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Stanford University Law School - Securities Class Action Clearinghouse
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TOWER C. SNOW, JR. (State Bar #58342)
PAUL R. BESSETTE (State Bar #139675)
JANE ROWEN (State Bar #162455)
BROBECK, PHLEGER & HARRISON LLP
One Market, Spear Street Tower
San Francisco, California 94105
Telephone: (415) 442-0900
DANIEL J. TYUKODY, JR. (State Bar #123323)
BROBECK, PHLEGER & HARRISON LLP
550 South Hope Street
Los Angeles, California 90071
Telephone: (213) 489-4060
Attorneys for Defendants
TOUCHSTONE SOFTWARE CORPORATION,
LARRY W. DINGUS, C. SHANNON JENKINS,
RONALD R. MAAS, KENNETH WELCH III,
DONALD C. WATTERS AND SIGMUND FIDYKE III
UNITED STATES DISTRICT COURT
CENTRAL DISTRICT OF CALIFORNIA
SOUTHERN DIVISION
DARRIN J. CARAMONTA, On Behalf ) NO. SACV 96-81-GLT (EEx)
of Himself and All Others )
Similarly Situated and ) CLASS ACTION
Derivatively on Behalf of ) and DERIVATIVE ACTION
TOUCHSTONE SOFTWARE )
CORPORATION, ) SUR-REPLY MEMORANDUM OF POINTS
) AND AUTHORITIES IN OPPOSITION
Plaintiff, ) TO PLAINTIFF'S MOTION FOR
) PRELIMINARY INJUNCTION TO
v. ) FREEZE ASSETS AND TO IMPOSE A
) CONSTRUCTIVE TRUST
LARRY DINGUS, et al., )
) Date: March 27, 1996
Defendants, ) Time: 1:00 p.m.
) Ctrm: 2
- and - )
)
TOUCHSTONE SOFTWARE )
CORPORATION, )
)
Nominal Defendant on )
Derivative Claims. )
_______________________________)
TABLE OF CONTENTS
Page
I. INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . 1
II. PLAINTIFF LACKS STANDING TO BRING THIS MOTION OR TO
CONDUCT ANY PROCEEDINGS . . . . . . . . . . . . . . . . . 2
A. The Reform Act Requires the Selection and Approval
of the Lead Plaintiff and Lead Counsel Before
Litigation May Proceed . . . . . . . . . . . . . . . 2
B. Plaintiff Has Failed to Give Meaningful Notice
Under the Reform Act . . . . . . . . . . . . . . . . 4
III. PLAINTIFF HAS FAILED TO MEET THE STRICT REQUIREMENTS
NECESSARY FOR AN ORDER FREEZING ASSETS . . . . . . . . . . 5
A. Plaintiff Has Failed to Establish Likelihood of
Success on the Merits . . . . . . . . . . . . . . . . 5
1. Plaintiff's Reference to Unpublished District
Court Authority on Asset Freeze Motions Has
Been Misleading in the Extreme . . . . . . . . . 6
2. Neither of Plaintiff's Two "Experts" Comes
Close to Presenting "Compelling Evidence" Or,
Indeed, Any Evidence Which Would Support An
Asset Freeze . . . . . . . . . . . . . . . . . . 9
3. Plaintiff Wholly Fails to Show Scienter . . . . 12
4. A Section 11 Claim Does Not Provide Plaintiff
with Any Greater Probability of Success on the
Merits . . . . . . . . . . . . . . . . . . . . . 14
B. Plaintiff Has Failed to Demonstrate a Significant
Threat of Irreparable Injury . . . . . . . . . . . . 16
C. The Balance of Hardships Does Not Tip in Favor of
Plaintiff . . . . . . . . . . . . . . . . . . . . . . 18
IV. FINAL EQUITABLE RELIEF IS A PREREQUISITE TO AN ORDER
FREEZING ASSETS . . . . . . . . . . . . . . . . . . . . . 19
V. PLAINTIFF IS NOT ENTITLED TO RESCISSION OR DISGORGEMENT
ON HIS SECTION 10(b) CLAIM . . . . . . . . . . . . . . . . 20
VI. PLAINTIFF IS NOT ENTITLED TO RESCISSION OR A CONSTRUCTIVE
TRUST ON HIS STATE LAW CLAIMS. . . . . . . . . . . . . . . 22
VII. PLAINTIFF IS NOT ENTITLED TO EQUITABLE REMEDIES ON HIS
DERIVATIVE CLAIMS, AS HE HAS NO STANDING TO BRING THEM . . 22
A. Plaintiff Cannot Represent Both Class and
Derivative Claims. . . . . . . . . . . . . . . . . . 22
B. Plaintiff's Failure to Show Contemporaneous
Ownership Is Fatal . . . . . . . . . . . . . . . . . 24
VIII. CONCLUSION . . . . . . . . . . . . . . . . . . . . . 25
ii.
TABLE OF AUTHORITIES
Page(s)
CASES
Abbey v. Computer Memories, Inc.,
634 F. Supp. 870 (N.D. Cal. 1986) . . . . . . . . . . . . 14
Anderson v. Clow,
[1993 Tr. Binder] Fed. Sec. L. Rep.
(CCH) ¶ 97,807 (S.D. Cal. Sept. 17, 1993) . . . . . . 15, 16
Arrington v. Merrill, Lynch, Pierce, Fenner & Smith, Inc.,
651 F.2d 615 (9th Cir. 1981) . . . . . . . . . . . . . . . 21
Bateson v. Magna Oil Corp.,
414 F.2d 128 (5th Cir. 1969),
cert. denied, 397 U.S. 911 (1970) . . . . . . . . . . . . 25
Big Country Foods, Inc. v. Board of Education,
868 F.2d 1085 (9th Cir. 1989) . . . . . . . . . . . . . . 17
Blackie v. Barrack,
524 F.2d 891 (9th Cir. 1975) . . . . . . . . . . . . . . . 20
Brickman v. Tyco Toys, Inc.,
731 F. Supp. 101 (S.D.N.Y. 1990) . . . . . . . . . . . . . 23
Daisy Sys. Corp. v. Finegold,
[1989 Tr. Binder] Fed. Sec. L. Rep.
(CCH) ¶94,520 (N.D. Cal. Sept. 20, 1988) . . . . . . . 24, 25
Federal Sav. & Loan Ins. Corp. v. Sahni,
868 F.2d 1096 (9th Cir. 1989) . . . . . . . . . . . . . . 17
Federal Trade Commission v. Singer,
668 F.2d 1107 (9th Cir. 1982) . . . . . . . . . . . . . . 18
Green v. Occidental Petroleum Corp.,
541 F.2d 1335 (9th Cir. 1976) . . . . . . . . . . . . . 20-22
Guenther v. Cooper Life Sciences, Inc.,
759 F. Supp. 1437 (N.D. Cal. 1990) . . . . . . . . . . . . 15
Huddleston v. Herman & MacLean,
640 F.2d 534 (5th Cir. 1981)
aff'd in part and rev'd in part 59 U.S. 375 (1983) . . . . 21
In re Dayco Corp. Derivative Sec. Litig.,
102 F.R.D. 624 (S.D. Ohio 1984) . . . . . . . . . . . . . 23
In re Diasonics Sec. Litig.,
599 F. Supp. 447 (N.D. Cal. 1984) . . . . . . . . . . . . 22
i.
In re Estate of Marcos Human Rights Litig.,
25 F.3d 1467 (9th Cir. 1994),
cert. denied sub nom Estate of Marcos v. Hilas,
____U.S. ____, 115 S. Ct. 934 (1995) . . . . . . . . . 19, 20
In re GlenFed Sec. Litig.,
11 F.3d 843, 850 (9th Cir. 1993),
vacated on other grounds, 42 F.3d 1541 (9th Cir. 1994) . . 16
In re Media Vision Technology Sec. Litig.
No. C-94-1515 EFL . . . . . . . . . . . . . . . . . 8, 9, 17
In re Oracle Sec. Litig.,
829 F.Supp. 1176 (N.D. Cal. 1993) . . . . . . . . . . 23, 24
In re Pacific Enterprises Sec. Litig.,
47 F.3d 373 (9th Cir. 1995) . . . . . . . . . . . . . 23, 24
In re Rasterops Sec. Litig.,
[1992-1993 Tr. Binder] Fed. Sec. L. Rep.
(CCH) ¶97,445 (N.D. Cal. Jan. 6, 1993) . . . . . . . . 24, 25
In re Wells Fargo Sec. Litig.,
12 F.3d 922 (9th Cir. 1993),
cert. denied, ___ U.S.___, 115 S. Ct. 295 (1994) . . . 13, 14
J. I. Case Co. v. Borak,
377 U.S. 426 84 S. Ct. 1555 (1964) . . . . . . . . . . . . 23
Kamen v. Kemper Finan. Svs.,
500 U.S. 90 (1991) . . . . . . . . . . . . . . . . . . . . 24
Kamerman v. Steinberg,
113 F.R.D. 511 (S.D.N.Y. 1986) . . . . . . . . . . . . . . 23
Kaplan v. Rose,
49 F.3d 1363 (9th Cir. 1994),
cert. denied, ___ U.S. ___, 116 S. Ct. 58 (1995) . . . . . 13
Lorber v. Beebe,
407 F. Supp. 279 (S.D.N.Y. 1976) . . . . . . . . . . . . . 15
Miller v. Telios Pharmaceuticals, Inc.,
Civ. No. 94-1554-IEG (RBB)
(S.D. Cal. January 11, 1995) . . . . . . . . . . . . . 1, 6, 7
Neomonitis v. Blackie,
No. SA CV 94-379 AHS (RWRX)
(C.D. Cal. June 20, 1994) . . . . . . . . . . . . . 1, 6, 17
Randall v. Loftsgaarden,
478 U.S. 647 (1986) . . . . . . . . . . . . . . . . . . . 20
Republic of the Philippines v. Marcos,
862 F.2d 1355 (9th Cir.) cert. denied,
490 U.S. 1035 (1989) . . . . . . . . . . . . . . . . . . . 17
ii.
Ryan v. Aetna Life Ins. Co.,
765 F. Supp. 133 (S.D.N.Y. 1991) . . . . . . . . . . . . . 23
Schwartz v. Harp,
1985 WL 5623 (C.D. Cal. 1985) . . . . . . . . . . . . . . 21
SEC v. Eurobond Exch., Ltd.,
13 F.3d 1334 (9th Cir. 1994) . . . . . . . . . . . . . . . 21
SEC v. Interlink Data Network of Los Angeles,
1993 U.S. Dist. LEXIS 20163 (C.D. Cal. 1993) . . . . . . . 21
SEC v. Seaboard, et al.,
677 F.2d 1289 (9th Cir. 1982) . . . . . . . . . . . . . . 22
Yamamoto v. Omiya,
564 F.2d 1319 (9th Cir., 1977) . . . . . . . . . . . . 22, 23
Statutes
California Corporations Code
Section 800 . . . . . . . . . . . . . . . . . . . . . . . 24
Section 25401 . . . . . . . . . . . . . . . . . . . . . . 22
Section 25501 . . . . . . . . . . . . . . . . . . . . . . 22
Section 25502.5 . . . . . . . . . . . . . . . . . . . . . 25
Federal Rules of Civil Procedure
Rule 9(b) . . . . . . . . . . . . . . . . . . . . . . . 9, 16
Rule 23.1 . . . . . . . . . . . . . . . . . . . . . . 24, 25
Federal Rules of Evidence
Rule 201 . . . . . . . . . . . . . . . . . . . . . . . . . 8
Securities Act of 1933
Section 11 . . . . . . . . . . . . . . . . . . . . . . . 13-16
Securities Exchange Act of 1934
Section 10(b) . . . . . . . . . . . . . . . . . . . . 20, 21
iii.
I. INTRODUCTION.
Defendants submit this sur-reply to address the serious
and extensive mischaracterizations of fact and misapplications of
law that are prevalent in plaintiff's reply memorandum (Pl. Reply
Mem."). Although the hearing on this matter is just two days away,
defendants feel compelled to set the record straight on several
points.
The Private Securities Litigation Reform Act of 1995
("The Reform Act") is designed to stop exactly this kind of fraud
by hindsight case. The Reform Act contains specific provisions for
the appointment of the lead plaintiff and the approval of lead
counsel, which were intended by Congress to control and supervise
the lawyers for the class. The clear import of these provisions
dictates that the plaintiff who first files has no standing to
pursue litigation strategies and tactics that might be inconsistent
with and detrimental to the interests of a truly adequate
plaintiff.
Plaintiff is asking for the extraordinarily drastic
remedy of an asset freeze, but he has failed to provide any
evidence of success on the merits that rises above the level of
speculation and innuendo, or to demonstrate that an asset freeze is
necessary to preserve "his" property from dissipation or diversion.
Worse yet, in their zeal to obtain an asset freeze, plaintiff and
his counsel have been less than candid with the Court, citing
unpublished cases such as Neomonitis v. Blackie, No. SA CV 94-379
AHS (RWRX) (C.D. Cal. June 20, 1994), ("Platinum Software") and
Miller v. Telios Pharmaceuticals, Inc., Civ. No. 94-1554-IEG (RBB)
(S.D. Cal. January 11, 1995), while simultaneously withholding
1.
critical facts that were pivotal to the orders granting the
freezes.
Plaintiff also relies on the declarations of Albert Rossi
and Mark Kangas, and throws down the gauntlet to defendants that
these declarations are unchallenged. But, as defendants show, the
declarations are barren of any evidentiary facts and do not
withstand critical analysis.
The Reform Act was intended to stop this kind of case, in
which a plaintiff fabricates baseless claims that could bring a
small, innocent company such as TouchStone to its financial knees.
There is simply no fraud here. TouchStone's independent "Big Six"
accounting firm, Deloitte & Touche, will issue its audit opinion in
TouchStone's 10-KSB at the end of the week. The opinion will not
be qualified as to any aspect of TouchStone's accounting, reporting
or revenue recognition principles. The opinion will only be
qualified as to the enormous contingent liability imposed by this
litigation. Such a qualification is, of course, not an opinion on
the merits of plaintiff's allegations under generally accepted
accounting principles ("GAAP"), but it is an illustration of why
Congress felt so strongly that these abusive lawsuits must end.
II. PLAINTIFF LACKS STANDING TO BRING THIS MOTION OR TO
CONDUCT ANY PROCEEDINGS.
A. The Reform Act Requires the Selection and
Approval of the Lead Plaintiff and Lead
Counsel Before Litigation May Proceed.
The clear import of the specific provisions in The Reform
Act for the appointment of the lead plaintiff and the approval of
lead counsel dictate that plaintiff has no standing to conduct any
proceedings in this case.
2.
The Statement of Managers confirms that The Reform Act is
designed in part to encourage institutional investors to take
control of securities class actions and thereby stop ill-founded,
lawyer-driven lawsuits from proceeding:
This Conference Report seeks to protect
investors, issuers, and all who are associated
with our capital markets from abusive
securities litigation. This legislation
implements needed procedural protections to
discourage frivolous litigation. . . . it
protects investors who join class actions
against lawyer-driven lawsuits by giving
control of the litigation to lead plaintiffs
with substantial holdings of the securities of
the issuer.
* * *
These provisions are intended to encourage the
most capable representatives of the plaintiff
class to participate in class action
litigation and to exercise supervision and
control over lawyers for the class. These
provisions are intended to increase the
likelihood that parties with significant
holdings in issuers, whose interests are more
strongly aligned with the class of
shareholders, will participate in the
litigation and exercise control over the
selection and actions of plaintiff's counsel.
Bessette Decl., Ex. E at 139 (emphasis added).
There can be no clearer expression of Congressional
intent. The express purpose of The Reform Act is to encourage
institutional investors and other parties with significant holdings
to become involved and control the actions of plaintiff's counsel.
If the Court were to allow this case to proceed without first
appointing the lead plaintiff and approving lead counsel, then
plaintiff will have succeeded in undercutting these specific
provisions of The Reform Act. Indeed, The Reform Act itself will
have been rendered a nullity, because plaintiff or his counsel
will be able to take actions inconsistent with and detrimental to the
3.
interests of a truly adequate plaintiff, which could result in
significant and unnecessary costs to TouchStone's current
shareholders.
B. Plaintiff Has Failed to Give Meaningful
Notice Under the Reform Act.
Plaintiff claims that his three-sentence "notice" in the
limited circulation Investors Business Daily is adequate because
one California district court recently ordered that backup summary
notice to class members of a proposed settlement be published once
in the Investors Business Daily. Pl. Reply Mem. at 3. This
example, however, actually underscores the inadequacy of
plaintiff's notice.1/
The summary notice published in the Investors Business
Daily was only backup notice -- primary notice to class members was
ordered to be mailed to all class members. See Hodges Supp. Decl.,
Ex. 1 at 6. Here, in contrast, the notice required under The
Reform Act is the primary notice to potential class members, and
should be significant enough to serve The Reform Act's purpose
(i.e., encourage investors with substantial holdings to participate
in litigation, control lawyers for the class and stop ill-founded
cases from proceeding). Moreover, plaintiff's scant three-sentence
notice could not possibly convey to anyone the meaningful
information required under The Reform Act, which undermines The
Reform Act's express purpose. See Bessette Decl., Ex. L.
____________________
1/ Interestingly, in the literally hundreds of securities
litigation cases settled by Milberg Weiss Bershad Hynes & Lerach
LLP ("Milberg Weiss"), plaintiff can point to only one case where
any court authorized the publication of even backup notice in the
Investors Business Daily. That fact alone is telling.
4.
III. PLAINTIFF HAS FAILED TO MEET THE STRICT REQUIREMENTS
NECESSARY FOR AN ORDER FREEZING ASSETS.
A. Plaintiff Has Failed to Establish Likelihood of
Success on the Merits.
Plaintiff has failed to offer any evidentiary facts -- as
opposed to mischaracterizations, hyperbole and conclusory
speculation -- to support his claim that Touchstone or any of the
Individual Defendants knew that Touchstone's quarterly financial
statements were false when made. There are no facts anywhere in
the record to explain why the increase in reserves in the fourth
quarter of 1995 is the subject of fraud rather than a totally
appropriate charge made in light of changed business circumstances,
namely the dramatic fall-off in sales of Microsoft Windows '95
upgrades.
In a reply brief replete with sweeping
mischaracterizations, there is no more telling statement than the
following:
Plaintiffs have submitted compelling evidence,
which defendants have not even attempted to
controvert, establishing that plaintiffs will
be successful in proving that defendants
violated the federal securities laws and state
law . . . .2/
Plaintiff simply chooses to ignore the arguments made in
defendants' Motion to Dismiss, and in the opposition to the instant
motion, that this litigation is precisely the type of "fraud by
hindsight" case that Congress intended to stop dead in its tracks.
____________________
2/ The sentence continues that "without an order in place
that will prevent defendants from dissipating the monies received
from their sale of over $2 million of their Touchstone stock, there
is a substantial likelihood that plaintiffs will not be able to
collect any judgment ultimately obtained." Plaintiff has not
offered a shred of evidence in support of this assertion. See
infra at III.B.
5.
Plaintiff has not even successfully pled a claim, much less made a
compelling case for victory. Notwithstanding this, defendants
respond to the allegedly "compelling evidence" that plaintiff says
requires the extraordinary preliminary relief that is requested
here.
1. Plaintiff's Reference to Unpublished District
Court Authority on Asset Freeze Motions Has
Been Misleading in the Extreme.
Plaintiff suggests that two unpublished district court
cases, Platinum Softwareand Telios Pharmaceuticals, are similar to
the facts before this Court, and that the relief requested here is
appropriate almost as a matter of course.3/ Pl. Reply Mem. at 15-
16. Nothing could be further from the truth. The true facts are
not apparent on the face of the unpublished orders or the
complaints themselves, and plaintiff has not provided the Court or
defendants with any factual information concerning these orders.4/
Defendants have obtained the transcripts of the hearings
in those cases, and have discovered that plaintiff has withheld
critical facts from the Court. These facts demonstrate that
Platinum Software and Telios Pharmaceuticals are nothing like this
case. In Platinum Software, for example, Judge Stotler was
initially concerned that there was "a lack of showing that any of
the defendants [had] secreted away assets or taken any steps to put
____________________
3/ Interestingly, plaintiff's counsel has sought an asset
freeze in many securities cases, yet they can point to only these
two unpublished orders to support this drastic relief.
4/ Plaintiff claims that "sufficient information about these
rulings is contained in the Orders themselves. . ." (Pl. Reply
Mem. at 15), but this is absurd. And it is no help to provide the
complaints from these cases. What this Court and the defendants
needed, and which the defendants only obtained at considerable cost
and effort, were the factual submissions made to the court.
6.
them beyond the reach of creditors . . . ."5/ In response to
this specific concern, Mr. Lerach of Milberg Weiss told the court
that one of the individual defendants had moved $1.5 million of
stock proceeds into a Swiss bank account while he tried to
establish a Florida residence! Bessette Suppl. Decl., Ex. B at 25-
26. Mr. Lerach further told the court that the other individual
defendants had spent large portions of their stock proceeds on
depreciating assets such as fancy automobiles (Lamborghini's and
Mercedes) and diamond rings. Bessette Suppl. Decl., Ex. B at 27.
On the basis of these evidentiary submissions, not plaintiff's
conclusory complaint, Judge Stotler granted the asset freeze, which
was "essentially such relief as defendants were willing to
stipulate to in earlier communications among the parties." Hodges
Decl., Ex. A at 4.
In Telios Pharmaceuticals, the company had filed for
bankruptcy on the morning of the hearing on the asset freeze.
Bessette Suppl. Decl., Ex. C at 78-79. Judge Gonzales was
concerned that the bankruptcy filing might indeed result in
irreparable harm because the corporation was then a dubious source
of funds (unlike the present case where the corporation has
approximately $13 million in cash). Bessette Suppl. Decl., Ex. C
at 101. It is clear that Judge Gonzales' chief concern was how the
bankruptcy might affect other creditors' claims on Telios
Pharmaceuticals' assets, and thus Judge Gonzales granted the
____________________
5/ See Supplemental Declaration of Paul R. Bessette in
Opposition to Plaintiff's Motion for Preliminary Injunction to
Freeze Assets and to Impose a Constructive Trust ("Bessette Suppl.
Decl."), Ex. B at 9.
7.
preliminary injunction to maintain the status quo.6/
Plaintiff also should have disclosed the many district
court cases that have flatly denied a freeze order. Ninth Circuit
district courts, in the face of much more compelling evidence
than that presented here, have routinely denied asset freeze motions.
For example, In re Media Vision Technology Sec. Litig., No. C-94-
1515 EFL ("Media Vision"), plaintiffs sought an order freezing
certain assets of individual defendants who allegedly violated the
securities laws by engaging in insider trading. At the time, the
Department of Justice was investigating the company, with a grand
jury having been impaneled, and the SEC was conducting a formal
investigation. Moreover, the company was in bankruptcy.7/ Despite
these facts, Judge Lynch of the Northern District denied the
requested asset freeze.8/
The facts here are far less compelling than those found
insufficient in Media Vision. There has been no restatement of
Touchstone's revenues or earnings. Indeed, except for the
possibility of material harm to the Company's financial position
arising from this lawsuit, which could be material to a company
this size, Deloitte & Touche is prepared to issue an otherwise
unqualified opinion resulting from Touchstone's 1995 year-end
____________________
6/ Bessette Suppl. Decl., Ex. C at 109-10.
7/ These facts have all been widely reported in the press and
pursuant to Fed. R. Evid. 201(b) and (c), this Court may take
judicial notice of them. A sample of a pertinent article is
attached to the Bessette Suppl. Decl. as Ex. E.
8/ The Media Vision order denying TRO and preliminary
injunction is attached to the Bessette Suppl. Decl. as Ex. D.
8.
audit.9/ The contrast between the facts in Media Vision on the one
hand, and the facts in this case, on the other, is dramatic, and it
compels the conclusion that this Court should deny the requested
freeze order.
2. Neither of Plaintiff's Two "Experts" Comes
Close to Presenting "Compelling Evidence" Or,
Indeed, Any Evidence Which Would Support An
Asset Freeze.
Plaintiff and his counsel next argue that their
"resident" accountant, Albert Rossi, offers "sufficient evidence of
scienter" and "valid evidence of defendant's fraud."10/
Notwithstanding the detailed description in defendant's motion to
dismiss of the reasons why plaintiff's accounting allegations do
not satisfy FRCP 9(b)11/, plaintiff engages in an interesting bit
of self-delusion and asserts that ". . . Mr. Rossi's declaration
is unrefuted in the record."12/ This statement is dead wrong, but
it poses no challenge whatsoever to find experienced, highly
respected accountants who agree that Mr. Rossi merely assumes his
result at the outset rendering his "expert" opinion materially
deficient.13/ This, of course, is precisely what the Ninth
____________________
9/ Even plaintiffs suggest no wrongdoing by Deloitte & Touche,
a highly respected accounting firm.
10/ On the "sufficient evidence of scienter" element,
plaintiff also points to defendants' (obviously disclosed) insider
sales in the secondary offering. This argument fails for the
reasons discussed infra at III.A.3.
11/ Bessette Suppl. Decl., Ex. G at 160-65.
12/ Pl. Reply Mem. at 20.
13/ An obvious dilemma exists for any defendant in this
procedural context, because with a motion to dismiss pending, no
defendant wants to get into a "battle of experts". If that
happens, plaintiff can win while losing. That would be a travesty
here, because Congress has clearly mandated that these fraud by
hindsight cases must end. However, out of an abundance of caution,
defendants offer the declaration of Mr. Neill Freeman, a
9.
Circuit has said about Mr. Rossi on prior occasions.
The failures of the Rossi Declaration to raise a
legitimate inference of fraud are many. The first point is
obvious: plaintiff himself discounts a substantial portion of
Rossi's opinion. Plaintiff alleges a class period beginning on May
2, 1995, with the announcement of 1995 first quarter results.
Complaint ¶¶ 1, 48. But Rossi actually says "Reserves for ... the
first three quarters of fiscal 1994 were materially understated
. . . .", Rossi Decl. ¶ 9(a) (emphasis added), and "it is highly
likely that TouchStone's interim financial statements for 1994,
were materially misstated and failed to conform to GAAP . . . ."
Id. ¶ 12 (emphasis added). What then accounts for plaintiff
beginning the class period on May 2, 1995? Either there is
something about Mr. Rossi's opinion that plaintiff himself
discounts, or this plaintiff is seriously wanting in his adequacy
as class representative.
Not surprisingly, the Rossi Declaration is also
internally inconsistent. Compare Rossi's statement that "in fact,
during 1994, it was standard in the software industry that
distributors and/or resellers had rights of return, including stock
balancing arrangements" id. ¶ 11 (emphasis added), with his later
reference to the statement in TouchStone's quarterly SEC filings
that there is a risk of product returns "'as a result of the
Company's strategic interest in assisting customers in balancing
____________________
distinguished C.P.A. and a Managing Director of Putnam Hayes &
Bartlett, Inc., who points out the many flaws in Mr. Rossi's
analysis of applicable accounting standards. Moreover, Mr. Rossi
contradicts himself in several key areas. Mr. Rossi's declaration
is a flimsy basis, at best, upon which to predicate a multimillion
dollar theory of fraud.
10.
and updating inventories.'" Id. ¶ 16. Rossi concludes that this
latter statement "is an admission that TouchStone would accept
returns of product if the customer could not resell the
product. . . . In effect, shipments of product were on a
contingent basis." Id. But, if rights of return and stock
balancing are industry standards, as indeed they are, how can the
Company's forthright disclosure of this fact be an "admission" of
"contingent sales," unless Mr. Rossi's opinion is that the entire
software industry is committing fraud? In reality, and as
discussed in the Freeman Declaration, there is nothing contingent
about such sales under FASB 48.14/
Plaintiff also seeks to show scienter with the following Rossi
statement: "In a company the size of TouchStone it would have been
inconceivable that the senior management was unaware of the
important policies and transactions occurring at TouchStone." Pl.
Reply Mem. at 18-19. Of course, Rossi's statement on its face says
absolutely nothing about knowledge of underreserves, or when
information became available to management, and thus does not have
anything to do with fraud.
As to Mr. Kangas, his blunt admission that his entire
opinion is grounded in the assumption that plaintiff's allegations
____________________
14/ Note too Rossi's statement that with Win 95 Advisor, "the
returns appear to be in excess of normal stock balancing
arrangements." Id. ¶ 17. Mr. Rossi makes a passing attempt at
describing "normal" in his footnote six, but it does not say much.
Is Rossi saying that TouchStone is guilty of financial fraud simply
because it accepted too many returns? How many is too many? Does
it matter when knowledge of higher returns occurred? Rossi's
analysis is fundamentally flawed because it fails to say anything
about what was happening in the market for Microsoft's Windows '95
upgrades -- what market expectations were for the product and how
these expectations changed over time. A real expert would have
wanted this question addressed and answered before making a knee-
jerk accusation of fraud.
11.
of fraud are correct, completely undermines his opinion for
purposes of plaintiff's motion.15/ If you assume the result,
there is no need to have an opinion.
3. Plaintiff Wholly Fails to Show Scienter.
Plaintiff never even acknowledges the heightened pleading
standard necessary to show scienter under The Reform Act.
Plaintiff has the burden to set forth facts supporting a strong
inference that each defendant knew that each of the alleged
misstatements was incorrect when made.16/
Plaintiff tries to conjure up fraud by tossing out
assorted mischaracterizations and conclusions. One of the most
egregious, patently false mischaracterizations occurs when
plaintiff alleges that "[o]n December 21, 1995 the Company admitted
that in the fourth quarter it was taking a $2 million charge for
sales that had been improperly recorded."17/ The truth, which
the Court can read for itself, is that the Company announced only
that it would be "booking additional reserves of approximately $2
million in anticipation of returns of unsold reseller inventories
of WIN '95 Advisor and Wincheckit 2.0".18/ There was nothing
"improperly recorded" about this revenue when booked, as evidenced
by (i) the fact that the quarterly financials are not being
____________________
15/ See Kangas Decl., ¶ 5 ("For purposes of my analysis, I
have assumed that plaintiff's allegations in the Complaint are
true").
16/ See Statement of Managers, Bessette Decl., Ex. E at 148
(the Conference Committee intended to strengthen the pleading
standard beyond the Second Circuit standard, which was then
regarded as the most stringent).
17/ Pl. Reply Mem. at 18; Complaint ¶ 113.
18/ See Bessette Decl., Ex. B at 8.
12.
restated; (ii) Deloitte & Touche's opinion on the 1995 year end
financials; and (iii) the analysis set forth in the Freeman Decl.
at ¶¶ 4-18. Finally, it stretches truth beyond all measure for
plaintiff to tell this Court, with no qualification whatsoever,
that "the Company admitted" a financial impropriety.19/
Moreover, a "strong inference" of scienter is not raised
by the mere fact that the Individual Defendants sold stock in the
secondary offering. Neither Kaplan v. Rose, 49 F.3d 1363 (9th Cir.
1994), cert. denied, ___ U.S. ___, 116 S. Ct. 58 (1995), nor In re
Wells Fargo Sec. Litig., 12 F.3d 922 (9th Cir. 1993), cert. denied,
___ U.S.___, 115 S. Ct. 295 (1994), is to the contrary.
The court in Kaplan explained that "[i]nsider trading in
suspicious amounts or at suspicious times is probative of
scienter." Id. at 1379. The court went on to explain that the
insider trading must be at times calculated to maximize personal
benefit from undisclosed insider information. Id. That situation
is not present here. The Individual Defendants sold portions of
their stock ranging from 26% to 50% on the secondary offering at
$13.50 per share, but the class period high for the stock price was
$17.67. Moreover, some of the Individual Defendants along with
stock analysts publicly stated prior to the secondary offering that
the stock's price was at a historic high because of the unusual
market circumstances in the summer of 1995 for anything having to
____________________
19/ Plaintiff cannot possibly meet this scienter standard and
tacitly admits as much by relying so heavily upon a new Section 11
claim in the recently filed Bodner case, which has not been served
on the defendants, has not been consolidated with the instant
action and is not properly raised on this motion. But as discussed
in Section III.A.4, infra, on substantive grounds a Section 11
claim is equally unavailing to plaintiff.
13.
do with Windows or the Internet.20/ Thus, the Individual
Defendants' sales were not in suspicious amounts, not at suspicious
times and not calculated to maximize personal benefit.21/
4. A Section 11 Claim Does Not Provide
Plaintiff with Any Greater Probability of
Success on the Merits.
In recognition of the fact that he has no probability of
success on the merits of his own claims, plaintiff attempts to
buttress his asset freeze motion with a Section 11 claim asserted
by a different plaintiff in a different not-yet-served action.22/
But this claim, like the others, is unavailing.
"Courts have universally held that 'in order to have a
valid §11 cause of action, [the plaintiff] must plead and prove
that his stock was issued pursuant to the particular registration
statement alleged to be defective.'" Abbey v. Computer Memories,
Inc., 634 F. Supp. 870, 871 (N.D. Cal. 1986) (granting summary
judgment for defendants due to plaintiffs' failure to trace stock
to registration statement). At the time of the secondary offering,
there were 4,920,468 shares of TouchStone stock already trading in
____________________
20/ See the August 22, 1995 Los Angeles Times article at
Bessette Supp. Decl., Ex. A at 3.
21/ In addition, Wells Fargo states only that plaintiff must
state facts showing motive and opportunity for the fraud. Id. at
931. As shown above, however, plaintiff has failed to adduce any
evidentiary facts, especially under the heightened pleading
standard in The Reform Act.
22/ Defendants can only surmise that, since plaintiff
Caramonta has not asserted a claim under Section 11, that his
reference to that claim in his reply brief refers to the Section 11
claim plaintiff Bodner has raised in Case No. SACV 96-243 LHM
(EEx). It is procedurally improper to raise in a reply brief
claims asserted by a different plaintiff in an entirely separate
lawsuit. The joinder by plaintiffs Bodner and Farber, complete
strangers to the instant action, in plaintiff Caramonta's motion
for an asset freeze is similarly improper. Rather than waging war
on plaintiff's procedural failings, however, defendants "cut to the
chase" and address the deficient Section 11 claim.
14.
the market. Bessette Decl., Ex. C at 13. The burden of tracing
shares to a particular offering rests squarely on the
plaintiff.23/ Plaintiff has failed to provide any evidence that
he or any other nominal plaintiff can trace his shares to satisfy
Section 11's threshold requirement.
Moreover, the Section 11 claim by itself does not state
a claim for relief.24/ First, as demonstrated in Defendants'
Motion to Dismiss, the Prospectus was not misleading. The
Prospectus contained explicit risk disclosures warning of the exact
events of which plaintiff now complains. In the interest of
brevity, defendants incorporate relevant portions of their Motion
to Dismiss by reference. Bessette Suppl. Decl., Ex. G at 155-58.
Second, a Section 11 claim cannot be maintained based on
subsequent events which render a Prospectus no longer current.
Anderson v. Clow, [1993 Tr. Binder] Fed. Sec. L. Rep. (CCH)
¶97,807, 97,989 (S.D. Cal. Sept. 17, 1993).25/ Like the plaintiff
____________________
23/ See Guenther v. Cooper Life Sciences, Inc., 759 F. Supp.
1437, 1439 (N.D. Cal. 1990). In a case of a firm commitment
underwriting, like TouchStone's August offering, it is virtually
impossible for a plaintiff to trace to the offering at issue. See,
e.g., Lorber v. Beebe, 407 F. Supp. 279, 286-87 (S.D.N.Y.
1976)(Section 11 claims must be dismissed unless the plaintiff can
trace, despite the fact it is often impossible to determine the
lineage of particular shares in situations where stock is held in
fungible accounts in street name).
24/ By its terms, Section 11 only concerns registration
statements. Accordingly, any alleged misstatements in roadshow
presentations, press releases, newspaper articles or analyst
reports cannot support a Section 11 claim. Anderson v. Clow, [1993
Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 97,807 at 97,986 (S.D. Cal.
Sept. 17, 1993).
25/ In Anderson, the court dismissed a Section 11 claim
explaining that "insofar as Plaintiffs suggest that [the Prospectus
was] rendered misleading by later events--such as product returns
greater than allowed for--they fail to state a claim. 'Section 11
by its terms applies to material misstatements and omissions in the
registration statement "when such part became effective."
15.
in Anderson, plaintiff here has based his entire case on the fact
that subsequent to the Prospectus, TouchStone experienced product
returns greater than that provided for in its financial statements.
As explained in Anderson, however, such subsequent events do not
support a Section 11 claim.
Finally, the Section 11 claim fails because plaintiff has
failed to plead the purported fraud with the particularity demanded
by Rule 9(b).26/ As discussed at length in Defendants' Motion to
Dismiss, plaintiff's allegations constitute no more than assumed
conclusions devoid of evidentiary basis. Bessette Suppl. Decl.,
Ex. G at 160-65. Such conclusions do not meet Rule 9(b)'s exacting
requirements.
B. Plaintiff Has Failed to Demonstrate a Significant
Threat of Irreparable Injury.
Plaintiff has utterly failed to show a significant threat
of irreparable harm, and has presented no evidence from which the
Court can infer that any stock sale proceeds are being secreted or
diverted, or that there is even the slightest risk that the
Individual Defendants will dissipate their sales proceeds prior to
the conclusion of this litigation.
Defendants never asserted or implied that Big Country
Foods, Inc. v. Board of Education, 868 F.2d 1085, 1088 (9th Cir.
1989), stood for the proposition that plaintiff must establish a
____________________
Accordingly, when subsequent events make an effective registration
statement [and prospectus] misleading, Section 11 does not apply.'"
Id. at 97,989.
26/ Rule 9(b) applies where, as here, a Section 11 claim
sounds in fraud. In re GlenFed Sec. Litig., 11 F.3d 843, 850 (9th
Cir. 1993), vacated on other grounds, 42 F.3d 1541 (9th Cir. 1994);
Anderson, ¶ 97,807 at 97,990 (dismissing Section 11 claims for
failure to plead fraud with Rule 9(b) particularity).
16.
significant threat of dissipating assets. Pl. Reply Mem. at 21.
Big Country does require, however, that plaintiff establish a
significant threat of irreparable injury. Id. at 1088. Plaintiff
argues that a possibility of dissipation exists sufficient to
impose an asset freeze merely because the Individual Defendants
have control over the proceeds.27/ Pl. Reply Mem. at 22. That
result is absurd, and was not at all stated or implied in
plaintiff's primary authority, Federal Sav. & Loan Ins. Corp. v.
Sahni, 868 F.2d 1096, 1097 (9th Cir. 1989).
Mere possession by itself cannot constitute a significant
threat of irreparable harm. If it could, a plaintiff could obtain
a preliminary injunction freezing assets in every single case,
whether or not there was any real risk of dissipation or diversion.
That is clearly not the law. Indeed, Judge Lynch in Media Vision
confirmed that there must be an actual risk of dissipation:
...plaintiffs have not demonstrated that there
is any risk that these individual defendants
will dissipate their assets. Unlike the
situations in cases cited by plaintiffs, the
Court does not find any evidence to support a
conclusion that defendants are likely to
dispose of, conceal, or send abroad the
profits obtained through the alleged insider
____________________
27/ In the cases plaintiff cites, however, such as Republic of
the Philippines v. Marcos, 862 F.2d 1355 (9th Cir.) cert. denied,
490 U.S. 1035 (1989), and Platinum Software, the individual
defendants had actually secreted or diverted assets prior to the
issuance of the freeze order, circumstances that not even this
plaintiff claims are present here. See Bessette Suppl. Decl., Ex.
B at 25-27;(Platinum Software) Marcos, 863 F.2d at 1362-63.
17.
trades. See e.g. Federal Trade Commission v.
Singer, 668 F.2d 1107, 1113 (9th Cir. 1982)
(absent a freeze, the record showed that the
defendants would either dispose of, conceal,
or send abroad all of the moneys obtained
through fraud). Defendants are all residents
of the Bay Area, and plaintiffs have put
forward no evidence that defendants have
concealed or dissipated, or are likely to
conceal or dissipate, any alleged profits from
insider trades.28/
There is no allegation that any of the Individual
Defendants have wasted any assets, nor that any investments will
not ultimately result in a higher return than the Treasury bills in
which plaintiff demands the funds be invested.
Finally, plaintiff cannot show irreparable harm in the
absence of an asset freeze. Touchstone is a financially sound
company that as of year-end 1995, had cash and cash equivalents of
nearly $13 million and total current assets of $19 million.29/
Total current liabilities, in contrast, are only $3.7 million.
Thus, there are adequate Company assets upon which plaintiff could
collect in the unlikely event judgment is entered.
C. The Balance of Hardships Does Not Tip in Favor of
Plaintiff.
Plaintiff asks this Court to take control of the
Individual Defendants' assets before there has even been a hearing
on defendants' response to the Complaint. The Individual
Defendants are hardpressed to imagine any more draconian or
oppressive type of order.
The conversion of the Individual Defendants' rightfully
obtained assets into Treasury bills is not, as plaintiff contends,
merely maintaining the status quo. Some of these assets have been
invested in growth and other stocks, and some have been invested in
real estate. It would cause the Individual Defendants extreme
hardship to convert these assets to Treasury bills. Moreover,
____________________
28/ Bessette Suppl. Decl., Ex. D at 136.
29/ These amounts are reflected in Touchstone's most recent
Form 10-KSB, which the Company expects to file in the next several
days.
18.
there is no justifiable reason to wreak this hardship on the
Individual Defendants, much less on the basis of boilerplate,
abusive, and factually ill-founded allegations.
IV. FINAL EQUITABLE RELIEF IS A PREREQUISITE TO AN ORDER
FREEZING ASSETS.
Under well-established Ninth Circuit law, plaintiff must
be entitled to final equitable relief before a preliminary
injunction may issue.
Plaintiff's effort to slide within the narrow exception
created by In re Estate of Marcos Human Rights Litig., 25 F.3d 1467
(9th Cir. 1994), cert. denied sub nom, Estate of Marcos v. Hilas,
____U.S. ____, 115 S. Ct. 934 (1995) ("Marcos II"), and the way he
tries to do it -- by purposefully failing to discuss the Court's
limited holding -- is disingenuous. Pl. Reply Mem. at 28, 29. In
Marcos II, the Ninth Circuit held that a district court had
authority to issue a preliminary injunction in the extraordinary
case where equitable relief was not sought, but only if the
plaintiff could establish that money damages would be an inadequate
remedy due to the impending insolvency of the defendant or that the
defendant had engaged in a pattern of secreting or dissipating
assets to avoid judgment:
We join the majority of circuits in concluding
that a district court has authority to issue a
preliminary injunction where the plaintiffs
can establish that money damages will be an
inadequate remedy due to impending insolvency
of the defendant or that defendant has engaged
in a pattern or secreting or dissipating
assets to avoid judgment. This holding is
thus restricted to only extraordinary cases in
which equitable relief is not sought. Our
conclusion thus avoids the concern in De Beers
of the "sweeping effect" that a plaintiff in
any action requesting damages can apply for an
injunction to sequester his or her opponent's
assets. 325 U.S. at 222-23, 65 S.Ct. at 1135.
19.
Id. at 1480 (emphasis added). Plaintiff has not made and cannot
make this showing. Thus, the narrow Marcos II exception is
inapplicable.30/
V. PLAINTIFF IS NOT ENTITLED TO RESCISSION OR DISGORGEMENT
ON HIS SECTION 10(b) CLAIM.
Plaintiff again resorts to sleight-of-hand by arguing
that it is "possible" for a court to grant rescission on a
Section 10(b) claim. In the Ninth Circuit, however, a plaintiff is
not entitled to rescission in a "fraud on the market" case.
Rescission is available only when the plaintiff is in privity with
the defendant.31/ In Green v. Occidental Petroleum Corp., 541
F.2d 1335 (9th Cir. 1976), Judge Sneed, in his concurrence,
explained that rescission was not available on a Section 10(b)
claim because:
the class members in this case did not deal
face to face with the corporate defendant.
Rather they purchased in the open market.
Whatever these purchasers 'lost' did not
directly accrue to the defendant. Such
benefits as did accrue were tangential and not
closely correlated to the purchasers 'losses.'
It follows that the proper measure of damages
is what the purchasers lost as a result of the
defendant's wrong, not what the defendant
____________________
30/ Plaintiff's assertion that "defendants' arguments are
unavailing because all of their authorities predate [Marcos II],
and most of them are decisions outside of this circuit," is
ridiculous. Pl. Reply Mem. at 29. First, the cases were cited by
plaintiff and only responded to by defendants. Second, since the
Marcos II exception does not apply here, pre-Marcos II Ninth
Circuit law controls and is dispositive.
31/ Plaintiff's attempted reliance on Randall v. Loftsgaarden,
478 U.S. 647, 662 (1986), is unavailing. The Supreme Court did not
hold that rescission is an available remedy on a Section 10(b)
claim. The Court merely "assumed, arguendo" that such a remedy
"may" be "sometimes" proper. Plaintiff's reliance on Blackie v.
Barrack, 524 F.2d 891, 908-909, (9th Cir. 1975), is similarly
unpersuasive. That court's mention of rescission was dicta,
without any discussion as to when such a remedy would be
appropriate.
20.
gained.
Id. at 1341.32/
Disgorgement is also unavailable to plaintiff. In the
Ninth Circuit, disgorgement has only been allowed in SEC actions.
See, e.g., SEC v. Eurobond Exch., Ltd., 13 F.3d 1334 (9th Cir.
1994); SEC v. Interlink Data Network of Los Angeles, 1993 U.S.
Dist. LEXIS 20163 (C.D. Cal. 1993).
Plaintiff purchased on the open market and was not in
privity with the defendants. Whatever may be in the realm of
theoretical "possibility" for strict privity cases, for the type of
case plaintiff pleads, rescission and disgorgement are simply
unavailable.
VI. PLAINTIFF IS NOT ENTITLED TO RESCISSION OR A CONSTRUCTIVE
TRUST ON HIS STATE LAW CLAIMS.
While Cal. Corp. Code Sections 25401 and 25501 provide
for rescission, the Ninth Circuit has held that liability under
those sections is limited to actual sellers in strict privity with
____________________
32/ Accord Arrington v. Merrill, Lynch, Pierce, Fenner &
Smith, Inc., 651 F.2d 615 (9th Cir. 1981) (recognizing court's
discretion to apply rescissionary measure of damages in case of
face-to-face misrepresentations); Schwartz v. Harp, 1985 WL 5623
(C.D. Cal. 1985) ("The rescissionary measure is contractual in
nature and is based on principles of restitution. Thus it is
appropriate where there is privity between the plaintiff and
defendant.").
Similarly, in Huddleston v. Herman & MacLean, 640 F.2d
534, 554-555 (5th Cir. 1981) aff'd in part and rev'd in part, 59
U.S. 375 (1983), the court held that rescission was unavailable and
explained the "[u]se of rescissional measure is usually limited to
cases involving either privity between plaintiff and defendant or
some specific fiduciary duty owed by brokers to their
customers...."
21.
the buyer.33/ Plaintiff has not, and cannot, plead privity and
thus is not entitled to rescission.
Similarly, plaintiff is not entitled to a constructive
trust because defendants did not receive plaintiff's property.
Thus, there is nothing to impose a constructive trust upon.34/
Green, 541 F.2d at 1341-42 (Sneed, J., concurring).
VII. PLAINTIFF IS NOT ENTITLED TO EQUITABLE REMEDIES ON HIS
DERIVATIVE CLAIMS, AS HE HAS NO STANDING TO BRING THEM.
A. Plaintiff Cannot Represent Both Class
and Derivative Claims.
An inherent conflict of interest exists where, as here,
a shareholder with the same counsel seeks to bring class and
derivative claims. Plaintiff sidesteps the issue by misstating the
Ninth Circuit's ruling in Yamamoto v. Omiya, 564 F.2d 1319 (9th
Cir., 1977), and by highlighting certain cases that advocate an
"ostrich-like" approach of waiting until the time of settlement to
identify and remedy the conflict. Pl. Reply Mem. at 11-14.
First, the Ninth Circuit in Yamamoto never confronted,
discussed or even addressed a purported conflict of interest. The
relevant issue in Yamamoto was whether class certification was
proper given that the injury involved was fundamentally an injury
to the corporation, which could be adequately addressed in a
____________________
33/ SEC v. Seaboard, et al., 677 F.2d 1289, 1296 (9th Cir.
1982); In re Diasonics Sec. Litig., 599 F. Supp. 447, 458-59 (N.D.
Cal. 1984) (dismissing claims for relief based on § 25401 for lack
of privity).
34/ It is telling that plaintiff failed to address any of the
authorities defendants cited establishing that he is not entitled
to a constructive trust.
22.
derivative suit. The court, relying on J. I. Case Co. v. Borak,
377 U.S. 426, 431, 84 S. Ct. 1555 (1964), recognized that a right
of action exists as to both derivative and direct claims and held
that a shareholder alleging claims related to a deceptive proxy
solicitation could bring both direct and derivative claims. Id. at
1325-26. The court never considered whether the simultaneous
prosecution of class and derivative claims with the same counsel
would present an inherent conflict of interest.
Second, although there is no per se rule against the
simultaneous prosecution of class and derivative claims by the same
shareholder with the same counsel,35/ the more recent and better-
reasoned cases, including cases in the Ninth Circuit and the
Northern District of California, find that such simultaneous
prosecution is an impermissible conflict of interest.36/ These
cases are better reasoned in part because they acknowledge the
reality that the vast majority of securities class actions settle
before trial, and plaintiff's counsel are quite obviously
interested in receiving their fees without any real concern as to
____________________
35/ See, e.g., In re Dayco Corp. Derivative Sec. Litig., 102
F.R.D. 624, 630 (S.D. Ohio 1984).
36/ See, e.g., In re Pacific Enterprises Sec. Litig., 47 F.3d
373, 378 (9th Cir. 1995); In re Oracle Sec. Litig., 829 F.Supp.
1176, 1183 (N.D. Cal. 1993); Ryan v. Aetna Life Ins. Co., 765 F.
Supp. 133, 135 (S.D.N.Y. 1991) (granting defendants' motion to
dismiss plaintiff's derivative claims because there was a conflict
between the derivative and direct class action relief); Brickman v.
Tyco Toys, Inc., 731 F. Supp. 101, 108-09 (S.D.N.Y. 1990) (denying
class certification because a conflict existed in the same nominal
plaintiff prosecuting a derivative and class action where
substantial recovery on class claim could reduce potential recovery
on behalf of corporation on derivative claim); Kamerman v.
Steinberg, 113 F.R.D. 511, 516 (S.D.N.Y. 1986) (impermissible
conflict of interest existed between derivative and class claims
because recovery in the class action may reduce potential recovery
in the derivative action).
23.
the source of such fees. Thus, the possibility that a derivative
claim will be sold out cheaply in favor of a class settlement is
more real than theoretical given the way the majority of these
cases are resolved.37/ This Court should follow these recent
cases and address the clear conflict early in the litigation to
avoid the huge costs which otherwise would be imposed on
TouchStone's shareholders.
B. Plaintiff's Failure to Show Contemporaneous
Ownership Is Fatal.
Plaintiff grasps at straws to persuade this Court he has
standing to bring the derivative claims. He argues that Cal. Corp.
Code §800 applies rather than FRCP 23.1, and that under §800 he has
standing. Faced with the identical issue, the court in Daisy Sys.
Corp. v. Finegold, [1989 Tr. Binder] Fed. Sec. L. Rep. (CCH)
¶ 94,520 (N.D. Cal. Sept. 20, 1988), dismissed derivative claims
for failure to satisfy the contemporaneous ownership requirement
and held that FRCP 23.1, not Cal. Corp. Code §800, controls. Id.
at 93,308-09.38/ Accord In re Rasterops Sec. Litig., [1992-1993
Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 97,445 (N.D. Cal. Jan. 6,
____________________
37/ See e.g. Pacific Enterprises Sec. Litig., 47 F.3d at 377
and In re Oracle Sec. Litig., 829 F. Supp. at 1177, 1183-84.
38/ Contrary to Plaintiff's misleading account, the Court in
Kamen v. Kemper Finan. Svs., 500 U.S. 90 (1991), held only that the
demand requirement and futility exception were substantive and
therefore governed by state law. The Court did not even discuss
the contemporaneous ownership requirement. The court in Daisy
Systems held that the requirement of pleading contemporaneous
ownership was procedural, not substantive, and therefore governed
by federal law. Daisy Sys. Corp. v. Finegold at 93,308-09.
24.
1993).39/ Plaintiff all but ignores Daisy Systems and makes a
desperate attempt to rely on old, out of circuit authority.40/
VIII. CONCLUSION.
For the foregoing reasons, and the reasons set forth in
defendants' opposition, the Court should deny plaintiff's
application for an asset freeze.
Dated: March 25, 1996 Respectfully submitted,
BROBECK, PHLEGER & HARRISON LLP
By ________________________________
Paul R. Bessette
Attorneys for Defendants
TouchStone Software Corporation, Larry W.
Dingus, C. Shannon Jenkins, Ronald R.
Maas, Kenneth Welch III, Donald C.
Watters and Sigmund Fidyke III
____________________
39/ Whether Cal. Corp. Code §25502.5 has a contemporaneous
ownership requirement is irrelevant. Rule 23.1's standing
requirements still apply. See Rasterops, ¶ 97,445 at 96,489.
40/ The "continuing wrong exception" found in Bateson v. Magna
Oil Corp., 414 F.2d 128, 130 (5th Cir. 1969), cert. denied, 397
U.S. 911 (1970), is inconsistent with the provisions of Rule 23.1,
and has not been adopted by the Ninth Circuit.
25.
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