BRUCE G. VANYO, State Bar # 060134
LAURIE B. SMILAN, State Bar # 116740
DAVID PRIEBE, State Bar # 148679
MICHELE E. ROSE, State Bar # 154656
SUSAN BOWER, State Bar # 173244
WILSON SONSINI GOODRICH & ROSATI
Professional Corporation
650 Page Mill Road
Palo Alto, California 94304-1050
Telephone: (650) 493-9300

Attorneys for Defendants

NOTICE OF MOTION

MEMORANDUM OF POINTS AND AUTHORITIES

INTRODUCTION

ARGUMENT

I. THE DEFENDANTS CANNOT BE LIABLE FOR STATEMENTS MADE BY OTHERS

A. The Non-Speaking Defendants Cannot Be Liable Under The Group Published Doctrine

B. The Defendants Are Not Liable For Third Party Analysts' Statements

II. THE COMPLAINT STILL FAILS TO PLEAD THE FACTUAL BASIS FOR ITS ALLEGATIONS

III. PLAINTIFFS STILL FAIL ADEQUATELY TO PLEAD THE "REASONS" WHY THE ALLEGED MISSTATEMENTS WERE KNOWINGLY FALSE OR MISLEADING WHEN MADE

A. The Complaint Still Fails Adequately To Plead "Reasons" Why the Challenged NOVA Statements Were False When Made

1. The old allegations about NOVA fail

2. The new allegations about NOVA also fail

3. Disclosed delays in a new system do not give rise to an inference of fraud

B. The Complaint Still Fails To Plead The "Reasons" Why Predictions Regarding Vanstar's Third and Fourth Quarter Earnings Were False When Made

1. The old allegations still fail

2. The new allegations also fail

IV. THE CHALLENGED FORWARD-LOOKING STATEMENTS --THE CORE OF THIS CASE--ARE NOT ACTIONABLE AS A MATTER OF LAW

V. PLAINTIFFS FAIL TO PLEAD FACTS SHOWING THAT VANSTAR'S ACCOUNTING WAS INCORRECT

A. The Merisel Accounting Allegations are Still Conclusory and Nonsensical

B. The NOVA Accounting Allegations Fail

VI. THE COMPLAINT FAILS TO PLEAD SPECIFIC FACTS GIVING RISE TO A STRONG INFERENCE OF SCIENTER

A. Plaintiffs Fail to Raise A Strong Inference Of Scienter

B. Senior Managements' Failure to Sell Any Stock Refutes Any Inference Of Fraud

C. Neither Vanstar's Desire To Raise Capital Nor Its Acquisitions Strategy Creates A "Strong Inference" Of Scienter

CONCLUSION

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

Allison v. Brooktree, 999 F. Supp. 1342 (S.D. Cal. 1998)

Allison v. Brooktree, No. 97-CV-0852TW (POR) slip op. (S.D.Cal. Nov. 27, 1998)

Blum v. Semiconductor Packaging Materials Co., Inc., No. C.A.97-7078,
     1998 WL 254035 (E.D. Pa., May 5, 1998)

Chill v. Gen'l Electric Co., 101 F.3d 263 (2d Cir. 1996)

Coates v. Heartland Wireless Comm., Inc., 26 F. Supp. 2d 910 (N.D. Tex. 1998)

Fisher v. Acuson Corp., No. C 93-20477 RMW (EAI),
     1995 WL 261439 (N.D. Cal. April 26, 1995)

Friedberg v. Discreet Logic, Inc., 959 F. Supp. 42 (D. Mass. 1997)

Genna v. Digital Link, 25 F. Supp. 2d 1032 (N.D. Cal. 1997)

Hannon v. Dataproducts Corp., 976 F.2d 497 (9th Cir. 1992)

Harris v. Ivax Corp., 998 F. Supp. 1449 (S.D. Fla. 1998)

Havenick v. Network Express, Inc., 981 F. Supp. 480 (E.D. Mich. 1997)

Head v. Netmanage, Inc., No. C97-4385 CRB, slip op. (N.D. Cal. Feb. 24 1998)

Hockey v. Medhekar, 30 F. Supp. 2d 1209 (N.D. Cal. 1998)

Hockey v. Medhekar, [1997 Tr. Binder] Fed. Sec. L. Rep. (CCH)
     ¶ 99,465(N.D. Cal. April 14, 1997)

Howard Gunty Profit Sharing v. Quantum Corp., No. 96 20711 SW,
     1997 WL 514993 (N.D. Cal. Aug. 14, 1997)

Howard Gunty Profit Sharing v. Quantum Corp., No. C96 20711 SW, slip op.
     (N.D. Cal. April 6, 1998)

In re Apple Computer Sec. Litig., 886 F.2d 1109 (9th Cir. 1989)

In re Caere Corp. Sec. Litig., 837 F. Supp. 1054 (N.D. Cal. 1993)

In re Crown America Realty Trust Sec. Litig., No. CIV. A 95202J,
     1997 WL 599299 (W.D. Pa. Sept. 15, 1997)

In re Cypress Semiconductor Sec. Litig., [1992 Tr. Binder]
     Fed. Sec. L. Rep. (CCH) ¶ 97,060 (N.D. Cal. Sept. 23, 1992)

In re Glenfed, Inc. Sec. Litig., 42 F.3d. 1541 (9th Cir. 1994)

In re Health Corp. of Am. Sec. Litig.,1999 WL 79057 (E.D. Pa. 1999)

In re Health Mangm't Systems, Inc. Sec. Litig., [1998 Tr. Binder]
     Fed. Sec. L. Rep. (CCH) ¶ 90,235 (S.D.N.Y. June 1, 1998)

In re Ross Systems Sec. Litig., [1994-95 Tr. Binder]
     Fed. Sec. L. Rep. (CCH) ¶ 98,363 (N.D. Cal. July 21, 1994)

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

In re Silicon Graphics, Inc. Sec. Litig., [1996-97 Tr. Binder]
     Fed. Sec. L. Rep. (CCH) ¶ 99,325 (N.D. Cal. Sept. 25, 1996)

In re Stac Elecs. Sec. Litig., 89 F.3d 1399 (9th Cir. 1996), cert. denied,
     520 U.S. 1103 (1997)

In re Syntex Corp. Sec. Litig., [1993 Tr. Binder] Fed. Sec. L. Rep.
     (CCH) ¶ 97,747 (N.D. Cal. Sept. 1, 1993)

In re Worlds of Wonder Sec. Litig., 35 F.3d 1407 (9th Cir. 1994)

In re Yes! Entertainment Corp. Sec. Litig., No. 97-01388 CRB
     slip op. (N.D. Cal. May 15, 1998)

Leonard v. NetFRAME Sys., Inc., [1995-1996 Tr. Binder]
     Fed. Sec. L. Rep. (CCH) ¶ 98,982 (N.D. Cal. Aug. 8, 1995)

May v. Borick, [Current Tr. Binder] Fed. Sec. L. Rep.
     (CCH) ¶ 99,438 (C.D. Cal. Mar. 3, 1997)

Medhekar v. United States District Court, 99 F.3d 325 (9th Cir. 1996)

Myles v. Midcom Comm., Inc., No. C96-6140, slip op. (W.D. Wa. Nov. 19, 1996)

Neubronner v. Milken, 6 F.3d 666 (9th Cir. 1993)

Northwest Forest Resource Council v. Glickman, 82 F.3d 825 (9th Cir. 1996)

Novak v. Kasakes, 997 F. Supp. 425 (S.D.N.Y. 1998)

O'Sullivan v. Trident Microsystems, Inc., [1993-1994 Tr. Binder],
     Fed. Sec. L. Rep. (CCH) ¶ 98,116 (N.D. Cal. Jan. 31, 1994)

Polk v. Fritz, No. 962712 MHP, slip op. (N.D. Cal. Mar. 5, 1998)

Rasheedi v. Cree Research, Inc., [1997 Tr. Binder]
     Fed. Sec. L. Rep. (CCH) ¶ 99,566 (M.D.N.C. Oct. 17, 1997)

Rubin v. Trimble, No. C-95-4353 MMC, 1997 WL 227956 (N.D. Cal. Apr. 28, 1997)

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

Seigel v. Lyons, [1995-96 Tr. Binder] Fed. Sec. L. Rep.
     (CCH) ¶ 99,227 (N.D. Cal. Apr. 26, 1996)

Shuster v. Symmetricon, Inc., [1997 Tr. Binder]
     Fed. Sec. L. Rep. (CCH) ¶ 99,437 (N.D. Cal. Feb. 25, 1997)

Stack v. Lobo, No. 95-20049-SW, 1995 WL 241448 (N.D. Cal. Apr. 20, 1995)

Stack v. Lobo, 903 F. Supp. 1361 (N.D. Cal. 1995)

Wallace v. Systems & Computer Tech. Corp, [Current Tr. Binder]
     Fed. Sec. L. Rep. (CCH) ¶ 99,578 (E.D. Pa. Sept. 23, 1997)

Wenger v. Lumisys, Inc., 2 F. Supp. 2d 1231 (N.D. Cal. 1998)

Wool v. Tandem, 818 F.2d 1433 (9th Cir. 1987)

15 U.S.C. § 78u-4 et seq.

15 U.S.C. § 78u-4(b)(1)

15 U.S.C. § 78u-4(b)(2)

15 U.S.C. § 78u-5(b)(2)(D)

15 U.S.C. § 78u-5(c)(1)(A)

15 U.S.C. § 78u-5(c)(1)(B)(i)

Fed. R. Civ. P. 9(b)

Fed. R. Civ. P. 12(b)(6)

H.R. Conf. Rep. No. 104-369, 104th Cong., 1st Sess. (1995)

On June 15, 1999 at 9:30 a.m., defendants will and hereby do move pursuant to Fed. R. Civ. P. 9(b) and 12(b)(6) for an order dismissing with prejudice the Second Amended Consolidated Complaint ("Complaint" or "SAC"). The issues presented in this Motion are: (1) whether a defendant not alleged to have made a misleading statement may be held liable for the statements of others; (2) whether plaintiffs' fraud allegations satisfy the stringent pleading standards of the Private Securities Litigation Reform Act ("Reform Act"), 15 U.S.C. § 78u-4 et seq.; and (3) whether plaintiffs have alleged (a) any actionable statements or omissions or (b) any facts supporting a strong inference that each defendant actually knew that the challenged forward looking statement (were false or was reckless in not knowing that the challenged accounting statements were fraudulent. As all of these issues must be answered in the negative, plaintiffs' Complaint must be dismissed.

This Court dismissed plaintiffs' First Amended Consolidated Complaint ("FAC") because plaintiffs had not pled particularized facts supporting their broad allegations of fraud. December 22, 1998 Order ("Order") (Declaration of Susan Bower ("Bower Decl."), Ex. 1). The new complaint is no different and no better. It is premised on the same improbable inferences and is just as lacking in particular facts as its predecessor.

First, the basic premise of the Complaint has not changed. Plaintiffs continue to allege that Vanstar's announcements of repeated delays in the anticipated roll-out of a new, one-of-a-kind in house computer system, NOVA, reflect not the vagaries of a new untried system but, rather, intentional fraud. Plaintiffs also continue to allege that the fact that Vanstar's Third Quarter¹ profit fell below Wall Street analysts' expectations reflects not the vagaries of a highly competitive and constantly changing market but, rather, intentional fraud. Finally, plaintiffs continue to allege that Vanstar's accounting was fraudulent. Plaintiffs assert that (1) Vanstar's decision, right before the IPO and the Class Period, to take a $31.1 million reserve (which had a decidedly negative impact) and (2) Vanstar's capitalization of NOVA costs violated GAAP -- even though Vanstar's auditors have never questioned either of these accounting judgments.

Second, the dearth of specific facts to support these improbable assertions -- the factor that doomed the prior compliant -- remains unremedied. As an initial matter, Plaintiffs still do not allege any facts showing that 14 of the 18 defendants even made any of the challenged statements or that non-party securities analysts' statements may be attributed to any defendant. Order at 4-5, 8-9. Moreover, plaintiffs still fail to set forth any factual basis for their allegations, instead relying on the "investigation of counsel," which they blithely assert is "likely" to be borne out "after reasonable opportunity for discovery." Id. at 7-8; SAC ¶154. Plaintiffs still fail to show why the challenged predictions concerning NOVA and future third and fourth quarter business prospects were false and known to be false when made, as the Reform Act's strict pleading standards require. Order at 8. Plaintiffs still fail to plead facts demonstrating the "reasons why" Vanstar's accounting judgments were material or in violation of GAAP. Order at 6, n.6. In addition, there is still no showing how the forward-looking statements that are central to this case could have misled investors about NOVA, or Vanstar's future financial performance, or business conditions such as supply and demand, given Vanstar's ample and repeated risk disclosures on this topic.

Although plaintiffs have now amended twice, and have had the benefit of extensive document discovery from Vanstar, Ernst & Young, and securities analysts (see February 5, 1999 Order (Bower Decl, Ex. 2)), plaintiffs have ignored this Court's directives and failed to cure the deficiencies of their prior complaints. Congress intended to hold plaintiffs to stringent pleading standards without the benefit of discovery. See Medhekar v. United States District Court, 99 F.3d 325, 328 (9th Cir. 1996) ("Congress clearly intended that complaints in these securities actions should stand or fall based on the actual knowledge of the plaintiffs rather than information produced by the defendants after the action has been filed."). Here, plaintiffs have not satisfied those standards even with discovery. Accordingly, the Complaint should be dismissed with prejudice.²

I. THE DEFENDANTS CANNOT BE LIABLE FOR STATEMENTS MADE BY OTHERS

A. The Non-Speaking Defendants Cannot Be Liable Under The Group Published Doctrine

As this Court previously recognized, in order to establish a Section 10(b) violation, plaintiffs must allege that the particular defendant made a misleading statement. Order at 4. See Neubronner v. Milken, 6 F.3d 666, 673 (9th Cir. 1993) (dismissing 10(b) claim where no false or misleading statement attributed to defendant). Plaintiffs still do not allege that defendants Kuntzendorf, Anderson, Laney, Moore, Manshouri, Sisson, Triant, Janeway, Vogelstein, Gross, Bard, or the Warburg entities made any statement. The Complaint therefore fails to state a claim against these defendants.

Nor may plaintiffs look to the "group pleading" doctrine to salvage their claims. First, after the Reform Act, which requires particularized facts to be pled with respect to each defendant, the continued viability of the doctrine is questionable. See 15 U.S.C. § 78u-4(b)(1), (2). As one of an increasing number of courts recently concluded:

[T]he continued vitality of the judicially created group-published doctrine is suspect since the [Reform Act] specifically requires that the untrue statements or omission be set forth with particularity as to "the defendant" and that scienter be plead in regards to "each act or omission" sufficient to give "rise to a strong inference that the defendant acted with the required state of mind." . . . To permit a judicial presumption as to particularity simply cannot be reconciled with the statutory mandate that plaintiffs must plead specific facts as to each act or omission by the defendant.

Allison v. Brooktree, 999 F. Supp. 1342, 1350 (S.D. Cal. 1998) ("Brooktree I").³

Second, and in any event, this Court has already ruled that plaintiffs' allegations are insufficient even under the group pleading doctrine. The Court previously rejected plaintiffs' allegations that "defendants directly or indirectly participated in the issuance of statements which were false and/or misleading," holding that "plaintiffs must plead with particularity defendants' participation in the day-to-day control of the corporation and their participation in the preparation of the allegedly false statements." Order at 4-5 (emphasis added). See also Wool v. Tandem, 818 F.2d 1433, 1440 (9th Cir. 1987). The Court also held that the group pleading doctrine "generally does not apply" to "shareholders such as the Warburg entities" and that "[p]laintiffs' conclusory allegations that the Warburg entities were controlling shareholders which had representatives on the Vanstar Board of Directors and therefore 'knew adverse non-public information' and 'directly or indirectly participated in the issuance of the statements which were false and/or misleading' (AC ¶ 37) are insufficient to state a claim under the Reform Act." Order at 5.

In response to the Court's prior ruling, plaintiffs offer only additional conclusory allegations such as that the non-speaking defendants (1) were "legally responsible for the . . . 'group published' information" (SAC ¶ 17); (2) were "'hands-on' managers" dealing with important issues facing Vanstar (id. ¶ 23); and (3) were "actively involved in Vanstar's management" (id. ¶ 24). These allegations are no more particular than those previously rejected by this Court. There are still no facts showing which defendants, if any, were involved in the preparation of which challenged statements and what exactly any one of them actually did. See Brooktree II, slip op. at 16 (rejecting identical allegations that non-speaking defendants were "hands on managers who dealt with important issues facing Brooktree's business").⁴ As to the Warburg entities, plaintiffs appear to have conceded the point    The Complaint contains no allegations that the Warburg entities participated in the preparation of any challenged statement.⁵

Accordingly, even if group pleading survives the Reform Act, the non-speaking defendants cannot be held liable because plaintiffs fail to plead particularized facts showing that each, or any, non-speaking defendant was involved in any challenged statements' preparation, approval or review. Order at 4-5. This time, these non-speaking defendants should be dismissed with prejudice.

B. The Defendants Are Not Liable For Third Party Analysts Statements

Just as before, plaintiffs seek to hold defendants responsible for numerous statements contained in reports published by analysts. This effort again fails. This Court previously held that "in order for defendants to be liable for statements made by analysts, plaintiffs must plead specific facts showing that defendants so entangled themselves in the analysts' statements so as to endorse them or adopt them as their own" and that "plaintiffs must (1) identify specific reports and the name of the insider who adopted them; (2) point to specific interactions between the insider and the analyst; and (3) set forth dates on which the interactions occurred." Order at 8-9. The Court also required that plaintiffs plead "and support with specific facts, that defendants 'knew the analysts' forecasts were unreasonable when they were issued.'" Order at 9-10. See also In re Caere Corp. Sec. Litig., 837 F. Supp. 1054, 1059 (N.D. Cal. 1993).⁶

Ignoring the Court's directive, plaintiffs have actually pleaded their entanglement allegations with less particularity than before.⁷ For example, plaintiffs previously alleged that the analysts' reports were written by "[the analyst], Tauscher and Rubin via communications in which a two-way flow of information occurred between them and they agreed upon the contents of the report." See, e.g., FAC ¶¶ 67, 78, 104, 119, 121, 126, 129, 130. Now, plaintiffs merely allege that the various analysts' reports were "based on information provided to __ by __." SAC ¶¶ 73, 83, 105, 120, 122, 124, 126, 127, 128.

In only four instances do plaintiffs even attempt to allege facts showing the requisite "two-way flow of information" (Caere, 837 F. Supp. at 1059) by alleging (1) that an analyst's report was provided to Rubin, Tauscher, and/or Amato, and (2) who then allegedly "commented" on the report.⁸ Compare SAC ¶¶ 78, 85, 89, 106 with FAC ¶¶ 72, 80, 85, 105. However, plaintiffs still fail to allege any factual particularity, such as what the alleged "comments" were, whether defendants allegedly accepted or rejected the analysts' conclusions, and whether defendants' alleged (but unspecified) comments were ever incorporated into the analysts' reports. As one court put it, "[p]laintiffs have refined their conclusory . . . allegations of entanglement by adding meaningless details." Stack v. Lobo, 903 F. Supp. 1361, 1372 (N.D. Cal. 1995). After receiving discovery from the analysts and from Vanstar, plaintiffs still fail to allege facts sufficient to attribute the analysts' statements to any defendant. These allegations should be dismissed.

II. THE COMPLAINT STILL FAILS TO PLEAD THE FACTUAL BASIS FOR ITS ALLEGATIONS

The Reform Act recognized that "[n]aming a party in a civil action for fraud is a serious matter." 15 U.S.C. 78u-4(b)(1); H.R. Conf. Rep. No. 104-369, 104th Cong., 1st Sess. at 41 (1995) ("Conf. Rep.") (Ex. 6).⁹ Because Congress found that Rule 9(b)'s requirement that fraud be pleaded with particularity "had not prevented abuse of the securities laws by private litigants" (Conf. Rep. at 41), the Reform Act adopted a new heightened standard for pleading fraud, requiring plaintiffs to have evidence of fraud before filing a complaint. Id. at 32. The Reform Act thus requires that a complaint based on information and belief, "shall state with particularity all facts on which that belief is formed." 15 U.S.C. 78u-4(b)(1) (emphasis added). In In re Silicon Graphics, Inc. Sec. Litig. ("Silicon Graphics II"), 970 F. Supp. 746, 763 (N.D. Cal. 1997) appeal docketed, No. 92-16240 (9th Cir. Nov. 19, 1997) Judge Smith interpreted this directive as requiring plaintiffs to plead all facts upon which information and belief allegations are made, including "names of confidential informants, employees, competitors, and . . . others who have provided information leading to the filing of the case."

In dismissing the prior complaint, this Court, like most others to address this issue, ruled that a complaint based upon "investigation of counsel" is the same as a complaint based "upon information and belief." Order at 7-8.¹⁰ Moreover, this Court, again like most others, held that plaintiffs' assertion that "after reasonable opportunity for discovery, substantial evidentiary support will likely exist for the allegations," was insufficient to satisfy the Reform Act's strict standards. Id.

Nonetheless, in the Complaint, plaintiffs again simply state that their "allegations [are] based on the investigation of counsel" and argue that discovery is likely to bear them out. SAC ¶ 154.¹¹ Despite discovery of over a hundred thousand pages of documents from Vanstar, Ernst & Young and non-party securities firms, the Complaint does not point to one specific internal document that supports plaintiffs' allegations that a single defendant knew that any of the challenged statements were false when made. Although plaintiffs allege that defendants issued false financial forecasts, plaintiffs do not point to a single specific internal forecast that differed from a public forecast. Similarly, although plaintiffs claim that NOVA was plagued with problems, they do not point to any internal reports that show this to be true or demonstrate that the alleged problems could not be timely resolved.

Indeed, plaintiffs make no effort to identify any information that supposedly supports any allegations pled in their Complaint. Plaintiffs merely lump together in a general way all the kinds of information (e.g., unidentified press releases and media reports) they supposedly reviewed without identifying which allegations were derived from which source. This tactic precludes the Court from determining whether any factual basis exists for any specific allegation.¹²

This is not a mere technical defect. It goes to the core issue under the Reform Act: do plaintiffs have a basis for their claim or is it all based on guesswork advanced with the "faint hope" that discovery might prove the guess to have been good? Conf. Rep. at 31. Where plaintiffs have already had the benefit of discovery, the Reform Act's information and belief pleading requirement should be applied with special rigor. Plaintiffs failure to allege a basis for their "belief" that a fraud occurred alone requires dismissal of this Complaint. Silicon Graphics II, 970 F. Supp. at 763-64.

III. PLAINTIFFS STILL FAIL ADEQUATELY TO PLEAD THE "REASONS" WHY THE ALLEGED MISSTATEMENTS WERE KNOWINGLY FALSE OR MISLEADING WHEN MADE

Like its predecessor, the Complaint alleges that Vanstar's forward-looking statements concerning the implementation of NOVA and the Company's third and fourth quarter financial prospects were false when made. Even before the Reform Act, plaintiffs were required to plead facts explaining why the failure to achieve predictions was due not to fate but to fraud. See In re Glenfed, Inc. Sec. Litig., 42 F.3d. 1541, 1549 (9th Cir. 1994) (en banc) ("plaintiffs must set forth facts explaining why the difference between the earlier and the later statements is not merely the difference between two permissible judgments, but rather the result of a falsehood.").

The Reform Act raised this already rigorous standard for pleading falsity. Thus, this Court directed plaintiffs to "specifically identify what information defendants had in their possession at the time the alleged statements or omissions were made to show knowledge of falsity. Order at 8 (emphasis in original). Plaintiffs do not satisfy this mandate.

A. The Complaint Still Fails Adequately To Plead "Reasons" Why the Challenged NOVA Statements Were False When Made

The Court's Order concerning pleading falsity with respect to the challenged NOVA statements is crystal clear:

[P]laintiffs allege that stress tests performed on NOVA had failed in fall 1995. FAC ¶ 66. Then, by inference, plaintiffs attempt to allege that defendants must have known this at the time frame for release of NOVA. See FAC ¶ 49, 55, 66. Plaintiffs must specifically plead what facts defendants had in their possession when they announced the purported time frame for release of NOVA that made the statements regarding release of NOVA false and misleading when made."

Order at 8. Again, no such facts are alleged.

1. The old allegations about NOVA fail

Plaintiffs continue to allege that Vanstar's predictions about the development and implementation of NOVA were false when made because Vanstar knew, but concealed from investors, a laundry list of "reasons" why NOVA could not be rolled out as planned. See SAC ¶¶ 69, 80, 97, 107, 115. Most of these allegedly omitted reasons are identical to those previously rejected by this Court. Compare SAC ¶¶ 69, 80, 97, 107, 115 with FAC ¶¶ 63, 74, 94, 106, 114.

For example, plaintiffs previously alleged that Vanstar's statements concerning NOVA were false when made was because:

VanStar's NOVA system was suffering from design deficiencies, hardware problems, serious software defects and operational problems which would prevent the effective operation and thus the deployment of that system for the foreseeable future;

[T]he design deficiencies, hardware bugs, software defects and operational problems with respect to the NOVA system were so substantial and serious that VanStar was unable to remedy them and they would delay the implementation and/or deployment of the NOVA system until at least mid-F98.

FAC ¶ 63(a-b). Although the Court held that these vague assertions about unspecified "bugs" and deficiencies failed to show that Vanstar knew it could not roll-out NOVA as planned, (Order at 8)¹³, plaintiffs now reallege these same supposed omissions:

Vanstar's NOVA system was suffering from design deficiencies, hardware problems, serious software defects, data conversion issues, and operational problems which would prevent the effective operation and deployment of that system for the foreseeable future;

NOVA's design deficiencies, hardware problems, software defects and operational problems were so substantial and serious that Vanstar was unable to remedy them and they would delay the implementation and/or deployment of the NOVA system until at least mid-F98;

SAC ¶ 69 (new allegations emphasized). See Appendix comparing the FAC's list of omissions to those in the SAC, with the few new allegations emphasized (Ex. 10). These virtually identical allegations add absolutely no factual detail and must be dismissed for the same reasons as before.

2. The new allegations about NOVA also fail

Although the new Complaint does contain a few seemingly specific allegations about NOVA, it is not the detail the Court required. SAC ¶¶ 28-34. While these few new allegations provide some evidence that some specific information about NOVA was known at some time, they still fail to identify which, if any, of the defendants, was aware of the information and its purported consequences (i.e., that NOVA could not be implemented as planned). In other words, these new allegations still fail to show that any prediction concerning NOVA's implementation was false when made. Order at 8.

Thus, although plaintiffs now allege that in November 1995 there had been "at least 8,500 hours of overrun" "due to scope changes, inefficiency, 'unnatural design', screw-ups, misses [and] rework" (SAC ¶ 28), there is nothing to indicate that five months later, when the class period began, these "screw ups" had not been resolved. Similarly, the allegations that "defendants" (which ones?) somehow "knew" (how?) "weeks" (how many?) before the IPO" that the system was "slow" and not "scaleable" are insufficient. SAC ¶¶ 30, 69. Even if defendants were shown to have known of these problems (which they are not), there is no showing that they knew they could not be fixed by the end of the then-predicted roll out period, e.g., by April 30, 1996.

Plaintiffs also allege that "[b]y early [19]96, Vanstar still had not completed critical tasks necessary to use the system," such as "converting . . . data," "selecting a reporting tool and creating the hundreds of reports NOVA was expected to generate" and "creating various software interfaces." SAC ¶ 29. These allegations fail for several reasons. First, there are no facts to indicate that any of these issues were apparent in "early 1996" as alleged.¹⁴ Second, there are no facts showing that Vanstar could not and knew it could not accomplish these tasks by April 30th. Third, there are no facts showing that the alleged failure to define every report or convert existing data was a material factor in NOVA's ultimate delay.

Instead, the Complaint itself points to the various factors that were much more likely to have caused the delays: (1) NOVA "would not run on an AS/400," the mainframe chosen by E&Y, NOVA's "creator" (SAC ¶¶ 28-31); (2) "E&Y had oversold its experience" (id. ¶ 31); and "E&Y did not know how to solve the problem (id., emphasis added)." And, the Complaint itself acknowledges that these factors (E&Y's lack of experience and lack of solutions) were not identified until a March 28, 1996 Board meeting - after the IPO. (Id. ¶¶ 28, 31). The only inference, if any, to be drawn, is that prior to that date, and prior to the IPO, E&Y had sung a different "don't worry, we can do it" sort of tune.

In sum, despite extensive document discovery from Vanstar and complete document discovery from E&Y (the "creator" of NOVA), the Complaint still fails to identify a single internal, contemporaneous document showing when senior management learned that "problems" with NOVA were "substantial and serious" and that they could not be remedied in the then-expected time frame for NOVA implementation. Indeed, the only clues provided by the Complaint indicate that Vanstar did not learn of such issues until "after" the IPO (id. ¶31) and repeatedly disclosed delays promptly after the nature and fact of problems were known and understood. SAC ¶¶ 31, 33, 72, 90.

3. Disclosed delays in a new system do not give rise to an inference of fraud

Courts have consistently held that where a new product or operation is being deployed, the fact that bugs -- and resulting delays -- occur does not transmute predictions about expected completion dates or performance into fraud. See May v. Borick, [Current Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 99,438, at 96,878 (C.D. Cal. Mar. 3, 1997) (fact that corporation knew of problems that ultimately resulted in delays in implementing its "state-of-the-art" chrome-plating plant, did not amount to fraud; "knowledge of problems does not make predicting an end to those problems fraud.").¹⁵ Rather, plaintiffs must come forward with evidence creating a strong inference that defendants actually knew¹⁶ those bugs or snags rendered their predictions impossible to achieve.¹⁷

Despite discovery, plaintiffs can point to no such facts. There are simply no facts showing that the problems that ultimately led to NOVA's delay were known -- or that their import was understood -- when earlier predictions were made. Instead, plaintiffs' own allegations are inconsistent with any inference of fraud. Those allegations show the Vanstar repeatedly announced delays in NOVA's implementation every time it became clear that it would not be possible to roll out the system within the previously announced time frame. See, e.g., SAC ¶¶ 31, 72 (alleging discussions regarding possible solutions to NOVA issues in April and June of 1996 and the May 13, 1996 announcement disclosing that NOVA deployment would be delayed from the end of April, 1996 to September, 1996); id. ¶¶ 33, 90 (alleging various NOVA issues during July through September, 1996 time frame and the August 27, 1996 announcement disclosing NOVA implementation would be delayed from September, 1996 to April, 1997). Plaintiffs again plead no "facts" and cannot even offer any plausible explanation why Vanstar, which voluntarily, candidly and repeatedly updated the market about NOVA's implementation status would not be motivated to get it right.

In sum, plaintiffs' new (and old) allegations concerning NOVA do not show that defendants' stated expectations concerning NOVA's implementation were false -- and known to be false -- when made. Order at 8. The NOVA claims should be dismissed.

B. The Complaint Still Fails To Plead The "Reasons" Why Predictions Regarding Vanstar's Third and Fourth Quarter Earnings Were False When Made

1. The old conclusory allegations still fail

Plaintiffs continue to allege that defendants made false forecasts about Vanstar's earnings prospects for the Third and Fourth Quarters of fiscal 1997 (November 1996 - March 1997). Plaintiffs allege that defendants' predictions were false because defendants failed to disclose certain information concerning Vanstar's business. See SAC ¶ 69, 80, 97, 107, 115. Just as with the NOVA allegations, the vast majority of these so-called "reasons" why Vanstar's forecasts were false when made are repleaded verbatim from the prior complaint. Plaintiffs again allege NOVA costs were increasing while benefits were decreasing (SAC ¶¶ 80, 97, 107, 115); SG&A expenses were not under control (id.); product demand was decreasing and growth was slow in Vanstar's service business (id.); and Vanstar was suffering from supply constraints (id.). See also Appendix A (comparing allegations in FAC to those in SAC). These defective allegations fail for the same reasons as before.

First, plaintiffs fail to plead with particularity why the alleged conditions would preclude Vanstar from meeting its alleged forecasts or were not already factored into Vanstar's forecasts. See Howard Gunty Profit Sharing v. Quantum Corp., No. 96 20711 SW, 1997 WL 514993, at *6-7 (N.D. Cal. Aug. 14, 1997) (Ex. 11) (complaint "does not plead with particularity why these canceled orders precluded Defendants from anticipating certain levels of sales")¹⁸. Second, many of the factors which supposedly rendered unspecified forecasts false were disclosed during the class period. See SAC ¶ 70 (disclosing supply constraints); ¶ 134 (citing Forms 10-Q for quarter ending January 31, 1997 and October 31, 1996, disclosing that SG&A expenses had increased in those quarters from the same quarters in the prior year to 11.5% from 10.2% and to 10.9% from 10.5%, respectively) (Exs. 12 & 13). Third, certain of these factors, such as shifts in consumer demand or a decline in other markets affecting the Company's products or services, are the result of external factors, beyond the Company's control. Such "intervening catastrophic events," do not support an inference of fraud as a matter of law. See Glenfed, 42 F. 3d at 1548; May v. Borick, Fed. Sec. L. Rep. at 96,872 (allegations that a "decline in demand" for product had a "significant and material adverse impact" on defendants' business point to external factors beyond defendants control and thus "undercut a claim for securities fraud").

2. The new conclusory allegations fail

In the Complaint, plaintiffs make some attempt to bolster their claim that defendants made false financial forecasts. First, plaintiffs allege defendants faxed projections to analysts before the IPO that projected NOVA cost benefits of $800,000 and $9.4 million in fiscal 1996 and 1997, respectively which, as a result of NOVA's test failures in late 1995, they "knew" NOVA would not achieve.¹⁹ SAC ¶ 39. Second, plaintiffs allege that Vanstar's rebate program with IBM would have a "potential $8-12 million impact on Vanstar's gross margins" when it expired at the end of second quarter 1997. Id. ¶ 41, 97. Finally, plaintiffs allege that defendants knew in November of 1996 that sales to Microsoft were below budget and that demand from Microsoft was softening. Id. ¶¶ 42, 107, 115.

These new allegations, however, still fail to state a claim. As to NOVA, (SAC ¶39), there are no allegations that in February 1996, when the alleged projections reflecting NOVA benefits were purportedly faxed to analysts, defendants knew of any "bugs" or that their existence would impact NOVA's implementation. See Section III.A., supra. Moreover, there are no facts showing: (1) which analyst received the alleged forecast, or (2) from whom, or (3) that this alleged forecast was ever publicly disclosed or incorporated in any analysts' report. See Section I.B., supra.

As to the Microsoft allegation, there is only the unsupported assertion -- but no factual support -- that sales to Microsoft were below budget and demand was soft. In any event, there are no facts demonstrating that a "softening" of sales from Microsoft would or did materially impact third and fourth quarter earning projections.

Moreover, it goes without saying that plaintiffs' uncorroborated speculation is not sufficient to show that any of these factors -- NOVA, IBM or Microsoft -- would have a material adverse impact on Vanstar's third and fourth quarter results or that they were not already factored into Vanstar's predictions. See Hockey v. Medhekar, [1997 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 99,465, at 97,075 (N.D. Cal. April 14, 1997) (dismissal of false forecasting allegations warranted were no facts alleged demonstrating projections were false when made).²⁰

Despite discovery, plaintiffs still do not point to any internal third or fourth quarter forecast that was inconsistent with any public forecasts, much less an internal forecast that was inconsistent with defendants' public forecasts due to an assessment of NOVA, or SG&A costs, or supply or demand from Microsoft. In other words, plaintiffs make no effort to demonstrate that any forecast was known to be false. Accordingly, these allegations are insufficient and must be dismissed.

IV. THE CHALLENGED FORWARD-LOOKING STATEMENTS --THE CORE OF THIS CASE--ARE NOT ACTIONABLE AS A MATTER OF LAW

All of the statements plaintiffs challenge about NOVA's implementation and benefits and third and fourth quarter earnings were forward-looking predictions at the time they were made. None of these forward-looking predictions are actionable as a matter of law. Under both the Reform Act's safe harbor and the "bespeaks caution" doctrine, Vanstar's specific warnings of the risks which ultimately materialized in the third and fourth quarters refute any claim that other statements were misleading.

The Reform Act established a safe harbor for forward-looking statements "to encourage issuers to disseminate [this] relevant information to the market without fear of open-ended liability." Conf. Rep. at 44. Under the safe harbor, when a company provides meaningful cautionary statements concerning the risks that predictions may not be achieved, as a matter of law, it cannot be held liable if those predictions do not come to pass. 15 U.S.C. §78u-5(c)(1)(A).²¹

Even before the Reform Act, the Ninth Circuit (and almost all others) embraced the "bespeaks caution" doctrine, routinely rejecting allegations that a company's optimistic predictions were misleading where the documents cited in the complaint revealed that the risks were disclosed. The essence of the bespeaks caution doctrine is that if a company warns investors in a meaningful way of the risks facing its business, investors cannot claim that they were misled as a matter of law. See In re Stac Elecs. Sec. Litig., 89 F.3d 1399, 1405 (9th Cir. 1996), cert. denied, 520 U.S. 1103 (1997) (affirming dismissal; statement must be misleading "in light of all the information then available to the market").²²

A claim for fraud cannot lie in this case for a fundamental reason: Vanstar's forward-looking statements were tempered by contemporaneous, meaningful disclosures of the very risks plaintiffs allege came to pass. As shown below, from the outset of the class period, Vanstar repeatedly warned of the very risks plaintiffs claim were concealed.

The IPO Prospectus²³ contained specific risk factor disclosures about the implementation and benefits of NOVA and Vanstar's business prospects. SAC ¶ 60. The Prospectus presented a six and one-half page section titled "Risk Factors," (id. at 7-13), many of which were repeated elsewhere in the document.²⁴ With respect to NOVA, the Prospectus warned three times that:

The Company has developed proprietary automated systems to enhance the delivery of its services. No assurance can be given that the Company's automated systems will function as anticipated, will result in lower costs to the Company or its customers or will not be rendered obsolete as a result of technological change.

Prospectus at 10, 28, 31-32.²⁵

Plaintiffs also complain that Vanstar did not disclose that it was experiencing difficulty in "obtaining a sufficient supply of computer hardware products to meet customer demand...." SAC ¶¶ 80, 97, 107, 115. However, the Prospectus specifically warned that Vanstar "historically has experienced significant revenue fluctuations because of shortages of supply from certain vendors. . . . In addition, the general availability of certain products, particularly state of the art computing and data communications products, is occasionally restricted [and] any such shortages in the future could have a material adverse effect on the Company." Id. at 10. Vanstar further cautioned:

There can be no assurance that vendors will be able to maintain an adequate supply of products to fulfill the Company's customer orders on a timely basis. The Company has experienced product supply shortages in the past and expects to experience such shortages from time to time in the future. Failure to obtain adequate product supplies or fulfill customer orders on a timely basis could have a material adverse effect on the Company's business, financial condition and results of operation.

Id. (emphasis added).

Plaintiffs also contend that Vanstar did not disclose that its networking services business was not growing as fast as anticipated, or fast enough to remedy the shortfalls in the hardware reseller business. See, e.g., SAC ¶¶ 80, 97, 107, 115. The Prospectus, however, also warned of this risk:

The Company has recently increased the focus of its business on the provision of network services and the Company expects to derive an increasingly larger portion of its operating income from the provision of services. The Company only recently began generating operating income from the provision of services and the Company's products revenue as a percentage of total revenue has been declining in recent periods. If the Company is not successful in implementing its strategy of focusing on sales of services, the Company's operating margins could decline and its ability to maintain profitability could be materially adversely affected. There can be no assurance that the Company will be able to sustain profitability on a quarterly or annual basis in the future.

Prospectus at 7-8 (emphasis added).

Vanstar's cautionary warnings did not stop at the IPO. Vanstar consistently updated its disclosures to keep investors apprised of NOVA's changing schedule and changes in supply and demand. See, e.g., SAC ¶ 72 (May 13, 1996 Computer Reseller article allegedly stated that deployment of the second part of NOVA would not occur until September 1996) (Ex. 17); ¶ 90 (August 27, 1996 Vanstar press release pushing back NOVA's completion date to after the class period) (Ex. 18); ¶ 70 (citing April 15, 1996 Computer Reseller News article allegedly stated that Vanstar was experiencing supply constraints) (Ex. 19); ¶ 102 (alleging that defendants stated on October 18, 1996 that "product supply from manufacturers was not keeping up.").

Plaintiffs also contend that Vanstar's 1996 Annual Report falsely stated that the Company "expect[ed] continued and substantial growth in both revenues and profitability," based on the potential success of NOVA and other corporate initiatives. SAC ¶ 82. In that Annual Report (Ex. 20), however, Vanstar presented the following safe harbor warning:

With the exception of historical information, this Annual Report includes certain forward-looking statements that involve risks and uncertainties. Among the risks and uncertainties to which the Company is subject are the Company's substantial indebtedness, the fact that the Company is indebted primarily to a single creditor, the Company's relationship to and business dealings with and with regard to Merisel FAB, Inc., product life cycles, technological change, the Company's relationship with its significant customers, intense price competition in the Company's markets, and the Company's dependence upon its key vendors. As a result, the actual results realized by the Company could differ materially from the statements made herein.

Plaintiffs further assert that Vanstar's December 2, 1996 announcement of second quarter earnings did not warn investors of the risks to success in the third quarter. SAC ¶ 108. The December 2 press release (Ex. 21), however, presented the following safe harbor warning:

This press release contains certain forward-looking statements that involve risks and uncertainties, including the risks that the business trends referred to herein may not continue and that Vanstar may not realize the full benefits contemplated by the refinancing plan referred to herein. Recipients of this press release are cautioned not to place undue reliance on the forward-looking statements made herein. (Emphasis added).

In light of these ample risk disclosures and cautionary warnings, the bespeaks caution doctrine -- which applies to all of the documents in question, including the prospectus -- and the Reform Act's safe harbor provision -- which applies to all forward looking statements made after the IPO -- render it impossible for plaintiffs to claim that Vanstar's forward-looking statements were misleading. Vanstar did not hide that it might experience problems concerning NOVA or that its general optimism about future financial growth might not be achieved. Rather, the repeated meaningful and cautionary disclosures throughout the class period made it crystal clear to the investment community that the Vanstar's expectations regarding NOVA and its financial future were subject to the very same business risks plaintiffs now claim were concealed. Accordingly, plaintiffs' claims must be dismissed on this basis as well. See Order at 6, n.7 (reserving decision on this point).

V PLAINTIFFS FAIL TO PLEAD FACTS SHOWING THAT VANSTAR'S ACCOUNTING WAS INCORRECT

A. The Merisel Accounting Allegations are Still Conclusory and Nonsensical

Plaintiffs again challenge Vanstar's disclosure in its IPO Prospectus concerning a $31.1 million provision against receivables due from Merisel, a provision that was reflected in Vanstar's financial statements for the quarter ended January 31, 1996 -- before the class period and before Vanstar went public. SAC ¶¶ 62-63. Although plaintiffs now purport to have supplied the "reasons" why Vanstar's accounting for the Merisel contingency violated GAAP and Section 10(b), the proffered "reasons" make no sense.

Plaintiffs allege that Vanstar improperly accounted for the Merisel transaction because it failed to disclose (1) that Merisel had renegotiated a retroactive reduction of the fees owed under its distribution service agreement with Vanstar and (2) $3.5 million of the $31.1 million reserve reflected the reversal of revenue previously recognized under the distribution agreement. SAC ¶ 62. Plaintiffs also allege that, given the fact that Merisel had expressed its desire to renegotiate the distribution service agreement six months earlier, Vanstar's recognition of revenue under that agreement in 1995 (before the Company went public) was somehow improper. Id. ¶ 63.

These allegations fail for a number of reasons. First, the IPO Prospectus actually disclosed (1) the renegotiation of the Merisel distribution service contract and (2) the fact of a retroactive reduction in the distribution fee, which, resulted in a reversal of certain pre-IPO (and pre-Class Period) revenue. The Prospectus disclosed "Effective as of January 31, 1996, the Company and Merisel FAB signed amendments to the asset purchase agreement and the distribution service agreement. The amendments provide that : . . . the distribution fee be reduced retroactive to April 1, 1995; . . ." Prospectus at F-18. Because Vanstar was not a public company until the IPO, it had no duty to disclose this information at any earlier point in time.²⁶

Second, plaintiffs do not plead how or why Vanstar's recognition of revenue in 1995 under the as-yet-unamended distribution service agreement amounts to fraud. Nor do they identify a single accounting principle violated by Vanstar's recognition of revenue under the distribution service agreement or its booking of the $31.1 million reserve for the extended credit. See In re Ross Systems Sec. Litig., [1994-95 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 98,363, at 90,498 (N.D. Cal. July 21, 1994) (granting motion to dismiss; plaintiff must allege accounting principle violated and facts constituting the violation). Thus, plaintiffs have not alleged facts showing that Vanstar's accounting was false at the time the Company published its statements in the IPO Prospectus.

Third, even if these pre-IPO quarters are somehow relevant, which they are not, plaintiffs fail to allege that Vanstar's decision to take the $31.1 million reserve for the Merisel contract or to renegotiate the agreement and reverse pre-IPO revenues, was due to fraud, rather than management's sound business judgment. See Stack v. Lobo, No. 95-20049-SW, 1995 WL 241448, at *4-5 (N.D. Cal. Apr. 20, 1995) (Ex. 23) (dismissing allegations based on company's decision to decrease accounts receivable reserve); Seigel v. Lyons, [1995-96 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 99,227, at 95,223 (N.D. Cal. Apr. 26, 1996) (dismissing allegations based on company's alleged failure to increase accounts receivable reserve; "no reason to suspect that the changes in these reserves were based on anything other than a permissible business judgment").

Indeed, Vanstar's accounting for the Merisel transaction was very conservative. After Merisel made a public announcement concerning its troubled financial condition, Vanstar reserved the full amount of its extended credit due from Merisel and reversed pre-class period revenues. This approach which negatively impacted Vanstar's financial statements, taken right before Vanstar went public and disclosed in the Prospectus, is inconsistent with any theory of fraud.

B. The NOVA Accounting Allegations Fail

Plaintiffs have added a new accounting allegation: that Vanstar improperly capitalized costs associated with developing NOVA in three quarters of fiscal 1997. SAC ¶¶ 133-140. Plaintiffs allege that because NOVA was "unsuccessful" and "did not and would not have future economic benefit" Vanstar should have written off capitalized costs related to the NOVA project or not capitalized those costs in the first place. Id. ¶139.

These NOVA accounting allegations fail for the same reason as plaintiffs' other NOVA allegations: plaintiffs do not allege that Vanstar knew during the class period that NOVA would not have future economic benefit. See Section III.A., supra. See also Leonard v. NetFRAME Sys., Inc., [1995-1996 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 98,982, at 93,779-80 (N.D. Cal. Aug. 8, 1995) ("To survive a motion to dismiss, plaintiffs cannot simply allege that specific accounting practices were violated without also providing specific underlying facts to support the allegations."). If anything, Vanstar's accounting for NOVA demonstrates that -- at that time -- Vanstar believed NOVA would result in "future economic benefits," as originally predicted. This new accounting allegation is simply a red herring lacking factual or legal support.

VI. THE COMPLAINT FAILS TO PLEAD SPECIFIC FACTS GIVING RISE TO A STRONG INFERENCE OF SCIENTER

To state a claim under the Reform Act, a complaint must contain "specific concrete facts" which give rise "to a strong inference that the defendant acted with the required state of mind," with respect to each alleged misstatement or omission. 15 U.S.C. § 78u-4(b)(2). See also Coates, 26 F. Supp. 2d at 916; Blum v. Semiconductor Packaging Materials Co., Inc., No. C.A.97-7078, 1998 WL 254035, at *3 (E.D. Pa., May 5, 1998) (Ex. 24). In enacting this standard, Congress repudiated prior Ninth Circuit law and found that even the Second Circuit's "strong inference" standard -- the most rigorous in the nation -- was not strong enough. Congress expressly rejected the "motive and opportunity" portion of the Second Circuit standard. See Silicon Graphics II, 970 F. Supp. at 757.²⁷

Instead, for forward-looking statements, like the majority of those challenged here, plaintiffs must allege facts creating a "strong inference" that a defendant had actual knowledge of the falsity of a statement. 15 U.S.C. § 785(c)(1)(B)(i). See also Hockey v. Medhekar, 30 F. Supp. 2d 1209, 1221 (N.D. Cal. 1998) (same); Harris, 998 F. Supp. at 1454-55. For all other statements, such as plaintiffs' claims of accounting fraud, plaintiffs must plead facts showing a "strong inference" that each defendant acted knowingly or recklessly. Coates, 26 F. Supp. 2d at 916; Brooktree I, 999 F. Supp. at 1351.

A. Plaintiffs Fail to Raise A Strong Inference Of Scienter

Because plaintiffs have not alleged facts establishing falsity concerning Vanstar's financial statements and predictions concerning NOVA and third and fourth quarter earnings, a fortiori, plaintiffs have not established that defendants knew those statements were false when made. Order at 8, n.10; Polk v. Fritz, No. 962712 MHP, slip op. at 20 (N.D. Cal. Mar. 5, 1998) (Ex. 25) (same). Plaintiffs' vague allegations that defendants were "actively involved in Vanstar's management" (SAC ¶ 24); "actually knew from internal corporate documents and conversation with other corporate officers and employees . . . the adverse non-public information" (id. ¶ 26); and "received frequent reports" and "closely monitored" the company's business (id. ¶ 27) are too conclusory to raise a "strong inference" of actual knowledge by each defendant. See Section II, supra. See Coates, 26 F. Supp. 2d at 921 ("plaintiffs must provide more details about the alleged negative internal reports, such as report titles, when they were prepared, who prepared them, to whom there were directed, their contents, and the sources from which plaintiffs obtained this information."); In re Silicon Graphics, Inc. Sec. Litig., [1996-97 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 99,325, at 95,966 )(N.D. Cal. Sept. 25, 1996) (rejecting similar allegations that defendants were aware of "negative internal reports"). Because plaintiffs fail to identify any specific information available to defendants showing that the challenged statements were false when made, plaintiffs fail to raise a strong inference of scienter as required by the Reform Act.

B. Senior Managements' Failure to Sell Any Stock Refutes Any Inference Of Fraud

Even under the now rejected "motive and opportunity" test, plaintiffs fail to plead facts giving rise to any inference of fraud. This is because Vanstar's three most senior officers Tauscher, Amato and Rubin -- the officers alleged to have made all of the challenged statements -- did not trade in Vanstar stock.²⁸ Tauscher alone owned over 2,000,000 Vanstar shares and options during the class period. Defendants Tauscher, Amato and Rubin all suffered significant losses when Vanstar's stock price declined. See 1997 Form 14A, filed with the SEC on August 11, 1997 at 4-7 (Ex. 26). It makes no sense that they would purposely mislead the market knowing the "truth" would come out shortly, yet not capitalize by the purported fraud. Brooktree I, 1998 WL 151787, at *10 (fact that defendant alleged to have made misstatements did not sell stock negates an inference of scienter). In re Health Mangm't Systems, Inc. Sec. Litig., [1998 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 90,235 (S.D.N.Y. June 1, 1998) (fact that senior officers did not sell stock negates inference of scienter).

Moreover, the fact that none of the senior executives alleged to have made false statements sold their stock refutes any inference of scienter with respect to the remaining defendants as well. Courts have consistently held that "the sale of stock by one company executive does not give rise to a strong inference of a company's fraudulent intent; the fact that other defendants did not sell their share during the relevant class period sufficiently undermines plaintiffs' claim" of scienter. San Leandro Emergency Med. Group Profit Sharing Plan v. Phillip Morris Cos., 75 F.3d 801, 814 (2d Cir. 1996); Myles v. Midcom Comm., Inc., No. C96-6140, slip op. at 17 (W.D. Wa. Nov. 19, 1996) (Ex. 27) (same); See also In re Cypress Semiconductor Sec. Litig., [1992 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 97,060, at 94,697 (N.D. Cal. Sept. 23, 1992) (although three directors traded, the Company's president's "failure to sell [his] stock, undermines plaintiffs' theory that defendants artificially inflated the price of Cypress stock so that they could sell [it] at a huge profit.").

C. Neither Vanstar's Desire To Raise Capital Nor Its Acquisitions Strategy Creates A "Strong Inference" Of Scienter

Plaintiffs assert that Vanstar's desire to conduct its IPO and raise capital to reduce debt and acquire more profitable entities gives rise to a strong inference of scienter, i.e., a "motive" to inflate the price of Vanstar's stock. SAC ¶¶ 45-51. Courts have consistently rejected similar allegations as insufficient. See, e.g., Chill v. Gen'l Electric Co., 101 F.3d 263, 268, n.5 (2d Cir. 1996); San Leandro Emergency Med. Group Profit Sharing Plan v. Philip Morris Cos., 75 F.2d 801, 814 (2d Cir. 1996) (allegations of company's desire to complete bond offering and maximize ongoing marketability of debt securities held insufficient to plead scienter); In re Health Management Systems, Inc. Sec. Litig., Fed. Sec. L. Rep. at 91,019 (a "[d]esire to consummate [a] corporate transaction does not constitute a motive for securities fraud"); In re Crown America Realty Trust Sec. Litig., No. CIV. A 95202J, 1997 WL 599299, at *25 (W.D. Pa. Sept. 15, 1997) (Ex. 30) (allegations of "desire to improve [defendant's] financial picture to enhance its ability to finance further capital improvements" held insufficient to plead scienter). This Court should do the same.

Defendants respectfully urge the Court to dismiss the Complaint without leave to amend. Although plaintiffs were given access to substantial discovery and detailed instructions from this Court, the deficiencies of their Complaint remain. Plaintiffs are unable to plead fraud here because there was no fraud. Accordingly, this Court should end this litigation now.

¹ Vanstar's fiscal year runs from May 1 to April 30. Its 1997 fiscal quarters are as follows: First Quarter (May 1 - July 31, 1996); Second Quarter (August 1 - October 31, 1996); Third Quarter (November 1, 1996 - January 31, 1997); Fourth Quarter (February 1 - April 30, 1997).

² Because plaintiffs fail to state a claim for primary violation of the securities laws, their section 20(a) claim for secondary control person liability also fails. In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1428 n.9 (9th Cir. 1994); O'Sullivan v. Trident Microsystems, Inc., [1993-1994 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 98,116, at 98,902 (N.D. Cal. Jan. 31, 1994).

³ See also, e.g., Allison v. Brooktree ("Brooktree II"), No. 97-CV-0852TW (POR), slip op. at 16 (S.D. Cal. Nov. 27, 1998) (Ex. 3) (same); Coates v. Heartland Wireless Comm., Inc., 26 F. Supp. 2d 910, 916 (N.D. Tex. 1998) ("Any remnant of the group pleading presumption that remained . . . before enactment of the PSLRA did not survive it."); In re Home Health Corp. of Am. Sec. Litig.,[Current Tr. Binder] Fed. Sec. L. Rep ¶ 90,414, at 91,863 (E.D. Pa. Jan. 29, 1999) (same).

⁴ See also Brooktree I, 999 F. Supp. at 1351 (it is unreasonable to presume that a company's officers "had either direct or indirect involvement with the preparation or communication of information outside their respective fields of expertise and spheres of influence") (Ex. 3); Head v. Netmanage, Inc., No. C97-4385 CRB, slip op. (N.D. Cal. Feb. 24 1998) (Ex. 4) (dismissing claims).

⁵ Plaintiffs' attempt to replead a theory of liability against the non-speaking defendants based on allegations that the defendants participated in a "scheme" fails. SAC ¶¶ 20-21. The Court squarely rejected nearly identical allegations last time. Order at 5, n.4.

⁶ See also In re Yes! Entertainment Corp. Sec. Litig., No. 97-01388 CRB, slip op. at 2 (N.D. Cal. May 15, 1998) (Ex. 5) (dismissing claims based on analysts' statements for failing to plead entanglement with particularity); Head v. Netmanage, Inc., supra., slip op. at 1 (same). Moreover, the Complaint still fails to allege a single specific fact indicating that defendants "knew that the analysts' forecasts were unreasonable when they were issued." Wenger v. Lumisys, Inc., 2 F. Supp. 2d 1231, 1249 (N.D. Cal. 1998); Caere, 837 F. Supp. at 1060. See also, Section III.B., infra.

⁷ For example, plaintiffs had previously alleged with greater specificity the communication allegedly giving rise to the analyst report in SAC ¶ 89. In the FAC, plaintiffs had previously alleged that Tauscher, Rubin and Amato spoke with the analyst from Alex. Brown and had detailed the information allegedly provided to him by defendants to include in his report. FAC ¶ 84. The detail of this alleged conversation has been entirely deleted from the current Complaint.

In other instances, plaintiffs have merely repeated the exact entanglement allegations as in the FAC. Compare SAC ¶¶ 103, 104, 123 with FAC ¶¶ 102, 103, 124.

⁸ Plaintiffs make a slight, non-substantive change to other paragraphs. Previously, plaintiffs alleged that defendants held conference calls with analysts and that subsequent analysts' reports were based on these conference calls and unspecified other conversations with defendants. Plaintiffs now instead allege that defendants had "follow up" conversations with certain analysts following the conference calls and that the analysts' reports were now based on the conference calls and the alleged, unspecified follow up conversations. In other words, plaintiffs now characterize the unspecified "other" conversations with analysts as "follow up" conversations with analysts. Compare SAC ¶¶ 65, 66, 67, 75, 76, 79, 100, 101, 109, 110, 111, 112, 114 with FAC ¶¶ 59, 60, 70, 73, 110, 111, 112, 113. See Brooktree II, slip. op. at 8-12 (rejecting identical allegations of "follow up" conversations).

⁹ The Conference Report is the authoritative statement of legislative intent. Northwest Forest Resource Council v. Glickman, 82 F.3d 825, 835 (9th Cir. 1996) ("[A] congressional conference report is recognized as the most reliable evidence of congressional intent because it represents the final statement of the terms agreed to by both houses.") (citation omitted).

¹⁰ See also Howard Gunty Profit Sharing v. Quantum Corp., No. C9620711 SW, slip op. at 7-8 (N.D. Cal. April 6, 1998) (Ex. 7) ("investigation of counsel" same as pleading on "information and belief"); In re Yes! Entertainment, No. 97-01388 CRB slip op. at 1 (Ex. 5); Silicon Graphics II, 970 F. Supp. at 763.

¹¹ Just as before, the majority of plaintiffs' allegations are tied to the statement in paragraph 154 (FAC ¶ 160), citing "investigation of counsel as the only basis for complaint's allegations." See Order at 7, n.8.

¹² Plaintiffs' reluctance to plead the basis of their allegations may be as simple as the "facts" do not support an inference of fraud. While defendants and the Court are left to guess at the basis for the allegations, certain allegations appear to be verbatim from documents produced by Ernst & Young in the state court action. For example, certain "new" NOVA allegations appear to be lifted from an E&Y document entitled "Vanstar Nova Implementation" (document no. EYH 007110-007119) (Ex. 8). See SAC ¶¶ 29, 34, 36 (that cleanup of data for 8000 customers had not been completed as of early 1996; and that as of October 1996 NOVA bridge was still unstable). Plaintiffs' Complaint suggests that defendants knew this information before Vanstar's IPO and private placement offering in March and October 1996, respectively. Id. However, while the E&Y document is not dated, its contents makes clear that it was prepared sometime after January 1997 -- well after any of the challenged statements were made. See EYH 007112 (referencing a January 7 status meeting in the past tense). This document, thus, absolutely fails to support any inference of fraud by Vanstar. If this document is indeed the "basis" of plaintiffs' new NOVA allegations, plaintiffs have taken great liberty in interpreting when it was created and to whom it was distributed. At bottom, because plaintiffs fail to allege the basis for their allegations, defendants and the Court are left guessing.

¹³ See also See Genna v. Digital Link, 25 F. Supp. 2d 1032 (N.D. Cal. 1997) (Ex. 9) (allegations that product was encountering "serious problems" and had "design and software problems" were too general).

¹⁴ See footnote 12, supra.

¹⁵ See also Wallace v. Systems & Computer Tech. Corp, [Current Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 99,578, at 97,873 (E.D. Pa. Sept. 23, 1997) (even where company had defects in key software product, "[a]s long as they did not know that the defect in the software was fatal to the product, they were entitled to assume business would pick up when they fix[ed] the problem"); Brooktree II, slip op. at 7, 8 (allegations that defendants' new software experienced "severe compatibility and stability problems" held insufficient to show that earlier predictions concerning software were false when made).

¹⁶ See Section VI, infra, explaining that "actual knowledge" of fraud is the standard for forward-looking statements such as those about NOVA.

¹⁷ See In re Apple Computer Sec. Litig., 886 F.2d 1109, 1115 (9th Cir. 1989) (evidence showing that two weeks before challenged statement were made, executives were warned that reliability problems with newly developed disk-drive (Twiggy) would require Apple to delay introduction of the Lisa computer).

¹⁸ See also Rubin v. Trimble, No. C-95-4353 MMC, 1997 WL 227956, at *14 (N.D. Cal. Apr. 28, 1997) (Ex. 14) (allegations that defendants knew of business slowdown and parts shortages insufficient to plead fraud because these allegations did not explain "why the [forecasted earnings] ultimately could not be met, despite the [alleged] problems.").

¹⁹ Plaintiffs also allege that in 1995 Vanstar "reduced-down" NOVA's functionality and knew that this less-functional system "would not provide the benefits to Vanstar's bottom line and future financial performance that Vanstar had repeatedly promised to analysts." SAC ¶ 28. However, there are no allegations that Vanstar's predictions regarding cost savings (made months later) were based on anything but the "reduced functional" version of NOVA that was ultimately developed by E&Y. While plaintiffs attempt to inject something sinister, it is not surprising -- or unusual -- that an idea conceived in 1994 was modified and refined during its years of development.

²⁰ See Fisher v. Acuson Corp., No. C 93-20477 RMW (EAI), 1995 WL 261439, at *6 (N.D. Cal. April 26, 1995) (Ex. 15) (allegations that company faced slowdown in European sales insufficient because plaintiffs had "not shown why these problems . . . precluded . . . [the company] from anticipating that international sales growth rate would outpace domestic sales growth").

²¹ See Harris v. Ivax Corp., 998 F. Supp. 1449, 1454-55 (S.D. Fla. 1998) (dismissing complaint on ground that defendants had provided sufficient cautionary statements: "It is sufficient that the cautionary statements identify meaningful and important factors that could affect future performance."); Rasheedi v. Cree Research, Inc., [1997 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 99,566, at 97,817 (M.D.N.C. Oct. 17, 1997) (dismissing complaint on ground that adequate cautionary statements were provided: "Defendants must identify significant factors that may cause results to materially differ--but not all factors.").

²² Shuster v. Symmetricon, Inc., [1997 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 99,437, at 96,867 (N.D. Cal. Feb. 25, 1997) ("There can be no liability under the securities laws, as a matter of law, where meaningful and specific cautionary disclosures are made regarding the subject matter of the alleged misrepresentation.").

²³ While the Reform Act's safe harbor does not apply to statements made in the Prospectus (15 U.S.C. § 78u-5(b)(2)(D)) the bespeaks caution doctrine still applies and precludes liability for the forward-looking statements in that document as well. Conf. Rep. at 46.

²⁴ The Prospectus also disclosed: This Prospectus contains certain forward-looking statements which involve risks and uncertainties. The Company's actual results could differ materially from the results anticipated in these forward-looking statements as a result of certain of the factors set forth in the following risk factors and elsewhere in this Prospectus. Prospectus at 7 (Ex. 16).

²⁵ Vanstar's Prospectus further warned that "[t]here can be no assurances that the Company . . . will not experience difficulties that could delay or prevent the successful development, introduction and marketing of product and service enhancements . . . ." Id. at 9.

²⁶ Plaintiffs misrepresent Vanstar's disclosures regarding the $31.1 million reserve. Concurrent with entering into the distribution service agreement with Merisel in 1994, Vanstar granted Merisel $20 million in extended, interest-bearing credit on its product purchases. Prospectus at F8-9. Vanstar increased the amount of the extended credit by $11.1 million effective January 31, 1996. Form 10K filed with the Securities and Exchange Commission on June 14, 1996 at 29-30 (Ex. 22). After Merisel's February 20, 1996 announcement, Vanstar conservatively booked a $31.1 million provision as of January 31, 1996 against its extended credit due from Merisel. Id.; Prospectus at F-18-19.

²⁷ See, e.g., Novak v. Kasakes, 997 F. Supp. 425, 430 (S.D.N.Y. 1998) ("The growing trend in the courts, and particularly in this district, is to find that Congress intended to strengthen the Second Circuit standard. The two leading Southern District [of New York] cases . . . both held that the pleading of motive and opportunity no longer suffices to raise a strong inference of scienter.") (citing cases); Friedberg v. Discreet Logic, Inc., 959 F. Supp. 42, 49-50 & n.2 (D. Mass. 1997) (following Silicon Graphics); Havenick v. Network Express, Inc., 981 F. Supp. 480, 527 (E.D. Mich. 1997) (same).

²⁸ None of the stock sales of any of the non speaking defendants is unusual or suspicious in timing or amount. Acito, 47 F.3d at 54 (only stock sales that are "unusual" or "suspicious" give rise to an inference of scienter). Although plaintiffs make much of the fact that the "[defendants who sold Vanstar stock had never before sold any VanStar stock" (SAC ¶ 52), the actual explanation is simple: the defendants were prohibited from selling stock during the "lock-up" for a 180 day period after the initial public offering and prior to the IPO, there was no public market for Vanstar stock. SAC ¶ id. Wenger, 2 F. Supp. at 1251 ("the fact the defendants had not traded before is of no moment whatsoever because the IPO lock-up prevented earlier trades."). Moreover, plaintiffs here inflate the percentage of outstanding shares actually sold by these Vanstar officers. See Appendix calculating stock sales. Bower Decl., Ex. 28. Defendants' total holdings, including options held, can be determined from defendants' publicly-available filings with the SEC on Forms 3 and 4. See id., Ex. 29. In any event the Court need not reach the issue because none of these defendants can be liable for statements they did not make. See Section I, supra.

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