JAMES A. diBOISE, State Bar No. 083296
DOUGLAS J. CLARK, State Bar No. 171499
DAVID P. O'BRIEN, State Bar No. 189675
JEANIE KIM, State Bar No. 186468
WILSON SONSINI GOODRICH & ROSATI
Professional Corporation
650 Page Mill Road
Palo Alto, CA 94304-1050
Telephone: (650) 493-9300
Facsimile: (650) 565-5100
Attorneys for Defendants
WARREN E. PINCKERT, II and
CHOLESTECH CORPORATION
UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF CALIFORNIA
SAN FRANCISCO DIVISION
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ROBERT REE, individually and on behalf of all Plaintiffs, v. WARREN E. PINCKERT, II, and
Defendants. |
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CASE NO.: C-99-0562 MMC NOTICE OF MOTION AND MOTION Date: January 14, 2000 |
MEMORANDUM OF POINTS AND AUTHORITIES
INTRODUCTION AND SUMMARY OF ARGUMENT
II. THE COMPLAINT DOES NOT SATISFY THE REFORM ACT'S REQUIREMENTS FOR PLEADING FALSITY
III. DEFENDANTS ARE NOT LIABLE FOR STATEMENTS MADE BY ANALYSTS OR THE PRESS
IV. VAGUE STATEMENTS OF GENERAL OPTIMISM ARE NOT ACTIONABLE
VI. THE COMPLAINT DOES NOT ADEQUATELY PLEAD SCIENTER
Acito v. IMCERA Group, Inc., 47 F.3d 47 (2d Cir. 1995)
Berger v. Ludwick, No. C-97-0728-CAL, slip op. (N.D. Cal. Sept. 15, 1998)
Blackin v. Red Brick Sys., No. C98-1206 MJJ, slip op. (N.D. Cal. Apr. 30, 1999)
Branch v. Tunnell, 14 F.3d 449 (9th Cir. 1994)
Copperstone v. TCSI Corp., No. C-97-3495-SBA, slip op. (N.D. Cal. Jan. 19, 1999)
David T. O'Neal Trust Dated 4/11/77 v. Vanstar Corp., No. C98-0216-MJJ, slip op.
(N.D. Cal. Dec. 22, 1998)
Greenfield v. U.S. Healthcare, Inc., 146 F.R.D. 118 (E.D. Pa. 1993), aff'd sub nom
Garr v. U.S. Healthcare, Inc., 22 F.3d 1274 (3d Cir. 1994)
Grossman v. Novell, Inc., 120 F.3d 1112 (10th Cir. 1997)
Harris v. IVAX Corp., 182 F.3d 799 (11th Cir. 1999)
Head v. NetManage, Inc., [Current Binder] Fed. Sec. L. Rep. (CCH) ¶ 90,412
(N.D. Cal. Dec. 30, 1998)
Hockey v. Medhekar, [1997 Transfer Binder], Fed. Sec. L. Rep. (CCH) ¶ 99,465
(N.D. Cal. Apr. 15, 1997)
In re Advanta Corp. Sec. Litig., 180 F.3d 525 (3d Cir. 1999)
In re Ascend Communications Sec. Litig., No. CV 97-8861 MRP, slip op.
(C.D. Cal. Feb. 2, 1999)
In re Boeing Sec. Litig., [1998 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 90,285
(W.D. Wash. Sept. 8, 1998)
In re Caere Corp. Sec. Litig., 837 F. Supp. 1054 (N.D. Cal. 1993)
In re CBT Group PLC Sec. Litig., No. C-98-21014 RMW, slip op.
(N.D. Cal. July 21, 1999)
In re Comshare, Inc. Sec. Litig., 183 F.3d 543 (6th Cir. 1999)
In re 1993 Corning Sec. Litig., [1996-1997 Transfer Binder] Fed. Sec. L. Rep.
(CCH) ¶ 99,244 (S.D.N.Y. May 15, 1996)
In re Crown Am. Realty Trust Sec. Litig., No. CIV. A. 95-202J, 1997 WL 599299
(W.D. Pa. Sept. 15, 1997)
In re Donald J. Trump Casino Sec. Litig., 7 F.3d 357 (3d Cir. 1993)
In re Fritz Cos. Sec. Litig., No. C-96-2712 MHP, slip op. (N.D. Cal. Mar. 5, 1998)
In re GlenFed, Inc. Sec. Litig., 42 F.3d 1541 (9th Cir. 1994)
In re Oak Tech. Sec. Litig., No. 96-20552 SW, 1997 WL 448168
(N.D. Cal. Aug. 1, 1997)
In re Silicon Graphics Inc. Sec. Litig., [1996-1997 Transfer Binder] Fed. Sec. L.
Rep. (CCH) ¶ 99,325 (N.D. Cal. Sept. 25, 1996)
In re Silicon Graphics Inc. Sec. Litig., 183 F.3d 970, 1999 U.S. App. LEXIS 14955
(9th Cir. Aug. 4, 1999)
In re Stac Elecs. Sec. Litig., 89 F.3d 1399 (9th Cir. 1996)
In re Syntex Corp. Sec. Litig., 855 F. Supp. 1086 (N.D. Cal. 1994)
In re Syntex Corp. Sec. Litig, 95 F.3d 922 (9th Cir. 1996)
In re Time Warner Inc. Sec. Litig., 9 F.3d 259 (2d Cir. 1993)
In re Trimble Navigation Sec. Litig., No. C-95-4353 MMC, 1997 WL 227956
(N.D. Cal. Apr. 28, 1997)
In re United Telecomm., Inc., Sec. Litig., 781 F. Supp. 696 (D. Kan. 1991)
In re Worlds of Wonder Sec. Litig., 35 F.3d 1407 (9th Cir. 1994)
In re YES! Entertainment Corp. Sec. Litig., No. C-97-01388-CRB, 1998 U.S. Dist.
LEXIS 22106 (N.D. Cal. May 15, 1998)
Leonard v. NetFRAME Systems, Inc., [1995-1996 Transfer Binder] Fed. Sec. L.
Rep. (CCH) ¶ 98,982 (N.D. Cal. Aug. 8, 1995)
Melder v. Morris, 27 F.3d 1097 (5th Cir. 1994)
Moorhead v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 949 F.2d 243
(8th Cir. 1991)
Raab v. General Physics Corp., 4 F.3d 286 (4th Cir. 1993)
Rasheedi v. Cree Research, Inc., [1997 Transfer Binder] Fed. Sec. L. Rep. (CCH)
¶ 99,566 (M.D.N.C. Oct. 17, 1997)
Ronconi v. Larkin, [1998 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 90,212
(N.D. Cal. May 1, 1998)
San Leandro Emergency Med. Group Profit Sharing Plan v. Phillip Morris Cos.,
75 F.3d 801 (2d Cir. 1996)
Superintendent of Insurance v. Bankers Life & Cas. Co., 404 U.S. 6, 92 S.Ct. 165,
30 L. Ed. 2d 128 (1971)
Wenger v. Lumisys, Inc., 2 F. Supp. 2d 1231 (N.D. Cal. 1998)
Zeid v. Kimberly, 973 F. Supp. 910 (N.D. Cal. 1997)
15 U.S.C. § 78u-4(b)(1)
15 U.S.C. § 78u-4(b)(2)
15 U.S.C. § 78u-4(b)(3)(A)
15 U.S.C. § 78u-5(c)(1)(A)(i)
15 U.S.C. § 78u-5(c)(1)(B)(i)
15 U.S.C. § 78u-5(e)
15 U.S.C. § 78u-5(i)(1)(A)
15 U.S.C. § 78u-5(i)(1)(B)
15 U.S.C. § 78u-5(i)(1)(C)
15 U.S.C. § 78u-5(i)(1)(D)
Fed. R. Civ. P. 11(b)(3)
Fed. R. Civ. P. 12(b)(6)
H.R. Conf. Rep. No. 104-369, at 41, reprinted in 1995 U.S.C.C.A.N. 730
Section 10(b)
Section 20(a)
PLEASE TAKE NOTICE that on January 14, 2000, at 9:00 a.m., or as soon thereafter as counsel may be heard, in the Courtroom of the Honorable Maxine Chesney, 450 Golden Gate Avenue, San Francisco, California, defendants Cholestech Corporation ("Cholestech" or the "Company") and Warren E. Pinckert, II will and hereby do move the Court for an order dismissing with prejudice plaintiffs' Amended Complaint (the "Complaint").
Pursuant to the Private Securities Litigation Reform Act of 1995 (the "Reform Act") and Federal Rules of Civil Procedure 12(b)(6), the Complaint should be dismissed because (a) it fails to plead with particularity the basis of its allegations; (b) it fails to plead facts giving rise to a strong inference of scienter; (c) it fails to plead any actionable misstatements; (d) it fails to plead adequate allegations of accounting fraud (or any other fraud); and (e) its allegations concerning forward-looking statements fail to state a claim.
Defendants' motion is based on this Notice and Motion, the accompanying Memorandum of Points and Authorities, the Declaration of David P. O'Brien in Support of Defendants' Motion to Dismiss (the "O'Brien Decl.") and the exhibits attached thereto, Defendants' Request for Judicial Notice, all pleadings and papers filed herein, oral argument of counsel, and any other matter which may be submitted at the hearing.
Cholestech Corporation is a Hayward-based company that develops, manufactures, and markets the Cholestech LDX System. The LDX System is an easy-to-use system that consists of a proprietary, telephone-sized machine, the LDX Analyzer, and a line of single-use, credit-card sized test cassettes. The LDX System enables health care providers to perform within five minutes a range of diagnostic tests on a single drop of blood. Cholestech's current cassette products are designed to measure and monitor blood cholesterol, related lipids and glucose for the treatment of cardiovascular disease and diabetes. Cholestech sells its products, primarily through third-party distributors, in four markets: the physician office laboratory ("POL") market, the pharmacy market, the health promotion market, and the international market. Defendant Pinckert is Cholestech's President and Chief Executive Officer, as well as a director of the Company.
The Class Period alleged in the Complaint is June 28, 1996 through June 25, 1998, a period of extraordinary growth for Cholestech. Cholestech's revenue for its fiscal year 1996 was $6.9 million.1 Cholestech's revenue for fiscal 1997 nearly doubled, to $12.86 million. Fiscal 1998, again, was a year of strong growth -- Cholestech's revenue was $21.7 million. On June 25, 1998, however, Cholestech announced that its revenue for the first fiscal quarter of 1999 (ending June 26, 1998) would be approximately $5 million, lower than analyst expectations. See Complaint ¶ 114. This announcement prompted a decline in Cholestech's stock price and represents the end of the ostensible Class Period.
What happened? As Cholestech announced, certain key distributor relationships were delayed and sales to domestic distributors were less than the Company had anticipated. Specifically, as the Complaint alleges, Cholestech had announced early in 1998 that it would raise the price of its LDX Analyzer in the first fiscal quarter of 1999. Cholestech's distributors accelerated their purchases of LDX Analyzers and, accordingly, bought less in the first quarter of 1999. Id. ¶¶ 122-24. Plaintiffs allege that the price increase was part of a scheme on Cholestech's part to boost March 1998 results to pull off a secondary offering of stock in mid-1998. Id. ¶ 123. Of course, that doesn't make sense. Cholestech also announced on June 25 that it was canceling its secondary offering. Id. ¶ 114.
How, then, do plaintiffs convert a failed sales strategy into a two-year alleged scheme to defraud? Plaintiffs contend that two years of Cholestech financial statements were false due to unspecified revenue recognition and other accounting issues. The accounting allegations are pure sophistry -- none of the detail required to state a securities fraud claim is evident in the Complaint. Also, plaintiffs allege that Cholestech was "stuffing the channel" for two years. Plaintiffs never bother to explain how Cholestech got away with "stuffing" its sales channels (logically, a one-time event) for two years.
In addition to its logical failings, the Complaint fails to satisfy the standards for pleading a securities fraud claim. The Complaint should be dismissed for the following reasons:
The Complaint fails to state a claim for securities fraud. Defendants respectfully submit that it should be dismissed with prejudice.
By passing the Reform Act, Congress "establish[ed] uniform and more stringent pleading requirements to curtail the filing of meritless lawsuits" under the federal securities laws. H.R. Conf. Rep. No. 104-369, at 41, reprinted in 1995 U.S.C.C.A.N. 730, 740 (the "Conf. Rep.") (O'Brien Decl. Ex. 1). The Reform Act requires that a 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) (emphasis added).
Plaintiffs do not profess to have personal knowledge of their allegations; hence, they are pleading on information and belief. See Blackin v. Red Brick Sys., No. C98-1206 MJJ, slip op. at 6-7 n.4 (N.D. Cal. Apr. 30, 1999) (noting that a complaint based on "investigation of counsel" is the same as a complaint based upon "information and belief").2 Because it is pleaded on information and belief, the Complaint must state "all facts" upon which plaintiffs' beliefs are based. See 15 U.S.C. § 78u-4(b)(1). These allegations are missing from the Complaint; a defect apparent in two ways: (1) the Complaint's global "basis of allegations" paragraph does not comply with the Reform Act; and (2) the "information and belief" recitations in the body of the Complaint are not accompanied by the factual detail the Reform Act demands.
First, in lieu of complying with the Reform Act's information and belief pleading requirements, plaintiffs offer the boilerplate allegation of the Complaint's first paragraph:
Plaintiffs, by their attorneys, for their amended complaint, allege the following upon personal knowledge as to themselves and their own acts, and upon information and belief based upon the investigation made by their attorneys as to all other matters. The investigation includes interviews with former employees, consultations with experts and others familiar with the business of Cholestech Corporation ("Cholestech" or the "Company"), as well as the thorough review and analysis of public statements, press releases and publicly-filed documents of Cholestech, and the review of news articles, and analysis of accounting rules and related literature.
Complaint at p. 2.
Courts applying the Reform Act have held repeatedly that this type of allegation does not comply with the statutory requirement. Judges Patel, Smith, Legge, Jenkins, and Breyer have dismissed complaints with similar "basis of allegations" paragraphs. All of these Judges have held that the Reform Act requires plaintiffs to plead with particularity the bases of their belief that defendants made false statements.3 The Ninth Circuit, in Silicon Graphics, also rejected a rote basis of allegations paragraph, stating: "This [basis of allegations] paragraph is an insufficient basis for fraud allegations because it fails to state 'with particularity all facts upon which [her] belief is formed.' 15 U.S.C. § 78u-4(b)(1). This means that a plaintiff must provide, in great detail, all the relevant facts forming the basis of her belief." Silicon Graphics, 1999 U.S. App. LEXIS 14955, at *39.
Second, the Complaint's periodic use of the phrase "information and belief," and the Complaint's occasional attempts at identifying facts supporting plaintiffs' belief, do not comply with the Reform Act's pleading requirements. A plaintiff must identify the source of information offered in support of plaintiffs' allegations and specific details concerning the content and origin of supposed "internal" documents. See Hockey, [1997 Transfer Binder] Fed. Sec. L. Rep. (CCH) at 97,081 ("Nowhere in plaintiffs' complaint is there a reference to a particular corporate documents or data. Plaintiffs do not attempt to show when these documents were created, by whom they were drafted, or even whether [the company] regularly prepared such documents.").
For example, in paragraphs 56 and 57, the Complaint obliquely refers to "internal corporate documents outlining the extent to which defendants used side deals to artificially inflate revenues." Complaint ¶ 56. To satisfy the Reform Act, plaintiffs must, at a minimum, identify the (1) source of the documents; (2) the date of the documents; (3) the person who created the documents; (4) the persons to whom the documents were distributed; and (5) the contents of the documents. If the documents exist, plaintiffs need not be shy about providing this information. See Silicon Graphics, 1999 U.S. App. LEXIS 14955, at *40. ("[Plaintiff] does not mention, for instance, how she learned of the reports, who drafted them, or which officers received them. Nor does she include an adequate description of their contents which we believe -- if they did exist -- would include countless specifics. . . .")
Because plaintiffs have not pleaded with particularity any factual basis for their belief that defendants committed securities fraud, the entire Complaint should be dismissed pursuant to the Reform Act. See 15 U.S.C. § 78u-4(b)(1), (b)(3)(A) (stating that a complaint which fails to "state with particularity all facts on which" a plaintiff's information and belief allegations are based "shall" be dismissed "on the motion of any defendant.")
The Reform Act requires a plaintiff to plead with particularity each statement alleged to be misleading and set forth in detail "the reason or reasons why each statement is false or misleading" when made. 15 U.S.C. § 78u-4(b)(1); In re Oak Tech. Sec. Litig., No. 96-20552 SW, 1997 WL 448168, at *3 (N.D. Cal. Aug. 1, 1997).4 The bulk of the Complaint's scattered compilation of allegedly false or misleading statements address either Cholestech's financial statements or its public discussions of its channel sales and installed base of LDX Systems. Below, defendants demonstrate that the Complaint fails to allege these statements were false when made.5
Even before the Reform Act heightened pleading standards, courts rejected generalized allegations of accounting fraud. Plaintiffs were required to identify specifically the challenged transactions and demonstrate that the amounts in question were material. See, e.g., In re Trimble Navigation Sec. Litig., No. C-95-4353 MMC, 1997 WL 227956, at *17 (N.D. Cal. Apr. 28, 1997); Leonard v. NetFRAME Systems, Inc., [1995-1996 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 98,982, at 93,779-80 (N.D. Cal. Aug. 8, 1995) (holding that "plaintiffs cannot simply allege that specific accounting practices were violated without also providing specific underlying facts to support the allegations.") (citation omitted). In addition, because accounting often involves judgments, plaintiffs were required to allege very specific facts to demonstrate why defendants' accounting judgments did not fall within the permissible range of accounting judgment. See In re GlenFed, Inc. Sec. Litig., 42 F.3d 1541, 1549 (9th Cir. 1994) (en banc) (holding that accounting decisions "are based on flexible accounting concepts, which, when applied, do not always (or perhaps ever) yield a single correct figure.").
After the Reform Act, courts in this District (and elsewhere) have applied these accounting pleading requirements even more strictly, holding that "[p]laintiffs must allege facts regarding the underlying transactions with particularity." Zeid v. Kimberly, 973 F. Supp. 910, 923 (N.D. Cal. 1997); see In re YES! Entertainment, 1998 U.S. Dist. LEXIS 22106, at *3 ("To state a claim against defendants for fraudulent financial statements plaintiffs must identify particular transactions underlying the defendants' alleged accounting deficiencies and they must allege facts regarding the underlying transactions with particularity.")
Plaintiffs allege that Cholestech misstated its financials by: (1) improperly recognizing revenue (Complaint ¶¶ 49, 73, 77, 84, 88, 96, and 105); (2) improperly failing to accrue losses for uncollectible accounts receivable (Complaint ¶¶ 136-37) ; and (3) improperly accounting for its inventory (Complaint ¶¶ 50-55). As demonstrated below, the Complaint does not even attempt to provide the factual detail required to state a claim for accounting fraud.
To plead fraudulent revenue recognition under the Reform Act, plaintiffs must allege "particular transactions where revenues were improperly recorded, including the names of the customers, the terms of specific transactions, when the transactions occurred, and the approximate amount of the fraudulent transactions." In re Oak Tech., 1997 WL 448168 at *8. The Complaint's allegations fall short of this standard.
Complaint paragraphs 49(b) and (c) are representative of the Complaint's revenue recognition allegations. See Complaint ¶¶ 84 and 96. Paragraph 49 alleges that Cholestech's financial results for the first fiscal quarter of 1997 were false because:
(b) The Company reported revenue and earnings in violation of GAAP, which revenues and earnings were materially overstated due to defendants' strategy to 'stuff the distribution channel' with excess product and book all such 'deliveries' as revenue and earnings, despite actual knowledge or reckless disregard for the fact that at the time there was insufficient demand by end-users for Cholestech's LDX system.
(c) A material portion of the Company's reported sales were what the Company referred to in internal documents as 'deals,' with such 'deals' frequently including side agreements allowing rights of return for products not sold to end-users. . . .
Complaint ¶ 49(b), (c). The allegations raise more questions than they answer. For example: (1) By how much were the quarter's revenues overstated? (2) By how much were earnings overstated? (3) Which transactions, with which customers, were "channel-stuffing" transactions? (4) What's a "deal"? (5) With whom were deals done? (6) What was the amount of each so-called deal? (7) Other than supposed rights of return, were there other terms to these deals? (7) What internal documents discuss these deals? (8) When were those documents created? Without this type of detail, the Complaint does not satisfy the Reform Act's pleading requirements. See Copperstone v. TCSI Corp., No. C-97-3495-SBA, slip op. at 16 (N.D. Cal. Jan. 19, 1999) ("Plaintiffs fail to identify any transactions in which TCSI recorded uncertain revenue. The Complaint only generally asserts that such transactions took place . . . Without more particularity, the allegations of accounting fraud based on unrecognized revenue must fail.").
The Complaint also alleges that Cholestech "failed to adequately accrue losses for uncollectible receivables in order to inflate its purported results." Complaint ¶ 137; see id. ¶ 136. This allegation also fails for lack of detail. Plaintiffs do not allege, as they must, the amount by which Cholestech, on a quarterly basis, supposedly under-accrued for the alleged losses or the transactions which account for the bad receivables. Plaintiffs just say Cholestech's accounting was wrong. That is not enough to state a securities fraud claim. See In re Fritz Cos. Sec. Litig., No. C-96-2712 MHP, slip op. at 10-11 (N.D. Cal. Mar. 5, 1998) (holding that complaint must plead facts showing that estimates were false when made); In re Boeing Sec. Litig., [1998 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 90,285 at 91,326 (W.D. Wash. Sept. 8, 1998) (dismissing claims of fraudulent accounting estimates because "plaintiffs' allegations do not provide the necessary link" between the accounting differences and any wrongdoing).
Plaintiffs borrow some allegations from a 1997 complaint filed by former Cholestech Chief Financial Officer Richard Janney to allege that Cholestech wrongfully accounted for the value of its inventory. These allegations, like the rest of plaintiffs' accounting allegations, fail to state a claim because they contain absolutely no detail concerning the specific items or transactions allegedly wrongfully accounted for, the timing of the allegedly wrongful accounting, or the amount of the allegedly wrongful accounting. See Complaint ¶¶ 50-55; In re Oak Tech., 1997 WL 448168, at *10. The Janney allegations also should fail because, far from identifying the fiscal period to which the allegations apply, plaintiffs aver that the allegations could relate to periods irrelevant to this action. See Complaint ¶ 50 (stating that allegations referred to period "[b]eginning in 1996, if not earlier" or "from 1992 through 1996"). Without guidance from plaintiffs, one could assume some or all of the Janney allegations apply to 1993, and not to the Class Period.6
The Complaint alleges that Cholestech misrepresented the installed base (the number of LDX Analyzers sold and in use) for its LDX Analyzers. See Complain ¶¶ 63, 64(a), 79, 80, 83, and 84(b). In paragraph 64(a), for example, the Complaint alleges that the Company's statements concerning its sales and installed base were false because:
The Company's internal controls were completely inadequate and only accounted for sales to distributors and did not track sell-through to end users and that, therefore, there was no reasonable basis for any statement by the Company regarding the number of "active Health Promotion accounts," the number of LDX Systems installed in physician office labs, or sites at which the LDX System was available.
Complaint ¶ 64; see id. ¶¶ 80 and 84(b). Plaintiffs do not explain the basis or source of their belief that the Company could not estimate the population of LDX Analyzers or Analyzer sales. For this reason alone, the Complaint is deficient and should be dismissed.
In addition, plaintiffs' critique of Cholestech's internal controls cannot support a securities fraud claim. See Complaint ¶ 64(b). These allegations are mere claims of mismanagement and therefore are not actionable under the federal securities laws. See, e.g., Superintendent of Insurance v. Bankers Life & Cas. Co., 404 U.S. 6, 12, 92 S.Ct. 165, 30 L. Ed. 2d 128 (1971) (holding that Section 10(b) was not violated by claims "which constitute no more than internal corporate mismanagement."). Courts have dismissed allegations virtually identical to those asserted here. See, e.g., In re United Telecomm., Inc., Sec. Litig., 781 F. Supp. 696, 698-701 (D. Kan. 1991) (allegations that defendant lacked "'internal controls and management information systems'" do not state a claim or securities fraud).
Plaintiffs contend that Cholestech is responsible for the contents of various analyst reports and press articles. See Complaint ¶¶ 20, 21, 83, 90, 92, 97-98, and 109. Plaintiffs, however, have not satisfied the requirements for establishing liability for these third-party statements.
Defendants can be liable for statements in analyst reports only if plaintiffs plead facts showing that defendants "put their imprimatur, express or implied" on the statements. In re Syntex Corp. Sec. Litig, 95 F.3d 922, 934 (9th Cir. 1996) (citations omitted). A complaint must "(1) identify specific [reports] and name the insider who adopted them; (2) point to specific interactions between the insider and the analyst which gave rise to the entanglement; and (3) state the dates on which the acts which allegedly gave rise to the entanglement occurred." In re Trimble, 1997 WL 227956, at *18 (quoting In re Caere Corp. Sec. Litig., 837 F. Supp. 1054, 1059 (N.D. Cal. 1993)).
Instead of complying with the requirements for pleading "entanglement" with analysts or "adoption" of analyst reports, plaintiffs rely on various iterations of boilerplate relating to analyst communications. Paragraphs 20-21 of the Complaint, for example, are a purported summary of Cholestech's interactions with analysts. These paragraphs are conclusory in the extreme and do not pertain to any specific communications with securities analysts.
Plaintiffs' allegations concerning specific reports are no better. See Complaint ¶¶ 83, 92, 97, 98, and 111. Plaintiffs' mode of operation is to couple quotations from an analyst report with a conclusory statement that Cholestech is responsible for the report's contents. For example, paragraph 98 accompanies a quote from a Genesis analyst report with the conclusory assertion that the report was "based on information, guidance and endorsements he received from Pinckert and [Cholestech Chief Financial Officer Andrea] Tiller." Complaint ¶ 98; see id. ¶¶ 83 (analyst made statements "based on information provided to him by defendants"); 84 (defendants "provided the information . . . and/or endorsed [the] report"); and 111 (analyst report "cited information which could only have come from defendants"). The Complaint is bereft of the detail required to establish liability for analyst reports: it fails to specify each statement made to each analyst, the falsity of the statement, and why the statement was false. See Wenger, 2 F. Supp. 2d at 1249; Trimble, 1997 WL 227956, at *18 (rejecting conclusory allegations that defendants reviewed and approved analyst reports).
Similarly, a defendant can be liable for statements made in news articles only if a complaint pleads with specificity "who allegedly supplied [the misleading] information. . . , how it was supplied, or how [defendants] could have controlled the content of the statement." Raab v. General Physics Corp., 4 F.3d 286, 288 (4th Cir. 1993) (securities laws do not require a company to police statements made by third parties for inaccuracies, even if the third party attributes the statement to that company).
The Complaint seeks to make defendants responsible for two articles in the general press. See Complaint ¶¶ 90 (O'Brien Decl. Ex. 2), and 109. The Complaint, however, is devoid of particularized facts alleging the circumstances of how the information was allegedly supplied to the press and how defendants could have controlled the articles' content. For example, while plaintiffs attempt to render defendants liable for a statement in the April 30, 1998 San Jose Mercury News article concerning Cholestech's installed base, it is interesting to note that the statement in question does not quote Pinckert or anyone else at Cholestech. See O'Brien Decl. Ex. 3; In re Ascend Communications Sec. Litig., No. CV 97-8861 MRP, slip op. at 31 (C.D. Cal. Feb. 2, 1999) ("[T]he author is not reporting based on first-hand observation, and it is not clear on what basis these statements are being reported and whether they can be properly attributed to [defendants].")
The Complaint challenges numerous inactionable, vague statements of puffery and general optimism, a natural consequence of plaintiffs' decision to include in the Complaint virtually every public statement Cholestech made over a two-year period. Courts consistently have held that general statements of corporate optimism cannot support liability for securities fraud. See, e.g., Wenger, 2 F. Supp. 2d at 1245 ("Vague statements of opinion are not actionable under the federal securities laws because they are considered immaterial and discounted by the market as mere 'puffing.'") (citation omitted).
For example, Cholestech made a number of routine, general statements concerning the growth of its business and its potential for profitability in the future. Paragraph 71 of the Complaint alleges that the following statements are somehow fraudulent: "Our initial target, health promotion, remains the primary driver of our growth. . .We believe as we enter fiscal 1998, we are positioned for growth in all our markets." See Complaint ¶¶ 70 ("We are now approaching our goal of sustained profitability"); 76 ("We have taken another significant step toward our goal of sustainable profitability. I am proud of Cholestech's execution of our leverage strategy during the quarter, delivering strong revenue growth while effectively managing costs to expand profits."); and 60 ("We are pleased with our continued progress toward the short term goal of profitability.")
Courts have found similar, allegedly false statements insufficient to form a basis for liability. See Raab, 4 F.3d at 289 (holding inactionable prediction of "an expected annual growth rate of 10% to 30% over the next several years" and statement that the company "is poised to carry the growth and success of 1991 well into the future."); Wenger, 2 F. Supp. 2d at 1245-46 (holding statements that "'we're the leader in a rapidly growing market'" and "'we're positioned to move forward now'" and "'we look forward to continually improving our performance'" were inactionable puffery); In re Syntex Corp. Sec. Litig., 855 F. Supp. 1086, 1095 (N.D. Cal. 1994) (holding statement "'we expect the second half of fiscal 1992 to be stronger than the first half, and the latter part of the second half to be stronger than the first'" were puffing, "which reasonable investors know do not guarantee future success.") (aff'd 95 F.3d 922 (9th Cir. 1996)).7
The Complaint challenges allegedly false and misleading forward-looking statements. See, e.g., Complaint ¶¶ 48, 60, 66, 68 72, 82 and 87. The allegations do not support liability for two reasons. First, certain of the statements warrant application of the Reform Act's safe harbor for forward-looking statements and are thus immune from liability. Second, the Company's consistent and thorough disclosure of the risks of its business permits application of the bespeaks caution doctrine to preclude liability.8
The Reform Act encourages companies to make forward-looking statements. Congress concluded that "'[u]nderstanding a company's own assessment of its future potential [is] among the most valuable information shareholders and potential investors could have about a firm.'" Conf. Rep. at 43 (citation omitted). Congress thus created a "safe harbor" for forward-looking statements. A "forward-looking" statement is defined as a projection of financial items, a description of management's plans for future operations or economic performance, or the stated assumptions underlying these projections. 15 U.S.C. § 78u-5(i)(1)(A)-(D). The goal of the safe harbor is "to provide certainty that forward-looking statements will not be actionable by private parties . . . if they are accompanied by a meaningful cautionary statement." Conf. Rep. at 44 (emphasis added).
The safe harbor immunizes a forward-looking statement that "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). "Cautionary statements" are "meaningful" if they "convey substantive information about factors that realistically could cause results to differ materially from those projected in the forward-looking statement, such as, for example, information about the issuer's business." Conf. Rep. at 43. A risk factor is "important" if it "could actually affect whether the forward-looking statement is realized." Id. at 43-44. Congress, however, did not intend to make its burdensome for a company to comply with the safe harbor. A company is not required to identify all factors or caution against every conceivable factor that may cause results to differ. A company is not even required to include "the particular factor that ultimately cause[d] the forward-looking statement not to come true . . . ." Conf. Rep. At 44. A company complies with the safe harbor if it identifies sufficiently important factors that could cause actual results to vary from the forward-looking statement. Rasheedi v. Cree Research, Inc., [1997 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 99,566, at 97,818 (M.D.N.C. Oct. 17, 1997) (dismissing claims; compliance with safe harbor immunizes forward-looking statements in press releases); Harris, 182 F.3d at 806, (same).
The Reform Act directs courts to determine at the pleading stage whether forward-looking statements are protected by the safe harbor. 15 U.S.C. § 78u-5(e). In this case, three of the Complaint's litany of allegedly false and misleading statements qualify for safe harbor immunity. See Complaint ¶¶ 48, 66, and 68.
Paragraph 48 is an excerpt from Cholestech's July 24, 1996 announcement of its financial results for the first fiscal quarter of 1997. The announcement contained a forward-looking statement: "With the proceeds of our public offering, we believe Cholestech has the resources to develop and deliver some exciting new diagnostic tests in the areas of osteoporosis, diabetes management and prostate cancer." Complaint ¶ 48. Plaintiffs allege that this statement was false because Cholestech "would not meet new product delivery timeframes and such tests were not likely to be ready to market for years." Id. ¶ 49(a) The Reform Act immunizes Cholestech's statement from liability because the Company complied with the safe harbor. Cholestech identified this statement as forward-looking and warned that it was subject to risks that could cause results to differ materially from expectations. See O'Brien Decl. Ex. 4 (Cholestech July 24, 1996 press release).9 Cholestech provided meaningful cautionary statements identifying important factors that could cause results to vary, including "the Company's ability to complete and successfully introduce new tests designed to extend the System's capabilities, the Company's ability to achieve acceptable manufacturing yields of test cassettes. . . ." Id.
The statements contained in paragraph 68 also are entitled to safe harbor immunity. Paragraph 68 contains a summary of Cholestech's April 16, 1997 announcement of its agreement with Amerisource Health Corporation ("Amerisource").10 The agreement was valued at $7 million and, according to CEO Pinckert, would "benefit both pharmacies and their customers as well as both companies." Complaint ¶ 68. Plaintiffs allege that the press release was false because it "gave the false impression that the agreement with Amerisource would lead to sharply increased sales for the LDX System in the Pharmacy market, a market not previously penetrated by the Company." Id. ¶ 69. Again, Cholestech noted the forward-looking statements and identified specific factors that could cause results to differ materially from the expectations created by the press release. See O'Brien Decl. Ex. 6 (April 16, 1997 press release, stating in relevant part: "[F]orward-looking statements involve risks and uncertainties including, without limitation, risks relating to development of technology, manufacturing capabilities, dependence on third-party suppliers, market acceptance of and demand for the company's products, impact of competitive products and pricing. . . .").
Because Cholestech complied with the safe harbor with respect to the statements alleged in paragraphs 48, 66 and 68, these statements are immune from liability.
The pre-Reform Act "Bespeaks Caution" doctrine remains an important principle governing forward-looking statements (in addition to the statutory safe harbor). Under this doctrine, a statement is not actionable when a company made meaningful and specific cautionary disclosures concerning the subject matter of the alleged misrepresentation. In re Stac Elecs. Sec. Litig., 89 F.3d 1399, 1408 (9th Cir. 1996).11 Where a company has made adequate, specific warnings of significant risk factors, plaintiffs may not bring a securities fraud claim based on statements or matters addressed by the risk factors. Moorhead v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 949 F.2d 243, 245-46 (8th Cir. 1991) (holding that plaintiffs had no claim based on any matter "addressed by the repeated, specific warnings of significant risk factors and the disclosures of underlying factual assumptions"). Cholestech made repeated, specific and meaningful disclosures about three core matters addressed by the Complaint: (1) development of new tests for the LDX System; (2) development of the pharmacy market; and (3) general market acceptance of the LDX System.
First, plaintiffs allege that defendants touted plans to create new tests for the LDX System but failed to disclose problems associated with the development of those tests. Specifically, plaintiffs allege that "[d]evelopment of new diagnostic tests . . . was delayed," that new tests would not be ready for "product delivery timeframes" and would not be ready "to market for years." See, e.g., Complaint ¶¶ 48, 49(a), 72 , 73(c), 83, 84(d), 87, and 88(b). Cholestech specifically warned, however, of the various risks associated with developing new tests. For example, Cholestech cautioned:
The Company believes that its revenue growth and future profitability will depend, in part, upon its ability to complete development of and successfully introduce these new tests. . . . There can be no assurance that the Company will not experience difficulties that could delay or prevent the successful development, introduction and marketing of these new tests . . . or that new tests will adequately meet the requirements of the applicable market or achieve market acceptance . . . If the Company is unable for technological or other reasons to complete the development, introduction and scale up of manufacturing of any new tests or if such new tests do not achieve a significant level of market acceptance, the Company's business, financial condition and results of operations could be materially adversely affected.
See O'Brien Decl. Ex. 7 at pp. 29-30 (excerpt from Cholestech's Annual Report on SEC Form 10-K405 ("10-K405") for the fiscal year ended March 27, 1998). The Company issued similar warnings throughout the Class Period. See id. Ex. 8 at pp. 13-14 (excerpts from Sept. 26, 1997 Report on SEC Form 10-Q ("10-Q")); Id. Ex. 9 at p.11 (excerpts from Cholestech 10-K405 for the fiscal year ended Mar. 29, 1996).
Second, the Complaint alleges that various statements were misleading based upon the Company's failure to disclose problems with "the development of the Pharmacy market." See, e.g., Complaint ¶¶ 61, 64(b), 69, 91, and 99. The Company explicitly warned, however, that it might not be able to penetrate or develop that market. See, e.g., O'Brien Decl. Ex. 9 at p. 13: "There can be no assurance that the Company will be able to penetrate the . . . pharmacy [market]."). Cholestech also disclosed problems associated with medical insurance reimbursement for LDX tests -- a condition plaintiffs claim was an undisclosed impediment to success in the pharmacy market:
The Company's ability to commercialize its products successfully in the United States will depend in part on the extent to which reimbursement for the costs of such products and related treatment will be available from government health authorities, private health insurers and other organizations . . . [T]he cost of the Cholestech L.D.X. System is generally not subject to reimbursement by government and other third party payors. In addition, the tests performed by public health departments, corporate wellness programs and other large volume users in the screening market are generally not subject to reimbursement.
Id. at p. 19. See id. Ex. 10, p. 31.
Finally, Plaintiffs allege that various positive statements concerning the Company's growth were false because the "the Company was having [problems] with acceptance of its flagship product, the LDX system." Complaint ¶ 2; Id. ¶¶ 5, 43, 67, 82, and 99. Cholestech repeatedly disclosed that it was uncertain that the product would meet with market acceptance:
In order for the Company to increase revenues and achieve profitability and positive cash flows from operations, the L-D-X System must achieve a significant degree of market acceptance among health care providers in the monitoring market, particularly POLs. . . . . Even if the advantages of the L-D-X System in diagnosing and monitoring patients with blood detected diseases are established as clinically significant, physicians, medical clinics, pharmacists and other health care providers may elect not to purchase and use the L-D-X System for any number of other reasons [.]
O'Brien Decl. Ex. 11 at p. 5 (excerpt from June 28, 1996 Cholestech Registration Statement on SEC Form S-1/A.) See, e.g., id. Ex. 12 at pp. 14-15 (Cholestech Dec. 26, 1997 10-Q).
The Complaint should be dismissed for the additional reason that its allegations do not meet the Reform Act's standard for pleading scienter. Under the Reform Act, 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 Reform Act thus supplanted the then-existing Ninth Circuit standard which allowed scienter to be averred generally, without a factual basis. See In re GlenFed, 42 F.3d at 1545.
In Silicon Graphics, the Ninth Circuit defined the "required statement of mind" for stating a claim under the Reform Act. See Silicon Graphics, 1999 U.S. App. LEXIS 14955 at *13. The opinion explains that the "'required state of mind'" for most acts of securities fraud is something more than negligence or mere recklessness. Id. Instead, plaintiffs must plead and prove "'at a minimum'" that defendants acted with "'deliberate recklessness.'" Id. The Ninth Circuit held that the scienter standard "reflect[s] some degree of intentional of conscious misconduct." Id.
Further, under the Reform Act, a complaint cannot just create a troubling scenario or an inference of scienter -- it must establish "a strong inference of scienter." The Ninth Circuit explained:
[P]laintiffs proceeding under the [Reform Act] can no longer aver intent in general terms of mere 'motive and opportunity' or "recklessness," but rather, must state specific facts indicating no less than a degree of recklessness that strongly suggests actual intent. Thus. . . the [Reform Act] requires plaintiffs to plead, at a minimum, particular facts giving rise to a strong inference of deliberate or conscious recklessness..
Id. at *21 (emphasis added). This interpretation follows from Congress' intent as expressed in the legislative history of the Reform Act.12
Importantly, however, the Complaint's scienter allegations do not satisfy any interpretation of "required state of mind," be it recklessness, motive and opportunity, or deliberate recklessness. As discussed below, each of the Complaint's scienter allegations lack particularity and fail to create a strong inference that defendants acted with the required state of mind.
Plaintiffs allege that defendant Pinckert, by virtue of his executive position at the Company, had access to certain, unspecified, internal documents, concealed that information, and thus, acted with the requisite scienter. See Complaint ¶ 15. The allegation is set forth below. When reading the allegation, the Court should bear in mind this question: could it be levied against any senior officer of any company?
Because of his Board membership and executive and managerial position with Cholestech, defendant Pinckert had access to adverse material non-public information about Cholestech's operations, finances, financial condition, products, inventories and present and future business prospects. He had such access via internal corporate documents, conversations and connections with other corporate officers and employees, attendance at management and Board of Directors meetings and committees thereof, and via reports and other information provided to them in connection therewith. Because of his possession of such information, defendant Pinckert knew or recklessly disregarded the fact that adverse facts specified herein had not been disclosed to and were being concealed from the public.
Id. The allegation is pure boilerplate -- it does not identify a single internal document, meeting, or report unique to Cholestech. Numerous courts have held that similar allegations were insufficient to plead scienter. See, e.g., In re Advanta, 180 F.3d at 539 (dismissing complaint; "allegations that a securities-fraud defendant, because of his position within the company, 'must have known' a statement was false or misleading are 'precisely the types of inferences which [courts] on numerous occasions, have determined to be inadequate to withstand Rule 9(b) scrutiny'") (quoting Maldonado v. Dominguez, 137 F.3d 1, 10 (1st Cir. 1998)).
Courts in this District have consistently followed this principle. Judge Whyte recently held that conclusory allegations of scienter based upon a defendant's job position and supposed access to internal reports are "insufficient to support a strong inference of fraudulent intent." In re CBT Group PLC Sec. Litig., No. C-98-21014 RMW, slip op. at 4-5 (N.D. Cal. July 21, 1999). Judges Armstrong, Breyer and Patel have also dismissed complaints based upon nearly identical internal document allegations. See, e.g., Copperstone, slip op. at 24; Head v. NetManage, Inc., [Current Binder] Fed. Sec. L. Rep. (CCH) ¶ 90,412, at 91,582 (N.D. Cal. Dec. 30, 1998); Hockey, [1997 Transfer Binder] Fed. Sec. L. Rep. (CCH) at 97,083. This conclusory style of pleading was insufficient prior to the Reform Act and falls short of any of the various Reform Act scienter interpretations.
Plaintiffs assert that the fact that defendants planned to raise capital in connection with the Company's secondary stock offerings establishes scienter. See Complaint ¶ 143. According to plaintiffs:
Foremost, the defendants wanted to artificially inflate the price of Cholestech's shares in order to present the Company's finances and prospects in a false positive light to ensure the success of their $13 million June 1996 secondary offering, create demand for Cholestech's shares so that the Company could tap the public markets for additional capital in the near future, and attempt to consummate a 1997 secondary stock offering of at least three million shares worth approximately $40 million for the Company.
Id. Attempts to base scienter on a company's desire to raise capital have been unavailing. See San Leandro Emergency Med. Group Profit Sharing Plan v. Phillip Morris Cos., 75 F.3d 801, 814 (2d Cir. 1996) (holding that allegations of company's desire to complete bond offering and maximize ongoing marketability of debt securities insufficient to plead scienter); In re 1993 Corning Sec. Litig., [1996-1997 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 99,244, at 95,381 (S.D.N.Y. May 15, 1996); In re Crown Am. Realty Trust Sec. Litig., No. CIV. A. 95-202J, 1997 WL 599299, at *25 (W.D. Pa. Sept. 15, 1997) (holding that allegations of "desire to improve [defendant's] financial picture to enhance its ability to finance further capital improvements" is insufficient to plead scienter).
The allegations in paragraph 143 are defective, moreover, because they defy economic reason and common sense. The June 1996 offering, for example, was done on a "firm commitment" basis. That is, Cholestech sold shares to the offering's underwriters for a fixed price. The underwriters sold stock to the public. O'Brien Decl. Ex. 11 at p. 55. In a firm commitment underwriting, the issuer (Cholestech) gets a fixed amount of money, regardless of whether the offering is a "success." See Corning, [1996-1997 Transfer Binder] Fed. Sec. L. Rep. (CCH) at 95,381 (holding that "motive" was not present because public statements did not affect the price of the offering).
The allegations concerning the 1998 offering also do not create a strong inference of scienter. Cholestech terminated the offering on June 25, 1998, the day the Company pre-announced its first quarter 1999 results which eventually precipitated this lawsuit. See Complaint ¶ 114. Plaintiffs allege that Cholestech engaged in a scheme to inflate the stock price to make the 1998 offering happen. The Complaint does not explain, however, why Cholestech cut its "scheme" short if doing the offering was the motive for the scheme. The allegation just doesn't make sense. See Corning, [1996-1997 Transfer Binder] Fed. Sec. L. Rep. (CCH) at 99,381.
Plaintiffs also allege that defendants were motivated to commit fraud in order to enrich themselves through stock sales and, oddly, the award of stock options. See Complaint ¶¶ 74, 145- 49. Under the Reform Act, "stock sales alone do not create a strong inference of scienter." Wenger, 2 F. Supp. 2d at 1251. The mere fact that a defendant sold stock does not give rise to a strong inference of scienter unless that defendant's stock sales were "unusual or suspicious." Acito v. IMCERA Group, Inc., 47 F.3d 47, 54 (2d Cir. 1995); In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1427 (9th Cir. 1994). To allege scienter premised on stock sales, plaintiffs must allege facts demonstrating that the sales were "dramatically out of line with prior trading practices at times calculated to maximize [insiders'] personal benefit from undisclosed inside information." Silicon Graphics, U.S. App. LEXIS 14955, at * 42. The Complaint does not even try to meet this standard.
First, plaintiffs allege that defendant Pinckert sold 25,000 shares of Cholestech stock during the Class Period -- an amount representing 25% of his Cholestech holdings, according to plaintiffs. Complaint ¶ 149. This is wrong. In calculating the percentage of Cholestech holdings Pinckert sold, plaintiffs only counted shares Pinckert owned and omitted from their calculation vested stock options that Pinckert could have converted to stock and sold during the Class Period. See Silicon Graphics, 1999 U.S. App. LEXIS 14955, at *45 (defining the proper calculation of defendant stock holdings to include vested options). During the Class Period, Pinckert owned 144,742 shares of stock and had 161,738 vested options to purchase stock; thus, his holdings available for sale were equivalent to 306,480 shares. Properly calculated, Pinckert sold only 8.16% of his Cholestech holdings available for sale. See O'Brien Decl. Ex. 13 (Certain filings on SEC Form 4 for defendant Pinckert); supra note 9. The fact that Pinckert retained 91.84% of his Cholestech holdings negates any inference of scienter. See In re Worlds of Wonder, 35 F.3d at 1425 (holding that there was no inference of scienter where defendants retained the bulk of their shares); Acito, 47 F.3d at 54 (dismissing director defendant who sold 380,000 shares two months before bad news disclosure because he retained large holdings).
Second, plaintiffs point to the stock sales of other, non-defendant Cholestech officers or directors in the hope of alleging scienter. Plaintiffs' shortcoming in this respect is a simple one -- they make no attempt to allege that these individuals did anything other than sell stock. See Complaint ¶¶ 148-149. Plaintiffs do not allege that these individuals made any false statements or knew of any particular, non-disclosed information. Plaintiff does not even identify their positions with the Company.
Plaintiffs' list of stock transactions by Cholestech insiders also has an interesting -- although unsurprising -- omission. Plaintiffs fail to inform the Court that Chief Financial Officer Andrea Tiller purchased 1,000 shares in the open market during the Class Period. See O'Brien Decl. Ex. 14 (Certain filings on SEC Form 4 for Andrea Tiller). Given that a purported accounting fraud is at the heart of the Complaint, it defies belief that one of the presumed masterminds of such a fraud, Cholestech's CFO, would buy stock at allegedly inflated prices prior to an announcement of long-concealed bad news. See NetManage, [Current Binder] Fed. Sec. L. Rep. (CCH) at 91,860 (dismissing complaint; holding that fact chief financial officer did not sell negated scienter and stating that it makes no sense that "the alleged masterminds of the fraudulent scheme" would not take advantage of the scheme).
Finally, the stock option allegations fail to create a strong inference of scienter. Plaintiffs allege that the stock options awarded to Pinckert and others during the Class Period were part of a scheme to enhance stock-related compensation. Complaint ¶¶ 147-48. This allegation could levied against executives of any company in any securities class action. Courts, therefore, routinely reject scienter allegations based on a motive to increase compensation. See, e.g., Acito, 47 F.3d at 54 (noting that increased executive compensation from a higher stock price cannot alone provide a motive for securities fraud or "virtually every company in the United States that experiences a downturn in stock price could be forced to defend securities fraud actions"); Melder v. Morris, 27 F.3d 1097, 1102 (5th Cir. 1994) (rejecting compensation-based scienter allegation, the court stated, "Accepting the plaintiffs' allegation of motive -- basically that the defendant officers and directors were motivated by incentive compensation -- would effectively eliminate the state of mind requirement . . . .").13
Defendants respectfully request that the Court dismiss the Amended Complaint with prejudice.
|
Dated: September 20, 1999 |
WILSON SONSINI GOODRICH & ROSATI By: _______________________________ Attorneys for Defendants |
1 Cholestech's fiscal year ends in March.
2 Defendants have submitted an appendix of unpublished authority with this memorandum. The cases in that appendix are organized alphabetically.
3 See Hockey v. Medhekar, [1997 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 99,465, at 97,081 (N.D. Cal. Apr. 15, 1997); In re Silicon Graphics Inc. Sec. Litig., [1996-1997 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 99,325, at 95,966 & n.11 (N.D. Cal. Sept. 25, 1996) David T. O'Neal Trust Dated 4/1/77 v. Vanstar Corp., No. C98-0216-MJJ, slip op. at 7 (N.D. Cal. Dec. 22, 1998); Berger v. Ludwick, No. C-97-0728-CAL, slip op. at 3 (N.D. Cal. Sept. 15, 1998); In re YES! Entertainment Corp. Sec. Litig., No. C-97-01388-CRB, 1998 U.S. Dist. LEXIS 22106, at *2 (N.D. Cal. May 15, 1998).
4 This new standard for securities cases is stricter than Federal Rules of Civil Procedure 9(b) and requires more specificity than would be required in a typical fraud case. See Ronconi v. Larkin, [1998 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 90,212, at 90,890 (N.D. Cal. May 1, 1998) (noting heightened standards of Reform Act).
5 As defendants discuss in their accompanying motion to dismiss pursuant to Federal Rules of Civil Procedure 8, the Complaint is disjointed and repetitious in the extreme. These qualities make it difficult to connect the allegedly false statements with the purported "reasons" why the statement is false or misleading. See Wenger v. Lumisys, Inc., 2 F. Supp. 2d 1231, 1243 (N.D. Cal. 1998) (dismissing similar allegations where a plaintiff "merely throws the statements and the alleged 'true facts' together in an undifferentiated clump and apparently expects the reader to sort out and pair each statement with a supposedly relevant 'true fact'").
6 In addition, plaintiffs have not identified an independent basis for including these allegations in this Complaint. Plaintiffs cannot blindly rely on these allegations; they must make their own independent investigation. See Fed. R. Civ. P. 11(b)(3). Copying allegations from another complaint does not satisfy that duty. See Greenfield v. U.S. Healthcare, Inc., 146 F.R.D. 118, 124 (E.D. Pa. 1993), aff'd sub nom Garr v. U.S. Healthcare, Inc., 22 F.3d 1274 (3d Cir. 1994) (signing attorneys improperly conducted only a cursory investigation and relied almost completely on a complaint filed by another firm for the facts underlying the class action claims).
7 Compare Complaint ¶¶ 87, 107 with In re Time Warner Inc. Sec. Litig., 9 F.3d 259, 266-67 (2d Cir. 1993) (rejecting as inactionable statement that executives "were excited by the possibilities for growth that will increase shareholder value, especially through strategic partnerships"). The Complaint contains other non-actionable statements of general optimism not specifically addressed above. See Complaint ¶¶ 79 (response of customers "has been very favorable"); 95 (expressing optimism regarding strong growth); 97 (same); 104 (stating 1998 was "exciting year for Cholestech" and "[c]ustomer response has been enthusiastic"); 106 (stating, among other general statements, that business "remains robust"); and 107 (stating, among other things, that company sees "healthy demand for . . . test panels.").
8 An additional reason that the Complaint's allegedly misleading forward-looking statements are not actionable is that the Complaint does not allege with particularity, as it must, that defendants made the statements "with actual knowledge . . . that the statement[s] [were] misleading." 15 U.S.C. § 78u-5(c)(1)(B)(i). See Harris v. IVAX Corp., 182 F.3d 799, 805-6 (11th Cir. 1999) (affirming dismissal of securities fraud complaint and rejecting conclusory allegations of actual knowledge).
9 On a motion to dismiss, the Court should consider the full text of documents referenced in the Complaint. Branch v. Tunnell, 14 F.3d 449, 454 (9th Cir. 1994). The Court may also take judicial notice of documents filed with the Securities and Exchange Commission ("SEC") whose authenticity is not questioned. This is proper on a motion to dismiss, especially where plaintiffs have admitted their claims are based in a review of Cholestech's public filings. See Silicon Graphics, 1999 U.S. App. LEXIS 14955, at *44.
10 See Complaint ¶¶ 66 and 67. The Complaint's allegations relating to paragraph 66 are similar to those in paragraph 68. Cholestech identified the risks associated with the Health Management agreement discussed in paragraph 66 and defendants are entitled to safe harbor immunity. See O'Brien Decl. Ex. 5 (April 3, 1997 Cholestech press release).
11 See Grossman v. Novell, Inc., 120 F.3d 1112, 1121-23 (10th Cir. 1997) (holding that cautionary statements in registration statement precluded liability); In re Donald J. Trump Casino Sec. Litig., 7 F.3d 357, 364 (3d Cir. 1993) (stating that prospectus "took considerable care to convey to potential investors the extreme risks inherent in the venture while simultaneously carefully alerting the investors to a variety of obstacles the [casino] would face . . . .").
12 Two other circuit courts have agreed that the Reform Act raised the scienter pleading standard to something more than just "motive and opportunity." In In re Comshare, Inc. Sec. Litig., 183 F.3d 543, 547-9 (6th Cir. 1999), the Sixth Circuit held that plaintiffs cannot plead scienter "by alleging facts merely establishing that a defendant had the motive and opportunity to commit fraud." The Third Circuit found that the "Reform Act establishes a pleading standard approximately equal in stringency to that of the [pre-Reform Act] Second Circuit," (including allegations of motive and opportunity) but recognized that "particularity" language in the Reform Act resulted in a "heightened standard." In re Advanta Corp. Sec. Litig., 180 F.3d 525, 534 (3d Cir. 1999).
13 Because plaintiffs do not state a Section 10(b) claim, their Section 20(a) claims (Complaint ¶¶ 157-59) must also be dismissed. See Wenger, 2 F. Supp.2d at 1252.
Source: File to epost from Wilson Sonsini Goodrich & Rosati