Source: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-cand-5_01-cv-21029/USCOURTS-cand-5_01-cv-21029-5/pdf.json

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

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Case No. C 01-21029 JF (RS)

ORDER DENYING MOTIONS TO DISMISS SAC AS TO LENT, HASHMAN, RIGIONE AND CAI ETC.

(JFLC2)

**E-Filed 3/20/06**

NOT FOR CITATION

IN THE UNITED STATES DISTRICT COURT

FOR THE NORTHERN DISTRICT OF CALIFORNIA

SAN JOSE DIVISION

IN RE NEXTCARD, INC. SECURITIES

LITIGATION.

_________________________________________

THIS DOCUMENT RELATES TO ALL

ACTIONS.

Case Number C 01-21029 JF (RS)

ORDER DENYING MOTIONS TO

DISMISS SECOND AMENDED

COMPLAINT AS TO DEFENDANTS

LENT, HASHMAN, RIGIONE AND

CAI; AND GRANTING MOTION TO

DISMISS SECOND AMENDED

COMPLAINT WITHOUT LEAVE TO

AMEND AS TO DEFENDANT

QURESHEY

[Doc. Nos. 263, 266, 267, 269, 272,

277, 278]

Before the Court are motions to dismiss Plaintiffs’ consolidated second amended class

action complaint (“SAC”) brought by Defendants Jeremy Lent (“Lent”), John Hashman

(“Hashman”), Bruce Rigione (“Rigione”), Yinzi Cai (“Cai”), and Safi Qureshey (“Qureshey”). 

The Court has considered the parties’ papers as well as the oral arguments presented at the

hearing on October 28, 2005. For the reasons discussed below, the motions to dismiss will be

denied as to Defendants Lent, Hashman, Rigione and Cai, and granted without leave to amend as

to Defendant Qureshey. 

Case 5:01-cv-21029-JF Document 325 Filed 03/20/06 Page 1 of 12
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1

 For ease of reference, NextCard and NextBank are referred to collectively as

“NextCard” or “the company.”

2

 Generally Accepted Accounting Principles.

2

Case No. C 01-21029 JF (RS)

ORDER DENYING MOTIONS TO DISMISS SAC AS TO LENT, HASHMAN, RIGIONE AND CAI ETC.

(JFLC2)

I. BACKGROUND

This is a stock-drop securities class action suit originally filed against NextCard, Inc.

(“NextCard”) and several of its officers and directors. The Court dismissed Plaintiffs’ first

amended consolidated class action complaint (“FAC”) with leave to amend on February 7, 2005,

and Plaintiffs filed the operative SAC on April 27, 2005, alleging in great detail a scheme by

which NextCard and several of its officers and directors used “accounting gimmickry” to inflate

the company’s financial results. In broad outline, Plaintiffs’ claims are as follows:

NextCard was an Internet-based provider of consumer credit that offered an online credit

approval system for a Visa card through its wholly-owned subsidiary, NextBank.1 SAC ¶ 2. 

Between April 19, 2000 and October 30, 2001 (“the class period”), NextCard and several of its

officers and directors made false or misleading statements to the market indicating that the

Internet credit card business was a success and was growing at a dramatic rate. Id. at ¶¶ 143-166. 

Form 10Qs and 10Ks filed during this period misrepresented the company’s financials and were

not prepared in accordance with GAAP.2 Id. at ¶¶ 132-39. Specifically, the company

“understated its loan loss allowances, provision for loan losses and charge-off rates by

improperly reclassifying certain credit losses as fraud losses and employing inappropriate

methodology for determining loan loss allowances.” Id. at ¶ 135. These practices allowed the

company to overstate its reported net interest income and understate its net losses during the class

period. Id. The company also understated its risk-weighted assets and overstated its risk-based

capital ratio by failing to include in its risk-weighted assets credit losses that had been classified

as fraud losses and sold to third parties. Id. 

On October 31, 2001, the company issued a press release stating that, as a result of

discussions with the Office of the Comptroller of the Currency (“OCC”) and the Federal Deposit

Insurance Corporation (“FDIC”), the company needed to take several steps to increase its

reserves and limit its lending activities. Id. at ¶ 113. These steps included substantially

Case 5:01-cv-21029-JF Document 325 Filed 03/20/06 Page 2 of 12
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3

 Plaintiffs do not assert claims against NextCard because of the company’s bankruptcy. 

Plaintiffs have reached settlement with respect to claims against NextCard’s outside auditor,

Ernst & Young, LLP.

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Case No. C 01-21029 JF (RS)

ORDER DENYING MOTIONS TO DISMISS SAC AS TO LENT, HASHMAN, RIGIONE AND CAI ETC.

(JFLC2)

increasing loan loss allowances; tightening underwriting criteria; reclassifying previously

recognized fraud losses as credit losses; and increasing risk weighted assets by more than $500

million. Id. at ¶¶ 113-14. These disclosures caused NextCard’s stock to decline 84% to $.87 per

share. Id. at ¶ 117. On February 7, 2002, the OCC closed NextBank and appointed the FDIC as

Receiver. Id. at ¶ 121. The company was delisted from NASDAQ on March 18, 2002 and filed

for bankruptcy on November 14, 2002. Id. at ¶ 123. The OCC, FDIC and SEC initiated separate

investigations into the events leading up to the company’s demise. Id. at ¶ 122.

Plaintiffs allege a claim under § 10(b) of the Securities Exchange Act of 1934

(“Exchange Act”) against Defendants Lent, Hashman, Rigione and Cai, and a control person

claim under to § 20(a) against these four individuals plus Defendant Qureshey.3

II. DISCUSSION

B. Section 10(b) Claim

1. Elements Of A § 10(b) Claim

The United States Supreme Court has clarified that only two types of conduct give rise to

liability under § 10(b) and Rule 10-b(5) promulgated thereunder: (1) the making of a material

misstatement or omission or (2) the commission of a manipulative act. Central Bank of Denver

v. First Interstate Bank of Denver, N.A., 511 U.S. 164, 177 (1994). While Plaintiffs assert that

Defendants engaged in a “fraudulent scheme” during the class period, see SAC ¶ 4, a

straightforward reading of the SAC makes clear that the gravamen of Plaintiffs’ § 10(b) claim is

that Defendants committed fraud on the market by means of material misstatements or

omissions. Under the fraud on the market theory, it is assumed that an investor who buys or sells

stock at the price set by an efficient market does so in reliance on the integrity of that price. 

Basic, Inc. v. Levinson, 485 U.S. 224, 247 (1988). Because publicly available information is

reflected in the market price, an investor’s reliance on the price necessarily means that the

investor is relying upon any public material misrepresentations or omissions. Id. 

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Case No. C 01-21029 JF (RS)

ORDER DENYING MOTIONS TO DISMISS SAC AS TO LENT, HASHMAN, RIGIONE AND CAI ETC.

(JFLC2)

Plaintiffs do not use the term “fraud on the market,” and cast a number of their

allegations in terms of the alleged “scheme” entered into by Defendants. However, Plaintiffs

identify the common class questions as: (a) whether Defendants issued false and misleading

statements during the class period; (b) whether Defendants acted with scienter in issuing such

statements; (c) whether Defendants are liable as control persons of the company; (d) whether the

market price of NextCard stock during the class period was artificially inflated because of

Defendants’ conduct; and (e) whether class members have been damaged. SAC ¶ 19. 

Accordingly, while allegations that Defendants were involved in a “scheme” are relevant to paint

a picture of what was going on at the company during the class period, and may be relevant to the

question of scienter, the Court’s focus must be on the alleged misrepresentations and omissions

made by Defendants.

The elements of a § 10(b) claim involving publicly traded securities are as follows: (1) a

material misrepresentation or omission; (2) scienter; (3) a connection with the purchase or sale of

a security; (4) reliance, often referred to in fraud on the market cases as “transaction causation”;

(5) economic loss; and (6) loss causation, i.e., a causal connection between the material

misrepresentation and the loss. Dura Pharmaceuticals, Inc. v. Broudo, --- U.S. ----, 125 S.Ct.

1627, 1631 (2005).

A dispute has arisen between the parties as to whether Plaintiffs may use the “group

published pleading doctrine.” Prior to the passage of the Private Securities Litigation Reform

Act of 1995 (“PSLRA”), Pub.L. No. 104-67 (1995), the Ninth Circuit held in a number of cases

that when false or misleading information is conveyed in prospectuses, registration statements,

annual reports, press releases, or other group published statements, it is reasonable to presume

that the statements are the result of the collective actions of the company’s officers. See, e.g.,

Blake v. Dierdorff, 856 F.2d 1365, 1369 (9th Cir. 1988); Wool v. Tandem Computers, Inc., 818

F.2d 1433, 1440 (9th Cir. 1987). It is an open question in this circuit whether the group

published pleading doctrine survives the PSLRA. Some district courts within the circuit have

concluded that the group published doctrine is alive and well. See, e.g., In re Secure Computing

Corp. Sec. Litig., 120 F.Supp.2d 810, 821-22 (N.D. Cal. 2000) (collecting cases); Silicon

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Case No. C 01-21029 JF (RS)

ORDER DENYING MOTIONS TO DISMISS SAC AS TO LENT, HASHMAN, RIGIONE AND CAI ETC.

(JFLC2)

Graphics Sec. Litig., 970 F.Supp. 746, 759 (N.D. Cal. 1997). Other district courts have

concluded the opposite. See, e.g., In re Immune Response Sec. Litig., 375 F.Supp.2d 983, 1031

(S.D. Cal. 2005); In re Syncor Intern. Corp. Sec. Litig., 327 F.Supp.2d 1149, 1171-72 (C.D. Cal.

2004). 

The Fifth Circuit, the only circuit squarely to address the issue, has concluded that the

group published pleading doctrine does not survive the PSLRA because the doctrine is

inconsistent with PSLRA requirements that statements or omissions be set forth with

particularity as to each defendant and that scienter be pleaded in a manner sufficient to give rise

to a strong inference that each defendant acted with the required state of mind. Southland Sec.

Corp. v. INSpire Ins. Solutions, Inc., 365 F.3d 353, 364-65 (5th Cir. 2004).

This Court adopts the reasoning of the decisions concluding that the group published

pleading doctrine no longer is viable after the PSLRA. As noted by the Fifth Circuit, it appears

to be totally inconsistent with the particularity requirements of the PSLRA to hold corporate

officers “responsible for unattributed corporate statements solely on the basis of their titles, even

if their general level of day-to-day involvement in the corporation’s affairs is pleaded.” 

Southland, 365 F.3d at 365. 

The Court’s conclusion makes little difference in the present case, because Plaintiffs do

not rely solely on the group published pleading doctrine, but also allege explicitly that

Defendants Lent, Hashman, Rigione and Cai participated in the preparation of the company’s

press releases and SEC filings. Section 10(b) liability extends to those who substantially

contribute to the drafting of the allegedly misleading statements. See In re Homestore.com, Inc.

Sec. Litig., 252 F.Supp.2d 1018, 1041 (2003) (holding that § 10(b) extends only to those

“connected in some material way to the drafting of the statements made to the investing public”). 

Plaintiffs allege that Lent, Hashman, Rigione and Cai “participated in the preparation and review

of the Company’s press releases and SEC filings. Thus, the false and misleading statements

included in press releases and SEC filings were made by and are attributable to all of the

defendants because the press releases and SEC filings were the collective actions of these

defendants.” SAC ¶ 16. 

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Case No. C 01-21029 JF (RS)

ORDER DENYING MOTIONS TO DISMISS SAC AS TO LENT, HASHMAN, RIGIONE AND CAI ETC.

(JFLC2)

2. Pleading Standards For § 10(b) Claim 

Claims asserted under the Exchange Act as amended by the PSLRA must meet

heightened pleading requirements. For example, a claim based upon a material

misrepresentation or omission must “specify each statement alleged to have been misleading” as

well as “the reason or reasons why the statement is misleading.” 15 U.S.C. § 78u-4(b)(1)(B). If

an allegation regarding the statement or omission is made on information and belief, the

complaint “shall state with particularity all facts on which that belief is formed.” Id. In addition,

a claim based upon a material misrepresentation or omission must “state with particularity facts

giving rise to a strong inference that the defendant acted with the required state of mind.” 15

U.S.C. § 78u-4(b)(2). When a claim is based upon a forward-looking statement, the required

state of mind generally is “actual knowledge” that the statement is false or misleading. 15 U.S.C.

§ 78u-5(c)(1)(B). Otherwise, the required state of mind is, at a minimum, “deliberate

recklessness.” In re Silicon Graphics Inc. Sec. Litig., 183 F.3d 970, 977 (1999).

In order meet the pleading standard for scienter, the plaintiff “must provide, in great

detail, all the relevant facts forming the basis of her belief.” Silicon Graphics, 183 F.3d at 985. 

“‘[T]he complaint must contain allegations of specific contemporaneous statements or conditions

that demonstrate the intentional or deliberately reckless false or misleading nature of the

statements when made.’” In re Read-Rite Corp. Sec. Litig., 335 F.3d 843, 846 (9th Cir. 2003)

(quoting Ronconi v. Larkin, 253 F.3d 423, 432 (9th Cir. 2001)). It is insufficient that the

allegations raise a “reasonable inference” that the defendants acted with the requisite state of

mind; the allegations must be sufficiently particularized to raise a “strong inference.” Id. at 848-

49.

Unusual or suspicious stock sales may constitute circumstantial evidence of scienter. 

Silicon Graphics, 183 F.3d at 986. However, “insider trading is suspicious only when it is

‘dramatically out of line with prior trading practices at times calculated to maximize the personal

benefit from undisclosed inside information.’” Id. (quoting In re Apple Computer Sec. Litig.,

886 F.2d 1109, 1117 (9th Cir.1989)). A plaintiff relying upon stock sales therefore must allege

specific facts regarding the circumstances of the alleged stock sales, such as the amount of shares

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Case No. C 01-21029 JF (RS)

ORDER DENYING MOTIONS TO DISMISS SAC AS TO LENT, HASHMAN, RIGIONE AND CAI ETC.

(JFLC2)

sold, the percentage of shares sold in comparison to the volume of shares that could have been

sold, the timing of the sales and whether the sales were consistent with prior trading history. Id. 

When determining the percentage of shares sold, stock options must be considered; there is no

reason to distinguish vested stock options from shares because the former easily can be converted

to shares and sold immediately. Id.

3. Statements Of Lent, Hashman, Rigione and Cai

In its order dismissing the FAC with leave to amend, the Court identified a number of

material misstatements alleged to have been made by Defendants, but concluded that Plaintiffs

had not sufficiently alleged that the statements were false or misleading, or that Defendants had

acted with the requisite scienter. The Court concludes that Plaintiffs have cured these defects in

their SAC. Plaintiffs adequately allege a number of statements and why those statements were

false or misleading when made. SAC ¶¶ 142-166. They describe in detail the alleged financial

difficulties of the company and Defendants’ attempts to conceal these difficulties through

inappropriate accounting practices. Finally, Plaintiffs identify the specific accounting practices,

explain why those practices violated GAAP and why the company’s resulting financials were

misleading. Id. at ¶¶ 132-139.

Plaintiffs also allege in detail facts demonstrating that the individual defendants knew

about, and participated in, the allegedly inappropriate accounting practices. SAC ¶¶ 11-14. 

Defendants argue that even if Defendants knew about the accounting practices that ultimately

were deemed inappropriate – for example, that the company was reclassifying credit losses as

fraud losses – the SAC does not allege facts demonstrating that Defendants knew the accounting

practices were inappropriate at the time. Defendants claim that the OCC’s later determinations

that the company had acted inappropriately surprised Defendants and the industry. While

Defendants certainly may re-assert this argument in future motion practice, the Court concludes

that for purposes of the instant motions to dismiss Plaintiffs have alleged facts sufficient to raise

a strong inference that Defendants knew that the accounting practices were inappropriate. For

example, Plaintiffs point to Defendant Hashman’s handwritten notation regarding “2/3 more

quarters of accounting gimmickery,” along with numerous internal emails, reports and

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Case No. C 01-21029 JF (RS)

ORDER DENYING MOTIONS TO DISMISS SAC AS TO LENT, HASHMAN, RIGIONE AND CAI ETC.

(JFLC2)

memoranda focused on ways to reclassify loans to make the company’s financial picture look

better. Id. at ¶ 11(h)-(m). Plaintiffs also allege that Defendants changed the company’s

accounting practices during the class period, for example, the ways in which the company

calculated loan loss reserves, in order to make the company’s financial picture look better. Id. at

¶ 11(o). Plaintiffs describe how the individual defendants met daily to devise ways to reduce

loan losses. Id. at ¶ 12(e). Defendant Cai was warned by a senior officer of the company that the

new treatment of fraud losses and credit losses was inappropriate. Id. at ¶ 12(f). Defendant Lent

received weekly status reports regarding the need to reclassify more credit losses into fraud

losses. Id. at ¶ 13(e). Defendant Rigione received memoranda informing him that the company

was adjusting its charge-off rates after excluding delinquent loans that had been categorized as

loans for sale, and Rigione knew that this methodology was improper. Id. at ¶ 14(f)-(g). 

The Court concludes that the factual allegations in the SAC, taken as a whole, are

sufficient to give rise to a strong inference of Defendants’ scienter. The Court is not persuaded

by Defendants’ argument that the certification of the company’s financials by its outside auditor,

Ernst & Young, LLP (“E&Y”), negates or weakens the inference of scienter. Plaintiffs originally 

named E&Y as a defendant in this action based upon allegations that E&Y was a knowing

participant in a scheme to defraud the market and in colluded in accounting improprieties. E&Y

has settled with Plaintiffs. Under these circumstances, the fact that E&Y certified the financials

does not raise an inference that the financials were appropriate or that Defendants were entitled

to rely upon E&Y’s certification.

The Court notes that three of the four Defendants named in the § 10(b) claim sold stock

during the class period. While the stock sales resulted in large monetary profits (approximately

$7.5 million for Lent), the percentage of stock sold was not excessive (less than 15% for Lent)

and it is not clear that the sales were out of line with prior activity. Plaintiffs do allege, however,

that the sales occurred after Lent instructed company employees not to sell stock for fear of

depressing the stock price. SAC ¶ 142. It is somewhat suspicious that three out of the four

individual defendants sold anyway.

In summary, the Court concludes that Plaintiffs have cured the defects noted in the

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Case No. C 01-21029 JF (RS)

ORDER DENYING MOTIONS TO DISMISS SAC AS TO LENT, HASHMAN, RIGIONE AND CAI ETC.

(JFLC2)

Court’s prior order, and have alleged facts sufficient to state a § 10(b) claim against Defendants

Lent, Hashman, Rigione and Cai. 

B. Section 20(a) Claim

Section 20(a) of the Exchange Act imposes joint and several liability on any “person who,

directly or indirectly, controls any person liable” for securities fraud, “unless the controlling

person acted in good faith and did not directly or indirectly induce” the violations. 15 U.S.C. §

78t(a). Plaintiffs allege a § 20(a) claim against Lent, Hashman, Rigione and Cai, and also against

Qureshey.

The Court concludes that Plaintiffs have alleged a sufficient factual basis to impose

control person liability against Lent, Hashman, Rigione and Cai. Plaintiffs allege with

particularity what positions each of these individuals held, and how and to what extent these

individuals participated in the day to day workings of the company. SAC ¶¶ 11-14.

However, the Court concludes that Plaintiffs have not alleged a sufficient factual basis to

impose control person liability against Qureshey. Unlike the other individual defendants,

Qureshey was an outside director of the company and a member of the Audit Committee and

Compensation Committee. SAC ¶ 15(a). The Court is unaware of any authority for the

proposition that an outside director may be held liable under § 20(a). Moreover, while Plaintiffs

do allege that Qureshey met with the company’s CFO to review accounting policies, financial

statements and the like, Plaintiffs do not allege that Qureshey was involved in the day to day

management of the company. See SAC ¶¶ 15(b)-(g). Accordingly, the § 20(a) claim against

Qureshey is subject to dismissal.

Leave to amend is to be granted with extreme liberality in securities fraud cases, because

the heightened pleading requirements imposed by the PSLRA are so difficult to meet. Eminence

Capital, LLC v. Aspeon, Inc., 316 F.3d 1048, 1052 (9th Cir. 2003). The United States Supreme

Court has articulated the applicable standard as follows:

In the absence of any apparent or declared reason – such as undue delay, bad faith

or dilatory motive on the part of the movant, repeated failure to cure deficiencies

by amendments previously allowed, undue prejudice to the opposing party by

virtue of allowance of the amendment, futility of amendment, etc. – the leave

sought should, as the rules require, be “freely given.”

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Case No. C 01-21029 JF (RS)

ORDER DENYING MOTIONS TO DISMISS SAC AS TO LENT, HASHMAN, RIGIONE AND CAI ETC.

(JFLC2)

Foman v. Davis, 371 U.S. 178, 182 (1962). Here, given the nature of Qureshey’s position with

the company, and the absence of authority for holding an individual in his position liable under §

20(a), together with the fact that Plaintiffs have failed to assert a viable claim against Qureshey

on two separate occasions, the Court concludes that granting leave to amend the § 20(a)

allegations against Qureshey would be futile. Accordingly, the Court concludes that leave to

amend is not appropriate notwithstanding the liberal standards set forth above. 

III. ORDER

(1) The motions to dismiss of Defendants Lent, Hashman, Rigione and Cai are

DENIED; and

(2) The motion to dismiss of Defendant Qureshey is GRANTED WITHOUT LEAVE

TO AMEND.

DATED: 3/20/06

__________________________________

JEREMY FOGEL

United States District Judge

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Case No. C 01-21029 JF (RS)

ORDER DENYING MOTIONS TO DISMISS SAC AS TO LENT, HASHMAN, RIGIONE AND CAI ETC.

(JFLC2)

This Order has been served upon the following persons:

Eric J. Belfi ebelfi@murrayfrank.com

Gustavo Bruckner bruckner@whafh.com

Joy Ann Bull JOYB@lerachlaw.com

Paul J. Collins pcollins@gibsondunn.com

Jonathan C. Dickey jdickey@gibsondunn.com

Tamara J. Driscoll ,

Alicia M. Duff aliciad@blbglaw.com, kayem@blbglaw.com

Bruce A. Ericson bruce.ericson@pillsburylaw.com

Jordan David Eth jeth@mofo.com

Mary Jane Edelstein Fait fait@whafh.com,

William Faulkner wfaulkner@mfmlaw.com, eschneider@mfmlaw.com

Lionel Z. Glancy info@glancylaw.com

Michael M. Goldberg info@glancylaw.com

Marc S. Henzel mhenzel182@aol.com

Bruce J. Highman attorneys@highman-ball.com

David M. Jolley djolley@cov.com,

Richard Allen Jones rjones@cov.com

J. Andrew Keyes akeyes@wc.com,

Charles Thomas Kimmett ckimmett@wc.com,

Jeffrey W. Lawrence jeffreyl@lerachlaw.com, e_file_sd@lerachlaw.com;

e_file_sf@lerachlaw.com

Kristin M. Lefevre kristin.lefevre@pillsburylaw.com

William S. Lerach e_file_sd@lerachlaw.com, e_file_sf@lerachlaw.com

James McManis jmcmanis@mfmlaw.com, clarsen@mfmlaw.com; smaes@mfmlaw.com

Ira M. Press ipress@kmslaw.com, lmorris@kmslaw.com

Paul A. Reynolds paul.reynolds@dlapiper.com,

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Case No. C 01-21029 JF (RS)

ORDER DENYING MOTIONS TO DISMISS SAC AS TO LENT, HASHMAN, RIGIONE AND CAI ETC.

(JFLC2)

Laurence M. Rosen lrosen@rosenlegal.com, larry.rosen@earthlink.net

Alan Schulman alans@blbglaw.com, robert@blbglaw.com; kristinas@blbglaw.com;

takeok@blbglaw.com; marenam@blbglaw.com; kayem@blbglaw.com

Christopher Paul Seefer chriss@lerachlaw.com, e_file_sd@lerachlaw.com;

e_file_sf@lerachlaw.com; KiyokoF@lerachlaw.com

Jacob R. Sorensen jake.sorensen@pillsburylaw.com

Shirli Fabbri Weiss shirli.weiss@dlapiper.com

Margaret L. Wu mwu@mofo.com, pwolfe@mofo.com

John S. Yun yunj@sec.gov, johnstonj@sec.gov

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