Source: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-cand-5_02-cv-04497/USCOURTS-cand-5_02-cv-04497-3/pdf.json

Nature of Suit Code: 850
Nature of Suit: Securities, Commodities, Exchange
Cause of Action: 15:78m(a) Securities Exchange Act

---

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

ORDER DENYING PLAINTIFFS' MOTION FOR LEAVE TO AMEND 

C-02-04497 RMW

SPT

E-FILED on 5/30/06

IN THE UNITED STATES DISTRICT COURT

FOR THE NORTHERN DISTRICT OF CALIFORNIA

SAN JOSE DIVISION

In re ESS TECHNOLOGY, INC.

SECURITIES LITIGATION

No. C-02-04497 RMW

ORDER DENYING PLAINTIFFS' MOTION

FOR LEAVE TO AMEND

[Re Docket No. 225]

This Document Relates to:

 ALL ACTIONS.

Plaintiffs move for leave to amend the Second Amended Complaint ("SAC") filed by lead

plaintiff Steve Bardack ("Bardack"). Plaintiffs have filed a Proposed Third Amended Complaint

("PTAC") concurrent with their motion. Plaintiffs in this securities class action consist of all

persons and entities who purchased or otherwise acquired the publicly traded securities of ESST

during the period beginning August 1, 2002 through and including September 12, 2002, excluding

short sellers, officers and directors of ESS Technology, Inc. ("ESST"), as well as their families and

the families of defendants. Defendants ESST, Robert L. Blair ("Blair"), Patrick Ang ("Ang"),

Frederick S. L. Chan ("Chan"), and James Boyd ("Boyd") oppose the motion. The court heard oral

argument by the parties on May 19, 2006. The court has read the moving and responding papers and

Case 5:02-cv-04497-RMW Document 240 Filed 05/30/06 Page 1 of 16
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

ORDER DENYING PLAINTIFFS' MOTION FOR LEAVE TO AMEND 

C-02-04497 RMW

SPT 2

considered counsels' arguments. For the reasons set forth below, the court DENIES plaintiffs'

motion for leave to amend.

I. BACKGROUND

A. Allegations in the Proposed Third Amended Complaint

This securities fraud action was initially brought on behalf of a class of persons who

purchased the publicly-traded securities of ESST between January 23, 2002 and September 12, 2002

("Initial Class Period"). The court's December 1, 2004 Order denied in part and granted in part

Defendants' Motion to Dismiss Plaintiff's Second Amended Complaint and Strike Portions Thereof

("Dec. 2004 Order") and the court's February 22, 2005 Order granted in part Defendants' Motion to

Strike Allegations in Plaintiff's Second Amended Complaint ("Feb. 2005 Order"). 

Defendant ESST is a designer, developer, and marketer of highly-integrated digital processor

chips used in multimedia applications. Chan, Blair, Boyd, and Ang are ESST's founder and

chairman, president and chief executive officer, chief financial officer, and chief operating officer,

respectively. It is not disputed that ESST met or exceeded its publicly announced revenue forecasts

for the first and second quarter of 2002. See Feb. 2005 Order at 4-5. The premise for this action is

ESST's announcement on September 12, 2002 that it would not meet its performance expectations

for the third quarter of 2002 and the subsequent sharp decline in ESST's share price. See Dec. 2004

Order at 3-4. Plaintiffs claim that prior to September 12, 2002 certain ESST officers made falsely

optimistic statements regarding ESST's performance to boost the share price. The court previously

determined that the earliest time plaintiffs have adequately alleged defendants knew of the shortfalls

announced on September 12 was sometime in August 2002. Feb. 2005 Order at 9. As such, the

court's Feb. 2005 Order set the class period from August 1, 2002 to September 12, 2002 ("Current

Class Period"). Id. Plaintiffs contend that evidence obtained through discovery reveals an

additional false statement and also provides support that the class period should run from April 24,

2002 to September 12, 2002 ("Proposed Class Period"). Pls.' Mot. at 1.

Case 5:02-cv-04497-RMW Document 240 Filed 05/30/06 Page 2 of 16
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

1 Backlog refers to orders for products that have not yet been shipped. Pls.' Mot. at 5.

2 Both the Daily Flash Report Summaries and the Executive K-Unit/K-Dollar Reports

provide backlog and billing information.

3 All references to the PTAC refers to the Corrected PTAC filed by plaintiffs on May

5, 2006.

4 The PTAC does not state when in July 2002 defendants alleged learned that ESST

had missed its June 2002 internal forecast. See PTAC ¶8.

5 The PTAC references that CW14 has seen the rolling forecast report before and was

familiar with it, but makes no factual allegations to support that any of the defendants received or

reviewed the rolling forecast report at issue. 

ORDER DENYING PLAINTIFFS' MOTION FOR LEAVE TO AMEND 

C-02-04497 RMW

SPT 3

In particular, during discovery plaintiffs obtained "Daily Flash Report Summaries" and

weekly "Executive K-Unit/K-Dollar Reports" which show ESST backlog1

 and billing trends,2 and a

rolling forecast report. Pls.' Mot. at 1, 4; PTAC ¶¶ 7, 8, 16.3

 These reports indicate declines in

backlog and billings levels starting as early as April 24, 2002, and failure to meet internal revenue

forecast for June sometime in July 2002.4

 Id. Plaintiffs contend that defendants Blair, Boyd, and

Chan knew of these declines in backlog and billing trends when they made misleading statements

during the Proposed Class Period. Id. In support plaintiffs offer a new confidential witness

("CW14"). According to the PTAC, CW14 is familiar with all three of these reports and has seen

them before.5

 PTAC ¶ 26(n). CW14 states that he recalls Blair's secretary handing Blair the Daily

Flash Report Summaries and the Executive K-Unit/K-Dollar Reports and that these two types of

reports were reviewed by Blair, Boyd, and Chan in regular weekly and monthly meetings. Id. 

According to the complaint, CW14 confirms that Blair, Boyd, and Chan did in fact receive the Daily

Flash Report Summaries and the Executive K-Unit/K-Dollar Reports because "they were each very

'hands on' and wanted to know every detail of the business." Id. As plaintiffs argument goes,

defendants knew of, but concealed, the trend of deteriorating backlog as early as April 24, 2002, and

thus statements made as early as April 24, 2002 are actionable.

On April 24, 2002, in a quarterly conference call, Blair told analysts "[t]ypically going into a

quarter, we have approximately 40 percent of the end shipments on backlog, and we believe this

quarter's no different." PTAC ¶ 3, 34. When asked whether backlog going into the second quarter

was about the same as going into the first quarter, Blair responded, "[i]t's, yes, similar." Id. 

Case 5:02-cv-04497-RMW Document 240 Filed 05/30/06 Page 3 of 16
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 Elsewhere the PTAC states that on April 22, 2002 the Executive K-Dollar report

indicated second quarter shipments and backlog of $35 million. PTAC ¶ 56.

7 The court refers to plaintiffs' brief where the citations to the (corrected) PTAC in

plaintiffs' brief in support of their motion appear erroneous and the particular paragraph of the PTAC

to which plaintiffs refer remains unclear to the court. The court also notes that some of the charts in

the PTAC are unclear as they refer to inconsistent dates. See, e.g., PTAC ¶¶ 52-53.

ORDER DENYING PLAINTIFFS' MOTION FOR LEAVE TO AMEND 

C-02-04497 RMW

SPT 4

Plaintiffs allege that at the time the backlog and billings reports indicated that backlog going into the

first quarter was approximately 37% of first quarter revenues while backlog going into the second

quarter was 22% of the forecast revenues for the second quarter. Id. ¶¶ 4, 34. At a point in time

nineteen days into the second quarter (April 19, 2002) ESST had total billings and backlog of $40.9

million6

 compared to total billings and backlog of $39.6 million eighteen days into the first quarter

(January 18, 2002). Pls.' Mot. at 7.7

On June 18, 2002 ESST issued a press release that included the statement "demand has

continued to be strong as our new customers ramp up their production." Id. ¶ 36. Further, "[t]he

second half of 2002 is also looking stronger than previously expected, and we will provide new,

increased guidance, with additional details and updates, when we report our second quarter results." 

Id. Plaintiffs contend that defendants made these statements when they "knew orders were

weakening." Pls.' Mot. at 6. The backlog reports indicate that as of June 17, 2002 backlog was less

than half of the backlog during the same time frame heading into the second quarter. Id. Total

backlog heading in to the second quarter was "nearly three times as much" as total backlog heading

into the third quarter. Id. 

On June 24, 2002 ESST issued a press release that included the statement "ESS Technology

continues to see strong demand for digital entertainment products both for the current quarter and

throughout the balance of 2002." Id. ¶ 5. In that same press release defendants increased their

guidance for the third quarter to $86-$90 million. Id. Plaintiffs assert that, looking at backlog

figures ten days before the start of a quarter, backlog was $10.9 million ten days before the second

quarter started and $5.3 million—a 50% decrease—ten days before the beginning of the third

quarter. Id. Therefore, plaintiffs contend that the June 24, 2002 press release statements were false

when made and that defendants concealed the decline in future orders from investors. Id.

Case 5:02-cv-04497-RMW Document 240 Filed 05/30/06 Page 4 of 16
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

8 Because the court has held that plaintiffs' SAC adequately pled knowledge sometime

in August 2002 and set the class period from August 1, 2002, the court does not address the

allegations for the period on or after August 1, 2002 in this order.

9 Though styled "First Amended Complaint" this was the second amended complaint.

ORDER DENYING PLAINTIFFS' MOTION FOR LEAVE TO AMEND 

C-02-04497 RMW

SPT 5

On July 24, 2002 defendants issued a press release with their second quarter financial results

and held their second quarter conference call with analysts. Id. ¶¶ 9, 38-39. The press release

reiterated the third quarter guidance: "we expect to grow our DVD unit shipment by 10%-15% in

the third quarter of 2002 compared to the second quarter, and expect overall revenues for the third

quarter to be $86-$90 million." Id. ¶ 38. Blair stated during the call that "[l]ooking forward, we

believe that in Q3 . . . revenue will be up from our second quarter that we just completed." Id. ¶39. 

Blair noted that despite the continued decline in PC shipments, "[w]e are projecting both DVD and

VCD shipments to grow in the third quarter." Id. Blair again reiterated the same revenue guidance

for the third quarter. Id. ¶¶ 9, 39. Plaintiffs contend that when defendants made these statements in

July 2002, the rolling forecast report indicated that ESST had missed its internal forecast for the

month of June 2002 by $7.2 million. Id. ¶ 8. In addition, the backlog report indicated that backlog

going into the third quarter was 13% of the forecast revenues for the third quarter. Plaintiffs also

assert that, looking at a point in time approximately 18 days into each of the first, second, and third

quarters, backlog had dropped from $24.4 million for the first quarter to $17.3 million for the second

quarter, to $9.5 million for the third quarter. Id. ¶ 7.8

Based on these new allegations, plaintiffs seek to amend the Current Class Period (August 1,

2002 through September 12, 2002) to the Proposed Class Period (April 24, 2002 through September

12, 2002). Additional underlying facts are discussed more fully in the Dec. 2004 Order and the Feb.

2005 Order. 

B. Procedural Background

On January 21, 2003 the court appointed Bardack to serve as lead plaintiff for the proposed

class. Bardack then filed an amended complaint on February 6, 2003, which defendants moved to

dismiss. Prior to the noticed May 23, 2003 hearing on the motion and upon stipulation by the

parties, Bardack then filed a First Amended Complaint.9

 Defendants again moved to dismiss which

Case 5:02-cv-04497-RMW Document 240 Filed 05/30/06 Page 5 of 16
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 Though styled "Second Amended Complaint" this was the third amended complaint.

ORDER DENYING PLAINTIFFS' MOTION FOR LEAVE TO AMEND 

C-02-04497 RMW

SPT 6

the court granted with 30 days leave to amend the complaint. On November 3, 2003 Bardack filed a

Second Amended Complaint ("SAC").10 In the Dec. 2004 Order the court denied in part and granted

in part defendants' motion. Leave to amend was denied given that plaintiffs had had "ample

opportunity to plead a viable complaint." Dec. 2004 Order at 19. On December 22, 2004

defendants filed a motion to strike further allegations in the SAC. In the Feb. 2005 Order the court

granted defendants' motion in part by striking from the SAC claims of alleged fraudulent conduct

occurring before August 1, 2002 from plaintiff's second amended complaint. Therefore, the

operative complaint is the SAC as modified by the Dec. 2004 Order and Feb. 2005 Order. 

On March 25, 2005, defendants filed their responsive pleading. Thereafter, discovery

commenced. On February 8, 2006 the court issued an order granting in part Bardack's motion for

class certification. On March 24, 2006 plaintiffs filed the present motion for leave to amend the

SAC. In connection the parties have stipulated to vacate the original May 15, 2006 date for close of

fact discovery. Plaintiffs concurrently filed their PTAC. 

II. ANALYSIS

A. The PSLRA

Congress enacted the Private Securities Litigation Reform Act of 1995 ("PSLRA") in large

part to deter abusive and frivolous securities fraud claims. No. 84 Employer-Teamster Joint Council

Pension Trust Fund v. Am. West Holding Corp., 320 F.3d 920, 931 (9th Cir. 2003) (citing Silicon

Graphics, 183 F.3d at 973); see also In re Daou Sys., Inc., 411 F.3d 1006, 1021 (9th Cir. 2005)

(citation omitted) (amended decision) ("Congress enacted the PSLRA to put an end to the practice of

pleading 'fraud by hindsight.'"). As the Ninth Circuit has explained, the abuses in securities class

action suits sought to be deterred by the PSLRA include:

(1) the practice of filing lawsuits against issuers of securities in response to

any significant change in stock price, regardless of defendants' culpability; (2)

the targeting of deep pocket defendants; (3) the abuse of the discovery process

to coerce settlement; and (4) manipulation of clients by class action attorneys.

Case 5:02-cv-04497-RMW Document 240 Filed 05/30/06 Page 6 of 16
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 However, Capital Ventures Int'l concerns a district court's decision to permit plaintiff

limited discovery prior to the time for lifting the stay of discovery under the PSLRA.

12 Medhekar involved whether the court should permit the plaintiff to proceed with

initial disclosures or whether such disclosures fell within the stay of discovery pending adequate

pleading in the first instance by the plaintiff. As such, Medhekar does not address the issue of

whether a complaint that meets the pleading requirements of the PSLRA may be amended based on

additional evidence obtained after the stay of discovery has been lifted. 

ORDER DENYING PLAINTIFFS' MOTION FOR LEAVE TO AMEND 

C-02-04497 RMW

SPT 7

SG Cowen Securities Corp. v. United States Dist. Ct., 189 F.3d 909, 911 (9th Cir.1999). "Congress

enacted the mandatory stay of discovery, in part, to prevent plaintiffs from filing frivolous lawsuits

and using it as a vehicle 'in order to conduct discovery in the hopes of finding a sustainable claim not

alleged in the complaint.'" In re Lantronix, Inc. Securities Litig., 2003 WL 22462393, *1 (C.D. Cal.

2003) (citation omitted); Feitelberg v. Credit Suisse First Boston LLC, 2003 WL 22434098, *2

(N.D.Cal. 2003) (noting that the PSLRA was intended to deter "strike suits"). In doing so Congress

was acknowledging that the "cost of discovery often forces innocent parties to settle frivolous

securities class actions." Id. (citation omitted). 

Defendants argue that the PSLRA bars attempts to use discovery to repair claims that cannot

stand without it. Defs.' Opp. at 6-7. However, the Ninth Circuit has not specifically addressed the

issue raised by the present motion: whether a plaintiff may, under the PSLRA, broaden § 10(b)

claims that have survived motions to dismiss based on new evidence obtained after the opening of

discovery. Defendants cite various cases that emphasize the policy behind the PSLRA. See e.g.,

Capital Ventures Int'l v. Network Commerce, Inc., No. C02-0682L, 2006 WL 681033 (W.D. Wash.

Mar. 16, 2006) (holding that opening discovery to permit plaintiffs to obtain evidence and amend

previously dismissed securities claims would be an "end run" around the PLSRA's pleading

requirement)11; Medhekar v. District Ct., 99 F.3d 325, 328 (9th Cir. 1996) ("Congress clearly

intended that complaints in these securities actions should stand or fall based on the actual

knowledge of the plaintiffs rather than information produced by the defendants after the action has

been filed.")12; Miller v. Champion Enters., 346 F.3d 660, 691-92 (6th Cir. 2003) (noting the district

court correctly held that "allowing repeated filing of amended complaints would frustrate the

Case 5:02-cv-04497-RMW Document 240 Filed 05/30/06 Page 7 of 16
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 In Miller, the plaintiffs had not stated any viable claims under the PSLRA.

14 The court does not find that plaintiffs seek to disobey the court's prior rulings which

had denied plaintiffs leave to amend as the present motion for leave to amend is based on

additionally discovered evidence.

ORDER DENYING PLAINTIFFS' MOTION FOR LEAVE TO AMEND 

C-02-04497 RMW

SPT 8

purpose of the PSLRA")13; but see Eminence Capital, 316 F.3d at 1052 (noting that liberality in

permitting leave to amend is especially important in the context of the PSLRA pleading

requirements because "[i]n this technical and demanding corner of the law, the drafting of a

cognizable complaint can be a matter of trial and error"). 

The court finds that defendants' argument is not persuasive in the context of the present

motion. The purpose and policy of the PSLRA is to discourage baseless suits. Miller, 346 F.3d at

691 (noting that the PSLRA's heightened pleading standard "evinces Congress's acknowledgment of

the burden an allegation of securities fraud places on the innocent defendant"). The abusive

litigation the PSLRA seeks to deter are frivolous suits which state no sustainable securities claim.

Thus, the PSLRA seeks to prevent suits in which the foundation of securities fraud cannot be pled by

imposing heightened pleading requirements and a stay of discovery. However, it does not follow

from these policies that where a plaintiff has stated viable securities claims under the PSLRA, the

PSLRA would otherwise restrict or modify the court's determination of whether to grant leave to

amend under Fed. R. Civ. P. 15.14

B. Leave to Amend

1. Legal standard

Fed. R. Civ. P. 15(a)'s edict that "leave shall be freely given when justice so requires" is "to

be applied with extreme liberality." Eminence Capital, LLC v. Aspeon, Inc., 316 F.3d 1048, 1051

(9th Cir. 2003) (quoting Owens v. Kaiser Found. Health Plan, Inc., 244 F.3d 708, 712 (9th Cir.

2001) (citations omitted)). "[P]rejudice to the opposing party . . . carries the greatest weight." 

Eminence Capital, 316 F.3d at 1052. "Adherence to these principles is especially important in the

context of the PSLRA." Id. Morever, in the Ninth Circuit, there is a strong policy permitting

amendment even after a responsive pleading has been filed. Allwaste, Inc. v. Hecht, 65 F.3d 1523,

1530 (9th Cir.1995). Nevertheless, "a district court need not grant leave to amend where the

Case 5:02-cv-04497-RMW Document 240 Filed 05/30/06 Page 8 of 16
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 Moreover, the April 24, 2002 statement relates to backlog going into the second

quarter. Plaintiffs could not allege that this statement caused the loss attributed to the September 12,

2002 announcement. 

ORDER DENYING PLAINTIFFS' MOTION FOR LEAVE TO AMEND 

C-02-04497 RMW

SPT 9

amendment: (1) prejudices the opposing party; (2) is sought in bad faith; (3) produces an undue

delay in litigation; or (4) is futile." AmerisourceBergen Corp. v. Dialysist West, Inc., 2006 WL

709199, *3 (9th Cir. 2006) (citations omitted) (certified for publication); see also Foman v. Davis,

371 U.S. 178, 182 (1962). 

2. Pleading requirements of the PSLRA

In opposing plaintiffs' motion, defendants argue that the new allegations cannot support an

inference that defendants made the statements with the requisite state of mind under the PSLRA. 

The court agrees. Plaintiffs rely upon CW14 and CW8 to establish that defendants received and

reviewed the reports, but fail to meet the PSLRA's requirements for confidential witnesses. In any

event, even assuming defendants reviewed each of these reports, taking all inferences of plaintiffs'

allegations, the reports of declines in backlog and billing do not give rise to a strong inference that

defendants' June and July 2002 statements regarding third quarter revenue were made with either

actual knowledge of their falsity or with deliberate recklessness with respect to falsity. Therefore,

amendment based on the new evidence cited by plaintiffs would be futile.15

a. Applicable state of mind

Under the PSLRA, "[a] complaint must specify each statement alleged to have been

misleading, the reason or reasons why the statement is misleading" and "state with particularity facts

giving rise to a strong inference that the defendant acted with the required state of mind." Ronconi

v. Larkin, 253 F.3d 423, 429 (9th Cir. 2001) (citations and quotations omitted); 15 U.S.C. §

78u-4(b)(1)-(2). To properly plead the required state of mind, a plaintiff must plead that defendants

had knowledge of, or were deliberately reckless regarding, the falsity of public statements at the

time the statements were made. Id.; In re Silicon Graphics Inc. Securities Litig., 183 F.3d 970, 975-

88 (9th Cir. 1999). Where the challenged statement is a forward-looking statement, the plaintiff

Case 5:02-cv-04497-RMW Document 240 Filed 05/30/06 Page 9 of 16
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 Each of the statements in the period between April 24, 2002 and July 24, 2002 which

plaintiffs seeks to add are contained in either ESST press releases or stated in ESST's quarterly

conference calls announcing financial results. The parties do not appear to dispute that the press

releases and the conference calls were accompanied by cautionary language. The court has

previously found that these press releases contain "sufficient meaningful cautionary language related

to its forward-looking statements in the releases to protect ESST under the PSLRA's Safe Harbor

provisions." Dec. 2004 Order at 14.

17 Plaintiffs also contend that any cautionary language was not sufficient given

defendants' alleged knowledge based on the backlog and billing reports.

18 While plaintiffs' contention that the April 24, 2002 statement is not forward looking

may have merit, the court does not reach that determination as it finds that plaintiffs have failed to

allege the requisite state of mind of either actual knowledge or deliberate recklessness with respect

to falsity. 

ORDER DENYING PLAINTIFFS' MOTION FOR LEAVE TO AMEND 

C-02-04497 RMW

SPT 10

must plead that the defendant had actual knowledge that the statement was false or misleading.16 15

U.S.C. § 78u-5(c)(1); In re Daou Sys., 411 F.3d at 1021 (citations and quotations omitted); Ronconi,

253 F.3d at 429. The court considers the totality of the plaintiffs' allegations and all reasonable

inferences to be drawn from the allegations, whether favorable or unfavorable. See In re Daou Sys.,

411 F.3d at 1022. 

The parties do not appear to dispute that the June 18, 2002, June 24, 2002, and July 24, 2002

statements are forward-looking, but plaintiffs argue that the April 24, 2002 statement is not forwardlooking.17 Pls.' Reply at 8. Therefore, as applicable here, plaintiffs need to establish a strong

inference that defendants made the statements with either actual knowledge of its falsity or reckless

disregard of its falsity.18 

b. Confidential witnesses

Plaintiffs' premise that defendants acted with either actual knowledge of falsity or deliberate

recklessness with respect to falsity hinges on their allegations that defendants' received and reviewed

the Daily Flash Report Summaries and the weekly Executive K-Unit/K-Dollar Reports which show

then current ESST backlog and billing information and the monthly rolling forecast report that

compared actual to forecast revenues. Pls.' Mot. at 1-2, 4; PTAC ¶¶ 31-32. According to the PTAC,

defendants' "knowledge of ESST's order backlog and billings" is demonstrated by the following

allegations: (1) statements by CW14 and CW8, (2) Blair "implicitly admitted that he was aware of

and followed ESST's order backlog when he stated that a typical quarter began with order backlog of

Case 5:02-cv-04497-RMW Document 240 Filed 05/30/06 Page 10 of 16
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

ORDER DENYING PLAINTIFFS' MOTION FOR LEAVE TO AMEND 

C-02-04497 RMW

SPT 11

40%" and made assurances regarding second quarter backlog, and (3) copies of the reports have

allegedly been produced from Blair and Boyd's personal files. PTAC ¶¶ 31-32. 

In the Ninth Circuit, a plaintiff does not necessarily have to name his or her confidential

witnesses. In re Daou Sys., 411 F.3d at 1015. However, the Ninth Circuit "strictly adhere[s] to the

PSLRA's mandate that the complaint state with particularity all facts on which a belief is formed,

and in doing so, requires that a plaintiff reveal the source of her information." Id. (citations and

quotations omitted). The confidential witness sources must be "described with sufficient

particularity to support the probability that a person in the position occupied by the source would

possess the information alleged and the complaint [must] contain adequate corroborating details"

such that the reliability of the source of information might be assessed. Id. In In re Daou Sys., the

Ninth Circuit found adequate particularity where the plaintiffs described the witnesses' job

description and responsibilities, provided the witnesses' title, and stated to which executive the

witnesses reported. Id.

Here, plaintiffs allege that CW14 was a manager in ESST's operations department during and

prior to the Class Period. Other than that statement we know nothing about CW14, his

responsibilities at ESST, and how he came to know the information he now states. Instead, the

PTAC merely alleges (1) CW14 is familiar with each of the three reports at issue and has seen them

before, (2) CW14 states he recalls Blair's secretary handing Blair the backlog and billing reports and

that these two reports were reviewed by Blair, Boyd, and Chan in regular weekly and monthly

meetings, and (3) CW14 confirms that defendants in fact received the backlog and billing reports

because they were very "hands on." PTAC ¶ 26(n). Plaintiffs' reply also asserts that CW8 confirms

defendants' receipt of the weekly executive report and the Daily Flash Report. Pls.' Reply at 7. 

CW8 was allegedly a chip production planner responsible for planning and placing wafer and chip

orders with ESST's manufacturers. PTAC ¶ 26(h). Contrary to plaintiffs' allegations that CW14

stated that the Executive Reports and Daily Flash Reports were "prepared in ESST's marketing

department with the assistance of Austin Sun" plaintiffs' allege that CW8, an individual who does

chip production planning and placed orders, was one of the individuals responsible for generating

the daily and weekly sales flash reports. Plaintiffs also allege that CW8 personally distributed these

Case 5:02-cv-04497-RMW Document 240 Filed 05/30/06 Page 11 of 16
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

19 That CW8, as a production planner, would use such reports seem the more likely

inference.

ORDER DENYING PLAINTIFFS' MOTION FOR LEAVE TO AMEND 

C-02-04497 RMW

SPT 12

reports to Blair, though CW14 asserts that he saw Blair's secretary handing those reports to Blair. 

Id.

 Taken together, plaintiffs' allegations do not clearly establish a strong inference that

defendants knew of the figures in the backlog and billing reports cited by plaintiffs at the time they

made the June 18, 2002, June 24, 2002, and July 24, 2002 statements. These allegations provide

little information as to the basis of CW14's alleged knowledge and CW8's statements contradict

rather than corroborate CW14's (and vice versa). CW8's responsibilities, as alleged, indicates that he

handles placing orders with suppliers rather than receiving orders from customers. The description

of CW8's responsibilities does not support the probability that a person in the position occupied by

CW8 would be the preparer of the backlog and billing reports.19 In addition, "[g]eneral allegations

of defendants' 'hands-on' management style, their interaction with other officers and employees, their

attendance at meetings, and their receipt of unspecified weekly or monthly reports are insufficient."

In re Daou Sys., 411 F.3d at 1022. Plaintiffs' contention that Blair's statements about backlog in a

conference call in response to analyst inquiries implies that he "was aware of and followed ESST's

order backlog" allows some inference, but not a strong one, that the defendants received and

reviewed the backlog, billing, and sales forecast reports. Similarly, plaintiffs' unsupported assertion

that these reports were produced from Blair's and Boyd's personal files do not give rise to an

inference of the requisite state of mind.

c. Backlog and forecast reports

Even if the court assumes that defendants actually received and reviewed the backlog and

billings reports, plaintiffs' allegations do not establish a strong inference that defendants knew or

acted with deliberate recklessness with respect to the April, June, and July 2002 statements at issue. 

Plaintiffs rely entirely on the backlog and billings reports to support scienter for the period prior to

Case 5:02-cv-04497-RMW Document 240 Filed 05/30/06 Page 12 of 16
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

20 Plaintiffs also makes no allegations corroborating defendants' alleged scienter in

April, June, or July. The court's Dec. 2004 Order found that the timing and sales of ESST shares by

Blair, Boyd, and Chan "do not suggest that defendants were scheming to keep the price of ESST

shares up while they unloaded part of their holdings." Dec. 2004 Order at 15-16. Blair's sales were

made pursuant to a pre-planned trading program established in December 2001. Id. at 15. Boyd's

and Chan's sales occurred on February 6, 2002, March 11, 2002, and May 7, 2002. Id. 

21 In particular, the Ninth Circuit had found that the plaintiff's pleadings that a

confidential witness, who was a vice president in sales and who prepared weekly or bi-weekly sales

status/backlog and forecast/pipeline information to the corporate officers satisfied the PSLRA

requirements. In re Daou Sys., 411 F.3d at 1016.

22 For example, during the July 24, 2002 conference call Blair stated "we believe that in

Q3, which is the traditionally largest quarter of the year, revenue will be up from our second quarter

that we just completed. This is because our customers are building for the coming holiday season." 

PTAC ¶ 39. At oral argument, plaintiffs' counsel suggested that defendants have not pointed to any

facts to support their reasons for the statements about third quarter guidance. However, under the

PSLRA it is plaintiffs' burden to plead with particularity that defendants' acted with the requisite

state of mind. Because the court does not find that plaintiffs' allegations establishes a strong

inference that defendants' had knowledge prior to August 2002, the court does not reach the

consideration of whether defendants have negated the inferences of plaintiffs' allegations by

ORDER DENYING PLAINTIFFS' MOTION FOR LEAVE TO AMEND 

C-02-04497 RMW

SPT 13

August 1, 2002.20 Plaintiffs point only to lower levels of backlog during the second quarter and first

month of the third quarter to support that the June and July 2002 third quarter revenue projections

were false when made.

In In re Daou Sys., the plaintiff alleged that the defendant "misrepresented its pipeline

expectations, stating that its position was extremely strong and remained healthy and would fuel

future earnings growth, that visibility of future earnings was outstanding, and that the company's

momentum was increasing." 411 F.3d at 1021 (quotations omitted). There, it was not disputed that

the defendant's had access to the pipeline reports.21 Nevertheless, citing the heightened pleading

requirements of the PSLRA, the Ninth Circuit held "[a]lthough these projections might have been

overly optimistic when made, they do not rise to the level of a material misrepresentation actionable

after enactment of the PSLRA." Id. Similarly, the lower levels of backlog at various points during

April, June, and July (as cited by plaintiffs) may indicate that defendants' third quarter guidance

given in June and July were "overly optimistic," but does not rise to the level of actionable

fraudulent statements. 

While lower backlog may infer lower future revenue, factors other than backlog levels may

be relied upon in making revenue projections.22 Moreover, lower backlog at the beginning of a

Case 5:02-cv-04497-RMW Document 240 Filed 05/30/06 Page 13 of 16
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

showing that they did not act with the requisite state of mind.

23 As defendants' noted at oral argument, plaintiffs' contention seems to presuppose a

upward linear trend in backlog. It remains unclear whether backlog for ESST generally fall at

predictable levels from quarter to quarter as might be the case for a company whose orders fall

within a predictable cycle each quarter.

24 Backlog levels likely have inherent variability because of the timing of customer

orders and of shipments by the company. Here, although backlog going into the second quarter

(presumably around April 1, 2002) was 22% of forecast revenues (compared to 37% going into the

first quarter), approximately 19 days later on April 19, 2002 billings and backlog totaled $40.9

million, greater than the $39.6 million at the comparable time for the first quarter. PTAC ¶¶ 4, 34;

Pls.' Mot. at 7. Then, on April 22, 2002 shipments and backlog totaled $35 million. PTAC ¶ 56. 

25 In addition, as noted earlier no allegations support that defendants received or

reviewed the forecast referred to by plaintiffs since CW14's only statement about the rolling forecast

was that he was familiar with and had seen that report before.

ORDER DENYING PLAINTIFFS' MOTION FOR LEAVE TO AMEND 

C-02-04497 RMW

SPT 14

quarter, without more, does not necessarily render that quarter's revenue likely to fall below

expectations.23 Here, plaintiffs' own allegations indicate that lower backlog at a particular point in

time does not automatically translate into lower revenues. Plaintiffs allege that backlog "going into

the second quarter" had declined to 22% of forecast revenues compared to backlog going into the

first quarter of 37%. PTAC ¶¶ 4, 34. However, ESST's actual second quarter revenue performance

exceeded its June 18, 2002 guidance.24 Decl. Sara M. Folchi Supp. Defs.' Opp. Pls.' Mot. ("Folchi

Decl.") Ex. C at 1. In fact, despite lower backlog "going into the second quarter," on June 18, 2002

ESST issued a press release increasing its second quarter guidance with respect to expected revenue

and earnings per share, and actual revenues later exceeded that increased guidance. PTAC ¶ 36;

Folchi Decl. Ex. B at 1. Thus, it does not follow that knowledge of deterioration in backlog in June

or July gives rise to a strong inference that the June and July statements about third quarter

performance were made with actual knowledge or deliberate recklessness with respect to falsity. 

ESST also missed its June 2002 internal forecast by $7.2 million. PTAC ¶ 8. Regardless,

ESST still exceeded its second quarter revenue estimates. As with the backlog reports, it is unclear

what inferences can specifically be drawn from the missed June forecast. Notably, the PTAC does

not provide any factual allegations (such as the bases for the internal forecasts, the accuracy of such

forecasts, or defendants' reliance on such forecasts) so that these internally prepared forecast could

be evaluated.25 Thus, the court cannot find that the missed June forecast gives rise to a strong

Case 5:02-cv-04497-RMW Document 240 Filed 05/30/06 Page 14 of 16
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

ORDER DENYING PLAINTIFFS' MOTION FOR LEAVE TO AMEND 

C-02-04497 RMW

SPT 15

inference that defendants' knew their June and July statements about third quarter performance were

false when made (or were deliberately reckless with respect to falsity).

III. ORDER 

For the foregoing reasons, the court DENIES plaintiffs' motion for leave to amend as futile.

DATED: 5/30/06 

RONALD M. WHYTE

United States District Judge

Case 5:02-cv-04497-RMW Document 240 Filed 05/30/06 Page 15 of 16
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

ORDER DENYING PLAINTIFFS' MOTION FOR LEAVE TO AMEND 

C-02-04497 RMW

SPT 16

Notice of this document has been electronically sent to:

Counsel for Plaintiff(s):

Luke O. Brooks lukeb@mwbhl.com 

Patrick J. Coughlin patc@mwbhl.com 

Lionel Z. Glancy info@glancylaw.com 

Michael M. Goldberg info@glancylaw.com 

John K. Grant johnkg@mwbhl.com 

Robert A. Jigarjian raj@classcounsel.com 

William S. Lerach billl@mwbhl.com 

Kevin Ruf info@glancylaw.com 

David R. Scott drscott@scott-scott.com 

Counsel for Defendant(s):

Meredith N. Landy mlandy@omm.com 

Counsel are responsible for distributing copies of this document to co-counsel that have not

registered for e-filing under the court's CM/ECF program.

Dated: 5/30/06 SPT

Chambers of Judge Whyte

Case 5:02-cv-04497-RMW Document 240 Filed 05/30/06 Page 16 of 16