Digital Link - CASE #: 96-CV-20867

Stanford University Law School - Securities Class Action Clearinghouse

[Web note: Page formatting approximates, but does not match exactly, that of filed paper document.]

STEVEN M. SCHATZ, State Bar # 118356
TIMOTHY T. SCOTT, State Bar # 126971
THOMAS J. MARTIN, State Bar # 150039
DANIEL W. TURBOW, State Bar # 175015
WILSON, SONSINI, GOODRICH & ROSATI
Professional Corporation
650 Page Mill Road
Palo Alto, California 94304-1050
Telephone: (415) 493-9300

Attorneys for Defendants
VINITA GUPTA, DANIEL L. PALMER,
TIMOTHY K. MONTGOMERY, STANLEY E.
KAZMIERCZAK, TONI BELLIN, BENJAMIN W.
BERRY, MOREY R. SCHAPIRA, GREGORY M. AVIS,
CHARLES R. MOORE and DIGITAL LINK CORPORATION

UNITED STATES DISTRICT COURT

NORTHERN DISTRICT OF CALIFORNIA

SAN JOSE DIVISION

GEORGE GENNA, On Behalf of Himself ) CASE NO.: C-96-20867-RMW (EAI)
and All Others Similarly Situated, )
) CLASS ACTION
Plaintiff, )
) NOTICE OF MOTION AND
v. ) DEFENDANTS' MOTION TO
) DISMISS; MEMORANDUM OF
DIGITAL LINK CORPORATION, VINITA ) POINTS AND AUTHORITIES IN
GUPTA, DANIEL L. PALMER, TIMOTHY ) SUPPORT THEREOF
K. MONTGOMERY, STANLEY E. )
KAZMIERCZAK, TONI BELLIN, )
BENJAMIN W. BERRY, MOREY R. ) Date: February 21, 1997
SCHAPIRA, GREGORY M. AVIS and ) Time: 9:00 a.m.
CHARLES R. MOORE, ) Judge: The Honorable Ronald
) M. Whyte
Defendants. )
)
___________________________________)

MOT. TO DISMISS AND MEMORANDUM
IN SUPPORT THEREOF C-96-20867-RMW (EAI)

TABLE OF CONTENTS

Page

INTRODUCTION, SUMMARY OF ARGUMENT AND ISSUES TO BE DECIDED ...... 1

ARGUMENT ........................................................ 3

I. DEFENDANTS CANNOT BE HELD LIABLE FOR THE
STATEMENTS OF ANALYSTS ................................ 3

A. Defendants Cannot Be Held Liable for Analyst
Statements Without A Showing of Entanglement ..... 3

II. THE BESPEAKS CAUTION DOCTRINE AND THE RECENTLY
ENACTED PRIVATE SECURITIES LITIGATION REFORM ACT
DEMAND DISMISSAL OF THE COMPLAINT. .................... 8

A. All Defendants Other than Gupta, Kazmierczak
and Digital Link Must Be Dismissed. .............. 9

B. Defendants' Disclosures and The "Bespeaks
Caution" Doctrine Preclude Liability In
This Case ....................................... 10

1. Digital Link's Disclosures and The
Bespeaks Caution Doctrine Preclude
Liability for Statement Regarding
GateWay .................................... 11

2. Digital Link's Disclosures and The
Bespeaks Caution Doctrine Preclude
Liability for Statement Regarding
International Sales ........................ 14

C. Plaintiff Fails to Plead Particular Facts
Establishing a "Strong Inference" that
Defendants Had "Actual Knowledge" That
Their Statements Were Fraudulent. ............... 15

1. Plaintiff Must Plead Particular Facts
That Constitute A "Strong Inference"
Of Fraudulent Intent. ...................... 16

2. The New State of Mind Requirement
For Claims Based on Forward-Looking
Statements Is "Actual Knowledge." .......... 19

3. Plaintiff Fails to Comply with the New
Pleading Requirements ...................... 20
a. Plaintiff Pleads No Facts Establishing
That Defendants Knew of and
Fraudulently Omitted to Disclose
Developments in the GateWay Program. .. 20
b. Plaintiff Has Not Pleaded Facts
Creating a "Strong Inference" That
Defendants Had and Concealed "Actual
Knowledge" That Digital Link Would Be
Unable to Meet Its Fourth Quarter
Forecast .............................. 23

III. PLAINTIFF'S CLAIMS FOR RELIEF RELATED TO GATEWAY ARE
TIME-BARRED ............................................... 24

CONCLUSION ..................................................... 26

MOT. TO DISMISS AND MEMORANDUM
IN SUPPORT THEREOF C-96-20867-RMW (EAI) -i-

TABLE OF AUTHORITIES

Page(s)

CASES

Acito v. IMCERA Group, Inc.,
47 F.3d 47 (2d Cir. 1995) ........................ 17,18,19,20

Aizuss v. Commonwealth Equity Trust,
847 F. Supp. 1482 (E.D. Cal. 1993) ........................ 24

Blake v. Dierdorff,
856 F.2d 1365 (9th Cir. 1988) .............................. 7

Central Bank of Denver, N.A. v. First Interstate Bank, N.A.,
114 S. Ct. 1439 (1994) ..................................... 9

Elkind v. Liggett & Myers, Inc.,
635 F.2d 156 (2d Cir. 1980) ............................ 4,6,7

Emrich v. Touche Ross & Co.,
846 F.2d 1190 (9th Cir. 1988) ............................. 12

Franke v. Midwestern Oklahoma Dev. Auth.,
428 F. Supp. 719 (W.D. Okla. 1976) ........................ 20

Gray v. First Winthrop Corp.,
82 F.3d 877 (9th Cir. 1996) ............................... 10

Hollinger v. Titan Capital Corp.,
914 F.2d 1564 (9th Cir. 1990) ............................. 20
I. Meyer Pincus & Assocs. P.C. v. Oppenheimer & Co.,
936 F.2d 759 (2d Cir. 1991) ............................... 10

In re 1993 Corning Sec. Litig.,
No. 93 Civ. 7015 (AGS), 1996 WL 257603
(S.D.N.Y. May 15, 1996) ................................... 19

In re Caere Corp. Sec. Litig.,
837 F. Supp. 1054 (N.D. Cal. 1993) .................... 4,5,14

In re Cirrus Logic Sec. Litig.,
No. C-93-1591 WHO, slip op. at 43-44
(N.D. Cal. Nov. 1, 1996) ................................. 7,8

In re Donald J. Trump Casino Sec. Litig.,
7 F.3d 357 (3d Cir. 1993),
cert. denied, 114 S. Ct. 1219 (1994) ...................... 10

In re GlenFed Inc. Sec. Litig.,
42 F.3d 1541 (9th Cir. 1994) ............................ 7,21

In re Glenfed, Inc. Sec. Litig.,
60 F.3d 591 (9th Cir. 1995) ................................ 9

In re Kendall Square Research Corp. Sec. Litig.,
868 F. Supp. 26 (D. Mass. 1994) ............................ 9

In re MTC Elec. Tech. Shareholders Litig.,
898 F. Supp. 974 (E.D.N.Y. 1995) ........................... 9
In re Network Equip. Tech. Inc. Litig.,
762 F.Supp. 1359 (N.D. Cal. 1991) .......................... 6

In re Ross Sys. Sec. Litig.,
[1994-95 Tr. Binder] Fed. Sec. L. Rep. (CCH)
¶ 98,363, at 90,499 (N.D. Cal. Jul. 21, 1994) .... 4, 5, 6, 14

In re Sciclone Pharm. Sec. Litig.,
No. C-94-1485 SBA, slip op. at 28-29,
(N.D. Cal. May 3, 1989) ................................... 14

In re Silicon Graphics Inc. Sec. Litig.,
No. C96-0393 FMS, 1996 WL 664639
(N.D. Cal. Sept. 25, 1996) .......................... 16,21,22

MOT. TO DISMISS AND MEMORANDUM
IN SUPPORT THEREOF C-96-20867-RMW (EAI) -ii-

In re Software Publishing Sec. Litig,
[1993-94 Tr. Binder] Fed. Sec. L. Rep. (CCH)
¶ 98,094, at 98,762 (N.D. Cal. Feb. 2, 1994) ............... 4

In re Stac Elecs. Sec. Litig.,
89 F.3d 1399 (9th Cir. 1996) .................. 4,5,6,10,11,13

In re Syntex Corp. Sec. Litig.,
855 F. Supp. 1086 (N.D. Cal. 1994),
aff'd, 95 F.3d 922 (9th Cir. 1996) .................... 4,6,14

In re Syntex Corp. Sec. Litig.,
95 F.3d 922 (9th Cir. 1996) ............................ 4,5,6

In re Time Warner Sec. Litig.,
9 F.3d 259 (2d Cir. 1993),
cert. denied, 114 S. Ct. 1397 (1994) ....................... 5

In re Valence Tech. Sec. Litig.,
No. C95-20459 JW, 1996 WL 37788, at *3
(N.D. Cal. Jan 23, 1996) .................................. 12

In re VeriFone Sec. Litig.,
11 F.3d 865 (9th Cir. 1993) ............................... 21

In re VeriFone Sec. Litig.,
784 F.Supp. 1471 aff'd, 11 F.3d 865 (9th Cir. 1993) ........ 4

In re Worlds of Wonder Sec. Litig.,
35 F.3d 1407 (9th Cir. 1994),
cert. denied, 116 S. Ct. 185 (1995) ............. 5,6,10,11,22

Kahn v. Kohlberg, Kravis, Roberts & Co.,
970 F.2d 1030, (2d Cir.), cert. denied,
506 U.S. 986 (1992) ....................................... 24

Kramer v. Time Warner Inc.,
937 F.2d 767 (2d Cir. 1991) ............................ 12,22

Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson,
501 U.S. 350 (1991) ....................................... 24

Marksman Partners v. Chantal Pharm. Corp.,
No. CV-96-0872-WJR,
1996 U.S. Dist. LEXIS 7179 (C.D. Cal. May 21, 1996) ....... 17

Menowitz v. Brown,
991 F.2d 36 (2d Cir. 1993) ................................ 24

Mills v. Polar Molecular Corp.,
12 F.3d 1170 (2d Cir. 1993) ............................... 19

O'Brien v. National Property Analysts Partners,
936 F.2d 674 (2d Cir. 1991) ............................... 19

Raab v. General Physics Corp.,
4 F.3d 286 (4th Cir. 1993) ......................... 3,5,11,14

Romani v. Shearson Lehman Hutton,
929 F.2d 875 (1st Cir. 1991) .............................. 10
San Leandro Emergency Med. Group Profit Sharing Plan
v. Philip Morris Cos.,
75 F.3d 801 (2d Cir. 1996) .............. 10,11,16,17,18,19,20

Shields v. Citytrust Bancorp, Inc.,
25 F.3d 1124 (2d Cir. 1994) ......................... 17,18,19

Siebert v. Nives,
871 F. Supp. 110 (D.Conn. 1994) ........................... 24

Siegel v. Lyons,
No. C-95-3588 DLJ 1996 WL 634206 *5
(N.D. Cal. Sept. 16, 1996) ............................... 7,8

Sinay v. Lamson & Sessions Co.,
948 F.2d 1037 (6th Cir. 1991) ............................. 10

MOT. TO DISMISS AND MEMORANDUM
IN SUPPORT THEREOF C-96-20867-RMW (EAI) -iii-

Stack v. Lobo,
No. 95-20049 SW, 1995 WL 241448 *9
(N.D. Cal. Apr. 20, 1995) .................................. 6

Sunstrand Corp. v. Sun Chem. Corp.,
553 F.2d 1033 (7th Cir.), cert. denied,
434 U.S. 875 (1977) ....................................... 20

Treganza v. Great Am. Communications Co.,
12 F.3d 717, (7th Cir. 1993), cert. denied,
114 S. Ct. 1837 (1994) .................................... 24

Vosgerichian v. Commodore Int'l,
862 F. Supp. 1371 (E.D. Pa. 1994) .......................... 9

Whirlpool Fin. Corp. v. GN Holdings, Inc.,
67 F.3d 605 (7th Cir. 1995)
citing 15 U.S.C. § 78i(e) ................................. 24

Wiesel v. Kennedy,
No. C95-4472 TEH slip op. at 5,
(N.D. Cal. Nov. 12, 1996) ............................... 7,14

Wool v. Tandem Computers Inc.,
818 F.2d 1433 (9th Cir. 1987) .............................. 9

STATUTES

17 C.F.R. §240.0-3 ............................................. 12

15 U.S.C. § 78a ............................................... 1,8

15 U.S.C. § 78i(e) ............................................. 24

The Private Securities Litigation Reform Act of 1995
(the "Reform Act"), Pub. L. No. 104-67 ................. 1,8,9

RULES

Federal Rules of Civil Procedure 9(b) and 12(b)(6) .............. 1

Rule 9(b) ........................................... 5,6,7,8,10,15

Rule 10b-5 ............................................ 10,19,24,25

Rule 12(b)(6) ................................................... 7

MOT. TO DISMISS AND MEMORANDUM
IN SUPPORT THEREOF C-96-20867-RMW (EAI) -iv-

NOTICE OF MOTION AND MOTION

PLEASE TAKE NOTICE THAT on February 21, 1997, at 9:00 a.m.,

in the Courtroom of the Honorable Ronald M. Whyte, 280 South First

Street, San Jose, California, defendants Digital Link Corporation

("Digital Link"), Vinita Gupta, Daniel L. Palmer, Timothy K.

Montgomery, Stanley E. Kazmierczak, Toni Bellin, Benjamin W. Berry,

Morey R. Schapira, Gregory M. Avis and Charles R. Moore

(collectively, the "defendants") will and hereby do move to dismiss

the Class Action Complaint with prejudice pursuant to Federal Rules

of Civil Procedure 9(b) and 12(b)(6) and The Private Securities

Litigation Reform Act of 1995 (the "Reform Act"), Pub. L. No. 104-

67, which added Section 21D and 21E to the Securities Exchange Act

of 1934, 15 U.S.C. § 78a.¹ Defendants seek dismissal of the Complaint with prejudice.

The motion is based on this notice, the memorandum of points and

authorities that follows, the accompanying declaration of Daniel W.

Turbow, defendants' request for judicial notice filed concurrently

herewith, all pleadings and papers filed herein, oral argument of

counsel, and any other matter which may be submitted at the

hearing.

INTRODUCTION, SUMMARY OF ARGUMENT AND ISSUES TO BE DECIDED

This is a securities class action filed against Digital Link

and its officers and directors. It is the second such action filed

by Mr. Genna; the first, filed in California state court, was

dismissed with leave to amend. Mr. Genna apparently concluded that

his chances in state court were so significantly weakened that it

was worth trying his luck in a federal forum. This action is Mr.

Genna's roll of the dice. It is a gamble, however, that has been

foreclosed by the United States Congress, which recently enacted

legislation that was intended to put an end to litigation exactly

like this suit.

Digital Link designs, develops, manufactures, markets and

sells high speed data communications equipment for wide-are

networks, or WANs. The Company's products represent cutting edge

____________________

¹The text of the Reform Act is contained in pages 1-30 of the
Conference Report, H.R. Conf. Rep. No. 104-369, 104th Cong., 1st
Sess. (1995) ("Conf. Rep."), which is attached as Exhibit 1 to the
accompanying Declaration of Daniel W. Turbow (hereinafter "Turbow
Decl. Exh. __").

MOT. TO DISMISS AND MEMORANDUM
IN SUPPORT THEREOF C-96-20867-RMW (EAI) -1-

technology in a rapidly evolving marketplace. This suit focuses on

one such product, W/ATM GateWay. Plaintiff alleges that the

defendants artificially inflated the price of Digital Link stock

during the period from September 12, 1994 to December 29, 1995 by

misleading investors as to the expected delivery and status of

GateWay and that the investors suffered damages when on October 17,

1995, Digital Link disclosed that GateWay required redesign, and

again on December 29, 1995, when Digital Link announced lower than

expected quarterly revenues and earnings.

Plaintiffs own allegations, however, rebut his theory of the

case. It is true that Digital Link announced in September 1994

that it expected shipments of GateWay to commence in the first

quarter of 1995, but that announcement was accompanied by an

express warning that many milestones had yet to be achieved. When

the first quarter of 1995 arrived, Digital Link announced that it

was still developing the product. Then, in the midst of the class

period, Digital Link announced that it had experienced the very

delays that plaintiff alleges were concealed. In its Form 10-Q for

the quarter ended June 30, 1995, Digital Link announced that

[t]he Company has experienced delays in the development
of their product. Given its complexity, there can be no
assurance that this product will not encounter further
technical or other difficulties which could significantly
delay its deployment or acceptance.

Complaint ¶ 78. Digital Link continued working on GateWay

throughout the summer. In October, 1995, it announced its third

quarter results and announced the redesign of the software aspects

of its GateWay product. Digital Link also announced at this time

that its international sales were slowing and that this slowdown

"will continue for the next several quarters." Complaint ¶ 74.

Digital Link's stock price declined. Finally, on December 29,

Digital Link pre-announced its anticipated fourth quarter results,

which reflected the very slowdown it had predicted nearly three

months previously.

Digital Link was rewarded for its candor first by a state

court securities fraud lawsuit, and now by this action. Plaintiff

initially sought the state court forum in order to avoid the

strictures of the recently enacted Reform Act, which plaintiff

recognized doomed his claim. Having met with resistance from the

state court and without even waiting to fill in the blanks of their

MOT. TO DISMISS AND MEMORANDUM
IN SUPPORT THEREOF C-96-20867-RMW (EAI) -2-

form complaint, plaintiff now seeks refuge in this court in search

of a friendly forum for the very types of claims that have been

roundly criticized by Congress in its enactment of the Reform Act.

The present complaint should be dismissed. First, the

complaint intentionally blurs together the statements of the

defendants, for which certain of the defendants are admittedly

responsible, with the statements of third party analysts, for which

the defendants have no responsibility. The first task of this

Court is to separate the wheat from the chaff and dismiss the

allegations against these defendants for the statements of third

party analysts. Having accomplished this task, the Court must then

assess whether the remaining allegations satisfy the requirements

recently enacted by Congress in the Reform Act. The answer is

"clearly not." First, plaintiff has sued a number of officers and

directors who made no public statements; these individuals should

be dismissed. Second, with respect to the remaining defendants, no

claim may survive because they disclosed the very facts allegedly

"omitted" and because their statements bespoke caution. Congress

expressly encouraged the continued development and application of

the bespeaks caution doctrine; Digital Link's adverse risk

disclosures in this case overwhelmingly dictate application of this

doctrine and dismissal of the complaint. Third, even if this

doctrine did not apply -- and it does -- plaintiffs have failed to

satisfy their burden to plead particular facts which give rise to a

strong inference that defendants acted with actual knowledge that

their forward looking statements were false. Finally, even if

these defects were not enough, plaintiff's claims based on GateWay

are barred by the statute of limitations; delays in the development

of GateWay were disclosed in the summer of 1995, more than fourteen

months before the filing of this action.

ARGUMENT

I. DEFENDANTS CANNOT BE HELD LIABLE FOR THE STATEMENTS
OF ANALYSTS

A. Defendants Cannot Be Held Liable for Analyst
Statements Without A Showing of Entanglement

Liability under the securities laws is personal: a defendant

"cannot be held liable for the independent statement of a third

MOT. TO DISMISS AND MEMORANDUM
IN SUPPORT THEREOF C-96-20867-RMW (EAI) -3-

party," including statements made by securities analysts. Raab v.

General Physics Corp., 4 F.3d 286, 288 (4th Cir. 1993). The

securities laws only require a defendant "to speak truthfully to

investors; they do not require the company to police stled [it]self with the [analyst's] report to

attribute its contents to [the defendant]." In re Ross Sys. Sec.

Litig., [1994-95 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 98,363, at

90,499 (N.D. Cal. Jul. 21, 1994); In re Caere Corp. Sec. Litig.,

837 F. Supp. 1054, 1059 (N.D. Cal. 1993). The defendant must

actually endorse or adopt the analyst's report to be liable. In re

Syntex Corp. Sec. Litig., 855 F. Supp. 1086, 1097 (N.D. Cal. 1994),

aff'd, 95 F.3d 922 (9th Cir. 1996) (a plaintiff must show that the

defendant "endors[ed] or approv[ed] the spin [the analyst] put on

the information"). To satisfy this standard, a plaintiff must

plead sufficient facts to show that the defendant "placed its

imprimatur" on the analyst report, by "expressly or impliedly

represent[ing] that the information was accurate or coincided with

the company's views." In re Software Publishing Sec. Litig,

[1993-94 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 98,094, at 98,762

(N.D. Cal. Feb. 2, 1994); accord Ross, [1994-95] Fed. Sec. L. Rep.

(CCH) ¶ 98,363, at 90,499. The entanglement standard is not a

"loose and capricious" one; courts must construe its requirements

strictly. Caere, 837 F. Supp. at 1059.

Lest there be any doubt regarding the entanglement

requirement, the Ninth Circuit has definitively held that a

plaintiff is required to allege adoption or entanglement. In In re

Stac Elecs. Sec. Litig., 89 F.3d 1399, 1410 (9th Cir. 1996), the

Ninth Circuit held that to be liable for third party forecasts,

"'defendants must have put their imprimatur, express or implied, on

the projections'" (quoting In re VeriFone Sec. Litig., 784 F.Supp.

1471, 1486, aff'd, 11 F.3d 865 (9th Cir. 1993)). See also Elkind,

635 F.2d at 163. Similarly, in Syntex, plaintiffs alleged that

defendants were responsible for analyst "statements and reports,

MOT. TO DISMISS AND MEMORANDUM
IN SUPPORT THEREOF C-96-20867-RMW (EAI) -4-

which misled the market and artificially inflated the value of

Syntex stock." In re Syntex Corp. Sec. Litig., 95 F.3d 922, 934

(9th Cir. 1996). Plaintiffs also contended that the "Defendants

'lied' to securities analysts who, in turn, misled the public by

repeating Defendants' representations." Id. The Ninth Circuit

dismissed the claims because defendants "did not adopt or entangle

[themselves] in the analysts statements." Id. Plaintiffs'

allegations were insufficient because they only alleged a "one-way

flow of information, from Syntex representative to analyst and from

the analysts to their customers." Id.

Moreover, since a showing of entanglement is central to the

overall allegation of securities fraud, the Ninth Circuit requires

that a plaintiff plead entanglement with heightened specificity, as

required by Rule 9(b). Stac, 89 F.3d at 1410 (allegations of

analyst entanglement were insufficient under Rule 9(b) because

plaintiffs "provide[d] no specific facts -- no names, no meetings,

no internal memoranda or documents, no specific conduct or

statement -- in support of its theory"). Accordingly, to state a

claim based on analysts' reports, a plaintiff must at least:

(1) identify specific forecasts and name the insider who
adopted them; (2) point to specific interactions between
the insider and the analyst which gave rise to the
entanglement; and (3) state the dates on which the acts
which allegedly gave rise to the entanglement occurred.

Caere, 837 F.Supp. at 1059 (emphasis added); Ross, [1994-95] Fed.

Sec. L. Rep. (CCH) ¶ 98,363, at 90,499. Courts ruling on motions

to dismiss have consistently found that the requirements of Rule

9(b) were not met where the plaintiff has failed to plead the names

of specific individuals making the statements. See, e.g., Stac, 89

F.3d at 1410 (plaintiffs do not satisfy Rule 9(b) where they fail

to plead specific statements and the specific individuals making

those statements); In re Time Warner Sec. Litig., 9 F.3d 259, 265

(2d Cir. 1993) (mere pleading of statements attributed to unnamed

individuals does not satisfy Rule 9(b)), cert denied, 114 S. Ct.

1397 (1994).²____________________

²The Ninth Circuit articulated the strong public policy
supporting strict application of Rule 9(b) in securities cases:
Rule 9(b) serves to give defendants adequate notice to allow
them to defend against the charges and to deter the filing of
complaints 'as a pretext for the discovery of unknown wrongs,'
to protect professionals from the harm that comes from being
subject to fraud charges, and to 'prohibit ... plaintiff[s]
from unilaterally imposing upon the court, the parties and
society enormous social and economic costs absent some factual
basis.'

Stac, 89 F.3d at 1405 (citations omitted). Rule 9(b)'s very purpose
is to preclude plaintiffs who lack facts from filing claims
accusing respected business people of fraud simply because he was
(continued...)

MOT. TO DISMISS AND MEMORANDUM
IN SUPPORT THEREOF C-96-20867-RMW (EAI) -5-

Plaintiff challenges several reports issued by securities

analysts at brokerage firms, alleging that defendants should be

liable for them. Complaint ¶¶ 46, 49, 50-53, 57-58, 60, 62, 63,

67, 70. Plaintiff fails to meet his pleading burden. With respect

to a number of the analyst reports, plaintiff merely alleges that

Digital Link (like virtually every other public company) met with

unidentified analysts on unidentified dates, supplied unidentified

information to them, and that the analysts' reports were "based on"

such information.³ These are precisely the kind of allegations

that innumerable courts have dismissed for failure to allege

entanglement. Syntex, 95 F.3d at 934. Moreover, the Amended

Complaint is silent as to who spoke to the analysts, when, to whom,

and what they said. Neither the time, the place, nor the content

of Digital Link's allegedly misleading statements is alleged. Such

conclusory allegations do not meet the requirements of Rule 9(b).

Ross, [1994-95] Fed. Sec. L. Rep. (CCH) ¶ 98,363, at ¶ 90,499

("conclusory allegation" that analysts' reports were "based on

information supplied by defendants" insufficient under Rule 9(b));

In re Network Equip. Tech. Inc. Litig., 762 F.Supp. 1359, 1367

(N.D. Cal. 1991) (plaintiffs do not satisfy Rule 9(b) "by averring

in a generic way that representations by [analysts] were 'based on'

information originating from [the] defendant"). Not only are these

allegations both too vague and insufficient to establish adoption

or entanglement, these allegations are also insufficient to allege

adequately a two-way flow of information between analysts and the

company, and thus do not state a claim against the defendants based

on the statements of analysts. See Syntex, 95 F.3d at 934.⁴____________________

²(...continued)
disappointed in his investment. Raab, 4 F.3d at 291 ("The market
has risks, the securities laws do not serve as investment
insurance"); see also In re Worlds of Wonder Sec. Litig., 35 F.3d
1407, 1420 (9th Cir. 1994) (securities laws do not insulate
investors against stock downturns or provide insurance against
risks), cert. denied, 116 S. Ct. 185 (1995) ("WOW").

³See Complaint ¶ 46 (alleging that the Bear Stearns report was
"approved" by Digital Link before it was issued); ¶¶ 50, 53, 62, 63
(alleging that prior to issuing report, analyst "met with,
interviewed and/or obtained key information" from Digital Link
executives including Gupta and Kazmierczak); ¶ 51 (alleging that
analyst's information had been "provided to it by Gupta and
Kazmierczak"); ¶ 52 (alleging that analysts's report was "based on
information provided to him by Gupta and Kazmierczak").

⁴A plaintiff cannot meet its burden merely by alleging a
"one-way flow of information" from the defendant to the analyst.
Syntex, 855 F. Supp. at 1097. Rather, plaintiff must plead
specific facts "which suggest a two-way flow of information between
a particular [ ] insider and a particular analyst." Stack v. Lobo,
No. 95-20049 SW, 1995 WL 241448, at *9 (N.D. Cal. Apr. 20, 1995)
(continued...)

MOT. TO DISMISS AND MEMORANDUM
IN SUPPORT THEREOF C-96-20867-RMW (EAI) -6-

Plaintiff also tries a second pleading approach regarding

analyst reports. Thus, in paragraphs 49, 57, 58, 60 and 67,

plaintiff purports to paraphrase statements by Ms. Gupta and Mr.

Kazmierczak to analysts and avers that the analyst "reported this

information to the market where it became part of the total mix of

information."

These allegations are likewise insufficient. A similar issue

was confronted by Judge Henderson in Wiesel v. Kennedy, No. C95-

4472 TEH, slip op. at 5 (N.D. Cal. Nov. 12, 1996) (Turbow Decl.

Exh. 3). In Wiesel, Judge Henderson dismissed plaintiff's

allegations based on analyst reports because plaintiffs failed

adequately to allege adoption or entanglement. The court then

addressed liability for statements made directly to analysts:

[T]he adoption requirement does not hinder plaintiffs
seeking to bring suit for specific misleading statements
made by insiders to analysts. In other words, plaintiffs
have a choice with analyst reports: they may either show
that the corporate insiders adopted the reports, and thus
may treat the reports as direct statements of the
corporation, or they may show that, irrespective of the
adoption of the reports, corporate insiders made specific
misleading statements to analysts in the course of
particular briefings. In either case, plaintiffs must
meet the requirements set down by Rule 12(b)(6) and Rule
9(b).

Id. (emphasis added). Plaintiff's ploy of paraphrasing rather than

quoting an alleged misstatement, and then seeking to hold

defendants liable for plaintiff's choice of words, fails to satisfy

this test and is insufficient. As the court recently held in

Siegel v. Lyons, the "change [of] a single word" can result in a

material difference in the actionability of a statement. No.C-95-

3588 DLJ, 1996 WL 634206, at *5 (N.D. Cal. Sept. 16, 1996) (Turbow

Decl. Exh. 4). Paraphrase is not a sufficient basis to impose

liability. As Judge Orrick found in comparable circumstances,

In the absence of proof of entanglement or adoption, a
company has no control over the way its statements are
transcribed in individual's notes, nor in the way its
statements are presented in analyst reports or in the
press. There is no guarantee that the statements are
transcribed accurately, nor that the reported statements
include any material qualifications provided by the
company necessary to make the reported statements not
misleading. It is plainly unfair to hold defendants
liable for the reporting of their statements by third
parties without independent corroboration of the accuracy
of the reported statements.

In re Cirrus Logic Sec. Litig., No. C-93-1591 WHO, slip op. at 43-

44 (N.D. Cal. Nov. 1,1996) (Turbow Decl. Exh. 5). These same

______________________

⁴(...continued)
("The plaintiff must allege that the insider provided misleading
information to an analyst, that the analyst relied on this
information in preparing a report, and that the insider somehow
endorsed or approved the report prior to or after its
publication.") ("Turbow Decl. Exh. 2") See Elkind, 635 F.2d at
163.

MOT. TO DISMISS AND MEMORANDUM
IN SUPPORT THEREOF C-96-20867-RMW (EAI) -7-

concerns dictate dismissal of plaintiff's allegations based on

paraphrase. Indeed, one of the most basic requirements of Rule

9(b) is that plaintiff allege the specific statements on which he

asserts liability. See In re GlenFed Inc. Sec. Litig., 42 F.3d

1541, 1548 (9th Cir. 1994) (holding that plaintiff must set forth

"specific descriptions of the representations made") (quoting Blake

v. Dierdorff, 856 F.2d 1365, 1369 (9th Cir. 1988); see also Reform

Act § 21D(b)(1)(B) (requiring that the Complaint "specify each

statement alleged to have been misleading").

Moreover, even assuming a misstatement to an analyst,

plaintiff in a fraud on the market case -- as this is -- must

allege precisely how the information entered the market. Cirrus

Logic, slip op. at 41. There is no shortage of analyst reports

alleged and quoted verbatim in the complaint. However,

suspiciously absent are allegations regarding how, and in what

words, the supposedly paraphrased statements to analysts entered

the market. Since this is an essential element of plaintiff's

claim, it must be alleged with the particularity required by Rule

9(b). See Siegel, 1996 WL 634206 at *5 (plaintiffs must show that

analysts reported the statements "plaintiff allege[] defendants

actually made").

For all of the reasons expressed above, the allegations in ¶¶

46, 49, 50-53, 57-58, 60, 62-63, 67 and 70 should be dismissed.

II. THE BESPEAKS CAUTION DOCTRINE AND THE RECENTLY
ENACTED PRIVATE SECURITIES LITIGATION REFORM ACT
DEMAND DISMISSAL OF THE COMPLAINT.

Plaintiff's remaining allegations fare no better than the

allegations regarding analyst reports. In December, 1995, Congress

enacted the Private Securities Litigation Reform Act of 1995, Pub.

L. No. 104-67, which added Sections 21D and 21E to the Securities

Exchange Act of 1934, 15 U.S.C. §78(a). In enacting the

legislation, Congress found "significant evidence of abuse in

private securities lawsuits" and sought to remedy this problem by

implementing "needed procedural protections to discourage frivolous

litigation." Conf. Rep. at 31-32.

Most pertinent to this motion are three specific provisions of

the new law. First, in enacting the legislation, Congress

expressly encouraged the further development of the bespeaks

MOT. TO DISMISS AND MEMORANDUM
IN SUPPORT THEREOF C-96-20867-RMW (EAI) -8-

caution doctrine, the judicially created doctrine providing that

adequate disclosure of risk may render defendants' statements not

misleading. Second, Congress provided that in order to state a

claim for securities fraud, plaintiffs' complaint must allege

specific facts giving rise to a strong inference of scienter.

Third, Congress provided that with respect to claims based on

forward-looking statements (which is what the present complaint is

based upon), the mental state required to be pled and proven is

actual knowledge of the false and misleading nature of the

challenged statements.

As set forth below, each of these changes, designed to curb

abusive securities litigation, demand that the current complaint

against Digital Link be dismissed.

A. All Defendants Other than Gupta, Kazmierczak
and Digital Link Must Be Dismissed.

As a threshold matter, plaintiff must allege a misleading

statement in order to state a claim under Section 10(b). The

Reform Act requires that "the complaint . . . specify each

statement alleged to have been misleading." §21D(b)(1). There is

absolutely no allegation that defendants Timothy Montgomery, Toni

Bellin, Benjamin Berry, Morey Schapira, Gregory Avis and Charles

Moore made any public statements whatsoever -- misleading or

otherwise. Nor may they be held liable under a theory of aiding

and abetting or conspiracy. Central Bank of Denver, N.A. v. First

Interstate Bank, N.A., 114 S. Ct. 1439, 1448 (1994) (Section 10(b)

prohibits only "the making of a material misstatement (or omission)

or the commission of a manipulative act" and does not impose

liability on persons who merely "giv[e] aid to a person who commits

a manipulative or deceptive act.") (emphasis added). The Ninth

Circuit has held that Central Bank eliminated all non-statutory

theories of secondary liability under Section 10(b), including

conspiracy liability. In re Glenfed, Inc. Sec. Litig., 60 F.3d

591, 592 (9th Cir. 1995). Following Central Bank, courts have held

that a person is not liable under Section 10(b) unless he actually

made the allegedly misleading statement. See In re MTC Elec. Tech.

Shareholders Litig., 898 F. Supp. 974, 987 (E.D.N.Y. 1995) ("[I]f

Central Bank is to have any real meaning, a defendant must actually

make a false or misleading statement in order to be held liable

under Section 10(b)"); In re Kendall Square Research Corp. Sec.

Litig., 868 F. Supp. 26, 28 (D. Mass. 1994); Vosgerichian v.

MOT. TO DISMISS AND MEMORANDUM
IN SUPPORT THEREOF C-96-20867-RMW (EAI) -9-

Commodore Int'l, 862 F. Supp. 1371, 1378 (E.D. Pa. 1994). Plaintiff

therefore fails to state a Section 10(b) claim against these

defendants, who should therefore be dismissed.

Plaintiff will no doubt argue that the "group pleading"

doctrine allows him to allege generally that all members of

management are liable for statements issued in the name of the

corporation. See e.g., Wool v. Tandem Computers Inc., 818 F.2d

1433, 1440 (9th Cir. 1987). The group pleading doctrine, however,

is a judicially created exception to Rule 9(b) and, as such, does

not survive Congress' enactment of the Reform Act. Congress there

expressly requires that in actions arising under Section 10(b) and

Rule 10b-5 "in which the plaintiff may recover money damages only

on proof that the defendant acted with a particular state of mind,

the complaint shall, with respect to each act or omission alleged

to violate this title, state with particularity facts giving rise

to a strong inference that the defendant acted with the required

state of mind." Particularized facts are now required with

respect to each defendant; it is no longer sufficient to group

defendants together in order to allege in undifferentiated fashion

that they collectively violated Section 10(b).

B. Defendants' Disclosures and The "Bespeaks
Caution" Doctrine Preclude Liability In This Case

Even without the benefits of the Reform Act, plaintiff's

claims here must be dismissed under pre-existing law. Before the

Reform Act, the Ninth Circuit had recognized that a defendants'

disclosure of the very facts alleged to have been concealed is

fatal to a claim for securities fraud. Stac, 89 F.3d at 1409.

Moreover, the Ninth Circuit also had embraced the "bespeaks

caution" doctrine. Id. at 1408-9; WOW, 35 F.3d at 1413-14. In the

recent decision in Stac Electronics, the Ninth Circuit dismissed

the complaint at the pleading stage on these bases, reiterating

that "[t]he 'bespeaks caution' doctrine has developed to address

situations in which optimistic projections are coupled with

cautionary language . . . affecting the reasonableness of reliance

on and the materiality of those projections. To put it another

way, the 'bespeaks caution doctrine' reflects the unremarkable

proposition that statements must be analyzed in context." Stac, 89

F.3d at 1408 (quoting WOW, 35 F.3d at 1414). Where forward-looking

statements are accompanied by such statements that "bespeak

caution," the forward-looking statements are not misleading and

thus not actionable as a matter of law. Congress noted approvingly

MOT. TO DISMISS AND MEMORANDUM
IN SUPPORT THEREOF C-96-20867-RMW (EAI) -10-

that many Circuits have applied the bespeaks caution doctrine to

dismiss securities class actions at the pleading stage,⁵ and

expressly encouraged its "further development."⁶ Moreover, this

analysis should be conducted at the pleading stage. See WOW, 35

F.3d at 1413 (quoting D. Langevoort, Disclosures that "Bespeak

Caution," 49 Bus. Law. 481, 482-83 (1994)).

1. Digital Link's Disclosures and The Bespeaks
Caution Doctrine Preclude Liability for
Statement Regarding GateWay

Digital Link's statements regarding GateWay should be

dismissed because they actually disclose the facts allegedly

omitted and because they bespoke caution. While plaintiff seeks to

avoid application of these doctrines by characterizing Digital

Link's disclosures as "boilerplate warnings" (Complaint ¶¶ 78-79),

those disclosures of risk factors were precise and specific

descriptions of the very "problems" that plaintiff alleges were

concealed. In the context of these specific risk disclosures,

defendant's forward-looking statements cannot have been misleading.

STAC, 89 F.3d at 1409. Digital Link's publicly-filed documents

"bespoke caution" about GateWay. Far from guaranteeing that it

would introduce GateWay by a certain time period, Digital Link

cautioned the market about the specific risks it faced in

developing the product and introducing it to the market.

Digital Link's initial announcement anticipated product

availability in the first quarter of 1995 (ended March 31, 1995).

This announcement was followed by the Company's Form 10-Q for the

September 1994 quarter, in which Digital Link warned that

[t]he Company is currently developing, and may in the
future develop, products with which the Company has only
limited experience, including the Company's future W/ATM

____________________

⁵See, e.g., Stac, 89 F.3d at 1408; San Leandro Emergency Med.
Group Profit Sharing Plan v. Philip Morris Cos., 75 F.3d 801, 811
(2d Cir. 1996) ("Philip Morris"); Raab, 4 F.3d 286 (4th Cir. 1993);
In re Donald J. Trump Casino Sec. Litig., 7 F.3d 357, 371 (3d Cir.
1993), cert. denied, 114 S. Ct. 1219 (1994); Romani v. Shearson
Lehman Hutton, 929 F.2d 875, 879 (1st Cir. 1991); I. Meyer Pincus &
Assocs. P.C. v. Oppenheimer & Co., 936 F.2d 759, 763 (2d Cir.
1991); Sinay v. Lamson & Sessions Co., 948 F.2d 1037, 1040 (6th
Cir. 1991). Gray v. First Winthrop Corp., 82 F.3d 877 (9th Cir.
1996), is not inconsistent with these cases; there was significant
evidence that the company had made false statements of historical
fact upon which its supposedly "cautionary" statements were
premised.

⁶See §21E; Conf. Rep. at 46 ("the Conference Committee does
not intend for the safe harbor provisions to replace the judicial
'bespeaks caution' doctrine or to foreclose further development of
that doctrine by the courts").

MOT. TO DISMISS AND MEMORANDUM
IN SUPPORT THEREOF C-96-20867-RMW (EAI) -11-

product . . . [T]the Company does not anticipate making
revenue shipments of its W/ATM GateWay product in 1994,
although the Company anticipates shipping trial units
at the end of 1994. The W/ATM product is a complex
development with many critical milestones yet to be
achieved. The next major milestone is fully loaded
capacity testing, which is expected to be done during the
fourth quarter of 1994. There can be no assurance that a
market for the W/ATM product will continue to develop or
that the Company's product will meet the needs of this
market.

See Form 10-Q for the quarter ended September 30, 1994, at 11-12

(emphasis added).⁷ Comparable warnings recur in virtually every

one of Digital Link's securities filings. See Form 10-K for the

year ended December 31, 1994 at 5; Form 10-Q for the Quarter ended

March 31, 1995 at 12; Form 10-Q for the Quarter ended June 30, 1995

at 11; Form 10-Q for the Quarter ended September 30, 1995 at 12

(respectively, JNO Exhs. B-E).

Digital Link's adverse risk disclosures were not limited to

its initial announcement of GateWay. On March 31, 1995, the

original target date for GateWay shipments, the Company announced

that it had "forged ahead with development of the W/ATM GateWay,"

that it was scheduled for revenue shipments "this year," and that

the Company planned on "continued development." Complaint ¶ 55.

Significantly, Digital Link did not announce that production

volumes of GateWay had shipped; instead, it stated that "evaluation

units were shipped to AT&T" and that "the Company is continuing to

develop the product" and expressly warned, as it had in the past,

that the product may not meet the market's needs. Id. ¶¶ 55, 56

(emphasis in original). The announcements made plain to the market

that in the first quarter 1995, the period in which Digital Link

had initially expected to be shipping GateWay, the Company was

still developing the product.

____________________

⁷Attached as Exhibit A to defendants' Request to Take Judicial
Notice. (hereinafter "JNO Exh. __"). This court may take judicial
notice of Digital Link's SEC filings. "'[W]hen passing on a motion
attacking the legal efficacy of the plaintiff's statement of his
claim, the court may properly look beyond the complaint only to
items in the record of the case or to matters of general public
record.'" Emrich v. Touche Ross & Co., 846 F.2d 1190, 1198 (9th s
laws to be filed with the [SEC] in determining a motion to dismiss
a complaint alleging material misrepresentations and omissions in
such documents.").

MOT. TO DISMISS AND MEMORANDUM
IN SUPPORT THEREOF C-96-20867-RMW (EAI) -12-

In April 1995, Digital Link announced that it made revenue

shipments of GateWay which was, in the Company's view, "a very

significant step toward the success of this product." Id. ¶ 61.

At the same time, however, Digital Link announced in its Form 10-Q

that "[t]he company is currently developing . . . products with

which the Company has only limited experience . . . including the

Company's future W/ATM GateWay" and that there could be no

assurance that GateWay would meet the needs of the market. JNO

Exh. C at 11-12 (emphasis added). The market was thus informed

that while progress had been made on GateWay, the product was still

being developed.

Digital Link's next statement regarding GateWay is fatal to

plaintiff's claim. During the class period in which Digital Link

was allegedly "concealing" problems with GateWay in order to

"inflate" its stock price, the Company announced in its Form 10-Q

for the quarter ended June 30, 1995, that:

The W/ATM GateWay product has not been deployed to end
user customers, and the Company has experienced delays in
the development of this product. Given its complexity,
there can be no assurance that this product will not
encounter further technical or other difficulties which
could significantly delay its deployment or acceptance.

See JNO Exh. D at 11 (emphasis added). This public statement not

only fully disclosed and apprised the market of the status of

GateWay, it also completely refutes plaintiff's theory that Digital

Link was attempting to conceal difficulties with GateWay. Indeed,

apart from conclusions and generalities, there is no allegation

that any of the alleged difficulties with GateWay were known prior

to the date of this disclosure. Where a defendant actually warns

of the very risks which later materialize and discloses that which

plaintiff contends was concealed, dismissal of the complaint is

appropriate. Stac, 89 F.3d at 1409.

Finally, Digital Link disclosed in October that because one of

the software elements of the product was not performing

satisfactorily, GateWay would not meet the market's needs and

therefore was being redesigned. This is precisely the outcome of

which Digital Link consistently warned; such candid warnings are

entirely inconsistent with plaintiff's claim of fraudulent

concealment.

MOT. TO DISMISS AND MEMORANDUM
IN SUPPORT THEREOF C-96-20867-RMW (EAI) -13-

2. Digital Link's Disclosures and The Bespeaks
Caution Doctrine Preclude Liability for
Statement Regarding International Sales

Plaintiff also alleges that defendants should be held liable

for failing to disclose weakening international sales. The fatal

defect to plaintiff's claim is that Digital Link disclosed

precisely what plaintiff claims it omitted. Prior to its October

17, 1995 announcements, Digital Link had limited its statements

regarding international sales to those disclosures required by the

SEC to be made in its quarterly filings. In those filings, Digital

Link accurately disclosed the percent of its net sales attributable

to international sales.⁸ Those accurate disclosures demonstrate, in

fact, that throughout the first ten months of the class period,

Digital Link's international sales were strengthening, not

weakening. Notwithstanding these strengthening international

sales, Digital Link warned in each of its 10-Qs as follows:

International sales are subject to inherent risks,
including longer payment cycles, gains and losses on
the conversion of U.S. dollars, unexpected changes in
regulatory requirements and tariffs, difficulties in
staffing and managing foreign operations, greater
difficulty in accounts receivable collection and
potentially adverse tax consequences, which may in
the future contribute to fluctuations in the Company's
business and operating results.

See JNO Exh. A at 9. Similar warnings appear in every Form 10-Q

and 10-K filed by Digital Link during the class period. See JNO

Exh. B at 13; JNO Exh. C at 8; JNO Exh. D at 9; JNO Exh. E at 9.

____________________

⁸Digital Link's other statements about international sales are
not actionable because they were either accurate statements of
historical fact or immaterially vague statements of optimism. For
instance, on April 17, 1995, it announced in connection with first
quarter results that "international and domestic revenues showed
significant growth." Similarly, in June of 1995, it announced that
an OEM agreement with Siemens "further strengthen[s] Digital Link's
international presence." Countless courts have held such
statements not actionable. See, e.g., Syntex, 855 F. Supp. at 1096
(dismissing statement that company expected "increased sales" and a
"very strong fiscal 1993"); Wiesel v. Kennedy, No. C95-4472 TEH,
slip op. at 8 (dismissing claims based on company's statements that
its product "continues to find support"); Caere, 837 F. Supp. at
1057 (dismissing statements that company was "well positioned" for
growth, had "expanded beyond [its] traditional markets", and had
"continuing strong sales); In re Sciclone Pharm. Sec. Litig., No.
C-94-1485 SBA, slip op. at 28-29 (N.D. Cal. May 3, 1989)
(dismissing company's statement that "everything we've seen is
positive") (Turbow Decl. Exh. 7); Raab, 4 F.3d at 289 (statements
that one of the company's divisions was "poised to carry the growth
and success of 1991 well into the future" lacked materiality as a
matter of law); Ross Sys., [1994-1995] Fed. Sec. L. Rep. (CCH) at
90,497 (dismissing statements that defendants were "pleased" with
"strong sales").

MOT. TO DISMISS AND MEMORANDUM
IN SUPPORT THEREOF C-96-20867-RMW (EAI) -14-

Then, on October 17, 1995, Digital Link reported its third

quarter results. Significantly, these results showed increased

revenues and earnings. In connection with reporting these

favorable results for the prior quarter, Digital Link noted that

international sales declined as a percent of revenue by three

percentage points. More to the point, Digital Link expressly

warned that this decline would continue into the next quarter and

beyond. As plaintiff alleges, Gupta and Kazmierczak told the

market that "The Company had seen a slowdown in sales to the UK

which negatively impacted revenues. The weakness in the UK market

was expected to continue into the fourth quarter." Complaint ¶ 73.

When the precise event of which Digital Link warned came to pass

and Digital announced in December that international sales had

weakened, plaintiff sued for fraud, alleging non-disclosure of

weakening international sales!

This is precisely the pattern of events that the bespeaks

caution doctrine is intended to foreclose. In the usual securities

fraud case, a company unexpectedly announces financial results

below analysts' expectations. Plaintiffs then sue, alleging that

the defendants should have issued an early warning of the factors

causing the disappointment. In this case, by contrast, Digital

Link announced results consistent with analysts' expectations but

also "bespoke caution" by warning of factors that might cause

results in future quarters to be less than expected. Digital Link

did precisely what plaintiffs usually claim that a company should

do -- it warned the market of adverse facts in advance. Digital

Link's conduct is a model of prompt disclosure and merits dismissal

of plaintiff's baseless claims.

C. Plaintiff Fails to Plead Particular Facts
Establishing a "Strong Inference" that
Defendants Had "Actual Knowledge" That Their
Statements Were Fraudulent.

In enacting the Reform Act, Congress found that Rule 9(b)'s

requirement that allegations of fraud be pleaded with particularity

"has not prevented abuse of the securities laws by private

litigants" and has led to "conflicting . . . distinctly different

standards" among the courts of appeal. Conf. Rep. at 41. To remedy

this problem, Congress created a new, "heightened pleading

standard" with "uniform and more stringent pleading requirements to

curtail the filing of meritless lawsuits." Id. Congress also

created a new state of mind requirement for cases based on forward-

MOT. TO DISMISS AND MEMORANDUM
IN SUPPORT THEREOF C-96-20867-RMW (EAI) -15-

looking statements -- actual knowledge.

1. Plaintiff Must Plead Particular Facts
That Constitute A "Strong Inference" Of
Fraudulent Intent.

With respect to each alleged violation of Section 10(b) (i.e.,

claims which require proof of a "particular state of mind")

plaintiff must "state with particularity facts giving rise to a

strong inference that the defendant acted with the required state

of mind." §21D(b)(2) (emphasis added). The "strong inference"

pleading standard was adapted from decisions in the Second Circuit:

The Conference Committee language is based in part on the
pleading standard of the Second Circuit. . . . Regarded
as the most stringent pleading standard, the Second
Circuit requirement is that the plaintiff state facts
with particularity, and that these facts, in turn, must
give rise to a strong inference' of the defendant's
fraudulent intent.

Conf. Rep. at 41. To satisfy the Second Circuit's "strong

inference" requirement, a plaintiff was required to allege either:

(i) specific facts that "constitut[e] circumstantial evidence of

reckless or conscious misbehavior," or (ii) "motive and opportunity

to commit fraud." Philip Morris, 75 F.3d at 812-13.

Congress, however, specifically intended to "strengthen" even

the existing Second Circuit standard. It therefore chose not to

codify the entire Second Circuit case law on the strong inference

standard. Instead, it expressly rejected the "motive and

opportunity" part of the standard:

Because the Conference Committee intends to strengthen
existing pleading requirements, it does not intend to
codify the Second Circuit's case law interpreting this
pleading standard. For this reason, the Conference
Report chose not to include in the pleading standard
certain language relating to motive, opportunity, or
recklessness.

Conf. Rep. at 41 & n.23. The legislative history leaves no

room for doubt that Congress intended to eliminate "motive and

opportunity" as a basis to plead fraudulent intent.⁹ See In Re

____________________

⁹The Senate Bill included an amendment proposed by Senator
Specter, which would have codified the Second Circuit's existing
"strong inference" standard and allowed a plaintiff to base
fraudulent intent on allegations of "motive and opportunity to
commit fraud" or "strong circumstantial evidence of conscious
misbehavior or recklessness." Amend. 1485, S. 240, 104th Cong.,
1st Sess. (1995) (Turbow Decl. Exh. 8). The conference committee
eliminated the Specter Amendment from the final version of the
bill, which Congress passed. In his letter to the Congress
explaining his veto, President Clinton stated:
(continued...)

MOT. TO DISMISS AND MEMORANDUM
IN SUPPORT THEREOF C-96-20867-RMW (EAI) -16-

Silicon Graphics Inc. Sec. Litig., No. C 96-0393 FMS, 1996 WL

664639 at *5 (N.D. Cal. Sept. 25, 1996) (Turbow Decl. Exh. 10).

The fact of stock sales by insiders is not sufficient to

satisfy the heightened pleading requirement created by the Act. In

the Second Circuit, stock sales by corporate insiders were relevant

only to show "motive and opportunity." See Acito v. IMCERA Group,

Inc., 47 F.3d 47, 52 (2d Cir. 1995); Philip Morris, 75 F.3d at 813-

14. Since Congress expressly rejected "motive and opportunity,"

allegations regarding stock sales cannot, by themselves, establish

a "strong inference" of fraudulent intent.¹⁰ Accordingly, the only approach permitted under the new statute

to plead a "strong inference" of fraudulent intent is to allege

specific facts "that constitute strong circumstantial evidence of

conscious misbehavior." Acito, 47 F.3d at 52 (emphasis added);

Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1128 (2d Cir.

1994). Second Circuit decisions are instructive as to this

____________________

⁹(...continued)
I am prepared to support the high pleading standard of
the [Second Circuit] -Ð the highest pleading standard
of any Federal circuit court. But the conferees make
crystal clear in the Statement of Managers their intent
to raise the standard even beyond that level. . . . The
conferees deleted an amendment offered by Senator Specter
and adopted by the Senate that specifically incorporated
Second Circuit case law with respect to pleading a claim
of fraud. Then they specifically indicated that they
were not adopting Second Circuit case law but instead
intended to "strengthen" the existing pleading
requirements of the Second Circuit. All this shows that
the conferees meant to erect a higher barrier to bringing
suit than any now existing. . .

H.R. Doc. No. 104-150, 104th Cong., 1st Sess. (1995) (Turbow Decl.
Exh. 9). Notwithstanding the President's objections, Congress
overrode his veto and passed the conference committee's bill.

¹⁰The decision in Marksman Partners v. Chantal Pharm. Corp.,
No. CV-96-0872-WJR, 1996 U.S. Dist. LEXIS 7179, at *32 (C.D. Cal.
May 21, 1996) (Turbow Decl. Exh. 11), that the statute includes
the "motive and opportunity" part of the Second Circuit test, is
clearly wrong. The court erred by relying on the House and Senate
reports which discussed earlier versions of the Act, instead of the
clear language of the conference report and the legislative history
including the rejection of the Specter Amendment and the
President's veto letter.

In any event, there is nothing about the timing or amounts
of the individuals' sales that supports a logical inference that
there was fraud here. What plaintiff has not alleged is that the
individual defendants' standard practice was to sell stock at
regular intervals during each quarter, and often the numbers of
shares sold by an individual defendant were exactly the same in
each period. See Complaint ¶ 80. Consequently, the individual
defendants' stock sales were totally unrelated to the price of
Digital Link's stock. Thus, plaintiff's allegations completely
fail to establish a pattern of fraudulent insider selling, and
therefore plaintiff has failed to create a strong inference of
fraudulent intent on the part of the individual defendants.

MOT. TO DISMISS AND MEMORANDUM
IN SUPPORT THEREOF C-96-20867-RMW (EAI) -17-

requirement. They establish that a forecast is actionable only if

the complaint pleads contemporaneous evidence of problems so

significant that defendants knew, or recklessly ignored, that it

was a "foregone conclusion" that the company would materially miss

its forecast a very high standard to meet.

For example, in Acito, a company expressed comfort with

estimates of strong earnings and stated "that the company's

overall growth would continue." 47 F.3d at 50. The next day,

however, the company's Kansas City plant flunked its third straight

FDA inspection and the company suspended operations there. One

month later, the company announced a significant after-tax charge

against earnings to correct the plant's problems and downgraded its

earnings estimates. Id. at 51. The Second Circuit rejected

plaintiffs' allegation that the company "should have foreseen that

the third FDA inspection would have negative consequences, given

the deficiencies noted in the first two inspections," holding that

"plaintiffs clearly have failed to allege facts constituting

circumstantial evidence of reckless or conscious misbehavior." Id.

at 51, 53. The court refused to infer that defendants should have

known the plant would fail the third inspection just because it had

failed the first two: "one cannot infer that it was a 'foregone

conclusion' that the Kansas City plant would fail the inspection

and adverse consequences would ensue. . . . [D]efendants' lack of

clairvoyance simply does not constitute securities fraud." Id. at

53 (emphasis added).

In Shields, a bank failed to disclose that it had eased its

policy for real estate loans. Two months after announcing it

expected a "12th consecutive year of record earnings," the bank

disclosed that declining real estate values required it to record a

$40 million charge for problem loans that would cause a loss for

the year. 25 F.3d at 1126. The Second Circuit rejected

plaintiff's allegation that the bank fraudulently failed to

disclose its collateral policy was "critically vulnerable" to

declining real estate values, because the complaint did no more

than "couple a factual statement with a conclusory allegation of

fraudulent intent" and did not "adduce the kind of circumstantial

evidence that would indicate conscious fraudulent behavior." Id.

at 1129. The court found that plaintiffs did not allege facts

establishing that the bank knew, when it made its optimistic

statements, that reserves were inadequate, or "that the company's

MOT. TO DISMISS AND MEMORANDUM
IN SUPPORT THEREOF C-96-20867-RMW (EAI) -18-

disclosures were inconsistent with current data. The pleading

strongly suggests that the defendants should have been more alert

and more skeptical, but nothing alleged indicates that management

was promoting a fraud." Id.

Finally, in Philip Morris, plaintiffs alleged that the company

had predicted favorable financial results, but failed to disclose

flagging sales for Marlboro cigarettes and its intention to

implement a radical new marketing strategy, drastically cutting

Marlboro prices to increase market share at the expense of short

term profitability, which would reduce annual earnings by $2

billion. 75 F.3d at 805. The Second Circuit rejected plaintiffs'

allegation that Philip Morris had been aware of slower Marlboro

sales and had actually been testing its new strategy months before

announcing it, because plaintiffs failed to "offer anything but

conclusory allegations to support their contention that defendants

knew long before the . . . announcement that Marlboro was in

trouble and that a change in strategy would be necessary." Id. at

810, 812. The court rejected the conclusory allegation that

"confidential company sales reports" revealed much earlier that

Marlboro sales were in trouble, because plaintiffs had not

specifically identified the reports, their authors, or the dates

when written. Id.¹¹ 2. The New State of Mind Requirement For
Claims Based on Forward-Looking Statements
Is "Actual Knowledge."

The Securities Reform Act imposes a new state of mind

requirement for forward looking statements that is even tougher

than that applied in Acito, Shields, and Philip Morris. The Second

Circuit previously had held that the required state of mind for any

Rule 10b-5 case was "recklessness." Acito, 47 F.3d at 52. Under

the Securities Reform Act, as a matter of statutory law, the state

____________________

¹¹See also Mills v. Polar Molecular Corp., 12 F.3d 1170, 1176
(2d Cir. 1993) (dismissing complaint; allegation that defendant
"made a number of contracts to register shares and never performed
any of them" insufficient to establish "strong inference" of
fraud); O'Brien v. National Property Analysts Partners, 936 F.2d
674, 677 (2d Cir. 1991) (dismissing complaint with prejudice;
conclusory allegation that auditor "knew of the partnerships'
impending financial difficulties, but nevertheless continued to
aver that financial projections in subsequent partnership offerings
were reasonable" constitutes "the very type of unsubstantiated
allegation that Rule 9(b) prohibits"); In re 1993 Corning Sec.
Litig., No. 93 Civ. 7015 (AGS), 1996 WL 257603, at *7-8 (S.D.N.Y.
May 15, 1996) (Turbow Decl. Exh. 12) (allegation defendant "knew,
as early as a week before the commencement of the Class Period, of
facts rendering it highly unlikely, if not impossible, that
[defendant] would report earnings increases" failed to give rise to
"strong inference" of fraud.).

MOT. TO DISMISS AND MEMORANDUM
IN SUPPORT THEREOF C-96-20867-RMW (EAI) -19-

of mind requirement for forward-looking statements is now much

higher: it is "actual knowledge." Thus,

[a] person . . . shall not be liable with respect to any
forward-looking statement, whether written or oral, if
and to the extent that . . . the plaintiff fails to prove
that the forward-looking statement . . . was made with
actual knowledge . . . that the statement was false or
misleading.

§21E(c)(1) & (B) (emphasis added); see Conf. Rep. at 44.

The Securities Reform Act's new heightened pleading

requirements, combined with its new state of mind requirement, can

mean only that the "strong inference" standard is now much stronger

than that previously applied in the Second Circuit. The combined

effect of the two new provisions is to require that plaintiff

allege with particularity facts "giving rise to a strong inference"

that defendant made the statement with "actual knowledge" that the

prediction could not be achieved. Here, plaintiff is required