In re Northpoint Communications Group, Inc.

• Citation: 221 F.Supp.2d 1090
• Decision Date: 28 May 2002
• Docket Number: No. C 01-01473 WHA.,C 01-01473 WHA.
• Parties: In re NORTHPOINT COMMUNICATIONS GROUP, INC., SECURITIES LITIGATION And Consolidated Cases. This Document Relates To: All Actions.
• Court: U.S. District Court — Northern District of California

Page 1090

221 F.Supp.2d 1090

In re NORTHPOINT COMMUNICATIONS GROUP, INC., SECURITIES LITIGATION

And Consolidated Cases.

This Document Relates To: All Actions.

No. C 01-01473 WHA.

United States District Court, N.D. California.

May 28, 2002.

COPYRIGHT MATERIAL OMITTED

Kevin J. Yourman, Esq., Weiss & Yourman, Los Angeles, CA.

Behram V. Parekh, Esq., Weiss & Yourman, Los Angeles, CA.

Joseph H. Weiss, Esq., Weiss & Yourman, New York City.

Reed R. Kathrein, Esq., Milberg Weiss Bershad Hynes & Lerach LLP, San Francisco, CA.

Lesley E. Weaver, Esq., Milberg Weiss Bershad Hynes & Lerach LLP, San Francisco, CA.

Jason T. Baker, Esq., Milberg Weiss Bershad Hynes & Lerach LLP, San Francisco, CA.

William S. Lerach, Esq., San Diego, CA.

Jay L. Pomerantz, Esq., Latham & Watkins, Menlo Park, CA.

Kevin H. Metz, Esq., Latham & Watkins, Menlo Park, CA.

Monica Y. Kim, Esq., Latham & Watkins, Menlo Park, CA.

Lionel Z. Glancy, Esq., Glancy & Binkow LLP, Los Angeles, CA.

Michael Goldberg, Esq., Glancy & Binkow LLP, Los Angeles, CA.

Robert C. Susser, Esq., New York City.

William S. Lerach, Esq., Milberg Weiss Bershad Hynes & Lerach LLP, San Diego, CA.

Darren J. Robbins, Esq., Milberg Weiss Bershad Hynes & Lerach LLP, San Diego, CA.

ORDER: (1) GRANTING IN PART AND DENYING IN PART THE INDIVIDUAL DEFENDANTS' MOTION TO DISMISS; AND (2) GRANTING IN PART AND DENYING IN PART DEFENDANTS' REQUEST FOR JUDICIAL NOTICE

ALSUP, District Judge.

INTRODUCTION

On December 21, 2001, the Court dismissed the first consolidated complaint in this securities class action upon concluding that lead plaintiff FB Capital Management of Kansas, Inc., had failed to adequately plead falsity as to some statements and facts conducive to a "strong inference" of scienter as to all. Instead, the story presented by the complaint was consistent with a good-faith effort to address customers' mounting financial troubles by increasing the allowance for bad debt and excluding certain amounts from revenue and earnings. Leave to amend was granted.

Lead plaintiff has now submitted an amended consolidated complaint. Plaintiff claims the new pleading addresses its predecessor's shortcomings. The individual defendants naturally disagree, asserting that the new complaint still fails to satisfy the standards set by the Private Securities Litigation Reform Act of 1995 and In re Silicon Graphics, Inc., 183 F.3d 970 (9th Cir.1999). This order holds that the first amended complaint states a claim with regard to several (though not all) of the statements challenged therein.

STATEMENT

The facts of this case are set forth in the Court's prior order, In re Northpoint Comm. Group. Inc., Sec. Litig, 184 F.Supp.2d 991 (N.D.Cal.2001), and will not be repeated in detail herein. The central thrust of plaintiff's fraud claim is that NorthPoint, a digital subscriber line (DSL) wholesaler, was at least deliberately reckless in reporting inflated and uncollectible revenue; failing to record losses for uncollectible receivables; and identifying as "installed" or "subscribers" certain lines that were actually uninstalled or affiliated with delinquent customers.¹ Furthermore, plaintiff alleges that NorthPoint's overstated condition made its announcements regarding a looming merger with Verizon deliberately reckless, since Verizon would back out of the merger upon learning of NorthPoint's true condition. Significantly, the first amended complaint adds compelling allegations regarding "sham" transactions between NorthPoint and its customers. The complaint is brought under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. Control-person liability is alleged under Section 20(a) of the Exchange Act. The control-person defendants are Michael Malaga, founder and Chairman of NorthPoint; Elizabeth Fetter, the President and CEO; Michael Glinsky, an Executive Vice President and CFO; and Herman Bluestein, an Executive Vice President and the Chief Development Officer.

ANALYSIS

Like the initial consolidated complaint, the first amended complaint attacks statements made between August and November 2000. These statements, primarily in press releases, pertain mostly to revenues and earnings for the second and third fiscal quarters of 2000; the merger with Verizon; and customer and line counts. In alleging falsity and scienter, the complaint relies chiefly on: (1) allegations attributed to more than a dozen confidential witnesses; (2) disclosures by competitors and customers; (3) "admissions" made by NorthPoint in a civil suit against Verizon, and Verizon's contra-charges in its answer to NorthPoint's complaint; (4) stock sales by Fetter, Malaga and Bluestein; and (5) the existence of the looming merger with Verizon as a motive for fraud.

The second amended complaint repeats several arguments rejected as insufficient by the December 2001 order, primarily concerning alleged admissions by NorthPoint, insider sales, and customer and competitor disclosures. Although inadequate on their own, these allegations may support a viable fraud claim when combined with the newly-added facts. Even though this order will focus mostly on the new allegations, its conclusions rely on consideration of the first amended complaint as a whole.²

To avoid needless iterations of briefing and argument, prior to hearing on the present motion to dismiss plaintiff was ordered to submit all facts related to its confidential witnesses that the complaint relied upon in forming its allegations. At hearing, plaintiff was instructed to file and serve all documents in its possession or control relied upon by the complaint and the exhibits incorporated by reference therein. Plaintiff's supplemental submissions are deemed incorporated within the complaint. Defendants were allowed to file a reply brief responding to plaintiff's submissions; they submitted a lengthy memorandum that addressed these filings.

1. Motion to Dismiss.

Defendants have moved to dismiss the second consolidated complaint pursuant to FRCP 9(b) and 12(b)(6). A motion to dismiss under FRCP 12(b)(6) should not be granted unless it appears beyond a doubt that the plaintiff can prove no set of facts in support of his claim that would entitle him to relief. Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 2 L.Ed.2d 80 (1957). To state a claim for a violation of Rule 10b-5, a plaintiff must allege: (1) a misstatement or omission (2) of material fact (3) made with scienter (4) on which plaintiff relied (5) which proximately caused its injury. DSAM Global Value Fund v. Altris Software, Inc., 288 F.3d 385, 388 (9th Cir.2002). Scienter is a mental state embracing an intent to deceive, manipulate, or defraud. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n. 12, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976). When attacked pursuant to FRCP 12(b)(6), well-pled allegations in a complaint must be treated as true, and all reasonable inferences drawn in the plaintiff's favor. See North Star Int'l v. Arizona Corp. Comm'n, 720 F.2d 578, 580 (9th Cir.1983). Conclusory allegations of law and unwarranted inferences, however, are insufficient to defeat a motion to dismiss. In re VeriFone Sec. Litig., 11 F.3d 865, 868 (9th Cir.1993). When ruling on a motion to dismiss, the district court may consider the facts alleged in the complaint, documents attached to the complaint, documents relied upon but not attached to the complaint when authenticity is not contested, and matters of which the Court takes judicial notice. Parrino v. FHP, Inc., 146 F.3d 699, 705-06 (9th Cir.1998).

2. Private Securities Litigation Reform Act (PSLRA).

In 1995, Congress enacted the PSLRA to curb what were perceived as abusive practices in securities-fraud litigation. In raising the bar for securities-fraud suits, the PSLRA toughened the already-stringent requirements for pleading fraud under FRCP 9(b). Cf. In re GlenFed, Inc., Sec. Litig., 42 F.3d 1541, 1548 (9th Cir.1994). Under the PSLRA, to adequately allege securities fraud a complaint must specify each statement alleged to have been misleading, the reason or reasons why the statement was misleading and, if an allegation is made on information and belief, all facts upon which that belief is formed. 15 U.S.C. 78u-4(b)(1). In other words, the lenient inferences in plaintiff's favor that are normally de rigeur in considering a motion to dismiss cannot paper over key factual deficiencies in a securities-fraud complaint.

A complaint must also state with particularity facts giving rise to a "strong inference" that the defendant(s) acted with the required state of mind. 15 U.S.C. 78u-4(b)(2). "While under Rule 12(b)(6) all inferences must be drawn in plaintiffs' favor, inferences of scienter do not survive if they are merely reasonable, as is true when pleadings for other causes of action are tested by motion to dismiss under Rule 12(b)(6).... Rather, inferences of scienter survive a motion to dismiss only if they are both reasonable and `strong' inferences." Greebel v. FTP Software, Inc., 194 F.3d 185, 195-96 (1st Cir.1999) (citations omitted). The allegations in a securities-fraud complaint do not give rise to a strong inference of scienter if the facts pled more strongly support an inference of no wrong-doing. See In re Guess?, Inc., Sec. Litig., 174 F.Supp.2d 1067, 1078 (C.D.Cal.2001); In re VISX, Inc., 2001 WL 210481 at *3 (N.D.Cal. Feb. 27, 2001).³ In this circuit, the complaint must plead facts conducive to a "strong inference" of some form of intentional misconduct — either actual knowledge of falsity or "deliberate recklessness" as to the truth or falsity of a statement. In re Silicon Graphics, 183 F.3d at 977.⁴

3. Judicial Notice.

In ruling on a motion to dismiss, a court may take judicial notice of a document if it is relied on in the complaint (regardless of whether it is expressly incorporated therein) and its authenticity is not disputed. Parrino, 146 F.3d at 706. In this vein, a court may consider SEC filings...