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Stanford University Law School - Securities Class Action Clearinghouse

Howard B. Sirota, Esq.
Saul Roffe, Esq.
SIROTA & SIROTA
747 Third Avenue 
New York, New York 10017
(212) 759-5555

Robert S. Brewer, Jr., Esq. (CSB No. 65294)
McKENNA & CUNEO, L.L.P.
750 B Street, Suite 3200
San Diego, California 92101
(619) 595-5400

Attorneys for Plaintiff,
Larry Frazier, Sr.


                   UNITED STATES DISTRICT COURT

                 NORTHERN DISTRICT OF CALIFORNIA


LARRY FRAZIER, SR.,            |  Civil Action No. C.96-2644
                               |
          Plaintiff,           |  CLASS ACTION COMPLAINT
                               |
     vs.                       |  DEMAND FOR JURY TRIAL
                               |
DIAMOND MULTIMEDIA SYSTEMS,    |
INC., WILLIAM J. SCHROEDER,    |
CHONG-MOON LEE, GARY B.        |
FILLER, and HYUNG HWE HUH,     |
                               |
          Defendants.          |
_______________________________|

     Plaintiff, by his attorneys, for his class action

complaint, alleges upon actual knowledge as to his own acts, and

upon information and belief as to all other matters, the sources

of which are public documents and filings by the defendants, and

counsel's investigation as follows:

                    JURISDICTION AND VENUE

     1.   This Court has jurisdiction over the subject matter of

this action pursuant to Section 27 of the Securities Exchange

Act of 1934 (the "Exchange Act"), 15 U.S.C. §78aa; 28 U.S.C.




§1331 and the principals of pendant and supplemental jurisdiction.      2.   The claims asserted herein arise under Sections 10(b) and 20(a) of the Exchange Act, 15 U.S.C. §§ 78j(b) and 78t(a); Rule 10b-5, 17 C.F.R. § 249.10b-5, promulgated under Section 10(b) of the Exchange Act by the Securities and Exchange Commission (the "SEC") and the common law.      3.   Venue is proper in this District pursuant to Section 27 of the Exchange Act and 28 U.S.C. 1391(b) and 15 U.S.C. 77v and 78aa.  Many of the acts and transactions constituting the violations of law alleged herein, including the preparation, issuance and dissemination of materially false and misleading information to the investing public, have occurred in this District.  The principal executive offices of defendant Diamond Multimedia Systems, Inc. and the offices from which certain financial statements, and reports were issued, are situated in this District.      4.   In connection with the acts, common course of conduct and the plan and scheme alleged herein, defendants used, directly and indirectly, the means and instrumentalities of interstate commerce, including the United States mails, interstate wire and telephone facilities.                           THE PARTIES      5.   Plaintiff purchased Diamond Multimedia Systems, Inc. ("Diamond" or the "Company") securities as spelled out more fully in Exhibit A attached hereto and has been damaged thereby.      6.   Diamond is a Delaware corporation located at 2880 Junction Avenue, San Jose, California.  Diamond manufactures and                                - 2 -
markets multimedia and communications add-in subsystems for personal computers.      7.   Defendant William Schroeder is President and Chief Executive Officer and a Director of Diamond and has held those positions since May 1994.  In the fiscal year ended December 31, 1995, Schroeder received $452,927.00 in salary, bonus and other compensation.  As of April 10, 1996, defendant Schroeder owned or controlled 1,177,818 shares of Diamond common stock.  During the Class Period, Schroeder sold 115,932 shares of Diamond common stock realizing approximately $2.4 million.      8.   Defendant Chong-Moon Lee is Chairman of the Board of Diamond and founded the Company in 1973.  He has held the position of Chairman of the Board since 1982 and, from 1982 through May 1994, he was President and Chief Executive Officer of Diamond.  As of April 10, 1996, Lee beneficially owned or controlled 2,674,757 shares of Diamond common stock.  During the Class Period, Lee sold 131,493 shares of Diamond common stock, realizing approximately $4 million.      9.   Defendant Gary B. Filler is Senior Vice-President and Chief Financial Officer of Diamond and has held those positions since August 1994.  In the fiscal year ended December 31, 1995, Filler received $363,078 in salary, bonus and other compensation.  As of April 10, 1996, Filler beneficially owned or controlled 320,973 shares of Diamond common stock.  During the Class Period, Filler sold approximately 119,527 shares of Diamond common stock, realizing approximately $2.6 million.      10.  Defendant Hyung Hwe Huh is Senior Vice-President and Chief Technical Officer of Diamond.  In the fiscal year ended                                - 3 -
December 31, 1995, Huh received $340,069 in salary, bonus and other compensation.  As of April 10, 1996, Huh beneficially owned or controlled 576,383 shares of Diamond common stock. Huh, during the Class Period, sold approximately 153,401 shares of Diamond common stock, realizing approximately $3.17 million.      11.  Defendants Schroeder, Lee, Filler and Huh are known herein as the "Individual Defendants."      12.  By reason of their positions as directors and/or executive officers of Diamond, each of the Individual Defendants possessed intimate knowledge of, participated in, or approved and ratified the deceptive and manipulative acts, practices and transactions complained of herein, and the material omissions and false and misleading statements contained in the reports and financial statements of the Company and in press releases and other reports of the Company, which constituted a course of conduct designed to defraud and deceive the members of the Class herein, and to perpetrate a fraud on the members of the Class herein.  These defendants participated in the alleged wrongdoing, in part, in order to prolong the illusion of Diamond's continued growth; and falsely portray Diamond and its offerings as successful, profitable ventures when they were not, so that they could (i) protect their executive and/or directorship positions and the substantial compensation and/or prestige they obtained thereby; (ii) inflate the apparent profits and future prospects of the Company in order to support the market for Diamond's securities and make possible various securities offerings; (iii) sell their own Diamond securities at artificially inflated prices, and (iv) conceal and cover up                                - 4 -
their own prior misconduct and mismanagement of Diamond and avoid being held responsible therefor.  Each of the Individual Defendants was a controlling person within the meaning of Section 20 of the Exchange Act and each exercised the power and influence to cause, and did cause, Diamond to engage in the unlawful conduct complained of herein.  Each of the Individual Defendants is sued as a participant in the wrongdoing alleged herein and in his capacity as a controlling person of Diamond. Moreover, each of the Individual Defendants traded in Diamond securities based upon material inside information not available to plaintiff and the Class.                    CLASS ACTION ALLEGATIONS      13.  This action is brought as a class action pursuant to Rule 23(a) and 23(b)(3) of the Federal Rules of Civil Procedure, on behalf of a class (the "Class") consisting of plaintiff and all other persons and entities who purchased converted, exchanged, or otherwise acquired Diamond securities of any kind from November 1, 1995 through the close of business on June 20, 1996, both dates inclusive (the "Class Period").  Excluded from the Class are the defendants herein, members of the immediate family of the defendants, any entity in which any of the defendants has a controlling interest, and the legal representatives, heirs, successors or assigns of any of the defendants.      14.  This action is properly maintainable as a class action for the following reasons:           (a)  Although the exact number of class members cannot be ascertained, they are so numerous and geographically                                - 5 -
dispersed that joinder of all class members is impracticable. Plaintiff believes that there are at least thousands of members of the Class.  As of April 10, 1996, more than 34.7 million shares of common stock were outstanding with more than 389 shareholders of record.  Diamond common stock traded on the NASDAQ National Securities Exchange, an efficient market.           (b)  There are common questions of law and fact involved herein which predominate over any questions affecting only individual members of the Class.  These common questions of law and fact include:                (i)    Whether defendants, during the Class Period, acted in concert and concealed from the public investors the true facts relating to the operations and financial condition of Diamond, including missing inventory, poor production performance, "antiquated" accounting practices and the amount of the Company's revenues, earnings and expenses.                (ii)   Whether defendants publicly disseminate false financial and other statements of the Company during the Class Period;                (iii)  Whether the defendants violated Section 10(b) and 20 of the Exchange Act and Rule 10b-5 promulgated thereunder;                (iv)   Whether the acts and omissions of defendants constitute violations of the common law;                (v)    Whether plaintiff and the other members of the Class sustained damages, and, if so, the proper measure thereof; / / /                                - 6 -
          (c)  The claims of plaintiff are typical of those of the Class in that plaintiff is a member of the Class and has no known interests that are antagonistic to or contrary to the interests of the Class.           (d)  Plaintiff will fairly and adequately protect the interests of the members of the Class and has retained competent counsel experienced in class and securities litigation to vigorously prosecute this action.           (e)  A class action is superior to other available methods for the fair and efficient adjudication of this controversy.  Plaintiff knows of no difficulty to be encountered in the management of this action which would preclude its maintenance as a class action.  Furthermore, since the damages suffered by individual class members may be relatively small, the expense and burden of individual litigation make it impracticable for the Class members to seek redress individually for the wrongs they have suffered.      15.  Plaintiff will rely, in part, upon the presumption of reliance established by the fraud-on-the-market doctrine in that:           (a)  defendants made public misrepresentations during the Class Period, as alleged herein;           (b)  the misrepresentations were material;           (c)  shares of Diamond common stock were traded on a developed national stock exchange, namely the NASDAQ, which is an efficient market within the meaning of that term in the context utilized herein; / / /                                - 7 -
          (d)  plaintiff and the other members of the Class purchased their Diamond shares between the time defendants made the misrepresentations and time the truth was revealed, and made such purchases without knowledge of the falsity of the misrepresentations.      16.  Based upon the foregoing, plaintiff is entitled to a presumption of reliance upon the integrity of the market for the purposes of class certification.  Similarly, plaintiff is entitled to a presumption of reliance with respect to the omissions alleged herein.                   WRONGFUL COURSE OF CONDUCT      17.  Throughout the Class Period, defendants engaged in a scheme whereby they repeatedly engaged in materially false and deceptive announcements and financial reporting in order to create the appearance of a thriving, growing corporation with excellent products when it was not.  This was done in order to artificially increase the price of Diamond stock, at least in part to enable Diamond to make acquisitions and to enable the Individual Defendants to make unwarranted profits on their own stock sales.      18.  On February 13, 1995, the Individual Defendants caused Diamond to file an S-1 Registration Statement for the initial public offering of Diamond shares, which was completed on or about April 12, 1995.  The initial public offering raised over $127 million.  Subsequently, the price of Diamond stock maintained a price level of approximately $20 per share. Because defendants intended to use Diamond securities for corporate acquisitions, and in order to reap huge unwarranted                                - 8 -
profits on the sale of their own securities, defendants began issuing materially false and misleading statements to artificially inflate the price of Diamond stock.      19.  On or about November 1, 1995, Diamond issued a press release which stated that the Company's Stealth64 Video 2001 Multimedia accelerator had been selected by Compaq as an integral part of Compaq's systems (the "First Press Release"). Defendants stated that the reason for such selection was the accelerator's "powerful graphics and video playback acceleration."      20.  On or about November 14, 1995, the Company filed a Form 10-Q with the SEC for the quarter ended September 30, 1995 (the "10-Q").  Said 10-Q was materially false and misleading in that it did not disclose that, increasingly, Diamond was experiencing problems and defects with its products.      21.  In the 10-Q, defendants disclosed the acquisition of the Supra Corporation ("Supra"), a manufacturer and marketer of modem products and the proposed acquisition of SPEA Software AG ("Spea"), which was disclosed in the Registration Statement and the Prospectus dated October 26, 1995 and November 21, 1995 respectively.      22.  On or about October 26, 1995, the Individual Defendants caused Diamond to file a Form S-1 Registration Statement with the SEC, which became effective on or about November 21, 1995 (the "Registration Statement").  Pursuant to the Registration Statement, Diamond offered 3,150,000 shares of common stock, 350,000 sold by, inter alia, defendants Lee, Huh, Schroeder and Filler (the "Offering").                                - 9 -
     23.  The 10-Q, the Registration Statement and the Prospectus dated November 21, 1995 (the "Prospectus") contained materially false and misleading financial statements for the quarter ended September 30, 1995, which financial statements contained materially overstated assets and net income.  The Prospectus fraudulently represented that net income for the nine months ended September 30, 1995 was a loss of $16,435,000 or a loss of $.66 per share, on a consolidated basis and total assets to be $182,180,000 as of September 30, 1995.  However, in both the Registration Statement and the Prospectus, defendants, in order to minimize the effects of the losses, included pro forma financial statements, including acquisitions, for the nine months ended September 30, 1995.  The pro forma figures were substantially different than the consolidated statements.  The pro forma figures represented net income to be $4,620,000 and earnings per share of $.16 with total assets of $225,752,000.      24.  Diamond's financial statements for the third quarter ended September 30, 1995 were included in the Registration Statement, and the Prospectus.  The financial statements state:           The accompanying interim consolidated           balance sheet of September 30, 1995 and           consolidated statements of operations and           cash flows for the nine months ended           September 30, 1995 and 1994 together with           the related notes are unaudited but include           all adjustments, consisting of only normal           recurring adjustments, which the Company           considers necessary to present fairly, in           all material respects, the consolidated           financial condition at September 30, 1995           and the consolidated results of operations           and cash flows for the periods ended           September 30, 1995 and 1994.  Results for           the nine months ended September 30, 1995 are           not necessarily indicative of results for           the entire year.                               - 10 -
          Diamond's Stealth series includes 3           multimedia accelerator product lines           the Stealth64 Video 3000 series, the Stealth           2001 series. . . and the Stealth64 Video           2001TV . . . .  The lower cost Stealth64           Video 2001 Series also supports video           playback through software-based           decompression, but uses lower-cost DRAM           memory and a lower performance multimedia           processor.  The Stealth64 Video 2001 series           is also upgradable to hardware-based MPEG           decompression and also features an           additional TV tuner upgrade module that           enables live television in a window.  The           Stealth64 Video 2001TV incorporates the           features of the Stealth64 Video 2001 and the           TV tuner in one integrated package, which           can be further upgraded to include hardware           MPEG decompression.      25.  Diamond's 10-Q for the third quarter ended September 30, 1995, states that: "Inventories are stated at the lower of cost (determined on a first-in, first-out basis) or market."      26.  On or about November 15, 1995 the Company acquired Spea.  On page 5 of the Prospectus, defendants state that "Spea is one of the leading suppliers of graphics accelerator subsystems for PCs in Europe.  During the fiscal year ended December 31, 1994... Spea had revenues of $107.4 million... and net losses of $2.4 million..."      27.  On November 21, 1995, based upon defendants representations, Montgomery Securities ("Montgomery"), an underwriter for the Offering, issued a report on Diamond authored by P.G. Fox (the "First Montgomery Report").  The report was based upon projected earnings of $1.77 per share in fiscal year 1996.  The First Montgomery Report reiterated the defendants' claims that Spea would substantially increase Diamond's revenues from Europe and that the introduction of the                               - 11 -
Stealth 3-D product would have a positive impact on fiscal year 1996 earnings and would not materially adversely impact the Company's sales of its Edge 3-D product and projected that Diamond would reach a price of $40 per share.  Defendants knew or recklessly disregarded that the information provided would be made public.      28.  The Registration Statement, the Prospectus, the First Press Release, the First Montgomery Report, and the 10-Q were materially false and misleading.  The true facts which defendants knew or recklessly disregarded and did not disclose, based upon internal Diamond information were that:           (a)  Diamond overstated its revenues and earnings for the third quarter ended September 30, 1995 by improperly recognizing revenues on "sales" which were contingent on resale and by failing to provide an adequate reserve for obsolete and excess inventory, failing to properly recognize the full cost of sales and by improperly inflating inventory levels.           (b)  Diamond's financial statements were, in fact, not in accordance with Generally Accepted Accounting Principles and did not state inventories at the lower of cost or market because they failed to provide adequate reserves for obsolete and excess inventory.           (c)  Diamond failed to provide adequate controls necessary to monitor, account for and accurately report inventory purchases and cost of sales.  As a result, Diamond's inventory levels were overstated and Diamond's cost of sales were understated. / / /                               - 12 -
          (d)  Prior to 1996, defendants lacked a reasonable basis to project Diamond's financial results or to accurately prepare Diamond's Financial Statements because Diamond lacked the accounting system and the internal controls necessary to prepare projections and financial statements.  The defendant relied upon a system of accounting which utilized manual logs which has been described by one of the defendants as "antiquated";           (e)  The TV tuner upgrade module for the Stealth64 Video 2001 contained significant design defects which were not entirely remedied throughout the fourth quarter of 1995. Shipments were repeatedly delayed because Diamond was only able to ship minimal volumes due to these defects;           (f)  The Stealth64 Video 2001 series lacked a driver for a Windows 95 application;           (g)  The Stealth64 Video 2001 was not being shipped in a format that was compatible with Windows NT or OS/2 operating systems;           (h)  The Stealth64 Video 3000 series had been shipped by the Company with driver problems which caused the Stealth64 Video 3000 series products to suffer from "lock-up."  A material portion of the product was being returned due to said "lock-up." As a result, the Stealth64 Video 3000 product was accumulating as excess and/or non-saleable inventory;           (i)  Due mainly to malfunctions in the processors utilized by Diamond in the 3000 series products said 3000 series products were working only with PCI buses; / / /                               - 13 -
          (j)  Customers were canceling orders and/or returning merchandise due to the misrepresentations made by defendants concerning their products abilities and quality; and           (k)  The Spea acquisition included the acquisition of millions of dollars of obsolete, overvalued and materially excess inventory.  Because defendants Schroeder and Filler undertook the investigation and analysis of Spea, they knew or should have known of the overvaluation of Spea.           (l)  Because of the facts stated herein, the defendants had no reasonable basis for the revenue and earnings projections made by them.      29.  On or about November 22, 1995, Montgomery issued a second report authored by P.G. Fox.  The Seconber 1, 1996, Donaldson and Alex issued favorable reports based upon the aforementioned conversations.                               - 14 -
As a result, the price of Diamond shares increased from $30.50 on November 29, 1995 to $33.75, on November 30, 1995, $37.25 on December 1, 1995, up to $40.75 on December 4, 1995, a thirty three percent increase.  In providing said information, defendants knew or recklessly disregarded that it would become public.      31.  On or about December 4, 1995, based in part on statements made by Schroeder to R. Stone, Cowen & Co. ("Cowen") issued on "strong buy" recommendation and set its price target of $44-47 per share for Diamond stock.  In providing said information, defendants knew or recklessly disregarded that it would become public.      32.  On or about December 5, 1995, at the Montgomery Technology Conference, defendant Schroeder stated that, although component supplies were tight, Diamond's, ISDN communications products and 3-D graphics products would have a major positive impact on Diamond's earnings in early 1996.      33.  On or about December 20, 1995, Donaldson issued a report authored by T.T. Rooney based upon information provided by defendants, who knew or recklessly disregarded that the information would be made public, which claimed that Diamond would have a 20-25% growth rate in 1996.      34.  The statements made by defendants from November 22, 1995 through December 20, 1995 by defendants and analysts to the public were materially false and misleading, and defendants knew or recklessly disregarded and did not disclose the fact that they were so, in that: / / /                               - 15 -
          (a)  The supply of chips from Rockwell for the Company's communication products was haphazard, including those for Diamond's telecommander boards.  As a result, Diamond's production line was halted due to the unavailability of the aforementioned chips which had a material negative effect on both margins and sales;           (b)  The Company's introduction of its Stealth 3-D product would necessarily have an adverse impact on the higher cost, higher priced, less desirable Edge 3-D product due to the fact that they competed against each other;           (c)  The Company's ISDN communications product would be delayed because Microsoft failed to timely provide a software driver necessary to operate the product.  The software driver would not be made available in sufficient numbers until at least the middle of the first quarter of 1996;           (d)  Prior to 1996, defendants lacked a reasonable basis to project Diamond's financial results or to accurately prepare Diamond's Financial Statements because Diamond lacked the accounting system and the internal controls necessary to prepare projections and financial statements.  The defendant relied upon a system of accounting which utilized manual logs which has been described by one of the defendants as "antiquated";           (e)  Diamond was experiencing high rates of return and customer dissatisfaction because of the previously described problems Diamond was having with the Stealth64 Video 2001 and Stealth64 Video 3200 products; and / / /                               - 16 -
          (f)  Because of facts stated herein, the defendants had no reasonable basis for the revenue and earnings projections then being made by them.      35.  On January 17, 1996, Diamond issued a press release containing its results for the year ended December 31, 1995. The Company reported revenue of $190.1 million for the year, as compared to $60.6 million for the fiscal year ended December 31, 1994.  However, defendants also announced "unexpected year end inventory adjustments" of $3.7 million due to "missing inventory".      36.  On the same day, defendants Schroeder and Filler spoke to securities analysts P.C. Rueppel of Alex, R. Stone of Cowen, P.G. Fox of Montgomery and T.T. Rooney of Donaldson.  In that conversation, Schroeder and Filler represented:           (a)  The Company was investigating the missing inventory but "didn't know what [had] happened";           (b)  That despite the missing inventory, there was "no change" in the Company's revenue projections;           (c)  That they were not aware of the inventory issue until the end of the fiscal year and quarter;           (d)  That demand for the Company's graphics and communications products continued to be "strong"; and           (e)  That the Company experienced "higher than expected" sales of its Edge 3-D product and anticipated that the product would continue to show growth in 1996.      37.  The foregoing representations were disseminated to the public via reports issued by Donaldson and Montgomery on January 18, 1996 and defendants knew or recklessly disregarded                               - 17 -
that the information would became public.  The information was also contained in Diamond's "Corporate Backgrounder" release to investors.      38.  Defendants knew or recklessly disregarded the fact that the statements referenced in paragraphs 35-37, supra, were materially false and misleading at least in part because defendants knew or recklessly disregarded and did not disclose that:           (a)  Diamond had no viable computer Management Information Systems or accounting infrastructure.  Its only method of ascertaining inventory was through the use of its pencil and spreadsheet methodology.           (b)  Contrary to their claims, defendants had no way of knowing whether or not the "missing" inventory had been stolen because Diamond had wholly inadequate internal controls and little or no inventory control systems in place during 1995. Instead, the defendants relied upon W.T. Kim to keep track of and to provide inventory data on an as-needed basis;           (c)  Prior to 1996, defendants lacked an accounting system and internal controls necessary to calculate and prepare Diamond's financial statements.  Instead, defendants relied upon a system of manual logs which defendant Schroeder testified was "antiquated."           (d)  Diamond was experiencing high rates of product return and customer dissatisfaction because of the previously stated problems with the Stealth64 Video 2001 and Stealth64 Video 3200. / / /                               - 18 -
     39.  As a result of the January 17, 1996 announcement, the price of Diamond stock fell from $26.25 to $17.4375 on January 18, 1996.      40.  On January 18, 1996, T.T. Rooney of Donaldson, a Diamond underwriter, and Schroeder held a conference call with numerous analysts throughout the country.  In those calls, Rooney and Schroeder maintained that the lack of internal controls had been remedied and that the impact of the $3.7 million loss was, in fact, minimal.  Rooney and Schroeder attempted to convince analysts to reduce their gross margin projection by a mere 1% for fiscal year 1996, although a larger reduction was warranted.      41.  On January 19, 1996, defendants announced that the previously discussed improvements to inventory and manufacturing control systems were "almost in place."  Defendant Schroeder also said that Diamond had still not determined what happened to the missing inventory, but that it consisted of products in the company's multimedia business.  Schroeder emphasized that the new inventory and manufacturing systems would provide Diamond with "a more professional way to manage its operations."      42.  On or about February 27, 1996 T.T. Rooney of Donaldson issued a report, based upon statements made by Filler and Schroeder, projecting Diamond's fiscal year 1996 earnings at $1.70 per share and representing that defendants "guided" Rooney's revenue projections to be increased by $10 million to $167.7 million.      43.  Due to the fact that, at this point, adjustments to Diamond's financial statements were imminent and the scheme to                               - 19 -
defraud could no longer be maintained at the same levels, defendants began a campaign of partial disclosures, or "limited hang-out", in order to soften the blow of the as yet undisclosed inflation of Diamond's stock price and to maintain artificially high levels as long as possible.      44.  From November 27, 1995 through May 10, 1996 defendants took full advantage of the artificially high levels of the price of Diamond stock.      45.  From November 27, 1995 through May 10, 1996, defendant Schroeder sold 115,932 shares of Diamond common stock at prices ranging from $18.89 to $29.92, including 40,000 shares on January 31, 1996 and 10,000 shares on February 1, 1996, just before the partial disclosures began.      46.  From November 27, 1995 through April 29, 1996, defendant Filler sold 119,527 shares of Diamond common stock at prices ranging from $18.88 to $29.92, including 40,000 shares on January 31, 1996, just before the partial disclosures began.      47.  Defendant Lee, from November 27, 1995 through December 5, 1995, sold a total of 131,993 shares of Diamond common stock at prices ranging from $29.92 to $31.25 prior to any disclosures, including the disclosure of the "missing" inventory.      48.  Defendant Huh sold 153,401 shares of Diamond stock from November 27, 1995 through March 1, 1996, at prices ranging from $17.00, to $29.92 per share, including 17,107 shares on November 27, 1995 and 18,622 shares on December 5, 1995, prior to any disclosures, including the disclosure of the "missing inventory".                               - 20 -
     49.  On April 1, 1996, Diamond issued two press releases. The first announced a new product, Diamond's Stealth 3D accelerator and stated that the accelerator;           Will deliver high-performance 2D graphics as           well as 3D animation and MPEG-l digital           video playback acceleration for PC's running           Microsoft's Windows 95, Windows 3.1x,           Windows NT 3.51 and DOS operating systems.           Designed for systems with a PCI bus, the new           Stealth 3D 2000 accelerates a new realm of           computer applications featuring realistic 3D           animation and video such as multimedia           applications and games.           The modular design of the Stealth 3D 2000           will also allow for the affordable addition           of a TV tuner option.  An OEM/VAR version of           Stealth 3D 2000 will be available in April           to Diamond OEM customers and through its           authorized distributors.  The retail version           of the Stealth 3D 2000 will be available in           June to consumers and dealers through           Diamond's network of mass merchants,           retailers and authorized distributors.                      The new Diamond Stealth 3D provides ultra           high-performance 2D capabilities as well as           powerful 3D graphics and video           acceleration," said Ken Wirt, vice president           of marketing, marketing, Diamond Multimedia           Systems, Inc.  Now PC users can take           advantage of the latest in immersive 3D           animation and continue to have improved           Stealth performance and reliability for           their Windows acceleration and business           application needs.      The second press release announced a $50 price reduction for Diamond's Edge 3-D multimedia accelerators.      50.  On April 18, 1996, Diamond issued a press release announcing its financial results for the first quarter of 1996. The press release stated:           Diamond Multimedia Systems, Inc. reported           increased revenues and earnings for the           quarter ended March 31, 1996.                               - 21 -
          For the first quarter of 1996, revenues           increased 134 percent to $187.6 million from           $80.3 million in the first quarter of 1995.           Diamond reported net income of $11.2           million, or $0.32 per share on 35.3 million           shares 22 outstanding for the quarter ended           March 31, 1996 versus net income of $6.1           million, or $0.28 per share on 20.9 million           shares outstanding, for the first quarter of           1995.                      During the quarter, Diamond continued to           experience solid demand for its products           including communications products.  The           Company's communications division, which           includes the recently acquired business of           Supra Corporation located in Vancouver,           Washington, accounted for 22 percent of           revenues or $42.1 million.  Excluding sales           from recently acquired subsidiaries,           revenues were up 58 percent from the prior           year period.                      Gross margin for the quarter was down from a           year ago to 21% primarily due to lower           selling prices.  During the second fiscal           quarter of 1996, however, declines in prices           for DRAMs and other components will result           in lower costs for the Company's products.           As a result gross margins are expected to           improve in the second quarter.      51.  On or about April 19, 1996, Schroeder and Filler once again spoke by telephone to R. Stone, P.C. Rueppel and P.G. Fox. In that call, Schroeder and Filler represented that:           (a)  The Company's inventory problem had been "resolved";           (b)  The Company's adopted adequate inventory controls;           (c)  The Company's graphics products, including its Stealth 3-D, Edge 3-D products and its communications products were experiencing "strong demand";           (d)  Diamond had reduced its inventory; / / /                               - 22 -
          (e)  Its connectivity products were experiencing strong market demand;           (f)  Diamond's margins would rebound substantially, to the 23 percent range the second quarter;           (g)  Diamond would earn approximately $0.39 per share in the second quarter, $1.72 per share for the full year and earnings would grow approximately 30% over the next two years; and           (h)  The Company's results for the second quarter would be a continuation of the Company's positive first quarter results with additional growth in revenues.      52.  The information that defendant's provided to the securities analysts was disseminated by these analysts in written reports on or about April 19, 1996.      53.  Meanwhile, defendants Filler and Schroeder collectively sold 13,750 shares of Diamond stock from April 23, 1996 through May 10, 1996.  Notably, the last stock sale by any of the Individual Defendants was May 10, 1996, just before the first substantial change in earnings forecasts.      54.  On or about May 24, 1996, Alex issued a report authored by P.C. Rueppel, based upon Rueppel's conversations with defendants Schroeder and Filler.  Rueppel's report decreased earnings projections to $1.45 for 1996 and reduced revenue projections to $165 million from $195 million for the quarter.  Based on concerns about inventory, Alex reduced its second quarter projections to earnings of $0.28 per share.      55.  The aforementioned statements from January 15, 1996 through May 24, 1996 were materially false and misleading.  The                               - 23 -
true facts, known or recklessly disregarding by defendants and not disclosed were that:           (a)  In order to meet revenue and earnings projections made by and on behalf of Diamond for the first quarter of 1996, the defendants had deliberately overshipped merchandise;           (b)  Diamond's customers were unwilling to accept additional product during the second quarter due to the overshipment in the first quarter;           (c)  Beginning by at least January 17, 1996, continuing throughout the first quarter of 1996, the defendants were offering substantial discounts and/or rights of return to the Company's wholesale, distributor and OEM customers in order to meet the revenue projections previously described. Defendants knew or recklessly disregarded the fact that a substantial portion of the "sold" products would be returned or that receivables recognized in conjunction with such "sales" would be written off;           (d)  Defendants and the Company were extending extremely lenient credit terms in order to get large clients to accept the Company's Edge 3-D product;           (e)  Many of Diamond's customers were planning to return all unsold Edge 3-D products;           (f)  The lower priced, higher quality Stealth 3-D product would cause the Company's Edge 3-D sales to disintegrate because they were competing products;           (g)  The total sales of Diamond's graphics products to Ingram Micro, Inc., Merisel, Inc. and Tech Data Corp., all major customers, were rapidly declining;                               - 24 -
          (h)  Margins had eroded and were materially less than those being projected by defendants;           (i)  The Company could not in fact, project gross margins of 23% due to the substantial price cuts and discounts implemented by defendants in early 1996, including those on the Edge and Javelin products which had a substantial negative impact on gross margins; and           (j)  Purchasers of certain Diamond products, including the Stealth64 Video 3000, were not getting the products they had purchased, but were receiving substitute products they had not purchased.      56.  Throughout the Class Period, defendants knew or recklessly disregarded that the financial results, announcements and representations made to the public were materially false and misleading in that defendants knew or recklessly disregarded the fact that:           (a)  In order to artificially boost Diamond's third quarter fiscal 1995 results to complete a stock offering, Diamond (i) improperly recorded revenues on contingent sales of its graphic accelerators; (ii) deliberately shipped excessive amounts of that product to its major customers defendants; and (iii) provided those customers extended or deferred payment terms or the absolute right of return of the product. Defendants knew or recklessly disregarded the fact that said action would negatively affect Diamond's revenues in the fourth quarter of fiscal 1995 and first quarter of 1996;           (b)  By the first quarter of 1996, Diamond's Edge 3-D product was not selling well through Diamond's distribution                               - 25 -
channel.  Sales of the Edge 3-D product were at such low levels that Diamond was giving customers huge discounts and unlimited return privileges and therefore expected to report lower margins for the first quarter of 1996 and extensive returns before the end of the second quarter 1996.           (c)  Diamond's largest distributors and customers had collectively decreased their purchases from Diamond during the second quarter of fiscal year 1996;           (d)  Diamond had accumulated large amounts of obsolete graphics products which defendants knew or recklessly disregarded would have to be written off or substantially written down;           (e)  Defendants falsely represented that Diamond was enjoying continued or "strong" demand for its graphics products;           (f)  Diamond was having increasing difficulty selling its Edge 3-D products due to weakening demand;           (g)  In order to sell products, Diamond was extending very lenient payment terms or unlimited right of return on products including, inter alia, the Edge 3D product.  This made it virtually certain that Diamond's revenues and earnings would decline later in fiscal 1996;           (h)  Diamond's forecasts of 23% gross margins for its foreseeable future, second quarter fiscal 1996 revenues of $165 million, earnings per share of $0.28 to $0.36 and a resumption of strong revenue and earnings growth in fiscal year 1997 lacked a reasonable basis in fact and were false and misleading;           (i)  Defendants' forecasts of second quarter fiscal 1996 revenues and earnings per share of approximately $0.30 and                               - 26 -
strong revenues and earnings per share growth for Diamond in fiscal year 1996 and 1997 were materially false and misleading, as they were contradicted by the adverse facts as set forth above;           (j)  Beginning by at least January 17, 1996, the defendants were offering substantial discounts and/or rights of return to Diamond's wholesale, distributor and OEM customers in order to meet the revenue projections made by and on behalf of the defendants;           (k)  That defendants knew or recklessly disregarded the fact that many of Diamond's customers were planning to return all unsold Edge 3-D products; and           (l)  The lower cost, higher quality Stealth 3-D product would adversely impact the Company's Edge 3-D sales, due to its lower price and better quality.      57.  On June 20, 1996, after the close of the stock market, Diamond suddenly revealed that it expected to report a loss or break-even in the second quarter of fiscal year 1996 on revenues of just $120 million due to extremely weak sales.  Diamond also stated to analysts that it would write down over $7.5 million in inventory in the quarter ended June 30, 1996.  Diamond's stock plunged to as low as $9-1/8 per share on these revelations on a volume of over 3 million shares.      58.  The financial statements of Diamond, beginning at least with the third quarter ended September 30, 1995, were not presented "fairly" and "in conformity with generally accepted accounting principles" because: / / /                               - 27 -
          (a)  The accounting principles selected and applied did not have general acceptance;           (b)  The accounting principles were not appropriate in the circumstances;           (c)  The financial statements, including the related notes, were not informative of matters that affected their use, understanding, and interpretation; and           (d)  The financial statements did not reflect the underlying events and transactions in a manner that presented the financial position and the results of operations within a range of acceptable limits that were reasonable and practicable to attain in financial statements.      59.  Further, said financial statements failed to disclose material adverse information and misrepresented the truth about Diamond's results of operations, financial condition, and future business prospects.  The material misrepresentations included Diamond's:           (a)  Overstatement of the carrying value of receivables and inventory as assets on its balance sheet;           (b)  Failure to disclose its exposure to contingent sales and/or sales subject to the right of return; and           (c)  Overstatement of income, assets and net worth due to the failure to timely and fully reserve for the return of merchandise which was sold subject to the right of return.    &nb least a reasonable possibility that a loss or an additional loss may have been incurred (Statement of Financial Accounting Standards No. 5, Accounting for Contingencies para. 10);           (c)  The principle that disclosure of accounting policies should identify and describe the accounting principles followed by the reporting entity and the methods of applying those principles that materially affect the financial statements (APB Opinion No. 22, paragraph 12);           (d)  The principle that contingencies that might result in gains usually are not reflected in the accounts since to do so might recognize revenue prior to its realization (Statement of Financial Accounting Standards No. 5, para. 17);           (e)  The principle that costs and losses that may be expected in connection with any returns of merchandise shall be accrued (Statement of Financial Accounting Standards No. 48, paragraph 7);           (f)  The principle that revenues should ordinarily be accounted for at the time a transaction is complete, with appropriate provision for uncollectible accounts (APB Opinion No. 10, paragraph 12);                               - 29 -
          (g)  The principles that revenues and gains generally are not recognized until realized or realizable, and revenues are considered to have been earned when the entity has substantially accomplished what it must do to be entitled to the benefits represented by the revenues (Statement Of Financial Accounting Concepts No. 5, paragraph 83);           (h)  The principle that the quality of reliability and, in particular, of representational faithfulness leaves no room for accounting representations that subordinate substance to form (Statement Of Financial Accounting Concepts No. 2, paragraph 160); and           (i)  The principle that asset valuation allowances for losses should be deducted from the assets or groups of assets to which they relate with appropriate disclosure (APB Opinion No. 12 paragraphs 2 and 3).                              COUNT I    Violations of Sections 10(b) of the Exchange Act and  Rule 10b-5 Promulgated Thereunder Against All Defendants      61.  Plaintiff repeats and realleges the allegation contained in paragraphs 1 through 60 of the Complaint as if set forth herein.      62.  The Securities described herein are securities, as defined in Section 2(1) of the Securities Act [15 U.S.C. §77b(1)] and Section 3(a)(9) of the Exchange Act (15 U.S.C. §78c(a)(10)].      63.  Defendants, by use of the means or instrumentality  of interstate commerce or the use of the mails, engaged in the use of manipulative and deceptive practices in connection with the                               - 30 -
sale of such securities to plaintiff and the members of the Class in violation of Section 10(b) of the Exchange Act, 15 U.S.C. §78j(b), and Rule 10b-5 promulgated thereunder.      64.  Such manipulative and deceptive practices included, inter alia, the use of untrue statements of material fact and the omission of material facts particularly alleged above that a reasonable investor would have considered important in making an investment decision in connection with Diamond.      65.  Such defendants knowingly or recklessly made such untrue statements and omissions of material fact for the purpose of inducing plaintiff and Class members to purchase such securities.      66.  Plaintiff and the members of the Class justifiably relied on such untrue statements and omissions of material fact in deciding to purchase such securities.      67.  Plaintiff and the members of the Class also justifiably relied on the honesty and integrity of such defendants and the processes and procedures supposedly used and followed to issue and sell the securities described herein, in deciding to purchase such securities.      68.  In fact, had the plaintiff and other Class members known of the fraud perpetrated by such defendants in connection with the issuance, distribution and sale of the securities described herein such securities could not have been sold at any price or at a price substantially below that price paid by plaintiff and the Class.      69.  As a result of such defendants' conduct, the plaintiff and the Class have suffered damages.                               - 31 -
     70.  By reason of the acts, omissions, practices, and courses of business set forth herein, these defendants have violated Section 10(b) of the Exchange Act [15 U.S.C. §78j(b)], and Rule 10b-5 promulgated thereunder [15 C.F.R. §240.10b-5].                             COUNT II     (Against the Individual Defendants For Violations              of Section 20 of the Exchange Act)      71.  Plaintiff repeats and realleges each and every allegation contained in paragraphs 1 through 70 above, as if set forth fully herein.      72.  The Individual Defendants acted as controlling persons of the Company within the meaning of Section 20 of the Exchange Act.  By reason of their positions as officers and/or directors and their substantial stock ownership, the Individual Defendants had the power and authority to cause the Company to engage in the wrongful conduct complained of herein.      73.  In their capacity as control persons of Diamond, each defendant had a duty to disseminate only truthful and accurate information to the investing public and to promptly correct any materially false and misleading statements disseminated so that the price of Diamond's common stock would be based on accurate and complete information.      74.  By reason of such wrongful conduct, the Individual Defendants are liable pursuant to Section 20 of the Exchange Act.  As a direct and proximate result of their wrongful conduct, plaintiff and the other members of the Class suffered / / /                               - 32 -
damages in connection with their purchases of the Company's securities during the Class Period.                            COUNT III                (Under the Common Law for Fraud              And Deceit Against All Defendants)      75.  Plaintiff repeats and realleges each and every allegation contained in paragraphs 1 through 74 as if fully set forth herein.      76.  This Count is asserted under principles of common law and California law.      77.  During the Class Period, defendants, individually and in concert, directly and indirectly, engaged and participated in, or knowingly devised a common plan and scheme and continuing course of conduct and conspiracy to conceal adverse material information about the Company's financial practices and its prior false and misleading representations to the public about Diamond's financial condition.  Defendants employed devices, schemes and artifices to defraud and engaged in acts, practices and a course of conduct as herein alleged in an effort to maintain an artificially high market price for the securities described herein, which included the making of untrue statements of material facts, omitting to state material facts necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, and engaging in transactions, practices, and courses of business which operated as a fraud and deceit upon the purchasers of securities described herein during the Class Period. / / /                               - 33 -
     78.  The false and misleading statements and omissions of defendants in relation to securities as described herein, and in their public announcements, were made with the intent to deceive and/or defraud plaintiff and the other Class members, or to aid and abet the deception and defrauding of plaintiff and the other Class members, or were made with such recklessness or indifference to truth as to constitute intent to deceive and defraud plaintiff and the other members of the Class.  Said acts by defendants were fraudulent, oppressive and malicious.  Each of the defendants, by acting as described above, did so knowingly or with such recklessness as to constitute a fraud and deceit upon plaintiff and the other members of the Class.      79.  The acts, practices and common course of conduct by defendants operated as a fraud and deceit upon (a) the market in securities described herein; (b) plaintiff and the other members of the Class who relied on (i) the aforesaid market and the market prices to reflect the true value of the securities described herein based on true, full, fair and lawful disclosure of material facts; (ii) Diamond's false and misleading financial statements and Diamond's documents described herein; and (iii) the presumed truthfulness of Diamond's disclosure of its financial condition, business, management, revenues, earnings, forecasts and future business prospects.      80.  As a result of the foregoing, defendants, directly and indirectly, committed fraud and deceit upon plaintiff and the Class.  Plaintiff therefore prays for an award of compensatory and punitive damages against defendants. / / /                               - 34 -
                            COUNT IV    (Negligent Misrepresentation Against All Defendants)      81.  Plaintiff repeats and realleges each and every allegation contained in paragraphs 1 through 80 as if fully set forth herein.      82.  The relationship of the defendants to plaintiff and members of the Class was such that plaintiff and members of the Class had the right and did in fact rely upon defendants for information concerning Diamond, and each defendant owed a duty to plaintiff and members of the Class to provide such information with due care regarding its accuracy, and knew or should have known that such information was utilized by plaintiff and members of the Class for a business purpose.      83.  Each of the defendants made and participated in the making of representations of fact to plaintiff and other members of the Class by means of various documents and statements as alleged herein.      84.  In making said representations, defendants, as alleged above, misrepresented material facts and omitted to state material facts necessary to be stated in order that plaintiffs and the Class would have all the material facts necessary for an informed decision.  Among the direct and proximate causes of said misrepresentations and omissions were the negligence and carelessness of the defendants, and the absence of any reasonable basis for belief in the truth of such statements.      85.  At the time said statements were made, plaintiff and the other members of the Class were ignorant of their falsity, and believed them to be true.  In reliance upon said statements,                               - 35 -
the superior knowledge and expertise of defendants, plaintiff and the other members of the Class were induced to and did purchase the securities described herein.  Had plaintiff and the other members of the Class known the truth, they would not have taken such action.  By reason thereof, plaintiff and the other members of the Class have been damaged.      WHEREFORE, plaintiff demands judgment on behalf of herself and the other Class members as follows:      A.   Declaring that this action be maintained as a class action pursuant to Rule 23 of the Federal Rules of Civil Procedure;      B.   Granting judgment in favor of plaintiff and the other Class members against defendants herein, and each of them, under the Counts I through IV for compensatory damages and under Count III for compensatory and punitive damages; together with pre-judgment interest at the maximum rate allowable by law;      C.   Awarding plaintiff the costs and disbursements of this action; including reasonable allowances of fees for plaintiff's attorneys and experts; and /// /// /// /// /// /// /// /// ///                               - 36 -
     D.   Granting plaintiff and the Class such other and further relief as the Court may deem just and proper. Dated:  July 24, 1996      Respectfully submitted,                            SIROTA & SIROTA                                              /s/                            By____________________________________                                           Saul Roffe                            McKENNA & CUNEO, L.L.P.                                              /s/                            By____________________________________                                     Robert S. Brewer, Jr.                            Attorneys for Plaintiff,                            Larry Frazier, Sr.                               - 37 -
                     DEMAND FOR JURY TRIAL           Plaintiff hereby demands a trial by jury of all issues triable before a jury. Dated:  July 24, 1996      Respectfully submitted,                            SIROTA & SIROTA                                              /s/                            By____________________________________                                           Saul Roffe                            McKENNA & CUNEO, L.L.P.                                              /s/                            By____________________________________                                     Robert S. Brewer, Jr.                            Attorneys for Plaintiff,                            Larry Frazier, Sr.                               - 38 -
               CERTIFICATION OF NAMED PLAINTIFF              PURSUANT TO FEDERAL SECURITIES LAWS      Larry Frazier, Sr. ("Plaintiff") certifies, as to the claims asserted under the federal securities laws, that:      1.   Plaintiff has reviewed the complaint and authorized its filing.      2.   Plaintiff did not purchase the security that is the subject of this action at the direction of plaintiff's counsel or in order to participate in this private action.      3.   Plaintiff is willing to serve as a representative party on behalf of the class, including providing testimony deposition and trial, if necessary.      4.   Plaintiff's transaction in the security that are the subject of this action during the Class Period is as follows:           a.   On May 16, 1996, Plaintiff purchased 3,000 shares at a price of $17.125 per share;           b.   On May 28, 1996, Plaintiff purchased an additional 3,500 shares at a price of $15.875 per share.      5.   During the three years prior to the date of this Certificate, Plaintiff has sought to serve or served as representative party for a class in the following actions filed under the federal securities laws: None      6.   The Plaintiff will not accept any payment for serving as a representative party on behalf of the class beyond the Plaintiff's pro rata share of any recovery, except such reasonable costs and expenses (including lost wages) directly relating to the representation of the Class as order or approved by the Court.
          I declare under penalty of perjury that the foregoing is true and correct. Dated: July 10, 1996                                                   /s/                                         _______________________                                            LARRY FRAZIER, SR.                                - 2 -
                 UNITED STATES DISTRICT COURT                 NORTHERN DISTRICT OF CALIFORNIA                               )                               ) LARRY FRAZIER SR.             )                Plaintiff(s)   )                               )         C 96-02644 SBA      -v-                      )                               ) INITIAL CASE MANAGEMENT SCHEDULING ORDER DIAMOND MULTIMEDIA SYSTEM     )           Civil L.R. 16-2                Defendant(s)   ) ______________________________)      IT IS HEREBY ORDERED THAT this action is assigned to the Honorable Saundra Brown Armstrong.  When serving the complaint or notice of removal, the plaintiff or removing defendant shall serve on all other parties a copy of this order, the handbook entitled "Dispute Resolution Procedures in the Northern District of California" and all other documents specified in Civil Local Rule 4-3. Counsel shall comply with the case schedule listed below unless the Court otherwise orders.                            CASE SCHEDULE Date       Event                                           Governing Rule ------------------------------------------------------------------------- 07/24/96   Complaint filed 09/09/96   Last day to file proof(s) or waiver(s) of       Civil L.R. 4-2            service 10/22/96   Last day to meet and confer re case management  Civil L.R. 16-4 11/01/96   Last day to complete initial disclosures        Civil L.R. 16-5 11/25/96   Last day to file/serve Case Management          Civil L.R. 16-6            Statement and ADR Certification                          & 16-7 12/04/96   Case Management Conference in            Courtroom 3, 4th Floor at 3:00 PM               Civil L.R. 16-8


8 Apr 1997