which would have permitted plaintiffs to plead simply facts that support their beliefs. See 141 Cong. Rec. H2848 (Mar. 8, 1995).
Because "Congress does not intend sub silentio to enact statutory language that it has earlier discarded in favor of other language," Immigration & Naturalization Serv. v. Cardoza-Fonseca, 480 U.S. 421, 442-43, 94 L. Ed. 2d 434, 107 S. Ct. 1207 S. Ct. 1207 (1986) (internal quotation marks and citation omitted), the Court concludes that plaintiffs must plead the sort of information described by Reps. Bryant and Dingell to meet the requirements of the SRA as enacted.
a. False and Misleading Statements
The Court first evaluates whether plaintiffs' complaint meets the lower threshold of Federal Rule of Civil Procedure 9(b) and the SRA's mandate to specify each statement alleged to have been misleading and the reason or reasons why the statement is misleading. Plaintiffs allege eleven false or misleading statements by defendants between September 13, 1995 and December 19, 1995. (FAC PP 50-60.) The content of these statements included (1) projections of SGI's growth rates, (FAC PP 51, 54, 55, 57); (2) optimism and assurances about demand for, and supply of, the Indigo2 IMPACT workstation, (FAC PP 50, 52, 53, 54, 57, 58); and (3) explanations and assurances about SGI's performance, (FAC PP 54, 57, 59, 60).
To meet the requirements of Rule 9(b) and the SRA, the FAC must "state precisely the time, place, and nature of the misleading statements, misrepresentation, and specific acts of fraud." Kaplan, 49 F.3d at 1370. The FAC meets this burden with regard to McCracken's statements of September 13, 1995, September 21, 1995, September 22, 1995, October 19, 1995, and November 2, 1995, because it identifies the speaker, the content, the audience, and the dates of the misleading statements. The FAC also meets this burden with respect to statements by SGI in its October 19, 1995 press release, with respect to statements by SGI "executives" in the October 19, 1995 conference call and the November 2, 1995 analyst conference, and with respect to statements in the November 1995 Report to Shareholders, because the complaint gives the defendants sufficient notice. Based on the information pled regarding the time, location, and content of these statements, SGI and its executives can identify who is being charged, and with what. For example, plaintiffs' allegations regarding statements by SGI executives at the analyst conference arise out of presentations given by "a dozen officers, including McCracken, Baskett, Burgess, Stephen Goggiano (Director of Marketing), Ramsey [sic], Oswald, and Sekimoto." (FAC P 57.) Defendants can identify which executives participated in the conference, gave presentations, and what those presentations covered.
In its earlier ruling, the Court held that plaintiffs' claims with respect to statements by SGI executives to Dean Witter on December 15, 1995, (Complaint P 50, FAC P 59), and Smith Barney "in the few days prior to December 19, 1995," (Complaint P 51, FAC P 60), did not meet this burden, because plaintiffs had not alleged with sufficient particularity the speaker, time, or place of these conversations. Because, as described in the original complaint, these statements were not given in an official capacity or in a formal context, they were not as identifiable as other unattributed statements alleged by plaintiffs. In the FAC, plaintiffs clarify that these statements were given by defendant McCracken and company treasurer Thomas J. Oswald. (FAC PP 59, 60.) The Court finds that this clarification sufficiently particularizes plaintiffs allegations for purposes of Rule 9(b) and the SRA.
In addition to alleging the time, place, and nature of the allegedly false and misleading statements, plaintiffs must explain why the statements were false or misleading when made. Glenfed, 42 F.3d at 1549. Plaintiffs allege eight reasons why defendants' statements were false and misleading:
. SGI's North American sales reorganization had been unsuccessful, resulting in diminished sales, below SGI's targets;
. SGI was unable to produce sufficient Indigo2 IMPACT workstations to meet consumer demand or internal growth targets because it was not receiving sufficient components from Toshiba;
. SGI used an "end of component 'acceptance test,'" resulting in a low yield of usable parts;
. SGI failed to qualify Toshiba to provide a sufficient quantity of component parts, resulting in low volume production;
. SGI was having problems ramping up the manufacturing of the R10000 chip for use in the upgraded Indigo2 IMPACT workstations;
. SGI sales in Germany and the United Kingdom were materially below expectations;
. SGI sales in France were much worse than expected; and
. SGI's OEM sales were trending downward.
(P 60.) Plaintiffs' belief that defendants' statements were false is based on defendants' announcements in 1996 that the company's poor showing resulted from the combined negative effects of these factors. (PP 63-64.) Plaintiffs allege that these conditions existed during the class period when defendants were making their optimistic statements. (PP 36-40.) Plaintiffs thus meet their burden of demonstrating why the statements were allegedly false and misleading. See Glenfed, 42 F.3d at 1548-1549 (holding that contemporary condition contrary to defendant's optimistic statements adequately pleads falsity); Fecht v. Price Co., 70 F.3d 1078, 1083 (9th Cir. 1995), cert. denied, 134 L. Ed. 2d 547, 116 S. Ct. 1422 (1996) (finding that allegations of specific problems undermining defendant's claims suffice to explain how they are false).
Defendants argue that plaintiffs have failed to establish that all of the alleged omissions are material. The materiality of an omission is a fact-specific determination that should ordinarily be assessed by a jury. See Fecht, 70 F.3d at 1080-81. Only if the immateriality of the statement is so obvious that reasonable minds could not differ should the Court resolve this question as a matter of law. Id. at 1081.
As the Court held in it's earlier order, defendants' statements, as pled in the original complaint, suggest that the omissions were material. For example, in its July 1995 conference call with analysts, SGI stated that the Indigo2 IMPACT would play a major part in meeting the forty percent growth target. (FAC P 47.) In its October 1995 conference call, SGI assured analysts that it would achieve forty percent growth because, among other things, its European business was strong, its sales force reorganization was successful, and the Indigo2 IMPACT was selling well. (P 54.) The Court found that such allegations of internal, production, or market conditions resulting in diminished sales or sales under target are not immaterial as a matter of law; those claims, therefore, cannot be dismissed. Plaintiffs' new claims relating to Toshiba's manufacturing difficulties and problems with the R10000 chip fall within this category.
Plaintiffs also present a new claim about SGI's first quarter shortfall. Plaintiffs have pushed the start of the class period back from October 19, 1995, to September 13, 1995, and now contend that defendants knew of the problems described above early enough that they should have disclosed them prior to announcing the first quarter shortfall in October. Plaintiffs concede, however, that SGI's first quarter results were "at the low end of expectations." (FAC P 8.) The company's first quarter revenues of $ 595 million were only five percent below market expectations of forty to forty-five percent growth (revenues in the range of $ 628-650 million). This shortfall is immaterial as a matter of law. See In re Convergent Tech. Sec. Litig., 948 F.2d 507, 514 (9th Cir. 1991) (holding that revenues ten percent below target are not actionable). For this reason, plaintiffs claims regarding the first quarter are dismissed with prejudice.
Having concluded that plaintiffs' claims generally meet the preliminary standard set by Federal Rule of Civil Procedure 9(b) and the SRA, the Court must determine whether plaintiffs have pled with particularity all facts on which their beliefs about the falsity of defendants statements are formed. At this point in the analysis, the line between pleading falsity and pleading fraud becomes blurred. As defendants note, in the Second Circuit, the information and belief pleading requirement appears to be an integral part of the strong inference standard for pleading scienter. See Philip Morris, 75 F.3d at 812-813 (finding that plaintiffs' allegations of negative internal reports failed to support claim's of falsity and scienter); Wexner v. First Manhattan Co., 902 F.2d 169, 172-73 (2d Cir. 1990) (holding that conclusory allegation of leak of confidential information without more failed to create inference of fraudulent intent); Crystal v. Foy, 562 F. Supp. 422, 424-25 (S.D.N.Y. 1983) (rejecting general allegations of fraud). Because plaintiffs' claims regarding the negative internal reports are also central to their allegations of scienter, the Court further analyzes this issue below.
To adequately plead scienter under SRA, plaintiffs must establish a strong inference of knowing or intentional misconduct. In doing so, plaintiffs must do more than speculate as to defendants' motives or make conclusory allegations of scienter; plaintiffs must allege specific facts. See Wexner, 902 F.2d at 172-73; Denny v. Barber, 576 F.2d 465, 470 (2d Cir. 1978). In this case, plaintiffs seek to couple allegations of defendants' awareness of negative internal reports with their false and misleading statements and stock sales to create a strong inference of fraud.
In dismissing plaintiffs' original complaint, the Court found that plaintiffs' general allegations of "negative internal reports" were too vague to raise a strong inference of fraud. Because every sophisticated corporation uses some kind of internal reporting system reflecting earlier forecasts, allowing plaintiffs to go forward with a case based on general allegations of "negative internal reports" would expose all those companies to securities litigation whenever their stock prices dropped.
The Second Circuit has recognized this problem, holding that unsupported general claims of the existence of internal reports are insufficient to survive a motion to dismiss. The Second Circuit requires plaintiffs to identify alleged internal reports specifically, providing names and dates. See Philip Morris, 75 F.3d at 812-13. The Court adopted this rule, believing that because the pleading standard under the SRA is at least as strict as the Second Circuit's, the Court could not require anything less of plaintiffs. The Court's finding is further supported by Congress's adoption of the strict information and belief standard described above.
In the FAC, plaintiffs have attempted to bolster their internal reports allegations. Plaintiffs describe a series of reports, including a "Fiscal Year 1996 Plan/Budget," (FAC PP 32-33), and monthly financial reports such as "Flash" reports, (FAC P 35), "Stop Ship" reports, (FAC P 37), and follow-up reports. (FAC P 37).
According to plaintiffs, the Fiscal Year 1996 Plan/Budget was completed in the spring of 1995, and detailed the corporation's projected operations and financials by product line and geographical area. (FAC P 32-35.) The plan allegedly discussed all of the areas that plaintiffs claim eventually became problems for SGI. Id. Plaintiffs contend that all defendants received regular daily and monthly reports about the company's performance, covering finances, orders, shipments, and inventories. (FAC P 34.) In addition to these reports, plaintiffs allege that defendants received flash reports regarding SGI's sales and Indigo2 IMPACT problems in early October, November, and December 1995, (FAC PP 36, 39-40), and a stop ship report further explaining the Indigo2 IMPACT problem in late September. (FAC PP 37-38.) Subsequently, SGI employees allegedly advised defendants of the steps they were taking to remedy the Indigo2 IMPACT problem via another report. (FAC P 37.)
Although these allegations are more elaborate than the ones dismissed in September 1996, they remain too generic to create a strong inference of fraud under the SRA. As defendants point out, any well-managed, billion dollar company with international operations and multiple products will generate a variety of reports at regular time intervals. Consequently, any company that has announced low earnings would be vulnerable to allegations that such reports exist and that they show "very poor results "well below forecasted and budgeted levels." See FAC PP 39-40. Indeed, the Second Circuit rejected more specific allegations--that confidential company sales reports showed that retail sales were declining at a rate of 8.3 percent--finding them insufficient to create a strong inference of fraud because they appeared to have been cobbled together in hindsight. See Philip Morris, 75 F.2d at 813.
To establish a strong inference of fraud, plaintiffs must provide more details about the alleged negative internal reports. The allegations should include the titles of the reports, when they were prepared, who prepared them, to whom they were directed, their content, and the sources from which plaintiffs obtained this information. See Id; Moll v. U.S. Title Life Ins. Co. of N.Y., 654 F. Supp. 1012, 1034-35 (S.D.N.Y. 1987); Morgan v. Prudential Group, Inc., 81 F.R.D. 418, 423-24 (S.D.N.Y. 1984); Decker v. Massey-Ferguson, Ltd., 534 F. Supp. 873, 878 (S.D.N.Y. 1981), aff'd in part, rev'd on other grounds, 681 F.2d 111 (2d Cir. 1982). This requirement is consistent with the SRA's information and belief standard, which requires plaintiffs to plead all facts on which their allegations are based.
Although plaintiffs have complied with the letter of the standard--alleging, for example, that all defendants received a "flash" report generated by the finance department on October 3-4, 1996, showing that sales were below forecasted levels--their allegations fail to conform to the spirit of the standard. If the Court allowed plaintiffs to go forward with such general allegations, the strengthened standard of the SRA would lose its meaning. Plaintiffs' in camera submission to the Court, which the Court has declined to review, suggests that plaintiffs may possess sources or specific facts that would improve their allegations about the negative internal reports. In the interest of justice, the Court will allow plaintiffs to supplement these allegations one time further. Plaintiffs are cautioned, however, that the Court expects any supplement to include all facts that form the basis of plaintiffs' allegations, as required by the SRA information and belief standard.
Plaintiffs also rely on defendants' stock sales in attempting to create a strong inference of fraud. All six defendants sold stock during the class period. (FAC P 68.) Defendant Burgess sold 250,588 shares for a total of $ 8,781,294; defendant Ramsay sold 20,000 shares for a total of $ 746,071; defendant McCracken sold 60,000 shares for a total of $ 2,186,000; defendant Sekimoto sold 7,600 shares for a total of $ 266,988; defendant Baskett sold 30,000 shares for a total of $ 1,097,500; and defendant Kelly sold 20,000 shares for a total of $ 743,200. (FAC P 68.) Defendants made their sales in the twenty-three days between October 30, 1995 and November 30, 1995. (FAC P 13.)
In evaluating defendants' scienter, the SRA requires the Court to consider each defendant's sales separately. See 15 U.S.C. § 78u-4(b)(2). Defendants' stock trading will not support a strong inference of fraud unless the sales are unusual or suspicious. See Acito, 47 F.3d at 54. In the Ninth Circuit, courts typically have not considered the amount and timing of stock sales on a motion to dismiss, see, e.g., In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1427 (9th Cir. 1994); In re Apple Computer Sec. Litig., 886 F.2d 1109, 1117 (9th Cir. 1989); however, under the strong inference standard, courts in the Second Circuit do consider this information. See, e.g., Acito, 47 F.3d at 54.
In dismissing the original complaint, the Court noted that defendants' SEC Forms 3 and 4, and SGI's 1995 proxy statement, show that defendants sold only a fraction of their total SGI holdings. Defendants collectively had available millions of options that could have been exercised and sold during the class period.
Considered in that context, defendants' actual sales were relatively small. The sales at issue also appeared generally consistent in amount with sales made in previous quarters. In its earlier ruling, however, the Court declined to examine each individual defendant's trading because it had already found that plaintiffs' allegations of negative internal reports were insufficient. The Court now conducts the required individual analyses.
Defendant McCracken, who sold 60,000 shares, had 2,305,382 shares and options available during the class period. His sales constituted sixteen percent of his stock holdings, and 2.6% of his available stock and options. Since 1994, defendant McCracken has frequently sold 30-50,000 shares of stock at a time. For these reasons, defendant McCracken's sales do not raise a strong inference of fraudulent intent, as a matter of law. See Acito, 47 F.2d at 54 (finding sales representing less than eleven percent of holdings unsuspicious).
Defendants Baskett's, Ramsay's, and Sekimoto's sales are similarly unsuspicious. Defendant Baskett, who sold 30,000 shares, had 390,577 shares and options available during the class period. His sales constituted 7.7% of his available stocks and options. Since 1994, he has frequently sold 25-60,000 shares of stock at a time. Defendant Ramsay, who sold 20,000 shares, had 489,978 shares and options available during the class period. His sales constituted 4.1% of his available stocks and options. Since 1994, he has frequently sold 10-40,000 shares of stock at a time. Defendant Sekimoto, who sold 7,600 shares, had 110,811 shares and options available during the class period. His sales constituted 6.9% of his available stocks and options. During the previous two quarters, which represent the extent of his trading history, defendant Sekimoto sold 4,800 shares and no shares respectively.
Defendants Kelly's and Burgess's sales are less easily explained. Defendant Kelly, who sold 20,000 shares, had 45,790 shares and options available during the class period. His sales constituted 43.6% of his available stocks and options. Defendant Burgess, who sold 250,588 shares, had 332,746 shares and options available during the class period. His sales constituted 75.3% of his available stocks and options.
Because these sales represent such a high percentage of each defendant's holdings, the Court cannot say that they are unactionable as a matter of law. Moreover, neither defendant has a significant trading history to which the Court can compare his class period sales. Defendants Kelly and Burgess raise a number of plausible explanations for the apparent unusual and suspicious nature of their trading; however, these explanations are not properly before the Court on a motion to dismiss. For these reasons, the Court finds that defendants Burgess's and Kelly's stock sales, while not alone sufficient to raise a strong inference of fraud, may be considered as evidence of fraud if plaintiffs are able to buttress their claims regarding negative internal reports.
For the foregoing reasons, the following claims are DISMISSED WITH PREJUDICE: (1) plaintiffs' claims of false and misleading statements relating to the first quarter; (2) plaintiffs' claims of insider trading against defendants McCracken, Baskett, Ramsay, and Sekimoto; and (3) plaintiffs' claims relating to the alleged fraudulent scheme against those defendants not also directly liable for making false or misleading statements or for insider trading.
The individual defendants' (Baskett, Burgess, Ramsay, and Sekimoto) motion for partial summary judgment on plaintiffs' false and misleading statement claims is GRANTED.
Plaintiffs' remaining claims against defendants shall remain under submission. Plaintiffs may file a supplement to strengthen the allegations of negative internal reports not to exceed five (5) pages within ten (10) days of this order. Defendants may file a supplemental brief of five (5) pages within ten (10) days of plaintiffs' submission. Plaintiffs are ORDERED to refrain from making additional legal argument in their submission.
The Court will issue a ruling on plaintiffs' motion for certification of its decision for interlocutory appeal at the same time that it issues an order regarding the claims that it has given plaintiffs leave to supplement.
Dated: May 22, 1997
FERN M. SMITH
United States District Judge