Source: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-cand-5_06-cv-05157/USCOURTS-cand-5_06-cv-05157-14/pdf.json

Nature of Suit Code: 160
Nature of Suit: Stockholder's Suits
Cause of Action: 12:22 Securities Fraud

---

1

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 This disposition is not designated for publication and may not be cited. 1

Case No. C 06-5157 JF

ORDER RE MOTION TO DISMISS ETC.

(JFLC3)

**E-Filed 03/26/2008**

NOT FOR CITATION

IN THE UNITED STATES DISTRICT COURT

FOR THE NORTHERN DISTRICT OF CALIFORNIA

SAN JOSE DIVISION

In re DITECH NETWORKS, INC. DERIVATIVE

LITIGATION

Case Number C 06-5157 JF

ORDER GRANTING WITH LEAVE 1

TO AMEND MOTION TO DISMISS

FOR FAILURE TO STATE A CLAIM

UPON WHICH RELIEF CAN BE

GRANTED; GRANTING IN PART

WITH LEAVE TO AMEND AND

DEFERRING IN PART MOTION TO

DISMISS FOR FAILURE TO

COMPLY WITH RULE 23.1

[re: docket nos. 71, 74]

I. BACKGROUND

1. Procedural Background

This derivative action arises from the alleged backdating and springloading of stock

options by directors and officers of nominal defendant Ditech Networks, Inc. (“Ditech” or “the

Company”). Plaintiff Donald W. Newman filed the initial complaint on August 23, 2006. The

Court has consolidated the Newman action and two other actions under the above caption. On

Case 5:06-cv-05157-JF Document 88 Filed 03/26/08 Page 1 of 17
1

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

2

Case No. C 06-5157 JF

ORDER RE MOTION TO DISMISS ETC.

(JFLC3)

March 2, 2007, Plaintiffs filed an amended consolidated complaint (“the Complaint”). That

complaint was dismissed without prejudice on July 16, 2007. In re Ditech Networks, Inc. Deriv.

Litig., No. C 06-5157 JF, 2007 WL 2070300 (N.D. Cal. July 16, 2007). Plaintiffs filed the

operative second amended complaint (“SAC”) on September 18, 2007. The SAC asserts claims

against the following individuals (“the Individual Defendants”):

Defendant Role in the Company

Timothy K.

Montgomery

President, CEO, and director, September 1998 to present.

Chairman of the Board of Directors (“the Board”), October 1999 to

present. 

Senior Vice President of Sales and Marketing, November 1997 to

September 1998.

Gregory M. Avis Director, February 1997 to present.

Member, Compensation Committee, 1999 to present.

William A.

Hasler

Director, May 1997 to present.

Member, Compensation Committee, at least 1999 to present.

Member, Audit Committee, at least 1999 to present.

Andrei M.

Manoliu

Director, June 2000 to present.

Member, Audit Committee, 2003 to present.

Edwin L. Harper Director, December 2002 to present.

David M.

Sugishita

Director, February 2003 to present.

Member, Audit Committee, 2003 to present; Chair of Audit Committee,

2004 to present.

Serge Stepanoff Vice President of Engineering & Development for Echo Cancellation

Products, September 1996 to May 2002.

William J.

Tamblyn

Chief Financial Officer, June 1997 to present.

Executive Vice President, May 2005 to present.

Vice President, June 1997 to May 2005.

Toni M. Bellin Vice President of Operations, December 1998 to July 2001.

Robert T.

DeVincenzi

Senior Vice President of Sales for Altamar Networks, July 2000 to June

2003.

Ian M. Wright Senior Vice President of Engineering for Optical Networking Products,

February 2000 to present.

Chalan M. Aras Vice President of Marketing, May 2004 to present.

Senior Director of Product Management, October 2003 to May 2004.

Lowell B.

Trangsrud 

Vice President, Operations since July 2000

As alleged in the SAC, for each of the four allegedly backdated option grants, Ditech’s

Case 5:06-cv-05157-JF Document 88 Filed 03/26/08 Page 2 of 17
1

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

3

Case No. C 06-5157 JF

ORDER RE MOTION TO DISMISS ETC.

(JFLC3)

compensation committee consisted of Defendants Hasler and Avis. By 2004, when the one

springloaded grant allegedly was made, a third independent director, Defendant Harper, had

joined the compensation committee. Defendants Manoliu, Sugishita, and before 2004, Harper,

are not accused of backdating options but are accused of having approved SEC filings, which

allegedly made false or misleading statements regarding Ditech’s procedures for granting

options. The remaining eight defendants are alleged to have received at least one backdated or

springloaded grant. 

The SAC asserts five claims Delaware law: (1) breach of fiduciary duty and/or aiding

and abetting, against the Individual Defendants; (2) unjust enrichment, against Defendants

Montgomery, Stepanoff, Tamblyn, Bellin, DeVincenzi, Trangsrud, Wright, and Aras ;(3) breach

of fiduciary duty and/or aiding and abetting relating to the backdated option grants, against

Defendants Avis and Hasler; (4) breach of fiduciary duty and/or aiding and abetting relating to

the May 18, 2004 option grants, against Defendants Avis, Hasler and Harper; and (5) breach of

fiduciary duty for making false and misleading statements against and/or aiding and abetting

relating to the May 18, 2004 option grants, against Defendants Avis, Hasler and Manoliu. 

On November 30, 2007, the Individual Defendants moved to dismiss the SAC for failure

to state a claim upon which relief can be granted, and Ditech moved to dismiss the Complaint for

failure to make demand. Plaintiffs oppose both motions. The Court heard oral argument on

February 8, 2008. 

2. Allegations of the SAC

Pursuant to the Company’s shareholder-approved stock option plans, the exercise price of

options may not be less than the fair market value of the stock on the date the option is granted. 

SAC at ¶ 34. However, the SAC alleges that

The Compensation Committee, of which Defendants Avis and Hasler were

members, had the sole authority to choose the dates, and in fact, did choose the

dates on which the stock options were granted. Avis and Hasler approved each

grant on a date after the reported grant date and knowingly used hindsight to pick

a date when Ditech’s stock was at a quaterly or monthly low. Avis and Hasler

knew that the Plan required them to use the Fair Market Value on the actual grant

date and knew that backdating to a date with a lower price violated the Plan. 

Notwithstanding the clear requirements of the Plan, Defendants Avis and Hasler

purported to grant stock options to Defendants Montgomery, Stepanoff and

Case 5:06-cv-05157-JF Document 88 Filed 03/26/08 Page 3 of 17
1

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

 The July 6, 2000 grants to Montgomery and Tamblyn were subsequently cancelled on 2

March 19, 2003. On September 23, 2003, Ditech granted Montgomery and Tamblyn

replacement option grants covering 25% of the number of shares subject to the cancelled options

with a exercise price of $10.35 per share. Thus, under the repricing, Montgomery received

option grants covering 58,000 shares and Tamblyn received option grants covering 10,000 shares

with an exercise prices of $10.35 per share. SAC at ¶ 38 n.11.

See n.2 above. 3

4

Case No. C 06-5157 JF

ORDER RE MOTION TO DISMISS ETC.

(JFLC3)

Tamblyn on August 10, 1999 and Defendant Bellin on October 4, 1999. Avis and

Hasler’s backdating was particularly egregious because on August 10, 1999 and

October 4, 1999 grant were backdated to coincide with the second-lowest

quarterly and lowest monthly prices . . . .

SAC at ¶ 41. Plaintiffs allege that the following is a complete list of all options granted by the 

Compensation Committee to Defendants Montgomery, Stepanoff, Tamblyn, Bellin, DeVincenzi,

and Wright from 1999 to January 2001:

Purported Date Recipient Number of Options Exercise Price

8/10/1999 Montgomery 253,888 $9.00

8/10/1999 Stepanoff 125,020 $9.00

8/10/1999 Tamblyn 149,586 $9.00

10/4/1999 Bellin 50,000 $24.69

7/06/00 Montgomery 232,000 $79.502

7/06/00 Tamblyn 40,000 $79.503

8/1/2000 DeVincenzi 133,934 $22.50

1/10/2001 Montgomery 400,000 $7.19

1/10/2001 DeVincenzi 160,000 $7.19

1/10/2001 Tamblyn 145,000 $7.19

1/10/2001 Wright 300,000 $7.19

SAC at ¶ 39. Plaintiffs allege that with the exception of the July 6, 2000 grants, which

subsequently were canceled, each of the aforementioned grant dates coincided with the lowest or

second-lowest closing price of Ditech stock in the month and/or quarter of the purported grant.

The SAC provides an analysis of the probability that such dates could have been selected at

random:

Case 5:06-cv-05157-JF Document 88 Filed 03/26/08 Page 4 of 17
1

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

5

Case No. C 06-5157 JF

ORDER RE MOTION TO DISMISS ETC.

(JFLC3)

Date

8/10/99 Second lowest price in fiscal quarter.

3.3% probability date was selected at random.

10/04/99 Lowest monthly price.

5% probability date was selected at random.

8/10/00 Lowest monthly price.

5% probability date was selected at random.

1/10/01 Second lowest price in two fiscal quarters

1.7% probability date was selected at random.

 SAC at ¶¶ 39-46. The SAC also includes an analysis by Merrill Lynch in support of its

inference that Defendants Avis and Hasler backdated the grants in question:

Calendar Year Management 20-

Day Return

Management

Annualized

Return

Investor

Annualized

Return

Management

Excess Return

1999 181% 3,264% 648% 2,616%

2000 51% 911% -66% 977%

2001 18% 318% -63% 380%

Average 83% 1,498% 173% 1,324%

SAC at ¶ 48. 

Defendants also allegedly engaged in option springloading on May 18, 2004.

“Springloading takes place when a stock option is granted at a time when the grantor(s) know

that the shares are actually worth more than the market value because the grantor(s) possess

material non-public information that would impact the company’s share price.” SAC at ¶ 50. 

Three springloaded stock option grants allegedly were made on May 18, 2004.

Purported Date Recipient Number of Options Exercise Price

5/18/04 Tamblyn 125,000 $13.37

5/18/04 Trangsrud 125,000 $13.37

5/18/04 Aras 100,000 $13.37

Case 5:06-cv-05157-JF Document 88 Filed 03/26/08 Page 5 of 17
1

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

6

Case No. C 06-5157 JF

ORDER RE MOTION TO DISMISS ETC.

(JFLC3)

SAC at ¶ 49-56. The grant price coincided with the third lowest price of 2004. Id. The

Company announced positive results on May 27, 2004, and Ditech shares closed at $20.61 per

share on May 28, 2004. Id. 

As alleged in the SAC, the May 18, 2004 option grants were made when defendants Avis,

Hasler and Harper knew that Ditech shares actually were worth more than their market value

because they possessed material non-public information that would impact [Ditech’s] share price. 

SAC at ¶ 50-56. As disclosed in the 2005 Proxy, the May 18, 2004 grant date was the only date

on which any of Ditech’s executeve officers Defendants Montgomery, Stepanoff, Tamblyn,

Belin, DeVincenzi, and Wright received option grants in the fiscal year ending April 30, 2005,

and that date corresponded with Ditech’s third lowest annual closing price. SAC at ¶¶ 49-56. 

When Ditech publicly announced is earnings, seven trading days after May 18, 2004, the news

drove Ditech’s stock price up nearly 30%, and the trading volume was apparently sixteen time

greater than in the preceding days. SAC at ¶ 53.

Plaintiffs claim that they have not made a demand on the Board because “demand would

be a futile and useless act because the Board is incapable of making an independent and

disinterested decision to institute and vigorously prosecute this action.” SAC ¶ 102. At the time

this action was commenced, the Board consisted of six directors: Montgomery, Avis, Hasler,

Manoliu, Sugishita, and Harper. SAC ¶ 103. According to Plaintiffs, five directors are incapable

of considering independently and disinterestedly a demand to commence and prosecute this

action vigorously. Id. The reasons for each director’s alleged incapacity to do so are summarized

in the table below: 

Director Reasons for Lack of Independence and Disinterestedness

Montgomery • Received backdated stock options.

• Sold Ditech stock for proceeds in excess of $39 million on the

basis of inside information.

Case 5:06-cv-05157-JF Document 88 Filed 03/26/08 Page 6 of 17
1

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

7

Case No. C 06-5157 JF

ORDER RE MOTION TO DISMISS ETC.

(JFLC3)

Avis • Sold Ditech stock for proceeds in excess of $43 million on the

basis of inside information.

• Knowingly and deliberately backdated stock option grants as a

member of the Compensation Committee, and is substantially

likely to be held liable for breaching his fiduciary duties.

• Colluded with the Officer Defendants, demonstrating that he is

unable or unwilling to act independently.

• Has served as Managing Partner of Summit, a venture capital and

private firm, since 1990. Summit invested in Ditech in 1997 and

is still listed as a Summit portfolio company.

Hasler • Sold Ditech stock for proceeds in excess of $4.4 million on the

basis of inside information.

• Knowingly and deliberately backdated stock option grants and

approved, signed, and disseminated false financial statements and

other false SEC filings as a member of the Audit and

Compensation Committees, and is substantially likely to be held

liable for breaching his fiduciary duties.

• Colluded with the Officer Defendants, demonstrating that he is

unable or unwilling to act independently.

Manoliu • Sold Ditech stock for proceeds in excess of $441,000 on the basis

of inside information.

• Knowingly and deliberately approved, signed, and disseminated

false financial statements and other false SEC filings as a member

of the Audit Committee, and is substantially likely to be held

likely for breaching his fiduciary duties.

• Colluded with the Officer Defendants, demonstrating that he is

unable or unwilling to act independently.

Sugishita • Sold Ditech stock for proceeds in excess of $516,000 on the basis

of inside information.

• Knowingly and deliberately approved, signed, and disseminated

false financial statements and other false SEC filings as a member

and Chair of the Audit Committee, and is substantially likely to

be held liable for breaching his fiduciary duty.

• Colluded with the Officer Defendants, demonstrating that he is

unable or unwilling to act independently.

Id. 

II. LEGAL STANDARD

1. Motion to Dismiss

For purposes of a motion to dismiss, the plaintiff’s allegations are taken as true, and the

Court must construe the complaint in the light most favorable to the plaintiff. Jenkins v.

McKeithen, 395 U.S. 411, 421 (1969). However, the court is not required “to accept legal

conclusions case in the form of factual allegations if those conclusions cannot reasonably be

drawn from the facts alleged.” Clegg v. Cult Awareness Network, 18 F.3d 752, 754-55 (9th Cir.

Case 5:06-cv-05157-JF Document 88 Filed 03/26/08 Page 7 of 17
1

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

 The parties agree that Delaware law applies to the instant action because Ditech is 4

incorporated in Delaware.

8

Case No. C 06-5157 JF

ORDER RE MOTION TO DISMISS ETC.

(JFLC3)

1994). Leave to amend must be granted unless it is clear that the complaint’s deficiencies cannot

be cured by amendment. Lucas v. Department of Corrections, 66 F.3d 245, 248 (9th Cir. 1995). 

When amendment would be futile, however, dismissal may be ordered with prejudice. Dumas v.

Kipp, 90 F.3d 386, 393 (9th Cir. 1996). Leave to amend is to be granted with extreme liberality

in securities fraud cases, because the heightened pleading requirements imposed by the PSLRA

are so difficult to meet. See Eminence Capital, LLC v. Aspeon, Inc., 316 F.3d 1048, 1052 (9th

Cir. 2003). 

On a motion to dismiss, the Court’s review is limited to the face of the complaint and

matters judicially noticeable. North Star International v. Arizona Corporation Commission, 720

F.2d 578, 581 (9th Cir. 1983); MGIC Indemnity Corp. v. Weisman, 803 F.2d 500, 504 (9th Cir.

1986); Beliveau v. Caras, 873 F.Supp. 1393, 1395 (C.D. Cal. 1995). However, under the

“incorporation by reference” doctrine, the Court also may consider documents that are referenced

extensively in the complaint and are accepted by all parties as authentic, even though the

documents are not physically attached to the complaint. In re Silicon Graphics, Inc. Securities

Litigation, 183 F.3d 970 (9th Cir. 1999).

2. The Demand Requirement

A shareholder derivative complaint must “allege with particularity the efforts, if any,

made by the plaintiff to obtain the action the plaintiff desires from the directors or comparable

authority and, if necessary, from the shareholders or members, and the reasons for the plaintiff's

failure to obtain the action or for not making the effort.” Fed. R. Civ. P. 23.1. The existence and

satisfaction of a demand requirement is a substantive issue governed by state law. See Kamen v.

Kemper Financial Services, Inc., 500 U.S. 90, 96-97 (1991). When the challenged decision is 4

that of the board in place at the time of the filing of the complaint, failure to make demand may

be excused if a plaintiff can raise a reason to doubt that a majority of the board is disinterested or

independent or that the challenged acts were the product of the board’s valid exercise of business

Case 5:06-cv-05157-JF Document 88 Filed 03/26/08 Page 8 of 17
1

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

9

Case No. C 06-5157 JF

ORDER RE MOTION TO DISMISS ETC.

(JFLC3)

judgment. Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984); see also Ryan v. Gifford, 918 A.2d

341, 352 (Del. Ch. 2007) (discussing Aronson). However, “[w]here there is no conscious

decision by the corporate board of directors to act or refrain from acting, the business judgment

rule has no application.” Rales v. Blasband, 634 A.2d 927, 933 (Del. 1993); see also Ryan, 918

A.2d at 352 (discussing Rales). In such a situation, demand may be excused only if a plaintiff

“can create a reasonable doubt that, as of the time the complaint is filed, the board of directors

could have properly exercised its independent and disinterested business judgment in responding

to a demand.” Id. at 353 (citing Rales, 634 A.3d 933-34). 

III. DISCUSSION

1. Motion to Dismiss for Failure to State a Claim Upon Which Relief Can Be Granted

a. Rule 9(b)

Defendants argue that, even though Plaintiffs no longer assert a section 10(b) claim,

Plaintiffs still must comply with Rule 9(b)’s heightened pleading standards because the SAC

“sounds in fraud.” Plaintiffs argue that the breach of fiduciary duty claims are sufficiently pled

under Rule 8(a) and that Rule 9(b) does not apply to these claims. 

In Vess v. Ciba-Geigy, Corp., USA, 317 F.3d 1097, 1103-05 (9th Cir. 2003), the Ninth

Circuit stated that “[i]t is established law, in this circuit and elsewhere, that Rule 9(b)’s

particularity requirement applies to state-law causes of action.” In Vess, the Plaintiff argued that

Rule 9(b) did not apply to the case because the state statutory claims he asserted did not require a

showing of fraud. Id. at 1103. However, Rule 9(b) is not limited to complaints that allege fraud

as such. Instead, 9(b) applies whenever a complaint alleges facts that “necessarily constituted

fraud.” Vess v. Ciba-Geigy Corp., USA 317, F.3d 1097, 1103-05 (9th Cir. 2003). “[I]n a case

where fraud is not an essential element of a claim, only allegations (“averments”) of fraudulent

conduct must satisfy the heightened pleading requirement of Rule 9(b). Allegations of nonfraudulent conduct need satisfy only the ordinary notice pleading standards of Rule 8(a).” Id. at

1105. 

Here, the SAC describes a unified course of allegedly fraudulent conduct, which is

characterized as “a secret scheme to grant undisclosed, in-the-money stock options to themselves

Case 5:06-cv-05157-JF Document 88 Filed 03/26/08 Page 9 of 17
1

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

10

Case No. C 06-5157 JF

ORDER RE MOTION TO DISMISS ETC.

(JFLC3)

and others by backdating stock option grants.” SAC at ¶ 2. While Plaintiffs have removed the

securities fraud claims from their complaint and have replaced them with state law claims

including claims for breach of fiduciary duty, the underlying allegations are the same. Plaintiffs

claim that Defendants breached their fiduciary duty by unduly benefitting Company insiders at the

expense of the Company through grants of backdated or springloaded stock options. Vess is clear

that Rule 9(b) applies to such allegations. Accordingly, Rule 9(b)’s heightened pleading standard

applies to the entire SAC.

b. Plaintiffs’ Allegations of Backdating and Springloading

Turning to the issue of whether Plaintiffs have alleged circumstances from which the court

reasonably may infer backdating or springloading, Plaintiffs argue that the SAC contains enough

information to allow the Court to draw the reasonable inference that Ditech backdated its stock

option grants to the individual Defendants.

1. Statistical Pattern

Plaintiffs allege that the SAC contains all of the discretionary options granted by the

Compensation Committee to the Defendants from1999 to 2001 (the “Backdating Period”). 

During the Backdating Period, the Compensation Committee granted to the individual Defendants

options only on five discrete grant dates. Plaintiffs allege that four of the five option grant dates

during the Backdating Period were selected with the benefit of hindsight, as each was granted at a

low point of Ditech’s stock price. Plaintiffs cite to In re Zoran, 511 F.Supp.2d 986, 1004 (N.D.

Cal. 2007), in which the court found a “striking” pattern where seven of thirty stock option grants

fell on the date with the lowest option price in the calendar month. Plaintiffs argue that if seven

of thirty constitutes a “striking” pattern, then four of five also must be strong evidence of

backdating. Plaintiffs acknowledge that the grants to the Defendants were discretionary and made

sporadically rather than according to a pre-set schedule. 

Defendants contend that these allegations do not show a statistically implausible pattern. 

They argue that Plaintiffs’ “pattern” actually reflects an arbitrary selection of four of seventy-one

grants made by Ditech between the date of its initial public offering and the date Plaintiffs filed

their initial complaint. Defendants assert that “Plaintiffs’ focus on just five Ditech officers, to the

Case 5:06-cv-05157-JF Document 88 Filed 03/26/08 Page 10 of 17
1

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

11

Case No. C 06-5157 JF

ORDER RE MOTION TO DISMISS ETC.

(JFLC3)

exclusion of many other senior executives and section 16 officers, necessarily introduced bias into

the analysis.” Reply 7:20-23. Defendants suggest that Plaintiffs’ analysis of a period of only

eighteen months cannot be justified by any change in Ditech personnel, events in the market, or

change in applicable law. 

Plaintiffs respond that they have included every stock option grant given to the named

Defendants from 1999 through January 2001, and that the Individual Defendants were chosen not

to skew the statistical analysis but rather because these individuals’ grants are the only grants

disclosed as required by law in the Company’s annual proxy statements. However, while

Plaintiffs explain why these particular Defendants were chosen, it is still not clear why the

particular time period was chosen and whether the Individual Defendants were granted other

options outside the time period. Plaintiffs assert only that the SAC lists each and every option

grant to the Defendants from 1999 through January 2001. Arguably, this failure to plead any facts

as to when other options were granted outside the time period selected by the Plaintiffs is a form

of statistical gerrymandering. See In re Linear Tech. Corp. Deriv. Litig., 2006 WL 3533024, at *3

(N.D. Cal. Dec. 7, 2006). Because Plaintiffs’ statistical analysis is incomplete, Defendants’

motion to dismiss the backdating allegations will be granted, with leave to amend.

2. Merrill Lynch Analysis

As noted above, the SAC also includes an analysis by Merrill Lynch. Plaintiffs allege that

the results of this analysis show that the annualized average return on stock options granted to

Defendants from 1999 to 2001 was 1,498%, compared to average investor annualized return of

173%. SAC at ¶ 48. Defendants again argue that the relevance and probative value of the Merrill

Lynch analysis depends on the selection of the grants to be analyzed and the time period covered

by the analysis. Accordingly, for the reasons stated above, this claim will also be dismissed with

leave to amend. 

3. Springloading

Plaintiff allege that the grant made on May 18, 2004 was springloaded because Ditech

shares actually were worth more than their market value and the Compensation Committee

possessed material non-public information impacting the Company’s share price. According to

Case 5:06-cv-05157-JF Document 88 Filed 03/26/08 Page 11 of 17
1

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

12

Case No. C 06-5157 JF

ORDER RE MOTION TO DISMISS ETC.

(JFLC3)

Plaintiffs, Ditech’s stock price “soared 29.5%” when Ditech announced its quarterly earnings

shortly after the grant was made. SAC at ¶ 53. Defendants argue that such conclusory

allegations–a grant was made, good news later was announced, the directors knew of the good

news when they made the grant–do not meet the heightened pleading requirements of Rule 9(b).

Plaintiffs’ earlier complaint was dismissed because it did not allege which Defendants authorized

the grants, approved the grants, or had knowledge that the grants were springloaded, nor did it

allege the specific material information that had not been made public previously. The Court

observed that while “it is not clear that Plaintiff will be able to state a claim for breach of fiduciary

duty by identifying only one allegedly improper grant date, the law in this area is still developing

and the Delaware Chancery Court has permitted at least one claim for breach of the duty of loyalty

and good faith to proceed on a springloading theory. See In re Tyson Foods, 919 A.2d 563, 593

(Del. Ch. 2007).” July 17, 2007 Order. In Tyson Foods, the court found that plaintiffs properly

had pled a claim of springloading where defendants granted options at $13.33 per share on

September 19, 2003, and four days later Tyson publicly announced that earnings would exceed 

expectations, propelling the sale price to $14.25. 

Defendants argue that Tyson Foods is distinguishable. They contend that in that case, the

directors intentionally used inside knowledge in order to enrich employees while avoiding

shareholder-imposed requirements. The shareholder-imposed requirements were set out in the

company’s stock option plan and provided that options could be only used to encourage future

performance by executives. Allegedly, the directors secretly violated that restriction by using

material, non-public information to issue options with the intent to circumvent the otherwise valid

shareholder approved restrictions. Defendants argue that Plaintiffs do not allege any of the facts

that were material to the decision in Tyson Foods. 

Recently in Desimone v. Barros, 924 A.2d 916, 946 (Del. Ch. 2007), the Delaware

Chancery Court held that a springloading claim must be supported by specific facts showing the

directors possessed material non-public information, harbored an illicit intent to enrich the

recipients at the expense of the shareholders, and chose to subvert the purposes of the company’s

shareholder-approved stock option plan. Desimone requires that the non-public information must

Case 5:06-cv-05157-JF Document 88 Filed 03/26/08 Page 12 of 17
1

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

13

Case No. C 06-5157 JF

ORDER RE MOTION TO DISMISS ETC.

(JFLC3)

be sufficiently important that it is likely have “a substantial effect on the stock’s trading price

months latter when the first of the options vested.” Id. at 946. Further, the company’s stock

performance must be presented on a market-adjusted basis, so that the company’s stock price

“swings” can be “correlated” to “overall market movements.” The Desimone court also noted the

problem with alleging just one springloaded grant:

[B]y contrast to the allegations in Tyson, where the complaint pled a multi-year

pattern of extraordinary options grants to key insiders-including members of the

board-just before the release of clearly material, market-moving positive

information, the complaint here contains weak allegations about a single alleged

instance of spring loading.

Id.

This Court finds the reasoning of Desimone persuasive. The SAC contains no factual

allegations as to the knowledge of the options recipients and instead makes only conclusory

allegations. Because Plaintiffs’ allegations of options springloading sound in fraud, Plaintiffs

must plead with particularity. Fed. R. Civ. P. 9(b); Atlantis Plastic Corp. v. Sammons, 558 A.2d

1062, 1066 (Del. Ch. 1989) (stating same rule under Delaware law). Accordingly, this claim will

be dismissed with leave to amend.

4. Allegations Against the Individual Defendants

In its previous order, the Court noted that the complaint “alleged a very limited number of

facts that pertain to a subset of the defendants, but then attempts to impose liability on all the

Individual Defendants.” 7/16/2007 Order, pg. 10. The SAC alleges that Defendants Avis, Hasler,

and Harper are liable because they “approved” allegedly backdated or springloaded options; (2)

Defendants Montgomery, Tamblyn, Avis, Hasler, and Manoliu are liable because the signed

DITECH’s SEC filing; and (3) all of the other Defendants are liable because they “received”

allegedly backdated or springloaded options. 

In Desimone, the court noted that “Desimone has not pled facts suggesting an inference

that the Sycamore board knowingly granted Sycamore’s officer backdated options. Desimone,

924 A.2d at 942. See also In re Verisign, Inc., Deriv Litig., 2007 WL 2705221, *30 (N.D. Cal.

Sept. 14, 2007) (plaintiffs did not plead “a single fact showing what each defendant knew, when

he/she knew it, or how he/she acquired that knowledge.”). Here, Plaintiffs have not alleged any

Case 5:06-cv-05157-JF Document 88 Filed 03/26/08 Page 13 of 17
1

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

14

Case No. C 06-5157 JF

ORDER RE MOTION TO DISMISS ETC.

(JFLC3)

prior knowledge on the part of the individual Defendants, and accordingly, the claims against

them will be dismissed with leave to amend.

4. Claim Six: Unjust Enrichment

The Individual Defendants argue that the Complaint fails to state a claim for unjust

enrichment because Plaintiffs have not alleged that other adequate remedies are not provided by

law or that the options recipients were enriched unjustly. The Court agrees. Plaintiffs have not

pled specific facts showing that the value of the Individual Defendants’ work was less than the

value of the options they received. Accordingly, the unjust enrichment claim will be dismissed,

with leave to amend. 

2. Motion to Dismiss for Failure to Make Demand

a. Standing Under Rule 23.1

Defendants claim that Plaintiffs lack standing to sue regarding all of the allegedly

backdated grants. Under Fed. R. Civ. Pro. 23.1, a shareholder suing derivatively must allege he

or she owned stock “at the time the transaction of which [the shareholder] complains.” Fed. R.

Civ. P. 23.1(b)(1). Delaware law also requires a shareholder bringing a derivative suit to have

been a shareholder at the time of the transaction. 8 Del. C. § 327. “The strict interpretation of the

rules serves to prevent strike suits and to ensure that a derivative plaintiff truly acts in the

corporation’s best interest.” In re MIPS Tech., Inc., 2008 WL 131915, *5 (N.D. Cal. 2008) citing

Conrad v. Blank, 940 A.2d 28, *41 (Del. Ch. Sept. 7, 2007) (holding that plaintiff lacked standing

to challenge stock option grants predating her ownership of the corporation’s stock). 

The Delaware Chancery Court has applied this rule in options backdating cases. In Ryan

v. Gifford, 918 A.2d 341, 358-59 (Del. Ch. 2007), the court held that a plaintiff could not assert

any claims arising before his ownership interest materialized on the date he acquired stock by

virtue of a merger. Similarly, in Desimone, 924 A.2d at 924-27, all claims predating plaintiff’s

ownership were also dismissed.

In the instant case, the four purported backdated grants were made on August 10, 1999,

October 4, 1999, August 1, 2000, and January 10, 2001. The allegedly springloaded stock grant

was made on May 18, 2004. Defendants contend that three Plaintiffs—Newman, McKenna, and

Case 5:06-cv-05157-JF Document 88 Filed 03/26/08 Page 14 of 17
1

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

15

Case No. C 06-5157 JF

ORDER RE MOTION TO DISMISS ETC.

(JFLC3)

Lau—did not own Ditech stock at the time of any of the challenged grants was made. Indeed,

Newman and McKenna allege that they first purchased Ditech stock in March, 2005. SAC at ¶¶

10-11. Lau also alleges that he first bought Ditech Stock in 2005. SAC at ¶12. Plaintiffs do

allege that one named Plaintiff, Lieberman, purchased Ditech stock on January 12, 2001. SAC at

¶ 13. Plaintiffs argue that Lieberman also should be permitted to assert claims arising from the

January 10, 2001 grant, because the facts suggest a reasonable inference that the actual grant was

made some time after January 12, 2001. Defendants argue that Lieberman has no basis for

asserting standing to challenge the January 10, 2001 grant under Delaware law.

 Section 327 makes ownership at the time of the challenged conduct as a prerequisite to

maintaining a derivative action. The primary purpose of section 327 is to prevent plaintiffs from

buying stock in order to maintain a derivative suit. Thus, in the instant case, if the backdating

occurred when Lieberman owned his stock, his interest in the company has been harmed by the

alleged backdating when he was a shareholder. However, Plaintiffs do not allege specifically that

Lieberman owned stock when the alleged backdating occurred, and at this point their suggestion

as to the actual date of such occurrence is speculative. Accordingly, based on their current

allegations, Plaintiffs have standing to pursue only those claims related to the May 18, 2004

springloaded grant. 

b. Disinterestedness and Independence

In its order of July 16, 2007, the Court stated that Plaintiffs likely could meet the demand

futility requirement provided the amended complaint alleged with sufficient particularity that each

of the directors approved the option grants or otherwise participated in wrongful conduct. 

Assuming that they can add sufficient particularity to their pleadings, it appears Plaintiffs can

meet the demand requirement. 

Case 5:06-cv-05157-JF Document 88 Filed 03/26/08 Page 15 of 17
1

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

16

Case No. C 06-5157 JF

ORDER RE MOTION TO DISMISS ETC.

(JFLC3)

IV. ORDER

Good cause therefor appearing, IT IS HEREBY ORDERED that the motion to dismiss for

failure to state a claim upon which relief can be granted is GRANTED WITH LEAVE TO

AMEND, and the motion to dismiss for failure to comply with Rule 23.1 is GRANTED WITH

LEAVE TO AMEND as to standing and DEFERRED as to Plaintiffs’ failure to make demand. 

Any amended complaint shall be filed within thirty days of the date of this order.

DATED: March 26, 2008

 

JEREMY FOGEL

United States District Judge

Case 5:06-cv-05157-JF Document 88 Filed 03/26/08 Page 16 of 17
1

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

17

Case No. C 06-5157 JF

ORDER RE MOTION TO DISMISS ETC.

(JFLC3)

This Order has been served upon the following persons:

Lawrence Timothy Fisher ltfisher@bramsonplutzik.com, moldenburg@bramsonplutzik.com 

Alan R Plutzik aplutzik@bramsonplutzik.com 

Diane E. Pritchard dpritchard@mofo.com, mbenedict@mofo.com, blevine@mofo.com 

Darryl P. Rains drains@mofo.com, dgillis@mofo.com 

Kathryn A. Schofield kschofield@bramsonplutzik.com,

moldenburg@bramsonplutzik.com 

Emanuel Shachmurove mshachmurove@sbtklaw.com 

Shawn A. Williams shawnw@lerachlaw.com, e_file_sd@lerachlaw.com;

e_file_sf@lerachlaw.com; aelishb@lerachlaw.com;

moniquew@lerachlaw.com; travisd@lerachlaw.com;

cwood@lerachlaw.com; jdavis@lerachlaw.com 

Eric L. Zagar ezagar@sbtklaw.com, rwinchester@sbtklaw.com;

der_filings@sbtklaw.com; kpopovich@sbtklaw.com 

Case 5:06-cv-05157-JF Document 88 Filed 03/26/08 Page 17 of 17