Lewis v. Sporck

Decision Date09 April 1985
Docket NumberNo. C 84-20343 WAI.,C 84-20343 WAI.
PartiesHarry LEWIS, Derivatively On Behalf of NATIONAL SEMICONDUCTOR CORPORATION, a Delaware corporation, Plaintiff, v. Charles E. SPORCK, Peter J. Sprague, Donald E. Weeden, Robert Beshar, Harry H. Wetzel, Neil Goldschmidt, John R. Finch, Pierre R. Lamond, F. Joseph Van Poppelen, Charles C. Cushing, Robert Berryman, Walter R. Conway, Frank Traenkle, E. Floyd Kvamme, David N. Martin, David Turner, William Cox, James Doodey, J. Philip Russell, Patrick Verderico, E. Joseph Willits, and National Semiconductor Corporation, a Delaware corporation, Defendants.
CourtU.S. District Court — Northern District of California

COPYRIGHT MATERIAL OMITTED

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William S. Lerach, Specthrie & Lerach, San Diego, Cal., Joseph W. Cotchett, Cotchett & Illston, San Mateo, Cal., for plaintiff.

Seymour Kurland, Wolf, Block, Schorr & Solis-Cohen, Philadelphia, Pa., Richard Haas, Lasky, Haas, Cohler & Munter, San Francisco, Cal., for defendants.

ORDER

INGRAM, District Judge.

I. INTRODUCTION

In this shareholder derivative action, plaintiff Lewis is suing on behalf of National Semiconductor Corporation ("NSC") to recover for NSC the damages it has suffered because of the allegedly unlawful activities of certain of its present and former directors, officers, and employees.

The acts on which this suit is based stem from two essentially separate series of events. The first is the alleged falsification of testing data in connection with the sale of electronic components by NSC to the Department of Defense ("DOD"). The second is the alleged theft of trade secrets from International Business Machines Corporation ("IBM").

The defendants to this action may be divided into four groups. First, defendants Sporck, Sprague, Weeden, Beshar, Wetzel, and Goldschmidt are alleged to have been members of the board of directors of NSC during the relevant time period and to be implicated in both the testing data and trade secret incidents ("director defendants"). In addition, Sporck is alleged to be president and chief executive officer of NSC when these events occurred. Second, defendants Finch, Lamond, Van Poppelen, Cushing, Berryman, Conway, Traenkle, and Kvamme are alleged to be current or former NSC employees who were involved in the testing data falsification incident ("testing data employee defendants"). Third, defendants Russell, Verderico, and Willits are alleged to have been involved in the testing data matter as the chief accounting officers of NSC at that time ("accounting officer defendants"). Fourth, defendants Martin, Turner, Cox, and Doodey are alleged to be current or former NSC employees who participated in the theft of trade secrets from IBM ("trade secret employee defendants").1

In addition to the named defendants, Lewis has identified four "co-actors" who are said to have participated in the trade secret theft. These are Barry B. Saffaie, Raymond J. Cadet, Tabasson Ayazi, and Jonathan M. Fram.

Plaintiff's complaint sets forth six causes of action, all of which are grounded on both the trade secrets and testing data matters. Count I alleges violations by all defendants of the Racketeer Influenced and Corrupt Organizations Act of 1970 ("RICO"), 18 U.S.C. §§ 1961 et seq. Count II alleges a violation by the director defendants and the accounting officer defendants of Section 13(b)(2) of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. § 78m(b)(2) (Amend.1977). Counts III and IV assert that all defendants have intentionally and negligently breached their fiduciary duties to NSC. Count V alleges that the director defendants have violated Section 2116 of the California Corporations Code. Count VI sets forth a claim that all defendants have violated Sections 17200-17208 of the California Business and Professions Code.

Defendants have moved to dismiss this complaint on a variety of grounds. First, they assert that all claims based on the trade secret theft must be dismissed because Lewis failed to make a demand on NSC's board of directors to bring this lawsuit and there is no showing that such a demand would be futile. Fed.R.Civ.P. 23.1. This motion is GRANTED and all such claims are DISMISSED WITHOUT PREJUDICE to a future assertion in conformance with Rule 23.1.

Second, defendants move to dismiss the RICO claim for failure to plead with the required particularity. This motion is GRANTED. Lewis shall have 30 days from the filing of this order to amend his complaint in accordance with the analysis below.

In addition, defendants move to dismiss the RICO count for failure to state a claim on various grounds. Two of the arguments advanced by defendants are that plaintiff must allege a "racketeering enterprise injury" and that each defendant must have a prior criminal conviction for the alleged predicate acts of racketeering activity. The Supreme Court has recently granted review of two cases which present these issues. Sedima, S.P.R.L. v. Imrex Co., Inc., 741 F.2d 482 (2d Cir.1984), cert. granted, ___ U.S. ___, 105 S.Ct. 901, 83 L.Ed.2d 917 (1985); Haroco, Inc. v. American National Bank and Trust Co. of Chicago, 747 F.2d 384 (7th Cir.1984), cert. granted, ___ U.S. ___, 105 S.Ct. 902, 83 L.Ed.2d 917 (1985). Therefore, defendants' motion on these grounds is DENIED WITHOUT PREJUDICE to a renewal of the motion after the Supreme Court issues its rulings. The remainder of defendants' motion as to the RICO claim is DENIED.

Third, defendants move to dismiss the claim under Section 13(b)(2) of the Exchange Act on the ground that no private right of action exists under that section. This motion is GRANTED and Count III is DISMISSED WITHOUT LEAVE TO AMEND.

Finally, defendants move to dismiss the state law claims for lack of diversity jurisdiction on the ground that defendant Beshar, like plaintiff, is a citizen of New York. This motion is DENIED WITHOUT PREJUDICE pending the resolution of the viability of plaintiff's federal claims.

II. FACTS

The alleged facts as to the testing data incident are as follows. NSC was in the business of selling military grade microcircuits to the DOD and to other defense contractors which sell electronic hardware to government. During the three year period from May 1978 to August 1981, NSC submitted compliance reports to the DOD which fraudulently stated that NSC had performed the required testing of the components it was selling. Government specifications require microcircuits earmarked for military use to be "burned in" for 160 continuous hours at a specified temperature, in order to detect defective products. Such tests were not performed. The director defendants, accounting officer defendants, and testing data employee defendants are alleged to have caused the data falsification and the submission of the fraudulent reports.

Based on these falsified reports, NSC was indicted for 17 counts of mail fraud, 18 U.S.C. § 1341, and 23 counts of making false statements to the federal government. 18 U.S.C. § 1001. No individuals were indicted. The company pled guilty to all counts and was fined $1.75 million.

The alleged receipt of trade secrets stolen from IBM arises out of the relationship between National Advanced Systems ("NAS"), a wholly-owned and controlled subsidiary of NSC, and Hitachi, Ltd. ("Hitachi"), a Japanese corporation. NAS markets in the United States IBM "plug-compatible" computers manufactured by Hitachi. The term "plug-compatible," as used in the computer industry, refers to equipment which is designed by reverse engineering of IBM products, which involves examining a piece of equipment to determine how it functions and then reproducing that product. This process allows NAS and Hitachi to produce functional copies of IBM's equipment which will operate with software written for use with IBM computer products with little or no modification to that software. To perform reverse engineering, Hitachi and NAS either have to acquire an IBM product which is already on the market or collect information about imminent product releases by IBM.

The complaint alleges that NAS, with the knowing approval of the director defendants and the trade secrets employee defendants hired the named co-actors to steal trade secrets from IBM to expedite the process of reverse engineering. These co-actors, some of whom were ex-IBM employees, are alleged to have delivered copies of several confidential IBM documents to NAS in 1981-1982. On June 30, 1982, co-actors Saffaie, Cadet and Ayazi were indicted for multiple counts of knowingly transporting stolen goods, 18 U.S.C. § 2314, and knowingly receiving, concealing, and storing stolen goods. 18 U.S.C. § 2315. As a result, IBM brought a trade secret misappropriation suit against NSC, which was settled for $3 million.

III. FUTILITY OF DEMAND ON NSC'S BOARD OF DIRECTORS

The complaint alleges that on December 22, 1982 plaintiff made a written demand on NSC's board of directors to institute actions to recover damages suffered as a result of the testing data incident. However, Lewis did not make a similar demand as to the trade secret matter, asserting instead that such a demand would be futile. Defendants argue that all claims based on the alleged trade secret thefts should be dismissed because Lewis has not demonstrated futility. I believe that this argument has merit.

Fed.R.Civ.P. 23.1 sets forth the requirements which a shareholder must satisfy before bringing a derivative action. It states in pertinent part:

the complaint shall also allege with particularity the efforts, if any, made by the plaintiff to obtain the action he desires from the directors or comparable authority and, if necessary, from the shareholders or members and the reasons for his failure to obtain the action or for not making the effort.

Fed.R.Civ.P. 23.1.

Paragraph 16(e) of the complaint sets forth the reasons why Lewis argues that making a demand would be futile:

(i) a majority of the Board of Directors actively participated in
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