MILBERG WEISS BERSHAD
HYNES & LERACH LLP
ALAN SCHULMAN (128661)
JAMES A. CAPUTO (120485)
TRAVIS E. DOWNS, III (148274)
TOR GRONBORG (179109)
600 West Broadway, Suite 1800
San Diego, CA 92101
Telephone: 619/231-1058

Attorneys for Plaintiffs

[Additional counsel appear on signature page.]

I. INTRODUCTION

II. FACTUAL ALLEGATIONS OF THE COMPLAINT

III. ARGUMENT

A. The PSLRA Does Not Apply To Pre-Enactment Conduct

B. The Complaint Satisfies Rule 9(b)'s And, To The Extent It Applies, The PSLRA's Pleading Standards

1. The Complaint Pleads Defendants' False Statements And Why They Were False When Made

a. NetManage's False Financial Statements

b. Defendants' False Statements Concerning The Company's Operations And Business Prospects

2. The PSLRA Did Not Eliminate Recklessness Or The Use Of "Motive And Opportunity" To Plead Scienter

3. The Complaint Pleads Facts Raising A Strong Inference Of Scienter

a. Defendants' Motive And Opportunity

b. Defendants' Reckless Or Conscious Behavior

C. Defendants Are Liable For Their Misleading Statements To Analysts

D. The Complaint Alleges Primary Violations Against All Defendants

1. Liability For Participating In A Fraudulent Scheme

2. Liability For Group-Published Information

3. Liability For Failing To Abstain From Trading Before Disclosing Adverse Information

E. Plaintiffs Have Properly Pleaded The Basis For Their Allegations

IV. CONCLUSION

I. INTRODUCTION

The Complaint alleges defendants falsely represented NetManage, Inc.'s ("NetManage" or the "Company") quarterly financial results, its future revenue and earnings growth, and the success of its marketing and computer software sales programs between 7/25/95 and 1/11/96 ("Class Period").⁽¹⁾ As a result, NetManage's stock price soared from $20-1/8 per share to a Class Period high of $34 per share, enabling insiders to sell 715,999 shares for over $14 million. This inflated stock price also allowed NetManage to purchase, at reduced cost, Syzygy Communications, Inc. ("Syzygy") and AGE Logic, Inc. ("AGE") in stock-for-stock acquisitions. These companies offered NetManage a broader software technology and product base. But NetManage was already suffering weakening sales and product demand. NetManage could not effectively distinguish its software products from competing programs offered by Microsoft Corporation ("Microsoft") through its Windows 95 operating system and by Netscape Communications, Inc. ("Netscape") through its Internet browser and applications software. Defendants could not conceive of a marketing or pricing strategy to cope with the changing marketplace. Expansion of NetManage's international sales proved expensive. Domestic sales programs foundered, as NetManage's own direct sales group competed with and undercut its distributors and resellers. On 1/12/96, NetManage revealed that it would report a sharp decline in 4Q95⁽²⁾ revenues, and its stock price collapsed from $14-9/16 to as low as $10 per share -- never to recover. To the last, NetManage proclaimed it was "the fastest growing public software company in the United States." ¶9.

Because Congress did not specifically direct that the Private Securities Litigation Reform Act of 1995 ("PSLRA"), 15 U.S.C. §§78u-4, 78u-5 be applied to conduct occurring before its effective date, it has limited application here, as all but one of defendants' false statements were made before 12/22/95. Thus, the law in effect when defendants' conduct occurred governs this action. Under 9th Cir. pleading standards and to the extent the PSLRA does apply, the Complaint is sufficient. It pleads each false financial and business-related statement, ¶¶65, 70, 73, 76, 82, 85, 90, 93, 95-98, 102, 105, 107, 110-13, 116-17, 120, why they were false when made, ¶¶6-10, 37, 42-43, 45, 47-48, 72, 81, 91, 103, 109, 118, 131, 133-44, and facts raising a strong inference of scienter, i.e., defendants inflated NetManage's stock to dispose of 715,999 shares of their own NetManage shares for over $14 million and to acquire Syzygy and AGE cheaply. ¶¶1, 11-12, 25, 41, 42-57, 95, 110, 145.

Defendants are liable for their false statements to securities analysts. These were statements to the market and are actionable because they mislead. Their optimistic statements similarly mislead. Defendants are also liable under the "group-published" information doctrine, the "disclose or abstain" doctrine, and because they participated in a scheme to defraud NetManage investors. Additionally, defendants Alon and Amaral are liable as control persons, without regard to their scienter, ¶¶151-53 -- allegations defendants do not contest. Taken together, plaintiffs' allegations state a significant and actionable securities fraud.

II. FACTUAL ALLEGATIONS OF THE COMPLAINT

NetManage develops and markets software protocols which allow computer network connections. ¶2. Its year-to-year growth in 1993 and 1994 was spectacular, far exceeding 100% and based almost exclusively on sales of NetManage's core connectivity protocol. ¶¶3, 8, 39.

Company founder Alon and a small number of handpicked executives and directors, NetManage's Executive Team, capitalized on NetManage's early success, lavishing themselves with numerous stock options and maintaining firm control over NetManage's finances and business affairs. ¶¶5, 27, 38-41. By early 1995 however, this same management group knew NetManage's boom period was ending and that a serious decline in Company profits was at hand. Even as large corporations manifested their increasing need for interconnectivity products, ¶6, the Individual Defendants were aware the Company's key software products could be rendered obsolete or superfluous by developments at Microsoft, which was preparing to release its Windows 95 operating system which incorporated a free connection protocol, and at Netscape, which was capturing the network browser and applications software markets. ¶60. Defendants' misrepresented their concern for and the impacts of these developments, asserting these events were an endorsement of the Company's technology and a harbinger of expanded sales. ¶¶8, 53, 74, 76, 85, 111, 118. Within NetManage, however, defendants were driven to take action because they knew NetManage could not achieve a competitive or effective marketing or pricing strategy. While defendants took drastic steps to change their marketing and acquire new products to stave off the imminent revenue collapse, they failed to disclose any of these problems to the public. ¶¶6-7, 9-10, 37, 42-43, 45, 47-48, 72, 81, 91, 103, 109, 118, 131, 133-34. They nevertheless did not refrain from profitably selling their own NetManage stock holdings. ¶¶1, 11-12, 145; Appendix A.

On 7/25/95, NetManage issued a press release falsely characterizing its 2Q95 results. While the press release publicly emphasized the Company's "continued success," defendants privately were scrambling to establish marketing and pricing fixes to preserve the Company's growth image. ¶65. Internal finance and sales reports, prepared by defendants Alon, Amaral, Galil, Bosch, Williams, Koretz and Geisler, on a daily and monthly basis, were increasingly falling out of line with projections made in NetManage's 1995 Annual Plan/Budget. ¶¶25, 42-57. At the same time, NetManage's Executive Team was meeting weekly to address the growing litany of problems facing NetManage. ¶¶43-44. These finance and sales reports and weekly meetings were contemporaneously recorded in NetManage's ECCO database for distribution to the Company's top management. ¶¶43-44.

After years of near effortless growth, NetManage faced the daunting prospect of having to expand the market for its limited product base against overwhelming competition. Internal Point of Sale Reports and Sell-Through Reports, as well as reports generated by the Telesales Group, all indicated that NetManage's products sales were materially below expectations. ¶¶44, 51. Based on these reports, defendants approved the inclusion of an increasing number of contingencies in the Company's sales contracts. ¶¶50, 133-44. Domestically and internationally, NetManage was forced to offer extensive rights of return and other contingencies to distributors and other resellers to increase sales. ¶¶50, 133-44. NetManage's top executives also agreed to exchange over $30 million in inflated stock to acquire software applications companies, Syzygy and AGE. ¶¶95, 110. Given the marketing and pricing pressures on NetManage's limited product base, these new product acquisitions, at any cost, were imperative. To further conceal their situation, defendants went so far as to represent that a software licensing agreement with Microsoft regarding the Company's protocols, an agreement which generated essentially no revenue for NetManage, would actually be beneficial. ¶¶49-57, 76, 111.

Ultimately, defendants' efforts foundered. They turned to subterfuge, misstating the status and prospects of the Company's business and products and improperly recognizing revenue to boost earnings. ¶¶7-9, 133-44. Defendants' failure to disclose the true state of the Company's finances and business proved successful, albeit temporarily. As NetManage's stock soared to record highs, based on defendants' false statements and reassurances, NetManage insiders engaged in a massive insider selling, unloading more than $14 million in NetManage shares. ¶¶1, 11-12, 67-69, 75, 77-80, 95, 104, 108, 110, 145. This inflation also effectively reduced the price of the Syzygy and AGE acquisitions. ¶¶1, 38.

Finally, on 1/12/96, NetManage shocked securities analysts and the investing public by revealing a significant revenue shortfall for 4Q95. ¶¶14-15, 125-30. Defendant Alon conceded that revenues from certain booked sales could not be recognized because various contingencies remained unresolved. NetManage's stock, which had traded as high as $34 per share, plunged to as low as $10 per share on this news. ¶¶15, 125-30.⁽³⁾

III. ARGUMENT

A. The PSLRA Does Not Apply To Pre-Enactment Conduct

Virtually all of defendants' false statements occurred before 12/22/95, the date of the PSLRA's enactment. The PSLRA cannot be applied retroactively to this misconduct.

Where Congress has not explicitly stated that legislation applies to pre-enactment conduct, the Supreme Court has mandated a strong presumption against retroactive application. Landgraf v. USI Film Prods., 511 U.S. 244, 280 (1994); SEC v. Fehn, 97 F.3d 1276, 1285 (9th Cir. 1996), cert. denied, ___ U.S. ___, 118 S. Ct. 59 (1997). The Supreme Court unanimously confirmed this rule in Hughes Aircraft Co. v. United States ex rel. Schumer, ___ U.S. ___, 117 S. Ct. 1871 (1997). Reversing the 9th Cir. for applying 1986 False Claims Act amendments to pre-1986 misconduct, the Court held:

[T]here is a "presumption against retroactive legislation [that] is deeply rooted in our jurisprudence." . . . "The 'principle that the legal effect of conduct should ordinarily be assessed under the law that existed when the conduct took place has timeless and universal appeal.'" . . . Accordingly, we apply this time-honored presumption unless Congress has clearly manifested its intent to the contrary.

Id. at 1876.

The PSLRA's only pertinent language precludes retroactivity, stating the PSLRA shall not apply to actions pending on 12/22/95. Pub. L. No. 104-67, §108, 109 Stat. 737, 758 (1995).⁽⁴⁾ Nothing is said of whether it applies to conduct occurring before 12/22/95 alleged in actions filed after 12/22/95. Because Congress has not "clearly manifested its intent" to apply the PSLRA to pre-enactment conduct, the presumption against retroactivity controls. Hughes, 117 S. Ct. at 1876; Landgraf, 511 U.S. at 280. The PSLRA therefore cannot be applied to the pre-enactment conduct alleged here, even though this action was filed after 12/22/95. See United States v. Bacon, 82 F.3d 822, 824 (9th Cir. 1996).⁽⁵⁾

B. The Complaint Satisfies Rule 9(b)'s And, To The Extent It Applies, The PSLRA's Pleading Standards

Contrary to defendants' windy discourse on the policies purportedly animating the PSLRA, Congress did not intend to hinder meritorious actions such as this one.⁽⁶⁾ Indeed, Congress reaffirmed the importance of private enforcement of the securities laws:

The overriding purpose of our Nation's securities laws is to protect investors . . . . Private securities litigation is an indispensable tool with which defrauded investors can recover their losses without having to rely upon government action. Such private lawsuits promote public and global confidence in our capital markets and help to deter wrongdoing and to guarantee that corporate officers, auditors, directors, lawyers and others properly perform their jobs.

H.R. Conf. Rep. No. 104-369, at 31 (1995) ("Conf. Rep.").

The PSLRA did not change Rule 12(b)(6). Allegations still must be taken as true and dismissed only if no conceivable set of facts supports plaintiffs' claims.⁽⁷⁾ The PSLRA, to the extent it applies, only requires a complaint to "specify each statement alleged to have been misleading . . . [and] why the statement is misleading," and to plead "facts giving rise to a strong inference that the defendant acted with the required state of mind." 15 U.S.C. §78u-4(b)(1) and (b)(2). In effect, the PSLRA combines the 9th Cir.'s requirement that a plaintiff plead the false statements and why they are false with the 2d Cir.'s requirement that pleaded facts support an inference of scienter to create a uniform pleading standard. Conf. Rep. at 41. Plaintiffs' allegations satisfy this uniform standard.

1. The Complaint Pleads Defendants' False Statements And Why They Were False When Made

Ninth Cir. decisions preceded the PSLRA in requiring the identification of the false statements and why they were false. 15 U.S.C. §78u-4(b); Cooper v. Pickett, 122 F.3d 1186, 1195 (9th Cir. 1997); Fecht v. Price Co., 70 F.3d 1078, 1082 (9th Cir. 1995), cert. denied, ___ U.S. ___, 116 S. Ct. 1422 (1996); In re GlenFed, Inc. Sec. Litig., 42 F.3d 1541, 1546 (9th Cir. 1994) (en banc). Allegations of internal problems undermining optimistic claims are sufficient to "explain how the claims are false." Fecht, 70 F.3d at 1083; Cooper, 122 F.3d at 1195. Rule 9(b) is "easily . . . satisfied" by alleging "optimistic" statements were made while defendants knew adverse facts contradicting them. Warshaw v. Xoma Corp., 74 F.3d 955, 960 (9th Cir. 1996); Cooper, 122 F.3d at 1195.

a. NetManage's False Financial Statements

The Complaint pleads NetManage's financial fraud with particularity, identifying the defendants directing the fraud, ¶¶22(b)-(c), 44-45, 51, 73, 107, 139, the third-party distributors, resellers and customers involved, ¶¶8, 133-34, and the accounting principles violated, ¶¶134-36. The Complaint also specifies how and by how much improperly recognized revenue inflated NetManage's results for 2Q95 and 3Q95. ¶¶133, 137-38.

Defendants' improper recognition of revenue is a classic §10(b) violation. Cooper, 122 F.3d at 1196 ("[a] company that 'substantially overstates it[s] revenues by reporting consignment transactions as sales . . . mak[es] false or misleading statements of material fact'"); Provenz v. Miller, 102 F.3d 1478, 1484 (9th Cir. 1996), cert. denied, ___ U.S. ___, 118 S. Ct. 48 (1997) (same); Marksman, 927 F. Supp. at 1306 (improper revenue recognition and Generally Accepted Accounting Principles ("GAAP") violations constitute material misstatement); Gross v. Medaphis Corp., [Current Binder] Fed. Sec. L. Rep. (CCH) ¶99,474, at 97,183 (N.D. Ga. 1997).

The 9th Cir. has resoundingly upheld financial fraud allegations strikingly similar to those here. In Cooper, the complaint alleged "that GAAP required Merisel to defer revenue recognition on . . . shipments until payment was received, and that Merisel failed to do so, instead reporting them immediately in order to overstate its revenues." Cooper, 122 F.3d at 1196. Affirming the allegations' sufficiency, the court held:

[T]he complaint identified who (eight of Merisel's customers), what (four types of improper revenue recognition), when (last two quarters of 1993 and first quarter of 1994), and where (reported in financial statements). The complaint alleges that Merisel misled by inflating its revenues by specific amounts, and by falsely claiming that its revenue recognition policy was stricter than it really was ("how"). This is more than fraud by hindsight.

Id.⁽⁸⁾

As in Cooper, the Complaint here identifies the "who" (less than 30 of NetManage's distributors and customers, ¶¶7-8, 57, 62, 133), "what" (the types of improper revenue recognition, ¶¶9-10, 72, 81, 91, 103, 109, 118, 131, 133, 137), "when" (2Q95 and 3Q95, ¶¶10, 72, 81, 91, 103, 109, 118, 131, 133), "where" (reported in financial statements, ¶¶132- 133, 138), and "how" (by falsely claiming that its revenue recognition practices were consistent with GAAP, ¶¶133, 138, 141). It also alleges that NetManage misled investors by overstating its revenues by specific amounts, that is, by at least $2 million, or approximately $.03 per share, in each disputed quarter. ¶138.⁽⁹⁾

Dismissive of this particularity, defendants argue the Complaint fails because it does not identify improper customer transactions. The Cooper court rejected this same argument, declining "to require that a complaint must allege specific shipments to specific customers at specific times with a specific dollar amount of improperly recognized revenue." 122 F.3d at 1197. "It is not fatal to the complaint that it does not describe in detail a single transaction (i.e., shipment) in which Merisel transgressed as [alleged], by customer, amount, and precise method. Comparable precedent does not require greater detail." Id. at 1196. "[I]f the complaint identifies the who, what, when, where and how, that suggests [financial] fraud." Cherednichenko v. Quarterdeck Corp., CV 97-4320-GHK(CWx), slip op. at 4 (C.D. Cal. Nov. 26, 1997) (upholding accounting fraud allegations under the PSLRA when no transactions identified) (Downs Decl., Ex. 2); see Cooper, 122 F.3d at 1196. This, the Complaint specifically does.

Defendants mischaracterize plaintiffs' accounting allegations as reflecting nothing more than a change in proper accounting methods. Defendants' argument misses the mark.⁽¹⁰⁾ That NetManage's distinct revenue recognition policies in 1994 and 1995 may reflect permissible accounting principles in the abstract is irrelevant. Plaintiffs have alleged unresolved contingencies throughout 2Q95 and 3Q95 were not properly treated under the existing 1994 revenue recognition policy. ¶138. Defendants knew that the delay in recognizing revenue effected by the accounting practice adopted at the end of 1995 was needed.⁽¹¹⁾ They simply refrained from employing it during 2Q95 and 3Q95. Therein lies the gravamen of plaintiffs' allegations.⁽¹²⁾

b. Defendants' False Statements Concerning The Company's Operations And Business Prospects

The Cooper decision also demonstrates the adequacy of the Complaint's nonaccounting allegations. There, plaintiffs' allegations were held actionable because "'falseness is clear from the facts that had existed all along and were later revealed.'" 122 F.3d at 1195.

Here, like Cooper, plaintiffs have identified defendants' positive statements about NetManage's current operations and prospects for profitable growth and how they were undermined by adverse information known throughout the Class Period. The Complaint alleges with particularity the time, place, manner and content of these false statements. ¶¶65, 70, 73, 76, 82, 85, 90, 93, 95-98, 102, 105, 107, 110-113, 116-17, 120. Typical of these misrepresentations were defendants' assertions that NetManage was "the fastest growing software company in the United States," ¶¶70, 90, the release of Windows 95 was a "great advantage for NetManage," ¶74, business was "robust," ¶96, "NetManage can maintain annual earnings growth rates of 40%-50% for the next few years," ¶83, and "NetManage's growth continues as the industry remains strong." ¶105.

The Complaint also explains why defendants' statements were false when made by alleging true facts contradicting defendants' optimism. ¶¶6-7, 9-10, 37, 42-45, 47-48, 72, 81, 91, 103, 109, 118, 131, 133-44. Specifically, defendants knew but did not disclose, ¶10:

• Quarterly income was overstated as revenue was being improperly recognized on unresolved contingent sales.
• Demand for NetManage's products and the Company's growth rate were slowing dramatically.
• NetManage products clogged both reseller and distribution sales channels because NetManage's expansive contingency agreements induced excess customer inventory.
• The cost of expanding international sales severely impacted profit margins.
• NetManage's direct Telesales Group competed directly with the Company's own resellers and distributors, eroding profits and customer confidence.
• Revenue and growth projections communicated to analysts lacked a reasonable basis given increasing competition and NetManage's ineffectual sales and marketing efforts.
• NetManage was unable to integrate or market effectively products obtained through the Syzygy and AGE acquisitions.
• Windows 95 and Netscape's browser and applications software were adversely and materially reducing the demand for NetManage's products.
• Earning projections of $0.68-$0.71 and $1.00-$1.05 per share for FY95 and FY96, respectively, were virtually unattainable given the marketing and pricing pressures facing NetManage.

These allegations plainly satisfy the falsity standard expressed by the 9th Cir. and codified by the PSLRA.⁽¹³⁾

Nevertheless defendants challenge four statements as being nonactionable, vague expressions of optimism. ¶¶73, 76, 95, 97. To the contrary, because "'[t]he investing public justifiably places heavy reliance on the statements and opinions of corporate insiders,'" the 9th Cir. has held that "'general expressions of optimism'" are actionable.⁽¹⁴⁾ Hanon v. Dataproducts Corp., 976 F.2d 497, 501, 503 (9th Cir. 1992); Provenz, 102 F.3d at 1487-88; Kaplan v. Rose, 49 F.3d 1363, 1375 (9th Cir. 1994), cert. denied, ___ U.S. ___, 116 S. Ct. 58 (1995).⁽¹⁵⁾

Defendants' rosy assertions that NetManage was "the fastest growing public software company in the United States," ¶70, enjoyed "very strong" demand for it software application products, ¶8, and the Windows 95 release was a "great advantage for NetManage" and "a huge endorsement," ¶76, are likewise actionable. These optimistic statements, together with those defendants highlight, positively color NetManage's business. But this optimism is contrary to then-existing internal conditions at the Company, including NetManage's GAAP violations and overstated financial results.⁽¹⁶⁾ ¶¶132-33, 138, 141. In any event, defendants' challenge to these statements turns on a materiality determination not properly undertaken on a motion to dismiss. Fecht, 70 F.3d at 1082.

2. The PSLRA Did Not Eliminate Recklessness Or The Use Of "Motive And Opportunity" To Plead Scienter

The PSLRA requires plaintiffs to plead facts "giving rise to a strong inference that the defendant acted with the required state of mind." 15 U.S.C. §78u-4(b)(2). The required state of mind under §10(b) is scienter, the "mental state embracing intent to deceive, manipulate, or defraud." Ernst & Ernst v. Hochfelder, 425 U.S. 185, 194 n.12 (1976).

Defendants argue that because Congress did not include motive, opportunity and recklessness language in the PSLRA, plaintiffs must allege conscious or intentional behavior. This is incorrect. In the 21 years since the Hochfelder decision, every Court of Appeals considering the issue has held that recklessness establishes §10(b) liability.⁽¹⁷⁾ No PSLRA provision expressly eliminates recklessness as the §10(b) liability standard. The PSLRA does eliminate recklessness liability in only two very specific contexts: forward-looking statements and joint and several liability. See 15 U.S.C. §§78u-5(c), 78u-4(g).

The PSLRA's "strong inference" standard comes from 2nd Cir. cases uniformly holding that §10(b) plaintiffs may raise a "strong inference" of scienter by pleading (a) motive and opportunity, or (b) facts showing reckless or conscious behavior.⁽¹⁸⁾ Nothing in the PSLRA's text suggests it overrules these decisions. Had Congress intended to do so, it would not have explicitly adopted the "strong inference" formulation.

Defendants here argue the PSLRA prevents motive and opportunity pleading to support scienter.⁽¹⁹⁾ Yet, the PSLRA's "strong inference" language was specifically added to bring all courts in line with the 2nd Cir. precedents on pleading scienter. S. Rep. No. 104-98, 104th Cong., 1st Sess., (1995) states:

The courts of appeal have interpreted Rule 9(b) in different ways, creating a distinctly different pleading standards among the circuits.

The Committee does not adopt a new and untested pleading standard that would generate additional litigation. Instead, the Committee chose a uniform standard modeled upon the pleading standard of the Second Circuit. . . . [C]ourts may find this body of law instructive.

Downs Decl., Ex. 3, at 15.⁽²⁰⁾

The vast majority of courts considering if the PSLRA eliminated recklessness liability or motive and opportunity pleading have concluded it did not.⁽²¹⁾ As the court in Health Management, 970 F. Supp. 192 recently held:

[M]otive and opportunity, as this concept has been developed by the Second Circuit and the district courts thereunder, is sufficient to plead a strong inference of scienter under the PSLRA. . . . If the standard to be imposed by the PSLRA was to be one of the "knowing misbehavior", Congress knew well how to state that standard. . . . The Court finds the omission of such language in the statute significant in concluding that the Second Circuit's pleading standard was not abrogated by the PSLRA.

Id. at 201.⁽²²⁾ Similarly, the SEC has urged that recklessness still suffices to establish scienter under the PSLRA:

The language and legislative history of the [PSLRA] leave no doubt that Congress adopted the Second Circuit's "strong inference" formulation for pleading the [PSLRA]'s "required state of mind." Because Congress adopted the Second Circuit's "strong inference" standard, absent contrary evidence, it may be presumed that it intended to adopt the judicial constructions of that standard. The settled judicial construction of that pleading standard includes both the circumstantial evidence of scienter test and the motive and opportunity test. Thus, Congress intended that courts would rely on these Second Circuit tests in interpreting the pleading standard of the [PSLRA].

See In re Silicon Graphics Sec. Litig., No. 97-16240, SEC as Amicus Curiae Brief at 15-16, (Downs Decl., Ex. 10) (footnote omitted).⁽²³⁾ Plaintiffs' allegations satisfy both prongs of the snference Of Scienter

As to defendants' pre-12/22/95 misconduct, scienter may be alleged generally -- just by saying it. GlenFed, 42 F.3d at 1544. Without question, the Complaint does that. To the extent the PSLRA does apply, a strong inference of scienter may be alleged through defendants' motive and opportunity for committing the fraud or through facts evidencing their reckless or conscious misbehavior. Cohen, 25 F.3d at 1173; Breard, 941 F.2d at 144. The Complaint does this too.

a. Defendants' Motive And Opportunity

Opportunity is clear. Defendants controlled the public dissemination of information about NetManage. ¶¶23, 26-28, 38, 42-51. They were the Company's top officers and spoke on its behalf to analysts and the market. They ran the Company and were responsible for generating and reporting its financial results. ¶¶53-55, 94, 100, 105, 112, 115, 117, 121, 124. Defendants unquestionably had the opportunity to manipulate NetManage's stock price. Cohen, 25 F.3d at 1174; Wellcare, 964 F. Supp. at 639; Marksman, 927 F. Supp. at 1312.

Motive is equally clear. Defendants inflated NetManage's stock price to acquire Syzygy and AGE (and to do so for fewer shares) and to profit from insider trading. ¶¶41, 95, 110, 145. Courts consistently recognize insiders' powerful motives to inflate a company's stock price in connection with an acquisition. In re Lotus Dev. Corp. Sec. Litig., 875 F. Supp. 48, 53 (D. Mass. 1995) ("Plaintiffs make well-pled allegations of motive. They allege that all of the defendants gained heavily from an artificially inflated stock price during the class period: the insiders through sizable sales of their personal stock holdings; and the company through an important stock-financed acquisition.").⁽²⁴⁾ Here, increasing competition and decreasing sales necessitated an expanded product base. NetManage's artificially inflated stock price facilitated that expansion and reduced its cost. ¶¶1, 41, 95, 110.

Insider selling is also a motive and when, as here, suspicious in timing or amount raises an inference of scienter. In re Apple Computer Sec. Litig., 886 F.2d 1109, 1117 (9th Cir. 1989); Appendix A (evidencing defendants' substantial stock sales during the Class Period as compared to the periods before and after they inflated NetManage's stock price). Defendants contend the timing of their stock sales was mere coincidence. They ignore the nonpublic, adverse facts known to them concerning NetManage's unlawful accounting practices and gloomy business prospects when they sold their stock. See, e.g., ¶¶10, 72, 81, 91, 103, 109, 118, 131, 133-44. The pattern of insider stock sales the 9th Cir. has held sufficient to create scienter pale in comparison to defendants' insider sales.⁽²⁵⁾ No matter how measured, the insider selling here is greater in the number of selling insiders (4), amount of stock sold (715,999 shares), and proceeds ($14 million) than in Provenz, Kaplan and Fecht. Worse yet, these insider sales were carefully timed to closely follow the price boost from defendants' false statements. See, e.g., ¶¶67-69, 71, 74-75, 77-80, 89, 92, 104, 106, 108, 119. These sales plainly motivated defendants' fraud. See ¶¶11, 145; Appendix A.

Defendants argue their potentially exercisable stock options must be considered as their holdings and, when done, their sales must be seen as more limited than what is pleaded, citing Silicon Graphics, 970 F. Supp. 746 and Hockey, ¶99,465. However, these two cases stand alone in the extensive federal jurisprudence involving insider selling as raising an inference of scienter. No other courts have ever engaged in the option analysis undertaken in Silicon Graphics and Hockey. Defendants' option holdings are not alleged in the Complaint and are the subject of plaintiffs' companion motion to strike. If the stock option holdings beyond what is alleged in the Complaint are relevant at all, they are a factual matter to be considered at summary judgment or at trial. See Cooper, 122 F.3d at 1193. For now, plaintiffs are entitled to have the Complaint's allegations concerning defendants' insider trading accepted as true.

b. Defendants' Reckless Or Conscious Behavior

The Complaint also pleads facts demonstrating defendants' recklessness or conscious misbehavior. See Breard, 941 F.2d at 144. Plaintiffs raise an inference of scienter if they allege defendants knew or recklessly ignored that their statements were false. Wells Fargo, 12 F.3d at 931; Hanon, 976 F.2d at 507.

As many courts have recognized, corporate books do not "cook" themselves. Extensive accounting manipulations of the sort alleged here are, by necessity, the product of conscious behavior by high level executives.⁽²⁶⁾ The Complaint's allegations establish that defendants artificially inflated NetManage's publicly reported 2Q95 and 3Q95 revenues and earnings per share by prematurely recognizing revenues on sales where rights of return and other contingencies existed. ¶¶73, 107, 133-44.

Each defendant's actual knowledge of the accounting improprieties is also alleged. ¶¶42-51. Specifically, defendants knew that NetManage's reported revenues and earnings were illusory based on access to daily, weekly and monthly internal reports⁽²⁷⁾ (including Point of Sale Reports, Sell-Through Reports, Monthly Flash Reports and the Annual Plan/Budget) and attendance at Board of Directors' and weekly Executive Team meetings. ¶¶42-54, 133-44. From their actual involvement in the granting of the rights of return and other generous payment and credit terms to NetManage's distributors and customers, defendants also had actual knowledge of the falsity of NetManage's reported 2Q95 and 3Q95 financial results. ¶¶42-51, 133-44.

In Cherednichenko, Downs Decl., Ex. 2, at 5, the court acknowledged the split of authority among the district courts regarding whether recklessness survived the PSLRA's enactment, but upheld the complaint, finding defendants acted knowingly:

We need not decide [whether recklessness survived the PSLRA] here because plaintiffs' complaint alleges strong circumstantial evidence of conscious behavior. Plaintiffs claim that defendants' knowledge arose from internal corporate documents (including operating plans, budgets, forecasts, and reports of actual operations) and attendance at management and Board of Directors' meetings . . . as well as from their involvement in granting Quarterdeck's largest distributors . . . the right to return unsold merchandise . . . .

Similarly, in In re ValueJet, Inc. Sec. Litig., No. 1:96-CV-1355-TWT, Order at 14 (N.D. Ga. Nov. 10, 1997) the court found knowing misconduct because the complaint "detail[ed] the [d]efendants' knowledge of safety and maintenance problems . . . at the same time the [d]efendants [made] representations in press releases . . . regarding ValueJet's safety." Id. at 14 (Downs Decl., Ex. 11).

Plaintiffs' allegations here are far more specific than those upheld in Cherednichenko and ValueJet. They allege that defendants knowingly and deliberately misled the market. ¶¶42-51, 133-44. They need not do more under any standard.

Finally, the close proximity in the time between revelations of the bad news (here, 1/12/96, ¶125) and the last of the false positive statements (here, 1/4/96, ¶123) "is circumstantial evidence that the Defendants knew that their optimistic statements were false." Powers, ¶99,483, at 97,267 (three-week time period); Cooper, 122 F.3d at 1195 (three-week time period); Friedberg, 959 F. Supp. at 51 (proximity between false statements and the bad news can provide circumstantial facts in support of scienter).

C. Defendants Are Liable For Their Misleading Statements To Analysts

NetManage, like most public companies, communicated with the market through securities analysts.⁽²⁸⁾ Some statements were made publicly through conference calls and investor presentations, ¶¶52-56, 66, 96, 113-15, and others were made individually to analysts and subsequently republished in their reports, ¶¶52, 54, 84, 88, 94, 100, 105, 115, 117 -- but all were false.

Section 10(b) prohibits false statements, whether made "directly or indirectly," 15 U.S.C. §78j(b), and §20(b) proscribes "any act . . . which . . . would be unlawful for [a] person to do under . . . this chapter . . . through or by means of any other person." 15 U.S.C. §78t(b). This statutory proscription directly addresses dissemination of false information through an intermediary, such as a securities analyst. The 9th Cir. has so held. Cooper, 122 F.3d at 1193⁽²⁹⁾ (false statements in conference calls and false information given to analysts for inclusion in reports); Provenz, 102 F.3d at 1488 (statements in analyst conference calls); Warshaw, 74 F.3d at 959 (statements to analysts); Fecht, 70 F.3d at 1080 (analysts' reports with approval and guidance with approval of the company). There can be no dispute as to insiders' liability for statements to analysts. Such statements do not differ from those in press releases, press interviews or corporate reports. They are statements to the market. If material, false and issued with scienter, §10(b) liability attaches. Warshaw, 74 F.3d at 959 ("[I]f defendants intentionally mislead securities analysts and the press in order to stave off a Xoma stock sell-off, than these third-party reports would be relevant to determine Xoma's securities fraud liability.").

"Entanglement," the sole focus of defendants' challenge, provides an alternative and readily distinguishable liability theory:

Defendants also argue that they cannot be held liable for allegedly misleading statements made to analysts, unless plaintiffs can prove Cirrus's entanglement with, or adoption of, the analysts' reports. This is not the law. Rule 10b-5 makes . . . no exception for misleading statements made to investment analysts.

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

In re Cirrus Logic Sec. Litig., 946 F. Supp. 1446, 1466-67 (N.D. Cal. 1996) (emphasis added and in original). Plaintiffs have pleaded that defendants are liable for their misstatements to analysts; neither adoption nor entanglement are required.⁽³⁰⁾ Moreover, although defendants effectively ignore it, plaintiffs have pleaded entanglement and adoption -- through a two-way information flow between defendants and analysts -- with required particularity.⁽³¹⁾

D. The Complaint Alleges Primary Violations Against All Defendants

1. Liability For Participating In A Fraudulent Scheme

Defendants Galil, Bosch, Williams and Koretz argue they are not liable because they did not speak. But §10(b) liability also derives from participation in a scheme to defraud investors. Ernst, 425 U.S. at 197-99 n.20. "Rule 10b-5 liability is not restricted solely to isolated misrepresentations or omissions; it may also be predicated on a 'practice, or course of business which operates . . . as a fraud . . . .'" Blackie v. Barrack, 524 F.2d 821, 903 n.19 (9th Cir. 1975).⁽³²⁾

The 9th Cir. in Cooper expressly recognized fraudulent scheme liability under §10(b):

Central Bank does not preclude liability based on allegations that a group of defendants acted together to violate the securities laws, as long as each defendant committed a manipulative or deceptive act in furtherance of the scheme.

122 F.3d at 1194; accord Affiliated Ute Citizens v. United States, 406 U.S. 128 (1972).

Selling stock while possessing inside information, as Galil, Bosch, Williams and Koretz did, is a deceptive act under §10(b). United States v. O'Hagan, ___ U.S. ___, 117 S. Ct. 2199, 2207 (1997) ("Trading on [material, nonpublic] information qualifies as a 'deceptive device' under §10(b) . . . .").

2. Liability For Group-Published Information

"'In cases of corporate fraud where the false and misleading information is conveyed in prospectuses, registration statements, annual reports, press releases, or other "group-published" information, it is reasonable to presume that these are the collective actions of the officers.'" In re GlenFed, Inc. Sec. Litig., 60 F.3d 591, 593 (9th Cir. 1995); Wool v. Tandem Computers, 818 F.2d 1433, 1440, 1442 (9th Cir. 1987). There is nothing in the PSLRA to indicate that Congress abolished the "group-published" information doctrine. Moreover, recent decisions evidence this doctrine's vitality after the PSLRA. See Health Management, 970 F. Supp. at 205; Powers, ¶99,483, at 92,267-68.

Here, Alon (Chairman/CEO/President), Amaral (CFO), Williams (V.P./Marketing), Bosch (Audit Committee member), Galil (Audit Committee member), and Koretz (V.P./N. American Sales) -- NetManage's Executive Team -- controlled NetManage's day-to-day operations and its group-published information. ¶¶5, 26-28, 32, 42-48, 51. They are responsible for the false and misleading statements in NetManage's 7/15/95, 10/18/95 and 10/24/95, 11/20/95 and 12/4/95 press releases, ¶¶65, 95, 97, 110, 111, and its 8/14/95 10-Q for 2Q95, and 11/13/95 10-Q for 3Q95, ¶¶73, 107 -- all "group-published" documents.⁽³³⁾ These allegations are sufficient at the pleading stage to establish these defendants' liability under the "group-published" information doctrine.

3. Liability For Failing To Abstain From Trading Before Disclosing Adverse Information

Defendants Alon, Galil, Bosch, Williams and Koretz are also liable under §10(b) for not disclosing adverse, nonpublic information before selling their NetManage stock. This is so even if they did not actually make any false statements. Fecht, 70 F.3d at 1080.

There is no doubt that an individual corporate insider in possession of material nonpublic information is prohibited by the federal securities laws from trading on that information unless he makes public disclosure. He must disclose or abstain from trading.

Shaw v. Digital Equip. Corp, 82 F.3d 1194, 1203 (1st Cir. 1996); Voit v. Wonderware Corp., [Current Binder] Fed. Sec. L. Rep. (CCH) ¶99,541, at 97,669 (E.D. Pa. 1997). Similarly, O'Hagen, 117 S. Ct. at 2207 held:

Trading on [material, non-public] information qualifies as a "deceptive device" under §10b, we have affirmed, because "a relationship of trust and confidence [exists] between the shareholders of a corporation and those insiders who have obtained confidential information by reason of their position with that corporation." . . . That relationship, we recognize, "gives rise to a duty to disclose [or to abstain from trading] because of the 'necessity of preventing a corporate insider from . . . taking unfair advantage of . . . uninformed . . . stockholders.'"

Defendants here are liable under §10b for failing to abstain or disclose.

E. Plaintiffs Have Properly Pleaded The Basis For Their Allegations

Rule 11(b) requires plaintiffs to affirm their allegations have evidentiary support or are likely to be supported after further investigation or discovery. Paragraph 160 simply notifies the Court plaintiffs have complied with Rule 11 and thereby the PSLRA. See 15 U.S.C. §78u-4(c)(1). This compliance cannot be twisted, as defendants attempt, to "admit" plaintiffs' allegations are baseless and ill-conceived. Nor, as defendants suggest, is this paragraph intended to summarize all facts evidencing defendants' fraud. These facts and the documents and information underlying them are specified throughout the Complaint. See, e.g., ¶¶10, 72, 81, 91, 103, 109, 118, 131.

Moreover, plaintiffs' allegations are based on counsels' investigation, not on "information and belief," and therefore the PSLRA's requirements do not control. Cherednichenko, Downs Decl., Ex. 2 at 3 n.3. Even if they did, applicable "information and belief" pleading standards have been met. Pre-PSLRA practice has long required stating facts to support a pleaders' "information and belief." Wool, 818 F.2d at 1439. Such allegations are adequate when Rule 9(b) is satisfied, i.e., "if the allegations are accompanied by a statement of the facts upon which the belief is founded." Id. Congress adopted the same standard. See 15 U.S.C. §78u-4(b)(1). Here, facts evidencing falsity and satisfying this standard have been extensively set forth. See, e.g., ¶¶10, 72, 81, 91, 103, 109, 118, 131.⁽³⁴⁾

IV. CONCLUSION

For the above-stated reasons, defendants' motion to dismiss should be denied in its entirety.

NETMANAG\SLA02667.BRF

1. Defendants include NetManage and the Individual Defendants: Zvi Alon (President, Chief Executive Officer, Walter Amaral (Chief Financial Officer, Uzia Galil, (Director), John Bosch (Director), Robert Williams (Vice President, Marketing), and Richard Koretz (Vice President, North American Sales). ¶¶23-24. All paragraph references ("¶_") are to the First Amended Complaint ("Complaint"); all emphasis is added and citations are omitted, unless otherwise noted.

2. NetManage's fiscal year tracks the calendar year. 4Q95 indicates the fourth fiscal quarter of 1995, ended December 31, 1995. Plaintiffs similarly abbreviate NetManage's fiscal quarters throughout.

3. While other interconnectivity companies have continued to prosper, NetManage stock has never recovered and currently trades in the $3 per share range. ¶1; Appendix B.

4. Numerous courts have confirmed that Congress did not intend that the PSLRA be applied retroactively. See, e.g., Klein v. Boyd, [1996-1997 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶99,352, at 96,780-81 (E.D. Pa. 1996); Baker v. Pfeifer, 940 F. Supp. 1168, 1176 (S.D. Ohio 1996); In re Prudential Sec. Ltd. Partnerships Litig., 930 F. Supp. 68, 77-81 (S.D.N.Y. 1996).

5. See also Maitland v. University of Minn., 43 F.3d 357, 361 n.3 (8th Cir. 1994) ("The date of filing is irrelevant; the date of 'the events in suit' determines whether a court must consider a statute's potential retroactive effect."); District 65 v. Prudential Sec., 925 F. Supp. 1551, 1569-70 (N.D. Ga. 1996) (PSLRA's elimination of civil RICO liability does not apply to pre-enactment conduct).

6. The California state court has already rejected defendants' pleading challenges to plaintiffs' parallel allegations against NetManage under California's securities laws. Head v. NetManage, Inc., No. CV-763295, Order at 1 (Santa Clara Super. Ct. July 16, 1997), attached to Declaration of Travis E. Downs III in Support of Plaintiffs' Opposition to Defendants' Motion to Dismiss Amended Complaint ("Downs Decl.") at Ex. 1.

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

8. In In re Wells Fargo Sec. Litig., 12 F.3d 922, 927 (9th Cir. 1993), the 9th Cir. held:

Wells Fargo responds that the Amended Complaint is deficient because it does not state how much the nine named corporations borrowed; when the loans were made; whether these loans were in default and, if so, when the default occurred; or whether reserves should have been established (but were not), and, if so, when and on what basis. However, this level of specificity is not required at the pleading stage.

Marksman also demonstrates the adequacy of the Complaint's accounting allegations. There, the court upheld improper revenue recognition allegations based on sales to a single customer. The Marksman plaintiffs alleged only "that defendants reported earnings on the sales of [Chantal's key product] to Stanson [a distributor] before such reporting was permitted under generally accepted accounting standards, which had the effect of inflating Chantal's income and artificially increasing its stock value." 927 F. Supp. at 1304.

9. In Head, the Santa Clara County Superior Court upheld virtually identical accounting allegations against NetManage. Downs Decl., Ex. 1, at 1.

10. Defendants' reliance upon Siegel v. Lyons, [1996-1997 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶99,227 (N.D. Cal. 1996), Leonard v. NetFrame Sys., Inc., [1995-1996 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶98,982 (N.D. Cal. 1995), and Stack v. Lobo, No. 95-20049, 1995 U.S. Dist. LEXIS 19966 (N.D. Cal. Apr. 19, 1995), is misplaced. The plaintiffs in those cases failed to plead any "direct evidence" of defendants' wrongdoing. For example, in Siegel, the plaintiffs alleged only that "'the Company's deferred revenue reported on its balance sheet declined significantly'" without pleading any facts explaining how or why that statement was false when made. Id. ¶99,227, at 95,223. Similarly, in Leonard, the plaintiffs did "not plead facts or circumstances to give rise to an inference that [NetFrame's] statements were false." ¶98,982, at 93,778-79.

Stack actually supports plaintiffs' position. In Stack v. Lobo, 903 F. Supp. 1361 (N.D. Cal. 1995), after the plaintiffs amended their complaint to add allegations regarding just two customers, the court held on a subsequent motion to dismiss that their complaint was actionable. The court rejected defendants' contention that plaintiffs were required to identify "any specific contemporaneous statements or documents known to Quickturn in early 1994 that should have alerted the company to Acri's and Ball's precarious financial situations." Id. at 1368. Further, the Stack court stated: "Plaintiffs need not plead detailed evidentiary facts that are in the sole possession and control of the Defendants." Id.

In re Ross Sys. Sec. Litig., No. C-94-0017, Order at 6 (N.D. Cal. Dec. 5, 1994), another case defendants cite, also favors plaintiffs' accounting claims. There, the court upheld a complaint which contained accounting fraud allegations no more particular than those here. Spiegler v. Wills, 60 F.R.D. 681, 682-83 (S.D.N.Y. 1973), is distinguishable as the plaintiffs there merely alleged a change in accounting "procedure -- from one accepted practice to another," without also alleging any GAAP violation. In contrast, plaintiffs here detail the GAAP standards NetManage's accounting practices violated. ¶¶133-44.

11. While NetManage's 1994 Annual Report represented that returns from distributors had been "insignificant," the 1995 Annual Report did not and could not make this statement, as defendants were well aware of the return contingencies which were still outstanding. See ¶140.

12. Defendants' assertions regarding what Arthur Andersen, L.L.P., NetManage's auditor, did or did not do is rank speculation. Nowhere is it alleged that Arthur Andersen endorsed, certified or even reviewed NetManage's 2Q95 or 3Q95 financial statements. Defendants cannot interject allegations into the Complaint which are not pled in order to obtain a dismissal. Indeed, defendants' "construction" necessarily presupposes that defendants told Arthur Andersen the truth, another unpleaded and improper conclusion.

13. GlenFed, 42 F.3d at 1548; Cherednichenko, Downs Decl., Ex. 2, at 3-4 (PSLRA does not alter 9th Cir. falsity pleading rules).

14. In a puzzling argument, defendants attempt to portray unspecified false statements as accurate statements of historical fact. Yet, the Complaint details how and why defendants' statements about NetManage and its financial performance and business prospects made in press releases, SEC filings and in conversations with securities analysts were misleading or false when made. For the reasons specified in ¶¶6-10, 37, 42-45, 47-48, 72, 81, 91, 102, 109, 118, 131 and 133-44, these statements were not harmless statements of historical facts. On the contrary, defendants' statements presented a misleading picture of NetManage's financial health and failed to disclose then-known adverse material facts, notwithstanding defendants' duty to make such facts public before selling their NetManage shares.

15. Thus, even a statement as allegedly "vague" or "general" as a defendant's representation that "`everything [is] going fine,'" is false and misleading under §10(b). Warshaw, 74 F.3d at 957-58; Hanon, 976 F.2d at 502 (projections of product's "`superior'" performance); Cooper, 122 F.3d at 1190 (representations that "business was strong," "demand was strong"); Kaplan, 49 F.3d at 1375-76 (representations that competitive position was "strong," "[p]rogress is excellent," "our outlook is bright" and "we see increased sales activity" as the "'market is responding favorably'" to a new product); Fecht, 70 F.3d at 1801 (representations that company "'feel[s] a little more optimistic about over near term future'" and sees an "overall improvement in the sales trends"); Gray v. First Winthrop Corp., 82 F.3d 877, 880 (9th Cir. 1996) (representations that company was "progressing `smoothly'").

16. Defendants argue nothing in the Complaint undermines Alon's pleasure with NetManage's financial condition and growth prospects. Defendants obviously overlook ¶¶6-10, 23(a), 26-28, 42-48, 53, outlining the contrary information available to Alon and establishing when he knew or reasonably should have known of it. Indeed, Alon had much to be displeased about concerning NetManage's revenue shortfall, marketing and price strategy failures, unchecked competition and slowing growth. His continued and unfounded optimism in light of this known adverse information makes his statements false.

17. See, e.g., Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1568-69 n.6 (9th Cir. 1990) (en banc).

18. See Cohen v. Koenig, 25 F.3d 1168, 1173 (2d Cir. 1994); Turkish v. Kasenetz, 27 F.3d 23, 28 (2d Cir. 1994); Breard v. Sachnoff & Weaver, Ltd., 941 F.2d 142, 143-44 (2d Cir. 1991), Cosmas v. Hassett, 886 F.2d 8, 12-13 (2d Cir. 1989). Prior to the PSLRA, other courts had previously applied a less stringent standard, but from the PSLRA's text, it is apparent that Congress adopted the 2d Cir.'s "strong inference" standard in preference to the other tests. Where a statutory test "contains a phrase that is unambiguous -- that has a clearly accepted meaning in both legislative and judicial practice -- we do not permit it to be expanded or contracted by the statements of individual legislators or committees during the course of the enactment process." West Virginia Univ. Hosps. v. Casey, 499 U.S. 83, 98-99 (1991).

19. In Marksman, 927 F. Supp. at 1311, defendants argued, as defendants do here, that a footnote in the Conference Committee demonstrates that Congress discarded the motive and opportunity test. The Court rejected this argument:

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

20. The Managers understood the PSLRA adopted the 2nd Cir. standard and preserved recklessness liability. Rep. Bliley, Manager for the House on the Conference Committee, confirmed that "[t]he conference report is careful not to change standards of liability under the securities laws." 14;the original House bill abolished liability for reckless conduct; the Senate bill did not, and the Senate position prevailed in conference." 141 Cong. Rec. S17984 (Dec. 5, 1995). Similarly, the Managers themselves confirmed that their Conference Report had "adopt[ed] . . . the Second Circuit standard" for pleading scienter. 141 Cong. Rec. S17959, col 2, S17957, col. 3 (Dec. 5, 1995). "This legislation, therefore, is using a pleading standard that has been successfully tested . . . in the real world." 141 Cong. Rec. S17957 (Dec. 5, 1995).

When Sen. Specter asked if the Conference Report repudiated 2nd Cir. case law, Sen. Dodd told him that it did not. "Basically, what we intended to do here was to codify the second circuit's pleading standards." 141 Cong. Rec. S17960 (Dec. 5, 1995). Sen. Domenici similarly explained that "the conference report adopts the pleading standard utilized by the second circuit court of appeals" and that among its advantages was the body of precedent applying the "strong-inference" standard: "This court-tested standard requires plaintiffs to plead facts in their complaint which give rise to a strong inference of securities fraud." 141 Cong. Rec. S17969 (Dec. 5, 1995). Sen. Grams, who served with Sens. Dodd and Domenici on the Conference Committee, confirmed that the legislation provided for "[c]odification of the pleading standard adopted by the second circuit court of appeals." 141 Cong. Rec. S17993 (Dec. 5, 1995).

21. Wiekel v. Tower Semiconductor Ltd., No. 96-3711, slip op. (D.N.J. Oct. 2, 1997) (Downs Decl., Ex. 4); Gilford Partners, L.P. v. Sensormatic Elecs. Corp., No. 96 C 4072, 1997 U.S. Dist. LEXIS 13724 (N.D. Ill. Sept. 5, 1997) (Downs Decl., Ex. 5); Galaxy Inv. Fund v. Fenchurch Capital Management, No. 96 C 8098, 1997 U.S. Dist LEXIS 13207 (N.D. Ill. Aug. 29, 1997) (Downs Decl., Ex. 6); Pilarczyk v. Morrison Knudsen Corp., 965 F. Supp. 311 (N.D.N.Y. 1997); In re Health Management Sec. Litig., 970 F. Supp. 192, 201 (E.D.N.Y. 1997) ("Second Circuit's pleading standard was not abrogated by the PSLRA."); OnBank & Trust Co. v. FDIC, 967 F. Supp. 81, 88-89 (W.D.N.Y. 1997) (PSLRA standard is based on 2nd Cir. precedent); In re Wellcare Management Group Sec. Litig., 964 F. Supp. 632, 638-40 (N.D.N.Y. 1997); Fugman v. Aprogenex, Inc., 961 F. Supp. 1190, 1195 (N.D. Ill. 1997) ("motive and opportunity" or "facts which 'constitute strong circumstantial evidence of conscious misbehavior or recklessness'" establish strong inference of scienter); Rehm v. Eagle Fin. Corp., 954 F. Supp. 1246, 1252 (N.D. Ill. 1997) ("§78-4(b)(2) adopts the Second Circuit standard"); Marksman, 927 F. Supp. at 1309 n.9, 1310-13 ("no basis to conclude that Congress altered the mental state requirement; "'motive and opportunity' test has not be discarded); Page v. Derrickson, No. 96-842-CIV-T-17C, 1997 U.S. Dist LEXIS 3673, at *27 (M.D. Fla. Mar. 24, 1997 (court applies "motive and opportunity" and "strong circumstantial evidence" test) (Downs Decl., Ex. 7); STI Classic Fund v. Bollinger Indus., No. 3-96-CV-823-R, 1996 U.S. Dist. LEXIS 21553, at *4 (N.D. Tex. Oct. 25, 1996) (Downs Decl., Ex. 8); Fischler v. AmSouth Bancorp., No. 96-1567-CIV-T-17A, 1996 U.S. Dist. LEXIS 17670, at *8 (M.D. Fla. Nov. 14, 1996) ("motive and opportunity" standard for raising a "strong inference" of scienter remains) (Downs Decl., Ex. 9).

22. A few contrary decisions, In re Silicon Graphics Sec. Litig., 970 F. Supp. 746 (N.D. Cal. 1997); Powers v. Eichen, [Current Binder] Fed. Sec. L. Rep. (CCH) ¶99,483, at 97,261 (S.D. Cal. 1997); Friedberg v. Discreet Logic, 959 F. Supp. 42 (D. Mass. 1997); Hockey v. Medhekar, [Current Binder] Fed. Sec. L. Rep. (CCH) ¶99,465 (N.D. Cal. 1997), mistakenly hold that the PSLRA eliminated the motive and opportunity test and recklessness liability. In all but one of these cases, although the court mistakenly held that recklessness is not sufficient, the complaints, containing allegations less detailed than here (and no allegations of financial fraud), were sustained under an "actual knowledge" standard.

23. Courts generally defer to the SEC's views in matters concerning the interpretation of the federal securities laws. See Basic, Inc. v. Levinson, 485 U.S. 224, 239 (1988).

24. Gross, ¶99,474, at 97,190 (where there was no insider trading, the court held allegations that defendants inflated the company's stock price in order to use inflated stock to acquire other companies sufficient to raise a strong inference of scienter); Harvey M. Jasper Retirement Trust v. Ivax Corp., 920 F. Supp. 1260, 1264 (S.D. Fla. 1995) (complaint upheld where false statements of Ivax were alleged as "Ivax planned to acquire McGaw [and] . . . the higher Ivax's stock price was, the fewer Ivax shares would have to be issued").

25. See Provenz, 102 F.3d at 1491 (one insider sold 20% of shares for $1.3 million, a second sold 90,000 shares, while a third (who made many of the false statements) sold 3,265 shares); Fecht, 70 F.3d at 1084 (sales of 30,000 shares for $1.6 million by 2 insiders); Kaplan, 49 F.3d at 1379 ($13.5 million in sales by 2 officers).

26. See Wellcare, 964 F. Supp. at 640 (allegations that corporate executive "had knowledge of, condoned, and/or encouraged . . . the deliberate overstatement of earnings by a number of means"); Rehm, 954 F. Supp. at 1255-56 (overstatement of earnings by persons responsible for calculating and releasing financial information shows scienter); Page, 1997 U.S. Dist. LEXIS 3673, at *30 (same); Marksman, 927 F. Supp. at 1313-14 (overstated revenues constituting a significant portion of total revenues raises a strong inference of scienter); Health Management, 970 F. Supp. at 203 (allegations that corporate insiders approved of plans for accounting fraud and false revenue recognition evidence scienter); Gross, ¶99,474, at 97,190 (allegation that corporate insiders engaged in a pervasive accounting fraud sufficiently alleged scienter).

27. These reports are identified, ¶¶42-47, 50-51, and their recipients specified. ¶¶23, 31, 37, 42-48, 50-51.

28. Analysts perform a function "necessary to the preservation of a healthy market." Dirks v. SEC, 463 U.S. 646, 658 (1983). The market relies on analysts to "'ferret out and analyze information,' . . . often . . . by meeting with and questioning corporate officers and others." Id. Thus, a company that provides false information to analysts can expect it to mislead not just them but the entire market. See Basic, 485 U.S. at 246 n.24; Dirks, 463 U.S. at 658-59 & n.17; Warshaw, 74 F.3d at 959; Fecht, 70 F.3d at 1080.

29. Defendants try desperately to distinguish Cooper as an inapplicable pre-PSLRA case. But, defendants do not even attempt to explain how the PSLRA affected pleading or liability standards for analyst statements. It did not and Cooper controls. Nor is defendants' purported factual distinction compelling. The mode of communication (a fax in Cooper) is unimportant; liability turns on the fact of a misleading communication to analysts.

30. Defendants' reliance upon In re Syntex Corp. Sec. Litig., 95 F.3d 922, 934 (9th Cir. 1996) and In re Stac Elecs. Sec. Litig., 89 F.3d 1399, 1411 (9th Cir. 1996), cert. denied, ___ U.S. ___, 117 S. Ct. 1105 (1997), is unavailing. Cooper and Warshaw confirm that Syntex and Stac cannot be interpreted as immunizing corporate insiders who mislead securities analysts and then avoid adopting or becoming entangled with the analysts' ultimate publication of defendants' false statement.

31. Compare ¶¶52-56, 84, 88, 94, 96, 100, 105, 115, 117 with In re Valence Tech. Sec. Litig., [1995 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶98,793, at 92,793 (N.D. Cal. 1995); In re Gupta Corp. Sec. Litig., 900 F. Supp. 1217, 1240-41 (N.D. Cal. 1994); In re Proxima Corp. Sec. Litig., [1993-1994 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶98,236, at 99,620 (S.D. Cal. 1994); see In re RasterOps Corp. Sec. Litig., [1994-1995 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶98,467, at 91,195 (N.D. Cal. 1994) (adoption manifest through reprint or distribution of reports).

32. Nothing in Central Bank, N.A. v. First Interstate Bank, N.A., 511 U.S. 164 (1994), undercuts the liability of any defendant alleged to have participated in a fraudulent scheme. See In re Software Toolworks Sec. Litig., 50 F.3d 615, 628 n.3 (9th Cir. 1995). Indeed, such participation is a primary violation of Rule 10b-5. As Central Bank stated: "In any complex securities fraud, moreover, there are likely to be multiple violators . . . ." 511 U.S. at 191. The PSLRA does not alter §10b liability in this regard.

33. Amaral also signed and thereby authorized the false 2Q95 and 3Q95 10-Qs. ¶¶73, 107.

34. Contrary to defendants' assertion, neither pre-existing case law nor the PSLRA requires plaintiffs to plead their sources. Facts and sources are two very different words, a distinction, the Silicon Graphics court mistakenly confounded. See Silicon Graphics, 970 F. Supp. at 767. Congress has made clear in enacting other securities laws that when it means the word "source," it uses it. See, e.g., 15 U.S.C. §78u(h)(2)(A)(v) ("impeding the ability of the Commission to identify or trace the source or disposition of funds"); 15 U.S.C. §78o-5(b)(2)(A) ("Such records shall describe . . . customary sources of capital . . . ."). In contrast, the PSLRA does not refer to "source." Congress required only that information and belief be supported by pleading all "facts" on which the belief was formed, and then only as to allegations regarding a "statement or omission," i.e., not to scienter. Moreover, forcing disclosure of plaintiffs' counsels' work product and confidential sources on this motion would deprive plaintiffs of the opportunity to seek Rule 26 protections embraced by Rule 11 and thereby the PSLRA.

I, the undersigned, declare:

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

2. That on December 9, 1997, declarant served the PLAINTIFFS' OPPOSITION TO DEFENDANTS' MOTION TO DISMISS AMENDED COMPLAINT by depositing a true copy thereof in a United States mailbox at San Diego, California in a sealed envelope with postage thereon fully prepaid and addressed to the parties listed on the attached Service List and that this document was forwarded to the following designated Internet site at:

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

4. Declarant also caused a true copy to be served via telecopier on defendants' counsel on December 9, 1997 and delivered a true copy to Federal Express for service on defendants' counsel on December 10, 1997.

I declare under penalty of perjury that the foregoing is true and correct. Executed this 9th day of December, 1997, at San Diego, California.