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
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
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,
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,
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.
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
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
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.
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
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
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
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
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,
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.
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
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
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 . . .
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,
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
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
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
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
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
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]
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
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
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,
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;
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
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.
[*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
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,
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
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
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
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
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
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
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