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STACK v. LOBO

September 14, 1995

LARRY STACK and ARI PARNES, on behalf of themselves and all others similarly situated, Plaintiffs,
v.
KEITH R. LOBO, et al., Defendants.



The opinion of the court was delivered by: WILLIAMS

 In this securities fraud class action, Plaintiffs allege that Quickturn Design Systems, Inc. and its officers and directors ("the Quickturn Defendants"), in concert with Morgan Stanley, Hambrecht & Quist and two of their analysts ("the Underwriters"), defrauded investors in violation of § 11 and § 12(2) of the Securities Act of 1933, 15 U.S.C. § 77k & 77l, § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder. In its Order of April 20, 1995 ("Dismissal Order"), the Court dismissed Plaintiffs' First Amended Complaint ("FAC") in its entirety with leave to amend. After Plaintiffs amended, both the Quickturn Defendants and the Underwriters moved to dismiss Plaintiffs' Second Amended Complaint ("SAC") pursuant to Fed. R. Civ. P. 12(b)(6) and 9(b). Based on the following, the Quickturn Defendants' motion to dismiss is GRANTED IN PART and DENIED IN PART, and the Underwriters' motion to dismiss is GRANTED.

 BACKGROUND

 Quickturn is a high-technology company located in Mountain View, California that designs and manufactures verification solutions for the design of integrated circuits and electronic systems. Quickturn's systems allow design engineers to create reprogrammable prototypes used in the fabrication of silicon chips. The Corporate Defendants are officers, directors, and outside directors of Quickturn. Plaintiffs are a group of individual investors who bought Quickturn common stock between December 15, 1993 and January 5, 1995 (the "Class Period").

 The facts leading to this lawsuit are as follows. On December 15, 1993, Quickturn completed an initial public offering ("IPO") in which the company issued 3.4 million shares of common stock at $ 12 per share. Morgan Stanley and Hambrecht & Quist served as lead underwriters of the Quickturn IPO.

 During early and mid-1994, Quickturn's stock price fluctuated in a volatile manner, from a high of $ 16-1/2 in mid-April to a low of $ 5-1/4 in mid-July. At the end of 1994, the stock price was slightly more than $ 13 per share.

 Then, on January 5, 1995, Quickturn announced that it had taken a $ 3.7 million writeoff during the fourth quarter of 1994. In response, the stock price fell more than 50 percent to $ 7-1/4 per share.

 Plaintiffs filed suit approximately two weeks later, on January 20, 1995, alleging that during the Class Period the Corporate Defendants and the Underwriters participated in a scheme to defraud the investing public by deceiving them about various aspects of Quickturn's current and future financial performance. According to Plaintiffs, Defendants became so desperate to keep pace with their earnings projections that they: 1) committed accounting fraud by making sales to less proven customers, by prematurely and improperly recognizing revenue, and by understating financial reserves for doubtful accounts; 2) issued false and misleading statements about Quickturn's financial situation, projected earnings, and business prospects, and; 3) adopted false and misleading statements made by securities analysts.

 LEGAL STANDARD

 Under the liberal federal pleading policies, a plaintiff need only give defendant fair notice of the claims against it. Conley v. Gibson, 355 U.S. 41, 47, 78 S. Ct. 99, 102, 2 L. Ed. 2d 80 (1957). A claim should not be dismissed unless it is certain that the law would not permit the requested relief even if all of the allegations in the complaint were proven true. Durning v. First Boston Corp., 815 F.2d 1265, 1267 (9th Cir. 1987), cert. denied, 484 U.S. 944, 108 S. Ct. 330, 98 L. Ed. 2d 358 (1987). Therefore, for purposes of this motion to dismiss, the Court assumes the truth of all factual allegations in the complaint as well as all reasonable inferences drawn from them.

 In complaints alleging fraud, however, the heightened pleading standards of Fed. R. Civ. P. 9(b) apply. This rule requires averments of fraud or inequitable conduct to be "stated with particularity." Fed. R. Civ. P. 9(b). Rule 9(b) does not necessitate pleading of detailed evidentiary matter. Nonetheless, mere conclusory allegations of fraud are insufficient. Moore v. Kayport Package Express, 885 F.2d 531, 540 (9th Cir. 1989). The plaintiff must include statements regarding the time place and nature of the alleged fraudulent activities, and must specifically identify what was misrepresented or concealed so as to give the opposing party notice of the particular conduct which is alleged to constitute the fraud. Id. Merely making general conclusory allegations of fraud, and then reciting a list of neutral facts, is not sufficient. Semegen v. Weidner, 780 F.2d 727, 731 (9th Cir. 1985).

 The Ninth Circuit recently clarified the scope of Rule 9(b) pleading requirements as applied to securities fraud actions in In re Glenfed, Inc. Securities Litigation, 42 F.3d 1541 (9th Cir. 1994) (en banc). According to the Glenfed court, a plaintiff does not state a claim for securities fraud merely by asserting that a company's revelation of bad news means that "earlier, cheerier" statements must have been false. Id. at 1548. Rather, the plaintiff must plead the specific circumstances of the alleged fraud, including the time, place, and nature of the statements made, and also facts demonstrating how the statements were false or misleading. Id. The Glenfed court further suggested that the most direct way to prove that representations were false when made is to point to inconsistent contemporaneous statements or omissions which contradict the challenged statements. Id. at 1549.

 DISCUSSION

 I. THE CORPORATE DEFENDANTS' MOTION TO DISMISS

 A. § 10(b) Claims

 Plaintiffs have filed their SAC in an attempt to state their allegations of fraud with particularity. After reviewing the changes Plaintiffs have made, the Court finds that the only claims that are sufficiently pled are those relating to Quickturn's $ 3.7 million writeoff during the fourth quarter of 1994 for sales to Acri and Ball. All of Plaintiffs' other allegations of fraud are still too vague and conclusory to pass muster.

 
1. The Law

 Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j, makes it unlawful to use in connection with "the mails or facilities of interstate commerce" any "manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe . . . ." Rule 10b-5 promulgated under section 10(b) provides as follows:

 
It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails, or of any facility of any national securities exchange,
 
(1) to employ any device, scheme, or artifice to defraud,
 
(2) to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of circumstances under which they were made, not misleading, or

 in connection with the purchase or sale of any security.

 17 C.F.R. § 240.10b-5 (1993).

 The elements of a § 10(b) claim are: 1) a false statement or an omission that rendered another statement misleading; 2) materiality; 3) scienter; 4) loss causation; and 5) damages. In re Apple Computer Sec. Litig., 886 F.2d 1109, 1113 (9th Cir. 1989), cert. denied, 496 U.S. 943, 110 L. Ed. 2d 676, 110 S. Ct. 3229 (1990).

 
2. Plaintiffs' Claims

 In the SAC, Plaintiffs identify numerous types of fraud allegedly committed by Defendants. For ease of analysis, the Court will divide these allegations into four general categories and examine each in turn: 1) accounting fraud; 2) the company's own statements; 3) analysts' reports and; 4) the "scheme" to defraud.

 
a. Accounting Fraud Allegations

 In the SAC, Plaintiffs assert the same four types of accounting fraud as in the FAC.

 
i. The $ 3.7 Million Writeoff

 Plaintiffs allege that Quickturn improperly recognized $ 3.7 million in revenue for two sales during the second quarter of 1994, and then was forced to write these sales off during the fourth quarter of 1994 when these customers could not pay their bills. In the Dismissal Order, the Court found these allegations to be deficient because they did not name the customers to whom the sales were made or explain why it was unlikely that those customers would be able to pay for their purchases.

 In their SAC, Plaintiffs have responded by naming the two customers, Acri and Ball, and by providing explanations of the financial problems the two companies were having when Quickturn made the sales to them. Specifically, Plaintiffs allege that in early 1994 Quickturn became aware that Acri was a "marginal company." SAC, P 12(b). Consequently, Quickturn refused to extend Acri customer credit, instead requiring cash payments. Plaintiffs further allege that Quickturn knew Acri's main sponsor, the French government, was "about to pull Acri's funding." SAC, P 12(b). With respect to Ball, Plaintiffs allege that Quickturn was aware that Ball had taken a $ 65.1 million loss in 1993, and that Ball's aerospace business had continued to flounder during 1994. SAC P 12(c). Plaintiffs contend that these allegations contain adequate particularity.

 Defendants respond that Plaintiffs still have not identified any specific contemporaneous statements or documents known to Quickturn in early 1994 that should have alerted the company to Acri's and Ball's precarious financial situations. With respect to Ball, Defendants also submit a 1993 10-K purportedly demonstrating that nothing in Ball's financial situation should have put Quickturn on notice that Ball would not be able to pay its bills.

 The Court agrees with Plaintiffs, and finds that their allegations are sufficiently particularized to withstand Rule 9(b) scrutiny. Plaintiffs have identified the customers in question and have provided facts which were or should have been known to Quickturn regarding these customers' financial situations. Taking Defendants approach, and requiring Plaintiffs to identify specific documents within Defendants possession that should have alerted them to Acri's and Ball's financial difficulties, would run afoul of Rule 9(b)'s proviso that Plaintiffs need not plead detailed evidentiary facts that are in the sole possession and control of the Defendants. See Wool v. Tandem Computers Inc., 818 F.2d 1433, 1439 (9th Cir. 1987).

 
ii. Adequacy of Reserve for Doubtful Accounts

 Plaintiffs also allege that Quickturn violated accounting principles by failing to allow adequate reserves for doubtful accounts receivables in its March 31, 1994, June 30, 1994, and September 30, 1994 financial statements. In the Dismissal Order, the Court found these allegations to be inadequate because they did not name any "less creditworthy" customers or explain why any such customers would have been unlikely to pay their bills. Instead, Plaintiffs relied solely on statistics regarding sales and accounts receivable that could have been indicative of numerous factors other than fraud.

 The only material change to these allegations that Plaintiffs make in their SAC is to use Acri and Ball as examples of "less creditworthy" customers. Plaintiffs have not pled any facts to support their claim that Quickturn failed to allow adequate reserves for sales to any other customers. Therefore, Plaintiffs' allegations about the reserve for doubtful accounts are dismissed except as it they relate particularly to Acri and Ball.

 
iii. Restructuring Reserve

 Plaintiffs further claim that Quickturn overstated the $ 9.4 million "restructuring charge" recorded as part of the PiE merger in June of 1993. In the Dismissal Order, the Court found that Plaintiffs had failed to allege any facts whatsoever that demonstrated how any restructuring charges were improper. In their SAC, Plaintiffs have now added the following sentence. "The portion of the restructuring charge that was excessive and intended to create the 'cushion' was included in the $ 4,266,00 portion of the reserve recorded for 'duplicate resources.'"

 Plaintiffs' addition does not change the Court's view that these allegations fail under Rule 9(b). Plaintiffs still do not explain how or why any particular restructuring charges were excessive. Plaintiffs appear to be simply guessing that the restructuring charge was overstated. Pure speculation such as this does not enable Plaintiffs to survive a motion to dismiss and entitle them to conduct discovery on their claims. See Tuchman v. DSC Communications Corp., 14 F.3d 1061, 1067 (5th Cir. 1994) (one of the purposes ...


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