BRUCE G. VANYO, State Bar # 060134
JEROME F. BIRN, JR., State Bar # 128561
IGNACIO E. SALCEDA, State Bar # 164017
REBECCA A. MITCHELLS, State Bar # 151683
TRACY TOSH LANE, State Bar #184666
WILSON SONSINI GOODRICH & ROSATI
Professional Corporation
650 Page Mill Road
Palo Alto, California 94304-1050
Telephone: (650) 493-9300

Attorneys for Defendants
NETMANAGE, INC., ZVI ALON, WALTER
AMARAL, UZIA GALIL, JOHN BOSCH,
ROBERT WILLIAMS and RICHARD KORETZ

INTRODUCTION AND SUMMARY OF ARGUMENT

ARGUMENT

I. PLAINTIFFS HAVE FAILED TO SATISFY THE REFORM ACT'S RIGOROUS PLEADING REQUIREMENTS

A. The Reform Act Requires Plaintiffs to Disclose All Information in their Possession Which Forms the Basis of Their Belief that the Defendants Committed Fraud

1. Compliance with Rule 11 Does Is Not Sufficient to Satisfy the Reform Act's Pleadings Standards

B. Plaintiffs' Unsupported Accounting Allegations Fail to Plead Specific Facts Showing That NetManage's Accounting Was Fraudulent

C. Plaintiffs Do Not Plead Any Factual Basis to Believe That Defendants Made False Forecasts

D. Plaintiffs' Allegations of Insider Stock Sales Do Not Give Rise to a Strong Inference of Fraud

1. The AGE Logic and Syzygy Acquisitions to Done Provide the Missing Strong Inference of Fraud

E. Galil, Bosch, Williams and Koretz Did Not Make a Statement

CONCLUSION

Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A.,
     511 U.S. 164 (1994)

Cooper v. Pickett, 137 F.3d 616 (9th Cir. 1997)

Gross v. Medaphis Corp., 977 F. Supp. 1463 (N.D. Ga. 1997)

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

In re Boston Tech., Inc. Sec. Litig., 8 F. Supp. 2d 43 (D. Mass. 1998)

In re Cirrus Logic Sec. Litig., 946 F. Supp. 1446 (N.D. Cal. 1996)

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

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

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

In re Interactive Network Inc. Sec. Litig., 948 F. Supp. 917 (N.D. Cal. 1996)

In re Oak Tech. Sec. Litig., No. 96-20552 SW, 1997 WL 448168
     (N.D. Cal. July. 1, 1997)

In re Ross Systems Sec. Litig. [1994-1995 Tr. Binder] Fed. Sec. L. Rep. (CCH)
     ¶ 98,363 (N.D. Cal. July 21, 1994)

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

Leonard v. NetFRAME Sys., Inc., [1995-1996 Tr. Binder] , Sec. L. Rep. (CCH)
     ¶ 98,982 (N.D. Cal. Aug. 8, 1995)

Malin v. IVAX Corp., No. 96-1843, 1998 WL 519595 (S.D. Fla. Aug. 18, 1998)

Medhekar v. United States District Court, 99 F.3d 325 (9th Cir. 1996)

Neubronner v. Milken, 6 F.3d 666 (9th Cir. 1993)

Novak v. Kasaks, 997 F. Supp. 425 (S.D.N.Y. 1998)

Plevy v. Haggerty, No. CV-97-9200-SVW, slip op. (C.D. Cal. Aug. 21, 1998)

Polk v. Fritz, No. C-96-2712, MHP (N.D. Cal. Mar. 5, 1998)

Ronconi v. Larkin, [Current Binder] Fed. Sec. L. Rep. (CCH) ¶ 90,212
     (N.D. Cal. May 1, 1998)

Siegel v. Lyons, [1996-97 Tr. Binder] Fed. Sec. L. Rep. (CCH) 99,227
     (N.D. Cal. Apr. 16, 1996)

Voit v. Wonderware Corp., 977 F. Supp. 363 (E.D. Pa. 1997)

Wenger v. Lumisys, Inc., 2 F. Supp. 2d 1231, 1251 (N.D. Cal. 1998)

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

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

Securities Exchange Act of 1934, Section 10(b) 15 U.S.C. § 78j(b)

Securities Exchange Act of 1934, Section 21D(b)(1), 15 U.S.C. § 78u-4(b)(1)

Securities Exchange Act of 1934, Section 21D(b)(2), 15 U.S.C. § 78u-4(b)(2)

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

Fed. R. Civ. P. 11

141 Cong. Rec. S17933, S17960 (Dec. 5, 1995)

H.R. Conf. Rep. No. 104-369, 104th Cong., 1st Sess. at 41 (1995)

In dismissing the First Amended Complaint, the Court gave plaintiffs specific instructions concerning the standard required to state a claim for securities fraud under the Reform Act. The Court warned plaintiffs to state with particularity all facts supporting their belief that defendants had committed a fraud; to allege with particularity facts showing that defendants' statements were false when made; and, to allege with particularity each defendant's involvement in making statements or participation in the daily control of NetManage.

Plaintiffs' Second Amended Complaint did not cure these defects. On the contrary, plaintiffs prefer to debate whether Congress intended what it said when it heightened the pleading standards for private securities class actions. Plaintiffs are pleading on information and belief, not on personal knowledge; yet plaintiffs ignore the requirement that they "state with particularity all facts on which that belief is formed." 15 U.S.C. § 78u-4(b)(1) (emphasis added); Order at 1. Instead, plaintiffs have repeated essentially the same boilerplate "Basis of Allegations" paragraph that they pleaded last time. Compare SAC ¶ 127 with First Am'd Cmpt. ¶ 160. Rather than comply with the statute and the Court's Order, plaintiffs remarkably contend that this new requirement is nothing but a codification of prior Ninth Circuit information and belief pleading standards. As this Court and other Judges in this District have made clear, the standard is now higher. Plaintiffs fail to meet the new standard.

Plaintiffs also repeat their allegation of accounting fraud, without any factual support. As in the First Amended Complaint, plaintiffs merely list NetManage's customers and make the conclusory assertion that unspecified amounts of revenue were improperly recognized on unidentified shipments to this laundry list of customers. SAC ¶ 99. Not one detail of any supposedly phony transaction is alleged. Similarly, while plaintiffs assert that defendants made false financial forecasts to and through financial analysts, plaintiffs never plead specific facts showing that these supposed forecasts were false, i.e., that they differed from NetManage's own internal expectations. Even before the Reform Act, courts required this minimal factual support.

Plaintiffs still fail to allege facts giving rise to any inference of scienter. The Reform Act requires plaintiff to "state with particularity facts giving rise to a strong inference that the defendant acted" with fraudulent intent. 15 U.S.C. § 78u-4(b)(2) (emphasis added). The Complaint alleges no more than the type of boilerplate allegations of motive that other courts have found insufficient. Indeed, in this case, the defendants' stock sales refute scienter. Even under plaintiffs' misleading approach for determining the percentage sold, the defendants retained 95.6 percent of their NetManage holdings. See SAC ¶ 111. Sales of such minuscule percentages refute any inference of fraud.

Finally, plaintiffs ignore the Reform Act's requirement that they plead with particularity each defendant's role in making false or misleading statements. Plaintiffs merely lump together the non-speaking defendants. Plaintiffs do not allege that these defendants actually did anything in preparing the allegedly false statements.

After two amendments and the benefit of the Court's guidance, plaintiffs have failed to cure the fundamental defects of their case: plaintiffs can point to no particular facts showing that a fraud occurred. Further leave to amend is not required. The Court should dismiss with prejudice.

I. PLAINTIFFS HAVE FAILED TO SATISFY THE REFORM ACT'S RIGOROUS PLEADING REQUIREMENTS

A. The Reform Act Requires Plaintiffs to Disclose All Information in their Possession Which Forms the Basis of Their Belief that the Defendants Committed Fraud.

The Reform Act significantly heightened the requirements for plaintiffs pleading a claim of securities fraud. Plaintiffs must "state with particularity all facts" upon which plaintiffs base their beliefs that a fraud occurred. 15 U.S.C. § 78u-4(b)(1)(B). Congress stressed that a plaintiff must plead "all facts in the plaintiff's possession" that support plaintiff's belief that a fraud occurred. H.R. Conf. Rep. No. 104-369, 104th Cong., 1st Sess. at 41 (1995). A plaintiff may not plead some facts and withhold others: plaintiff must plead "all" facts, and plead them "with particularity." Id.

In applying this standard, the Court explained that "Plaintiffs must state with particularity all facts on which their allegations as to why each statement is misleading is formed. 15 U.S.C. § 78u-4(b)(1)(B). For example, plaintiffs must state with particularity the facts upon which the allegations of paragraphs 103(a)-(m) are formed." Order at 1.

Plaintiffs respond by disputing this requirement. First, plaintiffs suggest that the Reform Act did not alter the previous standard for pleading in the Ninth Circuit. Pl. Mem. 5-6. Second, plaintiffs state that the Reform Act requires no more than compliance with Fed. R. Civ. P. 11. Pl. Mem. 6-7. Neither argument is a credible interpretation of the Reform Act.

As this Court has held, the Reform Act heightened the standard for pleading false and misleading statements on information and belief. Under prior Ninth Circuit caselaw, a plaintiff was only required to plead "a statement of the facts upon which [plaintiffs'] belief is formed." Wool v. Tandem Computers, Inc., 818 F.2d 1433, 1439 (9th Cir. 1987). The Reform Act requires more. In Polk v. Fritz, No. C-96-2712 MHP (N.D. Cal. Mar. 5, 1998),¹ Judge Patel dismissed a complaint with prejudice for failure to allege the bases of plaintiffs' allegations of accounting impropriety. Judge Patel explained that it was not enough for plaintiffs to satisfy the previous standard under Wool v. Tandem. Under Wool, "the Ninth Circuit did not specifically require a plaintiff, as the SRA does, to state all facts upon which a belief is based." Id. slip. op at 7; see In re Silicon Graphics, Inc. Sec. Litig., 970 F. Supp. 746, 763 (N.D. Cal. 1997) (the Reform Act "strengthened" the Ninth Circuit requirement for information and belief pleading "[i]n an effort to minimize discovery abuse . . . and unwarranted fraud claims[.]").

Although plaintiffs suggest that this requirement would be an onerous intrusion into work product, Pl. Mem. at 5, that is simply not the case. Congress determined that to prevent the abuses that had plagued these types of cases, it was imposing a new requirement: plaintiffs must plead with particularity all facts in their possession that form the bases for their allegations of fraud. Plaintiffs' speculations or suppositions are not enough.

Plaintiffs come nowhere near this new, higher standard. Plaintiffs do not try to identify the information that supposedly supports any particular beliefs pled in their complaint. Rather, in paragraph 127, plaintiffs merely lump together all of the purported sources of their allegations; plaintiffs do not specify which allegations were derived from which sources. This tactic precludes the Court from determining whether any factual basis exists for any allegation in the Complaint, and is directly contrary to the Court's previous Order. If a plaintiff has particular information from a particular source, the requirement of the Reform Act is not difficult. As Senator Dodd, one of the floor managers for the Reform Act, stated in the final debate: "What we were driving at here was to insist that . . . there be an explanation of where these facts come from[.]" 141 Cong. Rec. S17933, S17960 (Dec. 5, 1995) (Salceda Supp. Decl. A). Because plaintiffs have not provided even a minimal explanation, the Complaint must be dismissed.

Plaintiffs' failure to satisfy this requirement is especially notable here because these same plaintiffs, represented by the same counsel, have had extensive document discovery (and one deposition) in the parallel, factually-identical state case. Despite the Reform Act's mandatory stay, plaintiffs sought discovery in the state case for the admitted purpose of bolstering their federal complaint. Defendants protested that this tactic would undermine one of the central goals of the Reform Act, that complaints in "securities actions should stand or fall based on the actual knowledge of the plaintiffs rather than information produced by the defendants after the action has been filed," Medhekar v. United States Dist. Ct., 99 F.3d 325, 328 (9th Cir. 1996) (emphasis added). Nevertheless, the state court declined to put any limits on plaintiffs' use of state court discovery. See Def. Mem. at 6.

Plaintiffs do not dispute this. Rather, plaintiffs contend that the discovery "is principally only relevant to those plaintiffs' California state law claims in that [state] 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." Pl. Mem. at 5. Nonsense. The factual allegations of the two complaints are identical. Plaintiffs propounded sweeping document discovery. Defendants produced tens of thousands of pages, as did NetManage's auditors, Arthur Andersen LLP. Despite all of this discovery, the Complaint does not point to one specific internal document from NetManage or Arthur Andersen that supports plaintiffs' allegations of fraud.

For example, plaintiffs allege that Arthur Andersen "discovered serious irregularities" in NetManage's financial statements and "refused to permit . . . improper revenue recognition." SAC ¶ 106. Yet, plaintiffs cite to nothing in NetManage's documents or Arthur Anderson's workpapers to support this claim. The Complaint does not allege anything specific no specific transactions, no dates, no amounts, no correspondence between the auditors and NetManage; as before, plaintiffs merely list more than three dozen NetManage customers (SAC ¶ 99) and conclude that sales to all of them were improper. That style of pleading would have failed before the Reform Act.

Similarly, plaintiffs allege that defendants repeatedly issued false financial forecasts through analysts. Again, there is no factual support for this allegation. Having obtained discovery, plaintiffs should be able to point to a specific internal forecast that differed from a public forecast. But again, there is nothing. The best plaintiffs can do is to repeat the conclusory assertion that defendants received unspecified negative internal reports. SAC ¶¶ 21-22, 26-28. As the Court found in dismissing the earlier complaint, this is insufficient.

1. Compliance with Rule 11 Does Is Not Sufficient to Satisfy the Reform Act's Pleadings Standards.

Plaintiffs also suggest that a complaint satisfies the Reform Act's "heightened" pleading standard so long as it is not sanctionable under Rule 11. Pl. Mem. at 6-7. This is an incredible assertion. The Reform Act's pleading requirements and Rule 11 have different standards because they address different problems.

Rule 11 states that by filing a complaint or other pleading, counsel certifies that he has conducted a reasonable inquiry, and that "the allegations and other factual contentions [asserted in the pleading] have evidentiary support or . . . are likely to have evidentiary support after a reasonable opportunity for further investigation or discovery." Fed. R. Civ. P. 11(b)(3). Rule 11 severely restricts the circumstances under which counsel may be sanctioned should there prove to be a total absence of support for their allegations. This high threshold for punishing counsel whose certified complaint is woefully inadequate certainly has nothing to do with whether a private securities class action complaint states a claim under the Reform Act.

The Reform Act creates heightened pleading standards for what must be set forth in a complaint, and the standards for terminating cases at the pleading stage. These provisions were intended to spare defendants the burden of having to defend these cases at all. See Conf. Rep. at 31-32. The Reform Act could not accomplish its goals if any complaint that is not sanctionable survives the new pleading standard. If plaintiffs were correct, every complaint that was dismissed would be per se sanctionable. This is obviously not the case. Many complaints will fail the Reform Act's heightened pleading requirements but pass Rule 11's lenient standard for sanctions.

B. Plaintiffs' Unsupported Accounting Allegations Fail to Plead Specific Facts Showing That NetManage's Accounting Was Fraudulent.

Despite their access to internal documents and the auditors' workpapers, plaintiffs do not identify a single fraudulent transaction. The Complaint, like its predecessor, merely lists the names of over three dozen NetManage customers and makes the conclusory allegation that unspecified revenue was recognized improperly. SAC ¶ 99. Even before the Reform Act, this was insufficient. Plaintiffs were required to identify the challenged transactions with specificity and demonstrate that the amounts in question are material. E.g., In re Ross Systems Sec. Litig. [1994-1995 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 98,363, at 90,498-99 (N.D. Cal. July 21, 1994); see cases cited at Def. Mem. 9 n.4. Under the Reform Act, courts require much more. As Judge Williams stated in applying the Reform Act to dismiss similar allegations, "[s]imply listing customers and providing general, unsupported estimates of 'improper' sales does not meet the particularity requirements of Rule 9(b) and the Reform Act. Rather, plaintiffs must allege facts regarding the underlying transactions with particularity." Zeid v. Kimberley, 973 F. Supp. 910, 923 (N.D. Cal. 1997) (emphasis added); see In re Oak Tech. Sec. Litig., No. 96-20552 SW, 1997 WL 448168, at *8 (N.D. Cal. July. 1, 1997) (plaintiffs must allege "particular transactions where revenues were improperly recorded, including the names of the customers, the terms of specific transactions, when the transactions occurred, and the approximate amount of the fraudulent transactions. Merely providing the names of 'chief customers' . . . does not suffice."); see also Malin v. IVAX Corp., No. 96-1843, 1998 WL 519595, at *14 (S.D. Fla. Aug. 18, 1998) (Salceda Supp. Decl. Ex. B) ("Who were the customers given such shelf-stock adjustments? How much inventory of product did those customers buy? When was IVAX forced to adjust the price of that inventory and to what extent? To what extent did these adjustments affect IVAX's financial projections? These are just some of the questions that a complaint must answer to satisfy the requirements of § 21D(B)(1).").

Plaintiffs provide no such information. Plaintiffs mistakenly cite Cooper v. Pickett, 137 F.3d 616 (9th Cir. 1997), for the proposition that conclusory allegations of accounting fraud satisfy the Reform Act. Cooper, however, was a pre-Reform Act case that was analyzed under the Ninth Circuit's prior and more lenient Rule 9(b) standard.² Indeed, in Cooper, the Ninth Circuit itself noted that the Reform Act had changed the pleading requirements for securities fraud. Id. at 625 n.2.³ Courts applying the Reform Act reject Cooper's laundry list approach to pleading fraud. See Def. Mem. at 11-12, 15.

The Complaint does not contain facts that hint at any accounting irregularities. NetManage has never restated its financial results for 1995 or any prior fiscal period. If there were phony transactions, as plaintiffs allege, one would expect to see lots of returned product and an eventual dramatic increase in sales return reserves. Plaintiffs do not allege that NetManage's sales return reserves proved inadequate; indeed, they do not allege anything about sales returns. See Siegel v. Lyons, [1996-97 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 99,227, at 95,223 (N.D. Cal. Apr. 16, 1996) ("Given the lack of allegations of either direct or circumstantial evidence of falsity at the time the reserves were set and the lack of evidence that the reserves were actually inadequate, there is no reason to suspect that the changes in these reserves were based on anything other than a permissible business judgment."). In short, plaintiffs have not provided the Court with any factual basis to conclude that there was anything incorrect with NetManage's accounting, let alone that the accounting was fraudulent.

In trying to respond to this point, plaintiffs tie themselves in knots. Plaintiffs theory of fraud has been that Arthur Andersen discovered accounting irregularities at the end of 1995 during its audit, and forced NetManage to change its policy for recognizing revenue on distributor sales, thereby causing the disappointing fourth quarter. SAC ¶ 106-08. Defendants have pointed out that Arthur Andersen opined that NetManage's 1995 financial statements complied with generally accepted accounting principles, and that if Arthur Andersen found material problems with prior quarters, as plaintiffs allege, it would have required NetManage to restate its financial results. Yet Arthur Andersen issued an unqualified endorsement of NetManage's financial statements for all of 1995. See 1995 Annual Report at 35. Recognizing that this fact undercuts the theory of fraud, plaintiffs' opposition now suggests that Arthur Andersen issued a "clean" audit opinion because it was provided with inaccurate revenue figures. Pl. Mem. at 9-10. That argument, of course, is inconsistent with the theory that Arthur Andersen forced NetManage to change its accounting policies because of NetManage's improper practices. We put the question to the plaintiffs, after three attempts to plead a case, and all that discovery from NetManage and Arthur Andersen, which is it? The fact that plaintiffs cannot come up with a single fact to support a consistent theory of fraud about the key allegation of their case demonstrates that they have no factual basis for their allegations of accounting fraud.

Plaintiffs' allegation that NetManage improperly recognized revenue on certain sales to Japanese customers is likewise unsupported by any facts. Plaintiffs alleged that NetManage improperly recognized revenue on certain sales in Japan, where "delivery did not occur until after the end of the quarter." SAC ¶ 105. In their opening brief, defendants pointed out that this allegation does not state a violation of NetManage's publicly-disclosed accounting policies, much less constitute securities fraud. NetManage disclosed in both its 1994 and 1995 Annual Reports that it recognized revenue after "the software has been shipped," pursuant to AICPA Statement of Position 91-1. 1994 Annual Report at 22; 1995 Annual Report at 26. Accordingly, revenue is recognized based on when product is shipped, not when it arrives at the customer.

Plaintiffs now seek to recast the allegations of their Complaint via their opposition memorandum. The story now is that the Japanese customers did not "actually accept shipment" until after the end of the quarter because the product did not arrive at the customer until after the end of the quarter. Even if true, this allegation still does not state a claim. As NetManage disclosed, consistent with AICPA Statement of Position 91-1, NetManage recognized revenue upon shipment, not upon a customer's physical receipt of the product. Plaintiffs allege no facts suggesting that NetManage's contracts were not binding until a customer physically accepted the software, as opposed to when the customer issued the purchase order. See In re Cirrus Logic Sec. Litig., 946 F. Supp. 1446, 1464 (N.D. Cal. 1996) (granting summary judgment where both company policy and accounting principles authorized revenue recognition upon product shipment, not customer's receipt of product).

C. Plaintiffs Do Not Plead Any Factual Basis to Believe That Defendants Made False Forecasts.

Plaintiffs alleged that defendants Alon and Amaral made false forecasts about NetManage's prospects in conference calls with financial analysts. Defendants noted that this allegation was unsupported by any facts showing that these alleged forecasts differed from NetManage's internal forecasts. Def. Mem. at 10-13. It bears repeating that, despite extensive document discovery, plaintiffs still cannot cite to any contemporaneous internal forecast that was materially worse than Alon or Amaral's supposed public forecasts.

The best plaintiffs can do is repeat the conclusory allegations that the statements were false because defendants were aware of adverse "conditions" or "problems" at NetManage. Pl. Mem. at 10. These problems are essentially: (1) that sales for some NetManage products were below internal expectations; (2) that NetManage was having internal difficulties with its Telesales group and its Japanese sales office; and, (3) that demand for NetManage products was declining due to competition in the marketplace. Pl. Mem at 10-11; SAC ¶¶ 58, 75, 91. These supposed problems are mere conclusions. The Complaint does not identify any contemporaneous factual basis for any of these assertions.

First, plaintiffs allege that sales were "below internal expectations." Plaintiffs do not say what those internal expectations or actual sales were when defendants made their forecasts. No support is given for these allegations. The only conclusion the Court may draw is that plaintiffs are basing this allegation on speculation: if actual sales ultimately proved to be below NetManage's expectations, maybe defendants knew that earlier. The Reform Act requires facts, not speculation.

Second, although plaintiffs allege problems with the Telesales group and the Japanese sales office, plaintiffs do not allege what these "problems" were, what impact NetManage believed they would have on its forecasts, or what impact they in fact had on NetManage's performance. Even before the Reform Act, plaintiffs could not merely assert that optimistic statements were false because there were undisclosed problems that had an unidentified impact on financial results.⁴ Courts have not hesitated to dismiss such allegations under the Reform Act.⁵

Finally, plaintiffs allege that defendants' forecasts were undermined by competitive developments -- including Microsoft's planned inclusion of comparable technology in Windows '95. Again, plaintiffs do not allege anything specific about NetManage's contemporaneous knowledge of competitive developments. Plaintiffs also fail to plead any factual basis for their belief that Microsoft's intentions for Windows '95 were hidden from the market yet somehow within NetManage's special knowledge. In dismissing almost identical allegations in Oak Technology (that certain of Oak's customers were beginning to make the type of computer chip produced by Oak), Judge Williams noted such "conclusory allegations do not satisfy the requirements of Rule 9(b) and the Reform Act." 1997 WL 448168, at *5. Rather, plaintiffs had to provide specific details of how this information was passed to defendants, and the timing and amount of decreased orders. Id. Plaintiffs do not include such information in the Complaint.

D. Plaintiffs' Allegations of Insider Stock Sales Do Not Give Rise to a Strong Inference of Fraud.

The Reform Act requires a complaint to "state with particularity facts giving rise to a strong inference" of scienter. 15 U.S.C. § 78u-4(b)(2). In enacting this standard, Congress repudiated prior Ninth Circuit law. Congress found that even the Second Circuit's "strong inference" standard -- the most rigorous in the nation -- was not strong enough. Congress therefore expressly rejected the "motive and opportunity" portion of the Second Circuit standard. Judge Smithicon Graphics, 970 F. Supp. at 757. Numerous other courts, including courts in the Second Circuit have agreed.⁶

Without any direct evidence of wrongdoing, plaintiffs attempt to meet the Reform Act's scienter standard by pointing to the individual defendants' stock sales. First, plaintiffs say that the mere existence of stock sales shows that defendants made false statements and acted with fraudulent intent because they had the "motive and opportunity" to commit fraud. Pl. Mem. at 12-13. An individual's sale of stock, however, has nothing to do with whether a statement was false. The Reform Act requires specific factual allegations showing that a statement was false.

Moreover, allegations about defendants' stock sales cannot alone give rise to an inference of fraud. At most, stock sales are relevant to the issue of scienter only if the sales were unusual or suspicious. Wenger v. Lumisys, Inc., 2 F. Supp. 2d 1231, 1251 (N.D. Cal. 1998) ("stock sales alone cannot create a strong inference of scienter;" dismissing complaint) (citation omitted); In re Boston Tech., Inc. Sec. Litig., 8 F. Supp. 2d 43, 58 (D. Mass. 1998) ("the mere fact that insider stock sales occurred does not suffice to establish scienter;" dismissing complaint) (quotation omitted).⁷ In this case, the stock sales were neither unusual nor suspicious. Here is the dispositive fact: defendants collectively sold just 3.6 percent of their available NetManage stock and option holdings. Plaintiffs do not legitimately contest this fact. Under well-established case law, such allegations cannot show that the stock sales were unusual or suspicious, but, rather, refute an inference of fraudulent intent. Def. Mem. at 13-14.

Plaintiffs ask the Court to shut its eyes to the actual percentages of stock and options that each defendant sold. Plaintiffs contend that the Court should look only at the options that defendants exercised and sold, not the options that defendants could have exercised and sold but decided to keep. Pl. Mem. at 17-18. As several courts have held, this make no sense at all. Def. Mem. at 14-15 (citing cases). Defendants' stock and option holdings are in the public record. Having put the options at issue by alleging that defendants exercised options to sell stock, plaintiffs cannot manipulate the Court's analysis by selectively excluding defendants' overall stock and option holdings. (Defendants' Supplemental Opposition to Plaintiffs' Motion to Strike, filed herewith, contains a complete discussion of this issue.) Moreover, as noted in the opening brief, even if one were to ignore the vested options held by the individual defendants, they still retained the vast majority of their stock, and their sales here were neither unusual or suspicious. Even under plaintiffs' myopic approach, the defendants retained 95.6 percent of their stock. See SAC ¶ 111; Def. Mem. at 3, 15.

The actions of the two senior most executives at the Company, and the only ones alleged to have spoken to the market, are wholly inconsistent with fraud. Mr. Alon, NetManage's Chairman and CEO, sold a mere 3 percent of his stock (2.6 percent of his total holdings), retaining more than 8,800,000 shares of stock and options through the end of the class period. Mr. Amaral, the CFO, did not sell a single share of stock.

Moreover, defendants Williams and Galil both sold more stock during the first half of 1995 than they did during the second half of 1995 (the class period). Williams sold 37,400 shares during the class period, but 45,800 shares during the first half of 1995; Galil sold 92,500 shares during the class period, but 119,000 shares during the first half of 1995. Def. Mem. at 15. Plaintiffs do not dispute these facts. Where defendants sold more stock before the class period than during the class period, their class period sales obviously cannot give rise to a strong inference of fraud. Silicon Graphics, 970 F. Supp. at 768; Hockey v. Medhekar, [1997 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 99,465, at 97,083 (N.D. Cal. Apr. 15, 1997) (dismissing complaint; "defendants sold more shares before the class period than they did during the class period and sold only a small percentage of their collective holdings").

1. The AGE Logic and Syzygy Acquisitions to Done Provide the Missing Strong Inference of Fraud.

Plaintiffs also allege that the defendants were motivated to commit fraud so they could use NetManage's inflated stock to complete mergers with AGE Logic and Syzygy, two private companies. SAC ¶ 37-38. As explained in the opening brief, these conclusory allegations are insufficient for two reasons.

First, as is clear from the complaint, these acquisitions were tiny. At the beginning of 1995, NetManage had 40.9 million shares outstanding. SAC ¶ 18(a). To make the acquisitions, NetManage issued less than 1.5 million additional shares, SAC ¶ 38, less than 3 percent of its already outstanding shares. See Def. Mem. at 17.

Second, even under pre-Reform Act law, conclusory allegations of motive based on a desire to conclude acquisitions were insufficient. Def. Mem. at 17-18. With the Reform Act's heightened standard for scienter, plaintiffs must plead more than mere motive to increase the stock price in order to state a claim.⁸

E. Galil, Bosch, Williams and Koretz Did Not Make a Statement

Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164, 177 (1994), and In re GlenFed Inc. Sec. Litig., 60 F.3d 591, 592 (9th Cir. 1995), preclude plaintiffs from using non-statutory theories of secondary liability, such as allegations of aiding and abetting or conspiracy. Therefore, plaintiffs must plead all the requirements for primary liability against each defendant. Under Section 10(b), a person cannot be liable unless he made a false statement. Defendants Galil, Bosch, Williams, and Koretz are not alleged to have made a false statement.

Plaintiffs raise two theories to get around Central Bank and GlenFed. None applies here. First, plaintiffs say that they may avoid Central Bank by relying upon the group-published information doctrine. Pl. Mem. at 20. This pre-Reform Act doctrine allowed a plaintiff to meet the pleading requirements of Rule 9(b) by creating a presumption that certain officers of a company acted collectively to publish the company's allegedly false reports. GlenFed, 60 F.3d at 593. The doctrine has no validity under the new pleading standards of the Reform Act, which do not tolerate presumptions of fraud, but require plaintiffs to plead specific facts showing that each defendant made a false statement and acted with fraudulent intent. Even under group pleading, however, plaintiffs' conclusory allegations about the committee memberships or jobs of these defendants fail to demonstrate that they were involved in NetManage's daily affairs or in preparing its financial statements. Def. Mem. at 18-20. With respect to Williams and Koretz, vice presidents in sales and marketing, there is no allegation that they were involved in the preparation of any of NetManage's financial statements. Accordingly, they are not presumed to be responsible for such reports. Oak Tech., 1997 WL 448168, at *11 ("Plaintiffs must plead that these vice presidents were directly involved 'not only in the day-to-day affairs of [NetManage] in general but also in [the preparation of its] financial statements in particular.") (quoting Wool, 818 F.2d at 1440). Defendants Galil and Bosch were outside directors and served on the audit committee. Even before the Reform Act, courts routinely rejected allegations that outside directors were "privy to inside information" by their service of the board or its committees. In re Interactive Network Inc. Sec. Litig., 948 F. Supp. 917, 921 (N.D. Cal. 1996); see cases cited at Def. Mem. at 19 n.15.

Second plaintiffs contend that these defendants may be liable because they supposedly engaged in improper insider trading. Pl. Mem. at 20. But plaintiffs have not pleaded a claim for insider trading under Section 10(b), which requires that they trade contemporaneously with defendants. Neubronner v. Milken, 6 F.3d 666, 670 (9th Cir. 1993). In any case, allegations of insider trading are not a substitute for pleading that a defendant made a false statement. Oak Tech., 1997 WL 448168, at *12.

Plaintiffs have had more than a fair chance to state a case of securities fraud. Plaintiffs amended their original complaint in the face of defendants' first motion to dismiss. That complaint was dismissed by the Court with leave to amend specific deficiencies pointed out in the Court's Order. Notwithstanding the Reform Act's mandatory discovery stay, plaintiffs then had the opportunity to conduct discovery in the parallel state court case; despite this, plaintiffs' have not one fact or document showing that defendants committed fraud. The Second Amended Complaint should be dismissed with prejudice and the defendants allowed to return their attention to their business.

¹ Unless otherwise noted, slip opinions and documents incorporated by reference cited herein are attached to the previously filed Declaration of Ignacio E. Salceda. Slip opinions cited herein for the first time are attached to the Supplemental Declaration of Ignacio E. Salceda ("Salceda Supp. Decl.").

² In Polk v. Fritz, slip op. at 12, Judge Patel rejected the argument that Cooper did not require accounting fraud to be pleaded with particularity, and dismissed a complaint with prejudice. Judge Patel stated:

Cooper, although recently decided, did not deal with the pleading requirements under the SRA as the complaint at issue was filed on August 15, 1994. [Cite.] Thus, it did not consider the heightened pleading standards incorporated into the SRA, such as the requirement that a complaint pleaded on information and belief disclose all facts underlying the beliefs. In addition, the court respectfully notes that Cooper, while not purporting to overrule existing law, appears to conflict with earlier Ninth Circuit securities cases that required greater particularity in the pleading of fraud claims. See, e.g. Glenfed, 42 F.3d at 1549; In re Stac, 89 F.3d at 1405; Wool, 818 F.2d at 1439. The court will not parse these conflicts, however, since they arise in pre-SRA cases.

³ Even under Cooper, plaintiffs' allegations fail to show that NetManage's financial statements were false. In Cooper, plaintiffs alleged that defendants had overstated revenue, net income, and earnings per share by specific amounts, concealed high rates of returned product, and misapplied specific parts of the company's revenue recognition policy. 137 F.3d at 626. Here, plaintiffs can point only to NetManage's stated compliance with its accounting policies, list three dozen customers, and recite accounting standards. Plaintiffs do not plead specific facts showing that NetManage's financial statements were materially wrong.

⁴ E.g., Leonard v. NetFRAME Sys., Inc., [1995-1996 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 98,982, at 93,780 (N.D. Cal. Aug. 8, 1995) ("Plaintiff's conclusory attempt to plead as 'facts' the converse of the positive statements made by defendants does not satisfy Glenfed's requirement that a plaintiff identify particular facts indicating the falsity of defendants' statements.") (citing In re GlenFed, Inc. Sec. Litig., 42 F.3d 1541, 1552 (9th Cir. 1994) (en banc)).

⁵ See Zeid, 973 F. Supp. at 920 (list of undisclosed "adverse facts" not supported by "references to inconsistent contemporaneous statements or information made by or available to [d]efendants" is insufficient); Ronconi v. Larkin, [Current Binder] Fed. Sec. L. Rep. (CCH) ¶ 90,212, at 90,890 (N.D. Cal. May 1, 1998) (dismissing complaint for failure to allege specific facts showing company had "troubled operations"); Novak v. Kasaks, 997 F. Supp. 425, 431 (S.D.N.Y. 1998) (dismissing with prejudice where "the complaint fails to allege with sufficient specificity that at the time [defendants] made favorable statements to securities analysts, they were aware that much of their inventory was worthless or seriously overvalued, or were reckless as to whether that was the case").

⁶ See, e.g., Novak, 997 F. Supp. at 430 ("The growing trend in the courts, and particularly in this district, is to find that Congress intended to strengthen the Second Circuit standard. The two leading Southern District [of New York] cases . . . both held that the pleading of motive and opportunity no longer suffices to raise a strong inference of scienter.") (citing cases); Malin v. IVAX Corp., 1998 WL 519595, at *14 ("alleging motive and opportunity no longer automatically satisfies the scienter requirement"). See also cases cited at Def. Mem. 13 n. 7.

⁷ See also Silicon Graphics, 970 F.3d at 767-68; Plevy v. Haggerty, No. CV-97-9200-SVW, slip op. at 38 (C.D. Cal. Aug. 21, 1998) (Salceda Supp. Decl. Ex. C) ("Because selling stock does not per se raise a strong inference of scienter, it is plaintiffs' burden to allege in [the complaint] that the trading was unusual.") (citing In re Glenayre Technologies, Inc. Sec. Litig., 982 F. Supp. 294, 299-300 (S.D.N.Y. 1997)).

⁸ The Reform Act cases cited by plaintiffs are inapposite. For example, in Gross v. Medaphis Corp., 977 F. Supp. 1463 (N.D. Ga. 1997), the company pursued a "growth through acquisitions" strategy, acquiring more than 40 companies. In Voit v. Wonderware Corp., 977 F. Supp. 363 (E.D. Pa. 1997), the plaintiff was an officer and shareholder in the acquired company, and defendants admitted that surprise changes in management and strategy had been planned months before the representations made to the plaintiff during the acquisition negotiations.