Free Memorandum in Opposition - District Court of California - California

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1 COUGHLIN STOIA GELLER RUDMAN & ROBBINS LLP 2 SHAWN A. WILLIAMS (213113) CHRISTOPHER M. WOOD (254908) 3 100 Pine Street, Suite 2600 San Francisco, CA 94111 4 Telephone: 415/288-4545 415/288-4534 (fax) 5 [email protected] [email protected] 6 LABATON SUCHAROW LLP 7 CHRISTOPHER J. KELLER JONATHAN GARDNER 8 140 Broadway, 34th Floor New York, NY 10005 9 Telephone: 212/907-0700 212/818-0477 (fax) 10 [email protected] [email protected] 11 Co-Lead Counsel for Plaintiffs 12 [Additional counsel appear on signature page.] 13 UNITED STATES DISTRICT COURT 14 NORTHERN DISTRICT OF CALIFORNIA 15 CITY OF WESTLAND POLICE AND FIRE ) No. C 07-05111-JSW 16 RETIREMENT SYSTEM and PLYMOUTH ) COUNTY RETIREMENT SYSTEM, On ) CLASS ACTION 17 Behalf of Themselves and All Others Similarly ) Situated, ) PLAINTIFFS' OPPOSITION TO 18 ) DEFENDANTS' SUPERSEDING MOTION Plaintiffs, ) TO DISMISS THE [CORRECTED] 19 ) CONSOLIDATED CLASS ACTION vs. ) COMPLAINT 20 ) SONIC SOLUTIONS, et al., ) DATE: September 5, 2008 21 ) TIME: 9:00 a.m. Defendants. ) COURTROOM: The Honorable 22 ) Jeffrey S. White 23 24 25 26 27 28

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1 2 3 I. 4 II. 5 6 7 8 9 10 11 12 13 14 III. 15 16 17 18 19 20 21 22 23 24 25 26 27 28 4. 3. b. c.

TABLE OF CONTENTS Page INTRODUCTION ...............................................................................................................1 STATEMENT OF FACTS ..................................................................................................3 A. B. C. D. E. F. G. H. I. Sonic's Stock Option Plans......................................................................................3 Sonic's Accounting for Stock Option Grants ..........................................................3 Backdated Option Grants.........................................................................................4 Backdated Stock Option Grants to the Officer Defendants .....................................4 The Audit Committee Investigation.........................................................................4 Sonic's Stock Price Plummets .................................................................................5 Sonic's Restatement.................................................................................................5 The False and Misleading Financial Statements......................................................6 The Individual Defendants Benefit from Stock Sales..............................................7

ARGUMENT.......................................................................................................................7 A. B. Standard ...................................................................................................................7 Plaintiffs Have Adequately Alleged Defendants' Scienter Under the PSLRA .....................................................................................................................7 1. 2. Backdating Is an Intentional Act..................................................................8 The Complaint Adequately Alleges that the Individual Defendants Participated in or Approved of the Backdating..........................................11 a. The Complaint Particularly Alleges that Doris Backdated the Options .....................................................................................11 The Complaint Particularly Alleges that Leighton Knew that the Financial Statements Were False and Misleading ............13 The Complaint Adequately Alleges that Sauer, Greber, Langley and Marguglio Were Aware of and Tacitly Approved of the Backdated Options..............................................14

Defendants' Class Period Stock Sales Further Support the Already Strong Inferences of Their Scienter ...........................................................15 Appointing an Interested Committee to Evaluate Its Own Conduct Is Akin to Appointing a Wolf to Guard the Henhouse ..............................16

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1 2 3 4 6. 5 6 7 IV. 8 V. 9 10 VI. 11 12 A. 13 14 15 VII. 16 17 18 19 20 21 22 23 24 25 26 27 28
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Page 5. Defendants' Knowledge Is Further Supported by Their Positions of Responsibility ............................................................................................18 Defendants' Execution of Multiple False Documents Including False Financial Statements Supports a Strong Inference of Scienter ........20 Group Pleading ..........................................................................................22

7.

THE COMPLAINT ADEQUATELY ALLEGES "CONTROL PERSON" LIABILITY AS TO ALL INDIVIDUAL DEFENDANTS...............................................22 THE COMPLAINT ADEQUATELY STATES SECTION 20A INSIDER TRADING CLAIMS AGAINST DEFENDANTS DORIS, SAUER, ELY, GREBER, LANGLEY, LEIGHTON AND MARGUGLIO..............................................25 PLAINTIFFS HAVE SUFFICIENTLY PLED DEFENDANTS' PROXIES CONTAINED MATERIAL MISREPRESENTATIONS AND OMISSIONS IN VIOLATION OF SECTION 14(a) ....................................................................................27 There Is a Direct Link Between the Misrepresentation and/or Omission and the Proposed Transaction ................................................................................28 Plaintiffs Adequately Plead that Defendants Were Negligent in Connection with Issuing the 2005 Proxy Statement ..............................................29

B.

CONCLUSION..................................................................................................................30

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1 2 3 CASES

TABLE OF AUTHORITIES Page

4 Arthur Children's Trust v. Keim, 994 F.2d 1390 (9th Cir. 1993) ...........................................................................................24 5 Belova v. Sharp, 6 No. CV 07-299-MO, 2008 WL 700961 (D. Or. Mar. 13, 2008) .....................................................................................27, 28, 29, 30 7 Berman v. Thomson, 8 403 F. Supp. 695 (N.D. Ill. 1975) ......................................................................................29 9 Berson v. Applied Signal Tech., Inc., 527 F.3d 982 (9th Cir. 2008) ...................................................................................8, 19, 20 10 Buban v. O'Brien, 11 No. C 94-0331 FMS, 1994 WL 324093 (N.D. Cal. June 22, 1994) ..................................................................................................26 12 Commc'ns Workers of Am. Plan for Employees' Pensions & 13 Death Benefits v. CSK Auto Corp., 525 F. Supp. 2d 1116 (D. Ariz. 2007) .................................................................................8 14 Hollinger v. Titan Capital Corp., 15 914 F.2d 1564 (9th Cir. 1990) ...........................................................................................22 16 Howard v. Everex Sys., Inc., 228 F.3d 1057 (9th Cir. 2000) ...............................................................................15, 20, 21 17 In re 3COM Sec. Litig., 18 761 F. Supp. 1411 (N.D. Cal. 1990) ..................................................................................22 19 In re Am. Bus. Computers Corp. Sec. Litig., No. 913, 1994 WL 848690 (S.D.N.Y. Feb. 24, 1994).......................................................26 20 In re Applied Micro Circuits Corp. Sec. Litig., 21 No. 01CV0649 KAJB, 2003 WL 25419526 (S.D. Cal. July 15, 2003) .............................................................................................25, 26 22 In re AST Research Sec. Litig., 23 887 F. Supp. 231 (C.D. Cal. 1995) ....................................................................................26 24 In re CNET Networks, Inc., 483 F. Supp. 2d 947 (N.D. Cal. 2007) ...............................................................................18 25 In re Countrywide Fin. Corp. Deriv. Litig., 26 No. CV-07-06923-MRP (MANx), 2008 WL 2064977 (C.D. Cal. May 14, 2008) ..................................................................................................25 27 In re Daou Sys., Inc. Sec. Litig., 28 411 F.3d 1006 (9th Cir. 2005) ...........................................................................................14
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3 In re Hansen Natural Corp. Sec. Litig., 527 F. Supp. 2d 1142 (C.D. Cal. 2007) .............................................................................10 4 In re Juniper Networks Inc. Sec. Litig., 5 542 F. Supp. 2d 1037 (N.D. Cal. 2008) ..................................................................... passim 6 In re Lattice Semiconductor Corp. Sec. Litig., No. CV04-1255-AA, 2006 U.S. Dist. LEXIS 262 7 (D. Or. Jan. 3, 2006) ..........................................................................................................20 8 In re McKesson HBOC, Inc. Sec. Litig., 126 F. Supp. 2d 1248 (N.D. Cal. 2000) .................................................................14, 27, 29 9 In re NorthPoint Commc'ns Group, Inc., Sec. Litig., 10 221 F. Supp. 2d 1090 (N.D. Cal. 2002) .......................................................................19, 20 11 In re Openwave Sys. Sec. Litig., 528 F. Supp. 2d 236 (S.D.N.Y. 2007)..........................................................................25, 27 12 In re Read-Rite Corp. Sec. Litig., 13 335 F.3d 843 (9th Cir. 2003) .............................................................................................13 14 In re Silicon Graphics, Inc. Sec. Litig., 183 F.3d 970 (9th Cir. 1999) ...............................................................................................8 15 In re UnitedHealth Group PSLRA Litig., 16 No. 06-CV-1691 ..................................................................................................................8 17 In re Zoran Corp. Derivative Litig., 511 F. Supp. 2d 986 (N.D. Cal. 2007) ....................................................................... passim 18 Knollenberg v. Harmonic, Inc., 19 152 Fed. Appx. 674 (9th Cir. 2005)...................................................................................28 20 LDK Solar Sec. Litig., No. C 07-05182 WHA, 2008 U.S. Dist. LEXIS 42425 21 (N.D. Cal. May 29, 2008) ................................................................................16, 17, 19, 20 22 Lee v. The City of Los Angeles, 250 F.3d 668 (9th Cir. 2001) .............................................................................................18 23 Manshardt v. Fed. Judicial Qualifications Comm., 24 408 F.3d 1154 (9th Cir. 2005) .............................................................................................7 25 Middlesex Ret. Sys. v. Quest Software, Inc., 527 F. Supp. 2d 1164 (C.D. Cal. 2007) ..................................................................... passim 26 27 28
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3 No. 84 Employer-Teamster Joint Council Pension Trust Fund v. Am. West Holding Corp., 4 320 F.3d 920 (9th Cir. 2003) ..................................................................................... passim 5 Paracor Fin., Inc. v. GE Capital Corp., 96 F.3d 1151 (9th Cir. 1996) .............................................................................................24 6 Ryan v. Gifford, 7 918 A.2d 341 (Del. Ch. 2007)............................................................................................10 8 Siemers v. Wells Fargo & Co., No. C 05-04518 WHA, 2006 WL 2355411 9 (N.D. Cal. Aug. 14, 2006)..................................................................................................23 10 Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S. Ct. 2499 (2007)............................................................................................... passim 11 Wilson v. Great Am. Indus., 12 855 F.2d 987 (2d Cir. 1988)...............................................................................................29 13 Wool v. Tandem Computers, Inc., 818 F.2d 1433 (9th Cir. 1987) ...............................................................................22, 23, 25 14 15 STATUTES, RULES AND REGULATIONS 16 17 18 19 18 U.S.C. §1350..................................................................................................................................21 15 U.S.C. §78n(a) ...............................................................................................................................27 §78t-1(a).............................................................................................................................25

20 Federal Rules of Civil Procedure Rule 8 .................................................................................................................................23 21 Rule 9(b) ........................................................................................................................8, 23 Rule 12(b)(6)........................................................................................................................7 22 Securities and Exchange Act of 1934 23 §10(b)......................................................................................................................... passim §20(a) ......................................................................................................................... passim 24 §20A........................................................................................................................... passim 25 26 27 28
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SUMMARY OF ARGUMENT Defendants' motion to dismiss plaintiffs' §10(b) claim is essentially limited to an attack on

3 the specificity of plaintiffs' scienter allegations.1 However, the complaint more than adequately 4 pleads facts establishing a "cogent and compelling" inference of scienter as to each defendant under 5 Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S. Ct. 2499, 2510 (2007). Plaintiffs have shown 6 through powerful and unchallenged statistical evidence (a 1 in 11 million chance), together with 7 Sonic Solutions' ("Sonic" or the "Company") own admissions, that Sonic intentionally manipulated 8 the grant dates of numerous option grants (by intentionally backdating them to dates on which the 9 Company's stock was trading at historic lows) to enrich themselves. Plaintiffs have also shown that 10 the individual defendants were responsible for both managing and approving the option granting 11 process and for review and approval of the false and misleading statements issued during the Class 12 Period. Defendants manipulated the grant dates and then purposefully hid their failure to properly 13 account for the in-the-money backdated grants from the Company's shareholders, investors, auditors 14 and the U.S. Securities and Exchange Commission. The options backdating scheme at Sonic was 15 prolonged and pervasive, influencing most options granted from 1996 to 2005 and resulted in the 16 Company having to issue a restatement covering the entire Class Period. 17 This predicate violation of §10(b) also results in control liability against the individual

18 defendants under §20(a) since, as senior executive officers, board members and Audit Committee 19 members, each individual defendant was personally involved in the fraudulent acts, they controlled 20 the subject matter of the fraud (the backdating) and the false statements. See In re Juniper Networks 21 Inc. Sec. Litig., 542 F. Supp. 2d 1037, 1053 (N.D. Cal. 2008). 22 Further, the predicate §10(b) violation combined with plaintiffs' allegations that they traded

23 on the same day as two individual defendants, within one day of a third individual defendant, within 24 25 Defendants do not take issue with plaintiffs' allegations (i) that defendants issued materially misleading statements between October 23, 2002 and May 27, 2007 (the "Class Period") (and only 26 several defendants ­ Mark Ely and the outside directors ­ argue that the misstatements are not attributable to them), (ii) that defendants' fraud on the market establishes reliance, or (iii) loss 27 causation. 28
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1 nine days of a fourth individual defendant and that numerous class members traded 2 contemporaneously with each insider selling defendant is sufficient to state a claim for violation of 3 §20A of the Securities Exchange Act of 1934. See Middlesex Ret. Sys. v. Quest Software, Inc., 527 4 F. Supp. 2d 1164 (C.D. Cal. 2007). 5 Finally, plaintiffs adequately allege a §14(a) claim as (i) the 2005 Proxy Statement contained

6 false and misleading statements about Sonic's options practices and the Company's financials and 7 (ii) the corporate transaction voted on (the election of directors ­ defendants here) is directly linked 8 to the ongoing options backdating scheme at Sonic which lead to plaintiffs' damages. 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28
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1

Plaintiffs City of Westland Police and Fire Retirement System and Plymouth County

2 Retirement System submit this Memorandum of Points and Authorities in opposition to the motion 3 to dismiss filed by defendants. 4 5 I. 6 MEMORANDUM OF POINTS AND AUTHORITIES INTRODUCTION Falsity is not at issue. Sonic Solutions ("Sonic" or the "Company"), through (i) its own

7 internal investigation1 first made public in a February 1, 2007 press release and (ii) a restatement 8 announced in its FY07 Report on Form 10-K on February 26, 2008 (the "Restatement"), admits a 9 substantial number of stock options granted during the Class Period (October 23, 2002-May 27, 10 2007) were backdated and not correctly accounted for by the Company. While defendants have 11 claimed in their motion that the Audit Committee "explicitly concluded" that no one at the Company 12 had engaged in any intentional wrongful conduct (Defs' Brf. at 1),2 the Audit Committee members 13 who reached that conclusion are defendants in this matter.3 These self-exonerating conclusions 14 are neither surprising nor probative. 15 Plaintiffs' Complaint specifically details that Sonic, including certain of its former top

16 officers and the Audit Committee members, carried out a pervasive scheme that defrauded investors. 17 In general, their purpose was to (1) enrich themselves by acquiring in-the-money, backdated stock 18 options; (2) reduce the Company's reported compensation costs by hiding the negative impact of 19 these grants (and similar backdated grants to other Sonic employees); and (3) hire and retain key 20 employees without having to pay them high cash salaries. ¶4. 21 22 23 Sonic's internal investigation was conducted by its Management and Audit Committee, the very individuals accused of backdating options at the Company. ¶136 (All paragraph references 24 ("¶") are to the [Corrected] Consolidated Class Action Complaint for Violations of the Federal 25 Securities Laws ("Complaint"), filed May 27, 2008.) 2 "Defs' Brf." refers to Defendants' Superseding Notice of Motion and Motion to Dismiss the 26 [Corrected] Consolidated Class Action Complaint; Memorandum of Points and Authorities Thereof.. 27 28
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In fact, this action was commenced prior to the Audit Committee announcing its conclusions.

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1

The Complaint details how Sonic and its officers committed fraud by, among other things:

2 (1) intentionally backdating numerous stock options in violation of the Company's publicly filed 3 plans to achieve a more favorable exercise price than that of the date the options were actually 4 granted, while representing to the market and accounting for such stock option grants as though they 5 were granted at the then current market price; (2) failing to properly account for backdated options; 6 and (3) reporting false grant dates for options whereon the price of Sonic stock was substantially 7 lower than on the date the option was actually granted. 8 The Complaint details how the scheme resulted in widespread violations of Generally

9 Accepted Accounting Principles ("GAAP") that caused every single financial statement, proxy 10 statement and earnings press release issued during the Class Period to be materially false and 11 misleading when made.4 12 The Complaint further establishes that Sonic's Audit Committee, comprised at all relevant

13 times of Robert M. Greber ("Greber"), Peter J. Marguglio ("Marguglio") and R. Warren Langley 14 ("Langley"), allowed this scheme to go on for years. Each of the Stock Option Plans provided that 15 the CEO and Board of Directors ("Board") had responsibility for issuing options. The Audit 16 Committee was also required to review and/or sign off on every false statement issued pursuant to 17 this scheme, all of which misstated the true nature, scope and financial impact of Sonic's backdated 18 option grants and other aspects of the Company's financial health. ¶121. 19 As revealed by the Restatement, defendants' scheme to backdate stock options lasted from

20 1996 through 2004 ­ an eight-year period. ¶72. Defendants' misconduct caused Sonic to materially 21 understate compensation expense and overstate earnings throughout the Class Period. For example, 22 in FY03, Sonic overstated net income by $4.4 million, while reporting net income of only $2.5 23 million. Thus, for FY03 Sonic reported net income of $2.5 million when it should have reported a 24 net loss of $1.8 million ­ an overstatement of 173.91%. Similarly in FY02 and FY04, Sonic 25 overstated net income by 84.53% and 86.01%, respectively. Sonic's reported earnings per share 26
4 Defendants do not challenge the materiality of any of the alleged false and misleading 27 statements. 28

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1 ("EPS") were also grossly overstated during the Class Period. In FY03 alone, Sonic reported EPS of 2 $0.13 when it should have reported EPS loss of $(0.11). ¶36. 3 II. 4 5 STATEMENT OF FACTS A. Sonic's Stock Option Plans

By 2000, Sonic had in place several Stock Option Plans pursuant to which the Company

6 could grant stock options to its employees, officers, directors and consultants (the "Stock Option 7 Plans").5 See Exhibits 2-5.6 Each Stock Option Plan was administered by Sonic's Board and CEO 8 (¶¶18-21)7 and each explicitly provided that the exercise price of incentive stock options may not be 9 less than 100% of the fair market value of the Company's common stock on the day of the grant. 10 ¶¶18-21. The date of grant was defined, in turn, as the date as of which the Administrator approves 11 the grant. ¶23. Doris was the Company's CEO during the entire nine-year period that the Company 12 backdated options grants. 13 14 B. Sonic's Accounting for Stock Option Grants

The Notes to Sonic's Consolidated Financial Statements in its Forms 10-K for FY03 through

15 FY06, clearly and falsely explain that Sonic followed Accounting Principles Board Opinion No. 25 16 ("APB 25") in accounting for stock options. Additionally, these Notes state: 17 18 ¶¶28, 81, 90, 98, 106. 19 20 Sonic's Stock Option Plans consist of: (i) a stock option plan approved by Sonic's Board in September 1989, which provides for the grant of stock options to employees and consultants (¶18); 21 (ii) a Directors Stock Option Plan approved by Sonic's Board in 1994, which provides for the grant the non-employee members option 22 of stock options to in 1998, which provides forof the Board (¶19); (iii) a stockoptions plan approved by Sonic's Board the grant of incentive stock to employees (¶20); and (iv) a stock option plan approved by Sonic's Board in 2000, which provides for grants of 23 incentive stock options to employees (¶21). 24 6 All "Ex. __" references are to the exhibits annexed to the Appendix to Consolidated Class Action Complaint for Violations of the Federal Securities Laws, filed on March 21, 2008. 25 Indeed, Sonic stated, throughout the Class Period, that it was the responsibility of the entire Board to administer the Company's executive compensation plans. As Board members, Robert J. 27 Doris ("Doris"), Mary C. Sauer ("Sauer"), Greber, Marguglio and Langley had this responsibility. ¶¶124-125. 28 26
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All options to date have been granted as incentive stock options ... [which] must be granted at fair value at the date of the grant.

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APB 25 provides that public companies that grant in-the-money options must take a com-

2 pensation expense for the difference between the fair value of the stock on the grant date and the 3 exercise price of the option. The measurement date for determining when a grant is issued is the first 4 date that the number of options, the optionees and the exercise price are known with certainty. ¶¶295 30. This simple policy was repeatedly violated during the Class Period, resulting in Sonic 6 understating its compensation expenses and overstating its reported net income. 7 8 C. Backdated Option Grants

Between 1996 and 2004, Sonic reported 14 discretionary options grants ­ eight of which

9 were made on dates when Sonic's stock price was trading at its lowest price for the relevant month 10 and sometimes the lowest price for the fiscal quarter and/or fiscal year. The odds that these grants 11 were so fortuitously timed by chance are approximately 1 out of 11 million. ¶9. 12 13 D. Backdated Stock Option Grants to the Officer Defendants

Sonic's proxy statements, filed with the U.S. Securities and Exchange Commission ("SEC"),

14 demonstrate that the grant date of options to A. Clay Leighton ("Leighton"), Doris and Sauer on 15 July 12, 2001 was chosen with hindsight to ensure they were granted when Sonic's stock price was 16 at the monthly and quarterly low (and the second lowest price for the year), thereby ensuring 17 maximum personal benefits to the recipients (while violating the Company's publicly stated policy. 18 ¶14. Leighton was also granted backdated options on five other occasions: (i) on July 16, 1996, the 19 lowest price of the quarter and second lowest price for the year (¶11), (ii) on July 22, 1997, the 20 lowest price for the quarter (¶12), (iii) on November 30, 2000, the monthly low (¶13), (iv) on March 21 11, 2003, the lowest price of the month and the remaining calendar year (¶78), and (v) on May 10, 22 2004, the lowest price for April through June 2004 (¶87). 23 24 E. The Audit Committee Investigation

On or about February 1, 2007, Sonic announced an internal investigation ­ led by the Audit

25 Committee and Company management ­ into its past options practices. ¶¶46-47 Each of the 26 individuals responsible for the internal investigation is a named defendant in this suit and was 27 responsible for Sonic's option backdating. 28
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1 2

F.

Sonic's Stock Price Plummets

When Sonic finally shed light on the Company's true financial and operational condition, its

3 stock price plummeted. For example, on February 1, 2007, when the Company announced it had 4 commenced a "voluntary" review of its historical stock option grant practices, that the Company 5 lacked proper documentation for historic option grants and that its past financial statements should 6 not be relied upon, Sonic's stock price fell $1.35 from $18.03 to $16.68 (¶¶46-47; Ex. 1); and on 7 February 15, 2007, when Sonic issued its press release providing select additional details of the 8 fraud, including for the first time that it expected the amount of charges to be material, the 9 Company's stock price dropped $2.45 from $16.20 to $13.75 on February 16, 2007 (¶¶48-49; Ex. 8). 10 These two drops alone account for a loss of market capitalization of more than $99 million. 11 Sonic's stock price dropped another $1.29 on May 18, 2007 following revelation for the first time 12 that the Company expected to have to record additional cash and non-cash charges for stock-based 13 compensation expense as a result of the options backdating. ¶¶50-51; Ex. 9. 14 15 G. Sonic's Restatement

The Company announced a Restatement in its Form 10-K for FY07 to restate consolidated

16 financial statements for FY98-FY05. The failure to properly expense backdated in-the-money 17 option grants had the most significant impact during FY03-FY05 ­ the heart of the Class Period ­ 18 for which Sonic wrote off all but $3.21 million of the $22.163 million previously reported as net 19 income and reduced EPS by a combined $0.82. ¶139. 20 While the Restatement was carefully crafted to obfuscate the details of the backdating

21 scheme, the Company made a number of significant admissions, including the admission that "a 22 substantial number of stock options granted during the review period were not correctly 23 accounted for," in accordance with GAAP.8 The Restatement also admitted: 24 25 26 27 28
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·

"[O]ption grant agreements were typically dated "as of" with no separate date for the signature of a Company officer, and Company personnel indicated that these agreements were typically generated as part of the end-of-quarter reporting cycle, notwithstanding the Record Date appearing on the documents themselves.

Emphasis is added unless otherwise noted.

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1 2 3 4 5 6 7 8 9 10 Ex. 6. 11

·

"[T]he Audit Committee noted instances in which personnel actively discussed how to correct mistakes related to the documentation and related accounting treatment, and when to inform auditors of those mistakes . . . ." Under each of our various options plans, our CEO [Doris] was delegated the authority to make grants to employees other than executive officers. As described above, except in particular circumstances . . . the Company . . . generally lack[ed] contemporaneous grant documentation sufficient to support the Record Dates for these option grants. Prior to September 23, 2005, our CEO [Doris] would typically make grants to our non-founder executive officer(s) who are considered "executive officers" for purposes of Section 16 of the Exchange Act in the same manner as he would for nonexecutive employees of the Company. Pursuant to the delegation to him under our various option plans, the CEO [Doris] generally did not have express authority to grant options to Section 16 officers, as this power was reserved for the board. Nevertheless, these grants were made in a consistent fashion and it is apparent that our board was aware of these option grants and did not disapprove of them. . . .

·

·

H. 12 13

The False and Misleading Financial Statements

The Complaint details the specific false and misleading statements contained in each of Sonic's public statements, including its press releases and public filings with the SEC, during the 14 Class Period. See ¶¶74-109, 112; Exs. 10-24. Doris and Leighton signed each public filing as well 15 as Sarbanes-Oxley Act of 2002 ("SOX") certifications for each public filing from the beginning of 16 the Class Period through the filing of Sonic's Form 10-Q for the quarter ended June 30, 2005. 17 Thereafter each public filing as well as each SOX certification was signed by David C. Habiger 18 ("Habiger") and Leighton. Each Form 10-K issued during the Class Period was signed by Doris, 19 Sauer, Greber, Marguglio, Langley and Leighton. ¶¶79, 88, 96, 105. Habiger also signed the FY06 20 Form 10-K. ¶105. Defendants also filed false proxy statements during the Class Period, which 21 falsely represented that "the exercise price is equal to the fair market value of Sonic's common stock 22 on the date of grant." ¶¶83, 91, 100. 23 24 25 26 27 28
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As the Company's top executives, it is more than reasonable to infer that the officer

2 defendants approved Sonic's false press releases. This is especially true for the CFO, since each 3 press release contains financial results for the Company.9 4 5 I. The Individual Defendants Benefit from Stock Sales

During the Class Period, Doris, Sauer, Mark Ely ("Ely"), Greber, Langley, Leighton and

6 Marguglio each handsomely benefited from sale of stock as depicted in the following chart: 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 For example, Sonic issued a press release on October 23, 2002, while Leighton was CFO, in which Sonic reported its 2Q02 financial results in advance of its Form 10-Q. ¶74. The financial 27 results reported in that press release were materially false. 28
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Defendants' Insider Stock Sales During the Class Period Defendant Dates of Sales Shares Sold Proceeds Received 8/12/03 ­ 1/8/07 956,000 $17,025,285 Doris & Sauer 9/5/06 28,071 $428,083 Ely 8/4/03 ­ 9/7/05 40,000 $663,865 Greber 8/4/03-9/6/05 38,000 $696,462 Langley 8/12/03 ­ 8/25/05 261,000 $4,440,900 Leighton 8/22/03 ­ 8/28/03 20,000 $254,630 Marguglio 1,343,071 $23,509,225 Total III. ARGUMENT A. Standard

A court may dismiss a complaint under Federal Rule of Civil Procedure 12(b)(6) only "if it appears beyond doubt that the plaintiff can prove no set of facts to support his claims." Manshardt v. Fed. Judicial Qualifications Comm., 408 F.3d 1154, 1156 (9th Cir. 2005). In considering defendants' motion to dismiss, "[a]ll allegations of material fact made in the complaint are taken as true and construed in the light most favorable to the plaintiff." No. 84 Employer-Teamster Joint Council Pension Trust Fund v. Am. West Holding Corp., 320 F.3d 920, 931 (9th Cir. 2003). B. Defendants Admit Falsity ­ Plaintiffs Have Adequately Alleged Defendants' Scienter Under the Private Securities Litigation Reform Act

A plaintiff may allege scienter through facts "`giving rise to a strong inference' that defendants acted with the intent to deceive or with deliberate recklessness as to the possibility of

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1 misleading investors." Berson v. Applied Signal Tech., Inc., 527 F.3d 982, 987 (9th Cir. 2008) 2 (citing In re Silicon Graphics, Inc. Sec. Litig., 183 F.3d 970, 983 (9th Cir. 1999). "In the Ninth 3 Circuit, recklessness (as a form of intentional conduct) has long sufficed to establish scienter for 4 §10(b) purposes." In re Juniper Networks, Inc. Sec. Litig., 542 F. Supp. 2d 1037, 1046 (N.D. Cal. 5 2008). 6 The Supreme Court, in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S. Ct. 2499 (2007),

7 recently clarified that when evaluating a defendant's scienter, courts must consider whether an 8 inference of scienter is "cogent" and "at least as likely as" ­ but not more likely than ­ "any 9 plausible opposing inference." Tellabs, 127 S. Ct. at 2503, 2510 (emphasis in original). Moreover, 10 contrary to defendants' approach here, Tellabs clearly states that "[t]he inquiry . . . is whether all of 11 the facts alleged, taken collectively, give rise to a strong inference of scienter, not whether any 12 individual allegation, scrutinized in isolation, meets that standard." Id. at 2509 (emphasis in 13 original).10 Tellabs also cautions "[t]he inference that the defendant acted with scienter need not be 14 irrefutable, i.e., of the `smoking-gun' genre, or even `the most plausible of competing inferences.'" 15 127 S. Ct. at 2510 (citations omitted). As discussed below, the totality of plaintiffs' allegations of 16 scienter meet, if not far exceed, the pleading requirements of Rule 9(b), the Private Securities 17 Litigation Reform Act ("PSLRA") and Tellabs. 18 19 1. Backdating Is an Intentional Act

Backdating is an intentional act. Like betting on a horserace that has already been run, the

20 backdating assures the options granted bear the low exercise prices.11 In this way, the backdating 21 22 This means that "the tie goes to the Plaintiff." Commc'ns Workers of Am. Plan for Employees' Pensions & Death Benefits v. CSK Auto Corp., 525 F. Supp. 2d 1116, 1120 (D. Ariz. 23 2007) (interpreting Tellabs). Defendants' assertion that plaintiffs' inferences must "outweigh" 24 competing inferences is thus an inaccurate statement of law. Defs' Brf. at 12. 11 See In re UnitedHealth Group PSLRA Litig., No. 06-CV-1691 (JMR/FLN), 2007 U.S. Dist. 25 LEXIS 40623, at *6-*8 (D. Minn. June 4, 2007) ("[T]his case is incredibly simple. Plaintiffs claim defendants were playing a game with a stacked deck. When awarded options, with deliberately 26 selected grant dates which were already in the money, defendants were playing a game. . . . [T]he patsy was either the hapless corporation, which in varying ways defendants controlled, or the 27 corporation's shareholders, whose equity provided the game's antes and bloated pot."). 28
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1 maximizes the value of those options to their recipient. The backdating company avoids recording 2 compensation expenses for these backdated options because the options appear to have been granted 3 at-the-money on the purported "grant date." The intent is to circumvent compensation expenses that 4 would otherwise be clearly required by GAAP, and to afford the optionees the greater benefit from 5 the options without any appropriate cost to the company. Option backdating is often concealed by 6 falsifying documents, creating documents that purport to grant options "as of" a certain date, or by 7 failing to properly document the grants in the first place. Indeed, numerous courts have found 8 statistical evidence a pattern of "granting" options on unusually fortuitous dates to be highly 9 probative of intentional backdating. 10 Here, plaintiffs have shown through powerful statistical data, together with the Company's

11 own admissions, that Sonic intentionally manipulated the grant dates of thousands of options through 12 backdating. They have also demonstrated that those responsible for the backdating were the same 13 individuals that reviewed and approved the false and misleading statements alleged in the 14 Complaint. The statistical improbability that a company and its executives would by chance select 15 such fortunate grant dates is powerful evidence that such grant dates were retroactively selected. 16 The more remote the odds, the stronger is the inference of intentional misconduct. 17 For instance, in In re Zoran Corp. Derivative Litig., 511 F. Supp. 2d 986, 1004 (N.D. Cal.

18 2007), 7 of the 32 grants at issue were priced on the lowest trading day of the relevant month, the 19 odds of which occurring by chance was 1 in 1,151 and 9 of 32 were made on one of the two lowest 20 trading days in a month. On these facts, the court stated, "hitting the most favorable date seven 21 times out of 32 is a striking pattern" and "agree[d] that this pattern seems hugely suspicious." Id. 22 Based on these facts, the court held "[c]oupled with the statistical pattern of favorable grant dates 23 and the fact that the grant date could be chosen at the will of the compensation committee, plaintiff 24 has plainly succeeded in pleading that these grants were backdated." Id. at 1005. 25 Likewise, in Middlesex Ret. Sys. v. Quest Software, Inc., 527 F. Supp. 2d 1164, 1181 (C.D.

26 Cal. 2007), Quest admitted that "most" of the options it granted between 1998 and 2002 were not 27 properly dated. The court found the "extremely fortunate [grant] dates give rise to a strong inference 28 that backdating has occurred and that it was done intentionally." Id. at 1182. For additional support,
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1 the court considered the graphical representation of the allegedly backdated grants and found it 2 equally remarkable. Id. The court stated: 3 4 5 6 7 The graphical representation lends substantial support to the notion that no amount of "highly technical" accounting treatments can obscure the obvious: that someone at Quest was engaging in substantial, prolonged, and intentional backdating of stock options. In the parlance of the Tellabs holding, the Court can definitively state that the inference that intentional backdating occurred at Quest is more "cogent and compelling" than any opposing inference offered by Defendant. Thus, in accordance with Ninth Circuit precedent, the question then becomes whether Plaintiff has adequately pled that Defendants either knew of the backdating, or were deliberately reckless in not knowing of the backdating.

8 Id. (emphasis in original). 9 Plaintiffs allege here that Sonic made 14 discretionary option grants between 1996 and

10 2004.12 ¶9. Of these, Sonic purportedly made eight grants on dates when its stock was trading at its 11 lowest point in the relevant month.13 Id. According to the statistical analysis performed for 12 plaintiffs by Professor Eric Lie, the odds of this happening by chance are 1 in 11 million. Id. 13 Additionally, the outrageously fortuitous grant dates occurred consistently for approximately eight 14 years between 1996 and 2004. These extraordinary odds and the lengthy duration of the conduct 15 leave little doubt that individuals at Sonic deliberately manipulated the purported grant dates of the 16 Company's options.14 See Ryan v. Gifford, 918 A.2d 341, 355-56 (Del. Ch. 2007) (backdating of 17 stock options is intentional and egregious conduct resulting in a substantial likelihood of liability). 18 19 In all, Sonic made 24 grants between 1996 and 2004, but at least ten of these grants were non-discretionary grants awarded under Sonic's non-employee director plan, which grant dates could 20 not be manipulated. 21 See ¶¶10-15, 78 and 87 for a graphical representation of Sonic's stock price on and surrounding these backdated grants. 22 14 In Hansen Natural Corp. Sec. Litig., 23 analogous.reThere, the plaintiffs offered nothing527 F. Supp. 2d 1142 (C.D. Cal. 2007), is not but their own analysis comparing defendants' purported option grant dates and the company's trading price ten days after the grant to conclude the 24 company had backdated. Id. at 1155-56. There was no statistical analysis performed as to the likelihood that such grants were chosen by chance, nor was there any description 25 analytical methods were, what those methods were based on, or whether the same of what plaintiffs' methods had been used by anyone else or had been peer reviewed. Based on such "cursory allegations," the court 26 declined to draw an inference that the grants at issue were backdated. Id. Here, by contrast, Lead expert, Eric Lie, is the leading statistician 27 Plaintiffs' techniques for ferreting out backdating at on the issue of backdating and has pioneered the analytical public companies. His work has been discussed extensively since his seminal report was published in May 2005. Professor Lie, using proven 28
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1

Defendants claim that there is no evidence of intentional wrongdoing. Defs' Brf. at 8.

2 Sloppy paper work and lax controls surrounding the granting of options, however, cannot explain 3 how nearly 60% of Sonic's discretionary option grants were purportedly made on the absolute 4 lowest trading day in the relevant month.15 Moreover, while sloppy paper work might (during 5 discovery) explain why the wrong grant dates were used, it cannot explain how the wrong grant 6 dates so consistently and overwhelmingly benefited the defendants. Where, as here, the odds of 7 defendants selecting the purported grant dates by chance are 1 in 11 million, the far more compelling 8 inference is that someone at Sonic intentionally backdated the grants at issue and that failing to 9 properly document such grants was necessary to facilitate the backdating and is additional indicia of 10 fraud. See Zoran, 511 F. Supp. 2d 986; Quest, 527 F. Supp. 2d 1164. 11 12 Sonic's admissions place responsibility for backdating options at the feet of Sonic's top 13 officers and directors. 14 a. 15 16 The Complaint Particularly Alleges that Doris Backdated the Options 2. The Complaint Adequately Alleges that the Individual Defendants Participated in or Approved of the Backdating

According to the terms of Sonic's Stock Option Plans and representations in Sonic's annual

17 reports, Doris was responsible for administering option grants to the Company's non-§16 executive 18 officers. As admitted in Sonic's Restatement, however, Doris consistently made option grants to 19 Sonic's §16 officers as well. ¶53. Each of the allegedly backdated grants was made to a §16 officer 20 of the Company. ¶¶10-15, 78, 87. Thus, by Sonic's own admission, Doris made each of the 21 22 methods of statistical analysis of potentially backdated grants, has concluded the chance of the grant at selected at random 23 datesthatissue being Hansen, and is evenwere astronomical. This evidence is far more compelling than pleaded in stronger than the evidence of backdating pleaded in Quest and Zoran. 24
15 See also Ex. 7 (September 19, 2006 letter from the SEC's Chief Accountant stating, "The 25 existence of a pattern of past stock option grants with exercise prices equal to or near the lowest price of the entity's stock during the time period surrounding those grants could indicate that the 26 terms of those grants were determined with hindsight. Further, in some cases, the absence of documentation, in combination with other relevant factors, may provide evidence of fraudulent 27 intent.").

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1 allegedly backdated grants. As demonstrated by the statistical improbability that those grant dates 2 were selected at random, there is at least a strong, cogent and compelling inference that Doris 3 intentionally backdated the grants at issue. See Zoran, 511 F. Supp. 2d at 1005. 4 At the time Doris backdated these grants, he was well aware that the terms of Sonic's Stock

5 Option Plans (plans he had adopted as a member of the Board) did not permit backdating. ¶¶17-23; 6 Exs. 2-5. When he later signed and certified statements in the Company's annual reports affirming 7 that all of the options issued by the Company were granted "at the fair market value of Sonic 8 Solutions' Common Stock on the date of grant," Doris knew or was deliberately reckless in not 9 knowing that these statements were false and misleading because he had backdated options to make 10 them in-the-money when actually granted. ¶¶79-82, 88-90, 96-99. Those same annual reports 11 falsely confirmed that Sonic "account[s] for share-based employee compensation using the intrinsic 12 value method in accordance with APB No. 25," even though Doris knew the Company did not 13 expense the options he himself had backdated. Id. Accordingly, Doris knew or was deliberately 14 reckless in not knowing that the Forms 10-K and related financial statements were false and 15 misleading. 16 Doris also certified each of the false financial statements at issue pursuant to SOX. ¶¶37, 76-

17 99. In those certifications, he stated the reports did not contain any untrue statements of a material 18 fact or omit to state a material fact necessary to make the statements not misleading, and that the 19 reports fairly presented in all material respects the financial condition, results of operations and cash 20 flows of Sonic. ¶37. The Complaint alleges that he knew or was deliberately reckless in not 21 knowing that these statements were false, because he had intentionally backdated options in 22 violation of Sonic's Stock Option Plans, then falsely stated in the reports that all options were 23 granted at the fair market value on the date of the grant. 24 The Complaint alleges that the certifications Doris signed also falsely stated that he and

25 Leighton had designed adequate disclosure controls to ensure that all material information regarding 26 Sonic was properly reported, that he and Leighton had tested those controls and deemed them 27 adequate, and that all deficiencies in those controls, as well as any known frauds (whether material 28 or not), were reported to Sonic's Audit Committee and its auditors. ¶37.
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1

Moreover, Doris repeatedly and falsely stated that Sonic accounted for options in accordance

2 with APB 25, but the Restatement admitted there was "little or no contemporaneous grant-specific 3 documentation that satisfies the requirements for `measurement dates' under APB 25." ¶32. 4 However, Sonic admits that the grants Doris backdated consistently lacked the required 5 documentation ­ a most rudimentary control and one that was required by the Stock Option Plans 6 themselves. ¶136. These admissions that suggest that defendants had a contemporaneous

7 knowledge of the falsity of his statement, if the later statement directly contradicts or is inconsistent 8 with the earlier statement. See, Quest, 527 F. Supp. 2d at 1189 (citing In re Read-Rite Corp. Sec. 9 Litig., 335 F.3d 843 (9th Cir. 2003)). The Complaint adequately alleges that Doris knew or was 10 deliberately reckless in not knowing that the statements at issue were false and misleading when 11 issued, and thus there is a strong, cogent and compelling inference of Doris' scienter. 12 13 14 b. The Complaint Particularly Alleges that Leighton Knew that the Financial Statements Were False and Misleading

Leighton received six of the eight allegedly backdated grants. ¶¶11-14, 78. Leighton was

15 also Sonic's CFO and certified false and misleading financial reports during the Class Period. Each 16 misstated the Company's earnings and was not prepared in accordance with GAAP due to 17 defendants' failure to properly account for the backdated options under APB 25. ¶¶75-108. Many 18 of those reports also included statements that all options were granted at fair market value and were 19 accounted for properly under APB 25. ¶¶80, 89-90, 97, 106. As the recipient of numerous options 20 that were patently in-the-money when issued to him, it defies logic and common sense to suggest 21 Leighton did not know those statements were false and misleading. See Quest, 527 F. Supp. 2d at 22 1183-84 ("[T]he Court finds that the substantial number and value of the option grants given to 23 Defendants that consistently had measurement dates on either the lowest prices of the year or 24 immediately proceeding [sic] rapid rises in the Company's stock, combined with Defendant's key 25 positions relating to both the granting of and/or accounting for stock options gives rise to compelling 26 inference of either Defendants' actual knowledge or deliberate recklessness."). 27 Leighton's certifications also included false assurances that he and Doris had designed or

28 caused to be designed adequate internal controls such that the Company's publicly released financial
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1 reports were true and accurate in all material respects. ¶¶37, 76-108, 123, 129-130. As Sonic later 2 admitted, however, those controls contained glaring material weaknesses. ¶¶109, 123, 136. 3 Moreover, despite requirements in the Stock Option Plans that each option grant required a written 4 option agreement memorializing the grant, the Restatement admitted that grants were routinely made 5 without the proper paperwork. Id. Accounting for options for which he lacked required paperwork 6 is at the very least deliberately reckless. Considering option grants can only be backdated by either 7 falsifying documents or by failing to create the required documents in the first place, Leighton's 8 receipt of and accounting for options that lacked the required paperwork, by itself, strongly indicates 9 his scienter. Scienter is properly alleged when the complaint alleges both false statements and the 10 defendants' close involvement in the preparation of those statements. Zoran, 511 F. Supp. 2d at 11 1013 (citing In re Daou Sys., Inc. Sec. Litig., 411 F.3d 1006, 1022-24 (9th Cir. 2005)). 12 Leighton's removal as Sonic's CFO and reassignment following disclosure of defendants'

13 fraud is additional circumstantial evidence of scienter. See In re McKesson HBOC, Inc. Sec. Litig., 14 126 F. Supp. 2d 1248, 1274 (N.D. Cal. 2000); see also In re Adaptive Broadband Sec. Litig., No. C 15 01-1092 SC, 2002 WL 989478, at *14 (N.D. Cal. Apr. 2, 2002) (inference of scienter raised because 16 "[a]s Adaptive's financial difficulties were coming to light" by a restatement and an internal 17 investigation "three of the named individual defendants either left the company or were moved to 18 new positions"). 19 20 21 c. The Complaint Adequately Alleges that Sauer, Greber, Langley and Marguglio Were Aware of and Tacitly Approved of the Backdated Options

Sauer, Greber, Langley and Marguglio were each members of Sonic's Board during the Class

22 Period. ¶¶24, 63, 65-67. As such, they were required by the Stock Option Plans to administer stock 23 option grants to Sonic's directors and §16 officers. ¶¶18-25. The annual reports each signed also 24 confirmed that such options were administered by these defendants. ¶¶22, 79, 88, 96, 105. 25 Sonic admitted that Doris had actually made the option grants to the Company's §16 officers,

26 and further admitted "it is apparent that our board was aware of these option grants and did not 27 disapprove of them." ¶¶53, 136. Thus, according to Sonic's admission, Sauer, Greber, Langley and 28 Marguglio each knew of the misconduct. By condoning the improper usurpation of their duties,
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1 these defendants demonstrate at least severe recklessness towards the propriety of Sonic's option 2 grants. 3 Moreover, as members of the Audit Committee throughout the Class Period, Greber, Langley

4 and Marguglio "reviewed and discussed the audited consolidated financial statements for the [Class 5 Period] with the Company's management and has discussed the matters required to be discussed 6 pursuant to Statement on Auditing Standards No. 61 (Communications with Audit Committees) with 7 the representatives of KPMG LLP, the independent auditors of the Company." See, e.g., Ex. B at 7 8 to Defendants' Request for Judicial Notice. Each signed the false financial statements indicating 9 their approval of the reports' contents. Howard v. Everex Sys., Inc., 228 F.3d 1057 (9th Cir. 2000). 10 Finally, Sauer co-founded Sonic with her husband Doris. ¶63. Considering her oversight of option 11 grants as a Board member and her receipt of backdated options, it is reasonable to infer that she 12 knew the statements alleged were false and misleading. These facts taken together support a strong, 13 cogent and compelling inference of their scienter. Tellabs, 127 S. Ct. 2499. 14 15 Plaintiffs allege that defendants sold $23 million worth of Sonic stock during the Class 16 Period. Defendants argue that their stock sales do not give rise to a strong inference of scienter 17 because plaintiffs have not alleged these sales were "unusual" or "suspicious" in number or timing, 18 or relative to their past trading behavior. Defs' Brf. at 19-20. 19 The percentage of shares sold is less relevant in the backdating context because the long 20 duration of the fraud alleviates any need to sell large numbers of shares quickly. Quest, 527 F. Supp. 21 2d at 1185. Where a defendant believes the fraud will continue undetected for years or decades, 22 there is no compulsion to sell-off shares quickly. Id. Moreover, large sales may have actually raised 23 suspicion, causing early detection of defendant's scheme. Id. "Thus, the requirement that 24 percentages be pled is only relevant when the insider is aware of the time that the inside information 25 will be disclosed and there will be a resulting effect on the stock price." Id. 26 With respect to timing, "the nature of Defendants' alleged scheme was such that there was no 27 preordained date on which the allegations of improper backdating would be revealed with the 28
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Defendants' Class Period Stock Sales Further Support the Already Strong Inferences of Their Scienter

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1 resulting drop in stock price." Id. Additionally, once backdating became public, any large stock 2 sales by the defendants would have caused a strong appearance of impropriety. Id. "Thus, the fact 3 that Plaintiff has not pled facts relating to the timing of Defendants' sales is of little significance and 4 this factor neither weighs for nor against a finding of suspicious stock sales." Id. 5 Likewise, whether defendants' sales were consistent with their prior trading history is also

6 moot because defendants are alleged to have been backdating options since Sonic went public. Id. 7 Thus, defendants' entire trading history has been influenced by the backdating fraud, rendering any 8 comparison to their pre-Class Period trading histories irrelevant. Id. at 1187. Therefore, this factor 9 does not weigh for or against a finding of suspicious stock sales either. Id. Accordingly "[g]iven 10 that the first factor, `amount of shares sold' weighs in favor of a finding that the stock sales provided 11 a motive for Defendants' backdating, and that the second and third factors neither weigh for nor 12 against a finding of suspicious stock sales . . . the stock sales are `suspicious,' and thus provide a 13 possible motive for Defendants' actions." Id. 14 15 Defendants argue that the findings of the Audit Committee exonerate them from liability for 16 the admitted fraud. Defs' Brf. at 4-5. A special committee or audit committee, however, is not the 17 final arbiter of defendants' liability. In fact, courts have not hesitated to find scienter was alleged 18 even where an independent committee investigating the fraud found it lacking. In Zoran, the district 19 court denied the defendant's motion to dismiss the §10(b) claims of backdating against the 20 company's CEO and CFO despite the fact that its own internal investigation concluded "that there 21 was no evidence of wrongdoing by any member of the company's senior management." 511 F. 22 Supp. 2d at 997-98, 1013. Indeed, to find that a special committee appointed by the company could 23 extinguish a plaintiff's claims would improperly usurp the role of the courts and place an 24 unwarranted degree of control in the hands of management to determine who would judge their 25 culpability. See, e.g., LDK Solar Sec. Litig., No. C 07-05182 WHA, 2008 U.S. Dist. LEXIS 42425, 26 at *31-*32 (N.D. Cal. May 29, 2008). 27 28
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4.

Appointing an Interested Committee to Evaluate Its Own Conduct Is Akin to Appointing a Wolf to Guard the Henhouse

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1

The inequity of such a scenario is highlighted in the instant case where Sonic's

2 "independent" investigators were its Audit Committee--the same defendant directors (Greber, 3 Langley and Margulgio) who are alleged to have approved of the backdating and the making of 4 numerous false and misleading statements. This "wolf guarding the henhouse" scenario reeks of 5 self-interest and offers no shelter to defendants. See Quest, 527 F. Supp. 2d at 1190; see also LDK, 6 2008 U.S. Dist. LEXIS 42425, at *31-*32. For instance, in Quest, the defendants argued they could 7 not have intentionally violated the securities laws through backdating because each of the financial 8 statements at issue had been reviewed and approved by the company's auditors. The court 9 disagreed, stating: 10 11 12 13 14 15 The fact that the financial statements were audited is insufficient to negate a finding of knowledge or deliberate recklessness on the part of Defendants. Neither Defendants' Motion nor Reply states who performed the audits, whether the auditors were members of the board, whether the auditors were recipients of option grants, or whether auditing was done by an outside body hired by Quest. Plaintiff, however, has alleged that one of the members involved in the option backdating practices was also a member of the Audit Committee. To borrow from a colloquialism, this case presents a situation where the wolves were guarding the henhouse. Instead of protecting the company from reporting improper financial statements, those responsible for supervising and auditing the financial statements were the very same people facilitating and benefitting from Quest's financial improprieties.

16 Quest, 527 F. Supp. 2d at 1190. Here, plaintiffs allege that defendants Greber, Langley and 17 Marguglio knew or were deliberately reckless in not knowing that Doris had usurped his 18 administrative role of granting options to Sonic's officers and had backdated many of the grants he 19 made. ¶53. These defendants then signed annual reports during the Class Period which included 20 false statements assuring investors that Sonic did not grant in-the-money options, as well as inflated 21 earnings resulting from the improper accounting for backdated options. ¶¶79, 88, 96, 105. 22 Greber, Langley and Marguglio, as Sonic's Audit Committee, were responsible for ensuring

23 the Company had adequate internal controls and that its publicly released financial reports were 24 accurate. These same defendants then exonerated their own misconduct and that of their

25 confederates, and now seek to use their own biased conclusions as a shield to plaintiffs' claims.16 In 26 27 In their presentation of the facts, defendants state the special committee was "comprised solely of independent directors." Defs' Brf. at 4. While these directors may have been independent 28
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1 light of their self-interest, t