Our FirmAttorneysReport FraudContact Us  
Stanford University Law School - Securities Class Action Clearinghouse

STEVEN M. SCHATZ, State Bar # 118356
TIMOTHY T. SCOTT, State Bar # 126971
DANIEL W. TURBOW, State Bar # 175015
WILSON SONSINI GOODRICH & ROSATI
Professional Corporation
650 Page Mill Road
Palo Alto, California 94304-1050
Telephone: (650) 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
and All Others Similarly Situated,

                      Plaintiff,

           v.

DIGITAL LINK CORPORATION, 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,

                      Defendants.
________________________________________

 ) 
)
)
)
)
)
)
)
)
)
)
)
)
)
)
)
)		 CASE NO.: C-96-20867-RMW (EAI)
[filed Feb. 20, 1998]

CLASS ACTION

NOTICE OF MOTION AND
DEFENDANTS' MOTION TO
DISMISS FIRST AMENDED
COMPLAINT; MEMORANDUM OF
POINTS AND AUTHORITIES IN
SUPPORT THEREOF

Date: May 29, 1998
Time: 9:00 a.m.
Judge: The Honorable Ronald M. Whyte

TABLE OF CONTENTS

NOTICE OF MOTION AND MOTION

FACTS

THE COURT'S PRIOR ORDER

THE FIRST AMENDED COMPLAINT

ARGUMENT

I. THE ALLEGED PRE-CLASS STATEMENTS SHOULD BE DISMISSED

II. THE COMPLAINT FAILS TO ALLEGE SPECIFIC FACTS TO CREATE A STRONG INFERENCE THAT DEFENDANTS HAD ACTUAL KNOWLEDGE OF THE ALLEGED FRAUD OR ACTED WITH CONSCIOUS MISBEHAVIOR

III. DEFENDANTS' DISCLOSURES AND THE "BESPEAKS CAUTION" DOCTRINE PRECLUDE LIABILITY IN THIS CASE CONCLUSION

TABLE OF AUTHORITIES

CASES

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

Decker v. Massey-Ferguson, Ltd., 534 F. Supp. 873 (S.D.N.Y. 1981),
     aff'd in part, rev'd on other grounds, 681 F.2d 111 (2d Cir. 1982)

Duncan v. Pencer, [1995-96 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 99,043
     (S.D.N.Y. Jan. 18, 1996)

Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976)

Friedberg v. Discreet Logic Inc., 959 F. Supp. 42 (D. Mass. 1997)

Garcia v. United States, 469 U.S. 70 (1984)

Grossman v. Novell, Inc., 909 F. Supp. 845 (D. Utah 1995),
     aff'd, 120 F.3d 1112 (10th Cir. 1997)

Gulf Oil Corp. v. Copp Paving Co., 419 U.S. 186 (1974)

Havenick v. Network Express, Inc., 981 F. Supp. 480 (E.D. Mich. 1997)

Hockey v. Medhekar, [Current Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 99,465
     (N.D. Cal. Apr. 15, 1997)

Huey v. Honeywell, Inc., 82 F.3d 327 (9th Cir. 1996)

In re Baesa Sec. Litig., 969 F. Supp. 238 (S.D.N.Y. 1997)

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

In re Comshare, Inc. Sec. Litig., No. 96-73711-DT, 1997 U.S. Dist. LEXIS 17262
     (E.D. Mich. Sept. 18, 1997)

In re Donald J. Trump Casino Sec. Litig., 7 F.3d 357 (3d Cir. 1993)

In re Glenayre Techs., Inc. Sec. Litig., 982 F. Supp. 294 (S.D.N.Y. 1997)

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

In re Leslie Fay Cos. Sec. Litig., 871 F. Supp. 686 (S.D.N.Y. 1995)

In re Opti, Inc. Sec. Litig., No. C 95-3434 SBA (N.D. Cal. Mar. 31, 1997)

In re Seagate Technology II Sec. Litig., [1994-95 Tr. Binder]
     Fed. Sec. L. Rep. (CCH) ¶ 98,530 (N.D.Cal. Feb. 8, 1995)

In re Silicon Graphics, Inc. Sec. Litig., [1996-97 Tr. Binder]
     Fed. Sec. L. Rep. (CCH) ¶ 99,325 (N.D. Cal. Sept. 25, 1996)

In re Silicon Graphics Sec. Litig., 970 F. Supp. 746 (N.D. Cal. 1997)

In re Stac Elecs. Sec. Litig., 89 F.3d 1399 (9th Cir. 1996), cert. denied,
     117 S. Ct. 1105 (1997)

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

In re Worlds Of Wonder Sec. Litig., 35 F.3d 1407 (9th Cir. 1994)

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

Marksman Partners v. Chantal Pharm. Corp., 927 F. Supp. 1297 (C.D. Cal. 1996)

Morgan v. Prudential Group, Inc., 81 F.R.D. 418 (S.D.N.Y. 1978)

Norwood Venture Corp. v. Converse Inc., 959 F. Supp. 205 (S.D.N.Y. 1997)

Pache v. Wallace, [1995 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 98,643
     (E.D. Pa. Mar. 20, 1995), aff'd, 72 F.3d 123 (3d Cir. 1995)

People for Environmental Progress v. Leisz, 373 F. Supp. 589 (C.D. Cal. 1974)

Powers v. Eichen, 977 F. Supp. 1031 (S.D. Cal. 1997)

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

Roots Partnership v. Lands' End, Inc., 965 F.2d 1411 (7th Cir. 1992)

San Leandro Med. Group Profit Sharing Plan v. Philip Morris Cos.,
     75 F.3d 801 (2d Cir. 1996)

Shuster v. Symmetricom, Inc., [Current Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶99,581
     (N.D. Cal. June 15, 1997)

Wiesel v. Kennedy, No. C 95-4472 TEH (N.D. Cal. Nov. 12, 1996)

Zeid v. Kimberley, 973 F. Supp. 910 (N.D. Cal. 1997)

STATUTES

15 U.S.C. § 78u-4

15 U.S.C. § 78u-5

RULES

Fed. R. Civ. Proc. 9(b)

Fed. R. Civ. Proc. 12(b)(6)

MISCELLANEOUS

The Private Securities Litigation Reform Act of 1995, Pub. L. No. 104-67

Conference Report, H.R. Conf. Rep. No. 104-369, 104th Cong., 1st Sess. (1995)

Amend. 1485, S. 240, 104th Cong., 1st Sess. (1995)

H.R. Doc. No. 104-150, 104th Cong., 1st Sess. (1995)


NOTICE OF MOTION AND MOTION

PLEASE TAKE NOTICE THAT on May 29, 1998, 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 plaintiff's First Amended Class Action Complaint ("FAC" or "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 Sections 21D and 21E to the Securities Exchange Act of 1934.1

Defendants seek dismissal of the FAC 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.


FACTS

Digital Link designs, develops, manufactures, and sells high speed data communications equipment for wide-are networks, or WANs. The Company's products represent cutting edge 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. Plaintiff also alleges that Digital Link improperly recognized revenue from GateWay shipments to its OEMs.

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 critical 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

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.
Turbow Decl. Ex. B at 11. 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." Corrected 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. This lawsuit followed.

THE COURT'S PRIOR ORDER

This is plaintiff's second attempt to state a claim for securities fraud. This Court decisively rejected plaintiff's first attempt ("Corrected Complaint") as insufficient under the Private Securities Litigation Reform Act ("Reform Act"). See September 11, 1997 Order ("Order"). At the outset, this Court held that the heightened pleading requirements under the Reform Act apply to plaintiff's Complaint. See id. at 8:15-19. The Court found that with respect to forward-looking statements, the Reform Act requires plaintiff to "prove that the statement was made with 'actual knowledge' that it was false or misleading." See id. at 8:26-9:3 (quoting 15 U.S.C. § 78u-5(c)(1)).

The Court proceeded to methodically analyze each group of allegations asserted by plaintiff in his Corrected Complaint. With respect to statements made in September through November of 1994, this Court found that the allegedly omitted facts were too broad and conclusory to state a claim (see Order at 12:15-16), and that the complaint failed to allege any statements or facts demonstrating that the defendants knew of the alleged omissions (id. at 12:19-20), or when defendants first learned of the alleged "true facts." Moreover, the Court found that given Digital Link's express warnings and its announcement that "many milestones had yet to be achieved," Digital Link's "statements regarding GateWay were not necessarily made false by the alleged 'true facts.'" Id. at 12:21-22. Adopting the Reform Act's pleading requirements, the Court also found that the Corrected Complaint failed to plead facts sufficient to give rise to a strong inference of fraud. Id. at 12:24-13:1.

With respect to statements made in March through April of 1995 and in June through October of 1995, the Court adopted its reasoning for the prior group of statements, finding that the complaint failed to provide any specifics as to the problems being experienced by GateWay and when defendants first learned (if ever) of such problems. Id. at 14:2-6; 15:3-5. Finally, with respect to statements made in October through December of 1995, the Court found that plaintiff failed to allege either that the statements were misleading or that defendant knew the statements were misleading. The Court summarized its findings as follows:

The court concludes that plaintiff has not met his burden as to any of the defendants' statements. The Complaint fails to allege with specificity any contemporaneous statements or facts that were inconsistent with defendants' allegedly misleading statements. Plaintiffs' broad and conclusory allegations do not show with any specificity that defendants' statements were false and misleading at the time they were made.
Id. at 16:24-17:1. Moreover, even apart from these pleading insufficiencies, the Court found that Digital Link's "warnings based upon the current allegations of the complaint would appear to have appropriately advised the market of potential risks." Id. at 18:2-4.

In its order dismissing the complaint, this Court was very clear and specific in its directions to plaintiff:

What the court expects is an amended complaint that is concise and tailored to the specific facts of this case. If plaintiff can do so in good faith, he should plead facts which show that he has information supporting defendants' making of false or misleading statements with scienter and not just generalizations that suggest that he is just assuming that since Digital Link experienced development difficulties and did not perform as anticipated, defendants must have known of difficulties at the time they made their statements to the market. In other words, plaintiff must allege the particular misconduct of defendants.
Id. at 19:1-8 (original emphasis). Plaintiff's amended complaint fails to comply with the Court's directive.

THE FIRST AMENDED COMPLAINT

The FAC contains only four sets of substantive changes from the prior complaint.

First, plaintiff has added several paragraphs of alleged statements prior to the class period which plaintiff claims inflated the price of Digital Link's stock. See FAC ¶¶ 39-42. It is well established, however, that statements made prior to an alleged class period are not sufficient to sustain a claim of fraud during the class period.

Second, plaintiff has added allegations that as early as the fall of 1994, the Company became aware of deficiencies in the GateWay product through its "Design Validation Testing" ("DVT") and through "Beta Testing" reports from its OEM partners, AT&T and Siemens. According to plaintiff, these reports showed that GateWay "could not accurately process or flow data between ports loaded with over 500 channels -- less than fully loaded capacity." Id., ¶ 57. This same or nearly identical allegation is repeated throughout the FAC. See id. ¶¶ 58, 68, 71, 78, 82. However, plaintiff has simply taken generic reports that he assumes exist and attached to them common names used in the technology industry. Not surprisingly, plaintiff has not alleged any specific dates or titles of these reports, nor identified the author or recipient of them, nor alleged any specific statements from them. Nor does plaintiff allege that this supposed "deficiency" in GateWay was anything more than one of many milestones that Digital Link had expressly warned had yet to be achieved.

Third, plaintiff now alleges that because of the severity of the "problems" with GateWay, the alleged OEM purchasers of GateWay, AT&T and Siemens, were not obligated to make payments for shipments of GateWay to them. See id., ¶¶ 69, 79. Thus, plaintiff claims that Digital Link improperly recorded $1.5 million in revenues. See id. There are no specific facts alleged about the contracts Digital Link had with AT&T and Siemens, or the right of AT&T and Siemens to return the any of the alleged GateWay shipments, or that AT&T and Siemens in fact ever returned any product to Digital Link.

Finally, plaintiff has added several allegations in an effort to buttress its claim that Digital Link made false forecasts about its 4Q 1995 and calendar year 1995 earnings. Plaintiff alleges that Digital Link knew that the European market was switching to more "cost-effective" technology, and that the Company had lost a large domestic contract to a competitor, and thus the Company "knew" that these factors would result in poor sales and below-expected earnings in Digital Link's Fourth Quarter of 1995. Id., ¶ 85. Plaintiff does not allege when these "facts" became known to defendants, or allege any facts to demonstrate that the effect of any of these alleged negative events would necessarily cause Digital Link to miss its forecasted earnings. Moreover, plaintiff simply ignores that Digital Link expressly warned of a business slowdown in Europe before that slowdown caused it to report disappointing earnings.

None of these new allegations are sufficient to revive the complaint. Moreover, the only factual basis specified in the Complaint for these allegations is the "investigation of [plaintiff's] counsel." Id., ¶ 115. This is not enough under the Reform Act. Even if it were, plaintiff has failed to allege any new facts that would demonstrate that Digital Link's express warnings throughout the class period were somehow false; the bespeaks caution doctrine therefore further precludes liability. In sum, plaintiff has utterly failed to comply with this Court's Order that the Amended Complaint plead more than "generalizations that suggest that he is just assuming that since Digital Link experienced developmental difficulties and did not perform as anticipated, defendants must have known of difficulties at the time they made these statements." Order at 19:5-7. Plaintiff's fraud-by-hindsight complaint should be dismissed under the Reform Act.

ARGUMENT

I. THE ALLEGED PRE-CLASS STATEMENTS SHOULD BE DISMISSED

Plaintiff now alleges that defendants made a series of false statements prior to the alleged class period (see FAC ¶¶ 41-42) which plaintiff alleges "were alive and uncorrected and artificially inflating the price of Digital Link stock" at the beginning of the class period. See id., ¶ 43.

Plaintiff's pre-class allegations do not and cannot state a claim against any of the defendants and should be dismissed. It is well settled that statements made prior to the alleged class period cannot form the basis of a securities fraud. See In re Silicon Graphics, Inc. Sec. Litig., [1996-97 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 99,325 (N.D. Cal. Sept. 25, 1996) ("SGI I") (finding inactionable statements made before the alleged fraud commenced); In re Seagate Technology II Sec. Litig., [1994-95 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 98,530, at 91,583 (N.D.Cal. Feb. 8, 1995) (same). Because plaintiff may not maintain a claim based on alleged statements made before the class period, these statements must be dismissed.

II. THE COMPLAINT FAILS TO ALLEGE SPECIFIC FACTS TO CREATE A STRONG INFERENCE THAT DEFENDANTS HAD ACTUAL KNOWLEDGE OF THE ALLEGED FRAUD OR ACTED WITH CONSCIOUS MISBEHAVIOR

Plaintiff is required to plead particular facts establishing a "strong inference" that defendants acted with scienter. See Order at 12:24-13:1. For forward-looking statements, the Court found that the Reform Act requires that actual knowledge is the standard. See id. at 8:26-9:3. None of plaintiff's new -- and baseless -- allegations that the Company fraudulently concealed developments in the GateWay program, improperly recognized revenue, or concealed an anticipated slowdown in fourth quarter sales are sufficient to comply with the Court's Order and the pleading requirements of the Reform Act. Plaintiff's prior allegations related to GateWay were dismissed because plaintiff failed to allege any specific facts establishing the exact problems the product suffered and that Digital Link knew of these problems but failed to disclose them. See id. at 12, 14 (allegations of fraud based on "access to internal corporate data" insufficient to state a claim). In addition, the Court found that even if the alleged facts existed, they did not necessarily render many of the defendants' statements false. The Court also found that Digital Link warned that milestones had yet to be achieved, had announced on the expected release date that the product was still in development, and in June, expressly disclosed that the project had been delayed. Nothing has changed. Plaintiff now alleges that the alleged problems of GateWay were known to the defendants through their receipt of purported "DVT Reports" on GateWay in September-December 1994, as well as "Beta Testing" reports from AT&T and Siemens. See FAC ¶¶ 35, 51, 58.

Plaintiff's new allegations regarding these negative reports are "more specific" only in the sense that plaintiff has assigned a generic name to the reports -- "DVT" and "Beta" reports. Simply assigning generic names commonly used in the technology industry pertaining to categories of reports that any technology company would use is insufficient under the Reform Act. The complaint remains silent as to the title and dates of these reports, their authors, or any particular individual or individuals to which these reports were directed or sent. Not surprisingly, plaintiff also cannot quote a single specific statement from them.2 Moreover, nothing in plaintiff's allegations suggest that the "deficiencies" allegedly identified in the reports could not be corrected by the expected release date of GateWay. They simply allege that a product in development had a problem that required correction -- a fact perfectly consistent with Digital Link's public statements. This Complaint is no different than the last -- allegations of generic reports on unspecified dates in a general time period from October 1994 through January 1995 -- all constituting plaintiff's guess as to when the purported fraud "must have" occurred. See FAC ¶¶ 30, 51, 58. However, as this Court cautioned in its Order, plaintiff cannot simply allege that Digital Link "must have known of difficulties" -- specific facts are required. Order at 19:6.

These types of allegations have been repeatedly dismissed by courts in this district and in other districts. The Court in Silicon Graphics squarely addressed the sufficiency of pleading internal reports under the Reform Act. See SGI II, 970 F. Supp. at 765. In that case, the plaintiff in her first complaint had alleged that the defendants were aware of adverse, undisclosed information through unidentified "negative internal reports." Id. Judge Smith dismissed plaintiff's original complaint, holding that such allegations were insufficient to create a strong inference of fraud. Id. Plaintiff attempted to buttress that allegation in her amended complaint by alleging that defendants had received a "Fiscal Year 1996 Plan/Budget" as well as "Flash" or "Stop Ship" reports, the latter of which plaintiff alleged were supplied to defendants for each of three months during the critical time period. Id. at 765. Despite these more "elaborate" allegations, Judge Smith held that they were "too generic to create a strong inference of fraud under the [Reform Act]." Id. Thus, in order to state a claim upon such alleged internal reports, a plaintiff is required to allege the "titles of the reports, when they were prepared, who prepared them, to whom they were directed, their content, and the sources from which plaintiffs obtained this information." Id. at 767 (citing Moll v. U.S. Life Title Ins. Co. of N.Y., 652 F. Supp. 1012, 1034-35 (S.D.N.Y. 1987)); Hockey v. Medhekar, [Current Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 99,465, at 97,081-83 (N.D. Cal. Apr. 15, 1997) (allegations of unspecified internal reports, without specifying the date and author, insufficient under the Reform Act; plaintiff "must, at the very least, plead facts that reveal such documents existed"); Morgan, 81 F.R.D. at 423-24; Decker, 534 F. Supp. 878). The Court in SGI II reasoned that every public company generates reports on a regular basis, and that to allow a plaintiff to go forward based on unspecific allegations of these generic reports would make any company that later announced adverse information vulnerable to securities fraud lawsuits. See SGI II, 970 F. Supp. at 766.

The allegations in the instant Complaint are no different in substance or scope than those dismissed in SGI II. This not a mere oversight by plaintiff. This Court's Order gave plaintiff ample notice that he was required to allege the particular misconduct of defendants. Moreover, plaintiff filed his amended complaint on or about November 10, 1997, roughly six months after the court in SGI II made clear what particular facts needed to be alleged to create a strong inference of fraud based on alleged negative internal documents.3 Thus, plaintiff was well aware of this Court's directive to allege more specific facts and of the pleading requirements under the Reform Act. If in fact plaintiff had actually seen these reports, or they ever existed, why then did plaintiff fail to allege the requisite facts about them? Without these specific facts, these "new" allegations can only be seen as plaintiff's guesswork derived from hindsight and speculation.

In summary, while it may not necessarily be unreasonable for plaintiff to "believe" that Digital Link, like comparable companies of its size, prepares reports on the testing of its products, this belief is really no more than plaintiff's generalized assumptions about what "must have" taken place. However, as this Court instructed in its Order, this belief alone without specific factual allegations is insufficient. Because the allegations do not comply with the substantive and procedural requirements of the Reform Act, plaintiff's claims related to GateWay must therefore be dismissed.

Even if plaintiff were able to allege the necessary specific facts to establish that the negative DVT and Beta testing reports actually existed, the alleged contents of these reports do not create a strong inference of fraud. Plaintiff alleges that because GateWay's software "could not effectively or accurately control the flow of data between ports" at a certain capacity, the product would have to be redesigned and "could not be produced in quantity or sold commercially during 1995." See, e.g., Complaint ¶ 71(a). However, the marketplace is aware that complex technological products such as GateWay commonly have issues that arise during the development process. In fact, as discussed in more detail below, Digital Link expressly warned the market that GateWay was a "complex development with many critical milestones yet to be achieved" and that "'[t]here can be no assurance that a market for the W/ATM product will continue to develop . . . .'" Order at 17:23-25 (quoting Digital Link Form 10-Q for September 1994).

Moreover, plaintiff has not alleged any causal nexus between the alleged negative "facts," i.e., the data flow problem with GateWay's software, and plaintproduct, plaintiff's allegations do not create a strong inference of scienter.

Plaintiff's allegations of accounting fraud are also conclusory. In a series of factually unsupported allegations, plaintiff claims that Digital Link improperly included $1.5 million in revenue attributable to its shipments of GateWay and PremiseWay to AT&T and Siemens in the first and second quarters of 1995. See FAC ¶¶ 69, 79. Plaintiff alleges that this amount was improperly recognized because "Digital Link had not been able to deploy a working GateWay product and thus had not earned any such revenues." Id. According to the Complaint, because the products shipped to AT&T and Siemens were "trial or test products" and not "commercial versions," these companies "were not obligated to pay for and did not pay for" these products. Id.

Plaintiff's allegations fall hopelessly short of satisfying the stringent pleading requirements of the Reform Act. There are no facts, let alone specific ones, to support the allegation that Digital Link recognized $1.5 million in revenue from GateWay and, if it did, to even begin to question the propriety of Digital Link's alleged revenue. Noticeably absent are any allegations about the actual OEM agreement between Digital Link and AT&T or Siemens that even remotely suggest that these companies were not obligated to pay for, and in fact did not pay for, the products shipped to them. Without the indicia of accounting fraud, such as a restatement of revenue or increases of reserves, plaintiff has no basis to allege accounting fraud. These pleading deficiencies alone mandate dismissal of plaintiff's accounting fraud allegations.

Moreover, even if there were any facts to indicate that Digital Link improperly recognized revenue -- which it did not -- plaintiff has failed to allege any specific facts showing that this recognition was done with any fraudulent intent. The most that plaintiff has done is allege that Digital Link's financial statements were known to be false by the defendants because of "internal Digital Link corporate data" and "corporate meetings." See FAC ¶¶ 71, 82. This Court has already ruled that such a conclusory and unsupported allegation, without contemporaneous facts, is insufficient to state a claim. See Order at 12. Plaintiff is required to allege facts that establish that the defendants were actually aware of the accounting improprieties, rather than merely allege that internal corporate data was available to them. See In re Comshare, Inc. Sec. Litig., No. 96-73711-DT, 1997 U.S. Dist. LEXIS 17262, at *23-26 (E.D. Mich. Sept. 18, 1997) (Turbow Decl. Exh. C) (allegations of defendants' supposed awareness of negative internal reports insufficient to allege awareness of accounting violation). "Without allegations of fraudulent intent, violations of generally accepted accounting procedures do not support a securities fraud claim." Id., 1997 U.S. Dist. LEXIS 17262, at *25. Thus, the Complaint is utterly lacking in any facts to create a strong inference that defendants acted with scienter in allegedly recognizing revenue improperly, and for this additional reason, plaintiff's accounting fraud allegations must be dismissed.

Plaintiff again alleges that defendants knew that Digital Link's international operations were encountering serious problems and that Digital Link's domestic business was "soft" and its "competitive position there was being seriously eroded," such that Digital Link could not achieve earnings per share of $0.18 for the fourth quarter of 1995 and $0.64-$0.65 for the 1995 full year. FAC ¶ 85. As a result, plaintiff alleges that Digital Link made false statements on October 17, 1995 to securities analysts and in its 3rd Quarter 1995 Report to Shareholders issued shortly thereafter. Id., ¶¶ 83-84.

The only new allegations to support his claim are that because Digital Link had "many contacts in Europe, the Individual defendants knew that European network managers were increasingly opting for Frame-Relay Switching, which was more cost-effective" Id., ¶ 85. Plaintiff also alleges that the defendants knew that Digital Link's domestic business was "soft" because the Company had lost out on an important contract to provide switching products to MCI. Id. As a result, the defendants are alleged to have known that the Company would miss its Fourth Quarter 1995 and full year 1995 targets.

At the outset, the FAC conveniently ignores the fact Gupta and Kazmierczak told the market in October, before the Company missed analysts' expectations, that "the Company had seen a slowdown in sales to the UK which negatively impacted revenues" and that this "weakness in the UK market was expected to continue into the fourth quarter." Corrected Complaint ¶ 73.4 In the third quarter ended September 30, 1995, sales increased to $12.5 million (Turbow Decl. Exh. D at 8)..5 Digital Link announced that despite this increase, international sales as a percent of revenue had declined 3%, and warned that the slowdown would continue into and beyond the fourth quarter and for the next several quarters. See Corrected Complaint ¶ 74. None of plaintiff's new allegations can negate the impact of this explicit warning of declining sales, which conclusively refutes plaintiff's theory that the defendants were seeking to conceal or otherwise mislead the market with respect to conditions in Europe.

Even apart from this glaring defect, these new allegations are totally lacking in the requisite specifics. Plaintiff fails to allege a single date, specific or otherwise, as to when the defendants are alleged to have "known" this negative information.6 Without alleging facts establishing that this information was actually known to defendants prior to Digital Link's October 17, 1995 statements expressly warning of the international slowdown, plaintiff has not stated a claim. See Order at 16; see also In re Glenfed, Inc. Sec. Litig., 42 F.3d 1541, 1548-49 (9th Cir. 1994) (en banc). Moreover, the mere fact that some customers preferred a competitor's product does not dictate that it was a "foregone conclusion" that the Company would miss its Fourth Quarter. See Acito v. IMCERA Group, Inc., 47 F.3d 47, 53 (2d Cir. 1995). Likewise, plaintiff utterly fails to provide any facts as to when the alleged loss of the contract to the Digital Link's competitor occurred, much less allege that any of the defendants were aware of the loss of the contract before Digital Link made any of its alleged "misstatements." In fact, the loss of a major customer or contract may well disprove Digital Link's alleged liability; if the loss of the contract occurred after Digital Link made an alleged forecast, this would constitute a "change in circumstances" so as to explain why the Company's financial results did not meet the analysts' expectations. See Glenfed, 42 F.3d at 1548-49.

In its Order, this Court declined to reach the issue of whether Congress adopted the Second Circuit's pleading standards for scienter or whether Congress adopted a higher pleading standard. See Order at 13 n.6. As demonstrated above, because the FAC does not comply with the Court's Order, this Court again need not reach the issue. However, in the event that this Court finds that the FAC meets the lower Second Circuit standard -- which it does not -- the FAC does not meet the higher requirements for pleading scienter under the Reform Act.

Through the Reform Act, Congress intended to significantly change existing law by creating a heightened standard for pleading scienter. In doing so, Congress expressly rejected Ninth Circuit case law and found that the Second Circuit's "strong inference" standard -- the most rigorous in the nation -- was not strong enough. See Conf. Rep. at 41 & n.23; SGI II, 970 F. Supp. 755-56. Congress intended to strengthen even that standard. Accordingly, no longer can scienter be averred generally; instead, scienter must be pleaded "with particularity" -- a "minimal factual basis" for scienter will not suffice. Zeid v. Kimberley, 973 F. Supp. 910, 917 (N.D. Cal. 1997).7

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." San Leandro Med. Group Profit Sharing Plan v. Philip Morris Cos., 75 F.3d 801, 812-13 (2d Cir. 1996). 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. FN 23/
Conf. Rep. at 41 & n.23. Because the Conference Report is the definitive statement of Congressional intent,8 the legislative history leaves no room for doubt that Congress intended to eliminate "motive and opportunity" as a basis to plead fraudulent intent,9 and Congress consciously excluded "motive and opportunity."10

Numerous decisions, including SGI within this District, have held accordingly, eliminating the motive and opportunity test in and of itself as a means of establishing a strong inference of scienter.11 See SGI II, 970 F. Supp. at 757; Comshare, 1997 U.S. Dist. LEXIS 17262 at *14; Havenick v. Network Express, Inc., 981 F. Supp. 480, 528 (E.D. Mich. 1997); Powers v. Eichen, 977 F. Supp. 1031, 1038 (S.D. Cal. 1997); Friedberg v. Discreet Logic Inc., 959 F. Supp. 42, 47-50 (D. Mass. 1997); Norwood Venture Corp. v. Converse Inc., 959 F. Supp. 205, 208 (S.D.N.Y. 1997).12

There are no allegations supported by specific facts to create the inference, let alone a strong inference, that the defendants engaged in any conscious misbehavior. As demonstrated above, plaintiff has failed to allege specific facts demonstrating that any of the defendants' alleged statements were false or misleading. In addition, the FAC is utterly bereft of facts to support the allegations that defendants actually knew any of their statements were false or misleading at the time they were made, or otherwise consciously engaged in fraud. Without these allegations of specific facts, plaintiff has utterly failed to create a strong inference that any of the defendants engaged in any conscious misbehavior.

On the contrary, Digital Link actually disclosed many of the adverse facts alleged to have been concealed. As discussed in more detail below, Digital Link specifically disclosed to the market that the GateWay development had experienced delays, and eventually disclosed that the product needed to be redesigned. In addition, at the beginning of its Fourth Quarter in 1995, the Company disclosed that it expected the slowdown in the European market to continue through the Fourth Quarter and possibly last for several quarters. A company "bent on fraud" does not voluntarily disclose adverse facts such as these. See infra at p.22 n.21.

Even if this Court holds that plaintiff can create a strong inference through allegations of motive and opportunity, plaintiff has failed to do so here.13 At the outset, plaintiff's approach -- lumping together all of the individuals' sales -- is improper under the Reform Act. The Act requires plaintiff to plead particular facts establishing that each defendant acted with the requisite state of mind as to each challenged statement. 15 U.S.C. § 78u-4(b)(2). See SGI II, 970 F. Supp. at 766 ("In evaluating scienter, the [Reform Act] requires the Court to consider each defendant's sales separately.").

Even assuming arguendo that the individuals' sales may be considered collectively, plaintiff has not met his burden of showing that such sales create a "strong inference" of fraud. In arguing that defendants sold a large percentage of their holdings during the class period, plaintiff conveniently ignores the millions of shares, including exercisable options, that defendants could have sold during the class period but did not. For example, defendant Gupta, the CEO and Chairperson of the Board, sold only 2.4 % of her available holdings. In addition, plaintiff has skewed the numbers by including as "sales" $13.3 million (836,234 shares) in stock distributed by Summit Partners Holdings to its limited partners. Defendant Avis, a general partner, expressly disavowed virtually all beneficial interest in the shares distributed.14 In fact, Avis' pecuniary interest amounted to only 5,010 shares of the 836,234 total shares sold by the Summit general partnerships.

Moreover, plaintiff conveniently failed to point out that many of the sales by defendants Schapira, Berry and Palmer took place after these individuals had left the Company, hardly consistent with fraud. Palmer's post-resignation sales also came after the Company's stock price had declined following the October 1995 announcement regarding GateWay. Overall, the individual defendants sold only 10.9 % of the shares of their available holdings during the class period. The chart below provides a comparison of the actual stock sales of the individual defendants compared to the numbers alleged in the Complaint. These stock sales do not create a "strong inference" of fraudulent intent under prior law,15 let alone under the rigorous standards of the Reform Act.

Moreover, defendants' stock sales prior to the class period negate any inference of fraud during the class period. As shown in the chart below, the individual defendants actually sold more stock before the class period than during. In the eight month period after the Company's IPO and before the class period, the individual defendants sold 554,00016 shares of stock in which they had a financial or pecuniary interest, whereas during the class period they sold 531,510 shares. Therefore, plaintiff's allegations of defendants' stock sales fail to create any inference of fraudulent intent.
 
Defendant   Shares Sold Prior to Class Period   Shares Sold During Class Period
GUPTA 490,000 100,000
AVIS   5,010
BELLIN   15,000
KAZMIERCZAK 9,000 29,500
MONTGOMERY   55,000
MOORE 10,000 31,000
PALMER 30,000 249,500 (135,440 after resignation)
SCHAPIRA   5,000 (all after resignation)
BERRY 15,000 41,500 (18,000 after resignation)
ALL DEFENDANTS 554,000 531,510

III. DEFENDANTS' DISCLOSURES AND THE "BESPEAKS CAUTION" DOCTRINE PRECLUDE LIABILITY IN THIS CASE

In its Order, this Court recognized that the bespeaks caution doctrine protects defendants who make forward-looking statements. See Order at 17:19-20 (quoting 15 U.S.C. §78u-5(c) (1)). The bespeaks caution doctrine "provides a mechanism by which a court can rule as a matter of law that defendants' forward-looking representations contained enough cautionary language or risk disclosure to protect the defendant against claims of securities fraud" and "reflects the unremarkable proposition that statements must be analyzed in context." In re Stac Elecs. Sec. Litig., 89 F.3d 1399, 1408 (9th Cir. 1996), cert. denied, 117 S. Ct. 1105 (1997). Courts have held that the required analysis (including dismissal) should be conducted at the pleading stage. See, e.g., id.; WOW, 35 F.3d at 1413; In re Donald J. Trump Casino Sec. Litig., 7 F.3d 357 (3d Cir. 1993) (affirming dismissal of securities complaint based on risk disclosures in prospectus). Thus, dispositive Ninth Circuit authority holds that 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. See Stac, 89 F.3d at 1409. This Court also recognized that Digital Link warned the market of the potential risks of developing the GateWay product as well as apprised the market as to its status of development. See Order at 17-18. Finding that Digital Link's warnings were sufficient to "appropriately advise[] the market of potential risks," this Court instructed plaintiff to "plead what particular difficulty actually existed at the time of one or more of these warnings which made the warning misleading to the market." Id. at 18:3-5. Digital Link had warned in September 1994 that the GateWay product was a "complex development with many critical milestones yet to be achieved" and that "[t]here can be no assurance that a market for the W/ATM product will continue to develop . . . ." Id. at 17:23-25 (quoting Digital Link Form 10-Q for September 1994).17 The Company also stated at the time of the expected release date of GateWay that it was still continuing to develop the product.18 Later, in June 1995, Digital Link had "specifically stated that it had experienced delays in development and that further delays could be encountered which could significantly delay deployment or acceptance." Id. at 17:26-18:1.19 Under Stac and the bespeaks caution doctrine, the Company cannot be held liable because it disclosed these risks and facts to the market.

As demonstrated above, plaintiff's new allegations are insufficient to plead the existence of any allegedly undisclosed adverse facts and when and how the Digital Link became aware of such undisclosed adverse facts. See supra pp. 6-13. Even accepting plaintiff's allegations as true, there is no factual basis to conclude that any of the allegedly undisclosed problems rendered any of Digital Link's warnings false. Therefore, for this reason alone, plaintiff again has not pled any facts to negate Digital Link's warnings.

Furthermore, where, as here, once risks have been disclosed, they are part of the "total mix of information" in the market and qualify a defendant's later statements -- defendants need not repeat the warnings or disclosures every time the company makes a statement. The "total mix of information" would not be significantly altered if Digital Link were forced to repeat what it had already disclosed.20 This "leads to the inexorable conclusion that investors were specifically and adequately cautioned" about the relevant risks. Stac, 89 F.3d at 1409.

Although plaintiff has selectively omitted from the FAC many of Digital Link's disclosures apprising the market, these disclosures negate the existence of any fraudulent intent. Here, Digital Link kept the market constantly apprised of the status of GateWay and, in the midst of the alleged class period, filed a Form 10-Q announcing that the program had encountered delays. A company "bent on fraud" does not voluntarily disclose developmental delays, the very fact it is alleged by plaintiffs to have concealed. Nor does a company "bent on fraud" voluntarily pre-disclose an expected international sales slowdown in the next quarter. Far from creating an inference of fraud, the allegations here rebut it.21

Plaintiff also alleges that defendants should be held liable for failing to disclose