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In re Infosonics Corporation Derivative Litigation

September 4, 2007

IN RE INFOSONICS CORPORATION DERIVATIVE LITIGATION


The opinion of the court was delivered by: Honorable Barry Ted Moskowitz United States District Judge

ORDER DENYING MOTION TO DISMISS FOR LACK OF PERSONAL JURISDICTION, GRANTING MOTION TO DISMISS FOR FAILURE TO MAKE A DEMAND ON THE BOARD OF DIRECTORS, AND GRANTING IN PART AND DENYING IN PART MOTION TO DISMISS FOR LACK OF STANDING AND FAILURE TO STATE A CLAIM

Specially appearing Defendants Robert S. Picow ("Picow") and Randall P. Marx ("Marx") have filed a motion to dismiss for lack of personal jurisdiction. Nominal Defendant InfoSonics Corporation and individual Defendants Joseph Ram ("Ram"), Jeffrey A. Klausner ("Klausner"), Joseph C. Murgo ("Murgo"), Abraham G. Rosler ("Rosler") and Kirk A. Waldron ("Waldron") have filed a motion to dismiss for failure to make a demand on the Board of Directors, and a motion to dismiss for lack of standing and failure to state a claim. For the reasons discussed below, Picow and Marx's motion to dismiss for lack of personal jurisdiction is DENIED. Defendants' motion to dismiss for failure to make a demand on the Board of Directors is GRANTED, and Defendants' motion to dismiss for lack of standing and failure to state a claim is GRANTED IN PART AND DENIED IN PART.

I. BACKGROUND

This action is a derivative lawsuit brought by shareholders of InfoSonics Corporation ("InfoSonics" or the "Company") on behalf of the Company. InfoSonics is a Maryland corporation with headquarters in San Diego, California. Defendant Ram is the Chairman of the Board, President, CEO and a director of InfoSonics. Defendant Klausner is the CFO of InfoSonics. Defendant Murgo is the Vice President of Sales of InfoSonics. Defendant Rosler is the Executive Vice President and a director of InfoSonics. Defendant Marx is a director of Infosonics. Marx is also a Chairman of the Board's Audit and Compensation Committees and is a member of the Board's Nominating and Corporate Governance Committee. Defendant Picow is a director of InfoSonics and is also a member of the Board's Audit, Compensation, and Nominating and Corporate Governance Committees. Defendant Waldron is a director of InfoSonics and is a member of the Board's Audit, Compensation and Nominating and Corporate Governance Committees.

This action arises out of allegedly "backdated" stock options granted in December 2005 and the misclassification of warrants issued by InfoSonics, which later led to a restatement of its net income for the first quarter of fiscal year 2006.

A. Backdating of Stock Options

In a proxy statement filed with the SEC on July 8, 2005, the Company proposed to amend its 2003 stock option plan, and explained: "The Plan provides that the exercise price of incentive options granted cannot be less than the fair market value of the underlying common stock on the date the incentive options are granted." (Verified Consolidated Shareholder Derivative Complaint ("Compl.") ¶ 24.)

The Form 10-K filed on behalf of InfoSonics for fiscal year 2005, stated that "[o]n December 30, 2005, the Company granted options to purchase 220,500 shares of the Company's common stock to its executives and employees. The exercise price is $16.24. These options vest on the date of the grant. A compensation charge was not recorded in connection with the issuance of such options as the exercise price for the stock options granted was not less than the fair market value of the Company's common stock as of the date of the grant." (Compl. ¶ 25.)

However, Defendants Ram, Rosler, Klausner, Marx, Waldron, and Murgo did not disclose their stock option grants on a Form 4 until January 17, 2006. (Compl. ¶ 26.) Defendant Picow did not disclose his grant on a Form 4 until January 18, 2006. (Id.) The stock options were granted at the lowest price at which the Company's stock had been trading during the period from December 27, 2005 through January 20, 2006. (Compl. ¶ 26.) Plaintiffs allege that the InfoSonics' Board of Directors approved the grants of the options to Defendants even though the options were improperly backdated. (Id.)

According to Plaintiffs, Defendants took affirmative steps to conceal their backdating actions by authorizing or otherwise causing the Company to issue various SEC filings and public statements that contained false disclosures concerning the grant dates of options granted to InfoSonics insiders. (Compl. ¶ 92.) Plaintiffs allege that because InfoSonics failed to properly record the costs associated with the extra compensation given to Defendants and other insiders, its profits were overstated during the fiscal period in which the options were granted, necessitating a restatement of the Company's past financial results. (Compl. ¶ 60.) Plaintiffs further allege that the backdating of stock options can have severe tax consequences. (Compl. ¶ 61.)

B. Misclassification of Warrants

On January 30, 2006, InfoSonics issued warrants in connection with the private placement of common stock. The warrants were initially treated as a derivative liability.

On February 17, 2006, the SEC declared effective the Company's registration statement registering the shares underlying the warrants. (Compl. ¶ 28.) Consequently, the Company was required under the GAAP to reclassify the warrants as equity. (Id.) However, Defendants, including the members of InfoSonics' Audit Committee, directed InfoSonics to maintain the warrants' classification as a liability. (Id.) As a result of the misclassification of the warrants, InfoSonics improperly booked $564,342 in net income for the period from February 17, 2006 to March 31, 2006. (Id.)

On May 8, 2006, InfoSonics issued a press release announcing its financial results for the first quarter of 2006. The press release noted that "the Company had income from a non-cash change in fair value of derivative liability (for financing related warrants) of $963,000 and non-cash expense related to stock-option compensation of $52,000." (Compl. ¶ 71.) The misclassification of the warrants and inaccurately-stated financial results were repeated in the Company's Form 10-Q filed on May 15, 2006. (Compl. ¶ 73.)

On June 12, 2006, InfoSonics revealed that it would need to restate its reported net income for the first quarter of 2006 because the Company had improperly treated the warrants as a derivative liability. (Compl. ¶¶ 74-76.) On that same day, the company filed a Form10-Q/A, which stated: "Since these warrants became part of permanent equity on February 17, 2006, InfoSonics should have ceased applying the mark to market provisions of EITF 00-19, on that date. Accordingly, the net income for the quarter ended March 31, 2006 has been reduced by a non-cash amount of $564,000." (Compl. ¶ 76.)

Market reaction to the restatement was swift and severe. (Compl. ¶ 32.) InfoSonics' stock fell from a close of $24.22 on Friday, June 9, 2006 to a close of $17.38 on June 12, 2006. (Compl. ¶ 32.)

Plaintiffs allege that the misclassification of the warrants resulted in an artificial inflation of the Company's stock price, which Ram, Klausner, Murgo and Rosler utilized to their advantage. (Compl. ¶ 30.) From May through early June 2006, these defendants sold some 136,000 of their personally-held shares for over $2.9 million in proceeds. (Compl. ¶ 30.)

C. Claims Asserted

The Complaint asserts the following claims (1) Disgorgement under the Sarbanes- Oxley Act of 2002 against Defendants Ram and Klausner; (2) Violation of Section 14(a) of the Exchange Act against Ram, Rosler, Marx, Picow, and Waldron (the "Director Defendants"); (3) Violation of Cal. Corp. Code § 25402 (insider selling) against Ram, Klausner, Murgo, and Rosler; (4) Violation of Cal. Corp. Code § 25403 against the Director Defendants; (5) Breach of Fiduciary Duty for Insider Selling and Misappropriation of Information against Ram, Klausner, Murgo, and Rosler; (6) Breach of Fiduciary Duty against all Defendants; (7) Abuse of Control against all Defendants; (8) Gross Mismanagement against all Defendants; (9) Waste of Corporate Assets against ...


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