Docstoc

Tabs 4 and 5 - SCEFiling Home

Document Sample
Tabs 4 and 5 - SCEFiling Home Powered By Docstoc
					TAB 4
                                                                                                           Page 1




                                              1 of 1 DOCUMENT

                In re ADAPTIVE BROADBAND SECURITIES LITIGATION; This Document
                                    Relates to: ALL ACTIONS

                                               No. C 01-1092 SC

                UNITED STATES DISTRICT COURT FOR THE NORTHERN DISTRICT OF
                                        CALIFORNIA

                         2002 U.S. Dist. LEXIS 5887; Fed. Sec. L. Rep. (CCH) P91,759


                                            April 2, 2002, Decided
                                             April 2, 2002, Filed

DISPOSITION:    [*1] Defendants' Motion to Dismiss       For DEEPHAVEN MARKET NEUTRAL MASTER
DENIED. Defendants' Request for Judicial Notice          FUND, ADNAN KNAISH, GIULIO [*2] CARUSO,
GRANTED as to Exhibit A, and DENIED as to Exhibits       PETER MCGRATH, CLINT CAVANAUGH, DANA
B and C.                                                 CHANTER, LARRY COHEN, Plaintiffs: Reed R.
                                                         Kathrein, Patrick J. Coughlin, Milberg Weiss Bershad
                                                         Hynes & Lerach LLP, San Francisco, CA.
COUNSEL: For FRANK LETTIERI, JAMES K. NG,
LEON LEYBOVICH, Plaintiffs: Lionel Z. Glancy,            For BART LLOYD, Plaintiff: Reed R. Kathrein, Milberg
Glancy & Binkow LLP, Los Angeles, CA.                    Weiss Bershad Hynes & Lerach LLP, San Francisco, CA.

For GLAZER CAPITAL MANAGEMENT, L.P.,                     For DEEPHAVEN MARKET NEUTRAL MASTER
ASSET MANAGEMENT COMPANY, CHICHESTER                     FUND, ADNAN KNAISH, GIULIO CARUSO, PETER
OFFSHORE, Plaintiffs: Jeffrey A. Klafter, Bernstein      MCGRATH, CLINT CAVANAUGH, BART LLOYD,
Litowitz Berger & Grossmann, New York, NY.               DANA CHANTER, LARRY COHEN, Plaintiffs:
                                                         William S. Lerach, Milberg Weiss Bershad Hynes &
For GLAZER CAPITAL MANAGEMENT, L.P.,                     Lerach LLP, San Diego, CA.
ASSET MANAGEMENT COMPANY, CHICHESTER
OFFSHORE, Plaintiffs: Alan Schulman.                     For DONALD J. ANGELINI, JR., BEVERLY SAGE,
                                                         Plaintiffs: Daniel C. Girard, Robert A. Jigarjian, Girard
For GLAZER CAPITAL MANAGEMENT, L.P.,                     Lee & De Bartolomeo, San Francisco, CA.
ASSET MANAGEMENT COMPANY, CHICHESTER
OFFSHORE, Plaintiffs: Wolfram T. Worms, Bernstein        For DONALD J. ANGELINI, JR., Plaintiff: Anthony K.
Litowitz Berger & Grossmann LLP, San Diego, CA.          Lee, Girard Lee & De Bartolomeo, San Francisco, CA.

For JAMES K. NG, Plaintiff: Michael Goldberg, Glancy     For DONALD J. ANGELINI, JR., Plaintiff: Joshua N.
& Binkow LLP, Los Angeles, CA.                           Rubin, Abbey Gardy & Squitieri LLP, James S. Notis,
                                                         Abbey Gardy & Squitieri, New York, NY.
For DOUGLAS KEEFER, ROY SCOTT, JR.,
RICHARD J. BOOTH, Plaintiffs: Joseph J. Tabacco, Jr.,    For DONALD J. ANGELINI, JR., BEVERLY SAGE,
Jennifer S. Abrams, Berman DeValerio Pease Tabacco       Plaintiffs: Nadeem Faruqi, Shane T. Rowley, Stacey J.
Burt & Pucillo, San Francisco, CA.                       Dana, Faruqi & Faruqi LLP, Mark C. Gardy, Abbey
                                                         Gardy LLP, New York, NY.
For DAVID CHANG, SARAH DOUGHTY, Plaintiffs:
Joseph J. Tabacco, Jr., Berman DeValerio Pease Tabacco   For BART LLOYD, Plaintiff: Darren J. Robbins,
Burt & Pucillo, San Francisco, CA.                       Milberg Weiss Bershad Hynes & Lerach LLP, San
                                                                                                               Page 2
                         2002 U.S. Dist. LEXIS 5887, *2; Fed. Sec. L. Rep. (CCH) P91,759



Diego, [*3] CA.                                           Howard D. Finkelstein, Gregory A. Hartlett, Finkelstein
                                                          & Associates, San Diego, CA.
For LEON LEYBOVICH, Plaintiff: Mel E. Lifshitz,
Bernstein Liebhard & Lifshitz, New York, NY.              For ADAPTIVE BROADBAND CORPORATION,
                                                          FREDERICK D. LAWRENCE, DONNA S. BIRKS,
For RICHARD J. BOOTH, DAVID CHANG, Plaintiffs:            defendants: William S. Freeman, Grant P. Fondo, Cooley
Jeffrey C. Block, Michael G. Lange, Berman DeValerio      Godward LLP, Palo Alto, CA.
Pease Tabacco Burt & Pucillo, Boston, MA.
                                                          JUDGES: Samuel Conti, UNITED STATES DISTRICT
For RICHARD J. BOOTH, Plaintiff: Chauncey Steele,         JUDGE.
Berman DeValerio Pease Tabacco Burt & Pucillo,
Boston, MA.                                               OPINION BY: Samuel Conti
For RICHARD J. BOOTH, Plaintiff: Charles J. Piven,
                                                          OPINION
Law Offices of Charles J. Piven, Baltimore, MD.

For DAVID CHANG, Plaintiff: Chauncey D. Steele, IV,
                                                          ORDER DENYING            DEFENDANTS'        MOTION       TO
Berman DeValerio Pease Tabacco Burt & Pucillo,
                                                          DISMISS
Boston, MA.
                                                              I. INTRODUCTION
For DAVID CHANG, Plaintiff: Donald J. Enright,
Finkelstein Thompson & Loughran, Mark McNair, Law              This is a class action filed on behalf of all purchasers
Office of Mark McNair, Washington, DC.                    ("Plaintiffs") of the publicly-traded securities of Adaptive
                                                          Broadband Corporation ("Adaptive") against Adaptive
For DAVID CHANG, Plaintiff: Christopher T.
                                                          and four of its officers: Frederick D. Lawrence
Heffelfinger, Berman DeValerio Pease Tabacco Burt &
                                                          ("Lawrence"), Adaptive's former Chief Executive Officer
Pucillo, San Francisco, CA.
                                                          and Chairman of the Board of Directors; [*5] Donna S.
For DAVID CHANG, Plaintiff: Jody Anderman, LeBlanc        Birks ("Birks"), Adaptive's former Chief Financial
Maples & Waddell, Baton Rouge, LA.                        Officer; Daniel Scharre ("Scharre"), Adaptive's former
                                                          President and Chief Operating Officer and, later, its
For SARAH DOUGHTY, Plaintiff: Leo W. Desmond,             President, CEO and Director; and Peter J. Maloney
The Law Offices of Leo W. Desmond, West Palm Beach,       ("Maloney"), Adaptive's former Senior Vice President of
FL.                                                       Finance and later, its Chief Financial Officer (collectively
                                                          "Defendants"). On October 23, 2001 Plaintiffs filed a
For DANA CHANTER, Plaintiff: Marc S. Henzel, Law          Corrected Consolidated Complaint for violations of the
Offices of Marc S. Henzel, Philadelphia, PA.              Securities and Exchange Act of 1934. Specifically,
                                                          Plaintiffs allege all Defendants violated Sections 10(b) of
For LARRY COHEN, Plaintiff: David B. Kahn, Mark           the 1934 Act and Securities and Exchange Commission
[*4] E. King, Elissa C. Chase, David B. Kahn &            ("SEC") Rule 10b-5 and that the Individual Defendants
Associates, Northfield, IL.                               violated Section 20(a) of the 1934 Act. Now before the
                                                          Court are the Individual Defendants' Motion to Dismiss
For DAVID SHEEHY, Plaintiff: Bruce G. Murphy, Law
                                                          and Request for Judicial Notice. For the following
Offices of Bruce G. Murphy, Vero Beach, FL.
                                                          reasons, the Individual Defendants' Motion to Dismiss is
For DAVID SHEEHY, Plaintiff: Francis M. Gregorek,         denied and their Request for Judicial Notice is granted in
Francis A. Bottini, Jr., Betsy C. Manifold, Wolf          part and denied in part.
Haldenstein Adler Freeman & Herz LLP, San Diego, CA.
                                                              II. BACKGROUND
For T. ROBERT LACOUR, Plaintiff: Alfred G. Yates,
                                                              Adaptive is a Delaware corporation based in San
Jr., Law Office of Alfred G. Yates Jr., Pittsburgh, PA.
                                                          Jose, California. Before it filed for bankruptcy protection
For T. ROBERT LACOUR, Plaintiff: Jeffrey R. Krinsk,       on July 26, 2001, Adaptive supplied equipment related to
                                                                                                                     Page 3
                           2002 U.S. Dist. LEXIS 5887, *5; Fed. Sec. L. Rep. (CCH) P91,759



broadband wireless communication over the [*6]                  charge of Adaptive's order fulfillment department in 2000
Internet. As a result of its bankruptcy filing, all             until approximately July 2001. Id. at P 41. CW1 claims
proceedings against Adaptive in this Court are stayed           that Adaptive had specific policies for Revenue
pursuant to 11 U.S.C. § 362(a).                                 Recognition Procedure, Order Entry Procedure and
                                                                Commercial Booking Policy, all of which were
    Prior to its bankruptcy filing and throughout the class     incorporated into an Oracle database housing Adaptive's
period, Adaptive common stock was traded on the                 general ledger. Id. at P 43.
NASDAQ National Market System under the symbol
"ADAP." Changes were made to senior management on                   Confidential witness 2 ("CW2") began work at
or around January 11, 2001. Prior to January 11, 2001           Adaptive in 1999. In 2000, and until approximately July
Defendant Lawrence was Adaptive's Chairman and CEO,             2001, CW2 worked in Adaptive's finance division and
Defendant Birks was its CFO, Defendant Scharre was its          reported directly to Defendant Maloney. CW2 generated
President and COO and Defendant Maloney was the                 regular reports for senior management, including a "BBB
Senior Vice President of Finance. After January 11, 2001,       Customer Report" detailing billings, bookings and
Defendants Lawrence and Birks resigned, Defendant               backlog. Id. at P 42. These reports, which were generated
Scharre became the CEO, President and Director and              from Adaptive's Oracle database, were used by senior
Defendant Maloney became the CFO.                               management to support Adaptive's SEC filings and its
                                                                reports to the investing public and securities analysts. Id.
     The facts in this case are complicated slightly by the
fact that Adaptive switched operating calendars around              Confidential witness 3 ("CW3") worked for
the time the class period began. As of June 2000,               Adaptive and its predecessor company for 10 years. Id. at
Adaptive operated on a fiscal calendar year ending June         P 60. In 2000 and until approximately July 2001, CW3
30. The company later transitioned to a calendar ending         was a department head-level information officer in
December 31. For ease of reference, the Court, like the         Adaptive's Rochester, New York offices, the hub of
parties, will refer to a quarter by the month in which it       Adaptive's sales and order administration [*9]
ended, i.e., June 2000 Quarter, etc.                            department. Id. CW3 reported to Adaptive's Chief
                                                                Information Officer, Steve Bringham ("Bringham").
     The class period [*7] in this case extends from
August 10, 2000 through March 15, 2001. Plaintiffs                  Confidential witness 4 ("CW4") was an
allege that the Individual Defendants either participated       administrative assistant who worked for Defendants
in directly or sanctioned by virtue of their authority in the   Lawrence and Birks between July 2000 and February
company a scheme to improperly recognize revenue in             2001. Id. at P 63.
violation of Generally Accepted Accounting Principles
(GAAP). According to Plaintiffs, Defendants were                     For the purposes of a motion to dismiss, the Court
motivated by a desire to bolster the company's economic         takes all of Plaintiffs' allegations as true. They allege the
outlook in order to attract a merger partner. Specifically,     following misleading statements:
Plaintiffs allege that the Individual Defendants overrode
                                                                The Announcement of Fiscal Year 2000 Results
accounting methods and internal company policies to
extend credit to customers with questionable credit                  On the first day of the class period, August 10, 2000,
histories and to "ship" products to Adaptive's own              Adaptive issued a press release "prepared by defendants"
warehouse in an attempt to move them off the books.             and signed by Defendant Lawrence describing financial
According to Plaintiffs, contemporaneously with these           information and results of operations. Id. at PP 33, 89.
maneuvers, the Individual Defendants were reporting to          ("August 2000 release"). These same statements were
the investing public grossly overinflated revenue in order      included in an August 29, 2000 Annual Report on Form
to maintain or raise the price of Adaptive's securities.        10-K filed with the SEC. Id. at P 33.
     Plaintiffs describe statements from four confidential
                                                                    In the August 2000 release, Adaptive claimed a 106
witnesses who have reported details of Defendants'              percent increase in revenue for the June 2000 Quarter as
alleged fraud. Confidential witness 1 ("CW1") is a              compared to the previous quarter. Id. at P 34. Defendants
15-year employee of Adaptive and its predecessor,               Lawrence, Scharre and Birks were quoted in the release
California Microwave. CWI was a manager [*8] in
                                                                                                                    Page 4
                           2002 U.S. Dist. LEXIS 5887, *9; Fed. Sec. L. Rep. (CCH) P91,759



touting the company's success. Id. at PP 35-37. These               CW1 reported another alleged improper transaction
same three defendants signed the Form 10-K, filed              in the June 2000 Quarter, this one [*12] with Cybertech
August 29, 2000 for FY2000 which [*10] repeated                Wireless Inc. ("Cybertech"). Id. at P 48. Cybertech
figures detailed in the August 2000 Release. In the            canceled its June 2000 order and was in debt to Adaptive,
FY2000 10-K, Adaptive reported that it generally               having failed to pay for a prior shipment. Id. A customer
recognizes revenue "upon shipment to a credit-worthy           support representative, after calling Cybertech to confirm
customer." Id. at P 38.                                        that it had canceled its order, recommended that Adaptive
                                                               not ship it. Id. According to CW1, Defendant Maloney
    Plaintiffs claim this statement was false and              extended Cybertech's credit line, overrode the order entry
misleading because Adaptive falsified its financial results    procedures and directed Adaptive to ship the product to
by improperly recognizing revenue. According to CW1,           Cybertech anyway. Id. Cybertech refused the shipment
Defendant Maloney overrode these procedures frequently         and Adaptive refused the return until December 2000
in 2000 to ship products to companies that did not meet        when it was re-inputted into the Adaptive accounting
Adaptive's own creditworthiness standards, or to               system. Id.
companies that had canceled orders or never placed
orders in the first place. Id. at P 45. CW1 reported that           CW1 describes another transaction with TESSCO
Defendants Lawrence and Birks "knew what [Maloney]             Technologies, Inc. ("TESSCO"), also reflected in the
was doing" and "consented to his actions." Id. CW1             June 2000 Quarter results. Id. at P 49. Adaptive received
reported that "no one trusted [Maloney]" when it came to       TESSCO's order by email at approximately 11:00 p.m. on
compliance with internal order procedures. Id.                 a Saturday night from a TESSCO engineer. Id. This was
                                                               unusual since all prior (and subsequent) orders came via
     In particular, CW1 reported that at the end of June       purchase orders on TESSCO letterhead, as specified by
2000, Defendant Maloney overrode Adaptive's                    Adaptive's Order Entry procedure. Id. Adaptive's order
procedures for several transactions and created a second       administration department contacted TESSCO about the
set of accounting records for transactions that violated the   order and was informed that the TESSCO engineer [*13]
procedures and were recommended for rejection by               had not been authorized to make the purchase and that
Adaptive's Order Administration Department. Id. at P 46.       TESSCO did not want the product. Id. According to
According to CW1, Defendant Maloney [*11] kept a               CW1, Defendant Maloney overrode usual procedure and
separate accounting sheet for a $ 4 million purchase from      directed Adaptive to ship the product to TESSCO.
a customer called BroadbandNow, which became the               TESSCO refused to accept it. Id.
subject of arguments between Defendant Maloney and
employees in the order administration department and                According to Plaintiffs, all of these transactions were
finance division. Id. at P 47. CW1 told Defendant              reflected in the June 2000 Quarter financial statements.
Maloney that the $ 4 million transaction was not               Id. at PP 39, 48, 49.
supported by a purchase order. Id. Defendant Maloney
responded that a purchase order would be forthcoming,               On March 15, 2001 Adaptive admitted it wrongfully
but CW1 reports it never was. Id. CW1 discussed this           recorded the Broadband Now transaction. Id. at P 50. On
issue with the manager-level head of Adaptive's                July 5, 2001, Adaptive admitted that it had wrongfully
accounting department, who agreed that recording the           recorded a total of $ 4.8 million in revenue, or over 20
transaction was improper. CW1 reported that Defendant          percent of the year's total. Id. In its July 5, 2001 Annual
Maloney was confronted about the transaction by CW1            Report on Form 10-K, Adaptive told the SEC that the
and the accounting department manager. Id. In addition,        results reported in the August release were overstated
CW1 reported that email correspondence from June 2000          because of "two additional revenue transactions, one
between Defendant Maloney and the order administration         relating to an unauthorized shipment and the other to the
department chronicled admonitions to Defendant                 inappropriate recognition of a customer deposit, both
Maloney about his actions. CW1 and the accounting              recorded in the [June 2000 Quarter], which have also
manager "jokingly" gave Defendant a Monopoly-esque             been restated." Id. at P 51.
"get-out-of-jail-free card" in recognition of their view
                                                               Defendant Lawrence's Statements Relating to the Fuzion
that what he was doing was improper. Id.
                                                               Deal
                                                                                                                   Page 5
                          2002 U.S. Dist. LEXIS 5887, *13; Fed. Sec. L. Rep. (CCH) P91,759



     Prior to the class period, on July 18, 2000, Adaptive     merchandise in an Adaptive warehouse. [*16] Id. at P
issued a press release describing an agreement [*14] it        61. According to CW3, this struck him as unusual, and
had entered with Fuzion Wireless Communications                when he asked Bringham about it, he was told that the
("Fuzion") for the joint development of new technology         products belonged to Fuzion. Id.
for wireless broadband networks. Id. at P 53. On
September 22, 2000, Adaptive issued another press                   CW3 reported that the Fuzion relationship was
release announcing a $ 100 million contract with Fuzion.       handled in part by Defendant Scharre. Id. at P 62.
Id. Also on September 22, 2000, Bloomberg quoted               According to CW3, when the Fuzion/Adaptive
Defendant Lawrence's statements about the Fuzion deal.         partnership was announced on July 18, 2000, Defendant
Id. at P 55. Defendant Lawrence noted that "the contract       Scharre directed Adaptive employees to provide Fuzion
goes over a multiple-year period, but there is immediate       employees with access to Adaptive's technical
revenue for the current and following quarters. . . . This     information. Id. As an example, CW3 reported that
will hit our top-line growth over the next five years, and     Fuzion was granted the right to provide wireless services
when you add up our customer list, you'll see over 50          to Adaptive's Rochester office. Id. CW3 reported that
names and $ 1.5 billion in contracts." Id.                     Adaptive employees were subsequently ordered to
                                                               terminate all contact with Fuzion, and that questions from
     According to Plaintiffs, Lawrence's statement that        Fuzion employees were to be referred to Adaptive's
revenue would be reflected in the immediate quarter was        counsel. Id. CW3 then contacted Scharre to determine
false and misleading because Defendants knew that              whether he should continue to provide a Fuzion employee
Fuzion could not place or accept any orders from               with access to the Rochester facility. Id. Defendant
Adaptive before the close of the September 2000 Quarter.       Scharre told CW3 to stall the Fuzion employee, and not
Id. at P 56. Nonetheless, in an attempt to rush the order      to connect him to Adaptive's systems. Id. CW3 reported
through, Defendants demanded that the order                    that Fuzion had refused to pay Adaptive, and was
administration department fulfill a $ 13 million order         experiencing financial difficulties. Id.
from Fuzion before the close of the quarter. Id. at P 57.
According [*15] to CW2, Adaptive never received a                  CW4 confirmed that the products Adaptive [*17]
purchase order from Fuzion. Id. at P 58. Moreover, CW2         sold to Fuzion were stored at Adaptive's Sunnyvale,
reported that Fuzion had previously defaulted on an            California headquarters. Id. CW2 reported that Adaptive's
earlier, $ 12 million order, which under normal                general ledger did not record the Fuzion order in the first
procedures would preclude its being issued further credit.     quarter of FY01 because the order was never received,
Id. Nonetheless, according to Plaintiffs, Adaptive "senior     nor were the products shipped. Id. at P 64. CW2
management" extended Fuzion's credit to allow for              generated the BBB Customer Report for senior
another shipment. Id.                                          management to review. Id. CW2 reported that senior
                                                               management falsely altered the report to reflect the first
     CW1 reported that Fuzion could not accept products        quarter Fuzion sale. Id.
shipped under the new order. Id. According to CW1,
Defendants Maloney, Lawrence and Birks devised a               Announcement of September Quarter 2000 Results
scheme whereby Fuzion could "lease" storage space at
                                                                    On October 23, 2000, Adaptive released its financial
Adaptive's Sunnyvale, California headquarters. Id. at P
                                                               statements and results of operations for the September
59. Id. CW1 told Defendant Maloney that Adaptive could
                                                               2000 Quarter in a press release disseminated to investors.
not ship to its own warehouse without a written lease
                                                               Id. at P 65 ("October 2000 release"). On November 3,
agreement. Id. CW1 reported that Defendant Maloney
                                                               2000, Adaptive filed a quarterly report with the SEC on
overrode procedure and ordered Adaptive to "ship" the
                                                               Form 10-Q reporting these same revenue figures. Id. The
order, consisting of eight or nine tractor loads, to its own
                                                               October 2000 release reported revenue for the first
warehouse. Id.
                                                               quarter of FY2001 of $ 24.2 million, a 42 percent
    CW3 confirmed the informal arrangement between             increase from the previous quarter. Id. at P 66. It also
Fuzion and Adaptive. CW3 reported that he visited              contains statements from Defendants Lawrence, Birks
Adaptive's Sunnyvale, California headquarters in early         and Scharre, making glowing predictions for Adaptive's
July 2000 and noticed 15 pallets of 600 units of               future. Id. at P 67. Defendant Birks predicted a 30 percent
                                                               or greater [*18] quarter-to-quarter growth rate, and that
                                                                                                                    Page 6
                           2002 U.S. Dist. LEXIS 5887, *18; Fed. Sec. L. Rep. (CCH) P91,759



gross margins would increase by 10 percent to 40 percent        and Adaptive's deferral of $ 13 million in additional
by the March 2001 quarter. Id. The October 2000 release         shipments. Id. 1
announced a recorded net income of $ 1.7 million in the
September 2000 Quarter compared to a net loss of $ 15.9                1 This part of Plaintiffs' Complaint is difficult to
million for the June 2000 Quarter and a net loss of $ 3.9              follow. According to Plaintiffs, Adaptive
million for the comparable quarter of the previous year.               eventually admitted that the December 2000
Id. at P 68.                                                           revenue figures were overstated by 158.3 percent
                                                                       and that an initial net loss of $ 62.6 million turned
     The Form 10-Q report was signed by Birks. Id. at P                out to be $ 98.9 million. Id. at P 79. But Plaintiffs
69. It read, in part, "In the opinion of management, the               fail to direct the Court's attention to when and
accompanying unaudited condensed consolidated                          where this later admission was made.
financial statements contain all adjustments (all of which
are normal and recurring in nature) necessary to present        Adaptive's Recognition of Accounting Errors
fairly the financial position, results of operations and cash
                                                                    On March 15, 2001, the last day of the class period,
flows for the periods presented." Id. at P 89.
                                                                Adaptive issued a press release admitting it had
     Plaintiffs allege that the Fuzion order, worth $ 13        wrongfully recorded $ 4 million in June 2000 Quarter
million, was improperly included in the September 2000          revenue for a single, major customer, BroadbandNow. Id.
Quarter results, rendering the October 2000 release and         at P 80. The $ 4 million in question represented 23.4
the FY01 Form 10-Q false and misleading. Id. at P 70.           percent of the $ 17.1 million in revenue reported for the
On July 5, 2001, Adaptive admitted that its September           June Quarter 2000. Id. at P 39.
2000 Quarter revenues were overstated by 981.6 percent;
                                                                     In an April 18, 2001 press release, Adaptive
$ 21.4 million of the $ 23.6 million in revenue was
                                                                announced [*21] that Defendant Maloney had been
wrongly recorded. Id.
                                                                replaced as its CFO. Id. at P 81. On May 22, 2001,
      [*19] Adaptive also reported in the October 23,           Adaptive issued a press release announcing its securities
2000 release that it had backlog orders at the close of the     had been delisted by the NASDAQ. Id. at P 83.
September 2000 Quarter totaling $ 72.4 million. Id. at P
                                                                     On July 5, 2001, Adaptive filed its Annual Report on
66. According to Plaintiffs, Adaptive's reported backlog
                                                                Form 10-K with the SEC for the transition period July 1,
of orders was falsely inflated. Adaptive's invoicing
                                                                2000 to December 31, 2000 ("FY2001 10-K"). Id. at PP
system was based on 30-day net payment terms. Id. at P
                                                                51, 84. On the form, Adaptive for the first time disclosed
72. If a customer was 90-days past due or more, it was
                                                                the June 2000 "financing commitment" side letter for the
red-flagged for review by Defendant Maloney. Id. CW1
                                                                $ 4 million sale to BroadbandNow. Id. Adaptive told the
reported that purchase orders received prior to the close
                                                                SEC that it would reverse the transaction, which had been
of FY2000 with shipment dates between January and
                                                                reflected in the June 2000 quarter. Id. Adaptive also
March 2001 that were red-flagged were reported
                                                                revealed it was restating "two additional revenue
nonetheless. Id. CW2 reported that in the first and second
                                                                transactions, one relating to an authorized shipment and
quarters of FY2001 certain orders were shipped and
                                                                the other to the inappropriate recognition of a customer
never paid for and never returned, but were recorded by
                                                                deposit," both recorded in the June 2000 quarter. Id.
Defendant Maloney as having been returned to inventory
                                                                (quoting FY2001 10-K).
anyway. Id. at P 73.
                                                                     Upon discovering the side letter, Adaptive
Announcement of December 2000 Quarter Results
                                                                established a Special Investigation Committee and
     On January 25, 2001, Adaptive issued a press release       retained independent special counsel. Id. at P 84. The
detailing its results for the December 2000 Quarter. Id. at     committee's counsel reviewed sales transactions from
P 77. ("January 2001 Release"). It reported revenue of $        April 1, 2000 to December 31, 2000. Id. As a result,
8.4 million and $ 21.4 million in backlog, after a $ 55         Adaptive determined that extension of [*22] credit to
million backlog adjustment "due to softness in the U.S.         certain customers in the latter part of 2000 was not
Competitive [*20] Local Exchange Carrier." Id. It also          supportable, and decided to restate or reverse revenues
admitted Fuzion's default on a $ 12.4 million receivable        recorded in the June, September, and December 2000
                                                                                                                     Page 7
                          2002 U.S. Dist. LEXIS 5887, *22; Fed. Sec. L. Rep. (CCH) P91,759



quarters. Id. The FY2001 10-K also disclosed that              Gibson, 355 U.S. 41, 45-46, 2 L. Ed. 2d 80, 78 S. Ct. 99
severance payments to Defendants Lawrence and Birks            (1957); [*24] Gilligan v. Jamco Dev. Corp., 108 F.3d
were suspended in May 2001. Id.                                246 (9th Cir. 1997); Fidelity Financial Corp. v. Federal
                                                               Home Loan Bank of San Francisco, 792 F.2d 1432, 1435
      On July 26, 2001, Adaptive filed for federal             (9th Cir. 1986). All material allegations in the complaint
bankruptcy protection in the San Jose Division of the          are accepted as true and construed in the light most
Northern District of California Federal Bankruptcy Court.      favorable to the non-moving party. NL Industries, Inc. v.
Id. at P 86. Adaptive has yet to file a restated annual        Kaplan, 792 F.2d 896, 898 (9th Cir. 1986).
report for FY2000 and a restated quarterly report for the
first quarter of FY2001. Id.                                   B. Securities Fraud

Adaptive's Proposed Merger with Western Multiplex                   Rule 9(b) provides that "in all averments of fraud or
                                                               mistake, the circumstances constituting fraud or mistake
    The individual defendants owned at least 844,703           shall be stated with particularity." Fed. R. Civ. P. 9(b).
shares of Adaptive stock during the class period. (Mem.        The allegations must be "specific enough to give
of P&A's in Supp. of Defs.' Mot. to Dis. at 2:24).             defendants notice of the particular misconduct which is
Plaintiffs do not allege that any of the Individual            alleged to constitute the fraud charged so that they can
Defendants sold securities during the class period.            defend against the charge and not just deny that they have
Rather, Plaintiffs allege that the individual defendants       done anything wrong." Semegen v. Weidner, 780 F.2d
were attempting to artificially inflate the price of the       727, 731 (9th Cir. 1985).
company's stock in an attempt to attract a merger partner.
Plaintiffs support this hypothesis with certain facts about         Rule 9(b) applies to actions brought under the federal
a potential merger proposed during [*23] the class             securities laws. In re GlenFed, Inc. Sec. Litig., 42 F.3d
period.                                                        1541, 1548 (9th Cir. 1994)(en banc). In 1995, Congress
                                                               enacted the Private Securities Litigation Reform Act,
     On November 13, 2000, Adaptive issued a press             ("PSLRA"), to clarify and strengthen [*25] the
release announcing a merger agreement under which it           particularity requirements of Rule 9(b) in the context of
would be acquired by Western Multiplex Corporation             federal securities class actions. In the Ninth Circuit, this
("Western Multiplex"). Id. at P 74. Under the agreement,       requirement has been interpreted and explained by In re
Western Multiplex would issue $ 645 million in stock to        Silicon Graphics Sec. Litig., 183 F.3d 970 (9th Cir.
acquire Adaptive, and Defendants Lawrence and Scharre          1999).
would join the Board of Directors with Scharre also
acting as President and COO. Id.                                    Section 10(b) of the Securities Exchange Act of 1934
                                                               provides, in relevant part, that it shall be unlawful "to use
    On January 10, 2001, Adaptive issued a press release       or employ in connection with the purchase or sale of any
announcing that the merger had been called off due to          security registered on a national securities exchange or
unfavorable market conditions. Id. at P 75. The release        any security not so registered, . . . any manipulative or
also announced that Defendants Lawrence and Birks              deceptive device or contrivance in contravention of such
were retiring from Adaptive, and that Defendant Scharre        rules and regulations as the [SEC] may prescribe..." 15
had been promoted to CEO and that Defendant Maloney            U.S.C. § 78j(b). Exchange Commission Rule 10b-5,
had been promoted to CFO. Id. at P 75. As noted above,         issued by the SEC to implement Section 10(b), makes it
Defendant Maloney was relieved of the CFO position in          unlawful for any person to use interstate commerce:
April 2001. Id. at P 81.
                                                                          (a) To employ any device, scheme or
    III. LEGAL STANDARD                                               artifice to defraud,
A. Motion to Dismiss
                                                                      (b) To make any untrue statement of a
     A motion to dismiss will be denied unless it appears             material fact or to omit to state a material
that the plaintiff can prove no set of facts which would              fact necessary in order to make the
entitle her to relief. Fed. R. Civ. Pro. 12(b)(6); Conley v.          statements made, in the light of the
                                                                      circumstances under which they were
                                                                                                                      Page 8
                           2002 U.S. Dist. LEXIS 5887, *25; Fed. Sec. L. Rep. (CCH) P91,759



        made, not misleading, or                                 questioned." Fed. R. Evid. 201(b). In ruling on a motion
                                                                 to dismiss, a district court may take judicial notice of a
        (c) To engage in any act, practice, or                   document if the plaintiff relies upon it [*28] in her
        course of business which operates or                     complaint and its authenticity is not questioned. Parrino
        would [*26] operate as a fraud or deceit                 v. FHP, Inc., 146 F.3d 699, 706 (9th Cir. 1998). A court
        upon any person, in connection with the                  may consider SEC filings incorporated by reference in a
        purchase or sale of any security.                        complaint. Ronconi v. Larkin, 253 F.3d 423, 427 (9th Cir.
                                                                 2001); In re Silicon Graphics, 183 F.3d at 986.
 17 C.F.R. § 240.10b-5. A plaintiff bringing a claim
under these sections must show: (1) a false and                  IV. DISCUSSION
misleading statement or omission of material fact; (2)
reliance; (3) scienter; and (4) resulting damage. Paracor             In this securities class action, Plaintiffs claim that
Fin., Inc. v. General Elec. Capital Corp., 96 F.3d 1151,         Adaptive falsely reported financial results by improperly
1157 (9th Cir. 1996).                                            recording revenue in an attempt to inflate its stock price.
                                                                 According to Plaintiffs, revenue overstatement and
     The PSLRA places additional pleading requirements           inadequate loss recognition was effected by violating
on a plaintiff in a securities fraud action. To state a claim    generally-accepted accounting principles ("GAAP") and
under the PSLRA, for each defendant, a plaintiff must            Adaptive's own internal policies. As a result, FY2000 and
"specify each statement alleged to have been misleading,         FY2001 financial results were materially false and
the reason or reasons why the statement is misleading,           misleading when made. Plaintiffs claim they would not
and, if an allegation regarding the statement or omission        have purchased Adaptive stock at the prices they paid, or
is made on information and belief...[to] state with              at all, if they had known that the market price had been
particularity all facts on which that belief is formed." 15      inflated by Defendants' alleged fraud.
U.S.C. § 78u-4(b)(1). The plaintiff must also "state with
particularity facts giving rise to a strong inference that the        Plaintiffs allege violations of Section 10(b) of the
defendant acted with the required state of mind." 15             1934 Act and SEC Rule 10b-5 against all defendants and
U.S.C. § 78u-4(b)(2). The PSLRA further requires that a          violations of Section 20(a) of 1934 Act against the
district court, upon [*27] motion of the defendant,              individual defendants. They [*29] request class damages,
"shall" dismiss any complaint that does not meet these           interest and costs and any other equitable/injunctive relief
requirements. 15 U.S.C. § 78u-4(b)(3)(A).                        as the Court deems just and proper.

C. Control Person Liability                                           The Court will first address whether the Complaint
                                                                 states facts sufficient to support fraud generally under the
     Rule 20(a) of the 1934 Act defines control persons          PSLRA's heightened pleading standards. The Court will
as: "Every person who, directly or indirectly, controls any      next address whether the Complaint's allegations are
person liable under any provision of this chapter or of any      sufficient to support the claim that the individual
rule or regulation thereunder . . .." 15 U.S.C. § 78t(a).        defendants were control persons under Section 20(a).
Such a person "shall also be liable jointly and severally
with and to the same extent as such controlled to any                A. Section 10(b) and SEC Rule 10b-5
person to whom such controlled person is liable, unless
                                                                      Plaintiffs allege that Defendants engaged in a series
the controlling person acted in good faith and did not
                                                                 of conscious decisions to falsify financial statements in
directly or indirectly induce the act or acts constituting
                                                                 order to attract a merger partner and to profit personally
the violation or cause of action." Id.
                                                                 thereby. To support these allegations, Plaintiffs cite
D. Judicial Notice                                               reports from four confidential witnesses from inside the
                                                                 company. They also cite to Adaptive's own public
    A party requesting judicial notice must show that the        admission that it had misstated its financials, the
fact in question is not subject to reasonable dispute            NASDAQ's decision to delist Adaptive's stock,
because it is generally known in the community or                reshuffling (and replacement) of top executives and a
"capable of accurate and ready determination by resort to        failed merger attempt as evidence that Adaptive
sources whose accuracy cannot reasonably be                      knowingly, or at least with deliberate recklessness,
                                                                                                                   Page 9
                          2002 U.S. Dist. LEXIS 5887, *29; Fed. Sec. L. Rep. (CCH) P91,759



defrauded them by engaging in questionable business           statements were intentionally false, misleading or made
practices. Defendants dispute Plaintiffs' contention that     with deliberate recklessness, the complaint must allege
their Complaint [*30] pleads securities fraud with the        specific "contemporaneous statement or conditions"
necessary particularity.                                      demonstrating the deliberately reckless or intentional
                                                              nature of the statements at the time they were made.
     Under the PSLRA and Rule 9(b), a plaintiff must          Ronconi, 253 F.3d at 432; In re Vantive, 283 F.3d 1079,
show that an alleged false statement was false when           2002 U.S. App. LEXIS 4231, 2002 WL 398498 at *7. In
made, and must also plead specific facts creating a strong    assessing whether a complaint sufficiently pleads
inference that the fraud was committed with deliberate        scienter, it must be read in its entirety. In re Silicon
recklessness. In re Silicon Graphics, 183 F.3d at 974;        Graphics, 183 F.3d at 985.
Ronconi, 253 F.3d at 429. If an allegation regarding a
statement or omission is made on information and belief,           Plaintiffs argue scienter on many different levels.
the complaint must state with particularity all facts on      First, they argue that GAAP violations in and of
which that belief is based. 15 U.S.C. § 78u-4(b)(1).          themselves support an inference of scienter. They also
Allegations are presumed to have been made on                 argue that by restating its financials, Adaptive effectively
information and belief unless and until the plaintiffs        admitted that its original filings and releases were
demonstrate they have personal knowledge of the facts.        knowingly false when made. But most importantly,
In re Vantive Corp. Sec. Litig., 283 F.3d 1079, 2002 U.S.     Plaintiffs point to a series of deliberate transactions by
App. LEXIS 4231, 2002 WL 398498, at *2 n.3 (9th Cir.          corporate executives designed to override standard
2002).                                                        accounting procedures in an effort to attract a potential
                                                              buyer for the company. Plaintiffs argue that collectively,
     The first prong of the Silicon Graphics formula is       these transactions and the deliberateness with which they
satisfied here; Defendants do not contest that financial      were entered into support the necessary [*33] inference
statements for the June, September and December 2000          that the fraud alleged was knowing, or at least
Quarters were false when made. In their Motion to             deliberately reckless.
Dismiss, however, the Individual Defendants deny these
results were knowingly false when made; that is, [*31]        1. Unnamed Sources
they argue that Plaintiffs' complaint is fatally flawed for
failure to plead the required level of scienter. They              As an initial matter, the Court will address
explain the readjustment of Adaptive's financial              Defendants' concern over Plaintiffs' use of confidential
disclosures as the combined result of the discovery that      witnesses. Defendants claim the use of unnamed sources
some transactions had been improperly recorded and the        violates the PSLRA's particularity requirement.
collapse in the market for Adaptive's product which made      Defendants demand that Plaintiffs should be required to
prior credit extensions to certain customers insupportable.   at least provide the witnesses' names and titles, or more
                                                              facts establishing that they are likely to possess the
     In the Ninth Circuit, the required state of mind in a    information attributed to them. Defendants note in
securities fraud case is actual knowledge or "deliberate      particular that the Complaint is vague as to the starting
recklessness," or if the statement is forward-looking,        dates of three of the four witnesses, suggesting that they
"actual knowledge . . . that the statement was false or       may not have been working at the jobs that gave them
misleading." 15 U.S.C. § 78u-5(c)(1)(B)(i); Ronconi, 253      access to the knowledge they are supposed to have until
F.3d at 429. This stricter standard was codified in an        after the events happened.
attempt to prevent cases based upon "fraud by hindsight."
In re Silicon Graphics, 183 F.3d at 988 (internal citations       The credibility to be attributed to an anonymous
omitted).                                                     source should be evaluated on a case-by-case basis. In re
                                                              McKesson HBOC, Inc. Sec. Litig., 126 F. Supp. 2d 1248,
     A securities fraud complaint need not be dismissed       1271 (N.D. Cal. 2000). The failure to name sources may
for relying on circumstantial evidence, as long as that       reduce the weight to be allocated to their testimony when
evidence meets the "strong inference" standard. In re         evaluating the complaint's ability to meet the strict
Silicon Graphics, 183 F.3d at 996; In re Northpoint           requirements for pleading scienter. 126 F. Supp. 2d at
Comm. Group, Inc. Sec. Litig., 184 F. Supp. 2d 991, 997       1272. But [*34] the failure to name sources will not
(N.D. Cal. 2001). [*32] In order to adequately plead that     doom an otherwise well-plead securities complaint.
                                                                                                                     Page 10
                           2002 U.S. Dist. LEXIS 5887, *34; Fed. Sec. L. Rep. (CCH) P91,759



According to Silicon Graphics, a plaintiff need only             describe that CW1 had first-hand knowledge of
"mention . . . the sources of [plaintiff's] information." 183    Defendant Maloney's decision to extend credit to certain
F.3d at 985. This has been interpreted to mean that "it is       customers and to override internal accounting procedures
possible to identify sources and provide other                   in the process. They describe how CW2 generated reports
corroborating details without disclosing names of                and knew first-hand that a report had been altered to
sources." In re McKesson, 126 F. Supp. 2d at 1271.               reflect the Fuzion deal. They describe how CW3 saw for
                                                                 himself the Fuzion's supposedly completed order stored
     Plaintiffs' Complaint would be more credible if their       in Adaptive's Sunnyvale warehouse, a scheme later
sources were named, since, in the context of pleading            confirmed by his supervisor. While less concrete, the
securities fraud, the more detail the better. But their          information provided by CW4 confirms the Fuzion
refusal to provide this detail is not fatal. Plaintiffs allege   warehouse deal.
that CW1 was a 15-year employee of Adaptive and its
predecessor, California Microwave, and that in 2000 until             This is not to say that everything attributable to these
approximately July 2001 the witness was a manager in             witnesses is acceptable. CW1's allegations that
charge of Adaptive's order fulfillment department.               Defendants Lawrence and Birks actually "knew what
(Compl. at P 41.) Plaintiffs claim that CW2 began work           Peter was doing" and "consented to his actions," and that
at Adaptive in 1999 and from 2000 to July 2001 worked            "no one trusted [Maloney]" are far too vague. (Compl. P
in Adaptive's finance division and reported directly to          45). The same goes for CW2's allegations that "certain
Defendant Maloney. CW2's responsibilities included               orders during [the first and second [*37] quarters of
generating regular reports for senior management,                FY2001] had been shipped to customers, never paid for,
including a "BBB Customer Report" detailing billings,            and never returned." Id. at P 73. But the places where the
[*35] bookings and backlog. Id. at P 42. CW3 worked              complaint suffers for vagueness are counterbalanced by
for Adaptive and its predecessor company for 10 years.           detailed allegations elsewhere. The Court is persuaded
Id. at P 60. In 2000 and until approximately July 2001,          that on the whole, Plaintiffs have provided sufficient
CW3 was a department head-level information officer in           detail as to the job descriptions and responsibilities of
Adaptive's Rochester, New York office, the hub of                their confidential sources, and the ways in which they
Adaptive's sales and order administration department. Id.        came to know the information pleaded in Plaintiffs'
CW3 reported to Adaptive's Chief Information Officer.            complaint. The fact that they are not named, while not
Finally, CW4 is described as an administrative assistant         ideal, does not prove fatal to Plaintiffs' complaint.
who worked for Defendants Lawrence and Birks between
July 2000 and February 2001. Id. at P 63.                            2. The Allegedly Misleading Statements 2

     Defendants correctly note that Plaintiffs are vague as             2 The Court notes that while the hard numbers
to the dates witnesses one through three began work in                  falsely reported in press releases announcing
their positions. And it is indeed odd that employees                    financial results and corresponding SEC filings
whose descriptions give away so much of their identities                are actionable, the vast majority of the statements
would not let their names be used. But the Court finds                  made by the individual defendants to the media
that the failure to name them is more than compensated                  are not. Reasonable investors do not take heed of
for by the fact that the witnesses are long-term employees              puffery when making investment decisions. In re
whose positions are described in detail.                                Northpoint, 184 F. Supp. 2d at 1005 (citing Raab
                                                                        v. General Physics Corp., 4 F.3d 286, 288-90 (4th
    Defendants cite to In re Northpoint, a case in which                Cir. 1990)).
the use of eight confidential witnesses could not
overcome the PSLRA's particularity requirement. 184 F.                [*38] a. SEC Filings/Press Releases Announcing
Supp. 2d at 1001. But the Court finds that case to [*36]         Financial Results
be distinguishable. There, Judge Alsup noted that the
                                                                      Plaintiffs argue that a series of SEC filings and press
complaint never described the witnesses' duties, nor did it
                                                                 releases announcing financial results were false when
discuss how they came to learn of the information in the
                                                                 made, and were made with the intent to deceive or with a
complaint. Id. Here, by contrast, Plaintiffs provide much
                                                                 deliberately reckless regard for the truth. They attempt to
more that the four witnesses' titles. For example, they
                                                                 show scienter with a variety of corroborating
                                                                                                                   Page 11
                          2002 U.S. Dist. LEXIS 5887, *38; Fed. Sec. L. Rep. (CCH) P91,759



circumstantial evidence, the sufficiency of which the         Fuzion's faulty credit status and the questionable
Court will presently address.                                 arrangement to "ship" the order to Adaptive's own
                                                              warehouse. See In re Secure Computing Corp. Sec. Litig.,
    1) GAAP violations                                        184 F. Supp. 2d 980, 988-89 (N.D. Cal. 2001) ("Secure
                                                              II")(finding allegations about a scheme to warehouse
     Plaintiffs claim that in their zeal to prop up           unfinished products for which the government would not
Adaptive's financial health, Defendants deliberately          accept delivery and treating it as delivered for accounting
failed to follow the SEC's admonition that financial          purposes to support a strong inference of deliberate
statements filed with the SEC which are not prepared in       recklessness under the PSLRA); compare In re Guess?,
compliance with GAAP are presumed to be misleading            Inc. Sec. Litig., 174 F. Supp. 2d 1067, 1077 (C.D. Cal.
and inaccurate. 17 C.F.R. § 210.4-01(a)(1) ("SEC Reg.         2001) (failing to find sufficient evidence of scienter
S-X"). According to Plaintiffs, a failure to follow GAAP      allegations that did not amount to anything as "egregious
demonstrates deliberate recklessness in reporting             and the booking of entirely contingent contracts as sales,
financial results, and thus, scienter. Defendants disagree.   followed by hiding the side letters that established the
                                                              contingencies").
     While it is true that conclusory allegations of GAAP
violations standing alone cannot be used to prove                  Defendants' suggestion that these transactions might
intentional or reckless misconduct, if pled in detail and     somehow have been mismanagement, overconfidence
read in context, GAAP violations may support an               [*41] or "growing pains" is best raised on a motion for
inference of scienter. In re McKesson, 126 F. Supp. 2d at     summary judgment or at trial. At this stage in the
1273 [*39] ("After all, books do not cook themselves.");      litigation, by corroborating GAAP violations with
In re Cylink Sec. Litig., 178 F. Supp. 2d 1077, 1082 (N.D.    detailed      evidence       of  the     contemporaneous
Cal. 2001); compare In re Northpoint, 184 F. Supp. 2d at      decision-making behind the accounting errors, Plaintiffs
998 (finding GAAP violations alone to be insufficient         have set forth sufficient circumstantial evidence that the
proof of scienter).                                           statements released to the SEC and the investing public
                                                              were known to be false at the time they were made.
     GAAP violations are particularly credible evidence
                                                              Ronconi, 253 F.3d at 432 (holding that allegations of
where a plaintiff provides specific amounts by which
                                                              deliberate recklessness must be supported by
revenue was overstated, dates of transactions and/or the
                                                              "contemporaneous statements or conditions" of knowing
identities of the customers or company employees
                                                              falsity). Defendant Maloney's actions alone -- ignoring
involved. In re McKesson, 126 F. Supp. 2d at 1273;
                                                              basic accounting principles and refusing to heed warnings
compare In re Vantive, 283 F.3d 1079, 2002 U.S. App.
                                                              from the accounting department about the propriety of his
LEXIS 4231, 2002 WL 398498 at *7 (finding an
                                                              actions in overriding company policy -- are sufficient to
allegation of revenue overstatement insufficient where
                                                              suggest that he knew what he was doing would lead to
the amount of overstatement was not specified). Such
                                                              falsified financial results.
information is adequately supplied here. The Broadband
Now transaction in and of itself is specific as to amount         2) Financial Restatements
($ 4 million), approximate date (June 2000 Quarter) and
customer. In addition, Plaintiffs provide specific evidence        Plaintiffs allege that the fact that financials had to be
that there was an internal debate at Adaptive as to           restated at all supports an inference that they were
whether to override internal policies and GAAP                knowingly false when made. Again, Defendants disagree,
restrictions and book the transaction. Plaintiffs also        citing In re Comshare, Inc. Sec. Litig., 183 F.3d 542,
provide specific detail as to the TESSCO and Cybertech        553-54 (6th Cir. 1999).
transactions, both recorded in the [*40] June 2000
Quarter.                                                           While it [*42] is true that a one-time restatement,
                                                              without more, probably does not create the necessary
     The Court finds similarly sufficient detail in           strong inference of scienter, In re Northpoint, 184 F.
Plaintiffs' description of the September 2000 Quarter         Supp. 2d at 1003, there is at least one case from the
Fuzion deal for $ 13 million. There is detailed evidence      Northern District of California supporting Plaintiffs'
to suggest the customer, amount and approximate date of       position. In In re Cylink, the Court noted that "the mere
the Fuzion transaction, which was booked despite              fact that the statements were restated at all supports . . .
                                                                                                                    Page 12
                          2002 U.S. Dist. LEXIS 5887, *42; Fed. Sec. L. Rep. (CCH) P91,759



an inference [of scienter]." 178 F. Supp. 2d at 1084.              Defendants are correct that In re Silicon Graphics
Given the fact that Adaptive was forced to announce            explicitly rejected a plaintiff's attempt to ground scienter
restatements at least twice - once on March 15, 2001 and       on general, uncorroborated allegations that defendants
again on July 5, 2001 - the Court finds that while they        had received internal reports. 183 F.3d at 984, 985, 988.
would be insufficient to support a scienter inference on       To overcome In re Silicon Graphic's proscription against
their own, when coupled with the strong evidence of            vague references to a defendant's access to internal
deliberately reckless accounting, these restatements shore     reports, details such as dates and contents of the reports
up and place in context the allegations of fraud.              in question are required. In re Vantive, 283 F.3d 1079,
                                                               2002 U.S. App. LEXIS 4231, 2002 WL 398498 at *5.
    3) Corporate Reshuffling
                                                                    Plaintiffs actually make few if any references to
     As Adaptive's financial difficulties were coming to       company internal reports; their complaint rests on details
light, three of the named individual defendants either left    wholly unrelated to what company executives were
the company or were moved to new positions. On                 seeing or should have been seeing in internal memoranda.
January 11, 2001 Defendants Lawrence and Birks                 Unlike those cases in which scienter failed because it
resigned. In April 2001, Adaptive Defendant Maloney            could not be shown that executives should have known
was replaced as CFO and reassigned. In addition, in May        something because they [*45] had access to internal
2001, severance [*43] payments to Defendants Lawrence          documents detailing failing company prospects, this case
and Birks were suspended. Plaintiffs suggest that these        rests on other evidence, most notably, witness reports that
changes provide further support for an inference of            Defendants were deliberately violating accounting rules
scienter.                                                      with side agreements and insupportable credit extensions.
                                                               Indeed, the premise of Plaintiffs' theory of the case is that
     As with the restatement of Adaptive's financials,         Defendants perpetrated a scheme more notable for what
these changes, taken alone, would not support scienter.        was not in the BBB reports generated from Adaptive's
But because the changes occurred as Adaptive's                 general ledger. In other words, it would not even matter
financials were being restated and as Adaptive was             what the internal documents said, because according to
conducting its own internal investigation (which resulted      Plaintiffs, they were doctored. Defendants' argument
in a determination that the extension of credit to certain     about the use of internal reports as it relates to scienter is
customers was unsupportable), they add one more piece          therefore unavailing.
to the scienter puzzle. This comports with In re
McKesson, where the court inferred that the corporation            5) Motive/Stock sales
had a factual basis for firing employees for cause because
they "knew or should have known" of accounting                      Finally, Defendants argue that Plaintiffs' complaint is
improprieties. 126 F. Supp. 2d at 1274. While Adaptive's       fatally flawed in that it fails to allege that any of the
actions do not rise to such a level in this case (no one was   Individual Defendants made any stock sales during the
publicly fired), the fact that the CFO was moved and           class period. 3 The Court interprets Defendants' argument
former executives' severance payments were discontinued        to mean that the Complaint fails to demonstrate a motive
is highly suspicious, especially given the additional          for the alleged fraud.
allegations in the Complaint.
                                                                       3 Defendants have requested that the Court take
    4) Internal Reports                                                judicial notice of the fact that Defendant Scharre's
                                                                       purchased 10,000 shares of Adaptive stock
     Defendants take issue with Plaintiffs' reference to               between January 30, 2001 and February 5, 2001.
internal BBB Reports to support a scienter inference,                  (Defs. Req. for Judicial Notice, Ex. C). Plaintiffs
because [*44] while named, their contents are not                      oppose the request because the issue of stock sales
alleged in sufficient detail. Plaintiffs counter that the              was not raised in their Complaint. In the
details in their Complaint are sufficient; they allege that            alternative, Plaintiffs argue that Defendant
CW2 drafted some of them (BBB) and that the Fuzion                     Scharre's purchase only supports their theory; he
order was specifically left out of at least one of them.               wanted more shares so that he could sell more
Plaintiffs also claim that the existence of the BBB reports            shares post-merger. Because the Court denies the
is corroborated by their witnesses.                                    Request for Judicial Notice, see section IV C,
                                                                                                                   Page 13
                          2002 U.S. Dist. LEXIS 5887, *45; Fed. Sec. L. Rep. (CCH) P91,759



       infra, neither argument will be addressed in this             The $ 645 million merger agreement would have
       Order.                                                  made Defendants Lawrence and Scharre members of
                                                               Western Multiplex's board of directors, and Scharre
      [*46] Plaintiffs counter that Defendants sought to       would have become President and COO. (Compl. P 74).
profit personally from the proposed Western Multiplex          The merger was called off on January 10, 2001, and a
merger because their stock holdings, if sold to an             little over six months later, Adaptive filed for bankruptcy.
acquiring company, were collectively worth $ 14 million.       Id. at PP 75, 86. While these facts are not persuasive on
Plaintiffs hypothesize that a merger with Western              their own, when read in light of the facts supporting the
Multiplex would have allowed Defendants to sell all of         deliberately reckless accounting violations, the Court
their stock to the acquiring company without raising           finds that they support an inference that the individual
suspicion of insider trading.                                  defendants were falsifying Adaptive's revenue in an
                                                               attempt to bail the company out and save and perhaps
     Defendants dismiss this argument as boilerplate and       increase the value of their shares. In the process, many
conclusory. They argue that in addition to Plaintiffs'         investors, including Plaintiffs, could have also been
failure to make it in the original complaint, if this          misled.
argument were persuasive, every potential merger would
create an inference of scienter. Moreover, Defendants               The Court recognizes that in isolation, this evidence
contend that the stock they were holding after the merger      would not come close to the level required to strongly
would have been devalued once the financials were              infer scienter; as Defendants note, preserving a merger
restated. In support, Defendants cite Florida State Bd. of     may provide "an incentive to feign success," but on its
Admin. v. Green Tree Fin. Corp, 270 F.3d 645 (8th Cir.         own, a fraud case it does not make. In re Northpoint, 184
2001), for the proposition that a motive to overstate          F. Supp. 2d at 1003. But under the circumstances, when
revenue to make a company more attractive to potential         Plaintiffs relied [*49] on the misstated revenues and
buyers is "too thin a reed on which to hang an inference       purchased stock at inflated prices, the fact that
of scienter . . .." Id. at 664; see also In re McKesson, 126   Defendants did not sell their own stock matters little. In
F. Supp. 2d at 1274 n. 14 (recognizing [*47] that              re Nuko Info. Sys., Inc. Sec. Litig., 199 F.R.D. 338,
incentive compensation has been consistently rejected as       344-45 (N.D. Cal. 2000).
a motive for fraud, for if this was enough it "would
effectively eliminate the state of mind requirement as to           Plaintiffs are only obliged to state some set of facts
all corporate officers and defendants" (quoting Melder v.      giving rise to a strong inference of deliberate
Morris, 27 F.3d 1097, 1102 (5th Cir. 1994)).                   recklessness. If they have done so, it is irrelevant whether
                                                               another, different set of facts might have accomplished
     It is true that insider trading, if contemporaneous       the same thing. In re Cylink, 178 F. Supp. 2d at 1083.
with knowingly false statements, tends to directly support     Therefore, given the sufficiency of the facts supporting
the inference that a defendant knew that a statement she       the deliberately reckless GAAP violations, it makes no
made was false at the time she made it. Ronconi, 253           difference that there were no stock sales, or that the
F.3d at 434. But other motive evidence, while not as           Complaint only alludes to internal company reports.
persuasive, is not necessarily unpersuasive if coupled         These additional facts provide a backdrop for a portrait of
with other allegations of fraud. See, e.g., Howard v.          fraud, painted in sufficient detail to satisfy the Court that
Everex Sys., Inc., 228 F.3d 1057, 1064 (9th Cir. 2000)         the case is not one of the "fishing expeditions" the
(holding on summary judgment that a desire to raise            PSLRA was designed to discourage. At this stage, taken
company financing combined with other "red-flags" of a         as true, Plaintiffs' pleadings are sufficient to suggest
company's financial condition can be probative of a            egregious GAAP violations in necessary detail to support
motive to defraud investors); In re Imperial Credit Indus.     a scienter inference, and therefore a violation of federal
Sec. Litig., 2000 U.S. Dist. LEXIS 2340, No. CV                securities laws.
98-8842 SVW, 2000 WL 1049320, at *3 (C.D. Cal. Feb.
22, 2000) (finding allegations of motive to attract a buyer        In sum, the Court finds that the [*50] statements
"before the company fell apart entirely," while not            made about Adaptive's revenue and loss in the June,
sufficient to support an inference [*48] of scienter on        September and December 2000 Quarters may very well
their own, "still probative to the inquiry").                  have been made with a deliberately reckless regard for
                                                                                                                 Page 14
                          2002 U.S. Dist. LEXIS 5887, *50; Fed. Sec. L. Rep. (CCH) P91,759



the truth. The Complaint provides specific details about a     to the remaining three: Lawrence, Birks and Scharre.
scheme to overinflate revenue in clear violation of
internal policy and federal guidelines. Coupled with a             a. Group Published Information Doctrine
formal admission that the revenues were overstated in the
                                                                    Defendants take issue with Plaintiffs' reliance on
form of financial restatements filed with the SEC, public
                                                               group published information doctrine, which Defendants
admonition of those involved and the results of
                                                               argue has not survived the passage of the PSLRA. The
Adaptive's own internal investigation, Plaintiffs have
                                                               doctrine, described in Wool v. Tandem Computers, Inc.,
provided sufficient evidence to survive a motion to
                                                               818 F.2d 1433 (9th Cir. 1987), states that a defendant's
dismiss.
                                                               participation in securities fraud can be shown by
3. Allegations as to Each Individual Participant               reference to that defendant's position, since false
                                                               statements are the collective acts of officers:
     Aside from proving whether the statements
themselves were made with the requisite scienter,                         In cases of corporate fraud where the
Plaintiffs must also satisfy the Court that it can prove              false and misleading information is
who is liable for making them. Plaintiffs claim Section               conveyed in prospectuses, registration
10(b) violations against Adaptive and Defendants                      statements, annual reports, press releases
Lawrence, Birks, Scharre and Maloney. In addition to                  or other "group-published information," it
arguing that Plaintiffs have failed to allege scienter                is reasonable to presume that these are the
generally, Defendants also argue that Plaintiffs have                 collective actions of the officers. Under
failed to allege scienter separately as to each of these              such circumstances, a plaintiff fulfills the
individual defendants.                                                particularity requirement of Rule 9(b) by
                                                                      pleading the misrepresentations with
     As an initial matter, the Court is [*51] convinced               particularity and where possible [*53] the
that the allegations pertaining to Defendant Maloney are              roles of the individual defendants in the
specific enough to infer that he acted at least with                  misrepresentations.
deliberate recklessness. Plaintiffs allege that he overrode
internal revenue recognition policies and refused to           [Oil, Chemical & Atomic Workers, etc., Local No. 4-228
reverse his decision even after being confronted by            v. Union Oil Co.], 818 F.2d 437, 440; see also In re
accounting staff. (Compl. P 47.) In response, CW1 and          Glenfed Inc. Sec. Litig., 60 F.3d 591, 593 (9th Cir. 1995)
another accounting department staffer jokingly gave            (citing Wool with approval).
Defendant Maloney a "get-out-of-jail free" card in
recognition that he had acted inappropriately. Id.                  Both Wool and In re Glenfed were decided before the
Defendant Maloney is also alleged to have overridden an        enactment of the PSLRA. According to Defendants, the
internal policy that orders could not be shipped to            PSLRA now requires that falsity and scienter be pled as
Adaptive's own warehouse without a written lease               to each defendant. 15 U.S.C. §§ 78u-4(b)(1)-(2).
agreement. Id. at P 59. Again, Defendant Maloney was           Defendants acknowledge that the Ninth Circuit has yet to
confronted with the policy and ignored it. Together these      tackle head-on whether the group published information
allegations are detailed enough to pinpoint an inference       doctrine survives the PSLRA, but claim that it is clear
of scienter as to Defendant Maloney.                           that "its historical underpinnings have been destroyed."
                                                               (Mem. P&A's in Supp. of Defs.' Mot. to Dis., 11:21-22.)
     As to Defendants Lawrence, Birks and Scharre,
Plaintiffs' allegations amount to a series of suggestions           Plaintiffs cite numerous cases from the Ninth Circuit
that they "knew" about events, devised the fraudulent          affirming the viability of the group publication doctrine
schemes, or spoke publicly about revenue figures they          even after the passage of the PLSRA. See, e.g., In re
knew were false. Plaintiffs rely on the group publication      Guess?, 174 F. Supp. 2d at 1079-80 (recognizing the
doctrine and the core operations inference to support their    viability of the doctrine); In re Secure Computing Corp.
allegations [*52] of securities fraud against all individual   Sec. Litig., 120 F. Supp. 2d 810, 821-22 (N.D. Cal. 2000)
defendants, but as the Court has already determined that       ("Secure I") (collecting Ninth Circuit cases recognizing
the specific allegations as to Defendant Maloney stand on      the doctrine). The [*54] Court agrees that the doctrine
their own, it will only address the doctrine's application     has not been specifically abrogated, and is still good law
                                                                                                                    Page 15
                           2002 U.S. Dist. LEXIS 5887, *54; Fed. Sec. L. Rep. (CCH) P91,759



in this Circuit.                                                believes that the statements in the document are true.").
                                                                While it is true that a plaintiff cannot make general
     In this case, Plaintiffs rely on statements published in   references to a defendant's attendance at a meeting or her
press releases and SEC filings, both of which are subject       "hands-on" managerial style in an attempt to prove
to the group publication doctrine. Wool, 818 F.2d at            scienter, In re Vantive, 283 F.3d 1079, 2002 U.S. App.
1440. Defendants Lawrence, Birks and Scharre signed             LEXIS 4231, 2002 WL 398498 at *4, it is a different
the August 2000 10-K SEC report, which Plaintiffs allege        matter when an officer signs a document. In the latter
reported knowingly false revenue results for the June           case, the officer is effectively making a statement herself.
2000 Quarter. The same three Defendants were quoted in
the October 2000 release announcing Adaptive's                       Here, Plaintiffs allege that the FY00 Form 10-K was
September 2000 Quarter financial results, which                 signed by Defendants Lawrence, Birks and Scharre and
Plaintiffs allege falsely overstated revenue by nearly 981      that the Form 10-Q Report of September 2000 Quarter
percent. (Compl. PP 38, 66-67, 70.) 4 Under the group           results was signed by Birks. By signing the forms, which
publication doctrine, the statements are presumed to be         are alleged to contain a deliberately reckless and false
the collective acts of Adaptive's officers. At the time of      report of FY2000 revenue, these Defendants have
the August 2000 release, Defendant Lawrence was the             themselves become liable for securities fraud.
CEO and Chairman of the Board, Defendant Birks was
the CFO and Defendant Scharre was the President and                 B. Control Person Liability: Section 20(a)
COO of Adaptive. These were not just officers of the
                                                                     Plaintiffs hold the individual defendants responsible
company, they were the highest ranking officers, and the
                                                                for the alleged fraud as control persons under Section
Court has no trouble inferring that the press releases and
                                                                20(a) [*57] of the 1934 Act. The 1934 Act defines a
SEC filings that contain the false statements [*55] were
                                                                control person as someone "who, directly or indirectly,
issued with their blessing.
                                                                controls any person liable under any provision of this
        4 In the alternative, Plaintiffs rely on the core       chapter or of any rule or regulation thereunder . . .." 15
        operations inference, which states that if a proper     U.S.C. § 78t(a). Such a person "shall also be liable jointly
        factual foundation is laid, "it may be inferred that    and severally with and to the same extent as such
        facts critical to a business's core operations or an    controlled person to any person to whom such controlled
        important transaction are known to a company's          person is liable, unless the controlling person acted in
        key officers." In re Northpoint, 184 F. Supp. 2d at     good faith and did not directly or indirectly induce the act
        998. This requires a minimal showing that the           or acts constituting the violation or cause of action." Id.
        critical facts were "actually known within the
                                                                     To successfully plead control person liability,
        company." Id. Plaintiffs allege that Adaptive
                                                                Plaintiffs must show a primary violation of the federal
        consciously focused its efforts on their
                                                                securities laws and that each defendant "directly or
        AB-Access products, and that the importance of
                                                                indirectly" controlled the violator. Paracor Fin., Inc. v.
        this niche supports the inference that the corporate
                                                                General Elec. Capital, 96 F.3d 1151, 1161 (9th Cir.
        officers would have been well aware of important
                                                                1996); Hollinger v. Titan Capital. Corp, 914 F.2d 1564,
        transactions relating to it, including the Fuzion
                                                                1575 (9th Cir. 1990). According to Defendants, Plaintiffs
        and Broadband Now deals. (Compl. PP 18, 25,
                                                                have not pled control person liability with particularity.
        27, 39, 53, 67). Because the Court finds the group
                                                                Defendants contend that Plaintiffs must allege specific
        publication doctrine applicable to this case, it
                                                                facts to support each defendant's control over the
        need not address Plaintiffs' core operations
                                                                transaction or activity that gave rise [*58] to the primary
        inference.
                                                                violation.
    The Court's conclusion is supported by the Ninth
                                                                    According to Plaintiffs, the fact that the named
Circuit's recognition in Howard [*56] that when
                                                                individual defendants held important positions in the
corporate officers sign documents, they attest to their
                                                                company is sufficient at the pleadings stage. The Court
accuracy. 228 F.3d at 1061 ("When a corporate officer
                                                                agrees. While it is true that the identification of a control
signs a document on behalf of the corporation, that
                                                                person is "intensely factual," it is also true that a control
signature will be rendered meaningless unless the officer
                                                                person need not be a "culpable participant" in the alleged
                                                                                                                  Page 16
                          2002 U.S. Dist. LEXIS 5887, *58; Fed. Sec. L. Rep. (CCH) P91,759



fraud. Howard, 228 F.3d at 1065 (citing Hollinger, 914              Defendants request that the Court take judicial notice
F.2d at 1575; Paracor, 96 F.3d at 1161). Indeed, at least      of the following documents: 1) Adaptive's Form 10-K for
one court has determined that allegations that individual      the transition period July 1, 2000 to December 31, 2000
defendants, by virtue of their executive and managerial        filed with the SEC on July 5, 2001 attached to the
positions, could control and influence the company and         Request at Exhibit A; 2) Adaptive's Schedule 14A, Proxy
did so, are sufficient at the pleadings stage. In re Cylink,   Statement filed with the SEC on October 2, 2000 attached
178 F. Supp. 2d at 1089 ("Plaintiffs need not allege that      as Exhibit B to their Request; 3) Two statements of
the individual defendants actually participated in the         Changes in Beneficial Ownership ("Form 4s") filed on
wrongful conduct or exercised actual power to be               behalf of Defendant Scharre with the SEC on February 7,
derivatively liable under section 20(a).")                     2001 and March 9, 2001, reflecting Defendant Scharre's
                                                               purchases of Adaptive stock, attached as Exhibit C to the
     The Court finds that the allegations that the             Request. Plaintiffs oppose the Request, arguing that
Individual Defendants held the highest offices in the          judicial notice of the truth of documents referred to in a
corporation, spoke frequently on its behalf, and made key      complaint is not allowed.
decisions in how to present its financial results are
sufficient [*59] to survive Defendants' contention that             Federal Rule of Evidence 201(b) requires a party
the Complaint lacks specificity as to control person           requesting judicial notice to show that the fact in question
liability. Later in the proceedings, when and if Plaintiffs    not be subject to reasonable dispute because it is
present evidence of such control, Defendants will have         "generally known in the community" or "capable of ready
the opportunity to assert a good faith defense of lack of      determination by resort to sources whose accuracy cannot
participation. Howard, 228 F.3d at 1065; In re Cylink,         reasonably be questioned." Fed. R. Evid. 201(b). In ruling
178 F. Supp. 2d at 1089. Defendants' Motion to Dismiss         on a motion to dismiss, a district court may consider a
the control person liability claims against Defendants         document, including an SEC filing, if [*61] the plaintiff
Birks, Maloney, Scharre and Lawrence is therefore              relies upon it in her complaint and its authenticity is not
denied. 5                                                      questioned. Parrino, 146 F.3d at 705-06; Ronconi, 253
                                                               F.3d at 427; In re Silicon Graphics, 970 F. Supp. 746,
       5 As an aside, the Court notes that the Second          751-52 (N.D. Cal. 1997) (noting that the document must
       Claim for Relief in Plaintiffs' Complaint alleges       be "referenced in plaintiff's complaint" and "'central' to
       that the individual defendants are liable under         plaintiff's claim"). Importantly, if facts contained in a
       Section 20(a) only for their control over Adaptive,     document are disputed, a court may only consider the
       not for their liability for their collective acts as    document for the limited purpose of recognizing the fact
       corporate executives; that is, for their control over   that the document exists. Lee v. City of LA, 250 F.3d 668,
       each other. The fact that the case is stayed against    688-90 (9th Cir. 2001).
       Adaptive's pending bankruptcy may be
       problematic, since Plaintiffs cannot prove that              Plaintiffs properly concede that the Form 10-K
       Adaptive has committed a primary violation of           attached as Exhibit A was referenced in the Complaint.
       federal securities laws until the stay is lifted. As    The Court therefore takes judicial notice the fact that the
       noted, the establishment of a primary violation is      statements therein were made, but does not take judicial
       a threshold inquiry in determining control person       notice of their truth. Lee, 250 F.3d at 690.
       liability. Howard, 228 F.3d at 1065. The parties
       do not address this in their papers, but the Court           As to Exhibits B and C, Plaintiffs argue they are not
       assumes that since the individual defendants            subject to judicial notice at all because they are not
       themselves are named as Section 10(b) violators,        referenced or relied upon in the Complaint. According to
       the above analysis applies. According to the 1934       Plaintiffs, judicially noticing these documents would
       Act, joint and several liability can be imposed         improperly convert the motion to dismiss into a motion
       upon anyone who "controls any person liable             for summary judgment. Branch v. Tunnell, 14 F.3d 449,
       under any provision" of the Act. 15 U.S.C. §            454 (9th Cir. 1994). [*62]
       78t(a).
                                                                   Defendants allege that Plaintiffs must have relied on
     [*60] C. Judicial Notice                                  the Proxy Statement in Exhibit B in order to come up
                                                               with the Defendants' exact stock holdings. As far as the
                                                                                                                 Page 17
                          2002 U.S. Dist. LEXIS 5887, *62; Fed. Sec. L. Rep. (CCH) P91,759



Court can tell, however, Defendants were the first to         about motive in response to Defendants' Motion to
mention this number in their Motion to Dismiss. See           Dismiss, which explicitly referred to a lack of stock sales.
Mem. P&A in Supp. of Defs.' Mot. to Dis., 17:15. The          Therefore, the Court declines to take judicial notice of the
Court cannot see any other relevance for it, thus it will     Form 4S.
not be judicially noticed or incorporated by reference into
the Complaint.                                                    V. CONCLUSION

     As to Exhibit C, Defendant Scharre's Form 4s,                 For the above-mentioned reasons, Defendants'
Defendants say that as an SEC filing, under In re Silicon     Motion to Dismiss is hereby DENIED. Defendants'
Graphics, it is indisputable that it can be judicially        Request for Judicial Notice is GRANTED as to Exhibit
noticed. Defendants allege, moreover, that Plaintiffs         A, and DENIED as to Exhibits B and C. The parties shall
necessarily relied on it in their Complaint when they put     appear for a status conference on Friday, April 12, 2002
forth their theory about Adaptive's motive to inflate the     at 10:00 a.m. in Courtroom 1, San Francisco Division.
stock price.                                                  The parties shall file one joint statement seven days prior
                                                              to the status conference.
     The Court disagrees that there is no dispute as to
whether the Form 4s can be judicially noticed. If the             IT IS SO ORDERED.
parties dispute its authenticity or the form is not
                                                                  Dated: April 2, 2002
referenced in a plaintiff's complaint, it will not be
noticed. Here, there is no dispute that Defendant Scharre         Samuel Conti
sold stock, and the document was filed publicly. But
Plaintiffs never refer to stock sales by any defendant in         UNITED STATES DISTRICT JUDGE
their Complaint. [*63] Plaintiffs only raised their theory
TAB 5
                                                                                                        Page 1




                                          LEXSEE 540 F. SUPP. 2D 695

                  In re AFFILIATED COMPUTER SERVICES DERIVATIVE LITIGATION

                                        Master File No. 3:06-CV-1110-M

                UNITED STATES DISTRICT COURT FOR THE NORTHERN DISTRICT OF
                                  TEXAS, DALLAS DIVISION

                               540 F. Supp. 2d 695; 2007 U.S. Dist. LEXIS 92401


                                          December 13, 2007, Decided
                                           December 13, 2007, Filed

                                                          Theodore J Tacconelli, Ferry Joseph & Pearce PA,
COUNSEL: [**1] For Alaska Electrical Fund,                Wilmington, DE.
Derivatively on Behalf of AFFILIATED COMPUTER
SERVICES, Plaintiff: Joe Kendall, LEAD ATTORNEY,          For Jeffrey Rich, Defendant: Bill Dawson, LEAD
Hamilton Lindley, Willie Briscoe, Provost Umphrey Law     ATTORNEY, Jane Ann R Neiswender, Karen L
Firm - Dallas, Dallas, TX; Andrew W Hutton, Law           Hirschman, Matthew R Stammel, Stuart Tonkinson,
Office of Andrew W Hutton, San Diego, CA; Benny C         Vinson & Elkins, Dallas, TX; Jennifer B Poppe, Vinson
Goodman, III, Darren J Robbins, James I Jaconette, John   & Elkins, Austin, TX.
J Rice, Coughlin Stoia Geller Rudman & Robbins LLP,
San Diego, CA; David A Rosenfeld, Mario Alba, Jr,         For Joseph P. O'Neill, Dennis McCuistion, Defendants:
Lerach Coughlin Stoia Geller Rudman & Robbins,            Bruce W Collins, LEAD ATTORNEY, C Shawn
Melville, NY; Monique C Winkler, Coughlin Stoia Geller    Cleveland, Jesse Keith Shumway, Carrington Coleman
Rudman & Robbins LLP, San Francisco, CA; Robert B         Sloman & Blumenthal, Dallas, TX.
Weiser, Weiser Law Firm, Wayne, PA; Samuel H
                                                          For Frank A. Rossi, J Livingston Kosberg, Defendants:
Rudman, Coughlin Stoia Geller Rudman & Robbins,
                                                          Bruce W Collins, LEAD ATTORNEY, C Shawn
Melville, NY; Shawn A Williams, Coughlin Stoia Geller
                                                          Cleveland, Jesse Keith Shumway, Carrington Coleman
Rudman & Robbins, San Francisco, CA; Suzanne H
                                                          Sloman & Blumenthal, Dallas, TX; T Ray Guy, LEAD
Stevens, Coughlin Stoia Geller Rudman, San Diego, CA.
                                                          ATTORNEY, Alaina K Brooks, Meagan Martin, Weil
For Bennett Ray Lunceford, Ann M Lunceford, Consol        Gotshal & Manges - Dallas, Dallas, TX; Greg A
Plaintiffs: Joe Kendall, LEAD ATTORNEY, Hamilton          Danilow, John A Neuwirth, Weil Gotshal & Manges -
Lindley, Willie Briscoe, Provost Umphrey Law Firm -       New York, New York, NY.
Dallas, Dallas, TX; Andrew W Hutton, Law Office of
                                                          For Darwin Deason, [**3] Defendant: Lewis T LeClair,
Andrew W Hutton, San Diego, CA; Benny C Goodman,
                                                          LEAD ATTORNEY, Scott R Jacobs, McKool Smith -
III, Darren J Robbins, James I Jaconette, John J Rice,
                                                          Dallas, Dallas, TX; Charles W Miller, Heygood Orr
Travis E Downs, III, Coughlin Stoia Geller Rudman &
                                                          Reyes & Bartolomei, Dallas, TX; Gary A Bornstein,
Robbins LLP, [**2] San Diego, CA; Robert B Weiser,
                                                          Robert H Baron, Cravath Swaine & Moore, New York,
Weiser Law Firm, Wayne, PA; Suzanne H Stevens,
                                                          NY.
Coughlin Stoia Geller Rudman, San Diego, CA.
                                                          For Mark King, Defendant: Barry Frank McNeil, LEAD
For Jeffrey T Strauss, Consol Plaintiff: Christopher J
                                                          ATTORNEY, Christopher A Rogers, Kathleen M
Moser, LEAD ATTORNEY, Quilling Selander
                                                          Beasley, Haynes & Boone - Dallas, Dallas, TX; David M
Cummiskey & Lownds, Dallas, TX; Glenn F Ostrager,
                                                          J Rein, Karen Patton Seymour, Stephen Ehrenberg,
Ostrager Chong Flaherty & Broitman, New York, NY;
                                                          Sullivan & Cromwell LLP, New York, NY; Natalie N
Paul D Wexler, Bragar Wexler & Eagel, New York, NY;
                                                                                                                Page 2
                             540 F. Supp. 2d 695, *; 2007 U.S. Dist. LEXIS 92401, **3



Kuehler, Sullivan & Cromwell - New York, New York,         Rexford (Defendants Blodgett et al.); Warren Edwards
NY; Sarah R Teachout, Haynes & Boone, Dallas, TX.          and Mark King; Jeffrey Rich; Cerberus Capital
                                                           Management LP; and Supplemental Motions filed by
For Lynn Blodgett, John Rexford, John M Brophy,            Defendants Blodgett [**5] et al. and William L.
Defendants: Lewis T LeClair, LEAD ATTORNEY, Scott          Deckelman, Jr. Having considered all briefing on the
R Jacobs, McKool Smith - Dallas, Dallas, TX; Charles W     issue and arguments made at the hearing held on the
Miller, Heygood Orr Reyes & Bartolomei, Dallas, TX.        Motions on August 1, 2007, and for the reasons set forth
                                                           below, the Court DENIES Motions filed by Cerberus and
For Warren Edwards, Defendant: Barry Frank McNeil,         Black (individually) as moot, given that Plaintiffs have
LEAD ATTORNEY, Christopher A Rogers, Kathleen M            dismissed their claims against those Defendants, and
Beasley, Haynes & Boone - Dallas, Dallas, TX; Sarah R      GRANTS in part and DENIES in part the remaining
Teachout, Haynes & Boone, Dallas, TX.                      motions, as indicated herein. The Court GRANTS
                                                           Plaintiffs leave to amend their Complaint as indicated
For Affiliated Computer Services Inc, a Delaware
                                                           herein.
corporation, Defendant: Lisa Staler Gallerano, LEAD
ATTORNEY, David Ray McAtee, M Scott Barnard,               Background
Orrin Lea Harrison, III, Akin Gump Strauss Hauer &
Feld, Dallas, TX.                                               This case is a derivative action, brought on behalf of
                                                           the shareholders of ACS on June 22, 2006, for the alleged
For Clifford M Kendall, [**4] David W Black, Henry         backdating of stock options by various officers and
Hortenstine, Peter A Bracken, Defendants: Lewis T          directors of ACS. In their Amended Complaint filed
LeClair, LEAD ATTORNEY, Scott R Jacobs, McKool             April 6, 2007, Plaintiffs brought claims for violations of §
Smith - Dallas, Dallas, TX.                                10(b), Rule 10b-5, § 14(a), § 16(b), and § 20(a) of the
                                                           Securities Exchange Act of 1934, as well as state law
For William L Deckelman, Jr, Defendant: Steve Sumner,
                                                           claims for accounting, breach of fiduciary duties, abuse
LEAD ATTORNEY, Andrew Jee, Sumner Schick
                                                           of control, mismanagement, constructive fraud, corporate
Hamilton & Pace, Dallas, TX; David H Pace, David C
                                                           waste, unjust enrichment, rescission, and breach of
Schick, Sumner Schick & Pace, Dallas, TX.
                                                           contract. These claims ("the backdating claims") arise out
For Cerberus Capital Management LP, Defendant: Jean C      of Defendants' actions in allegedly causing, permitting,
Frizzell, LEAD ATTORNEY, Gibbs & Bruns LLP,                and/or concealing [**6] the backdating of stock option
Houston, TX; Gregory A Kasper, Schulte Roch & Zabel        grants to ACS's directors and top executive officers;
LLP, New York, NY; Jeremy Doyle, Laura Kissel, Robin       failing to properly investigate whether these grants were
C Gibbs, Gibbs & Bruns, Houston, TX.                       improperly made; and failing to require the grant
                                                           recipients to disgorge the options and the resulting
JUDGES: BARBARA M.G. LYNN, UNITED STATES                   proceeds from their exercise. Plaintiffs also claim that
DISTRICT JUDGE.                                            ACS's directors breached their fiduciary duties by
                                                           improperly pursuing a sale of the company in order to
OPINION BY: BARBARA M.G. LYNN                              insulate themselves from liability for the claims alleged
                                                           in this suit ("the buy-out claims"). Defendants filed
OPINION                                                    motions to dismiss all of these claims.

                                                           Prior Rulings
[*698] MEMORANDUM ORDER AND OPINION
                                                                At the hearing held by this Court on August 1, 2007,
    Before the Court are Motions to Dismiss filed by       Plaintiffs voluntarily [*699] dismissed without prejudice
Defendants Affiliated Computer Services, Inc. ("ACS");     their claims against Defendant David Black, who is a
J. Livingston Kosberg, Dennis McCuistion, Joseph P.        Florida resident. Plaintiffs also voluntarily dismissed
O'Neill, and Frank A. Rossi (Defendants Kosberg et al.);   without prejudice their buy-out claims, which they had
Lynn Blodgett, David W. Black, Peter A. Bracken, John      asserted against all Defendants. The motions of
M. Brophy, Darwin Deason, William L. Deckelman, Jr.,       Defendants Kosberg et al., Blodgett et al., and ACS to
Henry Hortenstine, Clifford M. Kendall, and John           dismiss Plaintiffs' buy-out claims are therefore DENIED
                                                                                                                     Page 3
                             540 F. Supp. 2d 695, *699; 2007 U.S. Dist. LEXIS 92401, **6



as moot. Since the only claim asserted against Cerberus        injury." ABC Arbitrage Plaintiffs Group v. Tchuruk, 291
Capital Management LP was the buy-out claim, Cerberus          F.3d 336, 348 (5th Cir. 2002). Under the heightened
is no longer a Defendant in the case. The Court therefore      pleading [**9] standards of the Private Securities
DENIES Cerberus Capital Management [**7] LP's                  Litigation Reform Act ("PSLRA"), if the Plaintiffs allege
Motion as moot. The Court also ruled at the hearing that       that a Defendant "made an untrue statement of a material
Plaintiffs had properly pleaded demand futility, so            fact" or "omitted to state a material fact necessary in
Motions filed by Defendants Rich, King, and Edwards to         order to make the statements made, in the light of the
dismiss Plaintiffs' Amended Complaint on that ground           circumstances in which they were made, not misleading,"
are DENIED. The Court dismissed Plaintiffs' § 16(b)            then "the complaint shall specify each statement alleged
claims (Count IV) at the hearing, holding that exemptions      to have been misleading, the reason or reasons why the
pursuant to Rules 16b-3(d)(1) and (3) applied. The Court       statement is misleading, and, if an allegation regarding
therefore GRANTS Edwards and King's Motion and                 the statement or omission is made on information and
Rich's Motion on that basis and dismisses Count IV of          belief, the complaint shall state with particularity all facts
Plaintiffs' Amended Complaint.                                 on which that belief is formed." 15 U.S.C. § 78u-4(b)(1).
                                                               Fed. R. Civ. P. 9(b) requires that "[i]n all averments of
Section 10(b) and Rule 10b-5 Claims                            fraud or mistake, the circumstances constituting fraud or
                                                               mistake shall be stated with particularity." The Fifth
     Plaintiffs assert claims under § 10(b) and Rule 10b-5,    Circuit has provided this summary test:
alleging that Defendants "engaged in acts, practices and a
course of conduct that included the making of, or                           [A] plaintiff pleading a false or
participation in the making of, untrue and/or misleading               misleading statement or omission as the
statements of material fact and/or omitting to state                   [*700] basis for a section 10(b) and Rule
material facts necessary in order to make the statements               10b-5 securities fraud claim must, to avoid
made about ACS not misleading," and that the                           dismissal pursuant to Rule 9(b) and 15
Defendants acted with scienter in doing so. Amended                    U.S.C. §§ 78u-4(b)(1) & 78u-4(b)(3)(A):
Complaint at PP 121, 123. In particular, Plaintiffs argue
that Defendants made false or misleading statements in                              (1) specify . . . each
ACS's public filings, including the 1994 initial public                        statement alleged to have
offering, and in Forms 10-K405 and 10-K filed from                             been     misleading,    i.e.,
[**8] 1996 to 2005. Id. at PP 56, 86. Plaintiffs allege that                   contended to be fraudulent;
the Registration and Prospectus for the 1994 initial public
offering contained material misrepresentations that the                            (2) [**10] identify the
exercise price of incentive stock options was equal to the                     speaker;
fair market value of ACS common stock. Plaintiffs allege
that the 1996-2005 Forms 10-K contained false                                     (3) state when and
representations that ACS was continuing to use                                 where the statement was
Accounting Principles Board ("APB") Opinion No. 25 in                          made;
accounting for stock options, even though ACS had not
taken a compensation expense since 1995 for                                         (4)      plead     with
"in-the-money" options, as required by APB No. 25.                             particularity the contents of
Plaintiffs also allege that the Defendants underreported                       the false representations;
ACS's tax liability each year from 2000 to 2005, resulting
                                                                                    (5)      plead   with
in tax penalties and interest that made reports of ACS's
                                                                               particularity    what  the
earnings, expenses, and liabilities materially false.
                                                                               person       making    the
     To state a claim under § 10(b) and Rule 10b-5, "a                         misrepresentation obtained
plaintiff must allege, in connection with the purchase or                      thereby; and
sale of securities: (1) a misstatement or an omission (2) of
                                                                                    (6) explain the reason
material fact (3) made with scienter (4) on which
                                                                               or reasons why the
plaintiffs relied (5) that proximately cause the plaintiffs'
                                                                               statement is misleading,
                                                                                                                      Page 4
                              540 F. Supp. 2d 695, *700; 2007 U.S. Dist. LEXIS 92401, **10



                i.e., why the statement is                       under the prior law. Margolies v. Deason, 464 F.3d 547
                fraudulent.                                      (5th Cir. 2006). Defendants claim that all of the Plaintiffs'
                                                                 claims that accrued before the date of the last option grant
                                                                 of July 22, 2002, are time-barred. 1

ABC Arbitrage at 350.                                                   1 At oral argument, counsel for Jeffrey Rich
                                                                        argued that claims accruing after July 21, 2001,
     Under the PSLRA, a complaint must state with                       but before SOX's July 30, 2002 enactment date,
particularity facts giving rise to a strong inference that the          including any claims based on the option grant
defendant acted with the required state of mind. Cent.                  dated July 23, 2002, are also time-barred under
Laborers' Pension Fund v. Integrated Elec. Servs., 497                  the three-year statute of repose applicable before
F.3d 546, 551 (5th Cir. 2007). "Importantly, the Supreme                SOX. However, the Court denied this argument at
Court recently stated that '[t]o determine whether the                  the hearing and found the Fifth Circuit's reasoning
plaintiff has alleged facts that give rise to the requisite             in Margolies v. Deason, 464 F.3d 547 (5th Cir.
'strong inference' of scienter, a court must consider                   2006) applicable here, concluding that the
plausible nonculpable explanations for the defendant's                  five-year period of repose (and the three year
conduct, as well as inferences favoring the plaintiff.'" Id.            statute of limitations) applies to claims filed after
(citing Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127               SOX's enactment date that were not time-barred
S. Ct. 2499, 2510, 168 L. Ed. 2d 179 (2007)). A                         as of that date, although based on facts that
complaint will survive a motion to dismiss "only if a                   predated SOX. Accord In re ExxonMobil Corp.
reasonable person would deem the inference of scienter                  Securities Litigation, 500 F.3d 189 (3d Cir. Nov.
cogent and at least as compelling as any opposing                       20, 2007).
inference one could draw from the [**11] facts alleged."
Tellabs, 127 S. Ct. at 2510.                                          [*701] A claim under § 10(b) that is based upon the
                                                                 backdating itself accrues on the date the option grant was
A. Statute of Repose                                             made. In re Ditech Networks, Inc. Derivative Litig., 2007
                                                                 U.S. Dist. LEXIS 51524, 2007 WL 2070300, *7 (N.D.
     Plaintiffs' claims are based on option grants dated         Cal. July 16, 2007). [**13] The Court rejects Plaintiffs'
March 9, 1995; March 8, 1996; April 7, 1997; May 18,             argument that the "continuing wrong" theory applies to
1998; October 8, 1998; September 13, 1999; July 11,              toll limitations and repose until the last alleged
2000; and July 23, 2002. For claims that accrued on or           misrepresentation was made. The Court finds that claims
prior to July 30, 1999, the statutes of limitations and          based on all but the last option grant date--July 23,
repose in effect prior to the Sarbanes-Oxley Act of 2002         2002--are time-barred under the statute of repose
(SOX) apply. Prior to SOX, "[l]itigation instituted              applicable to those claims, and therefore dismisses all of
pursuant to § 10(b) and Rule 10b-5 therefore must be             Plaintiffs' § 10(b) and Rule 10b-5 claims based on option
commenced within one year after the discovery of the             grants made on all of the prior dates. As to the July 23,
facts constituting the violation and within three years          2002 option, the Court does not conclude as a matter of
after such violation." Lampf, Pleva, Lipkind, Prupis &           law that it is barred by limitations.
Petigrow v. Gilbertson, 501 U.S. 350, 364, 111 S. Ct.
2773, 115 L. Ed. 2d 321 (1991). The statute of repose                 Plaintiffs also base their § 10(b) and Rule 10b-5
"serves as an absolute bar to any claims brought more            claims on allegedly false statements made in the 1994
than three years after accrual, regardless of when a             initial public offering and in Forms 10-K405 and 10-K
plaintiff discovered or could have discovered that he had        filed from 1996 to 2005. A claim under § 10(b) and Rule
a claim." Del Sontro v. Cendant Corp., 223 F. Supp. 2d           10b-5 based on dissemination of false financial
563, 570 (D. N.J. 2002) (citing Lampf at 363). Congress          statements accrues when the allegedly false or misleading
extended the statutes of limitation and repose to two and        statement was made. Del Sontro, 223 F. Supp. 2d at 573
five years, respectively, in SOX. 28 U.S.C. § 1658(b).           (citing Lampf). Plaintiffs' claims based on false
The statutes of limitation and repose in SOX apply to            statements in filings made before July 30, 1999, are all
cases filed after SOX's enactment [**12] date--July 30,          barred under the three-year statute of repose applicable
2002--if the claims were not time-barred as of that date         before SOX's enactment, and Plaintiffs' claims based on
                                                                                                                     Page 5
                             540 F. Supp. 2d 695, *701; 2007 U.S. Dist. LEXIS 92401, **13



false statements in filings made between [**14] July 30,        particularity each individual Defendant's role on the
1999 and June 21, 2001 (five years before suit was filed),      Compensation Committee or other basis for finding that
are barred under the five-year statute of repose under          these Defendants acted with scienter in approving the
SOX. Therefore, the only claims based on false                  option grants.
statements which survive the statute of repose are those
made on and after June 22, 2001. As to those which do                As for Rich, King, Blodgett, and Brophy, who all
survive, however, Plaintiffs have not pleaded with              received the alleged backdated option grants dated July
particularity what statements in those filings they allege      23, 2002, Plaintiffs cannot establish the requisite scienter
to be false. In other words, it is unclear whether Plaintiffs   based only on their receipt of such grants. Plaintiffs
allege that later filings contained false statements based      attempt to pair receipt with allegations of insider trading
on events not barred or whether they merely constitute          in order to satisfy the scienter prerequisite. However, to
"the issuance of a further financial statement that failed to   establish scienter, insider trading must be in suspicious
correct the prior false statement" made in time-barred          amounts, at suspicious times, and out of line with prior
filings. In re Ditech 2007 U.S. Dist. LEXIS 51524,              trading practices. Cent. Laborers' Pension Fund, 497
[WL]at *8. Like the Ditech court, this Court would view         F.3d at 552-53. "Insider trading alone cannot create a
the latter approach as one based on a continuing wrong          strong inference of scienter, but it may meaningfully
theory, which this Court rejects, and this Court would          enhance the strength of the inference of scienter." Id. The
find such claims time-barred. See id.; In re Atmel Corp.        Court must analyze whether Plaintiffs have alleged a link
Derivative Litig., No. 06-4592, 2007 U.S. Dist. LEXIS           between each Individual Defendant's alleged insider
54058, 2007 WL 2070299, *7 (N.D. Cal. July 16, 2007).           trading and his particular part in the alleged fraud." In re
However, the Court grants Plaintiffs leave to replead the       Blockbuster, Securities Litig., No. 03-0398, 2004 U.S.
particulars of the false statements they claim were made        Dist. LEXIS 7173, 2004 WL 884308, *18 (N.D. Tex.
in Forms 10-K405 and 10-K filings, from June 22, 2001,          Apr. 26, 2004). Plaintiffs generally plead, [**17] in chart
forward, based on claims not [**15] barred.                     form, the dates and amounts of the Individual Defendants'
                                                                alleged insider trading, but in the Court's view, the chart
B. Particularized Pleading and Scienter                         does not provide any basis for the Court to find the
                                                                trading suspicious. The Court grants Plaintiffs leave to
     Plaintiffs allege that on July 23, 2002, ACS made a        amend to plead insider trading as a basis for a strong
grant of 400,000 options to Rich, a grant of 600,000            inference of scienter as to these Defendants. In so doing,
options to Deason, a grant of 200,000 options to King, a        Plaintiffs must be mindful of the pleading requirements
grant of 75,000 options to Blodgett, and a grant of 75,000      articulated in Tellabs, supra.
options to Brophy. Plaintiffs further allege that
Defendants Deason, O'Neill, and Rossi, who served on                 With regard to Forms 10-K405 and Forms 10-K filed
the Compensation Committee at the time of the grants,           after June 22, 2001, Plaintiffs allege that Deason, Rich,
acted with scienter in violating § 10(b). To the extent         O'Neill, Rossi, and King signed all the forms; that
Plaintiffs rely only on the Defendants' membership on the       Hortenstine, Kendall, Deckelman, and Bracken signed
Committee to establish scienter, they have not                  the forms in 2001 and 2002; and, that Kosberg,
sufficiently pleaded scienter. Fener v. Belo Corp., 425 F.      McCuistion, and Edwards signed the forms from 2003 to
Supp. 2d 788, 797 (N.D. Tex. 2006) (citing Southland            2005. The fact that these Defendants signed the allegedly
Sec. Corp. v. INSpire Ins. Solutions, Inc., 365 F.3d 353        false or fraudulent documents constitutes a "specific
(5th Cir. 2004). Plaintiffs must establish that each            factual allegation" that links these individuals to the
individual Defendant had the requisite state of mind, but       statements at issue. Southland Sec. Corp. v. INSpire Ins.
not merely by relying on the positions held by the              Solutions, Inc., 365 F.3d 353, 365 (5th Cir. 2004).
Defendants in the company. Id. at [*702] 798; Abrams            However, the signatures of Deason, Rich, O'Neill, Rossi,
v. Baker Hughes Inc., 292 F.3d 424, 432 (5th Cir. 2002)         King, Hortenstine, Kendall, Deckelman, Bracken,
("A pleading of scienter may not rest on the inference          Kosberg, McCuistion, and Edwards on the Forms
that defendants must have been aware of the                     10-K405 and Forms 10-K [**18] are not sufficient, by
misstatement based on their positions within the                themselves, to establish scienter on behalf of those
company."). Therefore, the Court will [**16] grant              Defendants. Mortensen v. AmeriCredit Corp., 123 F.
Plaintiffs leave to amend in order to plead with                Supp. 2d 1018, 1027 (N.D. Tex. 2000) (finding complaint
                                                                                                                         Page 6
                              540 F. Supp. 2d 695, *702; 2007 U.S. Dist. LEXIS 92401, **18



"deficient" as to scienter when plaintiffs appeared "to rely     unlawful stock option backdating scheme, causing
generally on these defendants' signatures on financial           damages to the Company. Id. at PP 129-231. Plaintiffs
reports and their positions"); see In re Michaels Stores,        specifically allege two kinds of false statements in the
Inc. Sec. Litig., No. 03-0246, 2004 U.S. Dist. LEXIS             proxy statements: (1) that the stock options were priced at
24919 (N.D. Tex. Dec. 10, 2004) (dismissing § 10(b)              fair market value on the date of the grant and (2) that
claim as to individual who signed documents but as to            ACS followed and adhered to APB 25. Id. at P 89.
whom plaintiffs did not adequately plead state of mind);
see also Garfield v. NDC Health Corp., 466 F.3d 1255,                 Rule 14a-9 provides that "No solicitation subject to
1265-66 (11th Cir. 2006) (explaining that signed                 this regulation shall be made by means of any proxy
certification is probative of scienter only if plaintiffs        statement . . . which, at the time . . . it is made, is false or
plead facts indicating that the person signing the               misleading with respect to any material fact, or which
certification was severely reckless in certifying accuracy       omits to state any material fact necessary in order to
of financial statements); Cent. Laborers' Pension Fund,          make the statements therein not false or misleading." An
497 F.3d at 555 (holding that a strong inference of              omitted fact is material "if there is a substantial likelihood
scienter was proper only if the person signing the               that a reasonable shareholder would consider it important
certification of the 10-K "had reason to know, or should         in deciding how to vote." General Elec. Co. v. Cathcart,
have suspected, due to the presence of glaring accounting        980 F.2d 927, 932 (3d Cir. 1992) (quoting TSC Indus.,
irregularities or other [*703] 'red flags,' that the financial   Inc. v. Northway, Inc., 426 U.S. 438, 449, 96 S. Ct. 2126,
statements contained material [**19] misstatements or            48 L. Ed. 2d 757 (1976)).
omissions"). Though the Court questions whether
                                                                 A. Statute of Repose
Plaintiffs will be able to adequately plead scienter on
behalf of these individual Defendants, the Court will                 Like Plaintiffs' § 10(b) claims, the Court [**21] also
grant Plaintiffs leave to amend their Complaint to               finds that some of Plaintiffs' claims brought under § 14(a)
establish that each individual Defendant had the requisite       are time-barred. The Lampf "1-and-3" rule, providing a
state of mind.                                                   one-year statute of limitation and three-year statute of
                                                                 repose, applies to § 14(a) claims. Westinghouse Elec.
     However, since Plaintiffs have failed to show that
                                                                 Corp. v. Franklin, 993 F.2d 349, 353 (3d Cir. 1993); In re
Defendants Blodgett, Rexford, or Brophy signed any of
                                                                 Atmel Corp. Derivative Litig., No. 06-4592, 2007 U.S.
the documents at issue or that they were otherwise
                                                                 Dist. LEXIS 54058, 2007 WL 2070299, *8 (N.D. Cal.
responsible for the allegedly false or fraudulent
                                                                 July 16, 2007). The Court agrees with the recent decision
statements contained in those documents, Plaintiffs' §
                                                                 of In re ExxonMobil Corp. Securities Litigation, 500 F.3d
10(b) and Rule 10b-5 claims against those Defendants are
                                                                 189 (3d Cir. Nov. 20, 2007), that SOX does not extend
dismissed.
                                                                 limitations or repose for § 14(a) claims. A claim based on
Section 14(a) Claims                                             dissemination of false financial statements accrues when
                                                                 the allegedly false or misleading statement was made.
     Plaintiffs assert claims under § 14(a) against all the      Del Sontro v. Cendant Corp., 223 F. Supp. 2d 563, 573
Defendants who remain parties to the case, alleging that         (D. N.J. 2002). Therefore, all claims based on allegedly
the 1995-2005 proxy statements violated § 14(a) and              false or fraudulent proxy statements filed before June 21,
Rule 14a-9 because they omitted material facts,                  2003, are dismissed, as time-barred by the three-year
"including the fact that certain of the defendants were          statute of repose.
causing ACS to engage in an option backdating scheme, a
fact which defendants were aware of and participated in          B. Essential Link
from at least 1995." Amended Complaint at P 128.
                                                                      Defendants argue that Plaintiffs have failed to state a
Plaintiffs plead that, in the exercise of reasonable care,
                                                                 claim because they have failed to show that the proxy
Defendants should have known that the proxy statements
                                                                 statements were an essential link in accomplishment
were materially [**20] false and misleading and that the
                                                                 [*704] of the challenged corporate actions. An action
misrepresentations were material to Plaintiffs in voting
                                                                 under § 14(a) must challenge [**22] "a transaction
on each proxy statement and were an essential link in the
                                                                 which was the subject of the proxy materials, such as
accomplishment of the continuation of Defendants'
                                                                 approval of a merger agreement or the election of
                                                                                                                   Page 7
                             540 F. Supp. 2d 695, *704; 2007 U.S. Dist. LEXIS 92401, **22



corporate directors." Fisher v. Kanas, 467 F. Supp. 2d         F.3d 854, 863 (5th Cir. 2003). Since it is premature to
275, 282 (E.D.N.Y. 2006). Plaintiffs allege in their           decide these claims now, the Court denies the motions to
Amended Complaint that the "Proxy Statements were an           dismiss these claims, without prejudice to their being
essential link in the accomplishment of the continuation       reasserted against the Plaintiffs' to-be-filed Second
of defendants' unlawful stock option backdating scheme,        Amended Complaint.
as revelations of the truth would have immediately
thwarted a continuation of shareholders' endorsement of        State Law Claims
the directors' positions, the executive officers'
                                                                   Plaintiffs plead various state law claims in their
compensation and the Company's compensation
                                                               Amended Complaint: demand for an accounting (Count
policies." Amended Complaint at P 130. This allegation
                                                               V); intentional breach of fiduciary duty (Count VI);
is insufficient to state that an essential link exists.
                                                               breach of fiduciary duty and/or aiding and abetting
     The court in General Electric Company v. Cathcart,        (Count VII); abuse of control (Count VIII); gross
980 F.2d 927 (3d. Cir. 1992), rejected an argument based       mismanagement (Count IX); constructive fraud (Count
on such a tenuous connection, holding that "the mere fact      X); corporate waste (Count XI); unjust enrichment
that omissions in proxy materials, by permitting directors     (Count XII); rescission (Count XIII); and breach of
to win re-election, indirectly lead to financial loss          contract (Count XIV).
through mismanagement will not create a sufficient nexus
                                                                    Defendant ACS argues that the Court should decline
with the alleged monetary loss." 980 F.2d at 933; see also
                                                               to exercise jurisdiction over the state law claims.
In re VeriSign, Inc., Derivative Litig., No. 06-4165, 531
                                                               Plaintiffs have requested leave to amend their Amended
F. Supp. 2d 1173, 2007 U.S. Dist. LEXIS 72341, 2007
                                                               Complaint to allege diversity jurisdiction. Since the Court
WL 2705221 (N.D. Cal. Sept. 14, 2007)(holding [**23]
                                                               has limited discretion to decline to exercise jurisdiction
that plaintiffs failed to allege an injury stemming directly
                                                               over claims [*705] over which it has independent
from the transaction that was at immediate issue in the
                                                               federal jurisdiction, [**25] the Court declines to now
proxy, the election of directors). The Amended
                                                               dismiss such claims. This position may be reasserted as
Complaint does not plead an essential link.
                                                               to Plaintiffs' Second Amended Complaint.
     Although this Court has serious doubts that an
                                                               Conclusion
essential link between the proxy statements and the injury
caused by the backdating can be pleaded in good faith,              The Court DENIES the Motions filed by Cerberus
the Court grants Plaintiffs a single opportunity to plead      and Black (individually) as moot, given that Plaintiffs
such a link, if they can in good faith do so. If Plaintiffs    have on the record dismissed their claims against those
fail to sufficiently plead such a link, all of Plaintiffs'     Defendants. The Court DENIES Motions filed by Rich,
claims brought under § 14(a) will be dismissed.                King and Edwards to Dismiss Plaintiffs' Amended
                                                               Complaint for failure to plead demand futility. The Court
Section 20(a) Claims
                                                               GRANTS the same Defendants' Motions to Dismiss
     Section 20(a) of the Exchange Act makes "[e]very          Count IV of the Amended Complaint, and DISMISSES
person who, directly or indirectly, controls any person        Plaintiffs' claims brought under § 16(a) of the Exchange
liable under any provision of this chapter . . . liable        Act. The Court GRANTS Defendants' Motions to
jointly and severally with and to the same extent as such      Dismiss Plaintiffs' claims based on option grants dated
controlled persons." 15 U.S.C. § 78t(a). Plaintiffs plead      March 9, 1995; March 8, 1996; April 7, 1997; May 18,
that Defendants Rich, Deason, Blodgett, King, Edwards,         1998; October 8, 1998; September 13, 1999; and July 11,
Rexford, and Brophy, "by virtue of their positions with        2000. The Court GRANTS Defendants Blodgett,
ACS and their specific acts, were, at the time of the          Rexford, and Brophy's Motions to Dismiss Plaintiffs' §
wrongs alleged herein, controlling persons of ACS within       10(b) and Rule 10b-5 claims that are based on allegedly
the meaning of § 20(a) of the Exchange Act." Since             false Forms 10K-405 and Forms 10-K. The Court
controlling person liability is derivative [**24] of the       GRANTS Defendants' Motions to Dismiss Plaintiffs'
claims discussed above, the Court will dismiss the §           §14(a) and Rule 14a-9 claims based on allegedly false or
20(a) claims only if it dismisses all other claims brought     fraudulent proxy statements filed before June 21, 2003.
under the Exchange Act. Rosenzweig v. Azurix Corp., 332        However, the Court GRANTS [**26] Plaintiffs leave to
                                                                                                                 Page 8
                             540 F. Supp. 2d 695, *705; 2007 U.S. Dist. LEXIS 92401, **26



amend their Complaint (1) to plead the particular false        choose, a Second Amended Complaint, as ordered
statements that appear in filings made on or after July 22,    [**27] herein, along with a red-lined copy, noting all
2001, and to show that those false statements are based        changes in the Amended Verified Consolidated
on events that occurred within the five-year period            Shareholders Derivative Complaint. Any Motion to
thereafter; (2) to plead with particularity individual         Dismiss the Second Amended Complaint must be filed
Defendants' roles on the Compensation Committee or             by March 3, 2008. Responses are due on or before April
otherwise in approving the option grants dated July 23,        1, 2008. Any Replies are due on or before April 22, 2008.
2002; (3) to further detail alleged insider trading to         No changes other than those ordered or permitted herein
establish a basis for scienter as to the Defendants who        may be made to the Amended Verified Consolidated
received allegedly backdated option grants dated July 23,      Shareholders Derivative Complaint.
2002; (4) to plead with particularity scienter as to the
Defendants who signed Forms 10-K405 and Forms 10-K             SO ORDERED.
which are the basis for claims which are not time-barred;
                                                                   DATED: December 13, 2007.
(5) to allege the existence of an essential link between the
proxy materials filed July 22, 2003, or after and the              /s/ Barbara M.G. Lynn
backdating; and (6) to allege diversity jurisdiction. The
Court denies without prejudice Defendants' motions to          BARBARA M.G. LYNN
dismiss Plaintiffs' § 20(a) claims and to have the Court
refuse to exercise supplemental jurisdiction over              UNITED STATES DISTRICT JUDGE
Plaintiffs' state law claims.
                                                                   NORTHERN DISTRICT OF TEXAS
    By February 1, 2008, Plaintiffs shall file, if they

				
DOCUMENT INFO
Shared By:
Categories:
Tags:
Stats:
views:6
posted:2/11/2012
language:English
pages:27