BRUCE G. VANYO (060134)
JEROME F. BIRN, JR. (128561)
IGNACIO E. SALCEDA (164017)
TRACY TOSH LANE (184666)
REBECCA A. MITCHELLS (151683)
WILSON SONSINI GOODRICH & ROSATI
Professional Corporation
650 Page Mill Road
Palo Alto, California 94304-1050
Telephone: (650) 493-9300
Facsimile: (650) 565-5100

Attorneys for Defendants
NETMANAGE, INC., ZVI ALON, WALTER
AMARAL, UZIA GALIL and
DARRELL MILLER

Introduction and Summary of the Argument

Argument

A. The Corrected Bloomberg News Report And The Transcript Of The CNBC Interview Can And Should Be Considered With The Motion To Dismiss

B. The Court Can And Should Consider NetManage's SEC Filings

Conclusion

Branch v. Tunnell, 14 F.3d 449 (9th Cir. 1994)

Cooper v. Pickett, 137 F.2d 616 (9th Cir. 1998)

Cortec Indus., Inc. v. Sum Holding, L.P., 949 F.2d 42 (2d Cir. 1991)

Diceon Electronics, Inc. v. Calvary Partners, L.P., 772 F. Supp. 859 (D. Del. 1991)

E.E.O.C. v. General Telephone Co. of Northwest, Inc., 885 F.2d 575 (9th Cir. 1989)

Gray v. First Winthrop Corp., 82 F.3d 877 (9th Cir. 1996)

Haltman v. Aura Systems, 844 F. Supp. 544 (C.D. Cal. 1993)

Hennessy v. Penril Datacomm Networks, Inc., 69 F.3d 1344 (7th Cir. 1995)

In re AES Corp. Sec. Litig., 825 F. Supp. 578 (S.D.N.Y. 1993)

In re Delmarva Sec. Litig., 794 F. Supp. 1293 (D. Del. 1992)

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

In re Sun Microsystems, Inc. Sec. Litig., No. C-89-20351-RPA,
     1990 U.S. Dist. LEXIS 18740 (N.D. Cal. Aug. 20, 1990)

In re Wickes Cos. Sec. Litig., [1982-83 Tr. Binder] Fed. Sec. L. Rep. (CCH)
     ¶ 90,055 (S.D. Cal. 1983)

Kramer v. Time Warner, Inc., 937 F.2d 767 (2d Cir. 1991)

Liberty Mutual Ins. Co. v. Rotches Pork Packers, Inc., 969 F.2d 1384 (2d Cir. 1992)

Newport Components, Inc. v. NEC Home Electronics, 671 F. Supp. 1525 (C.D. Cal. 1987)

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

Ritter v. Hughes Aircraft Co., 58 F.3d 454 (9th Cir. 1995)

Southmark Prime Plus, L.P. v. Falzone, 776 F. Supp. 888 (D. Del. 1991)

State Farm Fire & Cas. Co. v. Westchester Inv. Co., 721 F. Supp. 1165 (C.D. Cal. 1989)

United States v. Anderson, 532 F.2d 1218 (9th Cir. 1976)

United States v. Bland, 961 F.2d 123 (9th Cir. 1992)

United States v. Central Gulf Lines, Inc., 747 F.2d 315 (5th Cir. 1984)

United States v. Jones, 29 F.3d 1549 (11th Cir. 1984)

United States v. Kerr, 981 F.3d 1050 (9th Cir. 1992)

17 C.F.R. § 240.14a-6

17 C.F.R. § 240.16a-2, 16a-3

15 U.S.C. § 78n

15 U.S.C. § 78p(a)

15 U.S.C. § 78u-4(b)(1)

15 U.S.C. § 78u-4(b)(2)

18 U.S.C. § 1001

Plaintiff alleges that defendant Alon made a false statement during a CNBC interview. SAC ¶ 56. Plaintiff's source for what Alon said at the interview is a news release issued May 20, 12:43 by Bloomberg, a non-party news agency. But plaintiff's source misreported what Alon said at the interview. The error in plaintiff's source is apparent from Bloomberg's second news release reporting on the CNBC interview and a transcript of the interview. Defendants rely upon the corrected Bloomberg release and the transcript in their motion to dismiss the Second Amended Complaint. Plaintiff moves to strike these two exhibits. Plaintiff instead wants the Court to turn a blind eye to the fact that plaintiff's source wrongly reported on what Alon said at the interview. Plaintiff wants the Court and the parties to waste resources litigating an obvious misreport by a third party news agency. The Court need not and should not allow plaintiff to proceed with a lawsuit premised on a misstatement by a third party that even the third party recognized was incorrect.

Plaintiff also seeks to strike defendants' reliance upon defendants' filings with the Securities and Exchange Commission. These SEC filings show the amount of total NetManage holdings during the class period by defendants Alon, Amaral and Galil. Although plaintiff alleges the amount and dates of each defendants stock sales (SAC ¶ 70), plaintiff selectively omits alleging the amount of these defendants' total holdings in NetManage. There is every reason to believe that plaintiff's allegations regarding the stock amounts and trades dates were derived from the very SEC filings that defendants request judicial notice. Well-established case law allows the Court to take judicial notice of these SEC filings. Accordingly, plaintiff's motion to strike should be denied.

A. The Corrected Bloomberg News Report And The Transcript Of The CNBC Interview Can And Should Be Considered With The Motion To Dismiss

Plaintiff alleges that Alon stated at a CNBC interview on May 20, 1996: "We are now expecting to see a major expansion in sales." SAC ¶ 56. Although the complaint does not allege the source of this alleged statement, plaintiff concedes the alleged quote comes from a Bloomberg news report. Plf's Mem. at 4. Defendants identified in their motion to dismiss, and plaintiff does not dispute, that plaintiff's source is a Bloomberg report dated May 20 at 12:43.

Five hours after Bloomberg released the May 20, 12:43 report relied upon by plaintiff, Bloomberg again reported on the CNBC interview. In the second report, Bloomberg deleted the sentence that plaintiff quotes from the first report, and instead stated:

During the past two years, NetManage started selling its software to wholesalers and resellers, boosting indirect distribution by more than 20 percent, Alon said.

He said the company is starting to see improved sales from an expansion of its sales force in telemarketing and other "direct" sales channels.

Ex. C.¹

That change is critical. Bloomberg's first report says "a major expansion of sales" without identifying direct or indirect sales. Plaintiff alleges this statement was false because NetManage was not increasing sales to end users, i.e., direct sales. SAC ¶ 63. Bloomberg's second report deleted that quote. In its place, Bloomberg reported NetManage's sales to wholesalers and resellers ("indirect sales") had increased 20% during the previous two years.

Plaintiff does not dispute that NetManage's indirect sales had increased during the prior two years. Thus, the complaint fails to explain why a statement regarding an expansion of indirect sales was false when made.

Bloomberg's second release also reported that Alon stated that the Company was "starting" to see more direct sales due to an expansion in the telemarketing sales force and other direct sales channels. The complaint does not allege facts refuting this alleged statement. Rather, the complaint alleges in conclusory terms that the telemarketing group was "inadequately trained" and that the sales force was competing with NetManage's VARs. SAC ¶ 63. Thus, plaintiff's allegations regarding Alon's alleged statement therefore fail to support plaintiffs' claim. 15 U.S.C. § 78u-4(b)(1).

Plaintiff's claim is not based on any statement by Alon (or any other defendant) to Bloomberg. Rather, plaintiff's claim is based on Alon's statement at the CNBC interview, the source for which is the Bloomberg May 20, 12:43 news release. In deciding defendants' motion to dismiss, the Court can and should consider matters that reference or relate to whether plaintiff's source misreported Alon's actual statement at the CNBC interview. See Branch v. Tunnell, 14 F.3d 449, 453 (9th Cir. 1994) ("'material which is properly submitted as part of the complaint may be considered' on a motion to dismiss" (citation omitted) (emphasis in Branch)). The corrected Bloomberg report and the transcript of the CNBC interview, therefore, should be considered to show that the Bloomberg report relied upon by plaintiff misreported the CNBC interview.

Plaintiff admits that his source for Alon's alleged statement is the Bloomberg May 20, 12:43 report. Bloomberg changed its report on the CNBC interview a mere five hours after the report relied upon by plaintiffs. Plaintiff cannot state a claim based on a non-party source where the source changed the very part of the report upon which plaintiffs based his allegation. Plaintiff does not dispute the authenticity of Exhibit C. Thus, the second Bloomberg report, Exhibit C, can and should be considered in defendants' motion to dismiss.

To dispel any doubt that plaintiff's source misreported the CNBC interview, defendants took the additional step of offering a transcript of the interview. Ex. D. The transcript shows that the Bloomberg report relied upon by plaintiff misrepresented Alon's statements. But, consistent with plaintiff's plan to ignore what Alon actually said at the interview, plaintiff seeks to strike the transcript because he says that it is a "self-serving transcript." Plf's Mem. at 5. Plaintiff does not identify any mistakes in the transcript. Plaintiff does not challenge the reliability of the company that transcribed the interview and prepared the transcript. Apparently plaintiff's only reasons for challenging the authenticity of the transcript is that he does not like what it says and that defendants submitted it with their motion to dismiss. This however does not make the transcript unreliable.

Plaintiff mistakenly relies on Cooper v. Pickett, 137 F.3d 616 (9th Cir. 1998), decided under law predating the Private Securities Litigation Reform Act of 1995. The Cooper plaintiffs, without alleging the sources of their allegations, alleged that the defendants made false statements to securities analysts during conference calls. The Court did not consider transcripts of conference calls because the transcripts were not referenced in the complaint and the plaintiffs objected to their authenticity. Id. at 623.

Here, however, plaintiff admits that the Bloomberg article is the source of plaintiff's allegation of Alon's statement. Defendants do not offer the transcript to show the truth of Alon's statement, i.e., that indirect sales were in fact increasing. Rather, defendants offer the transcript (and the corrected Bloomberg article) to show that plaintiff's source misreported Alon's alleged statement. Defendants' exhibits reveal that plaintiff's source was an obvious misrepresentation of the CNBC interview.

Defendants seek to preclude wasting the resources of the Court and the parties litigating a claim based on an obvious misreport by Bloomberg. The corrected Bloomberg article and the transcript dispel any doubt that plaintiff's source misrepresented Alon's statement. Thus, the Court should consider Exhibits C and D in determining defendants' motion to dismiss.

B. The Court Can And Should Consider NetManage's SEC Filings

The Reform Act requires plaintiffs to "state with particularity facts giving rise to a strong inference that the defendant[s] acted with" scienter. 15 U.S.C. § 78u-4(b)(2). Plaintiff's supposed "facts" to show scienter include allegations that defendants had the "motive" to make false statements in order to engage in improper insider trading. SAC ¶¶ 32-33, 69-79.²

A defendant's stock trades show a motive to engage in securities fraud if the amount of stock traded and the timing of the sales is unusual or suspicious. See Defs' Mem. at 14. Whether the amount traded is "unusual" is relative: 1,500 shares sold by a defendant whose total holdings were one million is, as a matter of law, not unusual and cannot support a Section 10(b) claim. Id. Total holdings include stock that the defendant owned and controlled, and vested options that the defendant could exercise and sell as stock. Id.

Although plaintiff alleges the dates of the defendants' supposed trades and the number of shares sold, plaintiff deceptively omits information about the defendants' total holdings. SAC ¶ 70. Plaintiff does not ignore the issue of total holdings. Indeed, plaintiff at length alleges why ownership of stock options should not be considered as part of a defendant's total holdings. Id. ¶¶ 71-79. Plaintiff even discusses NetManage's alleged repricing of stock options before the class period. Id. ¶ 77. Therefore, the issues of options as part of total holdings, and hence each defendant's total holdings is referenced in the Second Amended Complaint. The only information not alleged is the amount of each defendant's total holdings.

Plaintiff's decision to exclude this vital information is obvious: comparison of the alleged sales by Alon, Amaral, and Galil with their total holdings shows that, as a matter of law, none of these defendant's sales were unusual. Defs' Mem. at 14-16. Therefore, plaintiff's allegations fail to give rise to a strong inference of scienter. Id.

The amount of each defendant's total holdings is derived from information in the NetManage's 1996 Proxy Statement (Ex. E) and the individual defendants' Form 4 filings with the Securities and Exchange Commission. A public company, like NetManage, is required to file with the SEC its annual proxy statement to shareholders. 15 U.S.C. § 78n; 17 C.F.R. § 240.14a-6. Likewise, each insider of a public company must file a Form 3 or 4 with the SEC showing the insider's purchases and sales of the company's stock. 15 U.S.C. § 78p(a); 17 C.F.R. § 240.16a-2, 16a-3. Defendants request the Court to take judicial notice of these SEC filings to determine each defendant's total holdings.

Plaintiff argues that the Court should ignore the SEC filings because he questions the accuracy of the information in the SEC filings and the SEC filings constitute hearsay. Plf's Mem. at 5-8. Plaintiff's objections are not well taken. It is highly likely that plaintiff's allegations of the amount and date of each defendant's trades were taken from information in these filings. First, plaintiff alleges that his allegations are based on "NetManage's SEC filings." SAC ¶ 87. Second, plaintiff alleges that the defendants' insider trading "was publicly reported as soon as it occurred on the First Call network and other services that track stock sales by corporate insiders because for each of these sales these individuals were required to file notice of their sales on Form 4 with the SEC." Id. ¶ 71. The reasonable inference is that plaintiff's source of the insider trading allegations was either the SEC filings, or a service such as the First Call network which obtained its information about the defendants' stock trades from the SEC filings. Plaintiff's own allegations therefore are derived from the Form 4s. The SEC filings thus are incorporated by reference under Branch, 14 F.3d at 453.

Plaintiff's position was squarely rejected in In re Silicon Graphics, Inc. Sec. Litig., 970 F. Supp. 746 (N.D. Cal. 1997) (appeal pending). The Silicon Graphics plaintiffs alleged that the defendants engaged in improper insider trading, and that their allegations were based on "SGI's SEC filings." Id. at 758. Judge Smith found that the plaintiffs' motion to strike the SEC filings was "disingenuous because plaintiffs rely on the information contained in these filings in pleading their allegations." Id. Judge Smith found that even though the plaintiffs had not alleged the sources of their insider trading allegations, "the allegations can be derived only from [the SEC filings]. Plaintiffs cannot preclude consideration of defendants' SEC forms by artful pleading." Id. Thus, in addition to taking judicial notice of the SEC filings, Judge Smith ruled that the court could consider the documents under the incorporation by reference doctrine. Id. at 758-59.

Likewise, in Plevy v. Haggerty, Case No. CV-97-9200-SVW, slip op. (C.D. Cal. Aug. 21, 1998), Judge Wilson took judicial notice of the defendants' SEC filings, including the defendants' Form 4s, even though the filings were not cited or quoted in the complaint. Id. at 5. Judge Wilson pointed out that the complaint was based on "'a review of the public filings" of the defendant company. Therefore, the complaint "does reference those filings." Id. at 6. Furthermore, Judge Wilson held that "as these documents are public records required by the SEC to be filed, the Court may take judicial notice of them." Id.

It is well-established that a "district court may take judicial notice of the contents of relevant public disclosure documents required to be filed with the SEC as facts 'capable of accurate and ready determination by resort to sources whose accuracy cannot reasonably be questioned.'" Kramer v. Time Warner, Inc., 937 F.2d 767, 774 (2d Cir. 1991); see also Cortec Indus., Inc. v. Sum Holding, L.P., 949 F.2d 42, 47 (2d Cir. 1991) (court "may review and consider public disclosure documents required by law to be [filed] and which actually have been filed with the SEC, particularly where plaintiff has been put on notice by defendant's proffer of these public documents").³

Plaintiff argues that Kramer took judicial notice of the SEC filings that allegedly contained the misrepresentations at issue. Plf's Mem. at 7. But planitiff's allegations regarding the defendants' stock trades was taken from the SEC filings. Moreover, Kramer rejects plaintiff's question of the accuracy of defendants' SEC filings.

Plaintiff contends that the courts in the Ninth Circuit "have been reluctant to take judicial notice of SEC filings on motions to dismiss." Plf's Mem. at 6. However, the Ninth Court has held that judicial notice may be taken of matters less trustworthy than defendants' SEC filings, where the matter is "capable of sufficiently accurate and ready determination." Ritter v. Hughes Aircraft Co., 58 F.3d 454, 458-59 (9th Cir. 1995). In Ritter, the Ninth Court held that the district court properly took judicial notice of widespread layoffs at Hughes Aircraft based on a newspaper article: "judicial notice of layoffs at Hughes was not an abuse of discretion [because] [t]his is a fact which would be generally known in Southern California and which would be capable of sufficiently accurate and ready determination." Id.

Plaintiff mistakenly relies on the Hennessy v. Penril Datacomm Networks, Inc., 69 F.3d 1344 (7th Cir. 1995). Plf's Mem. at 5. In that case, an employee sued her former employer for gender and pregnancy discrimination. The plaintiff requested the court to take judicial notice of the defendant company's Form 10-K to determine the number of employees at a specific unit in the company in order to calculate punitive damages. Id. at 1354. The Seventh Circuit found that the district court's decision to exclude the Form 10-K was reasonable because the "fact in question here was not capable of accurate and ready determination by resort to the 10-K." Id. at 1355. That was because the Form 10-K reported on the entire company, which included the unit in question and two other unrelated units. Thus, the Form 10-K's reliability about the number of employees in the unit at issue was too questionable for purposes of judicial notice. Id.

In this case, however, defendants ask the Court to take judicial notice of the SEC filings as to the amount of the defendants' total holdings. Unlike Hennessy, plaintiff offers no reason to doubt the accuracy of those numbers as reported in the SEC filings. Plaintiff simply says that he "refuse[s] to concede" their accuracy. Plf's Mem. at 6-7. Plaintiff's position is untenable since plaintiff relied upon the SEC filings for his allegations regarding the defendants' stock trades.

Plaintiff misplaces reliance cases decided before the Ninth Circuit's adoption of the incorporation by reference doctrine in Branch and before enactment of the Reform Act. Plf's Mem. at 6. In In re Wickes Cos. Sec. Litig., [1982-83 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 90,055, at 95,002 (S.D. Cal. 1983), the court did not refuse to take judicial notice of SEC filings. Rather, the court considered the company's Registration Statement included in the complaint, but not "affidavits and exhibits" that were outside the pleadings. Id. The court then converted the motion to dismiss to a Rule 56 motion, and concluded that whether the statements in the prospectus were misleading was a disputed question of fact. Id.

Plaintiff's allegations here are not based on whether the amount of the defendants' total NetManage holdings as reported in the SEC filings was misleading. Indeed, plaintiff relies on those very filings for his allegations regarding stock trade information. Plaintiff cannot have it both ways; he cannot use the stock trade information in the SEC filings to premise his allegations and then deny defendants' ability to use those same SEC filings to show the defendants' total holdings.

Moreover, in Haltman v. Aura Systems, 844 F. Supp. 544, 550 (C.D. Cal. 1993), the issue of judicial notice was moot because the court granted in part the motion to dismiss without having to rely upon the proffered SEC documents. Similarly, in In re Sun Microsystems, Inc. Sec. Litig., No. C-89-20351-RPA, 1990 U.S. Dist. LEXIS 18740, at *5-6 (N.D. Cal. Aug. 20, 1990), the company requested judicial notice of its SEC filings because they were "matters of general public record." Although the court refused the request on those grounds, the court agreed to consider the SEC filings because they were referred to and were quoted in the complaint. Likewise, here plaintiff's source of his stock trade allegations is the defendants' SEC filings.

Plaintiff also mistakenly relies on cases considering whether to take judicial notice of orders issued by different courts. Plf's Mem. at 5-6 n.2. In Liberty Mutual Ins. Co. v. Rotches Pork Packers, Inc., 969 F.2d 1384, 1388-89 (2d Cir. 1992), the Second Circuit held that it was error to take judicial notice of an order from a different bankruptcy court and a decision by the Judicial Officer of the U.S. Department of Agriculture as to factual findings in those orders. The court said that the law concerning judicial notice of another court's orders is clear: the orders can be judicially noticed for the fact of the litigation, but not for the truth of the contents in the orders. Accord State Farm Fire & Cas. Co. v. Westchester Inv. Co., 721 F. Supp. 1165, 1166 (C.D. Cal. 1989) (citing Liberty Mutual and refusing to take judicial notice of the contents of a different court's orders); United States v. Jones, 29 F.3d 1549, 1553 (11th Cir. 1984) (taking judicial notice of the existence and filing of complaints in other lawsuits but not of the factual allegations in those complaints).

Defendants are not asking the Court to take judicial notice of orders or pleadings in other proceedings. Plaintiff offers no authority showing that the law concerning judicial notice of orders from other cases applies to judicial notice of documents such as SEC filings that plaintiff apparently relied upon for his allegations. Indeed, as shown above, the case law is different in this context.

In Silicon Graphics, Judge Smith also considered and rejected the same hearsay objection raised here. Judge Smith recognized that "[h]aving raised questions about defendants' stock sales, based their allegations on defendants' SEC filings, and submitted expert declarations that rely on the SEC forms at issue, plaintiffs can hardly complain when defendants refer to the same information in their defense." In re Silicon Graphics, 970 F. Supp. at 759. Judge Smith found that having "opened the door" by placing defendants' stock sales and SEC filings at issue, plaintiffs may not legitimately complain after defendants walked through. See also United States v. Anderson, 532 F.2d 1218, 1229 (9th Cir. 1976) (defendant who introduced hearsay statement waived objection); cf. United States v. Kerr, 981 F.2d 1050, 1052 (9th Cir. 1992); E.E.O.C. v. General Telephone Co. of Northwest, Inc., 885 F.2d 575, 578 (9th Cir. 1989).

Moreover, Judge Smith also held that the defendants' SEC filings were admissible as a business or government record. In re Silicon Graphics, 970 F. Supp. at 759 n.6. Defendants are required by law to file these documents when they sell NetManage stock, and are subject to criminal penalties for intentional misstatements or omissions. 18 U.S.C. § 1001; 15 U.S.C. § 78ff(a). Documents filed with a government agency under these circumstances qualify as government records. See United States v. Central Gulf Lines, Inc., 747 F.2d 315, 319 (5th Cir. 1984). Defendants' SEC filings also qualify as business records. See United States v. Bland, 961 F.2d 123, 127 (9th Cir. 1992). Alternatively, these documents may be admissible not to show the truth of the information but to show the lack of scienter. See Gray v. First Winthrop Corp., 82 F.3d 877, 885 n.10 (9th Cir. 1996). Thus, the SEC filings should be considered under this exception to the hearsay rule.

Thus, plaintiff's motion to strike the defendants' Proxy Statement (Ex. E) and references to the defendants' Form 4 filings should be denied.

For the foregoing reasons, plaintiff's motion to strike should be denied.

¹ "Ex. __" refers to the exhibits attached to the Declaration of Rebecca A. Mitchells supporting defendants' motion to dismiss the Second Amended Complaint.

² Defendants showed in their opening memorandum that the "motive and opportunity" test to show scienter is no longer valid under the Securities Reform Act. Defs' Mem. at 11-12. Nonetheless, defendants showed that the stock sales are insufficient to give rise to a strong inference that the defendants acted with scienter. Id. at 15-16.

³ See also In re AES Corp. Sec. Litig., 825 F. Supp. 578, 584 n.6 (S.D.N.Y. 1993); Diceon Electronics, Inc. v. Calvary Partners, L.P., 772 F. Supp. 859, 861 (D. Del. 1991); In re Delmarva Sec. Litig., 794 F. Supp. 1293, 1299 (D. Del. 1992); Southmark Prime Plus, L.P. v. Falzone, 776 F. Supp. 888, 892-93 (D. Del. 1991); Newport Components, Inc. v. NEC Home Electronics, 671 F. Supp. 1525, 1539 n.16 (C.D. Cal. 1987).