Free Reply to Response to Motion - District Court of Colorado - Colorado

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IN THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF COLORADO

Civil Action No. 00-cv-1864-REB-BNB (Consolidated with 00-cv-1908-REB-BNB, 00-cv1910-REB-BNB, 00-cv-1919-REB-BNB, 00-cv-1945-REB-BNB, 00-cv-1954-REB-BNB, 00-cv-1957-REB-BNB, 00-cv-1963-REB-BNB, 00-cv-1996-REB-BNB, 00-cv-2040-REBBNB, 00-cv-2074-REB-BNB, 00-cv-2149-REB-BNB, 00-cv-2243-REB-BNB, and 00-cv2316-REB-BNB)

In re ICG COMMUNICATIONS, INC. SECURITIES LITIGATION ______________________________________________________________________ DEFENDANTS' REPLY IN FURTHER SUPPORT OF THEIR MOTION TO DISMISS THE SECOND CONSOLIDATED AND AMENDED COMPLAINT ______________________________________________________________________ ARGUMENT I. THE SAC FAILS TO ALLEGE LOSS CAUSATION Plaintiffs do not contest--nor can they--that the SAC nowhere alleges that ICG's alleged line count overstatement or reciprocal compensation revenue inflation was ever disclosed. Under Dura Pharmaceuticals v. Broudo and other cases applying its standard, this failure dooms all the line count and reciprocal compensation revenue claims for failure to plead loss causation.1

1

See, e.g., Dura Pharms., Inc. v. Broudo, 125 S. Ct. 1627, 1634 (2005) (holding loss causation pleading inadequate absent allegation that "the share price fell significantly after the truth became known"); D.E. & J. Ltd. P'ship v. Conaway, Nos. 03-2334, 03-2417, 2005 U.S. App. LEXIS 11267, at *16-*17 (6th Cir. June 10, 2005) (holding that complaint failed to satisfy Dura's loss causation standard when it "did not plead that the alleged fraud became known to the market on any particular day . . . and did not connect the alleged fraud with the ultimate disclosure and loss") (Mot. Ex. F); In re Tellium, Inc. Sec. Litig., No. Civ. A. 02 CV 5878 (FLW), 2005 WL 2090254, at *3-*4 (D.N.J. Aug. 26, 2005) (finding complaint inadequate where it failed to allege concealed scheme was ever disclosed to the market, thereby affecting the stock price; disclosures of bad news that did not disclose the fraud held insufficient) (Ex. AA

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Plaintiffs do not even attempt to distinguish the bulk of these cases. And little wonder, as even the authority they cite confirms this result. In Sekuk Global Enters. v. KVH Indus., Inc., for example, the complaint alleged that the defendant company artificially inflated its stock price by concealing declining sales of its A5 land mobile satellite antennas. While the defendants argued that the press releases that caused the company's stock price to drop "did not attribute the declining revenue to sales of the A5," the press release itself was to the contrary. It disclosed that the revenue drop was attributable in part to "lower than expected sales of land mobile satellite systems," including those to the RV market--which indisputably included the A5. Thus, the court concluded that the complaint adequately alleged that the defendant company's share price "dropped after the truth regarding Defendants' misrepresentations became known."2 The SAC's allegations that Plaintiffs' Opposition quotes may adequately allege loss causation as to alleged undisclosed customer and network issues (those claims are otherwise inadequately pleaded). But they cannot link any drop in ICG's share price to any alleged line count fraud or reciprocal compensation revenue inflation because there

hereto); Liu v. Credit Suisse First Boston Corp. (In re Initial Pub. Offering Sec. Litig.), MDL 1554 (SAS), No. 21 MC 92 (SAS), 04 Civ. 3757 (SAS), 2005 U.S. Dist. LEXIS 12845, at *28-*29 (S.D.N.Y. June 28, 2005) (concluding that complaint failed to plead loss causation because it nowhere alleged that purportedly concealed information "was ever disclosed") (Mot. Ex. E); In re Alamosa Holdings, Inc., Sec. Litig., No. 5:03-CV-289-C, 2005 U.S. Dist. LEXIS 4904, at *79, *85 (N.D. Tex. Mar. 28, 2005) (holding that complaint failed to plead loss causation where there was no "corrective disclosure relating to the challenged representation") (Mot. Ex. G). Plaintiffs do not even attempt to distinguish Liu or Alamosa, and their attempt to differentiate Lentell v. Merrill Lynch & Co., Inc., 396 F.3d 161 (2d Cir. 2005), and D.E. & J. is meaningless. Just as in those cases, the SAC fails to allege "any causal connection between the corrective disclosures and the alleged fraud." (Pls. Opp. at 32 n.31.)
2

No. Civ.A. 04-306ML, 2005 WL 1924202, at *16-*17 (D.R.I. August 11, 2005) (Pls. Opp. Ex. 2).

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were never any disclosures that ICG's lines in service or reciprocal compensation revenue lagged its disclosed results. (See Pls. Opp. at 32-34.) Plaintiffs also attempt to obfuscate their failure to satisfy Dura's stringent loss causation standard by maintaining that the Court already applied it in its August 24, 2004 dismissal order. (Id. at 30­31.) But Dura did more than just adopt the Second Circuit's most stringent loss causation formulation; it also requires a separate loss causation analysis for each allegedly fraudulent statement to determine if "the subject of the fraudulent statement or omission was the cause of the actual loss suffered."3 But because this Court did not have the benefit of the Supreme Court's guidance, it incorrectly held that the loss causation element did not require a complaint to tie specific losses to specific misrepresentations. (August 24 Order at 21­22.) Because of Dura's intervening change in the law, Plaintiffs' contention that the Court has already ruled on the issue and that its determination is "law of the case" must be rejected.4 II. THE SAC'S CLAIMS ARE INADEQUATELY PARTICULARIZED A. Alleged Customer and Network Problems

The Court dismissed the CAC's allegations concerning purported customer and network problems because Plaintiffs had failed to allege that Bryan or Beans knew about these problems or that the network issues were not "fixable." (Aug. 24 Order at 20.) Even though Plaintiffs' Opposition attempts to rewrite the SAC, their amended pleading does not cure this deficiency.

3 4

Lentell, 296 F.3d at 175 (emphasis added); see also Dura, 125 S.Ct. at 1631.

Grigsby v. Barnhart, 294 F.3d 1215, 1218-19 (10th Cir. 2002) ("[A] subsequent, contrary decision of applicable law by a controlling authority" is an exception to the "law of the case" doctrine.).

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The Opposition relies heavily on allegations attributed to Jim Adkins and William S. Bean, even asserting that Adkins "described Beans's instructions to ICG to continue using the switches even while problems continued." (Pls. Opp. at 27.) But contrary to what the Opposition says, the SAC does not allege that either of these witnesses linked the network problems to Beans in any way. (See SAC ¶¶ 65­71.) Barrett Zahn is the only witness whom the SAC alleges to assert that Beans knowingly ordered ICG engineers to use the allegedly defective 5ESS switches, and Plaintiffs concede (as they must) that Zahn left the company long before Beans's alleged "order."5 Plaintiffs maintain that the Court should not consider this fact because merely identifying a witness by name and title is enough to establish that a witness's account is "reliable." But that unreliable approach is contrary to the strict pleading standards courts apply to securities fraud claims. A witness's name and job title, standing alone, cannot establish reliability where the witness's responsibilities or employment dates are inconsistent with the witness having knowledge of the subject matter.6 Closely

5

As for Bryan, no witness has tied him to the alleged customer and network problems in any way. Accordingly, no scienter inference for Beans or Bryan as to customer and network issue arises from any alleged witness accounts in the SAC.
6

See, e.g., Sorkin, LLC v. Fischer Imaging Corp., No. Civ.A. 03-CV-00631-R, 2005 WL 1459735, at *7, *9 (D. Colo. June 21, 2005) (dismissing revenue recognition allegations in the absence of facts showing how sources, whose jobs were unrelated to accounting, "would have had access to first-hand information about [Company's] accounting procedures" and "no facts [were] provided to show how a shipping and receiving clerk would have known how, when, or why the Company booked revenue"; further dismissing allegations attributed to witnesses who "did not work at [the company] during the Class Period") (Mot. Ex. I); In re Metawave Communications Corp. Sec. Litig., 298 F. Supp. 2d 1056, 1073-74 (W.D. Wash. 2003) (dismissing claims because plaintiffs did not adequately describe the "basis of personal knowledge" for various confidential witnesses' opinions about defendants' knowledge of the lack of sales); see also Adams v. Kinder-Morgan, Inc., 340 F.3d 1083, 1099 (10th Cir. 2003) (identifying six factors to be considered in evaluating complaint including whether plaintiff's source of information is disclosed and the reliability of the sources).

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scrutinizing the SAC's witness accounts is particularly appropriate in view of Plaintiffs' admitted mischaracterization of Kallet's statements. Nor does the RBO transcript fix the CAC's pleading defects. Plaintiffs now concede--contrary to the SAC's allegation--that neither Bryan nor Beans received the RBO transcript. Instead, they maintain in their brief that Bryan and Beans received a list of questions extracted from the RBO. But they also concede that the SAC nowhere alleges this, much less who prepared the questions list, when it was prepared or specifically what its contents were. Absent such allegations, Plaintiffs are not entitled to an inference that the report truly exists or to any scienter inference stemming from it.7 Thus, contrary to Plaintiffs' contention, Bryan and Beans are not seeking an "unlikely inference" that the report does not exist, but an application of long-standing law that defeats the SAC's allegations. Even if the Court were to consider the RBO transcript that neither Bryan or Beans ever received, the SAC's customer and network claims would still be inadequate.8 None of the highlighted RBO transcript questions quoted in the SAC indicates that ICG was suffering massive customer and network problems, let alone that such difficulties were insurmountable. (See SAC ¶¶ 80, 82, 83.) While Plaintiffs maintain that they should be entitled to the inference that these questions support the SAC's scienter pleading to the exclusion of any other reasonable inference, the Tenth
7

See In re Vantive Corp. Sec. Litig., 283 F.3d 1079, 1087-88 (9th Cir. 2002); Arazie v. Mullane, 2 F.3d 1456, 1467 (7th Cir. 1993).
8

Notably, Beans only joined the company in July 1999 and was not in the role of President or Chief Operating Officer until January 1, 2000, four months after the alleged RBO meeting occurred. (SAC ¶ 33.)

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Circuit has held squarely to the contrary, requiring courts deciding Reform Act motions to dismiss to "consider the inference suggested by the plaintiff while acknowledging other possible inferences, and determine whether plaintiff's suggested inference is `strong' in light of its overall context."9 Finally, in a last-ditch effort to salvage the customer and network claims, Plaintiffs assert that Bryan and Beans, by virtue of serving as ICG's CEO and COO, must have known about these issues. (Pls. Opp. at 28.) Courts throughout the nation--including this Court in its August 24 Order--have long condemned such speculation as inadequate to supply the legally indispensable "strong inference" of scienter.10 B. Reciprocal Compensation Revenue

The SAC's reciprocal compensation revenue allegations concerning the first two quarters of 2000 are deficient because they do not establish, as the Reform Act and Rule 9(b) require, that Bryan or Beans somehow knew that there was no reasonable prospect of collecting booked amounts.11 Plaintiffs do not contest--and therefore

9

Pirraglia v. Novell, Inc., 339 F.3d 1182, 1187-88 (10th Cir. 2003); accord Sorkin, 2005 WL 1459735, at *3 ("Pirraglia instructs that in evaluating allegations of scienter in a securities fraud complaint, the court may consider negative inferences that may be drawn against the plaintiff."). County of Santa Fe v. Public Serv. Co., 311 F.3d 1031, 1035 (10th Cir. 2002), is not to the contrary, as that case involved a motion to dismiss under Rule 12(b)(6), not a motion to dismiss for failure to satisfy the Reform Act or Rule 9(b).
10

See August 24 Order at 20; see also City of Philadelphia v. Fleming Cos., Inc., 264 F.3d 1245, 1264 (10th Cir. 2001); In re Advanta Corp. Sec. Litig., 180 F.3d 525, 539 (3d Cir.1999); Maldonado v. Dominguez, 137 F.3d 1, 9-10 (1st Cir. 1998); Melder v. Morris, 27 F.3d 1097, 1102 (5th Cir. 1994); In re Health Mgmt. Sys., Inc. Sec. Litig., No. 97 CIV. 1865, 1998 WL 283286, at *6 (S.D.N.Y. Jun 1, 1998) (Ex. BB hereto).
11

See, e.g., In re Vantive, 283 F.3d at 1089 (dismissing an allegation that company improperly booked revenue on a potentially disputable contract because Complaint failed to allege "how much money [the company] ultimately recognized on the [] contract"); Keeney v. Larkin, 306 F. Supp. 2d 522, 541 (D. Md. 2003) ("Pleading scienter sufficiently under the PSLRA `requires more than a misapplication of accounting principles,' and `allegations of a violation of GAAP provisions or SEC regulations, without corresponding fraudulent intent, are not sufficient to state a securities fraud claim.'") (quoting Chill v. Gen. Elec. Co., 101 F.3d 263, 270 (2d Cir. 1996)), aff'd, 102 Fed. Appx. 787 (4th Cir. 2004); Mortensen v. AmeriCredit Corp.,

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concede--that this is the case. Instead, they contend that the "law of the case" doctrine insulates the SAC's reciprocal compensation allegations from attack. They are wrong. For the "law of the case" doctrine to apply, the Court must have previously decided the issue.12 The August 24 Order does not even address the argument Bryan and Beans have advanced here, and therefore, there is no "law of the case" on this issue.13 And even if that doctrine were applicable, it is "discretionary, not mandatory."14 Because this Court is free to evaluate the SAC's new reciprocal compensation revenue allegations concerning 2000 without blindly applying the "law of the case" doctrine, and because those allegations cannot withstand scrutiny, they should be dismissed.15

123 F. Supp. 2d 1018, 1026-27 (N.D. Tex. 2000) (dismissing GAAP violation allegations because plaintiffs did not allege "knowing or severely reckless publishing of materially false information, either directly by specific factual allegations or indirectly by showing industry practice or an independent auditor's opinion rejecting the cash-in method"); In re Comshare, Inc. Sec. Litig., No. 96-73711-DT, 1997 WL 1091468, at *8 (E.D. Mich. Sept. 18, 1997) (dismissing complaint because it failed to allege that "any of the defendants committed the violations of revenue policy" or assert "which defendant knew what, how they knew it, or when"), aff'd, 183 F.3d 542, 553-54 (6th Cir. 1999) (Mot. Ex. J). See Arizona v. California, 460 U.S. 605, 618 (1983) (the "law of the case" doctrine "posits that when a court decides upon a rule of law, that decision should continue to govern the same issues in subsequent stages in the same case"); Quern v. Jordan, 440 U.S. 332, 347 n.18 (1979) ("The doctrine of law of the case comes into play only with respect to issues previously determined."). Indeed, the Tenth Circuit has recognized that the doctrine does not apply unless there is a final judgment that decided the issue. United States v. Bettenhausen, 499 F.2d 1223, 1230 (10th Cir. 1974).
12 13 14

See Quern, 440 U.S. at 347 n.18.

Grigsby, 294 F.3d at 1218 (noting that the "law of the case" doctrine is "primarily applicable between courts of different levels" and "to judicial review of administrative decisions") (citations omitted); see also Kennedy v. Lubar, 273 F.3d 1293, 1299 (10th Cir. 2001) (finding that "law of the case principles are not absolute" because "[a]lthough courts are often eager to avoid reconsideration of questions once decided in the same proceeding, it is clear that all federal courts retain power to reconsider if they wish") (citation omitted).
15

Plaintiffs suggest they have rectified the deficiency identified in the August 24 Order by adding allegations about the first and second quarters of 2000. (Pls. Opp. at 29, 29-30 n.26 (citing SAC ¶¶ 143, 145).) But the only new allegations concern the first quarter of 2000. (SAC ¶¶ 143, 145.) Thus, even if adding specific figures could cure the complaint's defect, and it cannot, the SAC still fails to plead a claim regarding the second quarter of 2000.

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C.

Line Count Allegations

In their opening brief, Bryan and Beans dissected the SAC's line count allegations and demonstrated why they fail to satisfy the Reform Act and Rule 9(b). Plaintiffs' primary response to this detailed analysis is to regurgitate the SAC's allegations, coupling them with conclusory assertions that the SAC "easily satisfies" the Reform Act. Whether viewed individually or taken as a whole, these allegations fail.16 In addition to this back-of-the-hand approach, Plaintiffs advance additional arguments in their Opposition based on facts that are not alleged in the SAC. For example: The Opposition asserts that Lucia Esposito attended weekly and monthly executive meetings (Pls. Opp. at 17 n.16), but she is not among the participants listed in the SAC (SAC ¶¶ 49­50). The Opposition also suggests that Esposito "confirmed" that Beans used Nancy Hoag's line count spreadsheets at weekly and monthly executive meetings. (Pls. Opp. at 10.) Setting aside that Esposito is not alleged to have attended these meetings, the SAC nowhere alleges this Esposito "confirmation."

The Opposition attributes to Vincent Dibiase an allegation that Bryan "signed off on this practice" of including "internal lines" in ICG's line count. (Pls. Opp. at 17 (citing SAC ¶ 114).) But while other sentences in that paragraph of the SAC are attributed to Dibiase, that conclusory allegation is attributed to no one. (See SAC ¶ 114.)

While the Opposition maintains that Rosales "witnessed" Beans instructing ICG employees to "create lines" (Pls. Opp. at 11), the SAC says no such thing. Rather, it substitutes supposition for the specific allegation that the Reform Act requires, as Rosales allegedly never witnessed Beans's conversations with these other employees. (SAC ¶¶ 121, 122.) The Opposition asserts that Bruce Tully stated that ICG's line count was inflated "as a result of Defendants' instructions." (Pls. Opp. at 20.) But the SAC alleges only
16

The sum of numerous allegations that fail to satisfy the Reform Act and Rule 9(b) is a defective complaint. See, e.g., Sorkin, 2005 WL 1459735, at *11 ("[c]onclusory allegations and information attributed to unreliable sources do not collectively create a strong inference of fraud"); In re CarterWallace, Inc. Sec. Litig., No. 94 Civ. 5704, 1999 WL 1029713, at *5 (S.D.N.Y. Nov. 10, 1999) (just as "[f]our cubic zirconias will never add up to one real diamond," four generic motives do not add up to a specific motive and are insufficient), aff'd, 220 F.3d 36 (2d Cir. 2000) (Ex. CC hereto).

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that Tully attributed the improper instruction to anonymous members of "senior management." (SAC ¶ 110.) The law forbids Plaintiffs from using their Opposition to rewrite the SAC.17 Plaintiffs' reliance on In re Rhythms Sec. Litig. is equally unavailing.18 In that case, the court found that plaintiffs adequately alleged scienter based primarily on the defendants' alleged "explicit orders" to subordinates to reclassify lines inappropriately.19 In contrast, the SAC's allegations that Beans ordered ICG employees to "create lines" or utilize other improper inflation techniques during the first half of 2000 are insufficiently particularized, based on inadequate hearsay, or both. Likewise, in Rhythms, the defendants allegedly had access to a proprietary database whereby they would track lines on a minute-by-minute basis "until midnight of the last day of each reporting period."20 Here, there is no allegation that Beans or Bryan tapped into any line counting database, let alone one that allowed them to witness increasing line counts up to the final moments of each quarter, as the Rhythms defendants allegedly did. Plaintiffs also assert that Rhythms demonstrates that the SAC's line revenue inflation allegations are adequate. (Pls. Opp. at 25.) But the SAC's failure to allege any line inflation with sufficient particularity dooms the line revenue allegations. Nor can the SAC supply the necessary line revenue allegations through its three witnesses, none of
17

See, e.g., Wright v. Ernst & Young LLP, 152 F.3d 169, 178 (2d Cir. 1998) (holding that a party may not amend its complaint through statements in briefs); Fadem v. Ford Motor Co., 352 F. Supp. 2d 501, 516 (S.D.N.Y. 2005) (same); Apffel v. Huddleston, 50 F. Supp. 2d 1129, 1133 (D. Utah 1999) ("Plaintiffs' memorandum in opposition to the motion to dismiss is not part of the complaint and cannot supplement or amend it."); Cont'l Bank, N.A. v. Caton, No. 88-1611-C, 1990 WL 129452, at *13 (D. Kan. Aug 6, 1990) ("Claims are not amended by a brief in opposition to the motion to dismiss.") (Ex. DD hereto).
18 19 20

300 F. Supp. 2d 1081 (D. Colo. 2004). Id. at 1090. Id.

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whom had any responsibility for booking revenue. These witnesses cannot reliably speak to revenue recognition issues absent some particularized basis for their knowledge.21 CONCLUSION For all the foregoing reasons, as well as those set forth in Defendants' opening brief, the SAC should be dismissed in its entirety with prejudice.22 Dated: September 6, 2005 Denver, Colorado O'MELVENY & MYERS LLP Bradley J. Butwin Jonathan Rosenberg William J. Sushon 7 Times Square New York, New York 10036 (212) 326-2000 Respectfully submitted, s/ Peter J. Korneffel Peter J. Korneffel, Jr. Brownstein Hyatt & Farber, P.C. 410 17th Street, 22nd Floor Denver, CO 80202-4437 T:(303) 223-1100 F:(303) 223-1111 [email protected] Attorneys for Defendants

21

See, e.g., Sorkin, 2005 WL 1459735, at *7 (dismissing revenue recognition allegations because plaintiffs provided no facts showing how sources, whose jobs were unrelated to accounting, "would have had access to first-hand information about [Company's] accounting procedures" and "no facts [were] provided to show how a shipping and receiving clerk would have known how, when, or why the Company booked revenue"); In re Metawave, 298 F. Supp. 2d. at 1073 (dismissing conclusory scienter allegations from confidential witness because they were "merely his opinion"); Anderson v. First Sec. Corp., 249 F. Supp. 2d 1256, 1267 (D. Utah 2002) ("[Plaintiffs'] contention that [the witness] is a credible source and, therefore, there is no need to require a factual basis for [the source's] conclusions is contrary to the PSLRA's pleading requirements."). Because this is at least Plaintiffs' second attempt to plead their claims (and really their third), see, e.g., In re Capstead Mortgage Corp. Sec. Litig., No. Civ.A.3:98-CV-1716-L, 2003 WL 22221320, at *2 (N.D. Tex. Sept. 19, 2003) (Ex. EE hereto); In re Exabyte Corp. Sec. Litig., 823 F. Supp. 866, 873 (D. Colo. 1993), the SAC should be dismissed with prejudice. See, e.g., PR Diamonds, Inc. v. Chandler, 364 F.3d 671, 699-700 (6th Cir. 2004) (agreeing that plaintiffs should not have been allowed to amend consolidated complaint because the Reform Act limits Rule 15); Smith v. Circuit City Stores, Inc., 286 F. Supp. 2d 707, 722-23 (E.D. Va. 2003) (dismissing consolidated amended complaint without leave to amend to "preserve[] the teeth of the Reform Act").
22

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CERTIFICATE OF SERVICE I hereby certify that on this 6th day of September, 2005, a true and correct copy of the foregoing DEFENDANTS' REPLY IN FURTHER SUPPORT OF THEIR MOTION TO DISMISS THE SECOND CONSOLIDATED AND AMENDED COMPLAINT was filed electronically with the Clerk of Court using the CM/ECF system which will send notification of such filing to the following e-mail addresses: [email protected] [email protected]

and I hereby certify that I have served the document to the following non CM/ECF participants as indicated below: Via FedEx and facsmilie Daniel L. Berger Mark Lebovitch Eric T. Kanefsky Bernstein Litowitz Berger & Grossmann, LLP 1285 Avenue of the Americas New York, NY 10019 Norman Berman Bryan A. Wood Joseph C. Merschman Berman DeValerio Pease Tobacco Burt & Pucillo One Liberty Square Boston, MA 02109

s/ Peter J. Korneffel Peter J. Korneffel, Jr. Brownstein Hyatt & Farber, P.C. 410 17th Street, 22nd Floor Denver, CO 80202-4437 T:(303) 223-1100 F:(303) 223-1111 [email protected] Attorney for Defendants
8053\1\934887.1