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OSHER v. JNI CORPORATION

March 10, 2004.

DAVID OSHER, on behalf of himself and all others similarly situated, Plaintiffs,
v.
JNI CORPORATION, et al., Defendants



The opinion of the court was delivered by: NAPOLEON JONES, District Judge

ORDER: (1) DENYING DEFENDANTS' REQUEST FOR JUDICIAL NOTICE [Doc. No. 126]
(2) GRANTING MOTION TO DISMISS THIRD AMENDED CONSOLIDATED COMPLAINT [Doc. No. 124]
By order dated August 25, 2003, the Court dismissed Plaintiffs' Second Amended Consolidated Complaint ("SACC") without prejudice and with leave to amend. On October 31, 2003, Plaintiffs filed their Third Amended Consolidated Complaint ("TACC"). Defendants have now moved to dismiss the TACC. (Doc. No. 124.) The Court finds this matter suitable for decision on the papers and without oral argument pursuant to Civil Local Rule 7.2(d)(1).

Background

 I. Factual History

  Plaintiffs represent a class of all purchasers of common stock of JNI Corporation ("JNI") between July 13, 2000, and March 28, 2001 (the "class period"). (TACC ¶ 1.) Plaintiffs allege that JNI's officers and directors conspired to artificially inflate the price of JNI stock during the class period so they could sell their personal holdings of JNI stock at inflated prices. (Id. ¶ 3.) Page 2 JNI designs and supplies Fibre Channel hardware and software products that connect computer servers and data storage devices to form storage area networks ("SANs"). (Id. ¶ 2.) Fibre Channel technology improves data communication speeds, connectivity, distance between connections, reliability and accessibility. (Id.) JNI markets a broad range of Fibre Channel host bus adapters and software products that facilitate advanced SANs device integration and management. (Id.)

  JNI's initial public offering ("IPO") occurred in October 1999, at which time its stock was priced at approximately $25 per share. (Id. ¶ 4.) Following the IPO, a parent company named Jaymark, Inc. held sixty percent of JNI's stock. (Id.) By the summer of 2000, JNI's stock was trading for about $25 per share, down from a prior range of $80-$100 per share. (Id.) Around this time, Plaintiffs allege that Defendants "devised a scheme to artificially inflate JNI's stock price and distribute their shares in an October 19, 2000, Secondary Offering." (Id.) In July 2000, Jaymark reorganized and distributed all its JNI stock to its shareholders, including Defendants Eric P. Wenaas, Terry M. Flanagan, Thomas K. Gregory, Charles McKnett, and John Stiska. (Id.) Pursuant to lock-up agreements, Defendants were limited in the amount of JNI stock they could sell through the Secondary Offering. (Id.) In the weeks prior to Jaymark's reorganization, Plaintiffs claim Defendants made false and misleading statements in the form of press releases and statements to analysts. (Id. ¶¶ 55-60.)

  On October 25, 2000, JNI completed its Secondary Offering at the price of $74 per share. (Id. ¶ 78.) The Secondary Offering provided net proceeds of $69 million to JNI and $245 million to Jaymark's shareholders, including $32 million to the individual defendants. (Id. ¶ 5.) Around the time of the Secondary Offering, Plaintiffs claim Defendants made a number of false and misleading statements designed to inflate the price of JNI stock. (Id. ¶¶ 73-79.) These statements were made (1) during a roadshow in October 2000, prior to the offering, (2) in a press release issued October 16, 2000, in which Defendants announced JNI's results for third quarter 2000, (3) during a conference call with analysts and investors on October 16, 2000, and (4) in JNI's prospectus dated October 19, 2000, issued in connection with the Secondary Offering. (Id. ¶¶ 73, 74, 76, 78.) As a result of Defendants' allegedly false and misleading statements, a Page 3 number of analysts issued extremely favorable reports about JNI and raised their earning estimates for JNI for the upcoming quarter and fiscal year. (Id. ¶¶ 94, 95.) JNI's stock price peaked at $126 per share on November 6, 2000. (Id. ¶ 98.)

  After the Secondary Offering and throughout the remainder of the class period, Plaintiffs claim Defendants continued to make false and misleading statements about JNI's performance and prospects. In November 2000, after unfavorable reports about JNI appeared in the media and JNI's stock's dropped to $63 per share, JNI made statements in a press release and during a conference call that Plaintiffs claim were false or misleading. (Id. ¶¶ 13, 107.) On December 11, 2000, JNI announced a lower-than-expected range of growth for fourth quarter 2000, causing JNI's stock to drop to $34-3/4 per share. (Id. ¶¶ 117-18.) Plaintiffs claim this announcement was misleading because JNI failed to disclose that results for fiscal year 2001 would also be "significantly lower" than estimates. (Id. ¶ 123.) On January 24, 2001, JNI reported its fourth quarter 2000 revenues and lowered its projections for fiscal year 2001, causing JNI's stock price to drop further to $20.06 per share. (Id. ¶ 16.) Plaintiffs claim this announcement was misleading because Defendants projected a strong second half for fiscal year 2001 and allegedly used accounting manipulations to inflate the reported results. (Id.) Finally, on March 28, 2001, JNI revised its forecast for first quarter 2001 downward and announced that revenues and earnings per share for fiscal year 2001 would be lower than projected. (Id. ¶ 17.) Following this announcement, JNI's stock dropped to $7-3/8 per share, and was trading at less than $7 per share at the time the TACC was filed. (Id.)

 II. Procedural History

  In April 2001, six securities fraud actions were filed in this district against JNI and its officers and directors. The Court subsequently consolidated the six related actions, appointed lead plaintiffs, and ordered lead plaintiffs to file an amended consolidated complaint. (Order Clarifying Order Granting Motions to Consolidate (February 21, 2002).)

  On March 25, 2002, Plaintiffs filed their First Amended Consolidated Complaint ("FACC"), naming as defendants JNI, former President and Chief Executive Officer Terry Flanagan, Chief Financial Officer Gloria Purdy, Chief Operating Officer Thomas Gregory, Chief Page 4 Technology Officer Charles McKnett, JNI Chairman and Jaymark CEO Eric Wenaas, and JNI director John Stiska. (FACC ¶ 22-23.) The FACC alleged five claims for relief: (1) violation of Section 10(b) of the Securities Exchange Act of 1934 ("1934 Act") and Rule 10b-5 against all Defendants, (2) violation of Section 20(a) of the 1934 Act against Flanagan, Purdy and Wenaas, (3) violation of Section 11 of the Securities Act of 1933 ("1933 Act") against JNI, Flanagan, Purdy, Wenaas, and Stiska, (4) violation of Section 12(a)(2) of the 1933 Act against all Defendants, and (5) violation of Section 15 of the 1933 Act against Wenaas, Flanagan and Purdy. Defendants moved to dismiss the FACC. By order dated March 26, 2003, the Court granted Defendants' motion to dismiss without prejudice and set forth specific pleading deficiencies for Plaintiffs to correct in an amended complaint. (Order Granting Motion to Dismiss (March 26, 2003) at 26-27 ("Order I").) On May 27, 2003, Plaintiffs filed a SACC, naming the same defendants and alleging the same five claims. Defendants again filed a motion to dismiss. On August 25, 2003, the Court granted Defendants' motion to dismiss the SACC without prejudice. (Ordering Granting Motion to Dismiss (Aug. 25, 2003) at 26-27 ("Order II").) Plaintiffs were advised that they would be given one additional opportunity to amend their complaint, after which no further amendments would be permitted. (Id.)

  On October 31, 2003, Plaintiffs filed a TACC. In this Complaint, Plaintiffs make allegations against the same six Defendants named in the previous two complaints. However, the Complaint alleges only two claims for relief, in contrast to the original five, (1) violation of Section 10(b) of the Securities Exchange Act of 1934 ("1934 Act") and Rule 10b-5 against all Defendants and (2) violation of Section 20(a) of the 1934 Act against Flanagan, Purdy, and Wenaas.*fn1 (TACC ¶ 20.) On December 12, 2003, Defendants moved to dismiss the TACC. Page 5

  Legal Standard

  A motion to dismiss under Federal Rule of Civil Procedure 12(b)(6) tests the sufficiency of the complaint. Navarro v. Block, 250 F.3d 729, 732 (9th Cir. 2001). Dismissal of a claim under this Rule is appropriate "only if `it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief.'" Navarro, 250 F.3d at 732 (quoting Conley v. Gibson, 355 U.S. 41, 45-46 (1957)). Dismissal is warranted under Rule 12(b)(6) where the complaint lacks a cognizable legal theory. Robertson v. Dean Witter Reynolds, Inc., 749 F.2d 530, 534 (9th Cir. 1984); Neitzke v. Williams, 490 U.S. 319, 326 (1989) ("Rule 12(b)(6) authorizes a court to dismiss a claim on the basis of a dispositive issue of law"). Alternatively, a complaint may be dismissed when it presents a cognizable legal theory but pleads insufficient facts under the theory. Robertson, 749 F.2d at 534.

  In reviewing a motion to dismiss under Rule 12(b)(6), courts must assume the truth of all factual allegations and construe them in the light most favorable to the nonmoving party. Cahill v. Liberty Mut. Ins. Co., 80 F.3d 336, 337-38 (9th Cir. 1996). However, legal conclusions need not be taken as true merely because they are cast in the form of factual allegations. W. Mining Council v. Watt, 643 F.2d 618, 624 (9th Cir. 1981) cert. denied, 454 U.S. 1031 (1981). When ruling on a motion to dismiss, courts may consider the facts alleged in the complaint, documents attached to the complaint, documents relied upon but not attached to the complaint when authenticity is not contested, and matters of which the Court takes judicial notice. Parrino v. FHP, Inc., 146 F.3d 699, 705-06 (9th Cir. 1998); Hal Roach Studios, Inc. v. Richard Feiner and Co., Inc., 896 F.2d 1542, 1555 n.19 (9th Cir. 1990); MGIC Indem. Co. v. Weisman, 803 F.2d 500, 504 (9th Cir. 1986).*fn2 Page 6

  Discussion

 I. Failure to State a Claim under Section 10(b) and Rule 10b-5

  A. Pleading Requirements of Section 10(b) and Rule 10b-5

  In December 1995, Congress enacted the Private Securities Litigation Reform Act of 1995 ("PSLRA"), which mandates that complaints alleging securities fraud comply with the heightened pleading standards of both the PSLRA and Rule 9(b) of the Federal Rules of Civil Procedure. See In re Vantive Corp. Sec. Litig., 283 F.3d 1079, 1091 (9th Cir. 2002). Failure to meet the heightened pleading requirements is cause for dismissal of the complaint. 15 U.S.C. § 78u-4(b)(3)(A).

  Under Ninth Circuit caselaw, Rule 9(b) imposes two distinct requirements on complaints alleging securities fraud. First, the basic notice requirements of Rule 9(b) require the complaint to "state precisely the time, place, and nature of the misleading statements, misrepresentations, and specific acts of fraud." Kaplan v. Rose, 49 F.3d 1363, 1370 (9th Cir. 1994). The Rule imposes a second requirement that the complaint "set forth an explanation as to why the statement or omission complained of was false and misleading." Yourish v. California Amplifier, 191 F.3d 983, 993 (9th Cir. 1999) (quoting In re GlenFed Sec. Litig., 42 F.3d 1541, 1548 (9th Cir. 1994) (enbane)). A complaint may satisfy this second requirement by "pointing to inconsistent contemporaneous statements or information . . . which were made by or available to the defendants." Yourish, 191 F.3d at 994 (quoting In re GlendFed, 42 F.3d at 1549); DeMarco, 149 F. Supp.2d at 1223. A complaint may not, however, demonstrate that a statement was false or misleading when made "merely by pointing to later inconsistent statements or conditions." In re GlenFed, 42 F.3d at 1548.

  Through the PSLRA, Congress clarified and strengthened the particularity requirements of Rule 9(b) as applied in the context of federal securities class action lawsuits. Under the Page 7 PSLRA, a complaint must identify (1) each statement alleged to have been misleading, (2) the reason or reasons why the statement is misleading, and (3) all facts on which that belief is formed. 15 U.S.C. § 78u-4(b)(1); In re Silicon Graphics Sec. Litig., 183 F.3d 970, 996 (9th Cir. 1999). If allegations are made on information and belief, "a plaintiff must provide, in great detail, all the relevant facts forming the basis of her belief. It is not sufficient for a plaintiffs pleadings to set forth a belief that certain unspecified sources will reveal, after appropriate discovery, facts that will validate her claim." Silicon Graphics, 183 F.3d at 985. If reports or other writings form the basis of a plaintiff's belief, the plaintiff should mention "the sources of her information with respect to the reports, how she learned of the reports, who drafted them, or which officers received them." Id. If a complaint relies on unnamed, confidential sources, a person need not be named "provided they are described in the complaint with sufficient particularity to support the probability that a person in the position occupied by the source would possess the information alleged." In re Seebeyond Technologies Corp. Sec. Litig., 266 F. Supp.2d 1150, 1158-59 (C.D. Cal. 2003) (citing Novak v. Kasaks, 216 F.3d 300, 313-14 (2d Cir. 2000)). "To contribute meaningfully toward a `strong inference' of scienter . . . allegations attributed to unnamed sources must be accompanied by enough particularized detail to support a reasonable conviction in the informant's basis of knowledge." In re Northpoint Communications Group, Inc., Sec. Litig., 221 F. Supp.2d 1090, 1097 (N.D. Cal. 2002). A complaint should at least include each witness's job title and describe their responsibilities within the Company. Id. Exact dates of employment, however, need not be included, as they "would significantly erode the confidentiality of these sources." In re Seebeyond, 266 F. Supp.2d at 1159.

  Scienter is a "mental state embracing intent to deceive, manipulate, or defraud." Silicon Graphics, 183 F.3d at 975 (Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n. 12 (1976)). With regard to this element, the PSLRA requires complaints alleging federal securities fraud to "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." 15 U.S.C. § 78u-4(b)(2). As interpreted by the Ninth Circuit, this language requires a private securities plaintiff to plead particular facts that constitute strong circumstantial Page 8 evidence of deliberately reckless or intentional misconduct. Silicon Graphics, 183 F.3d at 977. "[I]f the challenged act is a forward-looking statement, the required state of mind is `actual knowledge . . . that the statement was false or misleading.'" No. 84 Employer-Teamster Joint Council Pension Trust Fund v. America West Holding Corp., et al ("Am. West"), 320 F.3d 920, 931 (9th Cir. 2003) (quoting 15 U.S.C. § 78u-5(c)(1)), The court reviews the entire complaint to determine whether the totality of facts and inferences, including inference unfavorable to the plaintiffs, raises a strong inference of scienter. E.g., Gompper v. VISX, Inc., 298 F.3d 893, 897 (9th Cir. 2002).

  B. Alleged False and Misleading Statements

  1. July — September 2000

  The TACC alleges four instances between July and September 2000 in which Defendants reportedly made false and misleading statements: (1) on July 12, 2000, JNI announced a certification agreement with Compaq to supply JNI's products to customers (TACC ¶ 55); (2) on July 17, 2000, JNI issued a report claiming "record" second quarter 2000 results and "continued strong demand for JNI's products and its dominate position in the Fibre Channel storage area network sector of the high end market" (Id. ¶¶ 56-57); (3) on July 18, 2000, Bear Sterns analysts issued a favorable report based on "Company specific information provided by defendants, specifically Purdy and Flanagan, during a conference call announcing Q200 results" (Id. ¶ 58); and (4) on July 18, 2000, an analyst from DLJ issued a favorable report based on information provided by Defendants, "specifically Purdy and Flanagan during the July 17, 2000 conference call announcing Q200 results" (Id. ¶ 59). Plaintiffs claim that the first two statements made by JNI were false or misleading because of failure to disclose material adverse facts. (Id. ¶ 55, 57). With respect to the two analyst reports, Plaintiffs claim that "both reports repeated false or misleading information to the market that was provided by defendants Purdy and Flanagan and served to artificially inflate JNI's stock price." (Id. ¶ 60.)

  Plaintiffs allege that many of the false and misleading statements made by Defendants throughout the class period were false not because the facts reported were incorrect, but rather because of failure to disclose contemporaneous, adverse, material information. "Rule 10b-5 and Page 9 Section 14(e) in terms prohibit only misleading and untrue statements, not statements that are incomplete . . . To be actionable under the securities laws, an omission must be misleading; in other words it must affirmatively create an impression of a state of affairs that differs in a material way from the one that actually exists." Brody v. Transitional Hasp. Corp., 280 F.3d 997, 1006 (9th Cir. 2002).

  a. July 12. 2000 Announcement of Certification Agreement

  The allegedly false or misleading statement made on July 12, 2000, was an announcement that JNI had entered into a certification agreement with Compaq. In its last Order, the Court found that "the description of the July 12 statement . . . remains inadequate under the PSLRA because it is unclear which Defendants(s), if any, made or were directly responsible for the statement." (Order II at 8.) Plaintiffs have again failed to plead this allegation with the particularity required by Rule 9(b) and the PSLRA. (See TACC f 55.)

  Plaintiffs claim that the falsity of this statement is evidenced by Defendants' failure to disclose information about the difficulty JNI was experiencing with its Emerald III product. (TACC ¶¶ 62-63, 65-68.) In order for ah omission to mislead, it must "affirmatively create an impression of a state of affairs that differs in a material way from the one that actually exists." Brody, 280 F.3d at 1006. The statement at issue made no representations about the Emerald III product. The Compaq statement did not create any need for Defendants to disclose information about Emerald III. Accordingly, omitting the Emerald information did not render the Compaq announcement misleading.

  Plaintiffs state that "the announcement was an effort to convince investors that JNI was expanding beyond the Sun Microsystems platform, with an increased emphasis on PCI revenues. . . ." (TACC ¶ 55.) Motive may be used as circumstantial evidence of scienter. Silicon Graphics, 183 F.3d at 974. However, even if this allegations of motive were supported by facts identifying the source of Plaintiffs' information, motive does nothing to establish that the statement at issue was false or misleading. Without any allegations supporting the claim that the statement was false or misleading, and that it is attributable to specific defendants, this allegation continues to be inadequate. Page 10

  b. July 17. 2000. Press Release

  The July 17, 2000, press release reported record second quarter for fiscal year 2000 results, "including revenue of $24 million and EPS (before charges of $0.12)." (TACC ¶ 56.) The press release was allegedly "approved by the Individual Defendants as a `group-published' document,*fn3 and Purdy was listed as the contact person for the information in the press release." (Id.) The press release also quoted Flanagan stating that "the company's revenue growth of 30% reflected continued strong demand for its Unix and PC suit of products and the result of the company's aggressive market expansion initiatives," and other positive statements about the demand and expansion JNI was experiencing. (Id.)

  The press release reported JNI's second quarter earnings. Nowhere in the TACC is it alleged that these earning reports were false. Rather, Plaintiffs cite "Flanagan's statements about continued strong demand for JNI's products and its dominate position in the Fibre Channel storage area network sector of the high end market" as false or misleading because Defendants failed to disclose materially adverse facts. (TACC ¶ 57.) First, Plaintiffs cite information allegedly communicated to JNI from Sun employees as undermining the press release. (See TACC ¶ 62.) The inadequacy of the Sun allegation has been addressed in the Court's previous orders. In short, it has not been alleged that the omission of the Sun information "affirmatively create[d] an impression of a state of affairs that differs in a material way from the one that actually exist[ed]." Brody, 280 F.3d at 1006. The press release made no mention of Sun, and Plaintiffs have failed to plead fact that would establish, if true, that the Sun information meant that the state of affairs was materially different from that expressed in the press release. In addition, the allegation fails to plead scienter because no facts suggest that any of the defendants were privy to this information prior to the issuance of the press release. Page 11

  Next, Plaintiffs cite alleged problems with the Emerald III software as materially adverse information that Defendants omitted, rendering the press release misleading. Attempting to establish that the Emerald III information constituted material, adverse, contemporaneous information, the Complaint cites information from Virgilio Baterina, JNI's Asia Pacific Manager (TACC ¶ 63), emails to and from Purdy (TACC ¶ 65), and sales and marketing data documenting the Emerald products (TACC ¶ 67). However, Plaintiffs still fail to "describe, chart or graph" the alleged decline in demand. See Ronconi v. Larkin, 253 F.2d 423, 431 (9th Cir. 2001). Plaintiffs do not dispute the 30% revenue growth or the 50% backlog that JNI experienced in the second quarter. (See TACC ¶ 56.) These facts give strong support for the positive statements made by Flanagan. Without more information, the omission of problems with one product line does not suggest that the positive statements made by Flanagan were false or misleading.

  Plaintiffs also allege that the July 17, 2000, press release was false or misleading because Defendants failed to disclose the existence of a structure called the "Office of the President." (TACC ¶¶ 69-70.) Plaintiffs allege that with the creation of this group, Flanagan, JNI's President and CEO, was "effectively ousted from power." (TACC ¶ 69.) The group was allegedly formed sometime in Mid-June. (Id.) Flanagan remained President and CEO until he retired in November 2000. (TACC ¶ 117.) As Defendants note, the parties involved with this committee were already intimately involved in running the company by virtue of their positions. Gregory was the Chief Operating Officer. (TACC ¶ 25(c).) Purdy was the Chief Financial Officer. (TACC ¶ 25(b).) McRnett was the Chief Technology Officer. (TACC ¶ 25(d).) These three defendants were among the most powerful officers in the company. It is not unusual for officers other than the CEO to report to the Board. It is not unusual for other employees to report to them. Plaintiffs cite these developments as evidence of "major changes in senior management," however, the facts pled do not establish that these functions were out of line with those expected to be performed by senior officers, which is what Purdy, Gregory, and McKnett were. Plaintiffs ...


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