In Re: Cisco Systems Securities Litigation 01-CV-20418...

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CISCO DEFENDANTS’ STATEMENT OF RECENT AUTHORITIES, Case No. C-01 20481 JW

24367/00402/SF/5152438.1

DEAN S. KRISTY (State Bar No. 157646) KEVIN P. MUCK (State Bar No. 120918) KATHRYN FRITZ (State Bar No. 148200) FELIX S. LEE (State Bar No. 197084) ALICE L. JENSEN (State Bar No. 203327) CHRISTOPHER A. GARCIA (State Bar No. 215184) JENNIFER C. BRETAN (State Bar No. 233475) FENWICK & WEST LLP 275 Battery Street San Francisco, California 94111 Telephone: (415) 875-2300 Facsimile: (415) 281-1350 e-mail address: [email protected] DAN K. WEBB (Pro Hac Vice 2/16/05) ROBERT Y. SPERLING (Pro Hac Vice 2/16/05) ROBERT L. MICHELS (Pro Hac Vice 2/16/05) RONALD S. BETMAN (Pro Hac Vice 2/16/05) WINSTON & STRAWN LLP 35 West Wacker Drive Chicago, Illinois 60601-9703 Telephone: (312) 558-5600 Facsimile: (312) 558-5700 e-mail address: [email protected]

Attorneys for Defendants Cisco Systems, Inc., John T. Chambers, Larry R. Carter, Carol A. Bartz, Steven M. West, Edward R. Kozel, Donald T. Valentine, Robert L. Puette, Judith L. Estrin, Gary J. Daichendt, Donald J. Listwin, Carl Redfield and Michelangelo Volpi

UNITED STATES DISTRICT COURT

NORTHERN DISTRICT OF CALIFORNIA

SAN JOSE DIVISION

In re CISCO SYSTEMS, INC. SECURITIES LITIGATION

Case No. C-01-20418-JW CLASS ACTION

This Document Relates To: ALL ACTIONS.

CISCO DEFENDANTS’ STATEMENT OF RECENT AUTHORITIES IN SUPPORT OF MOTION FOR JUDGMENT ON THE PLEADINGS

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CISCO DEFENDANTS’ STATEMENT OF RECENT AUTHORITIES, Case No. C-01 20481 JW

1 24367/00402/SF/5152438.1

Pursuant to Local Rule 7-3(d), defendants Cisco Systems, Inc., John T. Chambers, Larry R.

Carter, Carol A. Bartz, Steven M. West, Edward R. Kozel, Donald T. Valentine, Robert L. Puette,

Judith L. Estrin, Gary J. Daichendt, Donald J. Listwin, Carl Redfield and Michelangelo Volpi

(collectively, the “Cisco Defendants”) hereby submit, in connection with their pending motion for

judgment on the pleadings, copies of the following cases:

Exhibit A: Morgan v. AXT, Inc., 2005 WL 2347125, *16-17 (N.D. Cal. Sept. 23, 2005) (White, J.);

Exhibit B: In re Portal Software, Inc. Sec. Litig., 2005 WL 1910923, *1-4, 16 (N.D. Cal. Aug. 10, 2005) (Walker, C.J.);

Exhibit C: In re Business Objects, S.A. Sec. Litig., 2005 WL 1787860, *9 (N.D. Cal. July 27, 2005) (Jenkins, J.);

Exhibit D: In re The Warnaco Group, Inc. Sec. Litig., 2005 WL 2293117, *8-10 (S.D.N.Y. Sept. 21, 2005) (Cedarbaum, J.);

Exhibit E: Davidoff v. Farina, 2005 WL 2030501, *15-16, 18 (S.D.N.Y. Aug. 22, 2005) (Buchwald, J.);

Exhibit F: In re Compuware Sec. Litig., 2005 WL 2258625, *2-6 (E.D. Mich. Sept. 12, 2005) (Taylor, J.);

Exhibit G: In re Acterna Corp. Sec. Litig., 378 F. Supp. 2d 561, 584-89, 591 (D. Md. July 26, 2005) (Chasanow, J.).

Dated: October 3, 2005 Respectfully submitted,

FENWICK & WEST LLP

By /s/ Kevin P. Muck Kevin P. Muck

Attorneys for the Cisco Defendants

EXHIBIT A

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Only the Westlaw citation is currently available.

United States Dis tr ict Court,

N.D. California.

Thomas 0. MORGAN, et at ., Plaintiffs,

V .

AXT, INC . and Morris S . Young, Defendants .

No. C 04- 4362 MJJ, C 05-5106 MJJ.

Sept. 23, 2005 .

ORDER DISMISSING PLAINTIFF'S COMPLAINTWITHOUT PREJUDICE

WHITE, J .

INTRODUCTION

*1 Before the Court is Defendants' motion to dismiss thisprivate securities fraud action. Plaintiff Thomas 0 . Morgan

("Plaintiff"'), fFN 1 ] representing a purported class of allpurchasers of AXT, Inc ., stock between February 6, 2001,and April 27, 2004, opposes the motion. For the following

reasons, the Court GRANTS Defendants' motion to dismiss,

but GRANTS Plaintiff leave to amend.

FN I . In an Order dated February 2, 2005, the Court

granted Plaintiff Morgan's motion for appointment

as lead plaintiff.

FACTUAL BACKGROUND

A. Background .

Defendant AXT, Inc.'s ("AXT" or the "Company") is apublicly-traded company that manufactures semiconductor

parts, known as substrates, used by a variety of electronicproducts including wireless and fiber optic

telecommunciations , lasers , light emitting diodes, satellitesolar cells, and consumer electronics such as cell phones .

AXT sells compound semiconductor non-silicon substrates

manufactured from gallium arsenide , indium phosphide, andgermanium. AXT employs its proprietary Vertical Gradient

Freeze method for manufacturing the non silicon substrates .During the period of time at issue in the instant lawsuit

(February 6, 2001, through April 27, 2004 (the "Class

Period")), AXT also produced and sold light-emitting diodes

("LEDs") and vertical cavity surface emitting laser chipsthrough its opto-electronic division. AXT sold its products

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to original equipment manufacturers ("OEMs") . The

particular testing required and characteristics of those AXTproducts were determined by the OEMs . Defendant Dr .

Morris S . Young ("Defendant Young") served as theCompany's CEO and Chairman of the Board during the

Class Period .

On February 6, 2001, AXT issued a press release reportingthe Company's strong commitment to its customers and

touting AXT's customers' confidence in AXT . The pressrelease referenced the Company's "supply of high quality

substrates" and reported that AXT was "pleased to support[its] strategic customers' substrate requirements for the yearand believe[d] that the value of the contracts under th[e]

[Supply Guarantee Program] is a good indicator of [AXT's]ability to deliver continued revenue and profit expansion ."

(Complaint ("Comp ."), 13 1 .)

On February 26, 2001, the Company filed its annual report

for FY 2000 on Form 10-K with the SEC . The 10-K stated:"We believe that our success is partially due to ourmanufacturing efficiency and high product yields and we

continually emphasize quality and process control

throughout our manufacturing operations ." The 10-K alsoexplained that AXTs policy was to recognize revenue whenits products were shipped to the customer as long as, inter

alfa, there are no customer acceptance requirements and no

remaining significant obligations . (Id., 132.)

On April 25, 2001, AXT issued a press release announcing

its financial results for the first quarter of 2001 . TheCompany reported that revenue was up a record $40 .1

million and that net income was up $5 million . In the press

release ,'AXT expressed its belief that its products' " strong

engineering design and development capability allows[AXT] to tailor [its] standard products to meet customer

specific requirements and gives [AXT] competitiveadvantages." (Comp., ¶ 33 .) On May 3, 2001, AXT filed itsquarterly report on Form 10-Q with the SEC, reaffirming

the Company's previously announced financial results forthe first quarter of 2001 .

*2 On July 25, 2001, AXT issued a press re lease

announcing its financial results for the second quarter of2001 . The Company reported that revenue reached a record

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$41 .3 million and that net income was up $5 .2 million. On

August 1, 2001, AXT filed its quarterly report on Form10-Q with the SEC, reaffirming the Company's previously

announced financial results for the second quarter of 2001 .

On October 24, 2001, AXT issued a press release

announcing its financial results for the third quarter of 2001 .

The Company announced that reported net losses for thequarter but stated that "strategic research and development

investments are positioning AXT well for continued

leadership" and that the Company's "VFG gallium arsenideand indium phosphide substrates continue to offer superior

features for manufacturers of high quality electronic andopto-electronic devices ." The press release went on to saythat AXT "believe[s] that [it] remain[s] the world leader in

providing both products ." (Comp., ¶ 38 .) On November 7,

2001, AXT filed its quarterly report on Form 10-Q with the

SEC, reaffirming the Company's previously announcedfinancial results for the third quarter of 2001 .

On February 6, 2002, AXT issued a press release

announcing its financial results for the fourth quarter of2001 and for FY 2001 . The Company again reported that its

speciali zed substrates "continue to offer supe rior features

for manufacturers of high quality electronic and

opto-electronic devices" and that the Company "expect[ed2

an increasing number of key customers to recognize thesuperiority of [AXT' s] technology in the future ." (Id., 140.)On March 26, 2002, AXT filed its Form 10-K annual report

with the SEC, re affirming the Company' s previously

announced financial results for the fourth quarter and for FY

2001, and. including the same description of AXT's revenue

recognition policy described in its FY 2000 annual report.

On April 24, 2002, AXT issued a press release announcing

its financial results for the first quarter of 2002. The

Company reported net losses for the quarter but stated that

its reputation for LED quality, value, and delivery was

growing . On May 3, 2002, AXT filed its quarterly report on

Form 10-Q with the SEC, reaffirming the Company's

previously announced financial results for the first quarterof 2002 .

On July 24, 2002, AXT issued a press release announcing

its financial results for the second quarter of 2002. The

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Company reported that revenue increased 14 % and stated,"We are particularly pleased with the growth of our LED

division, which has recorded double digit revenue growthfor the past three quarters, efficiently increased

manufacturing capacity to sustain this growth, improvedgrowth margins, and approached . overall profitability." On

August 15, 2002, AXT filed its quarterly report on Form10-Q with the SEC, reaffirming the Company's previously

announced financial results for the second quarter of 2002.Defendant Young also filed a certification pursuant to the

Sarbanes4)xley Act that the "information contained in theReport fairly presents, in all material respects, the financial

condition and result of operations of the Company . "

*3 On October 23, 2002, AXT issued a press releaseannouncing its financial results for the third quarter of 2002 .

The Company reported that "AXT will continue to benefitfrom the strength of our technology ." (Comp., 148 .) On

November 12, 2002, AXT filed its quarterly report on Form

10-Q with the SEC, reaffirming the Company's previously

announced financial results for the third quarter of 2002 .The Form 10- Q also stated that, "Based on their evaluation,

our principal executive officer and principal financial officer

concluded that our disclosure controls and procedures are

effective . "

On February 5, 2003, AXT issued a press releaseannouncing its financial results for the fourth quarter of

2002 and for FY 2002 . On March 21, 2003, AXT filed its

Form 10-K annual report with the SEC . In the 10-K, the

Company stated, "the lives of our substrate products arerelatively long and accordingly, obsolescence has

historically not been a significant factor ." The Company

again described its revenue recognition policy, as it had inits 2000 and 2001 annual reports . The 10-K also contained a

certification, pursuant to the requirements of theSarbanes-Oxley Act, averring that the report "does not

contain any untrue statement of material fact or omit to statea material fact" and that the financial statements" fairly

present in all material respects the financial condition" of

the Company .

On April 23, 2003, AXT issued a press re lease announcing

its financial results for the first quarter of 2003 . TheCompany reported net losses for the quarter . On May 9 ,

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2003, AXT filed its quarterly report on Form 10-Q with theSEC, reaffirming the Company's previously announced

financial results for the first quarter of 2003 . The 10-Q

reported certified that the Company's "disclosure controlsand procedures are effective."

On July 23, 2003, AXT issued a press release announcing

its financial results for the second quarter of 2004 . TheCompany reported net losses. On August 12, 2003, AXTfiled its quarterly report on Form I0-Q with the SEC,

reaffirming the Company's previously announced financialresults for the second quarter of 2003 . The I0-Q againcontained a certification regarding disclosure controls andprocedures as the May 10-Q had.

On October 22, 2003, AXT issued a press releaseannouncing its financial results for the third quarter of 2003 .

The Company again reported net losses . On November 13,2003, AXT filed its quarterly report on Form 10-Q with the

SEC, reaffirming the Company's previously announcedfinancial results for the third quarter of 2003, and containingcertifications regarding the Company's disclosure controls

and procedures.

On February 4, 2004, AXT issued a press releaseannouncing its financial results for the four th quarter of

2003 and for FY 2003 . On March 29, 2004, AXT filed itsForm 10-K annual report with the SEC . The 10-K certified

that the Company's disclosure controls and procedu res wereeffective and that the report contained no "untrue

statement[s ] of material fact" and did not "omit to state amaterial fact" and that the financial statements " fairly

present in all material respects the financial condition" ofthe Company.

*4 On April 27, 2004, AXT issued a press re lease revealing

that the "first quarter's financial review and verification

process ha [d] been delayed due to an investigation by

AXT"s Audit Committee of certain product testing practicesand policies." (Comp ., ¶ 64 .) The next day, AXT stock

dropped by 13 .64%. A day later, AXT's stock dropped

further, by nearly 23% , to close at $2.20 per share .

On May 24, 2004, AXT filed its quarterly report on Forml0-Q with the SEC, announcing that AXT had "not followed

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requirements for testing of products and provision of testing

data and information relating to customer requirements forcertain shipments made over the past several years ." The

10-Q reported that AXT then increased its reserve for salesreturns by $745,000, and recorded a $2 .1 million charge forobsolete inventory manufactured in the previous two andthree years because the specifications of its productsdiffered from customer orders. AXT also announced that ithad reassigned its CEO and Chairman of the Board,

Defendant Young to head up AXT's China unit, and hadreplaced the Company's independent auditor,PriceWaterhouseCoopers ("PwC") . (Comp ., ¶M 65- 68, 70 .)Plaintiff Morgan subsequently filed the instant lawsuit,IFN21 claiming that he and other members of the proposedclass who purchased shares of AXT stock between February

6, 2001, and April 27, 2004, were injured because they

bought AXT stock at artificially-inflated prices whichplummeted when the Company disclosed to the public theinternal investigation into its practices.

E1- Two separate lawsuits were brought byinvestors in AXT stock against AXT andDefendant Young: (1) City of Harper Woods

Employees Retirement Sys. v. A.X7 Inc., 04-04362MJJ, filed on October 15, 2004; and (2 ) Robertson

v. AXT, Inc., 04-05106 MJJ, filed on December 2,2004. In its February 2, 2005, Order, the Courtgranted Plaintiff Morgans motion to consolidate

the lawsuits.

B. The Complaint

In his Consolidated Complaint for Violations of the FederalSecurities Laws (hereinafter, the "Complaint"), Plaintiff

alleges that AXT and Defendant Young, AXT's formerChairman and Chief Executive Officer, violated §§ 10(b)

and 20(a) of the Securities and Exchange Act of 1934("Exchange Act"), 15 U.S .C. §§ 724(bl and 78(t)a, andSecurities and Exchange Commission ("SEC") Rule IOb-5,

17 C.F.R § 240 .10b-5 . According to Plaintiff, during the

Class Period, Defendants knowingly shipped products thatdid not conform to customer testing requirements or

specifications . Plaintiff alleges that Defendants failed toproperly account for products that were defective or couldnot be sold by improperly recognizing revenue on those

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sales even though Defendants knew the products would be

returned and failing to accrue adequate re serves . Plaintiff

claims that Defendants violated the secu rities laws by

knowingly issuing false or misleading statements aboutAXT's reserves , revenue , and income (hereinafter, the"financial statements"), and by knowingly issuing false or

misleading statements touting the quality of AXT's productsand AXT's ability to meet customer requirements

(hereinafter, the "quality statements") .

In his Complaint, Plaintiff alleges that his claims are

supported by the statements of three confidentialwitnesses--a Quality Technician who used to work for AXT,

a former AXT Corporate Vice President, and a former testerof returned AX T products . IFN31 The former QualityTechnician allegedly confirmed that the Company

knowingly shipped to customers products that did not meetcustomer specifications, that the Company was aware that

the products would be returned, and that almost every

shipment was, in fact, returned. Specifically, the techniciansaid that when AXT conducted specification checks on its

LED wafers for wavelength, luminosity, vision, and current,the wafers never met all the specifications . The former tester

of returned AXT products allegedly confirmed that thepassivation layer (the top protective layer) on AXT's LEDs

was consistently weak, making the LEDs easily andirreparably damaged. The tester allegedly said that AXTknew this was a problem and lacked adequate product

testing equipment. The former Corporate Vice Presidentallegedly confirmed that AXT failed to perform full testing

of its products and lacked the right equipment for testing .

(Comp ., ¶¶ 78-80. )

) In his Complaint, Plaintiff does not allege

that the third confidential witness--the tester of

returned AXT products-was ever an AXT

employee. In his opposition to the instant motion,

however, Plaintiff describes this witness as a

former AXT employee.

*5 Plaintiff alleges that during the Class Period, Defendants

reported that one of the Company's larger customers,

Agilent, had canceled its orders with AXT because AXTwas shipping products that did not conform to Agilent'sspecifications. Defendants characterized the shipping of

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out-of-spec products as a one-time event even though,

according to Plaintiff, AXT had shipped products that didnot meet customer specifications to many of its customers.

(Id. f 86 . )

On May 20 , 2005 , Defendants filed the instant mo tion to

dismiss pursuant to the Private Securiti es Litigation ReformAct of 1995 ("PSLRA"), and Rulm 2(b) and 12(b)(6) of the

Federal Rules of Civil Procedure, on the grounds thatPlaintiff has failed to plead his allegations with sufficientparticularity.

LEGAL STANDARDA. Federal Rules of Civil Procedure

A court may dismiss a complaint pursuant to Federal Rule

of Civil Procedure 12(b)(6 for the pleading of insufficient

facts under an adequate theory . Robertson v . Dean Witter

Reynolds. Inc . . 749 F .2d 530. 533-34 (9th Cir.1984). When

deciding upon a motion to dismiss pursuant to Rule

12 ( )f6). a court must take all of the material allegations in

the plaintiffs complaint as true, and construe them in the

light most ' favorable to the plaintiff. Parks School of

Business . Inc. v. Symington. 51 F.3d 1480. 1484 (9th

cit. 1995).

In the context of a motion to dismiss, review is limited to

the contents in the complaint. Aliarcom Pay Television. Ltd.

v. General Instrument Corp. . 69 F.3d 381. 385 (9th

Cir.1995). When matters outside the pleading are presented

to and accepted by the court, the motion to dismiss is

converted into one for summary judgment. However,

matters properly presented to the court, such as those

attached to the complaint and incorporated within its

allegations, may be considered as part of the motion to

dismiss . See Hal Roach Studios . Inc . v. Richard Feiner _&

Co. 896 F .2d 1542 . 1555 n. 19 (9th Cir.19891. Where a

plaintiff fails to attach to the complaint documents referred

to therein, and upon which the complaint is premised, a

defendant may attach to the motion to dismiss such

documents in order to show that they do not support the

plaintiffs claim . See Pacific Gateway Exchange, 169

F .Supp .2d at 1164 ; Branch v. Tunnell. 14 F .3d 449.44 (9th

Cir.1994 (overruled on other grounds) . Thus, the district

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cou rt may consider the full texts of documents that thecomplaint only quotes in part. See In re Stay Electronics

Sec. Lit . 89 F.3d 1399. 1405 n . 4 (1996 ), cert denied, 520

U .S. 1103 (1997) . This rule precludes plaintiffs "fromsurviving a Rule 12(b)(6) motion by deliberately omitting

references to documents upon which their claims are based ."Parrino v. FHP. Inc. . 146 F . 3d 699.705 (9th Cir.1998).

Rule 8(a) of the Federal Rules of Civil Procedure requires

only "a short and plain statement of the claim showing that

the pleader is entitled to relief." Accordingly, motions to

dismiss for failure to state a claim pursuant to Rule 12(b)(6)

are typically disfavored; complaints are construed liberally

to set forth some basis for relief, as long as they providebasic notice to the defendants of the charges against them .

In re McKesson HBOC, Inc. Sec. Litfg., 126 F.Supp . 1248,

1257 (N.D.Cal .2000). Where a plaintiff alleges fraud,however, Rule 9 requires the plaintiff to state withparticularity the circumstances constituting fraud . To meet

the heightened pleading requirements of Rule 9(b). the

Ninth Circuit has held that a fraud claim must contain threeelements : (1) the time, place, and content of the allegedmisrepresentations ; and (2) an explanation as to why the

statement or omission complained of was false ormisleading. In re GlenF . hac_ Sec . Litig. . 42 F .3d 1541 .1547-49 (9th Cir.1994).

*6 In the securities context, the pleading requirements areeven more stringent .

B . Private Securities Litigation Reform Act

In 1995, Congress enacted the PSLRA to provide"protections to discourage frivolous [securities] litigation."

H.R. Conf Rev . No. 104-369, . 104th Cong., 1st Sess. at 32

(Nov. 28, 1995). The PSLRA strengthened the

already-heightened pleading requirements of Rule 91b} .

Under the PSLRA, actions based on allegations of materialmisstatements or omissions must "specify each statementalleged to have been misleading, the reason or reasons why

the statement is misleading, and, if an allegation regarding

the statement or omission is made on information and belief,the complaint shall state with particularity all facts on whichthat belief is formed ." 15 U.S .C . § 78u-4(b)(I) .

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The PSLRA also heightened the pleading threshold for

causes of action brought under Section 10(b) and RulelOb-5 . Specifically, the PSLRA imposed strict requirements

for pleading scienter. Under the PSLRA, a complaint must"state with particularity facts giving rise to a strong

inference that the defendant acted with the required state ofmind." 15 U.S .C . § 78u-4(__)b (2) . The Ninth Circuit, ininterpreting the PSLRA, has held that "a private securities

plaintiff proceeding under the [PSLRA] must plead, in great

detail, facts that constitute strong circumstantial evidence ofdeliberately reckless or conscious misconduct" In re SiliconGraphics Inc. . 183 F .3d 970. 974 (9th Cir .1999) . If the

complaint does not satisfy the pleading requirements of the

PSLRA, upon motion by the defendant, the court must.dismiss the complaint . See 15 U .S .C . § 78u--402X] )

The PSLRA's Safe Harbor provision provides that a

securities fraud claim may not lie with respect to a statementthat is "identified as a forward- looking statement, and is

accompanied by meaningful cautionary statementsidentifying important factors that could cause actual results

to differ materially from those in the forward-looking

statement." 15 U .S .C.__J__7$u-5(c)f1](Al(I]. However, a

person may be held liable if the forward-looking statementis made with "actual knowledge . . . that the statement wasfalse or misleading ." 15 U.S .C . § 78u-5(c)(1)(B); No. 84

Employer-Teamster Joint Council Pension That Fund v .America West Holding Corp. . 320 F.3d 920 . 936 (9th

Cir.2003) ; but see In re Seebeyond Technologies Corp. Sec_Litfg. . 266 F_ Supp .2d 115 .. 1164-65 (C .D.CaI .2003)

(disagreeing with the analysis in America West and finding

that a defendant is immune from liability if it satisfies either

15 U.S .C . § 78u5(c)(1)(A) or (B)) .

ANALYSIS

1. Request For Judicial Notice

As a threshold matter, the Court addresses Defendants'request that the Court take judicial notice of thirteen

separate documents, eleven of which are expresslyreferenced in Plaintiffs Complaint and two of which are not .

Plaintiff does not object to Defendants' request .

A. Documents Referenced in Complaint

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*7 Defendants ask the Court to judicially notice thefollowing documents incorporated by reference in PlaintiffsComplaint: AXTs 10-Ks for the fiscal years endedDecember 31, 2000, December 31, 2002 , and December 31,2003; five AXT press releases, respectively dated February6, 2002, October 23, 2002, Februa ry 5, 2003, April 23,2003, and February 4, 2004; AXVs 10-Qs for the quartersended June 30, 2003 , and September 30, 2003 ; and AXTs

Current Report on SEC Form 8-K, filed on June 24, 2004 .These documents are attached to the Declaration of David

Banie as Exhibits A--K..

le of Evidence 201 allows a court to take judicialnotice of a fact "not subject to reasonable dispute in that it is.. . capable of accurate and ready determination by reso rt tosources whose accuracy cannot reasonably be questioned ."

Even where judicial notice is not appropriate, courts mayalso properly consider documents " whose contents area lleged in a complaint and whose authenticity no par ty

ques tions, but which are not physically attached to the[plaintiffs] pleadings ." Branch v. Tunnel. 14 F .3d 449.454t9th Cir.1994) .

Here, each of the documents described above is explicitlyincorporated by reference in Plain tiffs Complaint. (SeeComplaint, IN 32, 40 , 48, 50 , 51, 54, 57, 59, 60 , 61, 71 .)

Moreover, the documents are press releases and SEC filings,both of which are judicially noticeable in this context . See

In re Homestore . com . Inc. Sec. Litig. . 347 F . Supp.2d 814,

817 (1.I.D.Cal .2004) ( the court may take judicial no tice of

press releases) ; In re Calpine Corp . Sec. Leg. . 288

F.Supp.2d 1054. 1076 (N.D .Cal.2003) (the cou rt may takejudicial notice of public filings) . Accordingly, the Court

GRANTS Defendants' request and takes judicial notice ofExhibits A--K to the Banie Declaration .

B. Documents Not Referenced in Complaint

1 . Exhibit L-SEC Form 4 filed by Defendant Young

Defendants ask the Court to take judicial notice of SEC

Forms 4 filed on behalf of Defendant Young . Thesedocuments are attached to the Banie Declaration as ExhibitL. "In a securities action, a court may take judicial notice of

public filings when adjudicating a motion to dismiss. . . ."

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Calgine. 288 F .Supp .2d at 1076. The SEC Forms 4 at issue

here are publicly-available documents filed with the SEC .Accordingly, the Court takes judicial notice of the

documents attached as Exhibit L to the Banie Declaration .IFM4]

FN4 . Defendants also contend that Exhibit L

should be judicially noticed for two otherindependent reasons . First, the Complaint

references Defendant Young's sale of 200,000shares of AXT stock during the Class Period .According to Defendants, this is information thatPlaintiff could only have obtained from reviewing

Young's Forms 4, such that the documents areincorporated by implicit reference in the Complaintand should be judicially noticed. Second, the

Forms 4 are central to Plaintiffs allegation thatDefendant Young's Class Period stock sales are

probative of scienter, and should be judicially

noticed on that ground . Having already determinedthat the Forms 4 should be judicially noticed on the

ground that they are public documents, the Courtdeclines to address Defendants' separate grounds

for judicial notice.

2 . Exhibit M-AXT's Closing Stock Prices From February 6,

2001, Through April 29, . 200 4

Defendants also urge the Court to take judicial notice ofdocuments reflecting AXTs closing stock prices during the

Class Period . These documents are attached to the BanieDeclaration as Exhibit M. In the context of a motion todismiss a securities private fraud action, a court may takejudicial notice of a company's public stock prices.

L62mW= .C,2M- 347 2d at 816 . Accordingly, theCourt takes judicial notice of these documents .

11. Motion to Dismis s

*8 Defendants contend that Plaintiffs Complaint should bedismissed because Plaintiff fails to satisfy the heightened

pleading requirements under the PSLRA, fails to state aclaim under Rule 12fb1(6) . and fails to plead fraud with theparticularity required by Rule . The Court examinesPlaintiffs two claims separately .

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A. Plaintiffs First Cause of Action--Violation of Section10(b) of the Securities Exchange Act and Rule lOb- 5

Section 10(b) of the Securities Exchange Act (the "Act")

provides, in part, that it is unlawful "to use or employ inconnection with the purchase or sale of any security

registered on a national securities exchange or• any securitynot so registered, any manipulative or deceptive device or

contrivance in contravention of such rules and regulations asthe [SEC] may prescribe." 15 U.S .C . § 78j(b) . Rule lob-5,

promulgated under Section 10(b), makes it unlawful for any

person to use interstate commerce: (a) to employ anydevice, scheme, or artifice to defraud ; (b) to make anyuntrue statement of material fact or to omit to state a

material fact necessary in order to make the statementsmade, in the light of the circumstances under which they

were made, not misleading; or (c) to engage in any act,

practice, or course of business which operates or wouldoperate as a fraud or deceit upon any person, in connection

with the purchase or sale of any security . 17 C .F.R .

244 .1 Ob-5 .

For a claim under Section 10(b) and Rule lOb-5 to be

actionable , a plaintiff must allege : (1) a misrepresentation or

omission ; (2) of material fact; (3) made with scienter; (4) onwhich the plaintiff justifiably relied; (5) that proximately

caused the alleged loss. See Binder v. Gillespie . 184 F .3d1059 . 1063 (9th Cir.1999). A complaint must "specify each

statement alleged to have been misleading , the reason orreasons why the statement is misleading , and, if an

allegation regarding the statement or omission is made oninformation and belief, the complaint shall state with

particularity all facts on which that belief is formed." 15

U.S .C . § 78u-4(bb)(2) . As discussed above, in order to avoid

having the action dismissed, a plaintiff must "plead withparticularity both falsity and scienter." RoPwoni v. Larkin.

253 F .3d 423, 429 (9th Cir.2001) . The Ninth Circuit, inRonconi, articulated the rule as follows:

Because falsity and scienter in private secu rities fraud

cases are generally strongly inferred from the same set of

facts, we have incorporated the dual pleadingrequirements of 15 U.S .C . §§ 78u-4(b)(1) and (b) (2] into

a single inquiry . In considering whether a privatesecu rities fraud complaint can survive dismissal under

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Rule 12(b)(6). we must determine whether 'particularfacts in the complaint, taken as a whole, raise a stronginference that defendants intentionally or [with]

'deliberate recklessness' made false or misleadingstatements to investors! Where pleadings are notsufficiently particularized or where, taken as a whole,

they do not raise a ' strong inference ' that misleadingstatements were knowingly or [with] deliberate

recklessness made to investors , a private securities fraudcomplaint is properly dismissed under Rule 120061 .

*9 Id (citations and internal quotation marks omitted) .

Here, Plaintiff alleges that statements or omissions

attributable to Defendant AXT and Defendant Young werefalse and misleading and that Defendants knew thestatements were false and misleading at the time the

statements were made . The statements at issue can beseparated into two general categories : (1) statements toutingthe quality of AXT's products and the Company's ability to

meet customer specifications; and (2) AXT's financialstatements. With respect to both categories of statements,Defendants contend that Plaintiff has failed to plead thefalsity of the statements with sufficient particularity and has

failed to plead facts that, if true, would raise a strong

inference that Defendants acted with scicntcr. Additionally,Defendants assert that Plaintiff has failed to adequatelyplead loss causation pursuant to the Supreme Court's recent

holding in Dura Pharmaceuticals. Inc. v. Broudo. 125

S.Ct.1627 (2005 .

1 . FALSITY and SCIENTE R

a. Quality Statements

Plaintiff alleges that Defendants made false or misleadingstatements regarding the quality of its products throughoutthe Class Period . Specifically, Plaintiff takes issue with the

statements contained in various press releases issuedbetween February 6, 2001, and April 27, 2004, in which

Defendants reported that its products were of high quality,incorporated strong engineering design, had competitive

advantage, contained superior features, and met customers'

specific requirements . To support his claim that the qualitystatements were knowingly false or misleading, Plaintiffrelies on AXTs May 24, 2004, press release disclosing that

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the Company had not followed requirements for testing ofproducts and provision of testing data and information

relating to customer requirements for certain shipmentsmade over the past several years," and on the Company's

subsequent decisions to reassign its CEO, to increase itsreserve for sales returns by $745,000, and to record a $2 .1

million charge for obsolete inventory manufactured in theprior two and three years . Plaintiff construes AXT's May

2004 statements and conduct as an admission by Defendantsthat the quality statements were knowingly false when

made. Plaintiff also relies on the statements of the formerAXT Quality Technician, the former AXT Corporate Vice

President, and the former tester of returned AXT products(collectively, the "witnesses") to support falsity and scienter .

Finally, Plaintiff claims that the fact that Agilent, one of

AXT's customers, canceled its orders for AXT substratesduring the Class Period corroborates the witness statements

and Plaintiffs claims that the quality statements wereknowingly false .

Defendants contend that the product quality statements

were, at most, mere puffery, and are not actionable. In thealternative, Defendants argue that Plaintiff has not pled

sufficiently particularized facts that the statements werefalse or misleading when made nor has Plaintiff pled factsthat raise a strong inference of scienter . The Court addresses

each of Defendants' arguments in turn .

i. Puffery

*10 "General statements of optimism and 'puffing' about acompany or product are not actionable ." In re Foundry

Networks, Inc. Sec. Litig., 2003 U .S . Dist. LEXIS 18200,*47 (N .D. Cal. Aug 29, 2003) (citation omitted). "Vague,

amorphous statements , like 'soft forecasts' which a re 'merepuffery,' are inactionable because reasonable investors do

not consider 'soffit' statements or loose predictions importantin making investment decisions ." Id. (citation omitted) . "Nomatter how untrue a statement may be, it is not actionable if

it is not the type of statement that would significantly alterthe total mix of information available to investors ." Id.

(citing In re dole Com liter. Inc. Sec. Litig . . 243F.Su0.2d 1012, 1025 !N.©.Ca1 .20021). In FoundryNetworks, at issue was the company's statement that its"business remains on track ." The court held that the

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statement was inactionable puffery because the statementwas merely a very general statement of optimism about the

company's financial prospects , something that reasonable

investors would not rely on when making investmentdecisions . In No. 84 Employer-Teamster Joint CouncilPension Trust Fund v . . 4m. W. Holding Corp . . 320 F .3d 920(9th C .2003) ("America West" ), however, the NinthCircuit found statements at issue were not inactionable

puffery . Specifically, the court held that "[a] reasonable

investor would find significant the information regarding acompany's deferred maintenance costs, unsafe maintenancepractices, and possible sanction" because "a reasonableinvestor would consider the potential effects of each of thesefacts on the overall economic health of the company as

'significantly altering' the 'total mix' of information made

available ." Id. at 935 ; see also ,cilcr geld v. Paolo. 274F.Supp .2d 163, 175 (D .R .I .2003 1 (statement that company

was the " 'premier provider of high-speed DSL services inthe Northeast corridor . . . is much more than mere puffery ; it

is a statement of [the company 's] present status andcapabilities, and connotes that [the company] is

comparatively superior")) .

The lion' s share of the statements at issue here appear tomore closely resemble the statements at issue in AmericaWest or Scritchfield than those at issue in FoundryNetworks. For example, statements touting the superiority ofAXT's specific products, such as the October 24, 2001,

press release described in paragraph 38 of the Complaint, inwhich AXT reported that the Company's "VGF gallium

arsenide and indium phosphide substrates continue to offersuperior features for manufacturers of high quality

electronic and opto-electronic devices" are far lessgeneralized than the statements the Foundry Networks court

determined were inactionable . Such statements strike theCourt as information that an investor would consider whenmaking investment decisions . However, to make such adetermination would require the Court to make factualfindings which, at this stage in the litigation, would not beappropriate . Accordingly, the Court finds that whether the

quality statements at issue here are actionable as materialstatements is a question for another day ,

ii . Falsity and Scienter Not Sufficiently Pled

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*11 Assuming, arguendo, that the quality statements atissue were not mere puffery and are actionable as material

statements or omissions, the Court now turns to the questionof whether Plaintiff has alleged sufficiently particularized

facts to support his claim that the quality statements werefalse or misleading, and whether Plaintiff has alleged facts

that raise a strong inference of scienter, to surviveDefendants' motion to dismiss.

Plaintiff primarily relies on AXT's post-Class Period (May

2004) disclosure and the statements of three confidential

witnesses to support his claim that the product qualitystatements were false or misleading and that Defendants

knew those statements were false and misleading whenmade . Plaintiff also alleges that Agilent's cancellation of itsorder of AXT products during the Class Period supports his

claims of falsity and scienter. Additionally, Plaintiff allegesthat Defendant Young's sale of stock during the Class

Period supports an strong inference of scienter . For the

following reasons, the Court finds that the facts, as pled, areinsufficiently particularized to support Plaintiffs claim that

the quality statements violated federal securities laws.

(a) Witness Statements {FN5 1

FNS . For purposes of this analysis, the Court

assumes that the witnesses' purported statements

are true since, at this stage in the proceedings, theCourt must view all facts in the light mostfavorable to Plaintiff.

According to Plaintiff, the former Quality Technician

allegedly confirmed that the Company knowingly shippedto customers products that did not meet customer

specifications, that the Company was aware that theproducts would be returned., and that almost every shipmentwas, in fact, returned. Specifically, the technician said that

when AXT conducted specification checks on its wafers for

various criteria, the wafers never met all the specifications .

The former tester of returned AXT products allegedlyconfirmed that the passivation layer (the top protective

layer) on AXT's LEDs was consistently weak, making the

LEDs easily and irreparably damaged. The tester allegedlysaid that AXT knew this was a problem and lacked adequateproduct testing equipment. The former Corporate Vice

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President allegedly confirmed that AXT failed to perform

full testing of its products and lacked the right equipmentfor testing. (Comp., ¶¶ 78-80.) These statements, as

currently pled, are insufficient to satisfy create a sufficientfactual predicate for Plaintiffs claims under the PSLRA .First, Plaintiffs' Complaint fails to explain how any of the

witnesses would have personal and firsthand knowledge ofthe facts they allege to be true . See In re Daou SA .Inc._Sec.

Litig~. 411 F .3d 1006„ (9th ('ir.2005) (confidential sources

must be described "with sufficient particularity to supportthe probability that a person in the position occupied by the

source would possess the information alleged") . Forexample, Plaintiff does not explain the job responsibilities

of the Quality Technician and how he or she would knowabout the number or proportion of returns of AXTs

products. Second, the Complaint fails to point to anyspecific data to support the witnesses' contentions that

AXT's products were being returned . Third, the Complaintdoes not sufficiently describe the timing of the witnesses'observations and conclusions. Finally, assuming, as the

Court must, that the witnesses' statements are true and

AXT's products were consistently not being tested, did notmeet customer specifications, and were regularly beingreturned to the Company, the Complaint alleges no facts

that would allow the Court to infer that Defendants wereaware of these facts. The Complaint does not allege any

process by which upper management, presumably in chargeof issuing or approving press releases, would have been

aware of product returns or testing practices at themanufacturing level, much less how each of these particular

confidential witnesses was connected with Defendants suchthat they had contemporaneous knowledge of what AXTand Defendant Young knew. Accordingly, the witness

statements are insufficient, as currently pled, to supportfalsity and scienter here .

(b) AXT's Post-Class Period Statements and Conduct

*12 Plaintiff contends that AXT's May 24, 2004, disclosure

notifying the public that AXT had "not followedrequirements for testing of products and provision of testing

data and information relating to customer requirements for

certain shipments made over the past several years" supportshis contention that the quality statements issued during the

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Class Period were false and misleading and that Defendants

were aware the statements were false and misleading . The

Court disagrees.

The May 2004 disclosure does not say that every shipment

of every AXT product was non-conforming such that it can

be considered an admission that AXT's Class Period

statements regarding the quality of its products are rendered

false and misleading , Even if the May 2004 statement

admits that some of AXT"s products did not conform to

customer specifications, the statements at issue could stillhave been true in that the Company only claimed that its

products were competitive and that its products' design wasstrong. Moreover, even assuming the . statements were false

or misleading , the post-Class Period disclosure does not

raise a strong inference of scienter here. The fact that the

Company admitted, after the Class Pe riod, that it had failedto follow testing requirements on "certain shipments," is

insufficient to raise a strong inference that Defendants

knew, at the time the quality statements were made, that the

statements were false or misleading.

(c) Agilent Cancels Orders

Plaintiff alleges that during the Class Period, Defendants

disclosed that one of AXT's larger customers, Agilent, hadcanceled its orders for AXT products because AXT was

shipping products that did not conform to Agilent's

specifications. Plaintiff contends that this corroborates his

contention (and the confidential witness statements) that

AXT was aware that it was shipping non-conformingproducts to its customers such that the statements it issuedduring the Class Period regarding the quality of its products

and its competitive position in the marketplace were

knowingly false and misleading. Plaintiff also contends that

Defendants were aware that the problems with the Agilentshipments were not unique such that its statement to the

contrary was false and misleading. Plaintiff has failed to

allege any facts that support a finding that Defendants knew

that the non-conforming Agilent shipments were part of awidespread quality problem with AXT products .Accordingly, the Court finds that the fact that Agilent

canceled its orders with AXT is insufficient to demonstratethat the quality statements were knowingly false when

made .

(d) Defendant Young' s Stock Sales

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Plaintiff also relies on the stock sales of Defendant Youngas an indication of Defendants' scienter with respect to the

quality statements . Generally, stock sale allegations cannotraise an inference of scienter unless the plaintiff alleges

specific facts showing that the sales were "dramatically out

of line with prior trading practices at times calculated tomaximize the personal benefit from undisclosed inside

information ." Silicon Graphics._ I 83_E3d at_ 98b. Among the

re levant factors for a court to consider are : 1) the amount

and percentage of shares sold by insiders; 2) the timing of

the sales ; and 3) whether the sales were consistent with the

insider' s prior trading history . Id.

*13 Here , Plaintiff alleges that Defendant Young sold a totalof more than 200,D00 shares of his personally-held AXT

stock during the Class Period for g ross proceeds of

approximately $2.2 million . (Comp . at 1 91 .) Plaintiff

alleges no facts about the dates, prices per share , or sizes ofeach of Defendant Young ' s Class Period sales. Plaintiff alsofails to allege that Defendant Young's sales over the time

period in question were inconsistent with his prior trading

history . In light of the three factors above, Defendant

Young's Class Pe riod sale of stock, as alleged, is not

sufficiently suspicious , without more, to raise a strong

inference of scienter.

(e) Plaintiff's Allegations as a Whole

The Court must consider whether the totality of Plaintiffsallegations, even though individually lacking, are sufficient

to create a strong inference that Defendants issued allegedlyfalse or misleading statements touting the quality of AXT's

products with deliberate recklessness, if not actualknowledge. Lipton, 284 F.3d at 1038. Here, the sum is no

greater than its parts. Plaintiff has failed to allege

particularized facts that could lead the Court to infer thatDefendants intentionally, or with deliberate recklessness,

misrepresented the quality of AXTs products and itsstrategic position as compared with other manufacturers of

similar products . Because Plaintiffs first cause of action"lacks sufficient detail and foundation necessary to meet

either the particularity or strong inference requirements ofthe PSLRA," it must be dismissed. Silicon Graphics. 183

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F.3d at 984 .

b . Financial Statements

Plaintiff alleges that during the Class Period, Defendants

knowingly issued financial statements that overstatedrevenue, growth margins, and earnings in violation of

GAAP, rendering the statements false and misleading underthe Securities and Exchange Act . Specifically, Plaintiff

contends that the financial statements were knowingly false

or misleading in light of. (1) the Company's stated revenuerecognition policy requi ring that AXT not recognizerevenue where there is a customer acceptance requirement

or remaining significant obligation; (2) AXT's failure to

accrue adequate reserves; and (3) AXT's failure to take a

timely charge for inventory obsolescence. Plaintiff alsochallenges the qualitative statements regarding internal and

disclosure controls contained in the Sarbanes-Oxleycertifications accompanying AXT's quarterly filings

(beginning in April 2002). In support of these allegations,

Plaintiff again relies primarily upon the Company's May2004 disclosure and its subsequent decisions to increase its

reserves , charge for inventory obsolescence , and reassign its

CEO. Plaintiff also again relies on the confidential witness

statements , Agilent' s decision to cancel its order, and

Defendant Young's stock sales . Defendants argue that

Plaintiff has failed to allege a particularized factual basis for

his claim that the financial statements released during theClass Period were false and involved an improper

recognition of revenue , or that Plaintiff has alleged factsraising a strong inference that Defendants acted wi th the

requisite scienter. The Court agrees .

*14 It is generally accepted that standing alone, allegations

of GAAP violations do not establish scienter . In re Worlds

of Wonder Sec.Litig. . 35 F.3d 1407 . 1426 (9th Cir.1994).Rather, to plead fraudulent intent based on GAAP

violations , plaintiffs must allege facts showing that: (1)

specific accounting decisions were improper , and (2) the

defendants knew specific facts at the time that rendered their

accounting determinations fraudulent. DSAM Global Value

Fund v. Altris Software, Inc- 288 F .3d 385 . 390-91 M

Cir.20021. Plaintiff has not met this standard. As discussed

supra, Plaintiff only alleges that Defendants must have been

aware that its products were flawed and were being shipped

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to customers anyway based on the vague representations of

three confidential witnesses who do not describe the basisfor their knowledge, the time period of the general

awareness that this practice was occurring, any contact withAXT's upper management (or specifically, those making the

accounting and revenue recognition decisions), or anyspecific transactions on which revenue was knowinglyimproperly recorded . See Northpoint, 184 F .Supp.2d at 998("With accounting fraud, . . . the necessary scienter is in

general not established merely by the publication ofinaccurate accounting figures, or failure to follow generally

accepted accounting principles . More is needed.") Plaintiff

has failed to allege that particular accounting decisions were

improper or facts that support a strong inference thatDefendants were aware of facts that rendered their

accounting decisions fraudulent. In sum, Plaintiffs genericallegations of accounting fraud fall short of sufficiently

pleading scienter with respect to Defendants' practice ofrecognizing revenue.

The other factors upon which Plaintiff relies to support his

claim that AXT's financial statements were false or

misleading are also insufficiently pled. The Court examines

these in turn .

i . AXT's Post-Class Period Statements and Conduc t

Plaintiff claims that AXT's post-Class Period decisions to

take a $745,000 reserve, to take a $2 .1 million write-off, andto reassign its CEO and promote its CFO to the top spot at

the Company, demonstrate that the Company's financialstatements, issued during the Class Period, were false when

made and that Defendants knew they were false . The Courtdisagrees . These allegations are not pled with the requisite

particularity . Plaintiff contends that AXT's post-ClassPeriod decisions suggest that the Company should have

increased its reserve for returns by $745,000 during the

Class Period and that the Company's failure to do so rendersthe financial statements false . Plaintiff alleges no

contemporaneous facts to support that contention other than

the post-Class Period decision to increase the reserves . This

is a classic example of pleading fraud by hindsight, which is

exactly what Congress intended to eliminate with itsadoption of the PSLRA. See Silicon Graphics. 183 F.3d at988 : Acito v. IMCER.4 Group, 47 F .3d 47 .53 (2d Cir.1995)

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("Mere allegations that statements in one repo rt should have

been made in earlier reports do not make out a claim of

securities fraud .") Similarly, AXTs decision to write off$2 .1 million for inventory obsolescence after the close ofthe Class Period does not necessarily read back on what the

Company should have done , but did not do, during the ClassPeriod, or on the falsity of the Company's financialstatements during that period . A "pleading must provide

some particularized support regarding inventory levels, the

defendants' knowledge, and approximately when [the]plaintiffs think the write-down should have occurred." &XgPF.TsMf4RT Inc. Sec. Liti 61 F Supp 2d 982, 993

( .Ariz .l999) . Plaintiff fails to do so here. Additionally,

AXT's decision to reassign Defendant Young to head up theCompany ' s China Operations does not support an inference

of scienter here. Management changes "are not in and of

themselves evidence of scienter . Most major stock losses

are o ften accompanied by management departures, and itwould be unwise for courts to penalize directors for these

decisions ." In re Cornerstone Propane Partners . L .P. . 355

F.Supp.2d 1069. 1092 (N.D.Cal .2005,) . Plaintiff has not

alleged sufficiently particularized facts with respect toYoung's reassignment to support his claim that the financialstatements were false when made.

*15 Plaintiff also contends that the Sarbanes-Oxley

certifications signed by Defendant Young and filed with theSEC were false when made. Again, the Court finds that

Plaintiff has not alleged particularized facts to support his

claim that Defendant Young's averments that he hadexamined the Company's internal disclosure controls and

believed they were adequate, were false .

ii. Witness Statements jENC

, For purposes of this analysis, the Court

assumes that the witnesses' purported statementsare true since, at this stage in the proceedings, theCourt must view all facts in the light most

favorable to Plaintiff.

As discussed above, the confidential witness statements

relied on by Plaintiff here are insufficient, as currently pled,to support falsity or scienter. The Complaint fails to allegehow the witnesses would have known what accounting

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effect, if any, product returns would have on the Company'sfinancial statements, or how Defendants would have known

that the financial statements it released were false or

misleading in light of the alleged product returns . SeeJuniper Networks, Inc . Sec. Litig., 2004 U .S . Dist . LEXIS

4025, at *8 (N .D.Cal . Mar. 11, 2004) (allegations of falsefinancial forecasts are insufficient where plaintiffs failed to"plead specific facts demonstrating how the problems being

experienced translated into the need for Juniper to alter or

reduce its publicly issued projections") . Accordingly, theconfidential witness statements, as currently pled, areinsufficient to support falsity and scienter with respect to the

financial statements .

iii. Agilent Cancels Order

Plaintiff contends that AXTs announcement, during theClass Period, that Agilent had canceled its orders due to

AXT's failure to provide products that met Agilent's

specifications supports his claim that the financialstatements were false when made and that Defendants knewthe statements were false . While the Agilent orderwithdrawal suggests that AXT was not always shipping

products that conformed to customer specifications, Plaintiff

fails to allege sufficiently particularized facts that supporthis claim that this meant that the financial statements were

false or that Defendants knew they were false.

iv . Defendant Young's Stock Sales

As discussed supra, Plaintiff fails to allege sufficient detailsregarding Defendant Young's sales of stock during the Class

Period that would support the falsity of the financialstatements and Defendants' scienter with respect thereto ,

v . Plaintiffs Allegations as a Whole

As explained above, the Court must consider whether thetotality of Plaintiffs allegations, even though individually

lacking, are sufficient to create a st rong inference that

Defendants issued 'allegedly false or misleading financial

statements with deliberate recklessness , if not actualknowledge . Lipton, 284 F .3d at 1038 . Here , again, the sum

is no greater than its parts . See In re Nash Finch Co. Sec.Liza . 323 F.Su 2004 ("The

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Court finds the collective minutia offered here adds up tonothing. Just as two plus two will never equal five, these

allegations-whether considered apart or together-do not

add up to a strong inference of scienter.")Ll

FN7. At oral argument, Plaintiff alerted the Court

to the recent holding in In re Omnivision

Technologies, Inc ., 2005 U .S . Dist . LAS 16009,*1 (N.D,Cal . July 29, 2005). The Court finds thatthat case, distinguishable on its facts, does not alter

the Court's conclusions here . In Omnivision, it was

undisputed that the company's financial statementscontained errors . This is not the case here .

Additionally, in that case, the plaintiff alleged factssupporting a finding that the individual defendants,executives of the company in question, sold

personal shares of the company's stockdramatically out of line with their trading history .

That the Omnivision court found that the plaintiffs

complaint survived the defendants' motion todismiss, despite the PSLRA's heightened pleading

standard, does not mandate the same result here .

2 . Loss Causation

*16 In Dura Pharmaceuticals; the Supreme Court clarified

that alleging that a misrepresentation caused an inflated

purchase price does not, without more, demonstrate losscausation . To "touch upon" an economic loss is insufficient;plaintiffs must demonstrate an actual causal connection

between the defendant's alleged material misrepresentationand the economic loss suffered . 125 S.Ct. at 1633, This

holding reversed the Ninth Circuit's jurisprudence on thesubject, pursuant to which a plaintiff could satisfy the loss

causation requirement simply by alleging that stock price

was inflated due to the alleged misrepresentation .

Here, the Complaint simply states that because AXT's stockprices dropped significantly after the Company disclosed itsinternal investigation, Plaintiff, and other AXT shareholders

who purchased stock during the Class Period, lost money .

However, Plaintiff has not alleged a proximate, causal

connection between the alleged misrepresentationscontained in AXT's press releases and financial statementsand the consequent decline in AXT stock. Because other

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factors may have affected the Company's stock price duringthe Class Period, Plaintiff must allege more than just thatthe alleged misrepresentations inflated the stock price . See

id This is particularly true here where the AXT stock price

fluctuated significantly during the Class Period, at somepoints dropping lower than the price of the stock after the

April 27, 2004, disclosure regarding the Company's internalinvestigation. ME This suggests that the stock price was,

indeed, affected by factors other than Defendants' allegedfalse or misleading statements . Accordingly, the Court

finds, in light ofDura, that Plaintiffs allegations regardingloss causation are insufficient . Plaintiffs contention that the

Daou case mandates the contrary result is specious. In thatcase, the Ninth Circuit found that loss causation was

sufficiently pled but specifically held that because the

complaint disclosed that the price of the company's stockhad declined, during the class period, from $34.375 pershare to $18 .50 per share, before any corrective disclosure

was issued, any loss suffered between those figures could"not be considered causally related to Daou's allegedlyfraudulent accounting methods because before the

revelations began . . ., the true nature of Daou's financial

condition had not yet been disclosed." 411 F.3d at 1026-27 .Likewise, AXT s stock price dipped below the price to

which it ultimately fell after the April 2004 disclosure, thusrendering Plaintiffs attempt to causally link the alleged false

statements with his (and other purported class members')financial loss insufficiently pled.

FN8. On April 29, 2004, AXT's stock pricedropped to $2 .20 per share . Although the price had,

at various points during the Class Period, been ashigh as $40 per share, there was a substantial

period of time during the Class Period in whichAXT's stock price dropped below $2 per share .

B. Plaintiffs Second Cause of Action-Violation of Section20(a)

Section 20(a) of the Securities Exchange Act ("ExchangeAct") provides derivative liability for those who controlothers found to be primarily liable under the Act. In reRamp Networks,_ ..Inc, Sec_ Lit.. 201 F .Supp.2d 1051, 1063(N.D.Cal.2002) . Where a plaintiff asserts a Section 20(a)claim based on an underlying violation of Section 10(b), th e

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pleading requirements for both violations are the same. Id."To be liable under section 20(a), the defendants must beliable under another section of the Exchange Act."

Heliotrope General. Inc. v. Ford Motor Co. . 189 F .3d 971 .978 (9th Cir.1999) .

*17 Here, Plaintiff alleges that Defendant Young acted as a

controlling person of AXT within the meaning of Section

20(a) of the Act and is liable thereunder for the conduct

alleged Plaintiff claims that by virtue of Defendant Young's

position as CEO and Chairman of the Board of the

Company, he was responsible for preparing and

disseminating AXTs public releases and had the power and

the authority to cause the Company to engage in the

wrongful conduct complained of. Defendants argue that

Plaintiffs Section 20(a) cause of action fails because

Plaintiff has failed to state a cause of action pursuant to

Section 10(b) . The Court agrees . Because Plaintiff has failed

to adequately plead the underlying 10(b) violation, as

discussed supra, Plaintiffs Section 20(a) claim must also be

dismissed.

CONCLUSION

For the foregoing re asons, the Court GRANTS Defendants'

Motion to Dismiss without prejudice . Plaintiff must file anamended complaint within thirty days of the date of this

Order .

This Order terminates docket entry nos . 24 and 25 .

IT IS SO ORDERED.

END OF DOCUMENT

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C

Motions, Pleadings and Filings

Only the Westlaw citation is currently available.

United States District Court,N.D. California .

In re PORTAL SOFTWARE, INC SECURITIESLITIGATION

No. C-03-5138 VRW.

Aug. 10, 2005 .Mario Alba, Cauley Geller Bowman & RudmanLLP, Robert M. Rothman , Lerach Coughlin StoiaGeller Rudman & Robbins LLP, Melville, NY,Robert A . Jigarjian , Robert S. Green, JenelleWelling, Green & Jigarjian LLP, San Francisco,CA, Jonathan M. Stein , Cauley Geller Bowman &Rudman , LLP, Boca Raton, FL, for Plaintiffs .

Nina F. Locker, Peri Beth Nielsen, Wilson SonsiniGoodrich & Rosati, Palo Alto, CA, Joseph M .Barton, Solomon B . Cera, Gold Bennett Cera &Sidener LLP, San Francisco, CA, for Defendants.

ORDER

WALKER, Chief J.

*1 Plaintiffs in this securities fraud class actionface the unenviable task of complying with thestringent pleading requirements imposed on suchactions. All too frequently, and once again here,plaintiffs attempt this endeavor by a complaintreplete with evidentiary detail, but only a loose (andthe court thinks too loose) connection between thewrongful conduct alleged and its effect on the class .The Supreme Court has recently reminded lowerfederal courts that the heart of a fraud on asecurities market is the proximate causal linkbetween the misstatement or omission alleged and

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the resulting impact on the security's price . DuraPharms Ina v. Broudo, - U.S. -, 125 S.Ct.1627, 161 L.Ed.2d 577 (2005) . Despite the ratherforgiving interpretation of Dura in this circuit, seeIn re Daou Systems, Inc. Securities Litigation, 411F.3d 1006, 2005 WL 1431833 (9th Cir. June 21,2005), the operative pleading here fails to make thisconnection. Because plaintiffs will be allowed toamend, the court emphasizes the need for plaintiffto allege facts that link defendants' allegedwrongdoing to the class injury . A much shorter, buttargeted, pleading may well be more effective inmaking this connection than the rather distendedpleading now at bar. But there are othershortcomings in their pleadings that plaintiffs needto address and it is to these that the court devotesthe bulk of this order.

Plaintiff John Romeo (Romeo) and plaintiffPipefitters Local 522 & 633 Pension Fund Trust(Pipefitters) (collectively , plaintiffs), purport ing torepresent investors who purchased securities ofPortal Software Inc (Portal) between May 20, 2003,and November 13, 2003, inclusive (the "classperiod "), bring this action under the SecuritiesExchange Act of 1934 (the " '34 Act") and theSecurities Act of 1933 (the " '33 Act") . Plaintiffsallege that defendants Portal, John Little (Little),Howard A Bain HI (Bain) and A rthur C Patterson(Patterson) (collectively defendants ) violated theGenerally Accepted Accounting Principals (GAAP)by artificially inflating the price of Portal's stockand making false and misleading statements onwhich plaintiffs re lied, thereby incurring substantialfinancial loss from purchasing Portal stock atfraudulently inflated prices . Defendants ' move todismiss (Doc # 115) plaintiffs' third consolidatedamended complaint (TCAC ; Doc # 111 ) for failureto meet the particularity requirement imposed byFRCP 9(b) and the Private Securities LitigationReform Act (PSLRA) (amendments to the '33 and'34 Acts) . Plaintiffs oppose the motion, asserting

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that the TCAC states sufficiently particularizedclaims under § 10(b) and § 20(a) of the '34 Act, aswell as claims under §§ 11, 12(a)(2) and 15 of the'33 Act.

The court heard argument on these motions on July7, 2005. Based upon the parties' arguments and theapplicable federal taw, the court concludes that : (1)the allegations in plaintiffs' complaint are not pledwith sufficient particularity under the PSLRA andFRCP 9(b) ; (2) the allegations are not sufficient tosupport a strong inference of scienter under thePSLRA; (3) defendants' forward-looking statementsare protected by the PSLRA's safe harbor provision ;(4) claims under the '33 Act sound in fraud andtherefore fail with the '34 Act claims- Accordingly,the court GRANTS defendants' motion to dismiss inits entirety .

11*2 The factual and procedural histo ry is derivedfrom the TCAC and presumed true for purposes ofthis motion. Gompper v. P7SX, Inc., 298 F.3d 893,895 (9th Cir. 2002 ) . Portal provides billing andsubscriber management solutions to its clientsprimarily through its "Infranet" software . Portalcharges companies " license fees" for the Infranetproduct, as well as "service fees" for systemimplementation, consulting, maintenance andtraining . Prior to 2001 , the majority of Portal'scustomer base consisted of "dot-corn" start-upcompanies . Following the dot corn market crash of2001 , Portal lost many of its customers and incurredfinancial losses during fiscal 2002-2003 that wipedout more than 96% of Portal's equity . Portalsubsequently began to market its Infranet product tomore established and sophisticated businesscustomers , including telecommunications providers .

These new clients required g re ater customization ofthe software than had the dot-com startups , which inturn affected the way in which Portal couldrecognize license fee revenues . Pursuant to GAAP,if a software provider rewrites portions of itsproduct to conform to a c lient's unique needs, itmay not fully recognize the revenue on the licenseof software until such substantial modification hasbeen performed. Whereas Portal had historically

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been able to recognize revenue at the time itdelivered its Infranet product to the dot-corns, thegreater customization required by these new, moreestablished clients required Portal to deferrecognizing revenue from much of its contracts untilcustomization was complete . Plaintiffs allege thatduring the class period, Portal began to manipulateits license fees so it could recognize more revenue" up- front." TCAC at ¶¶ 41-42 .

To support their allegations that Portal improperlyrecognized revenue prematurely and in violation ofGAAP, plaintiffs rely on information from fourunnamed former Portal employees : (1) a controller;(2) a "Senior Business Analyst" ' (3) an accountsreceivable and revenue assurance assistant ; and (4)a "Senior Marketing Manager ." TCAC at q'¶41-54. The first three employees detail threedifferent methods of accounting fraud allegedlyundertaken by Portal management during the classperiod, while the Senior Marketing Manager allegesongoing product problems and a decreasing marketfor key elements of Portal's software offering.

The information provided by the former controllerinvolved Portal's method for recognizing licensingrevenue . Historically, Portal preliminarily offeredits customers a "developmental license," whichconsisted of a trial version of the software for a fewkey employees. Portal would charge only a"nominal" amount for this first license . Then, if theclient wished to obtain the full Infranet product,Portal would sell the client a "production license"and charge for the bulk of the contract. After fiscal2004, plaintiffs allege that Portal simply charged agreater portion of the contract price under thedevelopmental license, even though it was still onlya trial version and significant modifications yetwere to be performed under the production license .Plaintiffs also allege that Portal's outsideaccountants, Ernst & Young, disapproved of thisnew split license arrangement and reversed Portal'sposition, a determination which ultimately causedthe shortfall in earnings and resulting stock pricedecline . TCAC at ¶ 43 .

*3 Next, the former Senior Business Analystasserts that he was instructed by company officials ,

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including Bain, to falsify revenue recognitionstudies to justify premature recognition of revenue .Under GAAP, when a software contract providesfor both licensing and services, such as softwaremodification and implementation, the revenue fromeach element can only be recognized as it isperformed , so long as the "fair value " of eachelement is determinable . If the fair value of eachelement is not determinable , than recognition of theentire contract must be deferred until all elementshave been delivered, or until such time as the fairvalue of the remaining elements are determinable .The Senior Business Analyst avers that whenattempting to discern the fair value of elements of asoftware arrangement, he was directed by themanagement to "reverse engineer" the study toreach predetermined results. This employee, whoceased employment several months befo re the endof the class period, alleges that he was instructed tofalsify revenue recognition studies with regard tocontracts performed in "Greece, Italy, Columbia[sic] and Spain," including a contract with"Columbia [sic] Mobile." TCAC at'] 48 .

The third former employee on whom Plaintiffs relyis an accounts receivable and revenue assuranceassistant employed during the class period. Shealleges that "revenues related to [Portal' s] contractswith Onstar . .. [were] materially overstated duringthe third quarter of fiscal 2004 ." TCAC at 149 .Specifically, the former employee alleges thatPortal would recognize revenue from the suppo rt,maintenance and upgrade elements of the softwarecontract, even though the work had not yet beenperformed . This employee asserts that she obtainedthis knowledge because one of her duties ofemployment was to reclassify the prematurelyrecognized revenue for future qua rters . She claimsthat she talked to her manager about her concernswith the way Portal was classifying revenue, andwas subsequently dismissed from her position.TCAC at ¶ 49 .

Finally, plaintiffs proffer the testimony of a SeniorMarketing Manager to substantiate their allegationsthat Portal was misrepresenting the demand for itsproduct and concealing significant technicalproblems with its applications . Specifically, the

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marketing employee stated that portions of Portal'sbi lling so ftware were being rendered obsolete byCustomer Relationship Management (CRM)applications sold by vendors like SAP and Siebel.TCAC at ¶¶ 51-52. Moreover, Portal's Intranetproduct was having difficulty interfacing with theseCRM applications, resulting in unexpected costsand delays for Portal. TCAC at ¶¶ 53-54.Plaintiffs allege that Portal ' s management failed todisclose these technical difficulties and thedeclining demand for Portal's product during theclass period, thus concealing the true state ofPortal's financial health .

Plaintiffs' complaint alleges that the accountingfraud described above was undertaken bydefendants to inflate Portal ' s reported revenuenumbers, which were then used by defendants tocreate false and misleading statements regardingPortal's financial health and future businessprospects. According to plaintiffs, these false andmisleading statements artificially inflated Po rtal'sstock price and allowed defendants to complete a$60 million secondary offering on September 12,2003 . Plaintiffs' claims for violations of the '33 Actare based on alleged false and misleadingstatements made in the registration statement andprospectus issued in connection with the seconda ryoffering . TCAC at ¶¶ 142- 165 . Plaintiffs' claimsfor violations of the '34 Act are based on allegedfalse and misleading statements disseminated to theinvesting public via SEC filings and press releases .TCAC at ¶T 166-181 .

*4 After the close of the market on November 13,2003, defendants announced thatdue to contractdelays , revenue recognition deferrals and serviceexecution issues-Portal expected net losses of$0.36 to $ 0 .40 per share for the third quarter fiscal2004 . These losses were in contrast to the netprofits of $0.04 per share that Portal had previouslyprojected for the quarter . Subsequent to theNovember 11, 2003 , announcement, the price ofPortal's common shares plummeted 42% to $ 8.77 inafter hours trading . TCAC at ¶ 75 . Plaintiffs allegethat this decline in Portal ' s stock price at the end ofthe class period was "a direct result of the natureand extent of [d]efendant's prior misrepresentations ,

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omissions and fraudulent conduct concerning[Portal ' s] adverse business and financial conditionsfinally being revealed to investors and the market"and that plaintiffs " were damaged as a proximateresult thereof." TCAC at ¶ 76 .

IIIAs a preliminary matter, the court considersdefendants' request for judicial notice (RJN, Dec #119) regarding certain documents attached to thedeclaration of Randolph Gaw in support ofdefendants' motion (Gaw Decl, Doe # 116).Defendants contend that all the documents soattached are the proper subject of judicial noticepursuant to FRE 201 .

Exhibits N through U to the Claw declaration areForm 4s filed with the SEC regarding the stocksales of the individual defendants and othercorporate officers and directors, while exhibits Athrough H are the SEC filings of defendant Portal .Defendants contend that the court is authorized totake judicial notice of documents filed with theSEC. The court agrees that judicial notice of suchdocuments is proper. See, c g, Bryant v. AvadoBrands, Inc., 187 F .3d 1271, 1276 (11th Cir.1999) ;Allison v. Brooktree Corp., 999 F .Supp. 1342, 1352n3 (SD Cal 1998) . This conclusion is bolstered bythe fact that courts are specifically authorized, inconnection with a motion to dismiss a securitiesfraud complaint, to consider documents and filingsdescribed in the complaint under the incorporationby reference doctrine. See, a g, Ronconi v. Larkin,253 F.3d 423, 427 (9th Cir.2001) ; In re SiliconGraphics Securities Litigation, 183 F .3d 970, 986(9th Cir.1999) . Thus, the court takes notice of allthe documents attached to the Claw declaration thatwere filed with the SEC .

Exhibits I through M are Portal press releases,which defendants claim contain "safe harbor"warnings regarding any forward-looking statementsin the press releases. Judicial notice of theseexhibits is proper because the court is required, toconsider "any cautionary statement accompanying[a] forward- looking statement, which [is] notsubject to material dispute, cited by the defendant."15 USC § 78u-5(e). In addition, the court may take

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judicial notice of information that was publiclyavailable to reasonable investors at the time thedefendant made the allegedly false statements . SeeIn re The First Union Corp Securities Litigation,128 F Supp 871, 883 (WD NC 2001) . This is trueof press releases, even if they were not explicitlyreferenced in the complaint . See Wietschner v.Monterey Pasta Co., 294 F Supp 2d 1102, 1108- 09(N.D.Cal.2003).

*5 Exhibit V to the Gaw declaration is the"Statement of Position 97-2 Software RevenueRecognition." This is an accounting statementissued by the American Institute of Certified PublicAccountants . RJN Doc # 19 at 4 . Courts may takejudicial notice of documents that are alleged in thecomplaint and whose authenticity no partyquestions, even when not attached to the complaint .See Branch v. Tunnell, 14 F.3d 449, 454 (9thCir.1994) .

Finally, at oral argument on July 7, 2005, plaintiffssubmitted to the court three additional documentsand requested that the court take judicial notice ofthem in considering this motion. Doc # 130. Thesedocuments include (1) a Portal press release datedJune 30, 2005; (2) Portal's Form 8-K filed with theSEC on June 27, 2005; and (3) Portal's Form 10-Qfor the quarter ending October 31, 2004, filed withthe SEC on April 25, 2005 . Id. The court takesnotice of these documents, which are all publicfilings capable of judicial notice .

IVStandard of Review

FRCP 12(b)(6) motions to dismiss essentially "testwhether a cognizable claim has been pleaded in thecomplaint ." Scheid v. Fanny Farmer Candy Shops,Inc., 859 F. 2d 434, 436 (6th Cir.1988) . FRCP 8(a),which states that plaintiffs pleadings must contain"a short and plain statement of the claim showingthat the pleader is entitled to relief," provides thestandard for judging whether such a cognizableclaim exists . Lee v. City of Los Angeles, 250 F.3d668, 679 (9th Cir.2001 ) . This standard is a liberalone that does not require plaintiff to set forth all thefactual details of his claim; rather, all that thestandard requires is that plaintiff give defendant fair

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notice of the claim and the grounds for making thatclaim . Leatherman v. Tarrant County NarcoticsIntell & Coord Unit, 507 U.S . 163, 168, 113 S .Ct.1160, 122 L .Ed.2d 517 (1993) (citing Conley v.Gibson, 355 U.S . 41, 47, 78 S .Ct . 99, 2 L.Ed.2d 80(1957)) . To this end, plaintiffs complaint should setforth "either direct or inferential allegations withrespect to all the material elements of the claim" .Wittstock v. Van Sile, Inc., 330 F.3d 899, 902 (6thCir .2003).

Under Rule 12(b)(6), a complaint "should not bedismissed for failure to state a claim unless itappears beyond doubt that plaintiff can prove no setof facts in support of [her] claim which wouldentitle [her] to relief." Hughes v. Rowe, 449 U.S . 5,9, 101 S.Ct. 173, 66 L.Ed.2d 163 (1980) (citingHaines Y. Kerner, 404 U.S. 519, 520, 92 S.Ct. 594,30 L.Ed.2d 652 (1972)); see also Conley, 355 U.S .at 45-46 . All material allegations in the complaintmust be taken as true and construed in the lightmost favorable to plaintiff. See Silicon Graphics,183 F.3d at 980 nl0 . But "the court [is not] requiredto accept as true allegations that are merelyconclusory, unwarranted deductions of fact, orunreasonable inferences ." Sprewell v. Golden StateWarriors, 266 F.3d 979, 988 (9th Cir .2001) (citingClegg v. Cult Awareness Network 18 F.3d 752,754-55 (9th Cir. 1994)).

Review of a FRCP 12(bX6) motion to dismiss isgenerally limited to the contents of the complaint,and the court may not consider other documentsoutside the pleadings . Arpin v. Santa Clara ValleyTransportation Agency, 261 F.3d 912, 925 (9thCir.2001). The court may, however, considerdocuments attached to the complaint. Parks Schoolof Business, Inc. v. Symington, 51 F .3d 1480, 1484(9th Cir.1995) . If a plaintiff fails to attach to thecomplaint the documents on which the complaint isbased, a defendant may attach such documents to itsmotion to dismiss for the purpose of showing thatthe documents do not support plaintiffs claim . In reAutodes1 Inc. Securties Litigation, 132 F Supp 2d833, 837 (N.D.Cal.2000) (citing Branch v. Tunnel,14 F .3d 449, 454 (9th Cir.1994)) . This permits thecourt to consider the full text of a document that theplaintiffs complaint only partially quotes . Autodeslc

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132 F Supp 2d at 838 (citing In re Stac ElectronicsSecurities Litigation, 89 F.3d 1399, 1405 n4 (9thCir1996), cert. denied, 520 U.S. 1103, 117 S .Ct .1105, 137 L.Ed2d 308 (1997)) . Additionally, "[t]hecourt need not * * * accept as true allegations thatcontradict matters properly subject to judicial notice* * *." Sprewell, 266 F.3d at 988 (citing Mullis v.United States Bankr Ct. , 828 F .2d 1385, 1388 (9thCir. 1987)).

*6 But these liberal pleading standards describedabove have been substantially tightened in thecontext of securities litigation , as will be discussedinfra.

VThe TCAC alleges five causes of action. For thefirst and second causes of action , plaintiffs allegeviolations of sections 11 and 12(a)(2) of the '33 Actagainst all defendants . Plaintiffs ' first and secondcauses of action are based on the registrationstatement Portal filed for its seconda ry publicoffering (SPO) in September 2003 . Plainti ffs' thirdcause of action alleges control liability undersection 15 of the '33 Act against Lit tle, Bann andPatterson (the "individual defendants"). Plaintiffs'fourth cause of action alleges violations of section10(b) of the ' 34 Act and Rule 14b-5 promulgatedthereunder against all defendants. Lastly, plaintiffsallege control liability under section 20(a) of the '34Act against the individual defendants . The courtwill first address first plaintiffs' claims under the '34Act before turning to the claims brought under the'33 Act.

ASection 10 (b) and 20(a) of the Exchange Act of 1934Section 10(b) of the '34 Act and SEC Rule 10b-5,promulgated thereunder, make it unlawful for anyperson , in connection with the purchase or sale ofany security, to (1) engage in fraud or (2) make anuntrue statement regarding a material fact or (3)make a misleading statement by omitting a materialfact 15 U.S .C. § 78j(b); 17 CFA § 240.10b-5 .Consequently, the elements of a Rule lob-5 claimare: (1) a material misrepresentation or omission offact , (2) scienter, (3) a connection with the purchaseor sale of a secu rity, (4) transaction and loss

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causation, and (5) economic loss . See Dura, 125 SCt at 1633 .

Claims brought under Section 10(b) and Rule1Ob-5 must first meet the particularity requirementsof FRCP 9(b) . In re Stac, 89 F.3d at 1404 ; see alsoIn re GlenFed Inc. Securities Litigation 42 F.3d1541, 1545 (9th Cir.1994) (en bane). Rule 9(b)requires a plaintiff alleging fraud to "set forth whatis false or misleading about [the] statement[ ] andwhy it is false." GlenFed 42 F.3d at 1548 .

Second, a complaint must satisfy the more stringentrequirements imposed on securities fraud pleadingsby the PSLRA. Specifically, the PSLRA requiresthat a complaint (1) "specify each statement allegedto have been misleading [and] the reason or reasonswhy the statement is misleading * * * " (15 USC §78u-4(bxl)) ; (2) with respect to any suchallegations based upon information and belief,"state with particularity all facts on which that beliefis formed" (15 USC § 78u-4(b)(1)) ; and (3) "withrespect to each act or omission * * * state withparticularity facts giving rise to a strong inferencethat the defendant acted with the required state ofmind" (15 USC § 17u-4(bx2)). The required stateof mind, or scienter, is met where the complaintalleges that the defendants made the false ormisleading statements either intentionally or withdeliberate recklessness." In re Daou Systems, Inc.Securities Litigation, 411 F.3d 1006, 2005 WL1431833 (9th Cir. June 21, 2005) (citing SiliconGraphics, 183 F.3d at 974) (emphasis added) . Insecurities cases, falsity and scienter "are generallyinferred from the same set of facts and the tworequirements may be combined into a unitaryinquiry under the PSLRA." In re Vantive Corp .Securities Litigation, 283 F.3d 1079, 1091 (9thCir .2002) (citations omitted).

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analogous doctrine (which predates the enactmentof the PSLRA) is the "bespeaks caution" doctrine,which allows a court to rule as a matter of law thatdefendant's forward-looking statements containedenough cautionary language or risk disclosure toprotect against liability . See, e g, Proven v. Miller,102 F.3d 1478, 1493 (9th Cir. 1996) . If adefendant's statements are immunized under eitherdoctrine, dismissal of the complaint is appropriate .See id, Splash 1, 2000 U.S . Dist LEXIS at *29 .

Defendants challenge the sufficiency of plaintiffs''34 Act claims on several grounds : (1) plaintiffs'complaint lacks the specificity needed to pleadaccounting fraud; (2) plaintiffs fail to plead factsraising a strong inference of scienter; and (3)defendants' statements are protected by thePSLRA's safe harbor provision. Before turning tothe issue of safe harbor, the court will address thedefendants' first two contentions under the "unitaryinquiry" advocated in this circuit, as "falsity andscienter are generally inferred from the same set offacts * * * ." In re Vantive, 283 F .3d at 1091 .

Defendants contend that the TCAC should bedismissed because plaintiffs have not adequatelypled facts to support their allegations of accountingfraud or to support a strong inference of scienter . "Ifproperly pled, overstating of revenues may state aclaim for securities fraud, as under GAAP, revenuemust be earned before it can be recognized." In reDaou, 2005 WL 141833 at *5 (citations omitted)(emphasis in original) . Plaintiffs must plead factssufficient to support a conclusion that defendants"prepared the fraudulent financial statements andthat the alleged financial fraud was material ." See id(quoting In re Peerless Systems, Corp. SecuritiesLitigation, 182 F Supp 2d 982, 991 (S.D.Cal .2002).

*7 Even if plaintiffs meet these heightenedpleading requirements, however, the PSLRA carvesout a safe harbor from liability if the alleged false ormisleading statements were forward-looking andaccompanied by meaningful risk warnings . 15 USC§ 78u-5(c); see also In re Splash TechnologyHoldings, Inc Securities Litigation, 2000 U.S . ThatLEXIS 15369, *16 (ND Cal) (Splash I ) . An

Although violations of GAAP standards mayprovide evidence of scienter, see id, the complaintmust allege GAAP violations with suf ficientparticularity to support a strong inference ofscienter. See, e g, In re McKesson HBOC, Inc.Securities Litigation; 126 F Supp 2d 1248, 1273(N.D.Cal .2000) ("[w]hen significant GAAPviolations are described with par ticularity in the

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complaint, they may provide powerful indirectevidence of scienter. After all, books do not cookthemselves .".) The inquiry focuses on the specificityof the allegations ; "a general allegation that thepractices at issue resulted in a false report ofcompany earnings is not a sufficiently particularclaim of misrepresentation ." In re Daou 411 F.3d1006, 2005 WL 1431833 at *5 (quoting Greebel v.FTP Software, Inc., 194 F.3d 185, 203-04 (1stCir .1999) .

*8 The Ninth Circuit recently instructed thatcomplaints stating sufficiently particular accountingirregularities should include: "(1) such basic detailsas the approximate amount by which revenues andearnings were overstated; (2) the products involvedin the contingent transaction ; (3) the dates of any ofthe transactions ; or (4) the identities of any of thecustomers or [company] employees involved in thetransactions." In re Daou 411 F.3d 1006, 2005 WL1431833 at *6 (citations and internal quotationmarks omitted). Although the complaint need notprovide each and every detail described above, itshould enable a court to determine whether thealleged fraud "constituted widespread andsignificant inflation of revenue." Id.

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the First Circuit's "suggested criteria for assessingreliability of confidential witnesses ." In re Daou,411 F.3d 1006, 2005 WI. 1431833 at *4 . Thesecriteria include "the level of detail provided by theconfidential sources, the corroborative nature of theother facts alleged (including from other sources),the coherence and plausibility of the allegations, thenumber of sources, the reliability of the sources,and similar indicia." In re Cabletron Sys . Inc., 311F.3d 11, 29 (1st Cir .2002) . Moreover, when acomplaint relies on unnamed employees, courtsgenerally look for specific descriptions of theemployee's relevant duties and responsibilities toevaluate the reliability of their information . See, e g,In re Daora 411 F.3d 1006, 2005 WL 1431833 at *4(finding that confidential witnesses were describedwith a "large degree of particularity" where, in allcases, their job description and responsibilities weredelineated, and in some cases, plaintiffs identifiedthe executive to whom the employee reported) ; seealso In re Northpoint Communications Group, Ina,221 F Supp 2d 1090, 1097 (N.D.Cal.2002) (holdingthat a second amended complaint cured somespecificity problems of original complaint where itset out, in addition to job titles and tenure ofconfidential witnesses, their responsibilities at thecompany) .

Before reaching the substance of plaintiffs'complaint, the court notes that plaintiffs' allegationsare derived, in large part, from informationprovided by confidential witnesses . The NinthCircuit requires a particular inquiry to determine ifthe use of such confidential sources satisfies thePSLRA. See In re Daou 411 F .3d 1006, 2005 WL1431833 at *4. The inquiry focuses on whetherunnamed sources of information in the complaintare described "with sufficient particularity tosupport the probability that a person in the positionoccupied by the source, would possess theinformation alleged." Nursing Home Pension FundLocal 114 v. Oracle Corp., 380 F.3d 1226, 1233(9th Cir .2001) (quoting Novak v. Kasaks, 216 F.3d300, 314 (2d Cir.2000)) . These personal sourcesneed not be named so long as the information theyprovide is adequately corroborated by other facts .Silicon Graphics, 183 F.3d at 985 .

In In re Daou, the Ninth Circuit recently adopted

*9 The TCAC re lies in large part upon informationprovided by th ree unnamed former Portalemployees to substantiate allegations thatdefendants were engaging in accounting fraud inorder to overstate revenue . Plaintiff's identify theseemployees by either their titles or their positions inthe company, but generally fail to describe with anyparticularity the duties of each employee , or how orwhy they came to be familiar with the informationthey provide. Despite plaintiffs' failure to specifyeach employee's duties , in some cases theemployees' accounts themselves describe theirrelevant duties in the course of relating elements ofthe alleged accounting fraud. Consequently, thecourt cannot adopt wholesale the allegationsprovided by the unnamed employees in plainti ffs'complaint, Rather , in determining whether theTCAC adequately pleads violations of the securitieslaws, the court will rely only on factual allegationswhich evince reliability through detail, context an d

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corroboration.

With these legal principles in mind, the court turnsto plaintiffs' allegation that Portal engaged inaccounting fraud by falsely inflating revenues toconceal Portal's precarious financial condition .Specifically, plaintiffs allege that defendantsprematurely recognized revenue by (1) improperlycategorizing licensing revenue, (2) overstatingpurported billing rates to recognize greater costs ondelivered elements of a contract, (3) manipulatingthe fair value amount attributable to undelivereditems and (4) recognizing revenue before projectmilestones were approved by customers .

Plaintiffs allege that defendants manipulatedlicense ag reements into two parts and improperlypriced the first part of the license with the bulk ofthe contract fee so that they could recognize therevenue prematurely. TCAC IT 41- 43. Insupport of this allegation, plaintiffs rely entirely oninformation provided by a former controller . Id .Yet, the former controller's account does notcontain inherent indicia of reliab ility. First, heremployment with Portal ended almost a year beforethe class period even began. TCAC ¶ 41.Consequently, her . entire account of Portal'sfraudulent revenue recognition practices during theclass period are based on second -hand reports fromcompany "insiders ." Id ¶ 43 . Although she haspersonal knowledge to support her descriptions ofPortal's revenue recognition practices prior to theclass period, it is the allegations that Portal madefraudulent changes to these recognition practicesduring the class period that require "a reasonableconviction in the inform ant' s basis of knowledge ."In re NorthPoint, 221 F Supp 2d at 1097 . Hence,plaintiffs must describe the job title, job description,duties, and dates of employment for the controller'ssources before this information can be deemedreliable . Plaintiffs have made no attempt to providesuch information about any of the controller's" insiders ," and consequently, plainti ffs' allegationsregarding improperly bifurcated contracts are notpled with sufficient particularity.

*10 Plaintiffs' next allegations-that defendants"cooked" revenue numbers to recognize revenue

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prematurely-are somewhat better supported . TheTCAC identifies a "Senior Business Analyst" whoworked at Portal until July 2003, two months intothe class period . Although the complaint again failsspecifically to describe this employee's job duties,to whom he reported, or in which department heworked, his account ameliorates the shortfall . Aspart of his employment, the analyst asserts that hewas required to "reverse engineer" revenuerecognition studies to reach a predetermined result .TCAC 1 45. Moreover, the analyst asserts that hewas personally directed to create these false studiesby defendant Bain, the CFO. Id ¶ 47. Thesefabrications involved falsely selecting high billingrates to inflate revenues for work already performedon contracts (Id 1 46) or falsely calculating a lowvalue for undelivered elements so that greaterrevenue could be attributed to the elements alreadydelivered (Id ¶ 47) .

Although the Senior Business Analyst onlyidentifies one customer by name for whom hecreated false revenue recognition studies (ColumbiaMobile), he alleges that he was "required to performanalyses that matched management's predeterminedresults for work performed in * * * Greece, Italy,Columbia and Spain in connection with at least sixof Portal's major contracts" and that Portal booked$5 million in revenue as a result of these contracts .Id ¶ 48. Based on his personal involvement infraudulent activity at the behest of Bain, the courtconcludes that these allegations potentially supporta claim under the '34 Act . Moreover, the court findsthat the specificity of the account indicates a levelof reliability . Yet because the analyst's accountprovides no indication of how these allegedmanipulations affected Portal's financial earningsstatements, further corroboration is necessary tomeet the heightened pleading requirements of thePSLRA.

Next, the TCAC alleges that defendants engaged inimproper revenue recognition through testimony ofan accounts rece ivable and revenue assuranceassistant who a llegedly worked at Portal during theclass period. TCAC ¶ 49. Again, this employee'saccount self-identifies her duties and basis forknowledge, mitigating the TCAC' s failure to do so .

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For example, the assistant specifies that "one of[her] duties was to reclassify revenue for futurequarters ." Id ¶ 49 . It was through this work, shealleges , that she came to learn that Portal wasimproperly recognizing revenue from softwarelicensing contracts . Id . The assistant explains herbasis for knowledge : "I have been working withrevenue recognition for 12 years , and I understandthe way revenue is supposed to be recognized." Id.The assistant's account also alleges a particularcontract, with Onstar, for which Portal "materiallyoverstated [revenues] during the third quarter offiscal 2004." TCAC ¶ 49.

In the Ninth Circuit, "although overstatement ofrevenues in violation of GAAP may support aplaintiffs claim of fraud, the plaintiff must showwith particularity how the adjustments affected thecompany's financial statements and whether theywere material in light of the company's overallfinancial position." In re Daou, 411 F.3d 1006,2005 WL 1431833 at *7 . In In re Daau the panelfound that the plaintiff adequately described how"allegedly premature [revenue] recognition affectedDaou's financial bottom line" where the complaintpled "the approximate amount by which revenuesand earnings were overstated, * * * the dates ofsome of the transactions and the identities of thecustomers and the company employees involved inthe transactions ." Id at *8. For example, theplaintiffs in In re Daou alleged that only $5 .9million was eligible for recognition in the thirdquarter of 1997, 48% less than the $11 .3 millionthat Daou publicly reported. Id.

*11 In contrast, the TCAC is bereft of suchcomparisons . Only the Senior Business Analystalleges a dollar amount-$5 million-for prematurelyrecognized revenue . Even this figure is unconnectedto identified customers or dates , much less aspecific quarterly report against which to assess itsmateriality . Although the accounts receivableassistant allegedly reclassified improperly bookedrevenues, she does not indicate how much revenuewas reclassified or how this affected Portal'sfinancial statements. The contro ller's statements,lacking in personal knowledge , also fail to specifyhow much revenue the allegedly improper licensing

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contracts allowed Portal to recognize prematurely,and how that affected Portal's bottom line .

The TCAC also alleges that defendants engaged inaccounting fraud by recognizing "license andservice fees under * * * service arrangements priorto customer approval of specific project milestonesin violation of the Company's publicly statedrevenue recognition practices and policies" and inviolation of GAAP. TCAC ¶ 50. To support thisallegation , plaintiffs refer only to defendants'disclosure , subsequent to the class period , that itwas excluding $700,000 of previously reportedrevenue for fiscal 2004 due to a customer ' s refusalto approve project milestones . TCAC ¶ 84.Defendants argue that this disclosure related to acontract performed after the class period, butplaintiffs provide information indicating therestatement related to fiscal 2004 . TCAC ¶ 84.Even assuming this revenue was originallyannounced during the class period, the court findsthat plaintiffs ' single example of defendantsannouncement of revenue prior to customerapproval does not raise a strong inference ofscienter.

Plaintiffs allege that defendants also violated the'34 Act by materially misrepresenting the decliningdemand for Portal's products and services andfailing to disclose severe interface problems thatdelayed delivery and increased costs . TCAC ¶51-54. Support for this allegation, however, comesfrom only one unnamed employee, a SeniorMarketing Manager, who worked for only twomonths of the class period . From this employee'stitle, the court might infer such a position wouldafford knowledge of the market for Portal's product.Thus, this account could conceivably provideevidence of the "shrinking market and role forbilling software applications ." Id ¶ 52 . In addition,the employee identifies two vendors, SAP andSiebel, that offered products that "displaced the rolepreviously provided" by aspects of Portal's billingsoftware . Id ¶ 51 . But the specificity ends there .The employee fails to identify any of "Portal's largetelecommunications customers" for whom customerservice applications were no longer required as partof Portal's billing software . Id . And, although the

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marketing manager alleges that Portal was spendingtoo much time and money due to "excessive bugsand/or interface problems with other applications,"these allegations fail to indicate any specificcustomers, contracts, or dates . Id ¶ 54.

*12 The court Ends that plaintiffs' allegations ofaccounting fraud and material misrepresentationsare not pled with sufficient particularity and,consequently, do no raise a strong inference ofscienter . Plaintiffs, however, present an alternativebasis for demonstrating scienter; the complaintfocuses on defendants' stock sales and Portal's SPOto show that defendants had the motive andopportunity to mislead investors deliberately . Asdiscussed in the next section, however, theseallegations fail to plead a violation of section 10(b)adequately.

2Scienter

To demonstrate motive, plaintiffs allege thatdefendants engaged in insider trading during theclass period . The PSLRA "neither prohibits norendorses the pleading of insider trading as evidenceof scienter, but requires that the evidence meet the'strong inference' standard." Greebel, 194 F.3d at197. While "trading at suspicious times or insuspicious amounts" is probative of scienter, thetrading must be "unusual, well beyond the normalpatterns of trading by those defendants ." Id . Underthis standard, the court questions plaintiffs' relianceon the stock sales attributable to "company insiders"to demonstrate defendants' motive to conductaccounting fraud or issue misleading statements .First, defendant Little sold no personal stock .Defendant Bain sold 4,000 shares after exercising7,500 stock options, which means he did not sell3,500 shares .

Plaintiffs focus on "89 ,157 shares of Portalcommon stock" sold by "Portal insiders ." TCAC at¶ 65 . Most of these " insiders ," however, are notnamed defendants, nor do plaintiffs allege they wereinvolved in the fraudulent activity. Moreover,plaintiffs ' reliance on "suspicious" stock salesultimately fails because the stock sales do notappear suspicious at all . For example , plaintiffs

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focus on the period from May 28, 2003, to July 2,2003, which was "immediately after" the firstearnings announcement of the class period--but alsoafter the announcement of an alliance withMicrosoft . TCAC at ¶ 65 . Although plaintiffsallege that Portal common stock was artificiallyinflated during this period, they do not allege thatthe deal with Microsoft was improper . In fact,plaintiffs ignore the legitimate, positive effect theMicrosoft deal might have had on Portal's stock orthe role the Microsoft deal might have had in theexecutives' decision to sell . No attempt is made todelineate the "artificiality" of Portal's stock duringthis period, which is especially curious since itappears that Portal's stock actually dropped byseveral dollars after the first earnings announcementof the class period. TCAC at ¶ 140 (ChartingNASDAQ Index). Moreover, plaintiffs fail todemonstrate that the timing of the stock sales was"suspicious" where the TCAC does not provide acomparison of these sales with the executives'"normal patterns of trading ." Greebel, 194 F .3d at197 .

By contrast, plaintiffs' contention that defendantswere motivated to inflate artificially Portal's stockprice in the short term in order to conduct asuccessful secondary public offering and obtainmuch-needed operating capital does allege facts of apalpable motive for fraud. In fact, Portal raised $60million in September, just two months beforePortal's stock plummeted by over 40% . Plaintiffsallege that Portal's finances were such that the $60million was absolutely necessary to keep Portal a"going concern ." Plaintiffs' Opposition at 21 .Accordingly, this motive evidence is stronger thanthe generic "desire to raise capital" which can beattributed to every company . Metricom, 2004 U.S.Dist LEXIS 7834 at *110. But in the Ninth Circuit,such motive pleading must be combined withallegations of other "red flags" to be probative. Inre Vantive, 283 F.3d at 1097 . As discussed above,plaintiffs' allegations of accounting fraud lacksufficient particularity and cannot be combined withthis alleged motive to establish a strong inference ofscienter.

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Safe Harbor*13 In their motion to dismiss , defendants argue atgreat length that plaintiffs' TCAC does notadequately plead claims based on false projectionsor opinions . Defendants are correct that the PSLRAcarves out a safe harbor from liability forforward-looking statements that are accompanied bymeaningful cautionary language . 15 USC § 78u-5(c); see also In re Copper Mountain SecuritiesLitigation, 311 F Supp 2d 857, 866 (N.D.Ca1 .2004)(Walker, 1). Under the analogous "bespeakscaution " doctrine, a court may also find as a matterof law that " defendant ' s forward- looking statementscontained enough cautionary language or riskdisclosure to protect against liability ." Id at 866 .Mere boilerplate or generic warnings, however, areinsufficient ; "[t]he cautionary warning ought to beprecise and re late directly to the forward -lookingstatements at issue ." Id at 882. Moreover, this courthas previously found that "vague and * * *run-of-the-mill corporate optimism" is notactionable because no reasonable investor wouldrely on "mere puffery-" Id at 868-69 .

A close reading of plaintiffs' TCAC reveals that thevast majority of plaintiffs' allegations of "materiallyfalse and misleading statements" focus ondefendants ' statements regarding present orhistorical facts, such as Portal 's past quarterlyearnings based on (1) allegedly inflated revenues(TCAC ¶¶ 58, 60 , 64, 66, 67); (2) Portal's pastand current revenue recognition policies thatplaintiffs allege misrepresented the way in whichPortal was recognizing revenue (TCAC ¶¶ 61-64,68-70) ; . (3) omissions of past and current factsregarding declining sales and product demand aswell as difficulties marketing Portal's product(TCAC ¶ 64e-f); and (4) omissions of the presentfact that Portal was experiencing severe technicalproblems with its core products , which wereeroding its revenue stream (TCAC ¶ 64g). Butneither the PSLRA's safe harbor provision nor thebespeaks caution doctrine are applicable tostatements of historical fact. See e g, Livid HoldingsLtd v. Salomon Smith Barney, Inc., 403 F.3d 1050,1056-57 (9th Cir.2005) .

In fact, the only forward-looking statements that

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plaintiffs a llege were false or misleading whenmade are the revenue projections for fiscal 2004and the subsequent quarter's revenue projectionsthat accompanied Portal ' s public announcement offinancial results for the quarter just concluded . SeeTCAC ¶ 58 (May 20 , 2003, announcement offinancial results for quarter ending May 2 , 2003) ;TCAC ¶ 66 (August 19, 2003, announcement offinancial results for quarter ending August 1, 2003) .These announcements were made in press re leasesand included defendants' statements that Portalexpected revenues to grow by "10-12 %" over theprior year and that Portal would "return to proforma earnings" within the current fiscal year.TCAC ¶ 58 .

Both of these statements concerned "a projection ofrevenues" and "future economic performance" andthus were clearly forward-looking statements underthe PSLRA. 15 USC § 78u-5(i); Copper Mountain,311 F Supp 2d at 880 . The court now turns toplaintiffs' argument that defendants'forward-looking statements are unprotected by thePSLRA's safe harbor provision or the bespeakscaution doctrine because (1) the statements were notaccompanied by meaningful cautionary languageand (2) defendants knew they were false when made .

*14 The court finds that defendants'forward-looking statements were accompanied bycautionary language that was sufficiently specificand meaningful to warn investors of the risks thatactually materialized. First, defendants' May 20 andAugust 19 press releases-which contained the10-12% profit projection and "return to pro formaearnings" statements--each included "safe harbor"warnings that the statements were forward-lookingand subject to uncertainties and risk . Gaw Decl ; ExsI and J . Moreover, these press releases specified anumber of factors which might effect theprojections, including the migration to "larger,multi-year deals, which * * * may dampennear-term growth * * * and add[ ] to the volatility oflicense revenues ." Id .

In addition to those warnings contained in the pressreleases, both press releases referred investors tothe Form 10-K for additional warnings . Gaw Decl;


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Ex C. at 31 ("These and other factors are describedin detail in our Annual Report on Form 10-K for thefiscal year ended January 31, 2003 Thus,the information in the Form 10-K was incorporatedinto the "total mix of information in the document"available to reasonable investors, even though theForm 10-K did not actually accompany the pressreleases . Copper Mountain, 311 F Supp 2d at 876(citing Fecht v. The Price Co., 70 F .3d 1078, 1082(9th Cir . 1995). The Form 10-K contained severalpages of detailed and explicit warnings regardingPortal's dependence on a few large customers, therisks associated with long implementation periods,and the numerous variables which could adverselyaffect revenue recognition for any quarter. Also, theForm 10-K warned that Portal would begin offering"products and services for a 'bundled' price, suchthat a separate price would not be identified for theproduct and service components . Such a changemay significantly delay the timing of our revenuerecognition. " Gaw Decl; Ex C at 31 (emphasisadded) . Because these warnings hew to the actualdeficiencies that caused Portal's earningsshortfall-"contract delays and revenue recognitiondeferrals" with existing large customers--theyprovided sufficiently specific and material warningsto immunize defendants' forward-lookingstatements . See Copper Mountain: 311 F Supp 2d at882 .

Plaintiffs also assert that, regardless of cautionarylanguage, defendants are liable for theirforward-looking statements because they knew themto be false and misleading when made . Plaintiffs arecorrect that a forward-looking statement cannot beimmunized under the PSLRA if it was made with"actual knowledge * * * that the statement was falseor misleading." 15 USC 78u-5(c)(1)(B) . In thiscase, however, plaintiffs' argument is unavailingbecause plaintiffs have failed to demonstrate thatthe defendants knew that Portal would not achieve10-12% growth or return to pro forma ea rn ingswithin the year when the press releases were issued .As discussed above, the TCAC is deficient, in part,in that it fails to allege facts showing how thealleged accounting adjustments materia lly affectedthe company's financial statements. See supraN(AXI)(i). These facts are necessary not only to

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plead adequately accounting fraud or scienter on thepart of defendants, but also to demonstrate that thedefendants knew at the time the earningsprojections were armounced that Portal could notmeet those projections . Accordingly, Defendants'cannot be liable for the forward-looking statementsin the May 20 and August 19, 2005, press releases,and plaintiffs' claims premised on these statementsmust be dismissed .

420(a)

Control Liability*15 Section 20(a) provides for "controlling personliability ." To establish such liability, plaintiffs mustfirst demonstrate the existence of a violation underSection 10(b)-the "primary violation." CopperMountain, 311 F Supp 2d at 883 (citation omitted) ."[I]n the absence of a viable claim under Section10(b), any remaining Section 20(a) claims must bedismissed ." Id (citations omitted) .

Because the court has determined that plaintiffshave failed to state claims under Section 10(b),plaintiffs have "no basis upon which to premise aSection 20(b) claim" and the Section 20(b) claimsmust also be dismissed.

BSection 11, 12(a) (2) and 15 of the Securities Act of

1933Plaintiffs also bring claims against defendants forviolations of the '33 Act arising out of Portal'ssecondary public offering in September 2003 . Incontrast to claims brought under the '34 Act, section11 of the '33 Act creates a private remedy for apurchaser of a security where "any part of theregistration statement, when such part becameeffective, contained an untrue statement of amaterial fact or omitted to state a material factrequired to be stated there in or necessary to makethe statement therein not misleading ." 15 USC §77k(a) . "The plaintiff in a § 11 claim mustdemonstrate (I) that the registration statementcontained an omission or misrepresentation, and (2)that the omission or misrepresentation was material,that is, it would have misled a reasonable investorabout the nature of his or her investment." In re


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Stac, 89 F.3d at 1403-04 . "No scienter is requiredfor liability under § 11 ; defendants will be liable forinnocent or negligent material misstatements oromissions." Id (citations omitted) '33 Beforeaddressing the substance of the '33 Act claims, thecourt must first determine if they are time barred .

Relation BackDefendants challenge the timeliness of plaintiffs''33 Act claims . Section 13 of the '33 Act requiresthat claims under sections II and 12(a)(2) bebrought "within one year after the discovery of theuntrue statement or the omission, or after suchdiscovery should have been made by the exercise ofreasonable diligence." 15 USC § 77m. Plaintiffs'first complaint, filed on November 20, 2003, didnot include '33 Act claims. These claims were notadded until the second amended complaint (SAC),filed on March 30, 2005 (sixteen months later) .Defendants argue that plaintiffs discovered theconduct giving rise to the '33 Act claims at leastwhen the first complaint was filed . Consequently,defendants argue that the '33 Act claims aretime-barred.

Plaintiffs seek to avoid this bar by asserting that thenew claims in the SAC "relate back" to the initialcomplaint under FRCP 15(cX2) . Rule 15(c)(2)states that an amended complaint relates back to theinitial one for statute of limitations purposes if the"claim or defense asserted in the amended pleadingarose out of the conduct, transaction, or occurrenceset forth * * * in the original pleading." The crux ofthis inquiry is "whether the opposing party has beenput on notice about the claim or defense raised bythe' amended pleading ." SEC v. SeaboardCorporation; 677 F.2d 1301, 1314 (9th Cir.1982) .This court previously observed that the class noticefor the '34 Act claims would have put investors with'33 Act claims on notice . Doe # 100 . It follows thatdefendants were also put on notice of the potentialfor'33 Act claims arising from the same set of facts .

2Sound in Fraud

*16 Section 11 does not contain an element offraud, yet a complaint may be subject to the

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particularity requirements of Rule 9(b) if it "soundsin fraud ." Vess v. Ciba-Geigy Corp. USA, 317 F.3d1097, 1103 (9th Cir.2003 ) . If the complaint alleges"a unified course of fraudulent conduct and rel[ies]entirely on that course of conduct as the basis of aclaim * * * the claim is said to be 'grounded infraud or to 'sound in fraud,' and the pleading of thatclaim as a whole must satisfy the particularityrequirement of Rule 9(b)." Id at 1103-1104 .

In the TCAC, plaintiffs have made an artful attemptto avoid this requirement by carefullycompartmentalizing the counts under the '33 Actand '34 Act. Whereas the '34 Act claims allege thatdefendants knowingly or recklessly engaged in afraudulent scheme to overstate revenues, forexample, the '33 Act claims merely allege thatrevenues were negligently overstated . Yet the NinthCircuit has rejected this approach , finding that such"nominal efforts are unconvincing where thegravamen of the complaint is plainly fraud." In reStac, 89 F.3d at 1405 .

The court finds that plaintiffs' Section 11 claimclearly "sounds in fraud." Despite plaintiffs' pains toavoid Rule 9(b), it is clear that the factualallegations upon which the entire complaint restsallege knowing, reckless and wi ll ful conduct. Forexample, plaintiffs allege that defendants"negligently overstated [revenue] due to theDefendants' manipulation of the pu rported billingrates of Portal's employees ." TCAC ¶ 145(d). Yetplaintiffs' factual allegations supporting themanipulation of billing rates unequivocallydescribes the conduct as intentional and knowing .Id IQ 47, 48 . It strains credulity that plaintiffsshould allege that the overstatement of revenueswas merely "negligent " when it was a allegedly adirect result of defendants '- willful manipulation.Plaintiffs cannot avoid the theory they positthroughout the complaint : that defendantsfraudulently schemed to inflate revenues .Accordingly , the court fords that the claims underthe '33 Act sound in fraud, and therefore fail withthe '34 Act claims to meet the heightened pleadingrequirements of the PSLRA and Rule 9(b) .

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ConclusionFor the reasons stated above , the court GRANTSdefendants ' motion to dismiss in its entirety. Doc #115 . Plaintiffs ' TCAC is DISMISSED, but plaintiffsmay file an amended complaint remedying thepleading deficiencies identified in this order andcomplying with the following instructions .

An amended complaint should specify thosemisstatements plaintiffs allege were false ormisleading, including with regard to each statement :(1) the date made; (2) the speaker; (3) the content ;(4) the falsity ; (5) the basis for plaintiffs' allegationof falsity; and (6) scienter . The amended complaintshould also specify any omissions of fact thatdefendants were bound to disclose, including withrespect to each omission: (1) the date theinformation became known to the public ; (2) thefacts omitted ; (3) the date the duty to disclose arose ;(4) the basis for claiming that omitted informationwas known to defendants ; (5) the basis for claimingthat defendants had a duty to disclose ; and (6)scienter. Finally, in light of Duru, plaintiffs shouldendeavor to tether all allegations in the complaint tothe price movement of Portal's stock during theclass period . Any amended complaint must be filedwithin sixty (60) days of the date of this order.

*17 IT IS SO ORDERED .


Motions, Pleadings and Filings (Back to top )

- 2004 WL 2160168 (Trial Motion , Memorandumand Affidavit) Plaintiffs Opposition to Defendants'Motion to Dismiss the Consolidated AmendedComplaint (Sep. 30, 2004)

• 2003 WL 23795725 (Trial Pleading) Class ActionComplaint for Violations of Federal Securities Laws(Nov. 20, 2003)

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Only the Westlaw citation is currently available .

United States District Court,N .D. California .

In re BUSINESS OBJECTS S .A . SECURITIESLITIGATION,

No. C 04-2401 MJJ.

July 27, 2005 .Kim E . Levy, Peter E. Seidman , Steven G .Schulman, Milberg Weiss Bershad & SchulmanLLP, Nadeem Farugi, Farugi & Faruqi , New York,NY, Jeff S . Westerman, Milberg Weiss Bershad &Schulman LLP, Los Angeles, CA, for Plaintiff.

Claudia N. Main, Wilson Sonsini Goodrich &Rosati, San Francisco, CA, for Defendant

ORDER GRANTING DEFENDANTS' 12(bX6)MOTION TO DISMIS S

JENKINS, J.

*1 This Document Relates To : ALL ACTIONS

INTRODUCTIONBefore the Court is Businesss Objects, BernardLiautaud, James Tolonen, and John Olsen's("Defendants") Motion to Dismiss a federalsecurities fraud action brought against them by aclass consisting of all purchasers of BusinessObjects' stock ("Plaintiffs") between April 23, 2003and April 29, 2004 (the "Class Period") . Defendantsseek an Order dismissing the Consolidated ClassAction Complaint ("Complaint") with prejudiceunder the heightened pleading requirements of thePrivate Securities Litigation Reform Act of 1995("PSLRA") and pursuant to Federal Rule of CivilProcedure 12(6)(6) . For the following reasons,Defendants' motion is GRANTED with leave toamend .

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FACTUAL ALLEGATIONSThis motion arises from an Amended Complaintfiled against all Defendants alleging securities fraudin violation of section 10(b) and 20(a) of theSecurities Exchange Act. The allegations ofPlaintiffs' complaint relate to Business Objects'announcement on April 29, 2004, which disclosedits financial results for the first quarter of 2004 andits forecast its returns for the June 2004 quarter . In2003, Business Objects enjoyed revenue growth,reporting revenue of $118 .5 million, $129 millionand $129.1 million for the first three quarters of2003, respectively. On December 11, 2003,Business Objects announced it had completed itsacquisition of Crystal Decisions, Inc ., a privateCanadian company also in the business intelligencemarket.

On February 8, 2004, Business Objects reportedrevenue of $184.2 million for the December 2003quarter. The same day Business Objects reported itsresults, it also projected revenue of $208 to $218million and earnings per share . ("EPS") of $0 .03 to$0.09 (GAAP) and $0 .10 to $0.16 (non-GAAP) forthe March 2004 quarter. On April 29, 2004,Business Objects reported its financial results forthe March 2004 quarter . Business Objects earnedrevenue of $217 million and EPS of $0.04 (GAAP)and $0 .10 (non-GAAP) . In the same release,Business Objects also gave guidance for its June2004 quarter in the range of $220 to $225 mil lion,which was weaker than securities analysts hadanticipated. Several securities analysts expresseddisappointment with Business Objects' June 2004guidance and lowered their own forecast inresponse.

On April 30, 2004, the day the analyst reports wereissued, Business Objects stock price declined from$28.58 to $21.92. Business Objects ended upreporting revenue of $222 .2 million for the June2004 quarter .

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On May 4, 2004, Business Objects filed itsquarterly report on Form 10-Q for the March 2004quarter. In the Form 10-Q, Business Objectsdisclosed that the SEC had commenced an informalinquiry into its backlog practices- The 10-Q stated,"[w]hile we believe our practices are proper and inaccordance with generally accepted accountingprinciples in the United States, we can give noassurance as to the outcome of this inquiry ." Threemonths later, Business Objects disclosed that it hadreceived a "Wells" notice [FNI] from the SEC andthat it believed the SEC's inquiry related to the factthat Business Objects "does not disclose its backlogof unshipped orders . "

FNI . A "Wells" notice refers to the noticeprovided by the SEC when a decision hasbeen made to recommend to theCommission that a civil action be initiatedagainst an issuer.

LEGAL STANDARDSA. Rule 12(b)(6)

*2 A court may dismiss a complaint pursuant toFederal Rule of Civil Procedure 12(bX6) for eitherlack of a cognizable legal theory or the pleading ofinsufficient facts under an adequate theory.Robertson v. Dean Wier Reynolds, Inc., 749 F.2d530, 533-34 (9th Cir.1984) . When deciding upon amotion to dismiss for failure to state a claim uponwhich relief can be granted pursuant to FRCP12(b)(6), a court must take all of the materialallegations in the plaintiffs complaint as true, andconstrue them in the light most favorable toplaintiff. Parks School of Business, Inc. v.Symington, 51 F.3d 1480, 1484 (9th Cir.1995).Moreover, a complaint should not be dismissedunless a plaintiff could prove no set of facts insupport of his claim that would entitle him to relief.

Id.

In the context of a motion to dismiss , review islimited to the contents in the complaint . AllarcomPay Television, Ltd v. General Instrument Corp., 69F.3d 381 , 385 (9th Cir.1995) . When mattersoutside the pleading are presented to and acceptedby the court, the motion to dismiss is converted into

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one for summary judgment Where such aconversion takes place, all parties must be given anopportunity to present all material made pertinent tosuch a motion by Rule 56 . In re Pacific GatewayExchange, Inc. See. Lit., 169 F .Supp.2d 1160, 1164(N.D.Cal.2001); see also Fed .R.Civ.P. 12(b) .However, matters properly presented to the court ,such as those attached to the complaint andincorporated within its allegations, may beconsidered as part of the motion to dismiss . See HalRoach Studios, Inc. v. Richard Feiner & Co., 896F.2d 1542, 1555 n . 19 (9th Cir .1999).

Where a plaintiff fails to attach to the complaintdocuments referred to in it, and upon which thecomplaint is premised, a defendant may attach tothe motion to dismiss such documents in order toshow that they do not support plaintiffs claim . SeePacific Gateway Exchange, 169 F .Supp.2d at 1164 ;Branch v. Tunnel!, 14 F .3d 449, 454 (9th Cir.1994) .Thus, the district court may consider the full texts ofdocuments that the complaint only quotes in part .See In re Stay Electronics Sec. Lit., 89 F.3d 1399,1405 n. 4 (9th Cir.1996) . This rule precludes theplaintiffs "from surviving a Rule 12(bX6) motion bydeliberately omitting references to documents uponwhich their claims are based." Parrino v. FHP, Inc.,146 F .3d 699, 705 (9th Cir .1998) .

B. Section 10(b) and Rule I Ob- 5

Section 10(b) of the Securities Exchange Act("Exchange Act") provides, in part, that it isunlawful "to use or employ in connection with thepurchase or sale of any security registered on anational securities exchange or any security not soregistered, any manipulative or deceptive device orcontrivance in contravention of such rules andregulations as the [SEC] may prescribe ." 15 U .S .C .C 78j(b) .

Rule lob-S makes it unlawful for any person to useinterstate commerc e

*3 (a) To employ any device, scheme, or artificeto defraud.(b) To make any untrue statement of material factor to omit to state a material fact necessary inorder to make the statements made, in the light o f

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the circumstances under which they were made,not misleading, or(c) To engage in any act, practice , or course ofbusiness which operates or would operate as afraud or deceit upon any person, in connectionwith the purchase or sale of any secur ity .

17 C .F_R . § 240.10b- 5

To be actionable under section 10(b) and RulelOb-5, a plaintiff must allege: 1) amisrepresentation or omission ; 2) of material fact;3) made with scienter ; 4) on which the plaintiffjustifiably re lied; 5) that proximately caused thealleged loss . See Binder v. Gillespie, 184 F.3d1059, 1063 (9th Cir .1999) . Additionally, as in allactions alleging fraud, plaintiffs must state withparticularity the circumstances constituting fraud.Fed. R . Cis. P . 9(b) .

C. Section 20(a)

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for causes of action brought under Section 10(b)and Rule 10b-5 . Specifically , the PSLRA imposedstrict requirements for pleading scienter. Acomplaint under the PSLRA must "state withparticularity facts giving rise to a s trong inferencethat the defendant acted with the required state ofmind ." 15 U .S .C . § 78u-4(bX2) . The Ninth Circuit,in interpreting the PSLRA, has held that "a privatesecurities plaintiff proceeding under the [PSLRA]must plead, in great detail, facts that constitutes trong circumstantial evidence of deliberatelyreckless or conscious misconduct ." In re SiliconGraphics Inc., 183 F .3d 970, 974 (9th Cir.1999). Ifthe complaint does not satisfy the pleadingrequirements of the PSLRA, upon motion by thedefendant, the court must dismiss the complaint . See15 U.S .C . § 78u-4(b)(1) .

A. Rule 8

Section 20(a) of the Exchange Act providesderivative liability for those who control othersfound to be primarily liable under the Act. In reRamp Networks, Ina Sec. Lit., 201 F .Supp.2d 1051,1063 (N.D.Cal.2002). Where a plaintiff asserts asection 20(a) claim based on an underlyingviolation of section 10(b), the pleadingrequirements for both violations are the same. Id

D. Private Securities Litigation Reform Act

In 1995, Congress enacted the PSLRA to provide"protections to discourage frivolous [securities]litigation." H.R. Conf. Rep. No. 104-369, 104thCong., 1st Sess . at 32 (Nov. 28, 1995) . The PSLRAstrengthened the pleading requirements of Rules 8(a)and 9(b) . Actions based on allegations of materialmisstatements or omissions under the PSLRA must"specify each statement alleged to have beenmisleading, the reason or reasons why the statementis misleading, and, if an allegation regarding thestatement or omission is made on information andbelief, the complaint shall state with particularity allfacts on which that belief is formed." 15 U.S .C. §78u-4(bXl) .

The PSLRA also heightened the pleading th reshold

ANALYSIS

*4 Defendants argue that the complaint does notmeet the requirements of Rule 8 of the FederalRules Civil Procedure because of the "puzzle-style"nature of the Plaintiffs' allegations . Rule 8 requiresthat a plaintiff provide a "short and plain statement"describing why the plaintiff is "entitled to relief."The Court notes that the complaint often quotes theentire text of public documents and rarely gives anindication as to which statements are beingchallenged and why . However, the Court declines totake the drastic step of dismissal based on the formof the pleading. Instead, the Court joins theapproach of other courts in this district and willattempt to "glean the complaint," focusing on thosestatements that are in bold and italicized . See In reNorthpoint Communications Group, Inc., 184F.Supp.2d 991, 998 (N.D.Cal.2001) ; In reCornerstone Propane Partners, L.P. SecuritiesLitigation, 355 F.Supp.2d 1069, 1081(N.D.Cal.2005).

B. Falsity and Scienter

In order to support their claims under the PLSRA,Plaintiffs must first specify a "statement alleged tohave been misleading." 15 U.S.C. § 78u-4 (b)(1) .Additionally, in order to avoid having their action


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dismissed, Plaintiffs must "plead with particularityeither the alleged misleading statements orscienter[ .]" In re Fritz Cos. Sec. Litig., 282F.Supp.2d 1105, 1112 (N .D.Ca1 .2003) . The NinthCircuit has articulated the rule as follows :

Because falsity and scienter in private securitiesfraud cases are generally strongly inferred fromthe same set of facts, we have incorporated thedual pleading requirements of 15 U .S .C. §§78u-4(b)(1) and (b)(2) into a single inquiry . Inconsidering whether a private securities fraudcomplaint can survive dismissal under Rule12(b)(6), we must determine whether particularfacts in the complaint, taken as a whole, raise astrong inference that defendants intentionally or[with] deliberate recklessness made false ormisleading statements to investors . Wherepleadings are not sufficiently particularized orwhere, taken as a whole, they do not raise astrong inference that misleading statements wereknowingly or [with] deliberate recklessness madeto investors, a private securities fraud complaintis properly dismissed under Rule 12(b)(6) .

Ronconi v. Larkin 253 F.3d 423, 429 (9thCir .2001) (citations and internal quotation marksomitted) .

Plaintiffs allegations rely primarily upon 1)Defendants' statements regarding the purportedsuccessful integration of Crystal Decisions, and 2)Defendants' improper recognition of revenue infinancial statements. To satisfy the necessaryscienter requirement, Plaintiffs rely uponconfidential witness statements, stock sales, an SECinvestigation, and the temporal proximity betweenDefendants' alleged misrepresentations and thedisclosure of the truth .

1 . Crystal Decisions Integration

Plaintiffs allege that . Defendants made severalmaterial misrepresentations regarding theacquisition and integration of Crystal Decisions.However, while Plaintiffs' complaint contains pagesof text from Defendants' press releases and analystcalls, Plaintiffs quote only two allegedly falsestatements in their briefing to the Court . First, onJuly 18, 2003, Defendants issued a press release

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discussing the complimentary natures of themerging companies' product lines and its ability to"capitalize on significant growth opportunitiesresulting from complementary products ." [FN2]Plaintiffs also note Defendant Liautaud' .s statementon October 23 that "[o]ur management had beenworking closely with counterparts from CrystalDecisions in a disciplined process to developintegration plans that can be implemented onclosing." Plaintiffs also note that on October 23,2003, Defendants' press release stressed thatEnterprise 6 was the absolute key to BusinessObjects growth, and, according to Plaintifffs,highlighted that the integration of Crystal Decisionswas progressing smoothly. On December 11, 2003,January 8, 2004, and February 5, 2004, Plaintiff'sallege that Defendants issued press releases statingthat the integration of Crystal Dynamics hadprogressed smoothly and that Business Objectswould achieve significant growth based on thecompanies' complementary product lines . Plaintiffsargue that each of the press releases was falsebecause Defendants knew that serious integrationproblems with the companies' product lines existed,including the incompatibility of Enterprise 6, andthat it had plans to replace the product with CrystalEnterprise .

FN2. At oral argument, Plaintiffs indicatedthat they no longer rely on this statement inpressing their complaint .

*5 Defendants argue that Plaintiffs have notalleged facts demonstrating that the press releasesor Defendant Liautaud's statement were false whenmade. Defendants note that the integration effortinvolving Crystal Decisions did not begin untilDecember 11, 2003, and therefore the Court mustonly look to statements made after that time .Defendants assert that only two statements couldpossibly support Plaintiffs' claim : 1) the January 8,2004 announcement that the two companies' sales,marketing, professional services, alliances,technical support organizations, and websites "arenow one"; and 2) the February 5, 2004 press releasein which Defendant Liautaud said he was "pleased"with the progress of the integration efforts to date .

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Plaintiffs respond that the Amended Complaintadequately details the manner in which Defendantsmade material representations regarding theacquisition and integration of Crystal Decisions.Plaintiffs rely almost exclusively on the testimonyof its three confidential witnesses . Initially, theAmended Complaint states that a former BusinessObjects Senior Director of Customer TechnicalSupport, who worked at the company during theClass Period, knew that customer orders were beingdelayed and cancelled because of productintegration problems between Crystal Decisions andBusiness Objects. The Amended Complaint alsostates that a former Telecommunications AnalystProject Manager who worked at Crystal Decisionsconfirmed that when the acquisition of the twocompanies was announced, teams from the twocompanies were not allowed to integrate or evenshare information. Additionally, the AmendedComplaint states that a former Vice President ofProduct Strategy of Business Objects stated thatproduct coordination and product overlap becamean important issue for the integrated company .

The Ninth Circuit has warned against the use ofunnamed sources and stated that lilt is notsufficient for a plaintiff's pleadings to set forth abelief that certain unspecified sources will reveal,after appropriate discovery, facts that will validateher claim ." Silicon Graphics, 183 F.3d at 985 ."Instead, to meet this particularity requirement forpersonal sources of information, this circuit hasapplied the Second Circuit's standard that personalsources of information relied upon in a complaintshould be described in the complaint with sufficientparticularity to support the probability that a personin the position occupied by the source wouldpossess the information alleged ." In re DaouSystems, Inc. Sec. Litig., 397 F.3d 704, 711 (9thCir .2005) (internal quotation marks and citationsomitted) (amended and superseded on denial ofrehearing by 411 F.3d 1006 (9th Cir.2005)). "Whenplaintiffs rely on both confidential witnesses and onother facts, 'they need not name their sources aslong as the latter facts provide an adequate basis forbelieving that the defendants' statements werefalse ." ' Id. (quoting Novak v. Kasaks, 216 F.3d300, 314 (2d Cir.2000)) ; see also Silicon Graphics,

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183 F .3d at 985 (stating that the complaint shouldinclude "adequate corroborating details") .

*6 In Dauo Systems, the plaintiffs had numberedeach confidential witness, described his or her jobdescription and responsibilities, and in someinstances, provided the witnesses' exact title and towhich executive the witnessed reported. 397 F.3d at711 . The Dauo Systems court found that thespecificity of the plaintiffs' descriptions wassufficient to met the PSLRA's requirements forconfidential witnesses . Id at 712 .

Here, the Court finds that the Amended Complainthas failed to describe the confidential witnesseswith a sufficient degree of specificity . Indeed,unlike in Dauo Systems, the Amended Complaintprovides no more than the job title of theconfidential witnesses. For example, plaintiffs statethe exact job title of their first confidentialwitness--the Senior Director of Customer TechnicalSupport-but fail to provide any other detailregarding his or her job description andresponsibilities. See Northpoint 184 F.Supp.2d at1000 (finding the confidential-witness statementsinsufficient where the description of the confidentialwitnesses did not provide their job duties and howthe witnesses learned of the information alleged inthe complaint) . Plaintiff treats the other twoconfidential witnesses in a similar manner .Moreover, besides the statements of these threeconfidential witnesses, Plaintiffs have offered theCourt no corroborating evidence, such as internaldocuments or public filings, to support theirassertions of falsity .

However, even if, assuming arguendo, the Courtfound that Plaintiffs had described the confidentialwitnesses with sufficient specificity, the witnessstatements are long on speculation, but short onrelevant detail . The witnesses' conclusorystatements include phrases such as "productintegration problems" and "customer confusion,"but offer no insight into the pervasiveness of suchproblems. Furthermore, the witnesses statementsoffer no detail regarding how the witnesses learnedof the facts in their statements or how, if at all,Defendants knew about such facts . In short, these

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allegations are not pled with sufficient speci ficity

2. Financial Statements

Plaintiffs allege that during the Class Period,Defendants improperly recognized revenue inviolation of Generally Accepted AccountingPrinciples ("GAAP") and other accountingstandards , which made Business Objects' financialstatements false and misleading . In support of theseallegations , Plaintiffs rely primarily upon acon fidential witness statement and the SEC 's formalongoing investigation into Business Objects'accounting principles . Defendants contend thatPlaintiffs have failed to adequately allege that theireconomic losses were caused by the allegedly falsestatements, and in any event, Plaintiffs have alsofailed to allege with particularity that BusinessObjects recognized revenue improperly on accountof these practices .

Plaintiffs rely almost exclusively upon anunspecified former Senior Director's statement thatthe Vice President of Business Objects AllianceGroup admitted that some sales were not recordedin the quarter in which they were made . Plaintiffsalso allege that, in another case, "an employee" metwith "defendant" and Chief Operating Officer JohnOlsen to insist that an IBM order be shipped beforethe end of the quarter, rather than in the followingquarter, and that Business Objects ended up makingthe shipment by the end of the quarter but did notrecognize the revenue until the following quarter .

*7 Defendants respond that the former SeniorDirector's account lacks particularized detailsregarding the alleged accounting violations . It isgenerally accepted that allegations of violations ofGAAP or SEC regulations, without mor do notestablish scienter. In re Worlds of Wonder Sec.Litig, 35 F.3d 1407, 1426 (9th Cir.1994) . Rather,to plead fraudulent intent based on GAAPviolations, plaintiffs must allege facts showing that1) specific accounting decisions were improper, and2) defendants knew specific facts at the time thatrendered their accounting determinationsfraudulent . DSAM Global Value Fund v. AltrisSoftware, Inc., 288 F.3d 385, 390-91 (9th Cir .2002)

. Plaintiffs have not met this standard.

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The Senior Director's statement that "some saleswere not recorded in the quarter in which they weremade" is vague and conclusory. The Court is left tospeculate as to the date, sales quantity, and otherrelevant details regarding the transaction . Plaintiffsallegation regarding the IBM order suffers from thesame flaw. The allegation is unsupported by factsshowing any specifics regarding the transaction, forexample, how this employee learned whetherrevenue was recognized on the IBM order, when therevenue was recognized, and whether the revenuerecognition was improper . See Northpoint, 184F.Supp.2d at 998 ("With accounting fraud,however, the necessary scienter is in general notestablished merely by the publication of inaccurateaccounting figures, or failure to follow generallyaccepted accounting principles. More is needed .") .Furthermore, Plaintiffs fail to plead that Defendantshad any knowledge of Business Objects' accountingpractices, or that such practices were improper. Insum, such generic allegations of accounting fraudfall woefully short of sufficiently pleading scienterwith respect to Defendants' practice of recognizingrevenue .

Moreover, the Court is not persuaded thatPlaintiffs' improper revenue allegations are furtherevidenced by the SEC's formal investigation intoBusiness Objects' accounting practices . Plaintiffsassertion that the SEC's investigation "highlights therisk" that Business Objects has improperlyrecognized revenue is problematic . Certainly, theexistence of a "risk " that Business Objects hascommitted GAAP violations , without more, isinsufficient to raise a "strong inference" of scienter.Plaintiffs have offered no case authority to thecontrary .

3 . Stock Sales

Plaintiffs also rely on stock sales by DefendantLiautaud to support their allegations of scienter.Generally, stock sale allegations cannot raise aninference of scienter unless Plaintiffs allege specificfacts showing that the sales were "dramatically outof line with prior trading practices at times

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calculated to maximize the personal benefit fromundisclosed inside information ." Silicon Graphics,183 F.3d at 986. Among the relevant factors for acourt to consider are: 1) the amount and percentageof shares sold by insiders ; 2) the timing of the sales;and 3) whether the sales were consistent with theinsidees prior trading history. Id

*8 Liautaud sold over $6 million of stock duringthe class period, roughly 9.7% of his totalstockholdings . Liautaud's sales occurred soon afterthe Business Objects's quarterly earnings reports . Inlight of the Silicon Graphics factors, these sales arenot sufficiently suspicious to raise an inference ofscienter . To be certain, the fact that Liataud soldroughly 9 .7 of his total stockholdings is notparticularly powerful evidence of fraud . SeeRonconi, 253 F.3d at 435 (suggesting that sales of10-17% of holdings was not suspicious). Moreover,the timing of the stock sales are not overlysuspicious and Plaintiffs have failed to explain howthese sales, each of which occurred after BusinessObjects announced earnings results, could raise aninference of fraudulent intent . Additionally, anyinference of scienter is further negated by the factthat neither Defendant Tolonen nor DefendantOlsen sold any shares during the Class Period. SeeLipton Y. Pathogenesis Corp., 284 F.3d 1027, 1037(9th Cir.2002) (finding that insider sales did notsupport an inference of fraud when 'only [onedefendant] and not other insiders sold during theclass period, and the sales by [the one defendant]were only a small part of his total holdings") .Therefore, the Court finds that Liautaud's stocksales do not support an inference of scienter .

4. Proximity Between False Statements andDisclosure of the Truth

Plaintiffs argue that the close proximity betweenDefendants' misrepresentations and the disclosureof the truth helps bolster a strong inference ofscienter. Here, Plaintiffs allege that Defendants'statements in October 2003 through December 2003regarding the integration of Crystal Decisions wererevealed to be fundamentally incorrect andmisleading in Business Objects' April 29, 2004press release. Plaintiffs' argument fails, as an initial

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matter, because as previously noted, Plaintiffs' havenot sufficiently alleged that Business Objects' April29, 2004 press release was false or misleading.Moreover, a showing of "temporal proximity . . .without more, is insufficient to satisfy Rule 9(b) ."Yourish v. California Amplifier, 191 F.3d 983, 997(9th Cir.1999); see also Ronconi, 253 F .3d at 437(holding that "the five week period between theoptimistic statements and the below-expectionsearning report is not enough to sustain thecomplaint .") . [FN3 ]

FN3 . Plaintiffs' argument that scienter mayalso be inferred because Defendants'allegedly fraudulent conduct concernedBusiness Objects' core business is similarlyunpersuasive . See In re Read-Rite Corp.Sec. Litig., 335 F.3d 843, 848 (9thCir.2003) (rejecting the notion that astrong inference of scienter can bepresumed from allegations that relate to acompany's core operations) .

D. Allegations as a Whole

The Court must consider whether the totality of theComplaint's allegations, even though individuallylacking, create a strong inference that the individualDefendants acted with deliberate or consciousrecklessness . No. 84 Employer-Teamster JointCouncil Pension Trust Fund Y. America WestHolding Corp., 320 F.3d 920, 945 (9th Cir.2003)(holding that the allegations must be considered intheir totality in determining whether plaintiffs havemet the PSLRA standard) . To satisfy the NinthCircuit's interpretation of the PSLRA, Plaintiffs'allegations must give rise to a strong inference ofdeliberate recklessness, "provid[ing] a list of allrelevant circumstances in great detail ." SiliconGraphics, 183 F .3d at 974. The complaint here doesno such thing. Even after considering the totality ofPlaintiffs' allegations, the Court finds that Plaintiffs'complaint, as present written, is filled withimprecision and falls woefully short of the SiliconGraphics standard. Plaintiffs have failed to allegeparticularized facts that could lead the Court to inferthat Defendants knowingly misrepresented thedetails of Crystal Decision's integration or Busines s

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Objects' revenue reports . Therefore, where, as here,a securities fraud complaint "requires a laboriousdeconstruction and reconstruction of a great web ofscattered, vague, redundant and often irrelevantallegations," the spi rit and letter of the PSLRAsupport dismissal . Wenger v. Lumisys, Inc., 2F.Supp .2d 1231, 1243 (N.D.Cal .1998) . [FN4 ]

FN4. Since Plaintiffs have not met thePSLRA pleading standard, the Court doesnot need to decide whether Defendants'allegedly false statements fall within thesafe harbor provision under 15 U.S .C. §78u-5(c)(1)(A) or (B) .

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Ramp Networks, Inc, Sea Lit., 201 F.Supp .2d 1051,1063 (N.D.Ca1.2002). Where a plaintiff asserts asection 20(a) claim based on an underlyingviolation of section 10(b), the pleadingrequirements for both violations are the same . Id

Here, Plaintiffs assert that the individualDefendants are liable under this section because ofan underlying violation of section 10(b) . However,because Plaintiffs have failed to adequately pleadthe underlying I Ob-5 violation, the section 20(a)claims must be dismissed as well.

G. Dismissal Without Prejudice

E. Loss Causation

*9 In Dura Pharmaceuticals, Inc. v. Broudo, -U.S. -, 125 S.Ct . 1627, 161 L.Ld.2d 577 (2005),the Supreme Court clarified that alleging that amisrepresentation caused an inflated purchase pricedoes not, without more, demonstrate loss causation.To "touch upon" an economic loss is insufficient ;plaintiffs must demonstrate an actual causalconnection between the defendant's materialmisrepresentation and the economic loss suffered.Id at 1633. This holding reversed the NinthCircuit's jurisprudence on the subject which heldthat a plaintiff can satisfy the loss causationrequirement simply by alleging that a security'sprice at the time of purchase was inflated due to themisrepresentation .

Here, the complaint simply alleges that "Plaintiffsand the class have suffered damages in that, inre liance on the integrity of the market, they paidinflated prices for Business Objects publicallytraded securities ." Plaintiffs have not alleged aproximate, casual connection between the allegedmisrepresentation and the subsequent decline intheir stock . Therefore, as in Dura, Plaintiffs'allegations regarding loss causation are insufcient.

F. Rule 20(a) Liability

Section 20(a) of the Exchange Act providesderivative liability for those who control othersfound to be primarily liable under the Act . In re

Leave to amend under Federal Rule of CivilProcedure 15 should be liberally granted ."Dismissal with prejudice and without leave toamend is not appropriate unless it is clear . . . that thecomplaint could not be saved by amendment ."Eminence Capital v. Aspeon Inc., 316 F.3d 1048,1053 (9th Cir.2003) (error to refuse leave to amendin a securities fraud case to allow plaintiff to pleadscienter). Here, it is possible that Plaintiffs couldremedy their significant pleading defects in anamended complaint by adding detailed factualsupport for their allegations of false or misleadingstatements, and demonstrating that Defendants hadthe requisite scienter at the time the statements weremade. Accordingly, the Court dismisses theAmended Complaint without prejudice. ThePlaintiffs should file an amended complaint withinthirty (30) days from the date of this Order .

CONCLUSIONAfter consideration of the Amended Complaint inlight of the heightened pleading standards of thePSLRA and the requirements of Federal Rule ofCivil Procedure 12(b)(6), the Court GRANTSDefendants' motion to dismiss with leave to amend .

*10 IT IS SO ORDERED .


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United States District Court,

S .D. New York .

In re TR WARNACO GROUP, INC. SECURITIESLITIGATION (II)

No. 01 Civ. 3346(MGC).

Sept. 21, 2005 .Lovell Stewart Halebian, LLP, New York, NY, By :

Christopher Lovell, Ftedetick W, erkens.III. Robert W.

Rodriguez . for Plaintiffs.

Davis Polk & Wardwell, New York, NY, By: Daniel F' .

Kolb, Amelia T . R. Starr, Gina Caruso, for Deloitte &

Touche LLP .

CEDARBAUM, J .OPINION

*1 This action is the second of two securities class actions

filed in the wake of a series of belated financial restatementsmade by The Warnaco Group, Inc. ("Warnaco") . Thepresent action is brought on behalf of all purchasers of

Warnaco common stock between August 15, 2000 and June

8, 2001 . Plaintiffs brought claims against Wamaco andseveral of its officers and directors for violation of Sections

(10)(b) and 20(a) of the Securities Exchange Act of 1934,15 U.S .C . §§ 78i(b) and 78t[a). and a common law claim for

breach of fiduciary duty. In the course of the litigation,

plaintiffs amended the complaint to add Warnaco's outsideaccountant, Deloitte & Touche LLP ("Deloitte").

On September 26, 2003, Deloitte moved to dismiss the

claims against it pursuant to Fed .R.Civ.P . 9fbb and 12()(6] .After the claims against Deloitte had been dismissed

without prejudice, plaintiffs filed an amended complaint .Deloitte again moved to dismiss the claims against it . At the

oral argument, I instructed plaintiffs to file another amendedcomplaint which clearly sets forth the allegations against

Deloitte, and reserved decision on Deloitte's motion . OnJanuary 13, 2005, plaintiffs filed a 116 page amendedcomplaint against Deloitte.

BACKGROUND

This action arises from Warnaco's collapse in 2001 after

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numerous disclosures that it had significantly misreportedits financials for several years . Plaintiffs allege that Deloitte,

Warnaco's outside accountant during 2000 and 2001,

knowingly made a number of affirmative misstatementsduring the class period. Plaintiffs also allege that Deloitte

failed to correct statements it had made before the classperiod after discovering that they were false .

On May 16 , 2000 , before the class period, Warnaco filed itsannual audited financial statement on Form 10-K for the

fiscal year 1999 ("FY1999") . Amend. Compl . $$ 50, 74. As

later restatements revealed , that financial statementcontained numerous errors . It overstated Warnaco's total

stockholder equity by $30,131 ,000, or nearly five and onehalf percent of the reported amount of $563,316,000. Id. ¶¶1, 75 . $26, 000,000 of this overstatement was attributable to

the false valuation of reserves for returned, unsoldmerchandise , and $4 , 131,000 was attributable to the

misreporting of intercompany account balances between

Warnaco and its subsidiary, Designer Holdings Ltd .("Designer Holdings"). Id. IN 3, 11, 75 . In addition, thefinancial statement understated accounts payable by

$18,424,000 as a result of errors relating to Designer

Holdings, and overstated accounts receivable by$64,100,000, inventory by $11,900,000, and other assets by

$6,500 ,000. Id. ¶ 75 .

The FY1999 financial statement was accompanied by an

audit letter from Deloitte. The letter stated that Deloitte hadconducted an audit of Warnaco in accordance with

Generally Accepted Auditing Standards ("GAAS"), andthat, in Deloitte's opinion, Warnaco's financial statement"present[ed] fairly, in all material respects, the financial

position of The Warnaco Group, Inc. and subsidiaries as ofJanuary 1, 2000, and the results of their operations and their

cash flows for the year then ended in conformity with

accounting principles generally accepted in the UnitedStates of America." Id. 180.

*2 Plaintiffs allege that in September 2000, within the classperiod , a Warnaco executive began reporting to

management about accounting errors, poten ti ally involving

tens of millions of dollars, relating to Warnaco 's Designer

Holdings subsidiary. Id. IN 134-35. In November 2000,these errors were discussed at the third quarter audit revie w


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meeting, which Deloitte personnel attended . Id. % 132, 135 .

According to the amended complaint, as a result of thatmeeting, Deloitte became aware of the Designer Holdings

errors in the audited FY1999 financial statement . rFNI1 Id.

¶136 .

FN 1 . The amended complaint is unclear as to

whether Deloitte became aware in the fall of 2000of the full extent of the Designer Holdings errors,

or only the $4,131,000 error attributable to

misreporting of intercompany account balances.

Compare Amend- Compl. ¶ 132 ("[B]y November

2000, Deloitte knew that Warnaco's intercompanyaccounts with Designer Holdings were out of

balance and that Warnaco's financial condition waspotentially inflated as a result ."), with id. ¶ 136

(alleging that "the Designer Holdings relatederrors" were discussed in the third quarter 2000audit review meeting, which Deloitte attended).

For the purpose of this motion, this ambiguity is

construed in plaintiffs' favor. See ChambersTiMe Warner, I 282 F .34 147- 152 (2d

Cir 2002) .

In addition , the complaint alleges that in October 2000,

Warnaco's true financial condition was such that the

company was in default of its debt to equity ratio covenants

under its credit ag reements . Id. IN 4, 119-20, 137- 40 . To

avert discovery of this fact , Warnaco issued an interim

financial statement on November 14, 2000 that misreported

its condition . Id. ¶ 2, 10, 122 . The correct numbers for

Warnaco's cash and long term indebtedness, according tothe complaint, were made known to Deloitte in writing and

orally by November 3, 2000 . Id. ¶¶ 2, 10 . They were also

publicly disclosed in a press release on November 2, 2000 .

Id. ¶ 119 . However, before issuing the November 14, 2000

interim financial statement , Warnaco's management

allegedly changed these numbers . Id. ¶ 10 . According to the

complaint, Deloitte knew but failed to inform the public that

Warnaco was no longer in compliance with its debt

covenants . Id. 1173 .

The complaint also alleges that, within the class period,

Warnaco issued several quarterly financial statements that

contained numerous falsehoods . In addition to failing to

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disclose Warnaco ' s default under its credit agreements, thesequarterly statements significantly overstated stockholder

equity, accounts receivable , revenues, and assets ;

substantially understated liabilities; and misclassified

various inventory write-offs as "restructu ring charges" orcharges relating to "strategic review." Id. IN 90, 97-98, 101,

115, 117, 125-28. Plaintiffs allege that , although these

quarterly statements were unaudited , id ¶¶ 93, 113, theywere "examined or reviewed" by Deloitte and refer re d

investors "for further information" to the annual financial

statements that Deloitte had audited , id. 1171, 93, 106, 113,

147, 273 .

On March 29, 2001, after it had become publicly known that

Warnaco was not in compliance with its credit agreements,Warnaco issued a pre ss release announcing that it had

received a temporary waiver from its lenders and that it was

negotiating permanent amendments to its credit agreements

in order to avoid a possible default. Id 1154. On the same

day, Warnaco issued a chargeback restatement,acknowledging that it had understated reserves for retu rned,unsold merchandise in its financial statements for the years

1997 to 1999 . Id. ¶¶ 2, 60, 153 . According to the complaint,

Deloitte first became aware of this understatement in

mid-February 2000, but advised Warnaco not to disclose ituntil the Securities and Exchange Commission ("SEC")

began to investigate the company in early 2001 . Id. ¶¶ 2, 9,59-60.

*3 On April 13, 2001, Warnaco reported that it had received

an extension of the temporary waiver from its lenders, andthat it continued to be in discussions to revise its credit

agreements. Id . ¶ 156 . On April 17, 2001, Warnaco filed

with Form 10-K its annual audited financial statement forthe fiscal year 2000 ("FY2000") . Id. ¶ 158 . According to the

complaint, that statement contained a number of significant

falsehoods . It overstated stockholder equity and inventory

by, respectively, $97,675,000 and $1,252,000 , andunderstated liabilities and accounts payable by a total of

$96,762,000 . Id ¶ 160 .

The FY2000 financial statement was accompanied by anaudit letter from Deloitte . Id. 1 158 . In the letter, Deloitte

stated that it had audited Warnaco in accordance with

GAAS, and that "in our opinion , [Warnaco's ] consolidate d

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financial statements present fairly, in all material respects,the financial position of The Warnaco Group, Inc . and

subsidiaries as of December 30, 2000 and January 1, 2001,

and the results of their operations and their cash flows forthe years then ended in conformity with accounting

principles generally accepted in the United States ofAmerica." Id 1166 . In addition, however, Deloitte's auditletter stated that "[t]he Company was not in compliance

with certain covenants and . . . has a working capital

deficiency." These issues, Deloitte warned, "raisesubstantial doubt about [Wamaco's] ability to continue as a

going concern.. . . The company's ability to continue to

operate as a going concern is dependent on the outcome of

negotiations [with its creditors] or upon its ability torefinance its debt. "

On April 20, 2001, Warnaco issued a $190 ,459,000

restatement of its third quarter 2000 interim financialstatement . Id. ¶ 170 . Also in April 2000, Deloitte issued a

'material weakness ' letter to Warnaco , which was not

publicly disclosed, detailing the financial chaos within the

company, including the failu re to reconcile intercompanyaccounts and to have reliable accounting for international

operations . Id. 11 5, 181 .

In the end, plaintiffs allege , "Warnaco's true undisclosed

financial condition rendered [it] unable to obtain waivers

and caused it to have to file for bankruptcy." Id. ¶ 169 . OnJune 11 , 2001, Warnaco announced that it had voluntarilypetitioned for protection under Chapter II of the

Bankruptcy Code . Id ¶ 197 . Shortly thereafter, Warnacobegan issuing a number of restatements of the financial

statements audited by Deloitte . Id. ¶¶ 4, 198 . According tothe complaint, these restatements disclosed multiple

violations of GAAS by Deloitte in the audit of the FY1999

and FY2000 financial statements. Id. 167, 203, 210-11 .

DISCUSSION

The standard applied to a motion to dismiss a complaint iswell-established . A court must accept as true all

well-pleaded allegations in the complaint and draw allreasonable inferences in favor of the plaintiffs. Chambers v.

Time Warner. Inc. . 282 F .3d 147, 152 (2d Cir .2002) ; King v.

Simpson . 189 F.3d 284. 287 (2d Cir .1999) . A complaintmay be dismissed for failure to state a claim "only if it is

Page 3

clear that no re lief could be granted under any set of factsthat could be proved consistent with the [complaint's]

allegations ." Olken v. Fyvnerton 1999 Term Trust. Inc . . 98F.3d 2. 5 (2d Cir. 1996) (internal quotation omitted) . TheCourt need not, however , credit conclusory statements

unsupported by factual allegations . De Jesus v. Sears .Roebuck.& Co ., .Inc. . 87 .F.3d 65, 70 (2d Cir.1996) .

*4 Deloitte argues that plaintiffs ' amended complaint fails tostate a claim for securities fraud because it does not allege a

material misleading statement or omission attributable to

Deloitte within the class period and because it fails to pleadloss causation. In addition, Deloitte contends that theamended complaint fails to state a claim for breach of

fiduciary duty because Deloitte owed plaintiffs no such

duty.

1 . Securities Fraud Under Section 10(b) acrd Rule 10b-5

Section 10(b) of the Securities Exchange Act protectsinvestors by making it unlawful "[t]o use or employ, in

connection with the purchase or sale of any security . . ., anymanipulative or deceptive device or contrivance incontravention of such rules and regulations as the

Commission may prescribe as necessary or appropriate inthe public interest or for the protection of investors," 15

U.S .C. § 78j(h) . Rule lOb-5, promulgated by the SEC,

makes it unlawful: "(a) To employ any device, scheme, or

artifice to defraud, (b) To make any untrue statement of amaterial fact or to omit to state a material fact necessary in

order to make the statements made, in the light of thecircumstances under which they were made, not misleading,or (c) To engage in any act, practice, or course of business

which operates or would operate as a fraud or deceit upon

any person, in connection with the purchase or sale of anysecurity ." 17 C.F .R . § 240 .10b-5 .

To state a claim under Section 10(b) and Rule 1Ob-5 for amisleading statement or omission, as plaintiffs seek to do

here, plaintiffs must allege that the defendant "(1) mademisstatements or omissions of material fact; (2) with

scienter; (3) in connection with the purchase or sale ofsecurities; (4) upon which plaintiffs relied, and (5) thatplaintiffs' reliance was the proximate cause of their injury ."

Lentell v. Merrill Lynch .& Q . . .. Inc., 396 F.3d .16.1, 172 (d

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Cir.2005 . The Private Securities Litigation Reform Act of1995 ("PSLRA") provides that, where misleadingstatements or omissions under Section 10(b) are alleged, a

plaintiff must "specify each statement alleged to have beenmisleading , the reason or reasons why the statement is

misleading , and, if an allegation regarding the statement oromission is made on information and belief , the complaint

shall state with particularity all facts on which that belief isformed" 15 U.S .C . § 78u-4(b)(1).

A. MisleadingStatement or Omission

Plaintiffs contend that Deloitte made several actionable

misstatements or omissions during the class period . First,

they argue that Deloitte had a duty to correct the DesignerHoldings errors in Warnaco's FY 1999 financial statementafter discovering them in the fall of 2000. These errors,

plaintiffs allege, were relied upon by investors during theclass period because they appeared in the most recent

audited financial statement in existence at the time, to whichinvestors were periodically referred by Warnaco's class

period quarterly statements .

*5 It is settled that silence where there is a duty to disclosecan constitute a false or misleading statement within the

meaning of Section 10(b) and Rule lOb-5 . See Wright v .Ernst_ - Young LLP. 152 F.3d169, 177 (2d Cir.19981

(citing. Basic. Inc. v. Levinson. 485 U .S . 224, 239 n . 17

LIM. Consistent with that principle, "[a]ccounting firms. . . have a duty to take reasonable steps to correct

misstatements they have discovered in previous financialstatements on which they know the public is relying ."

Wrigkt. 152 F_3d at l77 (internal quotation omitted) ; seealso Shapiro v. Cantor. 123 F.3d 717, 721 (2d Cir .1997)

(noting that "in a situation in which the accountant 'gives anopinion or certifies statements' about a company--

statements which the accountant later discovers may nothave been accurate-- then the accountant has a duty to

disclose the fraud to the public") (quoting In re CascadeInt'l Sec. Litig~ . 894 ',Sapp. 433,_4n (S .D.Fla .1995) . The

duty to correct previous statements, however, extends onlyto statements the accounting firm audited . See LIT. an Int'I.Inv. That v. Corr fedd. 619 F2d 909,,_927 (2d Cir.1980)

("Andersen had no independent duty to see to the correctionof portions of the prospectus other than the financial

statement it prepared.") .

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Deloitte contends that even if it had discovered the Designer

Holdings errors in the fall of 2000, it hadno duty to disclosethem because they were, as a matter of law, immate rial. Tostate a cognizable claim for securities fraud, plaintiffs mustallege that Deloitte made misrepresentations that were

materi al . Basic . 485 U.S . at 238 . A statement or omission ismaterial if there is " a substantial likelihood" that it "wouldhave been viewed by the reasonable investor as having

significantly altered the 'total mix' of information madeavailable ." TSCIpdus.. Inc. v. Northway. Inc . . 426 U .S .

438 . 449 (1976) . The question of materiality "may becharacterized as a mixed question of law and fact," TSC

_US . at 450. and is genera lly inapprop riate fordetermination at the pleading stage of litigation , see Ganino,

228 F .3d at 166 ("We believe it is inappropriate todetermine at this stage of the litigation that [overstatementof income by 17 .7% after tax and 11 . 7% pre-tax for a givenquarter, and of 11 .9% after tax and 8% pre-tax for a periodof six months ], both in absolute terms and as percentages oftotal net income . . . were immaterial as a matter of law .");see also Oleck v. Fischer, No. 73 Civ . 1460(CSH), 1979WL 1217, at *13 (S . D.N.Y. June 8 , 1979) ("Nondisclosedfacts are not viewed in isolation. Materiality depends uponall the circumstances of the case .") .

According to the amended complaint, Deloitte discovered inthe fall of 2000 that the audited FY1999 financial statement

overstated stockholder equity by $4,131,000 of a total of$563,316,000 and understated accounts payable by

$18,424,000 . Amend. Compl . IM 11, 75 . Deloitte argues thatcourts have held comparable errors immaterial as a matter oflaw. See, e.g., In re Duke Energy Corp. Sec. Litig. . 282F.Supp.2d 158, 161 (S .D.N.Y_2003) ("[A]n inflation of

$217 million in the Company's revenues for the relevantperiod amounts to about 0.3% of Duke Energy's totalrevenues for that period [which constitutes] an immaterial

percentage as a matter of law ."); Fares v. Gateway 2000.Inc. . 122 F.3d 539, 546-47 (8th Cir .1997) (allegedoverstatement of assets by 2 percent was immaterial as amatter of law) ; In re Newell rmaid Inc. See. LjUZ .No. 99 C 6853 . 2000 WL 1705279, at *8 rni.D.Ill . Nov. 14.2000) (failure to disclose expenses amounting to less than

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one percent of overall revenues was immaterial as a matter

of law) .

*6 The alleged overstatement of Warnaco's stockholderequity in the FY1999 financial statement amounted to 0 .73

percent. The complaint provides no indication of the relativemeasure of the understatement of accounts payable

attributable to Designer Holdings allegedly made in the

FY1999 financial statement. if that understatement was of

comparably small proportion, Deloitte's argument that it had

no duty to correct the Designer Holdings errors is notwithout merit. However, since, as discussed below,plaintiffs fail to allege loss causation with respect to

Deloitte's failure to correct these errors, I need not decidewhether the errors were immaterial as a matter of law .

Plaintiffs also seek to hold Deloitte responsible forfalsehoods contained in quarterly financial statements issued

by Warnaco during the class period. Although the amended

complaint alleges that these statements contained a notationthat they were unaudited, plaintiffs contend that they areattributable to Detoitte because Deloitte "examined andreviewed" them . I 2l

FN2 . Plaintiffs fail to allege that the audited annual

statements were "incorporated by reference" intoWarnaco's quarterly statements, rendering Deloitte

responsible for the latter. The fact that the quarterlystatements referred investors "for further

information " to the audited annual statements is

insufficient for incorporation by reference . See

Markewi h v. Adikes . 422 F . Supp . 1144, 1147

(E.D.N .Y.l976) ; see also 17 C.F.R. §240 .12b-23(ay(2] (requiring, for incorporation by

reference into Form 10-Q, that "copies of any

information or financial statement incorporatedinto a registration statement or report by reference,

or copies of the pertinent pages of the documentcontaining such information or statement, shall be

filed as an exhibit to the statement or report') .

In Central Bank v. First Interstate Bank 511 U .S . 164

(1994). the Supreme Court held that a plaintiff cannot bringa claim for aiding and abetting securities fraud under

Section 10(b). In Shapiro, the Second Circuit, observed that

Page 5

"[i]f Central Bank is to have any real meaning, a defendant

must actually make a false or misleading statement in orderto be held liable under Section 10(b). Anything short of

such conduct is merely aiding and abetting, and no matterhow substantial that aid may be, it is not enough to trigger

liability under Section 10(b) ." Shiro. 123 F.3d at 720 .Accordingly, liability may not generally attach to a public

auditor for unaudited public statements the company made,which is the ease with Warnaco's quarterly statements . SeeWright, 152 FAA Lt 171 ("[Company's] press release did notattribute any assurances to Ernst & Young and, in fact, didnot mention Ernst & Young at all . Thus, Ernst & Young

neither directly nor indirectly communicated

misrepresentations to investors .") ; Shapiro, 123 F .3d at 721(noting that "if an accountant does not issue a public opinion

about a company, although it may have conducted internal

audits or reviews for portions of the company, theaccountant cannot subsequently be held responsible for the

company's public statements issued later merely because theaccountant may know those statements are likely untrue")(quoting In re Cascade. 894 F.Supp. at 443) ; In re

Rent-Way Sec. Litig 209 F.Supp.2d 493. 504(W.D Fa,202) (allegations of misstatements in unaudited

quarterly statements that did not identify auditor by namewere insufficient to state a claim under Section 10(b)) ; In-reKendall Square Research Corn . Sec. Litig. . 868 F.Supn . 26 .

28 (D .Mass .1994) ("[A]llegations that Price Waterhousereviewed and approved the quarterly financial statements

and the Prospectuses do not constitute the making of a

material misstatement; at most, the conduct constitutesaiding and abetting and is thus not cognizable under Section

10(b).").

*7 Plaintiffs' reliance on ln re Giabad Cussing. Ltd.

Securities Lit ga1i9u. 322 FSupp.2d- 3121 .D_N.Y,20441 is

unavailing. In that case, the plaintiffs sought to attribute toArthur Andersen unaudited statements which they allegedAndersen materi ally assisted in preparing . The Court

accepted the plaintiffs' argument with respect to somestatements, but rejected it as to others . It observed that to

hold an auditor responsible for statements it did not itselfmake, a plaintiff must allege " sufficient facts thatdemonstrate that a defendant was personally responsible for

making those statements, even if he or she is not identifie d

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as the speaker ." Gla al Crossing. 322 F.Supp.2d at 331 .

The Court then held that "[a] llegations that Andersen'prepared, directed or controlled,' 'helped create' or

'materially assisted in' preparing false statements issued byGlobal Crossing place its involvement well beyond the

realm of 'aiding and abetting liability precluded by CentralBank."Id. at 334 .

Even if substantial participation in preparation of an

unaudited statement is sufficient for primary liability under

Section 10 (b), LFN31 plaintiffs do not allege suchparticipation by Deloitte in this case . All that plaintiffs

allege is that Deloitte "examined and reviewed" thequarterly statements , and that it attended quarterly reviewmeetings . These allegations do not rise to the level of

involvement deemed sufficient in Global Crossing. See id.

at 333 (allegations that accountant "merely reviewed and

approved " unaudited statements or was "instrumental inhelping" company prepare them are insufficient to transcend

the proscribed category of aiding and abetting liabi lity under

Section 10(b)).

FN3 . As the Court in Global Crossing recognized,

the leading cases from the Second Circuit adopted

a 'bright line' test over a 'substantial participation'

test for the threshold required for a secondary

actor's conduct to implicate primary liability under

Section 10(b). See War h 152 F.3d at 175 :

Shapiro. 123 F .3d at 72Q. Although the Courtopined that a subsequent decision has moved

toward the ' substantial participation' test, that caseinvolved, as the Court recognized , a corporate

insider rather than an outside actor like a public

auditor. See In re S haiartic Corn. Sec. Lftig. . 252

F.3d Q. 75-76 (2d Cir .2001) (company vice

president could be liable for misstatements

disseminated by the company where he "wasp rimarily responsible" for communications with

investors and analysts and was "involved in the

drafting, producing, reviewing , and/or

disseminating of the false and misleadingstatements"). As was also noted in Global

Crossing, the In re Scholastic opinion discussesneither Wright, Shapiro, nor Central Bank

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Plaintiffs also seek to hold Deloitte responsible for failing todisclose a substantial understatement of rese rves for

returned merchandise in the FY1999 financial statement.

According to the amended complaint , in mid-February 2000Deloitte discovered that Warnaco had understated the valueof such reserves by $26, 000,000 . Amend. Compl . IN 59-60,

75. Neither Deloitte nor Warnaco disclosed this fact,however, until March 29, 2001 , following the

commencement of an SEC investigation into Warnaco's

finances . Id ¶ 60. Warnaco's stock price declined after the

correc tive disclosure was made. Id. ¶ 4.

This alleged omission is not actionable in this case . The

amended complaint expressly states that Deloitte discoveredthe understatement in mid-February 2000 , but failed todisclose it in the FY1999 financial statement. Both events

took place before the class period. Since plaintiffs do notallege that Deloitte discovered the falsehood within the class

period, they cannot maintain a claim against Deloitte for

failing to correct . Cf. In re Intl Bus. Machs . Corporate Sec .

Liii . 163 F .3d 102, lQT(2d_C__jxjM ("[A defendant] is

liable only for those statements made during the class

period .") . Were plaintiffs permitted to do so, all knowing

misstatements made before the class period , which remainuncorrected , would be actionable within the class period on

an omission theo ry.

*8 Plaintiffs also allege that Deloitte failed to publicly

disclose in October 2000 that Warnaco was no longer incompliance with its debt covenants . Amend. Compl . 1173 .

The amended complaint, however, does not allege factsshowing that Deloitte had a duty to disclose this

information . First, there is no allegation that Deloitte was

aware that Warnaco was in default under its creditagreement. Although plaintiffs allege that the true numbers

for Warnaco's cash and long term indebtedness were madeknown to Deloitte by November 3, 2000, and issued in a

press release the day before, they also allege that Wamacochanged those numbers before issuing the false interim

statement on November 14, 2000 . There is no allegation thatDeloitte knew that Warnaco's changed numbers were

fictitious . Moreover, even had Deloitte discovered that

Warnaco was in default, there is no allegation that Deloittemade a contrary prior statement that it had a duty to correct


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within the class period. The fact that Warnaco defaulted

under its credit agreements in October 2000 did not renderany of Deloitte's prior statements false, thereby giving rise

to a duty to correct . In addition , Deloitte had no duty to

correct Warnaco's false November 14, 2000 quarterly

statement, which it did not audit. See Wright. 152 E. dat

175 : IIT. 619 F .2d at 927.

Finally, plaintiffs argue that Deloitte is responsible for the

misstatements made in the FY2000 financial statement. This

statement is alleged to have been audited by Deloitte and tohave contained numerous significant falsehoods . See

Amend. Compl. ¶ 160 . Deloitte responds that, because its

audit opinion included a "going conce rn" qualification, the

financial statement as a whole could not, as a matter of law,

be deemed misleading . Deloitte cites no authority for the

proposition that a "going concern " qualification insulates apublic auditor from any liability for material misstatements

made in conjunction with the qualification . But see Dra

X . Alexander Grant Co . 905 F~24 453- 455-

(D .C.Cir.1990 ("Issuing a going concern opinion may notinsulate an accounting firm from liability but it must cutstrongly in its favor.") (citation omitted); see also In re

SviegeL Inc, Sec. Litig. . No . 02 C 8946.2004 ,at*42 (N.D.III . July 8 . 2004) ("Nor is [accounting fern]

entitled to dismissal because it threatened to issue a going

concern statement in the 2001 Form 10-K and 'never backed

down ." ') . Although the fact finder may determine that the

financial statement as a whole was not misleading, it cannot

be so deemed as a ma tter of law solely by reason of

Deloitte's "going concern" qualification.

B. Loss Causation

Thus, the only actionable misstatements and omissions inthe amended complaint are Deloitte's failure to disclose theDesigner Holdings errors, and the misstatements in the

FY2000 financial statement. Plaintiffs, however, fail to

plead loss causation with respect to either.

*9 An essential element of a claim for securities fraud is

loss causation . Ours Pharm., Inc v. Broudo. 125 S.Ct .

1627, 1629 (20051. This requirement is codified in thePSLRA, which provides that "[ijn any private action arising

under this chapter, the plaintiff shall have the burden of

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proving that the act or omission of the defendant alleged toviolate this chapter caused the loss for which the plaintiff

seeks to recover damages ." 15 U.S .C . § 78u-4fb)(4) . A

securities fraud plaintiff "must allege both transaction loss,i.e., that but for the fraudulent statement or omission, the

plaintiff would not have entered into the transaction ; andloss causation, i.e., that the subject of the fraudulentstatement or omission was the cause of the actual loss

suffered." Suez Equity Investors . L.P. v. Toronto Dominion

Bank 250 F .3d 87, 96 (2d Cir.2001) (emphasis in o riginal) .

The Supreme Court has recently rejected the theory that

artificial in fl ation of a security's purchase price is, without

more, su fficient to establish loss causation. [FN4) See Dura

Pharm. 125 S.Ct. at 1629 . Such a theory, the Court

observed, "would allow recovery where a misrepresentation

leads to an inflated purchase price but nonetheless does not

proximately cause any economic loss ." Id at 1633 : see also

Castellano v. Young, & Rubicam. Inc. . 257 F .3d 171 . 186

(2d Cir.200I) ("The loss causation requirement is intendedto fix a legal limit on a person 's responsibili ty, even for

wrongful acts.").

FN4 . This was the law of this Circuit even before

Duna Pharmaceuticals . See Emergent Capital Inv.

Mgmt. . LLC v. Stonenath Group . Inc. . 343 F .3d

189,198 (2d Cir.2003) .

Although the Supreme Court observed that "it should notp rove burdensome for a plaintiff who has suffered aneconomic loss to provide a defendant with some indicationof the loss and the causal connection that the plaintiff has in

mind," Du ham . 125 S.Ct. at 1634, it did notspecifically explain what allegations would suffice to plead

loss causation. In Lentell v. Merrill Lynch & Ca- .226 F34161 (2d Cir.22005). the Second Circuit addressed that issue .The Court held that a plaintiff can plead loss causation by

alleging either that (1) "the market reacted negatively to acorrective disclosure regarding the falsi ty" of the

defendant' s misstatements, or (2) that the defendant

"misstated or omitted risks that did lead to the loss ." Lentell.

396 F.3d at 175 : see also Fogarazzo v. Lehman Bros . . Inc. .

No. 03 Civ . 5194(SAS ). 2004 WL 1151542, at *1 0

(S .D .N .Y. May 21, 2004) (it is "enough that (1) themisrepre sentation artificially inflated the value of the

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security, or otherwise misrepresented its investment quality,

and (2) the subject of the misrepresentation caused thedecline in the value of the security") .

The amended complaint alleges that, as a result of Deloitte's

misrepresentations and omissions , "plaintiffs and other

members of the Class acquired Warnaco common stock

during the Class Period at artificially inflated high pricesand were damaged thereby ." Amend. Compl . ¶ 353 . As

noted, the mere artificial inflation of Wa rnaco' s stock price

is insufficient to plead loss causation . The amended

complaint further alleges , however, that as a result of

Deloitte's conduct "Warnaco was not shut down in early

October 2000 when, in reality, it was in clear default on itscredit agreements ." Id. J 4 . Plaintiffs also allege that in

April 2001, Deloitte failed to publicly disclose " the financial

chaos within Warnaco, " and that Warnaco's " taste financial

condition and internal chaos . . . prevented [it] from obtainingwaivers from its lenders of its default on its credit

agreement during March - June 2001 , caused its stock price

to decline to almost zero , and forced Warnaco to file for

bankruptcy protection on June 11 , 2001 ." Id

*10 With respect to Deloitte's failure to disclose the

Designer Holdings errors, the amended complaint containsno allegations that these errors, which Deloitte discovered in

the fall of 2000 and which were publicly corrected afterWarnaco's bankruptcy, played any part in the fall ofWarnaco's stock price or the company's ultimate demise.

The only loss causation allegation for the period prior toApril 2001 is that "Warnaco was not shut down in earlyOctober 2000" when it allegedly should have been because

it was in default under its credit agreements . As alreadydiscussed, however, Deloitte was under no duty to disclose

Warnaco's default since it is not alleged to have made a

prior contrary statement or to have known that Warnaco'spublished numbers, which indicated it was not in default,

were fabricated.

As for the falsehoods contained in the FY2000 financialstatement, plaintiffs allege that Deloitte's misrepresentationscaused their loss because "Warnaco's true undisclosed

financial condition rendered Warnaco unable to obtainwaivers and caused it to have to file for bankruptcy ." Id ¶

169 . Under Second Circuit law, however, this allegation is

insufficient to plead loss causation.

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To plead that Deloitte's misstatements and omissions in theFY2000 financial statement caused their loss, plaintiffs must

allege facts establishing that Deloitte concealed "some or allof the risk that materialized." Lentell 396 F.3d at 177. Here,

that risk, according . to the amended complaint, was

Warnaco's inability to obtain permanent waivers from itscreditors, which pushed the company into bankruptcy .Amend . Compl. ¶ 169. That risk, however, was

unambiguously disclosed in Deloitte's audit opinion

accompanying the FY2000 financial statement. Deloittewarned that Warnaco "was not in compliance with certaincovenants and has a working capital deficiency," and that it

may therefore not be able to carry on as a going concern.

In Lentell, the Second Circuit specifically addressed thequestion of what a plaintiff must allege to plead loss

causation where the allegedly fraudulent statement itself

disclosed the risk of loss that ultimately materialized:[W]here (as here) substantial indicia of the risk thatmaterialized are unambiguously apparent on the face of

the disclosures alleged to conceal the very same risk, a

plaintiff must allege [in order to plead loss causation] (i)facts sufficient to support an inference that it wasdefendant's fraud -rather than other salient factors--that

proximately caused plaintiffs loss ; or (ii) facts sufficient

to apportion the losses between the disclosed andconcealed portions of the risk that ultimately destroyed aninvestment.

Id. 396 F .3d at 177 . Here, plaintiffs have alleged neither.The amended complaint contains no allegations relating to

the apportionment of plaintiffs' losses between the disclosedand concealed portions of the risk that materialized. Nor doplaintiffs allege any facts from which it may be inferred that

Deloitte's failure to unmask the full depth of Warnaco's

troubles in the FY2000 financial statement contributed toWarnaco's inability to obtain waivers or Warnaco's ultimate

demise. Plaintiffs' assertion that "Warnaco's true

undisclosed financial condition rendered Warnaco unable to

obtain waivers" is conclusory and does not allege any factsin its support. It is insufficient "to support an inference that

it was defendant's fraud--rather than other salientfactors-that proximately caused plaintiffs loss ." Id.


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II. Breach of Fiduciary Duty

*11 Deloitte also moves to dismiss plaintiffs' claim of

breach of fiduciary duty. An accounting firm retained to

audit the financial statement of a company does not stand in

a fiduciary relationship with that company' s shareholders .

[E51 See Tad v. u erior Vending,533 (2d Dep't 2005) (accountant who rendered services to

corporation owed no fiduciary duty to a fifty percent

shareholder in corporation) ; Hamer v. Chess

N.Y.S .2d 243 . 244 (1st Dept 1987) (same) ; Facchini v.Miller, No. CV 9905876865, 2000 WL 175584, at *4

(Conn .Suner Ct. Jan. 31 . 2000) (accountant owed no

fiduciary duty to plaintiff shareholder who mere ly a lleged

reliance on financial information generated by accountant);

see also BHC Interim Fundin

Inc. . 283 F.Sunn .2d 968 . 987 (S .D.N,Y_,2003) ("[W]hen the

allegedly aggrieved party is at best a third party to an

accountant-client relationship , and no commercial

transaction is executed between two parties-indeed, when

no re lationship whatsoever exists between two parties--no

fiduciary duties may be imposed on either party .") (quoting

Greenblatt v. R' hard Potaskv Jewelers, No. 93 Q X,3652{x. 1994 WL 9754. at *4 (S.D .N .Y. Jan 13,

1994)) . The complaint the refore fails to state a claim againstDeloitte for breach of fiduciary duty.

FNS . Both parties have cited authorities from New

York and Connecticut on this issue . Because thereis no substantive difference between the laws of

these jurisdictions, no choice of law question

arises . See Int'l Bus, 11rMachs. Corp. v. Liberty Mut.

I,nss. Co. . 363 F .3d 137. 143 (2d Cir.20041 ("Choice

of law does not matter . . . unless the laws of thecompeting jurisdictions are actually in conflict .") .

CONCLUSION

For the foregoing reasons, Deloitte's motion to dismiss thecomplaint is granted.

SO ORDERED .

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END OF DOCUMENT

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EXHIBIT E

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United States District Court,S .D. New York .

DAVIDOFF, et al., Plaintiffs ,V.

FARINA, et al ., Defendants .No. 04 Cite. 7617(NkB) .

Aug. 22, 2005 .Jeffrey A. Klafter, Kurt B . Olsen , Klafter & OlsenLLP, White Plains , NY, Jonah Goldstein, RyanLlorens, Lerach Coughlin Stoia Geller Rudman &Robbins LLP, San Diego, CA, for Plaintiffs .

John D. Donovan, Jr., Ropes & Gray LLP, Boston,MA, for the Individual Defendants .

William H. Pratt, Kirkland & Ellis LLP, NewYork, NY, for Verizon .

Mitchell A. Lowenthal, Carmine D . Boccuzzi, Jr.,Cleary Gottlieb Steen & Hamilton LLP, New York,NY, for Smith Barney.

MEMORANDUM and ORDER

BUCHWALD, J .

*1 This putative securities class action arises out ofthe June 28, 2000 initial public offering of173,913,000 shares of Class A common stock (the"IPO") of Genuity, Inc . ("Genuity"), as well as thesubsequent demise and ultimate bankruptcy of thatcompany. Plaintiffs , who purchased shares ofGenuity during the putative class pe riod (whichextends from the TO through the filing ofbankruptcy), have sued Citigroup Global MarketsInc. (flkla Salomon Smith Barney Holdings Inc.)

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("Smith Barney"), [FN1] Verizon CommunicationsInc. ("Verizon") [FN2] and three former Genuityofficers (the "Individual Defendants"), [FN3]seeking damages for alleged violations of theUnited States securities laws . All defendants havemoved to dismiss plaintiffs' complaint on theground that it fails to state a claim for relief underFed .R.Civ .P. 12(b)(6) and fails to plead withsufficient particularity under both Fed.R.Civ.P. 9(b)and the Private Securities Litigation Reform Act of1995 (the "PSLRA"). For the reasons set forthherein, defendants' motions to dismiss are granted-

TN1. Smith Barney was one of two leadunderwriters for Genuity's IPO . Plaintiffsallege that as part of its responsibilities inthis regard, Smith Barney performed duediligence that included a review andapproval of Genuity's business plan .

FN2. As explained below, Verizon wascreated by a merger of GTE Corporationand Bell Atlantic Corporation, the samemerger that created Genuity as a spin-offcompany .

FN3. The Individual Defendants are PaulR. Gudonis, who was Genuity's Chairmanand C.E. O., Daniel P . O'Brien , who wasGenuity's Executive Vice President andC.F .O . , and Joseph C. Farina, who wasGenuity's President and C .O.O.

BACKGROUND [FN4]

FN4. The facts set forth below are drawnfrom plaintiffs' First Amended ClassAction Complaint .for Violation of theSecurities Exchange Act of 1934, datedNovember 19, 2004 (the "Complaint"),and are, as is appropriate in deciding thesemotions, assumed to be true herein .

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This lawsuit was instituted after Genuity filed forprotection under Chapter 11 of the United StatesBankruptcy Code on November 27, 2002 . OnOctober 2, 2003, tenuity filed with the bankruptcycourt a Second Amended Disclosure Statement insupport of the Consolidated Plan of Liquidation (the"Disclosure Statement"), which allegedly revealedto plaintiffs that Genuity had been significantlyundercapitalized since the company went public onJune 28, 2000. In their 79-page Complaint,plaintiff's allege that the June 27, 2000 Prospectusthat Genuity filed with the Securities and ExchangeCommission ("S .E.C.") in connection with the IPO(the "Prospectus"), as well as Genuity's spring 2000Form S-1 Registration Statement and twosubsequent amendments thereto, (collectively, the"IPO statements") were materially misleadingbecause they failed to disclose thisundercapitalization. Plaintiff's allege further thatvarious public statements made by Genuity about itsbusiness and financial health in the period betweenthe IPO and the company's ultimate bankruptcyfiling (collectively, the "post-IPO statements") werematerially misleading for a myriad of reasons . Theputative class period is alleged to extend throughthe entire solvent life of the company, from the June28, 2000 IPO through the November 27, 2002bankruptcy filing. Below, we outline the 1PD andsubsequent relevant events before detailingplaintiffs' allegations and defendants' arguments insupport of dismissal.

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Internet backbone providers as "hay [ing]the network scale and on-network traffic tooffer their customers connectivity tovirtually all addresses on the [I]nternet,either directly through their [I]nternetbackbone or through cost-free, high speedprivate connections to other Tier I Internetbackbones ." Compl. 1 2 .

*2 In July 1998, GTE and Bell AtlanticCorporation ("Bell Atlantic") announced aproposed merger, which would combine the twocompanies into what is now known as Verizon. Aspart of the merger, and in response to objections bythe Federal Communications Commission('P .C.C."), GTE and Bell Atlantic determined thatGTE Internetworking would be spun off to createan independent company, Genuity. [FN6] Pursuantto the spin-off plan, Genuity would conduct an IPOthat would give the public over 90.5% of the ClassA voting equity stock and Verizon (the mergedcompany) approximately 10% of the Class A stockand 95% of the Class B stock. Under the plan, onceVerizon obtained requisite approvals from statetelecommunications regulators, it would have theoption of converting its Class B stock into 80°/a ofthe outstanding Class A stock and thereby regainingcontrol of Genuity. Also pursuant to the plan,Verizon both retained rights of consent over variouscorporate actions by Genuity and was entitled toelect one member of Genuity's board of directors .

1 . Events Leading Up To the IP O

Genuity was a "Tier I" Internet backbone provider[FN5] that offered customers suites of managedInternet infrastructure services such as dedicatedand broadband access, web hosting and contentdelivery and value-added services such as Voiceover IP and managed Internet security services.Genuity's origins can be traced to BBNCorporation, a Massachusetts telecommunicationscompany that was acquired in 1997 by GTEInternetworking Inc . ("GTE Internetworking"), aholding company subsidiary of GTE Corporation("GTE") .

FN5. The Complaint defines Tier I

FN6. Under the Telecommunications Actof 1996, the former regional Baby Bells,such as Bell Atlantic, were prohibited fromowning long distance assets withoutobtaining approvals, referred to as "27IApprovals," from state regulators. Becausethe F.C.C. classified certain Internetbackbone assets of and services providedby GTE Internetworking as long distanceassets, it would not approve the GTE-BellAtlantic merger unless either those assetswere divested or GTE Internetworkingbecame independent of the mergedcompany .

II. The [PO

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Genuity's IPO was the largest in Internet history.According to the Complaint and the DisclosureStatement, when discussions about a possible IPObegan in the spring of 2000, the original targetoffering price was $25 per share, which would havegenerated approximately $4 .3 billion in proceeds .As discussed more fully below, plaintiffs allege thatGenuity's business plan was developed with thisfigure in mind. With preparations for the TOunderway, however, market conditions began todeteriorate and, as of June 24, 2000, at therecommendation of the investment bankers retainedto underwrite the IPO, GTE and Bell Atlanticpublicly hoped for an offering price of $12 to $15per share. [FN7] By June 28, 2000, however,market conditions had deteriorated further such thatthe company settled upon an $11 per share offeringprice, which would generate approximately $1 .9billion in proceeds. Notwithstanding these changes,plaintiffs allege, Genuity neither altered its businessplan nor disclosed in its Prospectus that the plan"was severely underfunded as a result of raisingonly $1 .9 billion [through] the IPO." Compl . ¶ 6 .The IPO was eventually conducted on June 28,2000 at an offering price of $11 per share and, asexpected, raised approximately $1 .9 billion inproceeds .

FN7. The Complaint alleges that thisoffering price was disclosed in thefinancial press on June 24, 2000 .

III. Events Subsequent to the IP O

From early June 2000 through September 2000,GTE and Bell Atlantic worked with their existingbank lenders, including Smith Barney's "sistercompany," Citibank, N.A., to obtain a credit facilityfor Genuity. On September 5, 2000, a $2 bill ioncredit facility (the "September 5, 2005 Loan"} wasestablished by a consortium of banks under anagreement that also provided that an event ofdefault would occur at such time, if ever, as Verizonwas no longer in a position to exercise its option toregain control of Genuity .

Immediately following the IPO, according to theComplaint, Genuity began to expend capital in

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accordance with its preexisting business plan at arate of approximately $400 million per quarter . Aspart of that spending plan, Genuity launched a $20million marketing and advertising campaign inSeptember 2000 promoting its "Black Rocket"product, which, according to promotional materials,would bundle key Internet infrastructure into onefully integrated package for mid- to large-sizedbusinesses. To entice potential buyers of theproduct, Genuity guaranteed that, once ordered,Black Rocket would be delivered within 10business days or the buyer would be credited for allinstallation fees . Additionally, Genuity guaranteedthat Black Rocket customers would receive creditsto their accounts if their product did not have"up-times" of at least 99 .9% .

*3 In March 2001, in order to obtain more neededcapital, Genuity secured a $500 million loan fromdefendant Verizon (the "Verizon Loan") . InSeptember 2001, the parties to the Verizon Loanamended the loan to make up to $2 billion availableto Genuity . As with the September 5, 2000 Loan,the Verizon Loan provided for cancellation ifVerizon did not maintain its option to reacquirecontrol of Genuity.

By the end of 2001, plaintiffs allege that Genuitywas facing serious financial difficulties as a resultof low revenues, failing sales programs, retention ofobsolete equipment and continued significantcapital expenditures under the business plan . OnJuly 21, 2002, Genuity's board of directors held aSunday night meeting at which it was decided thatGenuity would draw down the remaining $850million available to it under the September 5, 2000Loan. [F'N8] On July 24, 2002, Genuity announcedpublicly that Verizon had cancelled its option toreacquire control over Genuity and terminated theVerizon Loan. Finally, on November 27, 2002,Genuity filed for Chapter 11 bankruptcy protection .Plaintiffs allege that the bankruptcy filing was dueto Genuity's "inability to recover from thedrastically underfunded lPO, its continued high rateof capital expenditures, and its inability to acquirecapital from either the banks [that provided theSeptember 5, 2000 Loan] or Verizon." Compl. ¶16 . Genuity's stock, which, according to the

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Complaint, had been trading as high as $70 pershare in early 2001, was trading for pennies pershare at the time that bankruptcy was declared .

FNS. The Complaint alleges that DeutscheBank, one of the lenders involved in theSeptember 5, 2000 Loan, refused toforward its portion of the requested $850million "because it believed that Genuityrequested the funds only because Genuityknew that Verizon was backing out of itsplan to reacquire [tenuity] ." Compi. T15 . On July 23, 2002, Deutsche Bank senta letter to Genuity asking whether Genuityhad any reason to believe that Verizon wasno longer interested in reacquiringGenuity. Genuity did not answer DeutscheBank's letter and instead filed a breach ofcontract lawsuit against Deutsche Bank.

IV. The Alleged Misrepresentations

Plaintiffs assert two claims for relief. Claim Onealleges that the Individual Defendants and SmithBarney violated § 10(b) of the Securities ExchangeAct of 1934 (the "1934 Act"), 15 U .S .C. § 78j(b),and Rule lOb-5 thereunder, 17 C .F .R. § 240.10b-5,when the IPO statements and the post-IPOstatements were issued. Claim Two alleges that theIndividual Defendants and Verizon are liable for thealleged misleading statements as a result of theirstatus as "controlling persons" within the meaningof § 20(a) of the 1934 Act, 15 U.S .C. § 78t(a).Before discussing defendants' arguments in supportof dismissal, we briefly outline the statements thatplaintiffs allege were misleading .

A. The IPO Statements

As mentioned above, plaintiffs contend that theProspectus and the pre-IPO Registration Statement(and amendments thereto), were misleading becausethey failed to disclose to potential investors that theIPO offering price was substantially lower than hadinitially been anticipated and that Genuity's businessplan-and particularly its planned capitalexpenditures-had not been modified to take intoaccount the substantially lessened initial capital that

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would be available to the company at the eventualoffering price . In support of this argument, plaintiffsrely primarily on the Disclosure Statement thatGenuity filed with the bankruptcy court on October2, 2003 . That statement reads in relevant part asfollows :

*4 In early 1999, GTE Intemetworkingdeveloped a business plan for the expansion ofthe GTE/BBN Internet business . As mergerplanning between GTE and Bell Atlanticprogressed, the parties decided that the mergedcompany would, as part of its overall businessstrategy, enter into direct competition with AT &T, Sprint UUNet (a subsidiary of MCIWorldcom) and others to provide datatransmission and Internet backbone services .Accordingly, the merged GTE and Bell Atlanticwould require construction of a far largertelecommunications network than GTEInternetworking had originally beencontemplating. The two companies developedthis new, expanded business plan through thesummer and fall of 1999, in order to startconstruction of the expanded network as soon asthey consummated their merger . The companiesplanned to spend $11-13 billion in capital withinfive years to build its business and network withover 500 POPs. In early 2000 the GTE board ofdirectors approved this business plan for the GTEIntemetworking business. . . .As described above, Genuity Inc .'s business plancontemplated $11-13 billion of capitalexpenditures over five years . To fund this plan,Bell Atlantic and GTE began discussions withinvestment bankers in the spring of 2000 with aview toward raising $4.3 billion in an initialpublic offering of Genuity Inc. stock (the "IPO"),which was to remain with Genuity Inc. as thefoundation of its capitalization . The $4 .3 billiontarget was based on an estimated IPO price ofabout $25 per share .With preparations for the IPO underway, themarket for equity in telecommunications andInternet-based businesses began to deteriorate . Atthe recommendation of their investment bankers,GTE and Bell Atlantic lowered the target 1POshare price to a range of $12-15 per share .Notwithstanding the lower-than-expected 1P O

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price and the corresponding reduction in theinitial equity capitalization of Genuity Inc ., GTEand Bell Atlantic did not change the terms of theGenuity IPO Spin-Out . GTE and Bell Atlantic didnot cancel the IPO, because accomplishing theGenuity IPO Spin-Out was an absolute necessityand precondition to consummating the merger ofGTE and Bell Atlantic. Nor did GTE and BellAtlantic alter the Genuity Inc . Group businessplan, in part because they had sought approval ofthe merger from their respective shareholdersbased on a business plan that contemplated theGenuity Inc . Group constructing a massivetelecommunications network that would bereintegrated into Verizon as soon as Verizonobtained the requisite 271 Approvals .By June of 2000, owing to further decline of theindustry and the capital markets, the investmentbankers recommended a final price for the IPO of$11 per share, which would provide Genuity Inc .with only $1 .9 billion of initial equity capital, or40% of the sum anticipated when GTE and BellAtlantic formulated the Genuity Inc. Group'sbusiness plan. Notwithstanding this furtherreduction in the equity capitalization of GenuityInc., GTE and Bell Atlantic did not make anyattempt to alter the Genuity Inc . Group's businessplan or to defer the IPO. Nor did GTE and BellAtlantic contribute any additional equity capitalto Genuity Inc. to compensate for the shortfall inIPO proceeds and initial capitalization . On June27, 2000, the Genuity Inc. board of directorsapproved the $11 per share IPO pricing, and theIPO was consummated on June 30, 2000 . [FN9 ]

FN9. The other submissions in this caseindicate that the IPO actually occurred onJune 28, 2000 .

*5 Immediately after the IPO, the Genuity Inc .Group began its capital expenditure program inaccordance with its business plan . This caused theGenuity Inc . Group to spend cash at the rate ofapproximately $400 million per quarter. At thisrate, given its paid-in capital, the Genuity Inc .Group would have exhausted its cash in littlemore than 12 months . The Genuity Inc . Group'sbusiness plan, as GTE and Bell Atlantic had

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approved it, contemplated that Genuity Inc .would have to raise additional funds in the debtmarkets to supplement what was expected to bean initial equity capitalization of $4 .3 billion.

Murphy Decl ., Ex. F at 12-13 .

Relying on the Disclosure Statement, plaintiffsargue that Genuity's allegedly undisclosed businessplan was "predicated" and "dependent" on "initiallyraising $4.3 billion through the IPO ." Compl. ¶¶17, 65, 69, 189. Plaintiffs allege that the businessplan "contemplated Genuity's construction of amassive telecommunications network that would bereintegrated into Verizon as soon as Verizonobtained the requisite 271 approvals from stateregulators," id ¶ 19, and thus called for Genuity tospend capital "at a rate of $400 million per quarter,"id ¶ 11 . The Complaint further alleges thatGenuity's business plan required an initial"foundational" capital infusion of the intended $4.3billion from the IPO to "enable[ ] Genuity to pursueits Business Plan for almost three years without thenecessity of having to raise additional funds duringthat period and limit[ing] its need to obtainadditional financing from other sources," Compl. 1

17 . In contrast, plaintiffs argue, the $1 .9 billion thatthe IPO actually generated would last the companyapproximately twelve months at the plannedexpenditure rate. See id ¶ 11 . As a result,plaintiffs contend, Genuity's business plan wasundercapitalized from the beginning and the IPOstatements were materially misleading because theyfailed to disclose these facts to potential investors.

B. The Post- IPO Statements

Plaintiffs also allege that defendants made variousfalse or misleading statements in the wake of theIPO and leading up to Genuity's bankruptcy inNovember 2002. The statements alleged to be falseor misleading were made, for the most part, ininterviews with the press, press releases and S.E.C .filings. They are also numerous, but it isunnecessary to recount each statement individuallyhere because all of plaintiffs' post-IPO allegationsessentially reduce to four claims, namely : (i)Genuity's statements about its financial conditionthroughout the putative class period were


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misleading because Genuity was improperlyrecognizing revenue in violation of GAAP; (ii)Genuity's statements about its financial condition in2001 were misleading because tenuity improperlydelayed taking an impairment charge on allegedlyoutdated networking equipment for several months ;(iii) Genuity's optimistic representations regardingits Black Rocket product were misleading becausethey were unrealistic ; and (iv) Genuity's statementsabout its network capabilities were misleadingbecause Genuity's actual network capabilities weresubstantially less than the company publiclyrepresented them to be.

1 . Improper Revenue Recognition

*6 Plaintiffs allege that numerous statements madeby Genuity in its financial statements and in thepress regarding the company's financial health weremisleading because the company was improperlyrecording revenue under GAAP. The alleged GAAPviolations occurred in at least four distinct ways .First, plaintiffs allege that Genuity recognizedrevenue on sales contracts at the time the contractswere signed rather than when the products at issuewere delivered, "even though the contracts couldbe, and often were, cancelled" by Genuity'scustomers . Compl . ¶ 138 . Plaintiffs also allege thatGenuity improperly recognized revenue on"multi-year" contracts in full at the time thecontracts were signed rather than deferring revenueto later periods in which revenue would actually berealized . Plaintiffs allege that these practices"violated the basic GAAP concept that revenuemust be earned and realizable in order for acompany to recognize it." Compl . ¶ 138 .

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revenue on these contracts during the period inwhich they purported to be signed, the revenueassociated with them was not properly realizablebecause customers "had the ability to cancel theag reement[s] and in fact often did cancel theseagreements." Id ¶ 142 . Moreover, plaintiffsallege , recognizing revenue on these contracts at thetime of signing was improper because "the customerwas not required to pay anything until the serviceswere actually delivered ." Id ¶ 143 .

Third, plaintiffs allege that Genuity engaged in animproper "dark fiber swap" with Qwest, anotherInternet service provider, in the first quarter of2001. Compl. 27, 144-49. The allegedtransaction involved an exchange between thecompanies of "very large . . . fiber optical capacityassets for a period of 99 years." Id 1 144. Thecapacity exchanged "was dark fiber and was notanticipated to be lit up for the foreseeable future ."Id ¶ 145 . [FN1 0] Plaintiffs contend that, since theexchange "did not involve the culmination of anearnings process," the proper GAAP treatment ofthe transaction would have been for Genuity "torecord the asset received at the carrying value of theasset transferred" Id ¶ 147. Allegedly in violationof GAAP, however, Genuity treated the exchange astwo separate transactions whereby the company firstrecognized earnings associated with the transfer ofits capacity to Qwest and then recorded an assetpurchase in the same dollar amount for the capacityit received from Qwest, even though no moneyactually changed hands . [FN11 ] Plaintiffs allegethat Genuity's treatment of the transaction "wronglyinflated Genuity's revenue for this period ." Id ¶149. [FN12]

Second, and relatedly, plaintiffs allege that Genuityimproperly recognized revenue in connection with"last minute deals" in which, in order to "bridge thegap between the company's forecasted sales and itsactual sales," Genuity would enter into salesagreements with customers either (i) at the end of aquarter or (ii) at the beginning of a quarter but"backdate" the contracts to reflect a signing duringthe previous quarter. Compl . ¶¶ 141-43 . Thesetechniques were improper, plaintiffs allege,because, although Genuity would recognize the

FN1O. The Complaint does not define theterms "dark fiber" or "lit up ." We assumefor our purposes here that plaintiffs meanthat the fiber optical capacity exchangeddid not carry Internet traffic .

FNl1 . Plaintiffs allege that Qwestsubsequently acknowledged that the properaccounting treatment of transactions suchas this was to "record [ them] as exchangesof similar productive assets based on the


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carrying value of the optical capacityassets that we[re] provided in theexchanges-" Compl. 1 148. Plaintiffsfurther allege that the S.E.C. filed civilcharges against Qwest's executives "fortheir roles in an array of questionabledeals, including deals between Qwest andGenuity," and that "Qwest's accountingfurther led to a criminal investigation bythe Department of Justice and aninvestigation by the House Committee onEnergy and Commerce ." Id ¶ 150 .

FN12. Plaintiffs also allege that, in thethird quarter of 2000, Genuity engaged in atransaction with Qwest whereby Genuityacquired modems, equipment and servicesfor $260 million and Qwest paid Genuity a"bonus" of $4 million for closing thetransaction before the end of the quarter.Plaintiffs allege that Qwest's accountingtreatment of its receipt of the $260 millionwas of a "questionable nature ." It isunclear how, if at all, these allegationsrelate to plaintiffs' claims against Genuity.

*7 Finally, plaintiffs allege that revenue wasimproperly recognized on "fictitious" salesinvoices . Plaintiff's contend that the IndividualDefendants encouraged its sales staff to submitbogus invoices by instituting a policy whereby salesstaff would be paid commissions in full uponsubmission of an invoice and then, if the order wassubsequently cancelled, charged the amount of thecommission from the employee's next paycheck .Moreover, according to a "former Genuity PartnerManager, . . . several sales people submitted sizeablefictitious sales orders and then resigned fromGenuity before the orders were provisioned" Id ¶154-55 . Plaintiffs contend that Genuitysrecognition of revenue associated with such salesorders was improper because the revenue was notrealizable .

2. Delayed Impairment Charge on Long-LivedAssets

Plaintiffs' second post-IPO claim is that Genuity's

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statements regarding its financial condition in 2001were misleading because Genuity improperlydelayed taking a $2 .6 billion impairment charge onvarious networking equipment until the fourthquarter of 2001 that should have been taken in "late20001early 2001 ." Compl. IN 157-68 . Plaintiffsallege that, in late 2000, Genuity bulk purchasedmillions of dollars worth of routing and switchingequipment to supply future orders . Plaintiffs furtherallege that, by early 2001, $30-$50 million worth ofthe equipment was sitting in Genuity's "datacenters" unused, and it was apparent that "largeamounts" of Genuity's stockpiled networkingequipment had become "outdated and obsolete,"Compl . ¶ 31, in part because demand was shiftingaway from dial-up services to DSL and cablemodem services, id ¶ 167 .

Citing the Financial Accounting Standards Board's("FASB") Statement of Financial AccountingStandard ("SFAS") No. 121, plaintiff's argue thatGenuity was required to record an impairmentcharge "whenever events or changes incircumstances indicate that the carrying amount ofan asset may not be recoverable ." Plaintiffs contendthat, as a result of Genuity's networking equipmentbecoming "outdated and obsolete," demand forGenuity's services declined rapidly and it becameapparent in early 2001 that tenuity would notrecover the carrying amounts of a significantportion of its stockpiled equipment. Nevertheless,plaintiffs contend, Genuity improperly waited torecord the $2.6 billion charge until the fourthquarter of 2001 . [FN 13]

FN13. The Complaint states that thereason Genuity waited to record theimpairment charge was that the companywas seeking $2.3 billion in financing fromVerizon and various banks in 2001 andthat "Genuity would not have been able toobtain this additional $2 .3 billion offinancing in 3Q01 if it had properlyaccounted for its impaired assets." Id. ¶166 .

3 . Statements Concerning Black Rocke t

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The third class of alleged misrepresentationsconcern Genuity's Black Rocket product . As notedearlier, Black Rocket was a packaged bundle ofInternet services aimed to serve mid- to large-sizedbusiness. As also mentioned above, Genuityguaranteed to its customers that it would eitherdeliver Black Rocket within 10 days of a customer'sorder or credit all of the customer's installation fees .According to the Complaint, the product had an"average price tag of $100,000 to $1 million ."Compl. 1 12 .

*8 The Complaint alleges that , for several reasons,Genuity's public statements about Black Rocketwere misleading. First , plaintiffs allege thatGenuity's optimistic statements about BlackRockett's market potential were mislead ing becausethe networking technology on which Black Rocketwas based was quickly becoming obsolete at thetime Black Rocket was being ramped up . Second,plaintiffs contend that statements touting Genuity's10-day delivery guarantee were misleadinglyunrealistic because of the time-consumingcomplexity and amount of work involved indesigning , building, installing , testing anddelivering each customized Black Rocket product toeach individual customer . Third, plaintiffs allege,while Genuity represented to the public that BlackRocket sales were "extremely profitable," thecompany actually "was unable to determine thecosts of each Black Rocket insta llation due to thehigh level of customization required, which causedthe costs associated with each Black Rocket projectto vary greatly ." Compl . ¶ 36. Fourth, plaintiffsallege that Genuity's representations regardingdemand for and customer acceptance of BlackRocket were misleading . be cause " the Black Rocketservice offering was neither competitive norsuccessful due to lack of customer demand, theunrealistic installation guarantees , and the fact thatGenuity had over-purchased huge stockpiles ofequipment in anticipation of demand that failed tomaterialize and which quickly became outdated ." Id¶ 37 .

4. Statements Concerning Genuity's NetworkCapabilities

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The last category of alleged misrepresentations isGenuity's public statements about its fiber networkcapacity. According to the complaint, tenuity madepublic statements about "the substantial progress ofits network build-out." Compl. ¶ 38. Plaintiffsallege that these statements were false because "onmultiple occasions Genuity built temporary,non-functional structures ." Id . Moreover, plaintiffscontend, "[ajfter the phony sites were erected andannouncements about their completion were made,Genuity tore them down ." Id Plaintiffs allege that,as of mid-2001, only 10% of Genuity's fibernetwork was "actually lit" and that "the majority ofGenuity's fiber network was incapable of carryingnetwork traffic ." Id 139 .

V. Defendants' Motions to Dismiss

A ll defendants have moved to dismiss on theground that plaintiffs have neither stated a claim forrelief under Fed .R.Civ .P. 12(b)(6) nor pleaded withadequate particularity under Fed.R.Civ.P. 9(b) andthe PSLRA. All defendants argue that the IPOstatements were not misleading as a matter of lawboth because the securities laws did not requireGenuity to disclose prior targeted offering pricesthat it had chosen not to pursue in the actual IPOand because the Prospectus adequately warnedplaintiffs of the risks and facts that plaintiffs nowcontend materialized and caused them harm. Withrespect to the post-IPQ statements, defendants arguethat plaintiffs have failed to plead with sufficientparticularity and that, even if plaintifs' allegationswere sufficiently particularized, defendants'statements are protected under the PSLRA's safeharbor provision for forward-looking statements, see15 U.S.C. § 78u-5(c) . Defendants argue further thatplaintiffs have failed adequately to plead scienter or"loss causation," both of which are required underthe PSLRA. Finally, Verizon argues that the claimsagainst it should be dismissed both because Verizondid not "control" Genuity within the meaning of §20(a) of the 1934 Act and because Verizon is notalleged to have been a "culpable participant" in anywrongdoing. On July 28, 2005, the Court heard oralargument .

*9 For the reasons discussed below, we dismis s

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plaintiffs' complaint in its entirety on the groundthat, with respect to each alleged misrepresentation,plaintiffs have failed adequately to plead falsity,scienter and/or "loss causation. "

DISCUSSIONIn considering defendants' motions to dismiss, theCourt may consider the Complaint as we ll asdocuments on which plaintiffs clearly re lied indrafting the Complaint, such as the Prospectus andthe Disclosure Statement. See, e.g., Chambers v.Time Warner, Inc., 282 F . 3d 147, 153 (2d Cir.2002). We must accept as true all material factualallegations in the Complaint. Levy ex rel.Immunogen Inc. v. Southbrook Int'I Invs., Ltd., 263F.3d 10 , 14 (2d Cir.2001) . A motion to dismiss maybe granted only where " it appears beyond doubt thatthe plaintiff can prove no set of facts in support ofhis claim which would entitle him to re lief." Still v.DeBuono, 101 F . 3d 888 , 891 (2d Cir.1996)(quoting Conley v. Gibson, 355 U.S. 41, 45-46(1957 )) . In evaluating the Complaint under thisstandard, we first address plaintiffs' IPO claims .

1. The IPO Statements

Defendants argue that the IPO statements were notmisleading because they did not omit any factrequired to be disclosed under the securities laws .Defendants argue further that the 'bespeakscaution" doctrine precludes liability because theProspectus adequately informed plaintiffs of therisks of which they now complain . We agree that,under either of these rationales, plaintiffs' IPOclaims must fail.

The securities laws affirmatively require thedisclosure of information that may "render[ ] priorpublic statements materially misleading ." SanLeandro Emergency Medical Group Profit SharingPlan v. Philip Morris Cos., Inc., 75 F.3d 801, 810(2d Cir.1996) (quoting In re Time Warner IncSecurities Litigation, 9 F.3d 259, 268 (2d Cir .1993)) . Under the facts alleged in the present case, therelevant inquiry is essentially the same as thatrequired under the "bespeaks caution" doctrine,which holds that misstatements in the context of astock offering are immaterial as a matter of law

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when "it cannot be said that any reasonable investorcould consider them important in light of adequatecautionary language set out in the same offering ."Halperin v. eBanker USA.com, Inc., 295 F.3d 352,357 (2d Cir.2002) ; see also P. Stolz FamilyPartnership L.P. v. Daum, 355 F.3d 92, 96 (2dCir .2004) ("A defendant may not be liable . . . formisrepresentations in a prospectus if the allegedmisrepresentations were sufficiently balanced bycautionary language within the same prospectussuch that no reasonable investor would be misledabout the nature and risk of the offered security.") .

The required analysis comprises two steps: first wemust identify the risk that plaintiffs allege was notdisclosed in the IPO statements ; second, weexamine the IPO statements "to determine if areasonable investor could have been misled intothinking that the risk that materialized and resultedin [the] loss did not actually exist." Halperin, 295F.3d at 359.

*10 The allegedly undisclosed risk in this case wasthat the IPO would not provide Genuity withsufficient capital to proceed with its business plan .Even a cursory examination of the Prospectus,however, reveals that this risk and the factsunderlying it were fully disclosed to potentialinvestors. First, it was disclosed exactly how muchcash the business plan required Genuity to spendand at what rate :

• "Our capital expenditures program, as currentlycontemplated, will require between $11 billionand $13 billion during the five-year period endingDecember 31, 2004, the majority of which will befor the expansion of our network infrastructure ."Pratt Decl ., Ex. B at 9 . [FN 14]

FN14 . In fact , the estimated $ 11 billion to$13 bill ion , evenly spread over thefive-year period ending December 31,2004, would require an expenditure rate ofbetween $550 mill ion and $650 million perquarter, a sum that substantially exceedsthe $400 million per quarter that plaintiffsallege was actually spent .

• "We currently intend to spend $11 billion to $1 3

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billion over the five-year period endingDecember 31, 2004, of which approximately $1 .8billion to $2.0 billion is expected to be spentduring 2000, on the continued expansion of ournetwork infrastructure and other capitalexpenditures." Id at 10 .

Second, it was disclosed exactly how much capitalthe IPO would raise :

- "We estimate that the net proceeds from our saleof the 173,913,000 shares of Class A commonstock we are offering at the initial public offeringprice of $11 .00 per share will be approximately$1.8 billion." Id at 21 .

Third, it was disclosed at what rate the IPOproceeds would be spent and that, at the intendedspending rate, the proceeds would be completelydepleted in a matter of months :

• "Of the net proceeds of this offering, we intendto use approximately $1 .5 billion for capitalexpenditures, including approximately $1 .2billion in connection with the expansion of ourfiber network and approximately $300 million forexpansion of our product lines for delivery ofadvanced data services to our customers ." Id at21 .• "In the near term, we believe that the proceedsfrom this offering . . . should be sufficient to meetour cash needs through the first quarter of 2001 ."Id. at 34 .

Fourth, it was emphasized that significant capitalin addition to the IPO proceeds would be neededand that, if additional funding was not obtained,Genuity's business would suffer :

• "We will need significant additional capital tofund our business plan and achieve profitability ."Id at 10 .- "We may be unsuccessful in raising sufficientcapital on terms that we consider acceptable,when needed or at all . If this happens, we wouldhave to delay or abandon our development andexpansion plans, which would adversely affectour competitive position ." Id

In light of these disclosures, it is hard to imaginewhat could have further been said to complete thepicture of Genuity's financial situation. It had tohave been perfectly clear to anyone who read theProspectus that the initial capital infusion from the

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IPO would soon be gone and that Genuity wouldhave to rely on the capital markets to obtain theadditional financing that its business plan required .[FNI5]

FN15. Plaintiffs make much of the factthat, in connection with a motion filed onbehalf of Genuity in the bankruptcy courtto have a settlement of claims againstVerizon approved, the IndividualDefendants' attorneys, Ropes & Gray LLP,stated that they believed Genuity had a"potentially viable" breach of fiduciaryduty claim against Verizon based onGenuity's inadequate initial capitalization.Pl . Opp'n at 13-14. Plaintiffs attachinordinate significance to this statement,however . For one thing, a claim for breachof fiduciary duty against Verizon, even ifviable, would not imply that Genuity hadmade false statements in its IPOdocuments . For another, in the brief onwhich plaintiffs base their argument,Ropes & Gray ultimately concluded that :The shareholders of Genuity likely wouldhave an extremely difficult time stating aclaim for breach of fiduciary duty due toundercapitalization, because theregistration statement filed with the SEC,and the prospectus distributed to investors,at the time of the Genuity IPO containedextensive disclosure of the risk factorsconcerning Genuity's business plan andcapitalization and the shareholderspurchased their shares anyway. Any breachof fiduciary duty claim would, therefore,have to be brought on behalf of Genuity'screditors .Olsen Decl ., Ex B at 28 .

*11 Plaintiffs maintain, however, that theProspectus failed to disclose that Genuity's businessplan was "undercapitalized" in the sense that it was"predicated" on raising $4 .3 billion (the amountresulting from an IPO at $25 per share) in an IPO[FNI6] and that skilled investors knowing all of therelevant facts about the business plan would haveconcluded that the company was doomed to failur e


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from the start . [FN17] This argument simply is nottenable given that all of the operative facts-thebusiness plan's overall capital requirement of $11billion to $13 billion with capital expenditures inexcess of $400 million per quarter, the $1 .9 billionthat the IPO would generate, the scheduleddepletion of those proceeds in short order and thenecessity to immediately seek additional debtfinancing to cover the gap between the capitalgenerated through the IPO and that required underthe business plan-were fully disclosed. Moreover,plaintiffs acknowledge that several of the alleged"insiders" in this case--the Individual Defendants,Verizon and Smith Barney's parent,Citigroup--themselves acquired significant portionsof Genuity's public stock . [FN 18] Verizon,Citigroup and a consortium of other sophisticatedbanks further loaned Genuity billions of dollarsshortly after the IPO and throughout the duration ofthe company's solvency. And, up until shortlybefore Genuity's initial bankruptcy filing, Verizon isalleged to have intended to reacquire control of thecompany . These circumstances suggest in thestrongest of terms that sophisticated investors withthe most intimate knowledge of Genuity's businessplan and capitalization had confidence in thecompany's future and certainly did not think that thecompany was "undercapitalized" as plaintiffs usethat term. [FN19]

FN16. Plaintiffs conceded at oral argumentthat the previous target of $25 per share,which undoubtedly was a moving one inthe months preceding the IPO, was notrequired to be disclosed in the Prospectus .Plaintiffs further conceded that anysophisticated investor would have knownthat market conditions in the monthspreceding the IPO would have allowed ahigher offering price for Genuity sharesthan the $11 that was ultimately obtained.

FN 17. In this vein , plaintiffs referred theCourt during oral argument to the FifthCircuit' s decision in Matter of Mobile SteelCompany, which defined"undercapitalization " as a condition thatexists "if, in the opinion of a ski lled

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financial analyst, [existing capital] woulddefinitely be insufficient to support abusiness of the size and nature of the[company at issue] in light of thecircumstances existing at the time the[company] was capitalized ." 563 F .2d 692,703 (5th Cir.1977) . Plaintiffs argue thatthe "bespeaks caution" doctrine does notapply in the present case because thegravamen of their IPO claim is the allegedfailure of the Prospectus to disclose the"present fact" that the company's businessplan was "undercapitalized " under Matterof Mobile Steel Company' s defin ition, notthat the Prospectus failed to disclose the"future risk" that Genuity would fail due toinsufficient capital . See Pl. Gpp'n at 7-10(citing P. Stolz Family Partnership L.P.,355 F.3d at 97 (holding that "bespeakscaution " doctrine applies to warningsabout risks of future contingencies, not torepresentations of "[h]istorical or presentfact")) . Apart from the obvious question ofwhether there is a meaningful distinctionbetween these concepts under the factsalleged here, there is, for the reasonsdiscussed above , little support in theComplaint or in plaintiffs' othersubmissions for the notion that, at the timeof the IPO, "skilled financial analysts"thought that Genuity's capitalization wouldpreclude viability.

FNI8. Indeed, Citigroup and Verizontogether acquired approximately 21 .5% ofthe publicly traded shares .

FN19 . These facts also compel theconclusion that defendants did not act withthe scienter that is required under thesecurities laws. See Part II .C, infra.Indeed, it would have made no economicsense for defendants to invest literallybillions of dollars in a venture that theyknew would fail .

Finally, and perhaps most tellingly, plaintiff's'fundamental ' premise that tenuity had an


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undisclosed "business plan" that was "predicated"on a "foundational " infusion of $4.3 billion in IPOproceeds is a misreading of the DisclosureStatement . According to that statement , upon whichplaintiffs stated at oral argument their premise isentirely based, Genuity's "new, expanded businessplan" was "developed . . . through the summer andfall of 1999." Murphy Decl ., Ex . F at 11. TheDisclosure Statement also states , however, that theoriginal $4.3 billion IPO figure was not evencontemplated until months later, when "BellAtlantic and GTE began discussions withinvestment bankers in the spring of 2000" about apossible IPO. Id at 12 . The Disclosure Statementclarifies , moreover, that "the $4.3 billion target wasbased on an estimated IPO price of about $25 pershare" and thus was not some predetermined figurethat Genuity's analysts determined was necessary tofund the business plan. Id As defendants pointedout during oral argument , the "business plan" wasthus a spending plan and appears not to havecontemplated sources of capital, " foundational" orotherwise .

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Defendants seek to dismiss all of plaintiffs'post-IPO claims on numerous grounds, includingthat the Complaint fails to plead fraud withadequate particularity, that scienter is notsufficiently pleaded and that the PSLRA's "losscausation " requirement is not satisfied. [FN21]

FN21. Before evaluating these arguments,however, it is worth noting that theComplaint makes clear that the IPO claim,which we have just dismissed, is thelynchpin of plaintiffs' case in terms of thedefined class, which includes "allpurchasers of the publicly traded securitiesof Genuity . . . during the period from June28, 2000 through November 27, 2002 ."Compl. ¶ 1 . There is no delineation in theComplaint of any subclass related to any ofthe post-IPO statements . Yet the majorityof the post-IPO allegations, even ifsufficiently pleaded, would be applicableto only discrete and very narrow classes, ifany .

*12 Faced with the numerous financial disclosuresin the IPO statements and acknowledging that thereis no disclosure requirement for earlier hoped forIPO share prices, plaintiffs have devised a contortedclaim of failure to disclose a so-called businessplan, which is simply unsupported by the documentson which they rely . For the reasons stated above,plaintiffs' claim that the IPO statements werefraudulent is dismissed for failure adequately toallege any material misrepresentation. [FN20] Wenow turn to the post-IPO statements.

FN20. Plaintiffs clarified at oral argumentthat their claim against defendant SmithBarney is based solely on the IPOstatements, not on the post-IPO statements .Accordingly, Smith Barney must bedismissed as a defendant for the reasonsstated above, and the discussion thatfollows applies only to the allegationsagainst the Individual Defendants andVerizon .

11 . The Post-IPO Statements

A. Particularity

Defendants' principal objection to the post-IPOclaims is that plaintiffs fail to plead the existence offraudulent misrepresentations with the particularityrequired by Fed.R.Civ.P. 9(b) and the PSLRA. Weagree that the majority of plaintiff's' allegations lackthe requisite particularity and therefore must bedismissed.

1 . The L egal Standard

Where a complaint alleges fraud, Fed.R .Civ.P. 9(b)requires that " the circumstances constituting fraud. . . shall be stated with particularity." Where acomplaint alleges securities fraud as a result ofmisleading public statements, the PSLRA requiresthat the complaint "specify each statement allegedto have been misleading , the reason or reasons whythe statement is misleading , and, if an allegationregarding the statement or omission is made oninformation and belief; the complaint shall statewith particularity all facts on which that belief isformed ." 15 U .S .C . § 78u-4(b)(1).

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What these rules mean in the context of afraudulent misrepresentation claim under RulelOb-5 is that plaintiffs must "(1) specify thestatements that [they] contend[ ] were fraudulent,(2) identify the speaker, (3) state where and whenthe statements were made, and (4) explain why thestatements were fraudulent." Novak v. Kasaks, 216F.3d 300, 306 (2d Cir.2000) (internal citationomitted). While the particularity mandates ofFed .R.Civ.P. 9(b) and the PSLRA do not requireplaintiffs to plead "every single fact upon whichtheir beliefs concerning false or misleadingstatements are based," Novak 216 F .3d at 313, theydo require plaintiffs to plead facts "sufficient tosupport a reasonable belief as to the misleadingnature of the statement[s] or omission[s]," id at 314n. 1. Where improper accounting under GAAP isalleged, moreover, plaintiffs "must provide at thevery least some level of detail about the improperaccounting alleged to underlie misleadingstatements, and their materiality, in order to survivethe motion to dismiss phase." Gavish v. Revlon, Inc.,No. 00 Civ. 7291, 2004 WL 2210269, * 13(S.D.N.Y. Sept. 30, 2004); see also Rombach v.Chang, 355 F.3d 164, 174 (2d Cir.2004)("[P]laintiffs must do more than say that thestatements in the press releases were false andmisleading; they must demonstrate with specificityhow that is so .") ; San Leandro Emergency MedicalGroup Profit Sharing Plan, 75 F.3d at 812 (statingthat, "[i]n order to satisfy the requirements of Rule9(b), plaintiffs must allege in what respects thestatements at issue were false") . On the other hand,these particularity requirements are not meant to barpotentially meritorious securities claims wheremissing facts can only be obtained throughdiscovery . See, e.g., In re AOL Time Winner, Inc.Sec. and "ERISA" Litig., No. 02 Civ. 5575, 2004WL 992991, * 12 (S .D.N.Y. May 5, 2004).

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former Genuity employees and corporate insiders,plaintiffs' allegations regarding improper revenuerecognition are exceedingly general and do notexplain with any specificity what effect the allegedconduct had on the company's statements regardingits financial health . For example :

- Plaintiffs allege that recognizing revenue at thetime Genuity's contracts were signed wasimproper under GAAP because "most customers"had "cancellation rights" that were "often"exercised, Compl. ¶ 21, but plaintiffs do notallege which customers cancelled, what kinds of"cancellation rights" were retained, by whom theywere retained or how much revenue wasimproperly recognized as a result:• Plaintiffs allege that "[i]n many instances, . . . lastminute agreements were cancelled in thefollowing quarter," id ¶ 142, but plaintiffs donot explain which agreements were cancelled orhow much revenue was recognized as a result.• Plaintiffs allege that "Genuity would recognizerevenue from multi-year contracts in full upon thesigning of the contract," id ¶ 140, but they donot explain how often this was done, by whom orhow much revenue was improperly recognized.• -Plaintiffs allege that Genuity's sales team"creat[ed] fictitious sales orders," id ¶¶ 28,154-56, but plaintiffs do not indicate when, bywhom or what size "fictitious" orders weregenerated . [FN221

FN22. Nor do plaintiffs explain why, ifthere were truly an effort on Genuity's partto create "fictitious" sales orders, thecompany would have paid its sales peoplecommissions to do so. The more logicaland cheaper approach would have beensimply to create the allegedly fake orderswithout involving the sales staff at all .

* 13 Under these standards, most of plaintiffs'claims relating to the post-IPO statements cannotsurvive scrutiny under the particularity requirement .We now evaluate those claims seriatim.

2. Improper Revenue Recognition

Despite the Complaint's purported reliance on

More generally, it is impossible to tell from theComplaint whether this conduct could havematerially affected Genuity's financial statements soas to render them misleading to such . an extent as tocreate liability under the securities laws.

Nor do plaintiffs allege with any part icularity aconcerted scheme by any defendant or defendants to

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misrepresent Genuity's financial condition for anyparticular purpose. [FN23] It is impossible,therefore, to infer that the alleged improperaccounting activity infected Genuity's practices tosuch an extent as to have any material impact on thecompany's financial statements . Accordingly, withtwo exceptions, which we explain shortly, we mustdismiss plaintiffs' allegations of improper revenuerecognition as insufficiently particularized underFed .R.Civ.P. 9(b) and the PSLRA.

FN23. Plaintiffs allege simply that, "[i]norder to overstate its earnings and assets in2000-2002, Genuity violated GAAP andSEC rules by improperly recognizingrevenue and by failing to timely record acharge to write-down its impaired assets toreflect impairment of its long-lived assets ."Compl. ¶ 133 .

In opposing this result, plaintiffs rely heavily on Inre Computer Associates Class Action SecuritiesLitigation, 75 F.Supp.2d 68 (E.D.N.Y.1999) .However, the court in that case found that plaintiffshad alleged a "widespread" and "pervasivefraudulent scheme ." Id at 73-74. If we could saythe same here, we would have less hesitation toassume, . as the court in that case did, that materialityexisted as a "huge net effect in error as to thecompany's overall figures," id at 73, and thus tooverlook plaintiffs' failure to point to specificinstances of improperly backdated or "multi-year"contracts, "last minute deals" or "phony salesorders ." As it is, however, plaintiffs have simplyfailed to plead such an effect . Accordingly, in theabsence of allegations of a pervasive fraudulentscheme and in the absence of specifics aboutparticular transactions, we cannot determine to whatextent the allegedly wrongful conduct would affectGenuity's financial and press statements and renderthose statements materially misleading.

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Genuity improperly recognized revenue inconnection with its "dark fiber swap" with Qwest inthe first quarter of 2001, id 'f(¶ 27, 144-49 . Wefind that these allegations are sufficiently specificunder the Federal Rules and the PSLRA, and wetherefore decline to dismiss them on particularitygrounds . [FN2S ]

FN24 . Giving plaintiffs the benefit of thedoubt on these motions to dismiss, weassume that "sizeable" would equate tomateriality .

FN25. Plaintiffs also allege that, "[i]nDecember 2002, per a former GenuityAccount Representative, Genuitybackdated a multimillion dollar contractwith Verizon that was scheduled to closein I Q03 and recognized the revenueassociated with this contract in 4Q02,"Compl. ¶ 143; see also id ¶ 25. We dothink that this allegation is sufficientlyspecific to survive dismissal on grounds ofparticularity . However, the conduct allegedfalls outside the putative class period,which, according to the Complaint, endson November 27, 2002 . Accordingly, thisallegation is not relevant to the issuebefore us .

3 . Delayed Impairment Charge

With respect to the claims that Genuity improperlydelayed taking an impairment charge on $30-$50mil lion worth of outdated networking equipment in2001, while plaintiffs ' allegations could be moreprecisely drafted, we believe that they aresufficiently specific to avoid dismissal on groundsof particularity.

4 . Black Rocket

*14 The two exceptions , which are adequatelypleaded, are plaintiffs' allegations that : (1) accordingto a Genuity Project Manager named RickGoodwin , Genuity's Texas office backdated a"sizeable " [FN24] contract with AOL in the secondquarter of 2000, id ¶ 25, 143; and (ii) that

Plaintiffs' allegations with respect to Black Rocketare insufficiently particularized . Other than generalstatements about Genuity's difficulty in meeting its10-day delivery guarantee, inordinately high pricingand difficulty in ascertaining profitability, plaintiffsoffer no specific statements that are demonstrably

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false and materially misleading in the context of thefacts pleaded in the Complaint. [FN26] It is thusimpossible to tell from the Complaint whether thestatements at issue were false or misleading and, ifso, whether they were materially so .

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business that they manage ." ) (quoting Shields v.Cftytrust Bancorp, Inc., 25 F.3d 1124, 1129-30 (2dCir.1994)). Accordingly, plaintiffs' claims based onstatements about the Black Rocket product must bedismissed .

FN26. For example, plaintiffs allege thatGenuity's statement that Black Rocket wasbased on "industry-leading hardware andsoftware" was materially misleadingbecause Genuity's "equipment wasoutdated by the time they installed it andtechnologically inferior," Compl. ¶ 99,presumably because demand was shiftingaway from dial-up services toward DSLand cable, see id ¶ 167 . It is impossibleto evaluate from these allegations,however, what hardware was "outdated,"to what extent, or how, given that the trendtoward DSL and cable was undoubtedlynbt "inside" information, Genuity'sstatement could have been materiallymisleading to the public. Similarly,plaintiffs allege that Genuity's statementsthat Black Rocket was "extremelyprofitable" were misleading because it wasdifficult at the time to calculate the varyingprofit margin on each installation, but theydo not tell us whether Black Rocket was,in fact, profitable at the times the variousstatements were made. The Complaintsother allegations about Black Rocket aresimilarly unspecific .

Moreover, a substantial portion of plaintiffs'allegations with respect to Black Rocket center onGenuity's public touting of the product and itsmarket potential, without identifying any specificmaterial falsehoods in those statements . The SecondCircuit has made clear, however, that such pufferymust be allowed. See, e.g., Rombach v. Chang 355F.3d 164, 174 (2d Cir.2004) ( ' Up to a point,companies must be permitted to operate with ahopeful outlook: People in charge of an enterpriseare not required to take a gloomy, fearful ordefeatist view of the future; subject to what currentdata indicates, they can be expected to be confidentabout their stewardship and the prospects of the

5. Genuity's Network Capabilitie s

Plaintiffs' allegation that Genuity misrepresented itsnetwork capacity is likewise insufficiently specific .The Complaint goes no further in particularity thanto allege that Genuity made "public representationsregarding the substantial progress of its networkbuild-out," statements that allegedly were falsebecause "only approximately 10% of Genuity's fibernetwork was actually lit." Compl. ¶q 38-39.Plaintiffs provide no guidance as to what thealleged false statements were, who made them andwhen, why they were false when made or why tenpercent of Genuity's network being "actually lit"was not "substantial progress ." Accordingly, thisclaim is dismissed.

B. Loss Causation

*15 In light of the discussion above, only three ofplaintiffs' post-IPO allegations remain . Thoseallegations are that Genuity's statements about itsfinancial health were materially misleading because :(i) in the second quarter of 2000, Genuityimproperly recognized revenue when it backdated a"sizeable" contract with AOL; (ii) late in the firstquarter of 2001, Genuity improperly recognizedrevenue in connection with its "dark fiber swap"with Qwest; and (iii) in 2001, Genuity improperlydelayed by several months the taking of animpairment charge on. its outdated networkingequipment We now examine these claims againstdefendants' argument that plaintiffs have failed toplead "loss causation . "

To state a claim under the securities laws, aplaintiff must allege "loss causation," i.e., a causalconnection between the alleged materialmisrepresentation and the plaintiffs loss . See, e.g.,Dura Pharms., Inc- v. Broudo, _ U.S . _, 125S.Ct. 1627, 1631 (2005 ) . When a plaintiff allegesthat he was harmed by a misleading statement and

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subsequent decline in stock price, he or she mustallege that "the risk that caused the loss was withinthe zone of risk concealed by the misrepresentationsand omissions alleged." Lentell v. Merrill Lynch &Co., Inc., 396 F.3d 161, 173 (2d Cir .2005)(emphasis in original) . In other words, the plaintiffmust allege that " 'the subject of the fraudulentstatement or omission was the cause of the actualloss suffered,' . . . i.e., that the misstatement oromission concealed something from the market that,when disclosed, negatively affected the value of thesecurity ." Id (quoting Suez Equity Investors, L.P. V.Toronto Dominion Bank 250 F.3d 87, 95 (2dCir.2001)) (emphasis in original) . As the SecondCircuit has explained, a loss causation analysisexamines the relationship between the loss allegedand the information that the defendant allegedlymisstated or concealed. Id at 174. If thatrelationship is sufficiently direct, then the losscausation requirement is satisfied .

We find that plaintiffs have failed to plead losscausation with respect to all of the remainingclaims. First, with respect to the claim that Genuityimproperly delayed taking an impairment charge onits networking equipment in 2001, plaintiffsconceded at oral argument that "there is no losscausation associated with that revelation ." July 28,2005 Tr . 37 .

With respect to the allegation that Genuitybackdated a contract with AOL in mid-2000,plaintiffs do not allege that a decline in stock priceoccurred because the fact that the contract wasbackdated was disclosed to the pub lic or that anystock decline was related to the subject of contractitself. Nor do plaintiffs explain mo re generally howbackdating a contract from one quarter to theprevious one could have misrepresented Genuity'sagg regate financial position to investors who, likethe putative class members , held stock during bothquarters. {N27] Loss causation is thus not satisfiedas to this claim.

FN27 . It is important to note that theseobser vations apply equally to plaintiff's'other a llegations about improperlybackdated contracts , which were discussed

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above. Thus, even if those allegations hadbeen pleaded with sufficient particularity,they would nevertheless be dismissed forfailure to plead loss causation .

*16 Finally, with respect to the claim that tenuityimproperly recorded revenue from its "dark fiberswap" with Qwest, plaintiffs do attempt to allegeloss causation, but they fail to do so adequately .The Complaint alleges that, on February 21, 2002,approximately one year after the alleged "dark fiberswap," Genuity held a quarterly analysts' breakfastmeeting at which company management stated,among other things, "that the company neverrecorded swap revenues, was not in danger ofviolating its debt covenants and had access tosignificant funding." Compl. ¶ 116. The Complaintfurther alleges that, "[flollowing this announcement,Genuity shares fell nearly 10%--from $22 .20 pershare on February 20, 2002 to $20 per share onFebruary 21, 2002." Id 1 117. In opposingdefendants' loss causation argument, plaintiffscontend that Genuity's denial that it recorded swaprevenues caused the stock price dip: "AlthoughGenuity falsely denied engaging in such 'recordedswap revenues,' it is reasonable to infer that themarket discounted that denial in light of the'negative news coming out of [that] sector'regarding improperly 'recorded swap revenues." 'P1. Opp'n at 36 (alteration in original). In support ofthis argument, plaintiffs cite the Court's decision inIn re Flag Telecom Holdings, Ltd SecuritiesLitigation, 352 F .Supp.2d 429, 442 (S .D.N.Y.2005), which, plaintiffs note, describes a "46% stockprice drop on Flags February 13, 2002announcement that it had entered into revenue swaptransactions ." Pl . Opp'n at 36 . Plaintiffs concludethat, because it was becoming public at the time thatvarious telecommunications companies hadimproperly recognized revenue associated withfiber swaps, and because Genuity affirmativelycarne out and denied that it was engaging in thatpractice, the public did not believe Genuity's denialand discounted the value of Genuity's stockaccordingly .

Plaintiffs' argument must be rejected . There is noallegation that the February 21, 2002 stock pric e

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decline followed any revelation of information thatGenuity had recorded swap revenues . To thecontrary, the relevant statement during the February21, 2002 analysts' meeting was a denial thatGenuity had recorded such revenues. Plaintiffs'speculation that the public disbelieved that denialand therefore discounted the stock price is toostrained an inference even on a motion to dismiss .See, e.g., Lentell, 396 F .3d at 175 (Plaintiffs "mustallege facts that support an inference that[defendants'] misstatements and omissionsconcealed the circumstances that bear upon the losssuffered .") . From the facts alleged in the Complaint,the more reasonable inference is that Genuity'sstock price fell as part of the general decline in thatbusiness sector .

For these reasons , plaintiffs' remaining three claimsmust be dismissed for plaintiffs' failure to plead anyassociated loss causation.

C. Scienter

Although each of the post-IPO claims must bedismissed on grounds of insufficient particularity orloss causation, it is important to note that theseclaims are deficient for the additional reason thatplaintiffs have failed to plead scienter. Under thePSLRA, plaintiffs must "state with particularityfacts giving rise to a strong inference that thedefendant[s] acted with the required state of mind ."15 U.S.C. § 78u-4(bX2). To satisfy thisrequirement, which is a particularized version of theSecond Circuit's pre-PSLRA scienter pleadingstandard, see Novak, 216 F.3d at 3 ("When all issaid and done, we believe that the enactment ofparagraph (b)(2) did not change the basic pleadingstandard for scienter in this circuit (except by theaddition of the words 'with particularity') . '%plaintiffs must specifically allege facts that either:(i) demonstrate that defendants had a motive andopportunity to commit fraud; or (ii) constitutestrong circumstantial evidence of consciousmisbehavior or recklessness . See Ganino v. CitizensUtilities Co., 228 F.3d 154, 170 (2d Cir .2000) ;Rothman v. Gregor, 220 F.3d 81, 90 (2d Cir.2000).[FN28]

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FN28. This discussion of scienter is morerelevant to plaintiffs' claims against theIndividual Defendants than it is to theclaims against Verizon, who plaintiffsallege is liable on a "control person"theory under § 20(a) of the 1934 Act .Nonetheless, in the context of a claimunder § 20(a), plaintiffs are still required,in order to make out a prima facie case, toallege that Verizon "was in somemeaningful sense a culpable participant" inthe post-IPO statements. Boguslavsky v.Kaplan, 159 F.3d 715, 720 (2d Cir .1998)(quoting S.E.C. v. First Jersey Sec., Inc.,101 F .3d 1450, 1472 (2d Cir .1996)). TheComplaint, however, does not allege anyinvolvement by Verizon in the post-IPOstatements. In fact, the motives at issuehere would suggest that those who wereaware of any alleged wrongdoing woulddesire to keep Verizon in the dark in orderto avoid giving Verizon a reason not toexercise its option to reacquire thecompany. Moreover, plaintiffs' allegationsthat Verizon had the option to "reacquire"control over tenuity but never exercisedthat option belie plaintiffs' argument thatVerizon was a "control person" under §20(a) . Accordingly, the post-IPO claimsagainst Verizon must be dismissed on theadditional grounds that the Complaint doesnot satisfy the "control person" and the"culpable participation" requirements of §20(a) .

*17 Plaintiffs have not argued that motive oropportunity is alleged as to any of the post-IPOstatements. [FN29] With respect to the allegationsof GAAP violations, which comprise the bulk ofplaintiffs' post-IPO claims, this failure to allegemotive is fatal because allegations of GAAPviolations or accounting irregularities alone areinsufficient to state a securities fraud claim withoutevidence of "corresponding fraudulent intent ."Novak 216 F.3d at 309 (quoting Chill, 101 F.3d at270). Thus, even if it could be established that theIndividual Defendants were each aware of theallegedly improper accounting activity, plaintiffs


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would nevertheless have to establish that theIndividual Defendants intended to defraud thepublic about the content of Genuity's financialstatements or had some reason to do so . [FN3O] TheComplaint, however, is devoid of factualallegations, circumstantial or otherwise, indicatingthat the Individual Defendants acted with suchintent.

FN29. In their opposition papers, plaintiffsdo argue that they have adequately allegedmotive and opportunity with respect totheir claim that the IPO statements weremisleading, but they do not do so as totheir post-IPO claims.

FN30. Plaintiffs cannot establish therequisite fraudulent motive simply byalleging that the Individual Defendantsdesired to keep their jobs or increase theircompensation by artificially inflatingGenuity 's stock price . Cf., e.g., Novak 216F.3d at 307 ("Plaintiffs could not proceedbased on motives possessed by virtua lly allcorporate insiders . . ..") Plaintiffs must"assert a concrete and personal benefit tothe individual defendants resulting fromthe [alleged] fraud ." Kalnit v. Eichler, 264F.3d 131 , 139 (2d Cir.2001 ) . Plaintiffshave failed to do that. Even theComplaint's allegations about reasons thatthe alleged misrepresentations may havemade the company appear to beperforming better than it was , see, e.g.,Compl. T 141 (alleging that " last minutedeals" were entered into to "bridge the gapbetween the company's forecasted salesand its actual sales ") do not suggest anyconcrete benefit received by any IndividualDefendant .

With respect to the post-IPO statements regardingBlack Rocket and Genui ty's network capabilities,which we re unrelated to GAAP, plaintiffs mustallege, at the very least, facts constituting strongcircumstantial evidence of conscious misbehavioror recklessness. To satisfy this requirement,plaintiffs must allege "highly unreasonable" conduct

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representing "an extreme departure from thestandards of ordinary care . . . to the extent that thedanger was either known to the defendant [s] or soobvious that the defendant[s] must have been awareof it." Rothman, 220 F .3d at 90 (quoting Rolf v.Blyth, Eastman Dillon & Co., Inc., 570 F .2d 38, 47(2d Cir. 1978 )) ; see also Chill v. General ElectricCo., 101 F.3d 263, 269 (2d Cir .1996) (same) .Where, as here, there is no indication of motive,"the strength of circumstantial allegations must becorrespondingly greater ." Kalnit 264 F.3d at 142(quoting Beck v. hffrs. Hanover Trust Co., 820 F.2d46, 50 (2d Cir.1987)). Moreover, to the extentplaintiffs claim that defendants had knowledge ofspecific facts that rendered their public statementsmisleading, they "must supply some factual basisfor the allegation that the defendants [gained thisknowledge ] at some point during the time periodalleged ." Rotham, 220 F . 3d at 91 (quoting Posner Y.Coopers & Lybrand, 92 F.R.D. 765, 769 (S_D.N.Y.1981)).

Plaintiffs have not done this . They rely simply onthe Individual Defendants' positions as "Genuity'sthree highest officers" and, without differentiatingamong the Individual Defendants, argue that thoseindividuals were in a position to know certainthings . P1. Opp'n at 34 . [F'N31] As logical as it maybe, however, to assume that the IndividualDefendants collectively were aware of the specificsof Genuity's business, the PSLRA requires more inorder to attach liability to an individual for aspecific public statement. It requires that plaintiffs"specifically allege[ each] defendant['s] knowledgeof facts or access to information contradicting [his]public statements ." Novak, 216 F.3d at 308. Thegeneral rule, therefore, is that nonspecificallegations that a defendant's knowledge of certainpractices can be inferred from his or her highposition in a company are not sufficient to satisfythe PSLRA's heightened pleading requirement withrespect to scienter. See, e.g., In re NTL, Ina Sec.Lftig., 347 F.Supp.2d 15, 34 (S.D .N.Y.2004) ("Allegations that [defendants] should have knownabout [corporation's subsidiary's] financial statebased solely on their executive positions are notenough to plead scienter. " ); In re Sotheby'sHoldings, Inc. Sec. Litig., No. 00 Civ . 1041, 200 0

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WL 1234601, *7 (S .D.N.Y. Aug. 31, 2000) ("It iswell established that boilerplate allegations thatdefendants knew or should have known offraudulent conduct based solely on their boardmembership or executive positions are insufficientto plead scienter. " ) ; Duncan v. Pencer, No. 94 Civ .0321, 1996 WL 19043, *14 (S .D.N_Y. Jan. 18,1996) ("[Plaintiff] would totally thwart the scienterrequirements of Section 10(b) and Rule 9(b) if hecould satisfy them by simply listing the IndividualDefendants' job titles in the Complaint ."). [FN32]Other than general . allegations that it would be"logical" for the Individual Defendants to have beenaware of certain things, the Complaint gives us nofactual basis to conclude that actual knowledge onthe part of any Individual Defendant existed . [FN33]Under the PSLRA, such allegations are insufficien t

FN31. In the paragraph of their Complaintthat purports to set forth the basis ofplaintiffs' allegation that the IndividualDefendants "knew or acted in deliberatereckless disregard of the true state ofGenuity's business," plaintiffs allegesimply that: (i) "the large number ofrescissions of sales force commissions asorders were not provisioned or cancelledwould logically have been known to theIndividual Defendants ;" (ii) any failures ofGenuity to comply with its 10-dayprovisioning guarantee "would have beenknown to the Individual Defendants;" (iii)"the stockpiling of tens of millions ofdollars of equipment in 11 data centersowned by the Company would logicallyhave been at the direction of its mostsenior officers;" (iv) "[s]ales werebackdated specifically at the direction ofupper management;" (v) "[t]he dark fiberswap with Qwest could not have beenaccomplished without the complicity of theIndividual Defendants ;" and (vi)"Genuity's inability to competitively priceits outdated equipment was well within thepurview of the Individual Defendants'responsibilities ." Compl. 1191 .

FN32. Plaintiffs' reliance on our decision

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in In re Complete Management Inc.Securities Litigation, 153 F.Supp.2d 314,324-327 (S .D.N.Y.2001 ), is misplaced.Although we noted in that case that "[i]tthoroughly strain[ed] credulity to imaginethat the individual defendants, by virtue oftheir positions at CMI and the interactionswith GMMS that those positionsdemanded, were ignorant of the practicesat GMMS," we also explained thatplaintiffs had pleaded the alleged fraud andthe defendants ' knowledge of it with "greatspecificity ." The same cannot be said here .

FN33. Plaintiffs do adequately allege aspecific factual basis for one area ofknowledge: that Genuity's actual saleswere falling short of its sales forecasts . SeeCompl. ¶ 191 (alleging that : (i) defendantGudonis received "rolled-up sales results ;"(ii) defendant Farina received "an Excelspreadsheet with the Company's decliningsales results and orders" on a weekly basis ;(iii) that defendant Farina received"monthly Flash Reports showing theshortfall between forecasted and actualorders was always 'very significant;" ' and(iv) at his "Tuesday Morning Roll CallSales Meetings," defendant Farina"demanded explanations as to why salesand orders were not materializing") . Suchknowledge, however, does not bear onplaintiffs' allegations in this case, which donot include the claim that Genuity publiclystated that actual sales were meeting orexceeding the company's forecasts-

CONCLUSION*18 For the reasons set forth above, defend ants'motions to dismiss are granted and the Complaint isdismissed with prejudice. [FN34] The Clerk of theCourt is respectfully requested to close this case onthe Court's docket.

FN34 . In their opposition papers , plaintiffsrequest that, if the Cou rt deems theirallegations insufficient, they be afforded achance to replead. Plaintiffs do not specify

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what they would say in such an amendedpleading, however . Moreover, in severalpremotion letters submitted by defendantsto the Court, plaintiffs were alerted to thespecific bases of defendants' arguments insupport of dismissal discussed herein. Byletter from the Court dated November 4,2004, plaintiffs were given the opportunityto amend their complaint and werespecifically warned that, if they chose notto amend to address the points raised indefendants' premotion letters and the Courtsubsequently determined that defendants'arguments were correct, plaintiffs wouldnot be given another chance to amend . Inresponse, defying the dictates of Fed. R.Cite. P 8(a), and even allowing for theheightened pleading requirements in thiscase, plaintiffs submitted an exceedinglylengthy 79 page complaint recountingevery quarterly and annual S .E .C. filingand myriad public statements made byGenuity during the entire duration of thecompany's solvency. Notwithstanding itsbreadth, that pleading is insufficient for thereasons stated above. In thesecircumstances, we do not see any basis toallow plaintiffs to amend yet again .Accordingly, plaintiffs' request for leave todo so is denied.

SO ORDERED .

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• 1:04cv07617 (Docket)(Sep. 27, 2004)

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N



United States District Court,E.D. Michigan ,

Southern Division.In re COMPUWARE SECURITIES LITIGATION

No. Civ. 02-73793.

Sept . 12, 2005 .

Background : Investor filed putative securitiesfraud class action against corporation and itsofficers. Defendants moved for judgment onpleadings and for summary judgment, and anotherinvestor moved to intervene as class representativeand for class certification .

Holding : The District Court, Taylor, J., held thatinvestor failed to adequately plead loss causation.Defendants' motions granted .

[1] Securities Regulation €60.18

34913k60 . 18 Most Cited CasesIn cases involving publicly traded securities andpurchases or sales in public securities markets,securities fraud action' s basic elements include: (1)material misrepresentation or omission ; (2) scienter;(3) connection with purchase or sale of security ; (4)re liance, often referred to as "transactioncausation"; (5) economic loss; and (6) "losscausation," or casual connection between materialmis representation and loss . Securities Exchange Actof 1934, § 10(b), as amended, 15 U.S .C .A. § 78j(6) ;17 C.F.R. § 240.10b-5 .

[2] Securities Regulation X60.47349Bk60.47 Most Cited Cases

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Investor may not establish loss causation insecurities fraud action by merely alleging thatsecurity's price was inflated at time of investor'spurchase because of misrepresentation . SecuritiesExchange Act of 1934, §§ 10(b), 211)(b)(4), asamended, 15 U.S .C .A. §§ 78j(b), 78u-4 (b)(4); 17C.F.R. § 244 .10b-5 .

[3] Securities Regulation X60.47349Bk6Q.47 Most Cited Case sInvestor's allegations that it purchased softwarecompany's stock at inflated p rice as result ofcompany's misrepresentation regarding itsrelationship with its largest client and suffered losswhen company made unfavorable earningsannouncement were insufficient to plead losscausation necessary to support securities fraudclaim under Securities Exchange Act, even ifannouncement led to precipitous drop in stock'sprice, where investor had already sold its stockwhen announcement was made , and announcementwas not corrective disclosure. Securities ExchangeAct of 1934, §§ 10(b), 21D (b)(4), as amended, 15U.S .C.A . §§ 78j(b), 78u-4(bX4); 17 C.P.R. §240:10b-5-

[4] Securities Regulation X60 .53349Bk60.53 Most Cited Case sIn securities cases, plaintiffs are required to pleadshort simple statement giving rise to stronginference that defendants' misrepresentationsproximately caused its loss, not merely to state thatthere is proximate causation between the two .Securities Exchange Act of 1934, § 21D(bX4), asamended , 15 U.S .C .A. § 78u-4(bX4) .

[5] Courts x'99(1)106k99(l) Most Cited Cases"Law of the case doctrine" posits that when courtdecides upon rule of law, that decision shouldcontinue to govern same issues in subsequent stagesin same case.

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[6] Courts 099(1)106k99(1) Most Cited CasesLaw of the case doctrine does not prevent courtfrom revisiting prior ruling when subsequentdecision of superior court contradicts that priorruling.

[7] Securities Regulation €60.47349Bk6O .47 Most Cited Case sIf investor sells its stock before relevant truthbegins to leak out, misrepresentation will not haveled to any loss, and thus is not actionable under §10(b). Securities Exchange Act of 1934, § 10(b), 15U.S .C .A. § 78j(b) ; 17 C .F .R. § 240 .10b-5 .

[$] Securities Regulation )60.25349Bk60.25 Most Cited Case s

[8] Securities Regulation C=6O.47349Bk60 .47 Most Cited Case sIn fraud-on-the-market securities fraud cases,purchasing stock at inflated price will not itselfconstitute or proximately cause relevant economicloss . Securities Exchange Act of 1934, § 10(b), 15U.S .C .A. § 78j(b) ; 17 C .F .R . § 240 .1Ob-5 .Gregory D. Hanley, Kickham Hanley , StephenWasinger , Tammie J . Tischler, Wasinger, Kickham,Royal Oak, Ml, for Compuware SecuritiesLitigation .

MEMORAI'DUMOPINIONAND ORDERGRANTING MOTION TO DISMISS AND

GRANTING MOTION FORSUMMARY JUDGMENT, DENYING MOTION

TO INTERVENE AND DENYING MOTIONFOR CLASS

CERTIFICATION

TAYLOR, District Judge .

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consolidated Amended Complaint [FNI]("complaint") ; and Plaintiff Charles Butts' ("Butts")Motions to Intervene as Class Representative andfor Class Certification. This memorandumconstitutes the court's findings of fact andconclusions of law. For the reasons stated herein,Defendants' motions for Judgment on the Pleadingsand Summary Judgment are Granted. Butts'Motions for Intervention and for Class Certificationare Denied as Moot.

ILStatement of Facts

This action was initially filed on behalf of a classof investors who purchased Compuware commonstock during the period from June 26, 1999 to April3, 2002 (the "Class Period") . Compuware providescomputer software and consulting services,primarily for use with mainframe and client/serversystems, including those of International BusinessMachines ("IBM"), Inc .

HMEPS' complaint alleges that throughout theClass Period, Defendants issued a series of falseand misleading statements, which were designed toconceal from the investing public serious problemswith Defendants' business relationship with IBM .[FN2] Specifically, Defendants knew, but failed todisclose to investors that IBM had long beendissatisfied with Defendants' pricing of softwareproducts and that as a result, IBM was developingits awn line of competing software products and, infact, became a significant competitor of Defendants .HMEPS contends that on April 3, 2002,Defendants' revealed by press release that a revenueshortfall would require Defendants to takerestructuring and goodwill impairment charges inexcess of $365 million, sending Defendants' shareprices spiraling down more than 25% in one day .

LIntroduction

*1 Before the court is Compuware's ("Defendants")Renewed Motion for Judgment on the Pleadings,pursuant to Fed .R.Civ .P . 12(c) and Defendants'Motion for Summary Judgment, pursuant toFed.R.Civ .P . 56, on Plaintiff Houston MunicipalEmployees Pension System's ("HMEPS"),

Procedural History

HMEPS filed a complaint alleging violations ofSection 10(b) and 20 (a) of the Secu rities ExchangeAct of 1934, and Rule l0b-5 promulgatedthereunder. Defendants moved to dismiss thecomplaint, claiming, inter alias that HMEPS hadfailed to allege "loss causation ." By Memorandu m


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and Order dated February 3, 2004, this court deniedDefendants' Motion to Dismiss, rejectingDefendants' argument that the complaint failed toallege loss causation . In re Compuware Sec. Litig.,301 F.Supp.2d 672, 690-91 (E.D.Mich .2004).

HMBPS then filed a Motion for Class Certificationseeking an Order certifying the class and appointingHMEPS as the class representative. The courtdenied HMEPS' Motion, finding that becauseHIMEPS had sold all of its Compuware stock wellprior to Defendants' disclosure, HMEPS' claims ordefenses were not typical of the claims or defensesof the class, and that, therefore, HMEPS could notadequately protect the interest of the class .

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not have done so at the artificially inflated priceswhich they paid" (Compi .J 89), is insufficient as amatter of law .

Further, the Defendants contend that summaryjudgment should be granted against HMEPSbecause it is undisputed that HMEPS did not ownDefendants' stock at the time the alleged truth beganto leak out. Defendants argue, assuming arguendothat they failed to properly disclose the competitionwith IBM, that the alleged fraud caused no loss toHMEPS since it had already sold all of its stock inDefendants at the time the corrective disclosure wasmade. The case, they argue, therefore falls squarelywithin the Supreme Court's recent ruling in Dura,supra .

Subsequently, Butts moved to intervene and serveas class representative and moved for classcertification. Butts was represented by the samecounsel as had been 11MBPS . He contends that hesatisfies the elements for intervention and that hisserving as class representative would not causesevere prejudice to the Defendants. Further, hecontends that he purchased and held Defendants'stock throughout the Class Period, including at thetime of Defendants' disclosure, and, therefore, classcertification is appropriate because he does notsuffer the same failing as HUMPS' motion for classcertification .

*2 Defendants then filed a second Motion forJudgment on the Pleadings and for SummaryJudgment against HM EPS, moving to dismiss thecomplaint for failing to adequately plead losscausation. In its motions, Defendants contend,pursuant to the Supreme Court's recent holding inDura Pharmaceuticals, Inc, v. Broudo, --- U.S.-, 125 S.Ct. 1627, 161 L.Ed.2d 577 (2005), thatHMEPS may not establish loss causation by merelyalleging that the security price was inflated at thetime of its purchase because of a misrepresentation .Rather, the complaint must plead that theDefendants' misrepresentation directly andproximately caused its economic loss . Therefore,HUMPS' mere allegation that class members "wouldnot have purchased or otherwise acquired theirCompuware common stock, or if they had acquiredsuch securities during the Class Period, they would

III.Standard ofReview

A. Fed .R.Civ.P. 12(c)

In ruling on a motion to dismiss, the court "mustconstrue the complaint in a light most favorable tothe plaintiff," Helwig Y. Vencor, Inc. 251 F.3d 540,553 (6th Cir.2001) and accept as true "well pleadedfacts" set forth therein. In re Comshare, Inc., SeaLitig., 183 F.3d 542, 547 (6th Cir.1999) . The courtis not, however, bound to accept as trueunwarranted factual inferences or legal conclusionsunsupported by well-pleaded facts . SeeTeagardener v. Republic-Franklin Inc. PensionPlan, 909 F .2d 947, 950 (6th Cir. 1990) ; Morgan v.Church's Fried Chicken 829 F.2d 10, 12 (6thCir.1987).

B. Fed.R.Civ .P. 56

Summary judgment is proper where no genuineissue of material fact exists and the moving party isentitled to judgment as a matter of law .FedRCiv.P. 56. In considering such a motion, thecourt construes all reasonable factual inferences infavor of the nonmoving party. Matsushita Elec.Indus. Co. v. Zenith Radio Corp., 475 U.S . 574,587, 106 S .Ct. 1348, 89 L .Fd.2d 538 (1986) .

C. Federal Securities Laws

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[1] Sections 10(b) and 20(a) of the Exchange Actand Rule 1Ob-5 proscribe "fraudulent, materialmisstatements or omissions in connection with thesale or purchase of a security ." 15 U .S .C. § 78j(b),78t(a); 17 C.F .R. § 240.10b-5. Securities fraudallegations, like all fraud allegations, must be statedwith particularity in compliance with Rule 9(b) ofthe Federal Rules of Civil Procedure . In casesinvolving publicly traded securities and purchasesor sales in public securities markets, the action'sbasic elements include: (1) a materialmisrepresentation (or omission) ; (2) scienter, i .e ., awrongful state of mind ; (3) a connection with thepurchase or sale of a security; (4) reliance, oftenreferred to in cases involving public securitiesmarkets (fraud-on-the-market cases) as "transactioncausation" (nonconclusively presuming that theprice of a publicly traded share reflects a materialmisrepresentation and that plaintiffs have reliedupon that misrepresentation as long as they wouldnot have bought the share in its absence) ; (5)economic loss; and (6) "loss causation," i.e., acasual connection between the materialmisrepresentation and the loss . Dura, 125 S.Ct. at1631. Here, Defendants move to dismiss becausethe complaint's allegations are inadequate withrespect to the loss causation element .

Iv.Analysis

A. LOSS CAUSATION

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On February 3, 2004, this court denied Defendants'Motion to Dismiss, finding that the HMEPS'complaint adequately pled loss causation.Specifically, the court found that :

[for loss causation to exist, it is not necessarythat there was a disclosure and that a subsequentdrop in market price actually occurred. . . .

Plaintiffs have specifically alleged that theywould not have purchased or otherwise acquiredtheir Compuware common stock, or, if they hadacquired such securities during the Class Period,they would not have done . so at the artificiallyinflated prices which they paid.

In re Compuware Sec. Litig., 301 F.Supp.2d 672,691 (E.D.Mi6.2004)(internal quotationsomiltedXemphasis added) . In so holding, the courtrelied on Gray v. First Winthrop Corp., 82 F.3d 877(9th Cir .1996), which held that-

[t]he plaintiff must prove not only that, had heknown the truth, he would not have acted, but inaddition that the untruth was in some reasonabledirect, or proximate way responsible for his lass .The causation requirement is satisfied in a Rule10b-5 case only if the misrepresentation touchesupon the reasons for the investment's decline invalue.

Id at 886 (emphasis added) . Consistent with theNinth Circuit's findings,. the court ruled that'HIMEPS has sufficiently pleaded that the securities'price was inflated on the dates of purchase due toDefendants' misrepresentations ." In re Compuware,301 at 691 .

*3 Plaintiffs in securities fraud cases have longbeen required to prove "loss causation ," whichmeans that the plaintiff must allege economic loss,and that the defendant' s fraud caused the economicloss. See D.E. & J Ltd. Partnership v. Conaway,284 F.Supp .2d 719, 749-50 (E.D.Mich . 2003) ;Emergent Capital m v. Mgmt. LLC. v. . S'tonepathGroup, Inc., 343 F. 3d 189 , 198 (2d Cir.2003) . ThePrivate Securities Litigation Reform Act("PSLRA") codi fied the loss causation element inlob-5 claims, which provides that a plaintiff:

shall have the burden of proving that the act oromission of the defendant alleged to violate thischapter caused the loss for which the plainti ffseeks to recover damages .

15 U.S .C. § 78u-4(6}(4) .

[2] On April 19, 2005, in Dura Pharmaceuticals,Inc., V. Broudo, the Supreme Court held that aninvestor may not establish loss causation by merelyalleging that a security's price was inflated at thetime of the investor's purchase because of amisrepresentation. -- U.S. -, 125 S.Ct. 1627, 161L.Ed.2d 577 (2005). In Dura, plaintiffs alleged intheir complaint that the defendants' false statementsregarding the future FDA approval of a newasthmatic spray device artificially inflated the priceof defendants' stock. In holding that plaintiffs'complaint failed to adequately plead loss causation,the Supreme Court observed:

[T]he Ninth Circuit' s basic reason for findingthe complaint adequate, namely, that at the

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end of the day plaintiffs need only 'establish,'i.e., prove, that 'the price on the date ofpurchase was inflated because of themisrepresentation.' .. . In our view, thisstatement of the law is wrong. Normally, incases such as this one (i .e.,fraud-on-the-market cases), an inflatedpurchase price will not itself constitute orproximately cause the relevant economicloss ... . [O]ne might say that the inflatedpurchase price suggests that themisrepresentation (using language the NinthCircuit used) 'touches upon' a later economicloss . But, even if that is so, it is insufficient . To'touch upon' a loss is not to cause a loss, and itis the latter that the law requires.

*4 Dura, 125 S.Ct. at 1631 -32 (internal citationsomitted) .

The Supreme Court continued, to adequately pleadloss causation, a plaintiff must:

specify each misleading statement ; ... set forththe facts on which [a) belief that a statementis misleading was formed ; and . .. state withparticularity facts giving rise to a stronginference that the defendant acted with therequired state of mind .

Id at 1633 (2005)(citing 15 U.S.C. §§78u-4(b)(1), (2)Xintemal quotations omitted). Thestatute expressly imposes the burden on plaintiff toprove that the defendant's misrepresentations"caused the loss for which the plaintiff seeks torecover." Section 78u-4(b)(4). Here, IIMEPS'complaint failed to allege how Defendants'misrepresentation (or other fraudulent conduct)proximately caused its economic loss. As pled, thecomplaint would allow for recovery where amisrepresentation leads to an inflated purchaseprice but nonetheless does not proximately cause aneconomic loss because all stock had been soldbefore the allegedly true facts became known .

HIMEPS argues that the complaint more than meetsthe standard set forth in Dura. The complaint statesthat "[a]s a direct and proximate result ofDefendants wrongful conduct, [11MBPS] and theother members of the Class suffered damages inconnection with their respective purchases and sales

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of the Company's common stock during the ClassPeriod." Further, the complaint alleges that onMarch 12, 2002, ' Defendants announced theinitiation of litigation against IBM, which hadbegun to sell software applications in competitionwith those of Defendants. And on April 3, 2002, thescope of Defendants' misrepresentation with respectto its deteriorating relationship with IBM wasrevealed as Defendants announced that the companywould have a revenue shortfall, requiring a goodwillimpairment and restructuring charges in excess of$365 million . (Compl.158)

[3] HMEPS' contentions to the contrarynotwithstanding, the complaint exhibits the samedefective pleading identified by the Supreme Courtin Pura. First, HMEPS' complaint engages in athorough exposition of the allegedly false andmisleading statements . (Compl .¶¶ 35-54) Then italleges that IMPS purchased the Defendants'sstock at an inflated price as a result of Defendants'misrepresentation and suffered a loss (although ithad already sold its stock) when the Defendantsmade an unfavorable earnings announcement .(Comp .¶'Jf 88-89) Wholly absent from itspleadings, however, is a nexus between themisrepresentations of which HMEPS complains andthe losses they suffered . Without more, the H .I+IEPS'complaint states that "as a direct and proximateresult" (Compl .¶ 91) of Defendants' conduct111M EPS suffered losses by purchasing Defendants'stock at an inflated rate .

[4] The Court's opinion in Dura does not merelyrequire a plaintiff to include the magic words"direct and proximate " in connection with itsalleged loss . Plaintiffs must do more than usetalismanic language to cure an otherwiseinadequately pled complaint . If these allegationsmet the standard for pleading loss causation, "themere inclusion of boilerplate language wouldsuffice everywhere ' and would defeat therequirement that a plaintiff explain how the lossoccurred." D.E. & J. Ltd P'ship v. CharlesConaway, 133 Fed.Appx 994 , 1000 , 2005 WL1386448 (6th Cir.2005) . In securities cases,plaintiffs are required to plead a "short simplestatement" giving rise to a "s trong inference" that

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defendants ' misrepresentations proximately causedits loss-not merely to state that there is a proximatecausation between the two. See Dura, 125 S.Ct . at1633 ; D.E. & J Ltd P'shfp, 284 F .Supp .2d. at 747(holding that "[ i]f the investment decision isinduced by misstatements or omissions that arematerial and that were relied upon by the claimant,but are not the proximate reason for his pecuniaryloss, recovery under the Rule is not permitted") .

*5 HMEPS further contends that the causalityrequirement enunciated in Dura is satisfied bypleading that the Defendants' "shares plunged morethan 25% in a single day 'as a result of thecorrective announcement regarding [Defendants]previously concealed eroded software sales" andthat the complaint "cites analyst reports whichaugmented the allegations of a causal connectionbetween the disclosure of a real threat from IBM,eroded software sales, and the precipitous drop inthe price of [Defendants'] shares." (Resp. Sr . at 9)Thus, H11IEPS asserts that by citing a disclosurethat led to a sharp decline in the stock price (evenafter it had sold all shares) and providing analystreports purportedly tying the loss to the omission ofthe IBM competition, it demonstrates the pleadingof a causal connection .

As an initial matter, citing analyst reports assertingthat there was a causal connection betweenDefendants' Press Release announcing that thecompany would take a goodwill impairment andDefendants' misrepresentations, while arguablyaugmenting HMEPS' allegations, does not satisfythe causal connection pleading requirementenunciated in Dura Plaintiffs are charged withpleading the connection, listing what it is, therebygiving defendants notice of the losses it alleges .Further, Defendants' Press Release was not acorrective disclosure because it did not assert thatthe competition with IBM led to the companytaking the goodwill impairment. In fact, HMEPSconcedes that the March 12, 2002 Press Release,"finally began to disclose to the investing public thetruth about [Defendants] relationship with IBMwhen it initiated the ISM litigation" (Compl.¶ 55),nearly a month before the April Press Releaseannouncing the goodwill impairment. See D.E. & J

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Ltd P'ship, 284 at 748- 49, (holding that "[t]hemost common 'causal link' pled under this rule [losscausation] is a showing that the plaintiff suffered aneconomic loss fairly attributable to the public airingof the alleged fraud, i.e ., a significant stock pricedecline immediately following the announcementthat reveals the fraud to the public"); . In re ActernaCorp. Sec. Litig., 378 F.Supp.2d 561 (D.Md. July26, 2005)(same). Yet, T MEPS does not allege thata price decline immediately accompanied the March12, 2002, disclosure, leaving the court to speculatewhat portion of the loss, if any, should be attributedto the disclosure or whether the loss was caused byother factors . "It should not prove burdensomefor a plaintiff who has suffered economic loss toprovide a defendant with some indication of theloss and the causal connection that the plaintiffhas in mind" Dura, 125 S.Ct . at 1634. HMEPS'complaint fails to do so .

Law-of-the-Case Doctrine

[5] HMEPS further contends that Defendants'motion for judgment on the Pleadings violates"the-law-of-the-case" doctrine and should not beconsidered by this court . The-law-of-the-casedoctrine posits that when a court decides upon arule of law, that decision should continue to governthe same issues in subsequent stages in the samecase. See Scott v. Churchill, 377 F .3d 565, 569-70(6th Cir.2004)(quoting Arizona v. California, 460U.S. 605, 618, 103 S .Ct . 1382, 75 L.Ed.2d 318(1983)) . Because HMEPS complaint has not beenamended, HMEPS argues that the court's orderfinding in Defendants' original Motion to Dismissthat it pled loss causation should continue to governat this stage of the litigation .

-6 [6] HMEPS is correct in thatthe-law-of-the-case doctrine would otherwise apply .However, the Supreme Court makes clear in itsholding in Dura that a plaintiff must do more thanallege that it purchased stock at the inflated price .The law-of-the-case doctrine does not prevent acourt from revisiting a prior ruling when asubsequent decision of a superior court contradictsthat prior ruling. See e.g., Venn v. St. Paul Fire &Marine Ins. Co., 99 F.3d 1058, 1063 (11th


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Cir.1996)(noting that the "law of the case . . . doesnot apply to bar reconsideration of an issue when . . .controlling authority has since made a contrarydecision of law applicable to that issue") . Inaddition, "it is not improper for a court to departfrom a prior holding if it is convinced it is clearlyerroneous." U.S v. Certain Land in Detroit, 188F.Supp.2d 747, 753 (E.D.Mich.2002) . Failure todismiss HMEPS' complaint would ignore SupremeCourt precedent. Accordingly, Defendants' motionto dismiss the HMEPS' pleading is granted .

B. SUMMARY JUDGMENT

[7] [8] If an investor sells its stock "before the

relevant truth beg[i]n [s] to leak out, themisrepresentation will not have led to any loss ." SeeDura, 125 S.Ct. at 1631 ; D.E. & J Ltd. P'ship, 133FedAppx. at 999 ; In re Merrill Lynch & Co ., Inc.Research Reports Sec. Litig., 272 F.Supp.2d 243,254 (S.D.N.Y.2003); Arduini/Messina P'ship v.Nat'l Med Fin. Servs . Corp., 74 F.Supp .2d 352,361-62 (S .D.N.Y.1999). In fraud-on-the-marketcases like this one, purchasing at an inflated pricewill not itself constitute or proximately cause the

relevant economic loss . See Dura, 125 S.Ct. at1631 (holding that "at the moment the transactiontakes place , the plaintiff has suffered no loss ; theinflated purchase payment is offset by ownershipof a sha re that at that instant possessesequivalent value") .

Here, it is undisputed that HMEPS traded out ofDefendants' stock long before the alleged inflatedprice began to leak out of Defendants' stock price .The Sixth Circuit has held that:

Because a purchaser may sell the shares quicklybefore the relevant truth begins to leak out, aseller's misrepresentations (and its associatedinflated price) does not inevitably lead to a loss,but rather might mean a later loss . Even if thepurchaser later resells those shares at a lowerprice, that lower price may reflect, not the earliermisrepresentation, but changed economiccircumstances, changed investor expectations,new industry-specific or firm-specific facts,conditions, or other events, which takenseparately or together account for some or all of

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that lower price .D.E. & J Ltd P'shlp, 133 Fed .Appx. at 999(internal quotations and citations omitted) . Here ,HMEPS traded in and out of Defendants' stock(both profiting and suffering losses ), but did notown any of Defendants' shares after October 2001,almost five months before Defendants' March 12,2002, press release; the date HMEPS alleges thatthe inflated price began to leak out of Defendants'stock price . Therefore, it is undisputed that HMEPScannot prove that it suffered damages cognizableunder the Supreme Court's holding in Dura, even ifthe allegations had been properly pled.Accordingly, Defendant's motion for summaryjudgment is Granted as no material issues of factexist as to whether HMEPS owned Defendants'shares once the alleged inflated price began to leakout or loss causation if it had been adequately pled .

C. INTERVENTION & CLASSCERTIFICATION

*7 Butts filed a motion for intervention and forclass certification relying upon the same complaintsubmitted by HMEPS. As stated in section IV(A),HMEPS' complaint is dismissed on the pleadingsfor failing to plead loss causation. Inasmuch asButts' motions rely upon the same defectivepleading, [FN3] his motions for intervention andclass certification are fatally defective on their face,as he relies upon a complaint that fails to allege losscausation, and which has been dismissed.Accordingly, Butts' motions for intervention andclass certification are Denied as Moot.

V.Order Granting Defendants ' Motions to Dismiss

and for Summary Judgment, andDenying Butts' Motion for Intervention and Class

CertificationThe court having reviewed the file in this matter,having heard oral arguments, and otherwise beingfully advised in the premises ; now, therefore ,

IT IS ORDERED that Defendants' Motion toDismiss Plaintiffs' Consolidated AmendedComplaint on the Pleadings is hereby GRANTED,and Defendants ' Motion for Summary Judgment i s

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GRANTED.

TT IS FURTHER ORDERED that Butts' Motionsfor Intervention and Class Certification are herebyDISMISSED AS MOOT .

TT IS SO ORDERED.

FN 1 . This court entered an orderconso lidating Dinallo v. CompuwareCorp., Joseph A. Nathan, Henry A. Jailosand Laura L. Fournier (02-73793); and,Rosen v . Compuware Corp., Joseph A .Nathan, Henry A. folios and Laura L.Fournier (02-74073), on March 6, 2003 .The consolidated complaint againstCompuware also named Joseph A. Nathan,but substituted Peter Karmanos, Jr., andElizabeth A. Chappell for Henry Jallos andLaura Fournier, as individual Defendants .

FN2 . See In re Compuware Sec. Litig., 301F.Supp.2d 672, 676-80 (E .D.Mich.2004),for a summary of the dispute betweenDefendants and IBM. The dispute betweenDefendants and IBM was resolved anddismissed in March of 2005 .

FN3 . Butts' motion for intervention statesthat "[a]part from adding itself as a namedplaintiff, Plaintiff does not seek to amendany allegation of the AmendedComplaint." (Br. at 5 )

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Motions, Pleadings and Filings (Back to top)

• 2005 WL 2141849 (Trial Motion, Memorandumand Affidavit) Reply Memorandum of Law inFurther Support of Proposed Intervenor CharlesButts' Motion to Intervene as Class Representativeand Motion for Class Certification (Jul . 13, 2005)

END OF DOCUMENT

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EXHIBIT G

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HUnited States District Court,

D. Maryland .In re ACTERNA CORPORATION SECURITIES

LITIGATION .No. CIV.A. DKC 2003-1131 .

July 26, 2005 .

Background : Investors brought class action suitagainst officers and directors of corporation,alleging securities fraud under § 10(b), and raisingrelated state law claims, in connection with failureto write down good will arising from twoacquisitions. Claimants moved to strike certainexhibits presented by auditor, and defendantsmoved to dismiss .

Holdings: The District Court, Chasanow, J., heldthat:(1) exhibits would be stricken;(2) officers would not be associated withstatements, under group published doctrine;(3) scienter requirement was not satisfied as toofficers ;(4) scienter requirement was not satisfied as toauditor;(5) loss causation claim was not stated ; and(6) court lacked diversity jurisdiction over statelaw claims .Motions granted .

See, also, 220 F.R.D. 255 .

West Headnotes

[1] Securities Regulation €60.51349Bk60.51 Most Cited CasesMotive and opportunity to commit securities fraudare factors to be considered, along with others, indetermining whether complaint adequately allegesscienter required for securities fraud claim under §10(b), but are not essential . Securities Exchange

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Act of 1934, §§ 10(b), 21D (b)(2), as amended, 15U.S .C.A. §§ 78j(b), 78u-4(bX2) ; Fed .RulesCiv.Proc .Rule 9(b), 28 U .S .C .A .

[2] Securities Regulation X60.51349Bk60 . 51 Most Cited CasesTo state claim of securities fraud under § 10(b),plaintiffs must satisfy scienter requirement bypleading with pa rticularity facts specific to eachdefendant that create a strong inference that thedefendant acted knowingly or recklessly in makingmaterial misrepresentations or omissions . SecuritiesExchange Act of 1934, §§ 10(b), 211)(b)(2), asamended, 15 U.S.C .A. §§ 78j(b), 78u -4(bX2) ;Fed .Rules Civ.Proc.Rule 9(b), 28 U .S .C .A .

[3] Securities Regulation 0-60.47349Bk60 . 47 Most Cited Case sTo state claim of securities fraud under § 10(b),plaintiffs must satisfy "loss causation " requirement,by alleging causal connection between materialmisrepresentation and plaintiffs ' economic loss.Securities Exchange Act of 1934 , §§ 10(b),21D(b)(2), as amended, 15 U.S.C.A. §§ 78j(b),78u-4(b)(2); Fed .Rules Civ.Proc.Rule 9(b), 28U.S.C.A.

[4] Federal Civil Procedure X1832170Ak1832 Most Cited CasesFederal procedure rule limitation on documents thatmay be considered, in connection with ruling onmotion to dismiss for failure to state claim, todocuments referred to in complaint and relied uponby plaintiff in bringing action, precludedconsideration of press releases, public statements,and securities analysts reports, submitted bydefending auditor as exhibits in § 10(b) securitiesfraud action, when complaint only made obliquereference to "media coverage," without identifyingexhibits individually and averring reliance uponthem. Securities Exchange Act of 1934, § 10(b), asamended, 15 U.S.C.A. § 78j(b); Fed.RulesCiv .Proc .Rule 12(b)(6),28 U.S .C .A .

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[5] Securities Regulation 060.40349Bk60.40 Most Cited Case sUnder "group published" doctrine, corporateofficers and directors who are alleged to be inday-to-day control of the company may bepresumed, for pleading purposes in § 10(b)securities fraud case, to be collectively responsiblefor a company's group published information suchas prospectuses, registration statements, annualreports, press releases and other public filings .Securities Exchange Act of 1934, § 10(b), asamended, 15 U .S .C.A. § 78j(b) .

[6] Securities Regulation 0-60.40349Bk60.40 Most Cited CasesOfficers and directors of corporation would not bedeemed authors of statements allegedly constituting§ 10(b) securities fraud, under group publicationdoctrine, simply because their high positions andday-to-day involvement with activities implied theirinvolvement with statements. Securities ExchangeAct of 1934, §§ 10(b), 21D(bX2), as amended, 15U.S.C .A. §§ 78j(b), 78u-(bX2) ; Fed.RulesCiv .Proc .Rule 9(b), 28 U.S .C .A.

[71 Securities Regulation X60 .51349Bk60.51 Most Cited Case sScienter requirement, for stating claim of § 10(b)securities fraud against officers of corporation, wasnot satisfied through statement by formeraccountant and supervisor that work was being doneregarding write down of goodwill asset arising fromacquisition, at time top management was publiclydeclaring that good will write down was notrequired; work may well have been commissionedas part of obligation to periodically evaluate needfor write down, mandated under accounting rule .Securities Exchange Act of 1934, §§ 10(b),21D(bX2), as amended, 15 U.S .C .A. §§ 78j(b),78u-4(bX2) ; Fed.Rules Civ .Proc.Rule 9(b), 28U.S .C .A.

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management concern that goodwill arising from twoacquisitions had been overvalued; there wasinsufficient details regarding time and place ofmisgivings statements , and who made them.Securities Exchange Act of 1934, §§ 10(b),21D(bX2), as amended, 15 U.S .C.A. 78j(b),78u-4(b)(2); Fed.Rules Civ.Proc .Rule 9(b), 28U.S .C .A .

[9] Securities Regulation X60.51349Bk60 .51 Most Cited Case sScienter requirement, for stating claim of § 10(b)securities fraud against officers of corporation, wasnot satisfied through statement by employee ofissuing corporation that three high level financialofficers had primary responsibility for analyzingvalue of assets of company acquired by merger,goodwill of which was allegedly overvalued oncorporation's balance sheet; acquisition occurredyear before period in question, casting doubt onofficer's knowledge at time corporation announcedthat it would not be restating goodwill, said toviolate § 10(b), and necessary further specificfactual details were not supplied. SecuritiesExchange Act of 1934, §§ 10(b) ,21D(b)(2), as amended, 15 U .S.C.A. §§ 78j(b),78u-4(b)(2) ; Fed.Rules Civ.Proc.Rule 9(b), 28U.S.C.A.

[10] Securities Regulation )60 .51349Bk60.51 Most Cited CasesMotive and opportunity were not adequatelyalleged , as factors tending to establish scienterrequirement for stating § 10(b) securities fraud case,by conclusory allegations that top officers ofcorporation claimed that goodwill need not bewritten down as balance sheet asset, when theyknew write down was required , in order to preservetheir jobs and present level of benefits . SecuritiesExchange Act of 1934, §§ 10(b), 21D(bX2), asamended , 15 U.S.C.A. §§ 78j(b), 78u-4(bX2) ;Fed .Rules Civ.Proc .Rule 9(b), 28 U .S .C.A.

[81 Securities Regulation 60.51349Bk60 .51 Most Cited CasesScienter requirement, for stating claim of § 10(b)securities fraud against officers of corporation, wasnot satisfied through statements by senior financeemployees that there was long standing

[11] Securities Regulation € 6O.45(1)349Bk60.45(1) Most Cited Case sUpper management's detailed disclosure ofcorporation's self-styled "abysmal" financialcondition precluded determination that officers ha d

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requi red culpable state of mind needed to satisfyscienter requirement for stating securities fraudclaim under § 10(b), when they announced in se riesof public statements that it was not necessa ry towrite down goodwill arising from two acquisitions.Securities Exchange Act of 1934, §§ 10(b),21D(b)(2), as amended, 15 U.S.C.A. §§ 78j(b),78u-4 (b)(2); Fed . Rules Civ.Proc .Rule 9(b), 28U.S.C.A .

[12] Securities Regulation ('60.56349Bk60 .56 Most Cited CasesScienter requirement, for stating claim of § 10(b)securities fraud against auditor, was not satisfiedthrough statement by former accountant andsupervisor that work was being done regardingwrite down of goodwill asset arising fromacquisition, at time top management was publiclydeclaring that good will write down was notrequired; work may well have been commissionedas part of obligation to periodically evaluate needfor write down, mandated under accounting rule .Securities Exchange Act of 1934, §§ 10(b),21D(bX2), asamended, 15 U .S .C.A. §§ 78j(b), 78u-4(b)(2);Fed.Rules Civ .Proc .Rule 9(b), 28 U.S .C .A.

[13] Securities Regulation X60 .56349Bk6O .56 Most Cited CasesScienter requirement for stating claim of securitiesfraud under § 10(b), on part of auditor, was notsatisfied through allegations that auditor actedrecklessly in not investigating financial condition ofissuing corporation and insisting on earlier writedown of goodwill; financial information released bycorporation and auditor showed disclosure of grimfinancial condition of company, there wasconclusion that write down was not necessary nowbut might be in future, and there was write down ofanother major asset Securities Exchange Act of1934, §§ 10(b), 21D(bX2), as amended, 15U.S .C .A. §§ 78j(b), 78u-4(b)(2) ; Fed.RulesCiv.Proc .Rule 9(b), 28 U.S .C.A.

[14] Securities Regulation X60.45(3)349Bk60 .45(3) Most Cited CasesMagnitude of write down of corporation's goodwillassets, amounting to $388 million, did not support

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inference of scienter required to state claim of §10(b) securities fraud on part of auditors, allegingthat earlier statements that write down wasunnecessary were fraudulent; write down was notaccompanied by restatement of earlier earningsstatement, and was characterized as needed byfurther deterioration of corporation during currentreporting quarter. Securities Exchange Act of 1934,§§ 10(b), 21D(bX2), as amended, 15 U.S .C .A. §§78j(b), 78u-4(b)(2) ; Fed.Rules Civ.Proc .Rule 9(b),28 U.S .C.A.

[15] Securities Regulation E60.45(3)349Bk6a .45(3) Most Cited Casesto order for violations of generally acceptedaccounting principles (GAAP) tosupport scienter on part of auditors, in § 10(b)securities fraud claim , accounting practices must beso deficient that purported audit was no audit at all,or that no reasonable accountant would have madedecisions involved in present case if confrontedwith same facts . Securities Exchange Act of 1934, §§ 10(b), 21D(bX2), as amended, 15 U .S.C .A. §§78j(b), 78u-4(bX2) ; Fed.Rules Civ.Proc .Rule 9(b),28 U .S .c .A.

[16] Securities Regulation 060.47349Bk60 .47 Most Cited Case sIn order to state claim of loss causation, insecurities fraud case under § 10(b), it is insufficientto merely allege that value of shares was a rtificiallyenhanced by misrepresentations ; there must beshowing of causal link between misrepresentationand loss, such as significant drop in value of sharesimmediately following public disclosure of fraud .Securities Exchange Act of 1934, §§ 10(b),21D(b)(2), as amended, 15 U.S .C .A. §§ 78j(b),78u-4(b)(2); Fed . Rules Civ .Proc.Rule 9(b), 28U.S.C.A .

[171 Securities Regulation X60.47349Bk60.47 Most Cited CasesFailure to allege loss causation precluded statementof securities fraud claim under § 10(b), arising outof purchase of stock of corporation providing testand management services for optical transport,access and cable networks; during period inquestion there was 94% drop in value o f

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corporation 's stock, reflecting massive decline inmarket for products, and there was only one centper share decline in value of stock followingdisclosure of deferred write down of goodwill,constituting basis of fraud claim . SecuritiesExchange Act of 1934, §§ 10(b), 211)(b)(2), asamended, 15 U.S .C .A. §§ 78j(b), 78u- 4(bX2) ;Fed.Rules Civ.Proc.Rule 9(b), 28 U.S .C .A.

1181 Federal Courts €346I70Bk346 Most Cited CasesDistrict court sitting in Maryland lacked diversityjurisdiction over common law fraud class action,brought by lead investors whose combined claimsexceeded minimum jurisdictional amount, butwhose individual claims did not . SecuritiesExchange Act of 1934 , § 10(b), as amended, 15U.S .C .A . § 78j(b) ; 28 U .S .C .A. § 1332(a).*564 Sean Michael Handler, Joseph De Leo,Schiffrin & Barroway LLP, Bala Cynwyd, PA,Jaime Walker Luse, John Bucher Isbister, Tydingsand Rosenberg LLP, Baltimore, MD, for Plaintiffs.

Ned C. Lautenbach, Peter D . Isakoff, ChristinePei-Wen Hsu, Weil Gotshal & Manges LLP,Washington, DC, Panayiota G . Souras, James A.Meyers, Orrick Herrington & Sutcliffe LLP,Washington , DC, John Herbert Hall, Debevoise &Plimpton LLP, New York, NY, John ParkerSweeney, Michael J. Haliko, Miles & StonebridgePC, Baltimore, MD, for Defendants .

MEMORANDUM OPINION

CHASANOW, District Judge .

Presently pending and ready for resolution in thisclass action alleging violations *565 of federalsecurities laws are Defendants ' separate motions todismiss Plaintiffs' Consolidated Amended ClassAction Complaint under Fed .R .Civ.P. 12(bX6).Also pending is Plaintiffs ' motion to strike certainexhibits filed by DefendantPricewaterhouseCoopers LLP ("PwC") . The issueshave been fully briefed and the court now rules, nohearing being deemed necessa ry. Local Rule 105 .6.For the following reasons, Plaintiffs ' motion tostrike will be granted in part and denied in part, and

the motions to dismiss will be granted .

L Background

A. Factual Background

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The following facts are alleged in Plaintiffs'Consolidated Amended Class Action Complaint("the complaint"), filed on behalf of all persons whopurchased or otherwise acquired shares of ActernaCorporation ("Acterna" or "the company") commonstock between August 14, 2001, and October 29,2002 ("the Class Period") . [FNI] The defendants inthis action were five of Actema's most seniorofficers leading up to and during the Class Period("the individual Defendants"), Clayton, Dubilier &Rice, Inc. ("CD & R"), Acterna's largestshareholder, and PricewaterhouseCooper ("PwC"),Acterna's outside auditor. Defendant Ned C.Lautenbach joined Acterna in 1998, and at all timesduring the Class Period was Acterna's Chairmanand Chief Executive Officer ("CEO"). Lautenbachwas also a principal and director of CD & R.Defendant John D. Ratliff was the Senior VicePresident and Chief Financial Officer ("CFO") ofActerna's communications test and management unitfrom June 2000 to December 31, 2001 . On January1, 2002, Ratliff became Actema's Corporate VicePresident and CFO. Defendant Allan M. Klineserved as Actema's Corporate Vice President, CFO,and Treasurer until December 31, 2001, whenRatliff took over. Thereafter, Kline continued as amember of Acterna's Board of Directors ('"theBoard") . Defendant John R. Peeler had been amember of the Board since May 21, 1998. In July2001, he was elected President of the Board. At alltimes during the Class Period, he was President andCEO of Acterna's testing and management business .Defendant Robert W. Woodbury, Jr. was, at allrelevant times, Acterna's Corporate Vice Presidentand Principal Accounting Officer .

FNI. The complaint also contains commonlaw claims of fraud and breach of fiduciaryduties on behalf of all persons whopurchased or otherwise acquired shares ofActerna common stock prior to August 14,2001 and retained such shares through th e

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end of the Class Period.

1. Events Prior to Class Period

Actema provides test and management services foroptical transport, access, and cable networks tocustomers located around the world. In May 2000,Acterna, then known as Dynatech Corporation, paid$402 million to purchase Wavetek WandelGoltermann, Inc. ("WWG") . Approximately$274.8 million of the purchase price was allocatedto goodwill. M) In August 2000, Actenna paid$171 .5 million to purchase Superior ElectronicsGroup, Inc. dlbla Cheetah Technologies("Cheetah") . Approximately $87.7 million of thepurchase price was allocated to goodwill . As aresult of these acquisitions, Actema purportedlyadded approximately $362 .5 million in goodwill toits balance sheet, and positioned Acterna to be,according to Lautenbach, "a new company with thesize, the *566 resources and the products to becomea leader in the communications solutions industry ."Paper 28, 1 40.

FN2. According to the complaint, Acternawas founded in 1959 as DynatechCorporation, but changed its name toActerna in September 2000. For the sakeof simplicity, it will be referred to asActerna throughout .

Plaintiffs allege that the market initially respondedpositively to Actema's acquisitions, with its shareprice soaring from $10 .37 on February 14, 2000(the date of the announcement of the merger withWWG) to a peak of $41 .38 on August 29, 2000(immediately after the Cheetah acquisition) .However, during 2001 , there was a slowdown in theglobal communications industry , resulting inreduced capital spending in that sector, whichincluded many customers for Acterna 's test andmanagement products . As a result of the slowdown,Acterna' s share price began a steady decline, fallingfrom the one-time high of $41 . 38 on August 29,2000 to $ 5 .48 on August 14, 2001 (the beginning ofthe Class Period) . As will be discussed below,throughout the Class Period, Actema's financialwell-being continued to suffer severely as a result of

the slowdown.

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2. The Alleged Misrepresentations and Omissions

Plaintiffs allege that throughout the Class Period,Acterna issued numerous statements and filedquarterly and annual reports with the Securities andExchange Commission ("SEC") that the individualDefendants and PwC knew, or were reckless in notknowing, were materially false and misleadingbecause they failed to disclose and/ormisrepresented adverse facts about Actema'sfinancial performance . Essentially, the violationsPlaintiffs' allege can be boiled down to two maincategories: (1) pertaining to the testing andvaluation of Acterna's goodwill, and (2) pertainingto violations of Generally Accepted AccountingPrinciples ("GAAP").

First, with respect to statements and omissionsconcerning Actema's goodwill, in 2001, theFinancial Accounting Standards Board issuedFinancial Accounting Standards No. 142 ("FAS142") . FAS 142 requires companies to perform anannual test of their goodwill to determine if anyimpairment exists . If so, the company is required towrite down the goodwill and take a charge againstearnings. Plaintiffs allege that throughout the ClassPeriod, Actema filed numerous reports with theSEC, in which it stated that it had adopted FAS 142,that it had tested its goodwill pursuant to FAS 142,and that it had determined that its goodwill was notimpaired. Plaintiffs identify the following publicfilings as containing alleged misstatements : (1)First Quarter 2002 10-Q signed by Woodbury andKline (filed August 14, 2001) ; (2) Second Quarter2002 10-Q signed by Woodbury and Kline (filedNovember 14, 2001) ; (3) Third Quarter 2002 1O-Qsigned by Ratliff and Woodbury (filed February 13,2002); (4) 2402 Annual 10-K signed by all theindividual Defendants (filed June 18, 2002) ; (5)First Quarter 2003 10-Q signed by Ratliff (filedAugust 14, 2002). In addition, Plaintiffs point tothe financial statements Lautenbach and Ratliffcertified on August 14, 2002, attesting to theaccuracy of Acterna's statements, including thoseregarding the adoption of FAS 142 and thevaluation of Actema's goodwill .


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According to Plaintiffs, the Class Period began onAugust 14, 2001, when Acterna filed its FirstQuarter 2002 10-Q for the period ending June 30,2001 ("2002 I .Q. 10-Q"). In this filing, thecompany stated that although "[t]he provisions ofFAS 142 will be effective for fiscal years beginningafter December 15, 2001 . . . the Company haselected to early adopt the provisions effective April1, 2001 ." " Paper 28, ¶ 52 . Plaintiffs allege that bystating it had adopted FAS 142, Actema wasrepresenting that it had tested its goodwill forimpairment, that it would take a goodwill *567impairment charge if its goodwill was impaired, andthat if it was not taking a goodwill impairment, [it]was representing that its goodwill was notimpaired." Id

On November 14, 2001, Actema filed its SecondQuarter 2002 10-Q for the period ending September30, 2001 ("2002 2 .Q. 10-Q")_ In its filing, Acternareported that, due to the continued economicslowdown, net sales were down 12% from the sameperiod in the previous year, orders of its criticalcommunications test products were down 49% fromthe same period in the previous year, and it wasposting a $147 .5 million net loss for the quarter .With respect to its goodwill, Acterna reported a netof $435.8 million of which $379.8 million wasattributed to the Communications Test division . Italso stated that the company had "completed itstransitional impairment test of goodwill for allreporting units required under FAS 142 anddetermined that goodwill [was] not currentlyimpaired." Id., 1 59 (quoting 2002 2.Q. 10-Q).

Throughout the Class Period, Acterna' s financialcondition continued to deteriorate steadily. OnJanuary 30, 2002, Acterna issued a press releaseannouncing its financial results for the quarterending December 31, 2001 . As Plaintiff's admit, the"news was not good" Paper 28 , 1 62. Net saleswere down 33% from the same period in theprevious year, and down 21% from the previous

quarter. Sales of communications test productsdropped to $187 .2 million, down from $243 .9mil lion in the previous quarter. The company alsoreported a net loss that quarter of $74 million, or$0.39 per share . However, orders for

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communications test products rose 10% from theprevious quarter, but were down 45% from theprevious year. The company also reported a totaldebt of $1 .1 billion. On February 13, 2002, thecompany filed its Third Quarter 2002 10-Q ("20023.Q 10-Q") reiterating the poor financial resultsreported in the press release . It also stated, like inits earlier quarterly filings, that the company hadcompleted its transitional impairment test ofgoodwill as required under FAS 142 and haddetermined that goodwill was not currentlyimpaired .

On May 29, 2002, Acterna issued a press releaseannouncing its financial results for the quarterending March 31, 2002 (the fourth quarter of fiscalyear 2002). Again, the news was bleak . Thecompany disclosed that net sales for the quarterwere down 46% from the same period in theprevious year, and down 15% from the previousquarter. Sales of communications test productswere down from $299 million a year earlier to $147million . In addition, communications test productorders were down 66% from the prior year, and28% from the previous quarter. For the full fiscalyear 2002 (April 1, 2001 to March 31, 2002),Acterna's net sales were down 17% from fiscal year2001 . In addition, the company reported a net lossfor fiscal year 2002 of $375 million .

On June 18, 2002, Acterna filed its 10-K AnnualReport for the 2002 fiscal year ("2002 10-K"),which reiterated the financial results reported in theearlier press release . In addition, the companyexplained the methodology it used to ascertainwhether goodwill was impaired, as well as the effectthe implementation of FAS 142 had on valuation ofgoodwill . Once again, the company stated that ithad performed an annual impairment test asrequired by FAS 142, and had determined thatgoodwill was not impaired . Plaintiffs allege thisstatement was blatantly false because, as will bediscussed below, 'by March 2002 Acterna and PwChad determined that Acterna's goodwill wasimpaired and that the Company would have *568 totake a substantial goodwill impairment charge." Id,1 74. [FN3 ]

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FN3. PwC is alleged to have issued anessentially unqualified audit opinion,incorporated in the 2002 10-K, that wasitself materially false and misleading andrepresented an "extreme departure" fromGenerally Accepted Auditing Standards(GAAS) and Generally Accepted AuditingPrinciples (GAAP) . Paper 28, ¶ 107,108 .

On July 31, 2002, Actern.a announced its financialresults for the first quarter of fiscal year 2003 .Once again, the company reported decreased salesand orders from the previous quarter. On August14, 2002, Acterna filed its First Quarter 2003 10-Q("2002 I .Q . 10-Q") . In it, Acterna stated:

As a result of the continued industry slowdown,the Company continues to assess the value ofgoodwill on a quarterly basis. Such anassessment was performed at June 30, 2002 andbased on current quarter operating results andexpectations of future earnings, the Companydetermined that its goodwill was not impaired atJune 30, 2002.

Paper 28, ¶ 77 . However, the company expresslywarned that it "will continue to assess the value ofgoodwill for impairment on a quarterly basis andcan provide no assurance that an impairmentadjustment will not be necessary." Id. Also onAugust 14, 2002, Actema issued a press releasestating that the company had filed with the SEC itsForm 8-K report, with attached certifications fromDefendants Lautenbach and Ratliff, in which theyattested to the accuracy of Actema's financialstatements .

3 . The Goodwill Write-off

On October 30, 2002, Acterna issued a pressrelease announcing its financial results for thesecond quarter of fiscal 2003. In addition toreporting yet another disappointing quarter of salesand orders, the company took a charge of $388million for goodwill and other asset impairment inthe communications test unit. In part because of thegoodwill impairment charge, the company reporteda net loss of $284 million for the quarter . By thistime, the price of Actema's common stock had

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decreased approximately 94% throughout the ClassPeriod, falling from $5 .48 per share on the first day(August 14, 2001) to $0 .33 per share on the last(October 29, 2002). Despite the bleak financialportrait the company had been painting for severalquarters throughout the Class Period, and thedramatic decline in its stock price, Plaintiffs allegethat on October 30, 2002, Acterna "shocked thefinancial markets by taking a massive $388 milliongoodwill impairment charge" in the second quarterof fiscal 2003 . Id, 198 .

B. Procedural Background

On April 16, 2003, a securities fraud class actionwas filed against Acterna and the individualDefendants. The first suit in this class action,Huang et al. v. Acterna Corp ., et al., Civil ActionNo: DKC-03-1131, was filed by Sik-Lin Huang, onbehalf of a class consisting of all those whopurchased or otherwise acquired the common stockof Acterna between August 1, 2001 and October 31,2002, and who were damaged thereby. On August9, 2004, the court granted the motion of Joseph DeLeo and Stan Andrew for appointment as leadplaintiffs and their selection of lead counsel andrecaptioned the case as : In re Acterna CorporationSecurities Litigation . See Paper 23 . It also grantedPlaintiffs' request to file, if necessary, an amendedcomplaint. Id.

On October 6, 2004, Plaintiffs filed theirConsolidated Amended Class Action Complaint,dropping Acterna as a defendant due to its recentdischarge in bankruptcy, and naming , in addition tothe individual Defendants, PricewaterhouseCoopers * 569 LLP ("PwC") and Clayton, Dubilier& Rice, Inc ., ("CD & R"). [FN4] As mentionedabove, the amended complaint was fi led on behalfof all persons who purchased or otherwise acquiredshares of Acterna common stock between August14, 2001 , and October 29, 2002 ("the ClassPeriod" ) . Plaintiffs allege in the "first claim" thatthe individual Defendants and PwC violated § 10(b)of the Securities and Exchange Act, 15 U.S .C. §78j(b) (1997), and Rule 10b-5, 17 C.F .R. §240.10b-5, and in the "second claim " that theindividual Defendants and CD & R violated § 20(a)


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of the Securities and Exchange Act, 15 U.S.C. §78t(a). Plaintiffs also assert claims for common lawfraud against the individual Defendants and PwC,and breach of fiduciary duty against the individualDefendants .

FN4. In May 2003, Acterna filed forbankruptcy under Chapter 11 of theBankruptcy Code. Approximately fivemonths later, it emerged from Chapter 11reorganization as a privately held businessowned by CD & R and other lenders .

On January 14, 2005, the individual Defendants,PwC, and CD & R filed separate motions todismiss, each arguing that Plaintiffs have failed tostate a claim for a violation of § 10(b) and Rule14b-5, and that they have not met the heightenedpleading standard required under the PrivateSecurities Litigation Reform Act ("PSLRA") . SeePapers 42(PwC), 44 (the individual Defendants),and 45 (CD & R).

11 . Standard of Review

A motion to dismiss pursuant to Fed.R. .Civ.P .12(b)(6) will not be granted unless "it appearsbeyond doubt that the plaintiff can prove no set offacts in support of his claim which would entitlehim to relief." Conley v. Gibson, 355 U.S. 41,45-46, 78 S .Ct. 99, 2 L.Ed.2d 80 (1957) . Inreviewing the complaint, the court accepts allwen-pled allegations of the complaint as true andconstrues the facts and reasonable inferencesderived therefrom in the light most favorable to theplaintiff. Ibarra v. United States, 120 F .3d 472,473 (4th Cir .1997) . In deciding a Rule 12(bX6)motion, the court will consider the facts stated in thecomplaint and the documents attached to thecomplaint . The court may also consider documentsreferred to in the complaint and relied upon byplaintiff in bringing the action . Biospherics, Inc. v.Forbes, Inc., 989 F.Supp. 748, 749 (D.Md.1997)(citing Cortec Indus., Inc. v. Sum Holding, L.P.,949 F.2d 42, 46-48 (2nd Cir .1991)). Thus, it isappropriate for the court to consider any relevantpress releases and public disclosure documentsreferenced and relied upon by Plaintiffs without

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converting the motion to dismiss into a motion forsummary judgment . See In re Criimi Mae, Inc.Securities Litig., 94 F.Supp.2d 652, 656(D.Md.2000) .

To survive the motion to dismiss, Plaintiffs musthave alleged facts that show they are entitled torelief on their substantive causes of action . To statea claim for relief under § 10(b) and Rule I Ob-5,Plaintiffs must sufficiently allege that (1)Defendants made a false statement or omission ofmaterial fact (2) with scienter (3) upon whichPlaintiffs justifiably relied (4) that proximatelycaused Plaintiffs' damages . Phillips v. LCI Intl,Inc., 190 F.3d 609, 613 (4th Cir.1999) (citingHillson Partners Ltd P'ship v. Adage, Inc., 42 F .3d204, 208 (4th Cir.1994)). When, as here, a plaintiffalleges a "fraud on the market" theory, it is notnecessary to prove individual reliance on the falseor misleading statements . See Longman v. FoodLion, Inc., 197 F .3d 675, 682 n. 1 (4th Cir.1999) ;In re Criimi Mae, 94 F.Supp.2d at 656. Instead,Plaintiffs may show that they indirectly relied onstatements by relying on the integrity of the marketprice of the stock . *570Longman, 197 F .3d at 682n. 1 . However, as the Supreme Court recently hasmade clear, a plaintiff must still adequately allege"proximate causation and economic loss" in orderto survive a Rule 12(bX6) motion. See DuraPharmaceuticals, Inc- v. Broudo, - U.S. -, 125S.Ct. 1627, 1633, 161 L.Ed.2d 577 (2005) ( "The[PSLRAI thereby makes clear Congress ' intentto permit private securities fraud actions forrecovery where, but only where, plaintiffsadequately allege and prove the traditionalelements of causation and loss .") .

[1] Because § 10(b) claims are fraud claims, theplaintiff must also satisfy the pleading requirementsimposed by Fed.RCiv.P. 9(b) . In re Medimmune,Inc. Securities Litig., 873 F.Supp. 953, 960(D.Md. 1995) . Rule 9(b) requires that "[ijn allaverments of fraud or mistake, the circumstancesconstituting fraud or mistake shall be stated withparticularity ." Particularity of pleading is requiredwith regard to the time, place, speaker and contentsof the allegedly false statement, as well as themanner in which the statements are false and the

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specific facts raising an inference of fraud .Medimmune, 873 F .Supp. at 960; In re Criimi Mae,94 F .Supp.2d at 657 .

[2][3] The PSLRA imposes additional pleadingrequirements on plaintiffs in securities fraudactions . Most notably, the PSLRA has heightenedthe requirements of Rule 9(b) for pleading scienter .[FN5] Under Rule 9(b), "[m]alice, intent,knowledge, and other condition of mind of a personmay be averred generally ." Under the PSLRA,however, a complaint must, "with respect to eachact or omission alleged to violate this chapter, statewith particularity facts giving rise to a stronginference that the defendant acted with the requiredstate of mind" 15 U.S.C. § 78u-4(bx2). TheFourth Circuit has held that scienter under thePSLRA may be alleged by "pleading not onlyintentional misconduct, but also recklessness,"Ottmann v. Hanger Orthopedic Group Inc., 353F.3d 338, 344 (4th Cir .2003), and has definedrecklessness as "an act so highly unreasonable andsuch an extreme departure from the standard ofordinary care as to present a danger of misleadingthe plaintiff to the extent that the danger was eitherknown to the defendant or so obvious that thedefendant must have been aware of it ." Id at 343(quoting Phillips, 190 F .3d at 621) . Moreover, inevaluating scienter allegations, the Fourth Circuitapplies:

FN5. Scienter is a "mental state embracingan intent to deceive , manipulate ordefraud ." Ernst & Ernst v. Hochfelder,425 U.S. 185, 194 n. 12, 96 S.Ct . 1375, 47L.Ed.2d 668 (1976) .

a flexible, case -specific analysis . . . . [C]ourtsshould not restrict their scienter inquiry byfocusing on specific categories of facts, such asthose relating to motive and opportunity, butinstead should examine all of the allegations ineach case to determine whether they collectivelyestablish a strong inference of scienter. And,while particular facts demonstrating a motive andopportunity to commit fraud (or lack of suchfacts) may be relevant to the scienter inquiry, theweight accorded to those facts should depend on

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the circumstances of each case .Gttmann, 353 F.3d at 345-46 . [FN6] In sum, tosurvive a motion to dismiss, plaintiffs must *571successfully plead with particularity facts specific toeach defendant that create a strong inference thatthe defendant acted knowingly or recklessly inmaking material misrepresentations or omissions .See In re Royal Ahold N. V. Securities & ERISALitig., 351 F.Supp .2d 334, 369 (D .Md.2004) . Theymust also adequately allege "loss causation," i .e ., acausal connection between the materialmisrepresentation and the plaintiffs' economic loss.See Dura Pharms., 125 S.Ct . at 1631 ; Keeney v.Lar/an, 306 F.Supp.2d 522, 541 (D.Md.2003)(finding that the plaintiff pled no facts suggestingthat the delayed disclosure of the allegedly false andmisleading omission was a proximate cause of hiseconomic harm).

FN6 . As the court in Gttmann noted,motive and opportunity are factors thatshould be considered collectively with theother allegations in evaluating whether acomplaint successfully alleges scienter, butthey are not essential. 353 F .3d at 345-46 .Although motive may be a good indicationof scienter, simply alleging a defendant'sdesire to protect his job and compensationis not sufficient, because these motivesmay be seen as common to all corporateexecutives. In re Criimi Mae, 94F.Supp.2d at 660 .

III. Plaintiffs' Motion to Strike

[4] Before turning to the merits of the dismissalmotions, the court will first consider Plaintiffs'motion to strike certain exhibits filed by DefendantPwC. Specifically, Plaintiffs move to strike Exhibits4, 7, 8, 11, 14, 15, 17, 19, 23, and 25 because theywere not referred to in the complaint and were notrelied upon by Plaintiffs in bringing this action.Paper 55 . [FN7]

FN7. Plaintiffs do not object to, nor dothey dispute the accuracy of, the remainingExhibits attached to PwC 's motion todismiss .

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As stated above, when ruling on a 12(b)(6) motion,the court may consider documents referred to in thecomplaint and relied upon by the plaintiff inbringing the action. Biospherics, Ina, 989 F.Supp.at 749. "In securities fraud actions, courts will alsoexamine the other information that was publiclyavailable to reasonable investors at the time thedefendant made statements plaintiffs alleged werefraudulent, including documents or articles cited inthe complaint, SEC filings, press releases, stockprice tables, and other material on which plaintiffsallegations necessarily rely." In re First UnionCorp. Securities Litig., 128 F.Supp.2d 871, 883(W.D.N.C.2001) (citing Phillips, 190 F .3d at 617) .Plaintiffs have not specifically referred to ordiscussed any of the exhibits they seek to strike .

Defendant PwC counters that the exhibits Plaintiffsmove to strike were in fact relied upon, referred to,and integral to Plaintiffs' complaint . It points to thefirst paragraph of the complaint, in which Plaintiffsstate that their allegations are based on, inter alia,"review and analysis of press releases, publicstatements , news articles, securities analysts ' reportsand other publications disseminated by orconcerning Acterna," as well as "news articles,public filings, press releases and other publicinformation disseminated by or concerning [PwC] ."See Paper 28, ¶ 1 . However, neither thisparagraph , nor any others, demonstrates thatPlaintiffs re lied on the specific analysts' reports(Exs . 4, 7, 8, 11 , and 19) or public newspaper andnewswire ar ticles (Exs. 14, 15, 17, and 23)Plaintiffs seek to strike. Cf. In re Cree, Inc.Securities Litig., 333 F . Supp.2d 461, 470(M.D.N.C .2004) (striking certain exhibits wherePlaintiffs had not "explicitly relied" on the articlesin their complaint , but rather made "obliquere ferences to media coverage " concerning thealleged fraudulent conduct) . Accordingly, theseexhibits will not be considered.

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slowdown in the *572 global communicationsindustry that Plaintiffs explicitly refer to in theircomplaint . Accordingly, the court can, and will,take judicial notice of the drop in the Dow JonesIndex reflected by Exhibit 25, and will declinePlaintiffs' motion to strike that exhibit . SeeGreenhouse v. MCG Capital Corp ., 392 F.3d 650,655 n. 4 (4th Cir.2004) (taking judicial notice ofpublished stock prices and broader market datawithout converting a motion to dismiss into amotion for summary judgment); D.E. & J LtdP'ship v. Conaway, 284 F.Supp.2d 719, 749(E.D.Mich.2003) (taking judicial notice ofwell-publicized stock prices and market trendswithout converting a motion to dismiss into amotion for summary judgment in a securities fraudcase) ; In re USEC Securities Litig., 190 F.Supp.2d808, 826 n. 14 (D.Md2002) (taking judicial noticeof published New York Stock Exchange data.without converting motion to dismiss into a motionfor summary judgment) .

IV. Analysi s

The individual Defendants, PwC, and CD & Rhave all moved to dismiss Plaintiffs' complaint onnumerous grounds. The individual Defendantscontend that Plaintiffs' complaint fails to plead factsgiving rise to a strong inference of scienter and failsadequately to plead loss causation. PwC asserts thesame arguments with respect to scienter and losscausation, an4 contends that Plaintiffs have notadequately pled that the company's disclosures withrespect to the value of its goodwill were false ormaterially misleading. In the alternative, it assertsthat Plaintiffs' federal securities claims against it aretime-barred. Lastly, CD & R argues that Plaintiffshave failed to state a claim for a primary violationof § 10(b), and accordingly, that the controllingperson liability claims under § 20(a) must . bedismissed as well . See In re Criimi Mae, 94F.Supp.2d at 658 .

On the other hand, Exhibit 25 is a copy of the DowJones U.S. Telecommunications Index from August14, 2001 to October 29, 2002, reflecting the generaldecline in the telecommunications market duringthe Class Period. See Paper 42, Ex. 25. Plaintiffsdo not dispute that Exhibit 25 accurately reflects the

A. Scienter

1 . The Individual Defendants

Plaintiffs allege that the individual Defendants

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knew, or were reckless in not knowing, that thevalue of the goodwill acquired from WWG andCheetah was severely impaired, and that thecompany would need to take a charge againstearnings . Further, Plaintiffs allege that, byreporting that Acterna's goodwill was not impaired,and thus not taking any significant goodwill chargeagainst earnings during the Class Period, theindividual Defendants overstated Actema'searnings, which had the "cause and effect ofcreating in the market an unrealistically positiveassessment of Acterna and its business, prospectsand operations, thus causing the Company'scommon stock to be overvalued and artificiallyinflated at all relevant times ." Paper 28, ¶ 85 .

[5][6] First, the individual Defendants assert thatPlaintiffs improperly rely on the "group pleadingdoctrine" to establish scienter. Under this doctrine,corporate officers and directors who are alleged tobe in day-to-day control of the company may bepresumed, for pleading purposes, to be collectivelyresponsible for a company's "group published"information such as prospectuses, registrationstatements, annual reports, press releases and otherpublic filings . See In re Criimi Mae, 94 F.Supp .2dat 657. Undoubtedly, Plaintiffs' complaint is repletewith allegations that the scienter of each individualDefendant is established, in part, by virtue of hishigh ranking position in the company . See Paper28, ¶¶ 31, 32, 34, 35, 115-17, and 139 .Recognizing that Judge Blake recently rejected theapplication of the "group published" doctrine as"inconsistent with the particularity and specificityrequired by *573 the PSLRA and Rule 9(b),"Plaintiffs, nevertheless, invite this court to apply it .See In re Royal Ahold 351 F.Supp.2d at 369 .Following "the sound reasoning of other districtcourts in this Circuit that have addressed the issue,"as well as Judge Blake, the court will declinePlaintiffs' invitation . See, e.g., In re Royal Aholr4351 F .Supp.2d at 369 ; In re Cree, 333 F .Supp.2d at471 ; Glaser v. Enzo Biochem, Ina, 303 F.Supp.2d

724, 734 (E.D.Va.2003), rev'd on other grounds,126 Fed .Appx . 593 (4th Cir.2005) (unpublished) ;Smith v. Circuit City Stores, Inc., 286 F.Supp.2d707, 715 (E .D.Va .2003); In re First Union, 128F.Supp.2d at 888; In re CIENA Corp. Securities

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Litig., 99 F.Supp.2d 650, 663 n. 11 (D.Md.2000) ;In re Medimmune, 873 F .Supp. at 960-61 n. 7 .Accordingly, "Plaintiffs cannot claim that theindividual Defendants' titles or positions at[Acterna] establish that they must have known ofthe alleged fraud." In re Cree, 333 F .Supp.2d at475; see also Smith, 286 F.Supp.2d at 715(dismissing plaintiffs' attempt to establishdefendants' scienter because of their status as seniorofficers, access to confidential and proprietaryinformation, and interaction with other executives) ;In re First Union, 128 F.Supp.2d at 888 (rejectingplaintiffs' claim that "because of their positions ascorporate officers, defendants must have known ofthe allegedly false and misleading nature of all thealleged misstatements") .

[7] Plaintiffs, however, do not rely exclusively onthe group pleading doctrine to plead the individualDefendants' scienter . The complaint alleges, andPlaintiffs assert in their opposition brief, that theindividual Defendants' scienter can also beestablished by statements from four former Acternaemployees . See Paper 28, ¶¶ 118-21 ; Paper 53at 19-21 . Plaintiffs contend that the informationprovided by these former employees, (identified inthe complaint as W-1, W-2, W-3, and W-4), givesrise to a strong inference that the individualDefendants "had actual knowledge or [were]deliberately reckless in failing to ascertain the factthat Actema's goodwill was overstated throughoutthe Class Period and that the Company was requiredto take a substantial charge against earningspursuant to the requirements of FAS 142 ." Paper28,122.

First, according to W-1, a former accountant andsupervisor in Acterna's Corporate FinanceDepartment f om February 1996 to October 2003,the Corporate Finance Department and PwC had"started doing the work for it [the write-off] buthadn't finished the analysis yet- We were stillrecalculating then. I remember because of all thework I was doing." Paper 28, q¶ 11, 113, 118 .From these statements, Plaintiffs jump to theconclusion that "Defendants knew that Acternawould have to take a significant goodwillimpairment charge in March 2002," but


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nevertheless "continued to represent to the investingpublic that its goodwill was not impaired." Id., ¶11 . However, far from confirming that Defendants'had actual knowledge that Aeterna's goodwill wasimpaired" in March 2002, at most, Plaintiffs'allegations would demonstrate that Actema (andPWC) was conducting the impairment tests asrequired by FAS 142, but had not determinedwhether, and if so, how much, Acterna's goodwillwas impaired. In other words, the alleged fact thatActerna and PWC had "started doing the work for it[the write-off] but hadn't finished the analysis yet"is not sufficient to demonstrate that Acterna andPWC had concluded that Actema's goodwill wasimpaired. And, it would demonstrate even less thatany of the individual Defendants knew thatActerna's goodwill was impaired. In fact, it merelydemonstrates that as of that time, no conclusion hadbeen reached, as evidenced by W-1's *574 ownstatement that they were "still recalculating ."Noticeably absent from the complaint is anallegation that once the analysis was complete,Acterna and PWC concluded that there was animpairment to goodwill, that the individualDefendants were aware of that conclusion, and thatthey, nevertheless, consciously misrepresented intheir subsequent statements that it was not impaired .In sum, Plaintiffs' allegations with respect to whatW-1 can confirm are not sufficient to demonstratethat when the company ultimately issued itssubsequent reports, the statements regardinggoodwill contained therein were either false ormisleading, and, even if they were false, that theindividual Defendants acted with a conscious orreckless effort to defraud shareholders . [FN8] SeeKeeney, 306 F.Supp.2d at 538 .

FN8. Furthermore, because Plaintiffsallege that W-1 can. confirm that "byMarch 2002 Actema and PwC haddetermined that Acterna's goodwill wasimpaired," the purported facts that W-1can confirm bear only on the allegedmisstatements made after March 2002 .Thus, W -I's allegations do nothing to raisean inference of scienter with respect to anydefendant for any alleged misstatementsmade prior to March 2002 . See Paper 28,

Ift 50- 64 .

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[8] Moreover, not one of the Plaintiffs' confidentialwitnesses provides any information about how theindividual Defendants were involved in any allegedschemes to misrepresent the value of Acte rna'sgoodwill or, assuming such a scheme existed, howeach individual Defendant knew of the allegedfraud. See In re Cree, 333 F.Supp .2d at 474-75(finding that although some of the plaintiffs' claimsregarding improper business practices may havebeen alleged with sufficient particularity to raise aninference that they occurred, "none of theallegations raises a strong inference that [theDefendant officers and directors] acted withscienter" because "[n]ot one of Plaintiffs'confidential witnesses provides any informationabout how the individual Defendants were involvedin the alleged schemes or how each Defendant knewof the purported fraud"). As discussed above,nothing W-1 can allegedly provide sheds any lighton what the individual Defendants knew, or werereckless in not knowing, about the impairment ofgoodwill during the Class Period.

The allegations regarding the information that W-3and W-4 can provide also do not support a stronginference of scienter as to each individualDefendant. Plaintiffs allege that W-3, a seniorFinancial Analyst who worked in Actema's NorthCarolina office, "was aware of longstandingconcerns regarding the valuation of Cheetah'sassets" and that he "recalled discussions regardingthe goodwill associated with the Cheetahacquisition during which Acterna insiders statedthat the goodwill was overstated from the time ofthe acquisition ." Paper 28, 1 13 (emphasis added).Plaintiffs allege that W-3's assessment of theCheetah acquisition is corroborated by W-4, aformer Manager of Acterna's Professional ServicesDepartment, who described Cheetah as a "negativeacquisition" that was "completely worthless" and a"liability" from the start. Id. These allegations areinsufficient to support an inference of scienter forseveral reasons . First, regardless of what W-3,W-4, or other "Acterna insiders" were aware of withrespect to the Cheetah acquisition, Plaintiffs do notallege any facts as to what the individual


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Defendants knew and when . For example, W-3does not allege when the "discussions . . . regardingthe Cheetah acquisition" took place, and moreimportantly, whether any of the individualDefendants were present during these discussions,or how else they may have been privy to them .Merely alleging that "Acterna insiders" knew thatthe *575 goodwill associated with the Cheetahacquisition was overvalued is too general to showthat any individual Defendant had knowledge . Cf.In re Cree, 333 F.Supp.2d at 475 (stating that theplaintiffs' claim that the fraud "was well-knownwithin [the company]" was too general to show thatthe defendant officers and directors had knowledgeof the alleged fraud) ; In re First Union, 128F.Supp.2d at 886 (stating that "at a minimum," thePSLRA "requires that . . . for each allegedmisstatement or omission, plaintiffs must pleadfacts concerning, for example, when each defendantor other corporate officer learned that a statementwas false, how that defendant learned that thestatement was false, and the particular document orother source of information from with the defendantcame to know that the statement was false") (citingIn re Advanta Corp. Securities Litig., 180 F.3d 525,534 (3rd Cir .1999) (stating that the PSLRA requiresplaintiffs to plead "who, what, when, where, andhow" in order to establish scienter)).

[9] The closest Plaintiffs come to making anallegation that would support an inference ofscienter as to any of the individual Defendants istheir assertion that W-2 can confirm that Kline,Woodbury, and Ratliff were "intimately involved inall aspects of the WWG acquisition," and that they"had primary responsibility for analyzing the valueof the assets acquired from WWG, includingvaluation of acquired goodwill." Paper 28, ¶ 12 .However, this allegation falls short of meeting theheightened pleading requirement for demonstratingscienter for several reasons . First, this allegationspeaks to the knowledge of these individualDefendants with respect to WWG, and the valuationof its goodwill, at the time of acquisition, i .e., May2000. Whatever their roles might have been at thattime, W-2's information does not demonstrate thatthey had any knowledge regarding the valuation ofits goodwill during the Class Period-August 14,

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2001 to October 29, 2002-when they were allegedly"mis[leading] Plaintiffs and the investing public ."Id, ¶ S. Moreover, with respect to the falsity of thestatements, W-2 does not provide any specific factsto support the conclusory allegations that thestatements regarding goodwill released during theClass Period were in fact false or misleading. And,even assuming the statements were false, W-2 doesnot provide with any particularity facts giving riseto a strong inference that when Kline, Woodbury,and Ratliff signed the various filings, they eitherknew that the statements regarding the impairmentof goodwill were false, or were reckless in notknowing. See In re aspire Communications, Inc,Securities Litig., 127 F.Supp.2d 734, 741(D.Md.2001) ("With respect to each of [the]statements, the Complaint fails to adequatelyexplain why each statement was misleading and alsofails to identify with particularity specific factswhich would give rise to a strong inference thateach named defendant acted with scienter .") ; In reBoston Technology, Inc. Securities Litig., 8F.Supp.2d 43, 57 (D.Mass.1998) ("A lOb-5plaintiff must allege 'details of [defendants'] allegedfraudulent involvement,' including specifics as towhat defendants had knowledge of and when . Tosatisfy this requirement, complaints typicallyidentify internal reports, memoranda, or the like,and allege both the contents of those documents anddefendants possession of them at the relevanttime.") (internal citations and footnote omitted) .The allegations here simply do not support a"strong inference" that the individual Defendants"acted with fraudulent intent or that their actionsevince an 'extreme departure' from ordinary care ."Keeney, 306 F.Supp.2d at 539; see also Phillips,190 F.3d at 621 .

*576 [10] Plaintiffs also contend that, in additionto the allegations supported by the four formeremployees, the motives of the individualDefendants to commit securities violations areadditional factors supporting a strong inference ofscienter. "In order to demonstrate motive, aplaintiff must show 'concrete benefits that could berealized by one or more of the false statements andwrongful disclosure alleged.' " Phillips, 190 F .3d at621 (quoting Shields v. Citytrust Bancorp., Ina, 25

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F.3d 1124, 1130 (2nd Cir.1994)). The FourthCircuit has made clear that allegations, like the onesasserted here, that merely charge that executivescommitted fraud to prolong the benefits they holdor to retain an executive position do not, inthemselves, raise a strong inference of scienter .Phillips, 190 F.3d at 622; In re e.spire, 127F.Supp.2d at 734; In re Crifmi Mae, 94 F .Supp.2dat 661 . Recognizing that the scienter inquiry is notto be restricted "by focusing on specific categoriesof facts, such as those relating to motive andopportunity," facts (or lack of such facts)demonstrating motive nevertheless remainimportant in determining whether the factualallegations "collectively establish a strong inferenceof scienter." Ottmann 353 F.3d at 345-46 .Moreover, the weight accorded to those allegationsshould depend on the circumstances of each case .Id Here, where Plaintiffs' allegations purporting todemonstrate the individual Defendants' scienter areslight at best, allegations suggesting a motive toengage in fraudulent activities would need to beparticularly strong to have any significance. Cf Inre aspire, 127 F.Supp.2d at 744 (suggesting thecorollary that "when a defendant's motive to commitsecurities fraud is not readily apparent from acomplaint, the plaintiff faces a more stringentstandard for establishing fraudulent intent and muststate with particularity facts giving rise to a stronginference of fraud based on conscious behavior orsevere recklessness") . However, Plaintiffs'allegations of motive are in the vein of general,conclusory allegations about the desire of theindividual Defendants to retain their positions .Because such allegations of motive generally aredeemed insufficient, they should be accorded little,if any, weight and simply do not bolster Plaintiffs'contention that the individual Defendants acted withthe requisite scienter .

Moreover, "[i]f a motive to commit fraud can be arelevant (although not dispositive] circumstancesupport ing a claim of scienter , it would seem that aninabi lity to show motive can be a re levantcircumstance indicating the lack of scienter ."Cutsforth v. Renschler, 235 F . Supp .2d 1216, 1250(M.D.Fla . 2002) . Here, Plaintiffs have not allegedany concrete benefits that could be realized by the

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alleged false statements. For example, Plaintiffs donot allege that the individual Defendants sold anystock during the class period, thereby takingadvantage of their fraudulent scheme to artificiallyinflate the company's share price . See Phillips, 190F.3d at 622 ("To support a claim of motive basedon the benefit a defendant derives from an increasein the value of his holdings, a plaintiff mustdemonstrate some sale of 'personally-held stock' or'insider trading' by the defendant .") . The absence ofany allegations that any individual Defendant soldany of his personally held stock at inflated prices"plainly undermines the contention regardingmotive ." Cutsforth, 235 F.Supp.2d at 1250 (citingSan Leandro Emergency Medical Group ProfitSharing Plan v. Philip Morris Companies, Inc., 75 .F.3d 801, 814 (2nd Cir .1996) (concluding "that thesale of stock by one company executive does notgive rise to a strong inference of the company'sfraudulent intent," and "the fact that otherdefendants did not sell their shares during therelevant *577 class period sufficiently underminesplaintiffs' claim regarding motive")) ; see alsoKeeney, 306 F.Supp.2d at 535-36 (finding thatplaintiffs' complaint did not plead a strong inferenceof scienter in a "fraud on the market" case wheredefendants did not make any sales of their sharesduring the class period) . Thus, where allegations ofinsider trading or selling of personally-held stock"may strengthen an inference of scienter," In reMicroStrategy, Inc Securities Litig., 115 F .Supp.2d620, 643 (E.D.Va.2000), "there should be anegative inference regarding scienter as a result ofthe plaintiffs' unsuccessful attempt to demonstratemotive ." Cutsforth, 235 F .Supp.2d at 1250; seealso, e.g., In re e.spire. 127 F.Supp.2d at 743(concluding that "the trades relied upon by theplaintiffs were not made in quantities which weresuspicious enough to support a strong inference ofscienter") ; In re CIENA, 99 F.Supp.2d at 663(finding that "the fact that the individual defendantssold so little stock could be construed as negatingthe inference that there was fraud") . Plaintiffs,therefore, have not adequately alleged factsdemonstrating that the individual Defendants had amotive to engage in securities fraud . This shortfall,coupled with the weak inferences to be drawn fromPlaintiffs' other allegations, undermines Plaintiffs '


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assertion that the individual Defendants acted withthe required state of mind . Thus, the absence of anyallegations establishing a motive for the individualDefendants to engage in securities fraud cutsagainst Plaintiffs' argument .

[11] Finally, the company's full disclosure of thenegative, and, in Plaintiffs' own words, "abysmalfinancial results" during the time leading up to andthroughout the Class Period further militates againstan inference of scienter on the part of the individualDefendants. See Cttmann, 353 F .3d at 348 (findingthat although a truthful disclosure that reflectsnegatively on a company may not be adequate tocorrect an earlier misstatement, "it nonethelessmilitates against a finding that [defendants] actedwith a culpable state of mind"); In re BellSouthCorp . Securities Litig., 355 F.Supp.2d 1350, 1375(N.D.Ga.2005) ("Defendants' reasonable conductand substantial public disclosures do notdemonstrate highly unreasonable conduct which isan extreme departure from the standards of ordinarycare .") ; Cutsforth 235 F.Supp.2d at 1261 (findingdisclosures throughout the Class Period ofunfavorable information about the companyweighed against an inference of scienter on the partof the individual officers). Here, it is undisputedthat leading up to and throughout the Class Period,Acterna's public filings fully disclosed the financialproblems the company was experiencing, and, infact, attributed some of those problems to theWWG and Cheetah acquisitions. [FN9]

FN9. For example, on November 14, 2000,Acterna filed its Form 10-Q for the periodending September 30, 2000 ("2001 2 .Q .10-Q"), the second quarter for the 2001fiscal year, but the first • quarterly reportfollowing consummation of the WWG andCheetah acquisitions . See Paper 42, Ex . 2 .That filing made clear that the twoacquisitions had an initial negative impacton Actema's financial condition, statingthat "[a]s a result of the substantialindebtedness incurred in connection withthe WWG Merger and the Cheetahacquisition, the Company expects that itsinterest expense will be higher and will

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have a greater proportionate impact on netincome in comparison to prior periods ." Id.

at 12. It also reported an increase inoperation expenses "primarily as a result ofthe acquisition of WWG, which ha[d] ahigher cost structure than the Companyha[d] had historically." Id at 17. Inaddition, the company disclosed that it hadan operating loss of $26.8 million for thequarter, as compared to income of $21.6million for the same period the prior yearbecause of the "additional amortizationexpense, the amortization of the inventorystep-up from the acquisitions of WWG andCheetah, as well as expenses relating to theintegration of WWG with the Company'scommunications test segment and thewriteoff of in-process research anddevelopment costs ." Id at 18 .

*578 In Actema's 2002 1 .Q. 10-Q, filed on August14, 2001 and identified by Plaintiffs as commencingthe Class Period, the company disclosed that it hadmounting liquidity needs "primarily resulting fromdebt service on the substantial indebtednessincurred in connection with the WWG Merger andfrom the funding of working capital and capitalexpenditures." Paper 42, Ex. 5 at 20. Although netsales were up that quarter "primarily as a result ofthe WWG Merger," see id at 19, the company alsodisclosed that it had $1 .1 billion of debt and that itcould not provide any assurances that it could meetits debt service obligations, specifically warningthat its "future operating performance and ability to[meet its debt service obligations] will be, amongother things, subject to future economic conditionsand to financial, business and other factors, many ofwhich are beyond the Company's control ." Id at 20 .

For the following four quarters prior to the end ofthe Class Period, Plaintiffs ' own complaintdemonstrates that Acterna fully disclosed thedeclining sales, orders, and revenue, and increasingnet losses that the company was expe riencing . SeePaper 28 , ¶¶ 58-79 . Although it reportedthroughout the Class Period that it had tested itsgoodwill pursuant to FAS 142, finding that it wasnot impaired, the company explicitly warned on two


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separate occasions that due to the industryslowdown, goodwill might ultimately be assessed asimpaired. For example, in its 2002 3.Q 10-Q, thecompany warned that the "current global economicdownturn has further impacted a previously existingdownturn in the Company's communications . testsegment," and that "[i]f the Company's expectationsas to future results are diminished significantly,goodwill may be impaired and any resultingnoncash impairment charge may have an adverseeffect on results of operations ." Paper 42, Ex. 13 at4-5, 9 . Moreover, in the 2003 1 .Q 10-Q, the last10-Q filed within the Class Period, although thecompany determined that its goodwill was notimpaired for that period, it stated that as result ofthe continued industry slowdown, it would"continue to assess the value of goodwill forimpairment on a quarterly basis and can provide noassurance that an impairment adjustment will not benecessary in the future ." Id, Ex. 20. [FN10 ]

FN10 . It was the very next quarter, in fact,that Actema, "[a]s a result of theincreasingly severe market conditions, . . .revised and reduced its long term financialforecast," and recorded an impairmentcharge of $374.2 million. See id, Ex. 21at 9-10.

In light of the company's full disclosure of itssteadily declining financial conditions, its pressingliquidity needs and debt load brought on by theWWG and Cheetah acquisitions, as well as itsexpress warnings about the possibility of a futureimpairment to goodwill, Plaintiffs' assertion that theindividual Defendants consciously or recklessly"misled Plaintiffs and the investing public regardingActerna's business condition, financial stability andthe success of its acquisition program and strategy"is unavailing . See Paper 28, § 8 . Simply put,Acterna's substantial public disclosures, which werereplete with unfavorable financial information andexpress warnings about the possibility of writing offgoodwill, do not give rise to a strong inference ofintentional or reckless misconduct on the part of theindividual Defendants. See In re BellSouth, 355F.Supp.2d at 1376 ("That Defendants generallydisclosed the troubles in its Latin American

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operations urges against an across the boardinference of scienter, as does the *579 factDefendants, and not some outside entity, initiatedthe inquiry into the impairment of the goodwill thatresulted in the [$1 .277 billion] write down .") .

In sum, for the reasons discussed above, Plaintiffs'allegations fail to "collectively establish a stronginference of intentional or reckless behavior on thepart of the individual Defendants . See Ottmann,353 F.3d at 345-46. Accordingly, Plaintiffs'complaint does not meet the scienter pleadingrequirements under the PSLRA, and for this reasonthe claims against the individual Defendants mustbe dismissed. 15 U .S .C. § 78u-4(bX2)-(3) .

2. PricewaterhouseCoopers LLP (PwCJ

[12] Defendant PwC has also moved to dismissPlaintiffs' complaint on the grounds that theirallegations against PwC do not raise a stronginference that PwC acted with the requisite scienter .For many of the same reasons discussed above withrespect to the scienter of the individual Defendants,Plaintiffs' allegations fail to support a stronginference that PwC acted with scienter.

First, Plaintiffs allege that "W-1 establishes that atleast as of March 2002 PwC had actual knowledgethat the Company's goodwill was overstated and, asa result, PwC knew Acterna's financial statements[after that period] were not prepared in accordancewith GAAP." Paper 28, ¶ 109 . Plaintiffs thenrecite a host of Generally Accepted AccountingStandards ("GAAS") PwC allegedly failed toobserve. Id, ¶ 110, 112. As discussed above,however, to conclude that PwC had actualknowledge of an impairment to goodwill based onW-l's information would be an unreasonableinferential leap . According to W=1, Acterna'sCorporate Finance Department and PwC had"started doing the work for it [the write-off] buthadn't finished the analysis yet. We were stillrecalculating then . I remember because of all thework I was doing." Paper 28, q¶ 11, 113, 118 .From these statements, Plaintiffs jump to theconclusion that "Defendants knew that Acternawould have to take a significant goodwil l


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impairment charge in March 2002," butnevertheless "continued to represent to the investingpublic that its goodwill was not impaired ." Id, ¶11 . However, far from confirming that PwC "hadactual knowledge that Acterna's goodwill wasimpaired" in March 2002, at most, Plaintiffs'allegations demonstrate that PwC and Acterna wereconducting the required impairment analysis, buthad not determined whether, and if so, how much,Acterna's goodwill was impaired In other words,the fact that Acterna and PWC had "started doingthe work for it [the write-off] but hadn't finished theanalysis yet" does not sufficiently demonstrate thatPWC had concluded that Acterna's goodwill wasimpaired . In fact, it merely demonstrates that as ofthat time, no conclusion had been reached, asevidenced by W-l's own statement that they were"still recalculating." As mentioned above, absentfrom the complaint is an allegation that once theanalysis was complete, PWC had concluded thatthere was an impairment to goodwill, and that it,nevertheless, allowed the company to issue thesubsequent statements that it was not impaired . Inshort, Plaintiffs' allegations with respect to whatW-1 can confirm are not sufficient to demonstratethat when the company ultimately issued itssubsequent reports, including the 2002 Annual 10-KReport, the statements regarding goodwill containedtherein were either false or misleading, and, even ifthey were false, that PwC acted with either actualknowledge of their falsity or a high degree ofrecklessness.

*580 [13 ] Plaintiffs also allege . PwC "knew or wasreckless in not knowing the possibili ty of fraud dueto Acterna's declining revenues in its keycommunications test division, but PwC . . . .deliberately failed to investigate whether the declinein revenues and orders for communications testproducts and services would adversely impact thecarrying value of the goodwill that Acterna acquiredfrom the WWG and Cheetah acquisitions." Paper28, ¶ 111 . Plaintiffs allege PwC "deliberately orrecklessly ignor[ed ] such red flags" in violation ofseveral GAAS provisions . Id, ¶ 112 . In order forrecklessness to provide a strong inference ofscienter as defined by the PSLRA , Plaintiffs "mustallege facts demonstrating that 'the accounting

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practices were so deficient that the audit amountedto no audit at all or that . . . no reasonable accountantwould have made the same decisions if confrontedwith the same facts.' " In re Royal Ahola 351F.Supp2d at 385 (quoting Zucker v. Sasaki, 963F.Supp . 301, 307 (S.D.N.Y.1997)) (internalquotations and citations omitted) . "The meremisapplication of accounting principles [such asGAAP and GAAS] by an independent auditor doesnot establish scienter." Id (quotation and internalfootnotes omitted) . Rather, Plaintiffs must insteadallege facts demonstrating that "the nature of thoseviolations was such that scienter is properlyinferred." In re MicroSfrategy, 115 F . Supp.2d at651 . Violations that would contribute to a findingof scienter may include the auditor 's recklessdisregard of "red flags," or known risk factors thatthe auditor should have heeded and in responsemodified its audit process or opinion . In re RoyalAhold, 351 F . Supp .2d at 386.

Plaintiffs offer no support for their allegations thatPwC "failed to investigate" whether the decline inrevenues and sales would adversely impactgoodwill, or that it ignored "red flags" associatedwith Acterna's declining financial condition thatcould result in an impairment to goodwill . Rather,Acterna's public filings suggest otherwise . In thecompany's fiscal 2002 Annual 10-K, the first publicfiling after Plaintiffs allege PwC had actualknowledge" of the impaired goodwill, Actemareported that:

During the fourth quarter of fiscal 2002, as aresult of the substantial declining financialperformance within the communications testsegment [which includes WWG and Cheetah] andresulting reduced expectations for future revenuesand earnings, management performed anassessment of the carrying values of long-livedassets within the communications test segment .This assessment, based on estimated future cashflows of the assets, discounted to arrive at a valuetoday, quantified the impairment of acquiredintangible assets (principally core technology).As a result, a charge of $151 .3 million wasrecorded during the fourth quarter of fiscal 2002 .

Paper 42, Ex. 16 at C-20; see also id at B-10(explaining that an assessment of long-lived asset s


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within the communications test segment revealed animpairment, resulting in a recorded charge of$151.3 million) . Actema then stated that it had"completed its transitional impairment test ofgoodwill during the year ended March 31, 2002 forall reporting units required under FAS 142 . . . anddetermined that goodwill was not impaired ." Id atC-21 . Given that PAS 142 specifically provides that"[i]f goodwill and another asset (or asset group) of areporting unit are tested for impairment at the sametime, the other asset (or asset group shall be testedfor impairment before goodwill," and if "the assetgroup was impaired, the impairment loss would berecognized prior to goodwill being tested forimpairment," Plaintiffs' allegations that thecompany, and PwC as its outside auditor, failed to*581 adhere to FAS 142 fall flat.) They offernothing to suggest that once the company (andpresumably PwC) had tested and determined that asubstantial impairment charge and write-off forlong-lived assets was required, the company thenmistakenly concluded no impairment to its goodwillexisted.

Moreover, in its audit opinion included in theCompany's 2002 10-K, PwC reiterated that "[a]sdiscussed in Note B to the consolidated financialstatements, the Company has significant liquidityneeds ." Id at C-2 ; see also Paper 28, ¶ 107 .Note B contains numerous warnings and disclosuresregarding Actema's significant reductions inrevenues, earnings, and operations resulting fromthe economic "downturn within thetelecommunications sector." Id at C-8 to C-9 .Additionally, as discussed above, the companyexplicitly warned on two separate occasions thatdue to the industry slowdown, goodwill mightultimately be assessed as impaired. See Paper 42,Ex. 13 at 4- 5, 9; Ex. 20 at 8 . These observationsdemonstrate that, far from recklessly disregarding"red flags," or "failing to investigate" the impact ofActema's declining financial condition on itsgoodwill, PwC was acutely aware of the decliningfinancial conditions of the company, as it explicitlyrecognized, as well as the need that a futureadjustment to the company's goodwill mightbecome necessary.

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[14] Plaintiffs also argue that the magnitude of themisstatement raises a strong inference of PwC'sscienter. Paper 54 at 22 . However, unlike many ofthe company defendants in the cases Plaintiffs cite,Acterna did not restate its earnings or correct aprevious valuation of goodwill it had reported inerror in prior filings . Thus, unlike in those cases,Plaintiff's cannot merely rest on the conclusoryallegation that Acterna's goodwill representationsprior to its October 30, 2002 press release, in whichit announced a $388 million charge for goodwilland other asset impairment, were false ormisleading. Rather, it must provide sufficient factsto give rise to an inference that when Acternarepresented during the Class Period that there wasno impairment to goodwill, that, in fact, there wasan impairment. Only then would Defendants'statements to the contrary be false or misleading .

Plaintiffs point to Acterna's October 30, 2002 pressrelease announcing its financial results for thesecond quarter of 2003 as if it constituted anearnings restatement, or corrective disclosure, of itsfinancial numbers from previous quarters . As such,they contend that it was an admission that its earlierstatements were misleading and argue that the sizeof the write-off demonstrates PwC's scienter. SeePaper 28 , Q 14; Paper 54 at 22-24 . To supportthis argument, Plaintiffs cite to such cases as In reRoyal Ahola 351 F.Supp .2d at 342, In reMicroSYrateg7, 115 F.Supp.2d at 636, and In reWorldCom, Inc. Securities Litig., 2003 WL21488087 (S .D.N.Y . June 25, 2003) . See also In reWorldCom, Inc. Securities Litig., 352 F .Supp.2d472 (S.D.N.Y.2005) . However, in each of thesecases, the defendants restated significant financialnumbers it had admitted to reporting in error . SeeIn re Royal Ahol4 351 F . Supp . 2d at 342 ($1 .1billion restatement of earnings, $24.8 billionreduction in revenue ) ; In re MicrdRrategy, 115F.Supp .2d at 636 (reported net income of $18.9million over a three year period restated to reflectan actual net loss of more than $36 million andoverstated revenues of $66 million) ; In reWorldCom, 352 F . Supp.2d at 476 (restatingapproximately $76 billion in adjustments).Although "the fact that a restatement of financialsoccurred is not sufficient to raise a strong inference

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of scienter[,] . . . when the number, *582 size, timing,nature, frequency, and context of the misapplicationor restatement are taken into account, the balance ofthe inferences to be drawn from such allegationsmay shift significantly in favor of scienter ." In reMicroStrateg; 115 F_Supp.2d at 634-35; see alsoIn re Atlas Air Worldwide Holdings, Inc. SecuritiesLitig., 324 F.Supp.2d 474, 486 (S.D.N.Y.2004)("Although a restatement is not an admission ofwrongdoing, the mere fact that financial resultswere restated is sufficient basis for pleading thatthose statements were false when made.") . Here,Acterna's October 30, 2002 press release is not arestatement or correction of its financial numbersfrom previous quarters, but merely a report of itsfinancial numbers for the second fiscal quarter of2003. With respect to the goodwill impairmentcharge, the company explained in its 10-Q filedwith the Exchange C ommission :

During the quarter ending September 30, 2002,the market conditions with the communicationstest business experienced further declines . TheCompany observed a more pronounceddeterioration in customer bookings as well asfurther reductions in customer spending ontelecommunications products .As a result of the increasingly severe marketconditions, the Company revised and reduced itslong term financial forecast. Based on thisrevision of the long-term outlook, the Company,assisted by independent valuation consultants,completed an assessment of the carrying amountof goodwill in the communications test segment,as required by SFAS No . 142, "Goodwill andOther Intangible Assets" . The results of theimpairment analysis, which were derived byutilizing, among other methods, a discounted cashflow analysis and an analysis of other marketcomparables, indicated the carrying amount ofgoodwill within the communications test segmentexceeded its estimated fair value . Accordingly,the Company recorded an impairment charge of$374 .2 million. This charge was recorded withinthe communications test segment and has beenincluded in the impairment charge in theunaudited Statements of Operations .

Paper 42, Ex. 21 at 9-10. Far from the sort offinancial restatement or corrective disclosure in

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WorldCom, Royal Ahola or MicroS'trategy,Acterna's October 30, 2002 press release andsubsequent 10-Q fi ling evidence little, if anything,about its financial statements during the ClassPeriod. It certainly is not an acknowledgment, asPlaintiffs allege, "that Acterna's Class Periodfinancial statements concerning unimpairedgoodwill were false and misleading ." Paper 28, ¶14; cf. In re Atlas Air, 324 F.Supp.2d at 487 ("Thefact that Atlas announced [in 2002 ] the need tosignificantly adjust its reported financials for 2000is sufficient to indicate that the company's reportedfinancials for the first and second quarter of thatyear were materially false .") . And, even less so isthe write-off a fact raising a strong inference ofPwC's scienter.

[15] Plaintiffs also argue that the alleged violationsof GAAP, when coupled with other circumstantialevidence of fraud, give rise to a strong inference ofPwC's scienter. See, e.g., In re MicroStrategy, 115F.Supp .2d at 650-51 . However, as stated above, the"mere misapplication of accounting principles . . . byan independent auditor does not establish scienter ."In re Royal Ahold, 351 F.Supp .2d at 386 (quotingZucker, 963 F.Supp. at 307). As the MicroStrategycourt stated :

More is required; specifically, a plaintiff mustalso allege facts tending to show that "theaccounting practices were so deficient that theaudit amounted to no audit at all or that noreasonable accountant *593 would have made thesame decisions if confronted with the same facts ."Zucker, 963 F .Supp. at 307 (quotations omitted) .In other words, a plaintiff alleging an auditor's

scienter cannot meet the PSLRA pleadingstandard simply by alleging that the auditorviolated GAAS or other pertinent accounting andauditing principles in performing an audit andother services-specifically, by solely relying onthe inferentially ambiguous fact that an audit didnot conform to GAAS ; instead, a plaintiff mustallege other facts indicating that the nature ofthose violations was such that scienter is properlyinferred. In sum, to meet the PSLRA pleadingburden, a plaintiff must allege facts that place theGAAS violations in a context that "paint aportrait of an audit so reckless that a jury coul d

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infer an intent to defraud ." Jacobs v. Coopers &Lybrand, No. 97-CIV-3374 (RPP), 1999 WL101772, at * 14 (S.D.N.Y. March 1, 1999) .

In re MicroStrategy, 115 F.Supp.2d at 651(internal footnote omitted) .

Plaintiffs first contend that the confidential witnessstatements "paint a portrait" of a reckless audit byPwC that raises an inference of an intent to defraud .See Paper 54 at 21. However, as discussed abovein some detail, the statements by the confidentialwitnesses provide little, if any, support for anallegation that PwC had actual knowledge or wasreckless in failing to ascertain that Actema'sgoodwill was significantly impaired. Moreover, theargument that here, like in In re MicroStrategy, themagnitude of the misstatement and scope of thefraud "lend further probative weight to Plaintiffs'allegations that the GAAP violations in this caseraise a strong inference of scienter" is unpersuasivein light of the fact that Acterna, unlikeMicroStrategy, did not restate previously reportedfinancial numbers that it admitted were initiallyreported in error . See In re VicroStrategl, 115F.Supp.2d at 624-27, 651 . Moreover, not only werethe massive restatements critical to that courtreaching the conclusion that a strong inference ofthe defendant's scienter had been raised, but the factthat the accounting violations which resulted in sucha large restatement involved the violation of"relatively straightforward accounting principles"was important as well. Id at 652 . Here, Plaintiffsadmit in their opposition papers that FAS 142, themain accounting principle that Defendants allegedlyeither failed altogether to recognize or to applyproperly, calls for a "complicated analysis" indetermining the impairment of goodwill . See Paper54 at 13 . [FN11] Accordingly, Plaintiffs' relianceon In re MicroStrategy to support their assertionthat alleged violations of GAAP, coupled withcircumstantial evidence of fraud such as themagnitude of the restatement and the simplicity ofthe accounting violations alleged, is misplaced .

FN 11 . Moreover, even the article thatPlaintiffs' cite in their opposition to explainthe effect of FAS 142 suggests that itsimplementation is not straightforward . See

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Paper 54 at 3-5. In it, the authors state thatthe illustration they provide of theimpairment testing process required underFAS 142 "does not address thecomplications faced when estimating therequired fair values" of the variousoperation segments, or reporting unit, acompany is testing . See Ronald J. Huefner& James A. Largay III, The Effect of theNew Goodwill Accounting Rules onFinancial Statements, The CPA Journal(Oct .2004), available at, http://www.nysscpa. org/cpajournal/2004110041essentials/p30.1itin (last visited July22, 2005) .

In sum, Plaintiffs' allegations do not support astrong inference that PwC knew or recklesslydisregarded that Acterna's financial statements werematerially false or misleading due to the purportedovervaluation *584 of the company's goodwill . Nordo they support the conclusory allegation that "hadPwC conducted its audit in accordance with GAAS,it would have discovered the massive overvaluationof the Company's goodwill, the Company's failureto adhere to and comply with FAS 142, and theCompany's consequent overstatement of earningsduring the reporting periods in which it failed totimely write down its goodwill ." Paper 28, 1 109 .Plaintiffs' allegations, taken together, do not giverise to a strong inference that when PwC auditedActerna's 2002 financial statements and issued itsopinion, "it recklessly disregarded or outrightignored the risk of falsity of [those] financialstatements ." In re Oxford Health Plans, Inc.Securities Litig., 51 F.Supp.2d 290, 295(S.D.N.Y.1999) . Because Plaintiffs have failed to"state with particularity facts giving rise to a stronginference that [PwC] acted with the required state ofmind," they have failed to state a claim for reliefagainst PwC under § 10(b) of the Exchange Act andRule lOb-5 promulgated thereunder.

B. Loss Causation

[16] Even if Plaintiffs had sufficiently alleged thatone of the individual Defendants and/or PwC hadacted with the requisite scienter, the complaint stil l


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must be dismissed because it fails to include anyallegation to support the essential element of losscausation. In any private action arising under theSecurities and Exchange Act, "the plaintiff shallhave the burden of proving that the act or omissionof the defendant alleged to violate this chaptercaused the loss for which the plaintiff seeks torecover damages ." 15 U.S .C. § 78u-4(b)(4) . As theSupreme Court has recently stated, the PSLRA "makes clear Congress' intent to permit privatesecurities fraud actions for recovery where, butonly where, plaintiffs adequately allege and provethe traditional elements of causation and loss ."Dura Pharr, 125 S.Ct. at 1633 (emphasis added).[FN]2] Accordingly, "[a] direct or proximaterelationship between the loss and themisrepresentation must be shown ." Gasner v. Bd ofSupervisors of the County of Dinwiddie. Yu, 103F.3d 351, 360 (4th Cir .1996).

FN12. In addition to the text of thePSLRA, the legislative history of the Actalso makes clear that this is a pleadingrequirement: "The Conference Committeealso requires the plaintiff to plead and thenprove that the misstatement or omissionalleged in the complaint actually causedthe loss incurred by the plaintiff in newSection 21D(bX4) of the 1934 Act ."H.RConf.Rep. No. 104-369, at 41 (1995)(emphasis added) .

Courts have generally bifurcated the causationpleading requirement, requiring that a plaintiffallege facts establishing both "transactioncausation" and "loss causation ." See, e.g., Garner,103 F.3d at 360; see also, e.g., Lentell v. MerrillLynch & Co. Inc., 396 F .3d 161, 172 (2nd Cir.2005); Semerenko v. Cendant Corp., 223 F .3d 165, 184(3rd Cir .2040); Robbins v. Koger Properties, Inc.,116 F.3d 1441, 1447 (11th Cir .1997) . Thus, "[ i]n asuit brought under [§ 10(b) and] Rule lOb-5, theplaintiff must show both loss causation--that themisrepresentations or omissions caused theeconomic harm-- and transaction causation-thatthe violations in question caused the [plaintiff] toengage in the transaction in question ." Garner, 103F.3d at 360 (internal quotations omitted) (emphasis

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in original) ; Keeney, 306 F.Supp .2d at 541 ; Morrisv. Wachovia Securities, Inc., 277 F .Supp.2d 622,632 (E .D.Va.2003) ("It is settled that causationunder federal securities laws is two-pronged: aplaintiff must allege both transaction causation, i .e.,that but for the fraudulent statement or omission,the plaintiff would not have entered into the *585transaction ; and loss causation, i .e ., that the subjectof the fraudulent statement or omission was thecause of the actual loss suffered.") .

Transaction causation, another way of describingreliance, requires only an allegation that themisrepresentations or omissions caused the plaintiffto engage in the transaction in question . See, e.g.,Lentell, 396 F.3d at 172; Robbins, 116 F.3d at1447; D. E. & J Ltd P'ship, 284 F.Supp.2d at 747."As such , transaction causation is akin to actual or'but for' causation." Robbins, 116 F.3d at 1447 .Here , Defendants do not dispute that Plaintiffs haveadequately alleged transaction causation for a fraudon the market case, but only that they have not andcannot allege loss causation .

"Loss causation 'is the causal link between thealleged misconduct and the economic harmultimately suffered by the plaintiff .' " Lentell, 396F.3d at 172 (quoting Emergent Capital Inv. Mgmt.,LLC v. Stonepath Group, Ina, 343 F.3d 189, 197(2nd Cir.2a03)) ; see Dura Pharms., 125 S.Ct at1631 (defining loss causation as a "causalconnection between the materialmisrepresentation and the loss"). To establishloss causation, "a plaintiff must show 'that theuntruth was in some reasonably direct, orproximate, way responsible for his loss .' " Robbins,116 F.3d at 1447 (quoting Huddleston v. Herman &MacLean, 640 F.2d 534, 549 (5th Cir.1981), aff'din part, rev'd in part on other grounds, 459 U.S .375, 103 S .Ct. 683, 74 L.Ed.2d 548 (1983)) . Putanother way, a plaintiff must show that "themisrepresentation touches upon the reasons for theinvestment's decline in value ." Huddleston, 640F.2d at 549. [FN13] Accordingly, " 'a plaintiff mustallege . . . that the subject of the fraudulent statementor omission was the cause of the actual losssuffered,' i .e., that the misstatement or omissionconcealed something from the market that, whe n

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disclosed, negatively affected the value of thesecurity." Lentell, 396 F . 3d at 173 (internal citationomitted) (quoting Suez Equity Investors, L.P. v.Toronto-Dominion Bank 250 F.3d 87, 95 (2ndCir .2001)); see also Semerenko, 223 F.3d at 185(stating in a fraud on the market case allegingartificially inflated share prices , "[w]here the valueof the security does not actually decline as a resultof an alleged misrepresentation , it cannot be saidthat there is in fact an economic loss attributable tothat misrepresentation").

FN 13 . In an unpublished opinion, theFourth Circuit cited favorably toHuddleston, stating that "the relevantinquiry is whether the misstatement, insome reasonably direct way, 'touches upon'the reason for the investment's decline invalue ." Carlton v. Franklin, 911 F.2d 721,1990 WE. 116788, at *4 (4th Cit . Aug.2,1990) (per curiam)

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Paper 28, 141, 144 (emphasis added).Defendants contend that these specific allegations,as well as others throughout the complaint, do notadequately allege loss causation because theymerely allege that Defendants' purportedmisstatements and/or omissions artificially inflatedthe value of Acterna's stock price, but fail to allegeany economic loss proximately caused _ byDefendants . Plaintiffs counter that the Defendants'argument "disregard[s] Plaintiffs' unequivocalallegations that Defendants' false and misleadingstatements concerning the value of Actema'sacquired goodwill-which was worthless--and itsadherence to FAS 142, caused the price of Actema'sstock to be artificially inflated throughout the ClassPeriod." Paper 53 at 25 . Plaintiffs urge the court tofollow the precedents of the Eighth and NinthCircuits with respect to pleading loss causation,which merely require pleading that the price at thetime of purchase was overstated and sufficientidentification of the cause . Id at 26 .

Here, Plaintiffs allege:As a result of the dissemination of the materiallyfalse and misleading information and failure todisclose material facts, . . . the market price ofActerna's stock was artificially inflated during theClass Period . In ignorance of the fact marketprices of Acterna's publicly-traded common stockwere artificially inflated and relying directly orindirectly on the false and misleading statementsmade by Defendants, or upon the integrity of themarket in which the common stock trades, and/oron the absence of material adverse informationthat was known to or recklessly disregarded byDefendants but not disclosed in public statementsby Defendants during the Class Period, Plaintiffsand the other members of the Class acquiredActerna common stock during the Class Period atartificially high prices and were damagedthereby.

*586 As a direct and proximate result ofDefendants' wrongful conduct, Plaintiffs and theother members of the Class suffered damages inconnection with their respective purchases andsales of the Company's common stock during theClass Period.

It is now abundantly clear, however, that plaintiffscannot satisfactorily allege loss causation simply byalleging that they purchased securities at artificiallyinflated prices . In Dura Pharmaceuticals, theSupreme Court unanimously rejected the NinthCircuit's permissive pleading standard for losscausation . 125 S .Ct. at 1629. In that case, theplaintiffs alleged, similar to Plaintiffs here, that "[i]n reli ance on the integrity of the market, [theplaintiffs] .. . paid artificially inflated prices forDura securities and the plaintiffs suffereddamage[s] thereby." Id at 1630 (internalquotations omitted) . Compare id., with Paper 28, ¶85 ("Defendants' materially false and misleadingstatements during the Class Period resulted inPlaintiffs and other members of the Classpurchasing the Company's common stock atartificially inflated prices, thus causing the damagescomplained of herein.."}, and ¶ 141 . The Courtheld this kind of allegation fails adequately to allegeloss causation . It reasoned :

. . . Normally, in cases such as this one (i .e.,fraud-on -the-market cases ), an inflatedpurchase price will not itself constitute orproximately cause the relevant economic loss .For one thing, as a matter of pure logic, at the

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moment the transaction takes place, theplaintiff has suffered no loss ; the inflatedpurchase payment is offset by ownership of ashare that at that instant possesses equivalentvalue. Moreover, the logical link between theinflated share purchase price and any latereconomic loss is not invariably strong . Sharesare normally purchased with an eye toward alater sale. But if, say, the purchaser sells theshares quickly before the relevant truth beginsto leak out, the misrepresentation wi ll not haveled to any loss. If the purchaser sells laterafter the truth makes its way into the marketplace, an initially inflated purchase pricemight mean a later loss. But that is far frominevitably so. When the purchasersubsequently resells such shares, even at alower price, that lower price may reflect, notthe earlier misrepresentation, but changedeconomic circumstances, changed investorexpectations , new industry-specific orfirm-specific facts, conditions , or other events,which taken separately or together account forsome or all of that lower price.. .. Other thingsbeing equal , the longer the time betweenpurchase and sale , the more *587 likely thatthis is so, i .e., the more likely that other factorscaused the loss .

Dura Pharms., 125 S.Ct . at 1631,32. Looking atthe language of the PSLRA, the common-law rootsof securities fraud actions, and the treatment of losscausation by other courts of appeals, the Courtfound the Ninth Circuit's approach " inconsistentwith the law's requirement that a plaintiff provethat the defendant ' s misrepresentation (or otherfraudulent conduct) p roximately caused theplaintiffs economic loss." Id at 1633 (citingfavorably to Emergent Capital, 343 F.3d at 198 ;)Semerenko, 223 F.3d at 185; Robbins, 116 F .3d at1448; and Bastian v. Petren Resources Corp., 892F.2d 680, 685 (7th Cir .1990) . From this principle,the Court found the Dura complaint legallyinsufficient because it (1) failed "to claim thatDura 's share price fell significantly after thetruth became known ," (2) failed to specify "therelevant economic loss," and (3) failed to describethe "causal connection . . . between that loss and themisrepresentation[s] ." Id.

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Thus, in Dure, the Supreme Court not onlyendorsed, but made controlling, what had developedin the lower courts as the majority view: althoughalleging that a security was artificially inflated maysuffice to plead transaction causation, loss causationrequires the plaintiff to point to some causal linkbetween the alleged misrepresentations and aneconomic loss suffered by the plaintiff. "The mostcommon 'causal link' pled under this rule is ashowing that the plaintiff suffered an economic lossfairly attributable to the public airing of the allegedfraud, i.e ., a significant stock price declineimmediately following the announcement thatreveals the fraud to the public ." D.E. & J LtdP'ship, 284 F.Supp.2d at 748-49, af4 133Fed.Appx. 994 (6th Cir.2005) (unpublished); seealso Lentell, 396 F.3d at 173 ; Semerenko, 223 F.3dat 185 ; Robbins, 116 F .3d at 1447-48 .

In Lentell, the Second Circuit affirmed thedismissal of the plaintiffs' class action complaint forfailing adequately to allege loss causation. There,the plaintiffs alleged that when they invested, theywere relying on the integrity of the market(including the fraudulent statements and omissionsmade by the defendant company during the classperiod), that the shares plummeted throughout theclass period, and that their investments becamevirtually worthless. 396 F.3d at 175. The courtheld that even if the defendants' misstatementsartificially inflated the market price of thecompany's shares, the plaintiffs nevertheless failedto allege loss causation where there was "noallegation that the market reacted negatively to acorrective disclosure regarding the falsity of [thedefendants' statements] and no allegation that [thedefendants] misstated or omitted risks that did leadto the loss ." Id. ; see also Robbins, 116 F.3d at1448 (reversing the lower court and holding that theplaintiffs failed to satisfy the loss causationrequirement because there was no evidence of aconnection between the defendant'smisrepresentations and the economic loss, i .e ., thedecline in the price of the stock).

In D.E. & .7, the court dismissed the plaintiffs'securities fraud claim for failing adequately toallege a "causal nexus" between the allege d

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misrepresentations and the plaintiffs' economicharm. 284 F.Supp2d at 749. Like Plaintiffs here,the D.E. & J plaintiffs alleged that a plethora ofmisstatements, omissions, and violations of GAAPartificially inflated the share price of a company'sstock (Kmart Corporation) and that the plaintiffspurchased the stocks at the inflated prices .Moreover, like here, the price of the stock declinedsteadily throughout the class period, undoubtedlyresulting in economic losses *588 to the purchasers .However, relying on the principles addressedabove, the court found that the plaintiffs had notalleged a causal connection between the allegedmisrepresentations of the defendants "and theeconomic harm they suffered as a direct result ofthe alleged fraud." Id. Although the price of Kmartstock had declined 87% during the class period, thecourt took judicial notice of the fact that "the stockmarket, in general," was in a period of declineduring this period, and that "in contrast to thesubstantial decline in share price that occurred"during the Class Period, "Kmart stock dropped only$.05-from $1 .22 to $1 .17 [4%]-on May 15, 2002,[the last day of the class period,] when thecorrective disclosure was allegedly made." Id at749 n . 26.

[ 17] Here, Acterna's share price dropped 94%during the Class Period. Not only do Plaintiffs notallege that the rapid decline in Acterna's share pricewas caused in some way by Defendants' allegedmisrepresentations or omissions, their complaintsuggests otherwise, alleging that prior to the ClassPeriod, the global communications industryexperienced a severe economic slowdown thatcontinued throughout the Class . Period. Seegenerally Paper 28, ¶ 46 . As discussed above, thiseconomic slowdown resulted in a steady decline insales, orders, and revenues throughout the ClassPeriod, which, Plaintiffs' complaint demonstrates,the company fully disclosed in its public filings .This decline, however, was not unique to Acterna,as evidenced by the near 50% drop in the DowJones U.S. Telecommunications Index during theClass Period. See Paper 25, Ex. 25. "[W]hen theplaintiffs loss coincides with a marketwidephenomenon causing comparable losses to otherinvestors, the prospect that the plaintiffs loss was

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caused by the fraud decreases, and a plaintiffsclaim fails when it has not adequately ple[ Id factswhich, if proven, would show that its loss wascaused by the alleged misstatements as opposed tointervening events ." Lentell, 396 F.3d at 174(internal quotations omitted) ; see also D.E. & J,284 F.Supp .2d at 749 ("[L]oss causation cannot befound if an intervening cause was responsible forthe plaintiffs economic loss .") . Here, Plaintiffshave alleged no facts which, if proven, would showthat their economic loss, i.e., the decline in thevalue of their purchased stocks, was caused by thealleged misstatements of Defendants, as opposed toan alternative intervening event. In fact, Plaintiffs'allegation that "[b]y the time the Companybelatedly admitted the truth-i.e ., that the value ofits goodwill was severely impaired--the price ofActerna's common stock had already fallen" is aclear indicator that Defendants' alleged fraudulentconduct did not cause the precipitous decline inAetema's share price during the Class Period . SeePaper 28, 18 1 .

Moreover, in contrast to the sharp decline in shareprice that occurred during the Class Period, falling94% from $5 .48 on August 14, 2001 to $.33 onOctober 29, 2002, the price declined only onepenny (or 3%), to $ .32, on the day Acternaannounced its goodwill impairment, October 30,2002. See Paper 28, 1 47; Paper 42, Ex. I (chartof Acterna's daily stock prices from December 21,1999 to December 20, 2004). Contrary to Plaintiffs'allegation that when the company revealed the"truth" about its goodwill impairment, it "shockedthe financial markets," the stock history suggestsotherwise . On October 30, 2002, the day the"truth" was revealed, the share price hit a high of$0.43, well above the closing price the previousday, ultimately closing at $ .32, only a penny belowthe previous day's closing price. This fact stronglysuggests that Defendants' alleged misrepresentationsbore no relation to the precipitous drop thatoccurred during the Class *589 Period. Moreover,although not alleged by Plaintiffs, the fact that whenthe alleged "truth" was revealed, or, put anotherway, when a corrective disclosure was made, theshare price only dropped from $.33 to $.32, coupledwith the fact that nearly a week later, on November

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4, 2002, Acterna's stock closed at $37, or $ .04higher than it did the day before the announcedimpairment, strongly suggests that any decline inActerna's share price after October 30, 2002 wasnot a result of the alleged fraud being revealed, butrather a continuation of the rapid decline that begandue to the economic slowdown commencing in2001. [FN14] See Paper 42, Ex . 1 .

FNI4. Additionally, on December 2, 2002,over a month after the market had theopportunity to digest and consider theannounced impairment, Acterna's stockprice closed at $.33, the same price atwhich it closed the day before theimpairment was revealed and a pennyhigher than the day it was revealed .Perhaps this accounts for the complaint's "failure to claim that [Acterna's] shareprice fell significantly after the truthbecame known ." Dura Pharm&, 125S.Ct. at 1634.

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10(b), Rule lOb- 5 claim . Accordingly, for thisadditional reason, the court will grant the individualDefendants' and PwC's respective motions todismiss . [FNI5 ]

FN15. Because PwC is entitled to have thefederal claims against it dismissed on thealternative grounds of failure sufficientlyto allege scienter and failure to allege losscausation, the court need not consider itsremaining arguments for dismissal .

C. Section 20(a) Control Person Liabidi$y

Plaintiffs' failure to state a claim for a primarysecurities fraud violation precludes a finding ofcontrol person liability. In re Crumi Mae, 94F.Supp.2d at 662 (D.Md.2000) . The court willtherefore dismiss Plaintiffs' claim for violation of20(a) of the Exchange Act .

D. Common Law Fraud and Breach of FiduciaryDuty Claims

In sum, Plaintiffs' only allegation as to theeconomic loss suffered is that they purchasedActerna common stock at artificially inflated prices .The Supreme Court, endorsing what had developedas the majority view in the lower courts, has plainlyheld that "the 'arti ficially inflated purchase price'is not itself a relevant economic loss ." DuraPharms., 125 S.Ct. at 1634. Like the Duracomplaint, Plaintiffs' complaint does not claim thatActerna's share price "fell significantly after thetruth became known," nor does it provideDefendants "with notice of what the relevanteconomic loss might be or what the causalconnection might be between that loss and[Defendants] misrepresentation[s] ." It Withoutthe requirement that a plaintiff provide a defendantwith some indication of the economic loss and thecausal connection, the securities laws wouldbecome nothing more than a "partial downsideinsurance policy ." Id. (citing H.RConf.Rep. No.104-369, at 31). Having failed to identify therelevant economic loss and adequately allege thecausal nexus between the alleged misrepresentationsof Defendants and that loss, Plaintiffs have notsufficiently pled an essential element of their ¶

[18] Under 28 U.S .C. § 1367(c)(3), the court hasdiscretion to decline exercising supplementaljurisdiction over state law claims if the court "hasdismissed all claims over which it has originaljurisdiction . . . ." See Bigg Wolf Discount VideoMovie Sales, Inc. v. Montgomery County, Maryland256 F.Supp.2d 385, 400-01 (D.Md.2003). InUnited Mine Workers of America v. Gibbs, 383U.S. 715, 726, 86 S.Ct . 1130, 16 L.Ed.2d 218(1966), the Supreme Court cautioned that"[n]eedless decisions of state law should be avoidedboth as a matter of comity and to promote *590justice between the parties, by procuring for them asurerfooted reading of applicable law." The GibbsCourt went on to say that "if the federal law claimsare dismissed before trial . . . the state claims shouldbe dismissed as well ." Id; see also Hinson v.Norwest Fin. South Carolina, Inc., 239 F.3d 611,617 (4th Cir .2001) ("[W]e conclude that under theauthority of 28 U .S .C. § 1367(c), authorizing afederal court to decline to exercise supplementaljurisdiction, a district court has inherent power todismiss the case or, in cases removed from Statecourt, to remand, provided the conditions set forth

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in § 1367(c) for declining to exercise supplementaljurisdiction have been met .") .

Plaintiffs argue in their opposition that even if thefederal securities claims were dismissed, the courtstill has original jurisdiction over this matterpursuant to its diversity jurisdiction. See 28 U.S .C. §1332(a) . [FN16] First, Plaintiffs failed to assertdiversity as a basis for this court's jurisdictionanywhere in their complaint Not only is there noreference to § 1332, Plaintiffs fail to allege thecitizenship of any party, nor do they allege therequisite amount in controversy . However, in theiropposition brief, they assert that § 1332'srequirements are satisfied because the leadPlaintiffs, Joseph De Leo and Stan Andrews, areresidents of New York and Alabama, respectively,"and each of the individual Defendants acceptedservice (without protest) at the Company'sheadquarters in Germantown, Maryland, thusevincing their status as Maryland residents ." Paper53 at 37; see Gilman v. Wheat, First Securities, Inc.,896 F.Supp. 507, 509 n. 3 (D.Md.1995)("Diversity of citizenship in a class action dependssolely on the citizenship of the named parties .").Whatever the mere acceptance of service indicatesabout the citizenship of the individual Defendants,it demonstrates nothing about the citizenship of theremaining Defendants . [FN17]

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must meet the amount in controversy threshold .Plaintiffs contend that because De Leds andAndrew's "aggregate losses were $84,169, whichexceeds the $75,000 threshold for diversityjurisdiction," § 1332's requirements are met . Paper53 at 37 (emphasis added) . This plainly will notsuffice, as it is clear that the "requisite amount incontroversy cannot be met by aggregating theseparate claims of individual class plaintiffs ."Gilman, 896 F .Supp. at 509 (citing Snyder v. Harris,394 U.S. 332, 336, 89 S .Ct. 1053, 22 L.Ed.2d 319(1969)) . The non-aggregation rule "requires that atleast one individual must have claims greater than[$75,000] for a federal court to have diversityjurisdiction over the action ." Gilman, 896 F.Supp.at 509. Although not addressing this precise issue,the Supreme Court implicitly affirmed this rule inExxon Mobil Corporation v. Allapattah Services,Inc., - U.S. ---, 125 S.Ct. 2611, 2615, -- LEd.2d---- (2005), when it held that "where the otherelements of jurisdiction are present and at least onenamed plaintiff in the action satisfies theamount in-controversy requirement, § 1367 doesauthorize supplemental jurisdiction over the claimsof other plaintiffs . . . even if those *591 claims arefor less than the jurisdictional amount ." See also idat 2636 (Ginsburg, J ., dissenting) (recognizing that"in multiparty cases, including class actions, [theCourt has] unyieldingly adhered to thenonaggregation rule") .

FN16. Section 1332 grants federal districtcourts original jurisdiction over civilactions where "the matter in controversyexceeds the sum or value of $75,000,exclusive of interest and costs, and isbetween . . . citizens of different States . "

FN 17. Moreover, although acceptance ofservice in Maryland is enough for thiscourt to exercise personal jurisdiction overthe individual Defendants, seeMd.Code .Ann., Cts. & Jud. Proc. §6-102(a) (2002), it has no bearing on theissue of subject matter jurisdiction .

However, accepting Plaintiffs' assertions as true,and assuming the citizenship of De Leo andAndrews is diverse from all Defendants, they still

Because De Leo and Andrews impermissiblyattempt to aggregate their claims to meet thejurisdictional threshold, and a . review of theircertifications to this court when seekingappointment as lead plaintiffs indicates that theirindividual claims are well below the jurisdictionalthreshold, this court does not have diversityjurisdiction over this matter. See Paper 21, Ex. C(approximate losses of $47,419 and $36,750respectively). Because the court will dismiss theclaims over which it has federal questionjurisdiction, and does not have any other basis forexercising original jurisdiction, the court willdecline to exercise supplemental jurisdiction overthe remaining state law claims . Accordingly,Plaintiffs' remaining state law claims will bedismissed without prejudice . [FN18 ]


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FNI8. Plaintiffs request remand, ratherthan dismissal, of their state law claims,citing to Hinson. See Paper 53 at 37 n. 27 .This case was filed originally in this court,rather than removed from state court, andthus, is not subject to remand.

E. Motion to Amend the Complaint

Page 2 7

above, including the acknowledgment by Plaintiffsof intervening negative market forces, and Actema'sstock history prior to and after the alleged "truthwas revealed," it appears beyond doubt thatPlaintiffs can put forth no facts supporting thenecessary element of loss causation. Accordingly,Plaintiffs request to amend their complaint will bedenied .

Finally, in a footnote to one of their oppositionbriefs, Plaintiffs request an opportunity to amendthe complaint if the court deems the claims againstDefendants insufficiently pled. See Paper 53 at 42n. 30. Rule 15(a) provides in part that leave toamend "shall be freely given . when justice sorequires ." Fed.R.Civ .P. 15(a) . "In fact, such leave'should be denied only when the amendment wouldbe prejudicial to the opposing party, there has beenbad faith on the part of the moving party, or theamendment would be futile.' " Franks v. Ross, 313F.3d 184, 193 (4th Cir.2002) (quoting Edwards v.City of Goldsboro, 178 F.3d 231, 242 (4th Cir.1999)) (internal quotation and citation omitted) . Thedecision whether to grant leave to amend rests"within the sound discretion of the district court ."Davis v. Virginia Commonwealth Univ., 180 F.3d626, 628 (4th Cir .1999) (citing Foman v. Davis,371 U.S. 178, 83 S .Ct. 227, 9 L .Ed.2d 222 (1962));see also Medigen of Kentucky, Inc. v. Pub. Serv.Comm'n of West Virginia, 985 F.2d 164, 167-68(4th Cir.1993) (noting that "the federal rulesstrongly favor granting leave to amend") .

Considering the length of Plaintiffs' complaint,which demonstrates a thorough, albeit insufficient,effort to comply with the pleading requirements ofthe PSLRA, and the nature of its deficiencies,particularly with respect to its inability to allege anycausal connection between Plaintiffs' economic lossand Defendants' alleged misstatements, the courtconcludes allowing Plaintiffs an opportunity toamend would be futile . There is no indication intheir lengthy and sprawling complaint, or in theiropposition papers, that Plaintiffs would be able tostate with particularity any additional facts givingrise to a strong inference that PwC or the individualDefendants acted with the requisite scienter.Moreover, in light of the loss causation discussion

V. Conclusion

For the foregoing reasons, Plaintiffs' federalsecurities claims will be dismissed *592 for failureto state a claim, and the remaining state law claimswill be dismissed without prejudice .

END OF DOCUMENT

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In Re: Cisco Systems Securities Litigation 01-CV-20418...

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