MILBERG WEISS BERSHAD
HYNES & LERACH LLP
WILLIAM S. LERACH (68581)
ALAN SCHULMAN (128661)
600 West Broadway, Suite 1800
San Diego, CA 92101
Telephone: 619/231-1058
     - and -
JEFFREY W. LAWRENCE (166806)
LISA C. ATKINSON (163320)
DAVID R. STICKNEY (188574)
222 Kearny Street, 10th Floor
San Francisco, CA 94108
Telephone: 415/288-4545

LAW OFFICES OF JAMES V.
BASHIAN, P.C.
JAMES V. BASHIAN
500 Fifth Avenue
Suite 2700
New York, NY 10110
Telephone: 212/921-4110

WOLF POPPER LLP
STEPHEN D. OESTREICH
PATRICIA I. AVERY
845 Third Avenue
New York, NY 10022
Telephone: 212/759-4600

TO: ALL PARTIES AND THEIR RESPECTIVE COUNSEL OF RECORD

PLEASE TAKE NOTICE that on May 12, 1998, at 2:00 p.m. or as soon thereafter as the matter can be heard in the courtroom of the Honorable Saundra Brown Armstrong, United States District Court, Northern District of California, 1301 Clay Street, Oakland, California, plaintiffs will and do object to defendants' request for judicial notice and counter-move, in accordance with Civ. L.R. 7-3(c), for an Order striking defendants' Securities and Exchange Commission ("SEC") submissions, specifically TCSI Corporation's ("TCSI" or the "Company") 1996 and 1997 Proxy Statements attached as Exs. K and L to the Declaration of Christine A. Kendrick in Support of Defendants' Motion to Dismiss ("Kendrick Decl.").

I. INTRODUCTION

Defendants have submitted TCSI's 1996 and 1997 Proxy Statements in an effort to rebut the strong inference of scienter created by their massive insider sales during the Class Period. All defendants sold a combined total of over 5.5 million shares, including the 1.5 million sold by the Company in the March 1996 secondary offering, for total proceeds of over $105 million.⁽¹⁾ ¶¶1, 107.⁽²⁾ The Complaint alleges that this massive insider selling was unusual in both timing and amount because defendants' sales prior to the Class Period were insubstantial and in the 11 months after the Class Period amounted to only 30,000 shares -- 15,000 of which were sold by Roger A. Strauch after he resigned. These allegations are sufficient to raise an inference of bad faith and scienter. E.g., Kaplan v. Rose, 49 F.3d 1363 (9th Cir. 1994); Fecht v. Price Co., 70 F.3d 1078 (9th Cir. 1995); Warshaw v. Xoma Corp., 74 F.3d 955 (9th Cir. 1996); Friedberg v. Discreet Logic, 959 F. Supp. 42 (D. Mass. 1997); Powers v. Eichen, 977 F. Supp. 1031 (S.D. Cal. 1997).

Defendants do not challenge the stock sales, nor do they contest that their selling during the Class Period was vastly greater than both before and after the Class Period. Rather, they claim that because they had more stock and options at the end of the Class Period, the inference of scienter is rebutted and they offer their Proxy Statements in support of their position. These documents, they claim, prove that they had significant "holdings" of TCSI stock and options at the end of the Class Period, TCSI Defs' Mem. at 18; Rao Mem. at 15-16,⁽³⁾ and this fact, as a matter of law, precludes the inference that their sales during the Class Period were made with scienter. TCSI Defs' Mem. at 17-18. See Kendrick Decl., Exs. K and L. This Court should reject this "evidence" and defendants' contentions for several reasons. First, under Cooper v. Pickett, Case No. 95-55657, 1997 U.S. App. LEXIS 39330 (9th Cir. Jan. 30, 1998), these materials may not be considered on a motion to dismiss.

The court may not consider material beyond the pleadings on a motion to dismiss, particularly if the complaint does not specifically refer to it or if its authenticity is questioned. Id. at *14; Bonilla v. Oakland Scavenger Co., 697 F.2d 1297 (9th Cir. 1982); Costen v. Pauline's Sportswear, Inc., 391 F.2d 81 (9th Cir. 1968). In Cooper, the court disallowed the defendants' submission of conference call transcripts and a defendant's declaration on a motion to dismiss where they were neither parts of the complaint nor specifically incorporated by reference. 1997 U.S. App. LEXIS 39330, at **13-16. As in Cooper, plaintiffs here neither referenced nor mentioned any of these SEC materials in the Complaint. Thus, under Cooper, the Proxy Statements may not even be considered on this motion, let alone be used to establish defendants' lack of scienter as a matter of law. Id.

Further, even if such evidence could be considered on this motion, Fed. R. Evid. 201(b) requires that the facts sought to be judicially noticed are not subject to "reasonable dispute"; it must be capable of accurate and ready determination by sources whose accuracy cannot reasonably be questioned. Defendants' submissions clearly do not qualify on this basis, either. When courts allow judicial notice of SEC filings, they do so only to take note of the fact that the documents exist or contain certain assertions -- not as proof of the truth of those assertions. Kramer v. Time Warner, Inc., 937 F.2d 767, 774 (2d Cir. 1991). Here, the "facts" sought to be judicially noticed require not only that the Court accept the numbers in the Proxy Statement as accurate, but draw an inference about the significance of defendants' holding stock and options after the Class Period. However, the mere listing of available options does not warrant the inference. A decision on this issue is not "capable of accurate determination" (or indeed any determination) from the mere listing of exercisable options alone. Resolution of this issue will depend upon establishing facts through evidence, including, inter alia, the prices of the options, the vesting schedule and defendants' circumstances. Defendants' scienter requires a fully developed factual record in order to determine whether, as alleged, defendants' sales were unusual in timing and amount, which will depend upon the evidence presented. See Kaplan, 49 F.3d 1363; In re Apple Computer Sec. Litig., 886 F.2d 1109 (9th Cir. 1989). None of these issues can be resolved on a motion to dismiss.

Plaintiffs therefore object to defendants' improper submissions and ask this Court to decline to take judicial notice of them. In addition, pursuant to Civ. L.R. 7-3(c), plaintiffs counter-move the Court to strike from defendants' moving papers and their counsel's declaration any reference, whether direct or inferred, to their Proxy Statements.

II. ARGUMENT

A. This Court Should Strike The Exhibits Of And Defendants' References To The 1996 And 1997 Proxy Statements Because They Are Outside The Pleadings

Generally, a district court may not consider any material beyond the pleadings in ruling on a motion to dismiss. Cooper, 1997 U.S. App. LEXIS 39330, at *14; Branch v. Tunnell, 14 F.3d 449, 453 (9th Cir. 1994); see also Fecht, 70 F.3d at 1080 n.1. A document is "outside" the complaint if its contents are not specifically referred to in the complaint, or if its authenticity is questioned. Cooper, 1997 U.S. App. LEXIS 39330, at *14; Branch, 14 F.3d at 453-54. TCSI's Proxy Statements were not referred to in the Complaint. Thus, this Court should decline to consider them here.

1. Defendants Cannot Introduce Their Proxy Statements On This Motion To Dismiss

Defendants are foreclosed from introducing their own SEC filings on a motion to dismiss by Cooper, 1997 U.S. App. LEXIS 39330, at **15-16, which held that such submissions -- there, transcripts of conference calls and a declaration -- on a motion to dismiss are improper. Id. In so holding, the Ninth Circuit explained:

In the complaint, plaintiffs [did] not expressly mention or refer to the transcripts, or even identify their existence. . . . Further, plaintiffs disputed the authenticity and accuracy of the transcripts in the district court, and objected to their use . . . . The transcripts therefore cannot be considered in ruling on the motion to dismiss.

Id. at *15.

Cooper is directly on point here. The Complaint did not mention defendants' Proxy Statements at all. As in Cooper, they first appeared as exhibits to the Kendrick Declaration, which accompanied defendants' motion to dismiss as evidence to rebut plaintiffs' allegations.

As in Cooper, these documents are outside the Complaint, and any reference to them -- whether directly or indirectly -- should be stricken from both the memorandum and the accompanying Kendrick Declaration. Moreover, since the statements in the SEC filings are merely those of an adverse party to this dispute, they are not free from dispute as to their accuracy. Indeed, misstatements in SEC filings may themselves be the source of securities fraud actions. See Louis Loss & Joel Seligman, Securities Regulation, at 2052-53 (3d ed. 1990).

2. TCSI's Own Proxy Statements Are Not Proper Subjects For Judicial Notice On The Factual Issue Of Scienter

A judicially noticed fact must be

one not subject to reasonable dispute in that it is either (1) generally known within the territorial jurisdiction of the trial court or (2) capable of accurate and ready determination by resort to sources whose accuracy cannot reasonably be questioned.

Fed. R. Evid. 201(b) (emphasis added). In other words, for a fact to be judicially noticed, "indisputability is a prerequisite." Hennessy v. Penril Datacomm Networks, 69 F.3d 1344, 1354 (7th Cir. 1995). Clearly, that is not the case with defendants' statements offered to prove a fact (lack of scienter) in support of their case. Securities and Exchange Commission documents may be considered on a motion to dismiss only if not used to prove the truth of their contents but only to establish that they were filed. Id.; see Lovelace v. Software Spectrum, 78 F.3d 1015, 1018 (5th Cir. 1996).⁽⁴⁾ Thus, while the fact that the Proxy Statements were filed may be subject to judicial notice, their contents may not. Here, defendants seek not only to prove the truth of the contents of the Proxy Statements -- a purpose clearly not permitted on this motion -- but to have the Court draw an adverse inference that they could not have committed fraud based on the number of stock and options listed at the end of the Class Period. The Court should reject the use of those documents for this purpose for several reasons.

First, "[t]he Court should not use judicial notice to generate an evidentiary record and then weigh evidence . . . to dismiss [a] complaint." In re Network Equipment Techs., Inc. Litig., 762 F. Supp. 1359, 1363 (N.D. Cal. 1991). See 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) (court refused to take judicial notice of defendants' SEC filings because to do so would convert the motion to dismiss into one for summary judgment); Haltman v. Aura Sys., 844 F. Supp. 544, 550 (C.D. Cal. 1993) (unnecessary to take judicial notice of SEC documents on motion to dismiss); In re Wickes Cos. Sec. Litig., [1982-1983 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶99,055, at 95,002 (S.D. Cal. Jan. 6, 1983) (refusing to take judicial notice of SEC filings in a motion to dismiss).

The decisions that have allowed judicial notice of SEC filings have done so only because the documents noticed were the very documents alleged to contain the misrepresentations at issue, and even then "not to prove the truth of their contents but only to determine what the documents stated." Kramer, 937 F.2d at 774. In Diceon Electronics, Inc. v. Calvary Partners, L.P., 772 F. Supp. 859 (D. Del. 1991), the court noticed the filings only because they were not submitted for their truth. Defendants' Proxy Statements do not contain the misrepresentations alleged in the Complaint or have anything to do with its allegations. The Court is being asked to use the Proxy Statements to determine that defendants had more options at the end of the Class Period and then infer that they could not have had scienter in selling their stock during the Class Period. In effect, the Court is told to accept defendants' filings as factual evidence on a key issue -- scienter -- thereby protecting un-cross-examined witnesses and their version of the "facts." Factual determinations are improper on a motion to dismiss, and this use of documents from "without" the Complaint is clearly improper.

B. Defendants' "Exercisable" Options Do Not Establish Their Lack Of Scienter

Even if the truth of SEC filings could be assumed and weighed on a motion to dismiss -- which it cannot -- the filings show only that defendants had "exercisable options," 1996 Proxy Statement at 7, 1997 Proxy Statement at 7, not that they bought the options or that the options should be included in their "holdings." Exercisable options are far different from stock or exercised options, for that matter, and should not be included in defendants' "holdings."

Insiders' stock options do not carry the same economic risk as actual stock ownership. In particular, executives do not face the same risk of loss in stock options as they do with common stock -- because they do not pay for the options and because the company can always lower the exercise price of the options if the value of the stock falls.

Directors simply lower the options' exercise prices to the stock's current price level. Presto! The options can soon be back in the money again. It doesn't matter if the stock ever returns to the levels where the options were originally issued.

E.S. Browning & Laura Jereski, "In the Money: Firms With Sagging Stocks Set New 'Repricings' of Executive Options," Wall St. Journal, June 11, 1997 at 1, Lawrence Decl., Ex. J. By holding the options without exercising them, defendants can merely have the company reprice them and increase their profit. Indeed, that is precisely what has been done; the Company has repriced options each of the last two years. See 1996 Proxy Statement at 7 (repricing Ram A. Banin's options); 1997 Proxy Statement at 7 (repricing Ram A. Banin and Paul A. Farmer's options). Moreover, companies can reprice their options virtually at will. For example, TCSI's August 1, 1997 Proxy Statement (not submitted by defendants) reflects a repricing of an additional 30,000 options for Roger A. Strauch (who resigned from the Company) and an exchange of options (at lower exercise prices) for all employees. Lawrence Decl., Ex. I. Thus, defendants may not have exercised their options for any number of reasons -- including waiting for the options to be repriced.

In short, for defendants to rebut the inference of scienter, a factual record must be developed -- including evidence of the option exercise price relative to market price, the likelihood that defendants would reprice the options later (providing an even better opportunity for insiders to profit), and the risks of defendants getting caught if they sold too much. See In re Worlds of Wonder Sec. Litig., 35 F.3d 1407 (9th Cir. 1994). At trial or on summary judgment, defendants may be able to offer a satisfactory explanation sufficient to rebut the inference that the massive insider sales by all defendants at artificially inflated prices during the Class Period establishes that they acted with scienter. See Kaplan, 49 F.3d 1363; Apple, 886 F.2d 1109. At this stage, however, where the allegations are deemed to be true, defendants may not do so.

III. CONCLUSION

Defendants' request violates the fundamental rule that on a Rule 12(b)(6) motion, that allegations in a complaint must be accepted as true and that all reasonable inferences must be drawn in favor of the complaint. Warshaw, 74 F.3d at 957. Defendants are not permitted to submit as "evidence" documents that were not referenced in the Complaint and then argue favorable inferences from that "evidence" to contradict the Complaint's allegations. See Bonilla, 697 F.2d at 1301; Costen, 391 F.2d at 84-85. The purpose of a 12(b)(6) motion is to test the allegations of the complaint -- i.e., if everything the plaintiff alleges is true, then he has stated a claim. That determination necessarily precludes contrary "evidence" and inferences which are appropriately asserted at trial.

Accordingly, plaintiffs respectfully request that this Court refrain from considering defendants' submissions and grant plaintiffs' motion to strike the Proxy Statements, Exs. K and L attached to the Kendrick Declaration.

TCSI\BM000368.MIS

1. Thus, this is not a case like Acito v. IMCERA Group, 47 F.3d 47 (2d Cir. 1995), where only one outside director sold 11% of his stock. Here, the massive selling by all of the defendants clearly supports a strong inference of scienter. Even if defendants were correct about the percentages of stock they sold, it still would not rebut the inference of scienter. See Friedberg, 959 F. Supp. at 48-49 (five defendants sold 12%, two sold 33% and 50% -- sufficient to infer scienter).

2. "¶_" refers to paragraphs from the Complaint.

3. Wagner, of course, does not make this assertion, since he sold over 3.6 million shares in the March offering, making over $65 million.

4. Liberty Mutual Ins. Co. v. Rotches Pork Packers, Inc., 969 F.2d 1384, 1388 (2d Cir. 1992) (district court improperly took judicial notice of filed documents because it used them "to establish facts asserted therein"); State Farm Fire & Cas. Co. v. Westchester Inv. Co., 721 F. Supp. 1165, 1166 (C.D. Cal. 1989) (truth of argument contained in documents not judicially noticeable); United States v. Jones, 29 F.3d 1549, 1553 (11th Cir. 1994) (court may take judicial notice of another court's order only for the limited purpose of "recognizing" either the subject matter of the litigation or the judicial act that the order represents).

I, the undersigned, declare:

1. That declarant is and was, at all times herein mentioned, a citizen of the United States and a resident of the County of San Francisco, over the age of 18 years, and not a party to or interested in the within action; that declarant's business address is 222 Kearny Street, 10th Floor, San Francisco, California 94108.

2. That on February 19, 1998, declarant caused true copies of PLAINTIFFS' OBJECTION TO CONSIDERATION OF DEFENDANTS' 1996 AND 1997 PROXY STATEMENTS AND PLAINTIFFS' COUNTER-MOTION TO STRIKE EXHIBITS K AND L TO THE DECLARATION OF CHRISTINE A. KENDRICK to be delivered to Federal Express for service on each of the parties listed on the attached Service List on February 20, 1998.

3. That declarant caused this document to be forwarded to the following designated Internet site at:

I declare under penalty of perjury that the foregoing is true and correct. Executed this 19th day of February, 1998, at San Francisco, California.