Source: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-cand-3_03-cv-05138/USCOURTS-cand-3_03-cv-05138-1/pdf.json

Nature of Suit Code: 850
Nature of Suit: Securities, Commodities, Exchange
Cause of Action: 28:1331 Fed. Question: Securities Violation

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United States District Court

For the Northern District of California

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United States District Court

For the Northern District of California

IN THE UNITED STATES DISTRICT COURT

FOR THE NORTHERN DISTRICT OF CALIFORNIA

IN RE PORTAL SOFTWARE, INC

SECURITIES LITIGATION

 /

No C-03-5138 VRW

ORDER

Plaintiffs in this securities fraud class action face the

unenviable task of complying with the stringent pleading

requirements imposed on such actions. All too frequently, and once

again here, plaintiffs attempt this endeavor by a complaint replete

with evidentiary detail, but only a loose (and the court thinks too

loose) connection between the wrongful conduct alleged and its

effect on the class. The Supreme Court has recently reminded lower

federal courts that the heart of a fraud on a securities market is

the proximate causal link between the misstatement or omission

alleged and the resulting impact on the security’s price. Dura

Pharms Inc v Broudo, 125 S Ct 1627 (2005). Despite the rather

forgiving interpretation of Dura in this circuit, see In re Daou

Systems, Inc Securities Litigation, 2005 WL 1431833 (9th Cir June

21, 2005), the operative pleading here fails to make this

connection. Because plaintiffs will be allowed to amend, the court

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emphasizes the need for plaintiff to allege facts that link

defendants’ alleged wrongdoing to the class injury. A much

shorter, but targeted, pleading may well be more effective in

making this connection than the rather distended pleading now at

bar. But there are other shortcomings in their pleadings that

plaintiffs need to address and it is to these that the court

devotes the bulk of this order.

I

Plaintiff John Romeo (Romeo) and plaintiff Pipefitters

Local 522 & 633 Pension Fund Trust (Pipefitters) (collectively,

plaintiffs), purporting to represent investors who purchased

securities of Portal Software Inc (Portal) between May 20, 2003,

and November 13, 2003, inclusive (the “class period”), bring this

action under the Securities Exchange Act of 1934 (the “‘34 Act”)

and the Securities Act of 1933 (the “‘33 Act”). Plaintiffs allege

that defendants Portal, John Little (Little), Howard A Bain III

(Bain) and Arthur C Patterson (Patterson) (collectively defendants)

violated the Generally Accepted Accounting Principals (GAAP) by

artificially inflating the price of Portal’s stock and making false

and misleading statements on which plaintiffs relied, thereby

incurring substantial financial loss from purchasing Portal stock

at fraudulently inflated prices. Defendants’ move to dismiss (Doc

#115) plaintiffs’ third consolidated amended complaint (TCAC; Doc

#111) for failure to meet the particularity requirement imposed by

FRCP 9(b) and the Private Securities Litigation Reform Act

(PSLRA)(amendments to the ‘33 and ‘34 Acts). Plaintiffs oppose the

motion, asserting that the TCAC states sufficiently particularized

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claims under § 10(b) and § 20(a) of the ‘34 Act, as well as claims

under §§ 11, 12(a)(2) and 15 of the ‘33 Act.

The court heard argument on these motions on July 7,

2005. Based upon the parties’ arguments and the applicable federal

law, the court concludes that: (1) the allegations in plaintiffs’

complaint are not pled with sufficient particularity under the

PSLRA and FRCP 9(b); (2) the allegations are not sufficient to

support a strong inference of scienter under the PSLRA; (3)

defendants’ forward-looking statements are protected by the PSLRA’s

safe harbor provision ; (4) claims under the ‘33 Act sound in fraud

and therefore fail with the ‘34 Act claims. Accordingly, the court

GRANTS defendants’ motion to dismiss in its entirety.

II

The factual and procedural history is derived from the

TCAC and presumed true for purposes of this motion. Gompper v

VISX, Inc, 298 F3d 893, 895 (9th Cir 2002). Portal provides

billing and subscriber management solutions to its clients

primarily through its “Infranet” software. Portal charges

companies “license fees” for the Infranet product, as well as

“service fees” for system implementation, consulting, maintenance

and training. Prior to 2001, the majority of Portal’s customer

base consisted of “dot-com” start-up companies. Following the dotcom market crash of 2001, Portal lost many of its customers and

incurred financial losses during fiscal 2002-2003 that wiped out

more than 96% of Portal’s equity. Portal subsequently began to

market its Infranet product to more established and sophisticated

business customers, including telecommunications providers. 

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These new clients required greater customization of the

software than had the dot-com startups, which in turn affected the

way in which Portal could recognize license fee revenues. Pursuant

to GAAP, if a software provider rewrites portions of its product to

conform to a client’s unique needs, it may not fully recognize the

revenue on the license of software until such substantial

modification has been performed. Whereas Portal had historically

been able to recognize revenue at the time it delivered its

Infranet product to the dot-coms, the greater customization

required by these new, more established clients required Portal to

defer recognizing revenue from much of its contracts until

customization was complete. Plaintiffs allege that during the

class period, Portal began to manipulate its license fees so it

could recognize more revenue “up-front.” TCAC at ¶¶ 41-42. 

To support their allegations that Portal improperly

recognized revenue prematurely and in violation of GAAP, plaintiffs

rely on information from four unnamed former Portal employees: (1)

a controller; (2) a “Senior Business Analyst’” (3) an accounts

receivable and revenue assurance assistant; and (4) a “Senior

Marketing Manager.” TCAC at ¶¶ 41-54. The first three employees

detail three different methods of accounting fraud allegedly

undertaken by Portal management during the class period, while the

Senior Marketing Manager alleges ongoing product problems and a

decreasing market for key elements of Portal’s software offering. 

The information provided by the former controller

involved Portal’s method for recognizing licensing revenue. 

Historically, Portal preliminarily offered its customers a

“developmental license,” which consisted of a trial version of the

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software for a few key employees. Portal would charge only a

“nominal” amount for this first license. Then, if the client

wished to obtain the full Infranet product, Portal would sell the

client a “production license” and charge for the bulk of the

contract. After fiscal 2004, plaintiffs allege that Portal simply

charged a greater portion of the contract price under the

developmental license, even though it was still only a trial

version and significant modifications yet were to be performed

under the production license. Plaintiffs also allege that Portal’s

outside accountants, Ernst & Young, disapproved of this new split

license arrangement and reversed Portal’s position, a determination

which ultimately caused the shortfall in earnings and resulting

stock price decline. TCAC at ¶ 43.

Next, the former Senior Business Analyst asserts that he

was instructed by company officials, including Bain, to falsify

revenue recognition studies to justify premature recognition of

revenue. Under GAAP, when a software contract provides for both

licensing and services, such as software modification and

implementation, the revenue from each element can only be

recognized as it is performed, so long as the “fair value” of each

element is determinable. If the fair value of each element is not

determinable, than recognition of the entire contract must be

deferred until all elements have been delivered, or until such time

as the fair value of the remaining elements are determinable. The

Senior Business Analyst avers that when attempting to discern the

fair value of elements of a software arrangement, he was directed

by the management to “reverse engineer” the study to reach

predetermined results. This employee, who ceased employment

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several months before the end of the class period, alleges that he

was instructed to falsify revenue recognition studies with regard

to contracts performed in “Greece, Italy, Columbia [sic] and

Spain,” including a contract with “Columbia [sic] Mobile.” TCAC at

¶ 48.

The third former employee on whom Plaintiffs rely is an

accounts receivable and revenue assurance assistant employed during

the class period. She alleges that “revenues related to [Portal’s]

contracts with Onstar ... [were] materially overstated during the

third quarter of fiscal 2004.” TCAC at ¶ 49. Specifically, the

former employee alleges that Portal would recognize revenue from

the support, maintenance and upgrade elements of the software

contract, even though the work had not yet been performed. This

employee asserts that she obtained this knowledge because one of

her duties of employment was to reclassify the prematurely

recognized revenue for future quarters. She claims that she talked

to her manager about her concerns with the way Portal was

classifying revenue, and was subsequently dismissed from her

position. TCAC at ¶ 49.

Finally, plaintiffs proffer the testimony of a Senior

Marketing Manager to substantiate their allegations that Portal was

misrepresenting the demand for its product and concealing

significant technical problems with its applications. 

Specifically, the marketing employee stated that portions of

Portal’s billing software were being rendered obsolete by Customer

Relationship Management (CRM) applications sold by vendors like SAP

and Siebel. TCAC at ¶¶ 51-52. Moreover, Portal’s Infranet product

was having difficulty interfacing with these CRM applications,

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resulting in unexpected costs and delays for Portal. TCAC at ¶¶

53-54. Plaintiffs allege that Portal’s management failed to

disclose these technical difficulties and the declining demand for

Portal’s product during the class period, thus concealing the true

state of Portal’s financial health.

Plaintiffs’ complaint alleges that the accounting fraud

described above was undertaken by defendants to inflate Portal’s

reported revenue numbers, which were then used by defendants to

create false and misleading statements regarding Portal’s financial

health and future business prospects. According to plaintiffs,

these false and misleading statements artificially inflated

Portal’s stock price and allowed defendants to complete a $60

million secondary offering on September 12, 2003. Plaintiffs’

claims for violations of the ‘33 Act are based on alleged false and

misleading statements made in the registration statement and

prospectus issued in connection with the secondary offering. TCAC

at ¶¶ 142-165. Plaintiffs’ claims for violations of the ‘34 Act

are based on alleged false and misleading statements disseminated

to the investing public via SEC filings and press releases. TCAC at

¶¶ 166-181.

After the close of the market on November 13, 2003,

defendants announced that -- due to contract delays, revenue

recognition deferrals and service execution issues -- Portal

expected net losses of $0.36 to $0.40 per share for the third

quarter fiscal 2004. These losses were in contrast to the net

profits of $0.04 per share that Portal had previously projected for

the quarter. Subsequent to the November 11, 2003, announcement,

the price of Portal’s common shares plummeted 42% to $8.77 in after

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hours trading. TCAC at ¶ 75. Plaintiffs allege that this decline

in Portal’s stock price at the end of the class period was “a

direct result of the nature and extent of [d]efendant’s prior

misrepresentations, omissions and fraudulent conduct concerning

[Portal’s] adverse business and financial conditions finally being

revealed to investors and the market” and that plaintiffs “were

damaged as a proximate result thereof.” TCAC at ¶ 76.

III

As a preliminary matter, the court considers defendants’

request for judicial notice (RJN, Doc #119) regarding certain

documents attached to the declaration of Randolph Gaw in support of

defendants’ motion (Gaw Decl, Doc #116). Defendants contend that

all the documents so attached are the proper subject of judicial

notice pursuant to FRE 201. 

Exhibits N through U to the Gaw declaration are Form 4s

filed with the SEC regarding the stock sales of the individual

defendants and other corporate officers and directors, while

exhibits A through H are the SEC filings of defendant Portal. 

Defendants contend that the court is authorized to take judicial

notice of documents filed with the SEC. The court agrees that

judicial notice of such documents is proper. See, e g, Bryant v

Avado Brands, Inc, 187 F3d 1271, 1276 (11th Cir 1999); Allison v

Brooktree Corp, 999 F Supp 1342, 1352 n3 (SD Cal 1998). This

conclusion is bolstered by the fact that courts are specifically

authorized, in connection with a motion to dismiss a securities

fraud complaint, to consider documents and filings described in the

complaint under the incorporation by reference doctrine. See, e g,

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Ronconi v Larkin, 253 F3d 423, 427 (9th Cir 2001); In re Silicon

Graphics Securities Litigation, 183 F3d 970, 986 (9th Cir 1999). 

Thus, the court takes notice of all the documents attached to the

Gaw declaration that were filed with the SEC. 

Exhibits I through M are Portal press releases, which

defendants claim contain “safe harbor” warnings regarding any

forward-looking statements in the press releases. Judicial notice

of these exhibits is proper because the court is required to

consider “any cautionary statement accompanying [a] forward-looking

statement, which [is] not subject to material dispute, cited by the

defendant.” 15 USC § 78u-5(e). In addition, the court may take

judicial notice of information that was publicly available to

reasonable investors at the time the defendant made the allegedly

false statements. See In re The First Union Corp Securities

Litigation, 128 F Supp 871, 883 (WD NC 2001). This is true of press

releases, even if they were not explicitly referenced in the

complaint. See Wietschner v Monterey Pasta Co., 294 F Supp 2d

1102, 1108-09 (ND Cal 2003). 

Exhibit V to the Gaw declaration is the “Statement of

Position 97-2 Software Revenue Recognition.” This is an accounting

statement issued by the American Institute of Certified Public

Accountants. RJN Doc #19 at 4. Courts may take judicial notice of

documents that are alleged in the complaint and whose authenticity

no party questions, even when not attached to the complaint. See

Branch v Tunnell, 14 F3d 449, 454 (9th Cir 1994).

Finally, at oral argument on July 7, 2005, plaintiffs

submitted to the court three additional documents and requested

that the court take judicial notice of them in considering this

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motion. Doc #130. These documents include (1) a Portal press

release dated June 30, 2005; (2) Portal’s Form 8-K filed with the

SEC on June 27, 2005; and (3) Portal’s Form 10-Q for the quarter

ending October 31, 2004, filed with the SEC on April 25, 2005. Id. 

The court takes notice of these documents, which are all public

filings capable of judicial notice.

IV

Standard of Review

FRCP 12(b)(6) motions to dismiss essentially “test

whether a cognizable claim has been pleaded in the complaint.” 

Scheid v Fanny Farmer Candy Shops, Inc, 859 F2d 434, 436 (6th Cir

1988). FRCP 8(a), which states that plaintiff’s pleadings must

contain “a short and plain statement of the claim showing that the

pleader is entitled to relief,” provides the standard for judging

whether such a cognizable claim exists. Lee v City of Los Angeles,

250 F3d 668, 679 (9th Cir 2001). This standard is a liberal one

that does not require plaintiff to set forth all the factual

details of his claim; rather, all that the standard requires is

that plaintiff give defendant fair notice of the claim and the

grounds for making that claim. Leatherman v Tarrant County

Narcotics Intell & Coord Unit, 507 US 163, 168 (1993) (citing

Conley v Gibson, 355 US 41, 47 (1957)). To this end, plaintiff’s

complaint should set forth “either direct or inferential

allegations with respect to all the material elements of the

claim”. Wittstock v Van Sile, Inc, 330 F3d 899, 902 (6th Cir

2003). 

Under Rule 12(b)(6), a complaint “should not be dismissed

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for failure to state a claim unless it appears beyond doubt that

plaintiff can prove no set of facts in support of [her] claim which

would entitle [her] to relief.” Hughes v Rowe, 449 US 5, 9 (1980)

(citing Haines v Kerner, 404 US 519, 520 (1972)); see also Conley,

355 US at 45-46. All material allegations in the complaint must be

taken as true and construed in the light most favorable to

plaintiff. See Silicon Graphics, 183 F3d at 980 n10. But “the

court [is not] required to accept as true allegations that are

merely conclusory, unwarranted deductions of fact, or unreasonable

inferences.” Sprewell v Golden State Warriors, 266 F3d 979, 988

(9th Cir 2001) (citing Clegg v Cult Awareness Network, 18 F3d 752,

754-55 (9th Cir 1994)).

Review of a FRCP 12(b)(6) motion to dismiss is generally

limited to the contents of the complaint, and the court may not

consider other documents outside the pleadings. Arpin v Santa

Clara Valley Transportation Agency, 261 F3d 912, 925 (9th Cir

2001). The court may, however, consider documents attached to the

complaint. Parks School of Business, Inc v Symington, 51 F3d 1480,

1484 (9th Cir 1995). If a plaintiff fails to attach to the

complaint the documents on which the complaint is based, a

defendant may attach such documents to its motion to dismiss for

the purpose of showing that the documents do not support

plaintiff’s claim. In re Autodesk, Inc Securties Litigation, 132 F

Supp 2d 833, 837 (ND Cal 2000) (citing Branch v Tunnel, 14 F3d 449,

454 (9th Cir 1994)). This permits the court to consider the full

text of a document that the plaintiff’s complaint only partially

quotes. Autodesk, 132 F Supp 2d at 838 (citing In re Stac

Electronics Securities Litigation, 89 F3d 1399, 1405 n4 (9th Cir

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1996), cert denied, 520 US 1103 (1997)). Additionally, “[t]he

court need not * * * accept as true allegations that contradict

matters properly subject to judicial notice * * *.” Sprewell, 266

F3d at 988 (citing Mullis v United States Bankr Ct, 828 F2d 1385,

1388 (9th Cir 1987)).

But these liberal pleading standards described above have

been substantially tightened in the context of securities

litigation, as will be discussed infra.

V

The TCAC alleges five causes of action. For the first

and second causes of action, plaintiffs allege violations of

sections 11 and 12(a)(2) of the ‘33 Act against all defendants. 

Plaintiffs’ first and second causes of action are based on the

registration statement Portal filed for its secondary public

offering (SPO) in September 2003. Plaintiffs’ third cause of

action alleges control liability under section 15 of the ‘33 Act

against Little, Bain and Patterson (the “individual defendants”). 

Plaintiffs’ fourth cause of action alleges violations of section

10(b) of the ‘34 Act and Rule 10b-5 promulgated thereunder against

all defendants. Lastly, plaintiffs allege control liability under

section 20(a) of the ‘34 Act against the individual defendants. 

The court will first address first plaintiffs’ claims under the ‘34

Act before turning to the claims brought under the ‘33 Act. 

//

//

//

//

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A

Section 10(b) and 20(a) of the Exchange Act of 1934

Section 10(b) of the ‘34 Act and SEC Rule 10b-5,

promulgated thereunder, make it unlawful for any person, in

connection with the purchase or sale of any security, to (1) engage

in fraud or (2) make an untrue statement regarding a material fact

or (3) make a misleading statement by omitting a material fact. 15

U.S.C. § 78j(b); 17 CFR § 240.10b-5. Consequently, the elements of

a Rule 10b-5 claim are: (1) a material misrepresentation or

omission of fact, (2) scienter, (3) a connection with the purchase

or sale of a security, (4) transaction and loss causation, and (5)

economic loss. See Dura, 125 S Ct at 1633.

Claims brought under Section 10(b) and Rule 10b-5 must

first meet the particularity requirements of FRCP 9(b). In re

Stac, 89 F3d at 1404; see also In re GlenFed Inc Securities

Litigation, 42 F3d 1541, 1545 (9th Cir 1994) (en banc). Rule 9(b)

requires a plaintiff alleging fraud to “set forth what is false or

misleading about [the] statement[] and why it is false.” GlenFed,

42 F3d at 1548.

Second, a complaint must satisfy the more stringent

requirements imposed on securities fraud pleadings by the PSLRA. 

Specifically, the PSLRA requires that a complaint: (1) “specify

each statement alleged to have been misleading [and] the reason or

reasons why the statement is misleading * * *” (15 USC § 78u4(b)(1)); (2) with respect to any such allegations based upon

information and belief, “state with particularity all facts on

which that belief is formed” (15 USC § 78u-4(b)(1)); and (3) “with

respect to each act or omission * * * state with particularity

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facts giving rise to a strong inference that the defendant acted

with the required state of mind” (15 USC § 17u-4(b)(2)). The

required state of mind, or scienter, is met where the complaint

alleges that the defendants made the false or misleading statements

either intentionally or with deliberate recklessness.” In re Daou

Systems, Inc Securities Litigation, 2005 WL 1431833 (9th Cir June

21, 2005)(citing Silicon Graphics, 183 F3d at 974) (emphasis

added). In securities cases, falsity and scienter “are generally

inferred from the same set of facts and the two requirements may be

combined into a unitary inquiry under the PSLRA.” In re Vantive

Corp Securities Litigation, 283 F3d 1079, 1091 (9th Cir 2002)

(citations omitted).

Even if plaintiffs meet these heightened pleading

requirements, however, the PSLRA carves out a safe harbor from

liability if the alleged false or misleading statements were

forward-looking and accompanied by meaningful risk warnings. 15

USC § 78u-5(c); see also In re Splash Technology Holdings, Inc

Securities Litigation, 2000 US Dist LEXIS 15369, *16 (ND Cal)

(Splash I). An analogous doctrine (which predates the enactment of

the PSLRA) is the “bespeaks caution” doctrine, which allows a court

to rule as a matter of law that defendant’s forward-looking

statements contained enough cautionary language or risk disclosure

to protect against liability. See, e g, Provenz v Miller, 102 F3d

1478, 1493 (9th Cir 1996). If a defendant’s statements are

immunized under either doctrine, dismissal of the complaint is

appropriate. See id; Splash I, 2000 US Dist LEXIS at *29.

Defendants challenge the sufficiency of plaintiffs’ ‘34

Act claims on several grounds: (1) plaintiffs’ complaint lacks the

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specificity needed to plead accounting fraud; (2) plaintiffs fail

to plead facts raising a strong inference of scienter; and (3)

defendants’ statements are protected by the PSLRA’s safe harbor

provision. Before turning to the issue of safe harbor, the court

will address the defendants’ first two contentions under the

“unitary inquiry” advocated in this circuit, as “falsity and

scienter are generally inferred from the same set of facts * * *.” 

In re Vantive, 283 F3d at 1091.

1

Defendants contend that the TCAC should be dismissed

because plaintiffs have not adequately pled facts to support their

allegations of accounting fraud or to support a strong inference of

scienter. “If properly pled, overstating of revenues may state a

claim for securities fraud, as under GAAP, revenue must be earned

before it can be recognized.” In re Daou, 2005 WL 141833 at *5

(citations omitted) (emphasis in original). Plaintiffs must plead

facts sufficient to support a conclusion that defendants “prepared

the fraudulent financial statements and that the alleged financial

fraud was material.” See id (quoting In re Peerless Systems, Corp

Securities Litigation, 182 F Supp 2d 982, 991 (SD Cal 2002). 

Although violations of GAAP standards may provide

evidence of scienter, see id, the complaint must allege GAAP

violations with sufficient particularity to support a strong

inference of scienter. See, e g, In re McKesson HBOC, Inc

Securities Litigation, 126 F Supp 2d 1248, 1273 (ND Cal 2000)

(“[w]hen significant GAAP violations are described with

particularity in the complaint, they may provide powerful indirect

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evidence of scienter. After all, books do not cook themselves.”.) 

The inquiry focuses on the specificity of the allegations; “a

general allegation that the practices at issue resulted in a false

report of company earnings is not a sufficiently particular claim

of misrepresentation.” In re Daou, 2005 WL 1431833 at *5 (quoting

Greebel v FTP Software, Inc, 194 F3d 185, 203-04 (1st Cir 1999).

The Ninth Circuit recently instructed that complaints

stating sufficiently particular accounting irregularities should

include: “(1) such basic details as the approximate amount by which

revenues and earnings were overstated; (2) the products involved in

the contingent transaction; (3) the dates of any of the

transactions; or (4) the identities of any of the customers or

[company] employees involved in the transactions.” In re Daou,

2005 WL 1431833 at *6 (citations and internal quotation marks

omitted). Although the complaint need not provide each and every

detail described above, it should enable a court to determine

whether the alleged fraud “constituted widespread and significant

inflation of revenue.” Id.

Before reaching the substance of plaintiffs’ complaint,

the court notes that plaintiffs’ allegations are derived, in large

part, from information provided by confidential witnesses. The

Ninth Circuit requires a particular inquiry to determine if the use

of such confidential sources satisfies the PSLRA. See In re Daou,

2005 WL 1431833 at *4. The inquiry focuses on whether unnamed

sources of information in the complaint are described “with

sufficient particularity to support the probability that a person

in the position occupied by the source would possess the

information alleged.” Nursing Home Pension Fund, Local 114 v

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Oracle Corp, 380 F3d 1226, 1233 (9th Cir 2001) (quoting Novak v

Kasaks, 216 F3d 300, 314 (2d Cir 2000)). These personal sources

need not be named so long as the information they provide is

adequately corroborated by other facts. Silicon Graphics, 183 F3d

at 985. 

In In re Daou, the Ninth Circuit recently adopted the

First Circuit’s “suggested criteria for assessing reliability of

confidential witnesses.” In re Daou, 2005 WL 1431833 at *4. These

criteria include “the level of detail provided by the confidential

sources, the corroborative nature of the other facts alleged

(including from other sources), the coherence and plausibility of

the allegations, the number of sources, the reliability of the

sources, and similar indicia.” In re Cabletron Sys Inc, 311 F3d

11, 29 (1st Cir 2002). Moreover, when a complaint relies on

unnamed employees, courts generally look for specific descriptions

of the employee’s relevant duties and responsibilities to evaluate

the reliability of their information. See, e g, In re Daou, 2005

WL 1431833 at *4 (finding that confidential witnesses were

described with a “large degree of particularity” where, in all

cases, their job description and responsibilities were delineated,

and in some cases, plaintiffs identified the executive to whom the

employee reported); see also In re Northpoint Communications Group,

Inc, 221 F Supp 2d 1090, 1097 (ND Cal 2002)(holding that a second

amended complaint cured some specificity problems of original

complaint where it set out, in addition to job titles and tenure of

confidential witnesses, their responsibilities at the company). 

The TCAC relies in large part upon information provided

by three unnamed former Portal employees to substantiate

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allegations that defendants were engaging in accounting fraud in

order to overstate revenue. Plaintiffs identify these employees by

either their titles or their positions in the company, but

generally fail to describe with any particularity the duties of

each employee, or how or why they came to be familiar with the

information they provide. Despite plaintiffs’ failure to specify

each employee’s duties, in some cases the employees’ accounts

themselves describe their relevant duties in the course of relating

elements of the alleged accounting fraud. Consequently, the court

cannot adopt wholesale the allegations provided by the unnamed

employees in plaintiffs’ complaint. Rather, in determining whether

the TCAC adequately pleads violations of the securities laws, the

court will rely only on factual allegations which evince

reliability through detail, context and corroboration. 

With these legal principles in mind, the court turns to

plaintiffs’ allegation that Portal engaged in accounting fraud by

falsely inflating revenues to conceal Portal’s precarious financial

condition. Specifically, plaintiffs allege that defendants

prematurely recognized revenue by (1) improperly categorizing

licensing revenue, (2) overstating purported billing rates to

recognize greater costs on delivered elements of a contract, (3)

manipulating the fair value amount attributable to undelivered

items and (4) recognizing revenue before project milestones were

approved by customers.

Plaintiffs allege that defendants manipulated license

agreements into two parts and improperly priced the first part of

the license with the bulk of the contract fee so that they could

recognize the revenue prematurely. TCAC ¶¶ 41-43. In support of

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this allegation, plaintiffs rely entirely on information provided

by a former controller. Id. Yet, the former controller’s account

does not contain inherent indicia of reliability. First, her

employment with Portal ended almost a year before the class period

even began. TCAC ¶ 41. Consequently, her entire account of

Portal’s fraudulent revenue recognition practices during the class

period are based on second-hand reports from company “insiders.” 

Id ¶ 43. Although she has personal knowledge to support her

descriptions of Portal’s revenue recognition practices prior to the

class period, it is the allegations that Portal made fraudulent

changes to these recognition practices during the class period that

require “a reasonable conviction in the informant’s basis of

knowledge.” In re NorthPoint, 221 F Supp 2d at 1097. Hence,

plaintiffs must describe the job title, job description, duties,

and dates of employment for the controller’s sources before this

information can be deemed reliable. Plaintiffs have made no

attempt to provide such information about any of the controller’s

“insiders,” and consequently, plaintiffs’ allegations regarding

improperly bifurcated contracts are not pled with sufficient

particularity.

Plaintiffs’ next allegations -- that defendants “cooked”

revenue numbers to recognize revenue prematurely -- are somewhat

better supported. The TCAC identifies a “Senior Business Analyst”

who worked at Portal until July 2003, two months into the class

period. Although the complaint again fails specifically to

describe this employee’s job duties, to whom he reported, or in

which department he worked, his account ameliorates the shortfall. 

As part of his employment, the analyst asserts that he was required

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to “reverse engineer” revenue recognition studies to reach a

predetermined result. TCAC ¶ 45. Moreover, the analyst asserts

that he was personally directed to create these false studies by

defendant Bain, the CFO. Id ¶ 47. These fabrications involved

falsely selecting high billing rates to inflate revenues for work

already performed on contracts (Id ¶ 46) or falsely calculating a

low value for undelivered elements so that greater revenue could be

attributed to the elements already delivered (Id ¶ 47). 

Although the Senior Business Analyst only identifies one

customer by name for whom he created false revenue recognition

studies (Columbia Mobile), he alleges that he was “required to

perform analyses that matched management’s predetermined results

for work performed in * * * Greece, Italy, Columbia and Spain in

connection with at least six of Portal’s major contracts” and that

Portal booked $5 million in revenue as a result of these contracts. 

Id ¶ 48. Based on his personal involvement in fraudulent activity

at the behest of Bain, the court concludes that these allegations

potentially support a claim under the ‘34 Act. Moreover, the court

finds that the specificity of the account indicates a level of

reliability. Yet because the analyst’s account provides no

indication of how these alleged manipulations affected Portal’s

financial earnings statements, further corroboration is necessary

to meet the heightened pleading requirements of the PSLRA. 

Next, the TCAC alleges that defendants engaged in

improper revenue recognition through testimony of an accounts

receivable and revenue assurance assistant who allegedly worked at

Portal during the class period. TCAC ¶ 49. Again, this employee’s

account self-identifies her duties and basis for knowledge,

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mitigating the TCAC’s failure to do so. For example, the assistant

specifies that “one of [her] duties was to reclassify revenue for

future quarters.” Id ¶ 49. It was through this work, she alleges,

that she came to learn that Portal was improperly recognizing

revenue from software licensing contracts. Id. The assistant

explains her basis for knowledge: “I have been working with revenue

recognition for 12 years, and I understand the way revenue is

supposed to be recognized.” Id. The assistant’s account also

alleges a particular contract, with Onstar, for which Portal

“materially overstated [revenues] during the third quarter of

fiscal 2004.” TCAC ¶ 49. 

In the Ninth Circuit, “although overstatement of revenues

in violation of GAAP may support a plaintiff’s claim of fraud, the

plaintiff must show with particularity how the adjustments affected

the company’s financial statements and whether they were material

in light of the company’s overall financial position.” In re Daou,

2005 WL 1431833 at *7. In In re Daou, the panel found that the

plaintiff adequately described how “allegedly premature [revenue]

recognition affected Daou’s financial bottom line” where the

complaint pled “the approximate amount by which revenues and

earnings were overstated, * * * the dates of some of the

transactions and the identities of the customers and the company

employees involved in the transactions.” Id at *8. For example,

the plaintiffs in In re Daou alleged that only $5.9 million was

eligible for recognition in the third quarter of 1997, 48% less

than the $11.3 million that Daou publicly reported. Id. 

In contrast, the TCAC is bereft of such comparisons. 

Only the Senior Business Analyst alleges a dollar amount -- $5

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million -- for prematurely recognized revenue. Even this figure is

unconnected to identified customers or dates, much less a specific

quarterly report against which to assess its materiality. Although

the accounts receivable assistant allegedly reclassified improperly

booked revenues, she does not indicate how much revenue was

reclassified or how this affected Portal’s financial statements. 

The controller’s statements, lacking in personal knowledge, also

fail to specify how much revenue the allegedly improper licensing

contracts allowed Portal to recognize prematurely, and how that

affected Portal’s bottom line.

The TCAC also alleges that defendants engaged in

accounting fraud by recognizing “license and service fees under * *

* service arrangements prior to customer approval of specific

project milestones in violation of the Company’s publicly stated

revenue recognition practices and policies” and in violation of

GAAP. TCAC ¶ 50. To support this allegation, plaintiffs refer

only to defendants’ disclosure, subsequent to the class period,

that it was excluding $700,000 of previously reported revenue for

fiscal 2004 due to a customer’s refusal to approve project

milestones. TCAC ¶ 84. Defendants argue that this disclosure

related to a contract performed after the class period, but

plaintiffs provide information indicating the restatement related

to fiscal 2004. TCAC ¶ 84. Even assuming this revenue was

originally announced during the class period, the court finds that

plaintiffs’ single example of defendants announcement of revenue

prior to customer approval does not raise a strong inference of

scienter. 

Plaintiffs allege that defendants also violated the ‘34

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Act by materially misrepresenting the declining demand for Portal’s

products and services and failing to disclose severe interface

problems that delayed delivery and increased costs. TCAC ¶¶ 51-54. 

Support for this allegation, however, comes from only one unnamed

employee, a Senior Marketing Manager, who worked for only two

months of the class period. From this employee’s title, the court

might infer such a position would afford knowledge of the market

for Portal’s product. Thus, this account could conceivably provide

evidence of the “shrinking market and role for billing software

applications.” Id ¶ 52. In addition, the employee identifies two

vendors, SAP and Siebel, that offered products that “displaced the

role previously provided” by aspects of Portal’s billing software. 

Id ¶ 51. But the specificity ends there. The employee fails to

identify any of “Portal’s large telecommunications customers” for

whom customer service applications were no longer required as part

of Portal’s billing software. Id. And, although the marketing

manager alleges that Portal was spending too much time and money

due to “excessive bugs and/or interface problems with other

applications,” these allegations fail to indicate any specific

customers, contracts, or dates. Id ¶ 54. 

The court finds that plaintiffs’ allegations of

accounting fraud and material misrepresentations are not pled with

sufficient particularity and, consequently, do no raise a strong

inference of scienter. Plaintiffs, however, present an alternative

basis for demonstrating scienter; the complaint focuses on

defendants’ stock sales and Portal’s SPO to show that defendants

had the motive and opportunity to mislead investors deliberately. 

As discussed in the next section, however, these allegations fail

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to plead a violation of section 10(b) adequately.

2

Scienter

To demonstrate motive, plaintiffs allege that defendants

engaged in insider trading during the class period. The PSLRA

“neither prohibits nor endorses the pleading of insider trading as

evidence of scienter, but requires that the evidence meet the

‘strong inference’ standard.” Greebel, 194 F3d at 197. While

“trading at suspicious times or in suspicious amounts” is probative

of scienter, the trading must be “unusual, well beyond the normal

patterns of trading by those defendants.” Id. Under this

standard, the court questions plaintiffs’ reliance on the stock

sales attributable to “company insiders” to demonstrate defendants’

motive to conduct accounting fraud or issue misleading statements. 

First, defendant Little sold no personal stock. Defendant Bain

sold 4,000 shares after exercising 7,500 stock options, which means

he did not sell 3,500 shares. 

Plaintiffs focus on “89,157 shares of Portal common

stock” sold by “Portal insiders.” TCAC at ¶ 65. Most of these

“insiders,” however, are not named defendants, nor do plaintiffs

allege they were involved in the fraudulent activity. Moreover,

plaintiffs’ reliance on “suspicious” stock sales ultimately fails

because the stock sales do not appear suspicious at all. For

example, plaintiffs focus on the period from May 28, 2003, to July

2, 2003, which was “immediately after” the first earnings

announcement of the class period -- but also after the announcement

of an alliance with Microsoft. TCAC at ¶ 65. Although plaintiffs

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allege that Portal common stock was artificially inflated during

this period, they do not allege that the deal with Microsoft was

improper. In fact, plaintiffs ignore the legitimate, positive

effect the Microsoft deal might have had on Portal’s stock or the

role the Microsoft deal might have had in the executives’ decision

to sell. No attempt is made to delineate the “artificiality” of

Portal’s stock during this period, which is especially curious

since it appears that Portal’s stock actually dropped by several

dollars after the first earnings announcement of the class period. 

TCAC at ¶ 140 (Charting NASDAQ Index). Moreover, plaintiffs fail

to demonstrate that the timing of the stock sales was “suspicious”

where the TCAC does not provide a comparison of these sales with

the executives’ “normal patterns of trading.” Greebel, 194 F3d at

197. 

By contrast, plaintiffs’ contention that defendants were

motivated to inflate artificially Portal’s stock price in the short

term in order to conduct a successful secondary public offering and

obtain much-needed operating capital does allege facts of a

palpable motive for fraud. In fact, Portal raised $60 million in

September, just two months before Portal’s stock plummeted by over

40%. Plaintiffs allege that Portal’s finances were such that the

$60 million was absolutely necessary to keep Portal a “going

concern.” Plaintiffs’ Opposition at 21. Accordingly, this motive

evidence is stronger than the generic “desire to raise capital”

which can be attributed to every company. Metricom, 2004 US Dist

LEXIS 7834 at *110. But in the Ninth Circuit, such motive pleading

must be combined with allegations of other “red flags” to be

probative. In re Vantive, 283 F3d at 1097. As discussed above,

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plaintiffs’ allegations of accounting fraud lack sufficient

particularity and cannot be combined with this alleged motive to

establish a strong inference of scienter.

3

Safe Harbor

In their motion to dismiss, defendants argue at great

length that plaintiffs’ TCAC does not adequately plead claims based

on false projections or opinions. Defendants are correct that the

PSLRA carves out a safe harbor from liability for forward-looking

statements that are accompanied by meaningful cautionary language. 

15 USC § 78u-5(c); see also In re Copper Mountain Securities

Litigation, 311 F Supp 2d 857, 866 (ND Cal 2004)(Walker, J). Under

the analogous “bespeaks caution” doctrine, a court may also find as

a matter of law that “defendant’s forward-looking statements

contained enough cautionary language or risk disclosure to protect

against liability.” Id at 866. Mere boilerplate or generic

warnings, however, are insufficient; “[t]he cautionary warning

ought to be precise and relate directly to the forward-looking

statements at issue.” Id at 882. Moreover, this court has

previously found that “vague and * * * run-of-the-mill corporate

optimism” is not actionable because no reasonable investor would

rely on “mere puffery.” Id at 868-69.

A close reading of plaintiffs’ TCAC reveals that the vast

majority of plaintiffs’ allegations of “materially false and

misleading statements” focus on defendants’ statements regarding

present or historical facts, such as Portal’s past quarterly

earnings based on (1) allegedly inflated revenues (TCAC ¶¶ 58, 60,

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64, 66, 67); (2) Portal’s past and current revenue recognition

policies that plaintiffs allege misrepresented the way in which

Portal was recognizing revenue (TCAC ¶¶ 61-64, 68-70); (3)

omissions of past and current facts regarding declining sales and

product demand as well as difficulties marketing Portal’s product

(TCAC ¶ 64e-f); and (4) omissions of the present fact that Portal

was experiencing severe technical problems with its core products,

which were eroding its revenue stream (TCAC ¶ 64g). But neither

the PSLRA’s safe harbor provision nor the bespeaks caution doctrine

are applicable to statements of historical fact. See e g, Livid

Holdings Ltd v Salomon Smith Barney, Inc, 403 F3d 1050, 1056-57

(9th Cir 2005).

In fact, the only forward-looking statements that

plaintiffs allege were false or misleading when made are the

revenue projections for fiscal 2004 and the subsequent quarter’s

revenue projections that accompanied Portal’s public announcement

of financial results for the quarter just concluded. See TCAC ¶ 58

(May 20, 2003, announcement of financial results for quarter ending

May 2, 2003); TCAC ¶ 66 (August 19, 2003, announcement of financial

results for quarter ending August 1, 2003). These announcements

were made in press releases and included defendants’ statements

that Portal expected revenues to grow by “10-12%” over the prior

year and that Portal would “return to pro forma earnings” within

the current fiscal year. TCAC ¶ 58. 

Both of these statements concerned “a projection of

revenues” and “future economic performance” and thus were clearly

forward-looking statements under the PSLRA. 15 USC § 78u-5(i);

Copper Mountain, 311 F Supp 2d at 880. The court now turns to

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plaintiffs’ argument that defendants’ forward-looking statements

are unprotected by the PSLRA’s safe harbor provision or the

bespeaks caution doctrine because (1) the statements were not

accompanied by meaningful cautionary language and (2) defendants

knew they were false when made.

The court finds that defendants’ forward-looking

statements were accompanied by cautionary language that was

sufficiently specific and meaningful to warn investors of the risks

that actually materialized. First, defendants’ May 20 and August

19 press releases -- which contained the 10-12% profit projection

and “return to pro forma earnings” statements -- each included

“safe harbor” warnings that the statements were forward-looking and

subject to uncertainties and risk. Gaw Decl; Exs I and J. 

Moreover, these press releases specified a number of factors which

might effect the projections, including the migration to “larger,

multi-year deals, which * * * may dampen near-term growth * * * and

add[] to the volatility of license revenues.” Id. 

In addition to those warnings contained in the press

releases, both press releases referred investors to the Form 10-K

for additional warnings. Gaw Decl; Ex C. at 31 (“These and other

factors are described in detail in our Annual Report on Form 10-K

for the fiscal year ended January 31, 2003 * * *.”). Thus, the

information in the Form 10-K was incorporated into the “total mix

of information in the document” available to reasonable investors,

even though the Form 10-K did not actually accompany the press

releases. Copper Mountain, 311 F Supp 2d at 876 (citing Fecht v

The Price Co, 70 F3d 1078, 1082 (9th Cir 1995). The Form 10-K

contained several pages of detailed and explicit warnings regarding

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Portal’s dependance on a few large customers, the risks associated

with long implementation periods, and the numerous variables which

could adversely affect revenue recognition for any quarter. Also,

the Form 10-K warned that Portal would begin offering “products and

services for a ‘bundled’ price, such that a separate price would

not be identified for the product and service components. Such a

change may significantly delay the timing of our revenue

recognition.” Gaw Decl; Ex C at 31 (emphasis added). Because

these warnings hew to the actual deficiencies that caused Portal’s

earnings shortfall -- “contract delays and revenue recognition

deferrals” with existing large customers -- they provided

sufficiently specific and material warnings to immunize defendants’

forward-looking statements. See Copper Mountain, 311 F Supp 2d at

882. 

Plaintiffs also assert that, regardless of cautionary

language, defendants are liable for their forward-looking

statements because they knew them to be false and misleading when

made. Plaintiffs are correct that a forward-looking statement

cannot be immunized under the PSLRA if it was made with “actual

knowledge * * * that the statement was false or misleading.” 15

USC 78u-5(c)(1)(B). In this case, however, plaintiffs’ argument is

unavailing because plaintiffs have failed to demonstrate that the

defendants knew that Portal would not achieve 10-12% growth or

return to pro forma earnings within the year when the press

releases were issued. As discussed above, the TCAC is deficient,

in part, in that it fails to allege facts showing how the alleged

accounting adjustments materially affected the company’s financial

statements. See supra IV(A)(1)(i). These facts are necessary not

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only to plead adequately accounting fraud or scienter on the part

of defendants, but also to demonstrate that the defendants knew at

the time the earnings projections were announced that Portal could

not meet those projections. Accordingly, Defendants’ cannot be

liable for the forward-looking statements in the May 20 and August

19, 2005, press releases, and plaintiffs’ claims premised on these

statements must be dismissed.

4

20(a)

Control Liability

Section 20(a) provides for “controlling person

liability.” To establish such liability, plaintiffs must first

demonstrate the existence of a violation under Section 10(b) -- the

“primary violation.” Copper Mountain, 311 F Supp 2d at 883

(citation omitted). “[I]n the absence of a viable claim under

Section 10(b), any remaining Section 20(a) claims must be

dismissed.” Id (citations omitted).

Because the court has determined that plaintiffs have

failed to state claims under Section 10(b), plaintiffs have “no

basis upon which to premise a Section 20(b) claim” and the Section

20(b) claims must also be dismissed. 

B

Section 11, 12(a)(2) and 15 of the Securities Act of 1933

Plaintiffs also bring claims against defendants for

violations of the ‘33 Act arising out of Portal’s secondary public

offering in September 2003. In contrast to claims brought under

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the ‘34 Act, section 11 of the ‘33 Act creates a private remedy for

a purchaser of a security where “any part of the registration

statement, when such part became effective, contained an untrue

statement of a material fact or omitted to state a material fact

required to be stated therein or necessary to make the statement

therein not misleading.” 15 USC § 77k(a). “The plaintiff in a §

11 claim must demonstrate (1) that the registration statement

contained an omission or misrepresentation, and (2) that the

omission or misrepresentation was material, that is, it would have

misled a reasonable investor about the nature of his or her

investment.” In re Stac, 89 F3d at 1403-04. “No scienter is

required for liability under § 11; defendants will be liable for

innocent or negligent material misstatements or omissions.” Id

(citations omitted). Before addressing the substance of the ‘33

Act claims, the court must first determine if they are time barred.

1

Relation Back

Defendants challenge the timeliness of plaintiffs’ ‘33

Act claims. Section 13 of the ‘33 Act requires that claims under

sections 11 and 12(a)(2) be brought “within one year after the

discovery of the untrue statement or the omission, or after such

discovery should have been made by the exercise of reasonable

diligence.” 15 USC § 77m. Plaintiffs’ first complaint, filed on

November 20, 2003, did not include ‘33 Act claims. These claims

were not added until the second amended complaint (SAC), filed on

March 30, 2005 (sixteen months later). Defendants argue that

plaintiffs discovered the conduct giving rise to the ‘33 Act claims

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at least when the first complaint was filed. Consequently,

defendants argue that the ‘33 Act claims are time-barred.

Plaintiffs seek to avoid this bar by asserting that the

new claims in the SAC “relate back” to the initial complaint under

FRCP 15(c)(2). Rule 15(c)(2) states that an amended complaint

relates back to the initial one for statute of limitations purposes

if the “claim or defense asserted in the amended pleading arose out

of the conduct, transaction, or occurrence set forth * * * in the

original pleading.” The crux of this inquiry is “whether the

opposing party has been put on notice about the claim or defense

raised by the amended pleading.” SEC v Seaboard Corporation, 677

F2d 1301, 1314 (9th Cir 1982). This court previously observed that

the class notice for the ‘34 Act claims would have put investors

with ’33 Act claims on notice. Doc #100. It follows that

defendants were also put on notice of the potential for ‘33 Act

claims arising from the same set of facts.

2 

Sound in Fraud

Section 11 does not contain an element of fraud, yet a

complaint may be subject to the particularity requirements of Rule

9(b) if it “sounds in fraud.” Vess v Ciba-Geigy Corp USA, 317 F3d

1097, 1103 (9th Cir 2003). If the complaint alleges “a unified

course of fraudulent conduct and rel[ies] entirely on that course

of conduct as the basis of a claim * * * the claim is said to be

‘grounded in fraud’ or to ‘sound in fraud,’ and the pleading of

that claim as a whole must satisfy the particularity requirement of

Rule 9(b).” Id at 1103-1104.

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In the TCAC, plaintiffs have made an artful attempt to

avoid this requirement by carefully compartmentalizing the counts

under the ‘33 Act and ‘34 Act. Whereas the ‘34 Act claims allege

that defendants knowingly or recklessly engaged in a fraudulent

scheme to overstate revenues, for example, the ‘33 Act claims

merely allege that revenues were negligently overstated. Yet the

Ninth Circuit has rejected this approach, finding that such

“nominal efforts are unconvincing where the gravamen of the

complaint is plainly fraud.” In re Stac, 89 F3d at 1405. 

The court finds that plaintiffs’ Section 11 claim clearly

“sounds in fraud.” Despite plaintiffs’ pains to avoid Rule 9(b),

it is clear that the factual allegations upon which the entire

complaint rests allege knowing, reckless and willful conduct. For

example, plaintiffs allege that defendants “negligently overstated

[revenue] due to the Defendants’ manipulation of the purported

billing rates of Portal’s employees.” TCAC ¶ 145(d). Yet

plaintiffs’ factual allegations supporting the manipulation of

billing rates unequivocally describes the conduct as intentional

and knowing. Id ¶¶ 47, 48. It strains credulity that plaintiffs

should allege that the overstatement of revenues was merely

“negligent” when it was a allegedly a direct result of defendants’

willful manipulation. Plaintiffs cannot avoid the theory they

posit throughout the complaint: that defendants fraudulently

schemed to inflate revenues. Accordingly, the court finds that the

claims under the ‘33 Act sound in fraud, and therefore fail with

the ‘34 Act claims to meet the heightened pleading requirements of

the PSLRA and Rule 9(b). 

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V

Conclusion

For the reasons stated above, the court GRANTS

defendants’ motion to dismiss in its entirety. Doc #115. 

Plaintiffs’ TCAC is DISMISSED, but plaintiffs may file an amended

complaint remedying the pleading deficiencies identified in this

order and complying with the following instructions. 

An amended complaint should specify those misstatements

plaintiffs allege were false or misleading, including with regard

to each statement: (1) the date made; (2) the speaker; (3) the

content; (4) the falsity; (5) the basis for plaintiffs’ allegation

of falsity; and (6) scienter. The amended complaint should also

specify any omissions of fact that defendants were bound to

disclose, including with respect to each omission: (1) the date

the information became known to the public; (2) the facts omitted;

(3) the date the duty to disclose arose; (4) the basis for claiming

that omitted information was known to defendants; (5) the basis for

claiming that defendants had a duty to disclose; and (6) scienter. 

Finally, in light of Dura, plaintiffs should endeavor to tether all

allegations in the complaint to the price movement of Portal’s

stock during the class period. Any amended complaint must be filed

within sixty (60) days of the date of this order. 

IT IS SO ORDERED.

 

VAUGHN R WALKER

United States District Chief Judge

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