Free Motion to Dismiss - District Court of California - California

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1 SARA B. BRODY (Bar No. 130222) CAROL LYNN THOMPSON (Bar No. 148079) 2 CECILIA Y. CHAN (Bar No. 240971) MATTHEW D. THURLOW (Bar No. 243470) 3 HELLER EHRMAN LLP 333 Bush Street 4 San Francisco, CA 94104-2878 Telephone: (415) 772-6000 5 Facsimile: (415) 772-6268 [email protected] 6 [email protected] [email protected] 7 [email protected] 8 Attorneys for Defendants SONIC SOLUTIONS, DAVID C. HABIGER, 9 ROBERT J. DORIS, A. CLAY LEIGHTON, MARY C. SAUER, MARK ELY, ROBERT M. GREBER, 10 PETER J. MARGUGLIO and R. WARREN LANGLEY 11 12 13 14 15 CITY OF WESTLAND POLICE AND FIRE RETIREMENT SYSTEM AND PLYMOUTH 16 COUNTY RETIREMENT SYSTEM, On Behalf of Themselves and All Others Similarly 17 Situated, 18 19 v. Plaintiff, UNITED STATES DISTRICT COURT NORTHERN DISTRICT OF CALIFORNIA Case No.: C 07-5111(JSW) CLASS ACTION DEFENDANTS' SUPERSEDING NOTICE OF MOTION AND MOTION TO DISMISS THE [CORRECTED] CONSOLIDATED CLASS ACTION COMPLAINT; MEMORANDUM OF POINTS AND AUTHORITIES IN SUPPORT THEREOF Date: Time: Crtrm: Trial Date: September 5, 2008 9:00 a.m. 2 None Set

20 SONIC SOLUTIONS, DAVID C. HABIGER, ROBERT J. DORIS, A. CLAY LEIGHTON, 21 MARY C. SAUER, MARK ELY, ROBERT M. GREBER, PETER J. MARGUGLIO and R. 22 WARREN LANGLEY, 23 24 25 26 27 28 Defendants.

The Honorable Jeffrey S. White

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

TABLE OF CONTENTS Page INTRODUCTION.................................................................................................1 STATEMENT OF FACTS ....................................................................................2 A. B. Description of the Defendants.....................................................................2 Sonic's Stock Option Program, Historical Review and Restatement ................................................................................................3 Plaintiffs and Their Complaints. .................................................................6

SUMMARY OF ARGUMENT .............................................................................7 FRAUD PLEADING STANDARDS UNDER RULE 9(b) AND THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 ....................................................................................................................10 PLAINTIFFS FAIL TO STATE A SECTION 10(b) CLAIM AGAINST ALL DEFENDANTS ........................................................................ 12 A. Plaintiffs' Complaint Fails to Plead a Strong Inference of Scienter as to All Defendants.................................................................... 12 1. The Complaint Fails to Plead Scienter and Fraud with Particularity as to the Individual Defendants .................................. 13 Sonic's Restatement Does Not Give Rise to a Strong Inference of Scienter. ............................................... 14 Plaintiffs Do Not Allege Facts Demonstrating that Defendants Knowingly or Recklessly Backdated Options or Knowingly or Recklessly Violated Accounting Rules. ............................................................... 15 Defendants' Corporate Positions and Roles in Preparing Routine SEC Filings and Press Releases Cannot Give Rise to a Strong Inference of Scienter. .............................................................................. 17 Signing Forms 10-K, Forms 10-Q, and SOX Certifications Does Not Give Rise to a Strong Inference of Scienter. .......................................................... 18 Defendants Stock Sales Do Not Create a Strong Inference of Scienter. .......................................................... 19 i

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1 2 3 4 5 6 7 8 9 VI. 10 11 12 13 14 15 16 17 VII. 18 19 20 21 22 23 24 25 26 27 28 A. B. C. B. 2.

Defendants' Receipt of Allegedly Backdated Options Does Not Create a Strong Inference of Scienter. .............................................................................. 20 Plaintiffs' Failure to Plead Scienter as to the Individual Defendants Precludes an Inference of Scienter as to the Company. ........................................................... 21

f.

The Complaint Fails to Attribute Any Misstatements to Ely or the Outside Directors. ........................................................................... 22 The Court Should Dismiss Any Claim Plaintiffs Purport to State for "Scheme" Liability. ....................................................................24

THE COMPLAINT FAILS TO PLEAD A SECTION 14(A) CLAIM ............................................................................................................... 26 The Applicable Statute of Limitation Bars Plaintiffs' Section 14(a) Claim Based on the 2003 and 2004 Proxy Statements...................... 26 Plaintiffs Fail to State a Section 14(a) Claim as to the 2005 Proxy Statement........................................................................................ 27 1. 2. Plaintiffs Fail to Plead Causation or Direct Injury. ......................... 28 Plaintiffs Fail to Adequately Plead a Strong Inference of Negligence................................................................................. 30

PLAINTIFFS FAIL TO PLEAD A SECTION 20(a) "CONTROL PERSON" LIABILITY CLAIM AGAINST ALL DEFENDANTS ..................... 31

VIII. THE COMPLAINT FAILS TO STATE SECTION 20A INSIDER TRADING CLAIMS........................................................................................... 33 IX. CONCLUSION ................................................................................................... 35

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1 2 3

TABLE OF AUTHORITIES Page CASES

4 Alfus v. Pyramid Tech. Corp., 745 F. Supp. 1511 (N.D. Cal. 1990) ...........................................................................34 5 ATSI Communications, Inc. v. Shaar Fund, Ltd., 6 493 F.3d 87 (2d Cir. 2007) .........................................................................................11 7 Bell Atl. Corp. v. Twombly, --- U.S. ---, 127 S. Ct. 1955 (2007).............................................................................11 8 Buban v. O'Brien, 9 No. C 94-0331 FMS, 1994 WL 324093 (N.D. Cal. June 22, 1994)....................... 10, 34 10 Conley v. Gibson, 355 U.S. 41 (1957) .....................................................................................................11 11 Desaigoudar v. Meyercord, 12 223 F.3d 1020 (9th Cir. 2000) ................................................................................ 9, 27 13 DiLeo v. Ernst & Young, 901 F.2d 624 (7th Cir. 1990) ......................................................................................11 14 Dura Pharm., Inc. v. Broudo, 15 544 U.S. 336 (2005) .....................................................................................................8 16 Gaines v. Haughton, 645 F.2d 761 (9th Cir. 1981) ................................................................................ 28, 29 17 Gen. Elect. Co. by Levit v. Cathcart, 18 980 F.2d 927 (3rd Cir. 1992)................................................................................ 28, 30 19 Gompper v. VISX, Inc., 298 F.3d 893 (9th Cir. 2002) .................................................................................. 8, 12 20 Howard v. Everex Sys., Inc., 21 228 F.3d 1057 (9th Cir. 2000) ....................................................................................31 22 Howard v. Hui, No. C-92-3742-CRB, 2001 WL 1159780 (N.D. Cal. Sept. 24, 2001) ................... 31, 33 23 In re Apple Computer, Inc. Sec. Litig., 24 243 F. Supp. 2d 1012 (N.D. Cal. 2002) ......................................................................22 25 In re AST Research Sec. Litig., 887 F. Supp. 231 (C.D. Cal. 1995) ....................................................................... 10, 34 26 In re Asyst Tech., Inc. Deriv. Litig., 27 No. C-06-04669, 2008 WL 2169021 (N.D. Cal. May 23, 2008) ............................. 9, 27 28 iii
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1 In re Autodesk, Inc. Sec. Litig., 132 F. Supp. 2d 833 (N.D. Cal. 2000) .................................................................. 18, 31 2 In re CNET Networks, Inc., 3 483 F. Supp. 2d 947 (N.D. Cal. 2007) ........................................................................15 4 In re Copper Mountain Sec. Litig., 311 F. Supp. 2d 857 (N.D. Cal. 2004) ........................................................................20 5 In re Daou Sys., Inc. Sec. Litig., 6 411 F.3d 1006 (9th Cir. 2005) .............................................................................. 11, 17 7 In re Digital Island Sec. Litig., 223 F. Supp. 2d 546 (D. Del. 2002), aff'd 357 F.3d 322 (3d Cir. 2004) ...................... 33 8 In re Ditech Comms. Corp. Sec. Litig., 9 No. C 05-02406, 2006 WL 2319784 (N.D. Cal. Aug. 10, 2006) .......................... passim 10 In re ESS Tech., Inc. Sec. Litig., No C-02-04497, 2004 WL 3030058 (N.D. Cal. Dec. 1, 2004) .................................... 23 11 In re Exxon Mobil Corp. Sec. Litig., 12 387 F. Supp. 2d 407 (D.N.J. 2005) ......................................................................... 9, 27 13 In re GlenFed, Inc. Sec. Litig., 60 F.3d 591 (9th Cir. 1995) ........................................................................................18 14 In re Gupta Corp. Sec. Litig., 15 900 F. Supp. 1217 (N.D. Cal. 1994) ...........................................................................23 16 In re Hansen Nat. Corp. Sec. Litig., 527 F. Supp. 2d 1142 (C.D. Cal. 2007)................................................16, 18, 19, 31, 33 17 In re McKesson HBOC, Inc. Sec. Litig., 18 126 F. Supp. 2d 1248 (N.D. Cal. 2000) .......................................................... 27, 30, 31 19 In re McLinn, 739 F.2d 1395 (9th Cir. 1984) ....................................................................................28 20 In re Netopia, Inc. Sec. Litig., 21 No. C-04-03364, 2005 WL 3445631 (N.D. Cal. Dec. 15, 2005) ................................. 23 22 In re NextCard, Inc. Sec. Litig., No. C 01-21029, 2006 WL 708663 (N.D. Cal. Mar. 20, 2006) ............................. 20, 22 23 In re Oak Tech. Sec. Litig., 24 No. 96-20552, 1997 WL 448168 (N.D. Cal. Aug. 1, 1997) ........................................ 18 25 In re Pixar Sec. Litig., 450 F. Supp. 2d 1096 (N.D. Cal. 2006) ......................................................................19 26 In re Ramp Networks, Inc. Sec. Litig., 27 201 F. Supp. 2d 1051 (N.D. Cal. 2002) ......................................................................31 28 iv
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1 In re Read-Rite Corp., 335 F.3d 843 (9th Cir. 2003) ......................................................................................12 2 In re Recoton Corp. Sec. Litig., 3 358 F. Supp. 2d 1130 (M.D. Fla. 2005) ......................................................................25 4 In re Redback Networks, Inc. Sec. Litig., No. C03-5642 JF (HRL), 2006 WL 1805579 (N.D. Cal. Mar. 20, 2006) .................... 25 5 In re Ross Sys. Sec. Litig., 6 No. C-94-0017, 1994 WL 583114 (N.D. Cal. July 21, 1994)................................ 23, 24 7 In re Royal Dutch/Shell Transp. Sec. Litig., No. 04-374, 2006 WL 2355402 (D.N.J. Aug. 14, 2006) ................................... 9, 25, 26 8 In re Silicon Graphics Inc. Sec. Litig., 9 183 F.3d 970 (9th Cir. 1999) .......................................................................... 11, 12, 19 10 In re Silicon Storage Tech., Inc., No. C 05-0295, 2006 WL 648683 (N.D. Cal. Mar. 10, 2006) ......................... 12, 21, 22 11 In re Splash Tech. Holdings, Inc. Sec. Litig., 12 No. C 99-00109, 2000 WL 1727405 (N.D. Cal. Sept. 29, 2000)........................... 23, 33 13 In re Syntex Corp. Sec. Litig., 855 F. Supp. 1086 (N.D. Cal. 1994) ...........................................................................24 14 In re Tibco Software, Inc., 15 No. 05-2146, 2006 WL 1469654 (N.D. Cal. May 25, 2006) ................................. 23, 24 16 In re U.S. Aggregates, Inc. Sec. Litig., 235 F. Supp. 2d 1063 (N.D. Cal. 2002) .......................................................... 10, 16, 32 17 In re Verifone Sec. Litig., 18 784 F. Supp. 1471 (N.D. Cal. 1992) ...........................................................................34 19 In re Verisign, Inc. Deriv. Litig., 531 F. Supp. 2d 1173 (N.D. Cal. 2007) ............................................................... passim 20 In re Worlds of Wonder Se. Litig., 21 235 F. Supp. 2d 1063 (N.D. Cal. 2002) ......................................................................16 22 In re Zoran Corp. Deriv. Litig., 511 F. Supp. 2d 986 (N.D. Cal. 2007) .................................................................. 29, 31 23 JHW Greentree Capital, L.P. v. Whittier Trust Co., 24 No. 05 Civ. 2985 HB, 2005 WL 3008452 (S.D.N.Y. Nov. 10, 2005) ............... 9, 25, 26 25 Johnson v. Aljian, 490 F.3d 778 (9th Cir. 2007) .......................................................................... 10, 33, 34 26 Lentell v. Merrill Lynch & Co., 27 396 F.3d 161 (2d Cir. 2005) .......................................................................................25 28 v
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1 Medimatch, Inc. v. Lucent Tech., Inc., 120 F. Supp. 2d 842 (N.D. Cal. 2000) ........................................................................23 2 Morgan v. AXT, Inc., 3 No. 04-4362, 2005 WL 2347125 (N.D. Cal. Sept. 23, 2005) ...................................... 16 4 Neubronner v. Milken, 6 F.3d 666 (9th Cir. 1993) .................................................................................... 10, 34 5 Paracor Fin., Inc. v. Gen. Elec. Capital Corp., 6 96 F.3d 1151 (9th Cir. 1996) ................................................................................ 10, 33 7 Pugh v. Tribune Co., 521 F.3d 686 (7th Cir. 2008) ......................................................................................22 8 Ronconi v. Larkin, 9 253 F.3d 423 (9th Cir. 2001) ...................................................................... 8, 11, 19, 20 10 Rudolph v. UTStarcom, No. C 07-04578, 2008 WL 1734763 (N.D. Cal. April 14, 2008).......................... passim 11 Schnall v. Annuity & Life Re (Holdings,), Ltd., 12 No. 02-CV-2133, 2006 WL 2331138 (D. Conn. Aug. 10, 2006)................................. 24 13 Simpson v. AOL Time Warner Inc., 452 F.3d 1040 (9th Cir. 2006) ....................................................................................26 14 Simpson v. Homestore.com, Inc., 15 519 F.3d 1041 (9th Cir. 2008) ....................................................................................26 16 Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, Inc., 522 U.S. ---, 128 S. Ct. 761 (2008)........................................................................... 7, 8 17 Tellabs, Inc. v. Makor Issues & Rights, Ltd., 18 127 S. Ct. 2499 (2007) ........................................................................................ passim 19 Weiss v. Amkor Tech., Inc., 527 F. Supp. 2d 948 (D. Ariz. 2007).................................................................... passim 20 STATUTES 21 22 23 24 25 26 27 28 vi
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15 U.S.C. § 78t-1(a) ....................................................................................................... 34 15 U.S.C. §§ 78u-4 et seq. (PSLRA) ....................................................................... passim REGULATIONS 17 C.F.R. § 240.10b-5....................................................................................................24 17 C.F.R. § 240.14a-9(a)................................................................................................27

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1 TO ALL PARTIES AND THEIR COUNSEL OF RECORD: 2 PLEASE TAKE NOTICE that on September 5, 2008, at 9:00 a.m., in the United

3 States District Court for the Northern District of California, located at 450 Golden Gate 4 Ave., San Francisco, California, before the Honorable Jeffrey S. White in Courtroom 2, 5 17th Floor, Defendants Sonic Solutions ("Sonic"), David C. Habiger, Robert J. Doris, A. 6 Clay Leighton, Mary C. Sauer, Mark Ely, Robert M. Greber, Peter J. Marguglio and R. 7 Warren Langley (collectively referred to as "Defendants") will and hereby do move the 8 Court for an order dismissing with prejudice the "[Corrected] Consolidated Class Action 9 Complaint for Violations of the Federal Securities Law" (the "Complaint") pursuant to 10 Rules 9(b) and 12(b)(6) of the Federal Rules of Civil Procedure and the Private Securities 11 Litigation Reform Act of 1995, 15 U.S.C. §§ 78u-4 et seq. ("PSLRA"). 12 This Motion is based on this Notice of Motion and Motion, the attached

13 Memorandum of Points and Authorities, the Request for Judicial Notice and exhibits 14 attached thereto, all pleadings and papers on file in this action, and such additional evidence 15 and authority as may be offered at or before the time of oral argument on this Motion. 16 17 18 19 20 21 22 23 24 25 26 27 28 1
DEFENDANTS' SUPERSEDING MOTION TO DISMISS; MP&A CASE NO.: C 07-5111(JSW)

STATEMENT OF ISSUES (Civil Local Rule 7-4(a)(3))

1.

Whether the City of Westland and the Plymouth County Retirement System

("Plaintiffs") fail to adequately plead facts establishing a "cogent and compelling" inference of scienter as required by Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S. Ct. 2499, 2510 (2007), the PSLRA and Rule 9(b) of the Federal Rule of Civil Procedure so that their securities fraud claim against all Defendants under Section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act") and Rule 10b-5 promulgated thereunder should be dismissed? 2. Whether Plaintiffs fail to state a Section 10(b) claim against Defendants Ely,

Greber, Langley, and Marguglio where: (a) the Complaint fails to allege with the required particularity that these

Defendants were involved in the preparation of the allegedly misleading statements,

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1 2 3 4 5 6 7 8 9 10 11

and thus, fails to attribute any misstatements to these four individuals; and (b) the Complaint purports to state a claim for "scheme liability" by

merely recasting the misrepresentation claim? 3. Whether Plaintiffs fail to state a Section 14(a) claim where: (a) this lawsuit was brought more than three years after Sonic issued its

2003 and 2004 proxy statements; (b) the Complaint fails to plead the "essential link" between the alleged

injury to plaintiff and the alleged omissions in the 2005 proxy statement; and (c) the Complaint fails to plead with particularity that the Defendants acted

with a strong inference of negligence? 4. Whether Plaintiffs fail to state a Section 20(a) control person liability claim

12 against all Defendants under Section 20(a) of the Exchange Act where Plaintiffs fail to 13 plead a predicate violation of the securities laws? 14 5. Whether Plaintiffs fail to state a Section 20(a) control person liability claim

15 against Sonic where Sonic is an entity that cannot "control" its employees? 16 6. Whether Plaintiffs fail to state a Section 20(a) control person liability claim

17 against the Individual Defendants where the Complaint fails to allege with the required 18 particularity that the Individual Defendants exercised actual power or control over Sonic? 19 7. Whether Plaintiffs fail to state insider trading claims under Section 20A of the

20 Exchange Act against the Individual Defendants where Plaintiffs fail to adequately plead a 21 primary violation of the securities laws? 22 8. Whether Plaintiffs fail to state insider trading claims under Section 20A of the

23 Exchange Act against Defendants Sauer, Ely, and Marguglio where the Complaint fails to 24 allege that these Defendants made any stock sales that were "contemporaneous" with 25 Plaintiffs' sales? 26 9. Whether Plaintiffs fail to state insider trading claims under Section 20A of the

27 Exchange Act against Defendants Langley and Greber where the alleged sales made by 28 these Defendants were not "contemporaneous" with Plaintiffs' sales? 2
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1 2 I. 3

MEMORANDUM OF POINTS AND AUTHORITIES INTRODUCTION Plaintiffs assert that Sonic and certain of its officers and directors have violated the

4 federal securities laws by misrepresenting and concealing a scheme to issue backdated stock 5 options. Specifically, Plaintiffs claim that the Company falsely represented that stock 6 options were granted at fair market value and that Sonic's Forms 10-Q and Forms 10-K 7 during the class period consequently under-reported the Company's expenses, thereby over8 stating the Company's reported earnings or under-stating its reported losses. Plaintiffs point 9 to the Company's Form 10-K filed earlier this year with the Securities and Exchange 10 Commission (the "SEC"), which contained restated financial statements for prior periods 11 (the "Restatement"), as an admission that the Company's financial statements throughout 12 the class period were materially false and misleading. 13 Although the Company's Restatement may reflect an acknowledgement--after a

14 long and careful review by the Audit Committee--that the Company's grant processes were 15 weak and that grant documentation was inadequate in some instances, the Audit Committee 16 explicitly concluded that no one at the Company had engaged in any intentional wrongful 17 conduct or had any knowledge that the Company's accounting for options violated GAAP. 18 The Complaint--replete with newspaper articles about other companies' backdating 19 activities and extensive quotes from Sonic's public filings about its option grants and 20 investigation--is absolutely devoid of facts from which any reasonable inference could be 21 drawn that Defendants deliberately defrauded shareholders.1 22 As the Supreme Court made clear just last term in Tellabs, Inc. v. Makor Issues &

23 Rights, Ltd., 127 S. Ct. 2499, 2510 (2007), the Complaint must allege facts that give rise to 24 a strong inference of scienter which is "more than merely `reasonable' or `permissible'--it 25 must be cogent and compelling . . . in light of other explanations." Here, the only fact plead 26 27 28
In fact, Plaintiffs rushed to file a case asserting securities fraud claims before the Audit Committee had even concluded its investigation, based on the mere announcement that such an investigation was underway and that the Company had concluded that grant documentation was insufficient.
1

1
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1 in the Complaint to support an inference of scienter is the existence of the Restatement: 2 however, the equally and indeed more compelling inference fairly drawn from the 3 Restatement is--consistent with the conclusions of the Audit Committee as spelled out in 4 that Form 10-K--that the Company's grant approval processes and documentation were 5 weak, not that there was any intentional backdating or knowledge of improper accounting 6 for stock options. Accordingly, Plaintiffs' Complaint fails to adequately plead scienter and 7 their Section 10(b) claim must be dismissed. 8 Plaintiffs' Section 14(a) claim, based on alleged misstatements in Sonic's 2003, 2004

9 and 2005 proxy statements, fails for three reasons. First, the Section 14(a) claim based on 10 the 2003 or 2004 proxy statements is time barred. Second, as to the 2005 proxy statement, 11 Plaintiffs fail to allege facts showing the "essential link" between the alleged omissions and 12 any direct injury to Plaintiffs. Third, Plaintiffs fail to allege particularized facts giving rise 13 to a "strong inference of negligence". All of these pleading failures require dismissal of the 14 Section 14(a) claim. 15 Plaintiffs' claims for control person liability and insider trading under Section 20 of

16 the Exchange Act also should be dismissed. First, both of these claims fail because they 17 require a predicate violation of the federal securities laws and because Plaintiffs have failed 18 to plead any violations of the securities laws, they also cannot assert claims under Section 19 20(a). Moreover, Plaintiffs have failed to specifically plead facts establishing that any of 20 the Individual Defendants exercised control over the Company. And with regard to 21 Plaintiffs' insider trading claim under Section 20A, they have not established a right to 22 relief because Plaintiffs have not alleged that they purchased Sonic securities 23 contemporaneously with many of the Individual Defendants' purported sales. 24 II. 25 26 STATEMENT OF FACTS A. Description of the Defendants.

Sonic, located in Novato, California, is a California corporation that develops and

27 markets computer software related to digital media, such as data, photographs, audio, and 28 2
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2 1 video in digital formats. Compl. ¶ 59. Sonic became a public company in February 1994 3 2 and is traded on The Nasdaq Global Select Market. RJN Ex. A, at 14.

3

Defendants Robert J. Doris and Mary C. Sauer co-founded Sonic in 1986. Doris has

4 been the Chairman of the Board of Directors since the Company's formation. Compl. ¶ 61. 5 He also served as the CEO of Sonic from 1986 until he resigned from the position in 6 September 2005. Id. ¶ 61. Sauer has served as a Director and Company Secretary since its 7 founding. Id. ¶ 63. She also served as Vice President from 1986 to September 2005 and as 8 the Senior Vice President of Marketing and Sales from February 1993 to September 2005. 9 Id. 10 Defendants David C. Habiger, A. Clay Leighton, and Mark Ely are executive officers

11 of Sonic (collectively referred to as the "Officer Defendants"). Habiger joined Sonic in 12 1993, and became its President and Chief Operating Officer in April 2005. Id. ¶ 60. In 13 September 2005, he succeeded Robert Doris as the CEO of Sonic. Id. Leighton joined 14 Sonic in 1992 as a Vice President of Finance and later became the Senior Vice President of 15 Worldwide Sales and Finance. He served as the Company's Chief Financial Officer from 16 January 1999 to February 2008. Id. ¶ 62. Ely joined Sonic in 1992 and in September 2006, 17 became the Company's Executive Vice President, Strategy. Id. ¶ 64. 18 Defendants Robert M. Greber, R. Warren Langley, and Peter J. Marguglio

19 (collectively referred to as the "Outside Directors") are outside directors and members of 20 various Board Committees. These directors joined Sonic's Board in August 1993, August 21 1996 and June 2001, respectively. Id. ¶¶ 65, 66, 67. 22 23 B. Sonic's Stock Option Program, Historical Review and Restatement

Like many other technology companies, Sonic awards stock options as an integral

24 part of the compensation provided to employees, officers and directors. Compl. ¶ 17. 25 During the class period, the Company had various Stock Option Plans that governed the 26 27
All citations to "Compl." in the brief refer to the "[Corrected] Consolidated Class Action Complaint for Violations of the Federal Securities Law," filed on May 27, 2008.
3 2

28 Notice in Support of Motion to Dismiss, filed concurrently. 3

All "RJN Ex.__" citations in the brief refer to the exhibits attached to Sonic's Request for Judicial

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1 terms on which Sonic could issue options. See, e.g., id. ¶ 19 and 21. From 1998 until 2 September 2005, Doris, as CEO, was authorized to grant stock options. RJN Ex. A, at 7. 3 On September 23, 2005, the board adopted a resolution creating an employee options 4 subcommittee comprised of the CEO, Habiger, and the CFO, Leighton, to administer grants 5 to recipients other than directors and executive officers. Id. Directors typically received 6 grants at preset times, normally at the meeting of the Company's board of directors 7 immediately following each annual shareholder meeting. Id. 8 In the spring of 2006, journalists and academics identified several companies where

9 it appeared that stock option grants may have been issued on favorable dates and questioned 10 whether these companies had appropriately accounted for those grants. Compl. ¶¶ 42-44. 11 Some theorized that executives at these companies might have deliberately manipulated 12 grant documentation to suggest that grants were made at earlier dates when stock prices 13 were lower, i.e., backdating, so that recipients realized an immediate gain. Id. ¶¶ 42-46. 14 In the wake of the extensive press reports challenging perceived widespread

15 backdating and SEC pronouncements regarding stock option accounting, Sonic decided to 16 review its historical stock option practices. On February 1, 2007, the Company issued a 17 press release announcing that it had commenced a voluntary review of its historical and 18 current stock option grant practices and related accounting. Compl. ¶ 46. 19 The stock option review was conducted by the Audit Committee, comprised solely of

20 independent directors, with the assistance of legal counsel and outside consultants. RJN Ex. 21 A, at 5. The Audit Committee and its advisors conducted an extensive review, including an 22 assessment of Sonic's options granting policies and procedures, internal records, supporting 23 documentation, e-mail communications, and interviews of Company personnel. Id. 24 On February 26, 2008, the Audit Committee reported the results of its investigation.

25 Compl. ¶ 52 and RJN Ex. A. The Audit Committee found that the Company's employee 26 option granting processes were informal and that "it appears that insufficient attention was 27 devoted to ensuring that grant documentation was prepared or finalized by the Record 28 Date." RJN Ex. A, at 7. Accordingly, the Audit Committee concluded that for a large 4
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1 portion of the employee options issued prior to September 23, 2005, "there is little or no 2 contemporaneous grant-specific documentation that satisfies the requirements for 3 `measurement dates' under APB No. 25 and that would allow [Sonic] to maintain the
4 4 original grant date used for accounting purposes (the `Record Date')." Id. at 6. The Audit

5 Committee, however, did not find any evidence that management backdated grants or 6 committed any other misconduct. 7 In fact, the Audit Committee expressly concluded that there was no intentional

8 wrongful conduct by Sonic employees, officers, or directors, and that there was no evidence 9 that they "had any knowledge that their handling of option grants violated stock option 10 accounting rules." RJN Ex. A, at 7-8 (emphasis added). To the extent Sonic personnel 11 authorized grants using incorrect or unreliable dates, the Audit Committee found "no 12 evidence of an intent to purposefully circumvent stock option accounting rules or to 13 otherwise inaccurately report the financial results of the Company during the Review 14 Period." Id. at 8 (emphasis added). 15 The Audit Committee also did not find any evidence that the officers or directors

16 responsible for the Company's stock administration had taken steps to provide themselves 17 with options at better prices than those granted to other employees. Id. at 7. Moreover, the 18 Audit Committee found no indication of intent by those with responsibility for selecting 19 grant dates to benefit personally at the expense of the Company. Id. at 6-7. 20 Based on the results of the Audit Committee's extensive review, on February 26,

21 2008, the Company filed the Restatement, which restated its prior financial statements by 22 $29 million to adjust for compensation expenses relating to stock option grants. Compl. 23 ¶¶ 2, 52. 24 25
4

26 adjustment. In one case where full minutes were not available, certain measurement date adjustments were 27 made based upon the supporting documentation that was available. Additionally, the Audit Committee 28

Founders and directors grants were generally not determined to have record dates that required

identified two instances where written consents were used and the Company deemed the measurement date to be the date of the last signature. In both instances the change in measurement date was one day. RJN Ex. A, at 7.

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1 2

C.

Plaintiffs and Their Complaints.

Plaintiff, the City of Westland Police and Fire Retirement System ("the City of

3 Westland"), filed its initial complaint on October 4, 2007--eight months after the Company 4 announced its voluntary stock option review.5 The City of Westland purported to bring suit 5 on behalf of all Sonic shareholders who purchased securities between October 4, 2002 and 6 May 17, 2007 and alleged that the Company "had been manipulating stock option grant 7 dates to benefit insiders which caused the Company's proxy statements and Forms 10-Q 8 and Forms 10-K to be materially false and misleading." First Compl. ¶ 66(a). This 9 complaint asserted claims under Sections 10(b), Section 14(a), and Section 20(a) of the 10 Exchange Act against Sonic, Doris, Sauer, Habiger, Leighton and Ely. 11 Following the Company's Restatement in February 2008, the City of Westland

12 joined by the Plymouth County Retirement System filed a Consolidated Class Action 13 Complaint on March 21, 2008. According to Plaintiffs' consolidated complaint, Defendants 14 engaged in a fraudulent scheme that involved the knowing manipulation of stock option 15 grants to Company officers, directors and employees. Plaintiffs allege that Defendants 16 falsely represented that stock options were granted at fair market value, consistent with the 17 provisions of Sonic's stock option plans. Plaintiffs further allege that Sonic's Forms 10-Q 18 and Forms 10-K during the class period under-reported the Company's expenses and 19 thereby over-stated the Company's reported earnings or under-stated the reported losses. 20 Plaintiffs claim that the Company's Restatement amounts to an admission that the 21 Company's financial statements throughout the class period were materially false and 22 misleading. Compl. ¶ 2. 23 Plaintiffs' consolidated complaint not only named Doris, Sauer, Habiger, Leighton

24 and Ely as well as the Company as defendants, but also asserted claims against certain 25 26 27 28
Before plaintiff filed this shareholder class action, a number of derivative lawsuits were filed in both state and federal court alleging breach of fiduciary duty and other claims against Sonic's senior officers and directors. Counsel for Plaintiffs herein, initially filed a derivative claim on March 15, 2007 on behalf of plaintiff Ralph D. Wilder in the United States District Court for the Northern District of California which was subsequently dismissed voluntarily on September 6, 2007.
5

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1 outside directors during the class period: Greber, Marguglio and Langley. Plaintiffs 2 alleged that the CEO and the Board were responsible for administering the Company's 3 stock option plans. Compl. ¶ 24. The consolidated complaint further alleges that because 4 of their positions with the Company, the Individual Defendants had "the power and 5 authority to control the contents" of Sonic's public filings and that "because of their 6 positions," they further "knew that the adverse facts specified [in the Complaint] had not 7 been disclosed to and were being concealed from the public and that the representations 8 being made were then materially false and misleading." Id. ¶ 68. This complaint asserted 9 three claims under the federal securities laws: (1) violation of Section 10(b) of the 10 Exchange Act against all Defendants; (2) violation of Section 20(a) of the Exchange Act 11 (controlling person liability) against all Defendants; and (3) violation of Section 20A of the 12 Exchange Act (insider trading claims) against the Individual Defendants. Pursuant to a 13 stipulation agreed to by the parties and approved by the Court, Defendants filed their 14 motion to dismiss on May 23, 2008. 15 After Defendants filed their motions to dismiss, on May 27, 2008, Plaintiffs filed a

16 "[Corrected] Consolidated Class Action Complaint for Violations of the Federal Securities 17 Law"(the "Complaint"). Docket No. 34. This Complaint asserts an additional claim under 18 Section 14(a) of the Exchange Act for alleged omissions in Sonic's proxy statements. On 19 June 3, 2008, this Court entered an order permitting Plaintiffs to file the "corrected" 20 complaint. Docket No. 37. This order further permitted Defendants to file a superseding 21 motion to dismiss to address all claims. Id. 22 III. 23 SUMMARY OF ARGUMENT The Court should grant Defendants' Motion to Dismiss Plaintiffs' First Claim

24 asserting violations of Section 10(b) of the Exchange Act and Rule 10b-5 promulgated 25 thereunder. To state a claim under Section 10(b) and Rule 10b-5, a plaintiff must plead: (1) 26 a material misrepresentation or omission; (2) scienter; (3) in connection with the purchase 27 or sale of a security; (4) reliance; (5) economic loss; and (6) loss causation. See, e.g., 28 Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, Inc., 522 U.S. ---, 128 S. Ct. 761 7
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1 (2008); Dura Pharm., Inc. v. Broudo, 544 U.S. 336, 341 (2005). Rule 9(b) of the Federal 2 Rules of Civil Procedure and the PSLRA further require that plaintiffs plead these elements 3 by alleging particular facts "specify[ing] each statement alleged to have been misleading, 4 the reason or reasons why the statement is misleading, and, if an allegation regarding the 5 statement or omission is made on information and belief, the complaint shall state with 6 particularity all facts on which that belief is formed." Section 21D(b)(1)(B) of the PSLRA; 7 see also Ronconi v. Larkin, 253 F.3d 423, 429 (9th Cir. 2001). The Complaint falls far 8 short of pleading a Section 10(b) violation with the requisite specificity. 9 First, Plaintiffs have failed to allege facts giving rise to a compelling inference of

10 scienter. In order to survive a motion to dismiss, the inference of scienter plead by 11 Plaintiffs must be "cogent and compelling." Tellabs, Inc. v. Makor Issues & Rights, Ltd., 12 127 S. Ct. 2499, 2510 (2007). In assessing scienter, courts must consider all reasonable 13 inferences that can be taken from the complaint, including inferences that are unfavorable to 14 plaintiffs. See Gompper v. VISX, Inc., 298 F.3d 893, 897 (9th Cir. 2002). 15 Here, Plaintiffs allege that the Individual Defendants--simply by virtue of their

16 position at the Company, their access to information, and their routine corporate duties-- 17 knowingly participated in a backdating scheme and/or its concealment. There are no 18 particular facts alleged regarding each individual defendant establishing knowing 19 participation in any backdating scheme or intentional accounting violations. While 20 Plaintiffs point to the Restatement as evidence of materially misleading statements, as 21 reflected in the Restatement, the Audit Committee expressly concluded that there was no 22 evidence of intentional wrongdoing. Because Plaintiffs have failed to allege facts giving 23 rise to an inference of scienter on the part of any Individual Defendant, they also have not 24 sufficiently alleged scienter on the part of the Company. 25 Second, the Complaint fails to adequately attribute any misleading statement or

26 omission to Defendants Ely and the three Outside Directors (Greber, Marguglio and 27 Langley). Ely is not alleged to have signed any of the Company's public filings and the 28 Complaint does not allege specific facts demonstrating the role that any of the alleged 8
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1 Outside Directors played in the preparation of the Company's statements. Because the 2 Complaint fails to attribute any misstatement to Defendants Ely and the Outside Directors, 3 they may be liable under Section 10(b) only if Plaintiffs have stated a claim under 4 subsections (a) and (c), which together create what has become known as "scheme" 5 liability. However, scheme liability must be based on conduct that goes beyond the making 6 of false statements. In re Royal Dutch/Shell Transp. Sec. Litig., No. 04-374, 2006 WL 7 2355402, at *8 (D.N.J. Aug. 14, 2006); JHW Greentree Capital, L.P. v. Whittier Trust Co., 8 No. 05 Civ. 2985 HB, 2005 WL 3008452, at *7 (S.D.N.Y. Nov. 10, 2005). Because 9 Plaintiffs have failed to allege any misconduct in the Complaint beyond the alleged 10 misstatements, they cannot assert a valid Section 10(b) claim against Ely and the Outside 11 Directors. 12 Third, Plaintiffs' second cause of action under Section 14(a), based on alleged

13 omissions in Sonic's 2003, 2004 and 2005 proxy statements, should be dismissed. Compl. 14 ¶¶ 83, 91, 100, 101. To establish a Section 14(a) violation, Plaintiffs must plead that: (1) 15 the proxy statement contains a material misleading statement or omission; (2) the 16 misstatement or omission was made with the requisite level of culpability; and (3) that the 17 misstatement or omission was an "essential link" in the accomplishment of the proposed 18 transaction. Desaigoudar v. Meyercord, 223 F.3d 1020, 1022 (9th Cir. 2000); see also In re 19 Verisign, Inc. Deriv. Litig., 531 F. Supp. 2d 1173, 1213 (N.D. Cal. 2007). In addition, a 20 Section 14(a) claim must be brought within three years from the time the challenged proxy 21 statements were filed. See, e.g., In re Asyst Tech., Inc. Deriv. Litig., No. C-06-04669, 2008 22 WL 2169021, at *5 (N.D. Cal. May 23, 2008); In re Exxon Mobil Corp. Sec. Litig., 387 F. 23 Supp. 2d 407, 421-24 (D.N.J. 2005). The Section 14(a) claim based on the 2003 and 2004 24 proxy statements is time barred because these proxy statements were issued more than three 25 years before this lawsuit was filed. As to the 2005 proxy statement, the Complaint fails to 26 plead an "essential link" between any alleged misstatement and any injury to investors or to 27 plead any facts raising a "strong inference of negligence" on the part of the Defendants. 28 Accordingly, the Section 14(a) claim should be dismissed. 9
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1

Fourth, Plaintiffs' third cause of action fails to state a claim for control person

2 liability under Section 20(a) of the Exchange Act. Because the Complaint fails to 3 adequately allege a primary violation under the federal securities laws for the reasons set 4 forth above, it also fails to plead control person liability under Section 20(a). In re U.S. 5 Aggregates, Inc. Sec. Litig., 235 F. Supp. 2d 1063, 1076 (N.D. Cal. 2002). In addition, the 6 Complaint erroneously seeks to hold Sonic liable as a controlling person and fails to plead 7 with particularity that the Individual Defendants exercised the requisite control. As the 8 Ninth Circuit has held, a defendant's status as an officer or director does not create a 9 presumption of control for establishing control person liability. Paracor Fin., Inc. v. Gen. 10 Elec. Capital Corp., 96 F.3d 1151, 1163 (9th Cir. 1996). The Complaint's conclusory 11 allegation--that "[b]y reason of their positions with the Company, and their ownership of 12 Sonic stock, defendants had the power and authority to cause Sonic to engage in the 13 wrongful conduct"--makes no attempt to differentiate the various Defendants and plead 14 with particularity how these Defendants controlled Sonic. 15 Fifth, Plaintiffs' fourth claim alleging insider trading on the part of the Individual

16 Defendants in violation of Section 20A of the Exchange Act also should be dismissed. To 17 be liable under Section 20A, there must be an independent violation of another provision of 18 the securities laws. Johnson v. Aljian, 490 F.3d 778, 781 (9th Cir. 2007). Since Plaintiffs' 19 Section 10(b), Section 14(a), and control person claims fail, this claim also must fail as to 20 all Defendants. In addition, Plaintiffs must also plead with particularity that they traded 21 contemporaneously with Defendants. Neubronner v. Milken, 6 F.3d 666, 670 (9th Cir. 22 1993). With respect to Defendants Sauer, Ely, Marguglio, Langley and Greber, Plaintiffs 23 also have failed to allege that these Defendants sold stock contemporaneously with 24 Plaintiffs. Buban v. O'Brien, No. C 94-0331 FMS, 1994 WL 324093, at *2 (N.D. Cal. June 25 22, 1994); In re AST Research Sec. Litig., 887 F. Supp. 231, 233 (C.D. Cal. 1995). 26 IV. 27 28 10
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FRAUD PLEADING STANDARDS UNDER RULE 9(B) AND THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 In its last term, the United States Supreme Court clarified the standard applicable to

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1 Rule 12(b)(6) motions. See Bell Atl. Corp. v. Twombly, --- U.S. ---, 127 S. Ct. 1955, 1974 2 (2007). Under the standard announced in Twombly, a plaintiff must "provide the `grounds' 3 of his `entitle[ment] to relief'," a burden that "requires more than labels and conclusions." 4 Id. at 1965. "[A] formulaic recitation of the elements of a cause of action will not do." Id. 5 There must be "enough facts to state a claim to relief that is plausible on its face." Id. at 6 1974. Overruling the oft-cited standard of Conley v. Gibson, 355 U.S. 41 (1957), the 7 Supreme Court rejected the maxim that "a complaint should not be dismissed ... unless it 8 appears beyond doubt that the plaintiff can prove no set of facts in support of his claim." 9 Twombly, 127 S. Ct. at 1959. Instead, the "[f]actual allegations [in the complaint] must be 10 enough to raise a right to relief above the speculative level." Id. at 1959.6 11 For private actions arising under the federal securities laws, Rule 9(b) and the

12 PSLRA have long established additional pleading hurdles. As one court has explained, the 13 Rule 9(b) pleading standard requires plaintiff to allege "the who, what, when, where, and 14 how: the first paragraph of any newspaper story." DiLeo v. Ernst & Young, 901 F.2d 624, 15 627 (7th Cir. 1990). The PSLRA further requires that plaintiffs plead falsity with 16 particularity by "specify[ing] each statement alleged to have been misleading, the reason or 17 reasons why the statement is misleading, and, if an allegation regarding the statement or 18 omission is made on information and belief, the complaint shall state with particularity all 19 facts on which that belief is formed." Section 21D(b)(1)(B); see also Ronconi, 253 F.3d at 20 429. Alleging mere conclusions is insufficient. See, e.g., In re Daou Sys., Inc. Sec. Litig., 21 411 F.3d 1006, 1013 (9th Cir. 2005). To plead scienter under the PSLRA, plaintiffs must 22 "state with particularity facts giving rise to a strong inference that the defendant acted with 23 the required state of mind." Section 21D(b)(2); Daou, 411 F.3d at 1014. In the Ninth 24 Circuit, scienter means at a minimum deliberate or conscious recklessness. In re Silicon 25 Graphics Inc. Sec. Litig., 183 F.3d 970, 979 (9th Cir. 1999) (en banc). 26 27
Although Twombly was an antitrust case, its holding has been extended to federal securities claims. See, e.g., ATSI Communications, Inc. v. Shaar Fund, Ltd., 493 F.3d 87,2d Cir. 28 2007).
6

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1 V. 2 3 4

PLAINTIFFS FAIL TO STATE A SECTION 10(B) CLAIM AGAINST ALL DEFENDANTS A. Plaintiffs' Complaint Fails to Plead a Strong Inference of Scienter as to All Defendants

The Complaint must be dismissed because it fails to allege specific facts that give

5 rise to a strong inference of scienter. In the context of Section 10(b), scienter is a "mental 6 state embracing intent to deceive, manipulate, or defraud." Silicon Graphics, 183 F.3d at 7 975. Plaintiffs can only establish a strong inference of scienter if they plead facts "in great 8 detail" that "constitute strong circumstantial evidence" that Defendants knowingly or 9 recklessly violated Section 10(b). Id. at 974. A Section 10(b) claim must "contain 10 allegations of specific contemporaneous statements or conditions that demonstrate the 11 intentional or the deliberately reckless false or misleading nature of the statements when 12 made." In re Read-Rite Corp., 335 F.3d 843, 846 (9th Cir. 2003) (internal quotations and 13 citations omitted). Plaintiffs cannot "aver intent in general terms of mere `motive and 14 opportunity' or `recklessness,' but rather, must state specific facts indicating no less than a 15 degree of recklessness that strongly suggests actual intent." Silicon Graphics, 183 F.3d at 16 979. 17 As the Supreme Court recently held, in order to survive a motion to dismiss, the

18 inference of scienter plead by plaintiffs must be "more than merely `reasonable' or 19 `permissible' ­ it must be cogent and compelling . . . in light of other explanations." 20 Tellabs, 127 S. Ct. at 2510. In assessing scienter, courts must consider all reasonable 21 inferences that can be taken from the complaint, including inferences that are unfavorable to 22 plaintiffs. See Gompper, 298 F.3d at 897 (holding that to survive dismissal a strong 23 inference of scienter must be "the most plausible of competing inferences"). 24 Furthermore, courts must also consider whether plaintiffs have adequately plead

25 scienter as to each individual defendant. See In re Silicon Storage Tech., No. C 05-0295, 26 2006 WL 648683, at *22 (N.D. Cal. Mar. 10, 2006). Where, as here, "pleadings are not 27 sufficiently particularized or where, even taken as a whole, they do not raise a strong 28 inference of scienter, dismissal pursuant to 12(b)(6) is proper." In re Ditech Comms. Corp. 12
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1 Sec. Litig., No. C 05-02406, 2006 WL 2319784, at *7 (N.D. Cal. Aug. 10, 2006). 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 1. The Complaint Fails to Plead Scienter and Fraud with Particularity as to the Individual Defendants

The scienter allegations against the Individual Defendants fall far short of meeting the PSLRA and Rule 9(b) pleading standards. Plaintiffs generally allege that the Individual Defendants participated in a backdating scheme that artificially inflated the value of Sonic's stock, but do not allege any specific facts indicating that each Defendant (1) participated in approving improperly backdated options and/or (2) knew that the Company's failure to take a compensation charge for the backdated option grants had a material effect on the Company's financials. Instead of pleading with the requisite particularity, Plaintiffs infer that simply by virtue of their role or position in the Company, their access to information, and their routine corporate duties, the Individual Defendants knowingly participated in a backdating scheme and/or its concealment. Individually or collectively, such flimsy, over-generalized allegations do not create any inference of scienter, let alone a "strong" or "cogent and compelling" inference of scienter. Moreover, Plaintiffs' unsupported and conclusory allegations regarding the role of the Sonic officers and directors in the alleged backdating scheme are flatly contradicted by the facts. · By Plaintiffs' own admission, Habiger did not even become President and CEO of Sonic until September 2005, well after many of the instances of alleged backdating and misstatements occurred. Plaintiffs do not allege specific facts establishing that Habiger intentionally or recklessly backdated stock option grants and committed accounting violations before or after he became CEO. · The Complaint does not allege that Ely participated in the granting or approval of stock options and Plaintiffs do not allege specific facts that explain if or how he may have known about the alleged backdating, the proper accounting for stock options, and the financial misstatements. · As the Complaint concedes, Outside Directors Marguglio, Greber, and Langley had a limited role in granting and approving stock options. Plaintiffs do not allege facts showing that the Outside Directors knowingly or recklessly approved backdated stock options in violation of GAAP or that they attempted to conceal backdating or accounting violations. · Doris, Sauer, and Leighton are alleged to have received backdated options and to 13
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1 2 3 4 5 6 7 8 9 10 11 12

have had a role in granting or approving stock options, but are not specifically alleged to have knowingly or recklessly granted backdated options or made any effort to conceal the grant of backdated options. Nor are they specifically alleged to have knowingly committed accounting violations. In sum, the general allegations that Plaintiffs make throughout their Complaint in an effort to plead scienter are simply insufficient and are not enough to outweigh the equally compelling inference that none of the Individual Defendants participated in deliberately backdating option grants or had any knowledge that the Company's financial statements accounted for stock option grants improperly. Without more, the limited facts that Plaintiffs have alleged in the Complaint, as set forth below, have been repeatedly rejected by courts as insufficient to raise an inference of scienter. a. Sonic's Restatement Does Not Give Rise to a Strong Inference of Scienter.

Plaintiffs claim that Sonic's February 26, 2008 Restatement creates a strong

13 inference of scienter as to Defendants' knowledge of backdating and inadequate accounting 14 controls. Compl. ¶ 136. Plaintiffs conclude that the Restatement effectively functions as an 15 admission by Defendants that they deliberately or recklessly violated the securities laws.
7 16 Id. ¶¶ 126, 136.

17

But an inference of scienter does not necessarily follow from a restatement: "A

18 plaintiff cannot allege scienter simply because [the defendant] restated its financial 19 statements . . . . a mere violation of a generally accepted accounting principle (GAAP) or 20 accounting rules fails to plead scienter." Weiss v. Amkor Tech., Inc., 527 F. Supp. 2d 94821 49 (D. Ariz. 2007); see also Rudolph v. UTStarcom, No. C 07-04578, 2008 WL 1734763, at 22 *6 (N.D. Cal. April 14, 2008) (holding that Company's Restatement, among other factors, 23 was not enough to establish scienter in backdating fraud suit); see also In re CNET 24 25
Plaintiffs simply conclude that "[b]ecause the restatement admits that Doris was responsible for granting these backdated options, there can be no question that he was at least 26 deliberately reckless with respect to the statements alleged herein to be false." Compl. ¶ 128. And without pleading more, Plaintiffs also conclude that members of the Board (comprised of 27 Defendants Doris, Sauer, Greber, Marguglio, and Langley) knew that Doris "was issuing stock options in violation of the specific terms of shareholder approved stock option plans" and did 28 nothing to prevent these violations. Compl. ¶ 53.
7

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1 Networks, Inc., 483 F. Supp. 2d 947, 963 (N.D. Cal. 2007) (same). 2 While Plaintiffs attempt to use Sonic's Restatement as an admission of fraud, as

3 Plaintiffs grudgingly concede, Sonic's Restatement never states that intentional backdating
8 4 occurred at Sonic. Compl. ¶ 71. In fact, the Audit Committee concluded exactly the

5 opposite--that Sonic's officers and directors had not engaged in "self dealing or favoritism" 6 and that the "conduct of those who administered our options plans was not intentionally or 7 knowing[ly] wrongful." RJN Ex. A, at 8. 8 These findings are nearly identical to those of another audit committee in a recent

9 backdating case in the Northern District of California. In CNET Networks, 483 F. Supp. 2d 10 at 963, as here, the defendant company's "special committee concluded that there was no 11 wrongdoing by any current or recently resigned directors or officers." Id. In light of these 12 findings, the district court held that "absent other facts indicating fraud" plaintiffs had not 13 sufficiently plead facts supporting an inference of scienter. Id. So, too, here. Because 14 Sonic's Restatement admits no intentional or deliberately reckless conduct by Defendants, it 15 does not create a strong inference of scienter. 16 17 18 b. Plaintiffs Do Not Allege Facts Demonstrating that Defendants Knowingly or Recklessly Backdated Options or Knowingly or Recklessly Violated Accounting Rules.

Plaintiffs fail to allege specific facts demonstrating that any of the Individual

19 Defendants knowingly: (1) backdated stock option grants; and/or (2) violated stock option 20 accounting rules, including APB No. 25. Without providing any specific facts, Plaintiffs 21 allege that because eight of Sonic's fourteen discretionary stock grants between 1996-2004 22 "were purportedly granted on dates where Sonic's stock price was trading at" a monthly 23 low, this pattern "can only be the result of deliberate and systematic backdating." Compl. ¶ 24
8

25 documentation that satisfies the requirements for "measurement dates" under APB No. 25. But the 26 plausible that there was administrative sloppiness or error, rather than any effort to intentionally
absence of grant-specific documentation does not create a strong inference of scienter. It is equally conceal backdating. See Letter from Chief Accountant to Lawrence Silva, September 19, 2006, § G, inference of fraud). In fact, in light of the Audit Committee's findings that there was no intentional

Sonic's Restatement states that there was a lack of contemporaneous grant-specific

27 Compl. Ex. 7 (indicating that the absence of stock option documentation alone does not create an 28 wrongdoing, this is the more cogent and compelling inference to be drawn. 15
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1 72. Building on this unsupported assertion, Plaintiffs then claim that not only were the 2 grants intentionally backdated, but Defendants knowingly violated GAAP when they made 3 the grants. Compl. ¶¶ 121, 122, 124, 126, 127, 129, 130. 4 First, Plaintiffs cannot establish scienter merely by alleging that because options

5 were granted at monthly lows, Defendants therefore participated in a backdating scheme. 6 Compl. ¶ 72; see In re Hansen Nat. Corp. Sec. Litig., 527 F. Supp. 2d 1142, 1155 (C.D. Cal. 7 2007). In Hansen, the court held that in the absence of facts including "admissions by 8 Hansen that the stock option grants were backdated, statements by Hansen employees or 9 other witnesses that the stock option grants were backdated, or contemporaneous documents 10 demonstrating that the stock options grants were backdated," the plaintiff had failed to 11 create an inference of scienter. Id. Likewise, in this case, Plaintiffs have not alleged any 12 facts indicating that stock options were intentionally backdated or that the improperly dated 13 grants were anything other than the result of administrative sloppiness or errors. See 14 Rudolph, 2008 WL 1734763, at *6 (holding that the plaintiff's allegations "could equally 15 support the inference that stock options had been backdated through innocent bookkeeping 16 error"). 17 But even if Plaintiffs could establish that Defendants intentionally backdated stock

18 options, to plead a violation of the Exchange Act, they still must plead facts showing that in 19 doing so, Defendants knowingly violated stock option accounting rules. Weiss, 527 F. 20 Supp. 2d at 949 ("[a]lthough allegations of accounting violations may provide some support 21 for scienter allegations, they must be underpinned by other particularized allegations that 22 defendants possessed the requisite mental state); see also In re Worlds of Wonder Sec. 23 Litig., 235 F. Supp. 2d 1063, 1073 (N.D. Cal. 2002) ("even an obvious failure to follow 24 GAAP does not give rise to an inference of scienter"). In other words, "to plead fraudulent 25 intent based on GAAP violations, plaintiffs must allege facts showing that: (1) specific 26 accounting decisions were improper; and (2) the defendants knew specific facts at the time 27 that rendered their accounting determinations fraudulent." Morgan v. AXT, Inc., No. 0428 4362, 2005 WL 2347125, at *14 (N.D. Cal. Sept. 23, 2005); see also In re Daou Sys., Inc. 16
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1 Sec. Litig., 411 F.3d 106, 1014-15 (9th Cir. 2005). Plaintiffs fail to allege any specific facts 2 showing that Defendants knew both that stock options had been backdated and were not 3 properly accounted for under GAAP. Compl. ¶ 124. 4 For instance, Plaintiffs do not plead any specific facts tending to establish: (1) that

5 any of the Defendants were familiar with stock option accounting rules and decided not to 6 follow them; or (2) that any of the Defendants believed at the time that stock option grants 7 were made or anytime thereafter, that the accounting used by the Company was improper or 8 illegal. Weiss, 527 F. Supp. 2d at 949 ("Furthermore, as pointed out by the Defendants, the 9 accounting rules at issue, specifically APB No. 25, are complex and require accounting 10 expertise and judgment.").9 Because Plaintiffs do not link the alleged violations of the stock 11 option accounting rules to each Defendants' knowledge or intent, Plaintiffs have not 12 established a strong inference of scienter. 13 14 15 c. Defendants' Corporate Positions and Roles in Preparing Routine SEC Filings and Press Releases Cannot Give Rise to a Strong Inference of Scienter.

Plaintiffs also claim that by virtue of their corporate positions or roles on Board

16 Committees at Sonic, the Individual Defendants knowingly violated Section 10(b). 17 Plaintiffs allege that "because of their positions with the Company," Individual Defendants 18 "possessed the power and authority to control the contents of Sonic's quarterly reports, 19 press releases and presentations to securities analysts" and that they had the "ability and 20 opportunity" to prevent their issuance or demand their correction. Compl. ¶ 68. Plaintiffs 21 also allege that because of their positions Defendants knew that "adverse facts" had not 22 been disclosed and were "being concealed from the public." Id. Plaintiffs further allege 23 that members of the Sonic Board and the CEO, charged with administering the Company's 24 stock option plans, knew or should have known that the Company's financial statements 25
9

26 well known accounting rule in Silicon Valley, particularly for companies like Sonic which relied so 27 closely studied and well understood by Silicon Valley executives, but it is an unwarranted and 28 late 1990s and early 2000s.
extensively on option grants to compensate employees." Compl. ¶ 31. In 2008, APB 25 may be unsubstantiated stretch of the imagination to argue that executives recognized its importance in the

Plaintiffs refer to the esoteric APB 25