Source: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-cand-5_07-cv-02268/USCOURTS-cand-5_07-cv-02268-10/pdf.json

Nature of Suit Code: 190
Nature of Suit: Other Contract Actions
Cause of Action: 28:1331 Fed. Question

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United States District Court

For the Northern District of California

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ORDER GRANTING NOMINAL DEFENDANT'S MOTION TO DISMISS—07-02268 RMW

RSM

United States District Court

For the Northern District of California

E-FILED on 8/12/08

IN THE UNITED STATES DISTRICT COURT

FOR THE NORTHERN DISTRICT OF CALIFORNIA

SAN JOSE DIVISION

In re EXTREME NETWORKS, INC.

SHAREHOLDER DERIVATIVE

LITIGATION

______________________________________

This Document Relates To:

ALL ACTIONS.

No. C-07-02268 RMW

ORDER GRANTING NOMINAL

DEFENDANT'S MOTION TO DISMISS

[Re Docket No. 68]

Lead plaintiff Frank Grucel brings the present action as a derivative suit on behalf of

Extreme Networks, Inc. ("Extreme") against certain current and former directors and officers of

Extreme. Nominal defendant Extreme moves to dismiss the second amended complaint ("SAC") for

failure to make demand against the company or to plead with particularity that demand should be

excused. Extreme also moves to dismiss on the grounds that lead plaintiff Grucel lacks standing. 

Plaintiffs oppose the motion. The court has read the moving and responding papers and considered

the arguments of counsel presented at a hearing on August 8, 2008. For the reasons set forth below,

the court GRANTS Extreme's motion to dismiss. 

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ORDER GRANTING NOMINAL DEFENDANT'S MOTION TO DISMISS—07-02268 RMW

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I. FACTS

Lead plaintiff Grucel filed his original complaint on May 31, 2007. The SAC was filed on

February 25, 2008. Plaintiffs assert violations of federal securities and state laws against certain

current and former directors and officers of Extreme arising from stock option backdating. SAC ¶¶

1, 2. Specifically, plaintiffs allege that officers and directors of Extreme manipulated the grant dates

and associated documentation of stock options used to compensate Extreme employees and

directors. Id. ¶¶ 6, 9, 12, 14-17. Plaintiffs allege that the various illegal activities occurred between

1999 and 2006, which is the "relevant period" for this lawsuit. Id. ¶ 24. Because plaintiffs must

demonstrate that making a demand on the board of directors would have been futile (a factuallyintensive inquiry), the details of Extreme's corporate structure, history and transactions follow.

A. Structure of the Board of Directors

Extreme is a Delaware corporation with its principal executive offices in Santa Clara,

California. SAC ¶ 4. Extreme designs ethernet infrastructure solutions for enterprises and service

providers. Id. Its common stock is listed on the Nasdaq under the stock symbol EXTR. Id.

The Extreme board has two committees relevant to this motion. The Compensation

Committee "reviews the performance and compensation levels for executive officers and sets salary

and bonus levels and option grants under [the] stock option plan." Id. ¶ 61; see also id. ¶ 62. The

Audit Committee reviews and reports to the Board on:

(I) the financial reports and other financial information provided by the Company to

any governmental body or to the public, (ii) the Company's systems of internal and

external controls regarding finance, accounting, legal compliance and ethics that

management and the Board have established and (iii) the Company's auditing,

accounting and financial reporting processes in general. 

Id. ¶ 63.

At the time this suit was filed, Extreme's board of directors consisted of seven members,

Mark Canepa and defendants Gordon L. Stitt, W. Michael West, Harry Silverglide, Robert L. Corey,

Kenneth Levy and Charles P. Carinalli. Id. ¶¶ 29, 201. Stitt co-founded Extreme in 1996 and served

as president, CEO and director until August 2006 when he was appointed Chairman of the Board. 

Id. ¶ 39. West served as Chairman of the Board from September 2004 until August 2006. Id. ¶ 40. 

He continued to serve as a director until 2007. Id. Silverglide has been a director of Extreme since

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1

 Members not pertinent to the court's analysis have been omitted.

2

 Public records, such as SEC filings, are properly the subject of judicial notice, and routinely

considered in deciding a motion to dismiss in a securities case. See, e.g., In re CNET Networks, Inc., 483 F. Supp. 2d 947, 953-54 (N.D. Cal. 2007); In re Copper Mountain Sec. Litig., 311 F. Supp. 2d

857, 865 (N.D. Cal. 2004); In re Calpine Sec. Litig., 288 F. Supp. 2d 1054, 1076 (N.D. Cal. 2003).

ORDER GRANTING NOMINAL DEFENDANT'S MOTION TO DISMISS—07-02268 RMW

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June 2004 and served on the Audit Committee in 2006. Id. ¶¶ 30, 45. Corey joined the board in

December of 2003, the Compensation Committee in July 2004 and the Audit Committee in 2005. 

Id. ¶ 46. Levy has served on the Extreme board since October 2001 and served on the Audit

Committee in 2005 and the Compensation Committee in 2005 and 2006. Id. ¶¶ 30, 47. Carinalli has

been a director of Extreme since October 1996, served on the Compensation Committee from 1999-

2007 and served on the Audit Committee from 2001-2007. Id. ¶ 48.

The committee membership details are summarized in the following table1

:

Compensation Committee Audit Committee

FY98 Carinalli

FY99 Carinalli

FY00 Carinalli Carinalli

FY01 Carinalli Carinalli

FY02 Carinalli Carinalli

FY03 Carinalli Carinalli, Corey

FY04 Carinalli, Corey, Levy Carinalli, Corey, Levy

FY05 Carinalli, Corey, Levy Carinalli, Corey, Silverglide

See id. ¶ 30. Gordon Stitt and Michael West, although both serving on the board of directors, never

served on either the Compensation or Audit Committee.

According to Extreme's certificate of incorporation, Extreme directors are immunized to the

fullest extent permitted by the Delaware General Corporation Law. Decl. of Joseph E. Floren, Ex.

12 (June 27, 2008) (reproducing Extreme's certificate of incorporation as part of the Form S-1 filed

with the SEC).2

 Consequently, the directors cannot be held liable for any breach of fiduciary duty,

except for breaches of the duty of loyalty, actions involving intentional misconduct or actions taken

"not in good faith," and transactions from which they derive an improper personal benefit. See 8

Del. C. § 102(b)(7).

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ORDER GRANTING NOMINAL DEFENDANT'S MOTION TO DISMISS—07-02268 RMW

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B. Extreme's Investigation Into Backdating, and Restatement

Concerns about stock option backdating began with the now-famous Wall Street Journal

article of March 18, 2006 reporting academic research suggesting that various companies were

suspiciously lucky in selecting their option grant dates. On September 15, 2006, Extreme

announced in a Form 8-K that its directors appointed a special committee of outside companies to

review Extreme's historical practices and accounting for stock option grants. SAC ¶ 183. This

investigation delayed the filing of Extreme's Form 10-K for 2006 and jeopardized Extreme's listing

on Nasdaq. Id. ¶¶ 183-189. On January 8, 2007, Extreme announced that it had reached a

preliminary conclusion that the dates of some stock option grants differed from the actual grant

dates. Id. ¶ 186. Accordingly, Extreme advised that its past financial statements for the fiscal

periods 2000 through the third quarter of 2006 could not be relied upon and would need to be

restated. Id.

Extreme released further details of its investigation in its delayed Form 10-K for 2006, filed

on June 28, 2007. Id. ¶ 190. The special committee examined option grants from April 9, 1999

through September 30, 2006. Id. The review encompassed over 8,000 grants on 346 grant dates. 

Id. ¶¶ 190, 191. The grant date was incorrect for 72 of the 346 grant dates examined. Id. ¶ 191. 

While the deficiencies that led to incorrect reporting dates occurred predominantly between 1999

and 2001, they continued to some degree until 2005. Id. ¶ 190. The special committee found that

the Board had delegated option granting authority to the CEO for grants of 40,000 shares or less to

employees that were not officers or directors of the company. Id. ¶ 191. 

Extreme issued options to officers, directors or other individuals requiring the Board's

approval on 43 dates within the review period. Id. Of those 43 grant actions, 11 used the incorrect

dates, 9 with lower stock prices than the actual dates. Id. Although the special committee found no

evidence of fraud, in some cases the incorrect dates appear to have been the result of retrospective

selection based on price considerations. Id. ¶¶ 190, 191 (citing Extreme's Form 10-K filed June 28,

2007). Of the affected option grants to Extreme's directors and officers, none were exercised and all

but one grant have been surrendered or cancelled. Decl. of Joseph E. Floren, Ex. 2 at 54 (Extreme's

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ORDER GRANTING NOMINAL DEFENDANT'S MOTION TO DISMISS—07-02268 RMW

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Form 10-K filed June 28, 2007). In response to the special committee report, the board adopted new

processes to appropriately determine measurement dates. Id.

C. Instances of Alleged Backdating

Plaintiffs allege backdating at Extreme for 10 of the 12 publicly reported grants between

September 1999 and December of 2001. SAC ¶¶ 82-117. While the facts as pleaded would appear

to be sufficient to allege backdating of these grants, the complaint is rife with factual errors. The

complaint contains multiple incorrect stock prices. See id. ¶¶ 91, 95, 99. Additionally, the

complaint makes factually incorrect allegations. See id. ¶¶ 102, 105, 109. For example, the grant on

October 22, 2001 was alleged to be "the lowest share price for that month" (emphasis in original)

when it is in fact not in the lowest third of prices for the month. Id. ¶¶ 109. While a minority of

these errors appear to strengthen the allegations of backdating, these defects in the complaint raise

serious questions as to whether the complaint is well pleaded.

Plaintiffs also challenge four option grants between October 2003 and January 2006. Id. ¶¶

120-21. Three of these grants were reported in Form 4s that were filed outside of the two business

day SEC requirement. Id. ¶ 120. The Form 4 for the grant on September 29, 2004 was filed one day

late. Id. The price increase between the filing and the grant date was 9.46%. See id. The filing of

the Form 4 for the January 25, 2006 grant was five days late, resulting in a stock increase of 4%. 

See id. Finally, the plaintiffs acknowledge that the June 3, 2004 grant was filed within the two day

window required by the SEC, but note that it was issued on the lowest price of the month. Id. ¶ 121. 

The grants addressed in the complaint are summarized below:

Exercise

Price

Alleged Indicia of Backdating Defendant Recipients (directors

emphasized)

Sept. 17,

1999

$57.38 The stock price 20 days later was $87.25

resulting in a return of 52.07%.

The grant was not reported in a Form 4 until

Jan. 10, 2000.

From the Merrill Lynch analysis: the

management annualized return was 937%,

compared to 88.39% for investors.

The grant preceded a "run-up" in the share

price.

Hull: 100,000 options.

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Dec. 17,

1999

$66.62 The stock price 20 days later was $78

resulting in a return of 17.07%.

The grant was not reported in a Form 4 until

Jan. 26, 2001.

From the Merrill Lynch analysis: the

management annualized return was 307.5%,

compared to 88.39% for investors.

The grant preceded a "run-up" in the share

price.

Fukuda: 50,000 options.

Haddock: 170,000 options.

Palermo: 50,000 options.

Schneider: 170,000 options.

Silverglide: 140,000 options.

Stitt: 300,000 options.

Jan. 10, 2000 $76.00 This was the lowest share price for the

month and fiscal quarter.

The stock price 20 days later was $93

resulting in a return of 22.37%.

The grant was not reported in a Form 4 until

July 27, 2000.

From the Merrill Lynch analysis: the

management annualized return was 402.6%,

compared to 88.39% for investors.

The grant preceded a "run-up" in the share

price.

 Halabi: 100,000 options.

June 1, 2000 $49.50 This was the lowest share price for the

month.

The stock price 20 days later was $101.12

(reported incorrectly in complaint).

The grant was not reported in a Form 4 until

July 27, 2000.

The grant preceded a "run-up" in the share

price.

(As the complaint reported the incorrect

stock price, the Merrill Lynch and CFRA

analyses cannot be relied upon.)

Halabi: 100,000 options.

June 8, 2000 $75.00 The stock price 20 days later was $112

(reported incorrectly in complaint).

The grant was not reported in a Form 4 until

July 27, 2000.

The grant preceded a "run-up" in the share

price.

(As the complaint reported the incorrect

stock price, the Merrill Lynch and CFRA

analyses cannot be relied upon.)

Miller: 120,000 options.

July 5, 2000 $94.94

(reported

incorrectly

in

complaint)

The stock price 20 days later was $134.38

(also reported incorrectly in complaint).

The grant was not reported in a Form 4 until

June 8, 2001.

The grant preceded a "run-up" in the share

price.

(As the complaint reported the incorrect

stock price, the Merrill Lynch and CFRA

analyses cannot be relied upon.)

Stitt: 400,000 options.

Haddock: 200,000 options.

Schneider: 200,000 options.

Silverglide: 200,000 options.

Hull: 50,000 options.

Palermo: 200,000 options.

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 This error was noted and corrected in a letter to the court from plaintiff's counsel filed immediately

after the hearing on August 8, 2008. 

ORDER GRANTING NOMINAL DEFENDANT'S MOTION TO DISMISS—07-02268 RMW

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April 9, 2001 $14.57 This was the lowest share price for the

month and fiscal quarter. (It was not the

lowest share price of the year as reported in

the complaint. The entire month of October

was lower.)

The stock price 20 days later was $34.65

resulting in a return of 137.82%.

The grant was not reported in a Form 4 until

July 26, 2001.

From the Merrill Lynch analysis: the

management annualized return was 2480.7%,

compared to 70.83% for investors.

The grant preceded a "run-up" in the share

price.

Carinalli: 50,000 options.

Silverglide: 100,000 options.

Stitt: 200,000 options.

Complaint also states that "top

executive officers" received

"$600,000 options." It is unclear if

this is a scrivener's error or if the

plaintiffs are measuring this grant in

dollar amount as opposed to number

of shares.

Oct. 2, 2001 $6.42 This was the lowest share price for the

month and fiscal quarter. (It was also the

lowest share price of the year not the second

lowest as reported in the complaint.)

The grant was reported in a Form 4, 12 days

later on Oct. 18, 2001.

The stock price 12 days later was $10.78.

The grant preceded a "run-up" in the share

price.

(As the grant was reported 12 days later, the

use of analyses that rely on 20 day returns is

illogical. Consequently, the Merrill Lynch

and CFRA are inapplicable.)

Todd: 850,000 options.

Oct. 22, 2001 $10.64 This share price was not in the lowest third

of prices for the month. (The complaint

erroneously alleges that this was the lowest

share price of the month.)3

The grant was reported in a Form 3, 8 days

later on Nov. 1, 2001. (The complaint

erroneously alleges that it was reported 10

days later.)

The stock price 8 days later was $11.70.

The grant preceded a "run-up" in the share

price.

(As the grant was reported 8 days later, the

use of analyses that rely on 20 day returns is

illogical. Consequently, the Merrill Lynch

and CFRA are inapplicable.)

Levy: 100,000 options.

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ORDER GRANTING NOMINAL DEFENDANT'S MOTION TO DISMISS—07-02268 RMW

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Dec. 28,

2001

$12.76 This was the second lowest share price for

the month.

The grant was reported in a Form 4, 8 days

later on Jan. 4, 2002.

The stock price 8 days later was $16.55.

The grant preceded a "run-up" in the share

price.

(As the grant was reported 8 days later, the

use of analyses that rely on 20 day returns is

illogical. Consequently, the Merrill Lynch

and CFRA are inapplicable.)

Stitt: 750,000 options.

Schneider: 385,000 options.

Haddock: 385,000 options.

Carinalli: 137,500 options.

Oct. 23, 2003 $7.07 This was the third lowest share price for the

month. 

The grant was reported in a Form 4, 12 days

past the SEC deadline, on Nov. 12, 2003.

The stock price when reported was $9.69.

Unknown

June 3, 2004 $4.97 This was the lowest share price for the

month. 

The grant was reported in a Form 4 within

the two day SEC deadline.

The stock price when reported was $5.19.

Unknown

Sept. 29,

2004

$4.44 This was the third lowest share price for the

month. 

The grant was reported in a Form 4, one day

past the SEC deadline, on Oct. 4, 2004.

The stock price when reported was $4.86.

Unknown

Jan. 25, 2006 $4.74 The grant was reported in a Form 4, 5 days

past the SEC deadline, on Feb. 3, 2006.

The stock price when reported was $4.93.

Unknown

D. Procedural History

Lead plaintiff Grucel filed his original complaint on May 31, 2007. On June 8, 2007 Grucel

moved to have his case consolidated with two other actions against defendants, and to have himself

appointed lead plaintiff. In this motion Grucel asserted that he should be appointed lead plaintiff

because "he filed a particularly well-researched and comprehensive complaint" and "has thus

demonstrated his intention to aggressively represent the interests of Extreme Networks in this case

with energy, enthusiasm and vigor." Mot. to Consolidate Actions and to Appoint Frank A. Grucel,

Jr. Lead Pl. and Appoint Lerach Coughlin Stoia Geller Rudman & Robbins LLP Lead Counsel at 8-9

(June 8, 2007). 

Plaintiffs Yenna Wu and Linda Erikson did not make a timely opposition to this motion. On

July 10, 2007, plaintiffs Wu and Erikson filed a Motion to Consolidate Related Actions and Appoint

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4

 It appears that lead counsel, by filing an action on behalf of Bennett, are attempting to use the

consolidation procedure to add a plaintiff who is represented by them. As set forth below, the court

will require plaintiffs to move to appoint a new lead plaintiff and lead counsel.

ORDER GRANTING NOMINAL DEFENDANT'S MOTION TO DISMISS—07-02268 RMW

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Lead Plaintiffs and Lead Counsel. Subsequently, on July 31, 2007, Plaintiffs Wu and Erikson filed a

Notice of Withdrawal of Yenna Wu and Linda Erikson's Motion to Consolidate Cases and to

Appoint Lead Plaintiffs and Lead Counsel. On August 13, 2007, Grucel was appointed lead

plaintiff.

The first amended complaint was filed October 11, 2007. Nominal defendant Extreme filed

a motion to dismiss on November 26, 2007. The parties agreed to a stipulation allowing Grucel to

file a second amended complaint by February 25, 2008, and the first motion to dismiss was vacated. 

The SAC was filed on February 25, 2008. In the SAC, Grucel informs the court that he is no longer

able to "aggressively represent the interests of Extreme Networks in this case with energy,

enthusiasm and vigor," as he has disposed of his shares in Extreme. See SAC ¶ 36 n.7. In this same

footnote, the plaintiffs appear to be moving for permissive intervention under Fed. R. Civ. P. 24 of

Kathleen Wheatley, and moving to then substitute this new party as lead plaintiff. Id. ("plaintiffs

seek to substitute Kathleen Wheatley" who "is willing to intervene as plaintiff"). 

The SAC also makes reference to George Bennett, Jr. SAC ¶ 37. On February 20, 2008,

lead counsel filed a complaint on behalf of Bennett, Case No. 08-cv-01033-RMW. Five days later,

on February 25, lead counsel filed the SAC in the instant action naming Bennett as a party. SAC ¶

37. Lead counsel purported to notify the court that Bennett's case should be consolidated with the

instant action by including a footnote in the SAC. Id. ¶ 37 n.8. Lead counsel does not represent

plaintiffs Wu or Erikson. Plaintiffs Wu and Erikson are not mentioned in the SAC.4

 

II. ANALYSIS

Plaintiffs did not make a demand on the Extreme board before filing this suit. SAC ¶ 29. 

Nominal defendant Extreme moves to dismiss because plaintiffs have not adequately alleged that

demand on the board would have been futile. Further, Grucel has disposed of his shares of stock in

Extreme. Id. ¶ 36 n.7. Extreme thus also moves to dismiss because Grucel no longer has standing to

maintain this action.

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A. Grucel's Standing

The Federal Rules of Civil Procedure require a shareholder bringing a derivative suit to have

been a shareholder at the time of the challenged transaction and that the shareholder "fairly and

adequately represent the interests of shareholders." Fed. R. Civ. P. 23.1. As discussed above,

Grucel has sold his shares of stock in Extreme. The sale of his stock renders Grucel without

standing to maintain this action. Johnson v. Untied States, 317 F.3d 1331, 1333-34 (Fed. Cir. 2003)

("when a plaintiff bringing an action on behalf of the corporation is the legal owner of the stock at

the time of filing but does not maintain shareholder status throughout the course of litigation, the

plaintiff no longer has standing to bring the action"). Although Grucel can no longer proceed with

this action, another qualified shareholder can intervene on the grounds that their rights are no longer

represented. Malcolm v. Cities Serv. Co., 2 F.R.D. 405, 407 (D. Del. 1942). "The cause of action, if

there be one, remains unaffected by the sale of the plaintiff's stock." Id.; see also Pikor v. Cinerama

Prod. Corp., 25 F.R.D. 92, 94-95 (S.D.N.Y. 1960). Grucel's lack of standing is fatal to the operative

complaint, however, the presence of other plaintiffs as well as other shareholders seeking to

intervene dictates that the dismissal be without prejudice. See Pikor, 25 F.R.D. at 95. The court

expects that Grucel will withdraw from this action. 

As discussed above, the second amended complaint indicates that Kathleen Wheatley seeks

to intervene as lead plaintiff. SAC ¶ 36 n.7. Any party seeking permissive intervention must

actually file a motion with the court and not simply insert their name into the complaint. See Fed. R.

Civ. P. 24(b). A footnote in the complaint is not a substitute for following the rules of civil

procedure. If Kathleen Wheatley seeks to intervene in this matter she may file a motion before the

court. With Grucel's failure to adequately represent the shareholders and the potential addition of

intervening plaintiffs, the court needs to carefully consider who would best represent the interests of

Extreme. Accordingly, the parties should file new motions to appoint lead plaintiff and lead

counsel, detailing why a chosen individual would be the best representative for the affected

shareholders.

B. Failure to Verify Complaint

Rule 23.1(b) requires the complaint in a derivative action to be verified. The verification

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requirement exists to prevent baseless strike suits. Surowitz v. Hilton Hotels Corp., 383 U.S. 363,

371 (1966). Combined, Rule 11 and Rule 23.1 serve to assure the court "that some person, party,

attorney, advisor, or otherwise has responsibly investigated the allegations at the behest of the

named plaintiff, who then stands behind the merits of the complaint." Rogosin v. Steadman, 65

F.R.D. 365, 367 (S.D.N.Y. 1974). An unverified derivative complaint should be dismissed with

leave to amend. See, e.g., Glenbrook Capital Ltd. Partnership v. Kuo, 525 F. Supp. 2d 1130, 1146

(N.D. Cal. 2007); Wright, Miller & Kane, Federal Practice and Procedure § 1827, at 57-58 (2d ed.

1995); but see McDonough v. Americom Int'l Corp., 151 F.R.D. 140, 143 (M.D. Fla. 1993)

(declining to dismiss but requiring plaintiff to submit a verification within thirty days).

Rule 23.1(b)'s verification requirement has rarely been the subject of litigation, leaving many

questions about its limits and what requirement it imposes above and beyond Rule 11's required

reasonable investigation. See generally Wright, Miller & Kane, Federal Practice and Procedure §

1827 (2d ed. 1995). Rule 23.1's requirement appears similar to that imposed on private securities

plaintiffs under the Private Securities Litigation Reform Act. Compare Fed. R. Civ. P. 23.1 with 15

U.S.C. § 77z-1(a)(2). The certification requirement for private securities class actions was imposed

because Congress believed "that the plaintiff's bar had seized control of class action suits, bringing

frivolous suits on behalf of only nominally interested plaintiffs in the hope of obtaining a quick

settlement." Greebel v. FTP Software, Inc., 939 F. Supp. 57, 58 (D. Mass. 1996). Congress hoped

that requiring the investor to certify the complaint would "transfer[] control of the litigation from the

attorneys to the investors." In re USEC Securities Litigation, 168 F. Supp. 2d 560, 564 (D. Md.

2001).

Here, the second amended complaint has not been verified by anyone who is presently a

party to this action, however, a "verification" was signed and submitted by Kathleen Wheatley, who,

as discussed above, is not a party to the suit at this time. See SAC. The court has been unable to

find any authority suggesting that a complaint can be verified by an individual who is not a party to

the action. While Ms. Wheatley may at some point move to intervene in this action, she is not

properly a plaintiff, much less the lead plaintiff, and cannot verify the complaint in this matter. The

failure to verify is significant given the lead plaintiff's lack of standing and the apparent factual

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errors in the complaint. In light of these intervening events, it is appropriate to insist on verification

by a proper party to the case to confirm that the plaintiff investors still wish to pursue this case.

C. Demand Futility

Delaware law requires a derivative plaintiff to first make a demand on the board of directors

to address the shareholder's concerns. Ryan v. Gifford, 918 A.2d 341, 351-52 (Del. Ch. Ct. 2007). If

the shareholder chooses not to make a demand, the shareholder must plead with particularity why

such a demand is excused. Fed. R. Civ. P. 23.1(b)(3)(B); see, e.g., CNET Networks, 483 F. Supp. 2d

947.

1. Standards Governing Demand Futility

Delaware law has two standards for excusing demand. Compare Aronson v. Lewis, 473 A.2d

805, 812 (Del. 1984) with Rales v. Blasband, 634 A.2d 927, 933-34 (Del. 1993). "Where the

challenged transaction was not a decision of the board upon which plaintiff must seek demand," the

Rales test applies. See, e.g., Ryan, 918 A.2d at 353. The Rales test requires the plaintiff to allege

particular facts that "create a reasonable doubt that, as of the time the complaint is filed, the board of

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

responding to a demand." Id. at 353 (quoting Rales, 634 A.2d at 933-34).

Plaintiffs have made allegations challenging options granted between 1999 and 2006. While

the plaintiffs are entitled to inferences in their favor, those inferences must be reasonable ones. 

Despite numerous deficiencies in the complaint, plaintiffs have alleged sufficient facts to raise a

reasonable inference that some backdating occurred between 1999 and 2003. Plaintiffs have not

alleged with specificity facts sufficient to raise a reasonable inference of backdating after 2003. The

board in place at the time Grucel filed suit was not the same as the board in place between 1999 and

2003. Accordingly, the court applies the Rales standard to decide whether demand is excused. 

Accord Desimone v. Barrows, 924 A.2d 908, 927-28 (Del. Ch. Ct. 2007) (applying Rales where all

parties agreed it applied).

2. Whether the Extreme Board is Disinterested and Independent

 To successfully plead demand futility, plaintiffs must demonstrate that there is a reasonable

doubt that a majority of the board of directors are not disinterested and independent. Beam ex rel.

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Martha Stewart Living Omnimedia, Inc. v. Stewart, 845 A.2d 1040, 1048-49 (Del. 2004). A director

is presumed to be faithful to the corporation and able to objectively consider a demand. Id. at 1048. 

The plaintiffs must show, with particularity, why that presumption is overcome with respect to a

majority of the board. Id. at 1048-49. Accordingly, plaintiffs must demonstrate that there is a

reasonable doubt that at least four of the seven Extreme directors were not disinterested and

independent. In determining whether plaintiffs have pled demand excuse, the court notes that an

inquiry into a board's ability to consider a demand is context-dependent and fact-specific. Id. at

1049-50; see also Desimone, 924 A.2d at 931 (suggesting a "cautious" and "non-generic" approach

to considering challenges to options practices).

Accordingly, to plead demand futility plaintiffs must specifically allege facts that create a

reasonable doubt that a majority of directors are disinterested and independent. A substantial risk of

personal liability can create a reasonable doubt about a director's disinterestedness. Wood v. Baum,

__ A.2d __, 2008 WL 2600981 at *2 (Del. 2008). However, when directors are exculpated from

liability for certain conduct, the plaintiff must plead particularized facts alleging a non-exculpated

claim against the directors. Id. at *3. If directors are exculpated except for claims based on

"'fraudulent,' 'illegal' or 'bad faith' conduct," then "a plaintiff must also plead particularized facts that

demonstrate that the directors acted with scienter, i.e., that they had 'actual or constructive

knowledge' that their conduct was legally improper." Id.

In Wood, the Delaware Supreme Court upheld the dismissal of a complaint by the Court of

Chancery for failure to excuse demand. Id. at *4. Municipal Mortgage and Equity is a LLC with a

ten-member board of directors. Id. at *1. The operating agreement exempts directors from any

liability "except in the case of fraudulent or illegal conduct of such person." Id. The complaint

alleged "many violations of federal securities and tax laws but [did] not plead with particularity the

specific conduct in which each defendant 'knowingly' engaged." Id. at *3. When asked to identify

particularized facts that would establish actual or constructive knowledge, the plaintiff identified

facts falling into "four main categories: (a) the defendants executed MME's annual reports and other

publicly filed financial reports; (b) the defendants authorized certain transactions; (c) five of the

defendants served on MME's Audit Committee; and (d) other 'red flags'." Id. None of the alleged

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facts were sufficient to demonstrate actual or constructive knowledge. Id. Specifically, neither the

execution of financial reports by directors nor membership on a committee is sufficient to establish

scienter. Id. at *3-*4. 

Paragraph 201 comprises plaintiffs' allegations regarding demand futility. At the time suit

was filed, Extreme's board of directors consisted of Mark Canepa, Gordon L. Stitt, W. Michael

West, Harry Silverglide, Robert L. Corey, Kenneth Levy and Charles P. Carinalli. SAC ¶ 201. 

Plaintiffs make no allegations against director Canepa. See id. The complaint has boilerplate

allegations against all of the directors except Canepa consisting of knowledge of backdating based

on committee service, issuance of false financial statements and administration of stock option

grants. Id. The complaint alleges that Stitt, Carinalli, Silverglide and Levy are interested through

the receipt of backdated stock option grants. Id. Additionally, the complaint alleges that Stitt,

Carinalli and Silverglide participated in insider trading. Id.

a. Backdated Stock Option Grants

Plaintiffs do not contend that three of the directors, West, Corey and Canepa, are interested

by virtue of receiving backdated options. Plaintiffs allege, however, that Stitt, Carinalli, Silverglide

and Levy are interested because they received backdated stock option grants. SAC ¶ 201. These

alleged backdated options were granted on five separate occasions. Id. ¶ 116. However, there are

factual errors in the complaint for three of these five occasions. See option chart supra (July 5,

2000; April 9, 2001; Oct. 22, 2001).

Moreover, the one and only questioned grant to Levy does not appear to suggest backdating. 

The grant to Levy on October 22, 2001 was not even in the lower third of prices for that month. The

challenged grant was reported to the SEC within eight business days on a Form 3. SAC ¶ 109. A

Form 3 filing is an initial statement of ownership of a beneficial security. See 17 C.F.R.

§240.16a-3(a). The Form 3 was timely filed; the deadline for reporting an initial director grant is ten

days. 15 U.S.C. 78p(a)(2)(B). Levy joined the board in October 2001, SAC ¶ 47, and so the fact

that the option grant was reported on a Form 3 that same month suggests that the grant coincided

with Levy becoming a director. These facts alone do not raise a reasonable inference that this grant

was backdated. See In re CNET Networks, Inc., 483 F. Supp. 2d 947, 960 (N.D. Cal. 2007) ("Mere

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reliance on the numbers is not sufficient when plaintiffs are confronted with a legitimate,

judicially-noticeable explanation for the grant date. To plead with particularity that this grant was

backdated, plaintiffs would need to allege specific facts showing that this was not the true grant

date."); accord In re Zoran Corp., 511 F. Supp. 2d 986, 1007 (N.D. Cal. 2007) ("The bottom line is

that this grant seems to have been nothing more than the formulaic grant made to all directors upon

joining the board. Backdating is not indicated.").

Additionally, none of these options were ever exercised by any of the directors and, at most,

only one grant remains outstanding because the others were cancelled or surrendered. Decl. of

Joseph E. Floren, Ex. 2 at 54 (Extreme's Form 10-K filed June 28, 2007). Plaintiffs have not

pleaded any facts that would suggest that the directors received a benefit in exchange for the

cancellation or surrender of their options.

The Delaware Chancery Court has held that accepting backdated stock options creates a

reason to doubt a director's disinterestedness sufficient to disqualify him or her from being able to

consider a demand. Ryan, 918 A.2d at 356. This court has suggested, however, that a director who

no longer stands to benefit from backdated options may no longer be disqualified from considering a

demand. See CNET, 483 F. Supp. 2d at 962. Here, the directors appear to have lost any apparently

backdated stock options prior to the special committee report. Whether they were divested of any

challenged options before suit was filed is unclear from the pleadings. It is therefore a close call as

to directors Stitt, Carinalli, and Silverglide. It would be inappropriate, however, to disqualify Levy

from considering a demand on the board regarding backdating as the plaintiffs have not pleaded

facts sufficient to raise a reasonable inference that he is interested. Accordingly, even if directors

Stitt, Carinalli and Silverglide all held backdated options when suit was filed, the plaintiffs have

failed to establish that a majority of directors are interested due to holding backdated options.

b. Committee Membership, Filing of Statements and Administering

Stock Option Grants

The complaint alleges that all of the directors with the exception of Canepa should be

disqualified from considering a demand on the board because they served on either the

Compensation or Audit Committees, they filed false financial statements or were responsible for

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administering stock option grants. SAC ¶ 201. While plaintiffs do not address these allegations in

their brief, they are made in the complaint to excuse demand failure. 

"Delaware law on this point is clear: board approval of a transaction, even one that later

proves to be improper, without more, is an insufficient basis to infer culpable knowledge or bad faith

on the part of individual directors." Wood, 2008 WL 2600981 at *3. The Delaware Supreme Court

has also made clear that a director's execution of financial reports, without more, is insufficient to

create an inference that he had actual or constructive notice of any illegality. Id. at *3. The

complaint's boilerplate allegations without particularized facts as to knowledge or intent on the part

of any directors cannot overcome this. Demand excuse requires particularized facts.

 Plaintiffs have not alleged any facts establishing culpable knowledge or bad faith, and

therefore cannot raise a reasonable doubt as to disinterestedness. Consequently, they cannot show

that a majority of the directors are not disinterested or independent and so the complaint must be

dismissed. 

c. Insider Trading

Plaintiffs allege that directors Stitt, Silverglide and Levy participated in insider trading by

selling thousands of shares of stock based on knowledge of material non-public information. SAC

¶¶ 19, 39, 45, 48, 201, 204, 267-71. The complaint specifies the proceeds received from the sales

and a range of dates in which the sales took place. Id. ¶ 19. It does not set forth any other details.

"[I]t is unwise to formulate a common law rule that makes a director 'interested' whenever a

derivative plaintiff cursorily alleges that he made sales of company stock in the market at a time

when he possessed material, non-public information." Guttman v. Huang, 823 A.2d 492, 502 (Del.

Ch. Ct. 2003). In Guttman, Vice Chancellor Strine examined the details surrounding stock sales by

directors of NVIDIA and concluded that the plaintiffs had not pleaded sufficient facts to excuse a

demand on the board. Id. at 503-4. Specifically, Vice Chancellor Strine looked not at the dollar

proceeds but the pattern of trading, whether the directors' trading habits had changed year over year

and whether the directors had divested themselves of large percentages of their total ownership. Id;

accord In re Silicon Graphics Inc.,183 F.3d 970, 986 (9th Cir. 1999) (whether insider trading is

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suspicious depends upon: "(1) the amount and percentage of shares sold by insiders; (2) the timing

of the sales; and (3) whether the sales were consistent with the insider's prior trading history").

Plaintiffs have provided no particularized facts from which a reasonable inference of

wrongdoing can be drawn. The complaint details only date ranges spanning as much as six years

and dollar amounts of realized proceeds. It does not detail the percentage of the holdings sold by

Carinalli, Silverglide and Stitt. It does not detail their past trading history, the timing of the sales or

whether the pattern of trading is suspicious. It is a mere cursory allegation. Therefore, it would be

inappropriate to disqualify any directors from considering a demand based on these allegations.

D. Leave to Amend

Plaintiffs have not pleaded facts sufficient to show that a majority of the board in place when

the action was commenced are not disinterested or independent and so have not excused the failure

to make a demand. Based on the allegations and judicially noticeable SEC filings, none of the

directors appear to have received an improper benefit from an allegedly backdated option grant. 

Plaintiffs have failed to allege with particularity any facts from which it could be inferred that

particular directors knew or should have known of accounting improprieties and any facts

suggesting that the board knowingly allowed or participated in a violation of law. Finally, the

plaintiffs have failed to allege any facts suggesting that the sale of stock by directors was improper. 

In any event, even when backdating is "almost certain," the complaint must be dismissed unless it

provides adequate detail regarding the knowledge and roles of the defendants. In re Atmel Corp.,

2007 WL 2070299 at *6 (N.D. Cal. 2007).

Grucel also lacks standing to continue this action. However, Grucel's inability to plead facts

sufficient to excuse demand should not prejudice the shareholders he is no longer qualified to

represent. Consequently, the court grants leave to plaintiffs to move to appoint a new lead plaintiff

and counsel and to file an amended complaint.

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III. ORDER

For the foregoing reasons, the court GRANTS Extreme's motion to dismiss. Plaintiffs have

twenty days to move to appoint lead plaintiff and lead counsel and file an amended complaint.

DATED: 8/11/08

RONALD M. WHYTE

United States District Judge

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Notice of this document has been electronically sent to:

Counsel for Plaintiffs:

Robert Bramson rbramson@bramsonplutzik.com

Emanuel Shachmurove mshachmurove@sbtklaw.com

Aelish Marie Baig AelishB@csgrr.com

Lawrence Timothy Fisher ltfisher@bramsonplutzik.com

Alan R Plutzik aplutzik@bramsonplutzik.com

Frank James Johnson frankj@johnsonbottini.com

Shawn A. Williams shawnw@csgrr.com

Eric L. Zagar ezagar@sbtklaw.com

Counsel for Defendants:

John Henry Hemann jhemann@morganlewis.com

Jonathan DeGooyer jdegooyer@morganlewis.com

Joseph Edward Floren jfloren@morganlewis.com

Laura Alexis Lee llee@morganlewis.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: 8/12/08 /s/ MAG

Chambers of Judge Whyte

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