978-1285770178 Case Printout Case CPC-07-04 Part 2

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170A Federal Civil Procedure

170AVII Pleadings and Motions

170AVII(E) Amendments

Lori G. Feldman and Karen T. Rogers, Milberg Weiss LLP, New York, NY, for the plaintiffs-appellants.

Barnes H. Ellis, Lois O. Rosenbaum, and Brad S. Daniels, Stoel Rives LLP, Portland, OR, for the defendants–

appellees.

Zucco Partners, LLC and other named plaintiffs (collectively, “Zucco”), on behalf of those who purchased publicly–

traded securities of Digimarc Corporation (“Digimarc” or “the Company”) between April 22, 2003 and July 28,

2004, appeal the District of Oregon’s dismissal of their Second Amended Complaint, which alleges that Digimarc

(and two of its officers, Bruce Davis and E.K. Ranjit) violated sections 10(b) and 20(a) of the Securities Exchange

re Daou Systems, Inc. Securities Litigation, 411 F.3d 1006 (9th Cir.2005), we have yet to fully explain how the

Court’s Tellabs decision relates to much of our analysis under those cases.

The district court determined that, pursuant to Daou, the plaintiffs‘ complaint failed to allege scienter with the requi-

site particularity to survive dismissal under the PSLRA’s heightened pleading standard. Because we hold that the

F.3d at 1025, or whether certain statements relied upon by the complaint as false representations are for-

ward-looking statements protected from liability under the PSLRA’s “safe harbor” provision, 15 U.S.C. §

78u-5. See Employers Teamsters Local Nos. 175 & 505 Pension Trust Fund v. Clorox Co., 353 F.3d 1125,

1131-33 (9th Cir.2004).

tions alleging violations of California corporations law, meanwhile, were filed in California state court on October

19th, and subsequently re-filed in the District of Oregon. See In re Digimarc Corp. Derivative Litig., 549 F.3d 1223

were added to its consolidated class action, Zucco amended its original class action complaint, adding significant

detail to its formerly skeletal allegations. This First *989 Amended Complaint was filed on May 16, 2005, on behalf

of all those who purchased the publicly traded securities of Digimarc between April 22, 2003 and July 28, 2004 (the

“class period”), and alleged that Digimarc and the individual defendants engaged in the manipulative accounting

methods described above. Digimarc filed a Federal Rule of Civil Procedure 12(b)(6) motion to dismiss the First

The district court dismissed the complaint without prejudice, giving Zucco leave to amend. According to the district

court, the Second Amended Complaint was no better. After that complaint was filed on January 17, 2006, Digimarc

responded with another motion to dismiss, contending that Zucco had again failed to plead scienter adequately under

the PSLRA. This motion was granted on August 4, 2006, when the district court dismissed the complaint with prej-

L.Ed.2d 179 (2007). We review challenges to a dismissal for failure to state a claim under Federal Rule of Civil Pro–

cedure 12(b)(6) de novo. Livid Holdings, Ltd. v. Salomon Smith Barney, Inc., 416 F.3d 940, 946 (9th Cir.2005).

Such review is generally limited to the face of the complaint, materials incorporated into the complaint by reference,

and matters of which we may take judicial notice. Metzler Inv. GMBH v. Corinthian Colls., Inc., 540 F.3d 1049,

1061 (9th Cir.2008) (citing Tellabs, 127 S.Ct. at 2509). In undertaking this review, we will “accept the plaintiffs‘

Section 10(b) of the Securities Exchange Act of 1934 makes it unlawful for “any person … [t]o use or employ, in

connection with the purchase or sale of any security registered on a national securities exchange … any manipulative

or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe

plaint will survive a motion to dismiss under Federal Rule of Civil Procedure 12(b)(6) “only if a reasonable person

would deem the inference of scienter cogent and at least as compelling as any opposing inference one could draw

from the facts alleged.” 127 S.Ct. at 2510 (emphasis added). Thus, a court now reviewing a complaint’s scienter al-

“inquiry is inherently comparative.” Id. at 2510. A court must compare the malicious and innocent inferences cog-

nizable from the facts pled in the complaint, and only allow the complaint to survive a motion to dismiss if the mali-

cious inference is at least as compelling as any opposing innocent inference. See id. at 2510. See also Metzler In-

vestment, 540 F.3d at 1066.

liberate recklessness.” Id. at 974. Rather, the plaintiff must plead “a highly unreasonable omission, involving not

merely simple, or even inexcusable negligence, but an extreme departure from the standards of ordinary care, and

which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the

actor must have been aware of it.” Id. at 976 (quoting Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1569 (9th

Cir.1990); Sundstrand Corp. v. Sun Chem. Corp., 553 F.2d 1033, 1045 (7th Cir.1977)) (quotation marks omitted).

must also view the allegations as a whole. See South Ferry LP, No. 2 v. Killinger, 542 F.3d 776, 784 (9th Cir.2008)

(“ Tellabs counsels us to consider the totality of the circumstances, rather than to develop separately rules of thumb

for each type of scienter allegation.”). Thus, following Tellabs, we will conduct a dual inquiry: first, we will deter-

mine whether any of the plaintiff’s allegations, standing alone, are sufficient to create a strong inference of scienter;

second, if no individual allegations are sufficient, we will conduct a “holistic” review of the same allegations to de-

the resignations of Ranjit, two members of the accounting department, and the corporation’s auditing firm during the

class period, (4) statements made in filing the corporation’s Sarbanes-Oxley certifications, (5) the compensation

packages of the individual defendants, (6) the stock sales of the individual defendants occurring during the class

period, and (7) a private placement by the corporation during the class period. We address each of these allegations

in turn, and then, as Tellabs instructs, consider the allegations collectively to determine whether the complaint as a

justments” were necessary to meet analysts’ expectations.

The SAC also employs confidential witnesses to support its allegations of scienter with respect to Digimarc’s im-

The SAC alleges that “Digimarc purchased raw materials that went through several production processes with nu-

merous vendors before [they were] ready for use, and that each production process resulted in a loss of some of the

materials being processed.” When accounting for this loss of materials, the SAC contends that the “scrap rate” used

to estimate the loss of raw materials was “unreasonably low.” CW1 states that he/she calculated the “correct” scrap

rate (60 percent), met with a consultant for the company’s accounting system and Rahoul Banerja (then Digimarc’s

Plains accounting system,” and then used these databases, rather than the Great Plains system, to record its inventory

values at the end of each quarter. According to CW1 and CW2, Ranjit and others in charge of these separate data-

bases used them to improperly increase the amount of inventory reported by Digimarc. CW1 and CW2 claim that

“Ford and other finance department personnel munged [sic] the data in the separate Access databases at the end of

the month” to boost its reported income. Also, CW6 reports that Banerjea was “accessing Digimarc’s inventory ac-

CW1 reports meeting with Ranjit and other senior management several times in Fort Wayne, Indiana, and discussing

the inventory valuation and the use of the Great Plains system. CW1 also recounts talking over the telephone with a

Microsoft representative about the Great Plains system while Ranjit and Banerjea observed. During this phone con-

versation, “the Microsoft consultant walked through the process of how the inventory numbers were created in the

Great Plains system and confirmed that the numbers were correct.”

purchase expense could be capitalized.” Rao also told CW3 that Rao “was never instructed to close out projects with

capitalized expenses and therefore the research and development expenses that were being capitalized were improp-

erly accumulating on the Company’s balance sheet.”

Finally, Zucco contends that Digimarc left obsolete and overvalued inventory on its balance sheet, thereby overre-