Source: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-cand-3_04-cv-02013/USCOURTS-cand-3_04-cv-02013-0/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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UNITED STATES DISTRICT COURT

NORTHERN DISTRICT OF CALIFORNIA

In re LEXAR MEDIA, INC. SECURITIES

LITIGATION

 

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No. C-04-2013 SC

ORDER RE: DEFENDANTS'

MOTION TO DISMISS THE

CONSOLIDATED AMENDED

CLASS ACTION

COMPLAINT 

I. INTRODUCTION

On October 29, 2004, Lead Plaintiffs ("Plaintiffs") for the

above-captioned class action filed a Consolidated Amended Class

Action Complaint ("Amended Complaint"). Defendants Lexar Media,

Inc., Eric B. Stang, and Brian T. McGee ("Defendants") have now

moved for dismissal. For the reasons articulated below, this

Court GRANTS Defendants' Motion with respect to all claims and

also GRANTS Plaintiffs 30 days from the date of this Order to

amend their complaint.

II. BACKGROUND

Lexar Media, Inc. ("Lexar") is a designer, marketer, and

licensor of removable flash-based digital storage media and

related products. Amended Complaint at 1. Defendant Eric B.

Stang is Lexar's Chairman, President, and Chief Executive Officer. 

Id. at 3. Defendant Brian T. McGee is Lexar's Chief Financial
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Officer. Id. On April 15, 2004, after a period of rapid growth,

Lexar surprised the investing community by announcing that steep

price declines for its main products would negatively impact its

net income. Id. at 2. Lexar's stock fell by approximately one

third following the announcement. Id.

Plaintiffs filed their Amended Complaint on October 29, 2004. 

The Amended Complaint puts forth two causes of action. The first

is brought against all Defendants pursuant to Section 10(b) of the

Securities Exchange Act of 1934. The second is brought against

the Individual Defendants pursuant to Section 20(a) of the Act. 

The class period runs from October 16, 2003 to April 16, 2004.

The allegations underlying both claims are generally the

same. Plaintiffs allege that during the class period Lexar and

the Individual Defendants falsely encouraged the investing public

to believe that Lexar was insulated from the impact of declining

prices. Specifically, Plaintiffs allege, "Rather than disclose

these facts to the public, Defendants, during the Class Period,

continued to conceal the truth and instead publicly stated price

declines for its products would not occur and the second quarter

of 2004 would be strong." Id. at 6. Plaintiffs allege that the

Individual Defendants carried out this scheme so as to sell their

own shares in Lexar at artificially inflated prices. Id. at 2.

The Complaint focuses on a variety of statements made by

Defendants during the class period. For example, in an October

16, 2003 earnings conference call, Defendant Stang, speaking about

the market for flash drives, stated, "We see nothing that

indicates that it is slowing." Amended Complaint at 8. In a
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January 29, 2004 conference call, Stang referred to "accelerated

market growth in 2004." Id. at 9. In the same call, Stang also

said that Lexar was "seeing relatively stable industry pricing"

and that the company was "forecasting no major price declines." 

Id. Similarly, Lexar's March 15, 2004 Form 10-K, an annual report

filed with the U.S. Securities and Exchange Commission, stated,

"In the second half of 2003, prices of flash memory increased as

industry wide demand for flash memory outpaced the supply of flash

memory, which resulted in a general industry wide shortage. We

expect this trend to continue during the first half of 2004." Id.

at 10. Plaintiffs allege that such statements were "materially

false and misleading when made because they failed to disclose (1)

that inventory was collecting at Lexar's warehouses; (2) that

Lexar's product sales had slowed precipitously and (3) that this

and competition from other companies would cause Lexar to have to

slash prices which would result in lower revenues and margins." 

Id. Lead Plaintiffs seek to buttress these allegations with

statements made by a confidential witness who worked at Lexar as

an inventory controller. Opposition at 4.

In sum, Plaintiffs allege that Lexar's executives made lessthan-truthful statements with the purpose of selling stock at

artificially inflated prices.

III. LEGAL STANDARD

Under Rule 12(b)(6) of the Federal Rules of Civil Procedure,

a party may move for dismissal "for failure to state a claim upon

which relief can be granted." When presented with a motion to

dismiss, "[a]ll allegations of material fact are taken as true and
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construed in the light most favorable to the nonmoving party." 

Jacobellis v. State Farm Fire & Cas. Co., 120 F.3d 171, 172 (9th

Cir. 1997). "[A] complaint should not be dismissed for failure to

state a claim unless it appears beyond doubt that the plaintiff

can prove no set of facts in support of his claim which would

entitle him to relief." Conley v. Gibson, 355 U.S. 41, 45-46

(1957); see also Gompper v. VISX, Inc., 298 F.3d 893, 896 (9th

Cir. 2002).

Plaintiffs' claims are brought pursuant to Sections 10(b) and

20(a) of the Exchange Act. The Private Securities Litigation

Reform Act of 1995 ("PSLRA") controls the pleading standards for

these claims. In re Silicon Graphics, 183 F.3d 970, 973 (9th Cir.

1999). Under the PSLRA, a plaintiff "must plead, in great detail,

facts that constitute strong circumstantial evidence of

deliberately reckless or conscious misconduct." Id. at 974. More

specifically, a plaintiff "is required to state with particularity

all facts giving rise to a 'strong inference' of the required

state of mind." Id. at 983.

The Court notes that "an inevitable tension arises between

the customary latitude granted the plaintiff on a motion to

dismiss under Fed. R. Civ. P. 12(b)(6), and the heightened

pleading standard set forth under the PSLRA." Gompper, 298 F.3d

at 896. The Ninth Circuit, resolving this tension with a tilt

toward the heightened pleading standard of the PSLRA, has stated

that "to consider only inferences favorable to [plaintiffs']

position would be to eviscerate the PSLRA's strong inference

requirement." Id. at 896. Rather than considering only
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inferences in favor of plaintiffs, "the court must consider all

reasonable inferences to be drawn from the allegations, including

inferences unfavorable to the plaintiffs." (emphasis in original) 

Id. at 897. In other words, "[t]he heightened pleading

requirements of the Private Securities Litigation Reform Act are

an unusual deviation from the usually lenient requirements of

federal rules pleading." Ronconi v. Larkin, 253 F.3d 423, 437

(9th Cir. 2001). As stated in Ronconi, "[f]or a securities fraud

case based on false statements to survive a motion [to dismiss],

the pleading has to state particularized facts that, taken as a

whole, raise a strong inference that defendants intentionally or

with deliberate recklessness made false or misleading statements

to investors." Id.

IV. DISCUSSION

"To avoid dismissal under the PSLRA, the Complaint must

specify each statement alleged to have been misleading [and] the

reason or reasons why the statement is misleading ..." Nursing

Home Pension Fund v. Oracle Corp., 380 F.3d 1226, 1230 (9th Cir.

2004) (internal citations and quotations omitted). "In addition,

the PSLRA requires that the Complaint state with particularity

facts giving rise to a strong inference that the defendant acted

with the required state of mind, or scienter." Id. (internal

citations and quotations omitted). A complaint must be dismissed

if either of these two prongs are not met. Id. As discussed in

detail below, the Court finds that Plaintiffs have met neither of

these two prongs.

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A. Alleged misleading statements

Plaintiffs' Complaint details a series of statements made by

Lexar executives during the class period. Subsequent events

showed the statements to have been, at a minimum, overly

optimistic. For example, on January 29, 2004, during an analyst

conference call Defendant Stang described "accelerated market

growth in 2004" and stated, "We ourselves are forecasting no major

price declines." Amended Complaint at 9. Plaintiffs allege that

these statements "were materially false and misleading when made

because they failed to disclose (1) that inventory was collecting

at Lexar's warehouses; (2) that Lexar's product sales had slowed

precipitously and (3) that this and competition from other

companies would cause Lexar to have to slash prices." Id. at 10. 

Plaintiffs also point to Lexar's Form 10-K filed with the SEC on

March 15, 2004. In the report, Defendants indicated that Lexar

expected flash memory prices to increase in the first half of

2004. Id. Plaintiffs allege this was materially false and

misleading, pointing to the fact that Lexar slashed its prices

only 30 days later. Id. at 11.

The only support which Plaintiffs provide for their

allegations of misleading statements is the information provided

by "Confidential Witness #1" ("CW-1") and the fact that Lexar

announced price cuts for its products on April 15, 2004. 

Opposition at 7-9. For example, Plaintiffs allege, "According to

CW-1, who worked at Lexar as an inventory controller, by late 2003

retailers were no longer buying Lexar products, which caused

inventory to build up." Opposition at 7. Plaintiffs also allege,
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"In fact, according to CW-1, by April 2004, the Company had so

much unsold inventory it actually ran out of space to store it." 

Id.

The Court finds this proffered support for the allegations of

misleading statements to be insufficient. A rise in inventories

does not necessarily signify slowing sales. Without additional

facts, it is no less likely that a rise in inventories signifies

growing sales, or an anticipation of growing sales. Plaintiffs

invite this Court to view the rise in inventories in a negative

light; however, Plaintiffs offer no additional allegations to

support such an inference. This Court takes no issue with the use

of a confidential source. A complaint in a securities class

action may rely on a confidential source as long as the source is

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." In re Daou Systems, Inc., Nos.

02-56989, 02-57018, 2005 WL 1431833, at *4 (9th Cir. June 21,

2005). Furthermore, "[w]here plaintiffs rely on both confidential

witnesses and on other facts, they need not name their sources as

long as the latter facts provide an adequate basis for believing

that the defendants' statements were false." Id. (internal

citations and quotations omitted). In the case at hand, the Court

agrees that CW-1, as an inventory controller, would possess

information relating to rising inventory levels. Rather, the

problem with Plaintiffs' allegations is that CW-1 does not provide

an adequate basis for believing that the statements were false
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because the mere fact that inventories increased does not signify

by itself that sales were decreasing at the time of the rise. 

Given the heightened pleading requirements of the PSLRA, something

more than ambiguous comments about inventories is necessary. For

example, in Nursing Home Pension Fund, the complaint contained

"specific statements from former employees and managers ...

testifying to a major slowdown in sales." 380 F.3d at 1231. In

that case, one former vice president of finance stated that the

defendants would have known about the slowdown at least six weeks

before they publicly announced it. Id. In the case at hand, the

Court finds that Plaintiffs' pleadings do not contain any such

specific statements. Similarly, there is nothing unusual in the

business world about optimistic forecasts being followed by sudden

price declines and a steep stock decline. Under the logic put

forth by Plaintiffs, every time the stock market digested a new

forecast that resulted in a steep fall in a company's stock price,

the executives of that company would be liable for securities

fraud. That simply is not how our securities markets function. 

Almost every day, some company somewhere announces a change in its

business forecast that results in a steep fall in the share price. 

Not every such event gives rise to legal liability. Plaintiffs

have failed to put forth any facts which would suggest that such

liability exists here. 

B. Alleged scienter

Notwithstanding the above, even if this Court were to accept

Plaintiff's allegations of material misleading statements,

Plaintiffs have not plead the element of scienter with sufficient
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particularity to defeat the Motion at hand.

As a preliminary matter, the Court notes the connection

between a § 10(b) claim and a § 20(a) claim. "Scienter is an

essential element of a § 10(b) or Rule 10b-5 claim. And to

prevail on their claims for violations of § 20(a) ..., plaintiffs

must first allege a violation of § 10(b) or Rule 10b-5. Absent

pleading scienter with particularity, there can be no liability"

on either the § 10(b) claim or the § 20(a) claim. Lipton v.

Pathogenesis Corp., 284 F.3d 1027, 1035 (9th Cir. 2002) (internal

citations and quotations omitted). In other words, dismissal of

the § 10(b) claim necessitates dismissal of the § 20(a) claim as

well. Therefore, the Court will focus its analysis on the § 10(b)

claim.

Turning to the legal definition of the element of scienter

applicable here, the PSLRA's "required state of mind," in 15

U.S.C. § 78u-4(b)(2), "refers to the scienter requirement

applicable to [a section 10b claim]." In re Silicon Graphics, 183

F.3d at 975. The PSLRA states, "In any private action arising

under this title in which the plaintiff may recover money damages

only on proof that the defendant acted with a particular state of

mind, the complaint shall ... 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). The Ninth

Circuit has held that "the PSLRA language that the particular

facts must give rise to a strong inference of the required state

of mind [means] that the evidence must create a strong inference

of, at a minimum, 'deliberate recklessness.'" In re Silicon
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Graphics, 183 F.3d at 977 (internal quotations omitted). A

plaintiff bringing a claim controlled by the PSLRA, as Plaintiffs

do here, "can no longer aver intent in general terms of mere

'motive and opportunity' or 'recklessness,' but rather, must state

specific facts indicating no less than a degree of recklessness

that strongly suggests actual intent." Id. at 979.

In sum, a plaintiff must plead "particular facts giving rise

to a strong inference of deliberate or conscious recklessness." 

Id. However, there need not be any one fact that by itself shows

such recklessness. Rather, "[i]n assessing whether Plaintiffs

have sufficiently pled scienter, [a court] must consider whether

the total of plaintiffs allegations, even though individually

lacking, are sufficient to create a strong inference that

defendants acted with deliberate or conscious recklessness." 

Nursing Home Pension Fund, 380 F.3d at 1230 (internal citations

and quotation omitted).

Plaintiffs have put forth two bases in an effort to meet this

standard. First, Plaintiffs allege that the Defendants had

knowledge of the fraud. Opposition at 10. Second, Plaintiffs

allege that public records detailing insider selling of Lexar

stock shows scienter. Id. at 12. For the following reasons, the

Court disagrees with both arguments.

1. Knowledge of the Fraud

To support their assertion that Defendants had knowledge of

the fraud, Plaintiffs make three allegations: 1) that Lexar

slashed prices a mere 30 days after announcing it would not, 2)

that Defendants made false and misleading statements about
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problems of which they would surely have been aware, and 3) that

flash memory is Lexar's only business and therefore senior

executives must have known about the fraud. Id. at 10-12.

The first allegation, slashing prices a month after a

statement that prices were stable, is not by itself evidence of

fraud, especially in the technology industry. Ronconi, 253 F.3d

at 434 ("Problems and difficulties are the daily work of business

people. That they exist does not make a lie out of any of the

alleged false statements."). The heightened pleading requirements

of the PSLRA require some sort of factual allegation that the

price slashing was not a sudden development. Plaintiffs have not

put forth any such allegations except for the alleged inventory

buildup. As discussed in detail in the following paragraph, the

ambiguous nature of the inventory buildup renders it an

insufficient basis for denial of the Motion.

Regarding the second allegation, Plaintiffs claim that "a

virtual halt in sales for at least six months and a dramatic

overstock of inventory to a point that the Company ran out of

space to store it were serious enough problems that the Court can

infer that Defendants knew about them, or were reckless in not

knowing." Opposition at 11. At a minimum, these statements are

speculative exaggeration. They are certainly not statements which

could even remotely qualify as a basis for meeting the heightened

pleading standards of the PSLRA. It is not clear to the Court why

Plaintiffs even allege a "virtual halt in sales" since during the

class period, Lexar's sales hit record levels. Reply at 4. 

Nowhere in their papers do Plaintiffs dispute the financial
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statements of Lexar which show record sales. Nor do they make any

allegations that this revenue was improperly recorded. As for the

allegation that there was a "dramatic overstock of inventory,"

Plaintiffs at least make a minimal effort to provide some factual

support--Plaintiffs have put forth statements made by CW-1, the

confidential witness. Opposition at 3. For example, Plaintiffs

allege, "According to CW-1, who worked at Lexar as an inventory

controller, by late 2003 retailers were no longer buying Lexar

products, which caused inventory to build up." Opposition at 7. 

Plaintiffs also allege, "In fact, according to CW-1, by April

2004, the Company had so much unsold inventory it actually ran out

of space to store it." Id. It is true that the "most direct way

to show ... that the party making the statement knew that it was

false is via contemporaneous reports or data, available to the

party, which contradict the statement." Nursing Home Pension

Fund, 380 F.3d at 1230. However, it is not clear here that the

statements of CW-1 contradict the statements by Lexar executives. 

The Lexar executives stated that the flash memory market was

growing due to strong demand. Increased inventory levels would be

exactly what one would expect if executives forecast strong

demand. Were this a traditional motion to dismiss not controlled

by the PSLRA, the Court would have to assume as true the

Plaintiffs' negative view of the inventory buildup. However, the

PSLRA does control, and under the relevant case law, this Court

"must consider all reasonable inferences to be drawn from the

allegations, including inferences unfavorable to the plaintiffs." 

Gompper, 298 F.3d at 897. Given that Plaintiffs have provided no
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support for their claims of an uncontrolled inventory buildup

beyond the ambiguous statements of CW-1, who is not described as

anything more than an "inventory controller," the Court declines

to infer scienter on this basis.

The third allegation made by Plaintiffs to support the claim

that Lexar executives had knowledge of the fraud is that flash

memory is Lexar's only business and therefore senior executives

must have known about the fraud. Plaintiffs rely on In re

Peoplesoft, which states that "facts critical to a business's core

operations or an important transaction generally are so apparent

that their knowledge may be attributed to the company and its key

officers." No. C 99-00472 WHA, 2000 U.S.Dist. LEXIS 10953, at

*11, (N.D. Cal. May 26, 2000) (internal quotations and citation

omitted) citing to Epstein v. Itron, Inc., 993 F. Supp. 1314,

1325-26 (E.D. Wash. 1998). However, Plaintiffs' allegation of

scienter on this basis assumes as true that there was a fraud. 

Since the Court has rejected, as described above, Plaintiffs'

allegations of misleading statements, it would not make sense to

infer knowledge of those same misleading statements on the part of

Lexar's executives. In other words, because this Court finds

Plaintiffs' allegations of fraud to be lacking, there can be no

inference of scienter merely because flash memory was Lexar's core

business.

Overall, the Court finds that Plaintiffs have not adequately

plead scienter based on the theory that Lexar executives had

knowledge of the fraud.

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1

 Plaintiffs also point to stock sales totaling $6.8 million

by Chief Technology Officer Petro Estakhri. Opposition at 12. 

However, stock sales by non-defendants cannot be a basis for

establishing scienter unless the non-defendant intended to assist

defendants. In re Splash Tech. Holdings, 160 F. Supp. 2d 1059,

1082 (N.D. Cal. 2001) citing to In re PetSmart, 61 F. Supp. 2d 982,

1001 (D. Ariz. 1999). Furthermore, Estakhri, similar to Defendant

Stang, sold more stock in the three months prior to the class

period than in the six month class period itself. Motion at 22.

2 Defendants' statement is based on a "prior period" of three

months, compared with a "class period" of six months. Reply at 14. 

This provides even more support for Defendants' position.

14

2. The Insider Sales

As an alternative means of showing scienter, Plaintiffs state

that the Amended Complaint "also raises a strong inference of

deliberate action or conscious recklessness by pleading insider

sales in material amounts and at suspicious times." Opposition at

12. Under Ninth Circuit law, "[s]tock trades are only suspicious

when dramatically out of line with prior trading practices at

times calculated to maximize the personal benefit from undisclosed

inside information." Nursing Home Pension Fund, 380 F.3d at 1232

(internal citations and quotation omitted). "To evaluate

suspiciousness of stock sales, [a court considers] three factors:

(1) the amount and percentage of shares sold; (2) timing of the

sales; and (3) consistency with prior trading history." Id. 

In the instant case, Plaintiffs point to sales of Lexar stock

totaling $8.7 million by Defendant Eric Stang.1 Opposition at 12. 

Defendants counter that Stang "sold more stock prior to the class

period ... than he did during the longer class period."2

 Motion

at 21-22. The other Individual Defendant, McGee, did not sell any

stock at all during the class period. Motion at 22. Plaintiffs
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do not dispute these facts.

The fact that one individual defendant did not sell stock

during the class period and the other individual defendant sold

less stock than he had in the immediately prior period

significantly undercuts Plaintiffs' assertion that the insider

sales raise an inference of "deliberate action or conscious

recklessness." Looking at each of the three factors identified

above, the fact that Defendant Stang sold more shares in the

three-month period immediately prior to the six-month class period

itself suggests that the amount and percentage of shares sold was

not indicative of any fraud. Similarly, the same fact suggests

that the timing of sales during the class period was not unusual. 

Finally, it is clear that Defendant Stang's sales were consistent

with prior trading. When looking at a similar factual situation,

the Ninth Circuit has stated, "Context is important, especially

for assessing the weight to attach to the timing of sales." 

Fischer v. Vantive Corp., 283 F.3d 1079, 1092 (9th Cir. 2002). 

Given the overall context here of insiders selling shares in a

manner similar to periods outside the class period, the Court

finds that these stock sales are not suspicious because they are

not out of line with earlier transactions. Therefore, the insider

sales do not support a showing of scienter.

Furthermore, even if the Court were to assume, for argument's

sake, that the stock sales were unusual in their timing or amount,

suspicious insider stock sales by themselves do not create

liability under the statutes at issue. Rather, "stock sales are

helpful only in demonstrating that certain statements were
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misleading and made with knowledge or deliberate recklessness when

those sales are able to be related to the challenged statements." 

Fischer, 283 F.3d at 1093. As discussed above, Plaintiffs'

underlying allegations of misleading statements are lacking, and

"insufficient allegations of fraud elsewhere in the complaint have

a spillover effect" on an analysis of insider sales. Id.

Therefore, not only does the Court find that the insider sales are

not suspicious, but even if they were suspicious, the Court notes

that the underlying allegations are lacking.

In conclusion, the Court finds that the Amended Complaint

fails to state a sufficient basis for scienter on the part of the

Defendants.

V. CONCLUSION

Neither party disputes that Lexar and its executives made

optimistic statements about the company's performance that were

soon followed by a business slowdown and a dramatic decrease in

the stock price. However, there is nothing unusual or necessarily

unlawful about such a fact pattern. Businessmen are by nature

optimistic, and sudden stock price movements are often a sign that

the market is digesting new information about a company. 

Financial markets could hardly function if every significant

decline in a company's stock created liability on the part of

formerly optimistic executives. Rather, this fact pattern is only

unlawful if the optimistic statements are part of a fraudulent

plan. Plaintiffs here have put forth virtually no evidence to

suggest that there was such a fraudulent plan carried out by

Lexar's executives. Plaintiffs merely point to an anonymous
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source who sheds little light on Plaintiffs' allegations and some

far from unusual stock trades by senior management. Such

allegations come nowhere close to meeting the heightened pleading

requirements of the PSLRA. Therefore, the Court hereby GRANTS

Defendants' Motion to Dismiss in its entirety and hereby DISMISSES

all claims against all Defendants. The Court also GRANTS

Plaintiffs 30 days from the date of this Order to file a new

amended complaint, should they choose to do so. 

IT IS SO ORDERED.

Dated: July 5 , 2005

 /s/ Samuel Conti 

UNITED STATES DISTRICT JUDGE