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Stanford University Law School
- Securities Class Action Clearinghouse
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DAVID M. FURBUSH (State Bar No. 83447)
MEREDITH N. LANDY (State Bar No. 136489)
BROBECK, PHLEGER & HARRISON LLP
Two Embarcadero Place
2200 Geng Road
Palo Alto, CA 94303
Telephone: (650) 424-0160
Attorneys for Defendants
Raster Graphics, Inc. and Rak Kumar
UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF CALIFORNIA
SAN FRANCISCO DIVISION
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DONALD and CYNTHIA GRIMM, on Plaintiffs, v. RASTER GRAPHICS, INC. and RAK
Defendants.
Plaintiffs, v. RASTER GRAPHICS, INC. and RAK
Defendants. |
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Case No. C-98-0807 FMS CLASS ACTION Date: July 31, 1998
CLASS ACTION |
I. INTRODUCTION AND STATEMENT OF FACTS
II. REFORM ACT AND LEGAL STANDARD FOR A MOTION TO DISMISS
III. PLAINTIFFS DO NOT ALLEGE FACTS SUFFICIENT TO STATE A CLAIM FOR RELIEF UNDER THE SECURITIES EXCHANGE ACT
A. Plaintiffs Fail To Plead That Any of the Alleged Misstatements Were False When Made
B. The Third Quarter 10-Q Plainly Disclosed That It Involved Estimates Which Were Subject To Change; Any Inaccuracies In Such Estimates Are Thus Protected By The Truth-On-The-Market Defense
C. Plaintiffs Fail to Allege Facts Giving Rise to a Strong Inference of Scienter
1. A Restatement of Earnings Does Not Demonstrate Knowing and Intentional Misconduct
2. Plaintiffs' Generic Motives Cannot Satisfy The Scienter Standard Even Under The Motive and Opportunity Test
D. ALLEGATIONS BASED ON INFORMATION AND BELIEF FAIL TO SATISFY THE REQUIREMENTS OF THE REFORM ACT
IV. PLAINTIFFS' SECTION 20(a) CLAIM FALLS WITHOUT A 10b-5 CLAIM TO SUPPORT IT
Acito v. IMCERA Group, Inc.,
47 F.3d 47 (2d Cir. 1995)
Chill v. General Elec. Co.,
101 F.3d 263 (2nd. Cir. 1996)
Ernst & Ernst v. Hochfelder,
425 U.S. 185 (1976)
Friedberg v. Discreet Logic Inc.,
959 F. Supp. 42 (D. Mass. 1997)
Glickman v. Alexander & Alexander Services, Inc.,
[1995-1996 Transfer Binder] Fed. Sec. L. Rep.
(CCH) ¶ 99,101 (S.D.N.Y. Feb. 19, 1996)
Grossman v. Texas Commerce Bancshares, Inc.,
[1995-1996 Transfer Binder] Fed. Sec. L. Rep.
(CCH) ¶ 98,964 (S.D.N.Y. Sept. 15, 1995)
Holden v. Hagopian,
978 F.2d 1115 (9th Cir. 1992)
In re Apple Sec. Litig.,
886 F.2d 1109 (9th Cir. 1989)
cert. denied, 496 U.S. 943 (1996)
In re Baesa Sec. Litig.,
969 F. Supp. 238 (S.D.N.Y. 1997)
In re Cirrus Logic Sec. Litig.,
946 F. Supp. 1446 (N.D. Cal. 1996)
In re Crystal Brands Sec. Litig.,
862 F. Supp. 745 (D. Conn. 1994)
In re GlenFed, Inc. Sec. Litig.,
42 F.3d 1541 (9th Cir. 1994)
In re Oak Technology Sec. Litig.,
No. 96-20552 SW, 1997 WL 448168
(N.D. Cal. Jul. 1, 1997)
In re Ross Systems Sec. Litig.,
[1994 Transfer Binder] Fed. Sec. L. Rep.
(CCH) ¶ 98,363 (N.D. Cal. Jul. 21, 1994)
In re Silicon Graphics, Inc. Sec. Litig.,
970 F. Supp. 746 (N.D. Cal. 1997)
In re Silicon Graphics, Inc. Sec. Litig.,
[1996-1997 Transfer Binder] Fed. Sec. L. Rep.
(CCH) ¶ 99,325 (N.D. Cal. Sept. 25, 1996)
In re Software Toolworks, Inc. Sec. Litig.,
50 F.3d 615 (9th Cir. 1994),
cert. denied, 516 U.S. 987 (1995)
In re Stratosphere Corp. Sec. Litig.,
No. CV-5-96-0708 PMP (RLH), 1998 WL 167259
(D. Nev. Apr. 2, 1998)
In re Verifone Sec. Litig.,
11 F.3d 865 (9th Cir. 1993)
In re Worlds of Wonder,
35 F.3d 1407 (9th Cir. 1994),
cert. denied, 516 U.S. 868 (1995)
Marksman Partners v. Chantal Pharmaceutical Corp.,
927 F. Supp. 1297 (C.D. Cal. 1996)
Matthews v. Centex Telemanagement, Inc.,
[1994 Transfer Binder] Fed. Sec. L. Rep.
(CCH) ¶ 98,440 (N.D. Cal. June 8, 1994)
Norwood Venture Corp. v. Converse Inc.,
959 F. Supp. 205 (S.D.N.Y. 1997)
Papasan v. Allain,
478 U.S. 265 (1986)
Paracor Finance, Inc. v. General Electric Capital Corp.,
96 F.3d 1151 (9th Cir. 1996)
Shields v. Citytrust Bancorp, Inc.,
25 F.3d 1124 (2nd Cir. 1994)
Stack v. Lobo,
No. 95-20049 SW, 1995 WL 241448
(N.D. Cal. Apr. 20, 1995)
Western Mining Council v. Watt,
643 F.2d 618 (9th Cir. 1981)
Wool v. Tandem Computers, Inc.,
818 F.2d 1433 (9th Cir. 1987)
Zeid v. Kimberley,
930 F. Supp. 431 (N.D. Cal. 1996)
Zeid v. Kimberley,
973 F. Supp. 910 (N.D. Cal. 1997)
Securities Exchange Act of 1934,
Section 10(b)
Section 20(a)
Section 21D(b)
Section 21D(b)(1)(B)
Section 21D(b)(2)
Section 21D(b)(1)
Federal Rules of Civil Procedure, Rule 9(b)
Joint Explanatory Statement of the Committee of Conference,
Statement of Managers, H.R. Rep. No. 369,
104th Cong., 1st Sess. (1995)
Qualitative Characteristics of Accounting Information,
Statement of Concepts No. 2, ¶¶ 8, 10
(Fin. Acct. Standards Bd. 1980)
TO PLAINTIFFS DONALD AND CYNTHIA GRIMM AND ERIC DOWGOS AND THEIR ATTORNEYS OF RECORD:
PLEASE TAKE NOTICE that defendants Raster Graphics, Inc., and Rakesh Kumar's motion to dismiss will be heard on Friday, July 31, 1998 at 10:00 a.m., or as soon thereafter as the matter may be heard by the above-entitled Court in the courtroom of the Honorable Fern M. Smith, 450 Golden Gate Avenue, San Francisco, California.
Defendants will and hereby do move for an order dismissing the complaints pursuant to Rules 12(b)(6) and 9(b) of the Federal Rules of Civil Procedure and the Private Securities Litigation Reform Act of 1995 (the "Reform Act").
This motion is based on this Notice and Motion, the Memorandum of Points and Authorities, the Request for Judicial Notice and the Appendix of Authorities filed and served herewith, the papers, records and pleadings on file in this action, including such other papers as may be filed at or before the hearing on this motion, and arguments made by counsel at the time of the hearing of the motion.
1. Do plaintiffs plead fraud with the required particularity?
2. Are defendants' statements protected by the Truth-On-The Market Defense?
3. Do plaintiffs sufficiently allege that the defendants acted with the required state of mind?
4. Do plaintiffs state all facts supporting their "information and belief" allegations?
Raster Graphics is a leading manufacturer of large-format digital printers. Before July 1997, Raster Graphics enjoyed fourteen consecutive quarters of revenue growth and twelve quarters of increased profitability. Cplt 18. In the third quarter of 1997 (the quarter ending September 30, 1997), Raster instituted for the first time an equipment leasing program through which its clients could finance product purchases through a leasing company. Some of the initial sales financed through the leasing program were included in third quarter results announced in October of 1997. In the early part of 1998, Raster decided to reverse certain revenues from transactions involving sales that had not been funded by third party leasing partners as of September 30, 1997. Cplt 28. Raster then immediately announced to its shareholders and the rest of the investing public on February 3, 1998 -- just some three and a half months after originally announcing third quarter results, and without any intervening sales of stock by company insiders -- that it would restate its third quarter earnings to reflect these changes in revenue. Raster also announced that it had experienced greater exposure in accounts receivable than it had expected for the fourth quarter of 1997 and that it would, as all companies do from time to time, increase certain allowances for doubtful accounts. Cplt 27.
When Raster Graphics announced this unfortunate but otherwise routine news, its stock price dropped. Based on nothing more than this unremarkable setback, plaintiffs filed these lawsuits on March 2, 1998 and March 10, 1998.1/ The complaint purports to assert claims against Raster Graphics and its CEO, Rak Kumar, pursuant to sections 10(b) and 20(a) of the Securities Exchange Act of 1934 ("1934 Act") and Rule 10b-5. The core theory underlying plaintiffs' complaint is that defendants purposely misstated Raster's third quarter financial statements in order to maintain Raster's streak of consecutive earnings growth, inflate its stock price and place the company in a good position to renegotiate its line of credit in December 1997. This theory is both nonsensical and legally insufficient.
Comprised of conclusory and boilerplate allegations, the complaint is fatally devoid of the particularity required to comply with the heightened pleading requirements of the Reform Act. Notably absent are any specific allegations which demonstrate that any of the alleged misstatements were false when made or that the defendants acted with the requisite scienter. Absent such specific and particular allegations of scienter, plaintiffs' complaint should as a matter of law be dismissed.
The Reform Act was "prompted by significant evidence of abuse in private securities law suits." Joint Explanatory Statement of the Committee of Conference, Statement of Managers, H.R. Rep. No. 369, 104th Cong., 1st Sess., at 31 (1995) ("Conf. Rep."). In the hope of putting an end to such practices, Congress adopted rigorous new standards for pleading securities fraud and mandated that the court "shall" dismiss complaints that do not meet these heightened requirements. 1934 Act, Section 21D(b).
As this Court has recognized, a central tool of the effort to curb abusive litigation is a heightened standard for pleading scienter. With respect to each alleged act or omission, plaintiffs must "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind," and do so "with respect to each act or omission alleged. . . " In re Silicon Graphics, Inc. Sec. Litig., [1996-1997 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 99,325, at 95,961 (N.D. Cal. Sept. 25, 1996)("Silicon Graphics I").2/ Section 21D(b)(2).
Securities fraud complaints must also "specify each statement alleged to have been misleading [and] the reason or reasons why the statement is misleading . . ," Section 21D(b)(1)(B), including the time, place, manner and content of each and every statement they contend is actionable. Silicon Graphics I, [1996-1997 Transfer Binder] Fed. Sec. L. Rep. (CCH) at 95,961; Zeid v. Kimberley, 930 F. Supp. 431, 434 (N.D. Cal. 1996)("Zeid I"). Furthermore, allegations made on information and belief must "state with particularity all facts on which that belief is formed." Section 21D(b)(1)(B).
These new requirements augment and reinforce the Ninth Circuit's pre-reform mandate that the circumstances allegedly constituting fraud must be spelled out in detail. See, e.g., In re GlenFed, Inc. Sec. Litig., 42 F.3d 1541, 1547 (9th Cir. 1994)("GlenFed II"). Moreover, under long-settled law, plaintiffs cannot satisfy these standards by alleging conclusions in the guise of facts. See, e.g., Papasan v. Allain, 478 U.S. 265, 286 (1986); In re Verifone Sec. Litig., 11 F.3d 865, 868 (9th Cir. 1993); Western Mining Council v. Watt, 643 F.2d 618, 624 (9th Cir. 1981). The sufficiency of the complaint is tested after all unsupported and conclusory allegations are excised. See, e.g., Holden v. Hagopian, 978 F.2d 1115, 1121 (9th Cir. 1992).
To state a claim under section 10(b) of the 1934 Act, plaintiffs must plead facts establishing the following elements: (1) a misstatement or statement made misleading by an omission; (2) of a material fact; (3) upon which plaintiff relied; (4) which caused a loss; (5) which was made with scienter; and (6) which resulted in damage. Paracor Finance, Inc. v. General Electric Capital Corp., 96 F.3d 1151, 1157 (9th Cir. 1996). When the complaint is scrutinized under the heightened standards mandated by the Reform Act and Rule 9(b), it is evident that plaintiffs have failed to allege facts with particularity establishing that defendants made any actionable misrepresentation or omission.
Rule 9(b) provides that in all actions based on fraud, "the circumstances constituting the fraud must be pled with particularity." Fed. R. Civ. P. 9(b). Even prior to the Reform Act, the Ninth Circuit held that particularity requires that plaintiffs do more than "set forth. . . the neutral facts necessary to identify the transaction." GlenFed II, 42 F.3d at 1548. This particularity requirement mandates that plaintiffs not only demonstrate that the statement is false or misleading but also that it was false or misleading at the time it was made by alleging "inconsistent contemporaneous statements or information . . . which were made by or available to the defendants." Id. at 1549. If these requirements are not fulfilled, a complaint must be dismissed because "the court can only conclude that plaintiffs' allegations are based purely on speculation and conclusions drawn from hindsight." Zeid v. Kimberley, 973 F. Supp. 910, 920 (N.D. Cal. 1997)("Zeid II").
Here, plaintiffs allege that on February 3, 1998 Raster Graphics announced that the company had decided to reverse approximately $1 million of revenue booked in the third quarter, which represented sales to customers under the new lease financing program whose purchases had not been funded as of September 30, 1997. Plaintiffs attempt to transform this revision to the reported financial statements into accounting fraud by alleging in conclusory fashion that because third quarter revenue and net income were subsequently restated, these financial statements were necessarily false at the time they were issued.
This circular form of pleading was expressly rejected by the Ninth Circuit Court of Appeal and this court. As the Ninth Circuit observed in GlenFed II:
The fact that an allegedly fraudulent statement and a later statement are different does not necessarily amount to an explanation as to why the earlier statement was false. For example, both the valuation of assets and the setting of loan loss reserves are based on flexible accounting concepts, which, when applied, do not always (or perhaps ever) yield a single correct figure. In order to allege the circumstances constituting fraud, plaintiff 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. 42 F.3d at 1549.
And as Judge Patel of this court recently held in dismissing, with prejudice, a complaint which attempted to allege fraud solely on the basis of a financial restatement:
[t]he fact that defendant may have, through its restatement, corrected its prior assessment, does not establish that the earlier accounting judgment was false when made.3/
Plaintiffs are required to plead specific contemporaneous facts showing that defendants were aware that the financial statements were false when made because, as this court has noted, "GAAP is not a set of rules ensuring identical treatment of identical transactions; rather, it tolerates a range of reasonable treatments, leaving the choice among alternatives to management."4/ In re Cirrus Logic Sec. Litig., 946 F. Supp. 1446, 1457 (N.D. Cal. 1996), citing Thor Power Tool Co. v. C.I.R., 439 U.S. 522, 544 (1979). As a result, "[a]pplying generally accepted accounting principles requires that judgment be exercised as to the relative appropriateness of acceptable alternative principles and methods of application[.]" In re Cirrus Logic, 946 F. Supp. at 1457, quoting Disclosure of Accounting Policies, Accounting Principles Board Opinion No. 22, ¶ 5 (1972). Because the accounting rules recognize "a range" of acceptable judgments, the federal courts have routinely rejected fraud claims based upon alleged accounting error.
While two pages of the complaint enumerate a laundry list of basic GAAP principles, not one single sentence in the entire complaint -- apart from plaintiffs' conclusory allegations -- explains why the restatement resulted from anything more than the difference between permissible business judgments, let alone deliberate accounting fraud. See In re Ross Systems Sec. Litig., [1994 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 98,363, at 90,499 (N.D. Cal. Jul. 21, 1994)("[t]o 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").
Using this same fraud-by-hindsight formula, plaintiffs attempt to transform Raster Graphics' routine decision to increase its fourth quarter allowance for doubtful accounts into securities fraud. Cplt 27. This allegation rests on nothing more that the non-sequitur that, because defendants later decided to increase this allowance, it must previously have been inadequate and plaintiffs must have deliberately failed to disclose its inadequacy throughout the class period. Cplt ¶ 30(c), 31(b). A change to such reserves, does not (as a matter of law or logic) establish that the original estimate of reserves for doubtful accounts was false when made; it simply confirms that Raster Graphics' allowance for doubtful accounts is inherently an estimate and is inherently subject to change over time. Because plaintiffs have failed to establish that the original allowance for doubtful accounts (1) was not actually believed, (2) lacked any reasonable basis, or (3) was contradicted by undisclosed facts that seriously undermined its accuracy, In re Apple Sec. Litig., 886 F.2d 1109, 1113-14 (9th Cir. 1989) cert. denied, 496 U.S. 943 (1996), it cannot serve as the basis for a federal securities fraud claim. As this court noted in Matthews v. Centex Telemanagement, Inc.: "Reserves for bad debts are essentially predictions about the future. The fact that a future prediction turns out to be wrong does not mean it was fraudulent when made." [1994 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 98,440, at 91,033 (N.D. Cal. June 8, 1994).
Nowhere do plaintiffs allege specific contemporaneous facts to show that the allowance for doubtful accounts was inadequate at the time Raster Graphics filed its third quarter financial statements, much less facts showing that defendants were aware of any inadequacy. Their only attempt at such an allegation depends upon an assumption of clairvoyance: Plaintiffs allege that because several accounts were 90 days past due at the end of the fourth quarter (December 31, 1997) defendants must have known two months earlier (in October 1997) that these accounts would ultimately become more than 90 days past due! Nowhere do plaintiffs plead specific facts regarding one single account (much less several) that demonstrates that defendants were aware in October that the account would be 90 days past due at the end of December. Nothing in this complaint distinguishes it from that found inadequate in In re Cirrus Logic, 946 F. Supp. at 1460, (rejecting fraud claims that followed defendants' restatement of reported earnings which led to a 30% stock price drop: "plaintiffs' claims about how reserves should have been calculated `are only differences in business judgment viewed from hindsight.'"); or Stack v. Lobo, No. 95- 20049 SW, 1995 WL 241448, at * 4 (N.D. Cal. Apr. 20, 1995)("plaintiffs do not allege any facts showing that [defendant's] decision to set its reserve for doubtful accounts at a certain level was not a permissible business judgment.")
Moreover, nowhere do plaintiffs provide the specificity required under the Reform Act for pleading the particular transactions where reserves were allegedly inadequate, including the names of the customers, the terms of specific transactions, when the transactions occurred, and the approximate amount of the transactions. In re Oak Technology Sec. Litig., No. 96- 20552 SW, 1997 WL 448168, at *8 (N.D. Cal. Jul. 1, 1997); In re Fritz Companies, Memorandum and Order at 10.
In their most conclusory pleading effort plaintiffs allege that the February 3 press release "revealed problems related to Raster's business and financial operations which were by their very nature ongoing and severe," and "operative throughout the class period. " Cplt ¶ 34. These conditions, plaintiffs conclusorily allege, were "contrary to and or discredited by defendants' statements disseminated to the investing public during the class period." Id. This is the complaint's most egregious failure to comply with the strict pleading requirements for securities fraud. Plaintiffs never identify with any specificity what these ongoing problems were, much less specific facts demonstrating that defendants were aware of these problems throughout the class period.
Because the complaint fails to allege even one specific fact supporting the bald conclusion that the purported misrepresentations were false when made it must be dismissed as a matter of law. Stack, 1995 WL 241448, at * 4.
Raster Graphics disclosed that the numbers presented in its 3rd quarter 10-Q depended upon estimates and assumptions and that actual results could vary:
2. USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. These assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.5/
Thus, even if plaintiffs were able to allege specific facts to show that any of the estimates included in the Third Quarter 10-Q were inaccurate at the time they were made (which they have emphatically failed to do), it is undisputed that Raster Graphics notified investors that such estimates were not necessarily reliable. In similar circumstances, Judge Patel recently ruled that inaccuracies in financial estimates were protected by the "truth-on-the-market" doctrine.6/ In re Fritz Companies, Memorandum and Order at 14. As Judge Patel wrote:
Here, it is undisputed that Fritz's publicly-filed documents contained information that the estimate of merger expenses was subject to change. The Proxy statement, for example, declared that "it will not be feasible to determine the actual amount of the [merger] charge until the operational and transitional plans are completed." Proxy at 22. In addition, following its audit of Fritz's financial statements for the transition period, KPMG issued a management letter which stated that merger costs and bad debt allowances were "accounting estimates." Thus, it is clear that information regarding the possible adjustment of the merger expenses was "made credibly available to the market." Apple Computer, 886 F.2d at 1115; Kaplan, 49 F.3d at 1376.
Under the Reform Act, the standard for pleading scienter is clear:
To adequately plead scienter under SRA, plaintiffs must establish a strong inference of knowing or intentional misconduct. In doing so, plaintiffs must do more than speculate as to defendants' motives or make conclusory allegations of scienter; plaintiffs must allege specific facts.
In re Silicon Graphics, Inc. Sec. Litig., 970 F. Supp. 746, 766 (N.D. Cal. 1997)("Silicon Graphics II")[emphasis added]. The intent to deceive has always been a bedrock requirement of liability under section 10(b). Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n.12 (1976). Congress borrowed the "strong inference" language from the Second Circuit which, prior to reform, had the highest pleading standard in the country for scienter. Before the Reform Act, plaintiffs in the Second Circuit had to "allege facts that give rise to a strong inference of fraudulent intent." Acito v. IMCERA Group, Inc., 47 F.3d 47, 52 (2d Cir. 1995); Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1128 (2nd Cir. 1994). "The requisite `strong inference' of fraud [could] be established either (a) by alleging facts to show that defendants had both motive and opportunity to commit fraud, or (b) by alleging facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness." Id. at 1128; Marksman Partners v. Chantal Pharmaceutical Corp., 927 F. Supp. 1297, 1309 (C.D. Cal. 1996).
As the Conference Committee Report makes explicitly clear, Congress sought to impose pleading requirements even stronger than those developed in the Second Circuit. Conf. Rep. at 41 & n.23 ("the Conference Committee intends to strengthen existing pleading requirements"). Accordingly, after an in-depth analysis of legislative history, this Court has held that the Reform Act created a new, more demanding standard for pleading scienter, and concluded that Congress did not intend to include the "motive and opportunity" prong of the former Second Circuit test, and that a defendant cannot be liable in the absence of knowing or intentional misconduct. Silicon Graphics I, [1996-1997 Transfer Binder] Fed. Sec. L. Rep. (CCH) at 95,961-62. See also Silicon Graphics II, 970 F. Supp at 757. Other courts have come to the same conclusion.7/
Regardless of the standard applied, plaintiffs' allegations fall far short of the mark. They support no inference of scienter, much less the strong inference necessary to avoid dismissal. To establish a strong inference of scienter, plaintiffs must (at the very least) plead: (i) that such "adverse material facts" were actually known to the defendants at the time the statements were made; (ii) how the facts were made known to the defendants; (iii) why the facts rendered the statements misleading at the time they were made; and (iv) that defendants knew (or were reckless in disregarding) the falsity of the statements. See Section 21D(b)(1) of the 1934 Act; GlenFed II, 42 F.3d at 1548-49. Plaintiffs' complaint is devoid of any such particularized facts. Instead, plaintiffs resort to unsupported allegations that defendants "knew and/or recklessly disregarded the falsity of" the alleged misstatements and then summarizes the purportedly undisclosed facts. Cplt 30, 35, 39 and 42.
It is axiomatic that to plead a strong inference of scienter, plaintiffs must at a minimum plead facts demonstrating that the defendants were aware that the alleged misstatements were false at the time they were made. Zeid II, 973 F. Supp. at 924 (plaintiffs cannot plead scienter even under recklessness standard where plaintiffs "fail to allege contemporaneous facts" demonstrating that each misstatement was false when made because there are therefore "no specific facts to create an inference that Defendants knew the statements were false.") Plaintiffs have therefore failed to plead scienter under even pre-Reform Act standards. On this ground alone, plaintiffs' complaint must be dismissed.
Plaintiffs attempt to infer scienter from Raster Graphics' restatement of its third quarter financial results. Plaintiffs have pled no particular facts indicating that defendants were aware that the financial statements were false at the time they were made. The complaint merely assumes that because there was a restatement in February 1998, defendants must have acted with scienter in preparing the financial statements in October, 1997. Even under pre-Reform Act standards plaintiffs have failed to plead scienter. As this court and the Ninth Circuit has specifically noted, "[t]he mere publication of inaccurate accounting figures, or a failure to follow GAAP, without more, does not establish scienter." In re Worlds of Wonder, 35 F.3d 1407, 1426 (9th Cir. 1994), cert. denied, 516 U.S. 868 (1995); In re Software Toolworks, Inc., 50 F.3d 615, 627 (9th Cir. 1994), cert. denied, 516 U.S. 987 (1995)(same); Chill v. General Elec. Co., 101 F.3d 263, 265 (2nd. Cir. 1996)(restatement does not give rise to a strong inference of scienter.) In re Cirrus Logic, 946 F. Supp. at 1462 (same).
Plaintiffs' deficient pleading of scienter with respect to the third quarter financial statements is not saved by plaintiffs' vague allegations of Defendant Kumar's access to internal reports. See Cplt ¶ 39. As this court has noted "allegations of defendants' awareness of negative internal reports [coupled with] their false and misleading statements" do not "create a strong inference of fraud." Silicon Graphics II, 970 F. Supp. at 766-67; Zeid II, 973 F. Supp. at 924-25 (access to internal reports "which could be asserted against any corporate executive" without specifying which particular reports upon which the defendant relied "do not constitute specific facts of recklessness or conscious behavior.") Additionally, the Reform Act also mandates at a minimum that plaintiffs specifically identify such internal reports by providing names and dates of each report, which plaintiffs have failed to do here. Silicon Graphics II, 970 F. Supp. at 767 ("To establish a strong inference of fraud, plaintiffs must provide . . . details about the alleged negative internal reports. . . . The allegations should include the titles of the reports, when they were prepared, who prepared them, to whom they were directed, their content, and the sources from which plaintiffs obtained this information.")
Plaintiffs allege that defendants were motivated to falsify Raster Graphics' financial statements in order to "inflate or maintain the price of Raster Securities," Cplt 31; to "continue the illusion of Raster's consecutive earnings growth" (Cplt ¶ 31, 35(a)) and that defendants were motivated to commit fraud because Raster "was in need of renegotiating its bank facility prior to the end of the fiscal year." Cplt ¶ 35(b), 40. None of these generic motives are sufficient to allege scienter even under the motive and opportunity standard much less the heightened scienter standard of the Reform Act.8/
First, plaintiffs' mere allegations that defendants "were motivated to defraud the public to achieve an inflated stock price" are insufficient to establish scienter and "prevent dismissal under 9(b)." Marksman Partners, 927 F. Supp. at 1312; Acito, 47 F.3d at 54; Glickman v. Alexander & Alexander Services, Inc., [1995-1996 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 99,101, at 94,635 (S.D.N.Y. Feb. 19, 1996)(motive of increasing capital not enough to establish scienter.)
Moreover, the courts that have applied the motive and opportunity test have recognized that "allegations of motive that are generally held by similarly positioned executives and companies . . . are insufficient to sustain a claim under the securities laws." Marksman Partners, 927 F. Supp. at 1310 (quoting Glickman, [1995-1996 Transfer Binder] Fed. Sec. L. Rep. (CCH) at 94,635); See also Grossman v. Texas Commerce Bancshares, Inc., [1995-1996 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 98,964, at 93,657 (S.D.N.Y. Sept. 15, 1995)(motive of "maintain[ing] high credit ratings and a strong image of financial health so that the company will have continued access to . . . funds" not indicative of scienter); In re Crystal Brands Sec. Litig., 862 F. Supp. 745, 749 (D. Conn. 1994)(motive of maintaining good relations with lender not indicative of scienter); In re Stratosphere Corp. Sec. Litig., No. CV-5-96-0708 PMP (RLH), 1998 WL 167259, at * 16 (D. Nev. April 2, 1998)(motives of inflating stock price, "attract[ing] investor capital" and maintaining financing do not establish scienter). All executives and companies have an interest in earnings growth and maintaining good relationships with lenders. If these motives could serve as a basis for inferring fraud, then every corporation would be sued when its stock price dropped. Similarly, the renegotiation of a line of credit is a normal corporate event from which an inference of scienter cannot be drawn. Having alleged nothing more than generic motives that are common to all companies and executives, plaintiffs have failed to allege any motive from which a sufficient inference of scienter can be drawn.
Plaintiffs also attempt to allege that the departure of Raster Graphics' CFO is evidence that defendants acted with scienter. Plaintiffs have alleged no specific facts detailing why the CFO's departure was anything other than a normal corporate event. Absent such allegations, the CFO's departure cannot serve as the basis for scienter or securities fraud. As plaintiffs cannot allege scienter under any standard -- much less the heightened Reform Act standard -- their claims must be dismissed as a matter of law.
Since the information in plaintiffs' complaint is based on their review of Raster Graphics SEC filings, analysts reports, news releases and media reports, and these sources "do not provide plaintiffs with personal knowledge, . . . the complaint must be based on information and belief." Cplt Introductory Paragraph; Silicon Graphics II, 970 F. Supp. at 763. The Reform Act requires that complaints based on information and belief must "state with particularity all facts on which that belief is formed." Section 21D(b)(1)(B). Plaintiffs have not identified their sources with sufficient particularity as required by the Reform Act. The complaint does not identify a single individual who has provided information that has led to the filing of this lawsuit. On this basis alone plaintiffs' claims must be dismissed. See Silicon Graphics II, 970 F. Supp. at 763-64. (In complaints based on information and belief plaintiffs must plead the specific "names of confidential informants, employees, competitors, Government employees, members of the media and others who have provided information leading to the filing of the case . . . to meet the requirements of the [Reform Act].")
Plaintiffs' section 20(a) claim fails because it requires a primary violation and as shown above, the complaint fails to state such a claim. Paracor Finance, 96 F.3d 1151; Wool v. Tandem Computers, Inc., 818 F.2d 1433, 1440 n.8 (9th Cir. 1987). Therefore, the section 20(a) claim must be dismissed.
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DATED: May 21, 1998 |
BROBECK, PHLEGER & HARRISON LLP
/s/ |
1/ By order dated May 18, 1998, the following three cases were ordered related and assigned to the Hon. Fern M. Smith:
C98-807 FMS; Donald Grimm, et al. v. Raster Graphics, Inc. et al.
C98-938 FMS; Erik Dowgos v. Raster Graphics, Inc. et al.
C98-1489 SBA; Mark Moore et al. v. Raster Graphics, Inc. et al.
The Grimm and Dowgos complaints are substantially identical and therefore identical motions to dismiss are being filed concurrently with respect to these complaints. The Moore complaint has not yet been formally served and no motion has yet been filed with respect to it.
2/ Copies of this case and other cases which defendants rely upon, and which are not published in either the Federal Supplement or the Federal Reporter, are attached for the Court's convenience to defendants' Appendix of Non-Federal Authorities, filed concurrently herewith.
3/ In re Fritz Companies Sec. Litig., Memorandum and Order [re Motions to Dismiss, Strike] , No. 96-CV-2712, at 10 (N.D. Cal. March 5, 1998), attached as Exhibit A to the Request for Judicial Notice filed concurrently herewith. Defendants respectfully request that the court take judicial notice of the order pursuant to the authorities cited in their Request for Judicial Notice.
4/ The range of reasonable treatments under the governing accounting standards is further reflected in FASB Statement of Concepts No. 2: "Those who are unfamiliar with the nature of accounting are often surprised at the number of choices that accountants are required to make. Yet choices arise at every turn. . . There are some who seem to harbor the hope that somewhere waiting to be discovered there is a comprehensive scoring system that can provide the universal criterion for making accounting choices. Unfortunately, neither the Board nor anyone else has such a system at the present time, and there is little probability that one will be forthcoming in the foreseeable future." Qualitative Characteristics of Accounting Information, Statement of Concepts No. 2, ?? 8, 10 (Fin. Acct. Standards Bd. 1980)(Appendix Exhibit 2).
5/ Raster Graphics 10-Q, p.7, attached as Exhibit B to the Request for Judicial Notice filed concurrently herewith. Defendants request the Court to take judicial notice of the 10-Q cited in the complaint, pursuant to the authorities cited in their Request for Judicial Notice.
6/ Under the "truth-on-the-market" doctrine, a defendant's misrepresentation of or failure to disclose material information "may be excused where that information has been made credibly available to the market by other sources." In re Apple Computer Securities Litig., 886 F.2d 1109, 1115 (9th Cir. 1989), cert. denied, 496 U.S. 943 (1990).
7/ See, e.g., In re Baesa Sec. Litig., 969 F. Supp. 238, 239 (S.D.N.Y. 1997) (Reform Act expressly addresses and alters what is required to plead scienter, and pleading motive and opportunity does not, by itself, satisfy the pleading standard); Friedberg v. Discreet Logic Inc., 959 F. Supp. 42, 49-50 (D. Mass. 1997) ("In determining what the term 'strong inference of scienter' would require, this Court rules that the plaintiff must set forth specific facts that constitute strong circumstantial evidence of conscious behavior by defendants"); Norwood Venture Corp. v. Converse Inc., 959 F. Supp. 205, 208 (S.D.N.Y. 1997) ("under the [Reform Act] a plaintiff in a private securities litigation action must now plead specific facts that 'create a strong inference of knowing misrepresentation on the part of the defendants'" (quoting Silicon Graphics I)).
8/ As mentioned previously, the motive and opportunity standard provides that to plead scienter "a plaintiff must allege: 1) specific facts demonstrating that the defendant had a motive and an opportunity to commit fraud; or (2) specific facts constituting circumstantial evidence of conscious behavior or recklessness." Zeid II, 973 F. Supp. at 918; Marksman Partners, 927 F. Supp. at 1309. Plaintiffs have failed to allege scienter under either standard.