2006728_r01x_0404156
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2006728_r01x_0404156

Course Number: IFX 1032, 2009

College/University: Stanford

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Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 1 of 2 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 MELVIN R. GOLDMAN (BAR NO. 34097) mgoldman@mofo.com JORDAN ETH (BAR NO. 121617) jeth@mofo.com MIA MAZZA (BAR NO. 184158) mmazza@mofo.com MARK FOSTER (BAR NO. 223682) mfoster@mofo.com MORRISON & FOERSTER LLP 425 Market Street San Francisco, California 94105-2482...

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5:04-cv-04156-JW Document Case 111 Filed 07/28/2006 Page 1 of 2 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 MELVIN R. GOLDMAN (BAR NO. 34097) mgoldman@mofo.com JORDAN ETH (BAR NO. 121617) jeth@mofo.com MIA MAZZA (BAR NO. 184158) mmazza@mofo.com MARK FOSTER (BAR NO. 223682) mfoster@mofo.com 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AG SECURITIES LITIGATION This Document Relates To: ALL ACTIONS Master File No. CLASS ACTION C-04-4156-JW APPENDIX OF UNPUBLISHED AUTHORITIES CITED IN REPLY BRIEF IN SUPPORT OF MOTION FOR PARTIAL RECONSIDERATION OF MAY 22, 2006 ORDER Hearing Date: September 11, 2006 Time: 9:00 a.m. Judge: Honorable James Ware Courtroom: 8, 4th Floor APPENDIX OF UNPUBLISHED AUTHORITIES CITED IN REPLY BRIEF I/S/O MOTION FOR PARTIAL RECONSIDERATION MASTER FILE NO. C-04-4156-JW sf-2168514 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 2 of 2 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 Case APPENDIX OF UNPUBLISHED AUTHORITIES Tab In re Ashworth, Inc. Sec.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 APPENDIX OF UNPUBLISHED AUTHORITIES CITED IN REPLY BRIEF I/S/O MOTION FOR PARTIAL RECONSIDERATION MASTER FILE NO. C-04-4156-JW sf-2168514 1 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 1 of 10 TAB 1 Page 1 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 2 of 10 LEXSEE 2000 U.S. DIST. LEXIS 15237 In re ASHWORTH, INC. SECURITIES LITIGATION; This Document Relates to: ALL ACTIONS. Civil No. 99cv0121--L(JAH) UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF CALIFORNIA 2000 U.S. Dist. LEXIS 15237; Fed. Sec. L. Rep. (CCH) P91,243 July 18, 2000, Decided July 18, 2000, Filed SUBSEQUENT HISTORY: Motion granted by, in part, Motion denied by, in part In re Ashworth, Inc. Secs. Litig., 2002 U.S. Dist. LEXIS 27991 (S.D. Cal., May 10, 2002) DISPOSITION: [*1] Defendants' motion to dismiss GRANTED WITHOUT PREJUDICE. For NEW HAMPSHIRE RETIREMENT SYSTEM, plaintiff: Kurt B Olsen, The Olsen Law Firm, Washington, DC. JUDGES: M. JAMES [*2] LORENZ, UNITED STATES DISTRICT JUDGE. OPINIONBY: M. JAMES LORENZ OPINION: ORDER GRANTING DEFENDANTS' MOTION TO DISMISS WITHOUT PREJUDICE [Docket No. 24] This matter came on regularly for a hearing on Defendants' motion to dismiss Plaintiffs' Consolidated Amended Complaint. Blake M. Harper of Milberg Weiss Bershad Hynes & Lerach, LLP, Todd S. Collins of Berger & Montague, P.C., and Kurt Olsen of the Olsen Law Firm appeared for the Plaintiffs. Wayne W. Smith and Thomas S. Jones of Gibson, Dunn & Crutcher, LLP appeared for the Defendants. FACTUAL BACKGROUND Defendant Ashworth, Inc. (hereinafter referred to as "Ashworth" or "Company") designs, markets and distributes golf apparel, headwear, and shoes under the "Ashworth" brand name. (Consolidated Amended Complaint ("CAC") PP 5, 9.) Ashworth's products are sold in the U.S. and internationally in golf proshops, resorts, department and specialty stores. (CAC P 5.) The Company's stock is publicly traded on the NASDAQ. (CAC P 92.) The individual defendants are: (1) Chief Executive Officer and Ashworth Director Randall Herrel ("Herrel"); (2) founder, former designer, and Director John Ashworth ("Mr. Ashworth"); (3) former Chairman [*3] of the Board Gerald Montiel ("Mr. Montiel"); (4) for- COUNSEL: For BRIAN JOHNSON, plaintiff: William S Lerach, Arthur Charles Leahy, Milberg Weiss Bershad Hynes and Lerach, San Diego, CA. For BRIAN JOHNSON, JOHN GERVAIS, DEBRA KOPP, TONY LE, THOMAS KIDDER, JAMES R SANDOVAL, SHIRLEY SANDOVAL, NEW HAMPSHIRE RETIREMENT SYSTEM, plaintiffs: Todd S Collins, Berger and Montague, Philadelphia, PA. For JOHN GERVAIS, DEBRA KOPP, TONY LE, THOMAS KIDDER, JAMES R SANDOVAL, SHIRLEY SANDOVAL, NEW HAMPSHIRE RETIREMENT SYSTEM, plaintiffs: Arthur Charles Leahy, Milberg Weiss Bershad Hynes and Lerach, San Diego, CA. For ASHWORTH INC, RANDALL L HERREL, SR, GERALD W MONTIEL, JOHN L ASHWORTH, A JOHN NEWMAN, ANDRE P GAMBUCCI, MARY MONTIEL, 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. Page 2 2000 U.S. Dist. LEXIS 15237, *3; Fed. Sec. L. Rep. (CCH) P91,243 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 3 of 10 mer Chief Financial Officer John Newman ("Newman"); and (5) former Vice President--Manufacturing Mary Montiel ("Mrs. Montiel"). (CAC P 5.) The class period in this action is from September 4, 1997, through July 15, 1998. (CAC P 8.) After a successful 1993--94, Ashworth's business performed poorly from 1995 to mid--1997, causing its stock price to go from $10--$ 14 to $5--$ 7 per share. (CAC P 9.) Plaintiffs allege that as a result of the low stock price, the Company's executives and directors held thousands of then-worthless options and embarked on a fraudulent scheme to raise the stock price so they could exercise their options and sell their stock for a profit. (CAC P 10.) Plaintiffs state that during the class period, Defendants led the public to believe that they were turning Ashworth around by representing that Ashworth was experiencing "significant improvement" in its financial results, "increasing demand" for its products, and "substantial increase[s]" in booking and sales. (CAC PP 12, 35, 40, 47, 50-51, 56.) Plaintiffs also state that Defendants represented that Ashworth was successfully moving its production operations offshore, [*4] yielding costs savings and operating 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 Defendants extolled the quality of their products. (CAC PP 18, 44, 48.) Defendants also told the public that Ashworth's inventory levels were in accordance with their "plan," sufficiently high so that the Company could fill the many orders Ashworth had and satisfy the strong demand for its products. (CAC PP 12, 36, 40, 41, 58.) Defendants forecasted gross margins of 40% and earnings per share ("EPS") of $0.60+ for 1998. (CAC PP 12, 41, 52.) During the class period, the Company's stock went to an all--time high of $18 per share. (CAC P 11.) Plaintiffs contend that none of Defendants' representations were true. Rather, the "significant improvement" in Ashworth's financial results, "increasing demand" and Ashworth's "substantial increase[s]" in sales were fabricated by numerous phony sales, thereby falsely inflating Ashworth's revenues, gross margins and EPS in violation of GAAP. Plaintiffs state that the phony sales took the following forms: (1) Defendants shipped products for which there [*5] were no buyers to warehouses rented to park the goods, and recorded these shipments as sales (CAC PP 13--14); (2) Defendants shipped massive amounts of goods which had not been ordered, and for which there were no buyers, to Ashworth's independent sales representatives and recorded these shipments as sales. (CAC PP 14, 26, 82(a)); (3) Defendants forced Ashworth's sales representatives to take large amounts of merchandise they did not order or want (and which the representatives could return) under Ashworth's "car stock program," and recorded these shipments as sales (CAC PP 14, 26, 82(c)); (4) Defendants shipped merchandise to customers who had not ordered any, booking these shipments as sales (CAC PP 13, 82); (5) Defendants shipped customers non--conforming in--stock merchandise where the customers had ordered merchandise that was out--of-stock, so that Ashworth could immediately record these shipments as sales (CAC PP 14, 26, 82(e)); (6) Defendants also shipped goods months before customers wanted the merchandise sent, and immediately booked these early shipments as sales (CAC PP 14, 27, 82(d)); and (7) Defendants improperly recognized as revenue shipments of merchandise to customers [*6] that had 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, Club Corp. of America, American Golf Corp., T.J. Maxx, and the 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 falsely boosted its financial results by intentionally and improperly decreasing Ashworth's inventory reserves at a time when they should have been increased because of the buildup of excess inventory. (CAC PP 16, 71-79.) Plaintiffs further claim that Ashworth's representations it was successfully moving production offshore, that the quality of the products was high, and that they were "double sourcing" were false. Plaintiffs state that the offshore--produced products had numerous defects and were of inferior quality, and the move was not resulting in savings but was leading to greatly increased expenses, operational inefficiencies, and dramatically higher future costs. (CAC PP 61(a)-(b), (m).) In addition, contrary to Defendants' representations, Plaintiffs state that Ashworth was not double--sourcing. (CAC PP [*7] 21, 61(c).) Plaintiffs also state that inventory levels were not in accordance with the Defendants' "plan" or maintained so that they could fill orders; rather, demand for Ashworth's merchandise was weakening and the Company had more inventory than it needed. (CAC PP 61(c), (e), (j) - (k)). Plaintiffs contend that because of the foregoing adverse facts, Defendants knew their optimistic forecasts of gross margins of 40% and EPS of $0.60+ for 1998 were unattainable. (CAC P 61(o)). Plaintiffs state that the Defendants knew this true information "due to their access to internal Ashworth data." (CAC P 61.) Plaintiffs allege that while the stock was high, the individual Defendants sold 95%--100% of the total number of shares they actually owned during the Class Period, and Page 3 2000 U.S. Dist. LEXIS 15237, *7; Fed. Sec. L. Rep. (CCH) P91,243 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 4 of 10 from 43%-97% of their entire beneficial interests (which included their vested options to purchase shares) during such time. (CAC PP 22, 33). Collectively, this amounted to 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 be down $2 million to $3 million and that the Company's problems 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 problems. (CAC PP 64, 66--67.) Ashworth's stock then fell even further, and after the class period has been trading at around $4 per share. DISCUSSION Plaintiffs' Complaint alleges Defendants violated sections 10(b) and 20(b) of the Securities and Exchange Act and Securities and Exchange Commission Rule 10b5. Defendants have now moved to dismiss the consolidated amended complaint. In support of their motion, Defendants have requested the Court take judicial notice of various press releases, reports, and SEC filings. To the extent that this Court has relied on any of these documents in its analysis, it takes judicial notice of them pursuant to Federal Rule of Evidence 201. I. Applicable Law Regarding Motions to Dismiss Securities Fraud Complaints. When ruling on a motion to dismiss, the Court accepts all material allegations of fact as true and must construe those allegations in the light most favorable to the non--moving party. Durning v. First Boston Corp., 815 F.2d 1265, 1267 (9th Cir. 1987); [*9] North Star Int'l v. Arizona Corp. Comm'n, 720 F.2d 578, 581 (9th Cir. 1983). The Court may dismiss a complaint as a matter of law either for lack of a cognizable legal theory or for the absence of sufficient facts alleged under a cognizable legal theory. Robertson v. Dean Witter Reynolds, Inc., 749 F.2d 530, 534 (9th Cir. 1984). A court reviewing a motion to dismiss may consider the facts alleged in the complaint, documents attached to the complaint, and matters of which the Court takes judicial notice. See Hal Roach Studios, Inc. v. Richard Feiner & Co., 896 F.2d 1542, 1555 n.19 (9th Cir. 1989). A district court ruling on a motion to dismiss may also consider documents "whose contents are alleged in a complaint and whose authenticity no party questions, but which are not physically attached to the [plaintiff's] pleading" without converting the motion to a summary judgment motion Branch v. Tunnell, 14 F.3d 449, 453- (9th Cir. 1994). Further, the Ninth Circuit has -54 extended this rule to documents the authenticity of which is 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 of 1934 makes it unlawful to use in connection with the mails or instrumentalities of interstate commerce any "manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commissioner may prescribe." 15 U.S.C. 78j. SEC Rule 10b- promul-5, gated under section 10(b), provides: It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange, (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. In order for Plaintiffs [*11] to properly allege their first claim of relief brought under section 10(b) of the Exchange Act and SEC Rule 10b- they must state the -5, following: (1) defendants made a false statement or omission with regard to a material fact; (2) in connection with the purchase or the sale of a security; (3) with scienter; (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 (9th Cir. 1996). Scienter is a "mental state embracing intent to deceive, manipulate, or defraud." Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193- n.12, 47 L. Ed. 2d 668, -94 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 Private Securities Litigation Reform Act of 1995 ("PSLRA") to establish uniform and stringent pleading requirements for securities fraud actions, and "to put an end to the practice of pleading 'fraud by hindsight.'" In re Silicon Graphics, 183 F.3d at 958. The PSLRA specifies the required pleading standard for securities fraud actions: (1) Misleading [*12] statements and omissions Page 4 2000 U.S. Dist. LEXIS 15237, *12; Fed. Sec. L. Rep. (CCH) P91,243 Case 5:04-cv-04156-JW In any private action arising under this chapter in which the plaintiff alleges that the defendant ---(A) made an untrue statement of a material fact; or (B) omitted to state a material fact necessary in order to make the statements made, in the light of the circumstances in which they were made, not misleading; the complaint shall 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). Document 111 Filed 07/28/2006 Page 5 of 10 may demonstrate that the false or misleading character of a statement was clear from facts that existed all along and were later revealed. Id. at 1549. It may also "point[] to inconsistent contemporaneous statements or information . . . which were made by or available to the defendants." Id. A complaint may not, however, demonstrate that a statement was false or misleading when made "merely by pointing to later inconsistent statements or conditions." Id. II. Analysis. Defendants raise two types of challenges to the Consolidated Amended Complaint. First, Defendants argue that the complaint does not meet the requisite pleading standards as set forth by the PSLRA, Federal Rule of Civil Procedure 9(b), and In re Silicon Graphics. Second, Defendants contend that the alleged misrepresentations at issue in this case are not actionable. A. Pleading Challenges. As an initial matter, Plaintiffs argue the Complaint is not based on information and belief but rather on counsel's investigation and personal knowledge of former Ashworth personnel. But a complaint made upon investigation of counsel is the same as a complaint made [*15] on information and belief. In re Silicon Graphics Sec. Litig., 970 F. Supp. 746, 763-64 (N.D. Cal. 1997), aff'd, 183 F.3d 970. Further, although the Complaint states it is based on "knowledgeable sources," there are no allegations in the Complaint indicating that the Plaintiffs have personal knowledge of the facts underlying their allegations. Accordingly, the Court considers the Complaint to have been pled on information and belief. 1. Falsity. The statements at issue in the Complaint relate to the Company's health in terms of revenues and inventory, and production difficulties. Defendants argue that Plaintiffs fail to allege sufficient facts to support their claims that the statements at issue in this case were false when made. For the reasons discussed below, the Court finds that the Complaint does not plead with particularity how Defendants' statements regarding the Company's financial condition and production were false when made. a. Plaintiffs' Allegations Regarding Ashworth's Reported Revenues and Earnings. Plaintiffs argue that they have sufficiently pled that Ashworth violated GAAP n1 and SEC financial reporting requirements [*16] during the class period by improperly recognizing revenue through a variety of undisclosed practices to inflate Ashworth's revenues and EPS to support Defendants' statements that the Company was enjoy- In addition, the PSLRA requires complaints alleging federal securities fraud 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). As recently interpreted by the Ninth Circuit, this language requires "a private securities plaintiff . . . [to] plead, in great detail, facts that constitute strong circumstantial evidence of deliberately reckless or conscious [*13] misconduct." In re Silicon Graphics, 183 F.3d at 974. Recklessness satisfies the scienter requirement only insofar as it reflects some degree of conscious or deliberate misconduct; i.e., "a degree of recklessness that strongly suggests actual intent." Id. at 979. The PSLRA further provides that "the court shall, on the motion of any defendant, dismiss the complaint if the requirements of paragraphs (1) and (2) are not met." 15 U.S.C. 78u-4(b)(3)(A). Under Ninth Circuit caselaw, Rule 9(b) imposes two distinct requirements on complaints alleging securities fraud. First, the basic notice requirements of Rule 9(b) require the complaint to "state precisely the time, place, and nature of the misleading statements, misrepresentations, or specific acts of fraud." Kaplan v. Rose, 49 F.3d 1363, 1370 (9th Cir. 1994). The Rule imposes a second requirement that the complaint "set forth an explanation as to why the statement or omission complained of was false and misleading." In re Glenfed Sec. Litig., 42 F.3d 1541, 1548 (9th Cir. 1994) (en banc). A complaint may satisfy this second requirement [*14] in many ways. It Page 5 2000 U.S. Dist. LEXIS 15237, *16; Fed. Sec. L. Rep. (CCH) P91,243 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 6 of 10 ing a "substantial increase" in sales. Defendants contend that in fact the Complaint does not identify particular transactions where Ashworth improperly recognized revenues. Specifically, Defendants state that Plaintiffs fail to identify specific instances where Ashworth shipped product to a specified customer in a specified amount and booked that sale only to have that material returned at a later date. n1 GAAP "is a term of art encompassing a wide range of acceptable accounting procedures, such that 'an ethical reasonably diligent accountant may choose to apply any of a variety of acceptable procedures when that accountant prepares a financial statement.'" Lovelace v. Software Spectrum Inc., 78 F.3d 1015, 1021 (5th Cir. 1996). Plaintiffs respond that they are not required to allege a single specific [*17] transaction, specific shipments, specific customers, specific times, or specific dollar amounts. In so arguing, Plaintiffs cite In re Cooper, 137 F.3d 616, 627 (9th Cir. 1997), In re Wells Fargo Sec. Litig., 12 F.3d 922, 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 is misplaced. Cooper and Wells Fargo are pre--Reform Act cases and are therefore inapplicable. Further, in Wells Fargo, the plaintiffs identified the defendants' deliberate failure to disclose specific loans extended to identified borrowers. In re Wells Fargo, 12 F.3d at 926--27. Second, Schlagal and Cherednichenko are not officially--published opinions from other districts and therefore should not be cited as binding or persuasive authority on this Court. "Properly pled, overstating of revenues may state a claim for securities fraud, as under GAAP, 'revenue must 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 conclusion that defendant [] prepared the fraudulent financial statements and that the alleged financial fraud was material. In addition, plaintiffs must identify the particular transactions underlying [the] alleged accounting deficiencies." Id. (internal citations and quotations omitted). The Court agrees with the Defendants that Plaintiffs' allegations are conclusory and not properly pled. Significantly, Plaintiffs fail to identify contemporary internal reports or receipts that identify the terms of the challenged transactions. First, the Complaint alleges Defendants created phan- tom sales by shipping Ashworth merchandise to customers who had not placed orders while recording these shipments as "sales," and just before quarter ends, Defendants routinely shipped merchandise for which there was no buyer to warehouses of its sales representatives and recorded these shipments as sales. (CAC PP 13, 26.) The Complaint fails to allege any specific facts to substantiate these allegations, such as a detailed example where these events occurred. The Complaint also contends that before [*19] quarter ends, Ashworth's senior executives would contact the Company's sales representatives to convince them to take and store $50,000--$ 100,000 worth of goods, and on at least one occasion, Ashworth caused one of its sales representatives in the Southeast to ship $100,00 worth of merchandise to a rented warehouse and record the shipment as a sale even though there was no sale or customer for the merchandise. (CAC PP 14, 26.) Defendants also shipped massive amounts of merchandise to the warehouse of Regional Sales, Inc., an independent sales representatives, even though there were no sales or customers for such products. (CAC PP 14, 26.) As noted by Defendants, the Complaint does not detail a single transaction to substantiate this claim. Plaintiff's Complaint maintains that Defendants contacted customers at quarter--ends and offered special terms, including discounting, liberal rights of return, and extended payment terms to customers. (CAC PP 15, 27.) Although Plaintiffs list some customers that Defendants contacted and state that the Disney Co. received a favorable term "in one instance," there are no allegations describing the terms, the amounts involved, whether goods were [*20] actually returned, or how the agreements violated accounting standards. Similarly, the Complaint alleges Ashworth shipped "hundreds of thousands of dollars" to a company called Cyrk subject to an "unlimited right of return" and that returns did occur. However, the Complaint does not given an example discussing when the product was shipped, how much was returned, or whether the amounts returned were material. Insofar as the above allegations also amount to "channel stuffing" claims, they are insufficient. Channel stuffing "is the oversupply of distributors in one quarter to artificially inflate sales, which will then drop in the next quarter as distributors no longer make orders while depleting their excess supply." Steckman v. Hart Brewing, Inc., 143 F.3d 1293, 1298 (9th Cir. 1998). The First Circuit recently noted that "there is nothing inherently improper in pressing 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 may have some probative value insofar as the channel stuffing Page 6 2000 U.S. Dist. LEXIS 15237, *20; Fed. Sec. L. Rep. (CCH) P91,243 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 7 of 10 was done so as to artificially inflate income, "that [*21] value is weak." Id. at 202--03. Because there may be a number of legitimate reasons for attempting to achieve sales earlier, "channel stuffing" claims "do not support a strong inference of scienter." Id. at 203. Indeed, this Circuit has rejected "channel stuffing" claims. Steckman, 143 F.3d at 1298. In Steckman, the Ninth Circuit stated that "this claim is speculation made in hindsight." Id. Similarly, Defendants argue that Plaintiffs have not supported their position that Ashworth's statement of a "strong outlook" was false. The Complaint maintains that statement is false because Ashworth Europe had "outmoded and inefficient management" and "soft demand." (CAC P 61(d).) Further, the Complaint alleges that demand was not strong because demand for the Basics line was "weakening." Again, Defendants argue that the Complaint does not allege any specifics nor explains how the Defendants knew of the true facts. b. Inventory Accounting. Plaintiffs allege Ashworth's statement that inventory levels were "on plan" was false because in fact the Basics line was encountering "extreme price pressure," inventories were above internal [*22] budgets and forecasts, and management had not "fixed" inventory issues. (CAC PP 61(e), 61(j), 61(k).) Plaintiffs contend that Defendants improperly 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.) ARB No. 43, Chapter 4, statement 5 states: A departure from the cost basis of pricing the inventory is required when the utility of the goods is no longer as great as its cost. Where there is evidence that the utility of goods, in their disposal in the ordinary course of business, will be less than cost, whether due to physical deterioration, obsolescence, changes in price levels, or other causes, the difference should be recognized as a loss of the current period. This is generally accomplished by stating such goods at a lower level commonly designated as market. (CAC P 71.) Defendants state that notwithstanding Plaintiff's reliance on ARB No. 43, Chapter 4, statement 5, the Complaint does not articulate any facts indicated that Ashworth ever accounted for inventory in any other fashion or sold inventory for below cost. The Court agrees that Plaintiffs' allegations are [*23] insufficient. The Complaint does not provide any specificity or examples regarding inventory levels, sales at below cost, or inventory build up. Plaintiffs' general alle- gations that Ashworth's inventories were "materially increasing," demand for Ashworth's basics product line was decreasing, and costs were increasing are too conclusory. To support these allegations, Plaintiffs cite defendants 1998 SEC Form 10K in which the company stated it was disposing of excess prior season inventory. Plaintiffs' reliance on post--class period documents amounts to "fraud by hindsight" and is therefore insufficient to show there was information at the time the Defendants made the statements that contradicted the representations. In sum, the Court finds that the Complaint does not allege facts indicating what contemporary information known to the Defendants would have rendered the reserves false when made. The Complaint also does not allege particular facts indicating how or why the Company was underreserving for inventory. c. Production Difficulties Allegations. Defendants contend the Complaint's allegations that Ashworth was experiencing production difficulties misrepresent Ashworth's statements [*24] and are not pled with sufficient particularity. The Complaint asserts that "Ashworth management also said that the Company made its offshore products at more than one offshore plant --'double sourcing' --- thereby dismissing concerns that offshore production was risky in terms of quality and availability. (CAC P 12.) According to Plaintiffs, this statement was misleading because "Ashworth later admitted to production problems and inadequate controls in offshore factories leading to defective and substandard merchandise, and stated that it was going to implement double sourcing (essentially admitting that, contrary to prior representations, Ashworth lacked double sourcing during the Class Period." (CAC P 21.) Defendants argue that the only statement in the Complaint (other than generalized statements regarding off--shore sourcing saving money) is the paraphrased comment in the Wall Street Journal article "But Mr. Herrel dismisses such concerns, pointing out that the company is making some key products at more than one plant during the transition." (CAC P 44.) Defendants maintain that there was never any representation regarding double--sourcing all of Ashworth's overseas manufacturing. [*25] Further, Defendants contend that the later "admission" did not negate the article's statement. The Complaint alleges that on July 15, 1998, Ashworth announced that its revenues would experience a shortfall due to problems with "'the quality and timeliness of a few key styles of the Company's popular basics line received from offshore sources.'" (CAC P 62.) Defendants state that a review of the relevant part of full press release reads: Randall L. Herrel, Sr., President and Page 7 2000 U.S. Dist. LEXIS 15237, *25; Fed. Sec. L. Rep. (CCH) P91,243 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 8 of 10 Chief Executive Officer of Ashworth, Inc. (NASDAQ:ASHW), announced today that the quality and timeliness of a few key styles of the Company's popular basics line received from offshore sources in the third quarter of 1998, had fallen short of the Company's quality expectations and standards. In keeping with the Company's ongoing commitment to premium quality and customer satisfaction, the lower quality goods were not shipped to customers and the problem is being corrected. As a result of these production--related issues, the Company's sales in the third quarter will be affected by approximately $2.0 to $3.0 million but will still result in strong improvement over the corresponding quarter of fiscal 1997. [*26] Mr. Herrel further stated that, due to this problem, third quarter net income will equal or be slightly above last year and may also slightly impact net earnings in the fourth quarter of the current fiscal year. (Defs. Request for Judicial Notice ("RJN") Exh. A.) As pointed out by the Defendants, the full quote does not contradict the statement in the Wall Street Journal that Ashworth double--sourced "some" off--shore production. There is nothing that indicates a lack of double--sourcing for the "key styles." Accordingly, the Complaint's current allegations regarding production difficulties do not suffice to establish falsity. In addition, the Court finds insufficient Plaintiffs' allegations regarding Defendants' representations the Company was committed to quality. Plaintiffs maintain these statements were false because the offshore facilities were troubled with inadequate quality--control testing and insufficient supervision, causing Ashworth's off--shore merchandise to be riddled with defects such as mis--sized shirts and inferior quality products. The Complaint, however, does not provide any specific examples to support these assertions. Further, there are no allegations [*27] referencing internal documents stating that there were production problems. Plaintiffs only state that Defendants knew about this information because of their access to internal Ashworth data. These allegations are not sufficient to establish that Defendants' statements regarding the quality of the Company's products were false when made. 2. Scienter. Silicon Graphics requires a plaintiff to "plead, in great detail, facts that constitute strong circumstantial evidence of deliberate recklessness or conscious misconduct." In re Silicon Graphics, 183 F.3d at 974. Further, plaintiffs must provide great detail regarding all the facts forming the basis for their belief. Id. at 983. a. Defendants' Accounting Methods. As discussed above, the Court finds Plaintiffs' allegations of accounting fraud are insufficient to establish falsity. The Court further finds that these allegations are deficient in establishing scienter. In Worlds of Wonder Securities Litigation, the Ninth Circuit held that scienter "requires more than a misapplication of accounting principles." In re Worlds of Wonder Securities Litig., 35 F.3d 1407, 1426 (9th Cir. 1994); [*28] Hockey, 30 F. Supp. 2d at 1224. Plaintiffs "must prove that the accounting practices were so deficient that the audit amounted to no audit at all, or an egregious refusal to see the obvious, or to investigate the doubtful, or that the accounting judgments which were made were such that no reasonable accountant would have made the same decisions if confronted with the same facts." In re Worlds of Wonder, 35 F.3d at 1426. Further, even a deliberate violation of GAAP without more, does not amount to fraud, In re Worlds of Wonder, 35 F.3d at 1426. The absence of allegations specifying actual transactions where the challenged practices led to misstatements and omissions undermine Plaintiffs' scienter allegations. Plaintiffs must include at least basic details such as the approximate amount by which revenues and earnings were overstated, the products involved in the allegedly fraudulent transactions, the dates of the transactions, and as well as the identities any of the customers or Defendants' employees involved. Greebel, 194 F.3d at 205. In addition, the complaint does not identify how and when each Defendant became [*29] aware of the allegedly fraudulent transactions, nor each Defendant's involvement in the challenged practices. In so doing, Plaintiffs cannot make general allegations that Defendants had access to internal documents. Rather, to the extent Plaintiffs rely on internal reports, they must specify the contends of the reports, the names of those who prepared the reports, the names of those who reviewed the reports, and the names of those from which the information was obtained. See In re Silicon Graphics, 183 F.3d at 985 ("We would expect that a proper complaint which purports to rely on the existence of internal reports would contain at least some specifics from those reports as well as such facts as may indicate their reliability."). b. Insider Sales. Defendants also challenge Plaintiffs' claims of scienter based on the Individual Defendants' stock sales. "Allegations that a corporate insider either presented materially false information, or delayed disclosing materi- Page 8 2000 U.S. Dist. LEXIS 15237, *29; Fed. Sec. L. Rep. (CCH) P91,243 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 9 of 10 ally adverse information, in order to sell personally--held stock at a huge profit can supply the requisite 'motive' for a scienter allegation." In re Petsmart, Inc. Sec. Litig., 61 F. Supp. 2d 982, 999 (D. Az. 1999). [*30] "Thus, insider trading during the class period may support a strong inference of scienter." Id. at 999--1000; In re Silicon Graphics, 183 F.3d at 986. "But, 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, 61 F. Supp. 2d at 1000; In re Silicon Graphics, 183 F.3d at 986. 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 personal 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 at 986. Accordingly, where a corporate insider sells only a small fraction of his shares, the inference of scienter is weakened. In re Petsmart, 61 F. Supp. 2d at 1000. In addition, some courts have [*31] held that were an individual retains more shares than were sold, the resulting aggregate loss will defeat an inference of fraud. Id.; see In re Silicon Graphics, 183 F.3d at 986 (stating that "the proportion of shares actually sold by an insider to the volume of shares he could have sold is probative of whether the sale was unusual or suspicious"). Defendants argue that Plaintiffs have failed to show the Defendants' trading practices at issue were out of line with prior trades, and on this basis alone, the Complaint is inadequate to draw any reference from insider stock sales. Defendants further argue that a review of each of the Individual Defendants' stock sales are in line with prior trading or otherwise explainable. Herrel, who the Complaint focuses on, and the speaker in those instances where the Complaint identifies one, did not sell any stock during the class period, even though he held 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 class period. (CAC P 33.) Although the amount of shares he sold is significant, the Complaint's lack of specific allegations [*32] directly attributing fraudulent conduct or misrepresentations to Mr. Ashworth render the stock sales insufficient to support scienter. Mary Montiel sold 61,000 shares of Ashworth stock. (CAC P 33.) The Complaint alleges these sales constituted 100% of Ashworth stock Ms. Montiel owned, and 73% of her total beneficial ownership. Id. This amount is approximately 5% of the total stock sold by insider Defendants during the class period. This small percentage weighs against an inference of scienter. In re Silicon Graphics, 183 F.3d at 987. Further, the Complaint fails to allege facts that make these sales suspicious in light of the absence of any specific allegations directly attributing misrepresentations to Ms. Montiel or particularized facts indicating that Ms. Montiel had specific knowledge of the fraudulent manipulation of accounting practices that misrepresented the EPS. John Newman sold 48,000 shares of Ashworth stock, comprising around 4% of the alleged inappropriate sales. (CAC P 33.) Again, under Silicon Graphics, this small percentage undermines an inference of scienter. In re Silicon Graphics, 183 F.3d at 987. Gerald Montiel sold 452,000 [*33] shares during the class period. (CAC P 33.) The Court finds that Mr. Montiel's stock sales, alone, are insufficient to support a strong inference of scienter because the Complaint fails to make any specific allegations regarding misstatements by Mr. Montiel personally, and also lacks particularized facts showing that Mr. Montiel was aware of the Company's alleged fraudulent accounting practices. Plaintiffs contend that the scienter allegations of insider trading is bolstered by the fact that the Defendants can be inferred to have knowledge of the Company's key operations and factors affecting its key products. In support for this argument, Plaintiffs cite pre--Silicon Graphics cases - - 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, 959 F. Supp. 42, 51 (D. Mass 1997); and Cosmas v. Hassett, 886 F.2d 8, 10, 12--13 (2d Cir. 1989). The Court fails to see how these cases are persuasive in light of Silicon Graphics. Epstein, Powers, and Friedburg predate Silicon Graphics. Further, not only does [*34] Cosmas pre-date the PSLRA and Silicon Graphics, it is also from the Second Circuit. Silicon Graphics rejected the Second Circuit's standard for scienter, holding that a private securities plaintiff must plead "in great detail, facts that constitute strong circumstantial evidence of deliberately reckless or conscious misconduct." In re Silicon Graphics, 183 F.3d at 974, 979. n2 Because it relies on inapplicable law and cannot be reconciled with Silicon Graphics' standard for pleading scienter, Plaintiffs' argument that an inference of scienter should be drawn is unavailing. n2 For this reason, the Court is also not persuaded by Novak v. Kasaks, No. 98--9641, 216 F.3d 300, 2000 U.S. App. LEXIS 14349 (2d Cir. June 21, 2000). 2. Liability of Non--Speaking Defendants. Page 9 2000 U.S. Dist. LEXIS 15237, *34; Fed. Sec. L. Rep. (CCH) P91,243 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 10 of 10 Defendants contend that Plaintiffs cannot rely on the group pleading doctrine and because the Complaint fails to specify with particularity the conduct or knowledge of any individual defendant, and [*35] in particular Mr. and Mrs. Montiel and Mr. Ashworth, the Complaint is deficient. Plaintiffs respond that group pleading remains a valid theory of liability after the PSLRA, and that the non-speaking Individual Defendants are liable under that theory. The Court disagrees. Although other courts have held that the group pleading standard survives, this district has held that it likely does not. In Allison v. Brooktree, 999 F. Supp. 1342 (S.D. Cal. 1998), the Honorable Jeffrey T. Miller found that the "group pleading" doctrine did not survive the PSLRA. Allison, 999 F. Supp. at 1350-51. Judge Miller stated, "to permit a judicial presumption as to particularity simply cannot be reconciled with the statutory mandate that plaintiffs must plead specific facts as to each act or omission by the defendant." Id. at 1350. This Court concurs with Judge Miller's reasoning. Further, recognition of the group pleading doctrine would be at odds with Silicon Graphics' pleading requirements regarding scienter. n3 Plaintiffs' reliance on the group pleading doctrine is therefore misplaced. Accordingly, when amending the complaint, Plaintiffs must allege [*36] facts tying each of the alleged misstatements and omissions to each of the individual Defendants. n3 Although the group pleading doctrine does not apply to this case, the Court is mindful that there may be circumstances where it would be appropriate to attribute statements to a group of defendants, such as where a corporation's officers and directors are few in number and make corporate decisions on a group basis. B. Whether Plaintiffs' Claims are Actionable. Defendants also argue that the statements at issue in this case are not actionable on several grounds. First, Defendants argue that vague statements of optimism regrading the quality of Ashworth's products, its turnaround, or its prospects are not actionable because they are generic statements and "puffery." Defendants further argue that statements made in analyst reports are not actionable, nor are the Complaint's allegations regarding Defendants' financial reporting and sales. Because the Court finds that the Complaint does not meet the requisite [*37] pleading standards, it is premature to rule on whether the statements are actionable. C. Plaintiffs' 20(b) Claim. Rule 20(a) of the 1934 Securities and Exchange Act 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, however, a plaintiff must 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 being dismissed for failure to meet the requisite pleading requirements, Plaintiff's claim under 20(b) must also be dismissed. CONCLUSION Having considered the parties' briefs, the record, oral argument, applicable law, and good cause appearing, IT IS HEREBY ORDERED: 1. Defendants' motion to dismiss is GRANTED WITHOUT PREJUDICE. Plaintiffs shall file and serve an amended complaint within 60 days of the date this order is stamped "Filed." 2. The amended complaint shall not contain alleged misstatements that are inactionable on their face, such as vague [*38] and general statements of optimism, or accurate statements of historical fact. 3. The amended complaint shall comply with Federal Rule of Civil Procedure 8, and shall not group together the misrepresentations and omissions, and then list the reasons why they were false or misleading. Rather, Plaintiffs must concisely set forth each allegedly false or misleading statement or omission, and follow each statement or omission with the specific reasons why the statements were false when made or why the Defendants had a duty to disclose. In addition, the Plaintiffs shall specify which Defendants made the statements, and how and when each of the Defendants knew the "true facts" that should have been disclosed. 4. Plaintiffs are admonished that failure to comply with the requisite pleading standards may subject their complaint to dismissal with prejudice. IT IS SO ORDERED. Dated: 7/18/2000 M. JAMES LORENZ UNITED STATES DISTRICT JUDGE TAB 2 1 2 _1L.E D 06 JUN -2 PM 2 : 3 3 f `f !1 i_ nI 3I 4 5 6 i -11r: T r j DEPUT I 7 8 9 10 11 1N RE DURA PHARMACEUTICALS, Civil Ian . . 9cv0151-L(N-LS) INC. SECURITIES LITIGATION, ORDER GRANTING I N PART AND 12 1 DENYING IN PART MOTION TO 13 DISMISS THIRD CONSOLIDATED AMENDED COMPL AIN T 14 UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF CALIFORNI A This Document Relates to: All Actions [ Docket No . 119] 15 16 17 18 19 20 21 22 23 24 25 26 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 . 27 ' 28 EA RE D ON l a i s i j b 5 o)r 1 2 3 4 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 securi ties during the Class Period and held such securities 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 ri od ; 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 o f 5 6 7 8 9 10 I 12 13 14 15 16 17' marketing niche pharmaceutical drugs . Id. 1 . At that time, Dura typically purchased the rights 18 19 20 21 22 23 24 25 26 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 27 1 existing inhalers that depended on the user to successfully coordinate the use of the inhaler and 28 inhalation of the medication . Id. The Spires drug delivery system was a software-driven devic e 2 99uv0151 1 2 3 4 5 6 7 8 9 10 ll 12 13 14 15 16 17 18 19 20 21 22 23 24 25 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 Decembe r 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 199 7 26 I and continuing through the Class Period, Defendants began a "concerted campaign to falsel y 27 28 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 3 99ev015I 1 2 3 4 5 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- 6 j 28, 44 , 147, 171, 175-82 . 7 8 9 10 11 12 13 14 15 16 17 18 19 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 greatly diminished. As recently as one month ago, we reviewed our model with the Company line by line and were guided to higher Ceclor CD estimates . In our opinion, not too much could have changed between now and then, and we believ e that this revenue shortfall is not new news to Dura, but frankly, comes as a surprise to 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 , 20 I Dura admitted that, at least by December 1997, the wholesale channels had been clogged wit h 21 22 23 24 25 26 many months of excess Ceclcr CD inventory. Id. $ 49, 160 . After the Class Period ended, in April 1998, Dura placed an advertisement in Advance for 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 . 27 28 11 In September 23, 1998, Dura disclosed that it had submitted additional chemistry an d 4 99cvOt51 1 2 3 4 5 6 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 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 and because Dura had provided insuf fi cient 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 piros TM 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 un 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 th e 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 27 1 Consolidated Amended Complaint . This Court dismissed the Second Consolidated Amende d 281 5 99GVJIsL Complaint. In relevant part', this Court held that Plaintiffs had not adequately alleged los s 2 I causation as to the misrepresentations regarding Albuterol Spiros . 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 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 221 that courts must also look at scicnter allegations collectively . No. 84 Employer- Teamslee J1. 23 24 25 26 1 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 27 28 ` The Second Consolidated Amended Complaint alleges Defendants misrepresented the effectiveness of its sales force , the sales and success of its product Rondec, and the sales of Nasalide . The TAC does not rely on those alleged misrepresentations . 6 99cvo151 1 2 3 4 5 6 7 8 9 l0 11 12 13 14 15 16 17 18 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, th e 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 , 19 I and directed that Plaintiffs be given an opportunity to amend their complaint, inter alia, in a 20 21 22 23 24 25 26 27 28 manner that complies with the Supreme Court 's requirements for loss causation . APPLICABLE LAW REGARDING MOTIONS T O 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 7 99cv0151 1 2 3 4 5 6 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) . Section 10( b) of the Secu ri ties Exchange Act of 1934 makes it unlawful to use i n 7 ~ connection with the mails or facilities of interstate commerce any " manipulative or deceptiv e 8 9 1D 11 12 13 14 15 16 17 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 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 materi al fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, o r (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 .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. 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)). 111 8 99cw415I 18 19 20 21 22 23 24 25 26 27 28 , 126 S .Ct. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 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 `i ncorporate [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. 9 99CYO15i 28 I 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, 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 I Robertson Stephens & Co . ("Robertson Stephens"), and William Blair & Co . ("William Blair" ) 27 28 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 1D 99cVQ]51 1 2 3 4 5 6 7 8 9 1Q 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 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 o f 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 , 28 I and reiterated that the Company was on track to file the Albuterol Spires NDA in the second hal f 11 99ev415I 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 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 contri bute signifi cantly to Dura ' s long-term revenue and ea rnings 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 12 99CV0151 1 2 3 4 5 6 7 8 9 l0 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 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 13 99C%.0151 1 2 3 4 S 6 7 8 9 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 10 ~ problems that Dura retained an outside testing facility , Wyle Labs, to conduct highly accelerate d 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 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 14 99cvOISI 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 is 19 20 21 22 23 24 25 26 27 28 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 concern s 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 Allegation s 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 Causatio n 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 causation . 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 15 99c40151 1 2 3 4 5 6 7 8 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 9 10 12 13 14 15 16 17 18 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 191 associated with the 47% price decline that occurred between February 24, 1998, and February 20 21 22 23 24 25 26 27 28 The TAC also alleges that the February 24, 1998 announcement somehow caused losses associated with the misleading information about Albuterol Spiros' approvability . Defendants contend this allegation does not meet Dura's standard of proximate cause because nowhere in the February 24, 1998 announcement is there any indication of Spiros' mechanical or reliability problems . Plaintiffs do not attempt to defend this allegation in their opposition to the motion to dismiss . 16 9 JevOI5I 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, th e 1 2 3 4 5 6 7 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 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 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 occur ri ng during the class pe ri od, not months or years beyond its termination . In support, 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. Litig., No. 03CV1721, 2003 U .S . Dist. LEXIS 25022, at *23 (S .D . Cal . 17 99cv0151 1 2 3 4 5 6 7 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 ri ties 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 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 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 18 99cvl151 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 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 Sciente r 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 23, position occupied by the source would possess the information alleged . 7" Nursing Horne 24i Pension Fund, Local 144 v. Oracle Corp ., 380 F.3d 1226, 1233 (9th Cir . 2004) (quoting Novak 25 26 27 28 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 19 99cv0151 1 I similar indicia ."' Dacu, 41 1 F.3d at 1015 (quoting In re C'abletron Sys., Inc ., 311 F . Id 11, 292 1 30 (1st Cir . 2002)). 3 4 5 6 7 As an initial matter, the TAC does not identify any confidential witnesses as the source o f Plaintiffs' information regarding Dura 's problems with Albuterol Spiros and the purported fraudulent effort s 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 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 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 durin g 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 20 99cv0151 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 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 o f 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 , za p however, will allow Plaintiffs leave to amend the complaint so they can describe the sources o f 21 99cv0151 1 2 3 4 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 C D 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 22 99cv0151 5' 6 7 8 9 10 11 12 13 M 15 16 17 18 19 20 21 22 23 24 25 26 27 28 1 2 3 4 5 6 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 8 9 10 Ii 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 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 , statin g 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 , 23 99 cv4151 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 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 th e 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 wer e 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 Sciente r Defendants maintain Plaintiff`s 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 24 99cvO151 finds the TAC adequately alleges Defendants' knowledge of Ceclor CD's decreasing sales and 2 3 their efforts to inflate sales and earnings through "fire sales" and "load-ins ." When analyzing the Second Consolidated Amended Complaint, the Ninth Circuit held 4 I that the existence of reports showing Ceclor CD sales "were below internal projections an d 5 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 ." 7 S 9 10 11 12 13 14 15 16 17 18 1 920 21 22 23 24 25 26 27 28 25 99Cv0151 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 a rti fi cially 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 continued EPS growth .' Id. Plaintiffs do not allege how they obtained the information from th e 2 3 4 5 6 7 monthly reports . However, other allegations of the TAC corroborate Plaintiffs' theory tha t 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 11 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 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 25 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 in sales of its res piratory pharmaceuticals . In support for this statement, Defendants rel y on Dura's 1996 Annual Report filed on April 16, 1997, and request take judicial notice of that document under Federal Rule of Evidence 201 . Plaintiffs oppose the request. The Court agrees with Plaintiffs that it is improper to take judicial notice of a document for the pu-rpose of proving the truth 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 what statements 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 Annual Report as evidence the Defendants did not commit a securities violation . Plaintiffs do not oppose Defendants' request the Court take judicial notice of other SEC filings . Insofar as the Cou rt has relied on those documents, Defendants ' request is GRANTED . 26 99CY015I 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 The terms that were typically offered were a 6% or 12% discount on the price dependin g 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 thos e 27 99cva151 1 2 3 4 5 6 7 8 9 10 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 12 13 14 15 l6 17 18 19 20 21 22 23 24 25 26 27 28 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 28 9 CVOs i 1 2 3 4 5 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 6 I falsity and scienter regarding Dura 's Ceclor CD sales . 7 2 . Which Defendants Are Liabl e As discussed above , the TAC adequately alleges Defendants Newman , Gamer, and Spath4 9 10 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 con flicts 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 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 " Messrs. Weiherer and Strathrneyer also participated in the alleged scheme to overload wholesalers with Ceclor CD ; however, they are not Defendants in this action . 29 99cv4151 1 2 3 4 5 6 7 8 9 10 regarding Ceclor CD as to Defendants Prettyman , Woodbury, Brown , or Cook . b. Stock Sale s 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 12 13 14 15 16 17 1$ 19 20 21 22 23 24 25 26 27 28 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 follow30 99CVO151 1 2 3 4 5 6 7 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 9 10 11 12 13 14 15 16 17 1S 19 20 21 22 23 24 25 26 27 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 offi cer 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 31 99c'O151 28 1 2 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 ' 3 ~ positions in the Company insufficient to impute soienter . 4 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 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 2 I above, Plaintiffs have adequately pleaded the Company's sales of Ceclor CD were artificiall y 32 Y9cvOI5I 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 1$ 19 20 21 22 23 24 25 26 27 28 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 . 78u5(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 33 99cv0151 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 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 o f 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, 320 F.3d at 936 n . 14. 34 99CVOLS1 protection by the safe harbor provision or bespeaks caution doctrine . Cf. id, at 937 n . 15 (statin g 2 1 I that because there was a strong inference of actual knowledge, the statements were not protecte d 3 4 5 6 7 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. 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 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 35 99cv4151 1 securities analysts with the intent the analysts would relay the information to the market); 2 ~ Stratosphere, 1 F. Supp. 2d at 1105 (finding complaint deficient because it did not allege the 3 I time, place , and content of defendants' statements to the analysts) . 4 5 6 7 8 9 10 11 12 13 14 15 16 17 1s 19 20 21 22 23 24 25 26 27 28 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 36 94cvot5l deficient and therefore DISMISSED WITH LEAVE TO AMEND , 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 ALL PARTIESICOUNSEL 17 18 19 20 21 22 23 24 25 261 27 28 37 99cvOLS 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 M. 3 Ulf T STAT S DIS'I CT J DG E S LO 1 I COPY TO : HON. NITA L . STORMES UNITED STATES MAGISTRATE JUDGE Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 1 of 12 TAB 3 Page 1 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 2 of 12 7 of 26 DOCUMENTS IN RE GAMING LOTTERY SECURITIES LITIGATION; THIS DOCUMENT RELATES 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 NEW YORK 2001 U.S. Dist. LEXIS 13513 September 4, 2001, Decided September 5, 2001, Filed DISPOSITION: [*1] GalaxiWorld's motion pursuant to 28 U,S.C. 455(a) to request that Court disqualify itself from further proceedings denied. The class of plaintiffs ("Plaintiffs") opposes the motion. For the following reasons, the motion is denied. n1 Gaming Lottery's name was Laser Friendly Corporation until July 28, 1995. In April 1996, Gaming Lottery announced it would divest itself of its subsidiaries engaged in the manufacture of paper related gaming products and reincorporate in Bermuda. In January 1997, Gaming Lottery reincorporated in the British Virgin Islands and divested itself of its three subsidiaries. In September 1998, the corporation renamed itself GLC Limited and relocated its corporate offices to Gibraltar. In October 1998, GalaxiWorld Limited, a wholly owned subsidiary of GLC Limited, launched its internet casino gambling website. On July 1, 1999, GLC Limited announced that it had changed its name to GalaxiWorld.com Limited. [*2] For GAMING LOTTERY CORPORATION, defendant: Sheldon Eisenberger, The Law Offices of Sheldon Eisenberger, 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 Lottery Corporation n1) moves pursuant to 28 U.S.C. 455(a) for the Court to disqualify itself from further proceedings. BACKGROUND This class action, filed in 1996, is brought pursuant to Section 10(b) and Section 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. 78j(b) and 78t(a), and Rule 10b- of the Rules of the Securities and Exchange -5 Commission, 17 C.F.R. 240.10b--5, on behalf of purchasers of securities in Gaming Lottery, a Canadian corporation, during the period February 1, 1995, to May 24, 1996. (See Consolidated Amended Class Action Complaint, dated Jan. 13, 1997 ("Compl.") PP 35--36.) Defendants are alleged to have issued misleading public statements and financial reports between February 1, 1995, and May 24, 1996, causing the stock of Gaming Lottery to be overvalued. (Id.) As of January 10, 2000, fact discovery was to close on January 21, 2000, expert discovery was to close on February 21, 2000, a pre-trial COUNSEL: For DAVID PECARSKY, OVERALL SUPPLY, INCORPORATED, plaintiffs: Steven G. Schulman, Milberg, Weiss, Bershad, Hynes & Lerach, LLP, New York, NY. For JACK BANKS, LARRY WELTMAN, GAMING LOTTERY CORPORATION, defendants: Edward Brodsky, Proskauer Rose LLP, NY, NY. For JACK BANKS, LARRY WELTMAN, defendants: Sheldon Eisenberger, New York, NY. LARRY WELTMAN, defendant, Pro se, Thornhill, Ontario, CA. Page 2 2001 U.S. Dist. LEXIS 13513, *2 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 3 of 12 order was due on March 15, 2000, and trial was scheduled for April 4, 2000. A. Proskauer's Motion to Withdraw and Entry of Default Judgment Against GalaxiWorld in Favor of Plaintiffs By order to show cause dated January 10, 2000, Proskauer Rose LLP ("Proskauer"), counsel for defendants GalaxiWorld, Jack Banks [*3] and Larry Weltman, moved pursuant to S. & E.D.N.Y Civil Rule 1.4 n2 to withdraw as attorneys of record for defendants and for payment of fees and expenses. n3 Proskauer's motion to withdraw was based on GalaxiWorld's actions since the fall of 1999, when the proceeds of GalaxiWorld's insurance policy became exhausted and were no longer available to pay litigation fees and expenses. On November 15, 1999, GalaxiWorld had announced that it was to be taken private by Ostel Management Inc. ("Ostel"), a then--newly formed Nevis corporation owned by a Bermuda corporation whose principal office is in Monaco. (Affirmation of Edward Brodsky ("Brodsky Aff.") dated Jan. 10, 2000 P 8.) Ostel had agreed to purchase the controlling block of the common shares of GalaxiWorld and to extend a tender offer for the remainder. (Id.) GalaxiWorld had ceased to do business in the United States and Canada. (Declaration of Sheldon Eisenberger ("Eisenberger Decl.") dated June 21, 2001, Ex. C at 16.) The going--private transaction was scheduled to close on January 21, 2000. (Brodsky Aff. P 8.) By letter dated November 23, 1999, Banks, the President of GalaxiWorld, notified Proskauer to do no more [*4] work on behalf of GalaxiWorld without prior approval after December 15, 1999. ( Id. P 9.) By letter dated December 22, 1999, Banks informed Proskauer that defendant Weltman, who had been the Chief Financial Officer of GalaxiWorld, was no longer an officer of GalaxiWorld. ( Id. P 10.) On December 29, 1999, Banks advised Proskauer that it had a conflict of interest in representing both Mr. Weltman and GalaxiWorld, but Banks could not explain the conflict, saying that the December 29, 1999, letter had been written at the instruction of Ostel. (Id.) On January 3, 2000, Banks informed Proskauer that he had been instructed not to pay its outstanding invoices that had been previously approved for payment by Mr. Weltman, and that he would not be in further communication with Ostel until January 22, 2000, after the closing. ( Id. P 12.) Proskauer's attempts to discuss the cease work and non--payment notices with Ostel Management were rebuffed by Banks and by a Texas law firm representing Ostel. ( Id. P 13.) Based on this conduct, Proskauer became fearful that it would not be paid for its services, since after January 21, 2000, GalaxiWorld [*5] would be "owned by a private foreign company with no accountability," and GalaxiWorld's funds disbursed elsewhere, and Proskauer therefore feared that it would have lost any meaningful chance to recover the funds owed to it. (Id. P 2, 17.) n2 S. & E.D.N.Y. Civil Rule 1.4 provides: An attorney who has appeared as attorney of record for a party may be relieved or displaced only by order of the court and may not withdraw from a case without leave of the court granted by order. Such an order may be granted only upon a showing by affidavit or otherwise of satisfactory reasons for withdrawal or displacement and the posture of the case, including its position, if any, on the calendar. S. & E.D.N.Y. Civ. R. 1.4 (2001). n3 Proskauer had given prior notice of the motion to defendant Banks, President of GalaxiWorld, on January 7, 2000. By letter dated January 7, 2000, Proskauer notified Banks that it was obliged to move to withdraw as counsel and for payment of outstanding fees. (Id. Ex. I.) On January 10, 2000, Proskauer [*6] presented the Court with an order to show cause returnable on January 13, 2000, requesting such relief. The Court signed the order to show cause and, as requested, authorized service on Banks and Weltman by facsimile on January 10, 2000. In its memorandum in support of its application, Proskauer stated that "GalaxiWorld has had ample time to retain other counsel if that were what it wished to do, and Proskauer has in fact given notice that it cannot represent defendants under these circumstances and is obliged to withdraw as counsel." (Mem. of Law in Support of Proskauer's Motion dated Jan. 10, 2000, at 7.) On January 13, 2000, a hearing was held at which neither Banks, nor Weltman, nor GalaxiWorld through any representative 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 will never find [our] assets and we are not worried about it." (Transcript of Jan. 13, 2000, hearing at 25 (unsealed July 19, 2000).) Accordingly, Proskauer requested that the judgment require payment by January 18, 2000, to allow 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 giving Proskauer a priority to GalaxiWorld's assets and asked for a default judgment on their case, in view of the defendants' failure to appear. Plaintiffs' counsel also requested that the Court order GalaxiWorld to reimburse Plaintiffs's counsel $1130 advanced to Mr. Weltman to defray expenses he was expected to incur in coming to New York Page 3 2001 U.S. Dist. LEXIS 13513, *7 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 4 of 12 for his deposition. Proskauer's motion to withdraw as counsel and for payment of fees was granted on default and GalaxiWorld was ordered to: (1) pay Proskauer's fees and expenses in the amount of $762,611.34 on or before January 18, 2000; (2) reimburse Plaintiffs' counsel the $1130 advanced to Mr. Weltman; and the Court entered a restraining order against any disposition of assets of GalaxiWorld until such payments were made and new counsel entered an appearance. The Court's Order of January 13, 2000, also explicitly warned GalaxiWorld that if it did not file an appearance On or before January 18, 2000, a default judgment in favor of Plaintiffs might be entered against GalaxiWorld. In a letter dated January 19, 2000, defendant Banks stated that GalaxiWorld [*8] had not been given adequate notice of Proskauer's order to show cause and alleged that Proskauer had failed to represent GalaxiWorld properly in connection with settlement discussions. By Order dated January 19, 2000, upon the request from Banks, the judgment in favor of Proskauer was vacated and held in abeyance until January 25, 2000, to allow GalaxiWorld to appear and show cause why the judgment should not be entered. By memorandum endorsement dated January 20, 2000, upon a request from Proskauer, defendant Banks was ordered to appear in person at the January 25, 2000, hearing, and defendant Weltman was ordered to appear by telephone, to give testimony as material fact witnesses with respect to GalaxiWorld's allegations of misrepresentation by Proskauer in settlement discussions. n4 On January 25, 2000, the hearing was held at which neither Banks nor GalaxiWorld appeared, although defendant Weltman appeared by telephone. At the hearing on January 25, 2000, the Court took into consideration all the materials submitted by the parties and all the testimony given and arguments presented including testimony that GalaxiWorld had not cooperated with Proskauer in settlement discussions, [*9] and found that GalaxiWorld was in default, that $569,536.48 in outstanding fees and expenses had been incurred on Defendants' behalf by and were due to Proskauer in this litigation, that Plaintiffs' counsel had received reimbursement for the advance paid to defendant Weltman to cover his cost of attending his deposition in New York, and that the Court continued the restraining order to ensure payment of any judgments entered. In an Order and Judgment dated January 26, 2000: (1) a default judgment was entered against GalaxiWorld in favor of Plaintiffs: (2) an inquest was ordered to be held on February 9, 2000, regarding the amount of damages to be awarded which were claimed by Plaintiffs to be $22,048,844; (3) GalaxiWorld was ordered to pay Proskauer fees and expenses for services rendered in In re 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 requested an adjournment. On February 16, 2000, judgment was entered against GalaxiWorld in favor of Plaintiffs in the amount of $22,084,844 as of May 24, 1996. On March 6, 2000, the [*10] January 27, 2000, judgment was amended only as to the fees owed Proskauer, which were increased to $654,412.58. By Order dated April 24, 2000, the Court found that Proskauer's claim giving rise to the March 6, 2000, Amended Judgment was plenary and severable. On May 3, 2000, a Second Amended Judgment was entered pursuant to Federal Rule of Civil Procedure ("Fed. R. Civ. P.") 54(b) in favor of Proskauer against GalaxiWorld in the amount of $654,412.58. On May 11, 2000, an Amended Order and Judgment was issued, amending the judgment of February 16, 2000, and entering judgment pursuant to Fed. R. Civ. P. 54(b) with damages in the amount of $22,084,844 as of May 24, 1996, in favor of Plaintiffs against GalaxiWorld and continuing the restraining order on GalaxiWorld. n4 Mr. Weltman was allowed to appear by telephone because his wife was expecting to deliver their child at that time. On March 14, 2000, GalaxiWorld and Jack Banks, by Sheldon Eisenberger, Esq., filed Notices of Appeal of the judgments dated January 26, 2000, and [*11] March 6, 2000, and GalaxiWorld (but not Banks) filed a Notice of Appeal of the of the judgment dated February 16, 2000. n5 On May 11, 2000, GalaxiWorld and Banks filed a Notice of Appeal of the Second Amended Judgment dated May 3, 2000, and of the Order dated April 24, 2000. On May 19, 2000, GalaxiWorld filed a Notice of Appeal of the Amended Order and Judgment dated May 11, 2000. n5 On March 22, 2000, Mr. Eisenberger filed a notice of appearance on behalf of GalaxiWorld. On January 10, 2001, the Second Circuit Court of Appeals affirmed the judgment in favor of Proskauer. See Silva 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 Second Circuit Court of Appeals vacated the default judgment in favor of Plaintiffs against GalaxiWorld and remanded the case to this Court for further proceedings. See Pecarsky v. Galaxiworld.com Ltd., 249 F.3d 167 (2d Cir. 2001). B. Plaintiffs' Motion for Summary Judgment Against the Individual Defendants [*12] On February 24, 2000, Mr. Eisenberger filed a notice of appearance on behalf of defendants Banks and Page 4 2001 U.S. Dist. LEXIS 13513, *12 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 5 of 12 Weltman. On February 25, 2000, at a pre--trial conference, the Court ordered that: (1) except with respect to the deposition of Mr. Seale (a Fifth Amendment witness) fact discovery was closed; (2) final expert witness reports would be exchanged on March 15, 2000; (3) a pre--trial order would be submitted to the Court by April 3, 2000; and (4) a trial date was set for May 1, 2000. On April 14, 2000, Plaintiffs moved for summary judgment on liability and damages against defendants Jack Banks and Larry Weltman as controlling officers of GalaxiWorld. By Opinion and Order dated February 27, 2001, summary judgment was granted to Plaintiffs against individual defendants Banks and Weltman for the period of May 3, 1995, through May 24, 1996, with damages of $10 million, subject to upward or downward adjustment upon submission of proofs of claim by the class of plaintiffs. On March 7, 2001, judgment was entered against those defendants. On March 13, 2001, Banks and Weltman filed a Notice of Appeal. That appeal is now pending. C. The Enforcement [*13] Proceedings Orders On August 18, 2000, the Court granted Proskauer's and Plaintiffs' motions to compel GalaxiWorld to produce documents relating to the location of its assets and to appear for a deposition. n6 On October 18, 2000, the Court ordered defendant Banks and representatives of GalaxiWorld to appear at a hearing scheduled for November 2, 2000, at which neither Banks nor GalaxiWorld appeared or produced evidence. On November 6, 2000, the Court ordered that GalaxiWorld be held in contempt of court and fined $5,000 for each day from the date of entry of that order for failure to comply with the Court's Order of August 18, 2000, and ordered Banks and GalaxiWorld to appear and to show cause on November 14, 2000, why they should not be held in contempt for their failure to appear and give testimony and evidence in Plaintiffs' judgment enforcement proceedings. On November 14, 2000, defendants Banks, Weltman and GalaxiWorld moved by order to show cause for Plaintiffs to show why at a hearing to be held November 16, 2000, an order should not be entered: (1) staying the Order of Contempt; (2) reconsidering the Court's October 18, 2000, and November 6, 2000, Orders; (3) granting [*14] defendants a protective order requiring all depositions of defendants to be conducted in the place they reside; and (4) entering a Martindell protective order in the form previously submitted to the Court. On November 14, 2000, the hearing was reset to November 21, 2000. On November 21, 2000, neither GalaxiWorld nor Banks appeared at the hearing on the motion, but the Court gave Banks until November 27, 2000, to appear. On November 27, 2000, Banks did not appear and the Court held him in contempt and fined him $1,000 per day until he complies with the Court's October 18, 2000, Order. In an order entered December 5, 2000, the Court denied the motion of GalaxiWorld, Banks and Weltman, for the reasons stated at the November 21, 2000 hearing. n6 Proskauer had also initiated unsuccessful collection efforts against G.Cash Limited, which acted as a cashier for GalaxiWorld's ongoing internet gambling business. See In re Gaming Lottery Sec. Litig., 2000 U.S. Dist. LEXIS 17537, No. 96 Civ. 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 Court following the Second Circuit's decision vacating the default judgment against GalaxiWorld in favor of Plaintiffs, GalaxiWorld moved upon the declaration of Mr. Eisenberger, the exhibits attached thereto, the accompanying memorandum of law, and all prior proceedings and pleadings had herein to request that the Court disqualify itself from further proceedings pursuant to 28 U.S.C. 455(a). n7 GalaxiWorld contends that the Court has been predisposed against it in its rulings. (Def.'s Mem. at 2-8.) GalaxiWorld further contends that the Court's comments during certain oral arguments on motions highlight the appearance of bias on the part of the Court and that "ever since the withdrawal of Proskauer as counsel for defendants, the Court has exhibited strong negative bias towards defendants." (Id. at 8-12.) GalaxiWorld argues that "defendants cannot get a fair trial before this Court," and that its motion should be granted "because the Court's impartiality [sic] might reasonably be questioned." (Id. at 11.) n7 The memorandum in support of the motion states that it is "submitted on behalf of defendants GalaxiWorld.com Limited ("GLC"), Jack Banks and Larry Weltman in support of their motion that The Honorable Robert P. Patterson recuse himself from this case pursuant to 28 U.S.C. 455(a)." (Def.'s Mem. at 1.) Defendant GalaxiWorld's reply memorandum similarly states that it is submitted also on behalf of Banks and Weltman. (See Def.'s Reply Mem. at 1.) However, the Notice of Motion was filed on behalf of GalaxiWorld only. (See Notice of Motion dated June 21, 2001.) Plaintiffs correctly note that since summary judgment has been entered against defendants Banks and 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, although the briefs state that they are submitted on behalf of Page 5 2001 U.S. Dist. LEXIS 13513, *15 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 6 of 12 Banks and Weltman, the motion was brought by and therefore will be decided on behalf of GalaxiWorld only. [*16] On July 17, 2001, Plaintiffs opposed the motion, arguing that: (1) Defendant's motion is procedurally defective; and (2) adverse judicial rulings are not a proper ground for a recusal motion. n8 On July 31, 2001, Defendant submitted reply papers in further support of the motion. n8 In support of their opposition to GalaxiWorld's motion for disqualification, Plaintiffs submit information that was not before the Court at the time the rulings and remarks upon which GalaxiWorld bases its motion were made. That information is not relied upon in this Opinion and Order. DISCUSSION GalaxiWorld moves to request that the Court disqualify itself from further proceedings pursuant to 28 U.S.C. 455(a). The statute provides that: "Any justice, judge, or magistrate of the United States shall disqualify himself in any proceeding in which his impartiality might reasonably be questioned." 28 U.S.C. 455(a) (2001). A. Procedural Objections Plaintiffs argue that GalaxiWorld's [*17] motion is procedurally defective because: (1) the motion fails to satisfy the strict requirements of 28 U.S.C. 144; (2) it is untimely; (3) GalaxiWorld has not submitted material allegations stated with particularity as required by 144; and (4) the Court has no personal bias of an extrajudicial origin. 1. The procedural requirements of 28 U.S.C. 455(a) Two of Plaintiffs' procedural objections erroneously rely on the argument that a motion filed pursuant to 28 U.S.C. 455(a) must satisfy the strict requirements of 28 U.S.C. 144. n9 Although Plaintiffs contend that: (1) GalaxiWorld's motion does not satisfy the requirements of 144; and (2) GalaxiWorld has not submitted material 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 that 28 U.S.C. 455(a) is "wholly silent as to procedure." n10 United States 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 to obtain 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 are applicable to disqualification under 455(a)." Roberts v. Bailar, 625 F.2d 125, 128 & n.8 (6th Cir. 1980). Since there 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 are denied. n9 28 U.S.C. 144 provides: Whenever a party to any proceeding in a district court makes and files a timely and sufficient affidavit that the judge before whom the matter is pending has a personal bias or prejudice either against him or in favor of any adverse party, such judge shall proceed no further therein, but another judge shall be assigned to hear such proceeding. The affidavit shall state the facts and the reasons for the belief that bias or prejudice exists, and shall be filed not less than ten days before the beginning of the term at which the proceeding is to be heard, or good cause shall be shown for failure to file it within such time. A party may file only one such affidavit in any case. It shall be accompanied by a certificate of counsel of record stating that it is made in good faith. 28 U.S.C. 144 (2001). [*19] n10 Somewhat more recently, the Second Circuit stated that "we have not decided whether the filing of an affidavit of bias is required as a procedural prerequisite for 455." Apple v. Jewish Hosp. and Med. Ctr., 829 F.2d 326, 333 (2d Cir. 1987). "But when proffered, an affidavit is scrutinized for sufficiency." Id. Here, GalaxiWorld has submitted a declaration by counsel in support of its motion. 2. Untimeliness Second, Plaintiffs contend that the motion is untimely. Courts have found a timeliness requirement contained in 28 U.S.C. 455(a). "Although 455 does not contain such a requirement, timeliness has been read into this Page 6 2001 U.S. Dist. LEXIS 13513, *19 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 7 of 12 section . . . ." Apple v. Jewish Hosp. and Med. Ctr., 829 F.2d 326, 333 (2d Cir. 1987). In general, one seeking disqualification must do so "at the earliest possible moment after obtaining knowledge of facts demonstrating the basis for such a claim" of disqualification. Id.; see also Gil Enters., Inc. v. Delvy, 79 F.3d 241, 247 (2d Cir. 1996). "Untimeliness . . . is . . . a failure [*20] to seek recusal when it should first have been sought, that is, as soon as the facts on which it is premised are known to the parties." United States v. Bayless, 201 F.3d 116, 127 (2d Cir. 2000). "Untimeliness in making a motion for recusal can sometimes constitute the basis for finding an implied waiver." Id. The Second Circuit has written that, in the context of on-going litigation, it is important to present recusal applications promptly for at least two reasons. First, a prompt application affords the district judge an opportunity to assess the merits of the application before taking any further steps that may be inappropriate for the judge to take. Second, a prompt application avoids the risk that a party is holding back a recusal application as a fall--back position in the event of adverse 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 application in that case since the case was post--judgment and no action had occurred since 1970). In the case at hand, GalaxiWorld contends that the judgments against GalaxiWorld entered in January 2000 and the [*21] Court's orders against GalaxiWorld in November 2000, and statements made by the Court on January 13, 2000, January 25, 2000, February 9, 2000, February 29, 2000, and November 21, 2000, "manifest the appearance of bias" against GalaxiWorld. (Def.'s Mem. at 1.) Although those rulings and statements were all made in 2000, Defendant GalaxiWorld did not move for disqualification until June 21, 2001, which is seven months after the last statement was made on November 21, 2000, and more than a year and half after the first incidents allegedly demonstrating the appearance of bias. Given the time that has elapsed, it is difficult to see how this motion for disqualification has been made "at the earliest possible moment after obtaining knowledge of facts demonstrating the basis for such a claim." Apple, 829 F.2d at 333. GalaxiWorld argues that the present stage of the proceedings is the appropriate time to address the motion for disqualification because the case has been relatively dormant since the Second Circuit's opinion reversing entry of the default judgment against GalaxiWorld, which was rendered on May 10, 2001. n11 Although the motion for disqualification was not filed [*22] "at the earliest possible moment," since expert discovery is not yet complete, motions for summary judgment may yet be filed and trial is to be scheduled, the motion will not be denied as untimely but will be decided on its merits to ensure that confidence in the integrity of the Southern District is not tarnished. See Liljeberg v. Health Serv. Acquisition Corp., 486 U.S. 847, 860, 100 L. Ed. 2d 855, 108 S. Ct. 2194 (1988) (noting that the purpose of 455(a) is "to promote public confidence in the integrity of the judicial process"). n11 It could be argued that GalaxiWorld was not properly before this Court from the date it filed its Notice of Appeal, March 14, 2000, until the Second Circuit's decision on May 10, 2001. In support of its motion, however, GalaxiWorld relies on rulings and statements that were made in November 2000 during the pendency of its appeal, when GalaxiWorld was before this Court with respect to Proskauer's and Plaintiffs' attempts to enforce their respective judgments against it. [*23] 3. The extrajudicial source doctrine Third, Plaintiffs argue that GalaxiWorld's motion should be denied because the Court had no personal bias of an extrajudicial origin. Although the "extrajudicial source doctrine" applies to 455(a), "the fact that an opinion held by a judge derives from a source outside judicial proceedings is not a necessary condition for 'bias or prejudice' recusal . . . . Nor is it a sufficient condition" 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 extrajudicial source necessarily establishes bias, nor [does] the absence of an extrajudicial source necessarily preclude[] bias . . . ." Id. Defendant GalaxiWorld does not rely on or allege an extrajudicial source for the Court's alleged bias or prejudice. Since the lack of an extrajudicial source does 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 the underlying [*24] facts [to] entertain significant doubt that justice would be done absent recusal.'" In re Aguinda, 241 F.3d 194, 201 (2d Cir. 2001) (quoting United States v. Lovaglia, 954 F.2d 811, 815 (2d Cir. 1992)). "Thus, the test to be applied is an objective one which assumes that a reasonable person knows and understands all the Page 7 2001 U.S. Dist. LEXIS 13513, *24 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 8 of 12 relevant facts." In re Drexel Burnham Lambert Inc., 861 F.2d 1307, 1313 (2d Cir. 1988) (emphasis in original). "Quite simply and quite universally, recusal is required [under 455(a)] whenever 'impartiality might reasonably be questioned.'" Liteky, 510 U.S. at 548. The trial judge him--or herself must decide a motion filed pursuant to 28 U.S.C. 455(a). "Discretion is confided in the district judge in the first instance to determine whether to disqualify himself." In re Drexel Burnham Lambert Inc., 861 F.2d at 1312. "In deciding whether to recuse himself, the trial judge must carefully weigh the policy of promoting public confidence in the judiciary against the possibility that those questioning his impartiality might be seeking to avoid the adverse [*25] consequences of his presiding over their case." Id. "A judge is as much obliged not to recuse himself when it is not called for as he is obliged to when it is." Id. 1. The Court's Rulings GalaxiWorld argues that a reasonable person would conclude that the Court's partiality is questionable based on the Court's rulings, but adverse rulings per se do not amount to bias. See In re Int'l Bus. Mach. Corp., 618 F.2d 923, 929 (2d Cir. 1980) (noting that "we cannot agree that adverse rulings by a judge can per se create the appearance of bias under section 455(a)."). Rather, as the Supreme Court has stated, judicial rulings "can only in the rarest circumstances evidence the degree of favoritism or antagonism required . . . when no extrajudicial source is involved. Almost invariably, they are proper grounds for appeal, not for recusal." Liteky, 510 U.S. at 555. GalaxiWorld acknowledges that the Supreme Court has held that "judicial rulings alone almost never constitute a valid basis for a bias or partiality motion," but argues that the Court's rulings fall into the narrow exception noted by the Supreme Court because they allegedly "display [*26] a deep--seated favoritism or antagonism that would make fair judgment impossible." Id. In support of this argument, GalaxiWorld cites: (1) the Court's granting Proskauer's motion to withdraw as counsel and entry of judgment against GalaxiWorld in favor of Proskauer for unpaid fees, and the related decisions of the Court with respect to Proskauer's motion; (2) entry of a default judgment against GalaxiWorld with judgment of damages in the amount of $22,048,844 in favor of Plaintiffs against GalaxiWorld and the related decisions of the Court with respect to entry of the default judgment; and (3) the Court's granting on November 9, 2000, Plaintiffs' motion for contempt for GalaxiWorld's failure to comply with the Court's Order of August 18, 2000, which ordered GalaxiWorld to produce to Plaintiffs certain corporate documents that Plaintiffs had requested, and the related decisions of the Court with respect to the motion for con- tempt. First, with respect to the Proskauer's motion to withdraw as counsel and the entry of judgment against GalaxiWorld on behalf of Proskauer for unpaid fees, GalaxiWorld does not explain, nor can the Court discern, how granting Proskauer's motion for an [*27] order permitting Proskauer to withdraw as counsel for the defendants and ordering payment of outstanding fees, displays "deep-seated favoritism." That decision was upheld by the Second Circuit Court of Appeals. See Silva 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). Additionally, in granting Proskauer's motion, the Court explained its reasons at the hearing on January 13, 2000, stating, "I listened to Mr. Brodsky [of Proskauer] and I think that his client is not cooperating with him and under those circumstances I have no excuse for not granting his application to withdraw as counsel and to fix his fees." n12 (Eisenberger Decl. Ex. B at 31.) At the time Proskauer made its motion to withdraw as counsel and for payment of its fees, GalaxiWorld was about to be taken over by an offshore private company with whom Proskauer was unable to communicate and there remained no insurance to pay Proskauer's fees. The ruling presented a basis for appeal, which GalaxiWorld unsuccessfully pursued, but it does not display deep--seated favoritism or antagonism toward GalaxiWorld and it is not grounds for the Court [*28] to disqualify itself. n12 Mr. Brodsky had stated that his client had refused to give instruction since November 1999 and refused to respond to his telephone calls. (Transcript of Jan. 13, 2000 at 22--29 (unsealed on July 19, 2000)). Second, with respect to the entry of default judgment and the related rulings, Defendant appealed the default judgment and award of damages against GalaxiWorld to the Second Circuit Court of Appeals. That court reversed the default judgment and award of damages. See Pecarsky, 249 F.3d at 174-75. In support of its motion for disqualification, GalaxiWorld argues that "as indicated by the Second Circuit, this Court acted to enter a default judgment against GLC more quickly than usual." (Def.'s Mem. at 12.) It is true that the Second Circuit, in reversing the entry of default judgment, noted that "consideration of other cases in which default judgments have been entered illustrates that the district court in this case ordered a default judgment more quickly than usual. [*29] " Pecarsky, 249 F.3d at 172. However, the entry of the judgment here came at a time when GalaxiWorld was being taken over by an offshore private company which Proskauer believed would not pay GalaxiWorld's bills and when no Page 8 2001 U.S. Dist. LEXIS 13513, *29 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 9 of 12 insurance remained to pay any judgment. Entry of default judgment "more quickly than usual" under those circumstances would not cause a disinterested observer who was fully informed of the facts to entertain significant doubt that justice would be done absent recusal. The transcripts show that the Court was obviously trying to press GalaxiWorld and Ostel to bring in attorneys to defend the action. n13 The Court's entry of default judgment presented grounds for appeal, which GalaxiWorld successfully pursued, but it does not display deep--seated favoritism or antagonism toward GalaxiWorld and it is not grounds for the Court to disqualify itself. n13 GalaxiWorld chose to forego the typical procedure upon entry of default judgment of moving before the district court to vacate the default judgment under Federal Rules of Civil Procedure 55(c) and 60(b) and proceed to defend the action with Banks and Weltman who were represented by the same counsel. See Pecarsky, 249 F.3d at 170 (discussing GalaxiWorld's "unusual" choice to pursue an appeal rather than seeking vacatur of the default judgment from the district court). [*30] Third, GalaxiWorld complains that the Court "rubber stamped Plaintiffs' request for an order of contempt," and that "inexplicably the Court did not enter the Martindell order" that defendants had requested in their order to show cause of November 14, 2000. (Def.'s Mem. at 7.) Contrary to GalaxiWorld's contention that the order for contempt was "rubber stamped," the Court heard extensive argument and reviewed substantive briefing from counsel on the issue. Most importantly, despite the Court's orders, neither defendant Banks nor a representative from GalaxiWorld appeared at the hearing, nor were any of the requested documents produced, as required in the Court's order. Also contrary to GalaxiWorld's contention, the Court clearly explained reason for denying defendants' request for a Martindell protective order its ruling at the November 21, 2000, hearing, at which GalaxiWorld's counsel was present, when the Court stated: I am not going to grant the defendants a protective order requiring that all depositions of defendants be conducted in the place that they reside. And I am not going to enter a Martindell protective order in the form previously submitted to the Court [*31] because I don't think that a necessity has been shown for the entrance of a Martindell protective order or was at the time when it was originally submitted because the nature of the inquiry being made of Mr. Banks at that time was an inquiry as to the disposition of the assets that had taken place subsequent to the period involved in his prosecution. There was no claim by anyone that those transfers were criminal acts. (Eisenberger Decl. Ex. F at 40--41.) Here, an objective, disinterested observer who was fully informed of the fact that the Court had explained its reason for not entering the protective order, which was based on defendants' failure to make a sufficient showing of necessity, would not entertain significant doubt that justice would be done absent recusal. As with the other judicial rulings, this ruling may be grounds for an appeal but it is not grounds for disqualification. In sum, the rulings against GalaxiWorld, although adverse, do not display deep-seated favoritism or antagonism that would make fair judgment impossible. 2. The Court's Remarks GalaxiWorld argues that the Court's statements at various hearings created an appearance of bias. However, "judicial [*32] remarks during the course of a trial that are critical or disapproving of, or even hostile to, counsel, the parties, or their cases, ordinarily do not support a bias or partiality challenge." Liteky, 510 U.S. at 555; see also United States v. Conte, 99 F.3d 60, 65 (2d Cir. 1996) (noting that "events occurring in the course of judicial proceedings generally do not constitute a basis for recusal"). The Supreme Court has stated: Not establishing bias or partiality, however, are expressions of impatience, dissatisfaction, annoyance, and even anger, that are within the bounds of what imperfect men and women, even after having been confirmed as federal judges, sometimes display. A judge's ordinary efforts at courtroom administration---even a stern and short-tempered judge's ordinary efforts at courtroom administration---remain immune. 510 U.S. at 555--56 (emphasis in original). The Supreme Court has also explained, by quoting Judge Jerome Frank, that "'impartiality is not gullibility. Disinterestedness does not mean child--like innocence. If the judge did not form judgments of the actors in those court-house dramas called trials, he could [*33] never render decisions.'" Id. at 551 (quoting In re J.P. Linahan, Inc., 138 F.2d 650, 654 (2d Cir. 1943)). "Opinions formed by the judge on the basis of facts introduced or events occurring in the course of the current proceedings, or of prior proceedings, do not constitute a basis for a bias or partiality motion unless Page 9 2001 U.S. Dist. LEXIS 13513, *33 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 10 of 12 they display a deep--seated favoritism or antagonism that would make fair judgment impossible." 510 U.S. at 555. First, GalaxiWorld accuses the Court of "taking issue with Mr. Weltman's failure to appear in Court when his wife was having a baby, even though all parties had agreed to the adjournment." (Def.'s Mem. at 8.) However, as the transcript of the January 13, 2000, hearing makes clear, the Court was only informed that the parties had agreed to adjourn Mr. Weltman's deposition, not his appearance at the hearing on Proskauer's motion to withdraw as counsel: I really think [Mr. Weltman] ought to have appeared. Didn't I order that he appear? We have had one excuse after another from Mr. Weltman. It seems to me he was supposed to appear in November and then he had an excuse then and I said any time before maybe it was January 20 but whatever [*34] date it was and you all agreed on that and then now he has unilaterally avoided that. (Eisenberger Decl. Ex. B at 17--18.) Although counsel for Proskauer informed the Court that Plaintiffs had consented to the further adjournment of Mr. Weltman's deposition because his wife was expecting a baby and therefore his failure to appear at his deposition was not unilateral, the Court was raising the issue that Mr. Weltman was not present at the January 13, 2000, hearing. (Id.) Proskauer's order to show cause presented to the Court on January 10, 2000, and signed the same day, had ordered Mr. Weltman to appear at the January 13, 2000, hearing, and the Court stated that it had understood that, "the Order to Show Cause indicated he was going to appear here . . . ." (Id. at 34.) The consensual adjournment of Mr. Weltman's deposition for some other date does not explain or excuse his failure to appear at the hearing on Proskauer's order to show cause. GalaxiWorld also complains that later during the same hearing, the Court stated, "I think maybe [Mr. Weltman] is never going to show. Maybe he has another wife that is pregnant." (Id. at 34.) This poor attempt at humor merely [*35] displays the Court's obvious frustration with the discovery cutoff extensions caused by Mr. Weltman's repeated delays in completing his deposition. n14 Contrary to GalaxiWorld's assertions, however, the Court's observations that defendant Weltman had failed to appear at the January 13, 2000, hearing on Proskauer's order to show cause or had repeatedly rescheduled his deposition were "efforts at court administration," and even if they reflect impatience with Mr. Weltman's failure to have appeared for deposition or at the hearing held on January 13, 2000, such statements do not establish the appearance of bias or partiality. Accordingly, an objective, disinterested observer fully informed of the underly- ing facts would not entertain significant doubt that justice would be done absent recusal. n14 Mr. Weltman's deposition had begun in April 1999 but could not be completed at that time because of a lack of documents concerning Mr. Weltman's testimony before the SEC and the Nebraska, Ontario, and Missouri gaming regulatory commissions. (See Sept. 29, 1999, and Oct. 14, 1999, Letters from Plaintiffs; Oct. 15, 1999, Letter from Proskauer.) On October 14, 1999, Plaintiffs had requested that the Court compel defendant Weltman to attend his deposition in New York City, which was then scheduled for October 20--21, 1999, after Plaintiffs were advised that Defendants had canceled the deposition. On October 18, 1999, that request was denied by memorandum endorsement upon a letter from Proskauer dated October 15, 1999, in which Proskauer offered the deposition to be held in December, rather than in October 1999. (See Memorandum Endorsement dated Oct. 18, 1999, upon Proskauer's Oct. 15, 1999, Letter.) On November 30, 1999, Weltman's deposition was again rescheduled, this time to January 2000, due to Proskauer's scheduling conflicts and because defendant Weltman had injured his back. At the January 13, 2000, hearing, it was reported to the Court that Mr. Weltman had again obtained an adjournment of his deposition which was rescheduled from January to February 2000, this time because his wife was expecting a baby. [*36] Second, GalaxiWorld complains of the Court's belief that defendants' requests for additional time to engage new counsel were unreasonable, an assessment that the Second Circuit disagreed with in its decision on appeal. (Def.'s Mem. at 9.) GalaxiWorld identifies a remark made during the January 25, 2000, hearing, at which Mr. Weltman appeared by telephone. The Court stated: GalaxiWorld had an obligation to appear today, under court order. And it was adjourned for week. And I'm not going to allow the people to just turn around and ask for 30 days and 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 dealing with a four year old case in which the fact discovery cutoff had been repeatedly extended, trial was scheduled for April 4, 2000, and expert discovery was still to be completed. In its remark, the Court was expressing its Page 10 2001 U.S. Dist. LEXIS 13513, *36 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 11 of 12 frustration with GalaxiWorld's failure to obtain substitute counsel, despite the fact that GalaxiWorld had notified Proskauer in November 1999 that it should cease work and despite a court order to appear and a subsequent adjournment to permit GalaxiWorld to retain counsel, [*37] if only for the purpose of making a special appearance on behalf of the corporation. As with the Court's comments regarding Mr. Weltman's failure to appear, the statement is an effort at court administration and an objective, disinterested observer fully informed of the underlying facts would not entertain significant doubt that justice would be done absent recusal. Third, GalaxiWorld complains about the Court's response to Mr. Weltman's suggestion, made on January 25, 2000, at a time when he was no longer an officer of GalaxiWorld and when no counsel had appeared for the 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 account, you weren't interested. From your own account, you elected to play it that way. You live by the sword, you die by the sword. Your string has run out." (Id. at 94.) The Court refused Mr. Weltman's request for an adjournment for possible settlement discussions based in part on Mr. Weltman's account earlier during that hearing of his instruction as an officer of GalaxiWorld to Proskauer not to continue with settlement discussions, despite [*38] being advised by Proskauer to do so. (See id. at 63--64.) More importantly, Mr. Weltman's suggestion was a diversion from the subject the Court was dealing with, which was its efforts to encourage the retention of substitute counsel for the defendants, including suggesting that substitute counsel make only a limited appearance. (See id. at 92.) The Court's response was to redirect Weltman's attention to the issue of securing the appearance of an attorney for the defendants and not to allow time to be lost to that endeavor by the diversion of discussions of possible settlement by the principals. These remarks would not cause an objective, disinterested observer fully informed of these underlying facts to entertain significant doubt that justice would be done absent recusal. Fourth, GalaxiWorld complains that on February 9, 2000, the Court "traded disparaging comments of defendants 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 to have two duplicative bifurcated proceedings, one here, one there, to address fee matters," to which the Court replied: "Particularly [*39] when the defendant is now doing business out of Gibraltar." (Eisenberger Decl. Ex. D at 21.) This comment could not reasonably be interpreted as giving rise to the appearance of bias, since it is merely reflected the Court's agreement that Proskauer might have difficulty serving process on an offshore private company and bifurcated proceedings would waste time and resources. GalaxiWorld also cites the Court's agreement with the statement of Proskauer's counsel: "And tends not to show up at any hearing that anyone calls," to which the Court replied: "Or even have someone appear especially. All right." (Id.) The comment, based on GalaxiWorld's failure to appear at previous hearings, is again an effort at court administration to obtain the appearance of new counsel, even suggesting a special appearance, and under the circumstances would not cause an objective, disinterested observer fully informed of the underlying facts to entertain significant doubt that justice would be done absent recusal. Fifth, GalaxiWorld argues that on February 29, 2000, the Court "assumed that any transactions involving defendants were improper." (Def.'s Mem. at 10 (emphasis in original).) However, that [*40] argument is not supported by the Court's remark on which GalaxiWorld relies. On February 29, 2000, the Court remarked that: "Well, I am not saying one way or the other, but just saying that you can't assume anything on these transactions." (Eisenberger Decl. Ex. E at 21.) Contrary to GalaxiWorld's assertions, rather than assume that any transactions were improper, the Court plainly stated that it would not make any assumptions regarding the propriety of the transactions: "you can't assume anything." That statement would not cause an objective, disinterested observer fully informed of the underlying facts to entertain significant doubt that justice would be done absent recusal. Sixth, GalaxiWorld accuses the Court of sarcasm in asking the question during a hearing on the enforcement proceedings held on November 21, 2000, "You mean they are playing a game and they have taken their corporate documents and transferred them to a third party?" (Def.'s Mem. at 10.) This question was posed in response to GalaxiWorld's counsel's assertion, made without sworn statements in support, that GalaxiWorld was not in possession of its corporate documents relating to the disposition of the assets of [*41] its subsidiary, Specialty Manufacturing Inc., and the location of its assets which Plaintiffs had demanded during discovery. Questioning counsel's assertion that GalaxiWorld did not possess its own corporate documents would not cause an objective, disinterested observer fully informed of the underlying facts to entertain significant doubt that justice would be done absent recusal. Finally, GalaxiWorld objects to the Court's statement during the hearing on the enforcement proceedings held on November 21, 2000, that GalaxiWorld's counsel had been "using" a former Gaming Lottery shareholder named Page 11 2001 U.S. Dist. LEXIS 13513, *41 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 12 of 12 Frank Citrano. n15 (Id. at 10--11.) Citrano, who acknowledged being in touch with GalaxiWorld's counsel, sought a lifting of the Court's restraining order on a GalaxiWorld account at the Royal Bank of Scotland allegedly used to hold funds in the Ostel acquisition of GalaxiWorld so that he could receive a small portion of the account. GalaxiWorld had failed to produce the corporate documents relating to that transaction which had been requested by Plaintiffs and Proskauer. Without such documents, neither Proskauer nor Plaintiffs could review the corporate transaction in question to determine [*42] if it was a sham. The Court explained its remark in response to GalaxiWorld's counsel's exception, stating: "Yes. If you don't produce the documents they can't tell whether this isn't a sham transaction or not." (Eisenberger Decl. Ex. F at 15.) Such an observation, based on GalaxiWorld's failure to disclose its corporate records, would not cause an objective, disinterested observer fully informed of the underlying facts to entertain significant doubt that justice would be done absent recusal. n15 Mr. Citrano, a Gaming Lottery shareholder whom the Court permitted to appear, had been seeking, over the objection of both the judgment creditors, the lifting of the Court's restraining order on an account in GalaxiWorld's name at the Royal Bank of Scotland in Gibraltar so that he could receive a small portion of the account. Eventually the dispute was resolved to Citrano's satisfaction. (See Affidavit of Robert C. Finkel dated July 17, 2001 Ex. Y.) In sum, the remarks cited by GalaxiWorld that allegedly show bias [*43] and prejudice are efforts at court administration, or they question statements made by GalaxiWorld's counsel during conferences, or comment upon GalaxiWorld's delaying tactics, failure to appear despite court order, or refusal to reveal the location of its corporate documents. The judicial remarks in question, to the extent they are adverse to the positions of GalaxiWorld, are based on the facts placed before the Court and do not show deep-seated favoritism or antagonism. Thus, after consideration of the judicial rulings and statements relied on by GalaxiWorld in support of its motion for recusal pursuant to 28 U.S.C. 455(a), the Court concludes that GalaxiWorld has not met its obligation to show that "an objective, disinterested observer fully informed of the underlying facts [would] entertain significant doubt that justice would be done absent recusal." In re Aguinda, 241 F.3d at 201 (internal quotation omitted). "A judge is as much obliged not to recuse himself when it is not called for as he is obliged to when it is." In re Drexel Burnham Lambert Inc., 861 F.2d at 1312. Here, the Court is obliged not to recuse itself. [*44] Accordingly, GalaxiWorld's motion pursuant to 28 U.S.C. 455(a) to request that the Court disqualify itself from further proceedings is denied. CONCLUSION For the foregoing reasons, GalaxiWorld's motion pursuant to 28 U.S.C. 455(a) to request that the Court disqualify 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. TAB 4 Slip Copy Slip Copy, 2006 WL 1320466 (N .D.Cal .), Fed. Sec . L . Rep . P 93,891 (Cite as : S lip Copy) Page 1 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 , Kaplan Fox & Kilsheimer LLP, Robert S . Green , John W . Pillette, Robert A. Jigariian, Green Welling LLP, San Francisco, CA, Daniel S . Sommers, Marka A . Peterson, Cohen Milstein Hausefeld & Toll, P .L .L .C., Washington, DC, Lionel Z . Gl ancy , 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 Halebian & 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 Rosenfeld, 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 Robbins , Lerach Coughlin Stoia Geller Rudman Robbins LLP, Boca Raton, FL, for Plaintiffs. Grant P . Fondo, John C . Dwyer , Cooley Godward LLP, Palo Alto, CA, for Defendants . Michael M . Goldberg, Glancy & Binkow LLP, Los Angeles, CA, Douglas C. McDermo tt, Milberg, Weiss Bershad & Schulman, LLP, Seattle, WA, Laurence D . King , Linda M . Fong, Kaplan Fox & Kilsheimer LLP, San Francisco, CA, for Movants . ORDER GRANTING DEFENDANTS' 12(b)(6) MOINTRODUCTION *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 October 28 , 2003 .1 Defend ants seek an order dismissing the Fourth Amended Class Action Complaint ("FAC") with prejudice under the heightened pleading requirements of the Pri vate Securities Litigation Reform Act of 1995 ("PSLRA") an d pursuant to Federal Rules of Civil Procedure 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 . BACKGROUN D 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 announcement 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 HI V/AID S 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 prescribing 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 Copy Slip Copy, 2006 WL 1320466 (N .D.Cal .), Fed. Sec . L . Rep . P 93,891 (Cite as : Slip Copy) Page 2 Two weeks later, on July 31, 2003, Gilead issued a press release 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 prescription 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 forwardlooking 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 inventory 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 determine 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 despite 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 fin ancial results . The Form 10- Q also discussed the inventory build-up : "We estimate that this higher stocking resulted in $25 . 0 to $30 . 0 million of additional sales during the second quarter, which may adversely impact sales in the third quarter as wholesalers return to more normal 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 proFN2 motional practices of Viread. 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 announced net revenues of $194 .1 million, and sales of Viread of $115 .4 million. At that time, Gilead stated : "After reviewing NDC prescription trends, IMS inventory data and actual Viread sales , Gilead estimates there was approximately $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 experienced 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 marketing refers to the use for marketing purposes of information 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 promote 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 infection; and 3) marketing against Viread's safety profile . *3 Plaintiffs allege that Gilead's off-label marketing activities beg an as early as September 2001 at Gilead' s national sales meeting in Miami . There, sales and marketing employees allegedly were given information regarding Gilead' s 2006 Thomson/West. No Claim to Orig. U.S . Govt. Works . Slip Copy Slip Copy, 2006 WL 1320466 (N .D.Cal .), Fed. Sec . L . Rep . P 93,891 (Cite as : S lip Copy) Page 3 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 instructed, "overtly and covertly," at numerous regional and national sales meetings by Gilead executives to use off-label FN information to aggressively promote and sell Viread . 4 At these meetings, employees allegedly would be provided offlabel 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 vari ous meetings at which Gilead's sales and marketing team received specific instructions to market Viread offlabel. 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 promotional statements at the December 2001 Interscience Conference on Antimicrobial Agents and Chemotherapy conference. According to the Untitled FDA Letter, Gilead falsely and misleadingly promoted Viread by stating that it contained "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 pl ans 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. 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 letter ("FDA Warning Letter") notifying Gilead that it considered certain oral representations made by a Gilead representative at a promotion booth during a conference call in April 2003 to be improper . This conference took place during Gilead's second fiscal quarter of 2003, just prior to Defendants' 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 significance to the lett er . (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 attributable to off-label promotion . According to the FAC, this accounted 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 Action Complaint ("TAC") on March 11, 2005 . 5 On October 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 2006 Thomson/West. No Claim to Orig. U.S . Govt. Works . Slip Copy Slip Copy, 2006 WL 1320466 (N .D.Cal .), Fed. Sec . L . Rep . P 93,891 (Cite as : Slip Copy) Page 4 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 because they failed to allege loss causation in light of Dura Pharmaceuticals Inc . v. Broudo 544 U.S . 336, 125 S .Ct. PN 6 1627, 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 adequately 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 accompanied 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 disclosure 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 sho rtly 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 establish an actual "causal connection" between the defendants' material misrepresentation and the economic 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 previously 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- ject to reasonable dispute in that it is . . . capable of accurate and ready determination by resort to sources whose accuracy 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 .PN 8 FN8 . In its order dismissing the CAC the Court judicially 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 adequate theory . Robertson v. Dean Witter Reynolds . Inc . . 749 F .2d 530, 533-34 (9th Cir.1984) . When deciding upon a motion 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 converted into one for summary judgment. Where such a conversion takes place, all parties must be given an opportunity to present all material made pertinent to such a motion by 2006 Thomson/West. No Claim to Orig. U.S . Govt. Works . Slip Copy Slip Copy, 2006 WL 1320466 (N .D.Cal .), Fed. Sec . L . Rep . P 93,891 (Cite as : S lip Copy) Page 5 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 incorporated within its allegations, may be considered as part of the 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 documents 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 district court may consider the full texts of documents that the complaint only quotes in part. See In re Stac Electronics Sec . Lit. . 89 F .3d 1399, 1405 n . 4 (1996) , cert. denied, 520 U.S . 1103, 117 S .Ct . 1105, 137 L .Ed.2d 308 (1997). This rule precludes 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 registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [SEC] may prescribe ." 15 U .S .C . 78i(bl . Rule lob-5 makes it unlawful for any person to use interstate commerc e (a) to employ any device, scheme, or artifice to defraud ; (b) to make any untrue statement of material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading; or (c) to engage in any act, practice, or course of business which operates 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 . 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 alleged 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 section 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 under the 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 particula rity 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 inference that the defendant acted with the required state of mind." 15 U.S .C . 78u-4(b)(2) . The Ninth Circuit, in interpreting the PSLRA, has held that "a private securi ties plaintiff proceeding under the [PSLRA] must plead, in great 2006 Thomson/West. No Claim to Orig. U.S . Govt. Works . Slip Copy Slip Copy, 2006 WL 1320466 (N .D.Cal .), Fed. Sec . L . Rep . P 93,891 (Cite as : S lip Copy) Page 6 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 must dismiss the complaint. See 15 U.S .C. 78u-4(b)(1) . ANALYSI S After the Court dismissed Plaintiffs' TAC for failure to adequately allege loss causation, Plaintiffs amended their complaint on December 2, 2005 . Plaintiffs' amendments primarily 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 actual "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 allegations) and the drop in Gilead's stock price . Defendants contend that the additional information provided in the FAC has added little to Plaintiffs' previous complaint, which insuffi- ciently pled loss causation. 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) Defendants' 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' allegations 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 announcement 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 unreasonable 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 inference and do little to meet their loss causation pleading burden. FN9 . The Court noted in its Order that "this argument is flawed because the record reflects that investors never actually learned the extent of Defendants' 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 attempt to suppo rt these allegations with citations to genera l 2006 Thomson/West. No Claim to Orig. U.S . Govt. Works . Slip Copy Slip Copy, 2006 WL 1320466 (N .D.Cal .), Fed. Sec . L . Rep . P 93,891 (Cite as : S lip Copy) Page 7 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 Letter 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 higher 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 1V new light on the loss causation issue. FN10 . Defendants concede the demand for Viread did not increase at the same rate in the third quarter. The Court, however, finds a slowing increase in demand, alone, too speculative to adequately demonstrate loss causation. *8 Plaintiffs correctly argue that the heightened pleading standard does not apply to allegations that Defendants' misrepresentations 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. Bombardier 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 revelation of the misrepresentation .l I Parmalat involved a drop in securities price after disclosure of a fraud that understated Parmalat's debt by virtually $10 billion and overstated 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, Deloitte, 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 adequately pled loss causation because the "[d]efendants reasonably could have foreseen that Parmalat's inability to service 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 distinguishable . Similarly , the plaintiff in Teamsters alleged senior m anagement of Bombardier Capital Inc . (`BCI"), a manufactured housing asset- backed comp any , disregarded the companies' underwriting standards in favor of high- ri sk lo an s . Teamsters, 2005 U . S . Dist . LEXIS 19506, at *7 . BCI did not disclose on its Form 8-K filing or otherwise its actual underwriting practices and thus concealed the high-risk loans . Id. at *6 . The high-ri sk loan s turned into "bad loan s" and resulted in a sharp increase in delinquencies and foreclosure on BCI assets . Id. at *8 . As a result, BCI's stock certificates suffered a p ri ce decrease of 38% in less than three months. Id. at *7 . There the distri ct court found the plaintiff adequately alleged loss causation : Plaintiff has alleged that its loss was caused when a risk that was concealed by the defendants materialized in a foreseeable chain of events . The Complaint alleges that defendants' misrepresentations regarding ri gorous underwriting concealed the fact that the collateral pool contained a substantial number of high ri sk loans . The concealed ri sk mate ri alized when the collateral pool expe ri enced high delinquency rates and repossession on a sustained basis . Not surprisingly, BCI's earnings expectations then fell . BCI announced that it would write off the losses , rating agencies downgraded the Ce rtificates , and the value of plaintiffs investment declined. These allegations are sufficient to plead loss causation . 2006 Thomson/West. No Claim to Orig. U.S . Govt. Works . Slip Copy Slip Copy, 2006 WL 1320466 (N .D.Cal .), Fed. Sec . L . Rep . P 93,891 (Cite as : S lip Copy) Page 8 *9 Id. at *57 . The case before the Court, however, is substantially different. 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 proceed directly from the wrong alleged and must not be attributable 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 became public on August 7, 2003, and the loss which that revelation 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~alleged misrepresentation proximately caused their loss . FN 1 5 Accordingly, the Court must dismiss the Complaint. 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 inferences to be drawn from the allegations, "including inferences unfavorable to th e plainiffs ." Gompper v. VISX. Inc. . 298 F .3d 893, 897 (9th Cir.2002 . FN14 . The Court distinguishes this case from Daou. In Daou, the defendants fraudulently inflated 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 alleged a steep drop in stock price following disclosure of Defendants' "true financial health." Id. at 1026 . Here, however, Plaintiffs have not adequately connected the disclosure of Gilead's offlabel marketing and the drop in stock price in the FAC . Indeed, the evidence Plaintiffs have presented to the Court only supports an inference that the market gave little or no weight to the FDA Warning Letter. FN15 . Because Plaintiffs have not adequately alleged 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 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 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 adequately plead the underlying lOb-5 violation, the Section 20(a) claims must be dismissed against the individual Defendants as well . C . Dismissal With Prejudice A court considers five factors in determining whether to dismiss 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- 2006 Thomson/West. No Claim to Orig. U.S . Govt. Works . Slip Copy Slip Copy, 2006 WL 1320466 (N .D.Cal .), Fed. Sec . L . Rep . P 93,891 (Cite as : S lip Copy) Page 9 viously amended the complaint ." Id. (quoting Ascon Properties. 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 allegations . Because Daou was decided after Plaintiffs filed their TAC, the Court again granted leave to amend with respect to the issue of loss causation. Yet Plaintiffs still have not adequately alleged loss causation after having had another 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 of Dura and the requirements of Federal Rule of Civil Procedure 12(b)(6) , the Court GRANTS Defendants' 12(b)(6) Motion to DisFN miss the FAC with prejudice . 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 Litigatio n 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 ) 2006 WL 434928 (Trial Motion, Memorandum and Affidavit) Plaintiffs Corrected Memorandum of Points and Authorities in Opposition to Defendants' Motion to Dismiss the Fourth Consolidated Amended Complaint (Jan . 20, 2006) Original Image of this Document (PDF ) 2006 WL 434927 (Trial Motion, Memorandum and Affidavit) 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) 2005 WL 2613027 (Trial Motion, Memorandum and Affidavit) Class Action Defendants' Reply Memorandum in Support of Their Motion to Dismiss Plaintiffs' Third Consolidated Amiended Class Action Complaint (Aug . 15, 2005) Original Image of this Document (PDF) 2005 WL 2155747 (Trial Motion, Memorandum and Affidavit) Plaintiffs' Memorandum of Points and Authorities in Opposition to Defendants' Motion to Dismiss the Third Consolidated Amended Complaint (Jul. 11, 2005) Original Image of this Document (PDF) 2005 WL 2155748 (Trial Motion, Memorandum and Affidavit) Plaintiffs' Response to Defendants' Request for Judicial Notice (Jul. 11, 2005) Original Image of this Document (PDF ) 2004 WL 2160197 (Trial Motion, Memorandum and Affidavit) Plaintiffs' Memorandum of Points and Authorities in Opposition to Defendants' Motion to Dismiss (Oct . 26, 2004) Original Image of this Document (PDF) 2004 WL 2160201 (Trial Motion, Memorandum and Affidavit) Plaintiffs' Response to Defendants' Request for Judicial Notice (Oct. 26, 2004) Original Image of this Document (PDF ) 2004 WL 2160176 (Trial Motion, Memorandum and Affidavit) Memorandum of Points and Authorities in Support of Motion of Honhon Eichler and Duwayne D . Gadd for Appointment as Lead Plaintiffs, Approval of Lead Counsel, and Consolidation of the Related Actions (Jan . 12, 2004) Original Image of this Document (PDF ) 2004 WL 2160185 (Trial Motion, Memorandum and Affidavit) Memorandum in Support of the Motion of Trent St . Slip Copy, 2006 WL 1320466 (N .D .Cal.), Fed . Sec. L . Rep P 93,89 1 Briefs and Other Related Documents Back to top) 2006 WL 728109 (Trial Motion, Memorandum and Affidavit) Defendants' Corrected Reply Memorandum in Support of their Motion to Dismiss Plaintiffs' Fourth Consolidated Amended Class Action Complaint (Feb . 6, 2006) Original Image of this Document (PDF) 2006 WL 728108 (Trial Motion, Memorandum and Affi- 2006 Thomson/West. No Claim to Orig. U.S . Govt. Works . Slip Copy Slip Copy, 2006 WL 1320466 (N .D.Cal .), Fed. Sec . L . Rep . P 93,891 (Cite as : S lip Copy) Page 1 0 Clare for Appointment as Lead Plaintiff and for Approval of Selection of Lead and Liaison Counsel (Jan . 12, 2004) Original Image of this Document (PDF) 5 :04cv00100 (Docket) (Jan. 9, 2004) 3 :04cv00100 (Docket) (Jan. 9, 2004 ) 2003 WL 23796185 (Trial Pleading) Class Action Complaint for Violation of Federal Securities Laws (Dec . 23, 2003) Original Image of this Document (PDF) 3 :03cv05805 (Docket) (Dec . 23, 2003) 3 :03cv05592 (Docket) (Dec . 12, 2003) 4:03cv05391 (Docket) (Dec . 1, 2003) 3 :03cv05391 (Docket) (Dec . 1, 2003 ) 2003 WL 23795006 (Trial Pleading) Class Action Complaint for Violation of Federal Securities Laws (Nov. 27, 2003) Original Image of this Document (PDF) 3 :03cv05113 (Docket) (Nov. 18, 2003 ) 2003 WL 23795301 (Trial Pleading) Class Action Complaint for Violation of Federal Securities Laws (Nov. 17, 2003) Original Image of this Document (PDF) 3:03cv05088 (Docket) (Nov. 17, 2003 ) 2003 WL 23795765 (Trial Pleading) Class Action Complaint for Violations of Federal Securities Laws Jury Trial Demanded (Nov. 10, 2003) Original Image of this Document (PDF ) 2003 WL 23795794 (Trial Pleading) Consolidated Amended Class Action Complaint for Violation of Federal Securities Laws Demand for Jury Trial (Apr . 30, 2003) Original Image of this Document (PDF) END OF DOCUMENT 2006 Thomson/West. No Claim to Orig. U.S . Govt. Works . Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 1 of 19 TAB 5 Case 5:04-cv-04156-JW Case 5:04-cv-04802-JW Document 111 Document 74 Filed 03/01/2006 Filed 07/28/2006 Page 1 of 18 Page 2 of 19 1 2 3 4 5 6 7 8 9 10 IN THE UNITED STATES DISTRICT COURT FOR THE NORTHERN DISTRICT OF CALIFORNIA SAN JOSE DIVISION United States District Court 11 For the Northern District of California In re IMPAX LABORATORIES, INC. SECURITIES LITIGATION / NO. C 04-04802 JW ORDER GRANTING DEFENDANTS' MOTION TO DISMISS WITH LEAVE TO AMEND 12 13 This Document Relates to All Actions 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 / 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-04156-JW Case 5:04-cv-04802-JW Document 111 Document 74 Filed 03/01/2006 Filed 07/28/2006 Page 2 of 18 Page 3 of 19 1 2 3 4 5 6 7 8 9 10 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 United States District Court 11 For the Northern District of California 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 2 Case 5:04-cv-04156-JW Case 5:04-cv-04802-JW Document 111 Document 74 Filed 03/01/2006 Filed 07/28/2006 Page 3 of 18 Page 4 of 19 1 2 3 4 5 6 7 8 9 10 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 10b5 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 United States District Court 11 For the Northern District of California 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 3 Case 5:04-cv-04156-JW Case 5:04-cv-04802-JW Document 111 Document 74 Filed 03/01/2006 Filed 07/28/2006 Page 4 of 18 Page 5 of 19 1 2 3 4 5 6 7 8 9 10 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 United States District Court 11 For the Northern District of California 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 4 Case 5:04-cv-04156-JW Case 5:04-cv-04802-JW Document 111 Document 74 Filed 03/01/2006 Filed 07/28/2006 Page 5 of 18 Page 6 of 19 1 2 3 4 5 6 7 8 9 10 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' United States District Court 11 For the Northern District of California 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 5 Case 5:04-cv-04156-JW Case 5:04-cv-04802-JW Document 111 Document 74 Filed 03/01/2006 Filed 07/28/2006 Page 6 of 18 Page 7 of 19 1 2 3 4 5 6 7 8 9 10 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 Products sold by Teva or Teva's affiliates on a arms-length basis in each country in the Territory, 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 United States District Court 11 For the Northern District of California 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 The SAA is in the record at Def. Request for Judicial Notice, Exh. A, and shall be cited in this Order as "SAA." The SAA was specifically referenced to in the FAC, and the Court finds that it is sufficiently probative on Plaintiffs' claims to admit and refer to Defendants' submission of the contract. Section 11.3 of the SAA at p. 24 reads: "Within thirty (30) days following each Calendar Quarter during the Supply Term, Teva shall compute and report to Impax in a mutually acceptable format the Net Sales and Profit for each Product in each country in the Territory during that Calendar Quarter. . . . In addition, within seven (7) business days after the end of each month, Teva shall provide to Impax information (which could be good faith estimates if final data is not available) as to the amount of Net Sales, Profit, and number of units sold of each Product during that month." 6 2 1 Case 5:04-cv-04156-JW Case 5:04-cv-04802-JW Document 111 Document 74 Filed 03/01/2006 Filed 07/28/2006 Page 7 of 18 Page 8 of 19 1 2 3 4 5 6 7 8 9 10 Teva or its Affiliateds; (e) three percent (3%) as a contribution towards selling, administrative and other similar expenses of Teva; and (f) other specifically identifiable amounts included in the Product's gross sales that will have been or ultimately will be credited and are substantially similar to those listed above; in each case 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 United States District Court 11 For the Northern District of California 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 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 At oral argument, counsel for Plaintiffs indicated that there is an accounting distinction between "other specifically identifiable amounts included in the Product's gross sales that will have been or ultimately will be credited," and amounts which will ultimately be credited but are perhaps not "specifically identifiable." Pleading facts which support such a distinction would add particularity to Plaintiffs' allegations that Defendants acted with scienter in not taking into account Teva's customer credits to Teva's customers, and failing to maintain an adequate reserve despite the terms of the SAA. 7 3 Case 5:04-cv-04156-JW Case 5:04-cv-04802-JW Document 111 Document 74 Filed 03/01/2006 Filed 07/28/2006 Page 8 of 18 Page 9 of 19 1 2 3 4 5 6 7 8 9 10 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 United States District Court 11 For the Northern District of California 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 CW3, as described in the FAC, is "a manufacturing technician employed immediately prior to 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 position occupied by the source would possess the information alleged and the complaint contains adequate corroborating details." In re Daou, 411 F.3d at 1015 (citations omitted). It is unclear to the Court that a person in the position of a manufacturing technician would have knowledge about the travel plans of the company's senior management, and Plaintiffs have not alleged any other corroborating facts which would shed light on this matter. 8 4 Case 5:04-cv-04156-JW Document 111 Case 5:04-cv-04802-JW Document 74 Filed 03/01/2006 07/28/2006 Page 9 of 18 10 of 19 1 2 3 4 5 6 7 8 9 10 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 United States District Court 11 For the Northern District of California 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 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). 9 Case 5:04-cv-04156-JW Case 5:04-cv-04802-JW Document 111 Document 74 Filed 03/01/2006 Filed 07/28/2006 Page 10 of 18 Page 11 of 19 1 2 3 4 5 6 7 8 9 10 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 United States District Court 11 For the Northern District of California 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 10 Case 5:04-cv-04156-JW Case 5:04-cv-04802-JW Document 111 Document 74 Filed 03/01/2006 Filed 07/28/2006 Page 11 of 18 Page 12 of 19 1 2 3 4 5 6 7 8 9 10 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 United States District Court 11 For the Northern District of California 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 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 11 Case 5:04-cv-04156-JW Case 5:04-cv-04802-JW Document 111 Document 74 Filed 03/01/2006 Filed 07/28/2006 Page 12 of 18 Page 13 of 19 1 2 3 4 5 6 7 8 9 10 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 United States District Court 11 For the Northern District of California 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 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 5 It is unclear to this Court whether such a violation could be asserted. 12 Case 5:04-cv-04156-JW Case 5:04-cv-04802-JW Document 111 Document 74 Filed 03/01/2006 Filed 07/28/2006 Page 13 of 18 Page 14 of 19 1 2 3 4 5 6 7 8 9 10 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 United States District Court 11 For the Northern District of California 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 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 13 Case 5:04-cv-04156-JW Case 5:04-cv-04802-JW Document 111 Document 74 Filed 03/01/2006 Filed 07/28/2006 Page 14 of 18 Page 15 of 19 1 2 3 4 5 6 7 8 9 10 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 United States District Court 11 For the Northern District of California 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 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 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 14 Case 5:04-cv-04156-JW Case 5:04-cv-04802-JW Document 111 Document 74 Filed 03/01/2006 Filed 07/28/2006 Page 15 of 18 Page 16 of 19 1 2 3 4 5 6 7 8 9 10 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 the burden of proving that the act or omission of the defendant alleged to violate this chapter caused 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 United States District Court 11 For the Northern District of California 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 15 Case 5:04-cv-04156-JW Case 5:04-cv-04802-JW Document 111 Document 74 Filed 03/01/2006 Filed 07/28/2006 Page 16 of 18 Page 17 of 19 1 2 3 4 5 6 7 8 9 10 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 United States District Court 11 For the Northern District of California 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 16 Case 5:04-cv-04156-JW Case 5:04-cv-04802-JW Document 111 Document 74 Filed 03/01/2006 Filed 07/28/2006 Page 17 of 18 Page 18 of 19 1 2 3 4 5 6 7 8 9 10 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. United States District Court 11 For the Northern District of California 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 Dated: March 1, 2006 04cv4802mtd /s/ James Ware JAMES WARE United States District Judge 17 Case 5:04-cv-04156-JW Case 5:04-cv-04802-JW Document 111 Document 74 Filed 03/01/2006 Filed 07/28/2006 Page 18 of 18 Page 19 of 19 1 2 3 4 5 6 7 8 9 10 THIS IS TO CERTIFY THAT COPIES OF THIS ORDER HAVE BEEN DELIVERED TO: Azra Z. Mehdi azram@lerachlaw.com Dale E. Barnes dale.barnes@bingham.com Darren J. Robbins e_file_sd@lerachlaw.com Elizabeth P. Lin elin@milbergweiss.com Joseph Otto Click click@blankrome.com Monique Winkler MoniqueW@lerachlaw.com Patrick J. Coughlin patc@lerachlaw.com Robert S. Green RSG@CLASSCOUNSEL.COM Shana Eve Scarlett shanas@lerachlaw.com Tricia Lynn McCormick triciam@lerachlaw.com William S. Lerach billl@lerachlaw.com Willow E. Radcliffe willowr@lerachlaw.com Kerry Brainard 600 New Hampshire Avenue, N.W. Washington, DC 20037 Michael Joseph 600 New Hampshire Avenue, N.W. Washington, DC 20037 Dated: March 1, 2006 Richard W. Wieking, Clerk By:_/s/ JW Chambers__________ Melissa Peralta Courtroom Deputy United States District Court 11 For the Northern District of California 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 1 of 7 TAB 6 Page 1 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 2 of 7 LEXSEE 2006 U.S. DIST. LEXIS 12166 IN RE INVISION TECHNOLOGIES, INC. SECURITIES LITIGATION No. C04--03181 MJJ UNITED STATES DISTRICT COURT FOR THE NORTHERN DISTRICT OF CALIFORNIA 2006 U.S. Dist. LEXIS 12166; Fed. Sec. L. Rep. (CCH) P93,674 January 21, 2006, Decided January 24, 2006, Filed COUNSEL: [*1] For Regis Engelken, individually and 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, Mountain View, CA. For Sergio Magistri, Ross Mulholland, Defendants: Catherine Duden--Kevane, Susan Samuels Muck, Jennifer Corinne 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, UNITED STATES DISTRICT JUDGE. OPINIONBY: MARTIN J. JENKINS OPINION: ORDER GRANTING DEFENDANTS' MOTION TO DISMISS PLAINTIFFS' AMENDED CONSOLIDATED COMPLAINT INTRODUCTION Before the Court is Defendants' Motion to Dismiss the Amended Consolidated Complaint. Defendants InVision Technologies, Inc. ("InVision"), Sergio Magistri ("Magistri"), and Ross Mulholland's ("Mulholland") (collectively "Defendants") move to dismiss this private securities fraud action pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure. Lead Plaintiffs Glazer Capital Management, LP and Glazer Offshore Fund, Ltd. ("Plaintiffs"), oppose the motion. After careful consideration of the arguments of counsel and the papers submitted, the Court GRANTS Defendants' Motion to Dismiss with leave to amend the Complaint. FACTUAL BACKGROUND A. Background InVision manufactures and supplies computer tomography based detection products used in aviation security. Plaintiffs represent a purported class of all purchasers of InVision securities between March 15, 2004 and July 30, 2004 (the "Class Period"). Plaintiffs allege that Defendants committed [*3] securities fraud in violation of section 10(b) of the Securities and Exchange Act of 1934 ("Exchange Act"), Rule 10b- of the Securities -5 and Exchange Commission ("SEC"), and section 20(a) of the Exchange Act. Defendants Magistri and Mulholland (collectively the "Individual Defendants") were employed at InVision during the class period. Defendant Magistri served as the President and Chief Executive Officer of InVision during the class period. Defendant Mulholland served as InVision's Chief Financial Officer during that time On March 15, 2004, InVision issued a press release announcing that it was being acquired by General Electric Company ("GE") (the "March 15 Announcement"). On July 30, 2004, InVision issued a press release that it had met with the U.S. Department of Justice ("DOJ") and the Page 2 2006 U.S. Dist. LEXIS 12166, *3; Fed. Sec. L. Rep. (CCH) P93,674 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 3 of 7 Securities and Exchange Commission ("SEC") to discuss possible violations of the Foreign Corrupt Practices Act ("FCPA"). The DOJ and the SEC were investigating several transactions involving InVision employees located abroad, in which employees allegedly made payments to foreign officials in violation of the FCPA. On December 6, 2004, InVision and GE completed the merger. On that same day, InVision [*4] issued a press release announcing that it had entered into settlements with the DOJ and the SEC resolving the FCPA investigation. B. Alleged Misstatements Plaintiffs cite three statements alleged to have violated the Exchange Act. Plaintiffs allege that the March 15, 2004 Merger Announcement contained false statements. The announcement stated that the "acquisition is subject to normal closing conditions including customary regulatory approval." On March 15, 2004, the same day that InVision announced its proposed merger with GE, InVision filed its Form 10- for the fiscal year 2003 (the "2003 10-K -K"). Included with the 2003 10--K was a certification, pursuant to the Sarbanes--Oxley Act of 2002 ("Sarbanes-Oxley Certification"), signed by Magistri. According to the Complaint, the certification stated, in relevant part: The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures and have . . . designed such disclosure controls and procedures to ensure that material information . . . is made known to us by others within those entitities, . . . [and] [e]valuated the effectiveness of the registrant's [*5] disclosure controls and procedures. [We] have disclosed . . . [a]ny fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Complaint, P 26, Quoting the Sarbanes--Oxley certification for the 2003 10--K Also on March 15, 2004, InVision filed a copy of the merger agreement between InVision and GE (the "Merger Agreement"). According to the Complaint, the Merger Agreement stated, in relevant part: The Company and its Subsidiaries are (and since January 1, 2002 have been) in compliance in all material respects with all laws(including common law), statutes, ordinances, codes, rules,regulations, decrees and orders of Governmental Authorities(collectively, "Laws") applicable to the Company or any of its Subsidiaries, any of their properties or other assets or any of their businesses or operations (including those Laws related to Export Control Requirements and improper payments). Complaint P 28, Quoting the March 15, 2004 Merger 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- for the fiscal year 2002 (the -K "2002 10-K") filed March 27, 2003, and InVision's 10--Q report for the second quarter 2004 (the "Second Quarter 2004 10--Q") filed August 6, 2004. See Complaint P 36, 40,46. n1 n1 Defendants argue that these statements are not actionable because they were made outside of the Class Period, citing In re Clearly Canadian Sec. Litig., 875 F. Supp. 1410, 1420 (N.D. Cal. 1995). However, Plaintiffs are not asserting securities fraud claims based upon the truth or falsity of these statements. Rather, these statements were submitted in support of the falsity of other statements made within the Class Period. To the extent that these statements are used to demonstrate the truth or falsity of Class Period statements, they are relevant. See, In re Scholastic Corp. Securities Litigation, 252 F.3d 63, 72 (2d Cir. 2001) (finding pre-class statements could be relevant in demonstrating the falsity of class period statements.) [*7] LEGAL STANDARD A court may dismiss a complaint pursuant to Federal Rule of Civil Procedure 12(b)(6) if a plaintiff pleads insufficient facts under an adequate theory. Robertson v. Dean Witter Reynolds, Inc., 749 F.2d 530, 533--34 (9th Cir. 1984). When deciding a motion to dismiss pursuant to Rule 12(b)(6), a court must take all of the material allegations in the plaintiffs complaint as true, and construe them in the light most favorable to the plaintiff. Parks School of Business, Inc. v. Symington, 51 F.3d 1480, 1484 (9th Cir. 1995). In the context of a motion to dismiss, review is limited to the contents of the complaint. Allarcom Pay Television, Page 3 2006 U.S. Dist. LEXIS 12166, *7; Fed. Sec. L. Rep. (CCH) P93,674 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 4 of 7 Ltd. v. General Instrument Corp., 69 F.3d 381, 385 (9th Cir. 1995). When matters outside the pleading are presented to and accepted by the court, the motion to dismiss is converted into one for summary judgment. However, matters properly presented to the court, such as those attached to the complaint and incorporated within its allegations, may be considered as part of the motion to dismiss. See Hal Roach Studios, Inc. v. Richard Feiner & Co., 896 F.2d 1542, 1555 n.19 (9th Cir. 1989). [*8] Where a plaintiff fails to attach to the complaint documents referred to therein, and upon which the complaint is premised, a defendant may attach to the motion to dismiss such documents in order to show that they do not support the plaintiff's claim. See 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 on other grounds). Thus, the district court may consider the full texts of documents that the complaint only quotes in part. See In re Stac Electronics Sec. Lit., 89 F.3d 1399, 1405 n.4 (1996), cert denied, 520 U.S. 1103, 117 S. Ct. 1105, 137 L. Ed. 2d 308 (1997). This rule precludes plaintiffs "from surviving a Rule 12(b)(6) motion by deliberately omitting references to documents upon which their claims are based." Parrino v. FHP, Inc., 146 F.3d 699, 705 (9th Cir. 1998). Rule 8(a) of the Federal Rules of Civil Procedure only requires "a short and plain statement of the claim showing that the pleader is entitled to relief." Accordingly, motions to dismiss for failure to state a claim pursuant to Rule 12(b)(6) are typically disfavored; [*9] complaints are construed liberally to set forth some basis for relief, as long as they provide basic notice to the defendants of the 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 requirements are more stringent. 1. Securities Fraud Under 10(b) of the Exchange Act and SEC Rule 10b--5 Plaintiffs have alleged securities fraud in violation of section 10(b) and SEC Rule 10b--5. Under section 10(b) it is unlawful "to use or employ in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [SEC] may prescribe." 15 U.S.C. 78j(b). Rule 10b--5, promulgated under Section 10(b), makes it unlawful for any person to use interstate commerce: (a) to employ any device, scheme, or artifice to defraud; (b) to make any untrue statement of material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances [*10] under which they were made, not misleading; or (c) to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security. 17 C.F.R. 240.10b--5. The elements of a Rule 10b--5 violation are: (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 alleged loss. See Binder v. Gillespie, 184 F.3d 1059, 1063 (9th Cir. 1999). In order to state a claim under section 10(b), a complaint must overcome several pleading barriers. First, when alleging fraud, Rule 9(b) of the Federal Rules of Civil Procedure requires plaintiffs to state with particularity the circumstances constituting the fraud. To meet the heightened pleading requirements of Rule 9(b), a fraud claim must contain three elements: (1) the time, place, and content of the alleged misrepresentations; and (2) an explanation as to why the statement or omission complained of was false or misleading. In re GlenFed, Inc. Sec. Litig., 42 F.3d 1541, 1547- (9th Cir. 1994). [*11] -49 Next, a plaintiff must overcome the heightened pleading requirements of the Private Securities Litigation Reform Act (the "PSLRA"). Congress enacted the PSLRA in 1995 to provide "protections to discourage frivolous [securities] litigation." H.R. Conf. Rep. No. 104--369, 104th Cong., 1st Sess. at 32 (Nov. 28, 1995). Under the PSLRA, complaints alleging misrepresentations or omissions, must "specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed." 15 U.S.C. 78u-4(b)(1). Additionally, the PSLRA imposed heightened requirements for pleading scienter. Under the PSLRA, a complaint must "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." 15 U.S.C. 78u-4(b)(2). The Ninth Circuit, in interpreting the PSLRA, has held that "a private securities plaintiff proceeding under the [PSLRA] must plead, in great detail, facts that constitute [*12] strong circumstantial evidence of deliberately reckless or conscious misconduct." In re Silicon Graphics Inc., 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 must dismiss the complaint. See 15 U.S.C. 78u-4(b)(1). Even if a plaintiff overcomes the falsity and scienter pleading barriers, the PSLRA's Safe Harbor provision provides that a securities fraud claim may not lie with respect to a statement that is "identified as a for- Page 4 2006 U.S. Dist. LEXIS 12166, *12; Fed. Sec. L. Rep. (CCH) P93,674 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 5 of 7 ward--looking statement, and is accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward--looking statement." 15 U.S.C. 78u-5(c)(1)(A)(I). A person may be held liable if the forwardlooking statement is made with "actual knowledge . . . that the statement was false or misleading." 15 U.S.C. 78u-5(c)(1)(B); No. 84 Employer--Teamster Joint Council Pension Trust Fund v. America West Holding Corp., 320 F.3d 920, 936 (9th Cir. 2003); but see In re Seebeyond Technologies Corp. Sec. Litig., 266 F. Supp. 2d 1150, 1164--65 (C.D. Cal. 2003) [*13] (disagreeing with the analysis in America West and finding that a defendant is immune from liability if it satisfies either 15 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, "a plaintiff must set forth more than the neutral facts necessary to identify the transaction. The plaintiff must set forth what is false or misleading about a statement, and why it is false. In other words, the plaintiff must set forth an explanation as to why the statement or omission complained of was false or misleading." In re GlenFed Sec. Litig., 42 F.3d 1541, 1548 (9th Cir. 1994). In the instant case, Plaintiffs have failed to plead specific facts indicating exactly how the March 15 Announcement was false or misleading. Plaintiffs cite the following language: We're excited to become part of GE[.] . . . This transaction will improve market reach of the merged companies and accelerate development of technology and products to protect the public worldwide. I look forward to InVision's scientists working with GE's [*14] Global Research Center and GE's CT medical imaging capabilities . . . The acquisition is subject to normal closing conditions including customary regulatory approval. March 15 Announcement Plaintiff's complaint does not adequately specify what exactly is false or misleading about this statement. Plaintiffs cite paragraphs 58 and 71, contending that these allegations are sufficient to meet this pleading requirement. The Court does not agree. The language cited by Plaintiffs contains broad assertions about Defendants' duty to disclose that are vague in nature. They are not specifically directed to the March 15 Announcement, and they do not explain why that statement in particular was false or misleading. Under the PSLRA, plaintiffs must clearly plead, for each and every statement, why the that statement was false or misleading. Id. A plaintiff does not meet this burden by citing general allegations which are not directed to particular statements. Id. Here, on the face of the Complaint, it is not possible to discern precisely what is false or misleading about the March 15 Announcement. In order to meet the scienter pleading requirement, Plaintiffs must plead facts showing [*15] that Defendants knew that each statement was untrue or misleading at the time 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 is made, and later turns out to be false. In re Copper Mountain 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, Defendants knew that statements made therein were false or misleading. Plaintiffs have failed to do so in the Complaint before the Court. 2. Safe Harbor The PSLRA created a safe-harbor for liability for statements which were forward--looking and accompanied by meaningful warnings of risk. 15 U.S.C. 78u5(c). However, a person may be held liable if the forward--looking statement is made with "actual knowledge . . . that the statement was false or misleading." 15 U.S.C. 78u--5(c)(1)(B); No. 84 Employer--Teamster Joint Council Pension Trust Fund v. America West Holding Corp., 320 F.3d 920, 936 (9th Cir. 2003). [*16] Defendants argue that the March 15 Announcement fits squarely within the safe--harbor provision of the PSLRA. "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." America West, 320 F.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 operational expectations for the upcoming merger and falls within the safe--harbor provision of the PSLRA as it was accompanied by meaningful cautionary language. Plaintiffs argue that "allegations based upon omissions of existing facts or circumstances do not constitute forward-looking statements protected by the safe harbor . . ." Opposition 12:7--9. For this proposition, they cite Page 5 2006 U.S. Dist. LEXIS 12166, *16; Fed. Sec. L. Rep. (CCH) P93,674 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 6 of 7 America West, 320 F.3d. at 936--7, and In re ESS Tech., Inc. Secs. Litig., 2005 U.S. Dist. LEXIS 2593 at *15 (N.D. Cal. 2005). However, the Court has reviewed these cases and has determined that they do not address the issue at hand - - [*17] whether the safe--harbor provision does or -does not cover statements alleged to be misleading due to omissions of existing facts or circumstances. Although the Court finds that the March 15 Announcement is "forward--looking" for the purposes of the PSLRA, the Court is unable to decide whether the safe-harbor provision protects the statement from liability. This is because, as discussed above, it is not clear from the face of the Complaint exactly what about the March 15 Announcement it is that Plaintiffs allege is false or misleading. Until that issue is clarified, the Court cannot rule on the issue of safe--harbor immunity. B. The Sarbanes--Oxley Certifications and the Merger Agreement+ 1. Falsity The Sarbanes--Oxley Certifications contain statements to the effect that Defendants: 1) designed and maintained disclosure controls; 2) evaluated the effectiveness of these disclosure controls; 3) disclosed any change in the registrant's internal control over financial reporting; 4) disclosed all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting; 5) disclosed any fraud that involves management or other employees [*18] who have a significant role over financial reporting. It is not clear from the Complaint precisely which of these statements Plaintiffs allege to be false or misleading. Although the Complaint contains general allegations, none of these plead facts clearly contradicting statements actually made within the Sarbanes--Oxley certifications. For example, Plaintiffs' complaint states that InVision "did not . . . maintain a system of internal controls adequate to uncover unlawful activities or to insure compliance with . . . the FCPA." Complaint, P 52. It is not obvious to which of the above statements this allegation is directed. Nowhere in the Sarbanes--Oxley Certifications do Defendants make any statements regarding the adequacy of systems designed to insure compliance with the FCPA. The Certifications do assert that Defendants have disclosed all material weaknesses related to financial reporting controls known by Defendants at the time the statement was made. However, Plaintiffs' allegations do not 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] to interpret Defendants' statements well beyond their plain meaning. n2 The Court declines to do so. For each statement identified, Plaintiffs are required by the PSLRA to plead facts indicating why that statement is false or misleading. GlenFed, 42 F.3d at 1548. Obviously, Plaintiffs' factual allegations must be based upon what Defendants actually said, not upon Plaintiffs' desired interpretation of what Defendants said. Here Plaintiffs' factual allegations, even viewed in the light most favorable to Plaintiffs, do not in any way illuminate the truth or falsity of Defendants' actual Certification statements. Therefore, Plaintiffs have failed to meet their PLSRA burden in this respect. n2 Under Plaintiffs' apparent reading, the Court would have to read Defendants' statement to say that Defendants warranted the presence of systems which were adequate to uncover any and all improper conduct, even conduct outside the realm of financial 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 defendants acted with scienter. Ronconi v. Larkin, 253 F.3d 423, 429 (9th Cir. 2001). Plaintiffs allege the following in support of an inference of scienter: 1) that the DOJ FCPA settlement agreement between InVision and the DOJ contained language to the effect that InVision was aware of a high probability that potential FCPA violations were occurring; 2) InVision lacked certain internal control mechanisms; 3) the alleged FCPA violations followed similar patterns, thereby allegedly necessitating the approval of management; 4) the alleged FCPA violations were improperly recorded in InVision's financial statements; 5) the Individual Defendants had motive to withhold information about the alleged FCPA violations. (Complaint, P 67--71; 77-78). Defendants argue that Plaintiffs fail to plead any substantial facts with respect to the Individual Defendants and the requisite state of mind. Other than general assertions about the Individual Defendants' roles and responsibilities and motivations, Plaintiffs do not plead specific facts to support the allegation that Magistri [*21] or Mulholland actually knew about the FCPA violations between March and July 2004. 3 Defendants contend that it is improper to infer that defendants Magistri or Mulholland had knowledge of certain information merely by virtue of their position within the company, citing In re Syncor Int'l Corp. Secs. Litig., 327 F. Supp. 2d 1149, 1160 (D. Cal. 2004) for support. The Court agrees. There are insufficient facts alleged to infer that Magistri or Mulholland had any knowledge of the alleged FCPA violations in light of the PLSRA's heightened scienter requirements. n3 Page 6 2006 U.S. Dist. LEXIS 12166, *21; Fed. Sec. L. Rep. (CCH) P93,674 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 7 of 7 n3 Plaintiffs cite In re Lattice Semiconductor Corp. Secs. Litig, 2006 U.S. Dist. LEXIS 262 (D. Or. 2006) for the proposition that the Court should impute scienter as to Magistri and Mulholland based upon their Sarbanes Oxley certifications. Plaintiffs' reliance on Lattice is misplaced as that case presented a significantly greater number of facts concerning the inference on scienter than exists in the instant case. In Lattice, the plaintiffs' allegations demonstrated that the company's former controller "made improper journal entries with the knowledge of at least some of the individual defendants." Id. at 32. Moreover, the Lattice plaintiffs provided evidence of specific internal reports, databases and meetings, the purpose of which was to keep the individual defendants informed of the company's financial situation during the relevant time period. Additionally, the Lattice defendants allegedly admitted that the improper accounting entries which formed the basis of the plaintiff's claim were the result of deficiencies in the company's internal disclosure controls. In contrast, in the instant case, Plaintiffs have not alleged any such similar facts concerning actual knowledge on the part of the Individual Defendants, nor have they alleged facts linking the Sarbanes Oxley certifications to later admissions of improper financial disclosure controls. Accordingly, Lattice is inapposite. [*22] Similarly, the Court rejects Plaintiffs' contention that scienter should be imputed to Invision based upon the scienter allegations concerning Magistri and Mulholland. Plaintiffs' allegations are inadequate to create an inference of corporate scienter on the part of InVision. In re Apple Computer, Inc., 243 F. Supp. 2d 1012, 1023 (ND. Cal. 2002) ("A defendant corporation is deemed to have the requisite scienter for fraud only if the individual corporate officer making the statement has the requisite level of scienter, i.e., knows that the statement is false, or is at least deliberately reckless as to its falsity, at the time that he or she makes the statement . . . the Ninth Circuit has rejected the concept of "collective scienter" in attributing scienter 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 under Federal Rule of Civil Procedure 15 should be liberally granted. "Dismissal with prejudice and without leave to amend is not appropriate unless it is clear . . . that the complaint could not be saved [*23] by amendment." Eminence Capital v. Aspeon Inc., 316 F.3d 1048, 1053 (9th Cir. 2003) (error to refuse leave to amend in a securities fraud case to allow plaintiff to plead scienter). Here, it is possible that Plaintiffs could remedy their significant pleading defects in an amended complaint by adding detailed factual support for their allegations of false or misleading statements, and demonstrating that Defendants had the requisite scienter at the time the statements were made. The Court thereby GRANTS the motion to dismiss the Amended Complaint without prejudice. CONCLUSION After consideration of the Amended Complaint in light of the heightened pleading standards of the PSLRA and the requirements of Federal Rule of Civil Procedure 12(b)(6), the Court GRANTS Defendants' Motion to Dismiss the Amended Complaint with leave to amend. n4 Plaintiffs must file any amended complaint within 30 days of the filing of this order. Should Plaintiffs choose to amend their complaint, Plaintiffs must: 1) Clearly identify the precise portions of each statement that is alleged to be false; 2) Immediately thereafter, plead specific [*24] facts clearly indicating that the statement was false, and facts clearly indicating that Plaintiffs acted with the requisite state of mind; 3) and plead any other facts required by the PLSRA with the requisite particularity. Vague assertions 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 UNITED STATES DISTRICT JUDGE Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 1 of 10 TAB 7 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 2 of 10 Slip Copy Slip Copy, 2005 WL 3050970 (D.Conn.), Fed. Sec. L. Rep. P 93,586 (Cite as: Slip Copy) Page 1 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. 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, 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 StoltNielsen, 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. 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 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 2006 Thomson/West. No Claim to Orig. U.S. Govt. Works. Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 3 of 10 Page 2 Slip Copy Slip Copy, 2005 WL 3050970 (D.Conn.), Fed. Sec. L. Rep. P 93,586 (Cite as: Slip Copy) 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 anticompetitive arrangement. 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 StoltNielsen 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 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 pricefixing 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[ ] 2006 Thomson/West. No Claim to Orig. U.S. Govt. Works. Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 4 of 10 Page 3 Slip Copy Slip Copy, 2005 WL 3050970 (D.Conn.), Fed. Sec. L. Rep. P 93,586 (Cite as: Slip Copy) $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 motion a 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. 2006 Thomson/West. No Claim to Orig. U.S. Govt. Works. Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 5 of 10 Page 4 Slip Copy Slip Copy, 2005 WL 3050970 (D.Conn.), Fed. Sec. L. Rep. P 93,586 (Cite as: Slip Copy) 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- 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 (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-LeachBliley 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 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. 78u4(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). 2006 Thomson/West. No Claim to Orig. U.S. Govt. Works. Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 6 of 10 Page 5 Slip Copy Slip Copy, 2005 WL 3050970 (D.Conn.), Fed. Sec. L. Rep. P 93,586 (Cite as: Slip Copy) 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 10b5. 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 2006 Thomson/West. No Claim to Orig. U.S. Govt. Works. Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 7 of 10 Page 6 Slip Copy Slip Copy, 2005 WL 3050970 (D.Conn.), Fed. Sec. L. Rep. P 93,586 (Cite as: Slip Copy) 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 anticompetitive 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 anticompetitive 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 2006 Thomson/West. No Claim to Orig. U.S. Govt. Works. Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 8 of 10 Page 7 Slip Copy Slip Copy, 2005 WL 3050970 (D.Conn.), Fed. Sec. L. Rep. P 93,586 (Cite as: Slip Copy) 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 SK; 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 2006 Thomson/West. No Claim to Orig. U.S. Govt. Works. Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 9 of 10 Page 8 Slip Copy Slip Copy, 2005 WL 3050970 (D.Conn.), Fed. Sec. L. Rep. P 93,586 (Cite as: Slip Copy) 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. (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 anticompetitive 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 anticompetitive 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 anticompetitive 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 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 2006 Thomson/West. No Claim to Orig. U.S. Govt. Works. Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 10 of 10 Page 9 Slip Copy Slip Copy, 2005 WL 3050970 (D.Conn.), Fed. Sec. L. Rep. P 93,586 (Cite as: Slip Copy) 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 2006 Thomson/West. No Claim to Orig. U.S. Govt. Works. TAB 8 Slip Copy Slip Copy, 2006 WL 1699603 (D .Conn .) (Cite as : Slip Copy) Page 1 0 Bri efs 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 similarly situated, Plaintiffs , v. STOLT-NIELSEN S .A., Jacob Stolt-Nielsen, Niels G. StoltNielsen, Samuel Cooperman, and Reginald Jr . Lee, Defendants . 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 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 lOb-5, 17 C .F .R. 240 .10b-5 , promulgated thereunder, against StoltNielsen 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 plaintiffs' complaint . On November 10, 2005, this court granted defendants' motion to dismiss plaintiffs' previous complaint, and dismissed this case with prejudice. Upon reconsideration, this court amended its judgment to a dismissal without prejudice to filing an amended complaint on or before March 1, 2006 . Plaintiffs did file a Second Consolidated 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 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) . 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 engages 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 period 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 operators in the world, and several of SNTG's largest customers are among the world's major chemical companies . Plaintiffs FNI allege that, for the period of May 31, 2000 through February 20, 2003, SNTG engaged in a scheme to fix shipping rates, rig bids, and allocate customers . According to plaintiffs, certain SNTG employees made agreements with major competitors to coordinate bidding and divide customer contracts between themselves. SNTG employees al- 2006 Thomson/West. No Claim to Orig. U.S . Govt. Works . Slip Copy Slip Copy, 2006 WL 1699603 (D .Conn .) (Cite as : S lip Copy) Page 2 legedly met with 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 . FN 1 . Plaintiffs also allege that SNTG may have begun its anti-competitive conduct as early as 1998 . *2 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, 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 division increased to $19 .9 million for the full year of 2000 from $17 .8 million in 1999 . While pricing remains competitive 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 operations 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 repositioning 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 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. , 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 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., 64 (March 27, 2002)); *3 "[w]hile the results in the second quarter for the StoltNielsen 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 . . . . 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 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 leve l 2006 Thomson/West. No Claim to Orig. U.S . Govt. Works . Slip Copy Slip Copy, 2006 WL 1699603 (D .Conn .) (Cite as : S lip Copy) Page 3 of 77 .7% although the business continues to see a tight p ri- Plaintiffs allege that defendants engaged in fraudulent conFN2 cing environment," ( id., 68 ( October 8, 2002)) . duct that affected the purchase or sale of SNSA ' s ADRs. Specifically, plaintiffs claim that defendants had a duty to disclose to the investing public the nature and scope of their FN2 . All emphasis appears as it exists in the comanti-competitive agreements with other parcel tanker complaint . panies, and that defendants acted with scienter . Plaintiffs claim that defendants' failure to disclose Stolt's alleged anti-competitive conduct rendered these statements false or 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 all 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. 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 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 *4 Although the parties invite this court to do so, this court will not revisit its prior holdings in the absence of new allegations addressed thereto. Specifically, the court adheres to the following holdings : defendants' statements regarding competition in the marketplace, including each of the statements 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' statements. 3 With respect to the new allegations, the court holds as follows. FN3 . The court, however, elaborates upon its conclusions herein . See infra, II.B.3 . 1 . SCIENTER In order to successfully plead scienter under the PSLRA, an d pri or Second Circuit precedent, a plaintiff must "state facts with particularity that give ri se 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 ari sing 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 con- 2006 Thomson/West. No Claim to Orig. U.S . Govt. Works . Slip Copy Slip Copy, 2006 WL 1699603 (D .Conn .) (Cite as : Slip Copy) Page 4 stituting circumstantial evidence of either reckless or conscious 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 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. "[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 . *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 Cooperman, 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- 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 an d 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 Kenneth 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 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 : 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 costbenefit analysis prepared by Stolt regarding the profitability of conspiring with Odfjell versus `going to war' with Odfjell," (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 conspiracy with Odfjell, (id., 38) . Plaintiffs allege that, according to the Department of Justice, the April 10, 2001 fax was prepared in response to a request from Jacob StoltNielsen 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 announcement regarding the Dow contracts in which he referenced 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 shipping 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- 2006 Thomson/West. No Claim to Orig. U.S . Govt. Works . Slip Copy Slip Copy, 2006 WL 1699603 (D .Conn .) (Cite as : Slip Copy) Page 5 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 Cooperm an declined to do so , and that O 'Brien resigned in protest on March 1 , 2002 . According to plaintiffs , O'Bri en also voiced his concerns to "the highest autho rities in both SNTG and SNSA," (dkt .# 55, 52), including "Alan Winsor, 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 improper collusive behavior in our parcel tanker and intraEurope 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 Division ") 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 conscious 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 allege that Jacob Stolt-Nielsen commissioned a study regarding 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 comments 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- ent basis for holding Messrs . Cooperman and Lee personally 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 they were 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 complaint. There is no secondary liability for violating Section 10(b), such as by aiding and abetting the person primarily liable for violating Section 10(b) . See Central Bank of Denver. 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 misstatement or omission indicating an intent to deceive or defraud in connection with the purchase or sale of a security ."). The Court of Appeals for the Second Circuit has further held that "a secondary actor cannot incur primary liability under the Act for a statement not attributed to that actor at the time of its dissemination . . . . Thus, the misrepresentation 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 permitted 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 rejected 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 rejecting the defendant's argument, the court found that plaintiffs had alleged that the defendant "was involved i n 2006 Thomson/West. No Claim to Orig. U.S . Govt. Works . Slip Copy Slip Copy, 2006 WL 1699603 (D .Conn .) (Cite as : S lip Copy) Page 6 the drafting, producing, or reviewing and/or disseminating of the false and misleading statements issued by" the corporation ; "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 insider could be liable for misstatements attributed to the corporation 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 anticompetitive 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 disclose 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 improper 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 because SNSA was either a mere conduit for SNTG, through Cooperman and Lee, to perpetrate a fraud or was a coconspirator. As one court has aptly stated, "[t]o hold otherwise 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 disseminating the subsidiary's false information ." In re LaBranche Sec. Lit. . 405 F.Supp.2d at 352 . These allegations form a sufficient basis to hold SNTG, Cooperman, and 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 parcel 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 environment, when in fact it was not. Plaintiffs also allege that SNTG used many means to provide services to their customers, 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 success was achieved in a competitive environment for all services 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 disclosure of the omitted fact would have been viewed by th e 2006 Thomson/West. No Claim to Orig. U.S . Govt. Works . Slip Copy Slip Copy, 2006 WL 1699603 (D .Conn .) (Cite as : S lip Copy) Page 7 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. 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 lOb-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)) ; 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 significant . Therefore, this court adheres to its prior holding rejecting 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 connection with the purchase or sale of securities . Although the court is reluctant to invite a third round of motions addressed to the pleadings, it is obliged to do so under the circumstances with respect to plaintiffs' claim of scheme liability . Plaintiffs raise this claim, which is entirely distinct from 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 complaint. 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 complexity 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 opportunity for defendants to address plaintiffs' scheme liability claim in another motion if they wish to do so . Any additional motion practice will not delay discovery . III . CONCLUSION For the reasons set forth herein, defendants' motion to dismiss (dkt .# 57) is DENIED . With respect to plaintiffs' scheme liability claim, defendants' motion is DENIED without prejudice ; defendants may file another motion addressing 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 order from this court. So ordered. D .Conn .,2006 . Menkes v . Stolt-Nielsen S .A . Slip Copy, 2006 WL 1699603 (D .Conn.) Briefs and Other Related Documents (Back to top) 2006 WL 1029079 (Trial Motion, Memorandum and Affidavit) Memor andum of Law in Further Support of Plaintiffs' Motion for Reconsideration and in Reply to Defendants' Opposition to Plaintiffs' Motion for Reconsideration (J an. 4, 2006) Original Image of this Document (PDF) 3 :03cv00409 (Docket) (Mar . 7, 2003) END OF DOCUMENT 2006 Thomson/West. No Claim to Orig. U.S . Govt. Works . Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 1 of 10 TAB 9 Page 1 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 2 of 10 LEXSEE 2005 U.S. DIST. LEXIS 22752 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 OF MISSOURI, EASTERN DIVISION 2005 U.S. Dist. LEXIS 22752 September 30, 2005, Decided PRIOR HISTORY: Montalvo v. Tripos, Inc., 2005 U.S. Dist. LEXIS 22753 (E.D. Mo., Sept. 30, 2005) For Tripos, Inc., John P. McAlister, B. James Rubin, Defendants: Cheryl W. Foung, Diane M. Walters, Lloyd Winawer, 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 UNITED STATES DISTRICT JUDGE. OPINIONBY: Stephen N. Limbaugh OPINION: MEMORANDUM Lead Plaintiffs have filed this second amended complaint on behalf of purchasers of Tripos common stock between February 9, 2000 and July 2, 2002, inclusive. They assert violations of Section 10- of the Securities -b Exchange Act of 1934 and Rule 10b- thereunder (Count -5 I - all defendants) and Section 20(a) of the Securities Exchange Act of 1934 (Count II - individual defendants only). This matter is before the Court on defendants Tripos, McAlister, and Rubin's motion to dismiss (# 56), filed August 4, 2004. Over an extended period of time, the parties have [*3] filed lengthy and extensive responsive pleadings and the matter is now ripe for disposition. Defendants seek to dismiss this second amended complaint for failure to state a claim under Rule 12(b)(6) Fed.R.Civ.P., in connection with the "heightened pleading requirements" of the Private Securities Litigation Reform Act of 1995 (PSLRA), 15 U.S.C. 78u- and for failure -4, to state a claim for "control person liability" under Section 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. COUNSEL: [*1] For David Montalvo, individuallyy and on behalf of all others similarly situated, Plaintiff: Caroline Marshall, Kirk Chapman, MILBERG AND WEISS, New York, NY; David A. Rosenfeld, Samuel H. Rudman, LERACH AND COUGHLIN, LLP, Melville, NY; Don R. Lolli, DYSART AND TAYLOR, Kansas City, MO; J. Allen Carney, Marcus N. Bozeman, Tiffany Wyatt, CAULEY AND BOWMAN, Little Rock, AR; Marc A. Topaz, SCHIFFRIN AND BARROWAY, LLP, Radnor, PA; Martin W. Blanchard, SAUERWEIN AND BLANCHARD, P.C., Clayton, MO. For Deborah Schneider, Consolidated Filer Plaintiff: Don R. Lolli, DYSART AND TAYLOR, Kansas City, MO. For Roman Korbiak, Consolidated Filer Plaintiff: Don R. Lolli, DYSART AND TAYLOR, Kansas City, MO; Caroline Marshall, Kirk Chapman, MILBERG AND WEISS, New York, NY. For Kenneth L. Riney, individually and on behalf of all others similarly situated, Consolidated Filer Plaintiff: Don R. Lolli, DYSART AND TAYLOR, Kansas City, MO; Joseph R. Seidman, Jr., Mel E. Lifshitz, BERNSTEIN AND LIEBHARD, New York, NY. For W. Kent Kruske, individually and on behalf of all others similarly situated, Consolidated Filer Plaintiff: Don R. 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. Page 2 2005 U.S. Dist. LEXIS 22752, *3 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 3 of 10 78t(a). They aver, among a myriad of other things, that plaintiffs have continued to fail to 1) state with any particularity that any defendant acted with the required state of mind (scienter); 2) state with any particularity why any challenged statement was false or misleading when made; 3) state with any particularity all necessary facts forming the basis for the allegations regarding a "conspiracy" to commit deliberate accounting fraud; and 4) state with any particularity the acts committed by the individual defendants in connection with the alleged accounting fraud. The second amended complaint generally consists [*4] of two (2) primary claims: Firstly, that the defendants made or participated in making false and/or misleading statements leading to a "scheme to defraud" or course of conduct designed to operate as a fraud or deceit upon plaintiffs as investors between February 2000 and July 2002. They contend that defendants knew of certain events, including but not limited to, a lost software contract and improper accounting methods, which when eventually disclosed, caused a significant drop in the stock value. Lead Plaintiffs allege that despite knowledge of the negative events and accounting irregularities, defendants continued throughout 2001 to forecast extremely positive revenues 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 forecasts in making such purchases. Secondly, that defendant Ernst & Young, as outside auditor and accountant for Tripos, while performing audits: "falsely represented that it performed these audits in accordance with Generally Accepted Auditing Standards (GAAS) and issued materially false and misleading unqualified audit opinions as to those financial statements [*5] during the Class Period, claiming that the financial statements were prepared and presented in accordance with Generally Accepted Accounting Principles (GAAP). Additionally, E&Y consented to the use of its unqualified opinion letters for Tripos' financial statements contained in the Company's respective Form 1--Ks for fiscal 1999, 2000, and 2001.. E&Y also prepared and assisted Tripos in issuing the Company's materially false and misleading Form 10--Qs during the Class Period." Second Amended Complaint (# 31), filed May 5, 2004; pg. 6, P18. In passing on a motion to dismiss, a court must view the facts alleged in the complaint in the light most favor- able to the plaintiff. Scheuer v. Rhodes, 416 U.S. 232, 40 L. 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). The court must accept the allegations in the complaint as true and draw reasonable inferences in favor of the nonmoving party, dismissing the complaint only if "it appears beyond a reasonable doubt that plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Conley v. Gibson, supra, 355 U.S. at 45-46; [*6] see also, Moses.com Securities v. Comprehensive Software Systems, Inc., 406 F.3d. 1052, 1062 (8th Cir. 2005). "Although the pleading standard is liberal, the plaintiff must 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. Golden Sky Sys., 298 F.3d. 736, 740 (8th Cir. 2002). In viewing the complaint in the light most favorable to the plaintiff, the court should not dismiss it merely because the court doubts that the plaintiff will be able to prove all of the necessary allegations. Bennett v. Berg, 685 F.2d. 1053, 1058 (8th Cir. 1982). Thus, a motion to dismiss is likely to be granted "only in the unusual case in which a plaintiff includes allegations that show on the face of the complaint 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 Rule 10b--5 Plaintiffs allege violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b- Section -5. 10(b) and Rule 10b- prohibit fraudulent [*7] conduct in -5 the sale and purchase of securities. Section 10(b) 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 Commission "rules and regulations". Dura Pharmaceuticals v. Broudo, U.S. , 161 L. Ed. 2d 577, 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- (8th Cir. 2005); In re: K--Tel -54 International. Inc. Securities Litigation, 300 F.3d. 881, 888 (8th Cir. 2002); In re: Navarre Corp. Securities Litigation, 299 F.3d. 735, 741 (8th Cir. 2002). Rule 10b5 forbids, among other things, the making of any "untrue statement of material fact" or the omission of any material fact "necessary in order to make the statements made . . . not misleading." Dura Pharmaceuticals, 125 S.Ct. at 1631 citing 17 C.F.R. 240.10b--5 (2004). Private securities fraud actions brought under Section 10(b) and Rule 10b--5 require the pleading [*8] and showing of these elements: 1) a material misrepresentation or omission; 2) scienter (a wrongful state of mind); 3) a con- Page 3 2005 U.S. Dist. LEXIS 22752, *8 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 4 of 10 nection with the purchase or sale of a security; 4) reliance or "transaction causation"; 5) economic loss; and 6) "loss causation" or a causal connection between the material misrepresentation and the loss. Dura Pharmaceuticals, 125 S.Ct. at 1631; see Ferris, Baker Watts, at 854; Ktel, at 888; Navarre, at 741. Since Section 10(b) and Rule 10b--5 actions are grounded in fraud, the more stringent pleading standards of Rule 9(b) Fed.R.Civ.P. are applicable. 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 Sporting Goods Co., 943 F.Supp. 1143, 1152 (E.D.Mo. 1996). Pursuant to Rule 9(b) Fed.R.Civ.P., all allegations of fraud must be stated with particularity. To meet the requirements of Rule 9(b), a pleading must include "such matters as the time, place, and contents [*9] of false representations, as well as the identity of the person making the misrepresentation and what was obtained or 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 of Rule 9 requires plaintiffs to "specify the statements contended to be fraudulent, identify the speaker, state when and where the statements were made, and explain why the statements were fraudulent." In re BankAmerica Corp. Securities Litigation, 78 F.Supp.2d. 976, 987 (E.D.Mo. 1999)(citation omitted). "Conclusionary allegations that a defendant's conduct was fraudulent and deceptive are not 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 requirements of Rule 9 Fed.R.Civ.P. Ferris. Baker Watts, at 854; K-tel, at 889; see Navarre, at 742 [*10] (given that the PSLRA embodies the pleading requirements of Rule 9, plaintiffs do not need to meet the requirements of both, and the PSLRA supercedes; i.e. under Rule 9 state of mind can be averred generally; however, under the PSLRA, both falsity and scienter must be pleaded with particularity). Complaints brought under Section 10(b) and Rule10b--5 are governed by special heightened pleading standards adopted by Congress in the PSLRA. These heightened pleading standards are unique to securities actions and were adopted by Congress in an attempt to curb abuses of securities fraud litigation. Kushner v. Beverly Enterprises, 317 F.3d. 820, 826 (8th Cir. 2003) citing Navarre, at 741; see Chambers v. AMDOCS Ltd. (In re AMDOCS Ltd. Secs. Litig.),390 F.3d 542, 547 (8th Cir. 2004) citing Navarre, at 741. The PSLRA requires plaintiffs "to specify each misleading statement or omission and specify why the statement or omission was misleading." Kushner, at 826; Navarre, at 741--42; 15 U.S.C. 78u--4(b)(1). The complaint must also "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." Kushner, at 826; Navarre, at 741--42; [*11] 15 U.S.C. 78u-4(b)(2); see Ferris. Baker Watts, at 854; K-tel, at 889. The Act requires that the allegations collectively establish a strong inference of the required state of mind. Kushner, at 826. Any complaint failing to meet these pleading requirements must be 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 up to the particularity requirements. Ferris, Baker Watts, at 853; 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 formula for assessing the adequacy of scienter allegations. After reviewing the tests promulgated by the other circuits to meet the Reform Act's "strong inference of scienter" standard, the appellate court fashioned its own criteria for indicia of fraud: "Therefore, we can say three things about motive and opportunity allegations. First, motive and opportunity [*12] are generally relevant to a fraud case, and a showing of unusual or heightened motive will often form an important part of a complaint that meets the Reform Act standard. Second, in some cases the same circumstantial allegations that establish motive and opportunity also give additional reason to believe the defendant's misrepresentation was knowing or reckless. For instance, in insider trading cases, the timing of trades shows motive and opportunity, but it may also provide additional circumstantial evidence that the defendant knew of an advantage. Such allegations may meet the Reform Act standard, but if so it is because they give rise to a strong inference of scienter, not merely because they establish motive and opportunity. Third, when the complaint does not show motive and opportunity of any sort either the unusual, heightened motive highlighted in the Second Circuit cases, or even an everyday motive such as keeping one's job - then other allegations tending to show scienter would have to be particularly strong Page 4 2005 U.S. Dist. LEXIS 22752, *12 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 5 of 10 in order to meet the Reform Act standard." Florida State Bd. of Admin. v. Green Tree, at 660. Mere negligence does not violate federal securities law; however, [*13] severe recklessness may. Ferris, Baker Watts, at 854 (citations omitted). "Specifically, scienter may be demonstrated by severe recklessness involving 'highly unreasonable omissions or misrepresentations' amounting to 'an extreme departure from the standards of ordinary care, and that present a danger of misleading buyers or sellers which is either known to the defendant or is so obvious that the defendant must have been aware of it.' Recklessness, then, may be shown where unreasonable statements are made and the danger of misleading investors is so obvious that the defendant must have been aware of it." Kushner, at 828 citing K & S P'ship v. Cont'l Bank, N.A., 952 F.2d 971, 978 (8th Cir. 1991); see also, Ferris, Watts Baker, at 854. "This level of recklessness requires that defendants make statements that they know, or have access to information suggesting, are materially inaccurate." Ferris, Baker Watts, at 854 citing Navarre, at 746. The second amended complaint sets forth numerous public statements made by the defendants during the class period that the plaintiffs investors believe give rise to a strong inference of scienter [*14] because the defendants knew facts or had access to information that suggested that their public statements were not accurate and/or deliberately engaged in making false and misleading statements in order to defraud the investors as to the true financial condition of defendant Tripos. Examples of some of these allegedly inaccurate statements are as follows: 1) By late 2001 defendants were aware that Tripos had serious problems with its consulting line of business, including but not limited to, problems with multi--million dollar consulting contracts with Bristol Myers Squibb and Merck; and had missed a milestone in its consulting contract with Bayer AG resulting in the loss of a $1 million -- $1.5 million payment; however, Tripos, beginning on January 9, 2002 began issuing a series of press releases claiming that 2002 would be a bigger financially successful year than 2001 with a projected growth rate (including the consult- ing services business) of at least 25%. 2) Tripos reiterated its "aggressive growth expectations" in its February 6, 2002 press release. In response to its January 2002 and February 2002 press releases, Tripos stock closed at all-time highs. 3) Again, [*15] in March 2002, Tripos released a press release reaffirming its highly profitable sales and revenues expectations for 2002, stating them to be in the $60- mil-65 lion dollar range, and fully diluted earnings per share in a range from $.64 to $.70. 3) Finally, on April 24, 2002, Tripos issued a press release announcing the results for its first quarter of 2002: a 28% increase in revenues and a 23% increase in operating income. It further reiterated its firm belief in achieving its financial projections for 2002. 4) These press releases were issued proclaiming huge increases in revenue and operating income despite the alleged knowledge by the defendants that accounting regularities had fraudulently inflated revenues on financial statements from 1998--2002, including but not limited to: 1999 10--K, 1999 Annual Report, the first quarter 2000 10-Q, the second quarter 2000 10- the third -Q, quarter 2000 10- the 2000 10- the 2000 -Q, -K, Annual Report, the first quarter 2001 10--Q, the second quarter 2001 10--Q, the third quarter 2001 10- and the 2001 10-Q, -K. 5) Although losses had been sustained in connection with the Bayer AG and Bristol Myers Squibb consulting contracts, the defendants [*16] violated the GAAP by failing to record same. 6) On July 1, 2002, Tripos issued a press release revising downward its 2002 financial projections due in part to the severe ongoing problems in it consulting services business, including the missed milestone with the Bayer AG contract. 7) On July 24, 2002 Tripos issued another press release which continued to "mischaracterize" the reasons for its financial shortfall. It blamed the Bayer AG consulting contract event, even though problems had existed Page 5 2005 U.S. Dist. LEXIS 22752, *16 Case 5:04-cv-04156-JW since late 2001. Document 111 Filed 07/28/2006 Page 6 of 10 8) On February 12, 2004, Tripos announced the postponement of the release of its 2003 fourth quarter and year--end financial results due to its decision to "revise" its revenue recognition practice with respect to certain software licenses. The "revision" would require Tripos to restate its financial results for several prior years. 9) On March 31, 2004, Tripos announced that it had been improperly accelerating revenue and improperly accounting for its costs of sales on its time--based software arrangements since 1998 due to the "complexity of the accounting methods"; however, the basic software recognition policy that Tripos violated was stated in the original [*17] SOP 97- and in Tripos' own filings with the SEC. -2 Defendants counter that plaintiffs have failed to set forth the "particularities" as to why the statements are false or misleading. After careful review of the amended complaint, the Court finds that the plaintiffs have provided particulars about who made subject statements, when the statements were made, and demonstrated why the statements were allegedly false or misleading at the time they were made. While the defendants have spent considerable time and effort explaining how and why the statements are proper, none of these arguments undermine the plaintiffs' allegations at the pleading stage. The facts pleaded with particularity sufficiently create a strong inference of scienter, thus meeting the Reform Act standard. See, Green Tree Financial, at 667. Defendants further have contended that the statements contained in the subject press--releases are "forwardlooking" in substance and intent and thus are protected by the PSLRA's "safe harbor" provision of the PSLRA. 15 U.S.C. 78u-5(c)(1) and (2). The safe harbor provision protects forward-looking statements if they are identified and accompanied [*18] by risk disclosures, if they are immaterial, or if plaintiffs fail to prove that the person or persons making the subject statement(s) made them with actual knowledge that the statement was false or misleading. In re: Retek, Inc. Secs., 2005 U.S. Dist. LEXIS 35734, 2005 WL 1430296 (D.Minn. March 7, 2005); In re Pemstar, Inc., 2003 U.S. Dist. LEXIS 14452, 2003 WL 21975563 (D.Minn. Aug. 15, 2003). The safe harbor provision "does not insulate statements that misrepresent historical/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 that they simply are statements of future financial projections for 2002. Plaintiffs counter (with specific examples) that the subject statements were materially false and/or misleading when made because they omit adverse information concerning the problems that the defendants were then currently experiencing; i.e., had already missed a major milestone on the Bayer AG consulting contract and widespread customer dissatisfaction with the consulting divisions Metalayer system had already been expressed. Such [*19] problems were known and not insignificant when the statements were made; therefore, it was not that the statements were necessarily false but that defendants were in possession of material facts which they had a duty to disclose so as not to make such statements misleading. Furthermore, the Court concurs that any "cautionary language" was too generalized and "boilerplate" to make such language meaningful to the ordinary investor. The Court concludes that the safe harbor provision of the PSLRA is inapplicable. Defendants further contend that the plaintiffs' allegations of GAAP violations are not sufficient to plead the requisite scienter for the Section 10(b) and Rule 10b-5. The plaintiffs have alleged that the defendants were aware of the GAAP violations when made and were intentionally made to meet analysts' profitable expectations for the company. They assert that the restatements clearly show that the defendants failed to follow GAAP while accounting for Tripos' revenues derived from its "bundled software services" during the Class Period. It further contends that the accounting principles ignored are not "complex" as argued by the defendants, but rather are clear and specific [*20] as regards the recognition of revenue from the sale of software products and licences. Furthermore, plaintiffs argue that scienter is shown by the GAAP violations coupled with the restatements because the defendants blamed the need for restating Tripos' financial statements on "clarifying guidance" instead of the fact that they misapplied GAAP "that existed at the time the financial statements were prepared". Plaintiffs' assert that "In sum, the GAAP principles violated here were not complex or changing, but were long-standing and basic accounting principles. The Tripos defendants were charged with the responsibility of providing accurate statements of the Company's revenue and the individual defendants were sufficiently savvy to understand these principles and certainly had access to and information from others in the Company who did understand these principles well." Page 6 2005 U.S. Dist. LEXIS 22752, *20 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 7 of 10 Plaintiffs' Joint Memorandum of Law (# 64), pg. 44. Finally, plaintiffs contend that they have pled with sufficient particularity the GAAP violations at issue. They are: 1) Deferred the recording of estimated losses in excess of $829,000 on various contracts, including, primarily, the software [*21] consulting agreements with Bayer AG and Bristol Meyers Squibb (BMS), when GAAP required the immediate booking of the entire loss. Complaint P89. In addition, the Company failed to take a charge for the losses related to these two contracts in its interim financial statements. Complaint PP92, 96, 98. 2) Materially inflated revenues by $15.8 million for fiscal years 1998--2002, as well as net income and earnings per share by improperly accelerating revenues on time--based software arrangements by immediately recognizing the software portion of the arrangement rather than recognizing it ratably over the entire contract period as required by GAAP. Complaint PP86, 100--107. 3) Failed to identify and describe important judgments associated with its revenue recognition policy related to software licenses, in violation of specific GAAP provisions. Complaint PP86, 108--109. 4) Failed to disclose serious problems with its software consulting business and the dissatisfaction of some of its major customers, including that it had missed a major milestone with a significant customer and that customer's refusal to pay, in violation of GAAP provisions. Complaint PP4, 5, 50, 53, 57-65, 86--90, 98, [*22] 108--09. 5) Defendants improperly accounted for cost of sales, specifically royalty expense that was directly attributable to time--based software license arrangements in violation of GAAP. Complaint PP110--13. 6) Failed to design and implement an internal control system over the Company's contract estimation process sufficient to monitor contract compliance in order to recognize cost overruns on a timely basis. The fact that Tripos had to record two separate charges to income for contract losses incurred during the Class Period indicates an inadequate accounting and internal control system. Complaint PP119--20. Plaintiffs' Memorandum in Opposition (# 64), pgs. 47-48. Essentially, the plaintiffs argue that the accounting principles and standards that existed at the time of the original positive financial statements were clear and precise. They allege that the pervasiveness and indifference to the GAAP requirements resulting in such egregious violations, coupled with the fact that the restatements admit to these violations, evidences that Tripos intentionally misstated its revenues for its software licensing contracts throughout the Class Period. Defendants spend considerable [*23] time, not addressing the pleading standards but rather defending themselves against the allegations. "Allegations of GAAP violations are insufficient, standing alone, to raise an inference of scienter. Only where these allegations are coupled with evidence of corresponding fraudulent intent might they be sufficient." Ferris, Baker Watts, Inc. v. Ernst & Young, L.L.P., 395 F.3d. 851, 854 (8th Cir. 2005), aff'g 293 F.Supp.2d. 1003 (D.Minn. 2003) quoting In re Navarre, at 745 (citations omitted); 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 will ensure identical accounting treatment of identical transactions. [GAAP], rather, tolerate a range of 'reasonable' treatments, leaving the choice among alternatives to management." K--tel, at 890 quoting Thor Power Tool Co. v. C.I.R., 439 U.S. 522, 544, 58 L. Ed. 2d 785, 99 S. Ct. 773 (1979); In re Stellent, Inc. Securities Litigation, 326 F.Supp.2d. 970, 982 (D.Minn. 2004); Ferris, Baker Watts, 293 F.Supp.2d. at 1008. Here, the plaintiffs have alleged not only [*24] egregious GAAP violations, but also "evidence of corresponding fraudulent intent". They have set out with particularity the material misstatements in the public statements which omitted, among other things, the on-going problems with the software consulting business, and have set forth the GAAP violations which defendants do not deny as evidenced by their restatements. Essentially, the amended complaint alleges that defendants knew that certain company assets were impaired and that losses were certain, but that recognizing those losses (during the Class Period) would have lowered the company's stock price and threatened its ability to market and sell its products. The amended complaint further alleges that defendants delayed recognition of these losses in violation of GAAP, and delayed disclosure of these violations while publicly Page 7 2005 U.S. Dist. LEXIS 22752, *24 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 8 of 10 touting strong future profits and continued excellent business prospects with current customers. It is alleged that the "strategic non--disclosures" kept Tripos stock artificially high, attracting more investors, until the restatements were issued, causing a drastic stock price fall. The plaintiffs have identified specific documents and statements within those [*25] documents attributable to the defendants that allegedly artificially inflated Tripos' earnings and net tangible assets by deliberately hiding specific losses that were also identified. The allegations as a whole, taken as true, provide strong indicia of intentional wrongdoing on the part of the defendants. Evidence relevant to scienter includes: "insider trading in conjunction with false or misleading statements; a divergence between internal reports and public statements; disclosure of inconsistent information shortly after the making of a fraudulent statement or omission; bribery by top company officials; evidence of an ancillary lawsuit, charging fraud, which was quickly settled; disregard of current financial information acquired prior to the statement at issue; accounting shenanigans; and evidence 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 coupled there GAAP allegations with the "corresponding fraudulent intent" required under the Reform Act. Defendants [*26] assert that the plaintiffs have failed to adequately plead loss causation because the 2004 restatements were not announced until after the end of the Class Period, and moreover, little if any significant decline in the stock price occurred following these restatements. Thus, plaintiffs have failed to allege, and cannot allege, that their losses were causally related to the accounting allegations. Plaintiffs counter that the fact that the defendants waited until 2004 to announce its restatements due to GAAP violations should not insulate them from liability for issuing false statements during the Class Period. Plaintiffs contend that as of July 1, 2002 plaintiffs learned for the first time that the Company had missed a major milestone and that continued projected high earnings and revenue of past financial reports and statements had no basis in fact. This is when and why the stock price immediately dropped 61%. Plaintiffs further contend that "The February 12, 2004 restatement merely confirmed what 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." Lead Plaintiffs' Joint Response (# [*27] 82), pg.5. Plaintiffs further contend that their complaint is unlike the complaint considered by the Court in the recent case of Dura Pharmaceuticals, supra. because in the instant case the plaintiffs have not just generally pled that they had paid artificially inflated stock prices and suffered damages but, instead, have specifically set forth allegations of a causal connection between the stock price drop and the fraud committed; i.e., Tripos could not achieve its earnings targets because those targets were based on false financial statements. A private plaintiff who claims securities fraud must prove 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 United States Supreme Court considered what a plaintiff must allege and ultimately prove when establishing the element of "loss causation". Firstly, the Court considered the fact that "normally, in cases such as this one (i.e. fraud--on-the--market cases), an inflated purchase price will not itself 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 inflated purchase payment is offset by ownership of a share that at that instant possesses equivalent value. Moreover, the logical link between the inflated share purchase price and any later economic loss is not invariably strong. Shares are normally purchased with an eye toward a later sale. But if, say, the purchaser sells the shares quickly before the relevant truth begins to leak out, the misrepresentation will not have led to any loss. If, the purchaser sells later after the truth makes its way into the market place, an initially inflated purchase price might mean a later loss. But that is far from inevitably so. When the purchaser subsequently resells such shares, even at a lower price, that lower price may reflect, not the earlier misrepresentation, but changed economic circumstances, changed investor expectations, new industry--specific or firm--specific facts, conditions, or other events, which taken separately or together account 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 it would otherwise have been - -- a claim we - Page 8 2005 U.S. Dist. LEXIS 22752, *29 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 9 of 10 do not consider here.) Other things being equal, the longer the time between purchase and sale, the more likely that this is so; i.e., the more likely that other factors caused the loss." Id., 125 S.Ct. at 1631--32. The Court went on to recognize that a higher purchase price "will sometimes play a role in bringing about a future loss"; and thus, an inflated purchase price suggests that "the misrepresentation "touches upon" a later economic loss. Id., 125 S.Ct. at 1632. However, the law requires that such a misrepresentation cause a loss, not just merely "touch upon" a loss. Id., 125 S.Ct. at 1632. The Supreme Court continued to reason that the PSLRA requires specificity in securities fraud complaints because securities statutes "seek to maintain public confidence in the marketplace" and do by providing for private securities fraud actions; however, "the statutes make these latter actions available, not to provide investors with broad insurance against market losses, but to protect them against those economic losses that misrepresentation [*30] actually cause." Id., 125 S.Ct. at 1633. Given what a private securities fraud action must prove as to "loss causation", the Supreme Court held that simply alleging the existence of an "artificially inflated purchase price" is not itself a relevant economic loss. That alleging nothing more than the plaintiffs paying "artificially inflated prices" for certain securities, and that as a result plaintiffs suffered "damages" is not sufficient to adequately plead loss causation. Id., 125 S.Ct. at 1634. A complaint that alleges only this fails to provide a defendant with notice, as required of Rule 8 Fed.R.Civ.P., of what the relevant economic loss might be or of what the causal connection might be between the loss and the alleged misrepresentation. Id., 125 S.Ct. at 1634. Such lack of notice and causal connection is exactly the kind of harm the securities statutes were designed to eliminate. Id., 125 S.Ct. at 1634. Upon review of the plaintiffs' second consolidated amended complaint and given the Supreme Court's recognition that "ordinary pleading rules are not meant to impose a great [*31] burden upon a plaintiff", the Court finds that the plaintiffs have sufficiently alleged a causal connection between the purported fraud and the inflated stock price. Dura Pharmaceuticals, 125 S.Ct. at 1634 (citation omitted). Plaintiffs also assert claims against the individual defendants McAlister (Tripos' Chief Executive Officer, President, and a director) and Rubin (Tripos' Chief Financial Officer and Senior Vice--President as of October 2001) under 20(a) of the Exchange Act. Section 20(a) of the Exchange Act imposes liability on "every person who, directly or indirectly, controls any person liable" under the Exchange Act; and such liability should be imposed "unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action." A "control person" relationship exists whenever "(i) the alleged control person actually exercised control over the general operations of the primary violator and (ii) the alleged control person possessed----but did not necessarily exercise---the power to determine the specific acts or omissions upon which the underlying violation is predicated." Farley v. Henson, 11 F.3d. 827, 835 (8th Cir. 1993); [*32] see, Metge v. Baehler, 762 F.2d. 621, 624 (8th Cir. 1985); Stephenson v. Deutsche Bank 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 to be construed liberally. It has been interpreted as requiring only some indirect means of discipline or influence short of actual direction to hold a 'controlling person' liable." Farley, at 836 quoting Myzel v. Fields, 386 F.2d. 718, 738 (8th Cir. 1967); Stephenson, at 1059 (quoting both Farley and Myzel, supra.); see also, Martin v. Shearson Lehman Hutton, 986 F.2d. 242, 244 (8th Cir. 1993)(statute reaches persons who have only some indirect means of discipline or influence less than actual direction). Section 20(a) can impose liability upon "corporate officers and directors, even in those cases in which they did not directly participate in the bad acts." In re Acceptance Insurance Companies Sec. Litig., 352 F.Supp.2d. 940, 957 (D.Neb. 2004), aff'd [*33] 423 F.3d 899, 2005 U.S. App. LEXIS 18571, 2005 WL 2060912 (8th Cir. 2005) citing Metge v. Baehler, at 631. Finally, Section 20(a) is not subject to the heightened pleading standards of either the Reform Act or Rule 9(b) Fed.R.Civ.P. Stephenson, at 1060 citing In re Initial Pub. Offering Sec.Litig., 241 F.Supp.2d. 281, 397 n.185 (S.D.N.Y. 2003). Given the above-referenced legal principles, and in light of the Court's determination that the plaintiffs have sufficiently pled claims against these defendants for violations of Section 10(b) and Rule 10b-5, the Court will not dismiss the plaintiffs' claims against the individual defendants based on liability under Section 20(a). The parties have spent considerable time and effort arguing the "merits" of the second amended consolidated complaint; however, the bottom line is that the plaintiffs have pleaded that during the Class Period, the defendants had in their possession (or could have easily obtained) facts which rendered their financial results materially false when first stated to the investing public, and given these facts, intentionally delayed recognition of these "facts" in violation [*34] of GAAP, then intentionally delayed Page 9 2005 U.S. Dist. LEXIS 22752, *34 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 ORDER Page 10 of 10 recognition of the GAAP violations in order to induce plaintiffs to continue investing in a "profitable" enterprise. Without a doubt the "merits" of the allegations as presented can be argued fervently; however such a debate involves questions of fact "that cannot render the complaint[s] inadequate, lest the heightened pleading requirements of the Reform Act replace the function of a trial." Green Tree, at 666. The plaintiffs have satisfied the Reform Act standard and the defendants' motion to dismiss will be denied. Dated this 30th day of September, 2005. Stephen N. Limbaugh SENIOR UNITED STATES DISTRICT JUDGE In accordance with the memorandum filed herein this date, IT IS HEREBY ORDERED that defendants Tripos, McAlister, and Rubin's motion to dismiss (# 56) be and is DENIED. Dated this 30th day of September, 2005. Stephen N. Limbaugh SENIOR UNITED STATES DISTRICT JUDGE Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 1 of 15 TAB 10 Case 5:04-cv-04156-JW Slip Copy Slip Copy, 2005 WL 2347125 (N.D.Cal.) (Cite as: Slip Copy) Document 111 Filed 07/28/2006 Page 2 of 15 Page 1 Briefs and Other Related Documents Only 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, Michael 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 Piper Rudnick Gray Cary LLP, East Palo Alto, CA, for Defendants. ORDER DISMISSING PLAINTIFF'S COMPLAINT WITHOUT PREJUDICE JENKINS, J. INTRODUCTION *1 Before the Court is Defendants' motion to dismiss this private securities fraud action. Plaintiff Thomas O. Morgan FN1 ("Plaintiff"), representing a purported class of all purchasers of AXT, Inc., stock between February 6, 2001, and April 27, 2004, opposes the motion. For the following reasons, the Court GRANTS Defendants' motion to dismiss, but GRANTS Plaintiff leave to amend. FN1. In an Order dated February 2, 2005, the Court granted Plaintiff Morgan's motion for appointment as lead plaintiff. FACTUAL BACKGROUND A. Background Defendant AXT, Inc.'s ("AXT" or the "Company") is a publicly-traded company that manufactures semiconductor parts, known as substrates, used by a variety of electronic products including wireless and fiber optic telecommunciations, lasers, light emitting diodes, satellite solar cells, and consumer electronics such as cell phones. AXT sells compound semiconductor non-silicon substrates manufactured from gallium arsenide, indium phosphide, and germanium. AXT employs its proprietary Vertical Gradient Freeze method for manufacturing the non-silicon substrates. During the period of time at issue in the instant lawsuit (February 6, 2001, through April 27, 2004 (the "Class Period")), AXT also produced and sold light-emitting diodes ("LEDs") and vertical cavity surface emitting laser chips through its optoelectronic division. AXT sold its products to original equipment manufacturers ("OEMs"). The particular testing required and characteristics of those AXT products were determined by the OEMs. Defendant Dr. Morris S. Young ("Defendant Young") served as the Company's CEO and Chairman of the Board during the Class Period. On February 6, 2001, AXT issued a press release reporting the Company's strong commitment to its customers and touting AXT's customers' confidence in AXT. The press release referenced the Company's "supply of high quality substrates" and reported that AXT was "pleased to support [its] strategic customers' substrate requirements for the year and believe[d] that the value of the contracts under th[e] [Supply Guarantee Program] is a good indicator of [AXT's] ability to deliver continued revenue and profit expansion." (Complaint ("Comp."), 31.) On February 26, 2001, the Company filed its annual report for FY 2000 on Form 10-K with the SEC. The 10-K stated: "We believe that our success is partially due to our manufacturing efficiency and high product yields and we continually emphasize quality and process control throughout our manufacturing operations." The 10-K also explained that AXT's policy was to recognize revenue when its products were shipped to the customer as long as, inter alia, there are no customer acceptance requirements and no remaining significant obligations. (Id., 32.) On April 25, 2001, AXT issued a press release announcing its financial results for the first quarter of 2001. The Company reported that revenue was up a record $40.1 million and that net income was up $5 million. In the press release, AXT expressed its belief that its products' "strong engineering design and development capability allows [AXT] to tailor [its] standard products to meet customer specific require- 2006 Thomson/West. No Claim to Orig. U.S. Govt. Works. Case 5:04-cv-04156-JW Slip Copy Slip Copy, 2005 WL 2347125 (N.D.Cal.) (Cite as: Slip Copy) Document 111 Filed 07/28/2006 Page 3 of 15 Page 2 ments and gives [AXT] competitive advantages." (Comp., 33.) On May 3, 2001, AXT filed its quarterly report on Form 10-Q with the SEC, reaffirming the Company's previously announced financial results for the first quarter of 2001. *2 On July 25, 2001, AXT issued a press release announcing its financial results for the second quarter of 2001. The Company reported that revenue reached a record $41.3 million and that net income was up $5.2 million. On August 1, 2001, AXT filed its quarterly report on Form 10-Q with the SEC, reaffirming the Company's previously announced financial results for the second quarter of 2001. On October 24, 2001, AXT issued a press release announcing its financial results for the third quarter of 2001. The Company announced that reported net losses for the quarter but stated that "strategic research and development investments are positioning AXT well for continued leadership" and that the Company's "VFG gallium arsenide and indium phosphide substrates continue to offer superior features for manufacturers of high quality electronic and opto-electronic devices." The press release went on to say that AXT "believe[s] that [it] remain[s] the world leader in providing both products." (Comp., 38.) On November 7, 2001, AXT filed its quarterly report on Form 10-Q with the SEC, reaffirming the Company's previously announced financial results for the third quarter of 2001. On February 6, 2002, AXT issued a press release announcing its financial results for the fourth quarter of 2001 and for FY 2001. The Company again reported that its specialized substrates "continue to offer superior features for manufacturers of high quality electronic and opto-electronic devices" and that the Company "expect[ed] an increasing number 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 financial results for the fourth quarter and for FY 2001, and including the same description of AXT's revenue recognition policy described in its FY 2000 annual report. On April 24, 2002, AXT issued a press release announcing its financial results for the first quarter of 2002. The Com- pany reported net losses for the quarter but stated that its reputation for LED quality, value, and delivery was growing. On May 3, 2002, AXT filed its quarterly report on Form 10-Q with the SEC, reaffirming the Company's previously announced financial results for the first quarter of 2002. On July 24, 2002, AXT issued a press release announcing its financial results for the second quarter of 2002. The Company reported that revenue increased 14 % and stated, "We are particularly pleased with the growth of our LED division, which has recorded double digit revenue growth for the past three quarters, efficiently increased manufacturing capacity 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 financial results for the second quarter of 2002. Defendant Young also filed a certification pursuant to the Sarbanes-Oxley Act that the "information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company." *3 On October 23, 2002, AXT issued a press release announcing its financial results for the third quarter of 2002. The Company reported that "AXT will continue to benefit from the strength of our technology." (Comp., 48.) On November 12, 2002, AXT filed its quarterly report on Form 10-Q with the SEC, reaffirming the Company's previously announced 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 officer concluded that our disclosure controls and procedures are effective." On February 5, 2003, AXT issued a press release announcing its financial results for the fourth quarter of 2002 and for FY 2002. On March 21, 2003, AXT filed its Form 10-K annual report with the SEC. In the 10-K, the Company stated, "the lives of our substrate products are relatively long and accordingly, obsolescence has historically not been a significant factor." The Company again described its revenue recognition policy, as it had in its 2000 and 2001 annual reports. The 10-K also contained a certification, pursuant to the requirements of the Sarbanes-Oxley Act, averring that 2006 Thomson/West. No Claim to Orig. U.S. Govt. Works. Case 5:04-cv-04156-JW Slip Copy Slip Copy, 2005 WL 2347125 (N.D.Cal.) (Cite as: Slip Copy) Document 111 Filed 07/28/2006 Page 4 of 15 Page 3 the report "does not contain any untrue statement of material fact or omit to state a material fact" and that the financial statements" fairly present in all material respects the financial condition" of the Company. On April 23, 2003, AXT issued a press release announcing its financial results for the first quarter of 2003. The Company 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 financial results for the first quarter of 2003. The 10-Q reported certified that the Company's "disclosure controls and procedures are effective." On July 23, 2003, AXT issued a press release announcing its financial results for the second quarter of 2004. The Company reported net losses. On August 12, 2003, AXT filed its quarterly report on Form 10-Q with the SEC, reaffirming the Company's previously announced financial results for the second quarter of 2003. The 10-Q again contained a certification regarding disclosure controls and procedures as the May 10-Q had. On October 22, 2003, AXT issued a press release announcing its financial results for the third quarter of 2003. The Company 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 financial results for the third quarter of 2003, and containing certifications regarding the Company's disclosure controls and procedures. On February 4, 2004, AXT issued a press release announcing its financial results for the fourth quarter of 2003 and for FY 2003. On March 29, 2004, AXT filed its Form 10-K annual report with the SEC. The 10-K certified that the Company's disclosure controls and procedures were effective and that the report contained no "untrue statement[s] of material fact" and did not "omit to state a material fact" and that the financial statements" fairly present in all material respects the financial condition" of the Company. *4 On April 27, 2004, AXT issued a press release revealing that the "first quarter's financial review and verification process ha[d] been delayed due to an investigation by AXT's Audit Committee of certain product testing practices and policies." (Comp., 64.) The next day, AXT stock dropped by 13.64%. A day later, AXT's stock dropped further, by nearly 23%, to close at $2.20 per share. On May 24, 2004, AXT filed its quarterly report on Form 10-Q with the SEC, announcing that AXT had "not followed requirements for testing of products and provision of testing data and information relating to customer requirements for certain shipments made over the past several years." The 10-Q reported that AXT then increased its reserve for sales returns by $745,000, and recorded a $2.1 million charge for obsolete inventory manufactured in the previous two and three years because the specifications of its products differed from customer orders. AXT also announced that it had reassigned its CEO and Chairman of the Board, Defendant Young to head up AXT's China unit, and had replaced the Company's independent auditor, PriceWaterhouseCoopers ("PwC"). (Comp., 65-68, 70.) Plaintiff FN2 Morgan subsequently filed the instant lawsuit, claiming that he and other members of the proposed class who purchased shares of AXT stock between February 6, 2001, and April 27, 2004, were injured because they bought AXT stock at artificially-inflated prices which plummeted when the Company disclosed to the public the internal investigation into its practices. FN2. Two separate lawsuits were brought by investors in AXT stock against AXT and Defendant Young: (1) City of Harper Woods Employees Retirement Sys. v. AXT, Inc., 04-04362 MJJ, filed on October 15, 2004; and (2) Robertson v. AXT, Inc., 04-05106 MJJ, filed on December 2, 2004. In its February 2, 2005, Order, the Court granted Plaintiff Morgan's motion to consolidate the lawsuits. B. The Complaint In his Consolidated Complaint for Violations of the Federal Securities Laws (hereinafter, the "Complaint"), Plaintiff alleges that AXT and Defendant Young, AXT's former Chairman and Chief Executive Officer, violated 10(b) and 20(a) of the Securities and Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. 78j(b) and 78(t)a, and Se- 2006 Thomson/West. No Claim to Orig. U.S. Govt. Works. Case 5:04-cv-04156-JW Slip Copy Slip Copy, 2005 WL 2347125 (N.D.Cal.) (Cite as: Slip Copy) Document 111 Filed 07/28/2006 Page 5 of 15 Page 4 curities and Exchange Commission ("SEC") Rule 10b-5, 17 C.F.R 240.10b-5. According to Plaintiff, during the Class Period, Defendants knowingly shipped products that did not conform to customer testing requirements or specifications. Plaintiff alleges that Defendants failed to properly account for products that were defective or could not be sold by improperly recognizing revenue on those sales even though Defendants knew the products would be returned and failing to accrue adequate reserves. Plaintiff claims that Defendants violated the securities laws by knowingly issuing false or misleading statements about AXT's reserves, revenue, and income (hereinafter, the "financial statements"), and by knowingly issuing false or misleading statements touting the quality of AXT's products and AXT's ability to meet customer requirements (hereinafter, the "quality statements"). In his Complaint, Plaintiff alleges that his claims are supported by the statements of three confidential witnesses-a Quality Technician who used to work for AXT, a former AXT Corporate Vice President, and a former tester of reFN3 turned AXT products. The former Quality Technician allegedly confirmed that the Company knowingly shipped to customers products that did not meet customer specifications, that the Company was aware that the products would be returned, and that almost every shipment was, in fact, returned. Specifically, the technician said that when AXT conducted specification checks on its LED wafers for wavelength, luminosity, vision, and current, the wafers never met all the specifications. The former tester of returned AXT products allegedly confirmed that the passivation layer (the top protective layer) on AXT's LEDs was consistently weak, making the LEDs easily and irreparably damaged. The tester allegedly said that AXT knew this was a problem and lacked adequate product testing equipment. The former Corporate Vice President allegedly confirmed that AXT failed to perform full testing of its products and lacked the right equipment for testing. (Comp., 78-80.) FN3. In his Complaint, Plaintiff does not allege that the third confidential witness-the tester of returned AXT products-was ever an AXT employee. In his opposition to the instant motion, however, Plaintiff describes this witness as a former AXT employee. *5 Plaintiff alleges that during the Class Period, Defendants reported that one of the Company's larger customers, Agilent, had canceled its orders with AXT because AXT was shipping products that did not conform to Agilent's specifications. Defendants characterized the shipping of out-of-spec products as a one-time event even though, according to Plaintiff, AXT had shipped products that did not meet customer specifications to many of its customers. (Id., 86.) On May 20, 2005, 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 Plaintiff has failed to plead his allegations with sufficient particularity. LEGAL STANDARD A. Federal Rules of Civil Procedure A court may dismiss a complaint pursuant to Federal Rule of Civil Procedure 12(b)(6) for the pleading of insufficient facts under an adequate theory. Robertson v. Dean Witter Reynolds, Inc., 749 F.2d 530, 533-34 (9th Cir.1984). When deciding upon a motion to dismiss pursuant to Rule 12(b)(6), a court must take all of the material allegations in the plaintiff's complaint as true, and construe them in the light most favorable to the plaintiff. Parks School of Business, Inc. v. Symington, 51 F.3d 1480, 1484 (9th Cir.1995). In the context of a motion to dismiss, review is limited to the contents in 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 converted into one for summary judgment. However, matters properly presented to the court, such as those attached to the complaint and incorporated within its allegations, may be considered as part of the motion to dismiss. See Hal Roach Studios, Inc. v. 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 therein, and upon which the complaint is premised, a defendant may attach to the motion to dismiss such documents in order to show that they 2006 Thomson/West. No Claim to Orig. U.S. Govt. Works. Case 5:04-cv-04156-JW Slip Copy Slip Copy, 2005 WL 2347125 (N.D.Cal.) (Cite as: Slip Copy) Document 111 Filed 07/28/2006 Page 6 of 15 Page 5 do not support the plaintiff's claim. See Pacific Gateway Exchange, 169 F.Supp.2d at 1164; Branch v. Tunnell, 14 F.3d 449, 44 (9th Cir.1994) (overruled on other grounds). Thus, the district court may consider the full texts of documents that the complaint only quotes in part. See In re Stay Electronics Sec. Lit., 89 F.3d 1399, 1405 n. 4 (1996), cert denied, 520 U.S. 1103, 117 S.Ct. 1105, 137 L.Ed.2d 308 (1997). This rule precludes plaintiffs "from surviving a Rule 12(b)(6) motion by deliberately omitting references to documents upon which their claims are based." Parrino v. FHP, Inc., 146 F.3d 699, 705 (9th Cir.1998). Rule 8(a) of the Federal Rules of Civil Procedure requires only "a short and plain statement of the claim showing that the pleader is entitled to relief." Accordingly, motions to dismiss for failure to state a claim pursuant to Rule 12(b)(6) are typically disfavored; complaints are construed liberally to set forth some basis for relief, as long as they provide basic notice to the defendants of the charges against them. In re 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 particularity the circumstances constituting fraud. To meet the heightened pleading requirements of Rule 9(b), the Ninth Circuit has held that a fraud claim must contain three elements: (1) the time, place, and content of the alleged misrepresentations; and (2) an explanation as to why the statement or omission complained of was false or misleading. In re GlenFed, Inc. Sec. Litig., 42 F.3d 1541, 1547-49 (9th Cir.1994). *6 In the securities context, the pleading requirements are even 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 alreadyheightened pleading requirements of Rule 9(b). Under the PSLRA, actions based on allegations of material misstatements or omissions must "specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the state- ment 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 10b-5. Specifically, the PSLRA imposed strict requirements for pleading scienter. Under the PSLRA, a complaint must "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." 15 U.S.C. 78u-4(b)(2). The Ninth Circuit, in interpreting the PSLRA, has held that "a private securities plaintiff proceeding under the [PSLRA] must plead, in great detail, facts that constitute strong circumstantial evidence of deliberately reckless or conscious misconduct." In re Silicon Graphics Inc., 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 must dismiss the complaint. See 15 U.S.C. 78u-4(b)(1). The PSLRA's Safe Harbor provision provides that a securities fraud claim may not lie with respect to a statement that is "identified as a forward-looking statement, and is accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statement." 15 U.S.C. 78u-5(c)(1)(A)(I). However, a person may be held liable if the forward-looking statement is made with "actual knowledge ... that the statement was false or misleading." 15 U.S.C. 78u-5(c)(1)(B); No. 84 Employer-Teamster Joint Council Pension Trust Fund v. America West Holding Corp., 320 F.3d 920, 936 (9th Cir.2003); but see In re Seebeyond Technologies Corp. Sec. Litig., 266 F.Supp.2d 1150, 1164-65 (C.D.Cal.2003) (disagreeing with the analysis in America West and finding that a defendant is immune from liability 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' request that the Court take judicial notice of thirteen separate documents, eleven of which are expressly referenced in 2006 Thomson/West. No Claim to Orig. U.S. Govt. Works. Case 5:04-cv-04156-JW Slip Copy Slip Copy, 2005 WL 2347125 (N.D.Cal.) (Cite as: Slip Copy) Document 111 Filed 07/28/2006 Page 7 of 15 Page 6 Plaintiff's Complaint and two of which are not. Plaintiff does not object to Defendants' request. A. Documents Referenced in Complaint *7 Defendants ask the Court to judicially notice the following documents incorporated by reference in Plaintiff's Complaint: AXT's 10-Ks for the fiscal years ended December 31, 2000, December 31, 2002, and December 31, 2003; five AXT press releases, respectively dated February 6, 2002, October 23, 2002, February 5, 2003, April 23, 2003, and February 4, 2004; AXT's 10-Qs for the quarters ended June 30, 2003, and September 30, 2003; and AXT's Current Report on SEC Form 8-K, filed on June 24, 2004. These documents are attached to the Declaration of David Banie as Exhibits A-K. Federal Rule of Evidence 201 allows a court to take judicial notice of a fact "not subject to reasonable dispute in that it is ... capable of accurate and ready determination by resort to sources whose accuracy cannot reasonably be questioned." Even where judicial notice is not appropriate, courts may also properly consider documents "whose contents are alleged in a complaint and whose authenticity no party questions, 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 explicitly incorporated by reference in Plaintiff's Complaint. (See Complaint, 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. See In re Homestore.com, Inc. Sec. Litig., 347 F.Supp.2d 814, 817 (N.D.Cal.2004) (the court may take judicial notice of press releases); In re Calpine Corp. Sec. Litig., 288 F.Supp.2d 1054, 1076 (N.D.Cal.2003) (the court may take judicial notice of public filings). Accordingly, the Court GRANTS Defendants' request and takes judicial notice of Exhibits 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 documents are attached to the Banie Declaration as Exhibit L. "In a securities action, a court may take judicial notice of public filings when adjudicating a motion to dismiss...." Calpine, 288 F.Supp.2d at 1076. The SEC Forms 4 at issue here are publicly-available documents filed with the SEC. Accordingly, the Court takes judicial notice of the docuFN4 ments attached as Exhibit L to the Banie Declaration. FN4. Defendants also contend that Exhibit L should be judicially noticed for two other independent reasons. First, the Complaint references Defendant Young's sale of 200,000 shares of AXT stock during the Class Period. According to Defendants, this is information that Plaintiff could only have obtained from reviewing Young's Forms 4, such that the documents are incorporated by implicit reference in the Complaint and should be judicially noticed. Second, the Forms 4 are central to Plaintiff's allegation that Defendant Young's Class Period stock sales are probative of scienter, and should be judicially noticed on that ground. Having already determined that the Forms 4 should be judicially noticed on the ground that they are public documents, the Court declines to address Defendants' 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 of documents reflecting AXT's closing stock prices during the Class Period. These documents are attached to the Banie Declaration as Exhibit M. In the context of a motion to dismiss a securities private fraud action, a court may take judicial notice of a company's public stock prices. Homestore.com, 347 F.Supp.2d at 816. Accordingly, the Court takes judicial notice of these documents. II. Motion to Dismiss *8 Defendants contend that Plaintiff's Complaint should be dismissed because Plaintiff fails to satisfy the heightened pleading requirements under the PSLRA, fails to state a claim under Rule 12(b)(6), and fails to plead fraud with the 2006 Thomson/West. No Claim to Orig. U.S. Govt. Works. Case 5:04-cv-04156-JW Slip Copy Slip Copy, 2005 WL 2347125 (N.D.Cal.) (Cite as: Slip Copy) Document 111 Filed 07/28/2006 Page 8 of 15 Page 7 particularity required by Rule 9(b). The Court examines Plaintiff's two claims separately. A. Plaintiff's First Cause of Action-Violation of Section 10(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 in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [SEC] may prescribe." 15 U.S.C. 78j(b). Rule 10b-5, promulgated under Section 10(b), makes it unlawful for any person to use interstate commerce: (a) to employ any device, scheme, or artifice to defraud; (b) to make any untrue statement of material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading; or (c) to engage in any act, practice, or course of business which operates 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 claim under Section 10(b) and Rule 10b-5 to be actionable, 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 alleged loss. See Binder v. Gillespie, 184 F.3d 1059, 1063 (9th Cir.1999). A complaint must "specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement 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)(2). As discussed above, in order to avoid having the action dismissed, a plaintiff must "plead with particularity both falsity and scienter." Ronconi v. Larkin, 253 F.3d 423, 429 (9th Cir.2001). The Ninth Circuit, in Ronconi, articulated the rule as follows: Because falsity and scienter in private securities fraud cases are generally strongly inferred from the same set of facts, we have incorporated the dual pleading requirements of 15 U.S.C. 78u-4(b)(1) and (b)(2) into a single inquiry. In considering whether a private securities fraud complaint can survive dismissal under Rule 12(b)(6), we 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.' Where pleadings are not sufficiently particularized or where, taken as a whole, they do not raise a `strong inference' that misleading statements were knowingly or [with] deliberate recklessness made to investors, a private securities fraud complaint is properly dismissed under Rule 12(b)(6). *9 Id. (citations and internal quotation marks omitted). Here, Plaintiff alleges that statements or omissions attributable to Defendant AXT and Defendant Young were false and misleading and that Defendants knew the statements were false and misleading at the time the statements were made. The statements at issue can be separated into two general categories: (1) statements touting the quality of AXT's products and the Company's ability to meet customer specifications; and (2) AXT's financial statements. With respect to both categories of statements, Defendants contend that Plaintiff has failed to plead the falsity of the statements with sufficient particularity and has failed to plead facts that, if true, would raise a strong inference that Defendants acted with scienter. Additionally, Defendants assert that Plaintiff has failed to adequately plead loss causation pursuant to the Supreme Court's recent holding in Dura Pharmaceuticals, Inc. v. Broudo, --- U.S. ----, 125 S.Ct. 1627, 161 L.Ed.2d 577 (2005). 1. FALSITY and SCIENTER a. Quality Statements Plaintiff alleges that Defendants made false or misleading statements regarding the quality of its products throughout the Class Period. Specifically, Plaintiff takes issue with the statements contained in various press releases issued between February 6, 2001, and April 27, 2004, in which Defendants reported that its products were of high quality, incorporated strong engineering design, had competitive advantage, contained superior features, and met customers' specific requirements. To support his claim that the quality statements were knowingly false or misleading, Plaintiff re- 2006 Thomson/West. No Claim to Orig. U.S. Govt. Works. Case 5:04-cv-04156-JW Slip Copy Slip Copy, 2005 WL 2347125 (N.D.Cal.) (Cite as: Slip Copy) Document 111 Filed 07/28/2006 Page 9 of 15 Page 8 lies on AXT's May 24, 2004, press release disclosing that the Company had "not followed requirements for testing of products and provision of testing data and information relating to customer requirements for certain shipments made over the past several years," and on the Company's subsequent decisions to reassign its CEO, to increase its reserve for sales returns by $745,000, and to record a $2.1 million charge for obsolete inventory manufactured in the prior two and three years. Plaintiff construes AXT's May 2004 statements and conduct as an admission by Defendants that the quality statements were knowingly false when made. Plaintiff also relies on the statements of the former AXT Quality Technician, the former AXT Corporate Vice President, and the former tester of returned AXT products (collectively, the "witnesses") to support falsity and scienter. Finally, Plaintiff claims that the fact that Agilent, one of AXT's customers, canceled its orders for AXT substrates during the Class Period corroborates the witness statements and Plaintiff's claims that the quality statements were knowingly false. Defendants contend that the product quality statements were, at most, mere puffery, and are not actionable. In the alternative, Defendants argue that Plaintiff has not pled sufficiently particularized facts that the statements were false or misleading when made nor has Plaintiff pled facts that raise a strong inference of scienter. The Court addresses each of Defendants' arguments in turn. i. Puffery *10 "General statements of optimism and `puffing' about a company or product are not actionable." In re Foundry Networks, 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 `mere puffery,' are inactionable because reasonable investors do not consider `soft' statements or loose predictions important in making investment decisions." Id. (citation omitted). "No matter how untrue a statement may be, it is not actionable if it is not the type of statement that would significantly alter the total mix of information available to investors." Id. (citing In re Apple Computer, Inc. Sec. Litig., 243 F.Supp.2d 1012, 1025 (N.D.Cal.2002)). In Foundry Networks, at issue was the company's statement that its "business remains on track." The court held that the statement was inactionable puffery because the statement was merely a very general statement of optimism about the company's financial prospects, something that reasonable investors would not rely on when making investment decisions. In No. 84 EmployerTeamster Joint Council Pension Trust Fund v. Am. W. Holding Corp., 320 F.3d 920 (9th Cir.2003) ("America West" ), however, the Ninth Circuit found statements at issue were not inactionable puffery. Specifically, the court held that "[a] reasonable investor would find significant the information regarding a company's deferred maintenance costs, unsafe maintenance practices, and possible sanction" because "a reasonable investor would consider the potential effects of each of these facts on the overall economic health of the company as `significantly altering' the `total mix' of information made available." Id. at 935; see also Scritchfield v. Paolo, 274 F.Supp.2d 163, 175 (D.R.I.2003) (statement that company was the " `premier provider of high-speed DSL services in the Northeast corridor' ... is much more than mere puffery; it is a statement of [the company's] present status and capabilities, and connotes that [the company] is comparatively superior")). The lion's share of the statements at issue here appear to more closely resemble the statements at issue in America West or Scritchfield than those at issue in Foundry Networks. For example, statements touting the superiority of AXT's specific products, such as the October 24, 2001, press release described in paragraph 38 of the Complaint, in which AXT reported that the Company's "VGF gallium arsenide and indium phosphide substrates continue to offer superior features for manufacturers of high quality electronic and opto-electronic devices" are far less generalized than the statements the Foundry Networks court determined were inactionable. Such statements strike the Court as information that an investor would consider when making investment decisions. However, to make such a determination would require the Court to make factual findings which, at this stage in the litigation, would not be appropriate. Accordingly, the Court finds that whether the quality statements at issue here are actionable as material statements is a question for another day. ii. Falsity and Scienter Not Sufficiently Pled 2006 Thomson/West. No Claim to Orig. U.S. Govt. Works. Case 5:04-cv-04156-JW Slip Copy Slip Copy, 2005 WL 2347125 (N.D.Cal.) (Cite as: Slip Copy) Document 111 Filed 07/28/2006 Page 10 of 15 Page 9 *11 Assuming, arguendo, that the quality statements at issue were not mere puffery and are actionable as material statements or omissions, the Court now turns to the question of whether Plaintiff has alleged sufficiently particularized facts to support his claim that the quality statements were false or misleading, and whether Plaintiff has alleged facts that raise a strong inference of scienter, to survive Defendants' motion to dismiss. Plaintiff primarily relies on AXT's post-Class Period (May 2004) disclosure and the statements of three confidential witnesses to support his claim that the product quality statements were false or misleading and that Defendants knew those statements were false and misleading when made. Plaintiff also alleges that Agilent's cancellation of its order of AXT products during the Class Period supports his claims of falsity and scienter. Additionally, Plaintiff alleges that Defendant Young's sale of stock during the Class Period supports an strong inference of scienter. For the following reasons, the Court finds that the facts, as pled, are insufficiently particularized to support Plaintiff's claim that the quality statements violated federal securities laws. (a) Witness Statements FN5 FN5. For purposes of this analysis, the Court assumes that the witnesses' purported statements are true since, at this stage in the proceedings, the Court must view all facts in the light most favorable to Plaintiff. According to Plaintiff, the former Quality Technician allegedly confirmed that the Company knowingly shipped to customers products that did not meet customer specifications, that the Company was aware that the products would be returned, and that almost every shipment was, in fact, returned. Specifically, the technician said that when AXT conducted specification checks on its wafers for various criteria, the wafers never met all the specifications. The former tester of returned AXT products allegedly confirmed that the passivation layer (the top protective layer) on AXT's LEDs was consistently weak, making the LEDs easily and irreparably damaged. The tester allegedly said that AXT knew this was a problem and lacked adequate product testing equipment. The former Corporate Vice President allegedly confirmed that AXT failed to perform full testing of its products and lacked the right equipment for testing. (Comp., 78-80.) These statements, as currently pled, are insufficient to satisfy create a sufficient factual predicate for Plaintiff's claims under the PSLRA. First, Plaintiffs' Complaint fails to explain how any of the witnesses would have personal and firsthand knowledge of the facts they allege to be true. See In re Daou Sys., Inc. Sec. Litig., 411 F.3d 1006, (9th Cir.2005) (confidential sources must be described "with sufficient particularity to support the probability that a person in the position occupied by the source would possess the information alleged"). For example, Plaintiff does not explain the job responsibilities of the Quality Technician and how he or she would know about the number or proportion of returns of AXT's products. Second, the Complaint fails to point to any specific data to support the witnesses' contentions that AXT's products were being returned. Third, the Complaint does not sufficiently describe the timing of the witnesses' observations and conclusions. Finally, assuming, as the Court must, that the witnesses' statements are true and AXT's products were consistently not being tested, did not meet customer specifications, and were regularly being returned to the Company, the Complaint alleges no facts that would allow the Court to infer that Defendants were aware of these facts. The Complaint does not allege any process by which upper management, presumably in charge of issuing or approving press releases, would have been aware of product returns or testing practices at the manufacturing level, much less how each of these particular confidential witnesses was connected with Defendants such that they had contemporaneous knowledge of what AXT and Defendant Young knew. Accordingly, the witness statements are insufficient, 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, disclosure notifying the public that AXT had "not followed requirements for testing of products and provision of testing data and information relating to customer requirements for certain shipments made over the past several years" supports his contention that the quality statements issued during the Class Period were false and misleading and that Defendants were aware the statements were false and misleading. The 2006 Thomson/West. No Claim to Orig. U.S. Govt. Works. Case 5:04-cv-04156-JW Slip Copy Slip Copy, 2005 WL 2347125 (N.D.Cal.) (Cite as: Slip Copy) Document 111 Filed 07/28/2006 Page 11 of 15 Page 10 Court disagrees. The May 2004 disclosure does not say that every shipment of every AXT product was non-conforming such that it can be considered an admission that AXT's Class Period statements regarding the quality of its products are rendered false and misleading. Even if the May 2004 statement admits that some of AXT's products did not conform to customer specifications, the statements at issue could still have been true in that the Company only claimed that its products were competitive and that its products' design was strong. Moreover, even assuming the statements were false or misleading, the post-Class Period disclosure does not raise a strong inference of scienter here. The fact that the Company admitted, after the Class Period, that it had failed to follow testing requirements on "certain shipments," is insufficient to raise a strong inference that Defendants knew, at the time the quality statements were made, that the statements were false or misleading. (c) Agilent Cancels Orders Plaintiff alleges that during the Class Period, Defendants disclosed that one of AXT's larger customers, Agilent, had canceled its orders for AXT products because AXT was shipping products that did not conform to Agilent's specifications. Plaintiff contends that this corroborates his contention (and the confidential witness statements) that AXT was aware that it was shipping non-conforming products to its customers such that the statements it issued during the Class Period regarding the quality of its products and its competitive position in the marketplace were knowingly false and misleading. Plaintiff also contends that Defendants were aware that the problems with the Agilent shipments were not unique such that its statement to the contrary was false and misleading. Plaintiff has failed to allege any facts that support a finding that Defendants knew that the nonconforming Agilent shipments were part of a widespread quality problem with AXT products. Accordingly, the Court finds that the fact that Agilent canceled its orders with AXT is insufficient to demonstrate that the quality statements were knowingly false when made. (d) Defendant Young's Stock Sales Plaintiff also relies on the stock sales of Defendant Young as an indication of Defendants' scienter with respect to the quality statements. Generally, stock sale allegations cannot raise an inference of scienter unless the plaintiff alleges specific facts showing that the sales were "dramatically out of line with prior trading practices at times calculated to maximize the personal benefit from undisclosed inside information." Silicon Graphics, 183 F.3d at 986. Among the relevant factors for a court to consider are: 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. *13 Here, Plaintiff alleges that Defendant Young sold a total of more than 200,000 shares of his personally-held AXT stock during the Class Period for gross proceeds of approximately $2.2 million. (Comp. at 91.) Plaintiff alleges no facts about the dates, prices per share, or sizes of each of Defendant Young's Class Period sales. Plaintiff also fails to allege that Defendant Young's sales over the time period in question were inconsistent with his prior trading history. In light of the three factors above, Defendant Young's Class Period sale of stock, as alleged, is not sufficiently suspicious, 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's allegations, even though individually lacking, are sufficient to create a strong inference that Defendants issued allegedly false or misleading statements touting the quality of AXT's products with deliberate recklessness, if not actual knowledge. Lipton, 284 F.3d at 1038. Here, the sum is no greater than its parts. Plaintiff has failed to allege particularized facts that could lead the Court to infer that Defendants intentionally, or with deliberate recklessness, misrepresented the quality of AXT's products and its strategic position as compared with other manufacturers of similar products. Because Plaintiff's first cause of action "lacks sufficient detail and foundation necessary to meet either the particularity or strong inference requirements of the PSLRA," it must be dismissed. Silicon Graphics, 183 F.3d at 984. b. Financial Statements 2006 Thomson/West. No Claim to Orig. U.S. Govt. Works. Case 5:04-cv-04156-JW Slip Copy Slip Copy, 2005 WL 2347125 (N.D.Cal.) (Cite as: Slip Copy) Document 111 Filed 07/28/2006 Page 12 of 15 Page 11 Plaintiff alleges that during the Class Period, Defendants knowingly issued financial statements that overstated revenue, growth margins, and earnings in violation of GAAP, rendering the statements false and misleading under the Securities and Exchange Act. Specifically, Plaintiff contends that the financial statements were knowingly false or misleading in light of: (1) the Company's stated revenue recognition policy requiring that AXT not recognize revenue where there is a customer acceptance requirement or remaining significant obligation; (2) AXT's failure to accrue adequate reserves; and (3) AXT's failure to take a timely charge for inventory obsolescence. Plaintiff also challenges the qualitative statements regarding internal and disclosure controls contained in the Sarbanes-Oxley certifications accompanying AXT's quarterly filings (beginning in April 2002). In support of these allegations, Plaintiff again relies primarily upon the Company's May 2004 disclosure and its subsequent decisions to increase its reserves, charge for inventory obsolescence, and reassign its CEO. Plaintiff also again relies on the confidential witness statements, Agilent's decision to cancel its order, and Defendant Young's stock sales. Defendants argue that Plaintiff has failed to allege a particularized factual basis for his claim that the financial statements released during the Class Period were false and involved an improper recognition of revenue, or that Plaintiff has alleged facts raising a strong inference that Defendants acted with the requisite scienter. The Court agrees. *14 It is generally accepted that standing alone, allegations of GAAP violations do not establish scienter. In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1426 (9th Cir.1994). Rather, to plead fraudulent intent based on GAAP violations, plaintiffs must allege facts showing that: (1) specific accounting decisions were improper; and (2) the defendants knew specific facts at the time that rendered their accounting 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 aware that its products were flawed and were being shipped to customers anyway based on the vague representations of three confidential witnesses who do not describe the basis for their knowledge, the time period of the general awareness that this practice was occurring, any contact with AXT's up- per management (or specifically, those making the accounting and revenue recognition decisions), or any specific transactions on which revenue was knowingly improperly recorded. See Northpoint, 184 F.Supp.2d at 998 ("With accounting fraud, ... the necessary scienter is in general not established merely by the publication of inaccurate accounting figures, or failure to follow generally accepted accounting principles. More is needed.") Plaintiff has failed to allege that particular accounting decisions were improper or facts that support a strong inference that Defendants were aware of facts that rendered their accounting decisions fraudulent. In sum, Plaintiff's generic allegations of accounting fraud fall short of sufficiently pleading scienter with respect to Defendants' practice of recognizing revenue. The other factors upon which Plaintiff relies to support his claim that AXT's financial statements were false or misleading are also insufficiently pled. The Court examines these in turn. i. AXT's Post-Class Period Statements and Conduct Plaintiff claims that AXT's post-Class Period decisions to take a $745,000 reserve, to take a $2.1 million write-off, and to reassign its CEO and promote its CFO to the top spot at the Company, demonstrate that the Company's financial statements, issued during the Class Period, were false when made and that Defendants knew they were false. The Court disagrees. These allegations are not pled with the requisite particularity. Plaintiff contends that AXT's post-Class Period decisions suggest that the Company should have increased its reserve for returns by $745,000 during the Class Period and that the Company's failure to do so renders the financial statements false. Plaintiff alleges no contemporaneous facts to support that contention other than the postClass Period decision to increase the reserves. This is a classic example of pleading fraud by hindsight, which is exactly what Congress intended to eliminate with its adoption of the PSLRA. See Silicon Graphics, 183 F.3d at 988; Acito v. IMCERA Group, 47 F.3d 47, 53 (2d Cir.1995) ("Mere allegations that statements in one report should have been made in earlier reports do not make out a claim of securities fraud.") Similarly, AXT's decision to write off $2.1 million for inventory obsolescence after the close of the Class Period does not necessarily read back on what the Company should 2006 Thomson/West. No Claim to Orig. U.S. Govt. Works. Case 5:04-cv-04156-JW Slip Copy Slip Copy, 2005 WL 2347125 (N.D.Cal.) (Cite as: Slip Copy) Document 111 Filed 07/28/2006 Page 13 of 15 Page 12 have done, but did not do, during the Class Period, or on the falsity of the Company's financial statements during that period. A "pleading must provide some particularized support regarding inventory levels, the defendants' knowledge, and approximately when [the] plaintiffs think the writedown should have occurred." In re PETsMART, Inc. Sec. Litig., 61 F.Supp.2d 982, 993 (D.Ariz.1999). Plaintiff fails to do so here. Additionally, AXT's decision to reassign Defendant Young to head up the Company's China Operations does not support an inference of scienter here. Management changes "are not in and of themselves evidence of scienter. Most major stock losses are often accompanied by management departures, and it would be unwise for courts to penalize directors for these decisions." In re Cornerstone Propane Partners, L.P., 355 F.Supp.2d 1069, 1092 (N.D.Cal.2005). Plaintiff has not alleged sufficiently particularized facts with respect to Young's reassignment to support his claim that the financial statements were false when made. *15 Plaintiff also contends that the Sarbanes-Oxley certifications signed by Defendant Young and filed with the SEC were false when made. Again, the Court finds that Plaintiff has not alleged particularized facts to support his claim that Defendant Young's averments that he had examined the Company's internal disclosure controls and believed they were adequate, were false. ii. Witness Statements FN6 *8 (N.D.Cal. Mar. 11, 2004) (allegations of false financial forecasts are insufficient where plaintiffs failed to "plead specific facts demonstrating how the problems being experienced translated into the need for Juniper to alter or reduce its publicly issued projections"). Accordingly, the confidential witness statements, as currently pled, are insufficient to support falsity and scienter with respect to the financial statements. iii. Agilent Cancels Order Plaintiff contends that AXT's announcement, during the Class Period, that Agilent had canceled its orders due to AXT's failure to provide products that met Agilent's specifications supports his claim that the financial statements were false when made and that Defendants knew the statements were false. While the Agilent order withdrawal suggests that AXT was not always shipping products that conformed to customer specifications, Plaintiff fails to allege sufficiently particularized facts that support his claim that this meant that the financial statements were false or that Defendants knew they were false. iv. Defendant Young's Stock Sales As discussed supra, Plaintiff fails to allege sufficient details regarding Defendant Young's sales of stock during the Class Period that would support the falsity of the financial statements and Defendants' scienter with respect thereto. v. Plaintiff's Allegations as a Whole As explained above, the Court must consider whether the totality of Plaintiff's allegations, even though individually lacking, are sufficient to create a strong inference that Defendants issued allegedly false or misleading financial statements with deliberate recklessness, if not actual knowledge. Lipton, 284 F.3d at 1038. Here, again, the sum is no greater than its parts. See In re Nash Finch Co. Sec. Litig., 323 F.Supp.2d 956, 964 & n. 9 (D.Minn.2004) ("The Court finds the collective minutia offered here adds up to nothing. Just as two plus two will never equal five, these allegationswhether considered apart or together-do not add up to a FN7 strong inference of scienter.") FN7. At oral argument, Plaintiff alerted the Court FN6. For purposes of this analysis, the Court assumes that the witnesses' purported statements are true since, at this stage in the proceedings, the Court must view all facts in the light most favorable to Plaintiff. As discussed above, the confidential witness statements relied on by Plaintiff here are insufficient, as currently pled, to support falsity or scienter. The Complaint fails to allege how the witnesses would have known what accounting effect, if any, product returns would have on the Company's financial statements, or how Defendants would have known that the financial statements it released were false or misleading in light of the alleged product returns. See Juniper Networks, Inc. Sec. Litig., 2004 U.S. Dist. LEXIS 4025, at 2006 Thomson/West. No Claim to Orig. U.S. Govt. Works. Case 5:04-cv-04156-JW Slip Copy Slip Copy, 2005 WL 2347125 (N.D.Cal.) (Cite as: Slip Copy) Document 111 Filed 07/28/2006 Page 14 of 15 Page 13 to the recent holding in In re Omnivision Technologies, Inc., 2005 U.S. Dist. LEXIS 16009, *1 (N.D.Cal. July 29, 2005). The Court finds that that case, distinguishable on its facts, does not alter the Court's conclusions here. In Omnivision, it was undisputed that the company's financial statements contained errors. This is not the case here. Additionally, in that case, the plaintiff alleged facts supporting a finding that the individual defendants, executives of the company in question, sold personal shares of the company's stock dramatically out of line with their trading history. That the Omnivision court found that the plaintiff's complaint survived the defendants' motion to dismiss, despite the PSLRA's heightened pleading standard, does not mandate the same result here. 2. Loss Causation *16 In Dura Pharmaceuticals, the Supreme Court clarified that alleging that a misrepresentation caused an inflated purchase price does not, without more, demonstrate loss causation. To "touch upon" an economic loss is insufficient; plaintiffs must demonstrate an actual causal connection between the defendant's alleged material misrepresentation and the economic loss suffered. 125 S.Ct. at 1633. This holding reversed the Ninth Circuit's jurisprudence on the subject, pursuant to which a plaintiff could satisfy the loss causation requirement simply by alleging that stock price was inflated due to the alleged misrepresentation. Here, the Complaint simply states that because AXT's stock prices dropped significantly after the Company disclosed its internal investigation, Plaintiff, and other AXT shareholders who purchased stock during the Class Period, lost money. However, Plaintiff has not alleged a proximate, causal connection between the alleged misrepresentations contained in AXT's press releases and financial statements and the consequent decline in AXT stock. Because other factors may have affected the Company's stock price during the Class Period, Plaintiff must allege more than just that the alleged misrepresentations inflated the stock price. See id. This is particularly true here where the AXT stock price fluctuated significantly during the Class Period, at some points dropping lower than the price of the stock after the April 27, 2004, disclosure regarding the Company's internal investigFN8 ation. This suggests that the stock price was, indeed, affected by factors other than Defendants' alleged false or misleading statements. Accordingly, the Court finds, in light of Dura, that Plaintiff's allegations regarding loss causation are insufficient. Plaintiff's contention that the Daou case mandates the contrary result is specious. In that case, the Ninth Circuit found that loss causation was sufficiently pled but specifically held that because the complaint disclosed that the price of the company's stock had declined, during the class period, from $34.375 per share to $18.50 per share, before any corrective disclosure was issued, any loss suffered between those figures could "not be considered causally related to Daou's allegedly fraudulent accounting methods because before the revelations began ..., the true nature of Daou's financial condition had not yet been disclosed." 411 F.3d at 1026-27. Likewise, AXT's stock price dipped below the price to which it ultimately fell after the April 2004 disclosure, thus rendering Plaintiff's attempt to causally link the alleged false statements with his (and other purported class members') financial loss insufficiently pled. FN8. On April 29, 2004, AXT's stock price dropped to $2.20 per share. Although the price had, at various points during the Class Period, been as high as $40 per share, there was a substantial period of time during the Class Period in which AXT's stock price dropped below $2 per share. B. Plaintiff's Second Cause of Action-Violation of Section 20(a) Section 20(a) of the Securities Exchange Act ("Exchange 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 Section 20(a) claim based on an underlying violation of Section 10(b), the pleading requirements for both violations are the same. Id. "To be liable under section 20(a), the defendants must be liable under another section of the Exchange Act." Heliotrope General, Inc. v. Ford Motor Co., 189 F.3d 971, 978 (9th Cir.1999). *17 Here, Plaintiff alleges that Defendant Young acted as a 2006 Thomson/West. No Claim to Orig. U.S. Govt. Works. Case 5:04-cv-04156-JW Slip Copy Slip Copy, 2005 WL 2347125 (N.D.Cal.) (Cite as: Slip Copy) Document 111 Filed 07/28/2006 Page 15 of 15 Page 14 controlling person of AXT within the meaning of Section 20(a) of the Act and is liable thereunder for the conduct alleged. Plaintiff claims that by virtue of Defendant Young's position as CEO and Chairman of the Board of the Company, he was responsible for preparing and disseminating AXT's public releases and had the power and the authority to cause the Company to engage in the wrongful conduct complained of. Defendants argue that Plaintiff's Section 20(a) cause of action fails because Plaintiff has failed to state a cause of action pursuant to Section 10(b). The Court agrees. Because Plaintiff has failed to adequately plead the underlying 10(b) violation, as discussed supra, Plaintiff's Section 20(a) claim must also be dismissed. CONCLUSION For the foregoing reasons, the Court GRANTS Defendants' Motion to Dismiss without prejudice. Plaintiff must file an amended complaint within thirty days of the date of this Order. 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.) Briefs and Other Related Documents (Back to top) 2006 WL 1042253 (Trial Motion, Memorandum and Affidavit) Defendants' Reply in Support of Motion to Dismiss Amended Consolidated Complaint (Mar. 14, 2006) Original Image of this Document (PDF) 2006 WL 440801 (Trial Motion, Memorandum and Affidavit) Memorandum of Points and Authorities in Opposition to Motion to Dismiss Amended Consolidated Complaint (Jan. 31, 2006) Original Image of this Document (PDF) 2005 WL 3673019 (Trial Pleading) Amended Consolidated Complaint for Violations of the Federal Securities Laws (Nov. 14, 2005) 3:04cv04362 (Docket) (Oct. 15, 2004) END OF DOCUMENT 2006 Thomson/West. No Claim to Orig. U.S. Govt. Works. Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 1 of 11 TAB 11 Page 1 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 2 of 11 LEXSEE 2006 U.S. DIST. LEXIS 40624 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 2006 U.S. Dist. LEXIS 40624 June 9, 2006, Decided June 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 himself and all others similarly situated, Plaintiff: Robert J Hill, Claxton & Hill, Dallas, TX; Kimberly C Epstein, Lerach Coughlin Stoia Geller Rudman & Robbins - - San -Francisco, San Francisco, CA. For Alaska Electrical Pension Fund, Plaintiff: Joe Kendall, 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 - - San -Francisco, San Francisco, CA; Tamara J Driscoll, Lerach Coughlin 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, Lerach Coughlin Stoia Geller Rudman & Robbins - - San -Francisco, San Francisco, CA; Tamara J Driscoll, Lerach Coughlin Stoia Geller Rudman & Robbins ---- Seattle, Seattle, WA. For Harold Klagsbald, On Behalf of Himself and All Others Similarly Situated, Consol Plaintiff: Thomas E Bilek, Hoeffner & Bilek, Houston, TX; Mel E Lifshitz, Bernstein Liebhart & Lifshitz, New York, [*2] NY. For Thomas Butterworth, On Behalf of Himself and All Others Similarly Situated, Consol Plaintiff: William B Federman, Federman & Sherwood ---- Oklahoma City, Oklahoma City, OK. For Robert K Finnell, Individually and on Behalf of All Others Similarly Situated, Consol Plaintiff: Marc R Stanley, Martin Woodward, Roger L Mandel, Stanley Mandel & Iola, Dallas, TX. For Flowserve Corporation, Defendant: R Thaddeus Behrens, Haynes & Boone, Dallas, TX; Carrie Lee Huff, Nicholas Even, Haynes & Boone - Dallas, Dallas, TX. --For C Scott Greer, Defendant: Richard A Rohan, Fletcher Yarbrough, Jennifer E Morris, Todd A Murray, Carrington Coleman 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: Ellen B Sessions, Melissa J Swindle, Jenkens & Gilchrist --Dallas, Dallas, TX; Rodney Acker, Jenkens & Gilchrist, Dallas, TX. For Credit Suisse First Boston, Defendant: Ellen B Sessions, Jenkens & Gilchrist - - Dallas, Dallas, TX. -For PricewaterhouseCoopers LLP, Defendant: M Byron Wilder, Gibson Dunn & Crutcher - Dallas, Dallas, [*3] --TX; Dean J Kitchens, Gibson Dunn & Crutcher - - Los -Angeles, Los Angeles, CA. For Credit Suisse First Boston LLC, Defendant: Rodney Acker, Jenkens & Gilchrist, Dallas, TX; Melissa J Swindle, Jenkens & Gilchrist - Dallas, Dallas, TX. --For Robert K Finnell, Movant: Marc R Stanley, Stanley Mandel & Iola, Dallas, TX. For Joseph Verga, Movant: Robert J Hill, Claxton & Hill, Dallas, TX. JUDGES: JANE J. BOYLE, UNITED STATES Page 2 2006 U.S. Dist. LEXIS 40624, *3 Case 5:04-cv-04156-JW DISTRICT JUDGE. OPINIONBY: JANE J. BOYLE OPINION: MEMORANDUM DEFENDANTS' INTERLOCUTORY 1292 (b) Document 111 Filed 07/28/2006 Page 3 of 11 ORDER DENYING MOTION FOR APPEAL UNDER On November 18, 2005, the Court heard arguments on the Defendants' motions to dismiss and denied all three motions in a ruling from the bench followed by a written order on November 22, 2005. Defendants now seek certification on three issues they describe as "controlling questions of law", including: . Whether, in a case predicated on the fraud-on-the market theory, a plaintiff must plead that the alleged curative disclosure of the "truth" that resulted in the plaintiff's losses revealed each material fact allegedly misrepresented to satisfy the required element of loss causation; . Whether, in a case predicated on the fraud-on-the market theory, a plaintiff's claims under Section 11 are barred by the statutory negative causation defense where the alleged curative disclosure that the plaintiff claims resulted [*6] in his losses did not reveal the facts allegedly misrepresented in the challenged registration statements; and . Whether the PSLRA safe harbor for forward--looking statements protects from liability projections accompanied by meaningful cautionary language independent of the speaker's alleged state of mind. (Defs. Mot. to Certify ("Mot.") at 2) Plaintiffs oppose the motion on several grounds, arguing, inter alia, that the Defendants' "controlling questions" are simply fact-bound issues disguised as questions of law for 1292(b) purposes; that an interlocutory appeal will "retard" rather than advance the litigation; and that they will be severely prejudiced by any further postponement of discovery in this almost three-year--old case. II. This is a securities fraud action. The Defendants move to appeal this Court's interlocutory order denying their motions 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 follow, the motion is DENIED. I. BACKGROUND Defendant Flowserve Corporation, n1 is a world--wide manufacturer of pumps, valves, seals and related components in the "process industries." Plaintiffs, individuals who purchased publicly traded securities of Flowserve during the purported class [*4] period, allege that the Defendants violated federal securities laws by overstating the company's income and understating its costs in order to conceal its declining financial condition. As a result, Plaintiffs claim they suffered losses when the company's true financial condition was revealed in mid--2002 and the stock 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 and underwriters for the company. For purposes of this order, the Defendants will be collectively referred to as "Defendants" or "Flowserve." Plaintiffs filed this suit in August 2003 accompanied by a series of pleadings culminating in their 154--page Fifth Amended Complaint. Flowserve responded with motions to dismiss pursuant to Rules 12(b)(6) and 9(b) of the Federal Rules of Civil Procedure and the Private Securities Litigation Reform Act of 1995 ("PSLRA"). In their motions, the Defendants [*5] identified numerous perceived pleading deficiencies including--and relevant to this determination--that Plaintiffs failed to adequately plead loss causation; that Plaintiffs' claims are barred by the statutory negative causation defense; and that Plaintiffs' claims regarding Defendants' earnings projections statements are precluded by the PSLRA's "safe harbor" provision. 1292 (b) At the outset, it is important to understand the circumstances under which a party may appeal an interlocutory order. This is best approached by first reviewing the pertinent statutory language and then examining how the courts have interpreted and applied the provision. Section 1292(b) expressly permits a district court to certify an order for interlocutory appeal only if it "involves a controlling question [*7] of law as to which there is substantial ground for difference of opinion and that an immediate appeal from the order may materially advance the ultimate termination of the litigation." 28 U.S.C.A. 1292(b) (1994 & Supp. 2005). This terminology was intended to Page 3 2006 U.S. Dist. LEXIS 40624, *7 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 4 of 11 restrict the category of cases suitable for permissive appeal, but courts have not always agreed on the contours of the stated limitations. See 16 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 of the Univ. of Illinois, 219 F.3d 674, 676 (7th Cir. 2000) ("The [ 1292(b)] criteria, unfortunately, are not as crystalline as they might be. . . ."). For example, at times, courts including the Fifth Circuit have held that 1292(b) appeals are appropriate under only "exceptional" circumstances or in "big" cases. Clark--Dietz and Assocs.--Eng'rs v. Basic Constr. Co., 702 F.2d 67, 69 (5th Cir. 1983) (explaining that interlocutory appeals are permitted only under "exceptional" circumstances); see Gottesman v. Gen. Motors Corp., 268 F.2d 194, 196 (2d Cir. 1959) [*8] (clarifying that certification should be "strictly limited to the precise conditions stated in the law"); WRIGHT & MILLER, supra, 3929 at 365 & n.10 (internal citations omitted) (collecting cases holding interlocutory appeal appropriate only in "big" or "exceptional" cases). Conversely, at other times courts--the Fifth Circuit included--have employed a more flexible approach to 1292(b) appeals. In Hadjipateras v. Pacifica, S.A., Judge Brown promoted a more relaxed application of the provision: Each application is to be looked at . . . in the light of the underlying purpose reflected in the statute. . . . It was a judge--sought, judge-made, judge--sponsored enactment. Federal Judges from their prior professional practice, and more so from experience gained in the adjudication of today's complex litigation, were acutely aware of two principal things. First, certainty and dispatch in the completion of judicial business makes piecemeal appeal as permitted in some states undesirable. But second, there are occasions which defy precise delineation or description in which as a practical matter orderly administration is frustrated by the necessity of a waste of precious judicial [*9] time while the case grinds through to a final judgment as the sole medium through which to test the correctness of some isolated identifiable point of fact, of law, of substance or procedure, upon which in a realistic way the whole case or defense will turn. The amendment was to give to the appellate machinery of 1291 through 1294 a considerable flexibility operating under the immediate, sole and broad control of Judges so that within reasonable limits disadvantages of piecemeal and final judgment appeals might both be avoided. It is that general approach rather than the use of handy modifiers--which may turn out to be Shibboleths--that should guide us in its application and in determining whether the procedure specified has been substantially satisfied. 290 F.2d 697, 702--03 (5th Cir. 1961)); see also WRIGHT & MILLER, supra, 3929 at 368--69 & n. 16 (quoting Ex parte 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 of the spectrum. [*10] First, the decision to permit such an 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 district court's sound discretion"). Second, 1292(b) is not a vehicle to question the correctness of a district court's ruling or to obtain a second, more favorable opinion. McFarlin v. Conseco Servs., LLC, 381 F.3d 1251, 1256 (11th Cir. 2004) (quoting S. Rep. No. 85-2434 (1958), reprinted in U.S.C.C.A.N. at 5260--61)). Third, the issue for appeal must involve a question of law-not fact. Clark--Dietz, 702 F.2d at 69 (holding that "fact-review" issues are inappropriate for 1292 review). And a "question of law" does not mean the application of settled law to disputed facts. McFarlin, 381 F.3d at 1258 (citing Ahrenholz, 219 F.3d at 676). Thus, resolving the issue presented should not require the appeals court to go "hunting through the record" to see whether "a genuine issue of material fact may be lurking there. [*11] " Ahrenholz, 219 F.3d at 676. Fourth, the issue for appeal must involve a controlling question of law. Whether an issue of law is controlling generally hinges upon its potential to have some impact on the course of the litigation. At one end of the continuum, courts have found issues to be controlling "if reversal of the district court's opinion would result in dismissal of the 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) (citing Klinghoffer v. S.N.C. Achille Lauro, 921 F.2d 21, 24 (2d Cir. 1990)) (other citations omitted). An issue of law has also been termed controlling where "the certified issue has precedential value for a large number of cases." Id. On the other hand, an issue is not seen as controlling if its Page 4 2006 U.S. Dist. LEXIS 40624, *11 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 5 of 11 resolution on appeal "would have little or no effect on subsequent proceedings." John C. Nagel, Note, Replacing the Crazy Quilt of Interlocutory Appeals Jurisprudence with Discretionary Review, 44 DUKE L. J. 200, 212 (1994); WRIGHT & MILLER, supra, 3930 at 424. Between the extremes, courts have found the issue of [*12] whether an interlocutory appeal involves a controlling question of law to be "closely tied" to the requirement that the appeal will materially advance the ultimate termination of the litigation. WRIGHT & MILLER, supra, 3930 at 432; see also Nagel, supra, at 212 (courts have turned to the "materially advance" prong of 1292(b) in deciding whether an issue of law is controlling) (internal citations omitted). In sum, a controlling question of law--although not consistently defined--at the very least means a question of law the resolution of which could materially advance the ultimate termination of the litigation-thereby saving time and expense for the court and the litigants. WRIGHT & MILLER, supra, 3930 at 426 & n.25 (2ded. 1996 & Supp. 2005) (citing S.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 interlocutory appeal will "speed up the litigation." Ahrenholz, 219 F.3d at 676. "The institutional efficiency of the federal court system is among the chief concerns motivating 1292(b)." Strougo, 1997 U.S. Dist. LEXIS 12243, 1997 WL 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 accelerating or . . . simplifying trial court proceedings." WRIGHT & MILLER, supra, 3930 at 439. Finally, there must be substantial ground for difference of opinion over the controlling question of law for certification under 1292(b). This factor has been described as the least troubling for district courts. WRIGHT & MILLER, supra, 3930 at 419--20 (district courts "have not been bashful about refusing to find substantial reason to question a ruling of law"). Nonetheless, of all the 1292(b) criteria, this one is possibly the least predictable in application. Perhaps, as one commentary on 1292(b) recognized over thirty years ago, this is because "degrees of legal doubt escape precise quantification." Note, Interlocutory Appeals in the Federal Courts Under 28 U.S.C. 1292(b), 88 HARV. L. REV. 607, 623 (1975). That same commentary proposed a standard "that would require a trial court to believe that a reasonable appellate judge could vote for reversal of the challenged [*14] order" before the disagreement would be considered substantial under 1292(b). Id. Consistent with this line of thought, courts have found substantial ground for difference of opinion where: a trial court rules in a manner which appears contrary to the rulings of all Courts of Appeals which have reached the issue, if the circuits are in dispute on the question and the Court of Appeals of the circuit has not spoken on the point, if complicated questions arise under foreign law, or if novel and difficult questions of first impression are presented. 4 Am. Jur. 2d Appellate Review 128 (2005). But simply because a court is the first to rule on a question or counsel disagrees on applicable precedent does not qualify the issue as one over which there is substantial disagreement. Id. Nor does a party's claim that a district court has ruled incorrectly demonstrate a substantial disagreement. Wausau Bus. Ins. Co. v. Turner Constr. Co., 151 F. Supp. 2d 488, 491 (S.D.N.Y. 2001). In the end, "substantial" means just that-significantly great. MERRIAM-WEBSTER'S COLLEGIATE DICTIONARY 1174 (10th ed. 1998). [*15] III. ANALYSIS A. Loss Causation Pleading With the foregoing court opinions and commentary as a guide, the Court turns its attention to the merits of Flowserve's motion to certify to determine whether it has met the prerequisites for a for a 1292(b) appeal. Flowserve's first "controlling question" relates to loss causation pleading and reads: Whether, in a case predicated on the fraud-on--the market theory, a plaintiff must plead that the alleged curative disclosure of the "truth" that resulted in the plaintiff's losses revealed each material fact allegedly misrepresented to satisfy the required element of loss causation. Flowserve's contention that this issue is appropriate for a 1292 (b) appeal derives primarily from its interpretation of the Supreme Court's opinion regarding loss causation in 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 pleading standards in fraud--on--the--market cases by doing away with the "inflated purchase price" method of pleading loss causation and holding that loss causation could no longer be established solely by alleging an [*16] artificially inflated purchase price followed by a drop in stock price. Analyzing whether Flowserve has met its burden of demonstrating that its first "controlling question" meets Page 5 2006 U.S. Dist. LEXIS 40624, *16 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 6 of 11 the standards for a 1292(b) appeal necessarily begins with a review of the Dura case. Dura was a securities fraud class action which resolved a circuit split by dealing head--on with the "artificially inflated purchase price" method of pleading loss causation. The plaintiffs, who bought stock in a pharmaceutical company, alleged that the company made false statements about anticipated FDA approval of a new asthmatic spray device which in turn artificially inflated the company's stock price. When the company later announced lower than expected earnings, the stock price dropped significantly. Plaintiff--in pleadings subsequently endorsed by the Ninth Circuit--alleged loss causation as follows: "'In reliance on the integrity of the market, [the plaintiffs] . . . paid artificially inflated prices for Dura securities' and . . . suffered 'damage [s] thereby. . . .'" Id. at 340 (internal citations omitted). The narrow issue before the Dura Court was whether a plaintiff could [*17] satisfy the loss causation pleading and proof requirement "simply by alleging in the complaint and subsequently establishing that 'the price' of the security 'on the date of purchase was inflated because of the misrepresentation.'" Id. at 338 (emphasis in original). The Supreme Court found the answer to that question to be an unequivocal "no." The Court began its opinion by identifying the basic elements of a securities fraud action--including the indispensable requirement that plaintiffs prove "a causal connection between the material misrepresentation and the loss." Id. at 342. Taking issue with the Ninth Circuit's approval of the plaintiffs' pleadings, the Court stated: "normally, [in fraud--on--the--market cases,] an inflated purchase price will not itself constitute or proximately cause the relevant economic loss." Id. Reviewing the "tangle of factors affecting [stock] price", the Court concluded that the causal connection between an inflated purchase price and subsequent shareholder economic losses was tenuous at best. Id. at 343 ("the most logic alone permits us to say is that the higher purchase price will sometimes [*18] play a role in bringing about a future loss"). The opinion directed that plaintiffs in securities fraud cases must prove that the defendant's fraudulent conduct "proximately caused [their] economic loss" and determined that the "'inflated purchase price approach'"--standing alonewas not up to the task. Id. at 344--46. Addressing separately the pleading requirements for loss causation, the Dura Court made clear that plaintiffs could no longer rely solely on allegations of an "artificially inflated purchase price" to demonstrate the essential elements of proximate causation and economic loss. While the Court found the Dura plaintiffs' loss causation pleadings inadequate, it did not at the same time adopt more onerous pleading standards for such allegations. Rather, the Court clarified that Federal Rule of Civil Procedure 8(a)(2)'s "short and plain statement" rule would continue to govern loss causation pleadings. Id. at 346. So long as the allegations provide the defendant with fair notice of the 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] provide a defendant with some indication of the loss and the causal connection that the plaintiff has in mind." Id. at 347. In sum, Dura eliminated the "artificially inflated purchase price" method of proving loss causation, reemphasized the importance of demonstrating proximate cause and economic loss and renewed Rule 8 (a) (2)'s "short and plain statement" rule for such pleadings. Whether Dura heralded the change in loss causation pleading standards urged by Flowserve is another matter. Before moving to that issue, it bears mention that in various places in its briefing, Flowserve frames the loss causation "controlling question" for 1292(b) purposes in more general terms than in the introduction to its briefing. n2 To be clear, Flowserve's bottom line here is that post-Dura, loss causation must be pled in an almost formulaic manner requiring the plaintiff to plead that the "alleged curative disclosure of the 'truth' that resulted in the plaintiff's losses revealed each material fact allegedly misrepresented [or omitted] to satisfy the required element of loss causation"--a method this Court [*20] will refer to as "factfor--fact" pleading. n2 For example, Flowserve variously frames the "controlling legal issue" for 1292 (b)as "what must be alleged to satisfy the loss causation requirements set forth by Dura, the PSLRA and Fifth Circuit precedent" (Mot. at 5); "whether the Complaint's allegations, taken as true: . . . state a legally viable loss causation theory under the Supreme Court's decision in Dura" (Reply at 1); and "there is a substantial ground for a difference of opinion regarding whether Plaintiff's loss causation theory is legally valid." (Reply at 3). But it is clear from the entirety of its briefing that Flowserve rests its argument on the premise that Dura requires "fact-for--fact" pleading of loss causation. 1. Controlling Question of Law Plaintiffs first challenge Flowserve's motion to certify the loss causation issue as raising "fact-bound" pleading issues as opposed to legal questions. Interlocutory appeals have been allowed on pleading issues which raise difficult [*21] questions of substantive law but not when the is- Page 6 2006 U.S. Dist. LEXIS 40624, *21 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 7 of 11 sue raised is a "mere matter of properly pleading a claim sought to be brought within a recognized and generally sufficient legal theory." WRIGHT & MILLER, supra, 3931 at 453, 458--59 (A motion to dismiss a complaint "may rest . . . on resolution of a clearly determinative question of law . . . or . . . on questions merely of pleading etiquette."). Here, the Court is satisfied that Flowserve has raised an issue of law as opposed to fact regarding the requisite pleading standards for loss causation post--Dura. As articulated in its "controlling question 1" and accompanying argument, Flowserve contends that Dura requires Plaintiffs to demonstrate "a direct causal link between the misstatement and . . . [their] economic loss." (Mot. at 5- The "direct causal link", according to Defendants, -6) cannot be established "with respect to an alleged misrepresentation unless and until there is a revelation of the truth concerning that misrepresentation followed by a stock price decline." (Mot. at 5) (emphasis in original) The Court finds that this adequately raises a legal question as to the post-Dura minimum requirements for pleading [*22] a "legally viable loss causation theory." (Reply at 1) Whether it is a controlling question of law is another matter. Rather than decide that issue, the Court will assume without deciding that it is a controlling question and move to the "substantial disagreement" requirement where it clearly falls short. 2. Substantial Ground for Difference of Opinion In determining whether a substantial ground for difference of opinion exists in the context of 1292(b), the obvious first task is to identify the opinion at issue and then weigh the degree of disagreement. In other words, first and foremost, there must be a discernable opinion triggering the requisite disagreement. Drawn from its interpretation of Dura, Flowserve identifies the opinion at issue as: Whether, in a case predicated on the fraud-on-the market theory, a plaintiff must plead that the alleged curative disclosure of the "truth" that resulted in the plaintiff's losses revealed each material fact allegedly misrepresented to satisfy the required element of loss causation. Implicit in this question and expressed throughout its briefing is Flowserve's assumption that the Dura opinion signaled [*23] a change in loss causation pleading requirements beyond its narrow holding on the inflated purchase price theory. More to the point, from Dura and from certain Fifth Circuit cases dealing with proximate cause in other securities fraud contexts, Flowserve extracts "a substantial likelihood" that the Fifth Circuit will interpret Dura to impose a type of "fact-for--fact" loss causation pleading requirement. Taking it a step further, Flowserve submits that, post--Dura, the Fifth Circuit can reasonably be expected to hold that loss causation in fraud--on-the-market cases can only be shown by demonstrating that each fact allegedly misrepresented (the fraud) was also later revealed to the market triggering the drop in stock price. (Mot. at 7) Applied to this case, Flowserve's fact-for--fact pleading requirement would require Plaintiffs to allege that the precise topics of the alleged misrepresentations--Flowserve's historical financial statements, statements of debt covenant compliance and statements regarding the IDP and IFC acquisitions--were later one--by-one revised and revealed to the market in truthful terms. The obvious shortcoming for 1292(b) purposes is that Dura [*24] did not, even by way of dicta, express the opinion Flowserve now claims is the subject of substantial disagreement. As mentioned, the Dura court expressly declined to formulate precise standards for proving loss causation despite a request to do so by the Defendant and the 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- 11, 18--9, 20, Dura, 544 U.S. at 346 (No. 932)). Outside of rejecting the inflated purchase price approach, Dura's instructions on loss causation pleadings were limited to: reaffirming the applicability of Rule 8 (a) (2)'s short and plain statement rule to such pleadings; requiring that plaintiffs plead loss causation in a way that provides the defendant "'fair notice'" of their claims and the grounds underlying them; and suggesting that plaintiffs include allegations that the stock price "fell significantly after the truth became known." Id. at 1282 (citing Dura, 544 U.S. at 346-47). The Dura court did not endorse or address Flowserve's proposed "fact-for--fact" method [*25] of pleading loss causation. Id. (citing Dura, 544 U.S. at 346) (The Dura court did not purport to address whether loss causation allegations must "explicitly allege that the subject matter of the alleged misrepresentations . . . was revealed to the market by way of some 'corrective disclosure' that preceded the drop in the price of the stock (or the economic loss generally)."). "While the Court suggested that the plaintiffs needed to have alleged in some fashion that 'the truth [regarding the . . . misrepresented information] became known' before the "'share price fell'", the Court did not set forth guidelines as to whether such a revelation . . . must be direct [or] inferential.") Id. (citing Dura, 544 U.S. at 347). In actuality, Dura "left the lower federal courts free to continue to develop somewhat diverse approaches to the pleading of corrective disclosures preceding eco- Page 7 2006 U.S. Dist. LEXIS 40624, *25 Case 5:04-cv-04156-JW nomic losses." Id. Document 111 Filed 07/28/2006 Page 8 of 11 Thus the "opinion" on which Flowserve seeks Fifth Circuit guidance and over which it contends there is substantial disagreement is not reasonably drawn from the Dura case. Nor does any Fifth Circuit case suggest the interpretation [*26] of Dura urged by Flowserve. In fact, as pointed out by Plaintiffs, none of the cases relied upon by Flowserve are apposite to its position on Dura. n3 Cases and commentary following Dura and directly addressing the pleading issue substantiate that it did not effect a material change or foretell a shift in loss causation pleading requirements other than in the narrow area of inflated purchase price pleadings. See Patrick J. Coughlin, Eric Alan Isaacson and Joseph D. Daley, What's Brewing in Dura v. Broudo? The Plaintiffs' Attorneys Review the Supreme Court's Opinion and Its Import for Securities Fraud Litigation, 37 LOY. U. CHI. L. J. 1, 17 (2005) ("Clearly the [Dura] Court means for . . . [pleading loss causation] to be a fairly simple [exercise]. . . ."). n3 Flowserve cites In re Odyssey, 424 F. Supp. 2d 880 (N.D. Tex. 2005), in support of its loss causation pleading theory. (Notice of Supp. Auth. at 1) But In re Odyssey is distinguishable on several fronts. First, although the district court in Odyssey observed that the parties disagreed over "the scope of what Dura now requires a plaintiff to plead", the court did not endorse or even reference the type of fact--for--fact pleading method touted by Flowserve in this case. Odyssey, 424 F. Supp. 2d at 886. Second, the "false financial statements" claim in Odyssey (the only claim similar to those in this case) was rejected--not on loss causation pleading grounds--but under the PSLRA's safe harbor provision. Id. at 886--87. Finally, the language from Odyssey heavily relied upon by Flowserve as supporting its theory of loss causation pleading is pulled from a portion of the opinion addressing the resignation of the company's CEO--a claim utterly unlike any in this case. Id. at 887. [*27] In its In re Bradley Pharmaceuticals, Inc., Securities Litigation opinion, a district court in New Jersey squarely took on the issue of whether the method of pleading urged here by Flowserve was required post--Dura. 421 F. Supp. 2d 822 (D. N. J. 2006). The defendants in that case argued that "Dura requires Plaintiffs to 'allege a loss following the 'corrective disclosure' of the allegedly undisclosed misrepresentation.'" Id. at 828. They complained that the plaintiffs had not adequately pleaded loss causation because the alleged corrective disclosure (an SEC inquiry) did not address the subject of the alleged misrepresenta- tion (false statements in connection with the "sham" sale of a cold remedy). The district court rejected the defendants' argument with the following: We disagree with Defendants' rigid and dogmatic interpretation of Dura. In Dura, the Supreme Court only suggested that the plaintiffs needed to have alleged in some fashion that 'the truth became known' before 'the share price fell.' However, Dura did not address what type of events or disclosures may reveal the truth. Nor did Dura explain how specific [*28] such disclosures must be. See In re Winstar Communications, 2006 U.S. Dist. LEXIS 7618, 2006 WL 473885 (S.D.N.Y. 2006) (stating that in Dura, "the Court did not address the means by which the information is imparted to the public. Specifically, Dura did not set forth any requirements as to who may serve as the source of the information, nor is there any requirement that the disclosure take a particular form or be of a particular quality.") . . . see finally In re Worldcom, Inc. Sec. Litig., 388 F. Supp. 2d 319, 347, 2005 WL 2319118, at *23 (S.D.N.Y. 2005) (to satisfy loss causation under Dura, plaintiff must "establish that his losses were attributable to some form of revelation to the market of the wrongfully concealed information"). . . . Guided by a pragmatic understanding of Dura, the Court concludes that Plaintiffs have adequately pled loss causation. The revelation of the "truth" about the [cold remedy sale] did not take the form of a single, unitary disclosure, but occurred through a series of disclosing events. See, e.g., Greater Pennsylvania 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 omitted). In In re Enron Corp. Securities, Derivative and ERISA Litigation, the district court, in a lengthy analysis of Dura's effect on loss causation pleading, recognized that Dura did "not impose heightened or onerous pleading requirements." In re Enron Corp. Secs., Derivative and ERISA Litig., 2005 U.S. Dist. LEXIS 41240, No. MDL-1446, 2005 WL 3504860 at *15- (S.D. Tex. Dec. 22, -19 Page 8 2006 U.S. Dist. LEXIS 40624, *29 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 9 of 11 2005); see also In re Daou Sys., 411 F.3d 1006, 1026 (9th Cir. 2005) (another post--Dura opinion upholding loss causation pleadings--which alleged a sharp drop in stock price on the heels of a public revelation of the company's "true financial situation"--as sufficiently alleging pursuant to Dura "some indication that the drop in . . . stock price was causally related to Daou's financial misstatements"); Greater Pennsylvania Carpenters Pension Fund v. Whitehall Jewelers, Inc., 2005 U.S. Dist. LEXIS 12971, No. 04-C--1107, 2005 WL 1563206 *5 (N.D. Ill. June 30, 2005) (where, post--Dura, the district court let stand a pre-Dura ruling denying a motion to dismiss on loss causation grounds--finding allegations of defendants' [*30] numerous false statements about the financial condition of the company which were later revealed through partial disclosures relating to the fraud causing the stock price to drop sufficient to allege loss causation) (emphasis added). To sum up, since Dura, the circuits have continued to vary in their approaches to loss causation pleading-some with stricter requirements than others. But neither Dura nor any Fifth Circuit case requires the type of "fact-for-fact" method of loss causation pleading urged by Flowserve. Because there is no opinion expressly requiring or even reasonably suggesting Flowserve's proposed pleading approach, there is necessarily no substantial disagreement to support an interlocutory appeal. The circuits' disparate pleading requirements for loss causation do not amount to a substantial disagreement over whether fact-for--fact pleading should be required. Given the Dura Court's expressed allegiance to a "simple test" for loss causation pleadings under Rule 8 (a) (2), Flowserve's position favoring fact--for--fact precision in pleading is even less tenable. Finally, as pointed out by Plaintiffs, to impose a requirement in securities fraud cases that [*31] each fact misrepresented be in turn specifically confessed before liability could attach would discourage candor and inhibit the flow of precise, accurate information between corporations and shareholders. Because Flowserve's 1292 (b) motion with respect to loss causation fails on the "substantial disagreement" prong, the Court denies this part of the motion on that ground and will not address the other 1292 (b) factors. B. Negative Causation Defense Flowserve next moves to certify the following question regarding the statutory negative causation defense: Whether, in a case predicated on the fraud-on-the market theory, a plaintiff's claims under Section 11 are barred by the statutory negative causation defense where the alleged curative disclosure that the plaintiff claims resulted in his losses did not reveal the facts allegedly misrepresented in the challenged registration statements. This point merits no discussion because it mirrors the argument supporting the loss causation pleading issue above. In other words, to certify the negative causation question, the Court must accept Flowserve's premise that Dura requires fact-for--fact loss causation [*32] pleading. Thus for the same reasons set forth in the foregoing section, the Court rejects the negative causation argument and denies this portion of Flowserve's motion to certify. C. Safe Harbor n4 n4 (c) Safe Harbor. --(1) In general. - - Except as provided -in subsection (b), in any private action arising under this title that is based on an untrue statement of a material fact or omission of a material fact necessary to make the statement not misleading, a person referred to in subsection (a) shall not be liable with respect to any forward-looking statement, whether written or oral, if and to the extent that - -(A) the forward-looking statement is ---(i) identified as a forward-looking statement, and is accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forwardlooking statement; or (ii) immaterial; or (B) the plaintiff fails to prove that the forward-looking statement - -(i) if made by a natural person, was made with actual knowledge by that person that the statement was false or misleading; Page 9 2006 U.S. Dist. LEXIS 40624, *32 Case 5:04-cv-04156-JW or (ii) if made by a business entity; was ---(I) made by or with the approval of an executive officer of that entity, and (II) made or approved by such officer with actual knowledge by that officer that the statement was false or misleading. Document 111 Filed 07/28/2006 Page 10 of 11 bor provision does not a substantial disagreement make. Although, as mentioned, "degrees of legal doubt escape precise quantification," n5 Flowserve is hard pressed here to quantify the conflict between this Court's incorrect assessment of the law and the extensive authority to the contrary as "substantial." Thus, this issue is not a proper one for an interlocutory appeal and Flowserve's motion must be denied on this point as well. n6 n5 See Note, Interlocutory Appeals in the Federal Courts Under 28 U.S.C. 1292(b), 88 HARV. L. REV. 607 at 623. n6 Although the Court's sole task here is to decide Flowserve's motion for interlocutory appeal under 1292 (b)'s standards, it is important to clarify the effect of the Court's incorrect perception of the law on Flowserve's motion to dismiss. Specifically, despite the Court's inaccurate assessment of the effect of a defendant's state of mind on the operation of the first prong of the safe harbor provision, it need not as a consequence reverse that portion of its ruling on the motion to dismiss. More to the point, to qualify for safe harbor protection under the first prong, the statements at issue must be accompanied by "meaningful cautionary language." The Court has reviewed those portions of the pleadings that Flowserve contends are protected under the first prong of the safe harbor provision and determined that it is impossible without more information (via summary judgment) to tell whether the cautionary language describes the "principal or important risks" facing Flowserve at the time they were made. See Asher v. Baxter Int'l Inc., 377 F.3d 727, 733 (7th Cir. 2004); Makor Issues & Rights, Ltd. v. Tellabs, Inc., 437 F.3d 588, 599 (7th Cir. 2006) (quoting Asher, 377 F.3d at 733); and Marc H. Folladori, Protecting Forward--Looking Statements: The Private Securities Litigation Reform 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 presently determine if the accompanying cautionary language is "meaningful" thus dismissal under the safe harbor 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) 15 U.S.C. 78u--5(c)(1)(A) and (B). [*33] Flowserve's third controlling question relates to the PSLRA's "safe harbor" provision: Whether the PSLRA safe harbor for forward-looking statements protects from liability projections accompanied by meaningful cautionary language independent of the speaker's alleged state of mind. Reduced to its essence, Flowserve's argument boils down to a claim that the Court made a mistake in applying the PSLRA's safe harbor provision and in the process made an incorrect statement of law regarding the interplay between the two prongs of the provision. More precisely, Flowserve maintains that, in denying the Defendants' motions to dismiss, the Court conflated the two independent prongs of the PSLRA's safe harbor provision and incorrectly stated that Plaintiffs can defeat either prong by pleading that a defendant had actual knowledge of a statement's falsity. Citing the text of the safe harbor statute, its legislative history and a plethora of cases, Flowserve challenges the Court's suggestion of a "settled principle" that actual knowledge of falsity defeats either prong of the provision. (Mot. at 15--20) The Court agrees with Flowserve on this point. Nonetheless, that does not qualify [*34] the question for a 1292(b) appeal. To elevate the Court's misstatement into an issue appropriate for interlocutory appeal Flowserve must demonstrate that it meets 1292(b)'s standards as a controlling question of law over which there is substantial ground for difference of opinion and that an immediate appeal from the order may speed up the litigation. And the fact that this Court made a statement that conflicts with the weight of authority on the safe har- Page 10 2006 U.S. Dist. LEXIS 40624, *35 Case 5:04-cv-04156-JW Interlocutory Appeal (doc. 141) is DENIED. SO ORDERED. SIGNED June 9th, 2006 Document 111 Filed 07/28/2006 JANE J. BOYLE Page 11 of 11 UNITED STATES DISTRICT JUDGE June 13, 2006 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 1 of 12 TAB 12 Page 1 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 2 of 12 LEXSEE 2006 U.S. APP. LEXIS 16556 T. JEFFREY SIMPSON, on behalf of himself and all others similarly situated, and Plaintiff, 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, California June 30, 2006, Filed PRIOR HISTORY: [*1] Appeal from the United States District Court for the Central District of California. D.C. No. CV--01-11115--MJP. Marsha J. Pechman, District Judge, Presiding. In re Homestore.com, Inc. Sec. Litig., 252 F. Supp. 2d 1018, 2003 U.S. Dist. LEXIS 3499 (C.D. Cal., 2003) Coughlin Stoia & Robbins LLP, San Diego, California, on behalf of the Regents of the University of California as amicus curiae in support of appellant. Lawrence S. Robbins, Robbins, Russell, Englert, Orseck & Untereiner LLP, Washington, DC, on behalf of the American Institute of Certified Public Accountants as amicus curiae in support of appellees. David H. Braff, Sullivan & Cromwell LLP, New York, New York, on behalf of the Bond Market Association, 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 Judge Gould. OPINIONBY: Ronald M. Gould OPINION: GOULD, Circuit Judge: This consolidated class action litigation alleges that multiple actors engaged in a scheme to commit securities fraud by overstating the reported revenues of an Internet company, Homestore.com ("Homestore"). Homestore eventually restated [*3] its revenues, resulting in a decrease in revenues of more than $170 million and corresponding declines in Homestore's stock value. The district court dismissed the securities claims against Defendants--Appellees, relying on the Supreme Court's decision in Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164, 114 S. Ct. 1439, 128 L. Ed. 2d 119 (1994). In this appeal, the lead plaintiff, California State Teachers' Retirement System ("CalSTRS" or "Plaintiff"), seeks to reverse the district court's dismissal with prejudice of its claims under 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. 78j(b), against six outside defendants ("Defendants"): AOL Time Warner ("AOL") COUNSEL: Joseph W. Cotchett (argued) and Nancy L. Fineman, Cotchett, Pitre, Simon & McCarthy, Burlingame, California, for plaintiff--appellant California State Teachers' Retirement System. Peter T. Barbur (argued), Cravath, Swaine & Moore LLP, New York, New York; John B. Quinn, Quinn Emanuel Urquhart Oliver & Hedges LLP, Los Angeles, California, for defendant--appellee Time Warner Inc. Samuel Kadet, Skadden, Arps, Slate, Meagher & Flom LLP, New York, New York; Jeffrey Speiser, Stern & Kilcullen, Roseland, New Jersey, for defendants--appellees Cendant Corporation and Richard A. Smith. Carl S. Kravitz, Zuckerman Spaeder LLP, Washington, DC, for defendant--appellee David Colburn. J. Christian Word, Latham & Watkins LLP, Washington, DC, for defendant--appellee Eric 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 behalf of the Securities and Exchange Commission as amicus curiae in support [*2] of appellant. Peter H. Mixon, General Counsel, Sacramento, California; Keith Johnson, Chief Legal Counsel, Madison, Wisconsin, on behalf of the California Public Employees' Retirement System and the State of Wisconsin Investment Board as amici curiae in support of appellant. Eric Alan Isaacson, Lerach Page 2 2006 U.S. App. LEXIS 16556, *3 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 3 of 12 and two of its officers, Eric Keller and David Colburn; Cendant Corporation and one of its officers, Richard Smith; and L90, Inc. ("L90"). Plaintiff alleges Homestore entered into fraudulent transactions with these Defendants in which Homestore purchased revenue for itself and then recorded that revenue in violation of SEC accounting rules. In the alleged "triangular transactions," Homestore entered into sham transactions with "Third Party Vendors" who then [*4] returned the money to Homestore through contracts with AOL or L90. Plaintiff alleges Homestore overpaid for an asset owned by Cendant in return for Cendant's agreement that it would funnel some of the money back to Homestore through a related business entity. The complaint further alleged that the recording of gross revenue from these transactions contravened SEC rules regarding barter transactions or the buying of revenue, and that the triangular transactions were often done without the full knowledge of Homestore's auditor. The Supreme Court held in Central Bank that 10(b) does not allow recovery for aiding and abetting liability, Cent. Bank, 511 U.S. at 177--78, but cautioned that secondary actors were not always free from liability under 10(b) because they may still be liable as a primary violator. 511 U.S. at 191. We address here the scope of primary violation liability that the Supreme Court did not fully define in Central Bank. Plaintiff asserts that Defendants are primary violators under 10(b) for engaging in a "scheme to defraud." In response, Defendants argue that the Supreme Court in Central Bank limited primary liability [*5] under 10(b) to defendants who personally made a public misstatement, violated a duty to disclose or engaged in manipulative trading activity, and not to those engaged in a broader scheme to defraud. Although we hold that the scope of 10(b) includes deceptive conduct in furtherance of a "scheme to defraud," when all elements of 10(b) are otherwise satisfied, we conclude that Plaintiff's complaint insufficiently alleged that Defendants were primary violators of 10(b) based on their conduct in the furtherance of the scheme. I CalSTRS alleges in its First Amended Consolidated Complaint ("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--trip or barter transactions whereby Homestore recorded net revenues from its receipt of monies that came from Homestore's own cash reserves. Homestore created an online real estate website in 1996. In the late 1990s, there was an explosion of Internet start--up companies which consistently posted net losses and negative cash flows as those companies sought to develop leadership and market [*6] share in their industries. This development caused a corresponding shift in emphasis by financial analysts to the tracking and evaluation of revenues as an indicator of future earnings. Until 2001, Homestore was perceived as an Internet company that consistently matched or exceeded its estimated revenue goals. To meet its revenue expectations, Homestore relied increasingly on barter or round-trip transactions with other companies. In such transactions, Homestore paid a company, the company returned part of the money to Homestore by way of a different transaction, and Homestore recorded these returned funds as revenue. Internet companies have historically engaged in barter transactions between themselves, often in order to place advertising on each other's websites. Beginning in fiscal year 2000, the SEC implemented a new accounting standard that required companies engaging in barter transactions to report only the net revenue that was earned from these related transactions, rather than the gross revenue received. Facing increasing scrutiny from its auditor PWC, Homestore's barter transactions grew more complex. Homestore engaged in triangular transactions, with the result that PWC [*7] did not recognize that the revenue that Homestore recorded was related to a prior transaction funded by Homestore. As the district court succinctly summarized, in these triangular transactions: Homestore would find some third party corporation, one that was thinly capitalized and in search of revenues in order to "go public." Homestore then agreed to purchase shares in that company for inflated values or to purchase services or products that Homestore did not need. This transaction was contingent on the third party company "agreeing" to buy advertising from AOL for most or all of what Homestore was paying them. The money thus flowed through the third party to AOL, which then took a commission and shared "revenue" with Homestore. In re Homestore.com, Inc. Securities Litigation, 252 F. Supp. 2d 1018, 1023 (C.D. Cal. 2003). Against this background, we consider the allegations against the particular Defendants. A. Allegations Involving AOL, and its officers Keller and Colburn The history of Homestore and AOL for purposes of this appeal began with the creation of a legitimate part- Page 3 2006 U.S. App. LEXIS 16556, *7 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 4 of 12 nership in April 1998, whereby Homestore purchased the "exclusive [*8] right to have the only online real estate listing product on AOL." In a second legitimate deal with AOL, Homestore entered into an advertising reseller agreement, under which AOL agreed in March 1999 to sell advertising on the Homestore website and retain a commission. The triangular transactions at issue here occurred during the first two quarters of fiscal year 2001. Plaintiff alleges that Homestore entered into a series of sham transactions with various Third Party Vendors for some product or service that Homestore did not need. The Third Party Vendors would then contract with AOL for advertising on Homestore's website and AOL would give this money back to Homestore under their advertising reseller agreement. Both the Third Party Vendors and AOL would keep a portion of the money as a commission. Plaintiff only alleges that the first leg of the transaction was truly a sham because nothing of value was given in exchange for Homestore's payment. AOL continued to sell advertising on Homestore's website to Third Party Vendors, withholding commissions before passing the Vendors' payments on to Homestore. Plaintiff alleges that Defendant Eric Keller, as an employee of AOL, jointly developed [*9] these transactions with Homestore. Keller was also alleged to have contacted some of the Third Party Vendors that took part in these triangular transactions. Plaintiff alleges, without detailed support, that Defendant Colburn, Keller's supervisor, approved the improper transactions. AOL placed Keller on administrative leave in June 2001. AOL then attempted to include more accurate documentation of the round trip nature of additional triangular transactions that occurred at the close of the second quarter of 2001. Homestore convinced AOL to accept less descriptive documents, which would not alert PWC to the nature of the roundtrip transaction. AOL included a list of the "potential referral advertisers" as part of the second deal in 2001, but let Homestore add other companies not involved in the round--trip transactions so that the Third Party Vendors could not be identified. B. Allegations Involving Cendant and its officer Smith Cendant Corporation is a conglomerate with holdings in real estate, travel, and vehicle rentals. In 2001, it owned Move.com, the second largest real estate internet website after Homestore. Cendant sold Move.com to Homestore in the first quarter [*10] of 2001. In exchange for the site, Homestore transferred $750 million worth of Homestore stock to Cendant and placed Cendant's president, Richard Smith, on Homestore's board of directors. Plaintiff alleges that, although an outside firm appraised the site, Homestore "grossly overpaid" Cendant for this website, which Cendant considered a "bad asset." Plaintiff alleges that the Move.com transaction was contingent on a promise by Cendant to recycle some of Homestore's payment for Move.com back to Homestore. To accomplish this, Cendant set up a separate corporate entity, the Real Estate Technology Trust ("RETT"), and funded it with $95 million. Cendant, through RETT, then agreed to the payment of $80 million over two years in exchange for products and services from Homestore. There are no allegations that Cendant made efforts to conceal the contingent nature of these transactions. According to the allegations in the FACC, Cendant later agreed to use the remaining $15 million in RETT to purchase virtual tours from Homestore. At first, Cendant proposed a reciprocal agreement in which Homestore would purchase $15 million in products from Cendant at a later date. Homestore refused because [*11] this reciprocal transaction would prevent PWC from allowing Homestore to report the first $15 million as revenue. Cendant then dropped the reciprocal requirement and purchased the tours. C. Allegations Involving L90 L90 entered into triangular transactions with Homestore and various third parties during the second and third quarters of 2001. These transactions followed the business model created with AOL's participation. n1 At the end of the third quarter of 2001, PWC required a confirmation letter from L90 before it would certify Homestore's 10--Q filing. Initially, Mark Roah, a corporate officer for L90, refused to sign the confirmation letter. Fearing personal liability, Roah requested payment from Homestore and said that he wanted only to do "legitimate deals" with the company. Roah later dropped his demands and confirmed the revenue, but shortly thereafter Homestore's Chief Financial Officer Joseph Shew refused to sign the Form 10--Q report that included the revenues Roah had confirmed. Homestore then announced that it would restate its financial results to reflect lower revenue. n1 There are no allegations that L90 or its officers helped to develop these transactions such as Keller was alleged to have done. [*12] D. Procedural History Multiple class action complaints were filed between December 27, 2001, and February 13, 2002. These complaints were consolidated on February 22, 2002. On September 25, 2002, Homestore's former Chief Operating Page 4 2006 U.S. App. LEXIS 16556, *12 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 5 of 12 Officer, John Giesecke; former Chief Financial Officer, Joseph Shew; and Vice President of Finance, John DeSimone, pled guilty to securities fraud violations. On November 15, 2002, Plaintiff filed the FACC, which relied on the details recited in the plea agreements for these officers. Homestore and Peter Tafeen, former Executive Vice President of Business Development and Sales, answered the FACC, but all other defendants moved to dismiss. On March 7, 2003, the district court denied the motions to dismiss for Stuart Wolff, Homestore's former CEO, and its auditor PWC. The district court dismissed without prejudice the complaint as to the remaining Homestore insider defendants. Relevant to this appeal, the district court also dismissed the complaint as to the outside defendants with prejudice. In dismissing the complaint against the outside defendants, which it referred to as the "Business Partner Defendants," the district court observed that in [*13] previous cases in which courts found primary liability, a special relationship existed between the defendants and the shareholders. The district court ultimately determined that the outside defendants did not commit a primary violation because they only facilitated and participated in Homestore's fraud. The district court also determined that Plaintiff had not demonstrated reliance because the shareholders did not rely on the outside defendants' scheme but only on the statements made about the scheme by Homestore. II We review de novo the dismissal of claims pursuant to 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 fairly supported by the record, even if the district court did not reach 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 as true, and the allegations are construed in the light most favorable to the non--moving party, but conclusory allegations of law and unwarranted inferences [*14] are insufficient to defeat a motion to dismiss."Id. (internal quotations omitted). "Dismissal is proper under Rule 12(b)(6) if it appears beyond doubt that the non--movant can prove no set of facts to support its claims." Id. "The district court's dismissal of a complaint without leave to amend is reviewed de novo and is improper unless it is clear that the complaint could not be saved by any amendment." Livid Holdings Ltd. v. Salomon Smith Barney, Inc., 416 F.3d 940, 946 (9th Cir. 2005). Securities fraud must be pled with specificity. In the Private Securities Litigation Reform Act ("PSLRA"), Congress required that "a complaint must 'specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed.'" Lipton v. Pathogenesis Corp., 284 F.3d 1027, 1034 (9th Cir. 2002) (quoting 15 U.S.C. 78u--4(b)(1)). In addition, all allegations of deceptive conduct are generally subject to Federal Rule of Civil Procedure 9(b) [*15] , which requires that "the circumstances constituting fraud or mistake shall be stated with particularity." III We determine whether the Defendants' conduct, as alleged, is a primary violation of 10(b). Section 10(b) prohibits, in pertinent part, "any person, directly or indirectly, . . . [t]o use or employ, in connection with the purchase or sale of any security . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe." Securities Exchange Act of 1934 10(b), 15 U.S.C. 78j(b). To implement 10(b), the SEC promulgated Rule 10b--5, 17 CFR 240.10b- Rule 10b- is composed of -5. -5 three parts that describe the type of conduct prohibited by 10(b). The second part proscribes the making of "any untrue statement of a material fact" or the omission of any material fact that is necessary in order to make the statements made not misleading. Rule 10b-5(b), 17 CFR 240.10b--5(b). The first and third parts make it unlawful for any person "to employ any device, scheme, or artifice to defraud" or "to engage in any act, practice, [*16] or course of business which operates or would operate as a fraud or deceit upon any person." Rule 10b--5(a)& (c), 17 CFR 240.10b--5(a) & (c). Liability under Rule 10b--5 does not extend beyond the limits of 10(b). See Cent. Bank, 511 U.S. at 173 ("But the private plaintiff may not bring a 10b- suit -5 against 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, despite the broad view of the Rule advanced by the Commission in this case, its scope cannot exceed the power granted the Commission by Congress under 10(b)."). In Central Bank, the Supreme Court held "that the text of the 1934 Act does not itself reach those who aid and abet a 10(b) violation." 511 U.S. at 177; see also id. at 177- ("We -78 cannot amend the statute to create liability for acts that are not themselves manipulative or deceptive within the meaning of the statute."). The Court cautioned, however, that secondary actors, other than the securities issuer, may be liable as primary violators under 10(b) when all elements of [*17] the statute are satisfied: Page 5 2006 U.S. App. LEXIS 16556, *17 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 6 of 12 The absence of 10(b) aiding and abetting liability does not mean that secondary actors in the securities markets are always free from liability under the securities Acts. Any person or entity, including a lawyer, accountant, or bank, who employs a manipulative device or makes a material misstatement (or omission) on which a purchaser or seller of securities relies may be liable as a primary violator under 10b--5, assuming all of the requirements for primary liability under Rule 10b- are met. -5 Cent. Bank, 511 U.S. at 191. A private action under 10(b) and Rule 10b--5 must allege and prove all of the elements for primary liability for each defendant. The elements of a securities fraud claim are: (1) to use or employ any manipulative or deceptive device or contrivance; (2) scienter, i.e. wrongful state of mind; (3) a connection with the purchase or sale of a security; (4) reliance, often referred to in fraud--on-the-market cases as "transaction causation;" (5) economic loss; and (6) loss causation, i.e. a causal connection between the manipulative or deceptive device or contrivance and 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 the sufficiency of the allegations concerning three elements: (1) the use or employment of a deceptive device or contrivance by the Defendants; (2) in connection with the purchase or sale of securities; (3) that has been relied upon by the public. n2 n2 We do not consider the possibility of liability based on actionable omissions or manipulation sufficient to satisfy the requirement of a "manipulative or deceptive device or contrivance" under 10(b). There are no allegations that any Defendant was subject to a duty to disclose in the context of these transactions or engaged in manipulative trading activity. See Santa Fe Indus., Inc. v. Green, 430 U.S. 462, 476, 97 S. Ct. 1292, 51 L. Ed. 2d 480 (1977). vice in connection with the purchase or sale of securities, including deception [*19] as part of a larger scheme to defraud 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 of Ins. 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) and Rule 10b--5 prohibit all fraudulent schemes in connection with the purchase or sale of securities, whether the artifices employed involve a garden type variety of fraud, or present a unique form of deception.'" (quoting A. 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" has used or employed a deceptive device within the meaning of 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 liability under 10(b) only extends to "primary violators" and there is no liability for merely "aiding and abetting" a violation. 511 U.S. at 191. Since Central Bank, it is the duty of courts to determine what constitutes a "primary [*20] violation" of 10(b). With respect to the making of false statements or omissions, we have held that "substantial participation or intricate involvement in the preparation of fraudulent statements is grounds for primary liability even though that participation might not lead to the actor's actual making of the statements." Howard v. Everex Sys., Inc., 228 F.3d 1057, 1061 n.5 (9th Cir. 2000); see id. at 1061 (holding that signing and attesting to a statement, such that for all intents and purposes the signor--attestor made the statement, is sufficient to be considered a primary violator); see also In re Software Toolworks Inc. Sec. Litig., 50 F.3d 615, 628- & n. 3 (9th Cir. 1994) (holding -29 that drafting or editing false statements that the drafter-editor knows will be publicly disseminated is sufficient to be considered a primary violator). What it means to be a "primary violator" with respect to an alleged "scheme to defraud" has been less extensively discussed. In Cooper v. Pickett, 137 F.3d 616, 624 (9th Cir. 1997), we held that to be liable for a "scheme to defraud," "each defendant [must have] committed a [*21] manipulative or deceptive act in furtherance of the scheme." The relevant inquiry is: what conduct constitutes a manipulative or deceptive act in the furtherance of a scheme to defraud sufficient to render the defendant a "primary violator" of 10(b)? The SEC argues in its amicus brief that "Any person who directly or indirectly engages in a manipulative or deceptive act as part of a scheme to defraud can be a primary violator." n3 The SEC defines "a deceptive act" as "engaging in a transaction whose principal purpose A. The Use or Employment of a Deceptive Device or Contrivance The Supreme Court tells us that 10(b) is intended to prohibit the use or employment of any deceptive de- Page 6 2006 U.S. App. LEXIS 16556, *21 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 7 of 12 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 the false appearance of fact, constitutes a "deceptive act." n4 Participation in a fraudulent transaction by itself, however, is insufficient to qualify the defendant as a "primary violator" if the deceptive nature of the transaction or scheme was not an intended result, at least in part, of the defendant's own conduct. We hold that to be liable as a primary violator of 10(b) for participation in a "scheme to defraud," the defendant must have engaged in conduct that had the principal purpose and effect [*22] of creating a false appearance of fact in furtherance of the scheme. It is not enough that a transaction in which a defendant was involved had a deceptive purpose and effect; the defendant's own conduct contributing to the transaction or overall scheme must have had a deceptive purpose and effect. n5 n3 The arguments of the SEC are only persuasive authority to the extent that they are reasonable in light of the statutory authority. See Zandford, 535 U.S. at 819--20 ("[The SEC's] interpretation of the ambiguous text of 10(b), in the context of formal adjudication, is entitled to deference if it is reasonable"). To the extent that the SEC's proposed test purports to include aiding and abetting or coconspirator liability, we are constrained to reject it. See In re GlenFed, Inc. Sec. Litig., 60 F.3d 591, 592 (9th Cir. 1995). n4 "The consideration of purpose and effect of challenged actions not infrequently assists in determining whether a prohibition is to be applied to complex conduct. . . . [and its] importance. . . [in] judg[ing] the legality of challenged action is also a recurring theme in statutory law." The Wilderness Soc'y v. U.S. Fish & Wildlife Serv., 353 F.3d 1051, 1064 (9th Cir. 2003). [*23] [*24] Daou Systems, Inc., 411 F.3d 1006, 1017 (9th Cir. 2005); Silicon Graphics, 183 F.3d at 986. While the scienter element ensures a culpable state of mind and must be satisfied for recovery under 10(b), the "principal purpose" prong examines instead whether the challenged conduct of the defendant had a principal purpose, and not just an accidental effect, of creating a false appearance as part of a deceptive transaction or fraudulent scheme. Unlike the scienter requirement, the "purpose and effect" test is focused on differentiating conduct that may form the basis of a primary violation under 10(b) from mere aiding and abetting activity that the Supreme Court has held does not constitute a primary violation. A defendant may intend to deceive the public by substantially assisting another's misconduct as part of a scheme to defraud, but fail to perform personally any action that created a false appearance as part of this scheme. The scienter requirement, therefore, will not in all cases distinguish aiding and abetting from primary liability. In applying the "scienter" element, we look at whether a defendant's state of mind was sufficiently culpable for 10(b) liability. By contrast, we may examine the "principal purpose and effect" of the defendant's challenged conduct in a fraudulent scheme as an aid to assessing whether the defendant's conduct was sufficiently deceptive for 10(b) liability. n5 The "principal purpose" prong is related to but different from the element of scienter. For the element of scienter, we require "that a private securities plaintiff proceeding under the PSLRA must plead, in great detail, facts that constitute strong circumstantial evidence of deliberately reckless or conscious misconduct." In re Silicon Graphics Inc. Sec. Litig., 183 F.3d 970, 974 (9th Cir. 1999). Previous cases have found the scienter requirement satisfied by indirect evidence of a culpable state of mind, such as suspicious insider trading activity or knowledge of accounting violations. See In re Defendants argue that imposing liability for participation in an overall scheme to defraud would impose liability for conduct other than the making of a material misstatement or omission and would conflict with Central Bank. We disagree. We see no justification to limit liability under 10(b) to only those who draft or edit the statements released to the public. To the contrary, 10(b) prohibits any person or entity from using or employing any deceptive device, directly or indirectly, in connection with the purchase and sale of securities. See Robert A. Prentice, Locating That "Indistinct" and "Virtually Nonexistent" Line Between Primary and Secondary Liability under Section 10(b), 75 N.C. L. Rev. 691, 731 (1997) (asserting that "the view that one can be liable only for one's own statements arguably ignores the fact that both Section 10(b) and Rule 10b--5 condemn those who employ devices or make misstatements 'directly or indirectly'"). Furthermore, 10(b) "should be construed not technically and restrictively, but flexibly to effectuate its remedial purposes." Zandford, 535 U.S. at 819 (internal quotation marks omitted). Nor is "scheme [*25] to defraud" liability a substitute for aiding and abet- Page 7 2006 U.S. App. LEXIS 16556, *25 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 8 of 12 ting liability that the Supreme Court precludes in Central Bank. The focus of the inquiry on the deceptive nature of the defendant's own conduct ensures that only primary violators (that is, only those defendants who use or employ a manipulative or deceptive device) are held liable under the Act. Trial courts which have imposed liability under a "scheme to defraud" theory have often required that the defendant's actions in fraudulent transactions have a principal purpose and effect of creating a false appearance of fact 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 under 10(b) when "defendant was a primary architect of the scheme to finance the sham entities"); In re Global Crossing, Ltd. Sec. Litig., 322 F. Supp. 2d 319, 336--337 (S.D.N.Y. 2004)(allowing claims of primary liability to go forward where auditors "masterminded" company's misleading accounting practices); In re Lernout & Hauspie Sec. Litig., 236 F. Supp. 2d 161, 173 (D. Mass. 2003) (denying a motion [*26] to dismiss for outside business partners who invented sham corporate entities that allowed a corporation "to hide research and development expenses, create fictitious revenue, and ultimately overstate profits in [its] financial reports"). Conduct by the defendant that does not have a principal legitimate business purpose, such as the invention of sham corporate entities to misrepresent the flow of income, may have a principal purpose of creating a false appearance. 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 business purpose that are actually guaranteed 'loans' employed to inflate Enron['s] financial image are not above--board business practices."). Conduct that is consistent with the defendants' normal course of business would not typically be considered to have the purpose and effect of creating a misrepresentation. 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 consistent with the normal activity of such a business entity, standing alone, . . . [*27] are insufficient to state a claim of primary liability under Central Bank" (internal quotation marks omitted)). Participation in a legitimate transaction, which does not have a deceptive purpose or effect, would not allow for a primary violation even if the defendant knew or intended that another party would manipulate the transaction to effectuate a fraud. See In re Charter Commc'ns, Inc., Sec. Litig., 443 F.3d 987, 992 (8th Cir. 2006) (refusing to impose primary liability "on a business that entered into an arm's length non--securities transaction with an entity that then used the transaction to 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 designed and entered into the transactions knowing or even intending that Parmalat or its auditors would misrepresent the nature of the arrangements. That is, they substantially assisted fraud with culpable knowledge - in other words, they aided and abetted it."). If a defendant's conduct or role in an illegitimate transaction has the principal purpose and effect of creating a false appearance [*28] of fact in the furtherance of a scheme to defraud, then the defendant is using or employing a deceptive device within the meaning of 10(b). A test that examines the purpose and effect of a defendant's conduct in an alleged scheme to defraud, as a means to assess whether the defendant used or employed a deceptive device, ensures that the defendant's conduct is sufficiently deceptive to justify imposing primary liability. Thus, when determining whether a defendant is a "primary violator," the conduct of each defendant, while evaluated in its context, must be viewed alone for whether it had the purpose and effect of creating a false appearance of fact in the furtherance of an overall scheme to defraud. B. In Connection with the Purchase or Sale of Securities In addition to the use or employment of a deceptive or manipulative device or contrivance, 10(b) requires that the primary violation must be "in connection with the purchase or sale of any security." 15 U.S.C. 78j. In Zandford, the Supreme Court held that a broker's misappropriation of a brokerage account was a fraudulent "scheme to defraud" that was "in connection with" the sale of securities [*29] despite lacking any deception about the value of a security or "manipulation of a particular security." Zandford, 535 U.S. at 821. In Zandford, the broker fraudulently wrote checks to himself from a brokerage account that required the sale of securities in order to cash the checks. See id. Although the misappropriation of money did not affect the securities market until the check was later redeemed, the broker's scheme to defraud was not complete until the victim's securities were sold and the check was redeemed. See id. The Supreme Court held that the scheme to defraud "coincided" with the sale of securities, which satisfied the "in connection with" requirement of 10(b). Id. at 820. Similarly, a scheme to misrepresent the publicly reported revenue of a company may coincide with the purchase or sale of securities because the scheme will not be complete until the fraudulent information is introduced into the securities market. That every participant in the scheme did not release the information to the public does not diminish the causal connection between all defendants Page 8 2006 U.S. App. LEXIS 16556, *29 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 9 of 12 in the scheme and the securities market. See Cent. Bank, 511 U.S. at 191 [*30] (stating that "[i]n any complex securities fraud, moreover, there are likely to be multiple violators"). If multiple participants used or employed a deceptive device in furtherance of a scheme to misrepresent the reported revenues of a company, then all participants may be viewed as having acted in connection with the purchase or sale of securities. C. Reliance Another requirement for liability under 10(b) is reliance. See Cent. Bank, 511 U.S. at 180. "Reliance provides the requisite causal connection between a defendant's misrepresentation and a plaintiff's injury." Basic Inc. v. Levinson, 485 U.S. 224, 243, 108 S. Ct. 978, 99 L. Ed. 2d 194 (1988). A plaintiff may be presumed to have relied on a misrepresentation if the misleading or false information was injected into an efficient market. "Indeed, nearly every court that has considered the proposition has concluded that where materially misleading statements have been disseminated into an impersonal, well-developed market for securities, the reliance of individual plaintiffs on the integrity of the market price may be presumed." Id. at 247. The fraud--on--the-market presumption requires [*31] the dissemination of the misrepresentation into an efficient market, but not personal involvement by the defendant in disseminating this statement. See Knapp v. Ernst & Whinney, 90 F.3d 1431, 1436 (9th Cir. 1996) ("Because a material misrepresentation or omission is generally embedded in the market price of the security, an investor who purchases or sells the security will have presumably relied on the misrepresentation."). The requirement of reliance is satisfied if the introduction of misleading statements into the securities market was the intended end result of a scheme to misrepresent revenue. See In re ZZZZ Best Sec. Litig., 864 F. Supp. 960, 973 (C.D. Cal. 1994) ("Instead, the market's overall reliance on the Z Best fraudulent scheme, or at least the additional statements as released and issued by Z Best, is sufficient to satisfy the reliance element in the Rule 10b-5(a) & (c) claims."); see also 4 Alan R. Bromberg & Lewis D. Lowenfels, Bromberg & Lowenfels on Securities Fraud 7:469 (2d ed. 2006) ("Despite some earlier disagreement, it now seems settled that FOMT [the fraud--on-the-market-theory] applies to all three clauses of [*32] Rule 10b- (1) scheme to defraud, (2) misrepresentation -5: or omission, and (3) fraudulent course of business, not just to clauses (1) and (3)."). The scheme to defraud would not be complete until the fraudulent information has entered the securities market. See Parmalat, 376 F. Supp. 2d at 509 ("The banks made no relevant misrepresentations to those markets, but they knew that the very purpose of certain of their transactions was to allow Parmalat to make such misrepresentations. In these circumstances, both the banks and Parmalat are alleged causes of the losses in question."). We may presume, absent persuasive conflicting evidence, that purchasers relied on misstatements produced by a defendant as part of a scheme to defraud, even if the defendant did not publish or release the misrepresentations directly to the securities market. We conclude that conduct by a defendant that had the principal purpose and effect of creating a false appearance in deceptive transactions as part of a scheme to defraud is conduct that uses or employs a deceptive device within the meaning of 10(b). Furthermore, such conduct may be in connection with the purchase or sale of securities [*33] if it is part of a scheme to misrepresent public financial information where the scheme is not complete until the misleading information is disseminated into the securities market. Finally, a plaintiff may be presumed to have relied on this scheme to defraud if a misrepresentation, which necessarily resulted from the scheme and the defendant's conduct therein, was disseminated into an efficient market and was reflected in the market price. IV With these principles in mind, we address the adequacy of the allegations of the FACC at issue here. If the Defendants' conduct, as alleged in the FACC, had the purpose and effect of creating a false appearance from illegitimate transactions in furtherance of a scheme to misrepresent revenues, then Plaintiff has alleged a primary violation of 10(b). If the relevant actions by the Defendants were not deceptive, however, but only facilitated or assisted the fraudulent misreporting of legitimate transactions by Homestore, then Defendants were not primary violators under 10(b) and this complaint was correctly dismissed. A. Primary Liability of America Online (AOL) and its officers AOL and its officers are alleged to have [*34] played a role in the scheme to overstate the revenues of Homestore. According to the FACC, Eric Keller, a Senior Vice President at AOL, helped Homestore to organize and create the triangular transactions. The FACC further alleges that the triangular transactions were necessary to allow Homestore to overstate its revenues, and that the actions of AOL, Colburn and Keller assisted Homestore in misrepresenting the revenues from these transactions. But primary liability requires more than assertions of "helping" or "assisting" another's deception. To allege a primary violation, the complaint must allege that AOL or its officers actually engaged in a deceptive act. We have examined the specific allegations involving AOL and its officers to determine whether the FACC alleges conduct by the AOL Page 9 2006 U.S. App. LEXIS 16556, *34 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 10 of 12 Defendants that had the purpose and effect of creating a false appearance in fraudulent transactions that were part of a scheme to defraud. We conclude that the allegations are insufficient. It is not alleged that AOL or its officers created sham business entities or engaged in deceptive conduct as part of illegitimate transactions, and so we conclude that the element of using or employing a deceptive [*35] device is not adequately alleged in this respect. There is no indication from the FACC that the transactions engaged in by AOL were completely illegitimate or in themselves created a false appearance. n6 The substance of the allegations shows that AOL's role in the transactions was to act as a conduit for the flow of revenue between the Third Party Vendors and Homestore as an advertising agent, in accord with AOL's advertising reseller agreement with Homestore. n6 Defendants urge that the challenged transactions were not deceptive, and that only the reporting of revenues from these transactions by Homestore, conduct in which Homestore was not assisted by the Defendants, deceived the investing public about revenues of Homestore. The FACC does allege that Homestore entered into sham transactions with "Third Party Vendors" in return for a "quid pro quo" obligation from these vendors to buy Homestore advertising from AOL. Assuming the truth of allegations that no products of value were exchanged between the Third [*36] Party Vendors and Homestore, the FACC nonetheless does not allege that AOL itself entered into a transaction that had no legitimate economic value or created a false appearance. While the advertising transactions between the Third Party Vendors and AOL are alleged to contain suspect qualities, such as exaggerated commissions by AOL, there is no suggestion that actual advertisements were not purchased and sold by these companies. The FACC does not allege that the transactions contained a false appearance or other deceptive qualities, but rather that they were an opportunity for Homestore to take advantage of the advertising reseller agreement. This may pin liability on Homestore, but not on AOL or its officers. The FACC also alleges that AOL attempted to include additional documentation in subsequent transactions that would connect the referral agreements between Homestore and the Third Party Vendors with the advertising revenues from AOL. While the absence of this additional documentation allowed Homestore to misreport the revenues from the AOL advertising referrals as stand--alone transactions, any misrepresentation in the transactions involving AOL resulted from the additional agreements [*37] between Homestore and the Third Party Vendors and the misreporting of the income by Homestore. The transactions involving AOL did not create a false appearance until they were viewed in conjunction with Homestore's actions before and after the transaction. While AOL would be liable under 10(b) for its deceptive conduct as part of a scheme to defraud if AOL engaged in deceptive conduct, it may not be held liable for participating in legitimate transactions that became "deceptive" only when distorted by the willful or intentional fraud of another party. See Parmalat, 376 F. Supp. 2d at 505 ("Any deceptiveness resulted from the manner in which Parmalat or its auditors described the transactions on Parmalat's balance sheets and elsewhere."). In this case, the FACC does not allege with the required particularity that the transactions negotiated by Keller and performed by AOL created a false appearance. We conclude that the FACC failed to sufficiently allege with particularity that AOL committed actions with the purpose and effect of creating a false appearance in furtherance of a scheme to defraud. B. Primary Liability of Cendant and its officer Smith The [*38] FACC also alleges that Cendant participated in a scheme to defraud by engaging in triangular transactions. Cendant argues that the transactions were simply "simultaneously agreed upon business transactions" and were not deceptive or manipulative absent the application of improper accounting principles by Homestore. We agree that the FACC does not indicate how these transactions involving Cendant created a false appearance, independent from Homestore's misreporting of the income from these transactions as unrelated to any previous transaction. There are no allegations that show how the creation of the RETT and its funding by Cendant for future transactions with Homestore had the potential to misrepresent the reality behind the transactions. n7 In fact, the press release from Cendant quoted in the FACC acknowledges that subsequent purchases by Cendant were planned in conjunction with Homestore's acquisition of Cendant's websites. n7 In its opening brief, Plaintiff argues that Cendant took affirmative steps to conceal the true nature of the Move.com transaction. The paragraph in the complaint cited for this assertion only states that Cendant classified the $95 million funding of RETT as a "one time non-recurring expense." The FACC does not explain how this classification is false or a mischaracterization of the transaction. Page 10 2006 U.S. App. LEXIS 16556, *38 Case 5:04-cv-04156-JW [*39] Document 111 Filed 07/28/2006 Page 11 of 12 Although the creation of separate entities may indicate an attempt to conceal the source of funding for related transactions, see Lernout, 236 F. Supp. 2d at 173, the FACC does not allege that Cendant's specific actions in these transactions created a false appearance independent of the improper accounting by Homestore. The FACC does not allege with particularity that Cendant acted with the purpose and effect of creating a false appearance of Homestore revenues with the aim of deceiving the investing public, and we conclude that the complaint was properly dismissed against Cendant and Smith. C. Primary Liability of L90 The allegations involving L90 similarly fail to allege sufficiently that L90 used or employed a deceptive device by engaging in a fraudulent transaction as part of a scheme to defraud. There are no allegations that L90 helped to create or concoct this scheme, which allegedly followed the model set by AOL. As with AOL, there are no allegations that L90 acted with the purpose and effect of creating a false appearance in these transactions. Mark Roah, an officer for L90, allegedly signed a false statement attesting to the fact that the transactions [*40] were not contingent on other related transactions, which may suffice to state a valid claim for primary liability under 10(b). The day after the false confirmation letter was signed by Roah, however, Homestore's CFO refused to sign the financial report based on the misstatements within the report. The information contained in the false confirmation letter by L90, or any other false statement which resulted from this confirmation letter, was never introduced into the securities market as part of a scheme to defraud. Therefore, this statement was never used or employed in connection with the purchase or sale of securities and the allegations concerning the statement cannot state a valid claim under 10(b). V Because the FACC does not allege a valid claim for primary liability under any theory of liability, the district court properly dismissed the claims in the FACC against the Defendants. Dismissal without leave to amend is improper, however, unless it is clear that Plaintiff could not propose an amended complaint that states a valid claim under 10(b) for any of these Defendants. See Livid Holdings, 416 F.3d at 946. "Leave to amend need not be granted [*41] when an amendment would be futile." In re Vantive Corp. Sec. Litig., 283 F.3d 1079, 1097 (9th Cir. 2002). Futility of amendment may be shown by Plaintiff's failure to plead additional facts when given the opportu- nity. See id. at 1098 ("When given the opportunity, the plaintiffs declined to say what additional facts they might plead if given the chance to amend."). Here, the district court applied a more restrictive test of primary liability than called for under 10(b). Plaintiff was not offered the opportunity to state any additional facts that, if alleged, would state a valid claim for relief under the standards we have set forth. n8 We conclude that Plaintiff should have the opportunity to seek leave to file an amended complaint that may take advantage of the reasoning in this opinion. "In this technical and demanding corner of the law, the drafting of a cognizable complaint can be a matter of trial and error." Eminence Capital, LLC v. Aspeon, Inc., 316 F.3d 1048, 1052 (9th Cir. 2003). On remand to the district court, Plaintiff may argue to the district court that an amendment would not be futile based on the presence of additional [*42] relevant facts which it may plead. Defendants may argue any ground that they assert for denial of any proposed amendment. The district court may then decide in the first instance whether any amended complaint may be filed. n9 n8 Plaintiff raised the issue of amendment of the complaint in its briefing in the district court and on appeal. In the district court, Plaintiff argued in its opposition to Defendants' motions to dismiss that leave to amend should be granted if the district court found that the current complaint failed to state a valid claim. In its briefing to us, Plaintiff did not seek leave to amend until its reply brief. "We will not ordinarily consider matters on appeal that are not specifically and distinctly argued in appellant's opening brief." United States v. Ullah, 976 F.2d 509, 514 (9th Cir. 1992) (internal quotation marks omitted). However, "we may review an issue if the failure to raise the issue properly did not prejudice the defense of the opposing party." Id. We determine that review of the issue of amendment does not prejudice the defense of the Defendants because we only remand the issue of amendment for the district court to assess in the first instance, after the parties have had an opportunity to address the standards for amendment and whether it is futile under the legal standard we have announced concerning the elements of 10(b). [*43] n9 If the district court decides to grant leave to amend, then the motion to dismiss filed by Defendant Smith must be resolved. Smith argues that he must be dismissed from any further litigation in this case because a Settlement Agreement between Plaintiff and Homestore released from liabil- Page 11 2006 U.S. App. LEXIS 16556, *43 Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 VI Page 12 of 12 ity all former officers and directors of Homestore, which included Smith. Plaintiff argues that Smith was excluded from this release because of his position with Cendant, which was the primary source of his alleged liability in this case. This issue will be moot if amendment is not permitted. Moreover, if necessary, the district court, which approved this Settlement Agreement, may interpret this Agreement and any admissible extrinsic evidence in the first instance. We leave this motion for consideration by the district court. We affirm the district court's dismissal of the current complaint against Defendants. We remand so that Plaintiff may seek leave in the district court to amend the complaint if that can be done consistent with this opinion. Costs are awarded to Defendants--Appellees. AFFIRMED [*44] and REMANDED for further proceedings consistent with this opinion. Case 5:04-cv-04156-JW Document 111 Filed 07/28/2006 Page 1 of 12 TAB 13 Case 5:02-cv-02270-JW 5:04-cv-04156-JW Document 470 111 Filed 04/06/2006 07/28/2006 Page 1 of 11 2 12 1 2 3 4 5 6 7 8 9 10 IN THE UNITED STATES DISTRICT COURT FOR THE NORTHERN DISTRICT OF CALIFORNIA SAN JOSE DIVISION United States District Court 11 For the Northern District of California NO. C 02-02270 JW IN RE VERISIGN CORPORATION SECURITIES LITIGATION 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 / 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. ORDER GRANTING IN PART AND DENYING IN PART DEFENDANTS' MOTION TO DISMISS Case 5:02-cv-02270-JW 5:04-cv-04156-JW Document 470 111 Filed 04/06/2006 07/28/2006 Page 2 of 11 3 12 1 2 3 4 5 6 7 8 9 10 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 United States District Court 11 For the Northern District of California 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 2 Case 5:02-cv-02270-JW 5:04-cv-04156-JW Document 470 111 Filed 04/06/2006 07/28/2006 Page 3 of 11 4 12 1 2 3 4 5 6 7 8 9 10 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); United States District Court 11 For the Northern District of California 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 3 Case 5:02-cv-02270-JW 5:04-cv-04156-JW Document 470 111 Filed 04/06/2006 07/28/2006 Page 4 of 11 5 12 1 2 3 4 5 6 7 8 9 10 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 United States District Court 11 For the Northern District of California 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 4 Case 5:02-cv-02270-JW 5:04-cv-04156-JW Document 470 111 Filed 04/06/2006 07/28/2006 Page 5 of 11 6 12 1 2 3 4 5 6 7 8 9 10 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 because the true financial condition of the Company continued to be concealed from investors. In addition, investors still did not know that (1) VeriSign had reported overstated revenues, receivables, deferred revenue and earnings by improperly accounting for the two-year auto-renewals and acquired deferred revenue, (2) VeriSign was misreporting domain name registrations by concealing the number of free and promotional registrations and two-year auto-renewal registrations, (3) 5 United States District Court 11 For the Northern District of California 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 Case 5:02-cv-02270-JW 5:04-cv-04156-JW Document 470 111 Filed 04/06/2006 07/28/2006 Page 6 of 11 7 12 1 2 3 4 5 6 7 8 9 10 the extent to which VeriSign improperly recognized revenues on the roundtrip and barter transactions and the effect on the Company, (4) VeriSign had overstated earnings by failing to properly account for its long-term investments in non-public companies under the equity method and by failing to record impairment charges on many of the investments, and (5) VeriSign had reported overstated earnings by failing to reserve for its delinquent receivables. Moreover contrary 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 monies back to VeriSign. In essence, VeriSign was paying itself to boost up revenue from these "round trip" deals. Thus, while some of the artificial inflation was taken out of the stock with these disclosures, the true picture of VeriSign's business had not yet been 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 United States District Court 11 For the Northern District of California 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 6 Case 5:02-cv-02270-JW 5:04-cv-04156-JW Document 470 111 Filed 04/06/2006 07/28/2006 Page 7 of 11 8 12 1 2 3 4 5 6 7 8 9 10 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 United States District Court 11 For the Northern District of California 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 7 Case 5:02-cv-02270-JW 5:04-cv-04156-JW Document 470 111 Filed 04/06/2006 07/28/2006 Page 8 of 11 9 12 1 2 3 4 5 6 7 8 9 10 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 United States District Court 11 For the Northern District of California 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 8 Case 5:04-cv-04156-JW Case 5:02-cv-02270-JW Document 111 Document 470 Filed 07/28/2006 Filed 04/06/2006 Page 10of 11 Page 9 of 12 1 2 3 4 5 6 7 8 9 10 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 name business, including its inability to estimate renewal rates, overstatement of domain name revenues, misleading appearance of sequential deferred revenue growth, the undisclosed weakness in its registrar business beyond the purge of free and promotion names, $70-80 million in unexpected charges to expense and the reliabilty and visibility of VeriSign's future earnings. (TAC 401). While the present case is a close one, Plaintiffs appear to have alleged that the loss United States District Court 11 For the Northern District of California 12 13 14 15 16 17 18 19 from the domain name scheme was foreseeable from Defendants' actions in artificially inflating the 20 stock, and that the loss in stock price was caused by the disclosure of the concealed risk of the 21 domain name scheme. The Court finds that the disclosures of VeriSign's financial condition and 22 analyst reaction to this disclosure is sufficiently similar to the disclosure in Daou to find that the 23 Plaintiffs have adequately pled that their losses were proximately caused by the domain name 24 scheme as disclosed to the market on April 25, 2002. 25 C. 26 Rule 15(a) of the Federal Rules of Civil Procedure provides that leave to amend a complaint 27 28 9 Leave to Amend Case 5:02-cv-02270-JW 5:04-cv-04156-JW Document 470 111 Filed 04/06/2006 07/28/2006 Page 10 of 11 11 12 1 2 3 4 5 6 7 8 9 10 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, 2006 02cv2270mtd United States District Court 11 For the Northern District of California 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 /s/ James Ware JAMES WARE United States District Judge 10 Case 5:02-cv-02270-JW 5:04-cv-04156-JW Document 470 111 Filed 04/06/2006 07/28/2006 Page 11 of 11 12 12 1 2 3 4 5 6 7 8 9 10 THIS IS TO CERTIFY THAT COPIES OF THIS ORDER HAVE BEEN DELIVERED TO: Adam T. Savett asavett@cmht.com Alfred Glenn Yates yateslaw@aol.com Amy Freeman afreeman@omm.com Andrew M. Schatz aschatz@snlaw.net Christopher T. Heffelfinger cheffelfinger@bermanesq.com Darren J. Robbins e_file_sd@lerachlaw.com David Malcolm Furbush dfurbush@omm.com Deborah R. Gross debbie@bernardmgross.com Dennis J. Herman dennish@mwbhl.com Dhaivat H. Shah dshah@omm.com Ioana Petrou ipetrou@omm.com Jeffrey W. Lawrence jeffreyl@lerachlaw.com Jessica Anne Hoogs jhoogs@omm.com Joshua Seth Devore jdevore@cmht.com Lori E. Romley lromley@omm.com Marc L. Godino service@braunlawgroup.com Mark Wayne Robertson mrobertson@omm.com Meredith N. Landy mlandy@omm.com Noah Daniel Boyens nboyens@omm.com Patrick J. Coughlin patc@mwbhl.com Randi D. Bandman randib@mwbhl.com Shana Eve Scarlett shanas@milberg.com Shirley H. Huang shirleyh@mwbhl.com William S. Lerach billl@lerachlaw.com Simon Bahne Paris Spector, Roseman & Kodroff, P.C. 1818 Market Street, Suite 2500 Philadelphia, PA 19103 Dated: April 6, 2005 Richard W. Wieking, Clerk By:_/s/JW Chambers______ Melissa Peralta Courtroom Deputy United States District Court 11 For the Northern District of California 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 TAB 14 Slip Copy Slip Copy, 2005 WL 2893783 (N .D.Cal .), Fed. Sec . L . Rep . P 93,581 (Cite as : S lip Copy) Page 1 N Briefs and Other Related Document s United States District Court,N .D . California. In re VERISIGN CORPORATION SECURITIES LITIGATION 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 , Deborah 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 Office, Jeffrey W . Lawrence, Dennis J . Herman, Patrick J . Coughlin, Shang Eve Scarlett , Lerach Coughlin Stoia Geller Rudman & Robbins LLP, Christopher T . Heffelfinger, Berman Devalerio Pease & Tabacco, P .C ., San Francisco, CA, Amy Freeman, Mark Wayne Robe rtson, O'Melveny & Myers, 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 FO R 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 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 Commission Rule I Ob-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 Corporation 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 services"-services that verify and authenticate information transmitted over the Internet . Such services enable consumers 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 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 . Network Solutions charged each website listed on its registry at least $6 per year . Although some industry analysts supported this acquisition, others questioned whether VeriSign was paying too much. This skepticism allegedly placed pressure on Ver- 2006 Thomson/West. No Claim to Orig. U.S . Govt. Works . Slip Copy Slip Copy, 2005 WL 2893783 (N .D.Cal .), Fed. Sec . L . Rep . P 93,581 (Cite as : S lip Copy) Page 2 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 Internet 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 assortment 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 artificially inflated VeriSign's earnings-and stock price-via improper 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, startup 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 Amended Complaint 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 report at least $12 million in revenues on its financial statements during the Class Period . Id. However, Plaintiffs allege 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 exerted "significant influence" over its affiliates, Plaintiffs claim that the "equity method" was proper . Id. The "equity method" would not have permitted VeriSign to report any of the revenues received from its affiliates . Plaintiffs allege even further that Defendants artificially inflated VeriSign's earnings by improperly encouraging VeriSign's sales force to engage in a process known as "scrubbing." Consolidated Second Amended Complaint at 4 . "Scrubbing" is a method of double-counting : salespersons in one division would report 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 inflate VeriSign's revenues . Plaintiffs contend that they relied upon these misrepresentations to their detriment . Currently before this Court is Defendants' Motion for Judgment 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 causation, 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 pursuant 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 & Arthur 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 accept as true all allegations of material fact and must construe said allegations in the light most favorable to the nonmoving 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) insufficient facts stated under a cognizable theory. Moran, supra at 2006 Thomson/West. No Claim to Orig. U.S . Govt. Works . Slip Copy Slip Copy, 2005 WL 2893783 (N .D.Cal .), Fed. Sec . L . Rep . P 93,581 (Cite as : S lip Copy) Page 3 893 ; 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 ce rt ainty that a plaintiff would not be entitled to relief under any set of facts which could be proved . Rothman v . Yedder Park Management. 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 Commission "rules and regulations ." 15 U.S.C . 78j(b) . Rule lob-5 forbids the making of any "untrue statement of material 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 statutory 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 inference 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 an d 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 an d the loss ." Id at 1631 . The Court, in Dura, held that a plaintiff could not satisfy loss causation merely by alleging (and later establishing) that the price of the secu ri ties on the date of the purchase was inflated because of misrepresentation . Id, at 1627 . d In Dura, plaintiffs were a class of individuals who purchased stock in Dura Pharmaceuticals on the public market during the class period . Plaintiffs alleged that the comp any made false statements concerning its profits and its prospects 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 following day, the company's shares lost almost half their value, falling from $39 per share to $21 per share . Id. Subsequently, 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 reversing 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 market, 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 purchase 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 standard 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 ) 2006 Thomson/West. No Claim to Orig. U.S . Govt. Works . Slip Copy Slip Copy, 2005 WL 2893783 (N .D.Cal .), Fed. Sec . L . Rep . P 93,581 (Cite as : Slip Copy) Page 4 failed to describe the causal connection between the loss and the misrepresentation . Id. at 1634 . *4 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) . The Daou Court, however, specified that a plaintiff is not required to show that a misrepresentation was the sole reason for the investment's decline in value in order to establish loss causation. Id, at 1025 . As long as the misrepresentation d 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 inflate 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 purchased 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 precipitously after the defendants began to reveal figures showing 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 prematurely 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 dramatically 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 prematurely recognizing revenue. " Id. (emphasis in the original) . The Ninth Circuit found these allegations sufficiently specific to establish loss causation under Dura. 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 quotations omitted) (emphasis in original) . The plaintiffs in that case alleged that the defendants intentionally discounted earnings estimates and issued cautionary statements to excite the market and inflate prices when those estimates were beaten . Id. The IPO court held that the plaintiffs failed to allege 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 requirements 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 pleading 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 applicability of Fed.R.Civ .P . 8(a)(2) to loss causation, which requires only a "short and plain statement of the claim showing 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 causation 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) . 2006 Thomson/West. No Claim to Orig. U.S . Govt. Works . Slip Copy Slip Copy, 2005 WL 2893783 (N .D.Cal .), Fed. Sec . L . Rep . P 93,581 (Cite as : S lip Copy) Page 5 B. Plaintiffs Adequately Plead Loss Causation For One Of The Five Categories of Fraud Plaintiffs allege that Defendants issued numerous misrepresentations 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 recognition of reciprocal and related party transactions, (2) failure to timely write down alleged impaired assets, (3) improper accounting, (4) false segment reporting, and (5) upwards 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 services 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 improper 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 derived, 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 reported from regional sales divisions and fraudulently inflated 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 . To establish loss causation, Plaintiffs rely on three disclosures, 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 Complaint at 38 . In this report, the company, for the first time, revealed that approximately 10% of its revenue was attributable to reciprocal arrangements, or "barter transactions," and sales to the company affiliates that VeriSign had just invested 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 recognition of reciprocal and related party transaction . Plaintiffs allege that Defendants inflated earnings by improperly reporting more than $64 million of revenue as a result of numerous "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 nonmonetary 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 category of fraud, the Court fords that Plaintiffs have sufficiently 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 results were not up to our expectations as we encountered significant spending delays in our IT and telecom customer bases," Mr. Stratton Sclavos, Chairman and CEO of Ver- 2006 Thomson/West. No Claim to Orig. U.S . Govt. Works . Slip Copy Slip Copy, 2005 WL 2893783 (N .D.Cal .), Fed. Sec . L . Rep . P 93,581 (Cite as : S lip Copy) Page 6 iSign announced plans to restructure the company's operations 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 disclosure 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 manipulating its financial results ." (Plaintiffs' CSAC at 2 .) In contrast to Daou, where the complaint alleged deteriorating operating and expense margins, dramatically misplaced revenue results, and a revelation that the company's rapidly escalating 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 misrepresentations making up the second through fi fth categories 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 recognition of reciprocal and related party transactions . However, the three disclosures cited by the Plaintiffs in their complaint 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 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 amendments, 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 Period Are Denied Without Prejudic e Defendants contend that Plaintiffs do not allege loss causation with respect to any alleged economic loss after March 19, 2000, and therefore move to strike all alleged misstatements 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 responding to the challenged pleading . Fed .R .Civ .P . 12(f). However, Rule 12(f) allows a court to exercise its discretion, 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 adequately plead loss causation. Therefore, this Court does not deem it necessary at this time, to Rule on the merits of Defendants' motion to strike and to shorten the Class Period. Defendants' Motions to Shorten the Class Period and t o 2006 Thomson/West. No Claim to Orig. U.S . Govt. Works . Slip Copy Slip Copy, 2005 WL 2893783 (N .D.Cal .), Fed. Sec . L . Rep . P 93,581 (Cite as : S lip Copy) Page 7 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 Image of this Document (PDF) 2006 WL 1042093 (Trial Motion, Memorandum and Affidavit) Defendants' Reply in Support of Motion to Dismiss Third Amended Complaint (Mar . 13, 2006) Original Image of this Document (PDF) 2006 WL 709349 (Trial Motion, Memorandum and Affidavit) Plaintiffs' Opposition to Defendants' Motion to Dismiss Third Amended Class Action Complaint (Feb . 27, 2006) Original Image of this Document (PDF) 2006 WL 397993 (Trial Motion, Memorandum and Affidavit) Class Action Defendants' Notice of Motion and Motion to Dismiss Third Amended Class Action Complaint (Jan . 30, 2006) Original Image of this Document (PDF ) 2005 WL 2868471 (Trial Motion, Memorandum and Affidavit) Defendants' Reply in Support of Motion for Judgment on the Pleadings and Motion to Strike (Sep . 12, 2005) Original Image of this Document (PDF) 2005 WL 2613749 (Trial Motion, Memorandum and Affidavit) 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 2006 Thomson/West. No Claim to Orig. U.S . Govt. Works .

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Afghans Studying the Art of VotingOctober 4, 2004 By DAVID ROHDE and CARLOTTA GALL GHULAM ALI, Afghanistan, Sept. 28 - In front of Ed Morgan'seyes, democracy appeared to take root in Afghanistan. Mr. Morgan, 64, an American election expert, stood in