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March 30, 1992


The opinion of the court was delivered by: FERN M. SMITH


 In this securities class action, class plaintiffs ("Plaintiffs"), defendant underwriters Montgomery Securities and PaineWebber, Inc. ("Underwriters") and defendant auditor Deloitte & Touche ("Deloitte"), move the Court for summary judgment or partial summary judgment as follows:

 (1) Plaintiffs move for partial summary judgment against the Underwriters as to liability on Plaintiffs' Section 11 and 12(2) claims;

 (2) Underwriters move for summary judgment on all claims against them;

 (3) Plaintiffs move for partial summary judgment against Deloitte as to Section 11 and 10(b), and Rule 10b-5, liability on three issues;

 (4) Deloitte moves for summary judgment on all claims against it, or alternatively, for partial summary judgment as to any of the Section 11 and 10(b), and Rule 10b-5, claims against it.

 On December 31, 1991 the Court issued a tentative Order on the various cross-motions and scheduled a hearing. A hearing was held on February 14, 1992. The Court now issues its final Order, discussing the cross-motions in corresponding pairs; that is, (1) Plaintiffs vs. Underwriters and (2) Plaintiffs vs. Deloitte. *fn1" Relevant factual and evidentiary information will be incorporated and discussed as pertinent to each motion.


 Plaintiffs seek partial summary judgment against the Underwriters as to liability on Plaintiffs' Section 11 and 12(2) claims. The Underwriters seek summary judgment on all claims against them--i.e., Plaintiffs' Section 11, 12(2) and 10(b) claims against them. *fn2" Summary judgment is appropriate if "the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law." Fed. R. Civ. P. 56(c). *fn3" A dispute about a material fact is "genuine," "if the evidence is such that a reasonable jury could return a verdict for the nonmoving party." Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248, 91 L. Ed. 2d 202, 106 S. Ct. 2505 (1986).

 In order for Plaintiffs to attain summary judgment they must establish that summary judgment is appropriate as to every element of their securities claims. If the Underwriters can raise a genuine factual dispute as to any element--falsity, materiality, etc.--then the Plaintiffs' motion must be denied. Id. By contrast, the Underwriters can obtain summary judgment by defeating any one of those elements. Since defeating any one element will not only afford summary judgment to the Underwriters, but will also necessarily decide Plaintiffs' motion, the Court will first address the Underwriters' motion.

 I. Underwriters' Motion for Summary Judgment

 The Underwriters seek summary judgment on Plaintiffs' Section 11, 12(2) and 10(b) claims against them. According to the Underwriters, the evidence in the record indisputably demonstrates that their investigation in relation with the Registration Statement and Prospectus ("Prospectus") for Toolworks' July 1990 public offering ("Offering") satisfied the due diligence standard, and therefore exempts them from Section 11 or 12(2) liability. The Underwriters further claim that they are entitled to summary judgment on the Section 10(b) claims because Plaintiffs cannot prove the necessary scienter to establish primary or secondary liability under Section 10(b). Plaintiffs respond that the Underwriters cannot justify summary judgment since the evidence on the record: (1) establishes that the Prospectus was materially false and misleading and that the Underwriters failed to make a reasonable investigation of the accuracy of the Prospectus, *fn4" and (2) raises triable issues of fact with respect to Plaintiffs' Section 10(b) claims.

 For the reasons set forth below, and after a full hearing and an exhaustive review of the facts and evidence presented by the parties, the Underwriters' motion for summary judgment is GRANTED and Plaintiffs' motion for partial summary judgment is DENIED.

 A. Prospectus Claims

 Section 11 affixes liability to underwriters of stock by means of a prospectus which is materially misleading, unless they prove they exercised due diligence to discover and eliminate such false and misleading statements. Herman & MacLean v. Huddleston, 459 U.S. 375, 382, 74 L. Ed. 2d 548, 103 S. Ct. 683 (1983); 15 U.S.C. § 77k. Similarly, an underwriter who offers or sells a security by means of a prospectus which contains a material misstatement or omits a material fact is liable under Section 12(2), unless he establishes an affirmative due diligence defense. 15 U.S.C. § 771(2). *fn5" The standards under Sections 11 and 12(2) are therefore virtually the same. See Sanders v. John Nuveen & Co., 619 F.2d 1222, 1228 (7th Cir. 1980), cert. denied, 450 U.S. 1005, 68 L. Ed. 2d 210, 101 S. Ct. 1719 (1981). *fn6"

 Without conceding any elements of Plaintiffs' prima facie case on the Prospectus claims, the Underwriters seek summary judgment solely on the issue of due diligence. They claim that the investigation they performed in connection with the Offering entitles them to the "due diligence" defense. See, e.g., Feit v. Leasco Data Processing Equipment Corp., 332 F. Supp. 544 (E.D.N.Y. 1971) (absolving underwriters on ground of due diligence). Plaintiffs contend that the Underwriters cannot establish a due diligence defense because there is substantial evidence that the Underwriters failed to perform a reasonable investigation into (1) Toolworks' Nintendo business, (2) the results of the June 1990 quarter, and (c) recognition of revenues on Toolworks' Original Equipment Manufacture ("OEM") software licensing business. Plaintiffs further claim that it is not proper to decide the adequacy of due diligence on summary judgment, because what constitutes a reasonable investigation is a mixed question of law and fact for the jury to decide.

 1. Deciding the Adequacy of Due Diligence on Summary Judgment

 What is a factual and what is a legal question for purposes of summary judgment is not easily determined. See Pullman-Standard, Division of Pullman, Inc. v. Swint, 456 U.S. 273, 288, 102 S. Ct. 1781 (1982). At one extreme, the resolution of disputes over historical facts (a thing done, an action performed, or an event or occurrence) is a factual question for the jury. At the other extreme, when the facts material to the application of a pure rule of law are undisputed, the application is a matter of law for the court, requiring no trial. In between these extremes, there is a large continuum occupied by mixed questions of law and fact.

 Mixed questions of law and fact generally require the resolution of disputes over historical facts, a matter for the jury. When the dispute is not over historical facts, however, but over their legal significance, the issue may be appropriate for summary judgment. See Horton v. Taylor, 767 F.2d 471, 478 (8th Cir. 1985); Schwarzer, Summary Judgment Under the Federal Rules: Defining Genuine Issues of Material Fact, 99 F.R.D. 465, 472-73 (1984). After a careful review of the record, the Court finds that there are no genuine issues of material historical fact with regard to the Underwriter's due diligence defense. The disagreement between Plaintiffs and the Underwriters revolves around whether the due diligence performed was enough to entitle the Underwriters to a statutory defense under Section 11 and 12(2).

 The "application of standards set by statutes, regulations and precedent to undisputed facts will normally give rise to a 'question of law' for the court. That principle ensures that the law is applied in a uniform and predictable fashion." U.S. v. Rule Industries, Inc., 878 F.2d 535, 542 (1st Cir. 1989); see also McDermott Int'l, Inc. v. Wilander, 112 L. Ed. 2d 866, 111 S. Ct. 807, 818 (1991); Stissi v. Interstate and Ocean Transport Co., 765 F.2d 370, 374 (2d Cir. 1985). The Court, however, must decide whether the context in which the question arises makes it more appropriate for decision by judge or by jury. See, e.g., Rule Industries, Inc., 878 F.2d at 542 (Buy American Act presents rare instance where determination of statutory standard better suited for jury).

 A decision likely to have significant precedential impact on the resolution of an issue imbued with the need for consistency and reasoned resolution is generally better suited for determination by the judge than the jury. The Supreme Court has stated, albeit in the context of allocation between trial and appellate courts, that "regarding certain largely factual questions in some areas of the law, the stakes--in terms of impact on future cases and future conduct--are too great to entrust them finally to the judgment of the trier of fact." Bose Corp. v. Consumers Union of U.S., 466 U.S. 485, 501, 80 L. Ed. 2d 502, 104 S. Ct. 1949 n.17 (1984). The question of the due diligence defense in securities cases is such an issue.

 First, the due diligence defense is a statutory standard; as such, its application to undisputed historical facts should normally be a matter for the judge. See Rule Industries, Inc., 878 F.2d at 542. This ensures that the administration of the statutory defense benefits from consistency, uniformity and predictability. Id. Second, a decision on the due diligence defense generally affects a class of persons (as opposed to one person), making it in the nature of judicial rule making. See, e.g., Columbia Pictures Industries, Inc. v. Professional Real Estate Investors, Inc., 866 F.2d 278, 9 U.S.P.Q.2D (BNA) 1653 (9th Cir. 1989) (court decides as a matter of law that the renting of movies by a hotel to its patrons does not violate Copyright Act, an evaluative question that arguably is proper for a jury except that it potentially affects a large segment of the public); see also Keeton, Legislative Facts and Similar Things: Deciding Disputed Premise Facts, 73 Minn. L. Rev. 1, 20 (1988). Third, knowledge of what constitutes due diligence does not fall within the common experience of jurors, making it instead a question better suited for the judge. See, e.g., R.C. Dick Geothermal Corp. v. Thermogenics, Inc., 890 F.2d 139, 143 (9th Cir. 1989) (geographical boundaries of a market present a question of law since boundaries dispute involve esoteric cost-benefit analysis, an inquiry beyond the straightforward finding of historical facts or common sense judgment for which juries are best suited). Fourth, leaving the question of what constitutes due diligence to the jury will lead to a battle of experts. While this may be appropriate in some cases, with a question like due diligence, the inquiry does not lend itself to any objective standards. The experts, who basically become paid advocates, will simply express an opinion based on their own subjective viewpoints, which will be biased by their role. The jurors will then be forced to decide between these paid advocates. The resulting uncertainty will increase litigation against deep pocket defendants (such as underwriters) and encourage collusion between plaintiffs and the issuer, who will often be in a precarious financial situation already. These policy implications favor summary judgment as the preferred means of resolution. See, e.g., Anderson v. Creighton, 483 U.S. 635, 641, 646, 97 L. Ed. 2d 523, 107 S. Ct. 3034 (1987) (qualified immunity may be decided as a matter of law because of public policy concern to protect government agents from submitting to pretrial discovery); Collins v. Nagle, 892 F.2d 489, 494-95 (6th Cir. 1989) (probable cause for arrest and reasonableness of force proper for summary judgment where case turns on policy determination and there is no material dispute over what transpired); Dellums v. U.S. Nuclear Regulatory Comm'n, 274 App. D.C. 279, 863 F.2d 968, 971 n.5 (D.C. Cir. 1988) (causation decided on summary judgment when primarily a decision on policy). Finally, treating due diligence as a question of law, once the historical facts are undisputed, will apportion the risk more appropriately, encourage settlement at early stages and lead to more equitable and consistent results.

 The Court therefore finds that the adequacy of due diligence may be decided on summary judgment when the underlying historical facts are undisputed. See also Weinberger v. Jackson, [1990-91 Tr. Binder]Fed. Sec. L. Rep. (CCH) P95,693 at 98,255-56 (N.D. Cal. 1990) [hereinafter Weinberger]; Laven v. Flanagan, 695 F. Supp. 800, 811-12 (D.N.J. 1988).

 2. Applying the Due Diligence Standard

 Section 11 and 12(2) require a "reasonable" investigation by the Underwriters. Weinberger at 98,255; 15 U.S.C. §§ 77k(b)(3) & 771(2). This does not, as Plaintiffs imply, require an audit on the part of the Underwriters. Underwriters cannot "be expected to possess the intimate knowledge of corporate affairs of inside directors, and their duty to investigate should be considered in light of their more limited access." Feit, 332 F. Supp. at 582. Accordingly, underwriters may reasonably rely on SEC letters and documents (see Feit, 332 F. Supp. at 583 (underwriter entitled to rely on issuer's counsel's letter to SEC)), as well as on representations of management. See Weinberger at 98,255-06 (underwriters may rely on management's representations after several meetings and other verification). That is not to say that underwriters may "tacitly rely on management assertions" ( Feit, 332 F. Supp. at 582); rather, underwriters may rely on management's representations when it is reasonable to do so under the circumstances. It would be unreasonable, for example, to solely rely on management's representations when said representations could have been reasonably verified. See Escott v. BarChris Construction Corp., 283 F. Supp. 643, 696-97 (S.D.N.Y. 1968). It is not unreasonable, however, to rely on management's representations with regard to information that is solely in the possession of the issuer and cannot be reasonably verified by third parties. Underwriters cannot be expected to ferret out everything that management knows about the company; they only need to reasonably attempt to verify and believe the accuracy of the information in the prospectus. If the Underwriter's overall investigation was reasonable under the circumstances, they are entitled to a due diligence defense. See Weinberger at 98,255.

 a. Did Underwriters Perform a Reasonable Investigation of the Nintendo Business?

 Plaintiffs contend that the Underwriters failed to perform sufficient due diligence on Toolworks' Nintendo business, particularly with regards to the company's policy on product returns and price protection. The Court disagrees. The Underwriters interviewed over a dozen Toolworks and Mindscape officials, exploring all aspects of Toolworks' business. They then verified management's representations by contacting three major Nintendo customers, the distributors of Toolworks' PC software, three major software developers or licensees, and customers of the Priority subsidiary. They also contacted Nintendo of America regarding the health of the Nintendo market, inspected the factory where Miracle Piano was being manufactured, subjected Toolworks' fiscal 1991 budget to line-by-line scrutiny and reviewed its financial statements with Deloitte. *fn7" The Underwriters even obtained written representations from Toolworks and selling stockholders that the Prospectus was accurate, as well as a comfort letter from Deloitte.

 The Underwriters specifically confirmed with Toolworks' customers that they could not return nondefective Nintendo cartridges and surveyed Nintendo retailers (through Pillsbury, Madison & Sutro and John Weiss) to confirm no price-cutting on Toolworks' Nintendo products. They also properly followed up any "negative or questionable information [that] developed as a result of their investigation." Weinberger at 98,255. When an article in the June 18, 1990 issue of Barron's questioned the health of the Nintendo market, for example, the Underwriters again contacted senior executives at Nintendo of America and were assured that the Nintendo market was holding as expected. *fn8" Also, when the Underwriters discovered a memo suggesting that Walmart could return working cartridges, they followed up and confirmed that the memo was an error and that Walmart could in fact only return defective cartridges. *fn9" The Underwriters did not solely rely on the word of management (see Escott, 283 F. Supp. at 697); they performed a thorough and reasonable investigation of Toolworks' Nintendo business, which is reflected in the extensive risk warnings contained in the Prospectus. *fn10"

 b. Did Underwriters Perform a Reasonable Investigation on the June Quarter Results?

 Plaintiffs contend that the Underwriters failed to properly investigate Toolworks' June quarter results. The Court disagrees. The Underwriters repeatedly asked Toolworks about the quarter and were told that the only risk involved was whether cartridge orders due in June would arrive in time. *fn11" The Underwriters further received representation from Toolworks and Toolworks' outside auditors and counsel that, although preliminary results were not available, the results for the June quarter appeared to be satisfactory and consistent with expectations. Toolworks' counsel further represented to the SEC that the results for the quarter would be satisfactory. The Underwriters reasonably relied on such representations, particularly on the representations by the issuer and its counsel to the SEC. See Feit, 332 F. Supp. at 583.

 c. Description of the OEM Business

 The description of Toolworks' OEM business in the Prospectus was "expertised" by Deloitte. Underwriters may reasonably rely on expertised financial statements. 15 U.S.C. § 77k(b)(3)(C); see In re Gap Stores Securities Litigation, 79 F.R.D. 283, 297-98 (N.D. Cal. 1978); Escott, 283 F. Supp. at 687-97. Given the complexity of the accounting issues, the Underwriters were entitled to rely on Deloitte's expertise. The Underwriters, however, did not solely rely on Deloitte. They reviewed confirmations from each OEM, demanded a reconfirmation from Hyosung, and confirmed Toolworks' OEM revenue recognition policy with other accounting firms. *fn12" Their investigation of the OEM business was reasonable.

 As a result of the overall investigation and due diligence, the Underwriters reasonably believed the accuracy of the information contained in the Prospectus. They had no knowledge of any misrepresentation or omission, nor had they reason to disbelieve any of the representations made to them. The Prospectus in fact reflects that where serious risks were unveiled or suspected, warnings were issued. *fn13" This Court therefore finds that the Underwriters conducted a reasonable investigation under the circumstances and are accordingly entitled to a due diligence defense. *fn14"

 Summary judgment is therefore GRANTED in favor of the Underwriters with respect to Plaintiffs' Section 11 and 12(c) claims. *fn15"

 B. Section 10(b) Claims

 1. Primary Liability

 Section 10(b) liability requires a showing of scienter--a mental state embracing intent to deceive, manipulate, or defraud. Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1568 (9th Cir. 1990), cert. denied, 113 L. Ed. 2d 719, 111 S. Ct. 1621 (1991). Scienter may be satisfied either by proof of actual knowledge or by proof of recklessness. Id. at 1568-69. The reckless conduct necessary to satisfy the scienter requirement is conduct "involving not merely simple, or inexcusable negligence, but an extreme departure from the standards of ordinary care, and which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it." Id. at 1569 (citations omitted).

 The Underwriters contend that there is no evidence that they knew of any material misstatements in the Prospectus and assert that they cannot be held reckless since they performed a reasonable due diligence investigation. They also contend that scienter cannot be proved as to their projections issued immediately after the Offering. Plaintiffs respond that there is compelling evidence that the Underwriters had actual knowledge of material facts which were omitted or misrepresented in the Prospectus and in letters to the SEC, or recklessly closed their eyes to obvious facts which should have alerted them to the truth. Plaintiffs also respond that there is evidence that the Underwriters recklessly issued projections of Toolworks' June quarter results on the roadshow and in reports issued following the Offering.

 Scienter may properly be decided on summary judgment. See Weinberger at 98,255-56; see also In re Apple Computer Securities Litigation, 886 F.2d 1109, 1117-18 (9th Cir. 1989), cert. denied, 110 L. Ed. 2d 676, 110 S. Ct. 3229 (1990). The Underwriters may obtain summary judgment by simply showing that there is a failure of proof concerning scienter--an essential element of Plaintiffs' claim. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 257, 91 L. Ed. 2d 202, 106 S. Ct. 2505 (1986). Plaintiffs, on the other hand, must produce "specific facts" sufficient to establish the existence of scienter ( Celotex Corp. v. Catrett, 477 U.S. 317, 322, 91 L. Ed. 2d 265, 106 S. Ct. 2548 (1986)); speculative inferences drawn from circumstantial evidence will not necessarily do. See, e.g., Rose v. Wells Fargo & Co., 902 F.2d 1417, 1422-23 (9th Cir. 1990). Where, as here, there is absence of any motive, there exists a pattern inconsistent with scienter, or there is economic implausibility, plaintiffs bear a heavy burden in defeating summary judgment with inferences from circumstantial evidence. See Apple Computer, 886 F.2d at 1118 (no inference where defendants' overall pattern of conduct was inconsistent with scienter); California Architectural Bldg. Products, Inc. v. Franciscan Ceramics, Inc., 818 F.2d 1466, 1470-71 (9th Cir. 1987) (no inference where fraud implausible), cert. denied, 484 U.S. 1006, 98 L. Ed. 2d 650, 108 S. Ct. 698 (1988); Goldberg v. Household Bank, F.S.B., 890 F.2d 965, 967 (7th Cir. 1989) (same); Ochs v. Shearson Lehman Hutton, Inc., 768 F. Supp. 418, 427-28 (S.D.N.Y. 1991) (strong showing required absent a motive). *fn16" In other words, Plaintiffs are not entitled to the benefit of the doubt with respect to inferences from circumstantial evidence--only reasonable and non-speculative inferences under the circumstances of the case need be accepted. See In re Coordinated Pretrial Proceedings, 906 F.2d 432, 441 (9th Cir. 1990), cert. denied, 111 S. Ct. 2274 (1991). *fn17"

 As the Court previously found, the Underwriters carried out a reasonable investigation on all aspects of Toolworks, including those subjects alleged to be misrepresented or omitted. The Underwriters diligently investigated the condition of Toolworks' Nintendo business, OEM revenue recognition, and the June quarter results. Their actions with respect to these alleged misrepresentation or omissions cannot be considered reckless. Weinberger at 98,255-56. Nor have Plaintiffs, as the following analysis shows, provided "specific facts" sufficient to establish (or reasonably infer under the circumstances of this case) that the Underwriters knew of any material misstatements or omissions.

 a. Condition of Toolworks' Nintendo Business

 b. OEM Revenue Recognition

 Plaintiffs offer no evidence that the Underwriters knew that Toolworks' financial statements improperly recognized OEM revenue. Instead, Plaintiffs contend that certain "red flags" were so suspicious that the Underwriters' awareness of them amounts to scienter. "Aroused suspicions," however, "do not constitute actual awareness of one's role in a fraudulent scheme." Abell v. Potomac Ins. Co., 858 F.2d 1104, 1128 (5th Cir. 1988), cert. denied, 492 U.S. 918 (1989). To establish that a party "intended to violate the securities laws, plaintiffs must prove more than that the [defendants] recklessly ignored ...

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