As an initial matter, plaintiffs argue that the notes and reports are not hearsay because the evidence is offered to show merely that statements were made, as opposed to the truth of the statements. In the present situation, the distinction defies logic. Plaintiffs hope to introduce the notes and reports to establish the actual content of statements by Cirrus executives. Accordingly, the notes and reports are offered to show the truth of the assertion that Cirrus made specific fraudulent statements to analysts. Such evidence clearly falls within the definition of hearsay under Rule 801(c) of the Federal Rules of Evidence. Cypress, 891 F. Supp. at 1374. See also Larez v. City of Los Angeles, 946 F.2d 630, 640-44 (9th Cir. 1991) (holding that newspaper articles were inadmissible hearsay when used to prove that the defendant made the statements attributed to him in the article); Seagate, P 98,530 at 91,583-84 (finding statement on Dow Jones news wire attributed to Seagate executive inadmissible hearsay if offered to prove that the executive made the statement).
Plaintiffs offer three alternative bases for admissibility under exceptions to the hearsay rule outlined in Rule 803. First, they argue that Klesken's notes are admissible as present sense impressions pursuant to Rule 803(1). This exception to the hearsay rule permits the admission of statements "describing or explaining" an event or condition where "substantial contemporaneity of event and statement negative the likelihood of deliberate or conscious misrepresentation." Fed. R. Evid. 803(1) and 1972 advisory committee notes. Here, however, Klesken has testified that his notes contain his interpretations and analyses of conversations with Cirrus executives. (Klesken Dep. at 37:6-9, 40:4-41:19, 49:2-6, 97:11-22.) Such interpretations constitute subjective input in clear violation of the theory underlying Rule 803(1). Klesken's notes are not admissible as present sense impressions.
Second, plaintiffs argue that the notes and reports are admissible as business records under Rule 803(6). A hearsay statement is admissible as a business record if the writing was made by a person with knowledge at or near the time of the incident recorded, and the record is kept in the course of a regularly conducted business activity. Kennedy v. Los Angeles Police Dept., 901 F.2d 702, 717 (9th Cir. 1989). The record is not admissible, however, "if the source of the information or the method or circumstances of preparation indicate a lack of trustworthiness." Id. (citation omitted).
Here, Klesken himself has indicated the lack of accuracy of the proffered evidence with regard to the exact content of conversations with Cirrus executives. There is no way to distinguish Klesken's own statements and opinions from those of the Cirrus executives. Moreover, in the absence of proof of entanglement or adoption, a company obviously has no control over the way its statements are transcribed in an individual's notes, nor in the way its statements are presented in analyst reports or in the press. There is no guarantee that the statements are transcribed accurately, nor that the reported statements include any material qualifications provided by the company necessary to make the reported statements not misleading.
It is plainly unfair to hold defendants liable for the reporting of their statements by third parties without independent corroboration of the accuracy of the reported statements. See Raab v. General Physics Corp., 4 F.3d 286, 288 (4th Cir. 1993) ("Without control over Goldman Sachs's report, any statement made by General Physics personnel could be taken out of context, incorrectly quoted, or stripped of important qualifiers."); In re Gupta Corp. Sec. Litig., 900 F. Supp. 1217, 1237 (N.D. Cal. 1994) ("Analysts might quote corporate spokespersons out of context or inaccurately interpret remarks made by corporate insiders."). Klesken's notes are, therefore, not admissible as business records. Nor are the analyst reports admissible as business records to prove the statements attributed to Cirrus in the reports, because the analyst reports are clearly based on the analysts' notes.
The same lack of reliability precludes introduction of the notes or reports as admissions of a party opponent pursuant to Rule 801(d)(2). Klesken's interpretation and analysis of his conversations with Cirrus executives cannot be deemed to be admissions of the defendants.
Finally, plaintiffs argue that the evidence is admissible under the "catch-all" hearsay exception contained in Rule 803(24) of the Federal Rules of Evidence. The general requirements to admissibility under this exception demand that the evidence be more probative on the point for which it is offered than any other evidence the proponent could produce through reasonable efforts. Larez, 946 F.2d at 642. The court must balance the need for the evidence against its trustworthiness. Columbia, 155 F.R.D. at 475. Plaintiffs must demonstrate that the analyst who authored notes or a report is unavailable to testify to his or her recollection of the conversation reflected in the notes, and that the notes and reports have circumstantial guarantees of trustworthiness, i.e., that they accurately document the conversations. (See Fed. R. Evid. 803(24) and 1974 advisory committee notes.) Otherwise, the material is not admissible to prove that Cirrus made the statements attributed to it in the report.
For the reasons stated above, Klesken's notes, representing his interpretation of what was said, may not be considered trustworthy evidence of Cirrus's statements. The reports, based on the notes, are similarly untrustworthy. Thus, the notes and reports are inadmissible under Rule 803(24) to prove that Cirrus made the statements attributed to it. See Columbia, 155 F.R.D. at 475 (citations omitted) ("[Even] news accounts, unsupported by corroborating evidence and offered to prove that certain statements were made, will usually lack the 'circumstantial guarantees of trustworthiness' that Rule 803(24) requires'"). Klesken must testify as to his recollection of the entire conversation with the company executive to ensure that the Court views the allegedly misleading statements in their proper context.
If plaintiffs can prove, however, from evidence other than Klesken's reports or notes, that defendants made the allegedly misleading statements to Klesken, then Klesken's published reports should be admissible, but only as evidence that the statements reached the market. See Columbia, 155 F.R.D. at 474. Cf. Warshaw, 74 F.3d at 959 ("if defendants intentionally misled securities analysts and the press in order to stave off a Xoma stock sell off, then these third-party reports would be relevant to determine Xoma's securities fraud liability").
Based on the foregoing, the Court must grant summary judgment for defendants on all of plaintiffs' claims of fraud based on statements attributed to Cirrus in Klesken's analyst reports or notes that cannot be independently corroborated. Such corroboration may come in the form of testimony from the parties who participated in the conversations documented in the notes and reports. Where memories have faded, such corroboration may exist, under Rule 803(24), when the notes of several parties who participated in the conversation each contain reference to the statements allegedly made by the company executive. See Larez, 946 F.2d at 643; United States v. Valdez-Soto, 31 F.3d 1467, 1471 (9th Cir. 1994), cert. denied, 131 L. Ed. 2d 859, 115 S. Ct. 1969 (1995) ("we've recognized that corroborating evidence is a valid consideration in determining the trustworthiness of out-of-court statements for purposes of Rule 803(24)").
The Court also must grant summary judgment for defendants for all statements to Klesken that did not reach the market. Because it is unclear from the record precisely which claims are based on allegedly fraudulent statements by defendants that appear solely in Klesken's notes and reports, or that did not reach the market, the Court leaves it to the parties to determine precisely which statements are no longer in the case. Should the parties be unable to agree, motions in limine are the appropriate remedy.
The Court turns now to the third motion for summary judgment, regarding plaintiff's allegations that defendants violated Rule 10b-5 by making misleading public statements relating to revenue, gross margins, the PCSI merger, and other aspects of Cirrus's financial condition.
Plaintiffs also allege that defendants omitted to disclose material facts relating to Cirrus's revenues and gross margins. Because statements and alleged omissions must be analyzed in context, see, e.g., Syntex, 95 F.3d at 928-29; Worlds of Wonder, 35 F.3d at 1414, the Court addresses each corporate communication in sequence below.
1. October 22, 1992 Press Release.
On October 22, 1992, Cirrus issued a press release and held a teleconference call with research analysts to release Cirrus's second quarter 1993 financial results. Defendants Hackworth, Bartek, and Srinivasan participated in the conference call, which included a question and answer session. The press release reported revenues for the quarter ended September 30, 1992 of $ 76.3 million (up from $ 63 million in the first quarter) and earnings of $ 0.36 per share (up from $ 0.20 per share in the first quarter). (UF P 113.) The press release also stated:
This quarter we saw record revenues across all product lines as well as record operating income and earnings per share.... We're entering the third quarter with an excellent order backlog because of the growth in unit demand for personal computers and continuing market acceptance of our new products.
(UF P 114.)
Defendants contend the challenged statement in the October 22, 1992 press release was not misleading because total revenue for the second quarter was a record, earnings per share had increased from $ 0.20 to $ 0.36, and Cirrus's order backlog entering the third quarter was $ 98 million, representing a substantial increase over the $ 62 million backlog entering the second quarter. (Hackworth Decl. P 44.) Plaintiffs do not offer any evidence controverting this claim.
Accurate statements of historical fact such as these are not actionable. Cf. Convergent, 948 F.2d at 513 ("The challenged statements do not imply any comparison between the rate of past and future growth. They simply report past performance and assert specific limited predictions for the future."). Moreover, "statements regarding past events contain no implicit prediction that those events or conditions will continue in the future." Caere, 837 F. Supp. at 1058 (citations omitted). Plaintiffs' fraud claim based on the October 22, 1992 press release therefore must fail.
2. October 22, 1992 Conference Call.
The challenged statements made during the conference call and addressed on summary judgment are as follows:
a. Statements Concerning Revenue.
1. "While orders were strong in the disk drive area, the growth rate is more in line with market growth, while in our graphics products, the growth rate is more reflective of strong market share gain, as well as market growth." (UF P 115.)
2. "Older products for the disk drive market are surprisingly healthy." (UF P 116.)
3. "The overall market continues to feel strong. The outlook is for continued strength in disk drive unit shipment growth for 1993. The PC market continues with strong unit expansion, apparently driven by low prices as well as total globalization of the PC." (UF P 117.)
4. "Visibility strong as ever -- unit demand quite strong." (Def. Ex. 15.)
Plaintiffs characterize these statements as false or misleading statements pertaining to the strength of Cirrus's disk drive business. They claim that Cirrus should have disclosed (1) that its internal revenue forecasts for the Mass Storage and User Interface Divisions were declining, and (2) that Cirrus had problems with customers.
They base their argument on defendants' alleged knowledge that Cirrus's mass storage business was declining at the time these statements were made, citing as evidence a number of internal memoranda, reports, and customer demand forecasts. These memoranda and reports include the following:
1. A July 7, 1992 memorandum to Hackworth, Srinivasan, and others discussing potential pricing problems;
2. An August 25, 1992 memorandum that cautioned management about overbuilding in the disk drive market, stating that "[a] clear 'bubble' of potential over capacity in the disk drive industry could emerge as early as [the December 1992 quarter]" and that the Cirrus's forecasts for that quarter could be off by up to 10% (Def. Ex. 33 (emphasis deleted));
3. A September 14, 1992 memorandum to Hackworth, Srinivasan, and others entitled "Operations Staff Minutes & Open Action Items/Friday, 11 September 1992" that stated, "expect product mix changes at Conner and lower demand going forward" and "Cobra demand significantly lower going forward" (Pl. Ex. 368 at 1);
4. A September 17, 1992 demand forecast showing a downward revision in third quarter Mass Storage estimates;
5. A September 18, 1992 internal projection of FY93 revenue for Mass Storage of $ 150.5 million, down from the August forecast of $ 158 million, principally because of lower demand for the Cobra, Viper, and Cardinal products;
6. An October 8, 1992 demand forecast showing downward revisions in third and fourth quarter Mass Storage and User Interface estimates;
7. An October 13, 1992 memorandum to Srinivasan and others, stating, "we have recently experienced many reschedules & cancellations of product" (Pl. Ex. 549); and
8. An October 16, 1992 internal projection of FY93 revenue for Mass Storage of $ 140 million, down from the September forecast of $ 150.5 million, principally because of lower demand from Conner, Seagate, and Maxtor.
Defendants claim that the first statement, relating to growth rate, is not actionable because it is true. Cirrus's mass storage bookings for the second quarter were $ 37.8 million, the highest in the Company's history and a significant increase over first quarter bookings of $ 34.3 million. (Def. Ex. 722.) Overall bookings rose even more significantly, from $ 64.2 million to $ 80.8 million. (Def. Ex. 722.) Defendants maintain that, because of Hackworth's statement that mass storage growth tracked the growth of the market, the communication was, overall, a cautionary one.
With respect to the second statement, relating to the health of older products for the disk drive market, defendants maintain that this statement was consistent with Cirrus's October forecasts predicting that demand for older mass storage products would remain strong into calendar 1993 (Hackworth Decl. P 46) and, therefore, had a reasonable basis. They maintain it is too vague to be actionable, see Caere, 837 F. Supp. at 1057-58, and characterize the remainder of the disputed statements as general statements about the PC market also too vague to be actionable.
In order to prevail in a fraud-on-the-market case such as this, plaintiffs must "demonstrate that a particular statement, when read in light of all the information then available to the market, or a failure to disclose particular information, conveyed a false or misleading impression." Convergent, 948 F.2d at 512. Where plaintiffs claim, as here, that failure to disclose internal forecasts constitutes a material omission that "render[s] the company's forward-looking statements misleading," in order to defeat summary judgment plaintiffs "must show that defendants had a legally cognizable duty to disclose the projections." Lyondell, 984 F.2d at 1052.
As a general rule, a company has no duty to disclose internal projections. Provenz, 95 F.3d at 1386; see also Lyondell, 984 F.2d at 1052-53 ("[a] corporation may be called upon to make confidential projections for a variety of sound purposes where public disclosure would be harmful"); Convergent, 948 F.2d at 516 ("it is just good general business practice to make . . . projections for internal corporate use") (quoting Vaughn, 628 F.2d 1214, 1221); Stac, 89 F.3d at 1411 (citation omitted) ("Issuers need not reveal all projections. Any firm generates a range of estimates internally or through consultants. It may reveal the projection it thinks best while withholding others, so long as the one revealed has a 'reasonable basis.'"). A company does, however, have a duty to disclose internal projections that are made with "reasonable certainty." Provenz, 95 F.3d at 1386 (quoting Convergent, 948 F.2d at 516). Moreover, "a company has a duty to disclose the financial data and other material information upon which an internal forecast is based." Id.
In Provenz, the Ninth Circuit reversed the district court's grant of summary judgment for defendants on a number of claims, including a claim that statements by a company executive on a conference call to analysts were misleading in light of his failure to disclose certain internal projections. Although the executive predicted second quarter earnings would be close to the $ 624,000 reported for the first quarter, a spreadsheet prepared eight days before the conference call showed that the company forecasted internally a $ 4,000,000 loss for the second quarter. Id. Relying on testimony of company employees that the internal forecast represented "'the best, most accurate representation as of the time it was prepared of what the company's financial results [would] be like for the prospective quarter,'" and the fact that defendants had not disclosed to analysts either the projection or the financial information on which the internal forecast was based, the court found plaintiffs had raised a genuine issue of material fact with respect to whether defendants' statements during the conference call were misleading. Id.
This is not such a case. Far from representing the "best, most accurate representation . . . of the company's financial results" for the prospective quarter, id., the documents cited by plaintiffs, evidently designed to raise concerns and present action items, do not appear to have been prepared with anything approaching the level of certainty required for public disclosure. These are precisely the type of internal forecasts meant for internal use that a company is not required to disclose. Plaintiffs have offered no evidence that defendants were aware of any adverse facts that undermined the validity of their public statements and, thus, the claim falls squarely under Verifone, 11 F.3d at 869 (emphasis added) (citations omitted) ("absent allegations that [the company] withheld financial data or other existing facts from which forecasts are typically derived, the alleged omissions are not of material, actual facts. Therefore, the forecasts need not have been disclosed, and the failure to make the omitted forecasts did not render other statements that were made misleading").
In addition, defendants have offered evidence that Cirrus's internal projections for the Mass Storage division, even after downward revision, were in line both with Wall Street estimates and actual results for the quarter. This is also true for revenues as a whole. This suggests that defendants' statements had a reasonable basis, and that the market was not misled.
Thus, even though the Court finds the disputed statements not too vague to be actionable as a matter of law under Caere, and even construing the evidence in the light most favorable to the nonmoving party, the Court finds that plaintiffs have failed to raise a genuine issue of material fact with respect to whether the disputed statements were misleading.
b. Statements Concerning Gross Margin.
During the October 22, 1992 conference call, Hackworth made the following statement with respect to gross margin:
Gross margin was off about one percentage point from last quarter and Sam will cover this further in his report. Capacity has ramped superbly during the quarter and supply/demand will be in line by November. . . . Since we have been surprisingly successful in obtaining significant incremental wafer capacity commitments...in fact, well in excess of our perceived demand...we have decided to continue to press Acumos' original low-end/low-margin VGA chips into the low-end of the market, and given surplus capacity, they represent EPS that should not be left for the competition. We remain committed to our 50% [gross margin] model, and based on our current robust flow of new products in the second half of this fiscal year, we continue to believe the company is well positioned for a continuing upward bias in gross margin for the long run.
(UF P 118.)
Plaintiffs contend these statements were false and misleading when made. At the time of the call, they assert, both Hackworth and Srinivasan were aware that margins in Cirrus's two largest divisions, Mass Storage and User Interface (representing a significant portion of Cirrus's revenues and earnings), were under "severe pressure." (Pl. Opp'n at 8-9.) They cite as evidence the following:
1. Cirrus-prepared charts indicating a downward trend in margins over the past several quarters;
2. An October 15, 1992 internal projection showing margins for the Mass Storage division for the third and fourth quarters lower than for the second quarter;
3. A graph in Cirrus's October 19, 1992 Operations Review Package entitled "CRUS Gross Margin %" indicated that Cirrus's gross margin for the second quarter of fiscal 1993 was 46 percent. (UF P 119.) This graph projected that gross margins for the third and fourth quarters of fiscal 1993 would be 46.7 percent and 46.4 percent, respectively (UF P 119); and
4. An October 21, 1992 memorandum to Hackworth and Bartek, prepared in anticipation of the analyst conference call, that indicates that costs in the User Interface division "do not show adequate improvement over time." (Pl. Ex. 531.)
Defendants contend, first, that Hackworth's statement clearly discloses a decline in gross margin for the present quarter, predicting a return to 50 percent margins only over the long run. In their view, the reference to the sale of "low-end/low-margin VGA chips into the low-end market" was cautionary, further clarifying that 50 percent margins would not be achieved in the near future. Defendants also contend that Hackworth's statements had a reasonable basis, and were not inconsistent with Cirrus's internal forecasts. Finally, defendants maintain that Hackworth's statements that "we remain committed to our 50% [gross margin] model" and that Cirrus is "well positioned for a continuing upward bias in gross margin for the long run" were too vague to be actionable. See Caere, 837 F. Supp. at 1057-58 (statement that company was "well positioned" for growth held too vague to be actionable).
Plaintiffs have failed to offer evidence sufficient to raise a genuine issue of material fact with respect to whether these statements were misleading. Although reasonable investors could disagree with respect to whether Hackworth's statements predicted a near term decline in gross margin, as defendants allege, there can be no dispute that his reference to Cirrus's continuing commitment to the 50 percent gross margin model, and Cirrus's expectations for "a continuing upward bias in gross margin for the long run," were long-term predictions only. None of the evidence cited by plaintiffs "seriously undermine[s]," Wells Fargo, 12 F.3d at 930 (internal quotation marks omitted), the validity of these statements, or defendants' evidence that the statements had a reasonable basis when made.
3. Form 10-Q for Second Quarter.
On October 28, 1992, Cirrus filed its Form 10-Q for the second quarter. Plaintiffs challenge, in their third amended statement of claims, the following statement in the 10-Q:
Net sales for the six months of fiscal 1993 were $ 139.3 million, an increase of 31% over the $ 106.0 million reported for the same period of fiscal 1992. The revenue increase during fiscal 1993 compared to 1992 was largely due to an increase in sales of mass storage, display graphics, and audio and data conversion products. Mass storage revenue was driven by a combination of the strong demand for lower capacity products and increased demand for the new high capacity 3.5-inch drives and new small-form-factor disk drives.
(Defs. Ex. 351.)
Defendants assert that, as statements of historical fact, these statements are not actionable because they were true. See Convergent, 948 F.2d at 512-13. In addition, they point to cautionary language in the 10-Q that warns of the risks facing Cirrus in the third quarter, in particular with respect to gross margins and the mass storage division:
The marketplace is highly competitive with product price being a highly determinative selection criteria. There can be no assurance that the Company will continue to compete successfully as to these factors. Therefore, the current gross margin percentage may not be sustainable.