The opinion of the court was delivered by: JENSEN
D. LOWELL JENSEN, UNITED STATES DISTRICT JUDGE
This matter came on for hearing before this Court on February 6, 1991. Dana Welch of Shearman & Sterling presented arguments on behalf of defendants Network Equipment Technologies, Inc., Daniel Warmenhoven and Steven Schlumberger. K. Louise Francis of Heller, Ehrman, White & McAuliffe argued on behalf of defendant Barrett Roach. Paul Dawes of Latham & Watkins appeared representing defendant Bruce Smith. For the reasons set out below, defendant Network Equipment Technologies, Inc.'s motion to dismiss, which is joined by defendant Barrett Roach, is GRANTED IN PART AND DENIED IN PART. Defendant Barrett Roach's additional and separate motion to dismiss is GRANTED IN PART AND DENIED IN PART. Finally, defendant Bruce Smith's motion to dismiss is DENIED.
These motions arise in a securities fraud class action relating to Network Equipment Technologies, Inc., ("NET.") NET manufactures and sells high-tech communications products that allow a business with geographically disparate offices to link their personnel through a computer based network. NET stock is traded publicly through major exchanges.
In simplest terms, plaintiffs allege that defendant NET and certain managers of NET defrauded the purchasers of NET stock through a three step fraud. First, defendants fraudulently caused the financial records of NET to depict inflated and false sales, revenue, and profit figures. For example, plaintiffs allege that defendants inflated sales and revenue figures by shipping large quantities of goods to "customers" who had not ordered the goods, and by improperly recording revenue from these unordered "sales."
Second, defendants fraudulently caused the value of NET stock to rise by communicating the false and inflated financial records to investors in NET stock through letters, SEC filings, press releases, communications with independent financial analysts, and other means. Finally, the individual defendant managers profited by selling their own NET stock at the fraudulently inflated price.
Plaintiffs allege that this scheme fell apart when NET losses began to mount as customers refused to pay for unordered goods and NET was forced to either accept the return of the goods or complete sales through substantial discounts and other unprofitable incentives. NET's losses allegedly became impossible to hide, and management was forced to announce that financial figures previously provided to the SEC and released to the public were wrong. The value of NET stock dropped as a result of these announcements.
First, the Court found that certain allegations of fraud did not meet the particularity requirements of Federal Rule of Civil Procedure
9. In particular:
Paragraphs 34, 40-42, and 46 of the Amended Complaint allege unattributed misrepresentations which were communicated in unidentified forms to financial analysts and the press. These allegations fail to allege specifically either particular misrepresentations by identified defendants, or particular misrepresentation published through identified forms of group published information.
Second, the Court found that plaintiffs had failed to properly allege a claim for conspiracy to commit securities fraud. The Court explained, "To adequately plead conspiracy, Plaintiffs must plead specifically with regard to each Defendant the existence of an agreement and acts in furtherance of that agreement." Since plaintiffs plead neither an agreement nor acts in furtherance with particularity, their conspiracy claim was dismissed.
In addition to dismissing aspects of the complaint, the Court also upheld the plaintiffs' amended complaint in certain respects. Most relevant here, the Court applied the definition of recklessness adopted by the Ninth Circuit in Hollinger v. Titan Capital Corp., 914 F.2d 1564 (9th Cir. 1990), and found that plaintiffs complaint alleged recklessness sufficient to give rise to the "inference of scienter" required to state a claim under Rule 10b-5.
The Court also noted that the Ninth Circuit in Hollinger expressed its approval of respondeat superior claims in the securities fraud context and granted plaintiffs leave to amend their complaint to state a claim against defendants under a respondeat superior theory of liability.
On November 20, 1990, plaintiffs filed their Second Consolidated Amended Class Action Complaint, (the "second amended complaint,") which attempted to cure the two flaws identified above, restated plaintiffs' claim under Rule 10b-5, and added allegations supporting a respondeat superior theory of liability. On December 19, 1990, defendants filed the present motions to dismiss. Defendants NET, Daniel Warmenhoven ("Warmenhoven"), and Steven Schlumberger ("Schlumberger") argue that plaintiffs' second amended complaint (1) still fails to meet the scienter pleading requirements of Hollinger, (2) can not state a claim for respondeat superior liability, and (3) pleads conspiracy without sufficient particularity.
Defendant Barrett Roach ("Roach") joins NET, Warmenhoven, and Schlumberger's motion. Roach also argues (4) that particular allegations against fraud by Roach continue to fall short of the particularity requirement of Rule 9. Finally, defendant Bruce Smith ("Smith") separately attacks plaintiffs' conspiracy claims on grounds similar to those stated by NET, Warmenhoven and Schlumberger.
After reviewing the legal standard applied by the Court upon a motion to dismiss, the Court will treat defendants' four attacks on the second amended complaint in turn.
A. The Standard Of Review Applied Upon A Motion To Dismiss.
The question presented by a motion to dismiss is not whether a plaintiff will prevail in the action, but whether a plaintiff is entitled to offer evidence in support of his claim. "The accepted rule [is] that a complaint should not be dismissed for failure to state a claim unless it appears beyond doubt the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Conley v. Gibson, 355 U.S. 41, 78 S. Ct. 99, 102, 2 L. Ed. 2d 80 (1957). In the Ninth Circuit, the Court making this determination must assume that plaintiff's allegations are true, construe the complaint in a light most favorable to plaintiff, and resolve every doubt in plaintiff's favor. United States v. City of Redwood City, 640 F.2d 963, 966 (9th Cir. 1981).
Therefore, the Court will dismiss the complaint or any claim in it without leave to amend only if "it is 'absolutely clear that the deficiencies of the complaint could not be cured by amendment.'" Noll v. Carlson, 809 F.2d 1446, 1448 (9th Cir. 1987) quoting Broughton v. Cutter Laboratories, 622 F.2d 458, 460 (9th Cir. 1980) (per curiam).
B. Scienter Has Been Adequately Alleged Under Hollinger.
The role of scienter as an element of fraud under Rule 10b-5 was set out by this Court in ...