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Stanford University Law School - Securities Class Action Clearinghouse
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Howard B. Sirota, Esq.
Saul Roffe, Esq.
SIROTA & SIROTA
747 Third Avenue
New York, New York 10017
(212) 759-5555
Robert S. Brewer, Jr., Esq. (CSB No. 65294)
McKENNA & CUNEO, L.L.P.
750 B Street, Suite 3200
San Diego, California 92101
(619) 595-5400
Attorneys for Plaintiff,
Larry Frazier, Sr.
UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF CALIFORNIA
LARRY FRAZIER, SR., | Civil Action No. C.96-2644
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Plaintiff, | CLASS ACTION COMPLAINT
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vs. | DEMAND FOR JURY TRIAL
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DIAMOND MULTIMEDIA SYSTEMS, |
INC., WILLIAM J. SCHROEDER, |
CHONG-MOON LEE, GARY B. |
FILLER, and HYUNG HWE HUH, |
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Defendants. |
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Plaintiff, by his attorneys, for his class action
complaint, alleges upon actual knowledge as to his own acts, and
upon information and belief as to all other matters, the sources
of which are public documents and filings by the defendants, and
counsel's investigation as follows:
JURISDICTION AND VENUE
1. This Court has jurisdiction over the subject matter of
this action pursuant to Section 27 of the Securities Exchange
Act of 1934 (the "Exchange Act"), 15 U.S.C. §78aa; 28 U.S.C.
§1331 and the principals of pendant and supplemental
jurisdiction.
2. The claims asserted herein arise under Sections 10(b)
and 20(a) of the Exchange Act, 15 U.S.C. §§ 78j(b) and 78t(a);
Rule 10b-5, 17 C.F.R. § 249.10b-5, promulgated under Section
10(b) of the Exchange Act by the Securities and Exchange
Commission (the "SEC") and the common law.
3. Venue is proper in this District pursuant to Section
27 of the Exchange Act and 28 U.S.C. 1391(b) and 15 U.S.C. 77v
and 78aa. Many of the acts and transactions constituting the
violations of law alleged herein, including the preparation,
issuance and dissemination of materially false and misleading
information to the investing public, have occurred in this
District. The principal executive offices of defendant Diamond
Multimedia Systems, Inc. and the offices from which certain
financial statements, and reports were issued, are situated in
this District.
4. In connection with the acts, common course of conduct
and the plan and scheme alleged herein, defendants used,
directly and indirectly, the means and instrumentalities of
interstate commerce, including the United States mails,
interstate wire and telephone facilities.
THE PARTIES
5. Plaintiff purchased Diamond Multimedia Systems, Inc.
("Diamond" or the "Company") securities as spelled out more
fully in Exhibit A attached hereto and has been damaged thereby.
6. Diamond is a Delaware corporation located at 2880
Junction Avenue, San Jose, California. Diamond manufactures and
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markets multimedia and communications add-in subsystems for
personal computers.
7. Defendant William Schroeder is President and Chief
Executive Officer and a Director of Diamond and has held those
positions since May 1994. In the fiscal year ended December 31,
1995, Schroeder received $452,927.00 in salary, bonus and other
compensation. As of April 10, 1996, defendant Schroeder owned
or controlled 1,177,818 shares of Diamond common stock. During
the Class Period, Schroeder sold 115,932 shares of Diamond
common stock realizing approximately $2.4 million.
8. Defendant Chong-Moon Lee is Chairman of the Board of
Diamond and founded the Company in 1973. He has held the
position of Chairman of the Board since 1982 and, from 1982
through May 1994, he was President and Chief Executive Officer
of Diamond. As of April 10, 1996, Lee beneficially owned or
controlled 2,674,757 shares of Diamond common stock. During the
Class Period, Lee sold 131,493 shares of Diamond common stock,
realizing approximately $4 million.
9. Defendant Gary B. Filler is Senior Vice-President and
Chief Financial Officer of Diamond and has held those positions
since August 1994. In the fiscal year ended December 31, 1995,
Filler received $363,078 in salary, bonus and other
compensation. As of April 10, 1996, Filler beneficially owned
or controlled 320,973 shares of Diamond common stock. During
the Class Period, Filler sold approximately 119,527 shares of
Diamond common stock, realizing approximately $2.6 million.
10. Defendant Hyung Hwe Huh is Senior Vice-President and
Chief Technical Officer of Diamond. In the fiscal year ended
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December 31, 1995, Huh received $340,069 in salary, bonus and
other compensation. As of April 10, 1996, Huh beneficially
owned or controlled 576,383 shares of Diamond common stock.
Huh, during the Class Period, sold approximately 153,401 shares
of Diamond common stock, realizing approximately $3.17 million.
11. Defendants Schroeder, Lee, Filler and Huh are known
herein as the "Individual Defendants."
12. By reason of their positions as directors and/or
executive officers of Diamond, each of the Individual Defendants
possessed intimate knowledge of, participated in, or approved
and ratified the deceptive and manipulative acts, practices and
transactions complained of herein, and the material omissions
and false and misleading statements contained in the reports and
financial statements of the Company and in press releases and
other reports of the Company, which constituted a course of
conduct designed to defraud and deceive the members of the Class
herein, and to perpetrate a fraud on the members of the Class
herein. These defendants participated in the alleged
wrongdoing, in part, in order to prolong the illusion of
Diamond's continued growth; and falsely portray Diamond and its
offerings as successful, profitable ventures when they were not,
so that they could (i) protect their executive and/or
directorship positions and the substantial compensation and/or
prestige they obtained thereby; (ii) inflate the apparent
profits and future prospects of the Company in order to support
the market for Diamond's securities and make possible various
securities offerings; (iii) sell their own Diamond securities at
artificially inflated prices, and (iv) conceal and cover up
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their own prior misconduct and mismanagement of Diamond and
avoid being held responsible therefor. Each of the Individual
Defendants was a controlling person within the meaning of
Section 20 of the Exchange Act and each exercised the power and
influence to cause, and did cause, Diamond to engage in the
unlawful conduct complained of herein. Each of the Individual
Defendants is sued as a participant in the wrongdoing alleged
herein and in his capacity as a controlling person of Diamond.
Moreover, each of the Individual Defendants traded in Diamond
securities based upon material inside information not available
to plaintiff and the Class.
CLASS ACTION ALLEGATIONS
13. This action is brought as a class action pursuant to
Rule 23(a) and 23(b)(3) of the Federal Rules of Civil Procedure,
on behalf of a class (the "Class") consisting of plaintiff and
all other persons and entities who purchased converted,
exchanged, or otherwise acquired Diamond securities of any kind
from November 1, 1995 through the close of business on June 20,
1996, both dates inclusive (the "Class Period"). Excluded from
the Class are the defendants herein, members of the immediate
family of the defendants, any entity in which any of the
defendants has a controlling interest, and the legal
representatives, heirs, successors or assigns of any of the
defendants.
14. This action is properly maintainable as a class action
for the following reasons:
(a) Although the exact number of class members cannot
be ascertained, they are so numerous and geographically
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dispersed that joinder of all class members is impracticable.
Plaintiff believes that there are at least thousands of members
of the Class. As of April 10, 1996, more than 34.7 million
shares of common stock were outstanding with more than 389
shareholders of record. Diamond common stock traded on the
NASDAQ National Securities Exchange, an efficient market.
(b) There are common questions of law and fact
involved herein which predominate over any questions affecting
only individual members of the Class. These common questions of
law and fact include:
(i) Whether defendants, during the Class
Period, acted in concert and concealed from the public investors
the true facts relating to the operations and financial
condition of Diamond, including missing inventory, poor
production performance, "antiquated" accounting practices and
the amount of the Company's revenues, earnings and expenses.
(ii) Whether defendants publicly disseminate
false financial and other statements of the Company during the
Class Period;
(iii) Whether the defendants violated Section
10(b) and 20 of the Exchange Act and Rule 10b-5 promulgated
thereunder;
(iv) Whether the acts and omissions of
defendants constitute violations of the common law;
(v) Whether plaintiff and the other members of
the Class sustained damages, and, if so, the proper measure
thereof;
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(c) The claims of plaintiff are typical of those of
the Class in that plaintiff is a member of the Class and has no
known interests that are antagonistic to or contrary to the
interests of the Class.
(d) Plaintiff will fairly and adequately protect the
interests of the members of the Class and has retained competent
counsel experienced in class and securities litigation to
vigorously prosecute this action.
(e) A class action is superior to other available
methods for the fair and efficient adjudication of this
controversy. Plaintiff knows of no difficulty to be encountered
in the management of this action which would preclude its
maintenance as a class action. Furthermore, since the damages
suffered by individual class members may be relatively small,
the expense and burden of individual litigation make it
impracticable for the Class members to seek redress individually
for the wrongs they have suffered.
15. Plaintiff will rely, in part, upon the presumption of
reliance established by the fraud-on-the-market doctrine in
that:
(a) defendants made public misrepresentations during
the Class Period, as alleged herein;
(b) the misrepresentations were material;
(c) shares of Diamond common stock were traded on a
developed national stock exchange, namely the NASDAQ, which is
an efficient market within the meaning of that term in the
context utilized herein;
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(d) plaintiff and the other members of the Class
purchased their Diamond shares between the time defendants made
the misrepresentations and time the truth was revealed, and made
such purchases without knowledge of the falsity of the
misrepresentations.
16. Based upon the foregoing, plaintiff is entitled to a
presumption of reliance upon the integrity of the market for the
purposes of class certification. Similarly, plaintiff is
entitled to a presumption of reliance with respect to the
omissions alleged herein.
WRONGFUL COURSE OF CONDUCT
17. Throughout the Class Period, defendants engaged in a
scheme whereby they repeatedly engaged in materially false and
deceptive announcements and financial reporting in order to
create the appearance of a thriving, growing corporation with
excellent products when it was not. This was done in order to
artificially increase the price of Diamond stock, at least in
part to enable Diamond to make acquisitions and to enable the
Individual Defendants to make unwarranted profits on their own
stock sales.
18. On February 13, 1995, the Individual Defendants caused
Diamond to file an S-1 Registration Statement for the initial
public offering of Diamond shares, which was completed on or
about April 12, 1995. The initial public offering raised over
$127 million. Subsequently, the price of Diamond stock
maintained a price level of approximately $20 per share.
Because defendants intended to use Diamond securities for
corporate acquisitions, and in order to reap huge unwarranted
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profits on the sale of their own securities, defendants began
issuing materially false and misleading statements to
artificially inflate the price of Diamond stock.
19. On or about November 1, 1995, Diamond issued a press
release which stated that the Company's Stealth64 Video 2001
Multimedia accelerator had been selected by Compaq as an
integral part of Compaq's systems (the "First Press Release").
Defendants stated that the reason for such selection was the
accelerator's "powerful graphics and video playback
acceleration."
20. On or about November 14, 1995, the Company filed a
Form 10-Q with the SEC for the quarter ended September 30, 1995
(the "10-Q"). Said 10-Q was materially false and misleading in
that it did not disclose that, increasingly, Diamond was
experiencing problems and defects with its products.
21. In the 10-Q, defendants disclosed the acquisition of
the Supra Corporation ("Supra"), a manufacturer and marketer of
modem products and the proposed acquisition of SPEA Software AG
("Spea"), which was disclosed in the Registration Statement and
the Prospectus dated October 26, 1995 and November 21, 1995
respectively.
22. On or about October 26, 1995, the Individual
Defendants caused Diamond to file a Form S-1 Registration
Statement with the SEC, which became effective on or about
November 21, 1995 (the "Registration Statement"). Pursuant to
the Registration Statement, Diamond offered 3,150,000 shares of
common stock, 350,000 sold by, inter alia, defendants Lee, Huh,
Schroeder and Filler (the "Offering").
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23. The 10-Q, the Registration Statement and the
Prospectus dated November 21, 1995 (the "Prospectus") contained
materially false and misleading financial statements for the
quarter ended September 30, 1995, which financial statements
contained materially overstated assets and net income. The
Prospectus fraudulently represented that net income for the nine
months ended September 30, 1995 was a loss of $16,435,000 or a
loss of $.66 per share, on a consolidated basis and total assets
to be $182,180,000 as of September 30, 1995. However, in both
the Registration Statement and the Prospectus, defendants, in
order to minimize the effects of the losses, included pro forma
financial statements, including acquisitions, for the nine
months ended September 30, 1995. The pro forma figures were
substantially different than the consolidated statements. The
pro forma figures represented net income to be $4,620,000 and
earnings per share of $.16 with total assets of $225,752,000.
24. Diamond's financial statements for the third quarter
ended September 30, 1995 were included in the Registration
Statement, and the Prospectus. The financial statements state:
The accompanying interim consolidated
balance sheet of September 30, 1995 and
consolidated statements of operations and
cash flows for the nine months ended
September 30, 1995 and 1994 together with
the related notes are unaudited but include
all adjustments, consisting of only normal
recurring adjustments, which the Company
considers necessary to present fairly, in
all material respects, the consolidated
financial condition at September 30, 1995
and the consolidated results of operations
and cash flows for the periods ended
September 30, 1995 and 1994. Results for
the nine months ended September 30, 1995 are
not necessarily indicative of results for
the entire year.
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Diamond's Stealth series includes 3
multimedia accelerator product lines
the Stealth64 Video 3000 series, the Stealth
2001 series. . . and the Stealth64 Video
2001TV . . . . The lower cost Stealth64
Video 2001 Series also supports video
playback through software-based
decompression, but uses lower-cost DRAM
memory and a lower performance multimedia
processor. The Stealth64 Video 2001 series
is also upgradable to hardware-based MPEG
decompression and also features an
additional TV tuner upgrade module that
enables live television in a window. The
Stealth64 Video 2001TV incorporates the
features of the Stealth64 Video 2001 and the
TV tuner in one integrated package, which
can be further upgraded to include hardware
MPEG decompression.
25. Diamond's 10-Q for the third quarter ended
September 30, 1995, states that: "Inventories are stated at the
lower of cost (determined on a first-in, first-out basis) or
market."
26. On or about November 15, 1995 the Company acquired
Spea. On page 5 of the Prospectus, defendants state that "Spea
is one of the leading suppliers of graphics accelerator
subsystems for PCs in Europe. During the fiscal year ended
December 31, 1994... Spea had revenues of $107.4 million... and
net losses of $2.4 million..."
27. On November 21, 1995, based upon defendants
representations, Montgomery Securities ("Montgomery"), an
underwriter for the Offering, issued a report on Diamond
authored by P.G. Fox (the "First Montgomery Report"). The
report was based upon projected earnings of $1.77 per share in
fiscal year 1996. The First Montgomery Report reiterated the
defendants' claims that Spea would substantially increase
Diamond's revenues from Europe and that the introduction of the
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Stealth 3-D product would have a positive impact on fiscal year
1996 earnings and would not materially adversely impact the
Company's sales of its Edge 3-D product and projected that
Diamond would reach a price of $40 per share. Defendants knew
or recklessly disregarded that the information provided would be
made public.
28. The Registration Statement, the Prospectus, the First
Press Release, the First Montgomery Report, and the 10-Q were
materially false and misleading. The true facts which
defendants knew or recklessly disregarded and did not disclose,
based upon internal Diamond information were that:
(a) Diamond overstated its revenues and earnings for
the third quarter ended September 30, 1995 by improperly
recognizing revenues on "sales" which were contingent on resale
and by failing to provide an adequate reserve for obsolete and
excess inventory, failing to properly recognize the full cost of
sales and by improperly inflating inventory levels.
(b) Diamond's financial statements were, in fact, not
in accordance with Generally Accepted Accounting Principles and
did not state inventories at the lower of cost or market because
they failed to provide adequate reserves for obsolete and excess
inventory.
(c) Diamond failed to provide adequate controls
necessary to monitor, account for and accurately report
inventory purchases and cost of sales. As a result, Diamond's
inventory levels were overstated and Diamond's cost of sales
were understated.
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(d) Prior to 1996, defendants lacked a reasonable
basis to project Diamond's financial results or to accurately
prepare Diamond's Financial Statements because Diamond lacked
the accounting system and the internal controls necessary to
prepare projections and financial statements. The defendant
relied upon a system of accounting which utilized manual logs
which has been described by one of the defendants as
"antiquated";
(e) The TV tuner upgrade module for the Stealth64
Video 2001 contained significant design defects which were not
entirely remedied throughout the fourth quarter of 1995.
Shipments were repeatedly delayed because Diamond was only able
to ship minimal volumes due to these defects;
(f) The Stealth64 Video 2001 series lacked a driver
for a Windows 95 application;
(g) The Stealth64 Video 2001 was not being shipped in
a format that was compatible with Windows NT or OS/2 operating
systems;
(h) The Stealth64 Video 3000 series had been shipped
by the Company with driver problems which caused the Stealth64
Video 3000 series products to suffer from "lock-up." A material
portion of the product was being returned due to said "lock-up."
As a result, the Stealth64 Video 3000 product was accumulating
as excess and/or non-saleable inventory;
(i) Due mainly to malfunctions in the processors
utilized by Diamond in the 3000 series products said 3000 series
products were working only with PCI buses;
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(j) Customers were canceling orders and/or returning
merchandise due to the misrepresentations made by defendants
concerning their products abilities and quality; and
(k) The Spea acquisition included the acquisition of
millions of dollars of obsolete, overvalued and materially
excess inventory. Because defendants Schroeder and Filler
undertook the investigation and analysis of Spea, they knew or
should have known of the overvaluation of Spea.
(l) Because of the facts stated herein, the
defendants had no reasonable basis for the revenue and earnings
projections made by them.
29. On or about November 22, 1995, Montgomery issued a
second report authored by P.G. Fox. The Secon ber 1, 1996, Donaldson and Alex issued
favorable reports based upon the aforementioned conversations.
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As a result, the price of Diamond shares increased from $30.50
on November 29, 1995 to $33.75, on November 30, 1995, $37.25 on
December 1, 1995, up to $40.75 on December 4, 1995, a thirty
three percent increase. In providing said information,
defendants knew or recklessly disregarded that it would become
public.
31. On or about December 4, 1995, based in part on
statements made by Schroeder to R. Stone, Cowen & Co. ("Cowen")
issued on "strong buy" recommendation and set its price target
of $44-47 per share for Diamond stock. In providing said
information, defendants knew or recklessly disregarded that it
would become public.
32. On or about December 5, 1995, at the Montgomery
Technology Conference, defendant Schroeder stated that, although
component supplies were tight, Diamond's, ISDN communications
products and 3-D graphics products would have a major positive
impact on Diamond's earnings in early 1996.
33. On or about December 20, 1995, Donaldson issued a
report authored by T.T. Rooney based upon information provided
by defendants, who knew or recklessly disregarded that the
information would be made public, which claimed that Diamond
would have a 20-25% growth rate in 1996.
34. The statements made by defendants from November 22,
1995 through December 20, 1995 by defendants and analysts to the
public were materially false and misleading, and defendants knew
or recklessly disregarded and did not disclose the fact that
they were so, in that:
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(a) The supply of chips from Rockwell for the
Company's communication products was haphazard, including those
for Diamond's telecommander boards. As a result, Diamond's
production line was halted due to the unavailability of the
aforementioned chips which had a material negative effect on
both margins and sales;
(b) The Company's introduction of its Stealth 3-D
product would necessarily have an adverse impact on the higher
cost, higher priced, less desirable Edge 3-D product due to the
fact that they competed against each other;
(c) The Company's ISDN communications product would
be delayed because Microsoft failed to timely provide a software
driver necessary to operate the product. The software driver
would not be made available in sufficient numbers until at least
the middle of the first quarter of 1996;
(d) Prior to 1996, defendants lacked a reasonable
basis to project Diamond's financial results or to accurately
prepare Diamond's Financial Statements because Diamond lacked
the accounting system and the internal controls necessary to
prepare projections and financial statements. The defendant
relied upon a system of accounting which utilized manual logs
which has been described by one of the defendants as
"antiquated";
(e) Diamond was experiencing high rates of return and
customer dissatisfaction because of the previously described
problems Diamond was having with the Stealth64 Video 2001 and
Stealth64 Video 3200 products; and
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(f) Because of facts stated herein, the defendants
had no reasonable basis for the revenue and earnings projections
then being made by them.
35. On January 17, 1996, Diamond issued a press release
containing its results for the year ended December 31, 1995.
The Company reported revenue of $190.1 million for the year, as
compared to $60.6 million for the fiscal year ended December 31,
1994. However, defendants also announced "unexpected year end
inventory adjustments" of $3.7 million due to "missing
inventory".
36. On the same day, defendants Schroeder and Filler spoke
to securities analysts P.C. Rueppel of Alex, R. Stone of Cowen,
P.G. Fox of Montgomery and T.T. Rooney of Donaldson. In that
conversation, Schroeder and Filler represented:
(a) The Company was investigating the missing
inventory but "didn't know what [had] happened";
(b) That despite the missing inventory, there was "no
change" in the Company's revenue projections;
(c) That they were not aware of the inventory issue
until the end of the fiscal year and quarter;
(d) That demand for the Company's graphics and
communications products continued to be "strong"; and
(e) That the Company experienced "higher than
expected" sales of its Edge 3-D product and anticipated that the
product would continue to show growth in 1996.
37. The foregoing representations were disseminated to the
public via reports issued by Donaldson and Montgomery on
January 18, 1996 and defendants knew or recklessly disregarded
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that the information would became public. The information was
also contained in Diamond's "Corporate Backgrounder" release to
investors.
38. Defendants knew or recklessly disregarded the fact
that the statements referenced in paragraphs 35-37, supra, were
materially false and misleading at least in part because
defendants knew or recklessly disregarded and did not disclose
that:
(a) Diamond had no viable computer Management
Information Systems or accounting infrastructure. Its only
method of ascertaining inventory was through the use of its
pencil and spreadsheet methodology.
(b) Contrary to their claims, defendants had no way
of knowing whether or not the "missing" inventory had been
stolen because Diamond had wholly inadequate internal controls
and little or no inventory control systems in place during 1995.
Instead, the defendants relied upon W.T. Kim to keep track of
and to provide inventory data on an as-needed basis;
(c) Prior to 1996, defendants lacked an accounting
system and internal controls necessary to calculate and prepare
Diamond's financial statements. Instead, defendants relied upon
a system of manual logs which defendant Schroeder testified was
"antiquated."
(d) Diamond was experiencing high rates of product
return and customer dissatisfaction because of the previously
stated problems with the Stealth64 Video 2001 and Stealth64
Video 3200.
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39. As a result of the January 17, 1996 announcement, the
price of Diamond stock fell from $26.25 to $17.4375 on
January 18, 1996.
40. On January 18, 1996, T.T. Rooney of Donaldson, a
Diamond underwriter, and Schroeder held a conference call with
numerous analysts throughout the country. In those calls,
Rooney and Schroeder maintained that the lack of internal
controls had been remedied and that the impact of the
$3.7 million loss was, in fact, minimal. Rooney and Schroeder
attempted to convince analysts to reduce their gross margin
projection by a mere 1% for fiscal year 1996, although a larger
reduction was warranted.
41. On January 19, 1996, defendants announced that the
previously discussed improvements to inventory and manufacturing
control systems were "almost in place." Defendant Schroeder
also said that Diamond had still not determined what happened to
the missing inventory, but that it consisted of products in the
company's multimedia business. Schroeder emphasized that the
new inventory and manufacturing systems would provide Diamond
with "a more professional way to manage its operations."
42. On or about February 27, 1996 T.T. Rooney of Donaldson
issued a report, based upon statements made by Filler and
Schroeder, projecting Diamond's fiscal year 1996 earnings at
$1.70 per share and representing that defendants "guided"
Rooney's revenue projections to be increased by $10 million to
$167.7 million.
43. Due to the fact that, at this point, adjustments to
Diamond's financial statements were imminent and the scheme to
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defraud could no longer be maintained at the same levels,
defendants began a campaign of partial disclosures, or "limited
hang-out", in order to soften the blow of the as yet undisclosed
inflation of Diamond's stock price and to maintain artificially
high levels as long as possible.
44. From November 27, 1995 through May 10, 1996 defendants
took full advantage of the artificially high levels of the price
of Diamond stock.
45. From November 27, 1995 through May 10, 1996, defendant
Schroeder sold 115,932 shares of Diamond common stock at prices
ranging from $18.89 to $29.92, including 40,000 shares on
January 31, 1996 and 10,000 shares on February 1, 1996, just
before the partial disclosures began.
46. From November 27, 1995 through April 29, 1996,
defendant Filler sold 119,527 shares of Diamond common stock at
prices ranging from $18.88 to $29.92, including 40,000 shares on
January 31, 1996, just before the partial disclosures began.
47. Defendant Lee, from November 27, 1995 through
December 5, 1995, sold a total of 131,993 shares of Diamond
common stock at prices ranging from $29.92 to $31.25 prior to
any disclosures, including the disclosure of the "missing"
inventory.
48. Defendant Huh sold 153,401 shares of Diamond stock
from November 27, 1995 through March 1, 1996, at prices ranging
from $17.00, to $29.92 per share, including 17,107 shares on
November 27, 1995 and 18,622 shares on December 5, 1995, prior
to any disclosures, including the disclosure of the "missing
inventory".
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49. On April 1, 1996, Diamond issued two press releases.
The first announced a new product, Diamond's Stealth 3D
accelerator and stated that the accelerator;
Will deliver high-performance 2D graphics as
well as 3D animation and MPEG-l digital
video playback acceleration for PC's running
Microsoft's Windows 95, Windows 3.1x,
Windows NT 3.51 and DOS operating systems.
Designed for systems with a PCI bus, the new
Stealth 3D 2000 accelerates a new realm of
computer applications featuring realistic 3D
animation and video such as multimedia
applications and games.
The modular design of the Stealth 3D 2000
will also allow for the affordable addition
of a TV tuner option. An OEM/VAR version of
Stealth 3D 2000 will be available in April
to Diamond OEM customers and through its
authorized distributors. The retail version
of the Stealth 3D 2000 will be available in
June to consumers and dealers through
Diamond's network of mass merchants,
retailers and authorized distributors.
The new Diamond Stealth 3D provides ultra
high-performance 2D capabilities as well as
powerful 3D graphics and video
acceleration," said Ken Wirt, vice president
of marketing, marketing, Diamond Multimedia
Systems, Inc. Now PC users can take
advantage of the latest in immersive 3D
animation and continue to have improved
Stealth performance and reliability for
their Windows acceleration and business
application needs.
The second press release announced a $50 price reduction
for Diamond's Edge 3-D multimedia accelerators.
50. On April 18, 1996, Diamond issued a press release
announcing its financial results for the first quarter of 1996.
The press release stated:
Diamond Multimedia Systems, Inc. reported
increased revenues and earnings for the
quarter ended March 31, 1996.
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For the first quarter of 1996, revenues
increased 134 percent to $187.6 million from
$80.3 million in the first quarter of 1995.
Diamond reported net income of $11.2
million, or $0.32 per share on 35.3 million
shares 22 outstanding for the quarter ended
March 31, 1996 versus net income of $6.1
million, or $0.28 per share on 20.9 million
shares outstanding, for the first quarter of
1995.
During the quarter, Diamond continued to
experience solid demand for its products
including communications products. The
Company's communications division, which
includes the recently acquired business of
Supra Corporation located in Vancouver,
Washington, accounted for 22 percent of
revenues or $42.1 million. Excluding sales
from recently acquired subsidiaries,
revenues were up 58 percent from the prior
year period.
Gross margin for the quarter was down from a
year ago to 21% primarily due to lower
selling prices. During the second fiscal
quarter of 1996, however, declines in prices
for DRAMs and other components will result
in lower costs for the Company's products.
As a result gross margins are expected to
improve in the second quarter.
51. On or about April 19, 1996, Schroeder and Filler once
again spoke by telephone to R. Stone, P.C. Rueppel and P.G. Fox.
In that call, Schroeder and Filler represented that:
(a) The Company's inventory problem had been
"resolved";
(b) The Company's adopted adequate inventory
controls;
(c) The Company's graphics products, including its
Stealth 3-D, Edge 3-D products and its communications products
were experiencing "strong demand";
(d) Diamond had reduced its inventory;
/ / /
- 22 -
(e) Its connectivity products were experiencing
strong market demand;
(f) Diamond's margins would rebound substantially, to
the 23 percent range the second quarter;
(g) Diamond would earn approximately $0.39 per share
in the second quarter, $1.72 per share for the full year and
earnings would grow approximately 30% over the next two years;
and
(h) The Company's results for the second quarter
would be a continuation of the Company's positive first quarter
results with additional growth in revenues.
52. The information that defendant's provided to the
securities analysts was disseminated by these analysts in
written reports on or about April 19, 1996.
53. Meanwhile, defendants Filler and Schroeder
collectively sold 13,750 shares of Diamond stock from April 23,
1996 through May 10, 1996. Notably, the last stock sale by any
of the Individual Defendants was May 10, 1996, just before the
first substantial change in earnings forecasts.
54. On or about May 24, 1996, Alex issued a report
authored by P.C. Rueppel, based upon Rueppel's conversations
with defendants Schroeder and Filler. Rueppel's report
decreased earnings projections to $1.45 for 1996 and reduced
revenue projections to $165 million from $195 million for the
quarter. Based on concerns about inventory, Alex reduced its
second quarter projections to earnings of $0.28 per share.
55. The aforementioned statements from January 15, 1996
through May 24, 1996 were materially false and misleading. The
- 23 -
true facts, known or recklessly disregarding by defendants and
not disclosed were that:
(a) In order to meet revenue and earnings projections
made by and on behalf of Diamond for the first quarter of 1996,
the defendants had deliberately overshipped merchandise;
(b) Diamond's customers were unwilling to accept
additional product during the second quarter due to the
overshipment in the first quarter;
(c) Beginning by at least January 17, 1996,
continuing throughout the first quarter of 1996, the defendants
were offering substantial discounts and/or rights of return to
the Company's wholesale, distributor and OEM customers in order
to meet the revenue projections previously described.
Defendants knew or recklessly disregarded the fact that a
substantial portion of the "sold" products would be returned or
that receivables recognized in conjunction with such "sales"
would be written off;
(d) Defendants and the Company were extending
extremely lenient credit terms in order to get large clients to
accept the Company's Edge 3-D product;
(e) Many of Diamond's customers were planning to
return all unsold Edge 3-D products;
(f) The lower priced, higher quality Stealth 3-D
product would cause the Company's Edge 3-D sales to disintegrate
because they were competing products;
(g) The total sales of Diamond's graphics products to
Ingram Micro, Inc., Merisel, Inc. and Tech Data Corp., all major
customers, were rapidly declining;
- 24 -
(h) Margins had eroded and were materially less than
those being projected by defendants;
(i) The Company could not in fact, project gross
margins of 23% due to the substantial price cuts and discounts
implemented by defendants in early 1996, including those on the
Edge and Javelin products which had a substantial negative
impact on gross margins; and
(j) Purchasers of certain Diamond products, including
the Stealth64 Video 3000, were not getting the products they had
purchased, but were receiving substitute products they had not
purchased.
56. Throughout the Class Period, defendants knew or
recklessly disregarded that the financial results, announcements
and representations made to the public were materially false and
misleading in that defendants knew or recklessly disregarded the
fact that:
(a) In order to artificially boost Diamond's third
quarter fiscal 1995 results to complete a stock offering,
Diamond (i) improperly recorded revenues on contingent sales of
its graphic accelerators; (ii) deliberately shipped excessive
amounts of that product to its major customers defendants; and
(iii) provided those customers extended or deferred payment
terms or the absolute right of return of the product.
Defendants knew or recklessly disregarded the fact that said
action would negatively affect Diamond's revenues in the fourth
quarter of fiscal 1995 and first quarter of 1996;
(b) By the first quarter of 1996, Diamond's Edge 3-D
product was not selling well through Diamond's distribution
- 25 -
channel. Sales of the Edge 3-D product were at such low levels
that Diamond was giving customers huge discounts and unlimited
return privileges and therefore expected to report lower margins
for the first quarter of 1996 and extensive returns before the
end of the second quarter 1996.
(c) Diamond's largest distributors and customers had
collectively decreased their purchases from Diamond during the
second quarter of fiscal year 1996;
(d) Diamond had accumulated large amounts of obsolete
graphics products which defendants knew or recklessly
disregarded would have to be written off or substantially
written down;
(e) Defendants falsely represented that Diamond was
enjoying continued or "strong" demand for its graphics products;
(f) Diamond was having increasing difficulty selling
its Edge 3-D products due to weakening demand;
(g) In order to sell products, Diamond was extending
very lenient payment terms or unlimited right of return on
products including, inter alia, the Edge 3D product. This made
it virtually certain that Diamond's revenues and earnings would
decline later in fiscal 1996;
(h) Diamond's forecasts of 23% gross margins for its
foreseeable future, second quarter fiscal 1996 revenues of $165
million, earnings per share of $0.28 to $0.36 and a resumption
of strong revenue and earnings growth in fiscal year 1997 lacked
a reasonable basis in fact and were false and misleading;
(i) Defendants' forecasts of second quarter fiscal
1996 revenues and earnings per share of approximately $0.30 and
- 26 -
strong revenues and earnings per share growth for Diamond in
fiscal year 1996 and 1997 were materially false and misleading,
as they were contradicted by the adverse facts as set forth
above;
(j) Beginning by at least January 17, 1996, the
defendants were offering substantial discounts and/or rights of
return to Diamond's wholesale, distributor and OEM customers in
order to meet the revenue projections made by and on behalf of
the defendants;
(k) That defendants knew or recklessly disregarded
the fact that many of Diamond's customers were planning to
return all unsold Edge 3-D products; and
(l) The lower cost, higher quality Stealth 3-D
product would adversely impact the Company's Edge 3-D sales, due
to its lower price and better quality.
57. On June 20, 1996, after the close of the stock market,
Diamond suddenly revealed that it expected to report a loss or
break-even in the second quarter of fiscal year 1996 on revenues
of just $120 million due to extremely weak sales. Diamond also
stated to analysts that it would write down over $7.5 million in
inventory in the quarter ended June 30, 1996. Diamond's stock
plunged to as low as $9-1/8 per share on these revelations on a
volume of over 3 million shares.
58. The financial statements of Diamond, beginning at
least with the third quarter ended September 30, 1995, were not
presented "fairly" and "in conformity with generally accepted
accounting principles" because:
/ / /
- 27 -
(a) The accounting principles selected and applied
did not have general acceptance;
(b) The accounting principles were not appropriate in
the circumstances;
(c) The financial statements, including the related
notes, were not informative of matters that affected their use,
understanding, and interpretation; and
(d) The financial statements did not reflect the
underlying events and transactions in a manner that presented
the financial position and the results of operations within a
range of acceptable limits that were reasonable and practicable
to attain in financial statements.
59. Further, said financial statements failed to disclose
material adverse information and misrepresented the truth about
Diamond's results of operations, financial condition, and future
business prospects. The material misrepresentations included
Diamond's:
(a) Overstatement of the carrying value of
receivables and inventory as assets on its balance sheet;
(b) Failure to disclose its exposure to contingent
sales and/or sales subject to the right of return; and
(c) Overstatement of income, assets and net worth due
to the failure to timely and fully reserve for the return of
merchandise which was sold subject to the right of return.
&nb least a reasonable possibility that a loss or
an additional loss may have been incurred (Statement of
Financial Accounting Standards No. 5, Accounting for
Contingencies para. 10);
(c) The principle that disclosure of accounting
policies should identify and describe the accounting principles
followed by the reporting entity and the methods of applying
those principles that materially affect the financial statements
(APB Opinion No. 22, paragraph 12);
(d) The principle that contingencies that might
result in gains usually are not reflected in the accounts since
to do so might recognize revenue prior to its realization
(Statement of Financial Accounting Standards No. 5, para. 17);
(e) The principle that costs and losses that may be
expected in connection with any returns of merchandise shall be
accrued (Statement of Financial Accounting Standards No. 48,
paragraph 7);
(f) The principle that revenues should ordinarily be
accounted for at the time a transaction is complete, with
appropriate provision for uncollectible accounts (APB Opinion
No. 10, paragraph 12);
- 29 -
(g) The principles that revenues and gains generally
are not recognized until realized or realizable, and revenues
are considered to have been earned when the entity has
substantially accomplished what it must do to be entitled to the
benefits represented by the revenues (Statement Of Financial
Accounting Concepts No. 5, paragraph 83);
(h) The principle that the quality of reliability
and, in particular, of representational faithfulness leaves no
room for accounting representations that subordinate substance
to form (Statement Of Financial Accounting Concepts No. 2,
paragraph 160); and
(i) The principle that asset valuation allowances for
losses should be deducted from the assets or groups of assets to
which they relate with appropriate disclosure (APB Opinion No.
12 paragraphs 2 and 3).
COUNT I
Violations of Sections 10(b) of the Exchange Act and
Rule 10b-5 Promulgated Thereunder Against All Defendants
61. Plaintiff repeats and realleges the allegation
contained in paragraphs 1 through 60 of the Complaint as if set
forth herein.
62. The Securities described herein are securities, as
defined in Section 2(1) of the Securities Act [15 U.S.C.
§77b(1)] and Section 3(a)(9) of the Exchange Act (15 U.S.C.
§78c(a)(10)].
63. Defendants, by use of the means or instrumentality of
interstate commerce or the use of the mails, engaged in the use
of manipulative and deceptive practices in connection with the
- 30 -
sale of such securities to plaintiff and the members of the
Class in violation of Section 10(b) of the Exchange Act,
15 U.S.C. §78j(b), and Rule 10b-5 promulgated thereunder.
64. Such manipulative and deceptive practices included,
inter alia, the use of untrue statements of material fact and
the omission of material facts particularly alleged above that a
reasonable investor would have considered important in making an
investment decision in connection with Diamond.
65. Such defendants knowingly or recklessly made such
untrue statements and omissions of material fact for the purpose
of inducing plaintiff and Class members to purchase such
securities.
66. Plaintiff and the members of the Class justifiably
relied on such untrue statements and omissions of material fact
in deciding to purchase such securities.
67. Plaintiff and the members of the Class also
justifiably relied on the honesty and integrity of such
defendants and the processes and procedures supposedly used and
followed to issue and sell the securities described herein, in
deciding to purchase such securities.
68. In fact, had the plaintiff and other Class members
known of the fraud perpetrated by such defendants in connection
with the issuance, distribution and sale of the securities
described herein such securities could not have been sold at any
price or at a price substantially below that price paid by
plaintiff and the Class.
69. As a result of such defendants' conduct, the plaintiff
and the Class have suffered damages.
- 31 -
70. By reason of the acts, omissions, practices, and
courses of business set forth herein, these defendants have
violated Section 10(b) of the Exchange Act [15 U.S.C. §78j(b)],
and Rule 10b-5 promulgated thereunder [15 C.F.R. §240.10b-5].
COUNT II
(Against the Individual Defendants For Violations
of Section 20 of the Exchange Act)
71. Plaintiff repeats and realleges each and every
allegation contained in paragraphs 1 through 70 above, as if set
forth fully herein.
72. The Individual Defendants acted as controlling persons
of the Company within the meaning of Section 20 of the Exchange
Act. By reason of their positions as officers and/or directors
and their substantial stock ownership, the Individual Defendants
had the power and authority to cause the Company to engage in
the wrongful conduct complained of herein.
73. In their capacity as control persons of Diamond, each
defendant had a duty to disseminate only truthful and accurate
information to the investing public and to promptly correct any
materially false and misleading statements disseminated so that
the price of Diamond's common stock would be based on accurate
and complete information.
74. By reason of such wrongful conduct, the Individual
Defendants are liable pursuant to Section 20 of the Exchange
Act. As a direct and proximate result of their wrongful
conduct, plaintiff and the other members of the Class suffered
/ / /
- 32 -
damages in connection with their purchases of the Company's
securities during the Class Period.
COUNT III
(Under the Common Law for Fraud
And Deceit Against All Defendants)
75. Plaintiff repeats and realleges each and every
allegation contained in paragraphs 1 through 74 as if fully set
forth herein.
76. This Count is asserted under principles of common law
and California law.
77. During the Class Period, defendants, individually and
in concert, directly and indirectly, engaged and participated
in, or knowingly devised a common plan and scheme and continuing
course of conduct and conspiracy to conceal adverse material
information about the Company's financial practices and its
prior false and misleading representations to the public about
Diamond's financial condition. Defendants employed devices,
schemes and artifices to defraud and engaged in acts, practices
and a course of conduct as herein alleged in an effort to
maintain an artificially high market price for the securities
described herein, which included the making of untrue statements
of material facts, omitting to state material facts necessary in
order to make the statements made, in the light of the
circumstances under which they were made, not misleading, and
engaging in transactions, practices, and courses of business
which operated as a fraud and deceit upon the purchasers of
securities described herein during the Class Period.
/ / /
- 33 -
78. The false and misleading statements and omissions of
defendants in relation to securities as described herein, and in
their public announcements, were made with the intent to deceive
and/or defraud plaintiff and the other Class members, or to aid
and abet the deception and defrauding of plaintiff and the other
Class members, or were made with such recklessness or
indifference to truth as to constitute intent to deceive and
defraud plaintiff and the other members of the Class. Said acts
by defendants were fraudulent, oppressive and malicious. Each
of the defendants, by acting as described above, did so
knowingly or with such recklessness as to constitute a fraud and
deceit upon plaintiff and the other members of the Class.
79. The acts, practices and common course of conduct by
defendants operated as a fraud and deceit upon (a) the market in
securities described herein; (b) plaintiff and the other members
of the Class who relied on (i) the aforesaid market and the
market prices to reflect the true value of the securities
described herein based on true, full, fair and lawful disclosure
of material facts; (ii) Diamond's false and misleading financial
statements and Diamond's documents described herein; and (iii)
the presumed truthfulness of Diamond's disclosure of its
financial condition, business, management, revenues, earnings,
forecasts and future business prospects.
80. As a result of the foregoing, defendants, directly and
indirectly, committed fraud and deceit upon plaintiff and the
Class. Plaintiff therefore prays for an award of compensatory
and punitive damages against defendants.
/ / /
- 34 -
COUNT IV
(Negligent Misrepresentation Against All Defendants)
81. Plaintiff repeats and realleges each and every
allegation contained in paragraphs 1 through 80 as if fully set
forth herein.
82. The relationship of the defendants to plaintiff and
members of the Class was such that plaintiff and members of the
Class had the right and did in fact rely upon defendants for
information concerning Diamond, and each defendant owed a duty
to plaintiff and members of the Class to provide such
information with due care regarding its accuracy, and knew or
should have known that such information was utilized by
plaintiff and members of the Class for a business purpose.
83. Each of the defendants made and participated in the
making of representations of fact to plaintiff and other members
of the Class by means of various documents and statements as
alleged herein.
84. In making said representations, defendants, as alleged
above, misrepresented material facts and omitted to state
material facts necessary to be stated in order that plaintiffs
and the Class would have all the material facts necessary for an
informed decision. Among the direct and proximate causes of
said misrepresentations and omissions were the negligence and
carelessness of the defendants, and the absence of any
reasonable basis for belief in the truth of such statements.
85. At the time said statements were made, plaintiff and
the other members of the Class were ignorant of their falsity,
and believed them to be true. In reliance upon said statements,
- 35 -
the superior knowledge and expertise of defendants, plaintiff
and the other members of the Class were induced to and did
purchase the securities described herein. Had plaintiff and the
other members of the Class known the truth, they would not have
taken such action. By reason thereof, plaintiff and the other
members of the Class have been damaged.
WHEREFORE, plaintiff demands judgment on behalf of herself
and the other Class members as follows:
A. Declaring that this action be maintained as a class
action pursuant to Rule 23 of the Federal Rules of Civil
Procedure;
B. Granting judgment in favor of plaintiff and the other
Class members against defendants herein, and each of them, under
the Counts I through IV for compensatory damages and under
Count III for compensatory and punitive damages; together with
pre-judgment interest at the maximum rate allowable by law;
C. Awarding plaintiff the costs and disbursements of this
action; including reasonable allowances of fees for plaintiff's
attorneys and experts; and
///
///
///
///
///
///
///
///
///
- 36 -
D. Granting plaintiff and the Class such other and
further relief as the Court may deem just and proper.
Dated: July 24, 1996 Respectfully submitted,
SIROTA & SIROTA
/s/
By____________________________________
Saul Roffe
McKENNA & CUNEO, L.L.P.
/s/
By____________________________________
Robert S. Brewer, Jr.
Attorneys for Plaintiff,
Larry Frazier, Sr.
- 37 -
DEMAND FOR JURY TRIAL
Plaintiff hereby demands a trial by jury of all issues
triable before a jury.
Dated: July 24, 1996 Respectfully submitted,
SIROTA & SIROTA
/s/
By____________________________________
Saul Roffe
McKENNA & CUNEO, L.L.P.
/s/
By____________________________________
Robert S. Brewer, Jr.
Attorneys for Plaintiff,
Larry Frazier, Sr.
- 38 -
CERTIFICATION OF NAMED PLAINTIFF
PURSUANT TO FEDERAL SECURITIES LAWS
Larry Frazier, Sr. ("Plaintiff") certifies, as to the
claims asserted under the federal securities laws, that:
1. Plaintiff has reviewed the complaint and authorized
its filing.
2. Plaintiff did not purchase the security that is the
subject of this action at the direction of plaintiff's counsel
or in order to participate in this private action.
3. Plaintiff is willing to serve as a representative
party on behalf of the class, including providing testimony
deposition and trial, if necessary.
4. Plaintiff's transaction in the security that are the
subject of this action during the Class Period is as follows:
a. On May 16, 1996, Plaintiff purchased 3,000 shares
at a price of $17.125 per share;
b. On May 28, 1996, Plaintiff purchased an
additional 3,500 shares at a price of $15.875 per share.
5. During the three years prior to the date of this
Certificate, Plaintiff has sought to serve or served as
representative party for a class in the following actions filed
under the federal securities laws: None
6. The Plaintiff will not accept any payment for serving
as a representative party on behalf of the class beyond the
Plaintiff's pro rata share of any recovery, except such
reasonable costs and expenses (including lost wages) directly
relating to the representation of the Class as order or approved
by the Court.
I declare under penalty of perjury that the foregoing is
true and correct.
Dated: July 10, 1996
/s/
_______________________
LARRY FRAZIER, SR.
- 2 -
UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF CALIFORNIA
)
)
LARRY FRAZIER SR. )
Plaintiff(s) )
) C 96-02644 SBA
-v- )
) INITIAL CASE MANAGEMENT SCHEDULING ORDER
DIAMOND MULTIMEDIA SYSTEM ) Civil L.R. 16-2
Defendant(s) )
______________________________)
IT IS HEREBY ORDERED THAT this action is assigned to the
Honorable Saundra Brown Armstrong. When serving the complaint or
notice of removal, the plaintiff or removing defendant shall
serve on all other parties a copy of this order, the handbook
entitled "Dispute Resolution Procedures in the Northern District
of California" and all other documents specified in Civil Local Rule 4-3.
Counsel shall comply with the case schedule listed below unless the
Court otherwise orders.
CASE SCHEDULE
Date Event Governing Rule
-------------------------------------------------------------------------
07/24/96 Complaint filed
09/09/96 Last day to file proof(s) or waiver(s) of Civil L.R. 4-2
service
10/22/96 Last day to meet and confer re case management Civil L.R. 16-4
11/01/96 Last day to complete initial disclosures Civil L.R. 16-5
11/25/96 Last day to file/serve Case Management Civil L.R. 16-6
Statement and ADR Certification & 16-7
12/04/96 Case Management Conference in
Courtroom 3, 4th Floor at 3:00 PM Civil L.R. 16-8
8 Apr 1997