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28 c o o L E Y G o o w ~ L L P

ATTORNEYS AT LAW SAN FRANCISCO

KIRKLEY & P A m , llA’ DOROTHY YATES KIRKLEY (Pro Hac Vice) JULIE R. S C H W A R T Z (Pro Hac Vice) 999 Peachtree St., NE Atlanta, G A 30309 Telephone: (404) 892-878 1 Facsimile: (404) 892-3662

COOLEY GODWARD LLP PAUL A. REm (36133) One Maritime Plaza, 20th Floor Sari Francisco, CA 941 11-3580 Telephone: (415) 693-2000 Facsimile: (4 1 5 ) 95 1-3699

Attorneys for Defendant ALBERT J. BERGONZI

UNITED STATES DISTRICT COURT

NORTHERN DISTRICT OF CALIFORNIA

SAN JOSE DIVISION

IN RE M ~ K E S S O N HBOC, INC. SECURITIES LITIGATION

This Document Relates To:

All Actions

MASTER FILE NO. 99-CV-20743 RMW

CLASS ACTION

DEFENDANT ALBERT J. BERGONZI’S APPENDIX OF SLIP OPINION AUTHORITIES CITED IN REPLY BRIEF IN SUPPORT OF MOTION TO DISMISS THE AMENDED AND CONSOLIDATED CLASS ACTION COMPLAINT

492567 vl/SF @K2FOl!.DOC 082500

BERGONZI’S APPENDIX OF SLW OPINION AUTHOIUTY

(MASTER FILE No. 99-CV-20743 RMW

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28 COOLEV &IDWARD LLI ATTORNEYS AT LAW SIN FRANCISCO

CASES TAB

1. Kane v. Madge Networks h? V. No. C-96-20652-RMW (N.D. Cal. May 26, 2000) .......................................................... 1

554814 vl/SF BW3SOl!.DOC 082500/1256

1. BERGONZI’S APPENDIX OF SLIP OPINION AUTHORITY

(MASTER FILE No. 99-CV-20743 RMW

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IN THE LXITED STATES DISTRICT COGRT. M Y Z 6 ZCoE j

HERBERT KAt't' et al., On Behalf Of Themselves And -411 Others Similarly Simated,

. Plaintiffs,

V.

MADGE SETWORKS N.V. et al.,

Defendants.

NO. C-96-20652-R\IC\;

Defendants' motion to dismiss the complaint with prejudice pursuant to Rule 1 Z(b)(6) or'the

ederal Rules of Civil Procedure and plaintiffs' counter-motion to strike were submitted to the court

n May 19,2000 without oral irgument.' The court h+ read the moving and responding papers.

or the re&ons.set forth below, the court grants the motion to dismiss. The court denies plaintiffs'

Iunter-motion to strike as moot.

I. BACKGROUXD

This securities class action was filed a$er the trading price of publicly traded securities in

The motions were originally set for hearing on May 19,2000, bu t the parries stipulated that e matter should be.decided on the papers after the court issued its tentative ruling granting Ifendants' motion to dismiss.

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IKDER GRASTING DEFEYDAXTS' MOTION TO DISIIISS iYD DENYIYG PLAIZITIFFS' COUNTER-IIOTION TO STRIKE io. C-96-20652-RWV TTS

ORDER GRWTING DEFEXD.&iTS' MOTIObl TO DISMISS A i D DELNYING PLAINTIFFS' COUNTER-~vIOTION TO STRIKE

[Re: Docket No. 132 & 1361

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omissions; 1) failure to plead h~sicy mnd;or mamialicy of undisclosed hcts with p c i c G k y . :

3) failure to plead a duty to disclose; 4) failure to plead scienter to the deyree ofjpsciiicit.. r=z:::r-.:

by the Reform Act; and 5) failure to state 8 claim under Section 1 1 of :he Sscut:ies .Act 3: - . .Y:: ... ' The COUR addresses theses issues in iurn.

A. ~ T E R I A L I T Y OF ALLEGED >IISST.+TEMESTS OR O~~ssroy 's

The court has previously held that many of the statements made by :he &fendants a x : g * ' ::x .

class period were simply too vague to qualify as material misstatements of fact. Soneths!ess. ~ 5 s

complaint is filled with statements that. on their face, are immaterial puffery.

Examples include: I

D ' "the quarter was also characterized by the significant progress n-e made in combining the nvo . I i

companies" (Compl. 7 52); I !

I Madge and Lannet were "working together;" (Id.)

R. Madge personally believed that the Lannet acquisition was "fabulous'' (Id. fi 55) ;

bypassing resellers and marketing directly to end-users would "enhance" sales (Td.4 56);

"merger-related risks are not as s ipf icant as one might assume" (Id. 1 58);

Madge "made great strides toward our long-term goal of becoming the number one leader in

end-to-end switched nenvorking" (Id. 7 59);

hfadge anticipated increased revenues due to "strong demand for its new products" (Id. 1 61);

and

Madge had "marketing strengths" (id. 1 63).

iuch statements cannot be said to "have been viewed by the reasonable investor as having

i,hficantly altered the 'total mix' of information made available." TSC Indus.. Inc. v. Xonhwav,

nc.. 426 U.S. 438,449 (1976) (citation omitted). In a fraud-on-the market case such as this, the

. Defendants also a r p e that the "bespeaks caution" doctrine insulates them f?om liability for leir alleged misstatements and omissions, and that plaintiffs fail to plead their information-and- elief allegations in conformity with the Reform Act. Because the court finds that defendants' lotion is well-taken for the reasons listed above, the court does not reach these other, narrower iSUeS.

4

RDER GR4Z;TIYC DEFEYDAKTS' MOT101Y TO DISWSS

0. C-96-206jl-RMW S D DEXYIXG PL.AlYTIFFS' COCXTER-,\.lOTIOlY TO STRIKE

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soufls have demonstrated 3 willingness to find imrnatsrial as a matm oi13w a x x i n kind of rosy affirmation commonly heard fiom corporate managers snd r,urnbinyiy f amih r to the marketplace-loosely optimistic statements that are so v q x . 5 3 lacking in specificity, or so clearly constituting the opinions of the speaker, that EO reasonable investor could find them important to the total mix of information available.

;haw v. Digital Eauiu. Corn., S2 F.3d 1194, 1217 (1st Cir. 1996). Many, indeed most. or' kt

mtements in plaintiffs' complaints belong to the "rosy affirmation" category.

.I\ prime example is the complaint's repeated insistence that positive statements about

bladge's acquisition of Lannet were false. \\-hen one company acquires another, i t is to be expected

hat the acquiring company will characterize the acquisition in a positive light. Merging companies

hvays predict that they will integrate their sales forces and management teams and that they will

.chieve "synergies" fiom the Combination. Reasonable investors know better than to rely on these

tatements, which are all too familiar to market observers. Thus, in Grossman v. Novell. Inc., 110

:.3d 1 1 12 (10th Cir. 1997), the Court of X??eals held as a matter of law that the following

statements of corporate optimism" about a merger were immaterial:

1) Frankenberg's statements that Novell.had experienced "substantial success" in integrating the sales forces of the two companies, that the merger was moving "faster than we thought," and that the merger presented a "compelling set of opportunities" for the company; and 2) Novell's statements that "[bly moving rapidly to a fully integrated sales force, we are leveraging our combined knowledge of the expanding scope of network solutions," and that it "expects that network applications will quickly reshape customer expectations."

20 F.3d at 1121. The various alleged falsehoods in the complaint relating to the Lannet-Madge

lerger are no different fiom the statements in Grossman. The court concludes that the statements

ere are equally immaterial.

Similarly, companies almost always anticipate strong demand for their products. Not

Irprisingly, courts have rejected forecasts oi"strong demand" as immaterial. See. e.p., Schoenhaut

. h e n c a n Sensors. Inc., 956 F. Supp. 755,792 (S.D.N.Y. 1997) ("continued strong demand");

fRDER GRASTISG DEFE3D.ANTS' .\IOTIOS TO DISMISS LSD DESYIXG PUlrYTIFFS' COLYTER-3IOTIO3 TO STRIKE ;O. C-36-:C65t-iLMW TTS

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19951; see also In re Svntex Corn. Sec. Litiz., 355 F. Supp. lM6. 1096 (N.D. Cal.19Wr IC:T~L:S,

expected "increased sales" and "very strong fiscal 1993"). a, 95 F . X 922 19th Cir. ! G36 1.

. .

.I\ few of the alleged misstatements come closer to b c i q material. For ins t3nc~ lk!cg=.

continued to promote its marketins relationship with Cisco at a time when that re!xior,si:ip '.\.Jj

allegedly falling apart. Ctlile a company can be expected ta "puff' its own product x d nu3~~:7 . : i

abilities. !here is less tolerance for mischaracterizations of a company's relationship tvith :hird !

parties. At the very least, investors may be less wary of statements about a relationship ni!h 3 i I customer than they would be about a company's predictably glowing self-characterizations. a Marksman Partners. L.P. v. Chantal Pharmaceutical, 927 F. Supp. 1297, 1306 (C.D. Cal. 1996)

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:holding that defendant's improper accounting of sales to a key customer was not immaterial as a

naner of law).

However, close inspection shows that even the class-period statements about the Cisco

.elationship are extremely vague:

, November 29. 1995: Analysts at Oppenheimer reported that "Madge management has stated

that it does not expect the acquisition to alter the company's alliances with Cisco Systems."'

(Compl. fi 56.)

Januarv 23. 1996: Madge executives announced during a conference call that "Madge

continued to see strong demand for both token ring and Ethernet switch products both

throughits direct sales efforts and through Cisco for a portion of its token ringssitchss.

Madge was very pleased with its relationship with Cisco, which Was working very well." iK

1. There appears to be a particularity probiem with this allesation as well, inasmuch as the lrecise time and content of the communications behveen Madge executives and the Oppenheimer nalysts is not described in the complaint. .4 company is not responsible for the incorrect st3tements If stock analysts, unless the company has "intertwined" itself with the false.reports, either by llanting them or adopting_ them. See Weneer v. Lumisvs, Z F. Supp. 2d 1231, 1249-50 (X.D. Cal. 998). The facts of such Intertwining must be pleaded with particularity. See id.

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b Januan, 3 . 1996: 'Vadge's relationship with Cisco nad strengthened. n.35 juccesjfKl 2 ~ 2

continuing to flourish." 7 61.)

>larch 16. 1996: .LIadse revien.ed and approved an Oppcnheimer repon that stated:

"hporrantly, we point out that the Cisco and Madge relationship rcmnains i n t x t . " I[?. 6' ;

blast of these statements are general characterizations, not veritiably false assenions of h c t . Ti:=.

one arguably factual assertions is not even particularly optimistic: bladge claimed th3t Cisco \ i ' L j 3 : ! I sales channel for a "portion" of its ringswitches. (Plaintiffs do not contend that this panicaiar

statement tvas false.) However, these allegations may be sufficient for pleading purposes.' AS

iemonstrated below, these claims fail nonetheless because their falsity is not pleaded with

~articularity.

B. P L E m I N G OF FRAUD WITH P.ARTICULARITY

Even assuming the materiality of the alleged misstatements, plaintiffs continue to plead fraud

with inadequate particularity. Specifically, plaintiffs (1) fail to plead the "neutral circumstances" of

he alleged accounting fraud, and (2) fail to plead the falsity of the v'arious other false and misleading

itatements with the required specificity.

1. Failure to Piead Accountina Fraud with Pmicularitv

The complaint alleges two types of accounting fraud: (1) insufficient bad debt reserves in the

irst quarter of 1996, and (2) failure to write off inventory when its value sank because of decreasing

lemand.

Rule 9(b) of the Federal Rules of Civil Procedure requires that "the circumstances

onstitu!ing fraud or mistake shall be stated with particularity." Fed. R. Civ. P. 9(b). Among other

hmgs, this requires pleading of the "time, place, and content of alleged misrepresentation" (the

neutral facts necessary to identify the transaction"). GlenFed, 42 F.3d at 154748.

With regard to many of the alleged misrepresentations, the complaint adequately presents the

The court doubts this, however. Among other things, Madge had warned the market in ontemporaneous SEC filings that by acquiring Lannet, Madge tvas becoming a competitor of Cisco. Vasquez Decl. Ex. B at 15-19 (disclosing numerous risks associated with "intense industry ompetition").)

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M E R CRUTIYG DEFEYDANTS' .\IOTIO?( TO DlSSlISS 3D DENYIZlG PLAINTIFFS' COL'ZiTER-.\lOTION TO STRIKE 0. C-96-106jl-RUW TS

with regard to the Lannet receivables than Lanner had borne prt-merger.- Des?!!? these facts, the Individual Defendants deliberately did not record a charys ag2.ins; income io reflect the impaired value ofhhdye's receivables from the Lam.et \-.Lij. as such a charge Lvould h3ve been c o n t r q to their positive statements about !he integration of the companies and >ladye's hture prospects. Thus. as opposed ':o increasing its allotvance for doubtful accounts. the defendants intentionaily c3ussd Madge to reduce its allowance by S900.000 in lstQ 96 - a deliber;itc nanipuiation ~f its rinx~cial records to falsi& Madge's reponed results for lstQ 96. In 95. >1dgc ' j ratio oibad debt to net sales was approximately 3.2?'0. nhich given hldge's prcbl2n:s u.ith L m e t ' s V-IR;, should have increased in 96. Instead Madge reduced its allowance to mzterially overstate its 1 stQ 36 results.

:Compl. 7 90.) Absent tiom this paragaph is any allegation that any particuisr 3ccount 1 . t ' ~

:endered uncollectible by Madge's business decision to Zdopt a new marketins strategy. This is

nsufficient to suppon a claim of securities fraud. Stack v. Lobo, 903 F. Supp. 1361, 1368-69

'N.D. Cal. 1995) (dismissing claims for inadequate "doubthl account". reserves except as to IWO

lamed customers who had. impaired redi it).^

Failure to Write Off Inventorv

As plaintiffs correctly note, companies are also obliged to value their inventory in accordance

vith G M , whch requires that inventory be assessed at the lower of cost or market value.

'laintiffs allese that defendants knew that their inventory value had deteriorated based on three hcrs:

[ 11 hfadge's new Ringswitch product !vas selling very poorly because it lacked transparent-bridging capability such that the inventory Madge had accumulated of this product was not worth anywhere near the amount Mad,oe had originally estimated. [2] Demand for token ring adaptor card ind Ringswitch products from Cisco - the largest customer for Madge's products - had fallen dramatically beginning in the 4thQ 95 and even more so in the lstQ 96, meaning Madge's future sales of its Ringswitch inventory would be much lower than originally projected since Cisco, its largest single customer, was ,now refusing to purchase Ringswitch in any volume. [3 J Madge's inventory turnover had deteriorated si,snificantly over the past year and its inventory was, at 313 1/96. rurning over less than one time per quarter, a very

This statement is misleading because, as defendants note, Madge had in fact allocated dditional reserves to account for these developments. (Vasq.uez Decl. Ex. B at 5 1 (noting "an :counts receivable reserve for S1,500,000 for estimated exposures related to conforming policies :garding price protection and stock rotation because madge expects to extend these allowances to le Lannet product linett).)

Nowhere does the complaint allege that a specific Lanner reseller refused to pay for previous rders. Instead. throughout the complaint, it is allzged that Lamet resellers were "funous" and were :fusing to "cooperate" with Madge or to place new orders. This, however, is quite different from Ieging that the resellers would renege on their legal oblisation to pay their bills to Madge.

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RDER GRUTISG DEFENDASTS' MOTION TO DISMISS

3. C-36-:065l-R\lW YD DESl'ING PLAINTIFFS' COU.YTER-3IOTION TO STRlKE

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negative switch. 'Madge lied to analysts about increasing inventones !xi:: due :a intentionally accelerated buiidout to me?: increasing demand.

(Corn$. 4 57.) .\gain. plaintiifs have failed to plead xcountlng tial;d n i t i ? ? ~ ~ : x i ~ f : : . ?:~;:.::::s ._

l u r x l c . - . 3v0id pleading specific tiyurzs, jpealilng instead ofdemand :hat hac! "fiien d i - - " ' - ~ ' ' . -...-. I& . - . . . . '

p r o d x u that '.vere "stllin,o v e ~ poorly," and in1.entor-y t-umo\.e: that had "cietenoraI& ::~GI:::L::.:. . . . . -

h-hilz plaintiffs do plead that inventor). turnover \vas less than once per qaaKc: I 2nd Ax ii h i ?-.sa , more than nvice a quarter just a year previously), they fail to place that drop in ccnxx:. nor do 2.2; :

Lake xcount of the many other factors that influence tinanciai ratios such ?s inventor: r::mo~ e:. 500

Stack v. Lobo, No. C-95-200-19 SW, 1995 US. Dist. LENIS 13966. at * I 4 (S.3. Cd. .Apr. 20.

1995)) Thus, the alleged inventory valuation fraud is pled nith insufficient pmiculari;:;.

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-. 7 Failure to Plead Falsitv with Particularitv

Rule 9(b) mandates that the "circ&stances indicating falseness'' must be pleaded with

mticularity. GlenFed, 42 F.3d at 1518. Pleading falsity with particularity requires pleading of

inconsistent contemporaneous statements or information" indicating that the speaker knew that he

v a s not telling the truth. Id. at 1549.

Pleading of inconsistent contemporaneous facts must be itself particular. It is not enough to

llege that there was "confidential non-public information" that contradicted the false statement.

'ouish v. California ;bDlifier, 191 F.3d 983, 994 (9th Cir. 1999). Plaintiffs must also provide .

some detail about the alleged information. other than that its substance contradicted the substance

f the identified statement." Id. at 995. O@nvise, plaintiffs could always use artful pleading to

vade the requirement of pleading falsity with particulirity.

Because the misstatements alleged in the complaint are mostly immaterial, the pleading of

dsity is equally deficient. At times, plaintiffs resort to littlz more than name-calling:

On 11/28/95, Madge issued a release announcing the "completion" of the Lannet acquisition,.which stated:

''1 ~ersonallv believe that this is a fabulous acauisitiorl," added [Roben] Madge. "We are besinning to see immediate benetits tiom the combination of the two commnies. There has been no loss of momenrum within the two organizations. and we are alreadv oDeratino, as a fullv inteemed combined comDanv."

These statements uere deliberate lies as, in fact, the Lannet acquisition was not a 10

mender them any more actionable.

Even a lengthy recitation of seemingly specific "true facts" cannot s&stitu:c for p!s-Liz.;r

Blsity with particularity. For instance, the same pxagaph of the-Complaint offers :he faik*.i ;c;

'true facts" purportedly showins falsity:

The true facts. which the Individual Defendants kneiv. were: Madge had made, and was implementing. a decision to discontinue Lanner's VAR sales channel in favor of an expanded direct sales force. This had

momentum for Lannet's Ethernet products 3s the VARs were furious with Madge, refusing to cooperate \vith Madge and'had begun'to Curtail orders from Madgeilannet. Thus, Madge was being by the acquisition and not seeing immediate benefits. The integration of the sales and marketing departments of the nvo companies was not going well, but instead was resulting. in hct ion and ilI-m41. in pan: because of R. Madge's decision to drop the b a s , whom the Lannet sales and marketing organizations had cultivated and relied upon to make Lannet a success prior to the acquisition, and who now were complaining bitterly and curtailing orders. The head of Lannet U.S..4., Atkinson, a key figure necessary for L m e t ' s continued success, was not being "integrated," but instead was leaving the Company. The two companies were not "alreadv oDeratino as a fullv intekrated combined companv." Efforts at integrating Lannet into Madge were encountering serious and sustained difficulties and they were not operating 3s a fully integrated combined company. The sales and marketing departments of Madge and Lannet were not being "integrated" at ail, but rather were in conflict and upheaval. The Lannet sales'and markiting employees had been relegated to trying to calm the V.-uls, but denied the tools to help the V . U s . sell and service La,n.net products. The Madge salespeople were ineffective at selling Ethernet products because they lacked the technical training and knotv- how to successfidly market them. -4ls0, Lannet's Financial and Operations Department were not being successfully integrated, because the MIS and financial and accounting systems of the nio companies were incompatible and could not be harmonized.

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- alreadv caused disruption of the sales channel and a real loss of business

i: 7 5 5 . ) This is not entirely inadequate. However, many of these "true facts" are difficult to align

ith the allegedly false statements of optimism made by R. Madge. Moreover, they are not

.nicular. For instance, Atkinson is alleged to have 5etn in !he process of "leaving the Conpan);." 11

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"cumil" orders sees unexplained.'' SIoreover.'gi\.cn chat aany of the ailegsd "lies" JX .;* - \ - . - , , ,L . . .> ~ * A - . J . . - - . -

opiniun far x u n p l e , R. >ladye's personal belicfs), ;he pleadings 3re largely inadequxe i::

xidressing the degee to nhich :he speaker did not in fact believe those opinions.

Similar problcms mar plaintiffs' efforts to plead that the upbeat ~ . s s ~ s s F . ~ ~ c ~ ~ s oi!he Cisco

rsiarionship Lvere false. .As noted earlier. it ivould be troubling if hladge u'as 1ying.abour !is

:elationship with a key customer. Hoswer, the complaint provides little in the way of specifics

Cegarding the state of the !vladge-Cisco relationship. Instead, the complaint offers generalities ( the

eelationship was "adversely impacted," and Cisco w s "telling Madge it would sharply curtail

Irders"), which are simply repeated throughout the complaint 'with little variation. (Compl. 77 48.

53, 5 7 , 6 1 .) The complaint does not even hazard a guess at the numbers involved, nor is an)thing of

he form or substance of the communication benveen Cisco and Madge conveyed. Plaintiffs

herefore fail to plead with particularity the falsity of Madge's upbeat assessments of thc Lladge- I

Zisco relationshp. f i

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Finally, the court notes that the complaint consistently fails to allege with the requisite

articularity the falsity of defendants' earnings and revenue forecasts. While such forecasts may be

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1 I ctionable, plaintiffs must plead specific facts that show that such projections "lacked a reasonable

lasis at the time that they were made or were not issued in good faith." Wenzer v. Lumisvs. Inc., 1

'. Supp, 2d 12.31', 1249 (N.D. Cal. 1998). Plaintiffs' complaint fails in this reyard. For instance,

.owhere do plaintiffs allege what good-faith earnings projections would have been, nor do they

resent the facts that would go into making such projections. Instead. they assert. mantra-like, that

le forecasts "were actually known by each Individual Defendant to be false and unattainable." This

. Of course, much of this problem stems from lemselves. One reason that statements like "things indsight can always reveal problems that can make

RDER CR.GTI,YG DEFESDASTS' \lOTlO3 TO DIS3IISS SD D E S Y I S G PLAIYTIFFS' COUhTER-3lOTION TO STRIKE 0. C-96-10652-RLIW rs

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the vagueness of the allezed misstattmsnts are going well" are not actionable is that such optimism seem unfounded.

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is not adequate pleading of falsity (let alone adequate pleading ofscicnter).

c. DUTY TO DISCLOSE ADL'ERSE I~FORWATIOS

rhroughout the complaint, plaintiffs d ! c ~ e :hat deft '=r;txtj taled [o bis;'3je :IC: ::j< -1:~: .:.

information. However, it is well established that the fzdsrzl securities 1 3 t V j rarely rzcjgir? :c~;-:-::s

to disparage their own product lines or the skills o f h i r rr.anage:s. In re C72fizx:: > x . - I L:::: .

S90 F.Zd 623, 640 (3d Cir. 1990) (holding that Rule lob-5 did not require compsn!: :o Zisciass :?.x

its research was "meaningless" or that its management w-as "unfocused" and "unable to m c q e ' ' 1 .

Nor are companies required to predict that their future operations \vi11 fail. See id. at 64 1 b.oidi.2

that company was not required to disclose that its new products "were not amenable to being

marketed successfdly"). Many of the alleged omissions seem to be of this variety: for instance the i

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alleged failures to disclose problems in adding new features to the hngswitch. n-hich are alleged

:hroughout the complaint. .(Compl. 77 48, 53, 57, 61, 63, 69.) Other "omissions" appear to relate to !

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nformation that was readily available to the public, such as declining demand for hladge products.

3ee In re Stac Elecs. Sec. Litiq., 89 F.3d 1399, 1410 (9th Cir. 1996) (affirming dismissal of

:omplaint that alleged that defendants had failed to disclose weakened product demand. because

uch information is,publicly known, despite complaint's characterization of such infomation as con-

mblic and will "defeat claims of fiaud on the market.").

At a more fundamental level, plaintiffs fail to plead any facts that would give rise to a duty to

iisclose material non-public information. Plaintiffs appear to allege three sources of a duty to

iisclose: (1) a duty to update previous projections of success in deve1oping.a FDDI capability for the

tingswitch; (2) a duty to disclose triggered by affirmative representations; and (3) a duty to disclose

nformation when Madge issued shares to Lannet and Teleos shareholders.

Plaintiffs' first argument is unavailing. Before the class period, the most definitive statement

hat Madge had made about the release of FDDI capability for the hngswitch was that.it was

targeted" for the first quarter of 1996 as part of a broader "roadmap" for developing new products.

Vasquez Decl. Ex. A at 191-93.) These statements, themselves too vague to be actionable, could

.ot give rise to a subsequent duty to provide updated information announcing development I3

IRDER GK\STI.UC DEFEYDAXTS .VOTIOS TO DISMISS

0. C.36-106j l -WW TS

.SD DESI-;.XC PLAIXTIFFS' COL:STER-.~lOTlOZi TO STRIKE

disageed with Madge's decision to bypass resel!ers and engage in direct marketing. Hon,e\.er. I

general positive statements do not give rise to a duty to disclose the details of internal corporate

iisputes. See Cooueman. v. Individual. Inc., 171 F.3d 43, 50-5 1 (1st Cir. 1999) (holding thar

3ositive statements about company's business model in prospectus did not trizger duty to disclose a

iispute among the company's directors about the company's direction, even though such information

night have been material).

Finally, plaintiffs cite no apposite authority for the proposition that a company issuing shares

)f itself as part of a merger or acquisition has a duty to disclose material non-public information to

ts own shareholders. At least one m e from the Court of Appeals suggests otherwise. San Leandro

3mercencv Med. Plan v. PhiliD Morris, 75 F. 3d 801, 514 (Zd Cir. 1996) (holding that company's

ssuance of S7OO million in debt securities did not trigger duty to disclose adverse facts). Like other

.O. In addition, Madge "bespoke caution" to the market in SEC filings about its product Levelopment schedule: "Although Madge has announced its expected shpment dates for some of hese [new] products, schedules for high technology products are difficult to predict, and there can E no assurance that Madge will achieve its expected shipment dates of these or any other new or nhanced products developed by Madge." (Vasquez Decl. Es. D at 17.) In any case, investors heady know that product development schedules are uncenain at best. Cf. Stac, 89 F.5d at 14 10 notins that it is "public domain" information that high-technology products are uniquely susceptible o risk of obsolescence).

1. The one possible exception (as with issue of materiality) is the characterization of the Cisco elationship. Arguably, by representing that the Cisco-Madge relationship was "intact," defendam {ere then obliged to reveal that there were problems with that relationship. In any event. as .iscussed above, the allegations of falsity md xientzr relating to the Cisco relationship are deficient.

14

IRDER GRASTIYG DEFEYD.\STS' ?lOTlO?i TO DIS3lISS .SD DEYYISG PL.\IYTIFFS' COLSTER-.\IOTIOY TO STRIhX '0 C-96-20652-XLI'N TS

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Pl~intiffs'.theories ofscienter appear to be: 1 ) defendants knew their Statements ~ 2 : : fzij? I

because they received negative internal repons contradicting their public statsnents; -1) cteiezdms'

later statements'were admissions of falsity; 3) defendants $vert to inflat! :he trading pnce lladge

stock to avoid a dilutive effect tiom the Lannet and Teleos acquisitions; 4) two insiders sold 10?i, 3: - 1

1

I their holdings each; 5 ) some positive statements were made suspiciously close to the alleged

;orrective disclosures; 6) defendants' accounting kaud raises a strong inference of scienter; and 7 )

scienter was "manifest." The COUR will briefly address these theories of scienter in turn.

1. Yegative Internal ReDons

Plaintiffs fail to match up even one negative internal repon with any specific s!a:enent of the

iefendmts." All the complaint does is allege that the individual defendants were "hands-on

nanagers" who received information thou& "ehnail, teleconferences, and meetings." (Compl.

77 12, 15.) The complaint even attempts to turn the presence of a fax machine in a conference room

nto evidence of scienter. (&.I 15.) -411 these allegations do is ;how that defendants could have

.earned of infopnation contradicting their public statements, not that they actually did learn such

nformation (or that they,were deliberately reckless to the falsity of their-statements).'' Such

11. Indeed, scienter is pled as a separate section of the complaint, covering the entire class )eriod. This makes.it difficult to piece together allegations ofscienter with allegations of falsity. such pleading appears to violate the Reform'.%ct's requirement that plaintiffs plead scienter "\vith 'espect to each act or omission alleged to violate" the Securities Exchange Act. 15 U.S.C.

.3. #Plaintiffs' allegations of "angry" phone calls and "furious" V.Ws are so unspecific that they io not adequately plead falsity, let alone scienter.

15

i ?8 ~ - 4 ( b)( 3).

IRDER CRArYTlYC DEFEYDAYTS' .\IOTlO!u TO DISWSS L.SD DEN't'ISC PLAIS'TIFFS' CO~YTER-.~lOTlON TO STRJKE ;O. C-36-29652-RLlW' : X

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allega~ions are plainly insufficient under Silicon Grzzhics, nhich rejected dlegations t h : :!x

defendants there had receivcd monthly "F!ash Reports'' and ">lonrnly Financial S t ~ e n ~ r j

Psckages" and that they therdore hew-the true facts :ant:adictir,g their fdse stxrnents. - . . ': . .

F.2d at 9S4-85. The closest the complaint comes to slleging a specific "negative.inttm: :e?cr:" . - ;

that LVilliam .Atkinson. Law.et USA's fomer CEO toid R. lladge in the su rmer or' 1335 : h z ?.:j

direct marketing idea was "crazy." iid. 7 19.) (.~tkinson.~pparently 3150 believed that this dec:si<z

LVX "nauseating", althous~h he did not share that sentiment lvith R. Madge. !hi.).) This is r,ci ::ST. 2

"negative internal repon"-it is an internal c o p r a t e disagreement that can be expected any r i ~ , n = 1

:ompany decides to chanse course. -At best, the Atkinson-Madge conversation reveals that > I~dy- . !

as aware that the decision to bypass Lannet's resellers was not risk-free. However, there is no 1

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ndication that Madge ever represented that the'new marketing strategy was without risks.:'

-. 7 Later ".Admissions"

Madge's later admissions that it had experienced "difficulties in integrating" Madge and

-annet do not create a strong inference of scienter, despite the earlier rosy statements about the

vladge-Lannet merger. Althouzh the earlier optimistic statements may have been misguided, the

ater admissions only reveal that i t might have been unreasonable to be so optimistic, not that there

lad been any fraud. None of the admissions suggest that defendants knew all along that the merger

vould never be successful.

3. Motive to Avoid Stock Dilution

Plaintiffs allege that Madge and R. Madge wished to avo'id the dilutive effects of using stock

3 acquire Langet and Teleos by artificially boosting the price of Madge stock. At best, this is a

notive for fraud; it is not an allegation of particular hcts that would create a "strong inference" of

cienter. Moreover, it is a weak motive at best, because every corporation and large-scale

hareholder would have this motive. See In re PETstlART. Inc. Sec. Litig., 61 F. Supp. Zd 982,993

D. xriz. 1999) (rejectins allegation, even under pre-Riform Act standard, that motive to facilitate .

1

4. To the contrary, when Madge acquired Lanner, i t disclosed the risks of a possible swi!ch to irect marketing. (Vasquez Decl. Ex. B at 20.)

16

RDER GR-\STlYG DEFESDAaTS' 410TIOK TO DIS.)IISS

0. C.-96-?065l.R!.l\V TS

SD DEBL'ISG PLAliuTlFFS' COLSTER->lOT!O~ TO STFUKE

4. Insider Trading

In Silicon Grmhics, the Ninth Circuit held that insider trading by six defa~dants did [IO[ rzke

a strong inference of scienter because four of the defendants "sold a relatively small portion of their

total holdings and traded in a manner consistent with prior practice." Id. at 9s;. The Ninth Circuit

also noted innocenr explanations for the substantially larger sales by two insiders, one of whom Sold

75.3 percent of hs holdin,os in the company. See id. The insider trading in this case pales in

comparison. Only two insiders are alleged to have engaged in an^ trading during the class period.

Not one misleading statement is attributed to either of these insiders. No insiders (not even the

insider traders) are alleged to have left the class period with more money in hand than before the

:!ass period. The insiders who did trade sold only 20% of their holdings, and it is not alleged that

these sales were out of line with their previous sales. Plaintiffs have accordingly failed to raise a

strong inference of h u d through their insider trading allegations.

5 . Timins

. Plaintiffs arpe that the timing of some alleged misstatements demonstrates that the); nere

nade with scienter. For instance, plaintiffs point out "glowing" statements made by Madge only

four weeks before Madge revealed the disappointing figures that caused Madge shares to drop.

3owever, the final alleged statements made in ?n analyst's report of May 15, 1996 came at a time

xhen h d g e stock had already begun :o slip significantly, and even from theselective snippets

xovidtd by plaintiffs, i t is clear that defendants were largely seeking simply to allay investor

:onctrns ("recent concerns have been overdone . . . Madye Networks remains excellently positioned 17

IRDER GR-\.YTI;UG DEFEXDASTS' .MOTION TO DIS\IISS O D DENYIYG PLAIXTIFFS' COL'STER-.\IOT~OIY TO STRlKE {O. C-96-2C651-R\liV :TS

to continue to enjoy rapid revenue and earnings yowrh"). (Compl. -6 (emphaij d 2 : C 1.. - _.. .-.

m e . an upbeat analyst's report a month befor? the dlcged corectite Cisclosu:~s 15 ?.Liil:. 2 y : ; i . : : :

create a strong inference of scienter. -

6. Alleged Accounting Fraud

.?!aintiffs argue that the dlcged accounting improptkcies arc? tb.e;nsel';ss prcoi 01 j C . 2 - a n - * . .-...-..

because "books . . . do not cook themselves." Opp'n at 1 1 : 1 1. There is some [n th to this x;::r<::.

but the alleged accounting fraud here raises no such inference. First. i t is not cicar h o ~ :k c?ii:j-.;

accounting &aud benefitted anyone. because the allegedly false numbers Lverz cot re l czsd ::x:. :::

latter part of the class period, after hladge had already acquired Lannet and Teleos. Secod . the

3lleged accounting fiaud related to relatively "soti" categories of information-bad debt resen'es X: nvcntory valuation-that are difficult to calculate. Given the complaint's failure to specif) the e s ~ :

lamre of the alleged accounting tizud, the mere incorrectness of Madge's figures cannot by itself

;how scienter.

I .

7. "Manifest" Scienter

Finally, plaintiffs contend that the allegedly large, systemic problems in the hIxigc !

qanization must have alerted the defendants to the falsity of their statements. Opp'n at !2:5-3 i

"Defendants' knowledge of problems affecting Madge's core business is manifest.") The court is i i

lot persuaded. This broad-brush approach to pleading scienter evades the Reform Act's requirement I

hat plaintiffs point to specific facts rendering each alleged misstatement by defendants false. %-'nile

t might be reasonable to assume that high-ranlung corporate officials know about their companies i Iroblerns, the ,Reform Act requires a strong inference of scienter, not merely a reasonablz infercnce.

i jee In re Read-rite Corn. Sec. Litio,, No. C-98-20434 JF (N.D. Cal. filed Mar. 1,2000) (unpublished !

! ~ p . at 5) .

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c. FAILURE TO STATE .A SECTION 11 C L A I M i Plaintiffs seek to state a Section 11 claim based on Madge's allzged representation that the !

.ar!!et and Teleos mcrzers were fair, when, in fact, Madge stock was artificially inflated. .A close

nalysis reveals that this does not state a Section 1 1 claim. First. the actual documents tiled n ith tke I 1 8 .

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RDER GRASTISG DEFE3D.O'TS' .NOTIOS TO DIS.?IISS

0. C-96-:065l-R.LIW i TS

! 3D DEYYIYG PLAIXTIFFS' COC.UTER->IOTIOY TO STRIKE i

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SEC repcrt the recommendations of the Madge, Lsn.net, m.d Te!eos Boards that :he m=:;:r; X 272

fai.r to :he shareholders of their own companies. ( t ' q u e z Decl. Ex. B at 10: Ex. D x 3. ) ' E.. 2:. :f

bhdge stock was anificially inflated. this k t tvould 20t have be5n mst?rial to ~ I S ~ C C ' S

shxeholders, tvho could only have benefitted by allon-ing ccr;.,?any to purckse i r j x<'.;

subsidiaries with inrlated shares. In other ivords. if the stock tve:: r,oi anificis!l>. !n:i~:?C. ::?e

merger tvould have cost to Madge and its shareholders. This tvould hardiy hat.? n i ? r i x

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, .

transaction more fair as to them. & Elfenbein t'. American Fln. Ccn., 4S7 F. Supp. 619 I j.D.>.\-.

1980) (rejecting Section 1 1 claim by shareholders 3s to ivhom disclosure ofa1lcg:dly X Z C ? ~ ~ ]

lnfonnation Lvould have been harmfbl), affd mem., 652 F.Zd 53 (Zd Cir. 198 1). Of caurj<. the

mergers may not have been fair to Lannet and Teleos shareholders. but Madge did not make any

.epresentritions of fairness to them. Thus, plaintiffs fail to state a Section 1 1 claim against Madge.'"

IV. ORDER

For the foregoins reason, the COUR dismisses the complaint in its entirety. Although leave to

mend is liberally granted, this is the fifth amended complaint, and it shows little improvement over

he original complaint, which was filed four years ago. Plaintiffs have pointed to no new facts they

:odd allege, and their latest amendment demonstrates that their factual investigation has !ong since

:eased to yield new facts. Instead, plaintiffs are repeating vague allegations that the COUR has

reviously dismissed as inadequate. The court 'is left with the distinct impression that this case, even

nore than many complaints alleging securities baud, is essentially a case of "baud by hindsight."

Moreover, the Ninth Circuit's recent opinion in Silicon GraDhics underscores the high

tandard that plaintiffs must now meet to plead scienter in a securities case. The allegations in this

ase are much less compelling than that in Silicon Grauhicq; for instance, there is much less insider

rading alleged here than was alleged in Silicon Grauhics. Because leave to amend would therefore

5 . With regard to the Teleos acquisition, only the Teleos Board made any recommendations to :s shareholders. .

6. Moreover, defendants are correct that plaintiffs fail to plead facts showing that the board of liadge did not believe in the truth of its fairness opinion. See A . M . GollomD v. M3C Fin.. Inc., 756 . Supp. 225,233 (D. Md. 1991).

19

RDER GR4,YTISG DEFE.VD.43TS' JIOTION TO DIS!WSS .VD DE,YYISG PLAIKTIFFS' COLSTER-310TION TO STRJU 0. C-96-10652-RLfW TS

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be futile, the court will dismiss the complaint with prejudice. . . Plaintiffs' counter-motion to stilk? is denied 3s moot. because the CWR did ;.a <szj:cf: :.::

materials that were the subject o f t h t rot ion in deciding the motion to dismiss.

Finally, pursunt to 15 U.S.C. $ 73a-4(c)( 1). the court has conducted an indepscitni ::*, ::..:.

3fthe record. Jnd is satisfied that there is ao cause for sanctions purs.. U L L L - * - LO Ruie s t . t . o I 3 i - .

Federal Rules of Civil Procedurz. (In this regard. the court notes that no party has rr.o\.xt .:ji

anctions.)

/>L&y 7T - w+.r RONALD M. hHYTE United States District Judye

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Copy of order mailed on to:

Wil l iam S. Lerach Milberg iveiss Bershad Hynes & Lerach LLp 600 IYtst Broadway, Suite 1800 San Diego. CA 92 10 1

Patrick J. Couzhlin Milberg 1Veis;Bershad Hynes Sr Lerach LL? 100 Pine Street, Suite 2600

Counsel for plaintiffs

Llelvin R. Goldman blomson & Foerster LLP 123 Market Street ;an Francisco, CX 94105-24s2

Counsel for defendants

'1

WER GRAYTISC DEFE?+'D.AfiTS' MOTIOY TO DISMISS i D DESYlfiC PLAIYTIFFS' COUNTER-.\IOTION TO STXIIS 1. C-96-206jl-RUW 'S

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NORTHERN DISTRICT OF CALIFORNIA

NO. C 96-2712 MHP lUSAN POLK, et al.

Plaintiffs,

vs .

,YNN FRITZ, et a1 . Defendants.

lMAR x I; 19.98 / ENTERED IN CIVIL DOCKET

[n re FRITZ COMPANIES SECURITIES LITIGATION

/

Plaintiffs bring this shareholder class action against Fritz

Companies, Inc. and various individual officers and directors

(collectively "Fritz"). The complaint contains claims of

securities fraud under section 10(b) of the Exchange Act of 1934,

15 U.S.C. 5 78j(b), and accompanying Rule lob-5, and controlling

persons allegations under section 20 of that Act, 15 U.S.C. 5

78t(a). The class period runs from August 28, 1995 to July 23,

1996. The court has jurisdiction over this action pursuant to 5 27

of the Exchange Act, 15 U.S.C. 5 78aa and 28 U.S.C. B 1331.

Now before the court are plaintiffs' motion to strike and

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iefendant's motion to dismiss the complaint pursuant to Federal

tules of Civil Procedure 12 (b) and 9 (b) , and the Private Securities

Atigation Reform Act of 1995 ('SRA"), Pub. L . No. 104-67, which

lmends the Securities Exchange Act of 1934, 15 U . S . C . § 78a et seq.

laving considered the parties' arguments and submissions and for

;he reasons stated below, the court now issues the following

nemorandum and order.

3ACKGROUND

Fritz is a San Francisco-based international logistics

?rovider. Its President, Chairman and CEO is defendant Lynn Fritz,

qho is also the son of Fritz's founder. Lynn Fritz owns

2pproximately 39% of the outstanding stock of Fritz. Compl. 'TI

22 (a) . In May 1995, Fritz merged with Intertrans, a Texas-based

company. The merger was made pursuant to the Fritz Companies, Inc.

and Intertrans Corporation Joint Merger Proxy and Prospectus (the

"Proxy"). The merged company changed to a May 31 fiscal year end

from a calendar year. As a result, Fritz issued a form 10-K for

the January-May 1995 transitional period. Filed on August 28,

1995, the Form 10-K marks the beginning of the class period and

included a charge for merger-related expenses of close to $30

million. The Proxy, however, indicated that expenses could surpass

$30 million and could not be calculated conclusively "until the

operational and transition plans are completed." Proxy at 22

(Herrara Decl. Ex. B) . On July 24, 1996, Fritz restated its merger-related expenses,

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and announced it would be taking additional charges totaling $11

million. According to Fritz, the additional expense was necessary

because \'we underestimated final costs related to the full

integration of our two companies" and that \'[wle also erred in

adopting the Intertrans accounting system, as it has proved

inadequate, especially given our rapid growth." Herrera Decl. Ex.

D. Plaintiffs' lawsuits in both federal and state court followed

shortly afterwards.'

Plaintiffs have twice amended the complaint which is the

subject of this motion. In the complaint, plaintiffs identify

numerous allegations by Fritz that they contend were false or

misleading when made. According to plaintiffs, the statements can

generally be divided into three main categories. The first group

includes allegedly false financial statements that overstated

Fritz's earnings and revenues in violation of Generally Accepted

Accounting Principles ("GAAP"). Compl. 8 8 4 4 , 51, 54-55, 63-63,

68-69, 95-114. The second group consists of purported

misstatements concerning the success of the Intertrans merger.

Compl. n8 4 4 , 51, 4 4 , 7 6 . Finally, there are alleged mistatements

i regarding Fritz's acquisitions apart from Intertrans. Compl. 78 46-49, 57-60, 66, 71.

I.

A motion to dismiss will be denied unless it appears that the

plaintiff can prove no set of facts which would entitle him or her

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Corp. v. Federa l Home.-Loan-E3ankofSanFranrisco-, 792

F.2d 1432, 1435 (9th Cir. 19861, cCert. denied, 479 U.S. 1064

(1987). All material allegations in the complaint will be taken as

true and construed in the light most favorable to the plaintiff.

StYl&&-InC. v. Kaplan, 792 F.2d 896, 898 (9th Cir. 1986).

Although the court is generally confined to consideration of

the allegations in the pleadings, when the complaint is accompanied

by attached documents, such documents are deemed part of the

complaint and may be considered in evaluating the merits of a Rule

12(b) (6) motion. DurningJ. F i r s t B o ~ t Q r l A l X & , 815 F.2d 1265,

1267 (9th Cir.) , -denied s- llpmh~Ck.Ummunity Dev.

V. ~ u r n i n q , 484 U.S. 944 (1987). The court may also consider

documents incorporated by reference, Kramer v . T i m ~ Warner. I%,

937 F.2d 767, 773 (2d Cir. 1991); see-db~ v. COILUI&~

-, 667 F.2d 844, 848 (9th Cir. 19821, and documents Ilwhose

contents are alleged in the complaint and whose authenticity no

party questions", BranchZlbnndl, 14 F.3d 449, 453-54 (9th

Cir.) , -, 114 S.Ct. 2704 (1994); a . S P C . T,ltLgA, 89 F.3d 1399, 1405 (9th Cir. 1996).

11. I i d f L % N

Federal Rule of Civil Procedure 9(b) provides in pertinent

part that "in all averments of fraud or mistake, the circumstances

constituting fraud or mistake shall be stated with particularity."

Rule 9(b ) applies to actions brought under federal securities laws.

sf22 e . a . t L . . . . , 42 F.3d 1541,

1545 (9th Cir. 1994) (citations omitted).

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G l e n f e d ,

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the Ninth Circuit held that "Rule 9 (b) requires

llegations of the circumstances mtitutin_q

€raud."' IL at 1547. Conclusory facts and neutral allegations are

insufficient. LdL at 1548 (quoting Seme_aen v. W W , 7 8 0 F.2d

727, 731 (9th Cir. 1985)). Rather, a plaintiff must plead

?recisely the time, place and nature of the alleged fraudulent

xtivities. ~al_u_..andem_C~,mp-ut-e~~-Inc~., 818 F.2d 1433, 1439

(9th Cir. 1987)) . "In other words, the plaintiff must set forth an

3xplanation as to why the statement or omission complained of was

false or misleading.Il .GZenfed, 42 F.3d at 1548.

Furthermore, plaintiffs cannot plead "fraud by hindsight," in

which later events are used to support the falsity of earlier

statements. Instead, a plaintiff must set forth not only why

a given statement was false or misleading, but why it was false or

misleading w h e n . Ld, at 1549. This is done most directly by citing inconsistent contemporaneous statements or internal

information available to defendants. Tct

DISCUSSION

I. Statements

A . work

To survive defendant's motion to dismiss, plaintiffs'

complaint must 'specify each statement alleged 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 a l l facts on which that belief is formed." 15 u.S.C

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78~-4(1). This standard applies to both forward-looking and non

orward-looking statements.

Even before passage of the SRA, the Ninth Circuit had already

stablished strict pleading requirements for securities actions

lursuant to Federal Rule of Civil Procedure 9(b). Plaintiffs were

*epired to explain why the statement or omission complained of was

'alse or misleading when made. Glenfed, 42 F.3d at 1549. In

Lddition, the time, place and nature of the allegedly fraudulent

ctivities must have been pleaded with specificity: m a n v.

a, 49 F.3d 1363, 1370 (9th Cir. 19941, .c-ert.denW, 116 S.Ct.

i8. (1995) (citing Wool v. Tandem C ' o r n p u L e r s , a 818 F.2d 1433,

.439 (9th Cir. 1987)).

This court stated in an earlier order that, because the Ninth

lircuit already applied a heightened pleading standard in

securities case, the SRA did not change the standard for pleading

False and misleading statements in this Circuit. Because of this,

:he court concluded that it could apply pre-SRA Ninth Circuit

laselaw in order to determine whether plaintiffs have properly pled

that the statements at issue were false and misleading.

Based on further review of the SRA and the applicable

legislative history, the court now concludes that the SRA has

somewhat altered the standard for pleading false and misleading

statements. Specifically, the SRA mandates that 'if an allegation

regarding the statement or omission is made on information and

belief, the complaint shall state with particularity on

which that belief is formed." 15 U.S.C. § 78u-4(b) (1) (emphasis

added). In cases of.information and belief pleading, pre-SRA Nintl

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lircuit caselaw did require "a statement of the facts upon which

.he belief is formed." Ko-oL~-.TandemComputers.Inc., 818 F.2d

,433, 1439 (9th Cir. 1987) . However, the Ninth Circuit did not

;pecifically require a plaintiff, as the SRA does, to state all

iacts upon which a belief is based.'

In addition, the legislative history confirms that the SRA

lakes more stringent the applicable pleading standards.

;pecifically, after finding that the Second Circuit employed the

lost stringent pleading standard of the Courts of Appeal, the

Zonference Committee stated that "[blecause [it1 intends to

;trengthen existing pleading requirements, it does not intend to

:odify the Second Circuit's case law." H . R . Conf . . . . Rep. No. 104- !69, 104th Cong., 1st Sess. 41 (1995), 1995 U.S.C.C.A.N. 679,740.

Although parties do not address it, the court has reviewed the

:omplaint and concludes that it is pleaded on information and

Ielief. The court's conclusion is buttressed by f 125 of the

:omplaint, which states that it is based in part on "information

2btained from former employees and discussions with consultants"

and also states that plaintiffs "believe that after reasonable

opportunity for discovery, substantial evidentiary support will

likely exist for the allegations set forth at ffl, 5-6, 8-9, 22-35,

40, 42-43, 45, 50, 56, 61, 64, 67, 70, 75, 82-83, 86-88, 91, 93,

96, 98-99, 101-120, 122-124.'' ID T P S-- . .

. . + ec- 1 1 u, 970 F. Supp. 746, 763 (1997) (concluding, on the basis of a paragraph substantially similar to fl 125, that '[blecause the sources set forth . . . do not provide plaintiffs with personal knowledge, the complaint must be based on information and belief.")

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For the above reasons, and because plaintiffs have made no

real effort to argue that their pleading is not one based on

tnformation and belief, the court will apply the provision of the

;RA dealing with complaints pleaded on information and belief. In

iddition, the court finds that the SRA imposes more stringent

>leading standards for false and misleading statements than did

)re-SRA Ninth Circuit caselaw.

1. W s e FinancialStatements

The gravamen of plaintiffs' allegations regarding Fritz's

financial statements is that the statements overstated Fritz's

revenues and earnings in violation of GAAP. Under G M P , 'revenue

nust be earned before it can be recognized.', Provenz_Y, Mi-,

L O 2 F.3d 1478, 1484 (9th Cir. 1996) (emphasis in original).

Iccording to plaintiffs, there are five reasons why the financial

statements were false and misleading: 1) "Fritz failed to record at

Least $10 million of acquisitions costs and inflated earnings by at

least $6.6 million, or approximately $ . 4 0 per share, for the five

nonths ended May 31, 1995 and each subsequent quarter. 1199, 101Il;

2 ) "Fritz's May 31, 1995 financial statements disguised at least

$1.3 million of Intertrans ordinary bad debt as a merger-related

cost 1103Il; 3 ) 'Fritz fraudulently recorded $26 million of

potential merger candidate's pre-acquisition revenues as its own,

before the mergers took place, and recorded $7 million in revenues

from sales defenda.nts admit did not exist. 106, 107Il; 4) "Fritz

improperly recapitalized $2.1 million in software developments

costs during the third quarter ended February 29, 1996, which were

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)reViOUSly Written off as merger costs. t10811; 5 ) "Fritz failed to

tccount for uncollectible accounts receivable, including $4.7

nillion of Intertrans' accounts receivable over one year old, and

mother $5 million of other receivables. g~llO-ll.,t Plaintiffs'

lpposition at 8-9.

The court finds that plaintiffs have failed to adequately and

specifically state reasons why the financial statements were false

)r misleading when made. To begin with, plaintiffs appear to rely

In as-yet-unconducted discovery to support their allegations.

2ompl. 7 125 (stating that \\after reasonable opportunity for liscovery, substantial evidentiary support will likely exist for

:he allegations set forth at 91 1, 5-6, 8-9, 22-35, 40, 42-43, 45, 5 0 , 61, 64, 67, 70, 75, 82-83, 86-88, 91, 93, 96, 98-99, 101-120,

L22-124.") As this court has previously made clear, the S R p , as is

svidenced by its strict prohibitions of discovery during the

?endency of a motion to dismiss, was enacted in part to require

plaintiffs to make a showing, prior to discovery, that the

statements at issue were false or misleading. 15 U.S.C. § § 77u-

4 (b) (1) & ( 3 ) .

Plaintiffs, of course, argue that they have satisfied the

stringent pleading standard of the SRA and this Circuit. To begin

with, plaintiffs have compiled a chart that they maintain sets out

the alleged misstatements and how they were false or misleading

when made. Hodges Decl. Ex. A . This chart, however, does not

address the paragraphs in the complaint dealing with the financial

statements. Thus, the Hodges chart does nothing to demonstrate

that portions of the financial statements were false when made.

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Second, plaintiffs maintain that Fritz's subsequent

estatement that increased its earlier estimates of merger expenses

nd bad debts demonstrates that its earlier statements were false

hen made. Compl. f 100. While recognizing that such a

estatement is not an admission of securities fraud, plaintiffs

rgue that the restatement does tend to show that the original

llaintiffs recognize, under the standards announced in u n f e d .

'.3d at 1549-50. The Ninth Circuit explained that:

[tlhe fact that an allegedly fraudulent statement and a later statement are d i f f e r e n t does not necessarily amount to an explanation as to why the earlier statement was false. For example, both the valuation of assets and the setting of loan loss reserves are based on flexible accounting concepts, which, when applied, do not always (or perhaps ever) yield a single correct figure. In order to allege the circumstances constituting fraud, plaintiff must set forth facts explaining why the difference between the earlier and the later statements is not merely the difference between two permissible judgments, but rather the result of a falsehood. . . . [Pllaintiffs may need to draw on contemporaneous statements or conditions to make that demonstration.

v ,lenfed, 42 F.3d at 1549 (emphasis in original). The fact that

42

iefendant may have, through its restatement, corrected its prior

msessment, does not establish that the earlier accounting judgment

das false when made. Id- at 1540-41.

Thus, to properly state a claim for accounting fraud,

plaintiffs must "plead facts sufficient to support a conclusion

that [d]efendant[] prepared the fraudulent financial statements and

that the alleged financial fraud was material.', In re oak

, 1997 WL 448168 *8. In addition,

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)laintiffs 'must identify the particular transactions underlying

[the] alleged accounting deficiencies." Ld, (citing re wells

%go Sec. Llt-7 * .

g-, 12 F.3d 922, 926-27 (9th Cir. 1993), .c_ert.

knid, 513 U.S. 917 (1994) ) .

Here, plaintiffs' complaint fails to demonstrate how the

iinancial statements were false wherunade and not just through

lenefit of hindsight. Merely arguing, for example, that "Fritz

Eraudulently recorded $26 million of potential merger candidate's

?re-acquisition revenues as its ownt' does nothing to demonstrate

that any statements in Fritz's financial statements were false when

nade and does not meet the high particularity standards established

by the SRA and Ninth Circuit caselaw. This district has concluded

that, in order to adequately plead securities fraud based on

improper revenue recognition, "[pllaintiffs must allege, at a

ninimum, some particular transactions where revenues were

improperly recorded, including the names of the customers, the

terms of specific transactions, when the transactions'occurred, and

the approximate amount of the fraudulent transactions." In re O a k

T e c h n d l , at "8. Here, one scours plaintiffs' complaint and

papers in vain for any allegations that even come close to meeting

this standard.

Nor have plaintiffs adequately pled their allegations that the

financial statements contained statements which were misleading

because of material omissions by Fritz. For example, plaintiffs

maintain that "Fritz failed to record at least $10 million of

acquisitions costs. . . . 1 1 9 9 , 101." Nowhere, however, do

plaintiffs point to any information, such as facts known to Fritz

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t the time of the financial statements that it failed to disclose,

ending to show the nature of any costs that Fritz purportedly

eglected to record. This is insufficient under Rule 9(b) and the

RA.

At oral argument, plaintiffs argued that under the recent case

- I 122 F.3d 1186 (9th Cir. 1997) , . a s - a m e n & d 1998

L 32678 (1998), the complaint adequately pleads a securities fraud

ause of action based on false financial statements. In C c n p e r , he Ninth Circuit reversed the district court's dismissal with

cejudice of the plaintiffs' complaint, holding that plaintiffs had

let their pleading burdens under G h n k d . C-, 19'98 WL 32678

,11-13. Plaintiffs here maintain that their complaint is

:omparable to that at issue in C.oDp.er and thus sufficient to

rithstand defendant's motion to dismiss.

The court disagrees. C w , although recently decided, did

lot deal with the pleading requirements under the SRA as the

:omplaint at issue was filed on August 15, 1994. 1998 WL 32678,

'2. Thus, it did not consider the heightened pleading standards

incorporated into the SRA, such as the requirement that a complaint

pleaded on information and belief disclose a l l facts underlying the

beliefs. In addition, the court respectfully notes that -,

while not purporting to overrule existing law, appears to conflict

with earlier Ninth Circuit securities cases that required greater

particularity in the pleading of fraud claims. See, e,~,.Glenf, 4 2 F.3d at 1549; v, 89 F.3d at 1405; wool, 818 F.2d at

1439. The court will not parse these conflicts, however, since

they arise in pre-SRA cases.

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In addition, plaintiffs' claims must fail under the truth-on-

:he-market doctrine. It appears to the court that plaintiffs

?remise the reliance element of their fraud claims on the fraud-on-

:he-market doctrine. This doctrine allows plaintiffs who may not

lave read the alleged misrepresentations to rely upon market

Zonditions reflecting the fraud. The theory is that an established

narket assimilates all of the available information regarding a

Darticular stock and sets the stock price accordingly. Investors

nake their decisions in reliance upon the integrity of an informed

narket. Where material misrepresentations have been placed into

the mix of information or omissions render the market information

nisleading the stock price is skewed and investors may be

defrauded. S e e Basic v. Leyinsan, 108 S.Ct. 978, 989, 485 U.S.

224, 241-42 (1988). The "fraud-on-the-market" theory has another

significant benefit. It enables plaintiffs to proceed by way of a

class action because of general reliance on the market whereas

individual claims of reliance would be atypical and could defeat a

class action. Id- at 242 (concluding that "'[tlhe causal connection

between the defendants fraud and the plaintiffs' purchase of stock

in [a fraud-on-the-market] case is no less significant than in a

case of direct reliance on misrepresentations.'Il (citation

omitted) 1 .

Since the hypothesis is that the market reflects all available

information, there is a corollary doctrine called the "truth-on-

the-market" defense. Thus, if at the relevant time the market

contained countervailing information, it is less likely or not

likely that the market was defrauded. This Circuit has adopted the

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truth-on-the-market" defense, holding that in a fraud-on-the-

larket case, a defendant's misrepresentation of or failure to

lisclose material information '!may be excused where that

.nformation has been made credibly available to the market by other

:ources." A p p U m p u L e ~ , 8 8 6 F.2d at 1115; K a p h n , 49 F.3d at

.376.

Here, it is undisputed that Fritz's publicly-filed documents

Zontained information that the estimate of merger expenses was

;ubject to change. The Proxy statement, for example, declared that

\it will not be feasible to determine the actual amount of the

[merger] charge until the operational and transitional plans are

:ompleted." Proxy at 22. It addition, following its audit of

?ritz's financial statements for the transition period, PMG issued

2 management letter which stated that merger costs and bad debt

allowances were "accounting estimates." Thus, it is clear that

information regarding the possible adjustment of the merger

lxpenses was "made credibly available to the market." apple

1 ,ampyter, 886 F.2d at 1115; Kapdan, 49 F.3d at 1376.

2 . MisstatementsX.mcerdwe S u c c e s s of the_

Intertrans-- Plaintiffs point to four statements regarding the success of

the Intertrans merger which they allege were false or misleading

when made. Compl. 18 44, 51, 55, 7 6 . These alleged mistatements

were included in, respectively, a Form 10-K filed around August 28,

1995, a press release of October 2, 1995 reporting Fritz's results

from the first fiscal quarter, a Report to Shareholders issued

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xound October 16, 1995 and a press release of around May 24, 1996.

According to plaintiffs, the complaint properly demonstrates how

mach of the statements was false or misleading when made. Each

allegation will be considered in turn.

a. Form 10-K Qf_Bugws_tl995.

The statement at issue in the Form 10-K reports: "[iln

connection with [the Intertrans] merger, the Company recorded one-

time charges in May 1995 for transaction costs of $3.3 million and

$26.7 million of other costs relating to combining the operations."

Compl. 7 44.3 Unfortunately for plaintiffs, there is absolutely no showing that these statements were false or misleading when made.

In fact, plaintiffs do not discuss this paragraph in their

opposition, except to state that they have included "a descriptive

paragraph" in the complaint describing how these representations

were false and misleading. Compl. a 45. Basically, f 45 alleges that Fritz discovered, while

conducting due diligence prior to its decision to merge with

Intertrans, that the merger costs would be higher than those

reported in the Form 10-K. However, plaintiffs have cited to no

information, such as contemporaneous statements or documents, which

tend to show that Fritz' estimation of merger costs, which was also

contained in financial statements subject to a KPMG audit, was

false or misleading when made. Another court in this district has

recently concluded that unparticularized and unsupported

allegations of adverse information allegedly uncovered during a

routine due diligence investigation do not satisfy the requirements

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t *12 (N.D. C

I n r e V a l e n c e T e c h n & q Y 3 , e c - T 1 7 t.2 SI 1995 WL 274343 * .

al. 1 9 9 5 ) . This court agrees. Plaintiffs'

onclusory statements regarding the alleged falsity of the merger

iharges do not come close to the required "particularized

llegations of the circumstances constituting fraud." Glenfed, 42

'.3d at 1547.

b . ~ s . s - E e . k a s . e - o L Q c ~

The statement at issue in the October 2, 1995 press release

reports "[tlhe company attributes its continued rapid growth to . . a margin expansion resulting from its merger with Intertrans

'orporation ("Intertrans") which was completed on May 30, 1995. "

Iompl. 1 51.4 According to plaintiffs, this statement was

naterially false or misleading because the Intertrans accounting

system, which Fritz had planned to adopt for its air and ocean

Ereight forwarding systems, had not yet been fully integrated with

the already-existing Fritz operating system. Compl. 1 56(b) , (d) . It is undisputed that the Intertrans accounting system proved

to be inadequate for the merged companies. In fact, Fritz issued a

press release on July 24, 1995 stating that "[wle . . . erred in adopting the Intertrans accounting system, as it has proved

inadequate, especially given our rapid growth." Herrera Decl. Ex.

D. Plaintiffs argue that it was false or misleading for Fritz to

represent that it had merged with Intertrans when, in fact, the

accounting system for freight forwarding systems was not yet fully

integrated.

However, the court does not agree with plaintiffs that it was

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false or misleading for Fritz to state that it had merged with

Cntertrans when the accounting system had not yet been fully

integrated. The press release does not state that Fritz had

3lready successfully adopted Intertrans' accounting system, merely

:hat it had merged with Intertrans. Plaintiffs have failed to

iemonstrate how the non-integration of the accounting system tends

:o show that it was false or misleading f o r Fritz to state that it

lad merged with Intertrans. Presumably, two companies can

3fficially merge and yet still have matters to resolve regarding

issues such as automation or staffing. This would not suggest,

ztowever, as plaintiffs seem to believe, that a merger did not in

€act occur or that it was misleading for the company to represent

that it had merged with another company. Thus, the statements in

the press release are not actionable.

c . B e p m z L t o S h a r e h o l d e r s

The October 1995 Report to Shareholders announces that Fritz

"successfully merged Intertrans Corporation into our global

operations." The Report goes on to state that the acquisition of

Intertrans had resulted in growth for the company and that there

had been a "successful integration of Intertrans into the Fritz

family." compl. 1 5 5 .

As before, plaintiffs maintain that these statements were

false and misleading when made because Fritz had not yet fully

adopted the Intertrans accounting system and, in fact, ultimately

concluded that the Intertrans accounting system was inadequate for

the needs of the merged companies. And, as before, plaintiffs fail

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:o explain why incomplete adoption of the accounting system renders

?ritz's statements regarding the merger inaccurate. The press

release makes no representation regarding the Intertrans accounting

system. Without more, plaintiffs cannot meet the pleading burdens

imposed by the SRA and Rule 9 (b) .

d . PressReleaseofay39A

This press release concerned the resignation of Carsten

Wdersen, one of the named defendants in this action, from Fritz's

Board of Directors. Andersen stated "[f]ollowing the very

successful integration of Intertrans Corporation into the Fritz

global network over the last year, my mission is complete." Once

again, plaintiffs maintain that the undisputed incomplete adoption

of the accounting system rendered the statement regarding

"successful integration" of the two companies false and misleading.

The court concludes, once again, that plaintiffs have utterly

failed to demonstrate how or why this statement was false or

misleading when it was made. Andersen did not aver that Fritz had

successfully adopted Intertrans' accounting system, or indeed,

mention anything about the accounting system. Plaintiffs do not

explain how, in either their papers or their complaint (and the

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The final group of statements that plaintiffs allege were

ialse and misleading when made involve Fritz's acquisitions apart

irom Intertrans.5 According to plaintiffs, these statements are

tctionable because they omit information that would have made them

lot misleading. Compl. qT[ 4 6 - 4 9 , 5 7 - 6 0 , 6 6 , 71.

In their opposition, plaintiffs devote only nine lines to the

illeged misstatements regarding the non-Intertrans acquisitions.

Chey maintain that nothing more is required to demonstrate that

:hese statements were misleading than their allegation that:

defendants misrepresented acquisition profits and the costs of the acquisition program; that Fritz used acquisition charges to hide Fritz's payable accounts, bad debt, software costs, freight charges and other ordinary operating expenses enabling Fritz to disguise its deteriorating financial condition and failure to properly accrue for ordinary business expenses.

rhe court agrees with defendant that plaintiffs' belief that this

is sufficient to meet the pleading standards of Rule 9(b ) and the

SRA reveals that plaintiffs have no idea what the SRA and Rule 9(b)

actually require.

As the court has emphasized, plaintiffs must plead facts

supporting an inference that the statements at issue were false or

misleading when made. Glenfed, 42 F.3d at 1448-49; 15 U.S.C. 5

78~-4(b)(l). Conclusory statements such as those made by

plaintiffs do not satisfy the SRA's requirement of providing "the

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llaintiffs do not point t8

they are

o the pay

referring. In addition,

,able accounts, bad debt, s of tware

sosts, freight charges and other operating expenses that they

.llege Fritz was hiding behind its acquisition charges.

Without more, the court must conclude that plaintiffs have not

let their pleading burden. They have utterly failed to elucidate

.ny reasons why Fritz's statements regarding its acquisitions apart

irom Intertrans were false and misleading when made. Thus, the

lourt must dismiss plaintiffs' claims relating to alleged

lisstatements regarding Friz's non-Intertrans acquisitions,

:I. Scienter

Because the court has concluded that plaintiffs have failed to

leet their threshold burden of properly pleading facts supporting

in inference that the statements discussed above were false and

nisleading when made, defendant's motion to dismiss must be

yranted. Thus, the court need not address whether plaintiffs have

Iroperly plead scienter.

CII. Plaintiffs' Mo- to str*

In conjunction with defendant's motion to dismiss, plaintiffs'

Dring a cross-motion to strike a number of documents submitted by

iefendant. Specifically, plaintiffs move to strike Exhibit J to

<he Herrera Declaration, which consists of Copies Of documents

created by KPMG Peat Marwick. According to plaintiffs, these

documents may not be considered by the court because they are

neither referenced nor quoted in the complaint.

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Plaintiffs are incorrect. Although these documents were not

specifically referred to in the complaint, they were implicitly

referenced. For example, plaintiffs maintain that "in connection

with Peat's 1996 audit and in April 1997, Fritz was required to

record millions of dollars of internal bad debt." Compl. 7 93. This court has previously allowed, in conjunction with a motion to

dismiss in a securities fraud case, submission of documents

available to plaintiffs and implicitly referenced in their

complaint. -, 1996 WL 539711 "9 ( N . D . Cal.

1996). As the court stated in Padnes, "plaintiffs cannot make a

broad assertion of the absence of information which is contrary to

known facts in order to resist a motion to dismiss and plunge the

parties into lengthy and costly discovery." L Thus, plaintiffs'

motion to strike must be denied.'

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For the foregoing reasons, defendant's motion to dismiss is

;RANTED. The court does not grant plaintiffs leave to amend. This

is the third complaint in this action filed by attorneys who

specialize in securities class actions and promote themselves as

:he preeminent plaintiffs' securities firm. They should be able to

?lead a complaint that passes muster in one try. Three is

zertainly enough.

In addition, plaintiffs' cross-motion to strike is DENIED.

This order fully adjudicates or renders moot the motions

reflected at Docket ## 35-1 and 4 1 - 1 in case no. C - 9 6 - 2 7 1 2 and the

2lerk of the Court shall remove them from the pending motions list.

The Clerk of the Court shall also close the file.

IT IS SO ORDERED.

2 2

Chi6f Judgg United States District Court Northern District of California

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ENDNOTES

. Plaintiffs' counsel filed three state securities fraud complaints gainst the Fritz defendants in San Francisco Superior Court. ~ 1 1 hree actions were dismissed with prejudice pursuant to defendants' emurrers.

. Because pre-SRA Ninth Circuit caselaw did require particularity nd an explanation why the statement or omission complained of was alse or misleading when made, Glenfed, 42 F.3d at 1549, such caselaw s instructive to the court's analysis. For example, plaintiffs must till plead the time, place and nature of the allegedly fraudulent ctivities with specificity. Kaplan, 49 F.3d at 1370.

. This paragraph of the complaint contains other statements ,eleased in the Form 10-K. Plaintiffs themselves, however, have dentified the misstatements at issue as those dealing with the ,uccess of the merger with Intertrans. As these are the only ltatements dealing even marginally with the merger in this portion of ,he complaint, the court assumes that they are the statements to which daintiffs refer.

: . This press release also included information about Fritz's .ncreases in revenues, income and earnings per share. Plaintiffs' )apers, however, do not challenge the veracity of this information.

i. Fritz acquired a number of small logistics providers.

5 . For example, plaintiffs maintain that a press release of September 11, 1995, wherein "defendants announced the acquisition of :he operations of Rex Air Freight C.A. based in Caracas, Venezuala," vas misleading. Compl. 47. However, this press release, at least i s described by plaintiffs in their complaint, mentions nothing about :he costs or profits of the acquisition.

23