SHIRLI FABBRI WEISS (Bar No. 079225)
MARTIN H. MYERS (Bar No. 130218)
MARK H. HAMER (Bar No. 156997)
GRAY CARY WARE & FREIDENRICH LLP
401 B Street, Suite 1700
San Diego, California 92101
Telephone: (619) 699-4758
Facsimile: (619) 236-1048

Attorneys for Defendant
HARISH S. RAO

I. INTRODUCTION

II. THE COMPLAINT DOES NOT ALLEGE ANY SPECIFIC ACT OR STATEMENT BY RAO.

A. The "Scheme" Allegations Fail Because the Complaint Does Not Allege Any Act by Rao in Furtherance of the Supposed Scheme.

B. The "Group Published Information" Presumption Cannot Salvage Plaintiffs' Claim Against Rao.

III. THE COMPLAINT FAILS TO ALLEGE FACTS CREATING A "STRONG INFERENCE" THAT RAO ACTED WITH THE REQUIRED STATE OF MIND.

A. Nothing in the Complaint Could Possibly Support a Strong Inference That Rao Acted With "Conscious Behavior and Knowledge."

B. Neither Motive Nor Opportunity Has Been Pled Against Rao.

C. Rao's Vested Options, Reflected In The Judicially Noticeable Proxy Statements, Further Negate Any Inference Of Scienter.

IV. PLAINTIFFS SHOULD NOT BE GIVEN LEAVE TO AMEND BECAUSE IT WOULD BE FUTILE.

V. CONCLUSION

Acito v. IMCERA Group, Inc.,
     47 F.3d 47 (2d Cir. 1995)

Aizuss v. Commonwealth Equity Trust,
     847 F.Supp. 1482 (E.D.Cal. 1993)

Basic, Inc. v. Levinson,
     485 U.S. 224 (1988)

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

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

Cooper v. Pickett,
     1997 U.S.App. LEXIS 39330 (9th Cir. Feb. 2, 1998)

Cortec Industrial v. Sum Holding, L.P.,
     949 F.2d 42 (2d Cir. 1991), cert. denied, 503 U.S. 960 (1992)

Duncan v. Pencer,
     [1995-96 Tr. Binder] Fed.Sec.L.Rep. (CCH) ¶ 99,043 (S.D.N.Y. 1996)

Haskell v. Time, Inc.,
     857 F.Supp. 1392 (E.D.Cal. 1994)

Heathcote Associates v. Chittenden Trust Co.,
     958 F.Supp. 182 (D.Vt. 1997)

I. Meyer Pincus & Associate v. Oppenheimer & Co., Inc.,
     936 F.2d 759 (2d Cir. 1991)

In re Apple Computer Securities Litigation,
     886 F.2d 1109 (9th Cir. 1989), cert. denied, 496 U.S. 943 (1990)

In re Blech Securities Litigation,
     961 F.Supp 569 (S.D.N.Y. 1997)

In re Donald Trump Securities Litigation,
     7 F.3d 357 (3d Cir. 1993), cert. denied, 510 U.S. 1178 (1994)

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

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

In re Health Management, Inc. Securities Litigation,
     970 F.Supp. 192 (E.D.N.Y. 1997)

In re Oak Technology Securities Litigation,
     1997 U.S.Dist. LEXIS 18503 (N.D.Cal. Aug. 1, 1997)

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

In re Stac Electronics Securities Litigation,
     89 F.3d 1399 (9th Cir. 1996), cert. denied, 117 S.Ct. 1105 (1997)

In re Syntex Corp. Securities Litigation,
     95 F.3d 922 (9th Cir. 1996)

In re Valence Tech. Securities Litigation,
     1996 U.S.Dist. LEXIS 21773 (N.D.Cal. Feb. 13, 1996)

In re Valujet, Inc. Securities Litigation,
     [1997 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 99,579 (N.D.Ga. 1997)

In the Matter of Lake States Commodities, Inc.,
     936 F.Supp. 1461 (N.D.Ill. 1996)

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

Melder v. Morris,
     27 F.3d 1097 (5th Cir. 1994)

Pension Benefit Guaranty Corp. v. White Consolidated Industrial, Inc.,
     998 F.2d 1192 (3d Cir. 1993)

Powers v. Eichen,
     977 F.Supp. 1031 (S.D.Cal. 1997)

Primavera Familienstiftung v. Askin,
     1996 U.S.Dist. LEXIS 12683 (S.D.N.Y. Aug. 30, 1996)

S.E.C. v. U.S. Environmental, Inc.,
     897 F.Supp. 117 (S.D.N.Y. 1995)

San Leandro Emergency Med. Group Profit Sharing Plan v. Phillip Morris,
     75 F.3d 801 (2d Cir. 1996)

Serabian v. Amoskeag Bank Shares, Inc.,
     24 F.3d 357 (1st Cir. 1994)

Shaw v. Digital Equipment Corp.,
     82 F.3d 1194 (1st Cir. 1996)

Shields v. Citytrust Bancorp, Inc.,
      25 F.3d 1124 (2d Cir. 1994)

Steckman v. Hart Brewing, Inc.,
     [1996 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 99,420 (S.D.Cal. 1996)

Thornton v. Micrografx,
     878 F.Supp. 931 (N.D.Tex. 1995)

Watterson v. Page,
     987 F.2d 1 (1st Cir. 1993)

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

15 U.S.C. § 78u-4(b)(1)

15 U.S.C. § 78u-4(b)(2)

In their Opposition Memorandum ("Opp."), plaintiffs fail to identify any factual allegation sufficient to plead a securities law violation against Mr. Harish Rao. As in the Complaint, the Opposition identifies no statement uttered directly or indirectly by Mr. Rao. Nor is any act at all, including any act of "participation" in any scheme to defraud, alleged against this individual defendant. The Private Securities Litigation Reform Act of 1995 ("Reform Act") demands highly specific pleading of facts showing that each defendant acted, and that each defendant acted with the required level of intent. Plaintiffs have not alleged any facts indicating that Mr. Rao made any misrepresentation, performed any deceptive or manipulative act, or did anything in furtherance of any scheme to defraud. Certainly, the Complaint alleges no facts giving rise to a "strong inference" that Rao did anything with scienter.

The Opposition confirms that plaintiffs' decision to accuse Mr. Rao of fraud is based solely on two factors: (1) the fact that he was an officer of TCSi, which in itself is insufficient to state a fraud claim against him based on alleged statements by others; and (2) the fact that Mr. Rao sold his TCSi stock -- but long before the stock price reached the "inflated" level allegedly orchestrated through a "scheme to defraud." As to this individual, such allegations fall far short of the pleading requirements even under pre-Reform Act authority. Certainly, under the stringent requirements of the Reform Act which apply in this case, Mr. Rao must be dismissed.

Plaintiffs do not deny that their stock sale allegations against Rao -- the cornerstone of their "strong inference" of scienter -- are taken directly from TCSi's 1996 and 1997 Proxy Statements. Plaintiffs' Complaint did not disclose, however, that those same publicly filed documents also confirm that Rao held substantial vested options which he could have exercised but did not, further negating any inference of scienter. Rather than identifying the documents which formed the basis of their "information and belief" allegations, as required by the Reform Act, plaintiffs actually seek to suppress those documents with a counter-motion to strike. Rao will not burden the court with another pleading opposing that objection. Instead, Rao's arguments in opposition to the counter-motion will be included in this reply memorandum. Judicial notice of these documents, whose authenticity is beyond dispute and whose contents are alleged in the Complaint, is entirely proper and routinely taken on motions to dismiss.

A. The "Scheme" Allegations Fail Because the Complaint Does Not Allege Any Act by Rao in Furtherance of the Supposed Scheme.

The Opposition underscores a key deficiency in the Complaint's allegations against Rao: he did not make any statement, oral or written, to anyone at any time. The Complaint mentions some other individual defendants by name as the sources for certain alleged misstatements, but Rao is never alleged to be a speaker or writer of any "false" statement. No specific act of any kind by Rao, other than his job title and stock sales, is mentioned. Rule 9(b) "requires a plaintiff to attribute fraudulent acts or statements to a particular defendant." In re Valence Tech. Sec. Litig., 1996 U.S.Dist. LEXIS 21773, *11 (N.D.Cal. Feb. 13, 1996) (emphasis added). The most basic element of a securities fraud claim -- a fraudulent statement or act -- is simply not alleged against Rao.¹

Plaintiffs hope to mask this deficiency by tossing Rao in as one of many participants in an alleged "scheme." (Opp. at 43). This will not save their case. Contrary to plaintiffs' assertions, this label cannot compensate for the complete absence of factual allegations against Rao. The Supreme Court held that liability under section 10(b) can only extend to defendants who make a false statement or who commit a deceptive act, not to those who aid and abet such primary violators. Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164, 177 (1994). In so doing, the Court noted that "secondary actors" may still be liable but only "assuming all of the requirements for primary liability under Rule 10b-5 are met." Id. at 191. To evade the prohibition on aiding and abetting liability, plaintiffs argue that Rao can be liable as a member of a "scheme" -- even though the Complaint fails to allege any act by Rao himself in furtherance of the purported scheme. Plaintiffs manufacture this argument from a misreading of Cooper v. Pickett, 1997 U.S.App. LEXIS 39330 (9th Cir. Feb. 2, 1998), which simply noted that "Central Bank does not preclude liability based on allegations that a group of defendants acted together to violate the securities laws, as long as each defendant committed a manipulative or deceptive act in furtherance of the scheme." Id. at *21 (emphasis added). Plaintiffs cannot take refuge in the "scheme to defraud" liability of Rule 10b-5 when they have failed utterly to allege specific acts by Rao in furtherance of the purported scheme.

When multiple defendants are sued for an alleged "scheme to defraud," the complaint must allege "particular facts indicating the direct participation" of each defendant. In re Blech Sec. Litig., 961 F.Supp 569, 581 (S.D.N.Y. 1997). "By lumping together" all defendants, a complaint "does not fulfill the Rule 9(b) policy of safeguarding [the individual defendant's] reputation from the stain of allegations leveled with particularity against other parties." Id. Even if plaintiffs could state a claim against TCSi or other defendants in this case, which they have failed to do, additional particularized facts tying Rao to the purported "scheme" must still be alleged. See also Primavera Familienstiftung v. Askin, 1996 U.S.Dist. LEXIS 12683, *18 (S.D.N.Y. Aug. 30, 1996)(rejecting "scheme" allegations and noting that "[W]hile a substantial, integral role is necessary to primary liability under section 10(b) and Rule 106-5, it is not sufficient."); In the Matter of Lake States Commodities, Inc., 936 F.Supp. 1461, 1471-73 (N.D.Ill. 1996) (after Central Bank, claims for primary liability for a "scheme to defraud" must allege a misstatement or omission by each defendant, not just "participation" in the scheme); S.E.C. v. U.S. Environmental, Inc., 897 F.Supp. 117, 120 (S.D.N.Y. 1995) ("The defendant's 'personal involvement in a scheme or plan' to violate the Securities Acts, without more, is insufficient.").

Cooper itself undermines plaintiffs' attempt to use vague "scheme" allegations to mask a secondary liability claim. Cooper's analysis focused on an alleged scheme between corporate defendants and nonparty securities analysts (not between a company and its officers) and held the "scheme" allegations against the corporate defendants to be sufficient because acts in furtherance of the scheme -- making specified false statements to the analysts with intent to mislead the market -- was alleged against those defendants. Cooper, 1997 U.S.App. LEXIS 39330, at *20-21. Both the company in Cooper and its officer defendants were alleged to communicate with the analysts. Id. at *5-6. The court did not hold, as plaintiffs suggest, that a defendant can be liable with others under a scheme where that defendant is not alleged to have committed any acts in furtherance of the scheme.

Here, unlike Cooper, the supposed "scheme" between TCSi and Rao alleges no act by Rao in furtherance of the scheme: no direct or indirect statement, no act of participation in approving or disseminating such a statement, no interaction with the market, no specific interaction with analysts, no specific interaction with other defendants, no act of creating or approving the allegedly misleading accounting practices of TCSi. In short, no act at all is alleged. The only allegations mentioning Rao simply state his title, his group and committee assignments, and his stock sales. As the Ninth Circuit observed, "it is not reasonable to presume in every case. . . that a 'corporate scheme to defraud was collectively devised. . . .'" In re GlenFed, Inc. Sec. Litig., 60 F.3d 591, 593 (9th Cir. 1995) (quoting Blake v. Dierdorff, 856 F.2d 1365, 1369 (9th Cir. 1988)). If plaintiffs can sue individuals under a hollow "scheme" allegation without even alleging a single act in furtherance of it, then the aiding and abetting prohibition of Central Bank and Cooper will be meaningless and the Reform Act's stringent pleading requirements will have been circumvented. Plaintiffs have not pled a primary violation of section 10(b) by Rao.

B. The "Group Published Information" Presumption Cannot Salvage Plaintiffs' Claim Against Rao.

Plaintiffs' expansive interpretation of the "group published information" presumption would unravel Central Bank and undermine the Reform Act. Plaintiffs contend that, under this presumption, their allegations of Rao's job description alone can state a claim for fraud. The Complaint merely alleges that Rao was Vice President of the Object Software Group and a member of the executive committee (but not the audit committee which, in plaintiffs' words, "had responsibility over the financial statement irregularities and the removal of the constraint against improper recognition of revenue. . . ."(Opp. at 33)). In GlenFed, the plaintiffs also argued that the presumption is invoked where plaintiffs merely plead that individual defendants "hold positions on audit, executive and other committees that are responsible for overseeing the corporation's financial and disclosure activities." GlenFed, 60 F.3d at 592. The Ninth Circuit responded: "We disagree. Merely because the complaint identifies a corporation's outside directors, various committee assignments, and generic responsibilities for every committee does not mean that the presumption of 'group published information' is applicable." Id. at 592. The mere allegation that Rao sits on the executive committee is plainly insufficient to invoke the group information presumption under GlenFed.

Nor is Rao's title of Vice President of the Object Software Group sufficient to trigger the presumption. "To establish the liability of vice president defendants under the group pleading presumption," plaintiffs "must plead that these vice presidents were directly involved 'not only in the day-to-day affairs of [the company] but also in [the preparation of its] financial statements in particular.'" In re Oak Technology Sec. Litig., 1997 U.S.Dist. LEXIS 18503, *32-33 (N.D.Cal. Aug. 1, 1997) (quoting Wool v. Tandem Computers, Inc., 818 F.2d 1433, 1440 (9th Cir. 1987)). Rao is not alleged to be involved in the day-to-day management of the company or to have any involvement whatsoever in its communications, and plaintiffs admit he is not even a member of the committee responsible for TCSi's financial statements and accounting policies. Alleging titles and the committee or group duties alone does not permit plaintiffs to use the group publication doctrine to bypass the strict requirement to plead fraud with particularity against each individual defendant. See In re Valence Tech. Sec. Litig., 1996 U.S.Dist. LEXIS 21773, *19 (N.D.Cal. Feb. 13, 1996).

Even if the group pleading presumption could be used against Rao, the vast majority of the allegations in the Complaint do not involve the types of statements to which group pleading could apply. Only company statements "conveyed in prospectuses, registration statements, annual reports, [or] press releases" can be fairly presumed to be "collective actions of the corporate officers." GlenFed, F.3d at 593. In particular, the presumption does not apply to allegations of fraudulent statements contained in analysts' reports. Powers v. Eichen, 977 F.Supp. 1031, 1040 (S.D.Cal. 1997). In the Opposition, plaintiffs do not even contest this fact.² Thus, even if the presumption could extend to Rao at all, the allegations in paragraphs 44-47, 49, 54-55, 63-64, 67-70, 73, 75-77, 81-82 and 86 must be dismissed as to Rao.

Moreover, after the Reform Act, the viability of the presumption is highly doubtful. The presumption's lower pleading standard directly conflicts with the policy and purpose of the Reform Act's elevation of pleading standards. Plaintiffs respond that the Reform Act does not mention the presumption by name. (Opp. at 42). This obviously has never been a prerequisite to the application of statutory language. The Reform Act does not mention the GlenFed pre-Reform Act ruling that plaintiffs could plead state of mind generally "simply by saying that scienter existed," In re GlenFed, Inc. Sec. Litig. 42 F.3d 1541, 1547 (9th Cir. 1994), and yet the Reform Act's provisions clearly override this pleading standard. 15 U.S.C. § 78u-4(b)(2) (plaintiffs must plead with particularity the facts giving rise to a strong inference that the defendant acted with the required state of mind as to each misrepresentation.) Plaintiffs do not explain how a complaint could possibly meet the Reform Act's stringent new requirement to plead facts giving rise to a "strong inference" that "the defendant acted" with scienter, where multiple defendants are lumped together in a faceless mass under such a presumption. They offer no explanation because they cannot. The Reform Act's heightened pleading requirements for particularity and scienter require that courts scrutinize and re-evaluate pre-Reform Act doctrines which allowed more relaxed pleading of fraud.³

Plaintiffs also argue that Rao can be liable even if he did not personally make any false statements because he failed to disclose adverse non-public information which he allegedly knew when he sold his stock. This "insider trading" argument is specious. Claims for violations of section 10(b) based upon misstatements and those based upon insider trading rest on "distinct theories," and "an allegation of insider trading does not permit alleged misstatements to be attributed to a group." In re Oak Tech. Sec. Litig., 1997 U.S.Dist. LEXIS 18503, *34 (N.D.Cal. Aug. 4, 1997). Moreover, liability for insider trading under Rule 10b-5 requires specific pleading of the material information Rao possessed but did not disclose and, because such allegations of someone's "knowledge" are necessarily made on information and belief, plaintiffs must also allege all facts upon which such allegations are based. 15 U.S.C. § 78u-4(b)(7). Plaintiffs must also make specific allegations that they traded contemporaneously with Rao. Id. at *34-35; Silicon Graphics, 970 F. Supp. at 761. No such allegations are included, and no insider trading claim is stated against Rao.

A. Nothing in the Complaint Could Possibly Support a Strong Inference That Rao Acted With "Conscious Behavior and Knowledge."

Plaintiffs point to their allegations of accounting fraud as the key facts giving rise to a "strong inference" of "conscious behavior and knowledge" against all defendants. (Opp. at 31). Plaintiffs argue that "conscious misbehavior may be inferred from defendants' positions and their access to adverse information that they ignored or concealed" and the fact that "much of [TCSI's] revenues during the Class Period were generated by fraudulent accounting perpetrated at the individual defendants' direction." (Id. at 31, 33) However questionable the merits of such a contention, it has no application to Rao because no facts are alleged to tie Rao to the purported financial fraud. The Complaint does not allege that Rao had any accounting duties whatsoever and concedes that Rao is not even on the audit committee which oversees accounting issues. Obviously, if no facts are alleged to tie Rao to the financial fraud, then the financial fraud allegations cannot support an inference of scienter against him, let alone a "strong" inference of conscious behavior.

Other than Rao's stock sales, which are addressed below, no facts are alleged to suggest that Rao did anything at all. Plaintiffs simply list Rao's job title and committee assignments alone and pretend that these facts create a strong inference that he participated with other corporate and individual defendants in a scheme to defraud. If this pleading is sufficient against Rao, then the Reform Act's elevated scienter standard can be met in every case by simply transcribing all the officer and director names from a company's SEC filings and slapping them into the complaint.

B. Neither Motive Nor Opportunity Has Been Pled Against Rao.

As discussed in the Opening Memorandum, it is highly questionable whether mere "motive and opportunity" allegations can suffice to plead scienter under the Reform Act. The court, however, need not reach this issue with respect to Rao because plaintiffs cannot even meet that pre-Reform Act standard. Plaintiffs claim they have included three types of "motive" allegations in the Complaint: (1) that defendants sold stock "at huge gains"; (2) that they hoped to profit from the March 1996 secondary offering; and (3) that they hoped to increase their compensation. (Opp. at 35-36). None of these can state an actionable motive as to Rao.

First, plaintiffs argue that Rao sold 100% of his stock and thus his motive is properly pled. (Opp. at 36). However, since the selling of one's stock is consistent with perfectly legal and innocent motives, stock sales do not suggest a motive supporting a section 10(b) claim unless they are suspicious and unusual in timing and amount. Acito v. IMCERA Group, Inc., 47 F.3d 47, 54 (2d Cir. 1995); Shaw v. Digital Equipment Corp., 82 F.3d 1194, 1224 (1st Cir. 1996). The Opposition fails to address the main point raised in Rao's Opening Memorandum that Rao sold his stock at $18.49 per share, eleven dollars below the $29.75 trading high and 62% below the top price.⁴ If Rao was orchestrating a fraudulent scheme with others to profit from an artificially inflated stock price, why would he cash out long before sharing in the fruits of the scheme? If he knew that the stock price would skyrocket upwards due to his fraudulent manipulations, why would he sell so far below the artificially created peak trading price? Plaintiffs' speculation makes no sense. Rao's sales support an inference of innocence, not an inference of securities fraud. The court cannot "leave its common sense at the courthouse steps" when determining whether a rational motive has been alleged, and should reject the "nonsensical premise" that a defendant would "misrepresent information to a host of securities analysts" and "successfully orchestrat[e] the artificial inflation" of the stock price while declining "to enjoy the fruits of [his] fraud by selling [his] stock" at the inflated premium. Thornton v. Micrografx, 878 F.Supp. 931, 938 (N.D.Tex. 1995). Given the low selling price, Rao's sale of "100%" of his stock cannot possibly be construed as "suspicious" and cannot support an inference of motive. In fact, it negates such an inference.

The timing of Rao's sale further dooms plaintiffs' interpretation of its significance. The second alleged motive was the scheme to profit from the March 1996 secondary offering. Yet all of Rao's stock was sold on February 15, 1996 -- before the upward jump in TCSi's stock in the spring and summer of 1996 and before the March 1996 secondary offering. If Rao was participating in a scheme to lie to the market and "cook" the books to inflate TSCi stock for the secondary offering, he would not have sold long before that pivotal event occurred. If plaintiffs believe that sales of "millions of shares" by TCSi and Wagner after the March 1996 offering demonstrate the motive of those defendants (Opp. at 35-36), Rao's sale before that event necessarily negates any inference of his motive or scienter. Plaintiffs cannot have it both ways.

Plaintiffs are left with the tenuous argument that Rao's motive to commit fraud is established by the allegation that he wanted to get "bonuses and salaries." (Complaint, ¶ 30(c)). Courts have long rejected this argument which, if followed, would attribute fraudulent motive to every executive in every case. See Melder v. Morris, 27 F.3d 1097, 1102 (5th Cir. 1994); Serabian v. Amoskeag Bank Shares, Inc., 24 F.3d 357, 368 (1st Cir. 1994); Acito, 47 F.3d at 54; Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1130 (2d Cir. 1994).

C. Rao's Vested Options, Reflected In The Judicially Noticeable Proxy Statements, Further Negate Any Inference Of Scienter.

Thus, even looking solely at Rao's sale of stock and excluding his options, there is no possible inference of scienter. However, if Rao's total holdings -- stock and vested options -- are considered, the absurdity of attributing scienter to Rao is even more striking. Plaintiffs' eagerness to suppress the judicially noticeable Proxy Statements from this court's review highlights this fact. None of plaintiffs' arguments can undermine the fundamental reason why vested options must be considered when evaluating motive allegations. Plaintiffs' "motive" theory presumes that defendants committing a fraud will artificially inflate the company's stock and then cash in their portfolios at that artificial high because they know the sky is about to fall. The necessary corrollary of this theory is that if they retain their stock holdings, the inference of scienter is negated. Under this reasoning, there is absolutely no reason to treat stock and vested options -- which can be exercised for shares and sold immediately -- any differently. Silicon Graphics, 970 F.Supp. at 768. The fact that Rao held on to vested options while the stock price was "fraudulently" inflated rather than exercising his options and liquidating his shares undermines the inference of scienter.⁵

Plaintiffs' objection to judicial notice and counter-motion to strike are motivated by the fear that this court will review the documents which are undeniably the sources of the Complaint's stock sale allegations. This dispute over judicial notice would not have occurred had plaintiffs simply complied with the Reform Act's pleading requirements. The Reform Act demands that a complaint alleging on information and belief "shall state with particularity all facts upon which that belief is formed." 15 U.S.C. § 78u-4(b)(1); Silicon Graphics, 970 F.Supp. at 763. The source of the only allegation of fact against Rao -- his sale of stock in February 1996 -- is not specifically alleged. However, the obvious (and undisputed) information sources of Rao's stock sale data are the 1996 and 1997 Proxy Statements which were filed with the SEC. If plaintiffs "had fully described [the omitted document] in question, and had indicated the source of their information about it, there would be no need for defendants to file extraneous documents in an effort to defend themselves." Id. at 759 n.7. Plaintiffs should comply with the Reform Act, state their sources in the complaint, and stand by them. Instead, they have concealed their sources and now use their failure to comply with the Reform Act to object to defendants' submission of them simply because they contradict, rather than support, the inferences plaintiffs attribute to them.

This court has already rejected the precise argument asserted by plaintiffs. In In re Silicon Graphics, 970 F.Supp. 746 (N.D.Cal. 1997), this court properly took judicial notice of SEC filings not referenced in the complaint which were the sources for plaintiffs' allegations of insider stock trading. "Although plaintiffs do not cite to defendants' SEC forms in framing their insider trading allegations, the allegations can only be derived from those publicly filed documents," so judicial notice on a motion to dismiss was proper. Id. at 759. Where SEC filings are the source of the allegations, plaintiffs "cannot preclude consideration of defendants' SEC forms by artful pleading." Id. at 759.

Nor is Silicon Graphics the maverick opinion that plaintiffs suggest. On a motion to dismiss, judicial notice is routinely taken of documents "whose contents are alleged in the complaint and whose authenticity no party questions. . . ." Branch v. Tunnell, 14 F.3d 449, 454 (9th Cir. 1994)(emphasis added); In re Stac Electronics Sec. Litig., 89 F.3d 1399, 1405 n.4 (9th Cir. 1996), cert. denied, 117 S.Ct. 1105 (1997); In re Syntex Corp. Sec. Litig., 95 F.3d 922, 926 (9th Cir. 1996). Documents which are "integral" to the complaint, but are not fully quoted in it, are also considered on dismissal motions. San Leandro Emergency Med. Group Profit Sharing Plan v. Phillip Morris, 75 F.3d 801, 808-9 (2d Cir. 1996); Cortec Indus. v. Sum Holding, L.P., 949 F.2d 42, 47 (2d Cir. 1991), cert. denied, 503 U.S. 960 (1992); see also Aizuss v. Commonwealth Equity Trust, 847 F.Supp. 1482, 1488 n.6 (E.D.Cal. 1993); In re Donald Trump Sec. Litig., 7 F.3d 357, 368 n.9 (3d Cir. 1993), cert. denied, 510 U.S. 1178 (1994); I. Meyer Pincus & Assoc. v. Oppenheimer & Co., Inc., 936 F.2d 759, 762 (2d Cir. 1991)(same).

Documents "not attached to the complaint or incorporated by reference" can be considered on a motion to dismiss if "the documents are integral to the complaint and the claims alleged therein" and the plaintiff has "notice of them and an opportunity to respond to them" before the court's ruling. Heathcote Associates v. Chittenden Trust Co., 958 F.Supp. 182, 184-85 (D.Vt. 1997); Watterson v. Page, 987 F.2d 1, 3 (1st Cir. 1993)("[C]ourts have made narrow exceptions for documents the authenticity of which are not disputed by the parties; for official public records; for documents central to plaintiffs' claim; or for documents specifically referred to in the complaint"). Documents outside the complaint should be considered on a motion to dismiss (rather than converting it to a summary judgment motion) if the plaintiff had the document and based his complaint upon it, and if the plaintiff had notice of the court's consideration of the document and an opportunity to respond. Haskell v. Time, Inc., 857 F.Supp. 1392, 1397 (E.D.Cal. 1994) (consideration of exemplar documents submitted by defendants is proper on a motion to dismiss where plaintiff concedes "he certainly had exemplars either identical to or very similar to the ones provided by defendants when drafting the complaints" and plaintiff was on notice that defendants would base the motion to dismiss on the exemplars). Any other rule would allow a "plaintiff with a legally deficient claim [to] survive a motion to dismiss simply by failing to attach a dispositive document on which it relied." Pension Benefit Guar. Corp. v. White Consol. Indus., Inc., 998 F.2d 1192, 1196 (3d Cir. 1993).⁶

Here, plaintiffs do not dispute that the allegations of the date and amount of Rao's stock sales are transcribed from the 1996 TCSi Proxy Statement. The Complaint concedes that it is based upon "SEC filings." (Complaint, ¶ 124). Plaintiffs have not identified any other source for this information despite their obligation under the Reform Act to state any such source. 15 U.S.C. § 78u-4(b)(1). Plaintiffs concede that the stock sale allegation is central to their scienter claim against defendants. (Opp. at 36). While the 1996 Proxy Statement is not attached to the Complaint or specifically incorporated by reference, its "contents" -- the stock data for Rao -- are alleged, and it is "integral" to plaintiffs' complaint. This court should not tolerate plaintiffs' selective attempt to allege stock sales from the Proxy Statement but to suppress consideration of the remaining portions of that document, which confirm Rao's retention of vested options and negate any inference of scienter. If judicial notice were not taken under these circumstances, "complaints that quoted only selected and misleading portions of such documents could not be dismissed under Rule 12(b)(6) even though they would be doomed to failure." Kramer v. Time Warner, Inc., 937 F.2d 767, 774 (2d Cir. 1991).

Concerned by the implications of the option data, plaintiffs seek to rationalize why retaining vested options is not really the same thing as retaining stock. Nonsense. Plaintiffs' hair-splitting attempts to distinguish between stock and options do not withstand scrutiny. The "economic risk" of options compared to stock or the ability to re-price options are completely irrelevant to the "motive" analysis. Neither characterization, even if valid, would restrain liquidation by a corporate insider who orchestrated a fraud for the purpose of "cashing in" at a high price before the scheme was exposed. Even if he had the power to re-price options and even with the allegedly reduced "risk" of options, why would a defrauding insider hold his options until after the "adverse facts" are revealed and the price comes crashing down? Both stock and vested options would be "cashed in" if the defendant sought to profit from fraud and knew the stock was artifically inflated as plaintiffs allege.

Plaintiffs do not and cannot deny that Rao held substantial vested options which he could have exercised and sold for a profit while the stock price was high. He did not do so, even after the stock soared $11 above the price at which he did sell. This conduct is totally inconsistent with the allegation that he knew that the high price was artificially inflated and a crash was imminent. Properly considering his vested options, Rao retained 59% of his total holdings -- hardly the act of an insider aware of a fraud who wanted to take the money and run. See San Leandro Emergency Med. Plan v. Philip Morris, 75 F.3d 801, 814 (2d Cir. 1996); Acito, 47 F.3d at 54; In re Apple Computer Sec. Litig., 886 F.2d 1109, 1117 (9th Cir. 1989), cert. denied, 496 U.S. 943 (1990) ; Duncan v. Pencer [1995-96 Tr. Binder] Fed.Sec.L.Rep. (CCH) ¶ 99,043, ¶ 94,208 (S.D.N.Y. 1996). Rao's retention of his vested options, which plaintiffs so desperately seek to conceal from the court, are fatal to the allegation of Rao's scienter.

In their Opposition, plaintiffs fail to cite any additional facts which can be alleged in any amended complaint to cure the deficiencies in the allegations against Mr. Rao. Any amendment would be futile, so Mr. Rao can and should be dismissed without leave to amend. Steckman v. Hart Brewing, Inc. [1996 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 99,420, ¶ 96,745 (S.D.Cal. 1996); Zeid v. Kimberley, 973 F.Supp. 910, 925 (N.D.Cal. 1997).

For the foregoing reasons,⁷ Mr. Rao should be dismissed from this action without leave to amend.

Dated: March 19, 1998

¹ Where a person is not alleged to make any statement whatsoever, plaintiff must allege that the defendant had a duty to disclose the allegedly omitted fact. This is required because the federal securities laws do not create an independent duty to disclose. Basic, Inc. v. Levinson, 485 U.S. 224, 239 n. 17 (1988) ("Silence, absent a duty to disclose, is not misleading under Rule 10b.5.") Here, no facts are alleged showing that Mr. Rao owed plaintiffs a duty to speak. Therefore, he cannot be held liable for the alleged omissions and should be dismissed for this reason alone.

² Plaintiffs cite In re Valujet, Inc. Sec. Litig. [1997 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 99,579 (N.D.Ga. 1997), but in that case the court applied the group published information presumption only to those individual officers who had signed the Company's Form 10-K.

³ In the cases following the Reform Act in which the presumption is referenced, the courts' opinions contain no discussion analyzing the impact of the Reform Act's stringent pleading requirements and philosophy on the group published information presumption's relaxed pleading standard. (See, e.g., ValuJet Sec. Litig., [1997 Tr. Binder] Fed. Sec.L. Rep. (CCH) ¶ 99579 (N.D.Ga. 1997); In re Health Management, Inc. Sec. Litig. 970 F.Supp. 192 (E.D.N.Y. 1997).

⁴ In evaluating scienter, the Reform Act "requires the court to consider each defendant's sales separately." Silicon Graphics, 970 F.Supp at 767 (citing 15 U.S.C. § 78u-4(b)(2)).

⁵ Plaintiffs object strenuously to the relevance of vested option data only because the options were not exercised. If Rao had exercised his options and sold them at an inflated price, plaintiffs would certainly be arguing that those sales support an inference of scienter.

⁶ Plaintiffs' reliance on Cooper v. Pickett is mistaken. Cooper did not address the propriety of judicial notice of SEC filings from which plaintiffs derived their allegations; the documents proffered by defendants in that case were (1) transcripts of conference calls which were not even created when the complaint was filed and thus could not have been relied upon in drafting the complaint, and (2) a declaration explaining to whom projections were faxed. Cooper,,1997 U.S.App. LEXIS 39330, at *13-16. The court's refusal to take judicial notice of this evidence provides little guidance here.

⁷ As in his Opening Memorandum, defendant Rao specifically joins in the arguments made in the reply memoranda of his co-defendants TCSi and Wagner, as well as their oppositions to plaintiffs' counter-motion.

Securities Class Action Clearinghouse

U.S.D.C. N.D. Cal.

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Stanford University School of Law