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[Web note: Page formatting approximates, but does not match exactly, that of filed paper document.]
STEVEN M. SCHATZ, State Bar # 118356 TERRY T. JOHNSON, State Bar # 121569 MARTA CERVANTES, State Bar # 139082 THOMAS J. MARTIN, State Bar # 150039 REBECCA A. MITCHELLS, State Bar # 151683 WILSON, SONSINI, GOODRICH & ROSATI Professional Corporation 650 Page Mill Road Palo Alto, California 94304-1050 Telephone: (415) 493-9300 Attorneys for Defendants WILLIAM J. SCHROEDER, GARY B. FILLER, HYUNG HWE HUH and DIAMOND MULTIMEDIA SYSTEMS, INC. SUPERIOR COURT OF CALIFORNIA COUNTY OF SANTA CLARA JOANNE PASS, On Behalf of Herself ) CONSOLIDATED CLASS and All Others Similarly Situated, ) ACTIONS ) Plaintiff, ) CV758927; CV759012 and ) CV759270 v. ) ) MEMORANDUM ) SUPPORTING HYUNG HWE HUH, et al., ) DEFENDANTS' MOTION TO ) STAY PROCEEDINGS Defendants. ) ) DATE: November 12, 1996 ) TIME: 9:00 a.m. ____________________________________) DEPT: 17 I. INTRODUCTION To evade recently enacted requirements of the federal securities laws, securities fraud plaintiffs have adopted a strategy of two-track litigation. One case is filed in federal court, asserting federal securities law claims over which the federal courts have exclusive jurisdiction, along with pendent state claims. At the same time, another case is filed in California state court, allowing plaintiffs to skirt the procedural and discovery restrictions of federal law. This situation has arisen because of the enactment of recent reforms to the federal securities laws. The new provisions require stays of discovery while a motion to dismiss the complaint is pending. This rule was designed to stop the abusive practice of
filing vague securities fraud allegations, and using those claims as a license for broad-ranging discovery in the hope of discovering facts sufficient to survive federal pleading standards. Because California has no such automatic discovery stay while the pleadings are tested, securities fraud plaintiffs have adopted the approach of filing a state court action and using it to undertake the discovery that is not allowed in federal court. Thus, securities fraud plaintiffs try to get the best of both worlds -- the advantages of federal claims and the benefits of state court discovery. In this case, plaintiffs filed three virtually identical actions in state court and launched a barrage of extensive discovery before the three actions had even been consolidated. Meanwhile, another plaintiff filed an action in federal court. Discovery in that action is stayed consistent with the provisions of the new federal law. Plaintiffs here are using this action to evade the stay of discovery mandated in the federal case, subjecting defendants to the burden and expense that Congress sought to stop. But this legal maneuvering raises the specter of inconsistent rulings, since the state and federal actions involve the same defendants, nearly identical plaintiff classes and the same alleged wrongful conduct. This Court should exercise its discretion to stay these consolidated actions pending resolution of the federal case and thereby prevent these inconsistencies and abusive practices.1 II. BACKGROUND The plaintiffs in the consolidated state actions seek to represent a nationwide class of stock purchasers who bought stock in defendant Diamond Multimedia Systems, Inc. ("Diamond") from October 26, 1995 through June 20, 1996. State Complaint at ¶ 11.2 Along with Diamond, the defendants are Diamond officers Huh, Schroeder, and Filler, and Director Lee. The asserted wrongful conduct includes allegedly false statements relating to Diamond's products, inventory and forecasts. Plaintiffs allege violations of the California securities laws, Cal. Corp. Code §§ 25400, 25500, and fraud and deceit as codified by Civil Code §§ 1709 and 1710. ____________________ 1 This motion is made in the alternative to defendants' Demurrer and Motion to Strike, filed September 16, 1996, and defendants' Motion to Stay Merits Discovery, filed September 20, 1996. 2 The three state complaints are virtually identical and are collectively referred to as "State Complaint." -2-
As was noted in the Notice of Related Case previously filed by defendants, the federal case, Frazier v. Diamond Multimedia Systems, Inc. et al., was filed July 24, 1996 in the United States District Court for the Northern District of California.3 It is brought on behalf of a nationwide class of purchasers of Diamond stock from November 1, 1995 through June 20, 1996. Federal Complaint at ¶ 13. As in the state actions, the defendants are Diamond and its officers Huh, Schroeder, and Filler and Director Lee. The asserted wrongful conduct in the federal case is the same as in the state actions. Relief is sought in federal court for alleged violations of the federal securities laws, and for fraud, deceit and negligent misrepresentation under California law. III. ARGUMENT A. THE COURT MAY STAY THE CONSOLIDATED STATE ACTIONS PENDING RESOLUTION OF THE FEDERAL ACTION IN THE INTERESTS OF JUSTICE AND JUDICIAL ECONOMY The Court may stay these consolidated actions in favor of another forum "in the interest of substantial justice." Cal. Civ. Proc. Code § 410.30(a). "Granting a stay in a case where the issues in two actions are substantially identical is a matter addressed to the sound discretion of the trial court." Thomson v. Continental Ins. Co. (1967) 66 Cal.2d 738, 746. In particular, "[i]t is black letter law that, when a federal action has been filed covering the same subject matter as is involved in a California action, the California court has the discretion but not the obligation to stay the state court action." Caiafa Prof. Law Corp. v. State Farm Fire & Cas. Co. (1993) 15 Cal.App.4th 800, 804 (citing Thomson, 66 Cal.2d at 748; Farmland Irr. Co. v. Dopplmaier (1957) 48 Cal.2d 208, 215). B. A STAY OF THE CONSOLIDATED STATE ACTIONS SHOULD BE GRANTED PENDING RESOLUTION OF THE SUBSTANTIALLY IDENTICAL FEDERAL COURT PROCEEDING In assessing the propriety of a stay, California courts consider several factors: • "the importance of discouraging multiple litigation designed solely to harass an adverse party"; • the importance "of avoiding unseemly conflicts with the courts of other jurisdictions"; ____________________ 3 Class Action Complaint, Frazier v. Diamond Multimedia Systems, Inc. et al., No. C962644SBA (N.D.Cal. July 24, 1996) ("Federal Complaint"), attached as Ex. A to the Declaration of Rebecca A. Mitchells, filed herewith. -3-
• "whether the rights of the parties can best be determined by the court of the other jurisdiction because of the nature of the subject matter, the availability of witnesses or the stage to which the proceedings in the other court have already advanced"; and, • whether "the federal action is pending in California . . . ." Caiafa Prof. Law Corp., 15 Cal.App.4th at 804 (quoting Farmland Irr. Co., 48 Cal.2d at 215; Thomson, 66 Cal.2d at 747); see also Simmons v. Superior Court (1950) 96 Cal.App.2d 119, 125 (these premises guide the court "to avoid a multiplicity of suits and prevent vexatious litigation, conflicting judgments, confusion and unseemly controversy between litigants and courts"). Consideration of these factors dictates that judicial economy and the interests of justice are better served by staying the state consolidated actions pending resolution of the federal proceeding. A stay will promote the efficient resolution of the claims, since multiple actions take a greater toll on the parties' and the courts' resources, and might also result in conflicting rulings. 1. A Stay Will Prevent Waste of Resources and Unfair Burden on the Defendants Caused by Concurrent Litigation Involving Substantially Identical Parties and Issues Concurrent litigation of the state and federal actions unfairly burdens the defendants and wastes judicial resources. Accordingly, an action should be stayed where the parties and issues are "substantially identical" to those in another action. Farmland, 48 Cal.2d at 215. "'It is the policy of the law to reduce to the minimum the number of actions which may subsist between the same parties.'" Simmons, 96 Cal.App.2d at 130 (citation omitted). The defendants are identical in both these consolidated cases and the federal action. Also, it is beyond question that the class plaintiffs seek to represent (a nationwide class who purchased Diamond stock from October 26, 1995 through June 20, 1996) is "substantially identical" to the class the federal plaintiff seeks to represent (a nationwide class who purchased Diamond stock from November 1, 1995 through June 20, 1996). Likewise, the factual allegations and the nature of the claims in the consolidated state actions and federal action are substantially identical. Plaintiffs in both forums claim that the defendants made false and misleading statements causing plaintiffs to purchase Diamond stock at allegedly artificially inflated prices. Both the federal proceeding and these actions seek relief for alleged fraud and deceit under California law. The state actions allege violations of state securities laws; the federal action alleges violations of the federal securities law based on -4-
exactly the same legal theory and the same alleged facts, i.e., that the defendants knowingly or recklessly made false and misleading statements that deceived the investors as to the value of Diamond stock. Because these factual questions are the crux of both cases, a resolution of the federal action "will be determinative of all issues" included in the state court action. See Simmons, 96 Cal.App.2d at 128. As the California Supreme Court warned: [A] litigant may not, by eliminating or failing to plead related claims arising out of the same circumstances, evade the substantial identity rule. . . . the rules on staying an action would be almost meaningless if the plaintiff could automatically avoid a stay by juggling the pleadings and amending a particular claim in the jurisdiction where he did not wish to have the dispute tried. Thomson, 66 Cal.2d at 746, n. 5. Moreover, federal securities law cases are persuasive authority in the interpretation of California's corporate securities laws. See, e.g. People v. Figueroa (1986) 41 Cal.3d 714, 727. These considerations render the factual and legal issues "substantially identical." While the parties and issues are substantially identical, the differences between the procedures for federal and state discovery rest an unfair burden on defendants litigating in both forums. First, Federal Civil Procedure Rule 26(d) imposes a mandatory stay of discovery prior to an initial "meet and confer" conference among the parties. 28 U.S.C.A. § 26(d) (1996). California has no such rule. Second, the Private Securities Litigation Reform Act of 1995 ("Reform Act") requires a mandatory stay of discovery in federal securities class actions while a motion to dismiss is resolved. Pub.L.No. 104-67; see also H.R. Rep. 104-369, 104th Cong., 1st Sess. § 101(b) (Nov. 1995) (adding § 21D(b)(3)(B) to the federal Securities Exchange Act, which requires that "[i]n any private action arising under this title, all discovery and other proceedings shall be stayed during the pendency of any motion to dismiss . . . "). Through this provision, Congress sought to eliminate lawsuits that "force innocent parties to settle frivolous securities class actions" through the threat of costly discovery. Joint Explanatory Statement of the Committee of Conference, H.R. Rep. 104-369, 104th Cong., 1st Sess. 37 (Nov. 28, 1995). Congress also sought to remedy the type of abusive practices discussed earlier, whereby "discovery in securities class actions often resembles a 'fishing expedition' in which plaintiffs file suit in the hopes of later discovery of facts that would support a viable cause of action." Id.; see also Blue Chip Stamps v. Manor Drug Stores (1975) 421 U.S. 723, 741 (observing that discovery in -5-
securities class actions "permits a plaintiff with a largely groundless claim to simply take up the time of a number of other people, with the right to do so representing an in terrorem increment of the settlement value, rather than a reasonably founded hope that the process will reveal relevant evidence . . . ."). California has no such rule. Thus, although the Reform Act has curbed these "fishing expeditions" in federal courts, they have merely shifted to the state court forum. Defendants now face multiple actions in different forums on behalf of the same plaintiff class. One set of named plaintiffs obtains the advantages of federal substantive law, while the other set of plaintiffs attempt to avoid the federal discovery stay by seeking and obtaining discovery in the state action. While the Congressional preclusion of "fishing expeditions" has no California counterpart, a stay of these proceedings would serve California's interest in judicial economy by allowing the federal action to ferret out the groundless claims before judicial and defendant resources are wasted by burdensome and abusive discovery. A stay would promote judicial economy in all courts, reduce the risk of unfairly burdening defendants, and would deter the routine filing of parallel action in the future. 2. A Stay Precludes the Risk of Unseemly Judicial Conflicts Caused by Concurrent Litigation in Both the State and Federal Courts The virtually identical factual and legal issues involved in both the state and federal actions set the stage for inconsistent judicial findings and rulings. A stay of these actions would avert the risk of "unseemly conflicts" with the federal court. See Farmland, 48 Cal.2d at 215. As in Caiafa Prof. Law Corp., where arbitration proceedings were stayed pending resolution of a federal action, the court warned that the potential for "unseemly conflict" is great, unless both forums should reach the exact same resolution of the issues. On the other hand, if the broader federal fraud action is allowed to proceed to judgment first, it may well resolve the issues Caiafa seeks to decide through a section 2860 arbitration in the state court. In that instance, the section 2860 arbitration would be entirely unnecessary. "Unseemly conflict" will have been avoided and the interest in judicial economy well served. Caiafa Prof. Law Corp., 15 Cal.App.4th at 807. Similarly, in Schneider v. Vennard, class certification was denied in a securities fraud state action. Certification was denied, in part, -6-
because interest in judicial economy favored adjudicating a subsequently filed federal class action involving the same parties and same facts: It is undoubtedly preferrable from the point of view of the judicial system to resolve the instant dispute by one class action rather than by duplicate class actions in two jurisdictions. If two class actions were allowed to proceed simultaneously, the already overtaxed resources of two courts will have been devoted to the resolution of a single dispute. Judicial economy and efficiency would not be served by allowing both actions to proceed as class actions. Schneider v. Vennard (1986) 183 Cal.App.3d 1340, 1348. In these actions, "unseemly conflict" would arise if, for example, the courts in these proceedings differed on whether or not the defendants' statements were misleading or their conduct was fraudulent or deceitful under California law. Moreover, to the extent the classes of plaintiffs in the state and federal actions will differ the plaintiff class in these consolidated actions is only a subset of the federal class. If this case can be pursued as a class action at all, it can be pursued only on behalf of a class of California stock purchasers, rather than a nationwide class of stock purchasers as would be the case in federal court.4 Thus, while the federal action will include the members of the plaintiff class in this action, the opposite is not true. Therefore, inconsistent rulings might dispose of certain claims only as to a subset of a nationwide class. A stay of these consolidated actions would go far to fend off such unseemly conflicts. The federal court's judgment has the same collateral estoppel effect in California courts as it would in federal court. Matter of Estate of Hilton (1988) 199 Cal.App.3d 1145, 1168. Most, if not all, of the issues and claims in these state actions will be resolved by the federal action. Even if issues or claims remain after resolution of the federal case, this Court could then reach results clear of the specter of conflicting with federal rulings. 3. The Rights of the Parties Would Be Better Determined in the Federal Action A stay is called for because the rights of the parties are better determined in the federal forum. Accordingly, a federal ____________________ 4 The California securities laws under which plaintiffs seek relief require that each plaintiff purchased or sold stock "in this state." Cal. Corp. Code § 25400. Under § 25008(a), a transaction is "in this state" only where an offer to buy or sell is made or accepted in California, or the security was delivered in California and both the purchaser and the seller are domiciled in California. As argued more fully in defendants' Motion to Dismiss at Section I.A, plaintiffs have failed to allege that the members of a nationwide class fulfill this requirement. -7-
case that will resolve broader issues than those addressed in another forum distinguishes the federal court as a "better forum for deciding the full range of issues bearing on [the] subject matter." Caiafa Prof. Law Corp., 15 Cal.App.4th at 806 (arbitration of counsel fees issue stayed pending resolution of broader fraud and RICO claims asserted in federal court). In these proceedings, the federal court has exclusive jurisdiction over claims brought pursuant to the Securities Exchange Act of 1934. 15 U.S.C. § 78aa (exclusive federal jurisdiction provision). Federal judicial resolution of these claims will bear on most, if not all, of the issues raised in these proceedings. Additionally, the federal court's pendent jurisdiction over the common law fraud and deceit claims will completely address the Civil Code §§ 1709 and 1710 claims raised in these actions. Moreover, the federal court affords broader relief than is possible in state court. While it is unlikely that plaintiffs will be successful in their motion to certify anything more than a class of California purchasers of Diamond stock, the federal action asserts federal claims which may be brought on behalf of a nationwide class. Further, the state corporate law limit plaintiffs' claims to alleged misstatements made "for the purpose of inducing the purchase" of the defendants' securities. Cal. Corp. Code § 25400(d). No such restrictions apply to federal Rule 10b-5 claims. Indeed, the authors of the state corporate laws specifically drafted § 25400 to "repudiate[] . . . cases . . . in which the [federal] courts held that under Rule 10b-5 a corporation might become liable for trading losses . . . simply because it filed an allegedly false report with the [S.E.C.], although the corporation was not engaging in any market activity at the time." H. Marsh & R. Volk, Practice Under the California Corporate Securites Law of 1968, § 14.05[4], at 14-52 - 14-53 (1969). Thus, the federal action will resolve the state common law fraud claims as alleged in these proceedings, and will address the issues raised by state corporate securities law issues as part of the broader issues raised in the federal forum. While the state cases were filed first, that is not dispositive. Rather, the courts look more broadly at all of the factors discussed above, not just at the order of filing. The reasons discussed above for proceeding in federal court outweigh the earlier filing of the state court cases, and demonstrate that the state court cases should be stayed. -8-
4. Pendency of the Federal Action in California is a Critical Factor Favoring a Stay of These Actions That the federal action is in the Northern District of California is a "critical factor favoring a stay of the state court action." Caiafa Prof. Law Corp., 15 Cal.App.4th at 804 (citing Thomson, 66 Cal.2d at 747). When both the federal and state proceedings are in California, state courts are guided by a "strong policy of comity" because a stay of the state action would not cause "hardship on the plaintiff by forcing him to litigate in a distant state." Thomson, 66 Cal.2d at 747. The Northern District of California is here "of equal convenience to the parties and witnesses as is the state court." See Caiafa Prof state forum of abusive discovery "fishing expeditions" recently precluded by federal securities laws. A stay would thereby prevent an unfair burden on defendants of litigating in multiple forums under conflicting discovery procedures and of being subject to the abusive discovery tactics that the new federal rule was designed to prohibit. Respectfully submitted, Dated: September 20, 1996 WILSON SONSINI GOODRICH & ROSATI Professional Corporation /s/ By _______________________________ Terry T. Johnson Attorneys for Defendants William J. Schroeder, Gary B. Filler, Hyung Hwe Huh and Diamond Multimedia Systems, Inc. -9-