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IN RE RAMP NETWORKS
March 1, 2002
IN RE RAMP NETWORKS, INC. SECURITIES LITIGATION THIS DOCUMENT RELATES TO ALL ACTIONS
The opinion of the court was delivered by: Spero, United States Magistrate Judge.
ORDER GRANTING DEFENDANTS'
MOTION TO DISMISS SECOND
AMENDED COMPLAINT WITH
LIMITED LEAVE TO AMEND
Defendants' Motion to Dismiss Second Amended Complaint ("the Motion")
came on for hearing on Friday, January 25, 2002, at 9:30 a.m. For the
reasons stated below, Defendants' Motion is GRANTED and Plaintiffs'
Second Amended Complaint is DISMISSED, in part with leave to amend and in
part without leave to amend.
Plaintiffs bring this securities class action on behalf of public
investors who purchased securities from Ramp Networks, Inc. ("Ramp")
during the class period from November 15, 1999, through September 29,
2000. Second Amended Complaint ("SAC") at 1, 6 1. Plaintiffs allege that
Ramp "manipulated the Company's financial and accounting systems and
materially overstated Ramp's publicly-reported financial results
throughout the Class period." SAC at 1, 6 3. Plaintiffs are suing Ramp
and two individual defendants, Mahesh Veerina (CEO, President and
Chairman of the Board of Ramp throughout the class period) and Timothy
McElwee (Vice-President of Worldwide Sales for Ramp until March 31,
2000), for allegedly making false and misleading statements or omissions
in violation of § 10(b) of the Securities Exchange Act of 1934 ("1934
Act") and SEC Rule 10(b)(5). SAC at 53, 6 110. Plaintiffs also allege
claims under § 20(a) of the 1934 Act against Veerina and McElwee.
1. History and Performance of Ramp
Prior to its acquisition by Nokia Corporation, in January 2001, Ramp
was a Delaware corporation with its headquarters in Santa Clara,
California. SAC at 5, 66 13, 15. On June 22, 1999, Ramp completed an
Initial Public Offering ("IPO") of 3,853,000 shares. SAC at 10, 6 35.
Ramp is a provider of "shared Internet access solutions for the small
office market." SAC at 5, 6 14. Ramp has designed a line of products
called WebRamp. SAC at 11, 6 37. In 1999, Ramp began shifting from the
first generation of WebRamp products, using analog modems and ISDN
lines, to its second generation of WebRamp products, which focused on
broadband technologies such as DSL and cable modems. SAC at 11, 6 39. In
particular, Ramp began offering "broadband platforms that incorporated
security features designed to prevent unauthorized access to small office
networks using shared Internet connections." Id. As the demand for analog
products declined, investor reports issued by Kaufman Bros., L.P.
indicated that the investment community valued Ramp primarily for its
broadband and security business. Id.
On November 16, 1999, Ramp issued a press release stating that it had
conducted a survey that revealed that "DSL service is quickly emerging as
the broadband technology of choice for small businesses." November 16,
1999 Press Release, Exh. J to Defendant's Request For Judicial Notice;*fn1
See also SAC at 14, 6 44. According to the press release, these survey
results "confirm[ed] the overwhelming commitment from [Internet Service
Providers], carriers and [Value-Added Resellers] to bring DSL service to
their small business customers, and validate[d] Ramp's strategy to
provide the most scalable platform for software and corporate-class
services, independent of access method." Id.
On February 9, 2000, Ramp announced its fourth quarter and fiscal year
results for 1999 in another press release. February 9, 2000 Press
Release, Exh. J to Defendants' Request For Judicial Notice; see also SAC
at 15, 6 46. According to the press release,
Revenues for the fourth quarter of 1999 were $4.8
million, an increase of 62% over revenues of $3.0
million for the fourth quarter of 1998. For the year
ended December 31, 1999, Ramp reported revenues of
$18.2 million, an 85% increase over revenues of $9.9
million reported for the year ended December 31,
On March 30, 2000, Ramp filed with the SEC its annual report for the
year ended December 31, 1999, on Form 10-K. SAC at 14, 6 48; see also
1999 10-K, Exh. A to Request For Judicial Notice. Ramp stated that its
revenues increase 85% to $18.2 million for that year, from $9.9 million
in revenues in the previous year. Id. at 27. According to Ramp, the
"increase was primarily due to increased sales of the Company's WebRamp
200 and 300 series of analog products as well as sales of the new ISDN
WebRamp 410i product and the WebRamp 700 series for security." Id. Ramp
also stated that "revenue growth was reported in all geographic regions,
with particular strength in North America." Id.
On March 31, 2000, Ramp's Vice President of World Wide Sales, Timothy
J. McElwee, was fired after he was "nailed" for high product returns. SAC
at 28, 6 60(a). Sometime during the Class Period, McElwee sold 92,000
shares of Ramp common stock. SAC 7, 6 23 (alleging that "[d]uring the
Class Period, Defendant McElwee sold approximately 92,000 shares of Ramp
common stock at artificially inflated prices, while in possession of
undisclosed, materially adverse information about the Company").
On April 25, 2000, Ramp issued a press release reporting revenues for
the first quarter of 2000. April 25, 2000 Press Release, Exh. J to
Request For Judicial Notice; see also SAC at 20, 6 53. According to that
press release, "[r]evenues for the first quarter of 2000 were $5.6
million, an increase of 44% over revenues of $3.9 million for the first
quarter of 1999." Id. Veerina was quoted in the April 25, 2000 press
release as stating that "DSL orders and shipments drove our revenue
growth this quarter. . . . Orders for our broadband solutions exceeded
our expectations and we are increasing production to meet the demand."
Ramp's apparent success with its broadband products was reflected in an
analyst report by Dain Rauscher Wessels issued May 31, 2000. Exh. K to
Request for Judicial Notice; see also SAC at 35, 6 70. The report
We caught up with Ramp's management to discuss the
status of the company's June quarter along with some
of the recently announced product and sales
initiatives. We believe the quarter is tracking ahead
of expectations and we remain very comfortable with
our June quarter and fiscal 2000 estimates. . . . We
remain optimistic with respect to the opportunities
available to Ramp and believe that the company is
executing on its plan of becoming a significant
provider of value-added DSL CPE equipment.
On July 25, 2000, Ramp announced that its was postponing release of its
earnings for second quarter 2000, originally scheduled for July 25, by
one day. July 25, 2000 Press Release, Exh. J to Defendant's Request For
Judicial Notice; see also SAC at 35, 6 71. The next day, Ramp released
second quarter 2000 earnings in a press release which stated as follows:
July 26, 2000 Press Release, Exh. J to Defendants' Request For Judicial
A Dain Rauscher Wessels report issued on July 27, 2000, expressed
disappointment with Ramp's second quarter 2000 performance:
Ramp Networks released disappointing 2Q00 results
yesterday as analog product sales declined much faster
than expected. Revenues were $5.77 million, up 3.3%
sequentially from $5.58 million in the prior quarter
but $1.2 million shy of our $6.98 million estimate.
The shortfall was entirely in analog product sales,
which came in at $1.96 million, down 36% sequentially
and $1.18 million short of our $3.14 million
estimate. Broadband and security product sales were
strong, up 51.4% sequentially and in line with our
Balance Sheet: This quarter, the balance sheet has
become a major issue for Ramp. The company shipped
$8.3 million worth of product in the quarter, but only
recognized $5.77 million as sell through of analog
products slowed to a trickle. Much of the balance,
$1.35 million was booked as deferred revenue. This,
combined with a few slow-paying customers and a
back-end weighted manufacturing ramp for broadband
products, led to an increase in DSO to 141 days from
98 days. Inventory turns fell to 3.9x from 4.5x as the
company stocked components to alleviate component
shortages. Cash fell to $21.6 million from $32.7
July 27, 2000 Dain Rauscher Wessels Report, Exh. K to Defendants' Request
For Judicial Notice; see also SAC at 13, 6 43.
Another analyst report, prepared by Chase H & Q, came to similar
We are downgrading Ramp to Market Perform from BUY.
Ramp announced a Q2 00 shortfall of ($0.33)/share on
$5.8 million in revenue to our estimate of
($0.25)/share on $7M in revenue; . . . The shortfall
resulted from declines in sales of analog products by
resellers as well as longer- [than]- expected sales
cycles with large enterprise and carrier accounts.
Despite the revenue shortfall, the company actually
shipped slightly more than $7 million in product.
However, a large portion of the product shipped to
resellers did not sell out of the channel and
therefore the company did not recognize the revenue.
In addition to deferring sales, the company wrote off
about $900K for bad debt expenses, for uncollectible
accounts receivable that were more than 90 days old.
We are lowering our rating on Ramp to reflect a severe
deterioration in fundamentals.
July 27, 2000 Chase H & Q Report, Exh. L to Defendants' Request For
On August 14, 2000, Ramp filed its quarterly report on Form 10-Q for
the second quarter of 2000. SAC at 35, 6 72; see also Exh. E to Request
For Judicial Notice. In that report, Ramp stated that:
Revenue increased 27% to $5.8 million in the three
months ended June 30, 2000 from $4.5 million in the
three months ended June 30, 1999. The increase was
primarily due to continued growth in the WebRamp 700
series of security products and growth in our
Broadband products dominated by the Company's line of
SDSL and ADSL products servicing the "broadband"
Id. Ramp reported that 35% of its revenues in the second quarter were
derived from sales to a Chinese company, Xiao Tong Electronics Company.
On September 29, 2000, Ramp issued a press release announcing that it
expected revenues and earnings for the third quarter 2000, ending
September 30, to be "significantly lower" than the revenue and earnings
recorded in the prior quarter, ending June 30, 2000. September 29, 2000
Press Release, Exh. J to Defendants' Request For Judicial Notice; see
also SAC at 46, 6 86. Specifically, the press release stated that Ramp
expected that third quarter revenues would not exceed $1 million. Id. The
press release also stated that Ramp planned to restructure its
operations. Id. Apparently in response to the announcement, Ramp's stock
price fell again, from $3.5312/share at the close of trading on Friday,
September 29, 2000 to $2.375/share at the open of trading on Monday,
October 2, 2000. SAC at 46, 6 89.
2. Ramp's Revenue Recognition Policy
On November 14, 2000, Ramp filed its quarterly report for the third
quarter ending September 30, 2000. November 14, 2000 Quarterly Report,
Form 10 Q, Exh. F to Defendants' Request For Judicial Notice; see also
SAC at 49, 66 97-98. In that report, Ramp explained that it had decided
to abandon its previous accounting practice of recognizing revenue at the
time products were shipped in favor of a policy under which revenue would
not be recognized until it was "sold through" to customers. Id. at 7. The
report explained the change in accounting practices as follows:
Historically, revenue has been recognized by the
Company upon transfer of title and risks of
ownership, which generally occurred upon product
shipment. Certain agreements with distributors and
retailers provide for rights of return, co-op
advertising, price protection and stock rotation
rights. Under the guidelines and requirements of
Statement of Financial Accounting Standards ("SFAS")
48, "Revenue Recognition When Right of Return Exists,"
the Company concluded that it had sufficient history
and experience to quantify reserves required for these
provisions. Accordingly, Ramp provided an allowance
for returns and price adjustments and provided a
warranty reserve at the point of revenue recognition.
These reserves had been adjusted periodically based
upon historical experience and anticipated future
returns, price adjustments, and warranty costs.
In the first quarter of 2000, the Company launched a
new sales and marketing campaign that involved sales
of new technology and products to both existing and a
variety of new types of customers, including new
customers serving the relatively new Digital
Subscriber Loop (DSL) market. The DSL market
experienced significant fluctuations in supply and
demand in 2000. As a result, current customers and
potential customers experienced delays in the
provisioning of this marketplace which delayed demand
for the Company's products. During 2000 the Company
has experienced changing business conditions and
demand for product from its distributors.
Specifically, the Company experienced lower demand for
both new and existing products and a trend of
increasing past due accounts receivable from its
current distributors as well as from some of the
company's new customers. The Company has now decided
that this increase in past due accounts receivable
from distributors was a result of the distributors not
paying the company until product was ultimately "sold
through" to the customers. Additionally, certain new
customers returned a significant portion of previously
sold product in amounts greater than had been
estimated by the Company . . . .
The Company determined that given the current market,
a more preferable method of revenue recognition would
be to defer the recognition of revenue. Under this new
method, the Company will now record revenue on product
shipped to distributors when the product is ultimately
"sold through" to the customer. Additionally, the
Company will now defer revenues for all other
customers where collection and returns history is not
proven until such activity reflects the "sell through"
of products by Value-Added Resellers ("VAR") and
Managed Service Providers ("MSP").
Applying the new accounting practice, Ramp reported revenues of $3
million for the third quarter of 2000 ending September 30. Id. at 4.
Although these revenues reflected a 41% decrease as compared to the same
quarter for the previous year, they were substantially higher than
predicted in Ramp's September 29, 2000 Press Release. SAC at 50, 6 99. The
September 29 press release reported that Ramp expected its third quarter
earnings to be "no higher than $1 million." September 29, 2000 Press
Release, Exh. J to Defendants' Request For Judicial Notice.
On November 14, 2000, Ramp also filed amended quarterly reports for the
first and second quarters of 2000 restating revenues under the new
accounting policy, which Ramp applied retroactively beginning January 1,
2000. Exh. G (First Quarter 2000) and H (Second Quarter 2000) to Request
For Judicial Notice; see also SAC at 31, 6 64 (amended report for first
quarter 2000) and 41, 6 78 (amended report for second quarter 2000). The
Amended Quarterly Report for the first quarter of 2000 reflected that
revenues declined by 9% relative to the same quarter in 1999 to $3.5
million (rather than increasing by 44% to $5.6 million, as previously
reported). November 14, 2000 10-Q/A Form, Amended Quarterly Report at 5,
Exh. G to Defendants' Request For Judicial Notice. For the second quarter
of 2000, Ramp reported restated revenues of $5 million - an increase of
9.8% over the previous year - rather than the 27% increase to $5.8
million that was previously reported. Amended Quarterly Report, Form
10-Q/A at 5, Exh. G to Defendants' Request For Judicial Notice.
This class action lawsuit originated as three lawsuits filed between
October 3, 2000, and October 23, 2000, which were consolidated on January
9, 2001. See Order Consolidating Related Actions Against Ramp Networks,
Inc. and Mahesh Veerina, filed January 9, 2001. Following consolidation,
Plaintiffs filed their Consolidated Amended Complaint For Violation Of
Federal Securities Law ("CAC"). Defendants brought a Motion To Dismiss,
and on June 22, 2001, the Court granted Defendants' Motion to Dismiss
with leave to amend. Plaintiffs filed a Second Amended Complaint on
August 6, 2001. The sufficiency of the allegations in the Second Amended
Complaint is the subject of this Motion.
In the section of their SAC entitled "Summary of Action," Plaintiffs
allege that Defendants "manipulated the Company's financial and
accounting systems and materially overstated Ramp's publicly-reported
financial results throughout the Class Period." SAC at 1, 6 3. Plaintiffs
allege that Defendants' "revenue figures for the first and second
quarters of 2000 unreasonably failed to take into account expected
returns of product" because:
1) Ramp "dumped [products] on distributors who were
paid to accept and store Company merchandise for
revenue recognition purposes and then instructed to
remove the shrink wrap from Ramp products (to convey
the false impression that products had been `sold
through' or used) before returning them to the Company
as defective." SAC at 2, 6 4(a).
2) Defendants "shipped [products] to other companies
for revenue recognition purposes near the end of
quarterly or monthly reporting periods with the
understanding that the `buyers' would simply store the
merchandise at Ramp's expense before returning the
merchandise for full credit after the close of the
Company's reporting period." SAC at 2, 6 4(b).
3) Defendants "temporarily removed [products] from
Ramp's DisCopy Labs ("DCL") warehouse facility in
Fremont, California by `sweeper' trucks which arrived
on the last day of each quarter to move product off
the loading docks in order to book the `sales' of
these products as revenue for the quarter. SAC at 2, 6
Plaintiffs further allege that Defendants violated SFAS No. 48 by
booking sales as revenue before the product's price was fixed or
determinable. SAC at 4, 6 5. In particular, Plaintiffs alleged that
Ramp: 1) shipped product on the "slightest of verbal commitments;" 2)
shipped product "before a prospective buyer had tested Company equipment
or agreed to price and payment terms;" and 3) sent products to local
distributors, who were paid by Ramp to store the product pending
execution of the deal; these products were treated as returns if no deal
was executed. SAC at 3, 6 5.
Plaintiffs allege that Defendants also violated SFAS No. 48 by booking
sales that were, in fact, contingent sales as revenue. SAC at 3, 6 6.
Plaintiffs allege that such sales were made to distributors that included
Ingram Micro, Tech Data, Merisel, Merit, Multiple Zones, Inc., and
Synnex. Id. According to Plaintiffs, these distributors were not required
to pay Ramp for product until sold through to resellers or ultimate
Finally, Plaintiffs allege that Ramp violated SFAS No. 48 by making
sales to distributors that entailed "significant obligations to assist in
product resale." SAC at 3, 6 7. Plaintiffs allege that one such deal, for
between $900,000.00 and $1,000,000.00 in product, was made with
Telsource. Id. When resale efforts were unsuccessful, the product was
returned and Ramp's Vice President of Sales, Gary Metalonis, was fired.
According to Plaintiffs, Defendants were aware of these fraudulent
practices yet nonetheless deliberately "portrayed Ramp as a booming
company which was experiencing and would continue to experience rapidly
rising product sales." SAC at 3, 6 8. On the basis of these allegations,
Plaintiffs bring claims under §§ 10(b) and 20(a) of the 1934 Act.
C. Defendants' Motion To Dismiss
In their Opposition, Plaintiffs argue that they have alleged sufficient
specific facts to show scienter on the part of all Defendants and to meet
the pleading requirements for securities fraud claims. Specifically,
Plaintiffs argue that: 1) Ramp's third quarter restatement of revenues
constituted an admission that it made false and misleading statements
concerning both the magnitude of its revenues in the first and second
quarters of 2000 and its adherence to the requirements of SFAS No. 48; 2)
Ramp's allegations concerning specific improperly booked transactions
satisfy the pleading requirements of Rule 9(b) and the PSLRA; 3)
Plaintiffs have alleged specific facts establishing multiple violations
of SFAS No. 48, which in turn, gives rise to an inference of scienter;
and 4) Plaintiffs have alleged additional facts, beyond the Generally
Accepted Accounting Principles ("GAAP") violations, indicating the
existence of deliberate recklessness. Plaintiffs further argue that
Defendants' statements were neither "forward-looking" nor "puffery" and
therefore are not protected. In addition, Plaintiffs assert that they
have sufficiently alleged loss causation. Finally, they assert that they
have alleged sufficient facts to establish "control person" liability
under § 20(a).
A. Pleading Standards For Section 10(b) and 20(a) Claims
Section 10(b) of the 1934 Act provides that:
[i]t shall be unlawful for any person, directly or
indirectly, by the use of any means or instrumentality
of interstate commerce or of the mail, or of any
facility of any national security exchange . . . 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 in
contrivance or contravention of such rules and
regulations as the ...