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ALFUS v. PYRAMID TECH. CORP.

March 30, 1990

MARJORIE D. ALFUS, On Behalf of Herself and All Others Similarly Situated, Plaintiff,
v.
PYRAMID TECHNOLOGY CORP., RICHARD D. DOLINAR, WILLIAM SHELLOOE, WILLIAM D. ROLLNICK, STEPHEN G. TOLCHIN, AND KENT L. ROBERTSON, Defendants



The opinion of the court was delivered by: PECKHAM

 ROBERT F. PECKHAM, UNITED STATES DISTRICT JUDGE

 This matter is before the Court upon defendants' motion to dismiss the above entitled action. The Court has fully considered the submissions and arguments of the parties. GOOD CAUSE appearing therefor, the defendants' motion to dismiss is GRANTED for the reasons set forth herein. Plaintiff is GRANTED 30-days leave to amend her complaint. The stay of discovery, which was granted on August 11, 1989 pursuant to defendants' motion and continued on September 15, 1989, will be lifted in accordance with limitations set by the Court at the status conference to be held on April 27, 1990.

 This is a securities fraud class action brought against Pyramid Technology Corp. ("Pyramid"), several of its officers and one of its outside directors ("Defendant Rollnick"). Defendants move to dismiss the complaint on the grounds that plaintiff has failed to state a claim under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, and fails to satisfy the particularity requirements of Federal Rule of Civil Procedure 9(b). In addition, defendants seek the dismissal of the secondary liability claims of conspiracy and aiding and abetting, the insider trading claim and the negligent misrepresentation claim. Defendant Rollnick joins the motion to dismiss, and moves on his own behalf to strike the allegations of conspiracy against him and to dismiss the allegations of insider trading.

 Plaintiff opposes the motions, citing the strong presumption in favor of plaintiffs at this early stage of litigation, and charging defendants with failing to disclose known adverse information about "Pyramid's eroding financial health" while at the same time engaging in significant "insider" stock sales.

 FACTUAL BACKGROUND

 Pyramid produces super minicomputer systems, and dominates the so-called UNIX computer market. Complaint paras. 6, 13. Pyramid's stock price rose steadily from late 1987 until early 1989, but dropped relatively sharply on March 22 and 23, 1989. Id. P 31. The stock sold for $ 5.50 a share in November, 1987, rose to a high of $ 18.75 a share on March 13, 1989, and declined to $ 14.00 per share on March 22, 1989, when Pyramid cautioned three securities analysts to lower their estimates of Pyramid's earnings for the quarter ending March 31, 1989.

 The plaintiff class consists of all purchasers of Pyramid stock between October 31, 1988, the date that Pyramid reported its results for fiscal 1988, and March 23, 1989, the day after Pyramid made its announcement to the securities analysts. The named plaintiff, Marjorie Alfus, purchased 1000 shares of Pyramid stock at $ 16.25 a share on January 9, 1989, and 1200 shares at $ 18.75 on February 7, 1989. Id. P 5.

 The complaint makes essentially two allegations concerning the Rule 10b-5 claim. Pyramid allegedly represented that there was an increasing demand for its product when in fact it knew that its dominant market share made it unlikely that the Company would duplicate past growth rates. Id. P 19. Plaintiff bases its allegation on statements made in several press releases and an annual and quarterly report. Plaintiff also asserts that a statement introducing Pyramid's new product, the Corporate MIServer, was misleading for failing to disclose that there were no "firm" orders for the product. Id. P 27. Plaintiff also contends that the March 22, 1989 inquiry made by the securities analysts is alone enough to establish defendants' failure to disclose material information that it had well before that date.

 Count I further alleges that, in addition to being liable as direct participants, each defendant also conspired or aided and abetted the scheme to artificially maintain the price of Pyramid's common stock for their personal benefit. Count II alleges that defendants illegally sold their stock based upon inside information, and count III contends that defendants are liable for negligent misrepresentation.

 DISCUSSION

 I. LEGAL STANDARD ON MOTION TO DISMISS

 Pursuant to Federal Rule of Civil Procedure 12(b)(6), defendants move to dismiss all counts for failure to state a claim upon which relief can be granted. *fn1" In considering defendants' motion to dismiss, the Court must presume that the plaintiff's allegations are true, and grant the motion only if it appears "beyond doubt" that the plaintiff can prove no set of facts entitling her to relief. Sun Savings & Loan Assoc. v. Dierdorff, 825 F.2d 187, 191 (9th Cir. 1987); Federal Sav. and Loan Ins. Corp. v. Musacchio, 695 F. Supp. 1053, 1058 (N.D. Cal. 1988).

 II. COUNT I: VIOLATION OF SECTION 10(b) AND RULE 10b-5 *fn2"

 The Court finds "beyond doubt" that plaintiff is not entitled to relief on the facts as presently set forward in her complaint. There are sound historical and factual bases for each of the four statements of financial results. There are no facts to support plaintiff's allegations that omissions by corporate insiders made these statements misleading, or that the statements were made other than in good faith. As to the statement introducing the Corporate MIServer, there are no allegations in the complaint that corporate insiders were aware of significant technical problems with the product and were reckless in not disclosing such difficulties.

 A. Factual Background

 The crux of plaintiff's theory is that beginning with an October 31, 1988 press release, defendants issued five highly favorable public statements in a concerted effort to sustain Pyramid's public image as enjoying increasing growth in revenues and profitability, thereby maintaining Pyramid stock at an inflated price to their personal benefit. Defendants characterize the complaint as alleging that reporting past earnings and revenue growth implies future growth and success, and that Pyramid's "fraud" was its failure to make a prediction of future revenues and earnings after creating an inference that growth would continue. The five allegedly misleading statements will be discussed under this framework.

 1. October 31, 1988 press release : Pyramid issued a press release carried on the Business Wire which announced its earnings for both fiscal and fourth quarter 1988. Pyramid stated that it experienced record last quarter revenues and that net income for the whole year had increased by 355%. Complaint para. 17. Defendant Lussier *fn3" was quoted as saying that the period marks the "ninth consecutive quarter of growth in revenues and of improving profitability." Id.

 2. December 1988 shareholders' letter : In this letter, Chairman Lussier restated his earlier announcement of both fiscal and fourth quarter 1988 earnings. Id. P 18. He then stated that, in the coming year, Pyramid "will enhance our leadership position in the high-performance commercial open systems market with more products, broader third-party relationships and even stronger customer support." Id.

 3. January 17, 1989 press release : Pyramid announced its results for the first quarter of fiscal 1989, ended December 30, 1988. The statement reported gains in revenues but a decline in the Company's rate of profitability. Id. P 21. The record revenues for the first quarter were attributed to "strong demand for our products by commercial customers in the United States, particularly in the telecommunications market."

 4. February 10, 1989 quarterly report : Pyramid reported its results on Form 10-Q for the quarter ended December 30, 1988, and reiterated that "the revenue growth in the first quarter resulted from strong demand for our products by commercial customers in the United States, particularly in the telecommunications market." Id. P 23.

 5. February 13, 1989 press release : Pyramid announced its new Corporate MIServer product. Id. P 25. The securities analysts Goldman Sachs recommended Pyramid stock as a "buy" and stated that it believed its (Goldman Sachs') earning "estimates may prove conservative given the growing demand for cost effective UNIX-based solutions and the potential increase in the sales force productivity associated with these new models." Id. P 26.

 Rule 10b-5, enacted under Section 10(b), makes it unlawful "to make any untrue statement of fact or to omit to state a material fact necessary to make the statements made, in light of all the circumstances in which they were made, not misleading." 17 C.F.R. ยง 240.10b-5. The Supreme Court has set forth two basic prerequisites for a cause of action predicated upon Rule 10b-5. First, the plaintiff must show that the statements were misleading as to a material fact. Basic, Inc. v. Levinson, 485 U.S. 224, 108 S. Ct. 978, 986, 99 L. Ed. 2d 194 (1988). Second, there must exist a legally ...


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