MILBERG WEISS BERSHAD
HYNES & LERACH LLP
ALAN SCHULMAN (128661)
MARK SOLOMON (151949)
SALLIE A. BLACKMAN (141830)
600 West Broadway, Suite 1800
San Diego, CA 92101
Telephone: 619/231-1058

- and -

JOHN K. GRANT (169813)
222 Kearny Street, 10th Floor
San Francisco, CA 94108
Telephone: 415/288-4545

ABBEY, GARDY & SQUITIERI, LLP
JILL S. ABRAMS
JAMES J. SEIRMARCO
212 East 39th Street
New York, NY 10016
Telephone: 212/889-3700

BERNSTEIN LITOWITZ BERGER &
GROSSMANN LLP
DANIEL L. BERGER
JEFFREY N. LEIBELL
1285 Avenue of the Americas
33rd Floor
New York, NY 10019
Telephone: 212/554-1400

Attorneys for Lead Plaintiffs and the Class

II. ALLEGATIONS OF THE COMPLAINT

A. Diamond's Materially False And Misleading Financial Statements

1. Defendants Improperly Recognized Revenues On "Contingent Sales"

2. Defendants Improperly Recognized Revenue On Shipments Not Made Until The Next Quarter

3. Defendants Failed Adequately To Accrue For Price Protection

4. Defendants Failed Adequately To Reserve For Obsolete And Excess Inventory

5. Defendants Improperly Inflated Inventory Levels

6. Defendants Failed To Expense The Full Cost Of Inventory Sold

B. Misrepresentations Respecting Diamond's Key Products And Business Prospects

A. The Complaint Properly Sets Forth The Factual Bases For Plaintiffs' Claims

B. The Complaint Properly Pleads Scienter

1. The PSLRA Did Not Jettison Recklessness Or "Motive And Opportunity" As Means To Plead Scienter

2. The Complaint Satisfies The PSLRA's Scienter Pleading Standards

a. The Complaint Alleges Motive And Opportunity

b. The Complaint Alleges Circumstantial Evidence Of Conscious Or Reckless Behavior

C. The Complaint Properly Pleads False Statements To Analysts

D. The Complaint Properly Pleads Defendants' Liability For False Statements

E. The Complaint Pleads Actionable Misrepresentations

F. The Defendants Are Not Saved From Liability For Their Wrongful Conduct By Any Safe Harbor

G. The Defendants Are Not Saved By The Bespeaks Caution Doctrine

I. PRELIMINARY STATEMENT

II. ALLEGATIONS OF THE COMPLAINT

A. Diamond's Materially False And Misleading Financial Statements

1. Defendants Improperly Recognized Revenues On "Contingent Sales"

2. Defendants Improperly Recognized Revenue On Shipments Not Made Until The Next Quarter

3. Defendants Failed Adequately To Accrue For Price Protection

4. Defendants Failed Adequately To Reserve For Obsolete And Excess Inventory

5. Defendants Improperly Inflated Inventory Levels

6. Defendants Failed To Expense The Full Cost Of Inventory Sold

B. Misrepresentations Respecting Diamond's Key Products And Business Prospects

1. November 1995. Defendants' positive disclosures, which were included in the Registration Statement and in Diamond's November 7, 1995 press release (¶¶42-43), heralding Diamond's roll-out of new products, Stealth, Edge 3-D and the ISDN devices, were false and fundamentally misleading to investors when made. Based upon internal Diamond data, the Individual Defendants knew, among other things (¶45), that:

the TV tuner upgrade module for the Stealth64 Video 2001 was suffering significant design defects throughout the fourth quarter of 1995 and shipments were repeatedly delayed throughout the fourth quarter as Diamond was only able to ship minimal volumes;

the Stealth64 Video 2001 lacked a driver for a Windows95 application and was not being shipped in a format that was compatible with Windows NT or OS2 operating systems;

the Stealth64 Video 3000 series had been shipped by the Company with driver problems such that a material portion of the Stealth64 Video 3000 series products was suffering from "lock-up," and was being returned and accumulating as excess inventory;

the Stealth64 Video 3000 series products were working only with PCI buses, because of malfunctions in the processors utilized by the Company; and

the numerous product defects and misrepresentations made by defendants, including those detailed above, were resulting in customers cancelling orders and/or returning defective products.

2. November 1995 and December 1995. Between November 20, 1995 and December 20, 1995, defendants made a variety of highly positive statements about their acquisition of the German company SPEA, the introduction of new products, and their projections for near-term performance. Defendants communicated these statements and projections to the market through their regular communications with analysts. ¶¶47-48.⁽⁶⁾ Defendants' representations were false when made. Based upon internal Diamond data, the Individual Defendants knew, among other things (¶49), that:

the supply of Rockwell chips for the Company's communication products was haphazard, including those for Diamond's telecommander boards, and the Company's production line had to be halted many times while waiting for the arrival of Rockwell chips;

the Company's ISDN communications product would be delayed, because Microsoft had not yet provided the software driver necessary to operate the product, and the software driver would not be available in volume until at least the middle of the first quarter of 1996; and

due to severe operating and manufacturing problems at SPEA, it was highly unlikely that the acquisition would result in synergies with Diamond, nor was it likely that SPEA would prove accretive to Diamond's earnings immediately or even on a long-term basis.

4. January 18, 1996 and February 27, 1996. Defendants' statement during the January 18, 1996 nationwide conference call that they had cured Diamond's lack of internal controls, their representation that Diamond's inventory problems were "de minimis," and their forecast that Q1 revenue would be $10 million more than the $157 million previously forecast, all were false and misleading. Based upon internal Diamond data, and in addition to the reasons already described, defendants knew (a) that, beginning by at least January 17, 1996, and continuing throughout the first quarter of 1996, Diamond was offering substantial discounts and/or rights of return to wholesale, distributor and Original Equipment Manufacturer ("OEM") customers; and (b) that, as a result, substantial portions of "purchased" product would be returned or written off. ¶¶53-55.

5. April 1, 1996 press release. Diamond's April 1, 1996, press release announcing, among other things, a $50 price reduction on its Edge 3-D multimedia accelerators, was misleading. It failed to disclose that, due to the price protection guarantees Diamond promised to its customers, combined with the large amount of Edge 3-D product that defendants knew was still in the channels, Diamond had incurred a substantial liability. ¶57.

6. April 18 and 19, 1996 and March 31, 1996 Form 10-Q. Diamond's April 18, 1996 press release, defendants' April 19, 1996 nationwide conference call, and Diamond's March 31, 1996 Form 10-Q filed on May 6, 1996, all were materially misleading. Those various releases and reports represented that the Company was increasing revenue and earnings because of "solid demand" for its products, that its inventory issues had been "resolved," that its margins would rebound, that Diamond's performance in the second quarter would be a continuation of the success of the first quarter with more revenues, and that the reported results for the first quarter were fairly stated. All of these representations were fundamentally misleading because of defendants' improper financial accounting practices, as described above, and also because, as defendants knew:

Defendants were causing the Company to extend extremely lenient return privileges in order to get large clients to accept the Company's Edge 3-D product and defendants were aware of the fact that many of Diamond's customers were planning to return all unsold Edge 3-D products;

The lower cost, higher quality Stealth 3-D product would cannibalize the Company's Edge 3-D sales, especially given defendants decision to choose a $199 price point for the Stealth 3D 2000;

The total sales of Diamond's graphics products to Ingram Micro, Inc., Merisel, Inc. and Tech Data Corp. were declining;

The Company would not have gross margins of 23+%, given the substantial price cuts/discounts implemented by defendants in early 1996, including those on the Edge and Javelin products;

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; and

Diamond was experiencing precipitous declines in both U.S. modem sales and average modem sales prices. These declines were attributable in part to the fact that Supra, its recently acquired modem subsidiary, was (a) heavily Apple Macintosh oriented despite the Macintosh's declining market share; and (b) experiencing extreme competitive pressures from market-leader US Robotics because of US Robotics' large installed base and direct sales force.

¶¶58-61. During the period from November 27, 1995 through May 10, 1996, Diamond's insiders unloaded 523,110 shares of their Diamond stock at prices artificially inflated to as high as $31¼ per share, pocketing over $12.2 million.

Finally in June, 1996 the defendants admitted that instead of revenues of more than $160 million in the second quarter, revenues of only $120 million had been attained, that the company had written off $10 million to write down its inventory and account for the price protection deals it had given customers, and that it incurred a $7.3 million loss from operations for the second quarter. The stock plunged on the news to as low as $9-1/8. ¶64. 

III. ARGUMENT

A. The Complaint Properly Sets Forth The Factual Bases For Plaintiffs' Claims

Even if the Complaint is deemed to have been pled on information and belief, it would satisfy the PSLRA's requirement that it plead "all facts on which that belief is formed." Ninth Circuit precedent has always required an information and belief pleading to allege with particularity the facts upon which the pleader's belief was based, holding that the Rule 9(b) requirement is met where, as here, a complaint specified the challenged statements by date, speaker and content, and by pleading why they were false. Diamond Defendants contend, however, that the PSLRA requires more; they contend that plaintiffs must plead the sources of the facts that support the Complaint. But the PSLRA does not require the pleading of "sources." Instead, its states that information and belief allegations are to be supported by "facts." 15 U.S.C. §78u-4(b)(1). Accordingly, defendants cannot force plaintiffs to reveal their informants who have asserted facts to support plaintiffs' allegations.⁽⁸⁾

Diamond Defendants' formulation is fundamentally unworkable. A plaintiff's knowledge in an open market securities fraud suit necessarily will come from such sources as industry experts, competitors, customers, suppliers, and present and former employees, because it is impossible for a plaintiff to have personal knowledge of what went on inside the corporation. Indeed, in Wool v. Tandem Computers, Inc., 818 F.2d 1433, 1439 (9th Cir. 1987), the Ninth Circuit recognized that "in cases of corporate fraud, the plaintiffs cannot be expected to have personal knowledge of the facts constituting the wrongdoing." (Quotation & citations omitted.) The Wool court held that information and belief allegations must be sustained "if the allegations are accompanied by a statement of the facts upon which the belief is founded." Id.; accordConcha v. London, 62 F.3d 1493, 1503 (9th Cir. 1995), cert. dismissed, 116 S. Ct. 1710 (1996). Section 21D(b)(1) of the Securities Exchange Act of 1934 (the "Exchange Act"), tracks Wool's language requiring a complaint to state the "facts upon which that belief is founded." See 15 U.S.C. §78u-4(b)(1). Under this standard, information and belief allegations are adequate if "[e]ach alleged misstatement is identified by content, date, and the document or announcement in which it appeared," and "the manner in which such representations were false and misleading." Wool, 818 F.2d at 1439-40. The Complaint satisfies the Ninth Circuit's and the PSLRA's information and belief pleading standard, because it sets forth each misrepresentation, what was said, when it was said, who said it, and why the statements were misleading. 

B. The Complaint Properly Pleads Scienter

1. The PSLRA Did Not Jettison Recklessness Or "Motive And Opportunity" As Means To Plead Scienter

In Marksman Partners, L.P. v. Chantal Pharm. Corp., 927 F. Supp. 1297 (C.D. Cal. 1996), defendants argued, as do Diamond Defendants, that a Conference Report footnote demonstrates that Congress discarded the motive and opportunity test. Id. at 1310-11; Def. Mem. at 5.⁽¹¹⁾ Judge Rea, after a comprehensive analysis, was "unimpressed," however, with what the court termed an "oblique reference to 'motive, opportunity and recklessness'" as support for defendants' proposition that the motive and opportunity test was jettisoned:

The footnote, embedded as it is in the legislative history and not the body of the statute, implies that Congress chose not to codify motive and opportunity as pleading requirements but does not indicate that Congress chose to specifically disapprove the motive and opportunity test. The Court has little doubt that when Congress wishes to supplant a judicially-created rule it knows how to do so explicitly, and in the body of the statute.

The Chantal court also weighed the practical application of the motive and opportunity test, determining that any fears that application of the test would subvert Congress's intent to constrain meritless securities lawsuits were ill-founded; Judge Rea noted, for example, that courts applying the motive and opportunity test were unpersuaded with so-called generic allegations of motive. 927 F. Supp. at 1310. The court concluded, therefore, that the test "appears to be consistent with Congress's intent that scienter be pled with more than conclusory or generic allegations," and that the motive and opportunity test did not "present a barrier to the achievement of Congress's clear purpose of making scienter allegations more difficult to plead." Id. at 1310-11 (citation omitted). Judge Rea found the test to be an "exacting analysis," that is "wholly consistent with the PSLRA's standard." Id. (citation omitted). The Chantal court thus held that

there is no basis to conclude that Congress eradicated, sub silentio, the well-established "motive and opportunity" test for examining scienter pleadings in Section 10(b) and Rule 10b-5 cases. Because Second Circuit jurisprudence in the area of securities fraud claims is wholly consistent with both the language and purpose of the PSLRA, the Court finds the "motive and opportunity" test to be a suitable standard to employ in this case.

The Chantal court also expressly rejected, on several additional grounds, defendants' argument that recklessness had been supplanted as a standard of liability under the federal securities laws. 927 F. Supp. at 1309 n.9. Most significantly, the court dismissed as making little sense defendants' argument that Congress's intent to strengthen pleading requirements necessarily must result in a change to the nature of the scienter required. Id. That determination is on all fours with the position expressed by the Securities and Exchange Commission ("SEC") in an amicus brief it deemed necessary to submit in In re Silicon Graphics, Inc. Sec. Litig., No. C 96-0393 FMS (N.D. Cal. Jan. 31, 1997),⁽¹³⁾ concerning the defendants' pending motion to dismiss the amended complaint. The SEC urged the court to recognize that the PSLRA's express terms only purport to establish a standard for pleading and do not address, much less alter, the substantive element intend to codify the Second Circuit standard." Silicon Graphics, ¶99,325, at 95,962. However, what the Conference Report actually says, and what the Chantal court recognized, is that the Conference Committee did not intend to codify the case law interpreting the standard; the Conference Report makes no negative reference to the standard itself. Conference Report at 41. This misconception about the Conference Report footnote and related text led to the Silicon Graphics court's ill-founded conclusion: "Because Congress chose not to include that language from the Second Circuit standard relating to motive, opportunity, and recklessness, Congress must have adopted the Conference Committee view and intended that a narrower first prong apply." Silicon Graphics, ¶99,325, at 95,962.

The Silicon Graphics decision is wrong for a variety of reasons. See John C. Coffee, Jr., The Future of the Private Securities Litigation Reform Act: Or, Why the Fat Lady Has Not Yet Sung, 51 Bus. Law. 975, 977-85 (1996); Michael A. Perino, A Strong Inference of Fraud? An Early Interpretation of the 1995 Private Securities Litigation Reform Act, 1 Sec. Reform Act Litig. Rep. 397, 402-05 (1996). First, the court rejected plaintiff's logical argument, founded upon the proportionate liability provisions of the PSLRA, which restrict joint and several liability only to those defendants who "knowingly committed a violation of the securities laws," 15 U.S.C. §78u-4(g)(2)(A), that Congress would not have distinguished knowing conduct from non-knowing conduct for the application of joint and several liability if it had already eliminated liability for recklessness. Silicon Graphics, ¶99,325, at 95,963. The court's illogic was then exacerbated by its reliance on the PSLRA-added safe harbor provisions for forward-looking statements, which require, among other things, that complaints asserting claims based upon forward-looking statements allege that those statements were made with actual knowledge. Id. (citing 15 U.S.C. §78u-5(c)(1)(B)). The court, after acknowledging this tough standard, concluded that "[t]his standard applies whether the statements in question are forward-looking or not." Id. But the court ignored, just as it had in interpreting the PSLRA's proportionate liability provisions, that its interpretation would render those very safe harbor provisions, which were a significant component of the PSLRA, pure surplusage: Congress would not have had to single out forward-looking statements for special "safe harbor" treatment in order to encourage such disclosures if, as the Silicon Graphics court held, the PSLRA had already required the pleading of actual knowledge, as opposed to recklessness, to assert liability even for violations based misrepresentations or omissions of historical facts. The court's interpretations thus run counter to the well-established rule that meaning should be attributed to each subsection of a statute. E.g., United States v. Morton, 467 U.S. 822, 828 (1984); see also 2A Norman Singer, Sutherland on Statutory Construction §46.06, at 104 (5th ed. 1992)("A statute should be construed so that effect is given to all of its provisions, so that no part will be inoperative or superfluous, void or insignificant.").

Most importantly, the Silicon Graphics court ignored the practical implications of its decision. Nowhere in the Silicon Graphics opinion is there any explanation of how the court's newly articulated "only actual knowledge" standard would affect the initiation of private securities lawsuits. Such a standard certainly would eliminate the initiation of countless meritorious lawsuits in which the plaintiff could not allege actual knowledge. This concern was recognized in Chantal, and well-articulated in Rehm:

Ratcheting up the standard to conform with the stringent Second Circuit test satisfies Congress'[s] goal of curtailing abusive securities litigation, see Conf. Rep. at 32, while still leaving room for aggrieved parties to bring valid securities fraud claims. To impose a higher pleading standard would make it extremely difficult to sufficiently plead a 10b-5 claim--an outcome which would certainly be contrary to the broad remedial purposes of the federal securities laws.

The Commission has consistently supported a recklessness standard for Section 10(b) liability . . . because such a standard is needed to protect investors and the securities markets from fraudulent conduct and to protect the integrity of the disclosure process. A higher scienter standard would lessen the incentives for corporations to conduct a full inquiry into potentially troublesome or embarrassing areas, and thus would threaten the process that has made our markets a model for nations around the world.

The recklessness standard discourages deliberate ignorance and also prevents defendants from escaping liability simply because of the difficulty of proving knowledge or conscious intent on the basis of the circumstantial evidence frequently used in securities fraud cases. A retreat from the recklessness standard would greatly erode the deterrent effect of Section 10(b) actions.

As the Chantal analysis demonstrates, the PSLRA did not abrogate the Second Circuit standard. Diamond Defendants' position, articulated in Silicon Graphics, is based on grounds that are far too speculative to jettison well-respected and wholly satisfactory standards. Diamond Defendants' proposed limitation on well-founded private securities lawsuits conflicts with the purpose of such actions, which, as acknowledged by Congress, "promote public and global confidence in our capital markets and help to deter wrongdoing and to guarantee that corporate officers, auditors, directors, lawyers and others properly perform their jobs." Conference Report at 31.⁽¹⁶⁾

2. The Complaint Satisfies The PSLRA's Scienter Pleading Standards

a. The Complaint Alleges Motive And Opportunity

A common way to sufficiently allege motive to commit securities fraud is to plead, as the Complaint does, "that a corporate insider either presented materially false information, or delayed disclosing materially adverse information, in order to sell personally-held stock at a huge profit." Chantal, 927 F. Supp. at 1312 (citing Acito v. IMERCA Grp., Inc., 47 F.3d 47, 54 (2d Cir. 1995).⁽¹⁸⁾ Here, the Complaint alleges that, during the Class Period, the Individual Defendants made material misrepresentations to artificially inflate the market price of Diamond's stock in order to sell significant amounts of their holdings.⁽¹⁹⁾

The Complaint also properly pleads motive respecting the Secondary Offering. False information was disseminated, and adverse information was withheld, by, or on behalf of, Diamond, so that it could obtain over $94 million, and the Individual Defendants could obtain over $12.2 million, from the Secondary Offering. See Fecht, 70 F.3d at 1084 (corporate offering of securities and insider sales demonstrated circumstantial evidence defendants knew or had reason to know that financial condition of the Company was deteriorating well before they disclosed problems). 

b. The Complaint Alleges Circumstantial Evidence Of Conscious Or Reckless Behavior

C. The Complaint Properly Pleads False Statements To Analysts

In Cirrus, like here, defendants argued that plaintiffs' allegations, which set forth with particularity many of the misleading analysts' reports that either repeated, or were based upon, defendants' false statements to analysts (¶¶47, 51, 54, 59, 63), were insufficient, because plaintiffs did not plead that defendants had adopted those reports. The court observed that

Defendants confuse the test under which they can be held indirectly liable for misleading opinions or statements by analysts or other third parties with the test under which they can be held directly liable for their own misleading statements to analysts. Defendants "cannot escape liability simply because [they] carried out [their] alleged fraud through the public statements of third parties."

A company may not lie to securities analysts and avoid liability for its misrepresentations by refusing to adopt the analyst reports incorporating the misrepresentations. If a company chooses to speak to the market on a subject, through an analyst or otherwise, it is obligated to make a full and fair disclosure to ensure that its statements are not materially misleading.

D. The Complaint Properly Pleads Defendants' Liability For False Statements

E. The Complaint Pleads Actionable Misrepresentations

Diamond Defendants argue that misrepresentations respecting the strength of demand for Diamond's products are immaterial, because they are no more than "puffing." But the "puffing" defense as advanced by defendants would amount "to a seller's privilege to lie his head off, so long as he says nothing specific, on the theory that no reasonable man would believe him, or that no reasonable man would be influenced by such talk."⁽²⁷⁾ Misleading statements such as statements that there is a "strong demand" or a "solid demand" for Diamond's products purport to be statements of current fact that are of obvious importance to investors and thus are actionable. Warshaw, 74 F.3d at 959 (statement that "everything [was] going fine" held actionable); Kaplan v. Rose, 49 F.3d 1363, 1375-76 (9th Cir. 1994)(representations that products were successful, its competitive position remains "strong," "[p]rogress is excellent," and "outlook is bright"), cert. denied, ___ U.S. ___, 116 S. Ct. 58 (1995); Hanon v. Dataproducts Corp., 976 F.2d 497, 501 (9th Cir. 1992) ("general expressions of optimism may be actionable under the federal securities laws")(quoting In re Apple Computer Sec. Litig., 886 F.2d 1109, 1113 (9th Cir. 1989)).

In this case, plaintiffs allege that defendants represented that because Diamond was experiencing such a "strong," "solid" demand for its products, revenues would continue to grow. At the same time the defendants knew this to be false, because, to create the appearance of "strong" demand, they were secretly providing extremely liberal rights of return to customers (not the "limited" rights defendants claim were adequately disclosed), they were engaging in specifically alleged accounting abuses resulting in dramatic overstatements of income, and the products upon which their highly positive statements of growth were based were themselves plagued with serious problems, detailed by plaintiffs that were bound to foreclose success.⁽²⁸⁾

F. The Defendants Are Not Saved From Liability For Their Wrongful Conduct By Any Safe Harbor

defendants are liable for [statements deemed to be forward-looking] because at the time each of those statements was made, the speaker knew the statement was false and the statement was authorized and/or approved by an executive officer of Diamond who knew that those statements were false when made.

Diamond Defendants also ignore that, as the Complaint alleges, the safe harbor "does not apply to any of the allegedly false statements pleaded in th[e] Complaint," because "[n]one of the statements pleaded [in the Complaint was] identified as 'forward looking statements' when made," and because those statements were not "accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from the statements made." ¶33; see 15 U.S.C. §78u-5(c)(1)(A)(i).⁽³⁰⁾

G. The Defendants Are Not Saved By The Bespeaks Caution Doctrine

To avail themselves of supposed "cautionary" language in documents other than those in which misrepresentations were made, defendants bear the burden of establishing the "truth-on-the-market" defense. They must "prove that the information that was withheld or misrepresented" in specific documents was nonetheless "'"transmitted to the public with a degree of intensity and credibility sufficient to effectively counterbalance any misleading impression created by insider's one-sided representations."'" Provenz, 102 F.3d at 1492-93 (quoting Kaplan, 49 F.3d at 1376 (quoting Apple Computer, 886 F.2d at 1116)). This is an affirmative defense on which "[t]he defendants bear a heavy burden of proof." Provenz, 102 F.3d at 1493.⁽³¹⁾

Moreover, "inclusion of some cautionary language in a company's disclosures is 'not enough to support a determination as a matter of law that defendants' statements were not misleading.'" Warshaw, 74 F.3d at 959 (quoting Fecht, 70 F.3d at 1081). Cautionary language is sufficient only if it completely discredits the allegedly misleading statements so that "the risk of real deception drops to nil." Virginia Bankshares v. Sandberg, 501 U.S. 1083, 1097 (1991); accord SEC v. Rana Research, Inc., 8 F.3d 1358, 1363 (9th Cir. 1993). The statements must be "precise and directly address[ ] . . . the [defendants'] future projections,"; "[b]lanket warnings that securities involve a high degree of risk [are] insufficient to ward against a federal securities law claim." Provenz, 102 F.3d at 1493 (quotation omitted).

Here, the so-called "risk disclosures" cited by Diamond Defendants either are mere boilerplate, and thus not meaningfully cautionary, or do not address the misrepresentations alleged in the Complaint. The "risk disclosures" quoted from Diamond's Prospectus and Form 10-Km simply identify generic industry-wide possibilities as "risks" -- "pressure on revenues, earnings and margins, including price pressure, competition and rapid product obsolescence," Def. Mem. 12 -- but never purport to warn that, throughout the Class Period, (i) the Company's financial controls were woefully inadequate, (ii) the defendants overstated Diamond's runaway excess and obsolete inventory, (iii) revenue was prematurely recognized, or (iv) Diamond was suffering critical design and production problems with the very products on which defendants' projections of growth depended. Thus, the bespeaks caution doctrine is inapplicable.⁽³²⁾

IV. CONCLUSION

Respectfully submitted,

April 7, 1997

__________________________
MARK SOLOMON

MILBERG WEISS BERSHAD
HYNES & LERACH LLP
ALAN SCHULMAN
MARK SOLOMON
SALLIE A. BLACKMAN
600 West Broadway, Suite 1800
San Diego, CA 92101
Telephone: 619/231-1058

MILBERG WEISS BERSHAD
HYNES & LERACH LLP
JOHN K. GRANT
222 Kearny Street, 10th Floor
San Francisco, CA 94108
Telephone: 415/288-4545

ABBEY, GARDY & SQUITIERI, LLP
JILL S. ABRAMS
JAMES J. SEIRMARCO
212 East 39th Street
New York, NY 10016
Telephone: 212/889-3700

BERNSTEIN LITOWITZ BERGER &
GROSSMANN LLP
DANIEL L. BERGER
JEFFREY N. LEIBELL
1285 Avenue of the Americas
33rd Floor
New York, NY 10019
Telephone: 212/554-1400

Attorneys for Lead Plaintiffs
and the Class

DIAMOND\HAW00295.BRF

I, the undersigned, declare:

1. That declarant is and was, at all times herein mentioned, a citizen of the United States and a resident of the County of San Diego, over the age of 18 years, and not a party to or interested in the within action; that declarant's business address is 600 West Broadway, Suite 1800, San Diego, California 92101.

2. That on April 8, 1997, declarant served the PLAINTIFFS' MEMORANDUM OF POINTS AND AUTHORITIES IN OPPOSITION TO DIAMOND DEFENDANTS' MOTION TO DISMISS AMENDED CONSOLIDATED CLASS ACTION COMPLAINT by depositing a true copy thereof in a United States mailbox at San Diego, California in a sealed envelope with postage thereon fully prepaid and addressed to the parties listed on the attached Service List.

3. That there is a regular communication by mail between the place of mailing and the places so addressed.

I declare under penalty of perjury that the foregoing is true and correct. Executed this 8th day of April, 1997, at San Diego, California.

______________________________

MARY JO MIAL

1. The "Complaint" refers to the Amended Consolidated Class Action Complaint, cited as "¶__." Plaintiffs refer the Court to the Complaint for a full recitation of Plaintiffs' claims.

2. Diamond manufactures, markets and supplies computer products. The "Individual Defendants" are Diamond's Chairman, Chong-Moon Lee ("Lee"); its President and CEO, William J. Schroeder ("Schroeder"); Hyung Hwe Huh ("Huh"), Sr. V.P. and Chief Technical Officer of Diamond; and Gary B. Filler ("Filler"), Sr. V.P. and CFO of Diamond. "Diamond Defendants" refers collectively to Diamond, Schroeder, Huh and Filler. ¶26(c)-(e).

3. ViperPro Video, for example, operated well with Windows 3.1 and Windows 3.11, but it was an older product (first introduced in September 1994) that the Company did not support for Windows95; in addition, ViperPro's use of a P9130 Vietek processor necessarily made the driver support difficult for Windows95. ¶74.

4. For example, Diamond had to blindly estimate the quantity of chips on hand, because significant amounts of DRAM and VRAM chips were delivered to Diamond from Rockwell with little monitoring of the volumes received and returned. ¶77.

5. It has come to the attention of plaintiffs that a former employee of Diamond, Adel Habib, way back in December of 1995, filed a verified complaint against Diamond (followed by an amended verified complaint filed in June 1996) in which he alleges, upon penalty of perjury, that Diamond, Schroeder and various other Diamond executives deliberately misled investors concerning the status of "Motion Video Player," Stealth and the ISDN devices immediately before the beginning of the Class Period. Exhibit 1 to the Declaration of Sallie A. Blackman ("Blackman Decl."), filed concurrently herewith. Plaintiffs request that the Court take judicial notice of these pleadings.

6. These statements to analysts, as well as those alleged elsewhere in the Complaint, were disseminated by those analysts to the market where they became part of the total mix of information affecting Diamond's stock price. ¶¶48, 51, 59. The Complaint details, for each such representation, the firm and the analyst to whom the representation was made, the date of each report, and, to the extent possible at this stage, which Individual Defendant made the representation.

7. On a 12(b)(6) motion, plaintiffs' allegations must be accepted as true. Conley v. Gibson, 355 U.S. 41, 45-48 (1957) ("a complaint should not be dismissed for failure to state a claim unless it appears beyond doubt that the plaintiff can prove no sets of facts in support of his claim which would entitle him to relief"); NOW, Inc. v. Scheidler, 510 U.S. 249 (1994).

8. Defendants' requirement would expose plaintiffs' informants to retaliation, and compel the revelation of protected work-product. In fact, such disclosures would operate at cross purposes with the PSLRA's goals by discouraging the very kind of thorough pre-suit investigation that Congress sought to encourage, and thus undermine the presentation of meritorious cases. If we have made sufficient allegations but without the "inquiry reasonable under the circumstances" required by Rule 11, the proper remedy is to sanction us after the Court's mandatory Rule 11 inquiry under the PSLRA after the final adjudication of the case, see 15 U.S.C. §78u-4(c), but not to dismiss the Complaint.

9. Diamond Defendants' Motion to Dismiss Amended Consolidated Class Action Complaint (hereinafter "Def. Mem. ___").

10. See, e.g., Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1568-69 n.6 (9th Cir. 1990) (en banc); Woods v. Barnett Bank, 765 F.2d 1004, 1010 (11th Cir. 1985)(en banc); Hackbart v. Holmes, 675 F.2d 1114, 1117-18 (10th Cir. 1982); Sharp v. Coopers & Lybrand, 649 F.2d 175, 193 (3d Cir. 1981); Stokes v. Lokken, 644 F.2d 779, 783 (8th Cir. 1981); Broad v. Rockwell Int'l Corp., 642 F.2d 929, 961-62 (5th Cir. 1981) (en banc); Mansbach v. Prescott, Ball & Turben, 598 F.2d 1017, 1024 (6th Cir. 1979); Rolf v. Blyth, Eastman Dillon & Co., 570 F.2d 38, 46 (2d Cir. 1978); Sundstrand Corp. v. Sun Chem. Corp., 553 F.2d 1033, 1044 (7th Cir. 1977).

11. H.R. Conf. Rep. No. 104-369, 104th Cong., 1st Sess., reprinted in 1995 U.S.C.C.A.N. 679 ("Conference Report"), attached as Exhibit 1 to the Declaration of Marta Cervantes in support of Defendants' Motion to Dismiss the Class Action Complaint.

12. Many courts have followed Judge Rea's careful analysis. See Zeid v. Kimberley, 930 F. Supp. 431, 437-38 (N.D. Cal. 1996) (applying motive and opportunity test); Sloane Overseas Fund, Ltd. v. Sapiens Int'l Corp, N.V., 941 F. Supp. 1369, 1377 (S.D.N.Y. 1996) (noting PSLRA codified Second Circuit standard); Fischler v. Amsouth Bancorporation, Case No. 96-1567-CIV-T-17A, 1996 U.S. Dist. LEXIS 17670, at *8-*9 (M.D. Fla. Nov. 14, 1996) (applying Second Circuit standard to deny motion to dismiss) (Blackman Decl., Ex. 2); STI Classic Fund v. Bollinger Indus., Inc., No. 3-96-CV-0823-R, Report and Recommendation of United States Magistrate Judge and Order (N.D. Tex. Oct. 25, 1996 and Nov. 12, 1996) (adopting Magistrate Judge's report holding that "the more persuasive interpretation of the provisions of the PSLRA is that articulated by the court in Marksman Partners") (Blackman Decl., Ex. 3 at 2); Rehm v. Eagle Fin. Corp., Case No. 96-C-2455, 1997 U.S. Dist. LEXIS 767, at *18, (N.D. Ill. Jan. 27, 1997) (denying motion to dismiss; Second Circuit rule "best comports with the language, history, and purpose of the PSLRA") (Blackman Decl., Ex. 4).

13. Brief of the SEC, Amicus Curiae, Concerning Defendants' Motion to Dismiss the Amended Complaint ("SEC Brief"). (Blackman Decl., Ex. 5).

14. There is no need to consider the PSLRA's legislative history. See Hearn v. Western Conf. of Teamsters Pen. Trust Fund, 68 F.3d 301, 304 (9th Cir. 1995) ("Where the statute's language 'can be construed in a consistent and workable fashion,' we must put aside contrary legislative history.") (quoting Valentine v. Mobil Oil Corp., 789 F.2d 1388, 1391 (9th Cir. 1986)). But even if the legislative history is considered, there is no basis for Diamond Defendants', or the court's position in In re Silicon Graphic, Inc. Sec. Litig., [1996-1997 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶99,325, at 95,957 (N.D. Cal. Sept. 5, 1996). As the Chantal court observed, Congress, through the explanations provided in the Conference Report, acknowledged that the Second Circuit standard was the most stringent standard employed by any circuit; the court, focusing on the statutory text, noted as well that the language chosen by Congress mirrored the language used by the Second Circuit. Chantal, 927 F. the Senate Comm. on Banking, Housing, and Urban Affairs, 104th Cong., 1st Sess. 247 at 251-52 (1995) (test. of Hon. Arthur Levitt, Chmn., SEC).

16. Just two courts have followed Silicon Graphics, see Powers v. Eichen, Case No. Civil 96-1431-B (AJB) (S.D. Cal. March 13, 1997) and Bruce Friedberg v. Discreet Logic, Inc., No. 96-11232-EFH (D. Mass. March 7, 1997) (Blackman Decl., Ex. 8). In each case, however, although the courts made the mistake of holding that the legislative history establishes that recklessness as has been jettisoned, the complaints, containing allegations less detailed than here (and no allegations of false financial statements), each were sustained in their entirety under a "knowing" standard.

17. Opportunity "entail[s] the means and likely prospect of achieving concrete benefits by the means alleged." Shields, 25 F.3d at 1130.

18. Accord Fecht v. Price Co., 70 F.3d 1078, 1084 (9th Cir. 1995), cert. denied, 116 S. Ct. 1422 (1996); In re Apple Computer Sec. Litig., 886 F.2d 1109, 1117 (9th Cir. 1989); Deutsch v. Flannery, 823 F.2d 1361, 1365 & n.3 (9th Cir. 1987); In re Gupta Corp. Sec. Litig., 900 F. Supp. 1217, 1231 (N.D. Cal. 1994).

19. During the Class Period, Schroeder, Filler and Huh sold $2.4 million, $2.6 million and $3.1 million, or almost 10%, more than 30%, and more than 20%, respectively, of their Diamond stock. See ¶90.

20. A violation of SFAS 48, which is just one of the GAAP violations alleged in the Complaint, "can constitute one basis for a finding of scienter." Chantal, 927 F. Supp. at 1313 (citing Malone v. Microdyne Corp., 26 F.3d 471, 478-79 (4th Cir. 1994)).

21. It is implausible that Diamond's top executives were unaware of accounting abuses at the highest levels or of serious production problems with their most important products, such as the Company's Stealth and Edge products, as well as of the problems with Diamond's SPEA acquisition. See Cosmas v. Hassett, 886 F.2d 8 (2d Cir. 1989); Cohen, 25 F.3d at 1174.

22. E.g., Provenz v. Miller, 102 F.3d 1478, 1487-88 (9th Cir. 1996) (liability predicated on "conference call with market analysts" in which a corporate officer projected "'higher technology revenue performance . . . for the total year'"); Fecht, 70 F.3d at 1080 (claims stated based on various public statements--either prepared by the Company itself or by securities analysts with the approval and guidance of the Company); Cirrus, 946 F. Supp. at 1466-67; Simon v. American Power Conversion Corp., 945 F. Supp. 416, 429-30 (D.R.I. 1996).

23. Thus, in In re Stac Elec. Sec. Litig., 82 F.3d 1480 (9th Cir. 1996), and In re Syntex Corp. Sec. Litig., 855 F. Supp. 1086 (N.D. Cal. 1994), aff'd, 1996 U.S. App. LEXIS 24116 (9th Cir. 1996), only after holding defendants made no misleading statements themselves, did the court conclude that liability for third-party statements in those cases would require adoption. The Court did not consider the theory pled by plaintiffs here, that the Individual Defendants are liable for their own misstatements to analysts. See Cirrus, 946 F. Supp. at 1467 n.13. In any event, although Diamond Defendants ignore it, plaintiffs have pled adoption -- that defendants specifically adopted the January 18, 1996 reports of Donaldson, Lufkin & Jenrette ("DLJ") and Montgomery Securities (¶51) -- with all the particularity required by recent decisions in this Circuit.

24. Defendants are liable, even if they did not make any misleading statements, under the long-recognized abstain or disclose doctrine, because they each sold Diamond stock during the Class Period while in possession of material adverse non-public information. Chiarella v. United States, 445 U.S. 222, 230 (1980) ("Application of a duty to disclose prior to trading guarantees that corporate insiders . . . will not benefit personally through fraudulent use of material non-public information."); Dirks v. SEC, 463 U.S. 646, 654 (1983) (same); Feldman v. Simkins Indus., Inc., 679 F.2d 1299, 1303-04 (9th Cir. 1982) (same).

25. Defendants claim that the Complaint fails to distinguish statements made by Schroeder and Filler. Defendants ignore the allegations in ¶¶40 and 53 and they ignore the group pleading presumption to be applied at the pleading stage. Courts do not require plaintiffs 'to pinpoint precisely who uttered the statements' before the parties begin discovery." In re AnnTaylor Stores Sec. Litig., 807 F. Supp. 990, 1004 (S.D.N.Y. 1992). See Devany v. Chester, 813 F.2d 566, 569 (2d Cir. 1987) ("the degree of particularity required should be determined in light of such circumstances as whether the plaintiff has had an opportunity to take discovery"); Bernstein v. Crazy Eddie, Inc., 702 F. Supp. 962, 976 (E.D.N.Y. 1988) (same).

26. "[W]hether a public statement is misleading, or whether adverse facts were adequately disclosed is a mixed question to be decided by the trier of fact." Fecht, 70 F.3d at 1080-81 (collecting cases).

27. W. Page Keeton, et al., Prosser and Keeton on the Law of Torts §109, at 757 (5th ed. 1984). In securities cases "'there is no longer much room for judicial predilection in drawing the line between misrepresentation and "puffing"; for the "puffing" concept in the securities context has all but gone the way of the dodo.'" Flournoy v. Peyson, 701 F. Supp. 1370, 1376 (N.D. Ill. 1988) (quoting, L. Loss Fundamentals of Securities Regulation, 717 (2d ed. 1988)).

28. Diamond Defendants claim that in announcing the Company's new products they were under no duty to disclose the fundamental design and manufacturing problems being experienced is specious. An issuer of publicly-traded securities commits actionable fraud if it intentionally or recklessly misrepresents the status of its new products: Provenz, 102 F.3d at 1488-89; Hanon, 976 F.2d at 502; Apple Computer, 886 F.2d at 1113-14. Diamond Defendants also argue that their misrepresentations of demand could not have been misleading, because those misrepresentations were accompanied by actual financial results. But here, the actual financial results are themselves alleged to have been materially misleading because of among other things, Diamond's improper revenue recognition practices. The misrepresentations of demand could not have been "clarified" by any such "results," because those results do not isolate revenue for the specific products misrepresented by defendants.

29. Even without such an allegation, Diamond Defendants' argument cannot be sustained on a motion to dismiss. The provisions of the PSLRA they rely upon immunize a forward-looking statement only if a plaintiff "fails to prove that the forward-looking statement . . . was made with actual knowledge." 15 U.S.C. §78u-5(1)(B)(i) (emphasis added). On a motion to dismiss, the sufficiency of the allegations, not plaintiffs' "proof," is at issue.

30. The safe harbor does not, in any event, apply to the statements by defendants prior to the passage of PSLRA on December 22, 1995. Absent explicit congressional intent there is a presumption against retroactivity. See Landgraf v. USI Film Prods., 511 U.S. 244 (1994). The PSLRA evidences no explicit intent, in fact, it says nothing concerning conduct occurring before its enactment. See, e.g., District 65 v. Prudential Sec., 925 F. Supp. 1551, 1569-70 (N.D. Ga. 1996) (elimination of civil RICO does not apply to pre-enactment conduct); Klein v. Boyd, [1996-1997 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶99,352, at 96,160-61 (E.D. Pa. Nov. 18, 1996); Baker v. Pfeifer, 940 F. Supp. 1168, 1174-79 (S.D. Ohio 1996); In re Prudential Sec. Ltd. Partnerships Litig., 930 F. Supp. 68, 77-81 (S.D.N.Y. 1996).

31. ³¹ Whether the truth has "credibly entered the market and dissipated the effects of the misstatements," is a question of fact that requires evidence of the total mix of information in the market. Basic, Inc., 485 U.S. at 249 & n.29. Defendants cannot carry their burden on a motion to dismiss without affording plaintiffs an opportunity to submit evidence rebutting the defense. See id., ("[p]roof of that sort is a matter for trial"); Kaplan, 49 F.3d at 1378 n.3 (reversing summary judgment because "the ultimate resolution of this question is an issue for trial"); In re Taxable Mun. Bonds Litig., [1994-1995 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶98,405, at 90,780 (E.D. La. 1994) ("it is a rare case in which the defendant can carry its 'staggering burden' under the truth on the market defense, particularly at the summary judgment stage"); Warshaw, 74 F.3d at 959; Fecht, 70 F.3d at 1082.

32. Plaintiffs are not suing on a guarantee. Therefore, the fact that generic "risk disclosures" provide there can be "no assurance" that adverse possibilities will not occur cannot relieve defendants of liability. A principal element of defendants' fraud was their pretense that actual adverse events or circumstances that had already transpired were instead mere possibilities. In In re Opti, Inc. Sec. Litig., No. C-95-3434-SBA (N.D. Cal. March 31, 1997) (Blackman Decl., Ex. 9), in contrast, this Court found that defendants had disclosed the actual occurrence of present, adverse facts and events.
 

22 Aug 1997