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holding that "nonspeaking defendants" were not liable under the group pleading doctrine where "all of the allegedly false and misleading statements are either oral communications or written quotations of oral communications" of another defendant
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185 F.Supp.2d 1054w (N.D.Cal. 2000) Glen GAYLINN, et al., On Behalf of Themselves and All Others Similarly Situated Plaintiffs, v. 3COM CORPORATION, et al., Defendants. No. C-99-2185 MMC. United States District Court, N.D. California. June 9, 2000Editorial Note:
This opinion is published in the advance sheet at this citation, 185 F.Supp.2d 1054, Gaylinn v. 3Com Corporation, was withdrawn from the bound volume because it is not for publication. Spencer A. Burkholz, Milberg Weiss Bershad Hynes & Lerach LLP, San Diego, CA, Ira M. Press, Kirby McInerney & Squire LLP, New York City, Martin D. Chitwood, Corey D. Holzer, Chitwood & Harley, Atlanta, GA, Francis M. Gregorek, Wolf Haldenstein Adler Freeman & Herz LLP, San Diego, CA, Reed R. Kathrein, William S. Lerach, Stanley S. Mallison, Milberg Weiss Bershad Hynes & Lerach LLP, San Francisco, CA, for plaintiffs.
Boris Feldman, Keith E. Eggleton, Cynthia A. Dy, Dale M. Edmondson, Annah S. Kim, Wilson Sonsini Goodrich & Rosati, Palo Alto, CA, Daniel J. Bergeson, Michelle M. McCliman, Bergeson & Eliopoulos LLP, San Jose, CA, for defendants.
ORDER GRANTING MOTION TO DISMISS
CHESNEY, District Judge.
Before the Court is defendants' motion to dismiss plaintiffs' consolidated first amended complaint ("CFAC") pursuant to the Private Securities Litigation Reform Act of 1995, 15 U.S.C. § 78u-4 et seq., and Rule 12(b)(6) of the Federal Rules of Civil Procedure. Having considered the papers submitted in support of and in opposition to the motion, the Court deems the matter appropriate for decision on the papers, VACATES the hearing scheduled for June 9, 2000, and rules as follows.
BACKGROUND
The following facts are taken from the CFAC unless otherwise noted. This suit is a shareholder class action, brought on behalf of all purchasers of 3Com Corporation ("3Com") stock between September 22, 1998 and March 2, 1999 (the "class period"). (CFAC ¶ 1.)
Defendant 3Com is a company that sells computer networking products, including switches, hubs, and routers ("Enterprise System products"), network interface cards ("NICs"), and modems ("Client Access products"). (CFAC ¶ 1.) Also named as defendants are: Eric A. Benhamou ("Benhamou"), Chairman and Chief Executive Officer ("CEO") of 3Com; Richard W. Joyce ("Joyce"), Senior Vice President, Global Sales; Douglas C. Spreng ("Spreng"), Senior Vice President, Client Access Business Unit; Richard Edson ("Edson"), Senior Vice President, New Business Initiatives; Alan J. Kessler ("Kessler"), Senior Vice President, Global Customer Service; Casey G. Cowell ("Cowell"), Vice Chairman of the Board and consultant to 3Com; Ross W. Manire ("Manire"), Senior Vice President, Carrier Systems Business Unit; Debra J. Engel ("Engel"), Senior Vice President, Corporate Services; John H. Hart ("Hart"), Senior Vice President and Chief Technical Officer, and Christopher B Paisley ("Paisley"), Senior Vice President, Finance and Chief Financial Officer ("CFO") (collectively "individual defendants") (CFAC ¶ 21(a)--(j).)
The above allegations reflect positions held by the individual defendants during the class period.
On September 22, 1998, 3Com reported better-than-expected results for the first quarter of its fiscal year 1999 in a press release stating: "We are pleased to report continuous sequential improvements in our financial performance despite the historical effects of summer seasonality. We are starting to see the benefits of our new product cycle through stronger sales of recently introduced products across our four customer markets." (CFAC¶ 53.)
The quarter ending on August 28, 1998.
On the same day, Benhamou, the CEO of 3Com, and Paisley, the CFO of 3Com, held a conference call with various securities analysts, institutional investors, and large shareholders during which Benhamou and Paisley stated that: (1) 3Com had experienced strong growth during the first quarter with good demand for all product lines; (2) its CoreBuilder 9000 network switch had begun shipping and was selling strongly; (3) 3Com expected to see improved operating margins; (4) Latin American and United States sales were strong; (5) 3Com was achieving sustainable operational improvements and efficiencies; (6) 3Com was continuing to tightly mange its inventories; and (7) 3Com had not seen any slowing in PC Original Equipment Manufacturing ("OEM") sales. (CFAC ¶ 54.)
In subsequent one-on-one phone conversations with investment analysts occurring between September 22 and 23, 1998, Benhamou and Paisley repeated the above statements and also stated that 3Com expected very strong second quarter results and expected fourth quarter and fiscal year earnings-per-share ("EPS") to be $.39--$.47 and $1.30--$1.40, respectively. (CFAC ¶ 55) Following these conversations, various investment analysts issued favorable reports on 3Com and increased their 3Com EPS forecasts for the following quarters. (CFAC ¶ 55--67.)
At the time these statements are alleged to have been made, the "true facts" were that: (1) 3Com was engaging in "channel stuffing" to conceal soft and weakening demand for its Superstack II 3300 and 3900 "edge devices", and its flagship product, the CoreBuilder 9000 network "switch"; (2) 3Com was experiencing serious problems with its Superstack II 3300 and 3900 products; (3) 3Com was encountering serious problems with the CoreBuilder 9000; (4) 3Com had not completed the development of the management software necessary to run the full-featured CoreBuilder 9000; (5) 3Com was encountering lower-than-expected sales to its PC OEM customers; (6) sales of analog modems were significantly slowing down; (7) 3Com was experiencing weakness in its two-tiered distribution channel and was therefore offering certain distributors various price concessions; (8) 3Com was experiencing a material slowdown in demand in Latin America and the United States; and (9) as a result of these conditions defendants knew that their EPS forecasts for subsequent quarters could not be achieved. (CFAC ¶ 68(a)--(l).)
"Channel stuffing" occurs where a company induces its purchasers to purchase more product at the present time than they would in the normal course of business in order to bolster earnings figures in current quarters at the expense of later quarters. See Greebel v. FTP Software, Inc., 194 F.3d 185, 202 (1st Cir. 1999).
On December 22, 1998, 3Com reported favorable second quarter fiscal year 1999 results--EPS of $.36--and stated: "Second quarter results were driven primarily by sustained favorable market conditions across the networking industry and continuous improvements in our operational management ... New product momentum and seasonal strength also contributed positively to the quarter." (CFAC ¶ 74.)
After the release of the second quarter results, 3Com held another conference call with various securities analysts, institutional investors, and large shareholders. During the call, Benhamou and Paisley stated that 3Com was experiencing: (1) strong growth along all product lines; (2) improved and stable margins; (3) strong Latin American and domestic sales; (4) sustainable operational improvements and efficiencies; (5) no slowdown of its PC OEM sales; (6) strong CoreBuilder 9000 sales, and (7) stable prices for Adapter Cards. (CFAC ¶ 75.)
In subsequent one-on-one conversations with investment analysts occurring between December 22 and 23, 1998, Benhamou and Paisley repeated the above statements and also stated that 3Com was forecasting flattish third quarter EPS of $.35--$.37 and was increasing its fourth quarter and fiscal year 1999 EPS forecasts to $.40--$.45 and $1.35--$1.41, respectively. (CFAC.pp 76.)
Following these conversations, analysts issued favorable earnings reports on 3Com. (CFAC pp 76-90.) On December 22, 1998, Bloomberg reported an interview with Bruce Claflin ("Claflin"), the President and Chief Operating Officer of 3Com, in which Claflin stated that: (1) despite initial concerns, 3Com's Latin America business remained strong; (2) 3Com was experiencing improvements across every line; and (3) although the coming quarter is seasonably slow, 3Com had offsetting strengths in their CoreBuilder family. (CFAC ¶ 78.)
At the time of the December conference call and conversations, in addition to the "true facts" that existed at the time of the September 22, 1998 conference call and conversations, 3Com was now encountering more severe competition amidst slowing demand for its NIC products, which required 3Com to grant secret price cuts to key customers in November 1998 to stimulate NIC sales. (CFAC ¶ 92(l).)
On December 23, 1998, 3Com's stock price increased to its 1998 and class period high of $51-1/8 (CFAC. ¶ 78-90.) In the twenty-seven trading days following December 23, 1998, the individual defendants sold 4.2 million shares of 3Com for $189 million in trading proceeds. (CFAC ¶ 91.)
On January 20, 1999, 3Com held its mid-year conference for securities analysts and investors, in which Benhamou, Paisley, Spreng and Ron Sege ("Sege"), head of 3Com's Enterprise Systems Products division, all participated. (CFAC ¶ 95.) During the formal presentation at the conference 3Com executives stated that: (1) its business was picking up; (2) sales of the CoreBuilder 9000 were on target and proceeding well; (3) Client Access Products sales were strong and on plan; (4) 3Com was not experiencing pricing problems; and (5) 3Com was making no change in its existing guidance for EPS forecasts. (CFAC ¶ 95.)
In numerous one-on-one conversations with analysts at the meeting, Benhamou and Paisley assured the analysts that 3Com was making no change in its prior guidance or EPS forecasts. (CFAC ¶ 95.)
On January 21, 1999, 3Com announced that Sege was leaving 3Com. Sege was forced out as head of 3Com's Enterprise Systems Products division because of the serious problems encountered in developing the CoreBuilder 9000 and his failure to complete the commercial volume shipments of that product on time. (CFAC ¶ 106(d).)
On February 2, 1999, 3Com stock was at $47-1/8. By February 10, 1999 its stock had fallen to $30 1/16, as Ingram Micro and Tech Data (two large 3Com distributors) announced disappointing results and Cisco Systems told analysts that its systems business was not as strong as it had hoped it would be. (CFAC¶ 107.) On February 17, 1999, during an interview with Dow Jones News Service, and in various individual conversations with securities analysts, Benhamou stated, inter alia, that 3Com's EPS forecasts had not changed since its December 22, 1999 conference call and that 3Com's results would likely rebound strongly in the fourth quarter. (CFAC ¶ 110.)
On March 3, 1999, 3Com held a conference call with securities analysts in which it stated that third quarter revenues would decline and that its EPS would be $.23, below the $.36 forecasted during the class period. (CFAC ¶ 112.) 3Com stated that this decrease in revenue was due to: (1) poor sales of Enterprise Systems Products in Latin America and the United States; (2) weak sales of modems; (3) declining PC/OEM demand; (4) very poor performance of its Client Access Products business; (5) substantially lower demand for and declining sales of both adapter cards and modems; and (6) a fundamental slowdown in 3Com's business beyond mere seasonality. (CFAC ¶ 112.) That day, 3Com stock dropped to $22-3/4 as analysts cut their EPS forecasts. (CFAC ¶ 112.)
In a March 1999 interview with Network World Fusion, Edgar Masri ("Masri"), who replaced Sege as the new head of 3Com's Enterprise Systems Business, stated that: (1) 3Com had made some "unforgivable mistakes in the enterprise market"; (2) it had experienced long delays in the CoreBuilder 9000 roll out; (3) 3Com's poor customer infrastructure had hurt its business; and (4) "[o]ver the past three or four months [ ], there have been many indications that the enterprise market is slowing down." (CFAC ¶ 112.)
On May 24, 1999, an article appeared in USA Today in which Benhamou was quoted as stating: "Forty-five percent of our revenues are from product lines that have stopped growing ... Obviously this is not the ideal distribution of business." (CFAC ¶ 112.)
On May 11, 1999, plaintiffs filed the present action for securities fraud in contravention of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and SEC Rule 10b-5 promulgated thereunder. By order dated August 11, 1999, the Court granted a motion to consolidate related cases in this action and on September 10, 1999, plaintiffs filed a consolidated complaint. By order filed January 27, 2000, the Court granted defendant's motion to dismiss the consolidated complaint with leave to amend.
On February 28, 2000, plaintiffs filed the CFAC. On March 29, 2000, defendant's filed the present motion to dismiss pursuant to the Private Securities Litigation Reform Act of 1995, 15 U.S.C. § 78u-4 et seq., and Rule 12(b)(6) of the Federal Rules of Civil Procedure.
LEGAL STANDARD
A. Rule 12(b)(6)
A motion to dismiss under Rule 12(b)(6) cannot be granted unless "it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 102, 2 L.Ed.2d 80 (1957). Dismissal can be based on the lack of a cognizable legal theory or the absence of sufficient facts alleged under a cognizable legal theory. Balistreri v. Pacifica Police Dept., 901 F.2d 696, 699 (9th Cir. 1990). Dismissal is disfavored, however, and should be granted only in "extraordinary" cases. United States v. Redwood City, 640 F.2d 963, 966 (9th Cir. 1981).
Generally, a district court may not consider any material beyond the pleadings in ruling on a Rule 12(b)(6) motion. Hal Roach Studios, Inc. v. Richard Feiner And Co., Inc., 896 F.2d 1542, 1555 n. 19 (9th Cir. 1990). Material which is properly submitted as part of the complaint may, however, be considered. Id. In addition, documents specifically referred to in a complaint, though not physically attached to the pleading, may be considered where authenticity is unquestioned. Branch v. Tunnell, 14 F.3d 449, 454 (9th Cir. 1994). Mack v. South Bay Beer Distributors, Inc.,
In analyzing a motion to dismiss, the Court must accept as true all material allegations in the complaint and construe them in the light most favorable to the nonmoving party. NL Industries, Inc. v. Kaplan, 792 F.2d 896, 898 (9th Cir. 1986). Factual allegations may be disregarded, however, if contradicted by documents to which the court may properly refer. Durning v. First Boston Corp., 815 F.2d 1265, 1267 (9th Cir. 1987). Conclusory allegations, unsupported by the facts alleged, need not be accepted as true. Holden v. Hagopian, 978 F.2d 1115, 1121 (9th Cir. 1992).
B. Private Securities Litigation Reform Act of 1995
Section 10(b) of the Securities Exchange Act of 1934 states that it shall be unlawful "for any person ... [t]o use or employ, in connection with the purchase or sale of any security ... any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe." 15 U.S.C. § 78j(b). A plaintiff bringing a claim for securities fraud under § 10(b) and Rule 10b-5 must show: (1) a false and misleading statement or omission or material fact; (2) scienter; (3) reliance; and (4) resulting damages. Paracor Fin., Inc. v. General Electric Capital Corp., 96 F.3d 1151, 1157 (9th Cir. 1996).
In alleging a cause of action under Section 10(b), a plaintiff is subject to heightened pleading standards pursuant to the Private Securities Litigation Reform Act of 1995 ("PSLRA"). The PSLRA was enacted, in large part, to deter "opportunistic private plaintiffs from filing abusive securities fraud claims, in part, by raising the pleading standards for private securities fraud plaintiffs." In re Silicon Graphics Inc. Securities Litigation, 183 F.3d 970, 973 (9th Cir. 1999). The PSLRA contains two sections concerning the requirements for pleading a cause of action under the Exchange Act: (1) Section 21D(b)(1), "Misleading statements and omissions," 15 U.S.C. § 78u-4(b)(1); and (2) Section 21D(b)(2), "Required state of mind." 15 U.S.C. § 78u-4(b)(2).
Section 21D(b)(1) of the PSLRA requires that a plaintiff in a private securities fraud action alleging material misstatements or omissions, "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 all facts on which that belief if formed." 15 U.S.C. § 78u-4(b)(1).
Section 21D(b)(2) of the PSLRA requires that "the complaint shall, with respect to each such act or omission alleged to violate this chapter [the Securities Exchange Act of 1934], state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." 15 U.S.C. § 78u-4(b)(2).
Recently, in Silicon Graphics, the Ninth Circuit interpreted the PSLRA to require that "a private securities plaintiff proceeding under the PSLRA must plead, in great detail, facts that constitute strong circumstantial evidence of deliberately reckless or conscious misconduct.... In order to show a strong inference of deliberate recklessness, plaintiffs must state facts that come closer to demonstrating intent, as opposed to mere motive and opportunity." Silicon Graphics, 183 F.3d at 974.
Section 21D(b)(3) of the PSLRA states that "the court shall, on the motion of any defendant, dismiss the complaint if the requirements of paragraphs (1) and (2) [of Section 21D(b) ] are not met." 15 U.S.C. § 78u-4(b)(3)(A).
DISCUSSION
A. False and Misleading Statements
1. Pleading Standard
Defendants argue that plaintiffs have failed to allege fraud with sufficient specificity to meet the heightened pleading standard of the PSLRA and Silicon Graphics. In particular, defendants argue that plaintiffs have failed to set forth in sufficient detail the sources for their allegations that the alleged statements in question were actually false at the time they were made.
Plaintiffs argue that they are not required to set forth any facts with regard to the sources of their information or the basis of their allegations. Instead, plaintiffs argue, to plead a cause of action for securities fraud, they need only identify a false statement and explain why that statement is false.
Plaintiff's consolidated complaint, which was dismissed with leave to amend by order filed January 27, 2000, contained a boilerplate "Basis of Allegations" paragraph, stating that plaintiff's allegations were based on the investigation of counsel, including a review of various SEC documents, analyst reports, and press releases. (Cons.Compl.¶ 120.) In the CFAC, plaintiffs omit this "Basis of Allegations" paragraph and fail to identify any alternative basis for the allegations contained therein.
Plaintiffs' argument is not persuasive. The PSLRA and Silicon Graphics impose a heightened pleading standard for securities fraud cases that requires plaintiffs to set forth the basis of their fraud allegations in "great detail". Silicon Graphics, 183 F.3d at 985. This includes pleading the sources of plaintiff's information concerning allegations contained in the complaint. See Id. (dismissing complaint under PSLRA where plaintiff failed to plead, inter alia, the sources of plaintiff's information and how plaintiff learned of the reports); Greebel v. FTP Software, Inc., 194 F.3d 185, 194 (1st Cir. 1999) (affirming dismissal on the ground that plaintiffs must "set forth the source of the information" upon which their belief of fraud is based); Head v. NetManage, Inc., 1998 WL 917794 at *4 (N.D.Cal.1998) ("Plaintiffs' claim that they do not have to plead their confidential sources ... is unpersuasive"); Chan v. Orthologic Corp., 1998 WL 1018624 at *16 (D.Ariz.1998) ("Plaintiffs must set out specific facts regarding the source (documents, informants, etc.) of their information about the alleged meeting."); Novak v. Kasaks, 26 F.Supp.2d 658, 661 (S.D.N.Y.1998) ("Plaintiffs' failure to identify these [anonymous former employees and consultants] ... is contrary to the particularity requirements" of the PSLRA).
Plaintiffs also argue that if it is necessary to plead the sources of their information, they would provide the Court with an in carnera review of the sources of the CFAC. As held by the Ninth Circuit in Silicon Graphics, such a submission would be inappropriate and unsupported by authority. Silicon Graphics, 183 F.3d at 983 n. 12.
Accordingly, the Court finds that plaintiffs are required, under the PSLRA and Silicon Graphics, to plead the facts on which their allegations are based, including the sources of such information.
2. Plaintiff's Allegations of Falsity
Plaintiffs allege that the statements issued by defendants during the class period were false and misleading at the time they were made because in actuality, 3Com was: (1) experiencing general adverse business conditions; (2) experiencing problems with specific products; (3) engaging in channel stuffing; and (4) unable to meet its EPS estimates.
Plaintiffs first set of allegations assert that 3Com was experiencing general adverse business conditions during the class period, including: poor sales of Enterprise Systems in Latin America and the United States, weak modem sales, declining PC/OEM demand, poor performance of its Client Access Products and substantially lower demand for its adapter cards and modems.
Plaintiffs allege that these "true facts" were revealed by 3Com during a March 3, 1999 conference call. Plaintiffs fail to set forth, however, any specific facts regarding the conference call, including: the speakers; the alleged statements attributable to each speaker; the participants in the call; how plaintiff came to learn of the alleged admissions made during the call; and the source of plaintiff's knowledge about the call. Accordingly, the Court finds that plaintiffs have failed to provide sufficient facts to support their allegations with regard to the March 3, 1999 conference call. See Wenger v. Lumisys, Inc., 2 F.Supp.2d 1231, 1243 (N.D.Cal.1998).
Plaintiffs also allege that Masri and Benhamou admitted, during interviews given to Network World Fusion, and USA Today, that 3Com had been suffering from adverse business conditions. Both "admissions", however, refer to facts that existed at the time the interviews were given or to future predictions, and do not establish the falsity of any of the statements that were alleged to have been made during the class period.
Under the doctrine of incorporation by reference, the court may "consider documents whose contents are alleged in a complaint and whose authenticity no party questions, but which are not physically attached to the plaintiff's pleading." Silicon Graphics, 183 F.3d at 985. Accordingly, the Court takes judicial notice of "3Com's enterprise net chief speaks out", Network World Fusion, March 8, 1999, (Third Decl. Kim, Ex. 10), and "3Com unit hopes to give company a lift [.] 3Com rethinks mode of profit beyond modems", USA Today, May 24, 1999, p. 3B. (Third Decl. Kim, Ex. 11.)
In the Network Fusion interview, Masri stated, inter alia, that: "Over the past three or four months though, there have been many indications that the enterprise market is slowing down." (Decl. Kim, Ex. 10, "3Com's enterprise net chief speaks out", Network World Fusion, March 8, 1999.) Masri's reference to the slowdown in the enterprise market refers to market indications of future market conditions. As he states in the next paragraph: "Our sense is that there's going to be a bit of a slowdown." Id.
Further, even if the "true facts" were sufficiently pleaded, plaintiffs fail to identify with specificity any statement that would be rendered false by such allegations. Instead, plaintiffs offer vague, paraphrased allegations of oral statements that were made during conference calls and one-on-one conversations with securities analysts. Such allegations are insufficient to plead fraud with particularity under the PSLRA. See Wenger, 2 F.Supp.2d at 1246 (holding paraphrased allegations such as "[product] was succeeding"; "[product] was doing well"; or that defendant "enjoyed strong demand for its [products]" were insufficient to plead fraud under PSLRA). Accordingly, the Court finds that plaintiffs have failed to plead sufficient facts with regard to their allegations of general adverse business conditions to satisfy the pleading requirements of the PSLRA.
Plaintiffs next allege that the CoreBuilder 9000 and the Superstack II 3300 and 3900 products were plagued by technical difficulties and delays. Plaintiffs fail to identify any basis for their allegations regarding the Superstack product, and the only source of information that plaintiffs identify for alleged problems with the CoreBuilder 9000 is the Network World Fusion interview in which Masri allegedly admitted that 3Com had suffered long delays in the CoreBuilder 9000 roll-out. (CFAC ¶ 112.)
The statements made during the interview are too vague to support plaintiffs' allegations that the CoreBuilder 9000 was suffering from long delays and technical problems. Masri does not identify when the CoreBuilder 9000 was released or mention any problems with the product. Indeed, Masri even states that the CoreBuilder 9000 is "one of the better platforms out there on the market." (Third Decl. Kim, Ex. 10.)
The only reference to the CoreBuilder 9000 in the March 8, 1999 Network World Fusion interview occurs when Masri states: "We missed, in the past six years, two key cycles: basic high-density chassis with nice routing technology and 10/100 in the core. I believe it's an unforgivable mistake for a company like 3Com because we guessed that shift and those dynamics on the edge .... We have corrected our miss with the CoreBuilder 9000, one of the better platforms out there on the market." (Decl. Kim, Ex. 10, "3Com's enterprise net chief speaks out", Network World Fusion, March 8, 1999.)
Further, even if the CoreBuilder 9000 were suffering from delays, this fact would not necessarily contradict defendants' statements concerning strong sales and high product demand for the CoreBuilder 9000. Indeed, the CFAC concedes that the CoreBuilder 9000 product had strong pre-shipment orders during the class period. (CFAC ¶ 37(h)-(l).) See Wenger, 2 F.Supp.2d at 1247 ("All businesses from time to time suffer management problems and product delays, but may manage to 'do very well' despite these commonplace business wobbles.")
Accordingly, the Court finds that plaintiffs have failed to plead with the requisite specificity facts showing that 3Com's alleged statements regarding the CoreBuilder 9000 and the Superstack II 3300 and 3900 were false at the time they were made.
Plaintiff next alleges that 3Com engaged in channel stuffing to hide the declining demand for and falling sales of its products. Again, plaintiffs fail to set forth any basis for these allegations or provide any facts as to the source of their information. Further, as plaintiffs state in the CFAC, this alleged channel stuffing was consistent with 3Com's previously publicly disclosed channel inventory guidelines. (CFAC ¶ 45.) Accordingly, even if plaintiff's allegations with regard to channel stuffing were true, such activity would not be actionable under section 10-b. See In re Stac Elec. Sec. Litig., 89 F.3d 1399, 1407 (9th Cir. 1996) (holding no liability for channel stuffing where such practice had been disclosed).
Plaintiff's final set of allegations involves EPS forecasts that are alleged to have been made by Benhamou and Paisley.
The CFAC alleges, in general terms, that Benhamou and Paisley provided various securities analysts with EPS forecasts and assurances regarding future earnings in various one-on-one conversations in the days following quarterly earnings reports and at the January 20, 1999 mid-year conference. Plaintiffs fail to identify any source of information to support these allegations that Benhamou or Paisley provided the analysts with the alleged EPS forecasts. Further, plaintiffs fail to identify the specific conversations that are alleged to have taken place, the substance thereof, and the individual participants therein. Plaintiffs' blanket allegations are insufficient to meet the PSLRA's heightened pleading standards. See Wenger, 2 F.Supp.2d at 1241 (holding general allegations of one-on-one conversations insufficient under PSLRA).
Accordingly, the Court finds that plaintiffs have failed to plead with the requisite specificity, facts supporting their allegations with regard to 3Com's alleged EPS forecasts.
For the reasons expressed, the Court finds that the CFAC fails to state a cause of action for securities fraud under the heightened pleading standards of the PSLRA and Silicon Graphics.
B. "Non-Speaking Defendants"
Defendants argue that all individual defendants except for Benhamou and Paisley ("the non-speaking defendants") should be dismissed from this action for the additional reason that those defendants are not alleged to have issued false or misleading statements during the class period.
In Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164, 114 S.Ct. 1439, 128 L.Ed.2d 119 (1994), the Supreme Court rejected the theory of aiding and abetting (secondary) liability under the securities laws and held that only "primary violators" of section 10(b) may be held liable. Id. at 191, 114 S.Ct. 1439. See Oak Tech., 1997 WL 448168 at *9 (dismissing allegations of "scheme" to defraud investors based on Central Bank).
While the non-speaking defendants did not issue statements during the class period, plaintiffs argue that such defendants nonetheless can be held liable as primary violators of section 10(b) through the group-published doctrine. Under the group-published doctrine, false and misleading statements contained in jointly published documents, such as SEC reports, annual reports, press releases and other "group-published information" are deemed part of a collective work of those individuals involved in generating the documents. See Wool v. Tandem Computers, Inc., 818 F.2d 1433, 1442 (9th Cir. 1987); Allison v. Brooktree Corp., 999 F.Supp. 1342, 1350 (N.D.Cal.1998).
The group-published doctrine does not apply, however, to oral communications, Allison, 999 F.Supp. at 1350, and here, all of the allegedly false and misleading statements are either oral communications or written quotations of oral communications. Accordingly, the Court finds the individual defendants who are not alleged to have issued statements during the class period cannot be held liable for a violation of section 10(b) under the group-published doctrine.
The only allegedly false statements contained in 3Com's press releases are direct quotations from Benhamou. (CFAC ¶ ¶ 53, 74.)
Plaintiffs next argue that the non-speaking defendants are liable as primary violators of section 10(b) based on insider trading. To establish a claim for insider trading, the plaintiff must allege that a corporate insider traded in the securities of his corporation on the basis of material nonpublic information. See United States v. O'Hagan, 521 U.S. 642, 651, 117 S.Ct. 2199, 138 L.Ed.2d 724 (1997). See also Chiarella v. U.S., 445 U.S. 222, 227, 100 S.Ct. 1108, 63 L.Ed.2d 348 (1979) ("[A] corporate insider must abstain from trading in the shares of his corporation unless he has first disclosed all material inside information known to him."). Further, a plaintiff must allege that he traded contemporaneously with the defendant's illegal trades. See Neubronner v. Milken, 6 F.3d 666, 669-70 (9th Cir. 1993); Alfus v. Pyramid Tech. Corp., 745 F.Supp. 1511, 1522 (N.D.Cal.1990) (holding plaintiff must trade within a few days of defendant to meet contemporaneous trading requirement).
Here, as discussed earlier, plaintiffs fail to set forth with the requisite specificity the nature and source of the information in question. Further, plaintiffs fail to plead that they traded contemporaneously with defendants during their alleged illegal trades. Accordingly, the Court finds that plaintiffs have failed to plead a cause of action for insider trading. See Oak Tech., 1997 WL 448168 at *12 (dismissing claim for insider trading based on failure to plead specific facts as required by PSLRA).
C. Scienter
Defendants further argue that plaintiffs fail to plead a cause of action for securities fraud for the independent reason that they fail to allege with particularity the facts which give rise to the requisite scienter. To state a cause of action for securities fraud under the PSLRA, plaintiffs must "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." 15 U.S.C. § 78u-4(b)(2). This requires that "a private securities plaintiff proceeding under the PSLRA must plead, in great detail, facts that constitute strong circumstantial evidence of deliberately reckless or conscious misconduct." Silicon Graphics, 183 F.3d at 974.
In the present case, plaintiffs base their allegations of scienter on: (1) the fact that defendants must have known of the alleged "true facts", (2) the existence of adverse internal reports; and (3) unusual stock sales.
Plaintiffs first allege that defendants must have known of the falsity of their statements by virtue of their positions in the company. Courts have consistently rejected such general allegations as insufficient to plead scienter with the requisite specificity. See Silicon Graphics, 183 F.3d at 974 (holding "blanket statements that defendants must have been aware of the impending losses by virtue of their positions within the company" are insufficient to plead scienter under PSLRA); Lirette v. Shiva Corp., 27 F.Supp.2d 268, 283 (D.Mass.1998) (holding "general inferences that the defendants, by virtue of their position within the company, 'must have known' about the company's problems when they undertook allegedly fraudulent actions" are insufficient to meet PSLRA pleading standards).
Accordingly, the Court finds that plaintiff's allegations with regard to defendants' positions at 3Com fail to give rise to an inference of scienter
Plaintiffs next allege that defendants knew they were issuing false statements by reason of negative internal reports that were circulated at the time the statements were made. In Silicon Graphics, the Ninth Circuit held that general allegations of negative internal reports were insufficient to give rise to an inference of scienter and required the plaintiff to plead, inter alia, "[the alleged reports'] contents, who prepared them, which officers reviewed them and from whom she obtained the information." Id. at 984; see Wenger, 2 F.Supp.2d at 1250 (holding allegation that defendants were aware of the "true facts" because they had access to "internal corporate documents" was insufficient to plead scienter.). Here, plaintiffs rely on vague generalizations concerning "order reports", "backlog reports", "inventory reports", "shipment reports" and "financial reports". (CFAC pp 29-30.) Plaintiffs fail, however, to state with particularity the precise contents of the alleged negative internal reports, the individuals who prepared the reports, which officers received and reviewed each specific report, or from whom plaintiffs received the information concerning these alleged reports. Accordingly, the Court finds, as in Silicon Graphics, that plaintiffs' general allegations regarding negative internal reports fail to "constitute strong circumstantial evidence of deliberately reckless or conscious misconduct."
Finally, plaintiffs argue that their allegations of defendants' unusual stock sales are sufficient to plead scienter under the PSLRA. In Silicon Graphics, the court stated: "Although 'unusual' or 'suspicious' stock sales by corporate insiders may constitute circumstantial evidence of scienter, insider trading is suspicious only when it is 'dramatically out of line with prior trading practices at times calculated to maximize the personal benefit from undisclosed inside information.' " Silicon Graphics, 183 F.3d at 986 (citations omitted). Among the relevant factors to consider in this regard 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. These factors, however, are not exclusive, and the circumstances surrounding individual defendants' stock sales should be considered in determining whether evidence of such sales creates a strong inference of deliberate recklessness. Id. at 987-88.
Here, the stock sales of each individual defendant ranged from 4.1% (Paisley) to 100% (Manire) of their individual holdings. The defendants collectively sold $189 million of their stock holdings and vested options during the four months prior to 3Com's March 3, 1999 announcement that it would not meet its third quarter earnings estimates, and sold almost no stock in the seven months prior to the class period.
"Actual stock shares plus exercisable stock options represent the owner's trading potential more accurately than the stock shares alone." Silicon Graphics, 183 F.3d at 986. Accordingly, in considering the amount and percentages of stock sold during the class period, the Court considers defendants' stock holdings and vested options. The Court takes judicial notice of defendants' stock and vested option percentages as set forth in 3Com's August 1998 Proxy Statement and on Form 4s filed with the SEC. (Decl.Kim, Exs.D--E.)
In support of their argument that defendants' stock sales create a strong inference of scienter, plaintiffs have attached to the CFAC, a declaration from a statistician. The statistician attests that "the chances are remote--with odds of hundreds to one against-that the abnormal returns to the Insider Sales occurred by chance alone, independent of the defendants' possession and use of material, adverse non-public information...." (CFAC ¶ 119, Ex. 1 at 14.)
As stated, although the amount and timing of the stock sales by the defendants as a group may appear unusual at first, it is necessary to examine the circumstances surrounding the sales to determine whether such sales give rise to a strong inference of deliberate recklessness.
In determining whether an inference of scienter can be drawn, relevant considerations include whether the defendant selling the stock is alleged to have actually issued false and misleading statements and the role the defendant allegedly played in the scheme to defraud. See Silicon Graphics, 183 F.3d at 988 (considering circumstances surrounding stock sales such as whether defendant was alleged to have issued statement, and defendant's involvement with management); In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410 (3rd Cir. 1997) (holding allegations of stock sales insufficient to give rise to inference of scienter where two most powerful defendants were not alleged to have sold stock).
In In re Glenayre Tech., Inc., 1998 WL 915907 at *4 (S.D.N.Y.1998), the court held that stock trading by the defendants did not establish scienter where the CEO, CFO and Comptroller did not sell stock. "Certainly, one can assume that these high-ranking corporate officers, arguably the most knowledgeable of all Board members, would be part of any fraudulent scheme to benefit from insider information through pre-emptive stock sales. The absence of sales from these individuals, then, suggests that the [class period] trading by the seven defendants does not give rise to a strong inference of scienter." Id.
Similarly, in Head v. NetManage, Inc., 1998 WL 917794 at *4 (N.D.Cal.1998), the court held that the plaintiffs had failed to establish an inference of the requisite scienter where many of the defendants had sold stock during the class period, but the CEO, the CFO, and "alleged masterminds" of the fraudulent scheme sold very little.
Here, Claflin, the President and Chief Operating Officer of 3Com, is alleged to have issued false and misleading statements concerning the CoreBuilder 9000 product. (CFAC ¶ 78.) Claflin, however, is not alleged to have sold any stock during the class period and is not named as a defendant to this action.
Sege, the former head of 3Com's Enterprise Systems Products division, was the individual in charge of the CoreBuilder 9000 project, and presumably would have had the most knowledge of any of the 3Com executives about the alleged problems with the CoreBuilder 9000. Sege, however, is not alleged to have sold any stock during the class period and, like Claflin, is not named as a defendant in this case.
Benhamou, the CEO, and Paisley, the CFO, are the only two defendants that are alleged to have made any false and misleading statements, and are the two defendants who presumably would have been at the head of any scheme to defraud. Benhamou and Paisley, however, sold the least amount of stock of any of the defendants, 11.5% and 4.1% respectively.
The remaining defendants are not alleged to have made any false or misleading statements, and plaintiffs fail to set forth specific allegations as to what role, if any, these defendants played in assisting in the alleged fraudulent scheme to defraud shareholders.
Moreover, Manire, the defendant who sold the highest percentage of shares, 100%, and the largest amount of stock, sold most of his holdings after he left 3Com in 1998; under his 3Com Executive Stock Option Plan, Manire had to exercise his stock options within ninety days of his departure or forfeit them. (CFAC ¶ 21(g); Kim Decl. Ex. D at 5.) These facts tend to negate any inference of scienter that may arise from Manire's stock sales. See Greebel, 194 F.3d at 206 ("It is not unusual for individuals leaving a company ... to sell shares. Indeed, they often have a limited period of time to exercise their company stock options.") Cowell, the non-speaking defendant alleged to have sold the second largest amount of stock, is an outside director and, unlike the other defendants, does not occupy an executive position at 3Com. (CFAC ¶ 27.) Under the circumstances, the Court finds that the stock sales of the non-speaking defendants are insufficient to give rise to the requisite inference of scienter.
Plaintiffs allege that, as a "highly paid consultant" and as "part of 3Com's top management team or committee," Cowell "was intimately involved in 3Com's daily management actions and was in direct contact with 3Com's senior management on a daily basis and thus was fully aware of all details regarding 3Com's business." (CFAC pp 21(f).) Plaintiffs again fail to provide any specific facts to support their assertions.
Accordingly, the Court finds that the CFAC fails to state a cause of action under the PSLRA for the additional and independent reason that plaintiffs have not sufficiently pleaded scienter.
CONCLUSION
For the reasons set forth above, the Court hereby GRANTS defendants' motion to dismiss. Because plaintiffs assert they could plead additional facts if required to do so, said dismissal is with leave to amend. Any amended complaint shall be filed no later than thirty days from the date of this order.
IT IS SO ORDERED.
In the USA Today article, Benhamou is quoted as stating that he and his company "blundered badly." "Forty-five percent of our revenues are from product lines that have stopped growing ... Obviously this is not the ideal distribution of business." (Decl. Kim, Ex. 10, "3Com unit hopes to give company a lift [.] 3Com rethinks mode of profit beyond modems", USA Today, May 24, 1999.). Benhamou does not state that such conditions existed at the time the alleged false statements were made, but rather that such was the case in late May, almost three months after the class period had ended.