Opinion
No. C 00-01967 MHP
March 29, 2002
ORDER
This Document Relates To: ALL ACTIONS
These consolidated securities class actions were brought on behalf of individuals who purchased the publicly traded common stock of Terayon Communications Systems, Inc. between November 15, 1999 and April 11, 2000. Defendants' motion to dismiss the first amended consolidated complaint ("FAC") is now before the court. Having considered the arguments of the parties, and for the reasons set forth below, the court issues the following memorandum and order.
BACKGROUND
Because the first amended complaint has not been altered dramatically, the court reiterates the background allegations set out in this court's order of March 14, 2001. Terayon Communications Systems, Inc. ("Terayon") manufactures and markets cable modem systems that enable cable operators to offer Internet connection services to cable subscribers. Terayon's proprietary cable modem products are based on Synchronous Code Division Multiple Access ("S-CDMA") technology. The majority of Terayon's competitors have adopted the Time Division Multiple Access ("TDMA") technology. FAC ¶¶ 2, 27. Plaintiffs assert that the two technologies are not compatible. FAC ¶¶ 2, 27.
CableLabs is a cable industry consortium charged with enforcing an industry standard known as Data Over Cable System Interface Specification ("DOCSIS") for cable modems and cable head-ends. FAC ¶ 39. At present, the existing DOCSIS standard, referred to as DOCSIS 1.0, is based on TDMA technology. FAC ¶ 39. CableLabs has written specifications for an enhanced cable modem standard, DOCSIS 1.1, and was scheduled to begin testing different product submissions for DOCSIS 1.1 certification in the summer of 2000. FAC ¶ 39.
CableLabs has provided vendors with status reports regarding individual projects, including the possible certification of Terayon's S-CDMA technology as DOCSIS compliant. FAC ¶ 42. On September 8, 1999, the Board informed Terayon that it had not voted favorably on the possible inclusion of S-CDMA as an evolution of DOCSIS and that the Board was moving forward on including FA-TDMA technology in DOCSIS 1.1. FAC ¶ 43. The Board invited Terayon to submit "a prototype for testing and possible (but not certain) inclusion in a future release of the DOCSIS specification if the prototype met performance and cost requirements." FAC ¶ 43.
Plaintiffs allege that defendants made materially false and misleading statements regarding Terayon's S-CDMA technology and DOCSIS certification. Plaintiffs contend that defendants stated that the S-CDMA technology had been included in DOCSIS. See e.g. FAC ¶¶ 4, 74. In addition, plaintiffs allege that defendants represented that the S-CDMA technology would be included in a future release of DOCSIS. See e.g. FAC ¶¶ 46, 49, 50, 52. According to plaintiffs, both statements are false. See e.g. FAC ¶ 39, 48, 52. Plaintiffs allege that defendants were warned of the misstatements by CableLabs and members of its Certification Board. See e.g. FAC ¶¶ 52, 56. Plaintiffs contend that defendants continued to make false and misleading statements regarding DOCSIS certification even after receiving the warnings. FAC ¶¶ 52, 56-57, 61.
Plaintiffs allege that these false statements had the effect of misleading investors and artificially inflating the price of Terayon securities. See e.g. FAC ¶¶ 52, 54, 58. Plaintiffs contend that certain defendants took advantage of the inflated price of Terayon stock and the non-public information that the S-CDMA technology was not a part of the DOCSIS standard by selling their personal shares of Terayon common stock. FAC ¶¶ 54, 57, 59. In addition, they allege that defendants used the inflated price of Terayon stock to acquire other companies. See e.g. FAC ¶ 57.
Plaintiffs filed a consolidated complaint on September 21, 2000 ("the complaint"), alleging violation of section 10(b) and Rule 10b-5 (First Claim for Relief) and section 20(a) (Second Claim for Relief) of the Securities Exchange Act. Defendants filed a motion to dismiss the complaint. In a lengthy opinion filed March 14, 2001 this court analyzed which portions of the complaint withstood a motion to dismiss, which portions were to be dismissed and which portions could be repled.
On August 31, 2000, the court consolidated these actions and directed plaintiffs to file an amended consolidated complaint.
Section 10(b) of the Securities and Exchange Act of 1934, 15 U.S.C. § 78j(b), makes it 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 [Securities and Exchange] Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors." 15 U.S.C. § 78j(b).
Rule 10b-5 makes it unlawful "[t]o make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading". 17 C.F.R. § 240.10b-5 (b) (1995).
Section 20(a) provides: "Every person who, directly or indirectly, controls any person liable under any provision of this title or of any rule or regulation thereunder shall also be jointly and severally liable with and to the same extent as such controlled person to any person to whom the controlled person is liable, unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action." 15 U.S.C. § 78t(a). To be liable under section 20(a), the defendants must be liable under another section of the Exchange Act. See Heliotrope General, Inc. v. Ford Motor Co., 189 F.3d 971, 978 (9th Cir. 1999).
As a result, on April 13, 2001, plaintiffs filed their First Amended Complaint ("FAC"). Defendants' motion to dismiss the FAC followed.
LEGAL STANDARD
I. Rule 12(b)(6)
In considering the sufficiency of a complaint under Federal Rule of Civil Procedure 12(b)(6), the court will not grant a motion to dismiss "unless it appears beyond doubt that the plaintiff{s] can prove no set of facts in support of [their] claims which would entitle [them] to relief."Conley v. Gibson, 355 U.S. 41, 45-46 (1957). The Federal Rules do not require plaintiffs to plead in detail the facts upon which they base their claim; they must merely set forth a "short and plain statement of the claim" that gives defendants fair notice of its nature and grounds.See id. at 47 (citing Fed.R.Civ.P. 8(a)(2)). Rejecting the notion that "pleading is a game of skill in which one misstep by counsel may be decisive to the outcome, " the Federal Rules instead embody the principle that pleading should make possible a just decision on the merits. Id. at 48. Nevertheless, courts in the Ninth Circuit have often stated that unwarranted inferences and conclusory allegations of law, even when pled as facts, are insufficient to defeat a motion to dismiss. See e.g. In re Verifone Sec. Litig., 11 F.3d 865, 868 (9th Cir. 1993).
II. Rule 9(b)
Federal Rule of Civil Procedure 9(b) provides that "the circumstances constituting fraud or mistake shall be stated with particularity." Fed.R.Civ.P. 9(b). The Private Securities Litigation Reform Act of 1995 ("the Reform Act") modifies this requirement, providing that a securities fraud complaint shall 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. See 15 U.S.C. § 78u-4 (b)(1); In re Silicon Graphics Inc. Sec. Litig., 183 F.3d 970, 996 (9th Cir. 1999) (Browning, J. concurring).
DISCUSSION
I. Defendants' Attempts at Reconsideration
Defendants take undue advantage of the motion to dismiss to revisit arguments they made previously, arguments which the court clearly rejected and ruled upon in this court's March 14, 2001 Order. The court similarly rejects defendants' back-door attempt at reconsideration.
A. Forward-Looking vs. Current/Historical Statements
Much of defendants' current motion to dismiss focuses on the issue of scienter. In so doing, defendants attempt to cast this case as being about "predictions that may still come true." Defendants' Motion to Dismiss at p. 1. Defendants argue that since CableLabs may still adopt Terayon's S-CDMA technology at some unknown time in the future as part of "DOCSIS 1.2," Terayon's statements to the market could not have been misleading. Defendants' argument both mischaracterizes plaintiffs' First Amended Complaint and ignores findings this court has already made as part of it March 2001 Order.
While it is not directly relevant to the issues before the court, the court notes for the record that although Terayon claims that inclusion in DOCSIS 1.2 is still a possibility, Terayon has not provided the court with any information to support the position that inclusion is any more likely today than it was during the class period.
Plaintiffs' FAC contains two types of allegations regarding misrepresentation. First, plaintiffs allege that Terayon made misrepresentations about its ability to convince CableLabs to include S-CDMA technology in either the original version of DOCSIS and the upgraded DOCSIS 1.1. See e.g. FAC ¶ 4, 33. As to DOCSIS 1.2, plaintiffs allege that the material misstatements made by defendants were not that CableLabs would include S-CDMA in a future version of DOCSIS but that CableLabs had already accepted S-CDMA technology for DOCSIS 1.2.See, e.g. FAG ¶ 38, 42, 44. The court concurs that many of defendants' alleged false and misleading statements were current or historical, not forward looking. See, e.g., ¶¶ 36, 52, 54 (statements in SEC filings that CableLabs indicated that "it wants to proceed . . . on two parallel tracks: one for the inclusion of our S-CDMA" and the intention to include S-CDMA in a future version), ¶ 39 (statement in 11/30/99 conference call that "We have already gotten the qualification and the certification for the DOCSIS modem"), ¶ 39 (11/30/99 slides stating "Terayon's proven S-CDMA technology [was] chosen by CableLabs for inclusion in DOCSIS standards" and "Terayon's broadband technology [was] accepted for industry standards"), ¶ 51 (2/4/00 HQ report stating CableLabs has selected S-CDMA for the DOCSIS 1.2 specification), 659 (Fortune magazine article wherein Rakib stated there has been no misunderstanding between Terayon and CableLabs), ¶ 77 (3/6/00 banner advertisement stating "Cable Modems that Deliver . . . Industry Standard S-CDMA"), and ¶ 84 (3/20/00 website postings stating CableLabs has selected Terayon to co-author a new DOCSIS modem standard incorporating S-CDMA).
These statements describe decisions that purportedly had already been made by CableLabs. Shaw v. Digital Equip. Corp., 82 F.3d 1194, 1213 nn. 23-24 (1st Cir. 1996); Lilley v. Charren, 936 F. Supp. 708, 714 (N.D. Cal. 1996); Harden v. Raffensperger, Hughes Co., 65 F.3d 1392, 1405-06 (7th Cir. 1995). Defendants cite Ronconi v. Larkin, 253 F.3. 423 (9th Cir. 2001) for the proposition that the "'required state of mind' here is actual knowledge because all or virtually all of the statements challenged in the complaint are 'forward-looking statements.'" Def. Motion at p. 8. Defendants contention, asserted at the hearing, that their situation falls squarely within the purview of In re Syntex Corporation Securities, 95 F.3d 922 (9th Cir. 1995), is unavailing. In Syntex, defendants made certain statements about the potential FDA approval of over-the-counter Naprosyn. The FDA did in fact approve the drug seventeen months after the defendants had made the prediction that the FDA would do so. Defendants here argue that the situation is analogous since in August of 2001, Terayon received DOCSIS certification. The Syntex court ruled that defendants' statements about the likelihood of FDA approval were merely a "prediction far in advance" and were not actionable since plaintiffs had presented no evidence that the statement was false and misleading when made. While the Syntex case is on point, this court has already parsed out which types of statements are actionable as consisting of current or historical facts and which are not because they are "forward-looking." See e.g. Order at pps.5-6 ("Rakib's statement of expectation regarding future DOCSIS certification, where no final decision had yet been made, is not in and of itself misleading.") In the case at bar, the statements which this court finds actionable are significantly different from those in Syntex. Defendants here cannot legitimately claim they had no knowledge contradictory to their statements. This case is more similar to Warshaw v. Xoma Corp., 74 F.3d 955 (9th Cir. 1996), where "at the time the defendants made optimistic statements they already had knowledge of contradictory facts and information that they did not disclose to investors." Syntex, 95 F.3d at 933. Thus, the court will not revisit this issue in the guise of an argument over scienter.
The court notes that defendants' prior motion inherently conceded this point in arguing, Terayon's statements were not actionable since they inconsistently stated that the technology "had been" certified as DOCSIS compliant and that it "would be" certified. Order at 11.
Defendants also seek to reargue the court's specific findings as to whether certain particular statements were misleading. The court addresses these statements once again and finally.
The Ninth Circuit's very recent decision in In re The Vantive Corp. Securities Litigation, ___ F.3d ___, 2002 WL 398498 (9th Cir. March 15, 2002), does not change the analysis in this case. The alleged statements in Vantive were very general and indefinite unlike the statements asserted in the FAC. The stock transactions here, unlike the ones in Vantive, involved persons who made statements alleged to be false or misleading or whose trades are not above suspicion given all of the facts alleged. Therefore, the court finds Vantive does not dictate a different result.
B. The SEC Filings
The court has already ruled that many of defendants' statements in SEC filings were "plainly misleading" and "sufficient to withstand a motion to dismiss." The court also rejected the argument that the market could not have been misled by defendants' statements, finding that the "SEC filings are insufficient to cure defendants' misrepresentations as alleged by plaintiffs relating to CableLabs' DOCSIS certification." Order at 15. The court ruled that the cautionary statements included in Terayon's SEC filings were inadequate to alter the total mix of information made available to the public by defendants and thus defendants' SEC filings were not entitled to the protection of the safe harbor provision. It is this final point that defendants seek to reargue. Defs.' Mem. at 21. However, defendants point to no material differences in plaintiffs' FAC which would require this court to change its earlier ruling.
The court ruled that "Terayon's 'admission' in its SEC filings that the S-CDMA technology is not DOCSIS compliant does not limit the company's misstatements made in the SEC filings and to the public regarding CableLabs' DOCSIS certification." Order at 11-12. This court also rejected defendants' "reasonable belief' argument, ruling that the letters did not justify defendants' statements regarding the inclusion of S-CDMA technology in DOCSIS. Order at 12-14.
C. Terayon's Banner Advertisement
This court previously ruled that Terayon's 3/6/00 banner advertising Terayon as the company that possesses an "industry standard" S-CDMA technology was misleading and sufficient to withstand a motion to dismiss because it suggested that Terayon's S-CDMA technology was part of the industry standard known as DOCSIS. Order at 6-7. Repeating arguments previously rejected by this court, defendants contend they cannot be held liable for an advertisement. Defs' Mem. at 20. This court, however, has already ruled that the advertisement is false and misleading because "industry standard" is a term of art, and the statement falsely suggests that S-CDMA is part of the industry standard known as DOCSIS. Order at 6-7. Thus the court denies this portion of Defendants' current motion to dismiss.
D. Terayon's Web Site Posting
This court has ruled that the following statements which Terayon posted on its website on March 20, 2000 were misleading and sufficient to withstand a motion to dismiss:
The CableLabs standards body has selected Terayon to co-author a new DOCSIS modem standard incorporating the S-CDMA advanced PHY and its advantages.
The CableLabs standards body has recognized the value of S-CDMA technology to the cable industry by selecting Terayon to co-author the advanced cable modem standard specification, known as DOCSIS advanced PHY (DOCSIS 1.2).
Order at 7.
Again, there have been no material changes in the allegations of plaintiffs' FAC about the web site posting which would require the court to change its earlier ruling.
II. Amendments Required by the Court's March 14, 2001 Order
A. Deletions
As required by this court's March 14, 2001 order plaintiffs removed from the first amended complaint those allegations which the court determined were not actionable, namely: the allegations regarding the TeraJet Modem and the allegations regarding the Gilder Technology Report.
These allegations were formally on p. 8 and ¶ 9-10 of the Complaint.
Also, because the court's March 14, 2001 order held that the allegations were deficient as to Christopher J. Schaepe, a director of WPC Enterprises, and Mark A. Stevens, a director of Sequoia Capital VI, they are no longer listed as defendants in the FAC. Thus, in this regard, plaintiffs have complied with the court's order.
B. Repled Allegations
In several areas, the court found that plaintiffs would need to replead their allegations with greater specificity. Plaintiffs contend that they have now done so. Defendants take issue with the amended allegations. The court will review each amended allegation in turn.
(1) The November 30, 1999 Conference Call
Plaintiffs allege that defendants made misleading statements in a nationwide November 30, 1999 conference call for stock traders, hedge fund investors and analysts. After a hearing on this motion, plaintiffs submitted a document which purported to be a transcript of the November 30, 1999 conference call.
According to the transcript, Zaki Rakib stated in part:
We have a proven track record with SDMA technology. We have already gotten the qualification and certification for the DOCSIS modem and we are absolutely on track to continue to finish the development of the 1.2 System that will incorporate SDMA. The CableLabs have [sic] already given us the letter telling us that they want us to now provide the prototype and if the prototype delivers based on the specifications that they [sic] are pretty much frozen, than [sic] they will approve it from there on [and] the next step would be the certification, something that we expect to happen in late 2000, SO the prototype in mid-2000 at which point we would have the product ready and in late 2000, the certification process will start.
November 30, 1999 Transcript at 3-4.
The court in its earlier order determined that Zaki Rakib's statement that Terayon had "already gotten the qualification and certification for the DOCSIS modem" is plainly misleading if, as plaintiffs allege, the original DOCSIS specification is based on TDMA technology. Paragraph 28 of plaintiffs FAC now states clearly that "the only DOCSIS standard accepted by CableLabs is based on TDMA technology. . . . According to Cablelabs, both DOCSIS 1.0 and 1.1 have adopted TDMA technology only." FAC ¶ 28.
Furthermore, ¶ 39 of the FAC incorporates statements from the transcript of the November 30, 1999 conference call as well as the transcript itself, which has been appended to the FAC as Exhibit 2.
The court further ruled that this allegation, if it appeared in the complaint, would be sufficient to withstand a motion to dismiss. The court directed plaintiffs to incorporate the statements from the transcript into any amended complaint and append to such complaint a transcript of the conference call. Plaintiffs incorporated the statements from the transcript into the amended complaint and appended the transcript of the conference call. FAC ¶ 39, Ex. 2, p. 4.
(2) The March 6, 2000 Press Release
This Court previously ruled the complaint's allegation that the 3/6/00 press release was false and misleading due to Terayon over-shipping modems in 1Q00 lacked specificity because the allegation that defendants over-shipped modems was vague and did not identify the "estimates" on which it was based. Order at 7-8. The FAC now (1) identifies the "estimates" underlying the allegation that Terayon over-shipped modems to Shaw and Rogers in 1Q00, and (2) provides additional specificity. Order at 7-8, ¶¶ 59-74.
Plaintiffs now detail the number of modems purchased by Shaw and Rogers in 1Q00 to show inconsistency with the number of modems purchased by Shaw and Rogers in previous quarters. ¶¶ 69-74. In essence, plaintiffs assert that while Rogers had historically purchased significantly fewer modems than it installed (roughly half as many), in 1Q00 he purchased 32% more modems than he installed and 84% and 85% more than he purchased in 3Q99 and 4Q99 respectively. Similarly, plaintiffs assert that Shaw had previously purchased only 58% and 47% of the modems necessary for new subscriber installations during the last two quarters of 1999, but in the first quarter of 2000 purchased 88% of them modems needed. Plaintiffs combine this with the facts that these purchases were all made in the last three weeks of the quarter; that Shaw and Rogers are Terayon's largest customers and shareholders, each with a representative on Terayon's Board of Directors); and that as a result of these sales Terayon issued its first and only press release pre-announcing revenues in excess of analysts' estimates to support a theory that Terayon manipulated this sale to overshadow the negative impact of the Fortune magazine article and to maintain Terayon's "inflated" stock price. ¶¶ 59-66, 68.
Defendants contend that plaintiffs have provided no information to suggest that Terayon did not earn the revenue it reported. Defs' Mem. at 19. Plaintiffs, however, have not alleged that Terayon's March 2000 revenue statements were false. Instead, plaintiffs allege that Terayon was able to achieve these revenues only through concerted action with Shaw and Rogers, who purchased far more modems than were necessary for immediate customer installation. Thus, plaintiffs amended allegations withstand dismissal.
C. New Allegations
(1) The November 30, 1999 Conference Call and Internet Slide Presentation
In addition to amending the complaint to allege that the original DOCSIS specification was based on TDMA technology, ¶ 28, as discussed above, the FAC also now alleges that during the conference call Terayon posted two slides on the Internet which stated "Terayon's proven S-CDMA technology [was] chosen by CableLabs for inclusion in DOCSIS standards" and "Terayon's broadband technology [was] accepted for industry standards." ¶ 39. In accordance with the Order, plaintiffs have appended the transcript of the conference call and the two slides to the FAC and incorporated the statements from the transcript in the FAC. ¶ 39, Ex. 2, at 4. In the conference call, Z. Rakib stated:
As ordered by the court, Plaintiffs have appended source documents relating to their allegations of misrepresentation. See Exs. 1-7. (CableLabs' letters, conference call transcripts and Fortune article.)
We have a proven track with the S-CDMA technology. We have already gotten the qualification and the certification or the DOCSIS modem and we are absolutely on track to continue to finish the development of the 1.2 System that will incorporate S-CDMA.
Ex. 2, p. 4 (emphasis added).
Defendants contend that Rakib's statement that since "we have already gotten the qualification and the certification for the DOCSIS modem" was true because Terayon sells a TDMA-based modem. Defs' Mem. at 16-17. This contention ignores that Rakib made no mention of TDMA or that the statement was made immediately after Rakib said, "We have a proven track record with the S-CDMA technology." ¶ 39. Nor does the court credit defendants' contention that plaintiffs took this statement out of context, since allegation tracks attached transcript of the call. Thus, the court finds that the impression created by Rakib's statement was that he was referring to the S-CDMA technology and not the TDMA-based modem. Even literally true statements are actionable where they create a false impression. Kaplan v. Rose, 49 F.3d 1363, 1372 (9th Cir. 1994); Hoxworth v. Blinder, Robinson Co., 903 F.2d 186, 200 n. 20 (3d Cir. 1990), accord McMahan Co. v. Wherehouse Entm't, 900 F.2d 576, 579 (2d Cir. 1990). Moreover, the reference to the DOCSIS 1.2 renders the entire statement misleading. Order at 5.
Defendants also assert that the approval of the TeraJet modem provided a basis for defendants' optimism concerning DOCSIS certification for S-CDMA. Defs' Mem. at 17. The TeraJet modem utilized TDMA technology. See Order at 8.
(2) The January 18, 2000 Conference Call
This Court previously ruled that the statements made in the 1/18/00 conference call were not misleading because the statement only presented Rakib's hope and expectation regarding future DOCSIS certification. Order at 6. Plaintiffs have now expanded the allegations regarding Z. Rakib's statements in an attempt to explain why the statements were misleading. ¶¶ 43-44.
Responding to a question from an HQ analyst, Rakib stated:
. . . On the 1.1, we are making tremendous amount of progress in two areas: one in the area of providing the system which will be the prototype for DOCSIS to test — for CableLabs to test for purposes of a p proving the advanced PHY specifications, and in addition the DOCSIS modem which will be certified in the, I guess, the July-August time frame and would be 1.1 , but that modem would be ready for the advanced PHY DOCSIS.
¶ 43, Ex. 3 at 12 (emphasis added). Plaintiffs assert that Rakib's statement that the DOCSIS modem "will be certified" was misleading because Rakib knew that CableLabs had made no decision on whether S-CDMA would be included in a future version of DOCSIS and had only invited Terayon to submit a prototype for testing. ¶ 44. Plaintiffs also point to Rakib's response to Eric Allard during the conference call that the chairman of the DOCSIS committee expected "approval and a process of a certification [of Terayon's S-CDMA prototype] towards the end of the year" as false as shown by the 9/8/99 letter to which Rakib referred. After careful review of the amended allegations and supporting material, the court still finds that the statements made in the 1/18/00 conference call were not misleading because the statement only presented Rakib's hope and expectation regarding future DOCSIS certification.
(3) Statements Published by Analysts
In its March 14 Order, the Court ruled that "[c]orporate defendants may be directly liable under Rule 10b-5 for providing false or misleading information to third-party securities analysts made in order to disseminate false information to the investing public." Order at 8 (citing Warshaw v. Xorna Corp., 74 F.3d 9SS, 9S9 (9th Cir. 1996)). The Court ruled, however, that the allegations regarding statements made to analysts required amendment. Order at 9-10.
The allegations regarding the 2/17/00 Gilder report, which this Court previously ruled were not actionable, are not included in the FAC. Order at 9-10.
(a) The Hambrecht Quist Reports
With respect to the February 4, 2000 HQ analyst report which stated in part, "[j]ust as CableLabs has selected S-CDMA for the DOCSIS 1.2 specification, we believe EuroCable Labs is interested in adopting S-CDMA for future DVB standards, " the Court ruled the allegation was deficient because plaintiffs had not identified the source of the information or the timing of its disclosure. Order at 9. The FAC now alleges that on or about February 7, 2000, one of lead plaintiffs employees spoke to an associate analyst at HQ who stated that HQ got the information about S-CDMA from the "company" — meaning defendants Z. Rakib, S. Rakib and Fritz. ¶ 51. Defendants assert that this pleading is still deficient and that plaintiffs are required to plead additional facts. Defendants cite no authority for their contention. In contrast, plaintiffs cite In re McKesson HBOC Sec. Litig., 126 F. Supp.2d 1248, 1271 (N.D. Cal. 2000) which states that it is not necessary to disclose names of sources.
With respect to the March 7, 2000 report, plaintiffs have simply alleged that Hambrecht Quist's reiteration of their "Buy" rating for Terayon demonstrates that defendants continued to mislead the market. ¶ 79. However this court has already ruled that the "report does not employ language of certainty" and that the March 7, 2000 HQ report is not actionable. Thus these allegations must be dismissed.
(b) The Fortune Magazine Article
The court's March 14, 2001 Order ruled that Rakib's statements to Fortune magazine "understated the issue between CableLabs and Terayon relating to the certification process, " but that plaintiffs needed to amend the allegation and allege with specificity that "Rakib knowingly made a false statement with intent to mislead" and to append a copy of the Fortune article to the FAC. Order at 10-11. In response, the FAC identifies the following two statements by Rakib that "there has been no misunderstanding between Terayon and CableLabs" and that "the crux of the letter deals with terminology" as knowingly false and made with the intent to mislead the investment community into believing that CableLabs had not sent Terayon a cease and desist letter. ¶¶ 59-60. The Fortune article has been appended to the FAC as Exhibit 7. Defendants contend that Rakib was correct in stating there was no misunderstanding between Terayon and CableLabs based on the 3/2/00 letter from CableLabs. Defs' Mem at 18-19. However, the court has already rejected this contention. Order at 10.
III. Scienter
The remaining issue before the court is whether, given the totality of these repled allegations, plaintiffs have met their burden under the PSLRA of pleading in great detail facts that constitute strong circumstantial evidence of deliberately reckless or conscious misconduct. 15 U.S.C. § 78u-4 (b)(1). See In re Silicon Graphics, 183 F.3d at 974, 985, (the Court is to determine "whether [the] complaint, considered in its entirety , states facts which give rise to a strong inference of [scienter]."); Rothman, 220 F.3d at 92. Ronconi v. Larkin, much cited by defendants, does not change the standard set out in Silicon Graphics. Facts showing mere recklessness or a motive to commit fraud and an opportunity to do so may provide some reasonable inference of intent, but they are not sufficient to establish a strong inference of deliberate recklessness. See id.
A. Allegations Supporting A Strong Inference of Actual Knowledge
As the Ninth Circuit stated in Ronconi v. Larkin, falsity and scienter are generally strongly inferred from the same set of facts. CITE. The FAC pleads specific facts which plaintiffs allege show defendants knew their publicly reported statements regarding Terayon's S-CDMA technology were false when made. In particular, plaintiffs rely on letters from CableLabs to Terayon to show that defendants' statements were false and misleading, had no reasonable basis, and that defendants had actual knowledge of falsity. In re Silicon Graphics Sec. Lidg. ("SGI"), 183 F.3d 970, 985 (9th Cir. 1999) (scienter can be shown by the existence of internal reports contradicting defendants' positive public statements); In re Scholastic Corp. Sec. Litig., 252 F.3d 63, 76 (2d Cir. 2001) (scienter adequately pled for defendants who knew or should have known they were misrepresenting material facts with respect to the corporate business where complaint alleges defendants knew or had access to non-public information contradicting their public statements).
Plaintiffs build their case as follows: (1) Terayon's SEC filings show that defendants knew that getting Terayon's S-CDMA technology accepted in the U.S. was critical to the success of its business. ¶¶ 3, 30-32; (2) CableLabs' 9/8/99 letter informed defendants that CableLabs had not been able to vote to include S-CDMA in DOCSIS. ¶ 33, 58, Ex. 1;[15] (3) in a November 1999 conference call, defendants were again told by CableLabs that Terayon's S-CDMA technology would not be included in the DOCSIS specification. ¶ 42.
Defendants assert the 9/8/99 letter does not support the allegations that CableLabs told Terayon "that any future DOCSIS standard then under consideration . . . would not include Terayon's S-CDMA technology." Defs' Mem. at 14. However, in that letter (and the 11/99 conference call and letters sent to Terayon in 2000) CableLabs expressly told Terayon that S-CDMA would not be included in DOCSIS 1.1 and that no decision had been made for a DOCSIS 1.2 specification, let alone a DOCSIS 1.2 specification that included S-CDMA. ¶¶ 33, 42, 47, 58. The court previously ruled that the letters from CableLabs to Terayon made many of defendants' statements "plainly misleading" and "sufficient to withstand a motion to dismiss, Order at 13 (the 9/8/99 letter did not justify defendants' statements in Terayon's SEC filings regarding the inclusion of S-CDMA technology in DOCSIS).
Plaintiffs also look to CableLabs' 2/2/00 letter to Terayon demanding that it "cease and desist" from "making misleading statements concerning the DOCSIS specifications." ¶¶ 47, 58. This Court previously rejected defendants' contention that the 2/2/00 letter did not evidence falsity or scienter, finding that the letter notified Terayon that its technology was not included in the DOCSIS standard and might not be included in any revision. Order at 13-14. Defendants contend the allegations based on the February 2, 2000 letter must fail because, in effect, plaintiffs seek to hold defendants liable for failing to predict what a third party, CableLabs, would do. Defs' Mem. at 15 n. 10. Plaintiffs, however, have made no such allegations. Instead, plaintiffs have alleged that defendants mischaracterized CableLabs' position with respect to the inclusion of S-CDMA in the DOCSIS 1.0 or 1.1 specification. See Order at 14.
Moreover, defendants' reliance on Ronconi is misplaced. Defs' Mem. at 15. In Ronconi, the court found that the plaintiffs had pled no facts to show that the defendants lacked a reasonable basis to make optimistic forward-looking statements concerning a merger. Id., at *9-*10. Here, however, the 9/8/99, 2/2/00 and 2/25/00, letters to Terayon show that defendants' statements were made without a reasonable basis. Order at 13-14. The court notes that despite Terayon's optimism, S-CDMA has still not been adopted as part of DOCSIS.
Plaintiffs look also to CableLabs' 2/25/00 and 3/2/00 communications to Terayon. ¶ 58 Defendants assert that CableLabs' 3/2/00 letter retracted the 2/2/00 cease and desist letter. Defs'. Mem. at 5. However, the letter states that CableLabs believes that "the record is now correct" after sufficient steps have been taken, not that CableLabs was in error in issuing the cease and desist letter in the first place. See Ex.6
During the time of these communications, defendants continued to state that CableLabs had selected Terayon to co-author a new modem standard incorporating S-CDMA and that Terayon modems delivered industry standard S-CDMA. ¶¶ 77, 84. Moreover, the court previously ruled that it appeared Rakib understated the dispute with CableLabs relating to certification when questioned about the possibility of the cease and desist letter by a Fortune magazine reporter. ¶¶ 59, 60, 75 and Order at 10-11.
The numerous communications between CableLabs and Terayon are sufficient to meet the pleading standard under the PSLRA of establishing a strong inference of defendants' actual knowledge that their statements about Terayon's S-CDMA technology were false and misleading.
B. Allegations which Plaintiffs Assert Confirm the Inference of Scienter
Plaintiffs assert that Terayon's Acquisition Plan and stock sales when viewed in conjunction with the CableLabs' letters elevate the inference of scienter to clear and convincing proof. Plaintiffs say that the court cannot view the acquisition plan and stock sales in isolation, as defendants suggest. Defs. Motion at 10-13. The Ninth Circuit has held that in determining whether a complaint adequately alleges scienter, the complaint's allegations must be considered in their entirety and facts showing motive and opportunity to commit fraud can provide confirming reasonable inferences that help establish a strong inference along with other allegations. SGI, 183 F.3d at 974, 985.
(1) Stock Sales
Plaintiffs contend that defendants' stock sales establish scienter. Although unusual or suspicious stock sales by corporate insiders may constitute circumstantial evidence of scienter, insider trading is suspicious only when it is "dramatically out of line with prior trading practices at times calculated to maximize the personal benefit from undisclosed inside information." Id. (citing In re Apple Computer Sec. Litig., 886 F.2d 1109, 1117 (9th Cir. 1989)). Among the relevant factors are the amount and percentage of shares sold by insiders, the timing of the sales and whether the sales were consistent with the insider's prior trading history. See Silicon Graphics, 183 F.3d at 986. This court held in its March 14, 2001 Order that the allegations in the consolidated complaint regarding stock sales and acquisitions were insufficient because plaintiffs did not allege that defendants intentionally manipulated Terayon's stock price for the purpose of acquiring other companies or that defendants intended their misrepresentations to benefit an outstanding acquisition plan. Order at 19.
This Court previously ruled that plaintiffs' allegations as to the amount and timing of the sales raised the inference of recklessness but that plaintiffs had not alleged the sales were unusual or dramatically out of line with prior trading history. Order at 18-19. Defendants contend the existence of an acquisition plan is insufficient to create a strong inference of scienter. Defs' Mem. at 12. Courts have recognized the powerful motive to distort a company's stock price when the stock will be used to acquire another company. Order at 19 (citing Rothman v. Gregor, 220 F.3d at 93); see also In re Boeing Sec. Litig., 40 F. Supp.2d 1160, 1175 (W.D. Wash. 1998).
(2) Terayon's Acquisitions
In the FAC plaintiffs allege that once defendants were told that Terayon's S-CDMA technology had not been voted on favorably by CableLabs, defendants began an acquisition "spree" to diversify Terayon's business. ¶ 34. Defendants had a substantial incentive to maintain Terayon's artificially inflated price because the terms of each acquisition required Terayon to issue additional shares if Terayon's stock price declined. ¶ 34. Thus, defendants allegedly were motivated to keep Terayon's stock price artificially inflated in order to (1) acquire these companies for as few as shares as possible, (2) avoid paying additional consideration if the stock price declined and (3) accomplish the acquisitions at all. ¶¶ 7, 20, 34. Plaintiffs contend that Terayon's acquisition of other companies using artificially inflated Terayon stock establishes scienter. The Second Circuit has ruled that, in some circumstances, the artificial inflation of stock price in the acquisition context may be sufficient for securities fraud scienter. See Rothman v. Gregor, 220 F.3d 81, 93 (2d Cir. 2000).
Defendants argue that the allegations are "flimsy" because the ANE, the Internet Telecom and Ultracom acquisitions did not become final until after the Class Period. Defs' Mem. at 13. Defendants overlook that the prices for these acquisitions were set and disclosed well within the class period, providing defendants with the motive to maintain Terayon's artificially inflated stock price to complete the acquisitions. Indeed, Terayon in its Form 10K (Patz Decl. Ex O at 5) filed on March 30, 2000, disclosed that the Company had already entered into an Agreement with ANE valued at $85 million. Id. at 4. Defendants also disclosed Terayon had entered into an Agreement with Internet Telecom based on the fair market value of Terayon stock on the days preceding the merger announcement on March 13, 2000. In addition, defendants disclosed that in March 2000, the Company had entered into an agreement to acquire Ultracom in exchange for Terayon shares valued at $30 million which ultimately did close at $30 million on April 27, 2000. Id. Finally, Terayon disclosed that it had entered into an Agreement with Combox in February 2000 in which Combox shareholders would receive 775,000 shares of Terayon stock valued at approximately $92 million. Id. at 5. Therefore, these prices were agreed upon well within the class period and provided incentive for defendants to maintain the inflated stock price to complete the acquisitions on the agreed upon terms and to avoid paying additional consideration if the stock price declined. The same can be said for the Radwiz and Telgate mergers which were entered into after defendants received the 9/8/99 letter from CableLabs. Thus, while these two agreements were executed prior to the class period, the consideration was dependent upon the value of Terayon stock at the one-year and nine month anniversary dates. Plaintiffs have adequately alleged scienter in that defendants knew it was crucial to use its stock to quickly diversify its business as it was crippled by the CableLabs' decision not to include S-CDMA in DOCSIS 1.1. ¶ 34.
Terayon's recent announcement that it incurred massive charges of $574.7 million to write down the carrying value of its intangible assets related to the acquisitions is another indicator that defendants knew Terayon's stock was inflated when the acquisitions were made. See Rothman, 220 F.3d at 92 (magnitude of write-off is significant in supporting an inference of fraudulent intent). Indeed, as disclosed in the Company's most recent 10-Q, Terayon's intangible assets have declined 94% from $643.7 million as of 12/31/00 to $36.7 million as of March 31, 2001.
By analyzing the insider selling allegations in isolation, defendants ignore the fact that plaintiffs do not seek to sustain scienter on insider trading alone but as one component "in combination" with the other factors discussed. ¶ 98. While the FAC does not include allegations regarding defendants' prior trading history, the timing of defendants' sales — shortly after defendants made positive false statements about Terayon and shortly after defendants received the cease and desist letter — reasonably confirms other direct evidence — the CableLabs' letters — supporting a strong inference of scienter.
Fritz sold 10,000 shares for $575,000 one day after Terayon filed its 3Q99 10-Q. ¶ 37. This Court ruled the 10-Q contained "several misleading statements." Order at 17. The Rakibs sold 85,500 shares with each receiving proceeds of $9.8 million within ten days of the January 18 conference call in which Z. Rakib falsely assured the market that the next generation of DOCSIS would include S-CDMA. ¶¶ 43-45. Further, the timing of the February 2000 sales by the Rakibs and Fritz (within days of receiving the February 2, 2000 cease and desist letter) could hardly be more suspicious. The Rakibs sold over $2.1 million of their stock on February 3 and 4, immediately after receiving the cease and desist letter and Fritz sold an astounding 90% of his shares for $13.55 million when Terayon stock was trading at its historical high. ¶¶ 56, 96.
Finally, the reaction by participants in the April 11 conference call to the timing of the insider sales and defendants' evasive responses further support a strong inference of scienter. When the cease and desist letter was disclosed during the conference call, one incredulous call-in participant asked, "Are you telling me that you [sold stock] before you told the public shareholders that you had a cease and desist letter with this strong language?" ¶¶ 88-89. Rather than respond, Z. Rakib stated that he had already made enough comments on the subject. The failure to respond to the accusation is an adoptive admission by silence. United States v. Henke, 222 F.3d 633, 642 (9th Cir. 2000). Fritz denied he sold 100% of his holdings and lamely claimed most of his shares had not yet vested. In fact, however, Fritz sold over 90% of his vested holdings in 2/00. ¶ 90.
In short, defendants sold stock on the heels of the false positive statements when Terayon's share price was in the highest range reached during its history. ¶ 96 (chart). Defendants' insider sales, while not necessary to establish scienter in this case, are sufficiently suspicious to serve as a strong component of scienter, particularly when considered together with the other allegations. ¶ 98.
CONCLUSION
For the reasons stated above, the court GRANTS IN PART and DENIES IN PART defendants' motion to dismiss the consolidated complaint.
The first amended consolidated complaint is deemed amended consistent with this order and and defendants shall file their answer within thirty (30) days of the date of this order. The court will not entertain any further motions to dismiss. The parties shall arrange with the courtroom deputy for a Case Management Conference ("CMC") to be held within sixty (60)days of the date of this order and the joint CMC statement shall be filed at least ten (10) days in advance of the CMC.
IT IS SO ORDERED.