Source: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-cand-3_07-cv-00392/USCOURTS-cand-3_07-cv-00392-5/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

NORTHERN DISTRICT OF CALIFORNIA

ROSENBAUM CAPITAL, LLC,

Plaintiff,

 v.

JOHN E. MCNULTY, TIM STEINKOPF AND

SECURE COMPUTING CORPORATION,

Defendants.

 

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Case No. 07-0392 SC

ORDER DENYING

DEFENDANTS' MOTION TO

DISMISS

I. INTRODUCTION

This matter comes before the Court on the Motion to Dismiss

("Motion") by the defendants John E. McNulty ("McNulty"), Tim

Steinkopf ("Steinkopf") and Secure Computing Corporation

("Secure"), (collectively "Defendants"). See Docket No. 23. The

plaintiff Rosenbaum Capital, LLC ("Plaintiff"), filed an

Opposition, Defendants submitted a Reply, and Plaintiff, with

leave from the Court, filed a Surreply. See Docket Nos. 28, 31,

37. For the following reasons, the Court DENIES Defendants'

Motion.

II. BACKGROUND

Secure is a software corporation that develops network

security for large organizations. Mot. at 4. McNulty is Secure's

President, Chairman, and CEO and Steinkopf is Senior Vice

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President of Operations and CFO. Id. In January 2006, Secure

acquired CyberGuard Corporation ("Cyberguard"), another network

security corporation that offered similar products. Id. at 5. On

May 4, 2006, Secure issued a press release reporting 2006 first

quarter financial results and providing revenue and earnings

guidance for the second quarter of the year. Defendants' Request

for Judicial Notice ("RJN"), Docket No. 24, Ex. C at 1. In the

press release, Secure projected that revenues for the second

quarter of 2006 would be between $43 million and $45 million. Id.

at 4. Additionally, the press release contained statements from

Defendants McNulty and Steinkopf regarding the integration of

CyberGuard and Secure. McNulty was quoted as saying, "[w]e closed

the largest acquisition in the company's history, and began the

process of integrating Secure Computing's and CyberGuard's

worldwide operations. I am pleased to report that all phases of

the integration process are either on target or ahead of plan." 

Id. at 1. In explaining Secure's results for the first quarter,

Steinkopf was quoted stating: "Our ability to exceed our guidance

is a direct reflection on the speed and good progress we were able

to achieve in integrating CyberGuard into Secure Computing . . .

." Id. The press release also contained a warning that the

revenue projections are forward-looking statements and, as such,

are made pursuant to the safe harbor provision of the Private

Securities Litigation Reform Act, 15 U.S.C. § 78u-4 ("PSLRA"). 

Id. at 5.

On the same day that Secure issued the press release,

Defendants McNulty and Steinkopf participated in a conference call

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with investors and securities analysts. Id. Ex. B at 2, 3. This

call also began with a warning statement in which Defendants

stated: "During the course of this call . . ., we will make

forward-looking statements . . . . Such forward-looking

statements are subject to the safe harbor provision . . . ." Id.

at 3. During the call Defendants repeated the revenue and

earnings projections for the second quarter and also made the

following statements regarding the integration of Secure and

CyberGuard:

-- "We exited Q1 functioning as a well-integrated single

Company in all departments, both process-wise and culturally. 

This is ahead of our integration plan. And as a result, I believe

the Company is well positioned for the quarters ahead." Id. at 4.

-- "The Secure Computing and CyberGuard teams have done a

remarkable job coming together as one. Every part of the Company

. . . [is] now integrated and under one management team." Id. at

7.

On July 11, 2006, Secure issued a press release announcing

that its revenue and earnings were lower than had been projected

on May 4, 2006. Id. Ex. D. at 1. Secure noted that rather than

reaching a revenue range of $43 million to $45 million, as

previously anticipated, revenue for the second quarter was in fact

$38.7 million. Id. Ex. G at 1. In a conference call that same

day, Defendants McNulty and Steinkopf attributed part of the

revenue shortfall to the failure to close two large deals by the

end of the quarter. Id. Ex. F at 2-3. One of these transactions

would have generated $2.55 million in revenue and the other was to

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have yielded $1.3 million. Id. When analysts questioned McNulty

and Steinkopf about whether the merger with CyberGuard had any

detrimental impact on the second quarter results, McNulty

initially said he did not think so while Steinkopf indicated that

it might have had some impact. Id.

Plaintiff, an investor in Secure, subsequently filed suit in

this Court, alleging violations of sections 10(b) and 20(a) of the

Securities Exchange Act of 1934. On July 2, 2007, Plaintiff filed

a First Amended Complaint ("FAC"). See Docket No. 22. 

Plaintiff's claims are based primarily on the allegation that at

the time Defendants represented that the integration between

Secure and Cyberguard was proceeding well, they knew or should

have known that the integration was in fact facing significant

problems and these problems would negatively impact the financial

projections for the second quarter. See FAC ¶¶ 40-42. 

III. LEGAL STANDARDS

A. Motion to Dismiss

A Federal Rule of Civil Procedure 12(b)(6) motion to dismiss

tests the sufficiency of the complaint. Dismissal pursuant to

Rule 12(b)(6) is appropriate if the plaintiff is unable to

articulate "enough facts to state a claim to relief that is

plausible on its face." Bell Atlantic Corp. v. Twombly, 127 S.

Ct. 1955, 1974 (2007). "[F]aced with a Rule 12(b)(6) motion to

dismiss a § 10(b) action, courts must, as with any motion to

dismiss for failure to plead a claim on which relief can be

granted, accept all factual allegations in the complaint as true." 

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Tellabs, Inc. v. Makor Issues & Rights, LTD., 127 S. Ct. 2499,

2509 (2007). All reasonable inferences are to be drawn in favor

of the plaintiff. Everest & Jennings, Inc. v. Am. Motorists Ins.

Co., 23 F.3d 226, 228 (9th Cir. 1994). Unreasonable inferences or

conclusory legal allegations cast in the form of factual

allegations, however, are insufficient to defeat a motion to

dismiss. W. Mining Council v. Watt, 643 F.2d 618, 624 (9th Cir.

1981).

B. Private Securities Litigation Reform Act

Section 10(b) of the Securities Exchange

Act of 1934 forbids the "use . . . in

connection with the purchase or sale of

any security . . ., [of] any manipulative

or deceptive device or . . . in

contravention of such rules and

regulations as [SEC] may prescribe as

necessary or appropriate in the public

interest or for the protection of

investors."

Tellabs, 127 S. Ct. at 2507 (citing 15 U.S.C. § 78j(b))

(alterations and brackets in original).

Securities and Exchange Commission ("SEC") Rule 10b-5,

promulgated under the authority of section 10(b), in turn,

provides:

It shall be unlawful for any person . . .

(a) To employ any device, scheme, or

artifice to defraud, (b) To make any

untrue statement of a material fact or to

omit to state a material fact necessary

in order to make the statements made, in

light of the circumstances under which

they were made, not misleading, or (c) To

engage in any act, practice, or course of

business which operates or would operate

as a fraud or deceit upon any person, in

connection with the purchase or sale of

any security.

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17 C.F.R. § 240.10b-5.

The enactment of the PSLRA in 1995 significantly altered

pleading requirements in private securities fraud litigation by

requiring that a complaint plead with particularity both falsity

and scienter. In re Daou Systems, Inc., 411 F.3d 1006, 1014 (9th

Cir. 2005). Thus, under the PSLRA, a complaint alleging that the

defendant made a false or misleading statement must "specify each

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

reasons why the statement is misleading." 15 U.S.C. § 78u4(b)(1). In addition, the complaint must "state with

particularity facts giving rise to a strong inference that the

defendant acted with the required state of mind." Id. § 78u4(b)(2). In the Ninth Circuit this state-of-mind requirement

demands that "the complaint . . . allege that the defendants made

false or misleading statements either intentionally or with

deliberate recklessness." Daou Sys., 411 F.3d at 1015.

In addition to the heightened PSLRA pleading standards, "[i]t

is well established that claims brought under Rule 10b-5 and

section 10(b) must meet the particularity requirements of Federal

Rule of Civil Procedure 9(b)." Id. at 1014. Rule 9(b) states

"[i]n alleging fraud or mistake, a party must state with

particularity the circumstances constituting fraud or mistake." 

Fed. R. Civ. P. 9(b).

The basic elements of a Rule 10b-5 claim include the

following: (1) a material misrepresentation or omission of fact,

(2) scienter, (3) a connection with the purchase or sale of a

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security, (4) transaction and loss causation, and (5) economic

loss. Dura Pharms., Inc. v. Broudo, 544 U.S. 336, 341 (2005).

IV. DISCUSSION

Defendants argue that Plaintiff's Complaint should be

dismissed for three reasons: (1) the allegedly false and

misleading statements are statutorily protected by the safe harbor

provision of the PSLRA; (2) Plaintiff has failed to plead scienter

and falsity with the requisite factual particularity; and (3) the

confidential sources upon which Plaintiff bases his factual

allegations are, as a matter of law, insufficient.

A. Request for Judicial Notice

As a threshold matter, the Court addresses Defendants'

request that the Court take judicial notice of various documents. 

Federal Rule of Evidence 201 permits a court to take judicial

notice of a fact "not subject to reasonable dispute in that it is

. . . capable of accurate and ready determination by resort to

sources whose accuracy cannot reasonably be questioned." When

ruling on a 12(b)(6) motion to dismiss a § 10(b) action, courts

must consider the complaint in its entirety, including "documents

incorporated into the complaint by reference, and matters of which

a court may take judicial notice." Tellabs, 127 S. Ct. at 2509. 

Where a plaintiff fails to attach to the complaint the documents

upon which the complaint is premised, a defendant may attach such

documents in order to show that they do not support the

plaintiff's claim. In Re Pac. Gateway Exch., Inc., 169 F. Supp.

2d 1160, 1164 (N.D. Cal. 2001). In addition, under the

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incorporation by reference doctrine, a court may, on a Rule

12(b)(6) motion, consider documents whose contents are alleged in

a complaint but which are not physically attached to the pleading. 

Tellabs, 127 S. Ct. at 2509. Finally, a court may take judicial

notice of public filings, such as those made with the SEC. 

Dreiling v. Am. Exp. Co., 458 F.3d 942, 946 n.2 (9th Cir. 2006).

In the present case, all except one of the press releases and

conference-call transcripts that Defendants seek to have

judicially noticed are referenced in the Plaintiff's Amended

Complaint. These documents are therefore appropriate for judicial

notice. The exception is a conference-call transcript of Secure's

August 18, 2005, conference call. This transcript, however, is

publicly available and was disclosed to the market, and therefore

is appropriate for judicial notice. See In re Copper Mountain,

311 F. Supp. 2d 857, 864 (N.D. Cal. 2004). The remaining

documents Defendants seek to have judicially noticed are all SEC

filings. The Court therefore GRANTS Defendants' request and takes

judicial notice of Exhibits A1-8 and B1-5. 

B. Safe Harbor Provision of PSLRA

The safe harbor provision of the PSLRA provides that a

defendant shall not be liable with respect to any forward-looking

statement if:

(A) The forward-looking statement is-

(i) identified as a forward-looking

statement, and is accompanied

by meaningful cautionary

statements identifying

important factors that could

cause actual results to differ

materially from those in the

forward-looking statement; or

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(ii) immaterial; or

(B) the plaintiff fails to prove that

the forward-looking statement-

(i) if made by a natural person,

was made with actual knowledge

by that person that the

statement was false or

misleading . . . .

15 U.S.C. § 78u-5(c)(1). A "forward-looking statement" is

defined, in relevant part, as "a statement containing a projection

of revenues, income (including income loss), earnings . . . or

other financial items" or "a statement of future economic

performance" or "any statement of the assumptions underlying or

relating to any statement described [above]." Id. at § 78u5(i)(1). 

The first issue for the Court is whether the statements at

issue fall within the definition of "forward-looking." Regarding

Defendants' statements about the integration of CyberGuard and

Secure, it is clear that they are not forward looking. 

Defendants, for example, stated the following: "We exited Q1

functioning as a well integrated single Company in all

departments, both process wise and culturally. This is ahead of

the integration plan." Compl. ¶ 20. This statement described

events that had already occurred and conditions that were

supposedly already in existence. This statement thus falls

outside of the statutory definitions of "forward-looking." See 15

U.S.C. § 78u-5(i)(1). The statements regarding the condition of

the integration are not protected by the safe harbor provision of

the PSLRA.

Regarding Defendants' statements detailing revenue and

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1

 See Employers Teamsters Local Nos. 175 & 505 Pension Trust

Fund v. Clorox Co., 353 F.3d 1125, 1133 (9th Cir. 2004) (holding

that the PSLRA "provides that for forward-looking oral statements .

. . the safe harbor" applies if cautionary statements are

"'contained in a readily available written document'") (citing 15

U.S.C. § 78u-5(c)(2)(B)(i)).

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earnings projections, the Court agrees with Defendants that such

statements fall within the statutory definition for "forwardlooking." In addition, it is undisputed that these statements

were made in conjunction with cautionary statements. Plaintiff

does not dispute that Defendants included cautionary statements in

both their conference calls with analysts and their press

releases. See RJN Ex. B. at 3, Ex. C at 5. Furthermore, the

press release cross-referenced risk disclosures included in

Defendants' 2005 Form 10-K and other SEC filings.1 Id.

Defendants point to language in the 2005 Form 10-K that states:

"We may be unable to integrate our operations successfully and

realize all of the anticipated benefits of the merger with

CyberGuard Corporation." Id. Ex. J at 13. 

Defendants fail to recognize, however, that the PSLRA

requires "meaningful cautionary statements." 15 U.S.C. § 78u5(c)(1)(A)(i) (emphasis added). Another district court in

California has stated the following:

If the forward-looking statement is made

with actual knowledge that it is false or

misleading, the accompanying cautionary

language can only be meaningful if it

either states the belief of the speaker

that it is false or misleading, or, at

the very least, clearly articulates the

reasons why it is false or misleading. 

In re Seebeyond Tech. Corp. Sec. Litig., 266 F. Supp. 2d 1150,

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2

 "The PSLRA created a statutory version of [the bespeaks

caution] doctrine by providing a safe harbor for forward-looking

statements identified as such, which are accompanied by meaningful

cautionary statements." Clorox, 353 F.3d at 1132.

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1165 (C.D. Cal. 2003). The Court finds such reasoning persuasive. 

Plaintiff has alleged that Defendants' revenue and earning

projections were based, in part, on a characterization of the

integration that Defendants allegedly knew to be false. See

Compl. ¶ 20. Defendants' warning statements lose much, if not

all, of their value if, as Plaintiff has alleged, at the time

Defendants publicly stated that they "exited [the first quarter]

functioning as a well integrated single Company in all

departments," Opp'n at 2, Defendants in fact knew that the

integration was highly problematic. See In re WorldCom, Inc. Sec.

Litig., 294 F. Supp. 2d 392, 427 (S.D.N.Y. 2003) (stating that the

"doctrine of bespeaks caution2 provides no protection to someone

who warns his hiking companion to walk slowly because there might

be a ditch ahead when he knows with near certainty that the Grand

Canyon lies one foot away") (internal quotation marks omitted). 

Thus, the cautionary language used by Defendants is not

"meaningful" and Defendants are not entitled to the safe harbor

protection of 15 U.S.C. § 78u-5(c)(1)(A). 

For the reasons stated above, the Court finds that

Defendants' statements from the May 4, 2006, conference call and

press release are not protected by the safe harbor provision of

the PSLRA. 

C. Factual Particularity and Confidential Sources

Defendants argue that because the only evidence Plaintiff has

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submitted comes from five unnamed confidential sources, Plaintiff

has failed to present the particularized allegations of fact

required for a Rule 10b-5 claim. Regarding confidential sources,

the Ninth Circuit has stated that "[n]aming sources is unnecessary

so long as the sources are 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 contains adequate corroborating details." Daou Sys.,

411 F.3d at 1015 (internal citations omitted). 

In the present case, Plaintiff has provided sufficient

particularity regarding the confidential sources. For example,

Plaintiff has stated that Confidential Source # 1 was Director of

Administration as an executive at CyberGuard and Secure. FAC ¶

43. In this capacity, Confidential Source # 1 was responsible for

order processing, forecasting sales for the fiscal quarter,

implementing methods to meet revenue goals, and organizing the

maintenance department in customer support. Id. ¶ 44. In

addition, during at least part of the class period, Confidential

Source # 1 was allegedly working under and reporting to Secure's

Vice President of Production, who was responsible for supervising

aspects of the integration of Secure and CyberGuard. 

Plaintiff's other four confidential sources are also

described with similar particularity. See, e.g., FAC ¶ 57

(alleging that "Confidential Source No. 2 served as the Global

Original Equipment Manager ("OEM") Account Manager . . . at Secure

from 2001 until 2006. The Account Manager reported to Chris

Peterson, the VP of OEM and Channel Sales for Secure, who reported

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directly to Defendant McNulty."). In addition, the confidential

sources, when combined with Defendants' statements and press

releases, provide "adequate corroborating details." Daou, 411

F.3d at 1015. Thus, in light of the specificity of Plaintiff's

descriptions of its confidential witnesses, Plaintiff "has

sufficiently met the PSLRA's requirements for confidential

witnesses." Id.

Defendants argue that the Daou standard for confidential

sources is no longer valid because of the heightened PSLRA

pleading standard recently articulated by the Supreme Court in

Tellabs. As discussed above, the Court in Tellabs held that in

pleading the "strong inference that the defendant acted with the

required state of mind," 15 U.S.C. § 78u-4(b)(2), a "complaint

will survive . . . only if a reasonable person would deem the

inference of scienter cogent and at least as compelling as any

opposing inference one could draw from the facts alleged." 

Tellabs, 127 S. Ct. at 2510. Thus, Defendants argue, confidential

sources, by definition, could not give rise to a cogent and

compelling inference of scienter.

Defendants cite a post-Tellabs, Seventh Circuit opinion in

support of their argument. In Higginbotham v. Baxter

International, Inc., 495 F.3d 753 (7th Cir. 2007), the court

stated: "One upshot of the approach that Tellabs announced is

that we must discount allegations that the complaint attributes to

five confidential witnesses . . . . It is hard to see how

information from anonymous sources could be deemed 'compelling' or

how we could take account of plausible opposing inferences." Id.

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at 756-57. 

The Ninth Circuit has not yet spoken to the issue of whether

confidential sources, if described with the requisite

particularity, may give rise to the cogent and compelling

inference of scienter required by Tellabs. Without guidance

stating otherwise, this Court is unwilling to abandon the binding

Ninth Circuit precedent of Daou for the reasoning articulated by

the Seventh Circuit in Higginbotham. 

Such a decision is supported by the only other Circuit

besides the Seventh to address the post-Tellabs treatment of

confidential sources. In Central Laborers' Pension Fund v.

Integrated Electrical Services Inc., 497 F.3d 546 (5th Cir. 2007),

the Fifth Circuit did not read Tellabs to presumptively preclude

confidential sources. See id. at 552 (stating "[c]onfidential

source statements are a permissible basis on which to make an

inference of scienter"). Although the Fifth Circuit did not

discuss Tellabs in its analysis of confidential sources, the court

was clearly aware of the Tellabs decision as evidenced by numerous

citations to Tellabs in its lengthy discussion of the PSLRA

pleading standards. Id. at 551. Thus, Central Laborers' Pension

Fund suggests that, contrary to the Seventh Circuit's conclusion,

Tellabs does not presumptively prohibit confidential sources. 

In the present action, the Court finds that the information

provided by Plaintiff's confidential sources, in combination with

Defendants' statements and press releases, presents sufficiently

particularized allegations of fact as required for a Rule 10b-5

claim.

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D. Factual Allegations for Scienter and Falsity

Defendants also assert that Plaintiff's factual allegations

regarding the alleged violation are insufficient, as a matter of

law, to establish scienter and falsity. "As set out in §

21D(b)(2) of the PSLRA, plaintiffs must 'state with particularity

facts giving rise to a strong inference that the defendant acted

with the required state of mind.'" Tellabs, 127 S. Ct. at 2504

(citing 15 U.S.C. § 78u-4(b)(2)). In the Ninth Circuit, "the

required state of mind is one of deliberate or conscious

recklessness." No. 84 Employer-Teamster Joint Council Pension

Trust Fund v. Am. W. Holding Corp., 320 F.3d 920, 931 (9th Cir.

2003). The Court in Tellabs defined a "strong inference" as the

following:

[T]o determine whether a complaint's

scienter allegations can survive a

threshold inspection for sufficiency, a

court . . . must engage in a comparative

evaluation: it must consider, not only

inferences urged by the plaintiff . . .,

but also competing inferences rationally

drawn from the facts alleged. . . . To

qualify as "strong" within the intendment

of § 21D(b)(2), we hold, an inference of

scienter must be more than merely

plausible or reasonable--it must be

cogent and at least as compelling as any

opposing inference of nonfraudulent

intent.

Id. at 2504-05. Thus, a "complaint will survive . . . only if a

reasonable person would deem the inference of scienter cogent and

at least as compelling as any opposing inference one could draw

from the facts alleged." Id. at 2510. 

Defendants argue that Plaintiff's Complaint fails to create

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 The dual pleading requirements of falsity and scienter may

be incorporated "into a single inquiry, because falsity and

scienter are generally inferred from the same set of facts." In re

Read-Rite Corp., 335 F.3d 843, 846 (9th Cir. 2003). 

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this compelling inference of scienter and falsity.3 As discussed

in section B., supra, the Court is satisfied that the information

provided by Plaintiff's confidential sources, in combination with

Defendants' statements and press releases, presents the

sufficiently particularized allegations of fact required for a

Rule 10b-5 claim. Contrary to Defendants' argument that "the

facts alleged in the Complaint compel the conclusion that the

second quarter guidance was reasonable and well-founded when

made," Reply at 8, Plaintiff's allegations are commensurate with

the pleading requirements for the PSLRA and Federal Rule of Civil

Procedure 9(b). In short, Plaintiff has alleged that Defendants

knew of the problems with the integration yet still stated, in the

May 4 press release, that the integration was going well and that

its success would contribute to increased revenue. If these

factual allegations are accepted as true, then Plaintiff has

sufficiently pleaded violations of the Securities Exchange Act. 

Plaintiff has presented evidence, in the form of confidential

sources, that indicates that Defendants knew that the integration

was not proceeding smoothly. Defendants' statements in the press

release and during the conference call directly conflict with what

the confidential sources have stated. The totality of this

evidence, combined with the fact that Secure missed its revenue

projections, gives rise to a cogent and compelling inference of

scienter. 

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E. Two Missed Deals

Finally, Defendants make much of the fact that the missed

revenue projections can largely be attributed to two missed deals

at the end of the second quarter. Defendants argue that these two

missed deals account for all of the discrepancy between the

revenue projections of the May 4 press release and the actual

second quarter revenue. As noted above, the projected revenue was

$43 million to $45 million while the actual revenue was $38.7

million. According to Defendants, the two missed deals accounted

for total lost revenue of $3.85 million in the second quarter. 

Thus, as Defendants argue, had these two deals gone through as

planned, the revenue for the second quarter would have been $42.55

million ($38.7 million plus $3.85 million), just shy of the $43

million low end of the projected revenue range.

Under Tellabs, a court must look not only to the inference

urged by the plaintiff but also to any other inferences a

reasonable person could draw from the factual allegations. See

Tellabs, 127 S. Ct. at 2510 (stating that a "complaint will

survive . . . only if a reasonable person would deem the inference

of scienter cogent and at least as compelling as any opposing

inference one could draw from the facts alleged"). 

Defendants argue that because the two missed deals account

for much of the revenue shortfall, one could just as easily infer

from Plaintiff's allegations that the problems with the

integration had little or nothing to do with Secure's failure to

hit the projected revenue range. By Defendants' own admissions,

however, even if both deals had gone through, Secure still would

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have fallen short of the low end of the projected revenue range. 

Thus, something in addition to these deals caused the revenue

shortcomings. Whether problems with the integration was the cause

of the missed earnings is, at this stage, far from clear. What is

clear, however, is that Plaintiff has presented sufficiently

particularized allegations regarding Defendants' knowledge of

Secure's integration and its potential impact on revenue

projections. 

V. CONCLUSION

For the reasons stated above, Defendants' Motion to Dismiss

is DENIED.

IT IS SO ORDERED.

Dated: March 4, 2008 

UNITED STATES DISTRICT JUDGE

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