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IN RE FOUNDRY NETWORKS

August 29, 2003

IN RE FOUNDRY NETWORKS, INC. SECURITIES LITIGATION, THIS DOCUMENT RELATES TO: ALL ACTIONS


The opinion of the court was delivered by: Maxine Chesney, District Judge

ORDER GRANTING DEFENDANTS' MOTION TO DISMISS PLAINTIFFS' FIFTH AMENDED COMPLAINT
Before the Court is defendants' motion to dismiss plaintiffs' Fourth Amended Complaint*fn1 pursuant to Rules 9(b) and 12(b)(6) of the Federal Rules of Civil Procedure, and the Private Securities Litigation Reform Act of 1995 ("PSLRA"), filed April 7, 2003.*fn2 The matter came on regularly for hearing on June 13, 2003. John K. Grant and Shirley H. Huang of Milberg Weiss Bershad Hynes & Lerach LLP appeared on behalf of plaintiffs. Shirli Fabbri Weiss and Roy K. McDonald of Gray Gary Ware & Freidenrich LLP appeared on behalf of defendants. Having considered the papers submitted in support of and in opposition to the motion, and the arguments of counsel, the Court hereby rules as follows. Page 2

BACKGROUND

The underlying facts are discussed in the Court's prior orders filed June 6, 2002 and February 14, 2003, and are incorporated herein by reference.

In its February 14, 2003 order, the Court granted, with leave to amend, defendants' motion to dismiss plaintiffs Third Amended Complaint ("TAC"), in which plaintiffs asserted a claim under § 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. § 78j(b), and Rule 10b-5 of the Securities and Exchange Commission ("SEC"), 17 C.F.R. § 240.10b-5, as well as a claim based on control person liability under § 20(a) of the Exchange Act, 15 U.S.C. § 78t(a). The Court found that plaintiffs had failed to adequately plead that any of the six sets of statements in question were false or misleading, and that plaintiffs had failed to plead facts sufficient to raise a strong inference of scienter. On March 17, 2003, plaintiffs filed their Fourth Amended Complaint which asserts, as did the TAC, a claim under § 10(b) of the Exchange Act and Rule 10b-5 of the SEC, and under § 20(a) of the Exchange Act, in addition to a new claim for insider trading under § 20A of the Exchange Act, 15 U.S.C. § 78t-1. On April 7, 2003, defendants filed the instant motion.

On June 13, 2003, the Court conducted a hearing on defendants' motion to dismiss plaintiffs Fourth Amended Complaint, upon conclusion of which the Court deemed the matter submitted. On June 19, 2003, plaintiff filed a motion, by which plaintiff sought an order from the Court allowing briefing on plaintiffs request to file a Fifth Amended. Complaint The Fifth Amended Complaint is essentially identical to the Fourth Amended Complaint with the single exception that it includes one additional paragraph for purposes of alleging an additional false statement. On July 1, 2003, the Court granted plaintiffs' request, and on July 15, 2003 plaintiffs filed a Motion to Supplement Complaint and Further Opposition to Defendants' Motion to Dismiss, to which defendants, on July 29, 2003, filed opposition. Both the Motion to Supplement and the opposition thereto address at length the additional allegations set forth in the Fifth Amended Complaint and the sufficiency thereof to support a claim under § 10(b). By separate order filed concurrently herewith, the Court has granted plaintiffs' Motion to Supplement, by which plaintiffs are Page 3 afforded leave to file their Fifth Amended Complaint. Because the parties have been afforded arrive opportunity to address the additional allegations contained therein, the Court will consider the Motion to Dismiss, as supplemented by the briefing on the Motion to Supplement, as if the Motion to Dismiss had been directed in the first instance to the Fifth Amended Complaint (hereafter "FAC").

LEGAL STANDARD

A. Rule 12(b)(6)

Under Rule 12(b)(6), a complaint should not be dismissed unless a plaintiff can prove "no set of facts in support of his claim that would entitle him to relief." See Parks Sch. of Bus., Inc. v. Symington, 51 F.3d 1480, 1484 (9th Cir. 1995). In ruling on a motion to dismiss, the court must accept a plaintiffs factual allegations as true and construe them in the light most favorable to plaintiff. See Gompper v. VISX, Inc., 298 F.3d 893, 895 (9th Cir. 2002). "[C]onclusory allegations of law and unwarranted inferences are insufficient to defeat a motion to dismiss for failure to state a claim." Epstein v. Washington Energy Co., 83 F.3d 1136, 1139 (9th Cir. 1996).

B. Section 10(b) and the PSLRA

Section 10(b) of the Exchange Act states that "[i]t shall be unlawful for any person . . . [t]o use or employ, in connection with the purchase or sale of any security . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe." See 15 U.S.C. § 78j(b). A plaintiff bringing a claim for securities fraud must show: (1) a false and misleading statement or omission of material fact; (2) scienter; (3) reliance; and (4) damages. See Paracor Fin., Inc. v. General Electric Capital Corp., 96 F.3d 1151, 1157 (9th Cir. 1996).

A plaintiff alleging a cause of action for securities fraud is subject to "heightened pleading" standards as set forth in the PSLRA. See In re Silicon Graphics Inc. Sec. Litig., 183 F.3d 970, 974 (9th Cir. 1999). Under the PSLRA, a plaintiff in a private securities fraud action alleging material misstatements or omissions must "specify each statement alleged to have been misleading; the reason or reasons why the statement is misleading: Page 4 and if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed." See 15 U.S.C. § 78u-4(b)(1).

The PSLRA also provides that "the complaint shall, with respect to each such act or omission alleged to violate this chapter [the Securities Exchange Act of 1934], state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." See 15 U.S.C. § 78u-4(b)(2). In this circuit, as a general matter, the required state of mind is "deliberate or conscious recklessness." See No. 84 Employer-Teamster Joint Council Pension Trust Fund v. America West Holding Corp., 320 F.3d 920, 931 (9th Cir. 2003) (quoting Silicon Graphics, 183 F.3d at 979.) If the challenged. statement is forward-looking, however, the requisite state of mind is "actual knowledge." See Id. (quoting 15 U.S.C. § 78u-5(c)(1)). In determining whether plaintiffs' allegations are sufficient to raise a strong inference of scienter, a court must consider (1) "the total of plaintiffs' allegations," even though some allegations may be individually lacking, and (2) "all reasonable inferences capable of being drawn from the allegations, including inferences unfavorable to the plaintiffs." See America West, 320 F.3d 920, 938 (9th Cir. 2003) (internal quotations and citations omitted.)

Because "falsity and scienter in private securities fraud cases are generally strongly inferred from the same set of facts," the Ninth Circuit has incorporated the falsity and scienter requirements "into a single inquiry." See Ronconi v. Larkin 253 F.3d 423, 429 (9th Cir. 2001); see also America West, 320 F.3d at 932 (noting courts "generally examines the falsity and scienter requirements at the same time.") In conducting this inquiry, a court is to determine whether "particular facts in the complaint, taken as a whole, raise a strong inference that defendants intentionally or with deliberate recklessness made false or misleading statements to investors." See Ronconi v. Larkin, 253 F.3d at 429.

DISCUSSION

The Court first examines plaintiffs' revised allegations as to statements previously alleged to be false or misleading. The Court next addresses the allegedly false statement Page 5 set forth in the first instance in plaintiffs' FAC. Lastly, the Court addresses plaintiffs' new § 20A claim for insider trading.

A. Section 10(b) Claim: Statements Previously Alleged

Defendants argue that the FAC does not cure the deficiencies detailed in the Court's prior order dismissing the TAC. Specifically, defendants contend that with respect to plaintiffs' claim for securities fraud, (1) plaintiffs have failed to adequately plead that the statements were false or misleading, (2) plaintiffs have failed to plead sufficient facts to give rise to a strong inference that defendants acted with the requisite scienter, and (3) the forward-looking statements on which plaintiffs rely are not actionable under the PSLRA's "Safe Harbor" provisions.

As noted, the Court found that plaintiffs' TAC failed to adequately plead facts sufficient to show that any of the six sets of statements upon which plaintiffs relied were false or misleading. In their opposition to defendants' motion to dismiss, plaintiffs state that they "have amended their Complaint with respect to statements made in (1) defendants' October 17, 2000 conference call and (2) an October 24, 2000 interview of [defendant and Foundry CEO] Bobby Johnson published on November 13, 2000 in The Wall Street Transcript," but that they "have not materially amended their Complaint with respect to the September 6, 2000 statements, the September 7, 2000 conference call, the October 17, 2000 press release or the November 14, 2000 Form 10-Q filing." (See Opp. at 1:18-22, n. 3.) Although plaintiffs "incorporate their prior arguments by reference" with respect to such latter statements, plaintiffs "do not ask the Court to reconsider the prior ruling on these statements." (See Id.)

Accordingly, the Court examines herein plaintiffs' allegations only as to the statements made in the October 17, 2000 conference call and the October 24, 2000 interview.*fn3 Plaintiffs' opposition addresses four such statements: (1) the October 17, 2000 Page 6 statement that Foundry was "comfortable with a full year 2000 revenue target of approximately $400 million,"*fn4 (2) the October 24, 2000 statement that Foundry was seeing "good overall demand"; (3) the October 24, 2000 statement that Foundry's "biggest challenge [was] to . . . continue to meet demand"; and (4) the October 24, 2000 statement that Foundry "plan[ned] to continually increase quarterly profits each and every quarter." (See Opp. at 2; FAC ¶¶ 36, 42.)*fn5

As plaintiffs concede, defendants' October 17, 2002 revenue forecast and October 24, 2000 profit forecast are forward-looking statements. See America West, 320 F.3d at 936 ("A `forward-looking statement' is any statement regarding (1) financial projections, (2) plans and objectives of management for future operations, (3) future economic performance, or (4) the assumptions `underlying or related to' any of these issues.") Accordingly, to adequately allege scienter with respect to such statements, plaintiffs must plead with particularity facts giving rise to a strong inference that the defendant acted with actual knowledge that the statements were false or misleading. The two remaining statements, that Foundry was seeing "good overall demand" and that Foundry's "biggest challenge [was] to continue to meet demand," concern then existing conditions and, consequently, are not forward-looking. See id. at 937 (finding the statements "the settlement agreement's provisions will not have a material adverse effect on the Company's operations" and "we are not anticipating any major increase in Page 7 maintenance costs or the costs of oversights going forward" were not forward-looking because each was "a description of the present effects" of a settlement agreement) Accordingly, the requisite state of mind as to these statements is deliberate or conscious recklessness.

As in the TAC, plaintiffs allege that the above statements were false or misleading for six reasons. First, plaintiffs allege that despite Foundry's favorable third quarter results, defendants knew, based on several internal documents and discussions, that demand for their products was decreasing as a result of weak sales and demand in July 2000. (See FAC ¶¶ 41, 43.) Second, plaintiffs allege that Foundry had "significantly increas[ed] the number of contingency sales deals it made with its customers" in order to offset the slowing demand for Foundry's products. (See FAC ¶¶ 41, 43.) Third, plaintiffs allege that Foundry "concealed the fact that the third quarter results had only been achieved by making early shipment of product that had been ordered for shipment later in the fourth quarter," thus decreasing fourth quarter sales. (See FAC ¶¶ 41, 43.) Fourth, plaintiffs allege that defendants knew that fourth quarter demand had been reduced based on internal shipment and forecast reports that revealed that Foundry was "forecasting and shipping approximately 25% below prior projections and that sales revenue had dropped approximately 20%." (See FAC ¶¶ 41, 43.) Fifth, plaintiffs allege that according to a "senior networking executive" for one of Foundry's competitors, "demand was declining in October of 2000 and [there was] a substantial lack of new orders at that time, particularly in the ISP business area where his company had a significant overlap with Foundry in the same projects." (See FAC ¶ 28.) Sixth, plaintiffs allege that defendants knew of the weakening demand in the fourth quarter because Foundry sales personnel had indicated they would not be able to meet their sales quotas in the fourth quarter and thereafter requested lower quotas. (See FAC ¶¶ 27(d), 29.)

In its February 14, 2003 order, the Court found that each of these allegations was deficient. For the reasons discussed in the court's prior orders dated June 6, 2002 and February 14, 2003, and for the reasons discussed below, although plaintiffs have Page 8 bolstered several of these allegations with new facts, the allegations remain insufficient under the PSLRA to show that defendants actually knew the statements in question were false or misleading when made, or were deliberately reckless in making such statements.

1. Weak Demand

The FAC again alleges, as in the TAC, that the statements in question were false or misleading when made because defendants knew, by July 2000, that demand for Foundry's products was weakening. Specifically, plaintiffs allege, as in the TAC, that (1) during a semi-annual National Sales Conference in July 2000, Johnson and Robert W. Shackleton, Foundry Vice President — North American Sales, "indicated that Foundry expected slowing sales trends and softening demand" (see FAC ¶ 25(a)); (2) Johnson circulated a company-wide e-mail "on or about July 20, 2000," discussing "poor month-to-date sales results" (see FAC ¶ 25(b)); (3) Foundry's "internal actual-to-plan July 2000 reports revealed that Foundry was failing to make its internal July sales plan . . . and was suffering a 30% miss for that month" (see id.); and (4) Johnson, in late September 2000, circulated a memorandum that "discussed the slowing sales to ISPs."*fn6 (See FAC ¶ 26.)

As noted in the Court's prior orders, even assuming plaintiffs' allegations are sufficient to demonstrate that Foundry in fact experienced disappointing sales in July 2000, such allegations, in light of the record third quarter revenues experienced by

Foundry as of the end of September 2000,*fn7 are insufficient to demonstrate that the statements made by defendants were false or misleading when made* on October 17, 2000 and October 24, 2000. Plaintiffs offer no additional facts, but argue that the statements at the July conference demonstrate defendants knew at that time that demand for Foundry's products was weak and would continue to weaken. (See Opp. at 14.) The fact that Foundry executives remarked at a sales meeting in July 2000 that they Page 9 anticipated "slowing sales trends and softening demand," however, fails to raise an inference that defendants' revenue and profit forecast statements, or statements respecting demand, were false or misleading when made several months later in October 2000. No facts are alleged indicating either the time period to which the statement "slowing sales trends and softening demand" refers, or the effect of any such "slowing" or "softening." Indeed, Foundry had been experiencing strong growth, in each quarter, from Foundry's first quarter 1998 and it continued to do so through the third quarter 2000.*fn8 Plaintiffs' allegations as to the September 2000 memorandum do not assist in clarifying the above-noted ambiguities as plaintiffs' description of that memorandum is itself ambiguous, providing no facts as to the period, extent or effect of the slowing sales "discussed" therein. Without such additional facts, and in light of Foundry's record third quarter revenues in September 2000, plaintiffs' allegations remain insufficient to demonstrate either that the statements were false or to raise the requisite strong inference of scienter.

2. Contingency Sales

In its prior orders, the Court found insufficient plaintiffs' allegations as to contingency sales because plaintiffs had failed to allege: (1) any facts demonstrating that Foundry increased the number of contingency sales in response to decreasing demand, (2) the number of contingency sales actually made and the significance of these sales to Foundry's total business revenues, (3) facts indicating whether Foundry ever recognized any of these contingent sales as revenue, let alone in violation of generally accepted accounting principles ("GAAP"), and (4) whether any such contingency sales resulted in product returns caused by a customer's inability to pay. Plaintiffs were notified that, in order to satisfy the particularity requirement of the PSLRA, additional information was needed, such as the number of contingency sales actually made, to whom they were Page 10 made, the risks associated with such sales and the significance of these sales to Foundry's total business revenues.

As plaintiffs' FAC adds no new facts respecting contingency sales, the above-referenced deficiencies remain. Indeed, plaintiffs now state, for purposes of the instant motion, they are not asserting the contingency sales violated GAAP. Although plaintiffs argue that Foundry approximately doubled its contingency sales "in reaction to the weakened demand for Foundry's products," (see Opp. at 16), plaintiffs fail to offer any facts to show such connection, nor do plaintiffs allege any facts to show whether, and to what extent, an increase in contingency sales would affect Foundry's reported fourth quarter revenues. Barring any such facts, plaintiffs' conclusory assertion that an increase in contingency sales resulted from weakened demand fails to provide any support for plaintiffs' allegation that the statements in question were false or misleading, or that defendants acted with the requisite ...


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