Middlesex Retirement System v. Quest Software Inc et al

REPLY in Support of Motion MOTION to Dismiss Plaintiff's Second Amended Complaint 74

C.D. Cal.April 25, 2008

COOLEY GODWARD KRONISH LLP AT T O R N E Y S AT LA W SA N D I E G O 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 Defs.’ Reply ISO MTD SAC CV06-6863 DOC (RNB) COOLEY GODWARD KRONISH LLP KOJI F. FUKUMURA (189719) (kfukumura@cooley.com) AARON F. OLSEN (224947) (aolsen@cooley.com) 4401 Eastgate Mall San Diego, CA 92121 Telephone:(858) 550-6000 Facsimile:(858) 550-6420 Attorneys for Defendants Quest Software, Inc., Vincent C. Smith, Michael J. Lambert, Douglas F. Garn, David M. Doyle, and Kevin Brooks UNITED STATES DISTRICT COURT CENTRAL DISTRICT SOUTHERN DIVISION MIDDLESEX RETIREMENT SYSTEM, Individually and on Behalf of All Others Similarly Situated, Plaintiff, v. QUEST SOFTWARE, INC., VINCENT C. SMITH, M. BRINKLEY MORSE, MICHAEL J. LAMBERT, DOUGLAS F. GARN, DAVID M. DOYLE, JERRY MURDOCK, JR., and KEVIN BROOKS, Defendants. Case No. CV06-6863 DOC (RNB) DEFENDANTS’ REPLY IN SUPPORT OF MOTION TO DISMISS SECOND AMENDED COMPLAINT DATE: May 12, 2008 TIME: 8:30 A.M. CTRM: 9D JUDGE: Hon. David O. Carter Case 2:06-cv-06863-DOC-RNB Document 109 Filed 04/25/08 Page 1 of 24 Page ID #:1699 COOLEY GODWARD KRONISH LLP AT T O R N E Y S AT LA W SA N FR A N C I S C O 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 TABLE OF CONTENTS Page i. Defs.’ Reply ISO MTD SACCV06-6863 DOC (RNB) Defs.’ Mem. of P. & A. ISO of MTD SAC I. INTRODUCTION........................................................................................... 1 II. ARGUMENT .................................................................................................. 2 A. Knowledge That Stock Options Were Granted Pursuant to the “Bucket and Best-Price” Method is Insufficient to Establish Scienter.................................................................................................. 2 B. The Opposition Confirms That The SAC Fails to Allege a Violation of the 1999 Plan .................................................................... 6 C. Application of APB No. 25 Is Complex, Not “Unambiguous,” and Failure to Follow It Cannot Establish Scienter.............................. 9 D. Plaintiff’s Remaining Contentions Fail to Establish A Strong Inference of Scienter ........................................................................... 12 1. Insider Sales Are Insufficient Show Scienter........................... 12 2. The Size of Restatement and GAAP Violations Are Insufficient to Scienter. ............................................................ 12 3. Receipt of Misdated Stock Options is Insufficient to Scienter ..................................................................................... 13 4. Government Investigations Are Insufficient to Show Scienter ..................................................................................... 14 5. Plaintiff’s Allegations Concerning the Sarbanes-Oxley Act (“SOX”) Are Insufficient to Show Scienter ...................... 15 6. Motive And Opportunity Allegations Are Insufficient to Show Scienter ........................................................................... 16 7. Departure of Morse Is Insufficient to Show Scienter............... 17 8. Inability to Locate Select Documents in the Course of the Special Committee’s Investigation is Insufficient to Show Scienter ..................................................................................... 17 E. The Failure to Allege a Primary Violation Mandates Dismissal of the Insider Trading and Control Person Claims ............................. 18 F. Plaintiff Fails To Allege A “Scheme” ................................................ 19 III. CONCLUSION ............................................................................................. 19 Case 2:06-cv-06863-DOC-RNB Document 109 Filed 04/25/08 Page 2 of 24 Page ID #:1700 COOLEY GODWARD KRONISH LLP AT T O R N E Y S AT LA W SA N FR A N C I S C O 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 TABLE OF AUTHORITIES Page ii. Defs.’ Reply ISO MTD SACCV06-6863 DOC (RNB) CASES City of Austin Police Ret. Sys. v. ITT Educ. Serv., Inc., 388 F.Supp.2d 932, 942 (S.D. Ind. 2005) .......................................................... 15 DSAM Global Value Fund v. Altris Software, 288 F.3d 385 (9th Cir. 2002)........................................................................ 13, 17 Edward J. Goodman Life Income Trust v. Jabil Circuit, Inc., No. 8:06-cv-0716-T-23EAJ, slip op., 2008 WL 977357, at *14-*19 (M.D. Fla. Apr. 9, 2008)............................................................................... 3, 4, 5 Gompper v. VISX, Inc., 298 F.3d 893, 895-96 (9th Cir. 2002) .................................................................. 6 In re Ceridian Corp. Sec. Litig., 504 F.Supp.2d 603, 619 (D. Minn. 2007) ......................................................... 15 In re CNET Networks, Inc., 483 F. Supp. 2d 947, 955 (N. D. Cal. 2007) ...................................................... 10 In re Connetics Corp. Sec. Litig., 2008 WL 269467 (N.D. Cal. Jan. 29, 2008) ...................................................... 15 In re Copper Mountain Sec. Litig., 311 F. Supp. 2d 857 (N.D. Cal. 2004) ...................................................... 6,13, 19 In re Cornerstone Propane Partners, L.P. Sec. Litig., 355 F. Supp. 2d 1069 (N.D. Cal. 2005) ............................................................. 13 In re Hansen Natural Corp. Sec. Litig., 527 F. Supp.2d 1142, 1157 (C.D. Cal. 2007) ................................................................................................... 3 In re ICN Pharmaceuticals, Inc. Sec. Litig., 299 F. Supp. 2d 1055 (C.D. Cal. 2004).................................................... 7, 13, 16 In re Openwave Systems Sec. Litig., 528 F. Supp. 2d 236, 249 (S.D.N.Y. 2007).......................................................... 3 In re Silicon Graphics, Inc. Sec. Litig., 183 F.3d 970 (9th. Cir. 1999)............................................................................. 16 In re Sportsline.com Sec. Litig., 366 F. Supp. 2d 1159 (S.D. Fla. 2004)......................................................... 10, 14 In Re US Aggregates, Inc. Sec. Litig., 235 F. Supp. 2d 1063 (N.D. Cal. 2002) ............................................................. 13 In re Vantive Corp. Sec. Litig., at 1090-91........................................................................................................... 13 In re Witness Systems, Inc. Sec. Litig., No. 1:06-CV-1894, slip op., at 13-14 (N.D. Ga. Mar. 31, 2008)........................................................... 3, 4, 10, 11 Mesko v. Cabletron Sys., Inc., 311 F.3d 11, 39 (1st Cir. 2002) .......................................................................... 17 Ronconi v. Larkin, 253 F.3d 423, 435 (9th Cir. 2001)...................................................................... 12 Case 2:06-cv-06863-DOC-RNB Document 109 Filed 04/25/08 Page 3 of 24 Page ID #:1701 COOLEY GODWARD KRONISH LLP AT T O R N E Y S AT LA W SA N FR A N C I S C O 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 TABLE OF AUTHORITIES (continued) Page iii. Defs.’ Mem. of P. & A. ISO of MTD SACCV06-6863 DOC (RNB) Rudolph v. UTStarcom, et al., No. C 07-04578 SI., slip op., 2008 WL 1734763, at *5-*8 (N.D. Cal. Apr. 14, 2008)............................................................................. 3, 4, 5, 6, 12 Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. ___, 127 S. Ct. 2499, 2504 (2007) .......................................... 16, 17, 18 United States v. Reyes, 2007 WL 1574540, *3 (N.D. Cal. May 30, 2007) ......................................... 9, 11 United States v. Shanahan, 2008 U.S. Dist. LEXIS 29868, at *19 (D. Mo. Mar. 31, 2008)......................... 10 Weiss v. Amkor Tech., Inc., 527 F. Supp 2d 938, 949 (D. Ariz. 2007)................................................. 3, 10, 13 STATUTES 15 U.S.C. §78-4(b)(3)(C) ........................................................................................ 18 Case 2:06-cv-06863-DOC-RNB Document 109 Filed 04/25/08 Page 4 of 24 Page ID #:1702 COOLEY GODWARD KRONISH LLP AT T O R N E Y S AT LA W SA N D I E G O 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 Defs.’ Reply ISO MTD SAC CV06-6863 DOC (RNB) Defs.’ Mem. of P. & A. ISO of MTD SAC I. INTRODUCTION The Opposition is revealing of Plaintiff’s theory of fraud in this case. With respect to scienter, Plaintiff maintains that mere knowledge that stock option grant dates were selected pursuant to Quest’s “bucket and best price” methodology equates to: (i) knowledge of the relevant accounting rules (i.e. Accounting Principles Board Opinion (“APB”) No. 25); (ii) an understanding of how to determine an accounting “measurement date” under APB 25 and the accounting consequences that flow from a difference between a “measurement” date and a “grant” date; and (iii) knowledge that financial statements were materially misstated as a consequence of (i) and (ii). (See Plaintiff’s Mem. of P&A’s ISO Opposition (“Opp.), Doc. No. 103, at 10-12.) This theory, however, rests on a number of fundamental misconceptions. First, the SAC mistakenly characterizes the option grants as being improper, while it is actually the accounting for the option grants that raises issues.1 Additionally, both recent authority and established Ninth Circuit precedent make clear that Plaintiff may not conflate knowledge that the Company used a particular methodology to grant options with guilty knowledge of those three separate sets of facts. In addition, the Opp. confirms that the SAC fails to establish scienter for the following principal reasons: First, the Opp. confirms that the SAC fails to allege adequately a violation of the 1999 Stock Incentive Plan (“1999 Plan”). The Opp. fails to show that the selection of exercise prices pursuant to the “bucket and best price” methodology violated the 1999 Plan. The 1999 Plan allows Quest to grant two different types of stock options – Non-Statutory Stock Options (“NSOs”), and Statutory Tax Qualified Incentive Stock Options (“Tax Qualified Options”). It is critical to note 1 There is no limitation under the 1999 Plan, or under generally accepted accounting principles, with issuing a backdated option. There may be, however, an accounting implication. Case 2:06-cv-06863-DOC-RNB Document 109 Filed 04/25/08 Page 5 of 24 Page ID #:1703 COOLEY GODWARD KRONISH LLP AT T O R N E Y S AT LA W SA N D I E G O 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 2 Defs.’ Reply ISO MTD SACCV06-6863 DOC (RNB) that under the terms of the 1999 Plan, only Tax Qualified Options were subject to a limitation that option grants must be at a price equal to fair market value. Furthermore, as Plaintiff admits in the Opp., Quest granted exclusively NSOs.2 Accordingly, these allegations do not show a violation of the 1999 Plan and do not support a strong inference of scienter. Second, although the Opp. argues that APB No. 25 is simple and not subject to varied interpretation, substantial authority, including a Letter from the Office of the Chief Accountant of the SEC,3 concluded precisely the opposite. At the very least, these authorities show APB No. 25, and its application to the facts and circumstances here, is not “unambiguous,” as Plaintiff urges. As such, the fact that Quest’s employees failed to apply APB No. 25 properly does not (and cannot) show scienter. Finally, the Opp. confirms that Plaintiff’s remaining allegations are insufficient – whether standing alone or taken together. II. ARGUMENT A. Knowledge That Stock Options Were Granted Pursuant to the “Bucket and Best-Price” Method is Insufficient to Establish Scienter Contrary to Plaintiff’s contentions, knowledge of the so-called “intentional backdating” does not amount to securities fraud. (See Opp., Doc. No. 103, at 10- 12.) The SAC, and the Opp., confuse the concept of backdating with the accounting treatment for the transaction. In this case, knowledge that stock option grants were assigned pursuant to a flawed methodology (we have coined the term “bucket and best price”4 method to describe the method Quest used)5 does not – as a 2 With the exception of grants to two individuals since the inception of the 1999 Plan. 3 Letter dated September 19, 2006 from the Chief Accountant of the SEC (“OCA Letter”), App. Ex. E. 4 Plaintiff takes issue with the term “bucket and best price” methodology. (See Opp., Doc. No. 103, at 4, n.8.) This is a shorthand term we use to describe the practice at Quest where, starting in 1999, the Company typically dated new hire and merit stock option grants to employees on a monthly basis. (See App., Ex. B Case 2:06-cv-06863-DOC-RNB Document 109 Filed 04/25/08 Page 6 of 24 Page ID #:1704 COOLEY GODWARD KRONISH LLP AT T O R N E Y S AT LA W SA N D I E G O 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 3 Defs.’ Reply ISO MTD SACCV06-6863 DOC (RNB) matter of law – mean that Defendants “knew or were severely reckless in not knowing [that] Quest’s financial statements were materially false.” 6 (See Opp., Doc. No. 103, at 10); see also In re Hansen Natural Corp. Sec. Litig., 527 F. Supp.2d 1142, 1157 (C.D. Cal. 2007); Weiss v. Amkor Tech., Inc., 527 F. Supp 2d 938, 949 (D. Ariz. 2007); See In re Witness Systems, Inc. Sec. Litig., No. 1:06-CV- 1894, slip op., at 13-14 (N.D. Ga. Mar. 31, 2008);7 Edward J. Goodman Life Income Trust v. Jabil Circuit, Inc., No. 8:06-cv-0716-T-23EAJ, slip op., 2008 WL 977357, at *14-*19 (M.D. Fla. Apr. 9, 2008); Rudolph v. UTStarcom, et al., No. C 07-04578 SI, slip op., 2008 WL 1734763, at *5-*8 (N.D. Cal. Apr. 14, 2008). Recent decisions confirm that, in pleading scienter, a plaintiff may not conflate knowledge that the Company used a particular methodology to grant options with the critical knowledge about the treatment of such actions under the applicable accounting rules and their effect on the financial statements. See [Quest’s 2006 Annual Report, SEC Form 10-K, filed on December 7, 2007], Doc. No. 75-4, at 68.) This method further provided that the grant date for any given new hire would be based on the month during which the new hire signed an employment offer letter or started employment with the Company. (See id.) When options were granted to existing employees as merit grants, they were approved using the same practice and included in the monthly new-hire grant procedure. (See id.) Option grants for these grants for a given month were dated as of the trading date during that month on which the closing price for Quest Common Stock reported by Nasdaq was determined to be the lowest monthly closing price, and the exercise price established for those option grants was the closing sale price of the Common Stock on such date. (See id.) Quest made annual or broad-based, company-wide grants in 2000, 2001, and 2002 to executive and non-executive employees as of dates determined on the same basis as new hire or merit grants. (See id.) 5 Plaintiff mistakenly contends that Defendants “received options, the exercise or strike prices of which did not match the actual date on which defendants received them. . . .” (See Opp., Doc. No. 103, at 11.) (quoting In re Openwave Systems Sec. Litig., 528 F. Supp. 2d 236, 249 (S.D.N.Y. 2007). In fact, “the exercise price for all stock option grants was typically set at the closing sale price of [Quest’s] Common Stock on the original stated grant date.” App., Ex. B [Quest’s 2006 Annual Report, SEC Form 10-K, filed on December 7, 2007], Doc. No. 75-4, at 68.) 6 Contrary to Plaintiff’s contentions, “the exercise price for all stock option grants was typically set at the closing sale price of our Common Stock on the original stated grant date.” App., Ex. B [Quest’s 2006 Annual Report, SEC Form 10-K, filed on December 7, 2007], Doc. No. 75-4, at 68.) 7 A copy of this unreported decision is attached as Ex. G to the Fukumura Decl. for the convenience of the Court. Case 2:06-cv-06863-DOC-RNB Document 109 Filed 04/25/08 Page 7 of 24 Page ID #:1705 COOLEY GODWARD KRONISH LLP AT T O R N E Y S AT LA W SA N D I E G O 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 4 Defs.’ Reply ISO MTD SACCV06-6863 DOC (RNB) Witness, slip op., at 13-14; Jabil Circuit, Inc., slip op., 2008 WL 977357, at *14- *19; UTStarcom, slip op., 2008 WL 1734763, at *5-*8. In Witness, in the context of a very similar securities class action for non- disclosure of alleged stock option backdating, the court rejected this very theory. See Witness, slip op., at 12-14. Notably, both plaintiff’s theory of the case and key allegations in Witness virtually mirror those here. Just as here, the plaintiff in Witness alleged that Witness Systems, Inc. (a software company): • granted stock option with grant dates “selected in hindsight” to coincide with the Company’s low shares prices (Compare id. at 6 with SAC ¶174) and that Witness’ financial statements were, as a result, “false and misleading because they improperly accounted for stock options that were backdated in 2000 and 2001.” (Id. at 6; see SAC ¶212); • was identified in a May 2006 analyst report as one of the companies with potentially improper stock option granting practices (Compare id. at 7 with SAC ¶¶152- 153); • appointed a Special Committee of independent directors to investigate the matter (Compare id. at 8 with SAC ¶154); • disclosed, based on its preliminary internal review, that it expected to record an additional compensation charge (Compare id. at 8 with SAC ¶159); and • announced a restatement (Compare id. at 9 with SAC ¶165). In addition, the plaintiff in Witness alleged that as a result of defendants’ corrective disclosures, Witness’ share price fell from $18.19 to $12.91 (or approximately 29%). See id. at 8; see also SAC ¶221 (alleging a “20.10%” loss). The court in Witness refused to infer scienter from these allegations of so- called “backdating”: Although the CAC is lengthy, the details contained therein are simply insufficient to support a strong Case 2:06-cv-06863-DOC-RNB Document 109 Filed 04/25/08 Page 8 of 24 Page ID #:1706 COOLEY GODWARD KRONISH LLP AT T O R N E Y S AT LA W SA N D I E G O 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 5 Defs.’ Reply ISO MTD SACCV06-6863 DOC (RNB) inference of scienter. Specifically, the allegations are in the nature of a theory that Defendants must have known that the 2004 and 2005 financial were misstated due to backdating that occurred in 2000 and 2001. The CAC never explains when, or how, any or all Defendants learned about the details or circumstances pertaining to any backdated option grants. []Moreover, there are no allegations that the Individual Defendants are or were familiar with the accounting principles applicable to stock options, or that they knew that the proper accounting of the 2000 and 2001 options would necessitate a restatement of [certain] financial statements. [] For example, with respect to the Individual Defendants. . . nothing is alleged that would demonstrate that those individuals had any knowledge that disclosures during the Class Period might require future adjustments based on option grants made in 2000 and 2001. Witness, slip op., at 13-14 (emphasis added). The court’s decision in Jabil is also instructive. See Jabil, slip op., 2008 WL 977357, at *14-*19. The court in Jabil rejected the plaintiff’s theory that “individual defendant[s] ‘knew or should have known’ that Jabil had issued backdated stock options and had failed to properly account for the options.” Jabil, slip op., at *14. The allegations regarding Jabil’s stock option granting practices were also substantially similar to those in Quest and Witness. Compare Jabil, at *6-*8 with SAC (¶¶152-154;159; 165; 174) and Witness, slip op., at 6-9. Critically, like Quest, Jabil disclosed that their improper accounting for its option granting practices and the resulting corrections to its financial statements were driven by “changes in the Company's understanding of the requirements for identifying appropriate measurement dates for option grants as defined in relevant accounting guidance or errors in interpreting such guidance, and administrative and logistical errors made in effecting the options program.” Id. at *3. The court in Jabil, however, decisively refused to infer scienter from these allegations. See id. at *14-*19. Finally, the court in UTStarcom similarly refused to infer scienter from the alleged backdating practices. See UTStarcom, 2008 WL 1734763, at *7-*8 Case 2:06-cv-06863-DOC-RNB Document 109 Filed 04/25/08 Page 9 of 24 Page ID #:1707 COOLEY GODWARD KRONISH LLP AT T O R N E Y S AT LA W SA N D I E G O 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 6 Defs.’ Reply ISO MTD SACCV06-6863 DOC (RNB) (holding that plaintiff failed to plead intent or deliberate recklessness with respect to the alleged backdating). The above-referenced decisions do not present any issues of first impression for this Court with respect to scienter. Instead, these decisions are entirely consistent with this Circuit’s well-established precedent that knowledge of an allegedly undisclosed fact (i.e. such as Quest’s use of a “bucket and best price” method) does not equate to knowledge of the effect of that fact (i.e. treatment under APB No. 25 resulting in a compensation expense and resulting misstated financial statements). See, e.g., Gompper v. VISX, Inc., 298 F.3d 893, 895-96 (9th Cir. 2002) (although “the complaint adequately demonstrates the defendants were unquestionably aware of [the] claim against one of their core patents, in the end it fails to demonstrate the link between awareness of the claim and knowledge that the patents were therefore invalid.”); see also In re Copper Mt. Secs. Litig., 311 F. Supp. 2d 857, 872 (N.D. Cal. 2004). B. The Opposition Confirms That The SAC Fails to Allege a Violation of the 1999 Plan The Opp. confirms that the SAC fails to establish a violation of the 1999 Plan. The 1999 Plan allows Quest to grant two different types of stock options – NSOs, and Tax Qualified Options. It is critical to note that under the terms of the 1999 Plan, only Tax Qualified Options were subject to a limitation that option grants must be at a price equal to fair market value. Recognizing that its previous argument – that the 1999 Plan prohibited the use of the bucket and best price methodology – was factually incorrect pursuant to the plain language of the 1999 Plan, Plaintiff asserts three new arguments in its place. First, Plaintiff appears to argue that because Tax Qualified Options were granted to two individuals in the entire history of the 1999 Plan (since the 1999 Plan was put into effect), Defendants must have known that granting option below fair market value violated the 1999 Plan, and thus acted with scienter. (See Opp., Case 2:06-cv-06863-DOC-RNB Document 109 Filed 04/25/08 Page 10 of 24 Page ID #:1708 COOLEY GODWARD KRONISH LLP AT T O R N E Y S AT LA W SA N D I E G O 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 7 Defs.’ Reply ISO MTD SACCV06-6863 DOC (RNB) Doc. No. 103, at 22) (citing Defendants’ Reply ISO Motion to Dismiss FAC at 9, n.6.) Plaintiff’s argument is both incorrect and nonsensical. Neither the SAC nor any of the documents incorporated into it by reference mention the granting of any Tax Qualified Options. Further, even if the SAC had referenced those Tax Qualified Grants, the Opp. concedes that Plaintiff does not allege: (i) the number of stock options granted to these two individuals, (ii) whether those options were granted below market value, or (iii) whether a restatement – if any – of those Tax Qualified Options materially impacted any prior period financial statement.8 (See Opp., Doc. No. 103, at 22-23.) Accordingly, this contention fails to adequately establish a violation of the 1999 Plan sufficient to support an inference of scienter. See In re ICN Pharms., Inc., 299 F. Supp. 2d 1055, 1064 (C.D. Cal. 2004) (“Plaintiffs have failed both to substantiate that Defendants committed a violation of GAAP and have failed to provide detailed evidence of the contemporaneous decision-making behind the alleged accounting errors that would combine to show the required scienter. Plaintiffs have therefore not pled with particularity as required under Silicon Graphics and its progeny.”) Second, Plaintiff argues that Defendants violated the 1999 Plan because “option exercise prices were not fixed at the time of the grant date, but were ‘all prepared after the selected grant dates and were executed by members of the Board or Compensation Committee at a later time, in some cases as up to three months after the selected grant date.’” (Opp., Doc. No. 103, at 23) (quoting Def. App., Ex. B, [Quest’s 2006 Annual Report, SEC Form 10-K, filed on December 7, 2007] at 109). Plaintiff’s interpretation of that language in Quest’s 2006 10-K is not only wrong, it is the exact opposite of what Quest actually disclosed. Option grants were, in fact, fixed at the time of the grant date because they were fixed by way of a 8 Furthermore, Plaintiff does not dispute that all other stock options granted at Quest were NSOs. (See Opp., Doc. No. 103, at 23.) Case 2:06-cv-06863-DOC-RNB Document 109 Filed 04/25/08 Page 11 of 24 Page ID #:1709 COOLEY GODWARD KRONISH LLP AT T O R N E Y S AT LA W SA N D I E G O 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 8 Defs.’ Reply ISO MTD SACCV06-6863 DOC (RNB) methodology that automatically selected the grant date. In contrast, as the disclosure states clearly, the “unanimous written consents were prepared after the selected grant dates and were executed by members of the Board or Compensation Committee at a later time. . . .” (Id.) (Emphasis added.) The difference is that “unanimous written consents,” not “option exercise prices,” were prepared and executed later in time. In other words, the process of obtaining administrative approval of Quest’s stock option grants resulted in delays, and as a result of such delays, there was an additional compensation expenses associated with Quest’s historical stock option grants. It is hardly uncommon for Boards to prepare and execute unanimous written consents after selecting stock option grant dates. In fact, the Chief Accountant of the SEC acknowledged the practical difficulty of contemporaneous execution of required paperwork in connection with stock option grant approval, concluding that: in certain instances where a company’s facts, circumstances, and pattern of conduct evidence that the terms and recipients of a stock option award were determined with finality on an earlier date prior to the completion of all required granting actions [i.e. preparation and execution of unanimous written consents], it may be appropriate to conclude that a measurement date under [APB No.] 25 occurred prior to the completion of these actions.”9 (App., Ex. E [OCA Letter dated September 19, 2006], Doc. No. 75-9, at 264) (emphasis added). Stock option grant dates, on the other hand, were consistently selected using Quest’s “bucket and best price” methodology. (See Doc. No. 74, at 1-2.) 9 Under the guidance promulgated by the Chief Accountant of the SEC, the Special Committee and Quest were each more conservative than necessary in calculating the revised measurement dates for the stock option grants in question. Case 2:06-cv-06863-DOC-RNB Document 109 Filed 04/25/08 Page 12 of 24 Page ID #:1710 COOLEY GODWARD KRONISH LLP AT T O R N E Y S AT LA W SA N D I E G O 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 9 Defs.’ Reply ISO MTD SACCV06-6863 DOC (RNB) Third, Plaintiff argues that “whether or not [Defendants] violated the [1999] Plan,” they “intentionally and knowingly” made false statements in the Company’s SEC filings that “Quest issued all options at exercise prices equal to 100% of fair market value. . . .” (See Opp., Doc. No. 103, at 23.) The logic of Plaintiff’s argument is circular. Specifically, Plaintiff assumes what it seeks to prove – i.e. that Defendants’ misstatements were “intentional[]” and “knowing.” See id. Tellingly, Plaintiff does not even attempt to explain what makes Defendants’ statements at issue “intentional” or “knowing[].” See id. The Opp. fails to identify any red flags that could put Defendants on notice that Quest’s “bucket and best price” methodology was flawed, did not comply with APB No. 25, and resulted a compensation charge, which, in turn, drove the need for disclosure. Most importantly, the statement that stock options were priced based on the closing price on the grant date is true. (See App., Ex. B [Quest’s 2006 Annual Report, SEC Form 10-K, filed on December 7, 2007], Doc. No. 75-4, at 68.) The grant date was selected by the methodology and options were granted based on the closing price on the grant date. An accounting issue arises when the measurement date is different from the grant date. Accordingly, Plaintiff’s allegations of “knowing false statements” are conclusory and, therefore, insufficient to establish scienter. C. Application of APB No. 25 Is Complex, Not “Unambiguous,” and Failure to Follow It Cannot Establish Scienter The Opp. states that “Defendants either knew what the requirements of APB No. 25 were, or were deliberately reckless in continually representing to the public that they followed the rule if they did not know what it required.” (Opp., Doc. No. 103, at 12.) Further, Plaintiff infers Defendants’ guilty state of mind from the fact that “APB No. 25 is not so ambiguous or unclear.” (Opp., Doc. No. 103, at 13) (citing United States v. Reyes, 2007 WL 1574540, *3 (N.D. Cal. May 30, 2007). Case 2:06-cv-06863-DOC-RNB Document 109 Filed 04/25/08 Page 13 of 24 Page ID #:1711 COOLEY GODWARD KRONISH LLP AT T O R N E Y S AT LA W SA N D I E G O 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 10 Defs.’ Reply ISO MTD SACCV06-6863 DOC (RNB) To the contrary, numerous federal courts have held (and the OCA Letter confirms) that the identification of measurement dates10 (as opposed to the selection grant dates) under APB No. 25 can be anything but “unambiguous.” See Weiss v. Amkor Tech., Inc., 527 F. Supp 2d 938, 949 (D. Ariz. 2007) (dismissing stock option backdating case and stating that the “accounting rules at issue, specifically [APB] No. 25, are complex and require accounting expertise and judgment”); In re Sportsline.com Sec. Litig., 366 F. Supp. 2d 1159, 1168–69 (S.D. Fla. 2004) (dismissing restatement case involving stock options and stating that the principles of APB No. 25 are “far from obvious.”); United States v. Shanahan, 2008 U.S. Dist. LEXIS 29868, at *19 (D. Mo. Mar. 31, 2008) (The definition of measurement date under APB No. 25 may be unclear); In re CNET Networks, Inc., 483 F. Supp. 2d 947, 955 (N. D. Cal. 2007) (same); Witness, slip op., at 15-16. In fact, even the court in United States v. Reyes acknowledged that: “the precise timing of a grant is not always easy to discern.” Id., 2007 WL 1574540, at *3. Indeed, in light of the uncertainly that arises in the application of APB No. 25 when coupled with numerous administrative and employment-related factors, “on September 19, 2006, the Chief Accountant of the SEC, Conrad Hewitt, issued a letter identifying a few instances where a company could use the wrong measurement date without rising to the level of fraud.” Shanahan, 2008 U.S. Dist. LEXIS 29868, at *19. The very need for such interpretive guidance, let alone the varied scenarios of selecting measurement dates that the OCA Letter discusses, illustrate the complexity in the practical application of APB No. 25. Most recently, the court in Witness squarely rejected an argument that the accounting under APB 25 was “simplistic” for the purpose of inferring scienter: Plaintiff contends that application of relevant accounting, referred to APB Opinion No. 25, is relatively straightforward with respect to calculating the proper 10 It is the identification of a “measurement date” that drives the accounting consequence under APB No. 25. Case 2:06-cv-06863-DOC-RNB Document 109 Filed 04/25/08 Page 14 of 24 Page ID #:1712 COOLEY GODWARD KRONISH LLP AT T O R N E Y S AT LA W SA N D I E G O 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 11 Defs.’ Reply ISO MTD SACCV06-6863 DOC (RNB) compensation expense for stock options. It asserts that this is a simple process of subtracting the exercise price from the fair market value of [the Company’s] stock on the measurement date. However, Plaintiff’s assertion oversimplifies the application and substance of APB No. 25. While some of the necessary calculations may be straightforward once the proper measurement date has been determined, the initial determination of the measurement date is not so straightforward. See, e.g., APB 25.10 (acknowledging that “the measurement date may be later than the date of the grant or award” in certain circumstances); APB 25.11 (setting forth eight different measurement dates).” Witness, at 15-16. The incorrect “initial determination of the measurement date” (made pursuant to the “bucket and best price” methodology) is precisely what drove the restatement in this case.11 Accordingly, as the above-referenced courts expressly held, the application of APB No. 25 for selecting measurement dates can be complex. At the very least, the above-referenced decisions (and their divergence from the court’s opinion in U.S. v. Reyes) illustrate that this rule is not unambiguous.12 As such, incorrect application of APB No. 25 cannot support a strong inference of scienter. 11 “The more relevant question here is what facts are alleged to show that any of the Defendants had the requisite knowledge of the impact, under appropriate accounting principles, on the financial statements for 2004 and 2005 of corrections made with respect to options granted in 2000 and 2001.” Witness, at 17. Here, as in Witness, the SAC: “does not set forth particularized allegations that would show how Defendants, at the time the financial results [for relevant periods] were being disseminated during the Class Period, knew that the application of General Accounting Principles would have mandated a restatement of those financial results due to problems in the granting of options [several] years earlier.” Id. 12 See Webster’s Online Dictionary, “Unambiguous,” defined as “Having or Case 2:06-cv-06863-DOC-RNB Document 109 Filed 04/25/08 Page 15 of 24 Page ID #:1713 COOLEY GODWARD KRONISH LLP AT T O R N E Y S AT LA W SA N D I E G O 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 12 Defs.’ Reply ISO MTD SACCV06-6863 DOC (RNB) D. Plaintiff’s Remaining Contentions Fail to Establish A Strong Inference of Scienter13 1. Insider Sales Are Insufficient Show Scienter This Court has already determined that stock sales by Defendants in this case “standing alone” are insufficient to establish scienter. (See Order, Doc. No. 51, at 22) (holding that “further analysis is required”). Neither the SAC nor the opposition offer any new facts that would cure this deficiency. (See Opp., Doc. No. 103, at 23-24.) Furthermore, the SAC fails to allege that the specific timing of stock sales by any individual Defendant was suspicious. In addition, the Opp. fails to account for the fact that two of the Defendants, Vincent C. Smith and M. Brinkley Morse, never exercised or sold any stock options during the Class Period. (See Opp., Doc. No. 103, at 23-24.) These factors substantially undermine any inference that the stock trades by Defendants were suspicious. See Ronconi v. Larkin, 253 F.3d 423, 435 (9th Cir. 2001). 2. The Size of Restatement and GAAP Violations Are Insufficient to Scienter. Plaintiff concedes that the size of Quest’s 2006 restatement was driven by investigative decisions made in 2006. (See Opp., Doc. No. 103, at 17.) Plaintiff appears to suggest, however, that because “accounting errors [were] made. . . between 1999-June 20, 2003,” those errors (which were corrected in 2006) somehow show scienter. Plaintiff is incorrect. Courts have routinely held that accounting errors (without more) are insufficient to establish scienter. See, e.g., DSAM Global Value Fund v. Altris Software, Inc., 288 F.3d 385, 390 (9th Cir. exhibiting a single clearly defined meaning,” available at http://www.websters- online-dictionary.org/definition/UNAMBIGUOUS (last visited on Apr. 24, 2008); Cf. id. “Ambiguous,” defined as “Open to two or more interpretations,” available at http://www.websters-online-dictionary.org/definition/AMBIGUOUS (last visited on Apr. 24, 2008). 13 “[P]laintiff's scienter pleading is based on numerous factual allegations,” which “cannot support – either alone or taken collectively – an inference of scienter.” UTStarcom, slip op., 2008 WL 1734763, at *6. Case 2:06-cv-06863-DOC-RNB Document 109 Filed 04/25/08 Page 16 of 24 Page ID #:1714 COOLEY GODWARD KRONISH LLP AT T O R N E Y S AT LA W SA N D I E G O 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 13 Defs.’ Reply ISO MTD SACCV06-6863 DOC (RNB) 2002) (alleged violations of GAAP alone will not give rise to a strong inference of scienter); see also In re Vantive Corp. Sec. Litig., at 1090-91 (plaintiff must “allege specific contemporaneous conditions known to the defendants that would strongly suggest that the defendants understood” that their accounting was improper when disclosed) (emphasis supplied).14 3. Receipt of Misdated Stock Options is Insufficient to Scienter The Opp. argues that the SAC’s allegations that Defendants Smith, Morse, Garn, Doyle and Brooks received “numerous backdated stock option” evidence scienter. (See Opp., Doc. No. 103, at 10-11.) Yet, Plaintiff completely glosses over the fact that these Defendants received stock options pursuant to the “bucket and best price” methodology – the same way as every other employee receiving stock options at Quest at such time. (See Mem. P&A ISO Motion to Dismiss (“MTD”), Doc. No. 72-2, at 14-15).15 Accordingly, their receipt of improperly dated options is neither indicative of special treatment nor suspicious. See Amkor, 527 F.Supp.2d at 948-50 (finding that although some options appear to have been backdated, plaintiff failed to allege facts giving rise to a strong inference of scienter); Hansen, 527 F. Supp.2d at 1157 (“Plaintiff's failure to plead any facts related to the role or knowledge of any of the Officer Defendants or any Individual Defendant’s involvement in the alleged backdating scheme is fatal to Plaintiff’s showing of 14 See also In re ICN Pharmaceuticals, Inc. Sec. Litig., 299 F. Supp. 2d 1055, 1065 (C.D. Cal. 2004); In re Copper Mountain Sec. Litig., 311 F. Supp. 2d 857, 872 (N.D. Cal. 2004); In re Cornerstone Propane Partners, L.P. Sec. Litig., 355 F. Supp. 2d 1069, 1091 (N.D. Cal. 2005) (“In order to distinguish ‘deliberate recklessness’ from ‘ordinary carelessness,’ allegations of GAAP violations must be augmented by ‘facts that shed light on the mental state’ of defendants, rather than conclusory allegations that defendant must have known of the accounting failures due to the degree of departure from established accounting principles.”); In re US Aggregates, Inc. Sec. Litig., 235 F. Supp. 2d 1063, 1073 (N.D. Cal. 2002) (“[E]ven an obvious failure to follow GAAP does not give rise to an inference of scienter.”). 15 Quest consistently applied “bucket and best price” method. Contrary to Plaintiff’s suggestion (See Opp., Doc. 103, at 4-5; and 19 at n.33), the “lowest- price-of-the-month” is not inconsistent with the “lowest-price-of-the-quarter” method. Both were in place to adjust for the volatility in Quest’s stock price. Case 2:06-cv-06863-DOC-RNB Document 109 Filed 04/25/08 Page 17 of 24 Page ID #:1715 COOLEY GODWARD KRONISH LLP AT T O R N E Y S AT LA W SA N D I E G O 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 14 Defs.’ Reply ISO MTD SACCV06-6863 DOC (RNB) scienter both with respect to the Officer Defendants and with respect to [the Company]”); In re Sportsline.com Sec. Litig., 366 F. Supp. 2d 1159, 1168–69 (S.D. Fla. 2004) (allegations that stock options accounting issues that required restatement of two and a half years of financial statements were insufficient to plead scienter). Plainly, because Defendants (admittedly) could not know the size of the restatement until 2006, the amount of that restatement cannot be indicative of Defendants’ state of mind in years prior to 2006.16 4. Government Investigations17 Are Insufficient to Show Scienter Plaintiff attempts to infer scienter from the fact that Defendants Quest, Smith, Brooks, Morse (and a former Quest employee John Laskey) received “’Wells Notices’ from the SEC in connection with its investigation” of Quest. (See Opp., Doc. No. 103, at 3.) Federal courts have consistently held, however, that “[m]ere existence” of an SEC investigation “cannot support any inferences of 16 Plaintiff’s opposition argues that the “hypothetical” Defendants used in their brief (See Mem. P&A’s ISO Motion to Dismiss at 17 (and n.11) “suggests that somehow Quest may have exaggerated the Restatement amount. . . .” (Opp., Doc. No. 103, at 17, n.29.) To be clear, Defendants suggest nothing of the sort. Instead, Defendants’ hypothetical illustrates that the size of the restatement is merely a function of how many options the Special Committee repriced (and at which price), which in turn, is a function of how the Special Committee applied APB No. 25 in ascertaining corrected stock option measurement dates. Because Defendants could not possibly know (between 1999 and 2003) which revised exercise prices the Special Committee (in 2006) would select (and under APB No. 25 more than one date can serve as the measurement date, see supra, at 8-10), the size of the restatement here cannot be used to establish scienter. 17 Plaintiff cavalierly dismisses the fact that “more than 190 public companies” have been implicated in connection with their stock option granting practices and related accounting, arguing that the other 6000 public companies knew better. (See Opp., Doc. No. 103, at 20, n. 35; see SAC ¶80.) Plaintiff’s argument misses the mark. The vast majority of companies facing scrutiny for their stock option granting practices are technology companies, (with highly volatile stock prices) which attempted to implement a stock option granting practice that was fair to new employees at a time when their stock prices fluctuated wildly. In fact, the May 19, 2006 Goldman Sachs report (which the SAC cites, see ¶¶ 152-156; 162; 220) shows that all but three of the peer companies in Quest’s coverage group (11 infrastructure software companies) were identified as having potentially improper option granting policies (along with Quest). (See App. Ex. F, at 2-3.) Case 2:06-cv-06863-DOC-RNB Document 109 Filed 04/25/08 Page 18 of 24 Page ID #:1716 COOLEY GODWARD KRONISH LLP AT T O R N E Y S AT LA W SA N D I E G O 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 15 Defs.’ Reply ISO MTD SACCV06-6863 DOC (RNB) wrongdoing or fraudulent scienter on the part of [a] company or its senior management.” Hansen, 527 F.Supp.2d at 1662 (quoting City of Austin Police Ret. Sys. v. ITT Educ. Serv., Inc., 388 F.Supp.2d 932, 942 (S.D. Ind. 2005); In re Ceridian Corp. Sec. Litig., 504 F.Supp.2d 603, 619 (D. Minn. 2007) (“[A]s nothing has yet come of the SEC's investigation, the mere fact of the investigation does not appreciably add to the evidence supporting an inference of scienter.”); see also In re Connetics Corp. Sec. Litig., 2008 WL 269467 (N.D. Cal. Jan. 29, 2008) (granting motion to strike all paragraphs in complaint relying on SEC complaint, except for the paragraph referencing the existence of that complaint where plaintiff’s counsel had not conducted independent investigation). 5. Plaintiff’s Allegations Concerning the Sarbanes-Oxley Act (“SOX”) Are Insufficient to Show Scienter The Opp. argues that “the fact that Quest ‘ceased’ backdating options when the passage of SOX became imminent” shows scienter. (See Opp., Doc. No. 103, at 18.) As an initial matter, Quest stopped using the “bucket and best price” method in May 2002 – well in advance of the SOX’s effective date on August 29, 2002. (See Opp., Doc. No. 103, at 18, n.30) (quoting App. Ex. B, Doc. No. 75-4, at 68.)18 Furthermore, even assuming arguendo that Quest stopped using its “bucket and best price” method in May 2002 due to the passage of SOX (which is a wholly unsupported inference in the SAC), an innocent inference of non-culpable conduct significantly outweighs any competing inferences of scienter. Specifically, SOX required for the first time that Form 4s disclosing stock option grants be filed within 18 Plaintiff suggests that because “between May 1, 2002 and June 1, 2003, measurement date exceptions were noted for 45 grants covering 294,750 options, necessitating an additional compensation expense of $278,000,” Quest must have continued using its “bucket and best price” methodology beyond May 2002. (See Opp., Doc. No. 103, at 18, n.30) (quoting App. Ex. B, Doc. No. 75-4, at 110). However, nothing in the record or in Quest’s disclosures even remotely suggests that those outlier grants were made pursuant to Quest’s prior-used methodology. To the contrary, the additional expense of only “$278,000” (compared to approximately $136 million from prior years) shows a lack of a consistent methodology. Case 2:06-cv-06863-DOC-RNB Document 109 Filed 04/25/08 Page 19 of 24 Page ID #:1717 COOLEY GODWARD KRONISH LLP AT T O R N E Y S AT LA W SA N D I E G O 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 16 Defs.’ Reply ISO MTD SACCV06-6863 DOC (RNB) two days of the grant date. (See SAC ¶82.) Thus, a methodology for setting option grant dates that involved any degree of hindsight became unworkable as a practical matter because the new regulations made it impossible to comply with SEC filing deadlines for grant dates more than two days in the past. See id. This change in reporting time does not require one to conclude when or if an accounting charge should have been taken with respect to any previously granted options. In addition, this argument does not shed light on what any particular Defendant knew about the Company’s methodology of granting and accounting for stock options prior to SOX, much less whether any Defendant acted with the requisite intent to deceive, manipulate or defraud. Accordingly, this factor does not support an inference of scienter. The Supreme Court's recent decision in Tellabs also directed that courts consider “not only inferences urged by the plaintiff . . . but also competing inferences rationally drawn from the facts alleged,” Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. ___, 127 S. Ct. 2499, 2504 (2007). Tellabs requires this Court to look at the inferences set forth herein that weigh heavily against Plaintiff’s position. 6. Motive And Opportunity Allegations Are Insufficient to Show Scienter Plaintiffs persist in their argument that scienter can be inferred because “stock options can be incredibly lucrative to the option recipients, providing a strong motive for Defendants to commit their fraud. . . .” Such allegations of monetary motive, however, are patently insufficient. See, e.g., In re ICN Pharmaceuticals, Inc. Sec. Litig., 299 F. Supp. 2d 1055, 1069 (C.D. Cal. 2004) (citing In re Silicon Graphics, Inc. Sec. Litig., 183 F.3d 970, 974 (9th. Cir. 1999)); In re Pixar, 450 F. Supp. 2d at 1104 (“Even if Defendants did have a motive to Case 2:06-cv-06863-DOC-RNB Document 109 Filed 04/25/08 Page 20 of 24 Page ID #:1718 COOLEY GODWARD KRONISH LLP AT T O R N E Y S AT LA W SA N D I E G O 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 17 Defs.’ Reply ISO MTD SACCV06-6863 DOC (RNB) commit fraud . . . ‘[m]ere motive and opportunity is insufficient.’”); Witness, slip op., at 21.19 7. Departure of Morse Is Insufficient to Show Scienter20 The Opp. does not even attempt to explain how Morse’s departure or “refusal to cooperate with the Special Committee” creates an inference of scienter as to the Defendants. (See Opp., Doc. No. 103, at 25.) Nor does Plaintiff attempt to argue that Mr. Morse’s resignation was the result of fraudulent, as opposed to negligent, conduct. See id.; see also DSAM Global Value Fund v. Altris Software, 288 F.3d 385, 391 (9th Cir. 2002) (“Negligence, even gross negligence, does not rise to the level of the nefarious mental state necessary to constitute securities fraud under the PSLRA . . . .”). Accordingly, the circumstances of Mr. Morse’s departure do not show scienter. 8. Inability to Locate Select Documents in the Course of the Special Committee’s Investigation is Insufficient to Show Scienter Plaintiff argues that because select documentation reflecting when the “required approval” of stock option grants were signed by members of the Board could not be located during the Special Committee’s investigation, those documents must have been “destroyed, discarded or never existed in the first place.” (See Opp., Doc. No. 103, at 24.) Plaintiff’s contention is entirely conclusory and is not a rational inference that can be drawn from any facts in the SAC. A rational (and more plausible) non-culpable inference is that documentation was simply lost or misplaced, either as a result of innocent lack of oversight or at most— administrative sloppiness. See Tellabs, 127 S. Ct. at 2504 (inferences of culpability must be at least as strong as any other inferences that could be drawn in favor of 19 See also Mesko v. Cabletron Sys., Inc., 311 F.3d 11, 39 (1st Cir. 2002) (“’[C]atch-all allegations’ which merely assert motive and opportunity, without something more, fail to satisfy the PSLRA.”) 20 Plaintiff’s Opp. does not dispute (and therefore, concedes) that reassignment of Kevin Brooks does not evidence scienter. See Opp., passim. Case 2:06-cv-06863-DOC-RNB Document 109 Filed 04/25/08 Page 21 of 24 Page ID #:1719 COOLEY GODWARD KRONISH LLP AT T O R N E Y S AT LA W SA N D I E G O 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 18 Defs.’ Reply ISO MTD SACCV06-6863 DOC (RNB) defendants). Nor does Plaintiff attempt to find any motive for the supposed “destruction” of such documentation. After all, Defendants routinely (and openly) signed unanimous written consents after the fact.21 See supra, at 7. Accordingly, Plaintiff’s “spoliation” argument is pure unsupported conjecture. Plaintiff further argues that because in some cases “lists reflecting stock option grants processed by the Company’s stock plan administrator were different than the lists provided to and approved by either the Board or the Compensation committee,” Defendants must have engaged in some “nefarious” conduct. (See Opp., Doc. No. 103, at 24-25.) Once again, a non-culpable inference is much more plausible. By its terms (“different than… provided and approved’), the above statements implies the documents at issue were not modified by the Board. Subsequent alterations (whether intentional or not) could have been made for a variety of reasons, including: administrative errors, mistakes, sloppiness, addition of new employees to the grant list/buckets, removal of employees form grant lists due to their departure from Quest, and the promotion of employees that entitled them to additional options, etc. The multitude of such non-culpable explanations far outweighs the unsupported inference of “nefarious” conduct, especially where Defendants are not alleged to have benefited in any way from these “differences.” See Tellabs, 127 S. Ct. at 2504. 21 Moreover, neither allegations in the SAC nor anything in the record remotely suggest willfulness or even negligence. See 15 U.S.C. §78-4(b)(3)(C) (sanctions available only for “willful violation”). Case 2:06-cv-06863-DOC-RNB Document 109 Filed 04/25/08 Page 22 of 24 Page ID #:1720 COOLEY GODWARD KRONISH LLP AT T O R N E Y S AT LA W SA N D I E G O 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 19 Defs.’ Reply ISO MTD SACCV06-6863 DOC (RNB) E. The Failure to Allege a Primary Violation Mandates Dismissal of the Insider Trading and Control Person Claims 22 Because Plaintiff fails to state a cognizable Rule 10b-5 claim against any defendant, §20(a) claims must be dismissed. See In re Copper Mountain Sec. Litig., 311 F. Supp. 2d 857, 883 (N.D. Cal. 2004). In addition, with respect to Mr. Lambert, the Opp. fails to explain how Mr. Lambert (who joined Quest two years after it stopped using its “bucket and best price” methodology) controlled a primary violator. (See Opp., Doc. No. 103, at 10, n.19; Opp. to Murdock’s MTD, Doc. No. 104, at 22-24; Opp. to Morse’s MTD, Doc. No. 105, at 19-21.) Accordingly, the §20(a) against all Defendants, including Mr. Lambert, must be dismissed. F. Plaintiff Fails To Allege A “Scheme” Scheme liability in this case turns on “whether each 10b-5 Defendant’s conduct had ‘the principal purpose and effect of creating a false appearance of fact in furtherance of the scheme.’” (Order, Doc. No. 51, at 22.) The Opp. fails to show that Defendants’ “purpose” in knowing about Quest’s “bucket and best price,” failing to properly account for that methodology, and failing to disclose it was done “in furtherance” of any scheme. III. CONCLUSION Because the SAC fails to allege sufficiently a strong inference of scienter, a violation of the 1999 Plan, fails to show a knowing misapplication of APB No. 25, and for all the additional foregoing reasons, Defendants respectfully request that the Court dismiss the SAC. 22 The Opp. does not dispute that the SAC fails to allege that Mr. Garn violated §10(b) or §20(a). See Opp., Doc. No. 103, at 10, n.19; Opp. to Murdock’s MTD, Doc. No. 104, at 20-22.) The Court should also dismiss the §20A claim against the remaining Defendants because Plaintiff failed to adequately allege a predicate violation of the securities laws against those Defendants and failed to establish standing. Case 2:06-cv-06863-DOC-RNB Document 109 Filed 04/25/08 Page 23 of 24 Page ID #:1721 COOLEY GODWARD KRONISH LLP AT T O R N E Y S AT LA W SA N D I E G O 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 20 Defs.’ Reply ISO MTD SACCV06-6863 DOC (RNB) Dated: April 25, 2008 COOLEY GODWARD KRONISH LLP KOJI F. FUKUMURA (189719) AARON F. OLSEN (224947) /s/ Koji F. Fukumura Koji F. Fukumura Attorneys for Defendants Quest Software, Inc., Vincent C. Smith, Michael J. Lambert, Douglas F. Garn, David M. Doyle, and Kevin Brooks Case 2:06-cv-06863-DOC-RNB Document 109 Filed 04/25/08 Page 24 of 24 Page ID #:1722