BRUCE G. VANYO, State Bar # 060134
JEROME F. BIRN, JR., State Bar # 128561
IGNACIO E. SALCEDA, State Bar # 164017
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, ROBERT WILLIAMS AND
DARRELL MILLER.
UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF CALIFORNIA
SAN JOSE DIVISION
|
JOSEPH MOLINARI, JR., On Behalf of Plaintiff, v. NETMANAGE, INC., ZVI ALON, WALTER
Defendants. |
) |
CASE NO.: C-97-20544-JW DEFENDANTS' NOTICE OF Date: February 9, 1998 |
MEMORANDUM OF POINTS AND AUTHORITIES
INTRODUCTION AND SUMMARY OF ARGUMENT
A. Only Forward-Looking Statements Made with Actual Knowledge of Falsity are Actionable
B. The Reform Act also Raised the Standard for Falsity and Fraudulent Intent of Statements
II. THE COMPLAINT DOES NOT JUSTIFY IMPUTING TO DEFENDANTS STATEMENTS MADE BY ANALYSTS
Acito v. IMCERA Group, Inc.,
47 F.3d 47 (2d Cir. 1995)
Branch v. Tunnell,
14 F.3d 449 (9th Cir. 1994)
Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A.,
511 U.S. 164 (1994)
Cooper v. Pickett,
122 F.3d 1186 (9th Cir. 1997)
Duncan v. Pencer,
[1995-1996 Tr. Binder] Fed. Sec. L. Rep.
(CCH) ¶ 99,043 (S.D.N.Y. Jan. 18, 1996)
Garcia v. United States,
469 U.S. 70 (1984)
Ernst & Ernst v. Hochfelder,
425 U.S. 185 (1976)
Hockey v. Medhekar,
[Current Tr. Binder] Fed. Sec. L. Rep.
(CCH) ¶ 99,465 (N.D. Cal. Apr. 15, 1997)
Hollinger v. Titan Capital Corp.,
914 F.2d 1564 (9th Cir. 1990)
Howard Gunty Profit Sharing v. Quantum Corp.,
No. 96-20711, 1997 WL 514993
(N.D. Cal. Aug. 14, 1997)
In re Apple Computer Sec. Litig.,
886 F.2d 1109 (9th Cir. 1989)
In re Caere Corp. Sec. Litig.,
837 F. Supp. 1054 (N.D. Cal. 1993)
In re GlenFed, Inc. Sec. Litig.,
42 F.3d 1541 (9th Cir. 1994) (en banc)
In re GlenFed, Inc. Sec. Litig.,
60 F.3d 591 (9th Cir. 1995)
In re Kelly,
841 F.2d 908 (9th Cir. 1988)
In re Mobile Telecommunication Technologies Corp. Sec. Litig.,
915 F. Supp. 828 (S.D. Miss. 1995)
In re Ross Systems Sec. Litig.
[1994-1995 Tr. Binder] Fed. Sec. L. Rep.
(CCH) ¶ 98,363 (N.D. Cal. Jul. 21, 1994)
In re Silicon Graphics, Inc. Sec. Litig.,
[1996-1997 Tr. Binder] Fed. Sec. L. Rep.
(CCH) ¶ 99,325 (N.D. Cal. Sept. 25, 1996)
In re Silicon Graphics, Inc. Sec. Litig.,
970 F. Supp. 746 (N.D. Cal. 1997)
In re Software Publishing Sec. Litig.,
[1993-1994 Tr. Binder] Fed. Sec. L. Rep.
(CCH) ¶ 98,094 (N.D. Cal. Feb. 2, 1994)
In re Stac Elecs. Sec. Litig.,
82 F.3d 1480, 1492 (9th Cir.), superseded,
89 F.3d 1399 (9th Cir. 1996), cert. denied, 117 S. Ct. 1105 (1997)
In re Stac Electronics Sec. Litig.,
89 F.3d 1399 (9th Cir. 1996),
cert. denied, 117 S. Ct. 1105 (1997)
In re Syntex Corp. Sec. Litig.,
855 F. Supp. 1086 (N.D. Cal. 1994),
aff'd, 95 F.3d 922 (9th Cir. 1996)
In re Syntex Corp. Sec. Litig.,
95 F.3d 922 (9th Cir. 1996)
In re Worlds of Wonder Sec. Litig.,
35 F.3d 1407 (9th Cir. 1994)
Kramer v. Time Warner, Inc.,
937 F.2d 767 (2d Cir. 1991)
Leonard v. NetFRAME Systems, Inc.,
[1995-1996 Tr. Binder] Fed. Sec. L. Rep.
(CCH) ¶ 98,982 (N.D. Cal. Aug. 8, 1995)
Lovelace v. Software Spectrum Inc.,
78 F.3d 1015 (5th Cir. 1996)
Mack v. South Bay Beer Distrib.,
798 F.2d 1279 (9th Cir. 1986)
Medhekar v. United States District Court,
99 F.3d 325 (9th Cir. 1996)
Neubronner v. Milken,
6 F.3d 666 (9th Cir. 1993)
Norwood Venture Corp. v. Converse Inc.,
959 F. Supp. 205 (S.D.N.Y. 1997)
Raab v. General Physics Corp.,
4 F.3d 286 (4th Cir. 1993)
Resolution Trust Corp. v. Gallagher,
10 F.3d 416 (7th Cir. 1993)
San Leandro Emerg. Med. Group Profit Sharing Plan v. Philip Morris Cos.,
75 F.3d 801 (2d Cir. 1996)
Siegel v. Lyons,
[1996-1997 Tr. Binder] Fed. Sec. L. Rep.
(CCH) ¶ 99,227 (N.D. Cal. Apr. 26, 1996)
Voit v. Wonderware Corp.,
[Current Tr. Binder] Fed. Sec. L. Rep.
(CCH) ¶ 99,541 (E. D. Pa. Sept. 8, 1997)
Zeid v. Kimberley,
973 F. Supp. 910 (N.D. Cal. 1997)
Zuber v. Allen,
396 U.S. 168 (1969)
Securities Exchange Act of 1934, Section 10(b),
15 U.S.C. § 78j(b)
Securities Exchange Act of 1934, Section 20(a),
15 U.S.C. § 78t
Securities Exchange Act of 1934, Section 21D,
15 U.S.C. § 78u-4
Securities Exchange Act of 1934, Section 21E,
15 U.S.C. § 78u-5
Securities and Exchange Commission Rule 10b-5,
17 C.F.R. § 240.10b-5
Fed. R. Civ. P. 9(b)
Fed. R. Civ. P.11
Fed. R. Civ. P. 12(b)(6)
H.R. Conf. Rep. No. 104-369, 104th Cong., 1st Sess. 31 (1995)
Amend. 1485, S. 240, 104th Cong., 1st Sess. (1995)
H.R. Doc. No. 104-150, 104th Cong., 1st Sess. (1995)
On February 9, 1998 at 9:00 a.m., defendants NetManage, Inc., Zvi Alon, Walter Amaral, Uzia Galil, Robert Williams and Darrell Miller ("defendants") will and hereby do move to dismiss all claims alleged in the Complaint, pursuant to Fed. R. Civ. P. 9(b) and 12(b)(6) and the Private Securities Litigation Reform Act of 1995 ("Reform Act"), which added Sections 21D and 21E to the Securities Exchange Act of 1934, 15 U.S.C. §§ 78u-4, 78u-5 ("Exchange Act").1
The issues presented in this motion are: (1) whether the Complaint has alleged with particularity facts giving rise to a "strong inference" that defendants made forward-looking statements forecasts with actual knowledge of their falsity, as required by Sections 21D(b)(1) & (2) and 21E of the Exchange Act; (2) whether the Complaint has alleged with particularity facts giving rise to a "strong inference" that defendants acted with scienter, as required by Sections 21D(b)(1) & (2); (3) whether plaintiff has alleged specific facts showing that statements by securities analysts may be imputed to defendants; and (4) whether defendants Galil, Williams, and Miller may be liable under Section 10(b) where they are not alleged to have made a false statement.
In December 1995, "prompted by significant evidence of abuse in private securities lawsuits," Congress enacted the Private Securities Litigation Reform Act of 1995 ("Reform Act"), overriding President Clinton's veto. H.R. Conf. Rep. No. 104-369, 104th Cong., 1st Sess. 31 (1995) ("Conf. Rep.").2 One abuse of particular concern was that companies were being sued based on no more than a modest failure to meet quarterly forecasts. Congress sought to remedy these abuses by creating "needed procedural protections to discourage frivolous litigation." Id. at 32. Among these protections are a statutory "safe harbor" for forward-looking statements, "heightened pleading" standards much more rigorous than prior law in the Ninth Circuit, and a new state of mind requirement for forward-looking statements: "actual knowledge." Today, in order to survive a motion to dismiss, a complaint must plead all facts in plaintiff's possession that support his belief that defendants made a false statement. Those facts, in turn, must give rise to a "strong inference" that each defendant acted with the required fraudulent intent. Plaintiff's Complaint comes nowhere near satisfying these new standards.
This is a securities class action about a single quarter -- the June 1996 quarter. During this quarter, financial analysts made various independent (and diverging) forecasts about NetManage's future prospects. The Complaint contains boilerplate allegations that these forecasts were the product of communications with unidentified defendants. The Complaint challenges only two statements made by any of the defendants -- and plaintiff has one of those completely wrong.
Where is the fraud here? Plaintiff merely supposes that because NetManage experienced a disappointing June quarter, defendants "must have known" that this disappointment was coming. There are no contemporaneous facts alleged to support that supposition. There is no explanation of how defendants allegedly knew that NetManage would have a disappointing quarter. Instead, the Complaint weaves a tangled conspiracy of defendants committing fraud in order to avoid being sued for fraud.
Even before the passage of the federal Private Securities Litigation Reform Act of 1995, Pub. L. No. 104-67, this type of "missed quarter" case was routinely dismissed by federal courts. With the enactment of a "safe harbor" for forward-looking statements, which requires plaintiffs to show that forward looking statements were made with actual knowledge of their falsity, and the heightened pleading standard for falsity, this case should be dismissed without hesitation.
This is a case about NetManage's second quarter of 1996, which ended on June 30, 1996. The Class Period begins on April 18, 1996. A financial analyst in the Boston Group published a report recommending the purchase of NetManage stock. Complaint ¶ 39. One week later, NetManage announced the results of its first quarter of 1996: revenues of $33 million and earnings of $5 million. Complaint ¶ 40. The Complaint does not challenge these results as false. While some analysts were pleased, others thought the first quarter was disappointing. Compare Complaint ¶ 41 (citing positive Smith Barney report) with Complaint ¶ 42 (citing negative reports from Oppenheimer & Co. and Robertson Stephens & Co.).
The Complaint then cites only two statements made by NetManage's Chairman and CEO, Zvi Alon, expressing optimism about the Company's future. These are the only statements made by NetManage that are alleged to be false. As will be discussed below, plaintiff misquotes one of those statements and fails to explain how either statement is misleading, let alone how each statement was made with actual knowledge of its falsity.
The Complaint cites an additional four analyst reports discussing NetManage. These reports, published during the June quarter, were cautious about the Company's prospects.
On July 19, 1996, NetManage announced its results for second quarter of 1996, which ended June 30, 1996. The Company reported revenues of $26.8 million and earnings of $1.6 million. These results were below Wall Street's expectations. Complaint ¶ 51. As a result of this announcement, NetManage stock dropped from $10 3/8 to $9 5/8. Complaint ¶ 52.
How does this amount to securities fraud? At its heart, the Complaint alleges that in April 1996, NetManage's senior executives conspired to artificially inflate the price of NetManage's stock. They allegedly did this not by issuing glowing public statements, but by whispering into the unwitting ears of financial analysts about the Company's future prospects.
The suspected motivation for this alleged campaign is implausible. Months before the beginning of the class period, NetManage acquired two software companies, Syzygy Communications and AGE Logic, in exchange for NetManage stock. Complaint ¶ 5. Plaintiff claims that defendants were concerned that the former shareholders of these companies were upset by the drop in NetManage stock in January 1996 and thus the seeds of a plot were planted.3 According to the Complaint, defendants manipulated the stock price in order to placate these large shareholders in NetManage and to avoid being sued by them. Complaint ¶ 10.
Plaintiff does not explain how defendants thought that a short-term inflation would avoid the ire of these shareholders (none of whom have filed any actions against NetManage) or how defendants thought they could avoid the revelation of their "scheme." That this plot would be doomed to fail in short order does not seem to concern plaintiff. As Judge Williams recently stated in dismissing a similar allegation with prejudice, "the assertion that defendants were compelled to commit fraud by the fear of being sued for fraud is absurd. It is hard to see how defendants would benefit from fighting allegations of fraud with fraud or by making fraudulent statements to temporarily reverse a stock decline for the purpose of avoiding a lawsuit." Zeid v. Kimberley, 973 F. Supp. 910, 923-24 (N.D. Cal. 1997).
In addition, plaintiff alleges that defendants sought to inflate NetManage's stock price in order to cash out of their stock holdings. Complaint ¶¶ 10, 26, 55. In fact, defendants retained the vast majority of their stock and Mr. Alon, who is the only defendant alleged to have made a statement, retained 99.5 percent of his stock holdings.
This Complaint would have been dismissed even under prior Ninth Circuit law. Before the Reform Act, federal courts were extremely unreceptive to securities cases based on nothing more than a missed forecast. As the Ninth Circuit explained in In re GlenFed, Inc. Securities Litigation, "[i]n order to allege the circumstances constituting fraud, plaintiff must set forth facts explaining why the difference between the earlier and the later statements is not merely the difference between two permissible judgments, but rather the result of a falsehood." 42 F.3d 1541, 1549 (9th Cir. 1994) (en banc).4
The Reform Act dramatically raised the standards for such cases in several respects. First, in enacting a "safe harbor" for forward looking statements, Congress required plaintiffs to show that the statement was made with actual knowledge of falsity.
Second, Congress heightened the standard for pleading falsity and scienter. Congress found that existing law was permitting "the routine filing of lawsuits . . . whenever there is a significant change in an issuer's stock price, without regard to any underlying culpability of the issuer, and with only faint hope that the discovery process might lead eventually to some plausible cause of action . . . ." Conf. Rep. at 31.5 ("Silicon Graphics II.") Congress found that Rule 9(b) was not tough enough to "prevent[] abuse of the securities laws by private litigants." Id. at 41. To cure these abuses, Congress expressly created a new, "[h]eightened pleading standard" with "uniform and more stringent pleading requirements to curtail the filing of meritless lawsuits." Id. (emphasis added).
The Complaint does not come close to meeting these requirements.
In passing the Reform Act, Congress found that the existing system of private securities litigation had a "muzzling effect" on "the willingness of corporate managers to disclose information to the marketplace," and harmed shareholders by creating a "chilling effect . . . on the robustness and candor of disclosure," because companies and their officers were subjected to potentially limitless liability if they disclose projections that later turn out to be inaccurate. Conf. Rep. at 42-43. Congress was especially concerned about the chilling effect on high technology companies:
Technology companies -- because of the volatility of their stock prices -- are particularly vulnerable to securities fraud lawsuits when projections do not materialize. If a company fails to satisfy its announced earnings projections -- perhaps because of changes in the economy or the timing of an order or new product -- the company is likely to face a lawsuit.
Id. at 43.
In response to this problem, Congress sought to encourage companies to issue forward-looking statements by reducing the likelihood that they would get sued or face liability for faulty prognostication. Congress concluded that "[u]nderstanding a company's own assessment of its future potential [is] among the most valuable information shareholders and potential investors could have about a firm." Id. Congress therefore created a statutory "safe harbor" for forward-looking statements,6 "to enhance market efficiency by encouraging companies to disclose forward-looking information" without fear of liability. The goal of the safe harbor is "to provide certainty that forward-looking statements will not be actionable by private parties . . . if they are accompanied by a meaningful cautionary statement." Id. at 43-44 (emphasis added).
The safe harbor creates two new separate and independent defenses to liability for a forward-looking statement. First, a defendant shall not be liable for a forward-looking statement if it is "accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statement." Exchange Act § 21E(c)(1)(A). Second, a defendant shall not be liable unless plaintiff proves that the forward-looking statement "was made with actual knowledge" that it "was false or misleading."
Exchange Act § 21E(c)(B) (emphasis added).
The Reform Act also requires plaintiffs to plead with particularity each statement alleged to be misleading and to set forth in detail "the reasons why the statement is misleading." 15 U.S.C. § 78u-4(b)(1)(B). Because plaintiffs' allegations are made on information and belief, plaintiffs must "state with particularity all facts on which that belief is formed." Id. (emphasis added). The Conference Report leaves no doubt that Congress means what it said: "If an allegation is made on information and belief, the plaintiff must state with particularity all facts in the plaintiff's possession on which the belief is formed." Conf. Rep. at 41 (emphasis added). A complaint that does not meet these requirements "shall" be terminated at the pleading stage. 15 U.S.C. § 78u-4(b)(3)(A) (emphasis added)).
The particularized facts pleaded in a complaint must satisfy the Reform Act's rigorous new standard for pleading scienter -- actual knowledge of falsity in the case of the forward-looking statements at issue here. The new pleading standard requires plaintiffs to "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." § 21D(b)(2) (emphasis added). This is a dramatic change from prior Ninth Circuit law, which rejected any form of an "inference" test and allowed scienter to be averred "generally" without any factual basis, "simply by saying that scienter existed." GlenFed, 42 F.3d at 1545, 1547. Congress expressly rejected the Ninth Circuit's old standard for the pleading of scienter.7
The Reform Act's "strong inference" pleading standard "is based in part on the pleading standard of the Second Circuit." Conf. Rep. at 41 (emphasis added). To satisfy the Second Circuit's "strong inference" standard, a plaintiff was required to allege either (i) specific facts that "constitut[e] circumstantial evidence of reckless conscious misbehavior," or (ii) "motive and opportunity to commit fraud." San Leandro Emerg. Med. Group Profit Sharing Plan v. Philip Morris Cos., 75 F.3d 801, 812-13 (2d Cir. 1996). Although the Second Circuit's standard was "[r]egarded as the most stringent pleading standard," Congress intended to "strengthen" even that tough standard. Congress therefore expressly rejected the "motive and opportunity" and "recklessness" parts of that standard:
Because the Conference Committee intends to strengthen existing pleading requirements, it does not intend to codify the Second Circuit's case law interpreting this pleading standard. FN 23/
FN 23/ For this reason, the Conference Report chose not to include in the pleading standard certain language relating to motive, opportunity, or recklessness.
Conf. Rep. at 41 & n.23.
The legislative history leaves no doubt that Congress intended to eliminate "motive and opportunity" and "recklessness" as a basis to plead fraudulent intent. The Senate Bill had included an amendment proposed by Senator Specter, which would have codified the "motive and opportunity" and "recklessness" parts of the Second Circuit standard. Amend. 1485, S. 240, 104th Cong., 1st Sess. (1995) (Salceda Decl. Ex. B). The Conference Committee eliminated the Specter Amendment from the final version of the bill, which Congress passed. In vetoing the bill, President Clinton wrote that he could not agree with the deletion of the Specter amendment.8 Notwithstanding the President's objections, Congress overrode his veto for the first (and only) time and passed the Conference Committee's bill.
Several courts have held that the Conference Report, combined with this legislative history, establishes that Congress created a "heightened" pleading standard by eliminating the Second Circuit's "motive and opportunity" and "recklessness" prongs. Judge Smith has scrutinized this legislative history and come to this conclusion:
[I]n order to state a private securities fraud claim, plaintiffs must create a strong inference of knowing or intentional misconduct. See Hochfelder, 425 U.S. at 197. Knowing or intentional misconduct includes deliberate recklessness, as described in Hollinger and alluded to in Hochfelder. Motive, opportunity, and non-deliberate recklessness may provide some evidence of intentional wrongdoing, but are not alone sufficient to support scienter unless the totality of the evidence creates a strong inference of fraud.
Silicon Graphics II, 970 F. Supp. at 757 (citing Ernst & Ernst v. Hochfelder, 425 U.S. 185, 197 (1976), and Hollinger v. Titan Capital Corp., 914 F.2d 1564 (9th Cir. 1990)); In re Silicon Graphics, Inc. Sec. Litig., [1996-1997 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 99,325, at 95,961-62 (N.D. Cal. Sept. 25, 1996) ("Silicon Graphics I") (only approach permitted under Reform Act to plead a strong inference of fraud is to allege specific facts constituting "circumstantial evidence of conscious behavior by defendants").9
Plaintiff no doubt will argue that other courts have held that Congress was merely codifying the Second Circuit's strong inference standard. The debate about whether the standard is "recklessness" or "conscious misbehavior" is academic here. Because the only statements challenged in the Complaint are forward-looking, Congress specifically mandates the standard of "actual knowledge" of falsity.
The Complaint does not meet the Reform Act's rigorous new standards. Plaintiff starts with NetManage's missed Second Quarter results and merely assumes that Mr. Alon's forecasts were fraudulent. Entirely absent from the Complaint are specific factual allegations about how Mr. Alon supposedly knew that his statements were false.
Plaintiff offers nothing but the boilerplate of paragraph 70, titled "Basis of Allegations":
Because the PSLRA, §21(c) [15 U.S.C. §78u-4(c)], requires complaints to be pleaded in conformity with Federal Rule of Civil Procedure 11, plaintiff has alleged the foregoing based upon the investigation of his counsel, which included a review of NetManage's SEC filings, securities analysts' reports and advisories about the Company, press releases issued by the Company, media reports about the Company and discussions with consultants, and pursuant to Rule 11(b)(3), believes that substantial evidentiary support will likely exist for the allegations set forth in ¶¶ 1, 3-15, 22-30, 32-38, 39-48, 50-51, 53-55, 57-60, 62-63 and 65-69 after a reasonable opportunity for discovery.
This paragraph does not attempt to "state with particularity all facts" that form plaintiff's belief that NetManage committed fraud. Rather, conceding that he requires discovery -- which he believes is merely "likely" to provide support for his allegations -- plaintiff ignores the central tenet of the Reform Act: "Congress clearly intended that complaints in these 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 District Court, 99 F.3d 325, 328 (9th Cir. 1996) (emphasis added). The Complaint should be dismissed on this basis alone. See Howard Gunty Profit Sharing v. Quantum Corp., No. 96-20711 SW, 1997 WL 514993, at *3 (N.D. Cal. Aug. 14, 1997) ("Plaintiff's alleged need for discovery does not excuse it from satisfying the strict pleading requirements of Rule 9(b) and the Reform Act.") (Salceda Decl. Ex. D); Exchange Act § 21D(b)(3)(B), 15 U.S.C. § 78u-4(b)(3)(B) (all discovery shall be stayed during the pendency of a motion to dismiss).
Plaintiff makes the incredible assertion that the Reform Act's heightened pleading standard merely "requires complaints to be pleaded in conformity with Federal Rule of Civil Procedure 11." Complaint ¶ 70. In other words, plaintiff believes that a complaint survives the Reform Act's new heightened pleading standard as long as it is not sanctionable. This argument cannot be taken seriously. It would effectively nullify the heightened pleading standard.
Rule 11 already existed when Congress passed the Reform Act. In raising the pleading standard and requiring plaintiffs to plead all facts in their possession when they file a complaint, Congress intended to end "significant evidence of abuse in private securities lawsuits," by "implement[ing] needed procedural protections to discourage frivolous litigation." Conf. Rep. at 31-32. Congress explained that these protections should lead courts to dismiss cases at the pleadings, sparing defendants the burdens of having to defend these cases, and avoiding the "abuse of the discovery process to impose costs so burdensome that it is often economical for the victimized party to settle." Id. at 31. If Rule 11 had been sufficient to do this, ented these abuses. Id. If the Reform Act's pleading standards do no more than screen out complaints already sanctionable under Rule 11, Congressional intent would be thwarted and the heightened pleading standard rendered meaningless.
Courts applying the Reform Act have expressly rejected the form conclusory pleading used in this Complaint. Judges Patel and Smith both dismissed complaints with similar "Basis of Allegations" paragraphs. Judge Patel held that "the [Reform Act], as is evidenced by its strict prohibition of discovery during the pendency of a motion to dismiss, was enacted in part to require plaintiffs to make a showing that the statements at issue were false or misleading prior to discovery." Hockey v. Medhekar, [Current Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 99,465, at 97,081 (N.D. Cal. Apr. 15, 1997). See Silicon Graphics I, at 95,966 & n.11 (dismissing complaint; allegations of unspecified "negative internal reports" were boilerplate and identical to five other class action complaints).
What facts does plaintiff have that cause him to believe that Mr. Alon knowingly lied about the NetManage's prospects? Plaintiffs allege nothing but boilerplate, that "the Individual Defendants each knew NetManage's business was not performing as well as publicly represented" because of the Company's annual budget and forecast as well as unidentified "internal reports." Complaint ¶ 27. To date, three different Judges in this District applying the Reform Act have expressly rejected allegations of fraud based on unspecified allegations of "internal company reports."
Judge Smith rejected such allegations in Silicon Graphics I and Silicon Graphics II. Judge Smith reasoned that every company's management receives reports from its sales force and other internal reports. If the mere allegation that these reports were "negative" were sufficient, any public company could be sued for fraud whenever its stock price dropped -- the evil the Reform Act was intended to prevent. Judge Smith explained that the Reform Act requires plaintiffs to "provide more details about the alleged negative internal reports. The allegations should include the titles of the reports, when they were prepared, who prepared them, to whom they were directed, their content, and the sources from which plaintiffs obtained this information." Silicon Graphics II, 970 F. Supp. at 767. See Silicon Graphics I, at 95,966.
Judge Patel reached the same conclusion in Hockey v. Medhekar:
Nowhere in plaintiffs' complaint is there a reference to any particular corporate document or data. Plaintiffs do not attempt to show when these documents were created, by whom they were drafted, or even whether [the company] regularly prepared such documents. Nor do they try to explain precisely what was in the alleged documents, other than maintaining that they contained information that differed from defendants' public statements.
[Current Tr. Binder] Fed. Sec. L. Rep. ¶ 99,465, at 97,081. And Judge Williams applied the same reasoning in Zeid v. Kimberley:
[T]he only reference to supporting information is a general allegation that defendants had access to "internal corporate information" . . . . However, without any reference to particular corporate documents or other information, the Court can only conclude that Plaintiffs' allegations are based purely on speculation and conclusions drawn from hindsight.
Zeid v. Kimberley, 973 F. Supp. 910, 920 (N.D. Cal. 1997) (footnote and citation omitted).
The principle applied in these cases is not novel. Courts reached the same result under prior law. See San Leandro Emerg. Med. Group Profit Sharing Plan v. Philip Morris Cos., 75 F.3d 801, 812-13 (2d Cir. 1996) (requiring plaintiffs to specifically identify alleged negative internal reports, providing names and dates); In re Syntex Corp. Sec. Litig., 855 F. Supp. 1086, 1095 (N.D. Cal. 1994) ("[P]laintiffs' allegation that defendants possessed 'internal corporate data known only to them' comes nowhere close to satisfying Fed. R. Civ. P. 9(b)."), aff'd, 95 F.3d 922 (9th Cir. 1996). The Reform Act simply requires that the particularity requirement be applied with greater force.
In sum, plaintiff has not pleaded with particularity any factual basis for his belief that defendants made a single false statement, let alone facts giving rise to a strong inference that Mr. Alon acted with actual knowledge of the falsity of his statements. Plaintiff offers nothing but conclusory allegations about "internal corporate documents," and a "Basis of Allegations" paragraph that offers to live up to its name only after discovery.
The Complaint is peculiar. It is largely predicated on statements made by third parties, not the statements of the defendants. Plaintiff challenges only two statements allegedly made by defendant Alon, NetManage's Chairman and Chief Executive Officer. Neither of these alleged statements supports a claim.
Plaintiff first alleges that Mr. Alon told a CNBC interviewer: "We are now expecting to see a major expansion in sales." Complaint ¶ 43. Mr. Alon did not say that -- although the mistake is understandable. In a Bloomberg News Report of the interview, Mr. Alon was misquoted. Plaintiff lifted that misquote verbatim into the Complaint. See Bloomberg News Report, May 20, 1996, 12:43 pm ET (Salceda Decl. Ex. E). Bloomberg issued a revised report later that day without the misquote. Bloomberg's corrected story stated that Mr. Alon had referred to the growth in NetManage's indirect sales. Bloomberg News Report, May 20, 1996 5:21 pm ET (Salceda Decl. Ex. F).
In fact, what Mr. Alon said was much different. There can be no dispute about this because there is a tape of the CNBC interview.10 Mr. Alon was asked whether NetManage expected to increase its use of indirect sales (e.g., sales to distributors or value added resellers). He stated that NetManage had been expanding in that area for two years, and that it was now beginning to see an expansion in those sales. See Transcript of CNBC Interview at 4 (Salceda Decl. Ex. G). Plaintiff does not dispute that NetManage was expanding it indirect sales. On the contrary, the Complaint itself notes that, during 1995 and 1996, NetManage expanded its international sales force and began selling through retail distributors. See Complaint ¶ 4.
The second challenged statement is too vague and conclusory to support a claim. Plaintiff alleges that after the CNBC interview, someone from NetManage (apparently Mr. Alon) made a presentation to the Smith Barney High Technology Conference, and purportedly stated that NetManage was expecting strong revenue growth in the second half of the year as a result of recent product introductions. Complaint ¶ 43.
Even if plaintiff's misquote of the CNBC interview were taken at face value, neither of these statements would state a claim. The Complaint does not plead facts showing that defendant Alon did not believe the forward-looking statements to be true at the time they allegedly were made. Plaintiff does not allege one specific fact showing that Mr. Alon knew that his statements were false when made.
Even before the passage of the Reform Act, federal courts examining allegedly false forecasts have required plaintiffs to plead specific facts showing that these statements were not genuinely or reasonably believed. Because securities cases "often involve some more or less catastrophic event occurring between the time the complained-of statement was made and the time a more sobering truth is revealed (precipitating a drop in stock price)" courts have required plaintiffs to show with particularity that defendants knew at the time of their representations that their statements about the future were false or misleading. In re GlenFed, Inc. Sec. Litig., 42 F.3d at 1548-49 & n. 8 (citing cases). A plaintiff "must set forth more than neutral facts" and claim a fraud has been committed. Id. at 1548. Rather, plaintiffs "must set forth . . . an explanation as to why the disputed statement was untrue or misleading when made." Id. at 1549. In order to do this, a plaintiff must point to "inconsistent contemporaneous statements or information (such as internal reports)" showing that the statement was false. Id. It was not sufficient to allege in conclusory fashion that defendants knew or should have known of undisclosed information potentially undermining a forecast. As Judge Jensen explained in Leonard v. NetFRAME Systems, Inc., [1995-1996 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 98,982, at 93,780 (N.D. Cal. Aug. 8, 1995), "[p]laintiff'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."
With the benefit of hindsight, plaintiff merely alleges that defendants must have known that NetManage's expectations would not be met because the Company faced competition. Plaintiff alleges that Mr. Alon's alleged statements were undermined by the fact "known only to defendants through their access to NetManage data," that NetManage faced "competition from larger, more recognizable and better financed competitors." Complaint ¶ 11(b). See also id. ¶ 11(c) ("larger and better financed companies"); id. ¶ 11(e) ("larger competitors such as Microsoft and Netscape "). That is not enough to state a cause of action for securities fraud. As a matter of law, such allegations are insufficient.
In In re Stac Electronics Securities Litigation, 89 F.3d 1399 (9th Cir. 1996), cert. denied, 117 S. Ct. 1105 (1997), the Ninth Circuit affirmed dismissal of similar allegations. There, plaintiffs alleged that a company committed fraud because it did not disclose that Microsoft would introduce a competing product. The Ninth Circuit held that information concerning Microsoft's activities is, by its nature, not something that is known only by a competitor. It held that "customer resistance to purchasing a product in anticipation of newer products is precisely the sort of market awareness that we have held to defeat claims of fraud on the market." Id. at 1410 (citation omitted). That phenomenon is especially true in the computer industry, where knowledge of "rapid technological advances is information within the public domain." Id. (quotations omitted).11
Plaintiff alleges that stock sales by the individual defendants provide circumstantial evidence of their fraudulent intent. Under the Reform Act, stock sales by defendants "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)). Plaintiff contends that the individual defendants were motivated to defraud NetManage's shareholders in order to sell a substantial amount of NetManage stock. Complaint ¶¶ 10, 26, 55.
In fact, the opposite is true. Defendants did not unload their shares in NetManage, and the only individual defendant who is alleged to have made a statement sold a minuscule percentage of his vast holdings of stock. In addition, the other defendants' sales are not suspicious because they held substantial holdings of stock and vested options.
The only defendant alleged to have made a statement, NetManage's Chairman and CEO Zvi Alon, is alleged to have sold 40,000 of NetManage stock during the class period. What plaintiff fails to tell the Court, however, is that Mr. Alon retained more than 8.8 million shares of NetManage stock12. In other words, Mr. Alon retained 99.5 percent of his stock holdings while he was allegedly attempting to cash out his position at an artificially inflated price. It strains credulity to believe that the only defendant alleged to have lied so that he could unload his stock on the unsuspecting public retained 99.5 percent of his stock.
Nor are the sales by the other individual defendants suspicious. Uzia Galil, an outside director of NetManage and Mr. Alon's father-in-law, sold 43,000 shares. This was less than 3 percent of his more than 1,500,000 shares of stock, and significantly less than the shares he sold before the class period -- 92,500 shares in the second half of 1995, and 119,000 shares during the first half of 1995. 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 II, 970 F. Supp. at 768; Hockey, [Current Tr. Binder] Fed. Sec. L. Rep. at 97,083 (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").
Walter Amaral, the chief financial officer sold a mere 1,523 shares. The only defendant who is alleged to have sold substantial holdings is Darrell Miller, an outside director, who sold 80,000 shares
Overall, defendants sold less than 1.5 percent of their total holdings. In Silicon Graphics, Judge Smith held that individual defendants' sales of only 10 percent of their total holdings was insufficient as a matter of law to give rise to a strong inference of fraud. Silicon Graphics II, 970 F. Supp. at 768 (individuals' sales of 2.6%, 7.7%, 4.1%, and 6.9%, and overall sales of 10% of total holdings, do not raise strong inference of fraudulent intent).13 Here, defendants' minuscule stock sales, do not raise a strong inference that they acted with the intent to defraud. On the contrary, they refute plaintiff's claim that defendants were motivated to commit fraud so that they could sell their stock.
The Complaint does not allege that defendants made a single specific financial forecast concerning NetManage's future earnings or revenues during the class period. Instead, all but two of the statements challenged in the Complaint are based on opinions and forecasts contained in reports published by stock analysts. See Complaint ¶¶ 29, 41-42, 44, 47-48, 50. Because the Complaint does not allege specific facts showing that defendants were so entangled with these analyst reports that defendants effectively adopted them as their own, these third-party statements cannot form the basis of a claim against defendants.
Courts refuse to impose liability on corporate defendants for analyst reports unless plaintiffs plead facts showing that "defendants . . . put their imprimatur, express or implied, on the projections." In re Syntex Corp. Sec. Litig., 95 F.3d 922, 934 (9th Cir. 1996) (quoting In re Stac Elecs. Sec. Litig., 82 F.3d 1480, 1492 (9th Cir.), superseded, 89 F.3d 1399 (9th Cir. 1996), cert. denied, 117 S. Ct. 1105 (1997)). The facts underlying defendants' alleged endorsement must be pleaded with particularity. In re Stac Elecs. Sec. Litig., 89 F.3d 1399, 1410 (9th Cir. 1996), cert. denied, 117 S. Ct. 1105 (1997). Plaintiffs must "(1) identify specific forecasts and name the insider who adopted them; (2) point to specific interactions between the insider and the analyst which gave rise to the entanglement; and (3) state the dates on which the acts which allegedly gave rise to the entanglement occurred."14 In re Caere Corp. Sec. Litig., 837 F. Supp. 1054, 1059 (N.D. Cal. 1993).
The Complaint here satisfies none of those requirements. It is devoid of facts showing that defendants were so entangled with the analyst reports that they effectively placed their "imprimatur" upon the opinions stated in the reports. Which defendants provided information? What did they say? How were defendants' and the analyst's statements false?
In fact, if anything, the Complaint demonstrates that financial analysts had varying opinions about NetManage's prospects. While one analyst was pleased with NetManage's First Quarter results, the Complaint concedes that "[o]ther analysts were less enthusiastic." Complaint ¶ 42. On April 24, 1996, Smith Barney allegedly issued an upbeat report about NetManage. Complaint ¶ 41. On the same day, Oppenheimer & Co. lowered its forecast for NetManage's earnings. Complaint ¶ 42. Two days later, Robertson Stephens & Co. also lowered its estimates. Id. This divergence of opinion among financial analysts belies plaintiff's claim that defendants were feeding optimistic forecasts to the analysts. See In re Stac, 89 F.3d at 1410 (citing plaintiffs' failure to "explain the disparity in the projections of analysts" in affirming the dismissal of such claims with prejudice).
Plaintiff may cite the Court to the Ninth's Circuit's decision in Cooper v. Pickett, 122 F.3d 1186 (9th Cir. 1997), where a motion to dismiss was reversed. The facts alleged in the Cooper complaint are readily distinguishable. In Cooper, plaintiffs alleged that defendants had directly faxed their internal earnings forecast to a securities analyst. In contrast, plaintiff here relies on rote, conclusory allegations about every analyst report written about NetManage. Moreover, Cooper did not purport to overrule, or even discuss, Syntex or Stac, which remain good law. Accordingly, Cooper is unpersuasive here.
Moreover, the Complaint here pleads no facts showing that the analyst forecasts and predictions were false when made. Plaintiff again relies entirely on hindsight: given that actual results were worse than anticipated, plaintiff presumes that the analyst statements were false when made. The Complaint has not pleaded specific facts showing that the analysts or defendants knew that the forecasts were false, as the Reform Act requires
In Central Bank of Denver, N.A. v. First Interstate Bank of Denver , N.A., 511 U.S. 164 (1994), the Supreme Court held that there is no cause of action for aiding and abetting a violation of Section 10(b). The Court held that Section 10(b) prohibits only "the making of a material misstatement (or omission) or the commission of a manipulative act" and does not impose liability on persons who merely "giv[e] aid to a person who commits a manipulative or deceptive act." Id. at 177 (emphasis added). The Ninth Circuit has held that Central Bank eliminated all non-statutory theories of secondary liability under Section 10(b). In re GlenFed, Inc. Sec. Litig., 60 F.3d 591, 592 (9th Cir. 1995). Thus, a defendant may be sued for securities fraud only where the allegations meet "all of the requirements for primary liability under Rule 10b-5." Central Bank, 511 U.S. at 191; Silicon Graphics II, 970 F. Supp. at 759 (only primary participants in a Section 10(b) violation may be held liable).
In addition to the pleading defects relevant to all defendants, plaintiff fails to state a claim against defendants Galil, Williams, and Miller because these defendants are not alleged to have made a false statement. The only statements challenged by plaintiff are two oral statements allegedly made by Mr. Alon. Complaint ¶ 43. Thus, plaintiff has not stated a primary violation of Section 10(b). Neubronner v. Milken, 6 F.3d 666, 673 (9th Cir. 1993) (dismissing Section 10(b) claim where plaintiff failed to attribute false or misleading statement to defendant). The Complaint does not allege that these defendants are "controlling persons" of NetManage under Section 20(a) of the Exchange Act, 15 U.S.C. § 78t. Accordingly, all claims against these defendants must be dismissed.
For the foregoing reasons, defendants respectfully request that their motion to dismiss be granted.
|
Dated: November 19, 1997 |
Respectfully submitted, WILSON SONSINI GOODRICH & ROSATI By______________________________ Attorneys for Defendants |
1 Defendant Geisler has not been served and does not appear or join this motion
2 Attached as Exhibit A to the Declaration of Ignacio E. Salceda (³Salceda Decl.) filed in support of defendants¹ motion to dismiss.
3 Counsel for plaintiff in this litigation have also filed two identical class actions against NetManage arising out of the drop in NetManage¹s stock in January 1996. Head et al. v. NetManage, Inc. et al, Case No. CV763295 (Santa Clara Co. Sup. Ct.); Head et al. v. NetManage, Inc. et al., Case No. C-97-20061-JW (N. D. Cal.). In addition, Mr. Molinari is also a plaintiff in an identical suit filed against defendants in Santa Clara County Superior Court over the same events as are at issue in this case. Interactive Data Systems, Inc. et al v. NetManage, Inc. et al., Case No. CV764945 (Santa Clara Co. Sup. Ct.). Judge Turrone sustained defendants¹ demurrer to the initial complaint in that case, which was substantially identical to the Complaint before this Court. Plaintiffs filed an amended complaint, to which defendants demurred. The hearing on that demurrer is currently set for December 11, 1997.
4 See also, e.g., Raab v. General Physics Corp., 4 F.3d 286, 291 (4th Cir. 1993) (" Every prediction of success that fails to materialize cannot create on that account an action for securities fraud.").
5 As a matter of law, the Conference Report is the definitive statement of legislative intent: "[T]he authoritative source for finding the Legislature's intent lies in the Committee Reports on the bill, which 'represen[t] the considered and collective understanding of those Congressmen involved in drafting and studying proposed legislation.'" Garcia v. United States, 469 U.S. 70, 76 (1984) (quoting Zuber v. Allen, 396 U.S. 168, 186 (1969)); see Resolution Trust Corp. v. Gallagher, 10 F.3d 416, 421 (7th Cir. 1993) (conference report "is the most persuasive evidence of congressional intent besides the statute itself"); In re Kelly, 841 F.2d 908, 912 n.3 (9th Cir. 1988) (committee reports, not "[s]tray comments by individual legislators," provide the best expression of legislative intent.). See also In re Silicon Graphics, Inc. Sec. Litig., 970 F. Supp. 746, 757 (N.D. Cal. 1997).
6 A "forward-looking statement" is one that projects financial items, describes management's plans and objectives for future operations or economic performance, or any statement of the assumptions underlying the foregoing. Exchange Act § 21E(i)(1)..
7 Congress concluded that Rule 9(b)'s particularity requirement, particularly as interpreted by the Ninth Circuit, "has not prevented abuse of the securities laws by private litigants" and has led to "conflicting . . . distinctly different standards" among the courts of appeal. Conf. Rep. at 41..
8 President Clinton wrote: "The conferees deleted an amendment offered by Senator Specter and adopted by the Senate that specifically incorporated Second Circuit case law with respect to pleading a claim of fraud. Then they specifically indicated that they were not adopting Second Circuit case law but instead intended to 'strengthen' the existing pleading requirements of the Second Circuit. All this shows that the conferees meant to erect a higher barrier to bringing suit than any now existing." H.R. Doc. No. 104-150, 104th Cong., 1st Sess. (1995) (emphasis added) (Salceda Decl. Ex. C.).
9 See also Norwood Venture Corp. v. Converse Inc., 959 F. Supp. 205, 208 (S.D.N.Y. 1997) (concluding after extensive review of legislative history that "under the PSLRA a plaintiff in a private securities litigation action must now plead specific facts that 'create a strong inference of knowing misrepresentation on the part of the defendants'") (quoting Silicon Graphics I, at 95,963); Voit v. Wonderware Corp., [Current Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 99,541, at 97,673 (E. D. Pa. Sept. 8, 1997) ("We agree with the Norwood and Friedberg courts' interpretation of the PSLRA. The Act's legislative history suggests that it was intended at least to surpass the Second Circuit's 'motive and opportunity' and 'recklessness' standards.")..
10 The Court may take judicial notice of the contents of the interview as it is referenced in the Complaint. Branch v. Tunnell, 14 F.3d 449, 454 (9th Cir. 1994) ("[D]ocuments whose contents are alleged in a complaint and whose authenticity no party questions, but which are not physically attached to the pleading, may be considered in ruling on a Rule 12(b)(6) motion to dismiss."). Defendants have had a video tape of the interview transcribed for the Court's convenience. If the Court would prefer, defendants will submit a copy of the videotape itself..
11 See also In re Mobile Telecommunication Technologies Corp. Sec. Litig., 915 F. Supp. 828, 838 & n.7 (S.D. Miss. 1995) ("Upon PageNet's announcement of its intent to enter the market, [defendants] had no duty to disclose the obvious fact that competition would increase. . . . That is, defendants were not required to disclose the obvious: that if two companies offer comparable products in the same market, one at half the cost of the other and seeking to convert the other's customers, then there exists a competitive threat.") (Dismissing complaint)..
12 The information on stock holdings is derived from the public record, specifically, NetManage's 1996 Proxy Statement, filed with the SEC April 12, 1996 (Salceda Decl. Ex. H), and Form 4s filed by each defendant with the SEC. The Court may judicially notice documents filed with the SEC where their authenticity is not questioned. See Silicon Graphics II, 970 F. Supp. at 751-52; Silicon Graphics I, at 95,966. See also Lovelace v. Software Spectrum Inc., 78 F.3d 1015, 1018 (5th Cir. 1996); Kramer v. Time Warner, Inc., 937 F.2d 767, 774 (2d Cir. 1991); cf. Mack v. South Bay Beer Distrib., 798 F.2d 1279, 1282 (9th Cir. 1986). Defendants do not attach all of the Form 4s because they are voluminous. If plaintiff's counsel or the Court so requests, defendants will provide copies of the relevant Form 4s..
13 See Acito, 47 F.3d at 54 (no fraud where defendant held 89 percent of his holdings); Duncan v. Pencer, [1995-1996 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 99,043, at 94,208 (S.D.N.Y. Jan. 18, 1996) (dismissing complaint; stock sales of $29 million not "unusual" based on defendants' "substantial holdings" after sales); see also In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1425 (9th Cir. 1994) (no inference of scienter where defendants retained bulk of their shares); In re Apple Computer Sec. Litig., 886 F.2d 1109, 1117 (9th Cir. 1989) (insider sales of $84 million representing only 8% of their holdings not suspicious)..
14 Siegel v. Lyons, [1996-1997 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 99,227, at 95,225 (N.D. Cal. Apr. 26, 1996); Leonard, [1995-1996 Tr. Binder] Fed. Sec. L. Rep. at 93,781; In re Ross Systems Sec. Litig. [1994-1995 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 98,363, at 90,499 (N.D. Cal. Jul. 21, 1994); In re Software Publishing Sec. Litig., [1993-1994 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 98,094, at 98,762 (N.D. Cal. Feb. 2, 1994).