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

Lead Counsel for Plaintiffs





UNITED STATES DISTRICT COURT

NORTHERN DISTRICT OF CALIFORNIA





WALTER W. HEAD, III, et al., On Behalf of Themselves

and All Others Similarly Situated,

Plaintiffs,

vs.

NETMANAGE, INC., et al.,

Defendants.

__________________________________________

No. C-97-4385-CRB

CLASS ACTION


DATE: TBA

TIME: TBA

COURTROOM: The Honorable

Charles R. Breyer



PLAINTIFFS' OPPOSITION TO DEFENDANTS' MOTION TO

DISMISS THE SECOND AMENDED COMPLAINT



TABLE OF CONTENTS


I. INTRODUCTION

II. THE FACTUAL ALLEGATIONS OF THE COMPLAINT

III. THE COMPLAINT MEETS THE PSLRA'S PLEADING STANDARD AND CONFORMS WITH THIS COURT'S PREVIOUS GUIDANCE

IV. THE SO-CALLED NONSPEAKING DEFENDANTS ARE LIABLE FOR SECURITIES FRAUD

V. CONCLUSION



I. INTRODUCTION

To the detriment of thousands of investors, defendants' artificially inflated NetManage, Inc.'s ("NetManage") stock price between 7/25/95 and 1/11/96 (the "Class Period") in order to make multi-million dollar corporate acquisitions and unlawful insider sales exceeding $17.7 million. ¶¶1-8, 12, 36-38, 111.(1)

Defendants dismiss their fraudulent scheme despite plaintiffs' detailed allegations and significant amendments made in conformity with the Court's 2/24/98 Order ("Order").(2) Plaintiffs not only identify defendants' fraudulent assertions of NetManage's continued "success," "strong ongoing demand" and "strategic relationship" with Microsoft Corp. ("Microsoft") (¶¶6, 56, 65-66, 84), but also detail defendants' day-to-day management of NetManage (¶¶21-22, 24, 28-29, 33-34). They allege with particularity defendants' false statements (¶¶53-57, 61-74, 77-81, 83-89, 94), why these statements were false when made (¶¶24, 30, 58-59, 74-76, 91-92), and defendants' scienter (¶¶19, 25-29, 33-35). Plaintiffs' allegations surpass the pleading standard codified in the Private Securities Litigation Reform Act of 1995 ("PSLRA"). Taken as true, as they must be on a motion to dismiss, these allegations state actionable claims for the securities fraud perpetrated by all defendants. Defendants' motion should be denied.

II. THE FACTUAL ALLEGATIONS OF THE COMPLAINT

Founded by defendant Alon in 1990 and run by a small, hand-picked group of associates, NetManage develops and markets transmission control protocol/Internet protocol ("TCP/IP") software products. ¶1. NetManage's core products -- brand-named Chameleon and accounting for 90% of the Company's revenue -- are TCP/IP-based applications designed to facilitate network connections. ¶¶1, 2, 31. Initially, NetManage effortlessly sold Chameleon packages to large corporate accounts. TCP/IP, however, is an open, non-proprietary system which could not be protected by patent. ¶¶1-2.

In 1994, Microsoft incorporated the TCP/IP applications in test versions of its then-forthcoming Windows 95 ("Win95") operating system. ¶¶2, 8. At the same time, Netscape Communications, Inc. ("Netscape") was preparing to offer, free of charge, its own Internet browser and applications which would supplant many Chameleon functions. ¶8. Alon and his insular management group, who had lavished themselves with millions of dollars of stock options, learned from internal testing and customer reports that Microsoft and Netscape's new products would disrupt NetManage's niche market and undermine future marketing plans. ¶¶8, 30, 35. To overcome this desperate situation, defendants schemed to artificially inflate NetManage's stock price via a public relations campaign of positive information. Early in 1995, NetManage's insiders sold hundreds of thousands of shares of their NetManage stock at inflated prices. ¶¶4, 43. But, by 5/95, defendants' insider selling and investor concerns about 1Q95 results drove NetManage's stock price from over $20 down to only $13. ¶¶5, 12, 44.

This price decline stopped the insiders' personal NetManage stock sales and made it difficult and expensive to use the Company's stock for corporate acquisitions. ¶¶5, 37, 41, 44. As NetManage was unable to timely develop new applications or products and was internally aware of forthcoming competitive threats (¶¶30, 35, 36-37), such acquisitions were necessary to differentiate the Company's products from the Microsoft and Netscape offerings and to replace lost sales revenue (¶¶3, 30, 35-38). Lacking any available new product, defendants initiated the fraudulent scheme detailed in the Complaint to boost NetManage's stock price.

On 7/25/95, defendants launched their campaign to flood the market with positive statements about NetManage. ¶¶6, 53-55. Defendants misrepresented that NetManage was "successfully" pursuing a major international expansion in Europe and Japan, had expanded domestic distribution channels and was enjoying "continued success" in the retail market, all of which, defendants assured, were leading to dramatic increases in NetManage's 1995 revenue and earnings per share ("EPS"). ¶¶6, 47, 53-55, 66, 72, 80, 87. Defendants also represented that NetManage's new ECCO product was a "big success," its core Chameleon connectivity products were enjoying continuing "strong sales" and, as a result, NetManage was the "leader in TCP/IP applications software" and the "fastest growing public software company in the United States." ¶¶6, 55-56, 62-63, 65-66, 70-72, 78-79, 82, 84-86. They falsely asserted Win95 would be "a great advantage" for NetManage and, rather than undercut the Company's profits, would significantly increase the market and demand for NetManage's products. ¶¶6, 56, 58, 65, 84.

Defendants furthered their scheme by falsely reporting very strong 2Q95 and 3Q95 revenue and EPS growth. ¶¶7, 30, 53, 70. In truth, NetManage had improperly recognized millions of dollars of revenue on incomplete or contingent sales. ¶¶99-109. Defendants also falsely represented that the 2Q and 3Q results fairly presented NetManage's performance in conformity with Generally Accepted Accounting Principles ("GAAP"), were due to the strong ongoing demand for NetManage's products and the success of NetManage's international expansion, and demonstrated that Win95 had not hurt NetManage's business. ¶¶6, 53, 70, 99. Finally, defendants publicly projected that NetManage would achieve 95, 96 and 97 EPS of $.68-$.71, $1.00-$1.05, and $1.50+, respectively. ¶¶6, 54-55, 57, 63, 65, 67-68, 71-74, 79-80, 86-89, 94.

Defendants' misconduct drove NetManage's stock to a Class Period high of $34 by 12/95. ¶¶7, 10. As the stock traded at artificially inflated levels, defendants resumed their insider bailout. ¶¶7, 60, 82. Between 7/27/95 and 9/1/95, immediately after NetManage reported very strong 2Q95 results, defendants sold over $10.7 million of NetManage shares in unlawful insider trading. Then, during 10/95-11/95, immediately after NetManage reported improved 3Q95 results, defendants sold another $6.6 million of their NetManage stock. Id.

At the same time, defendants used the artificially inflated NetManage stock to acquire software companies in a desperate attempt to recapture market share and diversify NetManage's products. ¶¶3, 37, 41. In 10/95 and 11/95, defendants issued 1.44 million NetManage shares to acquire Syzygy Communications, Inc. ("Syzygy"), and AGE Logic, Inc. ("AGE"). ¶¶7, 13, 38, 64. By artificially inflating NetManage's stock price, defendants were able to make these acquisitions using only half the shares of NetManage stock the Company would have had to issue just six months before. ¶¶38, 41. This enabled defendants to acquire AGE and Syzygy on extremely favorable terms, without diluting Alon's control of the Company or the other defendants' stockholdings. ¶¶7, 37, 39.

While defendants scheme was successful, their efforts to solve the Company's numerous problems were not. Unwilling to suffer the consequences of revealing the true state of the Company's business, even into 12/95, defendants falsely represented that NetManage had in fact had a good 4Q95, and would still achieve 4Q95 EPS of $.19-$.21. ¶¶10, 85-90, 94-95. Finally, on 1/12/96, after NetManage's outside auditors discovered the improperly recognized revenue, defendants were forced to reveal NetManage's 95 EPS would be far below the levels previously projected. ¶¶10, 96. On this news, NetManage's stock collapsed, falling over 33% in one day, to just $10. Subsequently, except for 2Q96 when NetManage again fraudulently inflated its stock from $9-3/4 to $18-7/8, NetManage has reported horrible financial results, and currently trades below $2 per share. ¶¶97-98.(3)

III. THE COMPLAINT MEETS THE PSLRA'S PLEADING STANDARD AND CONFORMS WITH THIS COURT'S PREVIOUS GUIDANCE

Pleading falsity under the PSLRA requires identification of the false statements and why they were false when made. 15 U.S.C. §78u-4(b)(1). So have 9th Cir. decisions.(5) Allegations of internal problems undermining optimistic claims are sufficient "to explain how the claims are false." Fecht v. Price Co., 70 F.3d 1078, 1083 (9th Cir. 1995); Warshaw v. Xoma Corp., 74 F.3d 955, 960 (9th Cir. 1996) (same).

The Complaint pleads the known internal problems which demonstrate defendants' statements were false. ¶¶8-9, 21, 29-30, 37 (weakening Chameleon sales/poor ECCO sales); ¶¶58-59, 75-76, 91-92 (adversely and materially reduced market share resulting from Win95's and Netscape's browser introductions); ¶¶99-109 (falsified 2Q95 and 3Q95 financial statements). Thus, contrary to defendants' arguments, these are not "generalized" allegations which simply proclaim the opposite of NetManage's public disclosures. "Because 'falseness is clear from the facts that had existed all along and were later revealed,'" Cooper v. Pickett, 137 F.3d 616, 625-26 (9th Cir. 1998), these allegations are sufficient.

Defendants' rhetoric to the contrary, plaintiffs have not obtained full discovery in this action. The limited information received from a related state court action over defendants' repeated opposition is principally only relevant to those plaintiffs' California state law claims in that case. Thus, a higher level of scrutiny cannot be applied to the pleadings in this case, as defendants contend, simply because plaintiffs successfully investigated their state claims. Had Congress intended for courts to apply a more rigorous standard in cases where plaintiffs obtain investigative materials, it would have stated so. Because it did not, defendants' invitation for this Court to legislate and create one should be denied.

The instant Complaint's highly particularized pleading of defendants' fraud satisfies the PSLRA's requirement that "the complaint shall state with particularity all facts on which that belief is formed." 15 U.S.C. §78u-4(b)(1)(B).(6)

This standard is modeled after the information-and-belief pleading standard established by the 2d Cir. and 9th Cir. long before the PSLRA was enacted. Wool v. Tandem Computers, Inc., 818 F.2d 1433, 1439 (9th Cir. 1987) (information-and-belief allegations must be sustained "if the allegations are accompanied by a statement of the facts upon which the belief is founded").(7) Information-and-belief allegations are adequate if "[e]ach alleged misstatement is identified by content, date, and the document or announcement in which it appeared," and if they specify "the manner in which such representations were false and misleading." Wool, 818 F.2d at 1440. Here, the Complaint sets forth each misrepresentation (¶¶6, 9, 53-57, 61-74, 77-90), what was said and when (id.), and who said it and why the statement was false (¶¶8, 58-59, 75-76, 91-92, 99-109). This satisfies the PSLRA's information-and-belief standard in a corporate fraud case.

Plaintiffs need not plead their "sources" for the facts alleged. Defendants' Motion to Dismiss the Second Amended Complaint ("MTD") at 4-5. Nothing in the PSLRA's pleading requirement suggests that plaintiffs are required to disclose the identity of confidential sources.(8) If Congress had intended to create a drastically heightened information-and-belief provision, requiring plaintiffs to identify sources in order to state a claim, it would have so stated. See, e.g., 2 U.S.C. §691(b)(2) (expressly requiring consideration of "sources" of information); 15 U.S.C. §782(a)(5) (disclosure of the "exact nature, extent, and sources of data"). The identity of witnesses who were interviewed during counsel's investigation reveal an attorney's mental impressions and is, therefore, opinion work product.(9) Requiring identification of confidential sources in a complaint would eliminate work product or other Rule 26 protections. Indeed, not even Rule 11 requires public disclosure of sources. Zapata Gulf Marine Corp. v. Puerto Rico Maritime Shipping Auth., 133 F.R.D. 481, 486 (E.D. La. 1990) (permitting in camera inspection under Rule 11).

Defendants' improper recognition of revenue states a classic §10(b) violation. Provenz v. Miller, 102 F.3d 1478, 1484 (9th Cir. 1996) (improper revenue recognition and GAAP violations constitute material misstatement).

Both 9th Cir. and PSLRA precedents have resoundingly upheld financial fraud allegations strikingly similar to those here.(10) For example, 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." 137 F.3d at 626. Affirming the allegations' sufficiency, the 9th Cir. held:

Id. at 627.

The instant Complaint's accounting allegations parallel those in Cooper. The Complaint identifies who (34 NetManage customers (¶¶34, 99)), what (improper revenue recognition (¶¶8, 11, 58, 75, 91, 99, 105)), when (2Q95 and 3Q95 (¶¶11, 53, 70, 99, 104)), and where (reported in financial statements (¶¶53, 70, 99, 103, 104)). It also alleges defendants misled investors by inflating NetManage's revenues and EPS by specific amounts ($2 million and $.03 per share (¶104)), and by falsely claiming that its revenue recognition policy was consistent with GAAP ("how" (¶¶6, 101-02)).(11)

Defendants can do no more than quibble about these allegations. They object that the Complaint does not state "[w]hich sales to which customers were fraudulent," or "[w]hat were the amounts of the challenged sales." MTD at 9. 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." 137 F.3d at 627.

Id. It is enough that "the complaint point to specific quarters and specific customers, and provide dollar figures for each quarter." Id.; In re Wells Fargo Sec. Litig., 12 F.3d 922, 926-27 (9th Cir. 1993) (declining to require allegations of "when" loans were made or "how much" was borrowed). This plaintiffs have done. ¶¶99-105, 107-108.(12)

NetManage's improper recognition of $1.2 million of 3Q95 revenue on sales to "Japanese customers, includ[ing] Forval, Sumitomo, and NetOne" (¶105), that were not delivered until "after the end of the quarter," is also actionable. Under GAAP, "[t]he earnings process must be substantially completed and an exchange must have occurred before revenues can be recognized." Provenz, 102 F.3d at 1484. Defendants' contrary argument is at odds with accounting principles which mandate a product shipment is not a sale without customer acceptance and the passing of ownership's risks and rewards to the buyer. FASB Statement of Concepts No. 5, ¶84. Here, because Forval, Sumitomo and NetOne did not actually accept shipment of NetManage products until after the beginning of 4Q95, defendants violated GAAP and NetManage's own revenue recognition policy by prematurely recognizing revenues on those "sales." ¶105.

That NetManage's outside auditor, Arthur Andersen ("AA"), eventually issued a clean opinion on NetManage's FY95 financial statements is irrelevant. Plaintiffs challenge the accuracy of NetManage's unaudited 2Q95 and 3Q95 financial statements, about which defendants made optimistic but false statements. ¶¶99-109. In Provenz, 102 F.3d at 1491, the 9th Cir. held that where "defendants failed to disclose material information to their accountants," the defendants "will not be able to rely on the accountant's advice as proof of good faith." Here, defendants, each of whom reviewed weekly "Bookings Reports" and "Revenue Trend Analysis Reports" (¶26) containing the Company's information regarding when each sale was completed, were aware of or recklessly disregarded that NetManage's 2Q95 and 3Q95 earnings were materially overstated.(13) ¶¶28, 29-31. Based on their review of "Bookings Reports" and "Revenue Trend Analysis Reports," defendants actually knew that any "unqualified" AA opinion on NetManage's unaudited financial statements would be tainted because AA was working with erroneous revenue figures.

This case involves more than accounting fraud. Defendants also inundated the financial market with false statements about NetManage's business, products, and future prospects. E.g., ¶¶6, 54, 55, 57, 65, 67. Against the backdrop of apparent (but fraudulent) financial success, defendants told analysts and investors that NetManage's business was performing well and was on track for strong 3Q95, 4Q95, FY95 and FY96 earnings gains. E.g., ¶¶6, 53, 54 56, 62, 64, 65, 70, 71, 78, 79, 103. In truth, the purportedly good financial results reflected nothing more than fraudulent accounting (¶¶99, 103, 104), which alone explains why statements attributing strong results to various business factors were false (¶¶58(m), 75(n), 91(k), 103-104).

Defendants denigrate plaintiffs' detailed allegations, arguing the Complaint is devoid of internal documents or other information which demonstrate the falsity of defendants' statements. Plaintiffs, however, have specified the adverse "conditions" or "problems" inside NetManage which rendered defendants' statements false when made:

¶¶8, 58, 75, 91, 99. These allegations exceed the PSLRA's falsity standard.

According to defendants, statements that "NetManage revolutionizes the corporate internet," "is the leader in TCP/IP software," and is "the fastest growing software company" are too vague to be actionable. MTD at 13 n.6. Yet statements like these, made in connection with specific earnings projections (¶¶6, 54, 65, 86), are much more than "mere optimism." Cooper, 137 F.3d at 623; Casella v. Webb, 883 F.2d 805, 808 (9th Cir. 1989) ("[w]hat might be innocuous 'puffery' . . . standing alone may be actionable as an integral part of a representation of material fact when used to emphasize and induce reliance upon such representation"). Even general optimistic expressions may be actionable "if not genuinely and reasonably believed, or if the speaker is aware of undisclosed facts that tend seriously to undermine the statement's accuracy." Cooper, 137 F.3d at 620.(14) The adverse contemporaneous conditions undermining defendants' positive statements are alleged here. ¶¶6, 54, 65, 86. Accordingly, none of defendants' positive statements should be dismissed at the pleading stage.

Section 21D(b)(2) of the Exchange Act requires plaintiffs to plead facts giving rise to a "strong inference" of scienter. 15 U.S.C. §78u-4(b)(2). A "strong inference" of scienter is created by pleading facts showing defendants' motive and opportunity to commit fraud or circumstantial evidence showing reckless or conscious misbehavior.(15) While defendants cite SGI to challenge this standard, most courts, the SEC and the PSLRA's principal drafters agree this is the PSLRA pleading standard.(16) The Complaint's allegations, however, more than adequately allege scienter under any standard.

The Complaint alleges that defendants materially overstated NetManage's 2Q95 and 3Q95 revenues and EPS. ¶¶8, 29, 99, 103-105, 109. These allegations raise a strong inference of scienter. Bell v. Fore Sys., Inc., [Current Binder] Fed. Sec. L. Rep. (CCH) ¶90,244, at 91,068 (W.D. Pa. 1988) (allegations that defendants "engaged in improper [revenue recognition] practices in violation of GAAP" to "fraudulently conceal the deteriorating state of the Company's business and to artificially inflate its financial statements" raise a "strong inference of knowing or conscious behavior"), adopted by district court, 1998 U.S. Dist. LEXIS 9589 (W.D. Pa. 6/29/95); In re Ancor Communications, Inc. Sec. Litig., [Current Binder] Fed. Sec. L. Rep. (CCH) ¶90,251, at 91,107 (D. Minn. 1998) (allegations that defendants recorded revenue from various transactions with "liaisons" who had no obligation to pay until the products were ultimately sold to end-users raise a strong inference of scienter); Digi, 6 F. Supp. 2d at 1096-98 (allegations of improper accounting methods, artificially inflated earnings, and the concealment of material facts raise a strong inference of conscious misconduct and constitutes evidence of scienter).(17)

Knowledge of falsity also may be inferred from defendants' positions as NetManage's top officers, directors and members of the Company's insular management group, and from their access to adverse internal information. Ancor, ¶90,251, at 91,108 (holding company insiders are likely to have knowledge of problems associated with their company's "significant" products or transactions, resulting in a strong inference of defendants' conscious behavior); Digi, 6 F. Supp. 2d at 1097-98 (holding plaintiffs pled "strong circumstantial evidence of conscious behavior" by alleging defendants' positions of control and responsibility, failure to disclose problems with an important acquisition and insider stock sales, and the truth's impact on the company's stock price); Epstein, 993 F. Supp. at 1425 (holding knowledge of critical facts or transactions may be attributed to the company and its key officers); Warman, ¶90,167, at 90,528 (inferring knowledge from defendants' senior positions); Cherednichenko, ¶90,108, at 90,143 (inferring knowledge from the defendants' positions as senior officers and directors, receipt of internal reports, and attendance at board of directors' meetings).(18)

Here, plaintiffs allege numerous adverse conditions which defendants concealed while making false statements about NetManage's business: (1) NetManage's quarterly financial results were falsified and materially overstated; (2) NetManage's sales were declining materially as a result of Win95's introduction which incorporated a TCP/IP stack; (3) VARs were pushing other products; (4) Microsoft and Netscape were competing with and beating NetManage; (5) NetManage's management could not successfully establish marketing, product or pricing strategies to distinguish its product); and (6) NetManage's international, particularly its Japanese, and domestic expansion efforts drained capital without positive results. ¶¶8, 58-59, 75-76, 91-92, 99-109. This information was known to defendants from identified NetManage reports, "ECCO" file records, weekly staff meetings, "action item" discussions, and management conversations. ¶¶21, 23, 26-30. Plaintiffs here allege more than "generic" reports; they identify (even though not required) each report by NetManage's own title, subject matter and recipients, where available. In re Bausch & Lomb Sec. Litig., 941 F. Supp. 1352, 1361 (W.D.N.Y. 1996) (plaintiffs may plead scienter without identifying specific internal documents).(19)

Finally, the short time between defendants' last positive statement on 1/5/96 and NetManage's 1/12/96 revelations, only one week, is itself probative of fraud. ¶¶94, 95.(20)

Allegations that a corporate defendant utilized its inflated stock for corporate acquisitions raise a strong inference of scienter. In re Time Warner Sec. Litig., 9 F.3d 259, 269-70 (2d Cir. 1993); In re Cirrus Logic Sec. Litig., 946 F. Supp. 1446, 1477 (N.D. Cal. 1996) (denying summary judgment motion because plaintiffs cited several motives for fraud, including the desire to insure a favorable exchange ratio in a merger).

In Gross, 977 F. Supp. at 1472, a case with no insider trading, the court found both motive and a "'strong inference' of conscious deceit" where defendants "knowingly made numerous false and misleading statements in order to inflate the value of its stock which, in turn, allowed [d]efendants to acquire other companies it would not have been able to acquire had the value of its stock not been at sufficiently high levels." And in Voit v. Wonderware Corp., 977 F. Supp. 363, 373 (E.D. Pa. 1997), plaintiffs alleged "conscious behavior" where Wonderware benefited from purchasing another company with inflated shares of Wonderware stock. Other courts have sustained similar allegations.(21)

Here, defendants inflated NetManage's stock so they could buy Syzygy and AGE cheaply while minimizing dilution of defendants' stockholdings. ¶¶37, 39, 41. Syzygy and AGE were huge acquisitions for NetManage. The Syzygy deal was worth $8.6 million, while AGE cost $22 million. ¶38. NetManage's stock price inflation allowed it to issue at least 3 million fewer shares to accomplish these acquisitions. ¶38. This is a specific economic benefit that the defendants could rationally expect to achieve -- acquiring Syzygy and AGE for fewer NetManage shares -- at a time when NetManage had no currency but its own stock to use. Such facts demonstrate an opportunity to achieve "concrete benefits by the means alleged." Shields v. Citytrust Bancorp., 25 F.3d 1124, 1130 (2d Cir. 1994); Cohen, 25 F.3d at 1174 ("It hardly requires a stretch of the imagination to infer that the would-be purchasers in such circumstances had a motive to paint a far rosier financial picture than actually existed in order to induce [Eastern's owners] to part with a sizeable portion of their assets in exchange for a note.").

Insider trading is a motive and, when suspicious in amount or timing, raises an inference of scienter. Wells Fargo, 12 F.3d at 931; Wellcare Mgmt., 964 F. Supp. at 639; Marksman, 927 F. Supp. at 1312. Insider sales of 915,499 shares of NetManage stock at artificially inflated prices for proceeds of $17.7 million are, in the aggregate, massive by any measure. ¶¶13, 60, 82, 111. Kaplan, 49 F.3d at 1379; Provenz, 102 F.3d at 1491.

Defendants ask the Court to rule, as a matter of law, that the suspicious timing and amount of their stock sales were simply mere coincidence. MTD at 14-16. However, defendants ignore the nonpublic adverse facts concerning NetManage's fraudulent accounting practices and collapsing sales alleged to be known by them when they sold their stock at artificially inflated prices. ¶¶8, 22, 26-27, 31-33, 58-59, 75-76, 91-92, 99-109. Additionally, the pattern of insider sales establishing scienter in Provenz, Fecht and Kaplan pales in comparison with the insider sales here. No matter how measured, the insider selling here is greater in number of selling insiders (7), the amount sold (915,499 shares), and the proceeds received ($17.7 million).(22) ¶¶13, 18, 111. Worse yet, to capitalize fully on the artificial price inflation they created, defendants timed their NetManage stock sales to follow closely the Company's positive announcements in late 7/95-8/95 and late 10/95-11/95, and to conclude before NetManage's fraud was publicly disclosed. ¶¶60, 82, 96, 111.

Contrary to defendants' argument, Koretz was "an employee of NetManage" (¶18(g)) when he unloaded $3.4 million worth of his personal NetManage stock while aware of the nonpublic adverse information alleged (¶¶21, 24, 26, 28). Furthermore, Amaral's failure to sell NetManage stock does not negate scienter as to any defendant. Insider trading is not a prerequisite to finding scienter.(23) Finally, that Alon did not liquidate more of his NetManage shares at the top of the market is of no moment. On the contrary, Alon's "restraint" is consistent with an intent to defraud:

In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1427 (9th Cir. 1994).(24)

Defendants attach an improper and unverified chart which purportedly reflects the number of vested options they held and contend that these holdings negate any motive to commit fraud as a matter of law.(25) The deficiencies of this argument at this procedural stage are numerous. First, the chart is unverified, unsubstantiated, and constitutes extraneous self-serving information improperly raised on a motion to dismiss. Second, a vested stock option is not the equivalent of a share of common stock. ¶¶113-120.(26) Third, option holders do not face the same risks of loss as do owners of common stock. Options can always be repriced, often by the largest option holders themselves, to guarantee a profit, even if a company's stock price falls. ¶¶117-118.(27) For these reasons, defendants' "options" argument cannot defeat plaintiffs' Complaint.

Plaintiffs' prior allegations of false statements made to securities analysts were dismissed without prejudice because the Court found they had not been pleaded with sufficient particularity. Order at 1. This deficiency has been remedied in this Complaint, which sets out: (a) the dates, places and times defendants Alon and Amaral met with securities analysts and the subjects they discussed (¶¶47, 50, 54, 57, 63, 65, 71, 73); (b) the analysts' reports these defendants received for review and approval, which they did in fact review and approve, before publication of the reports (¶57); and (c) the specific EPS projections that Alon and Amaral provided to securities analysts for dissemination to the market (¶¶54-55, 57, 71-73).

The 9th Cir. reaffirmed the actionability of such allegations in Cooper, 137 F.3d at 624: "[T]hird-party securities analysts' reports, prepared with information provided by defendants, may be a basis for 10b-5 liability." The 9th Cir. rejected the same argument defendants make here that false statements made to "analysts, money and portfolio managers, institutional investors and large NetManage shareholders," (¶71), are not statements to the market. 137 F.3d at 624; Warshaw, 74 F.3d at 959 ("[a company] cannot escape liability simply because it carried out its alleged fraud through the public statements of third parties"); Cirrus, 946 F. Supp. at 1467 ("a company may be liable under Rule 10b-5 for its own . . . misrepresentations to analysts that reach the market, whether or not the company adopts the resulting analysts' reports"); Bryant, ¶90,275 at 91,252 (same).(28) Even though not required, the Complaint alleges defendants' "adoption" of analysts' reports. Compare ¶57 with In re Valence Tech. Sec. Litig., [1995 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶98,793, at 92,794 (N.D. Cal. 1995), and In re Gupta Corp. Sec. Litig., 900 F. Supp. 1217, 1237-38 (N.D. Cal. 1994).

IV. THE SO-CALLED NONSPEAKING DEFENDANTS ARE LIABLE FOR SECURITIES FRAUD

Defendants seek to immunize Bosch, Galil, Koretz and Williams from liability because they allegedly did not make any false statements. MTD at 18-20. This is incorrect.

In this Circuit, false statements in SEC filings, press releases and other "group published information" is presumptively the collective work of corporate officers and directors. In re GlenFed, Inc. Sec. Litig., 60 F.3d 591, 593 (9th Cir. 1995) ("GlenFed II"); Wool, 818 F.2d at 1440.(29) Here, Bosch, Galil, Koretz and Williams managed NetManage's daily affairs (¶¶18, 20-31, 35), deliberately published NetManage's publicly reported false 2Q95 and 3Q95 financial statements (¶¶20, 22, 24, 29-30, 99, 107), and profited from insider trading (¶¶12-13, 18, 60, 82, 111). Each is responsible for NetManage's false group-published reports and statements.(30)

Defendants Bosch, Galil, Koretz and Williams are also liable under §10(b) because they sold NetManage shares for millions in proceeds based on nonpublic adverse information, thereby profiting from a deceptive act within the scheme to defraud,(31) U.S. v. O'Hagan, 117 S. Ct. 2199, 2201 (1997) ("Trading on [inside] information qualifies as a `deceptive act' under §10(b)."); U.S. v. Smith, [Current Binder] Fed. Sec. L. Rep. (CCH) ¶90,274, at 91,243 (9th Cir. 1998) ("§10(b) . . . [is] violated when a corporate insider trades in the securities of his corporation on the basis of material, non-public information").(32) ¶¶12-13, 18, 60, 82, 111.

V. CONCLUSION

For the reasons stated above, defendants' motion should be denied.(33)

DATED: September 24, 1998

Respectfully submitted,



MILBERG WEISS BERSHAD

HYNES & LERACH LLP

ALAN SCHULMAN

JAMES A. CAPUTO

TRAVIS E. DOWNS, III

TOR GRONBORG







______________________________

TRAVIS E. DOWNS, III



600 West Broadway, Suite 1800

San Diego, CA 92101

Telephone: 619/231-1058



Lead Counsel for Plaintiffs

NETMANAG\DB00860.BRF

DECLARATION OF SERVICE BY MAIL

PURSUANT TO NORTHERN DISTRICT LOCAL RULE 23-2(c)(2)


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 September 25, 1998, declarant served the PLAINTIFFS' OPPOSITION TO DEFENDANTS' MOTION TO DISMISS THE SECOND 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:

http://securities.milberg.com

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

I declare under penalty of perjury that the foregoing is true and correct. Executed this 25th day of September, 1998, at San Diego, California.



______________________________

DEBORAH D. HAYES

1. "¶__" references are to the Second Amended Complaint ("Complaint"); emphasis is added and citations omitted unless otherwise indicated.

2. Defendants are NetManage, Zvi Alon (Chairman/CEO/Pres.), Walter Amaral (SVP/CFO), Uzia Galil (Director), Amatzia Ben-Artzi (VP/Bus. Develop.), John Bosch (Director), Richard Koretz (VP/Sales), Robert Williams (VP/Marketing) and Dan Geisler (VP/Int'l Marketing).

3. Defendants' fraud during 2Q96 is the subject of a related §10(b) class action, Molinari v. NetManage, Inc., No. C-98-202-CRB.

4. Courts must still apply Rule 12(b)(6) principles to motions to dismiss securities class action cases. In re Olympic Fin. Ltd. Sec. Litig., No. 97-496 (MJD/AJB), slip op. at 3 (D. Minn. 9/10/98); In re Boeing Sec. Litig., No. C97-17152Z, slip op. at 5-6 (W.D. Wash. 9/8/98) (Declaration of Travis E. Downs, III in Support of Plaintiffs' Opposition to Defendants' Motion to Dismiss the Second Amended Complaint ("Downs Decl."), Exs. 1-2).

5. In re GlenFed Inc. Sec. Litig., 42 F.3d 1541, 1548 (9th Cir. 1994) (en banc) ("The plaintiff must set forth what is false or misleading about a statement, and why it is false," and an "explanation as to why the statement or omission complained of was false or misleading.").

6. These allegations are based on counsel's investigation. Other courts have upheld similar allegations. Cherednichenko v. Quarterdeck Corp., [Current Binder] Fed. Sec. L. Rep. (CCH) ¶90,108, at 90,142 n.3 (C.D. Cal. 1997) (allegations based on counsel's investigation "not on information and belief"); Warman v. Overland Data, [Current Binder] Fed. Sec. L. Rep. (CCH) ¶90,167, at 90,529 (S.D. Cal. 1998) (same).

7. In re Digi Int'l, Inc. Sec. Litig., 6 F. Supp. 2d 1089, 1097 (D. Minn. 1998) (The PSLRA does not require "each and every 'information and belief' allegation [to] be supported by underlying documentary evidence."); In re Cephalon Sec. Litig., [1997 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶99,562, at 97,799 (E.D. Pa. 1997) ("[The PSLRA] does not require pleading all of the evidence and proof thereunder supporting plaintiff's claim.").

8. Plaintiffs respectfully submit that In re Silicon Graphics, Inc. Sec. Litig., 970 F. Supp. 746 (N.D. Cal. 1997), appeal pending, No. 97-16240 (9th Cir.) ("SGI"), is incorrectly decided. The SGI court held that "facts" meant "sources" based on statements of two Congressmen opposing a different information-and-belief pleading provision in an earlier version of the PSLRA, which required a plaintiff to plead "all information" not just "all facts." "Facts" is narrower than "information" and thus deletion of "all information" in favor of the narrower "all facts" language in the PSLRA strongly supports the conclusion that "all facts" does not include "all sources of all facts."

9. Hickman v. Taylor, 329 U.S. 495, 522 (1947) (the work-product doctrine protects information regarding which witnesses were contacted or interviewed by the attorney).

10. Cooper, 137 F.3d at 626 ("A company that 'substantially overstates it[s] revenues by reporting consignment transactions as sales . . . mak[es] false or misleading statements of material fact.'"); Miller v. Material Sciences Corp., 1998 U.S. Dist. LEXIS 10052, at *11-*12 (N.D. Ill. 6/25/98) (financial fraud allegations upheld under PSLRA); Digi, 6 F. Supp. 2d at 1096 (same); Zuckerman v. Foxmeyer Health Corp., 4 F. Supp. 2d 618, 623 (N.D. Tex. 1998) (same); Gross v. Medaphis Corp., 977 F. Supp. 1463, 1472 (N.D. Ga. 1997) (same); Marksman Partners, L.P. v. Chantal Pharm. Corp., 927 F. Supp. 1297, 1306 (C.D. Cal. 1996) (upholding allegations under the PSLRA "that defendants reported earnings on the sales of [a defendants key product] to [a distributor] before such reporting was permitted under [GAAP]," which artificially inflated defendants' stock value).

11. These allegations do not simply reflect, as defendants contend, a change from one permissible accounting method to another. MTD at 8. Whether or not NetManage's revenue recognition policies in FY94 and FY95 embrace permissible accounting principles in the abstract is irrelevant. Plaintiffs have alleged that unresolved contingencies throughout 2Q95 and 3Q95 were not properly treated under NetManage's existing 94 revenue recognition policy. ¶108. This is the gravamen of plaintiffs' allegations. Defendants' challenge to the materiality of plaintiffs' allegations must also fail. MTD at 8. The 9th Cir. has repeatedly held that materiality is a question for the trier of fact, holding that "only if . . . the materiality of the statement is 'so obvious that reasonable minds [could] not differ' are these issues 'appropriately resolved as a matter of law.'" Fecht, 70 F.3d at 1081; Warshaw, 74 F.3d at 957; see 17 C.F.R. §210.4-01(a)(1) (financial statements not in accordance with GAAP presumed misleading).

12. Defendants' cases are not to the contrary. In fact, In re Ross Systems, Inc. Sec. Litig., [1993-1994 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶98,363 (N.D. Cal. 1994), actually supports plaintiffs' Complaint. See In re Ross Systems, Inc. Sec. Litig., 1994 U.S. Dist. LEXIS 20385, at *6-*7 (N.D. Cal. 12/5/94) (upholding amended complaint which contained allegations no more particular than those alleged here). In Stack v. Lobo, 903 F. Supp. 1361, 1368 (N.D. Cal. 1995), the court upheld the amended complaint's accounting allegations because plaintiffs identified two customers and specified the amounts overstated in the defendants' financial statements. Defendants' reliance upon Zeid v. Kimberley, 973 F. Supp. 910 (N.D. Cal. 1996), appeal pending, No. 97-16070 (9th Cir.), and In re Oak Tech Sec. Litig., 1997 WL 448168 (N.D. Cal. 7/1/97), is also misplaced. There, unlike here, plaintiffs made only conclusory and general allegations of financial fraud. See Zeid, 973 F. Supp. at 922-23 (alleging only "unsupported estimates of 'improper' sales"); Oak, 1997 WL 448168, at *8 (alleging only names of "chief customers").

13. Defendants also received "Daily Trading Reports" (¶23), "Monthly Sales Analysis by Product and Time" (¶26), "Domestic/International Resell Reports" (¶¶23, 26), and "Retail Channel Sales Reports" (¶27), which alerted them to the falsity of NetManage's financial statements.

14. Warshaw, 74 F.3d at 957-58 ("everything [was] going fine" upheld as actionable); Kaplan v. Rose, 49 F.3d 1363, 1375 (9th Cir. 1994) (representations that the company's competitive position was "strong" and "[p]rogress is excellent" upheld); Hanon v. Dataproducts Corp., 976 F.2d 497, 501 (9th Cir. 1992) (representations of a product's "superior" performance were upheld).

15. Marksman, 927 F. Supp. at 1309 n.9, 1310; Rehm v. Eagle Fin. Corp., 954 F. Supp. 1246, 1252 (N.D. Ill. 1997); Zeid v. Kimberley, 930 F. Supp. 431, 438 (N.D. Cal. 1996) ("facts constituting circumstantial evidence of either 'reckless or conscious behavior' [or] 'establishing a motive to commit fraud and an opportunity to do so'"). Accord Cohen v. Koenig, 25 F.3d 1168, 1173-74 (2d Cir. 1994); Cosmas v. Hassett, 886 F.2d 8, 12-13 (2d Cir. 1989).

16. Boeing, slip op. at 18 (the "PSLRA did not eliminate recklessness as a basis for section 10(b) liability") (Downs Decl., Ex. 2); Bryant v. Apple South, [Current Binder] Fed. Sec. L. Rep. (CCH) ¶90,275, at 91,250 (M.D. Ga. 1998) (recklessness survives the PSLRA); Miller, 1998 U.S. Dist. LEXIS 10052, at *6 ("recklessness is sufficient under §10(b)"); Epstein v. Itron, Inc., 993 F. Supp. 1314, 1323-26 (E.D. Wash. 1998); Fugman v. Aprogenex, Inc., 961 F. Supp. 1190, 1195 (N.D. Ill. 1997); Rehm, 954 F. Supp. at 1252; Marksman, 927 F. Supp. at 1309 n.9, 1310; Page v. Derrickson, 1997 U.S. Dist. LEXIS 3673, at *27 (M.D. Fla. 3/25/97); Letters from Sens. Dodd, Gramm and D'Amato to SEC Chairman Levitt ("It was our intent, as we expressly stated during the legislative debate in 1995 . . . that the PSLRA adopt the pleading standard applied in the Second Circuit.") (emphasis in original) (see Downs Decl., Exs. 3-4).

17. Miller, 1998 U.S. Dist. LEXIS 10052, at *5 (allegations of financial fraud raise a strong inference of scienter); Gross, 977 F. Supp. at 1427 (allegation that corporate insiders engaged in a pervasive accounting fraud raise a strong inference of scienter); In re Health Mgmt. Sec. Litig., 970 F. Supp. 192, 203 (E.D.N.Y. 1997) (same); In re Wellcare Mgmt. Group Sec. Litig., 964 F. Supp. 632, 640 (N.D.N.Y. 1997) (same); Rehm, 954 F. Supp. at 1255-56 (same); Cherednichenko, ¶90,108, at 90,143 ("[C]ourts have found that allegations of financial fraud often provide strong circumstantial evidence of knowledge.").

18. Cosmas, 886 F.2d at 12-13 (finding a strong inference of scienter because corporate directors know of adverse facts affecting an important segment of their company's business); Cohen, 25 F.3d at 1174 (same).

19. See, e.g., ¶¶23, 26-28, 31 (identifying company-specific reports evidencing the negative trends alleged: "Monthly Sales Analysis by Product Time," "Monthly Sales Analysis by Revenue and Unit," "Revenue Trend Analysis Reports," "Domestic/International Resell Reports," "Monthly Budget Reports" for the Company's "Corporate," "Retail Channel Sales," "Manufacturing" and "Marketing" Departments, as well as "International Booking Reports," and information in corporate management "ECCO" files). Defendants' reliance on SGI is misguided. The SGI court concluded that specific internal documents must be pleaded based on a misinterpretation of San Leandro Emergency Medical Group Profit Sharing Plan v. Phillip Morris Cos., 75 F.3d 801, 812 (2d Cir. 1996). San Leandro did not hold that plaintiffs must identify specific internal documents to plead scienter, but rather, merely stands for the proposition that where plaintiffs fail to allege facts showing where the statements are false, an "unsupported general claim of the existence of corporate documents" will not suffice. Rather, the 2d Cir. held that knowledge of falsity had not been alleged. Id. Falsity, and the existence of NetManage internal sales reports, is alleged here. Therefore, neither SGI nor San Leandro supports defendants' position.

20. Fecht, 70 F.3d at 1083 (adverse disclosures coming ten weeks after the last optimistic statement held "circumstantial evidence that the optimistic statements were false when made"); Shaw v. Digital Equip. Corp., 82 F.3d 1194, 1224-25 (1st Cir. 1996) (positive statement made three weeks before revelations); In re Grand Casinos Sec. Litig., 988 F. Supp. 1273, 1283 (D. Minn. 1998) (seven months); Friedberg v. Discreet Logic, Inc., 959 F. Supp. 42, 51 (D. Mass. 1997) (five weeks).

21. In re Lotus Dev. Corp. Sec. Litig., 875 F. Supp. 48, 53 (D. Mass. 1995) (plaintiff made "well-pled allegations of motive" where the artificially inflated stock price allowed the company to make an important stock financed acquisition); In re PNC Sec. Litig., [1992 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶96,865, at 93,523 (W.D. Pa. 1992) ("PNC and the individual defendants allegedly were motivated by a desire to perpetuate PNC's ability to acquire banks at the lowest possible cost and thus with the minimum dilution to existing shareholders."); Harvey M. Jasper Retirement Trust v. Ivax Corp., 920 F. Supp. 1260, 1264 (S.D. Fla. 1995) (upholding complaint where there was no insider trading and complaint alleged "Ivax planned to acquire McGaw" and "the higher Ivax's stock price was, the fewer Ivax shares would have to be issued"); Zuckerman, 4 F. Supp. 2d at 627 (desire to make acquisition can provide motive).

22. 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 only 3,265); Fecht, 70 F.3d at 1084 (sales of 30,000 shares for $1.6 million by two insiders); Kaplan, 49 F.3d at 1379 ($13.5 million in sales by two insiders).

23. Wells Fargo, 12 F.3d at 931 ("While 'allegations of unusual insider trading by defendants immediately preceding the disclosure of negative news' may be . . . characteristic of a 'typical securities fraud class action,' they are not required."); Wellcare Mgmt., 964 F. Supp. 632 (same); Cherednichenko, ¶90,108, at 90,143 (plaintiffs' complaint alleges strong circumstantial evidence of conscious behavior where no insider selling alleged); Epstein, 993 F. Supp. 1314 (same).

24. Moreover, neither Williams' nor Galil's pre-Class Period insider sales are alleged in the Complaint, and, therefore, they cannot be considered on this motion. Digi, 6 F. Supp. 2d at 1097 n.5 (defendants cannot rebut their stock sales by pointing to alleged stock purchases, as such information is "evidence outside the four corners of the complaints"); Voit, 977 F. Supp. at 374 (plaintiffs' allegations regarding the amount of each defendant's stock sales must be accepted as true). However, even if considered, William's and Galil's stock sales are highly suspicious as they occurred immediately after NetManage's stock price rose on the Company's announcements of strong 2Q95 and 3Q95 results in 7/95 and 10/95, respectively. ¶¶60, 82, 111.

25. Plaintiffs have moved to strike this chart, as well as several other exhibits which defendants ask this Court to consider. Defendants cannot submit extraneous material and seek to have the Court draw inferences adverse to the Complaint. Digi, 6 F. Supp. 2d at 1097 n.5. Such arguments are properly reserved for trial and the development of a factual record.

26. A vested stock option does not carry the same economic risk as actual stock ownership. Consequently, when NetManage stock collapsed on 1/12/96, class members who owned stock suffered a very real economic loss. By contrast, option holders, such as defendants, did not lose any invested money. ¶116.

27. In fact, defendants did exactly that. ¶118. In early 1/96, after defendants knew NetManage would be forced to disclose poor financial results, Amaral contacted the Cooley Godward law firm for assistance in repricing NetManage's stock options. Thereafter, in 2/96, defendants repriced 2.3 million options, originally issued at prices up to $24.62 per share, at the then-current market price of $11.33 per share. ¶118. In one fell swoop, defendants eliminated any negative impact the disclosure of their fraud caused to the value of the their stock options, while actual stockholders, that is, plaintiffs, faced massive losses. ¶118.

28. With respect, Polk v. Fritz, No. C-96-2712 MHP, slip op. at 12 (N.D. Cal. 3/5/98), cited by defendants, is wrongly decided. In Cooper, the 9th Cir. confirmed that "[In re Stac Electronics, 89 F.3d 1399 (9th Cir. 1996)], and [In re Syntex Corp. Sec. Litig., 95 F.3d 922 (9th Cir. 1996)] do not preclude plaintiffs' claims that [defendant] made false . . . statements to securities analysts with the intent that the analysts communicate those statements to the market." 137 F.3d at 624. Rather, Stac and Syntex state an alternate basis for holding corporate defendants responsible for false analysts' reports. Id.

29. The "group publication" presumption survived the PSLRA. Powers, 977 F. Supp. at 1040-41; Health Mgmt., 970 F. Supp. at 208-09.

30. Unlike in cases cited by defendants (MTD at 19 n.15), plaintiffs detail Galil's and Bosch's involvement in the day-to-day control of NetManage, an involvement that far exceeded their titles as directors and members of the Audit Committee. ¶¶22, 24, 29, 30, 99, 107.

31. Contrary to defendants' assertions, "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." Cooper, 137 F.3d at 624.

32. Plaintiffs need not plead that they traded contemporaneously with defendants, as no insider trading claim under §20A is made here. See Order at 1.

33. If any portion of the Complaint is dismissed, leave to amend should be granted. Schreiber Distrib. Co. v. Serv-Well Furniture Co., 806 F.2d 1393, 1401 (9th Cir. 1986).