Rudolph v. UT Starcom et al

Memorandum in Opposition to 54 Defendants' Motion to Dismiss Plaintiff's Amended Class Action Complaint

N.D. Cal.March 14, 2008

Lead Plaintiff’s Opposition to Defendants’ MTD 3:07-CV-04578-SI i 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 Mark Punzalan (State Bar No. 247599) mpunzalan@finkelsteinthompson.com FINKELSTEIN THOMPSON LLP 100 Bush Street, Suite 1450 San Francisco, California 94104 Telephone: (415) 398-8700 Facsimile: (415) 398-8704 [Additional Counsel Listed on Signature Page] Lead Counsel UNITED STATES DISTRICT COURT NORTHERN DISTRICT OF CALIFORNIA SAN FRANCISCO DIVISION PETER RUDOLPH, individually and on behalf of all others similarly situated, Plaintiff, vs. UTSTARCOM, HONG LIANG LU, YING WU, MICHAEL SOPHIE, FRANCIS BARTON, AND THOMAS TOY, Defendants. ) ) ) ) ) ) ) ) ) ) ) ) ) ) Case No. 3:07-CV-04578-SI LEAD PLAINTIFF’S OPPOSITION TO DEFENDANTS’ MOTION TO DISMISS PLAINTIFF’S AMENDED CLASS ACTION COMPLAINT Date: April 4, 2008 Time: 9:00 a.m. Before: Hon. Susan Illston Case 3:07-cv-04578-SI Document 61 Filed 03/14/2008 Page 1 of 31 Lead Plaintiff’s Opposition to Defendants’ MTD 3:07-CV-04578-SI 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 TABLE OF AUTHORITIES............................................................................................................i INTRODUCTION...........................................................................................................................1 ISSUES TO BE DECIDED (LOCAL RULE 7-4(a)(3) ..................................................................2 STATEMENT OF FACTS..............................................................................................................3 ARGUMENT ..................................................................................................................................8 I. STANDARDS OF LAW ON A MOTION TO DISMISS ......................................8 II. LEAD PLAINTIFF HAS STATED A CLAIM FOR SECURITIES FRAUD UNDER SECTION 10(b) AND RULE 10b-5.........................................9 A. Lead Plaintiff has Alleged the Fraud With Sufficient Particularity ............9 B. Lead Plaintiff has Alleged Facts Giving Rise to a Strong Inference of Scienter ......................................................................................................11 1. The Pervasive and Systematic Accounting Violations Admitted by UTStarcom In Its Restatement Contribute to a Strong Inference of Scienter......................................................................12 2. Lead Plaintiff’s Confidential Witness Allegations Contribute to a Strong Inference of Scienter .......................................................14 3. The Sarbanes-Oxley Certifications Contribute to a Strong Inference of Scienter......................................................................15 4. Lead Plaintiff Adequately Alleges the Individual Defendants’ Involvement in the Stock Option Granting Process ......................16 5. The Individual Defendants’ Insider Trades Contribute to a Strong Inference of Scienter ..........................................................16 III. LEAD PLAINTIFF HAS ADEQUATELY PLED LOSS CAUSATION ............17 A. The November 7, 2006 Revelation was a Corrective Disclosure and Caused a Loss to Lead Plaintiff and the Class. .........................................19 B. Defendants Ask the Court to Draw Impermissible Inferences Concerning the July 24, 2007 Disclosure..................................................20 IV. LEAD PLAINTIFF HAS STATED A CLAIM FOR PROXY FRAUD UNDER SECTION 14(a) ......................................................................................21 Case 3:07-cv-04578-SI Document 61 Filed 03/14/2008 Page 2 of 31 Lead Plaintiff’s Opposition to Defendants’ MTD 3:07-CV-04578-SI ii 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 A. Lead Plaintiff has Identified the Misleading Statements in the Company’s Proxy Statements....................................................................21 B. Lead Plaintiff Has Alleged the Link Between the Misrepresentations and Shareholder Votes...............................................................................22 C. Lead Plaintiff has Adequately Alleged Defendants’ Knowledge and Recklessness With Regard to the Misrepresentations ...............................24 D. Lead Plaintiff’s Claims regarding the 2002-2006 Proxies Are Not Time Barred ........................................................................................................24 VI. LEAD PLAINTIFF HAS STATED A CLAIM FOR CONTROL PERSON LIABILITY PURSUANT TO SECTION 20(a) ...................................25 VI. CONCLUSION .....................................................................................................25 Case 3:07-cv-04578-SI Document 61 Filed 03/14/2008 Page 3 of 31 Lead Plaintiff’s Opposition to Defendants’ MTD 3:07-CV-04578-SI 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 Desaigoudar v. Meyercord, 223 F.3d 1020 (9th Cir. 2000) --------------------------------------- 22 Dura Pharms., Inc. v. Broudo, 544 U.S. 336 (2005) ------------------------------------------ 17, 19 Franklin v. Ernst, 571 F. Supp. 829 (N.D. Ohio 1983) -------------------------------------------- 22 Howard v. Everex Sys., 228 F.3d 1057, 1065 (9th Cir. 2000) ------------------------------------- 25 In re Adaptive Broadband Sec. Litig., No. 01-1092, 2002 WL 989478 (N.D. Cal. April 2, 2002) ------------------------------------------------ 12, 13 In re Amtel Corp. Deriv. Litig., No. C06-4592, 2007 WL 2070299 (N.D. Cal. July 16, 2007) --------------------------------------------------- 24 In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410 (3d Cir. 1997) ----------------------- 10 In re Cabletron Sys., Inc., 311 F.3d 11 (1st Cir.2002) --------------------------------------------- 14 In re CNET Networks, Inc., 483 F. Supp. 2d 947 (N.D. Cal. 2007) ------------------------------ 13 In re Cornerstone Propane Partners, L.P., 355 F. Supp. 2d 1069 (N.D. Cal. 2005)------ 12, 17 In re Credit Suisse-AOL Sec. Litig., 465 F.Supp.2d 34 (D. Mass. 2006) ------------------------ 21 In re Cylink Sec. Litig., 178 F.Supp. 2d 1077 (N.D. Cal. 2001)------------------------------ 10, 12 In re Daou Sys., Inc., 411 F.3d 1006 (9th Cir. 2005)---------------------------------- 14, 17, 18-20 In re Ditech Networks, Inc. Derivative Litig., No. 06-5157, 2007 WL 2070300 (N.D. Cal. July 16, 2007) --------------------------------------------------- 25 In re Immune Response Sec. Litig., 347 F.Supp. 2d 983, 1025 (S.D. Cal. 2005) ------- 8, 18, 21 In re Lattice Semiconductor Corp. Sec. Litig., No. 04-1255, 2006 U.S. Dist. LEXIS 262 (D. Or. Jan. 3, 2006)-------------------------------------------------------15 In re McKesson HBOC, Inc. Sec. Litig., 126 F. Supp. 2d 1248 (N.D. Cal. 2000) ----- 13, 15, 24 In re National Golf Properties, Inc., No. 02-1383, 2003 WL 23018761 (C.D. Cal. Mar. 19, 2003) -------------------------------------------------- 10 In re Omnivision Tech., No. 04-2297, 2005 U.S. Dist. LEXIS 16009 (N.D. Cal. July 29, 2005) --------------------------------------- 18 In re Ramp Networks, Inc. Sec., 201 F. Supp.2d 1051 (N.D. Cal. 2002) ------------------------ 10 Case 3:07-cv-04578-SI Document 61 Filed 03/14/2008 Page 4 of 31 Lead Plaintiff’s Opposition to Defendants’ MTD 3:07-CV-04578-SI ii 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 In re Secure Computing Corp. Sec. Litig., 120 F. Supp. 2d 810 (N.D. Cal. 2000) ------------- 10 In re Silicon Graphics Inc. Sec. Litig., 183 F.3d 970 (9th Cir. 1999) ---------------------------- 17 In re U.S. Aggregates, Inc. Sec. Litig., 235 F.Supp.2d 1063 (N.D. Cal. 2002) ----------------- 10 In re Vantive Corp. Sec. Litig., 283 F.3d 1079 (9th Cir. 2002) ----------------------------------- 16 In re Zoran Corp. Derivative Litig., 511 F. Supp.2d 986 (N.D. Cal. 2007) -------- 10, 21, 23-24 Kaplan v. Rose, 49 F.3d 1363 (9th Cir. 1994)------------------------------------------------------- 25 Livid Holdings Ltd. c. Salomon Smith Barney, 416 F.3d 940 (9th Cir. 2005)------------------- 24 Mills v. Electric Auto-Lite Co., 396 U.S. 375 (1970)------------------------------------------ 21, 22 No. 84 Employer-Teamster Join Council Pension Trust-Fund v. Am. West Holding Corp., 320 F.3d 920 (9th Cir. 2003)--------------------------------------------------------------------- 8, 9 Nursing Home Pension Fund, Local 144 v. Oracle Corp., 380 F.3d 1226 (9th Cir. 2004) ------------------------------------------------------------------- 8, 14 Parsons v. Jefferson-Pilot Corp., 789 F. Supp. 697 (M.D.N.C. 1992)--------------------------- 22 Plumbers & Pipefitters Local 572 Pension Fund v. Cisco Sys., Inc., 411 F.2d 1172 (N.D. Cal. 2005) ------------------------------------------------------------------- 18 Robbins v. Koger Props., Inc., 116 F.3d 1441 (11th Cir. 1997) ---------------------------------- 20 Shurkin v. Golden State Vintners Inc., 471 F. Supp. 2d 998 (N.D. Cal. 2006)------------------- 8 Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S.Ct. 2499 (2007)------------------- 8-9, 11-12 TSC Indus. V. Northway, Inc., 426 U.S. 438 (1976)------------------------------------------------ 23 Weiss v. Amkor Tech., Inc., 527 F. Supp. 2d 938 (D. Ariz. 2007) ---------------------------- 19-20 Statutes 109 Stat. 737 ---------------------------------------------------------------------------------------------- 8 28 U.S.C. § 1658(b)------------------------------------------------------------------------------------- 24 IRC § 422 ------------------------------------------------------------------------------------------------- 5 Pub. L. No. 104-67--------------------------------------------------------------------------------------- 8 Rules Federal Rule of Civil Procedure 8(a)(2)-------------------------------------------------------------- 17 Case 3:07-cv-04578-SI Document 61 Filed 03/14/2008 Page 5 of 31 Lead Plaintiff’s Opposition to Defendants’ MTD 3:07-CV-04578-SI 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 INTRODUCTION Lead Plaintiff, James R. Bartholomew, filed his Amended Class Action Complaint (the “Complaint”) on January 25, 2008. The Complaint specifically details how UTStarcom, Inc. (“UTStarcom” or the “Company”) and certain officers and directors -- Hong Liang Lu (Chief Executive Officer and Chairman of the Board), Ying Wu (Executive Vice President and Vice Chairman of the Board), Michael Sophie (Vice President of Finance and Chief Financial Officer), Francis Barton (Executive Vice President and Chief Financial Officer), and Thomas Toy (current Chairman of the Board)1 carried out a pervasive scheme of backdating and improper accounting for stock option grants. Backdating enabled the Defendants to utilize hindsight in choosing option grant dates with favorable exercise prices. Defendants carried out this scheme in direct violation of the publicly disclosed terms of UTStarcom’s various stock option plans. When the backdating scheme became public, UTStarcom was forced to restate years of financial statements (the “Restatement”). UTStarcom’s backdating scheme gives rise to claims under the federal securities laws because, as part of the scheme, Defendants issued a series of false and misleading statements regarding: (a) the terms of option grants; (b) the expenses associated with option grants; and (c) the strength of UTStarcom’s internal controls. Thus, Defendants, intentionally misled class members regarding, inter alia, the value of officer and director compensation, the Company’s compliance with Generally Accepted Accounting Principles (“GAAP”), the accuracy of the Company’s financial results (including net earnings and earnings per share), and the Company’s tax liabilities. ¶¶ 3, 9, 55-56, 64-72, 119-120.2 The Complaint details precisely how the Defendants carried out their scheme and how it resulted in GAAP violations that rendered false and misleading each and every financial statement that UTStarcom issued during the Class Period. 1 Lu, Wu, Sophie, Barton and Toy are collectively referred to as the “Individual Defendants.” 2 References to “¶ ___” are to paragraphs of the Complaint. Case 3:07-cv-04578-SI Document 61 Filed 03/14/2008 Page 6 of 31 Lead Plaintiff’s Opposition to Defendants’ MTD 3:07-CV-04578-SI 2 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 Despite the Complaint’s specifically alleged facts and the powerful inferences that can be drawn therefrom, Defendants still argue that neither scienter nor loss causation is adequately pled. Defendants’ challenges not only overlook the well-pled allegations of securities fraud contained in the Complaint, but also blatantly ignore the Company’s own admissions and its own public filings. UTStarcom has made known in the Restatement that the Company “did not use the proper date as the measurement date,” and therefore, stock options were granted with exercise prices below the fair market value of the Company’s common stock. ¶ 118. Further, the Company has conceded that an additional $25.5 million of stock-based compensation expenses should have been recognized from 1998-2005. Id. Moreover, the Company has admitted to backdating no less than 57% of all UTStarcom stock option grants from 2000 through 2005. ¶ 120. The Restatement tellingly states that “[a] key finding of the Governance Committee was that there were deficiencies with the process by which stock options were granted during the period from our initial public offering in 2000 through at least 2005, which resulted in accounting errors.” Id. The Governance Committee concluded that “certain members of management bear varying degrees of responsibility for the deficiencies in the process by which options were granted.” ¶ 121. These admissions cannot be disregarded or explained away on a motion to dismiss. Thus, Defendants’ motion must be denied. ISSUES TO BE DECIDED (LOCAL RULE 7-4(a)(3) 1. Has Plaintiff alleged fraud with sufficient particularity where he has specified each misstatement alleged to be misleading and the reason why the statement is misleading? 2. Has Plaintiff alleged with particularity facts that give rise to an inference of scienter that is cogent and compelling, or at least as compelling as any opposing inference one could draw from the facts? 3. Has Plaintiff provided Defendants with an indication of the loss and its causal connection where he has specifically pled corrective disclosures and subsequent share price drops? Case 3:07-cv-04578-SI Document 61 Filed 03/14/2008 Page 7 of 31 Lead Plaintiff’s Opposition to Defendants’ MTD 3:07-CV-04578-SI 3 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. Has Plaintiff adequately alleged that the misrepresentations were material to the shareholders in deciding to vote and that the proxy was necessary for the vote in question? 5. Has Plaintiff adequately alleged that the Defendants acted negligently by pleading particularized facts establishing Defendants’ scienter? 6. Does Section 804 of Sarbanes-Oxley extend the statute of limitations for Plaintiff’s § 14(a) claim for fraudulent conduct? 7. Has Plaintiff pled a cause of action under § 20(a)? STATEMENT OF FACTS In a five-year scheme to wrongfully increase the remuneration of the officers, directors and employees of UTStarcom3 and inflate the Company’s net income by underreporting compensation expenses, the Individual Defendants intentionally manipulated stock option grants by falsely “backdating” the grants so that the options were always “in the money.” The Governance Committee of UTStarcom’s Board of Directors, set up to internally investigate backdating of stock options at the Company, concluded that “certain members of management bear varying degrees of responsibility for the deficiencies in the process by which options were granted [during the period from UTSI’s initial public offering in 2000 through at least 2005, which resulted in accounting errors].” In fact, the Individual Defendants directly and intentionally participated in this scheme, going so far as to personally alter, and order their subordinates to alter, documentation to support the backdating of options. When this backdating scheme finally was disclosed, the Company was forced to restate its financial statements to increase its reported expenses and decrease its net income for the last five years. UTStarcom ultimately restated its previously filed financial statements for fiscal years 2000-2006 by approximately $25.5 million to account for these material compensation expenses. As a result of Defendants’ wrongful conduct, the Company’s stock 3 UTStarcom manufactures, integrates and supports IP-based, end-to-end networking and telecommunications solutions. ¶ 47. Case 3:07-cv-04578-SI Document 61 Filed 03/14/2008 Page 8 of 31 Lead Plaintiff’s Opposition to Defendants’ MTD 3:07-CV-04578-SI 4 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 price plummeted from a Class Period high of $45.36 per share on August 21, 2003 to a low of $3.88 per share on July 24, 2007 when the full truth about Defendants’ manipulation of stock options was disclosed. Throughout the Class Period, Defendants represented to the investing public that all option grants4 were made at the fair market value of UTStarcom stock on the date of the grant, i.e., the closing price of UTStarcom common stock on the date of grant, which could not be “in-the-money,” and that, indeed, UTStarcom’s various stock option plans required option grants at the fair market value of the stock. ¶¶ 48, 52, 66, 75, 85, 95, 105. In fact, however, as the Company has now admitted, Defendants, contrary to their representations to investors, granted options using exercise prices tied to prior dates, i.e., already in-the-money. ¶¶ 8, 9, 16, 19 113-21. In addition, in proxy statements dated April 2, 2003; August 22, 2003; April 7, 2004; April 18, 2004; June 16, 2006; and June 21, 2006 (as conceded by Defendants (see Def. Mem. at 25)), the Defendants misrepresented officer and director compensation by stating that the exercise price of the options granted was the same as the fair market price of the stock on that day, thereby omitting to state the true value of said compensation and that option grants were in fact backdated. ¶¶ 66, 161-66. This pervasive scheme extended over a period of five years and was well-known throughout the Company and by UTStarcom’s accountants. ¶¶ 2, 57-60, 62, 63, 130-31, 138. Indeed, as alleged, the Individual Defendants directly participated in the backdating of options: far from Defendants’ mischaracterization of the Complaint (Def. Mem. at 18-19), Confidential Witness No. 1 (CW#1), a former UTStarcom Human Resources Coordinator from 2005 through 2007 (¶ 57), directly witnessed defendants Barton and Sophie personally backdating options. ¶¶ 62, 131. CW#1, further, was directly instructed to backdate 4 As do many companies, UTStarcom, at the direction of its Board of Directors, used stock options as a form of compensation to recruit and retain key executives and employees. ¶50. Each of the Company’s stock option plans gave the Board of Directors the power to interpret and administer the plans, including the power to decide to whom grants would be awarded and at what strike price. ¶¶49-51. Case 3:07-cv-04578-SI Document 61 Filed 03/14/2008 Page 9 of 31 Lead Plaintiff’s Opposition to Defendants’ MTD 3:07-CV-04578-SI 5 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 employment documents in order to assure that options were granted “in-the-money.” ¶¶ 57- 58, 60. Moreover, CW#1 has stated that all paperwork associated with option grants was first approved by UTStarcom’s Stock Administrator and its General Counsel. ¶ 59. These backdated grants directly led to a material overstatement of UTStarcom’s net income and earnings per share (“EPS”). For every quarter and fiscal year from the fiscal year ended December 31, 2002 through the quarter ended March 31, 2005, UTStarcom showed increasing net income and EPS. ¶¶ 74, 78, 80, 82, 84, 88, 90, 92, 94, 98. However, these financial numbers were falsely buoyed by the backdating of options granted to UTStarcom officers, directors and employees. Even the periods where UTStarcom showed a net loss (¶¶ 102, 104, 110) would have been substantially worse but for Defendants’ manipulation of option grants. Under GAAP, if options are priced below a stock’s fair market value when they are awarded, there is an instant gain that obligated the Company, pursuant to Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), to recognize that gain as a compensation expense over the vesting period of the option. After June 2005, Statement of Financial Accounting Standards (“SFAS”) 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), required that the Company recognize the entire value of all option grants on the grant date amortized over the vesting period of the option. ¶ 8. However, in violation of GAAP, as set forth above, Defendants, contrary to their representations to investors that options were granted at the market value of UTStarcom stock on the grant date, actually used exercise prices tied to prior dates. By doing so, Defendants understated UTStarcom’s compensation expenses which consequently -- and in violation of Lu and Sophie’s Sarbanes-Oxley Act certifications -- propped up the Company’s net income (loss) and earnings (loss) per share, which then led to the artificial inflation of UTStarcom’s stock price, throughout the Class Period. Not only did the backdating of options cause UTStarcom to violate GAAP, it also caused the Company to understate its tax liabilities. ¶¶ 67-71. Section 421 of the Internal Revenue Code (“IRC”) allows special treatment for stock options not granted at a discount. Case 3:07-cv-04578-SI Document 61 Filed 03/14/2008 Page 10 of 31 Lead Plaintiff’s Opposition to Defendants’ MTD 3:07-CV-04578-SI 6 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 Under IRC § 422, such options are considered Incentive Stock Options (“ISO”), and, when the grantee exercises the option, any gain is not taxed as ordinary income, and, therefore, the Company is not responsible for any withholding associated with that gain. ¶¶ 68-70. However, if the option granted does not qualify as an ISO, it is considered a Non-Statutory Option (“NSO”), and the Company incurs withholding obligations on the employee’s gain. Id. When Defendants instituted their scheme to backdate options, they treated the options as ISOs, with the attendant benefit of eliminating the withholding obligation, when they should have treated the options as NSOs. ¶ 71. This had the effect of understating the Company’s tax liabilities. Id. It is important to note that the Individual Defendants directly and personally profited from the backdating of options. They were granted over 800,000 total options in 2002 and 2003, and the Company has confirmed that the vast majority of options received by employees during that time period were backdated. ¶¶ 9, 19, 118-21, 133-35. As a result, they wrongfully reaped proceeds of over $38.8 million from stock sales during the Class Period. ¶¶ 33-37. In the wake of the growing options backdating scandals of late 2006 and early 2007, on November 7, 2006, UTStarcom announced that it had begun a voluntary review of its historical equity award grant practices. ¶¶ 11, 113. On this news, UTStarcom’s stock price fell 9% from $10.23 per share on November 7, 2007 to a closing price of $9.32 per share on November 9, 2006. ¶ 113. On February 1, 2007, with no final results of the Company inquiry in hand, the Company updated the investigation, announcing that incorrect measurement dates for certain stock option grants were used; the investing community could no longer rely on UTStarcom’s financial statements for each of the three fiscal years in the period ended December 31, 2005 and financial statements for fiscal years prior to fiscal 2003; and that the Company expected to record additional compensation charges of approximately $ 50 million . ¶ 115. The Company’s stock price dipped to $8.90 per share on February 2, 2007. Case 3:07-cv-04578-SI Document 61 Filed 03/14/2008 Page 11 of 31 Lead Plaintiff’s Opposition to Defendants’ MTD 3:07-CV-04578-SI 7 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 Finally, on July 24, 2007, the full truth was disclosed. As a result of Defendants’ manipulation of option grants, a restatement of Company financials of approximately $28 million in fact would be necessary: . . . [I]n certain instances all actions that establish a measurement date under the requirements of Accounting Principles Board No. 25, Accounting for Stock Issued to Employees, had not occurred at the grant date, which had been used as the measurement date in accounting for Company stock option grants. A later date, when all such actions had taken place, should have been used as the measurement date for these stock options. The Audit Committee . . . then determined, in consultation with and on the recommendation of the Company’s management, the effect of using incorrect measurement dates would require the Company to record material additional stock-based compensation charges in its previously issued financial statements. The Company therefore announced its previously issued financial statements for the years 2000 through 2006, including interim periods within these fiscal years, should no longer be relied upon. The Company has now determined that the amount of the non-cash restatement will be approximately $28 million over the years 2000 through 2006. ¶ 116. As a result of this disclosure, UTStarcom’s stock price dropped by 22%, from $4.73 per share on July 23, 2007 to $3.70 per share on July 25, 2007. ¶ 117. On October 10, 2007, upon issuing its Form 10-Q for the quarter ending on September 30, 2007 (the “2007 3rd Quarter 10-Q”), the Company announced that its Governance Committee found that 17.9 million stock options of the 28.8 million options granted during 2000 through 2005 -- or 62% -- had incorrect measurement dates. ¶¶ 9, 120. Out of the 17.9 million option grants that used the wrong date, 10.3 million used exercise prices below UTStarcom’s closing price on the date of the grant, resulting in an increase in compensation- related expenses of over $32 million, including $6.1 million of additional non-cash stock- based compensation expense from 2.0 million options that were granted to officers and directors. ¶¶ 9, 120. The Company further conceded that it was liable for an additional $1.5 million in additional taxes as a result of its failure to properly date option grants and that it “has assumed responsibility for all additional payroll taxes plus related penalties and interest arising from the restatement of stock-based compensation, including amounts otherwise Case 3:07-cv-04578-SI Document 61 Filed 03/14/2008 Page 12 of 31 Lead Plaintiff’s Opposition to Defendants’ MTD 3:07-CV-04578-SI 8 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 payable by stock option recipients, and the Company’s restated financial statements include a $1.5 million accrual for this estimated expense.” ¶¶ 72, 120. As a result of the uncovering by the Company’s internal investigation of Defendants’ wrongful backdating of options, UTStarcom and the Individual Defendants acted to “correct” their wrongful behavior: Lu, Wu, Barton, Huang, Toy, along with three other officers and directors, elected to amend any of their previously granted stock options that might in the future be determined to be discounted stock options. ¶¶ 15, 129. On June 6, 2007, in the midst of the investigation, the Company announced that it was terminating its employment relationship defendant Wu. ¶¶ 18, 129. ARGUMENT I. STANDARDS OF LAW ON A MOTION TO DISMISS When considering a motion to dismiss, a court must accept the allegations as true and construe them in the light most favorable to the plaintiffs. Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S. Ct. 2499, 2509 n.4 (2007); Shurkin v. Golden State Vintners Inc., 471 F. Supp.2d 998, 1011 (N.D. Cal. 2006) (citing Schwarz v. U.S., 234 F.3d 428, 435 (9th Cir. 2001)). These well-settled standards apply with equal force to cases brought under the Private Securities Litigation Reform Act of 1995, Pub. L. No. 104-67, 109 Stat. 737 (“PSLRA”).5 The basic purposes of the securities laws mandate that reasonable inferences suffice and that evidence need not be pleaded. No. 84 Employer-Teamster Joint Council Pension Trust-Fund v. Am. West Holding Corp., 320 F.3d 920, 946 (9th Cir. 2003); see also In re Immune Response Sec. Litig., 375 F. Supp. 2d 983, 1018 (S.D. Cal. 2005) (“Courts must be careful not to set the [post-PSLRA pleading] hurdles so high that even meritorious actions cannot survive a motion to dismiss. Such a regime would defeat the remedial goals of the 5 See, e.g., In re Daou Sys. Inc. Sec. Litig., 411 F.3d 1006, 1013 (9th Cir. 2005) (“We accept the plaintiffs’ allegations as true and construe them in the light most favorable to plaintiffs.”) (citation omitted), cert. denied, 546 U.S. 1172 (2006); Nursing Home Pension Fund, Local 144 v. Oracle Corp., 380 F.3d 1226, 1229 (9th Cir. 2004)(“The general rule for 12(b)(6) motions is that allegations of material fact made in the complaint should be taken as true and construed in the light most favorable to the plaintiff). Case 3:07-cv-04578-SI Document 61 Filed 03/14/2008 Page 13 of 31 Lead Plaintiff’s Opposition to Defendants’ MTD 3:07-CV-04578-SI 9 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 federal securities laws.”) (citation omitted). Moreover, a complaint must be construed as a whole on a motion to dismiss. See Tellabs, 127 S. Ct. at 2509 (“courts must consider the complaint in its entirety”); see also Am. West, 320 F.3d at 945 (reversing a district court dismissal because “although…some of Plaintiffs’ allegations are individually lacking…the allegations in their totality are sufficient to meet the stringent pleading standard set forth in the PSLRA.”). II. LEAD PLAINTIFF HAS STATED A CLAIM FOR SECURITIES FRAUD UNDER SECTION 10(b) AND RULE 10b-5 A. Lead Plaintiff has Alleged the Fraud With Sufficient Particularity Lead Plaintiff has alleged with minute detail the precise false and misleading statements and omissions made by Defendants throughout the Class Period, and the reasons why these statements or omissions were false and misleading. The false and misleading statements alleged include but are not limited to the following: • that the Company had granted stock options in accordance with its 1997 Stock Option Plan and 2001 Director Plan, and that the exercise prices of the options that were granted under these plans were not less than the fair market value of UTStarcom’s common stock on the grant dates; ¶¶ 52, 53, 75, 85, 95, 105 • all statements regarding the amount of UTStarcom’s net income and EPS made from February 21, 2003 through August 9, 2006 in the Company’s Annual Reports (Form 10-K) and Quarterly Reports (Form 10-Q); ¶¶ 74, 77-84, 87-94, 97-104, 107-111 • all statements regarding the amount of UTStarcom’s expenses made from February 21, 2003 through August 9, 2006; ¶¶ 74, 77-84, 87-94, 97-104, 107-111 • that the stock options granted to Lu, Wu, Sophie, Barton and Toy had exercise prices not less than the fair market value of UTStarcom’s common stock on the grant dates; ¶¶ 52, 53, 66 • that UTStarcom’s financial statements were prepared in accordance with GAAP; ¶¶ 118-120. Case 3:07-cv-04578-SI Document 61 Filed 03/14/2008 Page 14 of 31 Lead Plaintiff’s Opposition to Defendants’ MTD 3:07-CV-04578-SI 10 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 • that UTStarcom properly accounted for stock option grants pursuant to APB 25; ¶¶ 74-111 • that UTStarcom maintained appropriate internal disclosure controls and procedures; ¶¶ 118-120 • that UTStarcom’s SEC filings were free of material misstatements or omissions; ¶¶ 76, 86, 96, 106 • that UTStarcom’s SEC filings complied with the requirements of the securities laws and fairly presented the financial condition and results of the Company; ¶¶ 76, 86, 96, 106 This is all that is required. See In re Secure Computing Corp. Sec. Litig., 184 F. Supp.2d 980, 985 (N.D. Cal. 2001) (stating that the PSLRA requires that the complaint specify each statement alleged to have been misleading that the reason of reasons why the statement is misleading); see also In re U.S. Aggregates, Inc. Sec. Litig., 235 F.Supp.2d 1063, 1069 (N.D. Cal. 2002). Moreover, given the fact that Defendants have restated the Company’s financials by $25.5 million for a multi-year period the materiality of these misrepresentations is not subject to dispute.6 The materiality of these facts is further corroborated by the UTStarcom share price drops in reaction to the disclosures of Defendants’ backdating.7 6 See In re Zoran Corp. Derivative Litig., 511 F. Supp.3d, 984, 1011 (N.D. Cal. 2007) (finding materiality adequately pled where plaintiff alleged that Zoran had to restate its financials and recognize a charge of twelve to fifteen million dollars in compensation expenses); In re Ramp Networks, Inc. Sec., 201 F. Supp.2d 1051, 1066 (N.D. Cal. 2002) (finding that a restatement provides evidence that statements made about revenue and accounting principles were false when coupled with specific allegations about practices that violate GAAP); In re Cylink Sec. Litig., 178 F. Supp.2d 1077, 1084 (N.D. Cal. 2001) (stating that “the mere fact that…statements were restated at all” is sufficient to establish falsity at the pleading stage). 7 See In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410, 1425(3d Cir. 1997) (holding that when a stock is traded in an efficient market, the materiality of disclosed information may be measured post hoc by looking to the movement in the period immediately following the disclosure); In re National Golf Properties, Inc., No. 02-1383, 2003 WL 23018761, *5 (C.D. Case 3:07-cv-04578-SI Document 61 Filed 03/14/2008 Page 15 of 31 Lead Plaintiff’s Opposition to Defendants’ MTD 3:07-CV-04578-SI 11 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 B. Lead Plaintiff has Alleged Facts Giving Rise to a Strong Inference of Scienter Lead Plaintiff’s allegations, when properly considered in their entirety, give rise to a strong inference that Defendants acted with the requisite scienter throughout the Class Period. In addressing the proper standard to be applied in considering whether a plaintiff’s allegations give rise to such an inference, the Supreme Court has held that: [C]ourts must consider the complaint in its entirety, as well as other sources courts ordinarily examine when ruling on Rule 12(b)(6) motions to dismiss…The inquiry, as several Courts of Appeals have recognized, is whether all of the facts alleged, taken collectively, give rise to a strong inference of scienter, not whether any individual allegation scrutinized in isolation, meets that standard. Tellabs, 127 S.Ct. at 2509 (2007) (citing Gompper v. VISX. Inc., 298 F.3d 893, 897 (9th Cir. 2002)). The alleged facts must give rise to an inference of scienter that is “cogent” and “compelling,” in other words “at least as compelling as any opposing inference one could draw from the facts alleged.” Id. Lead Plaintiff’s Complaint satisfies this standard, setting forth particularized allegations regarding UTStarcom’s pervasive backdating scheme and misrepresentations that give rise to a strong inference of scienter as to each Defendant. This inference is not only “cogent” and “compelling” - it is the only logical inference to be drawn. Defendants fail to suggest any facts that give rise to an inference of plausible non-fraudulent intent, instead taking each of Lead Plaintiff’s allegations one by one, and claiming that each one, viewed in isolation, is insufficient. This tactic is flatly inconsistent with the Tellabs standard, and should not be countenanced. Instead, the scienter analysis requires courts to consider all circumstances and all allegations, in toto. When taken as a whole (as they must be), the scienter facts pled in the Complaint paint an overwhelming and detailed portrait of Defendants’ scienter. Cal. Mar. 19, 2003) (finding materiality had been alleged at the pleading stage where drop in stock price followed a restatement of financials). Case 3:07-cv-04578-SI Document 61 Filed 03/14/2008 Page 16 of 31 Lead Plaintiff’s Opposition to Defendants’ MTD 3:07-CV-04578-SI 12 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 The magnitude, duration and materiality of UTStarcom’s admitted GAAP violations and the Restatement, combined with the Individual Defendants’ knowledge of the faulty accounting practices and direct involvement in the stock option granting process, and the information provided by the confidential witnesses all combine to provide a cogent and compelling inference of scienter. As such Defendants’ Motion to Dismiss should be denied. 1. The Pervasive and Systematic Accounting Violations Admitted by UTStarcom In Its Restatement Contribute to a Strong Inference of Scienter UTStarcom argues that “a restatement, by itself, indicates only that a company’s financials were incorrect, not the existence of an attempt to defraud.” Def. Mem. at 10. As stated above, UTStarcom’s attempt to address this allegation in isolation is improper under Tellabs. It is clear that the pervasive and systematic accounting violations detailed in the Restatement contribute to a strong inference of scienter. Further, Defendants’ contention that the Company’s Governance Committee found that “none of the current or former employees or directors of the Company engaged in intentional wrongdoing” is unavailing. Def. Mem. at 11. It comes as no surprise that the Company’s internal investigative committee did not admit that its own officers and directors had engaged in fraud. UTStarcom’s Restatement admits that every financial statement and accompanying press release issued by the Company and signed by Lu, Wu, Sophie, Toy and Barton during the Class Period and prior to the Class Period were materially false and misleading when made. ¶ 118-121. Indeed the Restatement details that Defendants backdated no fewer than 10.9 million options or 57% of all option grants during the period in question. Id. The pervasive, long term, repeated financial misstatements which gave rise to UTStarcom’s Restatement and admitted accounting violations thus contribute mightily to a strong inference that Defendants acted with intent or deliberate recklessness.8 Moreover, 8 See Cylink, 178 F. Supp.2d at 1084 (finding that the mere fact that the financials had to be restated supports an inference of scienter); see also In re Cornerstone Propane Partners, L.P., 355 F. Supp. 2d 1069, 1091 (N.D. Cal. 2005)(holding that allegations of GAAP violations provide support for plaintiffs’ allegations of scienter); see also In re Adaptive Broadband Sec. Case 3:07-cv-04578-SI Document 61 Filed 03/14/2008 Page 17 of 31 Lead Plaintiff’s Opposition to Defendants’ MTD 3:07-CV-04578-SI 13 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 “when significant GAAP violations are described with particularity in the complaint, they may provide powerful indirect evidence of scienter. After all, books do not cook themselves.” In re McKesson HBOC, Inc. Sec. Litig., 126 F. Supp.2d 1248, 1273 (N.D. Cal. 2000). This is particularly true in cases of options backdating, because options simply do not date themselves. Rather, it requires a specific act of will on the part of the officers and directors of a corporation to assign a date to the issuance of an option. Further, it requires a conscious, intentional act to date such options on a day other than that in which they are actually being authorized. See In re CNET Networks, Inc., 483 F. Supp.2d 947, 956 (N.D. Cal. 2007). Thus, and to paraphrase from McKesson, just as “books do not cook themselves,” options do not (indeed, cannot) backdate themselves. Indeed, statistical analysis indicates that the cumulative share price drops prior to UTStarcom option grants and cumulative gains in share price following the dates of option grants provides strong evidence that these dates were intentionally selected with the benefit of hindsight to enrich the grantees. ¶ 63. This was no coincidence. Significantly, UTStarcom does not deny that its historical financial statements were in error as a result of a failure to properly account for stock option grants. Indeed, Defendants have admitted that no fewer than 10.3 million options granted during the five year period were misdated. ¶ 120. Therefore, neither the GAAP violations, the materiality of those violations, nor the falsity of the financial statements is in dispute. ¶ 118-121. The magnitude, pervasiveness and duration of these admitted GAAP violations contributes compellingly to the strong inference of scienter.9 Litig., No. 01-1092, 2002 WL 989478, at *14 (N.D. Cal. April 2, 2002) (finding that a restatement is sufficient to support a scienter inference when coupled with strong evidence of deliberately reckless accounting). 9 The Ninth Circuit unequivocally has held that allegations of widespread or systematic GAAP violations such as those stated in the Complaint support a strong inference of scienter. Daou, 411 F.2d at 1018, 1020; see also Adaptive Broadband, 2002 U.S. Dist. LEXIS 5887, at ** 39, 42 (“While it is true that conclusory allegations of GAAP violations standing alone Case 3:07-cv-04578-SI Document 61 Filed 03/14/2008 Page 18 of 31 Lead Plaintiff’s Opposition to Defendants’ MTD 3:07-CV-04578-SI 14 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. Lead Plaintiff’s Confidential Witness Allegations Contribute to a Strong Inference of Scienter The Complaint contains allegations based upon direct, eye-witness observations of confidential witnesses who have related to Plaintiff’s counsel their experiences in connection with UTStarcom’s backdating scheme. These confidential witnesses disclosed that options backdating was a common practice at the Company and that at various times, CW#1 was directed to purposefully and intentionally alter documents for this purpose. ¶ 57-62. In light of the PSLRA's heightened pleading standard, plaintiffs relying on confidential witnesses to raise an inference of scienter must meet certain requirements. First, plaintiffs must describe each confidential witness “with sufficient particularity to support the probability that a person in the position occupied by the source would possess the information alleged.” Daou, 411 F.3d at 1015 (quoting Nursing Home, 380 F.3d at 1233) (internal quotation marks omitted). If a plaintiff adequately describes a confidential witness, the court then proceeds to a determination of the witness's reliability by evaluating “the level of detail provided by the confidential sources, the corroborative nature of the other facts alleged (including from other sources), the coherence and plausibility of the allegations, the number of sources [and] the reliability of the sources . . . . ” Id. (quoting In re Cabletron Sys., Inc., 311 F.3d 11, 29-30 (1st Cir.2002)). Here, the Complaint clearly alleges sufficient information to support the probability that the respective witnesses possessed the information alleged. ¶ 57-62. For example, Lead Plaintiff indicates that CW#1 was the Human Resources Coordinator at the Company from 2005 through 2007. ¶ 57. The complaint further details CW#1’s first hand account of the mechanics of stock option grant reports, where the Company maintained this information,10 cannot be used to prove intentional or reckless misconduct, if pled in detail and read in context, GAAP violations may support an inference of scienter.”) 10 CW#1 further described in detail how the paper trail of the backdated options was kept. ¶ 59. After approval by the Board of Directors, the backdated options would then be approved by the Company’s General Counsel and Stock Administrator. Id. According to CW#1, the Company maintained all information relating to the granting of the backdated options within Case 3:07-cv-04578-SI Document 61 Filed 03/14/2008 Page 19 of 31 Lead Plaintiff’s Opposition to Defendants’ MTD 3:07-CV-04578-SI 15 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 how the witness was involved in the backdating process and the involvement of outside auditors in the backdating scheme.11 ¶ 57-62. These details are more than sufficient to allow the Court to credit these allegations. Indeed, the witnesses’ detailed accounts of the backdating scheme as it operated within UTStarcom are nothing short of damning. CW#1 disclosed that during her time at the Company, UTStarcom actively backdated its stock option grants to senior executives to assure that they would receive the highest possible margins in the exercise and sales of their options. ¶ 57. She revealed that she was directed to purposefully and intentionally alter documents for this purpose. Id. In fact, CW#1 stated that she actually witnessed Defendants Barton and Sophie, at different times, fabricating and altering documents for the purpose of backdating options. Further, she indicated that the backdating scheme was a commonly discussed practice within the Company. Id. Confidential Witness #2, an Administrative Support Representative, corroborated and confirmed this statement. Id Fact-specific, detailed, eye-witness accounts of Defendants’ active, intentional role in a fraud obviously suffices at the pleading stage to give rise to a strong inference of scienter - particularly when pled in conjunction with other indicia of fraudulent intent. See McKesson, 126 F. Supp.2d at 1271. That is exactly what the Complaint pleads. 3. The Sarbanes-Oxley Certifications Contribute to a Strong Inference of Scienter Throughout the Class Period. the Individual Defendants certified the Company’s financial reports. Indeed, pursuant to these certifications, the Individual Defendants have admitted reviewing and being familiar with the Company’s financial reports. ¶76, 86, 96, 106, 123. an ADP HRIS system until September 2005 when they transitioned to an Oracle based system. Id. 11 During her interview, CW#1 recalled that the Company’s pre-audit accountants, Deloitte & Touche, frequently requested that the witness backdate various employment papers in order to bring the Company into apparent compliance for its audits by PriceWaterhouseCoopers. ¶ 58. Case 3:07-cv-04578-SI Document 61 Filed 03/14/2008 Page 20 of 31 Lead Plaintiff’s Opposition to Defendants’ MTD 3:07-CV-04578-SI 16 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 These certifications, signed pursuant to § 906 of Sarbanes-Oxley, can give rise to a strong inference of scienter. In re Lattice Semiconductor Corp. Sec. Litig., No. 04-1255, 2006 U.S. Dist. LEXIS 262, at **45-50 (D. Or. Jan. 3, 2006). Although Sarbanes-Oxley does not create a scheme of strict liability, the statements contained in the certifications themselves can constitute evidence of actual knowledge or deliberate recklessness on the part of the certifying officers. Id. This is so because the certifications create a presumption that the signators were familiar with, and responsible for, the preparation of the financial statements and certified their veracity. Id. Here, the certifications contribute to a strong inference of scienter because there is no dispute regarding the falsity of UTStarcom’s certified financial statements. ¶¶ 118-21. 4. Lead Plaintiff Adequately Alleges the Individual Defendants’ Involvement in the Stock Option Granting Process Lead Plaintiff has pled “specific contemporaneous conditions known to the defendants that would strongly suggest that the defendants understood” their statements to be false. See In re Vantive Corp. Sec. Litig., 283 F.3d 1079 (9th Cir. 2002). Lead Plaintiff’s complaint specifically alleges that the Officer Defendants, Lu, Wu, Sophie and Barton, as executives and members of the Board of Directors, personally authorized and approved the backdated stock option grants at issue. ¶ 33-36. Further, the Complaint alleges that Defendant Toy, as a member of the Audit and Compensation Committees, enabled the stock option backdating scheme to succeed. ¶ 37. Lead Plaintiff has thus clearly specified the roles that the Individual Defendants played in authorizing and approving backdated stock option grants.12 Plainly, allegations of the Defendants direct participation in this fraud contribute significantly to a strong inference of scienter. 12 Each of the Company’s stock option plans gave the Board of Directors or any of its Committees the full power to interpret and administer the plans. ¶ 50. Thus, the Board and, in particular, the Compensation Committee, were intimately involved in the process of granting (and, necessarily, dating) these options. Case 3:07-cv-04578-SI Document 61 Filed 03/14/2008 Page 21 of 31 Lead Plaintiff’s Opposition to Defendants’ MTD 3:07-CV-04578-SI 17 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. The Individual Defendants’ Insider Trades Contribute to a Strong Inference of Scienter The Individual Defendants directly and personally profited from the backdating of options: they were granted over 800,000 total options in 2002 and 2003, and the Company has confirmed that the vast majority of options received by employees during that time period were backdated. ¶¶ 9, 19, 118-21, 133-35. As a result, they wrongfully reaped proceeds of over $38.8 million from their stock sales during the Class Period. ¶¶ 33-37. “Unusual trading or trading at suspicious times or in suspicious amounts by corporate insiders has long been recognized as probative of scienter.” Daou, 411 F.3d at 1022. These massive insider sales, stemming from the exercise of backdated options and taking place while the Company was materially understating compensation expenses and overstating net income, certainly provide even more credence to a cogent, strongly compelling inference of Defendants’ scienter.13 III. LEAD PLAINTIFF HAS ADEQUATELY PLED LOSS CAUSATION The Supreme Court has held that pleading loss causation is governed by the notice pleading standard of Federal Rule of Civil Procedure 8(a)(2), which requires only a “short and plain statement of the claim showing that the pleader is entitled to relief.” Dura Pharm., Inc. v. Broudo, 544 U.S. 336, 346 (2005). Thus, a plaintiff must provide a short and plain statement giving “notice of what the relevant economic loss might be or what the causal connection might be between” the loss and the misrepresentation. Id. at 347. However, a plaintiff need only “provide a defendants with some indication of the loss and the causal connection that the plaintiff has in mind.” Id. (emphasis added). Under Dura, loss causation is sufficiently pled when the complaint alleges a causal link between the disclosure of previously undisclosed information and the decline in stock price. Id. at 336. In the Ninth Circuit, a complaint satisfies the loss causation pleading 13 See Cornerstone, 355 F. Supp. 2d at 1095 n.7 (finding that insider sales can form a basis for inferring scienter where the sales were unusual or suspicious); see also In re Silicon Graphic. Sec. Litig., 183 F.3d 970, 986 (9th Cir. 1999) (stating that “unusual” or “suspicious” stock sales by insiders can constitute circumstantial evidence of scienter). Case 3:07-cv-04578-SI Document 61 Filed 03/14/2008 Page 22 of 31 Lead Plaintiff’s Opposition to Defendants’ MTD 3:07-CV-04578-SI 18 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 requirement when it alleges “a causal connection between the deceptive acts that form the basis for the claim of securities fraud and the injury suffered by the plaintiff.” Daou, 411 F.3d at 1025. This causal connection is established where, as here, the revelation of the true facts which had been previously omitted or misrepresented causes the stock price to fall. See id.; see also Plumbers & Pipefitters Local 572 Pension Fund v. Cisco Sys., Inc., 411 F. Supp.2d 1172, 1177 (N.D. Cal. 2005) (finding loss causation adequately alleged where a drop in stock price followed a corrective disclosure). Further, under Daou, in order to show loss causation, a plaintiff need not show that a misrepresentation was the sole reason for the investment’s decline. 411. F.3d at 1025. Lead Plaintiff’s specific loss causation allegations meet the pleading requirements. In particular, the Complaint alleges: (a) Plaintiff purchased UTStarcom stock during the Class Period, ¶ 31; (b) the stock prices during the Class Period were artificially inflated due to Defendants’ undisclosed options backdating scheme, ¶¶ 3, 4, 45, 142, 145; (c) when the truth about Defendants’ backdating and its implications became known by the market, UTStarcom’s stock price declined, ¶¶ 3-4, 142-148; and (d) the disclosure of Defendants’ backdating scheme was a cause of the stock price declines, ¶¶ 3-4,142-148. Lead Plaintiff details facts regarding the misstatements and omissions and how the market negatively reacted to revelations of the fraud. These allegations satisfy the loss causation pleading requirements. Simply stated, and as more fully discussed below, the Complaint directly pleads that information revealed to investors the truth about the previously undisclosed backdating and proximately caused the fall in UTStarcom’s stock price on November 7, 2006 and July 24, 2007. As such, Lead Plaintiff has properly pled loss causation for each disclosure detailed in the Complaint.14 14 See Immune Response, 375 F. Supp.2d at 1025 (finding that allegations that the corrective disclosures caused the drop in stock price satisfies Dura); see also Plumbers &Pipe, 411 F. Supp. 2d at 1177-78 (finding stock declines following partial disclosures sufficient to plead loss causation under Dura); In re Omnivision Tech., No. 04-2297, 2005 U.S. Dist. LEXIS Case 3:07-cv-04578-SI Document 61 Filed 03/14/2008 Page 23 of 31 Lead Plaintiff’s Opposition to Defendants’ MTD 3:07-CV-04578-SI 19 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 A. The November 7, 2006 Revelation was a Corrective Disclosure and Caused a Loss to Lead Plaintiff and the Class. Lead Plaintiff adequately pled loss causation with respect to the November 7, 2006 revelation of previously undisclosed bad news regarding the Company’s internal investigation into its stock option grant practices. On that date, after the close of trading, the Company filed an SEC report on Form 8-K disclosing that the Company had commenced a review of its historic equity award grant practices. ¶ 147. The Form 8-K indicated that the Company had informed the SEC about the commencement of the review. Id. The Company claimed uncertainty in regard to the review’s effect on prior financial statements, and admitted that this stock option investigation would interfere with UTStarcom’s ability to timely file its SEC reports. ¶¶ 11-12, 147. The next trading day, UTStarcom’s stock dropped 9% as a result of this news. Id. Thus, the Amended Complaint alleges: (1) the disclosure of previously concealed negative facts related to the backdating scheme; and (2) an immediate drop in UTStarcom’s stock price due to the disclosure of this new information. Plainly, Lead Plaintiff has properly and sufficiently alleged loss causation in connection with this revelation. See Dura, 544 U.S. at 347; see also Daou, 411 F.3d at 1025; Cisco, 411 F. Supp.2d at 1177-78. Nevertheless, Defendants argue that the November 7th revelations were not a “corrective disclosure”. Def. Mem. at 6-7. This is ludicrous. Defendants were informing the market (and the SEC) of an internal investigation relating to options backdating that might (and eventually would) cause the Company to restate its financial reports. The market was obviously aware that companies do not announce such investigations, possible restatements and delays in future financial reports and filings unless there is substantial cause for concern - and the drop in the share price reflected this fact. This was, plainly, a corrective disclosure under Daou, which merely requires the allegations to provide “some indication that the drop in . . . stock price was causally related to . . . financial misstatements.” Daou, 411 F.3d at 1026. 16009, at **18-19 (N.D. Cal. July 29, 2005)(alleging that plaintiffs suffered damages when revelation of the true facts caused a decline in the value of their investments satisfies Dura). Case 3:07-cv-04578-SI Document 61 Filed 03/14/2008 Page 24 of 31 Lead Plaintiff’s Opposition to Defendants’ MTD 3:07-CV-04578-SI 20 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 Defendants’ reliance on Weiss v. Amkor Tech., Inc., 527 F. Supp. 2d 938 (D. Ariz. 2007), is unavailing. There, the plaintiff failed to sufficiently plead loss causation because Amkor’s stock price went up, not down, after corrective disclosures were issued regarding options backdating. Id. at 945-46. In this case, Lead Plaintiff alleges that disclosures regarding possible and actual backdating at UTStarcom caused temporally proximate declines in UTStarcom’s stock price.15 Nothing more is required. B. Defendants Ask the Court to Draw Impermissible Inferences Concerning the July 24, 2007 Disclosure On July 24, 2007, at the close of trading, Defendants revealed for the first time that the Company would be definitively forced to restate its financial results by over $28 million due to the backdating of employee stock options. ¶ 148. The next day, following this announcement, the Company’s share price dropped 22%. ¶ 148. Allegations such as this more than satisfy the loss causation pleading requirements of Dura and Daou. Defendants’ argument that this news was positive is meritless. It is inconceivable that the need to restate $28 million can be considered “good news,” as Defendants would like to characterize it. Rather, this was a revelation that an internal investigation had definitively found that the Company had backdated options, and had consequently under-reported compensation expenses and overstated income by $28 million over a period of several years. The notion that the market would react to this with anything other than a punitive share price drop is unsupportable. Moreover, to the extent that Defendants improperly contend that other disclosures on July 24, 2007 caused or contributed to UTStarcom’s share price drop, they ignore the legal reality that, at this phase of the litigation, a plaintiff is not required to show “that a misrepresentation was the sole reason for the investment’s decline in value” in order to establish loss causation. Daou, 411 F.3d at 1025 (quoting Robbins v. Koger Props., Inc., 116 15 Amkor is also inapposite as the court ruled there that plaintiffs could not allege loss causation based on an investigation of the stock option grants because the real discussion in the press release was the second quarter financial results. Id. at 946. Defendants’ November 6, 2007 had no discussion other than the stock option grant review. Case 3:07-cv-04578-SI Document 61 Filed 03/14/2008 Page 25 of 31 Lead Plaintiff’s Opposition to Defendants’ MTD 3:07-CV-04578-SI 21 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 F.3d 1441, 1447 n.5 (11th Cir. 1997) (emphasis added). Nevertheless, Defendants ask the Court to decide improperly (or at least prematurely) this precise issue of fact, contending that other disclosures on July 24, 2007 were the cause of the Company’s share price drop. This is not an appropriate question for this phase of the litigation.16 IV. LEAD PLAINTIFF HAS STATED A CLAIM FOR PROXY FRAUD Lead Plaintiff has more than adequately alleged each element of a §14(a) claim - that is, “that: (1) defendants made a material misrepresentation or omission in a proxy statement; (2) with the requisite state of mind; and (3) that the proxy statement was the transaction cause of harm of which plaintiff complaints.” Zoran., 2007 U.S. Dist. LEXIS 43402, *63 (N.D. Cal. June 5, 2007) (citing Mills v. Electric Auto-Lite Co., 396 U.S. 375, 384 (1970)). The Complaint specifically identifies false and misleading statements contained in the proxy statements and adequately alleges that the Defendants’ misrepresentations caused the injury suffered by Lead Plaintiff and the Class. As such the Motion must be denied on this count. A. Lead Plaintiff has Pled Misrepresentations in the Proxies Defendants claim that Lead Plaintiff’s complaint “does not quote a single statement from any of the Company’s proxies that are alleged to be misleading.” Def. Br. at 21. This contention is utterly (and obviously) false. The complaint specifically alleges that UTStarcom’s annual proxy statements for fiscal years 2002-2006 falsely stated that “the 16 See Immune Response, 347 F. Supp.2d at 1025 (“[W]hether the alleged omissions and misstatements actually were the cause-in-fact of the [decline in] price of [defendant’s] stock raises an issue of fact and, as such, is a question properly reserved for a motion for summary judgment or for the trier of fact.”); see also In re Openwave Sys. Sec. Litg., No. 07-1309, 2007 U.S. Dist. LEXIS 80558, at **41-44 (holding that where Openwave had disclosed other negative news on the same dates as one of the announcements regarding the backdating was not fatal to plaintiffs’ claim since, the issue of whether these disclosures actually caused all or part of the price drop was a matter left for proof at trial); In re CMS Energy Sec. Litig., No 02- 072004, 2005 Dist. LEXIS 439, at *5 (E.D. Mich. Jan. 7, 2005) (“[T]he court should not speculate on what degree of the price decline is attributable to the disclosure of [a particular fact].”); In re Credit Suisse-AOL Sec. Litig., 465 F.Supp.2d 34, 55 (D. Mass. 2006) (“Whatever the truth of the matter is, isolating the myriad causal factors that affect stock price is a factual question that should be decided at trial, with the help of qualified experts. It is not an issue appropriate for a motion to dismiss.”). Case 3:07-cv-04578-SI Document 61 Filed 03/14/2008 Page 26 of 31 Lead Plaintiff’s Opposition to Defendants’ MTD 3:07-CV-04578-SI 22 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 exercise price of the stock options was equal to the price of the stock on the date of the grant.” ¶ 66, 162. The Complaint further details the specific elements of each of the Company’s stock option plains detailed in the Proxy Forms. ¶ 49-53. B. Lead Plaintiff Has Alleged the Link Between the Misrepresentations and Shareholder Votes Defendants argue that Lead Plaintiff has failed to satisfy the “essential link” element required to plead a § 14(a) violation conveniently focusing on only one allegation in Lead Plaintiff’s complaint. Rather than support their argument with facts and case law, Defendants choose to illustrate how certain directors were still able to exercise stock options, despite share holder votes. Def. Mem. at 22-23. This has no bearing on how Defendants’ misstatements in their 2002-2006 proxy forms were essential links in the “accomplishment of the proposed transaction” in the proxy at issue. Desaigoudar v. Meyercord, 223 F.3d 1020, 1022 (9th Cir. 2000). The question is not whether Lead Plaintiff can allege and prove that the false statements in the proxy led to the vote in question, but rather (i) whether the alleged misrepresentations were material to the shareholders in deciding to vote; and (ii) whether the proxy was necessary for the vote in question.17 Defendants do not dispute that the proxies were an essential link to the shareholders’ votes. Lead Plaintiff’s Complaint specifically alleges that in order for the Company’s various stock option plans or amendments to such plans to have been approved, the board required shareholder approval. ¶ 49. Where, as here, the board required shareholder approval for implementation of or an amendment to a stock option plan or similar compensation plan, the essential link element is established. See, e.g.. Parsons v. Jefferson-Pilot Corp., 789 F. Supp. 697 (M.D.N.C. 1992); Franklin v. Ernst, 571 F. Supp. 829, 842 (N.D. Ohio 1983) (“In this 17 See Mills v. Electric Auto-Lite Co., 396 U.S. 375, 384-85 (1970) (explaining that where there has been a finding of materiality, a shareholder has made a sufficient showing of causal relationship between the violation and the injury for which he seeks redress if, as here, he proves that the proxy solicitation itself, rather than the particular defect in the solicitation materials, was an essential link in the accomplishment of the [corporate] transaction). Case 3:07-cv-04578-SI Document 61 Filed 03/14/2008 Page 27 of 31 Lead Plaintiff’s Opposition to Defendants’ MTD 3:07-CV-04578-SI 23 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 case, the plan, by its terms, required shareholder approval. The solicitation of proxies, therefore, was ‘an essential link in the accomplishment of the transaction.’ Accordingly, if the proxy statement contains a material misstatement or omission, the causation requirement is met.”). The 2003-2006 Proxies were also an essential link to the vote on the election and re- election of Lu, Wu and Toy.18 Courts routinely find that the essential link element is met where, as here, the proxy seeks a vote for the election of directions. See, Zoran, 2007 U.S. Dist. LEXIS 43402, **67-68. There can also be little doubt that the misrepresentations in UTStarcom’s Proxies were material to shareholders’ voting decisions. The Supreme Court long ago established that a misrepresentation or omission is material if “there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote.” TSC Indus. v. Northway, Inc., 426 U.S. 438, 449 (1976); see also Zoran, 2007 U.S. Dist. LEXIS 43402, at *63. Applying this test, courts have confirmed that facts regarding the nature, purpose, value and recipients of stock option grants and past practices are important factors to be considered by shareholders solicited to vote on an amendment to a stock option plan. See, e.g., Parson, 789 F. Supp. at 702 (“If an omissions or misstatement of one of these elements is made, the omission or misstatement is deemed material as a matter of law.”). Most recently, the court in Zoran, faced with a similar backdating case reiterated that “[h]ad shareholders known that defendants had not followed the dictates of the plan in the past, this likely would have changed their votes” regarding their authorization of stock options plans. 2007 U.S. Dist. LEXIS 43402, at **66-68. Accordingly, Lead Plaintiff has adequately alleged the materiality of Defendants’ misrepresentations regarding how they granted stock options, the terms of option grants to 18 The 2003 Proxy solicited shareholder votes for the re-election of Lu for a three year term on UTStarcom’s Board. The 2004 Proxy solicited shareholder votes for the re-election of Toy and Wu for a three year term on UTStarcom’s Board. The 2006 Proxy solicited shareholder votes for the re-election of Lu for a three year term on UTStarcom’s Board. Case 3:07-cv-04578-SI Document 61 Filed 03/14/2008 Page 28 of 31 Lead Plaintiff’s Opposition to Defendants’ MTD 3:07-CV-04578-SI 24 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 officers and directors and executive compensation. ¶ 8, 49-53, 66, 161-66. Whether the statements were indeed material is a question of fact for the jury. Livid Holdings Ltd. c. Salomon Smith Barney, 416 F.3d 940, 947 (9th Cir. 2005). C. Lead Plaintiff has Adequately Alleged Defendants’ Knowledge and Recklessness With Regard to the Misrepresentations Defendants contend that Lead Plaintiff has not adequately pled that Defendants acted negligently. This contention is without merit as Lead Plaintiff has pled particularized facts establishing Defendants’scienter, as discussed above. This higher standard covers negligence. McKesson, 126 F.Supp. 2d at 1268 n.10; Zoran, 511 F. Supp.2d at 1015. D. Lead Plaintiff’s Claims regarding the 2002-2006 Proxies Are Not Time Barred Defendants’ argument that § 14(a) claims for the admitted misrepresentations contained in the 2002-2006 Proxies are time barred ignores the fact that Lead Plaintiff alleges his § 14(a) claim for fraudulent conduct. Section 804 of Sarbanes-Oxley provides for a 5-2 limitation period for any fraud based claim brought under the Exchange Act. By its express terms, § 804 applies not only to § 10(b) claims, but to claims brought under a number of statues including the Exchange Act or the Securities Act. 28 U.S.C. § 1658(b). The sole limitation is that the claim must be “a private right of action that involves a claim of fraud, deceit, manipulation, or contrivance in contravention of a regulatory requirement concerning the securities law.” Thus, § 804 clearly applies to any claim sounding in fraud that is brought under the Exchange Act for contravention of a regulatory requirement concerning the securities laws.19 19 The Ninth Circuit has not yet opined on the issue of whether Sarbanes-Oxley applies to § 14(a) claims. While a few district courts across the country have declined to apply § 804 to § 14(a) claims sounding in negligence, they are inapposite because they did not address the issue of whether § 804 applies to § 14(a) claims sounding in fraud. See, e.g., In re Amtel Corp. Deriv. Litig., No. 06-4592, 2007 WL 2070299, at *8 (N.D. Cal. July 16, 2007). Case 3:07-cv-04578-SI Document 61 Filed 03/14/2008 Page 29 of 31 Lead Plaintiff’s Opposition to Defendants’ MTD 3:07-CV-04578-SI 25 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 Lead Plaintiff’s § 14(a) claims sounds in fraud, and therefore, § 804 applies. Consequently, Defendants’ argument that Lead Plaintiff’s § 14(a) claims with respect to the 2002, 2003 and 2004 Proxies are time barred is mistaken. VI. LEAD PLAINTIFF HAS STATED A CLAIM FOR CONTROL PERSON LIABILITY PURSUANT TO SECTION 20(a) Lead Plaintiff has adequately plead primary violations of the securities laws on behalf of Defendants Lu, Wu, Sophie, Barton and Toy, as control persons. As such, Lead Plaintiff has adequately stated a claim under Section 20(a). See In re Ditech Networks, Inc. Derivative. Litig., No 06-5157, 2007 WL 2070300, at *9 (N.D. Cal. July 16, 2007) (holding that “to state a claim under Section 20(a), a plaintiff must allege (1) a primary violation of federal securities law; and (2) that the defendant exercised actual power or control over the primary violator.”). Whether the Individual Defendants actually are “controlling persons” under § 20(a) is a question for the jury.20 VII. CONCLUSION For the foregoing reasons, the motion to dismiss should be denied in its entirety. Dated: March 14, 2008 Respectfully submitted, By:____________/s/_____________ Mark Punzalan FINKELSTEIN THOMPSON LLP 100 Bush Street Suite 1450 San Francisco, California 94104 Telephone: 415.398.8700 Facsimile: 415.398.8704 - and - Donald J. Enright, Esq. Elizabeth K. Tripodi FINKELSTEIN THOMPSON LLP 1050 30th Street, NW 20 See Howard v. Everex Sys., 228 F.3d 1057, 1065 (9th Cir. 2000)(quoting Kaplan v. Rose, 49 F.3d 1363, 1382 (9th Cir. 1994) (“Whether [the defendant] is a controlling person is an intensely factual question, involving scrutiny of the defendant’s participation in the day-to- day affairs of the corporation and the defendant’s power to control corporate actions.” ). Case 3:07-cv-04578-SI Document 61 Filed 03/14/2008 Page 30 of 31 Lead Plaintiff’s Opposition to Defendants’ MTD 3:07-CV-04578-SI 26 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 Washington, D.C. 20007 Telephone: 202.337.8000 Facsimile: 202.337.8090 Counsel for Plaintiffs Case 3:07-cv-04578-SI Document 61 Filed 03/14/2008 Page 31 of 31