This Rule 10b securities fraud class action is brought on behalf of purchasers of NetManage, Inc. software company stock between July 25, 1995 and January 11, 1996. By Order dated February 23, 1998, the Court dismissed the First Amended Complaint with leave to amend. In particular, the Court held that this action is governed by the Private Securities Litigation Reform Act of 1995 ("PSLRA"), and that the complaint is pled upon information and belief, and that as a result, plaintiffs must state with particularity all facts on which their allegations of fraud are based. See 15 U.S.C. § 78u-4(b)(1)(B).

Now before the Court is defendants' motion to dismiss the Second Amended Complaint ("SAC"). After carefully considering the papers submitted by the parties, including the supplemental pleadings, and having had the benefit of oral argument on December 23, 1998, the motion to dismiss is GRANTED without leave to amend.

NetManage develops and markets transmission control protocol/Internet ("TCP/IP") software products. NetManage's core products -- brand-named Chameleon and accounting for 90% of NetManage's revenue -- are TCP/IP based applications designed to facilitate network connections. TCP/IP is an open, non-proprietary system which cannot be protected by patent. The SAC alleges that in July 1995, when defendants became aware of competition from Microsoft and Netscape, and lacking any available new products, defendants initiated a fraudulent scheme to artificially inflate NetManage's stock price. The scheme included flooding the market with positive statements about NetManage and improperly recognizing millions of dollars of revenue on incomplete or contingent sales. In particular, plaintiffs allege that defendants published false financial statements for NetManage's second and third quarters, on July 25 and October 24, 1995, respectively. They allege that the statements were false because defendants improperly recognized revenue on sales where distributors and other customers had a right of return or there were other contingencies ("the accounting fraud"). Plaintiffs also allege that defendants made false forecasts about NetManage's prospects to the public and to analysts, and that defendants are liable for the opinions expressed by stock analysts who published reports about NetManage during the class period, as if defendants published those opinions themselves.

As the Court has previously stated, the PSLRA requires a plaintiff to "specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, ... [to] state with particularity all facts on which that belief is formed." 15 U.S.C. § 78u4(b)(1)(B) (emphasis added). In addition, the plaintiff must "state with particularity 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 Court shall dismiss any complaint that does not meet these requirements. See 15 U.S.C. § 78u-4(b)(3)(A). The Court will turn first to the false forecast allegations, and second to the allegations of accounting fraud.

A. The False Forecasts.

Plaintiffs' SAC identifies numerous allegedly false forecasts made by defendants to the public and to analysts, or by analysts in reports which defendants allegedly endorsed. Plaintiffs allege that the statements were false and misleading for the reasons set forth in paragraphs 8-9, 21, 29-30, 37, 58-59, 75-76, 91-92. For example, plaintiffs allege that the optimistic statements were false, in part, because of the following:

(a) Sales of NetManage's Chameleon and ECCO products were below NetManage's internal expectations, derived from the 96 plan/budget, because of weaker than anticipated demand and lower than expected price levels, due to intensive price competition which was adversely impacting NetManage's profitability;

(b) NetManage's direct Telesales group was inadequately trained in TCP/IP interconnectivity technology and was not able to successfully sell NetManage's Chameleon products in the increasing competitive environment that emerged in mid-95;

(c) Several of NetManage's VARs were downplaying NetManage's Chameleon products in favor of competing products -- or even refusing to sell Chameleon at all -- In retaliation again [sic] NetManage's practice of having its Telesales group directly compete with the VARs by targeting Fortune 1000 companies that NetManage knew had already been approached by or solicited by VARs;

(d) NetManage had learned from internal management discussions and discussions with its corporate account managers that the introduction of Win95 with its own embedded TCP/IP protocol and the rapid acceptance and popularity of Netscape's browser and software applications would adversely impact market demand for and acceptance of NetManage's products, thereby reducing NetManage's future EPS growth.

SAC ¶ 58. The SAC, however, is silent as to the facts upon which plaintiffs' belief as to the above allegations is formed. For example, the SAC does not identify the facts upon which plaintiffs base their allegations that NetManage sales were below internal projections. Nor does it identify what facts they base their allegations that the direct Telesis group was inadequately trained, or that VARs were downplaying Chameleon in favor of competitor's products. The boilerplate allegations of paragraph 127 are plainly insufficient. See In re Health Management Sys., Inc. Sec. Litig., No. 97CV1865-HB, 1998 WL 283286 *3 (S.D.N.Y. June 1, 1998).

Plaintiffs' reliance on Wool v. Tandem Computers, Inc., 818 F.2d 1433, 1439 (9th Cir. 1987), for the proposition that plaintiffs need only set forth each misrepresentation, what was said, when, and by whom, and why the statement was false, to survive a motion to dismiss is misplaced. Wool did not apply the PSLRA. The PSLRA, by its plain and unambiguous language, requires a plaintiff to plead all facts upon which his allegations made upon information and belief are based, and the Court so held, when it dismissed the First Amended Complaint.

Plaintiffs' claim that they do not have to plead their confidential sources, or that they do not have to plead each and every fact upon which their allegations are based, is unpersuasive. Assuming, without deciding, that plaintiffs do not have to plead the confidential sources of the facts upon which their allegations are based, or that they do not have to allege each and every fact upon which their allegations are based, their complaint still fails because they have not alleged any of the facts, with or without identifying their sources. For example, if plaintiffs' allegations as to the value added resellers' ("VARs") treatment of Chameleon were based upon conversations plaintiffs or their attorneys had with certain of the VARs, plaintiffs' could set forth the substance of those conversations without identifying with which particular VARs plaintiffs spoke. Plaintiffs, however, have not made any similar allegation. Their complaint is silent as to the basis for their allegations. For this reason alone the false forecast claims must be dismissed.

Assuming, however, that plaintiffs have pleaded the facts upon which they base their belief that defendants engaged in fraud, plaintiffs' false forecast claims fail for a second, independent but related reason. Since the SAC is devoid of specific particularized facts, it does not give rise to a strong inference of scienter, even if scienter includes recklessness as defined by plaintiffs. In other words, the complaint lacks the specific allegations necessary to raise an inference of fraud. For example, the SAC alleges that defendants were publicly making optimistic forecasts about NetManage at the same time NetManage's sales were not meeting internal forecasts. At oral argument plaintiffs explained that this allegation is based upon the facts set forth in paragraphs 26 and 27. Those paragraphs, however, allege nothing more than a description of NetManage's internal financial reporting system. If such allegations were sufficient to give rise to a strong inference of scienter, a plaintiff could state a fraud claim anytime a corporation does not meet its publicly-stated projections since any corporation with a modicum of sophistication has an internal financial reporting system. See In re Silicon Graphics, Inc. Sec. Lit., ("Silicon Graphics II") 970 F.Supp. 746, 766 (N.D. Cal. 1997). Without any alleged facts as to how NetManage was actually performing compared to the projections made by certain defendants, the SAC does not give rise to an inference, let alone a strong inference, of fraud.

Plaintiffs also allege that defendants knew their forecasts were false because they learned from internal management discussions that the introduction of Windows 95 would adversely impact demand for NetManage's products. See, e.g, SAC ¶ 58(d). They do not allege, however, what specifically defendants learned that was not already in the public domain. Without such facts, the allegation that Windows 95 was going to hurt NetManage's business does not give rise to a strong inference of fraud. The above examples are illustrative of the SAC's lack of specificity. That lack of specificity is fatal to plaintiffs' claims since their conclusory allegations simply do not give rise to a strong inference of the required state of mind.

The insider trading allegations do not give rise to the inference required to survive defendants' motion to dismiss. Stock sales "will not support a strong inference of fraud unless the sales are unusual or suspicious." Silicon Graphics II, 970 F.Supp. at 767 (citing Acito v. IMCERA Group, Inc., 47 F.3d 47, 54 (2d Cir. 1995)); see also Wenger v. Lumisys, Inc., 2 F.Supp. 2d 1231, 1251 (N.D. Cal. 1998) ("stock sales alone cannot create a strong inference of scienter"). Plaintiff's SAC does not allege any facts that would make defendants' stock sales unusual or suspicious enough to support a strong inference of scienter.

As a preliminary matter, the Court notes that it will consider the allegations as set forth in plaintiffs' SAC without taking into account the options held and not sold by defendants, even though the Court believes judicial notice of such facts is appropriate. Judicial notice is unnecessary here because the facts as alleged by plaintiffs do not give rise to the requisite scienter.

Based solely on plaintiffs' allegations, the defendants as a group sold only five percent of their stock holdings. Such a percentage does not support a strong inference that defendants were engaged in a fraudulent scheme to inflate the price of NetManage stock so as to make more money from their own stock holdings, at least in the absence of any factual allegations which support an inference that the collective sale of five percent of their holdings was unusual or suspicious. Plaintiffs argue that the Court should take into account the dollar amount and number of shares sold collectively by the defendants. Such numbers are relevant, however, only when considered in conjunction with the percentage of shares held by the defendants. As stated above, the complaint does not allege any facts that suggest the percentage of shares sold was unusual or suspicious.

The insider trading allegations similarly do not give rise to an inference of scienter even when each defendant's sales are considered individually. As to defendants Alon and Amaral, the CEO and CFO respectively of NetManage, and the alleged masterminds of the fraudulent scheme, the SAC alleges that during the class period Alon sold only three percent of his holdings (and thus retained 97% of his holdings), and that Amaral did not sell any stock. Such allegations do not support an inference of fraud. Plaintiffs contend that these defendants could not sell more of their stock because to do so would alert the public to a "bail out" and would cause the stock price to fall. Such an argument is essentially a concession that these defendants' stock sales do not support an inference of scienter; plaintiffs do not seriously contend that a lack of such sales support an inference of fraud, at least in the absence of any allegation that the lack or small amount of such sales was unusual or suspicious for some reason.

Defendant Galil, an outside director and the second largest shareholder (and defendant Alon's father-in-law) is alleged to have sold just 14% of his holdings. The SAC does not allege any facts that make Galil's sales unusual or suspicious enough to give rise to a strong inference of scienter. The amount of the sales themselves do not give rise to the required inference in light of the fact that he retained over 80% of his stock holdings. Nor does the timing of the sales. Plaintiffs claim the sales were made right after the false second and third quarter financial statements were made, on July 25 and October 24, respectively. The allegations, however, show that Galil did not sell until three weeks after the July 25 statement was issued. Moreover, if defendants were engaged in a fraudulent scheme to inflate the price of stock, common sense dictates that they would sell when they learned that their scheme would be discovered, that is, when they announced their disappointing fourth quarter results on January 12, 1996 and were forced (according to plaintiffs) to announce that they could no longer recognize revenue on contingencies. According to the allegations of the SAC, Galil did not make any trades after November 13, 1995. Indeed, no defendant traded after mid-November for the remainder of the class period. See Wegner, 2 F.Supp.2d at 1251 (holding that stock sales did not raise an inference of scienter where officers retained the vast majority of their shares and "none of the sales occurred at suspicious times, such as immediately before a negative announcement").

The insider trading allegations as to defendants Bosch, Koretz and Williams are insufficient for similar reasons. While defendant Bosch sold all of his approximately 9,600 shares on August 15, 1995, plaintiffs have not alleged any facts that make this sale suspicious, especially in light of the fact that he is not alleged to have personally made any of the false statements and was an outside director. Plaintiffs' contention that the timing is suspicious because Windows 95 was released in August is unpersuasive. As stated above, plaintiffs have failed to identify what specific information defendants, and Bosch in particular, knew about Windows 95 that was not publicly available.

Defendants Koretz and Williams sold 76% and 94% of their shares respectively during the class period. As with the other defendants, however, there is nothing suspicious or unusual about the timing of these sales. Moreover, the Court takes judicial notice of the fact that these defendants actually sold more shares during the six months preceding the class period. Accordingly, the stock sales of these defendants do not create a strong inference of scienter as the sales were consistent with their selling pattern during the period when they are not alleged to have engaged in the fraudulent scheme. See Silicon Graphics II, 970 F.Supp. at 768; Hockey v. Medhekar, 1997 WL 203704 *11 (N.D. Cal. April 15, 1997). In any event, even if their sales were somehow suspicious or unusual, they are insufficient to create the requisite strong inference of scienter in light of the lack of any specific allegations as to their fraudulent conduct, including the lack of any allegation that they personally made any of the allegedly fraudulent statements.

Plaintiffs' merger allegations similarly do not alone, or taken together with the other allegations of the SAC, give rise to a strong inference of scienter in light of the small percentage of stock at issue.

B. The Accounting Fraud.

Plaintiffs' accounting fraud allegations also fail. Even assuming that defendants have satisfied the PSLRA's requirement that they set forth all facts upon which their accounting fraud allegations are based, plaintiffs' allegations do not give rise to a strong inference of scienter. The gravamen of the accounting allegations is that unresolved contingencies on sales throughout 2Q95 and 3Q95, such as sales with a right of return, were improperly accounted thereby falsely inflating NetManage's 2Q95 and 3Q95 financials by two million dollars. See ¶¶ 99-109. Plaintiffs allege that NetManage's accounting policy was fraudulent because (1) it violated GAAP, (2) NetManage, at the insistence of its auditors, changed its policy in 1995 to defer revenue recognition where the right of return had not expired, (3) as a result of the change in policy, the 4Q95 results were less than expected, and (4) in the past NetManage had represented that returns were insignificant, but no such representation was made in the 95 report. See SAC ¶ 108.

These allegations do not give rise to a strong inference of scienter. As plaintiffs themselves allege, the annual reports disclosed the rights of return and that NetManage was accounting for revenue from such sales even though the rights of return existed. The facts that this policy may have violated GAAP and may have been subsequently changed do not support an inference of scienter, including recklessness. This is especially true given that the second and third quarter statements have never been restated even though NetManage continued to employ the accounting company that allegedly uncovered the fraud in the first place, and given that plaintiffs do not allege that any of the revenue which was prematurely accounted for was never actually realized by NetManage. Moreover, the allegation that NetManage did not include in its 1995 annual statement the representation that the returns were insignificant is false. The 1995 annual report, which the Court may consider since the SAC discusses it, includes the precise statement that plaintiffs allege was omitted.

Plaintiffs' reliance on Cooper v. Pickett, 137 F.3d 616 (9th Cir. 1998) is as misplaced as its reliance on Wool v. Tandem Computers, Inc., 818 F.2d 1433 (9th Cir. 1997). Cooper, like Wool, did not apply the PSLRA, and, in particular, did not apply the requirement that plaintiffs plead facts that give rise to a strong inference of the required state of mind.

In sum, the mere fact that NetManage changed its publicly-disclosed accounting policy that may have violated GAAP, and that the change led to lower reported revenues in the following quarter, does not support any inference of scienter, let alone the required strong inference. The insider trading and merger allegations do not supply the missing inference for the reasons discussed above.

For the foregoing reasons, defendants' motion to dismiss is GRANTED. As plaintiffs have already twice amended their complaint, and have not demonstrated that a further amendment would rectify the deficiencies in their complaint, the SAC is dismissed without leave to amend.

IT IS SO ORDERED.