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Stanford University Law School
- Securities Class Action Clearinghouse
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NOT FOR PUBLICATION
IN THE UNITED STATES DISTRICT COURT
FOR THE NORTHERN DISTRICT OF CALIFORNIA
SAN JOSE DIVISION
IN RE RATIONAL SOFTWARE | Case No. C-97-21001-JF
SECURITIES LITIGATION |
| ORDER1 GRANTING DEFENDANTS'
| MOTIONS TO DISMISS AND
| DISMISSING CONSOLIDATED
| COMPLAINT WITH LEAVE TO AMEND
| [filed Oct. 5, 1998]
| [Docket Nos. 36, 46]
________________________________|
Defendants' motions to dismiss were heard on September 28,
1998. For the reasons discussed herein, the motions are granted
and the consolidated complaint is dismissed with leave to amend.
I. BACKGROUND
Defendant Rational Software, Inc. ("Rational") designs,
markets and supports software applications and provides software
products and services. This class action arises from Plaintiffs'
allegations that they were damaged as a result of insider trading
of Rational stock. Specifically, Plaintiffs allege that on
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1 This disposition is not appropriate for publication and
may not be cited.
October 8, 1997 Rational's CEO, Paul Levy ("Levy"), disclosed to
an analyst named Rehan Syed ("Syed") that Rational's as-yet-
unannounced third quarter and year end earnings would be lower
than had been estimated. Plaintiffs allege that based upon this
information Syed advised clients of his firm Cowen & Co.
("Cowen") to sell Rational's stock immediately. Syed's customers
allegedly began selling large blocks of Rational stock, which
caused the price to fall almost five points by the end of the
trading day. Based upon these allegations, Plaintiffs, who also
traded Rational stock on October 8, 1997, assert insider trading
claims against Rational, Levy, Syed, and Cowen. The claims are
asserted under §§ 10(b) And 20A of the Securities and Exchange
Act of 1934 ("Act"), Rule 10b-5, and the California Corporations
Code.
Defendants Rational and Levy have filled a motion to dismiss
the complaint. Defendants Syed and Cowen have filed a separate
motion to dismiss. Plaintiffs oppose these motions.
II. LEGAL STANDARD APPLICABLE TO A MOTION TO DISMISS
For purposes of a motion to dismiss, the plaintiff's
allegations are taken as true, and the Court must liberally
construe the complaint in the light most favorable to the
plaintiff. See Jenkins v. McKeithen, 395 U.S. 411, 421, 89 S.Ct.
1843, 1849 (1969); Argabright v. United States, 35 F.3d 472, 474
(9th Cir. 1994). Leave to amend must be granted unless it is
clear that the complaint's deficiencies cannot be cured by
amendment. See Lucas v. Dep't of Corrections, 66 F.3d 245, 248
(9th Cir. 1995). However, where amendment would be futile,
dismissal may be ordered with prejudice. See Albrecht v. Lund,
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845 F.2d 193, 195-96 (9th Cir. 1988); Beezley v. Fremont
Indemnity Co., 804 F.2d 530, 531 (9th Cir. 1986); see also Dumas
v. Kipp, 90 F.3d 386, 393 (9th Cir. 1996)(holding that dismissal
without leave to amend was appropriate where the plaintiff had
filed four complaints and yet continued to allege insufficient
facts).
III. DISCUSSION
A. Claims Under § 10(b) And Rule 10b-5
Section 10(b) of the Securities Exchange Act Of 1934 makes
it unlawful for any person, by means of any instrumentality of
interstate commerce, the mails, or any facility of any national
securities exchange, to use or employ "any manipulative or
deceptive device or contrivance in contravention of such rules
and regulations as the Commission may prescribe" in connection
with the purchase or sale of any security registered on a
national securities exchange. 15 U.S.C. § 78j(b). Rule 10b-5,
promulgated under § 10(b), makes it unlawful, inter alia, to
"engage in any act, practice, or course of business which
operates or would operate as a fraud or deceit upon any person,
in connection with the purchase or sale of any security." 17
C.F.R. § 240.10b-5(c).
A corporate "insider" may be liable under § 10(b) and Rule
10b-5 for trading with knowledge of material, non-public
information. See Dirks v. SEC, 463 U.S. 646, 653-54, 103 S.Ct.
3255, 3261 (1983). While the securities laws do not impose a
general duty to disclose before trading on material, non-public
information, an insider's use of such information in breach of a
fiduciary duty owed to the corporation is considered fraudulent
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within the meaning of § 10(b) and Rule 10b-5. See id. The fraud
derives from the breach of the relationship of trust and
confidence existing between a corporation's shareholders and
persons who have obtained confidential information by reason of
their position within that corporation. See id.; see also United
States v. O'Hagan, ___ U.S. ___, 117 S.Ct. 2199, 2207 (1997).
Accordingly, an insider who trades on material, non-public
information in breach of a fiduciary duty to the corporation is
considered to have used a "deceptive device" under § 10(b) and
Rule 10b-5. O'Hagan, 117 S.Ct. at 2207; see also Dirks, 463 U.S.
at 653-54, 103 S.Ct. at 3261.
Liability for insider trading under § 10(b) and Rule 10b-5
has been extended to situations in which the insider does not
himself trade on material, non-public information, but rather
tips another person who trades or recommends trades on the
information. See Dirks, 463 U.S. at 659-60, 103 S.Ct. at 3264-
65; Radiation Dynamics, Inc. v. Goldmuntz, 464 F.2d 876, 887 (2nd
Cir. 1972); O'Connor & Associates v. Dean Witter Reynolds, Inc.,
529 F.Supp. 1179, 1187 (S.D.N.Y. 1981). In a tipping situation,
the tippee's obligation is viewed as arising from his role as a
participant after the fact in the insider's breach of fiduciary
duty. See Dirks, 463 U.S. at 659-60, 103 S.Ct. at 3264-65.
Accordingly, a tippee assumes a fiduciary duty not to trade or
recommend trades on material, non-public information only when
the insider has breached his fiduciary duty by disclosing
information to the tippee and the tippee knows or should know
that there has been such a breach. See Dirks, 463 U.S. at 659-
60, 103 S.Ct. at 3264-65; Radiation Dynamics, 464 F.2d at 887;
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O'Connor & Associates, 529 F.Supp. at 1187.
Whether an insider's disclosure of information is a breach
of fiduciary duty depends in large part on the purpose of the
disclosure. See Dirks, 463 U.S. at 662, 103 S.Ct. at 3265. The
test is whether the insider personally will benefit from the
disclosure. See id. Benefits which have been held sufficient to
demonstrate a breach of duty include pecuniary gain, reputational
benefit that will translate into future earnings, or gifting a
friend or relative with confidential information. See id., 463
U.S. at 663-64, 103 S.Ct. at 3266.
As with any claim of securities fraud, claim of insider
trading must meet heightened pleading requirements under Federal
Rule of Civil Procedure 9(b) ("Rule 9(b)") and the Private
Securities Litigation Reform Act of 1995 ("Reform Act"), Pub.L.
No. 104-67 (1995). Rule 9(b) requires that allegations of fraud
be made with particularity, including allegations of the times,
dates, places and other details of the allegedly fraudulent
activity. Fed.R.Civ.P. 9(b); see also In re AST Research
Securities Litigation, 887 F.Supp. 231, 235 (C.D. Cal. 1995).
The Reform Act requires that the complaint must "state with
particularity facts giving rise to a strong inference that the
defendant acted with the required state of mind." 15 U.S.C. §
78u-4(b)(2).
Applying these standards, the Court concludes that
Plaintiffs do not allege sufficient facts to assert violations of
§ 10(b) and Rule 10b-5. Plaintiffs allege that Levy told Syed
that Rational's as-yet-unannounced third quarter and year end
earnings would be lower than had been estimated. It cannot be
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disputed that Levy, as Rational's CEO, was a corporate insider,
or that as-yet-unannounced earnings information would constitute
material, non-public information. Further, Plaintiff alleges
facts sufficient to show that Syed and Cowen recommended trades
based upon this information, including news reports published on
the day in question which quoted Cowen as stating that Rational
was "off" and that analysts should lower their views. Plaintiffs
do not, however, allege facts sufficient to demonstrate that
Levy's disclosure was a breach of fiduciary duty or that Syed
knew or should have known that the disclosure was a breach of
fiduciary duty.
As is discussed above, the test of whether Levy's disclosure
breached a fiduciary duty is whether Levy obtained a personal
benefit from the disclosure. Plaintiffs allege that Levy
disclosed the information in order to build goodwill with Cowen
and Syed. In support of this allegation, Plaintiffs allege that
Cowen is a prominent securities firm in the area of high
technology securities investments, and that goodwill from Cowen
would translate into Cowen's recommendations that its customers
buy Rational stock. Plaintiffs also allege that Cowen might be
motivated to provide Levy and Rational with access to specialized
market information, or might owe Levy and Rational a favor.
These allegations are speculative and conclusory and are totally
unsupported by any facts whatsoever. While Plaintiffs cannot be
expected to read the Defendants' minds, they must allege some
concrete facts from which these speculations and conclusions
reasonably could be drawn. Allegations which have been held
adequate in other cases include statements that the tipper
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insider and tippee investment bank had a close relationship
evidenced by the tippee bank's issuance of favorable reports
about the corporation, see Energy Factors, Inc., v. Nuevo Energy
Co., 1992 WL 170683, at *4 (S.D.N.Y. July 7, 1992); that the
tipper insider stood to benefit financially from disclosing the
information in question, see Burlington Industries, Inc. v.
Edelman, 666 F.Supp. 799, 814 (M.D.N.C. 1987); and that the tip
was a gift to a friend, see S.E.C. v. Maio, 51 F.3d 623, 632 (7th
Cir. 1995). Plaintiffs have not alleged any such factual basis
for their allegations of personal benefit. Accordingly, the
claims under § 10(b) and Rule 10b-5 are subject to dismissal.
Even if Plaintiffs had alleged facts indicating that Levy's
disclosure constituted a breach of fiduciary duty, Plaintiffs do
not allege any facts demonstrating that Syed knew or should have
known that the disclosure constituted such a breach. This
failure provides an additional ground for dismissal as to the
claims against Syed and Cowen.
B. Claims Under § 20A
In addition to the liability imposed under § 10(b) and Rule
10b-5, § 20A of the Act imposes liability on any person who
violates the Act or the rules and regulations promulgated
thereunder by trading on securities while in possession of
material, non-public information. 15 U.S.C. § 78t-l(a). This
provision also imposes liability on any person who discloses
material, non-public information to the same extent as are those
persons who traded on such information. 15 U.S.C. § 78t-l(c). A
§ 20A claim may be brought by any person who traded
contemporaneously with the person possessing material, non-public
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information. 15 U.S.C. § 78t-l(a).
Section 20A imposes liability only upon those who violate
some other provision of the Act or a rule or regulation
promulgated thereunder. In this case, Plaintiffs' claims
regarding § 20A liability are based upon the § 10(b) and Rule
10b-5 claims. Since those claims fail to state a claim, the §
20A claim fails as well.
C. Claims Under The California Corporations Code
California Corporations Code §§ 25402 and 25502 impose
liability on persons who trade on material, non-public
information. However, only persons who actually bought
securities from or sold securities to the wrongdoer may pursue a
claim under these sections. See Cal.Corp.Code §§ 25402, 25502;
Daisy Systems Corp. v. Finegold, 1988 WL 166235 (N.D. Cal. Sept.
19, 1988). Plaintiffs do not allege that they bought securities
from or sold securities to a person in possession of material,
non-public information. Accordingly, Plaintiff's claims under
the California Corporations Code are subject to dismissal.
IV. ORDER
Defendants' motions to dismiss are granted and the
consolidated complaint is dismissed with sixty (60) days leave to
amend. In light of this ruling, the December 7, 1998 hearing on
Plaintiffs' motion for class certification is vacated. The
hearing will be reset in the event that Plaintiffs file an
amended pleading curing the deficiencies noted herein.
DATED: 10-1-98
/s/
______________________________
JEREMY FOGEL
United States District Judge
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Copies of this order mailed on 10/5/98 to:
Lionel Z. Glancy, Esq.
Peter A. Binkow, Esq.
Law Offices of Lionel Z. Glancy
1801 Avenue of the Stars, Suite 308
Los Angeles, CA 90067
Counsel is directed to serve this Order upon all other
counsel of record and upon any unrepresented parties who have
appeared. This Order is not effective until such service is
made.
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Source: Scanned paper copy of court-stamped document