUS COMMUNICATIONS, INC. Communications, Inc. Each motion seeks SECURITIES LITIGATION dismissal of plaintiffs' Third Amended Consolidated No. C 01-2661 MMC, 160, 163. Class Action Complaint, pursuant to the Private Securities Litigation Reform Act of 1995 (“PSLRA”) Aug. 5, 2005. and Rules 9(b) and 12(b)(6) of the Federal Rules of Civil Procedure. On April 29, 2005, plaintiffs filed a Corrected Third Amended Consolidated Class Action Elizabeth P. Lin, Milberg Weiss Bershad & Complaint (“Third Amended Complaint” or “TAC”). Schulman LLP, Kevin J. Yourman, Leigh Anne The Court granted the parties leave to file Parker, Weiss & Yourman, Michael David Braun, supplemental memoranda addressing the impact of Braun Law Group, P.C., Los Angeles, CA, John K. the amendments on the pending motions to dismiss Grant, Connie Cheung, Ex KanoS. Sams, II, Milberg and, after such supplemental memoranda were filed, Weiss Bershad Hynes & Lerach LLP, Reed R. took the motions under submission as of May 13, Kathrein, Lerach Coughlin Stoia Geller Rudman & 2005. For the reasons set forth below, the Court Robbins LLP, San Francisco, CA, Joseph H. Weiss, GRANTS in part and DENIES in part the Weiss & Lurie, New York, NY, William S. Lerach, Underwriter Defendants' motion, and GRANTS the Lerach Coughlin Stoia Geller & Robbins LLP, San Individual Defendants' motion. Diego, CA, for Plaintiffs. Elizabeth E. Karnes, Morgan Lewis & Bockius, Jennifer Jarratt Massey, Brobeck, Phleger & Harrison FN1. The positions held by the Individual LLP, Rebecca Justice Lazarus, Gibson, Dunn & Defendants during the relevant time period Crutcher, San Francisco, CA, David Malcolm are as follows: (1) Hancock, CEO and Furbush, O'Melveny & Myers LLP, Menlo Park, CA, Chairman of the Board (through September Jonathan C. Dickey, Paul J. Collins, Gibson, Dunn & 2001); (2) Case, Executive Vice President of Crutcher LLP, Palo Alto, CA, John D. Van Loben Finance and CFO (through May 2001); (3) Sels, Quinn Emanuel Urquhart Oliver & Hedges Mohamad, President of Worldwide Sales; LLP, Redwood Shores, CA, for Defendants. (4) Stolz, temporary CFO (effective May 2001); (5) Dollahite, Executive Vice ORDER GRANTING IN PART AND DENYING IN President of Customer Services, Support and PART UNDERWRITER DEFENDANTS' MOTION Quality; (6) Wegner, Senior Vice President TO DISMISS; GRANTING INDIVIDUAL of Legal and Corporate Affairs, General DEFENDANTS' MOTION TO DISMISS Counsel, and Secretary; (7) Brown, CHESNEY, J. Executive Vice President and CMO (through May 2001); (8) Yeack, Executive (Docket Nos. 160, 163) Vice President of Managed and Professional Services. (See TAC ¶ ¶ 27-34, 87.) *1 This Document Relates To: ALL ACTIONS BACKGROUND Before the Court are the two separate motions to dismiss filed by (1) defendants Goldman, Sachs & The above-titled action is a purported class action Co. (“Goldman Sachs”), Merrill Lynch & Co. brought on behalf of those individuals and entities (“Merrill Lynch”), Morgan Stanley Dean Witter who purchased securities issued by Exodus (“Morgan Stanley”), and J.P. Morgan (collectively, Communications, Inc. (“Exodus”) between April 20, “Underwriter Defendants”); and (2) defendants Ellen 2000 and September 25, 2001, inclusive (the “class FN2 M. Hancock (“Hancock”), R. Marshall Case period”). (See TAC ¶ 1.) (“Case”), Sam S. Mohamad (“Mohamad”), Dick Stoltz (“Stoltz”), Herbert A. Dollahite (“Dollahite”),

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FN2. Other than procedural history, the plead facts sufficient to raise an inference that following facts are taken from the Third defendants had made the alleged false or misleading Amended Complaint and, for purposes of statements with the requisite state of mind. Plaintiffs the instant motion, are presumed true. were afforded leave to amend.

Exodus “operated Internet Data Centers (‘IDCs') that *2 On July 11, 2002, plaintiffs filed their First leased space to Exodus's customers to place (‘co- Amended Consolidated Class Action Complaint locate’) the computer servers that ran the customers' (“First Amended Complaint” or “FAC”), which Internet operations.” (See TAC ¶ 2.) Exodus also significantly expanded the scope of the litigation. The “provided broadband access and other design and First Amended Complaint increased the class period management services to support commercial Internet from 11 weeks (March 30, 2001 to June 20, 2001) to operations.” (See id.) 73 weeks (April 20, 2000 to September 25, 2001). (Compare CAC ¶ 1 with FAC ¶ 1.) In addition, the On June 20, 2001, Exodus announced that its results First Amended Complaint added two new plaintiffs, for the second quarter of 2001 and for the fiscal year Thomas Welch and Martin Fox, and seven new 2001 FN3 would be below prior expectations, defendants, three of whom are former officers of whereupon the price of Exodus's stock fell almost Exodus, specifically, Mohamad, Brown and Yeack, 50%. (See TAC ¶ ¶ 93-94.) On July 12, 2001, the and four of whom are the Underwriter Defendants, first of many complaints against Exodus was filed in who were underwriters of Exodus's February 6, 2001 this district. secondary stock and note offerings (“February Offerings”). The First Amended Complaint included a new claim under § § 11 and 15 of the Securities FN3. As noted in the Court's prior order of Act of 1933 (“Securities Act”), 15 U.S.C. § § 77k, dismissal, Exodus's fiscal year ends on 77o, against former Exodus CEO Hancock, as well as December 31 and, consequently, its first new claims against the Underwriter Defendants, for quarter ends March 31 and its second violation of § 10(b) of the Exchange Act and § 11 of quarter ends June 30. (See Order Granting the Securities Act. The new claims against Hancock Underwriter Defendants' Motion To Dismiss and the Underwriter Defendants were based on With Leave to Amend; Granting Individual allegedly false statements made in the registration Defendants' Motion to Dismiss with Leave statements and prospectuses issued in connection to Amend (“Dismissal Order”), filed August with the February Offerings. 19, 2003, at 2 n. 2.) On August 19, 2003, the Court granted the motions On September 25, 2001, the last day of the class filed by the Underwriter Defendants and the period, the Wall Street Journal published an article Individual Defendants to dismiss the First Amended stating that Exodus's bankruptcy was forthcoming, Complaint, and afforded plaintiffs leave to amend. whereupon Exodus's stock, which had traded as high The Court dismissed all claims against the as $179 per share during the class period, fell to $0 Underwriter Defendants because plaintiffs failed to .17 per share. (See TAC ¶ 18.) The following day, allege facts sufficient to demonstrate conformity with September 26, 2001, Exodus filed for bankruptcy. the statute of limitations. The Court also held that the (See id.) § 10(b) claims against the Underwriter Defendants were subject to dismissal because plaintiffs failed to On December 13, 2001, plaintiffs filed a adequately allege scienter or that the statements in Consolidated Class Action Complaint, alleging the Registration Statements were false when made. claims against Hancock, Case, Stoltz, Dollahite, and The Court dismissed the § 11 claims against the Wegner, for violation of § § 10(b) and 20(a) of the Underwriter Defendants, with leave to amend, Securities and Exchange Act of 1934 (“Exchange because plaintiffs failed to adequately allege falsity Act”). A Corrected Consolidated Class Action with the particularity required by Rule 9(b). The Complaint (“Consolidated Complaint” or “CAC”) Court dismissed plaintiffs' § 10(b) claims against the was filed April 17, 2002. By order filed May 28, Individual Defendants because plaintiffs failed to 2002, the Court granted the defendants' motion to adequately allege scienter and that the allegedly false dismiss the Consolidated Complaint, finding and misleading statements were false when made. As plaintiffs had failed to adequately plead that any of an additional basis for dismissal, the Court held that the alleged statements were false or misleading at the plaintiffs had failed to allege sufficient facts to time they were made, and that plaintiffs had failed to demonstrate that the following claims were timely:

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(1) the § 10(b) claims against the Individual facts alleged under a cognizable legal theory. See Defendants as alleged by class members who Balistreri v. Pacifica Police Dept., 901 F.2d 696, 699 purchased securities between April 20, 2000 and (9th Cir.1990). March 31, 2001; and (2) the new § 10(b) claims asserted against Mohamad, Yeack, and Brown that Generally, a district court, in ruling on a Rule were based on statements made between March 31, 12(b)(6) motion, may not consider any material 2001 and June 20, 2001. The Court dismissed the § beyond the pleadings. See Hal Roach Studios. Inc. v. 11 claim against Hancock because plaintiffs failed to Richard Feiner And Co., Inc., 896 F.2d 1542, 1555 n. plead sufficient facts to show the claim was timely 19 (9th Cir.1990). Material that is properly submitted and failed to adequately allege falsity. Finally, the as part of the complaint, however, may be Court dismissed plaintiffs' claims for violation of § considered. See id. Documents whose contents are 20(a) of the Exchange Act and § 15 of the Securities alleged in the complaint, and whose authenticity no Act because such claims were dependent on a party questions, but which are not physically attached violation of § 10(b) or § 11, and plaintiffs had not to the pleading, also may be considered. See Branch adequately alleged a violation of either statute. v. Tunnell, 14 F.3d 449, 454 (9th Cir.1994). In addition, the Court may consider any document “the *3 On October 20, 2003, plaintiffs filed a Second authenticity of which is not contested, and upon Amended Consolidated Class Action Complaint which the plaintiff's complaint necessarily relies,” (“Second Amended Complaint”). On November 25, regardless of whether the document is referred to in 2003, before defendants responded to the Second the complaint. See Parrino v. FHP, Inc., 146 F.3d Amended Complaint, plaintiffs filed a motion for 699, 706 (9th Cir.1998). Finally, the Court may leave to file a Third Amended Complaint. The Court consider matters that are subject to judicial notice. granted the motion on January 12, 2004, and See Mack v. South Bay Beer Distributors, Inc., 798 plaintiffs filed their Third Amended Consolidated F.2d 1279, 1282 (9th Cir.1986). Class Action Complaint on January 15, 2004. Defendants thereafter filed the instant motions to In analyzing a motion to dismiss, the Court must dismiss. accept as true all material allegations in the complaint, and construe them in the light most On March 8, 2005, while the motions to dismiss were favorable to the nonmoving party. See NL Industries, under submission, plaintiffs filed a motion for leave Inc. v. Kaplan, 792 F.2d 896, 898 (9th Cir.1986). In to amend their Third Amended Consolidated Class analyzing a motion to dismiss, the Court may Action Complaint to add one line of text and one disregard factual allegations if such allegations are exhibit. On April 18, 2005, the Court granted the contradicted by the facts established by reference to motion and afforded the parties leave to file exhibits attached to the complaint. See Durning v. supplemental memoranda addressing the impact of First Boston Corp., 815 F.2d 1265, 1267 (9th the amendments on the pending motions to dismiss. Cir.1987). Conclusory allegations, unsupported by Plaintiffs' Corrected Third Amended Consolidated the facts alleged, need not be accepted as true. See Class Action Complaint was filed April 29, 2005. Holden v. Hagopian, 978 F.2d 1115, 1121 (9th The motions to dismiss were taken under submission Cir.1992). as of May 13, 2005, once the supplemental memoranda were filed. B. Section 10(b) and the PSLRA

LEGAL STANDARDS *4 Section 10(b) of the Exchange Act provides that “[i]t shall be unlawful for any person ... [t]o use or A. Rule 12(b)(6) employ, in connection with the purchase or sale of any security ... any manipulative or deceptive device or contrivance in contravention of such rules and A motion to dismiss under Rule 12(b)(6) cannot be regulations as the Commission may prescribe [.]” See granted unless “it appears beyond doubt that the 15 U.S.C. § 78j(b). Rule 10b-5 provides: plaintiff can prove no set of facts in support of his It shall be unlawful for any person ... claim which would entitle him to relief.” See Conley (a) To employ any device, scheme, or artifice to v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 2 L.Ed.2d defraud, 80 (1957). Dismissal can be based on the lack of a (b) To make any untrue statement of a material fact cognizable legal theory or the absence of sufficient or to omit to state a material fact necessary in order to

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The elements of a § 10(b)/Rule 10b-5 claim are (1) “a material misrepresentation (or omission)”; (2) “scienter, i.e., a FN4. “Allegations are deemed to have been wrongful state of mind”; (3) “a connection with the made on information and belief until the purchase or sale of a security”; (4) “reliance”; (5) plaintiffs demonstrate that they have “economic loss”; and (6) “ ‘loss causation,’ i.e., a personal knowledge of the facts.” In re The causal connection between the material Vantive Corp. Sec. Litig., 283 F.3d 1079, misrepresentation and the loss.” See Dura 1085 n. 3 (9th Cir.2002). Pharmaceuticals, Inc. v. Broudo, --- U.S. ----, ----, 125 S.Ct. 1627, 1631, 161 L.Ed.2d 577 (2005). False *5 In determining whether scienter has been statements in a registration statement are actionable adequately alleged, the Court must examine the under § 10(b) as well as under § 11. See Herman & totality of plaintiffs' allegations. See America West, Maclean v. Huddleston, 459 U.S. 375, 387, 103 S.Ct. 320 F.3d at 938. The Court must consider “ ‘all 683, 74 L.Ed.2d 548 (1983) (“We hold that the reasonable inferences to be drawn from the availability of an express remedy under Section 11 of allegations, including inferences unfavorable to the the 1933 Act does not preclude defrauded purchasers plaintiffs.” 'Seeee id. (quoting Gompper v. VISX, Inc., of registered securities from maintaining an action 298 F.3d 893, 897 (9th Cir.2002)). “District courts under Section 10(b) of the 1934 Act.”) should consider all the allegations in their entirety, together with any reasonable inferences that can be Any class action complaint alleging securities fraud drawn therefrom, in concluding whether, on balance, in violation of the Exchange Act is subject to the the plaintiffs' complaint gives rise to the requisite heightened pleading standards set forth in the Private inference of scienter.” Gompper v. VISX, Inc., 298 Securities Litigation Reform Act of 1995 F.3d at 897. To establish a strong inference of (“PSLRA”). See In re Silicon Graphics Inc. Sec. scienter, the allegations must show that an inference Litig., 183 F.3d 970, 973-74 (9th Cir.1999). Under the of fraud is “ ‘the most plausible of competing PSLRA, for all claims based on misrepresentations or inferences.” ’ See id. (quoting Helwig v. Vencor, Inc., omissions, plaintiffs must “specify each statement 251 F.3d 540, 553 (6th Cir.2001) (en banc)). alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an Because “falsity and scienter in private securities allegation regarding the statement or omission is fraud cases are generally strongly inferred from the made on information and belief, the complaint shall same set of facts,” the Ninth Circuit has incorporated state with particularity all facts on which that belief is the falsity and scienter requirements “into a single formed.” See 15 U.S.C. § 78u-4(b)(1). Plaintiffs inquiry.” See Ronconi v. Larkin, 253 F.3d 423, 429 “must provide all the facts forming the basis for (9th Cir.2001); see also America West, 320 F.3d at [their] belief in great detail.” See Silicon Graphics, 932 (noting the court “generally examines the falsity 183 F.3d at 983. FN4 The PSLRA also requires that and scienter requirements at the same time.”) In “the complaint shall, with respect to each such act or conducting this inquiry, a court is to determine omission alleged to violate [the Exchange Act], state whether “particular facts in the complaint, taken as a with particularity facts giving rise to a strong whole, raise a strong inference that defendants inference that the defendant acted with the required intentionally or with deliberate recklessness made state of mind.” See 15 U.S.C. § 78u-4(b)(2). The false or misleading statements to investors.” See required state of mind is “deliberate recklessness, at a Ronconi v. Larkin, 253 F.3d at 429. “The most direct minimum.” See Silicon Graphics, 183 F.3d at 974. way to show both that a statement was false when Plaintiffs “must plead, in great detail, facts that made and that the party making the statement knew constitute strong circumstantial evidence of that it was false is via contemporaneous reports or deliberately reckless or conscious misconduct.” See data, available to the party, which contradict the id. They “must state specific facts indicating no less statement.” See Nursing Home Pension Fund, Local

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144 v. Oracle Corp., 380 F.3d 1226, 1230 (9th Rule 10(b)(5), and violation of § 11 of the Securities Cir.2004). Act. Plaintiffs allege that the Underwriter Defendants are liable under both § 10(b) and § 11 because the registration statements and prospectuses issued in C. Section 11 of the Securities Act connection with the February Offerings (collectively “Registration Statements”) FN5 contained the Section 11 “creates a private remedy for any following false and misleading statements: (1) “We purchaser of a security if ‘any part of the registration believe that the acquisition [of GlobalCenter] statement, when such part became effective, enhances our global Internet Data Center contained an untrue statement of a material fact or infrastructure, strengthens our network, our customer omitted to state a material fact required to be stated support, sales and professional services therein not misleading.” ’ See In re Daou Systems, organizations, and expands our customer base”; FN6 Inc. Sec. Litig., 411 F.3d 1006, 1027 (9th Cir.2005) (2) Exodus achieved revenues of $280.4 million for (quoting 15 U.S.C. § 77k(a)). “Under § 11 of the the quarter ended December 31, 2000, and $818.4 Securities Act of 1933 ... any signer of [a] million for fiscal year 2000; (3) “[Exodus has] registration statement, any partner or director of the established a diverse base of customers and continues issuer, any professional involved in preparing or to focus on supporting the strong demand from the certifying the statement, and any underwriter of a enterprise market”; and (4) Exodus had 4500 registration statement may be liable[.]” Kaplan v. customers under contract. (See TAC ¶ ¶ 72-73, 345- Rose, 49 F.3d 1363, 1371 (9th Cir.1994). “The 346 (alterations in original).) FN7 plaintiff in a § 11 claim must demonstrate (1) that the registration statement contained an omission or misrepresentation, and (2) that the omission or FN5. The Third Amended Complaint states misrepresentation was material, that is, it would have that “[m]uch of the language in the misled a reasonable investor about the nature of his Registration Statement and Prospectus for or her investment.” See Daou, 411 F.3d at 1027 the note offering was similar to that (citation omitted); see also Herman & MacLean v. contained in the Prospectus for Exodus's Huddleston, 459 U.S. 375, 382, 103 S.Ct. 683, 74 secondary public offering.” (See TAC ¶ 73.) L.Ed.2d 548 (1983) (“If a plaintiff purchased a In their papers, the parties do not security issued pursuant to a registration statement, differentiate between the two registration he need only show a material misstatement or statements and prospectuses. omission to establish his prima facie case.”) FN6. “On September 28, 2000, Exodus *6 Significantly, scienter is not a requirement for entered into a definitive merger agreement liability under § 11, and “defendants will be liable to acquire GlobalCenter, an indirect wholly for innocent or negligent material misstatements or owned subsidiary of Global Crossing North omissions.” See Daou, 411 F.3d at 1027 (citation America, Inc.” See TAC ¶ 56. omitted). FN7. Except as indicated, plaintiffs do not Defendants to a § 11 claim, other than the issuer, can purport to quote these statements directly. establish a “due diligence” defense if they show that after reasonable investigation they had reasonable In their Motion to Dismiss, the Underwriter grounds to believe, and did believe, that, at the time Defendants raise three principal arguments: (1) both the registration statement became effective, the of the causes of action are barred by the applicable statements were true and there was no material one-year statute of limitations; (2) plaintiffs have omission. See Kaplan v. Rose, 49 F.3d at 1371 (citing failed to adequately allege a § 11 claim because 15 U.S .C. § 77k(b)(3)(A)). plaintiffs have failed to allege falsity with the particularity required by Rule 9(b) of the Federal Rules of Civil Procedure; and (3) plaintiffs have not DISCUSSION: UNDERWRITERS' MOTION TO adequately alleged a § 10(b) claim because plaintiffs DISMISS have failed to adequately allege falsity and scienter under the requirements of the PSLRA. As noted, the Third Amended Complaint alleges causes of action against the Underwriter Defendants for violation of § 10(b) of the Exchange Act and A. Statute of Limitations: Section 10(b) and Section

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11 Claims are timely if plaintiffs should have discovered the facts underlying those claims no earlier than July 11, The Court previously has held that the instant claims 2001. See Valence, 175 F.3d at 704. under § 10(b) and § 11 are timely if they were brought “within one year of either actual discovery or The Court previously dismissed the § 10(b) and § 11 inquiry notice” of the facts constituting the alleged claims against the Underwriter Defendants because violations. (See Dismissal Order at 8.) As to inquiry plaintiffs failed to allege any facts from which one notice, the Court, relying on the Ninth Circuit's could determine “at what point a reasonably diligent discussion in Berry v. Valence, 175 F.3d 699, 703-04 investor should have discovered the relevant facts (9th Cir.1999), held that it would apply “the Tenth underlying plaintiffs' claims against the Underwriter Circuit's formulation,” as set forth in Sterlin v. Defendants,” and failed to set forth the nature and Biomune Systems, 154 F.3d 1191, 1201 (10th scope of their investigation of the facts underlying Cir.1998). (See Dismissal Order at 8.) Under that their claims against the Underwriter Defendants. (See standard, “ ‘inquiry notice ... triggers an investor's Dismissal Order at 12.) duty to exercise reasonable diligence and ... the one- year statute of limitations begins to run once the Plaintiffs now allege, in the Third Amended investor, in the exercise of reasonable diligence, Complaint, that they did not discover, until December should have discovered the facts underlying the 2001, “the possibility that the Underwriter alleged fraud.” ’ See Valence, 175 F.3d at 704 Defendants may have underwritten Exodus's (quoting Sterlin, 154 F.3d at 1201) (ellipses in offerings pursuant to a false and misleading original). Thus, a court must ask (1) whether an Registration Statement and Prospectus.” (See TAC ¶ event/publication “raise[d] sufficient suspicion of 319.) According to the complaint, plaintiffs Martin fraud to cause a reasonable investor to investigate the Fox and Thomas Welch, the only named plaintiffs matter further,” and (2) when “a reasonably diligent who claim to have purchased stock or notes in, or inventor [should] have discovered the facts traceable to, the February Offerings, (see TAC ¶ 25), underlying the alleged fraudulent activity.” See first contacted plaintiffs' counsel on July 18, 2001 Valence, 175 F.3d at 704. “If the answer to the first and August 23, 2001, respectively. (See TAC ¶ 317.) question is yes, the answer to the second question Thereafter, plaintiffs allege, they “diligently would determine when the statute of limitations attempted to locate individuals with knowledge of began to run.” Id. Exodus's business practices.” (See id.) According to plaintiffs, it was not until their investigator's *7 For purposes of the statute of limitations, the interview with CW6, on December 4, 2001, at which question of when a reasonably diligent investor did CW6 stated that Exodus was not bringing in any new discover or should have discovered the alleged customers at the end of 2000, that plaintiffs first wrongdoing is a question of fact, rarely to be decided suspected that fraudulent conduct might have begun as a matter of law. See Mosesian v. Peat Marwick, prior to the second quarter of 2001. (See id.) On 727 F.2d 873, 877 (9th Cir.1984) (“The question of December 10, 2001, plaintiffs allege, they spoke with when [alleged wrongdoing] was or should have been CW9, Vice President of Facilities in Exodus's Santa discovered is a question of fact. It may be decided as Clara office, who informed plaintiffs that, in a matter of law only when uncontroverted evidence plaintiffs' words, “Exodus's management dismissed irrefutably demonstrates plaintiff discovered or his capital report and continued to build additional should have discovered the fraudulent conduct.”) IDCs when they knew that Exodus did not have the (internal citations and quotations omitted). capital to cover the expenses of these expansions.” Nevertheless, “a plaintiff must affirmatively plead (See id. ¶ 320.) Plaintiffs contend this statement led sufficient facts in his complaint to demonstrate them “to believe that there was a possibility that conformity with the statute of limitations.” See statements contained in the registration statements Toombs v. Leone, 777 F.2d 465, 468 (9th Cir.1985). issued in connection with Exodus's February 2001 secondary stock and note offerings were false and As noted, plaintiffs' claims against the Underwriter misleading.” (See id.) In addition, according to Defendants are based on alleged misstatements in the plaintiffs, unspecified “defendants fraudulently Registration Statements for the February Offerings. concealed their activities.” (See id. ¶ 316.) If a Because plaintiffs first asserted claims against the reasonably diligent investor would not have Underwriter Defendants in the First Amended discovered the facts underlying plaintiffs' claims Complaint, which was filed on July 11, 2002, against the Underwriter Defendants until at least July plaintiffs' claims against the Underwriter Defendants 11, 2001, one year before the first complaint

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To plaintiffs were aware of their potential claims against the extent defendants contend the complaint must be the Underwriter Defendants prior to July 12, 2001. dismissed unless plaintiffs have alleged facts (See Dismissal Order at 11-12.) sufficient to determine at what point a reasonably diligent investor should have discovered the relevant *9 The Underwriter Defendants also contend that facts underlying plaintiffs' claims against the plaintiffs were on inquiry notice of their claims Underwriter Defendants, recent Ninth Circuit against the Underwriter Defendants as early as June authority holds to the contrary. In Livid Holdings Ltd. 20, 2001, when Exodus announced its “disastrous” v. Salomon Smith Barney, 403 F.3d 1050 (9th second quarter of 2001 results. (See TAC ¶ 93.) Cir.2005), the Ninth Circuit addressed the statute of Poor financial results for one quarter do not limitations argument raised by the defendants therein, necessarily suggest that earlier statements were even though it had not been addressed by the district fraudulent, however. See Livid, 403 F.3d at 1060 court, as a possible alternative ground for affirming (noting that “financial problems alone are generally the district court's dismissal of the complaint. See id. insufficient to suggest fraud”); see also Gray v. First at 1058-60. The Ninth Circuit found it was “not Winthrop Corp., 82 F.3d 877, 881 (9th Cir.1996) evident, based on the allegations in the complaint,” (noting “poor financial performance, standing alone, that “Livid should have been aware of the fraud one does not necessarily suggest securities fraud” and year before it filed its complaint.” See id. at 1059-60. may be explained “by poor management, general There, the plaintiff, Livid, had alleged it first learned, market conditions, or other events unrelated to fraud, approximately fourteen months before the complaint creating a jury question on inquiry notice”). was filed, of a bankruptcy proceeding that triggered its first suspicion of fraud and an investigation. See Moreover, even assuming that Exodus's June 20, id. at 1060. Livid also alleged that it did not have 2001 announcement was sufficient to trigger inquiry actual notice of the alleged fraud until approximately notice of the possibility of fraud in earlier financial ten months before the complaint was filed, when it statements, such as those contained in the received a report from the independent auditor for the Registration Statements for the February Offerings, bankruptcy proceeding. See id. at 1059. The Ninth the statute of limitations would not begin running on Circuit noted that “financial problems alone are that date, but would only trigger a duty to begin an generally insufficient to suggest fraud” and that “the investigation. See Valence, 175 F.3d at 704. The filing of the bankruptcy petition alone seems unlikely statute of limitations would not begin to run until the to satisfy the inquiry-plus-due diligence standard, date when “a reasonably diligent inventor [should] especially since ... [the] question of what a have discovered the facts underlying the alleged reasonably prudent investor should have known is fraudulent activity.” See id. Plaintiffs allege that their particularly suited to a jury determination.” See id. at counsel began investigating after plaintiffs contacted 1060. Rather than finding the complaint subject to them, but that the investigation did not lead plaintiffs dismissal because Livid had failed to allege facts to suspect wrongdoing by the Underwriter sufficient to determine when a reasonable investor Defendants until December 2001. (See TAC ¶ 319.) would likely have learned of the alleged fraud, the The Underwriter Defendants do not suggest, let alone Ninth Circuit held that it could not decide as a matter specify, what plaintiffs should or could have done of law “whether Livid should have been on notice of that would have alerted them to the facts underlying the alleged fraud one year before the complaint was their causes of action against the Underwriter filed.” See id. The Ninth Circuit concluded that Defendants before the expiration of the relevant “[b]ecause the record does not establish that the three-week period between the date of Exodus's June statute of limitations for the federal securities claim 20, 2001 announcement and July 11, 2001, one year has run, we refuse to affirm the district court on this prior to the filing of the first complaint that contained alternative ground.” See id . at 1058. claims against the Underwriter Defendants. The issue of when a reasonably diligent investor should have The Underwriter Defendants further argue that discovered the facts underlying plaintiffs' claims allegations contained in plaintiffs' earlier-filed against the Underwriter Defendants may be decided

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 17 of 163 Not Reported in F.Supp.2d Page 8 Not Reported in F.Supp.2d, 2005 WL 1869289 (N.D.Cal.), Fed. Sec. L. Rep. P 93,357 (Cite as: Not Reported in F.Supp.2d) on a motion to dismiss only where “the facts needed claims brought under Section 11 when ... they are for determination of when a reasonable investor of grounded in fraud.” See In re Stac Electronics, 89 ordinary intelligence would have been aware of the F.3d 1399, 1404-05 (9th Cir.1996). The Ninth Circuit existence of fraud can be gleaned from the complaint further has clarified that where “fraud is not an and papers ... integral to the complaint.” See LC essential element of the claim, and where allegations Capital Partners, LP v. Frontier Insurance Group, of both fraudulent and non-fraudulent conduct are Inc., 318 F.3d 148, 157 (2nd Cir.2003) (ellipsis in made in the complaint,” only “allegations original). This is not such a case. The Court cannot (‘averments') of fraudulent conduct” must satisfy the conclude, as a matter of law, that a reasonably heightened pleading requirements of Rule 9(b), while diligent investor should have discovered wrongdoing “allegations of non-fraudulent conduct need satisfy in connection with the February Offerings within only the ordinary notice pleading standards of Rule three weeks of Exodus's June 20, 2001 announcement 8(a).” See Vess v. Ciba-Geigy Corp. USA, 317 F.3d of its second quarter of 2001 financial results. See, 1097, 1105 (9th Cir.2003). As further stated in Vess: e.g., Livid, 403 F.3d at 1060 (noting the “question of “ ‘Where averments of fraud are made in a claim in what a reasonably prudent investor should have which fraud is not an element, an inadequate known is particularly suited to a jury determination”). averment of fraud does not mean that no claim has been stated. The proper route is to disregard *10 Accordingly, the Underwriter Defendants' averments of fraud not meeting Rule 9(b)'s standard motion to dismiss the § 10(b) and § 11 claims and then ask whether a claim has been stated.” ’ See asserted against it, on the ground they are time- id. (internal quotation and citation omitted) (emphasis barred, will be DENIED. in original). Nevertheless, the Ninth Circuit made clear that where a plaintiff “allege[s] a unified course of fraudulent conduct and rel[ies] entirely on that B. Section 11 Claim: Sufficiency of Pleading course of conduct as the basis of a claim ... the claim is said to be ‘grounded in fraud’ or to ‘sound in The parties dispute whether the pleading fraud,’ and the pleading of that claim as a whole must requirements of Rule 9(b) of the Federal Rules of satisfy the particularity requirement of Rule 9(b).” Civil Procedure FN8 apply to plaintiffs' § 11 claim See id. at 1103-04 (citing Stac, 89 F.3d at 1404-05). against the Underwriter Defendants. The Court previously has held that plaintiffs' § 11 claim, as In the instant case, the Court found that the First alleged in the First Amended Complaint, was subject Amended Complaint made “no effort to distinguish to the pleading requirements of Rule 9(b) because the between the Underwriter Defendants and the § 11 claim sounded in fraud. (See Dismissal Order at Individual Defendants, but rather allege[d] a unified 28-29.) Plaintiffs now argue that they have amended course of fraudulent conduct as to all ‘defendants,’ their § 11 claim to make clear that their allegations averring consistently and repeatedly that the of fraud relate only to their § 10(b) claim. defendants knew the statements in question were false and misleading when made.” (See Dismissal Order at 29.) The Court noted that plaintiffs had FN8. When a complaint contains allegations pointed to “no allegations in the FAC to the effect of fraud, Rule 9(b) of the Federal Rules of that the false and misleading statements in the Civil Procedure requires that plaintiffs: (1) Registration Statements were either negligent or specify the alleged fraudulent innocent misrepresentations, because no such representations; (2) allege the allegations exist.” See id. at 30. Finally, relying on representations were false when made; (3) Stac, the Court rejected plaintiffs' contention that by identify the speaker; (4) state when and pleading their § 10(b) and § 11 claims in separate where the statements were made; and (5) counts, they adequately alleged a factual basis for state the manner in which the their § 11 claim that was not based on fraud. See id.; representations were false and misleading. see also Stac, 89 F.3d at 1405 n .2 (holding that SeeIn re GlenFed, Inc. Secur. Litig., 42 F.3d although plaintiff had “specifically disclaimed any at 1547 n. 7. allegations of fraud with respect to its Section 11 claims,” such “[n]ominal efforts are unconvincing Although a plaintiff alleging a claim under § 11 need when the gravamen of the complaint is plainly fraud not, as noted above, allege scienter or fraudulent and no effort is made to show any other basis for the conduct, the Ninth Circuit has held that “the claims levied at the Prospectus.”) particularity requirements of Rule 9(b) apply to

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*11 Since the Court's dismissal of the First Amended 343-355.) After itemizing the allegedly false and Complaint, the Ninth Circuit has issued its opinion in misleading statements and omissions contained in the Daou, in which the Ninth Circuit discussed Vess and Registration Statements for the February Offerings, Stac in the context of determining whether the plaintiffs allege that the Underwriter Defendants pleading standards of Rule 9(b) applied to the § 11 “owed to the purchasers of Exodus securities the duty claim at issue in Daou. See Daou, 411 F.3d at 1027- to make a reasonable and diligent investigation of the 28. The Ninth Circuit noted that “Rule 9(b) may statements contained in the [Registration Statements] prove fatal to 1933 Securities Act claims ‘grounded at the time [they] became effective, to assure that in fraud’ when the complaint makes a ‘wholesale those statements were true and that there was no adoption’ of the securities fraud allegations for omission to state material facts required to be stated purposes of the Securities Act claims.” See id. at in order to make the statements contained therein not 1028. The Ninth Circuit found such “wholesale misleading.” (See TAC ¶ 354.) Unlike the plaintiffs adoption” present in Daou because the complaint in Daou, plaintiffs here expressly allege that the alleged a fraudulent scheme by all defendants, and Underwriter Defendants were negligent by failing to incorporated all allegations previously averred in the conduct a reasonable investigation into the statements complaint for purposes of all of the claims. See id. at contained in the Registration Statements and do not 1028. Moreover, the plaintiffs in Daou “never incorporate their allegations of fraud into their claim rel[ied] on such conduct as negligence or mistake in for violation of § 11. Unlike the plaintiffs in Stac, stating their claims.” See id. plaintiffs here make more than a “nominal effort” at disclaiming fraud as a basis for the § 11 claims, and By contrast, in the instant case, the Third Amended expressly allege a separate basis for their § 11 claims Complaint contains significant new amendments to and their § 10(b) claims. the § 11 claims that distinguish those claims from the § 11 claims alleged in the First Amended *12 As a result of the amendments to the complaint, Complaint, and from those at issue in Daou and Stac. plaintiffs have made sufficiently clear their intent to While the First Amended Complaint had alleged, for assert two alternative theories of liability against the example, that all “defendants ... participated in an Underwriter Defendants based on misstatements in egregious accounting fraud ... including ... falsifying the Registration Statements: (1) a § 11 claim based Exodus's financial results” (see, e.g., FAC ¶ 1), the on negligent or innocent misrepresentations or Third Amended Complaint largely eliminates such omissions, (see TAC ¶ ¶ 306, 343-355), and (2) a § all-inclusive references to “defendants” and replaces 10(b) claim based on fraud, (see TAC ¶ ¶ 305, 356- them with references to “Individual Defendants.” 362). Rule 8(e)(2) of the Federal Rules of Civil (See, e.g., TAC ¶ 44 (“Individual Defendants Procedure expressly permits plaintiffs to state claims embarked on a scheme to defraud by, among other in the alternative. See Fed.R.Civ.P. 8(e)(2) (“A party things, ... falsifying Exodus's financial results”) .) As may set forth two or more statements of a claim or a result, plaintiffs no longer allege that the defense alternately or hypothetically, either in one Underwriter Defendants participated in all of the count or defense or in separate counts or defenses.”) fraudulent conduct allegedly engaged in by the There is no requirement that the claims be consistent. Individual Defendants. Further, plaintiffs now See Fed.R.Civ.P. 8(e)(2) (“A party may also state as expressly allege that the Underwriter Defendants many separate claims or defenses as the party has acted negligently by failing to conduct due diligence regardless of consistency.”) Thus, plaintiffs' assertion as to the veracity of the statements contained in the of separate claims against the Underwriter Registration Statements and only allege in the Defendants for violation of § 10(b) and § 11, based alternative that the Underwriter Defendants acted on the same conduct, but alleging differing states of with knowledge or deliberate recklessness because mind, is expressly permitted by Rule 8. they were aware that Exodus's financial results and forecasts were false due to improper revenue Moreover, the Supreme Court has recognized that recognition practices and Exodus's failure to conform “some conduct actionable under Section 11 may also with GAAP. (See TAC ¶ ¶ 305-306.) Finally, be actionable under Section 10(b).” See Herman & plaintiffs now expressly disclaim any allegations of MacLean v. Huddleston, 459 U.S. at 383. “[T]he fraud in their cause of action for violation of § 11 availability of an express remedy under Section 11 of (see TAC ¶ 343), set forth in that count all the the 1933 Act does not preclude defrauded purchasers specific conduct alleged to violate § 11, and do not of registered securities from maintaining an action incorporate in that count any of the other factual under Section 10(b).” See id. at 387 (emphasis allegations set forth in the complaint, (see TAC ¶ ¶ added). In short, nothing in the statutory scheme

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 19 of 163 Not Reported in F.Supp.2d Page 10 Not Reported in F.Supp.2d, 2005 WL 1869289 (N.D.Cal.), Fed. Sec. L. Rep. P 93,357 (Cite as: Not Reported in F.Supp.2d) precludes plaintiffs from proceeding against the Securities Litigation, 2005 WL 43463 at *9 (N.D.Cal. Underwriter Defendants under both § 10(b) and § Jan.6, 2005) (holding Rule 9(b) inapplicable to § 11 11. claim even though “many of the allegations in the [complaint] sound in fraud” because § 11 claim was The Ninth Circuit has held, where plaintiffs choose based on failure to conduct reasonable investigation not to allege “a unified course of fraudulent conduct,” and plaintiffs expressly disclaimed “any allegations but rather to allege “some fraudulent and some non- based on fraud or deliberate recklessness”); In re fraudulent conduct,” that “only the allegations of Turnstone Systems Inc. Securities Litigation, No. C- fraud are subject to Rule 9(b)'s heightened pleading 01-1256 SBA, slip op. at 23-37 (N.D.Cal. Feb. 4, requirements.” See Vess, 317 F.3d at 1104. “To 2003) (surveying case law at length and declining to require that non-fraud allegations be stated with apply Rule 9(b) to § 11 claim based on allegations of particularity merely because they appear in a negligence where the “gravamen of the [complaint] is complaint alongside fraud averments ... would fraud but the allegations underlying the Securities impose a burden on plaintiffs not contemplated by Act claims have been segregated out from those the notice pleading requirements of Rule 8(a).” See underlying the Exchange Act claims and do not aver id. at 1104. “Allegations of non-fraudulent conduct fraud”).FN9 need satisfy only the ordinary notice pleading standards of Rule 8(a).” See id. FN9. Although the Turnstone opinion has In the instant case, as noted, plaintiffs base their § 11 not been published, plaintiffs have submitted claims entirely on negligent or innocent a copy of the opinion as Exhibit Q to their misrepresentations, and base their § 10(b) claims Compendium of Unpublished Decisions against the Underwriter Defendants on fraudulent Cited in Plaintiffs' Oppositions to misrepresentations. In Vess, the Ninth Circuit held Defendants' Motions to Dismiss the Third that the district court erred in dismissing the Amended Consolidated Complaint. plaintiffs' entire complaint for failure to comply with Rule 9(b) because the state law claims at issue therein *13 As noted, a plaintiff states a § 11 claim by were based on both fraudulent and non-fraudulent alleging “(1) that the registration statement contained conduct and, thus, the allegations did “not rely an omission or misrepresentation, and (2) that the entirely on a unified fraudulent course of conduct.” omission or misrepresentation was material, that is, it See id. at 1105-06. The Ninth Circuit, in Stac, held would have misled a reasonable investor about the that Rule 9(b) applies to § 11 claims only where such nature of his or her investment.” See Daou, 411 F.3d claims sound in fraud, citing approvingly a Fifth at 1027 (citation omitted). “Allegations of non- Circuit case in which that court held that Rule 9(b) fraudulent conduct need satisfy only the ordinary applies to § 11 claims that are based on fraud rather notice pleading standards of Rule 8(a).” See Vess, than negligence. See Stac, 89 F.3d at 1405 (citing 317 F.3d at 1104. Plaintiffs adequately allege specific Melder v. Morris, 27 F.3d 1097, 1100 n. 6 (5th misrepresentations and omissions contained in the Cir.1994)). Here, because plaintiffs' § 11 claims are Registration Statements, and further allege how those based on negligent and innocent misrepresentations, misrepresentations and omissions were misleading. not fraud, and the complaint specifically alleges that (See, e.g., TAC ¶ ¶ 306, 343-355). Nothing more is plaintiffs “expressly disclaim any allegations of required. fraud” in connection with the § 11 claim, the Court finds Rule 9(b) does not apply. See Lone Star Ladies Accordingly, the Underwriter Defendants' motion to Investment Club v. Schlotzsky's, Inc., 238 F.3d 363, dismiss the § 11 claim asserted against them will be 369 (5th Cir.2001) (finding Rule 9(b) inapplicable to DENIED. § 11 claim where complaint alleged plaintiffs did “not assert that defendants [were] liable for fraudulent or intentional conduct and disavow[ed] C. Section 10(b) Claim: Sufficiency of Pleading any allegation of fraud”); see also Holmes v. Baker, 166 F.Supp.2d 1362, 1371-74 (S.D.Fla.2001) The Underwriter Defendants contend that plaintiffs (holding Rule 9(b) not applicable to § 11 claims have not adequately pleaded a § 10(b) claim as to based on erroneous financial statements in Prospectus any of the allegedly false statements made in the because no allegation of scienter; applying Rule 9(b) Registration Statements because plaintiffs have failed to § 10(b) claim based on fraudulent financial to establish falsity and scienter with the particularity statements); see also In re JDS Uniphase Corp. required by the PSLRA.

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As noted, plaintiffs allege that four statements in the *14 As plaintiffs thus effectively concede that they Registration Statements were false or misleading cannot state more facts about the GlobalCenter when made: (1) “We believe that the acquisition [of transaction to demonstrate the falsity of the statement GlobalCenter] enhances our global Internet Data about that transaction in the Registration Statements, Center infrastructure, strengthens our network, our the Court finds plaintiffs again have failed to allege customer support, sales and professional services with the particularity required by Rule 9(b) that such organizations, and expands our customer base”; (2) statement was false or misleading when made. Exodus achieved revenues of $280.4 million for the quarter ended December 31, 2000, and $818.4 million for fiscal year 2000; (3) “[Exodus has] 2. Statements Regarding Revenue established a diverse base of customers and continues to focus on supporting the strong demand from the Plaintiffs allege that the statements that Exodus had enterprise market”; and (4) Exodus had 4500 revenues of $280.4 million for the fourth quarter of customers under contract. (See TAC ¶ ¶ 72-73 2000 and $818.4 million for fiscal year 2000 were (alterations in original).) false because Exodus had engaged in four types of accounting improprieties: (1) recording revenue prior to rendering services; (2) recording revenue on 1. Statement Regarding Exodus's January 2001 cancelled or non-renewed contracts; (3) recording Acquisition of GlobalCenter revenue from transactions in which collectability was not probable; and (4) recording revenue and assets in Plaintiffs allege that the following statement in the conjunction with “bogus” barter transactions and Registration Statements was false and misleading failing to disclose such transactions. (See TAC ¶ when made: “We believe that the acquisition [of 264.) GlobalCenter] enhances our global Internet Data Center infrastructure, strengthens our network, our In dismissing the First Amended Complaint, the customer support, sales and professional services Court found plaintiffs had not adequately alleged that organizations, and expands our customer base.” (See the statements in the Registration Statements as to TAC ¶ 72.) The Court previously held that plaintiffs Exodus's revenue in the fourth quarter of 2000 and failed to adequately allege that the above-referenced fiscal year 2000 were false and misleading when statement was false because plaintiffs did not allege made, because plaintiffs failed to allege the amounts any facts that suggested that management's by which the revenues reported in the Registration statements of belief therein were untrue or Statements were misstated and failed to make misleading. (See Dismissal Order at 15.) “specific factual allegations regarding material accounting improprieties that affected the revenue In the First Amended Complaint, plaintiffs had statements contained in the Registration Statements.” alleged the statement was false and misleading (See Dismissal Order at 17-18 (citing In re Vantive because (1) Exodus's internal due diligence team had Corp. Sec. Litig., 283 F.3d 1079, 1091 (9th strongly recommended against the acquisition of Cir.1999).) GlobalCenter; (2) Exodus's Board of Directors was against the acquisition; (3) GlobalCenter's data Plaintiffs now allege that the Registration Statements centers in Tokyo, Sydney and London, and pending overstated Exodus's fourth quarter of 2000 revenues openings in Paris and Munich, all experienced by $25 million and its fiscal year 2000 revenues by substantial shortage in demand; and (4) the $70 million. (See TAC ¶ 128.) The Underwriter acquisition was nevertheless pushed through by Defendants argue, however, that plaintiffs still have Hancock because she wanted GlobalCenter for its not alleged “any particular amount associated with two IDCs in Manhattan. (See FAC ¶ 146.) Plaintiffs any particular accounting theory at any particular allege no new facts about the GlobalCenter point in time,” (see Motion at 24), and, thus, have not transaction in the Third Amended Complaint. Indeed, adequately alleged that the revenue statements in the in their opposition, plaintiffs state: “While plaintiffs Registration Statements were false or misleading still believe that defendants' statements concerning when made. the GlobalCenter acquisition were false and misleading, for the purpose of this opposition, Under GAAP, “revenue must be earned before it can plaintiffs will focus on the remaining three be recognized.” FN10 See Daou, 411 F.3d at 1016 statements.” (See Opp. at 11 n. 5.) (emphasis omitted). “When pleading irregularities in

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 21 of 163 Not Reported in F.Supp.2d Page 12 Not Reported in F.Supp.2d, 2005 WL 1869289 (N.D.Cal.), Fed. Sec. L. Rep. P 93,357 (Cite as: Not Reported in F.Supp.2d) revenue recognition, plaintiffs should allege (1) such 2001, (see id. ¶ 126(j)), states that all customers were basic details as the approximate amount by which subjected to false installation reports and this practice revenues and earnings were overstated; (2) the “enabled Exodus to begin invoicing and recognizing products involved in the contingent transaction; (3) revenue right after new sales were entered into, rather the dates of any of the transactions; or (4) the than to delay the process until installation was identities of any of the customers or [company] actually completed.” (See id. ¶ 154(c).) Further, employees involved in the transactions.” See id. according to plaintiffs, CW12, a senior collections (internal quotations omitted, brackets in original). specialist at Exodus from late 1999 through “Plaintiffs need not allege each of those particular September 2001, (see id. ¶ 126(l)), states that details,” however, but “must allege enough “customers that ordered new installations in IDCs information so that a court can discern whether the were consistently invoiced prior to installations alleged GAAP violations were minor or technical in having been completed, and many times prior to even nature, or whether they constituted widespread and beginning.” (See id. ¶ 155(a).) As an example, significant inflation of revenue.” See id. at 1017 plaintiffs allege that a document titled “Cu. Open (internal quotation and citation omitted). “ ‘[A] Orders by Customer-by Customer; Period: 02-00 as general allegation that the practice[ ] at issue resulted of 03/07/00,” pertaining to a customer identified as in a false report of company earnings is not a “Customer Nbr. 000661,” states that several items sufficiently particular claim of misrepresentation.” ’ were installed on “1/1/1900,” which, plaintiffs allege, See id. at 1016. Rather, “although overstatement of was a “place holder” indicating that the installation revenues in violation of GAAP may support a had not yet occurred. (See id. ¶ 155(b).) FN11 In plaintiff's claim of fraud, the plaintiff must show with addition, plaintiffs allege that, according to CW11, an particularity how the adjustments affected the Exodus credit and collections analyst from August company's financial statements and whether they 1999 through June 2001, (see id. ¶ 126(k)), Exodus were material in light of the company's overall had a “practice of inputting false installation dates in financial position.” See id. at 1018. order to begin billing customers.” (See id. ¶ 156.)

FN10. Plaintiffs allege that Exodus's FN11. Plaintiffs do not allege, however, that revenue recognition policy required the this customer was billed prior to installation. following four essential criteria to be met before revenue could be recognized: (1) Plaintiffs, however, do not, in any fashion, identify a “[p]ersuasive evidence of an arrangement single customer that was billed during fiscal year exists”; (2) “[d]elivery has occurred or 2000 prior to installation, nor do plaintiffs attempt to services have been rendered”; (3) “[t]he fee quantify the amount by which this alleged practice for the arrangement is fixed or overstated revenues in fiscal year 2000 or the fourth determinable”; and (4) “[c]ollectability is quarter of 2000. As noted, a “general allegation” that reasonably assured.” (See TAC ¶ 133.) a particular practice “resulted in a false report of company earnings is not a sufficiently particular *15 As the challenged statements in the Registration claim of misrepresentation”; rather, “the plaintiff Statements address Exodus's revenues in fiscal year must show with particularity how the adjustments 2000, the Court examines the Third Amended affected the company's financial statements and Complaint for specific factual allegations of whether they were material in light of the company's improprieties in revenue recognition in 2000. overall financial position.” See Daou, 411 F.3d at 1016, 1018.

a. Recording revenue prior to rendering services Accordingly, the Court finds plaintiffs have not alleged with the particularity required by Rule 9(b) Plaintiffs allege that Exodus had a practice, in fiscal that the statements of revenues for fiscal year 2000 year 2000, of generating “installation reports, which and the fourth quarter of 2000 contained in the triggered the onset of monthly invoicing and revenue Registration Statements were false and misleading recognition” before installation had begun. (See TAC when made as a result of Exodus's alleged practice of ¶ ¶ 153, 154(b).) billing customers prior to installation.

Plaintiffs allege that CW10, a credit and collections analyst for Exodus from July 1998 through June b. Recording revenue on cancelled or non-renewed

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contracts According to plaintiffs, CW22 performed data entry *16 Plaintiffs allege that Exodus's billing system and processed orders provided by Exodus's sales would invoice customers “in perpetuity” unless organization from 1999 to April 2001, and thereafter someone specifically input a change to a particular was one of two Exodus employees responsible for customer's billing, and that Exodus had a practice of processing cancellations. (See TAC ¶ 126(v).) not contacting customers to verify cancellations for Plaintiffs allege that CW22 first became aware of a purposes of changing the order system and significant number of cancellations in November and discontinuing invoicing. (See TAC ¶ 146.) December of 2000 and personally experienced a large According to plaintiffs, “[w]hen customers were number of cancellations “ordered by customers finally contacted by Exodus for payment, their months earlier,” but which had not been processed response to Exodus, if any, would simply be that they through the Siebel system. FN13 (See id. ¶ 151(a).) In were not going to pay the bill and were told they did addition, plaintiffs allege that, according to CW22, not have to.” (See id. ¶ 146(b).) Plaintiffs allege that, “in the first part of the 1Q01, many of the customers according to CW10, “invoicing would continue even booked at the end of the 4Q00 were cancelling- though the customer's equipment had been pulled out claiming that they had never ordered the services, or and Exodus was no longer performing services.” that they were not aware of how high the charges (See id. ¶ 147(b).) Plaintiffs allege that CW10 were, and could not afford the monthly program.” “believes that approximately 80% of the revenue (See id. ¶ 151(i).) Plaintiffs further allege that CW22 reported by Exodus” from fiscal year 2000 through told them that, prior to April 2001, “the vast majority the end of the Class Period was largely fraudulent. of customer cancellations were routinely delayed for (See id. ¶ 147(d).) Plaintiffs allege that CW11 months, until the credit and collections department “recalled that it was a common, daily occurrence for discovered through communications with the collectors to contact customers about old [accounts customers that the customers had pulled out months receivable], and be told that the customer had earlier and had notified salespersons,” and that cancelled months earlier.” (See id. ¶ 148(a).) CW11 “credits owed to these customers were routinely not estimated that as much as 40% of the revenue processed for posting against these overcharges.” recognized from late 2000 through Exodus's (See id. ¶ 151(c).) Plaintiffs allege that when CW22, bankruptcy in September 2001 was uncollectable, in April 2001, became one of two persons responsible “[b]ased on the number of accounts in the Solomon for processing cancellations, there were “stacks and system during the Class Period, and the fact that stacks and piles on the floor” of outstanding about half of those invoiced had actually cancelled.” cancellation request forms prepared by the credit and FN12 (See id. ¶ 148(c).) Plaintiffs allege no estimate collections department that had not yet been obtained from either CW10 or CW11 of the revenue processed, some of which were more than a year old improperly recognized in fiscal year 2000 or the and the majority of which had been prepared “months fourth quarter of 2000 on previously-cancelled earlier.” (See id. ¶ 151(e)-(f).) Plaintiffs, however, contracts, nor do they allege that CW10 or CW11 set forth no estimate obtained from CW22 of the identified any particular customer who cancelled revenue improperly recognized in fiscal year 2000 or during that time period yet continued to receive the fourth quarter of 2000 on previously-cancelled invoices from Exodus that were recorded as revenue. contracts, nor do they allege that CW22 identified any particular customer who cancelled during that time period yet continued to receive invoices from FN12. Plaintiffs allege that “Solomon” is an Exodus that were recorded as revenue. Exodus “financial database.” (See TAC ¶ 232(a).) FN13. According to plaintiffs, the Siebel According to plaintiffs, CW21, who held various system is Exodus's “order management management positions for Exodus from 1999 through system,” (see TAC ¶ 154(a)), and an 2003, (see TAC ¶ 126(u)), experienced difficulties in “installation database,” (see id. ¶ 232(a).) obtaining approval from Exodus's management to stop invoicing for cancelled contracts in 2001. (See *17 Plaintiffs allege that CW25, an Exodus customer TAC ¶ 149(a).) Such allegations do not support support representative responsible for resolving plaintiffs' allegation that revenues were overstated in disputes with “high profile and strategic account 2000 due to Exodus's failure to stop invoicing on customers,” (see TAC ¶ 126(y)), told them that in cancelled contracts. late 2000, it routinely took six months to process a

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 23 of 163 Not Reported in F.Supp.2d Page 14 Not Reported in F.Supp.2d, 2005 WL 1869289 (N.D.Cal.), Fed. Sec. L. Rep. P 93,357 (Cite as: Not Reported in F.Supp.2d) cancellation and that the cancelling customer would Plaintiffs allege that Exodus's revenue was overstated continue to be billed during that period. (See TAC ¶ in the Registration Statements because Exodus, 152(a).) Again, however, plaintiffs set forth no beginning in 2000, was extending credit to non- estimate obtained from CW25 of the revenue creditworthy customers. (See TAC ¶ ¶ 141-145.) The improperly recognized in fiscal year 2000 or the Third Amended Complaint alleges two new examples fourth quarter of 2000 on previously-cancelled of non-creditworthy customers, Alta Vista and contracts, nor do they allege that CW25 identified Vulcan. (See TAC ¶ 142.) any particular customer who cancelled during that time period yet continued to receive invoices from *18 With respect to Alta Vista, plaintiffs allege that Exodus that were recorded as revenue. Alta Vista did not stop making payments to Exodus until the first quarter of 2001. (See id. ¶ 142(i).) CW23, an Exodus finance analyst from August 2000 There is no allegation that Alta Vista was to May 2001 who was responsible for performing experiencing financial difficulties at any earlier date, collections, (see TAC ¶ 126(w)), allegedly became and thus no allegation that Exodus improperly aware between August and December 2000, that recognized revenue from Alta Vista in 2000. Exodus had a “huge issue” with continuing to bill customers who had cancelled services either With respect to Vulcan, plaintiffs allege that Vulcan completely or in part. (See TAC ¶ 178(a).) CW23 became a customer as of the first quarter of 2000, and estimated that from the fall of 2000 through the end continued to be carried as a customer until the end of of the class period, approximately 75% of customer 2001, when “the revenue associated with the deal, accounts receivable were not legitimately owed by approximately $1 million, was written off because Exodus customers. (See id. ¶ 178(b).) Plaintiffs, Vulcan had never paid.” (See id. ¶ 142(ii). Although however, allege no estimate obtained from CW23 of plaintiffs allege “some” of the Vulcan revenue “was the revenue improperly recognized in fiscal year improperly recognized because Exodus was not 2000 or the fourth quarter of 2000 on previously- performing any services,” plaintiffs fail to allege cancelled contracts, nor do they allege that CW23 when Exodus ceased performing services. Moreover, identified any particular customer who cancelled that Vulcan ultimately failed to pay its bill provides during that time period yet continued to receive no basis for inferring that it was not credit worthy at invoices from Exodus that were recorded as revenue. the time the deal was entered into or that the Underwriter Defendants were aware that Vulcan was In sum, although plaintiffs have alleged a general not creditworthy at the time the Registration practice by Exodus of failing to promptly process Statements were issued. cancellations during fiscal year 2000 and thereafter, they have not attempted to identify the amount of In addition to their allegations with respect to Alta revenue improperly recognized in 2000 as a result of Vista and Vulcan, plaintiffs allege that that practice. Moreover, although plaintiffs have Freerealtime.com was a “high risk contract” (see alleged a general practice by Exodus of billing TAC ¶ 143(e)(ii); plaintiffs allege that customers after cancellation, they have not identified Freerealtime.com became an Exodus customer in any customers who were improperly billed in 2000 2000 and “always presented a ‘hard collection” ’; after cancellation, nor have they alleged that Exodus plaintiffs do not allege, however, that any revenue recorded the amount of any such bills as revenue. attributable to Freerealtime.com was improperly recognized. (See TAC ¶ 143(e)(ii).) Additionally, Accordingly, the Court finds plaintiffs have not according to plaintiffs, when Federal Liaison Service alleged with the particularity required by Rule 9(b) (“FLS”) had problems with Exodus's equipment and that the statements of revenues for fiscal year 2000 refused to pay its bills for more than a year after the and the fourth quarter of 2000 contained in the problem was solved, CW21 wanted to shut down the Registration Statements were false and misleading equipment in January 2001, but was told by his when made as a result of Exodus's alleged practice of supervisor that he would have to obtain permission billing customers after cancellation. See Daou, 411 first from Exodus's executives. (See TAC ¶ 144(b).) F.3d at 1016-18. Plaintiffs fail to allege, however, that any revenue from FLS was improperly recognized in 2000.

c. Recording revenue from transactions in which Moreover, nowhere in plaintiffs' complaint do they collectability was not probable allege the amount by which Exodus's alleged extension of credit to non-creditworthy customers

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Accordingly, the Court finds plaintiffs have not FN14. As noted in the Court's Dismissal alleged with the particularity required by Rule 9(b) Order, the term “enterprise market” refers to that the statements of revenues for fiscal year 2000 customers other than “dot com” customers. and the fourth quarter of 2000 contained in the (See Dismissal Order at 22 n. 17.) Registration Statements were false and misleading when made as a result of Exodus's extension of credit In the First Amended Complaint, as noted in the to non-creditworthy customers from whom Dismissal Order, plaintiffs had alleged that (1) collectability was not probable. according to certain specified former Exodus employees, by late 2000 and early 2001, Exodus was experiencing weakness in sales, cancellations and a d. Recording revenue and assets in conjunction with drop in demand, (see FAC ¶ ¶ 133-140), and (2) “bogus” barter transactions and failing to disclose Exodus's own bankruptcy disclosure statement later such transactions acknowledged that “[b]eginning in late 2000 and early 2001 ... a substantial number of Exodus's *19 The Court previously found plaintiffs had failed traditional enterprise clients delayed-and in some to adequately allege that statements in the cases canceled-purchase decisions,” (see FAC ¶ Registration Statements that Exodus had revenues of 141). (See Dismissal Order at 18-19.) The Court $280.4 million for the fourth quarter of 2000 and found plaintiffs had failed to allege falsity with the $818.4 million for fiscal year 2000 were false due to requisite particularity because they had failed to Exodus's recording of revenue and assets in allege “any facts as to particular cancellations, how conjunction with “bogus” barter transactions and any such cancellations related to Exodus's overall failing to disclose such transactions. (See Dismissal business, or whether such cancellations were in the Order at 17-18.) The Court noted that only one such enterprise market.” (See Dismissal Order at 20.) barter transaction was alleged as having been conducted during fiscal year 2000, and the Defendants argue that plaintiffs' new allegations in transaction involved such a small dollar amount that the Third Amended Complaint are similar to those statements about that transaction would not have previously rejected by the Court as inadequate. been material. (See id. at 18.) The Underwriter Plaintiffs allege that CW17, who joined Exodus in Defendants again move to dismiss plaintiffs' claim, to January 2001 and regularly sat in on Exodus's weekly the extent it is based on improper recording of sales meetings, recalled that “the primary topic revenue from barter transactions, on the ground addressed at these meetings was ‘we're losing plaintiffs have failed to allege any additional barter business.” ’ (See TAC ¶ 216.) CW17 also allegedly transactions during fiscal year 2000. Plaintiffs do not learned in these sales meetings that Exodus “lost address their allegations as to barter transactions in several large potential deals in December 2000 their opposition. because customers had pulled out due to the economic downturn.” (See id.) Defendants correctly Accordingly, the Court finds plaintiffs have not point out that these allegations do not bear alleged with the particularity required by Rule 9(b) specifically on the strength of demand in the that the statements of revenues for fiscal year 2000 enterprise market. and the fourth quarter of 2000 contained in the Registration Statements were false and misleading *20 Plaintiffs allege that CW23 “refuted that Exodus when made as a result of Exodus's recording of was increasing its customer base because of revenue and assets in conjunction with “bogus” barter enterprise customers” because, according to CW23, transactions and failing to disclose such transactions. the majority of new customers “that Exodus counted toward an alleged increase in customer base during 1Q01 and 2Q01 were actually upgrades for existing 3. Statement Regarding Demand for Services accounts provided at no cost.” (See TAC ¶ 218.) As such statements do not focus on the period prior to

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 25 of 163 Not Reported in F.Supp.2d Page 16 Not Reported in F.Supp.2d, 2005 WL 1869289 (N.D.Cal.), Fed. Sec. L. Rep. P 93,357 (Cite as: Not Reported in F.Supp.2d) the issuance of the Registration Statements, they “Solomon” identified only 3500 active customers. permit no inference that Exodus's statement in the (See TAC ¶ 232(a).) Plaintiffs allege that the February 2001 Registration Statements that there was difference between the two numbers indicates that the “strong demand from the enterprise market” was approximately 1000 additional customers in the false at the time it was made. Moreover, CW23 is Siebel database reflected “potential deals input by the alleged to have been a finance analyst who sales organization, as well as potential customers “performed collections in the credit and collections who had never closed the deal with Exodus.” (See department” (see TAC ¶ 126(w)) and plaintiffs do id.) not allege that CW23 had personal knowledge of the demand for Exodus's services in the enterprise market *21 The Court previously found these allegations prior to the date of the Registration Statements. insufficient to allege falsity with particularity because, among other deficiencies, plaintiffs failed to The Third Amended Complaint contains somewhat allege the date on which the Solomon database more substantial allegations relating to CW16, who is reflected only 3500 customers. (See Dismissal Order alleged to have been responsible for creating detailed at 23.) In their Third Amended Complaint, plaintiffs proposals in response to requests for proposals have not alleged that date. (“RFPs”) from potential customers in the enterprise market from July 1999 through February 2003. (See Accordingly, plaintiffs again have failed to allege TAC ¶ ¶ 126(p), 217(a).) According to plaintiffs, with the particularity required by Rule 9(b) that the CW16 noticed a decline in RFPs beginning in the statement in the Registration Statements that Exodus third quarter of 2000, and a notable drop in the fourth had, at that time, 4500 customers was false or quarter of 2000. (See id. ¶ 217(b).) CW16 also misleading when made. allegedly estimated that the number of proposals produced in response to RFPs fell from about six in January 2001 to three or four per month in March and 5. Scienter April, and such proposals generally were in response to RFPs received a quarter or two earlier. (See id .) The Court dismissed the First Amended Complaint Although such allegations may suffice to allege with because “even assuming the statements in the particularity that Exodus was experiencing a drop in Registration Statements were false or misleading, RFPs from new enterprise customers at the time the plaintiffs fail to offer any facts sufficient to Registration Statements were issued, they say nothing demonstrate that the Underwriter Defendants acted about demand from Exodus's existing enterprise with the requisite state of mind in making the customers. Consequently, plaintiffs have not alleged statements.” (See Dismissal Order at 13.) Plaintiffs' with particularity that Exodus's overall demand from allegations in the Third Amended Complaint enterprise customers was dropping at the time it similarly are insufficient under the PSLRA to raise a stated that there was strong demand from the strong inference that the Underwriter Defendants enterprise market in the Registration Statements. intentionally or with deliberate recklessness made false or misleading statements to investors. Accordingly, the Court finds plaintiffs again have failed to allege with the particularity required by Rule As noted, the PSLRA requires the complaint to “state 9(b) that said statement was false or misleading when with particularity facts giving rise to a strong made. inference that the defendant acted with the required state of mind.” See 15 U.S.C. § 78u-4(b)(2). The Ninth Circuit has held that the required state of mind 4. Statement Regarding Number of Exodus is “deliberate recklessness, at a minimum,” and that Customers plaintiffs “must plead, in great detail, facts that constitute strong circumstantial evidence of Plaintiffs allege the statement that Exodus had 4500 deliberately reckless or conscious misconduct.” See customers (see TAC ¶ 72) was false or misleading Silicon Graphics, 183 F.3d at 974. In determining when made because that number “included customers whether scienter has been adequately alleged, the who were not active, who had cancelled and who had Court must examine the totality of plaintiffs' no ability to pay,” (see TAC ¶ 76.) Plaintiffs further allegations and consider “ ‘all reasonable inferences allege that although Exodus's “installation database, to be drawn from the allegations, including Siebel, may have reflected approximately 4500 inferences unfavorable to the plaintiffs.” ’ See ‘customers,” ’ the “financial database” known as America West, 320 F.3d at 938. To establish a strong

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 26 of 163 Not Reported in F.Supp.2d Page 17 Not Reported in F.Supp.2d, 2005 WL 1869289 (N.D.Cal.), Fed. Sec. L. Rep. P 93,357 (Cite as: Not Reported in F.Supp.2d) inference of scienter, the allegations must show that the February Offerings. an inference of fraud is “ ‘the most plausible of competing inferences.” ’ See Gommper v. VISX, 298 F.3d at 897. FN15. The Court, in ruling on a motion to dismiss, may consider documents whose The Third Amended Complaint contains only three contents are alleged in the complaint, and new alleged facts relating to the state of mind of any whose authenticity no party questions, but of the Underwriter Defendants, each of which relates which are not physically attached to the only to Goldman Sachs. As plaintiffs have failed to pleading. See Branch v. Tunnell, 14 F.3d at allege any new facts relating to the state of mind of 454. Merrill Lynch, Morgan Stanley, or J.P. Morgan, plaintiffs' § 10(b) claims against those defendants Plaintiffs also allege that, on April 17, 2001 and April again will be dismissed for failure to adequately 27, 2001, two months after the February Offerings, allege scienter. Goldman Sachs issued analyst reports identifying Exodus as a “recommend” buy, Goldman Sachs' With respect to Goldman Sachs, plaintiffs allege the highest investment classification. FN16 (See TAC ¶ following new facts. First, plaintiffs allege that a 80.) According to plaintiffs, Goldman Sachs research analyst sent an internal email on February 23, 2001, less than three weeks after the February Offerings, stating: FN16. Defendants also move for dismissal I have drafted a note that highlights our concerns yet of any § 10(b) claim plaintiffs may be does not translate into the lowering of numbers for alleging based on statements in these analyst specific companies. Considerations include: (1) we reports. The Court does not reach those believe that most of our cost back-end loaded 2001 arguments as plaintiffs have not clearly set numbers have to come down, (2) exds [EXODUS] is forth such a claim in their complaint. a major offender of back-end loading, but to lower numbers right after selling equity @ $18.50 could be Internal Goldman Sachs' reviews demonstrate that a problem. Goldman Sachs was in fact aware of the analyst's biased and misleading reports, recognizing that the *22 (See TAC ¶ 74.) The Underwriter Defendants analyst in question “has subordinated personal correctly argue that plaintiffs have misquoted this preferences on recommendations for ‘commercial’ email. The actual email states: “most of our cos back- [i.e., banking] reasons,” that “[o]ne gets the sense ended loaded 2001 numbers have to come down.” that he's been held captive to the agenda of other ... (See Underwriter Defendants' Request for Judicial were he allowed to exercise independent investment Notice, Ex. Q (emphasis added).) FN15 The thesis, he would have had a decidedly different take Underwriter Defendants contend that “cos” is an of this group's prospects,” and that “while I abbreviation for “companies” and not a misspelling understand he communicates what he really thinks to of “costs”, and that the reference in the email to a sele[c]t few, his public ratings have been an “back-end load[ing]” “was used to demonstrate that embarrassment to the firm.” the revenue estimates for these companies would (See TAC ¶ 80 (alterations in original).) Plaintiffs do require a big third and fourth quarter revenue not set forth the date of the alleged internal reviews, performance-“back-end loaded,” using industry and do not allege that the reviews addressed concerns jargon-for the companies to meet their forecasts.” about the analyst's recommendations and reports with (See Underwriter Defendants' Motion at 34.) respect to Exodus. Even assuming the quoted internal Plaintiffs dispute this interpretation. The Court reviews expressed concern with respect to the cannot resolve the parties' dispute about the meaning analyst's public views about Exodus, there is no of this email on a motion to dismiss. Regardless of allegation that these concerns were raised prior to the whether the email refers to back-end loaded costs or February Offering. In short, these allegations permit back-end loaded revenues, however, it is clear that no inference that Goldman Sachs acted with scienter the writer is concerned only about Exodus's “2001 in publishing the Registration Statements for the numbers.” (See TAC ¶ 74.) Thus, the email provides February Offerings. no basis for inferring that Goldman Sachs was aware of problems with Exodus's financial results for 2000 Finally, plaintiffs allege that the Securities and at the time of the February Offerings and acted with Exchange Commission filed a complaint against scienter in publishing the Registration Statements for Goldman Sachs on April 28, 2003 for “biased and

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 27 of 163 Not Reported in F.Supp.2d Page 18 Not Reported in F.Supp.2d, 2005 WL 1869289 (N.D.Cal.), Fed. Sec. L. Rep. P 93,357 (Cite as: Not Reported in F.Supp.2d) misleading analyst coverage, specifically including and § 15 claims fail because plaintiffs have not Goldman Sachs' coverage of Exodus,” and “for adequately pleaded, and are not able to plead, control violating rules of the National Association of person liability. Securities Dealers (NASD) and the New York Stock Exchange,” and that Goldman Sachs settled said The Court will begin its analysis with the Individual complaint. (See id. ¶ ¶ 15, 75 and TAC Ex. D.) The Defendants' arguments with respect to the statute of mere filing of a complaint, absent any findings that limitations. the allegations of the complaint are true, can provide no basis for a strong inference of scienter by Goldman Sachs at the time of the February Offerings. A. Statute of Limitations

*23 Accordingly, plaintiffs' § 10(b) claim against The Individual Defendants argue that the plaintiffs each of the Underwriter Defendants is subject to are barred by the statute of limitations from bringing dismissal for failure to adequately allege scienter. (1) the claims for violations in the period from April 20, 2000 to March 31, 2001 (the expanded class period first alleged in the First Amended Complaint), D. Summary (2) the claims asserted against Mohamad, Yeack, and Brown, and (3) the § 11 claim against Hancock. In sum, the Court will (1) DENY the Underwriter Defendants' motion to dismiss plaintiffs' § 10(b) and As noted, the instant claims under § 10(b) and § 11 § 11 claims as time-barred; (2) DENY the are timely if they were brought within one year of Underwriter Defendants' motion to dismiss plaintiffs' either actual discovery or inquiry notice of the facts § 11 claims as inadequately pleaded under Rule 9(b); constituting the alleged violations. “[I]nquiry notice and (3) GRANT the Underwriter Defendants' motion triggers an investor's duty to exercise reasonable to dismiss plaintiffs' § 10(b) claims for failure to diligence and the one-year statute of limitations adequately plead falsity and scienter under Rule 9(b) begins to run once the investor, in the exercise of and the PSLRA. reasonable diligence, should have discovered the facts underlying the alleged fraud.” ' See Valence, 175 F.3d at 704 (quoting Sterlin, 154 F.3d at 1201) DISCUSSION: INDIVIDUAL DEFENDANTS' (internal punctuation omitted). Thus, a court must ask MOTION TO DISMISS (1) whether an event/publication “raise[d] sufficient suspicion of fraud to cause a reasonable investor to The Third Amended Complaint asserts a claim for investigate the matter further,” and (2) when “a violation of § 10(b) of the Exchange Act and SEC reasonably diligent inventor [should] have discovered Rule 10(b)(5) against each of the Individual the facts underlying the alleged fraudulent activity .” Defendants, and a claim for violation of § § 11 and See Valence, 175 F.3d at 704. “If the answer to the 15 of the Securities Act against Hancock only. (See first question is yes, the answer to the second TAC ¶ ¶ 343-362Plaintiffs also assert a claim against question would determine when the statute of each of the Individual Defendants for violation of § limitations began to run.” Id. 20(a) of the Exchange Act for acting “as controlling persons of Exodus.” (See TAC ¶ ¶ 363-365.) The Individual Defendants raise four principal arguments 1. Claims Based on Violations During Expanded in their motion to dismiss: (1) plaintiffs fail to state a Class Period § 10(b) claim because they have failed to adequately allege falsity or scienter as to any of the statements *24 As noted, plaintiff's First Amended Complaint alleged to be false, and because the PSLRA's Safe asserted claims on behalf of persons and entities who Harbor provisions insulate the forward-looking purchased Exodus securities between April 20, 2000 statements in question from liability; (2) plaintiffs are and September 21, 2001, whereas the class period barred by the statute of limitations from asserting (a) alleged in the initial Consolidated Complaint covered the § 10(b) claims based on statements made in the purchases made between March 31, 2001 and June expanded class period; (b) the claims against Brown, 20, 2001, a substantially shorter period. Defendants Mohammad, and Yeack; and (c) the § 11 claim argue that the one-year statute of limitations bars the against Hancock; (3) the § 11 claim against Hancock claims raised by those members of the newly-alleged fails for the reasons set forth in the Underwriter class who purchased securities between April 20, Defendants' motion to dismiss; and (4) the § 20(a) 2000 and March 31, 2001.

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According to plaintiffs, CW1 told them, in June For the reasons set forth in the discussion respecting 2002, that Yeack and Brown both attended weekly the Underwriter Defendants' motion to dismiss, executive staff meetings during the first and second supra, plaintiffs have adequately pleaded facts quarters of 2001, at which CW1 repeatedly raised demonstrating conformity with the statute of with management his concerns about improper limitations as to plaintiffs' claims for wrongdoing recognition of revenue associated with continuing between April 20, 2000 and March 31, 2001. See billings for non-paying or cancelled customers. (See TAC ¶ ¶ 319-321, 331-34 (setting forth allegations TAC ¶ ¶ 323, 329.). that plaintiffs did not suspect wrongdoing occurring prior to the second quarter of 2001 until confidential The Individual Defendants argue that the facts witness interviews conducted in December 2001).FN17 alleged in support of plaintiffs' claims against Mohammad, Yeack and Brown are identical to those alleged against the other Individual Defendants and, FN17. The Court disregards plaintiffs' accordingly, plaintiffs cannot claim plaintiffs were allegations that defendants “fraudulently not similarly on notice as to their claims against concealed their activities,” (see TAC ¶ Mohammad, Yeack and Brown at the time the initial 316), as the Supreme Court has held that complaints were filed. The Individual Defendants equitable tolling is “fundamentally also point out that plaintiffs could easily have inconsistent” with the limitations period for determined that Mohammad, Yeack and Brown were securities violations. See Lampf, 501 U.S. at officers of Exodus by reviewing Exodus's March 31, 363; see also Pincay v. Andrews, 238 F.3d 2001 Form 10-K. The issue is not whether plaintiffs 1106, 1110 (9th Cir.2001) (describing were able to determine that Mohammad, Yeack and fraudulent concealment as form of equitable Brown were officers, however, but whether plaintiffs tolling). were alerted to facts suggesting Mohammad, Yeack and Brown were involved in the alleged fraud. 2. Claims Against Mohammad, Yeack and Brown Plaintiffs now allege specific facts as to the dates on which they first suspected Mohammad, Yeack and Plaintiffs' claims against Mohammad, Yeack and Brown of having engaged in wrongdoing. As all such Brown were first asserted in the First Amended dates are within one year of the date plaintiffs filed Complaint, which was filed July 11, 2002, more than their First Amended Complaint, i.e., the first one year after Exodus's June 20, 2001 announcement complaint in which plaintiffs alleged claims against that its results for the second quarter of 2001 and for Mohammad, Yeack and Brown, the Court finds the fiscal year would be below prior expectations. plaintiffs have adequately pleaded compliance with The Court previously dismissed plaintiffs' claims the statute of limitations with respect to their claims against Mohammad, Yeack and Brown, with leave to against said defendants. amend, because plaintiffs failed to allege any reason for their failure to assert claims against Mohammad, Yeack and Brown in their prior complaints. 3. Section 11 Claim Against Hancock

Plaintiffs now allege they did not discover the *25 For the reasons discussed earlier with respect to possibility that Mohammad was involved in the the Underwriter Defendants' motion to dismiss, alleged fraud until November and December 2001, plaintiffs likewise have adequately pleaded facts when they interviewed CW6, CW7, and CW9, who demonstrating conformity with the statute of informed plaintiffs that Mohammad “gave directions limitations as to plaintiffs' § 11 claim against to the sales teams,” gave “account executives Hancock. Compare TAC ¶ ¶ 319-321 (setting forth ‘marching orders' with respect to selling Exodus's allegations that plaintiffs did not suspect wrongdoing products and services,” and “played a tremendous by the Underwriter Defendants in connection with the part in Exodus's downfall.” (See TAC ¶ ¶ 325-26.) February Offerings until December 2001) with TAC According to plaintiffs, CW6 also told plaintiffs that, ¶ ¶ 331-334 (setting forth similar allegations as to prior to the second quarter of 2001, Exodus was not why plaintiffs did not suspect wrongdoing by bringing in any new customers. (See id. ¶ 325.) Hancock in connection with the February Offerings until December 2001). With respect to Yeack and Brown, plaintiffs allege they did not discover the possibility these defendants were involved in the alleged fraud until June 2002. B. Sufficiency of Pleading: Section 10(b) Claim

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1. Statements Regarding Exodus's Standards as to As noted, in assessing whether plaintiffs have Customer Creditworthiness adequately pleaded a § 10(b) claim under the PSLRA, the court “must determine whether particular In its prior complaint, plaintiffs alleged that Exodus's facts in the complaint, taken as a whole, raise a March 31, 2001 Form 10-K contained the following strong inference that defendants intentionally or with statements: (1) “We do not enter into arrangements ‘deliberate recklessness' made false or misleading unless collectability is reasonably assured at the statements to investors.” See Ronconi v. Larkin, 253 outset”; (2) “Existing customers are subject to F.3d at 429. “Where pleadings are not sufficiently ongoing credit evaluations based on payment history particularized or where, taken as a whole, they do not and other factors”; and (3) “If it is determined that raise a ‘strong inference’ that misleading statements collectability is not reasonably assured, revenue is were knowingly or with deliberate recklessness made recognized on a cash basis.” (See FAC ¶ 78.) The to investors, a private securities fraud complaint is Court previously dismissed plaintiffs' claim that these properly dismissed under Rule 12(b)(6).” See id. statements were false or misleading when made, and that the Individual Defendants knew about, or were Plaintiffs' § 10(b) claims against the Individual deliberately reckless as to, such falsity, for the Defendants are based on a series of public statements reasons set forth at length in the Court's Dismissal by Exodus, beginning with its announcement of its Order. (See Dismissal Order at 33-38.) first quarter of 2000 financial results on April 20, 2000, and ending with its September 26, 2001 *26 In dismissing the claim, the Court first rejected announcement that it had filed for Chapter 11 plaintiffs' reliance on statements by Hancock's bankruptcy. (See TAC ¶ ¶ 45-118.) Additionally, successor as Exodus's CEO, Richard Krause plaintiffs' § 10(b) claims are based on a series of (“Krause”), which were published on September 28, statements to the press by Hancock in August and 2001 and October 1, 2001, that Exodus had acquired September 2001. (See TAC ¶ ¶ 102-111.) The Third “customers who don't qualify to be customers,” (see Amended Complaint contains no public statements TAC ¶ 137), because such statements reflected an by Exodus that were not alleged in the First Amended assessment made six months after the March 31, Complaint, but does allege several statements to the 2001 Form 10-K and thus did not indicate knowledge press by Hancock that were not alleged in the First of falsity at the time the 10-K statements were made. Amended Complaint, specifically, an interview The Court further found the statements by Krause did published August 3, 2001 by Business Week Online, not indicate when Exodus acquired the “customers (see id. ¶ 103), an interview published August 13, who don't qualify to be customers,” and thus 2001 by Network World, (see id. ¶ 104), and an provided no basis for inferring that the statements in interview broadcast on CNN's Moneyline on August the March 31, 2001 Form 10-K were false when 23, 2001. (See id. ¶ 108). made. (See Dismissal Order at 33-34.) Plaintiffs now allege that in correspondence dated April 29, 2002, The Court previously dismissed the entirety of Krause's successor, Joe Stockwell, discussed “the plaintiffs' § 10(b) claims for failure to adequately extraordinary steps taken by the [Exodus bankruptcy] allege falsity and scienter. The Individual Defendants Estate between September 2001 and the end of move again to dismiss the § 10(b) claims, and argue January 2002 to clean up bad receivables.” (See TAC that plaintiffs' additional allegations fail to cure the ¶ 139.) Plaintiffs' reliance on this additional deficiencies identified by the Court in its prior statement, made more than six months after Krause's Dismissal Order.FN18 statements, similarly is unavailing, for the same reasons set forth above with respect to Krause's statements. FN18. The Court's analysis of the Individual Defendants' motion has been made more The Court, in its Dismissal Order, also found difficult by plaintiffs' decision not to plaintiffs' allegations with respect to information specifically address each of the subparts of obtained from CW1 and CW10 inadequately pleaded. the Individual Defendants' arguments, but (See Dismissal Order at 34-36.) The Court found that rather to set forth their argument against plaintiffs had failed to allege specific facts sufficient dismissal in four subparts that do not to support CW1's belief that Exodus had non- directly correspond with the arguments creditworthy customers and a lack of proper bad-debt made by the Individual Defendants. reserves, as well as CW10's belief that Hancock and Mohammad regularly approved high-risk customers

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 30 of 163 Not Reported in F.Supp.2d Page 21 Not Reported in F.Supp.2d, 2005 WL 1869289 (N.D.Cal.), Fed. Sec. L. Rep. P 93,357 (Cite as: Not Reported in F.Supp.2d) that had been rejected by the Credit and Collections Department and Finance Department. See id. at 34. In The Third Amended Complaint contains allegations particular, the Court noted that plaintiffs failed to with respect to an additional source, CW21, a former allege the number of non-creditworthy customers, the Exodus employee who managed the project managers identity of any such customers, the amount by which in the Austin/Dallas data centers. (See TAC ¶ 144.) Exodus's bad-debt reserves were insufficient, the According to plaintiffs, CW21, in the beginning of amount of revenue attributable to such customers, 2000, saw customers' credit applications for IDC and whether such customers failed to pay their bills. space, which included their credit report statements. See id. at 34-35. With respect to the handful of (See id.) Although many of these customers had no customers alleged in the First Amended Complaint to income and less than $30,000 in assets, plaintiffs have been high-risk or non-creditworthy, the Court allege, Mohammad pressured the finance department found that plaintiffs had failed to allege specific facts to approve their applications. (See id.) Plaintiffs fail as to why those customers were thought to have been to identify any of these customers by name, other non-creditworthy. See id. at 35. than Live Oak Telecom, and allege no facts to suggest that the amount of services provided to these Plaintiffs now point to two additional customers they customers exceeded their ability to pay. contend were non-creditworthy, specifically, Alta Consequently, plaintiffs fail to adequately allege how Vista and Vulcan. (See TAC ¶ 142.) Plaintiffs allege Exodus's creditworthiness standards were not met by that Alta Vista “became insolvent and stopped extending services to such customers. making payments” in the first quarter of 2001 and thereafter CW1 called Alta Vista's CFO to discuss According to plaintiffs, CW21 also observed that Alta Vista's outstanding invoices. (See id. ¶ 142(i).) non-creditworthy customers “who were not or could Following that meeting, according to plaintiffs, Alta not make payments were not shut down and, instead, Vista “restructured the deal,” and within a quarter, continued to be billed.” (See TAC ¶ 144(b)The only “kicked Exodus out.” (See id.) Far from suggesting customer specifically identified, however, is Federal fraud, plaintiffs' allegations with respect to Alta Vista Liaison Services (“FDS”), who, plaintiffs allege, demonstrate only that when Alta Vista had trouble “would not pay because the equipment it ordered was paying its bills, Exodus promptly responded and not compatible with the co-located equipment.” (See addressed the issue. id.) Although plaintiffs allege that FDS continued not making payments for more than a year after the *27 With respect to Vulcan, plaintiffs allege that compatibility problem was solved, (see id.), plaintiffs' Vulcan was an Exodus customer from the first allegations with respect to FDS suggest that FDS quarter of 2000 through the end of 2001, “when the disputed its bills because of concerns with Exodus's revenue associated with the deal, approximately $1 performance, not that FDS was not a creditworthy million was written off because Vulcan had never customer. paid.” (See TAC ¶ 142(ii).) According to CW1, plaintiffs allege, “some” of the revenue attributable to Plaintiffs further allege that although CW21 wanted Vulcan was improperly recognized “because Exodus to shut down FLS' equipment in January 2001, his was not performing any services and because Vulcan boss told him that he first would have to obtain was already well in default-perhaps one or two executive permission to do so. (See id.) Plaintiffs do quarters-on Exodus A/R.” (See id.) According to not allege that such permission was sought and plaintiffs, CW1 “attempted to get in touch with denied. responsible management at Vulcan and could not get his calls returned.” (See id.) Plaintiffs, however, *28 Plaintiffs also allege as new material that, allege no facts to suggest Vulcan was not according to CW5, Hancock would “frequently” creditworthy at the time it entered into any contract approve non-creditworthy customers in order to with Exodus, or that Exodus failed to conduct record revenues. (See id. ¶ 145.) According to ongoing credit evaluations. Indeed, the allegations plaintiffs, CW5 described one instance in which suggest that Exodus attempted to contact Vulcan service to a customer who owed approximately when it did not pay its bills, and ultimately stopped $700,000 was terminated, but Hancock and Case performing services for Vulcan as a result of its ordered the customer's service restored immediately; failure to pay. Finally, plaintiffs' allegation that service was restored, billing continued, and collection “some” revenue associated with Vulcan was was not made. (See id. ¶ 145.) Because plaintiffs fail improperly recognized is not pleaded with the to allege the name of the customer, the date service particularity required by Rule 9(b). was terminated and restored, or the circumstances

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 31 of 163 Not Reported in F.Supp.2d Page 22 Not Reported in F.Supp.2d, 2005 WL 1869289 (N.D.Cal.), Fed. Sec. L. Rep. P 93,357 (Cite as: Not Reported in F.Supp.2d) surrounding the termination and restoration of (See TAC App. Ex. B at 78.) Nonetheless, plaintiffs service, this incident is not alleged with the have failed to adequately allege that the statements particularity required by Rule 9(b). See Daou, 411 about collectability in Exodus's March 31, 2001 Form F.3d at 1016. 10-K were false at the time they were made, because the Oracle spreadsheet says nothing about whether In their prior complaint, plaintiffs included collectability was reasonably assured at the time allegations that the statements respecting Exodus began providing services to such customers collectability were false because Exodus was in fact or whether Exodus subjected its customers to seeking to collect a large amount of unpaid debt from ongoing credit evaluations, and provides no its customers, which allegations the Court found information as to how the past due accounts inadequately pleaded. (See Dismissal Order at 36.) receivable were recognized as revenue. The Court found inadequately pleaded plaintiffs' allegation that CW2, a former Exodus Employee who worked in a “Collection Task Force” set up by FN19. Although paragraph 172 of the Third Exodus, “learned that in 2001, Exodus was trying to Amended Complaint states that further collect close to $500 million in debts from allegations about the Oracle spreadsheet customers,” and that “[a]mong the debts the may be found in paragraph 85, such Collections Task Force attempted to collect included allegations actually appear in paragraph 168. American Airlines, which owed between $5 and $7 The spreadsheet itself is attached to the million to Exodus.” (See FAC ¶ 116; Dismissal complaint as Exhibit B. Order at 36.). In particular, the Court found such allegations were insufficient to demonstrate falsity or *29 Finally, in the Court's Dismissal Order, the Court scienter because plaintiff failed to provide the found inadequately pleaded plaintiffs' allegation that requisite facts respecting CW2's source of CW5, the Senior Manager of Credit and Collections information. (See Dismissal Order at 36.) The Third for Exodus, (see FAC ¶ 104(e)), prepared a reserve Amended Complaint includes no new allegations report “for the March 2001 close,” which report about the source of CW2's information. (See TAC ¶ “showed that 40% of the overall accounts receivable 172.) The Third Amended Complaint does, however, was not collectable.” (See Dismissal Order at 37-38 allege that “a spreadsheet from Exodus's new system, (quoting FAC ¶ 135).) The Third Amended Oracle, ... corroborates that, on August 31, 2001, a Complaint does not materially expand on these team of Exodus collectors were attempting to collect allegations. (See TAC ¶ 219.) over $551 million of receivables from over 5,000 customers.” (See id.) FN19 Plaintiffs allege that the Accordingly, the Court finds plaintiffs have not above-referenced Oracle spreadsheet further shows adequately pleaded that the Individual Defendants' that of the $551 million Exodus was attempting to statements about collectability of Exodus's accounts collect, more than $50 million was 91-120 days past receivable were false and misleading at the time they due, more than $85 million was 121-180 days past were made. due, and more than $122 million was more than 180 days past due. (See id. ¶ 168.) Plaintiffs attach to the Third Amended Complaint a declaration from Patrick 2. Statements Regarding Exodus's Revenue A. Rueckert, manager of Exodus's Texas Sales Recognition Project Management, authenticating the Oracle spreadsheet and attesting that the information Plaintiffs assert that Exodus's financial results, as contained therein was current as of August 9, 2001. stated in Exodus's 10Q reports regarding Exodus's (See TAC App. Ex. E.) As the Oracle spreadsheet first quarter of 2000 through its first quarter of demonstrates that more than $122 million in accounts 2001,FN20 were false or misleading because Exodus receivable was more than 180 days past due on recognized revenue in violation of GAAP and SEC August 9, 2001, such amounts were also more than rules by engaging in four types of accounting 30 days past due on March 31, 2001, the date of improprieties: (1) recording revenue prior to Exodus's Form 10-K, in which the challenged rendering services; (2) recording revenue on statements about collectibility were included. cancelled or non-renewed contracts; (3) recording Moreover, $122 million was a significant portion of revenue from transactions in which collectability was Exodus's total accounts receivable, as the Oracle not probable; and (4) recording revenue and assets in spreadsheet states that the amount of current accounts conjunction with bogus barter transactions and failing receivable as of August 9, 2001 was $108 million. to disclose such transactions. (See TAC ¶ 264.) The

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Individual Defendants move to dismiss plaintiffs' § Third Amended Complaint. 10(b) claim, to the extent such claim is based on such allegations, on the ground that plaintiffs have not adequately alleged any material misstatement of a. Recording Revenue Prior to Rendering Services Exodus's revenues and fail to make any showing that the Individual Defendants knew of either the The Court previously has dismissed plaintiffs' § existence, or the amount, of any such misstatements. 10(b) claim against the Individual Defendants, to the extent such claim was based on an alleged practice of recording revenue prior to rendering services, FN20. Specifically, plaintiffs allege that the because plaintiffs failed to adequately allege the following reported financial results were source of the confidential witnesses' knowledge of false: (1) first quarter of 2000 revenues of such practice, and because plaintiffs failed to allege $134.1 million and EBITDA profit of $1.7 facts with sufficient particularity to show the reported million (see TAC ¶ ¶ 45, 48); (2) second financial results were false when made or that any of quarter of 2000 revenues of $179.6 million the Individual Defendants had knowledge of such and EBITDA profit of $8.6 million (see falsity. (See Dismissal Order at 44-45.) TAC ¶ ¶ 52, 54); (3) third quarter of 2000 revenues of $229.6 million and EBITDA The Ninth Circuit has held that information obtained profit of $20.2 million (see TAC ¶ ¶ 57, from confidential witnesses may provide a basis for a 60); (4) fourth quarter of 2000 revenues of securities fraud complaint if the “sources are $280.4 million and EBITDA profit of $26.5 described with sufficient particularity to support the million (see TAC ¶ 70, 78); and (5) first probability that a person in the position occupied by quarter of 2001 revenues of $348.7 million the source would possess the information alleged and and EBITDA profit of $5.5 million (see the complaint contains adequate corroborating TAC ¶ ¶ 82, 91). details.” See Daou, 411 F.3d at 1015 (internal quotations omitted). Plaintiffs have amended the As noted, “[w]hen pleading irregularities in revenue complaint to allege that CW10 “is a former Exodus recognition, plaintiffs should allege (1) such basic employee who was responsible primarily for running details as the approximate amount by which revenues credit checks on prospective customers and who and earnings were overstated; (2) the products worked closely with collectors,” (see TAC ¶ 154), involved in the contingent transaction; (3) the dates and that CW12 is “a former Exodus collector,” (see of any of the transactions; or (4) the identities of any TAC ¶ 155). Neither allegation adequately sets forth of the customers or [company] employees involved in an explanation as to how the confidential witnesses the transactions.” See Daou, 411 F.3d at 1016 obtained knowledge about Exodus's revenue (internal quotations and citations omitted; alteration recognition practices. in original). “Plaintiffs need not allege each of those particular details,” however, but “must allege enough Plaintiffs also add a new allegation that Exodus information so that a court can discern whether the regularly input an installation date of 1/1/1900 into alleged GAAP violations were minor or technical in the Solomon database FN21 as “a ‘placeholder’ which nature, or whether they constituted widespread and indicated to Exodus internally that the items ordered significant inflation of revenue.” See id. (internal were ‘not installed.” ’ (See TAC ¶ 155(b).) Plaintiffs quotation and citation omitted). A “general allege that a document titled “Cu. Open Orders by allegation” that a particular practice “resulted in a Customer-by Customer; Period: 02-00 as of false report of company earnings is not a sufficiently 03/07/00,” pertaining to a customer identified as particular claim of misrepresentation.” See id. Rather, “Customer Nbr. 000661” indicates that several items “although overstatement of revenues in violation of were installed on “1/1/1900.” (See id.) Plaintiffs do GAAP may support a plaintiff's claim of fraud, the not allege, however, that this customer was billed plaintiff must show with particularity how the prior to installation and, indeed, does not allege the adjustments affected the company's financial name of any customer who was billed by Exodus statements and whether they were material in light of prior to installation based on an installation date, the company's overall financial position.” See id. at according to the Solomon database, of “1/1/1900.” 714.

*30 Accordingly, the Court turns to each of the FN21. As noted above, plaintiffs allege that accounting improprieties alleged by plaintiffs in the the Solomon database is an Exodus

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“financial database.” (See TAC ¶ 232(a).) (See TAC ¶ 151(a).) According to CW21, “the vast majority of customer cancellations were routinely In addition, plaintiffs add a new allegation that, delayed for months,” and Exodus continued to book according to CW11, an Exodus credit and collections revenue on hundreds of accounts that had actually analyst from August 1999 through June 2001, (see id. been cancelled for months. (See id. ¶ 151(b)-(c).) In ¶ 126(k)), Exodus had a “practice of inputting false April 2001, according to plaintiffs, CW22 processed installation dates in order to begin billing customers.” at least 125 cancellations, the majority of which came (See id. ¶ 156.) Plaintiffs fail to allege, however, the from cancellation requests prepared months earlier, name of any customer that CW11 identified who was and he continued to process hundreds of such billed prior to installation, the details of any such cancellations into the summer of 2001. (See id. ¶ transaction, or the amount by which any such pre- 151(f).) Plaintiffs again fail to identify any particular installation billing affected Exodus's financial customer who was billed subsequent to cancellation statements. and/or who entered into a side agreement, the dates of any such transactions, or the amount of revenue *31 Accordingly, the Court finds plaintiffs have not involved, much less the amount by which such successfully amended their complaint to state a § practice of post-cancellation billing affected Exodus's 10(b) claim based on fraudulently recognizing financial results. revenue prior to installation. Defendants argue that Exodus disclosed in its Form 10Q for the first quarter of 2001 that it sold its b. Recording Revenue on Cancelled or Non-renewed “services under contracts that typically [had] a Contracts minimum term of one year,” (see Individual Defendants' Request for Judicial Notice (“RJN”) Ex. Plaintiffs claim that Exodus's financial statements 23 at 11), and that plaintiffs fail to explain how were fraudulent as a result of a practice by Exodus of customers can unilaterally cancel their contracts and continuing to recognize revenue based on orders that why Exodus was not entitled to bill a customer for had been cancelled, and of entering into “side the entire period of their contract. Defendants also agreements” with customers, by which customers point out that plaintiffs themselves appear to who cancelled their contracts with Exodus would recognize that early termination of a contract required continue to be billed but were permitted to ignore the approval from Exodus, in that plaintiffs allege that at invoices. (See TAC ¶ 146.) The Court previously least one customer cancelled its contract “but waited dismissed this claim because “plaintiffs fail[ed] to for approval of the cancellation from Exodus.” (See identify any particular customer who was billed TAC ¶ 5.) The Court agrees that plaintiffs fail to subsequent to cancellation and/or who entered into a allege whether the contracts in question were side agreement, let alone the dates of any such cancelled prior to the end of their term and, if so, why transactions or the amount of revenue involved.” (See Exodus was not entitled to continue to bill customers Dismissal Order at 45-46.) for the duration of the contractually-agreed term.

In the Third Amended Complaint, plaintiffs add *32 Accordingly, the Court finds plaintiffs have not allegations obtained from CW21 and CW12. successfully amended their complaint to state a § Although CW21 and CW12, according to plaintiffs, 10(b) claim based on fraudulently recognizing observed Exodus continuing to invoice customers revenue on cancelled or non-renewed contracts. after the customers cancelled their contracts, (see TAC ¶ ¶ 149-150), plaintiffs do not allege any particular customer, of which CW21 or CW12 was c. Recording Revenue from Transactions in which aware, who was billed after cancellation. Collectability Was Not Probable

Plaintiffs also add allegations relating to CW22, “a Plaintiffs allege that “it was common practice for former Exodus employee who processed orders in the Exodus to enter into contracts with customers that sales group and then became one of two employees in had limited capital resources, many of which were the cancellations department formed in April 2001.” Internet companies on the verge of bankruptcy.” (See (See TAC ¶ 151.) CW22, according to plaintiffs, was TAC ¶ 268.) According to plaintiffs, “[t]hese aware, in November and December 2000, of a large transactions were in violation of GAAP and SEC number of cancellations “ordered” by customers rules as the collectibility was not reasonably months earlier, but which had not been processed. assured.” (See id.) The Court previously dismissed,

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 34 of 163 Not Reported in F.Supp.2d Page 25 Not Reported in F.Supp.2d, 2005 WL 1869289 (N.D.Cal.), Fed. Sec. L. Rep. P 93,357 (Cite as: Not Reported in F.Supp.2d) as inadequately pleaded, plaintiffs' § 10(b) claims to improperly recognized revenue from transactions the extent such claims were based on the recording of from which collection was not reasonably assured. revenue from transactions in which collectability was Plaintiffs do not allege that Exodus was aware of any not probable. (See Dismissal Order at 46.) problems with collectability as to any of the 275 customers involved in Project Resolve at the time Plaintiffs have amended their allegations to allege revenue was recognized. In addition, the mere fact that Exodus “failed to establish sufficient reserves for that a bill was disputed does not support the inference its deteriorating accounts receivable.” (See TAC ¶ that revenue from that transaction was improperly 269.) According to plaintiffs, in March 2001, CW5 recognized. prepared a reserve report for Exodus's management, including Wegner, Dollahite, Case and Hancock, Moreover, there is nothing to suggest the existence of which showed that 40% of the overall accounts Project Resolve itself was part of a fraudulent receivable was not collectible. (See id. ¶ ¶ 219, 270.) scheme. To the contrary, it suggests that Exodus was Plaintiffs allege that, according to CW21, the making a good faith effort to resolve billing disputes. Individual Defendants initiated “Project Resolve” at the beginning of April 2001, in an attempt to collect Finally, with respect to Exodus's calculation of as much cash as possible on outstanding customer reserves for doubtful accounts, plaintiffs balances.” (See TAC ¶ 270.) According to CW21, acknowledge that the first quarter of 2001 reserve for Project Resolve targeted 275 customers with disputed doubtful accounts was not included in Exodus's Form balances, who were chosen because they represented 10-Q and plaintiffs allege no basis for concluding the best chance of collecting cash. (See id. ¶ 272.) that the reserve was $23.8 million at the end of the Plaintiffs allege that the goal of the project was to first quarter of 2001. (See TAC ¶ 276 and n. 6.) Nor negotiate with the customers who had disputed do plaintiffs allege a basis for their conclusion that balances “in order to come to an agreement on how the reserve should have been at least $95 million at much the customer would remit to Exodus that time. (See id. ¶ 277.) immediately.” (See id.) According to CW21, the progress of Project Resolve was monitored via a Accordingly, plaintiffs fail to state a § 10(b) claim database titled “Project Resolve Summary Tracking based on (1) improper recognition of revenue from Database”; as of April 4, 2001, that database transactions from which collectability was not identified $23.4 million in disputed balances relating reasonably assured, (2) the existence of Project to the targeted 275 customers, and identified that Resolve, or (3) Exodus's calculation of reserves for amount as constituting 52.1% of the “Outstanding doubtful accounts receivable. Past Due” accounts receivable for that group of customers. (See id. ¶ ¶ 165-167, 274 and Ex. A.) Because Exodus considered the targeted 275 d. Recording revenue and assets in conjunction with customers as its best chance for collection, plaintiffs barter transactions contend, the Individual Defendants knew that at least 52.1% of Exodus's accounts receivable were Plaintiffs allege that the Individual Defendants uncollectible. (See id. ¶ 275.) Plaintiffs estimate that engaged in a fraudulent scheme “to improperly gross Exodus's accounts receivable reserve was only $23.8 up revenues based on fictitious or over valued million in the first quarter of 2001 and allege that it reciprocal/barter transactions.” (See TAC ¶ 278.) rose to $114 million by the third quarter of 2001, According to plaintiffs, “Exodus violated GAAP and which, according to plaintiffs, was 32.1% of Exodus's SEC rules by recording revenue on its reciprocal outstanding accounts receivable. (See id. ¶ ¶ 276-77.) (roundtrip)/barter transactions because the Plaintiffs allege: “Based on the information contained transactions had no economic substance as the in the ‘Project Resolve Summary Tracking Database’ companies merely entered into the reciprocal as well as the bad debt and revenue reserve reports arrangements so that Exodus could artificially inflate that showed 40% of Exodus's gross A/R was its revenues.” (See id .) Plaintiffs point to transactions uncollectible, Individual Defendants knew that with Oracle, Innoventry, Niku and Yahoo as Exodus should have recorded an accounts receivable examples of improper revenue recognition. (See id . ¶ reserve of at least $95 million by March 31, 2001 ¶ 207-209.) The Court previously has dismissed (1Q01), if not sooner.” (See id. ¶ 277.) these allegations with respect to the Oracle, Innoventry, and Niku transactions as inadequately *33 Plaintiffs' new allegations with respect to Project pleaded. (See Dismissal Order at 46-49.) Plaintiffs' Resolve add nothing to their allegations that Exodus allegations with respect to the Yahoo transaction did

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 35 of 163 Not Reported in F.Supp.2d Page 26 Not Reported in F.Supp.2d, 2005 WL 1869289 (N.D.Cal.), Fed. Sec. L. Rep. P 93,357 (Cite as: Not Reported in F.Supp.2d) not appear in the First Amended Complaint. respect to the Niku transaction because plaintiffs failed to adequately allege the particulars of the The Court previously dismissed plaintiffs' claim transaction, the source of CW1's knowledge thereof, based on the Oracle transaction because the the materiality of the transaction, or the Individual transaction was alleged to have occurred during the Defendants' knowledge of any improper motive fourth quarter of 1999, outside the class period. (See behind the transaction. (See Dismissal Order at 48.) Dismissal Order at 47.) Plaintiffs now allege that As plaintiffs fail to allege any new facts about the CW1, who was responsible for financial accounting Niku transaction, plaintiffs have failed to adequately and reporting for the Professional Services amend their § 10(b) claim based on said transaction. organization, “believes” that Exodus wrote off the cost of the Oracle licenses in the first quarter of 2001 With respect to the Yahoo transaction, plaintiffs as a bad debt and expense and that, although revenue allege that, on January 9, 2002, Yahoo filed a on the Oracle transaction was recorded in 1999, “response” in Exodus's bankruptcy proceedings, Exodus “improperly reported an overvalued asset which indicated that Yahoo's purchase of services (useless Oracle licenses) on its financial statements from Exodus, pursuant to a Master Service during the Class Period, through at least December Agreement entered into in October 1998, “was 2000.” (See TAC ¶ 207(a).) As defendants correctly dependent upon a commitment by Exodus to point out, plaintiffs have failed to allege the basis for purchase Yahoo! services.” (See TAC ¶ 209.) In CW1's “belief” that the Oracle licenses were written particular, plaintiffs allege that Yahoo stated, in its off in the first quarter of 2001. As noted, the PSLRA filing in the bankruptcy court, that Exodus “agreed to requires that if an allegation is made on information purchase Yahoo! services equal to ten percent (10%) and belief, “the complaint shall state with of Yahoo!'s payments to [Exodus].” (See id.) As particularity all facts on which that belief is formed.” defendants correctly point out, there is no allegation See 15 U.S.C. § 78u-4(b)(1). Moreover, as that the revenues from the Yahoo agreement were defendants also point out, even if the $5 million booked within the class period, or that the agreement Oracle licenses were improperly reported as assets, was improper in any way. As plaintiffs themselves that amount is only 0.1% of the $3.9 billion in assets recognize, barter transactions do not necessarily Exodus reported as of December 31, 2000, and only violate GAAP. (See TAC ¶ 281 (citing APB 29).) 0.2% of the $2.1 billion increase in assets reported from December 31, 1999 to December 31, 2000. (See Accordingly, plaintiffs fail to state a § 10(b) claim Individual Defendants' RJN Ex. 22 at 15.) To the based on improper recognition of revenue and assets extent plaintiffs seek to allege that the amount of the from barter transactions. Oracle transaction is material, the complaint fails to allege facts sufficient to support such allegation. See Basic Inc. v. Levinson, 485 U.S. 224, 231-32, 108 3. Statements Regarding Number of Exodus S.Ct. 978, 99 L.Ed.2d 194 (1988) (“[T]o fulfill the Customers materiality requirement ‘there must be a substantial likelihood that the disclosure of the omitted fact Plaintiffs allege that Exodus's April 26, 2001 press would have been viewed by the reasonable investor release, in which Exodus announced its first quarter as having significantly altered the ‘total mix’ of of 2001 results, fraudulently misrepresented the information made available.” ') Accordingly, number of its customers. (See TAC ¶ ¶ 82, 232.) plaintiffs have failed to adequately amend their § According to plaintiffs, Exodus's representations that 10(b) claim based on the Oracle transaction. it had approximately 4000 customers at the beginning of the quarter, and 4526 customers at the end of the *34 The Court previously dismissed plaintiffs' claim quarter, were overstated by approximately 1000 with respect to the Innoventry transaction because customers because the reported numbers of plaintiffs failed to adequately allege CW1's personal customers included both potential customers and knowledge of the transaction. (See Dismissal Order at customers who had cancelled. (See TAC ¶ ¶ 82, 47.) Plaintiffs now admit that CW1 “does not now 232.) The Court previously dismissed plaintiffs' § have a clear recollection” of the Innoventry 10(b) claim, to the extent such claim was based on transaction. (See TAC ¶ 207(b).) Accordingly, misrepresentations about the number of Exodus's plaintiffs have failed to adequately amend their § customers, because plaintiffs failed to adequately 10(b) claim based on the Innoventry transaction. allege facts showing that the customer count was false when made or facts giving rise to the requisite The Court previously dismissed plaintiffs' claim with strong inference of scienter. (See Dismissal Order at

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38-39.) specific customers who are alleged to have been overbilled, and whose accounts were not immediately *35 Plaintiffs continue to allege that the Solomon credited. (See id. ¶ 159.) Plaintiffs do not attempt to database contained only 3500 active customers, (see quantify, however, how the delayed processing of TAC ¶ 232(a)), but, as in the First Amended customer credits affected Exodus's financial reports. Complaint, plaintiffs fail to allege the date(s) on As noted, a “general allegation” that a particular which the Solomon database contained 3500 practice “resulted in a false report of company customers. Plaintiffs add a new allegation that CW25 earnings is not a sufficiently particular claim of “recalls that by the end of the 2Q01, the number of misrepresentation.” See Daou, 411 F.3d at 1016. actual active customers totaled between 1500 and Although plaintiffs have, in this instance, identified 2000.” (See TAC ¶ 152(a).) The number of the customers, plaintiffs also must show with customers at the end of the second quarter of 2001, particularity how the overstatement of revenues however, fails to demonstrate the falsity of Exodus's affected the company's financial statements and statements about the number of its customers at the whether the overstatement was material in light of the end of the first quarter of 2001. Finally, plaintiffs' company's overall financial position. See id. at 1018. allegations that, in July 2001 or later, adjustments were made to the Solomon and Siebel customer *36 Accordingly, plaintiffs fail to state a § 10(b) databases to delete customers who had cancelled or claim based on the allegation that Exodus had a were inactive, (See TAC ¶ ¶ 232, 234), permit no practice of delaying processing of customer credits. inference that Exodus's statements in April 2001 about the number of its customers were false when made. 5. Massaging of Financial Results

Accordingly, plaintiffs fail to state a § 10(b) claim In the Third Amended Complaint, plaintiffs add new based on Exodus's April 2001 statement about the allegations, based on “messages posted on a Yahoo number of its customers. board for Exodus alumni,” (see TAC ¶ 198), that Exodus “massaged its financial results by failing to use ‘real’ numbers.” (See id.) Plaintiffs identify the 4. Processing of Customer Credits authors of the postings only by first name, and fail to allege their positions at Exodus, or the basis for their In the Third Amended Complaint, plaintiffs add new knowledge of the information posted on the Yahoo allegations that Exodus's financial results during the message board. As noted above, “personal sources of class period were overstated because Exodus failed to information relied upon in a complaint should be timely credit customers who were overbilled. (See described in the complaint with sufficient TAC ¶ 193.) Plaintiffs allege that, according to particularity to support the probability that a person CW12, a former Exodus collections specialist from in the position occupied by the source would possess 1998 through September 2001, (see id. ¶ 126(I)), the information alleged.” See Daou, 411 F.3d at 1015 Exodus Controller Suzanne Colvin, at meetings (internal quotation and citation omitted). As plaintiffs during late 2000 and at the end of the first quarter of fail to do so, they fail to state a § 10(b) claim based 2001, told collectors that credits were not being on the allegation that Exodus “massaged” its issued because Exodus needed the revenue for its financial results. financial reports. (See id. ¶ 194.) According to CW12, plaintiffs allege, it was typical for Colvin to advise collectors at monthly meetings that 6. Delaying Recording of Expenses management did not want to approve credits because of the adverse impact such credits would have on Plaintiffs add new allegations, in their Third Exodus's financial reports. (See id.) Plaintiffs also Amended Complaint, that, according to CW1, Colvin allege that CW11, a former Exodus credit and “routinely kept track of expenses that were recorded collections analyst, (see id. ¶ 126(k)), recalled that in the wrong period and documented such expenses Exodus “carried a huge backlog of credits for all on an ‘ATF’-or ‘After the Fact’-report.” (See TAC ¶ types of over-billing and disputed charges, most of 201According to plaintiffs, based on information which went for months and even quarters without provided by CW1, a January 2001 ATF report being authorized[.]” (See id . ¶ 195.) “reflects $5.3 million of expenditures that were ‘out of period’,” of which amount, “at least $800,000 Plaintiffs cite a number of internal emails identifying should have been fully expensed during 4Q00.” (See

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TAC ¶ 202.) that Exodus and Sanrise entered into an agreement on December 28, 2000, pursuant to which Sanrise Plaintiffs do not allege any specific expenses that “acquired the data storage operations and equipment were recorded in the wrong period, however. of Exodus, and became the outsource provider of Plaintiffs also fail to allege any facts from which one Data Vault brand backup and restoration services to could infer that the expenses were recorded in the Exodus customers in its IDCs.” (See TAC ¶ 210.) wrong period as part of a fraudulent scheme, rather According to plaintiffs, the “purchase price” was than as the result of mere oversight. 8,450,000 shares of Sanrise preferred stock valued by Exodus at $25 million, a promissory note “in the Accordingly, plaintiffs fail to state a § 10(b) claim amount of $17.5 million,” and $5 million in cash. based on the allegation that Exodus delayed (See id.) Elsewhere in the Third Amended Complaint, recording expenses. plaintiffs allege that the transaction included a promissory note of “approximately $20 million.” (See id. ¶ 69.) 7. Misdating Checks Plaintiffs allege that Exodus made false and Plaintiffs allege that, in Exodus's bankruptcy misleading statements in reporting the Sanrise proceedings, the bankruptcy judge noted, on transaction. (See id. ¶ 211.) First, plaintiffs allege, September 3, 2003, that Krause, Exodus's new CEO, the total consideration for the transaction was $47.5 had testified that backdating of checks had occurred million, not $55.1 million as Exodus reported in its at Exodus. (See TAC ¶ 204.) Plaintiffs further allege Form 10-Q for the period ending March 31, 2001. that “[a]lthough the specific misdating of checks (See id .; see also Individual Defendants' RJN Ex. 23 event discussed by [the bankruptcy judge] appears to at 6.) have occurred after Exodus filed for bankruptcy, it is significant in that it sheds light on the character of the Next, according to plaintiffs, the value of the Sanrise Company's management and its corporate culture, preferred stock “was at best undeterminable and which apparently viewed such improper conduct as significantly overstated.” (See TAC ¶ 211.) In ‘business as usual.” ’ (See id.) Plaintiff also allege addition, plaintiffs allege that GAAP required Exodus that “the misdating of checks apparently was also to “defer any gain and recognize it on the cash basis standard business practice at Exodus during the Class as any proceeds are received” because Sanrise was in Period because Storagenetworks alleged, in its “very poor financial health.” (See id.) Further, complaint against Exodus, ... that misdating of checks plaintiffs allege that Exodus ultimately “returned the took place during the alleged time period.” (See id.; preferred stock and did not receive full value for the see also id. ¶ 181.) note[.]” (See id. ¶ 212.)

*37 Plaintiffs fail to allege any incident during the Finally, plaintiffs allege, a January 23, 2001 press class period in which Exodus misdated a check and, release about the Sanrise transaction was false and indeed, appear to concede they are unaware of any misleading “because it created the impression that such occurrence. Accordingly, plaintiffs fail to state a Sanrise made a straight purchase of Exodus's Data § 10(b) claim based on the allegation that Exodus Vault assets when in fact the parties had entered into misdated checks as part of a fraudulent scheme. a two-year license agreement that provided for Sanrise to operate the Data Vault services business.” (See id. ¶ 69.) 8. Sanrise Transaction As defendants point out, plaintiffs make conflicting In the First Amended Complaint, plaintiffs alleged allegations as to the amount of consideration Sanrise that Exodus improperly recognized revenue on a agreed to pay Exodus. (Compare id. ¶ ¶ 69, 210.) January 2001 transaction with Sanrise. (See FAC ¶ Plaintiffs also contradict themselves as to whether 111(f).) The Court previously dismissed plaintiffs' § Sanrise purchased assets from Exodus or entered into 10(b) claim, to the extent such claim was based on a lease. (Compare id. ¶ ¶ 69, 210.) Moreover, such allegations, because plaintiffs failed to respond plaintiffs fail to cite a single document, witness, or to defendants' arguments. (See Dismissal Order at 47 other source in support of their allegations as to the and n. 36.) content and value of the Sanrise transaction. As noted, when an allegation of fraud is made on In the Third Amended Complaint, plaintiffs allege information and belief, the PSLRA requires a

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 38 of 163 Not Reported in F.Supp.2d Page 29 Not Reported in F.Supp.2d, 2005 WL 1869289 (N.D.Cal.), Fed. Sec. L. Rep. P 93,357 (Cite as: Not Reported in F.Supp.2d) plaintiff to support its claim by alleging “with In the First Amended Complaint, plaintiffs alleged particularity all facts on which that belief is formed.” that various representations made by Hancock in See 15 U.S.C. § 78u-4(b)(1). “Allegations are articles published on August 27, 2001, August 28, deemed to have been made on information and belief 2001 and September 3, 2001, respecting whether until the plaintiffs demonstrate that they have Exodus would file for bankruptcy, were false when personal knowledge of the facts.” Vantive, 283 F.3d made. (See FAC ¶ ¶ 92, 93.) Plaintiffs quoted from at 1085 n. 3. As plaintiffs do not allege the source of only two of the articles: an article published in their information with respect to the content and Information Week on August 27, 2003, which value of the Sanrise transaction, plaintiffs have failed reported Hancock as saying: “We're viable ... We to plead with the requisite particularity their § 10(b) have sufficient cash”; and an article published in the claim based on the Sanrise transaction. San Jose Mercury News on August 28, 2001, which stated: “Exodus Chief Executive Ellen Hancock says the company is in no danger of filing Chapter 11. 9. Statements Regarding Adequacy of Funding and ‘We are capable of handling the debt and paying for Risk of Bankruptcy the debt,’ she says.” (See id.) Plaintiffs further alleged that Hancock resigned on September 4, 2001, a. Adequacy of Funding and Exodus filed for bankruptcy on September 26, 2001. (See FAC ¶ 97.) The Court dismissed plaintiffs' § 10(b) claim based on such statements, on *38 Plaintiffs allege that Exodus, in a press release the ground the mere temporal proximity between issued April 26, 2001, stated it was “fully funded to Hancock's statements and Exodus's bankruptcy was achieve its current business plan.” (See TAC ¶ 82.) insufficient to raise an inference of falsity or scienter On the same date, plaintiffs allege, Hancock, in a under the PSLRA. (See Dismissal Order at 52 (citing conference call with analysts, stated: “[W]e have a Ronconi v. Larkin, 253 F.3d 423, 437 (9th Cir2001) fully funded business plan.” (See id. ¶ 83.) (“We have allowed the temporal proximity of an According to plaintiffs, these statements were false allegedly fraudulent statement to bolster a complaint, and misleading because the Individual Defendants but we have never allowed the temporal proximity “were aware that Exodus was woefully short of funds between the two, without more, to satisfy the required to achieve its business plan.” (See id. ¶ requirements of Rule 9(b)”)). 252.) In particular, plaintiffs allege that Exodus had been presented with proposed business plans in *39 In the Third Amended Complaint, plaintiffs March and August 2000, which proposals showed allege additional public statements made by Hancock that Exodus needed “$3.2 billion to accomplish the in August and September 2001 about Exodus's goals set forth by the executive staff,” and that financial health. According to plaintiffs, Hancock, in Exodus executives “balked at these numbers” an interview published in Business Week Online on because, at the time, Exodus had only $750 million. August 3, 2001, stated: “[W]e have not just a viable (See id. ¶ 254.) The Court previously dismissed business, but a great business” and “[w]e have plaintiffs' § 10(b) claim, to the extent such claim was sufficient funding to run the business.” (See TAC ¶ based on such allegations, on the ground plaintiffs 103.) In an interview published August 13, 2001 by had failed to adequately allege the statements, that Network World, plaintiffs allege, Hancock stated: Exodus, in April 2001, had a fully funded business “[W]e do like the business we're in and we believe plan, were false when made. (See Dismissal Order at that we have sufficient cash to run it.” (See id. ¶ 50-51.) 104.) Plaintiffs further allege that, in an August 23, 2001 interview on CNN's Moneyline, Hancock stated, Although plaintiffs have amended their allegations, “We have sufficient cash to take us into next year.” the amendments do not address the deficiencies noted (See id. ¶ 108.) In addition, plaintiffs allege that in in the Court's Dismissal Order. Accordingly, the an article published September 3, 2001 in Computer Court finds plaintiffs have failed to plead with the Reseller News, Hancock was quoted, as follows: requisite particularity their § 10(b) claim, to the “The promise of increased business counters claims extent such claim is based on Exodus's April 2001 that Exodus is in financial straits,” Hancock says. statements about the adequacy of its funding. “We say that we're healthy, we say that we have sufficient cash, and we say that we brought in $200 million of new business in the first quarter and $200 b. Risk of Bankruptcy million in the second quarter,” she says. “We increased our customer base, and we're bringing in

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 39 of 163 Not Reported in F.Supp.2d Page 30 Not Reported in F.Supp.2d, 2005 WL 1869289 (N.D.Cal.), Fed. Sec. L. Rep. P 93,357 (Cite as: Not Reported in F.Supp.2d) very good, large customers. We indicated that we'd 20-21.) be cash-[earnings per share]-positive next year.” “Even if Exodus doesn't find more funding, it still has Accordingly, the Court finds plaintiffs have failed to enough cash to survive until it reaches profitability,” plead with the requisite particularity their § 10(b) Hancock adds. “The plan says we have enough claim, to the extent such claim is based on Hancock's money to get there.” statements in August and September 2001 about the state of Exodus's financial health. See America West, (See id. ¶ 111 (alteration in original).) According to 320 F.3d at 938 (noting courts must consider “all plaintiffs, Hancock further stated in the above-quoted reasonable inferences to be drawn from the article that Exodus would be profitable within a year. allegations, including inferences unfavorable to the (See id.) plaintiffs”) (internal quotation and citation omitted); see also Gompper v. VISX, Inc., 298 F.3d at 897 Plaintiffs additionally allege that despite Hancock's (holding that to establish a strong inference of public assertions in August and September 2001 that scienter, the allegations must show that an inference Exodus was in no danger of bankruptcy, a document of fraud is “the most plausible of competing filed in bankruptcy court on October 4, 2001 states inferences”) (internal quotation and citation omitted). that Exodus had entered into an agreement on July 17, 2001 with the law firm of Skadden, Arps, Slate, Meagher & Flom LLP (“Skadden Arps”) by which 10. Statement re: Price Increase Skadden Arps agreed to advise Exodus regarding its “financial and operational restructuring efforts” and Plaintiffs allege that, in an April 26, 2001 conference to represent it “if chapter 11 cases were commenced.” call with securities analysts and investors, Hancock (See id. ¶ 112.) In a declaration filed in the indicated that Exodus was increasing its prices bankruptcy court on October 5, 2001, plaintiffs despite discounting from competitors, by stating that allege, J. Gregory Milmore of Skadden Arps attested Exodus had “announced a price increase in the area that Skadden Arps had been retained in July 2001 to of [its] infrastructure as well as many of [its] assist Exodus “in their ... restructuring efforts by, managed professional services.” (See TAC ¶ 84.) among other things, advising [Exodus] regarding Plaintiffs allege that “despite Hancock's assertion that restructuring matters in general and preparing for the Exodus was increasing prices, Exodus was actually potential commencement and prosecution of chapter discounting to compete with competitors in the 11 cases for [Exodus].” (See id. ¶ 239.) Plaintiffs declining market [.]” (See id ¶ 86.) further allege that defendant Wegner testified in the bankruptcy proceedings, on August 8, 2003, that According to CW22, plaintiffs allege, Exodus would months before Exodus's bankruptcy filing, members waive installation charges and offer up to three of Exodus's management team, including Hancock, months of free service in 2000 and 2001. (See id. ¶ had “a few meetings” with Skadden Arps and Lazard 229.) Plaintiffs further allege that CW7 offered Freres Company “about strategic options ... as discounts to new and existing customers. (See id. ¶ [Exodus] entered the zone of insolvency.” (See id. ¶ 230.) In addition, according to plaintiffs, an internal 238.) Exodus document dated January 23, 2001 stated that setup charges had been “reduced to reflect the current *40 Plaintiffs' allegations suggest that Exodus was, at market.” (See id. ¶ 231.) the very least, preparing for the possibility of filing bankruptcy proceedings at the same time Hancock Hancock's statement that Exodus had increased its was making public statements that Exodus was in prices is not inconsistent with the offering of good financial health. Plaintiffs do not, however, discounts. There is no allegation, for example, that allege any facts suggesting Hancock's statements the base price of Exodus's services did not actually about Exodus's finances were false at the time they increase, nor is there an allegation that at the same were made. There is no allegation, for example, that time Hancock was announcing an increase in prices, Exodus did not have adequate cash on hand at the the frequency and amounts of discounts also time Hancock stated Exodus was adequately increased to the point that the net price of Exodus's financed. As defendants point out, “Exodus could services actually dropped. have had ample cash at the time of Ms. Hancock's statement, and still, in a proper and thorough effort *41 Accordingly, as an increase in prices is not by its executives to fulfill their fiduciary duties, have inconsistent with the offering of discounts, plaintiff prepared for future contingencies.” (See Motion at has not stated a § 10(b) claim based on Hancock's

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April 26, 2001 statement that Exodus was increasing forecasts differed from its publicly-announced its prices. forecasts. See Silicon Graphics, 183 F.3d at 985 (holding “a proper complaint which purports to rely on the existence of internal reports would contain at 11. Revenue Forecasts least some specifics from those reports”).

Plaintiffs allege the following statements respecting In the Third Amended Complaint, plaintiffs add financial forecasts were false or misleading when allegations based on information from CW24, an made: (1) an October 19, 2000 press release Exodus employee who, in February 2000, became forecasting revenues of approximately $1.8 billion responsible for business forecasting for all for fiscal year 2001; (2) an April 26, 2001 press professional services, and who, plaintiffs contend, release forecasting revenues in the amount of $360 “corroborated that Exodus's public forecasts were million for Exodus's second quarter of 2001 and $1.5 inflated.” (See TAC ¶ ¶ 126(x), 242.) According to billion to $1.6 billion for fiscal year 2001; (3) an CW24, the “Regional Business Forecast” spreadsheet April 26, 2001 conference call in which Case and forecasting procedures he had implemented reiterated these revenue forecasts and stated “we are “were subject to false or overstated inputs by sales still confident that we should be able to turn cash personnel and management.” (See id. ¶ 242(b).) Said EPS positive in the first half of next year,” and “false or overstated input[s]” are not pleaded with Hancock stated that Exodus expected “to turn cash specificity, however, and there is no allegation EPS positive during the first half of 2002”; (4) a May attempting to quantify the effect of such “false or 1, 2001 conference call in which Stoltz reaffirmed the overstated inputs” on Exodus's revenue forecasts. revenue forecasts of $360 million for the second Similarly, plaintiffs allege that, according to CW24, quarter of 2001 and $1.5 to $1.6 billion for fiscal year Exodus booked deals with customers who were in 2001; (5) a May 9, 2001 press release in which Stoltz financial trouble and who could not afford the said: “We believe we can achieve our financial plan services ordered, (see id. ¶ 242(c)), without alleging, by reorganizing and strengthening our operations”; however, that any particular customer was unable to and (6) a June 20, 2001 press release in which pay, or attempting to quantify the effect of such Exodus forecasted revenues of $315 million for the practice on Exodus's revenue forecasts. second quarter of 2001 and $1.35 billion for fiscal year 2001. (See TAC ¶ ¶ 57, 82-84, 88, 89, 93.) *42 Plaintiffs further allege that, according to CW24, revenue for professional services in the Bay Area Plaintiffs allege said forecasts were made without a dropped from $4 million in the first quarter of 2000 reasonable basis. (See id.) Plaintiffs allege that to $3.5 million in the second quarter of 2000 and $3.2 according to CW1, the controller for Exodus's million for the third quarter of 2000. (See id. ¶ Professional Services organization, Exodus's public 242(d)). According to plaintiffs, the Bay Area forecasts were substantially higher than its internal produced approximately 40% of the revenue for the forecasts. (See id.) Once a month, according to CW1, western region, which, in turn, generated 60-65% of a company-wide profit and loss statement (“P & L Exodus's overall revenue for professional services. statement”) was distributed to Hancock, Stoltz, (See id.) Plaintiffs allege that despite the drop in Dollahite, and Case, as well as other Exodus revenue for the Bay Area, Yeack's “stated ‘revenue management personnel, which included a forecast for goal’ for Professional Services was 40% quarter to the following year. (See id. ¶ 241(a).) Plaintiffs quarter growth,” while internal forecasting “showed allege that the forecasts provided to Exodus an average 7.5% growth per month during 2Q00 and management were “highly accurate,” but that the 3Q00.” (See id.) Plaintiffs fail to allege, however, public forecasts were “much higher than Exodus's how the drop in revenue for the Bay Area compared internally projected numbers.” (See id. ¶ 241(e) .) to revenue from other regions in the same periods. In Plaintiffs fail to allege the contents of the above- addition, the setting of an internal ‘revenue goal’ of referenced internal reports, however, and do not 40% growth is not the equivalent of a public forecast allege that any particular internal report contained a that such growth would actually be achieved. forecast that differed from a publicly-issued forecast issued contemporaneously. Plaintiffs allege that CW24 and others informed Yeack that Exodus's revenue numbers were not Accordingly, the Court finds plaintiffs have not reliable and that many “booked” deals should be alleged with the requisite particularity, based on the removed from the forecasts Exodus used for public allegations derived from CW1, that Exodus's internal projections, but that Yeack consistently instructed

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CW24 and other professional services management the Seattle sales team all sold 150% of quota, Exodus not to remove anything from the forecasts. (See id. ¶ would need approximately 40,000 square feet of 242(e).) CW24 does not allege any specific additional IDC space. (See id.) When CW24 pointed transaction that should have been removed from the out that the IDCs in Seattle already had 140,000 forecasts, however, nor does he attempt to quantify square feet of build out space available, and the effect that any such practice had on Exodus's recommended that Exodus refrain from building public forecasts. more unneeded capacity, plaintiffs allege, Hancock told CW24 to “mind his own business” and Yeack According to plaintiffs, CW24 prepared a report on told him that Exodus needed to continue building out October 5, 2000, titled “BAR ProServ Director's space in order to create the illusion of growth and to Financial Management Initiative,” when it became be perceived as an industry leader. (See id.) clear to him there was no way Exodus could meet its fourth quarter 2000 or fiscal year 2000 projections. There is no allegation, however, that Exodus ever (See id. ¶ 242(g).) According to CW24, plaintiffs built more IDC space in Seattle, or that the April 26, allege, the purpose of the report was to “urge 2001 statement that Exodus “was opening IDCs to Exodus's executives to address the continued and meet known customer demand” was a reference to increasing accrual and recognition of questionable the opening of new IDCs in Seattle. The only revenue, and inherent defects in the forecasting reference in the Third Amended Complaint to the process.” (See id.) In response, plaintiffs allege, building of new IDCs after April 26, 2001 appears in Yeack told CW24 not to be a “buffoon” and not to plaintiffs' summary of a July 26, 2001 Exodus press report negative information about the sales release, in which Exodus announced that it had built department's revenue projections.” (See id.) Again, new IDCs in Amsterdam, Dallas, Miami, and Paris. plaintiffs fail to attempt to quantify how Exodus's (See id. ¶ 100.) As the complaint still contains no public forecasts were affected. allegation that Exodus had excess IDC capacity in the locations where it proposed to open new IDCs or that Accordingly, the Court finds plaintiffs have failed to Exodus was opening new IDCs without first state a § 10(b) claim based on false and misleading assessing demand in those particular areas, the Court forecasts. finds plaintiffs have not stated a § 10(b) claim based on statements relating to IDC capacity and demand.FN22 12. Statements Regarding IDC Capacity and Demand

Plaintiffs allege the Individual Defendants “falsely FN22. The Court notes that plaintiffs have created the impression that Exodus's IDCs were full deleted from the complaint their prior and that demand was robust by stating, for example, allegations with respect to an August 22, on April 26, 2001, that ‘we are opening IDCs to meet 2001 interview with Hancock in which she known customer demand.” ’ (See TAC ¶ ¶ 84, 244.) was asked about excess IDC capacity and Plaintiffs allege such statements were false and explained: “You can't just add up all the misleading when made “because they failed to [unused hosting] space and say, ‘See you've disclose that Exodus's IDCs were, in fact, operating got all that space left.’ You need the space in under capacity.” (See id.) The Court previously the city or county, or you essentially lose dismissed plaintiffs' § 10(b) claim based on such business in those geographies. So even allegations because plaintiffs failed to allege that though we might have some [extra] space in Exodus had excess IDC capacity in the locations London, that doesn't help us address the where it proposed to open new IDCs or that Exodus French market or the market in Amsterdam was opening new IDCs without first assessing or Germany. Last quarter, we opened four demand in those particular areas. (See Dismissal new data centers: one in Amsterdam, one in Order at 52-55.) Paris, one in Dallas and one in Miami. So with all this discussion of glut, we're *43 In the Third Amended Complaint, plaintiffs add opening up data centers.” (See FAC ¶ the allegation that CW24 became aware, in 144(c) (alteration in original).) December 2000, of a plan by Exodus to “build-out ... a large amount of IDC space in Seattle.” (See TAC ¶ 13. Scienter: Stock Sales 245(c).) According to plaintiffs, CW24 prepared a budget analysis demonstrating that if the members of Plaintiffs allege that the stock sales by the Individual

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Defendants demonstrate they engaged “in insider complaint is plainly fraud and no effort is made to trading,” and that they acted with scienter in making show any other basis for the [§ 11] claims”). the allegedly false and misleading statements set forth in the Third Amended Complaint. (See TAC ¶ *44 As noted, the Court will grant the Underwriter 307.) The Court previously has held that plaintiffs' Defendants' motion to dismiss the § 10(b) claim allegations as to stock sales are insufficient to asserted against them, which claim is based on demonstrate scienter. (See Dismissal Order at 56-59.) precisely the same statements that form the basis of FN23 Defendants correctly point out that plaintiffs the § 11 claim against them, in part because have not amended their allegations as to stock sales plaintiffs have not adequately alleged falsity with the in any material way. Accordingly, assuming, particularity required by Rule 9(b). For the same arguendo, that plaintiffs have sufficiently pleaded reason, as plaintiffs have failed to adequately allege falsity as to one or more of the statements on which with the particularity required by Rule 9(b) that any they rely, the Court finds plaintiffs' allegations as to of the allegedly false statements contained in the stock sales are insufficient to demonstrate scienter. Registration Statements for the February Offerings were false when made, the Individual Defendants' motion to dismiss the § 11 claim asserted against FN23. As noted in the Court's prior order, Hancock likewise will be GRANTED. the Ninth Circuit has identified three factors relevant to the question of whether a defendant's stock sales gives rise to an D. Section 20(a) and Section 15 Claims inference of scienter: “(1) the amount and percentage of shares sold by insiders; (2) the Plaintiffs assert a claim against the Individual timing of the sales; and (3) whether the sales Defendants for violation of § 20(a) of the Exchange were consistent with the insider's prior Act FN24 based on the allegation that they “acted as trading history.” In re Silicon Graphics, 183 controlling persons of Exodus” and “had the power F.3d at 986. and authority to cause the Company to engage in the wrongful conduct complained of[.]” (See TAC ¶ C. Sufficiency of Pleadings: § 11 Claim Against 364.) Plaintiffs assert a claim against Hancock for Hancock violation of § 15 of the Securities Act FN25 “by virtue of her direct and indirect control and domination of As discussed above, the Court is not persuaded by the Exodus.” (See id. ¶ 343.) Underwriter Defendants' motion to dismiss the § 11 claim asserted against them, for the reason that Rule 9(b) has no application to such claim and the FN24. Section 20(a) provides: “Every complaint satisfies the notice pleading requirements person who, directly or indirectly, controls of Rule 8. Unlike the Underwriter Defendants, any person liable under any provision of this however, Hancock is alleged to have participated in a chapter or of any rule or regulation broad scheme to defraud investors by, among other thereunder shall also be liable jointly and things, falsifying Exodus's financial results. (See, e.g severally with and to the same extent as such ., TAC ¶ 44.) There is no allegation that Hancock controlled person to any person to whom acted negligently or mistakenly, in contrast to such controlled person is liable, unless the plaintiffs' allegations of negligence with respect to controlling person acted in good faith and the Underwriter Defendants. See Daou, 411 F.3d at did not directly or indirectly induce the act 1028 (finding Rule 9(b) applicable to pleading § 11 or acts constituting the violation or cause of claim where plaintiffs “never rel[ied] on such action.” 15 U.S.C. § 78t(a). conduct as negligence or mistake in stating their claims”). The § 11 claim against Hancock, unlike the FN25. Section 15 provides: “Every person § 11 claim against the Underwriter Defendants, is who, by or through stock ownership, thus “grounded in fraud,” and “ ‘the pleading of that agency, or otherwise, or who, pursuant to or claim as a whole must satisfy the particularity in connection with an agreement or requirement of Rule 9(b).” ’ See Daou, 411 F.3d at understanding with one or more other 1027 (quoting Vess, 317 F.3d at 1103-04); see also persons by or through stock ownership, Stac, 89 F.3d at 1405 n. 2 (rejecting “nominal agency, or otherwise, controls any person efforts” to disclaim allegations of fraud in connection liable under sections 77k or 77l of this title, with § 11 claim “where the gravamen of the shall also be liable jointly and severally with

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and to the same extent as such controlled law precludes them from seeking to assert such a person to any person to whom such claim against Exodus now. The issue, however, is not controlled person is liable, unless the whether Exodus itself can be held liable for violating controlling person had no knowledge of or the law, but whether the Individual Defendants can reasonable ground to believe in the existence be held liable, as controlling persons, for any of the facts by reason of which the liability violations of the law by Exodus. Although a predicate of the controlled person is alleged to exist.” to controlling person liability is proof of a violation 15 U.S.C. § 77o. of law by the controlled entity, see Howard v. Everex Systems, Inc., 228 F.3d at 1065, the Court has located To plead a prima facie case under § 20(a) of the no case holding that the controlled entity must Exchange Act, plaintiffs must plead: “(1) a primary actually be named as a defendant. In other words, the violation of federal securities laws; and (2) that the complaint may allege violations by Exodus, for defendant exercised actual power or control over the purposes of control person liability, without seeking primary violator.” Howard v. Everex Systems, Inc., to hold Exodus itself liable for those violations. See, 228 F.3d 1057, 1065 (9th Cir.2000). To plead a prima e.g., Howard v. Everex Systems, Inc., 228 F.3d at facie case under § 15 of the Securities Act, plaintiffs 1060, 1065 (finding officer of bankrupt corporation must likewise plead a primary violation of federal potentially liable under § 20(a), albeit without securities laws and that the defendant exercised discussing impact of bankruptcy); see also In re control over the primary violator. See In re Initial Hayes Lemmerz Int'l, Inc. Equity Securities Public Offering Securities Litigation, 241 F.Supp.2d Litigation, 271 F.Supp.2d 1007, 1021 n. 11 281, 352 (S.D.N.Y.2003). There can be no liability (E.D.Mich.2003) (“[I]f the complaint states a primary under § 20(a) or § 15 if a primary violation of § violation by the Company, even if the Company is 10(b) or § 11, respectively, is not sufficiently pled. not named in the complaint as a defendant, then a § See Heliotrope General Inc. v. Ford Motor Co., 189 20 claim can stand if the individuals were controlling F.3d 971, 978 (9th Cir.1999); Klein v. General persons.”); In re Citisource, Inc. Securities Nutrition Companies, Inc., 186 F.3d 338, 344 (3 rd Litigation, 694 F.Supp. 1069, 1077 (S.D.N.Y.1988) Cir.1999). (denying dismissal of § 20(a) claim where plaintiffs failed to sue primary violator; holding “liability of Defendants argue there can be no § 20(a) or § 15 the primary violator is simply an element of proof of liability based on defendants' alleged control of a section 20(a) claim, and that liability need not be Exodus, because no primary claim is alleged against actually visited upon the primary violator before a Exodus, and that plaintiffs cannot amend their controlling person may be held liable”); Elliott complaint to allege such a claim, due to expiration of Graphics, Inc. v. Stein, 660 F.Supp. 378 the statute of limitations and orders issued in (N.D.Ill.1987); Briggs v. Sterner, 529 F.Supp. 1155, Exodus's bankruptcy proceedings. As noted, the § 1770-71 (S.D.Iowa 1981) (holding officers and 20(a) and § 15 claims are based entirely on directors of non-defendant bankrupt corporation may defendants' alleged control of Exodus. (See TAC ¶ ¶ be liable as controlling persons under § 20(a) and § 343, 364.) Although plaintiffs asserted claims against 15). Exodus itself in their initial complaints, (see Individual Defendants' RJN Ex. 48), plaintiffs did not Thus, all that is required for plaintiffs to state a claim assert any claim against Exodus in any of the for controlling person liability is for plaintiffs to consolidated complaints, including the Third adequately allege that Exodus engaged in a primary Amended Complaint. The initial Consolidated Class violation of the securities laws and that the Individual Action Complaint, filed December 13, 2001, Defendants (or, in the case of the § 15 claim, approximately two months after Exodus filed Hancock) controlled Exodus. See, e.g., Howard v. bankruptcy proceedings, merely notes Exodus's Everex Systems, Inc., 228 F.3d at 1065. Plaintiffs bankruptcy, and asserts no claims against Exodus have not done so, however. There is no allegation in itself. (See Consolidated Class Action Complaint ¶ the complaint that Exodus violated any of the 22.) In the Third Amended Complaint, plaintiffs state securities laws. Although the complaint alleges, for that Exodus “is not named as a defendant herein due example, that the Individual Defendants participated to its bankruptcy and liquidation.” (See TAC ¶ 35.) in a “scheme to defraud,” (see TAC ¶ 44), there are no allegations that the acts of the Individual *45 The parties dispute whether plaintiffs abandoned Defendants are attributable to Exodus, nor is there their claim against Exodus by failing to include it in any allegation that Exodus otherwise committed the consolidated complaint, and whether bankruptcy violations of the securities laws. Assuming,

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 44 of 163 Not Reported in F.Supp.2d Page 35 Not Reported in F.Supp.2d, 2005 WL 1869289 (N.D.Cal.), Fed. Sec. L. Rep. P 93,357 (Cite as: Not Reported in F.Supp.2d) arguendo, the Individual Defendants' acts are For the reasons stated: attributable to Exodus, plaintiffs have not, as explained above, stated a claim against the Individual 1. The Underwriter Defendants' motion to dismiss the Defendants for a primary violation of the securities § 11 claim asserted against them is DENIED. The laws. Accordingly, plaintiffs' § 20(a) and § 15 Underwriter Defendants' motion to dismiss the § claims must be dismissed.FN26 10(b) claim asserted against them is GRANTED, and said claim is hereby DISMISSED with prejudice.

FN26. Plaintiffs also argue that their § 20(a) 2. The Individual Defendants' motion to dismiss is and § 15 claims can be based on the hereby GRANTED, and all claims asserted against Individual Defendants' control over each the Individual Defendants are hereby DISMISSED other. There is no such allegation in the with prejudice. complaint, however. 3. The Underwriter Defendants shall answer the § 11 *46 Accordingly, defendants' motion to dismiss claim within 30 days of the date of this order. plaintiffs' § 20(a) and § 15 claims will be granted. This order terminates Docket Nos. 160 and 163.

E. Dismissal Without Leave to Amend IT IS SO ORDERED.

Plaintiffs have had three opportunities to amend their N.D.Cal.,2005. consolidated complaint, and the Court has now In re Exodus Communications, Inc. Securities dismissed the complaint on three occasions. Other Litigation than successfully amending their § 11 claim to Not Reported in F.Supp.2d, 2005 WL 1869289 disavow an intent to base that claim on fraud, (N.D.Cal.), Fed. Sec. L. Rep. P 93,357 plaintiffs have failed repeatedly to successfully amend their claims. The Court recognizes the Ninth Briefs and Other Related Documents (Back to top) Circuit has held that leave to amend should be granted with “extreme liberality.” See Eminence • 2005 WL 3142895 (Trial Motion, Memorandum Capital, LLC v. Aspeon, Inc., 316 F.3d 1048, 1051 and Affidavit) Defendant Ellen Hancock's Notice of (9th Cir.2003). The Court may, however, consider Motion and Motion For: 1) Leave to File A Motion factors such as repeated failure to cure deficiencies for Reconsideration; 2) Certification Pursuant to ¢ by previous amendments in determining whether to y28 U.S.C. | 1292(b)¢ y¢ grant leave to amend. See id. at 1052 (citing Foman r;00002;;LQ;28USCAS1292;1000546;¢ r; and 3) A v. Davis, 371 U.S. 178, 182, 83 S.Ct. 227, 9 L.Ed.2d Stay of Discovery Pending Appeal; and Memorand 222 (1962)); see also In re Read Rite Corp. Securities um of Points and Authorities in Support Thereof Litigation, 335 F.3d 843, 845 (9th Cir.2003) (“The (Oct. 12, 2005) district court's discretion to deny leave to amend is • 2005 WL 3142894 (Trial Pleading) Answer of particularly broad where plaintiff has previously Defendants Goldman, Sachs & Co., Merrill Lynch & amended the complaint.”). Co., Morgan Stanley Dean Witter, and J.P. Morgan to Plaintiffs' Corrected Third Amended Consolidated Here, despite engaging in an extensive factual Complaint (Oct. 11, 2005) investigation, plaintiffs have been unable to amend • 2005 WL 3142893 (Trial Pleading) Defendant Ellen their complaint to state a claim for securities fraud. Hancock's Answer to Plaintiffs' Corrected Third There is no indication that plaintiffs would be able to Amended Consolidated Class Action Complaint for do so were the Court once again to grant leave to Violation of the Federal Securities Laws (Oct. 10, amend. 2005) • 2005 WL 2868440 (Trial Motion, Memorandum Accordingly, the Court will dismiss the complaint, and Affidavit) Individual Defendants' Brief in with the exception of the § 11 claim against the Opposition to Plaintiffs' Motion for Reconsideration Underwriter Defendants, with prejudice. of Order Granting Individual Defendants' Motion to Dismiss (Sep. 2, 2005) • 3:01cv02661 (Docket) (Jul. 12, 2001) CONCLUSION END OF DOCUMENT

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

Plaintiffs constitute a class of all those who Briefs and Other Related Documents purchased Netopia, Inc., common stock from Only the Westlaw citation is currently available. November 6, 2003, to August 16, 2004. They allege United States District Court,N.D. California. that Netopia and four of its officers or former In re NETOPIA, INC., SECURITIES LITIGATION officers-Alan Lefkof, David Kadish, William Baker, No. C-04-03364 RMW. and Thomas Skoulis-engaged in fraudulent accounting practices that inflated the price of Netopia Dec. 15, 2005. stock. After these alleged accounting irregularities came to light, the price of Netopia stock fell, harming the plaintiffs. The current complaint alleges two Michael David Braun, Andrew M. Schatz, Jeffrey S. causes of action: (1) violation of section 10(b) of the Nobel, Justin S. Kudler, Tricia Lynn McCormick, Exchange Act, 15 U.S.C. § 78j(b), and related Rule Stanley S. Mallison, Robert S. Green, Patrick J. 10b-5, 17 C.F.R. § 240.10b-5, against all defendants, Coughlin, Darren J. Robbins, William S. Lerach, and (2) violation of section 20(a) of the Exchange Marc A. Topaz, Richard A. Maniskas, Tamara Act, 15 U.S.C. § 78t(a), against all defendants other Skvirsky, Timothy J. Burke, Aaron L. Brody, Jules than Netopia. Brody, Tzivia Brody, for Plaintiffs. Howard S. Caro, Michael Ethan Liftik, Sara B. The complaint contains lengthy narratives about the Brody, Susan D. Resley, Walter F. Brown, Jamaar M. defendants' alleged wrongdoing in three Netopia Boyd, for Defendants. transactions or attempted transactions. The first occurrence, referred to by the parties as the “Chicago ORDER DENYING IN PART AND GRANTING IN transaction,” involved an agreement for Netopia to PART DEFENDANTS' MOTION TO DISMISS OR supply Interface Computer Communications, Inc., STRIKE (“ICC”) with computer products, which ICC would WHYTE, J. in turn sell to the Chicago public school system. The *1 THIS ORDER RELATES TO: ALL ACTIONS second occurrence, the “Philadelphia transaction,” was similar: Netopia was to sell ICC $750,000 worth of products, which ICC would then sell to the [Re Docket Nos. 81, 82, 85, 90, 100, 102, 103] Philadelphia public school system. In the third occurrence, the “Swisscom transaction,” Netopia Defendants Netopia, Inc., Alan Lefkof, and David allegedly shipped a large quantity of products to Kadish move to dismiss or strike certain portions of Swisscom AG just before the end of a quarter, the consolidated amended complaint.FN1 Kadish distorting the picture of Netopia's business that additionally moves to dismiss all claims against him investors received. under Fed.R.Civ.P. 12(b)(6). For the reasons given below, the court denies the defendants' motions to The Philadelphia transaction is, for the plaintiffs' dismiss except as to the § 10(b)(5) claim against action, the main event. Plaintiffs allege that in the defendant Kadish, grants the motion as to the § spring of 2003, Netopia began negotiating with ICC 10(b)(5) claim against defendant Kadish with twenty for Netopia to sell ICC software for the Philadelphia days leave to amend, grants the motion to strike the public schools. Consol. Am. Compl. (“CAC”) ¶ 32. allegations in paragraphs twenty-two through thirty- Peter Frankl was the Netopia salesman in charge of one, and denies the motion to strike other allegations. the Philadelphia transaction. Id. By September 2003, the individual defendants were aware that Frankl was possibly going to close a deal that would make the FN1. Defendants William Baker and Philadelphia transaction worth at least $500,000. Id. ¶ Thomas Skoulis join this motion. Baker 34. The Philadelphia school system did not have makes additional arguments why the motion funds available for the purchase, though, meaning should be granted; Skoulis does not. that the purchase would not take place before the end of the financial quarter on September 30, 2003. Id. ¶ I. BACKGROUND 35. Lefkof and Skoulis thought the Philadelphia transaction would help Netopia meet Wall Street

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 47 of 163 Slip Copy Page 2 Slip Copy, 2005 WL 3445631 (N.D.Cal.) (Cite as: Slip Copy) earnings estimates, so had Frankl negotiate a deal could expect a payment of around $300,000 in mid- with ICC: ICC would give Netopia a purchase order June. Id. ¶ 75. In May 2004, Gateway received a for $750,400 worth of software, but the parties would purchase order from the Philadelphia school system orally agree that ICC had no obligation to pay for $375,000 worth of Netopia software. Id. ¶ 81. A Netopia until the Philadelphia schools ordered month later, Gateway sent ICC a purchase order for Netopia's software from ICC and paid ICC. Id. ¶ ¶ the software in the amount of $337,500 .FN2 Id. 35-45. Kadish drafted a purchase order for the transaction which contained no payment terms, although “Netopia's standard payment terms were FN2. This amount represents the $375,000 ‘net 30.” ’ Id. ¶ ¶ 42-43. price the Philadelphia school system was paying, less the 10 percent fee ($37,500) due *2 This deal began to unravel almost immediately. to Gateway. Netopia's accounting department (apparently unaware of the oral contingency) sent ICC a letter asking ICC Baker, meanwhile, was still pressing ICC to pay to confirm to KPMG LLP, Netopia's outside auditors, Netopia $750,000. Id. ¶ 82. ICC's president, David that ICC owed Netopia $750,400 for software. Id. ¶ Andalcio, informed Frankl that it would send Netopia 46. ICC responded by sending Frankl a letter about $50,000 at the end of June. Id. ¶ 83. Lefkof, confirming that ICC did not owe Netopia anything apparently expecting ICC to adhere to its earlier for the Philadelphia transaction until the Philadelphia statement about paying in mid-June, had Imelda school system ordered software from ICC and paid Farrell, Netopia's “Corporate Controller,” send ICC for the software; Frankl received this letter on Andalcio a letter proposing that ICC pay Netopia October 7, 2003. Id. ¶ ¶ 47-50. In late October, the $750,400 in installments from June 28, 2004, to Philadelphia school system made clear that it was not September 15, 2004. Id. ¶ ¶ 84-87. The next day, willing to purchase Netopia software anytime soon. June 18, 2004, Andalcio called Farrell, rejecting the Id. ¶ ¶ 51-52. KPMG learned that Netopia had not proposed payment plan. Id. ¶ 88. “Kadish then came received the $750,400 and asked “Baker, Kadish and to Ms. Farrell's desk, stood over Ms. Farrell and put Lefkof about whether is was appropriate to the phone to his ear as well, and whispered answers recognize” revenue from the purchase order. Id. ¶ into Ms. Farrell's ear for her to say in response to Mr. 54. Andalcio's remarks.” Id. (Plaintiffs do not disclose the contents of this conversation.) On November 5, 2003, Netopia reported its financial results for the quarter and financial year ending *3 A week later, Andalcio e-mailed Baker that September 30, 2003. Id. ¶ 58. The $750,400 from the Andalcio was uncomfortable with the situation and Philadelphia transaction was reported as income for had sought the advice of legal counsel. Id. ¶ 91. the quarter and was the difference between Netopia Andalcio wrote that, on the advice of counsel, ICC reporting a net loss or net income for the quarter. Id. would not make any payments on the old purchase Netopia's stock price rose immediately afterwards. Id. order, and requested a new purchase order that ¶ 59. From November 10 and December 10, 2003, reflected all terms of the agreement between ICC and each of the individual defendants sold off hundreds Netopia. Id. On July 1, 2004, Kadish e-mailed of thousands of dollars worth of Netopia stock. Id. ¶ Andalcio that Netopia was willing to accept $337,500 64. as settlement of all claims between them, and enclosed an agreement to that effect dated June 30, Netopia continued its efforts to get the Philadelphia 2004. Id. ¶ 93. Kadish stated that if ICC did not sign school system to purchase software. Id. ¶ ¶ 65-66. In and return the proposed agreement by the next day, March 2004, Frankl and Skoulis tentatively brokered the “offer to compromise” would “be deemed a deal whereby the Philadelphia schools would agree withdrawn.” Id . Andalcio responded the next day to purchase $375,000 worth of Netopia software, but that his legal counsel had advised him not to sign the Gateway Inc. would be added as a second middleman proposed agreement because ICC had done nothing and take a 10 percent fee. Id. ¶ 66. Baker began wrong. Id. ¶ 94. asking ICC to start making payments since the sale was likely to go through. Id. ¶ 68-74. On April 27, On July 22, 2004, the audit committee of Netopia's 2004, ICC sent Baker and Frankl and e-mail board of directors announced that it was investigating reiterating that ICC's payments to Netopia were Netopia's dealings with ICC. Id. ¶ 96. Two months contingent on ICC being paid by the Philadelphia later, KMPG resigned as Netopia's outside auditor school system (and now Gateway), and that Netopia and withdrew its support for Netopia's financial

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 48 of 163 Slip Copy Page 3 Slip Copy, 2005 WL 3445631 (N.D.Cal.) (Cite as: Slip Copy) statements for the year ending September 30, 2003. Id. ¶ 111. Skoulis and Frankl were fired, and Baker was forced to resign. Id. ¶ ¶ 97-98. B. All defendants' motion to strike certain portions of the complaint

II. ANALYSIS The defendants move, in the alternative, to strike the allegations relating to the Chicago and Swisscom A. All defendants' motion to dismiss certain portions transactions, as well as the January, February, and of the complaint April 2004 price drops. A court may strike “any redundant, immaterial, impertinent, or scandalous matter.” Fed.R.Civ.P. 12(f). Motions to strike “are The defendants move to dismiss “allegations about disfavored by the courts, and should not be granted the Chicago transaction, Swisscom, and certain loss unless it is clear that the matter to be stricken can causation allegations because they do not allege facts have no possible bearing upon the subject matter of upon which a claim for relief can be based.” the litigation.” Naton v. Bank of Cal., 72 F.R.D. 550, Defendants have not moved to dismiss either cause of 551 n. 4 (N.D.Cal.1976). The defendants indicate action, and neither the Chicago transaction nor the they are concerned about the scope of discovery if the Swisscom transaction corresponds directly to either complaint is this sprawling; the court can imagine the plaintiffs' § 10(b) or § 20(a) causes of action. By other reasons the defendants want less in the its own terms, there does not appear to be any way to complaint, such as a desire to cut down on negative grant partial dismissal of a claim under Fed.R.Civ.P. publicity associated with this lawsuit. 12(b)(6). The defendants have not presented the court with any case where a court has dismissed under The Chicago transaction appears to have been Fed.R.Civ.P. 12(b)(6) only part of a complaint except completed by September 2002. See CAC ¶ ¶ 30-31. individual causes of action, nor can the court find This is well over a year before the beginning of the such a case. The plaintiffs conceded at oral argument class period (November 6, 2003). The four pages of that a motion to strike would be a more appropriate allegations covering the Chicago transaction are way to obtain the result they seek. immaterial under Fed.R.Civ.P 12(f) because they are not necessary for the plaintiffs to state their § 10(b) The court assumes that Fed.R.Civ.P. 12(b)(6)'s or § 20(a) causes of action. The presence of the language “failure to state a claim” means the rule Chicago transaction allegations in the CAC risks should not be used on subparts of claims; a cause of “delay[ ] and confusion of the issues.” See Fantasy, action either fails totally or remains in the complaint Inc. v. Fogerty, 984 F.2d 1524, 1528 (9th Cir.1993). under Fed.R.Civ.P. 12(b)(6). See Charles Alan The court will grant the defendants' motion to strike Wright & Arthur R. Miller, Federal Pleading & the allegations concerning the Chicago transaction, Procedure § 1358 (3d. ed.2004); but see Drewett v. paragraphs twenty-two through thirty-one of the Aetna Cas. & Sur. Co., 405 F.Supp. 877, 878 CAC. Because, though, of the Chicago transaction's (W.D.La.1975) (Fed.R.Civ.P.12(b)(6) “may be used similarity to the Philadelphia transaction, aspects of to challenge the sufficiency of part of a pleading such the Chicago transaction may still be relevant to the as a single count or claim for relief.”). The plaintiffs' case. defendants do not claim that the plaintiffs' § 10(b) or § 20(a) causes of action are missing an essential The court will not strike the allegations concerning element. The defendants' motion to dismiss the Swisscom transaction or the price drops because allegations about the Chicago and Swisscom they occurred during the class period. transactions are therefore denied.

*4 Defendants also move to dismiss allegations that C. Kadish's motion to dismiss all causes of action drops in Netopia's stock price in January, February, against him and April 2004 stemmed from a September 30, 2003, overstatement of Netopia's financial condition. As Kadish moves to dismiss both causes of action these time periods also do not correspond to a against him. particular cause of action, the court likewise denies this portion of the defendants' motion to dismiss. The court also declines to treat this motion to dismiss as 1. The section 10(b) cause of action one for summary judgment.

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“To state a claim under Section 10(b), 15 U.S.C. FN3. This doctrine is also referred to as the 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b5, “group pleading doctrine.” See In re Oxford [plaintiffs] must allege: (1) a misstatement or Health Plans, Inc., 187 F.R.D. 133, 142 omission (2) of material fact (3) made with scienter (S.D.N.Y.1999). (4) on which [plaintiffs] relied (5) which proximately caused their injury.” DSAM Global Value Fund v. FN4. It appears that in no case from the Altris Software, Inc., 288 F .3d 385, 388 (9th Northern District of California has the Cir.2002). Securities fraud is subjected to a Reform Act been found to have abrogated heightened pleading standard. First, allegations of the group-published information doctrine, securities fraud are subject to the particularity though few have analyzed the issue obligations imposed by Fed.R.Civ.P. 9(b). GlenFed, extensively. See In re Adaptive Broadband Inc. Sec. Litig., 42 F.3d 1541, 1545 (9th Cir.1994). Sec. Litig., 2002 U.S. Dist. LEXIS 5887, Fed.R.Civ.P. 9(b) provides that “[i]n all averments of *52-53 (N.D.Cal.2002) (Conti, J.) (“[T]he fraud or mistake, the circumstances constituting fraud doctrine has not been specifically abrogated, or mistake shall be stated with particularity. Malice, and is still good law in this Circuit.”); In re intent, knowledge, and other condition[s] of mind Secure Computing Corp. Sec. Litig., 120 may be averred generally.” Second, under the Private F.Supp.2d 810, 821 (N.D.Cal.2000) Securities Litigation Reform Act (the “Reform Act” (Wilken, J.) (“[T]he majority of the district or the “PSLRA”), Pub.L. No. 104-67, 202 Stat. 737 courts in the Ninth Circuit that have (1995) (codified at 15 U.S.C. § § 77k, 771, 77z-1, addressed the issue have concluded that the 77z-2, 78a, 78j-1, 78t, 78u, 78u-4, 78u-5), a plaintiff group published information presumption alleging a § 10(b) claim must “specify each survives the PSLRA”); In re Network statement alleged to have been misleading, the reason Associates, Inc., Sec. Litig., 2000 WL or reasons why the statement is misleading, and, if an 33376577, *13 (N.D.Cal.2000) (Alsup, J.) allegation regarding the statement or omission is (finding that allegations against defendants made on information and belief, the complaint shall do not satisfy even the group-published state with particularity all facts on which that belief is information doctrine and dismissing for formed.” 15 U.S.C. § 78u-4(b)(1). failure to state a claim).

*5 Kadish claims the allegations that he violated § This court feels that the better view is that the 10(b) contain two fatal defects: there is no allegation Reform Act precludes reliance on the group- he made a false statement, and the allegations of published information doctrine in this case. As noted scienter are inadequate. Plaintiffs claim they have in GlenFed, Fed.R.Civ.P. 9(b) and the Reform Act met the heightened standard because the Ninth's constitute separate pleading hurdles in securities Circuit group publication doctrine,FN3 see Wool v. fraud cases. Pleading group-published information Tandem Computers, Inc ., 818 F.2d 1433, 1440 (9th may still satisfy “the particularity requirement of Cir.1987), survived the Reform Act. In Wool, the Rule 9(b),” but it does not satisfy the more rigorous Ninth Circuit held that “[i]n cases of corporate fraud requirements of 15 U.S.C. § 78u-4(b)(1). One where the false or misleading information is district court noted that conveyed in prospectuses, registration statements, the continued vitality of the judicially created group- annual reports, press releases, or other ‘group- published doctrine is suspect since the PSLRA published information,’ it is reasonable to presume specifically requires that the untrue statements or that these are the collective actions of the officers. omissions be set forth with particularity as to “the Under such circumstances, a plaintiff fulfills the defendant” and that scienter be plead in regards to particularity requirement of Rule 9(b) by pleading the “each act or omission” sufficient to give “rise to a misrepresentations with particularity and where strong inference that the defendant acted with the possible the roles of the individual defendants in the required state of mind.” 15 U .S.C. § 78u-4(b) misrepresentations.” Id. (citations omitted). The (emphasis added). To permit a judicial presumption Ninth Circuit has yet to address the issue of whether as to particularity simply cannot be reconciled with the group-published information doctrine survives the the statutory mandate that plaintiffs must plead Reform Act, and other courts are divided on the specific facts as to each act or omission by the question.FN4 See Southland Sec. Corp. v. INSpire Ins. defendant. Solutions, Inc., 365 F.3d 353, 364 (5th Cir.2004). Allison v. Brooktree Corp., 999 F.Supp. 1342, 1350 (S.D.Cal.1998).

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Plaintiffs' allegations do not create “a strong According to the plaintiffs, paragraphs 100 and 129 inference” Kadish was aware that ICC did not owe of the CAC contain allegations that Kadish made Netopia $750,400 before the last alleged false statements. Opp'n at 26-27. This paragraph from misstatements of April 19, 2004.FN5 Anything Kadish the CAC is representative of what plaintiffs claim knew after that date (roughly paragraph seventy-one sufficiently pleads Kadish violated § 10(b): of the factual section of the CAC and thereafter) is On April 19, 2004, after the close of trading in the not directly relevant to Kadish's scienter. Kadish market, Netopia issued a press release (the “April claims that the allegations in the CAC support an Press Release”). The April Press Release (which inference that he was unaware of the fraud of Lefkof, listed Defendant Baker as the “contact” person and Baker, Skoulis, and Frankl. Mot. at 19. The court quoted Defendant Lefkof), inter alia, reported a net agrees that the CAC is not inconsistent with the loss for the second fiscal quarter of $1.6 million, or a theory that Kadish was unaware of the fraud; the loss of $0.07 per share and “trade receivables, net” of CAC therefore does not “give rise to a strong $15.185 million. Each of the Individual Defendants inference that” Kadish was aware of the fraud. directly participated in the drafting of the April Press Release. On April 19, 2004, following the issuance of the April Press Release, Defendants Lefkof and FN5. The statements alleged to be Baker conducted a conference call (the “April actionable under § 10(b) occurred on Conference Call”) with securities analysts and November 5, 2003; December 19, 2003; investors, in which Defendants, inter alia, January 20, 2004; February 17, 2004; and represented the net income, revenue and accounts April 19, 2004. CAC ¶ 100. receivable results reported in the April Press Release. Each of the Individual Defendants participated in the Plaintiffs have alleged that in September 2003, drafting of the prepared remarks stated at the outset Kadish drafted a $750,400 purchase order for the of the April Conference Call. Philadelphia transaction and e-mailed it to other Netopia employees with the message “Here is the *6 CAC ¶ 100(e); see also id. ¶ ¶ 100(a)-(d), 129. form of PO we will receive.” CAC ¶ 43. This draft Such allegations do not, under the Reform Act, purchase order contained no payment terms, although sufficiently plead that Kadish made a false statement, plaintiffs allege that “Netopia's standard payment as the plaintiffs cannot rely on the group-published terms were ‘net 30.” ’ Id. ¶ ¶ 42-43. Plaintiffs also information doctrine. Plaintiffs therefore have not claim they have alleged that Kadish was involved in stated a § 10(b) claim against Kadish because the the cover-up of the true nature of the Philadelphia CAC does not contain an adequate allegation that he transaction. Opp'n at 29. This is doubtful. The made a false statement. complaint contains an allegation that Skoulis told Frankl to tell Andalcio that “ ‘everyone knows' (i.e., Furthermore, the allegations that Kadish acted with Lefkof, Kadish and Baker)” that the Philadelphia scienter are also defective. The Reform Act sets a transaction contained a hidden contingency. CAC ¶ high standard for pleading scienter: 46. This falls far short of creating a strong inference In any private action arising under this chapter in that Kadish actually knew of the contingency; which the plaintiff may recover money damages only plaintiffs have merely alleged that somebody told on proof that the defendant acted with a particular somebody else to tell yet a third person that Kadish state of mind, the complaint shall, with respect to knew. Likewise, in April 2004 that “Kadish [was] each act or omission alleged to violate this chapter, becoming extremely concerned about the fact that state with particularity facts giving rise to a strong Netopia was still carrying the $750,400 as part of its inference that the defendant acted with the required reported accounts receivables,” id. ¶ 67, that Kadish state of mind. sought to have ICC “enter into a payment plan” for the $750,400, id. ¶ 68, or that Kadish was making 15 U.S.C.A. § 78u-4(b)(2). The Ninth Circuit has things difficult for Baker, id. ¶ 71, are not held that the required state of mind in securities fraud inconsistent with the theory that Kadish was unaware cases is “deliberately reckless or conscious of the contingency and trying to ensure Netopia was misconduct,” and that allegations of “mere motive paid $750,400 Kadish believed ICC owed. and opportunity” are insufficient. In re Silicon Graphics Inc. Sec. Litig., 183 F.3d 970, 974 (9th *7 Kadish whispering into the ear of Farrell while she Cir.1999). spoke to Andalcio is certainly suspicious, but plaintiffs do not provide the substance of Kadish's

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 51 of 163 Slip Copy Page 6 Slip Copy, 2005 WL 3445631 (N.D.Cal.) (Cite as: Slip Copy) instructions to Farrell. Plus, this call occurred on June scienter. 18, 2004, after the last alleged misstatement on April 19, 2004. FN6. Plaintiffs refer to the quarter ending Kadish's stock sales alone are inadequate to create a December 31, 2003, as “the first quarter of strong inference that Kadish acted with scienter. 2004,” CAC ¶ 117, which appears to Kadish's late 2003 stock sales were made after comport with Netopia's financial year-end of Netopia had released favorable financial information; September 30, see id. ¶ 58. Plaintiffs thus as the Ninth Circuit has noted, corporate officers seem to allege that the firing of Karl-Heinz often sell stock after such announcements. Lipton v. Mumm and the assignment of Kadish to the Pathogenesis Corp., 284 F.3d 1027, 1037 (9th Swisscom account occurred “in the early Cir.2002). Plaintiffs make much of the fact that part of” October, November, and December Kadish did not sell any stock for the forty-four 2003. See id. ¶ 177. months preceding his late 2003 sales. Opp'n at 29. As Kadish points out, selling stock shortly after the Even though the plaintiffs' pleading of Kadish's announcement that Netopia had its first positive- scienter is inadequate when considered piecemeal, income quarter since mid-2000 is not inherently the court must also consider “whether the total of suspicious. See Mot. at 22. “Although unusual or plaintiffs' allegations, even though individually suspicious stock sales by corporate insiders may lacking, are sufficient to create a strong inference that constitute circumstantial evidence of scienter, insider defendants acted with deliberate or conscious trading is suspicious only when it is dramatically out recklessness.” Lipton, 284 F.3d at 1038. Considering of line with prior trading practices at times calculated the allegations of the CAC against Kadish as a whole, to maximize the personal benefit from undisclosed the court is compelled to decide that plaintiffs have inside information.” Silicon Graphics, 183 F.3d at not created a strong inference that Kadish acted with 986. While his sale of 63 percent of his Netopia scienter. The drafting of the purchase order and the holdings in late 2003 is “dramatically out of line with whispering into Farrell's ear are particularly [his] prior trading practices,” the preceding forty-four suspicious, but significant details are omitted from months in which Kadish sold no stock largely the pleading of these actions. That many of Kadish's corresponds with a period in which Netopia reported alleged actions are consistent with either Kadish net losses each quarter. Therefore, in light of the lack being part of a conspiracy with the other defendants of allegations showing Kadish had “undisclosed or Kadish working against the conspiracy prevents a inside information,” Kadish's sales are not necessarily strong inference from being drawn either way. As suspicious. plaintiffs have not created a strong inference Kadish acted with scienter, the § 10(b) claim against him Finally, plaintiffs allege that Kadish's temporary must be dismissed.FN7 assignment as the salesman for the Swisscom account in late 2003 FN6 creates a strong inference that Kadish was aware of misstatements related to the Swisscom FN7. Plaintiffs did not raise allegations that transaction. Plaintiffs allege that Netopia shipped Kadish engaged in insider trading in “millions of dollars” worth of software to Swisscom violation of Rule 12b-5 until their opposition via boat “in the final days of December 2003.” CAC to Kadish's motion to dismiss. See Opp'n at ¶ 116. Accounting rules apparently dictated that 27-28. Plaintiffs cannot add an insider Netopia recognize the revenue from the boat trading claim in such a manner, and the shipments as soon as they were sent, which was in court will not consider it further in December 2003. See id. ¶ 116. Plaintiffs nonetheless connection with the current motion. claim that recognizing such revenue in December 2003 distorted Netopia's financial picture, because 2. The section 20(a) cause of action Swisscom would need that much less product in the next quarter. Opp'n at 28-29. Plaintiffs, however, do *8 Under § 20(a) of the Exchange Act, not allege anything other than Lefkof appointed Every person who, directly or indirectly, controls any Kadish to manage the Swisscom account; there is no person liable under any provision of this chapter or of allegation that Kadish ordered the timing or method any rule or regulation thereunder shall also be liable of the shipment, or was even aware software was jointly and severally with and to the same extent as shipped to Swisscom. This is insufficient under the such controlled person to any person to whom such Reform Act to show Kadish acted with the requisite controlled person is liable, unless the controlling

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 52 of 163 Slip Copy Page 7 Slip Copy, 2005 WL 3445631 (N.D.Cal.) (Cite as: Slip Copy) person acted in good faith and did not directly or discovery, or, indeed, before requiring defendants to indirectly induce the act or acts constituting the file an answer. Complaints fashioned as this one is violation or cause of action. are an unwelcome and wholly unnecessary strain on defendants and on the court system. 15 U.S.C. § 78t(a). The Ninth Circuit has held that “[i]n order to prove a prima facie case under § 20(a), *9 In re GlenFed, Inc. Sec. Litig., 42 F.3d 1541, 1554 plaintiff must prove: (1) a primary violation of (9th Cir.1994) (en banc ). This court has similar federal securities laws ... and (2) that the defendant feelings regarding the plaintiffs' fifty-page complaint, exercised actual power or control over the primary and understands the defendants' attempt to prune the violator.” Howard v. Everex Sys., Inc., 228 F.3d complaint down to a manageable size through their 1057, 1065 (2000). Whether a defendant such as motion to dismiss or strike. The complaint is Kadish “is a controlling person is an intensely factual needlessly cumbersome; plaintiffs do not need question, involving scrutiny of the defendant's anywhere near fifty pages to state two causes of participation in the day-to-day affairs of the action against five defendants, even under the corporation and the defendant's power to control heightened pleading standards of the Reform Act. corporate actions.” Kaplan v. Rose, 49 F.3d 1363, 1382 (9th Cir.1994) (internal quotation marks and In their opposition to the defendants' motion to citations omitted). “[I]n order to make out a prima dismiss or strike, the plaintiffs filed a thirty-two-page facie case, it is not necessary to show actual memorandum of points and authorities. Ten of these participation or the exercise of actual power; pages are a summary of the factual allegations of the however, a defendant is entitled to a good faith complaint. See Opp'n at 4-14. This ten-page summary defense if he can show no scienter and an effective appears to the court to be a much more useful version lack of participation.” Howard, 228 F.3d at 1065. of the complaint, and shows that the plaintiffs can The defendant bears the burden of proving he “acted present the complaint in a shorter form. “[A]s a in good faith and did not directly or indirectly induce matter of prudent case management,” the court will the violations.” Id. order plaintiffs to file a streamlined version of their complaint which does not exceed thirty-five pages Here, plaintiffs have made out a prima facie case for within twenty days of the date of this order. Plaintiffs a § 20(a) violation by Kadish. The first element is may include in their complaint amended allegations met: Defendants do not challenge that the CAC against defendant Kadish. contains an adequately-stated claim for a § 10(b) violation by Skoulis. The second element is also met: Plaintiffs allege that Skoulis reported to Kadish. CAC III. ORDER ¶ 11. Kadish bears the burden proving good faith, which he cannot meet solely with the ambiguous For the foregoing reasons, the court allegations of the CAC. (1) grants Kadish's motion to dismiss the § 10(b) cause of action against him with twenty days leave to amend; D. Plaintiffs' request for leave to amend their (2) grants the defendants' motion to strike paragraphs complaint twenty-two through thirty-one of the CAC; (3) otherwise denies the defendants' motion to Plaintiffs request leave to amend their complaint if dismiss or strike; and any portion of defendants' motion is granted. The (4) orders plaintiffs to file a streamlined version of court will grant this request. However, the Ninth their complaint not exceeding thirty-five pages within Circuit has noted that complaints in securities fraud twenty days of the date of this order. cases can be needlessly verbose. Expressing frustration with one 113-page complaint, the Ninth Circuit stated that N.D.Cal.,2005. To say that the drafting is infelicitous puts matters In re Netopia, Inc., Securities Litigation too kindly. The complaint is cumbersome almost to Slip Copy, 2005 WL 3445631 (N.D.Cal.) the point of abusiveness. We see nothing to prevent the district court, on remand, from requiring, as a Briefs and Other Related Documents (Back to top) matter of prudent case management, that plaintiffs streamline and reorganize the complaint before • 2006 WL 1042236 (Trial Pleading) Answer of allowing it to serve as the document controlling Defendant Thomas Skoulis to Second Consolidated

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

END OF DOCUMENT

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of fiscal year 1996. The next day Oak's stock Only the Westlaw citation is currently available. declined from $16 1/2 per share to $12 1/2 per United States District Court, N.D. California. share. In re OAK TECHNOLOGY SECURITIES LITIGATION. Between July 9, 1996 and September 5, 1996 four No. 96-20552 SW. federal class action lawsuits were filed against Oak alleging violations of sections 10(b) and 20(a) of the Aug. 1, 1997. Securities Exchange Act of 1934 and Rule FN1 10(b)(5). On December 18, 1996, this Court consolidated the four federal actions for all purposes. ORDER DISMISSING CONSOLIDATED Plaintiffs filed a Consolidated Amended Complaint AMENDED COMPLAINT WITH LEAVE TO (“Consolidated Complaint”) on January 31, 1997. AMEND SPENCER WILLIAMS, Senior District Judge. *1 This litigation is a consolidated securities class FN1. Additionally, six class action lawsuits action lawsuit filed on behalf of purchasers of the were filed against Oak in California State common stock of Oak Technology, Inc. (“Oak”) Superior Court for the County of Santa during the period of July 27, 1995 through May 22, Clara. 1996 (the “Class Period”) against Oak, twelve officers and directors of Oak, and Hambrecht and The Consolidated Complaint alleges that during the Quist, Inc. (“H & Q”). On May 21, 1997, after Class Period, July 27, 1995 through May 22, 1996, hearing oral argument, the Court took under Oak, certain officers and directors of Oak, and H & Q submission the Oak Defendants' (Oak and the twelve conducted a fraudulent scheme and course of individual Defendants) motion to dismiss Plaintiffs' business in order to artificially inflate the market Consolidated Complaint and Hambrecht and Quist's price of Oak common stock. Plaintiffs assert that motion to dismiss Plaintiffs' Consolidated Complaint. throughout the Class Period Oak and its officers and After carefully considering the papers, arguments of directors deceived the public by materially misstating counsel, and legal authority, the Court concludes that revenue and earnings, failing to adjust its financial Plaintiffs have failed to plead their claims with records for obsolete inventory, and engaging in particularity as required by Fed.R.Civ.P. 9(b) and the “sham” transactions with related parties in violation Securities Litigation Reform Act of 1995 (“Reform of Generally Accepted Accounting Principals Act”). 15 U.S.C. § 78u-4. Therefore, the Court (“GAAP”). The Consolidated Complaint also states DISMISSES Plaintiffs' Consolidated Complaint with that during the Class Period Defendants made leave to amend. misrepresentations regarding the demand for Oak's CD-ROM controller chips and the status of new Oak products in addition to releasing positive forecasts for revenue and earnings throughout fiscal 1996 and I. BACKGROUND 1997. Plaintiffs contend that Defendants engaged in this conduct to inflate the market price of Oak's stock Oak manufactures and sells controller chips and while selling “massive” amounts of personal Oak related products for CD-ROM and other multimedia stock holdings. products for use in personal computers. In February 1995, Oak completed its initial public offering of *2 In response to the Consolidated Complaint, the common stock, issuing 5.5 million shares. Oak Oak Defendants filed a motion to dismiss pursuant to conducted a secondary offering in May 1995, issuing Fed.R.Civ.P. 12(b). In their motion, the Oak 4.6 million additional shares. H & Q participated as Defendants assert that Plaintiffs claims, as alleged in an underwriter in both the initial and secondary the Consolidated Complaint, fail because: (1) offerings. Oak reported record earnings for the first Plaintiffs fail to allege any false statements with three quarters of fiscal year 1996 and Oak common sufficient particularity as required by Rule 9(b) and stock reached a high of $30 3/4 per share in late the Reform Act; (2) the allegedly false statements in February 1996. On May 22, 1996, Oak reported to analysts reports cannot be attributed to the Oak the public that it expected a loss for the fourth quarter

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Defendants; (3) the Consolidated Complaint does not allege sufficient facts to establish scienter; (4) Section 10(b) of the Securities Exchange Act of Plaintiffs' claims based on omissions are precluded 1934, 15 U.S.C. § 78j, makes it unlawful to use in by the bespeaks caution doctrine; (5) several of the connection with “the mails or facilities of interstate allegedly false statements are non-actionable positive commerce” any “manipulative or deceptive device or statements of optimism; (6) several of Plaintiffs' contrivance in contravention of such rules and claims are based on accurate reports of historical fact; regulations as the Commission may prescribe.” Rule (7) several claims are based on non-actionable 10b-5, promulgated under section 10(b), prohibits the allegations of corporate mismanagement; (8) making of “any untrue statement of a material fact” Plaintiffs fail to plead facts to show loss causation; or the omission of a material fact that would render and (9) Plaintiffs section 20(a) claim fails because the any statements made misleading in the light of Consolidated Complaint fails to state a claim for circumstances under which they were made. 17 primary liability or allege controlling person liability C.F.R. § 240.10b-5(b). The elements of Rule 10b-5 with particularity. claim are: (1) a false statement or ar omission of a material fact; (2) reliance; (3) scienter; and (4) H & Q filed a separate motion to dismiss contending resulting damages. Paracor Finance v. General that Plaintiffs' claims against H & Q fail because the Elec. Capitol Corp., 96 F.3d 1151, 1157 (9th Consolidated Complaint does not allege specific facts Cir.1996). If one of these elements is not present, showing that H & Q lacked a reasonable basis for its the claim fails. Id. reports. H & Q also asserts that Plaintiffs cannot maintain their claims against H & Q because H & Q does not owe a duty to Plaintiffs in regard to the C. Pleading Requirements allegedly misleading reports because H & Q disseminated the reports only to its clients. *3 Complaints alleging fraud must meet the heightened pleading standards of Fed.R.Civ.P. 9(b), which requires that “in all averments of fraud or II. LEGAL STANDARDS mistake the circumstances constituting fraud or mistake shall be stated with particularity.” As part A. Rule 12(b)(6) Standard of the recently enacted Securities Litigation Reform Act of 1995 (“Reform Act”), Congress clarified and strengthened the particularity requirements of Rule A complaint should only be dismissed under Rule 9(b) as applied in the context of federal securities 12(b)(6) of the Federal Rules of Civil Procedure class action lawsuits. Now, to survive a motion to where it appears beyond doubt that no set of facts dismiss, a complaint for violation of the federal could support plaintiff's claim for relief. Conley v. securities laws must meet the heightened pleading Gibson, 355 U.S. 41, 47, 78 S.Ct. 99, 2 L.Ed.2d 80 requirements which are set forth in the Reform Act. (1957); Durning v. First Boston Corp., 815 F.2d 15 U.S.C. § 78u-4(b). 1265, 1267 (9th Cir.1987), cert. denied, 484 U.S. 944, 108 S.Ct. 330, 98 L.Ed.2d 358 (1987). A First, the complaint must specify each false or complaint may be dismissed as a matter of law for misleading statement. 15 U.S.C. § 78u-4(b)(1). To two reasons: (1) lack of a cognizable legal theory, or satisfy this requirement, a complaint must “state (2) insufficient facts under a cognizable theory. precisely the time, place, and the nature of the Robertson v. Dean Witter Reynolds, Inc., 749 F.2d misleading statements, misrepresentations, and 530, 533-34 (9th Cir.1984). In reviewing a motion specific acts of fraud.” Kaplan v. Rose, 49 F.3d under Rule 12(b)(6), all allegations of material fact 1363, 1370 (9th Cir.1994), cert. denied, 516 U.S. are taken as true and must be construed in the light 810, 116 S.Ct. 58, 133 L.Ed.2d 21 (1995). most favorable to the non-moving party. Durning, 815 F.2d at 1267. However, “conclusory allegations Second, the Reform Act requires that the complaint of law and unwarranted inferences are insufficient to state the reasons why each statement is false or defeat a motion to dismiss for failure to state a misleading. 15 U.S.C. § 78u-4(b)(1). In some cases claim.” In re Verifone Sec. Litig., 11 F.3d 865, 868 involving fraud, a plaintiff may explain why a (9th Cir.1993). statement is false or misleading by merely pointing to facts that were later revealed which, due to their nature, were necessarily in existence at the time the B. Section 10(b) and Rule 10b-5 Claims statement was made. In re GlenFed, Inc. Sec. Litig.,

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42 F.3d 1541, 1548 (9th Cir.1994) (discussing the that the sheer volume of their allegations gives example of a house built on a landfill). Securities credibility to their claims. However, in the end, fraud cases, however, typically involve an Plaintiffs succeed only in clouding any well-founded intervening event, such as a decline in consumer claims with numerous unsupported and conclusory demand for the company's products or the appearance claims. of new competitors, that occurs between the time of the statement and the time the sobering facts are Second, Plaintiffs fail to adequately explain why any revealed. Id. “In the face of such intervening events, of the statements were false when made. “In order to a plaintiff must set forth, as part of the circumstances allege the circumstances constituting fraud plaintiff constituting fraud, an explanation as to why the must set forth facts explaining why the difference disputed statement was untrue or misleading when between the earlier and the later statements is not made.” Id. at 1548-49. This is most easily merely the difference between two permissible accomplished by identifying inconsistent judgments, but rather the result of falsehood.” contemporaneous statements or information made by GlenFed, 42 F.3d at 1549. or available to the defendants. Id. at 1549. The Consolidated Complaint sets forth numerous Third, with respect to each act or omission, the “adverse material facts” but contains only conclusory complaint must set forth particular facts that give rise allegations that the “adverse material facts” were in to a strong inference that defendant acted with the existence or known by Defendants at the time the required state of mind. 15 U.S.C. § 78u-4(b)(2). To allegedly misleading statements were made. Further, satisfy this requirement, the complaint must allege the Consolidated Complaint is devoid of specific either (1) specific facts demonstrating that the allegations of contemporaneous facts or information defendant had a motive and an opportunity to commit showing when the adverse facts arose. Thus, the fraud or (2) specific facts constituting circumstantial Court can only conclude that Plaintiffs' allegations of evidence of conscious behavior or recklessness if the falsity derive from later, sobering revelations made statement is not forward-looking. These allegations by Oak at the end of the Class Period.FN2 As such, of scienter cannot be conclusory in nature. Rather, Plaintiffs claims fail to meet the requirements of Rule they must constitute a substantial factual basis to 9(b) and the Reform Act because “it is clearly support a “strong inference” that the defendant acted insufficient for plaintiffs to say that the later, with the required state of mind. sobering revelations make the earlier, cheerier statement a falsehood.” GlenFed, 42 F.3d at 1548. These particularity requirements may be relaxed as to matters peculiarly within the defendants' knowledge and plaintiffs may allege such matters on the basis of FN2. The Consolidated Complaint provides information and belief. Wool v. Tandem Computers that in April and May of 1996, Oak reported Inc., 818 F.2d 1433, 1439 (9th Cir.1987). However, weakening sales for CD-ROM controller if an allegation regarding a statement or omission is products, due in part to the transition to 6X made on information and belief, the Reform Act and 8X speed drives, excess inventory and requires that the complaint state with particularity all failure to increase sales of multimedia facts on which the belief is formed. 15 U.S.C. § products. Consolidated Complaint ¶ ¶ 100 78u-4(b)(1). and 104.

In addition to these two general deficiencies, the III. DISCUSSION Consolidated Complaint suffers from several specific shortcomings which are described below. *4 In reviewing Plaintiffs' claims, the Court finds two general deficiencies that pervade the Consolidated Complaint. First, Plaintiffs mistake quantity for A. The Form of Plaintiffs' Allegations particularity. Instead of providing particularity as to each statement and each Defendant's involvement in As an initial matter, Plaintiffs' presentation of their the alleged fraud, Plaintiffs attempt to meet the allegations of false and misleading statements makes requirements of Rule 9(b) and the Reform Act by it unreasonably difficult for the Court and Defendants alleging a myriad of misleading statements and to interpret Plaintiffs' claims. Instead of identifying naming fourteen defendants as participants in the each allegedly false statement in one paragraph and scheme to defraud. Apparently, Plaintiffs believe explaining why each statement was false when made

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 57 of 163 Not Reported in F.Supp. Page 4 Not Reported in F.Supp., 1997 WL 448168 (N.D.Cal.) (Cite as: Not Reported in F.Supp.) in the following paragraph, the Consolidated (4) unreserved inventory. Complaint groups several allegedly false statements, often citing long passages with little, if any, explanation in the surrounding text of which 1. CD-ROM Controller Chip Demand and Sales particular statements were false and why they were false. Consolidated Complaint ¶ ¶ 54-72, 74-81, 83- Plaintiffs allege that throughout the Class Period 93.FN3 At the conclusion of each of these groups of Defendants falsely represented that demand for Oak's false and misleading statements, the Consolidated CD-ROM controller chips was “red hot,” Complaint sets forth the conclusory allegation that “exceptional” and “increasing” and that sales from the statements “were false and misleading when the CD-ROM controller chips would generate strong made” and lists “material adverse information” that earnings growth in fiscal 1996. ¶ ¶ 54, 56, 67, 72, 75, was not disclosed by Defendants. ¶ ¶ 73, 82, 95. 76, 87 and 92. According to the Consolidated Complaint, Defendants made these statements knowing that certain large customers, including FN3. All subsequent paragraph references Toshiba, were beginning to manufacture controller are to the Consolidated Complaint. chips internally and that other customers, including Mitsumi, Hitachi, Creative Technologies and NEC, *5 For example, paragraphs 54 through 72 of the had informed Oak that they would be dramatically Consolidated Complaint present seven pages of decreasing their purchases from Oak. ¶ ¶ 7 and 73. selected statements allegedly made by Oak or analysts during the time period from July 26, 1995 However, Plaintiffs merely allege, without providing through September 1995. However, the vast any supporting contemporaneous factual allegations, majority of adverse facts pertaining to all of these that these adverse facts arose before Defendants statements are lumped together in paragraph 73. made the allegedly misleading statements. These Thus, the burden is on the reader to sort out the conclusory allegations do not satisfy the requirements statements and match them with the corresponding of Rule 9(b) and the Reform Act. Plaintiffs must adverse facts to solve the “puzzle” of interpreting allege with particularity when this information was Plaintiffs' claims. passed to Defendants and what was said. When amending their pleading', Plaintiffs should, at a This “puzzle-style” pleading has been consistently minimum, include the following information: (1) criticized by the courts as an “unwelcome and wholly when Toshiba informed Oak of its intent to produce unnecessary strain on defendants and the court the chips internally; (2) when Toshiba reduced their system.” In re GlenFed, 42 F.3d 1554; See also, purchases as a result of internal production; (3) when Strassman v. Fresh choice, Inc., 1995 WL 743728, Mitsumi, Hitachi, Creative Technologies and NEC *4 (N.D.Cal. Dec.7, 1995). Given the level of informed Oak that they would be decreasing their experience of Plaintiffs' counsel, the Court cannot purchases; (4) when these customers decreased their understand why Plaintiffs' claims are alleged in this purchases; and (5) the approximate amount of these manner. Moreover, now that the Court has stated its “dramatic” reductions in purchases. dissatisfaction with this pleading tactic, any amended complaint that employs this form of pleading will be *6 Plaintiffs also allege that Defendants became summarily dismissed as improper under Fed.R.Civ.P. aware of the decline in demand for Oak's CD-ROM 8. chips through internal reports, presentations, and regularly scheduled meetings. General allegations of internal reports, presentations and meetings do not, B. False and Misleading Statements however, satisfy the pleading requirements for federal securities fraud class actions. Hockey v. Plaintiffs allege that during the Class Period Medhekar, 1997 WL 20374, *7 (N.D. Cal. April 15, Defendants conducted a scheme to defraud by 1997); Stack v. Lobo, 903 F.Supp. 1361, 1370 publishing false and misleading statements in press (N.D.Cal.1995). Further, adding the boilerplate releases, articles, analysts' statements, and reports. assertion that the reports and presentations were According to the Consolidated Complaint, these “regularly prepared” does not provide the requisite statements included false information concerning: particularity. Stack, 903 F.Supp. at 1370. Rather, to (1) CD-ROM controller chip demand and sales; (2) satisfy the pleading requirements of Rule 9(b) and the the transition from 2x and 4x to 6x and 8x speed Reform Act, Plaintiffs must identify specific reports drives; (3) revenues from multimedia products; and or presentations and what information was conveyed

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 58 of 163 Not Reported in F.Supp. Page 5 Not Reported in F.Supp., 1997 WL 448168 (N.D.Cal.) (Cite as: Not Reported in F.Supp.) in the reports or presentations. 87, and 92. For projections such as these to be actionable under the federal securities laws, Plaintiffs Here, Plaintiffs identify one presentation made by must demonstrate that the statement was not Ben Taniguchi, vice president of the Optical Storage genuinely believed, that there was no reasonable Business Unit, at a meeting on October 25, 1995. basis for that belief, or that the speaker was aware of During the presentation, Taniguchi allegedly “undisclosed facts tending to seriously undermine the “showed that the sales of Oak's CD-ROM chips accuracy of the statement.” In re Apple Computer would decline sharply, commencing early in calendar Sec. Litig., 886 F.2d 1109, 1113 (9th Cir.1989). In year 1996.” ¶ 78. While these allegations other words, Plaintiffs must allege facts showing that adequately identify the time and preparer of the Defendants lacked a reasonable basis for their internal report, they provide only vague and predictions. Further, these allegations, as with any conclusory information concerning the content of allegations of fraud, must be pled with particularity. Taniguchi's presentation. Further, Plaintiffs fail to explain how the information in Taniguchi's *7 In the Consolidated Complaint, Plaintiffs make presentation differed from statements made by the conclusory allegations that Oak was experiencing Defendants following the presentation. Therefore, “great difficulties” developing its new multimedia Plaintiffs' claims of misleading statements regarding products and that existing multimedia products “were CD-ROM controller chip demand are insufficient. not doing well.” ¶ ¶ 73, 82 and 95. However, Plaintiffs fail to provide any specific allegations to support their conclusory assertions. Thus, Plaintiffs 2. Transition from 2X and 4X to 6X and 8X Speed claims of misleading projections concerning Oak's Drives multimedia products clearly do not meet the particularity requirements of Rule 9(b) and the Plaintiffs allege that Defendants falsely stated that Reform Act. Oak was prepared for the transition to 6X and 8X speed drives, was experiencing no problems with the Plaintiffs also allege that Defendants misled the transition, and continued to benefit from the public by stating in an annual report, “[w]e believe transition from double speed to quad speed drives. that the substantial synergies among our areas of Further, they allege that Oak's fourth generation CD- expertise, including opportunities for product ROM controller, the OTI-910, supported multiple integration, provide us with a competitive advantage drive speeds of 4X, 6X, and 8X, was well received in the multimedia marketplace” and “[w]e develop and would show strong growth during fiscal 1996. ¶ ¶ our core technologies using a consistent set of design 54, 56, 58, 76, 86 and 87. To demonstrate the falsity tools, with an emphasis on building scalable and of these statements Plaintiffs allege that the OTI-910 reusable functional blocks.” ¶ ¶ 61 and 63. was not new but just a reworked version of a prior Plaintiffs contend that these statements were Oak product and “did not work on multiword DMA materially false because Oak's CD-ROM unit used and did not support full performance mode 3.” ¶ ¶ different tools and methodologies than Oak's MPEG 73(a) and 82(j). However, Plaintiffs fail to explain and 3-D units and because Oak's blocks were not how these alleged shortcomings in the OTI-910 reusable, scalable or functional. ¶ ¶ 62 and 64. demonstrate that Oak's transition to 6X and 8X speed drives was failing or that the OTI-910 controller was These allegations are insufficient for two reasons. defective or not well received. Thus, Plaintiffs have First, Plaintiffs fail to show why the statements were not sufficiently specified the reason or reasons why false. Stating that there are “substantial synergies” is the statements concerning transition to 6X and 8X not a representation that all of Oak's business units speed drives were misleading as required by the use the same tools and methodologies. Thus, Reform Act. 15 U.S.C. § 78u-4(b)(1). alleging that one business unit uses different tools than two other business units does not demonstrate that Defendants' statements regarding synergies were 3. Revenue from Multimedia Products false. Additionally, Plaintiffs' assertion that “the blocks developed by the various business units were Plaintiffs also allege that Defendants misled the not scalable, reusable functional blocks,” is public by predicting that Oak's multimedia products ambiguous, unsupported and conclusory. ¶ 64. would start generating revenue in early fiscal 1996 and would contribute to strong revenue growth Second, vague or amorphous statements cannot serve throughout 1996 and continue into 1997. ¶ ¶ 54, 56, as a basis for liability. Raab v. General Physics

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Corp., 4 F.3d 286, 288-90 (4th Cir.1993); In re deficiencies. In re Wells Fargo Sec. Litig., 12 F.3d Syntex Corp., 855 F.Supp. at 1095; Strassman, 1995 922, 926-27 (9th Cir.1993), cert. denied sub nom., WL 743720 at *5. Such statements are inactionable Wells Fargo & Co. v. Greenwald, 513 U.S. 917, 115 because reasonable investors do not consider them S.Ct. 295, 130 L.Ed.2d 209 (1994); In re Ross important in making investment decisions. Raab, 4 Systems Sec. Litig., Fed. Sec. L. Rep. ¶ 98,363 at F.3d at 289-90. Here, the statements regarding 90,499. PCH1H 1. Improper Revenue Recognition “synergies” and product integration are general, amorphous comments about Oak's efforts to integrate Plaintiffs allege that Oak improperly recognized its various products and do not refer to any particular revenues on sales where it granted unconditional products or even particular business units. No rights of return and extended payment terms with reasonable investor would rely on such vague assurances that the customer could return unsold statements, “and they are certainly not specific products. ¶ 117. According to the Consolidated enough to perpetrate fraud on the market.” Id. at 290. Complaint, Oak offered these terms to its “chief Thus, to the extent that Plaintiffs rely on these Japanese, Singapore and Taiwanese customers,” statements of “synergies” and product integration to resulting in approximately $75 million in overstated establish liability, Plaintiffs' claims are dismissed revenues. Id. In a separate paragraph, Plaintiffs state with prejudice. that Mitsumi Electric, Behavior Tech Computer, and NEC were “among” Oak's chief customers in Japan, Singapore, and Taiwan. ¶ 116. 4. Unreserved Inventory These allegations do not reach the level of The final category of allegedly misleading statements particularity required for maintaining claims based on warrants minimal commentary. Plaintiffs allege that fraudulent financial statements. To adequately plead Defendants misled the public when they made financial fraud based on improper revenue assurances that Oak was not accumulating excess recognition, Plaintiffs must allege, at a minimum, inventory of its CD-ROM controllers and that some particular transactions where revenues were controller chip inventory was under control. ¶ ¶ 54 improperly recorded, including the names of the and 87. However, Plaintiffs fail to specify the customers, the terms of specific transactions, when reason or reasons why these assurances were false. the transactions occurred, and the approximate Instead, they rely on the conclusory allegation that amount of the fraudulent transactions. Merely “Oak's inventories of the OTI-910 were increasing providing the names of “chief customers” and greatly, and Oak would be forced to take writeoffs of estimating the net effect of the alleged improper this inventory.” ¶ 82(m). Pleading securities fraud revenue recognition does not suffice. in such a conclusory manner is well below the standards set by the Reform Act. 2. Related Party Transactions

C. Financial Fraud Plaintiffs allege that during fiscal 1995 and the first three quarters of fiscal 1996, an entity named EDEE, *8 Plaintiffs allege that during the Class Period along with another company, Takaya, engaged in Defendants committed financial fraud by: (1) material transactions with Oak. ¶ 121. Plaintiffs recognizing revenues in violation of GAAP; (2) further allege that Oak “controlled” EDEE, which engaging in “sham” transactions with related parties; was located in the same building as Oak's Japanese and (3) failing to recognize a loss on excess inventory subsidiary, and that Oak used EDEE to “park” and purchase commitments in violation of GAAP. To inventory. Id. Therefore, according to Plaintiffs, adequately state a claim for accounting fraud, Oak violated GAAP by failing to disclose the nature Plaintiffs must plead facts sufficient to support a and effect of these related party transactions. conclusion that Defendants prepared fraudulent financial statements and that the alleged financial Once again, Plaintiffs allegations are plagued with fraud was material. In re Ross Systems Sec. Litig., ambiguities. Plaintiffs fail to identify the nature of [Current Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ the “material transactions” or the amount of any such 98,363 at 90,498 (N.D.Cal.1994). Although transactions. Plaintiffs also conclude that Oak Plaintiffs need not specify the exact dollar amount of controlled EDEE without providing any explanation each error, they must identify particular transactions or allegations to support this conclusion. Lastly, the underlying Defendants' alleged accounting Consolidated Complaint contains no information to

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 60 of 163 Not Reported in F.Supp. Page 7 Not Reported in F.Supp., 1997 WL 448168 (N.D.Cal.) (Cite as: Not Reported in F.Supp.) elucidate Takaya's role in the alleged accounting fraud or the relationship between Takaya, EDEE and D. Liability of the Individual Oak Defendants Oak. Thus, Plaintiffs provide a feeble basis for their claims of fraudulent related transactions and fall well In the Consolidated Complaint, Plaintiffs seek to short of meeting the pleading requirements of 9(b) impose liability not only against Oak and the officers and the Reform Act. who released the allegedly misleading statements but also against Oak's outside directors and various divisional vice presidents of Oak. Plaintiffs assert 3. Excess Inventory and Purchase Commitments that these Defendants are responsible for the allegedly misleading statements even though none of *9 Plaintiffs allege that in summer and fall of 1995 the statements can be directly attributed to them on Oak committed to purchase millions of dollars worth the grounds that: (1) they participated in the scheme of wafers during fiscal 1996 and thereafter. ¶ 124. to defraud; (2) they are responsible for the Plaintiffs further allege that at the time the Oak statements under the group published information Defendants issued the financial statements for the doctrine; and (3) they sold stock while in possession second and third quarters of fiscal 1996, Defendants of material inside information. knew that, due to lack of demand for Oak's controller chips, Oak did not need and would be unable to sell the wafers it was obligated to purchase. Id. Thus, 1. Scheme to Defraud Plaintiffs assert that the Oak Defendants should have recognized a loss on its purchase commitments and Plaintiffs allege that each of the outside director and that failure to do so constituted a violation of GAAP. vice president Defendants, “as persons selling Oak Id. common stock, were direct participants in the scheme to defraud.” ¶ ¶ 25-32. Plaintiffs' general This claim of financial fraud regarding excess wafers allegations of Defendants' fraudulent assistance are attempts to impose liability for a difficult business misguided. decision: when to recognize a loss on inventory that a company may not use. According to Plaintiffs, *10 Pursuant to the Supreme Court's ruling in Defendants violated GAAP by failing to recognize a Central Bank v. First Interstate Bank, 511 U.S. 164, loss for its purchase commitments during second and 114 S.Ct. 1439, 128 L.Ed.2d 119 (1994), this Court, third quarters of fiscal 1996. However, “GAAP is along with several other courts in this district, have not a set of rules ensuring identical treatment of held that secondary liability claims based on identical transactions; rather, it tolerates a range of allegations of “conspiracy” are not actionable under reasonable treatments, leaving the choice among section 10(b). Stack v. Lobo 1995 WL 241448, *10 alternatives to management.” In re Cirrus Logic Sec. (N.D.Cal. Apr.19, 1995); In re Syntex Corp. Litig., 946 F.Supp. 1446, 1457 (N.D.Cal.1996). Securities Litigation, 855 F.Supp. 1086, 1097-98 Thus, at the pleading stage, a plaintiff must allege (N.D.Cal.1994). Here, Plaintiffs' “scheme” facts sufficient to support a finding that the allegations are no more than a thinly disguised accounting decision is the result of fraud and not attempt to avoid the impact of the Central Bank “merely the difference between two permissible decision. See, e.g., Stack, 1995 WL 241448 at *10 judgments.” Glenfed, 42 F.3d at 1549. (dismissing the plaintiffs' “scheme” claims with prejudice) In re Gupta Corp. Securities Litigation, Here, the Consolidated Complaint does not contain 1994 WL 748988, *28 (N.D.Cal. Dec.9, 1994) any specific allegations to support the claim that (rejecting the plaintiffs' attempts to recharacterize Defendants committed fraud by failing to recognize a non-actionable conspiracy claims as “scheme” loss in the second and third quarters. Rather, the claims, and dismissing such claims with prejudice). Consolidated Complaint merely sets forth the Accordingly, Plaintiffs' claims of participation in a conclusory allegation that Defendants should have “scheme” to defraud investors must be dismissed. recognized a loss earlier because they were aware that demand for Oak's controller chips was “weakening severely and continuing to weaken.” ¶ 2. Group Pleading Exception 124. Thus, Plaintiffs once again fail to meet the particularity requirements of Rule 9(b) and the Rule 9(b) requires a plaintiff to attribute fraudulent Reform Act. acts or statements to a particular defendant. Schreiber Distributing v. Serv-Well Furniture Co.,

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806 F.2d 1393, 1401 (9th Cir.1986). However, the misstatements. In re Interactive Network, Inc. Sec. Ninth Circuit has recognized an exception to this Litig., 948 F.Supp. 917, 921 (N.D.Cal.1995). rule: In cases of corporate fraud where the false or Plaintiffs further allege that Defendants King, Black, misleading information is conveyed in prospectuses, and Tomlinson, as members of the Audit Committee registration statements, annual reports, press releases, of Oak's Board of Directors, “reviewed and approved or other “group-published information,” it is the issuance of Oak's false financial statements reasonable to presume that these are the collective during fiscal 1996.” ¶ ¶ 31, 32. However, Plaintiffs actions of the officers. Under such circumstances, a fail to allege these Defendants' specific roles in the plaintiff fulfills the particularity requirement of Rule review and approval of the allegedly false financial 9(b) by pleading the misrepresentations with statements. Allegations that outside directors merely particularity and where possible the roles of the held positions on committees responsible for the individual defendants in the misrepresentations. preparation and disclosure of a corporation's finances are insufficient to set forth the circumstances Wool, 818 F.2d at 1440. Notwithstanding the group constituting fraud with particularity. In re GlenFed, pleading exception to Rule 9(b), Plaintiffs must still Inc., 60 F.3d 591, 593 (9th Cir.1995); Rubin v. set forth the circumstances constituting the fraud. Trimble, 1997 WL 227956, at *19 (N.D.Cal.). Thus, That is, the group pleading exception does not excuse their conclusory allegation does not meet the Plaintiffs from setting forth the time, place and stringent pleading requirements of Rule 9(b) and the content of the alleged misstatements, GlenFed, 42 Reform Act. F.3d at 11547-48, as well as an explanation of why each of those statements was false when made. Id. at Plaintiffs further make the conclusory allegation that 1549. As explained above, Plaintiffs have not “Ko was involved in the day-to-day operations of alleged with sufficient particularity that Oak's Oak.” ¶ 29. Again, this general allegation does not statements were false when made. satisfy the strict pleading requirements of Rule 9(b) and the Reform Act. If, upon amendment, Plaintiffs can state with particularity why Oak's statements were false when Plaintiffs also fail to allege with particularity that Mr. made, Plaintiffs may seek to establish the liability of Hsu was involved in Oak's day-to-day operations, or the outside director Defendants for those statements. that he prepared or communicated group information However, in order to establish the liability of the to the public. Thus, with regard to each of the outside director defendants for Oak's allegedly outside director Defendants, the Consolidated misleading statements, Plaintiffs must satisfy the Complaint fails to allege facts demonstrating their requirements for the group pleading exception in the operational involvement with Oak, a prerequisite for Ninth Circuit: “To rely upon the ‘group published group pleading. information’ presumption, Plaintiffs' complaint must contain allegations that an outside director either To establish the liability of the vice president participated in the day-to-day corporate activities, or Defendants under the group pleading exception, had a special relationship with the corporation, such Plaintiffs must satisfy a necessarily stricter as participation in preparing or communicating group requirement. Since all of the inside officers in a information at particular times.” In Re GlenFed, 60 corporation, by virtue of their positions, are involved F.3d 591, 593 (9th Cir.1995). Moreover, the in daily corporate activities, merely pleading as much allegations concerning the outside director is not sufficient to establish their liability under the Defendants' involvement with Oak must satisfy the group pleading exception. To establish the liability particularity requirements set forth by the Reform of these Defendants for Oak's allegedly misleading Act. statements, Plaintiffs must plead that these vice presidents were directly involved “not only in the *11 Here, with regard to all of the outside director day-to-day affairs of [Oak] in general but also in [the Defendants, Plaintiffs allege that “because of [their] preparation of its] financial statements in particular.” positions with Oak, they knew the adverse non-public Wool, 818 F.2d at 1440. The existing Complaint information about Oak's business, finances, products, does not allege that these Defendants participated in markets and present and future business prospects.” ¶ the preparation or communication of allegedly ¶ 29, 30, 31, 32. However, general allegations that misleading information. Thus, Plaintiffs have failed outside directors were “privy to inside information” to establish the liability of the vice president are insufficient to establish their liability for alleged Defendants under the group pleading exception.

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with specificity that they traded contemporaneously with Defendants. Silicon Graphics, 1996 WL 3. Insider Trading 664639, at *9. Thus, Plaintiffs claims of insider trading must be dismissed. *12 Plaintiffs also argue that even if the outside director and vice president Defendants did not personally make false and misleading statements to E. H & Q's LIABILITY the public, and even if the group pleading exception is inapplicable, these Defendants are nonetheless Defendant H & Q contends that it cannot be liable to liable under 10b-5 for failing to disclose adverse non- Plaintiffs, who were not clients of H & Q, for the public information known to them when they sold allegedly misleading statements in its analysts' their stock. ¶ ¶ 12, 14, 133. reports. In response, Plaintiffs rely on the holdings of Warshaw v. Xoma Corp., 74 F.3d 955 (9th In their allegations of insider trading, Plaintiffs rely Cir.1996) and Fecht v. Price Co., 70 F.3d 1078 (9th on Chiarella v. U.S., 445 U.S. 222, 100 S.Ct. 1108, Cir.1995), for the proposition that if a company may 63 L.Ed.2d 348 (1979), in which the Supreme Court be held liable for publicly disseminating false established that rule 10b-5 not only bars fraudulent information through a securities analyst, then a statements, but in some contexts requires disclosure securities analyst itself must also be liable to the of facts known to an insider. “[A] corporate insider public at large for that same information. However, must abstain from trading in the shares of his neither Warshaw nor Fecht involved claims against corporation unless he has first disclosed all material securities analysts. Rather, these cases established inside information known to him.” Chiarella, 445 that where a public company “intentionally used U.S. at 227. [securities analysts] to disseminate false information to the investing public, ... [it] cannot escape liability Plaintiffs, however, confuse distinct theories of simply because it carried out its alleged fraud through recovery under Rule 10b-5. While an action for the public statements of third parties.” Warshaw, 74 insider trading is indeed an application of Rule 10b-5, F.3d at 959. it is not the same as an action based on misleading statements. Insider trading involves a failure to *13 Here, Plaintiffs seek to extend the holdings of disclose material information; it does not concern Warshaw and Fecht. In so doing, they draw an any affirmative misrepresentation. Moreover, an abrupt and unwarranted conclusion: “Given that Oak allegation of insider trading does not permit alleged itself ... can be held liable for using H & Q's analyst misstatements to be attributed to a group. Thus, reports as a conduit to the market, it is ridiculous to Plaintiffs cannot attribute Oak's alleged suggest that H & Q is immune from liability for misrepresentations to the outside director and vice disseminating its own misrepresentations through president Defendants merely by alleging insider those same analyst reports.” Plaintiffs' Opposition at trading. 16 (emphasis omitted). Yet, Plaintiffs' assessment is based on nothing more than their own normative Further, even as a separate theory of recovery under judgment. In fact, they do not offer any competent 10(b)-5 Plaintiffs' claims of insider trading fails. authority supporting the contention that a securities While the outside director and vice president analyst owes any duty at all to non-clients. See In re Defendants, as Oak “corporate insiders,” had a duty Valence Technology Securities Litig., 1996 WL 3778, to disclose material information when selling their *9 (N.D.Cal. January 23, 1996). Nevertheless, this shares in Oak,” Plaintiffs fail to specify what material Court will address the issue of H & Q's potential and information these Defendants possessed. Plaintiffs' actual liability in this case. general allegation that, “because of [their] ... position[s] with Oak,” each of the outside director and vice president Defendants “knew the adverse 1. Omissions in Analyst Reports non-public information about Oak's business, finances, products, markets and present and future H & Q cannot be liable to Plaintiffs under section business prospects,” 1 25-32, does not satisfy the 10(b) for any omissions in its analyst reports. The strict pleading requirements of Rule 9(b) and the Supreme Court has held that silence in connection Reform Act. As explained above, Plaintiffs have not with a purchase or sale of securities may indeed sufficiently specified the “adverse non-public operate as a fraud, “[b]ut such liability is premised information.” Additionally, Plaintiffs have not pled upon a duty to disclose arising from a relationship of

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 63 of 163 Not Reported in F.Supp. Page 10 Not Reported in F.Supp., 1997 WL 448168 (N.D.Cal.) (Cite as: Not Reported in F.Supp.) trust and confidence between parties to a allegations of fraud ... punctuated by a handful of transaction.” Chiarella, 445 U.S. at 230. Plaintiffs neutral facts.” Semegen v. Weidner, 780 F.2d 727, do not allege that any such relationship existed here. 731 (9th Cir.1985). Thus, the existing Complaint No named plaintiff was a client of H & Q. Moreover, fails to establish H & Q's liability for alleged Plaintiffs do not allege that H & Q sold any Oak misstatements in its analyst reports. stock during the class period; H & Q, that is, was not a “part[y] to [any] transaction” involving Oak stock. Thus, H & Q did not owe Plaintiffs a duty to disclose 3. Control Person Liability adverse facts, and it cannot be liable to Plaintiffs for any omissions in its analyst reports. Plaintiffs also contend that H & Q is liable as a control person of Mr. Hsu, who is himself liable, they argue, as a control person of Oak, for the alleged 2. Fraud on the Market Doctrine false and misleading statements inflating Oak's stock price. To state a claim for control person liability, While securities analysts cannot be liable to non- Plaintiffs must establish (1) a primary violation of the clients for omissions in their analyst reports, they can federal securities laws, and (2) “ ‘control’ by the be liable for affirmative misstatements in those alleged controlling person.” FN4 First Interstate Bank reports. The “fraud on the market doctrine” provides of Denver v. Pring, 969 F.2d 891, 897 (10th a basis for such liability. “In the usual claim under Cir.1992). Section 10(b), the plaintiff must show individual reliance on a material misstatement. Under the fraud on the market theory, the plaintiff has the benefits of FN4. In the regulations of the Securities and a presumption that he has indirectly relied on the Exchange Commission (SEC), “control” is alleged misstatement, by relying on the integrity of defined as “the possession, direct or indirect, the stock price established by the market.” In re of the power to direct or cause the direction Apple Computer Sec. Litig., 886 F.2d 1109, 1113-14 of the management and policies of a person, (9th Cir.1989). whether through the ownership of voting securities, by contract, or otherwise.” 17 While the fraud on the market doctrine relaxes the C.F.R. § 230.405. proof required for the reliance element in class action securities fraud litigation, In re MDC Holdings Here, as noted above, Plaintiffs fail to allege with Securities Litig., 754 F.Supp. 785, 800 particularity that Oak made any actionable (S.D.Cal.1990), it does not excuse plaintiffs from the misstatements. Where, as here, there are no primary strict pleading requirements of Rule 9(b) and the violations pled with particularity, all secondary Reform Act. To adequately allege fraud, a plaintiff liability claims must fail as well. See Stack v. Lobo, must set forth an explanation as to why the disputed 1995 WL 241448 at *10. statements were false or misleading when made. GlenFed, 42 F.3d at 1549. “This can be done most Furthermore, Plaintiffs have not adequately alleged directly by pointing to inconsistent contemporaneous that H & Q was a controlling person of Mr. Hsu and statements or information (such as internal reports) that Mr. Hsu, in turn, was a controlling person of which were made by or available to defendants.” Id. Oak. In general, the determination of who is a controlling person for purposes of liability under *14 Here, Plaintiffs allege that by disseminating false section 20(a) is “an intensely factual question,” information, H & Q committed a fraud on the market. Arthur Children's Trust v. Keim, 994 F.2d 1390, 1396 However, they do not plead with the requisite (9th Cir.1993), involving “scrutiny of the defendant's particularity. Plaintiffs fail to cite specifically any participation in day-to-day affairs of the corporation internal documents or other contemporaneous facts and the defendant's power to control corporate indicating that H & Q did not believe its projections actions.” Kaplan v. Rose, 49 F.3d 1363, 1383 (9th concerning Oak's performance. Instead, they merely Cir.1994). While Plaintiffs correctly note that recite portions of H & Q's analysts' reports and section 20(a) “premises liability solely on the control declare them fraudulent. ¶ ¶ 57, 70, 79, 88, 93, 97, relationship,” First Interstate Bank, N.A. v. Pring, 102. Even before the Reform Act heightened the 969 F.2d 891, 897 (10th Cir.1992); see also pleading requirements in securities fraud litigation, Hollinger v. Titan Capital Corp., 914 F.2d 1564, the Ninth Circuit rejected this style of pleading: It is 1575 (9th Cir.1990), they fail to recognize the insufficient merely to “set forth conclusory requirement that the circumstances of that “control

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 64 of 163 Not Reported in F.Supp. Page 11 Not Reported in F.Supp., 1997 WL 448168 (N.D.Cal.) (Cite as: Not Reported in F.Supp.) relationship” be pled with particularity. Here, again, based on allegations of “conspiracy” are not Plaintiffs have not satisfied the strict pleading actionable under section 10(b). Thus, Plaintiffs' requirements of Rule 9(b) and the Reform Act. claims of H & Q's participation in a “scheme” to defraud investors must be dismissed. As explained above, Plaintiffs do not allege with particularity that Mr. Hsu, an outside director of Oak, “participated in Oak's day-to-day operations,” or that IV. CONCLUSION he had “power to control [Oak's] corporate actions.” Kaplan, 49 F.3d at 1383. Thus, Plaintiffs fail to For the foregoing reasons, the Court orders that the establish the “control relationship” between Mr. Hsu Consolidated Complaint is hereby DISMISSED. and Oak required for control person liability. Plaintiffs may amend their complaint, in accordance with this order, within thirty (30) days. *15 Moreover, Plaintiffs fail to plead with particularity the “control relationship” between H & IT IS SO ORDERED. Q and Mr. Hsu. Plaintiffs allege that “[b]y reason of H & Q's position as underwriter, broker-dealer and N.D.Cal.,1997. market maker and its substantial ownership of Oak In re Oak Technology Securities Litigation common stock, H & Q had the power and authority ... Not Reported in F.Supp., 1997 WL 448168 to cause Hsu to engage in the wrongful conduct (N.D.Cal.) complained of herein.” ¶ 144. However, H & Q's “position” “does not create any presumption of END OF DOCUMENT control,” Arthur Children's Trust, 994 F.2d at 1397 (quoting 4 Louis Loss & Joel Seligman, Securities Regulation, 1724 (1990)) (emphasis in original), and does not by itself sustain an allegation of control person liability. In their general allegations, Plaintiffs do not delineate H & Q's involvement in Mr. Hsu's “day-to-day affairs” or how H & Q controlled Mr. Hsu's involvement with Oak. Furthermore, Plaintiffs fail to address the distinction between Hambrecht and Quist Asia Pacific, an overseas entity in which H & Q holds a minority interest, and H & Q itself. Thus, Plaintiffs do not satisfy the pleading requirements with respect to the “control relationship” necessary for control person liability.

In sum, the chain running from H & Q to Oak through Mr. Hsu has two very weak links. Plaintiffs have not sufficiently alleged a control relationship between Mr. Hsu and Oak. Similarly, they have not adequately specified the control relationship between H & Q and Mr. Hsu. Therefore, Plaintiffs fail in their ultimate attempt to establish a control relationship between H & Q and Oak.

4. The Scheme to Defraud

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

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is to these that the court devotes the bulk of this Briefs and Other Related Documents order. Only the Westlaw citation is currently available. United States District Court,N.D. California. In re PORTAL SOFTWARE, INC SECURITIES I LITIGATION No. C-03-5138 VRW. Plaintiff John Romeo (Romeo) and plaintiff Pipefitters Local 522 & 633 Pension Fund Trust Aug. 10, 2005. (Pipefitters) (collectively, plaintiffs), purporting to represent investors who purchased securities of Portal Software Inc (Portal) between May 20, 2003, and Mario Alba, Cauley Geller Bowman & Rudman LLP, November 13, 2003, inclusive (the “class period”), Robert M. Rothman, Lerach Coughlin Stoia Geller bring this action under the Securities Exchange Act Rudman & Robbins LLP, Melville, NY, Robert A. of 1934 (the “ '34 Act”) and the Securities Act of Jigarjian, Robert S. Green, Jenelle Welling, Green & 1933 (the “ '33 Act”). Plaintiffs allege that defendants Jigarjian LLP, San Francisco, CA, Jonathan M. Stein, Portal, John Little (Little), Howard A Bain III (Bain) Cauley Geller Bowman & Rudman, LLP, Boca and Arthur C Patterson (Patterson) (collectively Raton, FL, for Plaintiffs. defendants) violated the Generally Accepted Nina F. Locker, Peri Beth Nielsen, Wilson Sonsini Accounting Principals (GAAP) by artificially Goodrich & Rosati, Palo Alto, CA, Joseph M. inflating the price of Portal's stock and making false Barton, Solomon B. Cera, Gold Bennett Cera & and misleading statements on which plaintiffs relied, Sidener LLP, San Francisco, CA, for Defendants. thereby incurring substantial financial loss from purchasing Portal stock at fraudulently inflated ORDER prices. Defendants' move to dismiss (Doc # 115) WALKER, Chief J. plaintiffs' third consolidated amended complaint *1 Plaintiffs in this securities fraud class action face (TCAC; Doc # 111) for failure to meet the the unenviable task of complying with the stringent particularity requirement imposed by FRCP 9(b) and pleading requirements imposed on such actions. All the Private Securities Litigation Reform Act too frequently, and once again here, plaintiffs attempt (PSLRA) (amendments to the '33 and '34 Acts). this endeavor by a complaint replete with evidentiary Plaintiffs oppose the motion, asserting that the TCAC detail, but only a loose (and the court thinks too states sufficiently particularized claims under § 10(b) loose) connection between the wrongful conduct and § 20(a) of the '34 Act, as well as claims under § alleged and its effect on the class. The Supreme § 11, 12(a)(2) and 15 of the '33 Act. Court has recently reminded lower federal courts that the heart of a fraud on a securities market is the The court heard argument on these motions on July 7, proximate causal link between the misstatement or 2005. Based upon the parties' arguments and the omission alleged and the resulting impact on the applicable federal law, the court concludes that: (1) security's price. Dura Pharms Inc. v. Broudo, --- U.S. the allegations in plaintiffs' complaint are not pled ----, 125 S.Ct. 1627, 161 L.Ed.2d 577 (2005). Despite with sufficient particularity under the PSLRA and the rather forgiving interpretation of Dura in this FRCP 9(b); (2) the allegations are not sufficient to circuit, see In re Daou Systems, Inc. Securities support a strong inference of scienter under the Litigation, 411 F.3d 1006, 2005 WL 1431833 (9th PSLRA; (3) defendants' forward-looking statements Cir. June 21, 2005), the operative pleading here fails are protected by the PSLRA's safe harbor provision; to make this connection. Because plaintiffs will be (4) claims under the '33 Act sound in fraud and allowed to amend, the court emphasizes the need for therefore fail with the '34 Act claims. Accordingly, plaintiff to allege facts that link defendants' alleged the court GRANTS defendants' motion to dismiss in wrongdoing to the class injury. A much shorter, but its entirety. targeted, pleading may well be more effective in making this connection than the rather distended pleading now at bar. But there are other shortcomings II in their pleadings that plaintiffs need to address and it

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*2 The factual and procedural history is derived from consisted of a trial version of the software for a few the TCAC and presumed true for purposes of this key employees. Portal would charge only a motion. Gompper v. VISX, Inc., 298 F.3d 893, 895 “nominal” amount for this first license. Then, if the (9th Cir.2002). Portal provides billing and subscriber client wished to obtain the full Infranet product, management solutions to its clients primarily through Portal would sell the client a “production license” its “Infranet” software. Portal charges companies and charge for the bulk of the contract. After fiscal “license fees” for the Infranet product, as well as 2004, plaintiffs allege that Portal simply charged a “service fees” for system implementation, consulting, greater portion of the contract price under the maintenance and training. Prior to 2001, the majority developmental license, even though it was still only a of Portal's customer base consisted of “dot-com” trial version and significant modifications yet were to start-up companies. Following the dot-com market be performed under the production license. Plaintiffs crash of 2001, Portal lost many of its customers and also allege that Portal's outside accountants, Ernst & incurred financial losses during fiscal 2002-2003 that Young, disapproved of this new split license wiped out more than 96% of Portal's equity. Portal arrangement and reversed Portal's position, a subsequently began to market its Infranet product to determination which ultimately caused the shortfall more established and sophisticated business in earnings and resulting stock price decline. TCAC customers, including telecommunications providers. at ¶ 43.

These new clients required greater customization of *3 Next, the former Senior Business Analyst asserts the software than had the dot-com startups, which in that he was instructed by company officials, turn affected the way in which Portal could recognize including Bain, to falsify revenue recognition studies license fee revenues. Pursuant to GAAP, if a software to justify premature recognition of revenue. Under provider rewrites portions of its product to conform GAAP, when a software contract provides for both to a client's unique needs, it may not fully recognize licensing and services, such as software modification the revenue on the license of software until such and implementation, the revenue from each element substantial modification has been performed. can only be recognized as it is performed, so long as Whereas Portal had historically been able to the “fair value” of each element is determinable. If recognize revenue at the time it delivered its Infranet the fair value of each element is not determinable, product to the dot-coms, the greater customization than recognition of the entire contract must be required by these new, more established clients deferred until all elements have been delivered, or required Portal to defer recognizing revenue from until such time as the fair value of the remaining much of its contracts until customization was elements are determinable. The Senior Business complete. Plaintiffs allege that during the class Analyst avers that when attempting to discern the fair period, Portal began to manipulate its license fees so value of elements of a software arrangement, he was it could recognize more revenue “up-front.” TCAC at directed by the management to “reverse engineer” the ¶ ¶ 41-42. study to reach predetermined results. This employee, who ceased employment several months before the To support their allegations that Portal improperly end of the class period, alleges that he was instructed recognized revenue prematurely and in violation of to falsify revenue recognition studies with regard to GAAP, plaintiffs rely on information from four contracts performed in “Greece, Italy, Columbia [sic] unnamed former Portal employees: (1) a controller; and Spain,” including a contract with “Columbia [sic] (2) a “Senior Business Analyst” ' (3) an accounts Mobile.” TCAC at ¶ 48. receivable and revenue assurance assistant; and (4) a “Senior Marketing Manager.” TCAC at ¶ ¶ 41-54. The third former employee on whom Plaintiffs rely is The first three employees detail three different an accounts receivable and revenue assurance methods of accounting fraud allegedly undertaken by assistant employed during the class period. She Portal management during the class period, while the alleges that “revenues related to [Portal's] contracts Senior Marketing Manager alleges ongoing product with Onstar ... [were] materially overstated during the problems and a decreasing market for key elements third quarter of fiscal 2004.” TCAC at ¶ 49. of Portal's software offering. Specifically, the former employee alleges that Portal would recognize revenue from the support, The information provided by the former controller maintenance and upgrade elements of the software involved Portal's method for recognizing licensing contract, even though the work had not yet been revenue. Historically, Portal preliminarily offered its performed. This employee asserts that she obtained customers a “developmental license,” which this knowledge because one of her duties of

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Marketing Manager to substantiate their allegations that Portal was misrepresenting the demand for its product and concealing significant technical III problems with its applications. Specifically, the marketing employee stated that portions of Portal's As a preliminary matter, the court considers billing software were being rendered obsolete by defendants' request for judicial notice (RJN, Doc # Customer Relationship Management (CRM) 119) regarding certain documents attached to the applications sold by vendors like SAP and Siebel. declaration of Randolph Gaw in support of TCAC at ¶ ¶ 51-52. Moreover, Portal's Infranet defendants' motion (Gaw Decl, Doc # 116). product was having difficulty interfacing with these Defendants contend that all the documents so CRM applications, resulting in unexpected costs and attached are the proper subject of judicial notice delays for Portal. TCAC at ¶ ¶ 53-54. Plaintiffs pursuant to FRE 201. allege that Portal's management failed to disclose these technical difficulties and the declining demand Exhibits N through U to the Gaw declaration are for Portal's product during the class period, thus Form 4s filed with the SEC regarding the stock sales concealing the true state of Portal's financial health. of the individual defendants and other corporate officers and directors, while exhibits A through H are Plaintiffs' complaint alleges that the accounting fraud the SEC filings of defendant Portal. Defendants described above was undertaken by defendants to contend that the court is authorized to take judicial inflate Portal's reported revenue numbers, which were notice of documents filed with the SEC. The court then used by defendants to create false and agrees that judicial notice of such documents is misleading statements regarding Portal's financial proper. See, e g, Bryant v. Avado Brands, Inc., 187 health and future business prospects. According to F.3d 1271, 1276 (11th Cir.1999); Allison v. Brooktree plaintiffs, these false and misleading statements Corp., 999 F.Supp. 1342, 1352 n3 (SD Cal 1998). artificially inflated Portal's stock price and allowed This conclusion is bolstered by the fact that courts are defendants to complete a $60 million secondary specifically authorized, in connection with a motion offering on September 12, 2003. Plaintiffs' claims for to dismiss a securities fraud complaint, to consider violations of the '33 Act are based on alleged false documents and filings described in the complaint and misleading statements made in the registration under the incorporation by reference doctrine. See, e statement and prospectus issued in connection with g, Ronconi v. Larkin, 253 F.3d 423, 427 (9th the secondary offering. TCAC at ¶ ¶ 142-165. Cir.2001); In re Silicon Graphics Securities Plaintiffs' claims for violations of the '34 Act are Litigation, 183 F.3d 970, 986 (9th Cir.1999). Thus, based on alleged false and misleading statements the court takes notice of all the documents attached to disseminated to the investing public via SEC filings the Gaw declaration that were filed with the SEC. and press releases. TCAC at ¶ ¶ 166-181. Exhibits I through M are Portal press releases, which *4 After the close of the market on November 13, defendants claim contain “safe harbor” warnings 2003, defendants announced that-due to contract regarding any forward-looking statements in the delays, revenue recognition deferrals and service press releases. Judicial notice of these exhibits is execution issues-Portal expected net losses of $0.36 proper because the court is required to consider “any to $0.40 per share for the third quarter fiscal 2004. cautionary statement accompanying [a] forward- These losses were in contrast to the net profits of looking statement, which [is] not subject to material $0.04 per share that Portal had previously projected dispute, cited by the defendant.” 15 USC § 78u-5(e). for the quarter. Subsequent to the November 11, In addition, the court may take judicial notice of 2003, announcement, the price of Portal's common information that was publicly available to reasonable shares plummeted 42% to $8.77 in after hours investors at the time the defendant made the allegedly trading. TCAC at ¶ 75. Plaintiffs allege that this false statements. See In re The First Union Corp

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Securities Litigation, 128 F Supp 871, 883 (WD NC 899, 902 (6th Cir.2003). 2001). This is true of press releases, even if they were not explicitly referenced in the complaint. See Under Rule 12(b)(6), a complaint “should not be Wietschner v. Monterey Pasta Co., 294 F Supp 2d dismissed for failure to state a claim unless it appears 1102, 1108-09 (N.D.Cal.2003). beyond doubt that plaintiff can prove no set of facts in support of [her] claim which would entitle [her] to *5 Exhibit V to the Gaw declaration is the “Statement relief.” Hughes v. Rowe, 449 U.S. 5, 9, 101 S.Ct. 173, of Position 97-2 Software Revenue Recognition.” 66 L.Ed.2d 163 (1980) (citing Haines v. Kerner, 404 This is an accounting statement issued by the U.S. 519, 520, 92 S.Ct. 594, 30 L.Ed.2d 652 (1972)); American Institute of Certified Public Accountants. see also Conley, 355 U.S. at 45-46. All material RJN Doc # 19 at 4. Courts may take judicial notice of allegations in the complaint must be taken as true and documents that are alleged in the complaint and construed in the light most favorable to plaintiff. See whose authenticity no party questions, even when not Silicon Graphics, 183 F.3d at 980 n10. But “the court attached to the complaint. See Branch v. Tunnell, 14 [is not] required to accept as true allegations that are F.3d 449, 454 (9th Cir.1994). merely conclusory, unwarranted deductions of fact, or unreasonable inferences.” Sprewell v. Golden State Finally, at oral argument on July 7, 2005, plaintiffs Warriors, 266 F.3d 979, 988 (9th Cir.2001) (citing submitted to the court three additional documents and Clegg v. Cult Awareness Network, 18 F.3d 752, 754- requested that the court take judicial notice of them in 55 (9th Cir.1994)). considering this motion. Doc # 130. These documents include (1) a Portal press release dated June 30, 2005; Review of a FRCP 12(b)(6) motion to dismiss is (2) Portal's Form 8-K filed with the SEC on June 27, generally limited to the contents of the complaint, 2005; and (3) Portal's Form 10-Q for the quarter and the court may not consider other documents ending October 31, 2004, filed with the SEC on April outside the pleadings. Arpin v. Santa Clara Valley 25, 2005. Id. The court takes notice of these Transportation Agency, 261 F.3d 912, 925 (9th documents, which are all public filings capable of Cir.2001). The court may, however, consider judicial notice. documents attached to the complaint. Parks School of Business, Inc. v. Symington, 51 F.3d 1480, 1484 (9th Cir.1995). If a plaintiff fails to attach to the complaint IV the documents on which the complaint is based, a defendant may attach such documents to its motion to Standard of Review dismiss for the purpose of showing that the documents do not support plaintiff's claim. In re Autodesk, Inc. Securties Litigation, 132 F Supp 2d FRCP 12(b)(6) motions to dismiss essentially “test 833, 837 (N.D.Cal.2000) (citing Branch v. Tunnel, 14 whether a cognizable claim has been pleaded in the F.3d 449, 454 (9th Cir.1994)). This permits the court complaint.” Scheid v. Fanny Farmer Candy Shops, to consider the full text of a document that the Inc., 859 F.2d 434, 436 (6th Cir.1988). FRCP 8(a), plaintiff's complaint only partially quotes. Autodesk, which states that plaintiff's pleadings must contain “a 132 F Supp 2d at 838 (citing In re Stac Electronics short and plain statement of the claim showing that Securities Litigation, 89 F.3d 1399, 1405 n4 (9th the pleader is entitled to relief,” provides the standard Cir1996), cert. denied, 520 U.S. 1103, 117 S.Ct. for judging whether such a cognizable claim exists. 1105, 137 L.Ed.2d 308 (1997)). Additionally, “[t]he Lee v. City of Los Angeles, 250 F.3d 668, 679 (9th court need not * * * accept as true allegations that Cir.2001). This standard is a liberal one that does not contradict matters properly subject to judicial notice require plaintiff to set forth all the factual details of * * *.” Sprewell, 266 F.3d at 988 (citing Mullis v. his claim; rather, all that the standard requires is that United States Bankr Ct., 828 F.2d 1385, 1388 (9th plaintiff give defendant fair notice of the claim and Cir.1987)). the grounds for making that claim. Leatherman v. Tarrant County Narcotics Intell & Coord Unit, 507 *6 But these liberal pleading standards described U.S. 163, 168, 113 S.Ct. 1160, 122 L.Ed.2d 517 above have been substantially tightened in the (1993) (citing Conley v. Gibson, 355 U.S. 41, 47, 78 context of securities litigation, as will be discussed S.Ct. 99, 2 L.Ed.2d 80 (1957)). To this end, plaintiff's infra. complaint should set forth “either direct or inferential allegations with respect to all the material elements of the claim”. Wittstock v. Van Sile, Inc., 330 F.3d V

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based upon information and belief, “state with The TCAC alleges five causes of action. For the first particularity all facts on which that belief is formed” and second causes of action, plaintiffs allege (15 USC § 78u-4(b)(1)); and (3) “with respect to violations of sections 11 and 12(a)(2) of the '33 Act each act or omission * * * state with particularity against all defendants. Plaintiffs' first and second facts giving rise to a strong inference that the causes of action are based on the registration defendant acted with the required state of mind” (15 statement Portal filed for its secondary public USC § 17u-4(b)(2)). The required state of mind, or offering (SPO) in September 2003. Plaintiffs' third scienter, is met where the complaint alleges that the cause of action alleges control liability under section defendants made the false or misleading statements 15 of the '33 Act against Little, Bain and Patterson either intentionally or with deliberate recklessness.” (the “individual defendants”). Plaintiffs' fourth cause In re Daou Systems, Inc. Securities Litigation, 411 of action alleges violations of section 10(b) of the '34 F.3d 1006, 2005 WL 1431833 (9th Cir. June 21, Act and Rule 10b-5 promulgated thereunder against 2005) (citing Silicon Graphics, 183 F.3d at 974) all defendants. Lastly, plaintiffs allege control (emphasis added). In securities cases, falsity and liability under section 20(a) of the '34 Act against the scienter “are generally inferred from the same set of individual defendants. The court will first address facts and the two requirements may be combined into first plaintiffs' claims under the '34 Act before turning a unitary inquiry under the PSLRA.” In re Vantive to the claims brought under the '33 Act. Corp. Securities Litigation, 283 F.3d 1079, 1091 (9th Cir.2002) (citations omitted).

A *7 Even if plaintiffs meet these heightened pleading requirements, however, the PSLRA carves out a safe Section 10(b) and 20(a) of the Exchange Act of 1934 harbor from liability if the alleged false or misleading statements were forward-looking and accompanied by meaningful risk warnings. 15 USC § 78u-5(c); Section 10(b) of the '34 Act and SEC Rule 10b-5, see also In re Splash Technology Holdings, Inc promulgated thereunder, make it unlawful for any Securities Litigation, 2000 U.S. Dist LEXIS 15369, person, in connection with the purchase or sale of any *16 (ND Cal) (Splash I ). An analogous doctrine security, to (1) engage in fraud or (2) make an untrue (which predates the enactment of the PSLRA) is the statement regarding a material fact or (3) make a “bespeaks caution” doctrine, which allows a court to misleading statement by omitting a material fact. 15 rule as a matter of law that defendant's forward- U.S.C. § 78j(b); 17 CFR § 240.10b-5. looking statements contained enough cautionary Consequently, the elements of a Rule 10b-5 claim language or risk disclosure to protect against liability. are: (1) a material misrepresentation or omission of See, e g, Provenz v. Miller, 102 F.3d 1478, 1493 (9th fact, (2) scienter, (3) a connection with the purchase Cir.1996). If a defendant's statements are immunized or sale of a security, (4) transaction and loss under either doctrine, dismissal of the complaint is causation, and (5) economic loss. See Dura, 125 S Ct appropriate. See id; Splash I, 2000 U.S. Dist LEXIS at 1633. at *29.

Claims brought under Section 10(b) and Rule 10b-5 Defendants challenge the sufficiency of plaintiffs' '34 must first meet the particularity requirements of Act claims on several grounds: (1) plaintiffs' FRCP 9(b). In re Stac, 89 F.3d at 1404; see also In re complaint lacks the specificity needed to plead GlenFed Inc. Securities Litigation, 42 F.3d 1541, accounting fraud; (2) plaintiffs fail to plead facts 1545 (9th Cir.1994) (en banc). Rule 9(b) requires a raising a strong inference of scienter; and (3) plaintiff alleging fraud to “set forth what is false or defendants' statements are protected by the PSLRA's misleading about [the] statement[ ] and why it is safe harbor provision. Before turning to the issue of false.” GlenFed, 42 F.3d at 1548. safe harbor, the court will address the defendants' first two contentions under the “unitary inquiry” Second, a complaint must satisfy the more stringent advocated in this circuit, as “falsity and scienter are requirements imposed on securities fraud pleadings generally inferred from the same set of facts * * *.” by the PSLRA. Specifically, the PSLRA requires that In re Vantive, 283 F.3d at 1091. a complaint: (1) “specify each statement alleged to have been misleading [and] the reason or reasons why the statement is misleading * * * ” (15 USC § 1 78u-4(b)(1)); (2) with respect to any such allegations

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Defendants contend that the TCAC should be Daou, 411 F.3d 1006, 2005 WL 1431833 at *4. The dismissed because plaintiffs have not adequately pled inquiry focuses on whether unnamed sources of facts to support their allegations of accounting fraud information in the complaint are described “with or to support a strong inference of scienter. “If sufficient particularity to support the probability that properly pled, overstating of revenues may state a a person in the position occupied by the source would claim for securities fraud, as under GAAP, revenue possess the information alleged.” Nursing Home must be earned before it can be recognized.” In re Pension Fund, Local 114 v. Oracle Corp., 380 F.3d Daou, 2005 WL 141833 at *5 (citations omitted) 1226, 1233 (9th Cir.2001) (quoting Novak v. Kasaks, (emphasis in original). Plaintiffs must plead facts 216 F.3d 300, 314 (2d Cir.2000)). These personal sufficient to support a conclusion that defendants sources need not be named so long as the information “prepared the fraudulent financial statements and that they provide is adequately corroborated by other the alleged financial fraud was material.” See id facts. Silicon Graphics, 183 F.3d at 985. (quoting In re Peerless Systems, Corp. Securities Litigation, 182 F Supp 2d 982, 991 (S.D.Cal.2002). In In re Daou, the Ninth Circuit recently adopted the First Circuit's “suggested criteria for assessing Although violations of GAAP standards may provide reliability of confidential witnesses.” In re Daou, 411 evidence of scienter, see id, the complaint must F.3d 1006, 2005 WL 1431833 at *4. These criteria allege GAAP violations with sufficient particularity include “the level of detail provided by the to support a strong inference of scienter. See, e g, In confidential sources, the corroborative nature of the re McKesson HBOC, Inc. Securities Litigation, 126 F other facts alleged (including from other sources), the Supp 2d 1248, 1273 (N.D.Cal.2000) (“[w]hen coherence and plausibility of the allegations, the significant GAAP violations are described with number of sources, the reliability of the sources, and particularity in the complaint, they may provide similar indicia.” In re Cabletron Sys. Inc., 311 F.3d powerful indirect evidence of scienter. After all, 11, 29 (1st Cir.2002). Moreover, when a complaint books do not cook themselves.”.) The inquiry focuses relies on unnamed employees, courts generally look on the specificity of the allegations; “a general for specific descriptions of the employee's relevant allegation that the practices at issue resulted in a false duties and responsibilities to evaluate the reliability report of company earnings is not a sufficiently of their information. See, e g, In re Daou, 411 F.3d particular claim of misrepresentation.” In re Daou, 1006, 2005 WL 1431833 at *4 (finding that 411 F.3d 1006, 2005 WL 1431833 at *5 (quoting confidential witnesses were described with a “large Greebel v. FTP Software, Inc., 194 F.3d 185, 203-04 degree of particularity” where, in all cases, their job (1st Cir.1999). description and responsibilities were delineated, and in some cases, plaintiffs identified the executive to *8 The Ninth Circuit recently instructed that whom the employee reported); see also In re complaints stating sufficiently particular accounting Northpoint Communications Group, Inc., 221 F Supp irregularities should include: “(1) such basic details 2d 1090, 1097 (N.D.Cal.2002) (holding that a second as the approximate amount by which revenues and amended complaint cured some specificity problems earnings were overstated; (2) the products involved in of original complaint where it set out, in addition to the contingent transaction; (3) the dates of any of the job titles and tenure of confidential witnesses, their transactions; or (4) the identities of any of the responsibilities at the company). customers or [company] employees involved in the transactions.” In re Daou, 411 F.3d 1006, 2005 WL *9 The TCAC relies in large part upon information 1431833 at *6 (citations and internal quotation marks provided by three unnamed former Portal employees omitted). Although the complaint need not provide to substantiate allegations that defendants were each and every detail described above, it should engaging in accounting fraud in order to overstate enable a court to determine whether the alleged fraud revenue. Plaintiffs identify these employees by either “constituted widespread and significant inflation of their titles or their positions in the company, but revenue.” Id. generally fail to describe with any particularity the duties of each employee, or how or why they came to Before reaching the substance of plaintiffs' be familiar with the information they provide. complaint, the court notes that plaintiffs' allegations Despite plaintiffs' failure to specify each employee's are derived, in large part, from information provided duties, in some cases the employees' accounts by confidential witnesses. The Ninth Circuit requires themselves describe their relevant duties in the course a particular inquiry to determine if the use of such of relating elements of the alleged accounting fraud. confidential sources satisfies the PSLRA. See In re Consequently, the court cannot adopt wholesale the

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With these legal principles in mind, the court turns to Moreover, the analyst asserts that he was personally plaintiffs' allegation that Portal engaged in directed to create these false studies by defendant accounting fraud by falsely inflating revenues to Bain, the CFO. Id ¶ 47. These fabrications involved conceal Portal's precarious financial condition. falsely selecting high billing rates to inflate revenues Specifically, plaintiffs allege that defendants for work already performed on contracts (Id ¶ 46) or prematurely recognized revenue by (1) improperly falsely calculating a low value for undelivered categorizing licensing revenue, (2) overstating elements so that greater revenue could be attributed purported billing rates to recognize greater costs on to the elements already delivered (Id ¶ 47). delivered elements of a contract, (3) manipulating the fair value amount attributable to undelivered items Although the Senior Business Analyst only identifies and (4) recognizing revenue before project one customer by name for whom he created false milestones were approved by customers. revenue recognition studies (Columbia Mobile), he alleges that he was “required to perform analyses that Plaintiffs allege that defendants manipulated license matched management's predetermined results for agreements into two parts and improperly priced the work performed in * * * Greece, Italy, Columbia and first part of the license with the bulk of the contract Spain in connection with at least six of Portal's major fee so that they could recognize the revenue contracts” and that Portal booked $5 million in prematurely. TCAC ¶ ¶ 41-43. In support of this revenue as a result of these contracts. Id ¶ 48. Based allegation, plaintiffs rely entirely on information on his personal involvement in fraudulent activity at provided by a former controller. Id. Yet, the former the behest of Bain, the court concludes that these controller's account does not contain inherent indicia allegations potentially support a claim under the '34 of reliability. First, her employment with Portal Act. Moreover, the court finds that the specificity of ended almost a year before the class period even the account indicates a level of reliability. Yet began. TCAC ¶ 41. Consequently, her entire account because the analyst's account provides no indication of Portal's fraudulent revenue recognition practices of how these alleged manipulations affected Portal's during the class period are based on second-hand financial earnings statements, further corroboration is reports from company “insiders.” Id ¶ 43. Although necessary to meet the heightened pleading she has personal knowledge to support her requirements of the PSLRA. descriptions of Portal's revenue recognition practices prior to the class period, it is the allegations that Next, the TCAC alleges that defendants engaged in Portal made fraudulent changes to these recognition improper revenue recognition through testimony of practices during the class period that require “a an accounts receivable and revenue assurance reasonable conviction in the informant's basis of assistant who allegedly worked at Portal during the knowledge.” In re NorthPoint, 221 F Supp 2d at class period. TCAC ¶ 49. Again, this employee's 1097. Hence, plaintiffs must describe the job title, job account self-identifies her duties and basis for description, duties, and dates of employment for the knowledge, mitigating the TCAC's failure to do so. controller's sources before this information can be For example, the assistant specifies that “one of [her] deemed reliable. Plaintiffs have made no attempt to duties was to reclassify revenue for future quarters.” provide such information about any of the controller's Id ¶ 49. It was through this work, she alleges, that “insiders,” and consequently, plaintiffs' allegations she came to learn that Portal was improperly regarding improperly bifurcated contracts are not recognizing revenue from software licensing pled with sufficient particularity. contracts. Id. The assistant explains her basis for knowledge: “I have been working with revenue *10 Plaintiffs' next allegations-that defendants recognition for 12 years, and I understand the way “cooked” revenue numbers to recognize revenue revenue is supposed to be recognized.” Id. The prematurely-are somewhat better supported. The assistant's account also alleges a particular contract, TCAC identifies a “Senior Business Analyst” who with Onstar, for which Portal “materially overstated worked at Portal until July 2003, two months into the [revenues] during the third quarter of fiscal 2004.”

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TCAC ¶ 49. originally announced during the class period, the court finds that plaintiffs' single example of In the Ninth Circuit, “although overstatement of defendants announcement of revenue prior to revenues in violation of GAAP may support a customer approval does not raise a strong inference plaintiff's claim of fraud, the plaintiff must show with of scienter. particularity how the adjustments affected the company's financial statements and whether they Plaintiffs allege that defendants also violated the '34 were material in light of the company's overall Act by materially misrepresenting the declining financial position.” In re Daou, 411 F.3d 1006, 2005 demand for Portal's products and services and failing WL 1431833 at *7. In In re Daou, the panel found to disclose severe interface problems that delayed that the plaintiff adequately described how “allegedly delivery and increased costs. TCAC ¶ ¶ 51-54. premature [revenue] recognition affected Daou's Support for this allegation, however, comes from financial bottom line” where the complaint pled “the only one unnamed employee, a Senior Marketing approximate amount by which revenues and earnings Manager, who worked for only two months of the were overstated, * * * the dates of some of the class period. From this employee's title, the court transactions and the identities of the customers and might infer such a position would afford knowledge the company employees involved in the of the market for Portal's product. Thus, this account transactions.” Id at *8. For example, the plaintiffs in could conceivably provide evidence of the “shrinking In re Daou alleged that only $5.9 million was eligible market and role for billing software applications.” Id for recognition in the third quarter of 1997, 48% less ¶ 52. In addition, the employee identifies two than the $11.3 million that Daou publicly reported. vendors, SAP and Siebel, that offered products that Id. “displaced the role previously provided” by aspects of Portal's billing software. Id ¶ 51. But the *11 In contrast, the TCAC is bereft of such specificity ends there. The employee fails to identify comparisons. Only the Senior Business Analyst any of “Portal's large telecommunications customers” alleges a dollar amount-$5 million-for prematurely for whom customer service applications were no recognized revenue. Even this figure is unconnected longer required as part of Portal's billing software. Id. to identified customers or dates, much less a specific And, although the marketing manager alleges that quarterly report against which to assess its Portal was spending too much time and money due to materiality. Although the accounts receivable “excessive bugs and/or interface problems with other assistant allegedly reclassified improperly booked applications,” these allegations fail to indicate any revenues, she does not indicate how much revenue specific customers, contracts, or dates. Id ¶ 54. was reclassified or how this affected Portal's financial statements. The controller's statements, lacking in *12 The court finds that plaintiffs' allegations of personal knowledge, also fail to specify how much accounting fraud and material misrepresentations are revenue the allegedly improper licensing contracts not pled with sufficient particularity and, allowed Portal to recognize prematurely, and how consequently, do no raise a strong inference of that affected Portal's bottom line. scienter. Plaintiffs, however, present an alternative basis for demonstrating scienter; the complaint The TCAC also alleges that defendants engaged in focuses on defendants' stock sales and Portal's SPO to accounting fraud by recognizing “license and service show that defendants had the motive and opportunity fees under * * * service arrangements prior to to mislead investors deliberately. As discussed in the customer approval of specific project milestones in next section, however, these allegations fail to plead violation of the Company's publicly stated revenue a violation of section 10(b) adequately. recognition practices and policies” and in violation of GAAP. TCAC ¶ 50. To support this allegation, plaintiffs refer only to defendants' disclosure, 2 subsequent to the class period, that it was excluding $700,000 of previously reported revenue for fiscal Scienter 2004 due to a customer's refusal to approve project milestones. TCAC ¶ 84. Defendants argue that this disclosure related to a contract performed after the To demonstrate motive, plaintiffs allege that class period, but plaintiffs provide information defendants engaged in insider trading during the class indicating the restatement related to fiscal 2004. period. The PSLRA “neither prohibits nor endorses TCAC ¶ 84. Even assuming this revenue was the pleading of insider trading as evidence of

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 73 of 163 Not Reported in F.Supp.2d Page 9 Not Reported in F.Supp.2d, 2005 WL 1910923 (N.D.Cal.) (Cite as: Not Reported in F.Supp.2d) scienter, but requires that the evidence meet the absolutely necessary to keep Portal a “going ‘strong inference’ standard.” Greebel, 194 F.3d at concern.” Plaintiffs' Opposition at 21. Accordingly, 197. While “trading at suspicious times or in this motive evidence is stronger than the generic suspicious amounts” is probative of scienter, the “desire to raise capital” which can be attributed to trading must be “unusual, well beyond the normal every company. Metricom, 2004 U.S. Dist LEXIS patterns of trading by those defendants.” Id. Under 7834 at *110. But in the Ninth Circuit, such motive this standard, the court questions plaintiffs' reliance pleading must be combined with allegations of other on the stock sales attributable to “company insiders” “red flags” to be probative. In re Vantive, 283 F.3d at to demonstrate defendants' motive to conduct 1097. As discussed above, plaintiffs' allegations of accounting fraud or issue misleading statements. accounting fraud lack sufficient particularity and First, defendant Little sold no personal stock. cannot be combined with this alleged motive to Defendant Bain sold 4,000 shares after exercising establish a strong inference of scienter. 7,500 stock options, which means he did not sell 3,500 shares. 3 Plaintiffs focus on “89,157 shares of Portal common stock” sold by “Portal insiders.” TCAC at ¶ 65. Most Safe Harbor of these “insiders,” however, are not named defendants, nor do plaintiffs allege they were involved in the fraudulent activity. Moreover, *13 In their motion to dismiss, defendants argue at plaintiffs' reliance on “suspicious” stock sales great length that plaintiffs' TCAC does not ultimately fails because the stock sales do not appear adequately plead claims based on false projections or suspicious at all. For example, plaintiffs focus on the opinions. Defendants are correct that the PSLRA period from May 28, 2003, to July 2, 2003, which carves out a safe harbor from liability for forward- was “immediately after” the first earnings looking statements that are accompanied by announcement of the class period-but also after the meaningful cautionary language. 15 USC § 78u-5(c); announcement of an alliance with Microsoft. TCAC see also In re Copper Mountain Securities Litigation, at ¶ 65. Although plaintiffs allege that Portal 311 F Supp 2d 857, 866 (N.D.Cal.2004)(Walker, J). common stock was artificially inflated during this Under the analogous “bespeaks caution” doctrine, a period, they do not allege that the deal with Microsoft court may also find as a matter of law that was improper. In fact, plaintiffs ignore the legitimate, “defendant's forward-looking statements contained positive effect the Microsoft deal might have had on enough cautionary language or risk disclosure to Portal's stock or the role the Microsoft deal might protect against liability.” Id at 866. Mere boilerplate have had in the executives' decision to sell. No or generic warnings, however, are insufficient; “[t]he attempt is made to delineate the “artificiality” of cautionary warning ought to be precise and relate Portal's stock during this period, which is especially directly to the forward-looking statements at issue.” curious since it appears that Portal's stock actually Id at 882. Moreover, this court has previously found dropped by several dollars after the first earnings that “vague and * * * run-of-the-mill corporate announcement of the class period. TCAC at ¶ 140 optimism” is not actionable because no reasonable (Charting NASDAQ Index). Moreover, plaintiffs fail investor would rely on “mere puffery.” Id at 868-69. to demonstrate that the timing of the stock sales was “suspicious” where the TCAC does not provide a A close reading of plaintiffs' TCAC reveals that the comparison of these sales with the executives' vast majority of plaintiffs' allegations of “materially “normal patterns of trading.” Greebel, 194 F.3d at false and misleading statements” focus on defendants' 197. statements regarding present or historical facts, such as Portal's past quarterly earnings based on (1) By contrast, plaintiffs' contention that defendants allegedly inflated revenues (TCAC ¶ ¶ 58, 60, 64, were motivated to inflate artificially Portal's stock 66, 67); (2) Portal's past and current revenue price in the short term in order to conduct a recognition policies that plaintiffs allege successful secondary public offering and obtain misrepresented the way in which Portal was much-needed operating capital does allege facts of a recognizing revenue (TCAC ¶ ¶ 61-64, 68-70); (3) palpable motive for fraud. In fact, Portal raised $60 omissions of past and current facts regarding million in September, just two months before Portal's declining sales and product demand as well as stock plummeted by over 40%. Plaintiffs allege that difficulties marketing Portal's product (TCAC ¶ 64e- Portal's finances were such that the $60 million was f); and (4) omissions of the present fact that Portal

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 74 of 163 Not Reported in F.Supp.2d Page 10 Not Reported in F.Supp.2d, 2005 WL 1910923 (N.D.Cal.) (Cite as: Not Reported in F.Supp.2d) was experiencing severe technical problems with its at 31 (“These and other factors are described in detail core products, which were eroding its revenue stream in our Annual Report on Form 10-K for the fiscal (TCAC ¶ 64g). But neither the PSLRA's safe harbor year ended January 31, 2003 * * *.”). Thus, the provision nor the bespeaks caution doctrine are information in the Form 10-K was incorporated into applicable to statements of historical fact. See e g, the “total mix of information in the document” Livid Holdings Ltd. v. Salomon Smith Barney, Inc., available to reasonable investors, even though the 403 F.3d 1050, 1056-57 (9th Cir.2005). Form 10-K did not actually accompany the press releases. Copper Mountain, 311 F Supp 2d at 876 In fact, the only forward-looking statements that (citing Fecht v. The Price Co., 70 F.3d 1078, 1082 plaintiffs allege were false or misleading when made (9th Cir.1995). The Form 10-K contained several are the revenue projections for fiscal 2004 and the pages of detailed and explicit warnings regarding subsequent quarter's revenue projections that Portal's dependance on a few large customers, the accompanied Portal's public announcement of risks associated with long implementation periods, financial results for the quarter just concluded. See and the numerous variables which could adversely TCAC ¶ 58 (May 20, 2003, announcement of affect revenue recognition for any quarter. Also, the financial results for quarter ending May 2, 2003); Form 10-K warned that Portal would begin offering TCAC ¶ 66 (August 19, 2003, announcement of “products and services for a ‘bundled’ price, such financial results for quarter ending August 1, 2003). that a separate price would not be identified for the These announcements were made in press releases product and service components. Such a change may and included defendants' statements that Portal significantly delay the timing of our revenue expected revenues to grow by “10-12%” over the recognition.” Gaw Decl; Ex C at 31 (emphasis prior year and that Portal would “return to pro forma added). Because these warnings hew to the actual earnings” within the current fiscal year. TCAC ¶ 58. deficiencies that caused Portal's earnings shortfall- “contract delays and revenue recognition deferrals” Both of these statements concerned “a projection of with existing large customers-they provided revenues” and “future economic performance” and sufficiently specific and material warnings to thus were clearly forward-looking statements under immunize defendants' forward-looking statements. the PSLRA. 15 USC § 78u-5(i); Copper Mountain, See Copper Mountain, 311 F Supp 2d at 882. 311 F Supp 2d at 880. The court now turns to plaintiffs' argument that defendants' forward-looking Plaintiffs also assert that, regardless of cautionary statements are unprotected by the PSLRA's safe language, defendants are liable for their forward- harbor provision or the bespeaks caution doctrine looking statements because they knew them to be because (1) the statements were not accompanied by false and misleading when made. Plaintiffs are meaningful cautionary language and (2) defendants correct that a forward-looking statement cannot be knew they were false when made. immunized under the PSLRA if it was made with “actual knowledge * * * that the statement was false *14 The court finds that defendants' forward-looking or misleading.” 15 USC 78u-5(c)(1)(B). In this case, statements were accompanied by cautionary language however, plaintiffs' argument is unavailing because that was sufficiently specific and meaningful to warn plaintiffs have failed to demonstrate that the investors of the risks that actually materialized. First, defendants knew that Portal would not achieve 10- defendants' May 20 and August 19 press releases- 12% growth or return to pro forma earnings within which contained the 10-12% profit projection and the year when the press releases were issued. As “return to pro forma earnings” statements-each discussed above, the TCAC is deficient, in part, in included “safe harbor” warnings that the statements that it fails to allege facts showing how the alleged were forward-looking and subject to uncertainties accounting adjustments materially affected the and risk. Gaw Decl; Exs I and J. Moreover, these company's financial statements. See supra press releases specified a number of factors which IV(A)(1)(i). These facts are necessary not only to might effect the projections, including the migration plead adequately accounting fraud or scienter on the to “larger, multi-year deals, which * * * may dampen part of defendants, but also to demonstrate that the near-term growth * * * and add[ ] to the volatility of defendants knew at the time the earnings projections license revenues.” Id. were announced that Portal could not meet those projections. Accordingly, Defendants' cannot be In addition to those warnings contained in the press liable for the forward-looking statements in the May releases, both press releases referred investors to the 20 and August 19, 2005, press releases, and plaintiffs' Form 10-K for additional warnings. Gaw Decl; Ex C. claims premised on these statements must be

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 75 of 163 Not Reported in F.Supp.2d Page 11 Not Reported in F.Supp.2d, 2005 WL 1910923 (N.D.Cal.) (Cite as: Not Reported in F.Supp.2d) dismissed. are time barred.

4 1

20(a) Relation Back

Control Liability Defendants challenge the timeliness of plaintiffs' '33 Act claims. Section 13 of the '33 Act requires that claims under sections 11 and 12(a)(2) be brought *15 Section 20(a) provides for “controlling person “within one year after the discovery of the untrue liability.” To establish such liability, plaintiffs must statement or the omission, or after such discovery first demonstrate the existence of a violation under should have been made by the exercise of reasonable Section 10(b)-the “primary violation.” Copper diligence.” 15 USC § 77m. Plaintiffs' first complaint, Mountain, 311 F Supp 2d at 883 (citation omitted). filed on November 20, 2003, did not include '33 Act “[I]n the absence of a viable claim under Section claims. These claims were not added until the second 10(b), any remaining Section 20(a) claims must be amended complaint (SAC), filed on March 30, 2005 dismissed.” Id (citations omitted). (sixteen months later). Defendants argue that plaintiffs discovered the conduct giving rise to the '33 Because the court has determined that plaintiffs have Act claims at least when the first complaint was filed. failed to state claims under Section 10(b), plaintiffs Consequently, defendants argue that the '33 Act have “no basis upon which to premise a Section 20(b) claims are time-barred. claim” and the Section 20(b) claims must also be dismissed. Plaintiffs seek to avoid this bar by asserting that the new claims in the SAC “relate back” to the initial complaint under FRCP 15(c)(2). Rule 15(c)(2) states B that an amended complaint relates back to the initial one for statute of limitations purposes if the “claim or Section 11, 12(a)(2) and 15 of the Securities Act of defense asserted in the amended pleading arose out of 1933 the conduct, transaction, or occurrence set forth * * * in the original pleading.” The crux of this inquiry is “whether the opposing party has been put on notice Plaintiffs also bring claims against defendants for about the claim or defense raised by the amended violations of the '33 Act arising out of Portal's pleading.” SEC v. Seaboard Corporation, 677 F.2d secondary public offering in September 2003. In 1301, 1314 (9th Cir.1982). This court previously contrast to claims brought under the '34 Act, section observed that the class notice for the '34 Act claims 11 of the '33 Act creates a private remedy for a would have put investors with '33 Act claims on purchaser of a security where “any part of the notice. Doc # 100. It follows that defendants were registration statement, when such part became also put on notice of the potential for '33 Act claims effective, contained an untrue statement of a material arising from the same set of facts. fact or omitted to state a material fact required to be stated therein or necessary to make the statement therein not misleading.” 15 USC § 77k(a). “The 2 plaintiff in a § 11 claim must demonstrate (1) that the registration statement contained an omission or Sound in Fraud misrepresentation, and (2) that the omission or misrepresentation was material, that is, it would have misled a reasonable investor about the nature of his *16 Section 11 does not contain an element of fraud, or her investment.” In re Stac, 89 F.3d at 1403-04. yet a complaint may be subject to the particularity “No scienter is required for liability under § 11; requirements of Rule 9(b) if it “sounds in fraud.” defendants will be liable for innocent or negligent Vess v. Ciba-Geigy Corp. USA, 317 F.3d 1097, 1103 material misstatements or omissions.” Id (citations (9th Cir.2003). If the complaint alleges “a unified omitted) '33 Before addressing the substance of the course of fraudulent conduct and rel[ies] entirely on '33 Act claims, the court must first determine if they that course of conduct as the basis of a claim * * *

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 76 of 163 Not Reported in F.Supp.2d Page 12 Not Reported in F.Supp.2d, 2005 WL 1910923 (N.D.Cal.) (Cite as: Not Reported in F.Supp.2d) the claim is said to be ‘grounded in fraud’ or to misstatements plaintiffs allege were false or ‘sound in fraud,’ and the pleading of that claim as a misleading, including with regard to each statement: whole must satisfy the particularity requirement of (1) the date made; (2) the speaker; (3) the content; (4) Rule 9(b).” Id at 1103-1104. the falsity; (5) the basis for plaintiffs' allegation of falsity; and (6) scienter. The amended complaint In the TCAC, plaintiffs have made an artful attempt should also specify any omissions of fact that to avoid this requirement by carefully defendants were bound to disclose, including with compartmentalizing the counts under the '33 Act and respect to each omission: (1) the date the information '34 Act. Whereas the '34 Act claims allege that became known to the public; (2) the facts omitted; (3) defendants knowingly or recklessly engaged in a the date the duty to disclose arose; (4) the basis for fraudulent scheme to overstate revenues, for claiming that omitted information was known to example, the '33 Act claims merely allege that defendants; (5) the basis for claiming that defendants revenues were negligently overstated. Yet the Ninth had a duty to disclose; and (6) scienter. Finally, in Circuit has rejected this approach, finding that such light of Dura, plaintiffs should endeavor to tether all “nominal efforts are unconvincing where the allegations in the complaint to the price movement of gravamen of the complaint is plainly fraud.” In re Portal's stock during the class period. Any amended Stac, 89 F.3d at 1405. complaint must be filed within sixty (60) days of the date of this order. The court finds that plaintiffs' Section 11 claim clearly “sounds in fraud.” Despite plaintiffs' pains to *17 IT IS SO ORDERED. avoid Rule 9(b), it is clear that the factual allegations upon which the entire complaint rests allege N.D.Cal.,2005. knowing, reckless and willful conduct. For example, In re Portal Software, Inc. Securities Litigation plaintiffs allege that defendants “negligently Not Reported in F.Supp.2d, 2005 WL 1910923 overstated [revenue] due to the Defendants' (N.D.Cal.) manipulation of the purported billing rates of Portal's employees.” TCAC ¶ 145(d). Yet plaintiffs' factual Briefs and Other Related Documents (Back to top) allegations supporting the manipulation of billing rates unequivocally describes the conduct as • 2006 WL 728111 (Trial Motion, Memorandum and intentional and knowing. Id ¶ ¶ 47, 48. It strains Affidavit) Plaintiffs' Opposition to Defendants' credulity that plaintiffs should allege that the Motion to Dismiss Fourth Consolidated Amended overstatement of revenues was merely “negligent” Complaint (Feb. 8, 2006) when it was a allegedly a direct result of defendants' • 2004 WL 2160168 (Trial Motion, Memorandum willful manipulation. Plaintiffs cannot avoid the and Affidavit) Plaintiff's Opposition to Defendants' theory they posit throughout the complaint: that Motion to Dismiss the Consolidated Amended defendants fraudulently schemed to inflate revenues. Complaint (Sep. 30, 2004) Accordingly, the court finds that the claims under the • 2004 WL 2160162 (Trial Motion, Memorandum '33 Act sound in fraud, and therefore fail with the '34 and Affidavit) Response of Roxanne Googin to Act claims to meet the heightened pleading Motion of John Romeo for Consolidation, requirements of the PSLRA and Rule 9(b). Appointment of Lead Plaintiff and Approval of Selection of Lead and Liaison Counsel (Mar. 25, 2004) V • 2004 WL 2160159 (Trial Motion, Memorandum and Affidavit) Memorandum of Law in Support of Conclusion Roxanne Googin's Motion for Consolidation of Related Actions, for Appointment as Lead Plaintiff and for Approval of Selection of Lead Counsel (Jan. For the reasons stated above, the court GRANTS 20, 2004) defendants' motion to dismiss in its entirety. Doc # • 2003 WL 23795725 (Trial Pleading) Class Action 115. Plaintiffs' TCAC is DISMISSED, but plaintiffs Complaint for Violations of Federal Securities Laws may file an amended complaint remedying the (Nov. 20, 2003) pleading deficiencies identified in this order and complying with the following instructions. END OF DOCUMENT

An amended complaint should specify those

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former officers-defendants Bing Yeh, Yaw Wen Hu, Briefs and Other Related Documents Jack K. Lai, Yasushi Chikagami, Isao Nojima, and Only the Westlaw citation is currently available. Derek Best-misled investors by overstating SST's United States District Court,N.D. California. inventory value, by making false statements about the In re SILICON STORAGE TECHNOLOGY, INC., company's sales prices, and by failing to disclose that SECURITIES LITIGATION. the company lacked adequate internal controls to No. C 05-0295 PJH. ensure that inventory was properly valued. Plaintiffs assert that they were harmed when SST's stock price March 10, 2006. fell more than 22.5%, following an announcement that SST would write down the value of a portion of its inventory. Patrick J. Coughlin, Azra Z. Mehdi, Darren J. Robbins, William S. Lerach, Lerach Coughlin Stoia The consolidated amended class action complaint Geller Rudman & Robbins LLP, Christopher T. (“CAC”) alleges a cause of action for violation of § Heffelfinger, Julie Juhyun Bai, Berman Devalerio 10(b) of the Securities Exchange Act of 1934, 15 Pease & Tabacco, P.C., Joseph J. Tabacco, Jr., Nicole U.S.C. § 78j(b), and related Rule 10b-5, 17 C.F.R. § Lavallee, Berman Devalerio Pease Tabacco Burt & 240.10b-5, against all defendants; and for violation of Pu, San Francisco, CA, Jason S. Cowart, Marc I. § 20(a) of the Exchange Act, 15 U.S.C. § 78t(a), Gross, Stanley M. Grossman, Patrick V. Dahlstrom, against the six individual defendants. Pomerantz Haudek Block Grossman & Gross LLP, New York, NY, for James M. Baker on Behalf of Himself and all others Similarly Situated, Louisiana BACKGROUND District Attorneys' Retirement System. Eunice Jooyoun Lee, Jonathan B. Gaskin, Robert P. SST is based in Sunnyvale, California, where it Varian, Orrick, Herrington & Sutcliffe LLP, San operates three major facilities. According to periodic Francisco, CA, for Silicon Storage Technology Inc. reports filed by SST with the SEC, the company is a leading supplier of “flash memory” semiconductor ORDER GRANTING MOTION TO DISMISS devices for the digital consumer, including PHYLLIS J. HAMILTON, J. networking, wireless communications, and Internet *1 THIS ORDER RELATES TO: ALL ACTIONS computing markets. SST offers over 90 products based on its “Super-Flash” design and manufacturing Defendants' motion to dismiss the consolidated process technology, and also licenses its technology amended complaint came on for hearing before this to leading semiconductor companies for use in court on January 18, 2006. Plaintiffs appeared by various applications. Revenue from the sale of these their counsel Jason S. Cowart, and defendants products contributed approximately 50% of the appeared by their counsel Robert P. Varian and company's revenue during the proposed class period. Jonathan B. Gaskin. Having read the parties' papers and carefully considered their arguments, and good During the proposed class period, defendant Bing cause appearing, the court hereby GRANTS the Yeh (“Yeh”) was SST's President and Chief motion as follows Executive Officer; defendant Yah Wen Hu (“Hu”) was SST's Executive Vice President and Chief Operating Officer; defendant Derek Best (“Best”) INTRODUCTION was Senior Vice President for Sales and Marketing; defendant Yasushi Chikagami (“Chikagami”) was an This is a proposed class action alleging violations of outside director; defendant Isao Nojima (“Nojima”) the federal securities laws. The plaintiff class consists was Senior Vice President, Standard Memory of all those who purchased shares of common stock Product Group; and defendant Jack K. Lai (“Lai”) in defendant Silicon Storage Technology, Inc. (SST) was Chief Financial Officer. from April 21, 2004, to December 20, 2004. Plaintiffs allege that throughout the class period, Plaintiffs allege that SST and six of its officers or defendants made materially misleading statements

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 78 of 163 Slip Copy Page 2 Slip Copy, 2006 WL 648683 (N.D.Cal.) (Cite as: Slip Copy) concerning the value of SST's inventory, which in capable of accurate and ready determination by resort turn caused the company's statements of gross profit, to sources whose accuracy cannot be questioned. See net income, and total assets to be materially Fed.R.Evid. 201; see also In re Silicon Graphics, misleading. Plaintiffs claim that defendants knew or Inc., Sec. Litig., 183 F.3d 970, 986 (9th Cir.1999). should have known that prices of competing flash memory products sold by Intel and AMD had been declining during the class period, that SST's B. Defendants' Motion to Dismiss inventory should have been valued at levels well below those reported by defendants, and that the Defendants seek an order dismissing the CAC for company's gross profits, net income, and total assets failure to state a claim. Section 10(b) of the Securities were therefore overstated. Exchange Act provides, in part, that it is unlawful “to use or employ in connection with the purchase or sale *2 Plaintiffs allege that defendants failed to disclose of any security registered on a national securities that SST's valuation system lacked sufficient controls exchange or any security not so registered, any to ensure accuracy, and that its valuation process was manipulative or deceptive device or contrivance in completely arbitrary. Plaintiffs assert that “the truth contravention of such rules and regulations as the began to emerge” after the market closed on [SEC] may prescribe.” 15 U.S.C. § 78j(b). December 20, 2004, at which point SST announced it would write down the value of its inventory by $20- SEC Rule 10b-5, promulgated under the authority of $25 million. On this news, the price of the company's § 10(b), makes it unlawful for any person to use shares, which had closed at $7.01 before the interstate commerce announcement, fell to a low of $5.43 the following (a) To employ any device, scheme, or artifice to day, a drop of 22 .5%. defraud, (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to DISCUSSION make the statements made, in the light of the circumstances under which they were made, not A. Legal Standard misleading, or (c) To engage in any act, practice, or course of business which operates or would operate as a fraud A court should dismiss under Federal Rule of Civil or deceit upon any person, in connection with the Procedure 12(b)(6) for failure to state a claim only purchase or sale of any security. where it appears beyond doubt that plaintiff can prove no set of facts in support of the claim which *3 17 C.F.R. § 240.10b-5. would entitle the plaintiff to relief. Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 2 L.Ed.2d 80 (1957); To plead securities fraud under Section 10(b) of the Williamson v. Gen'l Dynamics Corp., 208 F.3d 1144, 1934 Act, plaintiffs must allege (1) a misstatement or 1149 (9th Cir.2000). All allegations of material fact omission (2) of material fact (3) made with scienter are taken as true and construed in the light most (4) on which plaintiffs relied (5) which proximately favorable to the nonmoving party. Gompper v. VISX. caused the plaintiffs' injury. DSAM Global Value Inc., 298 F.3d 893, 895 (9th Cir.2002). Fund v. Altris Software, Inc., 288 F.3d 385, 388 (9th Cir.2002). Similarly, the elements of a Rule 10b-5 Review is generally limited to the contents of the claim are (1) a material misrepresentation (2) made complaint. Allarcom Pay Television. Ltd. v. Gen. with scienter (3) in connection with the purchase or Instrument Corp., 69 F.3d 381, 385 (9th Cir.1995). sale of a security, (4) transaction and loss causation, However, material that is properly presented to the and (5) economic loss. In re Daou Sys., Inc., Sec. court as part of the complaint may be considered as Litig., 411 F.3d 1006, 1014 (9th Cir.2005). part of a motion to dismiss. Lee v. City of Los Angeles, 250 F.3d 668, 688-89 (9th Cir.2001). If a Under § 20(a) of the 1934 Act, joint and several plaintiff fails to attach to the complaint the liability can be imposed on persons who directly or documents on which it is based, defendant may attach indirectly control a violator of the securities laws. 15 to a Rule 12(b)(6) motion the documents referred to U.S.C. § 78t(a). Violation of § 20(a) is predicated in the complaint to show that they do not support on a primary violation under the 1934 Act. plaintiff's claim. Id. In addition, whether requested or Heliotrope Gen'l, Inc. v. Ford Motor Co., 189 F.3d not, the court may take judicial notice of facts that are 971, 978 (9th Cir.1999). Plaintiffs alleging a claim

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 79 of 163 Slip Copy Page 3 Slip Copy, 2006 WL 648683 (N.D.Cal.) (Cite as: Slip Copy) that individual defendants are “controlling persons” to establish uniform and stringent pleading of a company must allege 1) that the individual requirements for securities fraud actions, and “to put defendants had the power to control or influence the an end to the practice of pleading ‘fraud by company, 2) that the individual defendants were hindsight.” In re Silicon Graphics, 183 F.3d at 958. culpable participants in the company's alleged illegal The PSLRA heightened the pleading requirements in activity, and 3) that the company violated the federal private securities fraud litigation by requiring that the securities laws. Durham v. Kelly, 810 F.2d 1500, complaint plead both falsity and scienter with 1503-04 (9th Cir.1987); see also Howard v. Everex particularity. In re Vantive Corp. Sec. Litig., 283 F.3d Sys., Inc., 228 F.3d 1057, 1065 (9th Cir.2000). 1079, 1084 (9th Cir.2002); see also In re Daou Sys., 411 F.3d at 1014. If the complaint does not satisfy Defendants argue that the § 10-b claim should be these pleading requirements, the court, upon motion dismissed for failure to allege fraud with of the defendant, must dismiss the complaint. 15 particularity, and that the § 20 claim should be U.S.C. § 78u-4(b)(3)(A). dismissed because plaintiffs fail to state a claim for primary liability. Defendants also contend that dismissal is required because the facts before the 1. Falsity court demonstrate that the inventory write-down could not have taken place prior to the fourth quarter Defendants argue that the CAC does not adequately of 2004, because the demand for and pricing of flash allege falsity because it does not plead facts showing memory had been increasing, while SST's cost had that the alleged false statements were false when been declining. Defendants assert the fact that the made. Under the PSLRA-whether alleging that a write-down was appropriate in 4Q 2004 but not defendant “made an untrue statement of a material before is also confirmed by an audit completed by fact” or alleging that a defendant “omitted to state a PricewaterhouseCoopers after the December 20, material fact necessary in order to make the 2004, announcement. statements made, in the light of the circumstances in which they were made, not misleading”-the Generally, the Federal Rules of Civil Procedure complaint must specify each statement alleged to require that a plaintiff in federal court give a short, have been false or misleading, specify the reason or plain statement of the claim sufficient to put the reasons why each such statement is misleading, and, defendant on notice. See Fed.R.Civ.P. 8(a). However, if an allegation regarding the statement or omission is Rule 9 imposes a particularized pleading requirement made on information and belief, state with on a plaintiff alleging fraud or any claim premised on particularity all facts on which that belief is formed. fraud. See Fed.R.Civ.P. 9(b) (in actions alleging 15 U.S.C. § 78u-4(b)(1). fraud, “the circumstances constituting fraud or mistake shall be stated with particularity”). Plaintiffs allege that defendants made false and misleading statements concerning SST's sales prices, Under Rule 9(b), the complaint must allege specific inventory values, and accounting controls during the facts regarding the fraudulent activity, such as the class period, in connection with the release of SST's time, date, place, and content of the alleged quarterly financial returns for the first, second, and fraudulent representation, how or why the third quarters of fiscal year 2004, as follows: On representation was false or misleading, and in some April 21, 2004, the first day of the class period, SST cases, the identity of the person engaged in the fraud. stated in a press release that its inventory was worth In re GlenFed Sec. Litig., 42 F.3d 1541, 1547-49 (9th $69.9 million as of the end of the first quarter of Cir.1994). Because the plaintiff must set forth what is 2004.FN1 On May 7, 2004, SST filed its Form 10-Q false or misleading about a particular statement, he for 1Q 2004 with the SEC. The Form 10-Q, which must do more than simply allege the neutral facts was signed by Yeh and Lai, repeated the statement necessary to identify the transaction; he must also that SST's inventory was worth $69.9 million as of explain why the disputed statement was untrue or the end of 1Q 2004. The 10-Q also stated that the misleading at the time it was made. Yourish v. company's gross profit in the first quarter had been California Amplifier, 191 F.3d 983, 992-93 (9th $38.1 million, that its net income had been $14.2 Cir.1999). million, and that its total assets were $435 million. See CAC ¶ 53. *4 This case is also controlled by the provisions of the Private Securities Litigation Reform Act (“PSLRA”), which was enacted by Congress in 1995 FN1. The CAC alleges that Yeh also held a

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conference call on April 21, 2004, in which by SST's competitors AMD and Intel had been he stated that SST had experienced declining during the first three quarters of 2004, that “firming” sales prices in the first quarter of the value that was assigned to SST's flash memory 2004 and that the company expected SST's was inflated, and that SST would soon have to write average selling prices to “continue to down the value of its inventory. CAC ¶ 74. improve” in the second quarter. However, at the hearing, plaintiffs' counsel indicated that In the present motion, defendants assert that the claim plaintiffs did not include this statement as of fraud alleged in the CAC-that defendants one of the allegedly false and misleading defrauded investors by not announcing the intended statements. write-down earlier than they did-was based solely on SST's announcement in December 2004 that it would On July 21, 2004, defendants allegedly announced in take an inventory write-down due to changed market a press release that average selling prices were conditions, and provides a classic example of “firming” in 2Q 2004, and that the value of SST's pleading “fraud by hindsight.” Defendants contend inventory had increased from $69.9 million in 1Q that the CAC fails to allege falsity because it does not 2004 to $91 million in 2Q 2004. On August 5, 2004, specify why, how, or by how much the inventory SST filed its Form 10-Q for 2Q 2004 with the SEC. valuations allegedly exceeded the “correct” The Form 10-Q, which was signed by Yeh and Lai, valuations; does not indicate what valuation might repeated the statement that the value of SST's have been required at a given time; does not identify inventory was $91 million as of the end of 2Q 2004. any product, or class of products or components in The 10-Q also stated that SST's gross profit in 2Q SST's inventory; provides no allegations as to the 2004 had been $48.7 million, that its net income had cost or market price at which any product or been $22 million, and that its total assets were $466 component was, or should have been, carried on million. See CAC ¶ 58. SST's books; and alleges no contemporaneous facts demonstrating why the statements were false or *5 On October 20, 2004, SST issued a press release misleading at the time they were made. announcing its results for 3Q 2004. The company stated that revenue had decreased to $112.2 and that Defendants also argue that the CAC is deficient average sales prices had declined by 7 per cent. It because it is largely pled on information and belief, also stated that the value of SST's inventory was $138 but fails to include a statement of “all facts” on which million. In a conference call held the same day, Yeh that belief is based, in contravention of the allegedly stated that SST had no intention of writing requirements of the PSLRA. In addition, defendants down its inventory for the fourth quarter of 2004. On assert that other than the allegations that Yeh made November 15, 2004, SST filed its Form 10-Q for 3Q two statements in conference calls, and that Yeh and 2004 with the SEC. The Form 10-Q, which was Lai signed SST's Form 10-Qs, the CAC does not signed by Yeh and Lai, repeated the statements that allege that any particular defendant made any of the revenue had decreased to $112.2 million, that average statements at issue. sales prices had declined by 7 per cent, and that SST's inventory was valued at $138 million. The 10-Q also *6 In opposition, plaintiffs argue that the CAC stated that SST's gross profit in 3Q 2004 had been adequately pleads falsity. They contend that the CAC $39.5 million, that its net income had been $14.5 identifies material misstatements relating to SST's million, and that its total assets were $482.2 million. flash memory inventory values in the first, second, See CAC ¶ ¶ 67, 69, 73. and third quarters of 2004 (citing to CAC ¶ ¶ 53, 58, 67, 69, 73). They maintain that the CAC explains Plaintiffs allege that these statements were false and why these statements were false, based on misleading because the value of SST's inventory was contemporaneous facts-including allegations that actually less than the amounts stated-$69.9 million in SST's inventory valuation system lacked sufficient 1Q 2004, $91 million in 2Q 2004, and $138 million controls to ensure accuracy, that defendants were told in 3Q 2004-and that consequently, SST's gross profit, that this system was overstating value, that net income, and total assets were less than the defendants stated that market prices were rising or amounts stated. CAC ¶ ¶ 54, 59, 70. They also assert stabilizing at a time that such prices were in fact that the statement that SST did not plan to write plummeting, and that defendants made these down its inventory in 4Q 2004 was false and statements without also disclosing that their misleading because defendants knew or should have inventory valuation process was “completely known that the prices of flash memory manufactured arbitrary.”

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price of one type of 32-megabyte flash memory sold Plaintiffs also point to SST's 2004 Form 10-K, filed by Intel, which competed with products sold by SST, with the SEC on March 31, 2005, in which both SST steadily declined from $21.50 to under $15.00. and its outside auditors stated, As of December 31, 2004, [SST] did not maintain *7 Plaintiffs allege further that the average sales price effective controls over accounting for and review of of flash memory fell for every week during the period the valuation of inventory, the income tax provision June 13, 2004, through July 31, 2004, and continued and related balance sheet accounts and licensing to fall for every week thereafter until at least August revenue because [SST] lacked a sufficient 31, 2004. Plaintiffs assert that defendants knew or complement of personnel and a level of accounting should have known that the prices of various types of expertise that is commensurate with [SST's] financial flash memory sold by AMD and Intel, which reporting requirements. Specifically, [SST] lacked competed with products sold by SST, from April sufficient controls over the write down of inventory through July 2004-specifically, that the price for to the lower of cost or market, accounting for which AMD was selling one type of 4-megabyte complex licensing contracts with multiple elements, flash memory declined from $1.50 to less than $1.35; and processes and procedures related to the the price of one type of AMD's 8-megabyte flash determination and review of the quarterly and annual memory declined from $3.38 to $1.75; the price of tax provisions in accordance with generally two types of AMD's 16-megabyte flash memory acceptable accounting principles in the United declined from around $3.75 to around $2.75; and the States.... [T]his deficiency could result in a material price of one type of 32-megabyte flash memory sold missatement to the annual or interim consolidated by Intel steadily declined from over $19.00 to under financial statements that would not be prevented or $7.50. detected. Accordingly, that this control deficiency constitutes a material weakness. Finally, plaintiffs allege that the prices of flash memory sold by AMD and Intel, which competed with products sold by SST, declined from April Plaintiffs assert that there is no requirement that the through October 2004-specifically, that the price for CAC specify SST's sales prices or inventory which AMD was selling one type of 1-megabyte valuations on a product-by-product basis. They claim flash memory declined from $1.63 to under $1.00; that the cases cited by defendants say only that such the price of one type of AMD's 4-megabyte flash information is but one way to establish falsity. They memory declined from $1.50 to $1.15; the price of argue that when contemporaneous facts are cited with one type of AMD's 8-megabyte flash memory sufficient specificity to demonstrate that the declined from $3.38 to $1.50; the price of two types statements at issue were false, it is not necessary to of AMD's 16-megabyte flash memory declined from also include details about specific products in the over $3.75 to under $2.48; the price of one type of inventory valuation. AMD's 32-megabyte flash memory declined from over $10.00 to less than $5.00. Plaintiffs also assert The court finds that the CAC fails to allege falsity that when Intel announced its 3Q 2004 results on with particularity as required by the PSLRA and Rule October 12, 2004, the company indicated that 9(b). While plaintiffs have identified each statement because flash memory sales prices had fallen, and alleged to be false or misleading, they have not stated there was no reason to believe they would increase, it with particularity why each statement was false at the would write down the value of its flash memory time it was made. inventory. See CAC ¶ 72.

Plaintiffs allege that the statements about SST's However, the CAC states no facts regarding inventory were false because the market price for comparable products in SST's inventory or the cost or various types of flash memory was declining during market price of those products.FN2 Nor does the CAC the period between April and December 2004. state the reasons that the values stated at the time of Plaintiffs assert that from March 2004 through April the quarterly reports for 1Q 2004, 2Q 2004, and 3Q 21, 2004, the price for which AMD was selling one 2004 were inaccurate. For example, the CAC type of 32-megabyte flash memory, which competed contains no allegations of contemporaneous with products sold by SST, steadily declined from conditions or statements by defendants that contradict $12.50 to just over $10.00, while another type of SST's statements regarding inventory valuations, and AMD's 32-megabyte flash memory declined from identifies no internal report that contradicts the $16.50 to under $8.00. During the same period, the valuations or suggests that they might be fraudulent.

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The allegations relating to information obtained from FN2. Stating the cost or market value of the plaintiffs' confidential informants do not plead products in SST's inventory would be one particularized facts showing that the statements way-though not the only way-to allege regarding the value of SST's inventory were false contemporaneous facts showing that the when made because, as explained more fully below statements regarding inventory valuation in the discussion of scienter, the informants were not were false when made. employed at SST during the proposed class period, and because the CAC does not allege particularized Plaintiffs simply allege, in essence, that because SST facts indicating that the informants had personal wrote down its inventory in December 2004, the knowledge regarding the truth or falsity of the statements about inventory made prior to that time statements made in 2004 regarding the valuation of must have been false because the inventory turned SST's inventory. See In re Daou Sys., 411 F.3d at out not to be worth what SST had previously said it 1015. Under the PSLRA, “the complaint must was worth. This is, as defendants argue, a classic contain allegations of specific ‘contemporaneous example of pleading fraud by hindsight-a type of statements or conditions' that demonstrate the pleading that the PLSRA was specifically enacted to intentional or the deliberately reckless false or eliminate. misleading nature of the statements when made.” Ronconi v. Larkin, 253 F.3d 423, 432 (9th Cir.2001). The allegations in the CAC regarding the decline in The allegations relating to information obtained from prices for flash memory produced by AMD and Intel the confidential informants does not meet this do not support the claim that defendants made false standard. statements regarding SST's financial results during the first three quarters of 2004, for the reason that the The statements concerning internal controls made by SST documents referenced in the CAC indicate that SST and SST's external auditors most of the inventory charge was taken on SST's 8- PricewaterhouseCoopers in SST's 2004 10-K do not megabit and 16-megabit flash memory, while the support plaintiffs' claim that defendants made AMD and Intel products at issue were 4-megabyte, 8- materially false statements during the proposed class megabyte, 16-megabyte, and 32-megabyte flash period. First, as defendants note, this same boilerplate memory. Thus, the AMD and Intel flash memory was language is used in internal control review reports not, as the CAC alleges, a type of flash memory that filed by numerous other technology companies, as “competed with” products sold by SST.FN3 such review is mandated by Section 404 of Sarbanes- Oxley. In the present case, SST and its auditors used what appears to be standard phrasing, noting that in FN3. Moreover, the October 12, 2004, Intel the future, the control deficiency “could” result in a earnings release cited in CAC ¶ 65, a copy material misstatement to the company's financial of which is attached to defendants' statements. This is not a contemporaneous fact that Supplemental Request for Judicial Notice, shows that the statements about SST's inventory says nothing about flash memory prices, valuation were false when made in connection with about any decline in such prices, or about the release of financial results for the first three any inventory write-down pertaining to flash quarters of 2004. Moreover, SST's auditor memory products. PricewatershouseCoopers issued an unqualified audit opinion, identified no errors in the interim financials, *8 The allegations in the CAC that SST's inventory and did not require SST to restate any of the quarters valuation system lacked sufficient controls to ensure prior to 4Q 2004. accuracy and that its inventory valuation process was “completely arbitrary,” and that defendants were told that this system was overstating value, are based on 2. Scienter two sources-first, on information allegedly obtained by plaintiffs from their “confidential informants,” and Defendants argue that the CAC should be dismissed second, on a statement in SST's 2004 Form 10-K that because it fails to plead particularized facts that SST had not maintained effective controls over strongly suggest actual intent to deceive, manipulate, accounting for and review of the valuation of or defraud. Under the PSLRA, whether alleging that inventory, and a statement by SST to the same effect a defendant “made an untrue statement of material in the same Form 10-K. fact” or alleging that a defendant “omitted to state a

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 83 of 163 Slip Copy Page 7 Slip Copy, 2006 WL 648683 (N.D.Cal.) (Cite as: Slip Copy) material fact,” the complaint must, with respect to knew, or had access to facts that should have made each alleged act or omission, “state with particularity them aware, that the price of flash memory was facts giving rise to a strong inference that the declining in the industry generally, and that the value defendant acted with the required state of mind.” 15 assigned to flash memory in SST's inventory should U.S.C. § 78u-4(b)(2); see also In re Vantive, 283 therefore have been reduced. Third, plaintiffs assert F.3d at 1084. By requiring particularized, detailed that scienter is shown by allegations of defendants' allegations showing a strong inference of scienter, the motive to keep the price of SST's stock high, PSLRA was intended to “eliminate abusive and reflected in insider sales of stock during the class opportunistic securities litigation.” Gompper, 298 period, the SST board of directors' authorization of a F.3d at 897. stock repurchase program in July 2004, and SST's acquisition of another company in October 2004. *9 In the Ninth Circuit, the required state of mind is Finally, plaintiffs argue that defendants' scienter is “deliberate or conscious recklessness.” In re Silicon also shown by the allegations that defendants violated Graphics, 183 F.3d at 979. Mere motive and Generally Accepted Accounting Principles (GAAP) opportunity are not sufficient. Id. Recklessness and various unspecified SEC regulations, regulations satisfies scienter under § 10(b) “only ... to the extent of national stock exchanges, and customary business that it reflects some degree of intentional or practices. conscious misconduct.” Id. at 977. In assessing whether plaintiffs have sufficiently pled scienter, the court should consider “whether the total of plaintiffs' a. confidential informants allegations, even though individually lacking, are sufficient to create a strong inference that defendants *10 The CAC alleges that the information provided acted with deliberate or conscious recklessness.” No. by five confidential informants, and a sixth identified 84 Employer-Teamster Joint Council Pension Trust informant, shows the individual defendants' personal Fund v. Am. West Holding Corp., 320 F.3d 920, 938 involvement in, and “hands-on” management of, (9th Cir.2003) (citation and quotation omitted); see SST's business. In pleading fraud under the PSLRA, also Livid Holdings Ltd. v. Salomon Smith Barney, plaintiffs may rely on anonymous sources for Inc., 416 F.3d 940, 948-49 (9th Cir.2005) (district information, so long as they plead “corroborating court should evaluate scienter based on “totality of details” when allegations are based on non-public the allegations”). information. In re Silicon Graphics, 183 F.3d at 985; see also In re SeeBeyond Techs. Corp. Sec. Litig., On a Rule 12(b)(6) motion to dismiss a complaint 266 F.Supp.2d 1150, 1159 (C.D.Cal.2003). brought under the PSLRA, when considering whether “[P]ersonal sources of information relied upon in a plaintiffs have shown a strong inference of scienter, complaint should be ‘described in the complaint with the district court must also consider “all reasonable sufficient particularity to support the probability that inferences to be drawn from the allegations, a person in the position occupied by the source would including inferences unfavorable to the plaintiffs.” possess the information alleged.” ’ Nursing Home Gompper, 298 F.3d at 897 (noting the “inevitable Pension Fund, Local 144 v. Oracle Corp., 380 F.3d tension ... between the customary latitude granted the 1226, 1233 (9th Cir.2004) (quoting Novak v. Kasaks, plaintiff on a [12(b)(6) ] motion to dismiss ... and the 216 F.3d 300, 314 (2nd Cir.2000)). When plaintiffs heightened pleading standard set forth under the rely on facts beyond the information provided by the PSLRA). In other words, the court must consider all confidential witnesses, they need not name their the allegations in their entirety in concluding sources as long as the additional facts provide an whether, on balance, the complaint gives rise to the adequate basis for believing that the defendants' requisite inference of scienter. Id. statements were false. Id.

Plaintiffs assert that the “totality of the allegations” Defendants argue that the information provided by set forth in the CAC establish that defendants the six informants adds nothing to support the claims knowingly overvalued SST's inventory. First, in the CAC, because no informant worked at SST plaintiffs contend that the allegations in the CAC during the class period, because the informants were regarding information obtained from six informants all low-level employees far removed from establish scienter because those allegations show the management decisions, and because the informants personal involvement and “hands-on” management of report guesses, opinions, and suppositions instead of the individual defendants. Second, plaintiffs argue facts. Defendants also contend that plaintiffs fail to that the CAC pleads facts showing that defendants allege particularized facts showing that each

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 84 of 163 Slip Copy Page 8 Slip Copy, 2006 WL 648683 (N.D.Cal.) (Cite as: Slip Copy) individual source occupied a position such that he or by informants who were not present at SST at the she would possess the information alleged. time of the alleged misrepresentations, and who appear to have little information regarding either the Plaintiffs respond that the proposed class period valuation of the inventory or the defendants' alleged simply functions to define the plaintiff class, but does “scheme” to misstate the value of the inventory. The not restrict the universe of relevant or actionable facts information provided by these informants concerns in the case. They contend that while scienter itself events that predated and had no apparent connection must always be contemporaneous with the alleged with the alleged misstatements regarding the misstatements, the facts supporting an inference of valuation of SST's inventory. scienter will not always be. In other words, plaintiffs argue that the fact that none of the informants worked Finally, the CAC alleges that one of the informants at SST during the proposed class period is not provided at least two of the defendants with “excess significant, because pre-class period awareness of inventory reports,” and that at least two of the events can be relevant to show awareness of certain informants attended “meetings” at which the facts and therefore to demonstrate scienter. participants discussed issues relating to the amount and type of products held in inventory, and to the The court finds that the allegations regarding the six valuation of inventory. These allegations are informants do not create a strong inference that insufficient in light of the Ninth Circuit's decisions in defendants acted with deliberate or conscious In re Silicon Graphics, In re Vantive, and In re Daou recklessness with regard to the alleged false Sys.. statements concerning SST's inventory valuations and financial performance during the first three quarters In In re Silicon Graphics, the court rejected the of 2004. The court first notes three ways in which the plaintiff's attempt to establish scienter through allegations are generally insufficient. general allegations that the defendants had received internal reports, including daily reports, monthly First, the CAC fails to plead with particularity that financial reports, “Stop Ship” reports, and “Flash each individual informant occupied a position such Reports.” Id. at 984-98 & n. 14. The court held a that he or she would possess the information alleged, plaintiff can rely on the existence of reports as a and the allegations regarding such information are means of establishing knowledge only if the therefore insufficiently reliable. complaint includes “adequate corroborating details”- such as plaintiff's sources of information with respect *11 Second, none of the six informants was to the reports, how the plaintiff learned of the reports, employed at SST during the proposed class period; who drafted the reports, and which officers at the and the only one of the six who worked at the company received them, in addition to “an adequate company at all in 2004 admittedly did not know what description of their contents.” Id. at 985. SST was reporting as inventory. Thus, none of the informants was in a position to know whether In In re Vantive, the plaintiffs attempted to establish defendants overstated the value of SST's inventory such scienter by adverting to the defendants' “hands- when the company's financial results were reported on” management style, their “interaction with other for the first three quarters of 2004. The statements corporate officers and employees, their attendance at regarding events that occurred during the period 2000 management and board meetings, and reports through 2003 cannot substitute for the required generated on a weekly and monthly basis. Relying on particularized showing of scienter in 2004. In re Silicon Graphics, the Ninth Circuit held that such allegations did not adequately establish that the While it is true that facts relating to pre-class period defendants had knowledge of the supposedly “true events may in certain circumstances contribute to the but concealed” circumstances. In re Vantive, 283 creation of an inference of scienter, see, e.g., Zelman F.3d at 1087-88. v. JDS Uniphase Corp., 376 F.Supp.2d 956, 970 (N.D.Cal.2005), there must be some connection *12 As in Silicon Graphics and In re Vantive, between that scienter and the earlier events. Here, the plaintiffs in the present case have failed to cite to any issue is not pre-class period statements made by specific report, to mention any dates or contents of defendants, which can be said to create a strong reports, or to allege their sources of information inference of scienter in connection with false or about any reports. The allegations are similarly misleading statements made during the class period, deficient, for the same reasons, with respect to the but rather a number of largely irrelevant statements defendants' attendance at meetings and their “hands-

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 85 of 163 Slip Copy Page 9 Slip Copy, 2006 WL 648683 (N.D.Cal.) (Cite as: Slip Copy) on” managerial style. See also In re Daou Sys., 411 or conscious recklessness. It is also not clear how F.3d at 1022. Yeh, Hu, and Tsai could have “micro-managed” a “poor and unreliable” system. Finally, plaintiffs The court will now discuss each of the informants. provide no basis for CI # 1's opinion that SST Plaintiffs identify Confidential Informant No. 1 (CI # continued to manufacture large amounts of flash 1) as a “business control analyst” employed at SST memory, despite the alleged absence of buyers, from February 2000 through April 2004, who was because “officials” feared that SST would otherwise “part of a team that monitored inventory on a daily lose its manufacturing vendors to competitors. basis.” According to CI # 1, SST had “a poor and Plaintiffs do not explain how CI # 1 learned about the unreliable system in place for managing and alleged fears of these officials, or even who the monitoring inventory.” He/she asserts that defendants officials were. Yeh, Hu, and Tsai FN4 “called the shots” and micro- managed the system, including issues related to *13 Plaintiffs identify Confidential Informant No. 2 inventory valuation, and that Hu created his own (CI # 2) as an “inventory control analyst” employed databases and spreadsheets to track and value at SST from February 2000 through August 2002. CI inventory on a daily basis, even though SST kept # 2 reported to the director of manufacturing systems, track of inventory in a separate software application. and was responsible for receiving inventory With regard to inventory, this informant believed that shipments, tracking inventory locations, and ensuring “whatever it was that the company was reporting that the actual products in inventory matched those was way off the mark” (emphasis added). He/she identified in SST's databases. According to CI # 2, indicated that SST continued to manufacture large the Finance Department at SST was excluded from amounts of flash memory, even though there were the inventory valuation process. Instead, “the vice “no buyers” because the company's officers and presidents of the individual units (and in particular directors feared the company would lose its [d]efendant Hu),” made the inventory valuation manufacturing vendors to competitors if they slowed decisions. CI # 2 claimed that these valuations were down their production lines. CAC ¶ 46-47 made “regardless of actual price” and that the overall valuation process was “arbitrary, with only some relation to reality.” In this informant's opinion, the FN4. The CAC does not assert a claim defendants were “unwilling to decrease the value against a defendant “Tsai.” assigned to inventory” because doing so would be an admission of their own “engineering mistakes” or The CAC provides only a sketchy description of CI # “business errors.” He/she considered it was a “pride 1's job duties, claiming that he/she was “part of a issue”-that defendants created a culture of “hear-no- team that monitored inventory on a daily basis.” evil-see-no-evil.” CAC ¶ 48. However, plaintiffs do not identify the other members of this “team,” and, more significantly, do The CAC provides some description of CI # 2's not explain what they mean by “monitored duties, although in vague terminology (“receiving inventory.” Such a job description could include shipments,” “tracking inventory location”) suggesting anything from counting widgets in a box, to moving that CI # 2 functioned more as a warehouse or inventory from place to place in a warehouse, to manufacturing plant clerk than as an employee with filling customer orders, to preparing spread sheets some personal knowledge of inventory valuation. showing the types and amount of product in However, this informant left SST in August 2002, inventory. It is apparent from the allegations that CI # and the CAC alleges no facts showing a basis for any 1 had no personal knowledge of what SST was personal knowledge regarding the valuation of reporting as inventory, but the CAC does not even inventory during the proposed class period. In provide particularized detail sufficient to show what particular, the CAC provides no connection between this informant knew with regard to inventory CI # 2's assertion that the inventory valuation process management. was “arbitrary” between February 2000 and August 2002, and plaintiffs claims that defendants knowingly Moreover, in view of CI # 1's claim that SST had a misrepresented the value of SST's inventory during “poor and unreliable system in place for managing the period between April and December 2004. and monitoring inventory,” it is difficult to see how any job relating to monitoring inventory would have CI # 2's statement that the Finance Department was provided CI # 1 with knowledge of facts creating a excluded from the valuation process is contradicted strong inference that defendants acted with deliberate by CI # 4's statement that former CFO Jeff Garon

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(“Garon”) was involved in the decisions regarding June 2003, and the CAC states no facts showing a valuation, and is further contradicted by the basis for any personal knowledge regarding the allegation in the CAC that defendant Lai, CFO during valuation of inventory during the proposed class the proposed class period, was a participant in the period. In addition, the allegations regarding CI # 3's alleged fraudulent misstatement of inventory values. participation in meetings with “vice-presidents” lack In addition, CI # 2's claim that the valuations were sufficient particularized detail to provide a basis for made by “the vice presidents of the individual attributing to CI # 3 any personal knowledge business units” and “in particular [d]efendant Hu” regarding inventory or inventory valuation. The CAC does not provide sufficient detail regarding who does not provide the dates of the meetings, or identify actually made the valuation decisions, how CI # 2 the attendees or the substance of the matters knows who made the decisions, or how he/she knows discussed. Nor does the CAC identify the “vice- that the decisions were made “regardless of actual presidents” whom CI # 3 believed were “aware” of price.” Finally, plaintiffs provide no basis for CI # 2's the amount and type of products held in inventory, or opinion that defendants would not decrease the value provide any facts showing a basis for CI # 3's belief assigned to inventory because they were unwilling to that these individuals had this knowledge. admit their own engineering mistakes or business errors. Indeed, the CAC states no facts showing that Plaintiffs identify Confidential Informant No. 4 (CI # CI # 2 was qualified to psychoanalyze defendants' 4) as a “controller” employed at SST from October motivations with regard to inventory valuation. 1995 through April 2003. This informant worked directly for Garon, the then-CFO. CI # 4 is “certain” *14 Plaintiffs identify Confidential Informant No. 3 that defendant Yeh and defendant Hu reviewed and (CI # 3) as an individual employed at SST from 2000 monitored the inventory numbers “very, very through June 2003, who was also employed as a carefully” and that defendant Hu and “defendant “production control manager” from 1997 through Garon” (actually not a defendant) were responsible 2000.FN5 At SST, CI # 3 was responsible for for “the final decision about what value to place on “tracking shipments and inventory.” He/she is products held in inventory.” CI # 4 “participated in” “certain” that “the vice presidents” were intimately monthly and quarterly meetings where inventory aware of the amount and type of products held in valuation “was discussed” with Yeh, Garon, Hu, and inventory because he “participated in” twice-monthly defendant Best, plus “a former cost accountant” and meetings with “these individuals” concerning this “business unit managers,” and claims that subject. CAC ¶ 49. participants in these meetings would “go back and forth and argue” over whether certain products held in inventory were sellable, and if so, for what amount FN5. It is not clear from the CAC whether of money. According to this informant, there were a CI# 3 worked at SSI during the entire period “ton of red flags” where inventory was concerned, as from 1997 through 2003, or whether he/she warnings were frequently raised within the company was a production control manager at some that products held in inventory were out-of-date or other company during the period 1997 overvalued. CAC ¶ 50. through 2000, and began working at SST in 2000. *15 Plaintiffs do not describe this informant's job duties, simply stating that he/she was a “controller” Plaintiffs describe this informant's duties only briefly, who worked with SST's former CFO. From this without any indication of what is meant by description, it is impossible to tell whether CI # 4 had “production control” or “tracking shipments and a basis for personal knowledge of the facts alleged. inventory.” From plaintiffs' description, it is Moreover, CI # 4 left his/her employment at SST in impossible to tell whether CI # 3 was employed, for April 2003, and the CAC alleges no facts showing example, as an inventory clerk, entering data any basis for personal knowledge regarding the regarding products placed in inventory and shipped valuation of inventory during the proposed class out to customers; or as a shipping or mailroom clerk, period. Nor does the CAC provide any particularized simply packaging products removed from inventory facts showing that CI # 4 had any basis for the and shipping them to customers; or in some other opinion that defendants Yeh and Hu reviewed and capacity. Thus, it is impossible to tell whether this monitored the inventory numbers “very, very informant has any relevant personal knowledge. carefully” or that Hu and CFO Garon were responsible for decisions regarding inventory Moreover, CI # 3 left his/her employment at SST in valuation. The CAC asserts that CI # 4 participated in

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 87 of 163 Slip Copy Page 11 Slip Copy, 2006 WL 648683 (N.D.Cal.) (Cite as: Slip Copy) monthly and quarterly meetings in which inventory informed his manager Andy Arata (then-director of valuation was discussed, but does not provide the quality assurance) and unidentified “senior dates of any meetings, or identify the attendees (apart management” that the company needed to decrease from Yeh, Garon, Best, and Hu) or any details of the the value it was placing on its inventory because such matters discussed, or of the alleged arguments among values did not reflect actual market prices. He the meeting participants regarding inventory believed that “some inventory” was obsolete and valuation. worth only 10% to 20% of its accounted-for value. He indicated that his recommendations were Plaintiffs identify Confidential Informant No. 5 as consistently and systematically ignored and rejected employed at SST “through 2003” (no indication of by “senior management” and/or Arata, and that his starting date) as an operations analyst, responsible for frustration concerning the company's unwillingness “tracking and locating excess inventory.” In CI # 5's to accurately and truthfully value its inventory led opinion, SST “often manufactured excess products” him to quit SST in 2004. CAC ¶ 52. because the executives wanted to build up inventory, not because there was any actual market demand for Plaintiffs describe Thiemer's job duties only briefly, those products. He/she recalled that the operations stating only that he was responsible for a “variety of department repeatedly told upper management that issues” related to inventory, including inventory products held in inventory were “not moving.” valuation. However, plaintiffs do not explain He/she claims to have provided Yeh and Best with Thiemer's role in the valuation of inventory, or excess inventory reports that included provide any particularized facts that would provide a recommendations concerning the likelihood that basis for creating a strong inference that defendants products held in inventory could actually be sold. acted with deliberate indifference. Moreover, CAC ¶ 51. Thiemer left his employment at SST at the end of 2003, and the CAC alleges no facts showing any Plaintiffs describe this informant's duties only briefly, basis for personal knowledge regarding inventory without any indication of what is meant by “tracking valuation during the proposed class period. and locating excess inventory.” Moreover, CI # 5 left his/her employment at SST at the end of 2003, and Thiemer claims to have “regularly” communicated to the CAC alleges no facts showing any basis for his manager and unidentified “senior management” personal knowledge regarding events that occurred that SST's inventory was overvalued, but as with CI # during the proposed class period. CI# 5 refers to 5, the CAC does not provide the dates of these “excess inventory reports” that he/she allegedly alleged communications, or any details concerning provided to Yeh and Best, but the CAC provides no the inventory at issue. In addition, there is no details regarding the author of the reports, or the indication as to who is meant by “senior dates or contents of the reports, other than as stated management.” Thiemer also claims that “some above. In addition, plaintiffs provide no inventory” was obsolete, but plaintiffs provide no particularized facts showing that CI # 5 had any basis detail about this allegedly obsolete product-not the for his/her opinion that SST manufactured excess type, the quantity, or the value. products because SST's “executives” wanted to build up inventory. With regard to the claim that the The allegations regarding these confidential “operations department” repeatedly communicated to informants do not, as plaintiffs contend, show “upper management” that products in inventory could defendants' personal involvement in, and “hands-on” not be sold, the CAC does not provide any details management of, inventory valuation or any other regarding the identity of the employees in the particular aspect of SST's business, and do not plead operations department, the identity of the individuals the particularized facts required to show scienter in upper management, the dates of these alleged under the PSLRA. communications, or any details concerning the inventory at issue. b. knowledge of general decline in prices of flash *16 Informant Brian Thiemer was employed at SST memory from 2001 through 2003 as a “quality assurance engineer” in the company's “inventory control” Plaintiffs contend that defendants' knowledge that department. He was responsible for “a variety of SST's inventory should have been written down issues related to the [c]ompany's inventory, including earlier than it was is shown by the fact that they inventory valuation.” He claimed that he regularly knew, or should have been aware, that the selling

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 88 of 163 Slip Copy Page 12 Slip Copy, 2006 WL 648683 (N.D.Cal.) (Cite as: Slip Copy) prices of flash memory were declining in the industry prices, but rather reports an inventory write-down as during the class period. With regard to 1Q 2004, the a result of “lower chipset unit costs,” having nothing CAC asserts that defendants knew or should have to do with the selling prices of flash memory. been aware that from March 2004 through April 21, 2004, the selling prices of AMD's and Intel's 32- The court finds that the allegations regarding a megabyte flash memory had declined. The CAC also decline in prices for AMD and Intel flash memory do alleges that defendants knew or should have known not create a strong inference of scienter. The CAC that Forbes reported on May 24, 2004, that the prices does not plead particularized facts showing that of flash memory had declined because manufacturers defendants did in fact know these details of industry such as Intel and Samsung were offering price prices, news reports, and financial analysts' reports. reductions in order to win customers; and that CBS Moreover, as previously indicated, the flash memory News reported on June 3, 2004, that while Intel's produced by AMD and Intel did not have the same flash memory sales had suffered in 2003, its sales capacity as the flash memory produced by SST, and were increasing in 2004 and Intel was winning the products therefore were not competitive. The market share. See CAC ¶ 56. CAC does not explain the relevance of a drop in price of 8-megabyte, 16-megabyte, and 32-megabyte flash *17 With regard to 2Q 2004, the CAC asserts that memory to the valuation of SST's inventory of 8- defendants knew or should have been aware that the megabit flash memory. average sales price of various types of flash memory sold by AMD and Intel fell for every week during the period June 13, 2004, through July 31, 2004, and c. motive to inflate price of stock continued to fall thereafter until at least August 31, 2004. Plaintiffs also claim that defendants knew or The CAC alleges that defendants' scienter is shown should have known that financial analyst WR by their motive to inflate the price of SST's stock, and Hambrecht reported on June 8, 2004, that flash that this motive is shown by defendants' insider memory prices in 2Q 2004 were 5 per cent lower trading, by SST's announcement of a stock than they had been in 1Q 2004 and were likely to repurchase in July 2004, and by SST's announcement continue to decline in 3Q 2004. Plaintiffs assert that of its acquisition of another company in October in response to competition in the flash memory 2004. In the Ninth Circuit, motive and opportunity, market, SST was forced, by July 2004, to lower its standing alone, are not sufficient to establish scienter. prices on some types of flash memory by as much as See In re Silicon Graphics, 183 F.3d at 974 (facts that 4 per cent. See CAC ¶ 61. indicate a motive to commit fraud and opportunity to do so may provide some reasonable inference of With regard to 3Q 2004, the CAC asserts that intent, but they are not sufficient to establish a strong defendants knew or should have been aware that the inference of deliberate recklessness). However, price of various types of flash memory sold by AMD motive can be considered as part of the “totality of was declining, and that the value assigned to flash the allegations” regarding scienter. memory in SST's inventory should therefore have been reduced. Plaintiffs also allege that defendants knew or should have known that when Intel i. insider trading announced its 3Q 2004 results on October 12, 2004, it also indicated that because flash memory sales *18 The CAC alleges that defendants motive to keep prices had fallen, and there was no reason to believe price of stock high, as shown by insider sales of they would increase, it would write down the value of stock, by Nojima on June 2, 2004, on November 17, its flash memory inventory. See CAC ¶ 72. 2004, and on December 8, 2004; by Best on August 12, 2004; and by Chikagami on December 14, 15, Defendants argue that this market pricing information and 16, 2004. Plaintiffs assert that the timing of the is irrelevant, as the details do not concern SST November and December 2004 stock sales was products or prices, and do not even involve products suspicious in view of the fact that the company that competed with the 8-megabit SST products that announced on December 20, 2004, that it expected to were the focus of the write-down. They also assert take a $20-$25 million inventory charge and write that the October 12, 2004, Intel earnings release cited down the value of certain products held in inventory in the CAC says nothing whatsoever about flash to their estimated market value, and that the gross memory prices or any purported decline in prices, or margin for 4Q 2004 was expected to be in the range any inventory write-down pertaining to flash memory of 1% to 3%, compared with previous estimates of

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 89 of 163 Slip Copy Page 13 Slip Copy, 2006 WL 648683 (N.D.Cal.) (Cite as: Slip Copy) between 25% and 32%. *19 Moreover, even if the court were to find that the timing or amount of the stock sales was suspicious, The PSLRA “neither prohibits nor endorses the “stock sales are helpful only in demonstrating that pleading of insider trading as evidence of scienter, certain statements were misleading and made with but requires that the evidence meet the ‘strong knowledge or deliberate recklessness when those inference’ standard.” In re Daou Sys., 411 F.3d at sales are able to be related to the challenged 1022 (citation and quotation omitted). Stock trades statements.” In re Vantive Corp., 283 F.3d at 1093. are only suspicious when “dramatically out of line Because the CAC fails to plead particularized facts with prior trading practices at times calculated to showing that defendants made false or misleading maximize the personal benefit from undisclosed statements, such “insufficient allegations of fraud ... inside information.” In re Silicon Graphics, 183 F.3d have a spillover effect” on an analysis of insider at 986. To evaluate suspiciousness of stock sales, the sales. Id. court should consider the amount and percentage of shares sold, the timing of the sales, and whether the sales were consistent with prior trading history. ii. SST's stock repurchase Nursing Home, 380 F.3d at 1232. The CAC alleges that defendants' motive to keep the Here, it appears that most of SST's officers and price of SST's stock high is also shown by the directors sold no stock during the proposed class announcement on July 29, 2004, that SST's board of period, and that just as many insiders purchased stock directors had authorized a stock repurchase program as sold. Yeh and Lai-the only defendants specifically of up to $15 million worth of the company's common alleged to have made false or misleading statements stock. The CAC does not explain how either this are not alleged to have sold any stock. Best sold no announcement or the repurchase program creates a shares, but rather transferred some previously strong inference of scienter. pledged stock as collateral for a loan. Lai and Hu purchased-not sold-stock during the class period. Collectively, defendants sold less than 2% of their iii. SST's acquisition of G-Plus total holdings, and SST itself purchased $15 million worth of its own stock during the class period, at The CAC alleges that defendants' motive to keep the prices plaintiffs allege were inflated by its own fraud. price of SST's stock high is further shown by the announcement on October 18, 2004, that SST had Only Nojima and Chikagami sold stock. Nojima's signed an agreement to acquire substantially all the sales were not out of the ordinary, as those sales were assets of privately-owned G-Plus, Inc., pursuant to consistent with his trading pattern and sales for the which SST agreed to issue approximately $26 million preceding seven years. Although Nojima sold no in SST stock to G-Plus. The deal closed on shares in 2003, he did sell shares every other year November 5, 2004. Plaintiffs claim that it was in the starting in 1998, as shown by his Form 4s filed with interest of the company to keep its share price higher the SEC. Thus, Nojima's sales are insufficient to in order to facilitate this stock-financed transaction. create a strong inference of scienter. Allegations that defendants engaged in routine Foreign-based outside director Chikagami, who is not business activities or were motivated by concerns that alleged to have personally made any false statement, are shared by all companies and executives is not did sell a substantial amount of his holdings (total of sufficient to establish scienter. See Lipton v. 66%), and he is the only officer or director whose Pathogenesis Corp., 284 F.3d 1027, 1038 (9th stock sales are even marginally suspicious under the Cir.2002) (“[i]f scienter could be pleaded merely by Silicon Graphics standard. However, in view of the alleging that officers and directors possess motive fact that he owned a relatively small number of and opportunity to enhance a company's business shares compared with the officers of the company, prospects, virtually every company in the United the fact that he did not sell all his shares, the fact that States that experiences a downturn in stock price no one else's sales appear suspicious, and the fact that could be forced to defend securities fraud actions”). other insiders actually purchased shares during the SST's acquisition of G-Plus is an example of the type proposed class period, the court finds that of routine activity and generic motive that cannot Chikagami's sales are insufficient to creating a strong serve as a basis for alleging securities fraud. inference of scienter. The fact of this merger or buy-out, standing alone, is

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 90 of 163 Slip Copy Page 14 Slip Copy, 2006 WL 648683 (N.D.Cal.) (Cite as: Slip Copy) insufficient to create a strong inference of scienter. conservatism be used as a prudent reaction Moreover, even if the court were to find that this to uncertainty to try to ensure that acquisition provides some small support for an uncertainties and risks inherent in business inference of fraud, the fact of the buy-out would have situations are adequately considered. CAC ¶ to be considered in the context of the fact that SST 94. and several of its officers purchased millions of dollars of SST stock during the class period, at prices *20 Violation of GAAP standards can provide that plaintiffs claim were inflated by fraud. evidence of scienter. In re Daou Sys., 411 F.3d at 1016. However, “[t]o support even a reasonable inference of scienter, much less a strong inference, d. alleged violations of GAAP the complaint must describe the violations with sufficient particularity: a general allegation that the The CAC alleges that defendants' scienter is shown practices at issue resulted in a false report of by their violation of Generally Accepted Accounting company earnings is not a sufficiently particular Principles (GAAP)-specifically, certain principles set claim of misrepresentation.” Id. (citations and forth in FASB Statement of Concepts Nos. 1 and 2 quotations omitted). Put another way, simple FN6-and also by their violation of the requirements of allegations of failure to follow GAAP do not unidentified “SEC regulations, regulations of the establish scienter, because scienter requires more national stock exchanges and customary business than a misapplication of accounting principles. See, practices” to disclose the sort of adverse information e.g., In re Worlds of Wonder Sec. Litig., 35 F.3d that was allegedly concealed by defendants during 1407, 1426 (9th Cir.1994)). In order to distinguish the class period. “deliberate recklessness” from “ordinary carelessness,” allegations of GAAP violations must be augmented by facts that shed light on the mental FN6. As alleged in the CAC, these are (a) state of the defendants, rather than conclusory the principle that interim financial reporting allegations that defendants must have known of the should be based on the same accounting accounting failures because of the degree of principles used to prepare annual financial departure from established accounting principles. See statements; (b) the principle that financial DSAM, 288 F.3d at 390-91. reporting should provide information that is useful to present and potential investors and The CAC alleges that “[i]n order to inflate the price creditors and other users in making rational of [SST] stock, [d]efendants intentionally and/or with investment, credit, and similar decisions; (c) deliberate recklessness overstated the value of flash the principle that financial reporting should memory held in inventory in violation of [GAAP],” provide information about the economic and then simply proceeds to list a number of resources of an enterprise, the claims to accounting principles that were allegedly violated by those resources, and effects of transactions, this overvaluation. CAC ¶ ¶ 91-94. However, the events, and circumstances that change GAAP allegations contain no facts that shed light on resources and claims to those resources; (d) the mental state of the defendants, and as the CAC the principle that financial reporting should fails generally to allege scienter, the allegations of provide information about how management GAAP violations contribute nothing. In order to of an enterprise has discharged its plead facts showing a strong inference of fraud, stewardship responsibility to stockholders plaintiffs must provide detail-not merely, as here, for the use of enterprise resources trusted to simply recite various GAAP provisions and allege in it was violated; (e) the principle that general terms that the defendants failed to comply reporting should provide information about with them. an enterprise's financial performance during a period; (f) the principle that financial The CAC does not identify any transaction by name reporting should be reliable in that it or date, does not specify any dollar amounts, does not represents what it purports to represent was identify any product or class or products that should violated; (g) the principle of completeness, have been written down sooner under these various which means that nothing is left out of the accounting principles, does not state what the information that may be necessary to insure appropriate write-down would have been, or when it that it validly represents underlying events should have been taken, or why a write-down should and conditions; (h) the principle that have been taken in that amount at that time. Although

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 91 of 163 Slip Copy Page 15 Slip Copy, 2006 WL 648683 (N.D.Cal.) (Cite as: Slip Copy) the CAC refers to the GAAP provision requiring that Hu, Chikagami, Nojima, or Best made any false inventory be carried on the balance sheet at the lower statements at all, and does not plead facts sufficient of “cost” or “market value,” the CAC says nothing to create a strong inference that defendants Yeh and about either the cost or the market value of SST's Lai made false statements with scienter. As a inventory, and says nothing about how or when the defendant corporation can be deemed to have the defendants purportedly became aware of the requisite scienter for fraud only if the individual allegedly improper accounting practices, but rather corporate officer making the statement has the simply refers to general declines in market prices of requisite level of scienter, the claims against SST also flash memory products throughout the industry.FN7 fail on this basis.

Plaintiffs contend that the CAC establishes the FN7. Plaintiffs acknowledge that “GAAP, as individual defendants' scienter regarding inventory set forth in Accounting Research Bulletin valuation, citing to ¶ ¶ 46-52 of the CAC (the (‘ARB’) No. 43, Chapter 4, Inventory “confidential informant” allegations), where plaintiffs Pricing, requires that inventories be recorded argue, they have alleged that Yeh, Lai, Hum Nojima, at the lower of cost or market .” CAC ¶ 93. and Best were “participating in monthly and quarterly At the hearing, however, plaintiff's counsel meetings in which inventory valuations were conceded that plaintiffs were unable to determined;” and where they have also alleged that provide any information regarding the cost defendants “excluded the finance department from or market value of SST's inventory. As the valuation process” and that Hu created his own explained above, that deficiency is one database and spreadsheet to track and value reason that plaintiffs' allegations of GAAP inventory. violations are insufficient to create a strong inference of scienter. That is not to say that Plaintiffs assert that allegations of a “detail-oriented plaintiffs would not theoretically be able to management style” make it reasonable to infer that plead facts sufficient to create a strong the individual defendants became aware of the falsity inference of intent or deliberate recklessness of statements related to critical business functions. in the absence of details regarding cost or They note that Yeh and Lai signed the 10-Qs for 1Q market value, just that the facts as pled are 2004, 2Q 2004, and 3Q 2004, that Yeh made all false not adequate to show GAAP violations as oral statements (referring to the October 20, 2004, circumstantial evidence of scienter, under conference call), and that the CAC alleges that the applicable Ninth Circuit authority. See, e.g., other defendants played active roles in the inventory DSAM, 288 F.3d at 390-91. valuation process. Thus, they argue, all defendants are therefore liable for the false statements regarding In In re Daou Sys., the Ninth Circuit relied on the the inventory valuations under the group pleading combination of “widespread and significant” inflation doctrine, which holds that there is a presumption that of revenue and “specific allegations of [top allegedly false and misleading group published executives'] direct involvement in the production of information is “the collective action of officers and false accounting statements” to find the complaint directors.” raised a strong inference of scienter. In re Daou Sys., 411 F.3d at 1016, 1020, 1023. By contrast, the CAC The PSLRA requires, with regard to each false or makes no specific allegations of defendants' direct misleading statement or material omission, that the involvement, and instead relies on their general complaint “state with particularity facts giving rise to involvement in the management of SST and their a strong inference that the defendant acted with the alleged knowledge that the inventory valuation was required state of mind.” 15 U.S.C. § 78u-4(b)(2) “arbitrary .” (emphasis added). While the Ninth Circuit did rule in a pre-PSRLA case, Wool v. Tandem Computers, Inc., 818 F.2d 1433 (9th Cir.1987), that “it is reasonable to e. group pleading presume” that false or misleading information contained in prospectuses, registration statements, *21 As a final basis for dismissal, the court finds that annual reports, press releases, or other “group- the claims against the individual defendants fail published information” can be attributed to the because the CAC pleads no facts showing that any “collective actions of the officers” of the corporation, individual defendant made any statement with and that a securities fraud plaintiff “fulfills the scienter. The CAC does not allege that defendants particularity requirements of Rule 9(b) by pleading

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 92 of 163 Slip Copy Page 16 Slip Copy, 2006 WL 648683 (N.D.Cal.) (Cite as: Slip Copy) the misrepresentations with particularity and where causation, asserting that the boilerplate language in possible the roles of the individual defendants in the the CAC is substantially identical to the language misrepresentations,” id. at 1440, the Ninth Circuit has found inadequate by the Supreme Court in Dura not spoken in any officially published opinion on the Pharm., Inc. v. Broudo, 544 U.S. 336, 125 S.Ct. question whether the “group pleading” doctrine 1627, 1630, 161 L.Ed.2d 577 (2005). The CAC applies to allegations of scienter in a case governed alleges that the overvaluation of inventory and later by the PSLRA.FN8 disclosure of the lack of internal controls that led to the overvaluation caused a 22.5% decline in the price of SST's stock price. The court finds that the FN8. Other circuits have spoken on this allegations in the CAC do meet the requirements of issue, notably the Fifth Circuit in Southland Dura. Sec. Corp. v. INSpire Ins. Solutions, Inc., 365 F.3d 353, 364-65 (5th Cir.2004) (noting conflict among the courts, and holding that 4. Control Person Liability “[t]he ‘group pleading’ doctrine conflicts with the scienter requirement of the Adequate pleading of a primary violation of § 10(b) PSLRA”); see also Makor Issues & Rights, is required for a plaintiff to adequately plead control Ltd. v. Tellabs, Inc., 437 F.3d 588, 602-03 liability under § 20(a). See 15 U.S.C. § 78t. Because (7th Cir.2006); Phillips v. Scientific-Atlanta, the CAC fails to state a claim for primary liability Inc., 374 F.3d 1015, 1017-18 (11th under § 10(b) or Rule 10b-5, the court finds that the Cir.2004). claim for control person liability must be dismissed.

*22 The court is aware that some judges in this district have either applied the group-published CONCLUSION presumption without substantive analysis in cases controlled by the PSLRA, or have found that the In accordance with the foregoing, the motion to presumption has survived the enactment of the dismiss the consolidated amended complaint is PSLRA. See, e.g., In re Omnivision Techs., Inc., 2005 GRANTED, for failure to allege falsity with WL 1867717 at *5 (N.D.Cal., July 29, 2005); In re particularity, and for failure to allege scienter as to Adaptive Broadband Sec. Litig., 2002 WL 989478 at any defendant. The totality of plaintiffs' allegations *52-53 (N.D.Cal., April 2, 2002); In re Secure are insufficient under the heightened pleading Computing Corp. Sec. Litig., 120 F.Supp.2d 810, 821 standard of the PSLRA to raise a strong inference (N.D.Cal.2000). Other judges, however, have that defendants acted with deliberate or conscious concluded that plaintiffs must state with particularity recklessness in issuing statements regarding the value facts indicating that an individual defendant was of SST's inventory or in failing to disclose that SST directly involved in the preparation of allegedly lacked adequate internal controls to ensure that misleading statements published by an organization, inventory was properly valued. The dismissal is and have found the group-published presumption WITH LEAVE TO AMEND, and any amended inappropriate in light of the pleading standards complaint shall be filed no later than April 14, 2006. imposed by the PSLRA. See, e.g., In re Netopia, Inc., Sec. Litig., 2005 WL 3445631 at *5-6 (N.D.Cal., *23 Notwithstanding the fact that the dismissal is Dec.15, 2005); In re ESS Technology, Inc. Sec. Litig., with leave to amend, the court questions whether 2004 WL 3030058 at *12 (N.D.Cal.2004). Until such plaintiffs will be able to state a claim. The gravamen time as the Ninth Circuit does speak on this issue, of plaintiffs' complaint as presented in the CAC is this court interprets the above-cited provision of the that SST mismanaged the valuation of its inventory, PSLRA as requiring that plaintiffs plead facts and then failed to disclose that mismanagement. The showing scienter as to each defendant individually. In allegation that defendants should have written down other words, plaintiffs must allege the required state the inventory earlier than they did, or should have of mind as to each defendant who made an allegedly disclosed that SST's valuation system was misleading statement. “arbitrary,” is essentially a claim that there were material deficiencies in SST's inventory control procedures. Generally speaking, incidents of 3. Loss Causation fiduciary misconduct and internal mismanagement are not by themselves sufficient to trigger liability Defendants argue that the CAC fails to plead loss under the Exchange Act. Santa Fe Indus., Inc. v.

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 93 of 163 Slip Copy Page 17 Slip Copy, 2006 WL 648683 (N.D.Cal.) (Cite as: Slip Copy)

Green, 430 U.S. 462, 478-80, 97 S.Ct. 1292, 51 L.Ed.2d 480 (1977).

IT IS SO ORDERED.

N.D.Cal.,2006. In re Silicon Storage Technology, Inc. Slip Copy, 2006 WL 648683 (N.D.Cal.)

Briefs and Other Related Documents (Back to top)

• 2005 WL 3607720 (Trial Motion, Memorandum and Affidavit) Plaintiffs' Memorandum in Support of their Opposition to Defendants' Motion to Dismiss the Consolidated Amended Class Action Complaint (Nov. 4, 2005) Original Image of this Document (PDF) • 2005 WL 451836 (Trial Pleading) Complaint for Violation of the Federal Securities Laws (Jan. 20, 2005) • 3:05cv00295 (Docket) (Jan. 20, 2005) • 2005 WL 2868820 (Trial Motion, Memorandum and Affidavit) Defendants' Memorandum of Points and Authorities in Support of Motion to Dismiss Plaintiffs' Consolidated Amended Class Action Complaint (Jan. 4, 2005)

END OF DOCUMENT

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 94 of 163

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

price of TyCom stock and boost the company's Briefs and Other Related Documents profits. According to plaintiffs, the underwriters of the TyCom Offering, Goldman, Sachs & Co. NOT FOR PUBLICATION (“Goldman Sachs”), Citigroup Global Markets, Inc. United States District Court,D. New Hampshire. (f/k/a Salomon Smith Barney Inc.)(“SSB”), and Rosemarie STUMPF Merrill Lynch, Pierce, Fenner & Smith Incorporated v. (“Merrill Lynch”) (collectively, “Underwriters”) Neil R. GARVEY, et al. were complicit in this scheme, failed to disclose In re TYCOM LTD. SECURITIES LITIGATION conflicts of interest, and issued false statements in No. 03-CV-1352-PB, 02-MDL-1335-PB. their analysts' reports to inflate the value of TyCom stock. Sept. 2, 2005.

FN1. This case began as two separate James V. Bashian, Law Office of James V. Bashian actions filed in the United States District PC, Fairfield, NJ, for Rosemarie Stumpf. Court for the District of New Jersey: Stumpf v. Garvey, filed on July 24, 2003, and MEMORANDUM AND ORDER O'Loughlin v. Garvey, filed on September BARBADORO, J. 26, 2003. On October 30, 2003, the Judicial *1 This class action arises from a decision by Tyco Panel on Multidistrict Litigation (“MDL”) International Ltd. to sell off a minority interest in one issued a Conditional Transfer Order of its subsidiaries, TyCom Ltd. Plaintiffs purchased transferring Stumpf v. Garvey to this court shares of TyCom stock, either pursuant to a July 26, pursuant to 28 U.S.C. § 1407. By order 2000 Registration Statement and Prospectus dated November 10, 2003-prior to date on (“Prospectus”) for TyCom's initial public offering which the MDL transfer order became final- (“Offering”), or on the open market between July 26, the New Jersey District Court consolidated 2000 (“Effective Date”) and December 17, 2001 the two cases, approved the parties' selection (“Class Period”). Plaintiffs claim that defendants of lead counsel, and appointed Mark Newby Tyco, TyCom, L. Dennis Kozlowski, Mark H. as lead plaintiff. The consolidated complaint Swartz, and Neil R. Garvey devised a scheme to was filed on December 13, 2004. fraudulently reap more than $200 million in cash from the July 26, 2000 offering of common shares in In Count I, plaintiffs assert claims against all TyCom, a wholly owned subsidiary of Tyco. defendants based on § 11 of the Securities Act of Plaintiffs also claim that analysts employed by the 1933 (“Securities Act”), 15 U.S.C. § 77(k), and Underwriters of the Offering issued false reports in against Tyco and the individual defendants based on furtherance of the scheme. § 15 of the Securities Act. 15 U.S.C. § 77(o). In Count II, plaintiffs assert claims against all Plaintiffs elaborate on their claim in their defendants except Merrill Lynch based on § 10(b) of consolidated complaint FN1 (“Complaint”), by the Securities and Exchange Act of 1934 (“Exchange alleging that the Prospectus was materially false and Act”), 15 U.S.C. § 78j(b), and against Tyco and the misleading because it both misrepresented that the individual defendants based on § 20(a) of the demand for undersea fiber-optic cable bandwidth, Exchange Act. 15 U.S.C. § 78t(a). Defendants have TyCom's sole product, was increasing, and failed to moved to dismiss the Complaint on a variety of FN2 disclose that the market for bandwidth was already grounds. saturated with unused capacity. Plaintiffs allege that these materially false and misleading statements fraudulently induced them to purchase TyCom stock FN2. Tyco, TyCom, and Garvey filed a at an inflated price during the Class Period. Plaintiffs motion to dismiss the Complaint (Doc. No. also charge that defendants continued their 384). Kozlowki filed a separate motion to misconduct during the Class Period by engaging in dismiss (Doc. No. 391), but joined in the fraudulent revenue swaps to artificially inflate the legal arguments set forth by Tyco, TyCom

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and Garvey. Goldman Sachs, SSB, and marketing director, James F. Brennan, who in 1990 Merrill Lynch also filed a separate motion to had been convicted of bank fraud, played a central dismiss (Doc. No. 392), joining in Tyco's role in the Offering.FN3 arguments and setting forth additional arguments for dismissal. I address the arguments presented in all three motions. FN3. The First Circuit Court of Appeals affirmed Brennan's bank fraud conviction. I. BACKGROUND See United States v. Brennan, 994 F.2d 918, 930 (1st Cir.1993). A. Tyco's Telecommunications Cable Business C. Pre-Offering Demand For Undersea Bandwidth

Prior to April 1997, Tyco manufactured undersea Most of the cable that TyCom and other companies fiber optic telecommunications cable in its Simplex installed in 1999 and 2000 was unused “dark fiber” at Technologies unit. Simplex's major customer was AT the time of the Offering. “Dark fiber,” as opposed to & T Submarine Systems Inc. (“SSI”), whose “lit fiber,” is fiber that is laid undersea, but has not principal business was designing and laying undersea yet been connected to land, often due to a lack of cable systems to connect to land-based cable systems. demand. Based on a massive build-out of capacity by On April 11, 1997, Tyco and AT & T announced that Global Crossing, 360networks, and Level 3, there they had entered into an agreement for Tyco to was sufficient bandwidth capacity to meet anticipated acquire SSI. Tyco explained that SSI would operate future demand several times over. In fact, at the time in conjunction with its Simplex unit to become a fully of the Offering, the only demand for capacity on the integrated manufacturer, designer, and servicer of TGN was from companies such as Qwest, Global undersea fiber optic cable systems. Tyco completed Crossing, and Level 3, who themselves had excess the purchase on July 1, 1997, and renamed the new bandwidth capacity, but were interested in entity Tyco Submarine Systems Ltd. Tyco Submarine “swapping” their excess capacity for capacity on the was later renamed TyCom. At the time, Tyco owned TGN.FN4 Furthermore, those companies treated the 100% of the stock in TyCom. capacity transferred in swap transactions as revenue- producing sales, even though no money changed *2 Tyco's merger of Simplex and SSI was perfectly hands. timed to benefit from the growth in telecommunications companies that sought to own undersea cable systems. TyCom's revenue thus grew FN4. “Swaps” are reciprocal transactions in from $375.5 million in fiscal 1997 to $1.28 billion in which two telecommunications companies fiscal year 1998, and $1.63 billion in fiscal year exchange capacity on each other's network. 1999. TyCom's revenue in the first six months of Swaps “may be entered into for legitimate fiscal year 2000 was $1.27 billion. This growth was reasons, i.e. to acquire access on networks in fueled primarily by contracts with four of TyCom's a market that a company wishes to enter in largest customers, Level 3 Communications, exchange for capacity that has yet to be sold 360networks, Global Crossing, and Flag Telecom. and is not otherwise in use (‘dark fiber’). These customers raised cash to fund their operations However, swap transactions can also be through a series of public offerings in which the [used] by a company seeking to defraud Underwriters were participants. investors or its creditors to create the impression that the company is selling capacity when it is merely unloading useless B. Tyco's Decision to Sell Off a Minority Interest of dark fiber on one of its networks in TyCom exchange for useless dark fiber on a competitor's network,” thereby inflating the After an open-house for telecommunications research company's bottom line. In re Flag Telecom analysts in the fall of 1999, TyCom's management Holdings, Ltd. Sec. Litig., 352 F.Supp.2d decided to sell off a minority interest in the company 429, 461 (S.D.N.Y.2005) ( “Flag II” ). and construct the TyCom Global Network (“TGN”). The company later conducted “town hall meetings” at According to a senior director of global sales at TyCom's various locations to increase its employees' TyCom (“Employee E”), the company's network awareness of the TyCom Offering. TyCom senior engineers and other employees involved in designing

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 96 of 163 Not Reported in F.Supp.2d Page 3 Not Reported in F.Supp.2d, 2005 WL 2127674 (D.N.H.), Fed. Sec. L. Rep. P 93,522, 2005 DNH 125 (Cite as: Not Reported in F.Supp.2d) the TGN were “queasy” about the lack of sufficient final Prospectus with the Securities and Exchange market demand to support an additional global Commission (“SEC”) for the initial offering of network, and therefore strongly advised against the 61,130,435 shares of TyCom common stock at $32 spin-off. Compl. ¶ 74. According to Employee E, at per share. Id. ¶ 99. Goldman Sachs, SSB, and Merrill the time of the Offering, bandwidth capacity had Lynch were the co-lead underwriters of the Offering. already surpassed demand and the price of bandwidth Id. ¶ 101. Tyco planned to sell 14% of its interest in was plummeting. Id. ¶ 75. Another TyCom TyCom. Id. ¶ 102. employee, a shore-end installation engineer (“Employee G”), who was responsible for installing The Prospectus represented that $1,654,115,224 of submarine and terrestrial fiber optic cable systems, the $1,854,115,000 in estimated net proceeds from including the TGN, stated that in the late 1990s there the Offering would be used “toward the deployment was “more than enough capacity.” Id. ¶ 78. He added of the first phase of the TyCom Global Network.” that concerns within TyCom and Tyco about waning Compl. ¶ 100. According to the Prospectus, the demand and excess bandwidth capacity were not principal elements of TyCom's business strategy were disclosed to the public, and instead, TyCom's to deploy the TGN to address increasing demand, marketing and sales division “continued to forecast a transform into a provider of undersea bandwidth huge market” to potential investors. Id. ¶ 79. services, and deliver customer-driven network solutions. Id. ¶ 108. The Prospectus added that the *3 A former director of technology for TyCom TGN was likely to be successful because, based on (“Employee I”) similarly stated that concern over research conducted by the Yankee Group, global bandwidth demand at the time of the Offering was demand for undersea bandwidth capacity on the widely expressed among TyCom employees. Compl. transatlantic route was expected to increase “at a ¶ 84. TyCom's deputy director of global sales from compound annual growth rate of approximately 1997 to 2004 (“Employee D”) stated that despite the 123% from 2000 through 2005,” and demand on the efforts of the sales staff, coupled with almost weekly transpacific route was expected to “increase at a price reductions, no bandwidth was sold from the compound annual growth rate of 129%” over the beginning of 2000 until the middle of 2001. Id. ¶ 85. same period. Id. ¶ 109. TyCom's executives, including Garvey, were well aware that no sales of bandwidth had been made immediately prior to the Offering and that there were E. The Yankee Group Forecasts few expressions of interest from potential customers. Id. ¶ 86. A terminal engineer (“Employee J”) *4 Prior to the Offering, TyCom sent a Request for responsible for activating cables, and hence available Quotation (“RFQ”) to the Yankee Group, a bandwidth, stated that in many of the terminals only telecommunications and networking research and 1/32 of the capacity was being utilized and that consulting firm, asking for the preparation of “a TyCom was absorbing cancellations in contracts by demand analysis for various traffic destinations” for assuming ownership of the capacity that had been the period from 2000 through 2009. Compl. ¶ 90. In installed and completed. Id. ¶ 87. the RFQ, TyCom informed the Yankee Group that “[TyCom] had already completed a basic Global Supply and Demand-side analysis” and that it “would D. TyCom's Public Offering like [the Yankee Group] to use this analysis as a starting point” for its own analysis. Id. The RFQ On January 17, 2000, Tyco announced that, in emphasized that “the Yankee Group's final response to rapidly increasing market demand for presentation is expected to be a validation of previous undersea bandwidth, it planned to develop TyCom [TyCom] efforts ... intended to serve [in anticipated into a publicly traded company for the purpose of SEC filings] as an objective third-party view of designing, building, installing, operating, and global demand for network capacity.” FN5 Id. The maintaining its own global undersea fiber-optic RFQ was “carbon copied” to members of TyCom's communications network. Compl. ¶ 97. The TGN senior management, including Andrew Kowalik, was to be the “largest and most advanced global TyCom's head of strategic information. Id. ¶ 92. undersea telecommunications fiber optic network.” Id. Tyco common stock rose by $5.125 per share the next day, in part due to investor enthusiasm for the FN5. The RFQ further stated that after the proposed offering. Id. ¶ 98. On July 26, 2000, Yankee Group performed its “own demand TyCom filed an amended Registration Statement and analysis,” it would be required to “evaluate

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the [TyCom] Demand model and per share. Id. ¶ 199. Governali reiterated his projections, and then render an assessment “recommend list” rating and the $60 price per share as to its approach and consolidations” and in his October 18, 2000 report. Id. ¶ 207. “improve its own model if warranted....” Compl. ¶ 91. FN7. Under SEC regulations, the Employee H, a former global forecast analyst who Underwriters were prohibited from issuing worked for TyCom from 1998 to 2002, learned from research reports for twenty-five days Kowalik that the Yankee Group's forecasts predicted following the Offering. much larger demand growth than TyCom's internal analyses because the Yankee Group had relied on Jack Grubman of SSB echoed these ratings, initiating TyCom's falsely inflated projections.FN6 Compl. ¶ coverage with a “Speculative Buy” rating and a 12 to 93. In February 2000, TyCom's “Final View” of the 18 month target price of $75 per share. Compl. ¶ market projected that demand for the transatlantic 200. Grubman estimated that during the fiscal year routes would increase at an average of 51.25% per ending September 2000, TyCom's revenue would year between 2001 and 2005. Id. ¶ 94. Similarly, grow by 55.3% to $2.3 billion. Id. He added that demand for the transpacific routes for the same demand for undersea bandwidth was expected to period was projected to increase yearly by an average exceed supply and that TyCom was an attractive of 81.25%. Id. The Yankee Group's demand investment. Id. projections for the same period were significantly higher: it projected 71% average annual growth in the *5 In response to the August 21, 2000 analyst transatlantic region and 85.75% average annual coverage, TyCom stock closed on August 21, 2000 at growth in the transpacific region. Id. ¶ 95. Employee $42.875, up from the previous day's close of $37.75, B indicated that the Yankee Group's projections were on volume that was approximately three times the inflated by the inclusion of non-revenue-producing prior week's average daily volume. Compl. ¶ 206. reciprocal bandwidth swaps and did not reflect actual TyCom stock closed at a high of $45.438 on end-user demand. Id. ¶ 96. September 1, 2000. Id. ¶ 207.

On January 16, 2001, TyCom announced a “major” FN6. Employee H also alleges that Kowalik $82.5 million capacity sale on the transatlantic route told her that the Underwriters had explained of the TGN to DishnetDSL Limited of India to him and other senior TyCom executives (“DishnetDSL”). Compl. ¶ 208. The following day, what the sales and revenue projections had TyCom announced its financial results for the quarter to be in order to induce investors to buy ending December 31, 2000, and reported that the shares of TyCom and then instructed company's “strong earnings” were “driven by the Kowalik to “come back with the numbers to supply of third-party systems and sales of capacity on support those forecasts.” According to the TGN.” Id. ¶ 209. On February 23, 2001, TyCom Employee H, Kowalik then reported these issued a press release stating that “the transatlantic “falsely inflated demand numbers” to the portion of the TyCom Global Network (TGN), Yankee Group. Com pl. ¶ ¶ 88-89. scheduled to be placed in service in July 2001, will have its capacity increased sooner than planned to F. Post-Offering Trading in TyCom Stock meet demand for larger bandwidth increments, including wavelengths.” Id. ¶ 212. On July 27, 2000, TyCom stock rose by $4.52 per share as investors reacted positively to the Offering. Likewise, in an April 18, 2001 press release, TyCom Compl. ¶ 195. Beginning on August 21, 2000, the announced capacity sales on both the transatlantic Underwriters commenced analyst coverage of and transpacific routes. Compl. ¶ 214. TyCom shares TyCom.FN7 Id. ¶ 197. Craig Irvine of Merrill Lynch rose by $3.72, or 26%, to $18.25 per share in initiated coverage of TyCom with a near-term rating response to this news. Id. ¶ 215. On April 26, 2001, of “accumulate,” a long-term rating of “buy,” and a Governali reiterated his “recommend list” rating of 12-to 18-month target price of $60 per share. Id. ¶ TyCom stock, but reduced the price target to $40 per 198. Irvine reiterated this rating on October 7, 2000. share. Id. ¶ 250. TyCom made similar Id. Similarly, Frank Governali of Goldman Sachs announcements related to capacity sales in May, initiated coverage of TyCom with a rating of June, July, and August 2001. Id. ¶ ¶ 216-22. TyCom “recommend list” and a 12-month target price of $60 attributed its strong performance during this period to

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 98 of 163 Not Reported in F.Supp.2d Page 5 Not Reported in F.Supp.2d, 2005 WL 2127674 (D.N.H.), Fed. Sec. L. Rep. P 93,522, 2005 DNH 125 (Cite as: Not Reported in F.Supp.2d) its ability to generate capacity sales. Id. In his July 18, 2001 report, Grubman reiterated his “buy” rating for TyCom stock. Id. ¶ 190. Several weeks later, H. TyCom's Stock Prices Fall however, in his August 8, 2001 report, Grubman downgraded TyCom to “neutral.” Id. ¶ 254. *6 From a high price of $45.4375 on September 1, 2000, TyCom's stock began a long decline in value to a low closing price of $7.41 on September 27, 2001, G. TyCom's Swap Transactions as a result of a series of partial disclosures concerning reduced demand, oversupply, and declining prices for According to Employee K, a senior manager of bandwidth. Compl. ¶ 243. An article titled “Trouble terminal commissioning and network design, TyCom in Octopus Garden,” in the March 1, 2001 edition of was swapping capacity on the TGN with capacity on America's Network, attributed the decline in the price other carrier networks and recognizing these swaps as of TyCom stock to the oversupply of bandwidth and revenue, in violation of Generally Accepted the resulting plummeting prices, and cautioned that Accounting Principles (“GAAP”), particularly TyCom was running the “risk of running itself into Accounting Principles Board Opinion No. 29 (“APB the ground.” FN10 Id. ¶ 244. TyCom stock closed at No. 29”).FN8 Compl. ¶ 227. Employee H confirmed $18.04 per share the next day, after having traded as that TyCom would take a large block of dark fiber high as $25.09 the week before, and the company and exchange it for dark fiber on another company's announced that it would buy back as much as $500 proposed cable network. Id. ¶ 228. Similarly, million in common stock on the open market. Id. ¶ ¶ Employee C, project manager at TyCom's 246-47. TyCom's buy-back temporarily buoyed the Morristown, New Jersey facility, reported that price per share, but the decline soon resumed, and TyCom swapped capacity without the auditors' TyCom stock closed at $9.99 on April 4, 2001. Id. ¶ ¶ knowledge in an effort to boost revenue.FN9 Id. ¶ 248-49. 229.

FN10. On March 1, 2001, TyCom FN8. APB No. 29 requires that exchanges of competitor 360networks reported that it had non-monetary assets be accounted for by lost $355 million, or 55 cents per share, for calculating the fair value of the asset given the year that ended December 31, 2000. up or the asset received, whichever is more Accordingly, 360networks announced that it readily determinable. See In re Flag was scaling back its forecasts for profit, Telecom Holdings, Ltd. Sec. Litig., 308 revenue, and capital spending. Compl. ¶ F.Supp.2d 249, 263 (S.D.N.Y.2004) ( “Flag 245. I” ). Similarly, a June 22, 2001 article in The Wall Street FN9. According to Employee B, during the Journal Online reported that prices for bandwidth fourth quarter of fiscal year 2001, TyCom were falling “as much as 60%” and that the “amount discussed appropriate accounting treatment of underused long-haul fiber capacity in the U.S. is of its bandwidth swaps with its outside about 97%.” Compl. ¶ 253. auditor PricewaterhouseCoopers (“PwC”). PwC informed TyCom that it would not On October 4, 2001, Tyco announced an initial offer issue an opinion letter on TyCom's financial to exchange the TyCom shares it did not already own statements classifying the swaps as revenue. at an exchange rate of .2997 shares of Tyco common Compl. ¶ 257. stock per share of TyCom stock. Compl. ¶ 258. Before trading opened on October 19, 2001, Tyco An internal company document establishes that the and TyCom announced that they had entered into a purported sale to Dishnet announced on January 16, definitive agreement whereby a Tyco subsidiary 2001 was in fact a swap of capacity, and indicated would reacquire the outstanding minority interest in that DishnetDSL was not carrying traffic. Compl. ¶ TyCom at a ratio of .3133 shares of Tyco common 230. Moreover, the same document reveals that stock for every outstanding share of TyCom stock. TyCom also engaged in capacity swaps with Qwest Id. ¶ 260. On December 17, 2001, the date of the and Emergia and the total value of all non-swap lease merger, Tyco common stock closed at $55.80 per transactions through mid-September 2002 was only share, making the effective acquisition price of the $3,436,651. Id. ¶ ¶ 231-32. merger $17.48 per share. Id. ¶ 261. Employee B

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 99 of 163 Not Reported in F.Supp.2d Page 6 Not Reported in F.Supp.2d, 2005 WL 2127674 (D.N.H.), Fed. Sec. L. Rep. P 93,522, 2005 DNH 125 (Cite as: Not Reported in F.Supp.2d) suspects that Tyco acquired the minority interest in Fed.R.Civ.P. 9(b). TyCom to avoid having TyCom issue separate audited financial statements that would have revealed A plaintiff who alleges securities fraud under § 10(b) the lack of demand for TyCom's bandwidth and the of the Exchange Act must also satisfy the heightened extent to which the purported swap transactions did pleading standards of the PSLRA. To plead a not qualify for revenue recognition under GAAP. Id. material misrepresentation or omission under the ¶ 262. PSLRA the complaint must “specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an II. STANDARD OF REVIEW allegation regarding the statement is made on ‘information and belief,’ the complaint shall state Defendants challenge the Complaint pursuant to with particularity all facts on which the belief is Rules 12(b)(6) and 9(b) of the Federal Rules of Civil formed.” 15 U.S.C. § 78u-4(b)(1). To be actionable Procedure and the Private Securities Litigation as securities fraud, “the statements alleged to be Reform Act (“PSLRA”), 15 U.S.C. § 78u-4(b). misleading must be misleading to a material degree.” When considering a motion to dismiss pursuant to In re Cabletron Sys., Inc., 311 F.3d 11, 27 (1st Rule 12(b)(6), I must “accept as true all well-pleaded Cir.2002). A fact is material “if it is substantially allegations and give plaintiffs the benefit of all likely ‘that the disclosure of the omitted fact would reasonable inferences.” Cooperman v. Individual have been viewed by the reasonable investor as Inc., 171 F.3d 43, 46 (1st Cir.1999)(citing Gross v. having significantly altered the total mix of Summa Four, Inc., 93 F.3d 987, 991 (1st Cir.1996)). information made available.” ’ Id. at 34 (quoting However, while a court “deciding a motion to dismiss Basic Inc. v. Levinson, 485 U.S. 224, 231-32, 108 under Rule 12(b)(6) ... must take all well-pleaded S.Ct. 978, 99 L.Ed.2d 194 (1988)). Finally, the facts as true ... it need not credit a complaint's ‘bald PSLRA requires that a securities fraud claim plead assertions' or legal conclusions.” Shaw v. Digital facts with particularity that are sufficient to give rise Equip. Corp., 82 F.3d 1194, 1216 (1st Cir.1996) to a “strong inference” of scienter. 15 U.S.C. § 78u- (quoting Wash. Legal Found. v. Mass. Bar Found., 4(b)(2). 993 F.2d 962, 971 (1st Cir.1993)). A well-pleaded complaint must contain “factual allegations ... Section 11 of the Securities Act creates a right of respecting each material element necessary to sustain action for damages by securities purchasers when recovery under some actionable legal theory.” registration statements contain untrue statements of Glassman v. Computervision Corp., 90 F.3d 617, 628 material fact or material omissions, and plaintiffs can (1st Cir.1996)(internal quotations and citations trace their shares to those registration statements. 15 omitted). A motion to dismiss under Rule 12(b)(6) U.S.C. § 77k(a). Because fraud is not an essential should not be granted unless it “presents no set of element of a § 11 claim, a plaintiff asserting such a facts justifying recovery.” Cooperman, 171 F.3d at claim typically need only satisfy the liberal pleading 46 (citing Dartmouth Review v. Dartmouth Coll., 889 requirements of Fed.R.Civ.P. 8(a). See Giarraputo v. F.2d 13, 16 (1st Cir.1989)). Unumprovident Corp., 2000 WL 1701294, *9 (D.Me. Nov.8, 2000). Furthermore, unlike § 10(b), § 11 *7 Special pleading requirements apply to fraud does not require an allegation of scienter. claims. Fed.R.Civ.P. 9(b) states that “[i]n all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with III. ANALYSIS particularity.” “Rule 9(b) also requires that a plaintiff's averments of fraud specify the time, place, Defendants have launched a multi-pronged attack on and content of the alleged false or fraudulent the sufficiency of the Complaint. I evaluate the merits misrepresentations.” United States ex rel. Karvelas of each argument in turn. v. Melrose-Wakefield Hosp., 360 F.3d 220, 226 (1st Cir.2004). Moreover, when a cause of action sounding in fraud is based on “information and A. Section 10(b) belief,” Rule 9(b) requires the plaintiff to plead sufficient supporting facts to permit a conclusion that Although the Complaint includes many allegations the alleged belief is reasonable. See id. In contrast, that mirror those offered by the Lead Plaintiffs in the “[m]alice, intent, knowledge and other conditions of Tyco securities action pending in this court, see In re minds or a person may be averred generally.” Tyco Int'l Ltd. Sec. Litig., 2004 DNH 154 (Oct. 14,

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2004)(“Tyco II” ), the core allegations in this case, other companies in 1999 and 2000 was dark at the and those challenged most vigorously by defendants, time of the Offering and awaiting demand for are that (1) TyCom publicly represented that demand capacity,” that “the only demand that TyCom for bandwidth was “increasing” and was expected to experienced for the TGN at the time of the Offering continue to increase, even though TyCom knew that was from companies ... [that] themselves had excess the existing supply of available bandwidth greatly capacity and were interested in ‘swapping’ their exceeded demand projections; (2) TyCom failed to excess capacity for capacity on the TGN,” and that account for improper, non-revenue-producing swap “there were multiples of sufficient bandwidth transactions; and (3) analysts employed by the capacity to meet future demand.” Compl. ¶ ¶ 70-71, Underwriters issued materially false and misleading 73. The former employees add that only 1/32 of the reports on TyCom and other telecommunications capacity was being used and the price of bandwidth companies. I consider these arguments in light of the was rapidly declining. These allegations are more PSLRA's pleading requirements. than sufficient to establish that at the time of the Offering, statements that demand was increasing were materially false and misleading. 1. The Tyco Defendants FN11 Furthermore, I am not persuaded by the argument that defendants' statements concerning the demand FN11. The Tyco Defendants include Tyco, for bandwidth are non-actionable “puffery,” and are TyCom, Garvey, Kozlowski, and Swartz. further rendered immaterial by the “bespeaks caution” doctrine, such that a reasonable investor a. Failure to Plead False Statements or Omissions would not have relied on the identified statements concerning the demand for bandwidth in light of the (i) Statements Concerning Demand for Bandwidth extensive and detailed cautionary language in the Prospectus. Although courts have refused to find “material” as a matter of law “loosely optimistic *8 The Tyco Defendants, in an argument joined by statements that are so vague, so lacking in specificity the Underwriters, first contend that the § 10(b) claim ... that no reasonable investor” would rely on them, premised on the demand for bandwidth demand Shaw, 82 F.3d at 1217, the statements at issue here should be dismissed because plaintiffs have failed to are not merely vague statements of hope. See In re plead facts demonstrating that the statements in the Boston Tech. Inc. Sec. Litig., 8 F.Supp.2d 43, 60 Prospectus concerning bandwidth were untrue when (D.Mass.1998). Rather, they are specific and concrete they were made. They further argue that, even if statements concerning the market for bandwidth plaintiffs adequately alleged that the statements were demand. See id. They are therefore actionable under false when made, such statements are not actionable. § 10(b). See id. Additionally, the First Circuit has Neither argument is persuasive. held that the “bespeaks caution” defense applies only to forward-looking statements and is inapplicable First, plaintiffs have adequately alleged that the where, as in this case, the statements at issue include statement in the Prospectus that TyCom would false or misleading representations of present fact. deploy the TGN to “address the increasing demand See In re Stone & Webster, Inc., Sec. Litig., 414 F.3d for undersea fiber optic bandwidth” and other 187, 213 (1st Cir.2005). Here, the Prospectus falsely statements related to bandwidth demand were represented that the TyCom Offering and related materially false and misleading. The Complaint implementation of the TGN was undertaken to charges that TyCom knew at the time of the Offering “address the increasing demand for undersea fiber both that any anticipated increase in bandwidth optic bandwidth” existing in the telecommunications demand would be insignificant when compared to the market at the time of the Offering. Compl. ¶ 108. market's already-existing oversupply, and that the gap This statement and other similar statements in the between demand and supply would be more Prospectus are representations of the then-existing pronounced if TyCom were to complete the TGN. state of the bandwidth market and are conceivably in direct contradiction to TyCom's alleged knowledge Plaintiffs support their position by citing to the that bandwidth capacity already far exceeded statements of several former TyCom employees who demand. Id. ¶ ¶ 117-19. were involved with the Offering and development of the TGN. For example, these former employees state *9 I thus conclude that TyCom represented in the that “most of the fiber that was laid by TyCom and Prospectus that demand for bandwidth capacity was

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I therefore conclude that the plaintiffs have met the (ii) Improper Swap Transactions PSLRA's requirement that a claimant plead with particularity defendants' false and misleading The Tyco Defendants similarly challenge the § 10(b) statements by describing the improper reciprocal claims based on reciprocal swap transactions, arguing swaps entered into to artificially inflate revenue. See that these claims should be dismissed because Flag II, 352 F.Supp.2d at 463 (noting also that plaintiffs have failed to plead facts showing that these plaintiff pled facts demonstrating that many transactions were improper. companies were inflating revenues by entering into improper reciprocal swap transactions). As the court in Flag II explained, reciprocal swap transactions are improper when a company “is merely unloading useless dark fiber on one of its networks in b. Scienter exchange for useless dark fiber on a competitor's network,” thereby falsely inflating the company's *10 The Tyco Defendants, joined by the bottom line. 352 F.Supp.2d at 461. Plaintiffs allege Underwriters, next argue that plaintiffs' § 10(b) that after the Offering, defendants misrepresented claim concerning the demand for bandwidth and that TyCom had entered into contracts for sale of swap transactions should be dismissed for failure to capacity on the TGN totaling approximately $560 plead facts giving rise to a “strong” inference of million. Compl. ¶ ¶ 208-22. According to plaintiffs, scienter, as is required by the PSLRA. these contracts consisted almost entirely of reciprocal swaps with other telecommunications companies that “Liability under section 10(b) and Rule 10b-5 ... did not qualify for revenue recognition. Id. 226-29. requires scienter, a mental state embracing intent to In particular, plaintiffs identify three separate deceive, manipulate or defraud.” Cabletron, 311 F.3d improper swaps that TyCom misrepresented as at 38 (internal quotation marks omitted). To prove “sales” qualifying for revenue recognition: scienter, “a plaintiff must show either that the DishnetDSL ($82.5 million); Qwest ($140 million); defendant[s] consciously intended to defraud, or that and Emergia ($40 million). Id. they acted with a high degree of recklessness.” Stone & Webster, 414 F.3d at 193 (internal quotation marks Plaintiffs support these allegations with statements omitted); see Cabletron, 311 F.3d at 38 (explaining from four former TyCom employees and an internal that scienter also “may extend to a form of extreme TyCom document, Exhibit B, which identifies three recklessness that ‘is closer to a lesser form of intent” multi-million-dollar transactions as improper swaps. ’) (citation omitted). In the First Circuit, there is no For example, with respect to the DishnetDSL and “rigid formula for pleading scienter,” and courts Qwest transactions, Exhibit B indicates “[c]ustomer employ a “ ‘fact-specific approach’ that proceeds not carrying traffic.” Likewise, with respect to the case by case.” Id. (citation omitted). Accordingly, Qwest and Emergia transactions, Exhibit B notes that while scienter can be established through direct the deals involved exchanges for capacity. Moreover, evidence of “conscious wrongdoing,” a plaintiff may Exhibit B indicates that the DishnetDSL transaction also “combine various facts and circumstances was a “swap type deal to show revenue.” Plaintiffs indicating fraudulent intent-including those further allege that during the fourth quarter of fiscal demonstrating motive and opportunity-to satisfy the 2001, TyCom's auditor, PwC, refused to issue an scienter requirement.” Aldridge v. A.T. Cross Corp., opinion letter on TyCom financial statements that 284 F.3d 72, 82 (1st Cir.2002). classified TyCom's reciprocal swap transactions as revenue. Compl. ¶ 257; see also Compl. ¶ 234 The Complaint's allegations concerning demand for (pointing to an e-mail quoted in the Global Crossing bandwidth and those concerning the improper complaint, 02 Civ. 910(GEL)(S.D.N.Y.), indicating reciprocal swap transactions are interrelated and TyCom's willingness to participate in fraudulent interdependent. In effect, plaintiffs allege that the transactions intended to inflate its reported financial improper swap transactions were used to falsely

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 102 of 163 Not Reported in F.Supp.2d Page 9 Not Reported in F.Supp.2d, 2005 WL 2127674 (D.N.H.), Fed. Sec. L. Rep. P 93,522, 2005 DNH 125 (Cite as: Not Reported in F.Supp.2d) inflate TyCom's revenue, thus propping up stock plead particularized facts that support a strong prices, in order to perpetuate the fraudulent scheme inference of scienter with respect to each defendant. that was initiated when defendants misrepresented See In re Cross Media Mktg. Corp. Sec. Litig., 314 the market for undersea bandwidth prior to the F.Supp.2d 256, 263 (S.D.N.Y.2004) (dismissing Offering. As a result, the facts plaintiffs offer to claim where complaint “d[id] not adequately plead support a strong inference of scienter with respect to that each Defendant acted with ‘the required state of the claims premised on demand for bandwidth apply mind” ’); Tyco II, 2004 DNH 154 (noting that the with equal force to support a strong inference of group pleading doctrine “does not relieve a plaintiff scienter with respect to the improper swap of the duty to plead sufficient facts as to each transactions.FN12 defendant to support a strong inference that the defendant acted with scienter”) (emphasis added).

FN12. The Underwriters are in a different Second, plaintiffs allege that Goldman Sachs analyst position. Plaintiffs have not provided Governali and SSB analyst Grubman knew that there sufficient facts to support a strong inference was no demand for bandwidth “by virtue of their that the Underwriters acted with scienter access to senior TyCom management prior to and with respect to the improper swap after the Offering, and their relationship with the transactions. In fact, plaintiffs fail to allege other large bandwidth companies in the industry.” that the Underwriters were aware of these Compl. ¶ 204. However, sweeping and conclusory transactions at all. allegations that a defendant “must have known” the facts giving rise to an alleged fraud are insufficient to Plaintiffs have identified several factors that, taken sustain an inference of scienter. See, e.g., Maldonado together, are sufficient to support a strong inference v. Dominguez, 137 F.3d 1, 10 (1st Cir.1998)(finding that Tyco, TyCom, and the individual defendants generalized imputations of knowledge insufficient); acted with scienter. First, plaintiffs allege that the Orton v. Parametric Tech. Corp., 344 F.Supp.2d 290, underlying motive for the TyCom Offering was to 306 (D.Mass.2004)(rejecting “vague assertion that a allow Kozlowski and Swartz to personally profit and defendant must have known about the fraud by virtue to generate funds to forgive unauthorized, interest- of his position of authority” to plead a strong free loans that they had obtained from Tyco. inference of scienter). Plaintiffs combine these allegations of motive and opportunity with claims that defendants, armed with Finally, plaintiffs' unsubstantiated and conclusory knowledge of the imbalance between the demand for assertions that Grubman was the “engineer” of and supply of bandwidth, falsified internal demand TyCom's “scheme,” Compl. ¶ 7, and that he worked projections and enlisted the Yankee Group to use with TyCom executives to “devise[ ] a new business these artificially inflated projections to provide an plan” for TyCom, id. ¶ 8, are similarly insufficient to “objective third-party view of global demand for support a strong inference of scienter. Plaintiffs' network capacity” intended for use in SEC filings allegations that at an open-house Grubman told that themselves were false. They add that TyCom Garvey that Tyco could sell off a minority interest in engaged in improper swap transactions with other TyCom and “retain the profit” from a fiber-optics bandwidth providers to further perpetuate the fraud. network and that they should “get a handle on the Finally, plaintiffs allege that the individual company's hidden value” and “turn all of it into defendants engaged in unusual trading of Tyco stock gold,” id. ¶ 54, demonstrate only that Grubman was at suspicious times. Collectively, these allegations optimistic about TyCom's ability to succeed and be plead enough culpable facts to support the strong profitable in the telecommunications market. I inference that the individual defendants acted with therefore conclude that plaintiffs have not pleaded scienter. This inference can be imputed to Tyco and sufficient facts to demonstrate that the Underwriters TyCom as well. acted with scienter with respect to the claims involving the demand for bandwidth. *11 The Underwriters, however, are in a different position. First, plaintiffs impermissibly group together Merrill Lynch, Goldman Sachs, and SSB in c. Loss Causation their allegations, claiming that the “Underwriter Defendants” instructed Kowalik to falsify TyCom's The Tyco Defendants' next argument in favor of projections of market demand. Compl. ¶ ¶ 88-89. dismissal of the § 10(b) claim is that even if 123, 204. Under the PSLRA, a plaintiff is required to plaintiffs have adequately pleaded actionable

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 103 of 163 Not Reported in F.Supp.2d Page 10 Not Reported in F.Supp.2d, 2005 WL 2127674 (D.N.H.), Fed. Sec. L. Rep. P 93,522, 2005 DNH 125 (Cite as: Not Reported in F.Supp.2d) misstatements and scienter, their § 10(b) claim must generally, facts that were at odds with defendants' nevertheless be dismissed because they have failed to prior representations, the stock lost value and adequately plead loss causation.FN13 To survive a investors suffered a loss.” Pls.' Opp. to Issuer Defs.' Rule 12(b)(6) challenge to a § 10(b) claim, a plaintiff Mot. to Dismiss at 51. I agree. must allege that “the act or omission of the defendant alleged to violate [§ 10(b) ] caused the loss for which In Dura, the Supreme Court explained that a the plaintiff seeks to recover damages.” 15 U.S.C. § plaintiff's allegations of loss causation under § 10(b) 78u-4(b)(4); see Dura Pharms., Inc. v. Broudo, --- are only subject to the pleading standards of U.S. ----, ----, 125 S.Ct. 1627, 1631, 161 L.Ed.2d 577 Fed.R.Civ.P. 8(a)(2) requiring “a short and plain (2005) (defining loss causation as a “causal statement of the claim showing that the pleader is connection between the material misrepresentation entitled to relief.” 125 S.Ct. at 1634. The Court and the loss”). Hence, to properly plead loss further explained that because “ordinary pleading causation, a plaintiff must allege “that the rules are not meant to impose a great burden upon a misstatement or omission concealed something from plaintiff,” it “should not prove burdensome ... to the market that, when disclosed, negatively affected provide a defendant with some indication of the loss the value of the security.” Lentell v. Merrill Lynch & and the causal connection that the plaintiff has in Co., 396 F.3d 161, 173 (2d Cir.2005). mind.” Id.

Here, plaintiffs allege that, based on defendants' FN13. Defendants also contend that fraudulent misrepresentations, they purchased plaintiffs' failure to properly plead loss TyCom stock at an artificially high price. They causation with respect to the Exchange Act further allege that when the truth surfaced regarding claims establishes their affirmative defense the glut of bandwidth supply that was swamping of “no loss causation” with respect to the § market demand and driving bandwidth prices down, 11 and § 15 claims. See, e.g., In re DNAP stock prices dropped and they suffered losses. Sec. Litig., 2000 WL 1358619, at *3 Plaintiffs contend that these losses were caused by (N.D.Cal. Sep.14, 2000)(dismissing claim, defendants' material misstatements regarding the noting loss causation is an affirmative demand for and supply of undersea bandwidth.FN14 defense that may be raised on a motion to Hence, plaintiffs' economic loss was the decline in dismiss). the value of their stock that was the result of TyCom's misrepresentation of the market for *12 As the Supreme Court recently explained, bandwidth. What was initially concealed from plaintiffs cannot adequately plead loss causation TyCom investors, and what ultimately resulted in merely by alleging that they purchased securities at plaintiffs' losses, was the knowledge that, at the time artificially inflated prices. Dura Pharms., 125 S.Ct. at of the Offering, the demand for bandwidth would not, 1630. Rather, a plaintiff must show that he “suffered and in fact could not, keep pace with the supply, an economic loss fairly attributable to the public which was increasingly flooding the market with airing of the alleged fraud.” D.E. & J L.P. v. capacity. When this information was disclosed, the Conaway, 284 F.Supp.2d 719, 748-49 price of TyCom stock, like the prices of other (E.D.Mich.2003), aff'd, 2005 WL 1386448 (6th Cir. telecommunications stock, declined. In this case, the June 10, 2005)(unpublished). entire market for telecommunications stock reacted negatively to the revelation. Consequently, plaintiffs' Defendants argue that plaintiffs have failed to point showing that their loss was fairly attributable to the to any corrective disclosure followed by an public airing of the true state of the bandwidth immediate drop in the price of TyCom stock, and, as market, which had been falsely misrepresented to a result, the only reasonable inference that can be them by defendants, provides the causal link required drawn from the Complaint is that any decline in price by Dura.FN15 during the class period was caused by the crash of the telecommunications market. Plaintiffs respond that they have satisfied the pleading requirement by FN14. The Complaint's remaining alleging that “defendants' fraudulent allegations, those that mirror the claims misrepresentations and omissions caused the price of asserted by the plaintiffs in Tyco II, include TyCom stock to be artificially inflated, so that when, claims that the Prospectus was materially over time, the true facts came out regarding TyCom's false and misleading because it failed to prospects and the state of demand for bandwidth disclose: (1) that Tyco's executives were

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engaged in systematic looting of the company; (2) that Tyco's executives were FN16. Plaintiffs also charge that the financially motivated to use the proceeds of individual defendants, Kozlowski, Swartz, the Offering to satisfy unauthorized loans; and Garvey, violated § 20(a) of the (3) that Tyco's reported success was the Exchange Act. Section 20(a) imposes result of systematic accounting fraud; (4) derivative liability on defendants who pervasive analysts' conflicts; and (5) that “control” primary violators of securities defendants failed to notify investors of laws. See 15 U.S.C. § 78t(a). A necessary James Brennan's participation in the TyCom element of a control person claim under § offering and his criminal record. Plaintiffs 20(a) is a primary violation of the securities have not pleaded any facts that during the laws. See, e.g., Greebel, 194 F.3d at 207; class period these alleged misrepresentations Suna v. Bailey Corp., 107 F.3d 64, 72 (1st or omissions were disclosed to the market Cir.1997). The Tyco Defendants have not and that there was a resultant drop in the challenged the sufficiency of the § 20(a) value TyCom stock following the disclosure. claim except to the extent that this claim Hence, plaintiffs have not sufficiently depends on the existence of an underlying alleged that their losses were caused by violation of § 10(b). Hence, because the these purportedly fraudulent statements and Tyco Defendants' motion to dismiss the § omissions, and therefore cannot be the basis 10(b) claim is denied, the § 20(a) claim for plaintiffs' § 10(b) claim here. remains viable.

FN15. This case is distinguishable from 2. The Underwriter Defendants Lentell. In Lentell, the Second Circuit explained that “when the plaintiff's loss a. Analyst Conflicts coincides with a marketwide phenomenon causing comparable losses to other investors, ... a plaintiff's claim fails when it In addition to joining the Tyco Defendants in their has not adequately pleaded facts which, if arguments in favor of dismissal of the § 10(b) claim, proven, would show that its loss was caused the Underwriters add that plaintiffs' claim that the by the alleged misstatements as opposed to Prospectus failed to disclose analyst conflicts must be intervening events.” 396 F.3d at 174 dismissed. The crux of this allegation is that (internal quotations omitted). Here, the defendants had a duty to disclose in the Prospectus collapse of the market for that there was a conflict of interest between the telecommunications stock was arguably not Underwriters' investment banking and research an intervening event, but rather the departments. See Compl. ¶ ¶ 164-94. proximate result of defendants' misrepresentation of the demand for and In response, the Underwriters argue that plaintiffs supply of bandwidth capacity. have failed to plead a single fact showing that conflicts existed concerning TyCom.FN17 Although *13 I therefore conclude that these allegations, if plaintiffs devote nearly thirty paragraphs in the assumed to be true, are sufficient at this stage of the Complaint to allegations that conflicts of interest proceedings establish that the drop in TyCom's stock between the investment banking and research price was causally related to defendants' divisions of Goldman Sachs and SSB resulted in the misrepresentation both with respect to the projected publication of biased research reports on companies market demand for bandwidth and the significant in the telecommunications industry, they offer no excess of bandwidth supply. Dura Pharms., 125 S.Ct. facts connecting these alleged conflicts to TyCom. In at 1634. Even if, as defendants maintain, there had fact, as the Underwriters argue, plaintiffs' only been an intervening event that interrupted the chain allegations related to TyCom are the general of causation, such a determination is a matter of assertions that Goldman Sachs and SSB were the proof after discovery, either at summary judgment or underwriters of the TyCom Offering and that their at trial, and is not to be decided here on a Rule analysts later issued positive research reports on 12(b)(6) motion to dismiss. Lentell, 396 F.3d at 174. TyCom. Such conclusory allegations are insufficient Accordingly, the Tyco Defendants' motion to dismiss under the PSLRA and Rule 9(b). See Podany v. for failure to plead loss causation is denied. FN16 Robertson Stephens, Inc., 318 F.Supp.2d 146, 156 (S.D.N.Y.2004); In re Merrill Lynch & Co. Research

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Reports Sec. Litig., 272 F.Supp.2d 243, 252-53 intended to affect the market price of TyCom or an (S.D.N.Y.2003)(“Merrill II” )(dismissing claim that “attempt to induce” the purchase of TyCom stock is mutual fund purchased securities to obtain unpersuasive. See In re Salomon Analyst Level 3 investment banking business where plaintiffs alleged Litig., 350 F.Supp.2d 477, 493 n. 13 (S.D.N.Y.2004)( only that defendants performed investment banking “Level 3” )(“The Level 3 Complaint also alleges that services for, and issued analyst reports on, companies SSB's policies induced Grubman to issue ‘inflated whose securities were held by the fund). Moreover, recommendations' on other companies besides Level virtually all of plaintiffs' allegations that there were 3.... As with the conflicts allegations generally ... they conflicts at Goldman Sachs and SSB are based on cannot satisfy the particularity requirements of Rule documents or communications that post-date the 9(b) and the PSLRA for fraud or false statement of TyCom Offering. They therefore cannot support a opinion as to the Level 3 reports.”); Podany, 318 claim that the Prospectus for the Offering was false F.Supp.2d at 157-58. and misleading. See, e.g., Compl. ¶ 173 (e-mails from “August 2000”); id. ¶ 179 (communications in I therefore conclude that plaintiffs' allegations “December 2000,” “early 2001,” and “February regarding the Underwriters' duty to disclose analyst 2001”); id. ¶ 187 (e-mail from “June 2001”). conflicts are insufficient to satisfy the pleading requirements of a § 10(b) claim.

FN17. The Tyco Defendants also argue that there was no obligation on the part of b. Statements Contained In Analyst Reports FN18 TyCom or Tyco to disclose analyst conflicts in the Prospectus, and that any duty to disclose a conflict resides with the analyst or FN18. The Complaint points to three underwriter. See, e.g., Fogarazzo v. Lehman research reports authored by Goldman Sachs Bros., Inc., 341 F.Supp.2d 274, ---- analyst Governali: (1) an August 21, 2000 (S.D.N.Y.2004). I agree. Item 508(l)(1) of report in which Governali included TyCom Regulation S-K (17 C.F.R. § 229.508(l)(1)), on a “recommend list,” with a 12-month cited by plaintiffs require that underwriters price target of $60 per share, Compl. ¶ 199; of securities disclose “any transaction that (2) an October 18, 2000 report reiterating the underwriter intends to conduct during the “recommend list” rating and the $60 the offering that stabilizes, maintains, or price target, id. ¶ 207; and (3) an April 26, otherwise affects the market price of the 2001 report reiterating the “recommend list” offered securities.” Similarly, Regulation M, rating, but reducing the price target to $40 Item 101 (17 C.F.R. § 242.101(a)) makes it per share. Id. ¶ 250. “unlawful” for an underwriter of a security The Complaint also identifies three reports to “attempt to induce any person to bid for authored by SSB analyst Grubman: (1) an or purchase” a covered security during the August 21, 2000 report rating TyCom as a applicable restricted period. These “Speculative Buy” and setting a 12-18 regulations impose no duty to disclose on month price target of $75 per share, Compl. issuers. ¶ 200; (2) a July 18, 2001 report reiterating the “buy” rating, id. ¶ 190; and (3) an *14 Finally, plaintiffs' attempt to rely on Rule August 8, 2001 report downgrading Tycom 508(1)(1) of Regulation S-K and Rule 101 of to “neutral.” Id. ¶ 254. Regulation M is unavailing. Rule 508(1)(1) requires that the Prospectus disclose any transaction that the The Underwriters next argue that the § 10(b) claim underwriter intends to conduct during the offering against Goldman Sachs and SSB must fail because that stabilizes, maintains, or otherwise affects the plaintiffs have failed to plead a false statement in the market price of the offered securities.” 17 C.F.R. § TyCom analyst reports and have also failed to plead 229.508(1)(1). (Emphasis added). Likewise, Rule 101 with particularity facts creating a strong inference of prohibits an “attempt to induce” the purchase of “a scienter or loss causation. covered security” (i.e., the security being offered, see 17 C.F.R. § 242.100(b)). 17 C.F.R. § 242.101(a). Plaintiffs' § 10(b) theory against Goldman Sachs and Plaintiffs' strained attempt to characterize research SSB is based on allegations that their analysts, published on other companies in the Governali and Grubman, issued materially false and telecommunications industry as a “transaction” misleading reports concerning TyCom after the

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Offering, and on other companies prior to the Offering, in an attempt to inflate the value of FN19. Plaintiffs do not dispute that the companies in the telecommunications market. In their ratings and other statements in the analyst opposition to the Underwriters' motion to dismiss, reports are recommendations, or, in essence, plaintiffs add that the analysts' biased research reports expressions of the analysts' opinions. on securities in TyCom's industry “had the effect of inflating the public's perception of the value of ... the FN20. Indeed, it is not enough to allege only securities of issuers, such as TyCom, that competed “that an opinion was unreasonable, in the same market.” Pls.' Opp. To Underwriters' irrational, excessively optimistic, not borne Mot. to Dismiss at 20-21. At the heart of this theory out by subsequent events, or any other is the claim that the Governali and Grubman were characterization that relies on hindsight.” motivated to falsify their research reports and ratings Level 3, 350 F.Supp.2d at 489. to make them appear more favorable than their honestly-held opinions about the companies and their With respect to Governali, plaintiffs allege that his stocks. See Level 3, 350 F.Supp.2d at 483. reports did not reflect his true opinion, and were thus false and misleading, because he had “private The Underwriters first argue that plaintiffs have misgivings about the telecommunications market” failed to plead a false statement in the TyCom analyst and because he “knew that there was no demand for reports as required by Rule 9(b) and the PSLRA. The the [TGN]” by virtue of his “access to senior TyCom Underwriters also argue that plaintiffs cannot base a management ... and [his] relationship with other large claim on analyst reports concerning other issuers and bandwidth companies.” Compl. ¶ ¶ 199, 204. In other securities. I agree with both arguments. support of these allegations, plaintiffs point to a March 2000 e-mail in which Governali purportedly *15 Liability under § 10(b) can be predicated on questioned Global Crossing's earnings guidance and statements of opinion where “it can be shown not to his August 2000 statement that he was considering merely that a proffered opinion was incorrect or a downgrade of a number of Competitive Local doubtful, but that the speaker deliberately Exchange Carriers (“CLECs”). Id. ¶ ¶ 170-71, 173. misrepresented his actual opinions.” Level 3, 350 Unfortunately for plaintiffs, these allegations offer no F.Supp.2d at 489 (internal citations omitted). To insight as to what Governali believed about TyCom survive a motion to dismiss on a false statement of at the time he published his three reports, and are opinion claim, however, “a plaintiff must allege with therefore inadequate to satisfy the pleading particularity ‘provable facts' to demonstrate that the requirements of Rule 9(b) and the PSLRA. See Level statement of opinion is both objectively and 3, 350 F.Supp.2d at 492; Podany, 318 F.Supp.2d at subjectively false.” FN19 Id.; see Virginia Bankshares, 153-54; In re Merrill Lynch & Co. Research Reports Inc. v. Sandberg, 501 U.S. 1083, 1095-96, 111 S.Ct. Sec. Litig., 273 F.Supp.2d 351, 355 (S.D.N.Y.2003), 2749, 115 L.Ed.2d 929 (1991). Hence, the fatal flaw aff'd, 396 F.3d 161 (2d Cir.2005)(“Merrill I” in plaintiffs' allegations that Governali and Grubman )(noting that “e-mails concerning securities other issued false and misleading reports with respect to than 24/7 and Interliant fail to meet the Rule 9(b)(let other telecommunications companies prior to the alone the PSLRA) pleading requirements necessary TyCom Offering, and with respect to TyCom after to allege that Merrill Lynch made fraudulent the Offering, is that plaintiffs have failed to plead statements in reports concerning 24/7 or Interliant”). facts showing that either Governali or Grubman did Likewise, plaintiffs' attempt to impute to Governali not believe the recommendations and other knowledge that there was no demand for the TGN on statements in the reports at the time they were the basis of his “access to Tycom management” is made.FN20 See also In re Credit Suisse First Boston inadequate to establish that he did not believe his Corp. (Agilent Techs., Inc.) Analyst Reports Sec. reports on TyCom when he issued them. See Litig., 2005 WL 852455, at *6 (D.Mass. Mar.31, Maldonado, 137 F.3d at 10. 2005)(“Agilent Techs.” )(applying Virginia Bankshares and noting that what was missing were *16 Plaintiffs' attempt to plead that Grubman's three “specific allegations of ‘provable facts' that would reports did not reflect his honest opinion regarding support the twin inferences required: (1) that the TyCom suffers from similar defects and is therefore analysts did not believe that Agilent merited a ‘Buy’ equally inadequate. Here, plaintiffs seek to support rating and (2) that the ‘Buy’ rating was objectively their charge that Grubman did not believe his TyCom unsupportable”). reports by citing two e-mails authored by other SSB employees. This pleading approach is insufficient.

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Level 3, 350 F.Supp.2d at 491 (noting that reliance on 78u-4(b)(2); Greebel v. FTP Software, Inc., 194 F.3d “mischaracterizations of e-mails written by other 185, 196 (1st Cir.1999). Although in the typical case, SSB employees” is “plainly insufficient” to plead falsity and scienter are different elements, under a falsity of analyst report). false-statement-of-opinion theory, the two requirements are essentially identical. Level 3, 350 First, plaintiffs cite an e-mail from an SSB F.Supp.2d at 490. Consequently, where, as here, “the investment banker, stating that “TyCom gives the facts alleged are insufficient to support an inference appearance of being conservative with respect to of subjective disbelief in the opinions expressed, they multiples relative to the comps despite a very are likewise insufficient to support any inference of aggressive mode” to support their charge that scienter, let alone a strong one.” Agilent Techs., 2005 Grubman concealed his use of aggressive WL 852455, at *8. Plaintiffs' § 10(b) claim premised assumptions. Compl. ¶ 203. Yet, the e-mail refers on false analyst reports is thus dismissed.FN21 only to TyCom's assumptions, not Grubman's. Plaintiffs have not pleaded any facts concerning Grubman's assumptions, aggressive or otherwise, nor FN21. As I noted above, the Underwriters have they explained how the use of aggressive also challenge the § 10(b) claim premised assumptions could be misleading if the report on false analyst report on the alternative disclosed the assumption on which it was based. ground that plaintiffs' have failed to plead loss causation as to these reports. I need not Plaintiffs also rely on a February 28, 2001 e-mail in address this argument, however, because I which another SSB employee allegedly noted that in conclude that plaintiffs have failed to addition to the securities of several other issuers, establish that the statements in the report “[I][a]lso don't like TyCom or 360 (Tsix).” Compl. ¶ were false when they were made. 255. Again, plaintiffs' reliance is misplaced. This e- mail reveals nothing about what Grubman believed B. Section 11 with respect to his TyCom recommendations and there is no indication that Grubman authorized, *17 Section 11 of the Securities Act “imposes approved, agreed with, or even was aware of this liability on signers of a registration statement and on communication. See Nolte v. Capital One Fin. Corp., underwriters, among others, if the registration 390 F.3d 311, 315-16 (4th Cir.2004). These e-mails statement ‘contained an untrue statement of a thus cannot support plaintiffs' claim. material fact or omitted to state a material fact required to be stated therein or necessary to make the Plaintiffs also rely on the bald assertion that the statements therein not misleading.” ’ Glassman, 90 analysts' positive buy ratings on TyCom common F.3d at 623 (quoting 15 U.S.C. § 77k(a)). Typically, stock were the undisclosed quid pro quo for the fraud is not an element of a claim under § 11, and a underwriting retention, but fail to offer a single fact plaintiff asserting such a claim “may avoid altogether in support of this claim. Moreover, the remainder of any allegations of scienter or reliance.” Shaw, 82 plaintiffs' allegations are derived from regulatory F.3d at 1223. Consequently, claims asserted under § investigations concerning telecommunications 11 need only satisfy the pleading standards of Rule companies other than TyCom. 8(a), requiring “a short and plain statement of the claim showing that the pleader is entitled to relief.” In fact, plaintiffs have not pointed to a single Fed.R.Civ.P. 8(a). If, however, a complaint attempts contemporaneous fact to support their contention that to establish violations of § 11 and § 10(b) through the analysts' reports were not reflective of their allegations of a unified course of fraudulent conduct, authors' true opinions. Rather, plaintiffs rely on the complaint is said to “sound in fraud,” and the general allegations that Governali and Grubman had more rigorous pleading requirements of Rule 9(b) “private misgivings” about the telecommunications will apply to the § 11 and § 10(b) claims alike. See industry, as well as e-mails written by other SSB id.; Giarraputo, 2000 WL 1701294, at *9. employees that purport to represent Grubman's true opinion about TyCom. These allegations are In this case, plaintiffs urge that their § 11 claims do insufficient under Rule 9(b) and the PSLRA. not “sound in fraud,” and therefore should not be subjected to the pleading requirements of Rule 9(b). Finally, to adequately plead a § 10(b) claim, a The Underwriters counter that with respect to plaintiff must state with particularity facts sufficient plaintiffs' claims based on demand for bandwidth and to raise a “strong” inference of scienter. 15 U.S.C. § failure to disclose analyst conflicts and false

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 108 of 163 Not Reported in F.Supp.2d Page 15 Not Reported in F.Supp.2d, 2005 WL 2127674 (D.N.H.), Fed. Sec. L. Rep. P 93,522, 2005 DNH 125 (Cite as: Not Reported in F.Supp.2d) statements in analyst reports, fraud is at the very Swartz, and Garvey with violation of § 15 heart of the allegations. I find the Underwriters' of the Securities Act. Like § 20(a) of the argument on this point persuasive. Exchange Act, § 15 imposes derivative liability on defendants who “control” Despite plaintiffs' boilerplate disclaimer excluding primary violators of securities laws. See 15 those allegations that sound in fraud from their § 11 U.S.C. § 77o. Hence, a necessary element claim, they cannot avoid the strictures of Rule 9(b) of a control-person claim under § 15 is a where their core allegations allege a fraudulent primary violation of the securities laws. See, scheme. Here, the specific factual allegations on e.g., Greebel, 194 F.3d at 207; Suna v. which Count I is based aver that defendants Bailey Corp., 107 F.3d 64, 72 (1st “deliberately misrepresented TyCom's projections of Cir.1997). The Tyco Defendants challenge market demand in the [P]rospectus in order to the § 15 claim only to the extent that it defraud investors,” Compl. ¶ 142, and that the depends on the existence of an underlying Underwriters “specifically directed Andrew Kowalik violation of § 11. Thus, because the Tyco to falsify his projections.” Id. ¶ 204. Likewise, Defendants' motion to dismiss the § 11 predictive statements and projections are actionable claim is denied, the § 15 claim remains only if the speaker did not believe the statements viable. when they were made. See Boston Tech., 8 F.Supp.2d at 54 (noting that “optimistic predictions ‘that prove 2. Underwriter Defendants to be off the mark'-even the most specific ones-are not actionable ... unless there was intentional As I explained in Part III.A.2. above, plaintiffs' deception on the part of the defendant”). I therefore allegations concerning the failure to disclose analyst conclude that, at least as to these allegations, fraud conflicts and false statements in analyst reports are plainly lies at the core of the claim. See Hayduk v. insufficient under Rule 9(b) in the § 10(b) context. Lanna, 775 F.2d 441, 443 (1st Cir.1985). Accordingly, they are also insufficient to satisfy Rule 9(b)'s requirements as to plaintiffs' § 11 claim. Moreover, as to the allegations concerning analyst Moreover, even under the much less demanding conflicts and false statements in analyst reports, requirements of Rule 8(a), plaintiffs' vague and plaintiffs must establish that the analysts knowingly conclusory allegations concerning analyst conflicts misrepresented their actual opinions when they and false statements in the reports would be issued the reports. See Level 3, 350 F.Supp.2d at 490 insufficient to support their § 11 claim. (explaining that “[a]dequately alleging the falsity of a statement [of opinion] ... is the same as adequately alleging scienter.”). Accordingly, plaintiffs' § 11 C. Statute of Limitations claims concerning demand for bandwidth, analyst conflicts, and false reports must satisfy Rule 9(b). As an alternative ground for dismissal of the claims based on demand for bandwidth, defendants argue that these claims are time-barred. Claims brought 1. Tyco Defendants under § 11 and § 15 of the Securities Act must be brought “within one year after discovery of the *18 The Tyco Defendants challenge the sufficiency untrue statement or the omission, or after such of plaintiffs' § 11 claim based on statements in the discovery should have been made through the Prospectus concerning the demand for bandwidth. As exercise of reasonable diligence,” and “no later than I explained in Part III.A.1.a. above, plaintiffs' three years after the security was bona fide offered to allegations concerning bandwidth demand and the public....” 15 U.S.C. § 77m; see Dodds v. Cigna improper swap transactions are sufficient to satisfy Sec., Inc., 12 F.3d 346, 349 (2d Cir.1993); In re Tyco the strict and rigorous pleading requirements of Rule Int'l, Ltd., Sec. Litig., 185 F.Supp.2d 102, 115 9(b) and the PSLRA. It therefore follows that these (D.N.H.2002). Similarly, claims brought under § allegations also satisfy the requirements of Rule 9(b) 10(b) and § 20(a) of the Exchange Act prior to July in the context of a § 11 claim. I thus decline to 30, 2002 had to have been commenced within “one dismiss plaintiffs' § 11 claim premised on demand year after the discovery of the facts constituting the for bandwidth.FN22 violation and within three years after such violation.” FN23 Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson, 501 U.S. 350, 364, 111 S.Ct. 2773, 115 FN22. Plaintiffs also charge Kozlowski, L.Ed.2d 321 (1991) (§ 10(b) claims); Dodds, 12 F.3d

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 109 of 163 Not Reported in F.Supp.2d Page 16 Not Reported in F.Supp.2d, 2005 WL 2127674 (D.N.H.), Fed. Sec. L. Rep. P 93,522, 2005 DNH 125 (Cite as: Not Reported in F.Supp.2d) at 350 (§ 20(a) claims). *19 The original complaint in this action was filed on July 24, 2003. FN25 Defendants argue that the original complaint is untimely because it was filed more than FN23. Under Section 804 of the Sarbanes- one year after plaintiffs could have discovered the Oxley Act of 2002 (“SOX”), Pub.L. No. fact giving rise to their claims related to the demand 107-204, 116 Stat. 745 (2002), § 10(b) for bandwidth. Plaintiffs dispute defendants' assertion claims commenced after July 30, 2002 are that a March 1, 2001 article in America's Network, an subject to a two-year statute of limitations. April 12, 2001 article in Business Wire, and an April The Tyco Defendants argue that SOX's two- 17, 2001 Tyco press release put investors on notice year limitation period does not apply that statements in the July 26, 2000 Prospectus may retroactively to revive already time-barred have been false such that they could have filed a claims such as the § 10(b) claim here. See viable claim within one year. Foss v. Bear, Stearns & Co. ., 394 F.3d 540, 542 (7th Cir.2005); In re Enter. Mortgage Acceptance Co., Sec. Litig., 391 F.3d 401, FN25. A second, similar complaint was filed 410 (2d Cir.2004). Because I conclude that in a separate action on September 23, 2003. plaintiffs' § 10(b) claim based on the After the two related cases were demand for bandwidth was timely under the consolidated, the consolidated Complaint pre-SOX one-year statute of limitations, I was filed on December 13, 2004. need not determine if the SOX two-year limitations period applies to this case. Plaintiffs urge that these articles, which did not mention TyCom by name, merely notified TyCom A two-part test is used in the First Circuit to investors that the market for undersea bandwidth was determine when a plaintiff has sufficient notice of a not then as robust as defendants had projected, and securities fraud claim to trigger the one-year thus could not have alerted investors to the fact that limitations period. Young v. Lepone, 305 F.3d 1, 8 statements in the Prospectus were false at the time (1st Cir.2002). First, the party invoking the statute of they were made. Such generalized statements, limitations defense “must demonstrate that sufficient plaintiffs argue, were insufficient to have put them on ‘storm warnings' FN24 of fraud were on the horizon to inquiry notice. See In re DaimlerChrysler AG Sec. trigger a duty to inquire further.” Tyco II, 2004 WL Litig., 269 F.Supp.2d 508, 515 2348315, at *18 (citing Young, 305 F.3d at 8). If the (D.Del.2003)(rejecting notice inquiry where the defendant meets this burden, the plaintiff must then articles cited by defendants did not discuss “lawsuits produce evidence establishing that even a reasonably that had been previously filed, official investigations diligent investigation would not earlier have that were being conducted, or allegations and produced sufficient evidence to permit the filing of a incontrovertible objective evidence of fraud”); legally viable complaint. Id. Because “[t]he Thompson v. Metro. Life Ins. Co., 149 F.Supp.2d 38, multifaceted question of whether storm warnings 51 (S.D.N.Y.2001)(two dozen articles reflecting were apparent involves issues of fact,” and the “general public awareness” of industry wrongdoing “circumstances of each case must be explored insufficient to put plaintiffs on inquiry notice). independently,” in certain cases it may not be appropriate to resolve this issue on a motion to Plaintiffs further argue that it was not until dismiss.” Id. (also noting that “[i]n the archetypical September 2002, when Tyco issued a press release case ... it is for the factfinder to determine whether a detailing Kozlowski and Swartz's misconduct and particular collection of data was sufficiently announcing that it had filed suit against them, that aposematic to place an investor on inquiry notice”). they had reason to suspect that the statements in the Prospectus were false at the time they were issued. According to plaintiffs, this was the first “storm FN24. “Storm warnings” exist “[w]hen cloud” to cast a pall over the statements in the telltale warning signs augur that fraud is Prospectus. Following this disclosure, plaintiffs assert afoot,” such that if the warning signs are that they timely launched an investigation into “sufficiently portentous,” they may, “as a statements contained in the TyCom Prospectus and matter of law be deemed to alert a filed their initial complaint on July 24, 2003, well reasonable investor to the possibility of within one year of the storm warnings. If plaintiffs fraudulent conduct.” Young, 305 F.3d at 8. are correct, and at this juncture I must accept as true their well-pleaded facts, I agree that their claims are

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 110 of 163 Not Reported in F.Supp.2d Page 17 Not Reported in F.Supp.2d, 2005 WL 2127674 (D.N.H.), Fed. Sec. L. Rep. P 93,522, 2005 DNH 125 (Cite as: Not Reported in F.Supp.2d) not barred by the one-year statute of limitations. and Affidavit) Lead Plaintiffs' Motion for Partial Summary Judgment as to Liability on Claims against Tyco International, Ltd. under Section 11 of the IV. CONCLUSION Securities Act of 1933 (Apr. 4, 2006) Original Image of this Document (PDF) For the reasons set forth above, the motions to • 2006 WL 1044911 (Trial Motion, Memorandum dismiss as to Tyco, TyCom, Garvey, Kozlowski, and and Affidavit) Memorandum of Law in Support of Swartz are denied (Doc. Nos. 384 & 391). The Lead Plaintiffs' Motion to Compel the Production of Underwriters' motion to dismiss (Doc. No. 392) is Documents by Defendant Tyco International Ltd. granted. (Apr. 4, 2006) Original Image of this Document (PDF) SO ORDERED. • 2006 WL 1044913 (Trial Motion, Memorandum and Affidavit) Lead Plaintiffs' Motion to Compel the D.N.H.,2005. Production of Documents by Defendant Tyco Stumpf v. Garvey International, Ltd. (Mar. 31, 2006) Original Image of Not Reported in F.Supp.2d, 2005 WL 2127674 this Document (PDF) (D.N.H.), Fed. Sec. L. Rep. P 93,522, 2005 DNH 125 • 2006 WL 1333548 (Trial Motion, Memorandum and Affidavit) Lead Plaintiffs' Motion to Compel the Briefs and Other Related Documents (Back to top) Production of Documents by Defendant Tyco International, Ltd. (Mar. 31, 2006) Original Image of • 2006 WL 1356289 (Trial Motion, Memorandum this Document (PDF) and Affidavit) Supplemental Memorandum of Tyco • 2006 WL 1044905 (Trial Motion, Memorandum International Ltd. in Opposition to Plaintiff's Motion and Affidavit) Plaintiff's Assented-To Motion to Remand and in Support of its Cross-Motion to Concerning Application of Stipulated Protective Dismiss the Complaint (May 1, 2006) Original Image Order as Clarified (Mar. 28, 2006) Original Image of of this Document (PDF) this Document with Appendix (PDF) • 2006 WL 1356288 (Trial Motion, Memorandum • 2006 WL 1044895 (Trial Motion, Memorandum and Affidavit) Memorandum in Support of Certain and Affidavit) Lead Plaintiff's Memorandum of Law Defendants' Motion for an Order Establishing in Support of Motion for Class Certification (Mar. 8, Deposition Protocol (Apr. 25, 2006) Original Image 2006) Original Image of this Document (PDF) of this Document (PDF) • 2006 WL 1044893 (Trial Motion, Memorandum • 2006 WL 1044914 (Trial Pleading) Answer of and Affidavit) Lead Plaintiffs' Supplemental Goldman, Sachs & Co., Citigroup Global Markets Memorandum in Further Support of its Motion for Inc., and Merrill Lynch, Pierce Fenner & Smith, Class Certification (Mar. 6, 2006) Original Image of Incoporated to the Consolidated Securities Class this Document (PDF) Action Complaint (Apr. 10, 2006) Original Image of • 2006 WL 1044891 (Trial Motion, Memorandum this Document (PDF) and Affidavit) Supplemental Memorandum of Tyco • 2006 WL 1028916 (Trial Motion, Memorandum International Ltd. in Opposition to Lead Plaintiffs' and Affidavit) Memorandum of Law in Support of Motion for Class Certification (Feb. 24, 2006) Lead Plaintiffs' Motion for Partial Summary Original Image of this Document (PDF) Judgment as to Liability on Claims against Tyco • 2006 WL 691289 (Trial Motion, Memorandum and International, Ltd. under Section 11 of the Securities Affidavit) Supplemental Memorandum of Tyco Act of 1933 (Apr. 4, 2006) Original Image of this International Ltd. in Opposition to Lead Plaintiffs' Document (PDF) Motion for Class Certification (Feb. 24, 2006) • 2006 WL 1044907 (Trial Motion, Memorandum • 2006 WL 318872 (Trial Motion, Memorandum and and Affidavit) Lead Plaintiffs' Motion for A Affidavit) Reply Memorandum of Protective Order Preventing Tyco International, Ltd. Pricewaterhousecoopers LLP in Further Support of from Charging an Unjustified and Exorbitant Sum for its Motion for Summary Judgment on Loss Causation its Document Production (Apr. 4, 2006) Original (Jan. 26, 2006) Image of this Document (PDF) • 2006 WL 1044890 (Trial Motion, Memorandum • 2006 WL 1044908 (Trial Motion, Memorandum and Affidavit) Reply Memorandum of and Affidavit) Assented-To Motion of Lead Plaintiffs Pricewaterhousecoopers LLP in Further Support of to File Documents Under Seal - Level I (Apr. 4, its Motion for Summary Judgment on Loss Causation 2006) Original Image of this Document (PDF) (Jan. 23, 2006) Original Image of this Document • 2006 WL 1044909 (Trial Motion, Memorandum (PDF)

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• 2006 WL 1044887 (Trial Motion, Memorandum Complaint (Nov. 18, 2005) Original Image of this and Affidavit) Memorandum of Law of the Ballard Document (PDF) Plaintiffs in Opposition to Defendant Michael A. • 2005 WL 3742060 (Trial Motion, Memorandum Ashcroft's Motion to Dismiss the Complaint (Jan. 17, and Affidavit) New Jersey Fund Plaintiffs' 2006) Original Image of this Document (PDF) Memorandum of Law in Opposition to • 2006 WL 318853 (Trial Motion, Memorandum and Pricewaterhousecooper's Motion to Dismiss in Part Affidavit) Memorandum of Law of the Ballard the Second Amended Complaint (Nov. 11, 2005) Plaintiffs in Opposition to Defendant Michael A. • 2005 WL 3970145 (Trial Motion, Memorandum Ashcroft's Motion to Dismiss the Complaint (Jan. 17, and Affidavit) New Jersey Fund Plaintiffs' 2006) Memorandum of Law in Opposition to • 2006 WL 1044885 (Trial Motion, Memorandum Pricewaterhousecooper's Motion to Dismiss in Part and Affidavit) Answer of Neil Garvey to the the Second Amended Complaint (Nov. 11, 2005) Consolidated Securities Class Action Complaint (Jan. Original Image of this Document (PDF) 13, 2006) Original Image of this Document (PDF) • 2005 WL 3742059 (Trial Motion, Memorandum • 2006 WL 1044886 (Trial Motion, Memorandum and Affidavit) Memorandum of and Affidavit) Answer of Tycom and Tyco Pricewaterhousecoopers LLP in Support of its International Ltd. to the Consolidated Securities Motion for Summary Judgment on Loss Causation Class Action Complaint (Jan. 13, 2006) Original (Nov. 8, 2005) Image of this Document (PDF) • 2005 WL 3970144 (Trial Motion, Memorandum • 2005 WL 3742068 (Trial Motion, Memorandum and Affidavit) Memorandum of and Affidavit) Lead Plaintiffs' Memorandum of Law Pricewaterhousecoopers Llp in Support of its Motion in Opposition to Pricewaterhousecoopers LLP's for Summary Judgment on Loss Causation (Nov. 8, Motion for Summary Judgment on Loss Causation 2005) Original Image of this Document (PDF) (Dec. 23, 2005) • 2005 WL 3742073 (Trial Pleading) L. Dennis • 2005 WL 3970088 (Trial Motion, Memorandum Kozlowski's Answer to the Complaint (Nov. 4, 2005) and Affidavit) Lead Plaintiffs' Memorandum of Law • 2005 WL 3742074 (Trial Pleading) Answer (Nov. in Opposition to Pricewaterhousecoopers Llp's 4, 2005) Motion for Summary Judgment on Loss Causation • 2005 WL 3970143 (Trial Pleading) L. Dennis (Dec. 23, 2005) Original Image of this Document Kozlowski's Answer to the Complaint (Nov. 4, 2005) (PDF) Original Image of this Document (PDF) • 2005 WL 3742064 (Trial Motion, Memorandum • 2005 WL 3742056 (Trial Motion, Memorandum and Affidavit) New Jersey Fund Plaintiffs' and Affidavit) Memorandum of Defendants Tyco Memorandum of Law in Opposition to Defendant International Ltd., Tycom Ltd. And Neil R. Garvey in Dennis Kozlowski's Motion to Dismiss in Part the Opposition to Lead Plaintiff's Motion For Second Amended Complaint (Nov. 18, 2005) Clarification (Oct. 20, 2005) • 2005 WL 3742065 (Trial Motion, Memorandum • 2005 WL 3742057 (Trial Motion, Memorandum and Affidavit) Memorandum of New Jersey Fund and Affidavit) Memorandum of the Underwriter Plaintiffs in Opposition to Defendant Mark Belnick's Defendants in Opposition to plaintiffs' ''""motion for Motion to Dismiss in Part the Second Amended Clarification"' (Oct. 20, 2005) Complaint (Nov. 18, 2005) • 2005 WL 3970138 (Trial Motion, Memorandum • 2005 WL 3742066 (Trial Motion, Memorandum and Affidavit) Memorandum of Defendants Tyco and Affidavit) Memorandum of New Jersey Fund International Ltd., Tycom Ltd. and Neil R. Garvey in Plaintiffs in Opposition to Defendant Frank E. Walsh Opposition to Lead Plaintiff's Motion for Jr.'s Motion to Dismiss in Part the Second Amended Clarification (Oct. 20, 2005) Original Image of this Complaint (Nov. 18, 2005) Document (PDF) • 2005 WL 3970150 (Trial Motion, Memorandum • 2005 WL 3970139 (Trial Motion, Memorandum and Affidavit) New Jersey Fund Plaintiffs' and Affidavit) Opposition of Tyco International Ltd., Memorandum of Law In Opposition to Defendant Tycom Ltd., and Neil R. Garvey to Lead Plaintiff's Dennis Kozlowski's Motion to Dismiss In Part the Motion for Clarification (Oct. 20, 2005) Original Second Amended Complaint (Nov. 18, 2005) Image of this Document (PDF) Original Image of this Document (PDF) • 2005 WL 3970140 (Trial Motion, Memorandum • 2005 WL 3970152 (Trial Motion, Memorandum and Affidavit) Memorandum of the Underwriter and Affidavit) Memorandum of New Jersey Fund Defendants in Opposition to Plaintiffs' ""Motion for Plaintiffs in Opposition to Defendant Frank E. Walsh Clarification'' (Oct. 20, 2005) Original Image of this Jr.'s Motion to Dismiss in Part the Second Amended Document (PDF)

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• 2005 WL 3970141 (Trial Motion, Memorandum in Opposition to Tyco International, Ltd.'s Motion for and Affidavit) Opposition of the Underwriter Revision of Court Order Or, Alternatively, for Defendants to Plaintiffs'""Motion for Clarification'' Judgment on the Pleadings (Aug. 5, 2005) Original (Oct. 20, 2005) Original Image of this Document Image of this Document (PDF) (PDF) • 2005 WL 3970129 (Trial Pleading) Answer of Tyco • 2005 WL 3970137 (Trial Motion, Memorandum International Ltd. to the Complaint (Aug. 5, 2005) and Affidavit) Reply Memorandum of Defendant Original Image of this Document (PDF) Michael A. Ashcroft in Support of his Motion for • 2005 WL 3742046 (Trial Motion, Memorandum Revision of the Court's October 14, 2004 Order, or and Affidavit) Tyco Defendants' Memorandum in Alternatively, for Judgment on the Pleadings (Oct. Opposition to Lead Plaintiffs' Motion for Class 19, 2005) Original Image of this Document (PDF) Certification (Jul. 11, 2005) • 2005 WL 3742055 (Trial Motion, Memorandum • 2005 WL 3970087 (Trial Motion, Memorandum and Affidavit) Reply Memorandum of Defendant and Affidavit) Tyco Defendants' Memorandum in Michael A. Ashcroft in Support of His Motion for Opposition to Lead Plaintiffs' Motion for Class Revision of the Court's October 14, 2004 Order, or Certification (Jul. 11, 2005) Original Image of this Alternatively, for Judgment on the Pleadings (Oct. Document (PDF) 18, 2005) • 2005 WL 3970086 (Trial Motion, Memorandum • 2005 WL 3742054 (Trial Motion, Memorandum and Affidavit) Memorandum of Law in Support of and Affidavit) Lead Plaintiffs' Opposition to: Defendant Frank E. Walsh, Jr.'s Motion to Dismiss in Defendant Michael Ashcroft's Motion for Revision of Part the Second Amended Complaint (Jul. 1, 2005) Court Order or, Alternatively, for Judgment on the Original Image of this Document (PDF) Pleadings; Motion of L. Dennis Kozlowski for • 2005 WL 4018440 () Declaration of Jairaj Bridglal Revision of Court Order; and Defendants Frank E. Pachai (Jun. 23, 2005) Original Image of this Walsh and Mark A. Bel nick's Joinders in Tyco Document (PDF) International, Ltd.'s Motion for Revision of Court • 2005 WL 850786 (Trial Motion, Memorandum and Order or, Alternatively, for Judgment on the Affidavit) Motion of the Underwriters to Dismiss the Pleadings (Sep. 23, 2005) Consolidated Class Action Complaint (Mar. 11, • 2005 WL 3970136 (Trial Motion, Memorandum 2005) and Affidavit) Lead Plaintiffs' Opposition To: • 2004 WL 3770745 (Trial Pleading) Consolidated Defendant Michael Ashcroft's Motion for Revision of Securities Class Action Complaint (Dec. 13, 2004) Court Order Or, Alternatively, for Judgment on the Original Image of this Document (PDF) Pleadings; Motion of L. Dennis Kozlowski for • 2004 WL 2157238 (Trial Motion, Memorandum Revision of Court Order; and Defendants Frank E. and Affidavit) Reply Memorandum of Law of Walsh and Mark A. Bel nick's Joinders in Tyco Defendants L. Dennis Kozlowski and Mark H. International, Ltd.'s Motion for Revision of Court Swartz in Further Support of Their Motion to Order Or, Alternatively, for Judgment on the Dismiss (Sep. 13, 2004) Pleadings (Sep. 23, 2005) Original Image of this • 2004 WL 481754 (Trial Motion, Memorandum and Document (PDF) Affidavit) Memorandum of Law of Nominal • 2005 WL 3970135 (Trial Motion, Memorandum Defendant Tyco International Ltd. in Support of its and Affidavit) Lead Plaintiff's Memorandum of Law Motion to Dismiss Plaintiffs' Second Consolidated in Support of Motion for Clarification (Sep. 21, and Amended Derivative Complaint (Feb. 26, 2004) 2005) Original Image of this Document (PDF) • 2004 WL 481755 (Trial Motion, Memorandum and • 2005 WL 3742070 (Trial Pleading) L. Dennis Affidavit) Nominal Defendant Tyco International Kozlowski's Answer to the Complaint (Sep. 16, Ltd.'s Motion to Dismiss Second Amended 2005) Derivative Complaint (Feb. 26, 2004) • 2005 WL 3970131 (Trial Pleading) L. Dennis • 2002 WL 33009227 () Declaration of John W. Kozlowski's Answer to the Complaint (Sep. 15, Peavy III in Support of Defendant's Memorandum in 2005) Original Image of this Document (PDF) Opposition to Lead Plaintiffs' Motion for Class • 2005 WL 3742048 (Trial Motion, Memorandum Certification (Aug. 23, 2002) Original Image of this and Affidavit) Lead Plaintiffs' Memorandum of Law Document (PDF) in Opposition to Tyco International, Ltd.'s Motion for Revision of Court Order or, Alternatively, for END OF DOCUMENT Judgment on the Pleadings (Aug. 5, 2005) • 2005 WL 3970128 (Trial Motion, Memorandum and Affidavit) Lead Plaintiffs' Memorandum of Law

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primary Valence shareholders were Dawson, who FN4 founded the company in 1989, and Carl Berg, who United States District Court,N.D. California. contributed significantly to the initial investment. In re VALENCE TECHNOLOGY SECURITIES Montgomery Securities (“Montgomery”) acted as the LITIGATION. underwriter for Valence's initial public offering in No. C 94-1542-SC. May 1992 and for a common stock offering in November 1992. Montgomery and Alex. Brown & May 08, 1995. Sons Incorporated (“Alex. Brown”) were the co-lead underwriters of Valence's December 1993 common stock offering. Research analysts employed by ORDER RE: DEFENDANTS' MOTION TO DISMISS Montgomery issued reports regarding Valence, three of which are referenced in plaintiffs' complaint. I. INTRODUCTION Valence was never able to create a commercially viable battery. Plaintiffs allege defendants slowly released this information to the public so as to avoid *1 This matter concerns a securities class action a sudden drop in stock prices. For example, on May lawsuit brought on behalf of all persons who were 3, 1994, Valence announced that it was unable to purchasers of the common stock of Valence satisfy Motorola's product specifications and stated Technology, Inc. (“Valence”) between May 7, 1992 that the company did not know when or if it would be and August 10, 1994. The matter is now before the able to satisfy the terms of the highly publicized $100 court on all of the defendants' motions to dismiss. million supply contract. Following this The court finds that the Valence defendants' motion announcement, the price of Valence stock dropped to dismiss is GRANTED in part, DENIED in part; 50% to close at $5.25 per share. On June 16, 1994, the underwriters Montgomery and Alex. Brown' Valence announced that it was unable to manufacture motions to dismiss are GRANTED in part and batteries that met the product specifications of the DENIED in part. The individual defendants' motions much heralded $35 million Hewlett-Packard contract to dismiss are GRANTED in part, DENIED in part. -- a contract Valence had entered into five months earlier. Valence's stock plunged an additional 36% to close at $3.81. On August 9, 1994, Valence II. BACKGROUND announced it was abandoning its goal of manufacturing batteries utilizing the lithium metal Valence is a company engaged in the research, anode technology altogether. development and production of advanced lithium polymer rechargeable batteries for use in a variety of *2 Plaintiffs allege the defendants, along with the consumer electronic products, including cellular underwriters, committed fraud-on-the-market by telephones, portable computers, and automobiles. In misrepresenting to the investing public the true nature July, 1990, the company acquired battery technology of the battery's development and commercial from the Mead Corporation for approximately $2 viability. Plaintiffs claim defendants knew at all FN1 million. Wishing to convert lithium polymer times commercial mass production and usage of the battery technology into lightweight, energy-efficient batt ery product was an illusion; yet decided to batteries, the company began research and defraud investors so as to profit in the millions development of battery prototypes based on Mead's through insider sales and commission. Plaintiffs note FN2 technology. how Valence's stock, which at one point traded as high as $25.00 per share, now trades in the $3.00 The company issued three public offerings. It made range.FN5 Further, plaintiffs claim, throughout the its initial public offering in May 1992, and made Class Period, insiders sold their shares while the additional stock offerings in November, 1992 and prices were improperly inflated in order to recoup December, 1993. The offering materials for each their investment and simultaneously turn a profit. public offering included a prospectus, containing an extensive discussion of the risks Valence posed to Plaintiffs' allege securities fraud claims against investors.FN3 Prior to these public offerings, the

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Valence Technology, Inc.; Christine A. Russell, for two reasons: (1) lack of a cognizable legal theory Chief Financial Officer; Dale R. Shackle, Vice or (2) insufficient facts under a cognizable theory. President and Chief Technical Officer; David M. Balistreri v. Pacifica Police Dept., 901 F.2d 696, 699 Butte, Vice President, Marketing; William J. (9th Cir. 1990). Robertson v. Dean Witter Reynolds, Muscidae, Vice President, Operations; Calvin L. Inc., 749 F.2d 530, 533-34 (9th Cir. 1984). When Reed, who was Chairman of the Board of Directors, reviewing a motion to dismiss, all the allegations of Chief Executive Officer, and Chief Operating Officer material fact are taken as true and construed in the at various times; and Carl E. Berg, who helped found light most favorable to the non-moving party. Valence and was a member of the Board of Directors Abramson v. Brownstein, 897 F.2d 389 (9th Cir. since September, 1991 (collectively “Valence 1990). However, legal conclusions, deductions or defendants”); the underwriters Montgomery and opinions couched as factual allegations are not Alex. Brown (collectively the “underwriters”), as entitled to a presumption of truthfulness. Jones v. well as Lev M. Dawson, founder and Chief Executive Comm. Redevelopment Agency, 733 F.2d 646 (9th Officer until April, 1993, Chairman of the Board of Cir. 1984). Directors until October, 1993; and Alan F. Shugart, outside director since March, 1992 (“individual When ruling on a motion to dismiss, the court may defendants”). FN6 ,FN7 consider a variety of documents in addition to the complaint. First, the court may consider documents In essence, all of the defendants argue the complaint attached to the complaint. Durning v. First Boston, should be dismissed because (1) the “bespeaks Corp., 815 F.2d 1265, 1267 (9th Cir. 1987), cert. caution” doctrine adopted by this court and the Ninth denied, 484 U.S. 944 (1987). Second, the court may Circuit mandates dismissal when extensive and consider “documents whose contents are alleged in a specific risk factor disclosures exist in the complaint and whose authenticity no party questions, prospectuses or related documents and neutralize any but which are not physically attached to the possible misrepresentations, see In re Worlds of pleading.” Branch v. Tunnell, 14 F.3d 449, 454 (9th Wonder Sec. Litig., 35 F.3d 1407 (9th Cir. 1994) Cir.), cert. denied, 114 S.Ct. 2704 (1994). Third, the (“WOW”); (2) securities laws did not require court may review “public disclosure documents Valence to predict failure or disparage its research required by law to be and which actually have been and development efforts through continuous filed with the SEC.” Cortec Indus., Inc. v. Sum disclosures; (3) plaintiffs fail to plead the Holding L.P., 949 F.2d 42, 47 (2d Cir. 1991), cert. circumstances constituting fraud with the denied, 112 S.Ct. 1561 (1992). particularity required by the Ninth Circuit; (4) Valence's risk disclosures and the defendants' substantial investment time, effort, and money in B. Rule 9(b) Requirements developing the battery technology negate any inference of scienter; (5) most of the challenged Allegations of fraud must satisfy the requirements of statements are either vague statements of optimism, Fed.R.Civ.P. 9(b) to survive a motion to dismiss. which are not actionable; and (6) plaintiffs fail to Because § 10b-5 claims sound in fraud, they must plead a claim under Section 12(2) of the Securities meet the particularity requirements of Rule 9(b). Rule Act of 1933. 9(b) provides that: In all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be III. LEGAL STANDARD stated with particularity. Malice, intent, knowledge, and other condition of mind of a person may be A. Rule 12(b)(6) Motion averred generally.

The intent of Rule 9(b) is to “prevent the filing of A complaint should not be dismissed under Fed. R. claims merely to discover unknown wrongs.” In re Civ. P. 12(b)(6) “unless it appears beyond doubt that GlenFed, Inc. Sec. Litig., 11 F.3d 843, 847 (9th Cir. the plaintiff can prove no set of facts in support of his 1993), reh'g granted, 42 F.3d 1541 (9th Cir. 1994) claim which would entitle him to relief.” Conley v. (citing Semegen v. Weidner, 780 F.2d 727, 731 (9th Gibson, 355 U.S. 41, 45-46 (1957); Wool v. Tandem Cir. 1985)). Computers Inc., 818 F.2d 1433, 1439 (9th Cir. 1987). To satisfy Rule 9(b), securities class action plaintiffs *3 A complaint may be dismissed as a matter of law must allege fraud with enough particularity to give

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 115 of 163 Not Reported in F.Supp. Page 3 Not Reported in F.Supp., 1995 WL 274343 (N.D.Cal.), Fed. Sec. L. Rep. P 98,793 (Cite as: Not Reported in F.Supp.) defendants notice of the specific charges against them when made; basic research had not been completed so that defendants may respond to the charges. and Valence was never capable or close to capable of Kaplan v. Rose, Fed. Sec. L. Rep. (CCH) ¶ 98,422, commercial production. Plaintiffs contend 90,874 (9th Cir. 1994); Neubronner v. Milken, 6 F.3d fundamental flaws in the battery's technology existed 666, 671-72 (9th Cir. 1993). A complaint satisfies at the time the statement was made, including basic this standard if it states precisely the time, place, and problems in determining the proper chemical nature of the misleading statements, formulation for a viable and manufacturable polymer misrepresentations, and specific acts of fraud. electrolyte. Plaintiffs allege Valence misled investors Kaplan, Fed. Sec. L. Rep. (CCH) ¶ 98,422 at 90,874; to believe they had moved beyond a preliminary Neubronner, 6 F.3d at 672. The requirements of Rule stage in product development (had completed basic 9(b) may be “relaxed as to matters peculiarly within research), and were more focusing on commercial the opposing party's knowledge,” if the plaintiffs production of the battery (available as soon as 1994). cannot be expected to have personal knowledge of Plaintiffs claim that the omission of such information the facts prior to discovery. Wool v. Tandem and accompanying misrepresentations misled Computers, Inc., 818 F.2d 1433, 1439 (9th Cir. 1987) investors into relying on these misstatements and (citations omitted). However, where the plaintiffs subsequently buying improperly inflated stock. have received documentation that they could rely on in their complaint, such information may be Plaintiffs' complaint extensively describes the considered when analyzing the particularity of the sequence of events occurring during the twenty-seven allegations. month Class Period. Plaintiff sets out to describe how Valence was created, how the scheme operated, how the individual defendants participated in the scheme IV. DISCUSSION to defraud the public, including how the defendants used securities analysts and press to feed false A. Fraud Allegations -- § 10(b) Claims information to public investors, and how these analysts/underwriters actively or recklessly acquiesced. The complaint then analyzes each of the *4 In analyzing the § 10(b) claims made against the prospectuses, Valence's press releases, the various defendants, the court will look at the § 10(b) underwriters' analyst reports, and articles in various claims as they relate to the three categories of journals. Plaintiffs point out the allegedly false defendants. Within those three categories, the court statements made in the various documents, noting will analyze the various types of statements that how Valence either had no reasonable basis to make remain actionable. the statement, deliberately made the false statement, or if the statement was made by a third party, had a duty to disclose the adverse information to neutralize 1. Valence Defendants the misleading positive reports coming from third parties. Plaintiffs' principal contention is that Valence actively concealed from its prospectuses and other As noted above, to satisfy Rule 9(b), plaintiffs need public disclosures (1) the very nature of their battery to state more than the statements were false when product; (2) its development status; and (3) the made. They must provide some specific factual improbability of its commercial success within any of support for their contentions, listing not only the the time frames contemplated from the very outset. content, date, and document in which the The crux of plaintiffs' complaint centers on the very misstatement appeared, but the manner in which such first paragraph of the “Prospectus Summary” of each representations were false and misleading. Wool, 818 prospectus which states: F.2d at 1439. The Company has completed basic research for its batteries, has manufactured limited quantities of working prototypes and is presently developing the a. Existing Adverse ConditionsFN8 enhancements necessary to support commercial introduction of its products. *5 Plaintiffs' principal contention is that Valence misled the public by stating in their prospectuses they (emphasis added). had completed “basic research” and were about to engage in commercial production, based on their Plaintiffs argue this statement was blatantly false limited manufacturing of working prototypes and

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 116 of 163 Not Reported in F.Supp. Page 4 Not Reported in F.Supp., 1995 WL 274343 (N.D.Cal.), Fed. Sec. L. Rep. P 98,793 (Cite as: Not Reported in F.Supp.) present development of the enhancements necessary to support commercial introduction of its products.FN9 Plaintiffs also contend defendants misrepresented that i. basic research they were using a “solid” polymer electrolyte, as opposed to liquid polymer electrolytes. Plaintiffs According to plaintiffs, to have truthfully completed claim the gel-like substance they used had the basic research, Valence would have had to characteristics of a liquid and experienced the same demonstrate: (i) a true, liquid-free solid electrolyte capability and safety problems suffered by liquid battery; (ii) significant and positive cycle life and polymer electrolytes. Thus, to tout that Valence was safety data on actual size prototypes for the particular using a revolutionary “solid” based battery, with all application; (iii) a scaleable manufacturing plan; and the accompanying benefits, was materially (iv) a competitive cost structure. ¶ 62. misleading. *6 The court finds plaintiffs have specified with While plaintiffs spend most of the complaint listing enough detail why Valence's statements regarding the various misstatements, plaintiffs rely on three completion of basic research may have been paragraphs in their complaint to set forth how and misleading; thus, these allegations survive a motion why these assertions were false or misleading. See ¶ ¶ to dismiss. A reasonable investor could have thought 62-65. ¶ 61 sets forth the following statements made basic research included these aspects, and knowledge in the prospectuses: that they had not yet been in fact performed could [L]ithium polymer battery under development will have materially altered one's investment offer a number of significant advantages over decisionmaking. See Hanon v. Dataproducts, 976 currently available rechargeable batteries including: F.2d 497, 504 (9th Cir. 1992). -- Longer Operating Time: ... The Company's current prototype lithium polymer battery is capable of operating approximately four times longer on a single ii. longer operating time charge than standard NiCad [nickel-cadium] batteries of comparable weight. Plaintiffs contend that defendants failed to reveal that -- Size and Weight: ... The Company's current its prototype, represented by Valence as capable of prototype lithium polymer battery delivers equal operating four times longer on a single charge than a power from a battery that consumes approximately NiCad battery, was, in fact, a one-third of the volume and one-quarter of the weight miniature, incomplete, undersized laboratory battery, of today's commonly used rechargeable batteries. designed and tested in Valence's laboratory at a low --Rechargeable Characteristics: ... The Company's discharge rate, inadequate for the majority of current prototype lithium polymer battery is capable Valence's targeted markets, and could not be of over 150 deep discharge cycles and over 300 converted into a mass-produced battery acceptable by partial discharge cycles, with no loss of capacity due Valence customers. to partial discharge and recharge. ¶ 62. Once again, the court finds plaintiffs have ¶ 61. ¶ 62 comments on the falsity of these specified with enough detail to survive a motion to statements. ¶ 62 also sets forth how Valence falsely dismiss how defendants' statements regarding longer described its batteries as containing a “flexible solid operating time could be misleading, or that the polymer electrolyte” which had reduced “weight, omission of this information could have materially volume, and safety problems.” “The Company's persuaded a reasonable investor's decision. lithium polymer technology avoids [the] risks associated with liquid electrolytes.” Plaintiffs contend Valence actually used a gel-like substance iii. size and weight that created the same problems facing liquid electrolytes, thus, falsely represented the use of a Plaintiffs contend defendants overstate and solid. misrepresent the actual performance and energy density characteristics of batteries which could be The court finds that allegations concerning existing feasibly manufactured given the state of Valence's adverse conditions and technical problems known to technology. Plaintiffs allege the prototype used was a Valence at the time prospectuses and press releases miniature, incomplete, undersized laboratory battery were issued, but not disclosed to the public, are that was unlikely to meet requirements in power actionable. output, cycle life, safety, environmental impact, and

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 117 of 163 Not Reported in F.Supp. Page 5 Not Reported in F.Supp., 1995 WL 274343 (N.D.Cal.), Fed. Sec. L. Rep. P 98,793 (Cite as: Not Reported in F.Supp.) cost. Plaintiffs claim if the battery were to work at disclosing the medium of the substance, i.e., solid v. all, the battery would have only a 2-to-1 advantage in gel or liquid, are specific enough to satisfy Rule 9(b). weight and a 1.5-to-2 times advantage in volume, not Determination of the true state of the substance, and one-third the volume and one-quarter the weight whether such labelling was false or misleading, in touted by Valence. The court finds plaintiffs order to find a supportable cause of action, is better adequately specify how these statements could be left for summary judgment or determination by a trier misleading. of fact.

The next step is to determine if plaintiffs' allegations iv. recharge characteristics of existing adverse conditions are actionable under 10(b). Section 10(b)-5, 17 C.F.R. § 240.10b-5, Plaintiffs contend defendants failed to reveal that the enacted pursuant to Section 10(b) of the Securities prototype which purportedly was capable of 150 to Act of 1934, makes it unlawful “[t]o make any untrue 300 discharges, was specifically optimized in statement of a material fact or to omit to state a Valence's laboratory for the primary purpose of material fact necessary in order to make the maximizing recharging criteria without regard to statements made, in the light of the circumstances other factors such as weight and energy density. ¶ under which they were made, not misleading.” To 62. Defendants allegedly failed to disclose that the successfully allege securities fraud under § 10(b)-5, prototype (1) could not lead to the mass production of plaintiffs must allege reliance on a material a battery which Valence customers would accept for misstatement, and scienter. See Hanon v. commercial use in any electronic or other application Dataproducts Corp., 976 F.2d 497, 506-07 (9th Cir. and (2) was capable of only 100 or so discharge- 1992). recharge cycles, far below current NiCad technology. Plaintiffs allege reliance using the fraud-on-the- The court finds omission of such technical problems, market theory. “In the usual claim under Section if true, could be actionable, at least to survive a 10(b), the plaintiff must show individual reliance on a motion to dismiss. See Hanon, 976 F.2d at 501 material misstatement. Under the fraud on the market (finding issue of fact as to whether statements in first theory, the plaintiff has the benefit of a presumption quarter report praising the Dataproducts' printer were that he has indirectly relied on the alleged false and misleading because they were made when misstatement, by relying on the integrity of the stock Dataproducts knew the printer had severe technical price established by the market.” In re Apple problems). Computer Securities Litigation, 886 F.2d 1109, 1113- 14 (9th Cir. 1989), cert. denied, 496 U.S. 943 (1990). To prevail in a fraud on the market case, “the plaintiff v. solid vs. gel must demonstrate that a particular statement, when read in light of all the information then available to *7 Plaintiffs contend Valence falsely labelled the the market, or a failure to disclose particular battery as composed of a “solid” polymer electrolyte, information, conveyed a false or misleading when it was actually a jelly-like substance which impression.” In re Convergent Tech. Sec. Lit., 948 faces the same leakage and safety problems as a F.2d 507, 512 (9th Cir. 1991). Defendants may liquid electrolyte. ¶ 62. Plaintiffs contend Valence respond to a claim of fraud-on-the-market by failed to disclose that all attempts to utilize a truly asserting that the information allegedly withheld solid electrolyte which would provide suitable ion from the market had in fact entered the market. transfer at room temperature had failed. Apple, 886 F.2d at 1114.

In addition, ¶ 63 states how Ralph Brodd, Valence's The court finds plaintiffs have adequately pled then marketing director, falsely distinguished reliance on the alleged misstatements. The complaint Valence's “solid” lithium battery from other organic states plaintiffs allegedly purchased stock in reliance lithium polymers, the latter of which can leak and on the misstatements and were subsequently even explode or catch fire if punctured. Plaintiffs damaged when the stock prices, at one time claim the Valence battery contained the same organic improperly inflated, dropped in value dramatically. lithiums, with the same mechanical and chemical Given the presumption accompanying the fraud-on- instability. the-market theory, plaintiffs' allegations demonstrate reliance to survive a motion to dismiss. The court finds plaintiffs' allegations of falsity in

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*8 To establish § 10(b)-5 liability, plaintiffs must allegations of fraud, based on existing adverse also show that the defendants acted with scienter, that conditions, also survive a motion to dismiss based on is “a mental state embracing intent to deceive, § 10(b) of the Securities Act as against Valence manipulate, or defraud.” Ernst & Ernst v. Hochfelder, defendants. 425 U.S. 185 (1976), reh'g denied, 425 U.S. 986 (1976). To establish scienter, the Ninth Circuit requires a showing of either an actual intent do b. Statements of General Optimism and Puffery defraud or “a recklessness that is only one step down from intent.” Kaplan v. Rose, Fed. Sec. L. Rep. The Valence defendants assert several of plaintiff's (CCH) ¶ 98,422 (citing Hollinger v. Titan Capital allegations listed in the complaint represent general Corp., 914 F.2d 1564, 1569 (9th Cir. 1990), cert. and vague expressions of optimism that are mere denied, 499 U.S. 976 (1991). puffery and, thus, not actionable under the securities laws. Alfus v. Pyramid Tech. Corp., 745 F.Supp. Scienter is defined as an intent to deceive, 1511, 1519 (N.D.Cal. 1990). manipulate, or defraud. Ernst & Ernst v. Hochfelder, 425 U.S. at 193-94 n.12; In re GlenFed, 11 F.3d at *9 Statements of belief and optimism, like 847. To satisfy this definition, a complaint must projections, may be actionable under federal allege facts showing conduct “involving not merely securities law. Apple, 886 F.2d at 1113; Hanon, 976 simple, or even inexcusable negligence, but an F.2d at 501; In re Verifone, 11 F.3d 865, 870 (9th extreme departure from the standards of ordinary Cir. 1993). Numerous courts have held, however, that care, and which presents a danger of misleading general statements of optimism about the future and buyers or seller that is either known to the defendant “puffing” about the company or product are not or is so obvious that the actor must have been aware actionable. In re Syntax Corp. Sec. Litig., 855 of it.” Hollinger v. Titan Capital Corp., 914 F.2d F.Supp. 1086, 1095 (N.D.Cal. 1994); Alfus v. 1564, 1569 (9th Cir. 1990) (en banc), cert. denied, Pyramid Tech. Corp., 745 F.Supp. 1511, 1519 499 U.S. 976 (1991) (citations omitted). In general, (N.D.Cal. 1990); Raab v. General Physics Corp., 4 Rule 9(b) allows scienter to be pled generally. While F.3d 286, 289-90 (4th Cir. 1993). “Professional some courts have required the facts pled support a investors, and most amateur investors as well, know strong inference of fraudulent intent, see O'Brien v. how to devalue the optimism of corporate executives, National Property Analysts Partners, 936 F.2d 674, who have a personal stake in the future success of the 676 (2d Cir. 1991), the Ninth Circuit has refused Company.” In re Verifone Sec. Litig., 784 F.Supp. expressly to adopt this stricter standard as it relates to 1471, 1481 (N.D.Cal. 1992), aff'd, 11 F.3d 865 (9th scienter. See GlenFed, 42 F.3d at 1545. Cir. 1993) (citing Wielgos v. Commonwealth Edison Co., 892 F.2d 509, 515 (7th Cir. 1989)). The Valence defendants contend certain facts present in this case negate plaintiffs' allegations of scienter. A projection or statement of belief may be actionable Specifically, defendants claim any inference of where one of three implied factual assertions is scienter is negated by substantial risk disclosures, inaccurate: “‘(1) that the statement is genuinely defendants' “extraordinary” effort to develop the believed, (2) that there is a reasonable basis for that battery, which included devoting substantial amounts belief, and (3) that the speaker is not aware of any of time and money on the company, and stock sales, undisclosed facts tending to seriously undermine the which do not show insiders selling their stock accuracy of the statement.”’ Hanon, 976 F.2d at 501 irregularly. The court is unpersuaded by defendants' (quoting Apple, 886 F.2d at 1113). arguments. Any company bent on defrauding the public could purposely inject their prospectuses with As noted, defendants assert many of the alleged risk disclosures to shield themselves from future fraudulent statements asserted by plaintiffs are liability. Further, devotion of time and resources may merely vague statements of corporate optimism and help negate an inference of scienter for purposes of are not actionable. Further, they claim plaintiffs fail summary judgment or determination by a trier of fact, to plead sufficient facts demonstrating defendants did but it does not dismiss the claim in its entirety at this not genuinely and reasonably believe their statements stage in the litigation. Plaintiffs may aver scienter of general optimism when they were made, or that generally, which they have successfully done.FN10 they were aware of specific undisclosed facts that undermined the accuracy of such statements. Some of Because the court also finds plaintiffs adequately the statements include: plead reliance on alleged misstatements, the ¶ 66 -- “We are very excited about the tremendous

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Group Published Information portable electronic entertainment products.” ¶ 72 -- “We are very excited about the tremendous In the Ninth Circuit, allegations of securities fraud potential for lithium polymer batteries.” based on claims of allegedly false and misleading ¶ 75 -- “The significance of a business partner like statements in “prospectuses, registration statements, Motorola can't be overestimated. One of the world's annual reports, press releases, or other ‘group largest consumers of rechargeable batteries, Motorola published information”’ may rely on a presumption provides Valence with an extraordinary opportunity that these statements are the collective work of those to quickly gain acceptance for its products in this individuals within the company with direct important portable electronics market.” involvement in the day-to-day affairs of the ¶ 78 -- [in response to a negative Forbes article], company. Wool, 818 F.2d at 1440. Under the group “Sour grapes ... They don't know when I started, and pleading presumption, plaintiffs may satisfy the they don't know where I am ... Our process is easier specificity requirements of Rule 9(b) by pleading the to manufacture than theirs. They can believe what alleged misrepresentations with particularity and they want.” indicating the roles of individual defendants in the ¶ 79 -- “We are loyal to our cause and excited about alleged misrepresentations where possible. Id. our prospects. As you know the market offers a tremendous opportunity and we believe our The Valence defendants apparently concede group technology is superior.” pleading applies to statements made in the *10 ¶ 83 -- “I think Valence has gotten off to an prospectuses and press releases, but contest its excellent beginning during its formative stages.” application to analyst reports and articles published ¶ 103 -- “This agreement provides us with the by third parties. To hold corporate defendants liable opportunity to apply our technology in another for the statements of third party analysts, plaintiffs market.” must allege facts suggesting that the corporation “sufficiently entangled itself with the analysts' forecasts to render those productions ‘attributable to The court finds ¶ 66, ¶ 75, ¶ 78, and ¶ 83 are it.”’ Elkind v. Myers, Inc., 635 F.2d 156, 163 (2d Cir. actionable in that, when taking plaintiffs' allegations 1980). as true that defendants were aware of serious technical difficulties, the speaker was aware of Courts in this district have held that in order to plead undisclosed facts tending to seriously undermine the entanglement with the specificity required by Rule accuracy of these statements. 9(b), plaintiffs must identify at least the time, place, and nature of the alleged entanglement activity. See The court finds the remaining statements ¶ 72, ¶ 79, e.g., In re VeriFone, 784 F.Supp. at 1487. and ¶ 103, even taking plaintiffs' allegations as true, Specifically, plaintiffs must (1) identify specific are too vague and merely demonstrate general forecasts and the insider who adopted them; (2) point optimism; thus, are not actionable. These statements to specific interactions between the insider and the relate more to Valence's long-term prospects than analyst which gave rise to the entanglement; and (3) current position. Accepting plaintiff's allegation that state the dates on which the acts which allegedly gave basic research had not been completed when the rise to the entanglement occurred. Caere, 837 statements were released, defendants could have F.Supp. at 1059. It is not sufficient to allege that genuinely believed that their battery would one day defendants provided analysts with the information on be commercially viable. Certainly enough research which the analysts' reports were based. Plaintiffs could have been done so as not to seriously must also allege that defendants had some measure of undermine the accuracy of these optimistic control over the content of their final report or statements, whether forward-looking or not. See projection issued by the analysts. Caere, 837 F.Supp. Apple, 886 F.2d at 113. Further, a reasonable investor at 1059; VeriFone, 784 F.Supp. at 1486; In re could devalue the optimism ringing in each of these Software Publishing Sec. Litig., Fed.Sec.L.Rep. statements. Accordingly, these statements of (CCH) ¶ 98,094, 98,762 (N.D.Cal. 1994); In re optimism are not actionable under § 10(b) 5, and the Syntax Corp., 855 F.Supp. at 1097. Accordingly,

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¶ 53. It does not necessarily follow that because group pleading doctrine when he was an outside Valence knew all along of insurmountable director and shareholder because of the “special technological problems, Montgomery was aware of relationship” that existed due to Dawson's and participated in the fraud. See In re Verifone, 784 participation in drafting the documents containing F. Supp. at 1491. alleged misrepresentations. ¶ 121; In re Ross Sys. Sec. Litig., Fed. Sec. L. Rep. (CCH) ¶ 98,363 at Plaintiffs allege, however, that the underwriters failed 90,496 (N.D.Cal. 1994). The court finds that because in their due diligence efforts to either discover the Dawson was the CEO for the first four years of the problems or they discovered them and chose to company's existence, and because plaintiffs disregard them. ¶ 6, ¶ 46. The court finds these sufficiently allege Dawson's active participation in paragraphs constitute conclusory allegations and lack drafting some of the documents that contained the necessary specificity to satisfy Rule 9(b). misstatements, facts could be presented to demonstrate a special relationship between Dawson Accordingly, the underwriters' motions to dismiss and Valence even when he was an outside director or based on allegations of fraud are granted. Plaintiffs significant shareholder. Accordingly, plaintiffs' claim are granted thirty (30) days leave to amend their of fraud against Dawson post-April, 1993 survive a complaint to better specify why the underwriters motion to dismiss. Plaintiff will have to present lacked a reasonable basis for statements made in the evidence, however, of this special relationship to reports, or otherwise issued the reports in bad faith, survive summary judgment. thus, showing active participation in fraud. Moreover, because the court finds that plaintiffs have sufficiently linked the analysts reports to the Valence b. Roadshows defendants, the reports are also subject to the group pleading doctrine as they relate to Dawson. See In re The court finds plaintiffs' allegations against the RasterOps Corp. Sec. Litig., Fed. Sec. L. Rep. (CCH) underwriters as it relates to the roadshows also fail to ¶ 98,467 at 91,194 (N.D.Cal. 1994). satisfy Rule 9(b) specificity. Nowhere in the complaint do plaintiffs mention the time, place, date, Dawson also moves the court to dismiss specific or individual who made the misstatement during the statements made by Dawson. See ¶ ¶ 66, 67, 70, 72, roadshows. Plaintiffs also fail to allege with 75, 78, 79.FN12 With regard to ¶ 66, ¶ 75, and ¶ 78, specificity the exact misstatement. Accordingly, the court finds the statements contained therein plaintiffs allegations of fraud against the underwriters actionable against Dawson. See discussion supra. ¶ based on roadshows are dismissed. Plaintiffs are 72 and ¶ 79 are too vague to be relied on by a granted thirty days (30) leave to amend their reasonable investor; thus, are not actionable. ¶ 67 complaint. (“shipments are expected to begin in August ... test models of electrified Cadillac Allantes could hit the road next year”) is actionable as it involves specific 3. Individual Defendants forecasts the accuracy of which could be undermined given the existence of undisclosed, adverse a. Lev Dawson conditions. ¶ 70 does not connect a misstatement to Dawson specifically, but is actionable under the group pleading doctrine. While Dawson was the founder and initial director of Valence, in April of 1993, Dawson became an outside director of Valence. In October of 1993, b. Alan Shugart Dawson severed all ties with Valence, save $1.5 million in stock. Dawson apparently concedes he is Shugart moves to dismiss all § 10(b) claims raised liable under the group pleading doctrine for against him. Shugart argues plaintiffs fail to satisfy statements made prior to April, 1993, but moves the Rule 9(b) in that their only allegations directed at court to dismiss him from any liability for statements Shugart are that he was an outside director, on a made post-April, 1993. Plaintiffs argue Dawson is committee, and that in his capacity as a director he liable for statements made during the entire 27-month signed three Registration Statements. Shugart claims class period under the group pleading doctrine. these facts alone do not invoke the group pleading doctrine. The court disagrees. *13 Plaintiffs contend Dawson still falls under the

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While the court may not be satisfied with plaintiffs' disclosed the assumptions upon which the optimistic allegations if they only mentioned Shugart's position language was based. as an outside director and member of the company's audit and compensation committees, plaintiff Id. (quoting 814 F.Supp. at 858). Further, the doctrine highlights Shugart's role in signing all three precludes efforts to bicker over cautionary Registration Statements in conjunction with the disclosures or attack isolated statements taken out of prospectuses. FN13 The court finds the above facts, context. As the Ninth Circuit stated, “[t]he doctrine considered altogether, give rise to plaintiffs' ability to reflects the unremarkable proposition that statements discover facts demonstrating a “special relationship” must be analyzed in context.” Id. at 1414 (quoting between Shugart and Valence. Thus, the court finds Rubenstein v. Collins, 20 F.3d 160, 167 (5th Cir. plaintiffs satisfy the group pleading doctrine as it 1994)). relates to Shugart and their fraud claims against Shugart are actionable at this stage in the While WOW was decided at summary judgment, the proceedings. Ninth Circuit recognized that the bespeaks caution doctrine could be applied at the pleading stage: [t]he bespeaks caution doctrine provides a c. Carl Berg mechanism by which a court can rule as a matter of law (typically in a motion to dismiss for failure to *14 Carl Berg requests the court to dismiss all claims state a cause of action or a motion for summary against him. The court finds for the same reasons judgment) that defendants' forward-looking Shugart's motion to dismiss is denied, Berg's motion representations contained enough cautionary to dismiss is also denied. language or risk disclosure to protect the defendant against claims of securities fraud.

4. The “Bespeaks Caution” Doctrine Id. at 1413 (quoting Donald C. Langevoort, Disclosures that “Bespeaks Caution”, 49 Bus. Law. All defendants argue that under the “bespeaks 481, 482-83 (1994) (emphasis added). caution” doctrine, the extensive and specific risk factor disclosures in the prospectuses, as well as The bespeaks caution doctrine says in essence that if analyst reports, rebut any claim that the disclosures possibly misleading statements are accompanied by were false or misleading. cautionary language addressing the particular misleading fact, then the cautionary language In In re Worlds of Wonder Sec. Lit., 35 F.3d 1407 neutralizes any detrimental effect the possibly (9th Cir. 1994) (“WOW”), the Ninth Circuit misleading statement could have on the investor. In expressly adopted the “bespeaks caution” doctrine in In re Donald Trump Casino Securities Lit., 7 F.3d securities fraud litigation. As this court and the Ninth 357, 372 (3d. Cir. 1993), cert. denied, 114 S.Ct. 1219 Circuit held, the bespeaks caution doctrine presumes (1994), the district court addressed the applicability that a challenged disclosure is not misleading: of the bespeaks caution doctrine at the motion to ... [t]he doctrine holds that where a prospectus dismiss stage. The court turned to the Supreme contains adequate cautionary language disclosing Court's language in Virginia Bankshares, Inc. v. specific risks, no reasonable inference can be drawn Sandberg, 111 S.Ct. 2749 (1991), which stated “not that a statement regarding those risks was misleading. every mixture with the true will neutralize the deceptive. If it would take a financial analyst to spot Id. at 1413 (quoting WOW, 814 F.Supp. 850, 859 the tension between the one and the other, whatever (N.D.Cal. 1993) (Conti, J.)). Under the “bespeaks is misleading will remain materially so, and liability caution” doctrine, as adopted in this circuit:... should follow.” Id. at 2760. The Third Circuit noted economic projections, estimates of future how this notion comported with the general principle performance, and similar optimistic statements in a of the bespeaks caution doctrine, prospectus are not actionable when precise *15 because it merely underscores that when the cautionary language elsewhere in the document subject of a misrepresentation or omission is such adequately discloses the risks involved. It does not that the accompanying language does not diminish matter if the optimistic statements are later found to the importance of the misrepresentation or omission have been inaccurate or based on erroneous to the investor, the misrepresentation or omission assumptions when made, provided that the risk remains actionable. In a word, a misrepresentation or disclosure was conspicuous, specific, and adequately omission is actionable when materially misleading.

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-- Valence would have to overcome numerous and In re Donald Trump, 7 F.3d at 373. The court went formidable obstacles in order to manufacture on to note that materiality involves a context-specific commercial quantities of its lithium polymer battery, analysis such that warnings and cautionary language although neither Valence nor any other company had will sometimes suffice to render the allegedly experience in manufacturing such a battery; misleading misrepresentation or omission immaterial *16 -- Valence would have substantial future capital as a matter of law. But if a reasonable investor would needs, with no certainty of obtaining the necessary not offset the misleading effect with the funding; accompanying cautionary statement, then the -- There were significant product and manufacturing bespeaks caution doctrine is unavailable as a defense. safety risks.

Thus, the court must look to see if the cautionary language negated the potentially misleading effect of Defendants argue that contrary to plaintiffs' claim, such statements as basic research had been completed these and other disclosures in the prospectuses and a solid polymer electrolyte was used. If we find unmistakably informed any potential investor of the no reasonable juror could conclude that the subject obstacles to the development of the battery, the projection materially influenced a reasonable company's sole potential product. investor, then a motion to dismiss is proper because plaintiff has failed to state a claim. Id. Plaintiffs respond that defendants' “risk factors” fail to bespeak caution because they did not alert Defendants contend that their prospectuses and investors to then existing adverse conditions accompanying risk disclosures put investors on regarding battery development. According to immediate notice that Valence was a high risk plaintiffs, defendants' reliance on the “bespeaks investment, and that there were no assurances a caution” doctrine is misplaced because the commercially viable battery could be produced. In misrepresentations and omissions concern adverse particular, the prospectuses disclosed that: conditions already present and contemporaneously -- Valence was a “development stage company” with known to defendants, which were purposely and only a “prototype” battery; wrongfully withheld from the public, as opposed to -- The Company had lost money since its inception forward-looking projections. and expected to incur substantial operating losses for at least the next several years; The court finds plaintiffs' principal allegations -- To achieve profitability, Valence would have to concern existing misrepresentations, not forward- develop, manufacture and market its battery products, looking misrepresentations, thus, the “bespeaks and there was no assurance that any battery product caution” doctrine is inappropriate at this stage of the could be developed or manufactured at an acceptable litigation. If, after discovery is completed, plaintiffs cost; cannot present enough evidence of misstatements -- Significant work remained to be undertaken to regarding existing adverse information to either state refine the Company's lithium polymer battery a claim or create an issue of fact, and may only rely technology and to configure batteries to meet on forward-looking information not already commercial requirements. dismissed based on puffery, see supra, then the -- There could be no assurances that any such “bespeaks caution” doctrine may require dismissal of products would be successfully developed, meet plaintiffs' action in its entirety.FN14 applicable regulatory standards, be capable of being produced in commercial quantities at acceptable costs or be successfully marketed; B. § 15 and § 20 Claims -- There was no assurance that Valence's batteries would gain market acceptance; a number of Sections 15 and 20 impose liability upon persons companies with substantially greater resources were who control corporations committing violations of developing competing battery technologies; and the federal securities law. See 15 U.S.C. § 77o; 15 Company would have to develop a sizeable sales U.S.C. § 78t(a). “The purpose of these sections is to staff, product support capabilities, and distribution impose liability on persons who might attempt to channels; evade liability under common law principles utilizing -- Valence would have to rely on a limited number of “dummies” that would act in their place and under Original Equipment Manufacturing (“OEM”) their control.” WOW, 694 F.Supp. 1427, 1435 customer relationships, which were not assured; (N.D.Cal. 1988).

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(1988). Moreover, § 12(2) liability will not be Plaintiffs assert § 20(a) liability against defendants imposed on participants only “collateral” to the offer Dawson, Berg, Reed, and Shugart. Plaintiffs assert § or sale. Alleging that a defendant was a “substantial 15 liability against defendants Dawson, Berg, Reed, factor” in causing the sale is not sufficient to impose Shugart, and Russell. § 12(2) liability; the defendant himself must have solicited the sale in question. Pinter, 486 U.S. at 654. Generally a director or officer is not automatically liable as a controlling person. Burgess v. Premier The court finds plaintiffs state a claim under § 12(2) Corp., 727 F.2d 826, 832 (9th Cir. 1984). “There as it relates to both the Valence defendants and must be some showing of actual participation in the underwriters. corporation's operation or some influence before the consequences of control may be imposed.” Id. The director or officer does not have to be intimately 1. The Underwriters involved with the day-to-day operations of the company; they do, however, have to exert some Applying the Pinter standard to the underwriters, in control over the company or participate in the conjunction with the standard used for a 12(b)(6) corporations' operations. In re Xoma, Fed. Sec. L. motion, the court finds a set of facts establishing the Rep. (CCH) ¶ 96,491, at 92,163. The status of an underwriters as “sellers” is clearly plausible, based alleged controlling person is insufficient by itself to on plaintiffs' allegations in the complaint. For state a claim of power or culpable participation. example, ¶ 46 states Montgomery agreed to “Where there is an allegation, however, of influence orchestrate a multi-city roadshow shortly before the or actual participation in the corporation's operation, initial and follow-up public offerings, during which it and where the allegedly misleading statements are and Valence officials would travel to many cities to part of ‘group-published information’ it is reasonable present highly favorable information about the to presume at the pleading stage that corporate company. See WOW, 721 F.Supp. 1140, 1148 officers and directors are ‘controlling persons.”’ (N.D.Cal. 1989) (finding that allegations that WOW, 721 F.Supp. at 1148-1149; Wool, 818 F.2d at underwriters “orchestrated and controlled the sales 1441 (“the issue of control is a complex question of and distribution process ... is sufficient at this initial fact requiring a close examination of the particular pleading stage to assert § 12(2) liability over these situation and organization ... [[[and the] test for defendants”).FN15 Plaintiffs have pled how the establishing control should be construed liberally and underwriters had a financial interest in the sales and flexibly”). allegedly solicited sales through reports and roadshows. See Moore v. Kayport Package Exp., Inc., *17 The court finds plaintiffs have adequately pled 885 F.2d 531, 537 (9th Cir. 1989) (finding lawyers “controlling persons” for purposes of surviving a and accountants not liable under § 12(2) because motion to dismiss as it relates to all the officers and investors failed to allege these defendants played any directors, named in the complaint, including Shugart role in soliciting the purchases). The underwriters and Berg. Because the court finds all these argue plaintiffs fail to point to any actual sales by the defendants can fall under the group pleading doctrine underwriters to a named plaintiff. While the court at this point in the litigation, plaintiffs' complaint notes plaintiffs do not present a model pleading of a § survives a motion to dismiss as it relates to § 15 and 12(2) claim, plaintiffs do satisfy Rule 8(a)(2) which § 20 claims. provides that a pleading which sets forth a claim for relief shall contain “a short and plain statement of the claim showing that the pleader is entitled to relief.” C. 12(2) Claims Moore, 885 F.2d at 539 (finding plaintiffs adequately pled § 12(2) claim as it related to stockbrokers). Section 12(2) imposes liability on persons who offer or sell securities by means of any prospectus containing material misrepresentations or omissions. 2. Valence Defendants and Individual Defendants WOW, 721 F.Supp. at 1147. The Supreme Court has defined “seller” narrowly, holding that “liability *18 Whether the Valence defendants and individual extends only to the person who successfully solicits defendants qualify as “sellers” within the meaning of the purchase, motivated at least in part by a desire to § 12(2) is not so evident. In Pinter, the Court held serve his own financial interests or those of the that § 12(2) liability “extends only to the person who securities owners.” Pinter v. Dahl, 486 U.S. 622, 647 successfully solicits the purchase, motivated at least

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Montgomery moves to strike ¶ 47, which contains (3) Alan Shugart's motion to dismiss is GRANTED statements insinuating improper conduct by in part, DENIED in part. Montgomery in connection with other offerings, pursuant to Fed. R. Civ. Pro. 12(f). Rule 12(f) states a (4) Carl Berg's joinder in the above motions to court may strike from the pleading any redundant, dismiss is GRANTED in part, DENIED in part.

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issue. The question at this stage is whether (5) Montgomery's motion to strike ¶ 47 is Valence withheld or misrepresented facts GRANTED. that a reasonable investor would have found material, thus, making the misstatements or IT IS SO ORDERED. omissions actionable. Plaintiffs allege that Valence misled investors into believing their product was at a much more advanced stage FN1. Mead had allegedly invested $10 in development than Valence knew it to be. million in attempting to develop a Plaintiffs also claim the very risk factors technology aimed at overcoming the defendants claim shield them from liability significant safety and cycle life problems are themselves misleading and false. Under associated with pairing the highly reactive a 12(b)(6) motion, the court must accept and potentially explosive metal lithium with these allegations as true and instead analyze a solid polymer electrolyte to make a plastic whether they are pled properly and create an sheet-like battery. ¶ 36. actionable claim.

FN2. The acquisition agreement with Mead FN9. Nowhere in plaintiffs' papers or included a provision that if Valence was complaint is there adequate support for the unable to commercially introduce its contention that defendants knew from the lithium-based rechargeable battery by company's inception that a commercially January 1, 1997, Mead could terminate the viable battery was impossible. Accordingly, agreement and rights granted thereunder plaintiffs' claims are limited to alleged would revert to Mead. misrepresentations made after Valence began research and development of its FN3. These risk disclosures are set forth in battery, and the allegation contained in ¶ 5 greater detail at infra Part IV.A.4. (“Commercial mass production was always an illusion.”) is dismissed with prejudice. FN4. The company was originally incorporated under the name Ultracell, Inc.. FN10. The court notes this case is In March, 1992, the name was changed to distinguishable from Ross, cited by Valence Technology, Inc. defendants. Unlike the court in Ross, this court finds plaintiffs' conclusory allegations FN5. Valence has since abandoned its are supported with a factual basis. See ¶ ¶ efforts to create this solid polymer lithium- 62-65. based battery, refocusing its research and development efforts on different technology. FN11. For example, ¶ 67 discusses a Business Journal article containing alleged FN6. Plaintiffs recently dismissed Roberts misstatements that Valence later adopted as without prejudice. a press release.

FN7. Carl Berg also moves the court to FN12. As noted before, plaintiffs dismiss all claims against him in his adequately plead why these statements were individual capacity. allegedly false when made. See ¶ ¶ 62-65, ¶ 40, and discussion supra. FN8. Defendants concentrate the majority of their argument on the fact that much of FN13. The registration statement is the the complaint simply catalogs the basic disclosure document. 15 U.S.C. § § development and manufacturing difficulties 77f, 77g. Valence encountered; as if the mere existence of these problems constituted FN14. Because the court finds this doctrine securities fraud. Defendants also argue inapplicable at this stage in the litigation, plaintiffs were never misled as to the there is no need for the court at this time to commercial capability of the prototype address the applicability of the doctrine to battery cells, given the abundance of risk the analyst reports. disclosures. Defendants focus on the wrong

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FN15. The court does not find the Supreme Court's holding in Gustafson v. Alloyd Co., Inc., 115 S. Ct. 1041, (1995) requires dismissal of the underwriters for plaintiffs' § 12(2) claim. The Court in Gustafson held that § 12(2) does not apply to private placement transactions. Here, plaintiffs base their claims on sales arising out of three separate public offerings based on misleading prospectuses. Accordingly, Gustafson is distinguishable and has no effect on this court's holding. N.D.Cal. 1995 In re Valence Technology Securities Litigation Not Reported in F.Supp., 1995 WL 274343 (N.D.Cal.), Fed. Sec. L. Rep. P 98,793

END OF DOCUMENT

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Briefs and Other Related Documents This action is a securities class action brought on Only the Westlaw citation is currently available. behalf of all persons who purchased the common United States District Court, N.D. California. stock of Valence Technology, Inc. between May 7, In re VALENCE TECHNOLOGY SECURITIES 1992 and August 10, 1994. The action was LITIGATION. transferred from the San Francisco Division, Judge No. C 95-20459 JW. Samuel Conti, and reassigned to the San Jose Division, Judge James Ware. Jan. 23, 1996. In their Third Amended Complaint, Plaintiffs allege (1) violations of Section 10(b) of the Securities and Joseph J. Tobacco, Jr., Jeffrey W. Lawrence, Exchange Act of 1934 and Rule 10b-5 of the Berman, DeValerio, Pease & Tobacco, San Securities Act of 1933 against all defendants; (2) Francisco, CA, William S. Lerach, Patrick J. violations of Section 20(a) of The Exchange Act Coughlin, Milberg Weiss Bershad Hynes & Lerach, against some of the individual defendants and San Diego, CA, and Reed R. Kathrein, San Valence; (3) violations of Section 12(2) of the Francisco, CA, for Plaintiffs. Securities Act against certain individual defendants, Tower C. Snow and James A. Lico, Brobeck, Phleger Valence and the underwriters, Montgomery & Harrison, San Francisco, CA, for Defendant Lev Securities and Alex. Brown & Sons; and (4) M. Dawson. violations of Section 15 of the Securities Act against Robert P. Feldman, Wilson, Sonsini, Goodrich & some of the individual defendants. Defendants Rosati, Palo Alto, CA, for Defendants Valence Montgomery Securities and Alex. Brown & Sons, Technology, Inc., Christine Russell, Dale R. Shackle, Incorporated now move to dismiss with prejudice the David M. Butze, William J. Masuda, Calvin L. Reed allegations against them in Plaintiffs' Third Amended FN1 and Carl E. Berg. Complaint (TAC). Melvin R. Goldman, Paul T. Friedman, and Robert W. Orlowsky, Morrison & Foerster, San Francisco, FN2 CA, for Defendant Montgomery Securities. BACKGROUND

ORDER GRANTING DEFENDANT Valence is a company engaged in the research, MONTGOMERY SECURITIES' MOTION TO development and production of advanced lithium DISMISS THIRD AMENDED COMPLAINT; polymer rechargeable batteries for use in a variety of GRANTING DEFENDANT ALEX. BROWN & consumer electronic products, including cellular SONS, INC.'S MOTION TO DISMISS THIRD telephones, portable computers, and automobiles. AMENDED COMPLAINT Lev Dawson founded Valence in March 1989. The WARE, District Judge. company was originally incorporated under the name *1 The motion of Defendant Montgomery Securities Ultracell, Inc. In March 1992, the name was and the motion of Defendant Alex. Brown & Sons, changed to Valence Technology, Inc. In July 1990, Incorporated to dismiss Plaintiffs' Third Amended the company acquired battery technology from the Complaint pursuant to Federal Rules of Civil Mead Corporation for approximately $2 million. Procedure 9(b) and 12(b)(6), were submitted to the Court on December 8, 1995. The court has read the Valence then began research and development of moving and responding papers and considered the battery prototypes based on Mead's technology. The oral argument of counsel. Based upon all pleadings acquisition agreement with Mead included a filed to date, as well as on the oral argument of provision that if Valence was unable to commercially counsel, the Court GRANTS Defendant Montgomery introduce its lithium-based rechargeable battery Securities' motion and GRANTS Defendant Alex. January 1, 1997, Mead could terminate the agreement Brown & Sons' motion. and rights granted thereunder would revert to Mead. Valence wished to convert lithium polymer battery technology into lightweight, energy-efficient INTRODUCTION batteries.

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Amended Complaint responding to the Court's orders Valence made its initial public offering (“IPO”) in dismissing with leave to amend. Plaintiffs filed the May 1992, and made additional stock offerings in Third Amended Complaint on October 19, 1995. November 1992 and December 1993. Each public Montgomery and Alex. Brown now move to dismiss offering included a prospectus, which contained an this complaint on the grounds of failure to state a extensive discussion of the risks Valence posed to claim and for lack of particularity in pleading the investors. Before these public offerings the primary fraud claim. Valence shareholders were Dawson and Carl Berg, who had also contributed significantly to the initial investment. Montgomery Securities LEGAL STANDARDS (“Montgomery”) acted as the underwriter for Valence's IPO in May 1992 and for a common stock A claim may be dismissed as a matter of law for one offering in November 1992. Montgomery and Alex. of two reasons: “(1) lack of a cognizable legal theory Brown & Sons Incorporated (“Alex. Brown”) were or (2) insufficient facts under a cognizable legal the co-lead underwriters of Valence's December 1993 theory.” Robertson v. Dean Witter Reynolds, Co., common stock offering. Research analysts 749 F.2d 530, 534 (9th Cir.1984). “A complaint employed by Montgomery issued reports regarding cannot be dismissed for failure to state a claim unless Valence. Plaintiffs reference three of these reports it appears beyond doubt that the plaintiff can prove in their Third Amended Complaint. no set of facts in support of his claim which would entitle him to relief.” Conley v. Gibson, 355 U.S. 41, *2 Valence was not able to create a commercially 45-46 (1957); Moore v. City of Costa Mesa, 886 viable battery. When this information was released F.2d 260, 262 (9th Cir.1989). “[A] complaint should to the public, Valence's stock prices dropped not be dismissed if it states a claim under any legal dramatically. Plaintiffs allege that Defendants, along theory, even if the plaintiff erroneously relies on a with the underwriters, committed fraud on the market different legal theory.” Haddock v. Board of Dental by misrepresenting to the investing public the true Examiners, 777 F.2d 462, 464 (9th Cir.1985). nature of the battery's development and commercial viability. Plaintiffs claim that Defendants knew at “All material allegations in the complaint are to be all times that commercial mass production and usage taken as true and construed in the light most of the battery product was an illusion and yet they favorable to the non-moving party.” Sanders v. decided to defraud investors so as to obtain profits in Kennedy, 794 F.2d 478, 481 (9th Cir.1986); NL the millions through insider sales and commission. Indus., Inc. v. Kaplan, 792 F.2d 896, 898 (9th Plaintiffs note that Valence's stock, which at one Cir.1986). However, the Court will not accept point traded as high as $25 per share, dropped to wholly conclusory allegations. In re VeriFone $3.00.FN3 Securities Litig., 11 F.3d 865, 868 (9th Cir.1993); Western Mining Council v. Watt, 643 F.2d 618, 624 Plaintiffs allege that securities fraud claims against (9th Cir.1981), cert. denied, 454 U.S. 1031 (1981). Valence Technology, Inc. various officers and The Court need not accept legal conclusions asserted employees FN4 and the underwriters, Montgomery and in the complaint even if pled as “facts.” Papasan v. Alex. Brown. Allain, 478 U.S. 265, 286 (1986).

The underwriters Montgomery and Alex. Brown *3 When ruling on a motion to dismiss, a district were added as defendants in September 1994. They court may consider certain documents. The court moved to dismiss Plaintiffs' First Amended may consider documents attached to the complaint. Complaint and in May 1995, Judge Conti granted the “If a complaint is accompanied by attached underwriters' motions to dismiss the section 10(b) documents, the court is not limited by the allegations claims with leave to amend and denied the motions to contained in the complaint. These documents are dismiss the section 12(2) claims. After a motion by part of the complaint and may be considered in the underwriters to reconsider the ruling on the determining whether the plaintiff can prove any set of section 12(2) claims, Judge Conti dismissed these facts in support of his claim. Durning v. First Boston claims with leave to amend on September 19, 1995. Corp., 815 F.2d 1265, 1276 (9th Cir.1987), cert. While the motion for reconsideration was pending, denied, 484 U.S. 944 (1987) (citations omitted). The Plaintiffs filed a second amended complaint. The court may also consider “documents whose contents hearings on the underwriters' motions to dismiss were are alleged in a complaint and whose authenticity no vacated to allow Plaintiffs to file the operative Third party questions, but which are not physically attached

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 130 of 163 Not Reported in F.Supp. Page 3 Not Reported in F.Supp., 1996 WL 37788 (N.D.Cal.) (Cite as: Not Reported in F.Supp.) to the pleadings.” Branch v. Tunnell, 14 F.3d 449, aftermarket purchase and the public offerings so as to 454 (9th Cir.), cert. denied, 512 U.S. 1219, 114 S.Ct. state a claim under § 12(2).” Id. 2704 (1994). This does not convert the motion to dismiss into a motion for summary judgment. Id. *4 Plaintiffs' third amended complaint, filed on (citing Romani v. Shearson Lehman Hutton, 929 F.2d October 20, 1995, contains no amended allegations as 875, 879 n. 3 (1st Cir.1991)). Finally, a district court to thirteen of the fourteen named plaintiffs. The deciding a motion to dismiss a securities fraud action TAC does not allege a purchase by any of the named “may review and consider public disclosure plaintiffs in the May 1992 IPO or the November 1992 documents required by law to be and which actually secondary public offering. The amended allegations have been filed with the SEC....” Cortec Indus., Inc. refer only to Plaintiff Bergelson and only to a stock v. Sum Holding L.P., 949 F.2d 42, 47 (2nd Cir.1991), purchase on December 22, 1993, the day of Valence's cert. denied, 503 U.S. 960, 112 S.Ct. 1561 (1992). third offering. Defendants Montgomery and Alex. Brown thus contend that as plaintiffs have had the opportunity to amend their allegations as to the May DISCUSSION 1992 IPO or the November 1992 secondary public offering, and have failed to do so, all claims as to A. Section 12(2) Allegations those offerings should be dismissed with prejudice. The Court agrees. The Court hereby dismisses with prejudice all § 12(2) claims as to all plaintiffs other Section 12(2) of the Securities Act imposes liability than Bergelson. on sellers of securities sold “by means of a prospectus or oral communication, which includes an As to the purchase by Bergelson, the TAC states: untrue statement of a material fact or omits to state a On December 22, 1993, plaintiff Bergelson material fact necessary in order to make the purchased 200 shares of Valence stock on or directly statements, in the light of the circumstances under traceable to the Company's secondary public offering. which they were made, not misleading....” 15 U.S.C. The purchase price of the stock was $15.25, the price § 77l. the offering stock reached by the early afternoon of December 22. In connection with this purchase, Mr. Defendants Montgomery and Alex. Brown contend Bergelson received and reviewed Valence's that Plaintiffs have failed to amend their section prospectus for the December 22 offering. Mr. 12(2) claims as directed by Judge Conti after the Bergelson purchased this stock through the open most recent motions to dismiss. Initially, Judge market with the assistance of Prudential Securities, a Conti denied Defendants' motions to dismiss brokerage firm which made a market for Valence Plaintiffs' § 12(2) claims. However, the United stock. States Supreme Court decided Gustafson v. Alloyd Co., 513 U.S. 561, 115 S.Ct. 1061 (1995), during the Third Am.Compl. ¶ 20(n). briefing schedule for the initial motions to dismiss in this case. After a motion for reconsideration, the As the allegations on their face demonstrate that Court determined that it should revisit the sufficiency Plaintiff did not purchase in the Valence public of Plaintiffs' allegations as to the § 12(2) claims. offering, Plaintiffs appear to be claiming that a nexus See September 19, 1995 Order at 7. exists between this aftermarket purchase and the public offering on December 22, 1993. However, In the September 1995 order, Judge Conti held that Plaintiffs cite no authority for their proposition that § “the complaint is devoid of any allegations that these 12(2) supports liability for transactions “traceable” to named plaintiffs actually purchased stock through a public offering. The Supreme Court has stated that any of the public offerings or that their purchases “... the liability imposed by § 12(2) [ ] cannot attach were directly traceable to the public offerings. unless there is an obligation to distribute the Without more specificity, plaintiffs' section 12(2) prospectus in the first place (or unless there is an claims are not actionable.” September 19, 1995 exemption).” Gustafson v. Alloyd Co., 513 U.S. 561, Order at 10. The Court also determined that “the 115 S.Ct. 1061, 1067 (1995). The purchase at issue named plaintiffs have not alleged with sufficient in this case required no prospectus and no exemption particularity that either (1) they purchased Valence applies. The Court also held that “[t]he intent of stock directly through one of the three public Congress and the design of the statute require that § offerings, either on the offering date or within 90 12(2) liability be limited to public offerings.” Id. at days thereafter, or (2) a nexus exists between their 1071. Cases subsequent to Gustafson have held that

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 131 of 163 Not Reported in F.Supp. Page 4 Not Reported in F.Supp., 1996 WL 37788 (N.D.Cal.) (Cite as: Not Reported in F.Supp.) section 12(2) applies only to initial public offerings. Litig., 886 F.2d 1109, 1113 (9th Cir.1989), cert. See e.g., Stack v. Lobo, 903 F.Supp. 1361, 1375 denied, 496 U.S. 943 (1990). (N.D.Cal.1995). The Court is persuaded that § 12(2) applies only to a transaction which requires a Allegations of fraud must satisfy the requirements of prospectus to be delivered. The language in Federal Rule of Civil Procedure 9(b) to survive a Gustafson makes irrelevant whether the transaction is motion to dismiss. Because Section 10b-5 claims “traceable” to a public offering. Accordingly, the sound in fraud, they must meet the particularity Court hereby dismisses with prejudice Plaintiffs' § requirements of Rule 9(b), which provides: “In all 12(2) claims as to Plaintiff Bergelson for failure to averments of fraud or mistake, the circumstances state a claim. constituting fraud or mistake shall be stated with particularity. Malice, intent, knowledge, and other general condition of mind of a person may be averred B. Section 10(b) Allegations generally.” The intent of Rule 9(b) is to “prevent the filing of claims merely to uncover unknown wrongs.” Section 10(b) of the Securities Exchange Act of 1934 In re GlenFed Securities Litig., 11 F.3d 843, 847 (9th makes it unlawful to: Cir.1993) reh'g granted, 42 F.3d 1541 (9th Cir.1994) *5 directly or indirectly, by the use of any means or (citing Semegen v. Weidner, 780 F.2d 727, 731 (9th instrumentality of interstate commerce or of the Cir.1985)). mails, or of any facility of any national securities exchange- ... (b) [t]o use or employ, in connection In cases of corporate fraud, the requirements of Rule with the purchase or sale of any security registered on 9(b) may be “relaxed as to matters peculiarly within a national securities exchange or any security not so the opposing party's knowledge” since the plaintiffs registered, any manipulative or deceptive device or cannot be expected to have personal knowledge of contrivance in contravention of such rules and the facts constituting the wrongdoing. Wool v. regulations as the Commission may prescribe as Tandem Computers, Inc., 818 F.2d 1433, 1439 (9th necessary or appropriate in the public interest of the Cir.1987). for protection of investors.

15 U.S.C. § 78j. 1. Montgomery

Rule 10b-5, promulgated under § 10(b) provides: a. Analyst Reports It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails, or of any Defendant Montgomery contends that Plaintiffs' facility of any national securities exchange, section 10(b) claims based on allegedly misleading (1) to employ any device, scheme, or artifice to statements contained in three analyst reports should defraud, be dismissed because (1) plaintiffs have failed to add (2) to make any untrue statement of a material fact or allegations to the TAC which plead with particularity to omit to state a material fact necessary in order to why Montgomery allegedly lacked a reasonable basis make the statements made, in the light of for the statements in its analyst reports at the time circumstances under which they were made, not they were made; (2) many of the statements are misleading, or merely vague statements of optimism, which are not (3) to engage in any act, practice, or course of actionable as a matter of law; and (3) there is no business which operates or would operate as a fraud authority for Plaintiffs' argument that analysts owe a or deceit upon any person. duty for allegedly misleading statements in analyst reports that are not alleged to have been distributed to 17 C.F.R. § 240.10b-5 (1993). the public.

To state a claim for securities fraud, a plaintiff must allege “(1) a misstatement or an omission (2) of (1) Reasonable Basis material fact (3) made with scienter (4) on which the plaintiff relied (5) that proximately caused his *6 Montgomery contends that Plaintiffs have not injury.” McGonigle v. Combs, 968 F.2d 810, 817 altered their allegations with respect to the analyst (9th Cir. (1992), cert. dismissed, 506 U.S. 948, 113, reports despite Judge Conti's determination that S.Ct. 399 (1992); see also In re Apple Computer Sec. “plaintiffs' complaint supports Montgomery's defense

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 132 of 163 Not Reported in F.Supp. Page 5 Not Reported in F.Supp., 1996 WL 37788 (N.D.Cal.) (Cite as: Not Reported in F.Supp.) that Montgomery could have had a reasonable basis review would entail, Montgomery gave Macdonald for their projections, since they relied on Valence, only four work days to complete his project.... who, according to the complaint, ‘intentionally and [Macdonald admitted that] his analysis was less than recklessly misled securities analysts as part of the satisfactory, involving only a review of technical plan and scheme to inflate artificially the market documents primarily supplied to him directly by price of Valence's common stock.’ ” In re Valence Valence or indirectly through Montgomery Technology Sec. Litig., [1995 Transfer Binder] management ... Macdonald, however, was not Fed.Sec.L.Rep. (CCH) ¶ 98,793 at 92,794. permitted to perform any independent testing of the To allege fraud with particularity, a plaintiff must set Valence prototypes or the competing batteries. forth more than the neutral facts necessary to identify *7 [When] Macdonald began drafting his report to the transaction. The plaintiff must set forth what is Montgomery of his assessment ... he had no false or misleading about a statement, and why it is independent knowledge of the performance false. In other words, the plaintiff must set forth an characteristics of the Valence battery nor the explanation as to why the statement or omission composition of its electrolyte, which Valence complained of was false or misleading. A plaintiff heralded as a revolutionary technological might do less and still identify the statement breakthrough. complained of, indeed, the plaintiff might do less and still set forth some of the circumstances of the fraud. Third Am.Compl. ¶ ¶ 67-68. Plaintiffs allege that But the plaintiff cannot do anything less and still Macdonald communicated his concerns about the comply with Rule 9(b)'s mandate to set forth with foundations for his conclusions, deleted his earlier particularity those circumstances which constitute the assessment that sufficient data existed to permit a fraud. meaningful analysis of Valence's battery and competitors' technology, and cautioned Montgomery In re GlenFed, Inc. Securities Litig., 42 F.3d 1541, that laboratory-based evaluations were warranted. 1548 (9th Cir.1994) (en banc). Plaintiffs also allege that Montgomery was aware of, but ignored, Macdonald's concerns and refused to Defendant also contends that although Plaintiffs give him the opportunity to conduct further expand on their allegations about Montgomery's laboratory-based analysis, but directed Macdonald to technical consultant, Dr. Digby Macdonald, these review the IPO prospectus for technical accuracy. allegations merely state that Macdonald, as well as Finally, Plaintiffs allege that Macdonald had another Montgomery relied upon Valence, and thus these opportunity to undertake independent analysis when allegations do not rectify the pleading deficiencies he visited Valence's facilities on April 11, 1992, but Judge Conti previously identified in his May 8, 1995 the testing was conducted under Valence's control. order. In re Valence Technology Sec. Litig., [1995 Third Am.Compl. ¶ ¶ 69-71. Transfer Binder] Fed.Sec.L.Rep. (CCH) ¶ 98,793 at 92,794. In that order, Judge Conti determined that Montgomery argues that even if Macdonald stated “[i]t [does] not necessarily follow that because that the data he was to analyze was “of unknown Valence knew all along of insurmountable quality and uncertain foundation,” that Plaintiffs have technological problems, Montgomery was aware of not alleged that Macdonald knew that any of this data and participated in the fraud.” Id. at 92795 (citing In on which he based his analysis was fraudulent. re VeriFone Sec. Litig., 784 F.Supp. 1471, 1481 Plaintiffs respond that “the Complaint's specific (N.D.Cal.1992), aff'd 11 F.3d 865 (9th Cir.1993)). allegations regarding Montgomery and Alex. Brown Judge Conti then held that although Plaintiffs alleged demonstrate their own knowing or reckless disregard that the underwriters had failed in their due diligence for the truth about Valence and their active efforts to discover the problems or chose to disregard participation in promoting false and misleading them, that these allegations lacked the specificity statements to the investment community.” Plaintiffs' required by Federal Rule of Civil Procedure 9(b). Id. Opposition p. 19 (emphasis in original). Plaintiffs' at 92,795. allegations, however, merely conclude that Montgomery and Alex. Brown were reckless. In the TAC, Plaintiffs allege that: Alleging that Montgomery did not have a reasonable On or about February 24, 1992, Montgomery retained basis for the statements in the reports is not the same Dr. Digby Macdonald ostensibly to assist in a review as alleging facts which show that Montgomery knew, of Valence's battery project and a comparison with for example, that Valence's assurances were competing battery technologies. Notwithstanding deceptive. The Court need not accept legal the many technical and performance aspects such a conclusions asserted in the complaint even if pled as

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“facts.” Papasan v. Allain, 478 U.S. 265, 286 In re Apple, 886 F.2d at 1113 (citing Marx v. (1986). Computer Sciences Corp., 507 F.2d 485, 490 (9th Cir.1974)). Moreover, as in the first amended complaint, Plaintiffs continue to allege that: The statements at issue are contained in paragraphs In writing their reports about Valence, these analysts 64, 91 and 97. Paragraph 64 refers to a May 28, relied in substantial part upon information provided 1992 report by Montgomery which indicates that by and statements and reports made publicly by Valence has developed and is in the early [Valence], information provided privately to them by manufacturing stage of the battery and that it utilizes [Valence], and assurances by [Valence] (and in a solid polymer electrolyte. Plaintiffs allege that Montgomery's case, further assurances channeled statements in Paragraph 64 are false because Valence through the ill-founded work of an “independent” never used a solid polymer electrolyte. Plaintiff also battery consultant) that information in the analysts' contends that the cost of the raw materials alone reports was not at material variance from [Valence's] exceeds the report's estimate for the entire finished internal knowledge of its operations and prospects. battery.

Third Am.Compl. ¶ 53. Thus, as in the first Paragraph 91 refers to Montgomery's March 1, 1993 amended complaint, Plaintiffs allege in the TAC that report which stated that Valence's lithium polymer the analysts and underwriters relied upon Valence, battery technology is the “leader” in the rechargeable which allegedly assured them that the reports were battery market, that the product has the best price- accurate. Accordingly, the Court agrees with performance characteristics of any technology Defendant Montgomery that Plaintiff has not cured Montgomery had reviewed, that Valence has met all the pleading deficiencies of the first amended investor expectations and should continue to do so. complaint as they have not alleged any additional Paragraph 97 refers to a September 8, 1993 facts to show that Montgomery lacked a reasonable Montgomery report which states that Valence had basis for the statements in the analyst reports or that received funding and technical validation from the reports were not issued in good faith. potential end-users of the battery and that Montgomery believed that Valence's longer-term outlook remains quite attractive. (2) Statements of Optimism Defendants, however, contend that Plaintiffs fail to *8 Defendant Montgomery contends that Plaintiffs plead any facts which suggest that Montgomery did cannot state a claim based on any of the portions of not have a reasonable basis for the statements in the Montgomery analyst reports quoted in the TAC, as reports. In fact, Plaintiffs continue to plead that the these passages are too vague and subjective to be analysts relied in substantial part on information actionable as a matter of law. Plaintiffs allege that provided by Valence and that Valence assured them three statements made by Montgomery are that “information in the analysts' reports were not at misleading even though they may appear to be material variance from [Valence's] internal merely general optimistic statements. Plaintiffs knowledge of its operations and prospects.” TAC ¶ correctly contend that “... projections and general 53. Plaintiffs were permitted to amend their expressions of optimism may be actionable under the complaint to specify why the underwriters lacked a federal securities laws.” In re Apple Computer Sec. reasonable basis for statements made in the report. Litig., 886 F.2d 1109, 1113 (9th Cir.1989), cert. In re Valence Technology Sec. Litig., [1995 Transfer denied, 496 U.S. 943 (1990) (citations omitted). The Binder] Fed.Sec.L.Rep. (CCH) ¶ 98,793 at 92,795. Ninth Circuit continued in Apple: Since that order, Plaintiffs have filed two A projection or statement of belief contains at least amendments; however, they still do not plead any three implicit factual assertions: (1) that the facts which tend to show that the underwriters' statement is genuinely believed, (2) that there is a reports lacked a reasonable basis at the time they reasonable basis for that belief, and (3) that the were made or were not issued in good faith. speaker is not aware of any undisclosed facts tending Accordingly, the Court hereby dismisses all to seriously undermine the accuracy of the statement. Plaintiffs' section 10(b) claims against the A projection or statement of belief is actionable to the underwriters to the extent that they are based on extent that one of these implied factual assertions is misstatements in analysts' reports. In re GlenFed, inaccurate. Inc. Securities Litig., 42 F.3d 1541, 1549 (9th Cir.1994) (en banc) (plaintiffs must “elaborate

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 134 of 163 Not Reported in F.Supp. Page 7 Not Reported in F.Supp., 1996 WL 37788 (N.D.Cal.) (Cite as: Not Reported in F.Supp.) circumstances contemporary to the alleged false statement to explain how and why the statement was Plaintiffs also allege that: misleading when made.” ... Montgomery continued to advance Macdonald's ill-founded “assessment” while knowing or recklessly disregarding the inaccuracy and falsity of the (3) Analyst Reports-Duty to Non-Clients statements and comparisons it generated. As a result, Valence was successful in selling its stock in *9 Defendants contend that Plaintiffs fail to state a the public offering. Montgomery also agreed to help claim under section 10(b) on Plaintiffs' theory that a orchestrate a multi-city “roadshow” shortly before brokerage firm is liable to the entire marketplace, the initial and follow-on public offerings, during rather than just to its own clients for omissions in its which it and Company officials traveled to several analyst reports. Montgomery contends that it cannot cities to present highly favorable information about be liable under section 10(b) for omissions in its the Company. Much of the misleading technical analyst reports unless it breached a duty that it owed information in these roadshows derived from to Plaintiffs. The Supreme Court has held that Macdonald's flawed work and his presentation to silence in connection with a purchase or sale of Montgomery salespersons in mid-April 1992. These securities may operate as a fraud, “[b]ut such liability presentations helped create a strong demand for the is premised upon a duty to disclose arising from a stock so that more shares could be sold at a higher relationship of trust and confidence between parties price, thus financially benefitting Montgomery, the to a transaction.” Chiarella v. United States, 445 Company, and ultimately the defendant insiders who U.S. 222, 230 (1980). sold their shares on the November, 1992 offering.

Plaintiffs do not allege that any named plaintiff was a *10 Third Am.Compl. ¶ 47. client of Montgomery or that any named plaintiff read or relied upon any statements in any of The Ninth Circuit has recently reaffirmed the Montgomery's analyst reports, nor do they allege that GlenFed standard for pleading in a securities fraud any of Montgomery's reports were issued to the action: general public. Instead, Plaintiffs contend that In a securities fraud action, a pleading is sufficient because Montgomery and Alex. Brown chose to under Rule 9(b) if it identifies the circumstances of speak to the investment community through their the alleged fraud so that the defendant can prepare an analysts' reports, that they accepted a duty to disclose adequate answer. This notice requirement is materially adverse facts. Plaintiffs do not cite any satisfied by allegations of the “time, place and nature competent authority to support this contention.FN5 of the alleged fraudulent activities.” When a Accordingly, the Court hereby dismisses these fraudulent statement is alleged, the ‘plaintiff must set allegations with prejudice. forth what is false or misleading abut [the] statement, and why it is false.’ In other words, the plaintiff must “set forth, as part of the circumstances b. Roadshow Presentation Allegations constituting fraud, an explanation as to why the disputed statement was untrue or misleading when The allegations in the first amended complaint as to made.” Thus GlenFed requires a plaintiff to plead Roadshow Presentations were dismissed because evidentiary facts and the court to consider what “[n]owhere in the complaint do plaintiffs mention the inferences these facts will support-despite the pitfalls time, place, date, or individual who made the and inefficiencies of such an analysis at the pleading misstatement during the roadshows. Plaintiffs also stage[ ] and whether they are sufficient to satisfy the fail to allege with specificity the exact misstatement.” specificity requirement of Rule 9(b) as interpreted by In re Valence Technology Sec. Litig., [1995 Transfer GlenFed. Binder] Fed.Sec.L.Rep. (CCH) ¶ 98,793 at 92,975. Fecht v. The Price Company, No. 93-55541, 1995 The TAC alleges that “Macdonald's inadequately U.S.App. LEXIS 32320, at *11 (9th Cir. Nov. 20, supported ‘conclusions' found their way into 1995). Valence's IPO and subsequent prospectuses and Montgomery's and Alex. Brown's analysts' statements The Ninth Circuit also held that and salespersons' pitches.” Third Am.Compl. ¶ 7. [a] plaintiff may also satisfy Rule 9(b) with This allegation plainly fails to meet the specificity allegations of circumstantial evidence if the requirements of Federal Rule of Civil Procedure 9(b). circumstantial evidence alleged explains how and

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 135 of 163 Not Reported in F.Supp. Page 8 Not Reported in F.Supp., 1996 WL 37788 (N.D.Cal.) (Cite as: Not Reported in F.Supp.) why the statement was misleading when made. Defendant Montgomery contends that the allegations Thus, when there is an intervening event which might that it participated in a “scheme to defraud” is merely account for the conflict between the alleged an attempt to state a cause of action for section 10(b) misrepresentation and the current state of facts ... a “aiding and abetting.” Defendant contends that plaintiff may satisfy Rule 9(b) by alleging aiding and abetting liability has been explicitly inconsistent contemporaneous statements indicating rejected by the Supreme Court in Central Bank of that the defendant knew all along that the earlier Denver v. First Interstate Bank of Denver, 511 U.S. statement was false, or by showing that the conflict 164, 114 S.Ct. 1439, 1448 (1994). Central Bank held does not merely result from the earlier statement's that there can be no cause of action for aiding and being based on a different but equally permissible abetting under section 10(b). Id. at 1446-48. business judgment. Many courts, including those in this district, have Id. at *12-13 (9th Cir. Nov. 20, 1995) (citing In re held that “conspiracy” or “scheme” allegations are GlenFed, Inc. Sec. Litig., 42 F.3d 1541, 1548-49 (9th not actionable under section 10(b) after Central Cir.1994) (en banc)).FN6 Plaintiffs argue in their Bank. See, e.g., Stack v. Lobo, 903 F.Supp. 1361 opposition that they have adequately alleged in (N.D.Cal.1995) (citing In re Syntex Corp. Sec. Litig., paragraph 47 that the roadshows were part of the 855 F.Supp. 1086, 1097 (N.D.Cal.1994); In re Defendants' scheme to defraud. However, the RasterOps Corp. Sec. Litig., [Current Transfer allegations are conclusory; they do not meet the Binder] Fed.Sec.L.Rep. (CCH) ¶ 98,467 at 91,195 specificity requirements of Federal Rule of Civil (N.D.Cal.1994); In re Ross Sec. Litig., [1994-1995 Procedure 9(b). FN7 The section 10(b) claims are Transfer Binder] Fed.Sec.L.Rep. (CCH) ¶ 98,363 at dismissed to the extent that they are based on 90,495 (N.D.Cal.1994)). Courts have dismissed roadshow allegations. claims alleged as “schemes” on the grounds that they were merely non-actionable conspiracy claims that had been recharacterized. See, e.g., In re Gupta Sec. c. “Scheme to Defraud” Allegations Litig., [Current Transfer Binder] Fed.Sec.L.Rep. (CCH) ¶ 98,612 at 91,783-34 (N.D.Cal.1994). The In Paragraphs 40 through 47 of the TAC, Plaintiffs Court also finds persuasive In re MTC Elec. allege what they term “The Scheme.” The Technologies Shareholders Litig., 898 F.Supp. 974 allegations in paragraphs 40 to 43 allege that (E.D.N.Y.1995), which concludes: “[I]f Central Valence, through its controlling shareholders, Bank is to have any real meaning, a defendant must “create[d] an aura of legitimacy” in order to promote actually make a false or misleading statement in the stock. Paragraph 47 contains Plaintiffs' order to be held liable under Section 10(b). roadshow allegations, which the Court has already Anything short of such conduct is merely aiding and determined are insufficient to state a claim. Other abetting, and no matter how substantial that aid may than the roadshow allegations, Montgomery is be, it is not enough to trigger liability under Section mentioned only in paragraphs 44 to 46, which allege 10(b).” Id. at 987. that Montgomery and Valence's controlling shareholder and top management agreed that Montgomery would act as the lead underwriter; that 2. Alex. Brown & Sons Montgomery issued favorable reports that helped to maintain the market price of the stock; that Defendant Alex. Brown joins in Montgomery's Montgomery agreed to do “follow-up” offerings; and arguments as to Plaintiffs' section 10(b) claims and that in return for their services, Montgomery additionally contends that Plaintiffs have failed to requested and received an indemnification agreement rectify the pleading inadequacies identified by Judge and liability insurance coverage from Valence. Conti in the first amended complaint. Specifically, These allegations are conclusory. The Court need Alex. Brown contends that Plaintiffs cannot allege not accept such allegations. In re VeriFone Alex. Brown's participation in fraud with the Securities Litig., 11 F.3d 865, 868 (9th Cir.1993); specificity required by Federal Rule of Civil Western Mining Council v. Watt, 643 F.2d 618, 624 Procedure 9(b) as required by the Ninth Circuit in In (9th Cir.1981), cert. denied, 454 U.S. 1031 (1981). re GlenFed, Inc. Sec. Litig., 42 F.3d 1541 (9th Cir.1994) (en banc). *11 Even if the Court were to draw an inference that these allegations constitute a claim of conspiracy or scheme to defraud, the claim must still be dismissed. a. Analyst Reports

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Court agrees that the language in the TAC as to Alex. Alex. Brown argues that the allegations in the TAC Brown is conclusory and thus fails to state a claim. are almost identical to those dismissed by Judge Although Plaintiffs have added language to what was Conti in his May 8, 1995 order as too conclusory to paragraph 104 of the first amended complaint, state a claim. In particular, Alex. Brown argues that Paragraph 114 of the TAC does not allege the only statement directly attributed to it in the TAC evidentiary facts as required by GlenFed. is “a two line excerpt from Alex. Brown's January 26, 1994 analyst report [and this is] language that Judge The allegations in the TAC as to Alex. Brown still Conti has already held could not support a section fail to set forth what is false or misleading about the 10(b) claim.” The TAC contains two paragraphs statement and why it is false. There are no facts relating to Alex. Brown's analyst report. Paragraph upon which the court may draw inferences. Fecht v. 117 states: The Price Company, No. 93-55541, 1995 U.S.App. *12 On January 26, 1994, Alex. Brown issued a LEXIS 32320, at *11 (9th Cir. Nov. 20, 1995); In re report based on information furnished by Valence GlenFed, Inc. Sec. Litig., 42 F.3d 1541, 1548-49 (9th management. Alex. Brown initiated coverage of Cir.1994) (en banc). Moreover, despite having Valence with a “buy” recommendation, citing a several opportunities to add facts to their pleadings to “Large Profit Opportunity.” The report stated: support their claims against Alex. Brown, Plaintiffs [W]e expect the Company to turn profitable in F4Q have failed to do so. Accordingly, the Court hereby 1995, with EPS of $.02. Our FY1996 estimate of dismisses with prejudice all section 10(b) allegations $2.00 reflects ... that [the Company] should begin to against Defendant Alex. Brown that are based on generate large production volumes in the F4Q 1995. misrepresentations contained in analysts reports.

Paragraph 117 of the TAC is identical to paragraph b. Roadshow Presentation Allegations 104 of the FAC. Judge Conti has already determined that this language is not sufficient to state a claim as *13 The TAC's allegations as to Defendant Alex. Plaintiffs failed to specify why Alex. Brown lacked a Brown are conclusory and fail to meet the specificity reasonable basis for the statement or why the report requirements of Federal Rule of Civil Procedure 9(b). was issued in bad faith. In re Valence Technology Alex Brown was involved only in one follow-on Sec. Litig., [1995 Transfer Binder] Fed.Sec.L.Rep. offering and Plaintiffs have pleaded no facts which (CCH) ¶ 98,793 at 92,795. suggest a connection between Alex. Brown and the alleged misstatements at roadshows. As stated Paragraph 114 of the TAC states: above, despite having many opportunities to add facts Having chosen to avoid discovering and then to their pleadings to support their claims against disclosing the readily apparent problems listed above, Alex. Brown, Plaintiffs have failed to do so. the underwriters apparently felt no constraint about Accordingly, the Court hereby dismisses with what could and would be said about Valence, thereby prejudice all section 10(b) claims against Defendant allowing known false statements to continue to be Alex. Brown which are based on roadshow circulated. For example, Alex. Brown initiated allegations. coverage of Valence on January 19, 1994 by issuing a “buy” rating to further the scheme and course of conduct complained of herein. However, this rating c. “Scheme to Defraud” Allegations turned on false and misleading descriptions of the Valence battery's performance capabilities, its The scheme to defraud allegations against Defendant purported safety, and unfounded and unreasonable Alex. Brown are not alleged with the specificity projections for revenues equaling $500 million by required by Federal Rule of Civil Procedure 9(b). fiscal year 1996. See ¶ ¶ 66-74, 79. Alex. Brown's Plaintiffs have had several opportunities to amend willful ignorance and reckless disregard of the truth their allegations against Alex. Brown and have failed allowed it to headline its report with the false promise to allege Alex. Brown's participation in fraud with the of “Large Profit Opportunity From A Better Battery.” specificity required by the Ninth Circuit in In re GlenFed, Inc. Sec. Litig., 42 F.3d 1541 (9th Cir.1994) (en banc). In any event, as set forth above, such Alex. Brown contends that Plaintiffs still have not allegations fail to state a claim after Central Bank. identified any statements by Alex. Brown as false or Accordingly, the Court dismisses with prejudice all misleading, or why such statements are false. The allegations against Alex. Brown based on a scheme to

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 137 of 163 Not Reported in F.Supp. Page 10 Not Reported in F.Supp., 1996 WL 37788 (N.D.Cal.) (Cite as: Not Reported in F.Supp.) defraud. Litig., 12 F.3d 922, 933 (9th Cir.1993), cert. denied, 513 U.S. 917, 115 S.Ct. 295 (1994) and Hanon v. Dataproducts Corp., F.2d 497, CONCLUSION 504 (9th Cir.1992). However, these cases do not address the issue of liability grounded The Court hereby GRANTS Defendant Montgomery upon analyst statements. Securities' motion to dismiss and GRANTS Defendant Alex. Brown & Sons' motion to dismiss. FN6. Plaintiffs filed a statement of recent All claims against Defendants Montgomery and decision, directing the Court's attention to Defendant Alex. Brown are hereby DISMISSED this recent Ninth Circuit case. WITH PREJUDICE. FN7. The court rejects Plaintiffs' argument IT IS SO ORDERED. that the roadshow presentations are “closely guarded secrets.” Defendants correctly point out that if the information is not FN1. Defendant Valence Technology, Carl disclosed, Plaintiffs can not contend that any E. Berg, Calvin L. Reed, Christine A. allegedly misleading statements could affect Russell and Lev M. Dawson have joined in the market price of Valence stock. In any Montgomery Securities and Alex. Brown & event, the paragraphs referring to roadshows Sons' Motion to Dismiss Plaintiffs' claims in the TAC fail even to set forth the content for violation of Section 12(2) of the of the alleged misstatements. Securities Act of 1933. Defendant Alan F. Plaintiffs also argue that they have obtained Shugart has joined Defendant Montgomery “various scripts, repeating numerous Securities' Motion to Dismiss Plaintiffs' falsehoods highlighted in the complaint, Third Amended Complaint. Also, [which] evidence that the roadshows were Defendant Alex. Brown & Sons and designed to further the fraud.” Plaintiffs Defendant Montgomery Securities join in represent that they attach this material to a each others' motions. declaration in support of their opposition. However, on a motion to dismiss, the Court FN2. The background is taken from The may not consider these documents. Honorable Samuel Conti's September 19, “Generally, a district court may not consider 1995 order. any material beyond the pleadings in ruling on a Rule 12(b)(6) motion.” Hal Roach FN3. Valence has since abandoned its Studios, Inc. v. Richard Feiner & Co., 896 efforts to create this solid polymer-based F.2d 1542, 1555 n. 19 (9th Cir.1990). The battery, refocusing its research and Court will not consider the material filed by development efforts on different technology. Plaintiffs, as it declines to treat this motion as one for summary judgment. See FN4. Christine A. Russel, Chief Financial Fed.R.Civ.P. 12(b)(6). Officer; Dale R. Schackle, Vice President N.D.Cal.,1996. and Chief Technical Officer; David M. In re Valence Technology Securities Litigation Butze, Vice President, Marketing; William Not Reported in F.Supp., 1996 WL 37788 (N.D.Cal.) J. Masuda, Vice President, Operations; Calvin L. Reed, one-time Chairman of the Briefs and Other Related Documents (Back to top) Board of Directors, Chief Executive Officer, and Chief Operating Officer; Carl E. Berg, • 5:95CV20459 (Docket) (May. 03, 1994) who helped found Valence and member of the Board of Directors since September END OF DOCUMENT 1991; Lev. M. Dawson, founder and Chief Executive Officer until April 1993, Chairman of the Board of Directors until October 1993; and Alan F. Shugart, outside director since March 1992.

FN5. Plaintiffs cite In re Wells Fargo Sec.

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denies the motions of Scotia and Defendants Briefs and Other Related Documents McGuire and Hale.

United States District Court, S.D. New York. In Re WRT ENERGY SECURITIES LITIGATION FN1. Plaintiffs have also requested No. 96 CIV. 3610(JFK), 96 CIV. 3611(JFK). permission to communicate with persons who purchased senior notes of WRT Energy March 31, 1999. Corporation in the February 1995 public offering of such notes, and requested that the Court regulate communications between Milberg Weiss Bershad Hynes & Lerach LLP, New certain class members and Goldin York, Of Counsel: David Bershad, Esq., Richard H. Associates, L.L.C, the Liquidation Trustee Weiss, Esq., Kim E. Miller, Esq., Baskin, Bennett & in the WRT bankruptcy. The parties, by Komkov, L.L.P., Austin, TX, Of Counsel: James D. letters dated February 19, 1999 and March Baskin, Esq., Leon V. Komkov, Esq., David B. Kahn 1, 1999, have informed the Court that a & Associates, Ltd., Northfield, Of Counsel: David B. decision issued on January 22, 1999 by the Kahn, Esq., Mark E. King, Esq. , Henry F. Field, Bankruptcy Court for the Western District of Ltd., Chicago, IL, Of Counsel: Henry F. Field, Esq. , Louisiana has mooted these requests. The for Plaintiffs. Court, therefore, will not address these Well, Gotshal & Manges LLP, New York, Of applications. Counsel: Joseph S. Allerhand, Esq., Beth J. Jacobwitz, Esq., for Defendants Oppenheimer & Co., BACKGROUND Inc. Cadwalader, Wickersham & Taft, New York, Of This is an action brought on behalf of a putative class Counsel: Dennis J. Block, Esq., for Defendant of individuals who purchased securities of WRT Schroder Wertheim & Co., Incorporated. Energy Corporation (“WRT”), a now-bankrupt oil FN2 Miller & Wrubel P.C., New York, Of Counsel: and gas producer, during the period from October Martin D. Edel, Esq., Porter & Hedges, L.L.P., 20, 1993 through October 27, 1995 (the “Class Houston, TX, Of Counsel: Mark K. Glasser, Esq., for Period”). During the time period at issue in this Defendants Steven S. McGuire, Samuel C. Guy, action, McGuire was Chairman of the Board and Ronald E. Hale, Jr., Dominic Man-Kit Lam, and Chief Executive Officer of WRT, Guy was a Director James T. Rash. of WRT and its Executive Vice President, Hale was Lane & Mittendorf LLP, New York, Of Counsel: WRT's Chief Financial Officer, and Lam and Rash Robert J. Luddy, Esq. , Leonard Violi, Esq., for were Directors of WRT. Defendants Oppenheimer Defendant The Scotia Group, Inc. and Schroder were co-underwriters of an offering of WRT securities, acted as market makers in those OPINION AND ORDER securities, and served as analysts of WRT securities. KEENAN, District J. Defendant Scotia is a petroleum engineering firm *1 Before the Court are the motions to dismiss the which prepared an estimate of WRT's oil and gas Third Amended Consolidated Class Action reserves in connection with various offerings of WRT Complaint pursuant to Fed.R.Civ.P. 12(b)(6) and securities during the Class Period. 9(b), of defendants Steven S. McGuire, Samuel C. Guy, Ronald E. Hale, Jr., Dominic Man-Kit Lam, and James T. Rash (collectively, the “Individual FN2. On February 14, 1996, WRT filed a Defendants”); defendants Oppenheimer & Co., Inc. voluntary petition for bankruptcy in the (“Oppenheimer”) and Schroder Wertheim & Co. United States Bankruptcy Court for the Incorporated (“Schroder”) (collectively, the Western District of Louisiana. By Order “Underwriter Defendants”); and The Scotia Group, dated March 24, 1997, the Court severed Inc. (“Scotia”).FN1 For the reasons set forth below, the from this action all claims asserted against Court now grants the motions of the Underwriter WRT. Defendants and Defendants Guy, Lam, and Rash, but

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Plaintiffs commenced these consolidated actions on reserves of oil and gas. Generally, Plaintiffs claims of December 18, 1995 by filing two separate class wrongdoing by Defendants fall into seven categories: action complaints in the United States District Court (1) the overstatement and/or exaggeration of the for the Southern District of California. Those actions success WRT had in its revitalizing activities, a core subsequently were consolidated by Stipulation and aspect of WRT's business; (2) the misrepresentation Order dated May 2, 1996, and transferred to this of the technological capacities WRT had at its Court by Order of United States District Judge Barry disposal; (3) the overstatement of WRT's reserves in T. Moskowitz dated May 7, 1996. oil and gas; (4) the overstatement of WRT's net worth during the Class Period; (5) the misrepresentation of Plaintiffs filed an Amended Complaint on July 26, the capabilities of WRT's management; (6) WRT's 1996. On October 25, 1996, they filed a Second “looting” of corporate funds; and (7) WRT's inflated Amended Complaint with the consent of all parties representations about WRT's future performance. See for the sole purpose of adding Scotia as a defendant. Compl. ¶ 29. Plaintiffs also claim that WRT's The Second Amended Complaint was dismissed by financial statements were not prepared in accordance Order and Opinion on September 9, 1997, but with Generally Accepted Accounting Principles Plaintiffs were given leave to replead. (“GAAP”). See id. ¶ ¶ 90-102.

The Third Amended Consolidated Class Action In total, Plaintiffs identify nearly thirty documents in Complaint (the “Complaint”), dated October 24, which these allegedly misleading statements were 1997, alleges the following claims against made. These include: (1) press releases dated Defendants: (1) that Defendants violated § 10(b) of November 22, 1993, April 7, 1994, April 14, 1994, the Securities Exchange Act of 1934 (the “1934 May 17, 1994, August 2, 1994, November 1, 1994, Act”), and Rule 10b-5 of the rules promulgated by January 5, 1995, April 11, 1995, May 10, 1995, and the Securities Exchange Commission (“SEC”) May 31, 1995, see id. ¶ ¶ 33, 36, 37, 38, 42, 44, 51, thereunder; (2) that the Individual Defendants 68, 70, 72; (2) prospectuses and registration violated § 20(a) of the 1934 Act; (3) that Defendants statements issued in October 1993, January 1994, violated § 11 of the Securities Act of 1933 (the December 1994, and February 1995, see id. ¶ ¶ 30- “1933 Act”) in connection with the offering of Senior 32, 34, 48-49, 53-62; (3) reports to WRT Notes in February 1995 (the “Senior Notes shareholders in March 1994 and May 1995, see id. ¶ Offering”); (4) that the Individual Defendants ¶ 35, 69; (4) SEC filings dated April 14, 1994, May McGuire and Hale violated § 11 of the 1933 Act in 20, 1994, August 12, 1994, November 14, 1994, connection with an offering of preferred stock in March 31, 1995, May 12, 1995, and August 14, 1995, October 1993; (5) that the Underwriter Defendants see id. ¶ ¶ 37, 39, 42, 46, 64-65, 71, 76; (5) violated § 12(a)(2) of the 1933 Act in connection statements by defendant McGuire on July 29, 1994 with the Senior Notes Offering; and (6) that the and October 2, 1995, see id. ¶ ¶ 41, 77; (6) Individual defendants violated § 15 of the 1933 Act. statements and reports by Schroder dated September 23, 1994, November 4, 1994, November 28, 1994, *2 The facts alleged in the Complaint, accepted as January 13, 1995, and April 7, 1995, see id. ¶ ¶ 43, true for purposes of the instant motions, are as 45, 47, 52, 67; (7) reports by Oppenheimer dated follows. WRT was an oil and gas producer which March 6, 1995, April 4, 1995, June 14, 1995, and specialized in acquiring and revitalizing “mature” oil June 29, 1995, see id. ¶ ¶ 63, 66, 74, 75; and (8) and gas fields located primarily in Southern public announcements by WRT on November 28, Louisiana. WRT claimed that it could exploit the 1994 and December 20 and 29, 1994. See id. ¶ ¶ 47, natural resources in these fields, where previous 50. owners had failed, through the use of unique technology used to revitalize non-productive oil and Chronologically, the alleged misrepresentations and gas wells. omissions described in the Complaint are as follows. On October 20, 1993, WRT commenced a public Plaintiffs claim that during the Class Period the offering of approximately 1.1 million shares of Individual and Underwriter Defendants issued a preferred stock at $25 per share, for which WRT series of positive statements concerning the business received more than $25 million in proceeds. See id. ¶ and operations of WRT that were false and 30. Plaintiffs claim that the Prospectus and misleading, and for which there was no reasonable Registration Statement for this offering falsely stated basis. The claims against Scotia stem from certain that WRT had “demonstrate[d] its ability to use its reports Scotia prepared that estimated WRT's technology to find previously untapped reservoirs in

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 140 of 163 Not Reported in F.Supp.2d Page 3 Not Reported in F.Supp.2d, 1999 WL 178749 (S.D.N.Y.), Fed. Sec. L. Rep. P 90,456 (Cite as: Not Reported in F.Supp.2d) shut-in or abandoned wells and return such wells to gas reserves and production from mature oil fields .... commercial production”; that WRT used “advanced Our estimate for 1995 cash flow is $2.85 per share ...... production practices to increase production rates”; There currently are no other companies that we are that “its technology-based approach” gave it an aware of that can realize the same value as WRT in “advantage” over other oil and gas producers; that their targeted acquisitions. WRT was “the only oil and gas producer in the United States that own[ed] and operate[d] a complete Id. ¶ 43. In a November 4, 1994 report, Schroder set of radioactive logging tools and also ha[d] in- again stated that WRT had been using “proven and house capacity to re-evaluate previously completed proprietary technologies to increase oil and gas wells using such technology”; and that WRT had reserves and production from mature oil fields.” Id. ¶ “significantly improved production rates in many of 45. Plaintiffs claim that these statements began after the wells” on which it had applied its technologies. Schroder and WRT entered into a “financial Id. ¶ 31. The Prospectus also “spoke glowingly” advisory” agreement in July 1994.FN3 Id. ¶ 43. about the qualifications of WRT's management, and overstated WRT's proved oil and gas reserves as of December 31, 1992. The data concerning WRT's FN3. These claims concerning Schroder's reserves were derived from a report prepared by statement are typical of Plaintiffs' claims Scotia. Id. ¶ 32. against Schroder, and therefore the Court will not list all of Plaintiffs' claims *3 In January 1994, WRT again raised capital concerning statements made by Schroder. through an offering of 806,000 shares of WRT common stock which yielded more than $8,000,000. In December 1994, WRT publicly offered for sale The Prospectus for this offering falsely stated that another 489,500 shares of WRT common stock. WRT had successfully employed “advanced Plaintiffs claim that the Prospectus for that offering technologies to increase production rates” in repeated many of the previous claims about the abandoned wells, misrepresented the quality of success of WRT's technology, but failed to warn WRT's management, and again overstated its reserves investors that WRT's “advanced” “proprietary” based on a report prepared by Scotia. Id. ¶ 34. technologies already were failing. Id . ¶ ¶ 48-49. The Prospectus also included Scotia's statement of WRT's Plaintiffs claim that WRT's misrepresentations proved oil and gas reserves as of December 31, 1993, continued throughout 1994. WRT repeatedly which Plaintiffs allege were overstated. Id. ¶ 48. emphasized its success due to its “proprietary technologies” in its 1993 annual report to The crux of Plaintiffs' allegations stem from WRT's shareholders, id. ¶ 35; a May 17, 1994 WRT press Senior Notes Offering. On February 28, 1995, WRT release, id . ¶ 38; and a July 29, 1994 statement over commenced a public offering of 100,000 Units, each the Dow Jones newswire. Id. ¶ 40. In the Dow Jones consisting of $1,000 principal amount of Senior newswire, defendant McGuire stated: “We have over Notes and eight Warrants. Oppenheimer and 90% success rates of bringing wells back to life.” Id. Schroder acted as co-underwriters for this offering In an April 7 press release, WRT overstated its and participated in drafting the Prospectus. reserves. Id. ¶ 36. WRT's annual report, filed on April 14, and its quarterly reports, filed on May 20, *4 Plaintiffs allege that the Prospectus and August 12, and November 14, falsely stated that registration statement filed in connection with the WRT's net worth was close to $50 million, at a time Senior Notes Offering contain misrepresentations that when WRT's financial situation was “extremely cover all aspects of WRT's wrongful conduct. The precarious.” Id. ¶ ¶ 39, 42, 46. The quarterly reports Prospectus misrepresents WRT's technological were signed by Defendants McGuire and Hale, and methods and success. It falsely stated that “[w]ells McGuire, Hale, and Guy signed the annual report. that have been shut-in or abandoned” are re-entered with “technologically advanced” equipment and that Plaintiffs claim that on September 23, 1994, “[a]pplication of the Company's technologies ... has Defendant Schroder issued a report which stated, resulted in substantial increases in overall production without any reasonable basis, that: rates, oil and gas reserves and cash flow ... [and] the WRT Energy is the first of a new breed of Company has had an 84% success rate in identifying independent oil and gas producers that focus on and developing commercial oil and gas reserves in innovative production technology. The company shut-in wells.” Id. ¶ ¶ 53-54. Plaintiffs claim that the employs proprietary technology to increase oil and unrevealed reality, however, was that the “majority of

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 141 of 163 Not Reported in F.Supp.2d Page 4 Not Reported in F.Supp.2d, 1999 WL 178749 (S.D.N.Y.), Fed. Sec. L. Rep. P 90,456 (Cite as: Not Reported in F.Supp.2d) the[ ] well revitalization efforts were failures because they did not pay back the costs of the revitalization Id. ¶ 66. efforts.” Id. ¶ 54. In actuality, only 40% of the revitalization efforts were successful. Id. The Cracks in the fabric of WRT started to surface in the Prospectus also overstated the use and success of spring of 1995. Despite the onset of bad news, WRT's vaunted hydrocyclone technology. Id. ¶ 55. however, Defendants portrayed a positive outlook on Plaintiffs claim that three internal memoranda WRT to the public. In a May 10, 1995 press release, prepared by Scotia personnel, dated June 2, 1994, McGuire reported that WRT's results for the first February 1995, and July 17, 1995, see id. ¶ 3, and an quarter of 1995 were below expectations because of examination of WRT's reserve reports, see id. ¶ 83, “delays [of acquisition closings] combined with a confirm these claims. one-time financing charge of $800,000.” Id. ¶ 70. WRT stated, however, that it “look[ed] forward to The registration statement filed in connection with significant increases in quarterly oil and gas the Senior Notes Offering contained estimates of production.” Id. On June 29, 1995, Oppenheimer WRT's oil and gas reserves as of September 30, 1994. reported that recent weakness in the price of WRT Plaintiff's claim that these estimates prepared by securities should be regarded “as a purchase Scotia were materially overstated, as evidenced by opportunity.” Id. ¶ 75. On October 2, 1995, the fact that on April 6, 1996 WRT was forced to responding to a drop in the price of WRT securities, reduce its estimated reserve figures by 100%. See id. McGuire announced that “the Company knows no ¶ ¶ 58-59. reason for the precipitous decline in the value of its equity securities.” Id. ¶ 77. Plaintiffs allege that the materials filed in connection with the Senior Notes Offering contained other On October 27, 1995, in stark contrast to other misrepresentations and critical omissions. The statements made concerning WRT's business materials did not reveal that WRT was receiving less prospects, WRT announced that “it would implement than full market value for the gas and oil it sold, ‘cost reduction programs' and evaluate the ‘liquidity thereby jeopardizing the financial well-being of issues' then facing the Company.” Id. ¶ 78. Based on WRT. Id. ¶ 56. Plaintiffs claim that due to, inter alia, these revelations, WRT's stock price declined “bogus” accounting methods, see id. ¶ ¶ 90-102, the sharply. See id. ¶ 79. materials vastly overstated the net worth of WRT. Id. ¶ 60. The materials also promoted the talents of Throughout 1995, WRT had filed with the SEC the WRT's management team. Id. ¶ 61. Plaintiffs further 1994 annual report and the requisite quarterly reports claim that despite WRT's “looting of millions of for 1995. These filings all represented that WRT had dollars of WRT's funds,” the materials advised a net worth of over $50 million. On November 14, investors that the proceeds of the Senior Notes 1995, WRT issued its quarterly report, which was Offering would be used to purchase additional oil and signed by Hale. The report disclosed that “it is gas properties and to repay WRT's debt. Id. ¶ 62. unlikely that [WRT] will have sufficient cash to meet the ... interest payment on the Senior Notes,” that Less than one month after underwriting WRT's WRT doubted if it could continue as a “going Senior Notes Offering, Oppenheimer initiated concern” if current conditions persisted, and that coverage on WRT with an “analyst's buy” rating. McGuire and Guy had resigned on November 10, This began a series of statements and analyst reports 1995. Id. ¶ 80. by Oppenheimer that, similar to Schroder's reports, contained alleged misstatements concerning the On April 5, 1996, WRT issued a press release WRT's technology and its prospects for growth. acknowledging that a reexamination of its oil and gas These statements and reports are listed above. For reserves by an outside engineering firm showed that example, on April 4, 1995, Oppenheimer issued a its reserves had been more than 100% overstated and report stating the following: had to be reduced accordingly. See id. ¶ 81. WRT's *5 [W]e believe WRT shares deserve to carry a 1995 annual report, filed on June 12, 1996, revealed premium multiple to reflect the following that shareholders' equity was a negative $62 million competitive advantage: .... Technology Leadership. as of December 31, 1995, which was more than $100 Utilizing proprietary research, the company has million less than the approximately $50 million developed well logging and high volume water equity figure represented's in WRT's quarterly report extraction technologies. This allows the company to for the quarterly period ending September 30, 1995. significantly increase production and reserves .... See id. ¶ 82.

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the Court's duty is to assess the legal feasibility of the complaint rather than to weigh the evidence that DISCUSSION might be offered in support thereof. See, e.g., Geisler v. Petrocelli, 616 F.2d 636, 639 (2d Cir.1980). Defendants move to dismiss Plaintiffs' claims against Accordingly, the Court accepts Plaintiffs' factual them under Fed.R.Civ.P. 12(b)(6) for failure to state allegations as true and draws all reasonable a claim and on Fed.R.Civ.P. 9(b) grounds for failure inferences in Plaintiffs' favor. See Cooper v. Pate, to plead fraud with particularity. The Court first 378 U.S. 546 (1964). Therefore, Defendants' motions addresses the viability of Plaintiffs' claims under the should be granted only if it appears beyond doubt that 1933 Act and then turns to Plaintiffs' 1934 Act Plaintiffs can prove no set of facts in support of their claims. claims which would entitle them to relief. See Scheuer v. Rhodes, 416 U.S. 232, 236 (1974) (citing Conley v. Gibson, 355 U.S. 41, 45-46 (1957)). I. Plaintiffs' 1933 Act Claims § 10(b) of the 1934 Act provides that “[i]t shall be *6 In the Court's previous Order and Opinion, the unlawful for any person, directly or indirectly by use Court dismissed the claims under § § 11 and 12 of of any means or instrumentality ... [t]o use or employ, the 1933 Act because Plaintiffs did not plead that in connection with the purchase or sale of any they purchased the WRT securities in question during security ... any manipulative or deceptive device.” 15 an initial offering. Therefore, Plaintiffs did not have U.S.C. § 78j(b). Rule 10b-5 prohibits any “artifice to standing under § § 11 or 12 of the 1933 Act. The § defraud or any act which would operate as a fraud or 15 claim under the 1933 Act was also dismissed deceit upon any person, in connection with the because that was dependent on the viability of the purchase or sale of any security.” 17 C.F.R. underlying § § 11 and 12 claims. Plaintiffs have not cured their pleading deficiencies, but nevertheless § 240.10b-5(a), (c). § 10(b) and Rule 10b-5 were have included in the Complaint nearly identical designed as catch-all clauses for fraudulent practices. claims under the 1933 Act to preserve their rights. See Chiarella v. United States, 445 U.S. 222, 226 The Court hereby dismisses the 1933 Act claims for (1980). To state a claim under § 10(b) and Rule 10b- the same reasons they were dismissed in the Court's 5, “a plaintiff must plead that ‘in connection with the previous Order and Opinion. purchase or sale of securities, the defendant, acting with scienter, made a false representation or omitted to disclose material information and that plaintiff's II. Plaintiffs' 1934 Act Claims reliance on defendant's action caused [plaintiff] injury.” In re Time Warner Inc. Sec. Litig., 9 F.3d at Plaintiffs also assert § 10(b) and Rule 10b-5 claims 264 (quoting Bloor v. Carro, Spanbock, Londin, against Defendants. These claims are based on the Rodman & Fass, 754 F.2d 57, 61 (2d Cir.1985)); see allegedly false and misleading statements described also Royal American Managers, Inc. v. IRC Holding in the Complaint.FN4 Defendants move to dismiss Corp., 885 F.2d 1011, 1015 (2d Cir.1989). these claims for failure to state a cause of action under Fed.R.Civ.P. 12(b)(6) and for failure to plead fraud with the particularity required by Fed.R.Civ.P. 1. The Individual Defendants' and Underwriter 9(b). The Court addresses the motions to dismiss the Defendants' Motions § 10(b) and Rule 10b-5 claims in turn below. *7 The Court, in its previous Order and Opinion in this matter, found that Plaintiffs alleged sufficiently FN4. As Defendants concede, the Private the elements of a § 10(b) and Rule 10b-5 claim Securities Litigation Reform Act of 1995 based on the false and misleading statements made does not apply to this action because the Act by these parties. See In re WRT, 96 Civ. 3610, 96 was passed several days after Plaintiffs filed Civ. 3611(JFK), Order and Opinion, Sept. 9, 1997, their initial complaints in these consolidated slip op. at 19-26. The Court finds that in the actions. Complaint Plaintiffs similarly plead the elements of a § 10(b) and Rule 10b-5 claim against the Individual A. Defendants' Rule 12(b)(6) Motions Defendants and the Underwriter Defendants. Although Plaintiffs have added specificity to their When presented with a Fed.R.Civ.P. 12(b)(6) motion, allegations in constructing this fourth version of their

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 143 of 163 Not Reported in F.Supp.2d Page 6 Not Reported in F.Supp.2d, 1999 WL 178749 (S.D.N.Y.), Fed. Sec. L. Rep. P 90,456 (Cite as: Not Reported in F.Supp.2d) complaint, they have not added any new Cir.1994) (“[T]he inclusion of general cautionary misstatements made by the Underwriter or Individual language regarding a prediction would not excuse the Defendants. Therefore, the misstatements or alleged failure to reveal known material, adverse omissions that were pleaded sufficiently in the facts.”); Eckstein v. Balcor Film Investors, 8 F.3d Second Amended Complaint are pleaded sufficiently 1121, 1127 (7th Cir.1993) (“A prospectus stating a in the Third Amended Complaint. The success of the risk that such a thing could happen is a far cry from Underwriter and Individual Defendants' motions will one stating that this had happened. The former does once again turn on whether Plaintiffs have pleaded not put an investor on notice of the latter.”), cert. scienter with the specificity required by Rule 9(b). denied, 510 U.S. 1073 (1994); In re Prudential Sec. Inc. Ltd. Partnerships Litig., 930 F.Supp. at 72 (“[C]autionary language does not protect material 2. Scotia's Motion misrepresentations or omissions when defendants knew they were false when made.”). Scotia argues that the alleged fraudulent statements and omissions attributable to it are not actionable as a *8 To the extent that Scotia also argues that dismissal matter of law. First, Scotia argues that the risks of is required because the alleged misstatements or investing were disclosed fully in the prospectuses and omissions were not material, the Court disagrees. other registration materials. Although these Assuming Plaintiffs' allegations are true, the documents do contain numerous warnings about the information that Scotia allegedly failed to disclose risks in investing in WRT, see The Scotia Group, would certainly have “significantly altered the ‘total Inc.'s Mem. of Law in Supp. of its Mot. to Dism., at mix’ of information available.” TSC Indus., Inc. v. 5-6, those warnings do not bar Plaintiffs' claims as a Northway, Inc., 426 U.S. 438, 449 (1976). The vast matter of law. discrepancy between the reserves estimates in Scotia's reports and the amounts that Plaintiffs claim It is well-settled that “cautionary language, if were the reality (100% less than Scotia estimated) sufficient, renders ... alleged omission[s] or would be regarded by the reasonable investor as misrepresentations immaterial as a matter of law.” In material. re Donald J. Trump Casino Sec. Litig., 7 F.3d 357, 371 (3d Cir.1993), cert. denied, 510 U.S. 1178 Furthermore, the Court held in the previous Order (1994). This principle, commonly characterized as and Opinion that Plaintiffs' invocation of the “fraud- the “bespeaks caution” doctrine, provides a defense on-the-market” theory is sufficient to plead reliance. under § 10(b) where a defendant has warned See In re WRT, Sept. 9, 1997, slip op. at 22-23. investors specifically, in advance, of risks that later Therefore, Plaintiffs have sufficiently pleaded materialize, causing the investor's loss. If the reliance on Scotia's misstatements or omissions. cautionary language cited by the defendant “precisely address[es] the substance of the specific statement or Scotia's last argument is that the inclusion of 1934 omission that is challenged,” the bespeaks caution Act claims against it is procedurally improper. Scotia doctrine can be “applied at the pleading stage to argues that the Court did not afford Plaintiffs the dismiss securities fraud claims.” In re Prudential Sec. right to add a 1934 Act claim against Scotia in the Inc. Ltd. Partnerships Litig., 930 F.Supp. 68, 71-72 most recent amendment. The Court rejects this (S.D.N.Y.1996) (Pollack, J.). argument, however, because the Court was not specific as to which claims Plaintiffs were given Upon carefully reviewing and considering the leave to replead. The Court, in the spirit of cautionary language to which Scotia refers, the Court Fed.R.Civ.P. 15, was giving Plaintiffs a broad finds that these warnings do not require dismissal of opportunity to replead its complaint. Plaintiffs' claims. Although the materials that Scotia cites contain generalized warnings about future risks, To the extent that Scotia argues that Plaintiffs' 1934 the gravamen of Plaintiffs' claims is that Scotia failed Act claims against Scotia are time-barred, the Court to reveal adverse information about current holds that these claims against Scotia, pursuant to conditions, namely that the reserves estimates issued Fed.R.Civ.P. 15(c)(2), relate back to the date of the by Scotia vastly overstated WRT's reserves as of the original pleading. The 1934 Act claims against Scotia date upon which the reports were issued. The clearly arise out of the same conduct, transaction, or bespeaks caution doctrine does not protect against occurrence that gave rise to the original pleading in such failure to disclose current adverse conditions. this matter. See Rubinstein v. Collins, 20 F.3d 160, 171 (5th

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Defendants because it did not plead scienter with the B. Defendants' Rule 9(b) Motions specificity required by Fed.R.Civ.P. 9(b). In the instant Complaint, the Court again finds that The Defendants also contend that Plaintiffs' § 10(b) Plaintiffs have not pleaded the scienter element of a § and Rule 10b-5 claims do not satisfy the heightened 10(b) claim. Plaintiffs cannot meet either the motive pleading standard of Fed.R.Civ.P. 9(b). Federal Rule and opportunity standard or the conscious of Civil Procedure 9(b) provides that “[i]n all misbehavior or recklessness standard. averments of fraud ... the circumstances constituting fraud shall be stated with particularity.” To satisfy this rule in pleading a § 10(b) claim, “ ‘the complaint a. Motive and Opportunity must (1) specify the statements that the plaintiff contends were fraudulent, (2) identify the speaker, (3) Although it is undisputed that the Underwriter state where and when the statements were made, and Defendants had the “opportunity” to commit fraud, (4) explain why the statements were fraudulent.” ’ see In re WRT, Sept. 7, 1997, slip op. at 26, they Acito v. IMCERA Group, Inc., 47 F.3d 47, 51 (2d lacked the motive to do so. In its previous Order and Cir.1995) (quoting Mills v. Polar Molecular Corp., Opinion, the Court rejected Plaintiffs' allegations that 12 F.3d 1170, 1175 (2d Cir.1993)). the Underwriter Defendants were motivated to commit fraud by the prospect of receiving $3.5 Further, to plead scienter under Rule 9(b) sufficiently million in underwriting fees in connection with the to withstand a motion to dismiss, Plaintiffs must Senior Notes Offering, and unspecified other fees as allege facts supporting a strong inference of alleged advisors to WRT. See id. at 26-27. The Court Defendants' fraudulent intent. See O'Brien v. held that it would be unlikely for the Underwriter National Property Analysts Partners, 936 F.2d 674, Defendants' “to risk their reputations in order to 676 (2d Cir.1991). There are two ways to plead generate fees likely amounting to only a small scienter in the absence of direct knowledge of a percentage of their annual revenues.” Id. at 27. defendant's state of mind. “The first approach is to allege facts establishing a motive to commit fraud In the Complaint, Plaintiffs advance the same and an opportunity to do so. The second approach is arguments as before, and add certain new allegations to allege facts constituting circumstantial evidence of of motive. Plaintiffs' restatement of the old either reckless or conscious behavior.” In re Time allegations obviously fails, and their new motive Warner Inc. Sec. Litig., 9 F.3d 259, 269 (2d allegations fare no better. First, Plaintiffs allege that Cir.1993) (citation omitted), cert. denied, 511 U.S. WRT made payments to brokers as part of a 1017 (1994). Where a plaintiff relies upon the latter “deliberate and fraudulent scheme to promote its method of pleading fraud, “the strength of the stock.” See Compl. ¶ ¶ 109-13. There is not a single circumstantial allegations must be correspondingly allegation, however, to suggest that Oppenheimer or greater.” Beck v. Manufacturers Hanover Trust Co., Schroder, or any individuals associated with 820 F.2d 46, 50 (2d Cir.1987), cert. denied, 484 U .S. Oppenheimer or Schroder, received any such 1005 (1988).FN5 payments to promote the stock. Indeed, these allegations do not mention Oppenheimer or Schroder at all. See id. FN5. By letter dated February 19, 1999, Plaintiffs claimed that the Second Circuit's Next, Plaintiffs contend that because 1994 “was an recent opinion in Press v. Chemical especially poor year in the underwriting business, the Investment Servs. Corp., 1999 WL 49367 Underwriter Defendants were unusually hungry to (2d Cir. Feb. 4, 1999), clarified the book more underwriting business in the beginning of requirements for pleading scienter in this 1995,” and that promoting WRT also enhanced fees Circuit. After carefully reviewing the Press earned by Oppenheimer and Schroder as market opinion, the Court concludes that the makers in WRT securities. Id. ¶ 119. Plaintiffs also standards governing the instant motion to allege that “[t]he substantial fees to be obtained by dismiss are unaffected. Defendants Schroder and Oppenheimer for providing purported consulting services to the Company were a 1. The Underwriter Defendants' Motion further inducement for those Defendants to participate in the wrongdoing described herein.” Id. ¶ *9 The Court dismissed the previous iteration of 123. These allegations simply recast the prior ones Plaintiffs' complaint against the Underwriter found to be legally deficient, e.g., that the

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Underwriter Defendants participated in a fraud to Court explicitly rejected this same argument in its earn fees. FN6 previous Order and Opinion. See In re WRT, Sept. 9, 1997, slip op. at 28 (“[T]he allegation that a defendants' due diligence investigation “should have FN6. Plaintiffs last allegation is that the turned up the asserted improprieties in the offering Senior Notes Offering afforded the materials” is insufficient to satisfy Fed.R.Civ.P. Underwriter Defendants an opportunity to 9(b).”).FN7 curry favor with an influential Louisiana political group to increase the Underwriter Defendants' share of the politically- FN7. Plaintiffs also attempt to demonstrate connected underwriting business in that the Underwriter Defendants must have Louisiana. Id. ¶ 120. The Court, however, or should have known about the true facts of does not see the need to address such a far- WRT's business affairs by referring to two flung, conclusory allegation. memoranda prepared by Scotia, one dated June 2, 1994 and the other dated February, b. Conscious Misbehavior or Recklessness 1995. See Compl. ¶ ¶ 129, 136, 138, 139. Plaintiffs point to these letters to In bringing claims against the Underwriter demonstrate that the problems at WRT were Defendants, Plaintiffs are charging third-party so fundamental that the Underwriter advisers with fraud. The Court has just established Defendants had to have consciously ignored that Plaintiffs have not met the motive and the truth. This argument, however, is opportunity standard, therefore Plaintiffs must allege nothing more than another version of facts approaching a knowledgeable participation in Plaintiff's insufficient claim that the the fraud or a deliberate and conscious disregard of Underwriter Defendants should have known facts. Where third-party advisers are concerned, to the truth about WRT's affairs. These meet such a standard the allegations must memoranda, therefore, have no effect on the “approximate an actual intent to aid in the fraud Court's analysis. being perpetrated by the [ ] company.” Decker v. Massey-Ferguson, Ltd., 681 F.2d 111, 121 (2d Plaintiffs other set of arguments concern the activities Cir.1982). of Mark Miller, a former Oppenheimer employee, as described in a report prepared by an examiner *10 Plaintiffs advance two sets of arguments in their appointed in the WRT bankruptcy proceeding (the attempt to establish the Underwriter Defendants' “Bankruptcy Examiner's Report”). See Compl. ¶ ¶ conscious misbehavior or recklessness. First, the 114-18. Based on this report, plaintiffs allege that majority of Plaintiffs' new scienter allegations Mark Miller acted as an “ex officio advisor” to WRT revolve around the argument that the Underwriter and played a “central role” in the relationship Defendants either knew or recklessly disregarded between WRT and a company called Tri-Deck which virtually every single negative fact concerning WRT had entered into an agreement with WRT to purchase which plaintiffs have alleged in the Complaint. See and distribute WRT oil and gas. According to Compl. ¶ ¶ 125-144. Plaintiffs allege over and over Plaintiffs' allegations and the Bankruptcy Examiner's again that, under ordinary underwriting procedures, Report, the Tri-Deck deal resulted in a loss of Oppenheimer and Schroder should have been able to- approximately $3 million to WRT because WRT had or, in fact, did-learn during the course of their due agreed to sell oil and gas Tri-Deck at below market diligence in connection with the Senior Notes prices. See id. ¶ 115. Offering of all the alleged negative facts outlined above. See, e.g., id. ¶ ¶ 128, 133, 137, 139. These new allegations relating to the alleged involvement of Mark Miller with WRT and Tri-Deck At base, these allegations claim that if Oppenheimer have absolutely nothing at all to do with Schroder. and Schroder had properly done their jobs as Therefore, these claims cannot support a claim underwriters and performed due diligence against Schroder, and Schroder's motion to dismiss is adequately, they would have uncovered the truth granted because Plaintiffs have not pleaded scienter about WRT. These allegations constitute negligence with the specificity required by Fed.R.Civ.P. 9(b). at best, and these types of allegations against an underwriter have always been insufficient to establish But even as to Oppenheimer, these new allegations scienter under the federal securities laws. In fact, the are unavailing. The timing of Mark Miller's alleged

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Furthermore, companies would make for themselves, including there is no allegation that Miller had anything to do “the wells on which to perform workovers, how to with the preparation of any of the Oppenheimer nest perform them, and where and how to best drill research reports that the Court held were material new wells.” Id. Furthermore, Plaintiffs allege that misstatements or omissions. WRT owed Scotia $500,000 as of mid-1994, and that in February 1995 Scotia knew that “WRT ran out of *11 The Court also rejects Plaintiffs' contention that cash in mid-1994.” Id. ¶ 60. Lastly, Plaintiffs cite “Miller's vast knowledge concerning the business and two memoranda prepared by Scotia to demonstrate affairs of WRT should be imputed to Defendant that Scotia was aware of the problems at WRT. In Oppenheimer.” Id. ¶ 114. An employee's knowledge addition to WRT's cash problems, Scotia was aware may be imputed to a corporation only if such that WRT's performance was “hardly stellar,” that its knowledge was acquired by the employee while technology was “neither especially high tech nor at acting within the scope of employment, and for the this point in time, efficient,” and that WRT's public employer's benefit, and if such knowledge relates to a claims were “lots of noise ” for “very little matter to which the employee's authority extends. performance.” Id. ¶ 3 (emphasis in original). See, e.g., Corrigan v. Bobs-Merrill Co., 228 N.Y. 58, 68-69 (N.Y.1920); Weintraub v. Texasgulf Inc., 564 *12 Scotia argues that Plaintiffs' allegations are F.Supp. 1466, 1470 (S.D.N.Y.1983). The Complaint insufficient because they merely claim that Scotia's does not allege that Miller attained his “vast motive was to generate fees. Although such an knowledge” of WRT's business affairs because of his argument would be persuasive, see supra part II role as an analyst at Oppenheimer. Instead, the .B.1.a, the Court finds that Plaintiffs allege Scotia's Complaint suggests, and the Examiner's report motive was more than simple fee generation. supports, that Miller attained his knowledge of WRT Plaintiffs' claims are not, similar to its claims against as an “ex officio advisor” to WRT. See Compl. ¶ the Underwriter Defendants, that Scotia was 114; Exh. A, at 43-50. Clearly, Miller's role as “ex motivated to receive fees for the various reports it officio advisor” exceeds the scope of Miller's prepared and to secure future business. Rather, employment at Oppenheimer, and Oppenheimer did Plaintiffs allege that WRT and Scotia were so not stand to benefit from Miller's activities that interrelated that Scotia's financial viability depended stemmed from such a role. Therefore, these on WRT's success. Scotia's motivation lay not only in allegations fail to establish Oppenheimer's conscious receiving compensation for its estimate reports and misbehavior or recklessness, and Oppenheimer's generating future fees, but also in assuring that past motion to dismiss is granted. debts owed to Scotia would be paid and that Scotia's most important client prospered. At this stage of the case,FN8 it is not improper to infer that Scotia's 2. Scotia's Motion financial future was tied to that of WRT. At the very least, Scotia would have lost over fifty percent of its The Court finds that Plaintiffs have pleaded scienter business if WRT folded. with the specificity required by Fed.R.Civ.P. 9(b) to withstand Scotia's motion. Specifically, the Court finds that Plaintiffs have met the motive and FN8. The Court is in no way finding that opportunity standard. It is undisputed that Scotia had WRT and Scotia were as interrelated and the opportunity to commit fraud. The issue is whether interdependent as Plaintiffs claim, and this Plaintiffs have pleaded that Scotia had the motive to part of the Court's opinion is not to be used do so. by Plaintiffs in subsequent stages of this litigation as establishing the “law of the Plaintiffs allege that Scotia's motive lay in a case.” The Court is merely assuming that combination of the interrelationship between WRT Plaintiffs claims concerning Scotia are true. and Scotia, and Scotia's knowledge of WRT's problems. Plaintiffs claim that despite Scotia's Although Scotia cites many cases supporting its

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 147 of 163 Not Reported in F.Supp.2d Page 10 Not Reported in F.Supp.2d, 1999 WL 178749 (S.D.N.Y.), Fed. Sec. L. Rep. P 90,456 (Cite as: Not Reported in F.Supp.2d) position that Plaintiffs claims are insufficient because allegations that reiterate factual allegations made by their only motive allegation is fee Plaintiffs in the Second Amended Complaint. The generation/compensation. See Scotia's Mem. in Supp. allegations against the Individual Defendants in the of Mot. to Dism., at 14-15. These cases, however, are Complaint are not the same jumbled, confused inapposite to the instant situation. In none of the allegations that were advanced in the Second cases cited by Scotia is the third party defendant that Amended Complaint. Rather, the allegations in the is accused of § 10(b) violations so interrelated with, Complaint against the Individual Defendants detail a and dependent upon, the company for which the third pattern of misbehavior on the parts of McGuire and party performed its services as Scotia is to WRT. Hale that leads to the inference that these Individual Defendants' actions “approximate an actual intent to Scotia also argues that it was hired to do reserves aid in the fraud” alleged in the Complaint. See Chill reports for WRT only, and thus Scotia's assessment v. General Elec. Co., 101 F.3d 263, 269 (2d of WRT's technology, management, and success Cir.1996) (quoting Decker v. Massey-Ferquson, Ltd., cannot be the basis of liability for Scotia. This 681 F.2d 111, 121 (2d Cir.1982). The Court will argument misses the point. Plaintiffs are not claiming analyze Plaintiffs' allegations against each Individual that the statements in the Scotia memoranda are Defendant. independent bases upon which Plaintiffs can establish liability. Instead, Plaintiffs claim that these statements demonstrate that Scotia knew WRT's i. Defendant McGuire problems, thereby giving Scotia greater motive to issue favorable reserve reports. The inference that The Bankruptcy Examiner's report details the role can be properly drawn is that Scotia's knowledge of McGuire played in WRT. FN9 As the Examiner WRT's problems, when coupled with Scotia's Report states, McGuire “was in charge of the reliance on WRT and the interdependence of the two operations and apparently ran [WRT's] operations as firms, constitutes motive sufficient to withstand a he saw fit without a division of management Rule 9(b) motion. responsibilities, decision making authority, or basic accounting and bookkeeping controls” when WRT was first formed. Although such domination is not 3. The Individual Defendants' Motion unusual for small oil and gas companies in their infancy, McGuire's domination continued as WRT In granting the Individual Defendants' Rule 9(b) became a company that was traded in the public motion in the Court's previous Order and Opinion, securities markets. See Compl., Exh. A, at 1-2. The the Court granted the Individual Defendants' motion Bankruptcy Examiner's Report further concluded that because Plaintiffs' allegations against the Individual McGuire “gave directors or management only part of Defendants were not sufficiently specific. the information necessary to make an informed decision,” “acted contrary to the Board of Directors The Court, however, finds that Plaintiffs have cured instructions without informing them of his action,” the pleading defect in the Third Amended Complaint and made commitments and transactions on behalf of as it pertains to Defendants McGuire and Hale. WRT without anyone else's knowledge. The Although Plaintiffs do not contest the Court's finding Bankruptcy Examiner's Report also stated that WRT's in its previous opinion that Plaintiffs have not management was “miscast,” with numerous satisfied the motive and opportunity standard, employees working in jobs for which they were Plaintiffs correctly assert that the Third Amended unqualified. Id., Exh. A, at 2-3. The report sums up Complaint satisfies the conscious misbehavior McGuire's role by stating, “[i]n short, McGuire'[s] standard. strong personality dominated the management of [WRT] and no questions were asked.” Id., Exh. A, at 3. a. Conscious Misbehavior or Recklessness

*13 Plaintiffs have added over twenty paragraphs to FN9. It is proper for the Court to rely on the the Complaint that details the acts they claim Bankruptcy Examiner's Report because it is demonstrate the Individual Defendants conscious attached to the Complaint, and as such can misbehavior or recklessness in connection with be considered in a Rule 12(b)(6) motion. WRT's material misstatements or omissions. See Compl. ¶ ¶ 125-45. Plaintiffs have also clarified the Based on these conclusions, which are incorporated

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 148 of 163 Not Reported in F.Supp.2d Page 11 Not Reported in F.Supp.2d, 1999 WL 178749 (S.D.N.Y.), Fed. Sec. L. Rep. P 90,456 (Cite as: Not Reported in F.Supp.2d) into the Complaint, and the numerous press releases “involved in and intimately familiar with the day-to- and statements directly attributable to McGuire, there day operations and management of WRT,” and can be no doubt that Plaintiffs have adequately therefore must have been aware of the ongoing fraud pleaded McGuire's conscious misbehavior in at WRT. Id. ¶ 141. These allegations, coupled with connection with WRT's fraudulent conduct. If the the Bankruptcy Examiner Report's assessment that Bankruptcy Examiner's Report and the allegations in McGuire kept many people at WRT in the dark, do the Complaint are true, then McGuire orchestrated not suffice to plead Guy's conscious misbehavior. every detail of the fraud committed by WRT, and can The Court dismissed such conclusory, unsupported be held liable under the 1934 Act. allegations in its previous Order and Opinion in this matter, and Plaintiffs evidently have not discovered new facts that bolster its case against Guy. Therefore, ii. Defendant Hale the Individual Defendants' motion as it pertains to Guy is granted. Plaintiffs have also alleged sufficiently Hale's conscious misbehavior. First, Hale was an insider at WRT, and as WRT's CFO he was one of the most iv. Defendants Rush and Lam important officers of WRT. Hale signed every document submitted to the SEC during the Class The allegations in the Complaint against Rash and Period. Hale, as CFO of WRT, had to have known Lam are even weaker than those alleged against Guy. that the financial information contained in the Rash and Lam are not insiders at WRT, and the only materials submitted by WRT to the SEC was allegations against them are that they signed erroneous. In particular, the misrepresentations of materials submitted to the SEC in connection with WRT's net worth are directly attributable to Hale WRT's offering of 489,500 shares of common stock because he was the CFO. The Bankruptcy Examiner's in December 1994, id. ¶ 48, and that they signed the Report buttresses this inference about Hale's materials submitted to the SEC in connection with knowledge of WRT's financial misrepresentations. In the Senior Notes Offering. Id. ¶ 53. As stated above, the context of an illegal payment made to an outsider, given the clandestine practices of McGuire and their the report states that “[c]learly Hale was aware of the role as outside directors, these allegations do not lead accounting errors and the misleading content of to a conclusion that Rash and Lam's actions WRT's books. See Compl., Exh. A, at 7. approximated an actual intent to aid in the fraud committed at WRT. The Individual Defendants' *14 There are other allegations that demonstrate motion as it applies to Rash and Lam is granted. Hale's conscious misbehavior. The Complaint alleges that Hale was involved personally in directing improper payments by WRT. Id. ¶ 142-43. This III. Leave to Replead allegation is supported by the Bankruptcy Examiner's report Id., Exh. A., at 7. Hale also stated in a press The Court determines that, to the extent that the release issued on August 2, 1994, a time at which instant motions have been granted, Plaintiffs are not Plaintiffs allege WRT was in serious financial given leave to replead. Plaintiffs have already had trouble, id. ¶ 60, that “we expect continued increases two opportunities to plead causes of action against in production revenues, operating results and cash the Underwriter Defendants and Defendants Guy, flow for the remainder of 1994.” Id. ¶ 41. The Court Rash, and Lam. The Court finds that given the finds that these allegations establish Hale's conscious extensive investigation Plaintiffs have conducted in misbehavior in connection with WRT's fraudulent this matter, any further attempt at amending their conduct. complaint against these Defendants would be futile. Plaintiffs clearly take exception to the Court's ruling on their 1933 claims, but further amendment will not iii. Defendant Guy cure any defect according to the Court's ruling on the standing issue, a matter of law. The only allegations against Guy are that he signed WRT's 1993 annual report, id. ¶ 37, that he signed the Prospectus and registration materials in CONCLUSION connection with the senior Notes Offering, id. ¶ 57, that he resigned from WRT with McGuire on *15 For the reasons stated above, the Underwriter November 10, 1995, id. ¶ 80, and that he was Defendants' motion is granted, Scotia's motion is

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 149 of 163 Not Reported in F.Supp.2d Page 12 Not Reported in F.Supp.2d, 1999 WL 178749 (S.D.N.Y.), Fed. Sec. L. Rep. P 90,456 (Cite as: Not Reported in F.Supp.2d) denied, and the Individual Defendants' motion is denied as to McGuire and Hale, but granted as it pertains to Guy, Lam, and Rash. Plaintiffs are not given leave to replead the dismissed portions of its complaint. The parties that are still extant in this case shall appear for a status conference at 9:45 AM on April 19, 1999 in Courtroom 20C of the United States Courthouse, 500 Pearl Street, New York, New York.

SO ORDERED.

S.D.N.Y.,1999. In re WRT Energy Securities Litigation Not Reported in F.Supp.2d, 1999 WL 178749 (S.D.N.Y.), Fed. Sec. L. Rep. P 90,456

Briefs and Other Related Documents (Back to top)

• 1:96cv03611 (Docket) (May. 15, 1996) • 1:96cv03610 (Docket) (May. 15, 1996)

END OF DOCUMENT

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Not Reported in F.Supp. Page 1 Not Reported in F.Supp., 1995 WL 241448 (N.D.Cal.) (Cite as: Not Reported in F.Supp.)

December 15, 1993, Quickturn completed an initial Briefs and Other Related Documents public offering (“IPO”) in which the company issued Only the Westlaw citation is currently available. 3.4 million shares of common stock at $12 per share. United States District Court, N.D. California. Morgan Stanley and Hambrecht & Quist served as Larry STACK and Ari Parnes, on behalf of lead underwriters of the Quickturn IPO. themselves and all others similarly situated, Plaintiffs, During early and mid-1994, Quickturn's stock price v. fluctuated in a volatile manner, from a high of $16 Keith R. LOBO, et al., Defendants. 1/2 in mid-April to a low of $5 1/4% in mid-July. Civ. No. 95-20049 SW. At the end of 1994, the stock price was slightly more than $13 per share. April 20, 1995. Then, on January 5, 1995, Quickturn announced that it had taken a $3.7 million bad debt writeoff for sales ORDER DISMISSING PLAINTIFFS' FIRST to two customers who had advised Quickturn of their AMENDED COMPLAINT inability to pay. In response, the stock price fell SPENCER WILLIAMS, District Judge. more than 50 percent to $7 1/4 per share. *1 In this securities fraud class action, Plaintiffs allege that Quickturn Design Systems, Inc. and its Plaintiffs filed suit approximately two weeks later, on officers and directors (“the Corporate Defendants”), January 20, 1995, alleging that during the Class in concert with Morgan Stanley, Hambrecht & Quist Period the Corporate Defendants and the and two of their analysts (“the Underwriters”), Underwriters participated in a scheme to defraud the defrauded investors in violation of § 11 and § 12(2) investing public by deceiving them about various of the Securities Act of 1933, 15 U.S.C. § 77k & 77l, aspects of Quickturn's current and future financial § 10(b) of the Securities Exchange Act of 1934, 15 performance. According to Plaintiffs, Defendants U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § became so desperate to keep pace with their earnings 240.10b-5, promulgated thereunder. The Corporate projections that they: 1) committed accounting fraud Defendants now move to dismiss Plaintiffs' First by making sales to less proven customers, by Amended Complaint (“FAC”) pursuant to prematurely and improperly recognizing revenue, and Fed.R.Civ.P. 12(b)(6) and 9(b). The Underwriters by understating financial reserves for doubtful have moved for joinder in this motion. Based on the accounts; 2) issued false and misleading statements following, the Court GRANTS the Corporate about Quickturn's financial situation, projected Defendants' motion, and DISMISSES the claims earnings, and business prospects, and; 3) adopted against all Defendants. false and misleading statements made by securities analysts.

BACKGROUND *2 The Corporate Defendants moved to dismiss the Complaint on February 18, 1995. Subsequently, on Quickturn is a high-technology company located in March 6, 1995, Plaintiffs amended. The Corporate Mountain View, California that designs and Defendants, joined by the Underwriters, now move to manufactures verification solutions for the design of dismiss Plaintiffs' FAC. integrated circuits and electronic systems. Quickturn's systems allow design engineers to create reprogrammable prototypes used in the fabrication of LEGAL STANDARD silicon chips. The Corporate Defendants are officers, directors, and outside directors of Quickturn. Under the liberal federal pleading policies, a plaintiff Plaintiffs are a group of individual investors who need only give defendant fair notice of the claims bought Quickturn common stock between December against it. Conley v. Gibson, 355 U.S. 41, 47, 78 15, 1993 and January 5, 1995 (the “Class Period”). S.Ct. 99, 102, 2 L.Ed.2d 80 (1957). A claim should not be dismissed unless it is certain that the law The facts leading to this lawsuit are as follows. On would not permit the requested relief even if all of

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 151 of 163 Not Reported in F.Supp. Page 2 Not Reported in F.Supp., 1995 WL 241448 (N.D.Cal.) (Cite as: Not Reported in F.Supp.) the allegations in the complaint were proven true. authenticity no party questions, but which are not Durning v. First Boston Corp., 815 F.2d 1265, 1267 physically attached to the pleading.” Branch v. (9th Cir.1987), cert. denied, 484 U.S. 944, 108 S.Ct. Tunnell, 14 F.3d 449, 454 (9th Cir.1994), cert. 330, 98 L.Ed.2d 358 (1987). Therefore, for purposes denied, 114 S.Ct. 2704, 129 L.Ed.2d 832 (1994). of this motion to dismiss, the Court assumes the truth of all factual allegations in the complaint as well as all reasonable inferences drawn from them. DISCUSSION

In complaints alleging fraud, however, the I. THE CORPORATE DEFENDANTS' MOTION TO heightened pleading standards of Fed.R.Civ.P. 9(b) DISMISS apply. This rule requires averments of fraud or inequitable conduct to be “stated with particularity.” A. § 10(b) Claims Fed.R.Civ.P. 9(b). Rule 9(b) does not necessitate pleading of detailed evidentiary matter. Nonetheless, mere conclusory allegations of fraud are insufficient. Moore v. Kayport Package Express, 885 *3 After reviewing the allegations contained in the F.2d 531, 540 (9th Cir.1989). The plaintiff must FAC, the Court finds that Plaintiffs have failed to include statements regarding the time place and allege any facts in support of their § 10(b) claims nature of the alleged fraudulent activities, and must with sufficient particularity to satisfy Fed.R.Civ.P. specifically identify what was misrepresented or 9(b). Instead, Plaintiffs have concocted a classic concealed so as to give the opposing party notice of “fraud by hindsight” case. Plaintiffs' FAC contains the particular conduct which is alleged to constitute substantial amounts of boilerplate language, and is the fraud. Id. Merely making general conclusory devoid of any contemporaneous facts which tend to allegations of fraud, and then reciting a list of neutral show that any statements made by the Corporate facts, is not sufficient. Semegen v. Weidner, 780 F.2d Defendants or Underwriters were false when made. 727, 731 (9th Cir.1985). Plaintiffs' pleading strategy is to allege wrongdoing vaguely and conclusorily in general introductory The Ninth Circuit recently clarified the scope of Rule paragraphs, and then quote verbatim from financial 9(b) pleading requirements as applied to securities disclosures, press releases, and analysts' reports. In fraud actions in the case of In re Glenfed, Inc. sum, Plaintiffs have done exactly what Glenfed said Securities Litigation, 42 F.3d 1541 (9th Cir.1994) (en they could not: they have alleged in a conclusory banc). According to the Glenfed court, a plaintiff manner that because Plaintiffs made later sobering does not state a claim for securities fraud merely by statements, their “earlier cheerier” predictions must asserting that a company's revelation of bad news have been false. See Glenfed, 42 F.3d at 1548. means that “earlier, cheerier” statements must have been false. Id. at 1548. Rather, the plaintiff must The following sections will explain exactly how plead the specific circumstances of the alleged fraud, Plaintiffs § 10(b) allegations are defective. including the time, place, and nature of the statements made, and also facts demonstrating how the statements were false or misleading. Id. The 1. The Law Glenfed court further suggested that the most direct way to prove that representations were false when Section 10(b) of the Securities Exchange Act of made is to point to inconsistent contemporaneous 1934, 15 U.S.C. § 78j, makes it unlawful to use in statements or omissions which contradict the connection with “the mails or facilities of interstate challenged statements. Id. at 1549. commerce” any “manipulative or deceptive device or contrivance in contravention of such rules and In deciding a motion to dismiss, the court is not regulations as the Commission may prescribe....” limited by the allegations contained in the complaint Rule 10b-5 promulgated under section 10(b) provides if the complaint is accompanied by attached as follows: documents. Such documents are deemed part of the It shall be unlawful for any person, directly or complaint and may be considered in determining indirectly, by the use of any means or instrumentality whether the plaintiff can prove any set of facts in of interstate commerce, or of the mails, or of any support of the claim. Durning, 815 F.2d at 1267. facility of any national securities exchange, The court may also consider “documents whose (1) to employ any device, scheme, or artifice to contents are alleged in a complaint and whose defraud,

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(2) to make any untrue statement of a material fact or FAC, ¶ 104. According to Plaintiffs, Quickturn to omit to state a material fact necessary in order to shipped $3.7 million of its products “to two make the statements made, in the light of customers ($2 million to customer A, and $1.7 circumstances under which they were made, not million to customer B) who did not have the ability misleading, or or intention to pay,” FAC, ¶ ¶ 104, and recognized (3) to engage in any act, practice, or course of these sales as earnings “despite serious doubts as to business which operates or would operate as a fraud the collectibility of the revenue, so as to prevent or deceit upon any person, taking a loss in the second quarter.” FAC, ¶ 106. in connection with the purchase or sale of any Subsequently, during the fourth quarter of 1994, security. Quickturn was forced to write off these two sales. The resulting reduction in fourth quarter earnings 17 C.F.R. § 240.10b-5 (1993). made Quickturn's stock plummet more than 50 percent, and precipitated the current suit. Despite the fact that Rule 10b-5 says nothing about intent to defraud or knowledge of falsity, the Plaintiffs' allegations concerning the $3.7 million Supreme Court has ruled that recovery in a private writeoff fail to state a claim under Rule 9(b). The Rule 10b-5 lawsuit requires proof of the defendant's problem with Plaintiffs' allegations is that they do not scienter. Ernst & Ernst v. Hochfelder, 425 U.S. 185, explain how or why it was unlikely that the two 193, 96 S.Ct. 1375, 1381, 47 L.Ed.2d 668 (1976); customers in question lacked the “ability or see also, Aaron v. SEC, 446 U.S. 680, 690, 100 S.Ct. intention” to pay their bills. Plaintiffs do not name 1945, 1952-1953, 64 L.Ed.2d 611 (1980) (scienter the customers (aside from labelling them customers also required in lawsuit brought by SEC). The A and B), or specify any financial difficulties or other Hochfelder Court defined this scienter as “a mental reasons why payment was doubtful. Nor does the state embracing intent to deceive, manipulate, or mere fact that Plaintiffs mention the dollar amount of defraud.” Hochfelder, 425 U.S. at 194, n. 12, 96 the writeoff make their allegations adequate. See In S.Ct. at 1381, n. 12. re Genentech, Inc. Sec. Litig., [1989-90 Transfer binder] Fed.Sec.L.Rep. (CCH) ¶ 94,901 at 94969 (N.D.Cal.1990) (“The mere listing of dollar amounts 2. Plaintiffs' Claims in a complaint without identifying any factual allegations to support them is insufficient to Plaintiffs' § 10(b) allegations can be divided into withstand a motion to dismiss under Rule 9(b)”). four general categories: 1) accounting fraud; 2) the company's own statements; 3) analysts' reports, and; 4) the “scheme” to defraud. The Court will examine ii. Adequacy of Reserve for Doubtful Accounts each category of allegations in turn. Plaintiffs also allege that Quickturn violated accounting principles by failing to allow adequate a. Accounting Fraud Allegations reserves for doubtful accounts receivables in its March 31, 1994, June 30, 1994, and September 30, *4 Plaintiffs claim that the Corporate Defendants 1994 financial statements. FAC, ¶ 108-110. engaged in several types of accounting fraud in order According to Plaintiffs, these violations are to bolster earnings and deceive the investing public illustrated by the fact that Quickturn's reserve for bad about Quickturn's true financial situation and debts did not rise in proportion to the growth in sales prospects. Based on the following, Plaintiffs have to “less creditworthy customers (including foreign not pled any of their accounting fraud claims with customers with whom it had no prior credit sufficient particularity to satisfy Fed.R.Civ.P. 9(b). experience).” FAC, ¶ 109. The only specific facts pled in support of these allegations are that: 1) Quickturn's reserves decreased from 7% of gross i. The $3.7 Million Writeoff accounts receivable on December 31, 1993 to 4.8% on September 30, 1994, and; 2) the proportion of Plaintiffs central allegation is that, during the second Quickturn's sales to top 10 customers (such as IBM, quarter of 1994, Defendants improperly recognized Intel, and AMD) declined from 83% in early 1993 to $3.7 million in sales revenue “on purported sales of 50%-60% in early 1994. product for which payment was not probable or likely” in violation of standard accounting principles. *5 Again, Plaintiffs' allegations are inadequate.

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Plaintiffs do not specify who any of these so-called recognized revenue. Compare In re Wells Fargo “less creditworthy” customers are, or explain why Securities Litigation, 12 F.3d 922, 926-27 (9th any of them would be less likely to pay their bills. Cir.1993) (allegations which identified nine problem Nor do Plaintiffs clarify why foreign customers borrowers by name were adequate), cert. denied, 115 would be more prone to have credit problems, or S.Ct. 295, 130 L.Ed.2d 209 (1994). Nor do justify why a declining proportion of sales to top 10 Plaintiffs identify any contemporaneous facts or customers means that Quickturn should have statements which suggest that Defendants were increased its allowance for doubtful accounts. engaging in premature recognition of revenue. Finally, Plaintiffs do not allege any facts showing Instead, Plaintiffs rely solely on conclusory that Quickturn's decision to set its reserve for accusations, and statistics regarding revenue and doubtful accounts at a certain level was not a receivables which may be indicative of numerous permissible business judgment. After all, accounting factors aside from accounting fraud. After all, an principles do not require a company to set its reserve increase in the ratio of receivables to revenue, for doubtful accounts at any predetermined without more, does not warrant an inference of fraud. percentage of accounts receivable. See id. at 926.

In sum, Plaintiffs allegations are too conclusory to satisfy Rule 9(b), and their statistics are too b. The Company's Own Statements speculative to raise any inference of fraud. *6 Plaintiffs also claim that statements made by the Corporate Defendants in numerous press releases, iii. Restructuring Reserve conference calls, and the “pre-offering Roadshow” were false and misleading. As explained below, Next, Plaintiffs claim that Quickturn overstated the none of Plaintiffs allegations regarding these $9.4 million “restructuring charge” recorded as part statements are adequate. of the PiE merger in June of 1993. FAC, ¶ 111. According to Plaintiffs, by overstating this charge, Quickturn created a “cushion” for future earnings, i. Statements About Demand for, Sales of, and Market that it used to falsely portray the company as a more Reaction to Quickturn's Products successful enterprise than it actually was. FAC, ¶ 111. Plaintiffs allege that throughout the Class Period Quickturn's officers made various false statements Yet again, Plaintiffs' allegations fail for lack of about the demand for, sales of, and market reaction to particularity. Plaintiffs have alleged no facts that Quickturn's products. show the restructuring charge was excessive when recorded. Nor do Plaintiffs single out any particular First, Plaintiffs claim that Quickturn's officers falsely restructuring charges and specify how they were asserted that Quickturn's products were experiencing improper. As such, Plaintiffs' allegations are baldly strong demand and were being sold to a broadening conclusory, and thus clearly insufficient. customer base. FAC ¶ ¶ 57, 64, 66, 68, 69, 77, 91. According to Plaintiffs, these statements were false because Quickturn's emulation systems “suffered iv. Premature Recognition of Revenue from a competitive disadvantage” compared to other companies' products due to their high price. FAC, ¶ Lastly, Plaintiffs allege that Quickturn violated 76(c). These allegations are insufficient because accounting principles by recording revenue when it Plaintiffs do not allege any particular facts showing signed contracts for sales of its products, instead of at that Quickturn was having problems selling its the time of actual shipment. FAC, ¶ 107. products at the time the statements about demand and According to Plaintiffs, this premature recognition is customer base were made. demonstrated by the fact that “in the second quarter revenue decreased 10.5% from the first quarter, yet Second, Plaintiffs contend that on July 14, 1994, receivables increased 6.8%.” Id. Quickturn's officers falsely represented that “large sales not closed in the second quarter would, with Again, Plaintiffs' allegations fail for lack of one or two exceptions, be closed in the last two particularity. Plaintiffs do not name a single quarters of 1994.” FAC, ¶ 77. According to customer or sale where Quickturn prematurely Plaintiffs, Quickturn's officers “did not have any

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 154 of 163 Not Reported in F.Supp. Page 5 Not Reported in F.Supp., 1995 WL 241448 (N.D.Cal.) (Cite as: Not Reported in F.Supp.) adequate reason to believe” that these sales would iv. Descriptions of the Sales Force close, because Quickturn was having “fundamental problems in selling ... emulation systems.” FAC, ¶ Plaintiffs further allege that Quickturn made two 101(c). These allegations fail for the same reason as statements, in its December 15, 1993 Prospectus and the ones immediately above: Plaintiffs have not pled its 1993 10-K, misrepresenting that “the Company any facts tending to show that Quickturn's statements employs a highly skilled sales force ... capable of were false when made. serving the sophisticated needs of prospective customers' engineering and management staffs.” Third, Plaintiffs refer to statements made by FAC, ¶ ¶ 59, 67. According to Plaintiffs, these Quickturn officers regarding the introduction of new statements were untrue when made because products: the “Logic Animator” and the “System Quickturn's sales force was actually plagued with Realizer”. FAC, ¶ 57, 91, 92. These allegations high turnover, lacked adequate training, and was are inadequate because Plaintiffs do not even allege made up of some individuals who had never closed a that these statements were false. single sale. Id., ¶ ¶ 75, 76(a)-(b). The only facts pled in support of these allegations are hindsight explanations the Corporate Defendants made during ii. Comparisons of Actual Results to Internal conference calls on July 13, 1994 that “Quickturn Expectations stumbled in the 2Q because of sales execution,” that “poor execution in the selling effort caused the Plaintiffs also allege that three of Quickturn's officers closing of 5-6 large orders to slip”, and that made false statements on three occasions that demand “Quickturn did not manage a complex selling process for Quickturn's products was “stronger than well enough.” FAC, ¶ ¶ 11, 75, 78. expected”, and that Quickturn's sales performance was on target. FAC, ¶ ¶ 57, 66, 69. Plaintiffs claim Plaintiffs' allegations here once again fail for lack of that these statements were false because “sales were, particularity. Plaintiffs merely allege in a conclusory in fact, below levels internally planned or budgeted.” manner that Quickturn's sales force was inadequately FAC, ¶ 76(d). skilled and trained. Plaintiffs do not specify the types of problems involved, state the qualifications Again, Plaintiffs allegations are purely conclusory. that were lacking, or make any comparisons with the Plaintiffs do not cite the dates or preparers of any sales forces of similar companies. Furthermore, internal forecasts. Nor do they specify the manner in Plaintiffs fail to cite any contemporaneous facts or which any forecasts differed from the information statements in support of their arguments. divulged in Quickturn's public statements. Quickturn's later explanations in July of 1994 that poor sales execution was to blame for weak second quarter performance does not establish that problems iii. Comments About the Industry in sales were evident when the “earlier, cheerier” statements about the “highly skilled” nature of the Next, Plaintiffs claim that Quickturn's officers sales force were made. See Glenfed, 42 F.3d at misrepresented the state of the market for emulation 1548. Nor does a period of poor sales performance systems by characterizing it as “large and growing”, lead to an inference that the sales force was stating that emulation was accepted as “the preferred necessarily unskilled and undertrained. system-level verification solution for electronics systems design”, and claiming that “key segments of semiconductors ... have emerged as significant v. Predictions of the Future opportunities for emulation technology.” FAC, ¶ ¶ 57, 64. Lastly, Plaintiffs allege that on six occasions Quickturn's officers falsely represented that *7 Plaintiffs' allegations are inadequate because they Quickturn's earnings would increase and that fail to explain how these statements were false. profitable growth would continue into the future. Plaintiffs do not argue that the market for emulation FAC, ¶ ¶ 57, 61, 66, 69, 77, 92. The officers systems was not large and growing or that emulation predicted that “stronger than anticipated demand, was not accepted in the market. Nor do Plaintiffs combined with tight cost controls would result in cite any facts in support of such contentions. accelerating earnings per share for Quickturn in succeeding quarters and that the market for Quickturn's products ... would continue to expand

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 155 of 163 Not Reported in F.Supp. Page 6 Not Reported in F.Supp., 1995 WL 241448 (N.D.Cal.) (Cite as: Not Reported in F.Supp.) during the next several years.” FAC. ¶ 57; See specific interactions between the insider and the also, FAC, ¶ ¶ 66, 69, 92. The officers also stated analyst which gave rise to entanglement, and; 3) that Quickturn would “achieve strong continued state when these interactions occurred. Syntex, 855 profitable growth,” FAC, ¶ 61, and made specific F.Supp. at 1097; In re Caere Securities Litigation, projections for earnings per share. FAC, ¶ 57, 77. 837 F.Supp. 1054, 1059 (N.D.Cal.1993). In support of the falsity of these statements, Plaintiffs Furthermore, entanglement requires a two-way flow allege only that they were made without any of information. Syntex, 855 F.Supp. at 1097. The “reasonable basis.” FAC, ¶ ¶ 76(i)-(j), 101(l)-(n). plaintiff must allege that the insider provided misleading information to an analyst, that the analyst *8 These allegations are insufficient because relied on this information in preparing a report, and Plaintiffs have failed to plead any facts whatsoever that the insider somehow endorsed or approved the tending to show that these predictions were false report prior to or after its publication. See id. when made. Plaintiffs allege only that these (dismissing claims based on analysts' reports because statements lacked a “reasonable basis”, without there were “no factual allegations that [the insider] providing any specific support or explanation for how entangled himself with the report prior to or after its or why that was the case. publication ... by endorsing or approving the spin its authors put on the information he had disclosed or by attesting to the accuracy of its forecasts or c. Analysts' Statements conclusions”).

Plaintiff's FAC also alleges that Defendants are liable Here, Plaintiffs' FAC contains several generalized for misleading projections contained in twenty-seven paragraphs alleging that certain “senior officers of securities analysts' reports issued by Morgan Stanley, Quickturn (i.e., Lobo, D'Amour and Ostby) Hambrecht & Quist and Smith Barney. In their communicate[d] regularly with securities analysts.” motion to dismiss, Defendants respond that: 1) FAC, ¶ 41. These communications allegedly Plaintiffs have failed to sufficiently allege that included “telephone conference calls, meetings and Defendants adopted the analysts' projections as their analyst briefings”, and were conducted to cause the own, and; 2) Plaintiffs have failed to show that there analysts to “disseminate favorable information on was no reasonable basis for the analysts' statements Quickturn ... and to falsely present business and when they were made. prospects of Quickturn to the marketplace thus artificially inflating the market price of Quickturn's The general rule is that a company may be liable for stock,” FAC, ¶ 41. According to Plaintiffs, because analysts' forecasts which it fostered and reviewed but these senior Quickturn officials reviewed and failed to correct, if it expressly or impliedly approved drafts of analysts' reports, the analysts represented that the information in the forecasts was became “conduits ... through which Quickturn accurate or coincided with the company's views. In provided false information to the marketplace.” re Syntex Corp. Securities Litigation, 855 F.Supp. FAC, ¶ 44. 1086, 1097 (N.D.Cal.1994). For liability to attach, the plaintiff must demonstrate: 1) that a corporate *9 After these general allegations, Plaintiffs go on to insider adopted the analysts' forecasts, see Elkind v. cite and quote liberally from the specific analysts' Liggett & Myers, Inc., 635 F.2d 156, 163 (2d reports in question, FAC, ¶ ¶ 62, 63, 65, 70, 71, 72, Cir.1980), and; 2) that the insider knew the analysts' 73, 74, 78, 79, 80, 81, 82, 83, 84, 85, 86, 87, 88, 89, forecasts were unreasonable when made yet failed to 90, 93, 94, 95, 96, 97, 98, 99. However, Plaintiffs do disclose their unreasonableness to investors. See not point to specific interactions between Quickturn Wielgos v. Commonwealth Edison, 892 F.2d 509, 516 insiders and analysts which led to each of the reports (7th Cir.1989); In re Verifone Securities Litigation, being issued. 784 F.Supp. 1471, 1486-87 (N.D.Cal.1992). Plaintiffs' have failed to plead adoption with particularity for any of the analysts' statements. The i. Adoption general introductory paragraphs of the FAC alone, which allege that a group of three Quickturn insiders To plead adoption of analysts' statements with a made regular contacts with unspecified analysts, are sufficient degree of specificity to satisfy Rule 9(b), a not sufficient to satisfy Rule 9(b). These allegations plaintiff must: 1) identify specific analysts' forecasts are far too vague. There are no specific facts pled and name the insider who adopted them; 2) point to which suggest a two-way flow of information

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The only analysts' reports that even come close to satisfying the entanglement requirement are those d. The “Scheme” to Defraud seven that Quickturn allegedly copied and circulated as part of their “investor relations package.” See *10 Finally, Plaintiffs argue that Defendants FAC, ¶ 42. These reports are quoted in the FAC at participated in a “scheme” or “course of business” ¶ ¶ 62, 64, 70, 73, 81, 83, 87, 96. By reproducing designed to defraud the investing public. Plaintiffs and including these reports in their own stockholder characterize this as an “independent basis for informational materials, Quickturn may have liability” under § 10(b). See Plaintiffs' Opposition, impliedly represented that the information contained at 15. in those reports was accurate or reflected the company' own views. See In re RasterOps Plaintiffs' “scheme” claims are misguided for two Corporation Sec. Litig., [1994-95 Binder] reasons. First of all, pursuant to the Supreme Court's Fed.Sec.L.Rep. (CCH) ¶ 98,467, at 91,195 (N.D.Cal. ruling in Central Bank v. First Interstate Bank, 511 Oct. 31, 1994). However, because Plaintiffs do not U.S. 164, 114 S.Ct. 1439 (1994), several courts in identify the particular “investor relations package” or this district have held that secondary liability claims provide the date on which it was sent out, Plaintiffs' based on allegations of “conspiracy” are not allegations with respect to these analysts' reports fail actionable under § 10(b). Syntex, 855 F.Supp. 1097- as well. 98; RasterOps, [1994-95 Binder] Fed.Sec.L.Rep. (CCH) ¶ 98,467, at 91,195; In re Ross Securities Litigation, [1994-95 Binder] Fed.Sec.L.Rep. (CCH) ¶ ii. Unreasonableness 98,363, at 90,495 (N.D.Cal. July 21, 1994). Here, Plaintiffs' “scheme” allegations are no more than a Even if Plaintiffs had satisfied the adoption thinly disguised attempt to avoid the impact of the requirement, they have still failed to demonstrate Central Bank decision. See, e.g., In re Gupta Corp. unreasonableness: that the analysts' forecasts lacked Securities Litigation, 1994 WL 748988, *28 a reasonable basis when issued. (N.D.Cal. Dec. 9, 1994) (rejecting the plaintiffs' attempts to recharacterize non-actionable conspiracy An analyst's forecast is unreasonable only if, at the claims as “scheme” claims, and dismissing such time of publication, the speaker: 1) does not claims with prejudice). genuinely believe the statement; 2) has no reasonable basis for that belief, or; 3) is aware of Second, in the absence of any sufficiently pled, undisclosed facts tending to seriously undermine the actionable misrepresentations or omissions, there is accuracy of the statement. In re Verifone Securities no basis for liability under § 10(b). See Ross, [1994- Litigation, 11 F.3d 865, 870-71 (9th Cir.1993). It is 95 Binder] Fed.Sec.L.Rep. ¶ 98,363, at 90,495 (there not enough that the forecast merely turned out to be can be no secondary liability under § 10(b) without a incorrect. Id. (“the fact that the prediction proves to primary violation: “In civil cases conspiracy is a be wrong does not render the statement untrue when theory of liability available only when a completed made.”); Glenfed, 42 F.3d at 1548 (“It is clearly tort exists”). Where, as here, there are no primary insufficient for plaintiffs to say that the later, violations pled with particularity, any secondary sobering revelations make the earlier, cheerier liability claims must fail as well. statement a falsehood”). For the foregoing reasons, Plaintiffs' “scheme” claims Here, Plaintiffs have merely paraphrased or quoted are DISMISSED WITH PREJUDICE. sections of the analysts' reports, and then alleged generally that all these statements were false or misleading when published. See FAC, ¶ ¶ 76(i)-(j), B. § 11 and § 12(2) Claims 101(m)-(n). Plaintiffs do not point to any contemporaneous facts or information that undermine Plaintiffs also assert claims under § § 11 and 12(2) the accuracy or veracity of any particular statements of the Securities Act of 1933, 15 U.S.C. § 77k & 77l. when they were made. Such allegations are not pled Based on the following, Plaintiffs fail to state a claim with sufficient particularity to withstand scrutiny for relief under either of these statutory sections.

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2. § 11 Claims 1. Applicability of Fed.R.Civ.P. 9(b)'s Particularity Requirements to § 11 and § 12(2) Claims Although neither party specifically addresses the adequacy of Plaintiffs' § 11 cause of action, except to Under § 11, 15 U.S.C. § 77k, anyone who buys a argue over whether Rule 9(b)'s particularity security pursuant to a false or misleading registration requirements apply to it, Plaintiffs have failed to state statement may sue for damages. To prevail, the a claim under this statutory provision. plaintiff must demonstrate: 1) that the registration statement contained an omission or Section 11 imposes liability only for misrepresentation, and; 2) that the misrepresentation misrepresentations or omissions contained in or omission was material. See Verifone, 11 F.3d at “registration statements.” 15 U.S.C. 77k. An SEC 868-69. Under § 12(2), 15 U.S.C. § 771, buyers registration statement contains a cover letter, a have an express cause of action for rescission against preliminary prospectus, and a technical disclosures sellers of securities who make material section. The final prospectus is not part of the misrepresentations or omissions “by means of a registration statement; it is filed later as a separate prospectus or oral communication.” In contrast to § document. See 17 C.F.R. § 230.424. 10(b), liability under both § 11 and § 12(2) does not require scienter. See Kaplan v. Rose, [1994-95 Here, Plaintiffs' allege that they bought Quickturn Transfer Binder] Fed.Sec.L.Rep. (CCH) ¶ 98,422, at stock that was “issued pursuant to the Prospectus.” 90,874-75 (9th Cir. Oct. 11, 1994) (under § 11, FAC, ¶ ¶ 20-21. They go on to cite alleged false defendants may be held liable for innocent or and misleading statements contained in Quickturn's negligent material misrepresentations or omissions); December 15, 1993 Final Prospectus. See FAC, ¶ ¶ Ellis v. Carter, 291 F.2d 270, 272 (9th Cir.1961) (§ 58-60. Plaintiffs do not identify any 12(2) (relieves the plaintiff of proving scienter). misrepresentations or omissions contained in any part of the registration statement; nor do they state that *11 Plaintiffs argue that since their § 11 and § 12(2) they bought stock pursuant to such a statement. As claims do not allege fraud and do not require scienter, such, Plaintiffs' allegations fail to state a claim under Rule 9(b)'s particularity requirements are not § 11. See Shapiro, 964 F.2d at 288-89 (holding that applicable. Plaintiffs are correct. Although some Plaintiffs' allegations that they bought stock pursuant courts have applied Rule 9(b) to § 11 and § 12(2) to a “prospectus” did not state a claim under § 11 claims that merely adopt allegations of fraud in a because a prospectus and a registration statement are wholesale manner, see Melder v. Morris, 27 F.3d “distinctly separate document[s] under the federal 1097, 1100 n. 6 (5th Cir.1994); Shapiro v. UJB securities laws”). Financial Corp., 964 F.2d 272, 287-88 (3rd. Cir.1992), cert. denied, 113 S.Ct. 365, 121 L.Ed.2d 278 (1992), here Plaintiffs have explicitly excluded 3. § 12(2) Claims their fraud allegations from Counts I and II of the FAC. Instead, they base these counts solely on In the recent case of Gustafson v. Alloyd Co., Inc., averments of negligent or innocent material 513 U.S. 561, 115 S.Ct. 1061 (1995), the Supreme misrepresentations. FAC, ¶ ¶ 116-129. In this Court held that § 12(2) applies only to initial public situation, where there are no allegations of intentional offerings, not aftermarket transactions. Based on or willful fraudulent conduct, Rule 9(b) is not this decision, Defendants argue that Plaintiffs fail to applicable. See Phar-Mor, Inc. Securities Litigation, state a claim under § 12(2) because Plaintiffs do not 848 F.Supp. 46, 48 (W.D.Pa.1993) (refusing to apply allege that they bought stock in Quickturn's IPO. In Rule 9(b) to § 12(2) claim which tracked statutory response, Plaintiffs argue that, notwithstanding the language, and was worded solely in negligence Supreme Court's decision, they may recover under § terms). 12(2) because: 1) their shares are directly traceable to those issued in Quickturn's IPO, and; 2) their Therefore, Plaintiffs' § 11 and § 12(2) claims cannot shares should be deemed to be purchases in the be disposed of under the analysis of Section I.A. offering because they bought them within 90 days above. The Court must decide whether Plaintiffs' § thereafter. 11 and § 12(2) allegations state a claim for relief under the more lenient notice pleading standards. *12 Plaintiffs' arguments are unpersuasive. Even if the Court were to accept arguendo the proposition

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 158 of 163 Not Reported in F.Supp. Page 9 Not Reported in F.Supp., 1995 WL 241448 (N.D.Cal.) (Cite as: Not Reported in F.Supp.) that § 12(2) applies to aftermarket stock purchases N.D.Cal.,1995. bearing a sufficient nexus to an IPO, Plaintiffs have Stack v. Lobo not alleged any facts giving rise to an inference that Not Reported in F.Supp., 1995 WL 241448 their shares were either “directly traceable” to (N.D.Cal.) Quickturn's IPO or were purchased within 90 days thereof. Plaintiffs have merely alleged that they Briefs and Other Related Documents (Back to top) bought shares issued “pursuant to the Prospectus.” FAC, ¶ ¶ 20-21. Plaintiffs do not provide the dates • 5:95CV20049 (Docket) (Jan. 20, 1995) when they bought their stock, or specify any other circumstances demonstrating a close relationship END OF DOCUMENT between their purchases and the IPO. Based on the allegations in the FAC, Plaintiffs could have purchased their stock at any time before the Class Period ended on January 5, 1995, more than a year after the IPO.

In sum, because Plaintiffs do not allege any facts demonstrating a nexus between their purchases of stock and the IPO, they fail to state a claim under § 12(2).

II. THE UNDERWRITERS' MOTION TO DISMISS

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

CONCLUSION

Based on the foregoing, all claims in the FAC against all Defendants are DISMISSED as follows: 1) Plaintiffs' claims based on the “scheme” to defraud under § 10(b) are DISMISSED WITH PREJUDICE 2) All of Plaintiffs' other claims are DISMISSED WITH LEAVE TO AMEND.

Should Plaintiffs wish to file a Second Amended Complaint, they must do so by May 19, 1995. Thereafter, if both the Corporate Defendants and the Underwriters decide to file motions to dismiss, they should, if possible, coordinate their motions for hearing on the same date.

IT IS SO ORDERED.

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Williams v. WMX Technologies, Inc, 112 F.3d 175, th 177 (5 Cir.1997). A plaintiff's claims for a violation United States District Court, N.D. Texas, Dallas of § 10(b) of the 1934 Act must satisfy the strict Division. pleading requirements for fraud set out in Fed. R. Allan ZISHKA, et al., On Behalf of Themselves and Civ. P. 9(b) and the PSLRA. Fed. R. Civ. P. 9(b) All Others Similarly Situated, Plaintiffs, requires a specification of the alleged fraudulent v. statements, identification of the speaker, a description AMERICAN PAD & PAPER COMPANY, et al. of when and where the statements were made, and an Defendants. explanation of what makes such statements No. 3:98-CV-0660-M. fraudulent. Williams, 112 F.3d at 178. Where, as here, allegations are made on information and FN1 Sept. 13, 2000. belief, a plaintiff must state with particularity all facts on which the belief is formed. 15 U.S.C. § 78u- 4(b)(2). MEMORANDUM OPINION AND ORDER LYNN, J. *1 This is a securities fraud case, brought as a class FN1. Despite the fact that the Complaint action for the period from July 2, 1996 through purports to be predicated on an investigation December 17, 1997, against various persons and by Plaintiffs' counsel, the Court finds that entities associated with now bankrupt American Pad information and belief pleading triggers the & Paper (“Ampad”). Claims are asserted under § specificity requirement. 10(b) of the Securities Exchange Act of 1934 (“1934 Act”), SEC Rule 10b-5, and against certain For this and other similar cases pending before this Defendants under § 20(a) of the 1934 Act. The Court, the Court now adopts standards which it will Defendants are large shareholders of Ampad, certain apply in evaluating Complaints subject to the PSLRA of its officers and directors, the parent of its lending unless: (1) appellate courts whose decisions are bank, and certain of the underwriters for Ampad's dispositive in this district rule that the law mandates July 2, 1996 Initial Public Offering (“IPO”), who otherwise; or (2) Congress amends the PSLRA. First, later issued favorable analyst reports on Ampad. The for proof of scienter, which is “a mental state embracing intent to deceive, manipulate or defraud,” Defendants move to dismiss, claiming that under Fed. FN2 R. Civ. P. 9(b) and (12)(b)(6), and the Private the Court concludes that scienter can be based Securities Litigation Reform Act (“PSLRA”), upon allegations of “motive and opportunity” as Plaintiff's Complaint cannot withstand legal scrutiny. alternative to allegations of “conscious behavior or For the reasons discussed below, the Court finds the severe recklessness,” thereby following the lead of Complaint deficient and thus GRANTS the Motions most of the other courts in this district. See Branca v. Paymentech, Inc., No. 3:97-CV-2507-L, 2000 WL to Dismiss, but grants Plaintiffs leave to amend. * 145083, at 5 (N.D.Tex. Feb. 8, 2000); Coates v. The challenged Complaint is 136 pages long, but Heartland Wireless Communications, Inc., 55 despite its length, many of its allegations are F.Supp.2d 628, 642 (N.D.Tex.1999) (“Coates II”); undetailed and conclusory, it is undifferentiated as to Zuckerman v. Foxmeyer Health Corp., 4 F.Supp.2d the various Defendants, and repeats, multiple times, 618, 623 (N.D.Tex.1998); STI Classic Fund v. Bollinger Indus., No. 3:96-CV-823-R, 1996 WL vague and overly broad allegations. Such an * approach is insufficient to satisfy the heightened 885802, at 1 (N.D.Tex. Oct. 25, 1996), report and pleading standards of the PSLRA and Fed. R. Civ. P. recommendation adopted in STI Classic Fund v 9(b). Bollinger Indus. Inc., 1996 WL 866699 (N.D.Tex. Nov. 12, 1996); accord, Robertson v. Strassner, 32 To state a claim under § 10(b) of the 1934 Act, F.Supp.2d 443, 448 (S.D.Tex.1998). Second, this Plaintiffs must allege (1) a misrepresentation or Court rejects the notion of “group pleading,” and omission; (2) of a material fact; (3) made with the “group publication” and concludes that such intent to defraud; (4) on which the Plaintiffs relied; concepts, if previously sustainable, did not survive (5) which proximately caused the Plaintiffs' injury. the adoption of PSLRA. Coates v. Heartland

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Wireless Communications, Inc., 26 F.Supp.2d 910, Litig., 50 Supp.2d 662, 677 916 (N.D.Tex.1998) ( “Coates 1”). To comply with (E.D.Mich.1999) and In Re Silicon the PSLRA, Plaintiffs thus must plead with Graphics, Inc Sec. Litig., 183 F.3d 970, 987 particularity their allegations against each individual (9 th Cir.1999). In both of those cases, Defendant. The Court finds the Complaint at issue however, the courts analyzed the stock sales here generally deficient for its failure to delineate in detail and rejected the motive and specifically what each Defendant knew and what opportunity test for proof of scienter. Here, each Defendant said. Plaintiffs will be required to the Court adopts a more lenient standard, replead to remedy such omission. and declines to hold that sales yielding proceeds which appear to have covered Hanson and Gard's costs for all of their FN2. Ernst & Ernst v. Hochfelder, 425 U.S. Ampad stock investment cannot support a 185, 193 (1976). strong inference of fraud. The Court does not have before it admissible record PARTICULAR ASPECTS OF COMPLAINT evidence of the option prices, and consequently does not know that exercise of *2 The PSLRA requires a plaintiff to “state with the options was potentially attractive. particularity facts giving rise to a strong inference that the defendant acted with the required state of FN4. In the IPO, on July 2, 1996, Ampad's mind.” 15 U.S.C. § 78u-4(b)(2). The Court will thus stock sold at $15 per share. It fell to $7 3/4 review the scienter allegations in this Complaint as to per share on December 17, 1997, the last each Defendant. day of the class period.

Defendants Charles Hanson and Russell Gard, FN5. Some of these contentions are Ampad's Chief Executive Officer and Chief referenced in the briefs, not in the Operating Officer, respectively, sold a total of Complaint. Plaintiffs are directed to include 100,000 of their shares FN3 on November 10, 1997, such allegations in their Amended for $13 per share. Although Ampad's stock price Complaint, if they intend to rely on them. increased slightly shortly after their sales, it was not long before the stock price dropped substantially.FN4 With respect to the other individual defendants, the Plaintiffs allege that Hanson and Gard knew bad Complaint does not adequately allege scienter as to news about Ampad was forthcoming, and that they them. Defendant Lavine, an outside director, bought therefore sold enough stock to cover their cost or at Ampad stock on November 5, 1997 at $13.19, and least to avoid losses. FN5 The Court finds such apparently did not sell that stock during the class allegations sufficient to satisfy the motive aspect of period. (Other non-Defendant officers bought Ampad scienter. With respect to Hanson and Gard, given stock at $12.88 and $12.94 on October 29, 1997 and their key roles in the Company, opportunity to November 7, 1997, respectively). The other outside defraud is clearly extant. directors, Defendants Gay, Wolpow and Watterson, neither bought nor sold stock during the class period.

FN3. During the class period, Hanson and With respect to all of the outside directors, Lavine, Gard sold 20% of Ampad stock they owned, Gay, Wolpow and Watterson, a legally sufficient or 5% of their total stock and options. Five motive is not attributed to them. The fact that they are percent has been considered too employees of Bain Capital, which sponsored funds insignificant to support the “strong inference which owned substantial stock in Ampad, is, as a of fraud” required by the PSLRA, while matter of law, insufficient to provide them with a twenty percent has generally been motive to perpetrate a fraud. There is no adequate considered sufficient. Defendants thus urge pleading of claims against them under the higher that the Court should consider Hanson and “conscious behavior or severe recklessness' standard. Gard's options in calculating what Further, no individual allegations are asserted against percentage of their Ampad stock portfolios them except for the claim that each of them signed Hanson and Gard sold Plaintiff asserts the the 1996 10-K, and that all but Watterson signed converse argument. In urging that this Court Ampad's Registration Statement. In light of this should take options into account, Defendants Court's rejection of the group pleading/group cite In Re Credit Acceptance Corp. Sec. publication doctrine, those allegations do not state

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The allegation that during or prior to the IPO the Court finds such allegations insufficient as a matter Underwriter Defendants participated in the making of of law to constitute motive as a basis for establishing statements they knew or should have known to be scienter. See Melder v. Morris, 27 F.3d 1097, 1102- false.FN6 The vague hope of future business and the 04 (5 th Cir.1994); Tuchman v. DSC Communications existence of an indemnity do not provide an adequate Corp., 14 F.3d 1061, 1068-69 (5 th Cir.1994). Neither motive for the contention that the underwriters, later is the “conscious behavior or severe recklessness' acting as analysts, gave positive outlooks for standard satisfied by the allegations against Ampad's future, despite an alleged belief that such Defendants Benson and McAleer. positive spins were false. In fact, on this point, the Plaintiffs appear to be quite inconsistent. The *3 With respect to the Bain Defendants (Bain Plaintiffs allege both that the individual analysts were Capital, Inc., Bain Venture Capital, a California “misled” (Complaint at ¶ 127), and that company Limited Partnership, Tyler Capital Fund, L.P., Tyler insiders reviewed analysts' reports before they were Massachusetts, L.P., Tyler International L.P. II, BCIP issued and assured the analysts of their accuracy (see Trust Associates, L.P., and BCIP Associates), Complaint at ¶ 106), but simultaneously urge that the Plaintiffs' allegations of legally sufficient motive are analysts' statements were false, misleading and similarly lacking. Plaintiffs allege that the Bain recklessly made by “defendants.” (Plaintiffs' Brief at Defendants were motivated to commit fraud because 51-53). Such inconsistent and overly broad pleading they stood to make a substantial profit in the IPO, is insupportable under the PSLRA and Fed. R. Civ. P. would benefit from an inflation in the value of their 9(b). retained holdings, and could expect to obtain large advisory fees in the future. However, the investing Bain defendants retained 10 million Ampad shares, FN6. The underwriters are not even alleged which were not sold even when the stock price to have spoken during the pre-IPO exceeded $24. Such facts are wholly inconsistent roadshows. with the profit motive attributed to the Bain Defendants. If they knew, as Plaintiffs allege, that the *4 Finally, as to Defendant Bankers Trust Ampad “house of cards” was doomed to fail, they Corporation (“BTC”), a New York bank holding would have disposed of such shares. Bain Capital, company, the allegations against it in the Complaint Inc. and Bain Venture Capital, respectively, the are also insufficient. Plaintiffs must show how BTC management company and general partner of the four committed the wrongdoing alleged. It is insufficient investment funds, did not own Ampad stock. The for the Plaintiffs to allege conclusorily that BTC Court finds the compensation motive legally controlled or conspired with one or both of its insufficient to state a claim. subsidiaries, underwriter BT Securities, or Ampad's lender Bankers Trust Company (not named in the Sufficient allegations of “conscious behavior or Complaint). severe recklessness” are not stated as to the Bain Defendants; rather, such allegations are The allegations in the Complaint regarding the unsupportable conclusions without an adequate Williamhouse acquisition do not state actionable factual basis. To state a claim under the PSLRA claims. At page nine, the Ampad prospectus against those parties, Plaintiffs must allege what each accurately depicted Ampad's performance with (pro of the Bain Defendants knew, who specifically knew forma), and without (actual), Williamhouse's it, and when they learned it. Plaintiffs' claims that the numbers included. As a matter of law, there is Bain Defendants must have known the true facts nothing deceptive about such a disclosure. To the because the funds, managed by Bain, owned a extent Plaintiffs claim that Williamhouse's costs were substantial amount of Ampad stock, and because inaccurately reported by Ampad (Complaint ¶ several Bain employees were directors of Ampad, is 126(a)), Plaintiffs must plead more specifically what legally insufficient. See generally Tuchman v. DSC the deficiencies with the reporting were, what was Communications Corp., 14 F.3d 1061, 1068 (5 th known about the deficiencies, when and by whom,

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 162 of 163 Not Reported in F.Supp.2d Page 4 Not Reported in F.Supp.2d, 2000 WL 1310529 (N.D.Tex.), Fed. Sec. L. Rep. P 91,208 (Cite as: Not Reported in F.Supp.2d) and what effect the alleged misreporting had. proper claims actionable under the 1934 Act- particularly if they can support with facts claims that The Court finds the Plaintiffs' allegations regarding beginning in early 1997, certain Defendants knew, the LIFO reserve so confusing as to be legally contrary to their public disclosures, that the insufficient. In ¶ 50(e) of the Complaint, and at Williamhouse acquisition was not contributing what numerous other places as well, Plaintiffs contend that they had expected it would add to Ampad's bottom in 1996, Ampad's profits were being adversely line, that increasing paper prices had a serious affected by declining paper prices. However, the potential for adversely affecting Ampad's LIFO claim is apparently based on the premise that profitability, and that, contrary to prior public paper prices were rising (Complaint ¶ 129), that statements, Ampad would not be pursuing new proper LIFO accounting would thus decrease acquisitions and would not be introducing new profitability, and that the LIFO reserve thus should products. Plaintiffs may attempt to better delineate have been increased, not decreased. Plaintiffs allege such claims in their amended pleading. that the reserve was decreased for the third quarter of 1997, when Hanson and Gard made their sales, Based on the foregoing discussion, Defendants' presumably to artificially inflate Ampad's Motions to Dismiss the Complaint are granted. To the profitability and thus maximize its stock price and extent Plaintiffs may cure the deficiencies noted Hanson's and Gard's proceeds. In fact, however, herein, they are given one additional opportunity to Ampad's LIFO reserves in the third quarter of 1997, do so, by filing an Amended Complaint within forty- although less than the reserves in the first and second five days of the date of this Order. As an attachment quarters of 1997, were still more than twice what to the Amended Complaint, they shall provide a red- they had been in the last quarter of 1996. Plaintiffs' lined version, reflecting all additions and deletions pleadings are insufficient in claiming that anything made to the original Complaint. Plaintiffs are fraudulent was done with the LIFO reserves in 1997. directed to be specific, to eliminate confusing and During oral argument, Plaintiffs' counsel claimed that repetitive material and to present an amended by the third quarter of 1997, Ampad's LIFO reserve pleading which states facts with particularity as to was eliminated altogether. If that were true (and it each Defendant. The Court will look for weighty seems doubtful from the evidence before the Court) allegations in terms of substance, not in terms of the and paper prices were decreasing, seemingly no bulkiness of the Amended Complaint. With respect to fraud would be demonstrated. In light of the Bankers Trust Corporation and the outside directors confusing and vague nature of their claims regarding in particular, the Court assumes that Plaintiffs' claims the LIFO reserve, Plaintiffs are directed to replead. will, if reasserted, be substantially different from what they have asserted on theories which this Court The Court notes that the prospectus sets out four has rejected. Defendants shall then file such further pages of risk factors which appear directly at odds Motions to Dismiss as they deem appropriate, within with some of the Plaintiffs' allegations of forty-five days of the date of service of the Amended wrongdoing. When Plaintiffs replead, the Court will Complaint. Plaintiffs shall respond within thirty days carefully scrutinize the Complaint for allegations thereafter, and Defendants shall reply within twenty directly at odds with clearly, accurately disclosed days thereafter. The Court will then either schedule risks. Similarly, the Court will not treat as fraudulent the matter promptly for argument or rule without statements which merely articulate accurate historical argument. facts. All pending Motions to Dismiss are granted; *5 Finally, under Central Bank v. Interstate Bank, provided, however, Plaintiffs may replead within 511 U.S. 164 (1994), for a private claimant to state § forty five days of the date of this Order and further 10(b) claims, primary violations, not aiding and briefing, as set out herein, will follow. abetting claims, must be asserted in order to be sustainable. Plaintiffs' allegations against most of the SO ORDERED. Defendants sound to the Court like aiding and abetting claims. In repleading, Plaintiffs are directed N.D.Tex.,2000. to make clear the basis as to each Defendant for any Zishka v. American Pad & Paper Co. primary liability allegations under § 10(b). Not Reported in F.Supp.2d, 2000 WL 1310529 (N.D.Tex.), Fed. Sec. L. Rep. P 91,208 Despite the deficiencies in the Complaint alluded to above, the Plaintiffs have the potential for stating END OF DOCUMENT

Case 5:04-cv-04908-JW Document 146 Filed 06/02/2006 Page 163 of 163 Not Reported in F.Supp.2d Page 5 Not Reported in F.Supp.2d, 2000 WL 1310529 (N.D.Tex.), Fed. Sec. L. Rep. P 91,208 (Cite as: Not Reported in F.Supp.2d)