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ZEID v. KIMBERLEY

June 5, 1996

RICHARD ZEID and SIOM MISRAHI, On Behalf of Themselves and All Others Similarly Situated, Plaintiffs,
v.
JOHN A. KIMBERLEY, et al., Defendants.



The opinion of the court was delivered by: WILLIAMS

 Plaintiffs Richard Zeid and Siom Misrahi initiated this action against John A. Kimberley, Frank M. Richardson, Mark A. Rowlinson and Firefox Communications, Inc. alleging violations of sections 10(b) and 20(a) of the Securities Exchange Act of 1934 ("Securities Act") and Securities Exchange Commission ("SEC") Rule 10(b)(5). Defendants then filed a motion to dismiss pursuant to Section 21D(b)(3)(A) of the Securities Act and Fed. R. Civ. P. 9(b) and 12(b)(6). For the reasons set forth below, the Court DISMISSES PLAINTIFF'S CLAIMS WITH LEAVE TO AMEND. *fn1"

 I. BACKGROUND

 Defendant Firefox Communications, Inc. ("Firefox"), which was formed in England in 1989, develops, markets and supports software that allows users of local area networks to communicate with users on other networks, including the Internet. Defendants Kimberley, Richardson, and Rowlinson are officers and directors of Firefox.

 In 1994, Firefox decided to significantly expand its sales and marketing efforts in the United States and the United Kingdom. Fire fox also decided to conduct a public offering to generate the necessary capital to accomplish the expansion. On May 15, 1995, Firefox went public selling 2.3 million shares at $ 18 a share. That day, Firefox's stock rose to $ 29 1/2. The stock reached $ 30 per share by late May but then started to decline, falling to $ 21 3/4 per share by July 19. On July 20, Firefox released its results for the quarter ended June 30, 1995. Despite positive results, Firefox's stock continued to slide falling to $ 17 per share on August 3. During the remaining months of 1995 Firefox's stock remained volatile, ranging from $ 17 to $ 28 5/8 per share. Then, on January 3, 1996, Firefox announced that it expected a loss for its fourth quarter. That day, Firefox's stock plummeted from $ 22 5/8 to $ 10 1/4. On January 17, 1996, Firefox merged with FTP Software Inc. Under the terms of the merger, Firefox shareholders received one share of stock in the merged company for each share of Firefox stock.

 Plaintiffs filed this action on February 23, 1996. The Complaint alleges that, during the period of August 3, 1995 to January 2, 1996, Defendants conducted a fraudulent scheme and course of business so that they could sell the company at a higher price. In particular, plaintiffs contend that Defendants misrepresented to the investment community that Firefox was enjoying strong demand for its products and a successful expansion of its sales and marketing program in the U.S. Additionally, plaintiffs assert that Defendants violated SEC rules and generally accepted accounting principles ("GAAP") by improperly recognizing certain revenues and by failing to keep adequate reserves. Lastly, Plaintiffs allege that Firefox released false and misleading boilerplate warnings and disclaimers during the class period. According to the Complaint, this misconduct created an inflated stock price and resulted in the collapse of Firefox's stock when the fourth quarter loss was revealed on January 3, 1996.

 II. PLEADING REQUIREMENTS FOR SECURITIES FRAUD

 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.

 The Ninth Circuit clarified the scope of Rule 9(b) pleading requirements as applied to securities fraud actions in the case of In re Glenfed, Inc. Securities Litigation, 42 F.3d 1541 (9th Cir. 1994) (en banc). According to Glenfed, 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.

 Recently, Congress enacted the Private Securities Litigation Reform Act of 1995 ("Reform Act"), Pub. L. 104-67, which amended the Securities Exchange Act of 1934. In an effort to curtail the filing of abusive lawsuits Congress included in the Reform Act a section that establishes a uniform pleading standard. S.Rep.No. 98, 104th Cong., 1st Sess., 15 (1995). This section, which adopts a standard modelled after the Second Circuit's stringent pleading standard, provides:

 
REQUIREMENTS FOR SECURITIES FRAUD ACTIONS.-
 
(1) MISLEADING STATEMENTS AND OMISSIONS.- In any private action arising under this title in which the plaintiff alleges that the defendant-
 
(A) made an untrue statement of material fact; or
 
(B) omitted to state a material fact necessary in order to make the statements made, in light of the circumstances which they were made, not misleading;
 
the complaint shall specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed.
 
(2) REQUIRED STATE OF MIND.- In any private action arising under this title in which the plaintiff may recover money damages only on proof that defendant acted with a particular state of mind, the complaint shall, with respect to each act or omission alleged to violate this title, state with particularity facts giving ...

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