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IN RE NETOPIA

December 15, 2005.

IN RE NETOPIA, INC., SECURITIES LITIGATION. THIS ORDER RELATES TO: ALL ACTIONS.


The opinion of the court was delivered by: RONALD WHYTE, District Judge

ORDER DENYING IN PART AND GRANTING IN PART DEFENDANTS' MOTION TO DISMISS OR STRIKE
Defendants Netopia, Inc., Alan Lefkof, and David Kadish move to dismiss or strike certain portions of the consolidated amended complaint.*fn1 Kadish additionally moves to dismiss all claims against him under Fed.R.Civ.P. 12(b)(6). For the reasons given below, the court denies the defendants' motions to dismiss except as to the § 10(b)(5) claim against defendant Kadish, grants the motion as to the § 10(b)(5) claim against defendant Kadish with twenty days leave to amend, grants the motion to strike the allegations in paragraphs twenty-two through thirty-one, and denies the motion to strike other allegations.

I. BACKGROUND

  Plaintiffs constitute a class of all those who purchased Netopia, Inc., common stock from November 6, 2003, to August 16, 2004. They allege that Netopia and four of its officers or former officers — Alan Lefkof, David Kadish, William Baker, and Thomas Skoulis — engaged in fraudulent accounting practices that inflated the price of Netopia stock. After these alleged accounting irregularities came to light, the price of Netopia stock fell, harming the plaintiffs. The current complaint alleges two causes of action: (1) violation of section 10(b) of the Exchange Act, 15 U.S.C. § 78j(b), and related Rule 10b-5, 17 C.F.R. § 240.10b-5, against all defendants, and (2) violation of section 20(a) of the Exchange Act, 15 U.S.C. § 78t(a), against all defendants other than Netopia.

  The complaint contains lengthy narratives about the defendants' alleged wrongdoing in three Netopia transactions or attempted transactions. The first occurrence, referred to by the parties as the "Chicago transaction," involved an agreement for Netopia to supply Interface Computer Communications, Inc., ("ICC") with computer products, which ICC would in turn sell to the Chicago public school system. The second occurrence, the "Philadelphia transaction," was similar: Netopia was to sell ICC $750,000 worth of products, which ICC would then sell to the Philadelphia public school system. In the third occurrence, the "Swisscom transaction," Netopia allegedly shipped a large quantity of products to Swisscom AG just before the end of a quarter, distorting the picture of Netopia's business that investors received.

  The Philadelphia transaction is, for the plaintiffs' action, the main event. Plaintiffs allege that in the spring of 2003, Netopia began negotiating with ICC for Netopia to sell ICC software for the Philadelphia public schools. Consol. Am. Compl. ("CAC") ¶ 32. Peter Frankl was the Netopia salesman in charge of the Philadelphia transaction. Id. By September 2003, the individual defendants were aware that Frankl was possibly going to close a deal that would make the Philadelphia transaction worth at least $500,000. Id. ¶ 34. The Philadelphia school system did not have funds available for the purchase, though, meaning that the purchase would not take place before the end of the financial quarter on September 30, 2003. Id. ¶ 35. Lefkof and Skoulis thought the Philadelphia transaction would help Netopia meet Wall Street earnings estimates, so had Frankl negotiate a deal with ICC: ICC would give Netopia a purchase order for $750,400 worth of software, but the parties would orally agree that ICC had no obligation to pay Netopia until the Philadelphia schools ordered Netopia's software from ICC and paid ICC. Id. ¶¶ 35-45. Kadish drafted a purchase order for the transaction which contained no payment terms, although "Netopia's standard payment terms were `net 30.'" Id. ¶¶ 42-43. This deal began to unravel almost immediately. Netopia's accounting department (apparently unaware of the oral contingency) sent ICC a letter asking ICC to confirm to KPMG LLP, Netopia's outside auditors, that ICC owed Netopia $750,400 for software. Id. ¶ 46. ICC responded by sending Frankl a letter confirming that ICC did not owe Netopia anything for the Philadelphia transaction until the Philadelphia school system ordered software from ICC and paid ICC for the software; Frankl received this letter on October 7, 2003. Id. ¶¶ 47-50. In late October, the Philadelphia school system made clear that it was not willing to purchase Netopia software anytime soon. Id. ¶¶ 51-52. KPMG learned that Netopia had not received the $750,400 and asked "Baker, Kadish and Lefkof about whether is was appropriate to recognize" revenue from the purchase order. Id. ¶ 54.

  On November 5, 2003, Netopia reported its financial results for the quarter and financial year ending September 30, 2003. Id. ¶ 58. The $750,400 from the Philadelphia transaction was reported as income for the quarter and was the difference between Netopia reporting a net loss or net income for the quarter. Id. Netopia's stock price rose immediately afterwards. Id. ¶ 59. From November 10 and December 10, 2003, each of the individual defendants sold off hundreds of thousands of dollars worth of Netopia stock. Id. ¶ 64.

  Netopia continued its efforts to get the Philadelphia school system to purchase software. Id. ¶¶ 65-66. In March 2004, Frankl and Skoulis tentatively brokered a deal whereby the Philadelphia schools would agree to purchase $375,000 worth of Netopia software, but Gateway Inc. would be added as a second middleman and take a 10 percent fee. Id. ¶ 66. Baker began asking ICC to start making payments since the sale was likely to go through. Id. ¶ 68-74. On April 27, 2004, ICC sent Baker and Frankl and e-mail reiterating that ICC's payments to Netopia were contingent on ICC being paid by the Philadelphia school system (and now Gateway), and that Netopia could expect a payment of around $300,000 in mid-June. Id. ¶ 75. In May 2004, Gateway received a purchase order from the Philadelphia school system for $375,000 worth of Netopia software. Id. ¶ 81. A month later, Gateway sent ICC a purchase order for the software in the amount of $337,500.*fn2 Id. Baker, meanwhile, was still pressing ICC to pay Netopia $750,000. Id. ¶ 82. ICC's president, David Andalcio, informed Frankl that it would send Netopia about $50,000 at the end of June. Id. ¶ 83. Lefkof, apparently expecting ICC to adhere to its earlier statement about paying in mid-June, had Imelda Farrell, Netopia's "Corporate Controller," send Andalcio a letter proposing that ICC pay Netopia $750,400 in installments from June 28, 2004, to September 15, 2004. Id. ¶¶ 84-87. The next day, June 18, 2004, Andalcio called Farrell, rejecting the proposed payment plan. Id. ¶ 88. "Kadish then came to Ms. Farrell's desk, stood over Ms. Farrell and put the phone to his ear as well, and whispered answers into Ms. Farrell's ear for her to say in response to Mr. Andalcio's remarks." Id. (Plaintiffs do not disclose the contents of this conversation.)

  A week later, Andalcio e-mailed Baker that Andalcio was uncomfortable with the situation and had sought the advice of legal counsel. Id. ¶ 91. Andalcio wrote that, on the advice of counsel, ICC would not make any payments on the old purchase order, and requested a new purchase order that reflected all terms of the agreement between ICC and Netopia. Id. On July 1, 2004, Kadish e-mailed Andalcio that Netopia was willing to accept $337,500 as settlement of all claims between them, and enclosed an agreement to that effect dated June 30, 2004. Id. ¶ 93. Kadish stated that if ICC did not sign and return the proposed agreement by the next day, the "offer to compromise" would "be deemed withdrawn." Id. Andalcio responded the next day that his legal counsel had advised him not to sign the proposed agreement because ICC had done nothing wrong. Id. ¶ 94.

  On July 22, 2004, the audit committee of Netopia's board of directors announced that it was investigating Netopia's dealings with ICC. Id. ¶ 96. Two months later, KMPG resigned as Netopia's outside auditor and withdrew its support for Netopia's financial statements for the year ending September 30, 2003. Id. ¶ 111. Skoulis and Frankl were fired, and Baker was forced to resign. Id. ¶¶ 97-98.

  II. ANALYSIS

  A. All defendants' motion to dismiss certain portions of the complaint

  The defendants move to dismiss "allegations about the Chicago transaction, Swisscom, and certain loss causation allegations because they do not allege facts upon which a claim for relief can be based." Defendants have not moved to dismiss either cause of action, and neither the Chicago transaction nor the Swisscom transaction corresponds directly to either the plaintiffs' § 10(b) or § 20(a) causes of action. By its own terms, there does not appear to be any way to grant partial dismissal of a claim under Fed.R.Civ.P. 12(b)(6). The defendants have not presented the court with any case where a court has dismissed under Fed.R.Civ.P. 12(b)(6) only part of a complaint except individual causes of action, nor can the court find such a case. The plaintiffs conceded at oral argument that a motion to strike would be a more appropriate way to obtain the result they seek.

  The court assumes that Fed.R.Civ.P. 12(b)(6)'s language "failure to state a claim" means the rule should not be used on subparts of claims; a cause of action either fails totally or remains in the complaint under Fed.R.Civ.P. 12(b)(6). See Charles Alan Wright & Arthur R. Miller, Federal Pleading & Procedure § 1358 (3d. ed. 2004); but see Drewett v. Aetna Cas. & Sur. Co., 405 F.Supp. 877, 878 (W.D. La. 1975) (Fed.R.Civ.P. 12(b)(6) "may be used to challenge the sufficiency of part of a pleading such as a single count or claim for relief."). The defendants do not claim that the plaintiffs' § 10(b) or § 20(a) causes of action are missing an essential element. The defendants' motion to dismiss allegations about the Chicago and Swisscom transactions are therefore denied.

  Defendants also move to dismiss allegations that drops in Netopia's stock price in January, February, and April 2004 stemmed from a September 30, 2003, overstatement of Netopia's financial condition. As these time periods also do not correspond to a particular cause of action, the court likewise denies this portion of the defendants' motion to ...


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