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28 APPENDIX OF UNPUBLISHED AUTHORITIES CITED IN REPLY BRIEF I/S/O MOTION FOR PARTIAL RECONSIDERATION MASTER FILE NO. C-04-4156-JW sf-2168514

MELVIN R. GOLDMAN (BAR NO. 34097) [email protected] JORDAN ETH (BAR NO. 121617) [email protected] MIA MAZZA (BAR NO. 184158) [email protected] MARK FOSTER (BAR NO. 223682) [email protected] MORRISON & FOERSTER LLP 425 Market Street San Francisco, California 94105-2482 Telephone: 415.268.7000 Facsimile: 415.268.7522

Attorneys for Defendants INFINEON TECHNOLOGIES AG, INFINEON TECHNOLOGIES NORTH AMERICA, CORP., ULRICH SCHUMACHER, and PETER J. FISCHL

UNITED STATES DISTRICT COURT

NORTHERN DISTRICT OF CALIFORNIA

SAN JOSE DIVISION

In re INFINEON TECHNOLOGIES AG SECURITIES LITIGATION

This Document Relates To:

ALL ACTIONS

Master File No. C-04-4156-JW

CLASS ACTION

APPENDIX OF UNPUBLISHED AUTHORITIES CITED IN REPLY BRIEF IN SUPPORT OF MOTION FOR PARTIAL RECONSIDERATION OF MAY 22, 2006 ORDER

Hearing Date: September 11, 2006 Time: 9:00 a.m. Judge: Honorable James Ware Courtroom: 8, 4th Floor

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28 APPENDIX OF UNPUBLISHED AUTHORITIES CITED IN REPLY BRIEF I/S/O MOTION FOR PARTIAL RECONSIDERATION MASTER FILE NO. C-04-4156-JW sf-2168514

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APPENDIX OF UNPUBLISHED AUTHORITIES

Case

Tab

In re Ashworth, Inc. Sec. Litig.,

No. 99-CV-0121-L JAH,

2000 U.S. Dist. LEXIS 15237 (S.D. Cal. July 18, 2000) ................1

Dura Pharm. Inc. v. Broudo, No. 99-CV-0151-L-NLS, slip op. (S.D. Cal. June 2, 2006)........................................................ 2

In re Gaming Lottery Sec. Litig., No. 96-Civ.-5567-RPP, 2001 U.S. Dist. LEXIS 13513 (S.D.N.Y. Sept. 5, 2001) ..................... 3

In re Gilead Sci. Sec. Litig., No. C03-4999-MJJ, 2006 WL 1320466 (N.D. Cal. May 12, 2006)............................................ 4

In re Impax Labs. Sec. Litig., No. 5:04-CV-04802-JW, slip op. (N.D. Cal. Mar. 1, 2006)........................................................ 5

In re InVision Techs., Inc. Sec. Litig., No. C-04-03181-MJJ, 2006 U.S. Dist. LEXIS 12166 (N.D. Cal. Jan. 21, 2006) ....................... 6

Menkes v. Stolt-Nielsen S.A., No. 3:03-CV-409-DJS, 2005 WL 3050970 (D. Conn. Nov. 10, 2005) ...................................... 7

Menkes v. Stolt-Nielsen S.A., No. 3:03-CV-409-DJS, 2006 WL 1699603 (D. Conn. June 19, 2006) ....................................... 8

Montalvo v. Tripos, Inc., No. 4:03-CV-995-SNL, 2005 U.S. Dist. LEXIS 22752 (E.D. Mo. Sept. 30, 2005) ................... 9

Morgan v. AXT, Inc., No. C-04-4362-MJJ, 2005 WL 2347125 (N.D. Cal. Sept. 23, 2005) ....................................... 10

Ryan v. Flowserve Corp., No. 03-CV-1769-B ECF, 2006 U.S. Dist. LEXIS 40624 (N.D. Tex. June 9, 2006) ................ 11

Simpson v. AOL Time Warner Inc., No. 04-55665, 2006 U.S. App. LEXIS 16556 (9th Cir. June 30, 2006) ................................... 12

In re Verisign Corp. Sec. Litig., No. C-02-02270-JW, 2005 WL 2893783 (N.D. Cal. Nov. 2, 2005) ......................................... 13

In re Verisign Corp. Sec. Litig., No. C-02-02270-JW, Slip Op. (N.D. Cal. Apr. 6, 2006)........................................................... 14

Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 of 2

TAB 1

Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 1 of 10

LEXSEE 2000 U.S. DIST. LEXIS 15237

In re ASHWORTH, INC. SECURITIES LITIGATION; This Document Relates to: ALLACTIONS.

Civil No. 99cv0121--L(JAH)

UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OFCALIFORNIA

2000 U.S. Dist. LEXIS 15237; Fed. Sec. L. Rep. (CCH) P91,243

July 18, 2000, DecidedJuly 18, 2000, Filed

SUBSEQUENT HISTORY: Motion granted by, in part,Motion denied by, in partIn re Ashworth, Inc. Secs. Litig.,2002 U.S. Dist. LEXIS 27991(S.D. Cal., May 10, 2002)

DISPOSITION: [*1] Defendants' motion to dismissGRANTED WITHOUT PREJUDICE.

COUNSEL: For BRIAN JOHNSON, plaintiff: WilliamS Lerach, Arthur Charles Leahy, Milberg Weiss BershadHynes and Lerach, San Diego, CA.

For BRIAN JOHNSON, JOHN GERVAIS, DEBRAKOPP, TONY LE, THOMAS KIDDER, JAMESR SANDOVAL, SHIRLEY SANDOVAL, NEWHAMPSHIRE RETIREMENT SYSTEM, plaintiffs:Todd S Collins, Berger and Montague, Philadelphia, PA.

For JOHN GERVAIS, DEBRA KOPP, TONY LE,THOMAS KIDDER, JAMES R SANDOVAL, SHIRLEYSANDOVAL, NEW HAMPSHIRE RETIREMENTSYSTEM, plaintiffs: Arthur Charles Leahy, MilbergWeiss Bershad Hynes and Lerach, San Diego, CA.

For ASHWORTH INC, RANDALL L HERREL, SR,GERALD W MONTIEL, JOHN L ASHWORTH, AJOHN NEWMAN, ANDRE P GAMBUCCI, MARYMONTIEL, FRED COUPLES, JOHN NEWMAN,JOHN DAVID HANSON, defendants: Thomas S Jones,Gibson Dunn and Crutcher, Irvine, CA.

For THOMAS KIDDER, JAMES R SANDOVAL,SHIRLEY SANDOVAL, plaintiffs: Jeffrey R Krinsk,Finkelstein and Krinsk, San Diego, CA.

For NEW HAMPSHIRE RETIREMENT SYSTEM,plaintiff: John W Jeffrey, Jeffrey and Dreher, San Diego,CA.

For NEW HAMPSHIRE RETIREMENT SYSTEM,plaintiff: Kurt B Olsen, The Olsen Law Firm,Washington, DC.

JUDGES:M. JAMES[*2] LORENZ, UNITED STATESDISTRICT JUDGE.

OPINIONBY: M. JAMES LORENZ

OPINION:

ORDER GRANTING DEFENDANTS' MOTIONTO DISMISS WITHOUT PREJUDICE

[Docket No. 24]

This matter came on regularly for a hearing onDefendants' motion to dismiss Plaintiffs' ConsolidatedAmended Complaint. Blake M. Harper of Milberg WeissBershad Hynes & Lerach, LLP, Todd S. Collins of Berger& Montague, P.C., and Kurt Olsen of the Olsen Law Firmappeared for the Plaintiffs. Wayne W. Smith and ThomasS. Jones of Gibson, Dunn & Crutcher, LLP appeared forthe Defendants.

FACTUAL BACKGROUND

Defendant Ashworth, Inc. (hereinafter referred toas "Ashworth" or "Company") designs, markets anddistributes golf apparel, headwear, and shoes underthe "Ashworth" brand name. (Consolidated AmendedComplaint ("CAC") PP 5, 9.) Ashworth's products aresold in the U.S. and internationally in golf proshops, re-sorts, department and specialty stores. (CAC P 5.) TheCompany's stock is publicly traded on the NASDAQ.(CAC P 92.) The individual defendants are: (1) ChiefExecutive Officer and Ashworth Director Randall Herrel("Herrel"); (2) founder, former designer, and DirectorJohn Ashworth ("Mr. Ashworth"); (3) former Chairman[*3] of the Board Gerald Montiel ("Mr. Montiel"); (4) for-


U.S. Dist. LEXIS 15237, *3; Fed. Sec. L. Rep. (CCH) P91,243

mer Chief Financial Officer John Newman ("Newman");and (5) former Vice President--Manufacturing MaryMontiel ("Mrs. Montiel"). (CAC P 5.) The class periodin this action is from September 4, 1997, through July 15,1998. (CAC P 8.)

After a successful 1993--94, Ashworth's business per-formed poorly from 1995 to mid--1997, causing its stockprice to go from $10--$ 14 to $5--$ 7 per share. (CAC P9.) Plaintiffs allege that as a result of the low stock price,the Company's executives and directors held thousandsof then--worthless options and embarked on a fraudulentscheme to raise the stock price so they could exercise theiroptions and sell their stock for a profit. (CAC P 10.)

Plaintiffs state that during the class period, Defendantsled the public to believe that they were turning Ashwortharound by representing that Ashworth was experiencing"significant improvement" in its financial results, "in-creasing demand" for its products, and "substantial in-crease[s]" in booking and sales. (CAC PP 12, 35, 40, 47,50--51, 56.) Plaintiffs also state that Defendants repre-sented that Ashworth was successfully moving its produc-tion operations offshore,[*4] yielding costs savings andoperating efficiencies, and that it was "double sourcing"(i.e., making products at two different offshore locations).(CAC PP 12, 41, 44, 52, 58.) In addition, the Defendantsextolled the quality of their products. (CAC PP 18, 44,48.) Defendants also told the public that Ashworth's in-ventory levels were in accordance with their "plan," suf-ficiently high so that the Company could fill the manyorders Ashworth had and satisfy the strong demand forits products. (CAC PP 12, 36, 40, 41, 58.) Defendantsforecasted gross margins of 40% and earnings per share("EPS") of $0.60+ for 1998. (CAC PP 12, 41, 52.) Duringthe class period, the Company's stock went to an all--timehigh of $18 per share. (CAC P 11.)

Plaintiffs contend that none of Defendants' represen-tations were true. Rather, the "significant improvement"in Ashworth's financial results, "increasing demand" andAshworth's "substantial increase[s]" in sales were fabri-cated by numerous phony sales, thereby falsely inflatingAshworth's revenues, gross margins and EPS in viola-tion of GAAP. Plaintiffs state that the phony sales tookthe following forms: (1) Defendants shipped productsfor which there [*5] were no buyers to warehousesrented to park the goods, and recorded these shipmentsas sales (CAC PP 13--14); (2) Defendants shipped mas-sive amounts of goods which had not been ordered, andfor which there were no buyers, to Ashworth's indepen-dent sales representatives and recorded these shipmentsas sales. (CAC PP 14, 26, 82(a)); (3) Defendants forcedAshworth's sales representatives to take large amounts ofmerchandise they did not order or want (and which the

representatives could return) under Ashworth's "car stockprogram," and recorded these shipments as sales (CACPP 14, 26, 82(c)); (4) Defendants shipped merchandiseto customers who had not ordered any, booking theseshipments as sales (CAC PP 13, 82); (5) Defendantsshipped customers non--conforming in--stock merchan-dise where the customers had ordered merchandise thatwas out--of--stock, so that Ashworth could immediatelyrecord these shipments as sales (CAC PP 14, 26, 82(e));(6) Defendants also shipped goods months before cus-tomers wanted the merchandise sent, and immediatelybooked these early shipments as sales (CAC PP 14, 27,82(d)); and (7) Defendants improperly recognized as rev-enue shipments of merchandise to customers[*6] thathad no obligation to pay via unlimited rights of return,or to customers (such as Cyrk, Inc., Granite Golf Corp.,Cobblestone Golf Group, Edwin Watts Golf Shops, ClubCorp. of America, American Golf Corp., T.J. Maxx, andthe Walt Disney Co.) that had extended payment terms(up to 120 days). (CAC PP 15, 27, 61(h), 80, 82(b).)

In addition, Plaintiffs allege that Ashworth falselyboosted its financial results by intentionally and improp-erly decreasing Ashworth's inventory reserves at a timewhen they should have been increased because of thebuildup of excess inventory. (CAC PP 16, 71--79.)

Plaintiffs further claim that Ashworth's representa-tions it was successfully moving production offshore, thatthe quality of the products was high, and that they were"double sourcing" were false. Plaintiffs state that the off-shore--produced products had numerous defects and wereof inferior quality, and the move was not resulting insavings but was leading to greatly increased expenses,operational inefficiencies, and dramatically higher fu-ture costs. (CAC PP 61(a)--(b), (m).) In addition, con-trary to Defendants' representations, Plaintiffs state thatAshworth was not double--sourcing. (CAC PP[*7] 21,61(c).)

Plaintiffs also state that inventory levels were not inaccordance with the Defendants' "plan" or maintained sothat they could fill orders; rather, demand for Ashworth'smerchandise was weakening and the Company had moreinventory than it needed. (CAC PP 61(c), (e), (j) -- (k)).

Plaintiffs contend that because of the foregoing ad-verse facts, Defendants knew their optimistic forecastsof gross margins of 40% and EPS of $0.60+ for 1998were unattainable. (CAC P 61(o)). Plaintiffs state thatthe Defendants knew this true information "due to theiraccess to internal Ashworth data." (CAC P 61.)

Plaintiffs allege that while the stock was high, the in-dividual Defendants sold 95%--100% of the total numberof shares they actually owned during the Class Period, and



from 43%--97% of their entire beneficial interests (whichincluded their vested options to purchase shares) duringsuch time. (CAC PP 22, 33). Collectively, this amountedto 1,170,922 shares and over $15 million. (CAC PP 22,33.) On the last day of the class period ---- July 15, 1998 ----Defendants revealed that third quarter sales would bedown $2 million to $3 million and that the Company'sproblems might impact fourth[*8] quarter 1998 results.(CAC P 62.) Ashworth's stock then dropped from nearly$13 per share to $8--1/8 per share. (CAC PP 21, 63.) Later,Defendants revealed that Ashworth had inventory prob-lems. (CAC PP 64, 66--67.) Ashworth's stock then felleven further, and after the class period has been trading ataround $4 per share.

DISCUSSION

Plaintiffs' Complaint alleges Defendants violated sec-tions 10(b) and 20(b) of the Securities and ExchangeAct and Securities and Exchange Commission Rule 10b--5. Defendants have now moved to dismiss the consol-idated amended complaint. In support of their motion,Defendants have requested the Court take judicial noticeof various press releases, reports, and SEC filings. To theextent that this Court has relied on any of these documentsin its analysis, it takes judicial notice of them pursuant toFederal Rule of Evidence 201.

I. Applicable Law Regarding Motions to DismissSecurities Fraud Complaints.

When ruling on a motion to dismiss, the Court ac-cepts all material allegations of fact as true and mustconstrue those allegations in the light most favorable tothe non--moving party.Durning v. First Boston Corp.,815 F.2d 1265, 1267 (9th Cir. 1987);[*9] North StarInt'l v. Arizona Corp. Comm'n, 720 F.2d 578, 581 (9thCir. 1983).The Court may dismiss a complaint as a mat-ter of law either for lack of a cognizable legal theory orfor the absence of sufficient facts alleged under a cog-nizable legal theory.Robertson v. Dean Witter Reynolds,Inc., 749 F.2d 530, 534 (9th Cir. 1984).A court review-ing a motion to dismiss may consider the facts alleged inthe complaint, documents attached to the complaint, andmatters of which the Court takes judicial notice.See HalRoach Studios, Inc. v. Richard Feiner & Co., 896 F.2d1542, 1555 n.19 (9th Cir. 1989).A district court ruling ona motion to dismiss may also consider documents "whosecontents are alleged in a complaint and whose authenticityno party questions, but which are not physically attachedto the [plaintiff's] pleading" without converting the motionto a summary judgment motionBranch v. Tunnell, 14 F.3d449, 453--54 (9th Cir. 1994).Further, the Ninth Circuit hasextended this rule to documents the authenticity of whichis not contested, and upon which the plaintiff's complaint

necessarily relies.Parrino v. FHP, Inc., 146 F.3d 699, 706[*10] (9th Cir.),cert. denied, 525 U.S. 1001, 142 L. Ed.2d 423, 119 S. Ct. 510 (1998).

Section 10(b) of the Securities and Exchange Act of1934 makes it unlawful to use in connection with the mailsor instrumentalities of interstate commerce any "manipu-lative or deceptive device or contrivance in contraventionof such rules and regulations as the Commissioner mayprescribe."15 U.S.C. § 78j. SEC Rule 10b--5, promul-gated under section 10(b), provides:

It shall be unlawful for any person, directly or in-directly, by the use of any means or instrumentality ofinterstate commerce, or of the mails or of any facility ofany national securities exchange,

(a) To employ any device, scheme or artifice to de-fraud,

(b) To make any untrue statement of a material fact orto omit to state a material fact necessary in order to makethe statements made, in the light of the circumstancesunder which they were made, not misleading, or

(c) To engage in any act, practice or course of businesswhich operates or would operate as a fraud or deceit uponany person, in connection with the purchase or sale of anysecurity.

17 C.F.R. § 240.10b--5.

In order for Plaintiffs[*11] to properly allege theirfirst claim of relief brought under section 10(b) of theExchange Act and SEC Rule 10b--5, they must state thefollowing: (1) defendants made a false statement or omis-sion with regard to a material fact; (2) in connectionwith the purchase or the sale of a security; (3) with sci-enter; (4) upon which plaintiffs reasonably relied; (5)to his/her harm or detriment.Paracor Finance, Inc. v.General Electric Capital Corp., 96 F.3d 1151, 1157 (9thCir. 1996).Scienter is a "mental state embracing intentto deceive, manipulate, or defraud."Ernst & Ernst v.Hochfelder, 425 U.S. 185, 193--94 n.12, 47 L. Ed. 2d 668,96 S. Ct. 1375 (1976); In re Silicon Graphics, Inc. Sec.Litig., 183 F.3d 970, 975 (9th Cir. 1999).

In December of 1995, Congress enacted the PrivateSecurities Litigation Reform Act of 1995 ("PSLRA") toestablish uniform and stringent pleading requirements forsecurities fraud actions, and "to put an end to the practiceof pleading 'fraud by hindsight.'"In re Silicon Graphics,183 F.3d at 958.The PSLRA specifies the required plead-ing standard for securities fraud actions:

(1) Misleading[*12] statements and omis-sions



In any private action arising un-der this chapter in which theplaintiff alleges that the defen-dant ----(A) made an untrue statement ofa material fact; or(B) omitted to state a materialfact necessary in order to makethe statements made, in the lightof the circumstances in whichthey were made, not misleading;the complaint shall specify eachstatement alleged to have beenmisleading, the reason or rea-sons why the statement is mis-leading, and, if an allegation re-garding the statement or omis-sion is made on information andbelief, the complaint shall statewith particularity all facts onwhich that belief is formed.

15 U.S.C. § 78u--4(b)(1).

In addition, the PSLRA requires complaints allegingfederal securities fraud to "state with particularity factsgiving rise to a strong inference that the defendant actedwith the required state of mind."15 U.S.C. § 78u--4(b)(2).As recently interpreted by the Ninth Circuit, this lan-guage requires "a private securities plaintiff . . . [to] plead,in great detail, facts that constitute strong circumstan-tial evidence of deliberately reckless or conscious[*13]misconduct."In re Silicon Graphics, 183 F.3d at 974.Recklessness satisfies the scienter requirement only inso-far as it reflects some degree of conscious or deliberatemisconduct;i.e., "a degree of recklessness that stronglysuggests actual intent."Id. at 979.

The PSLRA further provides that "the court shall, onthe motion of any defendant, dismiss the complaint if therequirements of paragraphs (1) and (2) are not met."15U.S.C. § 78u--4(b)(3)(A).

Under Ninth Circuit caselaw, Rule 9(b) imposes twodistinct requirements on complaints alleging securitiesfraud. First, the basic notice requirements of Rule 9(b)require the complaint to "state precisely the time, place,and nature of the misleading statements, misrepresenta-tions, or specific acts of fraud."Kaplan v. Rose, 49 F.3d1363, 1370 (9th Cir. 1994).The Rule imposes a secondrequirement that the complaint "set forth an explanationas to why the statement or omission complained of wasfalse and misleading."In re Glenfed Sec. Litig., 42 F.3d1541, 1548 (9th Cir. 1994)(en banc). A complaint maysatisfy this second requirement[*14] in many ways. It

may demonstrate that the false or misleading character ofa statement was clear from facts that existed all along andwere later revealed.Id. at 1549.It may also "point[] toinconsistent contemporaneous statements or information. . . which were made by or available to the defendants."Id. A complaint may not, however, demonstrate that astatement was false or misleading when made "merely bypointing to later inconsistent statements or conditions."Id.

II. Analysis.

Defendants raise two types of challenges to theConsolidated Amended Complaint. First, Defendants ar-gue that the complaint does not meet the requisite plead-ing standards as set forth by the PSLRA,Federal Rule ofCivil Procedure 9(b), andIn re Silicon Graphics. Second,Defendants contend that the alleged misrepresentations atissue in this case are not actionable.

A. Pleading Challenges.

As an initial matter, Plaintiffs argue the Complaint isnot based on information and belief but rather on counsel'sinvestigation and personal knowledge of former Ashworthpersonnel. But a complaint made upon investigation ofcounsel is the same as a complaint made[*15] on in-formation and belief.In re Silicon Graphics Sec. Litig.,970 F. Supp. 746, 763--64 (N.D. Cal. 1997), aff'd, 183F.3d 970.Further, although the Complaint states it isbased on "knowledgeable sources," there are no allega-tions in the Complaint indicating that the Plaintiffs havepersonal knowledge of the facts underlying their allega-tions. Accordingly, the Court considers the Complaint tohave been pled on information and belief.

1. Falsity.

The statements at issue in the Complaint relate tothe Company's health in terms of revenues and inven-tory, and production difficulties. Defendants argue thatPlaintiffs fail to allege sufficient facts to support theirclaims that the statements at issue in this case were falsewhen made. For the reasons discussed below, the Courtfinds that the Complaint does not plead with particular-ity how Defendants' statements regarding the Company'sfinancial condition and production were false when made.

a. Plaintiffs' Allegations Regarding Ashworth'sReported Revenues and Earnings.

Plaintiffs argue that they have sufficiently pled thatAshworth violated GAAP n1 and SEC financial reportingrequirements[*16] during the class period by improp-erly recognizing revenue through a variety of undisclosedpractices to inflate Ashworth's revenues and EPS to sup-port Defendants' statements that the Company was enjoy-



ing a "substantial increase" in sales. Defendants contendthat in fact the Complaint does not identify particulartransactions where Ashworth improperly recognized rev-enues. Specifically, Defendants state that Plaintiffs fail toidentify specific instances where Ashworth shipped prod-uct to a specified customer in a specified amount andbooked that sale only to have that material returned at alater date.

n1 GAAP "is a term of art encompassing a widerange of acceptable accounting procedures, suchthat 'an ethical reasonably diligent accountant maychoose to apply any of a variety of acceptable pro-cedures when that accountant prepares a financialstatement.'"Lovelace v. Software Spectrum Inc., 78F.3d 1015, 1021 (5th Cir. 1996).

Plaintiffs respond that they are not required to allege asingle specific[*17] transaction, specific shipments, spe-cific customers, specific times, or specific dollar amounts.In so arguing, Plaintiffs citeIn re Cooper, 137 F.3d 616,627 (9th Cir. 1997), In re Wells Fargo Sec. Litig., 12 F.3d922, 927 (9th Cir. 1993), Schlagal v. Learning Tree Int'l,1998 U.S. Dist. LEXIS 20306, 1998 WL 1144581 (C.D.Cal. 1998),and Cherednichenko v. Quarterback Corp.,[1998 Transfer Binder]Fed. Sec. L. Rep. (CCH) P 90,108(C.D. Cal. 1997).Plaintiffs' reliance on these cases ismisplaced.CooperandWells Fargoare pre--Reform Actcases and are therefore inapplicable. Further, inWellsFargo, the plaintiffs identified the defendants' deliberatefailure to disclose specific loans extended to identifiedborrowers.In re Wells Fargo, 12 F.3d at 926--27.Second,Schlagal and Cherednichenkoare not officially--publishedopinions from other districts and therefore should not becited as binding or persuasive authority on this Court.

"Properly pled, overstating of revenues may statea claim for securities fraud, as under GAAP, 'revenuemust be earned before it can be recognized.'"Hockey v.Medhekar, 30 F. Supp. 2d 1209, 1216 (N.D. Cal. 1998).[*18] "To properly state a claim for accounting fraud,plaintiffs must plead facts sufficient to support a conclu-sion that defendant [] prepared the fraudulent financialstatements and that the alleged financial fraud was ma-terial. In addition, plaintiffs must identify the particulartransactions underlying [the] alleged accounting deficien-cies."Id. (internal citations and quotations omitted). TheCourt agrees with the Defendants that Plaintiffs' allega-tions are conclusory and not properly pled. Significantly,Plaintiffs fail to identify contemporary internal reports orreceipts that identify the terms of the challenged transac-tions.

First, the Complaint alleges Defendants created phan-

tom sales by shipping Ashworth merchandise to cus-tomers who had not placed orders while recordingthese shipments as "sales," and just before quarter ends,Defendants routinely shipped merchandise for whichthere was no buyer to warehouses of its sales representa-tives and recorded these shipments as sales. (CAC PP 13,26.) The Complaint fails to allege any specific facts tosubstantiate these allegations, such as a detailed examplewhere these events occurred.

The Complaint also contends that before[*19] quar-ter ends, Ashworth's senior executives would contact theCompany's sales representatives to convince them to takeand store $50,000--$ 100,000 worth of goods, and on atleast one occasion, Ashworth caused one of its sales repre-sentatives in the Southeast to ship $100,00 worth of mer-chandise to a rented warehouse and record the shipmentas a sale even though there was no sale or customer for themerchandise. (CAC PP 14, 26.) Defendants also shippedmassive amounts of merchandise to the warehouse ofRegional Sales, Inc., an independent sales representa-tives, even though there were no sales or customers forsuch products. (CAC PP 14, 26.) As noted by Defendants,the Complaint does not detail a single transaction to sub-stantiate this claim.

Plaintiff's Complaint maintains that Defendants con-tacted customers at quarter--ends and offered specialterms, including discounting, liberal rights of return, andextended payment terms to customers. (CAC PP 15, 27.)Although Plaintiffs list some customers that Defendantscontacted and state that the Disney Co. received a favor-able term "in one instance," there are no allegations de-scribing the terms, the amounts involved, whether goodswere [*20] actually returned, or how the agreementsviolated accounting standards. Similarly, the Complaintalleges Ashworth shipped "hundreds of thousands of dol-lars" to a company called Cyrk subject to an "unlimitedright of return" and that returns did occur. However, theComplaint does not given an example discussing when theproduct was shipped, how much was returned, or whetherthe amounts returned were material.

Insofar as the above allegations also amount to "chan-nel stuffing" claims, they are insufficient. Channel stuffing"is the oversupply of distributors in one quarter to artifi-cially inflate sales, which will then drop in the next quarteras distributors no longer make orders while depleting theirexcess supply."Steckman v. Hart Brewing, Inc., 143 F.3d1293, 1298 (9th Cir. 1998).The First Circuit recentlynoted that "there is nothing inherently improper in press-ing for sales to be made earlier than in the normal course."Greebel v. FTP Software, Inc., 194 F.3d 185, 202 (1st Cir.1999).Although Plaintiffs' "channel stuffing" claims mayhave some probative value insofar as the channel stuffing



was done so as to artificially inflate income, "that[*21]value is weak."Id. at 202--03.Because there may be anumber of legitimate reasons for attempting to achievesales earlier, "channel stuffing" claims "do not supporta strong inference of scienter."Id. at 203. Indeed, thisCircuit has rejected "channel stuffing" claims.Steckman,143 F.3d at 1298.In Steckman, the Ninth Circuit statedthat "this claim is speculation made in hindsight." Id.

Similarly, Defendants argue that Plaintiffs have notsupported their position that Ashworth's statement of a"strong outlook" was false. The Complaint maintains thatstatement is false because Ashworth Europe had "out-moded and inefficient management" and "soft demand."(CAC P 61(d).) Further, the Complaint alleges that de-mand was not strong because demand for the Basicsline was "weakening." Again, Defendants argue that theComplaint does not allege any specifics nor explains howthe Defendants knew of the true facts.

b. Inventory Accounting.

Plaintiffs allege Ashworth's statement that inventorylevels were "on plan" was false because in fact the Basicsline was encountering "extreme price pressure," inven-tories were above internal[*22] budgets and forecasts,and management had not "fixed" inventory issues. (CACPP 61(e), 61(j), 61(k).) Plaintiffs contend that Defendantsimproperly accounted for inventory in violation of GAAP,as set forth in the Accounting Research Bulletin ("ARB")No. 43, Chapter 4, Inventory Pricing. (CAC P 71.) ARBNo. 43, Chapter 4, statement 5 states:

A departure from the cost basis of pricingthe inventory is required when the utility ofthe goods is no longer as great as its cost.Where there is evidence that the utility ofgoods, in their disposal in the ordinary courseof business, will be less than cost, whetherdue to physical deterioration, obsolescence,changes in price levels, or other causes, thedifference should be recognized as a loss ofthe current period. This is generally accom-plished by stating such goods at a lower levelcommonly designated as market.

(CAC P 71.) Defendants state that notwithstandingPlaintiff's reliance on ARB No. 43, Chapter 4, statement5, the Complaint does not articulate any facts indicatedthat Ashworth ever accounted for inventory in any otherfashion or sold inventory for below cost.

The Court agrees that Plaintiffs' allegations are[*23]insufficient. The Complaint does not provide any speci-ficity or examples regarding inventory levels, sales at be-low cost, or inventory build up. Plaintiffs' general alle-

gations that Ashworth's inventories were "materially in-creasing," demand for Ashworth's basics product line wasdecreasing, and costs were increasing are too conclusory.To support these allegations, Plaintiffs cite defendants1998 SEC Form 10K in which the company stated it wasdisposing of excess prior season inventory. Plaintiffs' re-liance on post--class period documents amounts to "fraudby hindsight" and is therefore insufficient to show therewas informationat the timethe Defendants made thestatements that contradicted the representations. In sum,the Court finds that the Complaint does not allege factsindicating what contemporary information known to theDefendants would have rendered the reserves false whenmade. The Complaint also does not allege particular factsindicating how or why the Company was underreservingfor inventory.

c. Production Difficulties Allegations.

Defendants contend the Complaint's allegations thatAshworth was experiencing production difficulties mis-represent Ashworth's statements[*24] and are not pledwith sufficient particularity. The Complaint asserts that"Ashworth management also said that the Company madeits offshore products at more than one offshore plant ----'double sourcing' ---- thereby dismissing concerns that off-shore production was risky in terms of quality and avail-ability. (CAC P 12.) According to Plaintiffs, this state-ment was misleading because "Ashworth later admitted toproduction problems and inadequate controls in offshorefactories leading to defective and substandard merchan-dise, and stated that it was going to implement doublesourcing (essentially admitting that, contrary to prior rep-resentations, Ashworth lacked double sourcing during theClass Period." (CAC P 21.)

Defendants argue that the only statement in theComplaint (other than generalized statements regardingoff--shore sourcing saving money) is the paraphrased com-ment in theWall Street Journalarticle "But Mr. Herreldismisses such concerns, pointing out that the companyis making some key products at more than one plant dur-ing the transition." (CAC P 44.) Defendants maintainthat there was never any representation regarding dou-ble--sourcing all ofAshworth's overseasmanufacturing.[*25] Further, Defendants contend that the later "admis-sion" did not negate the article's statement. The Complaintalleges that on July 15, 1998, Ashworth announced thatits revenues would experience a shortfall due to problemswith "'the quality and timeliness of a few key styles ofthe Company's popular basics line received from offshoresources.'" (CAC P 62.) Defendants state that a review ofthe relevant part of full press release reads:

Randall L. Herrel, Sr., President and



Chief Executive Officer of Ashworth, Inc.(NASDAQ:ASHW), announced today thatthe quality and timeliness of a few key stylesof the Company's popular basics line re-ceived from offshore sources in the thirdquarter of 1998, had fallen short of theCompany's quality expectations and stan-dards. In keeping with the Company's ongo-ing commitment to premium quality and cus-tomer satisfaction, the lower quality goodswere not shipped to customers and the prob-lem is being corrected. As a result of theseproduction--related issues, the Company'ssales in the third quarter will be affected byapproximately $2.0 to $3.0 million but willstill result in strong improvement over thecorresponding quarter of fiscal 1997.[*26]Mr. Herrel further stated that, due to thisproblem, third quarter net income will equalor be slightly above last year and may alsoslightly impact net earnings in the fourthquarter of the current fiscal year.

(Defs. Request for Judicial Notice ("RJN") Exh. A.) Aspointed out by the Defendants, the full quote does notcontradict the statement in theWall Street JournalthatAshworth double--sourced "some" off--shore production.There is nothing that indicates a lack of double--sourcingfor the "key styles." Accordingly, the Complaint's currentallegations regarding production difficulties do not sufficeto establish falsity.

In addition, the Court finds insufficient Plaintiffs'allegations regarding Defendants' representations theCompany was committed to quality. Plaintiffs maintainthese statements were false because the offshore facilitieswere troubled with inadequate quality--control testing andinsufficient supervision, causing Ashworth's off--shoremerchandise to be riddled with defects such as mis--sizedshirts and inferior quality products. The Complaint, how-ever, does not provide any specific examples to supportthese assertions. Further, there are no allegations[*27]referencing internal documents stating that there wereproduction problems. Plaintiffs only state that Defendantsknew about this information because of their access tointernal Ashworth data. These allegations are not suffi-cient to establish that Defendants' statements regardingthe quality of the Company's products were false whenmade.

2. Scienter.

Silicon Graphicsrequires a plaintiff to "plead, in greatdetail, facts that constitute strong circumstantial evidenceof deliberate recklessness or conscious misconduct."In

re Silicon Graphics, 183 F.3d at 974.Further, plaintiffsmust provide great detail regarding all the facts formingthe basis for their belief.Id. at 983.

a. Defendants' Accounting Methods.

As discussed above, the Court finds Plaintiffs' alle-gations of accounting fraud are insufficient to establishfalsity. The Court further finds that these allegations aredeficient in establishing scienter. InWorlds of WonderSecurities Litigation, the Ninth Circuit held that scienter"requires more than a misapplication of accounting prin-ciples."In re Worlds of Wonder Securities Litig., 35 F.3d1407, 1426 (9th Cir. 1994);[*28] Hockey, 30 F. Supp. 2dat 1224.Plaintiffs "must prove that the accounting prac-tices were so deficient that the audit amounted to no auditat all, or an egregious refusal to see the obvious, or toinvestigate the doubtful, or that the accounting judgmentswhich were made were such that no reasonable accoun-tant would have made the same decisions if confrontedwith the same facts."In re Worlds of Wonder, 35 F.3dat 1426.Further, even a deliberate violation of GAAPwithout more, does not amount to fraud,In re Worlds ofWonder, 35 F.3d at 1426.

The absence of allegations specifying actual transac-tions where the challenged practices led to misstatementsand omissions undermine Plaintiffs' scienter allegations.Plaintiffs must include at least basic details such as the ap-proximate amount by which revenues and earnings wereoverstated, the products involved in the allegedly fraud-ulent transactions, the dates of the transactions, and aswell as the identities any of the customers or Defendants'employees involved.Greebel, 194 F.3d at 205.In addi-tion, the complaint does not identify how and wheneachDefendant became[*29] aware of the allegedly fraud-ulent transactions, nor each Defendant's involvement inthe challenged practices. In so doing, Plaintiffs cannotmake general allegations that Defendants had access tointernal documents. Rather, to the extent Plaintiffs relyon internal reports, they must specify the contends of thereports, the names of those who prepared the reports, thenames of those who reviewed the reports, and the namesof those from which the information was obtained.SeeIn re Silicon Graphics, 183 F.3d at 985("We would ex-pect that a proper complaint which purports to rely on theexistence of internal reports would contain at least somespecifics from those reports as well as such facts as mayindicate their reliability.").

b. Insider Sales.

Defendants also challenge Plaintiffs' claims of sci-enter based on the Individual Defendants' stock sales."Allegations that a corporate insider either presented ma-terially false information, or delayed disclosing materi-



ally adverse information, in order to sell personally--heldstock at a huge profit can supply the requisite 'motive' fora scienter allegation."In re Petsmart, Inc. Sec. Litig., 61F. Supp. 2d 982, 999 (D. Az. 1999).[*30] "Thus, insidertrading during the class period may support a strong infer-ence of scienter."Id. at 999--1000; In re Silicon Graphics,183 F.3d at 986."But, courts have repeatedly held thatthe mere existence of stock sales does not raise a stronginference of fraudulent intent. [citation] Plaintiffs havethe burden at the pleading stage of explaining why thestock sales were unusual or suspicious."In re Petsmart,61 F. Supp. 2d at 1000; In re Silicon Graphics, 183 F.3dat 986.To meet this burden, the plaintiffs must show thetrading was "'in amounts dramatically out of line withprior trading practices, at times calculated to maximizepersonal benefit from undisclosed inside information.'"In re Petsmart, 61 F. Supp. 2d at 1000(quoting Alfus v.Pyramid Technology Corp., 764 F. Supp. 598, 605 & n.1(N.D. Cal. 1991)); In re Silicon Graphics, 183 F.3d at986.Accordingly, where a corporate insider sells only asmall fraction of his shares, the inference of scienter isweakened. In re Petsmart, 61 F. Supp. 2d at 1000.Inaddition, some courts have[*31] held that were an indi-vidual retains more shares than were sold, the resultingaggregate loss will defeat an inference of fraud.Id.; seeIn re Silicon Graphics, 183 F.3d at 986(stating that "theproportion of shares actually sold by an insider to the vol-ume of shares he could have sold is probative of whetherthe sale was unusual or suspicious").

Defendants argue that Plaintiffs have failed to showthe Defendants' trading practices at issue were out of linewith prior trades, and on this basis alone, the Complaintis inadequate to draw any reference from insider stocksales. Defendants further argue that a review of each ofthe Individual Defendants' stock sales are in line withprior trading or otherwise explainable.

Herrel, who the Complaint focuses on, and the speakerin those instances where the Complaint identifies one, didnot sellanystock during the class period, even though heheld 100,000 vested options. (RJN Exh. E.) Accordingly,scienter cannot be properly inferred as to this Defendant.

John Ashworth sold 609,922 shares during the classperiod. (CAC P 33.) Although the amount of shares hesold is significant, the Complaint's lack of specific alle-gations[*32] directly attributing fraudulent conduct ormisrepresentations to Mr. Ashworth render the stock salesinsufficient to support scienter.

Mary Montiel sold 61,000 shares of Ashworth stock.(CAC P 33.) The Complaint alleges these sales consti-tuted 100% of Ashworth stock Ms. Montiel owned, and73% of her total beneficial ownership.Id. This amountis approximately 5% of the total stock sold by insider

Defendants during the class period. This small percent-age weighs against an inference of scienter.In re SiliconGraphics, 183 F.3d at 987.Further, the Complaint failsto allege facts that make these sales suspicious in light ofthe absence of any specific allegations directly attributingmisrepresentations to Ms. Montiel or particularized factsindicating that Ms. Montiel had specific knowledge ofthe fraudulent manipulation of accounting practices thatmisrepresented the EPS.

John Newman sold 48,000 shares of Ashworth stock,comprising around 4% of the alleged inappropriate sales.(CAC P 33.) Again, underSilicon Graphics, this smallpercentage undermines an inference of scienter.In reSilicon Graphics, 183 F.3d at 987.

Gerald Montiel sold 452,000[*33] shares duringthe class period. (CAC P 33.) The Court finds that Mr.Montiel's stock sales, alone, are insufficient to support astrong inference of scienter because the Complaint fails tomake any specific allegations regarding misstatements byMr. Montiel personally, and also lacks particularized factsshowing that Mr. Montiel was aware of the Company's al-leged fraudulent accounting practices.

Plaintiffs contend that the scienter allegations of in-sider trading is bolstered by the fact that the Defendantscan be inferred to have knowledge of the Company's keyoperations and factors affecting its key products. In sup-port for this argument, Plaintiffs cite pre--Silicon Graphicscases ----Epstein v. Itron, Inc., 993 F. Supp. 1314, 1325--26(E.D. Wash. 1998); Powers v. Eichen, 977 F. Supp. 1031,1039 (S.D. Cal. 1997); Friedberg v. Discreet Logic, 959F. Supp. 42, 51 (D. Mass 1997);andCosmas v. Hassett,886 F.2d 8, 10, 12--13 (2d Cir. 1989).The Court failsto see how these cases are persuasive in light ofSiliconGraphics. Epstein, Powers, andFriedburgpredateSiliconGraphics. Further, not only does[*34] Cosmaspre--date the PSLRA andSilicon Graphics, it is also fromthe Second Circuit.Silicon Graphicsrejected the SecondCircuit's standard for scienter, holding that a private se-curities plaintiff must plead "in great detail, facts thatconstitute strong circumstantial evidence of deliberatelyreckless or conscious misconduct."In re Silicon Graphics,183 F.3d at 974, 979.n2 Because it relies on inapplica-ble law and cannot be reconciled withSilicon Graphics'standard for pleading scienter, Plaintiffs' argument that aninference of scienter should be drawn is unavailing.

n2 For this reason, the Court is also not per-suaded byNovak v. Kasaks, No. 98--9641, 216 F.3d300, 2000 U.S. App. LEXIS 14349(2d Cir. June 21,2000).

2. Liability of Non--Speaking Defendants.



Defendants contend that Plaintiffs cannot rely on thegroup pleading doctrine and because the Complaint failsto specify with particularity the conduct or knowledgeof any individual defendant, and[*35] in particular Mr.and Mrs. Montiel and Mr. Ashworth, the Complaint isdeficient. Plaintiffs respond that group pleading remainsa valid theory of liability after the PSLRA, and that thenon--speaking Individual Defendants are liable under thattheory.

The Court disagrees. Although other courts have heldthat the group pleading standard survives, this district hasheld that it likely does not. InAllison v. Brooktree, 999F. Supp. 1342 (S.D. Cal. 1998),the Honorable JeffreyT. Miller found that the "group pleading" doctrine didnot survive the PSLRA.Allison, 999 F. Supp. at 1350--51.Judge Miller stated, "to permit a judicial presumptionas to particularity simply cannot be reconciled with thestatutory mandate that plaintiffs must plead specific factsas to each act or omission by the defendant."Id. at 1350.This Court concurs with Judge Miller's reasoning. Further,recognition of the group pleading doctrine would be atodds with Silicon Graphics'pleading requirements re-garding scienter. n3 Plaintiffs' reliance on the group plead-ing doctrine is therefore misplaced. Accordingly, whenamending the complaint, Plaintiffs must allege[*36] factstying each of the alleged misstatements and omissions toeach of the individual Defendants.

n3 Although the group pleading doctrine doesnot apply to this case, the Court is mindful that theremay be circumstances where it would be appropri-ate to attribute statements to a group of defendants,such as where a corporation's officers and directorsare few in number and make corporate decisions ona group basis.

B. Whether Plaintiffs' Claims are Actionable.

Defendants also argue that the statements at is-sue in this case are not actionable on several grounds.First, Defendants argue that vague statements of opti-mism regrading the quality of Ashworth's products, itsturnaround, or its prospects are not actionable becausethey are generic statements and "puffery." Defendants fur-ther argue that statements made in analyst reports are notactionable, nor are the Complaint's allegations regardingDefendants' financial reporting and sales. Because theCourt finds that the Complaint does not meet the requi-site [*37] pleading standards, it is premature to rule onwhether the statements are actionable.

C. Plaintiffs' § 20(b) Claim.

Rule 20(a) of the 1934 Securities and Exchange Actprovides for controlling person liability for every personwho, directly or indirectly, controls any person liable un-der any of the provisions of thistitle. 15 U.S.C. § 78t(a).To establish control person liability, however, a plaintiffmust show that a primary violation occurred.Wenger v.Lumisys, Inc., 2 F. Supp. 2d 1231, 1252 (N.D. Cal. 1998).Accordingly, because Plaintiff's § 10(b) claim is beingdismissed for failure to meet the requisite pleading re-quirements, Plaintiff's claim under § 20(b) must also bedismissed.

CONCLUSION

Having considered the parties' briefs, the record, oralargument, applicable law, and good cause appearing,ITIS HEREBY ORDERED:

1. Defendants' motion to dismiss isGRANTEDWITHOUT PREJUDICE. Plaintiffs shall file and servean amended complaint within 60 days of the date thisorder is stamped "Filed."

2. The amended complaint shall not contain allegedmisstatements that are inactionable on their face, suchas vague[*38] and general statements of optimism, oraccurate statements of historical fact.

3. The amended complaint shall comply withFederalRule of Civil Procedure 8, and shall not group together themisrepresentations and omissions, and then list the rea-sons why they were false or misleading. Rather, Plaintiffsmust concisely set forth each allegedly false or mislead-ing statement or omission, and followeachstatement oromission with the specific reasons why the statementswere false when made or why the Defendants had a dutyto disclose. In addition, the Plaintiffs shall specify whichDefendants made the statements, and how and when eachof the Defendants knew the "true facts" that should havebeen disclosed.

4. Plaintiffs are admonished that failure to complywith the requisite pleading standards may subject theircomplaint to dismissal with prejudice.

IT IS SO ORDERED.

Dated: 7/18/2000

M. JAMES LORENZ

UNITED STATES DISTRICT JUDGE


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_1L.E D06 JUN -2 PM 2 : 3 3

f `f !1 i_ nI i -11r: T r j

DEPUT I

UNITED STATES DISTRICT COURT

SOUTHERN DISTRICT OF CALIFORNI A

1N RE DURA PHARMACEUTICALS, Civil Ian. . 9cv0151-L(N-LS)INC. SECURITIES LITIGATION,

ORDER GRANTING I N PART ANDDENYING IN PART MOTION TODISMISS THIRD CONSOLIDATEDAMENDED COMPL AINT

This Document Relates to: All Actions [Docket No. 119]

This matter came on regularly for a hearing on Defendants' motion to dismiss the Third

Consolidated Amended Complaint ("TAC") . Patrick J . Coughlin and Tor Gronborg of Lerach

Coughlin Stoia Geller Rudman & Robbins LLP appeared for the Plaintiffs . William F . Sullivan

of Paul Hastings Janofsky & Walker appeared for the Defendants.

Having carefully reviewed the parties' briefs, oral argument, and applicable law, the

Court finds the TAC's allegations regarding Albuterol Spiros fail to meet the pleading

requirements under the Private Securities Litigation Reform Act of 1995 ("PSLRA"), 15 U .S.C.

§§ 78u-4(b)(1) and (2), and that the TAC's allegations regarding Defendants' statements about

Ceclor CD properly state a claim under the PSLRA against certain Defendants . The Court

therefore GRANTS IN PART and DENIES IN PART Defendants' motion to dismiss .

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BACKGROUND

Plaintiffs bri ng this action on behalf of purchasers of shares of Dura Pharmaceuticals, Inc .

(" Dura" or the "Company") securities from April 15, 1997 to February 24, 1998 ("Class Period")

including those purchasers who acquired their Dura secu ri ties during the Class Period and held

such secu rities until after September 23, 1998 , November 4, 1998, and December 4, 1998 .

{TAG ¶[ 1 .) Dura was a San Diego -based developer and marketer of presc ription pharmaceutical

products for the treatment of allergies , asthma and related respiratory conditions . Id. ¶ 61 . The

Individual Defendants held the following positions at Dura during the Class Pe riod ; Cam L.

Garner ("Garner") was President, Chief Executive Officer , Chief Operations Officer, and

Chairman; James W. Newman ("Newman") was Senior Vice President-Finance &

Administration and Chief Financial Officer; Charles W . Prettyman ("Prettyman ") was Senior

Vice President -Development and Regulatory Affairs; Walter F . Spath ("Spath") was Senior Vice

President- Sales & Marketing ; Mitchell R. Woodbury ("Woodbury ') was Senior Vice

President/General Counsel; Julia R. Brown ("Brown ") was Senior Vice President -Business

Development and Planning; and Joseph C . Cook ("Cook") was a director. Id. 162.

Dura became a publicly-traded company in 1992, pursuing a business strategy of

marketing niche pharmaceutical drugs . Id. ¶ 1 . At that time, Dura typically purchased the rights

to market drugs developed by large pharmaceutical companies that were approaching the end of

t he ir profi tability to those companies . Id. By 1995, Dura's management realized that given the

Company's size, it would he increasingly difficult to achieve continued revenue and earnings per

share ("EPS") growth solely by acquiring marketing rights to niche drugs . Id. ¶ 2 . Therefore,

Dura insiders decided to diversify the Company's business, and become a medical device

development company and develop its own proprietary drug products . Id. In 1995, Dura began

developing the Spiros drug delivery system for Albuterol ("AlbuteroI Spires" or "Spiros drug

delivery system"), a method of aerosolizing powders so that asthma medicines, including

Alhuterol, could be inhaled . Id. ¶ 3 . This system purportedly would have advantages over

existing inhalers that depended on the user to successfully coordinate the use of the inhaler and

inhalation of the medication . Id. The Spires drug delivery system was a software-driven devic e

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with software programmed to turn on a motor that activated an impeller inside the device, which

in turn extracted the Albuterol drug compound from the storage cassette that fit inside the

inhaler. Id. ¶ 4 . Dura's insiders created Spiros Development Corporation (' Spiros I") to incur

Dura's costs of developing the Spires drug delivery system . Id. 9 5 . Plaintiffs contend

development of the inhaler was plagued with significant electra-mechanical problems that

plagued Spiros' reliability, and stability problems with Albuterol .

In August 1996, Dura acquired from Eli Lilly the marketing rights for Cellar CD, a

prescription antibiotic . Id. ~¶ 29-30, 67 . Ceclor CD is a slow-release form of Ceclor, a secon d

generation cephalosporin gene rically known as cefaclor. fd, $ 30 . Its use decreased in the late

1990s as more powerful antibiotics with fewer significant side effects were developed . Id.

Prior to the Class Period, after reaching a then all-time high price of $47 .87 on December

31, 1996, Dura stock fell sharply to 527 .87 on April 14, 1997. Id. 7, 168. This decline

created problems for Dura's executives . Id. By early 1997, as Dura was conducting Phase III

clinical trials on Albuterol Spiros, Defendants were completing a major debt offering for Dura to

obtain working capital to acquire additional pharmaceutical products . Id.1 19 . The Defendants

also knew that Spiros I would exhaust its financial resources during 1997, and Dura would have

to exercise its option to repurchase Spiros T and finance a new follow-on Spiros Development

Corp. II entity to continue to pay for the ongoing development of Albuterol Spiros . Id. IT 6, 19,

168. In addition, the value of Dura's insiders' existing stock options to purchase thousands of

shares of Dura stock had been completely wiped out in early 1997 when Dura's stock price

dropped, and the cash bonuses for aura's top executives were dependent upon Dura meeting

internally set 1997 EPS targets and Dura's stock price performance during 1997 . Id . 11 20, 168,

172 . For these reasons, it was imperative to Dura's insiders that they drive Dura's stock higher

during 1997 . Id. ¶ 21, 168 .

According to Plaintiffs , in their effort to raise Dura 's stock price, beginning in April 1997

I and continuing through the Class Period, Defendants began a "concerted campaign to falsel y

persuade investors that Dura's sales were increasing and that Dura was successfully completing

the development and clinical trials of the Spiros drug delivery system ." Id. 11122, 169. Plaintiffs

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state Defendants concealed problems with the development of Albuterol Spires and falsely

represented sales of Ceclor CD were strong . Id. 1123-24, 29. Plaintiffs allege that during the

Class Period , the Individual Defendants engaged in suspicious insider trading, selling 188,626

shares for over S7 .3 million between May 12, 1997 and July 22, 1997, and selling over 190,000

shares between November 3, 1997 and January 6, 1998 for $9 .2 million in proceeds . Id. 27-

j 28, 44 , 147, 171, 175-82 .

On the last day of the Class Period, February 24, 1998, Dura revealed that it expecte d

lower-than-forecast 1998 revenues and 1998 EPS due to slower-than -expected sales of the

Ceclor CD and Nasarcl Nasalide product lines, and the need to increase the size of its sales force

from 270 to over 450 to try to boost sales of existing products. Id. ¶¶ 45, 159 . Dura ' s stock

thereafter dropped from $39 .13 on February 24, 1998 , to S20.75 on February 25, 1998, an

$18.38 per share , 47% one-day decline on a volume of 32 million shares. Id. One analyst's

reaction to Dura 's announcement was that :

Our confidence in management and their credibility with us has been greatlydiminished. As recently as one month ago, we reviewed our model with theCompany line by line and were guided to higher Ceclor CD estimates . In ouropinion, not too much could have changed between now and then, and we believ ethat this revenue shortfall is not new news to Dura, but frankly, comes as a surpriseto us .

Id .

Dura's business performed poorly during the balance of 1998. Id. ¶149 , 160. Sales o f

Ceclor CD fell to only S30 million . Id. 1 49 . In an Ap ri l 16, 1998 conference call with analysts ,

I Dura admitted that, at least by December 1997, the wholesale channels had been clogged wit h

many months of excess Ceclcr CD inventory. Id. ¶$ 49, 160 .

After the Class Period ended , in April 1998, Dura placed an advertisement in Advancefor

Managers of Respiratory Care regarding Albuterol Spiros . Id. ¶ 161 . On April 30, 1998, the

FDA sent Dura a letter of rebuke stating that. "the journal ad is in violation of the Federal Food,

Drug , and Cosmetic Act (the "Act') and its implementing regulations, because it promotes an

unapproved drug by making claims of safety and efficiency that have not been demonstrated by

substantial evidence (i .e. adequate and well -controlled studies ) ." Id. ¶ 162 .

28 11 In September 23, 1998, Dura disclosed that it had submitted additional chemistry and

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manufacturing control information requested by the FDA in support of the original New Drug

Application ('NDA"), thus finally revealing the long-known problems with the device . Id. IN

46, 163 . Dura also conceded that the Albuterol Spiros launch date had slipped to second quarter

1999. Id . In response to this announcement, Dura's stock price declined 28% from S 15 .25 on

September 23, 1998 to $10 .00 on September 25, 1998 . Id.

On November 4, 1998, Dura was forced to report that the FDA had rejected the A1butero l

Spiros NDA because the Spiros device was not reliable due to its unacceptably high failure rate

and because Dura had provided insuf ficient data to demonstrate Albuterol' s stability . Id. ¶T 47,

164. Defendants stated in a press release that the FDA "raised no issues on the clinical data with

the inhaler filed in the NDA demonstrating therapeutic comparability of Albuterol pirosTM with

Ventolin® (albuterol ) MDI using standard lung function measures ." Id. In response to this

disclosure , the Company' s stock price declined 21 % from $ 12.50 to $9.34 ❑n November 3, 1998 .

Id.

On November 6, 1998, the FDA issued a "Notice of Violation" to Dura , stating that

Dura's press release sent a message that "misleadingly minimizes the fact that Dura must

conduct a completely new clinical data [study] ." Id ¶¶ 48, 165 . Dura removed the press release

from the website, but did not publicly disclose the November 6, 1998 letter of rebuke until

December 4, 1998 . Id. When the FDA's letter was finally disclosed, Dura's stock price

declined an additional 13% from $12,56 to $10.50 . Id. Ultimately, Dura completely abandoned

the development of the Spires device for use with Aibuterol because Dura could not overcome

the reliability and stability problems . Id. 11 5 0, 165 .

Plaintiffs filed several class actions alleging violations of §§ 10(b) and 20(a) of the

Securi ties and Exchange Act and Rule 10 h- 5 promulgated by the Securities and Exchange

Commission. The cases were consolidated into the instant case number . By order dated July 12,

2000, this Court granted Defendants' motion to dismiss the Consolidated and Amended

Complaint, and dismissed the pleading without prejudice . Plaintiffs subsequently filed a Second

Consolidated Amended Complaint . This Court dismissed the Second Consolidated Amende d

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Complaint . In relevant part', this Court held that Plaintiffs had not adequately alleged los s

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I causation as to the misrepresentations regarding Albuterol Spiros .

This Court further found that Plaintiffs' allegations regarding Ceclar CD sales were

insufficient because "[t]he mere fact that intraqua rterly results lagged behind internal projections

does not, without more , require disclosure ." Glassrnan v. Computervision Corp., 90 F .3d 617,

631 (1st Cir. 1996) . The Court also held the Complaint ' s allegations regarding Ceclor CD were

conclusory because although Plain tiffs alleged the Company was shipping amounts of the

product "well in excess of the amount justified by or necessary to keep pace with current

prescription levels and thus Dura had created vastly excessive amount of inventory of Ceclor CD

in the distribution channel," the Second Consolidated Amended Complaint did not provide any

factual support on how Defendants knew at the time the dis tribution channels were clogged .

Rather, Plaintiffs alleged that after the Class Pe riod ended, Dura admitted there was excessive

inventory of Ceclor CD . This Court also held the Second Consolidated Amended Complaint's

allegations regarding scienter were deficient , analyzing each basis for scienter individually .

On appeal, the Ninth Circuit reversed . The appellate court held that Plaintiffs had in fac t

adequately pled loss causation because it was sufficient that they allege the stock price was

inflated at the time of purchase because of Defendants' fraud . Broudo v. Dura Phar r ., Inc.,

339 P.3d 933, 938-39 (9th Cir . 2003). The Ninth Circuit agreed with this Court and found

deficient Plaintiffs' allegations of scienter based on: (1) the existence of reports showing Ceclor

CD sales were below internal projection ; (2) stock sales ; and (3) channel stuffing. However,

after this Court dismissed the Second Consolidated Amended Complaint, the Ninth Circuit held

that courts must also look at scicnter allegations collectively . No. 84 Employer- Teamslee J1.

Council Pension Trust Fund v. ,4m . W. Holding Corp., 320 F.3d 920, 938 (9th Cir. 2003) . The

plinth Circuit thus vacated this Court's finding of no scienter and instructed this Court to

perform the final step of considering Plaintiffs' allegations collectively when conducting its

` The Second Consolidated Amended Complaint alleges Defendants misrepresented theeffectiveness of its sales force , the sales and success of its product Rondec, and the sales ofNasalide . The TAC does not rely on those alleged misrepresentations .

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scienter analysis . Broudo, 399 F.3d at 940. Finally, the Ninth Circuit held this Court should

have allowed Plaintiffs to amend the complaint to include, inter alia, statements by a

confidential witness who has direct knowledge that at least two of the Defendants discussed how

they could make stock analysts "perceive" that Dura was doing letter than it actual Iy was and

that one of the Defendant's oft-stated catch phrase to employees who questioned his tactics was

"let `em catch us." Id. at 941 . The Ninth Circuit held that "i[s]uch allegations are the type that

could demonstrate a strong inference that Dura knowingly or with deliberate recklessness made

false or misleading statements to investors ." Id.

The United States Supreme Court agreed to hear the loss causation issue . Last year, the

Supreme Court reversed the Ninth Circuit and held that an inflated purchase price by itself does

not constitute or proximately cause the relevant economic loss needed to allege and prove "loss

causation." Dura Pharms., Inc. v. Eroudo, 544 U.S. 336, 345-46 (2005) . The Court held that a

securities fraud plaintiff must allege and prove that a defendant's misrepresentation or other

fraudulent conduct proximately caused the plaintiff's economic loss, and thus must provide

defendants with notice of what the relevant economic loss might be and the causal connection

between the loss and the misrepresentation . Id. at 346 . The Court further held that Plaintiffs'

Complaint did not adequately plead loss causation . Id . at 346-47 .

The Ninth Circuit subsequently remanded the case to this Court for further proceedings ,

I and directed that Plaintiffs be given an opportunity to amend their complaint, inter alia, in a

manner that complies with the Supreme Court 's requirements for loss causation .

APPLICABLE LAW REGARDING MOTIONS TO DISMISS

SECURIT IES CLASS A TI N

A motion to dismiss under Federal Rule of Civil Procedure 12(b)(6) tests the sufficiency

of the complaint . Navarro u. Block, 250 F.3d 729, 732 (9th Cir . 2001). Dismissal of a claim

under this rule is appropriate only where "it appears beyond doubt that the plainti ff can prove no

set of facts in support of his claim which would entitle him to relief ." Conley v, Gibson, 355

U.S , 41, 45-46 (1957) ; avarro, 250 F.3d at 732. In reviewing a motion to dismiss under Rule

12(b)(6), the court must assume the truth of all factual allegations and must construe them in the

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light most favorable to the nonmoving party. Thompson v. Davis, 295 F .3d 890, 895 (9th Cir .

2002) ; Cahill v. Liberty Mut. Ins. Co., 80 F3 d 336, 337-38 (9th Cir . 1996). However, legal

conclusions need not be taken as true merely because they are cast in the form of factual

allegations . Roberts v. Corrothers, 812 F.2d 1173, 1177 (9th Cir . 1987) ; Western Mining

Council v. Watt, 643 F .2d 618 , 624 (9th Cir. 1981) .

Sec tion 10(b) of the Securities Exchange Act of 1934 makes it unlawful to use i n

~ connection with the mails or facilities of interstate commerce any " manipulative or deceptive

device or contrivance in contravention of such rules and regulations as the Commission ma y

prescribe ." 15 U .S.C. § 78j(b) . SEC Rule lOb- 5, promulgated under section 10(b), provides :

It shall be unlawful for any person, directly or indirectly, by the use of anymeans or instrumentality of interstate commerce, or of the mails or of any facilityof any national securities exchange ,

(a) To employ any device, scheme, or artifice to defraud,

(b) To make any untrue statement of a material fact or to omit to state amaterial fact necessary in order to make the statements made, in the light of thecircumstances under which they were made, not misleading, or

(c) To engage in any act, practice, or course of business which operates orwould operate as a fraud or deceit upon any person, in connection with thepurchase or sale of any security .

17 C.F .I . § 240.lOb-5 . The elements of a Rule lOb-5 claim are . (1) a misrepresentation or

omission of a material fact; (2) scienter ; (3) causation ; (4) reliance ; and (5) damages . In re Daau

Sys., Inc. Sec. Litig., 411 F.3d 1006, 1014 (9th Cir. 2005), cert. denied, U .S. , 126 S .Ct .

1335 (2006).

Claims brought under Rule IOb-5 and § 10(b) must meet Federal Rule of Civil Procedure

9(b)'s particularity requirement that "[iln all averments of fraud or mistake, the circumstances

constituting fraud or mistake shall be stated with particularity ." Fed. R. Civ . P. 9(b) ; see Dauu,

411 F.3d at 1014 ; Yourish v. Cal . Amplifier, 191 F.3d 983, 993 (9th Cir . 1999). In addition, in

1995, Congress enacted the PSLRA and altered the pleading requirements in private securities

fraud litigation by requiring a complaint "`plead with particularity both falsity and scienter."'

Daou, 411 F .3d at 1014 (quoting Gompper v. VJSX Inc., 298 F.3d 893, 895 (9th Cir. 2002)).

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When the plaintiff alleges the defendant either (1) made an untrue statement of materia l

fact or (2) omitted to state a material fact necessary to make statements made not misleading, the

PSL1 A requries the complaint to "`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." Davu, 411 F .3d at 1014 (quoting Gorpper, 298 F.3d at

895). Second, regarding scienter, the PSLRA requires the complaint to "state with particularity

facts giving rise to a strong inference that the defendant acted with the required state of mind."

15 U.S .C. § 78u-4(b)(2) ; Daou, 411 F. 3d at 1014. Scienter is defined as "a mental state

embracing intent to deceive, manipulate , or defraud ." Ernst & Ernst v. Hochfelder, 425 U, S .

185, 193 n .12 (1976) .

The Ninth Circuit `incorporate [s] the dual pleading requirements of §§ 78u-4(b)(1) and

(b)(2) into a single inquiry, because falsity and scienter are generally inferred from the same set

of facts." In re Read Rite Corp . Sec. Litig., 335 F.3d 843, 846 (9th Cir. 2003) ; Ronconi v.

Larkin, 253 F .3d 423, 429 (9th Cir. 2001). Thus, when evaluating whether a private securi ties

fraud complaint survives a motion to dismiss, the court "must determine whether particular facts

in the complaint, taken as a whole, raise a strong inference that defendants intentionally or [with]

deliberate recklessness made false or misleading statements to investors ." Ronconi, 253 F.3d at

429 (internal quotations omitted) ; accord Read Rite, 33$ F .3d at 846. "The requirement to plead

all the facts with particularity means that a plaintiff must provide a list of all relevant

circumstances in great detail ." Read Rite, 335 F .3d at 846 (internal quotations omitted) ; In re

Silicon Graphics Inc . Sec. Lifig., 183 F.3d 970, 984 (9th Cir. 1999). "To meet this pleading

requirement, the complaint must contain allegations of specific contemporaneous `statements or

conditions' that demonstrate the intentional or the deliberately reckless false or misleading

nature of the statements when made." Ronconi, 253 F.3d at 432 ; accord Read Rite, 335 F .3d at

846. In determining whether plaintiffs have adequately pled scienter, courts must consider

"`whether the total of plaintiffs" allegations, even though individually lacking, are sufficient to

create a strong inference that defendants acted with deliberate or conscious recklessness ."' Am .

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W, 320 F.3d at 938 (quoting Lipton v Pathogenesis Corp., 284 F.3d 1027, 1038 (9th Cyr .

2002)) . When conducting this analysis, the court must consider all reasonable inferences,

whether or not favorable to the plaintiffs . Daou, 411 F.3d at 1022 . "There pleadings are not

sufficiently particularized or where, taken as a whole, they do not raise a `strong inference' that

misleading statements were knowingly or [with) deliberate recklessness made to investors, a

private securities fraud complaint is properly dismissed under Rule 12(b)(6) ." Ronconi, 253

F .3d at 429 ; accord Read Rite, 335 F.3d at 846 .

SUFFICIENCY OF THE ALLEGATIONS O F

VIOLATIONS OF § 10(R) AND RU LE 1OB-5

Plaintiffs contend Defendants misrepresented the Company' s sales and busines s

performance throughout the Class Period and thereby inflated Dura's stock price . In particular,

Plaintiffs maintain Defendants made material misrepresentations and omissions regarding the

development of its Albutcrol Spiros product and the sales of Ceclor CD .

1. Albuterol Spiros

A. Allegations Regarding Albuterol Spiros

Plaintiffs allege that, as reported by analysts, Dura's Albuterol Spiros was an importan t

development for the company. (TAC IV 97, 125.) According to Plaintiffs, Dura made numerous

misrepresentations regarding Dura"s Albuterol Spiros drug delivery technology . Specifically,

Plaintiffs contend Dura's 1996 Annual Report, which was issued on April 15, 1997, stated the

device was a durable system, and touted the benefits of this product. (TAC 9 74.) A press

release issued that day reported better-than-expected IQ 1997 results and stated the Company

was continuing to develop its Albuterol Spiros product, Id. 175 . As a result of these

announcements , Dura's stock rose over 21 % from $27 .87 on April 14, 1997 to $34 an April 15,

1997 . Id. ¶ 76.

On April 15, 1997, Oppenheimer & Company, Inc . ('Oppenheimer"), Alex. Brown,

I Robertson Stephens & Co . ("Robertson Stephens"), and William Blair & Co . ("William Blair" )

issued reports on Dura and the development of Spiros. Id. 195 . These reports were based on

and repeated information provided in : (1) an April 15, 1997 conference call with secu rities

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analysts in conjunction with the 1996 Annual Report and press release ; and (2) in follow-up

conversations with Garner or Newman. Id . These reports stated that Spiros' development was

on track and Dura would soon be completing clinical trials . Id. Shortly thereafter on April 25,

1997, Oppenheimer issued a report on Dura based on and repeating information concerning

Dura's Spiros development provided in conversations with Garner and Newman that stated

Albuterol Spiros would be submitted to the FDA before the end of the year, Id . $ 96. On April

28, 1997, UBS Securities ("UBS") issued a report on Dura that was based on and repeated

information provided in conversations with Dura executives, including Garner or Newman, that

stated Spiros was allowing Dura to differentiate itself from a typical marketing company and the

Company would become more "fully integrated" through the development of the Spiros inhaler .

Id. 197 . The report also stated that the Company would file an NDA with the FDA in the

second half of 1997 and expected it to be approved in the second half of 1998, with Spiros

revenues adding about $58 million to Dura's current sales base in 1999 . Id. Between May 7 to

May 9, and on May 30, 1997, Vector Securities International ("Vector"), IJBS, and William

Blair issued similar reports stating that Dura was still on track to submit its first Spiros NDA

filing in the second half of 1997 . Id. 11 9 8-99 . On May 30, 1997, Alex . Brown and Vector also

reported that Dura would file its NDA for Albuterol Spiros in the second half of 1997 that could

add $100 million in revenues by 2000. Id. N 99.

Plaintiffs maintain Dura's June 5, 1997 press release announcing the completion of

clinical trials necessary for an NDA submission for Albuteral Spires was false and misleading .

Id. 11 100-01 . In that release, David S. Kabakoff, Dura's Executive Vice President and

President and CEO of Spiros Corp . stated Dura was pleased with the results to date and was

preparing the NDA for filing in the latter half of 1997 . Id. 11 100. On June 30, 1997, William

Blair reported that Newman had stated at an investment conference that Dura planned to file the

Albuterol Spiras NDA by fall of 1997 and that the Company was continuing to develop the

Spires product line aggressively . Id. ¶ 103 .

On July 15, 1997, Dura reported better-than-expected Q2 1997 results in a press release ,

I and reiterated that the Company was on track to file the Albuterol Spires NDA in the second hal f

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of 1997 . Id.1 106 . Also on that date, five analysts issued reports on Dura that were based on

and repeated information provided in a conference call and in follow-up conversations with

Garner and Newman , Id. I 115 . The analysts reported Dura was on track to file the Albuterol

Spiros NINA in the second half of 1997 , that Albuterol Spiros could be on the market in late

1998 with initial sales of $10 million growing to over $ 55 million by 2000, and that Albuterol

Spiros would contribute signi fi cantly to Dura ' s long -term revenue and ea rn ings growth. Id .

On July 25, 1997, Dura sold $287 .5 million in convertible notes . Id. $ 123. In August

1997, analysts issued reports on Dura that were based on and repeated information from Garner

and Newman stating that Spires possessed significant advantages over alternative inhalers

currently marketed or in development, and the launch of Albuterol Spiros in the second half of

1998 would be a watershed event for the Company . Id. $T 124-25 . Analysts issued similar

positive reports in September 1997 based on discussions with Garner and Newman . Id . 1 126.

On October 8, 1997, Dura reported at the UBS Life Science Conference that the NDA filing for

Albuterol Spiros was expected within days. Id.1 127 . On that day, UBS issued a report that

reiterated this information . Id. lj 128.

On these announcements , Dura 's stock rose 7.7% to $52 .25 - its then all-time hig h

price. Id.1 129. On October 10, 1997, Dura announced it was going to exercise its option to

buy Spiros for $45 .7 million and then take Spiros public . Id. The public sale included one

common share of a new company, Spiros II, as well as a warrant to buy one-fourth of a share of

Dura common stock. Id. The initial public offering was expected to raise between $75 million

and $86.25 million . Id . Dura said it would contribute some technology and technology rights, as

well as $75 million cash to Spiros II prior to the IPO . Id .

In mid-October , Dura reported better - than-expected Q3 1997 results . Id. 1 13 1 . Plaintiffs

contend that in a conference call and follow-up conversations with analysts , Defendants

reiterated that the NDA for AIbutercl Spiros would be filed in November 1997, and continued to

tout the significance of Albuterol Spiros on the Company's future revenues . Id. ~¶ 132, 142 . On

November 10, 1997 , Dura announced in a press release that it had submitted an NDA for

Albuterol Spiros with the FDA. Id. ¶ 143 . On December 17, 1997, Dura and Spiros II sold 5 . 5

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million Spires II units at $16 per unit , raising $88 million in needed new capital . Id. 1 144.

Each unit sold consisted of one share of callable common stock of Spiros II and one warrant t o

purchase one-fourth of one share of Dura common stock. Id_

On January 20, 1998, Dura reported better-than-expected Q4 results via a press release .

Id.1 149. After Dura reported better-than-expected Q4 1997 results, analysts issued reports

based on conversations with Gamer or Newman that stated Dura expected the FDA to approve

Albuterol Spiros by the end of 1998 . Id. ¶ 156-57 . The analysts further reported Dura expected

to launch Albuterol Spiros by early 1999, and that the product would be a significant portion of

the company's revenue. Id. T 156 .

Plaintiffs contend that contravening their public praise for the Spiros technology ,

Defendants knew since the fall of 1996 that there were serious reliability problems with the

Spiros device and stability problems with Albuterol . Id. ¶¶ 8, 9, 94. According to Plaintiffs, in

October 1996, Robert Eisele, Vice President of Product Development, documented these

problems in a list that was contained in a five to six page document setting forth necessary items

to he addressed before an NDA could be properly submitted . Id. ¶¶ 9-10, 94, 121 . Before Phase

III clinical trials began, Dura devised in-house experiments to test the efficacy of Albuterol

Spiros at certain temperatures and humidity levels . Id. ¶~ 11, 91 . Th is testing revealed

unacceptable levels of reduced efficacy when AIbuterol was exposed to humidity . Id .

According to Plaintiffs, Dura's own engineers objected to pursuing Phase III clinical trials

because of Albuterol Spiros's reliability and stability problems . Id. 119, 12. Dura was unable to

fix the problems prior to commencing Phase III clinical trials, and thus started Phase III clinical

trials with versions of Albuterot Spiros that had these defects and, in fact, changed the device

during clinical trials . Id. 1¶ 15, 90, 93, 117, 120 . The configuration of the product Dura used to

conduct clinical trials was unreliable and plagued by significant electro-mechanical problems ;

over 30% of the inhalers failed . Id .1J 13-14, 23, 90, 92, 117, 119 .

According to Plaintiffs, Defendants knew, based on their prior experience with the FD A

and the medical device industry, that the FDA would not approve an N DA for an unreliable

product and unstable drug . Id. ¶'192, 119 . Industry standards dictated that an NDA not be filed

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unless the early return rate was I% or less . Id . $1 13, 92, 119 . As a result of the inhaler's

reliability problems during Phase III clinical trials, Dura began making modifications to the

inhalers actually being used in the ongoing clinical trials to improve reliability . Id. IT 15, 90, 93

117, 120. Plaintiffs allege all modifications to the device were documented within the clinical

trial results and that senior management, including Defendant Prettyman, as Senior Vice

President of Regulatory Affairs, had to sign off on proposed modifications before they could be

made. Id. %T 16, 93, 120. Dura knew this would invalidate the Phase III clinical trials . Id.

18, 90, 117 .

Plaintiffs contend senior executives were so concerned about the inhaler's reliabilit y

~ problems that Dura retained an outside testing facility , Wyle Labs, to conduct highly accelerate d

life tests ("HALT") on the device while Phase III clinical trials were still ongoing. Id. $T 18 ,

146 . HALT are extreme condition tests designed to identify potential operational failures . Id .

Plaintiffs allege Defendants Garner, Prettyman, Spath, Woodbury, and Brown were

informed during an executive management meeting held every Monday from 8 :00 to 10:04 a. m .

of the problems encountered during the Phase III clinical trials and of Albuterol's stability

problems . Id. ¶j 92, 119. Further, Defendants Garner and Prettyman attended weekly Research

and Development meetings during which the Spiros device development team presented Phase

III clinical trial results and stability test results, and informed Garner and Prettyman that over

30% of the inhalers failed during clinical trials . Id. ¶J 11, 92, 102, 119. Minutes were also

generated from these meetings and circulated to senior management . Id. 1¶ 11, 17, 92 .

Plaintiffs aver that senior management at Dura "were kept constantly informed of th e

problems affecting the inhaler's reliability via product reports prepared by Mike Ligotke, the

Senior Product Engineer for the Spires device and Linda Gieschen, the Spiros Project Leader ."

Id. ¶ 17. These reports also contained information regarding the different configurations of the

inhaler, the different tests being performed, and the results cf those tests . Id . The reports were

prepared for and circulated in advance of and during weekly research and development meetings

attended by senior management . Id .

Plaintiffs contend that in addition to concealing the problems with Albuterol Spiros' s

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development , the Defendants concealed a pre-NDA filing meeting Dura conducted with the

FDA in May 1997. Id. ¶j 24, 101, 122 . By the time that meeting occurred , Dura had completed

clinical trials , and had received 95% of the data from the trials concerning chemical instability,

doser reliability and failure rates . Id . 1 24 . At that meeting , which included Garner and

Prettyman , the FDA raised concerns regarding the Spiros device's reliability and with

Albuterol ' s stability . Id. 11 25, 101, 122 .

Plaintiffs further contend there was internal dissension among Defendants whether to fil e

the NDA for the Spiros device . Id. ¶T 12, 28, 145 . In late October or early November 1997, a

meeting was held to discuss the NDA filing . Id. Defendants Garner and Prettyman attended,

and Prettyman made it clear that he did not want to file the NDA for which his department,

Regulatory Affairs, was responsible, because he knew based on his p rior experience that the

NDA would not be approved by the FDA. Id. ¶"J 28, 145. Despite this , he was overruled and

Dura filed the NDA on November 10, 1997 . Id.

B. Adequacy of The TAC's Allegations

Defendants present several challenges to the TAC' s allegations regarding Albutero l

Spiros. Defendants contend Plaintiffs fail to state a claim because they do not adequately plead

loss causation, and because the TAC does not plead falsity and scienter with particularity.

Defendants further contend that most of the statements alleged to be misleading are mere

"puffery" or protected by the PSLRA's safe harbor provision or the bespeaks caution doctrine .

Defendants also contend they cannot be held liable for statements made by third-party analysts .

1 . Loss Causation

One of the elements of a Rule Ob-5 cause of action that a Plaintiff must plead and prove

is loss causation . 15 U.S .C. § 78u-4(b)(4) ; Dura, 544 U.S . at 341 . As noted above, this Court

dismissed the Second Consolidated Amended Complaint' s allegations regarding Albuterol

Spiros on the basis the pleading did not adequately plead loss causa tion . The Ninth Circuit

reversed on this issue , and the Supreme Court reversed the Ninth Circuit, holding that securities

class action plaintiffs must allege that the misrepresentations proximately caused the plaintiffs'

economic loss . The Supreme Court's decision did not create a heightened pleading standard fo r

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loss causation: the Court noted its holding did not affect Rule 8(a)(2)'s applicability . Dura, 544

U.S . at 346. The Ninth Circuit remanded this case to this Court to allow Plaintiffs an

opportunity to amend the complaint in conformity with the Supreme Court's decision . The TAC

now alleges that Defendants' misrepresentations regarding Albuterol Spiros artificially inflated

Dura's stock price, (TAC 174-76, 95-100, 103, 105-06. 115, 125-29, 132-33, 142-43, 15G-57),

Defendants made corrective disclosures regarding Albuterol Spiros' stability and functionality

on September 23, 1998, November 4, 1998, and December 4, 1998, and the resulting stock drop

on those dates.' (TAC 159, 163-65, 183-98, 204 .)

Defendants contend Plaintiffs are impermissibly trying to expand the Class Period

through to December 4, 1998, but they are barred from doing so by the applicable statute of

limitations. The statute of limitations for this type of claim is one year after the discovery of the

facts constituting the violation and within three years after such violation . 15 U .S .C. § 78i(e) .

Defendants state Plaintiffs were on notice of the events and stock price declines that occurred on

September 23, November 4, and December 4, 1998 when they filed their action, but they

strategically elected to end the Class Period on February 24, 1998 . Defendants state the statute

of limitations has run regarding these newly added claims and they do not relate back to the

original complaint as the Plaintiffs who allegedly held stock on these three dates do not have an

identity of interest with the original Plaintiffs, whose claims and alleged damages were

associated with the 47% price decline that occurred between February 24, 1998, and February

25, 1998.

The Court is not persuaded by Defendants' arguments . First, Defendants' statute o f

limitations argument is premised on the assumption that Plaintiffs have added claims or clas s

mernbers , or attempted to expand the Class Period . A review of the TAC, however, reveals that

Plaintiffs are not attempting to expand the Class Period or add new class memhers . Rather, the

The TAC also alleges that the February 24, 1998 announcement somehow caused lossesassociated with the misleading information about Albuterol Spiros' approvability . Defendantscontend this allegation does not meet Dura's standard of proximate cause because nowhere inthe February 24, 1998 announcement is there any indication of Spiros' mechanical or reliabilityproblems. Plaintiffs do not attempt to defend this allegation in their opposition to the motion todismiss .

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TAC explains, in accordance with Dura, the causal relationship between Defendants' allegedly

fraudulent statements and the decline in stock price . The earlier complaint focused on the drop

in stock price following Dura's February 24, 1998 announcement, and failed to explain how the

misrepresentations regarding Albuterol Spiros touched upon the reasons for the decline in price .

But in the TAC, Plaintiffs allege that those who purchased shares during the Class Period and

held the stock on September 9, 1998, November 4, 1998, and December 4, 1998 suffered a loss

when information was revealed on those dates showing the Defendants had misrepresented the

development of Albuterol Spiros . Thus, they have explained how the misrepresentation s

regarding Albuterol Spiros proximately caused economic loss on those dates . Under the liberal

pleading requirements of Rule 8(a), these allegations are sufficient to meet the loss causation

requirement .

defendants next argue that Plaintiffs have cited no authority that allows them t o

manipulate the class claims by linking Class Period purchasers with losses associated with

various events and disclosures that occurred after the close of the Class Period . Defendants state

plaintiffs are essentially creating a "holder class" through December 4, 1998, which is

impermissible . Defendants are correct that "holder classes" are not entitled to sue under Section

10(b). Williams v . Sinclair, 529 F .2d 1383, 1389 (9th Cir. 1975). However, an improper "holder

class" is comprised of individuals who "neither purchased nor sold shares in reliance upon the

alleged misrepresentations or concealments." Id. In this case, the TAC alleges that Plaintiffs

purchased Dura's shares in reliance on, inter afia, Defendants representations regarding the

Company's development of Albuterol Spiros . Accordingly, none of the Plaintiffs constitute a

"holder class."

Defendants next argue the securities laws contemplate that the losses for which plaintiffs

seek recovery arc those occurring during the class pe ri od, not months or years beyond its

termination . In suppo rt, Defendants quote cases where district courts indicate a plaintiff 's loss

occurs during the class period . (Defs .' Mot. To Dismiss at 20, citing In re Portal Software, Inc.

Sec. Litig., No. C-03-5138-VRW, 2005 WL 1910923 , at * 16 (K D . Cal . Aug . 10, 2005), In re

Surebeam Corp. See. L itig., No. 03CV1721, 2003 U .S . Dist . LEXIS 25022, at *23 (S .D . Cal .

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Jan . 5, 2004); Aronson v. McKesson HROC, Inrc , 79 F . Supp . 2d 1146-1157-58 (N .D. Cal .

1999), In re Kirschner Med. Corp . Sec. Litig., 139 F.R.D. 74, 81-82 (D . Md. 1991)) . Kirschner

states a class period cannot extend beyond the date curative information was effectively

disseminated to the market . Kirschner, 139 F.R.D. at 81 -82 . However , neither Kirschner nor

any of the other cases the parties cite address whether a secu rities fraud claim is barred as a

matter of law when the corrective disclosures occur several months after the class period ends .

There is some appeal to requiring a corrective disclosure to occur at the end of the clas s

period. For instance, in this case, those who purchased Dura's stock after the Class Period ended

and suffered losses when the truth about Albuterol Spiros was revealed are, as Plaintiffs' counsel

stated in oral argument, "out of luck ." Although those purchasers suffered losses as a result of

Defendants' alleged misstatements and omissions regarding Albuterol Spiros, they will not

receive any compensation as their interests are not represented in this lawsuit . A rule requiring

the corrective disclosure to immediately follow the and of the Class Period would ensure such

purchasers' interests are protected . Nevertheless, the Court finds the authority Defendants cite

insufficient to impose such a requirement . When presented with this case, the Supreme Court

could have held that as a matter of law Plaintiffs cannot establish loss causation because the

corrective disclosures regarding Albuterol Spiros were made several months after the Class

Period ended . The Supreme Court did not so hold, and instead only required the Plaintiffs to

properly allege a causal connection between the economic losses suffered and the Defendants'

misrepresentations . Dura, 544 U .S. at 346-47 .

Finally, Defendants argue that Plaintiffs ' theory cannot be squared with other provision s

of the PSLRA, such as the "look-back" provision codified at 15 U .S .C . § 78u-4(e)(1), which

provides for an upward limitation on damages in a Section 14 (b) securities case . As Plaintiffs

point out , however, that statutory provision does not measure damages based on the end of the

class period . Rather , the PSLRA requires damages be calculated from the date the truth is

revealed: in other words , the damages are limited to "the mean trading pri ce of that security

during the 90-day trading period beginning on the date on which the information correcting the

misstatement or omission that is the basis for the action is disseminated to the market ." 1 5

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U.S.C. § 78u-4 (c)(1) .

In sum , the Court concludes the TAC adequately alleges loss causation regarding

Defendants ' alleged misstatements and omissions regarding Albuteral Spiro s ,

2 . Falsity and Scienter

Defendants maintain the TAC does not adequately allege falsity and scienter because

there are no factual allegations establishing a strong inference that, when reporting on the Spiros

clinical trials and the anticipated filing of the NDA, the Defendants knew that the Spires product

had defects that would delay or prevent FDA approval, or knew that any such defects could not

be corrected in a manner to allow for such approval . Defendants also challenge these allegations

an the basis Plaintiffs fail to state with particularity the facts upon which their allegations are

based .

Plaintiffs do not contend the TAC is based on their personal knowledge . Accordingly, the

TAC is plead on "information and belief." In the Ninth Circuit, a securities fraud complaint

based on information and belief has to "state with particularity all facts on which [a] belief is

formed," and in so doing, the plaintiff must reveal "the sources of her information ." Silicon

Graphics, 183 F.3d at 985 (citation and internal quotation marks omitted) ; accord Duou, 41 1

F .3d at 1015 . When the source of a plaintiffs information are internal reports, the plaintiff must

allege specifics regarding those reports : the sources of the plaintiff's information with respect to

the reports, how the plaintiff learned of the reports, who drafted the reports, which officers

received them, and the contents of those reports . Silicon Graphics, 183 F.3d at 985 . If a

plaintiff relies on the accounts of confidential witnesses, the complaint must describe such

personal sources "`with sufficient particularity to support the probability that a person in the

position occupied by the source would possess the information alleged . 7" Nursing Horne

Pension Fund, Local 144 v. Oracle Corp., 380 F.3d 1226, 1233 (9th Cir . 2004) (quoting Novak

v. Kasaks, 216 F.3d 300. 314 (2d Cir. 2000)) . An assessment of the reliability of witnesses

"`involves an evaluation, inter ofia, of the level of detail provided by the confidential sources,

the corroborative nature of the other facts alleged (including from other sources), the coherence

and plausibility of the allegations, the number of sources, the reliability of the sources, an d

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I similar indicia ."' Dacu, 41 1 F.3d at 1015 (quoting In re C'abletron Sys., Inc ., 311 F . Id 11, 29-

1 30 (1st Cir . 2002)) .

As an initial matter, the TAC does not identify any confidential witnesses as the source of

Plaintiffs' information regarding Dura's problems with Albuterol Spiros and the purported

fraudulent efforts to conceal those problems from the market. Instead , the TAC's allegations

regarding Alhuterol Spiros rely heavily on internal reports that purpo rtedly documented all the

problems with the inhaler 's development . The TAC discusses with some detail the Eisele List

that was prepared in October 1996 by Dura's Vice President of Product Development , and which

included a list of problems with the Spiros drug delivery system and the Albuterol casse tte.

JTAC IN 9, 94, 121 .) Problems identified in the Eisele List include the reliability of the Spiros

device and stability ofAlbuterol . Id. ¶ 10 . The pleading further alleges the Eisele List was

distributed to senior management during the weekly executive management meeting held every

Monday . Id. ¶{¶ 9, 94, 121 . Although Plaintiffs do not explain how they came to learn of the

Eisele List , there are sufficient details regarding this report to indicate its reliability .

However, the TAC does not adequately describe the sources of Plaintiffs' informatio n

supporting the allegations regarding the on-going problems with the development of Albutero]

Spires and Defendants' knowledge of those problems . Plaintiffs allege Dura conducted in-house

testing before Phase Ill clinical trials began, and that the testing showed problems with the

drug's efficacy. Id. % 11, 91 . According to Plaintiffs, Defendants were kept apprised of the

testing results "via chemical stability test results and analytical reports that were circulated

during weekly product development meetings" and in minutes generated from product

development meetings . Id. 1 11 . Absent from these allegations are any details regarding who

generated the testing results and the minutes, or how Plaintiffs came to learn of these results .

The timeline regarding these allegations is also only vaguely described as before Phase III

clinical trials ; it is not clear whether this in-house testing pre- or post-dated the Eisele List .

Similarly, the TAC's allegations regarding modifications to Albuterol Spiros during

Phase III clinical trials require more specificity as to the sources of Plaintiffs ' information .

Plaintiffs contend that modifications to the inhaler "were well documented within the clinica l

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trial results and reliability reports and each tcst run on each configuration was analyzed in a

separate report. "" Id. ¶~ 16, 93 . Plaintiffs allege Senior Project Engineer Mike Ligotke and

Project leader Linda Giese-hen were responsible for drafting these reports . Id. ¶ 93 . Plaintiffs do

not allege who received these reports, when they were received, or how Plaintiffs came to learn

of those reports .

Plaintiffs next allege that Defendants were kept constantly informed of the problem s

affecting the inhaler 's reliability via product reports prepared by Mike Ligotke, the Senior

Product Engineer for the Spiros device and Linda Gieschen , the Spiros Project Leader ." Id .

17. The TAC further alleges the reports were prepared for and circulated in advance of and

during weekly research and development meetings . Id. However, absent are any allegations

regarding when these reports were generated and distributed --- whether it was during some or

all of the Class Peri od, or whether these reports were generated prior to or after the Eisele List.

Thus, it is not clear whether these are the same reports that documented modifications to the

Spiros device during Phase III clinical trials . Further, there are no allegations regarding how the

Plaintiffs came to learn of those reports.

Several of the TAC's allegations regarding Defendants ' purported knowledge of

problems plaguing Albuterol Spiros and fraudulent intent are not attributed to any source . For

example, the TAC's allegations regarding internal dissent over whether to proceed with clinical

trials or file the NDA are not supported by references to internal documents or confidential

witnesses . Also absent is the source(s) of Plaintiffs' information regarding Dura's decision to

retain Wyle to conduct HALT . Similarly, the TAC does not identify the source of Plaintiffs '

al legations regarding the, weekly executive management meetings conducted every Monday from

8:00 to 10 :00 a.m . and Research and Development meetings . The absence of such allegations

are significant because the crux of Defendants' malfeasance comes from their decision to forge

ahead with clinical trials and the NDA submission notwithstanding their inability to remedy the

problems identified in the Eisele List .

For these reasons, the TAC 's allegations regarding Spires must be dismissed- The Court ,

however, will allow Plaintiffs leave to amend the complaint so they can describe the sources of

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their information in accordance with Silicon Graphics, Daou, and Nursing Home. Because the

Court finds the TAC does not adequately allege the sources of Plaintiffs ' information , it declines

to address Defendants' remaining challenges to these allegations at this time.

II . Ceclor CD

A. Allegations Regarding Ceelor CD

Plaintiffs contend that Defendants misrepresented and omitted critical information

regarding Dura's sales of Ceclor CD. Specifically, Plaintiffs allege that on April 15, 1997, Dura

announced in a press release better-than-expected Q 1 1997 results, stating that revenues for the

quarter totaled $40.9 million, net income was S8 .8 million, and EPS were $0 .19 - a 73 %

increase from $4.11 in first quarter 1496 . (TAC ¶ 75 .) In this release, Defendants boasted of

doubled revenues overall and singled out Ceclor CD's purported sales success and trumpeted

that Ceclor CD's "market share" of weekly new prescriptions of cefalcor had doubled from the

end of 1996. Id, Dura's stock rose over 21% from $27 .87 on April 14, 1997, to $34 on April

15, 2997 as a result of these announcements . Id. 176. Approximately two months later ,

Defendants delivered a similar message to the assembled investors and analysts at the William

Blair Investment Conference, Id. 1 103.

On July 15, 1997, Dura reported better-than-expected Q2 1997 results in a press release ,

stating that net income for the second quarter totaled S9 .3 million, or $0 .20 per share on

revenues of $43 .6 million compared to net income of S4 .6 million, or $0 .12 per share, on

revenues of $18.8 million in the second quarter that ended June 30, 1996 . Id. ¶ 106. Dura's

press release reported that Ceclor CD was well-received by physicians . Id ,

On October 8, 1997, Dura representatives appeared at the UBS Life Science Conference .

Id . 1 127, UBS thereafter reported that Dura presented compelling market share data regarding

Ceclor CD's progress in the U .S. cefaclor cephalosporin franchise, and that Ceclor registered

nearly a three-point sequential increase in market share between August and September . Id .

Shortly after the conference, Dura announced better-than-expected 3Q 1997 results, reporting

record earnings for both the third quarter and nine months year-to-date of 1997, compared to the

same period the previous year . Id.1 131 . The Company stated that net income for the third

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quarter totaled $11 .3 million, or $4 .24 per share, on revenues of $43 .3 million compared to net

income of $5.8 million, or $0 .14 per share, on revenues of $25.9 million for the third quarter

ended September 30, 1996 . Id. Dura primarily attributed the increase in revenues to growth in

sales of respiratory pharmaceuticals, which rose 91% to $36.1 million in the third quarter of

1997 compared to S 18.9 million in the third quarter of 1996 . Id. The pharmaceutical sales

growth was largely due in part to the impact of new product acquisitions and introductions, such

as Ceclor CD and Nasarel . Id. In a follow-up conference call, Vector reported Dura's

management indicated that earnings for 1998 could run in the low $1 .40's range . Id. 1132 .

On January 20, 1998 , Dura reported better-than-expected Q4 1997 results , stating

revenues were at $53 .5 million and S 181 .3 million for the quarter and the full year, respectively .

Id.1 149 . Excluding one-time charges , Dura would have had a net income of $18 .0 million, or

$0 .37 per share in the quarter, and $47.4 million , or $0.99 per share for the year, compared to a

net income of $9 .9 million, or SO .22 per share for the fourth quarter of 1996 and $24 .3 million,

or $0 . 60 per share for the full year 1996. Id. Dura also reported that its sales from

pharmaceuticals rose 89% to 5150 .5 million in 1 997 compared to $79.6 million in 1996, due in

part to product acquisitions . Id. In a press release , Garner was quoted as stating that the

Company's Ceclor CD market share of the oral solid cefaclor market rose from 8% at the

beginning of 1997 to 25% by year-end . Id.

Plaintiffs maintain these representations were false when made because sales of Ceclo r

CD were dropping throughout the Class Period . Id. ¶T 77(a), 134(a), 150. Plaintiffs attribute

the lower sales to the antibiotic's decreased use as more powerful antibiotics with fewer

significant side effects developed, the fact the drug was not covered by most managed-care

insurance, and problems with Dura 's sales force. Id. 1130-33. Actual sales of Ceclor CD fell

from 47,288 units in March 1997 (the month before the start of the Class Period) to 39,808 in

May 1997 (a month into the Class Period), and then fell to 24,797 units in July 1997 . Id. ¶j 31,

87 . According to Plaintiffs, Dura was artificially inflating its revenues and EPS by shipping

excessive amounts of Ceclor CD and other products to wholesalers, who were enticed to take

the product by price discounts, extended payment terms and/or other incentives . Id. 1134-43 ,

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77(b), 134(b), 150. Dura's sales representatives conducted "load-ins" and "fire sales" and were

instructed to "load wholesalers to the max " with Ceclor CD, pressuring them to sell even more

Ccclor CD near each quarter's end . Id.J1J 41, 77(b), 78-82 , 134(b), 150 .

B. Adequacy of The TAC's Allegation s

As with the TAC' s allegations regarding Albuterol Spiros, Defendants contend the

pleading's averments regarding Ceclor CD fail to state a claim because Plaintiffs have not

adequately pleaded the sources of their information or falsity and scienter with sufficient

particularity . Defendants also argue that many of the alleged statements about Ceelor CD were

non-actionable statements of general optimism puffery and cannot form the basis of a securities

claim . Defendants further contend they cannot be held liable for statements made by third-party

analysts .

1 . Falsity and Scienter

Defendants maintain Plaintiff s̀ have not adequately alleged falsity and scienter regardin g

Ceclor CD sales because the majority of Defendants' statements concern the growth in sales of

multiple Company respiratory pharmaceuticals, and are not confined to sales of Ceclor CD. In

addition, to the extent intern al Company projections allegedly predicted flat or declining sales,

the Company was not obligated to disclose such projections nor was such informatio n

inconsistent with statements by the Company about Ceclor CD. Defendants further contend the

allegations regarding Ceclor CD sales reports address only three time periods - March 1997,

May 1997, and July 1997 - only two of which are in the Class Period, and there are no

"specific numbers" or "percentages of decline" for the balance of the Class Period after July

1997. According to Defendants, Plaintiffs improperly attempt to plead "fraud by hindsight" by

republishing Dura's press releases and analysts' reports and repeating the same "true facts" that

Defendants supposedly "knew," without any evidentiary facts showing why that is so .

Defendants maintain Plaintiffs fail to identify any contemporaneous materials that contradict

any of Defendants' public statements . Instead, they plead boilerplate references to "sales

reports" and other internal information . Defendants argue Plaintiffs' confidential witnesses do

not provide sufficient corroborative details to establish reliability . The Court disagrees, an d

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finds the TAC adequately alleges Defendants' knowledge of Ceclor CD's decreasing sales and

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their efforts to in flate sales and earnings through "fire sales" and " load-ins ."

When analyzing the Second Consolidated Amended Complaint, the Ninth Circuit held

I that the existence of reports showing Ceclor CD sales "were below internal projections an d

Dura's knowledge of these reports, coupled with Dura ' s statements that it was pleased with sales

figures , are not specific facts that strongly suggest actual intent by Dura to mislead investors ."

Dura, 339 F . 3d at 940. The appellate court stated that i`Dura 's internal expectations could have

been aggressive and falling short of them may have been anticipated ." Id. In addition, the Ninth

Circuit stated that channel stuffing "may have some probative value insofar as the channel

stuffing was done so as to artificially inflate income, but there may also be other legitimate

reasons for attempting to achieve sales earlier ." Id. The appellate court also found the

complaint ' s allegations regarding insider trading were insufficient to establish scienter. Id .

Having carefully reviewed the TAC, the Court finds this pleading addresses th e

deficiencies in the Second Consolidated Amended Complaint identified by the Ninth Circuit .

The TAC's allegations regarding declining Ceclor CD sales and Defendants ' alleged efforts to

inflate sales through " load-ins" and "fire sales" are sufficiently corroborated by internal reports

and accounts from confidential witnesses . Although channel stuffing allegations alone may be

insufficient to establish scienter , when viewed as a whole , as this Court must , the TAC

adequately pleads a scheme by the Defendants to a rt ificially inflate EPS growth by shipping

excess amounts of product to wholesalers on the final few days of fiscal qu arters .

The TAC alleges monthly sales reports were prepared by Dura's Information Technology

Department from information obtained from IMS, a service that tracks prescription drug sales .

(TAC ¶ 111 .) The report compared actual versus planned sales of Dura's drug products, and

were prepared for and disseminated by Defendant Spath and kept Defendants apprised of Dura's

drug sales so they knew that such sales were below plan and insufficient for Dura to achiev e

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continued EPS growth.' Id. Plaintiffs do not allege how they obtained the information from the

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monthly reports . However, other allegations of the TAC corroborate Plaintiffs' theory that

Defendants misrepresented the sales of Ceclor CD for purposes of increasing Dura's stock price .

In particular , the TAC alleges the participants in the "fire sale " or "load-in" scheme :

Newman, Garner, Spath, Doug Welherer (Director of National Accounts), and Jack Strathmeyer

(National Account Manager) . (TAC ¶1 1 35, 37, 40, 43, 79, 154 .) The TAC further alleges details

of the scheme . In each quarter in 1997, about two or three weeks before a quarter's end when it

became apparent that the Company's revenues were going to fall short of estimates, Dura's

national accounts managers flew into San Diego to attend a sales meeting led by Defendant

Spath and Weiherer aimed at strategizing on deals and terms that they could offer their

respective third-party distributors as incentives to get them to take on large quantities of Ceclor

CD. I d. ¶ j 35, 78. National accounts managers dreaded the meetings because when they

occurred, they knew they would be directed to participate in what was referred to as "load-ins .,,

Id . At these meetings, Defendant Spath first made some general statements indicating that he

needed the sales reps to generate more revenue before the end of the quarter so Dura would meet

its quarterly projections . Id , Spath then left the meeting, and Weiherer got into the details of

how much in revenues the sales managers needed to generate in order for the Company to meet

the quarterly projections . Id. Weiherer then outlined specific discounts, payment extensions,

and rights of return that they should offer their respective customer accounts as incentives to

accept large orders of Ceclor CD . Id. They referred to this practice at Dura as "loading it in," a

"load-in" or a "fire sale," Id .

Defendants contend the decline in Ceclor CD sales was due to seasonal fluctuations insales of its res p iratory pharmaceuticals . In support for this statement , Defendants rely on Dura's1996 Annual Report filed on Apri l 16, 1997, and request take judicial notice of that documentunder Federal Rule of Evidence 201 . Plaintiffs oppose the request. The Court agrees withPlaintiffs that it is improper to take judicial notice of a document for the pu -rpose of proving thetruth of the document's statements. See Troy Group, Inc. v . Tilson , 364 F . Su pp. 2d 1149, 1152(C .D. Cal . 2005 ("SEC filings should be considered only for the purpose of determining whatstatements the documents contain , not to prove the truth of the documents ' contents .") (internal,potations omitted) . Accordingly , the Court declines to take judicial notice of the 1996 AnnualReport as evidence the Defendants did not commit a securities violation .

Plaintiffs do not oppose Defendants ' request the Court take judicial notice of other SECfilings . Insofar as the Cou rt has relied on those documents, Defendants ' request is GRANTED .

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The terms that were typically offered were a 6% or 12% discount on the price depending

on the volume of the order (higher volume orders received the higher percentage discount),

payment terms of 60, 90, or 120 days rather than the standard 30-day term, and would allow for

returns anywhere from three months to three years after shipment for full or half credit on the

purchase price . Id. ¶136, 41, 77(b), 79, 107(b), 134, 151 . Dura would experience 75% returns

of product sold subject to the load-ins, but still booked 100% of the revenues in the quarter the

deal was struck, and did not set aside any of the revenues as a reserve for returns . Id. ¶[ 39, 82.

The significant returns impacted the national account managers' quarterly sales bonuses . Id.

According to Plaintiffs, \ciherer, Spath, and other upper management would travel t o

meet with customer representatives at McKesson, Cardinal, Bergen Brunswig, and Dindley

Western even though these accounts technically were assigned to the national account managers .

Id. ¶ 37, 80, 151 . These customers constituted up to 60% of Dura's sales . Id. 1 4 1 . A former

national account manager recalls that "for a VP to call on a specific accounts was unheard of in

this industry" at the time, and it was well-known at Dura that Weiherer's involvement meant that

the Company was seeking to place a large "load-in" order of Ceclor CD with these customers .

!d. 180 .

The Plaintiffs rely on confidential witnesses for these allegations; in particular, a former

national accounts manager and a former Dura Regional Sales Director . Defendants contend

these descriptions are insufficient to meet the Ninth Circuit's particularity requirements

regarding confidential sources, and points to this Court's decision in Alaska Elec. Pension Fund

v. Adeceo S.A ., 371 F. Supp. 2d 1203 (S.D. Cal . 2005). In Adecco, this Court found the bald

allegation that a "former executive' provided information to be deficient . Adecco, 371 F. Supp .

2d at 1211 . There were no facts pled in the complaint regarding the witness' s duties, when the

executive worked at the company, or how the executive would have come to learn of the facts

attributed to him or her. See id.

Having reviewed the TAC, the Court agrees with Defendants that the former Dura

Regional Sales Director is not adequately described . In Daou, for example, the Ninth Circui t

found the complaint met the PSLRA's requirement for confidential witnesses because those

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witnesses were described with great specificity : plaintiffs numbered each witness and desc ribed

his or her jo description and responsibilities . Davu, 411 F.3d at 1016. In contrast, here, there

arc no allegations regarding the job duties of the former Regional Sales Director or how that

individual was privy to the information attributed to him or her . For example , the TAC alleges

the former Regional Sales Director "confirmed that Dura management , including Gamer and

additional defendants, met at the end of November or early December 1997 to discuss the fact

that Dura was not going to make its 4Q 1997 numbers," and that the Defendants discussed "fire

sales ." (TAC ¶T 1 52, 154 .) But there are no allegations as to how the Regional Sales Director

would have come to learn of this information .

However, the TAC does provide sufficient information regarding the former nationa l

accounts manager to support the probability that individual would possess the information

alleged. In particular, the national accounts manager was responsible for wholesalers and

managed care providers . Id . 1 150. That witness came to learn of the information attributed t o

him or her because of that witness's participation in the quarterly sales meetings and the

subsequent "load-ins" or "fire sales ." See id. IT 35, 37, 78, 80, 150. The witness would also

have information regarding how much Ceclor CD was returned as it would affect that

individual's bonus. See id. ¶~ 39, 82 .

Not only does the TAC contain more detailed allegations regarding Defendants '

purported scheme to ship excess Ceclor CD, but it also includes allegations that the Ninth Circuit

specifically found "are the type that could demonstrate a strong inference that Dura knowingly or

with deliberate recklessness made false or misleading statements to investors ." Dora , 339 F.3d

at 941 . These allegations are that Garner and Newman talked openly and frequently in public

areas at Dura about their plan to maximize the stock p rice so that they could "take the cash and

run." (TAC ¶ 171 .) The TAC also alleges these Defendants openly discussed how they could

make Dura appear more successful than it actually was. Id. When employees questioned

Newman about these tactics, he replied, " let `em catch us." Id, According to Plaintiffs,

Newman repeated this catch phrase so often it became part of the Compan y vernacular. Id .

Notably , these allegations are properly supported by a confidential witness . The TAC

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attributes these averments to a former finance department employee who worked closely with

Garner and Newman . Id. Garner also told this witness even before the Class Period began that

he did not intend to stay at Dura for more than a couple of years, when he expected to cash out

and do other things . fd .

In sum , the Court finds the TAC' s allegations regarding Ceclor CD adequately plea d

I falsity and scienter regarding Dura 's Ceclor CD sales .

2 . Which Defendants Are Liabl e

As discussed above , the TAC adequately alleges Defendants Newman , Gamer, and Spath4

were involved in the scheme to overload wholesalers with Ceclor CD to increase Dura's EPS,

and that they acted with the requisite scienter . However, there are no allegations implicating

Defendants Prettyman, Woodbury, Brown, or Cook . Instead, it appears the TAC attempts to

impute liability to these Defendants based on the group pleading doctrine, stock sales, their

positions in the Company, and motive. The Court does not find these allegations sufficient to

impose liability as to those Defendants .

a. Group Pleading

The group pleading doctrine allows a presumption that false and misleading informatio n

disseminated through documents were made by the collective action of the corporation's

officers . In re GlernFed, Inc., 60 F.3d 591, 593 (9th Cir . 1995); In re Syncor Int l Corp. See .

Litig., 327 F.3d 1149, 1171 (C.D . Cal . 2004). The Ninth Circuit has not opined whether this

doct ri ne remains viable after the enactment of the PSLRA . However, this Cou rt has joined other

courts in this district and concluded the group pleading doctrine did not survive the PSLRA .

Adecco, 371 F . Su pp . 2d at 1220-21 . Other circuits have similarly concluded that the group

pleading doctrine confl icts with the PSLRA' s scienter requirement . See, e.g., Makor Issues &

Rights, Ltd. V Tellabs, Inc., 437 F .3d 588, 602-03 (7th Cir . 2006); Southland Sec. Corp, v .

INSpire Ins . Solutions , Inc., 365 F .3d 353, 364-65 (5th Cir . 2004) . Accordingly , the Court finds

the group pleading doctrine is not a basis to impute liability for the Company's statements

" Messrs. Weiherer and Strathrneyer also participated in the alleged scheme to overloadwholesalers with Ceclor CD ; however, they are not Defendants in this action .

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regarding Ceclor CD as to Defendants Prettyman , Woodbury, Brown , or Cook .

b. Stock Sales

Stock sales by Prettyman, Woodbury, Brown, and Cook are also an insufficient basi s

upon which to impute liability as to these Defendants. Unusual or suspicious stock sales can

serve as circumstantial evidence of scienter . Ronconi, 253 F.3d at 434; Silicon Graphics, 183

F .3d at 986. "But not every sale of stock by a corporate insider shows that the share price is

about to decIine ." Ronconi, 253 F.3d at 435, Accordingly, "courts have repeatedly held that the

mere existence of stock sales does not raise a strong inference of fraudulent intent . [citation]

Plaintiffs have the burden at the pleading stage of explaining why the stock sales were unusual

or suspicious." In re PetSmart, Inc. Sec. Litig., 61 F . Supp. 2d 982, 1000 (D . Az. 1999) ;

Ronconi, 253 F.3d at 435; Silicon Graphics, 183 F.3d at 987. To meet this burden, the plaintiffs

must show the trading was in amounts "dramatically out of line with prior trading practices, at

times calculated to maximize the personal benefit from undisclosed inside information."

Ronconi, 253 F.3d at 435 (internal quotations omitted) . The Ninth Circuit has identified three

relevant factors when analyzing insider sales : "i(1) the amount and percentage of shares sold by

insiders; (2) the timing of the sales ; and (3) whether the sales were consistent with the insider's

prior trading history."' Id. (quoting Silicon Graphics, 183 F .3d at 986) .

The Ninth Circuit agreed with this Court's finding that the Second Consolidate d

Amended Complaint did not properly allege Defendants' trading practices during the Class

Period were dramatically out of line with their prior trading activities . Dura, 339 F .3d at 940,

The TAC's allegations regarding these Defendants' stock sales again fail to plead the

Defendants' stock sales during the Class Period were dramatically out of line with their prior

trading practices, or that those sales were done at a time maximize profits . They are therefore

insufficient to impute scienter as to Defendants Prettyman, Woodbury, Brown, and Cook .

C . Motive

The TAC alleges Defendants set out to drive Dura's stock higher during 1997 because

Defendants were completing a major debt offering for Dura to obtain working capital, and

because Dura would have to exercise its option to repurchase Spiros I and finance a new follow-

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on Spiros Development Corp . 11 entity to continue to pay for the ongoing development of

Albuterol Spiros . TAC 6, 19, 168 .) The Court does not find these allegations sufficient to

impute scienter as to Prettyman, Woodbury, Brown, and Cook vis-a-vis the Ceclor CD

averments . In the absence of any allegations inculpating them in the "fire sale" and "load-in"

scheme, Dura's need to obtain capital is a generic business motive courts have found insufficient

to base the requisite mental intent . See, e .g., Lipton, 284 F.3d at 1038 ("'If scienter could be

pleaded merely by alleging that officers and directors possess motive and opportunity to enhance

a company's business prospects, `virtually every company in the United States that experiences a

downturn in stock price could be forced to defend securities fraud actions ."') (quoting Acito V.

JMCERA Group, Inc., 47 F.3d 47, 54 (2d Cir.1995)) ; Pelsmart, 61 F. Supp. 2d at 999 ("A desire

to present a sound financial profile cannot be viewed, alone, as circumstantial evidence giving

rise to a strong inference of scienter.") .

d . Positions in the Company

Plaintiffs also seek to impute scie nter en Defendants Prettyman, Woodbury, and Brow n

based on their positions in the Company , arguing they ran Dura as "hands-on" managers and as a

result of their executive positions were aware of adverse non -public information . (See, e.g.,

TAC jj 83-85, 108-10, 135-37 .) This Court has held that "a complaint does not adequately

plead scienter by claiming that key officers knew the true facts by virtue of their "hands-on'

positions and involvement in the day -to-day management of the company." In re Peerless

Systems Corp . Sec. Litig., 182 F .Supp .2d 982 , 993 (S .D.Cal .2002) ; accord Adecco, 371 F. Supp.

2d at 1217. The Ninth Circuit and district courts in this circuit have similarly held that a

defendant's position in the company does not, without more, create a strong inference of

scienter . See, e.g., In re Vantive Corp. Sec. Litig ., 283 F.3d 1079, 1087 (9th Cir . 2002) ; In re

Splash Tech . Holdings Inc. See. Litig., 160 F .Supp.2d 1059, 1080-81 (IND. Cal. 2001) ; In re

Autodesk, Inc, Sec. Litig., 132 F .Supp .2d 833, 843-44 (N, D . Cal . 2000). "Rather than presume

individual officer and director defendants must have known about a fraud by virtue of their

positions within the defendant company, the persuasive force of each situation must be evaluated

individually ." Adecco, 371 F. Supp. 2d at 1217 (internal quotations omitted) . Given the absenc e

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of any allegations entangling Prettyman , Woodbury, and Brown in the scheme to loa d

wholesalers with Ceclor CD, the Court finds the TAC's allegations regarding these Defendants '

~ positions in the Company insufficient to impute soienter .

e . Allegations in Totality

When reviewing whether a complaint properly states a secu ri ties fraud claim under the

PSLRA, the court must consider "`whether the tota l of plaintiffs ' allegations , even though

individually lacking, are sufficient to create a strong inference that defendants acted with

deliberate or conscious recklessness ."' Daou, 411 F.3d at 1022 (quoting Nursing Home, 380

F .3d at 1230); Am . West, 320 F .3d at 938 . When "considering whether a strong inference of

scienter has been pled, `the court must consider all reasonable inferences to be drawn from the

allegations , including inferences unfavorable to the plaintiffs ."' Daou, 411 F .3d at 1022

(quoting Gonipper, 298 F.3d at 897) . Having reviewed the allegations in totality, the Court

concludes the TAC fails to state a claim as to Defendants Prettyman, Woodbury, Brown, and

Cook .

3. Puffery

Defendants contend that many of the statements attributed to the Individual Defendants

are mere "puffery" and optimistic statements about the future prospects of the Company that

cannot form the basis of a securities claim . "The `mere puffery' rule precludes liability for

vague, generalized and unspecific assertions of corporate optimism." In re Ligand Pharms., Inc.

Sec . Litig., No. 04CV 1620DMS(LSP), 2005 WL 2461151, at * 19 (S.D. Cal . Sept . 27, 2005) .

"`Statements that fall within the rule tend to use terms that are not measurable and not tethered

to facts that a reasonable person would deem important to a securities investment decision." Id.

(internal quotations omitted) . This rule has its limitations ; a projection of optimism becomes

actionable "when (1) the statement is not actually believed, (2) there is no reasonable basis for

the belief, or (3) the speaker is aware of undisclosed facts tending seriously to undermine the

statement's accuracy ."' Id. (internal quotations omitted) .

The statements regarding Ceclor CD are not subject to the puffery rule . As discusse d

I above, Plaintiffs have adequately pleaded the Company's sales of Ceclor CD were artificially

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inflated through the "fire sales" and " load-ins " orchestrated by certain of the Defendants .

Therefore, although statements that sales and demand for Ceclor CD were "strong ," that the

Company was "pleased" with Dura's performance and financial results, and that Cedar CD was

well received" by physicians are generalized, the facts alleged in the TAC lead to a strong

inference there was no reasonable basis for believing such statements to be true because the sales

were achieved by overloading wholesalers with the product . Accordingly, the puffery rule does

not insulate Defendants from liability .

4. Safe Harbor and "Bespeaks Caution"

Courts have refused to impose liability on statements which "bespeak caution ." This

doctrine "developed to address situations in which optimistic projections are coupled with

cautionary language . . . affecting the reasonableness of reliance on and the materiality of those

projections ." In re Worlds of Wonder Sec . Li g , , 35 F.3d 1407, 1414 (9th Cir. 1994). The

PSL12A's safe harbor provision provides that forward-looking statements cannot be the basis for

a securities fraud claim if. (1) the statement is identified as forward looking and is accompanied

by sufficient cautionary statements ; or (2) the person who made the forward-looking statement

did so without actual knowledge that the statement was false or misleading . The safe harbor

provision protects both written and oral forward-looking statements . See 15 U.S .C . § 78u-

5(c)(1)-(2) . The Ninth Circuit has held the PSLRA's safe harbor provision codified the

judicially-created bespeaks caution doctrine . Employers Teamsters Local Nos . 175 & 505

Pension Trust Fund v. Clorox Co., 353 F.3d 1125, 1132 (9th Cir. 2004). Accordingly, it is

appropriate to consider the application of the bespeaks caution doctrine and safe harbor

provision simultaneously . In re Copper Mountain Sec. Litig., 311 F. Supp. 2d 857, 876 (N .D .

Cal . 2004) .

Under the safe harbor provision, a person is not liable for a "forward looking" statemen t

provided the statement is identified as such, and is accompanied by meaningful cautionar y

statements identifying important factors that could cause actual results to differ materially fro m

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those in the forward-looking statement." 15 U .S.C . 78u-5(c)(1)(A)(i) ; Am. W, 320 F .3d at 936 .

A "forward- looking statement" " is any statement regarding ( 1) financial projections , (2) plans

and objectives of management for future operations, (3) future economic performance , or (4) the

assumptions `underlying or related to ' any of these issues ." Am. W., 320 F.3d at 936 .

Defendants contend that most of the challenged statements refer to Dura's future plans,

objectives, and business prospects relating to the development and hoped-for FDA approval of

the Spiros products, and its then newly-acquired Ceclor, Keftab, and Nasal idefNasarel product

lines . Defendants argue these statements are forward-looking and thus subject to the Reform

Act's safe harbor provisions .

Defendants contend Dura disclosed the risks associated with its recent acquisition of

Ceclor CD. For example, the Company's Form 10-Q filed on October 21, 1997 stated that

"[f]ailure to successfully market and sell Keftab, Ceclor CD, Nasarel or Nasalide would have a

material adverse effect on the Company's business, financial condition and results of

operations ." (Def's Req. for Jud . Not ., Ex. Q at 13 .) The Court finds neither the safe harbor

nor the bespeaks caution doctrine insulate Defendants from liability for their statements

regarding Ceclor CD .

The statements regarding Cedar CD at issue in this case are not "forward looking ."

Plaintiffs allege Defendants misted investors about the current sales and demand for Ceder CD,

and that antibiotic 's market share . (See, e.g., TAC ¶ 75 (discussing Ceclor CD' s market share of

weekly new prescriptions) ; id. ¶ 106 (stating that Ceclor CD is well-received by physicians)) .

Accordingly , neither the safe harbor provision nor the bespeaks caution doctrine are applicable .

Cf. Am. W., 320 F .3d at 936-37 (finding statements disclosing a fine imposed and the present

effects of the fine on the company not covered by the safe harbor provision ). Further, even if

these statements were subject to the safe harbor or bespeaks caution doctrine and were

accompanied by sufficient cautionary statements , as discussed above, the TAC adequately

alleges a strong inference they were made with actual knowledge of their falsity, precluding thei r

' "There are additional requirements for oral forward-looking statements ." Am. W, 320F.3d at 936 n . 14 .

34 99CVOLS1

protection by the safe harbor provision or bespeaks caution doctrine . Cf. id, at 937 n . 15 (stating

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I that because there was a strong inference of actual knowledge, the statements were not protecte d

by the safe harbor provision) .

5. Statements Made by Third-Party Analysts

Many of the TAC's allegations attribute statements by analysts to the Defendants .

Defendants argue they are not liable for those statements because Plaintiffs do not allege specific

facts to support the conclusion they were "sufficiently entangled" with the analysts' forecasts .

There are two types of liability related to statements made by analysts . In re Stratosphere Corp.

Sec. Litig ., I F .Supp .2d 1096, 1115 (D . Nev. 1998) . "First, a defendant may be directly liable

for false statements made to analysts in the connection of a sale of a security ." Id. Second, "a

defendant may be liable for statements made by an analyst if the defendant, or a company or its

officers or directors puts an express or implied imprimatur on the projections by endorsing or

adopting them." Id . "A defendant `adapts' an analysts' report or forecast when he or she

`sufficiently entangled himself [or herself] with the analysts' forecasts ."' Id. (quoting In re

Caere Corp. Sec. Lifig. 837 F .Supp. 1054, 1059 (N .D.Cal .1993)) . Plaintiffs respond that

"entanglement" allegations are only required where defendants provided truthful information to

analysts that was made misleading through modification by the analyst . They contend it is

sufficient to have alleged the analysts' reports were based on and repeated information

Defendants provided . The Court disagrees .

Plaintiffs may "forgo allegations of the defendants" adoption of the analysts' reports if th e

statements made to the securities analysts, which formed the basis of the repo rt , were misleading

and were made with the intent that they be communicated to the market ." Copperstone V. TCSI

Corp,, No. C 97-4395 SBA, 1999 WL 33295869, at *8 (N.D. Cal . Jan. 19 , 1999) . However,

Plaintiffs' allegations must conform to the PSLRA's pleading requirements . Id. Plaintiffs must

therefore "specify each statement to an analyst alleged to have been misleading ." Id. The TAC

does not contain any allegations specifying the statements Defendants made to analysts . Thus,

insofar as the TAC relies on statements in analysts ' reports, it must be dismissed . Cf. id. (finding

insufficient allegations that defendants made false and misleading statements to non-part y

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securities analysts with the intent the analysts would relay the information to the market);

~ Stratosphere, 1 F. Supp. 2d at 1105 (finding complaint deficient because it did not allege the

I time , place , and content of defendants' statements to the analysts) .

SUFFICIENCY OF THE ALLEGATIONS OF A ~ 2O() VIOLATION .

The TAC alleges a claim under § 20(a) of the 1934 Securities and Exchange Act agains t

defendants Newman, Garner, and Spath . Section 20(a) provides for controlling person liability

for every person who, directly or indirectly, controls any person liable under any of the

provisions of this title . 15 U .S.C . § 78t(a) . To establish control person liability, a plaintiff must

show that a primary violation occurred, and that the defendant exercised actual power or control

over the primary violator . Am. W., 320 F3d at 945 . Defendants argue that because Plaintiffs

fail to state a claim under § 10(b) and Rule 1 Ob-5, the § 20(a) claim must be dismissed as well .

Heliotrope General, Inc . v. Ford Motor, Co., 189 F .3d 971, 978 (9th Or . 1999) .

The Court agrees that insofar as the § 20(a) claim relies on the Defendants '

misrepresentations regarding Albuterol Spires ' development , the claim must be dismissed

because the allegations regarding Spiros have not been pleaded in accordance with the PSLRA .

However, the Cou rt has found the TAC properly states a violation of § 10(b ) and Rule lob-5

against Garner, Spath, and Newman for misrepresentations regarding sales and demand of

Ceclor CD . Accordingly, Defendants' motion to dismiss the 20(a) claim as to Gamer, Spath,

and Newman is denied insofar as it challenges the TAC' s allegations regarding sales and

demand for Ceclor CD .

CONCLUSION

Having considered the parties' briefs, the record, oral argument, applicable law, and goo d

cause appearing, IT IS HEREBY ORDERED :

1 . Defendants' motion to dismiss is GRANTED IN PART AND DENIED IN PAR T

[dock. no. 119] . The Court finds the TAC sufficiently states a claim under § 10(b) and Rule

14b-5, and § 20(a) against Defendants Dura, Garner, Newman, and Spath for their

representations and omissions regarding Ceclor CD . However, the TACs allegations based on

statements by analysts regarding Ceclor CD, and the statements regarding Albuterol Spiros are

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deficient and therefore DISMISSED WITH LEAVE TO AMEND ,

2. Within 30 days of the date this order is stamped "Filed," Plaintiffs may file an

amended complaint that addresses the deficiencies in pleading discussed above . If Plaintiffs do

not file an amended complaint in the time provided, the TAC shall proceed against Defendants

Dura, Garner, Newman, and Spath only and as to those Defendants' (not analysts' )

representations and omissions regarding Ceclor CD . Should Plaintiffs choose to proceed only on

those claims, Defendants shall file an Answer to the TAC within 45 days of the date this order is

stamped "Filed."

3 . Defendants' request far judicial notice is GRANTED insofar as the Court has relie d

on those documents .

IT IS SO ORDERED .

Dated ~

F

, --~an 1 IM. 3 S LOUlf T STAT S DIS'I CT J DGE

COPY TO :

HON. NITA L . STORMESUNITED STATES MAGISTRATE JUDGE

ALL PARTIESICOUNSEL

37 99cvOLS

TAB 3


7 of 26 DOCUMENTS

IN RE GAMING LOTTERY SECURITIES LITIGATION; THIS DOCUMENTRELATES TO: ALL ACTIONS: 96 Civ. 5567 (RPP), 96 Civ. 7527 (RPP), 96 Civ. 7936

(RPP)

Master File No. 96 Civ. 5567 (RPP)

UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF NEWYORK

2001 U.S. Dist. LEXIS 13513

September 4, 2001, DecidedSeptember 5, 2001, Filed

DISPOSITION: [*1] GalaxiWorld's motion pursuant to28 U,S.C. § 455(a) to request that Court disqualify itselffrom further proceedings denied.

COUNSEL: For DAVID PECARSKY, OVERALLSUPPLY, INCORPORATED, plaintiffs: Steven G.Schulman, Milberg, Weiss, Bershad, Hynes & Lerach,LLP, New York, NY.

For JACK BANKS, LARRY WELTMAN, GAMINGLOTTERY CORPORATION, defendants: EdwardBrodsky, Proskauer Rose LLP, NY, NY.

For JACK BANKS, LARRY WELTMAN, defendants:Sheldon Eisenberger, New York, NY.

LARRY WELTMAN, defendant, Pro se, Thornhill,Ontario, CA.

For GAMING LOTTERY CORPORATION, defendant:Sheldon Eisenberger, The Law Offices of SheldonEisenberger, New York, NY.

JUDGES: Robert P. Patterson, Jr., U.S.D.J.

OPINIONBY: Robert P. Patterson, Jr.

OPINION:

OPINION AND ORDER

ROBERT P. PATTERSON, JR., U.S.D.J.

Defendant GalaxiWorld.com Limited("GalaxiWorld") (formerly known as Gaming LotteryCorporation n1) moves pursuant to28 U.S.C. § 455(a) forthe Court to disqualify itself from further proceedings.

The class of plaintiffs ("Plaintiffs") opposes the motion.For the following reasons, the motion is denied.

n1 Gaming Lottery's name was Laser FriendlyCorporation until July 28, 1995. In April 1996,Gaming Lottery announced it would divest itselfof its subsidiaries engaged in the manufacture ofpaper related gaming products and reincorporate inBermuda. In January 1997, Gaming Lottery rein-corporated in the British Virgin Islands and di-vested itself of its three subsidiaries. In September1998, the corporation renamed itself GLC Limitedand relocated its corporate offices to Gibraltar.In October 1998, GalaxiWorld Limited, a whollyowned subsidiary of GLC Limited, launched its in-ternet casino gambling website. On July 1, 1999,GLC Limited announced that it had changed itsname to GalaxiWorld.com Limited.

[*2]

BACKGROUND

This class action, filed in 1996, is brought pursuantto Section 10(b) and Section 20(a) of the SecuritiesExchange Act of 1934,15 U.S.C. §§ 78j(b) and 78t(a), andRule 10b--5 of the Rules of the Securities and ExchangeCommission,17 C.F.R. 240.10b--5, on behalf of pur-chasers of securities in Gaming Lottery, a Canadian cor-poration, during the period February 1, 1995, to May24, 1996. (See Consolidated Amended Class ActionComplaint, dated Jan. 13, 1997 ("Compl.") PP 35--36.)Defendants are alleged to have issued misleading pub-lic statements and financial reports between February 1,1995, and May 24, 1996, causing the stock of GamingLottery to be overvalued. (Id.) As of January 10, 2000,fact discovery was to close on January 21, 2000, expertdiscovery was to close on February 21, 2000, a pre--trial


U.S. Dist. LEXIS 13513, *2

order was due on March 15, 2000, and trial was scheduledfor April 4, 2000.

A. Proskauer's Motion to Withdraw and Entry ofDefault Judgment Against GalaxiWorld in Favor ofPlaintiffs

By order to show cause dated January 10, 2000,Proskauer Rose LLP ("Proskauer"), counsel for defen-dants GalaxiWorld, Jack Banks[*3] and Larry Weltman,moved pursuant to S. & E.D.N.Y Civil Rule 1.4 n2 towithdraw as attorneys of record for defendants and forpayment of fees and expenses. n3 Proskauer's motion towithdraw was based on GalaxiWorld's actions since thefall of 1999, when the proceeds of GalaxiWorld's insur-ance policy became exhausted and were no longer avail-able to pay litigation fees and expenses. On November 15,1999, GalaxiWorld had announced that it was to be takenprivate by Ostel Management Inc. ("Ostel"), a then--newlyformed Nevis corporation owned by a Bermuda corpora-tion whose principal office is in Monaco. (Affirmation ofEdward Brodsky ("Brodsky Aff.") datedJan. 10, 2000 P8.) Ostel had agreed to purchase the controlling block ofthe common shares of GalaxiWorld and to extend a tenderoffer for the remainder. (Id.) GalaxiWorld had ceased todo business in the United States and Canada. (Declarationof Sheldon Eisenberger ("Eisenberger Decl.") dated June21, 2001, Ex. C at 16.) The going--private transactionwas scheduled to close on January 21, 2000. (BrodskyAff. P 8.) By letter dated November 23, 1999, Banks,the President of GalaxiWorld, notified Proskauer to dono more [*4] work on behalf of GalaxiWorld with-out prior approval after December 15, 1999. (Id. P9.) By letter dated December 22, 1999, Banks informedProskauer that defendant Weltman, who had been theChief Financial Officer of GalaxiWorld, was no longeran officer of GalaxiWorld. (Id. P 10.)On December 29,1999, Banks advised Proskauer that it had a conflict of in-terest in representing both Mr. Weltman and GalaxiWorld,but Banks could not explain the conflict, saying that theDecember 29, 1999, letter had been written at the instruc-tion of Ostel. (Id.) On January 3, 2000, Banks informedProskauer that he had been instructed not to pay its out-standing invoices that had been previously approved forpayment by Mr. Weltman, and that he would not be infurther communication with Ostel until January 22, 2000,after the closing. (Id. P 12.)Proskauer's attempts to dis-cuss the cease work and non--payment notices with OstelManagement were rebuffed by Banks and by a Texas lawfirm representing Ostel. (Id. P 13.)Based on this conduct,Proskauer became fearful that it would not be paid for itsservices, since after January 21, 2000, GalaxiWorld[*5]would be "owned by a private foreign company with noaccountability," and GalaxiWorld's funds disbursed else-where, and Proskauer therefore feared that it would have

lost any meaningful chance to recover the funds owed toit. (Id. P 2, 17.)

n2 S. & E.D.N.Y. Civil Rule 1.4 provides:An attorney who has appeared as at-torney of record for a party may berelieved or displaced only by order ofthe court and may not withdraw from acase without leave of the court grantedby order. Such an order may be grantedonly upon a showing by affidavit orotherwise of satisfactory reasons forwithdrawal or displacement and theposture of the case, including its po-sition, if any, on the calendar.

S. & E.D.N.Y. Civ. R. 1.4 (2001).

n3 Proskauer had given prior notice of the mo-tion to defendant Banks, President of GalaxiWorld,on January 7, 2000.

By letter dated January 7, 2000, Proskauer notifiedBanks that it was obliged to move to withdraw as coun-sel and for payment of outstanding fees. (Id. Ex. I.) OnJanuary 10, 2000, Proskauer[*6] presented the Courtwith an order to show cause returnable on January 13,2000, requesting such relief. The Court signed the orderto show cause and, as requested, authorized service onBanks and Weltman by facsimile on January 10, 2000. Inits memorandum in support of its application, Proskauerstated that "GalaxiWorld has had ample time to retainother counsel if that were what it wished to do, andProskauer has in fact given notice that it cannot repre-sent defendants under these circumstances and is obligedto withdraw as counsel." (Mem. of Law in Support ofProskauer's Motion dated Jan. 10, 2000, at 7.) On January13, 2000, a hearing was held at which neither Banks,nor Weltman, nor GalaxiWorld through any representa-tive appeared. Proskauer expressed fear that GalaxiWorld,under the direction of Ostel, would take the position that"we never have to pay these people," because "they willnever find [our] assets and we are not worried about it."(Transcript of Jan. 13, 2000, hearing at 25 (unsealed July19, 2000).) Accordingly, Proskauer requested that thejudgment require payment by January 18, 2000, to al-low the check to clear before the closing of the going--private transaction[*7] with Ostel on January 21, 2000.Plaintiffs' counsel objected to the relief requested as giv-ing Proskauer a priority to GalaxiWorld's assets and askedfor a default judgment on their case, in view of the defen-dants' failure to appear. Plaintiffs' counsel also requestedthat the Court order GalaxiWorld to reimburse Plaintiffs'scounsel $1130 advanced to Mr. Weltman to defray ex-penses he was expected to incur in coming to New York



for his deposition. Proskauer's motion to withdraw ascounsel and for payment of fees was granted on defaultand GalaxiWorld was ordered to: (1) pay Proskauer'sfees and expenses in the amount of $762,611.34 on orbefore January 18, 2000; (2) reimburse Plaintiffs' coun-sel the $1130 advanced to Mr. Weltman; and the Courtentered a restraining order against any disposition of as-sets of GalaxiWorld until such payments were made andnew counsel entered an appearance. The Court's Orderof January 13, 2000, also explicitly warned GalaxiWorldthat if it did not file an appearance On or before January18, 2000, a default judgment in favor of Plaintiffs mightbe entered against GalaxiWorld.

In a letter dated January 19, 2000, defendant Banksstated that GalaxiWorld[*8] had not been given adequatenotice of Proskauer's order to show cause and allegedthat Proskauer had failed to represent GalaxiWorld prop-erly in connection with settlement discussions. By Orderdated January 19, 2000, upon the request from Banks, thejudgment in favor of Proskauer was vacated and held inabeyance until January 25, 2000, to allow GalaxiWorldto appear and show cause why the judgment should notbe entered. By memorandum endorsement dated January20, 2000, upon a request from Proskauer, defendant Bankswas ordered to appear in person at the January 25, 2000,hearing, and defendant Weltman was ordered to appearby telephone, to give testimony as material fact witnesseswith respect to GalaxiWorld's allegations of misrepre-sentation by Proskauer in settlement discussions. n4 OnJanuary 25, 2000, the hearing was held at which nei-ther Banks nor GalaxiWorld appeared, although defen-dant Weltman appeared by telephone. At the hearing onJanuary 25, 2000, the Court took into consideration all thematerials submitted by the parties and all the testimonygiven and arguments presented including testimony thatGalaxiWorld had not cooperated with Proskauer in set-tlement discussions,[*9] and found that GalaxiWorldwas in default, that $569,536.48 in outstanding fees andexpenses had been incurred on Defendants' behalf by andwere due to Proskauer in this litigation, that Plaintiffs'counsel had received reimbursement for the advance paidto defendant Weltman to cover his cost of attending hisdeposition in New York, and that the Court continued therestraining order to ensure payment of any judgments en-tered. In an Order and Judgment dated January 26, 2000:(1) a default judgment was entered against GalaxiWorldin favor of Plaintiffs: (2) an inquest was ordered to beheld on February 9, 2000, regarding the amount of dam-ages to be awarded which were claimed by Plaintiffsto be $22,048,844; (3) GalaxiWorld was ordered to payProskauer fees and expenses for services rendered in Inre Gaming Lottery Securities Litigation in the amount of$569,536.48; and (4) the restraining order was continued.

On February 9, 2000, the inquest on damages was held,at which none of the defendants appeared or requestedan adjournment. On February 16, 2000, judgment wasentered against GalaxiWorld in favor of Plaintiffs in theamount of $22,084,844 as of May 24, 1996. On March 6,2000, the[*10] January 27, 2000, judgment was amendedonly as to the fees owed Proskauer, which were increasedto $654,412.58. By Order dated April 24, 2000, the Courtfound that Proskauer's claim giving rise to the March 6,2000, Amended Judgment was plenary and severable. OnMay 3, 2000, a Second Amended Judgment was enteredpursuant to Federal Rule of Civil Procedure ("Fed. R. Civ.P.") 54(b) in favor of Proskauer against GalaxiWorld in theamount of $654,412.58. On May 11, 2000, an AmendedOrder and Judgment was issued, amending the judgmentof February 16, 2000, and entering judgment pursuantto Fed. R. Civ. P. 54(b)with damages in the amount of$22,084,844 as of May 24, 1996, in favor of Plaintiffsagainst GalaxiWorld and continuing the restraining orderon GalaxiWorld.

n4 Mr. Weltman was allowed to appear by tele-phone because his wife was expecting to delivertheir child at that time.

On March 14, 2000, GalaxiWorld and Jack Banks, bySheldon Eisenberger, Esq., filed Notices of Appeal of thejudgments dated January 26, 2000, and[*11] March 6,2000, and GalaxiWorld (but not Banks) filed a Notice ofAppeal of the of the judgment dated February 16, 2000. n5On May 11, 2000, GalaxiWorld and Banks filed a Noticeof Appeal of the Second Amended Judgment dated May3, 2000, and of the Order dated April 24, 2000. On May19, 2000, GalaxiWorld filed a Notice of Appeal of theAmended Order and Judgment dated May 11, 2000.

n5 On March 22, 2000, Mr. Eisenberger filed anotice of appearance on behalf of GalaxiWorld.

On January 10, 2001, the Second Circuit Court ofAppeals affirmed the judgment in favor of Proskauer. SeeSilva Run Worldwide Ltd. v. Galaxiworld.com Ltd., 2 Fed.Appx. 78, 2001 U.S. App. LEXIS 524, 2001 WL 40902(2d Cir. Jan 10, 2001). On May 10, 2001, the SecondCircuit Court of Appeals vacated the default judgment infavor of Plaintiffs against GalaxiWorld and remanded thecase to this Court for further proceedings. SeePecarskyv. Galaxiworld.com Ltd., 249 F.3d 167 (2d Cir. 2001).

B. Plaintiffs' Motion for Summary [*12]Judgment Against the Individual Defendants

On February 24, 2000, Mr. Eisenberger filed a no-tice of appearance on behalf of defendants Banks and



Weltman. On February 25, 2000, at a pre--trial confer-ence, the Court ordered that: (1) except with respect tothe deposition of Mr. Seale (a Fifth Amendment witness)fact discovery was closed; (2) final expert witness reportswould be exchanged on March 15, 2000; (3) a pre--trialorder would be submitted to the Court by April 3, 2000;and (4) a trial date was set for May 1, 2000. On April14, 2000, Plaintiffs moved for summary judgment on li-ability and damages against defendants Jack Banks andLarry Weltman as controlling officers of GalaxiWorld. ByOpinion and Order dated February 27, 2001, summaryjudgment was granted to Plaintiffs against individual de-fendants Banks and Weltman for the period of May 3,1995, through May 24, 1996, with damages of $10 mil-lion, subject to upward or downward adjustment uponsubmission of proofs of claim by the class of plaintiffs.On March 7, 2001, judgment was entered against thosedefendants. On March 13, 2001, Banks and Weltman fileda Notice of Appeal. That appeal is now pending.

C. The Enforcement [*13] Proceedings Orders

On August 18, 2000, the Court granted Proskauer'sand Plaintiffs' motions to compel GalaxiWorld to pro-duce documents relating to the location of its assetsand to appear for a deposition. n6 On October 18,2000, the Court ordered defendant Banks and represen-tatives of GalaxiWorld to appear at a hearing sched-uled for November 2, 2000, at which neither Banksnor GalaxiWorld appeared or produced evidence. OnNovember 6, 2000, the Court ordered that GalaxiWorldbe held in contempt of court and fined $5,000 for eachday from the date of entry of that order for failure tocomply with the Court's Order of August 18, 2000, andordered Banks and GalaxiWorld to appear and to showcause on November 14, 2000, why they should not beheld in contempt for their failure to appear and givetestimony and evidence in Plaintiffs' judgment enforce-ment proceedings. On November 14, 2000, defendantsBanks, Weltman and GalaxiWorld moved by order toshow cause for Plaintiffs to show why at a hearing to beheld November 16, 2000, an order should not be entered:(1) staying the Order of Contempt; (2) reconsidering theCourt's October 18, 2000, and November 6, 2000, Orders;(3) granting[*14] defendants a protective order requir-ing all depositions of defendants to be conducted in theplace they reside; and (4) entering a Martindell protectiveorder in the form previously submitted to the Court. OnNovember 14, 2000, the hearing was reset to November21, 2000. On November 21, 2000, neither GalaxiWorldnor Banks appeared at the hearing on the motion, but theCourt gave Banks until November 27, 2000, to appear. OnNovember 27, 2000, Banks did not appear and the Courtheld him in contempt and fined him $1,000 per day untilhe complies with the Court's October 18, 2000, Order.

In an order entered December 5, 2000, the Court deniedthe motion of GalaxiWorld, Banks and Weltman, for thereasons stated at the November 21, 2000 hearing.

n6 Proskauer had also initiated unsuccessfulcollection efforts against G.Cash Limited, whichacted as a cashier for GalaxiWorld's ongoing inter-net gambling business. SeeIn re Gaming LotterySec. Litig., 2000 U.S. Dist. LEXIS 17537, No. 96Civ. 5567 (RPP), 2000 WL 1801840(S.D.N.Y. Dec.7, 2000).

[*15]

D. GalaxiWorld's Motion for Disqualification

On June 21, 2000, after remand to this Courtfollowing the Second Circuit's decision vacating thedefault judgment against GalaxiWorld in favor ofPlaintiffs, GalaxiWorld moved upon the declaration ofMr. Eisenberger, the exhibits attached thereto, the accom-panying memorandum of law, and all prior proceedingsand pleadings had herein to request that the Court disqual-ify itself from further proceedings pursuant to28 U.S.C. §455(a). n7 GalaxiWorld contends that the Court has beenpredisposed against it in its rulings. (Def.'s Mem. at 2--8.) GalaxiWorld further contends that the Court's com-ments during certain oral arguments on motions highlightthe appearance of bias on the part of the Court and that"ever since the withdrawal of Proskauer as counsel fordefendants, the Court has exhibited strong negative biastowards defendants." (Id. at 8--12.) GalaxiWorld arguesthat "defendants cannot get a fair trial before this Court,"and that its motion should be granted "because the Court'simpartiality [sic] might reasonably be questioned." (Id. at11.)

n7 The memorandum in support of the motionstates that it is "submitted on behalf of defendantsGalaxiWorld.com Limited ("GLC"), Jack Banksand Larry Weltman in support of their motion thatThe Honorable Robert P. Patterson recuse himselffrom this case pursuant to28 U.S.C. § 455(a)."(Def.'s Mem. at 1.) Defendant GalaxiWorld's re-ply memorandum similarly states that it is submit-ted also on behalf of Banks and Weltman. (SeeDef.'s Reply Mem. at 1.) However, the Noticeof Motion was filed on behalf of GalaxiWorldonly. (See Notice of Motion dated June 21, 2001.)Plaintiffs correctly note that since summary judg-ment has been entered against defendants Banksand Weltman and they have filed a notice of appeal,those defendants are not properly before the Court.(See Pls.' Mem. at 18 n.7.) Accordingly, althoughthe briefs state that they are submitted on behalf of



Banks and Weltman, the motion was brought by andtherefore will be decided on behalf of GalaxiWorldonly.

[*16]

On July 17, 2001, Plaintiffs opposed the motion, argu-ing that: (1) Defendant's motion is procedurally defective;and (2) adverse judicial rulings are not a proper groundfor a recusal motion. n8 On July 31, 2001, Defendantsubmitted reply papers in further support of the motion.

n8 In support of their opposition toGalaxiWorld's motion for disqualification,Plaintiffs submit information that was not beforethe Court at the time the rulings and remarks uponwhich GalaxiWorld bases its motion were made.That information is not relied upon in this Opinionand Order.

DISCUSSION

GalaxiWorld moves to request that the Court disqual-ify itself from further proceedings pursuant to28 U.S.C.§ 455(a). The statute provides that: "Any justice, judge,or magistrate of the United States shall disqualify him-self in any proceeding in which his impartiality mightreasonably be questioned."28 U.S.C. § 455(a) (2001).

A. Procedural Objections

Plaintiffs argue that GalaxiWorld's[*17] motion isprocedurally defective because: (1) the motion fails tosatisfy the strict requirements of28 U.S.C. § 144;(2) itis untimely; (3) GalaxiWorld has not submitted materialallegations stated with particularity as required by § 144;and (4) the Court has no personal bias of an extrajudicialorigin.

1. The procedural requirements of 28 U.S.C. §455(a)

Two of Plaintiffs' procedural objections erroneouslyrely on the argument that a motion filed pursuant to28U.S.C. § 455(a) must satisfy the strict requirements of28U.S.C. § 144.n9 Although Plaintiffs contend that: (1)GalaxiWorld's motion does not satisfy the requirementsof § 144; and (2) GalaxiWorld has not submitted mate-rial allegations stated with particularity as required by §144; Plaintiffs have not cited, nor has this Court found,any cases holding that motions filed pursuant to § 455(a)must comply with the procedural requirements of § 144.Rather, the Second Circuit has noted that28 U.S.C. §455(a) is "wholly silent as to procedure." n10UnitedStates v. Wolfson, 558 F.2d 59, 62 n.11 (2d Cir. 1977).[*18] The Sixth Circuit has similarly noted that "there

is no particular procedure that a party must follow toobtain judicial disqualification under § 455(a)," and that"neither the text nor the legislative history of § 455(a)contain any suggestion that the procedures of § 144 areapplicable to disqualification under § 455(a)."Roberts v.Bailar, 625 F.2d 125, 128 & n.8 (6th Cir. 1980).Sincethere is no requirement that a motion filed pursuant to §455(a) must comply with the procedural requirements of§ 144, Plaintiffs' procedural objections on that ground aredenied.

n928 U.S.C. § 144provides:Whenever a party to any proceedingin a district court makes and files atimely and sufficient affidavit that thejudge before whom the matter is pend-ing has a personal bias or prejudiceeither against him or in favor of anyadverse party, such judge shall pro-ceed no further therein, but anotherjudge shall be assigned to hear suchproceeding.The affidavit shall state the facts andthe reasons for the belief that bias orprejudice exists, and shall be filed notless than ten days before the beginningof the term at which the proceeding isto be heard, or good cause shall beshown for failure to file it within suchtime. A party may file only one suchaffidavit in any case. It shall be ac-companied by a certificate of counselof record stating that it is made in goodfaith.

28 U.S.C. § 144(2001).[*19]

n10 Somewhat more recently, the SecondCircuit stated that "we have not decided whetherthe filing of an affidavit of bias is required as aprocedural prerequisite for § 455."Apple v. JewishHosp. and Med. Ctr., 829 F.2d 326, 333 (2d Cir.1987)."But when proffered, an affidavit is scruti-nized for sufficiency." Id. Here, GalaxiWorld hassubmitted a declaration by counsel in support of itsmotion.

2. Untimeliness

Second, Plaintiffs contend that the motion is untimely.Courts have found a timeliness requirement contained in28 U.S.C. § 455(a). "Although § 455 does not containsuch a requirement, timeliness has been read into this



section . . . ."Apple v. Jewish Hosp. and Med. Ctr., 829F.2d 326, 333 (2d Cir. 1987).In general, one seekingdisqualification must do so "at the earliest possible mo-ment after obtaining knowledge of facts demonstratingthe basis for such a claim" of disqualification. Id.; seealsoGil Enters., Inc. v. Delvy, 79 F.3d 241, 247 (2d Cir.1996)."Untimeliness . . . is . . . a failure[*20] to seekrecusal when it should first have been sought, that is, assoon as the facts on which it is premised are known to theparties."United States v. Bayless, 201 F.3d 116, 127 (2dCir. 2000)."Untimeliness in making a motion for recusalcan sometimes constitute the basis for finding an impliedwaiver." Id. The Second Circuit has written that, in thecontext of on--going litigation,

it is important to present recusal applicationspromptly for at least two reasons. First, aprompt application affords the district judgean opportunity to assess the merits of the ap-plication before taking any further steps thatmay be inappropriate for the judge to take.Second, a prompt application avoids the riskthat a party is holding back a recusal appli-cation as a fall--back position in the event ofadverse rulings on pending matters.

In re Int'l Bus. Mach. Corp., 45 F.3d 641, 643 (2d Cir.1995) (noting that such considerations had no applica-tion in that case since the case was post--judgment and noaction had occurred since 1970).

In the case at hand, GalaxiWorld contends that thejudgments against GalaxiWorld entered in January 2000and the[*21] Court's orders against GalaxiWorld inNovember 2000, and statements made by the Court onJanuary 13, 2000, January 25, 2000, February 9, 2000,February 29, 2000, and November 21, 2000, "manifest theappearance of bias" against GalaxiWorld. (Def.'s Mem. at1.) Although those rulings and statements were all madein 2000, Defendant GalaxiWorld did not move for dis-qualification until June 21, 2001, which is seven monthsafter the last statement was made on November 21, 2000,and more than a year and half after the first incidentsallegedly demonstrating the appearance of bias. Giventhe time that has elapsed, it is difficult to see how thismotion for disqualification has been made "at the earli-est possible moment after obtaining knowledge of factsdemonstrating the basis for such a claim."Apple, 829 F.2dat 333.GalaxiWorld argues that the present stage of theproceedings is the appropriate time to address the motionfor disqualification because the case has been relativelydormant since the Second Circuit's opinion reversing en-try of the default judgment against GalaxiWorld, which

was rendered on May 10, 2001. n11 Although the motionfor disqualification was not filed[*22] "at the earliestpossible moment," since expert discovery is not yet com-plete, motions for summary judgment may yet be filedand trial is to be scheduled, the motion will not be deniedas untimely but will be decided on its merits to ensurethat confidence in the integrity of the Southern Districtis not tarnished. SeeLiljeberg v. Health Serv. AcquisitionCorp., 486 U.S. 847, 860, 100 L. Ed. 2d 855, 108 S. Ct.2194 (1988)(noting that the purpose of § 455(a) is "topromote public confidence in the integrity of the judicialprocess").

n11 It could be argued that GalaxiWorld was notproperly before this Court from the date it filed itsNotice of Appeal, March 14, 2000, until the SecondCircuit's decision on May 10, 2001. In support of itsmotion, however, GalaxiWorld relies on rulings andstatements that were made in November 2000 dur-ing the pendency of its appeal, when GalaxiWorldwas before this Court with respect to Proskauer'sand Plaintiffs' attempts to enforce their respectivejudgments against it.

[*23]

3. The extrajudicial source doctrine

Third, Plaintiffs argue that GalaxiWorld's motionshould be denied because the Court had no personalbias of an extrajudicial origin. Although the "extrajudi-cial source doctrine" applies to § 455(a), "the fact thatan opinion held by a judge derives from a source outsidejudicial proceedings is not a necessary condition for 'biasor prejudice' recusal . . . . Nor is it a sufficient condi-tion" for such recusal.Liteky v. United States, 510 U.S.540, 554, 127 L. Ed. 2d 474, 114 S. Ct. 1147 (1994)(emphasis in original). "Neither the presence of an extra-judicial source necessarily establishes bias, nor [does] theabsence of an extrajudicial source necessarily preclude[]bias . . . ." Id. Defendant GalaxiWorld does not rely onor allege an extrajudicial source for the Court's allegedbias or prejudice. Since the lack of an extrajudicial sourcedoes not preclude a finding of bias or prejudice, however,Plaintiffs' objection on that ground is not dispositive.

B. Substantive Analysis

"Section 455(a) requires a showing that would cause'an objective, disinterested observer fully informed of theunderlying[*24] facts [to] entertain significant doubt thatjustice would be done absent recusal.'"In re Aguinda,241 F.3d 194, 201 (2d Cir. 2001)(quotingUnited Statesv. Lovaglia, 954 F.2d 811, 815 (2d Cir. 1992))."Thus,the test to be applied is an objective one which assumesthat a reasonable person knows and understands all the



relevant facts."In re Drexel Burnham Lambert Inc., 861F.2d 1307, 1313 (2d Cir. 1988)(emphasis in original)."Quite simply and quite universally, recusal is required[under § 455(a)] whenever 'impartiality might reasonablybe questioned.'"Liteky, 510 U.S. at 548.

The trial judge him--or herself must decide a motionfiled pursuant to28 U.S.C. § 455(a). "Discretion is con-fided in the district judge in the first instance to determinewhether to disqualify himself."In re Drexel BurnhamLambert Inc., 861 F.2d at 1312."In deciding whether torecuse himself, the trial judge must carefully weigh thepolicy of promoting public confidence in the judiciaryagainst the possibility that those questioning his impar-tiality might be seeking to avoid the adverse[*25] con-sequences of his presiding over their case." Id. "A judgeis as much obliged not to recuse himself when it is notcalled for as he is obliged to when it is." Id.

1. The Court's Rulings

GalaxiWorld argues that a reasonable person wouldconclude that the Court's partiality is questionable basedon the Court's rulings, but adverse rulings per se do notamount to bias. SeeIn re Int'l Bus. Mach. Corp., 618 F.2d923, 929 (2d Cir. 1980)(noting that "we cannot agreethat adverse rulings by a judge can per se create the ap-pearance of bias under section 455(a)."). Rather, as theSupreme Court has stated, judicial rulings "can only in therarest circumstances evidence the degree of favoritism orantagonism required . . . when no extrajudicial source isinvolved. Almost invariably, they are proper grounds forappeal, not for recusal."Liteky, 510 U.S. at 555.

GalaxiWorld acknowledges that the Supreme Courthas held that "judicial rulings alone almost never con-stitute a valid basis for a bias or partiality motion," butargues that the Court's rulings fall into the narrow excep-tion noted by the Supreme Court because they allegedly"display [*26] a deep--seated favoritism or antagonismthat would make fair judgment impossible." Id. In supportof this argument, GalaxiWorld cites: (1) the Court's grant-ing Proskauer's motion to withdraw as counsel and entryof judgment against GalaxiWorld in favor of Proskauerfor unpaid fees, and the related decisions of the Courtwith respect to Proskauer's motion; (2) entry of a defaultjudgment against GalaxiWorld with judgment of dam-ages in the amount of $22,048,844 in favor of Plaintiffsagainst GalaxiWorld and the related decisions of the Courtwith respect to entry of the default judgment; and (3) theCourt's granting on November 9, 2000, Plaintiffs' motionfor contempt for GalaxiWorld's failure to comply withthe Court's Order of August 18, 2000, which orderedGalaxiWorld to produce to Plaintiffs certain corporatedocuments that Plaintiffs had requested, and the relateddecisions of the Court with respect to the motion for con-

tempt.

First, with respect to the Proskauer's motion to with-draw as counsel and the entry of judgment againstGalaxiWorld on behalf of Proskauer for unpaid fees,GalaxiWorld does not explain, nor can the Court dis-cern, how granting Proskauer's motion for an[*27] orderpermitting Proskauer to withdraw as counsel for the de-fendants and ordering payment of outstanding fees, dis-plays "deep--seated favoritism." That decision was upheldby the Second Circuit Court of Appeals. SeeSilva RunWorldwide Ltd. v. Galaxiworld.com Ltd., 2 Fed. Appx.78, 2001 U.S. App. LEXIS 524, 2001 WL 40902(2d Cir.Jan. 10, 2001). Additionally, in granting Proskauer's mo-tion, the Court explained its reasons at the hearing onJanuary 13, 2000, stating, "I listened to Mr. Brodsky [ofProskauer] and I think that his client is not cooperatingwith him and under those circumstances I have no excusefor not granting his application to withdraw as counsel andto fix his fees." n12 (Eisenberger Decl. Ex. B at 31.) Atthe time Proskauer made its motion to withdraw as coun-sel and for payment of its fees, GalaxiWorld was aboutto be taken over by an offshore private company withwhom Proskauer was unable to communicate and thereremained no insurance to pay Proskauer's fees. The rulingpresented a basis for appeal, which GalaxiWorld unsuc-cessfully pursued, but it does not display deep--seatedfavoritism or antagonism toward GalaxiWorld and it isnot grounds for the Court[*28] to disqualify itself.

n12 Mr. Brodsky had stated that his clienthad refused to give instruction since November1999 and refused to respond to his telephone calls.(Transcript of Jan. 13, 2000 at 22--29 (unsealed onJuly 19, 2000)).

Second, with respect to the entry of default judgmentand the related rulings, Defendant appealed the defaultjudgment and award of damages against GalaxiWorld tothe Second Circuit Court of Appeals. That court reversedthe default judgment and award of damages. SeePecarsky,249 F.3d at 174--75.In support of its motion for disqual-ification, GalaxiWorld argues that "as indicated by theSecond Circuit, this Court acted to enter a default judg-ment against GLC more quickly than usual." (Def.'s Mem.at 12.) It is true that the Second Circuit, in reversing theentry of default judgment, noted that "consideration ofother cases in which default judgments have been enteredillustrates that the district court in this case ordered a de-fault judgment more quickly than usual.[*29] " Pecarsky,249 F.3d at 172.However, the entry of the judgmenthere came at a time when GalaxiWorld was being takenover by an offshore private company which Proskauerbelieved would not pay GalaxiWorld's bills and when no



insurance remained to pay any judgment. Entry of de-fault judgment "more quickly than usual" under thosecircumstances would not cause a disinterested observerwho was fully informed of the facts to entertain signif-icant doubt that justice would be done absent recusal.The transcripts show that the Court was obviously tryingto press GalaxiWorld and Ostel to bring in attorneys todefend the action. n13 The Court's entry of default judg-ment presented grounds for appeal, which GalaxiWorldsuccessfully pursued, but it does not display deep--seatedfavoritism or antagonism toward GalaxiWorld and it isnot grounds for the Court to disqualify itself.

n13 GalaxiWorld chose to forego the typicalprocedure upon entry of default judgment of mov-ing before the district court to vacate the defaultjudgment underFederal Rules of Civil Procedure55(c) and60(b) and proceed to defend the actionwith Banks and Weltman who were represented bythe same counsel. SeePecarsky, 249 F.3d at 170(discussing GalaxiWorld's "unusual" choice to pur-sue an appeal rather than seeking vacatur of thedefault judgment from the district court).

[*30]

Third, GalaxiWorld complains that the Court "rubberstamped Plaintiffs' request for an order of contempt," andthat "inexplicably the Court did not enter the Martindellorder" that defendants had requested in their order toshow cause of November 14, 2000. (Def.'s Mem. at 7.)Contrary to GalaxiWorld's contention that the order forcontempt was "rubber stamped," the Court heard exten-sive argument and reviewed substantive briefing fromcounsel on the issue. Most importantly, despite the Court'sorders, neither defendant Banks nor a representative fromGalaxiWorld appeared at the hearing, nor were any ofthe requested documents produced, as required in theCourt's order. Also contrary to GalaxiWorld's contention,the Court clearly explained reason for denying defen-dants' request for a Martindell protective order its ruling atthe November 21, 2000, hearing, at which GalaxiWorld'scounsel was present, when the Court stated:

I am not going to grant the defendants a pro-tective order requiring that all depositions ofdefendants be conducted in the place thatthey reside. And I am not going to enter aMartindell protective order in the form pre-viously submitted to the Court[*31] becauseI don't think that a necessity has been shownfor the entrance of a Martindell protective or-der or was at the time when it was originallysubmitted because the nature of the inquiry

being made of Mr. Banks at that time wasan inquiry as to the disposition of the assetsthat had taken place subsequent to the pe-riod involved in his prosecution. There wasno claim by anyone that those transfers werecriminal acts.

(Eisenberger Decl. Ex. F at 40--41.) Here, an objective,disinterested observer who was fully informed of the factthat the Court had explained its reason for not enteringthe protective order, which was based on defendants' fail-ure to make a sufficient showing of necessity, would notentertain significant doubt that justice would be done ab-sent recusal. As with the other judicial rulings, this rulingmay be grounds for an appeal but it is not grounds fordisqualification. In sum, the rulings against GalaxiWorld,although adverse, do not display deep--seated favoritismor antagonism that would make fair judgment impossible.

2. The Court's Remarks

GalaxiWorld argues that the Court's statements at var-ious hearings created an appearance of bias. However,"judicial [*32] remarks during the course of a trial thatare critical or disapproving of, or even hostile to, coun-sel, the parties, or their cases, ordinarily do not supporta bias or partiality challenge."Liteky, 510 U.S. at 555;see alsoUnited States v. Conte, 99 F.3d 60, 65 (2d Cir.1996)(noting that "events occurring in the course of ju-dicial proceedings generally do not constitute a basis forrecusal"). The Supreme Court has stated:

Not establishing bias or partiality, however,are expressions of impatience, dissatisfac-tion, annoyance, and even anger, that arewithin the bounds of what imperfect menand women, even after having been con-firmed as federal judges, sometimes dis-play. A judge's ordinary efforts at court-room administration----even a stern and short--tempered judge's ordinary efforts at court-room administration----remain immune.

510 U.S. at 555--56(emphasis in original). The SupremeCourt has also explained, by quoting Judge Jerome Frank,that "'impartiality is not gullibility. Disinterestedness doesnot mean child--like innocence. If the judge did not formjudgments of the actors in those court--house dramascalled trials, he could[*33] never render decisions.'"Id. at 551(quotingIn re J.P. Linahan, Inc., 138 F.2d 650,654 (2d Cir. 1943))."Opinions formed by the judge on thebasis of facts introduced or events occurring in the courseof the current proceedings, or of prior proceedings, donot constitute a basis for a bias or partiality motion unless



they display a deep--seated favoritism or antagonism thatwould make fair judgment impossible."510 U.S. at 555.

First, GalaxiWorld accuses the Court of "taking issuewith Mr. Weltman's failure to appear in Court when hiswife was having a baby, even though all parties had agreedto the adjournment." (Def.'s Mem. at 8.) However, as thetranscript of the January 13, 2000, hearing makes clear,the Court was only informed that the parties had agreed toadjourn Mr. Weltman's deposition, not his appearance atthe hearing on Proskauer's motion to withdraw as counsel:

I really think [Mr. Weltman] ought to haveappeared. Didn't I order that he appear? Wehave had one excuse after another from Mr.Weltman. It seems to me he was supposed toappear in November and then he had an ex-cuse then and I said any time before maybeit was January 20 but whatever[*34] date itwas and you all agreed on that and then nowhe has unilaterally avoided that.

(Eisenberger Decl. Ex. B at 17--18.) Although counselfor Proskauer informed the Court that Plaintiffs had con-sented to the further adjournment of Mr. Weltman's depo-sition because his wife was expecting a baby and thereforehis failure to appear at his deposition was not unilateral,the Court was raising the issue that Mr. Weltman was notpresent at the January 13, 2000, hearing. (Id.) Proskauer'sorder to show cause presented to the Court on January 10,2000, and signed the same day, had ordered Mr. Weltmanto appear at the January 13, 2000, hearing, and the Courtstated that it had understood that, "the Order to ShowCause indicated he was going to appear here . . . ." (Id.at 34.) The consensual adjournment of Mr. Weltman'sdeposition for some other date does not explain or excusehis failure to appear at the hearing on Proskauer's order toshow cause. GalaxiWorld also complains that later duringthe same hearing, the Court stated, "I think maybe [Mr.Weltman] is never going to show. Maybe he has anotherwife that is pregnant." (Id. at 34.) This poor attempt athumor merely[*35] displays the Court's obvious frustra-tion with the discovery cutoff extensions caused by Mr.Weltman's repeated delays in completing his deposition.n14 Contrary to GalaxiWorld's assertions, however, theCourt's observations that defendant Weltman had failedto appear at the January 13, 2000, hearing on Proskauer'sorder to show cause or had repeatedly rescheduled his de-position were "efforts at court administration," and evenif they reflect impatience with Mr. Weltman's failure tohave appeared for deposition or at the hearing held onJanuary 13, 2000, such statements do not establish theappearance of bias or partiality. Accordingly, an objec-tive, disinterested observer fully informed of the underly-

ing facts would not entertain significant doubt that justicewould be done absent recusal.

n14 Mr. Weltman's deposition had begun inApril 1999 but could not be completed at thattime because of a lack of documents concerningMr. Weltman's testimony before the SEC and theNebraska, Ontario, and Missouri gaming regula-tory commissions. (See Sept. 29, 1999, and Oct. 14,1999, Letters from Plaintiffs; Oct. 15, 1999, Letterfrom Proskauer.) On October 14, 1999, Plaintiffshad requested that the Court compel defendantWeltman to attend his deposition in New York City,which was then scheduled for October 20--21, 1999,after Plaintiffs were advised that Defendants hadcanceled the deposition. On October 18, 1999, thatrequest was denied by memorandum endorsementupon a letter from Proskauer dated October 15,1999, in which Proskauer offered the depositionto be held in December, rather than in October1999. (See Memorandum Endorsement dated Oct.18, 1999, upon Proskauer's Oct. 15, 1999, Letter.)On November 30, 1999, Weltman's deposition wasagain rescheduled, this time to January 2000, due toProskauer's scheduling conflicts and because defen-dant Weltman had injured his back. At the January13, 2000, hearing, it was reported to the Court thatMr. Weltman had again obtained an adjournment ofhis deposition which was rescheduled from Januaryto February 2000, this time because his wife wasexpecting a baby.

[*36]

Second, GalaxiWorld complains of the Court's beliefthat defendants' requests for additional time to engage newcounsel were unreasonable, an assessment that the SecondCircuit disagreed with in its decision on appeal. (Def.'sMem. at 9.) GalaxiWorld identifies a remark made dur-ing the January 25, 2000, hearing, at which Mr. Weltmanappeared by telephone. The Court stated:

GalaxiWorld had an obligation to appear to-day, under court order. And it was adjournedfor week. And I'm not going to allow the peo-ple to just turn around and ask for 30 daysand 30 days and 30 days. It's an old game.They have to learn to respect the Court.

(Eisenberger Decl. Ex. C at 92.) The Court was deal-ing with a four year old case in which the fact discoverycutoff had been repeatedly extended, trial was scheduledfor April 4, 2000, and expert discovery was still to becompleted. In its remark, the Court was expressing its



frustration with GalaxiWorld's failure to obtain substitutecounsel, despite the fact that GalaxiWorld had notifiedProskauer in November 1999 that it should cease workand despite a court order to appear and a subsequent ad-journment to permit GalaxiWorld to retain counsel,[*37]if only for the purpose of making a special appearance onbehalf of the corporation. As with the Court's commentsregarding Mr. Weltman's failure to appear, the statementis an effort at court administration and an objective, dis-interested observer fully informed of the underlying factswould not entertain significant doubt that justice wouldbe done absent recusal.

Third, GalaxiWorld complains about the Court's re-sponse to Mr. Weltman's suggestion, made on January25, 2000, at a time when he was no longer an officerof GalaxiWorld and when no counsel had appeared forthe defendants, that "all three parties here at the table .. . spend the next 30 days to try and settle this matter."(Id. at 93.) The Court responded: "From your own ac-count, you weren't interested. From your own account,you elected to play it that way. You live by the sword, youdie by the sword. Your string has run out." (Id. at 94.) TheCourt refused Mr. Weltman's request for an adjournmentfor possible settlement discussions based in part on Mr.Weltman's account earlier during that hearing of his in-struction as an officer of GalaxiWorld to Proskauer not tocontinue with settlement discussions, despite[*38] beingadvised by Proskauer to do so. (See id. at 63--64.) Moreimportantly, Mr. Weltman's suggestion was a diversionfrom the subject the Court was dealing with, which wasits efforts to encourage the retention of substitute counselfor the defendants, including suggesting that substitutecounsel make only a limited appearance. (See id. at 92.)The Court's response was to redirect Weltman's attentionto the issue of securing the appearance of an attorneyfor the defendants and not to allow time to be lost tothat endeavor by the diversion of discussions of possiblesettlement by the principals. These remarks would notcause an objective, disinterested observer fully informedof these underlying facts to entertain significant doubt thatjustice would be done absent recusal.

Fourth, GalaxiWorld complains that on February 9,2000, the Court "traded disparaging comments of defen-dants with Proskauer Rose's attorney." (Def.'s Mem. at 9.)In the comments cited in support of GalaxiWorld's claim,Proskauer's counsel had argued that it was "pointless tohave two duplicative bifurcated proceedings, one here,one there, to address fee matters," to which the Courtreplied: "Particularly[*39] when the defendant is nowdoing business out of Gibraltar." (Eisenberger Decl. Ex. Dat 21.) This comment could not reasonably be interpretedas giving rise to the appearance of bias, since it is merelyreflected the Court's agreement that Proskauer might have

difficulty serving process on an offshore private com-pany and bifurcated proceedings would waste time andresources. GalaxiWorld also cites the Court's agreementwith the statement of Proskauer's counsel: "And tends notto show up at any hearing that anyone calls," to which theCourt replied: "Or even have someone appear especially.All right." (Id.) The comment, based on GalaxiWorld'sfailure to appear at previous hearings, is again an effortat court administration to obtain the appearance of newcounsel, even suggesting a special appearance, and underthe circumstances would not cause an objective, disin-terested observer fully informed of the underlying factsto entertain significant doubt that justice would be doneabsent recusal.

Fifth, GalaxiWorld argues that on February 29, 2000,the Court "assumed that any transactions involving de-fendants were improper." (Def.'s Mem. at 10 (empha-sis in original).) However, that[*40] argument is notsupported by the Court's remark on which GalaxiWorldrelies. On February 29, 2000, the Court remarked that:"Well, I am not saying one way or the other, but justsaying that you can't assume anything on these trans-actions." (Eisenberger Decl. Ex. E at 21.) Contrary toGalaxiWorld's assertions, rather than assume that anytransactions were improper, the Court plainly stated thatit would not make any assumptions regarding the pro-priety of the transactions: "you can't assume anything."That statement would not cause an objective, disinterestedobserver fully informed of the underlying facts to enter-tain significant doubt that justice would be done absentrecusal.

Sixth, GalaxiWorld accuses the Court of sarcasm inasking the question during a hearing on the enforcementproceedings held on November 21, 2000, "You mean theyare playing a game and they have taken their corporatedocuments and transferred them to a third party?" (Def.'sMem. at 10.) This question was posed in response toGalaxiWorld's counsel's assertion, made without swornstatements in support, that GalaxiWorld was not in pos-session of its corporate documents relating to the dis-position of the assets of[*41] its subsidiary, SpecialtyManufacturing Inc., and the location of its assets whichPlaintiffs had demanded during discovery. Questioningcounsel's assertion that GalaxiWorld did not possess itsown corporate documents would not cause an objective,disinterested observer fully informed of the underlyingfacts to entertain significant doubt that justice would bedone absent recusal.

Finally, GalaxiWorld objects to the Court's statementduring the hearing on the enforcement proceedings heldon November 21, 2000, that GalaxiWorld's counsel hadbeen "using" a former Gaming Lottery shareholder named



Frank Citrano. n15 (Id. at 10--11.) Citrano, who acknowl-edged being in touch with GalaxiWorld's counsel, soughta lifting of the Court's restraining order on a GalaxiWorldaccount at the Royal Bank of Scotland allegedly usedto hold funds in the Ostel acquisition of GalaxiWorldso that he could receive a small portion of the account.GalaxiWorld had failed to produce the corporate doc-uments relating to that transaction which had been re-quested by Plaintiffs and Proskauer. Without such docu-ments, neither Proskauer nor Plaintiffs could review thecorporate transaction in question to determine[*42] if itwas a sham. The Court explained its remark in response toGalaxiWorld's counsel's exception, stating: "Yes. If youdon't produce the documents they can't tell whether thisisn't a sham transaction or not." (Eisenberger Decl. Ex.F at 15.) Such an observation, based on GalaxiWorld'sfailure to disclose its corporate records, would not causean objective, disinterested observer fully informed of theunderlying facts to entertain significant doubt that justicewould be done absent recusal.

n15 Mr. Citrano, a Gaming Lottery shareholderwhom the Court permitted to appear, had beenseeking, over the objection of both the judgmentcreditors, the lifting of the Court's restraining orderon an account in GalaxiWorld's name at the RoyalBank of Scotland in Gibraltar so that he could re-ceive a small portion of the account. Eventually thedispute was resolved to Citrano's satisfaction. (SeeAffidavit of Robert C. Finkel dated July 17, 2001Ex. Y.)

In sum, the remarks cited by GalaxiWorld that al-legedly show bias[*43] and prejudice are efforts at

court administration, or they question statements made byGalaxiWorld's counsel during conferences, or commentupon GalaxiWorld's delaying tactics, failure to appear de-spite court order, or refusal to reveal the location of its cor-porate documents. The judicial remarks in question, to theextent they are adverse to the positions of GalaxiWorld,are based on the facts placed before the Court and donot show deep--seated favoritism or antagonism. Thus,after consideration of the judicial rulings and statementsrelied on by GalaxiWorld in support of its motion for re-cusal pursuant to28 U.S.C. § 455(a), the Court concludesthat GalaxiWorld has not met its obligation to show that"an objective, disinterested observer fully informed of theunderlying facts [would] entertain significant doubt thatjustice would be done absent recusal."In re Aguinda, 241F.3d at 201(internal quotation omitted). "A judge is asmuch obliged not to recuse himself when it is not calledfor as he is obliged to when it is."In re Drexel BurnhamLambert Inc., 861 F.2d at 1312.Here, the Court is obligednot to recuse itself.[*44] Accordingly, GalaxiWorld'smotion pursuant to28 U.S.C. § 455(a) to request that theCourt disqualify itself from further proceedings is denied.

CONCLUSION

For the foregoing reasons, GalaxiWorld's motion pur-suant to28 U.S.C. § 455(a) to request that the Courtdisqualify itself from further proceedings is denied.

IT IS SO ORDERED.

Dated: New York, New York

September 4, 2001

Robert P. Patterson, Jr.

U.S.D.J.


Slip Copy Page 1

Slip Copy, 2006 WL 1320466 (N .D.Cal .), Fed. Sec . L . Rep. P 93,891

(Cite as : S lip Copy)

0 TION TO DISMISS

Briefs and Other Related Documents MARTIN J. JENKINS, District Judge.

United States District Court,N .D. California.

In re GILEAD SCIENCES SECURITIES LITIGATION.

This Document Relates To All Actions .

Nos . C03 -4999 MJJ, C03-5391 MJJ, C04-0100 MJJ,

C03-5088 MJJ , C03-5592 MJJ, C03-5113 MJJ,

C03-5805 MJJ.

May 12, 2006 .

Christopher T. Heffelfinger, Joseph J . Tabacco, Jr. , Berman

Devalerio Pease & Tabacco, P .C ., Jonathan K. Levine , Ka-

plan Fox & Kilsheimer LLP, Robert S . Green , John W. Pil-

lette, Robert A. Jigariian, Green Welling LLP, San Fran-

cisco, CA, Daniel S . Sommers, Marka A. Peterson, Cohen

Milstein Hausefeld & Toll, P .L .L .C., Washington, DC, Li-

onel Z . Glancy , Peter A . Binkow, Glancy & Binkow LLP,

Los Angeles, CA, Joshua M. Lifshitz , Bull & Lifshitz, LLP,

Mel E. Lifshitz , Bernstein Liebhard & Lifshitz, LLP, Jeffrey

M. Norton, Robert I . Harwood, Wechsler Harwood Halebi-

an & Feffer LLP, Eric J. Belfi , Murray, Frank & Sailer LLP,

Jack G. Fruchter, Abraham Fruchter & Twersky LLP,

Steven G. Schulman, Milberg Weiss Bershad & Schulman

LLP, New York, NY, Chad E . Kauffman, Marc A. Topaz ,

Richard A . Maniskas , Schiffrin & Barroway LLP, Bala

Cynwyd, PA, David A. Rosenfeld, Samuel H. Rudman,

Cauley Geller Bowman & Rudman LLP, David Avi Rosen-

feld, Esq . , Samuel H. Rudman, Lerach Coughlin Stoia

Geller Rudman & Robbins LLP, Melville, NY, James M .

Orman, Law Offices of James M . Orman, Philadelphia, PA,

Lori G. Feldman, Milberg, Weiss Bershad & Schulman,

LLP, Seattle, WA, David Jude George , Robert Jeffrey Rob-

bins , Lerach Coughlin Stoia Geller Rudman Robbins LLP,

Boca Raton, FL, for Plaintiffs.

Grant P . Fondo, John C . Dwyer , Cooley Godward LLP, Pa-

lo Alto, CA, for Defendants .

Michael M. Goldberg, Glancy & Binkow LLP, Los

Angeles, CA, Douglas C. McDermo tt, Milberg, Weiss Ber-

shad & Schulman, LLP, Seattle, WA, Laurence D . King ,

Linda M. Fong, Kaplan Fox & Kilsheimer LLP, San Fran-

cisco, CA, for Movants .

ORDER GRANTING DEFENDANTS' 12(b)(6) MO-

INTRODUCTION

*1 Before the Court is Gilead Sciences, Inc . ("Gilead"),

John C . Mart in, John F . Milligan, Mark L. Perry, Norbert

W. Bischofberger, Anthony Carrociolo and William A.

Lee's ("Defendants") Motion to Dismiss a federal securi ties

fraud action brought against them by a class consisting of all

purchasers of Gilead stock between July 14, 2003 and Octo-

ber 28 , 2003 .1 Defendants seek an order dismissing the

Fourth Amended Class Action Complaint ("FAC") with

prejudice under the heightened pleading requirements of the

Private Securities Litigation Reform Act of 1995

("PSLRA") an d pursuant to Federal Rules of Civil Proced-

ure 12(b)(6) and 2($) . For the following reasons , the Court

GRANTS Defendants' motion with prejudice .

FN1 . Docket No. 140, filed on December 22, 2005 .

BACKGROUND

A. Factual History

The FAC is brought on behalf of a class consisting of all

persons who purchased or otherwise acquired Gilead stock

between July 14, 2003 and October 28, 2003 (the "Class

Period") . The allegations in the FAC relate to Gilead's an-

nouncement in July 2003 of its financial results for the

second quarter of 2003, and the impact its premier product,

Viread, had on those results . Viread is a antiretroviral drug

used to treat HIV/AIDS that Gilead introduced in 2001 . On

July 14, 2003, the first day of the class period, Gilead issued

a press release entitled "Gilead Sciences Expects Second

Quarter 2003 Financial Results Will Exceed Expectations,"

and stating, "[t]he increase in revenue was driven primarily

by strong sales growth of Viread ." The press release went

on to say that Viread sales increased due to "broader pre-

scribing patterns . . . as well as increases in U .S . wholesaler

inventory in the second quarter ." On the same day,

Bloomberg News identified Gilead spokeswoman Amy

Flood as stating that "[t]he main reason for the jump in

Viread sales is an increase in prescriptions, not inventory

stocking. "

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

Slip CopySlip Copy, 2006 WL 1320466 (N .D.Cal .), Fed. Sec . L . Rep. P 93,891

(Cite as : Slip Copy)

Two weeks later, on July 31, 2003, Gilead issued a press re-

lease containing its final results for the second quarter .

Gilead announced that it had net revenues of $230 .7 million

for the second quarter, of which $167 million related to

Viread. Gilead went on :

Viread sales growth was primarily driven by higher pre-

scription volume, a significant increase in U .S . wholesaler

inventories and a favorable European currency environment

compared to the same quarter last year. Gilead estimates

that increased stocking by U.S . wholesalers accounted for

$25-30 million in Viread sales in the second quarter .

The press release contained warnings regarding the forward-

looking statements and stated that the statements were

"subject to certain risks and uncertainties, which could

cause actual results to differ materially." Statements made

during Gilead' s earnings call of that same date, as well as on

its Form 10-Q filed August 14, 2003, contained similar

warnings .

Also on July 31, 2003, Gilead held a conference call with

analysts and other investors regarding its financial results .

During the call, an officer of Gilead stated:

*2 Of significant note, we believe that a substantial invent-

ory build occurred in U .S. distributor channel during the

second quarter as wholesalers anticipated the Viread price

increase announced on June 27th. Though difficult to de-

termine the exact figure for this inventory build, we estimate

that wholesaler inventories increased by $25 to $30 million

during the quarter. . . . Based on the U.S. inventory build up

seen in the second quarter, we anticipate Viread sales for the

third quarter will be at or below the sales level recognized

this second quarter . We expect these inventories to be drawn

down to more normal levels during this quarter.

According to the FAC, market analysts-including Morgan

Stanley, Prudential, and Bear Steams-continued to predict

strong demand for Viread in the third quarter of 2003 des-

pite the inventory overstock.

On August 14, 2003, Gilead filed its Form 10-Q for the

second quarter of 2003 . This form confirmed the previously

announced financial results . The Form 10- Q also discussed

the inventory build-up : "We estimate that this higher stock-

ing resulted in $25 . 0 to $30 .0 million of additional sales

Page 2

during the second quarter, which may adversely impact

sales in the third quarter as wholesalers return to more nor-

mal inventory levels and buying patterns ." The Form 10-Q

also disclosed the existence of a July 29, 2003 letter issued

by the FDA warning Gilead about certain aspects of its pro-

motional practices of Viread.FN2

FN2. Gilead initially made the FDA letter public

on August 7, 2003 .

In its October 28, 2003 Press Release, Gilead announced its

financial results for the third quarter of 2003, Gilead an-

nounced net revenues of $194 .1 million, and sales of Viread

of $115.4 million. At that time, Gilead stated : "After re-

viewing NDC prescription trends, IMS inventory data and

actual Viread sales , Gilead estimates there was approxim-

ately $33 to $37 million of inventory reduction by U.S .

pharmaceutical wholesalers during the third quarter of 2003

following an equivalent inventory build during the second

quarter of 2003 ." The next day, Gilead's stock dropped

$7.46 per share from $59 .46 per share to close at $52 per

share . Approximately one month later, on December 2,

2003, Gilead's stock price had recovered the entire drop ex-

perienced on October 29 and closed at $59 .83 per share .

Plaintiffs allege that for the period of at least September

2001 through, and subsequent to, the class period, Gilead

engaged in the off-label marketing of Viread . Off-label mar-

keting refers to the use for marketing purposes of informa-

tion such as the result of clinical studies and other material

on the uses of and the efficacy of an FDA-approved product

that has not been approved by the FDA for inclusion in the

product's package labeling. Pursuant to FDA guidelines,

pharmaceutical manufacturers such as Gilead may only pro-

mote an FDA-approved drug consistent with the contents of

its FDA-approved package labeling. Plaintiffs assert that the

off-label marketing took three forms : 1) marketing to HIV

patients co-infected with Hepatitis B virus ("HBV") ; 2)

marketing Viread as a first-line or initial therapy for HIV in-

fection; and 3) marketing against Viread's safety profile .

*3 Plaintiffs allege that Gilead's off-label marketing activit-

ies began as early as September 2001 at Gilead' s national

sales meeting in Miami . There, sales and marketing employ-

ees allegedly were given information regarding Gilead' s




submission of Viread clinical data and information to the

FDA and, with a "wink and a nod," were instructed to use

this information to sell Viread even though Viread had yet

to be approved-by the FDA . The FDA approved Viread in

October 2001 .1V3 Later, employees allegedly were instruc-

ted, "overtly and covertly," at numerous regional and na-

tional sales meetings by Gilead executives to use off-label

information to aggressively promote and sell Viread . FN4 At

these meetings, employees allegedly would be provided off-

label information such as updates on clinical trials of Viread

on large group meetings and then told in subsequent smaller

meetings to use this information to sell Viread. Defendants

Martin, Perry, Lee, Milligan, and Bischofberger allegedly

attended one or more of these regional and national sales

meetings .

FN3 . From October 2001 to August 2003, Viread's

market share increased steadily from zero to nearly

20 percent .

FN4 . The FAC states that Plaintiffs' confidential

witnesses (CW1 and CW2) attended various meet-

ings at which Gilead 's sales and marketing team re-

ceived specific instructions to market Viread off-

label. According to CW1, 85% to 95% of his

Viread sales were a result of off-label marketing .

Plaintiffs also allege that 85% to 90% of CW2's

Viread sales were a result of off-label marketing .

According to the FAC, Gilead received an Untitled FDA

Letter on March 14, 2002, advising the company that its

representatives had made false and misleading oral promo-

tional statements at the December 2001 Interscience Confer-

ence on Antimicrobial Agents and Chemotherapy confer-

ence. According to the Untitled FDA Letter, Gilead falsely

and misleadingly promoted Viread by stating that it con-

tained "no toxicities," was "extremely safe," and was

"extremely well-tolerated," despite the fact that its boxed

warning and Package Labeling advised to the contrary. The

Untitled FDA Letter further ordered Gilead to "immediately

cease making such violative statements ," and required

Gilead to submit a written response describing its intent and

plans to comply with the FDA's directives . Plaintiffs allege

that the false statements were made by Defendant Martin

and it was company-wide knowledge that Martin was the

cause of the Untitled FDA Letter.

Page 3

On March 21, 2002, Gilead responded saying that it was

"commit[ted] to ensure that future violative statements are

not made in the promotion of Viread." However, sixteen

months later, on July 29, 2003, the FDA issued a second let-

ter ("FDA Warning Letter") notifying Gilead that it con-

sidered certain oral representations made by a Gilead repres-

entative at a promotion booth during a conference call in

April 2003 to be improper . This conference took place dur-

ing Gilead's second fiscal quarter of 2003, just prior to De-

fendants' first class period announcement of outstanding

Viread sales and financial results which exceeded market

expectations .

This second FDA letter became public on August 7, 2003 .

According to the FAC, investors did not attribute much sig-

nificance to the letter . (FAC at ¶ 191 .) In response to the

FDA letter on November 7, 2003, defendant Martin wrote a

correction letter to the conference attendees .

Plaintiffs allege that Defendants provided so many off-label

instructional materials and were so forceful in promoting

off-label use, that 75% to 95% of Viread sales were attribut-

able to off-label promotion . According to the FAC, this ac-

counted for between $86 .7 million and $109.82 million of

Gilead's second quarter 2003 domestic Viread sales . (FAC

at ¶ 150.) Plaintiffs allege that Defendants maintained this

misleading image of Viread for a long enough period for the

stock price to become inflated and for Defendants to sell

their shares before the FDA made their second letter to

Gilead public .

B. Procedural History

*4 On January 25, 2005, the Court dismissed Plaintiffs'

Consolidated Amended Complaint ("CAC") with leave to

amend, finding that Plaintiffs failed to establish the requisite

connection between Gilead's off-label marketing activities

and the allegedly false 2003 second quarter reports.

Plaintiffs filed the Third Consolidated Amended Class Ac-

tion Complaint ("TAC") on March 11, 2005 . 5 On Octo-

ber 11, 2005 the Court dismissed Plaintiffs' TAC with leave

to amend ("Order") . Once again the Court found Plaintiffs'

pleadings deficient . Although the Court voiced its concern s




as to whether Plaintiffs adequately demonstrated that the

off-label marketing scheme "materially" affected Gilead's

sales or stock price, it did not reach that issue on the merits .

Instead the Court found Plaintiffs' pleadings deficient be-

cause they failed to allege loss causation in light of Dura

Pharmaceuticals Inc . v. Broudo 544 U.S . 336, 125 S .Ct.PN61627, 161 L .Ed.2d 577 (2005) , and In re Daou S stems

Inc . . 411 F .3d 1006 (9th Cir.2005) .' The Court held "in

light of Dura, it is evident that Plaintiffs have not ad-

equately alleged proximate causation and economic loss

with respect to Gilead's alleged off-label marketing

scheme." (Order at 12 :21-23 .) The Court ruled that

"Plaintiffs [did] not allege that a price drop immediately ac-

companied the disclosure of the FDA [W]arning [L]etter,

and hence the Court is left to speculate as to what portion of

the eventual loss, if any, should be attributed to the disclos-

ure or whether the loss was caused by other factors ." (Order

at 12 :23-26 .) Plaintiffs filed the FAC on December 2, 2005

in response to the Order.

FN5 . Plaintiffs filed their Second Consolidated

Amended Class Action Complaint on February 25,

2005 (Docket No . 99), which they amended shortly

thereafter with the TAC .

FN6 . The Supreme Court decided Dura after the

Court dismissed the CAC . Dura held that in order

to demonstrate loss causation, plaintiffs must estab-

lish an actual "causal connection" between the de-

fendants' material misrepresentation and the eco-

nomic loss suffered. Dura. 125 S .Ct. at 1631-33 .

FN7 . The Ninth Circuit decided Daou after the

Court dismissed the CAC as well . There, the Ninth

Circuit held that a plaintiff sufficiently pleads "loss

causation" by alleging that there was a steep drop

in defendants' stock price upon revelation of previ-

ously undisclosed facts . Daou. 411 F .3d at 1026 .

JUDICIAL NOTICE

In addition to the Motion to Dismiss the FAC, Defendants

have filed a Request for Judicial Notice , and ask the Court

to notice a number of documents . Federal Rule of Evidence

201 allows a court to take judicial notice of a fact "not sub-

Page 4

ject to reasonable dispute in that it is . . . capable of accurate

and ready determination by resort to sources whose accur-

acy can[ ]not reasonably be questioned." Plaintiffs do not

object to the Court's taking judicial notice of the requested

documents . The Court finds taking judicial notice of those

documents and all other requested documents appropriate

here . Branch v. Tunnell. 14 F .3d 449, 454 (9th Cir .1994),

cert. denied, 512 U.S. 1219, 114 S .Ct. 2704, 129 L.Ed.2d

832 (1997) ; In re Calpine Corp . Sec. Lit. . 288 F.Supp .2d

1054, 1076 (N .D.Cal .2003). Accordingly, the Court takes

notice of all such documents .PN8

FN8. In its order dismissing the CAC the Court ju-

dicially noticed several of the documents for which

Defendants ask for judicial notice in this motion to

dismiss. (Amended Order Granting Defendants'

12(b)(6) Motion To Dismiss, 5 :20-21 . )

LEGAL STANDARDS

A. Rule 12(b)(6)

A court may dismiss a complaint pursuant to Federal Rule

of Civil Procedure 12(b)(6) for either lack of a cognizable

legal theory or the pleading of insufficient facts under an ad-

equate theory . Robertson v. Dean Witter Reynolds . Inc . . 749

F.2d 530, 533-34 (9th Cir.1984) . When deciding upon a mo-

tion to dismiss for failure to state a claim upon which relief

can be granted 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) . Moreover, a complaint

should not be dismissed unless the plaintiff could prove no

set of facts in support of his claim that would entitle that

plaintiff to relief. Id.

*5 In the context of a motion to dismiss, review is limited to

the contents of the complaint. Allarcom Pay Television. 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 con-

verted into one for summary judgment. Where such a con-

version takes place, all parties must be given an opportunity

to present all material made pertinent to such a motion by




Rule 56 . In re Pacific Gateway Exchange. Inc . Sec. Lit. . 169

F.Supp.2d 1160, 1164 (N.D.Cal .2001) ; see also

Fed.R.Civ.P . 12(bl . However, matters properly presented to

the court, such as those attached to the complaint and incor-

porated within its allegations, may be considered as part ofthe motion to dismiss . See Hal Roach Studies . Inc. v.

Richard Feiner & Co. . 896 F.2d 1542, 1555 n . 19 (9th

Cir .1989) .

Where a plaintiff fails to attach to the complaint documents

referred to in it, and upon which the complaint is premised,

a defendant may attach to the motion to dismiss such docu-

ments in order to show that they do not support the

plaintiffs claim . See Pacific Gateway Exchange. 169

F.Supp.2d at 1164 ; Branch. 14 F .3d at 454. Thus, the dis-

trict 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 a plaintiff "from surviving a Rule 12(b)(6)

motion by deliberately omitting references to documents

upon which [the] claims are based ." Parrino v. FHP. Inc. .

146 F .3d 699, 706 (9th Cir.1998) .

B. Section 10(b) And Rule lOb- 5

Section 10(b) of the Securities Exchange Act ("Act")

provides, in part, that it is unlawful "to use or employ in

connection with the purchase or sale of any security re-

gistered on a national securities exchange or any security

not so registered, any manipulative or deceptive device or

contrivance in contravention of such rules and regulations as

the [SEC] may prescribe ." 15 U.S .C . § 78i(bl .

Rule lob-5 makes it unlawful for any person to use inter-

state 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 state-

ments made, in the light of the circumstances under which

they were made, not misleading; or

(c) to engage in any act, practice, or course of business

which operates or would operate as a fraud or deceit upon

any person, in connection with the purchase or sale of any

security .

17 C .F . R. § 240 .10b-5 .

Page 5

To be actionable under section 10(b) and Rule lOb-5, a

plaintiff must allege 1) a misrepresentation or omission ; 2)

of material fact ; 3) made with scienter; 4) on which the

plaintiff justifiably relied ; 5) that proximately caused the al-

leged loss . See Binder v . Gillespie . 184 F .3d 1059, 1063

(9th Cir.1999) . Additionally, as in all actions alleging fraud,

plaintiffs must state with particularity the circumstances

constituting fraud. Fed.R.Civ.P . 9(b) .

C . Section 20(a)

*6 Section 20(a) of the Act provides derivative liability for

those who control others found to be primarily liable under

the Act. In re Ramp Networks . Inc. Sec. Lit. . 201 F.Supp .2d

1051, 1063 (N .D.Cal .2002). Where a plaintiff asserts a sec-

tion 20 (a) claim based on an underlying violation of section

10(b), the pleading requirements for both violations are the

same . Id.

D. Private Securities Litigation Reform Ac t

In 1995 , Congress enacted the PSLRA to provide

"protections to discourage frivolous [securities] litigation."

H.R. Conf. Rep. No . 104-469, 104th Conf., 1st Sess . at 32

(1995) (Nov. 28, 1995) . The PSLRA strengthened the

pleading requirements of Rules 8(a) and 2(b). Actions based

on allegations of material misstatements or omissions underthe PSLRA 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) .

The PSLRA also heightened the pleading threshold for

causes of action brought under Section 10(b) and Rule

lob-5 . Specifically, the PSLRA imposed st rict requirements

for pleading scienter. A complaint under the PSLRA must

"state with particularity facts giving rise to a strong infer-

ence that the defendant acted with the required state ofmind." 15 U.S .C . § 78u-4(b)(2) . The Ninth Circuit, in inter-

preting the PSLRA, has held that "a private securi ties

plaintiff proceeding under the [PSLRA] must plead, in great




detail, facts that constitute strong circumst antial evidence of

deliberately reckless or conscious misconduct ." In re Silicon

Graphics. Inc . Sec . Lit. . 183 F.3d 970 .974 (9th Cir.1999) . If

the complaint does not satisfy the pleading requirements of

the PSLRA, upon motion by the defendant, the court mustdismiss the complaint. See 15 U.S .C. § 78u-4(b)(1) .

ANALYSI S

After the Court dismissed Plaintiffs' TAC for failure to ad-

equately allege loss causation, Plaintiffs amended their com-

plaint on December 2, 2005 . Plaintiffs' amendments primar-

ily consist of allegations that market analysts predicted an

increase in Gilead's sales despite the overstock of Viread .

Again, Plaintiffs rely on three types of allegations to support

their Section 10(b) action: 1) Defendants' statements and

omissions regarding wholesaler overstocking ; 2) the alleged

financial impact of the off-label marketing scheme ; and 3)

the individual Defendants' own stock sales . Defendants

move the Court to dismiss the FAC with prejudice pursuant

to the PSLRA and Federal Rules of Civil Procedure 9(b)

and 12(b)(6) , arguing that Plaintiffs fail to adequately plead

loss causation, falsity, and scienter .

A. Loss Causation

Allegations of "loss causation" are a necessary element of a

§ 10(b) claim. Dura. 125 S .Ct . at 1631 . Merely alleging that

a misrepresentation caused an inflated purchase price does

not, without more, demonstrate loss causation . Id. at

1631-32 . It is insufficient for a misrepresentation to "touch

upon" an economic loss ; a plaintiff must demonstrate an ac-

tual "causal connection" between the defendant's material

misrepresentation and the economic loss suffered. Id. at

1632 . In other words, "to prove loss causation, the plaintiff

must demonstrate a causal connection between the deceptive

acts that form the basis for the claim of securities fraud and

the injury suffered by the plaintiff." Daou. 411 F.3d at 1025 .

*7 Defendants argue that Plaintiffs still have not established

a "causal connection" between the disclosure of the FDA's

warning letter (containing the off-label marketing allega-

tions) and the drop in Gilead's stock price . Defendants con-

tend that the additional information provided in the FAC has

added little to Plaintiffs' previous complaint, which insuffi-

ciently pled loss causation.

Page 6

In support of their position, Plaintiffs point to the following

allegations from the FAC : 1) Defendants' alleged off-label

marketing caused increased prescriptions and sales, which

caused legitimate demand due to "explosive growth" ; 2) De-

fendants' scheme was followed by the FDA Warning Letter

forbidding Gilead from engaging in off-label marketing ; and

3) this letter caused a slow down in demand for Viread,

which in turn caused a slow down in sales, resulting in a

stock price decline . According to Plaintiffs, the resulting

slow down in sales and consequential stock decline was

"foreseeable and well within the `zone of risk' concealed by

Defendants' [off-label marketing] ." (Plaintiffs' Corrected

Memorandum of Points and Authorities in Opposition to

Motion to Dismiss FAC at 17 :17 . )

As the Court found in its previous order, Plaintiffs' allega-

tions regarding loss causation are simply too attenuated .

Plaintiffs continue to allege that the disclosure of the August

8, 2003 FDA Warning Letter coupled with the announce-

ment of disappointing sales in the October 28, 2003 Press

Release shocked investors and caused the price of Gilead

stock to drop. 9 To satisfy the loss-causation requirement,

Plaintiffs must allege that the material misrepresentation

caused their loss . The fundamental problem with Plaintiffs'

allegations is that they require the Court to make the unreas-

onable inference that a public revelation on August 8 caused

a price drop three months later on October 28 . There was no

price drop immediately after the August 8 revelation . The

new allegations in Plaintiffs' FAC merely reinforce the

Court's finding regarding the reasonableness of this infer-

ence and do little to meet their loss causation pleading bur-

den.

FN9 . The Court noted in its Order that "this argu-

ment is flawed because the record reflects that in-

vestors never actually learned the extent of Defend-

ants' off-label marketing scheme ." (Order Granting

Motion to Dismiss at 12 :18-19, Doc . No. 136) .

Several of Plaintiffs' new allegations require the Court to

make unwarranted inferences that the FDA Warning Letter

was the cause of the lower demand for Viread . Plaintiffs at-

tempt to suppo rt these allegations with citations to general




conclusions in market analyst reports by Morgan Stanley,

Prudential, and Bear Stearns . Neither the new allegations

nor the market analyst reports help Plaintiffs' loss causation

claim. First, Plaintiffs' assertion that the FDA Warning Let-

ter was the cause of the lower demand for Viread still does

not establish a causal connection. Even if the FDA Warning

Letter caused practitioners to reduce their Viread supply,

Plaintiffs still fail to connect that with the drop in stock

price .

Additionally, the Court finds the market analyst reports

problematic because they undermine Plaintiffs' theory that

the disclosure led to a decrease in demand. The reports do

not predict a decrease in demand at all. Indeed, they suggest

that the demand for Viread would continue to grow .

(Defendants' Motion to Dismiss FAC at Ex . G.) Further, the

reports simply restated what Gilead had already stated in its

October 28, 2003 Press Release-that Viread would expect

lower end-user demand during the third quarter due to high-

er than normal inventories entering that quarter.

(Defendants' Motion to Dismiss FAC at Ex . G, I.) Thus, the

Court finds that the market analyst resorts do not shed any

new light on the loss causation issue.1V

FN10 . Defendants concede the demand for Viread

did not increase at the same rate in the third

quarter. The Court, however, finds a slowing in-

crease in demand, alone, too speculative to ad-

equately demonstrate loss causation.

*8 Plaintiffs correctly argue that the heightened pleading

standard does not apply to allegations that Defendants' mis-

representations caused their loss . Dura. 125 S.Ct at

1633-34 . However, Plaintiffs reliance on In re Parmalat

Sec . Litigation . 375 F.Supp.2d 278 (S .D.N.Y.2005), and

Teamsters Local 445 Freight Div. Pension Fund v. Bom-

bardier Inc ., 2005 U.S . Dist. LEXIS 19506 (S .D.N.Y. Sept.

6, 2005), to support the proposition that merely alleging a

corrective disclosure followed by a decline in stock price is

sufficient to plead loss causation, is misplaced . The Court

finds this case distinguishable from Parmalat and Teamsters

as the price drop in those cases occurred soon after the rev-

elation of the misrepresentation .l I Parmalat involved a

drop in securities price after disclosure of a fraud that under-

stated Parmalat's debt by virtually $10 billion and overstated

Page 7

the corporation's assets by over $16 billion. Parmalat. 375

F.Supp.2d at 282 . To support their allegations of securities

fraud, the plaintiffs alleged that the company's auditor, De-

loitte, issued two financial reports with the understated

debts and overstated assets. Id. at 307 . About eighteen

months later, Parmalat was unable to repay its bonds when

they became due and publicly disclosed that a $4 .9 billion

bank account it supposedly held did not exist . Id. at 284.

This was immediately followed by a drop in stock price . Id

at 307 . There the district court found the plaintiffs ad-

equately pled loss causation because the "[d]efendants reas-

onably could have foreseen that Parmalat's inability to ser-

vice its debt would lead to a financial collapse ." Id.

FNl1 . The Court has reviewed the other cases to

which Plaintiffs cite and finds them equally distin-

guishable .

Similarly , the plaintiff in Teamsters alleged senior manage-

ment of Bombardier Capital Inc . (`BCI"), a manufactured

housing asset- backed comp any , disregarded the companies'

underwriting standards in favor of high- risk loan s . Team-

sters, 2005 U . S. Dist . LEXIS 19506, at *7 . BCI did not dis-

close on its Form 8-K filing or otherwise its actual under-

writing practices and thus concealed the high-risk loans . Id.

at *6 . The high-risk loans turned into "bad loan s" and resul-

ted in a sharp increase in delinquencies and foreclosure on

BCI assets . Id. at *8 . As a result, BCI's stock certificates

suffered a p rice decrease of 38% in less than three months.

Id. at *7. There the district court found the plaintiff ad-

equately alleged loss causation :

Plaintiffhas alleged that its loss was caused when a risk that

was concealed by the defendants materialized in a foresee-

able chain of events . The Complaint alleges that defendants'

misrepresentations regarding rigorous underwriting con-

cealed the fact that the collateral pool contained a substan-

tial number of high risk loans . The concealed risk mate rial-

ized when the collateral pool expe rienced high delinquency

rates and repossession on a sustained basis . Not surpris-

ingly, BCI's earnings expectations then fell . BCI announced

that it would write off the losses , rating agencies down-

graded the Ce rtificates , and the value of plaintiffs invest-

ment declined. These allegations are sufficient to plead loss

causation.




*9 Id. at *57 .

The case before the Court, however, is substantially differ-

ent. Both Parmalat and Teamsters involved the omission

and subsequent disclosure of substantial corporate debt that

clearly related to the decline in stock value . A fundamental

principle of causation is "that the injury averred must pro-

ceed directly from the wrong alleged and must not be attrib-

utable to some supervening cause ." FN12 Marburygmt. .

Inc . v. Kohn. 629 F .2d 705, 716-17 (2d Cir.1980) (Meskill,

J., dissenting) . It is worth reiterating that the FDA letter be-

came public on August 7, 2003, and the loss which that rev-

elation allegedly caused occurred nearly three months later

on October 29, 2003 . Consequently, the Court is left to

speculate as to what portion, if any, of that decrease should

be attributed to the alleged misconduct and what should be

attributed to other market factors . A court need not indulge

unwarranted inferences in determining whether a plaintiff

has adequately pled a necessary element . In re Verii one Sec .

Lit. . 11 F .3d 865, 868 (9th Cir.1993 . Even viewed in the

light most favorable to Plaintiffs, Court finds that

Plaintiffs have not adequately pled, under Dura, that t~al-

leged misrepresentation proximately caused their loss .

Accordingly, the Court must dismiss the Complaint. FN 1 5

FN12 . There are too many logical and factual gaps

in Plaintiffs' allegations to support the conclusion

that Defendants' alleged misconduct proximately

caused Gilead's stock decrease in October . Dura .

125 S.Ct. at 1632 . The FAC does not connect the

following chain of events, which it must for

Plaintiffs to adequately plead loss causation: 1) that

Defendants' alleged failure to disclose the off-label

marketing scheme caused a material increase in

sales; 2) that practitioners materially decreased

their demand for Viread due to the publication of

the FDA Warning Letter; and most importantly, 3)

that the alleged decrease in sales due to the FDA

letter proximately caused Gilead's stock to decrease

three months later

FN13 . The Court must consider all reasonable in-

ferences to be drawn from the allegations,

"including inferences unfavorable to the plainiffs ."

Gompper v. VISX. Inc. . 298 F.3d 893, 897 (9th

Cir.2002 .

Page 8

FN14 . The Court distinguishes this case from

Daou. In Daou, the defendants fraudulently in-

flated their stock price through accounting methods

which violated Generally Accepted Accounting

Practices. Daou. 411 F .3d at 1012 . There, the Ninth

Circuit found loss causation because plaintiffs al-

leged a steep drop in stock price following disclos-

ure of Defendants' "true financial health." Id. at

1026 . Here, however, Plaintiffs have not ad-

equately connected the disclosure of Gilead's off-

label marketing and the drop in stock price in the

FAC. Indeed, the evidence Plaintiffs have presen-

ted to the Court only supports an inference that the

market gave little or no weight to the FDA Warn-

ing Letter.

FN15 . Because Plaintiffs have not adequately al-

leged loss causation, the Court need not consider

whether Plaintiffs have adequately alleged falsity

or scienter.

B. Rule 20 (a) Liability

Section 20(a) of the Securities Exchange Act provides de-

rivative liability for those who control others found to be

primarily liable under the Act. In re Ramp Networks. Inc.

Sec. Lit. . 201 F .Supp.2d at 1063. Where a plaintiff asserts a

Section 20(a) claim based on an underlying violation of

Section 10(b), the pleading requirements for both violations

are the same . Id. Because Plaintiffs have failed to ad-

equately plead the underlying lOb-5 violation, the Section

20(a) claims must be dismissed against the individual De-

fendants as well .

C. Dismissal With Prejudice

A court considers five factors in determining whether to dis-

miss a complaint with prejudice : 1) bad faith, 2) undue

delay, 3) prejudice to the opposing party, 4) futility of the

amendment, and 5 ) whether plaintiff has previously

amended his complaint. Allen v. City of Beverly Hills. 911

F.2d 367, 373 (9th Cir.1990) . A court's "discretion to deny

leave to amend is particularly broad where plaintiff has pre-




viously amended the complaint ." Id. (quoting Ascon Prop-

erties. Inc. v. Mobil Oil Co. . 866 F .2d 1149, 1160 (9th

Cir .1989 ) .

Plaintiffs have filed four amended complaints, and this is

the third complaint that the Court has dismissed . The Court

found that Plaintiffs failed to allege with the requisite detail,

falsity and scienter, when it dismissed Plaintiffs' CAC with

leave to amend. The Court dismissed the TAC for failure to

adequately plead loss causation, but it reiterated its concerns

regarding the sufficiency of Plaintiffs' falsity and scienter al-

legations . Because Daou was decided after Plaintiffs filed

their TAC, the Court again granted leave to amend with re-

spect to the issue of loss causation. Yet Plaintiffs still have

not adequately alleged loss causation after having had an-

other opportunity to do so . Since Plaintiffs have failed to

remedy the deficiencies of their allegations in each amended

version, the Court finds that further amendment is futile .

Accordingly, the Court DISMISSES the Complaint with

prejudice .

CONCLUSIO N

*10 After consideration of the FAC in light ofDura and the

requirements of Federal Rule of Civil Procedure 12(b)(6) ,

the Court GRANTS Defendants' 12(b)(6) Motion to Dis-

miss the FAC with prejudice .FN

16 The Clerk of the Court

is directed to close this case.

FN16 . Docket No. 140, filed December 22, 2005 .

IT IS SO ORDERED .

N.D.Cal .,2006 .

In re Gilead Sciences Securities Litigation

Slip Copy, 2006 WL 1320466 (N .D.Cal.), Fed. Sec. L . RepP 93,89 1

Briefs and Other Related Documents Back to top)

• 2006 WL 728109 (Trial Motion, Memorandum and Affi-

davit) Defendants' Corrected Reply Memorandum in Sup-

port of their Motion to Dismiss Plaintiffs' Fourth Consolid-

ated Amended Class Action Complaint (Feb . 6, 2006) Ori-

ginal Image of this Document (PDF)


Page 9

davit) Defendants' Reply Memorandum in Support of their

Motion to Dismiss Plaintiffs' Fourth Consolidated Amended

Class Action Complaint (Feb. 3, 2006) Original Image of

this Document (PDF )


davit) Plaintiffs Corrected Memorandum of Points and Au-

thorities in Opposition to Defendants' Motion to Dismiss the

Fourth Consolidated Amended Complaint (Jan . 20, 2006)

Original Image of this Document (PDF )


davit) Plaintiffs Memorandum of Points and Authorities in

Opposition to Defendants' Motion to Dismiss the Fourth

Consolidated Amended Complaint (Jan . 17, 2006) Original

Image of this Document (PDF)


davit) Class Action Defendants' Reply Memorandum in

Support of Their Motion to Dismiss Plaintiffs' Third Con-

solidated Amiended Class Action Complaint (Aug . 15,

2005) Original Image of this Document (PDF)


davit) Plaintiffs' Memorandum of Points and Authorities in

Opposition to Defendants' Motion to Dismiss the Third

Consolidated Amended Complaint (Jul. 11, 2005) Original



davit) Plaintiffs' Response to Defendants' Request for Judi-

cial Notice (Jul. 11, 2005) Original Image of this Document

(PDF)


davit) Plaintiffs' Memorandum of Points and Authorities in

Opposition to Defendants' Motion to Dismiss (Oct . 26,



davit) Plaintiffs' Response to Defendants' Request for Judi-

cial Notice (Oct. 26, 2004) Original Image of this Document

(PDF)


davit) Memorandum of Points and Authorities in Support of

Motion of Honhon Eichler and Duwayne D . Gadd for Ap-

pointment as Lead Plaintiffs, Approval of Lead Counsel,

and Consolidation of the Related Actions (Jan . 12, 2004)

Original Image of this Document (PDF )


davit) Memorandum in Support of the Motion of Trent St .




Clare for Appointment as Lead Plaintiff and for Approval of

Selection of Lead and Liaison Counsel (Jan . 12, 2004) Ori-


• 5 :04cv00100 (Docket) (Jan. 9, 2004)

• 3 :04cv00100 (Docket) (Jan. 9, 2004 )

• 2003 WL 23796185 (Trial Pleading) Class Action Com-

plaint for Violation of Federal Securities Laws (Dec . 23,


• 3 :03cv05805 (Docket) (Dec . 23, 2003)

• 3 :03cv05592 (Docket) (Dec . 12, 2003)

• 4:03cv05391 (Docket) (Dec . 1, 2003)

• 3 :03cv05391 (Docket) (Dec . 1, 2003 )


plaint for Violation of Federal Securities Laws (Nov. 27,


• 3 :03cv05113 (Docket) (Nov. 18, 2003 )


plaint for Violation of Federal Securities Laws (Nov. 17,


• 3 :03cv05088 (Docket) (Nov. 17, 2003 )• 2003 WL 23795765 (Trial Pleading) Class Action Com-

plaint for Violations of Federal Securities Laws Jury Trial

Demanded (Nov. 10, 2003) Original Image of this Docu-

ment (PDF )

• 2003 WL 23795794 (Trial Pleading) Consolidated

Amended Class Action Complaint for Violation of Federal

Securities Laws Demand for Jury Trial (Apr . 30, 2003) Ori-


END OF DOCUMENT

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IN THE UNITED STATES DISTRICT COURT

FOR THE NORTHERN DISTRICT OF CALIFORNIA

SAN JOSE DIVISION

In re IMPAX LABORATORIES, INC. SECURITIES LITIGATION

/

This Document Relates to All Actions /

NO. C 04-04802 JW

ORDER GRANTING DEFENDANTS'MOTION TO DISMISS WITH LEAVETO AMEND

I. INTRODUCTION

Plaintiffs filed a securities class action against Defendants IMPAX Laboratories, and certain

of Impax's senior officers and directors (collectively, "Defendants") for alleged violations of the

Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. Presently before the

Court is Defendants' motion to dismiss Plaintiffs' First Amended Consolidated Complaint ("FAC").

The Court held a hearing on Defendants' Motion on February 6, 2006. Based on the arguments of

counsel at the hearing and on the papers submitted, the Court GRANTS Defendants' Motion to

Dismiss without prejudice.

II. BACKGROUND

Plaintiffs filed the present suit against Defendants on behalf of all persons who purchased

Impax securities between May 5, 2004 and November 3, 2004 ("Class Period"), alleging violations

of the Securities Exchange Act of 1934 and Rule 10b-5. Lead Plaintiff United Food & Commercial

Workers Union Local 655, AFL-CIO, Food Employers Joint Pension Plan ("Union"), and named

Plaintiff Dr. Melvin M. Owen purchased Impax securities during the Class Period and claim losses

Case 5:04-cv-04802-JW Document 74 Filed 03/01/2006 Page 1 of 18Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 2 of 19

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as a result of Defendants' actions. FAC ¶ 8-9.

Defendant Impax is a pharmaceutical company that develops, sells, and markets generic

pharmaceuticals, including variations of bupropion hydrochloride ("bupropion"), which is the

generic version of Wellbutrin and Zyban. FAC ¶ 4, 10. Individual Defendants Barry R. Edwards,

Dr. Charles Hsiao, Dr. Larry Hsu, Cornel C. Spiegler, David S. Doll, and David J. Edwards are

directors and officers of Impax. FAC ¶ 11-17.

Although not a party to this action, Teva Pharmaceutical Industries. Ltd., ("Teva") plays an

important role in both Plaintiffs' and Defendants' versions of the events in dispute. Teva is a global

pharmaceutical company that entered into a Strategic Alliance Agreement ("SAA") with Impax in

2001. The SAA provided that Impax would supply Teva with all of its requirements for twelve

controlled-release generic products and Impax would share profits with Teva. FAC ¶ 22-23. Under

the SAA, Impax provided Teva with its requirements for the twelve products, and Teva acquired

exclusive marketing rights for several Impax products, including two bupropion products. FAC

¶ 22-23.

The following facts are alleged in the FAC: On May 5, 2004, Impax announced its first ever

profitable quarter ("1Q04"), and shares of Impax rose $3.70 on trading volume of almost 3.7 million

shares. On August 9, 2004, Impax again reported a profitable quarter ("2Q04"). The profits in

1Q04 and 2Q04 were due in significant part to the sales of bupropion products. FAC ¶ 26. On

November 3, 2004, Defendants disclosed that certain financial reports would be delayed to allow

Impax's independent auditors more time to complete their review of Impax's financial statements.

Plaintiffs allege that this news caused the price of Impax to drop 23% on a volume of 6.77 million

shares traded. FAC ¶ 3. On November 9, 2004, Impax announced a restatement of its financial

results for the first and second quarters of 2004 due to adjustments made as a result of consumer

credits granted in March 2004 by Teva on sales of Impax's bupropion products. Plaintiffs claim that

Defendants' actions caused an eventual decline in Impax's stock price.

According to Plaintiffs, Defendants inflated the 1Q04 and 2Q04 revenues and failed to


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accrue adequate reserves for Teva's customer credits on bupropion. Plaintiffs further allege that

Defendants caused a build-up of bupropion even though Impax was not the first-to-market with a

generic Wellbutrin. FAC ¶ 27-29. The build-up of excess inventory is purportedly of particular

importance because the two-year shelf life of bottled bupropion made the excess inventory obsolete

and rendered worthless any inventory returned by Teva's customers. FAC ¶ 29. The first claim for

relief in the FAC is for violation of 10(b) of the Securities and Exchange Act of 1934 and Rule 10b-

5 thereunder, by issuing false or misleading statements about Impax's reserves, revenues, and

income. The second claim for relief in the FAC alleges a violation of Section 20(a) of the 1934 Act

for the acts of Defendants as control persons directing the acts underlying liability for the first claim

for relief. Defendants filed the instant motion to dismiss pursuant to the Private Securities Litigation

Reform Act of 1995 ("PSLRA") and rules 9(b) and 12(b)(6) of the Federal Rules of Civil Procedure,

on the grounds that Plaintiffs have failed to plead their allegations with sufficient particularity.

III. STANDARDS

A. Federal Rules of Civil Procedure

A court may dismiss a complaint pursuant to Rule 12(b)(6) for pleading "insufficient facts

under a cognizable legal theory.” Robertson v. Dean Witter Reynolds, 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 conclusory allegations. Western Mining Council v. Watt, 643 F.2d 618, 624 (9th Cir. 1981),

cert. denied, 454 U.S. 1031 (1981); Kennedy v. H & M Landing, Inc., 529 F.2d 987, 989 (9th Cir.

1976).

In determining the motion to dismiss, the court is limited to the contents in the complaint.

Allarcom Pay Television, Ltd. v. General Instrument Corp., 69 F.3d 381, 385 (9th Cir. 1995).

Documents presented to the court as attached to the complaint and incorporated within its


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allegations, may be considered as part of the motion to dismiss. See Hal Roach Studios, Inc. v.

Richard Feiner & Co., 896 F.2d 1542, 1555 n.9 (9th Cir. 2989). Where a plaintiff fails to attach to

the complaint documents referred to therein, and upon which the complaint is premised, a defendant

may attached to the motion to dismiss such documents to show that they do not support the

plaintiff's claim. In re Pacific Gateway Exch., Inc. Sec. Litig., 169 F. Supp. 2d 1160, 1164 (N.D.

Cal. 2001).

Claims brought under Rule 10b-5 and Section 10(b) must also meet the particularity

requirements of Federal Rule of Civil Procedure Rule 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 mistake shall be stated with particularity."

B. Private Securities Litigation Reform Act of 1995

A violation of section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) and

SEC Rule 10b-5 thereunder, 17 C.F.R. § 240.10b-5 requires (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, 1265 S. Ct. 1627, 1631

(2005). The Private Securities Litigation Reform Act of 1995 (PSLRA) imposed heightened

pleading requirements in private securities fraud litigation by amending the 1934 Exchange Act to

require that a complaint "plead with particularity both falsity and scienter." In re Daou, 411 F.3d at

1014. Following the PSLRA, 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, 1985 (9th Cir. 2002). Private securities fraud plaintiffs

must now also “state with particularity all facts which give rise to a strong inference that the

defendant acted with the required state of mind,” which is “intentionally or with deliberate

recklessness.” 15 U.S.C. § 78 u-5(b)(2); In re Silicon Graphics Sec. Litig., 183 F.3d 970, 974 (9th


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Cir. 1999) (facts must come closer to demonstrating intent as opposed to mere motive and

opportunity); Ronconi v. Larkin, 253 F.3d 423, 429 (9th Cir. 2001). In an "unusual deviation from

the usually lenient requirements of federal rules pleading," Ronconi v. Larkin, 253 F.3d at 427, a

court in a private securities fraud "must consider all reasonable inferences to be drawn from the

allegations, including inferences unfavorable to the plaintiffs" to determine "whether, on balance,

the plaintiffs' complaint gives rise to a reasonable inference of scienter." Gompper v. VISX, Inc.,

298 F.3d 893, 897 (9th Cir. 2002); Lipton v. PathoGenesis Corp., 284 F.3d 1027, 1038 (9th Cir.

2002).

IV. DISCUSSION

Defendants challenge the particularity and sufficiency of Plaintiffs' pleadings with regards to

scienter, loss causation, and the ancillary issue of control group liability.

A. Scienter

Tracing backwards the causal chain in the FAC, it appears to the Court that Plaintiffs claim

stock losses arising out of the market's reaction to Defendants' restatement of its reports for 1Q04

and 2Q04. The need for Defendants to restate reports, in turn, allegedly arose from Defendants'

inflation of revenues for 1Q04 and 2Q04, and various business practices which failed to mitigate the

gap between the inflated figures and the restated figures. According to Plaintiffs, this inflation of

revenues for 1Q04 and 2Q04 and the gap between the inflated figures and the restated figures was a

result of Defendants' failure to account for the customer credits given by Teva. During the period in

which revenues were inflated, Defendants allegedly made false and misleading statements regarding

Impax's financial condition.

In order for Plaintiffs to plead a "strong inference" DSAM Global Value Fund v. Altris

Software, 288 F.3d 385, 391 (9th Cir. 2002), that Defendant acted with scienter as to this purported

scheme, Plaintiffs must allege that Defendants knew or were deliberately reckless in not knowing

that the revenues were inflated at the time the false or misleading statements were made. In support

of its contention that Defendants acted with scienter, Plaintiffs allege facts regarding Defendants'


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1 The SAA is in the record at Def. Request for Judicial Notice, Exh. A, and shall be cited inthis Order as "SAA." The SAA was specifically referenced to in the FAC, and the Court finds that itis sufficiently probative on Plaintiffs' claims to admit and refer to Defendants' submission of thecontract.

2 Section 11.3 of the SAA at p. 24 reads: "Within thirty (30) days following each CalendarQuarter during the Supply Term, Teva shall compute and report to Impax in a mutually acceptableformat the Net Sales and Profit for each Product in each country in the Territory during thatCalendar Quarter. . . . In addition, within seven (7) business days after the end of each month, Tevashall provide to Impax information (which could be good faith estimates if final data is notavailable) as to the amount of Net Sales, Profit, and number of units sold of each Product during thatmonth."

6

operational control, accounting violations, certifications of financial reports, insider trading,

compensation package, and Impax's insufficient reserves and excessive inventory. In assessing

whether Plaintiffs have sufficiently pled a strong inference of scienter, the Court considers all

reasonable inferences, whether or not favorable to the plaintiff. Gompper v. VISX, Inc., 298 F.3d

893, 897 (9th Cir. 2002).

1. Strategic Alliance Agreement

As an initial matter, taking Plaintiffs' allegation for the source of the inflated revenues as

true, the terms of the SAA between Impax and Teva seriously undercut an inference that Defendants

knew or were deliberately reckless in not accounting for customer credits given by Teva.1 To the

contrary, a reading of the plain language in the SAA suggests that Teva, not Impax, had the

obligation to take into account the customer credits that Teva issued to Teva's customers. The FAC

alleges that Impax granted Teva exclusive marketing rights for its bupropion products, "shared with

Teva in the gross margins from its sale of the products," and "[r]evenues from the sale of bupropion

hydrochloride accounted for approximately 61% of Impax's quarterly total revenues" in 1Q04. FAC

¶ 24, 26. Under the SAA, Teva was required to report "Net Sales and Profit" to Impax on a periodic

basis.2 The SAA specifies the calculation of "net sales" as:

[O]n a Product-by-Product basis, the gross amount invoiced for each of the Productssold by Teva or Teva's affiliates on a arms-length basis in each country in theTerritory, less the sum of: (a) trade, quantity and/or cash discounts, allowances,rebates, retroactive price adjustments, free goods, bad debts, cash incentive payments(e.g. slotting allowance), and chargebacks; (b) credits or refunds for rejected,outdated or returned Product; (d) cost of short dated product, which is destroyed by


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3 At oral argument, counsel for Plaintiffs indicated that there is an accounting distinctionbetween "other specifically identifiable amounts included in the Product's gross sales that will havebeen or ultimately will be credited," and amounts which will ultimately be credited but are perhapsnot "specifically identifiable." Pleading facts which support such a distinction would addparticularity to Plaintiffs' allegations that Defendants acted with scienter in not taking into accountTeva's customer credits to Teva's customers, and failing to maintain an adequate reserve despite theterms of the SAA.

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Teva or its Affiliateds; (e) three percent (3%) as a contribution towards selling,administrative and other similar expenses of Teva; and (f) other specificallyidentifiable amounts included in the Product's gross sales that will have been orultimately will be credited and are substantially similar to those listed above; in eachcase determined in accordance with U.S. GAAP.

The calculation mandated by the SAA requires that net sales be reduced by an amount included in

gross sales that "ultimately will be credited." Plaintiffs have not alleged any facts which would

indicate that the customer credits would not reasonably fall into this category.3

Thus, in order for Plaintiffs to meet their burden of proving a strong inference of scienter, the

seemingly plain language of the SAA which requires Teva to report their customer credits to Impax.

In other words, Plaintiffs must plead facts which give rise to a strong inference that Defendants

knew or were deliberately reckless in not knowing that Teva was not accounting for customer credits

as seemingly required by the SAA.

2. Operational Control

The FAC alleges that Defendants acted with scienter based on Defendants' role as senior

management in a relatively small company. Impax had 453 employees as of February 27, 2004, and

only fourteen directors and executive officers. (FAC ¶ 78). As an initial matter, a statement that "the

Individual Defendants as the managers of a small company [are] likely to know of details related to

its most significant strategic alliance partner, Teva," is insufficient, without more to meet the

heightened pleading standards of the PSLRA. See In re Silicon Graphics Sec. Litig., 183 F.3d 970,

974 (9th Cir. 1999) (plaintiffs must plead a strong inference, not merely a reasonable inference of

scienter).

Plaintiffs use confidential witnesses to support their allegation that Defendants acted with

scienter by virtue of their status as directors and/or officers in a relatively small company. In the


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4 CW3, as described in the FAC, is "a manufacturing technician employed immediately priorto the class period." In this Circuit, confidential witnesses for securities complaints must be"described with sufficient particularity to support the probability that a person in the positionoccupied by the source would possess the information alleged and the complaint contains adequatecorroborating details." In re Daou, 411 F.3d at 1015 (citations omitted). It is unclear to the Courtthat a person in the position of a manufacturing technician would have knowledge about the travelplans of the company's senior management, and Plaintiffs have not alleged any other corroboratingfacts which would shed light on this matter.

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FAC, CW4, a human resource executive at Impax employed prior to the Class Period, states that all

of the Individual Defendants were involved in all aspects of the business because "with a small

company, senior leaders had to be involved in the details." FAC ¶ 78. Also according to CW4 and

CW34, senior management attended quarterly meetings at which some defendants "made a Microsoft

PowerPoint presentation that showed the results of the previous quarter and detailed plans for the

next quarter." General allegations of "hands-on" or "day-to-day" involvement are insufficient bases

for scienter. In re Autodesk, Inc. Sec. Litig., 132 F. Supp. 2d 833, 843-44 (N.D. Cal. 2000)

(presuming knowledge based on "hands-on" positions would "eliminate the necessity for specially

pleading scienter, as any corporate officer could be said to possess the requisite knowledge by virtue

of his or her position"). The presence of confidential witnesses to verbalize this general allegation

does not render the general allegation any more particularized.

Furthermore, even confidential witnesses' references in this case to specific Defendants are

insufficiently particular to support a strong inference of scienter. As to Defendant Dr. Larry Hsu,

the FAC relies on CW2 to support an allegation that "several departments reported directly to Dr.

Hsu...Dr. Hsu sat in on high-level interviews in these departments. Dr. Hsu, thus, controlled

significant departments at Impax." FAC ¶ 13. Such general allegations, even if about a particular

defendant, are insufficient to support a strong inference of scienter that Dr. Hsu knew or was

deliberately reckless in not knowing that the revenues for 1Q04 and 2Q04 were inflated.

Similarly, the FAC cites the statements of CW6, a staff accountant throughout the Class

Period, as allegations of scienter as to Defendants Doll and Spiegler. According to CW6,

Defendants Doll and Spiegler received "daily sales numbers," where "daily sales to Teva were


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shown on the sales report as the manufacturing cost of the product shipped, and that at month end,

Teva would tell Impax how much product had actually been sold to its customers." FAC ¶ 90.

Assuming that a staff accountant would know whether senior management at Impax reviews the

daily sales numbers, Plaintiffs have not alleged with sufficient particularity that these sales numbers

showing sales to Teva would be probative of the numbers actually at issue --namely, revenues

generated by Teva's sales to Teva's customers, or any credits that Teva might have given. Thus, the

statements of CW6 do not lead to a strong inference of scienter as to Defendants Doll and Spiegler.

In a related allegation, Plaintiffs claim that the "only reasonable inference" (FAC ¶ 75) to be

drawn from CFO Defendant Spiegler's December 2004 resignation from Impax is that he knew of

Impax's accounting violations and that "the proximity of this announcement to the restatement

demonstrates that Spiegler's retirement was no coincidence." FAC ¶ 14(c). Plaintiffs have not

provided particularized allegations beyond this conclusory statement. This District does not,

without more, permit an inference of scienter from the termination of a corporate officer. In re U.S.

Aggregates, Inc. Sec. Litig., 235 F. Supp. 2d 1063, 1074 (N.D. Cal. 2002).

In short, Plaintiffs have not alleged with sufficient particularity to support a strong inference

of scienter that Defendants, by virtue of their status within Impax, acted with scienter with regards to

the 1Q04 and 2Q04 revenues.

3. Accounting Violations

Plaintiffs allege that Defendants violated various accounting rules including internal

accounting practices, SEC rules, and federal accounting standards, in reporting or incorporating the

inflated 1Q04 and 2Q04 revenues. It is well established that even a deliberate violation of GAAP,

without more, is insufficient to establish the requisite scienter. In re Daou, 411 F.3d at 1022 (citing

In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1426 (9th Cir. 1994)). However, "significant

violations of GAAP standards can provide evidence of scienter so long as they are pled with

particularity." In re McKesson HBOC, Inc. Sec. Litig., 126 F. Supp. 2d 1248, 1273 (N.D. Cal.

2000).


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The particularity standards for permitting a strong inference of scienter to be drawn from

GAAP violations do not obviate the requirement that a defendant knew or was reckless in not

knowing of the factors underlying the particularly alleged GAAP violations. Plaintiffs argue that

they have met their burden of pleading scienter because they have met the particularity pleading

standard stated in Daou and first articulated in McKesson which requires: "(1) such basic details as

the approximate amount by which revenues and earnings were overstated; (2) the products involved

in the contingent transaction; (3) the dates of any of the transactions; or (4) the identities of any of

the customers or [company] employees involved in the transaction." In re Daou, 411 F.3d 1016

(citing In re McKesson 126 F. Supp. 2d at 1273) (alterations in In re McKesson). This is an

incomplete application of Daou. In Daou, the Ninth Circuit discussed the McKesson standards in

the section labeled "Material Misrepresentations or Omissions." Scienter was addressed in a

separate section which considered factors beyond pleading materiality with particularity. For

example, the court in Daou recognized that the plaintiffs' complaint stated: "CW9, a regional Sales

Vice President at Daou, confirmed that defendants G. Daou, D. Daou, and McNeill not only made

the decision on how much revenue to recognize without regard to any actual percentage of

completion, but directed the practice of automatically recognizing revenue upon contract signing and

ordering of equipment." The language in the "Scienter" section of Daou indicates that the

application of the rule in McKesson requires pleading with particularity as well as a showing that

defendants knew of the facts from which scienter could be inferred. See also In re U.S. Aggregates,

Inc. Sec. Litig., 235 F. Supp. 2d 1063, 1073 (N.D. Cal. 2002) (finding that plaintiffs relying on

McKesson must also show that the restatement was sizeable and the plaintiff must also plead

additional, specific allegations that the defendants had actual knowledge of relevant facts from

which scienter could be inferred).

Even assuming that there were violations of GAAP, the Court finds that Plaintiffs have not

met their burden of showing a strong inference of scienter. The restatement in this case was only for

two quarters, and in the end, Impax restated first quarter revenues by 11% and second quarter


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revenues by less than one-tenth of one percent. Additionally, Plaintiffs have not alleged operational

control by the Defendants with sufficient particularity to support a finding of scienter. See

discussion, supra. See also In re Daou, 411 F.3d at 1023 (basing its determination that the plaintiffs

had pled scienter as to GAAP violations with sufficient particularity on a finding that "plaintiffs

have alleged with specificity that the top executives actually directed the improper revenue

recognition in violation of both GAAP and their own accounting practices"). Particularly given the

reasonable implications of the SAA, the size of the restatement, and the failure to allege Defendants'

operational control with specificity, Plaintiffs have fallen short of pleading that the various alleged

accounting violations provide the requisite scienter. Conclusory allegations of accounting fraud may

not be bootstrapped into proof of intentional or reckless conduct. In re McKesson, 126 F. Supp. 2d

at 1273.

4. Certifications of SEC Filings

Sections 302 and 906 of the Sarbanes Oxley Act requires certain control persons to certify

annual and quarterly reports to the SEC. Defendants certified the 10-Q reports for 1Q04 and 2Q04.

Plaintiffs argue that the FAC contains a strong inference of scienter because it alleges that

Defendants "could not file § 302 certifications under Sarbanes-Oxley without knowing these crucial

details" about the accounting violations. (Pl. Opp. at 2.) Pursuant to § 906, Defendants B. Edwards

and Spiegler certified that "based on [their] knowledge, this quarterly report does not contain any

untrue statement of material fact" and "based on [their] knowledge, the financial statements, and

other financial information included in this quarterly report, fairly present, in all material respects,

the financial condition, results of operations, and cash flows of the registrant as of, and for, the

periods presented in this quarterly report." FAC ¶ 91. Although the text of the certification declares

knowledge, proving up scienter for the figures contained within in this fashion is bootstrapping at

best.

The § 302 certification signed by Defendants B. Edwards and Spiegler certify that the

certifying officers have designed disclosure controls and procedures in accordance with Exchange


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5 It is unclear to this Court whether such a violation could be asserted.

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Act Rules 12a-14 and 15d-14 and evaluated the effectiveness of these disclosure controls and

procedures. There is no knowledge requirement regarding the disclosure controls and procedures

requirement for § 302, but Plaintiffs have not alleged a separate cause of action for failure to

maintain disclosure controls and procedures under § 302.5 Because Plaintiffs have not alleged a

separate violation for the failure to maintain proper disclosure controls and procedures and scienter

for accounting violations in inflating revenue may not be bootstrapped from the signing of these

certifications, Plaintiffs may not base scienter for a 10b-5 violation solely on the signing of a § 302

or § 906 certification.

5. Insider Trading

Significant and suspicious insider trading may be probative of scienter. No. 84

Employer-Teamster Joint Council Pension Trust Fund v. America West Holding Corp., 320 F.3d

920, 944 (9th Cir. 2003). In considering whether stock sales by insiders raise an inference of

scienter a court is to consider "(1) the amount and percentage of shares sold by insiders; (2) the

timing of the sales; and (3) whether the sales were consistent with the insider's prior trading history."

In re Silicon Graphics, 183 F.3d at 986.

a. Magnitude

Under Plaintiffs' calculations, Defendants Doll, B. Edwards, D. Edwards, and Spiegler

disposed of 93%, 98%, 100% and 84% of their shares, respectively, during the Class Period. FAC

¶ 83. Although Plaintiffs exaggerate the magnitude of insider trading in the FAC in erroneously

excluding non-exercised exercisable options from the total number of shares owned as required by

In re Silicon Graphics,183 F.3d at 986-87 ("actual stock shares plus exercisable stock options

represent the owner's trading potential more accurately than the stock shares alone"), the insider

trading in this case occurred in no small quantity. The properly calculated percentage of shares

traded, however, generally falls below the threshold at which a Court finds the trading sufficiently

suspicious to create a strong inference of scienter. The trading of Defendants Spiegler and Doll who


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sold 46% and 36% of their available holdings would be suspicious were it not for the small quantity

of shares actually sold. See In re Silicon Graphics, 183 F.3d at 987 (insider's sale of 43.6% of

holdings not suspicious because the sales were only 5% of total insider sales). Defendants Spiegler

and Doll owned significantly far less stock and exercisable options than the other Defendants,

Spiegler's sales represented only 4% of the shares sold by all Defendants, while Doll's sales

represented only 2%.

Defendant D. Edwards, under Plaintiffs' calculations, sold 100% of his stock during the Class

Period. According to Defendants, Defendant D. Edwards sold 0% of his stock during the relevant

period. This discrepancy is due to Defendants' definition of the relevant period as only those sales

which occurred on June 7, 2004 when Defendants Doll, B. Edwards, and Spiegler sold their shares.

Plaintiffs allege scienter based on Defendants stock sales during the period in which the revenues

were inflated. Accordingly, the stock sales by Defendant D. Edwards on May 12, 2004 and May 13,

2004 are a part of Plaintiffs' allegations of scienter based on insider trading during the Class Period.

b. Timing

The FAC alleges that the Defendants' stock sales occurred at a time when the Defendants

knew that the share price was inflated and would decline once the true concealed facts became

public. In Lipton v. PathoGenesis Corp., the Ninth Circuit held that an insider's sale of stock after

announcement of positive quarterly results did not give rise to a finding of scienter, particularly

where the percentage sold was low. 284 F.3d 1027, 1037 (9th Cir. 2002). In this case, Defendants'

sales were made in the month following Impax's first ever profitable quarter, a time at which one

would expect some stock sales even absent fraudulently inflated revenues. Even though Defendants'

Doll, B. Edwards, and Spiegler sold their shares on June 7, 2004, Plaintiffs have not alleged facts

which would indicate the date is of particular importance, or that there was a coordinated effort by

three Defendants to unload stock at once.

Defendant D. Edwards sold his shares on May 12, 2004 and May 13, 2004. The Court does

not reach the question of whether Plaintiffs may allege scienter on behalf of all Defendants based on


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Defendant D. Edwards's stock sales during the class period. However, the sale of 100% of a

director's stock during the class period may be relevant to Plaintiffs' allegations that a Defendant

acted with scienter.

c. Relative to Prior Trading History

The FAC's allegations regarding Defendants' prior trading patterns are unclear. This Court is

not obligated to draw all inferences in favor of Plaintiff despite their failure to plead facts necessary

to their position. See In re Vantive Corp. Sec. Litig., 283 F.3d 1079, 1095 (9th Cir. 2002) ("when a

complaint fails to provide us with a meaningful trading history for purposes of comparison, we have

been reluctant to attribute significance to the defendant's stock sales").

6. Contingent Compensation

The related allegation that Defendants had a motive to commit fraud based on their

compensation packages are also insufficient to support a strong inference of scienter. Such

legitimate motives concerning compensation as tied to financial performance are shared by virtually

all corporations and their officers. See Lipton, 284 F.3d at 1038 ("if scienter could be pleaded

merely by alleging that officers and directors possess motive and opportunity to enhance a

company's business prospects, virtually every company in the United States that experiences a

downturn in stock price could be forced to defend securities fraud actions") (citations omitted).

Accordingly, allegations of such general applicability do not meet the heightened pleading

requirements of the PSLRA.

7. Insufficient Reserves and Failure to be First to Market

Plaintiffs have not alleged sufficient particular facts to support their allegations regarding

insufficient reserves and failure of Impax's generic Wellbutrin to be first to market. Plaintiffs claim

that the reserve level and failure to be first to market are material facts which should have been

disclosed or facts which support a finding of scienter as to inflated revenue. Plaintiffs allege that

Defendants knew that excessive inventory of bupropion products was inevitable because the

introduction of a new product may have required Impax to make a proportionate upward adjustment


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to its reserve provisions due to: (1) the newness of the product; (2) the uncertainty of revenues

associated with the new product particularly in light of Impax's failure to be first-to-market; (3) the

lack of a historical basis upon which to base reserves; and (4) restrictions imposed by the product

having a limited shelf life. FAC ¶ 40. These factors, however, are insufficient to support a strong

inference of an actual intent to defraud. See In re Silicon Graphics, 183 F.3d at 974. In other words,

even if Impax's inventory at some point in time was excessive it does not follow that Impax's

reported revenues were inflated as a result thereof or, more importantly, that Defendants knew of or

deliberately caused the inflation.

8. Totality of the Allegations

Where the complaint's allegations, considered individually, do not raise a strong inference of

scienter, the Court may consider whether the allegations in the aggregate give rise to a strong

inference of scienter. In re Daou, 411 F.3d at 1015. Given the reasonable implications of the SAA,

namely that Teva did not have to inform Impax about Teva's customer credits or Teva's own failure

to maintain a reserve, an evaluation of "all reasonable inferences to be drawn from the allegations,

including inferences unfavorable to the plaintiffs" Gompper, 298 F.3d at 897, indicates that the FAC

still falls short of a strong inference of scienter.

B. Loss Causation

Plaintiffs must also prove that a defendant’s securities fraud caused their economic loss. 15

U.S.C. § 78u-4(b)(4). The statute provides, in relevant part, the following:

Loss causation. In any private action arising under this chapter, the plaintiff shall have theburden of proving that the act or omission of the defendant alleged to violate this chaptercaused the loss for which the plaintiff seeks to recover damages.

Id. Recently, the Supreme Court in Dura clarified the loss causation pleading and proof requirement

in securities fraud cases as the “causal connection between the material misrepresentation and the

loss.” Dura Pharmaceuticals, Inc. v. Broudo, 125 S. Ct. 1627, 1631 (2005). The Dura court held that

a plaintiff could not satisfy loss causation merely by alleging (and later establishing) that the price of

the securities on the date of the purchase was inflated because of misrepresentation. Id. at 1627. In


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applying the Dura framework, the Ninth Circuit recognized that pleading loss causation is a difficult

task. In re Daou Systems, Inc., 411 F.3d 1006, 1014 (9th Cir. 2005). After assessing plaintiffs’

complaint, the Daou court found that the complaint adequately pled loss causation because the

allegations, if assumed true, were sufficient to provide the defendant “with some indication that the

drop in Daou’s stock price was causally related to Daou’s financial misstatements reflecting its

practice of prematurely recognizing revenue before it was earned.” Id. at 1026. The complaint

alleged that once the defendants began to reveal figures showing the company’s true financial

condition, “the result of prematurely recognizing revenue before it was earned, led to a ‘dramatic,

negative effect on 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 the 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 concluded that the plaintiffs adequately pled loss

causation.

The FAC alleges that Defendants' November 3, 2004 disclosure to the market signaled

difficulties in connection with Impax's bupropion products and overall financial health and was a

precursor to the additional announcement on November 9, 2004. The November 3, 2004

announcement stated that there was to be a delay in the release of its third quarter results. On the

same day, Andrx Corporation announced that it would lower its third quarter revenues due to credits

Teva had given on bupropion. The FAC alleges that following the November 3, 2004

announcement, the price of Impax stock fell $2.93 to $10.07, a drop of 23%. However, on

November 9, 2004, when Impax actually announced that it would be restating its results for the first

two quarters, its stock price increased and within two days exceeded the pre-November 3 closing

price.

Although the Court will not reach the loss causation argument at this time, the Court notes

that any amended complaint would benefit from an explanation as to any causal connection between


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the restatements and Plaintiffs' alleged economic loss despite the recovery of Impax's stock price

between November 9, 2004 and November 11, 2004. The FAC also includes facts about Impax's

delisting from NASDAQ and reissuance of debentures at a higher interest rate, FAC ¶ 6, but at oral

argument, Plaintiffs' counsel acknowledged that these facts are not the source of Plaintiffs' economic

loss.

C. Control Person Liability

To support a violation of Section 20(a), a plaintiff must prove: (1) "a primary violation of

federal securities law" and (2) "that the defendant exercised actual power or control over the primary

violator." Howard v. Everex Sys., Inc., 228 F.3d 1057, 1065 (9th Cir. 2000). "[I]n order to make out

a prima facie case, it is not necessary to show actual participation or the exercise of power; however,

a defendant is entitled to a good faith defense if he can show no scienter and an effective lack of

participation." Id.

Defendants argue that control person liability does not exist in this case because there is no

primary violation of a federal securities law. Currently, Plaintiffs have not met the heightened

pleading requirements for pleading a primary violation of a federal securities law under the PSLRA.

Accordingly, the dependent control person liability claim is also dismissed with leave to amend.

V. CONCLUSION

For the reasons stated above, the FAC is dismissed without prejudice. Should Plaintiffs wish

to file for leave to file a second amended consolidated complaint consistent with this Order,

Plaintiffs shall so move on or before April 21, 2006. The proposed amended complaint shall be

attached to any motion for leave to file an amended complaint.

Dated: March 1, 200604cv4802mtd

/s/ James Ware JAMES WAREUnited States District Judge


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THIS IS TO CERTIFY THAT COPIES OF THIS ORDER HAVE BEEN DELIVERED TO:

Azra Z. Mehdi [email protected] E. Barnes [email protected] J. Robbins [email protected] P. Lin [email protected] Otto Click [email protected] Winkler [email protected] J. Coughlin [email protected] S. Green [email protected] Eve Scarlett [email protected] Lynn McCormick [email protected] S. Lerach [email protected] E. Radcliffe [email protected]

Kerry Brainard600 New Hampshire Avenue, N.W.Washington, DC 20037

Michael Joseph600 New Hampshire Avenue, N.W.Washington, DC 20037

Dated: March 1, 2006 Richard W. Wieking, Clerk

By:_/s/ JW Chambers__________Melissa PeraltaCourtroom Deputy


TAB 6



IN RE INVISION TECHNOLOGIES, INC. SECURITIES LITIGATION

No. C04--03181 MJJ

UNITED STATES DISTRICT COURT FOR THE NORTHERN DISTRICT OFCALIFORNIA

2006 U.S. Dist. LEXIS 12166; Fed. Sec. L. Rep. (CCH) P93,674

January 21, 2006, DecidedJanuary 24, 2006, Filed

COUNSEL: [*1] For Regis Engelken, individuallyand on behalf of all others similarly situated, Plaintiff:Robert S. Green, 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 A. Binkow,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, Tanya Herrera,Emmett C. Stanton, Fenwick & West LLP, MountainView, CA.

For Sergio Magistri, Ross Mulholland, Defendants:Catherine Duden--Kevane, Susan Samuels Muck, JenniferCorinne Bretan, Fenwick & West LLP, San Francisco,CA; Songmee L. Connolly, Tanya Herrera, Emmett C.Stanton, Fenwick & West LLP, Mountain View, CA.

For GLAZER FUNDS, Movant: Lionel Z. Glancy,Glancy & Binkow LLP, Los Angeles, CA; Susan G.Kupfer, Glancy & Binkow LLP, San Francisco, CA;Jeffrey S. Abraham, Abraham, Fruchter & Twersky, LLP,New York, NY; Tanya Herrera, Fenwick & West LLP,Mountain View, CA; Michael M. Goldberg, Glancy &Binkow LLP, Los Angeles, CA.

JUDGES: MARTIN [*2] J. JENKINS, UNITEDSTATES DISTRICT JUDGE.

OPINIONBY: MARTIN J. JENKINS

OPINION:

ORDER GRANTING DEFENDANTS'MOTION TO DISMISS PLAINTIFFS' AMENDEDCONSOLIDATED COMPLAINT

INTRODUCTION

Before the Court is Defendants' Motion to Dismissthe Amended Consolidated Complaint. DefendantsInVision Technologies, Inc. ("InVision"), Sergio Magistri("Magistri"), and Ross Mulholland's ("Mulholland") (col-lectively "Defendants") move to dismiss this private se-curities fraud action pursuant toRule 12(b)(6) of theFederal Rules of Civil Procedure.Lead Plaintiffs GlazerCapital Management, LP and Glazer Offshore Fund, Ltd.("Plaintiffs"), oppose the motion. After careful considera-tion of the arguments of counsel and the papers submitted,the Court GRANTS Defendants' Motion to Dismiss withleave to amend the Complaint.

FACTUAL BACKGROUND

A. Background

InVision manufactures and supplies computer tomog-raphy based detection products used in aviation secu-rity. Plaintiffs represent a purported class of all pur-chasers of InVision securities between March 15, 2004and July 30, 2004 (the "Class Period"). Plaintiffs allegethat Defendants committed[*3] securities fraud in viola-tion of section 10(b)of the Securities and Exchange Actof 1934 ("Exchange Act"),Rule 10b--5of the Securitiesand Exchange Commission ("SEC"), andsection 20(a)ofthe Exchange Act. Defendants Magistri and Mulholland(collectively the "Individual Defendants") were employedat InVision during the class period. Defendant Magistriserved as the President and Chief Executive Officer ofInVision during the class period. Defendant Mulhollandserved as InVision's Chief Financial Officer during thattime

On March 15, 2004, InVision issued a press releaseannouncing that it was being acquired by General ElectricCompany ("GE") (the "March 15 Announcement"). OnJuly 30, 2004, InVision issued a press release that it hadmet with the U.S. Department of Justice ("DOJ") and the



Securities and Exchange Commission ("SEC") to discusspossible violations of the Foreign Corrupt Practices Act("FCPA"). The DOJ and the SEC were investigating sev-eral transactions involving InVision employees locatedabroad, in which employees allegedly made payments toforeign officials in violation of the FCPA.

On December 6, 2004, InVision and GE completedthe merger. On that same day, InVision[*4] issued apress release announcing that it had entered into settle-ments with the DOJ and the SEC resolving the FCPAinvestigation.

B. Alleged Misstatements

Plaintiffs cite three statements alleged to have vio-lated the Exchange Act. Plaintiffs allege that the March15, 2004 Merger Announcement contained false state-ments. The announcement stated that the "acquisition issubject to normal closing conditions including customaryregulatory approval."

On March 15, 2004, the same day that InVision an-nounced its proposed merger with GE, InVision filed itsForm 10--K for the fiscal year 2003 (the "2003 10--K").Included with the 2003 10--K was a certification, pur-suant to the Sarbanes--Oxley Act of 2002 ("Sarbanes--Oxley Certification"), signed by Magistri.

According to the Complaint, the certification stated, inrelevant part:

The registrant's other certifying officerand I are responsible for establishing andmaintaining disclosure controls and proce-dures and have . . . designed such disclosurecontrols and procedures to ensure that ma-terial information . . . is made known to usby others within those entitities, . . . [and][e]valuated the effectiveness of the regis-trant's [*5] disclosure controls and proce-dures. [We] have disclosed . . . [a]ny fraud,whether or not material, that involves man-agement or other employees who have a sig-nificant role in the registrant's internal controlover financial reporting.

Complaint, P 26, Quoting the Sarbanes--Oxley certi-fication for the 2003 10--K

Also on March 15, 2004, InVision filed a copy of themerger agreement between InVision and GE (the "MergerAgreement"). According to the Complaint, the MergerAgreement stated, in relevant part:

The Company and its Subsidiaries are(and since January 1, 2002 have been) in

compliance in all material respects withall laws(including common law), statutes,ordinances, codes, rules,regulations,decrees and orders of GovernmentalAuthorities(collectively, "Laws") applicableto the Company or any of its Subsidiaries,any of their properties or other assets or anyof their businesses or operations (includingthose Laws related to Export ControlRequirements and improper payments).

Complaint P 28, Quoting the March 15, 2004Merger Agreement

Plaintiffs also cite other statements in their complaint,including InVision's 10--Q report for the third quarter 2002(the[*6] "Third Quarter 2002 10--Q") filed November 12,2002, InVision's Form 10--K for the fiscal year 2002 (the"2002 10--K") filed March 27, 2003, and InVision's 10--Qreport for the second quarter 2004 (the "Second Quarter2004 10--Q") filed August 6, 2004.SeeComplaint P 36,40,46. n1

n1 Defendants argue that these statements arenot actionable because they were made outside ofthe Class Period, citingIn re Clearly CanadianSec. Litig., 875 F. Supp. 1410, 1420 (N.D. Cal.1995). However, Plaintiffs are not asserting secu-rities fraud claims based upon the truth or falsityof these statements. Rather, these statements weresubmitted in support of the falsity of other state-ments made within the Class Period. To the ex-tent that these statements are used to demonstratethe truth or falsity of Class Period statements, theyare relevant.See, In re Scholastic Corp. SecuritiesLitigation, 252 F.3d 63, 72 (2d Cir. 2001)(findingpre--class statements could be relevant in demon-strating the falsity of class period statements.)

[*7]

LEGAL STANDARD

A court may dismiss a complaint pursuant toFederalRule of Civil Procedure 12(b)(6)if a plaintiff pleads in-sufficient facts under an adequate theory.Robertson v.Dean Witter Reynolds, Inc., 749 F.2d 530, 533--34 (9thCir. 1984). When deciding a motion to dismiss pursuantto Rule 12(b)(6), a court must take all of the material al-legations in the plaintiffs complaint as true, and construethem in the light most favorable to the plaintiff.ParksSchool of Business, Inc. v. Symington, 51 F.3d 1480, 1484(9th Cir. 1995).

In the context of a motion to dismiss, review is limitedto the contents of the complaint.Allarcom Pay Television,



Ltd. v. General Instrument Corp., 69 F.3d 381, 385 (9thCir. 1995). When matters outside the pleading are pre-sented to and accepted by the court, the motion to dismissis converted into one for summary judgment. However,matters properly presented to the court, such as thoseattached to the complaint and incorporated within its al-legations, may be considered as part of the motion todismiss.See Hal Roach Studios, Inc. v. Richard Feiner& Co., 896 F.2d 1542, 1555 n.19 (9th Cir. 1989).[*8]Where a plaintiff fails to attach to the complaint docu-ments referred to therein, and upon which the complaintis premised, a defendant may attach to the motion to dis-miss such documents in order to show that they do notsupport the plaintiff's claim.See In re Pac. Gateway Exch.,Inc. Sec. Litig., 169 F. Supp. 2d 1160 at 1164; Branch v.Tunnell, 14 F.3d 449, 453 (9th Cir. 1994)(overruled onother grounds). Thus, the district court may consider thefull texts of documents that the complaint only quotes inpart. 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 plain-tiffs "from surviving aRule 12(b)(6)motion by deliber-ately omitting references to documents upon which theirclaims are based."Parrino v. FHP, Inc., 146 F.3d 699, 705(9th Cir. 1998).

Rule 8(a) of the Federal Rules of Civil Procedureonlyrequires "a short and plain statement of the claim show-ing that the pleader is entitled to relief." Accordingly,motions to dismiss for failure to state a claim pursuant toRule 12(b)(6)are typically disfavored;[*9] complaintsare construed liberally to set forth some basis for relief,as long as they provide basic notice to the defendants ofthe 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 however, the pleading re-quirements are more stringent.

1. Securities Fraud Under§ 10(b)of the Exchange Actand SECRule 10b--5

Plaintiffs have alleged securities fraud in violation ofsection 10(b)andSEC Rule 10b--5. Undersection 10(b)it is unlawful "to use or employ in connection with thepurchase or sale of any security registered on a nationalsecurities exchange or any security not so registered, anymanipulative or deceptive device or contrivance in con-travention of such rules and regulations as the [SEC] mayprescribe."15 U.S.C. § 78j(b). Rule 10b--5, promulgatedunderSection 10(b), makes it unlawful for any personto use interstate commerce: (a) to employ any device,scheme, or artifice to defraud; (b) to make any untruestatement of material fact or to omit to state a materialfact necessary in order to make the statements made, inthe light of the circumstances[*10] under which they

were made, not misleading; or (c) to engage in any act,practice, or course of business which operates or wouldoperate as a fraud or deceit upon any person, in connec-tion with the purchase or sale of any security.17 C.F.R. §240.10b--5. The elements of aRule 10b--5violation are:(1) a misrepresentation or omission; (2) of material fact;(3) made with scienter; (4) on which the plaintiff justifi-ably 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 undersection 10(b), a com-plaint must overcome several pleading barriers. First,when alleging fraud,Rule 9(b) of the Federal Rules ofCivil Procedurerequires plaintiffs to state with particu-larity the circumstances constituting the fraud. To meetthe heightened pleading requirements ofRule 9(b), a fraudclaim must contain three elements: (1) the time, place,and content of the alleged misrepresentations; and (2) anexplanation as to why the statement or omission com-plained of was false or misleading.In re GlenFed, Inc.Sec. Litig., 42 F.3d 1541, 1547--49 (9th Cir. 1994).[*11]

Next, a plaintiff must overcome the heightened plead-ing requirements of the Private Securities LitigationReform Act (the "PSLRA"). Congress enacted thePSLRA in 1995 to provide "protections to discouragefrivolous [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 allegedto have been misleading, the reason or reasons why thestatement is misleading, and, if an allegation regardingthe statement or omission is made on information and be-lief, the complaint shall state with particularity all factson 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, acomplaint must "state with particularity facts giving riseto a strong inference that the defendant acted with the re-quired state of mind."15 U.S.C. § 78u--4(b)(2). The NinthCircuit, in interpreting the PSLRA, has held that "a privatesecurities plaintiff proceeding under the [PSLRA] mustplead, in great detail, facts that constitute[*12] strongcircumstantial evidence of deliberately reckless or con-scious misconduct."In re Silicon Graphics Inc., 183 F.3d970, 974 (9th Cir. 1999). If the complaint does not satisfythe pleading requirements of the PSLRA, upon motion bythe defendant, the court must dismiss the complaint.See15 U.S.C. § 78u--4(b)(1).

Even if a plaintiff overcomes the falsity and scien-ter pleading barriers, the PSLRA's Safe Harbor provi-sion provides that a securities fraud claim may not liewith respect to a statement that is "identified as a for-



ward--looking statement, and is accompanied by mean-ingful cautionary statements identifying important factorsthat could cause actual results to differ materially fromthose 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 CouncilPension Trust Fund v. America West Holding Corp., 320F.3d 920, 936 (9th Cir. 2003); but see In re SeebeyondTechnologies Corp. Sec. Litig., 266 F. Supp. 2d 1150,1164--65 (C.D. Cal. 2003)[*13] (disagreeing with theanalysis inAmerica Westand finding that a defendant isimmune from liability if it satisfies either15 U.S.C. §78u--5(c)(1)(A)or (B)).

ANALYSIS

A. The March 15, 2004 Merger Announcement

1. Falsity and Scienter

In order for a complaint to allege securities fraud, "aplaintiff must set forth more than the neutral facts nec-essary to identify the transaction. The plaintiff must setforth what is false or misleading about a statement, andwhy it is false. In other words, the plaintiff must set forthan explanation as to why the statement or omission com-plained of was false or misleading."In re GlenFed Sec.Litig., 42 F.3d 1541, 1548 (9th Cir. 1994).

In the instant case, Plaintiffs have failed to pleadspecific facts indicating exactly how the March 15Announcement was false or misleading. Plaintiffs citethe following language:

We're excited to become part of GE[.] . . .This transaction will improve market reach ofthe merged companies and accelerate devel-opment of technology and products to pro-tect the public worldwide. I look forward toInVision's scientists working with GE's[*14]Global Research Center and GE's CT medi-cal imaging capabilities . . . The acquisitionis subject to normal closing conditions in-cluding customary regulatory approval.

March 15 Announcement

Plaintiff's complaint does not adequately specifywhat exactly is false or misleading about this statement.Plaintiffs cite paragraphs 58 and 71, contending that theseallegations are sufficient to meet this pleading require-ment. The Court does not agree. The language citedby Plaintiffs contains broad assertions about Defendants'duty to disclose that are vague in nature. They are not

specifically directed to the March 15 Announcement, andthey do not explain why that statement in particular wasfalse or misleading. Under the PSLRA, plaintiffs mustclearly plead, for each and every statement, why the thatstatement was false or misleading.Id. A plaintiff doesnot meet this burden by citing general allegations whichare not directed to particular statements.Id. Here, on theface of the Complaint, it is not possible to discern pre-cisely what is false or misleading about the March 15Announcement.

In order to meet the scienter pleading requirement,Plaintiffs must plead facts showing[*15] that Defendantsknew that each statement was untrue or misleading at thetime they were made.Yourish v. California Amplifier,191 F.3d 983, 994 (9th Cir. 1999). This prevents a"fraud by hindsight" situation, in which a statement ismade, and later turns out to be false.In re CopperMountain Securities Litigation, 311 F.Supp.2d 857, 866(N.D.Cal.,2004). Plaintiffs must therefore, plead specific,contemporaneous facts specifying that as of March 15,2004, the date of the Merger Announcement, Defendantsknew that statements made therein were false or mislead-ing. Plaintiffs have failed to do so in the Complaint beforethe Court.

2. Safe Harbor

The PSLRA created a safe--harbor for liability forstatements which were forward--looking and accompa-nied by meaningful warnings of risk.15 U.S.C. § 78u--5(c). However, a person may be held liable if the for-ward--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 CouncilPension Trust Fund v. America West Holding Corp., 320F.3d 920, 936 (9th Cir. 2003). [*16]

Defendants argue that the March 15 Announcementfits squarely within the safe--harbor provision of thePSLRA. "A forward--looking statement is any statementregarding (1) financial projections, (2) plans and objec-tives of management for future operations, (3) future eco-nomic performance, or (4) the assumptions underlyingor related to' any of these issues."America West, 320F.3d 936. The Court agrees that the statement is forward--looking for the purposes of the safe--harbor provision.The March 15 Announcement describes the operationalexpectations for the upcoming merger and falls within thesafe--harbor provision of the PSLRA as it was accompa-nied by meaningful cautionary language.

Plaintiffs argue that "allegations based upon omis-sions of existing facts or circumstances do not constituteforward--looking statements protected by the safe harbor. . ." Opposition 12:7--9. For this proposition, they cite



America West, 320 F.3d. at 936--7, andIn re ESS Tech.,Inc. Secs. Litig., 2005 U.S. Dist. LEXIS 2593 at *15 (N.D.Cal. 2005). However, the Court has reviewed these casesand has determined that they do not address the issue athand ---- [*17] whether the safe--harbor provision does ordoes not cover statements alleged to be misleading due toomissions of existing facts or circumstances.

Although the Court finds that the March 15Announcement is "forward--looking" for the purposes ofthe PSLRA, the Court is unable to decide whether thesafe--harbor provision protects the statement from liabil-ity. This is because, as discussed above, it is not clear fromthe face of the Complaint exactly what about the March15 Announcement it is that Plaintiffs allege is false ormisleading. Until that issue is clarified, the Court cannotrule on the issue of safe--harbor immunity.

B. The Sarbanes--Oxley Certifications and theMerger Agreement+

1. Falsity

The Sarbanes--Oxley Certifications contain state-ments to the effect that Defendants: 1) designed andmaintained disclosure controls; 2) evaluated the effective-ness of these disclosure controls; 3) disclosed any changein the registrant's internal control over financial report-ing; 4) disclosed all significant deficiencies and materialweaknesses in the design or operation of internal controlover financial reporting; 5) disclosed any fraud that in-volves management or other employees[*18] who havea significant role over financial reporting.

It is not clear from the Complaint precisely whichof these statements Plaintiffs allege to be false or mis-leading. Although the Complaint contains general alle-gations, none of these plead facts clearly contradictingstatements actually made within the Sarbanes--Oxley cer-tifications. For example, Plaintiffs' complaint states thatInVision "did not . . . maintain a system of internal con-trols adequate to uncover unlawful activities or to insurecompliance with . . . the FCPA." Complaint, P 52. It is notobvious to which of the above statements this allegation isdirected. Nowhere in the Sarbanes--Oxley Certificationsdo Defendants make any statements regarding the ade-quacy of systems designed to insure compliance with theFCPA. The Certifications do assert that Defendants havedisclosed all material weaknesses related tofinancial re-porting controlsknown by Defendants at the time thestatement was made. However, Plaintiffs' allegations donot in any way contract this point.

In order for the Court to construe the allegations,as plead, as actually alleging the falsity of Defendants'Certification statements, the Court would have[*19] tointerpret Defendants' statements well beyond their plain

meaning. n2 The Court declines to do so. For each state-ment identified, Plaintiffs are required by the PSLRA toplead facts indicating why that statement is false or mis-leading.GlenFed, 42 F.3d at 1548. Obviously, Plaintiffs'factual allegations must be based upon what Defendantsactuallysaid, not upon Plaintiffs' desired interpretation ofwhat Defendants said. Here Plaintiffs' factual allegations,even viewed in the light most favorable to Plaintiffs, do notin any way illuminate the truth or falsity of Defendants'actual Certification statements. Therefore, Plaintiffs havefailed to meet their PLSRA burden in this respect.

n2 Under Plaintiffs' apparent reading, the Courtwould have to read Defendants' statement to saythat Defendants warranted the presence of systemswhich were adequate to uncover any and all im-proper conduct, even conduct outside the realm offinancial reporting. Defendants said no such thing.

2. Scienter [*20]

Under the PSLRA, plaintiffs must plead, in detail,specific facts that give rise to a strong inference that de-fendants acted with scienter.Ronconi v. Larkin, 253 F.3d423, 429 (9th Cir. 2001). Plaintiffs allege the following insupport of an inference of scienter: 1) that the DOJ FCPAsettlement agreement between InVision and the DOJ con-tained language to the effect that InVision was aware of ahigh probability that potential FCPA violations were oc-curring; 2) InVision lacked certain internal control mech-anisms; 3) the alleged FCPA violations followed similarpatterns, thereby allegedly necessitating the approval ofmanagement; 4) the alleged FCPA violations were im-properly recorded in InVision's financial statements; 5)the Individual Defendants had motive to withhold infor-mation about the alleged FCPA violations. (Complaint, P67--71; 77--78).

Defendants argue that Plaintiffs fail to plead any sub-stantial facts with respect to the Individual Defendants andthe requisite state of mind. Other than general assertionsabout the Individual Defendants' roles and responsibilitiesand motivations, Plaintiffs do not plead specific facts tosupport the allegation that Magistri[*21] or Mulhollandactually knew about the FCPA violations between Marchand July 2004. 3 Defendants contend that it is improper toinfer that defendants Magistri or Mulholland had knowl-edge of certain information merely by virtue of theirposition within the company, citingIn re Syncor Int'lCorp. Secs. Litig., 327 F. Supp. 2d 1149, 1160 (D. Cal.2004)for support. The Court agrees. There are insufficientfacts alleged to infer that Magistri or Mulholland had anyknowledge of the alleged FCPA violations in light of thePLSRA's heightened scienter requirements. n3



n3 Plaintiffs citeIn re Lattice SemiconductorCorp. Secs. Litig, 2006 U.S. Dist. LEXIS 262 (D. Or.2006)for the proposition that the Court should im-pute scienter as to Magistri and Mulholland basedupon their Sarbanes Oxley certifications. Plaintiffs'reliance onLattice is misplaced as that case pre-sented a significantly greater number of facts con-cerning the inference on scienter than exists in theinstant case. InLattice, the plaintiffs' allegationsdemonstrated that the company's former controller"made improper journal entries with the knowledgeof at least some of the individual defendants."Id.at 32. Moreover, theLatticeplaintiffs provided ev-idence of specific internal reports, databases andmeetings, the purpose of which was to keep theindividual defendants informed of the company'sfinancial situation during the relevant time period.Additionally, theLattice defendants allegedly ad-mitted that the improper accounting entries whichformed the basis of the plaintiff's claim were theresult of deficiencies in the company's internal dis-closure controls. In contrast, in the instant case,Plaintiffs have not alleged any such similar factsconcerning actual knowledge on the part of theIndividual Defendants, nor have they alleged factslinking the Sarbanes Oxley certifications to later ad-missions of improper financial disclosure controls.Accordingly,Lattice is inapposite.

[*22]

Similarly, the Court rejects Plaintiffs' contention thatscienter should be imputed to Invision based upon thescienter allegations concerning Magistri and Mulholland.Plaintiffs' allegations are inadequate to create an infer-ence of corporate scienter on the part of InVision.In reApple Computer, Inc., 243 F. Supp. 2d 1012, 1023 (ND.Cal. 2002)("A defendant corporation is deemed to havethe requisite scienter for fraud only if the individual cor-porate officer making the statement has the requisite levelof scienter, i.e., knows that the statement is false, or is atleast deliberately reckless as to its falsity, at the time thathe or she makes the statement . . . the Ninth Circuit hasrejected the concept of "collective scienter" in attributingscienter to a corporation.");Nordstrom, Inc. v. Chubb &Son, Inc., 54 F.3d 1424, 1435--6 (9th Cir. 1995).

C. Dismissal Without Prejudice

Leave to amend underFederal Rule of Civil Procedure15should be liberally granted. "Dismissal with prejudiceand without leave to amend is not appropriate unless itis clear . . . that the complaint could not be saved[*23]by amendment."Eminence Capital v. Aspeon Inc., 316F.3d 1048, 1053 (9th Cir. 2003)(error to refuse leaveto amend in a securities fraud case to allow plaintiff toplead scienter). Here, it is possible that Plaintiffs couldremedy their significant pleading defects in an amendedcomplaint by adding detailed factual support for their alle-gations of false or misleading statements, and demonstrat-ing that Defendants had the requisite scienter at the timethe statements were made. The Court therebyGRANTSthe motion to dismiss the Amended Complaint withoutprejudice.

CONCLUSION

After consideration of the Amended Complaint inlight of the heightened pleading standards of the PSLRAand the requirements ofFederal Rule of Civil Procedure12(b)(6), the CourtGRANTS Defendants' Motion toDismiss the Amended Complaint with leave to amend.n4 Plaintiffs must file any amended complaint within 30days of the filing of this order. Should Plaintiffs choose toamend their complaint, Plaintiffs must: 1) Clearly iden-tify the precise portions of each statement that is allegedto be false; 2) Immediately thereafter, plead specific[*24]facts clearly indicating that the statement was false, andfacts clearly indicating that Plaintiffs acted with the req-uisite state of mind; 3) and plead any other facts requiredby the PLSRA with the requisite particularity. Vague as-sertions and allegations, scattered throughout Plaintiffs'Complaint will not serve to meet their PLSRA burden.

n4 Granting Docket No. 51, Motion to Dismiss.

IT IS SO ORDERED.

Dated: January 21, 2006

MARTIN J. JENKINS



TAB 7


Slip Copy Page 1Slip Copy, 2005 WL 3050970 (D.Conn.), Fed. Sec. L. Rep. P 93,586 (Cite as: Slip Copy)

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

Briefs and Other Related Documents

United States District Court,D. Connecticut.

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).

Nov. 10, 2005.

David Randell Scott, Erin Green Comite, Scott & Scott, Colchester, CT, for Plaintiffs. Christopher M. Curran, J. Mark Gidley, Peter J. Carney, Jaime M. Crowe, White & Case, Washington, DC, Donna Nelson Heller, Patrick J. McHugh, Finn Dixon & Herling, Stamford, CT, for Defendants.

MEMORANDUM OF DECISION SQUATRITO, J. *1 Lead plaintiffs, Irene Rucker and Gustav Rucker, bring this action on behalf of a putative class of purchasers of defendant Stolt-Nielsen S.A.'s (“SNSA”) American Depository Receipts (“ADRs”) for the period of May 31, 2000 through February 20, 2003 pursuant to Sections 10(b), 15 U.S.C. § 78j(b), and 20(a), 15 U.S.C. § 78t, of the Securities Exchange Act of 1934 (“the Exchange Act”), as amended by the Private Securities Litigation 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., Jacob Stolt-Nielsen, Niels G. Stolt-Nielsen, Samuel Cooperman, and Reginald J.R. Lee. Defendants have filed a motion to dismiss (dkt.# 29) all counts of the Consolidated Amended Class Action Complaint. For the reasons set forth herein, defendants' motion (dkt.# 29) is GRANTED.

I. FACTS

The following facts are alleged in the Consolidated Amended Class Action Complaint (hereinafter “complaint” or cited as “Dkt. # 28, ¶ ___”), are set forth in documents incorporated by reference into the

complaint, or are found in Stolt's public disclosure documents, or in other materials properly considered because plaintiffs have relied upon them in crafting their allegations. See Rothman v. Gregor, 220 F.3d 81, 88-89 (2d Cir.2000); In re Hunter Environmental Services, Inc. Securities Litigation, 921 F.Supp. 914, 917-18 (D.Conn.1996).

SNSA is a holding company that, through its subsidiaries, engages in worldwide transportation, storage, and distribution of bulk liquid chemicals and other similar materials. Greenwich, Connecticut based Stolt-Nielsen Transportation Group, Inc. (“SNTG”) is a subsidiary wholly owned by Stolt that engages in Stolt's business of liquid chemical transportation on worldwide seaborne trade routes. Jacob Stolt-Nielsen is the founder and current Chairman of SNSA, and Niels G. Stolt-Nielsen is the Chief Executive Officer of SNSA. Samuel Cooperman has been the Chairman of SNTG and Reginald J.R. Lee has been SNTG's Chief Executive Officer during the time period relevant to plaintiffs' claims.

At issue in this case is Stolt's FN1

transportation of bulk liquid chemicals. SNTG is one of the largest parcel tanker operators in the world, and several of SNTG's largest customers are among the world's major chemical companies. As described by Stolt,

FN1.

Where the distinction between SNSA and SNTG serves no purpose, the court will refer to SNSA and SNTG collectively as “Stolt.”

[t]he parcel tanker industry occupies a market niche in the worldwide tanker trade and represents only about 5% of the [deadweight tons] of the international tanker fleet. Unlike crude oil tankers which generally load a full cargo at one port for one customer and discharge at one destination, parcel tankers, as the name implies, carry many cargoes (as many as 58 parcels) for many customers on the same voyage and load and discharge cargo at many ports. A parcel tanker may carry a wide range of bulk liquids shipped in parcels of several hundred to several thousand tons each. (Dkt. # 33 Ex. B at 4). SNTG's parcel tankers typically transport lots greater than 150 metric tons in size. SNTG also transports bulk liquid chemicals by




using tank containers, which are smaller (24,000 liter maximum capacity) than the parcels used in SNTG's parcel tankers (100,000 liter minimum capacity) and can be transported by ship, rail car, or truck.

*2 Plaintiffs allege that, for the period of May 31, 2000 FN2

through February 20, 2003, Stolt engaged in

a scheme to fix shipping rates, rig bids, and allocate customers. According to newspaper articles and the affidavit of Special Agent John Sharp of the Federal Bureau of Investigation submitted in support of a criminal complaint filed against Richard Wingfield, SNTG's Managing Director, Tanker Trading Division, certain Stolt employees made agreements with major competitors of Stolt to coordinate bidding and divide customer contracts between themselves. Stolt employees allegedly met with employees of Stolt's competitors for this purpose on several different occasions, exchanged customer lists, and either purposefully did not bid on contracts to allow its competitors to gain the business or submitted artificially high bids to drive the contract price upward for the benefit of other parties to this anti-competitive arrangement.

FN2.

Plaintiffs also allege that Stolt may have begun its anti-competitive conduct as early as 1998.

Plaintiffs also allege that, for the period of May 31, 2000 through February 20, 2003, Stolt illegally shipped goods to and from countries such as Iran, Sudan, and Cuba that are subject to a U.S. trade embargo. Plaintiffs allege that Stolt, through U.S.-based SNTG employees, was actively involved in trade to these countries in violation of U.S. embargoes.

The value of Stolt's ADRs FN3

was adversely effected after news of these allegations became public. On November 22, 2002, published reports stated that the U.S. Department of the Treasury had been investigating SNTG to determine if SNTG had engaged in trade with certain nations in violation of U.S. trade embargoes. Stolt's ADRs dropped from the price of $7.62 per share to $6.50 per share after the publication of these reports. On February 20, 2003, published reports recounted the allegations of price-fixing and anti-competitive conduct, and the price of Stolt's ADRs dropped from $7.10 per share to $5.94 per share.

FN3.

An ADR is a “financial instrument[ ]

that allow[s] investors in the United States to purchase and sell stock in foreign corporations in a simpler and more secure manner than trading in the underlying security in a foreign market.” Pinker v. Roche Holdings Ltd., 292 F.3d 361, 365 (3rd Cir.2002). “ADRs are tradeable in the same manner as any other registered American security, may be listed on any of the major exchanges in the United States or traded over the counter, and are subject to the Securities Act and the Exchange Act.” Id. at 367.

Plaintiffs claim that a number of statements made by defendants during the class period were false or misleading because of these undisclosed illegal activities. Specifically, plaintiffs claim that the following statements were false or misleading in light of Stolt's clandestine illegal conduct: • “[t]he Company's businesses are subject to international conventions and U.S. and other governmental regulations which strictly regulate various aspects of the Company's operations,” (dkt. # 28, ¶ 61 (May 31, 2000, May 31, 2001, and May 31, 2002); see also id., ¶ 67 (October 26, 2001)); • “[s]hipments in the year 2000 increased from the downturn encountered in 1999. Increases were primarily the result of improved demand in three main operating regions of Asia Pacific, Europe and the United States. Shipment levels in 2001 continue to reflect improved demand particularly from the United States and Asia,” (id., ¶ ¶ 63 & 65 (October 26, 2001)); • “[g]rowth of 5% is anticipated in 2002 as a result of increased marketing and sales efforts in all regions,” (id., ¶ ¶ 64 & 72 (May 31, 2002)); *3 • “[t]he market for the integrated transportation and logistics services provided by SNTG is in its infancy. In providing such services, SNTG competes primarily with a few other terminal and transport companies who are developing such services.... SNTG's tanker operations compete with operators based primarily in Europe and the Asia Pacific region.... The competition in the tank container market is fragmented, although the relative size of the competition is increasing on a worldwide basis. SNTG also competes, to a lesser extent, with tank container leasing companies,” (id., ¶ 66 (October 26, 2001)); • “[e]xcluding the restructuring charges, the Stolt-Nielsen Transportation Group reported results on par with the first quarter of last year. Income from operations for SNTG's parcel tanker division was $20.5 million in the first quarter of 2002 compared to




$20.3 million in the first quarter of 2001.... Contracts of affreightment continue to be renewed at higher levels and SNTG recently renewed a multi-year contract for one of its largest customers. We are anticipating a pickup in rates in the second half of the year and throughout 2003 as the world economies continue their recovery[.] ... SNTG's tank container operations income improved to $4.7 million in the first quarter of 2002 compared to $2.7 million in the first quarter of last year. While shipments in the first quarter were similar to the comparable quarter last year, utilization rose to 71.1% compared to 67.7% last year. For the remainder of the year we anticipate seeing continued pressure on pricing while utilization should be similar to what we saw in the first quarter. We still see shipments for the year growing 5% compared to 2001,” (id., ¶ 68 (March 27, 2002)); • “[d]uring 2000, SNTG entered into co-service agreements with two Parcel tanker companies, Tokyo Marine and Seatrans, to improve the scheduling of SNTG's fleets, and increase operational efficiency and customer service. In January 2002, SNTG announced an additional co-service agreement with Jo Tankers. * * *SNTG personnel coordinate most of the marketing and sales efforts directly with SNTG's parcel tanker customers,” (id., ¶ 70 (May 31, 2002)); • “SNTG's strategy is to build a global network to take care of our customers' every bulk liquid logistic need from door to door throughout the world and to be the low cost provider of such services,” (id., ¶ 73 (May 31, 2002)); • “[w]hile the results in the second quarter for the Stolt-Nielsen Transportation Group were down compared to last year, our core contract business, particularly for specialty chemicals, remains healthy. We continue to see improvements in Stolt Offshore's results,” (id., ¶ 74 (June 26, 2002)); • “SNTG's tank container division's income from operations improved significantly to $6.3 million in the second quarter of 2002 compared to $4.0 million in the same quarter of 2001. Utilization in the second quarter compared to the same period last year rose 7.0% to 74.4%. Shipments are up some 6% although pricing continues to be tight,” (id. (June 26, 2002)); and *4 • “[t]he Stolt-Nielsen Transportation Group posted a solid quarter [.] ... SNTG's tank container division delivered another strong result with income from operations rising to $6.2 million from $5.6 million in the comparable quarter of 2001. Year-to-date shipments are up some 10% compared to last year and utilization in the third quarter hit a record level of 77.7% although the business continues to see a tight pricing environment,” (id., ¶ 76 (October 8, 2002)).

Plaintiffs claim that defendants' failure to disclose Stolt's alleged anti-competitive conduct or its alleged actions taken in violation of U.S. trade embargoes rendered these statements misleading.

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-5

promulgated thereunder against Stolt and the individual defendants; and (2) violation of 15 U.S.C. § 78t

against the individual defendants. Defendants seek dismissal of each count pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure.

A. STANDARD

When considering a Rule 12(b)(6)

motion to dismiss, the court accepts as true all factual allegations in the complaint and draws inferences from these allegations in the light most favorable to the plaintiff. See Scheur v. Rhodes, 416 U.S. 232, 236, 94 S.Ct. 1683, 40 L.Ed.2d 90 (1974); Bernheim v. Litt, 79 F.3d 318, 321 (2d Cir.1996). Dismissal is warranted only if, under any set of facts that the plaintiff can prove consistent with the allegations, it is clear that no relief can be granted. See Hishon v. King & Spaulding, 467 U.S. 69, 73, 104 S.Ct. 2229, 81 L.Ed.2d 59 (1984); Cooper v. Parsky, 140 F.3d 433, 440 (2d Cir.1998). “The issue on a motion to dismiss is not whether the plaintiff will prevail, but whether the plaintiff is entitled to offer evidence to support his or her claims.” United States v. Yale New Haven Hosp., 727 F.Supp. 784, 786 (D.Conn.1990)

(citing Scheuer, 416 U.S. at 232).

In its review of a motion to dismiss, the court may consider “only the facts alleged in the pleadings, documents attached as exhibits or incorporated by reference in the pleadings and matters of which judicial notice may be taken.” Samuels v. Air Transport Local 504, 992 F.2d 12, 15 (2d Cir.1993).

B. SECTION 10(b) CLAIM

Plaintiffs allege that defendants engaged in fraudulent conduct that affected the purchase or sale of Stolt's ADRs. Specifically, plaintiffs claim that defendants had a duty to disclose to the investing public the nature and scope of their anti-competitive agreements with other parcel tanker companies and the extent of its operations in nations subject to U.S.




trade embargo, such as Cuba, Iran, and Sudan. Defendants argue that they had no such duty to disclose this information, and that, even if a duty did arise, plaintiffs have not alleged that defendants acted with the requisite state of mind.

Section 10 of the Securities Exchange Act of 1934 provides, in pertinent part, that *5 It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange-

(b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, or any securities-based swap agreement (as defined in section 206B of the Gramm-Leach-Bliley Act), any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.

15 U.S.C. § 78j. Rule 10b-5, which was promulgated under the authority of Section 10, provides the following:It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange, (a) To employ any device, scheme, or artifice to defraud, (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.

17 C.F.R. § 240.10b-5. “For a plaintiff to state a viable cause of action for securities fraud under § 10(b), 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5(b), the complaint must allege that in connection with the purchase or sale of securities, defendant, acting with scienter, either made a false material representation or omitted to disclose material information so that plaintiff-acting in reliance either on defendant's false representation or its failure to disclose material information-suffered

injury and damages.” In re Scholastic Corp. Sec. Litig., 252 F.3d 63, 69 (2d Cir.2001).

In order to adequately establish the substantive elements of a violation of Rule 10b-5, plaintiffs must meet the pleading standard set forth in Rule 9(b) of the Federal Rules of Civil Procedure, the PSLRA, and precedent from the Court of Appeals for the Second Circuit. With respect to the existence of false or misleading statements, in order to meet Rule 9(b)'s requirement that “[i]n all averments of fraud or mistake, the circumstances of fraud or mistake shall be stated with particularity,” Fed.R.Civ.P. 9(b), “[t]he complaint must identify the statements plaintiff asserts were fraudulent and why, in plaintiff's view, they were fraudulent, specifying who made them, and where and when they were made.” In re Scholastic Corp. Sec. Litig., 252 F.3d at 69-70. FN4

FN4. The court finds that, at this stage of the proceedings, plaintiffs have complied with Rule 9 of the Federal Rules of Civil Procedure

even though certain actionable statements reference SNTG's tank container operations rather than its parcel tanker operations. Defendants' argument draws a nice distinction more properly reserved for the time when presentation of evidence is appropriate.

With respect to scienter, under the PSLRA, and prior Second Circuit precedent, a plaintiff must “state facts with particularity that give rise to a strong 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 this chapter in which the plaintiff may recover money damages only on proof that the defendant acted with a particular state of mind, the complaint shall, with respect to each act or omission alleged to violate this chapter, state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.”). The Court of Appeals for the Second Circuit has “recognized two distinct ways in which a plaintiff may plead scienter without direct knowledge of the defendant's state of mind. The first approach is to allege facts establishing a motive to commit fraud and an opportunity to do so. The second approach is to allege facts constituting circumstantial evidence of either reckless or conscious behavior.” In re Time Warner Inc. Sec. Litig., 9 F.3d 259, 268-69 (2d Cir.1993).




i. Material Omissions

*6 In order for an omission to be actionable, the omission must be material. “A statement is material only if there is a ‘substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the “total mix” of information made available.” ’ In re Int'l Bus. Machines Corporate 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 probable future of the company and [that] may affect the desire of investors 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 pleading stage, a plaintiff satisfies the materiality requirement of Rule 10b-5 by alleging a statement or omission that a reasonable investor would have considered significant in making investment decisions.” Ganino v. Citizens Utilities Co., 228 F.3d 154, 161 (2d Cir.2000). Because materiality is a mixed question of law and fact, judgment as a matter of law “may not be granted on the ground that alleged omissions are immaterial ‘unless they are so obviously unimportant to a reasonable investor that reasonable minds could not differ on the question of their importance.” ’ Castellano, 257 F.3d at 180

(quoting Goldman v. Belden, 754 F.2d 1059, 1067 (2d Cir.1985)); see Halperin v. eBanker USA.com, Inc., 295 F.3d 352, 357 (2d Cir.2002)

(“Recognizing that the materiality of an omission is a mixed question of law and fact, courts often will not dismiss a securities fraud complaint at the pleading stage of the proceedings, unless reasonable minds could not differ on the importance of the omission.”); Ganino, 228 F.3d at 162.

The trier of fact could find that the omissions alleged by plaintiffs were material. The allegations of Stolt's agreement to rig bids and fix prices are, as set forth in the complaint, sweeping in their scope, and the potential sanctions therefor could significantly impact Stolt's future operations and earnings. There is a “substantial likelihood that a reasonable shareholder” would consider this information important in deciding whether to conduct a transaction involving Stolt's ADRs. TSC Industries, Inc. v. Northway, Inc.,

426 U.S. 438, 449, 96 S.Ct. 2126, 48 L.Ed.2d 757 (1976).

ii. Duty to Disclose

Although the omissions alleged by plaintiffs could be material, defendants must have had a duty to disclose this information in order to be liable under Rule 10b-5. See Chiarella v. U.S., 445 U.S. 222, 228, 100 S.Ct. 1108, 63 L.Ed.2d 348 (1980)

(“[O]ne who fails to

disclose material information prior to the consummation of a transaction commits fraud only when he is under a duty to do so.”); In re Time Warner Sec. Litig., 9 F.3d at 267

(“[A] corporation is not required to disclose a fact merely because a reasonable investor would very much like to know that fact. Rather, an omission is actionable under the securities laws only when the corporation is subject to a duty to disclose the omitted facts.”). Although Rule 10b-5 generally does not “require management to accuse itself of antisocial or illegal policies,” Amalgamated Clothing and Textile Workers Union, AFL-CIO v. J.P. Stevens & Co., Inc., 475 F.Supp. 328, 331 (S.D.N.Y.1979), judgment vacated as moot 638 F.2d 7 (2d Cir.1980), management may be compelled to disclose uncharged FN5

illegal conduct when there is insider trading, when a statute or regulation requires disclosure, or when disclosure is necessary to prevent another statement from misleading the public. See Roeder v. Alpha Indus., Inc., 814 F.2d 22, 27 (1st Cir.1987)

(“Roeder claims that a corporation has an affirmative duty to disclose all material information even if there is no insider trading, no statute or regulation requiring disclosure, and no inaccurate, incomplete, or misleading prior disclosures. The prevailing view, however, is that there is no such affirmative duty of disclosure.”); see also Glazer v. Formica Corp., 964 F.2d 149, 156-57 (2d Cir.1992)

(adopting the Court of Appeals for the First Circuit's analysis of the duty to disclose set forth in Roeder ).

FN5.

Regulation S-K, which is discussed at a later point in this memorandum, mandates the disclosure of “any material pending legal proceedings” and “any such proceedings known to be contemplated by governmental authorities.” 17 C.F.R. § 229.103.

*7 In other words, the fact that a corporation's employees engaged in illegal conduct may well be material to the reasonable investor for several obvious reasons, but the obligation to disclose uncharged illegal conduct does not arise from the materiality of this information alone. Rather, in the present context, a duty to disclose uncharged illegal conduct arises when it is necessary to disclose this




conduct under the terms of a statute or regulation, or when it is necessary to disclose this conduct in order to prevent statements the corporation does make from misleading the public. Courts that have determined that corporations had a duty to disclose uncharged illegal conduct in order to prevent other statements from misleading the public have required a connection between the illegal conduct and the statements beyond the simple fact that a criminal conviction would have an adverse impact upon the corporation's operations in general or bottom line. See, e.g., In re Sotheby's Holdings, Inc., No. 00Civ.1041(DLC); 2000 WL 1234601, at *4 (S.D.N.Y. Aug.31, 2000)

(denying motion to dismiss securities fraud claims based upon an anti-competitive agreement and finding that defendants had a duty to disclose the anti-competitive conduct because the corporation stated that competition was “intense” with its “primary auction competitor,” which was a party to the anti-competitive agreement); In re Par Pharma., Inc. Sec. Litig., 733 F.Supp. 668, 677-78 (S.D.N.Y.1990)

(denying motion to dismiss securities fraud claims based upon failure to disclose a scheme to bribe Food and Drug Administration officials for the purpose of obtaining expedited approval of new drug applications because defendants compared the corporation's success to other corporations, projected similar results in the future, and conveyed the impression that defendants's success was due to a particular expertise); Ballan v. Wilfred Am. Educ. Corp., 720 F.Supp. 241, 249-50 (E.D.N.Y.1989)

(denying motion to dismiss securities fraud claims based upon a school's failure to disclose the extent of the school's abuse of the federal higher education loan system and finding that a duty to disclose the extent of the misconduct existed because the school minimized the potential consequences of the pending investigation in its public statements); but see Greenfield v. Prof'l Care, Inc., 677 F.Supp. 110, 113 (E.D.N.Y.1987)

(denying motion to dismiss securities fraud claims based upon falsification of patient eligibility for Medicaid reimbursement and finding that a duty to disclose the illegal conduct existed because “[i]nformation going directly to the financial condition of the company” is material). In other words, a corporation has a duty to disclose uncharged criminal conduct to prevent conveying, through its own public statements, a false impression to an investor and not for the sake of merely improving an investor's perspective.

Certain statements set forth in the complaint obligate Stolt to disclose its alleged uncharged anti-competitive activity because disclosure of this conduct was necessary to prevent misleading the

investing public. “A duty to disclose arises whenever secret information renders prior public statements materially misleading....” In re Time Warner Sec. Litig., 9 F.3d at 268. Here, Stolt's public statements set forth in paragraphs 66, 68, 74, and 76 do not disclose Stolt's alleged anti-competitive behavior and therefore could have misled a reasonable investor. Each of these statements directly references the uncharged anti-competitive conduct alleged in the complaint by stating that “SNTG's tanker operations compete with operators based primarily in Europe and the Asia Pacific region,” (dkt. # 28 ¶ 66), touting the fact that SNTG “recently renewed a multi-year contract for one of its largest customers,” which plaintiffs allege was the direct result of a conspiracy with Odfjell (id. ¶ 68), and describing the pricing environment in the market as “tight” (id. ¶ 74) and subject to continued “pressure” (id. ¶ 68).

*8 The case before the court is indistinguishable from the other cases in which district courts within the Second Circuit have found a duty to disclose uncharged illegal conduct arising from the corporation's own misleading statements. In In re Sotheby's Holdings, Inc., Sotheby's explicitly referenced its anti-competitive agreement with Christie's when it characterized competition between the two firms as “intense.” Sotheby's statements could have misled the investing public because it fostered an inaccurate view of the relationship between Sotheby's and Christie's: competition was not “intense” with respect to commissions. Here, Stolt describes the pricing environment as “tight” and subject to continued “pressure,” which is no different than stating that there is “intense” competition between its business rivals in that the statement conveys the false impression to investors that Stolt achieved success in a competitive pricing environment. Similarly, touting the renewal of a major contract that could have been the result of an illegal agreement conveys the false impression that this particular contract was procured through sound business practices.

In contrast, a trier of fact could not find Stolt's statements cited in paragraphs 61, 63, 64, 65, 67, 70, 72, and 73 materially misleading because the “subject matter of [each] statement is so attenuated from [the uncharged illegal conduct] that it could not reasonably be found to have created a false impression in a reasonable investor.” In re Par Pharm. Sec. Litig., 733 F.Supp. at 678;

cf. In re Time Warner Sec. Litig., 9 F.3d at 268

(“[W]e hold that when a corporation is pursuing a specific business goal and announces that goal as well as an intended




approach for reaching it, it may come under an obligation to disclose other approaches to reaching the goal when those approaches are under active and serious consideration.”). In these public statements, Stolt did not discuss competition between other companies such that the failure to disclose Stolt's illegal circumvention of competition rendered Stolt's statements misleading. Unlike other cases decided by district courts within the Second Circuit, Stolt did not flout its ability to expedite regulatory approval of new drugs when in fact a bribery scheme was the direct cause of this ability to expedite, see In re Par Pharm. Sec. Litig., 733 F.Supp. at 677-78,

nor did Stolt describe competition as “intense” and list “the amount of commission” as a factor in competition when in fact there was an illegal agreement to fix commissions with its only major competitor, see In re Sotheby's Holdings, Inc., 2000 WL 1234601, at *4 & n. 2. Not one of these statements has any direct connection to agreements to allocate customers, agreements to refrain from bidding, agreements to submit inflated bids, or actions taken in violation of U.S. trade embargoes; instead, each statement is a generic description of the state of the market as a whole, a recitation of historical facts about Stolt's operations, or vague forecasts of future success, which are too remote from Stolt's alleged illegal conduct to compel disclosure of this conduct.

*9 Plaintiffs also contend that disclosure of Stolt's alleged criminal conduct was required under Regulation S-K and the SEC's instructions to Form 20-K. Regulation S-K “states the requirements applicable to the content of the non-financial statement portions” of registration statements and annual reports that must be filed pursuant to federal securities law. 17 C.F.R. § 229.10(a). Item 101 of Regulation S-K provides that “[a] registrant shall describe any risks attendant to the foreign operations and any dependence on one or more of the registrant's segments upon such foreign operations.” 17 C.F.R. § 229.101(d)(3). The SEC's instructions for completing Form 20-F, which Stolt must follow when filing its annual report, state that Stolt must provide the following three items: (1) “[a] description of the material effect of government regulations on the company's business, identifying the regulatory body,” (dkt. # 33, Ex. A at 9); (2) information regarding significant factors, including unusual or infrequent events or new developments, materially affecting the company's income from operations, indicating the extent to which income was so affected. Describe any other significant component of revenue or expenses necessary to understand the company's results of operations.... Provide

information regarding any governmental economic, fiscal, monetary or political policies or factors that have materially affected, or could materially affect, directly or indirectly, the company's operations or investments by host country shareholders.

(id. at 11); and (3) “a summary of each material contract, other than contracts entered into in the ordinary course of business, to which the company or any member of the group is a party for the two years immediately preceding publication of the document ....,” (id. at 24).

Neither Regulation S-K nor the SEC's instructions for completing Form 20-F mandates the disclosure of the conduct at issue in this case. To construe the disclosure requirements cited by plaintiffs to compel disclosure of Stolt's alleged criminal actions in this case would eviscerate the well-established principle that Rule 10b-5 generally does not “require management to accuse itself of antisocial or illegal policies.” Amalgamated Clothing and Textile Workers Union, AFL-CIO, 475 F.Supp. at 331;

see U.S. v. Matthews, 787 F.2d 38, 49 (2d Cir.1986)

(“[A]t least so long as uncharged criminal conduct is not required to be disclosed by any rule lawfully promulgated by the SEC, nondisclosure of such conduct cannot be the basis of a criminal prosecution.”). For example, the “risk attendant to [Stolt's] foreign operation” referenced in Regulation S-K is no different than the risk inherent in any of the corporation's activities: the possibility that an employee will break the law while conducting the business of the corporation. Likewise, the “material contract[s]” referenced in the instructions for completing Form 20-F are in this case an agreement, or conspiracy, to perform a criminal act, which is conceptually no different than any other criminal act. If the regulation and instructions were read as plaintiffs advocate, a corporation would have to warn the investing public of the “risk” that an employee would break the law, or disclose the existence of a “material contract” that is actually an uncharged criminal conspiracy. There is simply no authority supporting plaintiffs' broad reading of Regulation S-K; a much more specific and decisive statement from the SEC is necessary to overcome the proposition, emphatically stated by the Court of Appeals for the Second Circuit in Matthews, that Rule 10b-5 does not mandate the disclosure of uncharged criminal conduct.

*10 Defendants' motion must therefore be denied with respect to the statements set forth in paragraphs 66, 68, 74, and 76, because Stolt had a duty to




disclose its alleged anti-competitive conduct arising from these statements. Defendants' motion is granted with respect to the statements set forth in paragraphs 61, 63, 64, 65, 67, 70, 72, and 73, as plaintiffs cannot prove that any defendant had a duty to disclose the uncharged criminal conduct alleged in the complaint arising from these statements. The court finds that defendants did not have a duty to disclose alleged uncharged violations of U.S. trade embargoes. Because the court concludes that plaintiffs have failed to state a claim for relief under the Exchange Act based upon its holding that defendants did not have a duty to disclose the information plaintiffs claim should not have been omitted, the court renders no opinion regarding plaintiffs' allegations of scienter with respect to any defendant as to paragraphs 61, 63, 64, 65, 67, 70, 72, and 73 of the complaint.

iii. Scienter

Having determined that certain statements made by defendants could be found to be false or misleading because defendants omitted information regarding SNTG's anti-competitive conduct, the court must determine whether plaintiffs have adequately alleged that the speaker of each false or misleading statement acted with the required scienter. Here, each statement was spoken by SNSA or by SNSA's agent on behalf of SNSA, while SNTG employees actually engaged in the anti-competitive activity. Plaintiffs must therefore allege that SNSA offered these potentially false of misleading statements with scienter.

In order to successfully plead scienter, plaintiffs must “allege facts that give rise to a strong inference of fraudulent intent.” 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 to show that defendants had both motive and opportunity to commit fraud, or (b) by alleging facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness.” Id.

Plaintiffs attempt to meet their pleading burden by way of the latter method. FN6

“[S]ecurities fraud claims typically have sufficed to state a claim based on recklessness when they have specifically alleged defendants' knowledge of facts or access to information contradicting their public statements. Under such circumstances, defendants knew or, more importantly, should have known that they were misrepresenting material facts related to the corporation.” Novak v. Kasaks, 216 F.3d 300, 308

(2d Cir.2000). Mindful of the admonition that “there are limits to the scope of liability for failure to adequately monitor the allegedly fraudulent behavior of others,” id. at 309,

plaintiffs attempt to establish

the sufficiency of their allegations against SNSA as follows.

FN6.

To the extent plaintiffs have alleged motive and opportunity to commit fraud, their attempt fails because they allege only “a generalized motive, one which could be imputed to any publicly-owned, for-profit endeavor....” Chill v. General Electric Co.,

101 F.3d 263, 268 (2d Cir.1996).

First, plaintiffs contend that, because SNTG's operations were so critical to SNSA's financial health, the trier of fact could infer that SNSA management must have known of SNTG's anti-competitive conduct. Plaintiffs point out that SNTG's business “represented approximately 43% of [SNSA's] net operating revenue [and] about 87% of 2000 income from operations,” (dkt. # 33 at 19 (quoting dkt. # 33, Ex. B at 5) (alterations in original, internal quotation marks omitted)), and that “parcel tanker operations ‘remain SNTG's single largest activity,” ’ (id. (quoting dkt. # 33, Ex. B at 5)). Plaintiffs also contend that Cooperman, who served as SNTG's chairman, must have been aware of SNTG's anti-competitive conduct and was in a position to relay this knowledge to SNSA.

*11 Plaintiffs also allege that SNSA employees were or should have been aware of SNTG's anti-competitive conduct. Plaintiffs allege that the primary perpetrator of the alleged anti-competitive conduct was Richard Wingfield, SNTG's Managing Director of its Tanker Trading Division. They allege that, during late 2000 through 2001, Wingfield met with Odfjell, which was one of SNTG's primary competitors in the parcel tanker business, to agree on pricing and allocate contracts and routes. Plaintiffs also allege that Wingfield discussed agreement about shipping rates with Tokyo Marine. Plaintiffs contend that Wingfield shared information about his anti-competitive activity as follows: an e-mail to “colleagues in Greenwich,” (dkt. # 28 ¶ 39(a)), a fax to Wingfield consisting of “a cost-benefit analysis prepared by Stolt regarding the profitability of conspiring with Odfjell versus ‘going to war’ with Odfjell,” (id. ¶ 39(c)), and an announcement to “the SNTG management board,” (id. ¶ 40). Plaintiffs allege that Paul O'Brien, SNTG's general counsel, was aware of Wingfield's activities, that O'Brien




asked Cooperman to suspend Wingfield and investigate his anti-competitive activities in February of 2002, that Cooperman declined to do so, and that O'Brien resigned on March 1, 2002.

Plaintiffs also allege that SNTG's “vice-president for SNTG's tanker trading,” identified as Pickering, stated, in a meeting between SNSA and SNTG employees, that “Odfjell and Stolt had reached an agreement that certain customers belonged to Stolt and others to Odfjell. They had ‘carved up the world.” ’ (Dkt. # 28 ¶ 33). They further allege that Kenneth Bloom, a SNSA “vice-president for logistics,” “expressed his concerns [about Pickering's statement] to Cooperman, then SNTG's Chairman.” (Id. ¶ 34).

As currently constituted, the complaint does not establish a clear link between those who were involved in the anti-competitive arrangements at SNTG and SNSA management. Although they do allege that word of anti-competitive activities reached the highest level of SNTG management in Cooperman, plaintiffs do not allege any facts supporting the conclusion that Cooperman relayed this information to SNSA management. See In re Alpharma Inc. Sec. Litig., 372 F.3d 137, 150 (3rd Cir.2004)

(holding that allegations that an executive's subordinate knew of corporate misconduct was “an insufficient basis upon which to impute knowledge” to the executive); Kushner v. Beverly Enterprises, Inc., 317 F.3d 820, 828 (8th Cir.2003)

(same). Further, the relative importance of SNTG's operations to SNSA's overall well-being, which should not be minimized, does not fill this factual void. Even though SNTG is far more critical to SNSA than Kidder Peabody & Co. was to General Electric Company in Chill because Kidder Peabody & Co. was one of twenty-four subsidiaries of GE Capital Services, Inc., which was one of twelve subsidiaries of General Electric Company, the court cannot, without any information in the complaint as to the manner by which information flowed from SNTG to SNSA and how involved SNSA was in monitoring SNTG's activities from which the anti-competitive conduct originated complete the link from those with knowledge of the anti-competitive conduct to SNSA's management. Without facts such as these, the court can only assume, and not infer, that SNSA's management knew about the illegal activity. Because plaintiffs have not alleged scienter on the part of SNSA and Niels G. Stolt-Nielsen, defendants' motion must be granted with respect to plaintiff's Section 10(b) claims.

III. CONCLUSION

*12 For the reasons set forth herein, defendants' motion to dismiss (dkt. # 29) is GRANTED. To summarize, the court finds as follows. First, defendants did not have a duty to disclose alleged uncharged illegal conduct with respect to the statements set forth in paragraphs 61, 63, 64, 65, 67, 70, 72, and 73 of the complaint. Second, defendants did have a duty to disclose the alleged uncharged anti-competitive conduct with respect to the statements set forth in paragraphs 66, 68, 74, and 76 of the complaint due to the nature of the statements themselves. Third, plaintiffs did not sufficiently allege that defendants made the statements set forth in paragraphs 66, 68, 74, and 76 of the complaint with the required scienter. Fourth, because plaintiffs' Section 20(a)

claims are derived from their Section 10(b) claims, which fail as a matter of law, these claims also fail as a matter of law. Each count of the Consolidated Amended Class Action Complaint is DISMISSED with prejudice. The Clerk of the Court shall close this file.

So ordered.

D.Conn.,2005. Menkes v. Stolt-Nielsen S.A. Slip Copy, 2005 WL 3050970 (D.Conn.), Fed. Sec. L. Rep. P 93,586

Briefs and Other Related Documents (Back to top)

• 2006 WL 1029079

(Trial Motion, Memorandum and Affidavit) Memorandum of Law in Further Support of Plaintiffs' Motion for Reconsideration and in Reply to Defendants' Opposition to Plaintiffs' Motion for Reconsideration (Jan. 4, 2006)

END OF DOCUMENT


Slip CopySlip Copy, 2006 WL 1699603 (D .Conn .)


0Briefs and Other Related Documents

Only the Westlaw citation is currently available .

United States District Court,D. Connecticut.

Joel MENKES , Individually and on behalf of all others sim-

ilarly situated, Plaintiffs ,

v .

STOLT-NIELSEN S .A., Jacob Stolt-Nielsen, Niels G. Stolt-

Nielsen, Samuel Cooperman, and Reginald Jr . Lee, Defend-

ants .

No . 3:03CV409(DJS) .

June 19, 2006 .

Mark S . Reich, Samuel H . Rudman, Lerach Coughlin Stoia

Geller Rudman & Robbins LLP-NY, Melville, NY, Erin

Green Comite, Scott & Scott, Colchester, CT, for Plaintiffs .

Christopher M. Curran, J. Mark Gidlev, Peter J . Carney ,

Jaime M. Crowe, White & Case-13th DC, Washington, DC,

Donna Nelson Heller, Patrick J . McHugh, Finn Dixon &

Herling, Stamford, CT, Jason S . Weathers, Michael P. Shea ,

Day, Berry & Howard, Hartford, CT, for Defendants .

MEMORANDUM OF DECISION

SQUATRITO, J .

*1 Lead plaintiffs, Irene Rucker and Gustav Rucker, bring

this action on behalf of a putative class of purchasers of de-

fendant Stolt-Nielsen S .A.'s ("SNSA") American Deposit-

ory Receipts ("ADRs") for the period of May 31, 2000

through February 20, 2003 pursuant to Sections 10(b), 15

U.S.C. § 78j(b), and 20 a , 15 U.S .C . § 78t, of the Securities

Exchange Act of 1934 ("the Exchange Act"), as amended

by the Private Securities Litigation Reform Act of 1995

("PSLRA"), 15 U.S.C. §§ 78a-78mm, and Rule lOb-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 Reginald J .R. Lee. Defendants have filed a motion to

dismiss (dkt .# 57) all counts of the Second Consolidated

Amended Class Action Complaint . For the reasons set forth

herein, defendants' motion (dkt .# 57) is DENIED .

I. BACKGROUND

Now pending before the court is a second motion to dismiss

Page 1

plaintiffs' complaint . On November 10, 2005, this court

granted defendants' motion to dismiss plaintiffs' previous

complaint, and dismissed this case with prejudice. Upon re-

consideration, this court amended its judgment to a dis-

missal without prejudice to filing an amended complaint on

or before March 1, 2006 . Plaintiffs did file a Second Con-

solidated Amended Class Action Complaint (hereinafter

"complaint" or cited as "Dkt . # 55, ¶ _") on March 1, 2006 .

Defendants filed a motion to dismiss the complaint on

March 20, 2006, and the motion has been fully briefed since

April 25, 2006 .

The following is an abridged version of facts alleged in the

complaint, set forth in documents incorporated by reference

into the complaint, or found in SNSA's public disclosure

documents, or in other materials properly considered be-

cause plaintiffs have relied upon them in crafting their alleg-

ations. See Rothman v. Gregor. 220 F.3d 81, 88-89 (2d

Cir.2000) ; In re Hunter Environmental Services . Inc. Secur-

ities Litigation . 921 F.Supp. 914, 917-18 (D .Conn.1996) .

Stolt-Nielsen S .A. ("SNSA") is a holding company that,

through its subsidiaries, engages in, among other things,

worldwide transportation, storage, and distribution of bulk

liquid chemicals and other similar materials . Greenwich,

Connecticut based Stolt-Nielsen Transportation Group, Inc.

("SNTG") is a subsidiary wholly owned by SNSA that en-

gages in liquid chemical transportation on worldwide

seaborne trade routes . Jacob Stolt-Nielsen is the founder and

current Chairman of SNSA, and Niels G . Stolt-Nielsen is

the Chief Executive Officer of SNSA. Samuel Cooperman

has been the Chairman of SNTG and Reginald J .R. Lee has

been SNTG's Chief Executive Officer during the time peri-

od relevant to plaintiffs' claims .

At issue in this case is SNTG's transportation of bulk liquid

chemicals. SNTG is one of the largest parcel tanker operat-

ors in the world, and several of SNTG's largest customers

are among the world's major chemical companies . Plaintiffs

allege that, for the period of May 31, 2000FNI

through

February 20, 2003, SNTG engaged in a scheme to fix ship-

ping rates, rig bids, and allocate customers . According to

plaintiffs, certain SNTG employees made agreements with

major competitors to coordinate bidding and divide custom-

er contracts between themselves. SNTG employees al-




legedly met with competitors for this purpose on several dif-

ferent occasions, exchanged customer lists, and either pur-

posefully did not bid on contracts to allow its competitors to

gain the business or submitted artificially high bids to drive

the contract price upward for the benefit of other parties tothis anti-competitive arrangement .

FN 1 . Plaintiffs also allege that SNTG may have be-

gun its anti-competitive conduct as early as 1998 .

*2 Plaintiffs claim that a number of statements made by de-

fendants during the class period were false or misleading be-

cause of these undisclosed illegal activities . Specifically,

plaintiffs claim that the following statements, disseminated

by SNSA or Jacob Stolt-Nielsen, were false or misleading in

light of SNTG's clandestine illegal conduct :

• "[i]ncome from operations for SNTG's tank container divi-

sion increased to $19 .9 million for the full year of 2000

from $17 .8 million in 1999 . While pricing remains compet-

itive in most markets, shipments in 2000 were up 11% from

1999 with similar growth anticipated in 2001," (dkt . # 55, ¶

57 (February 1, 2001)) ;

• "[f]or SNTG's tank container operations, income from op-

erations 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 comparable quarter,

pricing competition, weak utilization, and empty reposition-

ing costs negatively impacted the results . For the remainder

of the year, we anticipate overall growth in the business to

continue to be about 10% over last year and while we expect

to continue to see strong price competition, margins should

improve and by the latter half of the year be similar to the

comparable quarters of last year," (id., ¶ 59 (March 28,

2001)) ;

• "[s]hipments in the year 2000 increased from the downturn

encountered in 1999. Increases were primarily the result of

improved demand in three main operating regions of Asia

Pacific, Europe and the United States . Shipment levels in

2001 continue to reflect improved demand particularly from

the United States and Asia," (id., ¶ 61 (October 26, 2001)) ;

• "[t]he market for the integrated transportation and logistics

services provided by SNTG is in its infancy. In providing

such services, SNTG competes primarily with a few other

terminal and transport companies who are developing such

Page 2

services . . . . SNTG's tanker operations compete with operat-

ors based primarily in Europe and the Asia Pacific region . . . .

The competition in the tank container market is fragmented,

although the relative size of the competition is increasing on

a worldwide basis . SNTG also competes, to a lesser extent,with tank container leasing companies," (Id.., ¶ 63 (October

26, 2001 & May 31, 2002)) ;

• "[e]xcluding the restructuring charges, the Stolt-Nielsen

Transportation Group reported results on par with the first

quarter of last year. Income from operations for SNTG's

parcel tanker division was $20 .5 million in the first quarter

of 2002 compared to $20 .3 million in the first quarter of

2001 . . . . Contracts of affreightment continue to be renewed

at higher levels and SNTG recently renewed a multi-year

contract for one of its largest customers . We are anticipating

a pickup in rates in the second half of the year and

throughout 2003 as the world economies continue their re-

covery[ .] . . . SNTG's tank container operations income im-

proved to $4 .7 million in the first quarter of 2002 compared

to $2 .7 million in the first quarter of last year. While ship-

ments in the first quarter were similar to the comparable

quarter last year, utilization rose to 71.1% compared to

67.7% last year. For the remainder of the year we anticipate

seeing continued pressure on pricing while utilization

should be similar to what we saw in the first quarter . We

still see shipments for the year growing 5% compared to

2001," (id., ¶ 64 (March 27, 2002));

*3 • "[w]hile the results in the second quarter for the Stolt-

Nielsen Transportation Group were down compared to last

year, our core contract business, particularly for specialty

chemicals, remains healthy . We continue to see improve-

ments in Stolt Offshore's results . . . . SNTG's tank container

division's income from operations improved significantly to

$6.3 million in the second quarter of 2002 compared to $4 .0

million in the same quarter of 2001 . Utilization in the

second quarter compared to the same period last year rose

7.0% to 74.4%. Shipments are up some 6% although pricing

continues to be tight," (id., ¶ 66 (June 26, 2002)) ;

• "[t]he Stolt-Nielsen Transportation Group posted a solid

quarter [ .] . . . SNTG's tank container division delivered an-

other strong result with income from operations rising to

$6.2 million from $5 .6 million in the comparable quarter of

2001 . Year-to-date shipments are up some 10% compared to

last year and utilization in the third quarter hit a record leve l




Page 3

of 77 .7% although the business continues to see a tight p ri- Plaintiffs allege that defendants engaged in fraudulent con-

cing environment," ( id., ¶ 68 ( October 8, 2002)) .FN2 duct that affected the purchase or sale of SNSA ' s ADRs.

FN2 . All emphasis appears as it exists in the com-

plaint .

Specifically, plaintiffs claim that defendants had a duty to

disclose to the investing public the nature and scope of their

anti-competitive agreements with other parcel tanker com-

panies, and that defendants acted with scienter .

Plaintiffs claim that defendants' failure to disclose Stolt's al-

leged anti-competitive conduct rendered these statements

false or misleading.

II . DISCUSSION

Plaintiffs set forth two counts in their complaint: (1) viola-

tion of 15 U.S .C. § 78j(b) and 17 C .F .R. § 240.10b-5 pro-

mulgated thereunder against all defendants ; and (2) viola-

tion of 15 U.S .C. § 78t against the individual defendants .

Defendants seek dismissal of each count pursuant to Rule

12(b)(6) of the Federal Rules of Civil Procedure .

A. STANDARD

When considering a Rule 12(b)(6) motion to dismiss, the

court accepts as true all factual allegations in the complaint

and draws inferences from these allegations in the light

most favorable to the plaintiff. See Scheur v. Rhodes. 416

U.S. 232, 236, 94 S .Ct. 1683, 40 L .Ed.2d 90 (1974) ;

Bernheim v. Litt. 79 F.3d 318, 321 (2d Cir.1996) . Dismissal

is warranted only if, under any set of facts that the plaintiff

can prove consistent with the allegations, it is clear that no

relief can be granted . See Hishon v. King & Spaulding. 467

U.S. 69 . 73, 104 S .Ct . 2229, 81 L .Ed.2d 59 (1984) ; Cooper

v. Parskv. 140 F.3d 433, 440 (2d Cir .1998). "The issue on a

motion to dismiss is not whether the plaintiff will prevail,

but whether the plaintiff is entitled to offer evidence to sup-

port his or her claims ." United States v. Yale New Haven

Hosp. . 727 F.Supp. 784, 786 (D.Conn.1990) (citing Sch-

euer. 416 U.S. at 232) . In its review of a motion to dismiss,

the court may consider "only the facts alleged in the plead-

ings, documents attached as exhibits or incorporated by ref-

erence in the pleadings and matters of which judicial notice

may be taken." Samuels v. Air Transport Local 504. 992

F.2d 12, 15 (2d Cir .1993).

B. SECTION 10(b) CLAIM

*4 Although the parties invite this court to do so, this court

will not revisit its prior holdings in the absence of new al-

legations addressed thereto. Specifically, the court adheres

to the following holdings : defendants' statements regarding

competition in the marketplace, including each of the state-

ments set forth in the previous section of this memorandum,

could be materially false or misleading; defendants had a

duty to disclose information regarding their anti-competitive

conduct as a result of their own public statements set forth

herein referencing competition in the marketplace; and

plaintiffs's allegations regarding the integration of SNTG's

parcel tanker and tank container operations are sufficient to

link the anti-competitive conduct with defendants' state-

ments. 3 With respect to the new allegations, the court

holds as follows.

FN3. The court, however, elaborates upon its con-

clusions herein . See infra, § II.B.3 .

1 . SCIENTER

In order to successfully plead scienter under the PSLRA,

and prior Second Circuit precedent, a plaintiff must "state

facts with particularity that give rise to a strong 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 this chapter in which the

plaintiff may recover money damages only on proof that the

defendant acted with a particular state of mind, the com-

plaint shall, with respect to each act or omission alleged to

violate this chapter , state with particularity facts giving rise

to a strong inference that the defendant acted with the re-

quired state of mind.") . The Court of Appeals for the

Second Circuit has "recognized two distinct ways in which

a plaintiff may plead scienter without direct knowledge of

the defendant' s state of mind . The first approach is to allege

facts establishing a motive to commit fraud and an oppor-

tunity to do so . The second approach is to allege facts con-




stituting circumstantial evidence of either reckless or con-

scious behavior." In re Time Warner Inc . Sec. Litig. . 9 F .3d

259 .268-69 (2d Cir.1993). In order to successfully meet this

standard, plaintiffs must "allege facts that give rise to a

strong inference of fraudulent intent ." Shields v. Citytrust

Bancorp. . Inc. . 25 F .3d 1124. 1128 (2d Cir .1994) . "The re-

quisite `strong inference' of fraud may be established either

(a) by alleging facts to show that defendants had both

motive and opportunity to commit fraud, or (b) by alleging

facts that constitute strong circumstantial evidence of con-

scious misbehavior or recklessness ." Id.

Plaintiffs attempt to meet their pleading burden by way of

the latter method. "[S]ecurities fraud claims typically have

sufficed to state a claim based on recklessness when they

have specifically alleged defendants' knowledge of facts or

access to information contradicting their public statements .

Under such circumstances, defendants knew or, more im-

portantly, should have known that they were misrepresent-

ing material facts related to the corporation ." Novak v. Ka-

saks. 216 F .3d 300, 308 (2d Cir .2000). Mindful of the ad-

monition that "there are limits to the scope of liability for

failure to adequately monitor the allegedly fraudulent beha-

vior of others," id. at 309, plaintiffs attempt to establish the

sufficiency of their allegations against SNSA as follows .

*5 First, plaintiffs emphasize SNTG's relationship to SNSA .

Plaintiffs allege that SNTG's operations were critical to

SNSA's financial health, such that SNTG's business

"represented 39% of SNSA's net operating revenue, 94% of

income from operations, and 50% of SNSA's total assets" in

2001, and that SNTG "represented about 62% of SNSA's

net operating revenue and 73% of SNSA's total assets" in

2004 . (Dkt.# 55, ¶ 11 .) Plaintiffs also contend that Cooper-

man, who served as SNTG's chairman, and was in a position

to relay this knowledge to SNSA, was warned of and must

have been aware of SNTG's anti-competitive conduct . Also,

plaintiffs state that Niels Stolt-Nielsen, SNSA's CEO, and

Jacob Stolt-Nielsen, SNSA's founder and Chairman of the

Board, served on SNTG's Board of Directors during the

class period, and therefore had first-hand knowledge of

SNTG's operations .

Second, plaintiffs allege that SNSA employees were or

should have been aware of SNTG's anti-competitive con-

Page 4

duct . Plaintiffs allege that , in 1998, SNTG's "vice-president

for SNTG's tanker trading," Andrew Pickering , stated, in a

meeting between SNSA and SNTG employees, that "Odfjell

and Stolt had reached an agreement that certain customers

belonged to Stolt and others to Odfjell . They had `carved up

the world." ' (Dkt.# 55, ¶ 31 .) They further allege that Ken-

neth Bloom , a SNSA "vice-president for logistics,"

"expressed his concerns [ about Pickering ' s statement] to

Cooperman, then SNTG's Chairman." (Id. ¶ 34) .

Plaintiffs allege that the primary perpetrator of the alleged

anti-competitive conduct was Richard Wingfield, SNTG's

Managing Director of its Tanker Trading Division, and that

SNSA was aware of Wingfield's illegal activities . According

to plaintiffs, during late 2000 through 2001, Wingfield met

with Odfjell, which was one of SNTG's primary competitors

in the parcel tanker business, to agree on pricing and alloc-

ate contracts and routes . Plaintiffs also allege that Wingfield

discussed agreement about shipping rates with Tokyo Mar-

ine . Plaintiffs contend that Wingfield shared information

about his anti-competitive activity as follows : a May 24,

2000 e-mail to "colleagues in Greenwich," regarding Tokyo

Marine's desire to "cooperate on rates," (dkt .# 55, ¶ 37(a)) ;

an April 10, 2001 fax to Wingfield setting forth "a cost-

benefit analysis prepared by Stolt regarding the profitability

of conspiring with Odfjell versus `going to war' with Od-

fjell," (id., ¶ 37(c)) ; and a January 24, 2002 announcement

to "the SNTG management board," that "the Dow contracts

were all but locked up" as a result of SNTG's illegal con-

spiracy with Odfjell, (id., ¶ 38) . Plaintiffs allege that, ac-

cording to the Department of Justice, the April 10, 2001 fax

was prepared in response to a request from Jacob Stolt-

Nielsen for "an analysis of the pros and cons of continued

pricing collusion with Odfjell ." (Dkt .# 55, ¶ 49 .)

Plaintiffs allege that, after Wingfield's January 24, 2002 an-

nouncement regarding the Dow contracts in which he refer-

enced help from Odfjell, SNSA was put on notice of the

possibility that SNTG was violating the antitrust laws .

Plaintiffs allege that "SNSA officials discussed with

SNSA's attorneys in London the Companies' European ship-

ping efforts," and that "[t]hose attorneys worried that the

Companies were breaking Europe's antitrust laws ." (Dkt .#

55, ¶ 39 .) Plaintiffs allege that Paul O'Brien, SNTG's gener-




al counsel , was aware of Wingfield's activities , that O'Brien

asked Cooperman to suspend Wingfield and investigate his

anti-competitive activities in February of 2002, that Cooper-

man declined to do so , and that O 'Brien resigned in protest

on March 1 , 2002. According to plaintiffs , O'Brien also

voiced his concerns to "the highest autho rities in both

SNTG and SNSA," (dkt .# 55, ¶ 52), including "Alan Win-

sor, general counsel of SNSA ." (id., ¶ 54) .

*6 Finally, plaintiffs allege that SNSA offered the following

statements in several public filings :

[i]n 2002, we became aware of information that caused us to

undertake an internal investigation regarding potential im-

proper collusive behavior in our parcel tanker and intra-

Europe inland barge operations . Consequently , we decided

to voluntarily report conduct to the Antitrust Division of the

U.S. Department of Justice (the "DOJ" or "Antitrust Divi-

sion") and the Competition Directorate of the European

Commission ("EC").

(Dkt.# 55, ¶ 76 .)

Based upon the foregoing, plaintiffs have met the applicable

standard for pleading scienter by proving sufficient detail to

permit a strong inference that defendants engaged in con-

scious misbehavior. They have alleged that, in early 2002,

O'Brien communicated concerns about anti-competitive

conduct to SNSA management and SNSA's general counsel,

and that he resigned after raising his concerns . They also al-

lege that Jacob Stolt-Nielsen commissioned a study regard-

ing the advantages of anti-competitive arrangements with

Odfjell . These specific allegations, combined with the facts

that SNTG's operations were critical to SNSA's financial

well-being, that Jacob Stolt-Nielsen and Niels Stolt-Nielsen

were STNG board members, that Cooperman was aware of

potentially anti-competitive conduct within SNTG as far

back as 1998, and that Wingfield's January 24, 2002 com-

ments prompted questions from both O'Brien and SNSA's

London counsel provide the framework from which

plaintiffs may prove that defendants made the statements set

forth in the complaint with conscious disregard for the truth .

2 . LIABILITY OF COOPERMAN AND LEE

Defendants argue that plaintiffs "have pleaded no independ-

Page 5

ent basis for holding Messrs . Cooperman and Lee person-

ally liable for any alleged violations of Section 10(b) and

Rule lob-5 ." (Dkt . # 57 at 21 .) Plaintiffs contend that both

Cooperman and Lee, as well as SNTG, are primarily liable

for violating Section 10(b) and Rule lOb-5 because theywere responsible for withholding the information omitted

from SNSA's public statements even though they did not

directly communicate the false or misleading statements to

the public .

Cooperman and Lee were corporate officers of SNTG, and

were not part of SNSA's management, which was the source

of the false or misleading statements alleged in the com-

plaint. There is no secondary liability for violating Section

10(b), such as by aiding and abetting the person primarily li-

able for violating Section 10(b) . See Central Bank of Den-

ver. N.A. v. First Interstate Bank of Denver. N.A . . 511 U.S .

164, 191, 114 S.Ct . 1439, 128 L .Ed.2d 119 (1994) ; Shapiro

v . Cantor. 123 F.3d 717 . 720 (2d Cir.1997) ("A claim under

§ 10(b) must allege a defendant has made a material mis-

statement or omission indicating an intent to deceive or de-

fraud in connection with the purchase or sale of a secur-

ity ."). The Court of Appeals for the Second Circuit has fur-

ther held that "a secondary actor cannot incur primary liabil-

ity under the Act for a statement not attributed to that actor

at the time of its dissemination . . . . Thus, the misrepresenta-

tion must be attributed to that specific actor at the time of

public dissemination, that is, in advance of the investment

decision ." Wright v. Ernst & Young LLP. 152 F.3d 169, 175

(2d Cir.1998) .

*7 Despite the apparent bright-line rule regarding primary

liability, however, there have been circumstances where

courts bound to follow the foregoing decisions have permit-

ted claims against persons who did not actually utter the

false or misleading statements but nevertheless may be

deemed to have caused the statements to be uttered . In In re

Sholastic Corp . Securities Litigation. 252 F.3d 63 (2d

Cir.2001 , the Court of Appeals for the Second Circuit re-

jected a defendant's argument that the statements alleged in

the complaint attributed to the corporate defendant "have

not been properly made attributable to him ." Id. at 75 . In re-

jecting the defendant's argument, the court found that

plaintiffs had alleged that the defendant "was involved in




the drafting, producing, or reviewing and/or disseminating

of the false and misleading statements issued by" the cor-

poration ; "had access to internal corporate documents and

reports relating to" the subject matter of the statements; and

helped prepare the corporation's analysis of sales data . Id. at

76. The Court of Appeals therefore held that a corporate in-

sider could be liable for misstatements attributed to the cor-

poration and not the insider himself, a holding noted and

followed in several reported decisions by district courts

within the Second Circuit. See, e.g., In re Alstom SA Sec .

Lit. . 406 F.Supp.2d 433, 466-67 (S .D.N.Y.2005); In re

LaBranche 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) ; In re Global

Crossing. Ltd. Sec. Lit. . . 322 F.Supp.2d 319, 332-33

(S.D.N.Y.2004) .

SNTG, Cooperman, and Lee can be held primarily liable for

violating Section 10(b) . Their conduct goes well beyond

simply enabling or turning a blind eye to SNSA's fraud and

rises to the level of active participation in the dissemination

of false or misleading information. Plaintiffs allege that

Cooperman and Lee had knowledge of SNTG's anti-

competitive conduct alleged in the complaint as early as

1998, and that O'Brien specifically relayed his concerns

about Wingfield to them before he resigned. Plaintiffs also

allege that Cooperman and Lee were in a position to dis-

close the anti-competitive conduct to SNSA and render

SNSA's statements regarding SNTG's activities complete

and truthful, but, at best, they failed to do so, or at worst,

they conspired with SNSA to "mask and conceal the im-

proper activities implemented by SNTG in connection with

its antitrust measures ." (Dkt.# 55, ¶ 102 .) In either instance,

SNTG, Cooperman and Lee could be held responsible for

the false or misleading statements attributed to SNSA be-

cause SNSA was either a mere conduit for SNTG, through

Cooperman and Lee, to perpetrate a fraud or was a co-

conspirator. As one court has aptly stated, "[t]o hold other-

wise would enable parent companies to create subsidiaries

under which all of its business would be conducted and then

to shield the subsidiaries from Section 10(b) liability by dis-

seminating the subsidiary's false information ." In re

LaBranche Sec. Lit. . 405 F.Supp.2d at 352 . These allega-

tions form a sufficient basis to hold SNTG, Cooperman, and

Page 6

Lee primarily liable for violating Section 10(b) .

3 . MATERIALITY

*8 As previously referenced herein, defendants urge the

court to reconsider its ruling that plaintiffs' complaint meets

the standard set forth in Rule 9 of the Federal Rules of Civil

Procedure . Defendants argue that the statements alleged in

the complaint to be false or misleading reference SNTG's

tank container operations, which they allege are part of a

line of business distinct from its parcel tanker operations.

Defendants further assert that the complaint alleges that any

illegal anti-competitive activities took place within the par-

cel tanker line of business only, and that plaintiffs' failure to

link SNTG's illegal conduct within the parcel tanker line of

business with statements referencing the tank container line

of business renders the complaint insufficient pursuant to

Rule 9 .

Plaintiffs' complaint meets the applicable standard .

Plaintiffs' complaint alleges pervasive anti-competitive

activity within SNTG over a period of four years, and that

SNSA attempted to deceive the investing public by stating

that any business success was achieved in a competitive en-

vironment, when in fact it was not. Plaintiffs also allege that

SNTG used many means to provide services to their cus-

tomers, including parcel tankers and tank containers, and

that the statements set forth in the complaint could have

misled a reasonable investor into believing that SNTG's suc-

cess was achieved in a competitive environment for all ser-

vices it offers . These allegations are particular to the degree

required by applicable law because the complaint identifies

"the statements plaintiff asserts were fraudulent and why, in

plaintiffs view, they were fraudulent, [and] specif[ies] who

made them, and where and when they were made ." In re

Scholastic Corp. Sec. Litig. . 252 F.3d 63, 69-70 (2d

Cir.2001) .

Defendants' arguments, although framed within the context

of Rule 9 , are tantamount to an attack on the materiality of

the statements rather than an attack on the sufficiency of the

pleading . The dispositive issue, therefore, is whether the

false or misleading statements are material. "A statement is

material only if there is a `substantial likelihood that the dis-

closure of the omitted fact would have been viewed by th e




reasonable investor as having significantly altered the "total

mix" of information made available ." ' In re International

Business Machines Corporate Securities Litigation . 163

F.3d 102 . 106-7 (2d Cir .1998) (quoting Basic Inc. v. Levin-

son . 485 U .S . 224, 231-32, 108 S .Ct. 978, 99 L.Ed.2d 194

1988 ) . "Material facts include those that `affect the prob-

able future of the company and [that] may affect the desire

of investors 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 pleading stage, a

plaintiff satisfies the materiality requirement of Rule lOb-5

by alleging a statement or omission that a reasonable in-

vestor would have considered significant in making invest-

ment decisions ." Ganino v . Citizens Utilities Co. . 228 F .3d

154, 161 (2d Cir .2000) . Because materiality is a mixed

question of law and fact, judgment as a matter of law "may

not be granted on the ground that alleged omissions are im-

material `unless they are so obviously unimportant to a reas-

onable investor that reasonable minds could not differ on

the question of their importance ." ' Castellano. 257 F .3d at

180 (quoting Goldman 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

an omission is a mixed question of law and fact, courts often

will not dismiss a securities fraud complaint at the pleading

stage of the proceedings, unless reasonable minds could not

differ on the importance of the omission ."); Ganino. 228

F.3d at 162. At this juncture, the court cannot conclude that

the statements are not actionable as a matter of law ;

plaintiffs may be able to prove that an investor would have

considered the information misstated or withheld to be sig-

nificant . Therefore, this court adheres to its prior holding re-

jecting defendants' Rule 9 challenge to the complaint .

4 . SCHEME LIABILITY

*9 Plaintiffs have raised a claim under Rule lOb-5(a) and (c)

against the defendants for employing a scheme in connec-

tion with the purchase or sale of securities. Although the

court is reluctant to invite a third round of motions ad-

dressed to the pleadings, it is obliged to do so under the cir-

cumstances with respect to plaintiffs' claim of scheme liabil-

ity . Plaintiffs raise this claim, which is entirely distinct from

Page 7

their other claim under Rule lOb-5(b), in three pages of their

opposition memorandum, and defendants briefly address

this claim in their reply memorandum . The basis for scheme

liability is also not immediately apparent from the com-

plaint. The court cannot render an informed decision on the

record as it currently stands . Ordinarily defendants, as the

movants, would bear the consequences of a scant record, but

the state of the record is understandable given the complex-

ity of this case, the paramount importance of other issues

raised in this motion, and the manner in which the claim

was raised. On the other hand, plaintiffs have not made the

particulars of their claim immediately apparent from the

complaint. As such, the court will provide another opportun-

ity for defendants to address plaintiffs' scheme liability

claim in another motion if they wish to do so . Any addition-

al motion practice will not delay discovery .

III . CONCLUSION

For the reasons set forth herein, defendants' motion to dis-

miss (dkt .# 57) is DENIED. With respect to plaintiffs'

scheme liability claim, defendants' motion is DENIED

without prejudice ; defendants may file another motion ad-

dressing this claim on or before August 11, 2006. The

parties shall meet and confer as contemplated by Rule 26

of the Federal Rules of Civil Procedure , and shall submit a

proposed discovery plan on or before August 11, 2006 . The

stay of this litigation shall remain in effect until further or-

der from this court.

So ordered.

D.Conn .,2006 .

Menkes v . Stolt-Nielsen S .A .

Slip Copy, 2006 WL 1699603 (D .Conn. )



davit) Memor andum of Law in Further Support of Plaintiffs'

Motion for Reconsideration and in Reply to Defendants' Op-

position to Plaintiffs' Motion for Reconsideration (J an. 4,


• 3 :03cv00409 (Docket) (Mar . 7, 2003)

END OF DOCUMENT


TAB 9



DAVID MONTALVO, on behalf of Himself and All Others Similarly Situated, Plaintiffs,vs. TRIPOS, INC., JOHN P. MCALISTER, B. JAMES RUBIN, and ERNST & YOUNG,

L.L.P., Defendants.

Case No. 4:03CV995SNL

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


September 30, 2005, Decided

PRIOR HISTORY: Montalvo v. Tripos, Inc., 2005 U.S.Dist. LEXIS 22753 (E.D. Mo., Sept. 30, 2005)

COUNSEL: [*1] For David Montalvo, individuallyyand on behalf of all others similarly situated, Plaintiff:Caroline Marshall, Kirk Chapman, MILBERG ANDWEISS, New York, NY; David A. Rosenfeld, Samuel H.Rudman, LERACH AND COUGHLIN, LLP, Melville,NY; Don R. Lolli, DYSART AND TAYLOR, KansasCity, MO; J. Allen Carney, Marcus N. Bozeman, TiffanyWyatt, CAULEY AND BOWMAN, Little Rock, AR;Marc A. Topaz, SCHIFFRIN AND BARROWAY, LLP,Radnor, PA; Martin W. Blanchard, SAUERWEIN ANDBLANCHARD, P.C., Clayton, MO.

For Deborah Schneider, Consolidated Filer Plaintiff: DonR. Lolli, DYSART AND TAYLOR, Kansas City, MO.

For Roman Korbiak, Consolidated Filer Plaintiff: DonR. Lolli, DYSART AND TAYLOR, Kansas City, MO;Caroline Marshall, Kirk Chapman, MILBERG ANDWEISS, New York, NY.

For Kenneth L. Riney, individually and on behalfof all others similarly situated, Consolidated FilerPlaintiff: Don R. Lolli, DYSART AND TAYLOR, KansasCity, MO; Joseph R. Seidman, Jr., Mel E. Lifshitz,BERNSTEIN AND LIEBHARD, New York, NY.

For W. Kent Kruske, individually and on behalf of all oth-ers similarly situated, Consolidated Filer Plaintiff: DonR. Lolli, DYSART AND TAYLOR, Kansas City, MO;Karen Hanson Riebel, [*2] Richard A. Lockridge,LOCKRIDGE AND GRINDAL, Minneapolis, MN;Samuel H. Rudman, LERACH AND COUGHLIN, LLP,Melville, NY.

For Tripos, Inc., John P. McAlister, B. James Rubin,Defendants: Cheryl W. Foung, Diane M. Walters, LloydWinawer, Steven M. Schatz., WILSON AND SONSINI,Palo Alto, CA; Gerard T. Carmody, Kelley Field Farrell,CARMODY MacDONALD P.C., St. Louis, MO.

For Ernst & Young, LLP, Defendant: Michele L.Odorizzi, MAYER, BROWN, ROWE & MAW LLP,Chicago, IL; Charles A. Weiss, BRYAN CAVE LLP, St.Louis, MO.

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

OPINIONBY: Stephen N. Limbaugh

OPINION:

MEMORANDUM

Lead Plaintiffs have filed this second amended com-plaint on behalf of purchasers of Tripos common stockbetween February 9, 2000 and July 2, 2002, inclusive.They assert violations ofSection 10--bof the SecuritiesExchange Act of 1934 andRule 10b--5thereunder (CountI -- all defendants) andSection 20(a)of the SecuritiesExchange Act of 1934 (Count II -- individual defendantsonly). This matter is before the Court on defendantsTripos, McAlister, and Rubin's motion to dismiss (# 56),filed August 4, 2004. Over an extended period of time, theparties have[*3] filed lengthy and extensive responsivepleadings and the matter is now ripe for disposition.

Defendants seek to dismiss this second amended com-plaint for failure to state a claim underRule 12(b)(6)Fed.R.Civ.P., in connection with the "heightened pleadingrequirements" of the Private Securities Litigation ReformAct of 1995 (PSLRA),15 U.S.C. § 78u--4, and for failureto state a claim for "control person liability" underSection20(a)of the Securities Exchange Act of 1934,15 U.S.C.



§ 78t(a). They aver, among a myriad of other things, thatplaintiffs have continued to fail to 1) state with any par-ticularity that any defendant acted with the required stateof mind (scienter); 2) state with any particularity whyany challenged statement was false or misleading whenmade; 3) state with any particularity all necessary factsforming the basis for the allegations regarding a "conspir-acy" to commit deliberate accounting fraud; and 4) statewith any particularity the acts committed by the individ-ual defendants in connection with the alleged accountingfraud.

The second amended complaint generally consists[*4] of two (2) primary claims: Firstly, that the de-fendants made or participated in making false and/or mis-leading statements leading to a "scheme to defraud" orcourse of conduct designed to operate as a fraud or de-ceit upon plaintiffs as investors between February 2000and July 2002. They contend that defendants knew of cer-tain events, including but not limited to, a lost softwarecontract and improper accounting methods, which wheneventually disclosed, caused a significant drop in the stockvalue. Lead Plaintiffs allege that despite knowledge of thenegative events and accounting irregularities, defendantscontinued throughout 2001 to forecast extremely positiverevenues for defendant Tripos in order to encourage the"investors class" to purchase the Company's securities;and that the "investors class" relied on these false fore-casts in making such purchases. Secondly, that defendantErnst & Young, as outside auditor and accountant forTripos, while performing audits:

"falsely represented that it performedthese audits in accordance with GenerallyAccepted Auditing Standards (GAAS) andissued materially false and misleading un-qualified audit opinions as to those finan-cial statements[*5] during the Class Period,claiming that the financial statements wereprepared and presented in accordance withGenerally Accepted Accounting Principles(GAAP). Additionally, E&Y consented tothe use of its unqualified opinion letters forTripos' financial statements contained in theCompany's respective Form 1--Ks for fiscal1999, 2000, and 2001.. E&Y also preparedand assisted Tripos in issuing the Company'smaterially false and misleading Form 10--Qsduring the Class Period."

Second Amended Complaint (# 31), filed May 5, 2004;pg. 6, P18.

In passing on a motion to dismiss, a court must viewthe facts alleged in the complaint in the light most favor-

able to the plaintiff.Scheuer v. Rhodes, 416 U.S. 232, 40L. Ed. 2d 90, 94 S. Ct. 1683 (1974); Conley v. Gibson,355 U.S. 41, 45--46, 2 L. Ed. 2d 80, 78 S. Ct. 99(1957);Toombs v. Bell, 798 F.2d 297, 298 (8th Cir. 1986). Thecourt must accept the allegations in the complaint as trueand draw reasonable inferences in favor of the nonmovingparty, dismissing the complaint only if "it appears beyonda reasonable doubt that plaintiff can prove no set of factsin support of his claim which would entitle him to relief."Conley v. Gibson, supra, 355 U.S. at 45--46; [*6] seealso, Moses.com Securities v. Comprehensive SoftwareSystems, Inc., 406 F.3d. 1052, 1062 (8th Cir. 2005)."Although the pleading standard is liberal, the plaintiffmust allege facts ---- not mere legal conclusions ---- that,if true, would support the existence of the claimed torts.Moses.com, at 1062 citing Schaller Tel.Co. v. GoldenSky Sys., 298 F.3d. 736, 740 (8th Cir. 2002). In viewingthe complaint in the light most favorable to the plain-tiff, the court should not dismiss it merely because thecourt doubts that the plaintiff will be able to prove allof the necessary allegations.Bennett v. Berg, 685 F.2d.1053, 1058 (8th Cir. 1982). Thus, a motion to dismiss islikely to be granted "only in the unusual case in which aplaintiff includes 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).

Federal Securities Law --Section 10(b)and Rule10b--5

Plaintiffs allege violations ofSection 10(b)of theSecurities Exchange Act of 1934 andRule 10b--5. Section10(b)andRule 10b--5prohibit fraudulent[*7] conduct inthe sale and purchase of securities.Section 10(b)forbids(1) the "use or employment . . . of any . . . deceptivedevice," (2) "in connection with the purchase or sale ofany security," and (3) "in contravention of" Securitiesand Exchange Commission "rules and regulations".DuraPharmaceuticals v. Broudo, U.S. , 161 L. Ed. 2d577, 125 S.Ct. 1627, 1630--31 (2005) citing 15 U.S.C. §78j(b); see, Ferris, Baker Watts, Inc. v. Ernst & Young,L.L.P., 395 F.3d. 851, 853--54 (8th Cir. 2005); In re: K--TelInternational. Inc. Securities Litigation, 300 F.3d. 881,888 (8th Cir. 2002); In re: Navarre Corp. SecuritiesLitigation, 299 F.3d. 735, 741 (8th Cir. 2002). Rule 10b--5 forbids, among other things, the making of any "untruestatement of material fact" or the omission of any mate-rial fact "necessary in order to make the statements made. . . not misleading."Dura Pharmaceuticals, 125 S.Ct. at1631 citing 17 C.F.R. § 240.10b--5 (2004).

Private securities fraud actions brought underSection10(b)andRule 10b--5require the pleading[*8] and show-ing of these elements: 1) a material misrepresentation oromission; 2) scienter (a wrongful state of mind); 3) a con-



nection with the purchase or sale of a security; 4) relianceor "transaction causation"; 5) economic loss; and 6) "losscausation" or a causal connection between the materialmisrepresentation and the loss.Dura Pharmaceuticals,125 S.Ct. at 1631; see Ferris, Baker Watts, at 854; K--tel, at 888; Navarre, at 741. SinceSection 10(b)andRule 10b--5actions are grounded in fraud, the more strin-gent pleading standards ofRule 9(b) Fed.R.Civ.P.are ap-plicable. Carlon v. Thaman (In re NationsMart Corp.Sec. Litig.), 130 F.3d. 309, 320 (8th Cir. 1997); In re:BankAmerica Corp. Securities Litigation, 78 F.Supp.2d.976, 987 (E.D.Mo. 1999); Jakobe v. Rawlings SportingGoods Co., 943 F.Supp. 1143, 1152 (E.D.Mo. 1996).

Pursuant toRule 9(b) Fed.R.Civ.P., all allegations offraud must be stated with particularity. To meet the re-quirements ofRule 9(b), a pleading must include "suchmatters as the time, place, and contents[*9] of falserepresentations, as well as the identity of the personmaking the misrepresentation and what was obtainedor given up thereby."Bennett v. Berg, 685 F.2d. 1053,1062 (8th Cir. 1982); see also, Wiley v. Mitchell, et. al.106 Fed.Appx. 517, 521--22 (8th Cir. 2004)(unpublished).Compliance with the particularity requirements ofRule9 requires plaintiffs to "specify the statements contendedto be fraudulent, identify the speaker, state when andwhere 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). "Conclusionary 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 pleading re-quirements ofRule 9 Fed.R.Civ.P. Ferris. Baker Watts,at 854; K--tel, at 889; see Navarre, at 742[*10] (giventhat the PSLRA embodies the pleading requirements ofRule 9, plaintiffs do not need to meet the requirements ofboth, and the PSLRA supercedes; i.e. underRule 9stateof mind can be averred generally; however, under thePSLRA, both falsity and scienter must be pleaded withparticularity). Complaints brought underSection 10(b)andRule10b--5are governed by special heightened plead-ing standards adopted by Congress in the PSLRA. Theseheightened pleading standards are unique to securities ac-tions and were adopted by Congress in an attempt to curbabuses of securities fraud litigation.Kushner v. BeverlyEnterprises, 317 F.3d. 820, 826 (8th Cir. 2003) citingNavarre, at 741; see Chambers v. AMDOCS Ltd. (In reAMDOCS Ltd. Secs. Litig.),390 F.3d 542, 547 (8th Cir.2004) citing Navarre, at 741.

The PSLRA requires plaintiffs "to specify each mis-leading statement or omission and specify why the state-ment or omission was misleading."Kushner, at 826;Navarre, at 741--42; 15 U.S.C. § 78u--4(b)(1). The com-plaint must also "state with particularity facts giving riseto a strong inference that the defendant acted with therequired state of mind."Kushner, at 826; Navarre, at741--42; [*11] 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.Kushner, at 826. Any com-plaint failing to meet these pleading requirements mustbe dismissed.Kushner, at 826; In re: BankAmerica Corp.Securities Litigation, at 988; 15 U.S.C. § 78u--4(b)(3)(A).Finally, the Reform Act requires the courts to disregard"catch--all" or "blanket" assertions that do not live upto the particularity requirements.Ferris, Baker Watts, at853; AMDOCS, at 547; K--tel, at 889; Kushner, at 824;Florida State Bd. of Admin. v. Green Tree, 270 F.3d. 645,660 (8th Cir. 2001).

The Eighth Circuit has established a three--prong for-mula for assessing the adequacy of scienter allegations.After reviewing the tests promulgated by the other circuitsto meet the Reform Act's "strong inference of scienter"standard, the appellate court fashioned its own criteria forindicia of fraud:

"Therefore, we can say three things aboutmotive and opportunity allegations. First,motive and opportunity[*12] are generallyrelevant to a fraud case, and a showing of un-usual or heightened motive will often forman important part of a complaint that meetsthe Reform Act standard. Second, in somecases the same circumstantial allegations thatestablish motive and opportunity also giveadditional reason to believe the defendant'smisrepresentation was knowing or reckless.For instance, in insider trading cases, the tim-ing of trades shows motive and opportunity,but it may also provide additional circum-stantial evidence that the defendant knew ofan advantage. Such allegations may meet theReform Act standard, but if so it is becausethey give rise to a strong inference of scienter,not merely because they establish motive andopportunity. Third, when the complaint doesnot show motive and opportunity of any sort --either the unusual, heightened motive high-lighted in the Second Circuit cases, or evenan everyday motive such as keeping one'sjob -- then other allegations tending to showscienter would have to be particularly strong



in order to meet the Reform Act standard."

Florida State Bd. of Admin. v. Green Tree, at 660.

Mere negligence does not violate federal securitieslaw; however, [*13] severe recklessness may.Ferris,Baker Watts, at 854(citations omitted).

"Specifically, scienter may be demonstratedby severe recklessness involving 'highly un-reasonable omissions or misrepresentations'amounting to 'an extreme departure from thestandards of ordinary care, and that present adanger of misleading buyers or sellers whichis either known to the defendant or is so obvi-ous that the defendant must have been awareof it.' Recklessness, then, may be shownwhere unreasonable statements are made andthe danger of misleading investors is so obvi-ous that the defendant must have been awareof 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, WattsBaker, at 854. "This level of recklessness requires thatdefendants make statements that they know, or have ac-cess to information suggesting, are materially inaccurate."Ferris, Baker Watts, at 854 citing Navarre, at 746.

The second amended complaint sets forth numerouspublic statements made by the defendants during the classperiod that the plaintiffs investors believe give rise to astrong inference of scienter[*14] because the defendantsknew facts or had access to information that suggested thattheir public statements were not accurate and/or deliber-ately engaged in making false and misleading statementsin order to defraud the investors as to the true financialcondition of defendant Tripos. Examples of some of theseallegedly inaccurate statements are as follows:

1) By late 2001 defendants were aware thatTripos had serious problems with its consult-ing line of business, including but not limitedto, problems with multi--million dollar con-sulting contracts with Bristol Myers Squibband Merck; and had missed a milestone in itsconsulting contract with Bayer AG resultingin the loss of a $1 million -- $1.5 million pay-ment; however, Tripos, beginning on January9, 2002 began issuing a series of press re-leases claiming that 2002 would be a biggerfinancially successful year than 2001 with aprojected growth rate (including the consult-

ing services business) of at least 25%.

2) Tripos reiterated its "aggressive growthexpectations" in its February 6, 2002 pressrelease. In response to its January 2002 andFebruary 2002 press releases, Tripos stockclosed at all--time highs.

3) Again, [*15] in March 2002, Tripos re-leased a press release reaffirming its highlyprofitable sales and revenues expectations for2002, stating them to be in the $60--65 mil-lion dollar range, and fully diluted earningsper share in a range from $.64 to $.70.

3) Finally, on April 24, 2002, Tripos issueda press release announcing the results for itsfirst quarter of 2002: a 28% increase in rev-enues and a 23% increase in operating in-come. It further reiterated its firm belief inachieving its financial projections for 2002.

4) These press releases were issued proclaim-ing huge increases in revenue and operat-ing income despite the alleged knowledgeby the defendants that accounting regulari-ties had fraudulently inflated revenues on fi-nancial statements from 1998--2002, includ-ing but not limited to: 1999 10--K, 1999Annual Report, the first quarter 2000 10--Q, the second quarter 2000 10--Q, the thirdquarter 2000 10--Q, the 2000 10--K, the 2000Annual Report, the first quarter 2001 10--Q,the second quarter 2001 10--Q, the third quar-ter 2001 10--Q, and the 2001 10--K.

5) Although losses had been sustained in con-nection with the Bayer AG and Bristol MyersSquibb consulting contracts, the defendants[*16] violated the GAAP by failing to recordsame.

6) On July 1, 2002, Tripos issued a pressrelease revising downward its 2002 finan-cial projections due in part to the severe on--going problems in it consulting services busi-ness, including the missed milestone with theBayer AG contract.

7) On July 24, 2002 Tripos issued anotherpress release which continued to "mischar-acterize" the reasons for its financial short-fall. It blamed the Bayer AG consulting con-tract event, even though problems had existed



since late 2001.

8) On February 12, 2004, Tripos announcedthe postponement of the release of its 2003fourth quarter and year--end financial resultsdue to its decision to "revise" its revenuerecognition practice with respect to certainsoftware licenses. The "revision" would re-quire Tripos to restate its financial results forseveral prior years.

9) On March 31, 2004, Tripos announcedthat it had been improperly accelerating rev-enue and improperly accounting for its costsof sales on its time--based software arrange-ments since 1998 due to the "complexity ofthe accounting methods"; however, the basicsoftware recognition policy that Tripos vio-lated was stated in the original[*17] SOP97--2 and in Tripos' own filings with the SEC.

Defendants counter that plaintiffs have failed to setforth the "particularities" as to why the statements arefalse or misleading. After careful review of the amendedcomplaint, the Court finds that the plaintiffs have providedparticulars about who made subject statements, when thestatements were made, and demonstrated why the state-ments were allegedly false or misleading at the time theywere made. While the defendants have spent considerabletime and effort explaining how and why the statements areproper, none of these arguments undermine the plaintiffs'allegations at the pleading stage. The facts pleaded withparticularity sufficiently create a strong inference of sci-enter, thus meeting the Reform Act standard.See, GreenTree Financial, at 667.

Defendants further have contended that the statementscontained in the subject press--releases are "forward--looking" in substance and intent and thus are protectedby the PSLRA's "safe harbor" provision of the PSLRA.15 U.S.C. § 78u--5(c)(1)and(2). The safe harbor provisionprotects forward--looking statements if they are identifiedand accompanied[*18] by risk disclosures, if they areimmaterial, or if plaintiffs fail to prove that the person orpersons making the subject statement(s) made them withactual knowledge that the statement was false or mis-leading.In re: Retek, Inc. Secs., 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. Aug. 15, 2003). The safe harbor pro-vision "does not insulate statements that misrepresent his-torical/hard or current facts." In re: Pemstar, Inc. Sec. Lit.,supra.(citations omitted).

Defendants contend that the alleged false or mislead-

ing statements are nearly all "forward--looking" in thatthey simply are statements of future financial projectionsfor 2002. Plaintiffs counter (with specific examples) thatthe subject statements were materially false and/or mis-leading when made because they omit adverse informa-tion concerning the problems that the defendants werethen currently experiencing; i.e., had already missed amajor milestone on the Bayer AG consulting contract andwidespread customer dissatisfaction with the consultingdivisions Metalayer system had already been expressed.Such[*19] problems were known and not insignificantwhen the statements were made; therefore, it was not thatthe statements were necessarily false but that defendantswere in possession of material facts which they had a dutyto disclose so as not to make such statements mislead-ing. Furthermore, the Court concurs that any "caution-ary language" was too generalized and "boilerplate" tomake such language meaningful to the ordinary investor.The Court concludes that the safe harbor provision of thePSLRA is inapplicable.

Defendants further contend that the plaintiffs' allega-tions of GAAP violations are not sufficient to plead therequisite scienter for theSection 10(b)and Rule 10b--5. The plaintiffs have alleged that the defendants wereaware of the GAAP violations when made and were in-tentionally made to meet analysts' profitable expectationsfor the company. They assert that the restatements clearlyshow that the defendants failed to follow GAAP whileaccounting for Tripos' revenues derived from its "bun-dled software services" during the Class Period. It furthercontends that the accounting principles ignored are not"complex" as argued by the defendants, but rather areclear and specific[*20] as regards the recognition ofrevenue from the sale of software products and licences.Furthermore, plaintiffs argue that scienter is shown bythe GAAP violations coupled with the restatements be-cause the defendants blamed the need for restating Tripos'financial statements on "clarifying guidance" instead ofthe fact that they misapplied GAAP "that existed at thetime the financial statements were prepared". Plaintiffs'assert that

"In sum, the GAAP principles violated herewere not complex or changing, but werelong--standing and basic accounting princi-ples. The Tripos defendants were chargedwith the responsibility of providing accuratestatements of the Company's revenue and theindividual defendants were sufficiently savvyto understand these principles and certainlyhad access to and information from othersin the Company who did understand theseprinciples well."



Plaintiffs' Joint Memorandum of Law (# 64), pg. 44.Finally, plaintiffs contend that they have pled with suf-ficient particularity the GAAP violations at issue. Theyare:

1) Deferred the recording of estimated lossesin excess of $829,000 on various contracts,including, primarily, the software[*21]consulting agreements with Bayer AG andBristol Meyers Squibb (BMS), when GAAPrequired the immediate booking of the en-tire loss. Complaint P89. In addition, theCompany failed to take a charge for the lossesrelated to these two contracts in its interim fi-nancial statements. Complaint PP92, 96, 98.

2) Materially inflated revenues by $15.8 mil-lion for fiscal years 1998--2002, as well as netincome and earnings per share by improperlyaccelerating revenues on time--based soft-ware arrangements by immediately recogniz-ing the software portion of the arrangementrather than recognizing it ratably over theentire contract period as required by GAAP.Complaint PP86, 100--107.

3) Failed to identify and describe importantjudgments associated with its revenue recog-nition policy related to software licenses,in violation of specific GAAP provisions.Complaint PP86, 108--109.

4) Failed to disclose serious problems withits software consulting business and the dis-satisfaction of some of its major customers,including that it had missed a major mile-stone with a significant customer and thatcustomer's refusal to pay, in violation ofGAAP provisions. Complaint PP4, 5, 50, 53,57--65, 86--90, 98,[*22] 108--09.

5) Defendants improperly accounted for costof sales, specifically royalty expense that wasdirectly attributable to time--based softwarelicense arrangements in violation of GAAP.Complaint PP110--13.

6) Failed to design and implement an inter-nal control system over the Company's con-tract estimation process sufficient to moni-tor contract compliance in order to recog-nize cost overruns on a timely basis. Thefact that Tripos had to record two separate

charges to income for contract losses in-curred during the Class Period indicates aninadequate accounting and internal controlsystem. Complaint PP119--20.

Plaintiffs' Memorandum in Opposition (# 64), pgs. 47--48.

Essentially, the plaintiffs argue that the accountingprinciples and standards that existed at the time of theoriginal positive financial statements were clear and pre-cise. They allege that the pervasiveness and indifferenceto the GAAP requirements resulting in such egregiousviolations, coupled with the fact that the restatements ad-mit to these violations, evidences that Tripos intentionallymisstated its revenues for its software licensing contractsthroughout the Class Period. Defendants spend consider-able [*23] time, not addressing the pleading standardsbut rather defending themselves against the allegations.

"Allegations of GAAP violations are insufficient,standing alone, to raise an inference of scienter. Onlywhere these allegations are coupled with evidence of cor-responding 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 745(citationsomitted); see also, Kushner, at 827, 831; K--tel, at 886,894--95. This rule was established because the GAAP"are far from being a canonical set of rules that willensure identical accounting treatment of identical trans-actions. [GAAP], rather, tolerate a range of 'reasonable'treatments, leaving the choice among alternatives to man-agement."K--tel, at 890 quoting Thor Power Tool Co. v.C.I.R., 439 U.S. 522, 544, 58 L. Ed. 2d 785, 99 S. Ct.773 (1979); In re Stellent, Inc. Securities Litigation, 326F.Supp.2d. 970, 982 (D.Minn. 2004); Ferris, Baker Watts,293 F.Supp.2d. at 1008.

Here, the plaintiffs have alleged not only[*24] egre-gious GAAP violations, but also "evidence of correspond-ing fraudulent intent". They have set out with particular-ity the material misstatements in the public statementswhich omitted, among other things, the on--going prob-lems with the software consulting business, and haveset forth the GAAP violations which defendants do notdeny as evidenced by their restatements. Essentially, theamended complaint alleges that defendants knew that cer-tain company assets were impaired and that losses werecertain, but that recognizing those losses (during the ClassPeriod) would have lowered the company's stock priceand threatened its ability to market and sell its products.The amended complaint further alleges that defendantsdelayed recognition of these losses in violation of GAAP,and delayed disclosure of these violations while publicly



touting strong future profits and continued excellent busi-ness prospects with current customers. It is alleged thatthe "strategic non--disclosures" kept Tripos stock artifi-cially high, attracting more investors, until the restate-ments were issued, causing a drastic stock price fall. Theplaintiffs have identified specific documents and state-ments within those[*25] documents attributable to thedefendants that allegedly artificially inflated Tripos' earn-ings and net tangible assets by deliberately hiding specificlosses that were also identified.

The allegations as a whole, taken as true, providestrong indicia of intentional wrongdoing on the part ofthe defendants. Evidence relevant to scienter includes:

"insider trading in conjunction with falseor misleading statements;a divergence be-tween internal reports and public state-ments; disclosure of inconsistent informa-tion shortly after the making of a fraudu-lent statement or omission;bribery by topcompany officials; evidence of an ancillarylawsuit, charging fraud, which was quicklysettled;disregard of current financial in-formation acquired prior to the statementat issue; accounting shenanigans;and ev-idence of actions taken solely out of self--interest." (emphasis added)

In re Acceptance Insurance Cos. Securities Litigation,352 F.Supp.2d. 940, 958 quoting In re Navarre Corp.,at 747(internal citation omitted). Plaintiffs have coupledthere GAAP allegations with the "corresponding fraudu-lent intent" required under the Reform Act.

Defendants[*26] assert that the plaintiffs have failedto adequately plead loss causation because the 2004 re-statements were not announced until after the end of theClass Period, and moreover, little if any significant declinein the stock price occurred following these restatements.Thus, plaintiffs have failed to allege, and cannot allege,that their losses were causally related to the accountingallegations. Plaintiffs counter that the fact that the defen-dants waited until 2004 to announce its restatements dueto GAAP violations should not insulate them from liabil-ity for issuing false statements during the Class Period.Plaintiffs contend that as of July 1, 2002 plaintiffs learnedfor the first time that the Company had missed a majormilestone and that continued projected high earnings andrevenue of past financial reports and statements had nobasis in fact. This is when and why the stock price im-mediately dropped 61%. Plaintiffs further contend that"The February 12, 2004 restatement merely confirmedwhat the market had already incorporated when the stock

price dropped 61% ---- that the Company's financial state-ments were false and could not be relied upon." LeadPlaintiffs' Joint Response (#[*27] 82), pg.5. Plaintiffsfurther contend that their complaint is unlike the com-plaint considered by the Court in the recent case of DuraPharmaceuticals,supra.because in the instant case theplaintiffs have not just generally pled that they had paidartificially inflated stock prices and suffered damages but,instead, have specifically set forth allegations of a causalconnection between the stock price drop and the fraudcommitted; i.e., Tripos could not achieve its earnings tar-gets because those targets were based on false financialstatements.

A private plaintiff who claims securities fraud mustprove that the defendant's fraud caused an economic loss.Dura Pharmaceuticals, 125 S.Ct. at 1629; 15 U.S.C. §78u--4(b)(4). In Dura Pharmaceuticals,supra.,the UnitedStates Supreme Court considered what a plaintiff must al-lege and ultimately prove when establishing the elementof "loss causation". Firstly, the Court considered the factthat "normally, in cases such as this one (i.e. fraud--on--the--market cases), an inflated purchase price will not it-self constitute or proximately cause the relevant economic[*28] loss. The Court reasoned:

"For one thing, as a matter of pure logic,at the moment the transaction takes place,the plaintiff has suffered no loss; the inflatedpurchase payment is offset by ownership of ashare thatat that instantpossesses equivalentvalue. Moreover, the logical link betweenthe inflated share purchase price and anylater economic loss is not invariably strong.Shares are normally purchased with an eyetoward a later sale. But if, say, the purchasersells the shares quickly before the relevanttruth begins to leak out, the misrepresenta-tion will not have led to any loss. If, thepurchaser sells later after the truth makes itsway into the market place, an initially in-flated purchase pricemightmean a later loss.But that is far from inevitably so. When thepurchaser subsequently resells such shares,even at a lower price, that lower price mayreflect, not the earlier misrepresentation, butchanged economic circumstances, changedinvestor expectations, new industry--specificor firm--specific facts, conditions, or otherevents, which taken separately or togetheraccount for some or all of that lower price.(The same is true in respect to a claim that[*29] a share's higher price is lower that itwould otherwise have been -- -- a claim we



do not consider here.) Other things beingequal, the longer the time between purchaseand sale, the more likely that this is so; i.e.,the more likely that other factors caused theloss."

Id., 125 S.Ct. at 1631--32. The Court went on to recog-nize that a higher purchase price "willsometimesplaya role in bringing about a future loss"; and thus, an in-flated purchase price suggests that "the misrepresentation"touches upon" a later economic loss.Id., 125 S.Ct. at1632. However, the law requires that such a misrepresen-tationcausea loss, not just merely"touch upon" a loss.Id., 125 S.Ct. at 1632.

The Supreme Court continued to reason that thePSLRA requires specificity in securities fraud complaintsbecause securities statutes "seek to maintain public con-fidence in the marketplace" and do by providing for pri-vate securities fraud actions; however, "the statutes makethese latter actions available, not to provide investorswith broad insurance against market losses, but to protectthem against those economic losses that misrepresenta-tion [*30] actually cause."Id., 125 S.Ct. at 1633.

Given what a private securities fraud action mustprove as to "loss causation", the Supreme Court heldthat simply alleging the existence of an "artificially in-flated purchase price" is not itself a relevant economicloss. That alleging nothing more than the plaintiffs pay-ing "artificially inflated prices" for certain securities, andthat as a result plaintiffs suffered "damages" is not suffi-cient to adequately plead loss causation.Id., 125 S.Ct. at1634. A complaint that alleges only this fails to provide adefendant with notice, as required ofRule 8 Fed.R.Civ.P.,of what the relevant economic loss might be or of whatthe causal connection might be between the loss and thealleged misrepresentation.Id., 125 S.Ct. at 1634. Suchlack of notice and causal connection is exactly the kind ofharm the securities statutes were designed to eliminate.Id., 125 S.Ct. at 1634.

Upon review of the plaintiffs' second consolidatedamended complaint and given the Supreme Court's recog-nition that "ordinary pleading rules are not meant to im-pose a great[*31] burden upon a plaintiff", the Courtfinds that the plaintiffs have sufficiently alleged a causalconnection between the purported fraud and the inflatedstock price.Dura Pharmaceuticals, 125 S.Ct. at 1634(citation omitted).

Plaintiffs also assert claims against the individualdefendants McAlister (Tripos' Chief Executive Officer,President, and a director) and Rubin (Tripos' ChiefFinancial Officer and Senior Vice--President as of October

2001) under20(a)of the Exchange Act.Section 20(a)ofthe Exchange Act imposes liability on "every person who,directly or indirectly, controls any person liable" under theExchange Act; and such liability should be imposed "un-less the controlling person acted in good faith and didnot directly or indirectly induce the act or acts constitut-ing the violation or cause of action." A "control person"relationship exists whenever "(i) the alleged control per-son actually exercised control over the general operationsof the primary violator and (ii) the alleged control personpossessed----but did not necessarily exercise----the power todetermine the specific acts or omissions upon which theunderlying violation is predicated."Farley v. Henson, 11F.3d. 827, 835 (8th Cir. 1993); [*32] see, Metge v. Baehler,762 F.2d. 621, 624 (8th Cir. 1985); Stephenson v. DeutscheBank AG, 282 F.Supp.2d. 1032, 1059 (D.Minn. 2003);Piper Jaffray Cos., 38 F. Supp. 2d 771, 782 (D. Minn.1999). The control--person statute is "remedial and is tobe construed 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(quotingbothFarley and Myzel,supra.); see also, Martin v. ShearsonLehman Hutton, 986 F.2d. 242, 244 (8th Cir. 1993)(statutereaches persons who have only some indirect means ofdiscipline or influence less than actual direction).Section20(a)can impose liability upon "corporate officers and di-rectors, even in those cases in which they did not directlyparticipate in the bad acts."In re Acceptance InsuranceCompanies Sec. Litig., 352 F.Supp.2d. 940, 957 (D.Neb.2004), aff'd [*33] 423 F.3d 899, 2005 U.S. App. LEXIS18571, 2005 WL 2060912 (8th Cir. 2005) citing Metge v.Baehler, at 631. Finally,Section 20(a)is not subject to theheightened pleading standards of either the Reform Actor Rule 9(b) Fed.R.Civ.P. Stephenson, at 1060 citing In reInitial Pub. Offering Sec.Litig., 241 F.Supp.2d. 281, 397n.185 (S.D.N.Y. 2003). Given the above--referenced legalprinciples, and in light of the Court's determination thatthe plaintiffs have sufficiently pled claims against thesedefendants for violations ofSection 10(b)andRule 10b--5, the Court will not dismiss the plaintiffs' claims againstthe individual defendants based on liability underSection20(a).

The parties have spent considerable time and effortarguing the "merits" of the second amended consolidatedcomplaint; however, the bottom line is that the plaintiffshave pleaded that during the Class Period, the defendantshad in their possession (or could have easily obtained)facts which rendered their financial results materially falsewhen first stated to the investing public, and given thesefacts, intentionally delayed recognition of these "facts"in violation [*34] of GAAP, then intentionally delayed



recognition of the GAAP violations in order to induceplaintiffs to continue investing in a "profitable" enter-prise. Without a doubt the "merits" of the allegations aspresented can be argued fervently; however such a de-bate involves questions of fact "that cannot render thecomplaint[s] inadequate, lest the heightened pleading re-quirements of the Reform Act replace the function of atrial." Green Tree, at 666. The plaintiffs have satisfiedthe Reform Act standard and the defendants' motion todismiss will be denied.

Dated this 30th day of September, 2005.

Stephen N. Limbaugh

SENIOR UNITED STATES DISTRICT JUDGE

ORDER

In accordance with the memorandum filed herein thisdate,

IT IS HEREBY ORDERED that defendants Tripos,McAlister, and Rubin's motion to dismiss (# 56) be andis DENIED.

Dated this 30th day of September, 2005.

Stephen N. Limbaugh

SENIOR UNITED STATES DISTRICT JUDGE


TAB 10


Briefs and Other Related DocumentsOnly the Westlaw citation is currently available.

United States District Court,N.D. California.Thomas O. MORGAN, et al., Plaintiffs,

v.AXT, INC. and Morris S. Young, Defendants.

No. C 04-4362 MJJ, C 05-5106 MJJ.

Sept. 23, 2005.

Lionel Z. Glancy, Peter A. Binkow, Mark L. Labaton, Mi-chael M. Goldberg, Glancy Binkow & Goldberg LLP,Elizabeth P. Lin, Milberg Weiss Bershad & Schulman LLP,Los Angeles, CA, for Plaintiffs.David Priebe, Shirli Fabbri Weiss, Daivd Banie, DLA PiperRudnick Gray Cary LLP, East Palo Alto, CA, for Defend-ants.

ORDER DISMISSING PLAINTIFF'S COMPLAINTWITHOUT PREJUDICE

JENKINS, J.

INTRODUCTION

*1 Before the Court is Defendants' motion to dismiss thisprivate securities fraud action. Plaintiff Thomas O. Morgan(“Plaintiff”),FN1 representing a purported class of all pur-chasers of AXT, Inc., stock between February 6, 2001, andApril 27, 2004, opposes the motion. For the following reas-ons, the Court GRANTS Defendants' motion to dismiss, butGRANTS Plaintiff leave to amend.

FN1. In an Order dated February 2, 2005, the Courtgranted Plaintiff Morgan's motion for appointmentas lead plaintiff.

FACTUAL BACKGROUND

A. Background

Defendant AXT, Inc.'s (“AXT” or the “Company”) is a pub-licly-traded company that manufactures semiconductorparts, known as substrates, used by a variety of electronicproducts including wireless and fiber optic telecommunci-ations, lasers, light emitting diodes, satellite solar cells, and

consumer electronics such as cell phones. AXT sells com-pound semiconductor non-silicon substrates manufacturedfrom gallium arsenide, indium phosphide, and germanium.AXT employs its proprietary Vertical Gradient Freeze meth-od for manufacturing the non-silicon substrates. During theperiod of time at issue in the instant lawsuit (February 6,2001, through April 27, 2004 (the “Class Period”)), AXTalso produced and sold light-emitting diodes (“LEDs”) andvertical cavity surface emitting laser chips through its opto-electronic division. AXT sold its products to original equip-ment manufacturers (“OEMs”). The particular testing re-quired and characteristics of those AXT products were de-termined by the OEMs. Defendant Dr. Morris S. Young(“Defendant Young”) served as the Company's CEO andChairman of the Board during the Class Period.

On February 6, 2001, AXT issued a press release reportingthe Company's strong commitment to its customers andtouting AXT's customers' confidence in AXT. The press re-lease referenced the Company's “supply of high quality sub-strates” and reported that AXT was “pleased to support [its]strategic customers' substrate requirements for the year andbelieve[d] that the value of the contracts under th[e] [SupplyGuarantee Program] is a good indicator of [AXT's] ability todeliver continued revenue and profit expansion.”(Complaint (“Comp.”), ¶ 31.)

On February 26, 2001, the Company filed its annual reportfor FY 2000 on Form 10-K with the SEC. The 10-K stated:“We believe that our success is partially due to our manu-facturing efficiency and high product yields and we continu-ally emphasize quality and process control throughout ourmanufacturing operations.” The 10-K also explained thatAXT's policy was to recognize revenue when its productswere shipped to the customer as long as, inter alia, there areno customer acceptance requirements and no remaining sig-nificant obligations. (Id., ¶ 32.)

On April 25, 2001, AXT issued a press release announcingits financial results for the first quarter of 2001. The Com-pany reported that revenue was up a record $40.1 millionand that net income was up $5 million. In the press release,AXT expressed its belief that its products' “strong engineer-ing design and development capability allows [AXT] to tail-or [its] standard products to meet customer specific require-

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ments and gives [AXT] competitive advantages.” (Comp., ¶33.) On May 3, 2001, AXT filed its quarterly report onForm 10-Q with the SEC, reaffirming the Company's previ-ously announced financial results for the first quarter of2001.

*2 On July 25, 2001, AXT issued a press release announ-cing its financial results for the second quarter of 2001. TheCompany reported that revenue reached a record $41.3 mil-lion and that net income was up $5.2 million. On August 1,2001, AXT filed its quarterly report on Form 10-Q with theSEC, reaffirming the Company's previously announced fin-ancial results for the second quarter of 2001.

On October 24, 2001, AXT issued a press release announ-cing its financial results for the third quarter of 2001. TheCompany announced that reported net losses for the quarterbut stated that “strategic research and development invest-ments are positioning AXT well for continued leadership”and that the Company's “VFG gallium arsenide and indiumphosphide substrates continue to offer superior features formanufacturers of high quality electronic and opto-electronicdevices.” The press release went on to say that AXT“believe[s] that [it] remain[s] the world leader in providingboth products.” (Comp., ¶ 38.) On November 7, 2001, AXTfiled its quarterly report on Form 10-Q with the SEC, reaf-firming the Company's previously announced financial res-ults for the third quarter of 2001.

On February 6, 2002, AXT issued a press release announ-cing its financial results for the fourth quarter of 2001 andfor FY 2001. The Company again reported that its special-ized substrates “continue to offer superior features for man-ufacturers of high quality electronic and opto-electronicdevices” and that the Company “expect[ed] an increasingnumber of key customers to recognize the superiority of[AXT's] technology in the future.” (Id., ¶ 40.) On March 26,2002, AXT filed its Form 10-K annual report with the SEC,reaffirming the Company's previously announced financialresults for the fourth quarter and for FY 2001, and includingthe same description of AXT's revenue recognition policydescribed in its FY 2000 annual report.

On April 24, 2002, AXT issued a press release announcingits financial results for the first quarter of 2002. The Com-

pany reported net losses for the quarter but stated that itsreputation for LED quality, value, and delivery was grow-ing. On May 3, 2002, AXT filed its quarterly report onForm 10-Q with the SEC, reaffirming the Company's previ-ously announced financial results for the first quarter of2002.

On July 24, 2002, AXT issued a press release announcingits financial results for the second quarter of 2002. TheCompany reported that revenue increased 14 % and stated,“We are particularly pleased with the growth of our LED di-vision, which has recorded double digit revenue growth forthe past three quarters, efficiently increased manufacturingcapacity to sustain this growth, improved growth margins,and approached overall profitability.” On August 15, 2002,AXT filed its quarterly report on Form 10-Q with the SEC,reaffirming the Company's previously announced financialresults for the second quarter of 2002. Defendant Youngalso filed a certification pursuant to the Sarbanes-Oxley Actthat the “information contained in the Report fairly presents,in all material respects, the financial condition and result ofoperations of the Company.”

*3 On October 23, 2002, AXT issued a press release an-nouncing its financial results for the third quarter of 2002.The Company reported that “AXT will continue to benefitfrom the strength of our technology.” (Comp., ¶ 48.) OnNovember 12, 2002, AXT filed its quarterly report on Form10-Q with the SEC, reaffirming the Company's previouslyannounced financial results for the third quarter of 2002.The Form 10-Q also stated that, “Based on their evaluation,our principal executive officer and principal financial officerconcluded that our disclosure controls and procedures areeffective.”

On February 5, 2003, AXT issued a press release announ-cing its financial results for the fourth quarter of 2002 andfor FY 2002. On March 21, 2003, AXT filed its Form 10-Kannual report with the SEC. In the 10-K, the Companystated, “the lives of our substrate products are relativelylong and accordingly, obsolescence has historically not beena significant factor.” The Company again described its rev-enue recognition policy, as it had in its 2000 and 2001 annu-al reports. The 10-K also contained a certification, pursuantto the requirements of the Sarbanes-Oxley Act, averring that




the report “does not contain any untrue statement of materi-al fact or omit to state a material fact” and that the financialstatements” fairly present in all material respects the finan-cial condition” of the Company.

On April 23, 2003, AXT issued a press release announcingits financial results for the first quarter of 2003. The Com-pany reported net losses for the quarter. On May 9, 2003,AXT filed its quarterly report on Form 10-Q with the SEC,reaffirming the Company's previously announced financialresults for the first quarter of 2003. The 10-Q reported certi-fied that the Company's “disclosure controls and proceduresare effective.”

On July 23, 2003, AXT issued a press release announcingits financial results for the second quarter of 2004. TheCompany reported net losses. On August 12, 2003, AXTfiled its quarterly report on Form 10-Q with the SEC, reaf-firming the Company's previously announced financial res-ults for the second quarter of 2003. The 10-Q again con-tained a certification regarding disclosure controls and pro-cedures as the May 10-Q had.

On October 22, 2003, AXT issued a press release announ-cing its financial results for the third quarter of 2003. TheCompany again reported net losses. On November 13, 2003,AXT filed its quarterly report on Form 10-Q with the SEC,reaffirming the Company's previously announced financialresults for the third quarter of 2003, and containing certific-ations regarding the Company's disclosure controls and pro-cedures.

On February 4, 2004, AXT issued a press release announ-cing its financial results for the fourth quarter of 2003 andfor FY 2003. On March 29, 2004, AXT filed its Form 10-Kannual report with the SEC. The 10-K certified that theCompany's disclosure controls and procedures were effect-ive and that the report contained no “untrue statement[s] ofmaterial fact” and did not “omit to state a material fact” andthat the financial statements” fairly present in all materialrespects the financial condition” of the Company.

*4 On April 27, 2004, AXT issued a press release revealingthat the “first quarter's financial review and verification pro-cess ha[d] been delayed due to an investigation by AXT's

Audit Committee of certain product testing practices andpolicies.” (Comp., ¶ 64.) The next day, AXT stock droppedby 13.64%. A day later, AXT's stock dropped further, bynearly 23%, to close at $2.20 per share.

On May 24, 2004, AXT filed its quarterly report on Form10-Q with the SEC, announcing that AXT had “not fol-lowed requirements for testing of products and provision oftesting data and information relating to customer require-ments for certain shipments made over the past severalyears.” The 10-Q reported that AXT then increased its re-serve for sales returns by $745,000, and recorded a $2.1 mil-lion charge for obsolete inventory manufactured in the pre-vious two and three years because the specifications of itsproducts differed from customer orders. AXT also an-nounced that it had reassigned its CEO and Chairman of theBoard, Defendant Young to head up AXT's China unit, andhad replaced the Company's independent auditor, PriceWa-terhouseCoopers (“PwC”). (Comp., ¶¶ 65-68, 70.) PlaintiffMorgan subsequently filed the instant lawsuit,FN2 claimingthat he and other members of the proposed class who pur-chased shares of AXT stock between February 6, 2001, andApril 27, 2004, were injured because they bought AXTstock at artificially-inflated prices which plummeted whenthe Company disclosed to the public the internal investiga-tion into its practices.

FN2. Two separate lawsuits were brought by in-vestors in AXT stock against AXT and DefendantYoung: (1) City of Harper Woods Employees Re-tirement Sys. v. AXT, Inc., 04-04362 MJJ, filed onOctober 15, 2004; and (2) Robertson v. AXT, Inc.,04-05106 MJJ, filed on December 2, 2004. In itsFebruary 2, 2005, Order, the Court grantedPlaintiff Morgan's motion to consolidate the law-suits.

B. The Complaint

In his Consolidated Complaint for Violations of the FederalSecurities Laws (hereinafter, the “Complaint”), Plaintiff al-leges that AXT and Defendant Young, AXT's former Chair-man and Chief Executive Officer, violated §§ 10(b) and20(a) of the Securities and Exchange Act of 1934(“Exchange Act”), 15 U.S.C. §§ 78j(b) and 78(t)a, and Se-




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curities and Exchange Commission (“SEC”) Rule 10b-5, 17C.F.R § 240.10b-5. According to Plaintiff, during the ClassPeriod, Defendants knowingly shipped products that did notconform to customer testing requirements or specifications.Plaintiff alleges that Defendants failed to properly accountfor products that were defective or could not be sold by im-properly recognizing revenue on those sales even thoughDefendants knew the products would be returned and failingto accrue adequate reserves. Plaintiff claims that Defendantsviolated the securities laws by knowingly issuing false ormisleading statements about AXT's reserves, revenue, andincome (hereinafter, the “financial statements”), and byknowingly issuing false or misleading statements touting thequality of AXT's products and AXT's ability to meet cus-tomer requirements (hereinafter, the “quality statements”).

In his Complaint, Plaintiff alleges that his claims are sup-ported by the statements of three confidential witnesses-aQuality Technician who used to work for AXT, a formerAXT Corporate Vice President, and a former tester of re-turned AXT products.FN3 The former Quality Technicianallegedly confirmed that the Company knowingly shippedto customers products that did not meet customerspecifications, that the Company was aware that theproducts would be returned, and that almost every shipmentwas, in fact, returned. Specifically, the technician said thatwhen AXT conducted specification checks on its LEDwafers for wavelength, luminosity, vision, and current, thewafers never met all the specifications. The former tester ofreturned AXT products allegedly confirmed that the passiv-ation layer (the top protective layer) on AXT's LEDs wasconsistently weak, making the LEDs easily and irreparablydamaged. The tester allegedly said that AXT knew this wasa problem and lacked adequate product testing equipment.The former Corporate Vice President allegedly confirmedthat AXT failed to perform full testing of its products andlacked the right equipment for testing. (Comp., ¶¶ 78-80.)

FN3. In his Complaint, Plaintiff does not allegethat the third confidential witness-the tester of re-turned AXT products-was ever an AXT employee.In his opposition to the instant motion, however,Plaintiff describes this witness as a former AXTemployee.

*5 Plaintiff alleges that during the Class Period, Defendantsreported that one of the Company's larger customers, Agi-lent, had canceled its orders with AXT because AXT wasshipping products that did not conform to Agilent's specific-ations. Defendants characterized the shipping of out-of-specproducts as a one-time event even though, according toPlaintiff, AXT had shipped products that did not meet cus-tomer specifications to many of its customers. (Id., ¶ 86.)

On May 20, 2005, Defendants filed the instant motion todismiss pursuant to the Private Securities Litigation ReformAct of 1995 (“PSLRA”), and Rules 9(b) and 12(b)(6) of theFederal Rules of Civil Procedure, on the grounds thatPlaintiff has failed to plead his allegations with sufficientparticularity.

LEGAL STANDARD

A. Federal Rules of Civil Procedure

A court may dismiss a complaint pursuant to Federal Ruleof Civil Procedure 12(b)(6) for the pleading of insufficientfacts under an adequate theory. Robertson v. Dean WitterReynolds, Inc., 749 F.2d 530, 533-34 (9th Cir.1984). Whendeciding upon a motion to dismiss pursuant to Rule12(b)(6), a court must take all of the material allegations inthe plaintiff's complaint as true, and construe them in thelight most favorable to the plaintiff. Parks School of Busi-ness, Inc. v. Symington, 51 F.3d 1480, 1484 (9th Cir.1995).

In the context of a motion to dismiss, review is limited tothe contents in the complaint. Allarcom Pay Television, Ltd.v. General Instrument Corp., 69 F.3d 381, 385 (9thCir.1995). When matters outside the pleading are presentedto and accepted by the court, the motion to dismiss is con-verted into one for summary judgment. However, mattersproperly presented to the court, such as those attached to thecomplaint and incorporated within its allegations, may beconsidered as part of the motion to dismiss. See Hal RoachStudios, Inc. v. Richard Feiner & Co., 896 F.2d 1542, 1555n. 19 (9th Cir.1989). Where a plaintiff fails to attach to thecomplaint documents referred to therein, and upon whichthe complaint is premised, a defendant may attach to themotion to dismiss such documents in order to show that they




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do not support the plaintiff's claim. See Pacific Gateway Ex-change, 169 F.Supp.2d at 1164; Branch v. Tunnell, 14 F.3d449, 44 (9th Cir.1994) (overruled on other grounds). Thus,the district court may consider the full texts of documentsthat the complaint only quotes in part. See In re Stay Elec-tronics Sec. Lit., 89 F.3d 1399, 1405 n. 4 (1996), certdenied, 520 U.S. 1103, 117 S.Ct. 1105, 137 L.Ed.2d 308(1997). This rule precludes plaintiffs “from surviving a Rule12(b)(6) motion by deliberately omitting references to docu-ments 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 requiresonly “a short and plain statement of the claim showing thatthe pleader is entitled to relief.” Accordingly, motions todismiss for failure to state a claim pursuant to Rule 12(b)(6)are typically disfavored; complaints are construed liberallyto set forth some basis for relief, as long as they provide ba-sic notice to the defendants of the charges against them. Inre McKesson HBOC, Inc. Sec. Litig., 126 F.Supp. 1248,1257 (N.D.Cal.2000). Where a plaintiff alleges fraud,however, Rule 9(b) requires the plaintiff to state with partic-ularity the circumstances constituting fraud. To meet theheightened pleading requirements of Rule 9(b), the NinthCircuit has held that a fraud claim must contain three ele-ments: (1) the time, place, and content of the alleged mis-representations; and (2) an explanation as to why the state-ment or omission complained of was false or misleading. Inre GlenFed, Inc. Sec. Litig., 42 F.3d 1541, 1547-49 (9thCir.1994).

*6 In the securities context, the pleading requirements areeven more stringent.

B. Private Securities Litigation Reform Act

In 1995, Congress enacted the PSLRA to provide“protections to discourage frivolous [securities] litigation.”H.R. Conf. Rep. No. 104-369, 104th Cong., 1st Sess. at 32(Nov. 28, 1995). The PSLRA strengthened the already-heightened pleading requirements of Rule 9(b). Under thePSLRA, actions based on allegations of material misstate-ments or omissions must “specify each statement alleged tohave been misleading, the reason or reasons why the state-ment is misleading, and, if an allegation regarding the state-

ment or omission is made on information and belief, thecomplaint shall state with particularity all facts on whichthat belief is formed.” 15 U.S.C. § 78u-4(b)(1).

The PSLRA also heightened the pleading threshold forcauses of action brought under Section 10(b) and Rule10b-5. Specifically, the PSLRA imposed strict requirementsfor pleading scienter. Under the PSLRA, a complaint must“state with particularity facts giving rise to a strong infer-ence that the defendant acted with the required state ofmind.” 15 U.S.C. § 78u-4(b)(2). The Ninth Circuit, in inter-preting the PSLRA, has held that “a private securitiesplaintiff proceeding under the [PSLRA] must plead, in greatdetail, facts that constitute strong circumstantial evidence ofdeliberately reckless or conscious misconduct.” In re SiliconGraphics Inc., 183 F.3d 970, 974 (9th Cir.1999). If the com-plaint does not satisfy the pleading requirements of thePSLRA, upon motion by the defendant, the court must dis-miss the complaint. See 15 U.S.C. § 78u-4(b)(1).

The PSLRA's Safe Harbor provision provides that a securit-ies fraud claim may not lie with respect to a statement that is“identified as a forward-looking statement, and is accom-panied by meaningful cautionary statements identifying im-portant factors that could cause actual results to differ ma-terially from those in the forward-looking statement.” 15U.S.C. § 78u-5(c)(1)(A)(I). However, a person may be heldliable if the forward-looking statement is made with “actualknowledge ... that the statement was false or misleading.”15 U.S.C. § 78u-5(c)(1)(B); No. 84 Employer-TeamsterJoint Council Pension Trust Fund v. America West HoldingCorp., 320 F.3d 920, 936 (9th Cir.2003); but see In re See-beyond Technologies Corp. Sec. Litig., 266 F.Supp.2d 1150,1164-65 (C.D.Cal.2003) (disagreeing with the analysis inAmerica West and finding that a defendant is immune fromliability if it satisfies either 15 U.S.C. § 78u5(c)(1)(A) or(B)).

ANALYSIS

I. Request For Judicial Notice

As a threshold matter, the Court addresses Defendants' re-quest that the Court take judicial notice of thirteen separatedocuments, eleven of which are expressly referenced in




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Plaintiff's Complaint and two of which are not. Plaintiffdoes not object to Defendants' request.

A. Documents Referenced in Complaint

*7 Defendants ask the Court to judicially notice the follow-ing documents incorporated by reference in Plaintiff's Com-plaint: AXT's 10-Ks for the fiscal years ended December 31,2000, December 31, 2002, and December 31, 2003; fiveAXT press releases, respectively dated February 6, 2002,October 23, 2002, February 5, 2003, April 23, 2003, andFebruary 4, 2004; AXT's 10-Qs for the quarters ended June30, 2003, and September 30, 2003; and AXT's Current Re-port on SEC Form 8-K, filed on June 24, 2004. These docu-ments are attached to the Declaration of David Banie as Ex-hibits A-K.

Federal Rule of Evidence 201 allows a court to take judicialnotice of a fact “not subject to reasonable dispute in that it is... capable of accurate and ready determination by resort tosources whose accuracy cannot reasonably be questioned.”Even where judicial notice is not appropriate, courts mayalso properly consider documents “whose contents are al-leged in a complaint and whose authenticity no party ques-tions, but which are not physically attached to the[plaintiff's] pleadings.” Branch v. Tunnel, 14 F.3d 449, 454(9th Cir.1994).

Here, each of the documents described above is explicitlyincorporated by reference in Plaintiff's Complaint. (SeeComplaint, ¶¶ 32, 40, 48, 50, 51, 54, 57, 59, 60, 61, 71.)Moreover, the documents are press releases and SEC filings,both of which are judicially noticeable in this context. SeeIn re Homestore.com, Inc. Sec. Litig., 347 F.Supp.2d 814,817 (N.D.Cal.2004) (the court may take judicial notice ofpress releases); In re Calpine Corp. Sec. Litig., 288F.Supp.2d 1054, 1076 (N.D.Cal.2003) (the court may takejudicial notice of public filings). Accordingly, the CourtGRANTS Defendants' request and takes judicial notice ofExhibits A-K to the Banie Declaration.

B. Documents Not Referenced in Complaint

1. Exhibit L-SEC Form 4 filed by Defendant Young

Defendants ask the Court to take judicial notice of SEC

Forms 4 filed on behalf of Defendant Young. These docu-ments are attached to the Banie Declaration as Exhibit L.“In a securities action, a court may take judicial notice ofpublic filings when adjudicating a motion to dismiss....”Calpine, 288 F.Supp.2d at 1076. The SEC Forms 4 at issuehere are publicly-available documents filed with the SEC.Accordingly, the Court takes judicial notice of the docu-ments attached as Exhibit L to the Banie Declaration.FN4

FN4. Defendants also contend that Exhibit Lshould be judicially noticed for two other inde-pendent reasons. First, the Complaint referencesDefendant Young's sale of 200,000 shares of AXTstock during the Class Period. According to De-fendants, this is information that Plaintiff couldonly have obtained from reviewing Young's Forms4, such that the documents are incorporated by im-plicit reference in the Complaint and should be ju-dicially noticed. Second, the Forms 4 are central toPlaintiff's allegation that Defendant Young's ClassPeriod stock sales are probative of scienter, andshould be judicially noticed on that ground. Havingalready determined that the Forms 4 should be ju-dicially noticed on the ground that they are publicdocuments, the Court declines to address Defend-ants' separate grounds for judicial notice.

2. Exhibit M-AXT's Closing Stock Prices From February 6,2001, Through April 29, 2004

Defendants also urge the Court to take judicial notice ofdocuments reflecting AXT's closing stock prices during theClass Period. These documents are attached to the BanieDeclaration as Exhibit M. In the context of a motion to dis-miss a securities private fraud action, a court may take judi-cial notice of a company's public stock prices.Homestore.com, 347 F.Supp.2d at 816. Accordingly, theCourt takes judicial notice of these documents.

II. Motion to Dismiss

*8 Defendants contend that Plaintiff's Complaint should bedismissed because Plaintiff fails to satisfy the heightenedpleading requirements under the PSLRA, fails to state aclaim under Rule 12(b)(6), and fails to plead fraud with the




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particularity required by Rule 9(b). The Court examinesPlaintiff's two claims separately.

A. Plaintiff's First Cause of Action-Violation of Section10(b) of the Securities Exchange Act and Rule 10b-5

Section 10(b) of the Securities Exchange Act (the “Act”)provides, in part, that it is unlawful “to use or employ inconnection with the purchase or sale of any security re-gistered on a national securities exchange or any securitynot so registered, any manipulative or deceptive device orcontrivance in contravention of such rules and regulations asthe [SEC] may prescribe.” 15 U.S.C. § 78j(b). Rule 10b-5,promulgated under Section 10(b), makes it unlawful for anyperson to use interstate commerce: (a) to employ anydevice, scheme, or artifice to defraud; (b) to make any un-true statement of material fact or to omit to state a materialfact necessary in order to make the statements made, in thelight of the circumstances under which they were made, notmisleading; or (c) to engage in any act, practice, or course ofbusiness which operates or would operate as a fraud or de-ceit upon any person, in connection with the purchase orsale of any security. 17 C.F.R. § 240.10b-5.

For a claim under Section 10(b) and Rule 10b-5 to be ac-tionable, a plaintiff must allege: (1) a misrepresentation oromission; (2) of material fact; (3) made with scienter; (4) onwhich the plaintiff justifiably relied; (5) that proximatelycaused the alleged loss. See Binder v. Gillespie, 184 F.3d1059, 1063 (9th Cir.1999). A complaint must “specify eachstatement alleged to have been misleading, the reason orreasons why the statement is misleading, and, if an allega-tion regarding the statement or omission is made on inform-ation and belief, the complaint shall state with particularityall facts on which that belief is formed.” 15 U.S.C. §78u-4(b)(2). As discussed above, in order to avoid havingthe action dismissed, a plaintiff must “plead with particular-ity both falsity and scienter.” Ronconi v. Larkin, 253 F.3d423, 429 (9th Cir.2001). The Ninth Circuit, in Ronconi, ar-ticulated the rule as follows:Because falsity and scienter in private securities fraud casesare generally strongly inferred from the same set of facts,we have incorporated the dual pleading requirements of 15U.S.C. §§ 78u-4(b)(1) and (b)(2) into a single inquiry. Inconsidering whether a private securities fraud complaint can

survive dismissal under Rule 12(b)(6), we must determinewhether ‘particular facts in the complaint, taken as a whole,raise a strong inference that defendants intentionally or[with] ‘deliberate recklessness' made false or misleadingstatements to investors.’ Where pleadings are not suffi-ciently particularized or where, taken as a whole, they donot raise a ‘strong inference’ that misleading statementswere knowingly or [with] deliberate recklessness made toinvestors, a private securities fraud complaint is properlydismissed under Rule 12(b)(6).

*9 Id. (citations and internal quotation marks omitted).

Here, Plaintiff alleges that statements or omissions attribut-able to Defendant AXT and Defendant Young were falseand misleading and that Defendants knew the statementswere false and misleading at the time the statements weremade. The statements at issue can be separated into twogeneral categories: (1) statements touting the quality ofAXT's products and the Company's ability to meet customerspecifications; and (2) AXT's financial statements. With re-spect to both categories of statements, Defendants contendthat Plaintiff has failed to plead the falsity of the statementswith sufficient particularity and has failed to plead factsthat, if true, would raise a strong inference that Defendantsacted with scienter. Additionally, Defendants assert thatPlaintiff has failed to adequately plead loss causation pursu-ant to the Supreme Court's recent holding in Dura Pharma-ceuticals, Inc. v. Broudo, --- U.S. ----, 125 S.Ct. 1627, 161L.Ed.2d 577 (2005).

1. FALSITY and SCIENTER

a. Quality Statements

Plaintiff alleges that Defendants made false or misleadingstatements regarding the quality of its products throughoutthe Class Period. Specifically, Plaintiff takes issue with thestatements contained in various press releases issuedbetween February 6, 2001, and April 27, 2004, in which De-fendants reported that its products were of high quality, in-corporated strong engineering design, had competitive ad-vantage, contained superior features, and met customers'specific requirements. To support his claim that the qualitystatements were knowingly false or misleading, Plaintiff re-






















lies on AXT's May 24, 2004, press release disclosing thatthe Company had “not followed requirements for testing ofproducts and provision of testing data and information relat-ing to customer requirements for certain shipments madeover the past several years,” and on the Company's sub-sequent decisions to reassign its CEO, to increase its reservefor sales returns by $745,000, and to record a $2.1 millioncharge for obsolete inventory manufactured in the prior twoand three years. Plaintiff construes AXT's May 2004 state-ments and conduct as an admission by Defendants that thequality statements were knowingly false when made.Plaintiff also relies on the statements of the former AXTQuality Technician, the former AXT Corporate Vice Presid-ent, and the former tester of returned AXT products(collectively, the “witnesses”) to support falsity and sci-enter. Finally, Plaintiff claims that the fact that Agilent, oneof AXT's customers, canceled its orders for AXT substratesduring the Class Period corroborates the witness statementsand Plaintiff's claims that the quality statements were know-ingly false.

Defendants contend that the product quality statementswere, at most, mere puffery, and are not actionable. In thealternative, Defendants argue that Plaintiff has not pled suf-ficiently particularized facts that the statements were falseor misleading when made nor has Plaintiff pled facts thatraise a strong inference of scienter. The Court addresseseach of Defendants' arguments in turn.

i. Puffery

*10 “General statements of optimism and ‘puffing’ about acompany or product are not actionable.” In re Foundry Net-works, Inc. Sec. Litig., 2003 U.S. Dist. LEXIS 18200, *47(N.D. Cal. Aug 29, 2003) (citation omitted). “Vague,amorphous statements, like ‘soft forecasts' which are ‘merepuffery,’ are inactionable because reasonable investors donot consider ‘soft’ statements or loose predictions importantin making investment decisions.” Id. (citation omitted). “Nomatter how untrue a statement may be, it is not actionable ifit is not the type of statement that would significantly alterthe total mix of information available to investors.” Id.(citing In re Apple Computer, Inc. Sec. Litig., 243 F.Supp.2d1012, 1025 (N.D.Cal.2002)). In Foundry Networks, at issuewas the company's statement that its “business remains on

track.” The court held that the statement was inactionablepuffery because the statement was merely a very generalstatement of optimism about the company's financial pro-spects, something that reasonable investors would not relyon when making investment decisions. In No. 84 Employer-Teamster Joint Council Pension Trust Fund v. Am. W. Hold-ing Corp., 320 F.3d 920 (9th Cir.2003) (“America West” ),however, the Ninth Circuit found statements at issue werenot inactionable puffery. Specifically, the court held that“[a] reasonable investor would find significant the informa-tion regarding a company's deferred maintenance costs, un-safe maintenance practices, and possible sanction” because“a reasonable investor would consider the potential effectsof each of these facts on the overall economic health of thecompany as ‘significantly altering’ the ‘total mix’ of in-formation made available.” Id. at 935; see also Scritchfieldv. Paolo, 274 F.Supp.2d 163, 175 (D.R.I.2003) (statementthat company was the “ ‘premier provider of high-speedDSL services in the Northeast corridor’ ... is much morethan mere puffery; it is a statement of [the company's]present status and capabilities, and connotes that [the com-pany] is comparatively superior”)).

The lion's share of the statements at issue here appear tomore closely resemble the statements at issue in AmericaWest or Scritchfield than those at issue in Foundry Net-works. For example, statements touting the superiority ofAXT's specific products, such as the October 24, 2001,press release described in paragraph 38 of the Complaint, inwhich AXT reported that the Company's “VGF gallium ar-senide and indium phosphide substrates continue to offer su-perior features for manufacturers of high quality electronicand opto-electronic devices” are far less generalized thanthe statements the Foundry Networks court determined wereinactionable. Such statements strike the Court as informa-tion that an investor would consider when making invest-ment decisions. However, to make such a determinationwould require the Court to make factual findings which, atthis stage in the litigation, would not be appropriate. Ac-cordingly, the Court finds that whether the quality state-ments at issue here are actionable as material statements is aquestion for another day.

ii. Falsity and Scienter Not Sufficiently Pled














*11 Assuming, arguendo, that the quality statements at is-sue were not mere puffery and are actionable as materialstatements or omissions, the Court now turns to the questionof whether Plaintiff has alleged sufficiently particularizedfacts to support his claim that the quality statements werefalse or misleading, and whether Plaintiff has alleged factsthat raise a strong inference of scienter, to survive Defend-ants' motion to dismiss.

Plaintiff primarily relies on AXT's post-Class Period (May2004) disclosure and the statements of three confidentialwitnesses to support his claim that the product quality state-ments were false or misleading and that Defendants knewthose statements were false and misleading when made.Plaintiff also alleges that Agilent's cancellation of its orderof AXT products during the Class Period supports hisclaims of falsity and scienter. Additionally, Plaintiff allegesthat Defendant Young's sale of stock during the Class Peri-od supports an strong inference of scienter. For the follow-ing reasons, the Court finds that the facts, as pled, are insuf-ficiently particularized to support Plaintiff's claim that thequality statements violated federal securities laws.

(a) Witness Statements FN5

FN5. For purposes of this analysis, the Court as-sumes that the witnesses' purported statements aretrue since, at this stage in the proceedings, theCourt must view all facts in the light most favor-able to Plaintiff.

According to Plaintiff, the former Quality Technician al-legedly confirmed that the Company knowingly shipped tocustomers products that did not meet customer specifica-tions, that the Company was aware that the products wouldbe returned, and that almost every shipment was, in fact, re-turned. Specifically, the technician said that when AXT con-ducted specification checks on its wafers for various criteria,the wafers never met all the specifications. The former testerof returned AXT products allegedly confirmed that the pas-sivation layer (the top protective layer) on AXT's LEDs wasconsistently weak, making the LEDs easily and irreparablydamaged. The tester allegedly said that AXT knew this wasa problem and lacked adequate product testing equipment.The former Corporate Vice President allegedly confirmed

that AXT failed to perform full testing of its products andlacked the right equipment for testing. (Comp., ¶¶ 78-80.)These statements, as currently pled, are insufficient to satis-fy create a sufficient factual predicate for Plaintiff's claimsunder the PSLRA. First, Plaintiffs' Complaint fails to ex-plain how any of the witnesses would have personal andfirsthand knowledge of the facts they allege to be true. SeeIn re Daou Sys., Inc. Sec. Litig., 411 F.3d 1006, (9thCir.2005) (confidential sources must be described “with suf-ficient particularity to support the probability that a personin the position occupied by the source would possess the in-formation alleged”). For example, Plaintiff does not explainthe job responsibilities of the Quality Technician and howhe or she would know about the number or proportion of re-turns of AXT's products. Second, the Complaint fails topoint to any specific data to support the witnesses' conten-tions that AXT's products were being returned. Third, theComplaint does not sufficiently describe the timing of thewitnesses' observations and conclusions. Finally, assuming,as the Court must, that the witnesses' statements are true andAXT's products were consistently not being tested, did notmeet customer specifications, and were regularly being re-turned to the Company, the Complaint alleges no facts thatwould allow the Court to infer that Defendants were awareof these facts. The Complaint does not allege any process bywhich upper management, presumably in charge of issuingor approving press releases, would have been aware ofproduct returns or testing practices at the manufacturinglevel, much less how each of these particular confidentialwitnesses was connected with Defendants such that they hadcontemporaneous knowledge of what AXT and DefendantYoung knew. Accordingly, the witness statements are insuf-ficient, as currently pled, to support falsity and scienter here.

(b) AXT's Post-Class Period Statements and Conduct

*12 Plaintiff contends that AXT's May 24, 2004, disclosurenotifying the public that AXT had “not followed require-ments for testing of products and provision of testing dataand information relating to customer requirements for cer-tain shipments made over the past several years” supportshis contention that the quality statements issued during theClass Period were false and misleading and that Defendantswere aware the statements were false and misleading. The







Court disagrees.

The May 2004 disclosure does not say that every shipmentof every AXT product was non-conforming such that it canbe considered an admission that AXT's Class Period state-ments regarding the quality of its products are rendered falseand misleading. Even if the May 2004 statement admits thatsome of AXT's products did not conform to customer spe-cifications, the statements at issue could still have been truein that the Company only claimed that its products werecompetitive and that its products' design was strong.Moreover, even assuming the statements were false or mis-leading, the post-Class Period disclosure does not raise astrong inference of scienter here. The fact that the Companyadmitted, after the Class Period, that it had failed to followtesting requirements on “certain shipments,” is insufficientto raise a strong inference that Defendants knew, at the timethe quality statements were made, that the statements werefalse or misleading.

(c) Agilent Cancels Orders

Plaintiff alleges that during the Class Period, Defendantsdisclosed that one of AXT's larger customers, Agilent, hadcanceled its orders for AXT products because AXT wasshipping products that did not conform to Agilent's specific-ations. Plaintiff contends that this corroborates his conten-tion (and the confidential witness statements) that AXT wasaware that it was shipping non-conforming products to itscustomers such that the statements it issued during the ClassPeriod regarding the quality of its products and its competit-ive position in the marketplace were knowingly false andmisleading. Plaintiff also contends that Defendants wereaware that the problems with the Agilent shipments werenot unique such that its statement to the contrary was falseand misleading. Plaintiff has failed to allege any facts thatsupport a finding that Defendants knew that the non-conforming Agilent shipments were part of a widespreadquality problem with AXT products. Accordingly, the Courtfinds that the fact that Agilent canceled its orders with AXTis insufficient to demonstrate that the quality statementswere knowingly false when made.

(d) Defendant Young's Stock Sales

Plaintiff also relies on the stock sales of Defendant Youngas an indication of Defendants' scienter with respect to thequality statements. Generally, stock sale allegations cannotraise an inference of scienter unless the plaintiff alleges spe-cific facts showing that the sales were “dramatically out ofline with prior trading practices at times calculated to max-imize the personal benefit from undisclosed inside informa-tion.” Silicon Graphics, 183 F.3d at 986. Among the relev-ant factors for a court to consider are: 1) the amount andpercentage of shares sold by insiders; 2) the timing of thesales; and 3) whether the sales were consistent with the in-sider's prior trading history. Id.

*13 Here, Plaintiff alleges that Defendant Young sold a totalof more than 200,000 shares of his personally-held AXTstock during the Class Period for gross proceeds of approx-imately $2.2 million. (Comp. at ¶ 91.) Plaintiff alleges nofacts about the dates, prices per share, or sizes of each ofDefendant Young's Class Period sales. Plaintiff also fails toallege that Defendant Young's sales over the time period inquestion were inconsistent with his prior trading history. Inlight of the three factors above, Defendant Young's ClassPeriod sale of stock, as alleged, is not sufficiently suspi-cious, without more, to raise a strong inference of scienter.

(e) Plaintiff's Allegations as a Whole

The Court must consider whether the totality of Plaintiff'sallegations, even though individually lacking, are sufficientto create a strong inference that Defendants issued allegedlyfalse or misleading statements touting the quality of AXT'sproducts with deliberate recklessness, if not actual know-ledge. Lipton, 284 F.3d at 1038. Here, the sum is no greaterthan its parts. Plaintiff has failed to allege particularizedfacts that could lead the Court to infer that Defendants in-tentionally, or with deliberate recklessness, misrepresentedthe quality of AXT's products and its strategic position ascompared with other manufacturers of similar products. Be-cause Plaintiff's first cause of action “lacks sufficient detailand foundation necessary to meet either the particularity orstrong inference requirements of the PSLRA,” it must bedismissed. Silicon Graphics, 183 F.3d at 984.

b. Financial Statements








Plaintiff alleges that during the Class Period, Defendantsknowingly issued financial statements that overstated reven-ue, growth margins, and earnings in violation of GAAP,rendering the statements false and misleading under the Se-curities and Exchange Act. Specifically, Plaintiff contendsthat the financial statements were knowingly false or mis-leading in light of: (1) the Company's stated revenue recog-nition policy requiring that AXT not recognize revenuewhere there is a customer acceptance requirement or re-maining significant obligation; (2) AXT's failure to accrueadequate reserves; and (3) AXT's failure to take a timelycharge for inventory obsolescence. Plaintiff also challengesthe qualitative statements regarding internal and disclosurecontrols contained in the Sarbanes-Oxley certifications ac-companying AXT's quarterly filings (beginning in April2002). In support of these allegations, Plaintiff again reliesprimarily upon the Company's May 2004 disclosure and itssubsequent decisions to increase its reserves, charge for in-ventory obsolescence, and reassign its CEO. Plaintiff alsoagain relies on the confidential witness statements, Agilent'sdecision to cancel its order, and Defendant Young's stocksales. Defendants argue that Plaintiff has failed to allege aparticularized factual basis for his claim that the financialstatements released during the Class Period were false andinvolved an improper recognition of revenue, or thatPlaintiff has alleged facts raising a strong inference that De-fendants acted with the requisite scienter. The Court agrees.

*14 It is generally accepted that standing alone, allegationsof GAAP violations do not establish scienter. In re Worldsof Wonder Sec. Litig., 35 F.3d 1407, 1426 (9th Cir.1994).Rather, to plead fraudulent intent based on GAAP viola-tions, plaintiffs must allege facts showing that: (1) specificaccounting decisions were improper; and (2) the defendantsknew specific facts at the time that rendered their account-ing determinations fraudulent. DSAM Global Value Fund v.Altris Software, Inc., 288 F.3d 385, 390-91 (9th Cir.2002).Plaintiff has not met this standard. As discussed supra,Plaintiff only alleges that Defendants must have been awarethat its products were flawed and were being shipped to cus-tomers anyway based on the vague representations of threeconfidential witnesses who do not describe the basis fortheir knowledge, the time period of the general awarenessthat this practice was occurring, any contact with AXT's up-

per management (or specifically, those making the account-ing and revenue recognition decisions), or any specifictransactions on which revenue was knowingly improperlyrecorded. See Northpoint, 184 F.Supp.2d at 998 (“With ac-counting fraud, ... the necessary scienter is in general not es-tablished merely by the publication of inaccurate accountingfigures, or failure to follow generally accepted accountingprinciples. More is needed.”) Plaintiff has failed to allegethat particular accounting decisions were improper or factsthat support a strong inference that Defendants were awareof facts that rendered their accounting decisions fraudulent.In sum, Plaintiff's generic allegations of accounting fraudfall short of sufficiently pleading scienter with respect toDefendants' practice of recognizing revenue.

The other factors upon which Plaintiff relies to support hisclaim that AXT's financial statements were false or mislead-ing are also insufficiently pled. The Court examines these inturn.

i. AXT's Post-Class Period Statements and Conduct

Plaintiff claims that AXT's post-Class Period decisions totake a $745,000 reserve, to take a $2.1 million write-off, andto reassign its CEO and promote its CFO to the top spot atthe Company, demonstrate that the Company's financialstatements, issued during the Class Period, were false whenmade and that Defendants knew they were false. The Courtdisagrees. These allegations are not pled with the requisiteparticularity. Plaintiff contends that AXT's post-Class Peri-od decisions suggest that the Company should have in-creased its reserve for returns by $745,000 during the ClassPeriod and that the Company's failure to do so renders thefinancial statements false. Plaintiff alleges no contemporan-eous facts to support that contention other than the post-Class Period decision to increase the reserves. This is a clas-sic example of pleading fraud by hindsight, which is exactlywhat Congress intended to eliminate with its adoption of thePSLRA. See Silicon Graphics, 183 F.3d at 988; Acito v. IM-CERA Group, 47 F.3d 47, 53 (2d Cir.1995) (“Mere allega-tions that statements in one report should have been made inearlier reports do not make out a claim of securities fraud.”)Similarly, AXT's decision to write off $2.1 million for in-ventory obsolescence after the close of the Class Perioddoes not necessarily read back on what the Company should















have done, but did not do, during the Class Period, or on thefalsity of the Company's financial statements during thatperiod. A “pleading must provide some particularized sup-port regarding inventory levels, the defendants' knowledge,and approximately when [the] plaintiffs think the write-down should have occurred.” In re PETsMART, Inc. Sec.Litig., 61 F.Supp.2d 982, 993 (D.Ariz.1999). Plaintiff failsto do so here. Additionally, AXT's decision to reassign De-fendant Young to head up the Company's China Operationsdoes not support an inference of scienter here. Managementchanges “are not in and of themselves evidence of scienter.Most major stock losses are often accompanied by manage-ment departures, and it would be unwise for courts to penal-ize directors for these decisions.” In re Cornerstone Pro-pane Partners, L.P., 355 F.Supp.2d 1069, 1092(N.D.Cal.2005). Plaintiff has not alleged sufficiently partic-ularized facts with respect to Young's reassignment to sup-port his claim that the financial statements were false whenmade.

*15 Plaintiff also contends that the Sarbanes-Oxley certific-ations signed by Defendant Young and filed with the SECwere false when made. Again, the Court finds that Plaintiffhas not alleged particularized facts to support his claim thatDefendant Young's averments that he had examined theCompany's internal disclosure controls and believed theywere adequate, were false.

ii. Witness Statements FN6

FN6. For purposes of this analysis, the Court as-sumes that the witnesses' purported statements aretrue since, at this stage in the proceedings, theCourt must view all facts in the light most favor-able to Plaintiff.

As discussed above, the confidential witness statements re-lied on by Plaintiff here are insufficient, as currently pled, tosupport falsity or scienter. The Complaint fails to allegehow the witnesses would have known what accounting ef-fect, if any, product returns would have on the Company'sfinancial statements, or how Defendants would have knownthat the financial statements it released were false or mis-leading in light of the alleged product returns. See JuniperNetworks, Inc. Sec. Litig., 2004 U.S. Dist. LEXIS 4025, at

*8 (N.D.Cal. Mar. 11, 2004) (allegations of false financialforecasts are insufficient where plaintiffs failed to “pleadspecific facts demonstrating how the problems being experi-enced translated into the need for Juniper to alter or reduceits publicly issued projections”). Accordingly, the confiden-tial witness statements, as currently pled, are insufficient tosupport falsity and scienter with respect to the financialstatements.

iii. Agilent Cancels Order

Plaintiff contends that AXT's announcement, during theClass Period, that Agilent had canceled its orders due toAXT's failure to provide products that met Agilent's spe-cifications supports his claim that the financial statementswere false when made and that Defendants knew the state-ments were false. While the Agilent order withdrawal sug-gests that AXT was not always shipping products that con-formed to customer specifications, Plaintiff fails to allegesufficiently particularized facts that support his claim thatthis meant that the financial statements were false or thatDefendants knew they were false.

iv. Defendant Young's Stock Sales

As discussed supra, Plaintiff fails to allege sufficient detailsregarding Defendant Young's sales of stock during the ClassPeriod that would support the falsity of the financial state-ments and Defendants' scienter with respect thereto.

v. Plaintiff's Allegations as a Whole

As explained above, the Court must consider whether the to-tality of Plaintiff's allegations, even though individuallylacking, are sufficient to create a strong inference that De-fendants issued allegedly false or misleading financial state-ments with deliberate recklessness, if not actual knowledge.Lipton, 284 F.3d at 1038. Here, again, the sum is no greaterthan its parts. See In re Nash Finch Co. Sec. Litig., 323F.Supp.2d 956, 964 & n. 9 (D.Minn.2004) (“The Courtfinds the collective minutia offered here adds up to nothing.Just as two plus two will never equal five, these allegations-whether considered apart or together-do not add up to astrong inference of scienter.”) FN7

FN7. At oral argument, Plaintiff alerted the Court














to the recent holding in In re Omnivision Technolo-gies, Inc., 2005 U.S. Dist. LEXIS 16009, *1(N.D.Cal. July 29, 2005). The Court finds that thatcase, distinguishable on its facts, does not alter theCourt's conclusions here. In Omnivision, it was un-disputed that the company's financial statementscontained errors. This is not the case here. Addi-tionally, in that case, the plaintiff alleged facts sup-porting a finding that the individual defendants, ex-ecutives of the company in question, sold personalshares of the company's stock dramatically out ofline with their trading history. That the Omnivisioncourt found that the plaintiff's complaint survivedthe defendants' motion to dismiss, despite thePSLRA's heightened pleading standard, does notmandate the same result here.

2. Loss Causation

*16 In Dura Pharmaceuticals, the Supreme Court clarifiedthat alleging that a misrepresentation caused an inflated pur-chase price does not, without more, demonstrate loss causa-tion. To “touch upon” an economic loss is insufficient;plaintiffs must demonstrate an actual causal connectionbetween the defendant's alleged material misrepresentationand the economic loss suffered. 125 S.Ct. at 1633. Thisholding reversed the Ninth Circuit's jurisprudence on thesubject, pursuant to which a plaintiff could satisfy the losscausation requirement simply by alleging that stock pricewas inflated due to the alleged misrepresentation.

Here, the Complaint simply states that because AXT's stockprices dropped significantly after the Company disclosed itsinternal investigation, Plaintiff, and other AXT shareholderswho purchased stock during the Class Period, lost money.However, Plaintiff has not alleged a proximate, causal con-nection between the alleged misrepresentations contained inAXT's press releases and financial statements and the con-sequent decline in AXT stock. Because other factors mayhave affected the Company's stock price during the ClassPeriod, Plaintiff must allege more than just that the allegedmisrepresentations inflated the stock price. See id. This isparticularly true here where the AXT stock price fluctuatedsignificantly during the Class Period, at some points drop-ping lower than the price of the stock after the April 27,

2004, disclosure regarding the Company's internal investig-ation. FN8 This suggests that the stock price was, indeed,affected by factors other than Defendants' alleged false ormisleading statements. Accordingly, the Court finds, in lightof Dura, that Plaintiff's allegations regarding loss causationare insufficient. Plaintiff's contention that the Daou casemandates the contrary result is specious. In that case, theNinth Circuit found that loss causation was sufficiently pledbut specifically held that because the complaint disclosedthat the price of the company's stock had declined, duringthe class period, from $34.375 per share to $18.50 per share,before any corrective disclosure was issued, any losssuffered between those figures could “not be consideredcausally related to Daou's allegedly fraudulent accountingmethods because before the revelations began ..., the truenature of Daou's financial condition had not yet been dis-closed.” 411 F.3d at 1026-27. Likewise, AXT's stock pricedipped below the price to which it ultimately fell after theApril 2004 disclosure, thus rendering Plaintiff's attempt tocausally link the alleged false statements with his (and otherpurported class members') financial loss insufficiently pled.

FN8. On April 29, 2004, AXT's stock pricedropped to $2.20 per share. Although the price had,at various points during the Class Period, been ashigh as $40 per share, there was a substantial peri-od of time during the Class Period in which AXT'sstock price dropped below $2 per share.

B. Plaintiff's Second Cause of Action-Violation of Section20(a)

Section 20(a) of the Securities Exchange Act (“ExchangeAct”) provides derivative liability for those who control oth-ers found to be primarily liable under the Act. In re RampNetworks, Inc. Sec. Lit., 201 F.Supp.2d 1051, 1063(N.D.Cal.2002). Where a plaintiff asserts a Section 20(a)claim based on an underlying violation of Section 10(b), thepleading requirements for both violations are the same. Id.“To be liable under section 20(a), the defendants must be li-able under another section of the Exchange Act.” HeliotropeGeneral, Inc. v. Ford Motor Co., 189 F.3d 971, 978 (9thCir.1999).

*17 Here, Plaintiff alleges that Defendant Young acted as a














controlling person of AXT within the meaning of Section20(a) of the Act and is liable thereunder for the conduct al-leged. Plaintiff claims that by virtue of Defendant Young'sposition as CEO and Chairman of the Board of the Com-pany, he was responsible for preparing and disseminatingAXT's public releases and had the power and the authorityto cause the Company to engage in the wrongful conductcomplained of. Defendants argue that Plaintiff's Section20(a) cause of action fails because Plaintiff has failed tostate a cause of action pursuant to Section 10(b). The Courtagrees. Because Plaintiff has failed to adequately plead theunderlying 10(b) violation, as discussed supra, Plaintiff'sSection 20(a) claim must also be dismissed.

CONCLUSION

For the foregoing reasons, the Court GRANTS Defendants'Motion to Dismiss without prejudice. Plaintiff must file anamended complaint within thirty days of the date of this Or-der.

This Order terminates docket entry nos. 24 and 25.

IT IS SO ORDERED.

N.D.Cal.,2005.Morgan v. AXT, Inc.Slip Copy, 2005 WL 2347125 (N.D.Cal.)


• 2006 WL 1042253 (Trial Motion, Memorandum and Affi-davit) Defendants' Reply in Support of Motion to DismissAmended Consolidated Complaint (Mar. 14, 2006) OriginalImage of this Document (PDF)• 2006 WL 440801 (Trial Motion, Memorandum and Affi-davit) Memorandum of Points and Authorities in Oppositionto Motion to Dismiss Amended Consolidated Complaint(Jan. 31, 2006) Original Image of this Document (PDF)• 2005 WL 3673019 (Trial Pleading) Amended Consolid-ated Complaint for Violations of the Federal SecuritiesLaws (Nov. 14, 2005)• 3:04cv04362 (Docket) (Oct. 15, 2004)

END OF DOCUMENT




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TAB 11



JERRY RYAN, et al., Plaintiffs, V. FLOWSERVE CORPORATION, et al., Defendants.

CIVIL ACTION NO. 3: 03--CV--1769--B ECF

UNITED STATES DISTRICT COURT FOR THE NORTHERN DISTRICT OF TEXAS,DALLAS DIVISION


June 9, 2006, DecidedJune 9, 2006, Filed

PRIOR HISTORY: Ryan v. Flowserve Corp., 2005 U.S.Dist. LEXIS 1095 (N.D. Tex., Jan. 23, 2005)

COUNSEL: [*1] For Jerry Ryan, on behalf of him-self and all others similarly situated, Plaintiff: Robert JHill, Claxton & Hill, Dallas, TX; Kimberly C Epstein,Lerach Coughlin Stoia Geller Rudman & Robbins ---- SanFrancisco, San Francisco, CA.

For Alaska Electrical Pension Fund, Plaintiff: JoeKendall, Willie Briscoe, Provost Umphrey Law Firm ----Dallas, Dallas, TX; Lauren M Winston, Ex Kano S Sams,II, Kimberly C Epstein, Maria V Morris, Mary K Blasy,Shana E Scarlett, Shawn A Williams, Willow E Radcliffe,Lerach Coughlin Stoia Geller Rudman & Robbins ---- SanFrancisco, San Francisco, CA; Tamara J Driscoll, LerachCoughlin Stoia Geller Rudman & Robbins ---- Seattle,Seattle, WA.

For Massachusetts State Carpenters Pension Fund,Pipefitters, Locals 522 & 633 Pension Trust Fund,Plaintiffs: Kimberly C Epstein, Mary K Blasy, LerachCoughlin Stoia Geller Rudman & Robbins ---- SanFrancisco, San Francisco, CA; Tamara J Driscoll, LerachCoughlin Stoia Geller Rudman & Robbins ---- Seattle,Seattle, WA.

For Harold Klagsbald, On Behalf of Himself and AllOthers Similarly Situated, Consol Plaintiff: Thomas EBilek, Hoeffner & Bilek, Houston, TX; Mel E Lifshitz,Bernstein Liebhart & Lifshitz, New York,[*2] NY.

For Thomas Butterworth, On Behalf of Himself and AllOthers Similarly Situated, Consol Plaintiff: William BFederman, Federman & Sherwood ---- Oklahoma City,Oklahoma City, OK.

For Robert K Finnell, Individually and on Behalf ofAll Others Similarly Situated, Consol Plaintiff: Marc

R Stanley, Martin Woodward, Roger L Mandel, StanleyMandel & Iola, Dallas, TX.

For Flowserve Corporation, Defendant: R ThaddeusBehrens, Haynes & Boone, Dallas, TX; Carrie Lee Huff,Nicholas Even, Haynes & Boone ---- Dallas, Dallas, TX.

For C Scott Greer, Defendant: Richard A Rohan, FletcherYarbrough, Jennifer E Morris, Todd A Murray, CarringtonColeman Sloman & Blumenthal, Dallas, TX.

For Renee J Hornbaker, Defendant: David W Klaudt,Charles Watts Flynn, Locke Liddell & Sapp ---- Dallas,Dallas, TX.

For Banc of America Securities LLC, Defendant: EllenB Sessions, Melissa J Swindle, Jenkens & Gilchrist ----Dallas, Dallas, TX; Rodney Acker, Jenkens & Gilchrist,Dallas, TX.

For Credit Suisse First Boston, Defendant: Ellen BSessions, Jenkens & Gilchrist ---- Dallas, Dallas, TX.

For PricewaterhouseCoopers LLP, Defendant: M ByronWilder, Gibson Dunn & Crutcher ---- Dallas, Dallas,[*3]TX; Dean J Kitchens, Gibson Dunn & Crutcher ---- LosAngeles, Los Angeles, CA.

For Credit Suisse First Boston LLC, Defendant: RodneyAcker, Jenkens & Gilchrist, Dallas, TX; Melissa JSwindle, Jenkens & Gilchrist ---- Dallas, Dallas, TX.

For Robert K Finnell, Movant: Marc R Stanley, StanleyMandel & Iola, Dallas, TX.

For Joseph Verga, Movant: Robert J Hill, Claxton & Hill,Dallas, TX.

JUDGES: JANE J. BOYLE, UNITED STATES



DISTRICT JUDGE.

OPINIONBY: JANE J. BOYLE

OPINION:

MEMORANDUM ORDER DENYINGDEFENDANTS' MOTION FORINTERLOCUTORY APPEAL UNDER §1292 (b)

This is a securities fraud action. The Defendants moveto appeal this Court's interlocutory order denying theirmotions to dismiss Plaintiffs' Fifth Amended Complaint.The precise motion before the Court is Defendants'Motion to Certify November 22, 2005 Order for § 1292(b)Interlocutory Appeal (doc. 141). For the reasons that fol-low, the motion is DENIED.

I.

BACKGROUND

Defendant Flowserve Corporation, n1 is a world--widemanufacturer of pumps, valves, seals and related compo-nents in the "process industries." Plaintiffs, individualswho purchased publicly traded securities of Flowserveduring the purported class[*4] period, allege that theDefendants violated federal securities laws by overstatingthe company's income and understating its costs in orderto conceal its declining financial condition. As a result,Plaintiffs claim they suffered losses when the company'strue financial condition was revealed in mid--2002 and thestock price plummeted "75% from its Class Period high."(Fifth Am. Compl. PP 13, 328--49)

n1 Along with Flowserve Corporation,Plaintiffs have sued certain officers, auditors andunderwriters for the company. For purposes of thisorder, the Defendants will be collectively referredto as "Defendants" or "Flowserve."

Plaintiffs filed this suit in August 2003 accompaniedby a series of pleadings culminating in their 154--pageFifth Amended Complaint. Flowserve responded withmotions to dismiss pursuant toRules 12(b)(6)and9(b)of the Federal Rules of Civil Procedure and the PrivateSecurities Litigation Reform Act of 1995 ("PSLRA").In their motions, the Defendants[*5] identified numer-ous perceived pleading deficiencies including--and rele-vant to this determination--that Plaintiffs failed to ade-quately plead loss causation; that Plaintiffs' claims arebarred by the statutory negative causation defense; andthat Plaintiffs' claims regarding Defendants' earnings pro-jections statements are precluded by the PSLRA's "safeharbor" provision.

On November 18, 2005, the Court heard argumentson the Defendants' motions to dismiss and denied all threemotions in a ruling from the bench followed by a writ-ten order on November 22, 2005. Defendants now seekcertification on three issues they describe as "controllingquestions of law", including:

. Whether, in a case predicated on the fraud--on--the market theory, a plaintiff must pleadthat the alleged curative disclosure of the"truth" that resulted in the plaintiff's lossesrevealed each material fact allegedly misrep-resented to satisfy the required element ofloss causation;

. Whether, in a case predicated on the fraud--on--the market theory, a plaintiff's claims un-der Section 11are barred by the statutorynegative causation defense where the allegedcurative disclosure that the plaintiff claimsresulted[*6] in his losses did not reveal thefacts allegedly misrepresented in the chal-lenged registration statements; and

. Whether the PSLRA safe harbor for for-ward--looking statements protects from lia-bility projections accompanied by meaning-ful cautionary language independent of thespeaker's alleged state of mind.

(Defs. Mot. to Certify ("Mot.") at 2)

Plaintiffs oppose the motion on several grounds, ar-guing, inter alia, that the Defendants' "controlling ques-tions" are simply fact--bound issues disguised as questionsof law for§ 1292(b)purposes; that an interlocutory appealwill "retard" rather than advance the litigation; and thatthey will be severely prejudiced by any further postpone-ment of discovery in this almost three--year--old case.

II.

§ 1292 (b)

At the outset, it is important to understand the circum-stances under which a party may appeal an interlocutoryorder. This is best approached by first reviewing the per-tinent statutory language and then examining how thecourts have interpreted and applied the provision.Section1292(b)expressly permits a district court to certify an or-der for interlocutory appeal only if it "involves a control-ling question[*7] of law as to which there is substantialground for difference of opinion and that an immediateappeal from the order may materially advance the ulti-mate termination of the litigation."28 U.S.C.A. § 1292(b)(1994 & Supp. 2005). This terminology was intended to



restrict the category of cases suitable for permissive ap-peal, but courts have not always agreed on the contoursof the stated limitations.See16 CHARLES A. WRIGHT,ET AL., FEDERAL PRACTICE AND PROCEDURE §3929 at 366--67 (2d ed. 1996) [hereinafter WRIGHT &MILLER]. See generally Ahrenholz v. Bd. of Trustees ofthe Univ. of Illinois, 219 F.3d 674, 676 (7th Cir. 2000)("The [§ 1292(b)] criteria, unfortunately, are not as crys-talline as they might be. . . .").

For example, at times, courts including the FifthCircuit have held that§ 1292(b)appeals are appropriateunder only "exceptional" circumstances or in "big" cases.Clark--Dietz and Assocs.--Eng'rs v. Basic Constr. Co., 702F.2d 67, 69 (5th Cir. 1983)(explaining that interlocutoryappeals are permitted only under "exceptional" circum-stances);see Gottesman v. Gen. Motors Corp., 268 F.2d194, 196 (2d Cir. 1959)[*8] (clarifying that certificationshould be "strictly limited to the precise conditions statedin the law"); WRIGHT & MILLER, supra, § 3929 at365 & n.10 (internal citations omitted) (collecting casesholding interlocutory appeal appropriate only in "big" or"exceptional" cases).

Conversely, at other times courts--the Fifth Circuitincluded--have employed a more flexible approach to§1292(b)appeals. InHadjipateras v. Pacifica, S.A., JudgeBrown promoted a more relaxed application of the provi-sion:

Each application is to be looked at . . . in thelight of the underlying purpose reflected inthe statute. . . . It was a judge--sought, judge--made, judge--sponsored enactment. FederalJudges from their prior professional practice,and more so from experience gained in theadjudication of today's complex litigation,were acutely aware of two principal things.First, certainty and dispatch in the comple-tion of judicial business makes piecemeal ap-peal as permitted in some states undesirable.But second, there are occasions which defyprecise delineation or description in whichas a practical matter orderly administrationis frustrated by the necessity of a waste ofprecious judicial[*9] time while the casegrinds through to a final judgment as the solemedium through which to test the correct-ness of some isolated identifiable point offact, of law, of substance or procedure, uponwhich in a realistic way the whole case ordefense will turn. The amendment was togive to the appellate machinery of§ 1291through§ 1294a considerable flexibility op-erating under the immediate, sole and broad

control of Judges so that within reasonablelimits disadvantages of piecemeal and finaljudgment appeals might both be avoided. Itis that general approach rather than the useof handy modifiers--which may turn out to beShibboleths--that should guide us in its appli-cation and in determining whether the proce-dure specified has been substantially satis-fied.

290 F.2d 697, 702--03 (5th Cir. 1961)); see alsoWRIGHT& MILLER, supra, § 3929 at 368--69 & n. 16 (quotingExparte Tokio Marine & Fire Ins. Co., 322 F. 2d 113, 115(5th Cir. 1963))(criticizing other courts' "epithets" that§1292(b)is to be "'sparingly applied'").

Regardless of the approach--rigid or more flexible--some common ground can be gleaned from both ends ofthe spectrum.[*10] First, the decision to permit suchan appeal is firmly within the district court's discretion.Cheney v. U.S. Dist. Court for Dist. of Columbia, 542 U.S.367, 405 n.9, 124 S. Ct. 2576, 159 L. Ed. 2d 459 (2004)(Ginsburg, J., dissenting) (instructing that discretion for a§ 1292 (b)appeal lies "in the first instance in the districtcourt's sound discretion"). Second,§ 1292(b)is not a ve-hicle to question the correctness of a district court's rulingor to obtain a second, more favorable opinion.McFarlinv. Conseco Servs., LLC, 381 F.3d 1251, 1256 (11th Cir.2004)(quoting S. Rep. No. 85--2434 (1958), reprinted inU.S.C.C.A.N. at 5260--61)). Third, the issue for appealmust involve a question oflaw--notfact.Clark--Dietz, 702F.2d at 69(holding that "fact--review" issues are inappro-priate for§ 1292review). And a "question of law" doesnot mean the application of settled law to disputed facts.McFarlin, 381 F.3d at 1258(citing Ahrenholz, 219 F.3dat 676). Thus, resolving the issue presented should not re-quire the appeals court to go "hunting through the record"to see whether "a genuine issue of material fact may belurking there. [*11] " Ahrenholz, 219 F.3d at 676.

Fourth, the issue for appeal must involve acontrol-ling question of law. Whether an issue of law iscontrollinggenerally hinges upon its potential to have some impact onthe course of the litigation. At one end of the continuum,courts have found issues to be controlling "if reversal ofthe district court's opinion would result in dismissal ofthe action."Strougo v. Scudder, Stevens & Clark, Inc.,1997 U.S. Dist. LEXIS 12243, No. 96 CIV. 2136 (RWS),1997 WL 473566, at *7 (S.D.N.Y. Aug. 18, 1997)(citingKlinghoffer v. S.N.C. Achille Lauro, 921 F.2d 21, 24 (2dCir. 1990))(other citations omitted). An issue of law hasalso been termed controlling where "the certified issuehas precedential value for a large number of cases." Id.On the other hand, an issue is not seen as controlling if its



resolution on appeal "would have little or no effect on sub-sequent proceedings." John C. Nagel, Note,Replacing theCrazy Quilt of Interlocutory Appeals Jurisprudence withDiscretionary Review, 44 DUKE L. J. 200, 212 (1994);WRIGHT & MILLER, supra, § 3930 at 424. Between theextremes, courts have found the issue of[*12] whetheran interlocutory appeal involves a controlling question oflaw to be "closely tied" to the requirement that the appealwill materially advance the ultimate termination of the lit-igation. WRIGHT & MILLER, supra, § 3930 at 432;seealso Nagel, supra, at 212(courts have turned to the "ma-terially advance" prong of§ 1292(b)in deciding whetheran issue of law is controlling) (internal citations omit-ted). In sum, acontrolling question of law--although notconsistently defined--at the very least means a question oflaw the resolution of which could materially advance theultimate termination of the litigation--thereby saving timeand expense for the court and the litigants. WRIGHT &MILLER, supra, § 3930 at 426 & n.25 (2ded. 1996 &Supp. 2005) (citingS.E.C. v. Credit Bancorp, Ltd., 103 F.Supp. 2d 223, 227 (S.D.N.Y. 2000)).

A fifth and key concern consistently underlying§1292 (b) decisions is whether permitting an interlocu-tory appeal will "speed up the litigation."Ahrenholz, 219F.3d at 676. "The institutional efficiency of the federalcourt system is among the chief concerns motivating§1292(b)." Strougo, 1997 U.S. Dist. LEXIS 12243, 1997WL 473566, [*13] at *6 (citing Forsyth v. Kleindienst,599 F.2d 1203 (3d Cir. 1979)). Stated another way,§1292(b)is designed to minimize burdens "by accelerat-ing or . . . simplifying trial court proceedings." WRIGHT& MILLER, supra, § 3930 at 439.

Finally, there must be substantial ground for differ-ence of opinion over the controlling question of law forcertification under§ 1292(b). This factor has been de-scribed as the least troubling for district courts. WRIGHT& MILLER, supra, § 3930 at 419--20 (district courts "havenot been bashful about refusing to find substantial reasonto question a ruling of law"). Nonetheless, of all the§1292(b)criteria, this one is possibly the least predictablein application. Perhaps, as one commentary on§ 1292(b)recognized over thirty years ago, this is because "de-grees of legal doubt escape precise quantification." Note,Interlocutory Appeals in the Federal Courts Under 28U.S.C. § 1292(b), 88 HARV. L. REV. 607, 623 (1975).That same commentary proposed a standard "that wouldrequire a trial court to believe that a reasonable appel-late judge could vote for reversal of the challenged[*14]order" before the disagreement would be considered sub-stantial under§ 1292(b). Id. Consistent with this line ofthought, courts have found substantial ground for differ-ence of opinion where:

a trial court rules in a manner which ap-pears contrary to the rulings of all Courts ofAppeals which have reached the issue, if thecircuits are in dispute on the question and theCourt of Appeals of the circuit has not spokenon the point, if complicated questions ariseunder foreign law, or if novel and difficultquestions of first impression are presented.

4 Am. Jur. 2d Appellate Review § 128(2005). But simplybecause a court is the first to rule on a question or coun-sel disagrees on applicable precedent does not qualifythe issue as one over which there is substantial disagree-ment. Id. Nor does a party's claim that a district courthas ruled incorrectly demonstrate a substantial disagree-ment.Wausau Bus. Ins. Co. v. Turner Constr. Co., 151F. Supp. 2d 488, 491 (S.D.N.Y. 2001). In the end, "sub-stantial" means just that--significantly great. MERRIAM--WEBSTER'S COLLEGIATE DICTIONARY 1174 (10thed. 1998).[*15]

III.

ANALYSIS

A. Loss Causation Pleading

With the foregoing court opinions and commentaryas a guide, the Court turns its attention to the meritsof Flowserve's motion to certify to determine whetherit has met the prerequisites for a for a§ 1292(b)appeal.Flowserve's first "controlling question" relates to loss cau-sation pleading and reads:

Whether, in a case predicated on the fraud--on--the market theory, a plaintiff must pleadthat the alleged curative disclosure of the"truth" that resulted in the plaintiff's lossesrevealed each material fact allegedly misrep-resented to satisfy the required element ofloss causation.

Flowserve's contention that this issue is appropriate for a§ 1292 (b)appeal derives primarily from its interpretationof the Supreme Court's opinion regarding loss causationin Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336,125 S. Ct. 1627, 161 L. Ed. 2d 577 (2005). In Dura,the Supreme Court tightened the loss causation pleadingstandards in fraud--on--the--market cases by doing awaywith the "inflated purchase price" method of pleadingloss causation and holding that loss causation could nolonger be established solely by alleging an[*16] artifi-cially inflated purchase price followed by a drop in stockprice. Analyzing whether Flowserve has met its burden ofdemonstrating that its first "controlling question" meets



the standards for a§ 1292(b)appeal necessarily beginswith a review of theDura case.

Dura was a securities fraud class action which re-solved a circuit split by dealing head--on with the "arti-ficially inflated purchase price" method of pleading losscausation. The plaintiffs, who bought stock in a phar-maceutical company, alleged that the company madefalse statements about anticipated FDA approval of a newasthmatic spray device which in turn artificially inflatedthe company's stock price. When the company later an-nounced lower than expected earnings, the stock pricedropped significantly. Plaintiff--in pleadings subsequentlyendorsed by the Ninth Circuit--alleged loss causation asfollows: "'In reliance on the integrity of the market, [theplaintiffs] . . . paid artificially inflated prices forDurasecurities' and . . . suffered 'damage [s] thereby. . . .'"Id.at 340(internal citations omitted).

The narrow issue before theDura Court was whethera plaintiff could[*17] satisfy the loss causation pleadingand proof requirement "simply by alleging in the com-plaint and subsequently establishing that 'the price' of thesecurity 'on the date of purchasewas inflated because ofthe misrepresentation.'"Id. at 338(emphasis in original).The Supreme Court found the answer to that question tobe an unequivocal "no."

The Court began its opinion by identifying the basicelements of a securities fraud action--including the indis-pensable requirement that plaintiffs prove "a causal con-nection between the material misrepresentation and theloss."Id. at 342. Taking issue with the Ninth Circuit's ap-proval of the plaintiffs' pleadings, the Court stated: "nor-mally, [in fraud--on--the--market cases,] an inflated pur-chase price will not itself constitute or proximately causethe relevant economic loss."Id. Reviewing the "tangle offactors affecting [stock] price", the Court concluded thatthe causal connection between an inflated purchase priceand subsequent shareholder economic losses was tenu-ous at best.Id. at 343("the most logic alone permits usto say is that the higher purchase price willsometimes[*18] play a role in bringing about a future loss"). Theopinion directed that plaintiffs in securities fraud casesmust prove that the defendant's fraudulent conduct "prox-imately caused [their] economic loss" and determined thatthe "'inflated purchase price approach'"--standing alone--was not up to the task.Id. at 344--46.

Addressing separately the pleading requirements forloss causation, theDura Court made clear that plaintiffscould no longer rely solely on allegations of an "artificiallyinflated purchase price" to demonstrate the essential ele-ments of proximate causation and economic loss. Whilethe Court found theDura plaintiffs' loss causation plead-ings inadequate, it did not at the same time adopt more

onerous pleading standards for such allegations. Rather,the Court clarified thatFederal Rule of Civil Procedure8(a)(2)'s "short and plain statement" rule would continueto govern loss causation pleadings.Id. at 346. So long asthe allegations provide the defendant with fair notice ofthe plaintiff's claims and its grounds, the Court counseled,the pleadings will pass muster.Id. This means[*19] that"a plaintiff who has suffered an economic loss [must] pro-vide a defendant with some indication of the loss and thecausal connection that the plaintiff has in mind."Id. at347.

In sum,Dura eliminated the "artificially inflated pur-chase price" method of proving loss causation, reempha-sized the importance of demonstrating proximate causeand economic loss and renewedRule 8 (a) (2)'s "short andplain statement" rule for such pleadings. WhetherDuraheralded the change in loss causation pleading standardsurged by Flowserve is another matter. Before moving tothat issue, it bears mention that in various places in itsbriefing, Flowserve frames the loss causation "control-ling question" for§ 1292(b)purposes in more generalterms than in the introduction to its briefing. n2 To beclear, Flowserve's bottom line here is that post--Dura, losscausation must be pled in an almost formulaic mannerrequiring the plaintiff to plead that the "alleged curativedisclosure of the 'truth' that resulted in the plaintiff's lossesrevealed each material fact allegedly misrepresented [oromitted] to satisfy the required element of loss causa-tion"--a method this Court[*20] will refer to as "fact--for--fact" pleading.

n2 For example, Flowserve variously framesthe "controlling legal issue" for§ 1292 (b)as "whatmust be alleged to satisfy the loss causation re-quirements set forth byDura, the PSLRA andFifth Circuit precedent" (Mot. at 5); "whether theComplaint's allegations, taken as true: . . . statea legally viable loss causation theory under theSupreme Court's decision inDura" (Reply at 1);and "there is a substantial ground for a differenceof opinion regarding whether Plaintiff's loss causa-tion theory is legally valid." (Reply at 3). But it isclear from the entirety of its briefing that Flowserverests its argument on the premise thatDura requires"fact--for--fact" pleading of loss causation.

1. Controlling Question of Law

Plaintiffs first challenge Flowserve's motion to certifythe loss causation issue as raising "fact--bound" pleadingissues as opposed to legal questions. Interlocutory appealshave been allowed on pleading issues which raise difficult[*21] questions of substantive law but not when the is-



sue raised is a "mere matter of properly pleading a claimsought to be brought within a recognized and generallysufficient legal theory." WRIGHT & MILLER,supra, §3931 at 453, 458--59 (A motion to dismiss a complaint"may rest . . . on resolution of a clearly determinativequestion of law . . . or . . . on questions merely of pleadingetiquette.").

Here, the Court is satisfied that Flowserve has raisedan issue of law as opposed to fact regarding the requi-site pleading standards for loss causation post--Dura. Asarticulated in its "controlling question 1" and accompa-nying argument, Flowserve contends thatDura requiresPlaintiffs to demonstrate "a direct causal link between themisstatement and . . . [their] economic loss." (Mot. at5--6) The "direct causal link", according to Defendants,cannot be established "with respect to an alleged mis-representation unless and until there is a revelation ofthe truth concerning that misrepresentation followed bya stock price decline." (Mot. at 5) (emphasis in original)The Court finds that this adequately raises a legal questionas to the post--Dura minimum requirements for pleading[*22] a "legally viable loss causation theory." (Reply at1) Whether it is a controlling question of law is anothermatter. Rather than decide that issue, the Court will as-sume without deciding that it is a controlling questionand move to the "substantial disagreement" requirementwhere it clearly falls short.

2. Substantial Ground for Difference of Opinion

In determining whether a substantial ground for dif-ference of opinion exists in the context of§ 1292(b), theobvious first task is to identify the opinion at issue andthen weigh the degree of disagreement. In other words,first and foremost, there must be a discernable opiniontriggering the requisite disagreement. Drawn from its in-terpretation ofDura, Flowserve identifies the opinion atissue as:

Whether, in a case predicated on the fraud--on--the market theory, a plaintiff must pleadthat the alleged curative disclosure of the"truth" that resulted in the plaintiff's lossesrevealed each material fact allegedly misrep-resented to satisfy the required element ofloss causation.

Implicit in this question and expressed throughout itsbriefing is Flowserve's assumption that theDura opinionsignaled[*23] a change in loss causation pleading re-quirements beyond its narrow holding on the inflated pur-chase price theory. More to the point, fromDuraand fromcertain Fifth Circuit cases dealing with proximate causein other securities fraud contexts, Flowserve extracts "a

substantial likelihood" that the Fifth Circuit will interpretDura to impose a type of "fact--for--fact" loss causationpleading requirement. Taking it a step further, Flowservesubmits that, post--Dura, the Fifth Circuit can reasonablybe expected to hold that loss causation in fraud--on--the--market cases can only be shown by demonstrating thateachfact allegedly misrepresented (the fraud) was alsolater revealed to the market triggering the drop in stockprice. (Mot. at 7) Applied to this case, Flowserve's fact--for--fact pleading requirement would require Plaintiffs toallege that the precise topics of the alleged misrepresen-tations--Flowserve's historical financial statements, state-ments of debt covenant compliance and statements re-garding the IDP and IFC acquisitions--were laterone--by--onerevised and revealed to the market in truthful terms.

The obvious shortcoming for§ 1292(b)purposes isthatDura [*24] did not, even by way ofdicta, express theopinion Flowserve now claims is the subject of substan-tial disagreement. As mentioned, theDuracourt expresslydeclined to formulate precise standards for proving losscausation despite a request to do so by the Defendant andthe Solicitor General. Evan R. Chesler & J. Stephen Beke,Loss Causation Post--Dura, 1517 P.L.I. CORP. LAW &PRAC. COURSE, HANDBOOK SERIES 1277, 1280(2005) (citing Transcript of Oral Argument at 3--9, 11, 18--20,Dura, 544 U.S. at 346 (No. 932)). Outside of rejectingthe inflated purchase price approach,Dura's instructionson loss causation pleadings were limited to: reaffirm-ing the applicability ofRule 8 (a) (2)'s short and plainstatement rule to such pleadings; requiring that plaintiffsplead loss causation in a way that provides the defendant"'fair notice'" of their claims and the grounds underlyingthem; and suggesting that plaintiffs include allegationsthat the stock price "fell significantly after the truth be-came known."Id. at 1282 (citingDura, 544 U.S. at 346--47).

TheDuracourt did not endorse or address Flowserve'sproposed "fact--for--fact" method[*25] of pleading losscausation.Id. (citing Dura, 544 U.S. at 346) (The Duracourt did not purport to address whether loss causationallegations must "explicitly allege that the subject matterof the alleged misrepresentations . . . was revealed to themarket by way of some 'corrective disclosure' that pre-ceded the drop in the price of the stock (or the economicloss generally)."). "While the Court suggested that theplaintiffs needed to have alleged in some fashion that 'thetruth [regarding the . . . misrepresented information] be-came known' before the "'share price fell'", the Court didnot set forth guidelines as to whether such a revelation . . .must be direct [or] inferential.")Id. (citingDura, 544 U.S.at 347). In actuality,Dura "left the lower federal courtsfree to continue to develop somewhat diverse approachesto the pleading of corrective disclosures preceding eco-



nomic losses."Id.

Thus the "opinion" on which Flowserve seeks FifthCircuit guidance and over which it contends there is sub-stantial disagreement is not reasonably drawn from theDura case. Nor does any Fifth Circuit case suggest the in-terpretation[*26] of Duraurged by Flowserve. In fact, aspointed out by Plaintiffs, none of the cases relied upon byFlowserve are apposite to its position onDura. n3 Casesand commentary followingDura and directly addressingthe pleading issue substantiate that it did not effect a ma-terial change or foretell a shift in loss causation pleadingrequirements other than in the narrow area of inflatedpurchase price pleadings.SeePatrick J. Coughlin, EricAlan Isaacson and Joseph D. Daley,What's Brewing inDura v. Broudo? The Plaintiffs' Attorneys Review theSupreme Court's Opinion and Its Import for SecuritiesFraud Litigation, 37 LOY. U. CHI. L. J. 1, 17 (2005)("Clearly the [Dura] Court means for . . . [pleading losscausation] to be a fairly simple [exercise]. . . .").

n3 Flowserve citesIn re Odyssey, 424 F. Supp.2d 880 (N.D. Tex. 2005), in support of its loss cau-sation pleading theory. (Notice of Supp. Auth. at1) But In re Odysseyis distinguishable on severalfronts. First, although the district court inOdysseyobserved that the parties disagreed over "the scopeof what Dura now requires a plaintiff to plead",the court did not endorse or even reference thetype of fact--for--fact pleading method touted byFlowserve in this case.Odyssey, 424 F. Supp. 2dat 886. Second, the "false financial statements"claim in Odyssey(the only claim similar to thosein this case) was rejected--not on loss causationpleading grounds--but under the PSLRA's safe har-bor provision.Id. at 886--87. Finally, the languagefrom Odysseyheavily relied upon by Flowserve assupporting its theory of loss causation pleading ispulled from a portion of the opinion addressing theresignation of the company's CEO--a claim utterlyunlike any in this case.Id. at 887.

[*27]

In its In re Bradley Pharmaceuticals, Inc., SecuritiesLitigation opinion, a district court in New Jersey squarelytook on the issue of whether the method of pleading urgedhere by Flowserve was required post--Dura.421 F. Supp.2d 822 (D. N. J. 2006). The defendants in that case arguedthat "Dura requires Plaintiffs to 'allege a loss followingthe 'corrective disclosure' of the allegedly undisclosedmisrepresentation.'"Id. at 828. They complained that theplaintiffs had not adequately pleaded loss causation be-cause the alleged corrective disclosure (an SEC inquiry)did not address the subject of the alleged misrepresenta-

tion (false statements in connection with the "sham" saleof a cold remedy). The district court rejected the defen-dants' argument with the following:

We disagree with Defendants' rigid and dog-matic interpretation ofDura. In Dura, theSupreme Court only suggested that the plain-tiffs needed to have alleged in some fash-ion that 'the truth became known' before'the share price fell.' However,Dura did notaddress what type of events or disclosuresmay reveal the truth. Nor didDura explainhow specific[*28] such disclosures mustbe.See In re Winstar Communications, 2006U.S. Dist. LEXIS 7618, 2006 WL 473885(S.D.N.Y. 2006)(stating that inDura, "theCourt did not address the means by whichthe information is imparted to the public.Specifically,Dura did not set forth any re-quirements as to who may serve as the sourceof the information, nor is there any require-ment that the disclosure take a particular formor be of a particular quality.") . . .see fi-nally In re Worldcom, Inc. Sec. Litig., 388F. Supp. 2d 319, 347, 2005 WL 2319118,at *23 (S.D.N.Y. 2005)(to satisfy loss cau-sation underDura, plaintiff must "establishthat his losses were attributable to some formof revelation to the market of the wrongfullyconcealed information"). . . .

Guided by a pragmatic understanding ofDura, the Court concludes that Plaintiffshave adequately pled loss causation. The rev-elation of the "truth" about the [cold remedysale] did not take the form of a single, uni-tary disclosure, but occurred through a se-ries of disclosing events.See, e.g., GreaterPennsylvania Carpenter's Pension Fund v.Whitehall Jewellers, Inc., 2005 U.S. Dist.LEXIS 12971, 2005 WL 1563206 (N.D. Ill.2005). . [*29] . .

421 F. Supp. 2d at 828--29(some internal citation omit-ted).

In In re Enron Corp. Securities, Derivative and ERISALitigation, the district court, in a lengthy analysis ofDura's effect on loss causation pleading, recognized thatDura did "not impose heightened or onerous pleadingrequirements."In re Enron Corp. Secs., Derivative andERISA Litig., 2005 U.S. Dist. LEXIS 41240, No. MDL--1446, 2005 WL 3504860 at *15--19 (S.D. Tex. Dec. 22,



2005); see also In re Daou Sys., 411 F.3d 1006, 1026(9th Cir. 2005) (another post--Dura opinion upholdingloss causation pleadings--which alleged a sharp drop instock price on the heels of a public revelation of the com-pany's "true financial situation"--as sufficiently allegingpursuant toDura "some indication that the drop in . . .stock price was causally related to Daou's financial mis-statements");Greater Pennsylvania Carpenters PensionFund v. Whitehall Jewelers, Inc., 2005 U.S. Dist. LEXIS12971, No. 04--C--1107, 2005 WL 1563206 *5 (N.D. Ill.June 30, 2005)(where, post--Dura, the district court letstand a pre--Dura ruling denying a motion to dismiss onloss causation grounds--finding allegations of defendants'[*30] numerous false statements about thefinancial con-dition of the company which were later revealed throughpartial disclosures relating to the fraud causing the stockprice to drop sufficient to allege loss causation) (emphasisadded).

To sum up, sinceDura, the circuits have continuedto vary in their approaches to loss causation pleading--some with stricter requirements than others. But neitherDura nor any Fifth Circuit case requires the type of "fact--for--fact" method of loss causation pleading urged byFlowserve. Because there is noopinionexpressly requir-ing or even reasonably suggesting Flowserve's proposedpleading approach, there is necessarily no substantial dis-agreement to support an interlocutory appeal. The cir-cuits' disparate pleading requirements for loss causationdo not amount to a substantial disagreement over whetherfact--for--fact pleading should be required. Given theDuraCourt's expressed allegiance to a "simple test" for losscausation pleadings underRule 8 (a) (2), Flowserve's po-sition favoring fact--for--fact precision in pleading is evenless tenable. Finally, as pointed out by Plaintiffs, to im-pose a requirement in securities fraud cases that[*31]each fact misrepresented be in turn specifically confessedbefore liability could attach would discourage candor andinhibit the flow of precise, accurate information betweencorporations and shareholders.

Because Flowserve's§ 1292 (b)motion with respectto loss causation fails on the "substantial disagreement"prong, the Court denies this part of the motion on thatground and will not address the other§ 1292 (b)factors.

B. Negative Causation Defense

Flowserve next moves to certify the following ques-tion regarding the statutory negative causation defense:

Whether, in a case predicated on the fraud--on--the market theory, a plaintiff's claims un-der Section 11are barred by the statutorynegative causation defense where the allegedcurative disclosure that the plaintiff claims

resulted in his losses did not reveal the factsallegedly misrepresented in the challengedregistration statements.

This point merits no discussion because it mirrors theargument supporting the loss causation pleading issueabove. In other words, to certify the negative causationquestion, the Court must accept Flowserve's premise thatDura requires fact--for--fact loss causation[*32] plead-ing. Thus for the same reasons set forth in the foregoingsection, the Court rejects the negative causation argumentand denies this portion of Flowserve's motion to certify.

C. Safe Harbor n4

n4 (c) Safe Harbor. ----

(1) In general. ---- Except as providedin subsection (b), in any private actionarising under this title that is based onan untrue statement of a material factor omission of a material fact neces-sary to make the statement not mis-leading, a person referred to in sub-section (a) shall not be liable withrespect to any forward--looking state-ment, whether written or oral, if and tothe extent that ----

(A) the forward--looking statementis ----

(i) identified as aforward--lookingstatement, and isaccompanied bymeaningful cautionarystatements identifyingimportant factors thatcould cause actual resultsto differ materially fromthose in the forward--looking statement; or

(ii) immaterial; or

(B) the plaintiff fails to prove that theforward--looking statement ----

(i) if made by a naturalperson, was made withactual knowledge by thatperson that the statementwas false or misleading;



or

(ii) if made by a businessentity; was ----

(I) made by or with theapproval of an executiveofficer of that entity, and

(II) made or approved bysuch officer with actualknowledge by that offi-cer that the statement wasfalse or misleading.

15 U.S.C. § 78u--5(c)(1)(A)and(B).

[*33]

Flowserve's third controlling question relates to thePSLRA's "safe harbor" provision:

Whether the PSLRA safe harbor for for-ward--looking statements protects from lia-bility projections accompanied by meaning-ful cautionary language independent of thespeaker's alleged state of mind.

Reduced to its essence, Flowserve's argument boils downto a claim that the Court made a mistake in applying thePSLRA's safe harbor provision and in the process madean incorrect statement of law regarding the interplay be-tween the two prongs of the provision. More precisely,Flowserve maintains that, in denying the Defendants' mo-tions to dismiss, the Court conflated the two independentprongs of the PSLRA's safe harbor provision and incor-rectly stated that Plaintiffs can defeat either prong bypleading that a defendant had actual knowledge of a state-ment's falsity. Citing the text of the safe harbor statute,its legislative history and a plethora of cases, Flowservechallenges the Court's suggestion of a "settled principle"that actual knowledge of falsity defeats either prong ofthe provision. (Mot. at 15--20)

The Court agrees with Flowserve on this point.Nonetheless, that does not qualify[*34] the questionfor a § 1292(b)appeal. To elevate the Court's misstate-ment into an issue appropriate for interlocutory appealFlowserve must demonstrate that it meets§ 1292(b)'sstandards as a controlling question of law over whichthere is substantial ground for difference of opinion andthat an immediate appeal from the order may speed up thelitigation. And the fact that this Court made a statementthat conflicts with the weight of authority on the safe har-

bor provision does not a substantial disagreement make.Although, as mentioned, "degrees of legal doubt escapeprecise quantification," n5 Flowserve is hard pressed hereto quantify the conflict between this Court's incorrect as-sessment of the law and the extensive authority to thecontrary as "substantial." Thus, this issue is not a properone for an interlocutory appeal and Flowserve's motionmust be denied on this point as well. n6

n5 See Note,Interlocutory Appeals in theFederal Courts Under 28 U.S.C. § 1292(b), 88HARV. L. REV. 607 at 623.

n6 Although the Court's sole task here is todecide Flowserve's motion for interlocutory ap-peal under§ 1292 (b)'s standards, it is impor-tant to clarify the effect of the Court's incor-rect perception of the law on Flowserve's mo-tion to dismiss. Specifically, despite the Court'sinaccurate assessment of the effect of a defen-dant's state of mind on the operation of the firstprong of the safe harbor provision, it need notas a consequence reverse that portion of its rul-ing on the motion to dismiss. More to the point,to qualify for safe harbor protection under the firstprong, the statements at issue must be accompa-nied by "meaningful cautionary language." TheCourt has reviewed those portions of the plead-ings that Flowserve contends are protected underthe first prong of the safe harbor provision anddetermined that it is impossible without more in-formation (via summary judgment) to tell whetherthe cautionary language describes the "principalor important risks" facing Flowserve at the timethey were made.See Asher v. Baxter Int'l Inc., 377F.3d 727, 733 (7th Cir. 2004); Makor Issues &Rights, Ltd. v. Tellabs, Inc., 437 F.3d 588, 599 (7thCir. 2006) (quotingAsher, 377 F.3d at 733); andMarc H. Folladori, ProtectingForward--LookingStatements: The Private Securities LitigationReform Act of 1995 and Other Safeguards,1522 P.L.I. CORP. LAW & PRAC. COURSE,HANDBOOK SERIES 297, 334 (January 2006).This, in turn, means that the Court cannot presentlydetermine if the accompanying cautionary lan-guage is "meaningful" thus dismissal under the safeharbor provision is precluded at this time.

[*35]

IV.

CONCLUSION

For all of the foregoing reasons, the Defendants'Motion to Certify November 22, 2005 Order for § 1292(b)



Interlocutory Appeal (doc. 141) is DENIED.

SO ORDERED.

SIGNED June 9th, 2006

JANE J. BOYLE


June 13, 2006


TAB 12


LEXSEE 2006 U.S. APP. LEXIS 16556

T. JEFFREY SIMPSON, on behalf of himself and all others similarly situated, andPlaintiff, CALIFORNIA STATE TEACHERS RETIREMENT SYSTEM, Plaintiff--

Appellant, v. AOL TIME WARNER INC.; CENDANT CORPORATION; RICHARD A.SMITH; L90, aka Max Worldwide; DAVID COLBURN; ERIC KELLER, Defendants--

Appellees.

No. 04--55665

UNITED STATES COURT OF APPEALS FOR THE NINTH CIRCUIT

2006 U.S. App. LEXIS 16556

February 6, 2006, Argued and Submitted, Pasadena, CaliforniaJune 30, 2006, Filed

PRIOR HISTORY: [*1] Appeal from the United StatesDistrict Court for the Central District of California. D.C.No. CV--01--11115--MJP. Marsha J. Pechman, DistrictJudge, Presiding.In re Homestore.com, Inc. Sec. Litig.,252 F. Supp. 2d 1018, 2003 U.S. Dist. LEXIS 3499 (C.D.Cal., 2003)

COUNSEL: Joseph W. Cotchett (argued) and NancyL. Fineman, Cotchett, Pitre, Simon & McCarthy,Burlingame, California, for plaintiff--appellant CaliforniaState Teachers' Retirement System.

Peter T. Barbur (argued), Cravath, Swaine & Moore LLP,New York, New York; John B. Quinn, Quinn EmanuelUrquhart Oliver & Hedges LLP, Los Angeles, California,for defendant--appellee Time Warner Inc. Samuel Kadet,Skadden, Arps, Slate, Meagher & Flom LLP, NewYork, New York; Jeffrey Speiser, Stern & Kilcullen,Roseland, New Jersey, for defendants--appellees CendantCorporation and Richard A. Smith. Carl S. Kravitz,Zuckerman Spaeder LLP, Washington, DC, for defen-dant--appellee David Colburn. J. Christian Word, Latham& Watkins LLP, Washington, DC, for defendant--appelleeEric Keller. Daniel J. Tyukody, Orrick, Herrington &Sutcliffe LLP, Los Angeles, California, for defendant--appellee L90, Inc. d/b/a MaxWorldwide, Inc.

Michael L. Post, Senior Counsel, Washington, DC, on be-half of the Securities and Exchange Commission as ami-cus curiae in support[*2] of appellant. Peter H. Mixon,General Counsel, Sacramento, California; Keith Johnson,Chief Legal Counsel, Madison, Wisconsin, on behalf ofthe California Public Employees' Retirement System andthe State of Wisconsin Investment Board as amici cu-riae in support of appellant. Eric Alan Isaacson, Lerach

Coughlin Stoia & Robbins LLP, San Diego, California,on behalf of the Regents of the University of Californiaas amicus curiae in support of appellant. Lawrence S.Robbins, Robbins, Russell, Englert, Orseck & UntereinerLLP, Washington, DC, on behalf of the American Instituteof Certified Public Accountants as amicus curiae in sup-port of appellees. David H. Braff, Sullivan & CromwellLLP, New York, New York, on behalf of the Bond MarketAssociation, et al., as amici curiae in support of appellees.

JUDGES: Before: Robert R. Beezer, Thomas G. Nelson,and Ronald M. Gould, Circuit Judges. Opinion by JudgeGould.

OPINIONBY: Ronald M. Gould

OPINION: GOULD, Circuit Judge:

This consolidated class action litigation alleges thatmultiple actors engaged in a scheme to commit se-curities fraud by overstating the reported revenues ofan Internet company, Homestore.com ("Homestore").Homestore eventually restated[*3] its revenues, result-ing in a decrease in revenues of more than $170 millionand corresponding declines in Homestore's stock value.The district court dismissed the securities claims againstDefendants--Appellees, relying on the Supreme Court'sdecision inCentral Bank of Denver, N.A. v. First InterstateBank of Denver, N.A., 511 U.S. 164, 114 S. Ct. 1439, 128L. Ed. 2d 119 (1994).

In this appeal, the lead plaintiff, California StateTeachers' Retirement System ("CalSTRS" or "Plaintiff"),seeks to reverse the district court's dismissal with preju-dice of its claims under § 10(b) of the Securities ExchangeAct of 1934,15 U.S.C. § 78j(b), against six outside de-fendants ("Defendants"): AOL Time Warner ("AOL")


U.S. App. LEXIS 16556, *3

and two of its officers, Eric Keller and David Colburn;Cendant Corporation and one of its officers, RichardSmith; and L90, Inc. ("L90"). Plaintiff alleges Homestoreentered into fraudulent transactions with these Defendantsin which Homestore purchased revenue for itself and thenrecorded that revenue in violation of SEC accountingrules. In the alleged "triangular transactions," Homestoreentered into sham transactions with "Third Party Vendors"who then[*4] returned the money to Homestore throughcontracts with AOL or L90. Plaintiff alleges Homestoreoverpaid for an asset owned by Cendant in return forCendant's agreement that it would funnel some of themoney back to Homestore through a related business en-tity. The complaint further alleged that the recording ofgross revenue from these transactions contravened SECrules regarding barter transactions or the buying of rev-enue, and that the triangular transactions were often donewithout the full knowledge of Homestore's auditor.

The Supreme Court held inCentral Bankthat§ 10(b)does not allow recovery for aiding and abetting liabil-ity, Cent. Bank, 511 U.S. at 177--78, but cautioned thatsecondary actors were not always free from liability un-der§ 10(b)because they may still be liable as a primaryviolator. 511 U.S. at 191. We address here the scope ofprimary violation liability that the Supreme Court did notfully define inCentral Bank.

Plaintiff asserts that Defendants are primary violatorsunder § 10(b) for engaging in a "scheme to defraud."In response, Defendants argue that the Supreme Courtin Central Banklimited primary liability [*5] under§10(b) to defendants who personally made a public mis-statement, violated a duty to disclose or engaged in ma-nipulative trading activity, and not to those engaged ina broader scheme to defraud. Although we hold that thescope of§ 10(b) includes deceptive conduct in further-ance of a "scheme to defraud," when all elements of§10(b)are otherwise satisfied, we conclude that Plaintiff'scomplaint insufficiently alleged that Defendants were pri-mary violators of§ 10(b)based on their conduct in thefurtherance of the scheme.

I

CalSTRS alleges in its First Amended ConsolidatedComplaint ("FACC") that Homestore and its officers,along with its auditor PriceWaterhouseCoopers ("PWC"),AOL, Cendant, L90, and additional Third Party Vendors,committed securities fraud by engaging in round--tripor barter transactions whereby Homestore recorded netrevenues from its receipt of monies that came fromHomestore's own cash reserves.

Homestore created an online real estate website in1996. In the late 1990s, there was an explosion of Internet

start--up companies which consistently posted net lossesand negative cash flows as those companies sought todevelop leadership and market[*6] share in their indus-tries. This development caused a corresponding shift inemphasis by financial analysts to the tracking and evalu-ation of revenues as an indicator of future earnings. Until2001, Homestore was perceived as an Internet companythat consistently matched or exceeded its estimated rev-enue goals. To meet its revenue expectations, Homestorerelied increasingly on barter or round--trip transactionswith other companies. In such transactions, Homestorepaid a company, the company returned part of the moneyto Homestore by way of a different transaction, andHomestore recorded these returned funds as revenue.

Internet companies have historically engaged in bartertransactions between themselves, often in order to placeadvertising on each other's websites. Beginning in fiscalyear 2000, the SEC implemented a new accounting stan-dard that required companies engaging in barter trans-actions to report only the net revenue that was earnedfrom these related transactions, rather than the gross rev-enue received. Facing increasing scrutiny from its au-ditor PWC, Homestore's barter transactions grew morecomplex. Homestore engaged in triangular transactions,with the result that PWC[*7] did not recognize that therevenue that Homestore recorded was related to a priortransaction funded by Homestore. As the district courtsuccinctly summarized, in these triangular transactions:

Homestore would find some third party cor-poration, one that was thinly capitalized andin search of revenues in order to "go public."Homestore then agreed to purchase shares inthat company for inflated values or to pur-chase services or products that Homestoredid not need. This transaction was contin-gent on the third party company "agreeing"to buy advertising from AOL for most or allof what Homestore was paying them. Themoney thus flowed through the third partyto AOL, which then took a commission andshared "revenue" with Homestore.

In re Homestore.com, Inc. Securities Litigation, 252 F.Supp. 2d 1018, 1023 (C.D. Cal. 2003). Against this back-ground, we consider the allegations against the particularDefendants.

A. Allegations Involving AOL, and its officers Kellerand Colburn

The history of Homestore and AOL for purposes ofthis appeal began with the creation of a legitimate part-


U.S. App. LEXIS 16556, *7

nership in April 1998, whereby Homestore purchased the"exclusive [*8] right to have the only online real es-tate listing product on AOL." In a second legitimate dealwith AOL, Homestore entered into an advertising reselleragreement, under which AOL agreed in March 1999 tosell advertising on the Homestore website and retain acommission.

The triangular transactions at issue here occurred dur-ing the first two quarters of fiscal year 2001. Plaintiffalleges that Homestore entered into a series of sham trans-actions with various Third Party Vendors for some productor service that Homestore did not need. The Third PartyVendors would then contract with AOL for advertisingon Homestore's website and AOL would give this moneyback to Homestore under their advertising reseller agree-ment. Both the Third Party Vendors and AOL would keepa portion of the money as a commission. Plaintiff onlyalleges that the first leg of the transaction was truly asham because nothing of value was given in exchange forHomestore's payment. AOL continued to sell advertisingon Homestore's website to Third Party Vendors, withhold-ing commissions before passing the Vendors' payments onto Homestore.

Plaintiff alleges that Defendant Eric Keller, as an em-ployee of AOL, jointly developed[*9] these transactionswith Homestore. Keller was also alleged to have contactedsome of the Third Party Vendors that took part in thesetriangular transactions. Plaintiff alleges, without detailedsupport, that Defendant Colburn, Keller's supervisor, ap-proved the improper transactions. AOL placed Keller onadministrative leave in June 2001. AOL then attemptedto include more accurate documentation of the round tripnature of additional triangular transactions that occurredat the close of the second quarter of 2001. Homestoreconvinced AOL to accept less descriptive documents,which would not alert PWC to the nature of the round--trip transaction. AOL included a list of the "potential re-ferral advertisers" as part of the second deal in 2001, butlet Homestore add other companies not involved in theround--trip transactions so that the Third Party Vendorscould not be identified.

B. Allegations Involving Cendant and its officer Smith

Cendant Corporation is a conglomerate with hold-ings in real estate, travel, and vehicle rentals. In 2001,it owned Move.com, the second largest real estate inter-net website after Homestore. Cendant sold Move.com toHomestore in the first quarter[*10] of 2001. In exchangefor the site, Homestore transferred $750 million worth ofHomestore stock to Cendant and placed Cendant's presi-dent, Richard Smith, on Homestore's board of directors.Plaintiff alleges that, although an outside firm appraised

the site, Homestore "grossly overpaid" Cendant for thiswebsite, which Cendant considered a "bad asset." Plaintiffalleges that the Move.com transaction was contingent ona promise by Cendant to recycle some of Homestore'spayment for Move.com back to Homestore. To accom-plish this, Cendant set up a separate corporate entity, theReal Estate Technology Trust ("RETT"), and funded itwith $95 million. Cendant, through RETT, then agreed tothe payment of $80 million over two years in exchangefor products and services from Homestore. There are noallegations that Cendant made efforts to conceal the con-tingent nature of these transactions.

According to the allegations in the FACC, Cendantlater agreed to use the remaining $15 million in RETT topurchase virtual tours from Homestore. At first, Cendantproposed a reciprocal agreement in which Homestorewould purchase $15 million in products from Cendantat a later date. Homestore refused because[*11] thisreciprocal transaction would prevent PWC from allow-ing Homestore to report the first $15 million as revenue.Cendant then dropped the reciprocal requirement and pur-chased the tours.

C. Allegations Involving L90

L90 entered into triangular transactions withHomestore and various third parties during the secondand third quarters of 2001. These transactions followedthe business model created with AOL's participation. n1At the end of the third quarter of 2001, PWC requireda confirmation letter from L90 before it would certifyHomestore's 10--Q filing. Initially, Mark Roah, a corpo-rate officer for L90, refused to sign the confirmation letter.Fearing personal liability, Roah requested payment fromHomestore and said that he wanted only to do "legiti-mate deals" with the company. Roah later dropped his de-mands and confirmed the revenue, but shortly thereafterHomestore's Chief Financial Officer Joseph Shew refusedto sign the Form 10--Q report that included the revenuesRoah had confirmed. Homestore then announced that itwould restate its financial results to reflect lower revenue.

n1 There are no allegations that L90 or its of-ficers helped to develop these transactions such asKeller was alleged to have done.

[*12]

D. Procedural History

Multiple class action complaints were filed betweenDecember 27, 2001, and February 13, 2002. These com-plaints were consolidated on February 22, 2002. OnSeptember 25, 2002, Homestore's former Chief Operating


U.S. App. LEXIS 16556, *12

Officer, John Giesecke; former Chief Financial Officer,Joseph Shew; and Vice President of Finance, JohnDeSimone, pled guilty to securities fraud violations. OnNovember 15, 2002, Plaintiff filed the FACC, which reliedon the details recited in the plea agreements for these offi-cers. Homestore and Peter Tafeen, former Executive VicePresident of Business Development and Sales, answeredthe FACC, but all other defendants moved to dismiss. OnMarch 7, 2003, the district court denied the motions todismiss for Stuart Wolff, Homestore's former CEO, and itsauditor PWC. The district court dismissed without preju-dice the complaint as to the remaining Homestore insiderdefendants. Relevant to this appeal, the district court alsodismissed the complaint as to the outside defendants withprejudice.

In dismissing the complaint against the outside de-fendants, which it referred to as the "Business PartnerDefendants," the district court observed that in[*13] pre-vious cases in which courts found primary liability, aspecial relationship existed between the defendants andthe shareholders. The district court ultimately determinedthat the outside defendants did not commit a primary vi-olation because they only facilitated and participated inHomestore's fraud. The district court also determined thatPlaintiff had not demonstrated reliance because the share-holders did not rely on the outside defendants' schemebut only on the statements made about the scheme byHomestore.

II

We review de novo the dismissal of claims pursuantto Federal Rule of Civil Procedure 12(b)(6). Decker v.Advantage Fund, Ltd., 362 F.3d 593, 595--96 (9th Cir.2004). We may affirm a dismissal on any basis fairlysupported by the record, even if the district court did notreach the issue or relied on different grounds or reasoning.Adams v. Johnson, 355 F.3d 1179, 1183 (9th Cir. 2004)."All allegations and reasonable inferences are taken astrue, and the allegations are construed in the light mostfavorable to the non--moving party, but conclusory allega-tions of law and unwarranted inferences[*14] are insuf-ficient to defeat a motion to dismiss."Id. (internal quota-tions omitted). "Dismissal is proper underRule 12(b)(6)if it appears beyond doubt that the non--movant can proveno set of facts to support its claims."Id. "The districtcourt's dismissal of a complaint without leave to amendis reviewed de novo and is improper unless it is clear thatthe complaint could not be saved by any amendment."Livid Holdings Ltd. v. Salomon Smith Barney, Inc., 416F.3d 940, 946 (9th Cir. 2005).

Securities fraud must be pled with specificity. Inthe Private Securities Litigation Reform Act ("PSLRA"),Congress required that "a complaint must 'specify each

statement alleged to have been misleading, the reasonor reasons why the statement is misleading, and, if anallegation regarding the statement or omission is madeon information and belief, the complaint shall state withparticularity all facts on which that belief is formed.'"Lipton v. Pathogenesis Corp., 284 F.3d 1027, 1034 (9thCir. 2002) (quoting 15 U.S.C. § 78u--4(b)(1)). In addi-tion, all allegations of deceptive conduct are generallysubject toFederal Rule of Civil Procedure 9(b)[*15] ,which requires that "the circumstances constituting fraudor mistake shall be stated with particularity."

III

We determine whether the Defendants' conduct, asalleged, is a primary violation of§ 10(b). Section 10(b)prohibits, in pertinent part, "any person, directly or in-directly, . . . [t]o use or employ, in connection with thepurchase or sale of any security . . . any manipulative ordeceptive device or contrivance in contravention of suchrules and regulations as the Commission may prescribe."Securities Exchange Act of 1934 § 10(b),15 U.S.C. §78j(b). To implement§ 10(b), the SEC promulgated Rule10b--5,17 CFR § 240.10b--5. Rule 10b--5is composed ofthree parts that describe the type of conduct prohibited by§ 10(b). The second part proscribes the making of "anyuntrue statement of a material fact" or the omission ofany material fact that is necessary in order to make thestatements made not misleading. Rule 10b--5(b),17 CFR§ 240.10b--5(b). The first and third parts make it unlawfulfor any person "to employ any device, scheme, or artificeto defraud" or "to engage in any act, practice,[*16] orcourse of business which operates or would operate as afraud or deceit upon any person." Rule 10b--5(a)& (c),17CFR § 240.10b--5(a)& (c).

Liability under Rule 10b--5does not extend beyondthe limits of § 10(b). See Cent. Bank, 511 U.S. at 173("But the private plaintiff may not bring a 10b--5 suitagainst a defendant for acts not prohibited by the text of§10(b)."); Ernst & Ernst v. Hochfelder, 425 U.S. 185, 214,96 S. Ct. 1375, 47 L. Ed. 2d 668 (1976)("Thus, despitethe broad view of the Rule advanced by the Commissionin this case, its scope cannot exceed the power grantedthe Commission by Congress under§ 10(b)."). In CentralBank, the Supreme Court held "that the text of the 1934Act does not itself reach those who aid and abet a § 10(b)violation." 511 U.S. at 177; see also id. at 177--78("Wecannot amend the statute to create liability for acts thatare not themselves manipulative or deceptive within themeaning of the statute."). The Court cautioned, however,that secondary actors, other than the securities issuer, maybe liable as primary violators under§ 10(b)when all ele-ments of[*17] the statute are satisfied:


U.S. App. LEXIS 16556, *17

The absence of§ 10(b)aiding and abettingliability does not mean that secondary ac-tors in the securities markets are always freefrom liability under the securities Acts. Anyperson or entity, including a lawyer, accoun-tant, or bank, who employs a manipulativedevice or makes a material misstatement (oromission) on which a purchaser or seller ofsecurities relies may be liable as a primaryviolator under 10b--5, assumingall of the re-quirements for primary liability underRule10b--5are met.

Cent. Bank, 511 U.S. at 191.

A private action under§ 10(b)andRule 10b--5mustallege and prove all of the elements for primary liabilityfor each defendant. The elements of a securities fraudclaim are: (1) to use or employ any manipulative or de-ceptive device or contrivance; (2) scienter,i.e. wrongfulstate of mind; (3) a connection with the purchase or saleof a security; (4) reliance, often referred to in fraud--on--the--market cases as "transaction causation;" (5) economicloss; and (6) loss causation,i.e. a causal connection be-tween the manipulative or deceptive device or contrivanceand the loss.See Dura Pharmaceuticals, Inc. v. Broudo,544 U.S. 336, 341--42, 125 S. Ct. 1627, 161 L. Ed. 2d 577(2005).[*18]

The district court and the parties have questioned thesufficiency of the allegations concerning three elements:(1) the use or employment of a deceptive device or con-trivance by the Defendants; (2) in connection with thepurchase or sale of securities; (3) that has been reliedupon by the public. n2

n2 We do not consider the possibility of liabil-ity based on actionable omissions or manipulationsufficient to satisfy the requirement of a "manipu-lative or deceptive device or contrivance" under§10(b). There are no allegations that any Defendantwas subject to a duty to disclose in the context ofthese transactions or engaged in manipulative trad-ing activity.See Santa Fe Indus., Inc. v. Green, 430U.S. 462, 476, 97 S. Ct. 1292, 51 L. Ed. 2d 480(1977).

A. The Use or Employment of a Deceptive Device orContrivance

The Supreme Court tells us that§ 10(b) is intendedto prohibit the use or employment of any deceptive de-

vice in connection with the purchase or sale of securities,including deception[*19] as part of a larger scheme todefraud the securities market.See Ernst & Ernst, 425 U.S.at 199 n.20(defining "device" as "an invention; project;scheme; often, a scheme to deceive");Superintendent ofIns. v. Bankers Life & Cas. Co., 404 U.S. 6, 10 n.7, 92 S.Ct. 165, 30 L. Ed. 2d 128 (1971)("'We believe that§ 10(b)andRule 10b--5prohibit all fraudulent schemes in con-nection with the purchase or sale of securities, whetherthe artifices employed involve a garden type variety offraud, or present a unique form of deception.'" (quotingA. T. Brod & Co. v. Perlow, 375 F.2d 393, 397 (2d Cir.1967))). The Supreme Court has also held that a non--speaking actor who engages in a "scheme to defraud" hasused or employed a deceptive device within the meaningof § 10(b). See SEC v. Zandford, 535 U.S. 813, 821--22,122 S. Ct. 1899, 153 L. Ed. 2d 1 (2002).

In Central Bank, the Supreme Court held that liabil-ity under§ 10(b)only extends to "primary violators" andthere is no liability for merely "aiding and abetting" a vi-olation.511 U.S. at 191. SinceCentral Bank, it is the dutyof courts to determine what constitutes a "primary[*20]violation" of § 10(b). With respect to the making of falsestatements or omissions, we have held that "substantialparticipation or intricate involvement in the preparationof fraudulent statements is grounds for primary liabilityeven though that participation might not lead to the actor'sactual making of the statements."Howard v. Everex Sys.,Inc., 228 F.3d 1057, 1061 n.5 (9th Cir. 2000); see id. at1061 (holding that signing and attesting to a statement,such that for all intents and purposes the signor--attestormade the statement, is sufficient to be considered a pri-mary violator);see also In re Software Toolworks Inc. Sec.Litig., 50 F.3d 615, 628--29 & n. 3 (9th Cir. 1994)(holdingthat drafting or editing false statements that the drafter--editor knows will be publicly disseminated is sufficient tobe considered a primary violator).

What it means to be a "primary violator" with respectto an alleged "scheme to defraud" has been less exten-sively discussed. InCooper v. Pickett, 137 F.3d 616, 624(9th Cir. 1997), we held that to be liable for a "schemeto defraud," "each defendant [must have] committed a[*21] manipulative or deceptive act in furtherance of thescheme." The relevant inquiry is: what conduct consti-tutes a manipulative or deceptive act in the furtherance ofa scheme to defraud sufficient to render the defendant a"primary violator" of§ 10(b)?

The SEC argues in its amicus brief that "Any personwho directly or indirectly engages in a manipulative ordeceptive act as part of a scheme to defraud can be aprimary violator." n3 The SEC defines "a deceptive act"as "engaging in a transaction whose principal purpose


U.S. App. LEXIS 16556, *21

and effect is to create a false appearance of revenues."We agree with the SEC that engaging in a transaction,the principal purpose and effect of which is to create thefalse appearance of fact, constitutes a "deceptive act." n4Participation in a fraudulent transaction by itself, how-ever, is insufficient to qualify the defendant as a "pri-mary violator" if the deceptive nature of the transactionor scheme was not an intended result, at least in part, ofthe defendant's own conduct. We hold that to be liable as aprimary violator of§ 10(b)for participation in a "schemeto defraud," the defendant must have engaged in conductthat had the principal purpose and effect[*22] of creatinga false appearance of fact in furtherance of the scheme.It is not enough that atransactionin which a defendantwas involved had a deceptive purpose and effect; the de-fendant'sown conductcontributing to the transaction oroverall scheme must have had a deceptive purpose andeffect. n5

n3 The arguments of the SEC are only persua-sive authority to the extent that they are reasonablein light of the statutory authority.See Zandford, 535U.S. at 819--20("[The SEC's] interpretation of theambiguous text of§ 10(b), in the context of formaladjudication, is entitled to deference if it is reason-able"). To the extent that the SEC's proposed testpurports to include aiding and abetting or cocon-spirator liability, we are constrained to reject it.SeeIn re GlenFed, Inc. Sec. Litig., 60 F.3d 591, 592(9th Cir. 1995).

n4 "The consideration of purpose and effect ofchallenged actions not infrequently assists in de-termining whether a prohibition is to be applied tocomplex conduct. . . . [and its] importance. . . [in]judg[ing] the legality of challenged action is also arecurring theme in statutory law."The WildernessSoc'y v. U.S. Fish & Wildlife Serv., 353 F.3d 1051,1064 (9th Cir. 2003).

[*23]

n5 The "principal purpose" prong is related tobut different from the element of scienter. For theelement of scienter, we require "that a private secu-rities plaintiff proceeding under the PSLRA mustplead, in great detail, facts that constitute strongcircumstantial evidence of deliberately reckless orconscious misconduct."In re Silicon Graphics Inc.Sec. Litig., 183 F.3d 970, 974 (9th Cir. 1999).Previous cases have found the scienter requirementsatisfied by indirect evidence of a culpable stateof mind, such as suspicious insider trading activityor knowledge of accounting violations.See In re

Daou Systems, Inc., 411 F.3d 1006, 1017 (9th Cir.2005); Silicon Graphics, 183 F.3d at 986. Whilethe scienter element ensures a culpable state ofmind and must be satisfied for recovery under§10(b), the "principal purpose" prong examines in-stead whether the challenged conduct of the defen-dant had a principal purpose, and not just an acci-dental effect, of creating a false appearance as partof a deceptive transaction or fraudulent scheme.Unlike the scienter requirement, the "purpose andeffect" test is focused on differentiating conductthat may form the basis of a primary violation un-der§ 10(b)from mere aiding and abetting activitythat the Supreme Court has held does not consti-tute a primary violation. A defendant may intendto deceive the public by substantially assisting an-other's misconduct as part of a scheme to defraud,but fail to perform personally any action that cre-ated a false appearance as part of this scheme. Thescienter requirement, therefore, will not in all casesdistinguish aiding and abetting from primary lia-bility. In applying the "scienter" element, we lookat whether a defendant's state of mind was suffi-ciently culpable for§ 10(b) liability. By contrast,we may examine the "principal purpose and effect"of the defendant's challenged conduct in a fraud-ulent scheme as an aid to assessing whether thedefendant's conduct was sufficiently deceptive for§ 10(b)liability.

[*24]

Defendants argue that imposing liability for partic-ipation in an overall scheme to defraud would imposeliability for conduct other than the making of a mate-rial misstatement or omission and would conflict withCentral Bank. We disagree. We see no justification tolimit liability under § 10(b) to only those who draft oredit the statements released to the public. To the con-trary, § 10(b) prohibits any person or entity from us-ing or employing any deceptive device, directly or indi-rectly, in connection with the purchase and sale of secu-rities.SeeRobert A. Prentice,Locating That "Indistinct"and "Virtually Nonexistent" Line Between Primary andSecondary Liability under Section 10(b), 75 N.C. L. Rev.691, 731 (1997)(asserting that "the view that one canbe liable only for one's own statements arguably ignoresthe fact that bothSection 10(b)andRule 10b--5condemnthose who employ devices or make misstatements 'di-rectly or indirectly'"). Furthermore,§ 10(b) "should beconstrued not technically and restrictively, but flexibly toeffectuate its remedial purposes."Zandford, 535 U.S. at819 (internal quotation marks omitted). Nor is "scheme[*25] to defraud" liability a substitute for aiding and abet-


U.S. App. LEXIS 16556, *25

ting liability that the Supreme Court precludes inCentralBank. The focus of the inquiry on the deceptive nature ofthe defendant's own conduct ensures that only primary vi-olators (that is, only those defendants who use or employa manipulative or deceptive device) are held liable underthe Act.

Trial courts which have imposed liability under a"scheme to defraud" theory have often required that thedefendant's actions in fraudulent transactions have a prin-cipal purpose and effect of creating a false appearance offact in furtherance of the scheme to defraud.See Quaak v.Dexia S.A., 357 F. Supp. 2d 330, 342 (D. Mass. 2005)(finding sufficient allegations for primary liability un-der § 10(b)when "defendant was a primary architect ofthe scheme to finance the sham entities");In re GlobalCrossing, Ltd. Sec. Litig., 322 F. Supp. 2d 319, 336--337(S.D.N.Y. 2004)(allowing claims of primary liability to goforward where auditors "masterminded" company's mis-leading accounting practices);In re Lernout & HauspieSec. Litig., 236 F. Supp. 2d 161, 173 (D. Mass. 2003)(denying a motion[*26] to dismiss for outside busi-ness partners who invented sham corporate entities thatallowed a corporation "to hide research and developmentexpenses, create fictitious revenue, and ultimately over-state profits in [its] financial reports").

Conduct by the defendant that does not have a prin-cipal legitimate business purpose, such as the inventionof sham corporate entities to misrepresent the flow of in-come, may have a principal purpose of creating a falseappearance.See In re Enron Corp. Sec., Derivative &"ERISA" Litig., 310 F. Supp. 2d 819, 830 (S.D. Tex. 2004)("Sham business transactions with no legitimate businesspurpose that are actually guaranteed 'loans' employed toinflate Enron['s] financial image are not above--board busi-ness practices."). Conduct that is consistent with the de-fendants' normal course of business would not typicallybe considered to have the purpose and effect of creating amisrepresentation.See In re Enron Corp. Sec., Derivative& ERISA Litig., 235 F. Supp. 2d 549, 580 (S.D. Tex.2002)(finding that "conclusory allegations that are con-sistent with the normal activity of such a business entity,standing alone, . . .[*27] are insufficient to state aclaim of primary liability underCentral Bank" (internalquotation marks omitted)). Participation in a legitimatetransaction, which does not have a deceptive purpose oreffect, would not allow for a primary violation even ifthe defendant knew or intended that another party wouldmanipulate the transaction to effectuate a fraud.See In reCharter Commc'ns, Inc., Sec. Litig., 443 F.3d 987, 992(8th Cir. 2006)(refusing to impose primary liability "on abusiness that entered into an arm's length non--securitiestransaction with an entity that then used the transactionto publish false and misleading statements to its investors

and analysts");In re Parmalat Sec. Litig., 376 F. Supp.2d 472, 505 (S.D.N.Y. 2005)("At worst, the banks de-signed and entered into the transactions knowing or evenintending that Parmalat or its auditors would misrepresentthe nature of the arrangements. That is, they substantiallyassisted fraud with culpable knowledge -- in other words,they aided and abetted it.").

If a defendant's conduct or role in an illegitimate trans-action has the principal purpose and effect of creating afalse appearance[*28] of fact in the furtherance of ascheme to defraud, then the defendant is using or em-ploying a deceptive device within the meaning of§ 10(b).A test that examines the purpose and effect of a defen-dant's conduct in an alleged scheme to defraud, as a meansto assess whether the defendant used or employed a de-ceptive device, ensures that the defendant's conduct issufficiently deceptive to justify imposing primary liabil-ity. Thus, when determining whether a defendant is a"primary violator," the conduct of each defendant, whileevaluated in its context, must be viewed alone for whetherit had the purpose and effect of creating a false appearanceof fact in the furtherance of an overall scheme to defraud.

B. In Connection with the Purchase or Sale ofSecurities

In addition to the use or employment of a deceptiveor manipulative device or contrivance,§ 10(b) requiresthat the primary violation must be "in connection withthe purchase or sale of any security."15 U.S.C. § 78j. InZandford, the Supreme Court held that a broker's mis-appropriation of a brokerage account was a fraudulent"scheme to defraud" that was "in connection with" thesale of securities[*29] despite lacking any deceptionabout the value of a security or "manipulation of a par-ticular security."Zandford, 535 U.S. at 821. In Zandford,the broker fraudulently wrote checks to himself from abrokerage account that required the sale of securities inorder to cash the checks.See id.Although the misappro-priation of money did not affect the securities market untilthe check was later redeemed, the broker's scheme to de-fraud was not complete until the victim's securities weresold and the check was redeemed.See id.The SupremeCourt held that the scheme to defraud "coincided" withthe sale of securities, which satisfied the "in connectionwith" requirement of§ 10(b). Id. at 820.

Similarly, a scheme to misrepresent the publicly re-ported revenue of a company may coincide with the pur-chase or sale of securities because the scheme will not becomplete until the fraudulent information is introducedinto the securities market. That every participant in thescheme did not release the information to the public doesnot diminish the causal connection between all defendants


U.S. App. LEXIS 16556, *29

in the scheme and the securities market.See Cent. Bank,511 U.S. at 191[*30] (stating that "[i]n any complexsecurities fraud, moreover, there are likely to be multi-ple violators"). If multiple participants used or employeda deceptive device in furtherance of a scheme to mis-represent the reported revenues of a company, then allparticipants may be viewed as having acted in connectionwith the purchase or sale of securities.

C. Reliance

Another requirement for liability under§ 10(b)is re-liance.See Cent. Bank, 511 U.S. at 180. "Reliance pro-vides the requisite causal connection between a defen-dant's misrepresentation and a plaintiff's injury."BasicInc. v. Levinson, 485 U.S. 224, 243, 108 S. Ct. 978,99 L. Ed. 2d 194 (1988). A plaintiff may be presumedto have relied on a misrepresentation if the misleadingor false information was injected into an efficient mar-ket. "Indeed, nearly every court that has considered theproposition has concluded that where materially mislead-ing statements have been disseminated into an impersonal,well--developed market for securities, the reliance of in-dividual plaintiffs on the integrity of the market pricemay be presumed."Id. at 247. The fraud--on--the--marketpresumption requires[*31] the dissemination of the mis-representation into an efficient market, but not personalinvolvement by the defendant in disseminating this state-ment.See Knapp v. Ernst & Whinney, 90 F.3d 1431, 1436(9th Cir. 1996)("Because a material misrepresentation oromission is generally embedded in the market price of thesecurity, an investor who purchases or sells the securitywill have presumably relied on the misrepresentation.").

The requirement of reliance is satisfied if the introduc-tion of misleading statements into the securities marketwas the intended end result of a scheme to misrepresentrevenue.See In re ZZZZ Best Sec. Litig., 864 F. Supp.960, 973 (C.D. Cal. 1994)("Instead, the market's overallreliance on the Z Best fraudulent scheme, or at least theadditional statements as released and issued by Z Best, issufficient to satisfy the reliance element in theRule 10b--5(a)& (c)claims.");see also4 Alan R. Bromberg & LewisD. Lowenfels,Bromberg & Lowenfels on Securities Fraud§ 7:469 (2d ed. 2006) ("Despite some earlier disagree-ment, it now seems settled that FOMT [the fraud--on--the--market--theory] applies to all three clauses of[*32]Rule 10b--5: (1) scheme to defraud, (2) misrepresentationor omission, and (3) fraudulent course of business, not justto clauses (1) and (3)."). The scheme to defraud wouldnot be complete until the fraudulent information has en-tered the securities market.See Parmalat, 376 F. Supp. 2dat 509("The banks made no relevant misrepresentationsto those markets, but they knew that the very purposeof certain of their transactions was to allow Parmalat to

make such misrepresentations. In these circumstances,both the banks and Parmalat are alleged causes of thelosses in question."). We may presume, absent persuasiveconflicting evidence, that purchasers relied on misstate-ments produced by a defendant as part of a scheme todefraud, even if the defendant did not publish or releasethe misrepresentations directly to the securities market.

We conclude that conduct by a defendant that had theprincipal purpose and effect of creating a false appearancein deceptive transactions as part of a scheme to defraudis conduct that uses or employs a deceptive device withinthe meaning of§ 10(b). Furthermore, such conduct maybe in connection with the purchase or sale of securities[*33] if it is part of a scheme to misrepresent publicfinancial information where the scheme is not completeuntil the misleading information is disseminated into thesecurities market. Finally, a plaintiff may be presumed tohave relied on this scheme to defraud if a misrepresen-tation, which necessarily resulted from the scheme andthe defendant's conduct therein, was disseminated into anefficient market and was reflected in the market price.

IV

With these principles in mind, we address the ade-quacy of the allegations of the FACC at issue here. Ifthe Defendants' conduct, as alleged in the FACC, had thepurpose and effect of creating a false appearance fromillegitimate transactions in furtherance of a scheme tomisrepresent revenues, then Plaintiff has alleged a pri-mary violation of§ 10(b). If the relevant actions by theDefendants were not deceptive, however, but only facil-itated or assisted the fraudulent misreporting of legiti-mate transactions by Homestore, then Defendants werenot primary violators under§ 10(b) and this complaintwas correctly dismissed.

A. Primary Liability of America Online (AOL) and itsofficers

AOL and its officers are alleged to have[*34] played arole in the scheme to overstate the revenues of Homestore.According to the FACC, Eric Keller, a Senior VicePresident at AOL, helped Homestore to organize and cre-ate the triangular transactions. The FACC further allegesthat the triangular transactions were necessary to allowHomestore to overstate its revenues, and that the actionsof AOL, Colburn and Keller assisted Homestore in mis-representing the revenues from these transactions. But pri-mary liability requires more than assertions of "helping"or "assisting" another's deception. To allege a primary vi-olation, the complaint must allege that AOL or its officersactually engaged in a deceptive act. We have examinedthe specific allegations involving AOL and its officers todetermine whether the FACC alleges conduct by the AOL


U.S. App. LEXIS 16556, *34

Defendants that had the purpose and effect of creating afalse appearance in fraudulent transactions that were partof a scheme to defraud. We conclude that the allegationsare insufficient.

It is not alleged that AOL or its officers created shambusiness entities or engaged in deceptive conduct as partof illegitimate transactions, and so we conclude that theelement of using or employing a deceptive[*35] deviceis not adequately alleged in this respect. There is no in-dication from the FACC that the transactions engaged inby AOL were completely illegitimate or in themselvescreated a false appearance. n6 The substance of the alle-gations shows that AOL's role in the transactions was toact as a conduit for the flow of revenue between the ThirdParty Vendors and Homestore as an advertising agent, inaccord with AOL's advertising reseller agreement withHomestore.

n6 Defendants urge that the challenged transac-tions were not deceptive, and that only the reportingof revenues from these transactions by Homestore,conduct in which Homestore was not assisted bythe Defendants, deceived the investing public aboutrevenues of Homestore.

The FACC does allege that Homestore entered intosham transactions with "Third Party Vendors" in returnfor a "quid pro quo" obligation from these vendors to buyHomestore advertising from AOL. Assuming the truthof allegations that no products of value were exchangedbetween the Third[*36] Party Vendors and Homestore,the FACC nonetheless does not allege that AOL itself en-tered into a transaction that had no legitimate economicvalue or created a false appearance. While the advertis-ing transactions between the Third Party Vendors andAOL are alleged to contain suspect qualities, such as ex-aggerated commissions by AOL, there is no suggestionthat actual advertisements were not purchased and soldby these companies. The FACC does not allege that thetransactions contained a false appearance or other decep-tive qualities, but rather that they were an opportunity forHomestore to take advantage of the advertising reselleragreement. This may pin liability on Homestore, but noton AOL or its officers.

The FACC also alleges that AOL attempted to in-clude additional documentation in subsequent transac-tions that would connect the referral agreements betweenHomestore and the Third Party Vendors with the adver-tising revenues from AOL. While the absence of thisadditional documentation allowed Homestore to misre-port the revenues from the AOL advertising referrals asstand--alone transactions, any misrepresentation in the

transactions involving AOL resulted from the additionalagreements[*37] between Homestore and the ThirdParty Vendors and the misreporting of the income byHomestore. The transactions involving AOL did not cre-ate a false appearance until they were viewed in conjunc-tion with Homestore's actions before and after the trans-action. While AOL would be liable under§ 10(b)for itsdeceptive conduct as part of a scheme to defraud if AOLengaged in deceptive conduct, it may not be held liablefor participating in legitimate transactions that became"deceptive" only when distorted by the willful or inten-tional fraud of another party.See Parmalat, 376 F. Supp.2d at 505("Any deceptiveness resulted from the mannerin which Parmalat or its auditors described the transac-tions on Parmalat's balance sheets and elsewhere."). Inthis case, the FACC does not allege with the required par-ticularity that the transactions negotiated by Keller andperformed by AOL created a false appearance.

We conclude that the FACC failed to sufficiently al-lege with particularity that AOL committed actions withthe purpose and effect of creating a false appearance infurtherance of a scheme to defraud.

B. Primary Liability of Cendant and its officer Smith

The [*38] FACC also alleges that Cendant partici-pated in a scheme to defraud by engaging in triangulartransactions. Cendant argues that the transactions weresimply "simultaneously agreed upon business transac-tions" and were not deceptive or manipulative absentthe application of improper accounting principles byHomestore.

We agree that the FACC does not indicate how thesetransactions involving Cendant created a false appear-ance, independent from Homestore's misreporting of theincome from these transactions as unrelated to any previ-ous transaction. There are no allegations that show howthe creation of the RETT and its funding by Cendant forfuture transactions with Homestore had the potential tomisrepresent the reality behind the transactions. n7 In fact,the press release from Cendant quoted in the FACC ac-knowledges that subsequent purchases by Cendant wereplanned in conjunction with Homestore's acquisition ofCendant's websites.

n7 In its opening brief, Plaintiff argues thatCendant took affirmative steps to conceal the truenature of the Move.com transaction. The paragraphin the complaint cited for this assertion only statesthat Cendant classified the $95 million funding ofRETT as a "one time non--recurring expense." TheFACC does not explain how this classification isfalse or a mischaracterization of the transaction.


U.S. App. LEXIS 16556, *38

[*39]

Although the creation of separate entities may indi-cate an attempt to conceal the source of funding for re-lated transactions,see Lernout, 236 F. Supp. 2d at 173, theFACC does not allege that Cendant's specific actions inthese transactions created a false appearance independentof the improper accounting by Homestore. The FACCdoes not allege with particularity that Cendant acted withthe purpose and effect of creating a false appearance ofHomestore revenues with the aim of deceiving the in-vesting public, and we conclude that the complaint wasproperly dismissed against Cendant and Smith.

C. Primary Liability of L90

The allegations involving L90 similarly fail to allegesufficiently that L90 used or employed a deceptive de-vice by engaging in a fraudulent transaction as part ofa scheme to defraud. There are no allegations that L90helped to create or concoct this scheme, which allegedlyfollowed the model set by AOL. As with AOL, there areno allegations that L90 acted with the purpose and effectof creating a false appearance in these transactions.

Mark Roah, an officer for L90, allegedly signed a falsestatement attesting to the fact that the transactions[*40]were not contingent on other related transactions, whichmay suffice to state a valid claim for primary liabilityunder§ 10(b). The day after the false confirmation letterwas signed by Roah, however, Homestore's CFO refusedto sign the financial report based on the misstatementswithin the report. The information contained in the falseconfirmation letter by L90, or any other false statementwhich resulted from this confirmation letter, was neverintroduced into the securities market as part of a schemeto defraud. Therefore, this statement was never used oremployed in connection with the purchase or sale of secu-rities and the allegations concerning the statement cannotstate a valid claim under§ 10(b).

V

Because the FACC does not allege a valid claim forprimary liability under any theory of liability, the districtcourt properly dismissed the claims in the FACC againstthe Defendants. Dismissal without leave to amend is im-proper, however, unless it is clear that Plaintiff could notpropose an amended complaint that states a valid claimunder § 10(b) for any of these Defendants.See LividHoldings, 416 F.3d at 946. "Leave to amend need not begranted[*41] when an amendment would be futile."Inre Vantive Corp. Sec. Litig., 283 F.3d 1079, 1097 (9th Cir.2002). Futility of amendment may be shown by Plaintiff'sfailure to plead additional facts when given the opportu-

nity. See id. at 1098("When given the opportunity, theplaintiffs declined to say what additional facts they mightplead if given the chance to amend."). Here, the districtcourt applied a more restrictive test of primary liabilitythan called for under§ 10(b). Plaintiff was not offered theopportunity to state any additional facts that, if alleged,would state a valid claim for relief under the standards wehave set forth. n8 We conclude that Plaintiff should havethe opportunity to seek leave to file an amended complaintthat may take advantage of the reasoning in this opinion."In this technical and demanding corner of the law, thedrafting of a cognizable complaint can be a matter of trialand error."Eminence Capital, LLC v. Aspeon, Inc., 316F.3d 1048, 1052 (9th Cir. 2003). On remand to the dis-trict court, Plaintiff may argue to the district court thatan amendment would not be futile based on the presenceof additional [*42] relevant facts which it may plead.Defendants may argue any ground that they assert for de-nial of any proposed amendment. The district court maythen decide in the first instance whether any amendedcomplaint may be filed. n9

n8 Plaintiff raised the issue of amendment ofthe complaint in its briefing in the district courtand on appeal. In the district court, Plaintiff arguedin its opposition to Defendants' motions to dismissthat leave to amend should be granted if the districtcourt found that the current complaint failed to statea valid claim. In its briefing to us, Plaintiff did notseek leave to amend until its reply brief. "We willnot ordinarily consider matters on appeal that arenot specifically and distinctly argued in appellant'sopening brief."United States v. Ullah, 976 F.2d509, 514 (9th Cir. 1992)(internal quotation marksomitted). However, "we may review an issue if thefailure to raise the issue properly did not prejudicethe defense of the opposing party."Id. We deter-mine that review of the issue of amendment doesnot prejudice the defense of the Defendants be-cause we only remand the issue of amendment forthe district court to assess in the first instance, af-ter the parties have had an opportunity to addressthe standards for amendment and whether it is fu-tile under the legal standard we have announcedconcerning the elements of§ 10(b).

[*43]

n9 If the district court decides to grant leaveto amend, then the motion to dismiss filed byDefendant Smith must be resolved. Smith arguesthat he must be dismissed from any further litigationin this case because a Settlement Agreement be-tween Plaintiff and Homestore released from liabil-


U.S. App. LEXIS 16556, *43

ity all former officers and directors of Homestore,which included Smith. Plaintiff argues that Smithwas excluded from this release because of hisposition with Cendant, which was the primarysource of his alleged liability in this case. This is-sue will be moot if amendment is not permitted.Moreover, if necessary, the district court, whichapproved this Settlement Agreement, may inter-pret this Agreement and any admissible extrinsicevidence in the first instance. We leave this motionfor consideration by the district court.

VI

We affirm the district court's dismissal of the currentcomplaint against Defendants. We remand so that Plaintiffmay seek leave in the district court to amend the complaintif that can be done consistent with this opinion. Costs areawarded to Defendants--Appellees.

AFFIRMED [*44] and REMANDED for furtherproceedings consistent with this opinion.


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IN THE UNITED STATES DISTRICT COURT

FOR THE NORTHERN DISTRICT OF CALIFORNIA

SAN JOSE DIVISION

IN RE VERISIGN CORPORATIONSECURITIES LITIGATION

/

NO. C 02-02270 JW

ORDER GRANTING IN PART ANDDENYING 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 persons and entities that acquired VeriSign Corporation's ("VeriSign") common

stock, against VeriSign and four of its executives (collectively, "Defendants"), for violations of

Sections 10(b) and 20(a) of the Securities Exchange 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’ Motion 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, 125 S.Ct. 1627 (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.


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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

promulgated thereunder. VeriSign provides Internet "trust services" --services that verify and

authenticate information transmitted over the Internet. (TAC at ¶ 2.) Such services enable

consumers to safely transmit personal financial information over the Internet to complete

commercial transactions. (TAC at ¶ 2.)

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 pressure 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 ¶ 4.)

Not long after VeriSign acquired Network Solutions, the Internet boom “went bust.” The

demand for Internet "trust services" and for new Internet domain names declined, affecting

VeriSign's business. VeriSign's stock price fell from $196 per share (on the day it acquired Network

Solutions) to $75 per share (on January 24, 2001, the day before the Class Period).

Thereafter, Defendants allegedly employed "an assortment of schemes, artifices, and devices

to mislead investors about both the amount and source of revenues earned by [VeriSign]." (TAC

¶ 6.) 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


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scheme") (TAC ¶¶ 59-103), (2) improper accounting for roundtrip and other long-term investments

(TAC ¶¶ 104-114), (3) improper revenue recognition on barter transactions (TAC ¶¶ 115-116), (4)

failure to adequately reserve for uncollectible delinquent receivables (TAC ¶¶ 117-119), and (5)

false accounting for acquired deferred revenue in violation of GAAP (TAC ¶¶ 120-129). 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 misrepresentations to their

detriment when the disclosures after the following dates caused fraud-induced inflation 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 October 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 related-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 Judgment 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) for pleading "insufficient facts

under a cognizable legal theory.” Robertson v. Dean Witter Reynolds, 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);


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NL Indus., Inc. v. Kaplan, 792 F.2d 896, 898 (9th Cir. 1986). However, the Court will not accept

wholly conclusory allegations. Western Mining Council v. Watt, 643 F.2d 618, 624 (9th Cir. 1981),

cert. denied, 454 U.S. 1031 (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 Litigation 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 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 securities on the date of the purchase was inflated because of misrepresentation. 125 S.Ct. 1627,

1632 (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 misrepresents 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 depreciate[s]." Id. at

1632-1633 (quotations from Restatement of Torts, § 548A, Comment b, at 107 omitted) (alterations

in original).

Applying the Dura framework, the Ninth Circuit recognized that pleading loss causation is a

more difficult 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 as long as the misrepresentation is

a substantial cause of the investment’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' disclosures of a rapidly escalating work in progress

account resulting from prematurely recognizing revenue in holding that the plaintiffs sufficiently

alleged loss causation according to the standards of Dura. Declines in the price of Daou stock prior


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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 conjunction with the decisions of the Second

Circuit provides further guidance for plaintiffs attempting to plead loss causation. Although the

Ninth Circuit has not explicitly adopted or rejected the Second Circuit view following the Supreme

Court's decision in Dura, this District has found that "the Supreme Court in Dura Pharmaceuticals

endorsed the Second Circuit test for loss causation, as set forth in Lentell v. Merill Lynch & Co.,

396 F.3d 161 (2d Cir. 2005) and Emergent Capital Investment Management, LLC v. Stonepath

Group, Inc., 343 F.3d 189 (2d Cir. 2003)." Bennett v. H & R Block Financial Advisors, Inc., 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 Second Circuit standard, plaintiffs must allege that the subject 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 foreseeable and that the loss was caused by the

materialization of the concealed risk. Bennett, 2005 WL 2811757, at *3 (citing Lentell, 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 approximately 10% of its revenue was attributable to reciprocal arrangements, or “barter

transactions,” and sales to the company affiliates in which VeriSign had just invested. 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 continued to trade at artificially inflated prices becausethe true financial condition of the Company continued to be concealed frominvestors. In addition, investors still did not know that (1) VeriSign had reportedoverstated revenues, receivables, deferred revenue and earnings by improperlyaccounting for the two-year auto-renewals and acquired deferred revenue, (2)VeriSign was misreporting domain name registrations by concealing the numberof free and promotional registrations and two-year auto-renewal registrations, (3)


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the extent to which VeriSign improperly recognized revenues on the roundtripand barter transactions and the effect on the Company, (4) VeriSign hadoverstated earnings by failing to properly account for its long-term investments innon-public companies under the equity method and by failing to recordimpairment charges on many of the investments, and (5) VeriSign had reportedoverstated earnings by failing to reserve for its delinquent receivables. Moreovercontrary to VeriSign's March 19, 2002 statements regarding affiliate relationships,VeriSign's investments in its affiliates were dependent upon the affiliates'agreement to buy VeriSign's products or services, thereby transferring the moniesback to VeriSign. In essence, VeriSign was paying itself to boost up revenuefrom these "round trip" deals. Thus, while some of the artificial inflation wastaken out of the stock with these disclosures, the true picture of VeriSign'sbusiness had not yet been revealed.

(TAC ¶ 397, hereinafter "Paragraph 397".) Defendants claim that Paragraph 397 defeats any attempt

by Plaintiffs to plead loss causation based on losses which occurred prior to the 10-K released on

March 19, 2002 because 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 Company continued to be concealed from investors" is a clear statement 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., 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

market caus[ing] the artificial inflation" (Plaintiffs' Opposition to Defendants' Motion to Dismiss

Third Amended Class Action Complaint, hereinafter "Opp." at 3). This affirmative disclaimer


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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 allegations 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 reciprocal 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' 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 transactions." (emphasis added). In the context of the entire

paragraph, however, the same subsection (3) of Paragraph 397 continues by alleging that the market

was unqualifiedly unaware of "the effect on the Company," 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 financial condition of

VeriSign. If the market has not recognized 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 Plaintiffs, 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 in April 25, 2000

In the October Order, this Court held that the April 25, 2002 disclosure failed to plead loss


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causation because the disclosure was "not linked to any misstatements alleged 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 making 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 disclosure. Plaintiffs in the CSAC stated: “Even this disclosure, however, did not

acknowledge that VeriSign had been maintaining its revenue and earnings numbers by manipulating

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 portion ceases to be a

conclusive judicial 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 controvertible, 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 Jarnvagsstyrelsen 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 superceded by the TAC.

In the TAC, Plaintiffs appear to have met the standards 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

result of prematurely recognizing revenue" and the complaint also quotes an analyst who allegedly

stated "[w]hen you say one thing on the conference 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 (emphasis and alterations in original). Thus, the court in Daou found that the


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plaintiffs' pleadings as to loss causation 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 expectations as we encountered significant spending delays in our IT and telecom

customer bases...as well as more severe challenges in our Mass Markets domain name business" and

announced a restructuring of $70-80 million. (TAC ¶ 398.) 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 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 ¶ 400(b).) The TAC also

attempts to connect the disclosures to Defendants' domain name scheme:

Disclosure of problems in VeriSign's business, particularly its domain namebusiness, including its inability to estimate renewal rates, overstatement of domainname revenues, misleading appearance of sequential deferred revenue growth, theundisclosed weakness in its registrar business beyond the purge of free andpromotion names, $70-80 million in unexpected charges to expense and the reliabiltyand visibility of VeriSign's future earnings.

(TAC ¶ 401). While the present case is a close one, Plaintiffs 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 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


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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 “extreme 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 Siux 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

causation, and when the Court granted Plaintiffs leave to amend, 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 substantially prejudicial to Defendants who would have to engage in additional

motion practice on yet another amended complaint when Plaintiffs were already on notice 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 prejudice. Defendants' Motion to Dismiss is DENIED as to Plaintiffs'

allegations of loss causation regarding the domain name scheme revealed by the April 25, 2002

disclosure. Should Plaintiffs wish to proceed with this action, 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. The amended complaint shall be filed and

served on or before May 12, 2006.

Dated: April 6, 200602cv2270mtd

/s/ James Ware JAMES WAREUnited States District Judge


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THIS IS TO CERTIFY THAT COPIES OF THIS ORDER HAVE BEEN DELIVERED TO:

Adam T. Savett [email protected] Glenn Yates [email protected] Freeman [email protected] M. Schatz [email protected] T. Heffelfinger [email protected] J. Robbins [email protected] Malcolm Furbush [email protected] R. Gross [email protected] J. Herman [email protected] H. Shah [email protected] Petrou [email protected] W. Lawrence [email protected] Anne Hoogs [email protected] Seth Devore [email protected] E. Romley [email protected] L. Godino [email protected] Wayne Robertson [email protected] N. Landy [email protected] Daniel Boyens [email protected] J. Coughlin [email protected] D. Bandman [email protected] Eve Scarlett [email protected] H. Huang [email protected] S. Lerach [email protected]

Simon Bahne ParisSpector, Roseman & Kodroff, P.C.1818 Market Street, Suite 2500Philadelphia, PA 19103

Dated: April 6, 2005 Richard W. Wieking, Clerk

By:_/s/JW Chambers______Melissa PeraltaCourtroom Deputy


TAB 14



NBriefs and Other Related Documents

United States District Court,N .D. California.

In re VERISIGN CORPORATION SECURITIES LITIGA-

TION

No. C 02-02270 JW.

Nov. 2, 2005 .

Alfred Glenn Yates . Jr . , Law Office of Alfred G. Yates Jr,

P .C, Pittsburgh, PA, Andrew M. Schatz , Nancy A. Kulesa ,

Schatz & Nobel, P.C., Hartford, CT, Bernard M . Gross , De-

borah R. Gross, Law Offices of Bernard M . Gross, P .C .,

Philadelphia, PA, Darren J . Robbins , Randi D. Bandman ,

Shirley H . Huang, William S. Lerach, Lerach Coughlin

Stoia Geller Rudman & Robbins LLP, San Diego, CA,

Mark S . Willis, Steven J . Toll , Joshua Seth Devore, Jeffrey

W. Lawrence, Cohen Milstein Hausfeld & Toll PLLC,

Washington, DC, for Plaintiffs .

David Malcolm Furbush , Lori E. Romley, Meredith N .

Lando, O'Melveny & Myers LLP, Menlo Park, CA, Dhaivat

H. Shah, Jessica Anne Hoogs, Noah Daniel Boyens ,

O'Melveny & Myers LLP, loana Petrou, U .S . Attorney's Of-

fice, Jeffrey W. Lawrence, Dennis J . Herman, Patrick J .

Coughlin, Shang Eve Scarlett , Lerach Coughlin Stoia Geller

Rudman & Robbins LLP, Christopher T. Heffelfinger, Ber-

man Devalerio Pease & Tabacco, P .C., San Francisco, CA,

Amy Freeman, Mark Wayne Robertson, O'Melveny & My-

ers, Los Angeles, CA, Adam T. Savett, Lisa M. Mezzetti ,

Cohen, Milstein, Hausfeld & Toll, P .L .L.C., Washington,

DC, for Defendants .

CORRECTED ORDER GRANTING IN PART AND

DENYING IN PART DEFENDANTS' MOTION FOR

JUDGMENT ON THE PLEADINGS ; DENYING

WITHOUT PREJUDICE DEFENDANTS' MOTION TO

STRIKE AND MOTION TO SHORTEN THE CLASS

PERIO D

WARE, J.

1 . INTRODUCTION

*1 Plaintiffs initiated this securities class action lawsuit on

behalf of themselves and of a proposed class of persons and

Page 1

entities that acquired VeriSign Corporation's ("VeriSign")

common stock, against VeriSign and four of its executives

(collectively, the "Defendants"), for violations of sections

11 and 15 of the Securities Act of 1933 ("Securities Act"),

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

("Exchange Act"), and Securities and Exchange Commis-

sion Rule IOb-5 . Presently before this Court are Defendants'

Motion for Judgment on the Pleadings, Motion to Strike,

and Motion to Shorten the Class Period . The basis for these

motions rests in the recent Supreme Court decision in Dura

Pharms. . Inc. v. Broudo. --- U.S . ----. 125 S .Ct . 1627, 161

L.Ed.2d 577 (2005). The motions were noticed for hearing

on September 26, 2005 . The Court finds it appropriate to

take the motions under submission for decision without a

hearing, pursuant to Civil Local Rule 7 .1(b) . For the reasons

set forth below, this Court GRANTS in Part and DENIES in

Part Defendants' motion for judgment on the pleadings, and

denies without prejudice the motions to strike and to shorten

the class period .

II. BACKGROUND

Plaintiffs, on behalf of themselves and a proposed class of

persons and entities that purchased or acquired Verisign

Corporation's stock, filed an action against Verisign Corpor-

ation and four of its officers and directors, for violations of

the Securities Act, the Securities Exchange Act, and Rule

lob-5 . VeriSign is a leader in providing Internet "trust ser-

vices"-services that verify and authenticate information

transmitted over the Internet . Such services enable con-

sumers to safely transmit personal financial information

(such as credit card numbers) over the Internet to complete

commercial transactions .

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 sub-

sidiary . Network Solutions operated the official registry of

Internet domain names, such that anyone who wanted to re-

gister a website under the com, net, or org domains had to

register through Network Solutions . Network Solutions

charged each website listed on its registry at least $6 per

year . Although some industry analysts supported this ac-

quisition, others questioned whether VeriSign was paying

too much. This skepticism allegedly placed pressure on Ver-




iSign "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 ." Consolidated Second

Amended Complaint at 2 :3-5 .

Not long after VeriSign acquired Network Solutions, the In-

ternet boom "went bust ." VeriSign's business was hit and

the demand for Internet "trust services" and for new Internet

domain names declined . VeriSign's stock price fell from

$196 per share (on the day it acquired Network Solutions) to

$75 per share (on January 24, 2001, the day before the Class

Period).

*2 Thereafter, Defendants allegedly employed "an assort-

ment of schemes, artifices, and devices to mislead investors

about both the amount and source of revenues earned by

[VeriSign] ." Consolidated Second Amended Complaint at

2 :19-20 . In particular, Plaintiffs allege that Defendants arti-

ficially inflated VeriSign's earnings-and stock price-via im-

proper reporting and accounting practices . For example,

Plaintiffs allege that Defendants inflated VeriSign's earnings

by improperly reporting revenue generated from "round

trip" transactions . "Round trip" transactions are transactions

wherein VeriSign would invest cash in small, private, star-

tup businesses ("affiliates") that otherwise could not afford

VeriSign's services. In exchange for VeriSign's investment,

the affiliates would purchase VeriSign's products/services .

VeriSign, in turn, would report these purchases as revenue .

Plaintiffs also allege that Defendants artificially inflated

VeriSign's earnings by improperly accounting for VeriSign's

investments in affiliates . Consolidated Second AmendedComplaint at 2,3 . VeriSign used an accounting method

known as the "cost method" to account for its investments

in its affiliates . The "cost method" permitted VeriSign to re-

port at least $12 million in revenues on its financial state-

ments during the Class Period . Id. However, Plaintiffs al-

lege that the "equity method"-not the "cost method"-was the

proper method of accounting for VeriSign's investments in

affiliates . Id. According to Plaintiffs, the "equity method" is

proper when an investor exerts "significant influence" over

its investments . Because Plaintiffs claim that VeriSign exer-

ted "significant influence" over its affiliates, Plaintiffs claim

that the "equity method" was proper . Id. The "equity meth-

od" would not have permitted VeriSign to report any of the

Page 2

revenues received from its affiliates . Plaintiffs allege even

further that Defendants artificially inflated VeriSign's earn-

ings by improperly encouraging VeriSign's sales force to en-

gage in a process known as "scrubbing." Consolidated

Second Amended Complaint at 4 . "Scrubbing" is a method

of double-counting : salespersons in one division would re-

port their own sales and the sales of other salespersons in

other departments, as if they were their own. Id.

Plaintiffs claim that these practices and others led VeriSign

to issue materially false and misleading statements about

VeriSign's financial status . Defendants allegedly knew that

its business was flagging, yet it continued to artificially in-

flate VeriSign's revenues . Plaintiffs contend that they relied

upon these misrepresentations to their detriment .

Currently before this Court is Defendants' Motion for Judg-

ment on the Pleadings, Motion to Strike, and Motion to

Shorten the Class Period. Defendants contend that Plaintiffs

have not met their burden of adequately pleading loss causa-

tion, as set forth by the Supreme Court in the recent Dura

Pharm Inc., decision . Dura Pharm . . Inc. v. Broudo . --- U.S .

125 S .Ct . 1627, 161 L .Ed.2d 577 (U .S .2005) .

III . STANDARDS

*3 In ruling on a motion for judgment on the pleadings pur-

suant to Federal Rule of Civil Procedure 12(c) , the Court

applies the same standard as ruling on a motion to dismiss

pursuant to Rule 12(b)(6) . See 5C Charles A . Wright & Ar-

thur R. Miller . Federal Practice and Procedure § 1368

Q05). Under Rule 12(c), after the pleadings are closed, but

within such time as not to delay the trial, any party may

move for judgment on the pleadings . Fed. R. Civ. Pro.

12 c . In ruling on a motion to dismiss, the court must ac-

cept as true all allegations of material fact and must construe

said allegations in the light most favorable to the non-

moving party . Western Reserve Oil & Gas Co . v . New. 765

F.2d 1428. 1430 (9th Cir .1985). Any existing ambiguities

must be resolved in favor of the pleading . Walling v.

Beverly Enters. . 476 F.2d 393, 396 (9th Cir .1973) .

A complaint may be dismissed as a matter of law for two

reasons : (1) lack of a cognizable legal theory or (2) insuffi-

cient facts stated under a cognizable theory. Moran, supra at




893; 2A J . Moore, Moore 's Federal Practice ¶ 12 .08 at

2271 (2d ed . 1982 ) ; Robertson v. Dean Witter Reynolds .

Inc . . 749 F .2d 530, 533-34 (9th Cir.1984) . In order to grant

a motion to dismiss, it must appear to a certainty that a

plaintiff would not be entitled to relief under any set of facts

which could be proved . Rothman v . Yedder Park Manage-

ment. 912 F.2d 315, 316 (1990) .

IV. DISCUSSION

A. Loss Causation Under Dura

Section 10b of the Securities Exchange Act of 1934 forbids

(1) the "use or employment" of any "deceptive device," (2)

"in connection with the purchase or sale of any security,"

and (3) "in contravention of ' Securities and Exchange Com-

mission "rules and regulations ." 15 U.S.C. § 78j(b) . Rule

lob-5 forbids the making of any "untrue statement of mater-

ial fact," or the omission of any material fact "necessary in

order to make the statements made . . . not misleading." 17

C.F .R. § 240. lOb-5(b) . Congress imposed additional stat-

utory requirements on such a private action, when it passed

into law, the Private Securities Litigation Reform Act

("PSLRA") . 15 U.S.C. § 78u-4(b)(l)-(2) . Under the

PSLRA, a plaintiff must (1) specify "each statement alleged

to have been misleading and the reason why the statement is

misleading," and (2) allege "facts giving rise to a strong in-

ference that the Defendant acted with the required state of

mind ." Id. A plaintiff alleging fraud is also required to show

loss causation, i .e ., the plaintiff must prove that defendants'

securities fraud caused economic loss . Id.

The Supreme Court , in a recent decision , clarified this loss

causation pleading and proof requirement for secu rities

fraud cases . Dura Pharm . . Inc. v. Broudo . --- U .S . ----, 125

S.Ct . 1627, 161 L .Ed.2d 577 (U.S .2005) . Loss causation, as

defined by the Supreme Court, is the "causal connection

between the material misrepresentation and the loss ." Id at

1631 . The Court, in Dura, held that a plaintiff could not sat-

isfy loss causation merely by alleging (and later establish-

ing) that the price of the secu ri ties on the date of the pur-

chase was inflated because of misrepresentation . Idd, at 1627 .

In Dura, plaintiffs were a class of individuals who pur-

chased stock in Dura Pharmaceuticals on the public market

during the class period . Plaintiffs alleged that the comp any

Page 3

made false statements concerning its profits and its pro-

spects for future approval by the FDA of its products before

and during the purchase period. Id. at 1630. However, on

the last day of the purchase period, Dura Pharmaceuticals

announced that its earnings would be lower than previously

expected, principally due to slow drug sales . Id. The follow-

ing day, the company's shares lost almost half their value,

falling from $39 per share to $21 per share . Id. Sub-

sequently, when Dura Pharmaceuticals announced that the

FDA would not approve its products, the company's shares

temporarily fell but almost fully recovered within one week.

Id. With respect to economic loss, the complaint alleged that

"[i]n reliance on the integrity of the market, [the plaintiffs]

. . . paid artificially inflated prices for Dura securities" and

the "plaintiffs suffered 'damage[s]' thereby." Id. In revers-

ing the Ninth Circuit's jurisprudence on loss causation, the

Dura Court stated that "an inflated purchase price will not

itself constitute or proximately cause the relevant economic

loss" because the injury does not necessarily occur at the

time of the purchase. Id. at 1631-32. For instance, where

plaintiffs sold their stock immediately after purchasing it at

an inflated price, before the truth was disclosed to the mar-

ket, the plaintiffs may have suffered no economic loss at all.

Id. at 1631 . In concluding that plaintiffs did not adequately

plead loss causation, the Supreme Court held that, in light of

the numerous factors affecting share price an inflated pur-

chase price might suggest that the misrepresentation

"touches upon" a later economic loss, but could not be held

to have "caused" the economic loss . Id. at 1632 . Although

the Supreme Court also noted that its holding did not affect

the applicability of Fed.R.Civ .P . 8(a)(2) to loss causation

(i .e ., its holding did not create a heightened pleading stand-

ard for loss causation), the mere allegation that plaintiffs'

class purchased their shares at an artificially inflated price

did not serve to place the defendant with "fair notice of what

the Plaintiffs claim is and the grounds upon which it rests ."

Id. at 1634 (quoting Conley v. Gibson . 355 U .S. 41, 47, 78

S.Ct. 99, 2 L.Ed.2d 80 (1957) ). Even under this test,

plaintiffs' complaint failed to "provide the defendant with

some indication of the loss and the causal connection that

the plaintiff has in mind." Id. at 1634. Specifically, the

Court found that the complaint (1) failed to state that Dura's

share price fell significantly after the truth became known,

(2) failed to specify the relevant economic loss, and (3 )




failed to describe the causal connection between the loss and

the misrepresentation . Id. at 1634 .

*4 Applying the Dura framework, the Ninth Circuit recog-

nized that pleading loss causation is a difficult task. In re

Daou Systems. Inc . . 411 F.3d 1006, 1014 (9th Cir.2005) .

The Daou Court, however, specified that a plaintiff is not

required to show that a misrepresentation was the sole reas-

on for the investment's decline in value in order to establish

loss causation. Idd, at 1025 . As long as the misrepresentation

is a substantial cause of the investment's decline in value,

recovery will not be barred. Id. In Daou, plaintiffs, a class of

former investors, purchased Daou common stock between

February 13, 1997 and October 28, 1998 . Plaintiffs alleged

that defendants systematically and frequently violated the

Generally Accepted Accounting Principles ("GAAP") by

prematurely recognizing revenue in order to artificially in-

flate the price of Daou stock ; and that in relying on these

prices, plaintiffs suffered substantial personal losses .

Plaintiffs also alleged that if they had known of Daou's true

financial results and conditions, they would not have pur-

chased the shares, at least not at the inflated prices . Id. The

Daou court held that the complaint adequately pled loss

causation by showing that the price of Daou's stock fell pre-

cipitously after the defendants began to reveal figures show-

ing the company's true financial condition . Id. at 1025-26 .

The court found that the allegations, if assumed true, were

sufficient to provide the defendant "with some indication

that the drop in Daou's stock price was causally related to

Daou's financial misstatements reflecting its practice of pre-

maturely recognizing revenue before it was earned." Id. at

1026. The court relied on the plaintiffs' allegation that

"beginning in August 1998, the company disclosed that its

operating expenses and margins were deteriorating and, on

October 28, 1998, defendants revealed that Daou had dra-

matically missed its projected 3Q98 earnings and would

have to report a loss of $0 .17 a share ." Id. The complaint

also alleged that defendants revealed that "the Company's

rapidly escalating work in progress account represented over

$10 million in un-billed receivables-the direct result of pre-

maturely recognizing revenue. " Id. (emphasis in the origin-

al) . The Ninth Circuit found these allegations sufficiently

specific to establish loss causation under Dura.

Page 4

Interpreting Dura, some courts have required some

"corrective disclosure" before inflated purchase price can

constitute evidence of loss causation. In In re Initial Public

Offering Sec. Litig. . No. MDL 1554(SAS). 2005 WL

1162445 (S.D.N.Y. May 6, 2005) (hereinafter "IPO"), the

court stated that, in the Second Circuit, "to establish loss

causation, a plaintiff must allege . . . that the subject of the

fraudulent statement or omission was the cause of the actual

loss suffered, i .e ., the misstatement or omission concealed

something from the market that, when disclosed, negatively

affected the value of the security ." Id. at *3 (internal quota-

tions omitted) (emphasis in original) . The plaintiffs in that

case alleged that the defendants intentionally discounted

earnings estimates and issued cautionary statements to ex-

cite the market and inflate prices when those estimates were

beaten . Id. The IPO court held that the plaintiffs failed to al-

lege loss causation because the defendants' fraudulent

scheme was never disclosed to the market . Id.

*5 Relying on th IPO decision, Defendants in the present

action contend that Dura requires Plaintiffs to allege some

"corrective disclosure" before they can satisfy the require-

ments for pleading loss causation. They interpret Dura as

requiring evidence of "corrective disclosure' to satisfy loss

causation. Defendants' reply at 6 .

Notably, the Dura decision itself does not define the plead-

ing standard for loss causation. The Dura decision only

speaks in terms of the "truth" and "relevant truth." The

Dura court noted that its holding did not affect the applicab-

ility of Fed.R.Civ .P . 8(a)(2) to loss causation, which re-

quires only a "short and plain statement of the claim show-

ing that the pleader is entitled to relief." Dura. 125 S.Ct. at

1634 . The complaint must give the defendant "fair notice of

what the plaintiffs claim is and the grounds upon which it

rests ." Id. In satisfying this pleading standard, the complaint

needs to "provide the defendant with some indication of the

loss and the causal connection that the plaintiff has in

mind." Id. at 1634 (emphasis added). Similarly in Daou, the

court found that the complaint sufficiently alleged loss caus-

ation because the complaint provided the defendant "with

some indication that the drop in Daou's stock price was

causally related to Daou's financial misstatements ." Daou.

411 F .3d at 1026 (emphasis added) .




B. Plaintiffs Adequately Plead Loss Causation For One Of

The Five Categories of Fraud

Plaintiffs allege that Defendants issued numerous misrepres-

entations and omissions, causing VeriSign's stock prices to

be artificially inflated during the class period . Consolidated

Second Amended Complaint at 2 . The misstatements and

omissions alleged in Plaintiffs' second amended complaint

primarily fall into five categories : (1) improper revenue re-

cognition of reciprocal and related party transactions, (2)

failure to timely write down alleged impaired assets, (3) im-

proper accounting, (4) false segment reporting, and (5) up-

wards revision of sales data . Id. at 2 . Specifically, Plaintiffs

contend that VeriSign recognized at least $27 million from

transactions in which VeriSign bartered its products and ser-

vices for those of other companies, and recognized at least

$10 .5 million in reciprocal transactions in which it licensed

its software to other companies at or about the same time it

was purchasing goods and services from these companies .

Consolidated Second Amended Complaint at 3. Second,

Plaintiffs allege that VeriSign violated GAAP provisions by

failing to timely record a $74 million write down to reflect

an impairment in its investments in startup companies . Id. In

the third category, Plaintiffs allege that VeriSign used im-

proper accounting principles to report at least $12 million in

revenues . Id. In the fourth category, Plaintiffs allege that

VeriSign segmented its revenue and earnings by reference

to the type of customer from whom the revenues were de-

rived, rather than the type of service which was the basis for

the revenue, and that revenues from one VeriSign division

were "scrubbed" or transferred to another . Id. at 4 . Finally,

Plaintiffs allege that VeriSign took sales data that was re-

ported from regional sales divisions and fraudulently in-

flated them . Id. at 4 . All of the above alleged misstatements

were purportedly made by Defendants through various press

releases and revenue reports issued during the period from

January 2001 to March 2002 . Consolidated Second

Amended Complaint at 19, 23, 25, 28 . Plaintiffs contend

that by reporting incorrect revenue results, Verisign's press

reports falsely portrayed the corporation as being financially

secure .

*6 As discussed above, Plaintiffs must show loss causation

before they can prevail on their claim for securities fraud .

Page 5

To establish loss causation, Plaintiffs rely on three disclos-

ures, including : (1) a February 6, 2002 Bloomberg report,

(2) a March 19, 2002 report issued by VeriSign, and (3) an

April 25, 2002 press release disclosing earnings for 1Q02 .

The Bloomberg report simply stated that "VeriSign shares

fell 9 .5 percent on the concern that revenue at the manager

of the database of dot-com web addresses may be inflated

by sales to affiliated companies." (Plaintiffs' CSAC at 38 .)

Plaintiffs allege that this Bloomberg report caused "market

speculation" about inflated sales and resulted in a price

drop . On March 19, 2002, VeriSign filed its report on Form

10K for its FY01 . Consolidated Second Amended Com-

plaint at 38 . In this report, the company, for the first time,

revealed that approximately 10% of its revenue was attribut-

able to reciprocal arrangements, or "barter transactions,"

and sales to the company affiliates that VeriSign had just in-

vested in . Id. After the issuance of this report, VeriSign

stock dropped 10%, to close at $26 .42 . Id. This disclosure is

particularly pertinent to the first category of fraud, namely

that Defendants' engagement in improper revenue recogni-

tion of reciprocal and related party transaction . Plaintiffs al-

lege that Defendants inflated earnings by improperly report-

ing more than $64 million of revenue as a result of numer-

ous "round trip" transactions with its affiliates and other

small private companies in which VeriSign had invested in

order to provide them with a source of funds to purchase

products from VeriSign. Consolidated Second Amended

Complaint at 3 . Additionally, VeriSign allegedly improperly

reported at least $27 million in cash revenues based on non-

monetary barter transactions, in which VeriSign provided

domain names, digital certificates or other products to third

parties in exchange for their products or services . Id. With

regard to these specific allegations constituting the first cat-

egory of fraud, the Court fords that Plaintiffs have suffi-

ciently pled loss causation.

On April 25, 2000, VeriSign reported its 1Q02 results.

(Plaintiffs' CSAC at 40 .) VeriSign's ProForma net income

dropped $4 .1 million, from $71 .8 in December 2001 to

$67.7 in March, 2002 . Id. Stating that "our first quarter res-

ults were not up to our expectations as we encountered sig-

nificant spending delays in our IT and telecom customer

bases," Mr. Stratton Sclavos, Chairman and CEO of Ver-




iSign announced plans to restructure the company's opera-

tions to fully rationalize, integrate and align the resources of

the company . Id. at 41 . The Chairman anticipated charges of

$70-$80 million as a result of such restructuring. Id. On this

news, VeriSign stock dropped from $18 .24 to $9.89 per

share.

Plaintiffs contend that the April 25, 2000, disclosure caused

a third economic loss for them. However, the April 25 dis-

closure is not linked to any misstatements alleged in the

complaint. Plaintiffs' complaint essentially admits as much .

Specifically, Plaintiffs allege: "Even this disclosure,

however, did not acknowledge that VeriSign had been

maintaining its revenue and earnings numbers by manipulat-

ing its financial results ." (Plaintiffs' CSAC at 2 .) In contrast

to Daou, where the complaint alleged deteriorating operat-

ing and expense margins, dramatically misplaced revenue

results, and a revelation that the company's rapidly escalat-ing work in progress account represented over $10 million

in un-billed receivables, Plaintiffs' complaint in this case

does not plead any specific disclosure made by VeriSign on

April 25, 2000, as being the substantial cause for the decline

in stock price . As such, Plaintiffs' complaint fails to provide

Defendants with notice of what the causal connection might

be between their loss and the vast majority of alleged mis-

representations making up the second through fi fth categor-

ies of fraud. Dura Pharm., Inc. v. Broudo, 125 S.Ct. 1634

(U . S .2005) .

*7 In summary, Plaintiffs adequately plead loss causation as

to the first category of fraud, namely, allegations regarding

misstatements and omissions of improper revenue recogni-

tion of reciprocal and related party transactions . However,

the three disclosures cited by the Plaintiffs in their com-

plaint do not satisfy the causal link requirement as to the

other four categories of fraud alleged by Plaintiffs . This

Court therefore, denies Defendants' motion for judgment on

the pleadings with respect to category one of the alleged

fraud and grants the motion with respect to the remaining

four categories of fraud.

C. Plaintiffs' Request for Leave to Amend Complaint is

Granted

Plaintiffs request leave to amend the complaint if the Court

Page 6

grants Defendants' Motion for Judgment on the Pleadings.

Plaintiffs' Motion at 3 . Defendants' briefs do not address

Plaintiffs' request.

Rule 15(a) . Fed .R.Civ .P ., provides that a party may amend

his pleadings once as a matter of course at any time before a

responsive pleading is served . Otherwise a party may amend

only by leave of court or by written consent of the adverse

party. Id. Rule 15(a) further provides that leave 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 "extreme

liberality ." United States v. Webb. 655 F.2d 977, 979 (9th

Cir.1981 .

In light of the liberal policy in favor of allowing amend-

ments, this Court GRANTS Plaintiffs' request to amend

their complaint . Plaintiffs shall file and serve an amended

complaint on or before November 18, 2005 .

D. Defendants' Motions to Strike and to Shorten Class Peri-

od Are Denied Without Prejudic e

Defendants contend that Plaintiffs do not allege loss causa-

tion with respect to any alleged economic loss after March

19, 2000, and therefore move to strike all alleged misstate-

ments or omissions for which Plaintiffs fail to plead loss

causation, and to shorten the class period to end on March

19, 2000 . Defendants contend that because Plaintiffs fail to

adequately plead loss causation, their allegations qualify as

"immaterial, redundant, impertinent, or scandalous . "

Generally, a motion to strike must be made before respond-

ing to the challenged pleading . Fed .R.Civ .P. 12(f).However, Rule 12(f) allows a court to exercise its discre-

tion, at any time, to strike parts of the pleading that the court

deems "an insufficient defense or redundant, immaterial,

impertinent, or scandalous matter." Id.

In section "C" immediately above, this Court granted

Plaintiffs' request for leave to amend their complaint to ad-

equately plead loss causation. Therefore, this Court does not

deem it necessary at this time, to Rule on the merits of De-

fendants' motion to strike and to shorten the Class Period.

Defendants' Motions to Shorten the Class Period and t o




Strike the complaint are DENIED without prejudice .

V. CONCLUSION

*8 For the reasons stated above, Defendants' Motion for

Judgment on the Pleadings is GRANTED in part and

DENIED in part with leave to amend . Plaintiffs shall file

and serve an amended complaint on or before November 18,

2005. Defendants' Motions to Strike and to Shorten the

Class Period are DENIED without prejudice.

N.D.Cal .,2005 .

In re Verisign Corp . Securities Litigatio n

Slip Copy, 2005 WL 2893783 (N .D.Cal.), Fed. Sec. L . Rep .

P 93,58 1

Briefs and Other Related Documents Back to top)

• 2006 WL 1785803 (Trial Pleading) Plaintiffs' Fourth

Amended Class Action Complaint (May 12, 2006) Original



davit) Defendants' Reply in Support of Motion to Dismiss

Third Amended Complaint (Mar. 13, 2006) Original Image

of this Document (PDF)


davit) Plaintiffs' Opposition to Defendants' Motion to Dis-

miss Third Amended Class Action Complaint (Feb . 27,

2006) Original Image of this Document (PDF)• 2006 WL 397993 (Trial Motion, Memorandum and Affi-

davit) Class Action Defendants' Notice of Motion and Mo-

tion to Dismiss Third Amended Class Action Complaint

(Jan . 30, 2006) Original Image of this Document (PDF )


davit) Defendants' Reply in Support of Motion for Judgment

on the Pleadings and Motion to Strike (Sep . 12, 2005) Ori-



davit) Lead Plaintiffs' Opposition to Defendants' Motion for

Judgment On the Pleadings, Motion to Strike, and Motion to

Shorten Class Period (Aug. 31, 2005) Original Image of this

Document (PDF)

• 5 :02cv02270 (Docket) (May. 09, 2002)

END OF DOCUMENT

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