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IN RE PACIFIC GATEWAY EXCHANGE

August 16, 2001

IN RE PACIFIC GATEWAY EXCHANGE, INC., SECURITIES LITIGATION. THIS DOCUMENT RELATES TO: ALL ACTIONS.


The opinion of the court was delivered by: Hamilton, District Judge.

ORDER GRANTING MOTION TO DISMISS COMPLAINT

Now before the court is the motion of defendants Howard A. Neckowitz, Gail E. Granton, and Sandra D. Grey for an order dismissing the consolidated amended complaint. Having read the parties' papers and carefully considered their arguments and the relevant legal authority, and good cause appearing, the court hereby GRANTS the motion for the following reasons.

INTRODUCTION

This is a proposed class action alleging violation of the federal securities laws. Pacific Gateway Exchange, Inc. ("PGE"), which filed for bankruptcy protection in December 2000, was a telecommunications company providing long distance telephone service, and Internet and fiber optic bandwidth services. Defendant Howard Neckowitz was Chairman, President, and CEO of PGE until December 2000, defendant Sandra Gray was Chief Financial Officer until March 2000, and defendant Gail Granton was co-Chief Operations Officer until December 2000.

Plaintiffs, who purchased shares of stock in PGE, filed this action on behalf of themselves and all other persons who bought PGE stock from May 14, 1999, to March 31, 2000 (the proposed class period). Plaintiffs allege that during the class period, defendants issued false and misleading statements regarding PGE's revenue recognition practices and omitted to disclose that PGE had defaulted on a significant credit facility until several months after the default began, in violation of § 10(b) of the 1934 Securities Exchange Act, 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5. Plaintiffs also allege control person liability under § 20(a) of the 1934 Act, 15 U.S.C. § 78t(a).

Plaintiffs allege misstatements and material omissions in connection with defendants' release of PGE's financial results for each of the four quarters of 1999, in press releases and in reports filed with the SEC. Plaintiffs claim that throughout this period, defendants recognized revenue on bandwidth sales and swap agreements "up front," rather than ratably over the life of the agreement, in violation of Generally Accepted Accounting Principles ("GAAP"), and without making adequate disclosure of the effect of such overstatement of revenues. Plaintiffs also assert that defendants understated the expenses associated with the company's fixed assets. In addition, plaintiffs allege that PGE failed to disclose until March 2000 that it had been in default on its debt (the credit facility) to Bank of America since before December 1999.

Defendants now move to dismiss the consolidated amended complaint (herein, the "complaint") pursuant to Federal Rule of Civil Procedure 12 (b)(6), on the grounds that plaintiffs allege neither falsity nor scienter with the requisite particularity.

DISCUSSION

A. Legal Standard

1. Motions to dismiss under Federal Rule of Civil Procedure 12(b)(6).

A court should dismiss under Federal Rule of Civil Procedure 12(b)(6) for failure to state a claim only where it appears beyond doubt that plaintiff can prove no set of facts in support of the claim which would entitle the plaintiff to relief. See Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 2 L.Ed.2d 80 (1957); Pillsbury, Madison & Sutro v. Lerner, 31 F.3d 924, 928 (9th Cir. 1994). All allegations of material fact are taken as true and construed in the light most favorable to the nonmoving party. Smith v. Jackson, 84 F.3d 1213, 1217 (9th Cir. 1996).

Review is limited to the contents of the complaint. Allarcom Pay Television, Ltd. v. Gen. Instrument Corp., 69 F.3d 381, 385 (9th Cir. 1995). When matters outside the pleading are presented to and not excluded by the court, a Rule 12(b)(6) motion is to be treated as one for summary judgment, and all parties shall be given opportunity to present all material made pertinent to such a motion by Rule 56. See Fed.R.Civ.P. 12(b). However, material that is properly presented to the court as part of the complaint may be considered as part of a motion to dismiss. See Hal Roach Studios, Inc. v. Richard Feiner & Co., 896 F.2d 1542, 1555 n. 19 (9th Cir. 1989). If a plaintiff fails to attach to the complaint the documents on which it is based, defendant may attach to a 12(b)(6) motion the documents referred to in the complaint to show that they do not support plaintiffs claim. See Branch v. Tunnell, 14 F.3d 449, 454 (9th Cir. 1994).

2. Federal Rule of Civil Procedure 9(b)

Generally, plaintiffs in federal court are required to give a short, plain statement of the claim sufficient to put the defendants on notice. Fed.R.Civ.P. 8. In actions alleging fraud, however, "the circumstances constituting fraud or mistake shall be stated with particularity." Fed. R.Civ.P. 9(b). Under Rule 9(b), the complaint must allege specific facts regarding the fraudulent activity, such as the time, date, place, and content of the alleged fraudulent representation, how or why the representation was false or misleading, and in some cases, the identity of the person engaged in the fraud. See In re GlenFed, Inc. Sec. Litig., 42 F.3d 1541, 1547-49 (9th Cir. 1994).

3. Claims under the 1934 Act

Section 10(b) of the Securities Exchange Act provides, in part, that it is unlawful "to use or employ in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of ...


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