DEFENDANTS' NOTICE OFMOTION AND MOTION TODISMISS SECOND AMENDED COMPLAINT; MEMORANDUM Fed. R. Civ. P. 12(b)(6) and 9(b)
OF POINTS AND AUTHORITIES
IN SUPPORT OF MOTION TO
DISMISS

 

 

 

97cv00728 Berger v Ludwick et al (Bay Networks) - 5/4/98 Dfts Mtn To Dismss 2AC

TOWER C. SNOW, JR. (State Bar No. 58342)
KEVIN P. MUCK (State Bar No. 120918)
JANE ROWEN (State Bar No. 162455)
JAMES A. LICO (State Bar No. 169017)
ROBIN J. REILLY (State Bar No. 191579)
BROBECK, PHLEGER & HARRISON LLP
One Market, Spear Street Tower
San Francisco, CA 94105
Telephone: (415) 442-0900

MEREDITH N. LANDY (State Bar No. 136489)
BROBECK, PHLEGER & HARRISON LLP
Two Embarcadero Place
2200 Geng Road
Palo Alto, CA 94303
Telephone: (650) 424-0160

Attorneys for Defendants
Andrew K. Ludwick, Paul J. Severino, William J. Ruehle,
Ronald V. Schmidt, Jeffry R. Allen, Gary J. Bowen,
Dominic Orr, R. Stephen Cheheyl and Bay Networks, Inc.

UNITED STATES DISTRICT COURT

NORTHERN DISTRICT OF CALIFORNIA

PAUL BERGER, JOHN QUERCI, ROBERT
MASON, RONALD AND JUDITH HUGHES, MIN
RU, CHRISTOPHER FLYNN, CAL MELAND,
BARRY WOLINSKY, JOHN DRAKE, BRADLEY
PERNA, JASON MENDENHALL, THOMAS
JOHNSTON, KENNETH GRIFFIN, MARC A.
TOPAZ, LUIS SAN ANDRES, ALAN TRESKI,
DAVID M. KAMMERER, MICHAEL A.
INGENITO, KYNA SAH, CHINHI SONG, JONG E.
LEE, FONG OU, SUSAN BLACK and ROBERT
BORTNER, II, On Behalf of Themselves and All
Others Similarly Situated,

                      Plaintiffs,

           vs.

ANDREW K. LUDWICK, PAUL J. SEVERINO,
WILLIAM J. RUEHLE, RONALD V. SCHMIDT,
JEFFRY R. ALLEN, GARY J. BOWEN, DOMINIC
ORR, R. STEPHEN CHEHEYL, and
BAY NETWORKS, INC.,

                      Defendants.
___________________________________________

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No. C-97-0728-CAL
[filed May 4, 1998]

CLASS ACTION

DEFENDANTS' NOTICE OF
MOTION AND MOTION TO
DISMISS SECOND AMENDED
COMPLAINT; MEMORANDUM
OF POINTS AND AUTHORITIES
IN SUPPORT OF MOTION TO
DISMISS

Date: June 26, 1998
Time: 9:30 a.m.
Place: Courtroom 10


TABLE OF CONTENTS

NOTICE OF MOTION AND MOTION

POINTS AND AUTHORITIES

I. INTRODUCTION

II. FACTUAL BACKGROUND

III. SUMMARY OF ARGUMENT

IV. PLAINTIFFS' "INFORMATION AND BELIEF" ALLEGATIONS ARE INADEQUATE

V. PLAINTIFFS DO NOT ADEQUATELY ALLEGE THE ESSENTIAL ELEMENT OF SCIENTER

VI. PLAINTIFFS HAVE AGAIN FAILED TO ALLEGE ADEQUATELY THAT DEFENDANTS MADE ANY ACTIONABLE MISREPRESENTATIONS OR OMISSIONS CONCERNING BAY'S PRODUCTS

VII. PLAINTIFFS HAVE NOT STATED A CLAIM FOR MISREPRESENTATIONS OR OMISSIONS CONCERNING BAY'S ALLEGED BUSINESS OR ORGANIZATIONAL PROBLEMS

VIII. CONCLUSION



TABLE OF AUTHORITIES

CASES

Acito v. IMCERA Group, Inc.,
     47 F.3d 47 (2d Cir. 1995)

Bastian v. Petren Resources Corp.,
     892 F.2d 680 (7th Cir.),
     cert. denied, 496 U.S. 906 (1990)

Citibank, N.A. v. K-H Corp.,
     968 F.2d 1489 (2d Cir. 1992)

Glassman v. Computervision Corp.,
     90 F.3d 617 (1st Cir. 1996)

Glenbrook Homeowners Ass'n v. Scottsdale Ins. Co.,
     858 F. Supp. 986 (N.D. Cal. 1994)

Grossman v. Novell, Inc.,
     120 F.3d 1112 (10th Cir. 1997)

Hockey v. Medhekar,
     99 F.3d 325 (9th Cir. 1996)

Hockey v. Medhekar,
     [Current Binder] Fed. Sec. L. Rep.
     (CCH) ¶ 99,465 (N.D. Cal. April 15, 1997)

In re Apple Computer Sec. Litig.,
     886 F.2d 1109 (9th Cir. 1989),
     cert. denied, 496 U.S. 943 (1990)

In re Baesa Sec. Litig.,
     969 F. Supp. 238 (S.D.N.Y. 1997)

In re Convergent Technologies Sec. Litig.,
     948 F.2d 507 (9th Cir. 1991)

In re Cypress Semiconductor Sec. Litig.
     [1992 Transfer Binder] Fed. Sec. L. Rep.
     (CCH) ¶ 97,060 (N.D. Cal. Sept. 23, 1992)

In re GlenFed, Inc. Sec. Litig.,
     42 F.3d 1541 (9th Cir. 1994)

In re Silicon Graphics Inc. Sec. Litig.,
     [1996-1997 Transfer Binder] Fed. Sec. L. Rep.
     (CCH) ¶ 99,325 (N.D. Cal. Sept. 25, 1996)

In re Silicon Graphics Inc., Sec. Litig.,
     970 F. Supp. 746 (N.D. Cal. 1997)

In re Storage Technologies Corp. Sec. Litig.,
     804 F. Supp. 1368 (D. Colo. 1992)

In re Syntex Corp. Sec. Litig.,
     95 F.3d 922 (N.D. Cal. 1994),
     aff'd, 95 F.3d 922 (9th Cir. 1996)

In re VeriFone Sec. Litig.,
     784 F. Supp. 1471 (N.D. Cal. 1922),
     aff'd 11 F.3d 865 (9th Cir. 1993)

In re Worlds of Wonder Sec. Litig.,
     35 F.3d 1407 (9th Cir. 1994),
     cert. denied sub nom., 516 U.S. 909 (1995)

Kramer v. Time Warner Inc.,
     937 F.2d 767 (2d Cir. 1991)

Mathews v. Centex Telemanagement, Inc.,
     [1994-1995 Transfer Binder] Fed. Sec. L. Rep.
     (CCH) ¶ 98,440 (N.D. Cal. June 8, 1994)

McGonigle v. Combs,
     968 F.2d 810 (9th Cir.),
     cert. dismissed sub nom., 506 U.S. 948 (1992)

Paracor Finance, Inc. v. General Electric Capital Corp.,
     96 F.3d 1151 (9th Cir. 1996)

Raab v. General Physics Corp.,
     4 F.3d 286 (4th Cir. 1993)

Santa Fe Indus. Inc. v. Green,
     430 U.S. 462 (1977)

Shields v. Citytrust Bancorp, Inc.,
     25 F.3d 1124 (2d Cir. 1994)

TSC Indus., Inc. v. Northway, Inc.,
     426 U.S. 438 (1976)

Wool v. Tandem Computers, Inc.,
     818 F.2d 1433 (9th Cir. 1987)

Zeid v. Kimberley,
     973 F. Supp. 910 (N.D. Cal. 1997)

STATUTES

Federal Rules of Civil Procedure
     9(b)
     12(b)(6)

Securities Exchange Act of 1934
     Section 10(b)
     Section 20(a)
     Section 21D(b)(1)(B)
     Section 21D(b)(2)
     Section 21D(b)(3)(B)
     Section 21D(b)(4)
     Section 21E(c)(1)(B)



NOTICE OF MOTION AND MOTION

TO: ALL PARTIES AND THEIR COUNSEL OF RECORD:

NOTICE IS HEREBY GIVEN that on June 26, 1998, at 9:30 a.m. in Courtroom 10 of the United States District Court, 450 Golden Gate Avenue, San Francisco, California, defendants Andrew K. Ludwick, Paul J. Severino, William J. Ruehle, Ronald V. Schmidt, Jeffry R. Allen, Gary J. Bowen, Dominic Orr, R. Stephen Cheheyl and Bay Networks, Inc. (collectively, "defendants") will, and hereby do, move this Court for an order dismissing the Second Amended Complaint in this action with prejudice.

This motion is brought pursuant to Fed. R. Civ. P. 12(b)(6) and 9(b) and the Private Securities Litigation Reform Act of 1995 ("Reform Act"), on the grounds that plaintiffs fail to allege facts sufficient to state a claim against defendants and fail to allege fraud with particularity. Defendants' motion is based upon: this Notice; the following Points and Authorities; the accompanying Declaration of Kevin P. Muck, Appendix of Authority and Request for Judicial Notice; the pleadings, records, and papers on file in this action; such other papers as may be filed at or before the hearing; and arguments made by counsel at the time of the hearing on the motion.



POINTS AND AUTHORITIES

I. INTRODUCTION

After more than twelve months of work and three separate pleading efforts, plaintiffs and their cadre of lawyers are still unable to state a claim for securities fraud against Bay Networks, Inc. ("Bay" or "the Company") and its officers and directors. Indeed, the Second Amended Complaint ("SAC") is noteworthy primarily for plaintiffs' stubborn insistence on prosecuting an action based on nothing more than "fraud by hindsight." Stripped to its essentials, the SAC (like its two predecessors) is premised on little more than the fact that Bay experienced a temporary business setback in 1996. The Company's outstanding performance throughout the class period -- during which it earned profits in every single quarter, despite operating in one of the world's most competitive industries -- is blithely ignored in favor of superficial and unsubstantiated assertions that the defendants somehow knew trouble was lurking around the corner.

Plaintiffs know that the Reform Act obligates them to plead specific facts establishing that, among other things, each alleged statement was false at the time it was made, such false statements proximately caused their purported losses, and each statement was made with scienter. Plaintiffs are also required to set forth with particularity all facts supporting their "information and belief" allegations. The Court detailed for plaintiffs the precise pleading requirements imposed by law, and painstakingly identified the many ways in which their previous effort fell short. The fact that plaintiffs once again fail to plead facts establishing that anyone engaged in securities fraud -- and instead rely on bald assertions and subsequent business setbacks in a futile effort to suggest that misconduct must have occurred during the class period -- demonstrates that plaintiffs simply have no basis for their allegations. It is time to terminate this action.

II. FACTUAL BACKGROUND

Bay is headquartered in Santa Clara, and is one of the world leaders in computer internetworking. The Company was formed in October 1994 through the merger of SynOptics Communications ("SynOptics") and Wellfleet Communications ("Wellfleet"). SAC ¶ 23.

Although mergers always present business and organizational challenges, the new Company's operational results quickly proved the soundness of the combination. For the first full quarter of combined operations -- the quarter ending March 1995 -- Bay's revenues exceeded $350 million, with net income of nearly $40 million.1/ In the following quarter, revenues grew to $390.7 million, and net income rose to $54.4 million (a substantial increase over the combined results of SynOptics and Wellfleet for the same period in the preceding year). See July 25, 1995 Press Release (Muck Decl., Ex. B), cited at SAC ¶ 57. Bay's performance continued to surge through the remainder of 1995. The quarter ending September 1995 saw revenues increase to $438.3 million (up more than 46% from the same period the prior year), and net income hit $61.4 million (nearly 66% above the comparable period a year earlier). See October 17, 1995 Press Release (Muck Decl., Ex. C), cited at SAC ¶ 76. Fueled by enthusiastic demand for its products (including its switching products), the Company posted even more impressive results for the quarter ending December 1995. Revenues were $541.6 million, and net income (even after taking a one-time charge of $0.09 per share, or about $18 million, in connection with the acquisition of Xylogics, Inc.) was $58.8 million. See 10-Q for Quarter Ended 12/31/95 (Muck Decl., Ex. D), cited at SAC ¶ 91.

The process of developing and introducing new products is a difficult one, especially in the competitive and rapidly-changing networking industry. As the Company moved into 1996, product transition issues began manifesting themselves. These issues were most significant in some of the Company's switching and modular hub products. As the SAC reveals, Bay publicly -- and candidly -- discussed these issues and their impact on operations. See, e.g., SAC ¶ 115. Nonetheless, the Company generated revenues of $521.7 million for the March 1996 quarter, and (despite incurring merger and acquisition charges of more than $30 million) reported net income of $29.2 million. See April 11, 1996 Press Release (Muck Decl., Ex. A), cited at SAC ¶ 115.

The challenges created by product transition continued through 1996. The Company addressed these issues (by, inter alia, realigning its business units and expanding its product lines), and revenues stayed fairly constant over the next two quarters. See SAC ¶ 124. Operations continued to generate substantial profits. Net income for the June 1996 quarter was $55 million. See July 23, 1996 Press Release (Muck Decl., Ex. E), cited at SAC ¶ 127. Although expenses attributable to the acquisition of LANCity Corporation (more than $42 million) reduced net income for the September 1996 quarter, the Company still reported a profit of about $5.6 million. See October 14, 1996 Press Release (Muck Decl., Ex. F), cited at SAC ¶ 132.

Bay disclosed its results for the September 1996 quarter on October 14, 1996, and simultaneously announced that defendant Ludwick had resigned as president and CEO. SAC ¶ 132. Plaintiffs contend this disclosure -- which marks the end of the class period -- had an "immediate" and negative impact on Bay's stock price. SAC ¶ 133. Plaintiffs filed suit four months later.

Defendants moved to dismiss the original complaint. Plaintiffs chose not to oppose that motion, instead filing an amended complaint. Because the amendment failed to remedy the myriad defects in the original complaint, defendants again moved to dismiss. That motion was granted by the Court (with leave to amend) on February 6, 1998. The SAC was filed on April 3, 1998.2/

The most recent pleading is similar to its predecessors, both in its allegations and its deficiencies. Plaintiffs again allege that defendants falsely created a positive impression of Bay during the class period, and focus on two categories of alleged misrepresentations and omissions:

III. SUMMARY OF ARGUMENT

The SAC should be dismissed with prejudice for the following reasons:

IV. PLAINTIFFS' "INFORMATION AND BELIEF" ALLEGATIONS ARE INADEQUATE

In dismissing the first amended complaint, this Court specifically instructed plaintiffs that "if the allegations are going to be made on information and belief, they have to ... state with particularity all facts on which the belief is formed." Transcript, 2/6/98 ("Tr."), at 11:2-6, attached as Ex. G to Muck Decl. Despite this directive, the SAC fails to state those facts upon which plaintiffs' information and belief are based. Indeed, although plaintiffs admit that the entire SAC is based on information and belief (SAC ¶ 10), the statement of the purported basis for those allegations is virtually identical to the last amended complaint. Compare First Am. Comp. p. 2 with SAC ¶ 10.

As this Court is well aware, the heightened pleading standard for allegations made on information and belief was one of the key procedural protections implemented by the Reform Act. The statute is unambiguous: if a complaint is based on "information and belief," the plaintiff must "state with particularity all facts on which that belief is formed." Section 21D(b)(1)(B) (emphasis added).5/ Moreover, plaintiffs must plead those facts with the requisite particularity before they have the opportunity to conduct formal discovery. See Section 21D(b)(3)(B); Hockey v. Medhekar, 99 F.3d 325, 328 (9th Cir. 1996) ("Congress clearly intended that complaints in these securities actions should stand or fall based on the actual knowledge of the plaintiffs rather than information produced by the defendants after the action has been filed") (emphasis added).

In re Silicon Graphics Inc. Sec. Litig., 970 F. Supp. 746, 763 (N.D. Cal. 1997) (hereafter, "Silicon Graphics II"), spells out those requirements imposed by the Reform Act. Plaintiffs "must literally . . . include the names of confidential informants, employees, competitors, Government employees, members of the media, and others who have provided information leading to the filing of the case." Id. (quoting 141 Cong. Rec. H2848 (March 8, 1995) (remarks of Rep. Bryant), and 141 Cong. Rec. H2849 (March 8, 1995) (remarks of Rep. Dingell)).

By contrast, plaintiffs here have once again failed to specifically identify a single source for their allegations. See, e.g., SAC ¶ 10. The SAC does not, for example, contain the name of a single person or document upon which plaintiffs purportedly rely. Although plaintiffs have scattered oblique references to unidentified "former employees" at various points in the SAC (see, e.g., SAC ¶¶ 56, 70), these minimal changes do absolutely nothing to flesh out "all facts" on which plaintiffs' belief is purportedly based, and do not satisfy the requirements of Silicon Graphics II, which requires plaintiffs to identify these "former employees." Nor do plaintiffs describe how any of their supposed "sources" would have knowledge of matters alleged in the SAC.

The deficiencies in plaintiffs' information and belief allegations are substantial, and cut across virtually all of the purported misstatements and omissions relating to Bay's products and Bay's alleged business and organizational problems. Critically, all of plaintiffs' allegations concerning scienter -- which are necessarily based on information and belief, and are essential to plaintiffs' ability to state a claim -- must be disregarded because they do not satisfy the rigorous pleading requirements intended by Congress and detailed in Silicon Graphics II. This defect alone provides a sufficient basis to dismiss the SAC with prejudice.

V. PLAINTIFFS DO NOT ADEQUATELY ALLEGE THE ESSENTIAL ELEMENT OF SCIENTER

The elements of a Section 10(b) claim are: (1) a false statement or an omission that rendered a statement misleading; (2) materiality; (3) scienter; (4) loss causation; and (5) damages. Zeid v. Kimberley, 973 F. Supp. 910, 913-14 (N.D. Cal. 1997); In re Apple Computer Sec. Litig., 886 F.2d 1109, 1113 (9th Cir. 1989), cert. denied, 496 U.S. 943 (1990). In addition, as this Court explained in dismissing plaintiffs' amended complaint, "the complaints have to, first of all, specify each statement alleged to have been misleading, second, the reason or reasons why the statement is misleading. . . . In addition, where scienter is an element, as of course [it] is in this case under 10(b), the complaint must, with respect to each act or omission, state with particularity the facts giving rise to a strong inference that the defendant acted with the required state of mind." Tr. 5:8-19; see also Zeid, 973 F. Supp. at 914. As shown below, plaintiffs ignored the Court's directive.

Plaintiffs have failed to satisfy the Reform Act's requirement of "stat[ing] with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind," and to do so with respect to each act or omission alleged...." Section 21D(b)(2) (emphasis added). To establish a strong inference of scienter, plaintiffs must provide detailed facts. Silicon Graphics II, 970 F. Supp. at 767. As explained in Silicon Graphics II, even under the pre-Reform Act Second Circuit standard, unsupported general claims of the existence of negative or inconsistent internal reports were insufficient to establish scienter. For instance, to establish a strong inference of fraud based on internal reports, the plaintiffs must, at the very least, include "the titles of the reports, when they were prepared, who prepared them, to whom they were directed, their content, and the sources from which plaintiffs obtained this information." Id. (citations omitted). The SAC contains no such specific allegations.

Plaintiffs posit a series of alleged misstatements and omissions concerning the 28115, and have attempted unsuccessfully to assert that defendants made these statements with scienter. For example, plaintiffs claim that the individual defendants had actual knowledge of problems with the 28115 through their positions at Bay and their membership on the executive committee. SAC ¶ 60. However, they fail to state the date of a single meeting where, or identify a single internal document in which, the 28115 was discussed at all, much less the substance of the discussion. As this Court told plaintiffs, merely saying defendants "knew" statements were false is not adequate. Tr. 6:3-8.

Plaintiffs similarly make the conclusory assertion that the individual defendants instructed the sales force to "hold the market" by promising unrealistic delivery dates for products. SAC ¶ 51. Yet plaintiffs fail to state who communicated these "instructions," to whom they were communicated, when such communications occurred or what was said. Moreover, plaintiffs conspicuously fail to state the source of their supposed information.

Plaintiffs also allege that Severino oversaw the re-engineering of the 28115 and discussed it with all the other insider defendants before the 1995 Annual Report. SAC ¶ 62. Again, plaintiffs offer no detail concerning: when Severino discussed the 28115; with whom he had these discussions; the content of these discussions; or how such discussions demonstrate that anyone made statements with scienter. Moreover, plaintiffs again offer no source for this dubious allegation.

Along the same lines, plaintiffs allege that Ruehle, Bowen and Schmidt were also involved (with Severino) in re-design and re-engineering of the 28115. SAC ¶ 51. However, plaintiffs again fail to state facts establishing the source of this averment, what the "re-engineering" involved, when it commenced, the level of the individuals' involvement -- or, most importantly, how this involvement demonstrates that these individuals made statements about the 28115 with scienter.

The alleged misstatements and omissions relating to other Bay products, including the Centillion 100 and the 5000AH, are also unsupported by specific facts establishing scienter. For example, plaintiffs challenge an August 14, 1995 press release announcing a "target general availability" date for Centillion 100 enhancements (SAC ¶ 65) because defendants allegedly knew the target date could not be met. To support this bald conclusion plaintiffs state, without any hint of factual support, that "[i]t was known internally among the Bay sales force that Bay could not deliver" by the announced date. Id. ¶ 66. There are no facts explaining who in the sales force "knew" this information, how this "knowledge" was obtained, or to whom such knowledge was communicated. The conclusory averments do nothing to establish that the release was false when made, let alone establish scienter.

Similarly, plaintiffs are unable to plead facts showing that alleged product-related misstatements in the fall of 1995 were made with scienter. Plaintiffs claim that Bay's 1995 Annual Report, October 17, 1995 press release and 1996 First Quarter Report to Shareholders (SAC ¶¶ 74, 76, 80) were misleading because they failed to disclose problems in the products, including the 5000AH. However, the SAC contains no facts showing that product delays and manufacturing problems had manifested themselves at the time these statements were made. See Section VI.B., infra. Even more apparent is the failure to plead facts showing that anyone knew such problems were "plaguing" Bay at the time. Indeed, in light of the fact that one allegedly problematic product (the 28115) was already shipping in commercial volume (SAC ¶ 59), and the Company was experiencing record growth in both the September 1995 and December 1995 quarters, plaintiffs' conclusory assertions that defendants were aware of catastrophic production problems are ludicrous. Because plaintiffs' allegations of scienter do not even approach what is required under Silicon Graphics II, the product-related claims should be dismissed in their entirety.

Plaintiffs also contend that defendants made statements which failed to disclose various business and organizational problems affecting the Company (e.g., sales force conflicts, "channel stuffing," product overhang and inventory build-up). See, e.g., SAC ¶¶ 84, 93, 99, 105, 110. Putting aside whether these alleged misrepresentations and omissions are actionable, plaintiffs have not shown that any statement was made with scienter. In view of the Company's undeniable success throughout the class period, the suggestion that defendants knew that the Company was beset by systematic problems within its sales force, manufacturing department or the like is the worst sort of fraud by hindsight. Moreover, plaintiffs are unable to point to specific facts showing that anyone made a statement with knowledge that it was false (or even recklessly disregarding its falsity).

This defect is amply illustrated by two of the most prominent statements alleged in the SAC: comments attributed to Ludwick and Severino in March 1996. Plaintiffs allege that Ludwick said (in a March 15, 1996 Dow Jones article) that "sales momentum is very strong," "Sales numbers are there" and "Sales momentum is actually getting stronger." SAC ¶ 104. Ignoring the inherent vagueness of these alleged statements (e.g., whether the reference was to that particular quarter or some longer period), plaintiffs claim -- without any basis -- that Ludwick knew the statements were false when made. To establish this, plaintiffs rely on a statement, made six months later, in which the Company noted that "at mid-year we saw increased pressure on our switching products, as well as our shared media hub offerings, resulting in slower revenue growth." Id. ¶ 106. Of course, the latter statement was made with the benefit of hindsight, and in no way establishes that Ludwick's statement was false at the time it was made -- much less that he knew it was false. See In re GlenFed, Inc. Sec. Litig., 42 F.3d 1541, 1549 (9th Cir. 1994).

Plaintiffs make a similar "fraud by hindsight" argument with respect to Severino's alleged statement in late March 1996 that certain inventories "are in line with where they should be." SAC ¶ 109. Plaintiffs claim that Severino knew the statement was false because Bay went on to incur a write-down of unspecified inventory at the end of that same quarter. Id. ¶ 110. Yet there are no facts showing that the inventories Severino referred to were the ones written down, or that he had any inkling his statement might be inaccurate. Rather, plaintiffs unabashedly rely on "fraud by hindsight." Even before the Reform Act, such allegations would have been unavailing.

Undoubtedly recognizing their inability to satisfy the Reform Act's mandate, plaintiffs essentially recycle the inadequate "motive and opportunity" allegations from their earlier pleadings. See SAC ¶¶ 26 et seq. However, as this Court has held, the Reform Act imposes pleading requirements even more stringent than the former Second Circuit standard, and alleging "motive and opportunity" is no longer sufficient to plead scienter. Tr. 6:3-8. See, e.g., In re Baesa Sec. Litig., 969 F. Supp. 238, 242 (S.D.N.Y. 1997) (Reform Act expressly addresses and alters what is required to plead scienter, and pleading motive and opportunity is not sufficient to satisfy the pleading standard). Nonetheless, it is important to note that even under the former standard, plaintiffs' allegations would not have been sufficient to create a strong inference of scienter. To the contrary, the allegations negate any suggestion that defendants attempted to inflate the price of Bay stock.

Plaintiffs again claim that defendants' stock transactions during the seventeen-month class period are indicative of scienter. SAC ¶¶ 27-28. In reality, those transactions refute any notion that defendants tried to profit from the sale of stock at artificially inflated prices.

The fact that Bay -- itself a defendant -- purchased large amounts of stock during the class period proves that plaintiffs' entire case is illogical. SAC ¶¶ 36-38. These purchases demonstrate a good faith belief in Bay and its prospects, and are completely inconsistent with the notion that defendants knew the stock price was artificially inflated. Mathews v. Centex Telemanagement, Inc., [1994-1995 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 98,440, at 91,038 (N.D. Cal. June 8, 1994) (no scienter where company purchased 209,500 shares; "[i]t would have made no sense to purchase that stock if defendants knew the prices to be inflated"). For this reason alone, plaintiffs' allegations would have been inadequate even prior to the Reform Act.6/

Nor can plaintiffs derive any support from the individual defendants' stock sales. Even before Reform, such transactions would not give rise to a strong inference of scienter unless they are "unusual." Acito v. IMCERA Group, Inc., 47 F.3d 47, 54 (2d Cir. 1995); In re Cypress Semiconductor Sec. Litig. [1992 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 97,060, at 94,697 (N.D. Cal. Sept. 23, 1992). Plaintiffs here have not set forth facts demonstrating any unusual trading. In fact, defendants' stock sales were extremely modest in light of their total stock and option holdings. As demonstrated by defendants' filings on Form 4,7/ they sold only a small percentage of their collective holdings during the class period. Indeed, the three defendants alleged to have sold the most shares -- Ludwick, Severino and Schmidt -- had beneficial ownership of more than 8 million shares and options when the class period began.8/ Thus, the sales attributed to them in the Complaint constituted less than 10% of their holdings.

In other words, defendants did not "bail out" of the Company during the class period, but rather incurred massive losses when the stock price declined. These facts are completely inconsistent with plaintiffs' theory, and eviscerate any suggestion that defendants acted with scienter. See In re Silicon Graphics Inc. Sec. Litig., [1996-1997 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 99,325, at 95,966 (N.D. Cal. Sept. 25, 1996) ("Silicon Graphics I") (no scienter where defendants' sales were relatively small compared to their total holdings); Acito, 47 F.3d at 54 (stock sales by insiders only support a strong inference of scienter where plaintiff can show that trading activity was "unusual," meaning it was "in amounts dramatically out of line with prior trading practices, at times calculated to maximize personal benefit from undisclosed inside information"). Moreover, the absence of facts showing that defendants' sales were inconsistent with their usual selling practices underscores plaintiffs' failure to raise a strong inference of scienter. Silicon Graphics I at 95,967.

Plaintiffs also contend that the timing of defendants' sales was suspicious. SAC ¶ 28. In fact, Ludwick, Ruehle, Cheheyl, Allen and Bowen sold no shares after February 1996, and no defendant sold any shares after May 1996. See SAC ¶ 28. Indeed, the vast majority of the sales took place in 1995. This fact is significant because all defendants are alleged to have perpetrated a scheme to defraud into mid-October 1996. Insider sales that "occurred before the allegedly false or misleading statements were made ... cannot serve as motivation for later statements and thus did not occur at suspicious times." Hockey v. Medhekar, [Current Binder] Fed. Sec. L. Rep. (CCH) ¶ 99,465, at 97,083 (N.D. Cal. April 15, 1997). Thus, the timing of defendants' sales further destroys any suggestion that they acted with scienter.

Plaintiffs also hypothesize that defendants were motivated by unspecified "performance bonuses and other incentives" to engage in a fraudulent scheme. SAC ¶¶ 29-32. However, the SAC fails to identify these bonuses or other incentives, and contains no explanation of how such incentives would have rewarded defendants for temporarily inflating the Company's stock price. Even under the former Second Circuit standard, these allegations would be utterly inadequate to create a strong inference of scienter. See Acito, 47 F.3d at 54 (alleging defendants' compensation was dependent on stock value did not create a strong inference of scienter).

Equally futile is plaintiffs' allegation that defendants were prompted to inflate the Company's stock price during the class period to facilitate acquisitions. SAC ¶¶ 33-35. Significantly, the SAC refers to three stock-for-stock acquisitions, but of the three, one was completed just 15 days into the class period, and another was completed outside the class period altogether. These facts demonstrate the illogic of plaintiffs' argument. In any event, because plaintiffs plead no facts to support their fanciful theory, the SAC is inadequate. See Zeid, 930 F. Supp. at 438 (similar allegation inadequate where unsupported by facts that defendants were motivated to complete acquisition).

VI. PLAINTIFFS HAVE AGAIN FAILED TO ALLEGE ADEQUATELY THAT DEFENDANTS MADE ANY ACTIONABLE MISREPRESENTATIONS OR OMISSIONS CONCERNING BAY'S PRODUCTS

In addition to the lack of allegations demonstrating a strong inference of scienter, other fatal defects plague the SAC. For the reasons discussed below, the alleged statements concerning Bay's products are not actionable as a matter of law.

Loss causation is one of the essential elements of a Section 10(b) claim. Under the Reform Act, plaintiffs must establish that the alleged misstatements caused the loss for which they seek recovery. See Section 21D(b)(4). Because plaintiffs have not alleged facts demonstrating that any of the alleged misrepresentations or omissions regarding the 28115, Centillion 100 or 5000AH caused their purported damages, their claims fail as a matter of law.

The Reform Act essentially codified prior Ninth Circuit law that plaintiffs must prove loss causation. See McGonigle v. Combs, 968 F.2d 810 (9th Cir.), cert. dismissed sub nom., 506 U.S. 948 (1992). In McGonigle, the Ninth Circuit explained (in affirming a decision by this Court) that plaintiffs must establish two types of causation: transaction causation and loss causation. Transaction causation requires a showing that the purported misstatements or omissions induced the plaintiffs to purchase the stock. Id. at 820. Loss causation requires a showing that the misrepresentation or omission was in some reasonably direct, or proximate, way responsible for their loss. Id. at 821. "The causation requirement is satisfied in a Rule 10b-5 case only if the misrepresentation touches upon the reasons for the investment's decline in value." Id., (quoting Huddleston v. Herman & MacLean, 640 F.2d 534 (5th Cir. 1981)) (emphasis added). See also, Citibank, N.A. v. K-H Corp., 968 F.2d 1489, 1495 (2d Cir. 1992) ("a plaintiff must show that the economic harm that it suffered occurred as a result of the alleged misrepresentations"); Bastian v. Petren Resources Corp., 892 F.2d 680, 685-86 (7th Cir.), cert. denied, 496 U.S. 906 (1990) (plaintiffs must demonstrate that misrepresentation caused loss in order to establish liability under Rule 10b-5).

Thus, the mere allegation that plaintiffs purchased stock at artificially inflated prices is insufficient. They must also show that the purported misrepresentations caused their damage -- in other words, that the stock price declined because the market purportedly discovered that those particular facts had been misrepresented. McGonigle, 968 F.2d at 820. If the decline was not caused by such a disclosure, then loss causation is lacking. Id.

In this case, the SAC does not establish that Bay's stock drop was caused by the product-related statements at issue. With respect to the 28115, plaintiffs allege that Bay misleadingly represented the product began shipping in January 1995, but failed to disclose that it was recalled and did not ship in commercial quantities until August 1995. SAC ¶ 53. Notably lacking is any allegation that this purported misstatement caused any damage -- there are no facts showing that disclosure of delays in the 28115 ever had any impact on Bay's stock price. In fact, by alleging that the 28115 was shipping in commercial volume by August 1995, plaintiffs necessarily admit that the purported problems with the product had been resolved by that time -- long before the price drop prompting this lawsuit. Moreover, the "curative disclosure" which marks the end of the class period makes no reference to the 28115 or any other product problems. SAC ¶ 132.

Plaintiffs fare no better with the other alleged product-related misstatements. Although they aver that defendants falsely suggested that the Centillion 100 and 5000AH would be available in late 1995 (SAC ¶¶ 65-66, 68-69), they also concede that these products were shipping in commercial volume in 1996, long before the end of the class period. SAC ¶¶ 70, 96. The SAC is devoid of any facts tying the decline in Bay's stock price to these alleged misstatements -- or, for that matter, to anything having to do with problems with any of Bay's products.9/ Because plaintiffs cannot plead facts establishing the element of loss causation, the Court should dismiss with prejudice all claims based on product-related misrepresentations or omissions.

Throughout the SAC, plaintiffs attempt to establish the falsity of particular representations by pointing to subsequent statements or events that they contend are in some way inconsistent. The law is clear, however, that an inconsistency between a later statement and an earlier statement does not necessarily render the earlier one false or misleading. GlenFed, 42 F.3d at 1549. To allege falsity, a plaintiff should point to contemporaneous inconsistent statements by defendants or show that information available to defendants showed different results than defendants predicted. Id.

For example, plaintiffs rely heavily on a portion of the 1996 Annual Report, issued near the end of the class period, which states: "In early fiscal 1996, we introduced a 10/100 megabits per second (mb/s) Ethernet frame switch." SAC ¶ 52. Plaintiffs contend that statement referred to the 28115, and establishes that the May and July 1995 press releases stating that the 28115 had been shipping since January 1995 were misleading. Id. The allegation founders from the first because plaintiffs themselves admit that the 28115 actually began shipping in January 1995 (SAC ¶ 45), thus conceding that the challenged statements were literally true. Furthermore, the fact that a later statement is different from an earlier purported misstatement does not necessarily indicate that the earlier statement was false when made. Rather, plaintiffs must set forth facts explaining why the difference between the earlier and the later statements is not merely the difference between two permissible judgments. GlenFed, 42 F.3d at 1549. They have not satisfied this requirement.

Plaintiffs also fail to show that statements concerning other products, including the Centillion 100 and the 5000AH, were false when made. As discussed previously, plaintiffs complain about an August 14, 1995 press release which stated that the "target general availability" for the product was October. SAC ¶ 65. However, plaintiffs state no facts, other than hindsight, to establish that this statement was false when made. The fact that the prediction about target availability later turned out to be inaccurate does not render it untrue when made. In re Syntex Corp. Sec. Litig., 95 F.3d 922, 934 (N.D. Cal. 1994), aff'd, 95 F.3d 922 (9th Cir. 1996) ("because defendants' predictions proved to be wrong in hindsight does not render the statements untrue when made") (quoting In re VeriFone Sec. Litig., 784 F. Supp. 1471, 1486 (N.D. Cal. 1992) aff'd 11 F.3d 865 (9th Cir. 1993)).

Plaintiffs also allege that three other statements -- the 1995 Annual Report, an October 17, 1995 Press Release and the 1996 First Quarter Report to Shareholders -- falsely expressed optimism about product delivery. SAC ¶¶ 74, 76, 80. In particular, plaintiffs argue that defendants' statements were misleading in light of alleged delays in the introduction of certain products (principally, the 28115 and 5000AH) and purported manufacturing problems "plaguing" the Company. See SAC ¶¶ 75, 77, 81. This contention is also unsupported by facts demonstrating that the statements were false at the time they were made. In fact, when these statements were made in the fall of 1995, the production problems with the 28115 had (by plaintiffs' own allegation) been resolved, and the product was shipping in commercial quantity. SAC ¶ 59. Moreover, plaintiffs plead no facts showing that the 5000AH was behind schedule during this time frame; even if the 5000AH was not available in commercial quantities until 1996, that does not establish that, at the time of the challenged statements, product development was already behind schedule. See Syntex, 95 F.3d at 934; In re VeriFone Sec. Litig., 784 F. Supp. 1471 (N.D. Cal. 1922), aff'd 11 F.3d 865 (9th Cir. 1993).

Nor does the SAC contain facts establishing that Bay was suffering from systematic manufacturing problems. In fact, plaintiffs' own allegations show that the 28115 was shipping in volume, and the Company was in the midst of another wildly successful quarter. For the September 1995 quarter, Bay's revenues were up 46.3% over the same period for the prior fiscal year, and net income was up a whopping 65.9% (Muck Decl., Ex. C). Results for the following quarter were even more robust. This is hardly the profile of a "plagued" company, and the SAC contains no facts to the contrary. Consequently, plaintiffs have failed to plead adequately that the product-related statements were false when made.

A number of the alleged misrepresentations concerning Bay's products are forward-looking statements, including the August 14, 1995 statement that "target general availability" for certain Centillion 100 enhancements was in October. SAC ¶ 65. Under the Reform Act's "safe harbor," such forward-looking statements are not actionable unless plaintiffs plead specific facts demonstrating that the speaker had "actual knowledge" that the statement was false when made. Section 21E(c)(1)(B). In dismissing the previous complaint, this Court stated that, "in the process of amending, the plaintiff should take to heart the arguments that the defendant has made and strengthen their allegation[s] ... as much as they can . . . toward the objective of being able to plead actual knowledge." Tr. 10:5-9. Despite this admonition, the SAC falls far short of satisfying the Reform Act's requirements.

Indeed, plaintiffs hardly bothered to amend their pleading at all: they made virtually identical allegations regarding the August 14, 1995 press release in their Amended Complaint. See First Am. Comp. ¶¶ 68-69. Plaintiffs still do not provide facts demonstrating actual knowledge of falsity. Instead, plaintiffs make the conclusory allegation that "it was known internally among the Bay sales force" that Bay could not deliver the Centillion product on schedule, but that the sales force was instructed on orders from "Bay's upper management" to take customer orders anyway to "hold the market." SAC ¶ 66. Plaintiffs offer no specific facts supporting those bald assertions. There is no indication of when the sales force purportedly learned that the Centillion products would not be delivered on schedule, or from whom they obtained such knowledge. Similarly, there is no indication of who in "Bay's upper management" purportedly instructed the sales force to take customer orders in order to "hold the market," or when that purported directive was made. In fact, an equally reasonable (and more logical) interpretation of plaintiffs' allegations is that Bay's upper management truly believed at the time that the product would be available, and that is why the sales force was instructed to take customer orders for the products.

Plaintiffs also challenge a forward-looking statement relating to the Model 5000 AH: a September 12, 1995 press release which stated that "the Model 5000 AH . . . [is] scheduled for availability in the fourth [calendar] quarter of 1995." SAC ¶ 68 (emphasis added). Plaintiffs proffer several theories purportedly establishing actual knowledge. See SAC ¶ 70. Neither individually nor cumulatively, however, do those theories satisfy the Reform Act's pleading requirements. First, plaintiffs claim that "knowledgeable former Bay employees said they knew, at the time of the Press Release, that the products could not be ready by the date projected." Id. There is no identification of these "knowledgeable former employees," and no allegation as to what their knowledge is based upon or how these former employees would have any information as to the mental state of the highest ranking officers and directors of Bay.

Second, plaintiffs posit that the September 12, 1995 press release was issued in response to a press release by a Bay competitor. Id. Even if true, that would not establish that the contents of Bay's press release were false or that the speakers did not actually believe at the time that the product was scheduled for availability in the fourth calendar quarter of 1995.

Third, plaintiffs allege that in the first week of September 1995, Bay and its Executive Committee completed due diligence on the Xylogics acquisition and were briefed on the state of Bay's business and product development. Id. Plaintiffs state no facts indicating that anyone was told at these alleged meetings that the 5000AH would not be available in the fourth quarter of 1995.

Fourth, plaintiffs contend defendants had actual knowledge of falsity because on March 26, 1996 -- six months after the challenged press release -- Severino stated at a Merrill Lynch conference that the 5000AH would not ship until the June 1996 quarter. Id. Again, the fact that a statement of scheduled availability turns out to be incorrect does not mean it was false -- or that anyone knew it was false -- at the time it was made; this type of "fraud by hindsight" allegation was recognized as insufficient even before the Reform Act. See, e.g., Syntex, 95 F.3d at 934.

Despite the Court's admonition, the SAC contains no facts establishing that forward-looking statements were made with actual knowledge of falsity. Accordingly, all claims based on those statements should therefore be dismissed with prejudice.

As noted above, plaintiffs complain about statements concerning "target general availability" for certain Centillion 100 enhancements and the 5000AH. SAC ¶¶ 65, 68 (emphasis added). The communication of such a "target" cannot support a claim. A "corporation may ... provide the market with good faith predictions of its own future success.... Disclosure of this soft information by the corporation is optional, and liability will not attach for good faith, but erroneous, disclosure. Investors, knowing the inaccuracy inherent in forecasting, may choose to use or disregard predictions by the corporation at their option, after considering the value of such a prediction." VeriFone, 784 F. Supp. at 1482. Reasonable investors are well aware of the problems inherent in developing and bringing new products to market (especially with technology companies), and would not have relied on statements of "target general availability" in deciding whether to invest. See TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976); Syntex, 95 F.3d at 934 (statements related to future sales of new products were merely forecasts, which do not give rise to a securities fraud claim); VeriFone, 784 F. Supp. at 1485 (allegation based on failure to predict future sales does not state a claim).

Three other challenged statements -- the 1995 Annual Report, an October 17, 1995 Press Release and the 1996 First Quarter Report to Shareholders -- are also non-actionable, because they express (at most) optimism about product delivery. SAC ¶¶ 72-82. For example, the Letter to Shareholders in the 1995 Annual Report makes general statements concerning, among other things, Bay's sales forces, its multichannel distribution system and the merged Company's ability to achieve its financial and business goals during the first year of combined operations. SAC ¶ 74. Plaintiffs challenge these innocuous statements because defendants allegedly failed to disclose that: Bay was late-to-market with new products; there were internal engineering and marketing problems, including infighting and competition within the newly combined sales force; and Bay had not "merged and cross-trained" the original sales and support groups. SAC ¶ 75.

A statement cannot be actionable under Section 10(b) unless it involves a "material fact." See Paracor Finance, Inc. v. General Electric Capital Corp., 96 F.3d 1151, 1157 (9th Cir. 1996). Vague expressions of optimism do not provide a basis for fraud actions, because they lack materiality as a matter of law. See, e.g., Raab v. General Physics Corp., 4 F.3d 286, 289 (4th Cir. 1993); VeriFone, 784 F. Supp. at 1481. The average investor knows that such statements are too general and commonplace to rely upon. Raab, 4 F.3d at 289. The statements complained of in the 1995 Annual Report are (at most) vague expressions of optimism, and are not actionable as a matter of law. Grossman v. Novell, Inc., 120 F.3d 1112, 1121 (10th Cir. 1997) (statements made regarding merger, that corporation had experienced "substantial success" in integrating sales forces, that merger was moving "faster than we thought," and that merger presented "compelling set of opportunities," were immaterial statements of corporate optimism and would not support securities fraud claims). Plaintiffs fare no better with allegations concerning the October 17, 1995 press release and Report to Shareholders for quarter ended September 30, 1995. See SAC ¶¶ 76, 80. The challenged statements that "our product plans are on track" and "we are on track with the development and delivery of new products and service offerings that reflect the strength of the combined organizations" are merely vague expressions of optimism. As a matter of law, they are far too generalized to be material. Raab, 4 F.3d at 289; VeriFone, 784 F. Supp. at 1481. The statements make no specific predictions or guarantees of future success; rather, they broadly reflect the Company's optimism, and cannot be misleading as a matter of law. See Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1129 (2d Cir. 1994) ("misguided optimism is not a cause of action, and does not support an inference of fraud").10/

"A duty to disclose technical or developmental problems with a product may arise where a company makes strongly optimistic or concrete statements about that product that are in stark contrast to its internal reports." Glassman v. Computervision Corp., 90 F.3d 617, 635 (1st Cir. 1996) (emphasis added). Plaintiffs have not alleged any "strongly optimistic" statement about any of the products at issue which would trigger a duty to disclose alleged developmental problems, or identified a single internal report in "stark contrast" to the statements made. Thus, claims based on the failure to disclose alleged developmental problems with Bay's products should be dismissed.11/

VII. PLAINTIFFS HAVE NOT STATED A CLAIM FOR MISREPRESENTATIONS OR OMISSIONS CONCERNING BAY'S ALLEGED BUSINESS OR ORGANIZATIONAL PROBLEMS

Plaintiffs fare no better in their efforts to assert claims based on Bay's alleged misstatements and omissions concerning business or organizational problems. Even if plaintiffs could adequately allege that there were undisclosed problems regarding sales force conflicts, "channel stuffing," product overhang and inventories, such allegations do not support a claim for securities fraud.

As with their other claims, plaintiffs fail to plead facts demonstrating that any particular misrepresentation or omissions concerning Bay's purported business or organizational issues caused their losses. At no point do plaintiffs plead facts indicating that disclosure of sales force conflicts, "channel stuffing," product overhang, inventory problems or similar issues specifically caused the price of Bay's stock to decline -- a defect which dooms their claims. McGonigle, 968 F.2d at 820.

The statements attributed to Ludwick and Severino in March 1996 again illustrate plaintiffs' failure in this regard. Although plaintiffs allege conclusorily that Bay's stock price increased in response to Ludwick's vague statements about "sales numbers" and "sales momentum" (SAC ¶¶ 104 et seq.), they fail to demonstrate that disclosure of their purported inaccuracy caused their losses. Similarly, plaintiffs' allegation that Severino misstated Bay's inventory position on March 26, 1996 (id. ¶ 109) is unaccompanied by any facts showing that the Company's subsequent inventory write-down drove the stock price downward. Without such facts, there is no loss causation.

Plaintiffs allege that Bay misled the public by failing to disclose competition among the sales forces and by encouraging the public to believe that the merger was a success. For example, plaintiffs allege that statements made in 1995 Annual Report and July 25, 1995 press release were misleading for these reasons. SAC ¶¶ 84-85. Plaintiffs ignore the fact that, throughout 1995, Bay was unquestionably successful, and its revenues and profits (which were, of course, attributable to product sales) were going through the roof. For example, in the challenged July 25, 1995 press release, Bay reported that revenue for the fourth quarter of fiscal 1995 was up 35% from the same period in the prior year, and net income was up 56%. Revenue for fiscal year 1995 was up 24% from the prior year, and net income was $176.2 million (excluding non-recurring merger and acquisition related charges). See July 25, 1995 Release (Muck Decl., Ex. B). Plaintiffs do not challenge the accuracy of these reported results, which indisputably demonstrate a substantial degree of "success."

In light of the Company's performance during this time period, the existence of any competition among its sales ranks would have been trivial at best. "The securities laws do not require a corporation `to bury the shareholders in an avalanche of trivial information -- a result that is hardly conducive to informed decisionmaking.'" VeriFone, 784 F. Supp. at 1482, quoting TSC Indus., 426 U.S. at 448-49. See also, In re Convergent Technologies Sec. Litig., 948 F.2d 507, 516 (9th Cir. 1991).

Plaintiffs also allege that the Company's 10-Q for the quarter ending September 30, 1995 was false and misleading, because in spite of the existence of competition among the sales ranks, the Company attributed Bay's increase in revenue to "increasing unit sales of the Company's products through the Company's domestic direct sales force, its strength in international operations and continued execution of its multi-channel distribution strategy." SAC ¶¶ 88-89. Again, plaintiffs ignore Bay's reported results for the quarter at issue (which plaintiffs do not dispute): revenues of $438.3 million, up 46.3% from the same period for the prior year, and net income up 65.9% from the same period the prior year. See October 17, 1995 Press Release (Muck Decl., Ex. C). In light of these facts, it is evident that Bay had ample basis for its description of the reasons for its increased revenues.

Nevertheless, plaintiffs attempt to establish falsity by pointing to an announcement made in August 1996 -- nearly a year after the challenged statement was made -- that the Company had reorganized its development and marketing organizations as a result of challenges it faced during fiscal 1996. SAC ¶¶ 89-90. This is a non sequitur. Even if the "challenges" identified in August 1996 were known in the fall of 1995 (something which plaintiffs never establish), plaintiffs cannot explain why an appreciation of such challenges would demonstrate that the 10-Q (or any other statement) was false. In any event, plaintiffs cannot rely on statements made in August 1996 to establish that statements made in October 1995 were inaccurate (GlenFed, 42 F.3d at 1549), and plaintiffs conspicuously fail to identify any inconsistent statements contemporaneous with the 10-Q. Id. Claims based on a failure to disclose the existence of conflict among the sales forces should be dismissed with prejudice.

The portion of the SAC dealing with alleged "channel stuffing, inventory build-up and product overhang" is a hodgepodge of allegations which boils down to the basic allegation that the statements were misleading because they failed to predict a decline in demand due to product overhang and too much product already in the sales channel.

As an initial matter, plaintiffs do not adequately allege facts showing that Bay was suffering from these purported problems. Nonetheless, even if it was, and even if defendants believed that future results would decline as a result of "channel stuffing," inventory build-up or product overhang, claims based on the failure to disclose such beliefs cannot withstand a motion to dismiss. VeriFone, 784 F. Supp. at 1481; Convergent Technologies, 948 F.2d at 516. In VeriFone, plaintiffs alleged that defendants failed to disclose: delays in development of new products; the fact that a few sales had been atypically large and were not likely to be repeated; weak customer response to new products; and lack of potential in the Company's sales channels and core markets. 784 F. Supp. at 1477. The court held that defendants had no duty to disclose the speculative effects of such information, which amounted to forecasts of future results. Thus, the alleged omissions were not actionable, and the complaint was dismissed. Id. at 1484-85.

VeriFone is on all fours with plaintiffs' allegations. Plaintiffs focus on Bay's alleged failure to disclose facts showing: Bay was experiencing turf wars in its sales channels eroding Bay's competitive position (SAC ¶93(a)); Bay was losing market share because it was and continued to be late-to-market with key products (SAC ¶93(c)); slowing demand for products due to product overhang (SAC ¶ 96(a)); slow-down in demand for the System 5000 and 28115 due to the purported "channel stuffing" and instructions to "hold the market" (SAC ¶¶ 96(b), 97, 100, 101); Bay was losing share to its competitors (SAC ¶ 101); build up in inventory of the 28115 due to a slowdown in demand (SAC ¶ 102). Plaintiffs' allegations make it clear that the "omissions" they complain of are the failure to predict a downturn in future performance.

Plaintiffs make similar allegations with respect to what they term "partial disclosure" in several statements late in the class period. Each of those disclosures is challenged by plaintiffs, again because defendants allegedly did not disclose an expected future downturn in business. Specifically, plaintiffs complain that defendants failed to disclose: the decline in demand for Bay's 28115 and 5000 (SAC ¶ 116); Bay's disappointing operating results would continue (SAC ¶ 118); Bay was unable to get products to market on time and needed to cut prices to stimulate demand (SAC ¶ 123); Bay was continuing to lose market share, was being perceived by the market as unable to deliver new products on time and was losing customers to competitors (SAC ¶ 129). Each of these allegations amounts to nothing more than the claim that defendants should have disclosed a projected business downturn. For the reasons discussed previously, such claims are not actionable. VeriFone, 784 F. Supp. at 1484. Accordingly, to the extent that the SAC seeks recovery for the non-disclosure of such alleged problems as "channel stuffing," product overhang and inventory build-up, it should be dismissed with prejudice.12/

The allegations of "channel stuffing," product overhang and inventory problems are not actionable for another reason: defendants had no duty to disclose purported mismanagement. "[M]ismanagement by hindsight" claims are not cognizable under the securities laws. Santa Fe Indus. Inc. v. Green, 430 U.S. 462, 474-77 (1977); In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1419 (9th Cir. 1994), cert. denied sub nom., 516 U.S. 909 (1995) ("[p]laintiffs cannot use the benefit of 20-20 hindsight to turn management's business judgment into securities fraud").13/

The SAC also contains a jumble of additional allegations which also, upon examination, turn out to be nothing more than claims that Bay failed to disclose purported mismanagement. Specifically, plaintiffs allege that defendants failed to disclose: Bay's need to reorganize its business structure (SAC ¶ 116); Bay was unsuccessfully dealing with issues related to its transition to new products (SAC ¶ 118); Bay had been unable to execute its multichannel distribution strategy (SAC ¶ 123); Bay's previous product business unit had not served it well or helped it focus on its markets and customers; management had not met its product development or marketing plans; the sales force was engaged in turf wars and channel conflicts (SAC ¶ 125); there had been an "exodus" of employees and that Bay's internal controls were deficient, causing overpayment of sales commissions (SAC ¶ 126); and Bay's management was not dealing effectively with problems (SAC ¶ 129). For the reasons discussed above, such claims are not cognizable under the federal securities laws.14/

VIII. CONCLUSION

The SAC is plaintiffs' third attempt to plead a cognizable claim. It represents the best efforts of fifteen separate plaintiffs' firms specializing in securities litigation, and was drafted after this Court thoroughly detailed the deficiencies in the prior pleading. Yet plaintiffs still fail to state a claim against any of the defendants for securities fraud. The VeriFone court was faced with a similar situation and, in dismissing the complaint with prejudice, concluded "it would be unwise and an unfair burden on shareholders to give these law firms more than two bites at an apple they have not been able to get their teeth into." 784 F. Supp. at 1486. That conclusion applies with even greater force in this case. The SAC should be dismissed with prejudice.

Dated: May 4, 1998

BROBECK, PHLEGER & HARRISON LLP

By_______________________________________      Kevin P. Muck

Attorneys for Defendants


1/See April 11, 1996 release, attached as Ex. A to the Declaration of Kevin P. Muck ("Muck Decl."), cited at SAC ¶ 115. When a document is referenced in a complaint, it may be considered by the court on a motion to dismiss. Glenbrook Homeowners Ass'n v. Scottsdale Ins. Co., 858 F. Supp. 986, 987 (N.D. Cal. 1994).

2/The same plaintiffs' lawyers have also filed two duplicative complaints in California Superior Court, County of Santa Clara. Plaintiffs' motions for class certification in those actions were denied on April 13, 1998, and they have filed a notice of appeal.

3/See SAC ¶¶ 53-55, 57, 61, 65, 68, 73-74, 76, 78, 80, 112.

4/See SAC ¶¶ 84, 88, 92, 98, 104, 109, 115, 124, 128.

5/Unless otherwise stated, all statutory references are to the Securities Exchange Act of 1934.

6/Plaintiffs feebly try to blunt the effect of this fact, alleging that the purpose of the repurchase program was to raise the price of the Company's stock "after it had fallen in April 1996" and allow the Individual Defendants to "dump" their stock. SAC ¶ 38. Yet plaintiffs allege absolutely no facts to support this assertion. Moreover, the contention is illogical for several reasons: (1) it ignores the fact that nearly $50 million in stock was purchased by the Company before April 1996; (2) it suggests that the Company's directors -- including individuals who are not defendants -- were willing to squander corporate assets to further a fraudulent scheme from which they would not benefit; and (3) very few sales occurred between late April 1996 and the end of the class period.

7/Copies of the Individual Defendants' filings on Form 4 are attached as Exs. H-O to the Muck Decl. The Court may take judicial notice of documents filed with the SEC and consider them on a motion to dismiss. Kramer v. Time Warner Inc., 937 F.2d 767, 774 (2d Cir. 1991).

8/See Bay Networks, Inc. Form S-4 Registration Statement, filed on November 14, 1995, at pp. 57-59, showing beneficial ownership as of September 30, 1995. Excerpts of this Registration Statement are attached as Ex. P to the Muck Decl.

9/Plaintiffs make only one cursory attempt to show that a product-related disclosure prompted a stock drop: a March 1996 statement relating to the 58000. SAC ¶ 82. However, the 58000 is irrelevant to this action, because plaintiffs do not identify a single statement by Bay referring to that product. See fn. 11, infra.

10/Far more detailed statements have been held too vague to be actionable. See, e.g., In re Storage Technologies Corp. Sec. Litig., 804 F. Supp. 1368, 1372 (D. Colo. 1992) (statement that product would be "another blowout winner" not actionable); In re Syntex Sec. Litig., 855 F. Supp. 1086, 1095 (N.D. Cal. 1994) (statements that "I think we have a great future," "[w]e expect the second half of fiscal 1992 to be stronger than the first," "[e]verything is clicking [for the 1990's]," and "[n]ew products are coming in a wave, not in a trickle," are not actionable).

11/Although plaintiffs claim several times that the 58000 was late to market, they fail to identify any specific statements made by Bay relating to that product. Plaintiffs add a similar throwaway assertion about the 28104 switch without providing any facts regarding the product, when it was scheduled for release, when it was actually released or any statements referring to it. Thus, allegations concerning these products are irrelevant to plaintiffs' claims herein.

12/Plaintiffs also refer to several statements late in the class period which they do not contend to have been false or misleading. See SAC ¶¶ 114, 119, 126, 130 and 131.

13/In this regard, it is important to note that plaintiffs' repeated references to comments attributed to new CEO David House in a May 6, 1997 USA Today article (see SAC ¶¶ 6-7, 139) do nothing to advance their claims. The purported comments of Mr. House (i.e., that the merger "didn't take") represent, at most, the opinions of new management made with the benefit of hindsight, and are thoroughly irrelevant inasmuch as they: (a) do nothing to establish the defendants' state of mind during the class period; and (b) relate to management issues, which are not actionable as securities fraud.

14/Because plaintiffs have failed to allege a primary violation of Section 10(b), the claim for controlling person liability under Section 20(a) must also be dismissed. Wool v. Tandem Computers, Inc., 818 F.2d 1433, 1440 n.8 (9th Cir. 1987).




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