Free Motion for Leave - District Court of Colorado - Colorado

Case 1:04-cv-01006-RPM

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EXHIBIT 1

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UNITED STATES DISTRICT COURT FOR THE DISTRICT OF COLORADO

SPECIAL SITUATIONS FUND III, L.P., SPECIAL SITUATIONS CAYMAN FUND, L.P., SPECIAL SITUATIONS TECHNOLOGY FUND NEW, L.P., AND SPECIAL SITUATIONS TECHNOLOGY FUND II, L.P., ON BEHALF OF THEMSELVES AND OTHERS SIMILARLY SITUATED, Plaintiffs, v. QUOVADX, INC., LORINE R. SWEENEY, GARY SCHERPING, JEFFREY M. KRAUSS, FRED BROWN, J. ANDREW COWHERD, JAMES HOOVER, CHARLES J. ROESSLEIN, and JAMES GILBERT. Defendants. T. L. B. A.

Civil Action No. 1:04-cv-01006-RPM ORAL ARGUMENT REQUESTED DOCUMENT ELECTRONICALLY FILED

_____________________________________________________________________________ SPECIAL SITUATIONS FUND III, L.P., SPECIAL SITUATIONS CAYMAN FUND, L.P., SPECIAL SITUATIONS TECHNOLOGY FUND NEW, L.P., AND SPECIAL SITUATIONS TECHNOLOGY FUND II, L.P.'s SUPPLEMENTARY MEMORANDUM OF LAW IN FURTHER SUPPORT OF THEIR MOTION FOR PARTIAL SUMMARY JUDGMENT _____________________________________________________________________________

LOWENSTEIN SANDLER PC
Attorneys at Law 65 Livingston Avenue Roseland, New Jersey 07068 973.597.2500 Attorneys for Lead Plaintiffs Of Counsel: Lawrence M. Rolnick, Esq.

S5313/68 10/11/2006 1998203.02

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Lead Plaintiffs Special Situations Fund III, L.P., Special Situations Cayman Fund, L.P., Special Situations Technology Fund New, L.P., and Special Situations Technology Fund II, L.P. (collectively "Special Situations" or "Lead Plaintiffs") respectfully submit this reply brief in further support of their motion for partial summary judgment on Defendants' liability pursuant to 15 U.S.C. § 77k, in response to the Notice of Submission ("Notice of Submission") of Affidavit of Jeffrey Krauss ("Krauss Affidavit" or "Kraus Aff."), filed by defendant Quovadx, Inc. ("Quovadx") on August 29, 2006. 1. The Court Should Strike The Krauss Affidavit As Untimely And Not Based On Personal Knowledge. The Krauss Affidavit suffers from two fatal flaws that should cause it to be rejected by the Court. First, it is untimely, and despite Quovadx's protestations, Quovadx's failure to submit affidavits presenting admissible evidence based on personal knowledge of the affiant at the time they were due according to this Court's scheduling order cannot be remedied by its post-briefing submission of additional material. Second, the Krauss Affidavit suffers in large part from the same infirmity that plagued Quovadx's timely submissions in opposition to Lead Plaintiff's partial summary judgment motion: it is not based on personal knowledge. Quovadx cannot dispute that its filing of the Krauss Affidavit is woefully out of time. Consistent with the Federal Rules of Civil Procedure 56(c), Local Rule 7.1.E, and the scheduling order governing this case, Lead Plaintiffs moved for Partial Summary Judgment. Quovadx then opposed that motion on July 24, 2006, and Plaintiffs submitted their reply brief on August 17, 2006, all pursuant to the schedule established by order of the Court dated July 14, 2006. Then, without leave of court, Quovadx on August 29, 2006 -- weeks after the deadline established for the filing of its opposition papers -- submitted the supplemental Krauss Affidavit in further opposition to Lead Plaintiff's Motion for Partial Summary Judgment. Quovadx asserts that, without leave of Court, a party may serve opposing affidavits at any time "prior to the day of hearing." (Notice of Submission, ¶5).

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But the time at which responsive papers must be filed "prior to the day of hearing" is governed by the Court's rules and scheduling orders, not the whims of a party that, following complete briefing of the motion, realizes the fatal flaws of its earlier submissions, as Quovadx apparently has done here. Quovadx offers no authority for the proposition that, without leave of Court, it may continue to submit affidavits or other material up until the day that the motion is argued or decided. Indeed, Quovadx's approach to briefing mocks the very concept of a briefing schedule: it would allow the parties to continue to submit materials in support or opposition to a motion until the 11th hour, prohibiting either the parties or the Court from rational, orderly consideration of the motion. It would also render meaningless the right of the moving party to reply, as the opposing party could wait until after the moving party filed its reply papers to submit additional, purportedly relevant materials. Accordingly, Lead Plaintiffs oppose Quovadx's unilateral filing of an additional affidavit after the time prescribed by the Court's rules and the scheduling order in this case. Moreover, the Krauss Affidavit in many respects is not based on Krauss' personal knowledge, the same problem that, by Quovadx's own implicit admission, afflicts the interrogatory responses originally filed in opposition to Lead Plaintiffs' summary judgment motion. For example, the lengthy discussion in the Krauss Affidavit about Quovadx's alleged good faith belief that the letters of credit would be established and drawn upon (See Krauss Aff. Para. 6(f)) is on its face not based on personal knowledge and must be disregarded pursuant to Fed.R.Civ.P. 56(e). Even if the Court were to allow the submission of the Krauss Affidavit, it should disregard any statements by Mr. Krauss that are not based on his personal knowledge, including "knowledge" that he gained through presentations to Quovadx's Audit Committee by outside investigators, which are pure hearsay. See Thomas v. Int'l Bus. Machines, 48 F.3d 478, 485 ("hearsay testimony that would be inadmissible at trial may not be included in an affidavit to defeat summary judgment").

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2.

Even If The Court Accepts The Krauss Affidavit, Its Admissions Support Entry Of Summary Judgment In Favor Of Lead Plaintiffs. In the event that the court considers the Krauss Affidavit, Lead Plaintiffs submit

that the Affidavit supports their application for partial summary judgment. The Krauss Affidavit details a series of facts that were known to Quovadx before it filed the Registration Statement but that Quovadx failed to disclose in the Registration Statement or in the Form 10-Q for the third quarter of 2003 incorporated therein. These admitted omissions alone entitle Lead Plaintiffs to summary judgment: · According to the Krauss Affidavit, "on September 8, 2003, Quovadx entered into a Strategic Partner Outsourcing Agreement with Infotech India." ("Outsourcing Agreement"). There is no dispute that neither the Outsourcing Agreement nor the multi-million dollar payment obligations under the Outsourcing Agreement were disclosed in the Registration Statement or in the third quarter 2003 10-Q. Indeed, even though Infotech was Quovadx's largest customer and had on the same date entered into an agreement to purchase $7.6 million of software licenses from Quovadx (which itself had been disclosed only in a press release), Quovadx failed to disclose even the mere existence of the Outsourcing Agreement. · The Krauss Affidavit states that Quovadx estimated that during the first year of the Outsourcing Agreement it "would purchase from Infotech India up to $2,460,000 in outsourcing services." (Krauss Aff. ¶ 3) That expected payment obligation also was not disclosed in the Registration Statement. Moreover,

pursuant to the Outsourcing Agreement, Quovadx expressly agreed to establish an irrevocable letter of credit in favor of Infotech Network (USA), Inc. in the amount of $2,460,000. (See Outsourcing Agreement, Krauss Aff. Ex. B, at ¶2(b))

Quovadx's obligation to establish and fund that letter of credit in favor of Infotech was not disclosed.

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·

According to the Krauss Affidavit, "as of September 8, 2003, Quovadx knew that Infotech India, Infotech Texas and Infotech California had not been software distributors or sellers before Infotech entered into the distributor agreement." (Krauss Aff. ¶ 6(b)) Although Infotech was Quovadx's largest customer and accounted for 20% of third quarter revenue, Quovadx did not disclose this information in the Registration Statement or the third quarter 10-Q.

·

The Krauss Affidavit states that the Distributor Agreement required Infotech "to establish" a letter of credit in the amount of $5,460,000 by September of 2003 and a letter of credit in the amount of $2,140,000 by October 15, 2003 to secure payment of the $7.6 million to purchase obligation under the September 8, 2003 Distributor Agreement ("Distributor Agreement"). (See Krauss Aff. ¶¶ 2 and 6(c)) In fact, paragraph 5 of the Distributor Agreement went further, requiring Infotech to "have established and funded" the letter of credit by September 26, 2003. (See Distributor Agreement, Krauss Aff. Ex. A, at ¶ 5) At the time of the Registration Statement, the letters of credit had not been established and funded, but this fact was not disclosed in the Registration Statement.

·

According to the Krauss Affidavit, Quovadx paid Infotech $410,000 in October 2003 (after the deadline for establishing the letter of credit had passed) "for the purpose of providing a margin payment to Infotech's posses bank in India that would assist Infotech in establishing a letter of credit needed to secure Infotech's payment obligations under the Distributor Agreement." (Krauss Aff. ¶ 6(i)) Again, none of the facts about the letter of credit -- the obligation to fund it, the failure to fund it, and the payments made so that Infotech would fund it -- were disclosed. Moreover, the October 2003 payment shows Quovadx's knowledge that its largest customer had failed to meet the deadlines for establishing and

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funding letters of credit to secure its purchase when it filed the Registration Statement. · According to the Krauss Affidavit, "Infotech had not established the letters of credit before Quovadx shipped the software." (Krauss Aff. ¶ 6(d)) That fact was also not disclosed in the Registration Statement. Indeed, pursuant to the

Distributor Agreement, Quovadx was entitled to draw on the letter of credit upon evidence of shipment. (See Distributor Agreement, Krauss Aff. Ex. A at ¶ 5 ("Quovadx shall be entitled to draw against the letter of credit...for payment of license fees, upon presentment of an air bill, shipping or tracking number.")) Accordingly, at the time of the Registration Statement, Infotech was already in default of its obligations under the Distributor Agreement. This information was not disclosed in the Registration Statement. · The Krauss Affidavit reiterates the Board's finding that the Outsourcing Contract was an inducement for Infotech to enter into the Distributor Agreement. (Krauss Aff. ¶ 6(g)) Whether or not the Outsourcing Agreement was in fact "an

inducement," there is no dispute that both contracts were entered into simultaneously and that Quovadx never disclosed in the Registration Statement (or anywhere else) that the Outsourcing Agreement required Quovadx to make multi-million dollar payments to Infotech. Indeed, the Registration Statement and third quarter 10-Q did not even mention Infotech, the $7 million Distribution Agreement, or the contemporaneous Outsourcing Agreement. Krauss also repeats the fact that Quovadx employees had discussed the possibility that Quovadx would purchase outsourcing services from Infotech up to $10 million annually. (Krauss Aff. ¶ 6(g)) Again, since the entire outsourcing purchase obligation to Infotech was not disclosed, the fact that employees were discussing an additional $10 million in purchases annually is simply "icing on the cake."

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·

The Krauss Affidavit discloses that as of September 2004, Infotech had provided approximately "$1,200,000 in outsourcing services." (Krauss Aff. ¶ 6(i)) Of course, neither the Outsourcing Agreement, nor the accrual of a $1,200,000 liability for outsourcing services to Infotech, was disclosed in the Registration Statement. Ironically, although Quovadx paid $410,000 to Infotech in October 2003 to "assist Infotech in establishing a letter of credit" and paid an additional $1,960,000 on March 10, 2004, the Krauss Affidavit states that Quovadx "never received the full value of services in exchange for that payment." (Krauss Aff. ¶6(i)) Again, any and all information relating to Quovadx's prepayment (or overpayment) of monies for outsourcing services to its largest customer was material to investors who were not informed that Infotech has simultaneously entered into two contracts on the same day as both a purchaser and supplier of goods and services.

3.

The Krauss Affidavit Does Not Create A Genuine Question Of Material Fact. That the facts described above required disclosure in the Registration Statement

or the 10-Q it incorporated is a question of law, not of fact. SEC rules and regulations require companies to make certain disclosures as a matter of law, and whether or not the undisputed facts presented in the Krauss Affidavit were of the type that must be disclosed is a question for the Court, not a jury. For example, the law requires an issuer to disclose any "unusual or infrequent transactions." Clearly, the largest software licensing contract ever entered into in the history of Quovadx -- a contract that accounted for 20% of revenue in one quarter alone and was expected to generate multi-millions more in the future -- was itself an unusual or infrequent transaction, even absent additional circumstances. However, when that historical licensing

agreement was entered into simultaneously with an agreement to make multi-million dollar purchases from the same buyer, the transaction surely qualified as "infrequent or unusual." And because there is no factual dispute about the underlying facts (which are, after all, described in

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the Krauss Affidavit) or about whether a disclosure was made (since both the Registration Statement and the third quarter 2003 10-Q are silent as to both contracts), it is for the Court, not the jury, to decide whether this was a transaction that was required to be disclosed. Similarly, SEC rules and regulations provide that an issuer must disclose the identity of any customer who accounts for more than 10 percent of revenues and give a full description of the "relationship" between the issuer and that company. Here, there is no dispute that Infotech contributed more than 20% of revenues in the third Quarter. Accordingly, Quovadx was required as a matter of law to disclose Infotech's identity and fully disclose the relationship between the companies. It undisputedly did not do so. Because the relationship with Infotech was central to Quovadx's existing and future financial results, there is no doubt that the relationship was required to be disclosed fully and fairly to investors so that they could make their own informed choices about the financial results and prospects of Quovadx's business. These are not factual issues for the jury to decide. There is no doubt that the Registration Statement and third quarter 2003 10-Q failed to disclose anything about Infotech, failed to disclose the existence of either of the contracts, and failed to disclose any of the details surrounding the payment obligations or the letters of credit. The Court must decide whether this information was legally required to be disclosed. If the Court determines that the undisputed facts required disclosure, there are no material facts for the jury to decide, and Lead Plaintiffs are entitled to summary judgment. In sum, the Krauss Affidavit is untimely and in many respects not based on personal knowledge, and so should be rejected by the Court. But in any event, the Krauss Affidavit contains admissions that support Lead Plaintiffs' motion for summary judgment and fail to create a genuine issue of material fact. Lead Plaintiffs respectfully renew their request for an order granting them summary judgment.

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CONCLUSION For these reasons, and the reasons set forth in Lead Plaintiffs' opening and reply briefs, Lead Plaintiffs respectfully request that the Court grant summary judgment on liability in their favor against the Defendant. Respectfully submitted, LOWENSTEIN SANDLER PC

Dated: October 11, 2006

By:

s/ Lawrence M. Rolnick Lawrence M. Rolnick, Esq.

65 Livingston Avenue Roseland, NJ 07068-1791 Tel. 973.597.2500 Fax 973.597.2400 Attorneys for Lead Plaintiffs Special Situations Fund III, L.P., Special Situations Cayman Fund, L.P., Special Situations Technology Fund New, L.P., and Special Situations Technology Fund II, L.P.

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