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Case 5:04-cv-04156-JW Document 177 Filed 10/24/2007 of 2

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MELVIN R. GOLDMAN (BAR NO. 34097)[email protected] ETH (BAR NO. 121617)[email protected] MAZZA (BAR NO. 184158)[email protected] R.S. FOSTER (BAR NO. 223682)[email protected] & FOERSTER LLP425 Market StreetSan Francisco , California 94105-2482Telephone : 415.268.7000Facsimile : 415.268.7522

Attorneys for DefendantsINFINEON TECHNOLOGIES AG,INFINEON TECHNOLOGIES NORTH AMERICACORP., ULRICH SCHUMACHER, PETER J. FISCHL,T. RUDD CORWIN, and HEINRICH FLORIAN

UNITED STATES DISTRICT COURT

NORTHERN DISTRICT OF CALIFORNIA

SAN JOSE DIVISION

In re INFINEON TECHNOLOGIES AGSECURITIES LITIGATION

This Document Relates To:

ALL ACTIONS

Master File No. C-04-4156-JW

CLASS ACTION

APPENDIX OF UNREPORTEDCASES CITED IN SUPPORT OFREPLY TO DEFENDANTS'MOTIONS TO DISMISS THETHIRD AMENDED COMPLAINTAND REQUEST FOR JUDICIALNOTICE

Hearing: November 19, 2007Time: 9:00 a.m.Dept.: Courtroom 8, 4th floorJudge: Honorable James Ware

APPENDIX OF UNREPORTED CASES CITED IN REPLY TO MTD 3AC & RJNMASTER FILE No. C-04-4156-JW

sf-2411266

Case 5:04-cv-04156-JW Document 177 Filed 10/24/2007 of 2

1 APPENDIX

2 CASES EXHIBIT

3 In re CV Therapeutics, Inc., Sec. Litig.,

4No. 03-03709-SI, 2004 WL 1753251 (N.D. Cal. Aug. 5, 2004) .................................................1

Dutton v. D&K Healthcare Res.,5 No. 4:04CV147SNL, 2006 U.S. Dist. LEXIS 42553 (E.D. Mo. June 23, 2006) ........................2

6 Howard v. Hui,No. C 92-3742 CRB, 2001 WL 1159780 (N.D. Cal. Sept. 24, 2001) .................. .......................3

7In re Impax Labs, Inc. Sec. Litig.,

8 No. C-04-04802-JW, 2007 U.S. Dist. LEXIS 52356 (N.D. Cal. July 18, 2007) . .......................4

9 Instituto De Prevision Militar v. Merrill Lynch & Co., Inc.,No. 05-22721-CIV, 2007 WL 2900318 (S.D. Fla. Sept. 28, 2007) ..................... .......................5

10In re In Vision Techs., Inc. Sec. Litig.,

11 No. C-04-03181-MJJ, 2006 U.S. Dist LEXIS 76458 (N.D. Cal. Aug. 31, 2006) .......................6

12 Knollenberg v. Harmonic, Inc., No. 03-16238, 2005 WL 2980628 (9th Cir. 2005) .......................7

13 Libon v. Infineon Tech. AG,No. 3:04-CV-929, 2006 U.S. Dist. LEXIS 76430 (E.D. Va. Aug. 7, 2006) ........ ....................... 8

14Menkes v. Stolt-Nielsen, S.A.,

15 No. 03-CV-409-DJS, 2006 U.S. Dist. LEXIS 42644(D. Conn. June 19, 2006) ..................................................................................... ....................... 9

16In re Micron Techs. Sec. Litig.,

17 No. CV-06-085-S-BLW, 2007 U.S. Dist. LEXIS 12446 (D. Id. Feb. 21, 2007) . ..................... 10

18 Powell v. Idacorp, Inc.,

19No. 04-249-S-EJL, 2007 WL 1498881 (D. Idaho May 21, 2007) ............................................ 11

In re Regal Commcn's Corp. Sec. Litig.,20 No. 94-179, 1996 WL 411654 (E.D. Pa. July 17, 1996) .......................................................... 12

21 In re Refco Inc. Sec. Litig.,

22No. 05 Civ. 8626 (GEL), 2007 WL 1280649 (S.D.N.Y. Apr. 30, 2007) .................................. 13

Siemers v. Wells Fargo & Co.,23 No. C-05-04518 WHA, 2006 U.S. Dist. LEXIS 81097 (N.D. Cal. Oct. 24, 2006) .................. 14

24 In re VeriSign Corp. Sec. Litig.,

25No. 02-02270-JW, 2006 U.S. Dist. LEXIS 81419 (N.D. Cal. Apr. 6, 2006) ............................ 15

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APPENDIX OF UNREPORTED CASES CITED IN REPLY TO MTD 3AC & RJNMASTER FILE No. C-04-4156-JW

EXHIBIT 1

Case 5:04-cv-04156-JW Document 177-2 Filed 10/24/2007 Page 1 of 214

Briefs and Other Related DocumentsIn re CV Therapeutics, Inc.N.D.Cal.,2004.

United States District Court,N.D. California.In re CV THERAPEUTICS, INC. Securities Litiga-

tionNo. C 03-03709 SI.

Aug. 5, 2004.

Patrick J. Coughlin, Reed R. Kathrein, LerachCoughlin Stoia & Robbins LLP, Sylvia Wahba, Mil-berg Weiss Bershad & Shulman LLP, Robert A.Jigarjian, Green & Jigarjian LLP, San Francisco, CA,Darren J. Robbins, William S. Lerach, LerachCoughlin Stoia & Robbins LLP, San Diego, CA,Sean M. Handler, Esq., Schiffrin & Barroway, LLP,Bala Cynwyd, PA, for Plaintiffs.John C. Tang, Latham & Watkins, Paul H. Dawes,Latham & Watkins, Menlo Park, CA, Michele D.Johnson, Latham & Watkins, Costa Mesa, CA, forDefendants.

ORDER GRANTING IN PART AND DENYING INPART DEFENDANTS' MOTION TO DISMISS;

GRANTING IN PART AND DENYING IN PARTDEFENDANTS' MOTION FOR JUDICIAL NO-

TICEILLSTON, J.*1 This Document Relates to All Actions

On June 25, 2004, this Court heard argument on themotions to dismiss the consolidated complaint by de-fendants CV Therapeutics, Inc., Louis Lange, BrentBlackburn, Daniel Speigelman, and Luiz Belardinelli.Having carefully considered the arguments of theparties and the papers submitted, the Court DENIESthe motions to dismiss against CV Therapeutics andindividual defendants Lange and Speigelman. TheCourt GRANTS the motion to dismiss by individualdefendants Brent K. Blackburn and Luiz Belardinelliwithout leave to amend. The Court GRANTS in partand DENIES in part defendants' requests for judicialnotice. Reasons for the Court's decisions are set forthbelow.

BACKGROUND

This is a securities class action against CV Thera-peutics, Inc. (“the Company”) and certain of its of-ficers (the “individual defendants”) under Sections10(b) and 20(a), and Rule 10b-5 of the Securities Ex-change Act of 1934 (the “Exchange Act”). The caseis brought on behalf all purchasers of the publicly-traded securities of the Company between December30, 2002 and December 5, 2003 (“the class period”).

CV Therapeutics is a Palo Alto, California“biopharmaceutical company focused on the discov-ery, development and commercialization of newsmall molecule drugs for the treatment of cardiovas-cular diseases.” ConsolCompl. ¶ 2, 16. “Throughoutthe Class Period, defendants misled analysts, the in-vesting public and even the FDA [Food and DrugAdministration] into believing that their novel anti-anginal drug, Raxena, was safe and effective for pub-lic use in an unrestricted population, and that theCompany had conducted sufficient clinical studies toprove it.” Consol. Compl. ¶ 3. The complaint allegesthat defendants' false and misleading statements arti-ficially inflated the Company's stock. Consol. Compl.¶ 4.

Plaintiffs allege that in July, 2003, defendants mis-represented that the FDA had scheduled Raxena forreview by its Cardiovascular-Renal Advisory Com-mittee (the “Advisory Committee”) on September15-16, 2003, “an event which signifies that the FDAis ready to act on the drug.” Consol. Compl. ¶ 5. Yet,“[i]nternal FDA notes ... reveal that ... there was littlelikelihood that such a meeting could take place.” Id.When the Company acknowledged on August 1,2003, that “this alleged meeting was ‘cancelled,” ’the stock price fell 20.8%. Id. On October 23, 2003,the Company announced that the Advisory Commit-tee would review Raxena on December 9, 2003, res-ulting in a stock price increase from $18.22 per shareon October 22, 2003 to $22.45 per share on October23, 2003. Consol. Compl. ¶ 6.

On October 30, 2003, “the FDA issued an‘approvable letter with conditions' indicating that

Not Reported in F.Supp.2d Page 1Not Reported in F.Supp.2d, 2004 WL 1753251 (N.D.Cal.), 59 Fed.R.Serv.3d 251(Cite as: Not Reported in F.Supp.2d)

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‘additional clinical information is needed prior to ap-proval.” Consol. Compl. ¶ 7, citing Ex. 2. On thisnews the stock price fell 21.7%. Id. “On the eve ofthe December 9, 2003” hearing, the FDA released in-ternal documents in connection with its review of theCompany's Raxena New Drug Application (NDA).Documents released included the October 30, 2003Approvable Letter. The “documents reveal that theFDA found major deficiencies pertaining to the Com-pany's clinical studies, including the QT prolonga-tion,FN1 the efficacy in women, and the fact that98% of the study population was Caucasian.” Consol.Compl. ¶ 9, citing Ex. 4. On December 8, 2003, thestock price fell 27%, Consol. Compl. ¶ 10, and ana-lysts “slashed their estimates for the Company.” Con-sol. Compl. ¶ 11.

FN1. According to the Complaint, “Raxenais an anti-anginaltherapy drug, known to ex-tend the QT interval. Adverse pro-ar-rhythmic effects linked to QT interval pro-longation are of concern to the FDA. Sideeffects linked to QT interval prolongationinclude torsade de pointes, ventricular tachy-cardia, ventricular arrhythmia, ventricularectopy, ventricular fibrillation and flutter,cardiac arrest, sudden death, syncope, dizzi-ness and palpitations.” Consol. Compl. ¶ 34.

*2 According to the complaint, the defendants knewand concealed from the investing public the follow-ing information: first, the Company's July 7, 2003 an-nouncement of a forthcoming Advisory Committeemeeting was “misleading because neither the FDAnor CV Therapeutics had in fact yet decided to goahead with a September 2003 Advisory Committeemeeting for Raxena because of severe deficiencies inthe NDA”; second, the Company “was aware that itsdata regarding its findings of QT interval prolonga-tion posed serious concerns and had been portrayedin a misleading fashion to the investing public”; third,because “of the serious safety concerns regardingQT/QTc prolongation limiting chances of approvalfor the drug, the FDA had encouraged CV Therapeut-ics to study the drug as a second-line therapy”; fi-nally, defendants knew that “the safety and efficacydata of Raxena were so flawed and deficient that theNDA would not be approved without additional clin-

ical trials.” Consol. Compl. ¶ 14.

The lead plaintiff in this action, appointed by thisCourt on November 21, 2003, is David Crossen. Theindividual defendants are Louis G. Lange, a Com-pany founder and its Chairman and Chief ExecutiveOfficer (“CEO”); Brent K. Blackburn, the Company'sSenior Vice President of Drug Discovery and Pre-Clinical Development; Daniel K. Speigelman, a Seni-or Vice President of the Company and its Chief Fin-ancial Officer (CFO); and Luiz Belardinelli, theCompany's Vice President of Drug Research andPharmacologic Sciences. Consol. Compl. ¶¶ 20-23.Plaintiff alleges that each defendant is liable for mak-ing false statements or for failing to disclose “adversefacts known to him” about the Company.

Plaintiffs partly relied on four confidential witness in-terviews (CW 1-4) for the complaint's factual allega-tions. According to the witness interview statement,each confidential witness is a former employee or in-dependent contractor of the Company. Furthermore,each witness had “direct access to information thatsupports statements contained in the Complaint, andtheir accounts directly corroborate the independenttestimony of one another.” Consol. Compl. (WitnessInterviews) at 53. Now before the Court are motionsby the Company and by the individual defendants todismiss the complaint under Fed.R.Civ.P. 12(b)(6)and for the Court to take judicial notice of docu-ments.

LEGAL STANDARD

1. Rule 12(b)(6)

Under Federal Rule of Civil Procedure 12(b)(6), adistrict court must dismiss a complaint if it fails tostate a claim upon which relief can be granted. Thequestion presented by a motion to dismiss is notwhether the plaintiff will prevail in the action, butwhether the plaintiff is entitled to offer evidence insupport of the claim. See Scheuer v. Rhodes, 416 U.S.232, 236, 94 S.Ct. 1683, 40 L.Ed.2d 90 (1974), over-ruled on other grounds by Davis v. Scherer, 468 U.S.183, 104 S.Ct. 3012, 82 L.Ed.2d 139 (1984).

In answering this question, the Court must assumethat the plaintiff's allegations are true and must draw




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all reasonable inferences in the plaintiff's favor. SeeUsher v. City of Los Angeles, 828 F.2d 556, 561 (9thCir.1987). Even if the face of the pleadings suggeststhat the chance of recovery is remote, the Court mustallow the plaintiff to develop the case at this stage ofthe proceedings. See United States v. City of Red-wood City, 640 F.2d 963, 966 (9th Cir.1981).

*3 If the Court dismisses the complaint, it must thendecide whether to grant leave to amend. The NinthCircuit has “repeatedly held that a district courtshould grant leave to amend even if no request toamend the pleading was made, unless it determinesthat the pleading could not possibly be cured by theallegation of other facts.” Lopez v. Smith, 203 F.3d1122, 1130 (9th Cir.2000) (citations and internal quo-tation marks omitted).

2. Section 10(b) and Rule 10b-5

Section 10(b) of the Securities Exchange Actprovides, in part, that it is unlawful “to use or employin connection with the purchase or sale of any secur-ity registered on a national securities exchange or anysecurity not so registered, any manipulative or de-ceptive device or contrivance in contravention ofsuch rules and regulations as the [SEC] may pre-scribe.” 15 U.S.C. § 78j(b).

Rule 10b-5 makes it unlawful for any person to useinterstate commerce(a) To employ any device, scheme, or artifice to de-fraud,(b) To make any untrue statement of a material factor to omit to state a material fact necessary in order tomake the statements made, in the light of the circum-stances under which they were made, not misleading,or(c) To engage in any act, practice, or course of busi-ness which operates or would operate as a fraud ordeceit upon any person, in connection with the pur-chase or sale of any security. 17 C.F.R. § 240.10b-5

In order to state a claim under section 10(b) and Rule10b-5, the plaintiff must allege (1) a misrepresenta-tion or omission (2) of material fact (3) made withscienter (4) on which the plaintiff justifiably relied(5) that proximately caused the alleged loss. See

Binder v. Gillespie, 184 F.3d 1059, 1063 (9thCir.1999). Generally, plaintiffs in federal court arerequired to give a short, plain statement of the claimsufficient to put the defendants on notice. FederalRule of Civil Procedure also requires that “the cir-cumstances constituting fraud or mistake shall bestated with particularity.” Fed.R.Civ.P. 9(b).

3. Private Securities Litigation Reform Act

The Private Securities Litigation Reform Act of 1995(the “Reform Act” or the “PSLRA”) was enacted asan amendment to the Exchange Act. See In re SiliconGraphics Inc. Sec. Litig., 183 F.3d 970, 973 n. 2 (9thCir.1999). Under the Reform Act:In any private action arising under his chapter underwhich the plaintiff may recover money damages onlyon proof that the defendant acted with a particularstate of mind, the complaint shall, with respect toeach act or omission alleged to violate this chapter,state with particularity facts giving rise to a strong in-ference that the defendant acted with the requiredstate of mind. 15 U.S.C. § 78u-4(b)(2).

The required state of mind is “at a minimum, deliber-ate recklessness.” In re Silicon Graphics, 183 F.3d at983. Scienter may be pled and proven by reference tocircumstantial evidence. See In re Peoplesoft Sec. Lit-ig., No. C 99-0472, slip op. at 5 (May 26, 2000).However, when pleading on information and belief, aplaintiff must plead with “particularity” by“provid[ing] all facts forming the basis for[plaintiff's] belief in great detail.” In re SiliconGraphics, 183 F.3d at 983; see also 15 U.S.C. §78u-4(b)(1). Therefore, the Reform Act hasstrengthened the pleading requirements of FederalRule of Civil Procedure 9(b).

3. Rule 9(b)

*4 Rule 9(b) of the Federal Rules of Civil Procedurerequires that “[i]n all averments of fraud or mistake,the circumstances constituting fraud or mistake shallbe stated with particularity. Malice, intent, know-ledge, and other condition of mind of a person maybe averred generally.” Federal securities fraudclaims, like common law fraud claims, are subject tothe special pleading requirements of Rule 9(b). Se-




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megen v. Weidner, 780 F.2d 727, 731 (9th Cir.1985).

Rule 9(b) requires particularity in pleading the cir-cumstances constituting fraud. The Ninth Circuit hasinterpreted this requirement to mean that allegationsof fraud must be specific enough to give defendantsnotice of “the particular misconduct which is allegedto constitute the fraud.” See id. In the securities con-text, a plaintiff may aver scienter generally, but muststate the “time, place, and content” of the allegedmisrepresentations, and “an explanation as to why thestatement or omission complained of was false ormisleading.” In re Glen Fed, Inc. Sec. Litig., 42 F.3d1541, 1547-48 (9th Cir.1994)(en banc) (remanded toIn re Glen Fed, Inc. Sec. Litig., 60 F.3d 591 (9thCir.1995).

4. Control person liability

Under Section 20(a) of the Exchange Act, “[e]veryperson who, directly or indirectly, controls any per-son liable under any provision of this chapter or ofany rule or regulation thereunder shall also be liablejointly and severally with and to the same extent assuch controlled person ... unless the controlling per-son acted in good faith and did not directly or indir-ectly induce the act or acts constituting the violationor cause of action.” 15 U.S.C. § 78t(a).

5. Request for judicial notice

Generally, when considering a motion to dismiss, adistrict court must consider only the facts stated inthe plaintiffs' complaint, or in documents attached tothe complaint as exhibits or incorporated into thecomplaint by reference. Under certain circumstances,the court may also consider matters that are appropri-ate subjects of judicial notice under Fed.R.Evid. 201.Kramer v. Time Warner, 937 F.2d 767, 773 (2dCir.1991). While the general rule is that, “[m]attersoutside the pleadings are not to be considered by acourt in ruling on a 12(b)(6) motion to dismiss,” in asecurities action a court may also consider documentsthat the defendant has attached to its motion to dis-miss either as exhibits or accompanied by a requestfor judicial notice. Weiner v. Klais and Co., Inc., 108F.3d 86, 88 (6th Cir.1997).

DISCUSSION

1. The Company's motion to dismiss

In its motion to dismiss, the Company argues that de-fendants' statements concerning the efficacy andsafety of Raxena and its ultimate FDA approval had a“reasonable basis,” making the statements not falseor misleading when made. The Company argues thatplaintiffs' allegations demonstrate that the FDA con-cluded that “Raxena works” and that “at least four in-dependent Advisory Committee members providingFDA with expert advice concluded that Raxena issufficiently safe to be approved without furtherstudy.” Company's Motion at 1, citing Request forJudicial Notice (RJN) Ex. A at 361-67; 369-70; Com-pl. Ex. 7 at 1 (emphasis omitted). The Company ar-gues that plaintiffs have failed to meet the PSLRA'sheightened pleading standard for alleging fraud andthat plaintiffs have failed sufficiently to allege sci-enter.

*5 The Company divides the 27 challenged state-ments during the class period into five categories,which the Court adopts for the purpose of analysis:(1) Allegedly false or misleading optimistic state-ments regarding the likelihood of FDA approval,which statements fraudulently downplayed the exist-ence and significance of certain problems, principallythe significance of the QT prolongation issue;(2) Allegedly false or misleading statements regard-ing the data in the NDA, principally data that relatedto QT prolongation;(3) Allegedly false or misleading statements regard-ing the scheduling of the Advisory Committee meet-ing;(4) Allegedly false or misleading statements regard-ing the Approvable Letter; and(5) Allegedly false or misleading statements thatfailed to disclose the substance of ongoing discus-sions between CVT and the FDA between the timethe NDA was filed and the time the FDA issued itsApprovable Letter. Company's Motion at 12-13.FN2

FN2. Plaintiffs' Opposition categorizes theallegedly false or misleading statements intofour categories. The Court will use defend-ant's categorization in order to address themoving parties' arguments.













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In order to state a claim under Section 10(b), aplaintiff must allege specific facts showing that a de-fendant's statements were false or misleading whenthey were made. See Ronconi, 253 F.3d at 431, 434.The Company argues that the complaint fails to al-lege contemporaneous facts contradicting the chal-lenged statements, thus failing to show that the chal-lenged statements were false or misleading whenmade. Company's Motion at 14.FN3

FN3. For its argument concerning thePSLRA Safe Harbor and the Bespeaks Cau-tion Doctrine, as well as for its argument re-garding scienter, the Company relies on thearguments in the individual defendants' mo-tion to dismiss. Company's Motion at 25.

In their Opposition, plaintiffs argue that “defendantshave unwittingly provided plaintiffs with a smokinggun-the [FDA] Discipline Review Letter dated July17, 2003.” Oppo. at 1,FN4 citing Defs.' Decl. Ex.J.FN5 Plaintiffs argue that their complaint adequatelypled that “defendants continuously misrepresented tothe market their belief that Raxena was well on itsway to approval by the FDA, and that no significantissues posed a threat.” In its Reply, the Companycharacterizes the Discipline Review Letter as “just asnapshot of the discussions during the evolving pro-cess of moving a drug toward a final regulatory de-cision .” Company's Reply at 12. As the Court ex-plains below, the Complaint has survived the defend-ants' motions to dismiss, except with respect to de-fendants Blackburn and Belardinelli. Characteriza-tions of the allegations and evidence will need to waitfor the next stage of the litigation.

FN4. Plaintiffs have filed a consolidated op-position to the two motions to dismiss.

FN5. Plaintiffs seek incorporation of theDiscipline Review Letter into the complaintunder Branch v. Tunnel, 14 F.3d 449,453-54 (9th Cir.1994). Alternatively, theyseek leave to amend the complaint. Defend-ants have requested that the Court take judi-cial notice of the document, so the Courtgrants plaintiffs leave to amend because theletter contains four pages of very specific

concerns that the FDA had regarding Rax-ena, which defendants allegedly concealedfrom the public. Consol. Compl. ¶ 70.

A. “A reasonable basis” for statements concerning ef-ficacy and safety

The Company relies on DeMarco v. DepoTech Corp.,149 F.Supp.2d 1212 (S.D.Cal.2001), aff'd, No.01-55298, 2002 WL 461217 (9th Cir.2002) for its ar-gument that having a reasonable basis for believingin Raxena's safety and efficacy precludes defendants'liability for any alleged false or misleading state-ments. According to the Company, plaintiffs “ignorenumerous contemporaneous facts that providedample factual support for Defendants' statements.”Company's Motion at 15. For example, the Companyargues that plaintiffs have ignored that the October30, 2003 Approvable Letter stated, “there is evidencethat ranolazine is an effective anti-anginal drug in anundifferentiated population of patients, including pa-tients receiving submaximal treatment with otheranti-anginals.” Consol. Compl. Ex. 3. In their motionto dismiss, the individual defendants cite a commentduring the December 9, 2003 Advisory Committeemeeting made by Douglas Throckmorton, Director ofthe FDA's Division of Cardio-Renal Drug Products:

*6 I mean, Dr. Belardinelli, elegant presentation.Thank you for presenting an overview of the datafrom the sponsor's conclusions here. It's probably justworth noting that the FDA reviewers contested someaspects of the interpretation that you've presentedtoday and just informed us, in fact, that the reviewersdid conclude that there was evidence of transmuraldispersion under conditions of hypokalemia. I under-stand that you and they have had an opportunity totalk about that and disagree with that interpretation.Individuals' Motion to Dismiss (“Ind.Mot.”) at 7, cit-ing RJN Ex. A at 167-68.

The complaint alleges that defendants “consistentlydownplayed the severity of the QT interval prolonga-tion effect of Raxena.” Oppo. at 9. As just one ex-ample, Lange stated in a CNBC interview on Decem-ber 30, 2002, “we believe that for Ranolazine FN6

(ph) [the QT effect] won't be a particular problem forreview by the agency. It will be discussion item.”












Consol. Compl. ¶ 88. Plaintiffs argue that contempor-aneous facts indicate that this statement was false ormisleading when made. For example, plaintiffs pointto an FDA Clinical Review Document, which sum-marizes agency meeting minutes. “[C]oncerns raisedby the Agency in July, 2000 included ... QT prolong-ation, [which] remained a major concern and thecompany would have to prove that the clinical benefitoutweighed the safety risks.” On August 13, 2002,the minutes noted that “QT prolongation was a con-cern, and the Agency believed that additional safetydata were needed.” Consol. Compl. Ex. 4 at 13.

FN6. Both parties use the terms “Raxena”and “ranolazine” interchangeably.

Plaintiffs have alleged with particularity statementsthat were false and/or misleading when made; theyhave also demonstrated contemporaneous facts whichdemonstrate the falsity of the defendants' statements.As another Court held, “the concerns raised by theFDA ... were much more significant than a ‘bump onthe road’ and shed serious doubton the sufficiency ofthe trials. Accordingly, Defendants were obligated todisclose the FDA's concerns to render their statementnot misleading.” Amylin Pharmaceuticals, Inc. Sec.Litig., 2003 WL 21500525 at *8 (S.D.Cal.2003). At alater stage, the issue of the reasonableness of defend-ants' belief in their statements will arise again; fornow, the complaint has pled fraud with adequate par-ticularity.

B. Company argues that representations of NDA datawere accurate

The Company argues that plaintiffs have taken quota-tions out of context, thus misrepresenting the Com-pany's statements. For example, the complaint allegesthat defendant Lange said in a July 17, 2003 confer-ence call that “The QT affect [sic] that you see therecontinued to go up, and they will be in the 10 to 20millisecond range, but at a very symptomatic level.So, we are very comforted by the findings in thatstudy.” Consol. Compl. ¶ 101. Ex. 42. The complaintfurther alleges that this statement was false whenmade because “there were scores of instances of QTprolongation above 20 milliseconds of prolongationand 500 msec of interval, contrary to defendant

Lange's representations, as alleged in ¶¶ 62-70.” Con-sol. Compl. ¶ 102(e). The Company argues thatLange “was explaining mean QT prolongation, notraw numbers, and was referring to an extremely highdose.” Company's Motion at 17., citing Consol. Com-pl. Ex. 42 at 4; RJN Ex. C. According to the Com-pany, Lange's statement, taken in context, was accur-ate. Company's Motion at 17. The Company also ar-gues that “[n]othing in the Complaint or the confid-ential witness statements suggests that CVT scient-ists' alleged ‘manipulation’ of data was anything oth-er than the proper application of different correctionformulae to the QT data in conformity with acceptedscientific practices and in a manner consistent withFDA's instructions.” Company's Motion at 18.

*7 The Court will determine at a later stage, when therecord is more fully developed, whether plaintiffstook statements out of context. For now, plaintiffshave pled fraud with adequate particularity.

C. Statements regarding the cancellation of Septem-ber Advisory Committee Meeting

The Company argues that its July, 2003 statement re-garding a meeting scheduled to occur on September15, 2003 was accurate when made and the meeting'scancellation in August does not make the July state-ment inaccurate. Company's Motion at 19. The com-plaint alleges that Lange “admits to having prema-turely announced the Advisory Committee meetingbefore it was published in the Federal Register.” Con-sol. Compl. ¶ 83. In an August 4, 2003, conferencecall, Lange said, “obviously, today we wish we hadn'tdone it, but I want to say we were told by the FDAthat we were going to a September panel. And, youknow, that was in the queue for the federal registry.”Id. The complaint alleges that when the Companymade the July, 2003 statement, the FDA still awaitedadditional data from the Company. “CV Therapeuticslikely received a discipline letter and had decided toamend the NDA. Defendants, therefore, knew orwere at least deliberately reckless in announcing aSeptember 2003 review meeting.” Consol. Compl. ¶84. The Company argues that “[b]ecause the meetingwas cancelled before notice was due to be published[August 31, 2003 for a September 15, 2003 meeting],the fact that the meeting was not formally noticed in







the Federal Register or posted to the online calendardoes not change the fact that in July, FDA had in-formed CVT that the meeting had been scheduled.”Company's Motion at 19; 19, n. 33 (emphasis omit-ted).

On August 4, 2003, Lange and Speigelman conduc-ted a conference call with analysts to discuss theCompany's August 1, 2003 press release. Consol.Compl. ¶ 105. In the call, Lange explained that “moreor less routine stuff” had led to the cancellation of themeeting. Id. Despite having received the DisciplineReview Letter dated July 17, 2003, Lange said:We have not received any kind of non-approval let-ter, NOTHING, for example, regarding QTC [sic] ...or other issues in that regard ... we have received de-tailed questions surrounding such areas as statisticalmethods, preclinical methods, metabolism, toxico-logy and so forth ... they're routine and we should beable to resolve them. [W]e do not believe the newsimpacts the potential approvability of Raxena in anyway ... Consol. Compl. ¶ 105 (brackets and emphasisin the original).

Lange affirmed that nothing in the process so farmade him believe that another study would beneeded. Id. Lange also expressed confidence that theCompany would launch Raxena in 2004. “Now Iwant everyone to remember,” he said, “we still be-lieve that we're going to launch Raxena next year.”Id. In light of what Lange knew of the FDA's reserva-tions about Raxena when he made these statements,plaintiffs' complaint has pled fraud with sufficientparticularity.

D. Statements regarding the Approvable Letter

*8 The complaint alleges that the Company's state-ments regarding its receipt of an Approvable Letterwere false and misleading because they contained in-sufficient detail. The Company's October 30, 2003press release disclosed that it had received an Ap-provable Letter which stated that “additional clinicalinformation is needed prior to approval” of Raxena.Consol. Compl. Ex. 28. The complaint alleges thatthe company's stock price fell 21.7% in response tothis news and would have fallen further had the con-tents of the letter been adequately disclosed. Consol.

Compl. ¶ 114. The Company argues that its disclos-ure of the Approvable Letter's contents satisfied therequirements of Basic v. Levinson, 485 U.S. 224,231-32, 108 S.Ct. 978, 99 L.Ed.2d 194 (1988) (theomitted information would be deemed material ifthere is “a substantial likelihood that the disclosure ofthe omitted fact would have been viewed by the reas-onable investor as having significantly altered the‘total mix’ of information made available”) (citationomitted).

The Approvable Letter informed the Company that:[S]ubstantial additional clinical data are needed ... theAgency has three specific safety concerns that willneed to be addressed prior to approval: 1)[p]otentialtesticular toxicity, manifest as impairedfertility in rats ... 2) [d]elayed cardiac repolarization,manifest clinically as prolongation of the QT interval... you have neither provided sufficient rationale fordiscounting this as a potential clinical concern nordevised dosing strategies that would avoid significantQT prolongation in some patients ... Given that youhave demonstrated effects on a symptom (i.e.,angina), and given the availability of other anti-anginal drugs that do not prolong the QT interval,there needs to be a clear reason to approve a therapywith what appears to be an additional, possibly life-threatening risk ... 3)[a]dequate safety exposure ...The available data suggest a smaller effect of ran-olazine in women with angina; future clinical studiesshould further characterize this apparent gender dif-ference ... Consol. Compl. ¶ 85, citing ApprovableLetter (emphasis omitted).

The Complaint specifically alleges that the defend-ants fraudulently and misleadingly failed to reveal thedepth of the FDA's concerns.

E. Disclosure of ongoing discussion with the FDA

The Company argues that it had no duty to disclosethe substance of ongoing discussions between it andthe FDA. Company's Motion at 22. For this argu-ment, the Company relies on Medimmune, Inc. Sec.Litig., 873 F.Supp. 953, 966 (“[d]efendant, as a gen-eral proposition, had no duty to report its ongoingdiscussions with FDA during the review process”).Furthermore, “[i]n order for there to be liability under










10b-5 for omissions or nondisclosure, ... a duty tospeak must exist.” Id. (internal quotation marks andcitation omitted). Plaintiffs argue that once defend-ants started to reveal the contents of conversationswith the FDA, they had the duty to be truthful. Tosupport their argument, plaintiffs rely on Amylin,2002 U.S. Dist. LEXIS 19481 at *14 (S.D.Cal.2002),order amended on denial of reconsideration by In reAmylin Pharmaceuticals, Inc. Sec. Litig., 2003 WL21500525 (S.D.Cal.2003) and In re Sepracor, Inc.,Sec. Litig., 308 F.Supp.2d 20, 34 (D.Mass.2004)(motion to dismiss denied because defendants wererequired to disclose significant side effects pertainingto QT interval prolongation; animal studies revealingconcerns undermined company's predictions of itsdrug's success).

*9 In the instant case, the complaint contains manyparticularized allegations of defendants' representa-tions of Raxena's safety and efficacy, despite theirknowledge of the FDA's specific and serious reserva-tions. The Court, therefore, DENIES the Company'smotion to dismiss.

2. The individual defendants' motion to dismiss

The individual defendants have divided the chal-lenged statements into three categories: “allegedlyfalse statements regarding Raxena's efficacy andsafety profile, including the extent and significanceof QTc prolongation; allegedly false statements re-garding the scheduling and postponement of the ad-visory committee meeting; and allegedly false for-ward-looking statements about the likelihood of FDAapproval of Raxena.” Ind. Mot. at 2-3, citing state-ments attributed in the Consol. Compl. to specific in-dividual defendants (Lange at ¶¶ 88, 93, 101, 87, 94,100, 105; Speigelman at ¶ 109). The individual de-fendants argue that plaintiffs have not “adequately at-tributed” any allegedly false or misleading statementto Blackburn or Belardinelli. Ind. Mot. at 3.

A. Group-published information

The individual defendants concede that plaintiffshave pleaded with particularity concerning the twelvestatements above, specifically attributed to Lange andSpeigelman. However, defendants argue that

plaintiffs have failed to plead with particularity withregard to other statements allegedly attributed col-lectively to the individual defendants under the“group-published information doctrine.” Consol.Compl. ¶ 24, 87-91, 93-96, 99-101, 105, 107, 109,112-116. The group-published information doctrine“includes prospectuses, registration statements, annu-al reports, and press releases” and can excuse aplaintiff from attributing a statement to a particulardefendant if the plaintiff pleads that a company of-ficer was involved in the company's day-to-day af-fairs and in the preparation of its allegedly mislead-ing statements. In re Splash Tech. Holdings, Inc. Sec.Litig., 2000 WL 1727377, at *25 (N.D.Cal.2000)(citations omitted). The plaintiff must still plead withparticularly. Id. Defendants argue that plaintiffs havefailed to allege any false or misleading statementwith regard to Blackburn or Belardinelli, since theplaintiffs have failed to satisfy the requirements ofthe “group-published information doctrine” with re-gard to these two defendants.

The complaint has adequately pled Lange's and Spei-gelman's liability with respect to press releases andSEC filings under the group-published informationdoctrine. ¶¶ 20-22. As CEO and CFO, these two de-fendants had direct involvement in the Company'sday-to-day operations and were responsible for theCompany's representations in its press releases andSEC filings. See GlenFed, 60 F.3d 591, 593 (citationomitted); Howard v. Everex Sys., 228 F.3d 1057,1061-63 (9th Cir.2000).FN7 With respect to the otherindividual defendants, Blackburn and Belardinelli,however, the Complaint does not provide the basisfor individual liability under the group published in-formation doctrine. Consol. Compl. ¶¶ 21, 23. AsSenior Vice President of Drug Discovery and Pre-Clinical Development and Vice President of DrugResearch and Pharmacological Sciences, respect-ively, Blackburn and Belardinelli might or might nothave participated in the alleged misrepresentations inthe press releases and SEC filings. The Court, there-fore, GRANTS defendants' Blackburn's and Be-lardinelli's motions to dismiss as to group publishedinformation, without leave to amend .FN8

FN7. Even assuming arguendo that thegroup-published information doctrine failed





















to survive the PSLRA, Lange and Speigel-man were presumably directly responsiblefor the SEC filings and press releases andtheir liability for any misrepresentations inthese documents would not depend on thedoctrine.

FN8. The Court would ordinarily grant leaveto amend at this point, as to these individualdefendants. However, plaintiffs' counsel rep-resented at oral argument that he lacks anyadditional information regarding these twodefendants and he therefore did not seekleave to amend.

B. Scienter

*10 The individual defendants challenge the ad-equacy of plaintiffs' allegations to establish the neces-sary scienter, on various bases. They argue that to theextent that plaintiffs have relied on confidential wit-ness statements to establish scienter, the allegationsare insufficient to do so and the confidential wit-nesses lack the necessary qualifications. They disputeplaintiffs' allegations regarding alleged“manipulation” of data by using “QT correctionfactors.” Finally, they also argue that plaintiffs' alleg-ations of insider trading fail to create a strong infer-ence of scienter.

The Court disagrees. In a motion to dismiss, courtsmust consider “the larger question of whether [the]complaint, considered in its entirety, states factswhich give rise to a strong inference of deliberaterecklessness.” In re Silicon Graphics, 183 F.3d at985. As discussed above, the complaint pleads fraudwith particularity. Considered as a whole, the com-plaint also pleads scienter. “To date, the Companyhas not received approval from the [FDA] for any ofits drugs. Only one of the Company's drugs-Raxena...-has even reached the stage of being considered forFDA approval.” Consol. Compl. ¶ 2. “The Com-pany's survival depends on the approval of Raxena.”Consol. Compl. ¶ 50. Taken as a whole, the allega-tions of the complaint give rise to a strong inferenceof scienter with regard to the individual defendants.Since the complaint adequately pleads scienter, it isimputed to the Company. Nordstrom, Inc. v. Chubb

& Son, Inc., 54 F.3d 1424, 1435 (9th Cir.1995).

C. Safe harbor and bespeaks caution doctrines

The PSLRA contains a safe-harbor provision, so thatno liability will attach to the making of a forward-looking statement “if [it is] accompanied by mean-ingful cautionary statements identifying importantfactors that could cause actual results to differ materi-ally from those in the forward-looking statement.” Inre Vantive Corp. Sec. Litig., 110 F.Supp.2d 1209,1215 (N.D.Cal.2000) (citation omitted). Similarly,the “bespeaks caution” doctrine can protect a for-ward-looking statement that contains sufficient cau-tionary language or risk disclosure. In re Worlds ofWonder Sec. Litig., 35 F.3d 1407, 1413 (9thCir.1994). Defendants argue that sufficient warningsaccompanied all of its forward-looking statements.Ind. Mot. at 18 regarding press releases and confer-ence calls, citing Consol. Compl. Exs. 28, 29, 32, 33,38, 39, 40, 43, 45, 17, 19, 27, 34, 35, 42, and 44.

Plaintiffs correctly argue that the statements at issuewere allegedly fraudulent and/or misleading state-ments of historical fact. Oppo. at 34. For example,when the defendants possessed and failed to disclosedetailed information about the FDA's serious reserva-tions concerning Raxena's safety and efficacy, theyfailed to disclose historicalfacts. The fact that defend-ants used those inadequately disclosed historical factsto support unsound projections does not shield theiralleged misrepresentations as forward-looking state-ments. See, e.g, Amylin, 2003 U.S. Dist. LEXIS 7667,----16-17 (defendants' statements regarding clinicaltrials were not forward-looking; instead, they werestatements of “observed facts”).

*11 Furthermore, even if the statements were con-strued as forward-looking, the warnings accompany-ing the statements fail to shield the statements fromliability, since they did not indicate that the Companyalready knew that the FDA harbored serious doubtsabout Raxena. See, e.g., RJN Ex. U at 14 (SEC Form10-Q, filed for the Quarter ended June 30, 2002)(“Regulatory authorities such as the FDA may inter-pret these data differently, which could delay, limit orprevent regulatory approval of ranolazine”)(emphasis added). The FDA had already informed
















the Company and its officers of its concerns with re-gard to the Company's data; the use of the word“may” was misleading. The “bespeaks caution” doc-trine does not protect defendants' statements, either,since reasonable minds could find that the challengedstatements were not accompanied by cautionary lan-guage sufficient to make them not misleading. Amyl-in, 2002 U.S. Dist. LEXIS 19481 at *27-28 (citationomitted).

D. Analysts' statements

The individual defendants argue that analysts' state-ments cannot form the basis for liability becauseplaintiffs have failed to allege specifically that theanalysts relied on conversations with the Company.Ind. Mot. at 19, citing Consol. Compl. ¶ ¶ 89, 95,115. For liability to attach to the analysts' reports, ac-cording to defendants, plaintiffs would need to showthat a defendant provided misleading information toan analyst, who relied on the information to prepare areport, which the insider then endorsed or approved.Stack v. Lobo, 903 F.Supp. 1361, 1372(N.D.Cal.1995).

Plaintiffs argue, on the other hand, that liability forthe analysts' statements can rest on a “conduit the-ory.” Oppo. at 32. Under this theory, liability can at-tach when a defendant directly provides false or mis-leading information to an analyst with the intent thatthe analyst will communicate the information to themarket. See, e.g., Cooper v. Pickett, 137 F.3d 616,624 (9th Cir.1997). The complaint adequately pleadsthis theory of liability. Consol. Compl. ¶¶ 89, 94-95,113, 115. “A company may not lie to securities ana-lysts and avoid liability for its misrepresentations byrefusing to adopt the analyst reports incorporating themisrepresentations.” In re Cirrus Logic Sec. Litig.,946 F.Supp. 1446, 1467 (N.D.Cal.1996). Whether ornot plaintiffs will ultimately demonstrate such liabil-ity remains to be seen, but they have adequately pledsuch a theory.

E. Control person liability

Finally, the individual defendants argue that plaintiffshave failed to plead “even the rudimentary facts ne-cessary” to hold them liable as “control persons” un-

der § 20(a) of the Exchange Act. Ind. Mot. at 23. Thecomplaint alleges that “Speigelman, as CFO, was re-sponsible for financial reporting and communicationswith the market” and that “Lange, as CEO and Chair-man, was responsible for press releases issued by theCompany.” They both signed documents filed withthe SEC. Consol. Compl. ¶ 58. The complaint also al-leges that many of the press releases included Spei-gelman as the “contact person.” Consol. Compl. ¶¶58, 87, 90, 91, 96.

*12 Whether or not a person is a “control person” is“an intensely factual question.” No. 84 Employer-Teamster Joint Council Pension Trust Fund v. Amer-ica West Holding Corp., 320 F.3d 920, 945 (9thCir.2003) (citation omitted). The Court will allowplaintiffs to proceed on a theory of “control person”liability.

3. Defendants' Request for Judicial Notice

In ruling on a motion to dismiss, a court may take ju-dicial notice of a document if it is relied upon in thecomplaint (whether or not it is expressly incorporatedtherein) and its authenticity is not disputed. Parrinov. FHP, Inc., 146 F.3d 699, 706 (9th Cir.1988). TheCourt may also consider Securities and ExchangeCommission (“SEC”) filings relied upon in the com-plaint. See In re Silicon Graphics, 183 F.3d at 986. Intheir request that the Court consider the full text ofcertain documents attached to the complaint and/orcertain documents referenced or relied upon in thecomplaint and for judicial notice, defendants ask theCourt to take judicial notice of: Transcript, Cardi-ovascular and Renal Drugs Advisory Committee(“CRDAC”) hearing, December 9, 2003 (JohnsonDecl., Ex. A); FDA Background, Cardiovascular andRenal Drugs Advisory Committee meeting, Decem-ber 9, 2003 regarding NDA 21-526 (“FDA BriefingMaterials”) (Johnson Decl., Ex. D); July 17, 2003Discipline Review Letter (Johnson Decl., Ex. J); SECFilings (Johnson Decl. Exs. O, Z, AA, BB, T, V, U,CC, F, DD, EE, FF, GG, W, X, and Y); press releasesforming part of SEC filings (Johnson Decl., Exs. S,E, HH, II, H, L, JJ and KK); FDA Documents(Johnson Decl. Exs. G and Q); and Federal RegisterExcerpts (Johnson Decl., Exs. P and R). The Courttakes judicial notice of these documents, with the ex-























ception of Exs. KK and M. The Company issuedthese two press releases outside the class period andthey are not referenced in the complaint. Similarly,the Court declines to take judicial notice of the Com-pany's Form 10-Q for Q1 2004 (Johnson Supp. Decl.,Ex. LL) and the Company's June 2, 2004 press re-lease (Johnson Second Supp. Decl., Ex. MM). Fi-nally, plaintiffs argue that the Court cannot considerany documents for the “truth of their contents.”Oppo. at 1 (emphasis omitted). The Court does notrestrict its taking of judicial notice in this way.

Defendants also ask the Court to take judicial noticeof charts, prepared by defense counsel, containingportions of otherwise judicially noticeable facts(Johnson Decl., Exs. C, B, K, and N). The Court doesnot take judicial notice of these documents, since theCourt is capable of synthesizing information.

CONCLUSION

For the foregoing reasons, the Court DENIES CVTherapeutics' motion to dismiss. The Court DENIESthe motion to dismiss by individual defendants Langeand Speigelman. The Court GRANTS the motion todismiss by defendants Blackburn and Belardinelli. Atoral argument, plaintiffs' counsel represented that hehad no additional allegations to make against Black-burn and Belardinelli, so the Court does not grantplaintiffs leave to amend the complaint. The CourtGRANTS in part and DENIES in part defendants'Request for Judicial Notice. [docket 54, 55, 56, 79,82]

*13 IT IS SO ORDERED.

N.D.Cal.,2004.In re CV Therapeutics, Inc.Not Reported in F.Supp.2d, 2004 WL 1753251(N.D.Cal.), 59 Fed.R.Serv.3d 251

Briefs and Other Related Documents (Back to top)

• 2006 WL 1042136 (Trial Motion, Memorandumand Affidavit) Reply in Support of Motion to CompelProduction and for an Order to Show cause WhySanctions for Destruction of Documents should notbe Entered; Memorandum of Points and Authoritiesin Support Thereof (Mar. 17, 2006) Original Image

of this Document (PDF)• 2006 WL 1042137 (Trial Motion, Memorandumand Affidavit) Reply in Support of Plaintiffs' Motionto Compel Documents Designated as Privileged(Mar. 17, 2006) Original Image of this Document(PDF)• 2006 WL 1042135 (Trial Motion, Memorandumand Affidavit) Defendants' (1) Opposition toPlaintiff's Motion to Compel Production and for anOrder to Show cause Why Sanctions for Destructionof Documents should not be Entered and (2) Requestfor Costs Pursuant to F.R.C.P. 37 (Mar. 10, 2006)Original Image of this Document (PDF)• 2004 WL 2159160 (Trial Motion, Memorandumand Affidavit) Defendant CV Therapeutics, Inc.'sReply in Support of Motion to Dismiss the Consolid-ated Complaint for Failure to State A Claim (Jun. 25,2004) Original Image of this Document (PDF)• 2004 WL 2159164 (Trial Motion, Memorandumand Affidavit) Individual Defendants' Reply in Sup-port of Motion to Dismiss for Failure to State Claim(Jun. 25, 2004) Original Image of this Document(PDF)• 2004 WL 2159169 (Trial Motion, Memorandumand Affidavit) Defendants' Reply in Support of Re-quest that the Court Consider the Full Text of Docu-ments Attached to the Complaint, or Documents Ref-erenced or Relied upon in the Complaint, and Re-quest for Judicial Notice, in Support of Motions toDismiss for Failu re to State A Claim (Jun. 25, 2004)Original Image of this Document (PDF)• 2004 WL 2159171 (Trial Motion, Memorandumand Affidavit) Opposition to Supplemental Requestfor Judicial Notice and Second Supplemental Requestfor Judicial Notice (Jun. 25, 2004) Original Image ofthis Document (PDF)• 2004 WL 2159159 (Trial Pleading) Demand forJury Trial (Jan. 20, 2004) Original Image of this Doc-ument (PDF)• 2003 WL 23793574 (Trial Motion, Memorandumand Affidavit) Fred & Christine McBroom's Memor-andum of Points and Authorities in Opposition toDavid Crossen's Lead Plaintiff Motion (Nov. 21,2003) Original Image of this Document (PDF)• 2003 WL 23793580 (Trial Motion, Memorandumand Affidavit) Proposed Lead Plaintiff DavidCrossen's Memorandum of Points and Authorities in




http://www.westlaw.com/Find/Default.wl?rs=dfa1.0&vr=2.0&FindType=Y&SerialNum=2008966666










Support of Opposition to Competing Lead PlaintiffMotion (Nov. 21, 2003) Original Image of this Docu-ment (PDF)• 2003 WL 23793587 (Trial Motion, Memorandumand Affidavit) Defendants' Opposition to Requestsfor Heightened Evidence Preservation Measures inPlaintiffs' Motions for Consolidation and for Ap-pointment as Lead Plaintiff (Nov. 21, 2003) OriginalImage of this Document (PDF)• 2003 WL 23793596 (Trial Motion, Memorandumand Affidavit) David Crossen's Reply in Further Sup-port of his Motion for Appointment as Lead Plaintiff(Nov. 21, 2003) Original Image of this Document(PDF)• 3:03cv03709 (Docket) (Aug. 8, 2003)

END OF DOCUMENT






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EXHIBIT 2


LEXSEE 2006 U.S. DIST. LEXIS 42553

GARY DUTTON, Individually and on Behalf of All Others Similarly Situated,Plaintiff, vs. D&K HEALTHCARE RESOURCES, ET. AL., Defendants.

Case No. 4:04CV147SNL

UNITED STATES DISTRICT COURT FOR THE EASTERN DISTRICT OFMISSOURI, EASTERN DIVISION

2006 U.S. Dist. LEXIS 42553

June 23, 2006, DecidedJune 23, 2006, Filed

COUNSEL: [*1] For Gary Dutton, Individually and onbehalf of all others similarly situated, Plaintiff: Andrew J.Brown, Jonah H. Goldstein, Stephanie M Schroder,Thomas E Glynn, Debra J. Wyman, Ramzi Abadou,Helen J. Hodges, LERACH AND COUGHLIN, LLP,San Diego, CA; David A. Rosenfeld, Mario Alba, Jr.,Samuel H. Rudman, LERACH AND COUGHLIN, LLP,Melville, NY; Don R. Lolli, DYSART AND TAYLOR,Kansas City, MO; Guri Ademi, Shpetim Ademi, ADEMIAND O'REILLY, LLP, Cudahy, WI; Marc A. Topaz,SCHIFFRIN AND BARROWAY, LLP, Radnor, PA;Darren J. Robbins, LACKENBACH AND SIEGEL,Scarsdale, NY.

For United Food and Commerical Workers Union, Local655, Plaintiff: Bruce D. Oakes, Richard B. Fosher,OAKES AND FOSHER, LLC, St. Louis, MO; Darren J.Robbins, LACKENBACH AND SIEGEL, Scarsdale,NY; Andrew J. Brown, William S. Lerach, RamziAbadou, Helen J. Hodges, LERACH AND COUGHLIN,LLP, San Diego, CA.

For D&K Healthcare Resources, Inc., J. Hord Armstrong,III, Martin D. Wilson, Thomas S. Hilton, RichardPlotnick, Defendants: Edwin L. Noel, Glenn E. Davis,Jacqueline Ulin Levey, ARMSTRONG TEASDALE,LLP, St. Louis, MO.

For Bristol-Myers Squibb Company, Defendant:Elizabeth L. Grayer, Jeffrey B. Korn, Jessica [*2] R.Buturla, CRAVATH AND SWAINE, LLP, New York,NY; Evan R. Chesler, CRAVATH AND SWAINE, NewYork, NY; Joseph M. Rebein, Kevin M. Smith, SHOOKAND HARDY, Kansas City, MO.

For Geoffrey Moncrief, Leila Moncrief, ThomasCarradine, Movants: Andrew L. Barroway, Darren J.Check, Sean M. Handler, Stuart L. Berman, SCHIFFRINAND BARROWAY, LLP, Radnor, PA; David A.Rosenfeld, Samuel H. Rudman, LERACH ANDCOUGHLIN, LLP, Melville, NY; Don R. Lolli,DYSART AND TAYLOR, Kansas City, MO.

JUDGES: Stephen N. Limbaugh, SENIOR UNITEDSTATES DISTRICT JUDGE.

OPINION BY: Stephen N. Limbaugh

OPINION

MEMORANDUM

Lead Plaintiff has filed this second amendedcomplaint on behalf of purchasers of D&K HealthcareResources, Inc.'s (hereinafter referred to simply as D&K)common stock between August 10, 2000 and September16, 2002, inclusive. He asserts violations of Section 10(b)of the Securities Exchange Act of 1934 and Rule 10b-5thereunder (Count I - all defendants 1 and Section 20(a)of the Securities Exchange Ac of 1934 (Count II -Individual Defendants only). This matter is before theCourt on BMS's motion to dismiss (# 87), filed January28, 2005. Extensive responsive pleadings have been filedand this [*3] matter is now ripe for disposition.

1 The defendants in this case are as follows:D&K Healthcare Resources, Inc.; Bristol-MyersSquibb (hereinafter referred to as BMS); and J.

Page 1


Hord Armstrong, III, Martin D. Wilson, ThomasS. Hilton, and Richard Plotnick (hereinafterreferred to as the Individual Defendants).

Defendant BMS seeks to dismiss this secondamended complaint for expiration of the applicablestatute of limitations; for failure to state an actionableSection 10(b) primary violation claim; and/or for failureto state a claim under Rule 12(b)(6) Fed.R.Civ.P. inconnection with the fraud pleading requirements of Rule9(b) Fed.R.Civ.P. and/or the "heightened pleadingrequirements" of the Private Securities Litigation ReformAct of 1995 (PSLRA), 15 U.S.C. § 78u-4.

The claims contained in the second amendedcomplaint essentially boil down to an allegation that thedefendants all conspired to engage in a [*4] "scheme todefraud" or course of conduct designed to operate as afraud or deceit upon D&K investors between August 10,2000 and September 16, 2002. Lead Plaintiff alleges thatthe defendants participated in "channel-stuffing"transactions which were misreported in D&K's financialstatements and in media reports.

Specifically, the second amended complaint allegesthat, in order to take advantage of incentives offered byBMS, D&K "would purchase extremely large quantitiesof drugs from suppliers such as Bristol-Myers" during thealleged class period "and hold it until the priceincreased." Second Amended Complaint, P38. Thesecond amended complaint further alleges that BMSaccounted for approximately 50% of the Westindivision's sales during the class period. Second AmendedComplaint, P42. The second amended complaint furtheralleges that all inventory purchased "in excess of[D&K]'s ordinary course of business inventory level" was"nothing more than a consignment - and not a sale"pursuant to SAB 101, and was improperly reported asassets in D&K's financial statements. Second AmendedComplaint, P48. By including this excess inventory as"assets" on its balance sheet, "D&K improperly [*5]inflated its own financial statements - in violation ofGAAP - and misled investors as to the true basis for[D&K]'s increasing inventory sales and earnings".Second Amended Complaint, P51.

The second amended complaint alleges that, in anApril 25, 2002 press release, BMS announced BMS'financial results for the first quarter of 2002 and statedthat its U.S. pharmaceutical sales had decreased 20% inthat quarter. Second Amended Complaint, P74.

Moreover, Lead Plaintiff alleges that in the same April25th press release, BMS attributed a portion of thedecline to the overstocking of BMS' wholesalers withinventory. Second Amended Complaint, P74. LeadPlaintiff further alleges that on July 11, 2002, BMSdisclosed that the SEC had been investigating BMS'accounting for these large purchases since April 2002.Second Amended Complaint, P75. The second amendedcomplaint further alleges that BMS was "forced to stopthe practice of channel stuffing on or about April 2002".Second Amended Complaint, P13

According to the Lead Plaintiff, the "revelation ofthe fraud [came] in September 2002" when on September16, 2002, D&K announced to the market that it wouldmiss earnings projections by [*6] a large margin. SecondAmended Complaint, PP16, 77. The next day, allegedlyas a result of this announcement, D&K's stock price fellmore than 60%. Second Amended Complaint, P77. Aweek later, on September 24, 2002, "D&K finallydisclosed that it had been receiving 'special purchasingopportunities' but that they no longer existed for theCompany." Second Amended Complaint, P81.

Lead Plaintiff further alleges that on March 18, 2003,BMS filed its 2001 Form 10-K/A in which it restated itsfinancial results for 1999, 2000, 2001, and the first twoquarters of 2002 including its revenue from shipmentsmade to certain wholesalers. Second AmendedComplaint, P84. Lead Plaintiff alleges that, in thisrestatement, BMS "admitted to improperly recording alarge portion of its shipments to wholesalers as 'salesrather than consignments'". Second Amended Complaint,P84. Lead Plaintiff further alleges that "theseconsignments were the result of incentives that theyoffered to wholesalers 'towards the end of a quarter inorder to incentivize 2 wholesalers to purchase products inan amount sufficient to meet the Company's quarterlysales projections". Second Amended Complaint, P84.

2 Although the Court appreciates creativity inpleadings, it must draw the line at words such as"incentivize" that have failed to make it into anyrecognized English language dictionary.

[*7] Nowhere in the second amended complaintdoes the Lead Plaintiff assert that BMS actuallyparticipated in the preparation or dissemination of theallegedly fraudulent D&K financial statements and pressreleases/media reports upon which market analysts and/orinvestors relied. Nowhere in the second amended

Page 22006 U.S. Dist. LEXIS 42553, *3


complaint does the Lead Plaintiff assert that BMS madeany statement, misleading or otherwise, relating toD&K's financial reports, or that BMS had any duty todisclose any information regarding its businesstransactions with D&K's shareholders.

In its motion to dismiss, BMS contends that the LeadPlaintiff 1) has failed to bring this action within theapplicable two (2) year statute of limitations; 2) has, atbest, pleaded an "aiding and abetting" claim which is notactionable as a violation of Section 10(b) and Rule 10b-5;and 3) has failed to state any claim against it forviolations of Section 10(b) and Rule 10b-5.

In passing on a motion to dismiss, a court must viewthe facts alleged in the complaint in the light mostfavorable to the plaintiff. Scheuer v. Rhodes, 416 U.S.232, 94 S. Ct. 1683, 40 L. Ed. 2d 90 (1974); Conley v.Gibson, 355 U.S. 41, 45-46, 78 S. Ct. 99, 2 L. Ed. 2d80(1957); Toombs v. Bell, 798 F.2d 297, 298 (8th Cir.1986). [*8] The court must accept the allegations in thecomplaint as true and draw reasonable inferences in favorof the nonmoving party, dismissing the complaint only if"it appears beyond a reasonable doubt that plaintiff canprove no set of facts in support of his claim which wouldentitle him to relief." Conley v. Gibson, supra, 355 U.S.at 45-46; see also, Moses.com Securities v.Comprehensive Software Systems, Inc., 406 F.3d. 1052,1062 (8th Cir. 2005). "Although the pleading standard isliberal, the plaintiff must allege facts -- not mere legalconclusions -- that, if true, would support the existence ofthe claimed torts. Moses.com, at 1062 citing SchallerTel.Co. v. Golden Sky Sys., 298 F.3d. 736, 740 (8th Cir.2002). In viewing the complaint in the light mostfavorable to the plaintiff, the court should not dismiss itmerely because the court doubts that the plaintiff will beable to prove all of the necessary allegations. Bennett v.Berg, 685 F.2d. 1053, 1058 (8th Cir. 1982). Thus, amotion to dismiss is likely to be granted "only in theunusual case in which a plaintiff includes allegations thatshow [*9] on the face of the complaint that there is someinsuperable bar to relief." Fusco v. Xerox Corp., 676 F.2d332, 334 (8th Cir. 1982).

Sarbanes-Oxley Act of 2002 - Statute of Limitations inSecurities Fraud Cases

In 2002, Congress passed the Sarbanes-Oxley Act of2002, 28 U.S.C. § 1658(b), which established as newstatute of limitations for federal securities law claims.The new law applies a statute of limitations for private

securities fraud cases to shorter of two (2) years fromdate of discovery or five (5) years from date ofoccurrence. The Sarbanes-Oxley Act provides, inpertinent part:

"(b) . . . a private right of action thatinvolves a claim of fraud, deceit,manipulation, or contrivance incontravention of a regulatory requirementconcerning the securities laws, as definedin section 3(a)(47) of the SecuritiesExchange Act of 1934 (15 U.S.C.78c(a)(47)), may be brought not later thanthe earlier of --

(1) 2 years after the discovery of the factsconstituting the violation; or

(2) 5 years after such violation."

28 U.S.C § 1658(b)(1) and (2); In In re ADC Telcoms.,Inc. Sec. Litig., 409 F.3d. 974, 976-77 (8th Cir. 2005).[*10]

Defendant BMS alleges that the Lead Plaintiff waswell aware of the facts he claims constituted thesecurities law violations no later than September 2002 butfailed to file an amended complaint first naming BMS asa defendant until November 2004, more than 26 monthsafter discovering the conduct he now alleges wasfraudulent.

A plaintiff in a federal securities lawsuit is deemed tohave discovered fraud for purposes of triggering theapplicable statute of limitations not only when saidplaintiff actually discovers the alleged fraud but alsowhen said plaintiff was on "inquiry notice" of suchalleged fraud. Great Rivers Co-op of Southeastern Iowav. Farmland Indus., Inc., 120 F.3d. 893, 896 (8th Cir.1997) 3; see also, Ritchey v. Horner, 244 F.3d. 635,638-641 (8th Cir. 2001); Cohen, et. al. v. NorthwesternGrowth Corp. et. al., 385 F.Supp.2d. 935 (D.S.D. 2005).The determination of whether "inquiry notice' of federalsecurities fraud exists is an objective standard based uponfacts known to the plaintiff; i.e. when the plaintiff isaware of facts that would lead a reasonable person toinvestigate and consequently acquire actual [*11]knowledge of the alleged fraudulent conduct. Ritchey, at638; Great Rivers Cooperative of Southeastern Iowa, at896; Cohen, at 945. Inquiry notice exists when there are



"storm warnings" that would alert a reasonable person ofthe possibility of misleading information, disseminatedeither by an act or by omission. Great Rivers Cooperativeof Southeastern Iowa, at 896 citing Davidson v. Wilson,973 F.2d. 1391, 1402 (8th Cir. 1992); see also, Cohen, at945 citing Great Rivers, supra. and Davidson, supra.Although the issue of whether a plaintiff was on inquirynotice is often inappropriate for resolution on a motion todismiss under Rule 12(b)(6), where the complaintcontains facts needed to make a determination regardingwhether a reasonable investor of ordinary intelligencewould have been aware of the existence of the allegedfraud, a court may properly rule on the issue of inquirynotice on a motion to dismiss. Cohen, at 945 (internalcitations omitted). Finally, since the statute of limitationsargument is an affirmative defense, the defendant bearsthe burden of proof. Ritchey, at [*12] 639; see also,Comcast of Illinois X, L.L.C. v. Multi-Vision Electronics,Inc., 2005 U.S. Dist. LEXIS 32702 , F.Supp.2d. ,2005 WL 2177070 (D.Neb. September 8, 2005).

3 The relevant caselaw on the issue of timelinessin securities fraud cases for the most part predatethe enactment of the Sarbanes-Oxley Act on July30, 2002. However, it appears to this Court thatthe Eighth Circuit has yet to change its mind setas to the principles embraced in these pre-2002cases regarding inquiry notice; thus, until theEighth Circuit or the United States Supreme Courtdetermine that the doctrine of inquiry notice doesnot apply to the expanded statute of limitationsunder the Sarbanes-Oxley Act, the Court findsthat the principles set forth in such cases are stillapplicable and provide guidance to this Court.

In determining whether inquiry notice exists, theCourt must ascertain 1) the facts of which the plaintiffwas aware; 2) whether a reasonable person withknowledge of those same facts would have investigated[*13] the situation further; and 3) whether uponinvestigation, a reasonable person would have acquiredactual notice of the defendant(s)' misrepresentations.Ritchey, at 639 citing Great Rivers Cooperative ofSoutheastern Iowa, at 896; Cohen, at 945 citing GreatRivers, supra.

Upon consideration, the Court finds that dismissal ofthe Lead Plaintiff's Section 10(b) and Rule 10b-5 claimsis appropriate, as the statute of limitations expired nolater than September 24, 2004. Based upon the

allegations pled in the second amended complaint, LeadPlaintiff had inquiry notice, if not actual notice, of thealleged fraud as of September 2002.

Lead Plaintiff was aware of a "significant drop ofover 65%" in D&K's stock price from October 1999 toMay 2000. Second Amended Complaint, P34. Heattributed this drop to D&K's loss of two (2) of its biggestcustomers and the sales related to these customers asnoted in the company's 10-K for FY01. Lead Plaintiffavers that D&K implemented a strategy to compensatefor the loss of this business by engaging in "speculativepurchases" which it presented to the market and investorsin its public statements as "opportunities [*14] topurchase branded pharmaceuticals from manufacturers atattractive prices." Second Amended Complaint, P35.Second Amended Complaint, P36. Lead Plaintiff furtheravers that as of 2001 the Westin facility averaged $ 150million per month in sales; yet, on average each ofD&K's other distribution facilities only had sales ofapproximately $ 250 per year. Second AmendedComplaint, P39. Lead Plaintiff further avers that betweenNovember 2000 and October 2003, BMS was the largestsupplier of pharmaceuticals to the Weston facility,accounting for approximately 50% of the total inventory.Second Amended Complaint, P42. Lead Plaintiff furtheravers that in Spring 2002, BMS ceased making shipmentsof its pharmaceutical products to the Westin facility;however, throughout 2001 and 2002 D&K via numerouspress releases and its prospectus announced a secondaryoffering of its stock and expansion of its credit facilities.Second Amended Complaint, PP42, 69-73. Lead Plaintifffurther avers that on April 25, 2002 BMS issued a pressrelease announcing a decline in its revenue for the firstquarter of 2002 which it partly attributed to the"overstocking of the company's wholesalers withinventory. [*15] ". Second Amended Complaint, P74.Lead Plaintiff further avers that on July 11, 2002 BMSdisclosed publicly the SEC investigation into itsinventory and accounting practices. Second AmendedComplaint, P75. Lead Plaintiff further avers thatfollowing a conference call with analysts on August 14,2002, D&K, on September 16, 2002 "shocked the marketwhen it announced that it was reducing its 'EPS guidancebefore one-time charges related to the implementation ofSFAS 142 to approximately $ 0.13-$ 0.17, from $ 0.30 to$ 0.31.'" Second Amended Complaint, P77. LeadPlaintiff further avers that in a press release the same day,defendant Armstrong outlined the sales shortfallsresulting in a reversal of the growth in revenue and later



discussed same with analysts. Second AmendedComplaint, P77. Lead Plaintiff further avers that "[i]nresponse to these disclosures, on September 17, 2002, theprice of D&K common stock dropped more than 60% toclose at $ 9.51 per share on extremely high tradingvolume." Second Amended Complaint, P79. LeadPlaintiff further avers that in an article published in theSt. Louis Post-Dispatch on September 18, 2002 entitledInvestors Pummel D&K for Surprise Forecast. [*16]A.G. Edwards analyst Andrew Speller stated "[Y]ou hadthe end of a growth story", and he changed his "buy"rating on D&K to a "sell" as did analysts at four (4) otherbrokerage firms. Second Amended Complaint, P80. LeadPlaintiff further avers that also in this same articledefendant Wilson had stated that "some manufacturersmay be cutting back on deals in reaction to the Securitiesand Exchange Commission's inquiry into Bristol-MyersSquibb Co.'s accounting of its deal-based forward-sellingpractices" and that BMS had disclosed in April 2002 that"the sales incentives it used in previous years encouragedwholesalers to stockpile products." Second AmendedComplaint, P80. The Lead Plaintiff further avers that, onSeptember 24, 2002, in its Form 10-K for fiscal year2002, "D&K finally disclosed that it had been receiving'special purchasing opportunities'" which it was no longerreceiving. Second Amended Complaint, P81.

The Court finds that a reasonable investor ofordinary intelligence and through the exercise ofreasonable diligence would have been able to ascertainthe alleged fraud as of September 2002. Indeed, LeadPlaintiff, in its own pleading, affirmatively alleges that[*17] as of September 24, 2002 by virtue of D&K's 10-Kfiling, "these disclosures admitted to the market that thefinancial benefits achieved as a result of the fraudulentscheme had come to an end." Second AmendedComplaint, P15. Whether it be actual notice or inquirynotice, Lead Plaintiff failed to exercise reasonablediligence and the Section 10(b) and Rule 10b-5 claimsagainst BMS are time-barred.

Federal Securities Law - Section 10(b) and Rule 10b-5

Assuming arguendo that the federal securities claimsagainst defendant BMS are not time-barred, such claimsstill fail because they fail to state an actionable violationof Section 10(b) and Rule 10b-5.

In Count I of his second amended complaint, LeadPlaintiff alleges violations of Section 10(b) of theSecurities Exchange Act of 1934 and Rule 10b-5. Section

10(b) and Rule 10b-5 prohibit fraudulent conduct in thesale and purchase of securities. Section 10(b) forbids (1)the "use or employ[ment] . . . of any . . . deceptivedevice," (2) "in connection with the purchase or sale ofany security," and (3) "in contravention of" Securities andExchange Commission "rules and regulations". DuraPharmaceuticals v. Broudo, 544 U.S. 336, 125 S.Ct.1627, 1630-31, 161 L. Ed. 2d 577 (2005) [*18] citing 15U.S.C. § 78j(b); see, Ferris, Baker Watts, Inc. v. Ernst &Young, L.L.P., 395 F.3d. 851, 853-54 (8th Cir. 2005);K-Tel Int'l Sec. Litig. v. K-Tel Int'l, Inc. (In re K-Tel Int'lSec. Litig.), 300 F.3d. 881, 888 (8th Cir. 2002); Chen v.Navarre Corp.(In re Navarre Corp. Secs. Litig., 299F.3d. 735, 741 (8th Cir. 2002). Rule 10b-5 forbids, anyperson, directly or indirectly, from employing any device,scheme or artifice to defraud; in the making of any"untrue statement of material fact" or the omission of anymaterial fact "necessary in order to make the statementsmade . . . not misleading; or to engage in any act,practice, or course of business which operates or wouldoperate as a fraud or deceit upon any person inconnection with the purchase or sale of any security. InStoneridge Investment Partners, LLS v.Scientific-Atlanta, Inc. (In re Charter Communs., Inc.),443 F.3d. 987, 990 (8th Cir. 2006) citing 17 C.F.R. §240.10b-5; Dura Pharmaceuticals, 125 S.Ct. at 1631citing 17 C.F.R. § 240.10b-5 (2004).

In Central Bank of Denver v. First Interstate Bank ofDenver, 511 U.S. 164, 114 S. Ct. 1439, 128 L. Ed. 2d 119(1994), [*19] the Supreme Court found that § 10(b)prohibits only "manipulative or deceptive" devices orcontrivances, and that private plaintiffs "may not bring a[Rule] 10b-5 suit against a defendant for acts notprohibited by the text of § 10(b)." Central Bank, 511 U.S.at 173; Charter Communications, at 990. "In earliercases, the Court held that 'deceptive' conduct involveseither the misstatement or a failure to disclose by onewho has a duty to disclose. 'Manipulative,' as used in thesecurities context, is a 'term of art' and refers to illegaltrading practices such as 'wash sales, matched orders, orrigged prices, that are intended to mislead investors byartificially affecting market activity.'" CharterCommunications, at 990 (internal citations omitted).Based upon these earlier cases and the text and legislativehistory of the 1934 Act, the Court in Central Bank,supra., held that Rule 10b-5 does not reach those personswho only aid or abet a violation of § 10b. Central Bank,511 U.S. at 177; Charter Communications, at 990.However, the law's reach is not completely cut off as to



these persons:

"The absence [*20] of § 10(b) aidingand abetting liability does not mean thatsecondary actors in the securities marketsare always free from liability under thesecurities Acts. Any person or entity,including a lawyer, accountant, or bank,who employs a manipulative device ormakes a material misstatement (oromission) on which a purchaser or sellerof securities relies may be liable as aprimary violator under 10b-5, assumingall of the requirements for primaryliability under Rule 10b-5 are met."

Central Bank, 511 U.S. at 191; Charter Communications,at 991 quoting Central Bank, supra.

Upon review of Central Bank, supra., the EighthCircuit Court of Appeals concluded that it stood for three(3) governing principles: 1) the "categorical declaration"that a private plaintiff may not bring a Rule 10b-5 lawsuitagainst a defendant for acts not prohibited by the text of §10b included claims under Rule 10b-5(a) and (c), as wellas Rule 10b-5(b); 2) a device or contrivance is not"deceptive" within the meaning of § 10b, absent somemisstatement or failure to disclose by one who has a dutyto disclose; and 3) the term "manipulative" [*21] in §10b has a limited contextual meaning as defined in SantaFe Industries, Inc. v. Green, 430 U.S. 462, 476-77, 97 S.Ct. 1292, 51 L. Ed. 2d 480 (1977) and adopted by theCourt in Central Bank, supra. Charter Communications,at 992. "Thus, any defendant who does not make oraffirmatively cause to be made a fraudulent misstatementor omission, or who does not directly engage inmanipulative securities trading practices, is at most guiltyof aiding and abetting and cannot be held liable under §10(b) or any subpart of Rule 10b-5." CharterCommunications, at 992 (internal citations omitted).

Upon careful review of the Lead Plaintiff'sallegations as contained in his second amendedcomplaint, the Court determines that he has failed to statean actionable violation of Section 10(b) and Rule 10b-5.

The second amended complaint alleges that D&Kand BMS "engaged in a fraudulent 'channel-stuffing'scheme and misrepresented the Company's financialresults to the investing public." Second Amended

Complaint, P2. It further states that "Bristol-Myers wasan active, knowing and integral participant in the D&Kdefendants' fraud." Second Amended Complaint, P7.However, such statements [*22] are conclusionary andare not supported by the factual statements in the SecondAmended Complaint which allegedly detail the fraud as itwas perpetrated upon the plaintiff class. The market pricefor D&K stock was allegedly artificially inflated due tothe "growth which D&K defendants misleadinglyreported to the market and repeatedly forecasted forfuture quarters." Second Amended Complaint, P7.Furthermore, D&K stockholders are alleged to haverelied upon, not any action; i.e. sales by BMS to D&K,but rather upon D&K's "improper accounting . . . falseand misleading financial statements" in that "D&K'sClass Period financial statements improperly failed todisclose that a material amount of its reported sales werederived from supplier inventory it held on a consignmentbasis . . . D&K materially mislead investors about its truebusiness risks . . .". Second Amended Complaint, P103.Lead Plaintiff goes to great lengths to demonstrate the"falsehoods" of numerous other public statements madeby D&K during the Class Period. Second AmendedComplaint, PP108-148. The Lead Plaintiff clearlycharacterizes D&K as the alleged primary violator ofSection 10(b) and Rule 10b-5 because "by filing [*23]financial statements with the SEC which did not complywith GAAP during the Class Period, defendantsdisseminated financial statements of D&K which werepresumptively misleading and inaccurate." SecondAmended Complaint, P105.

The allegations of the Second Amended Complaintonly refer to material misrepresentations or omissionsmade by D&K in its financial statements and pressreleases/media reports upon which D&K shareholdersrelied when making an investment decision. There are noallegations that said shareholders relied upon anyfinancial statements and press releases/media reports ofBMS when making an investment decision regardingD&K. At best, all the Lead Plaintiff has stated is thatBMS engaged in certain business transactions with D&K,which D&K allegedly misreported in its financialstatements, thereby inflating D&K's reported assets andmisleading D&K investors as to the true nature of itsgrowing revenue. Whether or not these "businesstransactions" were a "scheme", a "conspiracy", or BMSwas an "active participant" is immaterial because neitherprimary liability or secondary liability can be establishedunless the Lead Plaintiff can show that BMS made a



materially false [*24] statement or omission upon whichD&K investors relied upon in making investmentdecisions regarding D&K. This very same situation wasaddressed by the 8th Circuit in Charter Communications,supra. The scheme alleged consisted of Charter enteringinto firm contracts with certain Vendors to purchaseset-top boxes at a set price; however, Charter then agreedto pay the Vendors an additional $ 20 per set-top box inexchange for the Vendors returning the additionalpayments to Charter in the form of advertising fees.Charter Communications, at 989.

"Plaintiffs alleged that these were shamor wash transactions with no economicsubstance, contrived to inflate Charter'soperating cash flow by some $ 17,000,000in the fourth quarter of 2000 in order tomeet the revenue and operating cash flowexpectations of Wall Street analysts.Charter accomplished the deception withfraudulent accounting by improperlycapitalizing the increased equipmentexpenses while treating the returnedadvertising fees as immediate revenue.Plaintiffs alleged that the Vendorsentered into these sham transactionsknowing that Charter intended toaccount for them improperly and that[*25] analysts would rely on theinflated revenues and operating cashflow in making stock recommendations.Plaintiffs did not allege that theVendors played any role in preparingor disseminating the fraudulentfinancial statements and press releasesthrough which Charter published itsdeception to analysts and investors."

Charter Communications, at 989-90 (emphasis added).Relying on Central Bank, supra., the district court hadconcluded that the plaintiffs' claims against the Vendorswere claims for aiding and abetting and thus, notactionable § 10(b) violations. Charter Communications,at 990-91. The district court based its conclusion on thefact that the plaintiffs did not assert that the Vendors hadmade any statement, omission, or action at issue or thatthey [plaintiffs] had relied on any statement, omission oraction made by the Vendors. Id., at 991. Furthermore, theplaintiffs had not alleged the Vendors were responsible orwere involved with the preparation of the allegedly

misleading financial statements, the allegedly improperinternal accounting practices, or the allegedly false and/ormisleading public statements made by Charter. [*26]Id., at 991. Finally, the plaintiffs had not alleged that theVendors had any duty to review the subject statements orany duty whatsoever to Charter's investors. Id., at 991.

The Eighth Circuit agreed with the district court'sfindings and holdings as to the Vendors. It reviewedCentral Bank, supra., and found that "any defendant whodoes not make or affirmatively cause to be made afraudulent misstatement or omission, or who does notdirectly engage in manipulative securities tradingpractices, is at most guilty of aiding and abetting andcannot be held liable under § 10(b) or any subpart of Rule10b-5." Charter Communications, at 992. The Court thenreviewed the case at hand and concluded:

"In this case, the focus of plaintiffs' §10(b) and Rule 10b-5 claims wasdeception -- they alleged a 'continuouscourse of conduct' in which Charterallegedly 'made and/or failed to correctpublic representations which were or hadbecome materially false and misleadingregarding Charter's financial results andoperations . . . However, neither Motorolanor Scientific-Atlanta [Vendors] wasalleged to have engaged in any suchdeceptive act. They [*27] did not issueany misstatement relied upon by theinvesting public, nor were they under aduty to Charter investors and analysts todisclose information useful in evaluatingCharter's true financial condition. None ofthe alleged financial misrepresentations byCharter was made by or even with theapproval of the Vendors. Accordingly, thedistrict court properly dismissed theclaims against the Vendors as nothingmore than claims, barred by Central Bank,that the Vendors knowingly aided andabetted the Charter defendants indeceiving the investor plaintiffs.

. . . we are aware of no case imposing§ 10(b) or Rule 10b-5 liability on abusiness that entered into an arm's lengthnon-securities transaction with an entitythat then used the transaction to publish



false and misleading statements to itsinvestors and analysts. The point issignificant. To impose liability forsecurities fraud on one party to an arm'slength business transaction in goods orservices other than securities because thatparty knew or should have known that theother party would use the transaction tomislead investors in its stock wouldintroduce potentially far-reaching dutiesand uncertainties for [*28] those engagedin day-to-day business dealings. Decisionsof this magnitude should be made byCongress."

Charter Communications, at 992-93.

Based upon the holdings in both Central Bank,supra. and Charter Communications, supra., this Courtfinds that the Lead Plaintiff has failed to make anyallegations of primary liability with respect to defendantBMS, that the Second Amended Complaint alleges onlyaiding and abetting and thus, the claim(s) as contained inCount I of the Second Amended Complaint must bedismissed.

In light of the Court's findings, the Court has no needto further address defendant BMS' claim that the LeadPlaintiff has failed to state a claim under Rule 9(b)Fed.R.Civ.P. and/or the "heightened pleading standard"of the PSLRA.

Dated this 23rd day of June, 2006.

Stephen N. Limbaugh

SENIOR UNITED STATES DISTRICT JUDGE

MEMORANDUM

Lead Plaintiff has filed this second amendedcomplaint on behalf of purchasers of D&K HealthcareResources, Inc.'s (hereinafter referred to simply as D&K)common stock between August 10, 2000 and September16, 2002, inclusive. He asserts [*29] violations ofSection 10(b) of the Securities Exchange Act of 1934 andRule 10b-5 thereunder (Count I - all defendants 1) andSection 20(a) of the Securities Exchange Act of 1934(Count II - Individual Defendants only). This matter isbefore the Court on Individual Defendant Plotnick'smotion to dismiss (# 92/ # 93), filed February 4, 2005.

Extensive responsive pleadings have been filed and thismatter is now ripe for disposition.

1 The defendants in this case are as follows:D&K Healthcare Resources, Inc.; Bristol-MyersSquibb (hereinafter referred to as BMS); and J.Hord Armstrong, III, Martin D. Wilson, ThomasS. Hilton, and Richard Plotnick (hereinafterreferred to as the Individual Defendants).

Defendant Plotnick seeks to dismiss this secondamended complaint for expiration of the applicablestatute of limitations; for failure to state a claim underRule 12(b)(6) Fed.R.Civ.P. in connection with the fraudpleading requirements of Rule 9(b) Fed.R.Civ.P. [*30]and/or the "heightened pleading requirements" of thePrivate Securities Litigation Reform Act of 1995(PSLRA), 15 U.S.C. § 78u-4; and for failure to state aclaim for "control person liability" under Section 20(a) ofthe Securities Exchange Act of 1934, 15 U.S.C. § 78t(a).

The claims of the second amended complaintessentially boil down to an allegation that the defendantsall conspired to engage in a "scheme to defraud" orcourse of conduct designed to operate as a fraud or deceitupon D&K investors between August 10, 2000 andSeptember 16, 2002. Lead Plaintiff contends that D&Kreported favorable earnings and expected earnings duringthis time-period while knowing that their accountingmethods were suspect and such positive predictions couldnot be realistically achieved. Lead Plaintiff further assertsthat the "lynchpin" of this scheme to defraud was anagreement among the defendants to help BMSimproperly inflate its revenue and earnings by enablingBMS to engage in "channel-stuffing"; i.e. D&Kpretending to "buy" large quantities of pharmaceuticalproducts from BMS when in fact such purchases werebeing warehoused on a consignment [*31] basis. LeadPlaintiff alleges that D&K then listed these"consignments" improperly as "assets" giving theimpression that its assets were much larger than theyactually were at the time. Lead Plaintiff contends thatBMS entered into this arrangement knowing that D&Kintended to account for the "channel stuffing" improperlyand that market analysts would rely upon these artificiallyinflated revenues and cash flow in making stockrecommendations. Lead Plaintiff does not assert thatBMS actually participated in the preparation ordissemination of the allegedly fraudulent financialstatements and press releases/media reports upon which



market analysts and/or investors relied.

In his motion to dismiss, Plotnick contends firstlythat the Lead Plaintiff has failed to bring this actionwithin the applicable two (2) year statute of limitations.Secondly, Lead Plaintiff has failed to state any claimagainst him for violations of Section 10(b) and Rule10b-5; and that as a middle-level manager with limitedsupervisory duties he fails to meet the standard for"control person liability" under Section 20(a).

In passing on a motion to dismiss, a court must viewthe facts alleged in the complaint [*32] in the light mostfavorable to the plaintiff. Scheuer v. Rhodes, 416 U.S.232, 94 S. Ct. 1683, 40 L. Ed. 2d 90 (1974); Conley v.Gibson, 355 U.S. 41, 45-46, 78 S. Ct. 99, 2 L. Ed. 2d80(1957); Toombs v. Bell, 798 F.2d 297, 298 (8th Cir.1986). The court must accept the allegations in thecomplaint as true and draw reasonable inferences in favorof the nonmoving party, dismissing the complaint only if"it appears beyond a reasonable doubt that plaintiff canprove no set of facts in support of his claim which wouldentitle him to relief." Conley v. Gibson, supra, 355 U.S.at 45-46; see also, Moses.com Securities v.Comprehensive Software Systems, Inc., 406 F.3d. 1052,1062 (8th Cir. 2005). "Although the pleading standard isliberal, the plaintiff must allege facts -- not mere legalconclusions -- that, if true, would support the existence ofthe claimed torts. Moses.com, at 1062 citing SchallerTel.Co. v. Golden Sky Sys., 298 F.3d. 736, 740 (8th Cir.2002). In viewing the complaint in the light mostfavorable to the plaintiff, the court should not dismiss itmerely because the court doubts that the plaintiff will beable to prove [*33] all of the necessary allegations.Bennett v. Berg, 685 F.2d. 1053, 1058 (8th Cir. 1982).Thus, a motion to dismiss is likely to be granted "only inthe unusual case in which a plaintiff includes allegationsthat show on the face of the complaint that there is someinsuperable bar to relief." Fusco v. Xerox Corp., 676 F.2d332, 334 (8th Cir. 1982).

Sarbanes-Oxley Act of 2002 - Statute of Limitations inSecurities Fraud Cases

In 2002, Congress passed the Sarbanes-Oxley Act of2002, 28 U.S.C. § 1658(b), which established as newstatute of limitations for federal securities law claims.The new law applies a statute of limitations for privatesecurities fraud cases to shorter of two (2) years fromdate of discovery or five (5) years from date ofoccurrence. The Sarbanes-Oxley Act provides, in

pertinent part:

"(b) . . . a private right of action thatinvolves a claim of fraud, deceit,manipulation, or contrivance incontravention of a regulatory requirementconcerning the securities laws, as definedin section 3(a)(47) of the SecuritiesExchange Act of 1934 (15 U.S.C.78c(a)(47)), may be brought [*34] notlater than the earlier of --

(1) 2 years after the discovery of the factsconstituting the violation; or

(2) 5 years after such violation."

28 U.S.C § 1658(b)(1) and (2); In In re ADC Telcoms.,Inc. Sec. Litig., 409 F.3d. 974, 976-77 (8th Cir. 2005).

Defendant Plotnick alleges that the Lead Plaintiffwas well aware of the facts he claims constituted thesecurities law violations no later than September 2002 butfailed to file an amended complaint first naming Plotnickas a defendant until November 2004, more than 26months after discovering the conduct he now alleges wasfraudulent.

A plaintiff in a federal securities lawsuit is deemed tohave discovered fraud for purposes of triggering theapplicable statute of limitations not only when saidplaintiff actually discovers the alleged fraud but alsowhen said plaintiff was on "inquiry notice" of suchalleged fraud. Great Rivers Co-op of Southeastern Iowav. Farmland Indus., Inc., 120 F.3d. 893, 896 (8th Cir.1997) 2; see also, Ritchey v. Horner, 244 F.3d. 635,638-641 (8th Cir. 2001); Cohen, et. al. v. NorthwesternGrowth Corp. et. al., 385 F.Supp.2d. 935 (D.S.D. 2005).[*35] The determination of whether "inquiry notice' offederal securities fraud exists is an objective standardbased upon facts known to the plaintiff; i.e. when theplaintiff is aware of facts that would lead a reasonableperson to investigate and consequently acquire actualknowledge of the alleged fraudulent conduct. Ritchey, at638; Great Rivers Cooperative of Southeastern Iowa, at896; Cohen, at 945. Inquiry notice exists when there are"storm warnings" that would alert a reasonable person ofthe possibility of misleading information, disseminatedeither by an act or by omission. Great Rivers Cooperativeof Southeastern Iowa, at 896 citing Davidson v. Wilson,



973 F.2d. 1391, 1402 (8th Cir. 1992); see also, Cohen, at945 citing Great Rivers, supra. and Davidson, supra.Although the issue of whether a plaintiff was on inquirynotice is often inappropriate for resolution on a motion todismiss under Rule 12(b)(6), where the complaintcontains facts needed to make a determination regardingwhether a reasonable investor of ordinary intelligencewould have been aware of the existence of the alleged[*36] fraud, a court may properly rule on the issue ofinquiry notice on a motion to dismiss. Cohen, at 945(internal citations omitted). Finally, contrary to thedefendants' assertion that the burden lies with the LeadPlaintiff, since the statute of limitations argument is anaffirmative defense, the defendants bear the burden ofproof. Ritchey, at 639; see also, Comcast of Illinois X,L.L.C. v. Multi-Vision Electronics, Inc., 2005 U.S. Dist.LEXIS 32702, F.Supp.2d. , 2005 WL 2177070(D.Neb. September 8, 2005).

2 The relevant caselaw on the issue of timelinessin securities fraud cases for the most part predatethe enactment of the Sarbanes-Oxley Act on July30, 2002. However, it appears to this Court thatthe Eighth Circuit has yet to change its mind setas to the principles embraced in these pre-2002cases regarding inquiry notice; thus, until theEighth Circuit or the United States Supreme Courtdetermine that the doctrine of inquiry notice doesnot apply to the expanded statute of limitationsunder the Sarbanes-Oxley Act, the Court findsthat the principles set forth in such cases are stillapplicable and provide guidance to this Court.

[*37] In determining whether inquiry notice exists,the Court must ascertain 1) the facts of which the plaintiffwas aware; 2) whether a reasonable person withknowledge of those same facts would have investigatedthe situation further; and 3) whether upon investigation, areasonable person would have acquired actual notice ofthe defendant(s)' misrepresentations. Ritchey, at 639citing Great Rivers Cooperative of Southeastern Iowa, at896; Cohen, at 945 citing Great Rivers, supra.

Upon consideration, the Court finds that dismissal ofthe Lead Plaintiff's Section 10(b) and Rule 10b-5 claimsis appropriate, as the statute of limitations expired nolater than September 24, 2004. Based upon theallegations pled in the second amended complaint, LeadPlaintiff had inquiry notice, if not actual notice, of thealleged fraud as of September 2002.

Lead Plaintiff was aware of a "significant drop ofover 65%" in D&K's stock price from October 1999 toMay 2000. Second Amended Complaint, P34. Heattributed this drop to D&K's loss of two (2) of its biggestcustomers and the sales related to these customers asnoted in the company's 10-K for FY01. Lead Plaintiff[*38] avers that D&K implemented a strategy tocompensate for the loss of this business by engaging in"speculative purchases" which it presented to the marketand investors in its public statements as "opportunities topurchase branded pharmaceuticals from manufacturers atattractive prices." Second Amended Complaint, P35.Lead Plaintiff also avers that in 2000, defendantPlotnick's company Jaron, Inc. was acquired by D&K atwhich time Plotnick became the division head for thecompany's Weston, Florida division. As division head,Plotnick became the Vice-President and General Managerof Procurement. Second Amended Complaint, P36. LeadPlaintiff further avers that as of 2001 the Weston facilityaveraged $ 150 million per month in sales; yet, onaverage each of D&K's other distribution facilities onlyhad sales of approximately $ 250 per year. SecondAmended Complaint, P39. Lead Plaintiff further aversthat between November 2000 and October 2003, BMSwas the largest supplier of pharmaceuticals to the Westonfacility, accounting for approximately 50% of the totalinventory. Second Amended Complaint, P42. LeadPlaintiff further avers that in Spring 2002, BMS ceasedmaking shipments of its pharmaceutical [*39] productsto the Westin facility; however, throughout 2001 and2002 D&K via numerous press releases and itsprospectus announced a secondary offering of its stockand expansion of its credit facilities. Second AmendedComplaint, PP42, 69-73. Lead Plaintiff further avers thaton April 25, 2002 BMS issued a press release announcinga decline in its revenue for the first quarter of 2002 whichit partly attributed to the "overstocking of the company'swholesalers with inventory.". Second AmendedComplaint, P74. Lead Plaintiff further avers that on July11, 2002 BMS disclosed publicly the SEC investigationinto its inventory and accounting practices. SecondAmended Complaint, P75. Lead Plaintiff further aversthat following a conference call with analysts on August14, 2002, D&K, on September 16, 2002 "shocked themarket when it announced that it was reducing its 'EPSguidance before one-time charges related to theimplementation of SFAS 142 to approximately $ 0.13-$0.17, from $ 0.30 to $ 0.31.'" Second AmendedComplaint, P77. Lead Plaintiff further avers that in apress release the same day, defendant Armstrong outlined



the sales shortfalls resulting in a reversal of the growth inrevenue [*40] and later discussed same with analysts.Second Amended Complaint, P77. Lead Plaintiff furtheravers that "[i]n response to these disclosures, onSeptember 17, 2002, the price of D&K common stockdropped more than 60% to close at $ 9.51 per share onextremely high trading volume." Second AmendedComplaint, P79. Lead Plaintiff further avers that in anarticle published in the St. Louis Post-Dispatch onSeptember 18, 2002 entitled Investors Pummel D&Kfor Surprise Forecast, A.G. Edwards analyst AndrewSpeller stated "[Y]ou had the end of a growth story", andhe changed his "buy" rating on D&K to a "sell" as didanalysts at four (4) other brokerage firms. SecondAmended Complaint, P80. Lead Plaintiff further aversthat also in this same article defendant Wilson had statedthat "some manufacturers may be cutting back on deals inreaction to the Securities and Exchange Commission'sinquiry into Bristol-Myers Squibb Co.'s accounting of itsdeal-based forward-selling practices" and that BMS haddisclosed in April 2002 that "the sales incentives it usedin previous years encouraged wholesalers to stockpileproducts." Second Amended Complaint, P80. The LeadPlaintiff further avers [*41] that, on September 24, 2002,in its Form 10-K for fiscal year 2002, "D&K finallydisclosed that it had been receiving 'special purchasingopportunities'" which it was no longer receiving. SecondAmended Complaint, P81.

The Court finds that a reasonable investor ofordinary intelligence and through the exercise ofreasonable diligence would have been able to ascertainthe alleged fraud as of September 2002. Indeed, LeadPlaintiff, in its own pleading, affirmatively alleges that asof September 24, 2002 by virtue of D&K's 10-K filing,"these disclosures admitted to the market that thefinancial benefits achieved as a result of the fraudulentscheme had come to an end." Second AmendedComplaint, P15. Given that Lead Plaintiff characterizesdefendant Plotnick as instrumental, if not the key player,in the alleged fraudulent scheme, Lead Plaintiff's failureto not name him as a defendant until November 2004(well after the filing of the original complaint) does notdemonstrate the reasonable exercise of due diligence.Defendant Plotnick's alleged conduct was evidently not awell-kept secret given the pervasive witness accounts bythe numerous unidentified persons in the SecondAmended [*42] Complaint. Furthermore, there isnothing to indicate that his whereabouts were unknown tothe Lead Plaintiff until November 2004. Whether it be

actual notice or inquiry notice, Lead Plaintiff failed toexercise reasonable diligence and the Section 10(b) andRule 10b-5 claims against him are time-barred.


Assuming arguendo that the federal securities claimsagainst defendant Plotnick are not time-barred, suchclaims still fail because they fail to meet the pleadingstandards of Rule 9(b) Fed.R.Civ.P. and the heightenedpleading standards of the PLSRA.

In Count I of his second amended complaint, LeadPlaintiff alleges violations of Section 10(b) of theSecurities Exchange Act of 1934 and Rule 10b-5. Section10(b) and Rule 10b-5 prohibit fraudulent conduct in thesale and purchase of securities. Section 10(b) forbids (1)the "use or employ[ment] . . . of any . . . deceptivedevice," (2) "in connection with the purchase or sale ofany security," and (3) "in contravention of" Securities andExchange Commission "rules and regulations". DuraPharmaceuticals v. Broudo, 544 U.S. 336, 125 S. Ct.1627, 1630-31, 161 L. Ed. 2d 577 (2005) [*43] citing 15U.S.C. § 78j(b); see, Ferris, Baker Watts, Inc. v. Ernst &Young, L.L.P., 395 F.3d. 851, 853-54 (8th Cir. 2005);K-Tel Int'l Sec. Litig. v. K-Tel Int'l, Inc. (In re K-Tel Int'lSec. Litig.), 300 F.3d. 881, 888 (8th Cir. 2002); Chen v.Navarre Corp.(In re Navarre Corp. Secs. Litig., 299F.3d. 735, 741 (8th Cir. 2002). Rule 10b-5 forbids, anyperson, directly or indirectly, from employing any device,scheme or artifice to defraud; in the making of any"untrue statement of material fact" or the omission of anymaterial fact "necessary in order to make the statementsmade . . . not misleading; or to engage in any act,practice, or course of business which operates or wouldoperate as a fraud or deceit upon any person inconnection with the purchase or sale of any security. InStoneridge Investment Partners, LLS v.Scientific-Atlanta, Inc. (In re Charter Communs., Inc.),443 F.3d. 987, 990 (8th Cir. 2006) citing 17 C.F.R. §240.10b-5; Dura Pharmaceuticals, 125 S.Ct. at 1631citing 17 C.F.R. § 240.10b-5 (2004).

In Central Bank of Denver v. First Interstate Bank ofDenver, 511 U.S. 164, 114 S. Ct. 1439, 128 L. Ed. 2d 119(1994), [*44] the Supreme Court found that § 10(b)prohibits only "manipulative or deceptive" devices orcontrivances, and that private plaintiffs "may not bring a[Rule] 10b-5 suit against a defendant for acts notprohibited by the text of § 10(b)." Central Bank, 511 U.S.at 173; Charter Communications, at 990. "In earlier



cases, the Court held that 'deceptive' conduct involveseither the misstatement or a failure to disclose by onewho has a duty to disclose. 'Manipulative,' as used in thesecurities context, is a 'term of art' and refers to illegaltrading practices such as 'wash sales, matched orders, orrigged prices, that are intended to mislead investors byartificially affecting market activity.'" CharterCommunications, at 990 (internal citations omitted).Based upon these earlier cases and the text and legislativehistory of the 1934 Act, the Court in Central Bank,supra., held that Rule 10b-5 does not reach those personswho only aid or abet a violation of § 10b. Central Bank,511 U.S. at 177; Charter Communications, at 990.However, the law's reach is not completely cut off as tothese persons:

"The absence [*45] of § 10(b) aidingand abetting liability does not mean thatsecondary actors in the securities marketsare always free from liability under thesecurities Acts. Any person or entity,including a lawyer, accountant, or bank,who employs a manipulative device ormakes a material misstatement (oromission) on which a purchaser or sellerof securities relies may be liable as aprimary violator under 10b-5, assumingall of the requirements for primaryliability under Rule 10b-5 are met."


Upon review of Central Bank, supra., the EighthCircuit Court of Appeals concluded that it stood for three(3) governing principles: 1) the "categorical declaration"that a private plaintiff may not bring a Rule 10b-5 lawsuitagainst a defendant for acts not prohibited by the text of §10(b) included claims under Rule 10b-5(a) and (c), aswell as Rule 10b-5(b); 2) a device or contrivance is not"deceptive" within the meaning of § 10(b), absent somemisstatement or failure to disclose by one who has a dutyto disclose; and 3) the term "manipulative" [*46] in §10(b) has a limited contextual meaning as defined inSanta Fe Industries, Inc. v. Green, 430 U.S. 462, 476-77,97 S. Ct. 1292, 51 L. Ed. 2d 480 (1977) and adopted bythe Court in Central Bank, supra. CharterCommunications, at 992. "Thus, any defendant who doesnot make or affirmatively cause to be made a fraudulentmisstatement or omission, or who does not directly

engage in manipulative securities trading practices, is atmost guilty of aiding and abetting and cannot be heldliable under § 10(b) or any subpart of Rule 10b-5."Charter Communications, at 992 (internal citationsomitted).

Private securities fraud actions brought under Section10(b) and Rule 10b-5 require the pleading and showing ofthese elements: 1) a material misrepresentation oromission; 2) scienter (a wrongful state of mind); 3) aconnection with the purchase or sale of a security; 4)reliance or "transaction causation"; 5) economic loss; and6) "loss causation" or a causal connection between thematerial misrepresentation and the loss. DuraPharmaceuticals, 125 S.Ct. at 1631; see Ferris, BakerWatts, at 854; K-tel, at 888; Navarre, at 741. SinceSection 10(b) [*47] and Rule 10b-5 actions are groundedin fraud, the more stringent pleading standards of Rule9(b) Fed.R.Civ.P. are applicable. Carlon v. Thaman (In reNationsMart Corp. Sec. Litig.), 130 F.3d. 309, 320 (8thCir. 1997); In re: BankAmerica Corp. SecuritiesLitigation, 78 F.Supp.2d. 976, 987 (E.D.Mo. 1999);Jakobe v. Rawlings Sporting Goods Co., 943 F.Supp.1143, 1152 (E.D.Mo. 1996).

Pursuant to Rule 9(b) Fed.R.Civ.P., all allegations offraud must be stated with particularity. To meet therequirements of Rule 9(b), a pleading must include "suchmatters as the time, place, and contents of falserepresentations, as well as the identity of the personmaking the misrepresentation and what was obtained orgiven up thereby." Bennett v. Berg, 685 F.2d. 1053, 1062(8th Cir. 1982); see also, Wiley v. Mitchell, et. al. 106Fed.Appx. 517, 521-22 (8th Cir. 2004)(unpublished).Compliance with the particularity requirements of Rule 9requires plaintiffs to "specify the statements contended tobe fraudulent, identify the speaker, state when and [*48]where the statements were made, and explain why thestatements were fraudulent." In re BankAmerica Corp.Securities Litigation, 78 F.Supp.2d. 976, 987 (E.D.Mo.1999)(citation omitted). "[C]onclusionary allegations thata defendant's conduct was fraudulent and deceptive arenot sufficient to satisfy the rule." Commercial Prop.Inv.,Inc. v. Quality Inn Int'l. Inc., 61 F.3d. 639, 644 (8th Cir.1995).

The Private Securities Litigation Reform Act(PSLRA), 15 U.S.C. § 78u-4, embodies the pleadingrequirements of Rule 9 Fed.R.Civ.P. Ferris, Baker Watts,at 854; K-tel, at 889; see Navarre, at 742 (given that the



PSLRA embodies the pleading requirements of Rule 9,plaintiffs do not need to meet the requirements of both,and the PLSRA supercedes; i.e. under Rule 9 state ofmind can be averred generally; however, under thePLSRA, both falsity and scienter must be pleaded withparticularity). Complaints brought under Section 10(b)and Rule 10b-5 are governed by special heightenedpleading standards adopted by Congress in the PSLRA.These heightened pleading standards are unique [*49] tosecurities actions and were adopted by Congress in anattempt to curb abuses of securities fraud litigation.Kushner v. Beverly Enterprises, 317 F.3d. 820, 826 (8thCir. 2003) citing Navarre, at 741; see Chambers v.AMDOCS Ltd. (In re AMDOCS Ltd. Secs. Litig.), 390F.3d 542, 547 citing Navarre, at 741.

The PSLRA requires plaintiffs "to specify eachmisleading statement or omission and specify why thestatement or omission was misleading." Kushner, at 826;Navarre, at 741-42; see, In Re: Cerner Corp. SecuritiesLitigation, 425 F.3d. 1079, 1083 (8th Cir. 2005)(aplaintiff must plead falsity by specifying each allegedlymisleading statement and the reasons why each statementis misleading); 15 U.S.C. § 78u-4(b)(1). The complaintmust also "state with particularity facts giving rise to astrong inference that the defendant acted with therequired state of mind." Kushner, at 826; Navarre, at741-42; 15 U.S.C. § 78u-4(b)(2); see Ferris, Baker Watts,at 854; K-tel, at 889. The Act requires that the allegationscollectively establish a strong inference of the requiredstate of mind. Cerner Corp., at 1083; [*50] Kushner, at826. Any complaint failing to meet these pleadingrequirements must be dismissed. Kushner, at 826; In re:BankAmerica Corp. Securities Litigation, at 988; 15U.S.C. § 78u-4(b)(3)(A). Finally, the Reform Act requiresthe courts to disregard "catch-all" or "blanket" assertionsthat do not live up to the particularity requirements.Ferris, Baker Watts, at 853; Amdocs, at 547; K-tel, at889; Kushner, at 824; Florida State Bd. of Admin. v.Green Tree, 270 F.3d. 645, 660 (8th Cir. 2001). "In orderto satisfy the Reform Act's falsity pleading standard, acomplaint may not rest on mere allegations that fraud hasoccurred." Cerner Corp., at 1083 citing Navarre, at 742.

The Eighth Circuit has established a three-prongformula for assessing the adequacy of scienterallegations. After reviewing the tests promulgated by theother circuits to meet the Reform Act's "strong inferenceof scienter" standard, the appellate court fashioned itsown criteria for indicia of fraud:

"Therefore, we can say three thingsabout motive and opportunity allegations.First, motive and opportunity are generallyrelevant [*51] to a fraud case, and ashowing of unusual or heightened motivewill often form an important part of acomplaint that meets the Reform Actstandard. Second, in some cases the samecircumstantial allegations that establishmotive and opportunity also giveadditional reason to believe thedefendant's misrepresentation wasknowing or reckless. For instance, ininsider trading cases, the timing of tradesshows motive and opportunity, but it mayalso provide additional circumstantialevidence that the defendant knew of anadvantage. Such allegations may meet theReform Act standard, but if so it isbecause they give rise to a stronginference of scienter, not merely becausethey establish motive and opportunity.Third, when the complaint does not showmotive and opportunity of any sort - eitherthe unusual, heightened motivehighlighted in the Second Circuit cases, oreven an everyday motive such as keepingone's job - then other allegations tendingto show scienter would have to beparticularly strong in order to meet theReform Act standard."

Florida State Bd. of Admin. v. Green Tree, at 660. Thus,inferences of scienter will survive a motion to dismissonly it they are "both [*52] reasonable and strong."Cerner Corp., at 1084 citing Kushner, at 827. "Scienter isnormally a factual question to be decided by a jury, butthe complaint must at least provide a factual basis for itsscienter allegations." Cerner Corp., at 1084-85 citingK-tel, at 894.

Mere negligence does not violate federal securitieslaw; however, severe recklessness may. Ferris, BakerWatts, at 854 (citations omitted).

"Specifically, scienter may bedemonstrated by severe recklessnessinvolving 'highly unreasonable omissionsor misrepresentations' amounting to 'an



extreme departure from the standards ofordinary care, and that present a danger ofmisleading buyers or sellers which iseither known to the defendant or is soobvious that the defendant must have beenaware of it.' Recklessness, then, may beshown where unreasonable statements aremade and the danger of misleadinginvestors is so obvious that the defendantmust have been aware of it."

Kushner, at 828 citing K & S P'ship v. Cont'l Bank, N.A.,952 F.2d. 971, 978 (8th Cir. 1991); see also, Ferris,Watts Baker, at 854. "This level of recklessness requiresthat defendants make [*53] statements that they know, orhave access to information suggesting, are materiallyinaccurate." Ferris, Baker Watts, at 854 citing Navarre,at 746.

The general allegations and speculations containedthroughout the Second Amended Complaint, and inparticular, Count I are inadequate under the pleadingrequirements of Rule 9 Fed.R.Civ.P. and the heightenedpleading requirements of the PSLRA. While the SecondAmended Complaint attributes specific statements toothers, especially the other Individual Defendants, thereis not a single (mis)statement attributed to defendantPlotnick. There is not a single allegation that defendantPlotnick signed or caused to by signed any documentsubmitted to the SEC or any document disseminated tothe investing public. The allegations against defendantPlotnick consist solely of his ability to buy product fromBMS which the Lead Plaintiff contends was thecenterpiece of the ultimate scheme to artificially inflatethe stock price and mislead investors. These allegationsconsist of:

1) D&K's rapid increase of sales andearnings pre-2002 were due to the fact that". . . D&K was only able to 'get [*54]product' because defendant Plotnick - withknowledge and approval of the otherIndividual Defendants - agreed topurchase product from Bristol-Myers andothers on terms that were intended to (anddid) mislead investors."

Second Amended Complaint, P4.

2) Due to the "illicit nature" of the

deals with BMS, Individual DefendantsArmstrong and Hilton "made sure thefinancial results for Plotnick's divisionwere not reported through the Companylike every other division, and Plotnick wasnever required to provide back-up supportfor his division's financial results throughthe normal accounting channels - unlikeevery other division in the Company.Likewise, Plotnick was careful not toshare the terms of his arrangements withBristol-Myers with others within his owndivision. Thus, even though Plotnick'sdivision was the singular reason for theCompany's rapid growth during the ClassPeriod, other than the IndividualDefendants, nobody 'knew what [Plotnick]did or how he did it . . . No one questionedhim because he made so much money forthe Company.'"


3) The Lead Plaintiff characterizesPlotnick as Individual DefendantsWilson's and Armstrong's [*55] "gloryboy" because Plotnick's division was"single-handedly responsible for the rapidgrowth in sales and earnings for the entireCompany during the Class Period."


4) Lead Plaintiff alleges that basedupon an unidentified witness, Plotnick wasthe head of all pharmaceutical purchasing,and furthermore, "became extremelysuccessful in the so-called 'speculativepurchases' of drugs."

Second Amended Complaint,PP37-38.

5) Lead Plaintiff alleges that no onebut Plotnick knew the name of thesalesperson or contact person at BMS orwas privy to the details of the dealsPlotnick made with BMS. This "secrecy"was fostered by "surround[ing] himself inthe small, 12-person Weston facility officewith trusted employees such as his best



friend, and a brother-in-law."


Essentially, the Lead Plaintiff's allegations againstdefendant Plotnick are that he made profitable deals withBMS which not only benefitted his division, but theentire company. Furthermore, that he did not discuss hisdeals with fellow employees except for a few trusted onesin his division. Finally, that Plotnick reported directly toupper management; [*56] that the monthly financialreports were not prepared by Plotnick but rather by thedivision's controller under the supervision of Chuck Levy(Vice President of Financial Services for D&K); andPlotnick's expense accounts were reviewed by D&K'scontroller, who reported to D&K's senior management.Second Amended Complaint, PP52-56.

None of these allegations point to any involvementby Plotnick with D&K's financial statements, accountingstatements, or any information disseminated to theinvesting public. None of these allegations even remotelylink Plotnick to the content or timing of D&K's publicdisclosures. None of these allegations provide anyspecific evidence of Plotnick's participation in the generaloperations of D&K. At best, these allegations depict ashrew businessman who put together profitable deals forhis division with BMS. At worse, these allegations maymarginally depict a middle manager aiding and abettingsenior management with the alleged channel-stuffingscheme to artificially create growth in revenue andindirectly cause the alleged misrepresentations about saidrevenue. However, liability does not attach under § 10(b)and/or Rule 10b-5 for aiding and abetting. [*57] CentralBank, supra.; Charter Communications, supra.

The Lead Plaintiff has failed to allege any factsrelating to any identified statement attributable todefendant Plotnick which shows that Plotnick was awareor should have been aware of such statement(s)misleading the investing public. The Lead Plaintiff hasonly provided speculation and generalizations to cast abad light on Plotnick doing anything but buying andselling pharmaceutical products from BMS in such amanner as to make money for the company. Havingfailed to meet the pleading requirements for a claimagainst defendant Plotnick for violation of § 10(b) andRule 10b-5, said claims as contained in Count I againstdefendant Plotnick will be dismissed.

Section 20(a) - Controlling Person Liability

Lead Plaintiff also asserts a claim against defendantPlotnick under 20(a) of the Exchange Act. Section 20(a)of the Exchange Act imposes liability on "every personwho, directly or indirectly, controls any person liable"under the Exchange Act; and such liability should beimposed "unless the controlling person acted in goodfaith and did not directly or indirectly induce [*58] theact or acts constituting the violation or cause of action."A "control person" relationship exists whenever "(I) thealleged control person actually exercised control over thegeneral operations of the primary violator and (ii) thealleged control person possessed-- but did not necessarilyexercise-- the power to determine the specific acts oromissions upon which the underlying violation ispredicated." Farley v. Henson, 11 F.3d. 827, 835 (8thCir. 1993); see, Metge v. Baehler, 762 F.2d. 621, 624(8th Cir. 1985); Stephenson v. Deutsche Bank AG, 282F.Supp.2d. 1032, 1059 (D.Minn. 2003); Piper JaffrayCos., 38 F. Supp. 2d. 771, 782 (D.Minn. 1999). Thecontrol-person statute is "remedial and is to be construedliberally. It has been interpreted as requiring only someindirect means of discipline or influence short of actualdirection to hold a 'controlling person' liable." Farley, at836 quoting Myzel v. Fields, 386 F.2d. 718, 738 (8th Cir.1967); Stephenson, at 1059 (quoting both Farley andMyzel, supra.); see also, [*59] Martin v. ShearsonLehman Hutton, 986 F.2d. 242, 244 (8th Cir.1993)(statute reaches persons who have only someindirect means of discipline or influence less than actualdirection). Section 20(a) can impose liability upon"corporate officers and directors, even in those cases inwhich they did not directly participate in the bad acts." Inre Acceptance Insurance Companies Sec. Litig., 352F.Supp.2d. 940, 957 (D.Neb. 2004), aff'd 423 F.3d 899,2005 WL 2060912 (8th Cir. August 29, 2005) citingMetge v. Baehler, at 631. Finally, Section 20(a) is notsubject to the heightened pleading standards of either theReform Act or Rule 9(b) Fed.R.Civ.P. Stephenson, at1060 citing In re Initial Pub. Offering Sec.Litig., 241F.Supp.2d. 281, 397 n.185 (S.D.N.Y. 2003).

Upon consideration, the Court will dismiss the LeadPlaintiff's claim of controlling person liability, ascontained in Count II of the Second Amended Complaint,against defendant Plotnick.

As stated before, the Second Amended Complaintsimply alleges that defendant Plotnick ran the Westin,



Florida [*60] distribution center for D&K and was incharge of all purchases of pharmaceuticals for D&K. TheSecond Amended Complaint also alleges that defendantPlotnick made profitable deals with defendant BMSwhich he chose not to openly discuss except with a fewtrusted employees. Furthermore, the Second AmendedComplaint alleges that although there were somedifferences in how the Westin division's financial reportswere handled, said reports were still prepared by thatdivision's controller, not defendant Plotnick, and wereprovided to D&K's controller. Finally, the SecondAmended Complaint alleges that although D&K'scontroller believed Plotnick may have been "padding" thecorporate expense report with personal expenses, the factremains that his expense report was reviewed by D&K'scontroller who reported to D&K's senior management.

What the Second Amended Complaint fails to allegeis any involvement by defendant Plotnick with D&K'sfinancial statements, accounting protocols, the content ortiming of public disclosures (i.e. media releases and/orprospectuses), or the general operations of D&K. TheLead Plaintiff fails to provide any factual basis as to howPlotnick's purchasing responsibilities [*61] placed him ina position of control within the company capable ofdirecting and/or influencing corporate affairs. The LeadPlaintiff fails to allege any facts which remotely rise to aninference that Plotnick was a policymaker within thecorporate structure of D&K. Plotnick was based inFlorida, while senior management was based in Missouri.His division's business transactions and finances weresupervised by senior management. The allegationscontained in the Second Amended Complaint areinsufficient to establish controlling person liability upondefendant Plotnick pursuant to Section 20(a) of theExchange Act. 3 Thus, Count II, as directed againstdefendant Plotnick, will be dismissed.

3 Defendant Plotnick also asserts that controllingperson liability cannot be established becausethere is no underlying § 10(b) and Rule 10b-5liability. If a plaintiff fails to establish anactionable claim for violation(s) of § 10(b) and/orRule 10b-5, then a § 20(a) claim is also notactionable. Navarre, at 748; Parnes v. Gateway2000, 122 F.3d. 539, 550 n.12 (8th Cir. 1997); seealso, In re BankAmerica Corp. SecuritiesLitigation, 78 F.Supp.2d. 976, 992 (E.D.Mo.1999). However, at this point, the Court has notmade a determination as to the federal securities

claims against the remaining IndividualDefendants and D&K.

[*62] Dated this 23rd day of June, 2006.

Stephen N. Limbaugh


MEMORANDUM

Lead Plaintiff has filed this second amendedcomplaint on behalf of purchasers of D&K HealthcareResources, Inc.'s (hereinafter referred to simply as D&K)common stock between August 10, 2000 and September16, 2002, inclusive. He asserts violations of Section 10(b)of the Securities Exchange Act of 1934 and Rule 10b-5thereunder (Count I - all defendants 1) and Section 20(a)of the Securities Exchange Act of 1934 (Count II -Individual Defendants only). This matter is before theCourt on D&K and Individual Defendants' 2 motion todismiss (# 90/# 91), filed February 4, 2005. Extensiveresponsive pleadings have been filed and this matter isnow ripe for disposition.

1 The defendants in this case are as follows:D&K Healthcare Resources, Inc.; Bristol-MyersSquibb (hereinafter referred to as BMS); and J.Hord Armstrong, III, Martin D. Wilson, ThomasS. Hilton, and Richard Plotnick (hereinafterreferred to as the Individual Defendants).2 Although the instant motion includes argumenton behalf of defendant Plotnick, he filed aseparate motion to dismiss which was recentlygranted by the Court; thus, argument(s) pertainingto him will not be address in this memorandum.

[*63] Defendants seek to dismiss this secondamended complaint for failure to state a claim under Rule12(b)(6) Fed.R.Civ.P., in connection with the "heightenedpleading requirements" of the Private SecuritiesLitigation Reform Act of 1995 (PSLRA), 15 U.S.C. §78u-4, and for failure to state a claim for "control personliability" under Section 20(a) of the Securities ExchangeAct of 1934, 15 U.S.C. § 78t(a). They aver, among amyriad of other things, that the Lead Plaintiff has failedto 1) state with any particularity facts demonstrating thatD&K made improper purchases of pharmaceuticalproducts; i.e. engaged in channel-stuffing, with defendantBMS; 2) state with any particularity facts demonstratingthat the subject sales were in fact "consignments"; 3)



state with any particularity all necessary facts forming thebasis as to the allegations that subject sales wereconsignments and that D&K's financial statementsviolated GAAP 3 due to failure to note subject sales asconsignments; and 4) state with any particularity that anydefendant acted with the required state of mind (scienter)during the Class [*64] Period in perpetuating the allegedfraud upon D&K investors.

3 Generally Accepted Accounting Principles

The second amended complaint generally allegesthat the defendants all conspired to engage in a "schemeto defraud" or course of conduct designed to operate as afraud or deceit upon D&K investors between August 10,2000 and September 16, 2002. Lead Plaintiff asserts thatthe "lynchpin" of this scheme to defraud was anagreement among the defendants to help BMSimproperly inflate its revenue and earnings by enablingBMS to engage in "channel-stuffing"; i.e., D&Kpretending to "buy" large quantities of pharmaceuticalproducts from BMS when in fact such purchases werebeing warehoused on a consignment basis. Lead Plaintiffalleges that D&K then listed these "consignments"improperly as assets giving the impression that its assetswere much larger than they actually were at the time.Lead Plaintiff alleges that D&K's SEC filings, pressreleases, and other statements (by D&K and/or IndividualDefendants) during [*65] the 2001, 2002, and 2003fiscal years were false or materially misleading becausethey reported favorable earnings and expected earningsduring this time-period while knowing that theiraccounting methods were suspect and such positivepredictions could not be realistically achieved.Specifically, Lead Plaintiff claims that various statementswere false and/or misleading because 1) they created a"false impression" that D&K's significant positive growthwas coming from a legitimate business enterprise wheninstead the positive revenue was the "direct result ofdefendants' channel-stuffing scheme"; 2) defendantsknew "given the terms of the incentive-laden andchannel-stuffing deals with suppliers such asBristol-Myers", there was a significant risk that D&K's"special purchasing opportunities" would end "at anymoment"; and 3) the "consignment deals" with BMSallowed D&K to inflate its assets on its balance sheets;thereby, violating GAAP. 4

4 The majority of the Lead Plaintiff's allegationsregarding the alleged falsity and misleading

nature of various statements attributed to thedefendants are contained in PP89-148 of thesecond amended complaint.

[*66] In passing on a motion to dismiss, a courtmust view the facts alleged in the complaint in the lightmost favorable to the plaintiff. Scheuer v. Rhodes, 416U.S. 232, 94 S. Ct. 1683, 40 L. Ed. 2d 90 (1974); Conleyv. Gibson, 355 U.S. 41, 45-46, 78 S. Ct. 99, 2 L. Ed. 2d80(1957); Toombs v. Bell, 798 F.2d 297, 298 (8th Cir.1986). The court must accept the allegations in thecomplaint as true and draw reasonable inferences in favorof the nonmoving party, dismissing the complaint only if"it appears beyond a reasonable doubt that plaintiff canprove no set of facts in support of his claim which wouldentitle him to relief." Conley v. Gibson, supra, 355 U.S.at 45-46; see also, Moses.com Securities v.Comprehensive Software Systems, Inc., 406 F.3d. 1052,1062 (8th Cir. 2005). "Although the pleading standard isliberal, the plaintiff must allege facts -- not mere legalconclusions -- that, if true, would support the existence ofthe claimed torts. Moses.com, at 1062 citing SchallerTel.Co. v. Golden Sky Sys., 298 F.3d. 736, 740 (8th Cir.2002). In viewing the complaint in the light mostfavorable to the plaintiff, the court should [*67] notdismiss it merely because the court doubts that theplaintiff will be able to prove all of the necessaryallegations. Bennett v. Berg, 685 F.2d. 1053, 1058 (8thCir. 1982). Thus, a motion to dismiss is likely to begranted "only in the unusual case in which a plaintiffincludes allegations that show on the face of thecomplaint that there is some insuperable bar to relief."Fusco v. Xerox Corp., 676 F.2d 332, 334 (8th Cir. 1982).


In Count I of his second amended complaint, LeadPlaintiff alleges violations of Section 10(b) of theSecurities Exchange Act of 1934 and Rule 10b-5. Section10(b) and Rule 10b-5 prohibit fraudulent conduct in thesale and purchase of securities. Section 10(b) forbids (1)the "use or employ[ment] . . . of any . . . deceptivedevice," (2) "in connection with the purchase or sale ofany security," and (3) "in contravention of" Securities andExchange Commission "rules and regulations". DuraPharmaceuticals v. Broudo, 544 U.S. 336, 125 S.Ct.1627, 1630-31, 161 L. Ed. 2d 577 (2005) citing 15 U.S.C.§ 78j(b); see, [*68] Ferris, Baker Watts, Inc. v. Ernst &Young, L.L.P., 395 F.3d. 851, 853-54 (8th Cir. 2005);K-Tel Int'l Sec. Litig. v. K-Tel Int'l, Inc. (In re K-Tel Int'l



Sec. Litig.), 300 F.3d. 881, 888 (8th Cir. 2002); Chen v.Navarre Corp.(In re Navarre Corp. Secs. Litig., 299F.3d. 735, 741 (8th Cir. 2002). Rule 10b-5 forbids, anyperson, directly or indirectly, from employing any device,scheme or artifice to defraud; in the making of any"untrue statement of material fact" or the omission of anymaterial fact "necessary in order to make the statementsmade . . . not misleading; or to engage in any act,practice, or course of business which operates or wouldoperate as a fraud or deceit upon any person inconnection with the purchase or sale of any security. InStoneridge Investment Partners, LLS v.Scientific-Atlanta, Inc. (In re Charter Communs., Inc.),443 F.3d. 987, 990 (8th Cir. 2006) citing 17 C.F.R. §240.10b-5; Dura Pharmaceuticals, 125 S.Ct. at 1631citing 17 C.F.R. § 240.10b-5 (2004).

In Central Bank of Denver v. First Interstate Bank ofDenver, 511 U.S. 164, 114 S. Ct. 1439, 128 L. Ed. 2d 119(1994), the Supreme Court found that [*69] § 10(b)prohibits only "manipulative or deceptive" devices orcontrivances, and that private plaintiffs "may not bring a[Rule] 10b-5 suit against a defendant for acts notprohibited by the text of § 10(b)." Central Bank, 511 U.S.at 173; Charter Communications, at 990. "In earliercases, the Court held that 'deceptive' conduct involveseither the misstatement or a failure to disclose by onewho has a duty to disclose. 'Manipulative,' as used in thesecurities context, is a 'term of art' and refers to illegaltrading practices such as 'wash sales, matched orders, orrigged prices, that are intended to mislead investors byartificially affecting market activity.'" CharterCommunications, at 990 (internal citations omitted).Based upon these earlier cases and the text and legislativehistory of the 1934 Act, the Court in Central Bank,supra., held that Rule 10b-5 does not reach those personswho only aid or abet a violation of § 10(b). Central Bank,511 U.S. at 177; Charter Communications, at 990.However, the law's reach is not completely cut off as tothese persons:

"The absence of § 10(b) aiding andabetting [*70] liability does not mean thatsecondary actors in the securities marketsare always free from liability under thesecurities Acts. Any person or entity,including a lawyer, accountant, or bank,who employs a manipulative device ormakes a material misstatement (oromission) on which a purchaser or seller

of securities relies may be liable as aprimary violator under 10b-5, assumingall of the requirements for primaryliability under Rule 10b-5 are met."


Upon review of Central Bank, supra., the EighthCircuit Court of Appeals concluded that it stood for three(3) governing principles: 1) the "categorical declaration"that a private plaintiff may not bring a Rule 10b-5 lawsuitagainst a defendant for acts not prohibited by the text of §10(b) included claims under Rule 10b-5(a) and (c), aswell as Rule 10b-5(b); 2) a device or contrivance is not"deceptive" within the meaning of § 10(b), absent somemisstatement or failure to disclose by one who has a dutyto disclose; and 3) the term "manipulative" in § 10(b) hasa limited [*71] contextual meaning as defined in SantaFe Industries, Inc. v. Green, 430 U.S. 462, 476-77, 97 S.Ct. 1292, 51 L. Ed. 2d 480 (1977) and adopted by theCourt in Central Bank, supra. Charter Communications,at 992. "Thus, any defendant who does not make oraffirmatively cause to be made a fraudulent misstatementor omission, or who does not directly engage inmanipulative securities trading practices, is at most guiltyof aiding and abetting and cannot be held liable under §10(b) or any subpart of Rule 10b-5." CharterCommunications, at 992 (internal citations omitted).

Private securities fraud actions brought under Section10(b) and Rule 10b-5 require the pleading and showing ofthese elements: 1) a material misrepresentation oromission; 2) scienter (a wrongful state of mind); 3) aconnection with the purchase or sale of a security; 4)reliance or "transaction causation"; 5) economic loss; and6) "loss causation" or a causal connection between thematerial misrepresentation and the loss. DuraPharmaceuticals, 125 S.Ct. at 1631; see Ferris, BakerWatts, at 854; K-tel, at 888; Navarre, at 741. SinceSection 10(b) and Rule 10b-5 actions are [*72] groundedin fraud, the more stringent pleading standards of Rule9(b) Fed.R.Civ.P. are applicable. Carlon v. Thaman (In reNationsMart Corp. Sec. Litig.), 130 F.3d. 309, 320 (8thCir. 1997); In re: BankAmerica Corp. SecuritiesLitigation, 78 F.Supp.2d. 976, 987 (E.D.Mo. 1999);Jakobe v. Rawlings Sporting Goods Co., 943 F.Supp.1143, 1152 (E.D.Mo. 1996).

Pursuant to Rule 9(b) Fed.R.Civ.P., all allegations of



fraud must be stated with particularity. To meet therequirements of Rule 9(b), a pleading must include "suchmatters as the time, place, and contents of falserepresentations, as well as the identity of the personmaking the misrepresentation and what was obtained orgiven up thereby." Bennett v. Berg, 685 F.2d. 1053, 1062(8th Cir. 1982); see also, Wiley v. Mitchell, et. al. 106Fed.Appx. 517, 521-22 (8th Cir. 2004)(unpublished).Compliance with the particularity requirements of Rule 9requires plaintiffs to "specify the statements contended tobe fraudulent, identify the speaker, state when and wherethe statements were [*73] made, and explain why thestatements were fraudulent." In re BankAmerica Corp.Securities Litigation, 78 F.Supp.2d. 976, 987 (E.D.Mo.1999)(citation omitted). "[C]onclusionary allegations thata defendant's conduct was fraudulent and deceptive arenot sufficient to satisfy the rule." Commercial Prop.Inv.,Inc. v. Quality Inn Int'l, Inc., 61 F.3d. 639, 644 (8th Cir.1995).

The Private Securities Litigation Reform Act(PSLRA), 15 U.S.C. § 78u-4, embodies the pleadingrequirements of Rule 9 Fed.R.Civ.P. Ferris, Baker Watts,at 854; K-tel, at 889; see Navarre, at 742 (given that thePSLRA embodies the pleading requirements of Rule 9,plaintiffs do not need to meet the requirements of both,and the PLSRA supercedes; i.e. under Rule 9 state ofmind can be averred generally; however, under thePLSRA, both falsity and scienter must be pleaded withparticularity). Complaints brought under Section 10(b)and Rule 10b-5 are governed by special heightenedpleading standards adopted by Congress in the PSLRA.These heightened pleading standards are unique tosecurities actions and [*74] were adopted by Congress inan attempt to curb abuses of securities fraud litigation.Kushner v. Beverly Enterprises, 317 F.3d. 820, 826 (8thCir. 2003) citing Navarre, at 741; see Amdocs, at 547citing Navarre, at 741.

The PSLRA requires plaintiffs "to specify eachmisleading statement or omission and specify why thestatement or omission was misleading." Kushner, at 826;Navarre, at 741-42; see, In Re: Cerner Corp. SecuritiesLitigation, 425 F.3d. 1079, 1083 (8th Cir. 2005)(aplaintiff must plead falsity by specifying each allegedlymisleading statement and the reasons why each statementis misleading); 15 U.S.C. § 78u-4(b)(1). Under thePSLRA, the circumstances of the fraud must be statedwith particularity, including "such matters as the time,place and contents of false representations, as well as, the

identity of the person . . . and what was obtained or givenup thereby . . . [t]his means the who, what, when, where,and how." K-tel, at 890 quoting Parnes v. Gateway 2000,Inc., 122 F.3d. 539, 549-50 (8th Cir. 1997). Thecomplaint must also "state with particularity [*75] factsgiving rise to a strong inference that the defendant actedwith the required state of mind." Kushner, at 826;Navarre, at 741-42; 15 U.S.C. § 78u-4(b)(2); see Ferris,Baker Watts, at 854; K-tel, at 889. The Act requires thatthe allegations collectively establish a strong inference ofthe required state of mind. Cerner Corp., at 1083;Kushner, at 826. Any complaint failing to meet thesepleading requirements must be dismissed. Kushner, at826; In re: BankAmerica Corp. Securities Litigation, at988; 15 U.S.C. § 78u-4(b)(3)(A). Finally, the Reform Actrequires the courts to disregard "catch-all" or "blanket"assertions that do not live up to the particularityrequirements. Ferris, Baker Watts, at 853; Amdocs, at547; K-tel, at 889; Kushner, at 824; Florida State Bd. ofAdmin. v. Green Tree, 270 F.3d. 645, 660 (8th Cir.2001). "In order to satisfy the Reform Act's falsitypleading standard, a complaint may not rest on mereallegations that fraud has occurred." Cerner Corp., at1083 citing Navarre, at 742.

The Eighth Circuit has established a three-prong[*76] formula for assessing the adequacy of scienterallegations. After reviewing the tests promulgated by theother circuits to meet the Reform Act's "strong inferenceof scienter" standard, the appellate court fashioned itsown criteria for indicia of fraud:

"Therefore, we can say three thingsabout motive and opportunity allegations.First, motive and opportunity are generallyrelevant to a fraud case, and a showing ofunusual or heightened motive will oftenform an important part of a complaint thatmeets the Reform Act standard. Second, insome cases the same circumstantialallegations that establish motive andopportunity also give additional reason tobelieve the defendant's misrepresentationwas knowing or reckless. For instance, ininsider trading cases, the timing of tradesshows motive and opportunity, but it mayalso provide additional circumstantialevidence that the defendant knew of anadvantage. Such allegations may meet theReform Act standard, but if so it is



because they give rise to a stronginference of scienter, not merely becausethey establish motive and opportunity.Third, when the complaint does not showmotive and opportunity of any sort - eitherthe unusual, [*77] heightened motivehighlighted in the Second Circuit cases, oreven an everyday motive such as keepingone's job - then other allegations tendingto show scienter would have to beparticularly strong in order to meet theReform Act standard."

Florida State Bd. of Admin. v. Green Tree, at 660. Thus,inferences of scienter will survive a motion to dismissonly it they are "both reasonable and strong." CernerCorp., at 1084 citing Kushner, at 827. "Scienter isnormally a factual question to be decided by a jury, butthe complaint must at least provide a factual basis for itsscienter allegations." Cerner Corp., at 1084-85 citingK-tel, at 894.

Mere negligence does not violate federal securitieslaw; however, severe recklessness may. Ferris, BakerWatts, at 854 (citations omitted).

"Specifically, scienter may bedemonstrated by severe recklessnessinvolving 'highly unreasonable omissionsor misrepresentations' amounting to 'anextreme departure from the standards ofordinary care, and that present a danger ofmisleading buyers or sellers which iseither known to the defendant or is soobvious that the defendant must have beenaware of it. [*78] ' Recklessness, then,may be shown where unreasonablestatements are made and the danger ofmisleading investors is so obvious that thedefendant must have been aware of it."

Kushner, at 828 citing K & S P'ship v. Cont'l Bank, N.A.,952 F.2d. 971, 978 (8th Cir. 1991); see also, Ferris,Watts Baker, at 854. "This level of recklessness requiresthat defendants make statements that they know, or haveaccess to information suggesting, are materiallyinaccurate." Ferris, Baker Watts, at 854 citing Navarre,at 746.

The second amended complaint sets forth numerous

public statements made by the defendants during the classperiod that the Lead Plaintiff believes gives rise to astrong inference of scienter because the defendants knewfacts or had access to information that suggested thattheir public statements were not accurate and/ordeliberately engaged in making false and misleadingstatements in order to defraud the investors as to the truefinancial condition of defendant D&K. Examples of someof these allegedly inaccurate statements/omissions are asfollows:

1) The primary omission by thedefendants is their failure to disclose thechannel-stuffing [*79] transactions andconsignment sales with BMS; therebyfalsely representing D&K's true financialcondition and future.

2) This omission as to the true natureof its business with BMS "colored" thecredibility of D&K's statements, pressreleases, and analyst reporting during theClass Period:

*Analyst report by BearStearns, dated 9/14/2000stated: "DK WD CEO HordArmstrong, PresidentMarty Wilson, and CFOTom Hilton presented atthe Bear Stearns HealthcareConference on Wednesday.We walked awaycomfortable that thecompany is able to workpast the difficulties it hadexperienced in theaftermath of the loss of twosignificant customers, andreiterate our EPS estimatesand Attractive rating onshares.

We believe that thecompany has takenadvantage of losing its twolargest customers toconcentrate on local andregional retail business,which should produce



significantly highermargins. Managementpointed to good successsigning new customers toreplace the lost mail-orderbusiness, and we believethat the company is betteroff concentrating on itscore customer base withinits geographical reach ofthe midwest and contiguousstates."

*In D&K's 2001 10-K,D&K "boasted" [*80] thatits continuing financialsuccess was due to the"experience and expertiseof our management team inthis area, we also employsophisticated informationand inventory managementsystems to understand thedemand for particularproducts in advance ofbuying them fordistribution."

*In the Prospectus forthe secondary stockoffering in June 2001,defendants stated: "Thegrowth of our business inthis area has beenconstrained by our accessto working capital requiredto take advantage of theprocurement opportunitiesmade available to us bymanufacturers. We believethat the proceeds from theoffering and cash generatedfrom our business on anongoing basis will enableus to take advantage ofmore of the purchasingopportunities madeavailable to us bymanufacturers."

*In an April 24, 2002press release announcingrecord financial revenues,defendants stated: "D&K'snational pharmacy chainbusiness achieved sales of $385.8 million in the thirdquarter, an increase of41.0%, or $ 112.1 million.The improvement in thistrade class over the sameperiod last year is largelydue to strong relationshipswith both suppliers and thechains, which we have beenable to optimize with [*81]our improved capitalstructure."

*Again on August 14,2002, defendants attributedD&K's strong showing toits secondary stock offeringand new credit facilities:"Fueled by the capital fromour July 2001 follow-onequity offering andexpanded credit facilities,D&K again achieved newheights in fiscal 2002,surpassing everyperformance goal set foreach quarter and the fullyear."

*Also on August 14,2002, [following BMS'disclosure of the SECinvestigation into itsinventory and accountingpractice] defendants held aconference call withanalysts in which defendantWilson stated: "I thinkbecause of the situationwith Bristol, there has beenreactions to the situationwith Bristol by thepharmaceutical companies,although after just have



been meeting with a lot ofthe big former [sic]companies, I don't see thatthere will be a significantchange overall in themarket . . . As I mentionedon the call, we still expectthe price increases to befavorable to us, comparedto what they were in 2001and prior to that, whichobviously has a big impacton our gross margins.Overall, manufacturers arenervous. They aredefinitely reviewing theirpolicies and procedures.[*82] You know, so far wedon't feel that there - theopportunities are just goingto dry up total."

*On September 16,2002 D&K announced itwas reducing its "EPSguidance before one-timecharges related to theimplementation of SFAS142 to approximately $0.13-$ 0.17, from $ 0.30-$0.31." DefendantArmstrong stated: "Havingjust completed the reviewof results for the twomonths ended August 31, itis prudent to reduce ourguidance given sales andmargin trends that arebelow plan in both of ourprincipal trade classes.While this is disappointingnear-term development,particularly givenexpectations based on ourpast sales momentum, weremain very confident thatour business model,personnel, industryrelationships and trackrecord with customers

should enable us toovercome these short-termchallenges and eventuallyreturn our business to itshistorical growth trends . . .Given the uncertaintycreated by revenue andmargin shortfalls in bothour principal trade classes,it is difficult to predict nearterm trends. Accordingly,we have revised out Q1guidance and are now inthe process of reassessingcustomer demand, industrytrends and our projections,to provide accurate andtimely [*83] informationto our investors. We look toupdate our investors onthese issues, as well asguidance for the balance offiscal 2003, in conjunctionwith our Q1 conference callin late October.Accordingly, D&K cannotat this time reaffirm itsguidance for FY 2003,provided on August 14,2002, which anticipatedrevenues of 'at least $ 2.8billion' and EPS beforeone-time charges related tothe implementation ofSFAS 142 of 'at least $1.75'".

*The September 16,2002 press release alsocontinue to state that "[T]hesales shortfall is principallythe result of fewer thanexpected purchasing andsales opportunitiesavailable during the period.D&K's sales in the nationalchain business have beenvariable from month tomonth historically, drivenlargely by opportunistic



purchases frompharmaceutical companiesfor distribution primarily tonational chains."

*Following theSeptember 17, 2002 pricedrop of D&K commonstock, on September 24,2002 D&K filed its Form10-K for fiscal year 2002with the SEC in which itdisclosed that it had beenreceiving "specialpurchasing opportunities"which no longer existed. Itfurther stated that "[W]econtinue to makereplenishment and forward[*84] purchases but do notanticipate any specialpurchasing opportunities inthe near future, with thissupplier."

*On January 22, 2003,D&K issued a press releaseannouncing it financialresults for the secondquarter of fiscal 2003, theperiod ending December31, 2002. The press releasestated: "D&K Healthcareachieved a gross profitmargin of 4.00 percent,compared to last year'ssecond quarter gross profitmargin of 4.14 percent. Thedecline results primarilyfrom a lower gross marginin the national pharmacychain trade class due tofewer attractively pricedpurchasing opportunities."

Defendants argue that the Lead Plaintiff has failed toset forth the "particularities" as to why the statements are

false or misleading. After careful review of the secondamended complaint, the Court finds that the LeadPlaintiff has provided particulars as to who made thesubject statements, when the statements were made, anddemonstrated why the statements were allegedly false ormisleading at the time they were made. While thedefendants have spent considerable time and effortexplaining how and why the statements are proper, noneof these arguments undermine the Lead Plaintiff'sallegations [*85] at the pleading stage. The facts pleadedwith particularity sufficiently create a strong inference ofscienter, thus meeting the Reform Act standard. See,Green Tree Financial, at 667.

Defendants further have contended that statementscontained in press releases and other venues were"forward-looking" in substance and intent; thus, protectedby the PSLRA's "safe harbor" provision. 15 U.S.C. §78u-5(c)(1) and (2). The "safe harbor" provision protectsforward-looking statements if they are identified andaccompanied by risk disclosures, if they are immaterial,or if plaintiff(s) fail to prove that the person or personsmaking the subject statement(s) made them with actualknowledge that the statement was false or misleading. Inre: Retek, Inc. Securities, et. al., 2005 U.S. Dist. LEXIS35734, 2005 WL 1430296 (D.Minn. March 7, 2005); Inre Pemstar, Inc., 2003 U.S. Dist. LEXIS 14452, 2003 WL21975563 (D.Minn. August 15, 2003) 5. The "safeharbor" provision "does not insulate statements thatmisrepresent historical/hard or current facts." In re:Pemstar, Inc. Sec. Lit., supra. (citations omitted).

5 Although it is not the Court's usual practice tocite to unpublished court opinions, it will do so asto opinions within the circuit which it believesprovides guidance to the Court in determining theissue at hand.

[*86] Defendants contend that the alleged false ormisleading statements are nearly all "forward-looking" inthat they simply are statements of future financialprojections. They further contend that such statementswere rendered "harmless" by the consistent use of"cautionary language" as to the financial projections. TheLead Plaintiff counters that these statements werematerially false and/or misleading when made becausethey omit adverse information concerning the allegedchannel-stuffing transactions and/or consignments as thetrue basis for the inflated revenue predictions. The LeadPlaintiff contends that this information was known and



significant when the statements were made; therefore, itwas not that the statements in and of themselves werenecessarily false but that the defendants were inpossession of material facts which they had a duty todisclose so as not to make such statements misleading.

Upon consideration, the Court finds that thecautionary language accompanying the subject statementswas too generalized and "boilerplate" to make suchlanguage meaningful to the ordinary investor and thus,the subject statements are not protected by the "safeharbor" provision of [*87] the PSLRA.

Defendants further contend that the Lead Plaintiff'sallegations regarding GAAP violations are not sufficientto plead the requisite scienter for the Section 10(b) andRule 10b-5. The Lead Plaintiff contends that thedefendants were aware of the GAAP violations whenmade and were intentionally made to meet analysts'profitable expectations for the company. The LeadPlaintiff argues that D&K knowingly failed to properlyaccount for the subject sales transactions as consignedinventory which in turn contributed to the falsity of thefinancial statements issued throughout the class period.

Essentially, the Lead Plaintiff argues that theaccounting principles and standards that existed at thetime of the issuance of the subject financial statementswere clear and precise as to consigned inventory. Hefurther alleges that the pervasiveness and indifference tothe GAAP requirements resulting in such egregariousviolations evidences that D&K intentionally misstated itsrevenues throughout the class period. Defendants spendconsiderable time, not addressing the pleading standards,but rather defending themselves against the allegations.They simply argue that there were no GAAP [*88]violations because the subject sales transactions were notconsigned inventory.

"Allegations of GAAP violations are insufficient,standing alone, to raise an inference of scienter. Onlywhere these allegations are coupled with evidence ofcorresponding fraudulent intent might they be sufficient."Ferris, Baker Watts, Inc. v. Ernst & Young, L.L.P., 395F.3d. 851, 854 (8th Cir. 2005), aff'g 293 F. Supp. 2d.1003 (D.Minn. 2003) quoting In re Navarre, at 886,894-95. This rule was established because the GAAP "arefar from being a canonical set of rules that will ensureidentical accounting treatment of identical transactions.[GAAP], rather, tolerate a range of 'reasonable'treatments, leaving the choice among alternatives to

management." K-tel, at 890 quoting Thor Power Tool Co.v. C.I.R., 439 U.S. 522, 544, 99 S. Ct. 773, 58 L. Ed. 2d785 (1979); In re Stellent, Inc. Secs. Litig., 326 F. Supp.2d 970, 982 (D.Minn. 2004); Ferris, Baker Watts, 293 F.Supp. 2d at 1008.

Here, the Lead Plaintiff has alleged not onlyegregious GAAP violations, but also "evidence ofcorresponding fraudulent intent". He has set out withparticularity [*89] the material misstatements in thepublic statements which omitted, among other things, thealleged channel-stuffing transactions and the allegednature of the "sales" as actually being consignedinventory. Essentially, the second amended complaintalleges that the defendants knew that certain companyassets were impaired by the nature of businesstransactions with BMS and that losses were certain in thenear future, but that recognizing this "fact" during theclass period would have lowered the company's stockprice and threatened its ability to market and sell thestored pharmaceuticals. The second amended complaintfurther alleges that defendants delayed recognition of thetrue nature of these channel-stuffing transactions, anddelayed accounting for the true nature of thesetransactions as consigned inventory while publiclytouting strong future profits and continued excellentbusiness prospects with current customers. It is allegedthat these strategic nondisclosures kept D&K stockartificially high, attracting more investors, until theSeptember 2002 press release was issued causing adrastic stock price fall.

The allegations as a whole, taken as true, providestrong indicia [*90] of intentional wrongdoing on thepart of the defendants, at least at the pleading stage.Evidence relevant to scienter includes:

"insider trading in conjunction with falseor misleading statements; a divergencebetween internal reports and publicstatements; disclosure of inconsistentinformation shortly after the making of afraudulent statement or omission; briberyby top company officials; evidence of anancillary lawsuit, charging fraud, whichwas quickly settled; disregard of currentfinancial information acquired prior to thestatement at issue; accountingshenanigans; and evidence of actionstaken solely out of self-interest."



In re Acceptance Insurance Cos. Securities Litigation,352 F. Supp. 2d. 940, 958 quoting In re Navarre, at 747(internal citations omitted), aff'd 423 F.3d. 899 (8th Cir.2005). The Lead Plaintiff has coupled his GAAPallegations with the "corresponding fraudulent intent"required under the Reform Act.

Finally, the defendants argue that the allegationsregarding the Individual Defendants' alleged insidertrading are factually incorrect because Armstrong,Wilson, and Hilton actually ended up with more [*91]stock at the end of the class period than at the beginningof the class period. They further argue that the stock saleswere nothing more than regular consistent quarterly salesfollowing D&K's public financial filings. Essentially,they argue there was nothing inherently wrong aboutthese stock sales. The Lead Plaintiff argues that thesestock sales were significant in amount, expertly timed,and indicate knowledge of an advantage on the part ofArmstrong, Wilson, and Hilton. The Lead Plaintiffcontends that these stock sales were made not only on theheels of false positive financial statements but also at thetime of BMS' April 2002 disclosure of the SECinvestigation and its restatement of earnings. Such salesare viewed as unusual and suspicious. In re Navarre, at747; K-tel, at 896. Furthermore, Lead Plaintiff contendsthat these stock sales were different from prior sales as tothe amount of stock sold.

Upon review, it appears to the Court that the LeadPlaintiff's allegations are sufficient, at the pleading stage,to raise a strong inference of scienter on the part of theIndividual Defendants as to their stock sales during theclass period. The parties are arguing [*92] the merits ofthe allegations; e.g.. whether the calculation of the salesshould include or not include exercised or unexercisedoptions. The merits of the allegations are not for theCourt to consider at this time.

The Lead Plaintiff also asserts claims against theIndividual Defendants Armstrong, Wilson and Hiltonunder 20(a) of the Exchange Act. Section 20(a) of theExchange Act imposes liability on "every person who,directly or indirectly, controls any person liable" underthe Exchange Act; and such liability should be imposed"unless the controlling person acted in good faith and didnot directly or indirectly induce the act or actsconstituting the violation or cause of action." A "controlperson" relationship exists whenever "(I) the alleged

control person actually exercised control over the generaloperations of the primary violator and (ii) the allegedcontrol person possessed-- but did not necessarilyexercise-- the power to determine the specific acts oromissions upon which the underlying violation ispredicated." Farley v. Henson, 11 F.3d. 827, 835 (8thCir. 1993); see, Metge v. Baehler, 762 F.2d. 621, 624(8th Cir. 1985); Stephenson v. Deutsche Bank AG, 282F.Supp.2d. 1032, 1059 (D.Minn. 2003); [*93] PiperJaffray Cos., 38 F. Supp. 2d. 771, 782 (D.Minn. 1999).The control-person statute is "remedial and is to beconstrued liberally. It has been interpreted as requiringonly some indirect means of discipline or influence shortof actual direction to hold a 'controlling person' liable."Farley, at 836 quoting Myzel v. Fields, 386 F.2d. 718,738 (8th Cir. 1967); Stephenson, at 1059 (quoting bothFarley and Myzel, supra.); see also, Martin v. ShearsonLehman Hutton, 986 F.2d. 242, 244 (8th Cir.1993)(statute reaches persons who have only someindirect means of discipline or influence less than actualdirection). Section 20(a) can impose liability upon"corporate officers and directors, even in those cases inwhich they did not directly participate in the bad acts." Inre Acceptance Insurance Companies Sec. Litig., 352 F.Supp. 2d 940, 957 (D.Neb. 2004), aff'd 423 F.3d 899,2005 WL 2060912 (8th Cir. August 29, 2005) citingMetge v. Baehler, at 631. Finally, Section 20(a) is notsubject to the heightened [*94] pleading standards ofeither the Reform Act or Rule 9(b) Fed.R.Civ.P.Stephenson, at 1060 citing In re Initial Pub. OfferingSec.Litig., 241 F.Supp.2d. 281, 397 n.185 (S.D.N.Y.2003). Given the above-referenced legal principles, andin light of the Court's determination that the LeadPlaintiff has sufficiently pled claims against thesedefendants for violations of Section 10(b) and Rule10b-5, the Court will not dismiss the claims against theIndividual Defendants based on liability under Section20(a).

The parties have spent considerable time and effortarguing the "merits" of the second amended complaint;however, the bottom line is that the Lead Plaintiff haspleaded that during the class period, the defendants had intheir possession facts which rendered their financialresults materially false when first stated to the investingpublic, and given these facts, intentionally delayedrecognition of these "facts" in violation of GAAP, thenintentionally delayed recognition of the GAAP violationsin order to induce the plaintiffs to continue investing in a"profitable" company. Without a doubt the "merits" of the



allegations [*95] as presented can be argued fervently;and may not hold up once evidence as to the "merits" ispresented; however, such a debate involves questions offact "that cannot render the complaint inadequate, lest theheightened pleading requirements of the Reform Actreplace the function of a trial." Green Tree, at 666. TheLead Plaintiff has satisfied the Reform Act standard and

the defendants' motion to dismiss will be denied.

Dated this 23rd day of June, 2006.

Stephen N. Limbaugh




EXHIBIT 3


Howard v. HuiN.D.Cal.,2001.Only the Westlaw citation is currently available.

United States District Court, N.D. California.Joan C. HOWARD, et al., Plaintiffs,

v.Steven L.W. HUI, Wong's International (Holdings)

Limited and Gatcombe Corp., N.V., Defendants.No. C 92-3742-CRB.

Sept. 24, 2001.

MEMORANDUM AND ORDERBREYER, J.*1 In this securities fraud class action, plaintiffs al-lege that defendants participated in a scheme withEverex Systems, Inc. (“Everex”) to artificially in-flate the price of Everex stock by releasing falseand misleading information to the public and to en-gage in insider trading. After a series of motions,amended complaints, a jury trial, and a reversal bythe Ninth Circuit, plaintiffs filed their ThirdAmended Complaint (“TAC”) against defendantsSteven L.W. Hui (“Hui”), Wong's International(Holdings) Ltd. (“WIH”), and Gatcombe Corpora-tion (“Gatcombe”). Plaintiffs seek to hold WIH andGatcombe-outside shareholders-liable for state-ments made by Hui and Everex.

Now before the Court is the motion to dismiss filedby defendants WIH and Gatcombe. After carefullyreviewing the papers filed by both parties and hav-ing had the benefit of oral argument on September7, 2001, the Court GRANTS the motion to dismissfor the reasons set forth below.

BACKGROUND

Everex was a designer, manufacturer, and retailerof computers and computer products, and defendantHui served as Everex's Chief Executive Officer(“CEO”) and Chairman of the Board. WIH and Gat-combe, a wholly owned subsidiary of WIH, formedand funded Everex and were major shareholders ofEverex stock. Michael Wong (“Wong”) served as

an outside director of Everex and indirectly owneda large amount of Everex stock through his hold-ings in WIH.

Plaintiff Joan Howard (“Howard”) filed this classaction lawsuit in September 1992, pursuant to sec-tions 10(b) FN1 and 20(a) FN2 of the SecuritiesExchange Act of 1934, alleging that Everex, Hui,and Wong engaged in a scheme to artificially in-flate the price of Everex stock by releasing falseand misleading information to the public fromNovember 21, 1991 to December 10, 1992.

FN1.“It shall be unlawful for any person,directly or indirectly, by the use of anymeans or instrumentality of interstate com-merce or of the mails, or of any facility ofany national securities exchange ... (b) Touse or employ, in connection with the pur-chase or sale of any security registered ona national securities exchange or any se-curity not so registered ... any manipulativeor deceptive device or contrivance in con-travention of such rules and regulations asthe [SEC] may prescribe.”15 U.S.C. § 78j.

FN2.“Every person who, directly or indir-ectly, controls any person liable under anyprovision of this chapter or of any rule orregulation thereunder shall also be liablejointly and severally with and to the sameextent as such controlled person to anyperson to whom such controlled person isliable, unless the controlling person actedin good faith and did not directly or indir-ectly induce the act or acts constituting theviolation or cause of action.”15 U.S.C. §78t(a).

Shortly thereafter, Everex filed for bankruptcy andall actions against it were stayed. In May 1993,Howard amended her complaint to add defendantsWIH and Gatcombe. In November 1994, the Court,the Honorable Charles Legge, FN3 dismissed WIHand Gatcombe, who reside overseas, for lack of

Not Reported in F.Supp.2d Page 1Not Reported in F.Supp.2d, 2001 WL 1159780 (N.D.Cal.)(Cite as: Not Reported in F.Supp.2d)







personal jurisdiction and dismissed the section10(b) claim against Wong on the ground that theclaim was not pled with sufficient particularity. TheCourt subsequently held that Wong was not a con-trol person for purposes of plaintiffs' section 20(a)claim, and granted summary judgment in Wong'sfavor. Howard's remaining claims were limited toHui and proceeded to trial in August 1998. At theconclusion of Howard's case, the court dismissedall the claims against Hui, and plaintiff appealed.

FN3. This case was later reassigned to thisCourt in June of 2001.

The Ninth Circuit reversed in part, holding that thedistrict court erred in dismissing WIH and Gat-combe for lack of personal jurisdiction and in dis-missing the claims against Hui. Howard v. EverexSystems, Inc., 228 F.3d 1057, 1069 (9th Cir.2000).In particular, the court held that the evidence wassufficient to support a verdict in plaintiff's favor. Id.However, the Ninth Circuit affirmed the entry ofsummary judgment in favor of Wong on the section20(a) control person liability claim. Id. at 1067.

*2 On February 9, 2001, Howard filed a SecondAmended Complaint (“SAC”) which added CharlesAnderson as a plaintiff. Anderson was added as aplaintiff because, unlike Howard, he traded contem-poraneously with defendants and has standing tobring insider trading claims. The SAC assertedthree causes of action against WIH and Gatcombe:violations of section 10(b), section 20(a), and an in-sider trading claim under section 20(A).FN4

FN4.“Any person who violates any provi-sion of this chapter or the rules or regula-tions thereunder by purchasing or selling asecurity while in possession of material,nonpublic information shall be liable in anaction in any court of competent jurisdic-tion to any person who, contemporan-eously with the purchase or sale of securit-ies that is the subject of such violation, haspurchased (where such violation is basedon a sale of securities) or sold (where suchviolation is based on a purchase of securit-

ies) securities of the same class.”15 U.S.C.§ 78t-1(a).

WIH and Gatcombe subsequently moved to dismissthe SAC, and plaintiffs filed an opposition with anerrata including an allegation that Gatcombe viol-ated section 10(b) by filing a rule 144 notice whenselling Everex stock. The Court struck plaintiffs' er-rata, and granted defendants' motion to dismiss withleave to amend. First, the Court held that the allega-tions were insufficient to show that WIH and Gat-combe were control persons for purposes of the fin-ancial statements at issue. Second, the Court heldthat plaintiffs failed to plead their section 10(b) andrule 10b-5 claims with sufficient particularity. TheCourt also determined that plaintiffs had not suffi-ciently pled scienter. Lastly, the Court held thatthere could be no liability under section 20(A) be-cause plaintiffs had not properly pled the requisiteunderlying violation.

On June 8, 2001, plaintiffs filed their ThirdAmended Complaint (“TAC”) and the case wassubsequently reassigned to this Court. WIH andGatcombe now move to dismiss the TAC on thegrounds that: (1) plaintiffs fail to plead that WIHand Gatcombe were control persons for purposes ofthe section 20(a) claim; (2) plaintiffs fail to pleadthat defendants made material misrepresentationsunder rule 10b-5 or section 10(b); (3) Anderson'sinsider trading claims are time-barred, lack particu-larity, fail to allege scienter; and (4) Anderson'ssection 20(A) claim is otherwise defective due tothe absence of a requisite underlying violation offederal securities law.

DISCUSSION

I. Legal Standard

A rule 12(b)(6) motion to dismiss for failure tostate a claim is viewed with disfavor. SeeGilligan v.Jamco Dev. Corp., 108 F.3d 246, 249 (9thCir.1997). Under rule 12(b)(6), a complaint shouldnot be dismissed unless a plaintiff can prove “no setof facts in support of his claim that would entitlehim to relief.”Parks Sch. of Bus., Inc. v. Symington,51 F.3d 1480, 1484 (9th Cir.1995). The court must







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take the non-moving party's factual allegations astrue and must construe those allegations in the lightmost favorable to the non-moving party. Seeid.Thecourt must also draw all reasonable inferences infavor of the non-moving party. SeeUsher v. City ofLos Angeles, 828 F.2d 556, 561 (9th Cir.1987).However, “conclusory allegations of law and un-warranted inferences are insufficient to defeat amotion to dismiss for failure to state a claim.”Ep-stein v. Washington Energy Co., 83 F.3d 1136,1139 (9th Cir.1996).

II. Control Person Claims

*3 Plaintiffs' section 20(a) claim against WIH andGatcombe is based on the theory that WIH and/orGatcombe were “control persons.” “In order toprove a prima facie case under § 20(a), plaintiffmust prove: (1) a primary violation of federal se-curities laws ... and (2) that the defendant exercisedactual power or control over the primaryviolator.”Howard, 228 F.3d at 1065. Plaintiffs al-lege that defendants were control persons with re-spect to Everex and/or Hui, the primary violators,based on the following: (1) WIH and Gatcombeowned the largest Everex stock percentage: 19.6%;(2) WIH and Gatcombe approved each director ofthe Everex board of directors; (3) the vice chairmanof WIH represented WIH and Gatcombe on theEverex board; (4) WIH convinced the Everex boardof directors to rescind Hui's resignation; (5) Huiwas indebted to WIH and Gatcombe as a result ofloans, and Hui had control over Everex; (5) Everexprohibited its officers from trading stock concur-rently with WIH and Gatcombe at defendants' re-quest; (6) WIH and Gatcombe arranged for Everexfinancing through Far East lenders; (7) WIH andGatcombe caused Everex to defer filing for bank-ruptcy; (8) Gatcombe and Everex used the samelaw firm; (9) friends and family of WIH and Gat-combe benefitted from less than arms length trans-actions with Everex; (10) WIH and Gatcombe re-ceived material non-public information from Ever-ex; and (11) WIH and Gatcombe convinced Everexto prevent its officers from trading stock at thesame time as Gatcombe. Plaintiffs asserted all butthe last two of the allegations in their dismissed

SAC.

Plaintiffs' TAC also contains allegations that WIHand Gatcombe “had control over Everex's financialreporting” as demonstrated by the fact that: (1)WIH and Gatcombe's “representative on Everex'sboard of directors reviewed and approved[Everex's] financial statements for its first quarterfiscal 1992”; and (2) WIH and Gatcombe “retainedthe power to review and approve [Everex's] finan-cial statements for its second quarter fiscal1992.”TAC ¶¶ 77, 194.

There is no concrete test for establishing whether adefendant is a control person. SeeWool v. TandemComputers, Inc., 818 F.2d 1433, 1441 (9thCir.1987) (“[T]he concept of control, in the contextof the securities law, is an elusive notion for whichno clear-cut rule or standard can be devised.”). Thedecision “is an intensely factual question” and“involves scrutiny of the defendant's participationin the day-to-day affairs of the corporation and thedefendant's power to control corporateactions.”Howard, 228 F.3d at 1065 (quoting Ka-plan v. Rose, 49 F.3d 1363, 1382 (9th Cir.1994)).General control over a company is not enough;plaintiffs must allege that the defendants were act-ive in the day-to-day affairs of Everex or Hui orthat they exercised specific control over the prepar-ation and release of the financial statements. Seeid.at 1067 n. 13.

*4 Defendants base their motion on two alleged de-ficiencies in plaintiffs' complaint. First, defendantsassert that plaintiffs have not pled defendants' con-trol liability with enough particularity to satisfy rule9(b). In particular, they contend that plaintiffs' con-trol theory allegations do not establish anythingmore than general control. In addition, defendantsargue that plaintiffs' allegations concerning defend-ants' alleged control over Everex's financial report-ing are dependent on Michael Wong, whose dis-missal by the Ninth Circuit severs the link for WIHand Gatcombe's control liability.

A. Control Over Financial Reporting

The TAC alleges that defendants, through Michael

























Wong, “reviewed and affirmatively approved thepublic dissemination of the first quarter fiscal 1992financial statements.”TAC § 77; seealso Plaintiff'sOpposition p. 16. Wong was a director of WIH andalso served as an outside director of Everex duringa portion of the class period. He therefore serves asa potential link between WIH and Gatcombe andEverex for purposes of control liability. However,the Ninth Circuit held as a matter of law that Wongwas not a control person.Howard, 228 F.3d at1065-67. Therefore, plaintiffs' claim must fail to theextent that it relies on Wong to establish defend-ants' control over the financial statements at issue.Plaintiffs also claim, however, that WIH and Gat-combe had control over Everex and Hui independ-ent of any control they may have had throughWong. The Court must therefore decide if the TAC,unlike the SAC, sufficiently alleges control liabilityindependent of any of the allegations which are de-pendent on Wong.

B. Sufficiency of the Allegations

The new allegations in the TAC-that WIH and Gat-combe received material nonpublic informationfrom Everex and also convinced Everex to preventits officers from trading stock at the same time asGatcombe-are insufficient to establish defendants'control person liability. As with the allegations ofthe SAC, plaintiffs' TAC allegations, assuming theyare true as the Court must, do not establish that de-fendants were active in the day-to-day affairs ofEverex, through Hui or otherwise, or that they exer-cised any specific control over the financial state-ments. SeeHoward, 228 F.3d at 1067 n. 13.Plaintiffs' section 20(a) claim therefore fails as amatter of law.

Plaintiffs respond that the Court is erroneously ap-plying a heightened pleading standard; that is, asummary judgment standard or the more stringentpleading requirements of the PSLRA. The Courtdisagrees. Plaintiff's section 20(a) claim is an alleg-ation of fraud. Allegations of fraud must be pledwith particularity. SeeFed.R.Civ.P. 9(b). While aplaintiff need not plead (or ultimately establish) thecontrol person's scienter distinct from the con-

trolled corporation's scienter, seeHoward, 228 F.3dat 165, a plaintiff must plead the circumstances ofthe control relationship with sufficient particularityto satisfy rule 9(b).SeeIn re Oak Tech. Sec. Litig.,No. 96-20552 SW, 1997 WL 446168, at *14(N.D.Cal. Aug. 1, 1997); seealsoIn re Glenfed, Inc.Sec. Litig., 60 F.3d 591, 593 (9th Cir.1995)(affirming dismissal of section 20(a) claim for fail-ing to plead that the control person “participated inthe day-to-day corporate activities, or had a specialrelationship with the corporation, such as a particip-ation in preparing or communicating group inform-ation at particular times.”). Accordingly, on a mo-tion to dismiss, the Court is required to reviewplaintiffs' allegations as to the circumstances of thecontrol relationship and determine whether they aresufficient to establish control person liability.SeeOak Tech., 1997 WL 446168, at *14 (dismissingplaintiffs' section 20(a) claim for failure to pleadthe circumstances of the control relationship withsufficient particularity); seealsoBerry v. ValenceTech., Inc., 175 F.3d 699, 706-07 (9th Cir.), cert.denied,538 U.S. 1019 (1999) (affirming 12(b)(6)dismissal of the defendant for failure to sufficientlyallege how the defendant controlled or otherwiseinfluenced the alleged misstatements).

III. Fraudulent Misrepresentation

*5 Plaintiffs' section 10(b) and rule 10b-5 claimsagainst defendants are based on the rule 144 noticedefendants filed in connection with a sale of Everexstock. See Rule 144(h) (requiring the notice to befiled by any seller of more than 500 shares, or anyamount of stock with an aggregate sale price in ex-cess of $10,000 within a three month period). De-fendants were required to file the rule 144 Noticewith the Securities Exchange Commission upon thesale of their Everex shares. The Notice containsboilerplate language asserting that the personselling the securities does not know “any materialadverse information in regard to the current andprospective operations of the Issuer [Everex] of thesecurities to be sold which has not been publiclydisclosed.”TAC §§ 118, 122, 130. Plaintiffs allegethat WIH and Gatcombe were aware of adverse un-disclosed information at the time they submitted the




















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rule 144 Notice, and therefore the notice was falseand misleading.

In order to establish a section 10(b) violation,plaintiffs must prove that the statements were ma-terial. Materiality exists when “ ‘there is a substan-tial likelihood that a reasonable investor would con-sider the information important in making an in-vestment decision” ’ Caravan Mobile Home Sales,Inc. v. Lehman Brothers Kuhn Loeb, Inc., 769 F.2d561, 565 (9th Cir.1985) (quoting Vaughn v. Tele-dyne, Inc., 628 F.2d 1214, 1221 (9th Cir.1980)).Materiality is a fact-specific inquiry that is gener-ally left for the jury unless the materiality is “so ob-vious that reasonable minds cannot differ.” Durningv. First Boston Corp., 815 F.2d 1265, 1268 (9thCir.1987). Nonetheless, courts may, and do, dismisssection 10(b) claims for lack of materiality on rule12(b)(6) motions. Seee.g.,In re Syntex Corp. Sec.Litig., 95 F.3d 922, 932 (9th Cir.1996) (affirmingdismissal for failure to state a claim regarding ma-teriality of statements); In re Stac Elects. Sec. Lit-ig., 89 F.3d 1399, 1405 (9th Cir.1996) (affirmingthe dismissal of plaintiffs' complaint for failure toestablish that statements were materially mislead-ing); In re VeriFone Sec. Litig., 11 F.3d 865, 870(9th Cir.1994) (dismissal on 12(b)(6) grounds prop-er where omissions are not material).

The question here is whether an investor wouldconsider the rule 144 statement to be important.Plaintiffs do not cite a single case to support theirassertion that rule 144 statements can give rise tosection 10(b) liability. As defendants point out, it isthe sale of stock by a major shareholder that is amaterial event. The TAC does not include any al-legations that suggest that the statement signed inconjunction with the sale is information that a reas-onable investor would consider important. Accord-ingly, plaintiffs' section 10(b) claim fails as a mat-ter of law.

IV. Insider Trading Claims

Anderson's insider trading claims are brought undersection 10(b), rule 10b-5 and section 20(A). De-fendants move to dismiss Anderson's insider trad-

ing claims on three independent grounds: (1) theclaims are barred by the statute of limitations; (2)they fail to satisfy rule 9(b); and (3) they fail to suf-ficiently allege scienter. As the Court concludesthat Anderson's claims are barred by the statute oflimitations, it need not address defendants' addi-tional arguments.

*6 The statute of limitations for a section 20(A) vi-olation is five years from the date of the last trans-action that is the subject of the violation. 15 U.S.C.§ 78t-1(b)(4). The statute of limitations for a sec-tion 10(b) claim is three years. 15 U.S.C. § 78i(e).The section 20(A) claim is based on Anderson'sMarch 20, 1992 transaction, and therefore Ander-son's section 20(A) claim should have been broughtby March 20, 1997 and the section 10(b) claim byMarch 20, 1995. However, as is set forth above,Anderson did not bring his insider trading claimsuntil February 2000. Therefore, Anderson's claimscan proceed only if either “relation back” or equit-able tolling applies.

A. Relation Back Doctrine

The relation back doctrine preserves a plaintiff'sability to add a new plaintiff only when “(1) the ori-ginal complaint gave the defendant adequate noticeof the claims of the newly proposed plaintiff; (2)the relation back does not unfairly prejudice the de-fendant; and (3) there is an identity of interestsbetween the original and newly proposedplaintiffs.”In re Syntex Corp. Sec. Litig., 95 F.3d922, 935 (9th Cir.1996) (citing Besig v. DolphinBoating & Swimming Club, 683 F.2d 1271,1278-79 (9th Cir.1982)).

“An amendment equitably may relate back whenthe prior complaint has given adequate notice of thefacts supporting a claim.”Besig v. Dolphin Boating& Swimming Club, 683 F.2d 1271, 1278 (9thCir.1982). In order to relate back, the new claimmust arise from the same core of operative factspled prior to the expiration of the statute of limita-tions. If the focus of the litigation changes dis-tinctly upon the amendment of a complaint, relationback is not justified. Seeid. at 1279.Where a new




























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plaintiff with a new claim is sought to be added, theadversary must have notice about the operationalfacts as well as “fair notice that a legal claim exis-ted in and was in effect being asserted by, the partybelatedly brought in.”Leachman v. Beech AircraftCorp., 694 F.2d 1301, 1308-09 (D.C.Cir.1982)(citing Williams v. United States, 405 F.2d 234, 238(5th Cir.1968)).

Howard's original complaint was limited to claimsunder section 10(b) and 20(a). Although the origin-al complaint made reference to stock sales for thepurpose of establishing scienter, it did not notifydefendants that an insider trading claim may be as-serted against them. Furthermore, Anderson's in-sider trading claims involve an independent core ofoperative facts. Insider trading claims require a pre-dicate violation of a securities law, contemporan-eous trading of defendant and plaintiff, and a profitgain or loss. 15 U.S.C. § 78t-1(a)-(b). The addition-al facts necessary to plead a section 20(A) claimtherefore involve proof of the contemporaneoustrading as well as evidence of profit or loss in addi-tion to the underlying offense. Because the only no-tice defendants received regarding insider tradingconsisted of references to stock sales for the pur-poses of establishing scienter, plaintiffs have notmet their burden of establishing adequate notice.

*7 Plaintiffs' argument regarding identity of interestis equally unavailing. In Syntex, the Ninth Circuitheld that two groups of plaintiffs had different in-terests for purposes of the relation-back doctrinebecause they bought stock at different values andafter different statements were made by defendants.Syntex, 95 F.3d at 935. Although Anderson was amember of the class when the original complaintwas filed, he asserts an entirely new claim thatHoward did not and could not allege due to lack ofstanding. Thus, with respect to the new insider trad-ing claim, Anderson has different interests fromHoward. Accordingly, the relation-back doctrinedoes not rescue Anderson's insider trading claims.

B. Tolling

As an alternative to relation back, plaintiffs argue

that the insider trading claims were equitably tolled.Plaintiffs allege that Anderson could not havebrought suit prior to the Ninth Circuit's reversal be-cause the district court had previously determinedthat WIH and Gatcombe were not subject to person-al jurisdiction. Plaintiffs rely on Seattle AudubonSociety v. Robertson, 931 F.2d 590 (9th Cir.1991),to argue that the doctrine of impossibility shouldtoll the statute of limitations until the Ninth Circuitheld that WIH and Gatcombe were subject to theCourt's jurisdiction.

Plaintiffs' “impossibility” argument is unpersuas-ive. In Seattle Audubon, the court tolled the statuteof limitations because of a district court's erroneousdetermination that a statute was constitutional. Id.at 598.The plaintiffs appealed the district court'sruling, but in the meantime did not bring the actionwhich on its face was barred by the statute whichthe district court had upheld. Seattle Audubon islimited to the “particular circumstances of [its] un-usual case.”Id. at 597.As the D.C. Circuit observed,Seattle-Audubon“was expressly limited to its pecu-liar circumstances, in particular the unusually shortlimitations period [15 days], and the diligence ofthe plaintiff in pursuing its case,” and therefore thecase “does not support the broad proposition” that“the presence of adverse precedent automaticallyleads to equitable tolling.”Boling v. United States,220 F.3d 1365 (D.C.Cir.2000).

Here, there was no legal impediment to Andersonbringing his insider trading claims. The class wasnot certified at the time the Court dismissed WIHand Gatcombe for lack of personal jurisdiction, andthus Anderson was not bound by that determina-tion. Accordingly, Anderson's insider tradingclaims are time-barred.

V. Section 20(A) Claim

Liability under section 20(A) is dependent on anunderlying violation of the Securities Act. 15U.S.C. § 78t-1(a). If plaintiffs have failed to allege“an actionable independent underlying violation ofthe '34 Act,” they cannot maintain a claim undersection 20(A).In re VeriFone Sec. Litig., 11 F.3d





























865, 872 (9th Cir.1993). As the Court has con-cluded that plaintiffs cannot maintain a claim undersection 10(b), section 20(a) or rule 10b-5, Ander-son's section 20(A) claim must be dismissed forfailure to establish a predicate violation of the Se-curities Exchange Act.

CONCLUSION

*8 For the foregoing reasons, defendants WIH andGatcombe's motion to dismiss is GRANTED in itsentirety. As plaintiffs have already been grantedleave to amend once, and as they have not comeforward with any additional allegations not in-cluded in the TAC, the dismissal is without leave toamend.

IT IS SO ORDERED.

N.D.Cal.,2001.Howard v. HuiNot Reported in F.Supp.2d, 2001 WL 1159780(N.D.Cal.)

END OF DOCUMENT








EXHIBIT 4


LEXSEE 2007 US DIST LEXIS 52356

In re Impax Laboratories, Inc. Securities Litigation

NO. C 04-04802 JW

UNITED STATES DISTRICT COURT FOR THE NORTHERN DISTRICT OF

CALIFORNIA, SAN JOSE DIVISION


July 18, 2007, Decided July 18, 2007, Filed

PRIOR HISTORY: In re Impax Labs., Inc., Sec. Litig., 2007 U.S. Dist. LEXIS 723 (N.D. Cal., Jan. 3, 2007) COUNSEL: [*1] For Charles Rosen, On behalf of him-self and All others similarly situated, Plaintiff: Azra Z. Mehdi, Patrick J. Coughlin, LEAD ATTORNEYS, Wil-low E. Radcliffe, Lerach Coughlin Stoia Geller Rudman & Robbins LLP, San Francisco, CA.; Darren Jay Rob-bins, William S. Lerach, Lerach Coughlin Stoia Geller Rudman & Robbins LLP, San Diego, CA. For Edward Mihalik, Plaintiff: Robert S. Green, Green Welling LLP, San Francisco, CA. For Dr. Melvin M Owen, Plaintiff: Azra Z. Mehdi, LEAD ATTORNEY, Lerach Coughlin Stoia Geller Rudman & Robbins LLP, San Francisco, CA.; Shana E. Scarlett, LEAD ATTORNEY, Hagens Berman Sobol Shapiro LLP, Berkeley, CA. For IMPAX Laboratories, Inc., Defendant: Dale E. Bar-nes, Jr., LEAD ATTORNEY, Bingham McCutchen LLP, San Francisco, CA.; Joseph Otto Click, LEAD ATTOR-NEY, Blank Rome LLP, Washington, DC.; Kerry Brainard, Michael Joseph, Washington, DC. For Barry R. Edwards, Charles Hsiao, Larry Hsu, Cornel C. Spiegler, David S. Doll, David J. Edwards, Defen-dants: Joseph Otto Click, LEAD ATTORNEY, Blank Rome LLP, Washington, DC.; Kerry Brainard, Michael Joseph, Washington, DC. For United Food & Commercial Workers Union Local 655, AFL-CIO, Food Employers Joint Pension Plan, Movant: [*2] Monique Winkler, LEAD ATTORNEY, Azra Z. Mehdi, Lerach Coughlin Stoia Geller Rudman & Robbins LLP, San Francisco, CA.; Shana E. Scarlett, LEAD ATTORNEY, Hagens Berman Sobol Shapiro

LLP, Berkeley, CA.; Tricia Lynn McCormick, Lerach Coughlin Stoia Geller Rudman & Robbins LLP, San Diego, CA. For Haiduk Group, Movant: Elizabeth Pei Lin, Milberg Weiss & Bershad LLP, Los Angeles, CA. For Thomas Galvin, Jr., Movant: Robert S. Green, Green Welling LLP, San Francisco, CA. JUDGES: JAMES WARE, United States District Judge. OPINION BY: JAMES WARE OPINION ORDER DENYING DEFENDANTS' MOTION TO DISMISS THIRD AMENDED CONSOLIDATED COMPLAINT I. INTRODUCTION

This is a securities fraud class action brought on be-half of investors who acquired Impax Laboratories, Inc. ("Impax") securities between May 5, 2004 and Novem-ber 3, 2004 (the "Class Period") against Impax and cer-tain of Impax's senior officers and directors (collectively, "Defendants"). Impax is a specialty pharmaceutical com-pany that develops, sells and markets generic pharma-ceuticals, including generic equivalents of drugs Well-butrin and Zyban. Plaintiffs allege violations of Section 10(b) and 20(a) and Rule 10b-5 of the Securities Ex-change Act of 1934 ("Exchange Act"). Presently [*3] before the Court is Defendants' Motion to Dismiss Third Amended Consolidated Complaint. The Court conducted a hearing on June 21, 2007. Based on the papers submit-ted to date and the oral arguments of counsel, the Court DENIES Defendants' Motion to Dismiss.


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II. BACKGROUND

Plaintiffs filed this suit on behalf of all persons who purchased Impax securities during the class period. Plaintiffs allege the following:

Plaintiffs 1 purchased Impax securities during the Class Period and suffered losses as a result of Defendants' actions. 2 Individual Defendants Barry R. Edwards, Dr. Charles Hsiao, Dr. Larry Hsu, Cornel C. Spiegler, David S. Doll, and David J. Edwards were directors, officers, or high-ranking employees of Impax during the Class Period. (TAC PP 14-20.)

Non-party Teva Pharmaceuticals In-dustries, Ltd. ("Teva") is a global pharma-ceutical company and one of the world's largest generic drug companies. (TAC P 70.) Part of Teva's strategy is to reach the market with generic versions of branded pharmaceuticals as quickly as possible; it develops alliances with partners to acquire rights to generic products, or otherwise shares development costs or litigation risks. Id.

In June 2001, Impax and [*4] a Teva subsidiary entered into a Strategic Alli-ance Agreement ("SAA"). (TAC PP 3, 69.) Under the SAA, Teva received exclu-sive U.S. prescription-marketing rights for six of Impax's products, including bu-propion products; Impax shared in Teva's profits from sales of the products. (TAC P 71.) Non-party Andrx Corporation ("Andrx") was also a signatory to the SAA. (TAC P 73.)

On March 22, 2004, Impax an-nounced that the Food and Drug Admini-stration ("FDA") had granted final mar-keting approval to its Abbreviated New Drug Application ("ANDA") for bu-propion 150 mg controlled release tablets. (TAC P 170.) Impax immediately began shipping 100 mg and 150 mg doses of bu-propion to Teva to sell to the market. Id. As a result, on May 5, 2004, Impax re-ported its first profitable quarter, 1Q04, with revenues of $ 38.8 million, $ 26.6 million of which was attributable to Im-pax's share of bupropion revenues. (TAC P 80.) Similarly, Impax reported on Au-gust 4, 2004 that its 2Q04 revenues were $ 30.8 million, of which $ 8.1 million was

attributable to Impax's share of bupropion revenues. (TAC P 280.)

On November 3, 2004, Impax an-nounced that its 3Q04 results would be delayed to review customer credits on bu-propion [*5] given by its strategic part-ner:

IMPAX Laboratories, Inc . . . today announced that the Company has postponed its release of 2004 third quarter financial results to Tuesday, No-vember 9, 2004 in order to allow its independent audi-tors more time to complete their review of the Com-pany's third quarter finan-cial statements, including the timing of certain cus-tomer credits on bupropion products marketed by a strategic partner. Results were originally scheduled to be announced on Thurs-day, November 4, 2004.

(TAC P 135.) Impax's stock price de-clined from $ 13.00 on November 3, 2004 to $ 10.07 on November 4, 2004, a one-day decline of 23 percent on a volume of 6.77 million shares. (TAC P 140.) The November 3 announcement did not ex-plicitly notify investors that Impax would be forced to restate the 1Q04 and 2Q04 financial results. (TAC P 141.) On No-vember 9, 2004, Impax released its 3Q04 results and restated its 1Q04 and 2Q04 re-sults. (TAC P 144.) It lowered its 1Q04 results by $ 4.3 million and its 2Q04 re-sults by $ 281,000, reducing earnings by $ 0.07 per share. Id. Impax's stock increased in value over the following two days, from $ 11.85 on November 9, 2004 to $ 13.30 on November 11. 2004. [*6] (TAC 148.)

1 The named Plaintiffs are United Food & Commercial Workers Union Local 655, AFL-


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CIO, Food Employers Joint Pension Plan; and Dr. Melvin M. Owen. (TAC PP 11-12.)

2 (Third Amended Consolidated Complaint for Violations of Sections 10(b) and 20(a) of the Se-curities Exchange Act of 1934 PP 11-12, hereaf-ter, "TAC," Docket Item No. 112.) Defendant Impax is a small pharmaceuticals company that develops, sells, and markets generic pharmaceuti-cals, including variations of bupropion hydro-chloride ("bupropion"), the generic version of Wellbutrin (an anti-depressant) and Zyban (a smoking cessation agent). (TAC P 3.)

Plaintiffs' Third Amended Consolidated Complaint alleges two causes of action against Impax: (1) Claim 1, for violation of Section 10(b) of the Exchange Act and Rule 10b-5, by issuing false or misleading statements about Impax's reserves, revenues, and income, and (2) Claim 2, for violation of Section 20(a) of the Exchange Act, for control person liability. Presently before the Court is Defendants' Motion to Dismiss the Third Amended Complaint. III. STANDARDS

Pursuant to Federal Rule of Civil Procedure 12(b)(6), a complaint may be dismissed against a defen-dant for failure to state [*7] a claim upon which relief can be granted against that defendant. Dismissal may be based on either the lack of a cognizable legal theory or the absence of sufficient facts alleged under a cognizable legal theory. Balistreri v. Pacifica Police Dep't, 901 F.2d 696, 699 (9th Cir. 1990); Robertson v. Dean Witter Rey-nolds, Inc., 749 F.2d 530, 533-534 (9th Cir. 1984). For purposes of evaluating a motion to dismiss, the court "must presume all factual allegations of the complaint to be true and draw all reasonable inferences in favor of the nonmoving party." Usher v. City of Los Angeles, 828 F.2d 556, 561 (9th Cir. 1987). Any existing ambiguities must be resolved in favor of the pleading. Walling v. Beverly Enters., 476 F.2d 393, 396 (9th Cir. 1973).

However, mere conclusions couched in factual alle-gations are not sufficient to state a cause of action. Pa-pasan v. Allain, 478 U.S. 265, 286, 106 S. Ct. 2932, 92 L. Ed. 2d 209 (1986); see also McGlinchy v. Shell Chem. Co., 845 F.2d 802, 810 (9th Cir. 1988). The complaint must plead "enough facts to state a claim for relief that is plausible on its face." Bell Atlantic Corp. v. Twombly, 550 U.S. , 127 S. Ct. 1955, 1974, 167 L. Ed. 2d 929 (2007). Courts may dismiss a case without leave to amend if [*8] the plaintiff is unable to cure the defect by amendment. Lopez v. Smith, 203 F.3d 1122, 1129 (9th Cir. 2000).

Claims brought under Section 10(b) of the Exchange Act and Rule 10b-5 must meet the particularity require-ments of Federal Rule of Civil Procedure 9(b). In re Daou Sys., Inc. Sec. Litig., 411 F.3d 1006, 1014 (9th Cir. 2005). Rule 9(b) requires that "[i]n all averments of fraud or mistake, the circumstances constituting fraud or mis-take shall be stated with particularity."

Moreover, claims brought under Section 10(b) and Rule 10b-5 must also meet the stringent pleading stan-dards of the Private Securities Litigation Reform Act of 1995. To plead a violation of Section 10(b) of the Ex-change Act, 15 U.S.C. § 78j(b) and SEC Rule 10b-5, 17 C.F.R. § 240.10b-5, a plaintiff must allege (1) a material misrepresentation or omission of fact, (2) scienter, (3) a connection with the purchase or sale of a security, (4) transaction and loss causation, and (5) economic loss. Dura Pharm., Inc. v. Broudo, 544 U.S. 336, 125 S. Ct. 1627, 161 L. Ed. 2d 577 (2005). The PSLRA amends the Exchange Act to require that a private securities fraud litigation complaint "plead with particularity both falsity and scienter." In re Daou, 411 F.3d at 1014. [*9] Spe-cifically, a complaint alleging securities fraud must "specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed." 15 U.S.C. § 78u-4(b)(1); In re Vantive Corp. Sec. Litig., 283 F.3d 1079, 1085 (9th Cir. 2002). IV. DISCUSSION

Defendants move to dismiss on the grounds that Plaintiffs have failed to adequately allege loss causation and scienter. The Court considers each issue in turn.

A. Loss Causation

Defendants contend that Plaintiffs' two new relevant allegations, which concern Impax's August 4, 2004 press release announcing 2Q04 results and a November 4, 2004 Teva conference call, do not remedy the deficien-cies the Court previously found in Plaintiffs' loss causa-tion allegations. (Defendants' Notice of Motion and Mo-tion to Dismiss Third Amended Consolidated Complaint and Memorandum of Points and Authorities in Support Thereof at 8, hereafter, "Motion," Docket Item No. 115.)

To plead loss causation adequately, a plaintiff must allege a causal connection between [*10] the defendant's material misrepresentation and the plaintiffs loss; that is, the "misstatement or omission concealed something from the market that, when disclosed, negatively affected the value of the security." 15 U.S.C. § 78u-4(b)(4); Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336, 341, 125 S. Ct. 1627, 161 L. Ed. 2d 577 (2005); Lentell v. Merrill Lynch & Co., 396 F.3d 161, 173 (2nd Cir. 2005). The


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plaintiff "must allege . . . that the subject of the fraudu-lent statement or omission was the cause of the actual loss." Lentell, 396 F.3d at 173 (quoting Suez Equity In-vestors, L.P. v. Toronto Dominion Bank, 250 F.3d 87, 95 (2nd Cir. 2001) (emphasis in original.)) If a plaintiff al-leges a fraud on the market, a mere allegation of an in-flated purchase price does not constitute or proximately cause a relevant economic loss, because:

[A]t the moment that the transaction takes place, the plaintiff has suffered no loss; the inflated purchase payment is off-set by ownership of a share that at that in-stant possesses equivalent value. More-over, the logical link between the inflated share purchase price and any later eco-nomic loss is not invariably strong. Shares are normally purchased with an eye to-ward a later sale. But if, [*11] say, the purchaser sells the shares quickly before the relevant truth begins to leak out, the misrepresentation will not have led to any loss. If the purchaser sells later after the truth makes its way into the market place, an initially inflated purchase price might mean a later loss. But this is far from in-evitably so. When the purchaser subse-quently resells such shares, even at a lower price, that lower price may reflect, not the earlier misrepresentation, but changed economic circumstances, changed investor expectations, or other events, which taken separately or together account for some or all of that lower price.

Id. at 342-43.

The Ninth Circuit considered loss causation under the Dura framework in the case of In re Daou Systems, Inc., 411 F.3d 1006, 1014 (9th Cir. 2005). The court held that the Daou complaint adequately pled loss causation by alleging that "the drop in Daou's stock price was causally related to Daou's financial misstatements re-flecting its practice of prematurely recognizing revenue before it was earned." Id. at 1026. The complaint alleged that the defendants' belated revelation of the company's true financial condition "led to a 'dramatic, negative ef-fect on [*12] the market, causing Daou's stock to decline to $ 3.25 per share, a staggering 90% drop from the Class Period high of $ 34.375 and a $ 17 per share drop from early August 1998.'" Id. (emphasis in original.) Lastly, the complaint alleged that "Daou's stock price has never recovered and the Company has never been able to match the artificially inflated revenues reported during

the Class Period." Id. The Daou court found these allega-tions sufficient to plead loss causation.

In this case, whether Plaintiffs have adequately pled loss causation is grounded on two events that allegedly occurred in 2004. Specifically, Plaintiffs attempt to link Impax's May 5, 2004 announcement of 1Q04 results to the losses they allegedly suffered on two instances: the August 4, 2004 "partial revelation" of 2Q04 reduced sales and the November 3, 2004 "full revelation" con-cerning the 1Q04 and 2Q04 results. Plaintiffs' theory of loss causation is as follows:

In May 2004, Impax made at least three material misstatements or omissions.

First, Impax stated in a press release that its 1Q04 revenues were a record $ 38.8 million, up more than 240% from 1Q03. (TAC 80, PP 183.) This was false and misleading because Defendants' [*13] recognition of revenues on bupropion sales was premature and improper; they lacked sufficient information to recognize revenue on bupropion sales because they did not know the terms and conditions of Teva's sales to its customers. (TAC P 84.) Moreover, Impax decreased its reserves, failing to accrue any reserves for sales of bupropion. (TAC P 125.)

Second, Impax's President, Defendant Larry Hsu, stated in the same press re-lease, "The launch of our generic Well-butrin SR represents IMPAX's single largest product opportunity to date. Ac-cording to NDCHealth, U.S. sales of Wellbutrin SR 100 mg and 150 mg, mar-keted by GlaxoSmithKline (NYSE:GSK), were approximately $ 1.4 billion in the twelve months ended February 29, 2004 . . ." (TAC P 154.) Defendants' "product opportunity" statement was false and mis-leading because it suggested that Impax had a much larger market share of the market for generic bupropion drugs than was actually the case. (TAC P 158.) In particular, (1) Impax's initial shipments of bupropion had already "filled the pipe-line" of customer demand (thus ensuring that future orders would be dramatically reduced); (2) Impax was aware that price protection credits had been issued [*14] to consumers; and (3) Teva had informed Impax that it should stop building bu-propion inventory. (TAC PP 101-03, 158, 170-75.)


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Third, Impax's May 10, 2004 Report on Form 10-Q stated:

The rebates, charge-backs, returns and other credits decreased for the three months ended March 31, 2004 to approximately 14% of product sales as compared to approximately 22% for the comparable period in 2003. This de-crease was mainly due to Bupropion Hydrochloride 100mg and 150 mg Con-trolled Release Tablets, Loratadine, and Pseu-doephedrine Sulfate (5 mg/120 mg) 12-hour Ex-tended Release Tablets which are exempt from re-bates, chargebacks and other credits as per the agreements with Schering- Plough, Wyeth, and Novar-tis . . .

(TAC P 192.) This statement was false and misleading because the terms of the SAA gave Teva the ability to allow for returns and credits, and Teva did in fact do so. 3 (TAC P 197.)

The reality of the situation was par-tially revealed to the market in August 2004. 4 On August 4, 2004, Impax an-nounced that its financial results for 2Q04 were well-below investor expectations (actual earnings per share ("EPS") of $ 0.01 per share, compared to analyst ex-pectations of $ 0.03 per share). The press [*15] release also stated:

Total revenues for the second quarter of 2004 were $ 30.8 million, more than double total revenues of $ 14.1 million in the prior year's second quarter . . . . The sequential quarter decline was due to timing of bupropion shipments and pipeline filling, par-ticularly as related to the launch of Bupropion Hy-

drochloride in the first quarter. During the 2004 second quarter, IMPAX's revenues from sales of Bu-propion Hydrochloride products, through our stra-tegic alliance agreements with Teva and Andrx, were approximately $ 8.1 mil-lion, compared with $ 23.9 million in the first quarter. . .

(TAC P 280.) In response, the market closed down from $ 13.97 to $ 12.00 on an increased trading volume of 7.1 million shares. (TAC P 134.) The reality of the situation was fully revealed to the market on November 3, 2004, when Impax ulti-mately revealed that its 3Q04 results would be delayed to review customer credits on bupropion products:

IMPAX Laboratories, Inc . . . today announced that the Company has postponed its release of 2004 third quarter financial results to Tuesday, No-vember 9, 2004 in order to allow its independent audi-tors more time to complete their review of the Com-pany's [*16] third quarter financial statements, in-cluding the timing of cer-tain customer credits on bupropion products mar-keted by a strategic part-ner. Results were origi-nally scheduled to be an-nounced on Thursday, No-vember 4, 2004.

(TAC P 135.)

Of the November 3, 2004 press re-lease, the Court previously held:

Impax's November 3 an-nouncement concerned only the release of 3Q04 results. The November 3 announcement did not in-dicate that the 1Q04 or


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2Q04 financial statements or revenues would be al-tered. However, Plaintiffs' Second Amended Com-plaint only alleges material misstatements or omissions with respect to Impax's 1Q04 and 2Q04 financial results. Since Impax's No-vember 3 press release does not address these fi-nancial results, the Court finds that it did not dis-close a previously made misstatement or omission.

(Order Granting Defendants' Motion to Dismiss Second Amended Consolidated Complaint with Leave to Amend at 7, Docket Item No. 110.)

3 That is, the SAA provided, "Teva shall have the sole and exclusive right to determine all terms and conditions of sale of the Products to its cus-tomers." (TAC P 197.)

4 Additionally, Plaintiffs allege that in reality, the bupropion products were not exempt from [*17] credits, as Defendant Spiegler explained in a November 9, 2004 conference call:

The September, 2004, financial report indicated two major sales credits issued by Teva in Septem-ber of 2004, which was our share of this credit for an aggregate of about $ 3.5 million . . . . As a re-sult of all our discussions with Teva it was determined that these credits related to March 2004 sales . . .

(TAC PP 196.)

In this case, the specific subject of the allegedly fraudulent statements was Impax's 1Q04 and 2Q04 reve-nues. Fraudulent statements were allegedly made in May 2004 when Impax announced erroneous 1Q04 revenues and made unqualifiedly optimistic statements about the financial opportunity to Impax that bupropion repre-sented. In August 2004, the "truth" became partially ap-parent to the market. Impax's August 4, 2004 announce-ment that its 2Q04 financials results were well below

investors' expectations and that timing of product ship-ments and pipeline filling had proved problematic, made it known to the market that Impax's entry into the bu-propion market would not be as facile as the company's May 2004 statements indicated. This announcement was accompanied by a significant same-day price decline. [*18] In light of the August 2004 disclosure, which ex-plicitly pertained to Impax's 1Q04 and 2Q04 results, the Court now finds it reasonable to infer that the market understood the company's November 3, 2004 announce-ment to potentially implicate 1Q04 and 2Q04 customer credits and revenues as well. See Wagner v. Barrick Gold Corp., No. 03 Civ. 4302, 2006 U.S. Dist. LEXIS 3854 at *10-12 (S.D.N.Y. Jan. 31, 2006). As alleged, the November 3, 2004 announcement caused another signifi-cant same-day price decline. The Court finds that Plain-tiffs have adequately alleged a causal connection be-tween Defendants' misrepresentations as to 1Q04 and 2Q04 revenues and Plaintiffs alleged loss.

The Court finds that Plaintiffs have adequately al-leged loss causation. 5

5 Since the Court finds that Plaintiffs have ade-quately alleged loss causation based on the Au-gust and November 2004 press releases, the Court does not consider the relevance of Plain-tiffs' allegations concerning Teva's November 4, 2004 conference call concerning the timing of the credits issued to Teva's customers on bupropion sales. (See TAC P 142.)

B. Scienter

The parties dispute whether Plaintiffs have ade-quately alleged scienter.

The Supreme Court [*19] has defined "scienter" as a "mental state embracing intent to deceive, manipulate, or defraud." Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193-94 n.12, 96 S. Ct. 1375, 47 L. Ed. 2d 668 (1976). In the Ninth Circuit, recklessness (as a form of intentional conduct) has long sufficed to establish scienter for § 10(b) purposes. Nelson v. Serwold, 576 F.2d 1332, 1337 (9th Cir. 1978).

Congress enacted the PSLRA to "deter opportunistic private plaintiffs from filing abusive securities fraud claims, in part, by raising the pleading standards for pri-vate securities fraud plaintiffs." In re Silicon Graphics Inc. Sec. Litig., 183 F.3d 970, 973 (9th Cir. 1999). Post-PSLRA, a plaintiff must allege with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind. 15 U.S.C. § 78u-4(b)(2). At minimum, a plaintiff must plead particular facts giv-ing rise to a strong inference of deliberate recklessness. In re Silicon Graphics, 183 F.3d at 979. In determining whether a plaintiff has adequately pled scienter, a court


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must consider whether the totality of the plaintiff's alle-gations, although individually lacking, gives rise to the "strong inference" required by the PSLRA. Nursing Home Pension Fund, Local 144 v. Oracle Corp., 380 F.3d 1226, 1230 (9th Cir. 2004).

Congress [*20] did not further define the "strong in-ference" requirement. The Supreme Court has recently clarified the requirement. To determine whether a plain-tiff has alleged facts giving rise to a "strong inference" of scienter, a court must consider both (1) plausible noncul-pable explanations for the defendant's conduct; and (2) inferences favoring the plaintiffs. Tellabs, Inc. v. Makor Issues & Rights, Ltd., No. 06-484, 127 S. Ct. 2499, 168 L. Ed. 2d 179, 2007 U.S. LEXIS 8270 at *10-11 (U.S. June 21, 2007). Evidence of scienter must be more than merely "reasonable" or "permissible" - it must be "co-gent" and "at least as compelling as any opposing infer-ence one could draw from the facts alleged." 6 127 S. Ct. 2499, 2007 U.S. LEXIS 8270 at *10-11, 30.

6 This is because [a]n inference of fraudulent in-tent may be plausible, yet less cogent than other, nonculpable explanations for the defendant's con-duct." Id.

Plaintiffs have alleged a number of facts, which they contend - in their totality - are sufficient to plead scienter with particularity. The Court summarizes each set of allegations below, and then considers their sufficiency. 1. GAAP Allegations

Plaintiffs allege the following:

Defendants prematurely and improperly recognized revenue on bupropion prod-ucts, "despite [*21] knowing that the terms and conditions of sale to Teva's cus-tomers allowed for price adjustments and therefore, prices were not fixed and de-terminable." (TAC P 91.) First, Teva pub-lically stated in its Form 20-F, filed im-mediately prior to the Class Period, that its practice was to allow for different types of credits and returns from its cus-tomers, including shelf-stock adjustments, chargebacks, and volume rebates. (TAC PP 95-100.) Defendants Doll and B. Ed-wards were previously employed by Teva's marketing department. (TAC PP 14(a), 18(b), 99.) Moreover, Defendants Doll, B. Edwards, and Spiegler were in regular contact with Teva's management. (TAC PP 161-65.) Second, Defendant B. Edwards was specifically informed by Teva's Executive Vice President in 1Q04

that Teva had issued credits to Walgreens concerning bupropion. (TAC PP 01-03.)

Defendants also knew that Teva's monthly reports containing the details of bupropion sales did not include a column for reserves or returns until October 2004. (TAC P 121.) Defendants Spiegler and Doll were explicitly informed by Teva that Teva was not accruing reserves spe-cific to bupropion, because Teva had es-tablished a 4 percent reserve for returns [*22] in computing Teva's aggregate net sales. 7 (TAC P 381.)

7 This was possible because Teva's revenues were sufficiently large that "it is possible that Teva could not have accrued any reserves on bu-propion sales at all and might still have been in compliance with GAAP." (TAC P 112.)

The SAA formed by Impax and Teva provided, in pertinent part, as follows: 8

Teva was granted the "sole and exclusive right" to determine the terms and conditions of sale of the Prod-ucts to its customers. (SAA § 11:4.) Within thirty days following each calendar quarter, Teva was required to provide to Impax "in a mutually acceptable format . . . the Net Sales and Profit for each Product." (SAA § 11.3.) "Net Sales" were defined as:

[T]he gross amount invoiced for each of the Products sold by Teva or Teva's Af-filiates on an arms-length basis in each country in the Territory, less the sum of: (a) trade, quantity and/or cash discounts, allowances, rebates, retroactive price ad-justments, free goods, bad debts, cash in-centive payments (e.g. slotting allow-ance), and chargebacks; (b) credits or re-funds for rejected, outdated or re-turned Product; (c) any tax, duty or other government charge upon or related to the sale, [*23] delivery or use of that Product; (d) cost of short dated Product, which is destroyed by Teva or its Affili-ates; (e) three percent (3%) as a contribu-tion towards selling, administrative and other expenses of Teva; and (f) other spe-cifically identifiable amounts included in the Product's gross sales that will have been or ultimately will be credited and are substantially similar to those listed above;


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in each case determined in accordance with U.S. GAAP.

(SAA § 1.4.26.) (emphasis added). Lastly, "Profits" were defined as "an amount equal to Net Sales less the appli-cable Manufacturing Costs." (SAA § 1.4.33.)

8 Defendants have requested that the Court take judicial notice of the SAA. (Defendants' Request for Judicial Notice in Support of Defendants' Mo-tion to Dismiss the Third Amended Consolidated Complaint Ex. A, hereafter, "SAA," Docket Item No. 116.) Pursuant to Federal Rule of Evidence 201, the Court grants Defendants' request. The remainder of Defendants' requests for judicial no-tice are denied.

After considering the SAA and the allegations of the Third Amended Complaint, Plaintiffs' expert concluded as follows:

Both Defendants' (1) recognition of 100% of bupropion revenues and (2) fail-ure [*24] to accrue any reserves for those revenues, were improper under GAAP. (TAC Ex. C P 39.) More particularly, he concluded that prior to recognizing reve-nues from products sold under the SAA, Impax's management should have ob-tained a sufficient understanding of Teva's marketing and sales policies, internal con-trols, and accounting policies and proce-dures related to sales under the SAA--particularly since there were several con-ditions present that increased the risk of improper revenue recognition. (TAC Ex. C P 16.) Lastly, he opines that Defendants could not properly have delegated their GAAP responsibilities to Teva through the SAA. (TAC Ex. C P 151.)

GAAP requires that revenue is only recognized when, inter alia, the seller's price to the buyer is fixed and determinable. See Securities and Exchange Commis-sion Staff Accounting Bulletin 101, available at http://www.sec.gov/interps/account/sab101.htm. 9 Viola-tions of GAAP standards can provide evidence of sci-enter; when "significant" violations are described, they provide "powerful indirect" evidence of scienter. Daou, 411 F.3d at 1016 (internal citations omitted). Moreover, expert accounting analysis may be one type of allegation that contributes [*25] to a strong inference that defen-

dants knew of alleged accounting improprieties. Oracle, 380 F.3d at 1233-34.

9 The Court takes judicial notice of the SEC's website pursuant to Federal Rule of Evidence 201.

The Court previously directed Plaintiffs to, ". . . plead facts which give rise to a strong inference that De-fendants knew or were deliberately reckless in not know-ing that Teva was not accounting for customer credits as seemingly required by the SAA." (See Order Granting Defendants' Motion to Dismiss with Leave to Amend at 7, hereafter, "2006 Order," Docket Item No. 74.) Plain-tiffs have now adequately alleged that Defendants knew that credits were necessary to induce sales of bupropion for a number of reasons, and that Teva was in fact issu-ing such credits. (TAC PP 89, 162-63, 171.) Plaintiffs have further alleged that Defendants willfully recognized 100 percent of bupropion revenues without accruing any reserves. (TAC PP 91-125.)

These allegations give rise to potentially opposing inferences. On one hand, they support an inference that Defendants significantly violated GAAP by recognizing revenues improperly, which is one form of "powerful indirect" evidence of scienter. On the other [*26] hand, the allegations also support an inference that Impax sim-ply relied on Teva's contractual commitment to report sales as directed by the terms of the SAA. On balance, however, the Court finds that Plaintiffs' new allegations give rise to a strong, cogent inference that Defendants knew, or were deliberately reckless in not knowing, that Teva was not accounting for customer credits in the manner required by the SAA.

These allegations weigh in favor of finding that Plaintiffs have adequately alleged scienter. 2. Resignations of Impax's CFO and CEO

As supporting evidence of scienter, Plaintiffs allege the departure of Impax's CFO and CEO:

Approximately one month after Impax released the details of its restatement, it announced that its CFO, Individual De-fendant Spiegler, would retire from Impax in early 2005. (TAC P 400.) On August 15, 2006, Impax announced that Individ-ual Defendant B. Edwards was resigning as CEO and a member of Impax's board of directors, effective October 1, 2006. (TAC P 404.)


2007 U.S. Dist. LEXIS 52356, *

Proximate resignations or replacements of high-ranking officers or directors do not alone support sci-enter. However, particularly when such "corporate re-shuffling" occurs in tandem with financial [*27] re-statements, these changes "add one more piece to the scienter puzzle." In re Adaptive Broadband Sec. Litig., No. C 01-1092 SC, 2002 U.S. Dist. LEXIS 5887, at *42-43 (N.D. Cal. Apr. 2, 2002); see also In re McKesson HBOC Sec. Litig., 126 F. Supp. 2d 1248, 1274 (N.D. Cal. 2000).

These allegations, too, give rise to potentially oppos-ing inferences. On one hand, Impax did not publically fire or comment unfavorably on the departures of either its former CFO or CEO. Moreover, the resignation of Individual Defendant B. Edwards came one and a half years after the events alleged in the Third Amended Complaint. B. Edwards' resignation was not proximate in time to the financial restatements--and Plaintiffs have not alleged facts clearly tying the two together. 10 Accord-ingly, the Court finds that there are many plausible ex-planations for his resignation unrelated to culpability for the alleged Section 10(b) violations; B. Edwards' resigna-tion, then, does not weigh in favor of a finding of sci-enter.

10 Plaintiffs allege, "No reason was given for defendant B. Edward's (sic) resignation, but the massive scale of the fraud at Impax, its enormous consequences for the Company, B. Edwards' knowledge [*28] of the bupropion credits granted to Teva's customers, and B. Edwards (sic) insider sales totaling $ 2.6 million were likely factors in his departure from the Company." (TAC P 404.) However, these allegations are mere unsupported speculation.

On the other hand, Individual Defendant Spiegler's retirement was announced in close proximity to the news of Impax's financial restatements. The Court considers the totality of the allegations against Spiegler in tandem with his proximate departure from Impax. For instance, Plaintiffs have alleged, "According to the November 2, 2004 SLC Minutes, the SLC agreed that due to Spiegler's interference with the ongoing investigation, by, for ex-ample, suggesting that employees who were being inter-viewed by the SLC ask the SLC "to put all requests in writing," "it would be preferable for Spiegler to have no supervisory role or other involvement with respect to Impax employees' communications with the SLC and its independent counsel." (TAC P 403.) As alleged, the Court finds that Spiegler's departure provides minimal, non-dispositive supporting evidence of scienter. 3. Focus on Bupropion as Principal Source of Com-pany Revenues

As further evidence of scienter, [*29] Plaintiffs al-lege that Defendants were a small core of managers who were "fully focused" on bupropion sales:

In its 2003 Form 10-K report, Impax identified itself as a "small company" with 453 employees as of February 27, 2004. (TAC P 45.) As of February 27, 2004, it only had six executive officers, five of which are named as Individual Defen-dants in this action. Id. Prior to Impax's rollout of bupropion, the company had operated with negative cash flow for each of the eighteen quarters since its incep-tion. (TAC P 75.) Its 2003 cash flow, at [19,223,000), was a 26 percent deteriora-tion over its 2002 cash flow. Id. Bu-propion was the product that garnered Impax a strategic alliance with Teva, a global pharmaceutical company with 2003 net sales of $ 3.3 billion. (TAC PP 70, 74.) In 1Q04, Impax's first profitable quarter, bupropion accounted for 61 per-cent of Impax's revenues. (TAC P 69.)

Facts critical to a business' core operations or an im-portant transaction are so apparent that their knowledge may be attributed to the company and its key officers. In re Read-Rite Corp. Sec. Litig., 335 F.3d 843, 848 (9th Cir. 2003). However, post-PSLRA, allegation of these facts serves to establish, [*30] at most, a "reasonable inference" of a company's or key officer's knowledge. Id. That is, these allegations are not independently adequate to satisfy the scienter requirement, but may be consid-ered as one aspect of a scienter analysis. Indeed, follow-ing the PSLRA, the Ninth Circuit has rejected as "pat-ently incredible" the argument, when made by high-ranking individual defendants, that they were unaware of major business events likely to have a significant impact on the company's financial condition. See No. 84 Em-ployer-Teamster v. America West Holding Corp., 320 F.3d 920, 943 (9th Cir. 2003).

To summarize the above-described allegations: at relevant times, Impax was a small company with low revenues and few high-ranking members of management. Bupropion was the single largest of Impax's products, accounting for more than half of the company's revenues. On one hand, these allegations bolster an inference of scienter -- specifically, that Defendants were aware of Impax's financial picture with respect to bupropion. This primary inference in turn supports the secondary infer-ence, discussed supra, that Defendants were aware that Impax was significantly violating GAAP by improperly


2007 U.S. Dist. LEXIS 52356, *

and prematurely [*31] recognizing revenues. On the other hand, for the same reasons previously discussed, the primary inference could also support an. inference that though Defendants were aware of the financial as-pects of bupropion sales and the SAA, they simply relied on Teva's contractual commitment to report sales as di-rected by the SAA. On balance, and for the reasons pre-viously explained, the Court finds that Plaintiffs' allega-tions support a strong, cogent inference of scienter. Al-though Plaintiffs' allegations with respect to bupropion as the principal source of company revenues are not inde-pendently adequate to satisfy the scienter the require-ment, the Court simply considers them in its analysis of whether the totality of Plaintiffs' allegations give rise to a strong inference of scienter.

In total, Plaintiffs have alleged (1) that Defendants significantly violated GAAP by improperly and prema-turely recognizing revenues; (2) the proximate departure of one high-ranking official within the company; and (3) the company's focus on bupropion as its principal source of revenue. For the reasons explained supra, these alle-gations collectively support a strong inference - at least as compelling as any opposing [*32] inference of non-fraudulent intent - that Defendants' actions were taken with at least deliberate recklessness. The Court finds that Plaintiffs have adequately alleged scienter. 11

11 Plaintiffs also cite (1) material weaknesses in Defendants' internal controls; and (2) Defendants' stock sales, "unusual in timing and amount" as further evidence of alleged scienter. (Opposition at 24-25.) The Court previously found both types of allegations insufficient to establish scienter. (2006 Order at 11-14.) In light of its current find-ing that Plaintiffs have adequately alleged sci-enter, the Court need not reconsider the relevance of these particular allegations to scienter. This is because Plaintiffs only need state one set of facts giving rise to a strong inference of deliberate recklessness. If they have done so, it is irrelevant

whether another different set of facts might have accomplished the same thing. See, e.g. In re Cylink Secs. Litig., 178 F. Supp. 2d 1077, 1083 (N.D. Cal. 2001).

C. Control Person Liability

To allege a Section 20(a) violation adequately, a plaintiff must state (1) a primary violation of federal se-curities law and (2) that the defendant exercised actual power and control [*33] over the primary violator. Howard v. Everex Sys., Inc., 228 F.3d 1057, 1065 (9th Cir. 2000). To establish a prima facie case, a plaintiff need not show the defendant's participation or exercise of power. Moreover, a defendant is entitled to a good faith defense if he or she can show no scienter and an effective lack of participation. Id.

Defendants do not separately contend that Plaintiffs' Section 20(a) claim should be dismissed. The Court has now found that Plaintiffs have adequately alleged a pri-mary violation of Section 10(b) of the Exchange Act and Rule 10b-5. Morever, Plaintiffs have alleged that Defen-dants exercised actual power and control over the pri-mary violators. (TAC P 468.)

The Court finds that Plaintiffs have adequately al-leged control person liability. V. CONCLUSION

The Court DENIES Defendants' Motion to Dismiss. Defendants shall file an Answer in accordance with Fed. R. Civ. P. 12(a)(4)(A). The parties shall appear for a Case Management Conference on September 24, 2007 at 10 AM. Pursuant to the Civil Local Rules of the Court, the parties shall file a joint case management statement ten (10) days before the date of the conference.

Dated: July 18, 2007

JAMES WARE

United States [*34] District Judge


EXHIBIT 5


Instituto de Prevision Militar v. Merrill Lynch &Co., Inc.S.D.Fla.,2007.Only the Westlaw citation is currently available.

United States District Court,S.D. Florida.INSTITUTO DE PREVISION MILITAR, Plaintiff,

v.MERRILL LYNCH & CO., INC., Eduardo A.

Coloma, Merrill Lynch, Pierce, Fenner & Smith In-corporated, and All Parents, Subsidiaries, and Affil-

iates of Merrill Lynch & Co., Inc., and MerrillLynch, Pierce, Fenner & Smith Incorporated, De-

fendants.No. 05-22721-CIV.

Sept. 28, 2007.

Frank Patrick Cuneo, Juan Aedo Gonzalez, Liebler,Gonzalez & Portuondo, PA, Miami, FL, forPlaintiff.David Scott Mandel, Mandel & Mandel, LLP,Rudolph F. Aragon, White & Case, Miami, FL,Richard Lance Robbins, Patricia A. Gorham, EllenB. Cohen, Sutherland Asbill & Brennan, Atlanta,GA, for Defendants.

K. MICHAEL MOORE, United States DistrictJudge.*1 THIS CAUSE came before the Court upon Mer-rill Lynch's Motion to Dismiss (dkt # 64) andEduardo Coloma's Motion to Dismiss Counts I, II,IV, V, and VI (dkt # 65).

UPON CONSIDERATION of the Motions, the re-cord, and being otherwise fully advised in thepremises, the Court enters the following Order.

I. BACKGROUND

Plaintiff Institute de Prevision Militar (“Plaintiff”or “IPM”) is a quasi-governmental agency of theRepublic of Guatemala that, inter alia, manages thepension funds for members of the GuatemalanArmed Forces. 2nd Amend. Compl. ¶ 2. Beginningin July 2001, non-party Pension Fund of America

(“PFA”) solicited IPM to open a “retirement trustaccount” using IPM's pension fund monies.Id. ¶18.The retirement trust accounts offered by PFApurported to have investment and insurance com-ponents. PFA was not registered as a broker-dealeror investment adviser. Id. ¶ 20.PFA presented itselfto IPM as a business partner of Merrill Lynch. Id. ¶20.IPM invested $7,726,799.92 with PFA with theunderstanding that PFA would invest the money insecure accounts with Merrill Lynch. Id. ¶¶21-25.PFA used IPM's money to open an accountwith Merrill Lynch in PFA's name. PFA engaged inan embezzlement and money laundering schemeand mishandled and misappropriated much ofPlaintiff's money. Id. ¶¶ 16-41.IPM alleges thatMerrill Lynch “knowingly provided substantial as-sistance to [PFA]'s fraudulent scheme and/or reck-lessly disregarded numerous red flags, and its ac-tions and omissions were a proximate cause of thedamages incurred by IPM.” Id. ¶ 41.

On November 26, 2002, IPM filed a lawsuit inMiami-Dade Circuit Court against PFA, allegingtwelve claims for relief.FN1Id. ¶ 42.The Miami-Dade Circuit Court issued an ex parte temporary in-junction against PFA, but it did not take effect be-cause IPM could not post the requisite$5,000,000.00 bond.Id. ¶ 43 As a result of this Statecourt action, IPM subpoenaed several financial in-stitutions holding PFA funds, including MerrillLynch. Based on the lawsuit, past dealings, and oth-er information, IPM decided to liquidate its ac-count. Id. ¶ 44.On February 10, 2003, the CircuitCourt granted a motion by IPM to compel MerrillLynch to liquidate all of IPM's funds and transferthem to a trust account at Shutts & Bowen, LLP. Id.¶ 45.Ultimately, IPM recovered only $4,898,681.04of its fund monies. See id. ¶¶ 46-50.

FN1. The claims were: (1) Conversion; (2)Unjust Enrichment; (3) Temporary Injunc-tion; (4) Constructive Trust; (5) Breach ofContract; (6) Fraud; (7) Breach of Fidu-ciary Duty; (8) Fraud in the Inducement;(9) Civil Conspiracy; (10) Violation of Fla.

Slip Copy Page 1Slip Copy, 2007 WL 2900318 (S.D.Fla.)(Cite as: Slip Copy)










Stat. § 517.12; (11) Violation of Fla. Stat.§ 517.301; (12) Accounting.

IPM is also a plaintiff in the related class actionsCordova, et al. v. Lehman Brothers, Inc.,05-CIV-21169-MOORE/GARBER (S.D.Fla.) andInstitute de Prevision Militar v. Lehman Bros. Inc.,05-CIV-22827-MOORE/GARBER (S.D.Fla.). OnFebruary 10, 2006, this Court issued a Consolida-tion Order (dkt # 50) in this case consolidatingthese three related cases for the purposes of discov-ery. In each of these three related actions, thisCourt has held (dkt # 60 & 85) that the SecuritiesLitigation Uniform Standards Act (“SLUSA”) pree-mpts all state law based claims in each complaint.The Court dismissed Plaintiff's Complaint andgranted leave to file a second amended complaintpleading federal securities law claims (dkt # 60).On September 25, 2006, Plaintiff filed its SecondAmended Complaint (dkt # 62) restating its statelaw claims, but also adding federal securities claimsunder Sections 12(1) and 15 of the 1933 SecuritiesAct, and under Section 10(b) of the 1934 SecuritiesExchange Act and Rule 10b-5. On April 27, 2007,the Court issued an Order (dkt # 85) in which theCourt granted Plaintiff another opportunity toamend its complaint. Plaintiff did not file a ThirdAmended Complaint within the time allowed.

*2 Defendants bring the instant Motions to Dismissarguing that the state law claims were properly dis-missed under SLUSA, that Plaintiff does not state aclaim under Sections 12(1) or 15, that Plaintiff'sclaims under Section 10(b) and rule 10b-5 are time-barred or, alternatively, fail because the frauds/omissions are not pled with the required particular-ity, the factual allegations do not give rise to a“strong inference” of scienter, and/or Plaintiff doesnot adequately plead loss causation and reliance.

II. STANDARD

A motion to dismiss for failure to state a claimmerely tests the sufficiency of the complaint; itdoes not decide the merits of the case. Milburn v.United States, 734 F.2d 762, 765 (11th Cir.1984).On a motion to dismiss, the Court must construe the

complaint in the light most favorable to the plaintiffand accept the factual allegations as true. SEC v.ESM Group, Inc., 835 F.2d 270, 272 (11thCir.1988).“[A] complaint should not be dismissedmerely because a plaintiff's allegations do not sup-port the particular legal theory he advances, for thecourt is under a duty to examine the complaint todetermine if the allegations provide for relief onany possible theory.”Bowers v. Hardwick, 478 U.S.186, 201-02, 106 S.Ct. 2841, 92 L.Ed.2d 140(1986) (Blackmun, J., dissenting) (quotations omit-ted); see Brooks v. Blue Cross & Blue Shield ofFla., Inc., 116 F.3d 1364, 1369 (11th Cir.1997).Nonetheless, to withstand a motion to dismiss, acomplaint must allege facts sufficient “to raise aright to relief above the speculative level[ .]”BellAtlantic Corp. v. Twombly, --- U.S. ----, ---- - ----,127 S.Ct. 1955, 1964-65, 167 L.Ed.2d 929 (2007).Further, “a plaintiff's obligation to provide thegrounds of his entitlement to relief requires morethan labels and conclusions, and a formulaic recita-tion of the elements of a cause of action will notdo.”Twombly, 127 S.Ct. at 1964-65 (citations andquotes omitted).

III. ANALYSIS

A. Securities and Exchange Act § 10(b) and Rule10b-5

Section 10(b) of the Securities Exchange Act of1934 forbids the “use or employ, in connection withthe purchase or sale of any security ..., [of] any ma-nipulative or deceptive device or contrivance incontravention of such rules and regulations as the[SEC] may prescribe as necessary or appropriate inthe public interest or for the protection of in-vestors.”15 U.S.C. § 78j(b). SEC Rule 10b-5 imple-ments section 10(b) by declaring it unlawful:(a) To employ any device, scheme, or artifice to de-fraud,(b) To make any untrue statement of a material factor to omit to state a material fact necessary in orderto make the statements made, in the light of the cir-cumstances under which they were made, not mis-leading, or(c) To engage in any act, practice, or course of




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business which operates or would operate as a fraudor deceit upon any person, in connection with thepurchase or sale of any security.

17 CFR § 240.10b-5; Tellabs, Inc. v. Makor Issues& Right, Ltd., ---U.S. ----, ----, 127 S.Ct. 2499,2507, 168 L.Ed.2d 179 (2007). Section 10(b) af-fords a right of action to purchasers or sellers of se-curities injured by its violation. Tellabs, 127 S.Ct.at 2507 (citations omitted).

*3 To state a claim “under § 10(b) and Rule 10b-5,a plaintiff must show the following: ‘(1) a misstate-ment or omission, (2) of a material fact, (3) madewith scienter, (4) on which plaintiff relied, (5) thatproximately caused his injury.’”Ziemba v. CascadeIntern., Inc., 256 F.3d 1194, 1202 (11th Cir.2001)(citing Bryant v. Avado Brands, Inc., 187 F.3d1271, 1281 (11th Cir.1999)). A section 10(b)private right of action exists only for primary con-duct violating securities laws; the private right ofaction does not extend to secondary actors who arealleged merely to have aided or abetted a manipu-lative or deceptive act. Central Bank v. First Inter-state Bank, 511 U.S. 164, 191, 114 S.Ct. 1439, 128L.Ed.2d 119 (1994) (eliminating aiding and abet-ting liability in private causes of action).

1. Fraud, Misrepresentations and Omissions

To survive a motion to dismiss, a plaintiff's claimsof fraud under § 10(b) and Rule 10b-5 must satisfythe requirements of Fed.R.Civ.P. 9(b), which re-quires that “the circumstances constituting fraud ormistake shall be stated with particularity.”Ziemba,256 F.3d at 1202. “The particularity rule serves animportant purpose in fraud actions by alerting de-fendants to the ‘precise misconduct with which theyare charged’ and protecting defendants ‘againstspurious charges of immoral and fraudulent behavi-or.’ “ Ziemba, 256 F.3d at 1202 (citing Durham v.Bus. Management Assocs., 847 F.2d 1505, 1511(11th Cir.1988)). “The application of Rule 9(b)...‘must not abrogate the concept of notice pleading.’“ Id. Further, “Rule 9(b) must be read in conjunc-tion with Rule 8(a) [of the Federal Rules of CivilProcedure], which requires a plaintiff to plead only

a short, plain statement of the grounds upon whichhe is entitled to relief.” Brooks v. Blue Cross andBlue Shield of Florida, Inc., 116 F.3d 1364, 1371(11th Cir.1997) (citing O'Brien v. National Prop-erty Analysts Partners, 719 F.Supp. 222, 225(S.D.N.Y.1989)).

“Rule 9(b) is satisfied if the complaint sets forth‘(1) precisely what statements were made in whatdocuments or oral representations or what omis-sions were made, and (2) the time and place of eachsuch statement and the person responsible for mak-ing (or, in the case of omissions, not making) same,and (3) the content of such statements and the man-ner in which they misled the plaintiff, and (4) whatthe defendants obtained as a consequence of thefraud.’”Ziemba, 256 F.3d at 1202 (citing Brooks,116 F.3d at 1371). A list containing allegations offraud describing the nature and subject of state-ments has been found to be sufficient, even whereprecise words used were not alleged. Brooks, 116F.3d at 1371 (citing Seville Indus. Machinery Corp.v. Southmost Machinery Corp., 742 F.2d 786, 791(3rd Cir.1984)).

Plaintiff alleges that Defendants helped PFA carryout its fraudulent scheme by assisting PFA in mar-keting PFA's pension funds, and by allowing PFAto use Merrill Lynch's name, marketing literature,company seal, good reputation, and to hold MerrillLynch out as the custodian and safeguard of in-vestors' funds. 2nd Amend. Compl. ¶¶ 17-21, 37,41, 48, 132; Pl. Resp. at 12. However, allegationsof “substantial assistance in [an] alleged fraud” orplaying a “significant role in drafting, creating, re-viewing, or editing allegedly fraudulent [marketingmaterials]” are “the kinds of [aiding and abetting]allegations that were rejected in CentralBank.”Ziemba, 256 F.3d at 1205. Prior to the Su-preme Court eliminating private causes of actionfor aiding and abetting securities fraud in CentralBank, the Eleventh Circuit required plaintiffs bring-ing private causes of action for aiding and abettingsecurities fraud to show that the defendant (1) had“general awareness that his role was part of anoverall activity that [was] improper,” and (2)“knowingly and substantially assisted the viola-

























































tion.”Rudolph v. Arthur Andersen & Co., 800 F.2d1040 (11th Cir.1986). Therefore, to show primaryliability under section 10(b), a plaintiff must beable to show a defendant had more than “generalawareness that his role was part of an overall activ-ity that [was] improper” and did more than“substantially assist” a violation.

*4 Most of Plaintiff's allegations are nothing morethan allegations that Defendants aided and abettedPFA in its fraudulent activities. For example,Plaintiff alleges that “Merrill Lynch knew it wouldbe held out to investors as the custodian of investorfunds and the vehicle for insuring the proper hand-ling of investor funds,” but falls short of allegingthat Merrill Lynch misrepresented that it would bethe custodian of investor funds. 2nd Amend. Com-pl. ¶ 17, 19-21 (emphasis added). If PFA held Mer-rill Lynch out as something other than what it was,then any fraud was on the part of PFA, not neces-sarily Merrill Lynch. Plaintiff alleges that “[w]ithMerrill Lynch's assistance, [PFA] successfully mar-keted its retirement trust plans to IPM,” that “withMerrill Lynch's assistance, [PFA] was presented asbeing a business partner of Merrill Lynch,” and that“Merrill Lynch knowingly provided substantial as-sistance to [PFA]'s fraudulent scheme.” 2ndAmend. Compl. ¶ 19, 20, 41 (emphasis added).However, Defendants are not liable to Plaintiff, aprivate party, for giving “substantial assistance” toPFA's fraud. See Ziemba, 256 F.3d at 1205. Forsimilar reasons Plaintiff's allegations that MerrillLynch “agreed to serve as co-sponsor,” “agreed toserve as custodian and trustee,” and “allowed itscorporate name, corporate logos and ... its corporatereputation to be utilized in [PFA's materials],” alsofail to state a claim for primary liability. 2ndAmend Compl. ¶ 17, 20 (emphasis added). Plaintiffalleges that it was mislead by PFA's use of MerrillLynch's name, because Merrill Lynch's name andreputation made Plaintiff assume that the pensionfunds would be more secure. However, thatPlaintiff hoped the investment would be secure orthought Merrill Lynch had a good reputation is notenough to create primary liability.

Further, most of Plaintiff's allegations do not satisfy

the particularity requirements of Rule 9(b), becausePlaintiff does not point to particular statements orwording in specific documents. Rather than namingparticular documents or marketing materials con-taining misleading information, Plaintiff, for themost part, refers generally to “trust agreements andrelated solicitation and promotional materials” or“trust agreements, certificates, and other docu-ments.”See e.g. 2nd Amend. Compl. ¶ 20.

Also, Plaintiff does not allege “what Defendantsobtained as a consequence of the fraud.”SeeZiemba, 256 F.3d at 1202. Plaintiff does not allegethat Defendants made any withdrawals from the ac-counts for personal purposes or otherwise misap-propriated Plaintiff's money. Plaintiff does not al-lege that Defendants allowed any withdrawals otherthan those made by PFA, whose name was listed onthe account. Rather, the major fraud described isthe misuse, by PFA, of Plaintiff's money, the largeunauthorized withdrawals that PFA made for im-proper purposes. However, Plaintiff does not allegethat Merrill Lynch profited as a result of the mis-handling or misappropriation of Plaintiff's moneydone by PFA or its directors. Plaintiff does not al-lege that Merrill Lynch has in its possession or usedany of the money missing from Plaintiff's account;rather, the Plaintiff's missing money is alleged tohave been misappropriated by PFA for “[PFA's]own benefit and for [PFA's] principals' personaluse.” 2nd Amend. Compl. ¶ 34. Assuming Plaintiffintended the Second Amended Complaint to imply,even though Plaintiff does not state it, that Defend-ants profited because PFA solicited business anddeposited the money into Merrill Lynch accounts,this appears to be the same general business profitthey would receive from any sales representative le-gitimately opening a new account, not necessarilybecause of the fraud. Arguably Merrill Lynchwould have profited more if PFA had not madelarge withdrawals from the account.

*5 Plaintiff argues that by allowing PFA to useMerrill Lynch's name to perpetrate a fraud, Defend-ants mislead investors into believing that investingin PFA's pension funds would be a secure invest-ment. Plaintiff cites Rudolph v. Arthur Andersen &












Co., which states “[s]tanding idly by while knowingone's good name is being used to perpetrate a fraudis inherently misleading.”800 F.2d 1040 (11thCir.1986). However, Rudolph predates CentralBank and did not distinguish precisely betweenprimary liability and aiding and abetting liability.Shapiro v. Cantor, 123 F.3d 717, 721 n. 2 (2ndCir.1997). More importantly, Rudolph is distin-guishable because it deals with liability of account-ants, not business partners. In Rudolph, the Elev-enth Circuit emphasized that accountants have aduty to independently evaluate a company andwhen they offer an opinion or certify financialstatements, they undertake “a special relationshipof trust vis-a-vis the public” and hold themselvesout as “an independent professional source of assur-ance.”Rudolph, 800 F.2d at 1044. Companies andpeople in business with each other to jointly marketa product, on the other hand, do not have this“special relationship of trust” to the public. Com-panies in a joint venture do not independently eval-uate and certify to the public the quality of the busi-ness practices and financial statements of eachbusiness partner; neither do they hold themselvesout to the public as being independent or disinter-ested.

Plaintiff alleges that Defendants authored a letter ofrecommendation attesting to the integrity of PFA'sbusiness practice, that Defendants knew would bedistributed to Plaintiff to guarantee the safety of thepension funds and give a false sense of security.2nd Amend. Compl. ¶¶ 35-36. However, “to beprimarily liable under § 10(b) and Rule 10b-5, thealleged misstatement or omission upon which aplaintiff relied must have been publicly attributableto the defendant at the time that the plaintiff's in-vestment decision was made.”Ziemba, 256 F.3d at1205 (emphasis added). Plaintiff wired its invest-ment to Merrill Lynch “on or about October 23,2001.” 2nd Amend. Compl. ¶ 22. The letter of re-commendation was written “on or about December4, 2001.” 2nd Amend. Compl. ¶ 35. Because theletter of recommendation was written over a monthafter Plaintiff made its investment decision,Plaintiff could not have relied upon any statementin the letter of recommendation “at the time that the

plaintiff's investment decision wasmade.”Therefore, Plaintiff cannot state a section10(b) claim based on misrepresentations in the let-ter of recommendation.

Plaintiff alleges that Plaintiff met with Defendantsand PFA on January 22, 2002, and Defendants rati-fied their relationship with PFA and misrepresentedto Plaintiff that they would not authorize any trans-actions on Plaintiff's account without Plaintiff'swritten consent. 2nd Amend. Compl. ¶ 37. Again,Defendant's investment decision was made on orbefore October 23, 2001; therefore, any misrepres-entations made at the January 22, 2002 meeting oc-curred after the investment decision and cannot beused by Plaintiff as a basis for section 10(b) liabil-ity.

*6 Many of the omissions, alleged by Plaintiff, alsooccurred after the investment decision and thereforecannot be a basis for primary liability under § 10(b)and Rule 10b-5. See Ziemba, 256 F.3d at 1205.Plaintiff alleges that Defendants failed to informIPM that its account “was not setup or managed asa pension fund account.” 2nd Amend. Compl. ¶ 27.Plaintiff alleges that Defendants failed to informPlaintiff about substantial and unauthorized accounttransactions. 2nd Amend. Compl. ¶¶ 37-39, 49.Plaintiff also alleges that Defendants failed to in-form Plaintiff about their failure to fulfill the roleof custodian and trustee of its funds. 2nd Amend.Compl. ¶ 49. Each of these allegations involvesomissions which allegedly occurred after the in-vestment decision was made; therefore, these omis-sions cannot support primary liability for Defend-ants under § 10(b) and Rule 10b-5.

Otherwise, Plaintiff alleges that Defendants “failedto inform IPM that the securities it jointly marketedwith Pension Fund of America were unregistered,”and failed to disclose “that the securities at issuewere required to be registered.” 2nd Amend. Com-pl. ¶ 132. Plaintiff alleges that Defendants failed toinform Plaintiff that “[PFA] was required to re-gister as a broker-dealer and investment advisor,and that [PFA] had failed to do so.” 2nd Amend.Compl. ¶ 133. Plaintiff also alleges that Defendants
















omitted information about an artificial increase inPFA's net worth of about 1000% over a shortamount of time. 2nd Amend. Compl. ¶ 34.

However, “a defendant's omission to state a materi-al fact is proscribed only when the defendant has aduty to disclose.”Ziemba, 256 F.3d at 1206 (citingRudolph, 800 F.2d at 1043). The Eleventh Circuithas recognized that a duty to disclose arises undertwo circumstances, (1) “[w]here a defendant's fail-ure to speak would render the defendant's own priorspeech misleading or deceptive,” and (2) “wherethe law imposes special obligations, as for account-ants, brokers, or other experts, depending on thecircumstances of the case.”Id. Factors to be con-sidered in determining whether a duty to discloseexists include: “the relationship between theplaintiff and defendant, the parties' relative accessto the information to be disclosed, the benefit de-rived by the defendant from the purchase or sale,defendant's awareness of plaintiff's reliance on de-fendant in making its investment decision, ... de-fendant's role in initiating the purchase or sale[,] ...the extent of the defendant's knowledge and the sig-nificance of the misstatement, fraud or omission,[and] ... [t]he extent of the defendant's participationin the fraud.”Id.

Plaintiff argues that “having spoken by permittingits name to be used in joint solicitation materials toinvestors and by authoring letters to investors de-signed to vouch for PFA's business, Merrill Lynchhad a duty to correct misrepresentations containedin those solicitation materials.”PL Resp. at 13-14(emphasis added). However, in the SecondAmended Complaint, Plaintiff only identifies oneletter of recommendation authored by Defendantsto vouch for PFA's business; and, as discussedabove, Plaintiff's investment decision occurred pri-or to receiving the letter, so Defendants cannot beheld liable for omitting to correct information inthat letter. Otherwise, it appears Plaintiff is arguingthat as long as one company's name is listed on an-other company's solicitation materials, then the firstcompany has vouched for all of the other com-pany's business practices and is thereby responsiblefor any misconduct or fraud committed by that oth-

er company and its directors. Adopting such a rulewould too broadly expand liability and would re-quire the Court to find misstatements by implica-tion, rather than to analyze the specific wording ofstatements actually made, as required by the partic-ularity requirement of Rule 9(b).

*7 Additionally, having a good business reputationdoes not automatically create a duty or obligationfor a company to always act according to its reputa-tion; rather, actions in business whether good orbad are what create a reputation. It would be quite astretch to say that a person commits fraud wheneverhe acts contrary to his reputation, merely becausesomeone expected him to act another way. Further,allegations that Merrill Lynch permitted PFA to useits name on advertising materials or did not requestthat its name be removed, really allege aiding andabetting liability, not that Merrill Lynch engaged infraud sufficient for primary liability. Otherwise,Plaintiff does not point to any earlier statementmade by Defendants that failure to disclose the al-legedly omitted information would have renderedmisleading or deceptive.

Alternatively, Plaintiff argues that Defendants as-sumed a special fiduciary duty to Plaintiff by allow-ing themselves to be represented as a custodianand/or trustee of the Plaintiff's funds and as beingresponsible for ensuring safe handling of theirmoney. Pl. Resp. at 13-14; 2nd Amend. Compl. ¶¶17-21.“[F]or a confidential or fiduciary relationshipto exist under Florida law, there must be substantialevidence showing some dependency by one partyand some undertaking by the other party to advise,counsel, and protect the weaker party.”Lanz v. Res-olution Trust Corp., 764 F.Supp. 176, 179(S.D.Fla.1991). That Plaintiff believed Defendantswould undertake a fiduciary role if they invested isnot alone sufficient to create a duty to disclose. SeeId.Further, Defendants must have had a duty to dis-close at the time of the investment decision, and theinformation that should have been disclosed musthave been known and relevant at the time of the in-vestment decision. See Ziemba, 256 F.3d at 1205.Plaintiff does not allege that Defendants met withPlaintiff prior to their investment decision or made















any attempt to advise or counsel them; rather, itwas PFA who directly solicited Plaintiff's invest-ment and entered into the “Trust Agreement” withPlaintiff. 2nd Amend. Compl. ¶¶ 18-21. Plaintiffdoes allege that Defendants allowed the MerrillLynch name and logo to be used in PFA's solicita-tion materials; however, this falls short of allegingthat Defendants undertook to advise, counsel, orprotect Plaintiff. Even if Plaintiff could show thatDefendants assumed a fiduciary duty as a custodianor trustee of Plaintiff's funds, that duty would havebegun after the investment decision, when PFAused Plaintiff's money to open the account withMerrill Lynch.

Plaintiff's argument that Defendants undertook a fi-duciary duty to IPM is further weakened by the factthat Plaintiff did not have an account in its namewith Merrill Lynch or any other formal relationshipwith Defendants; the account with Merrill Lynchwas opened by PFA and was in PFA's name. Def.Mot. at 7; 2nd Amend. Compl. ¶ 25. Further,Plaintiff is inconsistent in its allegations of whetheror not Defendants had knowledge of PFA's fraudand the allegedly omitted information. In severalparagraphs in the Second Amended Complaint,Plaintiff alleges that Defendants did not know aboutPFA's fraud because they ignored “warning signs,”never investigated, did not conduct the required duediligence inquiries, and neglected to scrutinize themanagement of Plaintiff's account. 2nd Amend.Compl. ¶¶ 27, 29, 30, 31. Additionally, the inform-ation Defendants allegedly failed to disclose wasaccessible to Plaintiff. For example, it would nothave been difficult for Plaintiff to review availableinformation on PFA and see that PFA had experi-enced an artificial increase in net worth over a shortamount of time. That the securities marketed byPFA were unregistered and that PFA was not leg-ally registered as a broker-dealer and investmentadvisor, is also information that Plaintiff could havediscovered through an investigation of the registriesprior to investing such a large some of money.

*8 All factors considered, the Court holds thatPlaintiff's allegations are insufficient to show De-fendants had a duty to disclose, and are insufficient

to state a private cause of action under § 10(b) andRule 10b-5 for primary liability against Defendants.

2. Strong Inference of Scienter

To establish liability under § 10(b) and Rule 10b-5,a private plaintiff must prove that the defendant ac-ted with scienter, “a mental state embracing intentto deceive, manipulate, or defraud.”Ernst & Ernstv. Hotchfelder, 425 U.S., 185, 193 n. 12, 96 S.Ct.1375, 47 L.Ed.2d 668 (1976). A showing of severerecklessness can satisfy the scienter requirement.Ziemba, 256 F.3d at 1202 (citing McDonald v. AlanBush Brokerage Co., 863 F.2d 809, 814 (11thCir.1989)). However, “ ‘[s]evere recklessness islimited to those highly unreasonable omissions ormisrepresentations that involve not merely simpleor even inexcusable negligence, but an extreme de-parture from the standards of ordinary care, andthat present a danger of misleading buyers or sellerswhich is either known to the defendant or is so ob-vious that the defendant must have been aware ofit.’ ”Id.

To survive a motion to dismiss, a plaintiff must“state with particularity facts giving rise to a stronginference that the defendant acted with the requiredstate of mind.”15 U.S.C. § 78u-4(b)(2) (emphasisadded); Tellabs, 127 S.Ct. at 2504. To qualify as a“strong inference” within the meaning of the stat-ute, “an inference of scienter must be more thatmerely plausible or reasonable-it must be cogentand at least as compelling as any opposing infer-ence of nonfraudulent intent.”Tellabs, 127 S.Ct. at2504-05.“[T]o determine whether a complaint's sci-enter allegations can survive threshold inspectionfor sufficiency, a court ... must engage in a compar-ative evaluation; it must consider, not only infer-ences urged by the plaintiff, ... but also competinginferences rationally drawn from the factsalleged.”Tellabs, 127 S.Ct. at 2504.

Plaintiff urges the Court to infer that Defendantsacted with an intent to deceive, manipulate, and/ordefraud from the factual allegations that MerrillLynch “jointly marketed” PFA's trust accounts,“jointly solicited” investors, authored marketing






















materials, placed Plaintiff's money in a fund titledin PFA's name rather than a trust account, thatPFA's solicitation materials included false informa-tion, that Defendant Coloma communicatedmonthly with PFA's officers, that Merrill Lynch ig-nored “red flags” and “warning signs” includingunusual account activity and large withdrawalsfrom the account, that PFA's net worth increasedsubstantially over a short period of time, that IPMhad filed a lawsuit against PFA in 2002 allegingfraud and the looting of investor accounts, and thatthe securities PFA was selling were unregistered se-curities being sold in violation of securities law. Pl.Resp. at 14-16.

Defendants assert that the facts alleged by Plaintiffmerely show that Defendants had a business rela-tionship with PFA, not that Defendants intention-ally or with severe recklessness involved them-selves in PFA's fraud. The Court finds it would bereasonable to infer that PFA also mislead Defend-ants, and that Defendants might have had a businessrelationship without knowing of PFA's fraud. ThatDefendants jointly marketed PFA's funds, jointlysolicited customers, and knew that PFA was usingMerrill Lynch's name on documents sent to in-vestors does not necessarily mean that Defendantshad more than a regular business relationship withPFA. Likewise, a normal business relationship witha large account holder could reasonably lead De-fendant Coloma to communicate monthly withPFA's officers.

*9 Plaintiff's Response alleges that Defendants“authored various documents attesting to PFA'strustworthiness and business success.”However, theSecond Amended Complaint specifically allegesonly one document, a letter of recommendation, au-thored by Defendants. 2nd Amend. Compl. ¶¶35-36. This letter of recommendation was writtenafter Plaintiff invested its funds with PFA. 2ndAmend. Compl. ¶¶ 22, 35. Because the letter waswritten after the investment decision, it is not asstrong an indication of intent at the time of the in-vestment decision. This allegation also reasonablyleads to the alternative inference that Defendantswere also deceived by PFA. Otherwise, Plaintiff

does not point to any specific wording “authored”by Defendants that might show they had the requis-ite scienter.

Some of Plaintiff's allegations suggest that Defend-ants did not have knowledge of PFA's fraud.Plaintiff alleges that “Merrill Lynch never investig-ated whether [PFA] had proper licenses and regis-trations for either securities or insurance invest-ments.” 2nd Amend. Compl. ¶ 29. Plaintiff allegesthat Merrill Lynch “ignored numerous warningsigns,” and “neglected to scrutinize the manage-ment of the account[.]” 2nd Amend. Compl. ¶ 31.

Plaintiff argues that Defendants were severely reck-less in ignoring or not responding to the “red flags”and “warning signs.” Severe recklessness must“approximate actual intent to aid in the fraud” and“must be shown to such an extent that a reasonablefinder of fact could actually infer fraudulent intentfrom it.”Chill v. General Elec. Co., 101 F.3d 263,269 (2nd Cir.1996) (citations omitted); see alsoZiemba, 256 F.3d at 1202 (simple and inexcusableneglect are not sufficient to show scienter; rather,there must be an “extreme departure from thestandards of ordinary care.”). The alleged “redflags” and “warning signs” include unusual accountactivity, large withdrawals from the account, thatPFA's net worth increased substantially over a shortperiod of time, that IPM had filed a lawsuit againstPFA in 2002 alleging fraud and the looting of in-vestor accounts, that the securities PFA was sellingwere unregistered securities being sold in violationof securities law, and that PFA was not properly re-gistered as a broker-dealer or investment advisor.Pl. Resp. at 15-16.

It is undisputed that PFA was the account holderlisted on Merrill Lynch's records, and it is not un-usual, let alone severely reckless, for Merrill Lynchto allow an account holder to withdraw funds. De-fendants are not required to carefully scrutinize anaccount holder's every action and question the ac-count holder's motives. Allegations that Defendantsshould have known that the money in the accountwas pension fund money and should have beenmore suspicious of the account activity in a pension









fund account might support a showing of negli-gence, but not, without more, a showing of severerecklessness. That PFA's net worth increased rap-idly over a short amount of time is suspicious, butnot dispositive.

*10 Plaintiff's argument that Defendants shouldhave been aware of and warned Plaintiff of PFA'sfraud based on its alleged knowledge of the suitbrought by Plaintiff against PFA in 2002 is unper-suasive. Plaintiff made its investment decision onor before October 23, 2001. 2nd Amend. Compl. ¶22. Because IPM brought this lawsuit in 2002, aftertheir investment, knowledge of the lawsuit cannotbe used to show that Defendants knew about PFA'sfraud or had the requisite scienter at the time of theinvestment decision.

The factual allegations that PFA was selling unre-gistered securities in violation of securities law, andthat PFA was not properly registered as a broker-dealer or investment advisor are more troubling.Defendants are sophisticated and experienced in in-vesting in securities and would be expected to in-vestigate securities being jointly marketed by themand make some reasonable investigation of thestatus of a prospective business partner brokeringsecurities. However, there has been significant litig-ation and argument in this and in the related PFAfraud cases on the issue of whether and how the re-tirement trust funds sold by PFA were subject tofederal law. See e.g. Cordova v. Lehman Bros.,Inc., 413 F.Supp.2d 1309, 1316-17 (S.D.Fla.2006).Although the Court has held that these are “coveredsecurities” subject to federal securities law, the ex-tent of argument over this issue shows that the issueof how securities law, including the application ofthe 1933 Securities Act, applies to these retirementtrusts is a non-frivolous issue. While the Court be-lieves the status of the retirement trusts as securitiesrequired to be registered is clear, the Court cannotsay that failure to discover this information wouldbe sufficient to show more than inexcusable neglectfor scienter purposes. Overall, the allegations thatDefendants entered a business relationship to mar-ket funds without checking important backgroundinformation, including the registration status of

their business partner, are troubling and might sup-port a showing of negligence or even inexcusableneglect. However, the Court finds that allegationsin the Second Amended Complaint of MerrillLynch's failure to adequately investigate PFA andits trust funds are not sufficient, under the circum-stances, to show severe recklessness to the degreerequired.

The Court holds that inferences, from the factual al-legations, that Defendants did not intentionally orby severe recklessness violate § 10(b) and Rule10b-5 are at least slightly more compelling than theinferences suggested by Plaintiff.FN2

FN2. It is notable that the Securities andExchange Commission (“SEC”) thor-oughly investigated the underlying facts ofthe PFA fraud and appear to have con-cluded that Defendants did not intention-ally involve themselves in PFA's fraud,SEC v. Pension Fund of America, Case No.05-20863-CIV-MOORE/GARBER.TheSEC did not include Defendants as partiesin the litigation against PFA and its prin-cipals. Id. In the Complaint, the SEC asser-ted that PFA had “misrepresented their re-lationships with major financial institu-tions and broker-dealers, falsely holdingthe institutions out as trustees or custodi-ans for investors' funds.”Id. at Compl. ¶ 2.The SEC asserted that PFA's representa-tions that Merrill Lynch and other financialinstitutions were trustees or custodianswere false and that, “[n]one of the finan-cial insitutions has ever served as a trusteeor custodian for investors.”Id. at Compl. ¶¶31-32. The SEC asserted that PFA forgedinvestment certificates with counterfeitseals to perpetuate their lies about relation-ships with financial institutions, ant that“none of the financial institutions author-ized [PFA] ... to use their trademarks.”Id.at Compl. ¶ 33.

3 Reasonable Reliance







“Reliance is an essential element of a cause of ac-tion under Rule 10b-5.”Ross v. Bank South, N.A.,885 F.2d 723, 728 (11th Cir.1989). Plaintiff doesnot directly respond to Defendants' argument thatPlaintiff has not adequately pled reasonable reli-ance. See Def. Mot. at 18-19; Def. Reply at 8-9.Further, Plaintiff alleges it “rel[ied] upon MerrillLynch's reputation,” when it entered into the TrustAgreement, rather than alleging it relied on anyspecific misrepresentation.

*11 Plaintiff does raise the “fraud on the market”theory. Under the “fraud on the market” theory,“[w]hen the fraud alleged is so pervasive that ab-sent the fraud the bonds could not have been mar-keted, the reliance element is established by thebuyer's reliance on the integrity of themarket.”Ross, 885 F.2d at 729. However, a plaintiffmust show that the securities “could not have beenoffered on the market at any price absent the fraud-ulent scheme.”Id. (citation and quotations omitted).The Court finds that Plaintiff has not made allega-tions sufficient to make this showing. Further, thePFA retirement trust funds were not sold in a effi-cient market.

4. Loss Causation

To survive a motion to dismiss, “something beyondthe mere possibility of loss causation must be al-leged.”Twombly, 127 S.Ct. at 1966 (citing DuraPharmaceuticals, Inc. v. Broudo, 544 U.S. 336, 125S.Ct. 1627, 161 L.Ed.2d 577 (2005). To establishloss causation, “a plaintiff must show ‘that the un-truth was in some reasonably direct, or proximate,way responsible for his loss.’ “ Robbins v. KogerProperties, Inc., 116 F.3d 1441, 1447 (11thCir.1997) (citing Huddleston v. Herman &MacLean, 640 F.2d 534, 549 (5th Cir. Unit A1981), aff'd in part, rev'd in part on other grounds,459 U.S. 375, 103 S.Ct. 683, 74 L.Ed.2d 548(1983)). “If the investment decision is induced bymisstatements or omissions that are material andthat were relied on by the claimant, but are not theproximate reason for his pecuniary loss, recoveryunder the Rule is not permitted.” Id. In other words,a plaintiff must show that “the misrepresentation

touches upon the reasons for the investment's de-cline in value.” Id.

Plaintiff alleges that “Merrill Lynch knowinglyprovided substantial assistance to [PFA]'s fraudu-lent scheme and/or recklessly disregarded numer-ous red flags, and its actions and omissions were aproximate cause of the damages incurred by IPM,”and that “[a]s a direct and proximate result of theconduct alleged herein, IPM has suffered damagesin connection with its investments with [PFA].”2nd Amend. Compl. ¶¶ 41, 135. Plaintiff arguesthat these allegations are sufficient to allege losscausation and survive a motion to dismiss. Pl. Resp.at 17-19. Plaintiff argues that “precision is unneces-sary at [the motion to dismiss] stage.”Pl. Resp. at18 (citing Whitbread (US) Holdings, Inc. v. BaronPhilippe de Rothschild, S.A., 630 F.Supp. 972,978-79 (S.D.N.Y.1986)). However, the SupremeCourt, in Bell Atlantic Corp. v. Twombly, held that,to survive a motion to dismiss, allegations are re-quired to be “more than labels and conclusions, anda formulaic recitation of the elements of a cause ofaction will not do.”Twombly, 127 S.Ct. at 1964-65.The Court finds Plaintiff's conclusory statementsthat its damages were proximately caused by De-fendants actions and omissions are insufficient. TheCourt finds nothing else in the Second AmendedComplaint that alleges how the alleged misrepres-entations and omissions of Defendants caused thedecline in the value of Plaintiff's investment. There-fore, the Court holds that Plaintiff has not ad-equately pled loss causation.

B. Other Claims

*12 Plaintiff has argued several times that its statelaw claims are not preempted under SLUSA. Thiscontention has been firmly rejected by Orders (dkt# 60 & 85) of this Court. The Court sees no reasonto reconsider these issues now. Accordingly, eachof Plaintiff's claims restating a state law claim shallbe dismissed with prejudice.

Defendants argue that the federal claims under sec-tions 12 and 15 are time barred and unavailable toPlaintiff under the circumstances of this case.






























Plaintiff does not dispute either of these contentionsin its Response (dkt # 73). The Court finds that De-fendants have met their burden and shown thatPlaintiff does not state a claim under these sections,and Plaintiff has not refuted Defendants' showing.

IV. CONCLUSION

Based on the foregoing, it is

ORDERED AND ADJUDGED that EduardoColoma's Motion to Dismiss Counts I, II, IV, V,and VI (dkt # 65) is GRANTED. It is further

ORDERED AND ADJUDGED that Merrill Lynch'sMotion to Dismiss (dkt # 64) is GRANTED. TheSecond Amended Complaint is hereby DISMISSEDWITH PREJUDICE. This Clerk of Court is instruc-ted to CLOSE this case. All pending motions areDENIED AS MOOT.

DONE AND ORDERED.

S.D.Fla.,2007.Instituto de Prevision Militar v. Merrill Lynch &Co., Inc.Slip Copy, 2007 WL 2900318 (S.D.Fla.)

END OF DOCUMENT




EXHIBIT 6



Analysis As of: Jan 14, 2007

IN RE INVISION TECHNOLOGIES, INC. SECURITIES LITIGATION

No. C04-03181 MJJ

UNITED STATES DISTRICT COURT FOR THE NORTHERN DISTRICT OF CALIFORNIA


August 31, 2006, Decided PRIOR HISTORY: In re Invision Techs., Inc. Sec. Litig., 2006 U.S. Dist. LEXIS 12166 (N.D. Cal., Jan. 21, 2006) COUNSEL: [*1] For Regis Engelken, individually and on behalf of all others similarly situated, Plaintiff: Robert S. Green, LEAD ATTORNEY, Green Welling LLP, San Francisco, CA; Marc A. Topaz, Richard A. Maniskas, Tamara Skvirsky, Schiffrin & Barroway, LLP, Radnor, PA; Michael M. Goldberg, Glancy & Binkow LLP, Los Angeles, CA. For Glazer Funds, Plaintiff: Peter Arthur Binkow, LEAD ATTORNEY, Michael M. Goldberg, Glancy Binkow & Goldberg LLP, Los Angeles, CA. For Giovanni Lanzara, Defendant: Catherine Duden-Kevane, Susan Samuels Muck, Fenwick & West LLP, San Francisco, CA; Songmee L. Connolly, Emmett C. Standton, Fenwick & West LLP, Mountain View, CA; Tanya Herrera, Stein & Lubin, San Francisco, CA. For Sergio Magistri, Ross Mulholland, Defendants: Catherine Duden-Kevane, Jennifer Corinne Bretan, Susan Samuels Muck, Fenwick & West LLP, San Fran-cisco, CA; Songmee L. Connolly, Emmett C. Standton, Fenwick & West LLP, Mountain View, CA; Tanya Herrera, Stein & Lubin, San Francisco, CA. For Glazer Funds, Movant: Lionel Z. Glancy, LEAD ATTORNEY, Michael M. Goldberg, Glancy & Binkow LLP, Los Angeles, CA; Jeffrey S. Abraham, Abraham,

Fruchter & Twersky, LLP, New York, NY; Susan G. Kupfer, [*2] Glancy & Bickow, San Francisco, CA. JUDGES: MARTIN J. JENKINS, UNITED STATES DISTRICT JUDGE. OPINION BY: MARTIN J. JENKINS OPINION:

ORDER GRANTING DEFENDANTS' MOTION TO DISMISS

INTRODUCTION

Before the Court is Defendants' Motion to Dismiss the Second Amended Consolidated Complaint. n1 De-fendants InVision Technologies, Inc. ("InVision"), Ser-gio Magistri ("Magistri"), and Ross Mulholland's ("Mul-holland") (collectively "Defendants") move to dismiss this private securities fraud action pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure. Lead Plaintiffs Glazer Capital Management, LP and Glazer Offshore Fund, Ltd. ("Plaintiffs") oppose the motion. After careful consideration of the arguments of counsel and the papers submitted, the Court GRANTS Defen-dants' Motion to Dismiss without leave to amend.

n1 Docket No. 84, Filed March 27, 2006.

FACTUAL BACKGROUND A. Factual Background


2006 U.S. Dist. LEXIS 76458, *

InVision manufactures and supplies computer tomo-graphy based detection products used in aviation secu-rity. [*3] Plaintiffs represent a purported class of all purchasers of InVision securities between March 15, 2004 and July 30, 2004 (the "Class Period"). Plaintiffs allege that Defendants committed securities fraud in vio-lation of section 10(b) of the Securities and Exchange Act of 1934 ("Exchange Act"), Rule 10b-5 of the Securi-ties and Exchange Commission ("SEC"), and section 20(a) of the Exchange Act. Defendants Magistri and Mulholland (collectively the "Individual Defendants") were employed at InVision during the class period. De-fendant Magistri served as the President and Chief Ex-ecutive Officer of InVision during the class period. De-fendant Mulholland served as InVision's Chief Financial Officer during that time.

On March 15, 2004, InVision issued a press release announcing that it was merging with the General Electric Company ("GE") (the "March 15 Announcement") for $ 50.00 per share. On that same day, InVision filed its Form 10-K for the fiscal year 2003 (the "2003 10-K") and attached a copy of the merger agreement with GE (the "Merger Agreement") to the filing.

Several weeks later, on July 30, 2004, InVision is-sued a press release indicating that the merger might be delayed pursuant [*4] to discussions with the U.S. De-partment of Justice ("DOJ") and the Securities and Ex-change Commission ("SEC") concerning possible viola-tions of the Foreign Corrupt Practices Act ("FCPA") (the "July 30 Announcement"). The investigation concerned allegedly improper payments by InVision employees to foreign officials in exchange for government contracts. On that day, InVision's share price fell from $ 49.66 to $ 43.27 share.

On December 6, 2004, InVision and GE completed the merger for $ 50.00 per share along the same terms originally announced. On that same day, InVision issued a press release announcing that it had entered into a set-tlement with the DOJ and the SEC resolving the FCPA investigation. On February 14, 2005, the SEC issued an order adopting Defendants' settlement offer which re-quired Defendants to pay disgorgement penalties and to alter their business practices (the "SEC Order"). B. Procedural Background

Plaintiffs originally filed this action on August 4, 2004. Plaintiffs amended their complaint on March 25, 2005. On January 23, 2006, the Court granted Defen-dants' motion to dismiss the amended complaint, but granted Plaintiffs leave to amend to cure the [*5] defi-ciencies highlighted by the Court. n2 In that order, the Court stated, "In order to meet the scienter pleading re-quirement, Plaintiffs must plead facts showing that De-

fendants knew that each statement was untrue...at the time they were made... Plaintiffs must therefore plead specific, contemporaneous facts specifying that as of March 15, 2004, the date of the Merger Announcement, Defendants knew that statements made therein were false or misleading. Plaintiffs have failed to do so in the Com-plaint before the Court." The Court also cautioned Plain-tiffs that their allegations failed to meet the falsity plead-ing requirement.

n2 Docket No. 77, Filed January 23, 2006.

On February 22, 2006, Plaintiffs filed a second amended consolidated complaint ("SACC"). Subse-quently, Defendants filed the instant motion to dismiss pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure.

LEGAL STANDARD

A court may dismiss a complaint pursuant to Fed-eral Rule of Civil Procedure 12(b)(6) if a plaintiff [*6] pleads insufficient facts under an adequate theory. Robertson v. Dean Witter Reynolds, Inc., 749 F.2d 530, 533-34 (9th Cir. 1984). When deciding a motion to dis-miss pursuant to Rule 12(b)(6), a court must take all of the material allegations in the plaintiffs complaint as true, and construe them in the light most favorable to the plaintiff. Parks School of Business, Inc. v. Symington, 51 F.3d 1480, 1484 (9th Cir. 1995).

In the context of a motion to dismiss, review is lim-ited to the contents of the complaint. Allarcom Pay Tele-vision, Ltd. v. General Instrument Corp., 69 F.3d 381, 385 (9th Cir. 1995). When matters outside the pleading are presented to and accepted by the court, the motion to dismiss is converted into one for summary judgment. However, matters properly presented to the court, such as those attached to the complaint and incorporated within its allegations, may be considered as part of the motion to dismiss. See Hal Roach Studios, Inc. v. Rich-ard Feiner & Co., 896 F.2d 1542, 1555 n.19 (9th Cir. 1989). Where a plaintiff fails to attach to the complaint documents referred to therein, and upon which the [*7] complaint is premised, a defendant may attach to the motion to dismiss such documents in order to show that they do not support the plaintiff's claim. See Pacific Gateway Exchange, 169 F. Supp. 2d at 1164; Branch v. Tunnell, 14 F.3d 449, 454 (9th Cir. 1994) (overruled on other grounds). Thus, the district court may consider the full texts of documents that the complaint only quotes in part. See In re Stac Electronics Sec. Lit., 89 F.3d 1399, 1405 n.4 (1996), cert. denied, 520 U.S. 1103, 117 S. Ct. 1105, 137 L. Ed. 2d 308 (1997). This rule precludes plaintiffs "from surviving a Rule 12(b)(6) motion by de-


2006 U.S. Dist. LEXIS 76458, *

liberately omitting references to documents upon which their claims are based." Parrino v. FHP, Inc., 146 F.3d 699, 705 (9th Cir. 1998).

Rule 8(a) of the Federal Rules of Civil Procedure only requires "a short and plain statement of the claim showing that the pleader is entitled to relief." Accord-ingly, motions to dismiss for failure to state a claim pur-suant to Rule 12(b)(6) are typically disfavored; com-plaints are construed liberally to set forth some basis for relief, as long as they provide basic notice to the defen-dants of the [*8] charges against them. In re McKesson HBOC, Inc. Sec. Litig., 126 F. Supp. 2d 1248, 1257 (N.D. Cal. 2000). In the securities fraud context how-ever, the pleading requirements are more stringent. 1. Securities Fraud Under § 10(b) of the Exchange Act and SEC Rule 10b-5

Plaintiffs have alleged securities fraud in violation of section 10(b) and SEC Rule 10b-5. Under section 10(b) it is unlawful "to use or employ in connection with the purchase or sale of any security registered on a na-tional securities exchange or any security not so regis-tered, any manipulative or deceptive device or contriv-ance in contravention of such rules and regulations as the [SEC] may prescribe." 15 U.S.C. § 78j(b). Rule 10b-5, promulgated under Section 10(b), makes it unlawful for any person to use interstate commerce: (a) to employ any device, scheme, or artifice to defraud; (b) to make any untrue statement of material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading; or (c) to engage in any act, practice, or course of business which operates [*9] or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security. 17 C.F.R. § 240.10b-5. The elements of a Rule 10b-5 viola-tion are: (1) a misrepresentation or omission; (2) of mate-rial fact; (3) made with scienter; (4) on which the plain-tiff justifiably relied; (5) that proximately caused the alleged loss. See Binder v. Gillespie, 184 F.3d 1059, 1063 (9th Cir. 1999).

In order to state a claim under section 10(b), a com-plaint must overcome several pleading barriers. First, when alleging fraud, Rule 9(b) of the Federal Rules of Civil Procedure requires plaintiffs to state with particu-larity the circumstances constituting the fraud. To meet the heightened pleading requirements of Rule 9(b), a fraud claim must contain three elements: (1) the time, place, and content of the alleged misrepresentations; and (2) an explanation as to why the statement or omission complained of was false or misleading. In re GlenFed, Inc. Sec. Litig., 42 F.3d 1541, 1547-49 (9th Cir. 1994).

Next, a plaintiff must overcome the heightened pleading requirements of the Private Securities Litigation Reform Act (the "PSLRA"). [*10] Congress enacted the PSLRA in 1995 to provide "protections to discourage frivolous [securities] litigation." H.R. Conf. Rep. No. 104-369, 104th Cong., 1st Sess. at 32 (Nov. 28, 1995). Under the PSLRA, complaints alleging misrepresenta-tions or omissions, must "specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed." 15 U.S.C. § 78u-4(b)(1).

Additionally, the PSLRA imposed heightened re-quirements for pleading scienter. Under the PSLRA, a complaint must "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." 15 U.S.C. § 78u-4(b)(2). The Ninth Circuit, in interpreting the PSLRA, has held that "a private securities plaintiff proceeding under the [PSLRA] must plead, in great detail, facts that constitute strong circumstantial evidence of deliberately reckless or con-scious misconduct." In re Silicon Graphics Inc., 183 F.3d 970, 974 (9th Cir. 1999). [*11] If the complaint does not satisfy the pleading requirements of the PSLRA, upon motion by the defendant, the court must dismiss the complaint. See 15 U.S.C. § 78u-4(b)(1).

Even if a plaintiff overcomes the falsity and scienter pleading barriers, the PSLRA's Safe Harbor provision provides that a securities fraud claim may not lie with respect to a statement that is "identified as a forward-looking statement, and is accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statement." 15 U.S.C. § 78u-5(c)(1)(A)(i). A person may be held liable if the forward-looking statement is made with "actual knowledge ... that the statement was false or misleading." 15 U.S.C. § 78u-5(c)(1)(B); No. 84 Employer-Teamster Joint Council Pension Trust Fund v. America West Holding Corp., 320 F.3d 920, 936 (9th Cir. 2003); but see In re Seebeyond Technologies Corp. Sec. Litig., 266 F. Supp. 2d 1150, 1164-65 (C.D. Cal. 2003) (disagreeing with the analysis in America West and finding [*12] that a defendant is immune from liability if it satisfies either 15 U.S.C. § 78u-5(c)(1)(A) or (B)).

ANALYSIS

Plaintiffs cite three alleged misstatements by Defen-dants, all of which appeared in the March 15, 2004 Merger Agreement, which was included as an attachment to the 2003 10-K filed that same day. As an initial mat-ter, Plaintiffs' premise that statements contained in a merger agreement that has been attached as an exhibit to


2006 U.S. Dist. LEXIS 76458, *

a public filing, necessarily constitutes an independent, public reaffirmation of those merger statements, is dubi-ous. "[S]tatements must be analyzed in context." In re Worlds of Wonder Securities Litigation, 35 F.3d 1407, 1414 (9th Cir. 1994). It is ambiguous, at best, whether Defendants intended, by the act of including a copy of the merger agreement as an attachment to an SEC filing, to affirmatively re-assert to the public every statement contained within that agreement as of the date of its in-clusion. n3 This is especially true given that the state-ments within the merger agreement were made for an entirely different purpose, namely, to memorialize the private merger agreement between InVision and [*13] GE and were made at an earlier date; the assertions con-tained therein were more likely directed toward InVi-sion's merger partner GE at the close of the merger nego-tiations, rather than at the public in general at the time of the SEC filing. Nonetheless, the Court turns to the al-leged misstatements identified by Plaintiffs.

n3 Plaintiffs cite Sheehan v. Little Switzer-land, Inc., 136 F. Supp. 2d 301, 305 (D.Del.,2001), for the proposition that statements contained within documents which accompany public filings should be interpreted as affirmative representations on the part of the filer. In Shee-han, it was alleged that defendants failed to dis-close material information about the expiration of a "firm financing commitment" from their in-vestment bankers. Sheehan is distinguishable from the instant case in that the alleged misstate-ments appeared independently in a press release issued by the defendants. The Sheehan court noted that the defendants merely "repeated the al-leged misstatements in various SEC filings by at-taching a copy of the merger agreement." Id. In the instant case we have no such independent as-sertion of the alleged misstatements through a press release. All of the statements alleged to have been misleading are located solely in the at-tached Merger Agreement. As this Court noted above, it is ambiguous as to whether the act of at-taching a document to a public filing constitutes a public affirmation of the statements contained therein. Unlike Sheehan, where the defendants first asserted the misleading statements in a press release, there is no such obvious indication of on the part of Defendants to publically represent the contents of the Merger Agreement.

[*14]

Plaintiffs first cite section 3.8(a) of the Merger Agreement (the "Compliance Statement"), in which De-fendants stated:

The Company and its Subsidiaries are (and since January 1, 2002 have been) in compliance in all material respects with all laws (including common law), statutes, ordinances, codes, rules, regulations, de-crees and orders of Governmental Au-thorities (collectively, "Laws") applicable to the Company or any of its Subsidiaries, any of their properties or other assets or any of their businesses or operations (in-cluding those Laws related to Export Con-trol Requirements and improper pay-ments). March 15, 2004 Merger Agreement § 3.8(a), Motion, Ex. C (emphasis added).

Plaintiffs assert that this statement was false or mis-leading because InVision allegedly violated the FCPA on three separate occasions, and was therefore "not in com-pliance in all material respects with all laws." Plaintiffs also argue that this statement was false because Defen-dants allegedly "failed to maintain internal controls as required by Section 13(b) of the Exchange Act." (Com-plaint P29).

In the second statement alleged to be false, located in section 3.5(d) of the Merger Agreement, [*15] De-fendants stated that "[t]he Company is in compliance in all material respects with the provisions of Section 13(b) of the Exchange Act." (March 15, 2004 Merger Agree-ment § 3.5(d), Motion, Ex. Q. Plaintiffs allege that this statement was materially misleading because Defendants "books and records did not accurately and fairly reflect its transaction and the dispositions of its assets." (Com-plaint P31).

Finally, Plaintiffs allege that section 3.5(d) of the Merger Agreement was materially false. In that section, Defendants stated:

Neither the Company nor any of its Sub-sidiaries nor, to the Knowledge of the Company, any director, officer, agent, employee or other Person acting on behalf of the company or any of its Subsidiaries, has (I) used any corporate or other funds for unlawful contributions, payments, gifts or entertainment, or made any unlawful expenditures relating to political activity to government officials or others or established or maintained any unlawful or unrecorded funds in violation of Sec-tion 30A of the Exchange act.


2006 U.S. Dist. LEXIS 76458, *

March 15, 2004 Merger Agreement § 3.5(d), Motion, Ex. C

Plaintiffs assert that this statement was false be-cause, as described [*16] above, Defendants allegedly violated the FCPA. 1. Falsity

Defendants contend that Plaintiffs misconstrue the scope of the Compliance Statement in the Merger Agreement. In that statement, Defendants assert that, "[t]he Company...is...in compliance in all material re-spects with all laws." Plaintiffs read this statement as an unconditional affirmation of compliance with all laws, including violations existing at the time of which Defen-dants were unaware. Defendants contend that this frag-ment of section 3.8 must be read in context to establish its true meaning. The remainder of the paragraph states that, "[s]ince January 1, 2002, neither the Company nor any of its Subsidiaries has received written notice to the effect that a Governmental Authority claimed or alleged that the Company or any of its Subsidiaries was not in compliance in a material respect with any Law applica-ble to the Company or any of its Subsidiaries, any of their material properties or other assets or any of their business or operations..." March 15, 2004 Merger Agreement § 3.8(a), Motion, Ex. C. Defendants argue that this subsequent language indicates that the original representation, despite its broad [*17] language, encom-passed only known compliance violations. The Court finds this argument persuasive. For obvious reasons it would have been impossible for Defendants to have dis-closed violations that they were not aware of. As a matter of logic it makes little sense to read Defendants' state-ment as affirming the non-existence unknown violations. Interpreted within the context of the subsequent lan-guage, Defendants' statement must be read as containing an implied "knowledge" qualification. Therefore, in or-der for this statement to be false, Plaintiffs must plead specific contemporaneous facts indicating that Defen-dants knew that they were not in compliance with the law - e.g. that they knew InVision had violated the FCPA or that Defendants knew that their internal controls were insufficient for the purposes of Section 13(b). Plaintiffs have plead no specific allegations indicating that Defen-dants knew of facts at the time that this statement was made such that it would render this statement false. 2. Scienter

Defendants next argue that Plaintiffs have failed to plead scienter with the requisite specificity. The PSLRA provides that a complaint must "state with [*18] particu-larity facts giving rise to a strong inference that the de-fendant acted with the required state of mind." 15 U.S.C.

§ 78u-4(b)(2). To have acted with the required state of mind, defendant must have either acted intentionally or with "deliberate recklessness." In re Daou Systems, Inc. Sec. Litig., 411 F.3d 1006, 1014-15 (9th Cir.2005). "Recklessness only satisfies scienter under § 10(b) to the extent that it reflects some degree of intentional or con-scious misconduct." In re Silicon Graphics, 183 F.3d at 977; see also DSAM Global Value Fund v. Altris Soft-ware, Inc., 288 F.3d 385, 389 (9th Cir.2002) (stating that in order to allege a strong inference of deliberate reck-lessness, a plaintiff must state "facts that come closer to demonstrating intent, as opposed to mere motive and opportunity") (citations omitted). Therefore, a plaintiff must "plead, at a minimum, particular facts giving rise to a strong inference of deliberate or conscious reckless-ness." In re Silicon Graphics, 183 F.3d at 979. A reason-able inference is not enough. Id. at 974. A complaint merely alleging [*19] that a defendant had the motive and opportunity to commit fraud is insufficient. Id.

Plaintiffs must therefore plead specific facts indicat-ing that Magistri and Mulholland had knowledge of the falsity of the above statements, and made such misstate-ments intentionally, or recklessly with "some degree of intention at or conscious misconduct." n4 The Complaint contains the following allegations in support of an infer-ence of scienter on the part of Magistri and Mulholland: 1) that InVision "had a limited number of customers" suggesting that it "it is reasonable to conclude that the Defendants were aware of the details of every transaction involving these customers" 2) that "InVision authorized the payment of bribes"; 3) that "senior executives" had to approve these payments; 4) that "InVision was aware of the high probability" that their employees would use the payment as bribes; 5) that Magistri knew details about InVisions' projects in the countries where the improper payments allegedly occurred; 6) that Magistri and Mul-holland signed SOX certifications indicating that InVi-sion had procedures in place capable of detecting viola-tions; 7) that GE was allegedly able to detect the im-proper [*20] payment within a few weeks while con-ducting due diligence for the merger, and finally 8) that Magistri and Mulholland stood to benefit from the merger financially. (Complaint at PP37, 38, 40, 42-51, 54, 61). Plaintiffs essentially argue that given the rela-tively small number of InVision customers, Defendants' affirmation that they had access to financial reporting mechanisms, and the fact that GE was able to discover the improper payments after only a few weeks of due diligence, taken together, these allegations create a strong inference of contemporaneous knowledge on the part of Magistri and Mulholland about the overseas pay-ments. The Court does not agree.


2006 U.S. Dist. LEXIS 76458, *

n4 As an initial matter, the Court notes that Plaintiffs do not plead facts indicating that Mul-holland signed the Merger Agreement or was in-volved in its preparation. "Plaintiffs must allege facts tying each of the alleged misstatements and omissions to each of the Defendants," In re Im-mune Response Securities Litigation, 375 F. Supp. 2d 983, 1031 (S.D.Cal.,2005) Accordingly, Plaintiffs fail to state a claim against Mulholland for statements made in the merger agreement.

[*21]

There are several problems with Plaintiffs' scienter allegations. The fact that InVision had controls in place to detect financial and accounting irregularities does not imply that these controls were also designed to detect violations of unrelated federal regulations, such as the FCPA. Even if the Court assumes that Defendants were in receipt of some financial information through InVi-sion's formal control mechanisms, it cannot infer that these mechanisms would have also alerted

Defendants to the improper payments. Moreover, Plaintiffs' own pleadings undermine this line of argu-ment. The Complaint states that "InVision...failed to maintain intern controls as required by...the Exchange Act...InVision had an internal controls problem...they lacked even basic internal controls to make sure the company complied with the law." (Complaint P 29, in-ternal quotations omitted). In other words, Plaintiffs al-lege that InVisions' internal controls were insufficient to detect violations of the law. Since "[t]he district court must consider all reasonable inferences to be drawn from the allegations, including inferences unfavorable to the plaintiffs" the Court must infer that it would have been [*22] unlikely that InVision's internal controls would have alerted Defendants to any FCPA violations. Gomp-per v. VISX, Inc., 298 F.3d 893, 897 (9th Cir.2002).

Additionally, Plaintiffs borrow heavily from the February 14, 2005 SEC Order in formulating their sci-enter allegations. This is problematic since the SEC Or-der simply alleges scienter in a conclusory fashion. For example, the SEC order states, "[a]t the time of the pay-ment, based on the information provided to the Regional Sales Manager and the Senior Executive, InVision was aware of a high probability that the distributor intended to use part of the funds it received from InVision to pay for foreign travel and other benefits for airport officials." (Muck Decl, Exh. I, § A). Similarly, referencing the SEC order, Plaintiffs allege that "InVision was aware of the high probability that the sales agent intend to use part of the commission to make gifts..." (Complaint at 45). The SEC order provides no other information to support this conclusion; Plaintiffs' complaint does little more than reference this language and rely on its assertions. As

described above, the PSLRA does not permit conclusory allegations of scienter. [*23] The PSLRA requires the pleading of specific, contemporaneous facts creating a strong inference of scienter, and Plaintiffs cannot meet this burden simply by referencing the conclusory state-ments of others. To permit this would essentially vitiate the PSLRA pleading requirement.

Moreover, the SEC Order does not even mention Defendants Magistri or Mulholland by name, leaving the Court to speculate about precisely to whom the knowl-edge allegations apply. The SEC statements indicate at best that somebody at InVision was aware of the prob-ability of an improper payment; not necessarily those individuals who authored the statements at issue here. n5 Plaintiffs fail to link the allegations of knowledge from the SEC Order to Defendants Magistri or Mulholland. The SEC order simply attributes knowledge to "InVi-sion", and the Ninth Circuit "has rejected the concept of 'collective scienter' for the purposes of establishing fraud" on the part of a corporation. In re Apple Com-puter, Inc., 243 F. Supp. 2d 1012, 1023 (ND. Cal. 2002); Nordstrom, Inc. v. Chubb & Son, Inc., 54 F.3d 1424, 1435-6 (9th Cir. 1995). A corporation acts through its employees, and the finding [*24] of corporate liability under 10(b) requires the finding of scienter on the part of at least one individual defendant responsible for the mis-statements. Chubb, 54 F.3d 1424 at 1435-36 ("Corporate scienter relies heavily on the awareness of the directors and officers, who...are necessarily aware...of the danger of misleading buyers and sellers.") Since Plaintiffs allege no facts specifically indicating that Magistri or Mulhol-land knew that the statements were false at the time they were made, the Court finds that Plaintiffs have failed to meet their scienter pleading burden under the PSLRA.

n5 The Complaint alleges that the improper payments took place overseas, in the Philippines, Thailand, and China, far away from InVision's headquarters in the United States.

CONCLUSION

For the foregoing reasons, the Court GRANTS De-fendants' motion to dismiss. "Four factors relevant to whether a motion for leave to amend pleadings should be denied: undue delay, bad faith or dilatory motive, futility [*25] of amendment, and prejudice to the opposing party." United States v. Webb, 655 F.2d 977, 980 (9th Cir.1981). In its previous dismissal order, the Court iden-tified several deficiencies in Plaintiffs' complaint and granted Plaintiffs the opportunity to cure these deficien-cies through amendment. Very little has changed sub-stantively in the amended complaint. Because Plaintiffs have failed to cure the scienter deficiencies identified in


2006 U.S. Dist. LEXIS 76458, *

the previous order despite being offered the opportunity to do so, amendment appears futile. Accordingly, the complaint is dismissed WITHOUT LEAVE TO AMEND. n6 The Clerk of the Court is instructed to close the file.

n6 On August 21, 2006, Plaintiffs submitted a letter brief requesting leave to amend in light of an August 15, 2006 SEC complaint filed against former Senior Vice President of Sales and Market for Invision, David Pillor ("Pillor"). (Doc. No. 101) The Court has reviewed the letter and the at-tached complaint, and finds that it does not ad-dress the prime deficiency in the pleading-namely, the absence of specific allegations indi-cating that the individual who made the alleged misstatement, here Magistri, had the requisite

scienter and knew that the statement was false at the time that he made it. The proposed allegations solely concern Pillor, and do nothing to cure Plaintiffs' pleading deficiency. Accordingly, the Court finds that granting Plaintiffs leave to amend the complaint to add these additional alle-gations would not cure the identified deficiencies, and are thus futile. Webb, 655 F.2d 980.

[*26] IT IS SO ORDERED.

MARTIN J. JENKINS

UNITED STATES DISTRICT JUDGE Dated: August 31, 2006


EXHIBIT 7


Knollenberg v. Harmonic, Inc.C.A.9 (Cal.),2005.This case was not selected for publication in theFederal Reporter.Please use FIND to look at the ap-plicable circuit court rule before citing this opinion.(FIND CTA9 Rule 36-3.)

United States Court of Appeals,Ninth Circuit.Robert G. KNOLLENBERG, et al., Plaintiffs-Ap-

pellants,v.

HARMONIC, INC., et al., Defendants-Appellees.No. 03-16238.

Argued and Submitted Feb. 17, 2005.Decided Nov. 8, 2005.

Background: Shareholders filed putative class ac-tion against acquired corporation, acquiring corpor-ation, and several of their top executives for viola-tions of securities laws in connection with declinein stock price of both corporations around the timemerger. The United States District Court for theNorthern District of California, 2002 WL31974384, Phyllis J. Hamilton , J., granted defend-ants' motion to dismiss, and plaintiffs appealed.

Holdings: The Court of Appeals held that:

(1) allegations that corporations and their execut-ives failed to disclose key customer's demand foracquiring corporation's products had declined andwould continue to do so were insufficient to stateclaim of securities fraud;

(2) allegations that statements favorable to acquiredcorporation or merger were misleading were insuf-ficient to claim of securities fraud;

(3) allegations that acquired corporation's salesweakness had become “common knowledge”among acquiring corporation's management andemployees were insufficient to support strong infer-ence of scienter required for securities fraud claim;

(4) insider trading allegations were insufficient to

raise strong inference of scienter;

(5) shareholders failed to state a proxy solicitationviolation claim;

(6) shareholders stated claim for liability for mater-ial misstatements or omissions in registration state-ment;

(7) shareholders adequately pleaded liability forsale of securities by means of misleading prospect-us; and

(8) shareholders' allegations were sufficient to statea secondary claim for “control person” liabilityclaim against acquiring corporation's president, butnot corporation.

Affirmed in part, reversed in part, and remanded.West Headnotes[1] Securities Regulation 349B 60.51

349B Securities Regulation349BI Federal Regulation

349BI(C) Trading and Markets349BI(C)7 Fraud and Manipulation

349Bk60.50 Pleading349Bk60.51 k. In General. Most

Cited CasesShareholders' allegations, that acquired and acquir-ing corporations and their executives failed to dis-close key customer's demand for acquiring corpora-tion's products had declined and would continue todo so, were insufficient to state claim of securitiesfraud, absent facts establishing corporations or ex-ecutives knew statements were false or acted withdeliberate recklessness as to whether statementswere false; shareholders failed to make precise al-legations explaining how alleged statement that ac-quiring corporation was experiencing “strong de-mand” for its products was misleading or untrue,and failed to explain how allegedly omitted factswould have been viewed by reasonable investor ashaving significantly altered total mix of informationmade available. Securities Exchange Act of 1934,

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§§ 10(b), 21D(b)(2), 15 U.S.C.A. §§ 78j(b),78u-4(b)(2); 17 C.F.R. § 240.10b-5.

[2] Securities Regulation 349B 60.51




Cited CasesShareholders' allegations that acquiring corporationknew that key customer's management of its invent-ory would result in a slowing of its purchases fromcorporation until inventory was deployed by cus-tomer were insufficient to raise a “strong inference”of scienter, so as to satisfy requirements of PrivateSecurities Litigation Reform Act (PSLRA) for se-curities fraud claim under § 10(b) and Rule 10b-5;shareholders failed to allege basic facts regardingeither customer's “weekly forecasts” or corpora-tion's internal reports, and failed to show corpora-tion or its executives were aware that customer hadbeen canceling orders. Securities Exchange Act of1934, §§ 10(b), 21D(b)(2), 15 U.S.C.A. §§ 78j(b),78u-4(b)(2); 17 C.F.R. § 240.10b-5.

[3] Securities Regulation 349B 60.28(15)



349Bk60.17 Manipulative, Deceptiveor Fraudulent Conduct

349Bk60.28 Nondisclosure; InsiderTrading

349Bk60.28(10) Matters to BeDisclosed

349Bk60.28(15) k. Mergers,Acquisitions, Reorganizations or Tender Offers.Most Cited CasesShareholders' allegations that statements favorableto acquired corporation or merger were misleading,insofar as such statements failed to disclose thatseveral of acquired corporation's largest customers

withdrew their orders shortly after merger an-nouncement, were insufficient to claim of securitiesfraud. Securities Exchange Act of 1934, §§ 10(b),21D(b)(2), 15 U.S.C.A. §§ 78j(b), 78u-4(b)(2); 17C.F.R. § 240.10b-5.




349Bk60.50 Pleading349Bk60.54 k. Nondisclosure. Most

Cited CasesShareholders' allegations that acquired corpora-tion's sales weakness had become “common know-ledge” among acquiring corporation's managementand employees “well before the merger” and thatcorporations and executives had obligation to dis-close such information to the market were insuffi-cient to support “strong inference” of scienter, so asto satisfy requirements of Private Securities Litiga-tion Reform Act (PSLRA) for securities fraud claimunder § 10(b) and Rule 10b-5; allegation of“common knowledge” did not comport withPSLRA's requirement that shareholders allege therequired state of mind as to each defendant whomade an allegedly misleading statement. SecuritiesExchange Act of 1934, §§ 10(b), 21D(b)(2), 15U.S.C.A. §§ 78j(b), 78u-4(b)(2); 17 C.F.R. §240.10b-5.





Cited CasesShareholders' allegations that “insider selling” onpart of certain executives of acquired corporationdemonstrated merged corporations and their execut-ives had motive and opportunity to mislead in-vestors were insufficient to raise a “strong infer-
























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ence” of scienter, so as to satisfy requirements ofPrivate Securities Litigation Reform Act (PSLRA)for securities fraud claim under § 10(b) and Rule10b-5; under terms of merger agreement, acquiredcorporation and its executives were required to ex-ercise their stock options. Securities Exchange Actof 1934, §§ 10(b), 21D(b)(2), 15 U.S.C.A. §§78j(b), 78u-4(b)(2); 17 C.F.R. § 240.10b-5.



349BI(C) Trading and Markets349BI(C)4 Proxies

349Bk49.28 k. Pleading. Most CitedCasesShareholders failed to state a proxy solicitation vi-olation claim, under the Securities Exchange Act,where shareholders failed to present facts demon-strating corporate directors did not believe thatmerger was in the “best interests” at time they maderecommendation or facts that would lead investor toconclude corporations or their executives kneweither customer would not be buying as muchproduct in the future as it had in the past or that ac-quired corporation's performance was down fromits previous comparable levels. Securities ExchangeAct of 1934, § 14, 15 U.S.C.A. § 78n(a); 17 C.F.R.§ 240.14a-9.



349BI(B) Registration and Distribution349BI(B)4 Registration Statements

349Bk25.17 False Statements or Omis-sions; Accuracy

349Bk25.18 k. In General. MostCited CasesShareholders' allegations, that acquiring corpora-tion and its executives omitted from registrationstatement facts that key customer's orders had de-clined, that acquired corporation's sales had slowedafter announcement of merger, and that acquiringcorporation's stock declined 47% that day after

press release disclosed that corporation expected itssecond quarter revenue to be approximately half theamount previously represented, were sufficient tostate a claim for liability for material misstatementsor omissions in registration statement. SecuritiesAct of 1933, § 11, 15 U.S.C.A. § 77k.



349BI(B) Registration and Distribution349BI(B)5 Prospectuses and Communica-

tions349Bk25.55 False Statements or Omis-

sions; Accuracy349Bk25.57 k. Particular Prospect-

uses or Communications. Most Cited CasesShareholders' allegations, that acquiring corpora-tions and its executives omitted from prospectus thefacts that key customer's orders had declined, thatacquired corporation's sales had slowed after an-nouncement of merger, and that corporations andexecutives were negligent in omitting to state thesefacts from their prospectus, adequately pleaded li-ability for sale of securities by means of misleadingprospectus. Securities Act of 1933, § 12(a)(2), 15U.S.C.A. § 77l(a)(2).





349Bk25.20 Persons Liable349Bk25.20(1) k. In General.

Most Cited Cases

Securities Regulation 349B 25.61(4)



tions















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349Bk25.61 Persons Liable349Bk25.61(4) k. Controlling

Persons. Most Cited Cases

Securities Regulation 349B 60.40



349Bk60.39 Persons Liable349Bk60.40 k. In General; Control

Persons. Most Cited CasesShareholders' allegations were sufficient to state asecondary claim for “control person” liability claimagainst acquiring corporation's president; share-holders alleged that president signed registrationstatement for merger, and jointly with acquired andacquiring corporations, actively caused the pro-spectus to be drafted, revised, and approved. Secur-ities Act of 1933, § 15, 15 U.S.C.A. § 77o; Securit-ies Exchange Act of 1934, § 20, as amended, 15U.S.C.A. § 78t(a).






Most Cited Cases





sions; Accuracy349Bk25.61 Persons Liable

349Bk25.61(4) k. ControllingPersons. Most Cited Cases





Persons. Most Cited CasesShareholders' allegations that acquiring corporationexerted control over itself failed to state secondaryclaim for “control person” liability claim againstcorporation. Securities Act of 1933, § 15, 15U.S.C.A. § 77o; Securities Exchange Act of 1934, §20, as amended, 15 U.S.C.A. § 78t(a).





Cited CasesShareholders failed properly to allege loss causa-tion, as was required under Private Securities Litig-ation Reform Act (PSLRA) to state securities fraudclaim under § 10(b) and Rule 10b-5; although theyalleged that the named representatives for the putat-ive class purchased stock during the class periodand that the stock price then fell, shareholders didnot allege that any of these same plaintiffs soldstock at a loss caused by alleged fraud or misrep-resentation by merged corporations or their execut-ives. Securities Exchange Act of 1934, §§ 10(b),21D(b)(2), 15 U.S.C.A. §§ 78j(b), 78u-4(b)(2); 17C.F.R. § 240.10b-5.

*677 David Kessler, Andrew L. Barroway, Schif-frin & Barroway, Bala Cynwyd, PA, Edward M.Gergosian, Esq., Benjamin Galdston, Barrack, Ro-dos & Bacine, William S. Lerach, Esq., ChristopherLometti, Jay P. Saltzman, Samuel P. Sporn, Esq.,Schoengold & Sporn, P.C., New York, NY, for















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Plaintiffs-Appellants.Terry T. Johnson, Esq., Cheryl W. Foung, Jerone F.Birn, Wilson Sonsini Goodrich & Rosati, Palo Alto,CA, Melvin R. Goldman, Esq., Morrison & Foer-ster LLP, San Francisco, CA, for Defendants-Ap-pellees.Sanford Svetcov, Esq., Reed R. Kathrein, Esq.,Patrick J. Coughlin, Esq., Susan K. Alexander,Esq., Shawn A. Williams, Esq., Stan S. Mallison,Lerach Coughlin Stoia Geller Rudman & Robbins,LLP, San Francisco, CA, William S. Lerach, Esq.,Eric A. Isaacson, Esq., Lerach Coughlin StoiaGeller Rudman & Robbins, LLP, San Diego, CA.

Appeal from the United States District Court for theNorthern District of California, Phyllis J. Hamilton,District Judge, Presiding. D.C. No. CV-00-2287-PJH.

Before: ALARCÓN, SILVERMAN, and BEA, Cir-cuit Judges.

MEMORANDUM

FN* This disposition is not appropriate forpublication and may not be cited to or bythe courts of this circuit except as providedby Ninth Circuit Rule 36-3.

**1 In this securities fraud class action, Plaintiffs-Appellants Robert G. Knollenberg (“Knollenberg”)et al. brought this putative class action against De-fendants-Appellees Harmonic Inc. (“Harmonic”)and C-Cube Microsystems, Inc. (“Old C-Cube”)and several of their top executives for violations ofsecurities laws in connection with the decline instock price of both companies around the time ofthe May 3, 2000 merger between Harmonic and OldC-Cube.FN1

FN1. Plaintiff Knollenberg seeks to repres-ent a putative class of persons who pur-chased or otherwise acquired (1) shares ofHarmonic between January 19, 2000 andJune 26, 2000 (the “Class Period”) and (2)shares of Old C-Cube prior to the merger(between January 19, 2000 and May 3,2000).

Because the parties are familiar with the facts andprocedural history of the case, we do not recitethem here in detail except as necessary to our de-cision.

I. BACKGROUND

On October 27, 1999, Harmonic and C-Cube an-nounced that Harmonic would acquire DiviCom,Inc. (“DiviCom”, a division of C-Cube). They filedForm 8-K with the Securities and Exchange Com-mission (“SEC”), which contained their proposedmerger agreement. On April 24, 2000, the share-holders of both companies voted to approve themerger. On May 3, 2000, the merger was com-pleted. Pursuant to the merger, Harmonic acquiredDiviCom and Old C-Cube ceased to exist.FN2

FN2. C-Cube Microsystems was renamedC-Cube Semiconductor, Inc. (later re-named C-Cube Microsystems, Inc.) (“NewC-Cube”).

On June 28, 2000, Plaintiffs filed a securities classaction complaint in the district court alleging De-fendants and several of their executives made aseries of misleading statements for the purpose ofobtaining shareholder approval of Harmonic's ac-quisition of C-Cube's DiviCom division *678 whilethey engaged in insider selling and thereby violatedSections 10b, 14(a), and 20(a) of the Securities Ex-change Act of 1934 (the “1934 Act”); Rules 10b-5and 14a-9 promulgated under the 1934 Act; andSections 11, 12 and 15 of the Securities Act of 1933(the “1933 Act”).

II. LEGAL STANDARDS

We review de novo the district court's order dis-missing Plaintiffs' Second Amended Complaintwith prejudice for repeated failure adequately tostate a claim for violations of the securities lawsunder the Private Securities Litigation Reform Actof 1995 (“PSLRA”), 15 U.S.C. § 78u-4(b), andFederal Rule of Civil Procedure 9(b). See28 U.S.C.§ 1291; In re Silicon Graphics, Inc. Sec. Litig., 183F.3d 970, 983 (9th Cir.1999). We review the dis-trict court's denial of leave to amend for abuse of





















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discretion. See Gompper v. VISX, Inc., 298 F.3d893, 895 (9th Cir.2002).

III. DISCUSSION

A. Claims Under Section 10(b) of the 1934 Actand Rule 10b-5

To plead securities fraud under Section 10(b) of the1934 Act or Rule 10b-5, Plaintiffs must allege: “(1)a misstatement or omission (2) of material fact (3)made with scienter (4) on which [plaintiffs] relied(5) which proximately caused [the plaintiffs'] in-jury.” DSAM Global Value Fund v. Altris Software,Inc. 288 F.3d 385, 388 (9th Cir.2002).

Under the PSLRA, Plaintiffs must “state with par-ticularity facts giving rise to a strong inference thatthe defendant acted with the required state of mind”with respect to each act or omission. See15 U.S.C.§ 78u-4(b)(2); In re Vantive Corp. Sec. Litig., 283F.3d 1079, 1084 (9th Cir.2002). By requiring par-ticularized, detailed allegations showing a stronginference of scienter, the PSLRA was intended to“eliminate abusive and opportunistic securities lit-igation.” Gompper, 298 F.3d at 897.

**2 As to forward looking statements made by theDefendants, Plaintiffs must allege facts demonstrat-ing a strong inference defendants made those state-ments with actual knowledge that they were false.15 U.S.C. § 78u-5(c)(1)(B)(I); In re Vantive Corp.Sec. Litig., 283 F.3d 1079, 1085 (9th Cir.2002). Aforward looking statement is any statement regard-ing “(1) financial projections, (2) plans and object-ives of management for future operations, (3) futureeconomic performance, or (4) the assumptions‘underlying or related to’ any of these issues.” SeeNo. 84 Employer-Teamster Joint Council PensionTrust Fund v. America West Holding Corp., 320F.3d 920, 936 (9th Cir.2003). A forecast is action-ably false if “ ‘there is no reasonable basis for thebelief’ ” or “ ‘the speaker is aware of undisclosedfacts tending seriously to undermine the statements'accuracy.’ ” Provenz v. Miller, 102 F.3d 1478, 1487(9th Cir.1996) (citation omitted).

As to non-forward looking statements made by the

Defendants, Plaintiffs must allege facts demonstrat-ing a strong inference defendants made those state-ments with intentional falsity or with deliberaterecklessness as to the statements' falsity. Id.

Claims that a defendant “could have” or “shouldhave” known that the statements were false are in-sufficient to satisfy the standard for either forwardlooking or non-forward looking statements.“Negligence, even gross negligence, does not riseto the level of the nefarious mental state necessaryto constitute securities fraud under the PSLRA.”DSAM, 288 F.3d at 391.

Plaintiffs allege that Defendants Harmonic and sev-eral of its executives (Ley, Dickson, Yost, Flatow,Nazarathy, Kvamme,*679 Lane, Lemieux, Vail-laud), and New C-Cube and several of its execut-ives (Balkanski, Lookabaugh, Brown, Foreman,McKinney, Padval, Valentine, Walcykowski, Futaand Reyes) made false or misleading statements inviolation of Section 10(b) and Rule 10b-5.

Analysis of the Second Amended Complaint,however, demonstrates that there are no materiallymisleading statements or omissions, nor are thereallegations raising a “strong inference of scienter.”

1. Misstatements or Omissions of Material Fact

Plaintiffs allege Defendants sought to inflate thevalue of the stock of both companies to convinceshareholders to approve the merger and to allow theC-Cube Defendants to sell their personal shares.

Plaintiffs allege Defendants published several falsefinancial statements FN3 and press releases duringthe class period that were materially misleading in-sofar as the financial documents failed to disclose:(1) AT & T's demand for Harmonic products in thefiscal year for 2000 had declined and would contin-ue to do so; and (2) DiviCom's business had slowedfollowing the October 1999 announcement of thepending merger causing lower revenues in thefourth fiscal quarter of 2000.

FN3. As discussed below, Plaintiffs allegemisleading statements were made in the






























following documents: (1) eight joint C-Cube and Harmonic press releases; (2)Harmonic's 1999 Form 10-K and firstquarter for 2000 Form 10-Q; (3) the March23, 2000 Form S-4 Registration Statement;and (4) seven analyst reports.

A. AT & T's Demand for Harmonic Products

**3 [1] Plaintiffs allege Defendants made severalstatements that Harmonic was experiencing “strongdemand” for its products from traditional operatorssuch as AT & T, and these statements were mis-leading because Defendants knew AT & T had beencancelling orders for 2000 and the record sales forthe fourth quarter of 1999 were the result of the factthat AT & T was obligated to pay for large quantit-ies of previously ordered custom-built product. Asa result, Plaintiffs allege, Defendants knew that AT& T would place few new orders in the first quarterof 2000 and failed to disclose this information.

Plaintiffs fail to make precise allegations explaininghow the alleged statement that Harmonic was ex-periencing “strong demand” for its products wasmisleading or untrue. According to Plaintiffs' alleg-ations, Harmonic did not make a concrete predic-tion about future sales, only a statement about cur-rent sales. Further, Plaintiffs fail to allege exactlywho at Harmonic knew about the alleged decline insales from AT & T, when they knew it, how it wascommunicated to them, or how many sales ordersAT & T had cancelled. Nor do Plaintiffs explainhow the allegedly omitted facts would have beenviewed by a reasonable investor as having signific-antly altered the total mix of information madeavailable. See In re Stac Electronics Sec. Litig., 89F.3d 1399, 1408-09 (9th Cir.1996).

Without more, the statements that there was “strongdemand” are insufficient to meet the heightenedpleading standard under the PSLRA. See Ronconi v.Larkin, 253 F.3d 423, 431 (9th Cir.2001) (statementthat “sales growth was accelerating” does not ad-equately allege facts giving rise to claim under10(b); rather “[p]laintiffs do not specify facts orevidence that show why the statement was false at

the time it was made nor that defendants knew orwith deliberate recklessness disregarded that it wasfalse”).

*680 Accordingly, Plaintiffs' allegations are insuf-ficient to state a claim of fraud under Section 10(b)or Rule 10b-5 because Plaintiffs fail adequately tostate facts establishing that the defendants knew thestatements were false or acted with deliberate reck-lessness as to whether the statements were false.

B. Scienter Regarding AT & T Statements

Not only did Plaintiffs fail to plead material mis-statements or omissions with regard to Harmonics'sales to AT & T, Plaintiffs also failed adequately toplead specific facts which give rise to a “strong in-ference” of scienter that Defendants either knewtheir statements were false or made the statementswith deliberate recklessness as to the statements'veracity. See, e.g., Karacand v. Edwards, 53F.Supp.2d 1236, 1252 (D.Utah 1999) (“Where, ashere, plaintiffs have not adequately pleaded falsity,it is unnecessary to determine whether they haveadequately pleaded scienter.”). Even assuming, ar-guendo, that Plaintiffs here have adequatelypleaded violations under 10(b), they nonethelessstill fail to plead facts that give rise to a “strong in-ference” of deliberate recklessness or actual know-ledge.

**4 [2] Plaintiffs allege that the Harmonic Defend-ants “monitored inventory” through AT & T'sweekly order forecasts and prepared internal reportsbased on information contained in such reports.From the knowledge obtained from monitoring theinventory, the Harmonic defendants “w[ere] awarethat AT & T had been canceling and pushing outthe scheduling of orders all throughout 1999” andthat “AT & T had an excessive inventory and back-log from its late-1999 purchases of Harmonicproducts.” Therefore, Plaintiffs allege, the Harmon-ic Defendants “knew [in early 2000] that AT & T'smanagement of this inventory would result in aslowing of its purchases from Harmonic until thisinventory was deployed by AT & T.”

These allegations are insufficient to raise a “strong













inference” of scienter. While courts have held thatinternal reports may support a strong inference ofscienter, a complaint relying on the existence ofsuch reports must contain “at least some specificsfrom those reports as well as such facts as may in-dicate their reliability.” Nursing Home PensionFund, Local 144 v. Oracle Corp., 380 F.3d 1226,1230-31 (9th Cir.2004). Here, Plaintiffs fail to al-lege basic facts (such as author, date prepared, con-tents) regarding either AT & T's “weekly forecasts”or Harmonic's internal reports. See In re SiliconGraphics, Inc. Sec. Litig., 183 F.3d 970, 977 (9thCir.1999) (dismissing claim where plaintiffs failedto state the source of information regarding the re-ports, how she learned of them, who drafted them,or which officers received them); see also Lipton v.Pathogenesis Corp., 284 F.3d 1027, 1231 (9thCir.2002) (same).

Nor do Plaintiffs allege facts to show that any par-ticular Harmonic Defendant was aware that AT & Thad been cancelling orders. Plaintiffs fail to allegethat the same person who read these internal reportswas the person who released the alleged misleadingstatements. Plaintiffs' allegation the Harmonic De-fendants therefore knew AT & T would be slowingits purchases of Harmonic inventory is unsupportedby factual allegations. Finally, Plaintiffs' allega-tions with respect to the information allegedlyprovided by unnamed management sources is insuf-ficient. See Haft v. Eastland Fin. Corp., 772F.Supp. 1315 (D.R.I.1991) (holding that recountingof analysts' opinions did not prove ‘underlying fac-tual support’ necessary to create a “strong inferenceof scienter.”).

*681 C. DiviCom Sales

[3] Plaintiffs also allege that shortly after the an-nouncement of the Harmonic-C-Cube (DiviCom)merger, several of DiviCom's largest customerswithdrew their orders from DiviCom because suchcustomers were concerned that DiviCom's acquisi-tion by a cable company would “draw the com-pany's focus and development efforts” from itssatellite products to cable products.

Accordingly, Plaintiffs allege Defendants' state-ments favorable to DiviCom or the Harmonic-C-Cube (DiviCom) merger were misleading insofaras such statements presented DiviCom in a morepositive light than was warranted given that Di-viCom's largest customers had withdrawn orders.Thus, Plaintiffs allege that the Harmonic defend-ants:**5 failed ... to disclose DiviCom's poor perform-ance to the market, despite the fact that ... Di-viCom's sales weakness had become ‘commonknowledge’ among Harmonic management and em-ployees well before the merger.

Plaintiffs' allegations are insufficient for severalreasons. First, Plaintiffs fail to specify the amountby which DiviCom's sales declined. See In reVantive Sec. Litig., 283 F.3d 1079, 1088 (9thCir.2002) (affirming district court's dismissal ofplaintiff's claim under Section 10(b) whereplaintiffs alleged misstatements regarding inferiorproduct features that resulted in “slow sales” ofsuch products).

Second, Plaintiffs fail to allege facts establishingDefendants had knowledge the merger announce-ment would precipitate a decline in orders. Here,Plaintiffs allege the announcement of the merger it-self caused DiviCom's customer's to “back away.”However, Plaintiffs do not allege facts demonstrat-ing Defendants knew such would be the market re-action.

Third, Plaintiffs fail to plead the source of the in-formation about DiviCom's future after announce-ment of merger plans with sufficient particularity.Rather, plaintiffs state that “former employees” arethe source of this information that the lagging Di-viCom sales were “common knowledge” among“Harmonic management.” Significantly, however,Plaintiffs fail to allege facts demonstrating that the“former employees” consulted were in a position toknow what management knew. See In re SplashTech. Holdings, Inc., Sec. Litig., 160 F.Supp.2d1059, 1080 n. 15 (N.D.Cal.2001) (reliance on“confidential informants” was not sufficient in theabsence of “any information that the Court might



























use to evaluate the confidential informants' basesfor alleging that the defendants had access to ad-verse information.”).

Fourth, the allegation that Defendants misled in-vestors by failing to publish DiviCom's financialresults for 1999 and the first quarter of 2000 beforethe scheduled date of the merger is insufficient be-cause Plaintiffs fail to allege facts demonstratingthat any Harmonic defendant had a duty to publishthese results prior to the merger. Silence, absent aduty to disclose, is not actionable. See, e.g., Brodyv. Transitional Hosps. Corp., 280 F.3d 997, 1006(9th Cir.2002) (10b-5 prohibits misleading state-ments, not ones that are merely “incomplete.”).

D. Scienter Regarding DiviCom

[4] Plaintiffs allege “DiviCom's sales weakness hadbecome “common knowledge” among Harmonicmanagement and employees “well before the mer-ger” and defendants had an obligation to disclosesuch information to the market.

This allegation is insufficient to support a “stronginference” of scienter. The allegation that it was“common knowledge” that sales had declined doesnot comport *682 with the PSLRA's requirementthat plaintiffs allege the required state of mind as toeach Defendant who made an allegedly misleadingstatement and is therefore insufficient. See15U.S.C. § 78u-4(b)(2).

2. Allegations of Insider Sales do not Raise a“Strong Inference” of Scienter

**6 [5] Plaintiffs next allege that “insider selling”on the part of certain executives of C-Cube FN4

demonstrates Defendants had “motive and oppor-tunity” to mislead investors and such insider salesgive rise to a strong inference of scienter.

FN4. Plaintiffs alleged insider trading onthe part of Harmonic's executives as well.However, Plaintiffs concede on appeal thatthey are no longer asserting claims againstFlatow and Yost. Accordingly, there are noremaining claims as to “insider sales” by

Harmonic's executives.

In general, to determine whether a particular insidersale is “suspicious,” courts consider the followingfactors: “(1) percentage of shares sold by the in-siders; (2) timing of the sales; and (3) whether thesales were consistent with the trader's previous his-tory.” See In re Silicon Graphics, 183 F.3d at 986(quoting In re Apple Computer Sec. Litig., 886 F.2d1109, 1117 (9th Cir.1989)).

Plaintiffs' allegations are insufficient here because,under the terms of the merger agreement, the C-Cube Defendants were required to exercise theiroptions. Defendants sold some of their stock toraise the money necessary to exercise their vestedoptions and purchase the underlying shares. Ac-cordingly, Plaintiffs fail to allege facts from whichthis court can conclude that insider selling givesrise to a “strong inference” of scienter.

B. Claims Under Section 14(a) of the 1934 Act andRule 14a-9 Promulgated Thereunder

[6] Plaintiffs also bring claims under Section 14(a)of the Securities Exchange Act of 1934, 15 U.S.C.§ 78n(a), and SEC Rule 14a-9 promulgated there-under. 17 C.F.R. § 240.14a-9. Plaintiffs allege De-fendant Harmonic, and certain of its executives(Ley, Nazarathy, Kvamme, Lane, Lemieux, andVaillaud) and Defendant New C-Cube and certainof its executives (Balkanski, McKinney, Padval,Valentine, Futa and Reyes) made false or mislead-ing statements in proxy solicitations that were dis-tributed to certain putative class members for thepurpose of inducing them to approve the proposedmerger between Harmonic and C-Cube (DiviCom)in violation of Section 14(a) and Rule 14a-9.

To state a claim under Section 14(a), a plaintiffmust establish that “(1) a proxy statement containeda material misrepresentation or omission which (2)caused the plaintiff injury and (3) that the proxy so-licitation, [rather than the particular defect in thesolicitation materials], was an ‘essential link in theaccomplishment of the transaction.’ ” AtlanticCoast Airlines Holdings v. Mesa Air Group, Inc.,295 F.Supp.2d 75, 81-82 (D.D.C.2003) (quoting

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General Elec. Co. v. Cathcart, 980 F.2d 927, 932(3d Cir.1992)) (quoting Mills v. Elec. Auto-LiteCo., 396 U.S. 375, 385, 90 S.Ct. 616, 24 L.Ed.2d593 (1970)).

Moreover, the PSLRA pleading requirements applyto claims brought under Section 14(a) and Rule14a-9. See In re McKesson HBOC, Inc. Sec. Litig.,126 F.Supp.2d 1248, 1267 (N.D.Cal.2000).However, unlike Section 10(b), Section 14(a)“lacks any reference to a ‘manipulative device orcontrivance ... to indicate a requirement of sci-enter.” Id. at 1263. Accordingly, negligence is suf-ficient to support a claim for a violation of Section*683 14(a) for both forward looking and non-forward looking statements. Id. at 1267 (“a Section14(a) plaintiff must plead with particularity factsthat give rise to a strong inference of negligence”).

**7 None of Plaintiffs' allegations state a claim un-der Section 14(a). First, statements that the mergerwas “in the best interests of the shareholders” wereexpressions of opinion. See In re McKesson, 126F.Supp.2d 1248 at 1265. To state a claim uponwhich relief can be granted, plaintiff must allege“particularized facts showing that the opinion wasboth subjectively and objectively false.” See Vir-ginia Bankshares, Inc. v. Sandberg, 501 U.S. 1083,1095-96, 111 S.Ct. 2749, 115 L.Ed.2d 929 (1991).Here, Plaintiffs do not allege such particularizedfacts. Nor can they show that the merger was not“in the best interests of the shareholders.” Even ifthey could, Plaintiffs' Second Amended Complaintis bereft of facts alleged which demonstrate the dir-ectors did not believe that the merger was in the“best interests” at the time they made the recom-mendation, let alone a “strong inference” of negli-gence.

Second, Plaintiffs do not allege any facts thatwould lead an investor to the conclusion Defend-ants knew AT & T would not be buying as muchHarmonic product in the future as it had in the pastor that DiviCom's performance was down from itsprevious comparable levels.

Accordingly, Plaintiffs fail to state a claim for relief

under Section 14(a) and Rule 14a-9.

C. Claims Under Sections 11 and 12 of the 1933Act

Next, Plaintiffs bring claims under Sections 11 and12 of the Securities Act of 1933. 15 U.S.C. §§ 77k,771(a)(2).

Claims brought under Sections 11 and 12 of the1933 Act are not subject to the heightened pleadingrequirements of the PSLRA. See In re Stac Elec-tronics Sec. Litig., 89 F.3d at 1404. Rather, onlythose allegations of violations of Sections 11 and12 which “sound in fraud” must be pleaded withparticularity under Fed.R.Civ.P. 9(b). See In reStac, 89 F.3d at 1404.

2. Section 11(a) of the 1933 Act

[7] Defendants may be liable for violations of Sec-tion 11 for innocent or negligent misstatements oromissions. See Herman & MacLean v. Huddleston,459 U.S. 375, 382, 103 S.Ct. 683, 74 L.Ed.2d 548(1983). Plaintiffs allege Defendant Harmonic andcertain Harmonic executives (Ley, Dickson, Naz-arathy, Kvamme, Lane, Lemieux and Vaillard)made material misstatements or omissions of mater-ial fact in Harmonic's Registration Statement. Tostate a claim under Section 11(a), a plaintiff mustallege that: (1) the registration statement containedan omission or misrepresentation; and (2) the omis-sion or misrepresentation was material. See In reStac Electronic Sec. Litig., 89 F.3d at 1403-04.

Plaintiffs allege Harmonic omitted the followingmaterial facts from its Registration Statement onForm S-4 filed with the SEC on March 23, 2000:(1)AT & T's orders from Harmonic had declined and(2) DiviCom's sales had slowed after the October1999 announcement of the merger between Har-monic and C-Cube (DiviCom).

Plaintiffs allege that in its June 26, 2000 press re-lease, Harmonic disclosed that it expected secondquarter revenue of $74 million to $82 million, ap-proximately half the amount previously representedby Defendants and expected by the market. The









































press release also stated that its reduction in earn-ings was due, in large part, *684 to the reduction inorders from AT & T. The next day, June 27, 2000,Harmonic's stock declined 47% from over $40 pershare to just over $23 per share.

**8 These claims are not “grounded in fraud” be-cause Plaintiffs allege a basis for Section 11 liabil-ity other than fraud; i.e., the omission of a materialfact from the Registration statement. Notably,plaintiffs do not rely on a unified course of fraudu-lent conduct or on the “wholesale adoption” of theirsecurities fraud allegations. See In re Daou Sys-tems, Inc., 411 F.3d 1006, 1027-28 (9th Cir.2005).Plaintiffs also disclaim any allegations of fraud.While a disclaimer alone is insufficient to re-characterize a complaint whose gravamen is plainlyfraud, here plaintiffs have made an effort to plead anon-fraudulent basis for Section 11 liability. See Inre Stac Electronics Sec. Litig., 89 F.3d at 1405 n. 2.Accordingly, Plaintiffs' claims under Section 11 arenot subject to Fed.R.Civ.P. 9(b)'s particularity re-quirements. See In re Exodus Communications,Inc., Sec. Litig., No. C-01-2661-MMC, 2005 WL2206693, at *1 (N.D.Cal. Sept.12, 2005).

In sum, Plaintiffs' allegations are sufficient to statea claim under Section 11. Plaintiffs allege the Re-gistration Statement contained omissions and allegethat the omissions were material. Since the com-plaint is not “grounded in fraud,” that is all thatSection 11 requires. See In re Stac Electronic Sec.Litig., 89 F.3d at 1403-04 (citing Kaplan v. Rose,49 F.3d 1363, 1371 (9th Cir.1994)).

2. Section 12(a)(2) of the 1933 Act

[8] Plaintiffs also bring claims under Section12(a)(2) of the 1933 Securities Act against Defend-ants Harmonic and Ley.

To state a claim under Section 12(a)(2), Plaintiffsmust allege: (1) that the prospectus contained anomission or misrepresentation; and (2) that theomission or misrepresentation was material. See Inre Stratosphere Corp. Sec. Litig., 1 F.Supp.2d1096, 1120 (D.Nev.1998) (citing Pinter v. Dahl,486 U.S. 622, 646-48, 108 S.Ct. 2063, 100 L.Ed.2d

658 (1988)).

Here, Plaintiffs reiterate the allegations that theHarmonic Defendants omitted from their prospect-us filed with the SEC on March 23, 2000(“Prospectus”) the facts that: (1) AT & T's orders ofHarmonic had declined and (2) DiviCom's sales hadslowed after the October 1999 announcement of themerger between Harmonic and C-Cube (DiviCom).Plaintiffs also allege Defendants were negligent inomitting to state these facts from their prospectus.

Plaintiffs have adequately pleaded a violation ofSection 12(a)(2) by alleging that Defendants negli-gently omitted material facts from the prospectus.See In re Stratosphere Corp. Sec. Litig., 1F.Supp.2d at 1120. For the reasons discussed aboveregarding Plaintiffs' Section 11 claims, Plaintiffs'claims under Section 12(a)(2) are not “grounded infraud” and, therefore, are not subject toFed.R.Civ.P. 9(b).

D. Secondary Claims of Control Person LiabilityUnder § 15 of the 1933 Act and § 20(a) of the 1934

Act

Finally, Plaintiffs allege secondary claims for“control person” liability against Defendants Har-monic and Ley under Section 15 of the SecuritiesAct of 1933, 15 U.S.C. § 77o, and against Defend-ants Harmonic, New C-Cube, Ley and Balkanskiunder Section 20(a) of the Securities Exchange Actof 1934, 15 U.S.C. § 78t(a).

**9 As to Plaintiffs' claims under Section 20(a) ofthe 1934 Act, Plaintiffs have not met the thresholdrequirement of adequately pleading a primary viol-ation of the *685 federal securities laws. See, e.g.,Paracor Finance, Inc. v. General Elec. CapitalCorp., 96 F.3d 1151, 1161 (9th Cir.1996).

To state a claim for control person liability underSection 15 of the 1933 Act, this circuit requires thePlaintiff to plead: (1) the defendant had the powerto influence or control the primary violator and (2)the defendant actively used this influence or controlso as to be a “culpable participant” in the primaryviolation. See Durham v. Kelly, 810 F.2d 1500,





































1503-04 (9th Cir.1987).

[9] Here, as to Defendant Ley, Plaintiffs plead thefirst prong adequately by alleging Ley's position asPresident, CEO and Chairman of the Board of Har-monic. See In re Immune Response Sec. Litig., 375F.Supp.2d 983 (S.D.Cal.2005) (allegations of con-trol by virtue of board position or stock ownershipsufficient to meet first prong). Plaintiffs plead thesecond prong adequately by alleging that Leysigned the Registration statement, and jointly withhis co-defendants, actively caused the prospectus tobe drafted, revised and approved. Cf. In re CalpineCorp. Sec. Litig., 288 F.Supp.2d 1054, 1081(N.D.Cal.2003) (Plaintiffs failed to state a Section15 claim when they did not allege defendants eithersigned or were involved in the preparation of theprospectus that contained material misstatements oromissions).

[10] Plaintiffs' theory of control person liabilityagainst Defendant Harmonic is unclear, since itrests on allegations that Harmonic exerted controlover itself. While Plaintiffs thus fail to state a claimagainst Harmonic under Section 15, they might beable to cure this defect by amending the complaintto identify a primary violator over whom Harmonicexercised control.

IV. Loss Causation

[11] Finally, a private securities fraud action mustinclude allegations of facts establishing economicloss to the plaintiffs caused by the defendants' fraudor misrepresentation. Dura Pharmaceuticals, Inc. v.Broudo, 544U.S. 336, ----, 125 S.Ct. 1627, 1629,161 L.Ed.2d 577 (2005). Here, Plaintiffs failedproperly to allege loss causation. Although they al-lege that the named representatives for the putativeclass purchased stock during the class period andthat the stock price then fell, they do not allege thatany of these same Plaintiffs sold stock at a losscaused by the Defendants' fraud or misrepresenta-tion.

Accordingly, Plaintiffs have failed to allege a ne-cessary element to their cause of action for securit-ies fraud under Section 10(b) of the 1934 Act.

V. CONCLUSION

For the foregoing reasons, Plaintiffs have failed ad-equately to plead violations of Sections 10(b) and14(a) of the 1934 Act under the heightened plead-ing standards of the PSLRA. After three attempts,Plaintiffs have failed to plead proper causes of ac-tion under the PSLRA. Furthermore, the defects inPlaintiffs' Second Amended Complaint cannot beremedied by further amendment. See Desaigoudarv. Meyercord, 223 F.3d 1020, 1026 (9th Cir.2000).Plaintiffs' claim under Section 20(a) of the 1934Act likewise must also fail. Accordingly, we affirmthe district court's dismissal with prejudice ofPlaintiffs' 1934 Act claims.

**10 Plaintiffs have, however, pleaded violationsof Sections 11 and 12 of the 1933 Act adequately.Accordingly, we reverse the dismissal Plaintiffs'claims under Sections 11 and 12 of the 1933 Act.

Further, Plaintiffs' allegations are sufficient to statea claim against Ley under *686 Section 15 of the1933 Act. Thus, we reverse the district court's dis-missal of the Section 15 claim against Ley. We af-firm dismissal of Plaintiff's Section 15 claimagainst Harmonic, but grant leave to amend. Eachparty shall bear its own costs on appeal.

AFFIRMED IN PART, REVERSED IN PART andREMANDED.

C.A.9 (Cal.),2005.Knollenberg v. Harmonic, Inc.152 Fed.Appx. 674, 2005 WL 2980628 (C.A.9(Cal.)), Fed. Sec. L. Rep. P 93,554

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EXHIBIT 8


LEXSEE 2006 US DIST. LEXIS 76430

SEMYON LIBON, Plaintiff, v. INFINEON TECHNOLOGIES, AG, et al., Defen-

dant.

Civil Action No. 3:04CV929

UNITED STATES DISTRICT COURT FOR THE EASTERN DISTRICT OF VIR-GINIA, RICHMOND DIVISION


August 7, 2006, Decided August 7, 2006, Filed

COUNSEL: [*1] For Semyon Libon, Plaintiff: Thomas Hunt Roberts, LEAD ATTORNEY, Thomas H. Roberts & Associates PC, Richmond, VA. For Infineon Technologies AG, Infineon Technologies Dresden, GmbH & Co. OHG, Infineon Technologies Richmond, LP, Defendants: Daryl Eugene Webb, Jr., LEAD ATTORNEY, Mary Leslie Parpart, Matthew Benjamin Kirsner, Troutman Sanders LLP, Richmond, VA. JUDGES: M. Hannah Lauck, United States Magistrate Judge. OPINION BY: M. Hannah Lauck OPINION REPORT AND RECOMMENDATION

Before the Court is the Defendant's Motion to Dis-miss claims of securities fraud. The Plaintiff, Semyon Libon, brought a Complaint against the Defendants In-fineon Technologies AG ("Infineon"), a German corpo-ration; its subsidiaries Infineon Technologies Richmond, LP ("Infineon Richmond"), and Infineon Technologies Dresden, GmbH & Co. OHG ("Infineon Dresden"); and Henryk Schoder. 1 Libon asserted claims under Title VII of the Civil Rights Act of 1964, 42 U.S.C. § 2000e et seq., the Age Discrimination in Employment Act, 29 U.S.C. § 621 et seq., the Family and Medical Leave Act, 29 U.S.C. § 2601 et seq., the Securities Exchange [*2] Act of 1934 ("Securities Act"), 15 U.S.C. § 78a et seq., the Virginia Securities Act, Va. Code Ann. § 13.1-501 et seq. (Michie 1995 & Supp 2005), and various state and foreign laws.

1 There is no indication that Schoder has been served or has entered an appearance in this case.

Infineon Richmond filed a Motion to Dismiss that the District Court granted in part. (Docket Nos. 11, 13.) Infineon and Infineon Dresden filed Motions to Dismiss, which the District Court referred to a magistrate judge for report and recommendation. The Magistrate Judge recommended that the Motions to Dismiss be granted. (Docket No. 51.) The District Court adopted the report and recommendation in part, dismissing all claims against Infineon and Infineon Dresden (Docket No. 61) and granting leave to amend only the claims under the Securities Act against Infineon (Docket No. 64).

Libon filed a ninety-four page Amended Complaint in which he reasserts claims under the Securities Act and Virginia Securities [*3] Act. 2 As evidence of the De-fendant's violation of Section 10(b) of the Securities Act ("Section 10(b)"), 15 U.S.C. § 78j(b), and its implement-ing regulation, 17 C.F.R. § 240.10b-5 (2005) ("Rule 10b-5"), Libon alleges, in an exhaustive 95 page pleading, that Infineon, while engaging in illegal price-fixing, is-sued false statements that distorted the company's reve-nues and concealed its anti-competitive acts. Infineon moved to dismiss the Amended Complaint, and Libon has responded. The District Court referred the Motion to Dismiss to the undersigned Magistrate Judge for report and recommendation. The Court held oral argument on the Motion to Dismiss, which is now ripe for adjudica-tion.

2 In the Amended Complaint, Libon included all of the previously dismissed claims, but noted that they were not reasserted unless the District Court reconsidered its prior decision. Unlike the federal Securities Act claims, the District Court did not grant leave to amend the Virginia Securities Act


2006 U.S. Dist. LEXIS 76430, *

claims. Thus, despite Libon's attempt to amend the Virginia Securities Act claims, they are not properly before this Court.

[*4] I. Standard of Review

A motion to dismiss under Rule 12(b)(6) of the Fed-eral Rules of Civil Procedure tests the sufficiency of dispositive issues of law. See Alexander v. Gilmore, 202 F. Supp. 2d 478, 480 (E.D. Va. 2002). The applicable standard requires dismissal when "it appears certain that the plaintiff cannot prove any set of facts in support of [her or] his claim entitling [her or] him to relief." Ed-wards v. City of Goldsboro, 178 F.3d 231, 244 (4th Cir. 1999). The Court must view the allegations and all rea-sonable inferences drawn therefrom in the plaintiff's fa-vor. See id. Yet, the Court need neither accept a plain-tiff's unwarranted conclusory allegations or unreasonable inferences nor lend credence to allegations that contra-dict matters properly established by judicial notice or exhibit. Veney v. Wyche, 293 F.3d 726, 730 (4th Cir. 2002). II. Findings of Fact

Libon's claim of securities fraud arises from his pur-chase of Infineon stock pursuant to an initial public of-fering ("IPO"). While employed at Infineon Richmond, on February 23, 2000, Libon received an email message from Ilke Fluegge, [*5] an Infineon employee. Attribut-ing statements to Ulrich Schumacher, Infineon's Presi-dent and Chief Executive Officer, the message proposed that employees share in the success of the company and become "co-owners of Infineon." (Am. Compl. P 15.) In the ensuing weeks, Infineon held a party in conjunction with the IPO. (Id. P 66.) And on March 16, 2000, Libon purchased 1,000 shares of Infineon stock at $ 33.92 per share. (Id. PP 66, 68.) When he purchased the stock, Li-bon relied on various statements made in a Prospectus and preliminary copies of the Prospectus issued by In-fineon. (Id. P 69.) A. Statements Prior to Stock Purchase

On March 10, 2000, Libon received a copy of In-fineon's Prospectus, which was dated March 13, 2000. (Id. P 69.) Libon asserts that the following statements contained in the Prospectus were false or misleading:

(1) This relatively favorable pricing en-vironment continued into the first quarter of the 2000 financial year, during which our Memory Products segment achieved earnings before interest, minority interest and taxes (EBIT) of [euro] 125.8 million, compared with a loss of [euro] 122.1 mil-lion in the comparable period [*6] of the

1999 financial year. DRAM [, or dynamic random access memory,] remains an im-portant part of our business, and we be-lieve that our technological leadership in this area positions us well to compete ef-fectively in terms of both costs and mar-gins. (Am. Compl. P 17.)

(2) Our focus on selected growth sec-tors within the semiconductor market and our high level of research and develop-ment expenditures have enabled us to grow significantly in recent years. Our sales grew from [euro] 2,125.7 million in the 1995 financial year to [euro] 4,237.3 million in the 1999 financial year, a com-pound annual growth rate of approxi-mately 19%. This growth rate is substan-tially higher than that of the semi-conductor industry as a whole and has en-abled us to increase our market share sig-nificantly. (Id. P 76.)

(3) Against a background of substan-tial price decreases in the market for dy-namic random access memory, or DRAM, the percentage of our net sales comprised by memory products during the last five years has been as high as 41.2% in the 1995 financial year and as low as 20.7% in the 1998 financial year. This percent-age increased to 30.3% in the 1999 finan-cial year. As a result [*7] of substantial investments over the last several years, we believe our DRAM products are highly competitive, particularly in terms of ca-pacity and feature size. We plan to strengthen our market position in memory by targeting leading-edge products that require more technological expertise and that are less susceptible to rapid price de-clines. We believe that our expertise in memory products confers important com-petitive advantages in providing comples [sic] system-on-chip solutions for our cus-tomers. ( Id. P 80.)

(4) As key elements in implementing our strategy, we seek to: . . . Attract and retain senior management and other highly qualified personnel, in particular research and development personnel, by fostering employee ownership though share ownership and share option plans. (Id. P 84.)


2006 U.S. Dist. LEXIS 76430, *

(5) Net sales . . . [[euro] 3,175.3 Mil-lion in 1998 and [euro] 4,237.3 Million in 1999]. (Id. P 88.)

(6) You should carefully consider the risks described below before making an investment decision. The occurrence of any of the following events could harm us . . . . Additional risks not currently known to us or that we now deem immaterial may also harm us and [*8] affect your in-vestment. (Id. P 90.)

(7) We also believe that we are a technological leader in the DRAM market and that our strength in this area positions us well to compete effectively in terms of both costs and margins and to take advan-tage of any prolonged upturn in demand for DRAM products. (Id. P 94.)

(8) Our ability to compete success-fully depends on elements both within and outside of our control, including: . . . pric-ing . . . . (Id. P 97.)

(9) Our Memory Products division develops, manufacturers [sic] and markets semiconductor memory products with various packaging and configuration op-tions and performance characteristics for use in standard and embedded memory applications. Taking into account subse-quent consolidation in that industry, we were the fifth largest producer of DRAM in 1999 in terms of revenue, with a worldwide market share of approximately 8%. (Id. P 120.)

(10) The accompanying financial statements have been preparted in accor-dance with United States generally ac-cepted accounting principles ("U.S. GAAP") on a basis which reflects the combined historical financial statements of the transferred businesses assuming [*9] that Infineon had exited [sic] as a separate legal entity and including North Tyneside as noted above, for all prior pe-riods. (Id. 35 at P 168.) 3

A final statement from the Prospectus, Statement (11), provided a summary of financial data, including net sales, gross profits, net income, and earnings for 1999. (Id. P 119.)

3 Beginning on page 35, the Amended Com-plaint jumps in numbering from paragraph 120 to 68. As a result, the Amended Complaint contains two paragraphs numbered 68 through 120, each containing different allegations. For the duplicate paragraphs numbered out of the original se-quence, the page and paragraph are noted.

Libon alleges that the statements contained in the Prospectus were misleading because they did not dis-close that Infineon was knowingly engaged in illegal price fixing, thereby "distorting market forces, ...removing competition..., [and] artificially increasing revenues...." (Id. PP 72-73, 77, 81, 85, 91.) Evidencing the demonstrable falsity of these [*10] statements, Libon asserts that had Infineon believed it was competitive it would not have needed to engage in price fixing. (Id. PP 95, 104.) Furthermore, Infineon did not "disclose dishon-esty and illegal conduct as a risk factor [sic]." (Id. P 75.) In deciding to purchase Infineon stock, Libon relied on the statements in the Prospectus. (Id. PP 74, 78, 82, 86, 89, 92-93, 96.) As damages, Libon asserts that he pur-chased Infineon stock at $ 33.92, but since 2002, the stock has traded at between $ 5.70 and $ 9.25. (Id. PP 79, 83.)

Libon also asserts that on March 13, 2000, Schumacher told him, "Throughout the world people are investing trust in our future. We will always be careful to honour this." (Id. P 100.) According to Libon, this state-ment was false because Infineon failed "to disclose that it was engaged in price fixing, artificially skewing the market forces and prices" and had "no present intent to honor the trust of investors." (Id. P 101.)

As to the alleged violations of generally accepted accounting principles ("GAAP"), Libon cites eight prin-ciples, but does not correlate any principle to any fact alleged in the Amended Complaint. (Id. 79-81 at [*11] P 104(a)-(h).) Without further elaboration, Libon asserts that Infineon violated GAAP because its earnings were "artificially inflated by the price-fixing scheme in its 1999-2002 financial statements . . . ." (Id. 79 at P 101.) B. Statements Subsequent to the Stock Purchase

Libon provides various statements attributed to In-fineon and third parties from April 2000 through April 2004. (Id. 36-75 at PP 70-96.) Many of the statements reference Infineon's earnings and revenue expectations. An April 24, 2001, statement noted "continued falling prices of DRAMs. The earnings decrease also reflects the lack of revenues from the Hard Disk Drive (HDD) busi-ness . . . ." (Id. 44 at P 82.) On November 13, 2001, In-fineon issued a press release concerning fiscal year 2001 and fourth quarter results that reported


2006 U.S. Dist. LEXIS 76430, *

a decrease of 22 percent from the previ-ous fiscal year. Revenue decrease resulted from a sharp decline in the overall semi-conductor market, which market analysts forecast will experience negative growth of more than 30 percent in this calendar year. Revenue decline was driven by weaker demand and deteriorating market conditions particularly for memory and [*12] mobile communication products.

. . . .

Outlook for 2002

In the fiscal year 2001 market condi-tions in the semiconductor industry dete-riorated significantly. Leading market analysts have again lowered their expecta-tions for the semiconductor market as a whole and currently predict a decline of more than 30 percent for calendar year 2001 as well as a moderate single-digit growth rate for 2002. The market devel-opment in the next six months remains. [sic] Uncertain [sic] and will be impacted by the slowdown of the world economy and the uncertainty of the current global political environment.

(Id. 46, 52 at P 85.)

Libon asserts that Infineon falsely reported its fiscal year results from 1999 to 2002 in filings with the Securi-ties and Exchange Commission and in press releases in "order to inflate the price of Infineon's stock and make its refinacing of debt and acquisition possible . . . ." (Am. Compl. 78 at P 99.) Libon alleges that as Infineon's price fixing scheme ended in June 2002, it attempted to under-state its liabilities to conceal its illegal activities. (Id. 65 at P 88.)

C. Revelation of Justice Department Investiga-tion and Plea Agreement

[*13] On July 19, 2004, Infineon acknowledged that it had accrued charges of $ 190,000,000 in connec-tion with a Justice Department investigation into its anti-competitive activities. (Id. P 106, p. 77 at 197.) These charges "resulted in a net loss in the third quarter of [euro] 56 million, compared to net income of [euro] 39 million in the previous quarter, and to a net loss of [euro] 116 million a year ago." (Id.)

On September 15, 2004, the Associated Press pub-lished an article detailing that Infineon had agreed to plead guilty in the District Court for the Northern District of California to price fixing. (Id. P 107, p. 77 at P 98.)

According to the terms of the agreement, Infineon would admit to conspiring with other companies to fix prices of its computer memory products from July 1999 to June 2002 and would pay a fine of $ 160,000,000. (Id.) As a result of active concealment by Infineon, the fact of In-fineon's price fixing was not publicly known until Sep-tember 15, 2004. (Id. P 118.) D. Stock Price

On the day Libon purchased Infineon stock, March 16, 2000, the closing price was $ 70.63. (Def.'s Mem. Supp. Mot. Dismiss, Webb Decl. Att. A.) 4 [*14] In-fineon stock reached its highest closing mark of $ 87.31 on June 27, 2000. (Id.) The stock price declined, and from late-September 2000 to June 2001, it traded in the $ 40s and $ 30s. (Id.) In June 2001, the stock further de-clined into the $ 20s and on September 26, 2001, closed at $ 11.07. (Id.) The stock slowly edged up and began consistently trading in the $ 20s in December 2001. (Id.) In April 2002, however, the stock price dipped into the $ 10s and began trading consistently at less than $ 10 from September 2002 to June 2003 when the price rebounded into the $ 10s. (Id.)

4 Because the daily closing price of Infineon's stock is capable of accurate and ready determina-tion from a reliable source, it is an appropriate subject for judicial notice under Rule 201(b) of the Federal Rules of Evidence. See In re Syncor Int'l Corp. Secs. Litig., 327 F. Supp. 2d 1149, 1156-57 (C.D. Cal. 2004).

On July 16, 2004, the last trading day before In-fineon announced the accrued costs [*15] of the Justice Department's antitrust investigation, its stock price closed at $ 11.80. (Id.) On July 19, 2004, the stock closed at $ 11.62, and closed at $ 12.00 on the following day. (Id.) On September 13, 2004, the day before the Associated Press announced the plea agreement, In-fineon's stock closed at $ 10.30. (Id.) When the plea agreement was announced, Infineon stock closed at $ 10.28, and the following day closed at $ 10.07. (Id.) In-fineon stock continued to trade at $ 10 until November 4, 2004, when it closed up at $ 11.06. (Id.) III. Analysis A. Securities Act Claims

Section 10(b) of the Securities Act prohibits "the use or employ[ment], in connection with the purchase or sale of any security . . . [of] any manipulative or deceptive device or contrivance . . . ." 15 U.S.C. § 78j(b). Rule 10b-5 prohibits making "any untrue statement of a material fact or [omitting] to state a material fact necessary in order to make the statements made, in the light of the


2006 U.S. Dist. LEXIS 76430, *

circumstances under which they were made, not mislead-ing . . . in connection with the purchase or sale of any security." 17 C.F.R. § 240.10b-5. [*16] To set forth a violation of § 10(b) and Rule 10b-5, a plaintiff must demonstrate, "'(1) the defendant made a false statement or omission of material fact (2) with scienter (3) upon which the plaintiff justifiably relied (4) that proximately caused the plaintiff's damages.'" Ottmann v. Hanger Or-thopedic Group, Inc., 353 F.3d 338, 342 (4th Cir. 2003) (internal quotation marks omitted) (quoting Phillips v. LCI Int'l, Inc., 190 F.3d 609, 613 (4th Cir. 1999)).

Pursuant to Rule 9(b) of the Federal Rules of Civil Procedure, allegations of securities fraud must be pled with particularity. Southland Sec. Corp. v. Inspire Ins. Solutions, Inc., 365 F.3d 353, 362 (5th Cir. 2004). To be sufficient, the allegations need only provide "'a short and plain statement of the claim showing that the pleader is entitled to relief.'" Dura Pharm., Inc. v. Broudo, 544 U.S. 336, 125 S. Ct. 1627, 1634, 161 L. Ed. 2d 577 (2005) (quoting Fed. R. Civ. P. 8(a)(2)). These standards are supplemented by certain provisions of the Private Securi-ties Litigation Reform Act of 1995, Pub. L. No. 104-67, 109 Stat. 737 ("PSLRA"), in which Congress codified [*17] the pleading requirements for securities fraud ac-tions. See Kushner v. Beverly Enters., Inc., 317 F.3d 820, 826 (8th Cir. 2003); Glaser v. Enzo Biochem, Inc., 303 F. Supp. 2d 724, 732 (E.D. Va. 2003). As pertains to this case, the PSLRA details the standards for pleading mate-rial misrepresentation, state of mind, and loss causation. See 15 U.S.C. § 78u-4(b)(1), (2), (4).

1. "In Connection with Purchase of Security"

To be actionable under the Securities Act, a state-ment must be made in connection with the purchase or sale of a security. Dura, 125 S. Ct. at 1631; Schatz v. Rosenberg, 943 F.2d 485, 489 (4th Cir. 1991). Other than the statements contained in the Prospectus, no statement contained in the Amended Complaint ante-dated Libon's purchase of Infineon stock. (See Am. Compl. 36-78 at PP 70-98.) Accordingly, the post-purchase, non-Prospectus statements could not have im-pacted Libon's decision to purchase stock and cannot provide a basis for liability under the Securities Act. See Roots P'ship v. Lands' End, Inc., 965 F.2d 1411, 1420 (7th Cir. 1992); [*18] In re First Chicago Corp. Sec. Litig., 789 F. Supp. 919, 924 (N.D. Ill. 1992); Konstanti-nakos v. FDIC, 719 F. Supp. 35, 37-38 (D. Mass. 1989); In re Epic Mortgage Ins. Litig., 701 F. Supp. 1192, 1250 (E.D. Va. 1988). Thus, Libon's claims must rise or fall on statements issued prior to his purchase of stock. 2. Material Misrepresentation

Under the PSLRA, the plaintiff "shall specify each statement alleged to have been misleading, the reason or

reasons why the statement is misleading, and, if an alle-gation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed." 15 U.S.C. § 78u-4(b)(1). "To allege a false statement or omission of material fact, a plaintiff 'must point to a fac-tual statement or omission -- that is, one that is demon-strable as being true or false.'" Ottmann, 353 F.3d at 342-43 (quoting Longman v. Food Lion, Inc., 197 F.3d 675, 682 (4th Cir. 1999)). The plaintiff must also allege that a statement is false or that an omission renders the statement [*19] misleading. Id. at 343. A satisfactory complaint will state with particularity the time, place, speaker and contents of the false statement. Glaser, 303 F. Supp. 2d at 734. Furthermore, the misrepresentation or omission must be material such that "'a reasonable purchaser or seller of a security (1) would consider the fact important in deciding whether to buy or sell the se-curity or (2) would have viewed the total mix of informa-tion made available to be significantly altered by disclo-sure of the fact.'" Ottmann, 353 F.3d at 343 (quoting Longman, 197 F.3d at 683).

In essence, Libon claims that Infineon's statements as to competition and its revenues or sales mislead be-cause they failed to disclose its anti-competitive acts that reduced competition and artificially inflated the stock price. Libon contends that the statements in or omissions from the Prospectus were made on behalf of Infineon and, thus, are attributable to Infineon. See Southland, 365 F.3d at 365. No unqualified affirmative duty for a corpo-ration to disclose its misconduct exists. See Lewis v. Chrysler Corp., 949 F.2d 644, 652 (3d Cir. 1991); [*20] Roeder v. Alpha Indus., Inc., 814 F.2d 22, 27 (1st Cir. 1987). An omission of a material fact is not actionable unless the corporation owes a duty of disclosure. Murphy v. Sofamor Danek Group (In re Sofamor Danek Group), 123 F.3d 394, 400 (6th Cir. 1997); Connelly v. Gen. Med. Corp., 880 F. Supp. 1100, 1115 (E.D. Va. 1995). "Silence, absent a duty to disclose, is not misleading un-der Rule 10b-5." Basic, Inc. v. Levinson, 485 U.S. 224, 239 n.17, 108 S. Ct. 978, 99 L. Ed. 2d 194 (1988). How-ever, "when a corporation does make a disclosure--whether it be voluntary or required--there is a duty to make it complete and accurate." Roeder, 814 F.2d at 26. Where an omission affirmatively misleads and creates a false impression, a duty of disclosure arises. ZVI Trading Corp. Employees' Money Purchase Pension Plan & Trust v. Ross (In re Time Warner, Inc. Sec. Litig.), 9 F.3d 259, 267-68 (2d Cir. 1993); In re Syncor, 327 F. Supp. 2d at 1170 (citing Brody v. Transitional Hosps. Corp., 280 F.3d 997, 1006 (9th Cir. 2002)). This duty of disclo-sure extends to illegal conduct [*21] when required by statute or regulation, when insider trading exists, or when disclosure would prevent another statement from mis-leading the public. Menkes v. Stolt-Nielsen S.A., 2005


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U.S. Dist. LEXIS 28208, No. 3:03CV409, 2005 WL 3050970, at *6 (D. Conn. Nov. 10, 2005); In re Sotheby's Holdings, Inc. Sec. Litig., 2000 U.S. Dist. LEXIS 12504, No. 00 Civ. 1041, 2000 WL 1234601, at *4 (S.D.N.Y. Aug. 31, 2000).

a. Statements as to Competition

While touting the competitiveness of its products or its increased market share in the Prospectus Statements (1), (2), (3), (7), and (8), Infineon simultaneously was actively engaged in manipulating the competition through illegal price fixing. By representing that its products were competitive, Infineon incurred a duty to disclose its illegal anti-competitive activities. See Decker v. Kraftsow (In re Craftmatic Sec. Litig.), 890 F.2d 628, 640 (3d Cir. 1989); Menkes, 2005 WL 3050970, at *7 (requiring connection between the illegal activity and the statement for duty of disclosure to arise). After touting its competitiveness, the omission of Infineon's illegal price-fixing and anti-competitive behavior from its pub-lic statements created a false [*22] impression. It is be-yond question that a reasonable prospective investor would find information of illegal activity material to her or his decision whether to purchase a security. Galati v. Commerce Bancorp, Inc., Civil No. 04-3252, 2005 U.S. Dist. LEXIS 26851, at *17 (D.N.J. Nov. 7, 2005). Thus, Libon satisfactorily has pled that Statements (1), (2), (3), (7), and (8) constituted material misrepresentations.

b. Statements as to Revenues and Sales

Libon asserts that Statements (1), (2), (3), (5), (9), and (11) of the Prospectus, which in whole or in part addressed sales and revenue figures, misled because they did not disclose that Infineon's illegal price fixing artifi-cially inflated those figures. Libon does not allege that the figures were incorrect, and he does not explain how the price fixing inflated revenues and sales. To be ac-tionable, allegedly misleading statements may not be too remote from the illegal anti-competitive conduct. Men-kes, 2005 WL 3050970, at *8. The plaintiff must show that the earnings statements were not accurate. See Ga-lati, 2005 U.S. Dist LEXIS 26851, at *22. Under the stringent pleading requirements [*23] of the PSLRA, the Court cannot assume a correlation between a corpora-tion's illegal conduct and revenues, especially when the Plaintiff has provided no particular facts to support his conclusions. See In re Gilead Scis. Sec. Litig., 2005 U.S. Dist. LEXIS 3170, No. C03-4999, 2005 WL 181885, at *9 (N.D. Cal. Jan. 26, 2005). But see In re Van Der Moolen Holding N.V. Sec. Litig., 405 F. Supp. 2d 388, 401 (S.D.N.Y. 2005). Accordingly, Statements (5), (9), and (11), and the portions of (1), (2), and (3) concerning sales and revenues do not evince material misrepresenta-tions.

c. Statements as to Compliance with GAAP

Libon contends that Statement (10) of the Prospec-tus, in which Infineon asserted compliance with GAAP, misled because it failed to disclose the effects of In-fineon's anti-competitive behavior on its accounting statements. Libon does not state with particularity any facts in support of his contention, but merely lists various accounting principles that Infineon's statements allegedly violated. Reiterating financial statements of a company without explaining with particularity why a certain GAAP principle applies or how those statements violate GAAP is insufficient. [*24] See In re PEC Solutions, Inc. Secs. Litig., 2004 U.S. Dist. LEXIS 29873, No. 03-CV-331, 2004 WL 1854202, at *12 (E.D. Va. May 25, 2004), aff'd, 418 F.3d 379, 125 Fed. Appx. 490 (4th Cir. 2005); Smith v. Circuit City Stores, Inc., 286 F. Supp. 2d 707, 719 (E.D. Va. 2003); cf. In re Miller Indus., Inc. Sec. Litig., 12 F. Supp. 2d 1323, 1328-29 (N.D. Ga. 1998) (finding sufficient allegations that identified par-ticular transactions and false statements and the account-ing principles they violated). Moreover, the Court would have to infer or speculate as to the connection between Infineon's illegal price fixing and its accounting proce-dures. Thus, Libon has not demonstrated that Statement (10) from the Prospectus concerning compliance with GAAP was false or misleading.

d. Puffery

The last two statements at issue concern Infineon's expressed desire to attract and retain qualified employees and foster employee ownership, as related in Statement (4) of the Prospectus and Schumacher's promise to honor investors' trust. These statements express vague inten-tions, but are not factual and amount to little more than puffery. See In re Cable & Wireless, PLC, Sec. Litig., 321 F. Supp. 2d 749, 766-67 (E.D. Va. 2004). [*25] Nei-ther would have been considered material by a reason-able investor. See Longman, 197 F.3d at 685. Accord-ingly, these statements are not actionable.

e. Statement as to Risk

Libon asserts that the risk warning in Statement (6) of the Prospectus misled because it did not advise of a risk of illegal price fixing. His argument that cautionary language in itself may create liability follows the holding of the District Court in the Southern District of New York, In re Van Der Moolen, 405 F. Supp. 2d at 400. Adopting the contrary position as stated by the District Court for the Northern District of California, Infineon argues that "warnings regarding potential adverse factors are not actionable as a matter of law." Zeid v. Kimberley, 930 F. Supp. 431, 437 (N.D. Cal. 1996). No court in the Fourth Circuit has addressed these diverging holdings. In this jurisdiction, however, cautionary statements have significance in that they "may negate the materiality of an alleged misrepresentation or omission." Gasner v. Bd


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of Supervisors, 103 F.3d 351, 358 (4th Cir. 1996). This case does not warrant an extension of this so-called [*26] "bespeaks caution" doctrine. Omitting a risk warning as to illegal activity has no significance apart from the fac-tual misstatements of Infineon's competitiveness. The warnings are alone not material, and any liability as-signed to a risk warning would be merely cumulative of the liability for the underlying factual misstatements. Thus, this Court finds that cautionary language in the Prospectus does not in itself create liability.

On the other hand, the declaration of risk factors contained in the Prospectus (Def.'s Mem. Supp. Mot. Dismiss Ex. C at 8-15) does not diminish the misleading nature of Infineon's statements concerning illegal activi-ties. "[A] vague or blanket (boilerplate) disclaimer which merely warns the reader that the investment has risks will ordinarily be inadequate to prevent misinformation. To suffice, the cautionary statements must be substantive and tailored to the specific future projections, estimates or opinions . . . challenge[d]." In re Westinghouse Sec. Litig., 90 F.3d 696, 707 (3d Cir. 1996). The risk disclo-sures in the Prospectus do not warn of illegal conduct. Furthermore, such a warning would not have absolved Infineon given that [*27] it was engaged in price fixing at the time the Prospectus was issued. See Rubinstein v. Collins, 20 F.3d 160, 171 (5th Cir. 1994) ("To warn that the untoward may occur when the event is contingent is prudent; to caution that it is only possible for the unfa-vorable events to happen when they have already oc-curred is deceit.") (citations omitted). Accordingly, the risk warnings contained in the Prospectus do not negate the materiality of Infineon's misstatements and omissions as to illegal price fixing. 3. Scienter

"'[S]cienter' refers to a mental state embracing intent to deceive, manipulate, or defraud." Ernst & Ernst v. Hochfelder, 425 U.S. 185, 194 n.12, 96 S. Ct. 1375, 47 L. Ed. 2d 668 (1976). In addition to a showing of inten-tional misconduct, a plaintiff may plead scienter by dem-onstrating recklessness. Ottmann, 353 F.3d at 343-44. The Fourth Circuit defines "recklessness" as "an act so highly unreasonable and such an extreme departure from the standard of ordinary care as to present a danger of misleading the plaintiff to the extent that the danger was either known to the defendant or so obvious that the de-fendant must have been aware [*28] of it." Phillips, 190 F.3d at 621 (citations and internal quotation marks omit-ted). To satisfy the scienter requirement of the PSLRA, the plaintiff must, "with respect to each act or omission alleged to violate [the Securities Act], state with particu-larity facts giving rise to a strong inference that the de-fendant acted with the required state of mind." 15 U.S.C. § 78u-4(b)(2). While heightening the standard for plead-

ing scienter, this provision did not alter the standard of proof or type of evidence required to demonstrate sci-enter. Phillips, 190 F.3d at 620. When inquiring into scienter, courts should not focus "on specific categories of facts, such as those relating to motive and opportunity, but instead should examine all of the allegations in each case to determine whether they collectively establish a strong inference of scienter." Ottmann, 353 F.3d at 345.

A strong inference of scienter may arise from allega-tions that the defendant "(1) benefitted in a concrete and personal way from the purported fraud, (2) engaged in deliberately illegal behavior, (3) knew facts or had access to information suggesting [*29] that [its] public state-ments were not accurate, or (4) failed to check informa-tion [it] had a duty to monitor." Kushner, 317 F.3d at 827. Libon alleges, in Statements (1), (2), (3), (7), and (8), that Infineon fixed prices to suppress competition and inflate artificially its stock price. Infineon admitted in a plea agreement that it had engaged in illegal price fixing from July 1999 to June 2002. While carrying out its scheme, Infineon courted investors, including Libon, through statements in the Prospectus that touted the competitiveness of its products and omitted reference to its illegal suppression of competition. As a public state-ment issued on behalf of the corporation, the Prospectus is attributable to Infineon. See Southland, 365 F.3d at 365. 5 It does not automatically follow that by issuing the statements in the Prospectus Infineon possessed the req-uisite scienter. See id. at 366-67. However, a subsequent admission of illegality, such as the plea agreement, sup-ports an inference that Infineon knew of the illegal con-duct, which was ongoing, when it issued the Prospectus. See In re Syncor, 327 F. Supp. 2d at 1161-63. [*30] 6 The allegations of illegality raise a strong inference of at least a reckless misrepresentation. See In re Miller, 12 F. Supp. 2d at 1332. Thus, Libon has satisfied the pleading requirement for scienter as to Statements (1), (2), (3), (7), and (8).

5 Imputing knowledge to the corporation as to its public statements does not also impute knowl-edge to any corporate officer absent a showing that the officer made the statement or knew that it was false and misleading. See Southland, 365 F.3d at 365; City of Philadelphia v. Fleming Cos., 264 F.3d 1245, 1264 (10th Cir. 2001). The scienter requirement of the PSLRA repudiated the sort of group pleading that would attribute knowledge to a corporate officer based on her or his position in the corporation. Southland, 365 F.3d at 364-65; In re Cable & Wireless, 321 F. Supp. 2d at 772-73.

6 The result reached by the Eighth Circuit, and urged by Infineon, in Kushner, 317 F.3d 820, is


2006 U.S. Dist. LEXIS 76430, *

distinguishable. In Kushner, the court determined that the guilty plea of a "handful of employees" at a subsidiary did not indicate a company-wide scheme or demonstrate that the defendant parent corporation possessed the requisite scienter. Id. at 829. Here, Infineon, the corporation itself, pled guilty to price-fixing, thereby establishing a strong inference that the corporate defendant had knowledge of the illegal activity.

[*31] 4. Loss Causation

The plaintiff bears the burden of proving that the de-fendant's misrepresentations "caused the loss for which the plaintiff seeks to recover damages." 15 U.S.C. § 78u-4(b)(4). 7 This provision requires a causal connection between the misstatement and the loss suffered. 8 Dura, 125 S. Ct. at 1631. A plaintiff need not demonstrate that the misstatement was the sole cause of the loss, but she or he must "prove that defendant's misrepresentation was a substantial cause of the loss by showing '[a] direct or proximate relationship between the loss and the misrep-resentation.'" Miller v. Asensio & Co., 364 F.3d 223, 232 (4th Cir. 2004) (quoting Gasner, 103 F.3d at 360). Merely asserting that stock was purchased at an inflated price is usually insufficient to establish loss causation. Dura, 125 S. Ct. at 1631. A corporation becomes liable to a stock purchaser for misstatements made in connec-tion with a stock purchase when those misstatements are aired and as a result the stock value depreciates. Id. at 1633; In re Acterna, 378 F. Supp. 2d at 585. [*32]

7 The loss requirement consists of two compo-nents: transactional causation or reliance and loss causation. In re Acterna Corp. Sec. Litig., 378 F. Supp. 2d 561, 584 (D. Md. 2005).

8 Under the fraud on the market theory, "the price of a company's stock is determined by the available material information regarding the company and its business . . . . Misleading state-ments will therefore defraud purchasers of stock even if the purchasers do not directly rely on the misstatements . . . ." Basic, 485 U.S. at 241-42. Seeming to reference this theory, Libon asserts that he relied on "the integrity of the market" (Am. Compl. 82 at P 109) and alluded to "allega-tions [in the Amended Complaint] related to the misrepresentation of the market" (Pl.'s Brief Opp. Mot. to Dismiss 8). In spite of these vague state-ments, Libon consistently asserted that he actu-ally relied upon statements made in the Prospec-tus and to him by Infineon's president in choosing whether to purchase Infineon stock, thereby indi-cating that he was asserting actual reliance and not a fraud on the market theory. The outcome,

whether through fraud on the market or actual re-liance, is unchanged. The Defendant has not taken issue with Libon's allegations of reliance.

[*33] Libon has not adequately pled loss causation. While asserting that Infineon's anti-competitive scheme inflated the stock price from July 1999 to June 2002, Libon simultaneously pleads facts that ascribe a different cause. The Amended Complaint demonstrates that a gen-eral downturn in the market from 2001 to 2002 caused Infineon's stock price to plummet. (See Am. Compl. 46, 52, 53 at P 85, 58 at P 86.) The stock price fell from a high of $ 87.31 in June 2000 to around $ 15 by June 2002. (Def.'s Mem., Webb Decl. Att. A.) No allegation links or even suggests that Infineon's illegal price fixing, as opposed to market forces, caused the drop in stock price.

Moreover, as the Supreme Court instructed in Dura, the relevant inquiry focuses on the effect disclosure of illegal activity had on the stock price. The disclosure on July 19, 2004 (of charges accrued in connection with the antitrust investigation) and the disclosure on September 15, 2004 (of the plea agreement) had a negligible effect: Infineon's stock price decreased approximately 20 cents or less than 2% of the stock's value. Indeed, the stock price rose only days after the plea agreement was made public. That the stock [*34] price remained essentially unchanged after the illegal price fixing was revealed ne-gates any inference that the prior non-disclosure caused the loss. Furthermore, Libon has not alleged facts that could raise even a reasonable inference that the public had knowledge of any misstatements prior to the 2004 disclosures or that such knowledge caused the decline in stock price. To the contrary, he asserts that the "truth" as to Infineon's conspiracy to fix prices was not publicly known until September 15, 2004. (Am. Compl. P 118.) Thus, under the facts alleged, Libon has not established loss causation, and the claims may not proceed. B. Control Liability

Section 20(a) of the Securities Act imposes liability upon a person who controls another who commits securi-ties fraud. 15 U.S.C. § 78t. To establish a claim under the control provision, a plaintiff must set forth a viable claim of securities fraud. See Ottmann, 353 F.3d at 342 n.2; In re Epic Mortgage, 701 F. Supp. at 1251. Because Libon has not established an underlying violation of the Securi-ties Act, the 20(a) claim fails. 9

9 The PSLRA requires a court, upon dismissal of a securities fraud action, to make findings as to the plaintiff's compliance with Rule 11(b) of the Federal Rules of Civil Procedure. 15 U.S.C. § 78u-4(c). As noted in a prior Report and Recom-mendation (Docket No. 51), the claims alleged in


2006 U.S. Dist. LEXIS 76430, *

the Complaint and Amended Complaint do not rise to a level warranting sanctions. Accordingly, the Court RECOMMENDS that no sanctions be awarded.

[*35] C. Securities Claims under Virginia Law

The District Court did not grant Libon leave to amend Claim 226, which he brought under the Virginia Securities Act. (See Docket No. 64.) Accordingly, this claim is not properly before the Court. Even were the claim properly presented, the Court would find it barred by the applicable two year statute of limitations, Va. Code Ann. § 13.1-522(D), as asserted by the Defendant. This statute does not provide for a discovery rule, but states "unqualifiedly that a claim must be brought within two years 'after the transaction upon which it is based.'" Caviness v. Derand Res. Corp., 983 F.2d 1295, 1306 (4th Cir. 1993) (quoting Va. Code Ann. § 13.1-522(D)); accord Cors v. Langham, 683 F. Supp. 1056, 1058-59 (E.D. Va. 1988). Thus, the claim for violation of the Vir-ginia Securities Act, filed more than two years after its accrual, is barred by the applicable statute of limitations. D. Motion to Amend

At the end of his Brief in Opposition, Libon requests leave to amend should the Court find his pleading defi-cient. He did not assert any grounds or facts in support of his request and at oral [*36] argument was unable to articulate additional facts in support of his claims. Addi-tionally, and without leave of court, Libon submitted supplemental authority concerning another securities fraud action against Infineon brought in the Northern District of California. The Defendant opposes leave to amend.

The District Court already has permitted Libon one amendment to the complaint. Courts have, under the lib-eral standard in such claims, see Laber v. Harvey, 438 F.3d 404, 426 (4th Cir. 2006), granted a party more than one opportunity to amend a complaint. See, e.g., In re Gilead Scs., 2005 WL 181885, at *11; In re Foundry Networks Secs. Litig., 2003 U.S. Dist. LEXIS 18244, No. C 00-4823, 2003 WL 23211577, at *11 (N.D. Cal. Feb. 14, 2003); Connelly, 880 F. Supp. at 1109-10. Here, however, Libon has twice placed before the Court size-able complaints attempting to establish securities fraud. Libon has addressed pleading issues in his brief in oppo-

sition, at oral argument, and in a supplemental filing. No effort has properly set forth allegations stating a claim for securities fraud. In such circumstances, a district court may properly deny leave to amend. [*37] See Southland, 365 F.3d at 385; Iron Workers Local 16 Pen-sion Fund v. Hilb Rogal & Hobbs Co., 432 F. Supp. 2d 571, 595 (E.D. Va. 2006); Smith, 286 F. Supp. 2d at 722-23; see also In re PEC Solutions, 418 F.3d at 391, 125 Fed. Appx. 490 (upholding district court's denial of leave to amend where plaintiffs had a prior opportunity to amend and further amendment would have been futile). Accordingly, the Court RECOMMENDS that Libon's request for leave to amend be denied. IV. Conclusion

Based on the foregoing reasons, the Court hereby RECOMMENDS that the Defendant's Motion to Dismiss (Docket No. 69) be GRANTED and that the Plaintiff's Claims 1 and 2, and to the extent that Claim 226 is be-fore the Court, against Infineon be DISMISSED.

It is further RECOMMENDED that the Plaintiff's request to file a second amended complaint be DENIED.

The Parties are ADVISED that they may file spe-cific written objections to the Report and Recommenda-tion within ten (10) days of the date of entry hereof. Each objection should be labeled with the corresponding head-ing from the Report and Recommendation, should be numbered, and should identify with [*38] specificity the legal or factual deficiencies of the Magistrate Judge's findings. Failure to file specific objections in a timely manner to the Report and Recommendation may result in the entry of an Order dismissing the Complaint. See Fed. R. Civ. P. 72(b). It may also preclude further review or appeal from such judgment. See Wright v. Collins, 766 F.2d 841 (4th Cir. 1985).

The Clerk is directed to send a copy of the Report and Recommendation to counsel of record and to the Honorable Henry E. Hudson. M. Hannah Lauck

United States Magistrate Judge

Richmond, Virginia

Date: AUG - 7 2006


EXHIBIT 9



JOEL MENKES, Individually and on behalf of all others similarly situated,Plaintiffs, v. STOLT-NIELSEN S.A., JACOB STOLT-NIELSEN, NIELS G.STOLT-NIELSEN, SAMUEL COOPERMAN, and REGINALD JR. LEE,

Defendants.

No. 3:03CV409(DJS)

UNITED STATES DISTRICT COURT FOR THE DISTRICT OF CONNECTICUT


June 19, 2006, Decided

PRIOR HISTORY: Menkes v. Stolt-Nielsen S.A., 2005U.S. Dist. LEXIS 28208 (D. Conn., Nov. 10, 2005)

COUNSEL: [*1] For Joel Menkes, Ind & o/b/o allothers similarly situated, Plaintiff: David Randell Scott,Scott & Scott, Colchester, CT; Erin Green Comite, Scott& Scott, Colshester, CT.

For Irene Rucker, Ind & o/b/o All Others SimilarlySituated, Gustav Rucker, Ind & o/b/o All OthersSimilarly Situated, Plaintiffs: Mark S. Reich, LerachCoughlin Stoia Geller Rudman & Robbins LLP-NY,Melville, NY; Samuel H. Rudman, Lerach CoughlinStoia Geller Rudman & Robbins LLP-NY, Melville, NY;Erin Green Comite, Scott & Scott, Colshester, CT.

For Stolt-Nielsen SA, Samuel Cooperman, Reginald JRLee, Defendants: Christopher M. Curran, White & Case -13th DC, Washington, DC; Donna Nelson Heller, FinnDixon & Herling, Stamford, CT; J. Mark Gidley, White& Case - 13th DC, Washington, DC; Jason S. Weathers,Day, Berry & Howard, Hartford, CT; Michael P. Shea,Day, Berry & Howard-HTFD-CT, Hartford, CT; PatrickJ. McHugh, Finn Dixon & Herling, Stamford, CT; PeterJ. Carney, White & Case - 13th DC, Washington, DC;Jaime M. Crowe, White & Case - 13th DC, Washington,DC.

For Jacob Stolt-Nielsen, Niels G. Stolt-Nielsen,Defendants: Jason S. Weathers, Day, Berry & Howard,Hartford, CT; Michael P. Shea, Day, [*2] Berry &Howard-HTFD-CT, Hartford, CT; Peter J. Carney, White& Case - 13th DC, Washington, DC; Jaime M. Crowe,White & Case - 13th DC, Washington, DC.

JUDGES: DOMINIC J. SQUATRITO, UNITEDSTATES DISTRICT JUDGE.

OPINION BY: DOMINIC J. SQUATRITO

OPINION

MEMORANDUM OF DECISION

Lead plaintiffs, Irene Rucker and Gustav Rucker,bring this action on behalf of a putative class ofpurchasers of defendant Stolt-Nielsen S.A.'s ("SNSA")American Depository Receipts ("ADRs") for the periodof May 31, 2000 through February 20, 2003 pursuant toSections 10(b), 15 U.S.C. § 78j(b), and 20(a), 15 U.S.C. §78t, of the Securities Exchange Act of 1934 ("theExchange Act"), as amended by the Private SecuritiesLitigation Reform Act of 1995 ("PSLRA"), 15 U.S.C. §§78a-78mm, and Rule 10b-5, 17 C.F.R. § 240.10b-5,promulgated thereunder, against Stolt-Nielsen S.A.,Stolt-Nielsen Transportation Group, Jacob Stolt-Nielsen,Niels G. Stolt-Nielsen, Samuel Cooperman, and ReginaldJ.R. Lee. Defendants have filed a motion to dismiss (dkt.# 57) all counts of the Second Consolidated AmendedClass Action [*3] Complaint. For the reasons set forthherein, defendants' motion (dkt. # 57) is DENIED.

I. BACKGROUND

Now pending before the court is a second motion todismiss plaintiffs' complaint. On November 10, 2005, thiscourt granted defendants' motion to dismiss plaintiffs'previous complaint, and dismissed this case with

Page 1


prejudice. Upon reconsideration, this court amended itsjudgment to a dismissal without prejudice to filing anamended complaint on or before March 1, 2006.Plaintiffs did file a Second Consolidated Amended ClassAction Complaint (hereinafter "complaint" or cited as"Dkt. # 55, P ") on March 1, 2006. Defendants filed amotion to dismiss the complaint on March 20, 2006, andthe motion has been fully briefed since April 25, 2006.

The following is an abridged version of facts allegedin the complaint, set forth in documents incorporated byreference into the complaint, or found in SNSA's publicdisclosure documents, or in other materials properlyconsidered because plaintiffs have relied upon them incrafting their allegations. See Rothman v. Gregor, 220F.3d 81, 88-89 (2d Cir. 2000); Levin v. Hunter Envtl.Servs. (In re Hunter Envtl. Servs.), 921 F. Supp. 914,917-18 (D. Conn. 1996). [*4]

Stolt-Nielsen S.A. ("SNSA") is a holding companythat, through its subsidiaries, engages in, among otherthings, worldwide transportation, storage, anddistribution of bulk liquid chemicals and other similarmaterials. Greenwich, Connecticut based Stolt-NielsenTransportation Group, Inc. ("SNTG") is a subsidiarywholly owned by SNSA that engages in liquid chemicaltransportation on worldwide seaborne trade routes. JacobStolt-Nielsen is the founder and current Chairman ofSNSA, and Niels G. Stolt-Nielsen is the Chief ExecutiveOfficer of SNSA. Samuel Cooperman has been theChairman of SNTG and Reginald J.R. Lee has beenSNTG's Chief Executive Officer during the time periodrelevant to plaintiffs' claims.

At issue in this case is SNTG's transportation of bulkliquid chemicals. SNTG is one of the largest parcel tankeroperators in the world, and several of SNTG's largestcustomers are among the world's major chemicalcompanies. Plaintiffs allege that, for the period of May31, 2000 1 through February 20, 2003, SNTG engaged ina scheme to fix shipping rates, rig bids, and allocatecustomers. According to plaintiffs, certain SNTGemployees made agreements with major competitors tocoordinate [*5] bidding and divide customer contractsbetween themselves. SNTG employees allegedly metwith competitors for this purpose on several differentoccasions, exchanged customer lists, and eitherpurposefully did not bid on contracts to allow itscompetitors to gain the business or submitted artificiallyhigh bids to drive the contract price upward for the

benefit of other parties to this anti-competitivearrangement.

1 Plaintiffs also allege that SNTG may havebegun its anti-competitive conduct as early as1998.

Plaintiffs claim that a number of statements made bydefendants during the class period were false ormisleading because of these undisclosed illegal activities.Specifically, plaintiffs claim that the followingstatements, disseminated by SNSA or JacobStolt-Nielsen, were false or misleading in light of SNTG'sclandestine illegal conduct:

. income from operations for SNTG's tank containerdivision increased to $ 19.9 million for the full year of2000 from $ 17.8 million in 1999. While pricing [*6]remains competitive in most markets, shipments in2000 were up 11% from 1999 with similar growthanticipated in 2001," (dkt. # 55, P 57 (February 1,2001));

. for SNTG's tank container operations, income fromoperations fell to $ 2.7 million in the first quarter of 2001,down from $ 4.9 million in the first quarter of last year.While shipments were up 10% from the comparablequarter, pricing competition, weak utilization, andempty repositioning costs negatively impacted theresults. For the remainder of the year, we anticipateoverall growth in the business to continue to be about10% over last year and while we expect to continue tosee strong price competition, margins should improveand by the latter half of the year be similar to thecomparable quarters of last year," (id., P 59 (March 28,2001));

. shipments in the year 2000 increased from thedownturn encountered in 1999. Increases were primarilythe result of improved demand in three main operatingregions of Asia Pacific, Europe and the United States.Shipment levels in 2001 continue to reflect improveddemand particularly from the United States and Asia,"(id., P 61 (October 26, 2001));

[*7] . the market for the integrated transportationand logistics services provided by SNTG is in its infancy.In providing such services, SNTG competes primarilywith a few other terminal and transport companies whoare developing such services. . . . SNTG's tankeroperations compete with operators based primarily in



Europe and the Asia Pacific region. . . . The competitionin the tank container market is fragmented, although therelative size of the competition is increasing on aworldwide basis. SNTG also competes, to a lesser extent,with tank container leasing companies," (id., P 63(October 26, 2001 & May 31, 2002));

. excluding the restructuring charges, theStolt-Nielsen Transportation Group reported results onpar with the first quarter of last year. Income fromoperations for SNTG's parcel tanker division was $ 20.5million in the first quarter of 2002 compared to $ 20.3million in the first quarter of 2001. . . . Contracts ofaffreightment continue to be renewed at higher levelsand SNTG recently renewed a multi-year contract forone of its largest customers. We are anticipating apickup in rates in the second half of the year andthroughout 2003 as the world [*8] economies continuetheir recovery[.] . . . SNTG's tank container operationsincome improved to $ 4.7 million in the first quarter of2002 compared to $ 2.7 million in the first quarter of lastyear. While shipments in the first quarter were similar tothe comparable quarter last year, utilization rose to 71.1%compared to 67.7% last year. For the remainder of theyear we anticipate seeing continued pressure onpricing while utilization should be similar to what wesaw in the first quarter. We still see shipments for theyear growing 5% compared to 2001," (id., P 64 (March27, 2002));

. while the results in the second quarter for theStolt-Nielsen Transportation Group were down comparedto last year, our core contract business, particularly forspecialty chemicals, remains healthy. We continue to seeimprovements in Stolt Offshore's results. . . . SNTG'stank container division's income from operationsimproved significantly to $ 6.3 million in the secondquarter of 2002 compared to $ 4.0 million in the samequarter of 2001. Utilization in the second quartercompared to the same period last year rose 7.0% to74.4%. Shipments are up some 6% although pricingcontinues [*9] to be tight," (id., P 66 (June 26, 2002));

. the Stolt-Nielsen Transportation Group posted asolid quarter[.] . . . SNTG's tank container divisiondelivered another strong result with income fromoperations rising to $ 6.2 million from $ 5.6 million in thecomparable quarter of 2001. Year-to-date shipments areup some 10% compared to last year and utilization in thethird quarter hit a record level of 77.7% although the

business continues to see a tight pricing environment,"(id., P 68 (October 8, 2002)). 2

Plaintiffs claim that defendants' failure to discloseStolt's alleged anti-competitive conduct rendered thesestatements false or misleading.

2 All emphasis appears as it exists in thecomplaint.

II. DISCUSSION

Plaintiffs set forth two counts in their complaint: (1)violation of 15 U.S.C. § 78j(b) and 17 C.F.R. § 240.10b-5promulgated thereunder against all defendants; and (2)violation of 15 U.S.C. § 78t [*10] against the individualdefendants. Defendants seek dismissal of each countpursuant to Rule 12(b)(6) of the Federal Rules of CivilProcedure.

A. STANDARD

When considering a Rule 12(b)(6) motion to dismiss,the court accepts as true all factual allegations in thecomplaint and draws inferences from these allegations inthe light most favorable to the plaintiff. See Scheuer v.Rhodes, 416 U.S. 232, 236, 94 S. Ct. 1683, 40 L. Ed. 2d90 (1974); Bernheim v. Litt, 79 F.3d 318, 321 (2d Cir.1996). Dismissal is warranted only if, under any set offacts that the plaintiff can prove consistent with theallegations, it is clear that no relief can be granted. SeeHishon v. King & Spalding, 467 U.S. 69, 73, 104 S. Ct.2229, 81 L. Ed. 2d 59 (1984); Cooper v. Parsky, 140 F.3d433, 440 (2d Cir. 1998). "The issue on a motion todismiss is not whether the plaintiff will prevail, butwhether the plaintiff is entitled to offer evidence tosupport his or her claims." United States v. Yale NewHaven Hosp., 727 F. Supp. 784, 786 (D. Conn. 1990)(citing Scheuer, 416 U.S. at 232). In its review of [*11] amotion to dismiss, the court may consider "only the factsalleged in the pleadings, documents attached as exhibitsor incorporated by reference in the pleadings and mattersof which judicial notice may be taken." Samuels v. AirTransp. Local 504, 992 F.2d 12, 15 (2d Cir. 1993).

B. SECTION 10(b) CLAIM

Plaintiffs allege that defendants engaged infraudulent conduct that affected the purchase or sale ofSNSA's ADRs. Specifically, plaintiffs claim thatdefendants had a duty to disclose to the investing public



the nature and scope of their anti-competitive agreementswith other parcel tanker companies, and that defendantsacted with scienter.

Although the parties invite this court to do so, thiscourt will not revisit its prior holdings in the absence ofnew allegations addressed thereto. Specifically, the courtadheres to the following holdings: defendants' statementsregarding competition in the marketplace, including eachof the statements set forth in the previous section of thismemorandum, could be materially false or misleading;defendants had a duty to disclose information regardingtheir anti-competitive conduct as a result of their ownpublic statements [*12] set forth herein referencingcompetition in the marketplace; and plaintiffs'sallegations regarding the integration of SNTG's parceltanker and tank container operations are sufficient to linkthe anti-competitive conduct with defendants' statements.3 With respect to the new allegations, the court holds asfollows.

3 The court, however, elaborates upon itsconclusions herein. See infra, § II.B.3.

1. SCIENTER

In order to successfully plead scienter under thePSLRA, and prior Second Circuit precedent, a plaintiffmust "state facts with particularity that give rise to astrong inference of the required state of mind." Novak v.Kasaks, 216 F.3d 300, 312 (2d Cir. 2000); see 15 U.S.C.§ 78u-4(b)(2) ("In any private action arising under thischapter in which the plaintiff may recover moneydamages only on proof that the defendant acted with aparticular state of mind, the complaint shall, with respectto each act or omission alleged to violate this chapter,state [*13] with particularity facts giving rise to a stronginference that the defendant acted with the required stateof mind."). The Court of Appeals for the Second Circuithas "recognized two distinct ways in which a plaintiffmay plead scienter without direct knowledge of thedefendant's state of mind. The first approach is to allegefacts establishing a motive to commit fraud and anopportunity to do so. The second approach is to allegefacts constituting circumstantial evidence of eitherreckless or conscious behavior." In re Time Warner Inc.Sec. Litig., 9 F.3d 259, 268-69 (2d Cir. 1993). In order tosuccessfully meet this standard, plaintiffs must "allegefacts that give rise to a strong inference of fraudulentintent." Shields v. Citytrust Bancorp., Inc., 25 F.3d 1124,1128 (2d Cir. 1994). "The requisite 'strong inference' of

fraud may be established either (a) by alleging facts toshow that defendants had both motive and opportunity tocommit fraud, or (b) by alleging facts that constitutestrong circumstantial evidence of conscious misbehavioror recklessness." Id.

Plaintiffs attempt to meet their pleading burden byway of the latter method. "Securities [*14] fraud claimstypically have sufficed to state a claim based onrecklessness when they have specifically allegeddefendants' knowledge of facts or access to informationcontradicting their public statements. Under suchcircumstances, defendants knew or, more importantly,should have known that they were misrepresentingmaterial facts related to the corporation." Novak v.Kasaks, 216 F.3d 300, 308 (2d Cir. 2000). Mindful of theadmonition that "there are limits to the scope of liabilityfor failure to adequately monitor the allegedly fraudulentbehavior of others," id. at 309, plaintiffs attempt toestablish the sufficiency of their allegations againstSNSA as follows.

First, plaintiffs emphasize SNTG's relationship toSNSA. Plaintiffs allege that SNTG's operations werecritical to SNSA's financial health, such that SNTG'sbusiness "represented 39% of SNSA's net operatingrevenue, 94% of income from operations, and 50% ofSNSA's total assets" in 2001, and that SNTG"represented about 62% of SNSA's net operating revenueand 73% of SNSA's total assets" in 2004. (Dkt. # 55, P11.) Plaintiffs also contend that Cooperman, who servedas SNTG's chairman, [*15] and was in a position torelay this knowledge to SNSA, was warned of and musthave been aware of SNTG's anti-competitive conduct.Also, plaintiffs state that Niels Stolt-Nielsen, SNSA'sCEO, and Jacob Stolt-Nielsen, SNSA's founder andChairman of the Board, served on SNTG's Board ofDirectors during the class period, and therefore hadfirst-hand knowledge of SNTG's operations.

Second, plaintiffs allege that SNSA employees wereor should have been aware of SNTG's anti-competitiveconduct. Plaintiffs allege that, in 1998, SNTG's"vice-president for SNTG's tanker trading," AndrewPickering, stated, in a meeting between SNSA and SNTGemployees, that "Odfjell and Stolt had reached anagreement that certain customers belonged to Stolt andothers to Odfjell. They had 'carved up the world.'" (Dkt.# 55, P 31.) They further allege that Kenneth Bloom, aSNSA "vice-president for logistics," "expressed his



concerns [about Pickering's statement] to Cooperman,then SNTG's Chairman." (Id. P 34).

Plaintiffs allege that the primary perpetrator of thealleged anti-competitive conduct was Richard Wingfield,SNTG's Managing Director of its Tanker TradingDivision, and that SNSA was aware of [*16] Wingfield'sillegal activities. According to plaintiffs, during late 2000through 2001, Wingfield met with Odfjell, which was oneof SNTG's primary competitors in the parcel tankerbusiness, to agree on pricing and allocate contracts androutes. Plaintiffs also allege that Wingfield discussedagreement about shipping rates with Tokyo Marine.Plaintiffs contend that Wingfield shared informationabout his anti-competitive activity as follows: a May 24,2000 e-mail to "colleagues in Greenwich," regardingTokyo Marine's desire to "cooperate on rates," (dkt. # 55,P 37(a)); an April 10, 2001 fax to Wingfield setting forth"a cost-benefit analysis prepared by Stolt regarding theprofitability of conspiring with Odfjell versus 'going towar' with Odfjell," (id., P 37(c)); and a January 24, 2002announcement to "the SNTG management board," that"the Dow contracts were all but locked up" as a result ofSNTG's illegal conspiracy with Odfjell, (id., P 38).Plaintiffs allege that, according to the Department ofJustice, the April 10, 2001 fax was prepared in responseto a request from Jacob Stolt-Nielsen for "an analysis ofthe pros and cons of continued pricing collusion withOdfjell. [*17] " (Dkt. # 55, P 49.)

Plaintiffs allege that, after Wingfield's January 24,2002 announcement regarding the Dow contracts inwhich he referenced help from Odfjell, SNSA was put onnotice of the possibility that SNTG was violating theantitrust laws. Plaintiffs allege that "SNSA officialsdiscussed with SNSA's attorneys in London theCompanies' European shipping efforts," and that "thoseattorneys worried that the Companies were breakingEurope's antitrust laws." (Dkt. # 55, P 39.) Plaintiffsallege that Paul O'Brien, SNTG's general counsel, wasaware of Wingfield's activities, that O'Brien askedCooperman to suspend Wingfield and investigate hisanti-competitive activities in February of 2002, thatCooperman declined to do so, and that O'Brien resignedin protest on March 1, 2002. According to plaintiffs,O'Brien also voiced his concerns to "the highestauthorities in both SNTG and SNSA," (dkt. # 55, P 52),including "Alan Winsor, general counsel of SNSA." (id.,P 54).

Finally, plaintiffs allege that SNSA offered thefollowing statements in several public filings:

in 2002, we became aware ofinformation that caused us to undertake aninternal investigation regarding [*18]potential improper collusive behavior inour parcel tanker and intra-Europe inlandbarge operations. Consequently, wedecided to voluntarily report conduct tothe Antitrust Division of the U.S.Department of Justice (the "DOJ" or"Antitrust Division") and the CompetitionDirectorate of the European Commission("EC").

(Dkt. # 55, P 76.)

Based upon the foregoing, plaintiffs have met theapplicable standard for pleading scienter by provingsufficient detail to permit a strong inference thatdefendants engaged in conscious misbehavior. They havealleged that, in early 2002, O'Brien communicatedconcerns about anti-competitive conduct to SNSAmanagement and SNSA's general counsel, and that heresigned after raising his concerns. They also allege thatJacob Stolt-Nielsen commissioned a study regarding theadvantages of anti-competitive arrangements withOdfjell. These specific allegations, combined with thefacts that SNTG's operations were critical to SNSA'sfinancial well-being, that Jacob Stolt-Nielsen and NielsStoltNielsen were STNG board members, thatCooperman was aware of potentially anti-competitiveconduct within SNTG as far back as 1998, and thatWingfield's January 24, 2002 comments [*19] promptedquestions from both O'Brien and SNSA's London counselprovide the framework from which plaintiffs may provethat defendants made the statements set forth in thecomplaint with conscious disregard for the truth.

2. LIABILITY OF COOPERMAN AND LEE

Defendants argue that plaintiffs "have pleaded noindependent basis for holding Messrs. Cooperman andLee personally liable for any alleged violations of Section10(b) and Rule 10b-5." (Dkt. # 57 at 21.) Plaintiffscontend that both Cooperman and Lee, as well as SNTG,are primarily liable for violating Section 10(b) and Rule10b-5 because they were responsible for withholding theinformation omitted from SNSA's public statements even



though they did not directly communicate the false ormisleading statements to the public.

Cooperman and Lee were corporate officers ofSNTG, and were not part of SNSA's management, whichwas the source of the false or misleading statementsalleged in the complaint. There is no secondary liabilityfor violating Section 10(b), such as by aiding and abettingthe person primarily liable for violating Section 10(b).See Central Bank of Denver, N.A. v. First Interstate Bankof Denver, N.A., 511 U.S. 164, 191, 114 S. Ct. 1439, 128L. Ed. 2d 119 (1994); [*20] Shapiro v. Cantor, 123 F.3d717, 720 (2d Cir. 1997) ("A claim under § 10(b) mustallege a defendant has made a material misstatement oromission indicating an intent to deceive or defraud inconnection with the purchase or sale of a security."). TheCourt of Appeals for the Second Circuit has further heldthat "a secondary actor cannot incur primary liabilityunder the Act for a statement not attributed to that actorat the time of its dissemination. . . . Thus, themisrepresentation must be attributed to that specific actorat the time of public dissemination, that is, in advance ofthe investment decision." Wright v. Ernst & Young LLP,152 F.3d 169, 175 (2d Cir. 1998).

Despite the apparent bright-line rule regardingprimary liability, however, there have been circumstanceswhere courts bound to follow the foregoing decisionshave permitted claims against persons who did notactually utter the false or misleading statements butnevertheless may be deemed to have caused thestatements to be uttered. In In re Scholastic Corp.Securities Litigation, 252 F.3d 63 (2d Cir. 2001), theCourt of Appeals for the Second Circuit rejected a [*21]defendant's argument that the statements alleged in thecomplaint attributed to the corporate defendant "have notbeen properly made attributable to him." Id. at 75. Inrejecting the defendant's argument, the court found thatplaintiffs had alleged that the defendant "was involved inthe drafting, producing, or reviewing and/ordisseminating of the false and misleading statementsissued by" the corporation; "had access to internalcorporate documents and reports relating to" the subjectmatter of the statements; and helped prepare thecorporation's analysis of sales data. Id. at 76. The Courtof Appeals therefore held that a corporate insider couldbe liable for misstatements attributed to the corporationand not the insider himself, a holding noted and followedin several reported decisions by district courts within theSecond Circuit. See, e.g., In re Alstom SA Secs. Litig.,

406 F. Supp. 2d 433, 466-67 (S.D.N.Y. 2005); In reLaBranche Sec. Lit., 405 F. Supp. 2d 333, 351-52(S.D.N.Y. 2005); Seippel v. Sidley, Austin, Brown &Wood, LLP, 399 F. Supp. 2d 283, 295 (S.D.N.Y. 2005); Inre Global Crossing, Ltd. Sec. Lit., 322 F. Supp. 2d 319,332-33 (S.D.N.Y. 2004). [*22]

SNTG, Cooperman, and Lee can be held primarilyliable for violating Section 10(b). Their conduct goes wellbeyond simply enabling or turning a blind eye to SNSA'sfraud and rises to the level of active participation in thedissemination of false or misleading information.Plaintiffs allege that Cooperman and Lee had knowledgeof SNTG's anti-competitive conduct alleged in thecomplaint as early as 1998, and that O'Brien specificallyrelayed his concerns about Wingfield to them before heresigned. Plaintiffs also allege that Cooperman and Leewere in a position to disclose the anti-competitiveconduct to SNSA and render SNSA's statementsregarding SNTG's activities complete and truthful, but, atbest, they failed to do so, or at worst, they conspired withSNSA to "mask and conceal the improper activitiesimplemented by SNTG in connection with its antitrustmeasures." (Dkt. # 55, P 102.) In either instance, SNTG,Cooperman and Lee could be held responsible for thefalse or misleading statements attributed to SNSAbecause SNSA was either a mere conduit for SNTG,through Cooperman and Lee, to perpetrate a fraud or wasa co-conspirator. As one court has aptly stated, "to holdotherwise [*23] would enable parent companies to createsubsidiaries under which all of its business would beconducted and then to shield the subsidiaries fromSection 10(b) liability by disseminating the subsidiary'sfalse information." In re LaBranche Sec. Lit., 405 F.Supp. 2d at 352. These allegations form a sufficient basisto hold SNTG, Cooperman, and Lee primarily liable forviolating Section 10(b).

3. MATERIALITY

As previously referenced herein, defendants urge thecourt to reconsider its ruling that plaintiffs' complaintmeets the standard set forth in Rule 9 of the FederalRules of Civil Procedure. Defendants argue that thestatements alleged in the complaint to be false ormisleading reference SNTG's tank container operations,which they allege are part of a line of business distinctfrom its parcel tanker operations. Defendants furtherassert that the complaint alleges that any illegalanti-competitive activities took place within the parcel



tanker line of business only, and that plaintiffs' failure tolink SNTG's illegal conduct within the parcel tanker lineof business with statements referencing the tank containerline of [*24] business renders the complaint insufficientpursuant to Rule 9.

Plaintiffs' complaint meets the applicable standard.Plaintiffs' complaint alleges pervasive anti-competitiveactivity within SNTG over a period of four years, andthat SNSA attempted to deceive the investing public bystating that any business success was achieved in acompetitive environment, when in fact it was not.Plaintiffs also allege that SNTG used many means toprovide services to their customers, including parceltankers and tank containers, and that the statements setforth in the complaint could have misled a reasonableinvestor into believing that SNTG's success was achievedin a competitive environment for all services it offers.These allegations are particular to the degree required byapplicable law because the complaint identifies "thestatements plaintiff asserts were fraudulent and why, inplaintiff's view, they were fraudulent, [and] specifies whomade them, and where and when they were made." In reScholastic Corp. Sec. Litig., 252 F.3d 63, 69-70 (2d Cir.2001).

Defendants' arguments, although framed within thecontext of Rule 9, are tantamount to an attack on themateriality [*25] of the statements rather than an attackon the sufficiency of the pleading. The dispositive issue,therefore, is whether the false or misleading statementsare material. "A statement is material only if there is a'substantial likelihood that the disclosure of the omittedfact would have been viewed by the reasonable investoras having significantly altered the "total mix" ofinformation made available.'" Kowal v. IBM (In re IBMCorporate Sec. Litig.), 163 F.3d 102, 106-7 (2d Cir.1998) (quoting Basic Inc. v. Levinson, 485 U.S. 224,231-32, 108 S. Ct. 978, 99 L. Ed. 2d 194 (1988))."Material facts include those that 'affect the probablefuture of the company and [that] may affect the desire ofinvestors to buy, sell, or hold the company's securities.'"Castellano v. Young & Rubicam, Inc., 257 F.3d 171, 180(2d Cir. 2001) (quoting SEC v. Texas Gulf Sulphur Co.,401 F.2d 833, 849 (2d Cir. 1968)). "At the pleadingstage, a plaintiff satisfies the materiality requirement ofRule 10b-5 by alleging a statement or omission that areasonable investor would have considered significant inmaking investment decisions. [*26] " Ganino v. CitizensUtilities Co., 228 F.3d 154, 161 (2d Cir. 2000). Because

materiality is a mixed question of law and fact, judgmentas a matter of law "may not be granted on the ground thatalleged omissions are immaterial 'unless they are soobviously unimportant to a reasonable investor thatreasonable minds could not differ on the question of theirimportance.'" Castellano, 257 F.3d at 180 (quotingGoldman v. Belden, 754 F.2d 1059, 1067 (2d Cir. 1985));Halperin v. eBanker USA.COM, Inc., 295 F.3d 352, 357(2d Cir. 2002) ("Recognizing that the materiality of anomission is a mixed question of law and fact, courts oftenwill not dismiss a securities fraud complaint at thepleading stage of the proceedings, unless reasonableminds could not differ on the importance of theomission."); Ganino, 228 F.3d at 162. At this juncture,the court cannot conclude that the statements are notactionable as a matter of law; plaintiffs may be able toprove that an investor would have considered theinformation misstated or withheld to be significant.Therefore, this court adheres to its prior holding rejecting[*27] defendants' Rule 9 challenge to the complaint.

4. SCHEME LIABILITY

Plaintiffs have raised a claim under Rule 10b-5(a)and (c) against the defendants for employing a scheme inconnection with the purchase or sale of securities.Although the court is reluctant to invite a third round ofmotions addressed to the pleadings, it is obliged to do sounder the circumstances with respect to plaintiffs' claimof scheme liability. Plaintiffs raise this claim, which isentirely distinct from their other claim under Rule10b-5(b), in three pages of their oppositionmemorandum, and defendants briefly address this claimin their reply memorandum. The basis for schemeliability is also not immediately apparent from thecomplaint. The court cannot render an informed decisionon the record as it currently stands. Ordinarilydefendants, as the movants, would bear the consequencesof a scant record, but the state of the record isunderstandable given the complexity of this case, theparamount importance of other issues raised in thismotion, and the manner in which the claim was raised.On the other hand, plaintiffs have not made theparticulars of their claim immediately apparent from thecomplaint. [*28] As such, the court will provide anotheropportunity for defendants to address plaintiffs' schemeliability claim in another motion if they wish to do so.Any additional motion practice will not delay discovery.

III. CONCLUSION



For the reasons set forth herein, defendants' motion todismiss (dkt. # 57) is DENIED. With respect toplaintiffs' scheme liability claim, defendants' motion isDENIED without prejudice; defendants may fileanother motion addressing this claim on or before August11, 2006. The parties shall meet and confer ascontemplated by Rule 26(f) of the Federal Rules of CivilProcedure, and shall submit a proposed discovery planon or before August 11, 2006. The stay of this litigation

shall remain in effect until further order from this court.

So ordered this 19th day of June, 2006.

/s/ DJS

DOMINIC J. SQUATRITO

UNITED STATES DISTRICT JUDGE



EXHIBIT 10



In re MICRON TECHNOLOGIES, INC. SECURITIES LITIGATION.

Case No. CV-06-085-S-BLW

UNITED STATES DISTRICT COURT FOR THE DISTRICT OF IDAHO

2007 U.S. Dist. LEXIS 12446; Fed. Sec. L. Rep. (CCH) P94,170

February 21, 2007, Decided

SUBSEQUENT HISTORY: Reconsideration denied byIn re Micron Techs., Inc. Sec. Litig., 2007 U.S. Dist.LEXIS 30395 (D. Idaho, Apr. 25, 2007)

COUNSEL: [*1] For City of Roseville Employees'Retirement System, on behalf of itself and all otherssimilarly situated, Plaintiff: Bruce S Bistline, PhilipHoward Gordon, LEAD ATTORNEY, GORDON LAWOFFICES, Boise, ID; David A Rosenfeld, LEADATTORNEY, LERACH COUGHLIN STOIA &ROBBINS, Melville, NY; John K Grant, LEADATTORNEY, LERACH COUGHLIN STOIA &ROBBINS, San Francisco, CA; Mary Blasy, LEADATTORNEY, Lerach Coughlin Stoia Geller Rudman &Robbins, LLP, San Francisco, CA.

For Local 282 Pension Trust Fund and Saginaw Policeand Fire Retirement System, Saginaw Police and FireRetirement System, Plaintiff: Sam Johnson, LEADATTORNEY, JOHNSON & MONTELEONE, Boise, ID.

For Daniel Doyle, Plaintiff: Reed Garrett Smith, LEADATTORNEY, Seiniger Law Offices, P.A., Boise, ID;Wm Breck Seiniger, SEINIGER LAW OFFICES, Boise,ID.

For Todd Simon, Plaintiff: M. Patrick Duffin, LEADATTORNEY, M. Patrick Duffin, PA, Idaho Falls, ID;Philip Howard Gordon, LEAD ATTORNEY, GORDONLAW OFFICES, Boise, ID.

For Arthur S.K. Fong, Plaintiff: Philip Howard Gordon,LEAD ATTORNEY, GORDON LAW OFFICES, Boise,ID.

For Philip H Gordon, Plaintiff: Philip Howard Gordon,LEAD ATTORNEY, GORDON LAW OFFICES, Boise,

[*2] ID; Seth Klein, Schatz Novel Izard, PC, Hartford,CT.

For Bruce Bistline, Plaintiff: Bruce S Bistline, LEADATTORNEY, GORDON LAW OFFICES, Boise, ID.

For Harvey L. Backmender, Plaintiff: Terry MMichaelson, LEAD ATTORNEY, HAMILTONMICHAELSON & HILTY, Nampa, ID.

For Chemical Valley Pension Fund of West Virginia,International Union of Operating Engineers, Local 132Pension Plan, Plaintiff: John K Grant, LEADATTORNEY, LERACH COUGHLIN STOIA &ROBBINS, San Francisco, CA.

For Seymour Berman, as Trustee for the FBO SeymourBerman Revokable Trust, Plaintiff: John K Grant, LEADATTORNEY, LERACH COUGHLIN STOIA &ROBBINS, San Francisco, CA; Seth Klein, LEADATTORNEY, Schatz Novel Izard, PC, Hartford, CT.

For Micron Technology, Inc., Steven R Appleton, WilburG. Stover, Jr., Michael W Sadler, Defendant: Barry M.Kaplan, Douglas W Greene, LEAD ATTORNEY,Wilson Sonsini Goodrich & Rosati, Seattle, WA; Nina F.Locker, LEAD ATTORNEY, Wilson Sonsini Goodrich& Rosati, Palo Alto, CA; Richard H Greener, LEADATTORNEY, Greener Banducci Shoemaker P.A., Boise,ID; Daniel J. Gordon, Wade L. Woodard, GreenerBanducci Shoemaker P.A., Boise, ID.

JUDGES: Honorable B. Lynn Winmill, Chief [*3] U. S.District Judge.

OPINION BY: Honorable B. Lynn Winmill

Page 1


OPINION

MEMORANDUM DECISION AND ORDER

INTRODUCTION

The Court has before it Micron's motion to dismissand plaintiffs' motion to amend. The Court heard oralargument on these motions on February 5, 2007, and tookthe motions under advisement. For the reasons expressedbelow, the Court will deny Micron's motion to dismissand grant plaintiffs' motion to amend.

FACTUAL BACKGROUND

This § 10(b) class action was filed by Micronshareholders allegedly injured by Micron's participationin an illegal price-fixing conspiracy. 1 Micron's motion todismiss alleges in part that this suit is barred by thetwo-year statute of limitations. See 28 U.S.C. § 1658(b).This suit was filed on February 24, 2006. To resolve thelimitations issue, it is crucial to divide events into thoseoccurring more than two years before this suit was filed --that is, prior to February 24, 2004 -- and events occurringthereafter.

1 Plaintiffs have also made a claim under § 20(a)of the Securities Exchange Act. It providesderivative liability for those who control othersfound to be primarily liable under the Act. In reRamp Networks, Inc. Sec. Lit., 201 F.Supp.2d1051, 1063 (N.D.Cal.2002).

[*4] 1. Events Prior to February 24, 2004

Micron produced Dynamic Random Access Memory(DRAM) chips for use primarily in computers. DRAMwas Micron's principal product, and thus Micron's stockprice tracked closely with the price of DRAM.

In 2001, Micron allegedly entered into a globalprice-fixing conspiracy to ensure high DRAM prices andhigh Micron stock prices. Even though computer demandwas down in 2001, the prices for DRAM were risingrapidly. At the same time, Micron's Vice-President ofWorldwide Marketing, Michael Sadler, and other Micronofficials, issued public statements attributing high DRAMprices to market forces.

Plaintiffs allege that these statements were falsebecause Micron officials knew it was illegal price-fixing,

not market factors, that led to increasing DRAM prices.Plaintiffs allege that Micron's deception had the desiredeffect: Micron's stock price increased.

On June 17, 2002, the U.S. Department of Justice(DOJ) issued a federal grand jury subpoena to Micron,seeking documents relating to communications betweenDRAM manufacturers regarding the pricing and sales ofDRAM chips. DOJ also issued subpoenas to the othertwo largest global manufacturers [*5] of DRAM,Samsung and Infineon Technologies.

A DOJ spokeswoman refused to provide any detailsbeyond the fact that the DOJ was investigating thecomputer memory chip industry. Press accounts includeda quote from a "federal official, speaking on condition ofanonymity," who "confirmed that the subpoenas werepart of an ongoing criminal investigation." See Exhibit 14at p. 2. Micron publically disclosed the service of thesubpoena, and announced that it would cooperate withthe DOJ, although it denied that it violated antitrust laws.See Exhibit 13.

On June 21, 2002, the Wall Street Journal reportedthese events, noting that the investigation "follows asharp but brief price increase for [DRAM] earlier [in2002]." See Exhibit 19. While prior investigationsfocused on dumping by foreign chip makers, recent exitsby some companies reduced competition, "therebyconcentrating greater pricing power in the hands of a fewlarge suppliers." Id. The Journal quoted earlier statementsby Dell Computer's CEO, Michael Dell, expressing alarmat the "cartel-like behavior of a couple of DRAMsuppliers." Id. Dell had concluded that the collusion was"successful for a very short [*6] period of time." Id. Thearticle then noted that DRAM prices "shot up to $ 4.50each in [the first quarter of 2002] from an average of $1.97 each in the fourth quarter of last year." Id. Otherswere not convinced that collusion was behind pricemovements, and they cited the inherent volatility of theDRAM market as the cause of price swings. Id.

By June 24, 2002, the press was reporting "anapparent admission by a Mosel-Vitelic officer of pricefixing meetings" between his company, HynixSemiconductor and Samsung, large DRAM producers.Exhibit 21. These reports did not mention Micron.

Within the next three months, sixteen antitrustactions were filed against Micron and other producers.These suits were filed by DRAM purchasers who claimed

Page 22007 U.S. Dist. LEXIS 12446, *3; Fed. Sec. L. Rep. (CCH) P94,170


they were victims of the high prices caused by theprice-fixing. The complaints allege that in the fall of2001, Micron and the other defendants entered into asecret agreement to reduce supply by 20%, resulting inprice hikes. See Exhibit 40. However, the complaints citeno evidence in support of these allegations.

By October 30, 2002, there were twenty-three suchsuits. While Micron's stock price was $ 48.83 per share in[*7] March of 2001, it had dropped to $ 6.76 by the closeof the class period, February 13, 2003.

By February 10, 2003, the press was reporting"unconfirmed reports that Micron . . . was preparing toadmit anti-competitive practices . . . ." See Exhibit 25.That same article stated that a former Micron salesmanager had agreed to plead guilty to "obstructing the[DOJ] investigation by altering and concealingdocuments that contained information about the pricingof competitors' pricing." Id.

On December 17, 2003, the DOJ issued a pressrelease revealing in detail the Micron manager'sobstruction of justice. See Exhibit 26. The manager,Alfred Censullo, altered his notes of conferences withother Micron managers concerning, among other things,"prices at which competing DRAM suppliers would selltheir products to major [computer makers] in upcomingprice negotiations." Id. He also concealed 14 pages "fromhis notebooks that contained competitor pricinginformation and obvious alterations . . . ." Id. His purposewas "to disguise the nature, source, and accuracy ofinformation . . . concerning contacts and communicationsbetween DRAM suppliers relating to the pricing [*8] andsale of DRAM." Id.

On December 31, 2003, the Los Angeles Timesreported that at a Federal Trade Commission (FTC) trialearlier that year, chip-maker Rambus Inc. "presentedevidence that chip makers including Micron conspired tofix prices." See Exhibit 29. No further detail was providedon the nature of this evidence.

The "evidence" referred to in this article waspublically available at the FTC before December 31,2003. Investors led by the Los Angeles Times article toexamine the FTC public record would have discoveredproposed Findings of Fact and Conclusions of Law,prepared by Rambus, that summarized the evidencesubmitted by Rambus in the FTC trial. See Exhibit 43.These Findings are dated September 8, 2003. See

Affidavit of Greene at p. 3; Appendix A to Motion toDismiss at p. 9.

This evidence included an e-mail from Micronmanager Kathy Radford dated November 26, 2001. Id.Rambus summarizes part of that e-mail by stating in itsFindings that Radford "described the efforts of Infineonand Samsung to raise DDR prices, and stated that Micronintended to try to raise its prices to all of the OEM[original equipment manufacturers]." Id. [*9] Rambusthen quotes from the email wherein Radford reported that"the consensus from all suppliers is that if Micron makesthe move, all of them will do the same and make it stick."Id.

2. Events Occurring After February 24, 2004

On February 26, 2004, an article in the Wall StreetJournal Europe discussed in detail the Radford e-mail.See Exhibit 1 to Plaintiffs' Response Brief. On September15, 2004, Infineon Technologies pled guilty to criminalcharges of illegal DRAM price-fixing between 1999 and2002.

On November 11, 2004, Micron's CEO SteveAppleton publically admitted for the first time that theDOJ investigation revealed evidence of DRAMpricefixing by Micron employees and its competitors.Two days later, the Idaho Statesman newspaper publishedan article revealing that Micron had signed an agreementwith DOJ whereby Micron would participate in the DOJ'sCorporate Leniency Policy, which provides that inexchange for Micron's full cooperation, it would not besubject to any prosecution or penalty.

ANALYSIS

1. Standard of Review - General

Micron brings its motion to dismiss under Rule12(b)(6), but submits material outside the [*10]pleadings. This converts the motion to one under Rule 56for summary judgment. See Rule 12(b). The plaintiffshave not objected to the submission of extrinsicdocuments, or requested time to do additional discovery,but have instead submitted extrinsic documents of theirown. Accordingly, the Court will treat the motion as onefor summary judgment under Rule 56, and determinewhether there exist any genuine issues of material fact.

Micron bears the initial burden to demonstrate the



absence of any genuine issue of material fact. See T.W.Elec. Serv., Inc. v. Pac. Elec. Contractors Ass'n, 809 F.2d626, 630 (9th Cir.1987). Once Micron does so, theburden shifts to plaintiffs to set forth, by affidavit or asotherwise provided in Rule 56, specific facts showing thatthere is a genuine issue for trial. See Rule 56(e). ThisCourt must not weigh the evidence or pass on thecredibility of witnesses but is instead limited todetermining whether there is any genuine issue for trial.See Abdul-Jabbar v. Gen. Motors Corp., 85 F.3d 407,410 (9th Cir.1996).

2. Standard of Review -- Statute of Limitations Issues

A defendant raising the statute [*11] of limitationsas an affirmative defense has the burden of proving thatthe action is time-barred. See California Sansome Co. v.U.S. Gypsum, 55 F.3d 1402, 1406 (9th Cir. 1995). Whenthe issue turns on when a reasonable person should havediscovered certain facts for statute of limitationspurposes, the question is one of fact, generally for a juryto resolve. Nevada Power Co. v. Monsanto Co., 955 F.2d1304, 1307 (9th Cir. 1992). However, whereuncontroverted evidence irrefutably proves the plaintiffsknew or should have known of the conduct, the time ofdiscovery may be decided as a matter of law. Flowers v.Carville, 292 F.Supp.2d 1225 (D.Nev. 2003). This hasbeen described as an "extremely difficult burden . . . ."Nevada Power, 955 F.3d at 1308. Micron is thereforeentitled to summary judgment only if uncontrovertedevidence establishes that the two-year limitations periodbegan running before February 24, 2004, an extremelydifficult burden to satisfy.

3. Section 10(b) Statute of Limitations

The Ninth Circuit has considered, without resolving,whether § 10(b)'s limitations period begins with actual[*12] or inquiry notice. Berry v. Valence Technology,Inc., 175 F.3d 699, 704 (9th Cir.1999). In Berry, theCircuit declined to adopt either standard, but stated that"[i]f we were to adopt inquiry notice, we would agreewith the Tenth Circuit's formulation of that standard [inSterlin v. Biomune Sys., 154 F.3d 1191 (10th Cir.1998)]."

This standard asks two questions: (1) Would areasonable investor have been on inquiry notice?; and (2)If so, when should a reasonable investor have discoveredthe facts sufficient to meet the pleading standards forbringing a § 10(b) action?

With regard to the first question, inquiry notice existswhen circumstances "raise sufficient suspicion of fraud tocause a reasonable investor to investigate the matterfurther." Berry, 175 F.3d at 704. While the facts need notprovide investors "with full knowledge of the fraud," theymust be "sufficient to excite inquiry into the possibility offraudulent conduct." Id. at 705. The plaintiff "need not . .. have fully discovered the nature and extent of the fraudbefore [he was] on notice that something may have beenamiss. Inquiry notice [*13] is triggered by evidence ofthe possibility of fraud, not full exposition of the scamitself." Sterlin, 154 F.3d at 1203. To determine ifplaintiffs are on inquiry notice, the Court examines

any financial, legal, or other data, suchas public disclosures in the media aboutthe financial condition of the corporationand other lawsuits alleging fraudcommitted by the defendants, that providethe plaintiff with sufficient storm warningsto alert a reasonable person to theprobability that there were eithermisleading statements or significantomissions involved in the sale ofsecurities.

In re Infonet Services Corp. Securities Litigation, 310F.Supp.2d 1106, 1113-14 (C.D.Cal. 2003).

If the answer to that first question is yes -- and theinvestor is on inquiry notice -- the answer to the secondquestion determines when the period begins to run:"[W]hen should a reasonably diligent investor havediscovered the facts underlying the alleged fraudulentactivity?" Id. In answering this question, "[a] reasonableinvestor is presumed to have information available in thepublic domain, and therefore . . . is imputed withconstructive knowledge [*14] of this information."Berry, 175 F.3d at 703, n. 4.

This second question fosters fairness for plaintiffswho are on inquiry notice but "could not reasonably havediscovered within [two years] sufficient facts to file a suitwhich satisfied the particularized pleading requirements"of the securities laws. Sterlin, 154 F.3d at 1203. Thesource of those strict rules is the Private SecuritiesLitigation Reform Act of 1995 (PSLRA). The PSLRArequires plaintiffs suing under § 10(b) to "plead in greatdetail" their allegations. In re Silicon Graphics Inc.Securities Litigation, 183 F.3d 970, 974 (9th Cir. 1999).



Given the heightened pleading standard imposed by thePSLRA, it is only fair to delay the start of the limitationsperiod until an investor, exercising reasonable diligence,should have discovered sufficient facts to satisfy thosestandards.

To quantify the critical mass of facts needed tosatisfy those standards, the Court will review the PSLRApleading requirements and the elements of a § 10(b)action. To state a claim under § 10(b), plaintiffs mustallege: (1) a misstatement or omission (2) of material fact(3) made with [*15] scienter (4) on which plaintiffsrelied (5) which proximately caused their injury. SeeDSAM Global Value Fund v. Altris Software, Inc., 288F.3d 385 (9th Cir. 2002). The PSLRA requires plaintiffsto "state with particularity facts giving rise to a stronginference that [Micron] acted with [scienter]." 15 U.S.C.§ 78u-4(b)(2).

"The proof of scienter in fraud cases is often a matterof inference from circumstantial evidence." In reSoftware Toolworks Inc., 50 F.3d 615, 628 (9thCir.1994). Thus, plaintiffs need not have direct proof offraud to meet the PSLRA pleading requirements, butplaintiffs must "plead, in great detail, facts that constitutestrong circumstantial evidence of deliberately reckless orconscious misconduct." In re Silicon Graphics Inc.Securities Litigation, 183 F.3d 970 (9th Cir. 1999).Recklessness is:

a highly unreasonable omission,involving not merely simple, or eveninexcusable negligence, but an extremedeparture from the standards of ordinarycare, and which presents a danger ofmisleading buyers or sellers that is eitherknown to the defendant or is so obviousthat the [*16] actor must have been awareof it.

Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1569(9th Cir.1990) (quotations omitted). To allege a "stronginference of deliberate recklessness," plaintiffs "muststate facts that come closer to demonstrating intent, asopposed to mere motive and opportunity." SiliconGraphics, 183 F.3d at 974.

The PSLRA sets a strict standard because "Congressintended for complaints under [§ 10(b)] to stand or fallbased on the actual knowledge of the plaintiffs rather

than information produced by the defendants after theaction has been filed." In re Daou Systems, Inc., 411 F.3d1006, 1021 (9th Cir. 2005), cert. denied, 546 U.S. 1172,126 S. Ct. 1335, 164 L. Ed. 2d 51 (2006) (quotingMedhekar v. United States Dist. Ct., 99 F.3d 325, 328(9th Cir.1996)). 2 Daou bases this holding on a provisionof the PSLRA, 15 U.S.C. § 78u-4(b)(1). 3

2 As noted earlier, plaintiffs have also brought aclaim under § 20(a) of the Securities ExchangeAct based on the underlying § 10(b) claim. In thiscase, the pleading requirements for bothviolations are the same. In re Gilead SciencesSecurities Litigation, 2005 U.S. Dist. LEXIS 3170,2005 WL 181885 (N.D. Cal. 2005).

[*17]3 That Act requires that all suits based onallegations of material misstatements or omissionsunder the PSLRA must "specify each statementalleged to have been misleading, the reason orreasons why the statement is misleading, and, ifan allegation regarding the statement or omissionis made on information and belief, the complaintshall state with particularity all facts on which thatbelief is formed." 15 U.S.C. § 78u-4(b)(1).

To summarize all of these standards in the context ofthis case, the Court must answer the following twoquestions to resolve Berry's inquiry-plus-duediligencetest: (1) Would a reasonable investor in Micron stock beon inquiry notice prior to February 24, 2004, that Micronhad committed fraud in connection with the purchaseand/or sale of Micron stock?; (2) If so, should aninvestor, exercising reasonable diligence, havediscovered facts giving rise to a strong inference of fraud,sufficient to pass the PSLRA's pleading standards, priorto February 24, 2004?

4. First Issue: Inquiry Notice

To answer Berry's first question, [*18] the plaintiffswere clearly on inquiry notice before February 24, 2004.By the end of December, 2003, reasonable Microninvestors would have known that (1) they had earlierrelied on statements of Micron officials that marketforces were the cause of high DRAM prices; (2) thatMicron stock prices were directly related to DRAMprices; (3) that Micron and other DRAM manufacturerswere under investigation by the DOJ; (4) that pressreports included the opinions of market analysts and legal



experts that the DOJ was investigating whether there wasillegal collusion between Micron and other DRAMmanufacturers to fix prices; (5) that Dell Computer'sCEO Michael Dell had accused DRAM manufacturers of"cartel-like behavior" that had led to a short-term pricehike; (6) that the Wall Street Journal had reported that themost popular DRAM chips had "shot up" to $ 4.50 apiecefrom $ 1.97 in a short period; (7) that press accountsreported an "apparent admission" by one official ofprice-fixing meetings between DRAM manufacturersHynix and Samsung; (8) that 24 civil antitrust suits hadbeen filed alleging that Micron colluded with otherDRAM manufacturers to fix DRAM prices; (9) that suchcollusion [*19] might render false Micron's statementsthat market forces caused high DRAM prices; (10) thatMicron stock losses could be related to DRAM pricedrops which in turn were related to collusive activity (orits cessation); (11) that press reports revealed that aMicron manager had admitted to altering and concealinghis notes to disguise the nature of price communicationsbetween DRAM suppliers; and (12) that the Los AngelesTimes had reported that Rambus had introduced evidenceto the FTC that Micron had conspired to fix prices.

All of this information would "excite inquiry" by areasonable investor into whether Micron committed fraudin connection with the purchase or sale of Micron stock.Thus, as a matter of law, plaintiffs were on inquiry noticeby December 31, 2003.

5. Second Issue: Due Diligence Discovery

By itself, inquiry notice does not trigger thelimitations period until such time as an investor,exercising reasonable diligence, should have discoveredsufficient facts to satisfy the PSLRA's heightenedpleading requirements for a § 10(b) action. This is theissue that is difficult to resolve as a matter of law.

By December 31, 2003, with all the background[*20] listed above, a crucial piece of evidence wasrevealed -- the Los Angeles Times reported that Rambushad submitted evidence to the FTC that Micron conspiredto fix prices. A summary of that evidence -- the Radforde-mail -- was then available at the FTC for any diligentinvestor.

The Rambus litigation was no obscure proceeding.The Wall Street Journal had earlier reported on thelitigation in the same article discussing the DOJ'sinvestigation of Micron. See Exhibit 19 to Greene

Affidavit. That article included a web-link to the FTC'scomplaint against Rambus. Id. at p. 3.

Plaintiffs argue that the Radford e-mail discussionwas buried deep in a lawyer-drafted document that wassimply a proposed decision, not anything officiallyentered by the FTC. While that is true, a diligent investorwould not have to sift through mountains of materiallooking for the needle in a haystack, as plaintiffs' imply.The Los Angeles Times -- no obscure fish-wrap -- hadalerted diligent investors that evidence of Micron'sprice-fixing was submitted by Rambus during its FTCtrial. That clue provided a short-cut for diligent investors,who could quickly narrow their search through FTC[*21] files to a document prepared by Rambussummarizing its trial evidence, i.e., Rambus's proposedFindings. Sure enough -- the Radford e-mail wasdescribed in detail there.

Micron's intent to fix prices leaps out of Rambus'sdescription of Radford's e-mail, even to the lay reader.There is nothing disguised, subtle, or confusing about it;no reasonably diligent investor would have overlooked it.Its importance is highlighted by plaintiffs' own discussionof it in their complaint. See Complaint at P 2. 4

4 Obviously, the Court is not holding that thee-mail is enough to establish price-fixing. TheCourt is simply accepting plaintiffs' ownargument that the Radford e-mail helps them meetthe PSLRA pleading standards.

While this evidence would appear at first glance tosatisfy the strict PSLRA pleading standards, and thusstart the limitations period running, the Court cannotignore the Circuit's standard of review on these issues. Asdiscussed above, the Circuit has held that when an issueturns on when [*22] a reasonable person should havediscovered certain facts for statute of limitationspurposes, the question is one of fact, generally for a juryto resolve. Nevada Power Co. v. Monsanto Co., 955 F.2d1304, 1307 (9th Cir. 1992). This has been described as an"extremely difficult burden . . . ." Nevada Power, 955F.3d at 1308.

Given this, the Court is concerned about finding -- asa matter of law -- that the Los Angeles Times article is thetipping point, warranting summary judgment. While thearticle may have led a diligent investor to the Radforde-mail, the article itself did not discuss that e-mail. Giventhe complete lack of discovery, the Court is not aware of



the full context in which the article appeared. NevadaPower sets a very high standard that the Court cannotfind is met at this point. For that reason, the Court willnot grant summary judgment on Berry's second questionconcerning when plaintiffs should have discoveredevidence sufficient to satisfy the PSLRA pleadingstandards.

6. Actual Notice

Because this Circuit has not yet settled on a singletest, district courts must apply both the actual notice andinquiry-plus-due [*23] diligence standards. LividHoldings Ltd. v. Salomon Smith Barney, Inc., 416 F.3d940, 951 (9th Cir. 2005). If the actual discovery testrequires examination of what plaintiffs knew, there arequestions of fact because no discovery has been done.

However, Berry equates actual discovery withconstructive discovery:

An actual discovery standard does notrequire determining precisely when eachplaintiff actually knew of facts sufficientto make out a claim of fraud. Courts canimpute knowledge of public informationwithout inquiring into when, or whether,individual shareholders actually knew ofthe information in question."

Berry, 175 F.3d at 703, n. 4. This standard seems toequate the actual discovery standard with thedue-diligence discovery standard discussed above. Giventhat the Court has found questions of fact on the latter, itfollows that similar questions of fact exist regarding theformer. Summary judgment will therefore be deniedunder this test as well.

7. PSLRA Pleading Sufficiency

The Court has already discussed the strict pleadingstandard set forth in the PSLRA and will not repeat thatdiscussion [*24] here. That pleading standard is satisfiedhere. It is a close question whether the Radford e-mailwould have been enough to satisfy the standard, but theplaintiffs have identified a number of other e-mails,discovered later, to support their charges.

Moreover, plaintiffs have alleged specific falsestatements, identifying both the dates on which they weremade and the persons who made them. These allegations

sufficiently plead falsity because they assert that Micronofficials explained DRAM pricing as a product of marketfactors rather than price-fixing.

The complaint also alleges that Micron employeesdeliberately and knowingly engaged in a scheme tomanipulate DRAM prices so that Micron could appearprofitable to investors. Those investors were allegedlyinjured when Micron's deliberate price-fixing schemeceased and DRAM prices dropped.

Plaintiffs must allege that Micron's fraud wasconducted "in connection with" securities transactions.SEC v. Rana Research, 8 F.3d 1358 (9th Cir. 1993).Plaintiffs meet that test here by alleging a closeconnection between DRAM prices and Micron's stockprice, so that Micron's false statements and price-fixingscheme would artificially [*25] raise DRAM prices,attracting investors that would bid up the price of Micronshares.

The complaint further contains sufficient allegationsof scienter. The discussion of Micron's e-mails, inconnection with Micron's own admissions regarding theDOJ investigation, raise a strong inference of scienter, orintent to defraud, assuming the allegations are true.

Micron argues that plaintiffs have failed to plead losscausation. The Court disagrees. Plaintiffs assert thatMicron's false statements about market forces causinghigher DRAM prices lured investors who were laterdamaged when Micron stock values fell after theprice-fixing ceased. Plaintiffs have further made specificallegations that the Micron stock movements were notdue to volatility in the stock market.

On the whole, the Court finds that the strict PSLRApleading standards are met in this case.

8. Motion to Amend

Given the liberal provisions of Rule 15, especially atthis early stage of the litigation, the Court will grantplaintiffs' motion to amend.

9. Conclusion

The Court has denied Micron's motion to dismiss andgranted plaintiffs' motion to amend. Counsel are directedto contact the [*26] Court's clerk, LaDonna Garcia, forthe purpose of scheduling a Case ManagementConference to set various deadlines, including those for



discovery and the filing of dispositive motions.

ORDER

In accordance with the terms of the MemorandumDecision set forth above,

NOW THEREFORE IT IS HEREBY ORDERED,that the motion to dismiss (Docket No. 54), which theCourt shall construe as a motion for summary judgment,is DENIED.

IT IS FURTHER ORDERED, that the motion to

amend (Docket No. 59) is GRANTED.

IT IS FURTHER ORDERED, that counsel aredirected to contact the Court's clerk LaDonna Garcia(208-334-9021) to set up a Case ManagementConference.

DATED: February 21, 2007

Honorable B. Lynn Winmill

Chief U. S. District Judge



EXHIBIT 11


Powell v. Idacorp, Inc.D.Idaho,2007.Only the Westlaw citation is currently available.

United States District Court,D. Idaho.Morgan POWELL, individually and on behalf of all

others similarly situated, Plaintiffs,v.

IDACORP, INC., et al., Defendants.Nos. CIV. 04-249-S-EJL, 04-322-S-EJL.

May 21, 2007.

David A. Rosenfeld, Samuel H. Rudman, LerachCoughlin Stoia & Robbins LLP, Melville, NY, EliGreenstein, John K. Grant, Lerach Coughlin Stoia& Robbins, San Francisco, CA, Philip Howard Gor-don, Gordon Law Offices, Boise, ID, for Plaintiffs.David G. Hetzel, Leboeuf Lamb Greene & Macrae,New York, NY, Dennis F. Kerrigan, Jr., LeboeufLamb Greene & Macrae, Hartford, CT, Rex Black-burn, Daniel Loras Glynn, Blackburn & Jones LLP,Boise, ID, for Defendants.

EDWARD J. LODGE, U.S. District Judge.*1 Before the Court is Defendants' motion to dis-miss. On February 26, 2007, Chief MagistrateJudge Mikel H. Williams held a hearing on the mo-tion and thereafter issued a report and recommenda-tion, recommending that the motion to dismiss begranted. (Dkt. No. 108). Any party may challenge aMagistrate Judge's proposed recommendation re-garding a dispositive motion by filing written ob-jections within ten days after being served with acopy of the Report and Recommendation. 28 U.S.C.§ 636(b)(1)(C). The district court must then “makea de novo determination of those portions of the re-port or specified proposed findings or recommenda-tions to which objection is made.”Id. The districtcourt may accept, reject, or modify in whole or inpart, the findings and recommendations made bythe Magistrate Judge. Id.; see alsoFed.R.Civ.P.72(b). In contrast, the Court reviews a MagistrateJudge's nondispositive order under a clearly erro-neous or contrary to law standard.Fed.R.Civ.P.

72(a); 28 U.S.C. 636(b)(1)(A).

In this case, Plaintiff has filed objections contend-ing the Chief Magistrate Judge failed to properlyapply the law and erred in concluding that the com-plaint failed to allege loss causation. The Defend-ants filed a response to the objections asserting theChief Magistrate Judge's conclusions are correctbut also that the Court should find that the alternat-ive reasons for dismissal raised in the initial motionalso provide grounds for granting the motion to dis-miss. Defendants' response to the objections furtherargue that the amended complaint has alleged nonew facts and that the allegations/conclusions madein the complaint are unsupported by any facts.

The lead Plaintiff has brought this action on behalfof persons who acquired publicly issued securitiesof Idacorp, Inc. between February 1, 2002 and June4, 2002 (“Class Period”) against Defendants Ida-corp, Inc. (“Idacorp”), Jon H. Miller, Jan B. Pack-wood, J. Lamont Keen, and Darrel T. Anderson.The complaint alleges federal securities law viola-tions raising claims pursuant to § 10(b) and § 20(a)of the 1934 Act and Rule 1 0b-5. The scheme andfraudulent activity alleged in the complaint in-volved Idacorp's use of its subsidiaries, IdahoPower Company (“IPC”) and Idacorp Energy(“IE”), in improper energy trading and hedgingactivities and financial manipulations before andduring the Class Period. Plaintiff alleges the De-fendants engaged in financial transactions withnon-creditworthy entities and entered into impropercontracts which resulted in falsely inflated valuesof Idacorp assets and manipulation of earnings asreflected in misleading financial forecasts uponwhich, Plaintiff alleges, he relied in purchasingshares at artificially inflated prices which later lostvalue when the truth about Idacorp became known,thereby causing Plaintiff's losses.

This Court adopted the previous report and recom-mendation of Chief Magistrate Judge Williamsgranting the motion to dismiss based on the

Slip Copy Page 1Slip Copy, 2007 WL 1498881 (D.Idaho)(Cite as: Slip Copy)






















Plaintiff's failure to plead loss causation. ThePlaintiff was allowed to amend his complaint tocure the deficiency. Thereafter, Defendants filedtheir second motion to dismiss the Plaintiff'samended complaint and the Chief Magistrate Judgeissued the report and recommendation currently be-fore the Court. Having considered the record, theobjections, and the report and recommendation, theCourt issues the following order.

*2 On this motion the Defendants ask that the com-plaint be dismissed pursuant to Federal Rule ofCivil Procedure 12(b)(6). In considering a motionto dismiss pursuant to Federal Rule of Civil Proced-ure 12(b)(6), “all well-pleaded allegations of mater-ial fact are taken as true and construed in a lightmost favorable to the non-moving party.”WylerSummit P'ship v. Turner Broad. Sys., Inc., 135 F.3d658, 661 (9th Cir.1998) (citation omitted).However, the court does not necessarily assume thetruth of legal conclusions merely because they arecast in the form of factual allegations in plaintiff'scomplaint. See Clegg v. Cult Awareness Network,18 F.3d 752, 754-55 (9th Cir.1994). There is astrong presumption against dismissing an action forfailure to state a claim. See Gilligan v. Jamco Dev.Corp., 108 F.3d 246, 249 (9th Cir.1997) (citationomitted).“ ‘The issue is not whether a plaintiff willultimately prevail but whether [he] is entitled to of-fer evidence in support of the claims.’ “ Id.(quoting Scheuer v. Rhodes, 416 U.S. 232, 236, 94S.Ct. 1683, 40 L.Ed.2d 90 (1974), overruled onother grounds by Harlow v. Fitzgerald, 457 U.S.800, 807, 102 S.Ct. 2727, 73 L.Ed.2d 396 (1982)).Consequently, the court should not grant a motionto dismiss “for failure to state a claim unless it ap-pears beyond doubt that the plaintiff can prove noset of facts in support of his claim which would en-title him to relief.” Conley v. Gibson, 355 U.S. 41,45-46, 78 S.Ct. 99, 2 L.Ed.2d 80, (1957); see alsoHicks v. Small, 69 F.3d 967, 969 (9th Cir.1995). Aclaim is sufficient if it shows that the plaintiff is en-titled to any relief which the court can grant, even ifthe complaint asserts the wrong legal theory or asksfor improper relief. See United States v. Howell,318 F.2d 162, 166 (9th Cir.1963).

Plaintiff maintains the amended complaint properlyalleges loss causation based on the same theory ofloss causation as was made in the original com-plaint: Idacorp used its subsidiaries, IPC and IE, toengage in improper energy trading and hedgingactivities and financial manipulations before andduring the Class Period for the purpose of artifi-cially inflating Idacorp's earnings and stock priceand when the true financial condition of Idacorpwas later revealed the stock price collapsed therebycausing loss to investors. (Dkt. No. 109, p. 2). Theamended complaint alleges that the company'sApril, 2002 and June, 2002 statements revealed in-formation about Idacorp's true financial conditionand the “impact” the Defendants' prior misrepres-entations had on the company's worth which causedthe drop in price. (Dkt. No. 92, p. 5). The Plaintiffasserts this satisfies the loss causation requirementsin Daou because it “began to reveal figures show-ing the company's true financial condition.”(Dkt.No. 109, p. 5). Defendants argue the amended com-plaint fails to allege any new facts which meet theloss causation requirement and agrees with theChief Magistrate Judge's determination that “thetruth about the alleged misrepresentation ... [must]make its way into the marketplace,” which has notbeen alleged in this case. (Dkt. No. 111, pp. 2, 7).

I. Pleading Requirement:

*3 Plaintiff argues the heighten pleading require-ments for securities cases does not apply to the losscausation element; asserting that only notice plead-ing is required under Dura. Plaintiff is correct. SeeBroudo v. Dura Pharmaceuticals, 544 U.S. 336,346-47, 125 S.Ct. 1627, 161 L.Ed.2d 577 (2005).What is required for a plaintiff to allege loss causa-tion is that the share price “fell significantly afterthe truth became known” about the material mis-statements or omissions. Dura, 544 U.S. at 347(concluding that the complaint must provide de-fendants with notice of what that relevant economicloss might be and what the causal connection mightbe between the loss and the misrepresentation).

II. Loss Causation:





































A. Application of the Law to the Amended Com-plaint:

Plaintiff objects to the Chief Magistrate Judge's ap-plication of the facts of this case to the applicablelaw. Defendants maintain that the amended com-plaint fails to properly allege loss causation andthat the allegations that are made are unsupported.

The amended complaint contains new languagewhich more clearly describes Plaintiff's theory ofloss causation but continues to alleges that the mis-representations were undisclosed; arguing that theDefendants' statements during the class period were“partial disclosures” of the “impact” the Defend-ants' misconduct had on the company. (Dkt. No. 92,¶¶ 8-9) (stating the April and June 2002 forecast re-ductions were “partial disclosures of Idacorp's actu-al reliance on misrepresentations and manipulativetransactions in order to inflate its financial results,forecasts, and stock price.”); see also (Dkt. No. 92,¶¶ 34, 55, 56, 59). In sum, the amended complaintalleges:Plaintiff and other class members suffered losseswhen defendants reduced Idacorp's financial fore-casts on April 12, 2002 and June 4, 2002, whichresulted in sharp declines in Idacorp's stock price.The reductions in Idacorp's stock price revealed theimpact of defendants' misrepresentations, manipu-lative transactions and improper financial adjust-ments and the impact of defendants' inability tocontinue to engage in such misconduct in the fu-ture.

(Dkt. No. 92, ¶¶ 92-96). The alleged “manipulativescheme” was further revealed following the ClassPeriod when Defendants admitted their conduct tothe FERC and entered into the settlement agree-ment. (Dkt. No. 92, ¶¶ 59, 74, 76). Plaintiff arguesthese admissions to the FERC provided the detailsof how the Defendants' defrauded investors but thatthe impact of the fraud had already been revealed,digested, and responded to by the market when theApril and June 2002 earnings forecasts were issued.

The Supreme Court held in Dura that merely al-leging loss as a result of artificially inflated prices

is insufficient to plead the loss was caused by a se-curities violation. A plaintiff must “prove that thedefendant's misrepresentation (or other fraudulentconduct) proximately caused the plaintiff's econom-ic loss.”Broudo v. Dura Pharmaceuticals, 544 U.S.336, 125 S.Ct. 1627, 161 L.Ed.2d 577 (2005)(concluding that the complaint must provide de-fendants with notice of what that relevant economicloss might be and what the causal connection mightbe between the loss and the misrepresentation). Ul-timately, the Supreme Court found that the law re-quires “that a plaintiff prove that the defendant'smisrepresentation (or other fraudulent conduct)proximately caused the plaintiff's economicloss.”Id. Subsequently, the Ninth Circuit issued itsdecision in Daou which concluded that the com-plaint's allegations that the drop in stock price wascausally related to the financial misstatements be-cause the price of stock fell precipitously followingthe company's disclosure of its true financialhealth.In re Daou Systems, Inc., Securities Litiga-tion, 411 F.3d 1006 (9th Cir.2005).

*4 Having reviewed the amended complaint, thisCourt concludes that the amended complaint hasfailed to cure the pleading deficiencies for losscausation as it fails to plead a causal connectionbetween the alleged losses and the material misrep-resentations. The amended complaint now includesallegations that the Defendants' statements duringthe class period were “partial disclosures” revealingthe “impact” of the Defendants' misconduct towhich the market reacted resulting in losses to thePlaintiff. This theory runs head-long into the sameproblem the initial complaint presented; putting thecart before the horse by arguing that the “impact”of the misconduct caused the losses before the mis-conduct was known. Even if the scheme was begin-ning to “unravel,” the fact that the statements, fore-casts, and earnings guidance issued by the Defend-ants during the Class Period continued to concealthe misconduct, as Plaintiff alleges, makes it im-possible for the misconduct to have caused the mar-ket's reaction lowering the price because the truthof the misrepresentations was still unknown to themarket. Assuming Plaintiff's allegations in the com-plaint are true, the 2002 statements relied upon by










Plaintiff do not allege loss causation because, as thecomplaint itself states, the truth regarding the al-leged misstatements was still being concealed bythe Defendants. Because the misstatements re-mained concealed from the public, as the complaintalleges, the drop in stock price could not have beencaused by the market's reaction to the misconduct.

B. Distinguishing Daou Decision:

Plaintiff contends the Chief Magistrate Judge im-properly distinguished the Daou case on the basisthat the Defendant in Daou admitted their fraud.See In re Daou Systems, Inc., Securities Litigation,411 F.3d 1006 (9th Cir.2005). Plaintiff argues therewas no admission in Daou nor is one required forloss causation; maintaining that the allegations inthis case regarding the forecast reductions are sim-ilar to the revelations accepted in Daou which re-quires only that the disclosures “began to revealfigures showing the company's true financial condi-tion.”(Dkt. No. 88, p. 7) (quoting Daou, 411 F.3d at1026). Defendants disagree, arguing the company'sstatement in Daou revealed the company's priormisconduct whereas the alleged misconduct in thiscase was not revealed until well after the ClassPeriod had ended. (Dkt. No. 89, p. 5). While gener-ally revelations beginning to show the “true finan-cial condition” of a company are sufficient underDaou, the Court agrees with the Magistrate Judgethat the facts here are different.

In Daou, the Ninth Circuit determined loss causa-tion had been pled where the complaint alleged thatthe losses were a result of the company's August1998 disclosure of its true financial conditionwhich revealed the company's misconduct. Daou,411 F.3d at 1026. The fact that prior to the August1998 disclosure the company continued to concealthe misconduct is important to the decision as evid-enced by the Ninth Circuit's recognition that priorto the August 1998 revelation “the defendantsfailed to disclose the actual figures to analysts toconceal the fact that Daou's operating earnings andmargins were deteriorating as a result of the[misconduct].”Id.(concluding that because the com-plaint did not allege any revelations of the com-

pany's true financial health prior to August of 1998that any losses suffered prior to August 1998“cannot be considered causally related.”).

*5 Here, the revelations pointed to in the complaintdid not reveal the “true financial condition” of Ida-corp because, as stated in the complaint, the Apriland June 2002 forecast reductions “partially re-vealed the impact” of the misconduct but that theDefendants continued to conceal the “improper andmanipulative transactions.” (Dkt. No. 92, ¶ 59).Even if the forecast reductions were “partial revela-tions” of the “impact” of the Defendants' miscon-duct on the company, the Court finds that loss caus-ation has not been pled because the amended com-plaint still alleges that the Defendants' continued toconceal the misconduct and, therefore, any marketreaction was not caused by knowledge of the im-proper activity. The Chief Magistrate Judge's con-clusion is consistent with this determination as itturns on when the alleged misconduct became“known to the market,” thereby causing losses toinvestors. The Chief Magistrate Judge determined,as this Court has, that because the misrepresenta-tions were not made known to the marketplace untilafter the Class Period, the decline in stock price hasnot been causally linked to the improper activitiesof the Defendant.

C. Overtron Contract:

The Defendants argue the Overtron contract prob-lems fail to support the Plaintiff's claim for losscausation because the market was never advisedthat the Overtron contract impacted the companies'earnings. Plaintiff argues the lack of response bythe market to the pre-class information regardingIdacorp's involvement with un-creditworthy coun-terparties like Overtron is explained by the fact thatthe market had not yet digested the impact of theseactivities on Idacorp. In contrast, the subsequentstrong market response to the April and June 2002forecasts are, Plaintiff argues, a clear indication thatIdacorp's true financial condition was being re-vealed to the market.

Having reviewed the amended complaint, the Court












finds that the facts regarding the Overtron contract,revealed prior to the Class Period, do not supportloss causation. The Plaintiff's theory is that thelosses were caused following the forecast reduc-tions which began to reveal the truth about the De-fendants' true financial health as a result of havingengaged in risky relationships with many uncredit-worthy customers. Plaintiff argues it was not untilthe forecast reductions that the market had digestedthe impact of the Defendants' improper conduct,such as the Overtron deal, and the market did notreact until the forecasts were issued in 2002. Thefacts regarding the Overton contract, however, cutagainst Plaintiff's theory because it evidences thefact that the forecast reductions in April and June of2002 did not reveal any new information that hadnot been previously disclosed to the public.FN1ThePlaintiff's theory ignores the existence of other mar-ket factors and that the pleading requirement forloss causation exists, in part, to ensure that thelosses alleged were caused by the misconduct andnot other market factors. See Dura, 544 U.S. at343-45. Based on the facts alleged here, it is im-possible to say that the price reduction on these par-ticular days in the volatile energy market wascaused by Defendants' misconduct because the mis-conduct was not yet known to the market. Becausethe amended complaint fails to allege facts whichdemonstrate the loss causation element, the motionto dismiss is granted.

FN1. The facts of the Overton deal weremade known before the Class Period. (Dkt.No. 68, Exhibit D).

III. Leave to Amend:

*6 The initial complaint in this action was filed onMay 26, 2004 and later consolidated on August 31,2004. (Dkt.Nos.1, 26). A consolidated complaintwas filed on October 29, 2004. (Dkt. No. 30). Fol-lowing the first report and recommendation in thiscase, the Court allowed Plaintiff an opportunity toamend the complaint as to loss causation. AfterPlaintiff filed the amended complaint Defendantsfiled the motion to dismiss which the Court hasconsidered in this order. (Dkt.Nos.91, 92, 95).

The report and recommendation recommends deny-ing the Plaintiff's request to again amend the com-plaint, concluding that any amendment would befutile. Based on the de novo review of the record,this Court agrees with recommendation of the ChiefMagistrate Judge. Although Rule 15 provides thatleave to amend “shall be freely given when justiceso requires,” such a request is not necessary whereallowing another chance to amend the complaintwould be futile. See Fed.R.Civ.P. 15(a); Bowles v.Reade, 198 F.3d 752, 757-58 (9th Cir.1999)(“Liberality in granting a plaintiff leave to amend issubject to the qualification that the amendment notcause undue prejudice to the defendant, is notsought in bad faith, and is not futile. Additionally,the district court may consider the factor of unduedelay.”) (citation omitted). Accordingly, the Courtwill deny the second request to amend as being fu-tile.

Having conducted a de novo review of the objectedto portions of the Report and Recommendation, theCourt finds that Chief Magistrate Judge Williams'Report and Recommendation is well founded in thelaw and consistent with this Court's own view ofthe evidence in the record. Acting on the recom-mendation of Chief Magistrate Judge Williams, andthis Court being fully advised in the premises, ITIS HEREBY ORDERED that except to the extentit has been modified by the Court herein, the Reportand Recommendation entered on March 6, 2007(Dkt. No. 108) is should be and is hereby, INCOR-PORATED by reference and ADOPTED as modi-fied by this order.

THEREFORE IT HEREBY ORDERED Defend-ants' Motion to Dismiss (Dkt. No. 95) is GRAN-TED. Plaintiff's motion to amend (Dkt. No. 100) isDENIED.

JMIKEL H. WILLIAMS, United States MagistrateJudge.

Currently pending before the Court for its consider-ation is Defendants' Motion to Dismiss (Docket No.95-1), filed June 16, 2006. Having reviewed all











briefing submitted, as well as other pertinent docu-ments in the Court's file, and having heard oral ar-guments, the Court makes its Report and Recom-mendation as follows.

Background.

This is a class action suit on behalf of persons whoacquired publicly issued securities of Idacorp, Inc.between February 1, 2002, and June 4, 2002 (“classperiod”). Plaintiffs allege that the Defendants viol-ated federal securities laws through improper en-ergy trading activities, manipulation of earnings,and the issuance of false and misleading financialforecasts. As a result, Plaintiffs allegedly purchasedIdacorp, Inc., securities at artificially inflated pricesduring the class period.

*7 The Defendant, Idacorp, Inc., (“Idacorp”) is de-scribed as an energy holding company which oper-ates through seven subsidiaries, two of which areinvolved here: Idaho Power Company and IdacorpEnergy. Idaho Power Company (“IPC”) is strictly aregulated electric public utility company that gener-ates, transmits, distributes, sells and purchases elec-tric energy for its customers. Idacorp Energy (“IE”)was an unregulated company that engaged in en-ergy trading, hedging, and marketing of electricityand natural gas.

In 2001, Idacorp was listed as a Fortune 500 com-pany with $5.6 billion in revenue. It was among thetop five power marketers in the West and wasamong the top twenty in the nation, mainly due toIE's success, which accounted for over $4 billion ofthe 2001 revenue. (IE had been a major player inselling power to California during its energy crisisthat year.) At its height, Idacorp stock sold at $40per share. In addition to Idacorp, the other namedDefendants are: John Miller (Idacorp's Chairman ofthe Board), Jan Packwood (Idacorp's President andCEO and IPC's CEO), J. Lamont Keen (Idacorp'sExecutive Vice President and IPC's President andChief Operating Officer), and Darrel Anderson(Idacorp's Vice President of Finance and Treasurer

and Chief Financial Officer).

Plaintiffs generally allege that, during the classperiod, IE manipulated earnings and financial fore-casts in order to maintain a false perception of con-tinued growth. Plaintiffs allege the Defendantsknew that public announcements they were makingabout earnings potential were false and that thePlaintiffs relied on this information to their detri-ment.

The first public announcement occurred on Febru-ary 1, 2002. Idacorp reported record financial earn-ing for 2001, which were attributed to IE trades.Idacorp projected that earnings per share (“EPS”)on its stock for 2002, of $2.90 to $3.20. Stock ana-lysts projected that IE would individually contrib-ute EPS of $1.59 for 2002. Plaintiffs allege that theDefendants knew at the time the announcement wasmade that the earnings results and forecasts werematerially false and misleading and that the pre-dicted future earnings potential was inflated.

A second public announcement was made by Ida-corp on April 12, 2002, and the 2002 EPS amountwas reduced to the range of $2.20 to $2.50 pershare. Stock analysts also projected that IE wouldcontribute lower EPS of $0.92 for 2002. Plaintiffsallege this announcement was necessary due to thegovernment agencies' scrutiny and that Idacorpknew that it would be unable to continue to manip-ulate projected earnings for 2002.

On May 22, 2002, Idacorp announced that it hadbeen requested to turn over documents to the Feder-al Energy Regulatory Commission (“FERC”). Thenon May 30, 2002, the state of California broughtsuit against IPC for price gouging after it allegedlysold power to California at inflated prices during its2001 energy crisis.

A third public announcement about earnings poten-tial was made by Idacorp on June 4, 2002. The2002 EPS projection was further reduced to therange of $1.35 to $1.70 per share and it was an-nounced that it was expected that no revenue wouldbe generated by IE in 2002 and perhaps even a lossof $0.25 per share was expected. (The actual loss




based on IE's performance ended up being $0.39per share.) On June 21, 2002, seventeen days afterthe end of the class period, Idacorp announced thatit was discontinuing IE's operations. By then, Ida-corp's stock price had dropped to $27 per share.

*8 Eventually, the governmental agency investiga-tions revealed improprieties in IE trading practices;that IPC and IE had engaged in collusive conductwhich conferred improper benefits on IE at the ex-pense of IPC customers; that various provisions ofthe Federal Power Act, 16 U.S.C. § 824, et seq.(governing sales of wholesale electricity), were vi-olated; and that the Company's own code of con-duct was violated. Idacorp, IE, and IPC entered intosettlement agreements with both FERC (on May 16,2003), and IPUC (on March 15, 2004), which resul-ted in millions of dollars being refunded to IPCcustomers from both IPC and IE.

Plaintiffs brought a class action alleging two causesof action: violation of Section 10(b) of the 1934 Se-curities Exchange Act and Rule 10b-5, 17 C.F.R. §240. 10b-5; and violation of Section 20(a) of the1934 Securities Exchange Act. This Court previ-ously found that the Plaintiffs had failed to estab-lish loss causation and recommended that Defend-ants' Motion to Dismiss (Docket No. 56) be grantedand regarded Plaintiffs' request to amend as futile.

The District Court Judge agreed with the recom-mendation as to the Plaintiffs' failure to establishloss causation, but he disagreed, in part, by grantingPlaintiffs an opportunity to amend. (MemorandumOrder (Docket No. 91 at 6)). On May 1, 2006,Plaintiffs filed the First Amended ConsolidateComplaint (“FACC”) for violation of the FederalSecurities Laws (Docket No. 92) and Defendantsagain moved to dismiss the FACC, resulting in thepending motion currently before the Court.

Standard of Review.

A motion to dismiss under Fed.R.Civ.P. 12(b)(6)should not be granted unless it appears beyond adoubt that the plaintiff can prove no set of facts insupport of his claim that would entitle him to relief.

Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99,2 L.Ed.2d 80 (1957). When attacked pursuant toRule 12(b)(6), well-pled allegations in a complaintmust be treated as true, and all reasonable infer-ences drawn in the plaintiff's favor. See North StarInt'l v. Arizona Corp. Comm'n, 720 F.2d 578, 580(9th Cir.1983). Conclusory allegations of law andunwarranted inferences, however, are insufficient todefeat a motion to dismiss. In re VeriFone Sec. Lit-ig., 11 F.3d 865, 868 (9th Cir.1993). When rulingon a motion to dismiss, the district court may con-sider the facts alleged in the complaint, documentsattached to the complaint, documents relied uponbut not attached to the complaint when authenticityis not contested, and matters of which the Courttakes judicial notice. Parrino v. FHP, Inc., 146F.3d 699, 705-06 (9th Cir.1998), superseded bystatute on other grounds,28 U.S.C. § 1453(b), asrecognized in Abrego Abrego v. Dow Chemical Co.,146 F.3d 676 (9th Cir.2006).

In considering the Private Securities Litigation Re-form Act (“PSLRA”), a court must employ aheightened standard of review when dealing withsecurities fraud. In 1995, Congress enacted thePSLRA to curb what were perceived as abusivepractices in securities-fraud litigation. In raising thebar for securities-fraud suits, the PSLRA toughenedthe already-stringent requirements for pleadingfraud under FRCP 9(b).See Cooper v. Pickett, 137F.3d 616, 625 (9th Cir.1997) Under the PSLRA, toadequately allege securities fraud, a complaint mustspecify each statement alleged to have been mis-leading, the reason or reasons why the statementwas misleading, and, if an allegation is made on in-formation and belief, all facts upon which that be-lief is formed. 15 U.S.C. § 78u-4(b)(1). A com-plaint must also state with particularity facts givingrise to a “strong inference” that the defendant(s) ac-ted with the required state of mind. 15 U.S.C. §78u-4(b)(2).

Analysis of Motion to Dismiss.

*9 Judge Lodge held that under both Dura andDaou, Plaintiffs' previous Complaint failed to es-
































tablish loss causation. (Memorandum Order(Docket No. 91 at 5)). However, the Judge did al-low Plaintiffs an opportunity to amend their com-plaint solely in regards to the issue of loss causa-tion. (Memorandum Order (Docket No. 91 at 6)).Defendants responded by filing a second Motion toDismiss (Docket No. 95-1) claiming that Plaintiffsstill have not established loss causation.

The Supreme Court has outlined some of the neces-sary elements a plaintiff must establish to proceedin an action involving publically tradedsecurities.Dura Pharmaceuticals, Inc. v. Broudo,544 U.S. 336, 342, 125 S.Ct. 1627, 161 L.Ed.2d577 (2005). One of those elements being “ ‘losscausation’ i.e., a causal connection between the ma-terial misrepresentation and the loss. Id. Private se-curity fraud actions are available, “not to provideinvestors with broad insurance against marketlosses, but to protect them against those economiclosses that misrepresentations actually cause.”DuraPharmaceuticals, Inc. v. Broudo, 544 U.S. 336,345, 125 S.Ct. 1627, 161 L.Ed.2d 577 (2005).While the pleading requirements are not in place“to impose a great burden upon a plaintiff,” allow-ing a plaintiff to go forward absent indication ofcausation would be contrary to the purpose inten-ded by the heightened pleading requirements. Seeid. at 347.

Under Dura, to establish loss causation a plaintiff isrequired to “prove that defendant's misrepresenta-tion (or other fraudulent conduct) proximatelycaused the plaintiff's economic loss .”Id. at 346;(Memorandum Order (Docket No. 91 at 3)). It isthe plaintiff's burden to establish the causal connec-tion between the decline in share price and the al-leged misrepresentation. In re Daou Systems, Inc.,Securities Litigation, 411 F.3d 1006, 1025-26 (9thCir.2005).

Plaintiffs claim to have established this causal con-nection by relying on language from the Daou de-cision. Plaintiffs allege that like the defendants inDaou, here Defendants released reduced financialforecasts that revealed the company's “true finan-cial condition” and led to a decline in the value of

stock purchased. Daou, 411 F.3d at 1026;(Plaintiffs' Memorandum in Opposition to Motionto Dismiss (Docket No. 100 at 15)). Plaintiffs statethat loss causation is satisfied because the loweredforecasts were evidence that defendants were nolonger able to continue to use financial manipula-tions in operating the company. (Plaintiffs' Memor-andum in Opposition to Motion to Dismiss (DocketNo. 100 at 15)).The reduction of Idacorp's forecasts and the dispar-ity between the previously reported results and thenew forecasts revealed the impact of defendant'smisrepresentations, manipulative transactions andimproper financial adjustments on Idacorp's repor-ted financial results and the impact of Idacorp's in-ability to continue to engage in such misconduct inthe future due to increased regulatory scrutiny.

*10 (Plaintiffs' FACC (Docket No. 92 at 60)).

This argument is essentially the same argument thatwas presented in Plaintiffs' previous ConsolidatedComplaint, which was dismissed by the DistrictCourt. Compare (Plaintiffs' Consolidated Com-plaint (Docket No. 30 at 4))with (Plaintiffs' Consol-idated Complaint (Docket No. 30 at 4-5)). Plaintiffshave failed to allege any new and pertinent facts tosupport the conclusory allegations already rejected.In reviewing Plaintiffs' FACC and in hearing oralarguments, this Court has been unable to identifyany new facts pled by Plaintiffs to support the con-clusion that Defendants' actions became knownduring the class period. As the District Court previ-ously stated:As determined by the Magistrate Judge, these an-nouncements did not reveal information not previ-ously disclosed to the public; instead, the companyhad previously announced that several factors couldpossibly impact the stock prices including deterior-ating credit conditions. Because the company dis-closed the risks involved with entering into the al-leged un-creditworthy counterparties prior to the re-duction in stock prices, Plaintiff has failed to allegeloss causation. Additionally, this Court finds themore telling failure in the pleading is the fact thatthe truth about the alleged misstatements was notrevealed until after the class period and, thus, the




















decline in stock price as alleged by Plaintiff wasnot caused by the forecast reductions.

(Memorandum Order (Docket No. 91 at 4)).Plaintiffs have not alleged new facts but have in-stead offered more explanation and comparison tothe Daou decision.

As the District Court stated in its decision, the factsin this case are different than in Daou.The defend-ants in Daou, like the Defendants here, revealedthat they had missed their projected earnings andwould report a loss on its shares. Daou, 411 F.3d at1026. However, the court in Daou stated“[n]otably, the [amended complaint] alleg[ed] that‘Defendants further revealed that the Company'sprogress account represented over $10 million inunbilled receivables-the direct result of prema-turely recognizing revenue.’ “ Daou, 411 F.3d at1026 (emphasis in the original). Thus, the defend-ants in Daou directly revealed to the public that ithad engaged in improper revenue recognition dur-ing the class period. Id.

In this case, Plaintiffs have not alleged any factsdemonstrating that Defendants' conduct was dis-closed during the class period, but only that a dropin share price occurred, and that as a result of thisdrop Defendants' true financial condition becameknown. In a fraud on the market case, an allegationof an inflated purchase price standing along is notsufficient to prove loss causation. See Dura, 544U.S. 336 at 342, 125 S.Ct. 1627, 161 L.Ed.2d577.“[T]he Supreme Court's decision in Duramakes clear that in fraud-on-the-market cases in-volving publicly traded stocks, plaintiffs cannotplead loss causation simply by asserting that theypurchased the security at issue at an artificially in-flated price....”Livid Holdings Ltd. v. Salmon SmithBarney, Inc., 416 F.3d 940, 944 (9th Cir.2005)(internal citations omitted). The purpose of aprivate security action is “not to provide investorswith a broad insurance against market losses, but toprotect them against those economic losses thatmisrepresentations actually caus[ed].”Dura Phar-maceuticals, Inc., 544 U.S. 336, 345, 125 S.Ct.1627, 161 L.Ed.2d 577 (2005).

*11 Unlike Daou, Defendants' accounting practicesremained concealed until after the class period hadended and the government investigations were com-pleted. There was no indication in the mentionedpress releases that improper activity had occurredwhich would have caused the drop in share price.To the contrary, Plaintiffs' FACC acknowledgesthat this misconduct was not disclosed to the pub-lic. (Plaintiffs' FACC (Docket No. 92 at 37)).

Plaintiffs cite to a decision from the District ofIllinois to support their argument that loss causationis satisfied arguing that the “truth began to leakout” concerning Defendants misconduct during theclass period. In re Motorola Securities Litigation,2007 WL 487738 at *30 (N.D.Ill.2007). However,this case is readily distinguishable based upon thesame principles used to distinguish Daou.In Mo-torola, there is much discussion regarding whattypes of events or disclosures are sufficient to satis-fy loss causation. Id. at *28.The court in that caseconcluded that loss causation can be demonstratedin a variety of ways and does not necessarily need a“corrective disclosure” regarding the precise actthat caused to drop in value to satisfy loss causa-tion. Id. at *28-29.However, as that court pointedout, a plaintiff must still demonstrate that the truthabout the alleged misrepresentation, which were re-lied upon, did in fact make its way into the market-place. Id. (emphasis added).

The facts from this case are analogous to the Mo-torola court's discussion of the first press release(The February 23 Warning) where Motorola an-nounced a reduced earnings forecast. Id . at*30.The Motorola court held that the announce-ment reducing the earnings forecast could not betied to any misconduct that was known in the mar-ketplace. Id. Regardless of the standard adopted,the plaintiffs must “have alleged in some fashionthat the truth became known before the shared pricefell.”Id. at 28.In this case, Plaintiffs have failed toallege facts to support that Defendants' conduct be-came known in any fashion to the marketplace dur-ing the class period. To the contrary, Plaintiffs'FACC states that the misconduct was hidden fromthe public and thus loss causation is not satisfied.























Plaintiffs also repeatedly refer to Defendants' con-tract with Overton as reason for the drop in stockvalue. However, again as stated previously in theDistrict Judge's decision, that fact was alreadymade know two months prior to the start of theclass period by way of a conference call and a post-ing on the company website. (Declaration of DennisKerrigan (Docket No. 68 at Exhibit D-5)). There-fore, the problem with the Overton contract was notrevealed during the class period.

Defendants argue that Plaintiffs have failed to al-lege “even one new fact” in the FACC to supporttheir position. (Defendants' Memorandum in Sup-port of Motion to Dismiss (Docket No. 95-2 at 6)).The Court also is unable to find any new relevantfactual allegations in Plaintiffs' FACC that wouldsupport Plaintiffs' conclusions. Plaintiffs havefailed to allege new facts that would alter the Dis-trict Court's previous analysis. For instance, in theparagraphs located below Plaintiffs' heading“Summary of Allegations Concerning Loss Causa-tion,” (Plaintiffs' FACC (Docket No. 92 at 59))Plaintiffs continue to make conclusory statementsthat are lacking any factual support to demonstratethat Defendants' misconduct was made known tothe marketplace during the class period.

*12 Plaintiffs do provide a more detailed explana-tion of the case law upon which they rely andprovide a better explanation of their argument.However, despite the clearer articulation ofPlaintiffs' position, Plaintiffs have still failed to al-lege any new facts that would aid the Court inreaching a different conclusion.

In Plaintiffs' Consolidated Complaint, the allega-tions of loss causation referred to the forecast re-ductions in April and June of 2002 as revealing pri-or misappropriations and causing a fall in stockprice. In Plaintiffs' FACC, those same forecasts arestill relied upon to show loss causation without anyadditional fact being pled to establish the linkbetween the drop in share price and Defendants'misconduct becoming known during the class peri-od. (Plaintiffs' FACC (Docket No. 92 at 59-61)).There are no allegations that Defendants' wrongful

conduct became known to the marketplace until al-most a year after the class period had ended.

Leave to Amend

In the alternative, Plaintiffs again request that theCourt grant them an opportunity to amend theircomplaint to satisfy the element of loss causation.(Plaintiffs' Memorandum in Opposition to Motionto Dismiss (Docket No. 100 at 18.))Generally, un-der Fed.R.Civ.P. 15(a) a court should freely giveleave to amend when justice so requires. To aid inits analysis, the Supreme Court has given the dis-trict courts the following factors to consider whendeciding whether to allow leave to amend:In the absence of any apparent or declared reason-such as undue delay, bad faith or dilatory motive onthe part of the movant, repeated failure to cure defi-ciencies by amendments previously allowed, undueprejudice to the opposing party by virtue of allow-ance of the amendment, futility of amendment,etc.-the leave sought should, as rules require, be“freely given.”

Foman v. Davis, 371 U.S. 178, 182, 83 S.Ct. 227, 9L.Ed.2d 222 (1962); Eminence Capital, LLC v. As-peon, Inc., 316 F.3d 1048 1052 (9thCir.2003).“Dismissal with prejudice and withoutleave to amend is not appropriate unless it is clearon de novo review that the complaint could not besaved by amendment.”Id.

In this Court's previous recommendation, it dis-missed Plaintiffs' Consolidated Complaint with pre-judice denying leave to amend. (R & R (Docket No.86 at 17)). The District Judge was inclined to agreewith this Court's recommendation, but due to therecent Ninth Circuit decision on point, Plaintiffswere allowed an opportunity to amend.(Memorandum Order (Docket No. 91 at 6)). Thefailure to demonstrate loss causation in Plaintiffs'FACC further emphasizes the futility of allowingPlaintiffs another opportunity to amend.

Plaintiffs were given the opportunity to amend theircomplaint specifically in regard to loss causationand the recent controlling case law from the Ninth











Circuit and Supreme Court. Plaintiffs have failed tocorrect the deficiencies discussed above and havenot established loss causation. The Court finds thatDaou is distinguishable from the case as hand anddoes not help Plaintiffs' case. In addition, even un-der a more liberal interpretation of Dura, Plaintiffshave not alleged that Defendants' misconduct be-came know to the marketplace in any fashion dur-ing the class period. Plaintiffs have again failed toallege the necessary facts to demonstrate loss caus-ation and granting another opportunity to amend thecomplaint would be futile.

Conclusion.

*13 In conclusion, the Court finds that the Plaintiffshave not satisfactorily pled loss causation for thereasons outline above. Because this is an essentialelement to Plaintiffs' cause of action, it is not ne-cessary for the Court to address the other groundsadvanced by either party. In addition, based on therecord before the Court, it does not appear thatPlaintiffs could cure the deficiencies in their FACCand that it would be futile to allow an amendmentunder Fed.R.Civ.P. 15. The Court therefore recom-mends that the motion to dismiss be granted andthat the case be dismissed.

Based upon the foregoing, the Court being other-wise fully advised in the premises, the Courthereby RECOMMENDS that:

1) Defendants' motion to dismiss (Docket No.95-1), filed June 16, 2006, be GRANTED.

2) Plaintiffs' request for leave to amend beDENIED.

3) Written objections, if any, to this Report and Re-commendation must be filed no later than March16, 2007, or as a result of failing to do so, that partymay waive the right to raise factual and/or legal ob-jections to the United States Court of Appeals forthe Ninth Circuit.

4) Written replies, if any to the objections to thisReport and Recommendation must be filed no later

than March 23, 2007.

D.Idaho,2007.Powell v. Idacorp, Inc.Slip Copy, 2007 WL 1498881 (D.Idaho)

END OF DOCUMENT





EXHIBIT 12


In re Regal Communications Corp. Securities Litig-ationE.D.Pa.,1996.

United States District Court, E.D. Pennsylvania.In re REGAL COMMUNICATIONS CORPORA-

TION SECURITIES LITIGATION.This Document Relates to all Actions.

Master File No. 94-179.

July 17, 1996.

Barry E. Ungar, Mann, Ungar, Spector, Labovitz,P.C., Sherrie R. Savett, Philadelphia, PA, RichardSchiffrin , Schiffrin & Craig, Ltd., Bala Cynwyd,PA, Susan R. Gross, Law Offices of Bernard M.Gross, P.C., Philadelphia, PA, Donald B. Lewis,Law Offices of Donald B. Lewis, Bala Cynwyd,PA, M. Richard Komins, Gerald J. Rodos, Barrack,Rodos & Bacine, Philadelphia, PA, Nancy Kabooli-an, Abbey and Ellis, New York City, for Brad Rich-man and Jacob Bailis.Howard J. Kaufman, Edmund B. Luce, Kaufman,Coren & Ress, Philadelphia, PA, for Arthur L. Toll.Joseph M. Donley, Kittredge, Donley, Elson,Fullem & Embick, Richard J. Sestak, Kittredge,Donley, Elson, Fullem & Embick, Philadelphia,PA, for Bruce B. Edmondson.Bruce B. Edmondson, Brandon, FL, pro se.Laurence Z. Shiekman, Paul R. Rosen, Spector,Gadon & Rosen, P.C., Sherrie R. Savett, Phil-adelphia, PA, Mark Gardy, Abbey & Ellis, NewYork City, Gerald J. Rodos, Barrack, Rodos & Ba-cine, Philadelphia, PA, for Regal CommunicationsCorp.Henry H. Janssen, Rapp, White, Janssen & German,Ltd., Philadelphia, PA, for Coopers & Lybrand.Jeffrey G. Weil, Jan P. Levine, Dechert, Price &Rhoads, Philadelphia, PA, Judah I. Labovitz , Phil-adelphia, PA, Marguerette N. Hosbach, Ernst andYoung LLP, New York City, John W. Frazier, IV,Montgomery, McCracken, Walker & Rhoads, Phil-adelphia, PA, Kathryn A. Oberly, Ernst and Young,New York City, Michael L. Rugen, Heller, Ehrman,

White and McAuliffe, San Francisco, CA, for Ernst& Young LLP.

MEMORANDUMGILES, District Judge.*1 Plaintiffs allege violations by the defendantsFN1 of Sections 10(b) and 20 of the Securities Ex-change Act of 1934, as amended 15 U.S.C. § 78j(b)and 78t(a), and Rule 10b-5 promulgated thereunderby the Securities Exchange Commission (“SEC”),17 C.F.R. 240.10b-5 (Count I); violations of Sec-tions 11 and 15 of the Securities Act of 1933, asamended 15 U.S.C. §§ 77k and 77o (Count II); andcommon law negligent misrepresentation underPennsylvania common law (Count IV).

FN1. The defendants are Arthur L. Toll(“Toll”) and Bruce B. Edmondson(“Edmondson”), and Ernst & Young, LLP(“E & Y”). During the relevant time peri-ods, Arthur Toll was Chairman of theBoard of Directors and Chief ExecutiveOfficer of Regal Communications(“Regal”), and Bruce Edmondson wasRegal's Executive Vice President, ChiefFinancial Officer, and a director of Regal.

Much of the facts of this case are documented inthis court's memorandum and order certifying theclass. See In Re Regal Communications, No.94-179, 1995 WL 550454 (E.D.Pa. September 12,1995). For the purposes of deciding this motion, itwill suffice to say that plaintiffs contend that de-fendants issued a series of materially false and mis-leading public statements about Regal's operations,prospects and financial standing, thereby creating amisleadingly optimistic picture and resulting in anartificially inflated price of Regal securities duringthe Class Period. The allegations of misconductagainst Toll and Edmondson are numerous and in-clude counterfeited documents, forged signaturesand phantom transactions.

Plaintiffs' claims against E & Y stem from its auditand opinion of Regal's 1992 financial statements

Not Reported in F.Supp. Page 1Not Reported in F.Supp., 1996 WL 411654 (E.D.Pa.), Fed. Sec. L. Rep. P 99,274(Cite as: Not Reported in F.Supp.)







































(the “1992 financials”) which were included inRegal's registration statement Form 10-K filed withthe SEC and prospectus for Regal's June 1993debenture offering. The 1992 financials reportedaccounts receivable of approximately $12.3 million.Three of these receivables, totaling approximately$7.5 million, were non-existent. As a result, Regalwas able to report a profit in 1992 instead of a largeloss. E & Y concedes that it is almost certain thatplaintiffs will show that these receivables werefraudulent. However, E & Y takes issue withplaintiffs' allegations that E & Y issued an unquali-fied opinion on the 1992 financials without prop-erly confirming that these receivables did, in fact,exist. Plaintiffs essentially argue that E & Y's auditwas such a deviation from generally accepted ac-counting standards (“GAAS”) that it amounted to asham audit and therefore, E & Y is jointly liable forthe misrepresentations.

Before the court is E & Y's motion for partial sum-mary judgment. For the reasons which follow, themotion is granted in part and denied in part.

STANDARD FOR SUMMARY JUDGMENT

Summary judgment under Fed.R.Civ.P. 56(c) is ap-propriate when there remains no material issue offact upon which a reasonable jury could find in fa-vor of the non-moving party or the moving party isentitled to judgment as a matter of law. “One of theprincipal purposes of the summary judgment rule isto isolate and dispose of factually unsupportedclaims or defenses.” Celotex Corp. v. Catrett, 477U.S. 317, 322-27 (1986).

The inquiry on summary judgment is whether theevidence presents a sufficient factual disagreementto require submission to a jury, or whether the evid-ence is so one-sided that the moving party deservesjudgment in its favor as a matter of law. Andersonv. Liberty Lobby, Inc., 477 U.S. 242, 251-52(1986). Disputed facts are material if they might af-fect the outcome of the suit. Id. at 249. The courtmust view all inferences to be drawn from the factsin the light most favorable to the non-moving party,id. at 247-48, but inferences based on mere specula-

tion or conjecture cannot create a fact dispute suffi-cient to defeat summary judgment. Robertson B. Al-lied Signal, Inc., 914 F.2d 360, 383 n. 12 (3dCir.1990). The non-moving party must demonstratethrough specific evidence, that there remains agenuine issue of material fact and show that a ra-tional jury could return a verdict for the non-moving party. Celotex, 477 U.S. at 322-27.

DISCUSSION

*2 E & Y asserts that summary judgment should begranted in its favor on all the claims except for theSection 11 claims by class members who purchasedRegal debentures prior to January 14, 1994 andheld to that date or later. We now address each ofthe bases offered by E & Y.

A. The Existence of Scienter

E & Y first moves for summary judgment againstplaintiffs' 10(b) claims. One of the requisite ele-ments of a claim under Section 10(b) of the Securit-ies Exchange Act of 1934 and Rule 10b-5 is proofthat the defendant acted with scienter, namely theintent to deceive, manipulate, or defraud. Herman& MacLean v. Huddleston, 459 U.S. 375, 382(1983). E & Y contends that plaintiffs can offer noevidence from which a jury could reasonably con-clude that E & Y acted with scienter. We disagree.

Proof of reckless conduct will satisfy the scienterrequirement. McLean v. Alexander, 599 F.2d 1190,1197-98 (3d Cir.1979). Reckless conduct is “highlyunreasonable [conduct], involving not merely inex-cusable negligence, but an extreme departure fromthe standards of ordinary care, and which presents adanger of misleading buyers or sellers that is eitherknown to the defendant or is so obvious that theactor must have been aware of it.” McLean, 599F.2d at 1197 (alteration in original) (quoting Sund-strand Corp. v. Sun Chemical Corp., 553 F.2d1033, 1045 (7th Cir.1977)). “A showing of shoddyaccounting practices amounting at best to a preten-ded audit, or of grounds supporting a representationso flimsy as to lead to the conclusion that there wasno genuine belief of it have traditionally supporteda finding of liability.” Id. at 1198.





































Where an auditor virtually hands over the confirma-tion process to the corporation being audited, areasonable jury could find that the auditor had nogenuine belief in the accuracy of thosereceivables.FN2 Plaintiffs have shown a genuine is-sue of fact as to whether E & Y gave Regal controlover the confirmation letters. There is evidencewhich infers that the Uprise confirmation was neversent by E & Y.FN3 Similarly, E & Y claims to havereceived a confirmation on the Inphomation receiv-able, but that document has been purportedly lost.Moreover, there are E & Y work papers which im-ply that the Inphomation confirmation was not re-ceived. (Confirmation Control Log, Pls.' Ex. 29).Finally, it is conceded that the third confirmation-the INFO receivable-was not received.FN4 Al-though E & Y counters this evidence with numer-ous explanations, it is precisely the job of a jury toweigh the credibility of those explanations.

FN2. This is particularly true where, ashere, plaintiffs intend to present evidenceshowing that the auditor knew the corpor-ate officers had been associated with priorinstances of securities fraud. (Pls.' Mem. at62-63; Supp.Mem. at 2).

FN3. For example, it is virtually certainthat plaintiffs will show that the signatureof Thomas Pileggi on the Uprise receivablewas a forgery. At the very least this raisesan inference that E & Y did not actuallysend the confirmation to Uprise, but ratherallowed someone at Regal to handle theconfirmation process. Further, the confirm-ation is dated three days before E & Y pur-portedly sent it. (Pl.'s Mem. at 51-54).

FN4. Moreover, plaintiffs have also showna factual issue as to whether Craig Cohen,the auditor handling the INFO receivable,actually sent out a confirmation letter. Co-hen's work papers contain the notation thatthis receivable needed confirmation. (Pls.'Mem. at 38-39).

E & Y claims to have performed numerous addi-

tional procedures to confirm the receivables whichnegate any finding of recklessness as a matter oflaw. These allegations, in some cases relying ondocuments no longer in existence or that are argu-ably suspect,FN5 only raise more issues of fact.Whether E & Y's audit was reckless is clearly aquestion of fact to be determined by a jury.

FN5. For example, E & Y purports that theINFO receivable was supported by vendorstatements, but those statements cannot befound in the work papers. (Pls' Mem. at 43n. 13). Similarly, the Uprise receivable waspurportedly supported by invoices andshipping documents which no longer exist.(Def.'s Mem. at 13-14). Finally, the pur-ported payment checks from Uprise aresimply treasurers checks with the name“Uprise Sales” typed in. (Pls.' Ex. 34).

B. The Proposed January 14, 1994 Cut-Off Date.

*3 E & Y moves for summary judgment against allclass members who purchased securities after Janu-ary 14, 1994 (the date this lawsuit was announcedto the public), arguing that by this date, the invest-ing community had knowledge of fraud at Regal.Thus, E & Y argues that (1) it has rebutted the pre-sumption of reasonable reliance on E & Y's opin-ion, and (2) that its opinion was no longer materialafter January 14, 1994.

Under the fraud-on-the-market theory, “[a]ny show-ing that severs the link between the alleged misrep-resentation and either the price received (or paid) ...will be sufficient to rebut the presumption.” BasicInc. v. Levinson, 485 U.S. 224, 248 (1988). If truthof the misstatements entered the market and dissip-ated the effects of those misstatements, plaintiffscannot be said to have relied on the market price.Id. at 248-49 (emphasis added). The presumption ofreliance, however, is not rebutted as soon as anypublic statement is made. Id. at n. 28 (“We do notintend conclusively to adopt any particular theoryof how quickly and completely publicly availableinformation is reflected in market price”). Thefraud-on-the-market presumption deals with the









market's reflection of the value through the price ofthe stock. Moskowitz v. Lopp, 128 F.R.D. 624, 631(E.D.Pa.1989). Thus, summary judgment is inap-propriate so long as a reasonable jury could findthat the market price of Regal stock was still artifi-cially inflated after January 14, 1996.

Here it cannot be said that the disclosures made byJanuary 14, 1994, as a matter of law, dissipated theeffects of the alleged misrepresentations. The factthat the price of Regal stock fell 28 per cent afterthe April 14, 1994 disclosure FN6 at least raises afactual issue of whether the market was fully ap-prised of the fraud any earlier. (Affid. of J.Torkelsen, Pls.' Ex. 35). Sherin v. Gould, 115F.R.D. 171, 175 (E.D.Pa.1987) (holding that a dropin market price following a second public an-nouncement precluded a finding, as a matter of law,that the first announcement fully cured the misrep-resentation). Moreover, as a matter of policy, it isunreasonable to charge prospective stock pur-chasers with access to every bit of information thatmay impact their decision. See In re Western UnionSecurities Litigation, 120 F.R.D. 629, 638(D.N.J.1988).

FN6. It is conceded that it was not untilApril 14, 1994, that the public announce-ment was made that the 1992 financialsand E & Y's certification could not be re-lied on.

As to the materiality of the alleged misstatements,while E & Y argues that the financials were overfifteen months old by January 14, 1996, it providesno authority to support the proposition that an aud-itor's opinion becomes “stale” as a matter of lawwithin a certain time frame. It is true that Regal hadissued subsequent quarterly financial statements,but those statements refer back to the informationin the Form 10-K incorporating E & Y's opinion.(Pls.' Mem. at 90). Plaintiffs' expert states that in-vestors typically rely on a company's most recentForm 10-K. (Pls.' Ex. 35). Finally, where the mar-ket price of Regal stock fell 28 per cent after dis-closure that E & Y's opinion was no longer reliable,a jury could reasonably find that E & Y's opinion

was still material.

*4 For these reasons, we are also unpersuaded by E& Y's argument that class members who retainedtheir stock after January 14, 1996, cannot provecausation as a matter of law. Assuming that the de-cision to retain stock after knowledge of an allegedfraud constitutes a second investment decisionwhich breaks the causal chain, there still remains afactual question as to when the market reflectedknowledge of the alleged fraud. It may well be thecase that some of the more knowledgeable or vigil-ant class members suspected fraud prior to April14, 1996. (Def.'s Mem. at 57-59). However, it is fora jury to decide whether there was sufficient in-formation in the market so as to impute knowledgeto the entire class.

C. E & Y's Negative Causation Defense

E & Y moves for partial summary judgment on theclaims under Section 11 of the Securities Act of1933, as amended 15 U.S.C. §§ 77k, against allplaintiffs who sold their debentures prior to Janu-ary 13, 1994. Section 11(e) provides an affirmativedefense, known as the defense of negative causa-tion, for defendants who can prove that the declinein the value of the security in question was notcaused by the alleged misrepresentations. 15 U.S.C.§ 77k(e). See also McMahan & Co. v. WherehouseEntertainment, Inc., 65 F.3d 1044, 1048 (2dCir.1995). E & Y argues that the first disclosure ofpotential problems with the 1992 financials oc-curred when Regal filed its Form 8-K with the SECon January 13, 1994. Thus, any decline in the priceof the debentures prior to this date cannot be attrib-uted to the alleged misrepresentations.

As a general rule, any decline in price before dis-closure may not be charged to the defendants. SeeAkerman v. Oryx Communications, Inc., 810 F.2d336, 342 (2d Cir.1987). However, because of thealleged fraud, price may not accurately reflect thevalue of the securities. McMahan, 65 F.3d at 1048.Plaintiffs' expert will testify that the value of theDebentures at the time of issuance was $200 and re-mained constant throughout the Debenture period.


























(Pls.' Mem. at 99). Therefore, when and how muchthe value of the Debentures declined is a factual is-sue for the jury.

D. The “Controlling Persons” Claim

E & Y moves for summary judgment on the claimsarising under Section 20(a) of the Securities Ex-change Act of 1934, 15 U.S.C. § 78t(a), and Sec-tion 15 of the Securities Act of 1933, 15 U.S.C. §77o. The purpose of these “controlling persons”provisions is to impose secondary liability on onewho controls a violator of the securities laws andfails to show he acted in good faith. Rochez Broth-ers, Inc. v. Rhoades, 527 F.2d 880, 889 (3dCir.1975).FN7 Plaintiff's concede that E & Y didnot control anyone other than its own audit team.However, no individual auditors are named defend-ants in this action. Where, as here, the defendant isalleged to be primarily liable for violations of thesecurities laws, it makes no sense to assert second-ary liability under Sections 15 and 20(a). A personcannot be both the controller and the controlled.Summary judgment is granted as to the portions ofCount I and Count II alleging liability pursuant to15 U.S.C. §§ 77o, 78t(a).

FN7. Although Rochez only addresses Sec-tion 20(a), it's definition of “control” isequally applicable to Section 15. See In reChambers Development Securities Litiga-tion, 848 F.Supp. 602, 618 (W.D.Pa.1994).

E. The Common Law Claims

*5 Finally, E & Y moves for summary judgment onplaintiffs' common law claims of negligent misrep-resentation (Count IV), arguing that plaintiffs can-not show the necessary elements of reliance andprivity. Although plaintiffs present no argument todefend this largely duplicitous claim, we neverthe-less find persuasive authority exists to deny sum-mary judgment.

Pennsylvania recognizes the claim of negligentmisrepresentation as stated in Section 552 of theRestatement (Second) of Torts.FN8 Reliance is anecessary element of this tort. Plaintiffs concede

that they do not intend to prove actual reliance, butshall rely upon the fraud-on-the-market theory.(Pls.' Mem. at 100).

FN8. The relevant provisions provide:(1) One who, in the course of his business,profession or employment, or in any othertransaction in which he has a pecuniary in-terest, supplies false information for theguidance of others in their business trans-actions, is subject to liability for pecuniaryloss caused to them by their justifiable reli-ance upon the information, if he fails to ex-ercise reasonable care or competence inobtaining or communicating the informa-tion.(2) ... the liability stated in Subsection (1)is limited to loss suffered(a) by the person or one of a limited groupof persons for whose benefit and guidancehe intends to supply the information orknows that the recipient intends to supplyit; and(b) through reliance upon it in a transactionthat he intends the information to influenceor knows that the recipient so intends or ina substantially similar transaction.Restatement (Second) of Torts, § 552(1977).

In certifying the class, this court noted that thefraud-on-the-market theory has not been adopted bythe Pennsylvania courts for claims of negligent mis-representation. See Peil v. Speiser, 806 F.2d 1154,1163 n. 17 (3d Cir.1986). However, the continuingvalidity of the Peil footnote is questionable in lightof the Supreme Court's adoption of the theory inBasic, Inc. v. Levinson, 485 U.S. 224 (1988). See,e.g., Healthcare Services Group, Inc. Sec. Litiga-tion, No. 91-6097, 1993 WL 54437, at *6 (E.D.Pa.Mar. 1, 1993); In re Atlantic Financial Fed. Sec.Litig., No. 89-0645, 1990 WL 171191, at *2-3(E.D.Pa. Oct. 31, 1990). We find the reasoning ofthese cases persuasive. Peil was predictingPennsylvania law in absence of any case law on thesubject. If the Third Circuit were confronted withthis issue today, we think that it would find that the







































“reasoning [of Basic ] is no less persuasive in anegligent misrepresentation case concerning a se-curities market.” Atlantic, 1990 WL 171191, at *2.

E & Y also argues that plaintiffs must show thatthey were in privity with E & Y in order to pursue aclaim for negligent misrepresentation. In Eisenbergv. Gagnon, 766 F.2d 770, 779 (3d Cir.1985), cert.denied,474 U.S. 946 (1985), the Third Circuit rejec-ted this argument. We recognize that district courtsin this circuit have been divided as to whether Eis-enberg is limited to its facts. See In re Phar-Mor,Inc. Sec. Litig., 892 F.Supp. 676, 690-93(W.D.Pa.1995) (collecting cases). Nevertheless, theplain language of Section 552 allows a claim to bebrought against one acting in the course of his busi-ness to be brought by members of a class intendedto be benefitted the information disclosed. The lim-itations are clearly enunciated and we are loathe toinfer another absent guidance from the Third Cir-cuit. See, e.g., In re Intelligent Electronics, Inc.Sec. Litig., Nos. 95-7663, 95-7712, 1996 WL304852, at *4 (holding that both the plain languageof Section 552 and policy considerations make aprivity requirement inappropriate).

CONCLUSION

Although E & Y assert numerous arguments againstholding them liable under the securities laws, theyare more properly presented to a jury. There arematerial issues of fact precluding summary judg-ment at this time. Under the plaintiffs' theory,however, E & Y cannot be a controlling personwithin the meaning of 15 U.S.C. §§ 77o, 78t. Sum-mary judgment shall be granted in their favor onthis limited issue.

*6 An appropriate order follows.

ORDER

AND NOW, this 15th day of July, 1996, upon con-sideration of the motion of defendant Ernst &Young (“E & Y”) for partial summary judgmentand for the reasons which follow, it is herebyORDERED that:

1. The motion is GRANTED in part. Ernst &Young are not “controlling persons” within themeaning of Section 15 of the Securities Act of1933, 15 U.S.C. § 78t(a) or Section 20(a) of the Se-curities Exchange Act of 1934, 15 U.S.C. § 77o.

2. In all other respects, the motion is DENIED.

E.D.Pa.,1996.In re Regal Communications Corp. Securities Litig-ationNot Reported in F.Supp., 1996 WL 411654(E.D.Pa.), Fed. Sec. L. Rep. P 99,274

END OF DOCUMENT









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EXHIBIT 13


In re Refco, Inc. Securities LitigationS.D.N.Y.,2007.

United States District Court,S.D. New York.In re REFCO, INC. SECURITIES LITIGATION

No. 05 Civ. 8626(GEL).

April 30, 2007.

Background: Various defendants in large securit-ies class action arising from the collapse of issuerand its affiliated companies moved for dismissal orpartial dismissal of the complaint as to them.

Holdings: The District Court, Lynch, J., held that:

(1) Rule 144A bond offering memoranda did notqualify as a “prospectus or oral communication”within meaning of Securities Act provision creatingliability for misstatements in prospectuses;

(2) initial offering of unregistered bonds and sub-sequent offer to exchange the notes for registeredsecurities did not constitute a single transactioncovered by Securities Act;

(3) claims under Securities Act for misstatements inregistration statements were not subject toheightened requirements for pleading fraud;

(4) investors stated control-person liability claimsagainst directors and officers who “prepared andapproved” initial public offering (IPO) registrationstatement or were directly involved in corporation'sday-to-day operations;

(5) investors adequately alleged that corporate of-ficers had motive and opportunity to commit fraud;

(6) allegation that audit committee defendants re-ceived grants of stock not common to all boardmembers was sufficient to support an inference ofmotive; and

(7) Securities Exchange Act created a private rightof action against those who controlled acts of in-

sider trading.

Motions granted in part and denied in part.West Headnotes[1] Federal Civil Procedure 170A 1832

170A Federal Civil Procedure170AXI Dismissal

170AXI(B) Involuntary Dismissal170AXI(B)5 Proceedings

170Ak1827 Determination170Ak1832 k. Matters Considered

in General. Most Cited CasesIn deciding motions to dismiss, court may considerdocuments that are referenced in the complaint,documents that the plaintiffs relied on in bringingsuit and that either are in the plaintiffs' possessionor that the plaintiffs knew of when bringing suit, ormatters of which judicial notice may be taken.






uses or Communications. Most Cited CasesPrivate Rule 144A bond offering memoranda didnot qualify as a “prospectus or oral communica-tion” within meaning of Securities Act provisioncreating liability for misstatements in prospectuses.Securities Act of 1933, § 12(a)(2), 15 U.S.C.A. §77l(a)(2); 17 C.F.R. § 230.144A.




349Bk25.17 False Statements or Omis-

503 F.Supp.2d 611 Page 1503 F.Supp.2d 611, Fed. Sec. L. Rep. P 94,312(Cite as: 503 F.Supp.2d 611)




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sions; Accuracy349Bk25.18 k. In General. Most

Cited Cases






uses or Communications. Most Cited CasesInitial offering of unregistered bonds and sub-sequent offer to exchange the notes for registeredsecurities did not constitute a single transactioncovered by Securities Act provision creating liabil-ity for misstatements in registration statements orSecurities Act provision creating liability for mis-statements in prospectuses. Securities Act of 1933,§§ 11, 12(a)(2), 15 U.S.C.A. §§ 77k, 77l(a)(2); 17C.F.R. § 230.144A.






Most Cited CasesBond underwriter defendants were not subject to li-ability under Securities Act provision creating liab-ility for misstatements in registration statements fordirect involvement in unregistered bond offering;there were no allegations suggesting that bond un-derwriter defendants held themselves out in any re-spect as to the public offering, no allegations sug-gesting that the bond underwriter defendants boreany risk with respect to that transaction, and no al-legations of any specific role played by defendantsin the underwriting of the public offering. Securit-

ies Act of 1933, §§ 2(a)(11), 11, 15 U.S.C.A. §§77b(a)(11), 77k; 17 C.F.R. § 230.144A.

[5] Federal Civil Procedure 170A 636

170A Federal Civil Procedure170AVII Pleadings and Motions

170AVII(A) Pleadings in General170Ak633 Certainty, Definiteness and

Particularity170Ak636 k. Fraud, Mistake and Con-

dition of Mind. Most Cited CasesHeightened requirements for pleading fraud applyto claims under Securities Act provision creating li-ability for misstatements in registration statementsonly insofar as the claims are premised on allega-tions of fraud. Securities Act of 1933, § 11, 15U.S.C.A. § 77k; Fed.Rules Civ.Proc.Rule 9(b), 28U.S.C.A.





dition of Mind. Most Cited CasesLanguage at the beginning of each Securities Actclaim for misstatements in registration statementsdisclaiming any intent to allege fraud is by itself in-sufficient to protect those claims from stringent re-quirements for pleading fraud. Securities Act of1933, § 11, 15 U.S.C.A. § 77k; Fed.RulesCiv.Proc.Rule 9(b), 28 U.S.C.A.





dition of Mind. Most Cited CasesInvestors' claims under Securities Act for misstate-ments in registration statements were not subject to




























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heightened requirements for pleading fraud wherethey disclaimed fraud and expressly pled negli-gence in connection with those claims. SecuritiesAct of 1933, § 11, 15 U.S.C.A. § 77k; Fed.RulesCiv.Proc.Rule 9(b), 28 U.S.C.A.





349Bk25.21 Grounds of and De-fenses to Liability

349Bk25.21(3) k. Materiality;Reliance. Most Cited CasesInvestors who purchased unregistered bonds andthen traded them for registered bonds did not state aclaim under Securities Act provision creating liabil-ity for misstatements in registration statementsbased on omissions in bond registration statement;investors failed to allege that the omitted informa-tion would have made a reasonable shareholder anyless likely to favor the exchange, and thereforefailed to show that any omissions or misrepresenta-tions were material. Securities Act of 1933, § 11,15 U.S.C.A. § 77k.



349BI(B) Registration and Distribution349BI(B)1 Registration Requirement in

General349Bk11.14 Persons Subject to Regu-

lation or Liability349Bk11.19 k. Control Persons or

Groups and Underwriters Dealing with Them. MostCited CasesTo prevail on a Securities Act control-person liabil-ity claim, plaintiff is required to prove actual con-trol, not merely control person status. SecuritiesAct of 1933, § 15, 15 U.S.C.A. § 77o; 17 C.F.R. §240.12b-2.






Groups and Underwriters Dealing with Them. MostCited CasesControl-person liability exists under Securities Actonly where there is a primary violation. SecuritiesAct of 1933, § 15, 15 U.S.C.A. § 77o.






Most Cited CasesAllegations that defendant directors and officers“prepared and approved” initial public offering(IPO) registration statement or were directly in-volved in corporation's day-to-day operations, in-cluding financial reporting and accounting, weresufficient to allege that those defendants exercisedcontrol over corporation at the time misstatementsin initial public offering (IPO) registration state-ment and prospectus became effective, and there-fore stated control-person liability claims againstthose defendants. Securities Act of 1933, § 15, 15U.S.C.A. § 77o; 17 C.F.R. § 240.12b-2.




























































Groups and Underwriters Dealing with Them. MostCited CasesFor purposes of determining whether a defendantcan be held liable for securities violations on basisof control theory, issue is whether the defendanthas the power to direct or cause the direction of themanagement and policies of a person, not whetherthat power is exercised at the direction of another.Securities Act of 1933, § 15, 15 U.S.C.A. § 77o; 17C.F.R. § 240.12b-2.





Persons. Most Cited Cases




349Bk60.39 Persons Liable349Bk60.41 k. Aiders and Abettors.

Most Cited CasesA defendant must actually make a false or mislead-ing statement in order to be held liable for securit-ies fraud; anything short of such conduct is merelyaiding and abetting, and no matter how substantialthat aid may be, it is not enough to trigger liabilityunder Section 10(b). Securities Exchange Act of1934, § 10(b), 15 U.S.C.A. § 78j(b); 17 C.F.R. §240.10b-5.




349Bk60.50 Pleading

349Bk60.51 k. In General. MostCited CasesUnder the doctrine of group pleading, securitiesfraud plaintiffs can circumvent the general pleadingrule that fraudulent statements must be linked dir-ectly to the party accused of the fraudulent intentby relying on a presumption that statements in pro-spectuses, registration statements, annual reports,press releases, or group-published information, arethe collective work of those individuals with directinvolvement in the everyday business of the com-pany; alleging direct involvement in the company'severyday business is critical to support the pre-sumption. Securities Exchange Act of 1934, §10(b), 15 U.S.C.A. § 78j(b); 17 C.F.R. § 240.10b-5.





Cited CasesAllegations that each of three officers “preparedand approved” the allegedly fraudulent documents,and that each was a corporate insider or affiliatewith direct involvement in the daily affairs of thecompany were sufficient under group pleading doc-trine to plead fraud with the requisite particularity.Private Securities Litigation Reform Act of 1995, §101(b), 15 U.S.C.A. § 78u-4(b).




349Bk60.50 Pleading349Bk60.53 k. Misrepresentation.

Most Cited CasesAllegations that audit committee defendants ap-proved misleading bond registration statement, hadextensive access to company's internal information,were responsible for overseeing the integrity of






















































company's financial statements, and approved thosefinancial statements for all relevant periods weresufficient under the group pleading doctrine toplead fraud with the requisite particularity. PrivateSecurities Litigation Reform Act of 1995, § 101(b),15 U.S.C.A. § 78u-4(b).





349Bk60.27 Misrepresentation349Bk60.27(1) k. In General.

Most Cited Cases




349Bk60.43 Grounds of and Defensesto Liability

349Bk60.45 Scienter, Intent,Knowledge, Negligence or Recklessness

349Bk60.45(1) k. In General.Most Cited CasesAlthough pre-class-period statements can be relev-ant for showing whether defendants had knowledgethat their later statements were false, those state-ments cannot themselves give rise to liability forsecurities fraud. Securities Exchange Act of 1934, §10(b), 15 U.S.C.A. § 78j(b); 17 C.F.R. § 240.10b-5.





Persons. Most Cited CasesGroup pleading doctrine is a doctrine of attribution,

not of complicity, and therefore does not give riseto securities fraud liability for later statements by adefendant's former associates. Securities ExchangeAct of 1934, § 10(b), 15 U.S.C.A. § 78j(b); 17C.F.R. § 240.10b-5.





Cited CasesGroup pleading doctrine has no effect on thePrivate Securities Litigation Reform Act's (PSLRA)scienter requirement; doctrine, which merely givesplaintiffs the benefit of a presumption that certainkinds of statements were made by certain kinds ofdefendants, does not permit plaintiffs to presumethe state of mind of those defendants at the time thealleged misstatements were made. Private Securit-ies Litigation Reform Act of 1995, § 101(b)(2), 15U.S.C.A. § 78u-4(b)(2).





Cited CasesTo establish an adequate motive to commit securit-ies fraud, plaintiffs, in order to meet Private Secur-ities Litigation Reform Act's (PSLRA) scienter re-quirement, must allege a motive that is concrete andpersonal to the defendant charged with making themisstatement or omission. Private Securities Litiga-tion Reform Act of 1995, § 101(b)(2), 15 U.S.C.A.§ 78u-4(b)(2).




























































349Bk60.45(1) k. In General.Most Cited CasesMere desire to increase officer compensation orstock prices does not give rise to a “strong infer-ence” of fraudulent intent required to satisfy PrivateSecurities Litigation Reform Act's (PSLRA) sci-enter requirement. Private Securities Litigation Re-form Act of 1995, § 101(b)(2), 15 U.S.C.A. §78u-4(b)(2).





Cited CasesInvestors adequately alleged that corporate officershad motive and opportunity to commit fraud, andtherefore satisfied Private Securities Litigation Re-form Act's (PSLRA) scienter requirement; investorsalleged that officers had a direct financial interestin initial public offering (IPO), and by fraudulentlyconcealing the uncollectible receivables, they coulddrive up demand for company's shares, whichwould result in purchases of shares from whichthey would be directly compensated, and that eachofficer prepared and approved the relevant mis-statements. Private Securities Litigation ReformAct of 1995, § 101(b)(2), 15 U.S.C.A. §78u-4(b)(2).




349Bk60.50 Pleading

349Bk60.51 k. In General. MostCited CasesRecklessness is adequately alleged in securitiesfraud action when a plaintiff specifically alleges de-fendants' knowledge of facts or access to informa-tion contradicting their public statements. PrivateSecurities Litigation Reform Act of 1995, §101(b)(2), 15 U.S.C.A. § 78u-4(b)(2).






349Bk60.45(1) k. In General.Most Cited CasesScienter cannot be inferred in securities fraud ac-tion solely from the fact that, due to the defendants'board membership or executive managerial posi-tion, they had access to the company's internal doc-umentation as well as any adverse information;however, scienter may be found where there arespecific allegations of various reasonably availablefacts, or “red flags,” that should have put the of-ficers on notice that the public statements werefalse. Private Securities Litigation Reform Act of1995, § 101(b)(2), 15 U.S.C.A. § 78u-4(b)(2).





Cited CasesInvestors did not adequately allege recklessness ofparent company's vice president for global market-ing, and chief operating officer (COO) with respectto fraudulent transactions of subsidiary or companycontrolled by parent's chief executive officer (CEO)
















































where there were no allegations that those defend-ants had any responsibility for reviewing thosecompanies' books or any other basis for concludingthat those officers should have been familiar withany of those companies' transactions; however, al-legations of recklessness were sufficient with re-spect to parent's chief financial officer (CFO) andgeneral counsel, who had responsibility for parent'sfinancial well-being, and to whom the regular ap-pearance and disappearance of a large receivable atthe end of parent's financial periods was a glaringred flag. Private Securities Litigation Reform Actof 1995, § 101(b)(2), 15 U.S.C.A. § 78u-4(b)(2).






349Bk60.45(1) k. In General.Most Cited CasesMere membership in a committee with oversight re-sponsibilities is not enough to give rise to an infer-ence of recklessness for purposes of satisfyingPrivate Securities Litigation Reform Act's (PSLRA)scienter requirement. Private Securities LitigationReform Act of 1995, § 101(b)(2), 15 U.S.C.A. §78u-4(b)(2).





Cited CasesAllegations that an audit committee failed to takesteps to prevent fraud may suffice to satisfy PrivateSecurities Litigation Reform Act's (PSLRA) sci-enter requirement where plaintiffs identify specific

actions that the committee-members should havetaken that would have prevented the fraud;however, where plaintiffs fail to describe the chainof events by which defendants should have dis-covered or averted the fraud, the allegations do notgive rise to an inference of scienter. Private Securit-ies Litigation Reform Act of 1995, § 101(b)(2), 15U.S.C.A. § 78u-4(b)(2).





Cited CasesSecurities fraud plaintiffs, who alleged that auditcommittee was anemic in its oversight function andthat an unidentified employee caught the fraud afteronly two months of employment, failed to ad-equately allege that the audit committee defendantswere so reckless as to give rise to an inference ofscienter. Private Securities Litigation Reform Actof 1995, § 101(b)(2), 15 U.S.C.A. § 78u-4(b)(2).





Cited CasesAllegation that audit committee defendants re-ceived grants of stock not common to all board-members was sufficient to support an inference ofmotive for purposes of alleging scienter in securit-ies fraud action. Private Securities Litigation Re-form Act of 1995, § 101(b)(2), 15 U.S.C.A. §78u-4(b)(2).


















































dition of Mind. Most Cited CasesInvestors' allegations with respect to auditor's ma-terial misstatements were sufficiently particular tostate securities fraud claim because they gave audit-or ample notice of the ways in which its unqualifiedaudit reports allegedly misrepresented the proprietyof its auditing practices and company's accountingpractices. Securities Exchange Act of 1934, §10(b), 15 U.S.C.A. § 78j(b); Fed.RulesCiv.Proc.Rule 9(b), 28 U.S.C.A.




tions349Bk25.65 k. Pleading. Most Cited

Cases





Cited CasesWith respect to securities law claims against is-suer's auditor, investors adequately alleged losscausation as to losses suffered after the date of theinitial press release disclosing omitted uncollectiblereceivables and disavowing the financial state-ments; allegations could support an inference thatforeseeability linked the omitted information andthe ultimate injury in the case. Securities ExchangeAct of 1934, § 10(b), 15 U.S.C.A. § 78j(b); Securit-ies Act of 1933, § 11, 15 U.S.C.A. § 77k.


349B Securities Regulation

349BI Federal Regulation349BI(C) Trading and Markets

349BI(C)7 Fraud and Manipulation349Bk60.43 Grounds of and Defenses

to Liability349Bk60.45 Scienter, Intent,

Knowledge, Negligence or Recklessness349Bk60.45(3) k. Accountants,

Attorneys, Underwriters and Brokers. Most CitedCasesFor an accountant to be found to have acted reck-lessly during an audit, its alleged misconduct mustapproximate an actual intent to aid in the fraud be-ing perpetrated by the audited company; plaintiffsmust prove that the accounting practices were sodeficient that the audit amounted to no audit at all,or an egregious refusal to see the obvious, or to in-vestigate the doubtful, or that the accounting judg-ments which were made were such that no reason-able accountant would have made the same de-cisions if confronted with the same facts. SecuritiesExchange Act of 1934, § 10(b), 15 U.S.C.A. §78j(b).




349Bk60.50 Pleading349Bk60.56 k. Conduct of Ac-

countants or Attorneys. Most Cited CasesAuditor's recklessness was sufficiently alleged insecurities fraud action against auditor, which waspremised on its alleged false statements about itsown auditing practices and company's accountingpractices; the size of the company's fraudulenttransactions, the fact that at least some of com-pany's officers were allegedly involved in orches-trating them, and the volume of documentation al-legedly created, together with the others, estab-lished a strong inference of scienter on auditor'spart. Securities Exchange Act of 1934, § 10(b), 15U.S.C.A. § 78j(b); Private Securities Litigation Re-form Act of 1995, § 101(b)(2), 15 U.S.C.A. §78u-4(b)(2).























































Groups and Underwriters Dealing with Them. MostCited Cases



349BI(C) Trading and Markets349BI(C)1 In General

349Bk35.15 k. Controlling Persons.Most Cited CasesControl-person liability provisions of Securities Actand Securities Exchange Act are parallel provi-sions, and their terms are interpreted in the samemanner. Securities Act of 1933, § 15, 15 U.S.C.A.§ 77o; Securities Exchange Act of 1934, § 20(a), 15U.S.C.A. § 78t(a).




349Bk35.15 k. Controlling Persons.Most Cited CasesUnlike Securities Act, control-person liability pro-vision of Securities Exchange Act requires that theplaintiff must also allege culpable participation insome meaningful sense by the controlling person inthe fraud. Securities Act of 1933, § 15, 15 U.S.C.A.§ 77o; Securities Exchange Act of 1934, § 20(a), 15U.S.C.A. § 78t(a).





dition of Mind. Most Cited CasesHeightened pleading requirement applies to the“culpable participation” element of control-personliability claim under Securities Exchange Act;plaintiff must plead with particularity facts givingrise to a strong inference that the controlling personknew or should have known that the primary violat-or, over whom that person had control, was enga-ging in fraudulent conduct. Securities ExchangeAct of 1934, § 20(a), 15 U.S.C.A. § 78t(a).





Persons. Most Cited CasesComplaint alleging that the shell entities that con-trolled primary violator were defendant gave rise toa strong inference of defendant's culpable participa-tion so as to state control-person liability claim un-der Securities Exchange Act. Securities ExchangeAct of 1934, § 20(a), 15 U.S.C.A. § 78t(a).





Persons. Most Cited CasesFor purposes of control-person liability claims un-der Securities Exchange Act, culpable participationwas adequately alleged as to those defendants as towhom motive and opportunity, but not recklessness,had been adequately alleged. Securities ExchangeAct of 1934, § 20(a), 15 U.S.C.A. § 78t(a).





























































Persons. Most Cited CasesFor purposes of “culpable participation” element ofcontrol-person liability claim under Securities Ex-change Act, allegation that almost four billion dol-lars in fraudulent loans passed through corporateentity through which all of the allegedly fraudulenttransactions passed was sufficient to raise an infer-ence of recklessness as to co-owner. Securities Ex-change Act of 1934, § 20(a), 15 U.S.C.A. § 78t(a).




349Bk35.15 k. Controlling Persons.Most Cited CasesControl-person liability claim under Securities Ex-change Act requires that the defendant have actualcontrol over the transaction in question. SecuritiesExchange Act of 1934, § 20(a), 15 U.S.C.A. §78t(a).





Cited CasesFor purposes of “culpable participation” element ofcontrol-person liability claim under Securities Ex-change Act, allegations that board members weredeeply involved in the day-to-day management ofcompany and had “unfettered access” were insuffi-cient to allege recklessness where there were no al-legations supporting a “strong inference” that theboard members were actually aware of the red flags

in question; however, allegation that board mem-bers stood to profit personally and directly fromany oversubscription of shares purchased in initialpublic offering (IPO) in a way not common to allboard members supported an inference of motive.Securities Exchange Act of 1934, § 20(a), 15U.S.C.A. § 78t(a).

[42] Securities Regulation 349B 60.28(2.1)




349Bk60.28 Nondisclosure; InsiderTrading

349Bk60.28(2) Duty to Discloseor Refrain from Trading

349Bk60.28(2.1) k. In Gener-al. Most Cited CasesThere can only be insider trading liability under Se-curities Exchange Act if the predicate violation ofthe Exchange Act was an act of insider trading. Se-curities Exchange Act of 1934, § 20A, 15 U.S.C.A.§ 78t-1.





Persons. Most Cited CasesSecurities Exchange Act creates a private right ofaction against those who control acts of insidertrading, as well as the primary violators who dir-ectly engage in them. Securities Exchange Act of1934, § 20A, 15 U.S.C.A. § 78t-1.

*617 John P. Coffey, Max W. Berger, Salvatore J.Graziano, John C. Browne, and Jeremy P.Robinson, Bernstein Litowitz Berger & GrossmanLLP, New York, New York, and Stuart M. Grant,James J. Sabella, Megan D. McIntyre, Jeff A. Al-





































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meida, Christine M. Mackintosh, and Jill Agro,Grant & Eisenhofer P.A., New York, New Yorkand Wilmington, Delaware, for Lead Plaintiffs Pa-cific Investment Management Company, LLC andRH Capital LLC and the Prospective Class.Robert B. McCaw, Lori A. Martin, John V.H.Pierce, and Dawn M. Wilson, Wilmer Cutler Pick-ering Hale and Dorr LLP, New York, New York,for the “144A” or “Bond Underwriter” Defendants.Jeffrey T. Golenbock and Adam C. Silverstein,Golenbock Eiseman Assor Bell & Peskoe LLP,New York, New York, for Defendants Phillip R.Bennett, Refco *618 Group Holdings Inc., and Phil-lip R. Bennett Three Year Annuity Trust.Bruce R. Braun, Bradley E. Lerman, Linda T.Coberly, and David Mollón, Winston & StrawnLLP, New York, New York and Chicago, Illinois,and Margaret Maxwell Zegel and Tracy W. Berry,Grant Thornton LLP, Chicago, Illinois, for Defend-ant Grant Thornton LLP.Michael T. Hannafan, Blake T. Hannafan, andNicholas A. Pavich, Hannafan & Hannafan, Ltd.,Chicago, Illinois, and Norman Eisen and MelindaSarafa, Zuckerman Spaeder LLP, New York, NewYork, for Defendant Tone Grant.Helen B. Kim and Marc D. Powers, Baker &Hostetler LLP, New York, New York and LosAngeles, California, and Richard E. Nathan, NathanLaw Office, Los Angeles, California, for DefendantDennis A. Kleina.Stuart L. Shapiro, Matthew J. Sava, and Yoram J.Miller, Shapiro Forman Allen Sava & McPhersonLLP, New York, New York, for Defendants JosephJ. Murphy and Gerald M. Sherer.Ivan Kline, Stuart I. Friedman, and Elizabeth D.Meacham, Friedman & Wittenstein, New York,New York, for Defendant William M. Sexton.Holly K. Kulka, Heller Ehrman LLP, New York,New York, for Defendant Philip Silverman.Greg A. Danilow and Paul Dutka (Seth Goodchildand Joshua S. Amsel, on the brief), Weil, Gotshal &Manges LLP, New York, New York, for the “THL”and “Audit Committee” Defendants.Barbara Moses and Rachel Korenblat, Morvillo,Abramowitz, Grand, Iason, Anello & Bohrer, P.C.,New York, New York, for Defendant Robert Tros-

ten.

LYNCH, District Judge.Various defendants in this large securities class ac-tion arising from the collapse of Refco Inc. and itsaffiliated companies (“Refco”) move for dismissalor partial dismissal of the First Amended Complaintas to them. This opinion addresses ten motions todismiss by twenty-eight defendants, many of whomraise overlapping arguments. Accordingly, to avoidan unduly duplicative and lengthy opinion, themovants' legal arguments will be grouped together.Detailed discussions of relevant factual allegationswill be reserved for the legal analyses that requirethem, and the initial discussion of background factswill accordingly be brief.

I. The Allegations

A. The Alleged Fraudulent Scheme

Refco was a provider of brokerage and clearing ser-vices in the international derivatives, currency andfutures markets.FN1 Part of Refco's business modelinvolved giving loans to its trading clients, whichthe clients then used to leverage larger trades.(Compl. ¶¶ 2, 87, 382.) At a certain point, Refcobegan making loans without adequately assessingthe customers' credit-worthiness or their tradingactivities. These risky loans began to backfire in1997 and 1998, when several global financial crisescaused Refco and a number of its largest customersto suffer massive trading losses. (Compl. ¶¶ 31,383-97.) *619 The loans were now “uncollectiblereceivables” that would never be paid. (P. Mem. 8.)

FN1. The name “Refco,” as usedthroughout this opinion, refers to RefcoInc., the publicly traded company formedpursuant to the August 2005 initial publicoffering (“IPO”) described below, as wellas to Refco Group Ltd., LLC, the companythrough which Refco's business wasprimarily conducted prior to the IPO.(Compl. ¶¶ 20-21.)









































Rather than disclose these uncollectible receivablesto the public and Refco's investors, Refco's man-agement allegedly devised a scheme to hide them.First, they transferred the loans onto the books ofRefco Group Holdings, Inc. (“RGHI”), an entityowned and controlled by defendant Phillip R. Ben-nett, Refco's president, CEO, and Chairman(Compl. ¶ 32) and Tone Grant, Bennett's prede-cessor as CEO (id. ¶ 41). As a result, RGHI owedhundreds of millions of dollars to Refco. In order tohide RGHI's obligation to Refco, the complaint al-leges, a series of fraudulent transactions were ar-ranged by which the RGHI receivable was made todisappear from Refco's books.

The transactions all worked in essentially the sameway. First, Refco Capital (a Refco subsidiary)would make loans to a third party.FN2 This moneywas transferred into accounts in the third party'sname at Refco. (Com pl.¶¶ 417-18). The third partywould then loan an equivalent amount to RGHI; theloan agreements between the third party and RefcoCapital required that the money be used only forthat purpose.FN3 (Id. ¶ 411.) These loans to RGHIwere guaranteed by Refco itself; Bennett-on behalfof Refco as guarantor-signed the loan agreementbetween the third party and RGHI. (Com pl.¶¶415-18.) RGHI then used the loan from the thirdparty to pay down the money it owed to Refco forthe uncollectible receivables. (Compl. ¶ 416.) Thus,Refco Capital was loaning money to RGHI for usein temporarily paying off its debt to Refco. Thisseries of transactions would take place a few daysbefore the end of the relevant financial period, andwould be undone within two weeks. (Compl. ¶409).

FN2. It appears from the complaint thatmost or all of the loans at issue originatedfrom Refco Capital, a subsidiary, not fromRefco itself. (Compl. ¶¶ 403, 405.) Al-though the Complaint in various placesuses “Refco” and “Refco Capital” inter-changeably, it is clear in context that RefcoCapital was the source of the loans. For ex-ample, paragraph 409 of the complaintclearly uses “Refco” to refer to “Refco

Capital,” as is apparent from the allegationthat the loan agreement was signed byDavid Weaver, the Chief AdministrativeOfficer at Refco Capital.

FN3. The third parties were compensatedfor this service by the interest on theirloans to RGHI, which was greater than theinterest they were charged by Refco Capit-al. (Compl. ¶ 413.) The payments of in-terest, however, were made by Refco Cap-ital, not RGHI. (Id. ¶ 418.)

The loans in question were substantially greaterthan Refco's reported net income. A February 2005loan, for example, was for $595 million, 337% ofRefco's reported net income for the relevant fiscalyear. (Compl. ¶ 560.) A February 2004 loan was for$970 million, 518% of Refco's reported net incomefor the relevant fiscal year. (Id.) If compared toquarterly income, of course, the size of the loans iseven more dramatic: a November 2004 loan for$545 million was the equivalent of 3,045% of Re-fco's reported net income for that quarter. (Id.) FN4

FN4. Plaintiffs argue that loans for sums inexcess of Refco's net earnings were unusu-al (Compl. ¶ 562), but do not provide in-formation about other loans with which tocompare the fraudulent loans. Defendantspoint out that the loans represented lessthan 1% of Refco's alleged assets duringthe Class Period. (See id.¶¶ 177, 515).

Thus, Refco Capital was loaning enormous sums ofmoney to the third party while Refco guaranteed anequivalent loan from the third party to RGHI.Meanwhile, Refco Capital-not RGHI-paid to thethird party the interest purportedly owed by RGHI.(Id. ¶ 563.) The transactions *620 took place insubstantially the same form over the course of sixyears.

None of these transactions was disclosed to thepublic in the filings discussed below. Thus, in ef-fect, Refco was loaning money to itself, throughthird parties, to hide its dismal financial situationfrom the public and its investors.




B. The Relevant Transactions

The various transactions at issue in this case tookplace while the fraudulent scheme above was ongo-ing.

1. The Rule 144A Bonds and the Exxon CapitalExchange

In June 2004, Refco issued $600 million of 9%Senior Subordinated Notes due in 2012. Thesebonds were sold to the defendants referred to byplaintiffs as the “Bond Underwriter Defendants,”who call themselves the “144A Defendants.” Thesedefendants then immediately resold the bonds to in-stitutional buyers, including some of the plaintiffs.(See Compl.¶¶ 94-95, 100-08.) The bonds were un-registered pursuant to Securities and ExchangeCommission (“SEC”) Rule 144A, 17 C.F.R. §230.144A, which exempts private placements toqualified institutional buyers from the registrationrequirements of the Securities Act, and were thusissued pursuant to an offering memorandum ratherthan a registration statement. (Compl. ¶¶ 105-108.)Plaintiffs allege that this offering memorandumcontained various false statements concerning Re-fco's financial performance and viability. (Id.¶¶109-143.) The unregistered bond offering was mar-keted to institutional investors at a nationwide roadshow in July 2004 (the “Road Show”).

Plaintiffs argue that this unregistered bond offeringwas the first step in a single plan of financing. Thesecond step in this putative plan came when Refcoissued registered bonds, which holders of the Rule144A Bonds acquired by exchanging their Rule144A bonds for registered bonds in a transactionknown as an “Exxon Capital exchange.”

The registered bond offering was made pursuant toa Form S-4 Registration Statement (Wilson Decl.Ex. C) (the “Bond Registration Statement”), whichwas filed with the SEC on October 12, 2004, andbecame effective on the day the registered bondswere issued, April 13, 2005. The registration state-ment was not yet effective at the time of the Rule144A offering. (Compl. ¶¶ 149-50.) Plaintiffs al-lege that this statement, too, contained various false

statements of material fact. (Id.¶¶ 153-65.)

2. The August 2005 IPO

In August 2005, Refco conducted a successful ini-tial public offering (“IPO”), underwritten by fifteenbanks including the three banks that served as un-derwriters for the Rule 144A offering. (See P.Mem. 14 n. 8). In the IPO, Refco sold approxim-ately 20% of its shares to plaintiff RH Capital andother members of the putative class. (Compl. ¶166.) The IPO was conducted pursuant to a Form S-1 registration statement dated April 8, 2005, FormS-1/A registration statements dated May 27, July 1,July 20, July 25, August 8, and August 10, 2005,and a Form 424B1 prospectus dated August 10,2005. (Id. ¶ 168.) Again, plaintiffs allege that thesefilings contained false statements of material fact.(Id.¶¶ 172-98.)

3. The October 2005 Press Release and Refco'sCollapse

On October 10, 2005, Refco issued a press releaseannouncing that it had discovered an “undisclosedaffiliate transaction.” (Id. ¶ 199.) The press releasedisclosed the existence of a $340 million receivableowed to the company by “an entity controlled byPhillip R. Bennett”*621 (that is, RGHI), and indic-ated that Bennett had repaid the receivable in cashas of October 10. It suggested that the receivablerepresented RGHI's assumption of a debt owed by athird party to Refco, which “may have been uncol-lectible.” (Id.) Because this receivable had not beendisclosed in the previously-filed financial state-ments, the press release concluded that these state-ments “should no longer be relied upon.” (Id. ¶200.) Refco's stock price dropped 45% in a singleday. (Id. ¶ 202.) Plaintiffs allege, however, that thispress release did not disclose the full extent of Re-fco's troubles, because it downplayed the impactthat the disclosure would have on Refco's business.(Id.¶¶ 202-03.) An investigation by the SEC wasimmediately commenced, and on October 12, 2005,Bennett was arrested as a flight risk. (Id.¶¶ 205-06.)Refco's stock price continued to decline sharply un-til the New York Stock Exchange (“NYSE”) halted




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trading of Refco shares on October 13, 2005. (Id. ¶208.) On October 17, 2005, Refco announced that itwas filing for bankruptcy. (Id. ¶ 209.)

This litigation was initiated on October 11, 2005. Inan order dated February 8, 2006 (Doc. # 63), theCourt appointed RH Capital Associates LLC (“RHCapital”) and Pacific Investment ManagementCompany LLC (“PIMCO”) as lead plaintiffs pursu-ant to 15 U.S.C. § 78u-4(a)(3)(B) and 15 U.S.C. §77z-1(a)(3). A consolidated class action complaintwas filed on April 3, 2006, and the First AmendedConsolidated Class Action Complaint (Doc. # 86)(the “complaint”) was filed on May 5, 2006. Papersrelating to the ten motions to dismiss now pendingwere submitted between July and November of2006, and the motions are now fully briefed. Beforediscussing the substance of these motions, a briefintroduction to the various movants is appropriate.

C. The Movants

There are ten separate motions to dismiss pending,several of which are filed on behalf of more thanone defendant. This section briefly identifies themovant or group of movants behind each of the tenmotions.

1. Phillip R. Bennett, RGHI, and the BennettTrust

Defendant Phillip R. Bennett was the President,Chief Executive Officer and Chairman of Refco un-til he was forced to resign in October 2005.(Compl. ¶ 32.) Bennett held his interests in Refcoboth directly and through RGHI and the Phillip R.Bennett Three Year Annuity Trust (the “BennettTrust”), both of which he controlled. (Id.¶¶ 26-28.)

2. Tone Grant

Tone Grant was the President of Refco Group be-fore Bennett was promoted to that position inSeptember 1998, at which time Grant ended his em-ployment with Refco. Grant continued to own 50%of RGHI, which in turn owned approximately 43%of Refco Group, until the August 2004 bond offer-ing. (Id. ¶ 23.) To avoid confusion with defendant

Grant Thornton, this opinion will refer to ToneGrant by his full name.

3. William Sexton

William Sexton was Executive Vice President andChief Operating Officer (“COO”) of Refco Groupbeginning in August 2004. He briefly served asCEO of Refco after Bennett's resignation. (Id. ¶34.)

4. Joseph J. Murphy and Gerald M. Sherer

Joseph Murphy was an Executive Vice Presidentfor global marketing at Refco beginning in 1999.Plaintiffs also allege that he served as an officer ofcertain *622 Refco subsidiaries, but these do not in-clude Refco Capital or RGHI, the subsidiaries mostdirectly involved in the allegedly fraudulent trans-actions. (Id. ¶ 36.)

Gerald Sherer was Chief Financial Officer (“CFO”)and an Executive Vice President of Refco Groupbeginning in January 2005. (Id. ¶ 33.)

5. Robert Trosten

Robert Trosten was Sherer's predecessor as CFO ofRefco Group. He served in that capacity from 2001to October 2004. (Id. ¶ 40.)

6. Philip Silverman

Philip Silverman was secretary of several Refco en-tities, including RGHI, and was Controller of RefcoGroup during 2004 and 2005. (Id. ¶ 37.)

7. Dennis Klejna

Dennis Klejna was an Executive Vice President andGeneral Counsel of Refco Group from 1999 untilthe company's collapse. (Id. ¶ 38.)

8. The THL and Audit Committee Defendants

The “THL Partners Defendants” FN5 and the “THLIndividual Defendants” FN6 (together, the “THLDefendants”) are entities and individuals affiliatedwith Thomas H. Lee Partners, L.P., a private equity





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firm that invested $507 million in Refco prior to itscollapse. In June 2004, the THL Defendants helpedRefco with a leveraged buyout, in which the THLDefendants acquired a 57% equity stake in Refco.The remaining 43% was held by RGHI, which, inturn, was owned by Bennett. This gave the THLDefendants a dominant position on Refco's board ofdirectors and a controlling interest in Refco's stock.

FN5. The “THL Partners Defendants” areThomas H. Lee Partners, L.P., Thomas H.Lee Equity Fund V, L.P., Thomas H. LeeParallel Fund V, L.P., Thomas H. LeeEquity (Cayman) Fund V. L.P., THLEquity Advisors V, LLC, Thomas H. LeeInvestors Limited Partnership, and The1997 Thomas H. Lee Nominee Trust.

FN6. The “THL Individual Defendants”are Thomas H. Lee, David V. Harkins,Scott L. Jaeckel and Scott A. Schoen.

The Audit Committee Defendants FN7 are threeformer Refco outside directors who were membersof Refco's audit committee.

FN7. The “Audit Committee Defendants”are Ronald L. O'Kelley, Leo R. Breitmanand Nathan Gantcher.

9. Grant Thornton LLP

Grant Thornton LLP was Refco's outside auditor. Itis the subject of two claims under the Securities Actinvolving the October 2004 Bond RegistrationStatement, and one claim under Section 10(b) of theExchange Act. Each of the three claims arises fromthe audit reports Grant Thornton prepared on Re-fco's year-end financial statements beginning in theyear 2003.

10. The Bond Underwriter Defendants

Defendants Credit Suisse Securities (USA) LLC(“Credit Suisse”), Banc of America Securities LLC(“BAS”), and Deutsche Bank Securities Inc.(“Deutsche Bank”) refer to themselves as the“144A Defendants,” while plaintiffs refer to them

as the “Bond Underwriter Defendants.” (P. Mem.53-54.) These banks were the underwriters for theRule 144A private placement of Refco bonds. Thisopinion will refer to them as the “Bond UnderwriterDefendants.”

The complaint makes claims under both the Secur-ities Act of 1933 and the Securities Exchange Actof 1934. While few defendants move to dismiss allthe claims *623 against them, many defendantsmove to dismiss some, and many of their argumentsoverlap. There are several overarching issuesraised: (1) whether there can be liability under Se-curities Act §§ 11 and 12 for involvement in theRule 144A private placement of unregisteredbonds; (2) the sufficiency of allegations of control-person liability under Securities Act § 15 based onthe Bond Registration Statement; (3) whether theExchange Act § 10(b) and Rule 10b-5 claims areadequately pled with respect to scienter and specif-ic allegations of misrepresentation; (4) whetherplaintiffs have adequately alleged their ExchangeAct claims against Grant Thornton, Refco's auditor;(5) whether plaintiffs have adequately stated aclaim for control-person liability under the Ex-change Act; and (6) whether the insider-trading al-legations against a few of the defendants are ad-equate.

I. Standards for Motions to Dismiss

On a motion to dismiss, the allegations in the Com-plaint are accepted as true, and all reasonable infer-ences drawn in favor of the plaintiffs. Grandon v.Merrill Lynch & Co., 147 F.3d 184, 188 (2dCir.1998). The Court's task is “not to weigh theevidence that might be presented at trial but merelyto determine whether the complaint itself is legallysufficient.” Goldman v. Belden, 754 F.2d 1059,1067 (2d Cir.1985). Therefore, motions to dismissshould only be granted if it appears that theplaintiffs can prove no set of facts in support oftheir claim that would entitle them to relief. RyderEnergy Distrib. Corp. v. Merrill Lynch Commodit-ies, Inc., 748 F.2d 774, 779 (2d Cir.1984).

[1] In deciding motions to dismiss, the Court may















consider documents that are referenced in the Com-plaint, documents that the plaintiffs relied on inbringing suit and that either are in the plaintiffs'possession or that the plaintiffs knew of whenbringing suit, or matters of which judicial noticemay be taken. Chambers v. Time Warner, Inc., 282F.3d 147, 153 (2d Cir.2002). “[W]hen a plaintiffchooses not to attach to the complaint or incorpor-ate by reference a document upon which it reliesand which is integral to the complaint, the courtmay nonetheless take the document into considera-tion in deciding the ... motion to dismiss, withoutconverting the proceeding to one for summaryjudgment.” Int'l Audiotext Network, Inc. v. AT & TCo., 62 F.3d 69, 72 (2d Cir.1995) (internal citationand quotation marks omitted). Thus, for purposes ofa motion to dismiss, a court may consider:any written instrument attached to it as an exhibitor any statements or documents incorporated in itby reference, as well as public disclosure docu-ments required by law to be, and that have been,filed with the SEC, and documents that theplaintiffs either possessed or knew about and uponwhich they relied in bringing the suit.

Rothman v. Gregor, 220 F.3d 81, 88-89 (2dCir.2000) (internal citations omitted).

II. Claims Under Sections 11 and 12 of the Secur-ities Act

Several defendants move to dismiss Counts Oneand Three of the Amended Complaint, which in-volve §§ 12 and 11 of the Securities Act, respect-ively. Essentially, § 11 creates liability for misstate-ments in registration statements for public offer-ings, 15 U.S.C. § 77k, while § 12 creates liabilityfor misstatements in prospectuses. 15 U.S.C. § 77l.

The first set of transactions on which the relevantclaims are based was the private placement offeringof $600 million in Senior Subordinated Notes. (SeeConfidential Offering Circular, July 22, 2004,Wilson Decl. Ex. B. (the “Offering Memor-andum”).)*624 As discussed above, the notes wereunregistered pursuant to SEC Rule 144A, 17 C.F.R.§ 230.144A, which exempts private placements to

qualified institutional buyers from the registrationrequirements of the Securities Act. See15 U.S.C. §77d(2) (exempting from registration requirements“transactions by an issuer not involving any publicoffering”); see alsoIn re Livent, Inc. NoteholdersSecs. Litig., 151 F.Supp.2d 371, 431(S.D.N.Y.2001). Among the purchasers of unre-gistered bonds in this offering were plaintiffsPIMCO and PIMCO High Yield Fund. The BondUnderwriter Defendants acted as lead initial pur-chasers-that is, underwriters-for this issue.

The second set of transactions was the public offer-ing of registered bonds pursuant to a Form S-4 Re-gistration Statement (Wilson Decl. Ex. C) (the“Bond Registration Statement”). In this offering,Refco allowed holders of unregistered bonds to ex-change their bonds for registered bonds in a trans-action known as an “Exxon Capital exchange.”(Compl. ¶ 149.) See Exxon Capital Holding Corp.,SEC No-Action Letter (May 13, 1988). The BondUnderwriter Defendants are not identified as under-writers in the Bond Registration Statement, andclaim not to have been involved in this transactionin any fashion whatsoever.

A. Claims Arising From the Rule 144A Offeringand the Subsequent Public Offering

Count One of the Complaint makes claims under §12(a)(2) of the Securities Act based on alleged mis-statements in the Rule 144A Offering Memor-andum. This count is challenged by a group of de-fendants that includes the Bond Underwriter De-fendants and several defendants whom plaintiffsclaim “solicited the [plaintiffs'] purchases of the144A Bonds.” (Compl. ¶ 275.) FN8 This group ofdefendants argues that § 12(a)(2) does not apply toprivate offering memoranda.

FN8. Specifically, the defendants whomake this argument are Bennett (BennettMem. 9-12), Trosten (Trosten Mem. 8-14),and the THL Partners Defendants(THL/Audit Comm. Mem. 11-20). Murphymakes the same argument in the context ofcontesting control-person liability


















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(Sherer/Murphy Mem. 34-35), as does Sil-verman (Silverman Mem. 13-14).

The Bond Underwriter Defendants also move todismiss Count Three of the complaint, which makesclaims under § 11 of the Securities Act based on theBond Registration Statement, on the grounds thattheir involvement in Refco's collapse was limited tounderwriting the June 2004 private placement ofbonds pursuant to Rule 144A, and that this privateplacement is not a “public offering” subject to theterms of the Act.

Plaintiffs make three arguments in defense of theirclaims arising from the Rule 144A offering: first,that the Rule 144A offering itself is covered by §12(a)(2); second, alternatively, that the Rule 144Aoffering should be treated as part of a two-steptransaction which, viewed as a whole, falls withinthe coverage of § 12(a)(2) or § 11; and third, thatthe Bond Underwriter Defendants were directly in-volved with the creation of the Bond RegistrationStatement and are therefore subject to liability un-der § 11 even if the Rule 144A offering is notcovered.

1. The Rule 144A Offering Cannot Give Rise toLiability Under § 12(a)(2)

[2] Section 12(a)(2) of the Securities Act extends li-ability to any person whooffers or sells a security ... by means of a prospect-us or oral communication, which includes an untruestatement of a material fact or omits to state a ma-terial *625 fact necessary in order to make thestatements ... not misleading.

15 U.S.C.A. § 77l (a)(2). Thus, if the OfferingMemorandum or some other relevant documentdoes not qualify as a “prospectus or oral commu-nication” within the meaning of the statute, thenplaintiffs' § 12(a)(2) claims based on the Rule 144Aoffering must be dismissed.

The Supreme Court held in Gustafson v. AlloydCo., Inc., 513 U.S. 561, 115 S.Ct. 1061, 131L.Ed.2d 1 (1995), that the work “prospectus” refersto “documents related to public offerings by an is-

suer or its controlling shareholders,” that is, docu-ments that “must include the information containedin registration statement.” Id. at 569, 115 S.Ct.1061 (emphasis added; internal quotation marksomitted). The phrase “oral communication,” theCourt explained, refers only to oral communica-tions relating to a prospectus, and therefore doesnot change the analysis. Id. at 567-68, 115 S.Ct.1061. Thus, § 12(a)(2) liability “cannot attach un-less there is an obligation to distribute the prospect-us in the first place.” Id. at 571, 115 S.Ct. 1061.

The Second Circuit further clarified this rule inYung v. Lee, 432 F.3d 142 (2d Cir.2005), holdingthat § 12(a)(2) does not apply to the distribution ofa prospectus prepared in connection with a publicoffering to a purchaser in a private transaction. Id.at 149. Even where the defendants' marketing ef-forts in connection with the private transaction re-lied heavily upon the same prospectus used in apublic offering, there was no liability because de-fendants were not obligated to distribute the pro-spectus in connection with that transaction. Id. Un-der Yung, therefore, the issue is whether the defend-ants in this case were obligated to distribute a pro-spectus in connection with the Rule 144A transac-tion at issue.

Rule 144A specifically provides that securities soldin compliance with its provisions “shall be deemednot to have been offered to the public.” 17 C.F.R. §230.144A(c). Plaintiffs rely heavily on the fact thatthe Rule 144A Offering Memorandum included thesame information that would later be included inthe Bond Registration Statement, but the test iswhether there was any requirement that that inform-ation be included in the Offering Memorandum.SeeGustafson, 513 U.S. at 569, 115 S.Ct. 1061.Plaintiffs point to no such requirement.

The complaint explicitly acknowledges that “theBonds were exempt-from-registration pursuant toRule 144A.”(Compl. ¶ 273.) To concede that an is-suance is properly exempted from registration un-der Rule 144A is to concede that the issuance com-plies with the conditions of the rule, and securitiesissued in compliance with the conditions of the rule




























“shall be deemed not to have been offered to thepublic.” 17 C.F.R. § 230.144A(c).FN9 In otherwords, exemption from registration and non-publicstatus are necessary consequences of compliancewith the conditions of Rule 144A. If the Rule 144Abonds were *626 exempt from registration becausethey complied with Rule 144A, they were non-public by definition.FN10 District courts in theSecond Circuit have consistently dismissed §12(a)(2) claims based on Rule 144A offerings onthe grounds that “offerings under Rule 144A are bydefinition non-public, and offering memoranda dis-tributed in connection with such offerings cannotgive rise to Section 12(a)(2) liability.” Am. High-Income Trust v. Alliedsignal, 329 F.Supp.2d 534,543 (S.D.N.Y.2004); see alsoAIG Global Secs.Lending Corp. v. Banc of Am. Secs. LLC, 254F.Supp.2d 373, 388-389 (S.D.N.Y.2003).

FN9. Plaintiffs note that the full text ofRule 144A provides that securities soldpursuant to its terms “shall be deemed notto have been offered to the public withinthe meaning of section 4(3)(A) of the[Securities] Act,”17 C.F.R. § 230.144A(c)(emphasis added), and argue that it wouldtherefore be inappropriate to deem Rule144A offerings non-public for purposes of§ 12(a)(2). The regulation's languagehardly suggests, however, that an offeringthat is private by its terms, and by federalregulation for purposes of one provision ofthe act, should be considered public forpurposes of another provision. Indeed,Gustafson itself was based on the premisethat the Securities Act “is to be interpretedas a symmetrical and coherent regulatoryscheme, one in which the operative wordshave a consistent meaning throughout.”Gustafson, 513 U.S. at 569, 115 S.Ct.1061.

FN10. Plaintiffs argue that § 12 liabilitydoes not depend upon whether an offeringwas registered. SeeGustafson, 513 U.S. at579, 115 S.Ct. 1061 (noting that dealingsmay violate § 12 “even though they are not

related to the fact of registration” )(emphasis in original) (internal quotationmarks omitted). This is true, but irrelevant.If the bonds were entitled to an exemptionfrom registration under Rule 144A, theywere also entitled to be deemed non-public.

Plaintiffs assert that the SEC “has made clear thatits promulgation of Rule 144A was not intended tolimit the reach of § 12(a)(2), and that it believes §12(a)(2) should apply to Rule 144A/Exxon Capitalexchange transactions” (P. Mem. 47 (emphasis inoriginal)), conveying the impression that the SECagrees with their legal analysis. However, althoughthe SEC would be “in sympathy on policy grounds”with a finding of § 12(a)(2) liability, it believes that“the more likely reading of Gustafson... is that ...the Supreme Court would not have deemed the of-fering memorandum in the Rule 144A offering tobe a prospectus.” (Letter of Aug. 9, 2001, fromDavid M. Becker, General Counsel of the SEC, tothe U.S. Dist. Ct. for the Dist. of S.C., In re Safety-Kleen Bondholders Litig., No. 3:00-1145-17, Cof-fey Dec. Ex. 1, at 3.) This Court agrees with theSEC and with prior courts in this district that undercurrent law a Rule 144A offering does not give riseto liability under § 12(a)(2).

Plaintiffs rely on the pre-Gustafson case of HillYork Corp. v. Am. Int'l Franchises, Inc., 448 F.2d680 (5th Cir.1971), for the proposition that “thequestion of public offering is one of fact and mustdepend upon the circumstances of each case.” Id. at687. It is true that a few post-Gustafson cases inother districts have applied this reasoning to findthat a § 12(a)(2) claim based on a Rule 144A offer-ing could survive a motion to dismiss. See, e.g.,Inre Enron Corp. Secs., Derivative & ERISA Litig.,310 F.Supp.2d 819, 859-866 (S.D.Tex.2004). Asnoted above, however, courts in the Southern Dis-trict of New York have repeatedly declined to fol-low this reasoning. Even if it were followed, noth-ing in the alleged facts of this case suggests that theRule 144A offering was public.

Plaintiffs assert that “the Rule 144A Bonds were






























offered to a subset of the investing public” (P.Mem. 44), but this is disingenuous. In a broadsense, any private transaction involves “a subset ofthe investing public”-every investor is a “subset” ofthe investing public just as every citizen is a subsetof the general public. The Offering Memorandumby its terms, however, required the terms of the of-fer not to be made public, and made clear that theoffering was “personal to the offeree ... and [did]not constitute an offer to any other person or to thepublic generally.” (Offering Memorandum, WilsonDecl. Ex. B., at ii.) The Offering Memorandum alsoprovided that the notes were not registered with theSEC (id. at ii-iii), which, for the reasons discussedabove, clearly implies that they are non-public un-der Rule 144A. See*627In re WorldCom, Inc. Secs.Litig., 294 F.Supp.2d 431, 454 (S.D.N.Y.2003)(“WorldCom I” ) (relying on similar language tohold that “[t]he fact that the [offering in question]was a private placement is clear from its face”).Nothing in the complaint suggests that the Rule144A offering was directed at the general investingpublic. “[N]o matter how the plaintiff might wordthe claim, the document involved cannot be‘silkenized’ into a § 12 [ (a) ](2) ‘prospectus'.”Glamorgan Coal Corp. v. Ratner's Group PLC, No.93 Civ. 7581, 1995 WL 406167, at *3 (S.D.N.Y.July 10, 1995). In short, plaintiffs have offered nopersuasive reason why the Rule 144A offeringshould be treated as public within the meaning of §12(a)(2).

2. The Rule 144A Offering and the Exxon CapitalExchange Do Not Constitute a Single Transaction

Covered By § 12(a)(2) or § 11

[3] Plaintiffs argue that even if the Rule 144A of-fering itself is not covered by § 12(a)(2), it shouldbe treated as part of a single, two-step transactionthat is covered by that provision. They argue that aninitial purchaser or underwriter that prepares an of-fering memorandum for a private placement ofnotes is liable under § 12 when the issuer of thenotes later exchanges them for registered bonds inan Exxon Capital exchange. In other words,plaintiffs contend that the entire two-step process(the initial offering of unregistered bonds, followed

by the Exxon Capital exchange) was a single“public offering.” They make the same argumentwith respect to § 11 of the Securities Act, 15 U.S.C.§ 77k.

District courts have rejected similar efforts to sub-ject Rule 144A transactions to § 12(a)(2) liabilityby treating them as part of larger transactions.SeeAm. High-Income Trust, 329 F.Supp.2d at 543;In re Interbank Funding Corp. Secs. Litig., 329F.Supp.2d 84, 94-95 (D.D.C.2004). “The processby which an issuer offers bonds through a privateplacement under Rule 144A of the Securities Act,and subsequently offers to exchange the Rule 144Anotes for registered securities-an “ ‘Exxon Capitalexchange offer’-is typical of high-yield debt issu-ance.” Am. High-Income Trust, 329 F.Supp.2d at541. Therefore, to treat the two transactions as partof a single plan “would render Rule 144A ineffect-ive for a very substantial number of securities trans-actions, and defeat the capital market financing ob-jectives the Rule 144A exemption was designed toachieve.” Livent, 151 F.Supp.2d at 431-32(addressing a similar integration argument in a § 11context). If an Exxon Capital exchange brought un-registered bonds within the scope of § 11 or § 12,qualified institutional buyers who participated inthe exchange would be considered underwriters un-der the Securities Act and would be required to filetheir own registration statement, which would sig-nificantly undermine Rule 144A's goal of promot-ing liquidity in secondary securities markets. Id. at431.

The SEC, like courts in this district, has taken theposition that no liability under § 12(a)(2) arises in atwo-step transaction of this kind. Letter from JacobH. Stillman, Solicitor, Office of the General Coun-sel of the SEC, to the U.S. Dist. Ct. for the N. Dist.of Ala., dated Nov. 28, 2006, In re HealthSouthSecs. Litig., No. CV-03-BE-1500-S (Letter fromRobert B. McCaw to the Court, dated Dec. 1, 2006,Ex. A), at 8-11. As the SEC noted, the concept of“integration” on which the plaintiffs' theory ispremised is a specific doctrine in securities law bywhich courts determine whether multiple securitiestransactions should be considered part of the same


























offering for purposes of determining whether ex-emptions from the registration requirements apply.To apply it to the *628 facts of this case would be“to apply ‘integration’ in an entirely novel mannerwhich stands the concept on its head,” because“[t]he Commission, and securities market parti-cipants, recognize the two steps to be separatetransactions.” Id. at 11.Indeed, as the SEC noted,the qualified institutional buyers certainly relied onthat understanding when they decided to becomeinvolved in the Rule 144A transaction. Id.

Plaintiffs allege that the Offering Memorandumwas used as the foundation for preparing the BondRegistration Statement, that the two documentswere substantially similar in content, and that theparties preparing the Offering Memorandum knewand understood that they were preparing statementsthat would also be included in the Bond Registra-tion Statement. (Compl. ¶ 153.) Two transactionsdo not become one, however, simply because theyinvolve the same statements. Plaintiffs have failedto show that the two transactions were one for pur-poses of § 12(a)(2). Thus, Count One of the com-plaint, which makes claims under § 12(a)(2) basedon the Rule 144A offering, must be dismissed.

Count Three of the complaint makes claims againstvarious defendants-including the Bond UnderwriterDefendants FN11-pursuant to Section of 11 of theSecurities Act, 15 U.S.C. § 77k. Count Three isbased on alleged misstatements in the Bond Regis-tration Statement, not the Rule 144A OfferingMemorandum. Section 11 imposes liability for ma-terial misrepresentations in a registration statement,and by its terms applies only to registeredofferings.FN12 Plaintiffs argue, however, that theBond Underwriter Defendants may be liable under§ 11 for misstatements in the Rule 144A OfferingMemorandum because the unregistered and re-gistered offerings should be treated as one transac-tion for purposes of § 11. The arguments againstplaintiffs' integration theory discussed above applywith equal force to plaintiffs' § 11 claims, and sothe Rule 144A offering and the subsequent publicoffering will not be treated as one integrated trans-action for purposes of § 11. SeeLivent, 151

F.Supp.2d at 431-32.

FN11. Specifically, Count Three names de-fendants Bennett, Murphy, Lee, Sexton,Silverman, Maggio, Klejna, the THL Indi-vidual Defendants, the Audit CommitteeDefendants, Refco Futures, Westminster-Re-fco, Lind-Waldcock, Grant Thornton, andthe Bond Underwriter Defendants. (Compl.¶ 300.)

FN12. Of course, there are no registrationstatements for offerings of unregisteredbonds.

3. The Bond Underwriter Defendants Are Not Li-able Under § 11 For Their Involvement in the

Preparation of the Bond Registration Statement

[4] The only remaining question with respect to li-ability under §§ 11 and 12 is whether the Bond Un-derwriter Defendants are subject to § 11 liability fordirect involvement in the creation of the Bond Re-gistration Statement. The Bond Underwriter De-fendants move to dismiss Count Three as againstthem on the grounds that their involvement waslimited to the Rule 144A offering. In order to be li-able under § 11 for misstatements in the Bond Re-gistration Statement, the defendants must qualify as“underwriters” within the meaning of §11(a)(5).FN13 The term “underwriter” is definedby the Securities Act as:

FN13. Section 11(a) lists five categories ofdefendants who may be held liable underits provisions. The first four categories arethose who are named in or sign the regis-tration statement, or who are partners ordirectors of the issuer. 15 U.S.C. §77k(a)(1)-(4). Thus, only the remainingcategory, “underwriter[s],” is potentiallyapplicable here.

*629 any person who has purchased from an issuerwith a view to, or offers or sells for an issuer inconnection with, the distribution of any security, orparticipates or has a direct or indirect participationin any such undertaking, or participates or has a









participation in the direct or indirect underwritingof any such undertaking; but such term shall not in-clude a person whose interest is limited to a com-mission from an underwriter or dealer not in excessof the usual and customary distributors' or sellers'commission.15 U.S.C.A. § 77b(a)(11).

In this case, plaintiffs allege “upon information andbelief” that the Bond Underwriter Defendants“participated in the preparation of the Bond Regis-tration Statement.” (Compl. ¶¶ 153, 307.) FN14

This conclusory allegation of participation in thepreparation of the statement includes no detailwhatsoever; plaintiffs make no specific allegationsas to the extent of this participation or what actualactions the defendants took.

FN14. It appears that plaintiffs do not relyupon this allegation as a basis to maintainCount One, which does not explicitly relyon this allegation; nor does plaintiffs'memorandum of law rely on this claim inopposing the Bond Underwriter Defend-ants' motion to dismiss the § 12(a)(2)claims against them. Presumably this is be-cause plaintiffs' § 12(a)(2) claim involvesmisstatements in the Rule 144A OfferingMemorandum, rather than the Bond Regis-tration Statement for the subsequent publicoffering.

The term “underwriter” in the Securities Act hasbeen broadly interpreted. Thus, the Seventh Circuithas held that it includes “a party retained solely tomake minimum interest rate recommendations andparticipate in the preparation of a registration state-ment but which does not purchase or sell securities,solicit orders, take part in the actual distribution,assume any risk of sale of the securities or do otherthings commonly associated with an underwriter'srole.” Harden v. Raffensperger, Hughes & Co.,Inc., 65 F.3d 1392, 1396 (7th Cir.1995).“Underwriter” is not, however, a term of unlimitedapplicability that includes anyone associated with agiven transaction. “It is crucial to the definition of‘underwriter’ that any underwriter must participate

in the distribution of a security.” McFarland v.Memorex Corp., 493 F.Supp. 631, 644(D.C.Cal.1980). Thus, parties have been found notto meet the definition where there was “no allega-tion ... that the [the parties] purchased any [of therelevant] securities with a view to distribution orthat they offered or sold any security on behalf of[the issuer].” Id.“[U]nderwriters are subjected to li-ability because they hold themselves out as profes-sionals who are able to evaluate the financial condi-tion of the issuer.” Id. at 646. This is precisely whatthe Underwriting Defendants did not do with re-spect to the public offering in this case. Plaintiffshave alleged no facts suggesting the Bond Under-writer Defendants held themselves out in any re-spect as to the public offering; on the contrary, anyrole they may have played in that offering was nev-er publicly acknowledged. Nor do any of the allega-tions in the Amended Complaint suggest that theBond Underwriter Defendants bore any risk withrespect to that transaction. “An underwriter buyssecurities directly or indirectly from the issuer andresells them to the public, or he performs some act(or acts) that facilitates the issuer's distribution. Heparticipates in the transmission process between theissuer and the public.” Ingenito v. Bermec Corp.,441 F.Supp. 525, 536 (S.D.N.Y.1977).

Because the plaintiffs have failed to make any spe-cific allegations of “participation” of the kind thatwould qualify the *630 Bond Underwriter Defend-ants as underwriters of the public offering, theplaintiffs' conclusory allegation that they“participated” in the creation of a registration state-ment, read in isolation, would likely be insufficientto survive a motion to dismiss. “Conclusory allega-tions or legal conclusions masquerading as factualconclusions will not suffice to [defeat] a motion todismiss.” Smith v. Local 819 I.B.T. Pension Plan,291 F.3d 236, 240 (2d Cir.2002) (internal citationomitted). Even if this bare allegation could sufficein some circumstances, it does not here, because inthe context of the entire complaint it is clear thatthe word “participated” refers entirely to defend-ants' participation in the Rule 144A offering-not toactual participation in the creation of the Bond Re-gistration Statement.FN15


















FN15. Of course, if the Court has miscon-strued the complaint and the plaintiffs in-tended to allege some other participation inthe creation of the Bond RegistrationStatement, plaintiffs can seek leave to filean amended complaint explaining the par-ticipation on which they rely.

Plaintiffs state that the Bond Underwriter Defend-ants were “paid as underwriters and ... performedthe functions of underwriters in connection with theBond Offering-including contacting potential in-vestors, organizing road shows, preparing the offer-ing documents, and conducting a ‘due diligence’ in-vestigation.” (P. Mem. 54.) Despite plaintiffs' artfuluse of the phrase “Bond Offering” to describe boththe Rule 144A offering and the subsequent publicoffering, it is clear from the Amended Complaintthat all of these actions took place in the context ofthe Bond Underwriter Defendants' work on theRule 144A offering, not the subsequent public of-fering. (Compl. ¶¶ 107, 144, 147-48, 153.)Plaintiffs' memorandum of law clarifies that the“indirect participation” alleged (P. Mem. 55) in-cludes the Bond Underwriter Defendants' participa-tion in the Road Show in July 2004 during whichthe Rule 144A bonds were marketed toinvestors.FN16 Plaintiffs' theory is that because theRule 144A bonds by their terms anticipated thepossibility of an exchange for registered bonds, theBond Underwriter Defendants by soliciting pur-chasers for the Rule 144A bonds in fact “solicited[investors] to participate in both steps of the BondOffering.” (P. Mem. 54.) Once plaintiffs' theorythat the “two-step process” was in fact a singletransaction is rejected, therefore, plaintiffs' claim of“indirect participation” (P. Mem. 55) in this contextbecomes irrelevant. The alleged “indirect participa-tion” also includes the actual underwriting of theRule 144A offering, with the knowledge that thebonds would later be exchanged for registeredbonds (P. Mem. 54-55), an argument that also ne-cessarily fails once the plaintiffs' single-transactiontheory is rejected.

FN16. The relevant factual allegation hereis that “[t]he Offering Memorandum [for

the Rule 144A bonds], which describedand provided for the entire two-step pro-cess by which the Bonds were transmittedinto the market ... was used ... to solicit[plaintiffs] not only to participate in thefirst step of the offering, but also to parti-cipate in the second step.” (Compl. ¶ 106.)

Of course, a court reviewing a motion to dismiss isrequired to draw all inferences in favor of the non-moving party. Here, however, the single sentencealleging that the Bond Underwriter Defendants par-ticipated in the public offering presents a legal con-clusion, not a factual allegation, and must be readin the context of the factual allegations to which itrefers. “Conclusory allegations, unwarranted de-ductions of facts or legal conclusions masqueradingas facts will not prevent dismissal of Section 11claims.” *631In re Merrill Lynch & Co., Inc. Re-search Reports Secs. Litig., 272 F.Supp.2d 243, 253(S.D.N.Y.2003) (internal citations, alterations andquotation marks omitted). Plaintiffs have in factfailed to allege any specific role whatsoever in theunderwriting of the public offering; their only rel-evant allegation is simply a reproduction of the stat-utory requirement of “direct or indirect participa-tion,” 15 U.S.C. § 77b(a)(11), and in context eventhat allegation pertains to matters that do not giverise to § 11 liability. Accordingly, the Bond Under-writer Defendants' motion to dismiss Count Threeas to them will be granted.

B. Motions to Dismiss the § 11 Claims For Fail-ure to Allege Fraud With Sufficient Particularity

Defendants Silverman, Klejna, Bennett, and GrantThornton FN17 argue that the claims relating to §11 of the Securities Act (Compl.¶¶ 299-132,313-328) sound in fraud, and are therefore subjectto a higher pleading standard. (Silverman Mem.22-24; Klejna Mem. 30-33; Bennett Mem. 19-21;FN18 Grant Thornton Mem. 15-18.) This argumentis without merit.

FN17. Grant Thornton does not argue thatthe § 11 claims are insufficient if Rule 9'sstandards do not apply.










FN18. Bennett makes this argument as achallenge to the claims of control-personliability against RGHI and the BennettTrust. (Bennett Mem. 19-21.)

Rule 9(b) of the Federal Rules of Civil Procedureprovides that “[i]n all averments of fraud or mis-take, the circumstances constituting fraud or mis-take shall be stated with particularity.” To meet therequirements of Rule 9(b), a complaint must “(1)specify the statements that the plaintiff contendswere fraudulent, (2) identify the speaker, (3) statewhere and when the statements were made, and (4)explain why the statements were fraudulent.” Millsv. Polar Molecular Corp., 12 F.3d 1170, 1175 (2dCir.1993).

[5] The Second Circuit has acknowledged that“fraud is not an element or a requisite to a claimunder Section 11,” and that “a plaintiff need allegeno more than negligence to proceed under Section11.” Rombach v. Chang, 355 F.3d 164, 171 (2dCir.2004). Accordingly, Rule 9(b)'s standards applyto Section 11 claims only “insofar as the claims arepremised on allegations of fraud.” Id. Applying thisanalysis, however, the court found implications offraud in language that closely tracked the languageof Section 11 itself:Plaintiffs assert that their Section 11 claims “do[ ]not sound in fraud” but the wording and imputa-tions of the complaint are classically associatedwith fraud: that the Registration statement was“inaccurate and misleading;” that it contained“untrue statements of material facts;” and that“materially false and misleading written state-ments” were issued.

Rombach, 355 F.3d at 171 (emphasis in original).This passage presents something of a conundrum,because applied literally, it would seem to requireapplying a 9(b) standard to all claims under § 11.Section 11 applies when “any part of the registra-tion statement ... contained an untrue statement of amaterial fact or omitted to state a material fact re-quired to be stated therein or necessary to make thestatements therein not misleading.” 15 U.S.C.A. §77k(a) (emphasis added). SeeJohnson v. NYFIX,

Inc., 399 F.Supp.2d 105, 122 (D.Conn.2005).FN19

Fraud, of *632 course, implies more than falsity,and the mere fact that a statement is misleading (asare all false statements, whether intentionally, neg-ligently or innocently made) does not make itfraudulent.

FN19. Johnson noted that “the terms ofsection 11 require any plaintiff to establishthat a registration statement ‘contained anuntrue statement of material fact or omit-ted to state a material fact required to bestated therein or necessary to make thestatements therein not misleading,’ ” butapplied a Rule 9(b) standard because theallegations referred to “materially false andmisleading statements.” 399 F.Supp.2d at122.

It is clear that the Second Circuit did not intendRombach as an instruction that all § 11 pleadingsshould be subjected to the Rule 9(b) standard.SeeRombach, 355 F.3d at 178 (finding that § 11claims against certain defendants sounded in negli-gence, not fraud). Nor can the Second Circuit haveintended that all allegations directly reproducingthe language of § 11 be subject to Rule 9(b); asRombach acknowledges, violations of § 11 claimsdo not necessarily involve fraud. 355 F.3d at 171.Therefore, the court's conclusion that the particularlanguage in Rombach was indicative of fraudshould be read in the context of the pleadings at is-sue in that case, in which the plaintiffs “[did] notassert any claim of negligence on the part of the In-dividual Defendants, nor [did] they specify anybasis for such a claim.” Rombach v. Chang, No. 00Civ. 0958, 2002 WL 1396986, at *4 (E.D.N.Y. June7, 2002). Rombach necessarily requires a case-by-case analysis of particular pleadings to determ-ine whether “the gravamen of the complaint isplainly fraud.” 355 F.3d at 172, quoting In re StacElecs. Secs. Litig., 89 F.3d 1399, 1405 n. 2 (9thCir.1996). In this case, the gravamen of the § 11claims is plainly not fraud.

The complaint in this case is carefully structured soas to draw a clear distinction between negligence





































and fraud claims. The Securities Act claims arefound in the first half of the complaint (¶¶ 86-379);the Exchange Act allegations, which include allega-tions of fraud by some-but not all-of the defendantsnamed in the Securities Act claims, are found in thesecond half of the complaint (¶¶ 381-720). Thiscareful division makes it easy to distinguishbetween the two, and the substance of the allega-tions keeps the distinction as clear as does the com-plaint's structure. The relevant factual allegationsare contained in a section called “Defendants' Neg-ligence” (Com pl.¶¶ 249-258), which alleges ex-actly that.

The Securities Act section of the complaint allegesvarious untrue or misleading statements in the Of-fering Memorandum, the Bond Registration State-ment, and the IPO Registration Statement. As to thedefendants' intent, however, these claims are care-fully couched in the language of negligence. Forexample, plaintiffs allege that Refco's corporate of-ficers and auditors “did not conduct a reasonableinvestigation of the statements contained in the Of-fering Memorandum and the Bond RegistrationStatement, and did not possess reasonable groundsfor believing that the statements in those documentswere true and not misleading.” (Compl. ¶ 252.) De-fendants have pointed to no allegations in the Se-curities Act section of the complaint that containeven a hint of fraud.

As Silverman notes (Silverman Mem. ¶ 24), thecomplaint certainly accuses Refco itself of conceal-ing uncollectible receivables. (Compl. ¶ 199.) In-deed, it is clear that plaintiffs believe that Refcoand various persons associated with it, includingmost, if not all, of the defendants, were engaged ina massive fraud. This fact, however, does not takeaway plaintiffs' right to plead in the alternative thatdefendants violated provisions requiring only negli-gence. SeeRombach, 355 F.3d at 171 (“The samecourse of conduct that would support a Rule 10b-5claim may as well *633 support a Section 11 claimor a claim under Section 12(a)(2).”).

[6][7] Of course, “[p]laintiffs cannot evade the Rule9(b) strictures by summarily disclaiming any reli-

ance on a theory of fraud or recklessness.” In re JPMorgan Chase Secs. Litig., 363 F.Supp.2d 595, 635(S.D.N.Y.2005). Thus, the language at the begin-ning of each Securities Act claim disclaiming anyintent to allege fraud is by itself insufficient to pro-tect those claims from Rule 9(b)'s stringent require-ments.FN20 In this case, however, plaintiffs havedone more than disclaim fraud; they have specific-ally pled alternate theories of fraud and negligence.As the Third Circuit held in a similar case,

FN20. Each Securities Act claim beginswith this careful sentence: “Plaintiffs re-peat and reallege each and every allegationabove as if fully set forth herein, except al-legations that the Defendants made the un-true statements of material facts and omis-sions intentionally or recklessly.” (Compl.¶¶ 270, 284, 299, 313, 329, 342, 361, 369.)

plaintiffs ... do not merely disavow already-pled al-legations of fraud in connection with their Section11 and Section 12(a)(2) claims, leaving the court tosift through those allegations in search of somelesser included claim of strict liability. Rather, bothplaintiffs have expressly pled negligence in connec-tion with their Section 11 and 12(a)(2) claims. Weregard this difference in pleading as dispositive.In re Suprema Specialties, Inc. Secs. Litig., 438F.3d 256, 272 (3d Cir.2006) (internal citations, al-terations, and quotation marks omitted). Defendantsdo not argue that the complaint is insufficientlyspecific if Rule 9(b)'s standards are not applied. Ac-cordingly, the motions by defendants Silverman,Klejna, Bennett, and Grant Thornton to dismiss the§ 11 claims (Count Three) and the control-personclaims based on underlying § 11 violations (CountFour) for failure to satisfy Rule 9(b)'s standardswill be denied.

C. Whether Unregistered Bondholders HaveStanding to Make § 11 Claims Based on the

Bond Registration Statement

[8] Several defendants move to dismiss the § 11claims as to those plaintiffs who acquired the Re-gistered Bonds by exchanging unregistered Rule


















144A bonds for them. (See Sexton Mem. 23-26,Klejna Mem. 33-35, THL/Audit Comm. Mem. 22,and Grant Thornton Mem. 20-23; response at P.Mem. 58-62.) This argument applies to the § 11claims made on behalf of plaintiffs who purchasedunregistered bonds and then traded them for re-gistered bonds in the Exxon Capital exchange, butdoes not reach the claims of those plaintiffs whoacquired registered bonds on the open market.

The defendants frame the argument in several dif-ferent ways, all of which are based on the idea thatthe Bond Registration Statement had nothing to dowith the unregistered bondholders' decision to ex-change their unregistered bonds for registeredbonds. Thus, Grant Thornton frames the question asone of what statements are material under § 11, ar-guing that “any positive or negative news containedin the registration statement would have impactedthe bondholder's holdings regardless of whether heexchanged his stock.” (Grant Thornton Memo 21.)Sexton argues these plaintiffs have no standing(Sexton Mem. 23-23) and that they “lack the re-quired causation nexus with the Registration State-ment” (Sexton Reply 14).FN21 Klejna, who is notbeing sued for *634 any role in the unregisteredbond offering, argues that it would be unfair to holdhim responsible for an investment decision byplaintiffs in which he had no involvement. (KlejnaReply 14.)

FN21. Relatedly, Klejna argues that unre-gistered bondholders cannot “ ‘trace’ their[securities] to the allegedly defective regis-tration statement.” DeMaria v. Andersen,318 F.3d 170, 176 (2d Cir.2003). (See Kle-jna Mem. 34.) See alsoGuenther v. CooperLife Sciences, Inc., 759 F.Supp. 1437, 1439(N.D.Cal.1990). (“[T]o have standing un-der section 11, plaintiffs must establishthat they purchased shares either (1) dir-ectly in the public offering for which themisleading registration statement was filedor (2) traceable to that public offering.”)The Second Circuit held in Barnes v. Osof-sky, 373 F.2d 269, 271-73 (2d Cir.1967),that § 11's private right of action was avail-

able only to plaintiffs who had purchasedthe securities in question directly from theissuer. Id. at 272-73. In other words, § 11'scoverage is available only to those who ac-quired a security issued pursuant to the re-gistration statement, not to those who pur-chased other similar securities already onthe market at the time the registrationstatement was issued. In this case,plaintiffs did purchase the securities issuespursuant to the registration, so the“traceability” requirement is not directlyimplicated here.

The questions of standing, reliance, materiality, andcausation are related, because “materiality is intim-ately bound up with the concept of reliance,” and“[r]eliance, in turn, is linked to causation.” In reMcKesson HBOC, Inc. Secs. Litig., 126 F.Supp.2d1248, 1260 (N.D.Cal.2000). Put another way, amisstatement is material if an investor acted in reli-ance upon it and was thereby caused to suffer dam-ages.

The parties argue at some length about whether it isappropriate to impose a reliance requirement on §11 claims. Although the caselaw is not entirelyclear as to the circumstances in which reliance canbe relevant to a § 11 claim, the better reading of §11 seems to be that it “creates a presumption that‘any person acquiring such security’ was legallyharmed by the defective registration statement.”APA Excelsior III L.P. v. Premiere Techs., Inc., 476F.3d 1261, 1271 (11th Cir.2007). “To say that reli-ance is ‘presumed’ is simply not the same thing assaying that reliance is ‘irrelevant.’ ” Id. at 1272.But seeWestinghouse Elec. Corp. v. '21' Int'l Hold-ings, Inc., 821 F.Supp. 212, 218 (S.D.N.Y.1993)(“Reliance is not a factor in a § 11 action, and thusimpossibility of reliance can be no bar to a § 11claim. As long as a plaintiff can show that the par-ticular securities he purchased were registered bymeans of a materially false registration statement,he has a claim under § 11.”(internal citations omit-ted).) Whether framed as a question of materialityor reliance, it seems clear as a matter of law and lo-gic that plaintiffs should be entitled to no recovery




























when it can be established with certainty that theywere not harmed in any way by the relevant misrep-resentations.

Defendants offer at least two different reasons tothink that reliance was impossible in the presentcase, that is, that any misstatements in the BondRegistration Statement were immaterial as toplaintiff unregistered bondholders. The first conten-tion is that the unregistered bondholders' relevantinvestment decision was already made at the timethey purchased the unregistered bonds. As Sextonputs it, “[p]laintiffs' investment decision could nothave possibly been affected or ‘impelled’ by the re-gistration statements because their investment com-mitment to Refco was made when they purchasedthe Rule 144A Bonds prior to the issuance of theregistration statement.” (Letter from Stuart I. Fried-man to the Court, dated Mar. 1, 2007; see SextonMem. 24-25.) In other words, “[c]ompletion of themandated exchange was the performance of a min-isterial act.” (Klejna Mem. 34.) FN22

FN22. This version of the argument relieson the so-called “commitment theory” ofsecurities law, which originally developedin the context of statute of limitationsquestions as the proposition that “the timeof a ‘purchase or sale’ of securities withinthe meaning of Rule 10b-5 is to be determ-ined as the time when the parties to thetransaction are committed to one another.”Radiation Dynamics, Inc. v. Goldmuntz,464 F.2d 876, 891 (2d Cir.1972). Thus, inany case where a contract requires sub-sequent payments, those payments are donot affect the statute of limitations, be-cause “once plaintiff has committed itselfto the transaction, the claim accrues andthus the statute begins to run.” Kahn v.Kohlberg, Kravis, Roberts & Co., 970 F.2d1030, 1040 (2d Cir.1992). This conceptwas subsequently expanded to other areasof securities and contracts law as the prin-ciple that “[o]nce the decision is made andthe parties are irrevocably committed tothe transaction, there is little justification

for penalizing alleged omissions or mis-statements which occur thereafter andwhich have no effect on the decision.” SECv. Nat'l Student Mktg. Corp., 457 F.Supp.682, 703 (D.D.C.1978). Defendants con-tend that it would be similarly pointless topenalize them for statements made afterthe plaintiffs' decision to invest in the rel-evant bonds was already made.

*635 In a case to which defendants seek to analo-gize this one, the Eleventh Circuit concluded thatwhere plaintiffs had made a binding and irrevocablecommitment to purchase the relevant investmentsprior to the issuance of the registration statement,there could be no liability under § 11. APA Excelsi-or, 476 F.3d 1261, 1275-76. Section 11's presump-tion of reliance is rebutted, in other words, wherethe plaintiffs were irrevocably committed to pur-chase the securities before the registration state-ment issued, because “[t]o hold otherwise wouldmean that an impossible fact will be presumed inPlaintiffs' favor.” Id. at 1273. Defendants argue thatplaintiffs' claims similarly should be dismissed onthe grounds that the unregistered bondholders, likethe parties in APA Excelsior, were irrevocably com-mitted to the Exxon Capital exchange when theypurchased the unregistered bonds.

At this stage of the litigation, however, it cannot besaid with certainty that “the plaintiffs lacked thepower or authority to back out” of the Exxon Capit-al exchange. Pell v. Weinstein, 759 F.Supp. 1107,1114 (M.D.Pa.1991). It is true that, according to thecomplaint, the unregistered bondholders would nothave bought the unregistered bonds without the un-derstanding that they would be exchanged for Re-gistered Bonds. (Compl. ¶ 104.) Furthermore, thecomplaint alleges that the Exxon Capital exchangewas “mandated by the Offering Memorandum andthe underwriting contracts.” (Compl. ¶ 100(emphasis added).) In context, however, it is clearthat it was the issuers of the bonds, not the pur-chasers, who were obligated under this arrange-ment. Plaintiffs allege that the “co-issuers” of thebonds “undertook to use their best efforts to offerthe Registered Bonds in exchange for the 144A























Bonds.” (Compl. ¶ 103.) An undertaking on the of-feror's side does not oblige the offerree to accept.

Nothing in the plaintiffs' allegations suggests thatplaintiffs were irrevocably committed to the ExxonCapital exchange. Indeed, plaintiffs contend that“unless and until they affirmatively exchanged thebonds ... the Rule 144A bondholders retained theoption of rejecting the exchange offer and keepingtheir registered bonds.” (Letter from Stuart M.Grant to the Court, dated Mar. 12, 2007.) Defend-ants have pointed to no language in the relevantdocuments suggesting otherwise. Defendants pointout that the unregistered bondholders allegedly de-cided to buy the unregistered bonds specifically be-cause they understood that the bonds would be ex-changed for registered bonds. Alleging thatplaintiffs had made a decision, however, is not thesame as alleging that they had entered into a com-mitment. Although *636 plaintiffs certainly inten-ded to exchange their 144A bonds for registeredbonds, there is at least a question of fact as towhether the Bond Registration Statement couldhave had any impact on their decision to participatein the Exxon Capital exchange.

As a question of irrevocable commitment, there-fore, defendants' arguments are unpersuasive. Thereare other ways to frame the issue, however.Plaintiffs argue that “a jury could find ... that thereis a substantial likelihood that a reasonable investorwould consider that information [in the RegistrationStatement] important when deciding whether topurchase the [144A Bonds] and exchange them forRegistered Bonds.” (P. Mem. 61 (emphasis added).)Plaintiffs' phrasing assumes that the unregisteredand registered bond offerings may be treated as asingle transaction, a theory that has already been re-jected for the reasons discussed above. It is there-fore necessary to ask what the unregistered bond-holders-already owners of non-tradeable Refcobonds-could have done differently had the BondRegistration Statement been fully candid about Re-fco's alleged foul deeds and dreadful prospects. Un-der this line of inquiry, it is not an irrevocable com-mitment that rebuts the presumption of reliance, butrather the fact that plaintiffs had no other options.

“[W]hen presented with a Rule 12(b)(6) motion, acomplaint may not properly be dismissed ... on theground that the alleged misstatements or omissionsare not material unless they are so obviously unim-portant to a reasonable investor that reasonableminds could not differ on the question of their im-portance.” Goldman v. Belden, 754 F.2d 1059, 1067(2d Cir.1985).FN23 The Second Circuit has heldthat where “the omitted information would not havemade a reasonable shareholder any less likely to fa-vor the objected-to transaction, ... such an omission,material or not, could not have caused the injury forwhich damages are sought.” Minzer v. Keegan, 218F.3d 144 (2d Cir.2000). Applying this materialityanalysis to a case where plaintiffs' only optionswere to trade their preferred stock for commonstock, or to redeem it at a price substantially belowthe market price, the Fifth Circuit held that therecould be no liability for misrepresentations because“respondents d [id] not indicate how they mighthave acted differently had they had prior notice” ofthe true facts behind the misrepresentations.Dwoskin v. Rollins, Inc., 634 F.2d 285, 291 n. 4(5th Cir.1981). SeealsoElfenbein v. Am. Fin. Corp.,487 F.Supp. 619, 627 (S.D.N.Y.1980).

FN23. Goldman was analyzing materialityfor purposes of the Exchange Act, but themateriality analysis is the same in both theSecurities Act and Exchange Act contexts.Kronfeld v. Trans World Airlines, Inc., 832F.2d 726, 731 (2d Cir.1987).

The same principle applies here, because plaintiffshave not alleged that unregistered bondholderswould have been any less likely to go through withthe Exxon Capital exchange had the Bond Registra-tion Statement been accurate. Plaintiffs have not al-leged that the unregistered bonds differed in any re-spect from the registered bonds for which they wereexchanged, except that the registered bonds werefreely tradeable. Had the plaintiffs known the truestate of Refco's affairs, they would have had noreason to avoid making make their holdings trade-able; on the contrary, they would have had everyreason to rid themselves of the bonds as soon aspossible. Plaintiffs have failed to allege that the



















omitted information would have made a reasonableshareholder any less likely to favor the Exxon Cap-ital exchange. They have therefore failed to *637show that any omissions or misrepresentations werematerial. Accordingly, Counts Three and Four willbe dismissed as to any plaintiffs who obtained re-gistered bonds in the Exxon Capital exchange.

III. Control-Person Liability Under Securities Act§ 15

A. Standards for Control-Person Liability

[9] To make out a claim for control-person liabilityunder section 15 of the Securities Act, plaintiffsmust allege “(a) a primary violation by a controlledperson, and (b) control by the defendant of theprimary violator.” In re Global Crossing, Ltd. Secs.Litig., No. 02 Civ. 910, 2005 WL 2990646, at *7(S.D.N.Y. Nov. 7, 2005) (“Global Crossing III” ).Control entails “ ‘the power to direct or cause thedirection of the management and policies of a per-son, whether through the ownership of voting se-curities, by contract, or otherwise.’ ” SEC v. FirstJersey Secs., Inc., 101 F.3d 1450, 1472-73 (2dCir.1996), quoting 17 C.F.R. § 240.12b-2. To pre-vail on a § 15 claim, “[a] plaintiff is required toprove actual control, not merely control personstatus.” In re IPO Secs. Litig., 241 F.Supp.2d 281,352 (S.D.N.Y.2003) (emphasis omitted).

B. Control Person Liability for the Rule 144AOffering Memorandum

[10] As an initial matter, the dismissal of CountOne, the count pertaining to the Rule 144A Offer-ing Memorandum, necessarily requires the dis-missal of Count Two, which pertains to control-per-son liability for the statements made in the Rule144A Offering Memorandum. As noted above, con-trol-person liability exists only where there is aprimary violation, and so the conclusion that mis-statements in the Offering Memorandum cannotgive rise to liability requires the further conclusionthat those misstatements cannot give rise to control-person liability. Accordingly, Count Two will bedismissed in its entirety.

C. Control Person Liability for the Bond Regis-tration Statement and the IPO Registration

Statement

[11] Count Four of the complaint alleges control-person liability for misstatements in the Bond Re-gistration Statement. Counts Six and Eight allegecontrol-person liability for misstatements in the Au-gust 2005 IPO Registration Statement and prospect-us. There is no dispute that misstatements in thesedocuments would constitute a primary violation ofthe Securities Act; therefore, the sole issue with re-spect to Counts Four, Six and Eight is whether theplaintiffs have adequately alleged that the defend-ants named in these counts exercised control overRefco at the time the statements became effective.

As this Court found in an earlier case, allegations ofcontrol under Section 15 are subject only to notice-pleading requirements, and accordingly survive mo-tions to dismiss “as long as it is at least plausiblethat plaintiff could develop some set of facts thatwould pass muster.” In re Global Crossing III,2005 WL 2990646, at *8. Thus, the Court in thatcase concluded that even though the facts alleged inthe complaint, taken alone, were insufficient toconstitute control, the case did not fit “into that nar-row category of cases in which it is ‘implausible’ ormere ‘unlikely speculation’ that plaintiffs can de-velop a record that would support a finding of con-trol, especially given the decidedly fact-basednature of the control inquiry.” Id. (internal citationsand quotation marks omitted).FN24

FN24. Sexton contends that “culpable par-ticipation” is an element of a claim underSection 15. (Sexton Mem. 21.) It is not. Inre Global Crossing, Ltd., Secs. Litig., No.02 Civ. 910, 2005 WL 1907005, at *11(S.D.N.Y. Aug. 8, 2005)(“Global CrossingII” ); seeIn re Vivendi Universal, S.A., 381F.Supp.2d 158, 188 (S.D.N.Y.2003) (“theapparent majority of judges in the SouthernDistrict ... have determined that culpableparticipation is not an element of § 15”).

*638 [12] Under these standards, defendants' argu-



























ments for dismissal are unpersuasive. DefendantBennett moves to dismiss the Section 15 allegationsagainst defendants RGHI and the Bennett Trust,noting that this Court has previously held that mereminority ownership is insufficient to constitute con-trol under Section 15. SeeGlobal Crossing III, 2005WL 2990646, at *8. However, the Court held in thesame case that such allegations were sufficient tosurvive a motion to dismiss, because it was not im-plausible that plaintiffs could develop a record thatcould support a finding of control. Bennett also ar-gues that RGHI and the Bennett Trust cannot be li-able under a control theory because the complaintalleges that they were controlled by him. (BennettMem. 15.) As a matter of logic, however, it makeslittle sense to say that controlling entities should es-cape liability on the grounds that other entities inturn controlled them. The issue is whether the en-tity has “the power to direct or cause the directionof the management and policies of a person,”FirstJersey, 101 F.3d at 1472-73, not whether thatpower is exercised at the direction of another. Infact, “[t]he ‘control person’ provisions were in-cluded in the federal securities laws to ‘preventpeople and entities from using ‘dummies' to do thethings that they were forbidden to do by the securit-ies laws.’ ” In re Flag Telecom Holdings, Ltd. Secs.Litig., 352 F.Supp.2d 429 (S.D.N.Y.2005) (internalcitations and quotation marks omitted).FN25

FN25. Bennett also argues that the plead-ing standard of Rule 9(b) should apply tothe Section 15 allegations, because“allegations of fraud permeate the Com-plaint.” (Bennett Mem. 21.) This argumentis no more meritorious as applied to Sec-tion 15 than it was when applied to Section11.

Defendant Klejna argues that the mere signing ofthe Bond Registration Statement is insufficient tosupport control liability. Klejna notes the principlethat one purpose of control liability is to preventpowerful individuals or entities from arranging for“dummies” to sign in their stead, and contends thatthis principle militates against finding control as tothe actual signatories. (Klejna Mem. 25-26.)

However, “[t]he very fact that a director is requiredto sign these critical documents charges the directorwith power over the documents and represents tothe corporation, its shareholders, and the public thatthe corporation's director has performed her rolewith sufficient diligence that she is willing and ableto stand behind the information contained in thosedocuments.” WorldCom I, 294 F.Supp.2d at 420. “Itdoes comport with common sense to presume that aperson who signs his name to a report has somemeasure of control over those who write the re-port.” Jacobs v. Coopers & Lybrand, L.L.P., No. 97Civ. 3374, 1999 WL 101772, at *18 (S.D.N.Y.Mar.1, 1999). Thus, signature on an SEC filingcontaining the misrepresentations that are the sub-ject of a claim is suggestive of control. In anyevent, the complaint goes on to allege that Klejna'sposition as Executive Vice President and GeneralCounsel gave him some degree of control over Re-fco, and that he was directly involved in its day-to-day operations, including financial reporting andaccounting. (Compl. ¶¶ 321, 350, 678, 697.) Thatsuffices as an allegation of control.

*639 Sexton argues that the allegations of controlagainst him with respect to the IPO Registrationstatement must be dismissed because they are based“solely upon Sexton's status as an officer of RefcoGroup.” (Sexton Mem. 22.) “However, where ... thecorporate officers are a narrowly defined groupcharged with the day-to-day operations of a publiccorporation, it is reasonable to presume that theseofficers had the power to control or influence theparticular transactions giving rise to the securitiesviolations.” Maywalt v. Parker & Parsley Petro-leum Co., 808 F.Supp. 1037, 1054 (S.D.N.Y.1992)(internal citations and quotation marks omitted).Moreover, the complaint specifically alleges thatSexton “prepared and approved” the IPO Registra-tion Statement. (Compl. ¶ 34.) This is sufficient forpurposes of a motion to dismiss.

Murphy argues that the Section 15 allegationsagainst him should be dismissed (Murphy/ShererMem. 31-25), but he signed the Bond RegistrationStatement (Compl. ¶ 36), which is a sufficient basisfor control liability, and allegedly “prepared and





















approved” the IPO Registration Statement. (Id.)Moreover, as an Executive Vice President of Refcoand President of various Refco subsidiaries,Murphy's role was central enough to make it plaus-ible that the plaintiffs will be able to develop suffi-cient evidence to show control.

Silverman argues that mere allegations of officerstatus are insufficient to establish control.(Silverman Mem. 7.) He also argues that he wasnot, as alleged, the Controller of Refco in 2004 and2005, and that the extensive alleged involvement ofother defendants in the road show and other corpor-ate activities somehow demonstrates that he wasnot deeply involved in these events. (Id. at 7-11.)Of course, arguments pertaining to the truth of theallegations and the weight of the evidence have noplace in a motion to dismiss. The complaint allegesthat Silverman signed the Bond Registration State-ment (Compl. ¶ 37), and that he prepared and ap-proved it, and that he was deeply involved with Re-fco's day-to-day activities. (Id. ¶ 388.) This isenough to support the allegations of control.

The Audit Committee Defendants argue that the al-legations of control against them are inadequate.(THL/Audit Comm. Mem. 36-38.) The complaint,however, alleges that these defendants were re-sponsible for overseeing Refco's financial report-ing, accounting, and internal controls, and coordin-ating outside audits. (Compl. ¶¶ 322, 268.) As an-other court in this district found in a similar case,the audit committee was clearly the body chargedwith the specific responsibility of overseeing [thecompany's] accounting and financial reporting and,therefore, with keeping [the company] on thestraight and narrow. A reasonable jury could findthat the audit committee's recommendations wouldcarry sufficient weight ... that the audit committeehad the practical ability to direct [the company's]accounting policies. The audit committee defend-ants need not, of course, have actually exercisedthat authority to be held liable as control persons.

In re JWP Inc. Secs. Litig., 928 F.Supp. 1239, 1260(S.D.N.Y.1996).

The THL Individual Defendants also challenge theallegations in Count Four, arguing that those allega-tions are based merely on their status, rather thanactual control. (THL/Audit Comm. Mem. 38-40.)The complaint alleges that THL Partners acquired a57% stake in Refco prior to the issuance of theBond Registration Statement, and that each of theTHL Individual Defendants was a control person ofTHL Partners. (Compl. ¶¶ 48-52.) “Control *640over a primary violator may be established byshowing that the defendant possessed ‘the power todirect or cause the direction of the management andpolicies of a person, whether through the ownershipof voting securities, by contract, or otherwise.’ ”First Jersey, 101 F.3d at 1472-73, quoting 17C.F.R. § 240.12b-2. Moreover, the complaint al-leges that the THL Individual Defendants were atall relevant times directors of Refco, and that they“prepared and approved” the Bond RegistrationStatement. Thus, it is not implausible that plaintiffscould develop a record that could support a findingof control as to the THL Individual Defendants.

In short, the movants have failed to offer any con-vincing arguments for the dismissal of the Section15 claims under the Securities Act, with the excep-tion of the claims in Count Two. Accordingly, theirmotions to dismiss Counts Four, Six and Eight willbe denied.

IV. Exchange Act § 10(b) and Rule 10b-5 Allega-tions Against the Officer and Audit Committee

Defendants

Section 10(b) of the Securities Exchange Act of1934, 15 U.S.C. § 78j(b), provides that it shall beunlawful “[t]o use or employ, in connection withthe purchase or sale of any security registered on anational securities exchange or any security not soregistered ... any manipulative or deceptive deviceor contrivance in contravention of such rules andregulations as the [SEC] may prescribe as necessaryor appropriate in the public interest or for the pro-tection of investors.” Pursuant to this authority, theSEC issued Rule 10b-5, 17 C.F.R. § 240.10b-5,which makes it unlawful “[t]o make any untruestatement of a material fact or to omit to state a ma-













terial fact necessary in order to make the statementsmade, in the light of the circumstances under whichthey were made, not misleading.”

The defendants subject to § 10(b) claims make avariety of challenges, which fall into two basicgroups. First, some defendants argue that theplaintiffs have failed to sufficiently allege that theymade material false statements. Second, various de-fendants argue that the plaintiffs have failed to suf-ficiently allege that any false statements were madewith scienter. Accordingly, this section discussesfirst the issue of material false statements, and thenthe question of scienter. The Exchange Act allega-tions against Grant Thornton, Refco's auditor, arediscussed separately in a subsequent section.

A. Material False Statements

To state a claim under Section 10(b), “a plaintiffmust plead that the defendant, in connection withthe purchase or sale of securities, made a materiallyfalse statement or omitted a material fact, with sci-enter, and that the plaintiff's reliance on the defend-ant's action caused injury to the plaintiff.”Lawrence v. Cohn, 325 F.3d 141, 147 (2dCir.2003), quoting Ganino v. Citizens Utils. Co.,228 F.3d 154, 161 (2d Cir.2000). A statement oromission is material if it “would have been viewedby the reasonable investor as having significantlyaltered the ‘total mix’ of information made avail-able.” TSC Industries Inc. v. Northway, Inc., 426U.S. 438, 449, 96 S.Ct. 2126, 48 L.Ed.2d 757(1976).

The PSLRA and Rule 9(b) of the Federal Rules ofCivil Procedure impose particularity requirementson Section 10(b) complaints, mandating that they“(1) specify the statements that the plaintiff con-tends were fraudulent, (2) identify the speaker, (3)state where and when the statements were made,and (4) explain why the statements were fraudu-lent.” *641Stevelman v. Alias Research, Inc., 174F.3d 79, 84 (2d Cir.1999) (citations and internalquotation marks omitted); see15 U.S.C.A. §78u-4(b)(1) (PSLRA requirements for pleadingmisrepresentation).

The movants in this case do not dispute that thecomplaint adequately identifies the fraudulent state-ments, where and when they were made, and whythey were fraudulent. Instead, their challenges allpertain to the identity of the speaker, and fall intotwo basic groups. First, some defendants argue thatthe complaint inappropriately groups them together,failing to tie them individually to the allegedlyfraudulent statements. Second, some defendants ar-gue that they cannot be implicated in the making ofthe allegedly fraudulent statements because of thetiming of those statements.FN26

FN26. Grant Thornton, the outside auditor,also challenges the specificity of the alleg-ations tying it to the allegedly fraudulentstatements. These arguments are addressedin Section V of this opinion.

1. Challenges Pertaining to Group Pleading (TheOfficer Defendants)

[13][14] “[A] defendant must actually make a falseor misleading statement in order to be held liableunder Section 10(b). Anything short of such con-duct is merely aiding and abetting, and no matterhow substantial that aid may be, it is not enough totrigger liability under Section 10(b).” Wright v.Ernst & Young LLP, 152 F.3d 169, 175 (2dCir.1998) (internal quotation marks and alterationsomitted). “[W]hen fraud is alleged against multipledefendants, a plaintiff must set forth separately theacts complained of by each defendant. A complaintmay not simply clump defendants together in vagueallegations to meet the pleading requirements ofRule 9(b).” Rich v. Maidstone Fin., Inc., 98 Civ.2569, 2001 WL 286757, at *6 (S.D.N.Y. Mar.23,2001). Under the doctrine of group pleading,however, plaintiffs can “circumvent the generalpleading rule that fraudulent statements must belinked directly to the party accused of the fraudu-lent intent” by “rely[ing] on a presumption thatstatements in prospectuses, registration statements,annual reports, press releases, or group-publishedinformation, are the collective work of those indi-viduals with direct involvement in the everydaybusiness of the company.” In re BISYS Sec. Litig.,






























397 F.Supp.2d 430, 438 (S.D.N.Y.2005), quoting Inre NTL Secs. Litig., 347 F.Supp.2d 15, 22 n. 26(S.D.N.Y.2004).

Alleging direct involvement in the company'severyday business is critical to support the pre-sumption. Thus, allegations that a defendant wassimply “an affiliate and contracted to performwork” or even that it “own[ed] and control[led]”the identified speaker will be insufficient. In reParmalat Secs. Litig., No. 05 Civ. 4015, 479F.Supp.2d 332, 340-41 (S.D.N.Y.2007).

As defendants point out, some courts have held thatthe PSLRA implicitly abrogated or abolished thegroup pleading doctrine. In Southland Secs. Corp.v. INSpire Ins. Solutions Inc., 365 F.3d 353 (5thCir.2004), the Fifth Circuit concluded that thegroup pleading doctrine “cannot withstand thePSLRA's specific requirement that the untrue state-ments or omissions be set forth with particularity asto ‘the defendant’ and that scienter be pleaded withregard to ‘each act or omission’ sufficient to give‘rise to a strong inference that the defendant actedwith the required state of mind.” Id. at 364-65,quoting 15 U.S.C. § 78u-4(b).

As the Fifth Circuit acknowledged, however, thePSLRA “does not explicitly abolish the doctrine.”Id. at 365. Nor is there any apparent contradictionbetween the *642 idea that each defendant's rolemust be pled with particularity and the fact that cor-porate officers may work as a group to produce par-ticular document. Therefore, this Court joins themajority of district courts in this district and othersin holding that the group pleading doctrine is “aliveand well.” In re BISYS Secs. Litig., 397 F.Supp.2d430, 439 (S.D.N.Y.2005); seeid. at 439 n. 42(collecting cases).

[15] Defendants Murphy, Klejna and Silverman ar-gue that the complaint fails to tie them to the al-leged fradulent statements with enough specificity.(Sherer/Murphy Mem. 13-14; Klejna Mem. 8-13;Silverman Mem. 15-16.) The Complaint alleges,however, that each of these three officers “preparedand approved” the allegedly fraudulent documents.

(Compl. ¶¶ 36, 37, 38). Moreover, the Complaintalleges that each of these three defendants “was acorporate insider or affiliate with direct involve-ment in the daily affairs of the company.” BISYS,397 F.Supp.2d at 440-441. (See Compl.¶¶ 36, 37,38). These allegations of their involvement in thecreation of the alleged misstatements is sufficient tosurvive the motions to dismiss.

[16] Similarly, the Audit Committee Defendantscontend that the plaintiffs have alleged “no specialrelationship with the corporation” or “access to in-formation more akin to a corporate insider.”(THL/Audit Comm. Mem. 24 n. 15.) “Allegationsof membership on an Audit Committee may, in cer-tain circumstances, provide a basis for liability un-der the group pleading doctrine.” In re Alstom SA,406 F.Supp.2d 433, 449 (S.D.N.Y.2005) ( “AlstomI” ). Plaintiffs allege that the Audit Committee De-fendants served on the Audit Committee from atleast October 12, 2004, when they approved theBond Registration Statement, through the time ofRefco's bankruptcy (Compl.¶¶ 42-45), and that theyhad extensive access to Refco's internal informa-tion, were responsible for overseeing the integrityof Refco's financial statements, and approved thosefinancial statements for all relevant periods.(Compl. ¶¶ 42-45, 268; see P. Mem. 93-94.) Theseallegations are sufficient under the group pleadingdoctrine. SeeIn re Adelphia Commc'ns Corp. Secs.and Deriv. Litig., 398 F.Supp.2d 244, 250(S.D.N.Y.2005) (applying group pleading doctrineto members of the board with equity interest and“access to information concerning the company'sday-to-day business”).

2. Challenges Based on the Timing of the FalseStatements (Trosten and Sherer)

Trosten, Refco's former CFO, argues that plaintiffshave failed to identify any material misrepresenta-tions made by Trosten within the class period,defined by the complaint as August 5, 2004, to Oc-tober 17, 2005. (Compl. at 1.) (Trosten Mem.16-17; see P. Mem. 94-95). He makes two argu-ments: first, that he resigned on October 4, 2004,eight days before the filing of the Bond Registra-









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tion Statement, and that he is therefore not liablefor any misrepresentations in that document; andsecond, that any misstatements in the OfferingMemorandum or road show are irrelevant becausethey happened in July 2004 (Compl.¶¶ 105, 144),prior to the start of the Class Period on August 5.

Plaintiffs contend that Trosten “is subject to liabil-ity for his false statements at the Road Shows at inthe Offering Memorandum.” (P. Mem. 95.) Thesetransactions are not, however, asserted as a basisfor liability in the complaint. The section of thecomplaint that deals with the “False and MisleadingStatements” on which Exchange Act liability isbased describes in detail three sets of statements(the May *643 2005 press release and Form 8-K,the 2005 year-end press release and 2005 Form10-K, and the First Quarter 2006 press release andassociated filings) (Compl.¶¶ 526-551), and refer-ences the Bond Registration Statement and the IPORegistration Statement (Compl. ¶ 525), but makesno mention of misstatements in the Bond OfferingMemorandum or at the Road Show. Moreover,Count Nine of the complaint alleges that misstate-ments were made “throughout the Class Period.”(Compl. ¶ 639.) Thus, plaintiffs cannot now arguethat the earlier statements should be the basis of li-ability.

[17] Even if pre-class-period statements were al-leged as a basis for liability in the complaint, theywould not survive the motion to dismiss. TheSecond Circuit has held that “[a] defendant ... is li-able only for those statements made during theclass period.” In re IBM Secs. Litig., 163 F.3d 102,107 (2d Cir.1998). Although pre-class-period state-ments can be relevant for showing whether defend-ants had knowledge that their later statements werefalse, In re Scholastic Corp. Secs. Litig., 252 F.3d63, 72 (2d Cir.2001), those statements cannot them-selves give rise to liability.FN27

FN27. Plaintiffs' arguments against thisrule are not unpersuasive. A class period isdelimited in order to identify the individu-als who claim membership in the class, notto identify the conduct that injured them,

as is clear in context when the Complaintidentifies the plaintiffs as those “who pur-chased or acquired [relevant securities]between August 5, 2004 and October 17,2005 (the “Class Period”).” (Id.)Indeed,this is why it is called the “Class Period,”not the “Liability Period.” Thus, it mightlogically be concluded that “[t]he fact thatthe proposed class period begins after thefirst of the alleged misstatements does notmake those earlier statements irrelevant ornot actionable.” Zelman v. JDS UniphaseCorp., 376 F.Supp.2d 956, 966(N.D.Cal.2005). However, as noted above,the Second Circuit has spoken clearly onthis question, and this Court is bound by itsconclusion.

As to whether Trosten may be held liable for mis-statements in the Bond Registration Statement,which was filed after his departure from Refco, thegeneral rule is of course that “a defendant must ac-tually make a false or misleading statement in orderto be held liable under Section 10(b). Anythingshort of such conduct is merely aiding and abetting,and no matter how substantial that aid may be, it isnot enough to trigger liability under Section 10(b).”Wright, 152 F.3d at 175 (internal quotation marksand alterations omitted). Trosten did not himselfmake the misstatements in the Bond RegistrationStatement, and he can therefore be held liable onlyif he falls within the group pleading doctrine, whichis an exception to this general requirement.

“Alleging direct involvement in the company'severyday business is critical to support the pre-sumption.” Parmalat, 2007 WL 869012 at *4. TheComplaint does not allege that Trosten remained in-volved in Refco's everyday business after his depar-ture (Compl. ¶ 40), and therefore fails to satisfy therequirements of the doctrine. Nor does the com-plaint allege that Trosten prepared or approved theBond Registration Statement; the only factual pre-dicate offered for Trosten's liability for misstate-ments in the Bond Registration Statement is that heknew that the statements in the Offering Memor-andum would be repeated in the Bond Registration


















Statement. (P. Mem. 95.) This argument, however,would give rise to liability far beyond the scope al-lowed by the group pleading doctrine, because itwould give rise to liability in any case where a mis-statement is regularly or predictably repeated foranyone involved in prior iterations of the statement.

[18] The group pleading doctrine is a presumptionthat certain statements are *644 “the collectivework of those individuals with direct involvementin the everyday business of the company.” BISYS,397 F.Supp.2d at 438. It is a doctrine of attribution,not of complicity, and therefore does not give riseto liability for later statements by a defendant'sformer associates. SeeLattanzio v. Deloitte &Touche LLP, 476 F.3d 147, 153 (2d Cir.2007) (as toan accountant, plaintiff must allege a misstatementthat is attributed to the defendant “at the time of itsdissemination,” and cannot rely on alleged assist-ance in the drafting or compilation of a filing). Ac-cordingly, the Exchange Act claims against Trostenmust be dismissed.

Sherer also makes an argument based on the timingof the relevant statements. He contends that he isnot responsible for statements Refco made beforeJanuary 2005, when Sherer began working at Re-fco. (Sherer/Murphy Mem. 13-14.) Plaintiffs' memoclarifies that they do not seek to hold him respons-ible for statements made prior to that time. (P.Mem. 94.) Although the substantive counts of thecomplaint do not specifically indicate that Sherer isnot subject to claims for misstatements before thispoint (see Compl.¶¶ 638-645), the Court acceptsthat any claims against Sherer arising from mis-statements before January 2005 have now beenabandoned. Accordingly, Sherer's motion to dismisssuch claims against him will be denied as moot.

B. Scienter

The Officer Defendants and the Audit CommitteeDefendants argue that the Exchange Act countsagainst them must be dismissed for failure to satisfythe scienter element of an Exchange Act claim. (SeeSexton Mem. 9-17; Silverman Mem. 16-22; KlejnaMem. 13-24; Sherer/Murphy Mem. 16-31; see P.

Mem. 105-112).FN28

FN28. Although Trosten is among thesedefendants (see Trosten Mem. 17-22), hisarguments need not be addressed in lightof the conclusion that plaintiffs have failedto identify him with relevant misstate-ments.

The state of mind that must be alleged in an actionunder section 10(b) and Rule 10b-5 is “ ‘an intentto deceive, manipulate or defraud.’ ” Ganino, 228F.3d at 168, quoting Ernst & Ernst v. Hochfelder,425 U.S. 185, 193 n. 12, 96 S.Ct. 1375, 47 L.Ed.2d668 (1976). To state a claim for securities fraud, thePSLRA requires that plaintiffs “state with particu-larity facts giving rise to a strong inference that thedefendant acted with the required state of mind.” 15U.S.C. § 78u-4(b)(2). SeeNovak v. Kasaks, 216F.3d 300, 310 (2d Cir.2000) (noting that thePSLRA “did not change the basic pleading standardfor scienter in this circuit.”).

To satisfy this requirement, “a complaint may (1)allege facts that constitute strong circumstantialevidence of conscious misbehavior or recklessness,or (2) allege facts to show that defendants had bothmotive and opportunity to commit fraud.” Rothman,220 F.3d at 90. Conscious misbehavior or reckless-ness may be inferred where the complaint suffi-ciently alleges that the defendants: (1) “benefittedin a concrete and personal way from the purportedfraud”; (2) “engaged in deliberately illegal behavi-or”; (3) “knew facts or had access to informationsuggesting that their public statements were not ac-curate”; or (4) “failed to check information theyhad a duty to monitor.” Novak, 216 F.3d at 311(internal citations omitted). As to motive and op-portunity, “[m]otives that are generally possessedby most corporate directors and officers do not suf-fice; instead, plaintiffs must assert a concrete andpersonal benefit to the individual defendants result-ing*645 from the fraud.” Kalnit v. Eichler, 264F.3d 131, 139 (2d Cir.2001).

[19] The group pleading doctrine “has no effect onthe PSLRA's scienter requirement. It merely gives






























plaintiffs the benefit of a presumption that certainkinds of statements were made by certain kinds ofdefendants. It does not permit plaintiffs to presumethe state of mind of those defendants at the time thealleged misstatements were made.” BISYS, 397F.Supp.2d at 440.

1. The Officer Defendants' Motive and Opportun-ity to Commit Fraud

Silverman, Sexton, Klejna, Sherer, and Murphycontend that plaintiffs have failed to adequately al-lege their motive and opportunity to commit fraud.

[20] To establish an adequate motive to commit se-curities fraud, plaintiffs must allege a motive that isconcrete and personal to the defendant charged withmaking the misstatement or omission. Kalnit, 264F.3d at 139. This must be more than “a generalizedmotive, one which could be imputed to any pub-licly-owned, for-profit endeavor.” Chill v. Gen.Elec. Co., 101 F.3d 263 (2d Cir.1996).“Motivesthat are generally possessed by most corporate dir-ectors and officers do not suffice.” Kalnit, 264 F.3dat 139. The desire for the corporation to appearprofitable, the desire to keep stock prices high, andeven the desire to keep stock prices high in order toincrease officer compensation, are insufficient be-cause they are “common to all corporate executivesand, thus, too generalized to demonstrate scienter.”Id. Similarly, “[t]o allege a motive sufficient tosupport the inference [of scienter], a plaintiff mustdo more than merely charge that executives aim toprolong the benefits of the positions they hold.”Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124,1130 (2d Cir.1994).

[21] Of course, the desire to keep stock prices highor to increase one's own compensation are often theactual motive for corporate fraud, but “[i]f scientercould be pleaded on that basis alone, virtually everycompany in the United States that experiences adownturn in stock price could be forced to defendsecurities fraud actions.” Acito v. IMCERA Group,Inc., 47 F.3d 47, 54 (2d Cir.1995). “[T]he ‘not com-monly shared’ limitation on motive inhibits someplaintiffs who have been genuinely defrauded from

obtaining a remedy,”JP Morgan Chase, 363F.Supp.2d at 619, but the mere desire to increaseofficer compensation or stock prices does not giverise to a “strong inference” of fraudulent intent be-cause such desires are omnipresent, and can as eas-ily be a sign of simple ambition or run-of-the-millgreed as of fraud. Cf.id. at 618 n. 14 (discussingwhether plaintiffs must plead facts that exclude oth-er inferences that are equally plausible to scienter).

[22] To show motive in this case, plaintiffs allegethat the officers of Refco in the year leading up tothe IPO “stripped close to $1 billion from the Com-pany” in a variety of ways. (Compl. ¶ 582.) Thefirst wave of the “frenzy,” according to plaintiffs,began in June 2004 with the THL Partner Defend-ants' purchase of a 57% stake in Refco from RGHI.Plaintiffs allege that Murphy, Sexton, and Klejnareceived large sums of money-from $6.5 million to$13.7 million-from this buyout pursuant to a“Company-endorsed profit-sharing agreement li-quidated by [RGHI].” Plaintiffs also allege that thedefendants received certain “unusually large”grants of common stock, without indicating whenthese grants took place, other than saying they were“[i]n the lead-up to the IPO.”(Compl. ¶ 585.)Motive, however, entails “concrete benefits thatcould be realized *646 by one or more of the falsestatements and wrongful nondisclosuresalleged,”Shields, 25 F.3d at 1130, and plaintiffs donot explain how these first floods of money relateto the alleged fraud.

Plaintiffs also rely on a number of more general be-nefits that would accrue from the IPO. For ex-ample, the IPO would allow the defendants to cre-ate a public trading market that would allow the de-fendants to sell their stock for huge profit or use itas collateral for personal loans (Compl. ¶ 588), andwould create a capital infusion that would increasethe book value of all Refco shares, including theshares the defendants retained.FN29 (Id.)Moreover, plaintiffs allege that the officer defend-ants received-again, at an unspecified time-“huge”grants of restricted stock units (“RSUs”). Fifty per-cent of these grants would vest in four years, whilefifty percent were conditional on the company's





























performance. (Compl. ¶ 591.) The officers alsowere entitled to bonuses conditioned on companyperformance. (Compl. ¶ 593.) It is not necessary todecide whether these incentives, in the aggregate,would have given the defendants a sufficientmotive to commit fraud, because another allegationrelating to the defendants' motive is enough to suf-fice.

FN29. Plaintiffs also allege that the IPOwould result in a “huge one-time ‘specialdividend’ payment that would ... line thepockets of these corporate insiders.”(Compl. ¶ 588.) It is not clear what thisrefers to; presumably, it is a reference tothe “green shoe” option, as plaintiffs havenot alleged any other special dividend fromthe IPO.

The IPO underwriting agreement provided for a so-called “green shoe” option providing that in theevent the IPO was oversubscribed, the underwriterswould be authorized to sell more shares than origin-ally provided for at the offering price. (Compl. ¶168.) The proceeds of any such sale would be dis-tributed directly to the shareholders of record be-fore the IPO-including the officer defendants andthe THL Partner Defendants. (Id. ¶ 587.) Thus, “bycreating sufficient demand for Refco stock at thetime of the IPO, these Defendants received an extracash payment from the sale of shares dedicated tocover the oversubscription.” (Id.) The IPO was in-deed oversubscribed, and the defendants receivedpayments ranging from Sherer's $349,800 to Kle-jna's $201,135. (Id. ¶ 587.)

“[M]otive is adequately pleaded where theplaintiffs allege that the defendants sold their ownshares while at the same time misrepresenting cor-porate performance in order to inflate stock prices.”Marcus v. Frome, 329 F.Supp.2d 464, 473(S.D.N.Y.2004). The Second Circuit has held thatmotive is adequately alleged where the defendantswho made false statements inflating the value ofshares “sold tens of thousands of shares during theperiod that the allegedly defrauded customers werepurchasing them.” Shields, 25 F.3d at 1131. Ac-

cording to the complaint, the officers had a directfinancial interest in the IPO. By fraudulently con-cealing the uncollectible receivables, they coulddrive up demand for Refco shares, which wouldresult in purchases of shares from which defendantswould be directly compensated. This is a concretebenefit directly flowing from the alleged fraud, andis accordingly sufficient to give rise to a strong in-ference of motive.

Several defendants point out that they purchasedstock in the IPO, which, they argue, is inconsistentwith the motive to commit fraud. They cite In reRegeneron Pharmaceuticals, Inc. Securities Litiga-tion, No. 03 Civ. 3111, 2005 WL 225288 (S.D.N.Y.Feb. 1, 2005), in which the court stated that “[i]t iswell settled that ... the purchase of additional com-pany shares *647 during the class period-is incon-sistent with an intent to commit fraud.” Id. at *22.Regeneron, however, dealt with alleged misstate-ments by corporate officers about the effectivenessof a new drug marketed by their company.FN30

Purchasing shares in the company is indeed incon-sistent with a belief that the drug's effectiveness hasbeen fraudulently overstated, because that fact willinevitably become known; one does not buy seatson a sinking ship. In this case, however, the factsalleged in the complaint do not make clear that thedefendants knew the ship was sinking. The defend-ants might have believed that the uncollectible re-ceivables held by RGHI could be hidden indefin-itely or at some point permanently disposed of (forexample, by RGHI actually paying Refco for them),and that Refco's stock would accordingly continueto rise.

FN30. The same is true of In re SymbolTechnologies Class Action Litigation, 950F.Supp. 1237, 1245 (E.D.N.Y.1997)(“Plaintiffs do not allege a motive to com-mit fraud. This is not surprising, since thecompany and defendant Amato, as well astwo high-ranking financial officers, pur-chased shares of Symbol stock during theclass period”), on which Regeneron relied;Symbol dealt with allegedly false projec-tions of future performance that would


















have been shortly disproved. Klejna alsocites In re Sina Corp. Securities Litigation,No. 05 Civ. 2154, 2006 WL 2742048(S.D.N.Y. Sept. 26, 2006), in which thecourt noted that “If the Individual Defend-ants indeed failed to disclose certain factsin order to personally profit from inside in-formation, one would reasonably expectthat they would hold fewer shares of stockbefore the anticipated plunge in the stock'sprice than they held the year before.” Id. at*12. It is not clear from the allegations inthis case that the defendants anticipated aplunge.

Murphy and Sexton make a similar argument, rely-ing on In re Health Management Systems, Inc. Se-curities Litigation, No. 97 Civ. 1865, 1998 WL283286 (S.D.N.Y. June 1, 1998), which held thatthe fact that defendants actually purchased shares“undermines plaintiff's claim that defendantsdelayed notifying the public so that they could selltheir stock at a huge profit.” Id. at *6. Again, thecase is not analogous; nothing about defendants'purchase of shares in the IPO is inconsistent withtheir alleged efforts to inflate the demand for Refcostock. The defendants in Health Management al-legedly planned to profit by selling shares; the factthat they purchased shares thus directly rebuttedplaintiffs' theory. The scheme in this case did notdepend upon defendants' selling their shares.

Defendants are free to argue to a finder of fact thattheir actions were inconsistent with an intent tocommit fraud. It might be possible to argue, for ex-ample, that plaintiffs' allegations are implausiblebecause Refco would have been seen as too riskyan investment by anyone who knew of the scheme.However, despite the demands of Rule 9(b) and thePSLRA, this is, after all, a motion to dismiss, andarguments such as these are inappropriate at thisstage. Plaintiffs have adequately alleged that the of-ficer defendants stood to profit in a direct, personal,and concrete way from the alleged fraud.

As to opportunity, the defendants' arguments areeasily dispensed with. They argue that plaintiffs' al-

legation that each defendant prepared and approvedthe relevant misstatement are insufficient to estab-lish opportunity to commit fraud. (See,e.g., SextonMem. 16.) They do not explain, however, whythese allegations do not suffice. Opportunity entails“the means and likely prospect of achieving con-crete benefits by the means alleged.” Shields, 25F.3d at 1130. The defendants' involvement in thepreparation of the statements at issue was of coursethe “means and likely prospect” offraudulently*648 inflating demand for Refcoshares. They were corporate officers of Refco withthe power to approve those statements, and cannotseriously dispute that “[s]uch senior executiveshave the opportunity to commit fraud.” Am. BankNote Holographics, 93 F.Supp.2d at 444. Thus,plaintiffs have adequately alleged that Silverman,Sexton, Klejna, Sherer, and Murphy had sufficientmotive and opportunity to give rise to a “strong in-ference,” 15 U.S.C. § 78u-4(b)(2), of scienter.

2. The Officer Defendants' Knowledge or Reck-lessness

Although the finding that motive and opportunityhave been adequately alleged is sufficient to dis-pose of the argument that plaintiffs have not ad-equately alleged scienter as to these defendants, theissue of the officer defendants' knowledge or reck-lessness will be addressed because it is relevant tothe discussion of control-person liability in a latersection of this opinion.

[23] To support an inference of recklessness,plaintiffs must allege facts showing that the defend-ants' conduct was “highly unreasonable, represent-ing an extreme departure from the standards of or-dinary care to the extent that the danger was eitherknown to the defendant or so obvious that the de-fendant must have been aware of it.” Rothman, 220F.3d at 90. Recklessness is adequately allegedwhen, inter alia, a plaintiff “specifically alleges de-fendants' knowledge of facts or access to informa-tion contradicting their public statements.” In re eS-peed, Inc. Secs. Litig., 457 F.Supp.2d 266, 282(S.D.N.Y.2006).
























Sexton, Silverman, Klejna, Sherer, and Murphy ar-gue that the plaintiffs have failed to adequately al-lege facts giving rise to a strong inference that theyacted with the requisite state of mind, that is, know-ledge or recklessness. They contend that plaintiffs'allegations fail because they have not pointed tospecific pieces of information to which defendantshad access that would have alerted them to thewrongdoing in progress, noting that “conclusory al-legations that a corporate officer had ‘access' to in-formation that contradicted the alleged misstate-ments are insufficient to raise a strong inference ofrecklessness.” Kinsey v. Cendant Corp., No. 04Civ.0582, 2005 WL 1907678, at *5 (S.D.N.Y. Aug.10, 2005).

Aside from defendants' role in the corporation, thecomplaint's allegations of recklessness focusprimarily on the allegedly fraudulent transactionsthemselves, in particular their size, their timing andrecurrent nature, and their obvious lack of businesspurpose. The transactions were certainly large, andtheir timing, recurrent nature, and obvious lack ofbusiness purpose would certainly have been suspi-cious to anyone who became aware of them.Plaintiffs also rely on the allegation that Refco hada history of similar violations, which they claim“should have alerted the Inside Defendants andGrant Thornton to the risk of financial manipula-tion.” (Compl. ¶ 576.) This history allegedly in-cluded at least 140 citations from the CFTC for vi-olations including filing false trading reports andinadequate record-keeping-“the worst record in theindustry.” (Id.) “Refco's culture of rule-breakingand repeated legal troubles should have, and but fortheir recklessness would have, alerted GrantThornton and the Inside Defendants (who, unlikeoutside investors, had unfettered access to Refco'smanagers, books, and records) to Refco's fraudulentfinancial reporting.” (Id. ¶ 576.) Specifically,plaintiffs allege that Refco had earlier been implic-ated in CFTC and SEC enforcement actions whereRefco was accused of improperly shifting clientfunds between related party accounts and *649 pay-ing off its own debt, actions similar to the schemeat issue here. (Id.¶¶ 577, 578, 579.) This history,they contend, was essentially a roadmap to discov-

ery of the fraud, had anyone cared to look into it.

The red flags on which plaintiffs rely are glaringlysuggestive of fraud, but only to those who were orshould have been aware of them. While a red flagneed not “reveal to a defendant all aspects of a giv-en fraud,”In re Van der Moolen Holding N.V. Secs.Litig., 405 F.Supp.2d 388, 406 (S.D.N.Y.2005),plaintiffs must allege that “facts which come to adefendant's attention would place a reasonableparty in defendant's position on notice of wrongdo-ing.” Id. In this case, there was certainly a monsterunder the bed; the question is whether anyone had areason to look there.

[24] “[S]cienter cannot be inferred solely from thefact that, due to the defendants' board membershipor executive managerial position, they had access tothe company's internal documentation as well asany adverse information.” In re Winstar Commc'ns,No. 01 Civ. 3014, 2006 WL 473885, at *7(S.D.N.Y. Feb. 27, 2006). The inquiry into whethercorporate officers should have known of facts in-dicating the falsity of public statements is a fact-specific one; scienter may be found where there are“specific allegations of various reasonably avail-able facts, or ‘red flags,’ that should have put theofficers on notice” that the public statements werefalse. Goplen v. 51job, Inc., 453 F.Supp.2d 759,774-775 (S.D.N.Y.2006).

Where the parent corporation is allegedly put onnotice of the true underlying facts, scienter can beestablished, seeIn re Alstom SA Sec. Lit., 454F.Supp.2d 187, 199 (S.D.N.Y.2006) (“Alstom II” )(finding scienter where the parent corporation “hadbeen directly alerted at its highest corporate levelsas to this potentially adverse issue”). But “[f]raudcannot be inferred simply because [a parent com-pany's officers] might have been more curious orconcerned about the activity at [its subsidiary].”Chill, 101 F.3d at 270. “[I]ntentional misconduct orrecklessness cannot be presumed from a parent's re-liance on its subsidiary's internal controls.” Id. at271 (internal citations and quotation marks omit-ted).


























During the relevant time period, each of the movingdefendants was an Executive Vice President of Re-fco, but none is alleged to have been an officer ofRefco Capital or (with the exception of Silverman)RGHI. (Compl. ¶¶ 33-38.) Silverman was Control-ler and Secretary of Refco. Sherer, who joined Re-fco in January 2005, was CFO from that timethrough Refco's collapse; Sexton was COO; Klejnawas General Counsel; and Murphy was in charge ofglobal marketing. (Id.) As to these officers,plaintiffs allege essentially that the ongoing fraudwas so large and conspicuous, so poorly hidden,and so consistent with prior violations that the of-ficer defendants must have been aware of it. Theycontend that the defendants' “positions in ... theCompany, and their concomitant access to insideinformation, also raise a strong inference that [they]knew or recklessly disregarded the truth about thetransactions discussed above. The Officer Defend-ants were responsible for the Company's operationsand played a critical role in its management.”(Compl. ¶ 565.) Thus, they contend, the defendants'“access to, and obligation to monitor, all the under-lying facts and circumstances of these transactionsraises a strong inference of scienter.” (Id.)

The allegations against some of the defendants arestronger than others. Silverman's alleged role in Re-fco and related parties raises a strong inference ofknowledge or recklessness. Whether or not his *650duties as Secretary and Controller of Refco in-cluded monitoring related-party transactions in-volving subsidiaries like Refco Capital-a questionnot addressed in the complaint-Silverman was Sec-retary of RGHI (Compl. ¶ 37), the entity mostdeeply implicated in the fraudulent transactions.Plaintiffs also point out that Silverman was askedby the Board of Refco to resign at the same time asBennett and Maggio. (Id.) This fact at least sug-gests that the Board-which was in a position toknow-believed he was in a position to have learnedof the fraud. Moreover, Silverman allegedly signedan agreement by which BAWAG, which allegedlyserved as one of the third-party intermediaries forthe fraudulent loans, obtained in 2004 an undis-closed equity interest in Refco. (Compl. ¶ 269(a).)This could be read to suggest that he was not only

involved with the day-to-day operations of RGHI,but in particular in dealings with the third party thatfacilitated the fraud. While a reasonable fact-findermight certainly conclude that Silverman was notconscious or reckless with respect to the fraud,these allegations at least give rise to a “strong infer-ence” sufficient to allow plaintiffs to go forwardwith discovery as to Silverman.

[25] The allegations as to Murphy and Sexton, onthe other hand, are inadequate. Plaintiffs never ex-plain, for example, what business Murphy, Refco'svice president for global marketing, would havehad reviewing the books of Refco Capital or RGHI.Sexton, who was Refco's COO (and, briefly, CEO),no doubt had more responsibility for Refco's opera-tions, but plaintiffs make no allegations whatsoeverconcerning the relationship between Refco Capital,the subsidiary, and Refco, the entity for which Sex-ton worked. The complaint states that Refco CapitalMarkets Ltd. “is a Bermuda-based Refco subsidiarythat traded over-the-counter derivatives in a largelyunregulated market” (Compl. ¶ 25),FN31 butwhether the two entities were entirely separate oreffectively one, and whether Refco's officers hadany involvement whatsoever in the operations ofRefco Capital, is left entirely to theimagination.FN32 Thus, the complaint gives nobasis on which to conclude that Sexton or Murphyshould have been familiar with any transactions ori-ginating with that company.

FN31. Although it has no effect on the out-come of the present motion, it should benoted that Klejna asserts that there are infact two separate entities that might be re-ferred to as “Refco Capital”: Refco CapitalMarkets Ltd., and Refco Capital LLC.(Klejna Mem. 21 n. 12.)

FN32. The complaint does make clear thatthe loan agreements between Refco Capitaland the third party were signed by DavidWeaver, the Chief Administrative Officerat Refco Capital (¶ 409), rather than by anyof the moving defendants.




Nor do plaintiffs allege any reason to think thatSexton or Murphy should have been aware of theactivities of RGHI. Plaintiffs more than amply al-lege that all defendants had a basis for knowingRGHI “was a related party controlled by Refco'sPresident and CEO.”(¶ 566.) This can hardly bequestioned; as Klejna notes, the relationshipbetween Refco and RGHI was disclosed in the IPORegistration Statement and the Bond RegistrationStatement. (Compl. ¶ 99.) Plaintiffs do not,however, allege that Sexton-or, indeed, any of thecorporate officers moving for dismissal, with theexception of Silverman-was involved in RGHI'sday-to-day operations, much less the relevant trans-actions. SeeIn re NYSE Specialists Secs. Litig., 405F.Supp.2d 281, 314 (S.D.N.Y.2005) (holding thatplaintiffs had failed to allege scienter where therewere no allegations that corporate parent“recklessly disregarded” red flags that should haveput it *651 on notice of subsidiary's fraudulentscheme). It is not clear that Sexton's responsibilitiesas COO would have involved oversight of transac-tions such as the ones at issue, or monitoring Re-fco's financial situation. Nor do plaintiffs allege anyreason why Sexton or Murphy should have knownthat Bennett had signed for Refco as a guarantor forthe relevant loans.

The only aspect of the fraudulent transactions thatwould presumably have appeared on Refco's ownbooks was the last step, in which RGHI used theloan from the third party to pay down the money itowed to Refco for the uncollectible receivables.(Compl. ¶ 416.) A Refco officer reviewing Refco'sbooks might have seen RGHI temporarily payingoff “at least a portion of the receivable owed.”FN33 (Id.) The complaint does not specify,however, whether this payment against the RGHIreceivable appeared in any reports or statementsroutinely reviewed by officers such as Sexton. Theother stages in the transactions would apparentlynot have been reflected in Refco's books at all. Asnoted above, the complaint does not allege that thefraudulent transactions began at Refco itself; in-stead, the money came from Refco Capital, a subsi-diary with which the Officer Defendants are not al-leged to have been involved.FN34 Indeed, in the

plaintiffs' chart summarizing the form of thesetransactions, no arrow representing a loan or a debtoriginates from Refco itself. (Id. ¶ 517.) Nothing inthe complaint supports the strong inference thatMurphy or Sexton had responsibility for monitoringthose books.

FN33. It appears that the scheme was de-signed not to pay off all of Refco's uncol-lectible receivables, but merely to paythem down. (See Compl. ¶ 240.)

FN34. As discussed above, the complaintin places uses the word “Refco” to refer toRefco Capital. Thus, as to the transactionsfor which BAWAG served as intermediary,the complaint frequently states that themoney originated with “Refco,” a termwhich the complaint defines to include Re-fco itself “and all of its predecessors andaffiliates,” (Compl. Ex. 1. at viii), but doesnot explain whether this term is used to de-note Refco or Refco Capital. In at least oneplace, it is clear that where the portions ofthe complaint dealing with BAWAG loansrefer to money originating from “Refco,”they mean money originating with “RefcoCapital Markets,” not Refco itself (Compl.¶ 500). The complaint nowhere allegesotherwise with respect to the otherBAWAG transactions. (Id.¶¶ 472-501.)Moreover, the complaint elsewhere statesbroadly that “[t]he funds used in the circu-lar transactions originated with Refco Cap-ital.” (Id. ¶ 569.) In transactions with otherthird parties, too, Refco Capital was thesource of the money. (Id. ¶ 505.)

Plaintiffs' allegations of a history of similar viola-tions by Refco is relevant insofar as it would havemade the red flags brighter, but again, unless thishistory required a defendant to make further invest-igations that would have uncovered the fraud, thehistory would not make visible red flags otherwiseoutside defendants' range of vision. Nor does itmatter that an employee at Refco allegedly dis-covered the fraud after working there for only two







months (Compl. ¶ 608), because the complaint nev-er identifies this employee's position, or the re-sponsibilities pursuant to which he or she dis-covered the fraud. No doubt there were some em-ployees at Refco whose positions put them intoclose contact with the massive fraud, but absent anallegation that puts defendants themselves into suchcontact, that fact cannot defeat a motion to dismiss.Nor does the suspiciously large severance paymentallegedly made to Trosten (¶ 575) raise an inferenceof scienter as to the individual defendants, becausethe complaint fails to specify which of them, if any,were or should have been aware of it. (Id.)

*652 Plaintiffs's allegations as to Sherer and Klejnaare more specific. Sherer, the CFO, was responsib-ility for Refco's financial well-being, and the regu-lar appearance and disappearance of a large RGHIreceivable at the end of Refco's financial period'swas a glaring red flag. Moreover, the fraudulenttransactions were allegedly orchestrated by one ormore attorneys at an unnamed law firm. (Compl. ¶¶403-05.) The plaintiffs allege that Sherer, as CFO,and Klejna, as General Counsel, were responsiblefor receiving and authorizing the payment of billsfrom this firm that “described the legal work per-formed ... in connection with documenting thetransactions.” (Compl. ¶ 595.) It is of course pos-sible that Bennett orchestrated the legal workwithout the help or knowledge of the corporate of-ficers responsible for supervising the law firm, butthe allegation that Sherer and Klejna stood betweenBennett and the law firm in the relevant chain ofcommand supports a strong inference that theywere aware of the work being done. The size of thetransactions, their recurrent nature, and their obvi-ous lack of business purpose may not themselves besufficient to support an inference of scienter, but to-gether with the allegations concerning the roles andresponsibilities of Silverman, Sherer, and Klejna,they suffice.

Thus, plaintiffs have adequately alleged reckless-ness as to Silverman, Sherer and Klejna, but not asto Sexton and Murphy. Because motive and oppor-tunity have been adequately alleged as to all five ofthese defendants, however, a strong inference of

scienter has been raised as to each, and their mo-tions to dismiss for failure to allege scienter will bedenied.

3. The Audit Committee Defendants' Recklessness

The Audit Committee Defendants also argue thatplaintiffs have failed to adequately allege scienteras to them. (THL/Audit Comm. Mem. 25-34; see P.Mem. 105-113.) Although the allegations of reck-lessness as to the Audit Committee Defendants areinsufficient to give rise to a strong inference offraud, the allegations of motive and opportunity areenough to survive a motion to dismiss.

As to recklessness, “courts have been hesitant tofind a strong inference of audit committee mem-bers' scienter in cases providing general allegationsof circumstantial evidence.” In re Marsh & Mclen-nan Cos., Inc. Secs. Litig., 501 F.Supp.2d 452, 487,2006 WL 2057194, at *29 (S.D.N.Y. July 20,2006). Reckless conduct in a § 10(b) claim“represents an extreme departure from the stand-ards of ordinary care ... to the extent that the dangerwas either known to the defendant or so obviousthat the defendant must have been aware of it.”Chill, 101 F.3d at 269. “[J]ust because a defendantis a director and member of the company's auditcommittee does not lead automatically to an infer-ence that the person acted with conscious disregardof a known risk as opposed to with gross negli-gence or even negligence.” Jacobs, 1999 WL101772, at *16.

Plaintiffs allege in detail the responsibilities for in-ternal procedures and oversight that went withmembership in the Audit Committee. (Compl. ¶¶599-601.) Specifically, the Audit Committee's du-ties allegedly included oversight of Refco's ac-counting and internal control policies and proced-ures and of the internal controls themselves; assess-ment and management of the company's exposureto risk; management of internal audit projects; andmeetings with inside and outside counsel to reviewlegal and regulatory matters, including any mattersthat might have a material impact on Refco's finan-cial statements; and reviewing and discussing with













management “material financial arrangements*653of the Company which do not appear on the finan-cial statements of the Company.” (Id. ¶ 601.) Thecomplaint also alleges that Audit Committee De-fendant O'Kelley, the chairman of the Committee,was qualified as an independent “audit committeefinancial expert” as defined by the SEC, which re-quired extensive experience and expertise on hispart. (Id. ¶ 602.)

[26] Mere membership in a committee with over-sight responsibilities, however, is not enough togive rise to an inference of recklessness. “[C]ourtshave routinely rejected the attempt to plead scienterbased on allegations that because of defendants'board membership and/or their executive manageri-al positions, they had access to information con-cerning the company's adverse financial outlook.”Health Mgmt. Sys., No. 97 Civ. 1865, 1998 WL283286, at *6 (S.D.N.Y. June 1, 1998). It is notenough to allege “that the Audit Committee had aduty to monitor regulatory and legal compliance”;rather, plaintiff must identify “information thatreached the Audit Committee and that they eitherknew about or were reckless in ignoring.” Marsh &McLennan, 2006 WL 2057194, at *29. “Simplystating that a defendant had a duty to monitor is in-sufficient to raise a strong inference of scienterwithout allegations of what information was reas-onably available to them or how they were recklessin their duties.” Id.

As to the specific information revealing fraud thatthe Audit Committee Defendants Plaintiffs knew orshould have known of, plaintiffs can point only tocertain “significant deficiencies” in Refco's auditprocedures which were brought to the Committee'sattention by Refco's auditor in February 25, 2005.(Compl. ¶¶ 603-07.) These deficiencies were: (1) aneed to increase the resources of Refco's financedepartment, “to be able to prepare financial state-ments that are fully compliant with all SEC report-ing guidelines on a timely basis”(id. ¶ 603), and (2)a “lack of formalized procedures for closing [theCompany's] books”(id.(alterations in original)). TheIPO Registration Statement defined “significant de-ficiency” as “a deficiency that results in more than

a remote likelihood that a misstatement of financialstatements that is more than inconsequential willnot be prevented or detected.” (Id.) Plaintiffs allegethat these deficiencies “should have alerted [theAudit Committee Defendants] that there was a sig-nificant risk of fraudulent activity at the Company.”(Id. ¶ 604.) They also allege that the deficiencies“created an environment where it was easy for Ben-nett, Maggio and others to fraudulently manipulateRefco's financial statements.” (Id.)

Plaintiffs do not explain how correction of these de-ficiencies would have resulted in discovery of thefraud. Nor is it obvious that it would have; more re-sources for the finance department or more formal-ized procedures might have necessitated more careon the part of the perpetrators, but plaintiffs do notexplain what aspects of the fraud would have beenrevealed by a strengthening of procedure or an in-flux of resources to the finance department. Al-leging that the defendants should have prospect-ively tightened controls is not the same as allegingthat they should have investigated specific red flagsthat would have led them to the fraud. Plaintiffshave essentially claimed that the Audit Committee'snegligence made it too easy to commit fraud at Re-fco, but even if true, this is not the same as allegingthat they knew or should have known of the fraud.

[27] Allegations that an audit committee failed totake steps to prevent fraud may suffice whereplaintiffs identify specific actions that the commit-tee-members should have taken that would haveprevented*654 the fraud. Livent, 78 F.Supp.2d at221 (“[I]f the Outside Directors were aware that theCompany's management information systems werecapable of manipulating the accounts without leav-ing a paper trail, and failed, despite this awareness,to take steps to insure that such manipulations werenot being performed, including a review of thework of D & T, this might constitute recklessnesssufficient to infer scienter.”); JWP, 928 F.Supp. at1257 (denying summary judgment where a reason-able factfinder could conclude that “the audit com-mittee defendants were aware of a laundry list ofdubious accounting practices that should havecaused them to investigate and to uncover the




http://www.westlaw.com/Find/Default.wl?rs=dfa1.0&vr=2.0&DB=999&DocName=1998WESTLAW283286&FindType=Y









massive fraud at JWP.”). However, where plaintiffsfail to describe the chain of events by which de-fendants should have discovered or averted thefraud, the allegations do not give rise to an infer-ence of scienter. In re WorldCom, Inc., Secs. Litig.,No. 02 Civ. 3288, 2003 WL 23174761, at *5(S.D.N.Y. Dec. 3, 2003)(“WorldCom II” ) (“even ifthe Lead Plaintiff had sufficiently alleged a breachof a well-defined duty to communicate, it has notalleged that Internal Audit would have reported tothe Audit Committee in the Fall of 2001 that it haduncovered information indicative of fraud orwrongdoing, or even information requiring furtherinvestigation.”); Marsh & McLennan, 2006 WL2057194, at *30 (“There are no facts alleged toshow that closer scrutiny of those transactionswould have put any of the defendants on notice ofthe misconduct.”).

[28] Here, as in WorldCom II,the Amended Complaint describes what the AuditCommittee Defendants might have learned if theyhad done a better job or if they had been more ag-gressive or diligent. Section 10(b), however, doesnot impose liability for negligence or impose oblig-ations ex post facto. There is simply no adequatebasis to infer from the allegations in the AmendedComplaint that the Audit Committee Defendantsthemselves were aware or must have been aware ofthe accounting fraud.

WorldCom II, 2003 WL 23174761, at *5. “TheAmended Complaint's allegations reveal at most anAudit Committee that ... was anemic in its oversightfunction. The allegation that a defendant generallyfailed to perform a job well, however, is not a sub-stitute for the particularized pleading that a defend-ant knowingly or recklessly engaged in fraud.” Id.at *6.

Similarly, plaintiffs' allegation that an unidentifiedemployee caught the fraud after only two months ofemployment at Refco (Compl. ¶ 608) does nothingto help identify the information from which theAudit Committee knew or should have known ofthe fraud in progress, because plaintiffs fail toidentify the information from which this employee

identified the fraud. If the employee was reviewingthe same information as the Audit Committee De-fendants, the allegation could be relevant, butplaintiffs do not even suggest that this was thecase.FN35 In short, plaintiffs have failed to ad-equately allege that the Audit Committee Defend-ants were so reckless as to give rise to an inferenceof scienter.

FN35. If plaintiffs can plead that theunidentified employee learned of the fraudby reviewing information known to theAudit Committee, they can of course seekleave to amend their complaint to allegethat.

4. The Audit Committee Defendants' Motive andOpportunity

Some of the alleged motives alleged as to the of-ficer defendants discussed above are also alleged asto the Audit Committee Defendants, in particularthe grants of *655 Refco common stock (Compl. ¶585), but the Audit Committee Defendants are notalleged to have benefitted from the “green shoe”option that supported the inference of motive as tothe corporate officers discussed above. (Compl. ¶587.) The only other motive allegation against thesedefendants is that each of the three received 20,000restricted stock units (“RSUs”) in advance of theIPO. They were the only board members to receivethese grants. (Compl. ¶ 592.) The RSUs would be-come worthless were the fraud exposed. (Id.¶¶591-92.)

[29] In general, an “unparticularized interest in ex-ecutive compensation tied to stock price perform-ance is not a sufficient motive for fraud.” Geiger,933 F.Supp. at 1190. In this case, however, the al-legation that no other directors received grants ofRSUs makes those grants sufficiently unusual tosupport the required inference of motive. Cf.World-Com I, 294 F.Supp.2d at 412 (to determine whetherinsider sales were unusual, “the court may considerwhether other directors also sold or held theirshares during the relevant period”). It could be in-ferred from the fact that grants were made directly













to the Audit Committee-and only to the Audit Com-mittee-that the RSU grants were part of a quid proquo in exchange for the Committee's overlookingthe fraudulent transactions, or a specifically tailoredincentive for them to overlook the transactions, orboth. Because only these boardmembers receivedthe RSUs, this allegation is not “common to all,”boardmembers, Kalnit, 264 F.3d at 139, and is suf-ficient to support an inference of motive. Thus, theAudit Committee Defendants' motion to dismiss forfailure to allege scienter will be denied.FN36

FN36. The Audit Committee Defendantsdo not dispute that they had the opportun-ity to engage in fraud.

V. Exchange Act Claims Against Grant Thornton

A. The Exchange Act Allegations Against GrantThornton

Plaintiffs allege that Grant Thornton made falsestatements in its unqualified audit reports for thefiscal years 2003, 2004 and 2005, which were in-cluded in the Company's fiscal year 2005 AnnualReport. (Compl. ¶¶ 54, 532.) In these reports,plaintiffs allege that Grant Thornton falsely stated(1) that its audits conformed with Generally Accep-ted Auditing Standards (“GAAS”),FN37 and (2)that it had concluded that Refco's financial state-ments were presented in accordance with GenerallyAccepted Accounting Principles (“GAAP”).FN38

*656 (Compl. ¶¶ 306, 336, 532.) Grant Thorntonmakes several arguments in support of its motion todismiss these claims. First, it argues that plaintiffshave failed to identify the material misstatements atissue with sufficient particularity. Second, it arguesthat plaintiffs cannot show loss causation as to cer-tain losses. Third, it argues that plaintiffs havefailed to allege facts giving rise to a strong infer-ence of scienter on its part. Each of these argumentsis without merit.

FN37. The Complaint defines GAAS asthe auditing standards issued or adopted bythe Public Company Accounting OversightBoard (“PCAOB”) established by the Sar-banes-Oxley Act of 2002, together with the

auditing standards issued by the AmericanInstitute of Certified Public Accountants(“AICPA”). (Compl. ¶ 206 (mis-numberedparagraph on page 94, between ¶¶ 225 and226); id. ¶ 226.)

FN38. The Complaint defines GAAP as:those principles recognized by the account-ing profession as the conventions, rules,and procedures necessary to define accep-ted accounting practices at a particulartime. GAAP principles are the officialstandards accepted by the SEC and pro-mulgated in part by the American Instituteof Certified Public Accountants(“AICPA”). GAAP consists of a hierarchyof authoritative literature. The highest au-thority is comprised of Financial Account-ing Standards Board (“FASB”) Statementsof Financial Accounting Statements(“SFAS”), followed by FASB Interpreta-tions (“FIN”), Accounting PrinciplesBoard Opinions (“APB Opinion”), andAICPA Accounting Research Bulletins(“ARB”). GAAP provides other authoritat-ive pronouncements including, among oth-ers, the FASB Concept Statements(“FASCON”).(Compl. ¶ 212.)

B. Material Misstatements by Grant Thornton

[30] Grant Thornton argues that plaintiffs' Ex-change Act claims against it should be dismissedfor failure to comply with Rule 9(b)'s particularityrequirements, in that the plaintiffs have failed to al-lege with specificity the material misstatements onwhich their claims are based. (Grant ThorntonMem. 15-17; see P. Mem. 87-89). There is no ques-tion that plaintiffs have pointed with adequate spe-cificity to the statements alleged to be false; asnoted above, plaintiffs allege that in GrantThornton's audit reports for the fiscal years 2003,2004 and 2005, which were included in the Com-pany's fiscal year 2005 Annual Report, GrantThornton falsely stated (1) that its audits conformedwith GAAS and (2) that it had concluded that Re-







fco's financial statements were presented in accord-ance with GAAP. Rather, Grant Thornton's conten-tion is that plaintiffs have failed to explain whythose statements were false.

As to the failure of Grant Thornton's audits to con-form with GAAS, plaintiffs allege that over theyears that Grant Thornton served as Refco's auditor,it made only one attempt to confirm that one of themassive loan transactions that took place at the endof each reporting period was an actual loan, andthat Grant Thornton made no effort to determinewhether this was in fact an arm's-length transaction.(Compl. ¶¶ 232, 239, 554-67.) Plaintiffs also allegethat Grant Thornton failed to detect the massivefraud (id.¶¶ 227; 237-238) and to remain properlyindependent (¶ 228). As to the failure of Refco'sfinancial statements to conform with GAAP,plaintiffs allege that the statements failed to dis-close significant related-party transactions (Id.¶¶215-19) and that Refco was a guarantor of thosetransactions (id. ¶ 221), and that the statements vi-olated general principles of GAAP requiring thatfinancial statements contain a thorough and com-plete report of relevant information. (Id.¶¶ 224-25.)FN39

FN39. Allegations that an auditor“prepared, directed or controlled,” “helpedcreate” or “materially assisted in” prepar-ing false statements are sufficient to giverise to liability. Global Crossing I, 322F.Supp.2d at 334. In this case, however,the false statements for which GrantThornton is allegedly liable are not Refco'sstatements, but Grant Thornton's auditsthemselves.

These allegations are sufficiently particular to sur-vive the motion to dismiss, because they give GrantThornton more than ample notice of the ways inwhich its unqualified audit reports allegedly mis-represented the propriety of its auditing practicesand Refco's accounting practices. Grant Thorntonargues that these alleged problems with its auditswould not constitute a violation of the relevantstandards, but “[a]lthough the question of whether

GAAP has been violated might appear to be a legaldetermination, the element of what is ‘generally ac-cepted’ makes this difficult to decide as a matter oflaw.” In re Global Crossing, Ltd. Secs. Litig., 322F.Supp.2d 319, 339 (S.D.N.Y.2004) ( “GlobalCrossing I” ). At the motion to dismiss stage, theplaintiffs' assertion that certain practices were notgenerally accepted *657 “must be taken as true.”Id. at 339. Therefore, Grant Thornton's argumentthat the complaint puts it “in the impossible posi-tion of trying to divine Plaintiffs' allegations”(Grant Thornton Mem. 17) is without merit.

C. Loss Causation As To Grant Thornton

[31] Grant Thornton argues that plaintiffs' claimsagainst it-both the § 11 claims and the § 10 claims-must be dismissed because plaintiffs have not ad-equately alleged loss causation as to losses sufferedafter October 10, 2005, the date of the initial pressrelease disclosing the hidden uncollectible receiv-ables and disavowing the financial statements.

Grant Thornton argues that the October 10, 2005,disclosure of the related-party loan to RGHI andannouncement that Refco's prior financial state-ments could not be relied upon (Compl. ¶ 620)“removed from the marketplace the only allegedmisinformation that could possibly have been at-tributed to the audit firm.” (Grant Thornton Reply8.) It contends that after the October 10 disclosure,“the marketplace was on notice that the financialstatements could not be relied upon, so investorsnecessarily would have known that the audit opin-ion concerning those financial statements could notbe relied upon either.” (Id. at 8-9.) Conceding thatRefco's stock continued to decline after this disclos-ure, Grant Thornton contends that the later declinewas due to the liquidity problems following the“mass exodus” of Refco's customers and Bennett'sarrest. (Id.) Therefore, it argues, any misstatementsin its audit reports were not the cause of lossessuffered after the October 10 disclosures.

Grant Thornton is free to make such arguments tothe factfinder, but it seems more than plausible toargue, as plaintiffs do, that the exodus of Refco's









customers was due, in part, to the allegedly falsestatements by Grant Thornton and the other defend-ants. (Compl. ¶ 621.) Plaintiffs' allegations couldsupport an inference “that foreseeability links theomitted information and the ultimate injury in thiscase, in contrast to cases where external and un-foreseeable factors such as market crashes were thedirect cause of a plaintiff's loss.” Castellano v.Young & Rubicam, Inc., 257 F.3d 171, 190 (2dCir.2001). Accordingly, Grant Thornton's argumentregarding loss causation is without merit.FN40

FN40. Grant Thornton also argues that al-legations in the criminal indictment againstBennett, along with allegations in the com-plaint in this case, suggest that “a centralpurpose of the scheme was to hide the truthfrom Grant Thornton.” (Grant ThorntonMem. 14.) This argument, of course, hasno place in a motion to dismiss.

D. Grant Thornton's Recklessness

Grant Thornton argues that plaintiffs have failed toadequately allege that any false statements in itsaudit reports were made knowingly or recklessly, orthat it had motive and opportunity to commit thefraud. (Grant Thornton Mem. 5-15; see P. Mem.97-104). Because the plaintiffs have adequately al-leged facts giving rise to a strong inference of reck-lessness, it is unnecessary to reach the question ofmotive.

[32] “The standard for pleading auditor scienter isdemanding.” Marsh & McLennan, 2006 WL2057194, at *30. For an accountant to be found tohave acted recklessly during an audit, its allegedmisconduct must “approximate an actual intent toaid in the fraud being perpetrated by the auditedcompany.” Rothman, 220 F.3d at 98 (citation andinternal quotation marks omitted). This *658 stand-ard requires more than “a failure to follow GAAP.”Vladimir v. Deloitte & Touche LLP, 95 Civ. 10319,1997 WL 151330, at *3 (S.D.N.Y. Mar.31, 1997).Plaintiffs must prove that “[t]he accounting prac-tices were so deficient that the audit amounted tono audit at all, or an egregious refusal to see the ob-

vious, or to investigate the doubtful, or that the ac-counting judgments which were made were suchthat no reasonable accountant would have made thesame decisions if confronted with the same facts.”S.E.C. v. Price Waterhouse, 797 F.Supp. 1217,1240 (S.D.N.Y.1992) (internal quotation marks andcitations omitted). Because “[i]t is elementary that,on a motion to dismiss, the Complaint must be readas a whole,”Yoder v. Orthomolecular NutritionInst., Inc., 751 F.2d 555, 562 (2d Cir.1985), the redflags must be viewed in the aggregate; defendants“cannot secure dismissal by cherry-picking onlythose allegations susceptible to rebuttal and disreg-arding the remainder.” In re Philip Svcs. Corp.Secs. Litig., 383 F.Supp.2d 463, 476(S.D.N.Y.2004).

[33] As noted above, the claims against GrantThornton are premised on its alleged false state-ments about its own auditing practices and Refco'saccounting practices. Plaintiffs' memorandum fo-cuses on the red flags that allegedly should havealerted Grant Thornton to the fraud; apparently,their argument is that from the scale and obvious-ness of the fraud, it can be inferred either (1) thatGrant Thornton actually knew of the fraud, inwhich case of course its certifications were false; or(2) that Grant Thornton didn't know of the fraud,which could only happen as a result of audit pro-cedures that were (contrary to the claims in their re-ports) so substandard that the auditors would haveto have known they were sub-standard.

To demonstrate Grant Thornton's recklessness,plaintiffs rely on many of the same allegationsmade against the officer defendants. They note the“suspicious timing, recurrent pattern and unusualnature of the related-party transactions” (P. Mem.97) and the large size of the sham loans in compar-ison to Refco's net income. (Id.) Some of these redflags are not alleged to have been known by GrantThornton; for example, plaintiffs do not allege thatGrant Thornton knew the transactions were beingrouted back to Refco-related entities after they wereloaned to third parties, or that Grant Thornton knewthat Refco Capital was paying interest on the fraud-ulent loans.FN41 As discussed above, however, the


























complaint supports an inference that the appearanceand disappearance of large receivables at the end offinancial reporting periods was reflected in Refco'sbooks, and large transactions near the end of finan-cial reporting periods can be a significant red flag.In re Winstar Commc'ns, No. 01 Civ. 3014, 2006WL 473885, at *11 (S.D.N.Y. Feb. 27, 2006).

FN41. Plaintiffs allege that Grant Thornton“recklessly failed to discover” that RefcoCapital was paying the interest. (Compl. ¶563.)

As to these large transactions, plaintiffs note thatGrant Thornton only arranged for one confirmationrequest for the related-party transactions. In Fall2004, Refco Capital sent a confirmation request tothe third party known as “Customer X,” asking thatthey confirm certain information to Grant Thornton.(Compl. ¶ 554.) The Statement of Account attachedto the confirmation request showed that Refco (bywhich plaintiffs presumably mean Refco Capital)had loaned $325,000,000 to Customer X on Febru-ary 25, 2002, three days prior to the end of Refco'sfiscal year. (Compl. ¶ 556.) Customer X confirmed*659 this information and sent it, along with aStatement of Account, to Grant Thornton. GrantThornton did not ask for any further information.Nor did Grant Thornton send confirmation requestsin fiscal years 2003, 2004, or 2005. (Compl. ¶ 559.)

Plaintiffs do not explain what would have beenlearned if such requests had been sent, and ofcourse Refco was in the business of making loans,some of them presumably falling close to the end ofits fiscal year. Absent an allegation that GrantThornton knew or discovered that the loan wouldbe routed back to RGHI, the failure to send moreconfirmation requests is not direct evidence of a re-fusal to see the obvious. In the context of the otherallegations of scienter as to Grant Thornton,however, the firm's apparent lack of interest inlarge receivables that briefly disappeared from Re-fco's books at the moment when they would havebeen reportable forms an important part of thebroader picture.

Plaintiffs also contend that the fraud was“documented in plain terms in numerous documentsmaintained at the Company.” (P. Mem. 100.) Thecomplaint does allege that numerous such docu-ments existed. (Compl. ¶ 400) For example,plaintiffs claim that the unnamed law firm facilitat-ing the transaction drew up agreements and othertransaction documents with the third partiesthrough which the money passed, including a guar-antee letter from Refco Group. (Id. ¶ 405.) “Thedocumentation for each of these transactions wascreated by the Law Firm.”(Id. ¶ 406.) Many of thedocuments, such as the loan agreement pursuant towhich Refco Capital loaned money to Customer X,were between Refco Capital or RGHI and the thirdparty. (Id.¶¶ 409, 412.) Bennett signed guaranteeagreements for some of these loans on behalf of Re-fco. (Id. ¶ 425.) FN42

FN42. Plaintiffs also rely on internal state-ments of RGHI's accounts at Refco, whichallegedly contained line-items reflectingthe circular flow of funds between RGHIand BAWAG. (Compl. ¶ 567.) In at leastone case, a transfer from BAWAG toRGHI was followed a short time later by atransfer of slightly more money fromRGHI back to BAWAG. In other words, itwould have been apparent to a reviewer ofthese records that BAWAG had loanedRGHI a large sum of money. There isnothing obviously suspicious about this,however; the relevant parties were in thebusiness of making loans and investments,and the circular transactions were suspi-cious because they involved money beingloaned from one Refco-related partythrough BAWAG to another Refco-relatedparty-something that plaintiffs do not al-lege that RGHI's account statements reflec-ted.As to one circular transaction involvingBAWAG, the complaint alleges that afterRGHI received the loan from BAWAG,RGHI unwound the transaction by sendingthe money back to “Refco” (again, thisseems to refer to Refco Capital)-without







using BAWAG as an intermediary. Thecomplaint specifically notes that in thiscase, the line-item representing the returnof money to Refco is not identified inRGHI's records; the relevant line-item ismarked only “transfer.” (¶ 567(b).) In oth-er words, the relevant records contain atransfer from BAWAG to RGHI, followedby an unspecified “transfer.” For this trans-action, then, it would not even have beenapparent to a reviewer of records that thetransfer was a loan from BAWAG toRGHI.

Of course, it could turn out that the documents re-lating to these loans, guarantees, and other transac-tions were kept carefully hidden in the files of thirdparties to which Grant Thornton had no access.Given the size of the transactions, the fact that atleast some of Refco's officers were allegedly in-volved in orchestrating it, and the volume of docu-mentation allegedly created, however, this allega-tion-together with the others-contributes to a stronginference of scienter on Grant Thornton's part. Ac-cordingly, Grant Thornton's argument*660 that theplaintiffs have failed to allege scienter is withoutmerit, as are its other challenges to the ExchangeAct claims.

VI. Control-Person Liability Under Exchange Act§ 20(a)

Most of the moving defendants argue that the con-trol-person liability claims against them under §20(a) of the Exchange Act must be dismissed. Un-der § 20(a):Every person who, directly or indirectly, controlsany person liable under any provision of thischapter or of any rule or regulation thereunder shallalso be liable jointly and severally with and to thesame extent as such controlled person is liable, un-less the controlling person acted in good faith anddid not directly or indirectly induce the act or actsconstituting the violation or cause of action.

15 U.S.C. § 78t(a).

To make out a prima facie case under § 20(a) of the

Exchange Act, a plaintiff “must show a primary vi-olation by the controlled person and control of theprimary violator by the targeted defendant, andshow that the controlling person was in some mean-ingful sense a culpable participant in the fraud per-petrated by the controlled person.” First Jersey,101 F.3d at 1472. Defendants do not argue thatplaintiffs have failed to allege a primary violation.

[34] Section 20(a) and Section 15 are parallel pro-visions, and their “terms are interpreted in the samemanner.” Global Crossing I, 322 F.Supp.2d at 349.Accordingly, the challenges to the allegations ofcontrol by defendants Bennett, RGHI, the BennettTrust, Sexton, Murphy, Silverman, the Audit Com-mittee Defendants, and the THL Individual Defend-ants are without merit, for the reasons discussedabove in the context of liability under § 15 of theSecurities Act. The only remaining issue for thesedefendants is therefore whether plaintiffs have ad-equately alleged culpable participation in the fraud.

[35][36] Unlike § 15, § 20(a) requires that theplaintiff must also “allege culpable participation ‘insome meaningful sense’ by the controlling personin the fraud.” FN43 Id., quoting Burstyn v. World-wide Xceed Group, Inc., No. 01 Civ. 1125, 2002WL 31191741, at *7 (S.D.N.Y. Sept. 30, 2002). Al-though “control” may be pleaded in accordancewith Rule 8(a)'s notice-pleading standard, seeIn reParmalat Secs. Litig., 383 F.Supp.2d 616, 627 & n.53 (S.D.N.Y.2005), a heightened pleading require-ment applies to the “culpable participation” ele-ment;*661 the plaintiff “must plead with particular-ity facts giving rise to a strong inference that thecontrolling person knew or should have known thatthe primary violator, over whom that person hadcontrol, was engaging in fraudulent conduct.” Id.(internal quotation marks omitted); seeGlobalCrossing III, 2005 WL 2990646, at *7.

FN43. The holding that § 20(a) requiresculpable participation, while § 15 does not,may seem to contradict the observationthat the terms of the two provisions aresubstantially identical and “are interpretedin the same manner.” Global Crossing I,






















322 F.Supp.2d at 349. There is, however,one respect in which the terms of the con-trol-person provisions differ. Section 15provides that there shall be no liabilitywhere “the controlling person had noknowledge of or reasonable ground to be-lieve in the existence of the facts by reasonof which the liability of the controlled per-son is alleged to exist.” 15 U.S.C.A. § 77o(emphasis added). Section 20(a), on theother hand, gives rise to no liability where“the controlling person acted in good faithand did not directly or indirectly induce theact or acts constituting the violation orcause of action.” 15 U.S.C.A. § 78t(a)(emphasis added). Thus, an allegation ofnegligence does not state a violation of §20(a) if the negligence was in good faith;the same is not true of § 15. It is in partfrom this language requiring a lack of“good faith” that the Second Circuit in-ferred that § 20(a) was “obviously[intended] to impose liability only on thosedirectors ... who are in some meaningfulsense culpable participants in the fraudperpetrated by controlled persons.” Lanzav. Drexel & Co., 479 F.2d 1277, 1299 (2dCir.1973).

A. Bennett and the Bennett Entities

[37] Bennett argues that certain counts should bedismissed because he cannot be both primarily li-able as a direct violator of the Acts and secondarilyliable as a “controlling person.” (Bennett Mem.12-14.) It is true that dicta in Kalnit v. Eichler, 85F.Supp.2d 232 (S.D.N.Y.1999), suggest that wherea “plaintiff alleges that [defendants] had knowledgeof the misrepresentations and omissions ... the[defendants] could not be control persons.” Id. at246. Other courts, however, have consistently heldthat “[a]lhough a defendant ultimately may not beheld liable as both a primary violator and a con-trolling person, [pleading] such alternative theoriesof liability [is] permissible.” Parmalat, 375F.Supp.2d at 310. Bennett's argument is with Rule8(e)(2) of the Federal Rules of Civil Procedure,

which allows alternate pleading and provides that“[a] party may also state as many separate claims ordefenses as the party has regardless of consist-ency.”

RGHI and the Bennett Trust also move for dis-missal of the § 20(a) counts against them. They ar-gue that the complaint fails to allege that they con-trolled Refco-an argument rejected in the context ofthe Securities Act § 15 discussion above-and thatthe plaintiffs have failed to allege culpable particip-ation. Inexplicably, they contend that “[p]laintiffsdo not allege that RGHI and the Trust played anyrole in the alleged fraudulent scheme.” (BennettMem. 18.) On the contrary, plaintiffs' theory of thefraud centers around the claim that RGHI was thehiding place for Refco's uncollectible receivables.Moreover, the complaint alleges that Bennett, theprimary actor in the fraud, controlled RGHI and theTrust, which in turn controlled Refco. (Compl. ¶261.) Thus, Bennett's control of Refco was exer-cised through the shell entities, and those entitieswere the means by which he exercised his power toorchestrate the fraudulent scheme. In essence, thecomplaint alleges that the shell entities that con-trolled Refco were Bennett. This is enough to giverise to a strong inference of culpable participation.

B. Sexton, Klejna, Murphy, Sherer, Silverman,and the Audit Committee Defendants

[38] Section 20(a)'s culpable participation require-ment is similar to the scienter requirement of Sec-tion 10(b); plaintiffs must “plead with particularityfacts giving rise to a strong inference that the con-trolling person knew or should have known that theprimary violator, over whom that person had con-trol, was engaging in fraudulent conduct.” In reGlobal Crossing, Ltd. Secs. Litig., 471 F.Supp.2d338, 351 (S.D.N.Y.2006) (“Global Crossing IV” )(internal citations, alterations and quotation marksomitted); but seeAlstom I, 406 F.Supp.2d at 490(noting that “[d]isagreement exists within theSecond Circuit ... as to precisely what conduct, bey-ond negligence, [culpable participation] entails.”).Thus, the conclusion above that plaintiffs have suf-ficiently plead scienter as to defendants Silverman,


























Sexton, Klejna, Sherer FN44 and Murphy, thus re-quires the conclusion *662 that plaintiffs haveshown culpable participation as to those defendants.

FN44. Sherer does not challenge plaintiffs'allegations that he controlled Refco, onlywhether plaintiffs have sufficiently pledthat he was a culpable participant. (ShererMem. 36.)

As discussed above, plaintiffs' scienter allegationsgive rise to a sufficiently strong inference that de-fendants Sexton and Murphy had motive and oppor-tunity to commit fraud, but not that they acted withknowledge or recklessness. The same is true of theAudit Committee Defendants. Courts in this districthave reached different conclusions as to whether al-legations of motive to commit fraud suffice to sup-port an allegation of culpable participation wherethere are insufficient allegations to support an infer-ence of knowledge or recklessness. CompareIn reFlag Telecom Holdings, Ltd. Secs. Litig., 308F.Supp.2d 249, 273 (S.D.N.Y.2004) (“[I]f aplaintiff pleads facts establishing that the controlperson had motive and opportunity to commitfraud, plaintiff has pled ‘culpable participation.’ ”)withIn re Independent Energy Holdings PLC Secs.Litig., 154 F.Supp.2d 741, 771-72 & n. 23(S.D.N.Y.2001) (“Plaintiffs have failed to cite asingle case where the culpable participation pronghas been satisfied solely based on allegations of thecontrolling person's financial motive.”).

It makes little sense, however, to hold that the samefacts are sufficient to support a claim for primary li-ability but insufficient to support a claim for con-trol liability. If alleged facts raise a strong inferencethat a defendant acted with scienter as to a particu-lar misstatement, those facts must necessarily raisea strong inference that the defendant's participationas a control person was culpable. Accordingly,culpable participation has been adequately allegedeven as to those defendants as to whom motive andopportunity, but not recklessness, have been ad-equately alleged. The motions to dismiss the §20(a) claims against Silverman, Sexton, Klejna,Sherer, Murphy, and the Audit Committee Defend-

ants will be denied.

C. Tone Grant

[39] Defendant Tone Grant's challenge to the alleg-ations of control-person liability against him (ToneGrant Mem. 17-22) is meritless. Grant was al-legedly the co-owner of RGHI with Bennett, andRGHI was the central mechanism in the allegedfraud. Bennett and Grant were the only two ownersof RGHI, the corporate entity through which all ofthe allegedly fraudulent transactions passed.(Compl. ¶¶ 41, 517-18.) Aside from serving as aholding company for Bennett's and Grant's interestsin Refco, RGHI had no other business, so plaintiffs'allegation that almost four billion dollars in fraudu-lent loans passed through RGHI is more than suffi-cient to raise an inference of recklessness as toGrant. (Id. ¶ 515.)

D. Trosten

Trosten, like the other officer defendants, chal-lenges the allegations of control-person liabilityagainst him. (Trosten Mem. 22-24.) Plaintiffs' §20(a) claims against Trosten rely on their scienterallegations, as do their claims against the other of-ficer defendants. Because of the conclusion abovethat the § 10(b) claims against Trosten must be dis-missed because none of the relevant misstatementscan be attributed to him, this opinion has yet toconsider the scienter allegations against Trosten,and so he must be treated separately from the otherofficer defendants.

[40] Plaintiffs rely on their allegations of scienteragainst Trosten (P. Mem. 104, 120) for their allega-tions of culpable participation against him.Plaintiffs have clearly alleged not only that Trostenwas reckless in failing to discovery the fraud, butthat he actually knew about it. For example,plaintiffs allege that Trosten and Bennett *663agreed with RGHI and BAWAG to unwind specificfraudulent transactions (Compl.¶¶ 489, 494) andthat Trosten was the person BAWAG contacted toconfirm the terms of the loans. (Id.) There can beno question that plaintiffs have raised a strong in-ference that Trosten had the requisite scienter.












However, a claim under § 20(a) requires culpableparticipation-that is, actual involvement in themaking of the fraudulent statements by the putat-ively controlled entity. Put another way, a claim un-der § 20(a) requires that the defendant have “actualcontrol over the transaction in question.” Ross v.Bolton, No. 83 Civ. 8244, 1989 WL 80428(S.D.N.Y. Apr.4, 1989) (internal citation and quota-tion marks omitted). Thus, for the same reasons thatTrosten escapes primary liability for the allegedmisstatements, plaintiffs' § 20(a) claims against himmust also be dismissed.

E. The THL Partner and Individual Defendants

The THL Partner and Individual Defendants movefor dismissal of the § 20(a) claims against them, ar-guing that both the allegations of control and the al-legations of culpable participation against them areinsufficient as a matter of law. (THL/Audit Comm.Memo 40-46.) The arguments as to control are re-jected for the reasons discussed above in the con-text of these defendants' challenges to the allega-tions of control under § 15 of the Securities Act.

[41] As to the allegations of culpable participationby the THL Defendants, plaintiffs' allegations ofrecklessness are too thin to survive the motion todismiss, but their allegations of motive and oppor-tunity will suffice for reasons previously discussed.Plaintiffs allege that the THL Individual Defend-ants were members of Refco's Board of Directors,and that they were “deeply involved in the day-to-day management of Refco.” (Compl. ¶ 264.)They allege that the THL Partner Defendants“dominated Refco's Board of Directors,” con-trolling half of its Board, and that after the LBOthese defendants had the ability to control all as-pects of Refco's business. (Id. ¶ 263.) They also al-lege that defendant THL Managers V, LLC (“THLManagers”), of which defendant Thomas H. LeePartners is the managing member, entered an agree-ment with Refco under which THL Managers wasretained to advise Refco in connection with virtu-ally all aspects of Refco's affairs. (Id.) Plaintiffs ar-gue that the “unfettered access” afforded by thisrole, combined with the red flags discussed above

in the context of the recklessness allegationsagainst the other defendants, supports an inferenceof culpable participation as to the THL Defendants.However, plaintiffs have made no allegations what-soever as to how the THL Defendants' “unfetteredaccess” would have led them across particular doc-uments in which the red flags would have been ap-parent, and these allegations must therefore fail forthe same reason the allegations against some of theofficer defendants failed: there is no allegation sup-porting a “strong inference” that the defendantswere actually aware of the red flags in question.

Plaintiffs also allege that the THL Defendants had“unusual and significant motives” for committingfraud. The THL Defendants, like the officer defend-ants discussed above, were shareholders of recordbefore the IPO, and therefore stood to profit per-sonally and directly from any oversubscription ofshares pursuant to the so-called “green shoe” op-tion. For the reasons discussed above, this allega-tion is sufficient to support an inference of motiveas to these defendants, and their motion to dismissthe § 20(a) claims against them must accordinglybe denied.

*664 VII. Insider Trading Claims Under Ex-change Act § 20A

Section 20A of the Exchange Act provides:Any person who violates any provision of thischapter or the rules or regulations thereunder bypurchasing or selling a security while in possessionof material, nonpublic information shall be liable inan action in any court of competent jurisdiction toany person who, contemporaneously with the pur-chase or sale of securities that is the subject of suchviolation, has purchased (where such violation isbased on a sale of securities) or sold (where suchviolation is based on a purchase of securities) se-curities of the same class.

15 U.S.C. § 78t-1.

Bennett argues that the complaint's allegations ofinsider trading under § 20A of the Exchange Actare insufficient because they fail to allege with par-ticularity that Bennett's trading was contemporan-









eous with the plaintiffs'. (Bennett Mem. 21-23.)SeeWilson v. Comtech Telecommc'ns Corp., 648F.2d 88, 94-95 (2d Cir.1981) (“Any duty of disclos-ure is owed only to those investors trading contem-poraneously with the insider”). Bennett is alleged tohave sold at least 5.375 million shares in the IPO,which commenced on August 10, 2005. (Compl. ¶¶166, 710.) Plaintiffs are alleged to have purchasedshares in the same IPO. (Compl. ¶ 362.) Bennettmakes no attempt to explain how these events,which took place on the same day, could be anymore contemporaneous. His argument is withoutmerit.

Defendants THL Funds and Thomas H. Lee In-vestors Limited Partnership-two of the THL De-fendants-also challenge the § 20A allegationsagainst them.FN45 (THL/Audit Comm. Mem.46-47; see P. Mem. 127-129.) They argue that a §20A claim for insider trading can only be based onpredicate liability under § 10(b)-not predicate liab-ility under § 20(a)'s control-person provisions.

FN45. The defendants argue that no pre-dicate violation has been alleged, becausethe underlying § 20(a) control-personclaims fail as a matter of law. This argu-ment is rejected for the reasons discussedon the context of § 20(a) control-person li-ability above; plaintiffs have adequately al-leged a § 20(a) claim against the THL De-fendants.Defendants also argue that the complaint“fails to contain any specific factual alleg-ations that these defendants knowinglypossessed material non-public informationwhen they sold their shares in theIPO.”(THL/Audit Comm. Mem. 47.) TheTHL Defendants themselves in a relatedcase have alleged that they conducted anextensive review of Refco's financial in-formation. Complaint, Thomas H. LeeEquity Fund V., L.P., et al v. Phillip R.Bennett, et al., No. 05 Civ. 9608, 2005 WL3655797 (S.D.N.Y. Nov. 14, 2005)(Coffey Decl. Ex. D), at ¶¶ 21-22, refer-enced at Compl.¶¶ 119, 572. A claim for

insider trading “does not require ... that acausal connection exist between the know-ing possession of the information and thetrade, that is, it does not require that thedefendant ‘use’ the information when trad-ing.” In re Oxford Health Plans, Inc., 187F.R.D. 133, 143 (S.D.N.Y.1999). Defend-ants object to plaintiffs' reliance on thisdocument, but it is appropriate at the mo-tion to dismiss stage to rely on “any state-ments or documents incorporated in [thecomplaint] by reference, as well as ... doc-uments that the plaintiffs either possessedor knew about and upon which they reliedin bringing the suit.” Rothman, 220 F.3d at88-89 (internal citations omitted). Thus,plaintiffs have adequately alleged that theTHL Defendants knowingly possessed ma-terial nonpublic information.

Not all violations of the Exchange Act can serve aspredicate violations for purposes of § 20A; the pre-dicate violation must be an act of insidertrading.FN46 Section*665 20A liability is limitedto “[a]ny person who violates any provision of thischapter or the rules or regulations thereunder bypurchasing or selling a security while in possessionof material, nonpublic information.”(emphasis ad-ded). “The reference to ‘this chapter’ [in § 20A] isto the '34 [Exchange] Act, and the language of thestatute is thus quite plain that to state a claim under§ 20A, a plaintiff must plead a predicate violationof the '34 Act or its rules and regulations.'' JacksonNat. Life Ins. Co. v. Merrill Lynch & Co., Inc., 32F.3d 697, 703 (2d Cir.1994).

FN46. Acts of insider trading fall with §10(b)'s prohibition of the use of “any ma-nipulative or deceptive device or contriv-ance” in the purchase or sale of securities,15 U.S.C. § 78j(b). See17 C.F.R. §240.10b-5. Insider trading qualifies as a“manipulative or deceptive device or con-trivance” giving rise to liability under §10(b) because insider trading involves theinsiders taking unfair advantage of the un-informed stockholders with whom they

























have “a relationship of trust and confid-ence.” United States v. O'Hagan, 521 U.S.642, 652, 117 S.Ct. 2199, 138 L.Ed.2d 724(1997), quoting Chiarella v. United States,445 U.S. 222, 228, 100 S.Ct. 1108, 63L.Ed.2d 348 (1980).

[42] The terms of § 20A do not limit its coverage toviolators of § 10(b); rather, the required “predicateviolation” may be of any section of the ExchangeAct, provided the violation was effected “by pur-chasing or selling a security while in possession ofmaterial, nonpublic information” (emphasis added).That is, there can only be § 20A liability if the pre-dicate violation of the Exchange Act was an act ofinsider trading. Section 20A “creates a private rightof action to enforce the existing prohibition on in-sider trading under § 10(b) caselaw, and does notcreate a new definition of insider trading.” De-Marco v. Robertson Stephens Inc., 318 F.Supp.2d110, 126 (S.D.N.Y.2004). “The language of § 20Amakes clear that ... Congress sought to alter theremedies available in insider trading cases, andonly in insider trading cases.” Lampf, Pleva, Lip-kind, Prupis & Petigrow v. Gilbertson, 501 U.S.350, 362, 111 S.Ct. 2773, 115 L.Ed.2d 321 (1991);seeJackson Nat. Life Ins. Co., 32 F.3d at 703(“Congress added § 20A ... to remedy the very spe-cific problems inherent in prosecuting insider trad-ing cases”).

[43] The question raised by defendants' motion,then, is whether control-person violations of § 20(a)can constitute insider trading, that is, “violat[ing]any provision of this chapter or the rules or regula-tions thereunder by purchasing or selling a securitywhile in possession of material, nonpublic informa-tion” under § 20A. Put differently, the question iswhether § 20A creates a private right of actionagainst those who control acts of insider trading, aswell as the primary violators who directly engage inthem. There is little precedent on this issue; theparties have identified no case directly addressingthe question of whether § 20A liability may bepremised on a § 20(a) violation, and the Court hasfound none.FN47

FN47. SeeMakor Issues & Rights, Ltd. v.Tellabs, Inc., 437 F.3d 588, 605 (7thCir.2006) (“Whether § 20(a) control-per-son liability standing alone can serve as the“separate underlying violation” requiredfor § 20A insider trading is an open ques-tion of law and raises an important issue ofstatutory interpretation that should not bedecided in a vacuum. No party in this litig-ation has provided more than cursory brief-ing of this issue, and therefore we take noposition on its resolution, leaving it for fur-ther factual and legal development duringthe course of the litigation.”).

Section § 20(a) provides liability for any personwho “controls any person liable under any provi-sion of this chapter or of any rule or regulationthereunder,”15 U.S.C. § 78t(a). It further providesthat a control person is liable “jointly and severallywith and to the same extent as such controlled per-son, unless the controlling person acted in goodfaith and did not *666 directly or indirectly inducethe acts or acts constituting the violation of cause ofaction.” 15 U.S.C. § 78t(a) (emphasis added). Theemphasized language clearly provides that liabilityagainst a control person is coterminous with liabil-ity against the person controlled. If so, the privateright of action created by § 20A should extend tothe controller.

This reading is consistent with the statute's lan-guage and purpose. Section 20A provides liabilityfor insider-trading violations of “any provision ofthis chapter or the rules or regulations thereunder.”15 U.S.C. § 78t-1. If § 10(b) were the only provi-sion that could serve as the basis for liability, Con-gress could have simply identified § 10(b) and therules enforcing it as the basis for liability.Moreover, control person liability involves morethan mere vicarious responsibility for another'swrongdoing; it extends to those who culpably parti-cipate in the primary violation, and it would bestrange to create a private right of action against theprimary violator but not those who culpably parti-cipate in the primary violation as controlling per-sons through the vehicle of persons or entities that





























they control. Defendants have produced no author-ity or rationale for the proposition that § 20A liabil-ity cannot be predicated on a control-person insidertrading violation. Accordingly, their argument is re-jected, and their motion to dismiss the § 20A claimsagainst them will be denied.

For the foregoing reasons, it is hereby ORDEREDthat the motions to dismiss by the “144A” or “BondUnderwriter” Defendants (Doc. # 257) and RobertTrosten (Doc. # 282) are granted. The motions todismiss by Phillip R. Bennett, et al. (Doc. # 260),Grant Thornton LLP (Doc. # 265), William Sexton(Doc. # 266), Phillip Silverman (Docs. 268, 294),Dennis Klejna (Doc. # 273), the THL and AuditCommittee Defendants (Doc. # 277), Joseph J.Murphy and Gerald M. Sherer (Doc. # 279), andTone Grant (Doc. # 303), are granted in part anddenied in part.

Counts One and Two of the First Amended Com-plaint are dismissed in their entirety, and CountThree is dismissed as against the Bond UnderwriterDefendants. Counts Three and Four are dismissedas to those plaintiffs who traded their unregisteredRule 144A bonds for registered bonds in the ExxonCapital exchange. All claims against defendantRobert Trosten are also dismissed. The motions todismiss are in all other respects denied.

SO ORDERED.

S.D.N.Y.,2007.In re Refco, Inc. Securities Litigation503 F.Supp.2d 611, Fed. Sec. L. Rep. P 94,312

END OF DOCUMENT




EXHIBIT 14



RONALD SIEMERS, individually and on behalf of all others similarly situated,Plaintiff, v. WELLS FARGO & CO.; WELLS FARGO FUNDS MANAGEMENT,

LLC; WELLS CAPITAL MANAGEMENT, INC.; H.D. VEST INVESTMENTSERVICES; WELLS FARGO INVESTMENTS, LLC; STEPHENS, INC.; and

WELLS FARGO FUNDS TRUST, Defendants.

No. C 05-04518 WHA

UNITED STATES DISTRICT COURT FOR THE NORTHERN DISTRICT OFCALIFORNIA


October 24, 2006, DecidedOctober 24, 2006, Filed

SUBSEQUENT HISTORY: Claim allowed by, Claimdismissed by, Motion denied by Siemers v. Wells Fargo& Co., 2007 U.S. Dist. LEXIS 21935 (N.D. Cal., Mar. 9,2007)

PRIOR HISTORY: Siemers v. Wells Fargo & Co., 2006U.S. Dist. LEXIS 60858 (N.D. Cal., Aug. 14, 2006)

COUNSEL: [*1] For The McDaniel Family Trust,individually, and o/b/o All Others Similarly Situated,Plaintiff: Michael R. Reese, Gutride Sailer LLP, NewYork, NY.; Adam Gutride, Seth A. Sailer, Gutride SafierLLP, San Francisco, CA.; Janine Lee Pollack, New York,NY.; Jules Brody, Mark Levine, Stull Stull & Brody,New York, NY.; Patrice L. Bishop, Stull, Stull & Brody,Los Angeles, CA.

For Ronald Siemers, Plaintiff: Adam Gutride, GutrideSafier LLP, San Francisco, CA.; Michael R. Reese, KimE. Richman, Gutride Sailer LLP, New York, NY, US.

For Wells Fargo & Company, Defendant: Bruce A.Ericson, Jacob R. Sorensen, Kristin M. Lefevre, PillsburyWinthrop Shaw Pittman LLP, San Francisco, CA.;Clifford C. Hyatt, David Longjohn Stanton, PillsburyWinthrop Shaw Pittman LLP, Los Angeles, CA, US.;Thomas O. Jacobs, Vanessa M. Hoffmann, Office of theGeneral Counsel, Wells Fargo & Co., San Francisco, CA,US.

For Wells Fargo Fund Management, LLC, Wells Capital

Management Incorporated, Stephens Inc., Wells FargoFunds Distributor, LLC, Wells Fargo Funds Trust,Defendants: Gilbert R. Serota, Patricia J. Medina, JasonM. Skaggs, Howard Rice Nemerovski Canady Falk &Rab, San Franciso, CA.

For [*2] H.D. Vest Investment Services, Defendant:Bruce A. Ericson, Jacob R. Sorensen, Kristin M. Lefevre,Pillsbury Winthrop Shaw Pittman LLP, San Francisco,CA.; Clifford C. Hyatt, David Longjohn Stanton,Pillsbury Winthrop Shaw Pittman, LLP, Los Angeles,CA, US.

For Well Fargo Investments LLC, Defendant: Bruce A.Ericson, Jacob R. Sorensen, Pillsbury Winthrop ShawPittman LLP, San Francisco, CA.; Vanessa M.Hoffmann, Office of the General Counsel, Wells Fargo &Co., San Francisco, CA, US.

JUDGES: WILLIAM ALSUP, UNITED STATESDISTRICT JUDGE.

OPINION BY: WILLIAM ALSUP

OPINION

ORDER GRANTING IN PART AND DENYING INPART MOTION TO DISMISS

INTRODUCTION

Page 1


This action alleges securities fraud and excessiveinvestment-adviser fees. By prior order dated August 14,2006, defendants' motions to dismiss the firstconsolidated amended complaint were granted in part anddenied in part. Plaintiff was granted leave to amend thecomplaint, and did so. Defendants now move to dismissthe second amended consolidated complaint. For thefollowing reasons, defendants' motion to dismiss isGRANTED IN PART and DENIED IN PART.

STATEMENT

The class-action complaint at issue here alleges apattern [*3] of conflicts of interest and excessive fees inthe mutual-funds business of several Wells Fargocompanies. Defendants allegedly engaged in anundisclosed scheme to pay secret compensation tobroker-dealers for steering their customers toward certainmutual funds (without regard to the merits of theinvestment advice). Defendants say the trust's investmentadvisers and fund distributors merely bought"shelf-space" for their products in retail brokerages, muchas a cereal manufacturer pays a grocery chain forplacement of corn flakes at shoppers' eye level. Inplaintiffs' view, they paid kickbacks. The broker-dealersallegedly did not adequately disclose this conflict ofinterest to investors, instead holding themselves out asproviding unbiased investment advice to consumers. Inreturn for steering investors toward particular funds, thebroker-dealers received secret compensation from thefunds' investment advisers. The investment advisers paidthem in the form of direct payments, a practice called"revenue sharing," and/or guaranteed business inexecuting the mutual funds' securities trading, a practicecalled "directed brokerage." The broker-dealer companiesallegedly pushed their [*4] brokers to sell particularfunds by offering them higher bonuses and other benefits.

This grew the total assets of Wells Fargo mutualfunds. As the funds grew, so did the percentage cut of theinvestment advisers and the distributors. To finance thesecret payments to the broker-dealers, the investmentadvisers and distributors charged excessive adviser fees,breaching their own fiduciary duties to the funds.

Plaintiff thus alleges that he was harmed in twoways: (i) he received biased advice from broker-dealerswhen he thought he was getting impartialrecommendations, and (ii) the fund assets were dissipatedby paying excessive fees to the investment advisers anddistributors.

* * *

Wells Fargo & Co. was a diversifiedfinancial-services company and the corporate parent ofthe other Wells Fargo companies. Wells Fargo FundsTrust controlled the Wells Fargo complex of mutualfunds. Two companies, Wells Fargo Funds Management,LLC, and Wells Capital Management, Inc., managed thetrust's mutual funds. Wells Fargo Funds Management,LLC, implemented the trust's investment policies andsupervised Wells Capital Management, Inc., whichhandled day-to-day management, including placingorders [*5] for the purchase and sale of securities. Twocompanies were distributors for the funds: Wells FargoFunds Distributor, LLC, and Stephens, Inc. These entitiesperformed marketing and other services for Wells FargoFunds Trust. Two defendants were broker-dealers forshares in the mutual funds: Wells Fargo Investments,LLC and H.D. Vest Investment Services, LLC (SecondAmended Consolidated Complaint ("Second Am.Compl.") PP 16--28).

The court-appointed lead plaintiff, a resident ofMinnesota, bought and sold shares of funds thatparticipated in the Wells Fargo shelf-space program.Plaintiff continues to hold some of those shares. Heclaims that he lost money in these transactions (SecondAm. Compl. P 15, Exh. B). Plaintiff certified that thesesecurities were held in or acquired through his IndividualRetirement Account (IRA) and general account (ReeseDecl., Feb. 16, 2006, Exh. C).

To summarize the allegations, the investor boughtshares of a mutual fund. Wells Fargo Funds Trust thentook some of this investment, charging it as a fee orexpense to the investor, and paid it to Wells Fargo FundsManagement, LLC, Wells Capital Management, Inc.,Wells Fargo Funds Distributor, LLC, and/or [*6]Stephens, Inc. One or more of those companies alreadyhad reached an undisclosed agreement with Wells FargoInvestments, LLC and/or H.D. Vest Investment Services,LLC. In that agreement, the broker-dealer promised topromote the fund either directly or by making it easier forsales agents to market or process purchases of thepreferred funds. In return, the investment adviser and/ordistributor guaranteed one of two things. The first was totrade the fund's portfolio through the broker-dealer, thusguaranteeing it a steady flow of commissions, sometimesat higher rates than the broker-dealer otherwise couldearn. The second type of promise was to pay one or more



lump sums to the broker-dealer. The August 14 orderexplained that the complaint satisfactorily alleged, amongother things, that for purposes of Section 36(b) of theInvestment Company Act of 1940, "that the investmentadvisers and distributors were passing to the funds thecost of self-serving kickbacks, that they did not provideadequate services because they failed to achieve evenaverage returns on investments, that they failed to pass oneconomies of scale and that they charged more thaninvestment advisers to similar [*7] funds" (Aug. 14Order at 30).

Furthermore, the August 14 order also held that thecomplaint alleged violations of Section 12(a)(2) of theSecurities Act of 1933, 15 U.S.C. 77l(a)(2), and SEC Rule10b-5, 17 C.F.R. 240.10b-5. When prospectuses for thefunds were issued stating that the investment adviser"may" consider sales of fund shares in deciding how toaward future trading business when, in fact, theinvestment adviser had already entered into kickbackarrangements. As the August 14 order held, failing todisclose the scheme was material to investors. If thepayments were enough to drive sales, disclosure of themwould have been material to an investor considering abroker's advice to buy those shares (Aug. 14 Order at9--10).

* * *

On May 2, 2006, defendants moved to dismiss thefirst consolidated amended complaint. By order datedAugust 14, 2006, this Court denied, in large part,defendants' motions to dismiss the complaint. Siemers v.Wells Fargo & Co., 2006 U.S. Dist. LEXIS 60858, No. C05-04518 WHA, 2006 WL 2355411, at *1 (N.D. Cal. Aug.14, 2006). The order held that plaintiff had stated claimsin Counts I through IV, which alleged violations ofSection 12(a)(2) of the Securities Act of 1933, [*8] 15U.S.C. 77l(a)(2); Section 15 of the 1933 Act, 15 U.S.C.77o; Section 10(b) of the Securities Exchange Act of1934, 15 U.S.C. 78j(b); Securities Exchange CommissionRule 10b-5, 17 C.F.R. 240.10b-5; and Section 20(a) of the1934 Act, 15 U.S.C. 78t. The motions to dismiss weredenied as to those counts (Aug. 14 Order 8-22). TheAugust 14 order granted the initial motions to dismisswith respect to Count VI, which alleged violation ofSection 36(b) of the Investment Company Act of 1940,and Count VII, which alleged violation of Section 48(a)of the Investment Company Act of 1940. This order doesnot disturb the August 14 order, which allowed a

substantial part of this case to move forward.

Plaintiff was granted leave to amend the complaintand filed a second amended consolidated complaint onAugust 31, 2006. It differed from the first complaintinsofar as it (1) shortened the class period to conformwith the August 14 order's holding with respect to thestatute of limitations; (2) added language to make clearthat plaintiff held shares of the Wells Fargo [*9] Fundsas of the filing of this action, and continues to holdshares, thereby purporting to establish standing to bring aclaim under Section 36(b); and (3) eliminated Count VIIof the first amended complaint (Second. Am. Compl. PP1, 15, 169; Aug. 14 Order at 19).

Defendants now move to dismiss various counts ofthe second amended complaint. Specifically:

. Broker-dealer H.D. Vest moves todismiss Counts I and IV for lack of ArticleIII standing. Count I alleges that thebroker-dealers violated Section 12(a)(2) ofthe Securities Exchange Act of 1933, 15U.S.C. 77l(a)(2). In Count IV, plaintiffaccuses all defendants of engaging in ascheme to deceive the investing public, inviolation of Section 10(b) of the SecuritiesExchange Act of 1934, 15 U.S.C. 78j(b),and Securities and Exchange CommissionRule 10b-5, 17 C.F.R. 240.10b-5.

. Defendants move to dismiss CountVI on the grounds that plaintiff may notsue on behalf of Wells Fargo Funds hedoes not own. In Count VI, plaintiffaccuses the investment advisers anddistributors of breaching fiduciary dutiesto the Wells Fargo Funds Trust bycharging [*10] excessive fees andexpenses, in violation of Section 36(b) ofthe Investment Company Act of 1940, 15U.S.C. 80a-35(b).

. Distributor Stephens moves todismiss Count VI on the grounds that thereare insufficient facts establishing thatStephens could be liable under Section36(b) of the Investment Company Act of1940.

. Six defendants--H.D. Vest,



Stephens, Wells Fargo Funds Distributor,Wells Fargo Funds Management, WellsCapital Management, and Wells Fargo &Co.--move to dismiss Count IV as itpertains to them, on the grounds thatplaintiff did not adequately allege scienteras to each of them. All defendants move todismiss Count IV to the extent that itmakes allegations about the sale andmarketing of the proprietary Wells FargoFunds.

ANALYSIS

A motion to dismiss under Rule 12(b)(6) tests thelegal sufficiency of the claims alleged in the complaint. Acomplaint should not be dismissed "unless it appearsbeyond doubt that the plaintiff can prove no set of facts insupport of his claim which would entitle him to relief."Conley v. Gibson, 355 U.S. 41, 45-46, 78 S. Ct. 99, 2 L.Ed. 2d 80 (1957). However, "conclusory allegations oflaw and unwarranted [*11] inferences are insufficient todefeat a motion to dismiss for failure to state a claim."Epstein v. Wash. Energy Co., 83 F.3d 1136, 1140 (9thCir. 1996).

In complaints that do not allege fraud, plaintiffs needonly make "a short and plain statement of the claim," thusgiving the defendant fair notice of the claim and of thegrounds upon which it rests. Conley, 355 U.S. at 47(quoting Fed. R. Civ. P. 8(a)(2)). Allegations of fraud,however, must meet the heightened pleading standards ofRule 9(b). These require allegations of particular factsgoing to the circumstances of the fraud, including time,place, persons, statements made, and an explanation ofhow or why such statements are false or misleading. In reGlenfed, Inc. Sec. Litig., 42 F.3d 1541, 1547--48 & n.7(9th Cir. 1994) (en banc).

In addition, the Private Securities Litigation ReformAct of 1995 requires class-action plaintiffs allegingviolations of the 1934 Act to specify each misleadingstatement, to explain why the statement was misleadingand, if an allegation is made on information and belief, tolist all facts upon which [*12] that belief is formed. 15U.S.C. 78u-4(b)(1). The complaint must also state withparticularity facts giving rise to a "strong inference" thatthe defendant knowingly or with deliberate recklessnessmade false statements or omitted a material fact. 15

U.S.C. 78u-4(b)(2); In re Silicon Graphics Sec. Litig.,183 F.3d 970, 977 (9th Cir. 1999).

These PSLRA requirements are in "inevitabletension [with]... the customary latitude granted theplaintiff on a motion to dismiss..." Gompper v. VISX,Inc., 298 F.3d 893, 896 (9th Cir. 2002). In consideringwhether to dismiss a securities-fraud claim, a court is notrequired to draw all reasonable inferences in theplaintiff's favor, as it is for most Rule 12(b)(6) motions.See Usher v. Los Angeles, 828 F.2d 556, 561 (9th Cir.1987) (stating Rule 12(b)(6) standard). A court insteadmust consider all reasonable inferences, whetherunfavorable or favorable to the plaintiffs. Gompper, 298F.3d at 896. Furthermore, a court is not required "toaccept legal conclusions cast in the form of factualallegations if those conclusions cannot [*13] reasonablybe drawn from the facts alleged." Clegg v. CultAwareness Network, 18 F.3d 752, 754-55 (9th Cir. 1994).

1. TIMELINESS OF DEFENSES IN DEFENDANTS'MOTION.

As a threshold issue, plaintiff contends thatdefendants' latest motion to dismiss fails to address anynew issues of fact or law, and should be denied pursuantto Federal Rule of Civil Procedure 12(g). Rule 12(g)states:

If a party makes a motion under this rulebut omits therefrom any defense orobjection then available to the party whichthis rule permits to be raised by motion,the party shall not thereafter make amotion based on the defense or objectionso omitted, except a motion as provided insubdivision (h)(2) hereof on any of thegrounds there stated.

Rule 12(h)(2), in turn, states:A defense of failure to state a claim

upon which relief can be granted, adefense of failure to join a partyindispensable under Rule 19, and anobjection of failure to state a legal defenseto a claim may be made in any pleadingpermitted or ordered under Rule 7(a)[governing answers and counterclaims], orby motion for judgment on the pleadings,[*14] or at the trial on the merits.



The Ninth Circuit has recognized that Rule 12, "andspecifically subdivisions (g) and (h), promote the earlyand simultaneous presentation and determination ofpreliminary defenses." Chilicky v. Schweiker, 796 F.2d1131, 1136 (9th Cir. 1986), rev'd on other grounds, 487U.S. 412, 108 S. Ct. 2460, 101 L. Ed. 2d 370 (1988).

This order recognizes that several of defendants'arguments should have been brought in defendants' firstmotions to dismiss. Specifically, defendants' standingallegation with respect to H.D. Vest, the scienterarguments specific to Count IV, and the contentionregarding Stephens' liability under Count VI all couldhave been brought in defendants' first motions. For thefollowing reasons, however, this order nonethelessadjudicates those arguments. First, defendants move todismiss claims against H.D. Vest for lack of Article IIIstanding. Standing "is perhaps the most important" of thejurisdictional doctrines and "is not subject to waiver."United States v. Hays, 515 U.S. 737, 742, 115 S. Ct.2431, 132 L. Ed. 2d 635 (1995). Second, this orderrecognizes that the August 14 order plausibly could havebeen read to invite defendants to make [*15] furtherscienter arguments. The order stated: "Movants, however,do not make defendant-specific challenges to the scienterallegations. The Court declines to do so for them" (Aug.14 Order at 15). This order now addresses thedefendant-specific challenges. Third, defendants have nolegitimate excuse for not raising the argument as toStephens' liability under Count VI. This order finds,however, that because it is easily denied, the Court willexercise its discretion to adjudicate this argument.

This order cautions defendants against makingarguments in the future that should have been brought inthe instant motion or the earlier motions to dismiss. Asone court stated, "it is a waste of judicial resources toconsider motion after motion in which defendants raisethe same defense over and over, each time testing a newargument. Allowing such a tactic means that defendantspotentially could stall litigation indefinitely as long asthey can conjure up a new argument on which to base afailure to state a claim defense." Sprint Telephony PCS,L.P. v. County of San Diego, 311 F. Supp. 2d 898, 905(S.D. Cal. 2004).

2. STANDING TO SUE H.D. VEST--COUNTS IAND IV.

[*16] Broker-dealer H.D. Vest is named as a

defendant in Counts I and IV, and contends that plaintifflacks Article III standing to sue it. To establish Article IIIstanding, a plaintiff must demonstrate: "(1) it has sufferedan 'injury in fact' that is (a) concrete and particularizedand (b) actual or imminent, not conjectural orhypothetical; (2) the injury is fairly traceable to thechallenged action of the defendant; and (3) it is likely, asopposed to speculative, that the injury will be redressedby a favorable decision." Friends of the Earth, Inc. v.Laidlaw Envtl. Servs. (TOC), 528 U.S. 167, 180-81, 120S. Ct. 693, 145 L. Ed. 2d 610 (2000). Accordingly, if aplaintiff cannot trace an injury to a defendant, theplaintiff lacks standing with regard to that defendant.Here, nothing in the second amended complaint suggeststhat plaintiff opened or held an account with H.D. Vest,that he spoke with any financial consultants who workedfor H.D. Vest, or that he relied on anything that H.D.Vest said. The complaint simply does not allege any basisfor which plaintiff has standing to sue H.D. Vest. O'Sheav. Littleton, 414 U.S. 488, 494, 94 S. Ct. 669, 38 L. Ed. 2d674 (1974) ("[I]f none of the named plaintiffs [*17]purporting to represent a class establishes the requisite ofa case or controversy with the defendants, none may seekrelief on behalf of himself or any other member of theclass."). Plaintiff's opposition notably does not disputethis deficiency of the second amended complaint. 1

1 Count I alleges that the broker-dealerdefendants violated Section 12(a)(2) of theSecurities Act of 1933. Section 12(a)(2) onlyimposes liability against a defendant that "offersor sells a security... to the person purchasing suchsecurity from him." 15 U.S.C. 77l(a)(2). Count IValleges that H.D. Vest violated Section 10(b) ofthe Exchange Act of 1934 and SEC Rule 10b-5.Section 10(b) imposes liability only againstpersons who make false or misleading statements"in connection with the purchase or sale of anysecurity." 15 U.S.C. 78j(b). The second amendedcomplaint does not allege that H.D. Vest everoffered or sold a security to plaintiff. Nor does thesecond amended complaint allege that H.D. Vestever made a false or misleading statement toplaintiff in connection with the purchase or sale ofa security.

[*18] Plaintiff contends that the standing deficiencyin the second amended complaint should not preclude suitagainst H.D. Vest for several reasons. First, plaintiffcontends that this Court did not intend to consider the



issue of standing at the pleading stage. Specifically,plaintiff refers to a statement by the Court at a hearing onFebruary 9, 2006: "I know there's a potentialcomplication in this case that maybe the defense is goingto raise an argument that [plaintiff] can't representeveryone, and if that happens, then we may have toappoint a second or third or fourth lead plaintiff. I don'tknow how that will play out, assuming that argument hasany merit" (Reese Exh. 1 at 7). Plaintiff contends thatdeferring ruling on the standing issue is preferablebecause standing is "so intertwined with issues pertinentto class certification that, under Ortiz v. FibreboardCorp., 527 U.S. 815, 119 S. Ct. 2295, 144 L. Ed. 2d 715(1999), decision on those issues must be deferred untilclass certification" (Opp. 6).

Not so. Standing "is a jurisdictional element thatmust be satisfied prior to class certification." Lee v.Oregon, 107 F.3d 1382, 1390 (9th Cir. 1997). Plaintiff[*19] cites Ortiz for the proposition that classcertification may be considered before a court rules onthe issue of Article III standing. In the Ortiz decision,"class certification issues [were]... 'logically antecedent'to Article III concerns,... and themselves pertain[ed] tostatutory standing, which may properly be treated beforeArticle III standing." 527 U.S. at 831. Ortiz, however, hasbeen narrowly construed by the Ninth Circuit only toapply "in the very specific situation of a mandatoryglobal settlement class." Easter v. Am. W. Fin., 381 F.3d948, 962 (9th Cir. 2004). Thus, according to the NinthCircuit, Ortiz "does not require courts to consider classcertification before standing." Plaintiff may not acquirestanding "through the back door of a class action." Alleev. Medrano, 416 U.S. 802, 828-29, 94 S. Ct. 2191, 40 L.Ed. 2d 566 (1974) (Burger, C.J., concurring in part anddissenting in part).

Second, plaintiff contends that the juridical-linkdoctrine provides him with a ground to pursue claims onbehalf of investors against all defendants, including H.D.Vest. The Seventh Circuit has explained the doctrine:

The juridical link [*20] doctrine aroseout of the Ninth Circuit's decision in LaMar v. H & B Novelty & Loan Co., 489F.2d 461 (9th Cir. 1973). La Mar held thata plaintiff without a cause of actionagainst a specific defendant cannot "'fairlyand adequately' protect the interests ofthose who do have such causes of action,"

for purposes of Rule 23(a). Nevertheless,...the court went on to hold that if theplaintiffs as a group--named andunnamed--have suffered an identicalinjury at the hands of several partiesrelated by way of a conspiracy orconcerted scheme, or otherwise"juridically related in a manner thatsuggests a single resolution of the disputewould be expeditious," the claim could goforward.

Payton v. County of Kane, 308 F.3d 673, 678-79 (7th Cir.2002) (internal citations omitted). Defendants correctlynote, however, that the juridical-link doctrine has beenheld not to apply to standing questions at the pleadingstage. The "doctrine, developed in the context of classcertification analysis under [Rule] 23, should properlyremain in the analysis of adequacy and typicality ofplaintiffs for which it was originally conceived."Forsythe v. Sun Life Fin., Inc., 417 F. Supp. 2d 100, 119n.19 (D. Mass. 2006); [*21] see also Henry v. CircusCircus Casinos, Inc., 223 F.R.D. 541, 544 (D. Nev. 2004)(stating that a "doctrine developed under Rule 23 basedon judicial efficiency and expedience does not play a rolein an Article III standing analysis"). This order finds thatat the pleading stage, the juridical-link doctrine isunavailable to plaintiff. The cases cited by plaintiff,Luyando v. Bowen, 124 F.R.D. 52, 57-58 (S.D.N.Y.1989), and Heffler v. United States Fidelity & GuarantyIns. Co., 1992 Ud.S. Dist. LEXIS 3090, C 90-7126, 1992WL 50095, at *4 (E.D. Pa. Mar. 10, 1992), properlyapplied the doctrine in the class-certification context, notat the pleading stage.

Plaintiff has not alleged any injury "traceable to thechallenged action of H.D. Vest. Specifically, the secondamended complaint does not allege that H.D. Vest madea misrepresentation to plaintiff, that plaintiff bought orsold a mutual fund in reliance on that misrepresentation,or that plaintiff suffered a cognizable harm as a result ofH.D. Vest's actions. Accordingly, this order finds that themotion to dismiss as to defendant H.D. Vest must begranted. This deficiency as to Counts I and IV maypossibly be repaired [*22] by the addition of anothernamed plaintiff who dealt with H.D. Vest. This orderaddresses below how plaintiff may proceed in amendingthe complaint.

3. STANDING TO SUE ON BEHALF OF WELLS



FARGO FUNDS PLAINTIFF DOES NOTOWN--COUNT VI.

Count VI accuses the investment advisers anddistributors of breaching fiduciary duties to the WellsFargo Funds Trust by charging excessive fees andexpenses, in violation of Section 36(b) of the InvestmentCompany Act of 1940, 15 U.S.C. 80a-35(b). This count isbrought by the holders of Wells Fargo Funds "for thebenefit of the Wells Fargo Funds against the DistributorDefendants and Investment Adviser Defendants" (SecondAm. Compl. P 212). The August 14 order held that,although plaintiff alleged "a variety of detailed facts thatsupport the Section 36(b) claim," he "failed to allege thathe owned any of the relevant securities on the day the suitbegan." Accordingly, the order found that he failed todemonstrate standing to pursue the Section 36(b) claimbut permitted plaintiff to amend the complaint to allegestanding (Aug. 14 Order at 30-31).

Plaintiff's second amended complaint alleges that he"held the shares of [*23] the Wells Fargo Funds asreflected in attachment B at the time this action wasoriginally filed and has continued, and continues, to holdthese shares of the Wells Fargo Funds" (Second Am.Compl. P 15). Attachment B to the second amendedcomplaint indicates that plaintiff owns three Wells Fargomutual funds (Second Am. Compl. Exh. B). Defendantscontend that the three funds that plaintiff owns are theonly funds that Count VI may properly encompass. Thus,according to defendants, plaintiff does not have standingto sue the other eighty-seven Wells Fargo funds that henever owned (Br. 5; Reply Br. 6).

Section 36(b) provides that a private action may onlybe brought "by a security holder of such registeredinvestment company on behalf of such company." 15U.S.C. 80a-35(b). Here, the Wells Fargo Funds Trust isthe registrant of all the Wells Fargo Funds, which areorganized as several series (Second Am. Compl. P 28).The SEC has "taken the position on several occasions thateach series of a series investment company is or shouldbe treated as a separate issuer under other sections of andrules under the 1940 Act." In re Washington CapitalJoint Master Trust, SEC No-Action Letter, 2006 SECNo-Act. LEXIS 618, 2006 WL 2771188, [*24] at *3 n.9(Sept. 25, 2006); see also In re Principal Investors FundInc., S.E.C. No - Action Letter, 2005 SEC No-Act.LEXIS 562, 2005 WL 1160193, at *3 (May 13, 2005).Other district courts that have considered this question

have held that because the funds are individuallyregistered, under Section 36(b), plaintiff has no Article IIIstanding to sue those funds he did not personally own. Inre Salomon Smith Barney Mut. Fund Fees Litig., 441 F.Supp. 2d 579, 604-08 (S.D.N.Y. 2006); In reAllianceBernstein Mut. Fund Excessive Fee Litig., 2005U.S. Dist. LEXIS 24263, No. 04 Civ. 4885 (SWK), 2005WL 2677753, at *9-10 (S.D.N.Y. Oct. 19, 2005); In reEaton Vance Corp. Secs. Litig., 220 F.R.D. 162, 164-71(D. Mass. 2004). According to those courts, "because thenamed Plaintiffs have not purchased shares in the...Funds at issue, they cannot establish injuries caused bythe advisers of those Funds.... Without the requisitedemonstration of an injury, none of the named Plaintiffsmay seek relief on behalf of himself or any other memberof the class." In re AllianceBernstein Mut. FundExcessive Fee Litig.,, 2005 U.S. Dist. LEXIS 24263 at*36, 2005 WL 2677753, at *10 (internal citations andquotations [*25] omitted). This order follows the weightof authority from other district courts and from the SEC.Plaintiff cannot sue on behalf of funds he does not own. 2

2 This order declines to apply the limitedexception recognized in Batra v. InvestorsResearch Corp., 1991 U.S. Dist. LEXIS 14773,No. 89-0528-CV-W-6, 1992 WL 278688, *2-3(W.D. Mo. 1991). In Batra, the court held that theplaintiffs had standing to sue the directors offunds in which they did not own shares. Batra hasbeen explained to apply to cases in which"management fees were assessed at theinvestment company level, rather than at theportfolio level." In re AllianceBernstein Mut.Fund Excessive Fee Litig., 2005 U.S. Dist. LEXIS24263 at *37, 2005 WL 2677753, at *10. It isconceded that the second amended complaintalleges that at least some agreements were enteredon behalf of all funds rather than individual funds(Second Am. Compl. P 163). After consideringthe weight of recent authority and relevant SECrulings, however, this order respectfully disagreeswith the Batra decision.

[*26] Defendants' motion to dismiss Count VI forlack of standing as to the Wells Fargo Funds plaintiffdoes not own is granted. This pleading deficiency mightbe cured by the addition of other named plaintiffs whoowned funds other than those owned by plaintiff. Thisorder addresses below how plaintiff may proceed inamending the complaint.



4. STEPHENS' LIABILITY UNDER SECTION36(b)--COUNT VI.

Defendants also move to dismiss defendant Stephensfrom Count VI of the second amended complaint.Defendants contend that the complaint does not allegesufficient facts to establish that Stephens is liable underSection 36(b) of the Investment Company Act of 1940, 15U.S.C. 80a-35(b). Under Section 36(b), an action mayonly be brought "by a security holder of such registeredinvestment company on behalf of such company, againstsuch investment adviser, or any affiliated person of suchinvestment adviser, or any other person enumerated insubsection (a) of this section." Subsection (a) of Section36, in turn, permits suit against an "officer, director,member of any advisory board, investment adviser, ordepositor" of the registered investment company, or the"principal [*27] underwriter, if such registered companyis an open-end company, unit investment trust, orface-amount certificate company."

Defendants contend that the second amendedcomplaint does not allege that Stephens is: (1) an affiliateof any of the Wells Fargo-related defendants; (2) an"investment adviser"; or (3) an officer, director, advisoryboard member, or underwriter of any of the Wells FargoFunds. Defendants are correct insofar as the secondamended complaint itself does not allege that Stephenswas anything other than a "distributor," even thoughStephens was deeply involved in the scheme. Plaintiffcontends, however, and this order agrees, that Stephenswas an underwriter and thus may be liable under Section36(b).

Plaintiff relies on the prospectus dated April 11,2005, which describes several Wells Fargo AdvantageVariable Trust Funds, including one of the funds ownedby plaintiff--the Wells Fargo Advantage Small CapGrowth Fund. The prospectus explains that before April11, 2005, "Stephens served as the principal underwriterdistributing securities of the... Small Cap Growth...Fund[] on a continuous basis" (Reese Exh. A at 45). Thisorder finds that the prospectus satisfactorily [*28] allegesthat Stephens is a "principal underwriter," an entity whomay be sued under Section 36(b). Although theinformation in the prospectus was not attached to thesecond amended complaint, it is appropriate forconsideration under the "incorporation by reference"doctrine, which permits consideration of documents"whose contents are alleged in a complaint and whose

authenticity no party questions, but which are notphysically attached to the plaintiff's pleading." Knievel v.ESPN, 393 F.3d 1068, 1076 (9th Cir. 2005). Here, theprospectuses are central to the complaint, which allegesthat the prospectus is misleading as to the existence of thepayback scheme. Moreover, defendant does not contestthe authenticity of the prospectus. This order finds thatthe second amended complaint has properly alleged thatStephens is a proper defendant under Count VI as a"principal underwriter" of a fund owned by plaintiff.

5. ACTS AND SCIENTER--COUNT IV.

The foregoing Parts Three and Four dealt with theSection 36(b) claims. Now, we turn to the Section 10(b)claim. Count IV alleges, as to all defendants, violations ofSection 10(b) of the 1934 Act, 15 U.S.C. 78j(b) [*29] ,and Rule 10b-5, 17 C.F.R. 240.10b-5. When damages aresought, as here, the complaint "shall, with respect toeach... omission... state with particularity facts giving riseto a strong inference that the defendant acted with therequired state of mind." 15 U.S.C. 78u-4(b)(2).According to the Ninth Circuit, to sustain an action underSection 10(b) and Rule 10b-5, the plaintiff must "plead, ingreat detail, facts that constitute strong circumstantialevidence of deliberately reckless or consciousmisconduct." In re Silicon Graphics Inc. Sec. Litig., 183F.3d 970, 974 (9th Cir. 1999). "When determiningwhether plaintiffs have shown a strong inference ofscienter, the court must consider all reasonable inferencesto be drawn from the allegations, including inferencesunfavorable to the plaintiffs." Gompper v. VISX, Inc., 298F.3d 893, 897 (9th Cir. 2002).

A. ACTS AND SCIENTER ALLEGED AS TONON-BROKER-DEALER ANDNON-REGISTRANT DEFENDANTS.

In their first round of motions to dismiss, alldefendants moved to dismiss Count IV. They contended,among other things, that the complaint did not adequately[*30] allege scienter. The August 14 order found that theallegations in the first consolidated complaint satisfiedthe Ninth Circuit's heightened pleading standard. Theorder found, in relevant part:

Defendants obviously knew of the actualcompensation arrangements. The NASDfindings against H.D. Vest and WellsFargo Investments (incorporated into thecomplaint) delineated specific programs



designed to promote sales of certain funds'shares and Wells Fargo Investments'system of ranking preferred funds. Thefact that defendants had the incentiveprograms in place indicates that theybelieved these programs would drive sales.In light of this conscious strategy, thefailure to disclose the full extent of thepayback programs raises a stronginference of scienter. Buttressing thisconclusion is plaintiff's allegation that thedirectors of the Wells Fargo Funds Trustknew about the already-in-placearrangements but left in placewatered-down disclosures

(Aug. 14 Order at 14-15). The order noted in a footnote,however: "[n]ot all defendants may have had such intentor recklessness. Movants, however, do not makedefendant-specific challenges to the scienter allegations.The [*31] Court declines to do so for them" (ibid.). Therelevant portions of the complaint relied on by that orderhave not changed after the amendments to the complaint(Second Am. Compl PP 34,39-55,164). Defendants'motion now claims to raise scienter arguments as tospecific corporate defendants. In addition to the scienterargument, however, defendants' motion actually raisesthe issue of whether all of the defendants may be heldliable for the misstatements of only a subset ofdefendants.

The second amended complaint asserts thatdefendants violated Section 10(b) and Rule 10b-5 whenthey failed to disclose to the public the paybackarrangement in the prospectuses. The August 14 orderheld that the scheme should have been disclosed to thepublic, and that such information was material toinvestors (Aug. 14 Order at 9-14). As the complaint iscurrently constructed, however, it seems clear that onlyWells Fargo Funds Trust and the broker-dealerdefendants were the entities that actually failed todisclose the scheme. They were the only "speakers."Accordingly, defendants concede that scienter wasproperly alleged against Wells Fargo Investments, as abroker-dealer that did business with [*32] plaintiff, andWells Fargo Funds Trust, as the issuer of prospectusesand statements of additional information ("SAI") forWells Fargo Funds that plaintiff bought and sold (Br. 11).3

3 Defendants raise a scienter argument withrespect to H.D. Vest. But that assertion is basedentirely on plaintiff's lack of standing to sue H.D.Vest, discussed above. The second amendedcomplaint alleges facts supporting the conclusionthat H.D. Vest, as a broker-dealer, madestatements that misled the public about theexistence of the scheme (Second Am. Compl P90). As above, the pleading deficiency withrespect to H.D. Vest might be cured with theaddition of another named plaintiff. Theremainder of this Part discusses the allegations asto the five other defendants, Stephens, WellsFargo Funds Distributor, Wells Fargo FundsManagement, Wells Capital Management, andWells Fargo & Co.

Defendants contend, however, that because theremaining five defendants--Stephens, Wells Fargo FundsDistributor, Wells Fargo Funds Management, [*33]Wells Capital Management, and Wells Fargo & Co.--arenot alleged in the second amended complaint to havebeen "speakers," the allegations against those defendantscannot give rise to a strong inference of scienter.According to defendants, "[t]here simply is no act oromission to which an accusation of a wrongful mentalstate can attach" (Br. 10-11). Defendants' argument issomewhat more than a challenge to the second amendedcomplaint's allegation of scienter. Defendants' assertionessentially questions the extent to which the five otherdefendants, who themselves made no representation tothe public, may be liable for acts of the broker-dealerdefendants and Wells Fargo Funds Trust. The NinthCircuit has held that "substantial participation or intricateinvolvement in the preparation of fraudulent statements isgrounds for primary liability even though thatparticipation might not lead to the actor's actual makingof the statements." Howard v. Everex Sys., Inc., 228 F.3d1057, 1061 n.5 (9th Cir. 2000) (citing In re SoftwareToolworks Inc. Sec. Litig., 50 F.3d 615, 628-29 & n. 3(9th Cir. 1994)). "There is a significant difference...between mere [*34] participation in a scheme tomisrepresent and those directly attesting to the truth of astatement by making (in the ordinary sense) that verystatement." Id. at 1061.

While it may be true that the five defendants hereknew about the misstatements, "[i]t takes more than mereknowledge... to amount to an actionable omission. Rule10b-5 is violated by nondisclosure only when there is a



duty to disclose." Paracor Fin., Inc. v. GE Capital Corp.,96 F.3d 1151, 1157 (9th Cir. 1996). The August 14 orderfound, without distinguishing between defendants, thatdefendants "had a duty to state all facts that werenecessary to make their affirmative statements notmisleading. The representation left the impression thatthe payback arrangement might (or might not) materializewhen it was, in reality already a done deal. This wasmisleading" (Aug. 14 Order at 9). The order did notdiscuss, however, whether specific corporate defendantshad been involved in making the misrepresentations.

The issue, then, is the extent to which the defendantsmay be liable as non-speakers. The Ninth Circuit has heldthat "to be liable as a primary violator of [Section] 10(b)for [*35] participation in a 'scheme to defraud,' thedefendant must have engaged in conduct that had theprincipal purpose and effect of creating a falseappearance of fact in furtherance of the scheme."Simpson v. AOL Time Warner, Inc., 452 F.3d 1040, 1048(9th Cir. 2006). In Howard, the Ninth Circuit held that anofficer who signs an SEC filing makes a statement underSection 10(b), even if the officer did not participate in thedrafting of the document. See id. at 1061. As to the fivedefendants at issue here, the second amended complaintcontains no allegations that any of them signed orapproved the prospectuses and SAIs that misled thepublic. Plaintiff is correct that the second amendedcomplaint alleges that the prospectuses and SAIs weremisleading "in that they failed to disclose that theInvestment Advisor Defendants were making kickbackpayments from assets of mutual fund investors" (Opp.13). But misleading statements about a company's role ina scheme is not the same as that company itselfmisleading investors. Simpson, 452 F.3d at 1048 ("It isnot enough that a transaction in which a defendant wasinvolved had a deceptive [*36] purpose and effect; thedefendant's own conduct contributing to the transaction oroverall scheme must have had a deceptive purpose andeffect."). Here, the complaint alleges that the distributorsand investment advisers made the kickback payments,and that those payments were not disclosed to theinvesting public. Nothing in the complaint, however,establishes that the investment advisors, the distributors,or Wells Fargo & Co. engaged in "substantialparticipation or intricate involvement in the preparationof" the misleading statements in the prospectuses andSAIs. Howard, 228 F.3d at 1061 n.5. As non-speakingactors, those defendants are not liable under Section10(b).

As to the issue of scienter, this order finds that thesecond amended complaint falls short of alleging, in"great detail, facts that constitute strong circumstantialevidence of deliberately reckless or consciousmisconduct" on behalf of the five non-broker-dealer andnon-registrant defendants. In re Silicon Graphics Inc.Sec. Litig., 183 F.3d at 974. Plaintiff's only basis foralleging scienter against Wells Fargo FundsManagement, Wells Capital Management, Wells FargoFunds [*37] Distributor, and Stephens is that they hadreached agreements with the broker-dealers--H.D. Vestand/or Wells Fargo Investments--to promote their fundsdirectly. The complaint also alleges that Wells Fargo &Co., as the parent of many of the other defendants, wasthe "ultimate beneficiary of the secret plan and scheme toendorse the Shelf Space to the detriment of the Funds andtheir investors," and thus that "it too was liable for theacts and omissions at issue" (Second Am. Compl P 16;Opp. 14). General allegations of tangential relationshipsto the actual misstatements made to the public areinsufficient to support a strong inference of scienter.There is nothing to suggest that the five defendants were"involved in the day-to-day operations of [thebroker-dealers or Wells Fargo Funds Trust], much lessheavily involved in the details and personally directing"the publication and dissemination of misleadingstatements. In re Daou Sys., Inc., 411 F.3d 1006, 1024(9th Cir. 2005).

For the foregoing reasons, the motion to dismissCount IV as to H.D. Vest, Wells Fargo FundsManagement, Wells Capital Management, Wells FargoFunds Distributor, and Stephens must be granted. [*38]At the hearing, plaintiff's counsel represented that thecomplaint could be amended to allege that somedefendants played a role in the issuance and filing of theprospectuses. This order addresses below how plaintiffmay proceed in amending the complaint.

B. SCIENTER ALLEGED AS TO WELLSFARGO-BRANDED FUNDS

Defendants next contend that Count IV should bedismissed as to all defendants to the extent that Count IVmakes allegations about the sale and marketing of theproprietary Wells Fargo Funds. Defendants assert thatplaintiff has not established that the investing publicwould perceive the "revenue-sharing" scheme asmisleading with respect to the Wells Fargo Funds.Defendants distinguish between mutual funds bearing the



"Wells Fargo" name and the "third-party" shelf-spacefunds. Defendants contend that because all defendants,except Stephens, were under Wells Fargo ownership, noreasonable investor would have expected a WellsFargo-affiliated broker to give unbiased advice about aWells Fargo-named fund (Br. 11-14). 4

4 Defendants' casting of this argument as a"scienter" argument is somewhat disingenuous.The argument focuses on whether defendants'statements promoting the Wells Fargo-brandedfunds to the public could be construed asmisstatements giving rise to liability underSection 10(b). This has more to do withdefendants' duty to disclose and the materiality ofits misstatements than it has to do with scienter.

[*39] This order disagrees with defendants'contention that "any investor would be aware of thepossibility that a Wells Fargo broker might favor a WellsFargo product, and might be paid more when a WellsFargo product [was] sold" (Br. 13). The second amendedcomplaint here is directed at conduct allegedly harmingpeople who "purchased one or more of the Wells FargoFunds and/or one or more non-Wells Fargo fundsparticipating in Wells Fargo's revenue sharing anddirected brokerage arrangements" (Second Am. Compl. P1). More important, the second amended complaintalleges that Wells Fargo states on its website that itsemployees "avoid any actual or perceived conflict ofinterest... and comply with the letter and the spirit of thelaw" (id. at P 31). The website also states that WellsFargo's financial consultants will "provide soundfinancial advice for customers... and create new wealthfor them" (id. at P 30). These allegations from the secondamended complaint establish that a reasonable investorwould not have thought that a broker who was avoiding"any actual or perceived conflict of interest" would havepushed Wells Fargo-branded funds harder than others.The August 14 order [*40] held that "[i]f a reasonableinvestor knows the broker-dealer has a paybackagreement to showcase a particular fund, the investor islikely to take a harder look at the recommendation" (Aug.14 Order at 10). 5 The investors thought they weredealing with unbiased broker-dealers, when in fact theywere not.

5 With respect to the Wells Fargo-brandedfunds, the kickback payment was not a direct feepayment, but an allocation of "revenue net of

certain expenses" (Second Am. Compl. P 47).Defendants highlight the fact that the arrangement"was a cashless allocation of revenues betweenaffiliates with a common parent" (Br. 12)(emphasis in original). This order finds thatwhether the kickbacks were lump-sum paymentsor a "cashless allocation of revenues" is irrelevantto defendants' instant argument.

As they did in their first motions to dismiss,defendants again rely on Castillo v. Dean Witter Discover& Co., 1998 U.S. Dist. LEXIS 9489, No. 97 Civ. 1272(RPP), 1998 WL 342050, at *9 (S.D.N.Y. June 25, 1998).This Court [*41] has previously ruled, however, thatCastillo is not persuasive here. This order reiterates that"[u]nlike the plaintiffs in Castillo,... plaintiff here citesauthority on his side, namely the various SEC orders,"that the broker-dealers should have disclosed thepaybacks they received to push various funds. Aspreviously held, "the development of disclosure standardsby the SEC, as laid out in its orders, has eclipsedCastillo" (2006 U.S. Dist. LEXIS 60858 at *23, Aug. 14Order). See, e.g., In re Morgan Stanley DW, Inc., 2003SEC LEXIS 2732, Admin. No. 3-11335, 2003 WL22703073 (Nov. 17, 2003) (discussing similar schemeused by Morgan Stanley DW-fund complexes andMorgan Stanley DW as broker-dealer). This order findsthat defendants' contention lacks merit. Accordingly,their motion to dismiss Count IV, insofar as it pertains torepresentations about the Wells Fargo Funds, is denied.

CONCLUSION

For the foregoing reasons, the motion to dismissCounts I and IV as to defendant H.D. Vest isGRANTED. The motion to dismiss Count VI for lack ofstanding as to the Wells Fargo Funds plaintiff does notown is GRANTED. The motion to dismiss Count VI asto Stephens is DENIED. The motion [*42] to dismissCount IV as to H.D. Vest, Wells Fargo FundsManagement, Wells Capital Management, Wells FargoFunds Distributor, Stephens, and Wells Fargo & Co. isGRANTED. The motion to dismiss Count IV to theextent it pertains to representations about the Wells FargoFunds is DENIED. 6

6 Plaintiff and defendants also filed requests forjudicial notice pursuant to Federal Rule ofEvidence 201. No objections to those requestswere filed. Plaintiff's request as to Exhibit 1,excerpts from transcripts of proceedings before



this court in this action, is GRANTED. ReynaPasta Bella, LLC v. Visa USA, Inc., 442 F.3d 741,746 n. 6 (9th Cir. 2006) (taking judicial notice ofcourt transcripts). Plaintiff's request as to Exhibit2, excerpts from the April 11, 2005 Prospectusand SAI for the Wells Fargo Advantage SmallCap Growth Fund, is GRANTED. Lovelace v.Software Spectrum, 78 F.3d 1015, 1018 (5th Cir.1996) (taking judicial notice of mandatory SECfilings only for statements' contents, rather thantruth). Plaintiff's request as to Exhibit 3, an SECorder instituting action in the matter ofMassachusetts Financial Services, is GRANTED.That document is cited in paragraph 86 of thesecond amended complaint. Defendants' requestas to Exhibits 1-6, Wells Fargo & Co.'s publicdisclosure documents filed with the SEC, isGRANTED. Lovelace, 78 F.3d at 1018.Defendants' request as to Exhibits 7 and 8, UnitedStates Patent and Trademark Office electronicsearch results for the marks "Wells Fargo" and"Wells Fargo Funds," is GRANTED. Lee v. Cityof Los Angeles, 250 F.3d 668, 688-89 (9th Cir.2001).

[*43] Plaintiff may seek leave to amend by filing amotion proposing yet another complaint, to be filed andserved by NOVEMBER 17, 2006. Counsel for plaintiff

has represented that the McDaniel Family Trust and otherplaintiffs who previously volunteered to serve as leadplaintiff will be able to cure most of the standing issues.Counsel also has represented that other investors arewilling to be added. The motion seeking leave to amendmust be accompanied by a declaration of counselshowing that all new proposed plaintiffs have beenacquired in a professionally proper way. See, e.g., Cal. R.Prof. Conduct 1-400(C) ("A solicitation shall not be madeby or on behalf of a member or law firm to a prospectiveclient with whom the member or law firm has no familyor prior professional relationship, unless the solicitationis protected from abridgment by the Constitution of theUnited States or by the Constitution of the State ofCalifornia."). The motion shall be briefed and heard onthe normal 35-day track. Leave to amend may or may notbe granted depending on the outcome of the motion. Anyand all points that would be part of any dismissal motionmust be included in the opposition [*44] so as to avoidsubsequent motion practice (if leave is allowed).

IT IS SO ORDERED.

Dated: October 24, 2006

WILLIAM ALSUP

UNITED STATES DISTRICT JUDGE



EXHIBIT 15


1 of 1 DOCUMENT

IN RE VERISIGN CORPORATION SECURITIES LITIGATION

NO. C 02-02270 JW

UNITED STATES DISTRICT COURT FOR THE NORTHERN DISTRICT OF

CALIFORNIA, SAN JOSE DIVISION


April 6, 2006, Decided PRIOR HISTORY: In re Verisign, Inc. Sec. Litig., 2005 U.S. Dist. LEXIS 10438 (N.D. Cal., Jan. 13, 2005) DISPOSITION: [*1] GRANTED IN PART and DENIED IN PART. COUNSEL:

For James H. Harrison, JR, On Behalf of Himself and All Others Similarly Situated, Plaintiff: Alfred Glenn Yates, Jr., LEAD ATTORNEY, Law Office of Alfred G. Yates Jr., P.C., Pittsburgh, PA; Andrew M. Schatz, LEAD ATTORNEY, Nancy A. Kulesa, LEAD ATTORNEY, SCHATZ & NOBEL, Hartford, CT; Ber-nard M. Gross, LEAD ATTORNEY, Deborah R. Gross, LEAD ATTORNEY, Law Offices of Bernard M. Gross, P.C., Philadelphia, PA; Darren J. Robbins, LEAD ATTORNEY, William S. Lerach, LEAD ATTORNEY, Lerach Coughlin Stoia Geller Rudman & Robbins LLP, San Diego, CA; Jennie Lee Anderson, LEAD ATTORNEY, Randi D. Bandman, LEAD ATTORNEY, Shirley H. Huang, LEAD ATTORNEY, Jeffrey W. Law-rence, Lerach Coughlin Stoia Geller Rudman & Robbins LLP, San Francisco, CA; Mark S. Willis, LEAD ATTORNEY, Steven J. Toll, LEAD ATTORNEY, Joshua Seth Devore, Cohen Milstein Hausfeld & Toll, P.L.L.C., Washington, DC. For Ralph Michael, Plaintiff: Shirley H. Huang, LEAD ATTORNEY, Lerach Coughlin Stoia Geller Rudman & Robbins LLP, San Francisco, CA. For R.C. JERNER, Proposed Lead Plaintiff, Petitioner: Andrew M. Schatz, LEAD ATTORNEY, Nancy A. Ku-lesa, LEAD ATTORNEY, SCHATZ & NOBEL, Hart-ford, [*2] CT; Marc Lawrence Godino, Glancy Binkow & Goldberg LLP, Los Angeles, CA. For Verisign Inc, Defendant: David Malcolm Furbush, LEAD ATTORNEY, Lori E. Romley, LEAD

ATTORNEY, Meredith N. Landy, LEAD ATTORNEY, O'Melveny & Myers LLP, Menlo Park, CA; Dhaivat H. Shah, LEAD ATTORNEY, Jessica Anne Hoogs, Noah Daniel Boyens, O'Melveny & Myers LLP, San Fran-cisco, CA; Ioana Petrou, LEAD ATTORNEY, U.S. At-torney's Office, San Francisco, CA; Amy Freeman, Mark Wayne Robertson, O'Melveny & Myers, Los Angeles, CA. For Stratton D. Sclavos, Robert J. Korzeniewski, Dana L. Evan, Quentin Gallivan, Defendants: Dhaivat H. Shah, LEAD ATTORNEY, Jessica Anne Hoogs, Noah Daniel Boyens, O'Melveny & Myers LLP, San Francisco, CA; Ioana Petrou, LEAD ATTORNEY, U.S. Attorney's Of-fice, San Francisco, CA; David Malcolm Furbush, LEAD ATTORNEY, Lori E. Romley, LEAD ATTORNEY, Meredith N. Landy, LEAD ATTORNEY, O'Melveny & Myers LLP, Menlo Park, CA; Amy Free-man, Mark Wayne Robertson, O'Melveny & Myers, Los Angeles, CA. For Raymond E. Donnelly, Movant: Christopher Paul Seefer, LEAD ATTORNEY, Dennis J. Herman, Patrick J. Coughlin, Shana Eve Scarlett, Lerach Coughlin Stoia Geller Rudman & Robbins LLP, San Francisco, [*3] CA; Simon Bahne Paris, LEAD ATTORNEY, Spector, Roseman & Kodroff, P.C., Philadelphia, PA; Shirley H. Huang, LEAD ATTORNEY, Jeffrey W. Lawrence, Ler-ach Coughlin Stoia Geller Rudman & Robbins LLP, San Francisco, CA. For Michael Michael, Movant: Jeffrey W. Lawrence, Lerach Coughlin Stoia Geller Rudman & Robbins LLP, San Francisco, CA. For Wilson Telephone Company, Inc., Sheet Metal Workers' Local Union No. 19 Pension Fund, Movants: Christopher Paul Seefer, LEAD ATTORNEY, Dennis J. Herman, Patrick J. Coughlin, Shana Eve Scarlett, Lerach Coughlin Stoia Geller Rudman & Robbins LLP, San


2006 U.S. Dist. LEXIS 81419, *

Francisco, CA; Shirley H. Huang, LEAD ATTORNEY, Jeffrey W. Lawrence, Lerach Coughlin Stoia Geller Rudman & Robbins LLP, San Francisco, CA. For Stoneridge Investment Partners, LLC, Movant: Deb-orah R. Gross, LEAD ATTORNEY, Law Offices of Bernard M. Gross, P.C., Philadelphia, PA; Dennis J. Herman, Lerach Coughlin Stoia Geller Rudman & Rob-bins LLP, San Francisco, CA; Shirley H. Huang, LEAD ATTORNEY, Jeffrey W. Lawrence, Lerach Coughlin Stoia Geller Rudman & Robbins LLP, San Francisco, CA. For Ralph Michael, Movant: Dennis J. Herman, Patrick J. Coughlin, Shana Eve Scarlett, Lerach Coughlin Stoia [*4] Geller Rudman & Robbins LLP, San Francisco, CA; Shirley H. Huang, LEAD ATTORNEY, Jeffrey W. Lawrence, Lerach Coughlin Stoia Geller Rudman & Robbins LLP, San Francisco, CA. For Oregon Telephone Co., 3rd party plaintiff: Christo-pher Paul Seefer, LEAD ATTORNEY, Dennis J. Her-man, Patrick J. Coughlin, Shana Eve Scarlett, Lerach Coughlin Stoia Geller Rudman & Robbins LLP, San Francisco, CA; Shirley H. Huang, LEAD ATTORNEY, Jeffrey W. Lawrence, Lerach Coughlin Stoia Geller Rudman & Robbins LLP, San Francisco, CA; Adam T. Savett, Lisa M. Mezzetti, Cohen, Milstein, Hausfeld & Toll, P.L.L.C., Washington, DC; Christopher T. Heffelf-inger, Berman DeValerio Pease & Tabacco, P.C., San Francisco, CA. JUDGES: JAMES WARE, United States District Judge. OPINION BY: JAMES WARE OPINION:

ORDER GRANTING IN PART AND DENYING IN PART DEFENDANTS' MOTION TO DISMISS

I. INTRODUCTION

Plaintiffs initiated this securities class action lawsuit on behalf of themselves and of a proposed class of per-sons and entities that acquired VeriSign Corporation's ("VeriSign") common stock, against VeriSign and four of its executives (collectively, "Defendants"), for viola-tions of Sections 10(b) and 20(a) of the Securities Ex-change [*5] Act of 1934 and Rule 10b-5 promulgated thereunder, and Sections 11 and 15 of the Securities Act of 1933. Presently before this Court is Defendants' Mo-tion to dismiss Plaintiffs' Third Amended Complaint ("TAC") on the basis that Plaintiffs have insufficiently alleged loss causation under the standards set forth by the Supreme Court in Dura Pharm., Inc. v. Broudo, 544 U.S. 336, 125 S. Ct. 1627, 161 L. Ed. 2d 577 (2005). On

March 27, 2006, the Court held a hearing on Defendants' Motion. For the reasons set forth below, this Court GRANTS IN PART and DENIES IN PART Defendants' motion to dismiss and permits Plaintiffs to file an amended complaint consistent with this Order.

II. BACKGROUND

Plaintiffs, on behalf of themselves and a proposed class of persons and entities that purchased or otherwise acquired VeriSign's common stock between January 25, 2001 and April 25, 2002, inclusive ("Class Period"), filed an action against VeriSign Corporation and four of its officers and directors, for violations of the Securities Act, the Securities Exchange Act, and Rule 10b-5 prom-ulgated thereunder. VeriSign provides Internet "trust services" --services that verify and authenticate [*6] information transmitted over the Internet. (TAC at P2.) Such services enable consumers to safely transmit per-sonal financial information over the Internet to complete commercial transactions. (TAC at P2.)

On March 7, 2000, VeriSign announced that it would issue $ 21 billion in new stock to acquire Network Solutions, Inc. ("Network Solutions") and turn it into a wholly-owned subsidiary. Network Solutions operated the official registry of Internet domain names, such that anyone who wanted to register a website under the .com, .net, or .org domains had to register through Network Solutions. Although some industry analysts supported this acquisition, others questioned whether VeriSign was paying too much. This skepticism allegedly placed pres-sure on VeriSign "to show that it was growing at a rate greater than could have been realized by either VeriSign or Network Solutions as a stand-alone company." (TAC at P4.)

Not long after VeriSign acquired Network Solutions, the Internet boom "went bust." The demand for Internet "trust services" and for new Internet domain names de-clined, affecting VeriSign's business. VeriSign's stock price fell from $ 196 per share (on the day it acquired Network [*7] Solutions) to $ 75 per share (on January 24, 2001, the day before the Class Period).

Thereafter, Defendants allegedly employed "an as-sortment of schemes, artifices, and devices to mislead investors about both the amount and source of revenues earned by [VeriSign]." (TAC P6.) In particular, Plaintiffs allege that Defendants artificially inflated VeriSign's earnings and stock through a "scheme to defraud" carried out in five general ways: (1) improper accounting for domain name sales and false and misleading reporting of domain name sales metrics ("domain name scheme") (TAC PP59-103), (2) improper accounting for roundtrip and other long-term investments (TAC PP104-114), (3) improper revenue recognition on barter transactions (TAC PP115-116), (4) failure to adequately reserve for


2006 U.S. Dist. LEXIS 81419, *

uncollectible delinquent receivables (TAC PP117-119), and (5) false accounting for acquired deferred revenue in violation of GAAP (TAC PP120-129). Plaintiffs claim that these practices led VeriSign to issue materially false and misleading statements about VeriSign's financial status. Plaintiffs contend that they relied upon these mis-representations to their detriment when the disclosures after the following [*8] dates caused fraud-induced in-flation to come out of the stock price: (1) October 25, 2001, (2) January 25, 2002, (3) February 26, 2002, (4) March 19, 2002, and (5) April 25, 2002.

Plaintiffs initially filed their complaint in May of 2002. Following an order consolidating related cases, Plaintiffs filed a Consolidated Amended Class Action Complaint ("CACAC"). The Court granted in part and denied in part Defendants' motion to dismiss the CACAC, and Plaintiffs were permitted to amend their complaint. Plaintiffs filed a Consolidated Second Amended Complaint ("CSAC") in May of 2004. On Oc-tober 31, 2005, the Court granted in part Defendants' Motion for Judgment on the Pleadings, finding that in the CSAC, Plaintiffs had only sufficiently alleged a scheme of improper revenue recognition of reciprocal and re-lated-party transactions, and only alleged loss causation from this scheme as to the disclosure on March 19, 2002. (Order Granting in Part Defendants' Motion for Judg-ment on the Pleadings, hereinafter "October Order," Docket Item No. 445.) Plaintiffs were again granted leave to amend, and subsequently filed the TAC.

III. STANDARDS

A court may dismiss a complaint pursuant to Rule 12(b)(6) [*9] for pleading "insufficient facts under a cognizable legal theory." Robertson v. Dean Witter Rey-nolds, Co., 749 F.2d 530, 534 (9th Cir. 1984). When deciding a motion to dismiss a complaint under Rule 12(b)(6), the court takes all material allegations in the complaint as true and construes these material allegations in the light most favorable to the non-moving party. Sanders v. Kennedy, 794 F.2d 478, 481 (9th Cir. 1986); NL Indus., Inc. v. Kaplan, 792 F.2d 896, 898 (9th Cir. 1986). However, the Court will not accept wholly con-clusory allegations. Western Mining Council v. Watt, 643 F.2d 618, 624 (9th Cir. 1981), cert. denied, 454 U.S. 1031, 102 S. Ct. 567, 70 L. Ed. 2d 474 (1981); Kennedy v. H & M Landing, Inc., 529 F.2d 987, 989 (9th Cir. 1976).

IV. DISCUSSION

Defendants claim that the TAC does not sufficiently allege loss causation. Under the Private Securities Litiga-tion Reform Act ("PSLRA"), 15 U.S.C. § 78u-4(b)(1)-(2) a plaintiff alleging securities fraud is required to show loss causation, i.e., the plaintiff must prove that the defendants' securities fraud caused [*10] economic loss.

In Dura Pharm., Inc. v. Broudo,, the Supreme Court held that a plaintiff could not satisfy loss causation merely by alleging (and later establishing) that the price of the secu-rities on the date of the purchase was inflated because of misrepresentation. 544 U.S. 336, 125 S. Ct. 1627, 1632, 161 L. Ed. 2d 577 (2005). Emphasizing the "common-law roots of the securities fraud action" the Supreme Court in Dura cited with approval the standard for proximate cause in the Restatement of Torts "in setting forth the judicial consensus" that "a person who misrep-resents the financial condition of a corporation in order to sell its stock becomes liable to a relying purchaser for the loss the purchaser sustains when the facts ... become generally known and as a result share value depreci-ate[s]." Id. at 1632-1633 (quotations from Restatement of Torts, § 548A, Comment b, at 107 omitted) (altera-tions in original).

Applying the Dura framework, the Ninth Circuit recognized that pleading loss causation is a more diffi-cult task than simply alleging transaction causation. In re Daou Systems, Inc., 411 F.3d 1006, 1025 (9th Cir. 2005). The Daou Court, however, held that [*11] as long as the misrepresentation is a substantial cause of the in-vestment's decline in value, recovery will not be barred. Id. The Ninth Circuit in Daou relied on the plaintiffs' allegations of the defendants' disclosures of deteriorating operating expenses and margins, and defendants' disclo-sures of a rapidly escalating work in progress account resulting from prematurely recognizing revenue in hold-ing that the plaintiffs sufficiently alleged loss causation according to the standards of Dura. Declines in the price of Daou stock prior to the disclosure of "the true nature of Daou's financial condition" were, as a matter of law, unrelated to the plantiffs' allegations of Defendants' fraud. Id. at 1026-27.

Reading the Ninth Circuit's decision in Daou in con-junction with the decisions of the Second Circuit pro-vides further guidance for plaintiffs attempting to plead loss causation. Although the Ninth Circuit has not explic-itly adopted or rejected the Second Circuit view follow-ing the Supreme Court's decision in Dura, this District has found that "the Supreme Court in Dura Pharmaceuti-cals endorsed the Second Circuit test for loss causation, as [*12] set forth in Lentell v. Merrill Lynch & Co., 396 F.3d 161 (2d Cir. 2005) and Emergent Capital Invest-ment Management, LLC v. Stonepath Group, Inc., 343 F.3d 189 (2d Cir. 2003)." Bennett v. H & R Block Finan-cial Advisors, Inc., 2005 U.S. Dist. LEXIS 25273 at 6, CV 04-4848MHP, 2005 WL 2811757, at *3 (N.D. Cal. Oct. 27, 2005). This Court agrees with the reasoning of the court in Bennett in interpreting the Supreme Court's decision in Dura as resolving a circuit split in favor of the Second and Third Circuits' pleading standard for loss causation. See Dura, 125 S. Ct. at 1630. Under the Sec-


2006 U.S. Dist. LEXIS 81419, *

ond Circuit standard, plaintiffs must allege that the sub-ject of the fraudulent statement or omission was the proximate cause of the actual loss suffered --in other words, plaintiffs must allege both that the loss was fore-seeable and that the loss was caused by the materializa-tion of the concealed risk. Bennett, 2005 U.S. Dist. LEXIS 25273 at 8, 2005 WL 2811757, at *3 (citing Len-tell, 396 F.3d at 173). A. Disclosure in March 19, 2002

As alleged in the TAC, VeriSign's 10-K report on March 19, 2002 revealed for the first time that approxi-mately 10% [*13] of its revenue was attributable to re-ciprocal arrangements, or "barter transactions," and sales to the company affiliates in which VeriSign had just in-vested. Following the issuance of VeriSign's 10-K the TAC alleges the following market reaction:

In response, VeriSign's stock dropped 10% to close at $ 26.42 on March 20, 2002. But VeriSign's stock price contin-ued to trade at artificially inflated prices because the true financial condition of the Company continued to be concealed from investors. In addition, investors still did not know that (1) VeriSign had reported overstated revenues, receivables, deferred revenue and earnings by improperly ac-counting for the two-year auto-renewals and acquired deferred revenue, (2) VeriSign was misreporting domain name registrations by concealing the number of free and promotional registrations and two-year auto-renewal registrations, (3) the extent to which VeriSign improperly recognized revenues on the roundtrip and barter transactions and the effect on the Company, (4) VeriSign had overstated earnings by failing to properly account for its long-term investments in non-public companies under the equity method and by failing to record [*14] impairment charges on many of the investments, and (5) VeriSign had reported overstated earn-ings by failing to reserve for its delinquent receivables. Moreover contrary to VeriSign's March 19, 2002 statements re-garding affiliate relationships, VeriSign's investments in its affiliates were depend-ent upon the affiliates' agreement to buy VeriSign's products or services, thereby transferring the monies back to VeriSign. In essence, VeriSign was paying itself to boost up revenue from these "round trip"

deals. Thus, while some of the artificial inflation was taken out of the stock with these disclosures, the true picture of VeriSign's business had not yet been re-vealed.

(TAC P397, hereinafter "Paragraph 397".) Defendants claim that Paragraph 397 defeats any attempt by Plain-tiffs to plead loss causation based on losses which oc-curred prior to the 10-K released on March 19, 2002 be-cause Paragraph 397 affirmatively alleges that the market was unaware of VeriSign's "true financial condition" as of March 20, 2002.

From the Court's plain reading of Paragraph 397, the allegation that "the true financial condition of the Com-pany continued to be concealed from investors" is a clear statement [*15] that as of March 20, 2002, the market did not know the Company's "true financial condition" and thus the losses prior to March 20, 2002 could not have been based, in whole or in part, on the market's awareness of the Company's "true financial condition." In Daou, the Ninth Circuit specifically held that any loss suffered prior to when the complaint alleges that the "true nature of Daou's financial condition" was disclosed to the market "cannot be considered causally related" to the fraud alleged in the complaint. Daou, 411 F.3d at 1026-27. See also Morgan v. AXT, Inc., 2005 U.S. Dist. LEXIS 42346 at 49, No. C 04-4362 MJJ, 2005 WL 2347125, at *16 (N.D. Cal. Sept. 23, 2005) (holding that a dramatic decline in stock price prior to a corrective disclosure is not causally related to the false statements alleged). Paragraph 397 affirmatively disclaims any causal connection between events prior to March 20, 2002 and all parts of the scheme alleged to have been perpetrated by the Defendants --Plaintiffs characterize the five subsections of Paragraph 397 as including "all of the misinformation that defendants had put into the mar-ket caus[ing] the artificial inflation" (Plaintiffs' Opposi-tion to Defendants' [*16] Motion to Dismiss Third Amended Class Action Complaint, hereinafter "Opp." at 3). This affirmative disclaimer effectively negates any attempt to "provide a defendant with some indication of the loss and the causal connection that the plaintiff has in mind," Dura, 125 S. Ct. at 1634.

Plaintiffs' attempt to explain the affirmative allega-tions contained in Paragraph 397 are unpersuasive. At the hearing, counsel for Plaintiffs argued that the March 19, 2002 disclosure merely disclosed a part of the recip-rocal arrangement scheme and thus, this disclosure was merely a step towards the eventual full disclosure of the true financial condition of VeriSign on April 25, 2002. Taken out of context, a single line from Paragraph 397 may support Plaintiffs' argument that Defendants'


2006 U.S. Dist. LEXIS 81419, *

scheme was revealed in a piecemeal fashion via the March 19, 2002 disclosure: "[I]nvestors still did not know that... (3) the extent to which VeriSign improperly recognized revenues on the roundtrip and barter transac-tions." (emphasis added). In the context of the entire paragraph, however, the same subsection (3) of Para-graph 397 continues by alleging that the market was un-qualifiedly unaware [*17] of "the effect on the Com-pany," of these roundtrip and barter transactions that were disclosed; in other words, as far as the market was concerned, a revelation of these roundtrip and barter transactions did not reveal anything about the true finan-cial condition of VeriSign. If the market has not recog-nized the effect to the Company of these transactions as of March 20, 2002, then losses to the company's stock as of March 20, 2002, must have been caused by a market response to something other than Defendants' alleged roundtrip and barter transaction scheme. Even taking these allegations in the light most favorable to the Plain-tiffs, Plaintiffs have insufficiently alleged how it would be possible for a loss to be caused by the disclosure of a type of transaction where the market was unaware of "the effect on the Company" of that type of transaction. Since VeriSign's "true financial condition" continued to be hidden from the market as of March 20, 2002, losses in VeriSign's stock price prior to March 20, 2002 were not a result of a scheme which hid the company's true financial condition from the market. Allegations of losses prior to March 20, 2002 are dismissed. B. Disclosure [*18] in April 25, 2000

In the October Order, this Court held that the April 25, 2002 disclosure failed to plead loss causation because the disclosure was "not linked to any misstatements al-leged in the complaint" and Plaintiffs did not "plead any specific disclosure made by VeriSign on April 25, 2002, as being the substantial cause for the decline in stock price." (October Order at 10.) Based on the insufficiency of Plaintiffs' pleadings in the CSAC, the Court found that the CSAC "fails to provide Defendants with notice of what the causal connection might be between their loss and the vast majority of alleged misrepresentations mak-ing up the second through fifth categories of fraud." Id. (citing Dura, 125 S. Ct. at 1634).

Defendants argue that Plaintiffs are bound to their statements in the CSAC about the April 25, 2002 disclo-sure. Plaintiffs in the CSAC stated: "Even this disclosure, however, did not acknowledge that VeriSign had been maintaining its revenue and earnings numbers by ma-nipulating its financial results." (Plaintiffs' CSAC at 2.) Plaintiffs have removed this paragraph from the TAC. As a rule, "when a pleading is amended or withdrawn, the superseded [*19] portion ceases to be a conclusive judi-cial admission; but it still remains as a statement once

seriously made by an authorized agent, and as such it is competent evidence of the facts stated, though contro-vertible, like any other extrajudicial admission made by a party or his agent." Huey v. Honeywell, Inc., 82 F.3d 327, 333 (9th Cir. 1996) (quoting Kunglig Jarnvagssty-relsen v. Dexter & Carpenter, Inc., 32 F.2d 195, 198 (2nd Cir. 1929)). Plaintiffs' statements in the CSAC may be admissible against them at trial, but are not properly considered at this stage when the CSAC has been super-ceded by the TAC.

In the TAC, Plaintiffs appear to have met the stan-dards of Daou in pleading loss causation as to part of the scheme. In Daou, the Ninth Circuit found that Plaintiffs had adequately pled loss causation because the complaint alleged that Defendants "revealed that the Company's rapidly escalating work in progress account represented over $ 10 million in unbilled receivables --the direct re-sult of prematurely recognizing revenue" and the com-plaint also quotes an analyst who allegedly stated "[w]hen you say one thing on the conference [*20] call and report something different on the 10-Q, that raises concern... You have got to question whether they are manufacturing earnings." Daou, 411 F.3d at 1026 (em-phasis and alterations in original). Thus, the court in Daou found that the plaintiffs' pleadings as to loss causa-tion were sufficient because the plaintiffs alleged that investors knew or at least had strong suspicions about Daou's true financial condition based on possible past malfeasance.

In this case, the TAC alleges that VeriSign's 1Q02 report disclosed an operating margin of 19%, up from 13%, and large operating losses. The 1Q02 report also stated "our first-quarter results were not up to our expec-tations as we encountered significant spending delays in our IT and telecom customer bases...as well as more se-vere challenges in our Mass Markets domain name busi-ness" and announced a restructuring of $ 70-80 million. (TAC P398.) On this news, VeriSign stock dropped from $ 18.24 to $ 9.89 per share. In the TAC, Plaintiffs allege analysts' statements of "surprise," "shock," and "concern" regarding the financial state of VeriSign following VeriSign's 1Q02 report. The majority of these statements [*21] are forward-looking in perspective, but an analyst report from Legg Mason Wood Walker, Inc. stated: "We believe that credibility concerns and a lack of confidence in estimates are likely to serve as a key overhang on VeriSign shares." (TAC P400(b).) The TAC also at-tempts to connect the disclosures to Defendants' domain name scheme:

Disclosure of problems in VeriSign's business, particularly its domain name business, including its inability to esti-


2006 U.S. Dist. LEXIS 81419, *

mate renewal rates, overstatement of do-main name revenues, misleading appear-ance of sequential deferred revenue growth, the undisclosed weakness in its registrar business beyond the purge of free and promotion names, $ 70-80 mil-lion in unexpected charges to expense and the reliabilty and visibility of VeriSign's future earnings.

(TAC P401). While the present case is a close one, Plain-tiffs appear to have alleged that the loss from the domain name scheme was foreseeable from Defendants' actions in artificially inflating the stock, and that the loss in stock price was caused by the disclosure of the concealed risk of the domain name scheme. The Court finds that the disclosures of VeriSign's financial condition and analyst reaction [*22] to this disclosure is sufficiently similar to the disclosure in Daou to find that the Plaintiffs have adequately pled that their losses were proximately caused by the domain name scheme as disclosed to the market on April 25, 2002. C. Leave to Amend

Rule 15(a) of the Federal Rules of Civil Procedure provides that leave to amend a complaint shall be freely given when justice so requires. Federal policy strongly favors determination of cases on their merits and amendments to pleadings should be allowed with "ex-treme liberality." United States v. Webb, 655 F.2d 977, 979 (9th Cir. 1981).

Despite the liberal policy in favor of allowing amendments, this Court also recognizes an interest in creating a stationary target. See Sisseton-Wahpeton Sioux Tribe vs. United States, 90 F.3d 351, 355 (9th Cir. 1996) (where the party seeking an amendment has previously

been granted leave to amend, a court's discretion to deny leave to amend is particularly broad). In the CSAC, Plaintiffs' allegations as to the market reaction to the April 25, 2002 defeated their allegations of loss causa-tion, and when the Court granted Plaintiffs leave to amend, [*23] Plaintiffs simply removed the allegations in question. To permit a similar scenario as to Paragraph 397 at this stage would create undue delay and be sub-stantially prejudicial to Defendants who would have to engage in additional motion practice on yet another amended complaint when Plaintiffs were already on no-tice of the Court's concerns with prior complaint and Plaintiffs would simply allege the opposite of what they had alleged in the prior complaint. The Court will not allow Plaintiffs to again amend its complaint simply to remove affirmative allegations in the TAC.

V. CONCLUSION

For the reasons stated above, Defendants' Motion to Dismiss is GRANTED IN PART and DENIED IN PART. As to Plaintiffs' allegations of loss prior to March 20, 2002, Defendants' Motion is GRANTED with preju-dice. Defendants' Motion to Dismiss is DENIED as to Plaintiffs' allegations of loss causation regarding the do-main name scheme revealed by the April 25, 2002 dis-closure. Should Plaintiffs wish to proceed with this ac-tion, Plaintiffs shall file and serve an amended complaint alleging only losses subsequent to March 20, 2002 and regarding the domain name scheme revealed by the April 25, 2002 disclosure. [*24] The amended complaint shall be filed and served on or before May 12, 2006. Dated: April 6, 2006

/s/ James Ware

United States District Judge
