Stanford University Law School - Securities Class Action Clearinghouse
                                             
    NOT FOR PUBLICATION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

____________________

     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, 2
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 3
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; 4
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 5
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 6
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 7
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 8
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. 9



Source: Scanned paper copy of court-stamped document