The opinion of the court was delivered by: WHYTE
ORDER GRANTING DEFENDANTS' MOTIONS TO DISMISS WITH LEAVE TO AMEND AND GRANTING IN PART AND DENYING IN PART PLAINTIFF'S MOTION TO STRIKE
Before the court are two motions to dismiss pursuant to Federal Rules of Civil Procedure 12(b)(6) and 9(b), and the Private Securities Litigation Reform Act of 1995 ("Reform Act"). One motion was brought on behalf of defendants Lumisys, Inc. ("Lumisys" or "Company"), Stephen J. Weiss, Craig Klosterman, John M. Burgess, Linden J. Livoni, Eystein G. Thordarson, Douglas G. DeVivo, Jesse I. Treu, Helios Partners Limited Partnership and Bala S. Manian (together, the "Lumisys defendants"). The other was brought on behalf of defendants Hambrecht & Quist LLC ("Hambrecht & Quist"), UBS Securities, Inc. ("UBS Securities") and Volpe Welty & Co. ("Volpe Welty") (together, the "underwriters"). The court scheduled oral argument for March 6, 1998, but after the parties stipulated to the court's tentative ruling dismissing the complaint in its entirety, no oral argument was held. For the reasons set forth below, the court grants both motions to dismiss with leave to amend.
Plaintiff Gary Wenger brings this securities class action lawsuit against Lumisys, six of its officers and directors,
two controlling Lumisys shareholders,
and three investment banking firms,
on behalf of himself and all persons
who purchased Lumisys common stock between November 15, 1995, the day of Lumisys' initial public offering ("IPO"), and July 11, 1996, the day Lumisys lowered its revenue expectations for 1996.
Lumisys designs, develops, manufactures, markets and sells medical film digitizer products that permit the transmission and viewing of X-ray, ultrasound and MRI images over computer networks. In his complaint filed on July 10, 1997 ("Complaint"), plaintiff alleges that all defendants violated federal securities laws, specifically § 10(b) of the Securities Act of 1934 ("1934 Act") and Securities and Exchange Commission ("SEC") Rule 10b-5, and that Weiss, Klosterman, Helios Partners, Manian, Treu and Lumisys violated § 20(a) of the 1934 Act. The Lumisys insiders and controlling shareholders allegedly decided to pursue a public offering of Lumisys stock in order to enable them to sell off a significant amount of stock at high prices before various adverse facts about Lumisys became public. In addition, an IPO would allow the insiders to sell Lumisys stock to public investors without having to incur a due diligence investigation into Lumisys' business by a sophisticated adversarial buyer. Complaint PP3, 4. To accomplish their scheme, Lumisys' insiders and controlling shareholders allegedly sought out the help of the underwriters. The three underwriters all agreed to participate in the scheme in order "to get the underwriting business for Lumisys' IPO." Id. P33. In addition, the underwriters "would pocket millions from the IPO proceeds as the lead underwriters on the IPO and make millions more later by acting as marketmakers in Lumisys stock and by coordinating the sales of the Lumisys' insiders' stock." Id. P6. Plaintiff also alleges that the underwriters were further motivated to participate in the scheme because they had extracted "an illegal agreement that Lumisys would indemnify and hold them harmless from suits for any false statements in connection with the IPO, and also made certain that Lumisys had purchased millions in directors' and officers' liability insurance." Id.
The Complaint alleges that defendants made false and misleading statements about Lumisys' products and business prospects in an effort to drive up the price of Lumisys stock following the company's IPO. Their fraudulent scheme allegedly artificially inflated the price of Lumisys stock from an IPO price of $ 8 per share to a class period high of $ 30, allowing Lumisys insiders to sell and dispose of their shares of stock at as high as $ 26 1/2 per share before various problems were revealed and the price fell to about $ 7 per share.
Plaintiff sets forth a long list of allegedly false and misleading statements made by defendants prior to and throughout the class period, id. PP54, 55-86, and follows this list with a 12-part paragraph alleging the "true facts" suppressed by defendants, id. P88. Plaintiff also alleges that these "true facts" "were [...] available to the defendants" during and prior to the class period, and that defendants "knew the adverse non-public information about the business of Lumisys as well as its future business prospects via access to internal corporate documents." Id. P27, 88. The Complaint also alleges that each individual defendant "wilfully participated in the issuance of statements which were false and/or misleading." Id. P27. The Complaint centers on allegations that defendants misrepresented the state of one of Lumisys' subsidiaries, Imagraph Corp. ("Imagraph"), as well as the state of Drastic Technologies, Inc. ("Drastic"), a company in which Lumisys had a 20% interest. The Complaint also alleges that the defendants misrepresented product demand and future revenues and earnings per share ("EPS").
The Complaint states that its allegations are "based upon the investigation of [plaintiff's] counsel, which included a review of Lumisys' SEC filings, securities analysts' reports and advisories about the Company, press releases issued by the Company, media reports about the Company, private investigations, information obtained from former employees and discussions with consultants, and, pursuant to [Fed. R. Civ. P.] 11(b)(3), [plaintiff] believes that after reasonable opportunity for discovery, substantial evidentiary support will likely exist for the allegations set forth at PP2-7 [the fraudulent scheme], 17 [the "true facts"], 19 [that defendants personally profited by selling their stock at inflated prices], 33 [underwriters' fraudulent scheme], 35-54 [the fraudulent scheme] 79-80 [early release from the 180-day lock-up, Treu's distribution of shares to partners], 88 [a repeat of paragraph 17's "true facts"] and 92 [insider trading]." Id. P 114.
A. Federal Rule of Civil Procedure 12(b)(6)
The issue to be decided on a motion to dismiss is whether the moving party has shown beyond a doubt that the opposing party can prove no set of facts in support of its claim entitling it to relief. Conley v. Gibson, 355 U.S. 41, 78 S. Ct. 99, 102, 2 L. Ed. 2d 80 (1957). A complaint may be dismissed as a matter of law for two reasons: (1) lack of a cognizable legal theory or (2) insufficient facts under a cognizable legal theory. Robertson v. Dean Witter Reynolds, Inc., 749 F.2d 530, 533-34 (9th Cir. 1984) (citing 2A J. Moore, Moore's Federal Practice P12.08 at 2271 (2d ed. 1982)). In determining a motion to dismiss, all allegations of the complaint should be construed in the opposing party's favor. Sun Savings & Loan Assoc. v. Dierdorff, 825 F.2d 187, 191 (9th Cir. 1987). Moreover, to dismiss, it must appear to a certainty that the plaintiff would not be entitled to relief under any set of facts that could be proved. Wool v. Tandem Computers, Inc., 818 F.2d 1433, 1439 (9th Cir. 1987). Motions to dismiss are therefore generally viewed with disfavor under this liberal standard. Intake Water Co. v. Yellowstone River Compact Comm., 590 F. Supp. 293, 296 (D.C. Mont. 1983), aff'd, 769 F.2d 568 (9th Cir. 1985), cert. denied, 476 U.S. 1163, 106 S. Ct. 2288, 90 L. Ed. 2d 729 (1986).
In cases alleging securities laws violations, motions to dismiss are subject to stricter standards because whether a statement or omission is misleading to potential investors "requires delicate assessments of the inferences a 'reasonable shareholder' would draw from a given set of facts and the significance of those inferences to him, and these assessments are peculiarly ones for the trier of fact." Fecht v. Price Co., 70 F.3d 1078, 1080 (9th Cir. 1995) (citation omitted). Thus, "only if the adequacy of the disclosure or the materiality of the statement is so obvious that reasonable minds could not differ are these issues appropriately resolved as a matter of law." Id. at 1081 (internal quotations omitted).
B. Federal Rule of Civil Procedure 9(b)
Rule 9(b) applies to actions brought under the federal securities laws. In re GlenFed., Inc. Sec. Litig., 42 F.3d 1541, 1544 (9th Cir. 1994). Rule 9(b) provides that "in all averments of fraud and mistake, the circumstances constituting the fraud or mistake shall be pleaded with particularity." Mere conclusory allegations of fraud are insufficient. Moore v. Kayport Package Express, Inc., 885 F.2d 531, 540 (9th Cir. 1989). The allegations must be specific enough "to give defendants notice of the particular misconduct which is alleged to constitute the fraud charged so that they can defend against the charge and not just deny that they have done anything wrong." Semegen v. Weidner, 780 F.2d 727, 731 (9th Cir. 1985). A complaint meets this standard if it alleges the time, place and content of the alleged fraudulent representation or omission; the identity of the person engaged in the fraud; and "the circumstances indicating falseness" of "the manner in which [the] representations [or omissions] were false and misleading." GlenFed, 42 F.3d 1541 at 1547-48. Thus, a plaintiff must provide an explanation as to how an alleged statement or omission was false or misleading when made. Id. at 1548.
The heightened pleading standard of Rule 9(b) is not an invitation to disregard the requirement of simplicity, directness, and clarity of Fed. R. Civ. P. 8. McHenry v. Renne, 84 F.3d 1172, 1178 (9th Cir. 1996). Every plaintiff filing a complaint in a federal district court must prepare his complaint in conformity with Rule 8, which requires that a complaint contain "a short and plain statement of the claim showing that the pleader is entitled to relief," Fed. R. Civ. P. 8(a), and that "each averment of a pleading shall be simple, concise, and direct," Fed. R. Civ. P. 8(e).
C. Liability under Section 10(b) and Rule 10b-5
Section 10(b) of the 1934 Act makes it unlawful for any person:
To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange[,] . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [SEC] may prescribe as necessary or appropriate in the public interest or for the protection of investors.
15 U.S.C. § 78j(b). Rule 10b-5, enacted thereunder, makes it unlawful "to make any untrue statement of material fact or to omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading." 17 C.F.R. § 240.10b-5(b). To successfully allege a violation of Rule 10b-5, a plaintiff must show (1) a false and misleading statement or omission of material fact; (2) scienter; (3) reliance; and (4) resulting damages. Paracor Fin., Inc. v. General Elec. Capital Corp., 96 F.3d 1151, 1157 (9th Cir. 1996).
D. False or Misleading Statements and Omissions
To state a claim for securities fraud, a plaintiff must plead with particularity the circumstances of the fraud, including the statements made and an explanation as to why or how such statements are false or misleading. Fed. R. Civ. Proc. 9(b); GlenFed, 42 F.3d at 1548. Simply because statements are different or conflict does not mean fraud exists. The Ninth Circuit explains:
The fact that an allegedly fraudulent statement and a later statement are different does not necessarily amount to an explanation as to why the earlier statement was false. . . . In order to allege circumstances constituting fraud, plaintiff must set forth facts explaining why the difference between the earlier and the later statements is not merely the difference between two permissible judgments, but rather the result of a falsehood.
GlenFed, 42 F.3d at 1549. To allege falsity, a plaintiff should point to contemporaneous, inconsistent statements by defendants or show that information available to defendants showed different results than defendants predicted. See id.
E. Private Litigation Securities Reform Act
1. Requirements for alleging securities fraud
The Reform Act
requires that a complaint in a securities fraud action specify each statement alleged to have been false or misleading. 15 U.S.C. § 78u-4(b)(1)(B). The complaint must also set forth the reason or reasons why the statement was false or misleading. Id. To sufficiently plead falsity, the complaint must show (1) facts describing undisclosed problems in detail, and (2) facts showing the problems arose before the allegedly misleading statements were made. In re Oak Technology Sec. Litig., 1997 U.S. Dist. LEXIS 18503, 1997 WL 448168, *5 (N.D. Cal. August 1, 1997); Hockey v. Medhekar, 1997 U.S. Dist. LEXIS 8558, 1997 WL 203704, *8 (N.D. Cal. April 15, 1997); Zeid v. Kimberley, 973 F. Supp. 910, 920 (N.D. Cal. 1997). Next, the complaint must state with particularity the facts which give rise to a "strong inference that the defendant acted with the required state of mind." 15 U.S.C. § 78u-4(b)(2).
2. Safe harbor for forward-looking statements
With respect to forward-looking statements, defendants cannot be held liable if the forward-looking statement was "accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statement" or if plaintiff fails to prove that the statement was made with "actual knowledge" that it was false or misleading. 15 U.S.C. § 78u-5(c)(1).
A. Plaintiff's Motion to Strike Lumisys' Conference Call Transcripts
Lumisys has requested the court take judicial notice of the transcripts of two conference calls it held with investors and securities analysts, one on February 1, 1996 (the "February Call"), and another on April 11, 1996 (the "April Call").
Plaintiff has moved to strike these transcripts. Lumisys wishes to bring these transcripts to light because they allegedly demonstrate (1) that plaintiff has grossly mischaracterized many of the statements alleged to have been made during those two calls, and (2) the April Call transcript reveals that the Company delivered a safe harbor warning before making earnings and revenue projections. Klosterman Decl. Ex. B, C.
Plaintiff paraphrases Weiss and Klosterman as representing that Imagraph's ICE Clarity product was being successfully developed and that Lumisys' investment in Drastic was succeeding. However, according to the partial February Call transcript, Klosterman stated that the ICE project had "slipped," and that volume shipments would not occur until the latter half of the year. Id. Ex. C. The April transcript indicates that Klosterman stated:
We also began some initial beta shipments of the Imagraph ICE product. As previously stated, we do not expect any significant volume shipments of the ICE product before late 1996, due to the delay in the product launch and the lag time of the OEM sales cycle.
Id. Ex. B. With regards to Drastic, Klosterman made the following statement in the February Call:
[Drastic's product] is expected to include the Imagraph ICE compression board and is a first step in moving the Imagraph products more into the systems business. The product has applications in cardiology, advertisement insertion for the cable TV market and the film editing business. Lumisys spent $ 300K for both the minority position and a five-six month option to purchase the remaining portion of the company. A decision to exercise this option would probably occur in the second quarter of 1996.
Id. Ex. C. In the April Call, he stated:
Lumisys continues to monitor its minority investment in Drastic Technologies in the progress of its disk-based VCR product. Drastic is currently running somewhat underplanned, but appears to be well positioned for the NAB, which is the National Association of Broadcasters trade show taking place next week in Las Vegas. Lumisys retains a buy-out option for the remainder of Drastic's equity. This option is currently scheduled to expire during the second quarter.
The Complaint also alleges that Lumisys did not deliver any safe harbor warning at the April Call. Complaint P98. However, the April transcript indicates that Klosterman prefaced his announcements with a safe harbor warning:
Good afternoon, and thank you for joining us today. As in most presentations, the following discussion contains forward looking statements, and our actual results may differ materially from those discussed here. Additional information concerning factors that could cause such a difference can ...