Opposition Brief — Miller v. Pezzani

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BEST AVAILABLE COPY.

anand

—

In The

Disenms Court of the

October Term, 1995

r

IN RE WORLDS OF WONDER SECURITIES LITIGATION

ROSETTA MILLER; WALTER UNTERMEYER; ALAN

NISSELSON; TRUDY WHITMAN NISSELSON; PAUL

GREENSTEIN; HOWARD H. WESTON, AS TRUSTEE FOR

THE FLORIDA MUNICIPAL, INC., RESTATED DEFINED

BENEFIT TRUST AND PLAN; and SYLVIA WIND, on

behalf of themselves and the certified class of purchasers

of the securities of Worlds of Wonder, Inc.,

Petitioners,

Vv.

ANGELO M. PEZZANI; DONALD D. KINGSBOROUGH;

RICHARD B. STEIN; JOHN B. HOWENSTINE; BARRY H.

MARGOLIS; DELOITTE & TOUCHE; SMITH BARNEY,

HARRIS UPHAM & CO.; JOSEPHINE ABERCROMBIE; and

WORLDS OF WONDER SHARES PARTNERSHIP,

Respondents.

oe

ial

On Petition For Writ Of Certiorari To The

United States Court Of Appeals

For The Ninth Circuit

-

BRIEF IN OPPOSITION TO PETITION

FOR WRIT OF CERTIORARI

Daniet J. Barcrson

Mark E. Warre

BEerGEsoNn, Euiopoutos, GrapDy

& Gray

Ten Almaden Boulevard,

Suite 200

San Jose, CA 95113

Telephone: (408) 291-6200

QUESTIONS PRESENTED

(1) Did the Ninth Circuit properly apply the princi-

ples set forth in Virginia Bankshares v. Sandberg, 501 U.S.

1083 (1991), to the facts of this case in determining that

plaintiffs failed to present sufficient probative evidence of

a material misstatement or omission in the Prospectus?

(2) Did the Ninth Circuit properly apply settled

summary judgment standards to the facts of this case in

granting summary judgment in favor of defendants on

the issue of scienter, where plaintiffs presented no direct

evidence of scienter and the defendants presented direct

evidence that their overall conduct was inconsistent with

the speculative inferences urged by plaintiffs?

(3) Did the Ninth Circuit properly apply settled

summary judgment precedent in rejecting speculative

inferences urged by plaintiffs where the direct evidence

rendered such inferences unreasonable?

If.

ii

TABLE OF CONTENTS

Page

STATEMENT OF THE CASE ... 0.22. sccceeses 1

Ais. PACT ons 8EA ees Hs beth hada aeenes 1

B: Paocmarais DaGWs..< ons. ws Soa eecavenkas 3

SUMMARY OF ARGUMENT.................. 4

ARGUMENT |... <6 cdscin neds binintetepuces ees 7

A. Tuere Is No NeEep For Supreme Court REvIEw

Or THe NINTH Circurt’s DETERMINATION THAT

THE Prospectus CONTAINED No MATERIAL Mis-

REPRESENTATIONS OR OMISSIONS........-.+++-: 7

1. The Ninth Circuit Concluded that the

Prospectus Contained No Material Mis-

representations or Omissions Based on a

Review of the Evidence............... 7

a. Soles Oe a fc oe oh ies 12

b. Ssvhbewinl COMMONS: 5 i065 iisseci cance 13

2. The Ninth Circuit’s Determination that

the Prospectus Contained no Material

Misrepresentations or Omissions is

Consistent with Supreme Court Prece-

dent and the Decisions of Other Circuits

APP SARE RR PBL a ont a Se ge 14

B. THe NintH Circurt’s HotpiInc ON ScIENTER

Was BasepD ON THE Speciric Facts IN Tuts Case

erp NN PS ae DNS gai Pas BEN BR Se ea 18

C. THe NintH Circuit Appuiep THE Correct Sum-

MARY JUDGMENT STANDARDS .........-2-0e00- 22

TV. CORNEA as «<b anes suthacubarvasneen un 24

iii

TABLE OF AUTHORITIES

Page(s)

Cases

Acito v. IMCERA Group, 47 F.3d 47 (2d Cir. 1995) .... 21

Anderson v. Liberty Lobby, Inc., 477 U.S. 242 (1986) 22, 23

Ernst & Ernst v. Hochfelder, 425 U.S. 185, reh’g

Po ee Gt. a) ee eee or ere 18

Hanon v. Dataproducts Corp., 976 F.2d 497 (9th Cir.

Lp ERE Sn GR Mine PGR SA ine ge oa Sa re a a ae

I. Meyer Pincus & Assoc., P.C. v. Oppenheimer & Co.,

ee Sn EAE SAME ROMS oo cch onc cincecnsstcecyes 15

In re Apple Computer Sec. Litig., 886 F.2d 1109 (9th

Cir. 1989), cert. denied, 496 U.S. 943 (1990) 21, 22, 23

In re Browning-Ferris Indus. Sec. Litig., 876 F. Supp.

ee NN EE as bain ene ensues ekher even ss 10, 16

In re Coordinated Pretrial Proceedings in Petroleum

Prods. Antitrust Litig., 906 F.2d 432 (9th Cir.

1990), cert. denied, 500 U.S. 959 (1991)............. 23

In re Donald J. Trump Casino Sec. Litig., 7 F.3d 357 (3d

Cir. 1993), cert. denied, 114 S.Ct. 1219 (1994)... 8, 15, 17

In re In-Store Advertising Sec. Litig., 878 F. Supp.

Se Ee OE tik ny cane sg omd mene ys Gene nye ess 19

In re Software Toolworks Sec. Litig., 50 F.3d 615 (9th

Cir. 1994), petition for cert. filed, 63 U.S.L.W. 3892

(U.S. June 12, 1995) (No. 94-2027)................- 19

In re Valence Technology Sec. Litig., No. C94-1542-SC,

1995 WL 274343 (N.D. Cal. May 8, 1995) ........ 10, 16

iv

TABLE OF AUTHORITIES - Continued

Page

In re Worlds of Wonder Sec. Litig., 147 F.R.D. 208

(N.D. Cah: 1999) ioe is nd ons sc cacwev eae obtes eens 3

In re Worlds of Wonder Sec. Litig., 147 F.R.D. 214

(ND. Cal I9GZD sins kcecsnexsdsquni pies caseesen ses >

In re Worlds of Wonder Sec. Litig., [1989-90 Tr.

Binder] Fed. Sec. L. Rep. (CCH) { 95,004 (N.D.

Cal, FO isc sds Guvawes oe cei hee cha erie ena ie aes 3

In re Worlds of Wonder Sec. Litig., [1990-91 Tr.

Binder] Fed. Sec. L. Rep. (CCH) { 95,689 (N.D.

Cab. SOO i Seniesa Si vk CORR eh i a ns 3

In re Worlds of Wonder Sec. Litig., [1992 Tx. Binder]

Fed. Sec. L. Rep. (CCH) { 97,018 (N.D. Cal.

1992) «i pcinn KdRbn CoA aah Rice eh vee Rbaoks Cheese tears 3

In re Worlds of Wonder Sec. Litig., 694 F. Supp. 1427

(NLD. Cab: SOG) oo tes dea cee Pe cegk has Soaen ess 3

In re Worlds of Wonder Sec. Litig., 721 F. Supp. 1140

END. Sek: ZO a. wap nan cn ck cheek kaa eee as 3

In re Worlds of Wonder Sec. Litig., 814 F. Supp. 850

(ND. Cal: 29605 oii nis cinuecsscetves items eevee. 3

Kaplan v. Rose, 49 F.3d 1363 (9th Cir. 1994), petition

for cert. filed, 63 U.S.L.W. 3849 (U.S. May 10,

1995) (No... 96-1005 0 esas cneisete aint 9, 10, 16

Kline v. First W. Gov’t Sec., 24 F.3d 480 (3d Cir.),

Cert. Gente, 2335'S. te Be Cees so eek aveecesctacs 17

Layne & Bowler Corp. v. Western Well Works, Inc.,

261 Ui SOF, FOS COME eae a Ss 5

Malone v. Microdyne Corp., 26 F.3d 471 (4th Cir.

BODE). isig Sho E i Macs FF ols tee ea ewecanes 19

Matsushita Elec. Indus. Co. v. Zenith Radio, Corp.,

Po TE BE OO had, cease cae aeas 20, 21, 22, 23

Vv

TABLE OF AUTHORITIES - Continued

Page

Mayer v. Mylod, 988 F.2d 635 (6th Cir. 1993)...... 16, 17

Melder v. Morris, 27 F.3d 1097 (5th Cir. 1994)........ 19

Moorhead v. Merrill Lynch, Pierce, Fenner & Smith,

te., PRP Fan 263 ey Cie 1999) 22 ek i eo es 15

Pommer v. Medtest Corp., 961 F.2d 620 (7th Cir.

NORA a Soin oak oe SUN axe eNe ces bade ob4 oo be Canon cues 17

Rice v. Sioux City Memorial Park Cemetery, Inc., 349

Mite POP ARE ea ick ns Wh oa 4d aban cata h ree cated C4 C8 5

Romani v. Shearson Lehman Hutton, 929 F.2d 875

Se Bs a is 8s a ACER SOPRA A ha ae oes 16

Rubinstein v. Collins, 20 F.3d 160 (5th Cir. 1994).. 8, 15, 16

Saitzberg v. TM Sterling/Austin Assocs., 45 F.3d 399

RRS GU Ee ie sod hac ei cen is hewn vies 16

Sinay v. Lamson & Sessions Co., 948 F.2d 1037 (6th

Oe NURS Fit es oe es oo wii bo ke ewan we RAVES pt Ae

Smolen v. Deloitte, Haskens & Sells, 921 F.2d 959 _

OR I gs tN ks Wane h aac hae aed ek ECE VA Ve 0 23

Stamatio v. Hurco Cos., Inc., No. IP 94308C, 1995

WL 431916 (S.D. Ind. July 18, 1995)............... 19

TSC Industries v. Northway, Inc., 426 U.S. 438 (1976) .... 15

Thornton v. Micrografx, 878 F. Supp. 931 (N.D. Tex.

sg Berelyetbets BaGiigte eee itnd coe agp tie at he maar ne ee 21

Virginia Bankshares v. Sandberg, 501 U.S. 1083

CEPR isi oi ale pc cus teeeethes ee hbacias bakes 8, 14, 15

Whirlpool Fin. Corp. v. GN Holdings, 873 F. Supp.

BN PU i PES cack erie heehee ds c<dganeses 10, 16

vi

TABLE OF AUTHORITIES — Continued

Page

STATUTES

Securities Act of 1933

Section 11,19: ULC. & 77MORR sc. < docs 64 Cabiscessteees 4

Securities Act of 1934

Section 10(b), 15 U.S.C. § 78k(j)(b) ...........-55-. 19

RULES

Securities and Exchange Commission Rule 10b-5,

17 CBR: 9 Dees ocd cn chekedesakelveboesa 4,19

Supreme Court Rule 10.22. idsWadekedbevevivsveeseas 5

Respondents/defendants Donald D. Kingsborough,

Angelo M. Pezzani, and Richard B. Stein (the “Officers”)

file this brief in opposition to the Petition for Writ of

Certiorari (“Pet.”) filed by Petitioners Rosetta Miller, Wal-

ter Untermeyer, Alan Nisselson, Trudy Whitman

Nisselson, Paul Greenstein, Howard H. Weston, as trustee

for the Florida Municipal, Inc., Restated Defined Benefit

Trust and Plan, and Sylvia Wind (“Plaintiffs”).

I. STATEMENT OF THE CASE

A. Facts

Worlds of Wonder (“WOW”) was founded in March

1985 to manufacture and sell Teddy Ruxpin, an animated

story-telling bear. Teddy Ruxpin began shipping in

August 1985 and was the nation’s best selling toy for that

Christmas season. WOW recorded net sales of $93 million

in its first full fiscal year ended March 31, 1986. WOW’s

second major product, Lazer Tag, became the best selling

toy in the 1986 Christmas season, while Teddy Ruxpin

maintained its popularity, giving WOW two of the best

selling toys of the season. For the fiscal year ended March

31, 1987, WOW had net sales of approximately $327 mil-

lion. (A3).?

At the February 1987 New York Toy Fair, WOW intro-

duced its new product lines and extensions of existing

products to a favorable reception. Based on the indica-

tions of interest and orders from customers following Toy

Fair, WOW’s sales and marketing departments projected

1 References to the appendices bound with Plaintiffs’ peti-

tion are styled “(A___).”

sales of $700 million to $800 million for fiscal year 1988,

beginning April 1, 1987. WOW’s fiscal year 1988 financial

plan, which was approved by WOW’s Board in April

1987, conservatively projected net sales of $542 million. |

(A25).

In order to finance the expanded product develop-

ment and manufacturing needed to meet the anticipated

demand for the company’s products, on June 4, 1987,

WOW conducted an $80 million public offering of con-

vertible debentures. The risk disclosure in the Prospectus

was so extensive that the two major rating agencies,

Moody’s and Standard & Poors, rated the debentures as

below investment grade, i.e., “junk bonds,” meaning that

the debentures carried a severe risk of default. The mar-

ketplace clearly understood the investment risks, for it

demanded a yield on the debentures that reflected the

substantial risk entailed by their purchase. The interest

rate on the debentures was 50% higher than the prevail-

ing rate for investment grade corporate debentures. (A3-

A4).

Although Lazer Tag sales in April-May 1987 had

declined from Christmas levels, management believed

that this was due to the normal seasonality (the April-

June quarter is traditionally the weakest in the toy indus-

try) and to WOW’s decision, on the advice of outside

consultants, to withdraw Lazer Tag advertising tempo-

rarily after a boy playing with Lazer Tag was accidentally

shot by a Los Angeles area law enforcement officer in

April 1987. WOW planned to resume advertising in the

Fall of 1987 and projected strong Lazer Tag sales for all of

fiscal 1988. For a variety of reasons, however, WOW’s

expectations were not met. Disappointing sales for the

Oe

1988 Christmas season (beginning in September and

October) combined with the substantial expenses

incurred in increasing production to meet the expected

but unrealized demand, caused severe cash difficulties.

WOW filed for bankruptcy on December 21, 1987.

B. Proceepincs BELow

The District Court granted the motion of the Officers

and other defendants for summary judgment. In re Worlds

of Wonder Sec. Litig., 814 F. Supp. 850 (N.D. Cal. 1993).2

The Ninth Circuit affirmed summary judgment for the

Officers, directors and underwriters, holding that the

2 The Ninth Circuit noted that the district court’s grant of

summary judgment in 1993 occurred “after a tortured five years

of proceedings.” (A5 (citing In re Worlds of Wonder Sec. Litig., 694

F. Supp. 1427 (N.D. Cal. 1988) (dismissing Plaintiffs’ complaint);

In re Worlds of Wonder Sec. Litig., 721 F. Supp. 1140 (N.D. Cal.

1989) (dismissing in part Plaintiffs’ amended complaint); In re

Worlds of Wonder Sec. Litig., [1989-90 Tr. Binder] Fed. Sec. L. Rep.

(CCH) { 95,004 (N.D. Cal. 1990) (certifying Plaintiffs’ class); In

re Worlds of Wonder Sec. Litig., [1990-91 Tr. Binder] Fed. Sec. L.

Rep. (CCH) { 95,689 (N.D. Cal. 1990) (denying shareholders’

motion for summary judgment); In re Worlds of Wonder Sec.

Litig., [1992 Tr. Binder] Fed. Sec. L. Rep. (CCH) { 97,018 (N.D.

Cal. 1992) (granting Plaintiffs’ motion to quash); In re Worlds of

Wonder Sec. Litig., 147 F.R.D. 208 (N.D. Cal. 1992) (denying

Officers’ motion to quash Plaintiffs’ subpoena to Securities

Exchange Commission); In re Worlds of Wonder Sec. Litig., 147

F.R.D. 214 (N.D. Cal. 1992) (denying Plaintiffs’ motion to compel

Deloitte to produce internal audit manuals))). After the Ninth

Circuit panel affirmed the District Court’s grant of summary

judgment, Plaintiffs petitioned for rehearing and suggested the

appropriateness of rehearing en banc, which petition also was

denied.

debenture Prospectus was not materially misleading as a

matter of law.3 The Ninth Circuit held that the risk dis-

closure warned investors that the toy industry and

WOW’s sales were highly seasonal, with the majority of

sales occurring in the Christmas season; that WOW

would be adversely affected by a seasonal sales shortfall;

that internal controls had continually lagged behind

WOW’s growth; and that WOW’s cash position was pre-

carious and that the company would need additional

bank credit. The panel also found that Plaintiffs failed to

provide probative evidence that the Prospectus contained

any material misstatement or omission concerning

WOW’s existing sales practices, liquidity, or internal con-

trols. (A14-A28).

With respect to the Rule 10b-5 claim, the Ninth Cir-

cuit held that the Class had not presented probative

evidence of scienter, and that the defendants’ overall

conduct — including the post-offering expansion of the

Company, the disclosure of adverse information, and

minimal stock sales — negated an inference of scienter.

(A39-A40).

Il. SUMMARY OF ARGUMENT

The Petition primarily concerns the Ninth Circuit's

holding with respect to the outside auditors, Deloitte &

3 The panel affirmed in part and reversed in part as to the

outside auditors. The panel affirmed summary judgment for the

auditors on the Rule 10b-5 claim, holding that Plaintiffs had not

provided sufficient evidence of scienter. The panel reversed

summary judgment in favor of the auditors on the Section 11

claim, and remanded those claims for trial.

Touche (“Deloitte”), and the Court’s application of sum-

mary judgment standards to Plaintiffs’ claims against

Deloitte. To the extent that the Petition addresses the

claims against the Officers, Plaintiffs provide no basis for

this Court to grant a writ of certiorari.

Plaintiffs do not challenge the legal principtes

applied by the Ninth Circuit. Instead, they claim that the

Ninth Circuit misapplied those principles to the facts of

this case, resulting in the wrong holding. Plaintiffs thus

urge this Court to review the factual and evidentiary

arguments that were thoroughly considered and rejected

by the courts below. Bui Plaintiffs’ dissatisfaction with

the Ninth Circuit’s fact-bound application of settled law,

without more, is not an appropriate basis for Supreme

Court review. See Rice v. Sioux City Memorial Park Ceme-

tery, Inc., 349 U.S. 70, 79 (1955) (stressing the importance

that the Court not grant a writ of certiorari “ ‘except in

cases involving principles the settlement of which is of

importance to the public as distinguished from that of the

parties, and in cases where there is a real and embarrass-

ing conflict of opinion and authority between the circuit

courts of appeal.’”) (quoting Layne & Bowler Corp. v.

Western Well Works, Inc., 261 U.S. 387, 393 (1923)); see also

Sup. Ct. R. 10. Further, Plaintiffs’ arguments that the

Ninth Circuit misapplied the law and that its resulting

holding conflicts with the decisions of this Court and the

other Circuit Courts are based solely on mischaracteriza-

tions of the factual and legal bases for the Ninth Circuit's

decision.

Plaintiffs’ factual misstatements permeate their Peti-

tion. Plaintiffs make the same evidentiary arguments that

were considered and rejected by the Ninth Circuit and

the district court. After reviewing the evidence presented

by the Plaintiffs below, the Ninth Circuit determined that

the evidence did not support Plaintiffs’ factual assertions.

The Ninth Circuit held that WOW’s difficulties with its

internal controls had been adequately disclosed; that

there was no “collapse” in sales at the time of the offer-

ing; that WOW was not experiencing a “liquidity crisis”

at the time of the debenture offering; and that WOW did

not fail to disclose material information about its sales

practices. The evidence supporting these findings was

thoroughly discussed in the Ninth Circuit’s opinion.

(A14-A28); see also Section I(A), supra.

Plaintiffs also misstate three separate aspects of the

Ninth Circuit’s holding: 1) the manner in which the Ninth

Circuit reached its determination that the debenture Pros-

pectus contained no materially misleading statements; 2)

the Ninth Circuit’s holding regarding scienter; and 3) the

manner in which the Ninth Circuit applied well-settled

summary judgment standards.

Plaintiffs challenge the Ninth Circuit’s application

(but not adoption) of the “bespeaks caution” doctrine.

Plaintiffs assert that the Ninth Circuit held that risk dis-

closure per se “immunizes material misrepresentations or

omissions of existing facts.” Pet. at 25. To the contrary, the

Ninth Circuit, after thoroughly reviewing the evidence,

held that the Prospectus contained no material misrepre-

sentations or omissions of existing fact. That determina-

tion was based on.a measured and fact-specific

application of settled law in a manner that was wholly

consistent with Supreme Court precedent and the deci-

sions of the other Circuits.

Plaintiffs also erroneously state that the Ninth Circuit

ignored Plaintiffs’ evidence of scienter. Rather, the Ninth

Circuit, after reviewing all of the facts, held that Plaintiffs

had not presented probative evidence of scienter, and

that the evidence presented by defendants negated any

inference of scienter.

Finally, Plaintiffs assert that the Ninth Circuit

“improperly weigh[ed] and resolvi[ed] conflicts in the

evidence.” Pet. at 29. However, the Ninth Circuit thor-

oughly considered the evidence in light of controlling

standards for summary judgment.

Ill. ARGUMENT

A. Tuere Is No Neep For Supreme Court Review

Or THe Nintu Circurr’s DetermMinaTION THAT

THe Prosprecrus ConTAINED No MareriAt Mis-

REPRESENTATIONS Or OmiISSIONS.

1. The Ninth Circuit Concluded that the

Prospectus Contained No Material Misrep-

resentations or Omissions Based on a

Review of the Evidence.

The Ninth Circuit conducted a “de novo” review of

the evidence and affirmed the district court’s determina-

tion that the “ ‘textual part’ of the Debenture Prospectus

was not materially false and misleading.” (A6-A7). In

conducting that review, the Ninth Circuit was mindful

that materiality is a “fact-specific issue which should

ordinarily be left to the trier of fact,” but noted that

Plaintiffs can defeat summary judgment “only by show-

ing a genuine issue of fact with regard to a particular

statement by the company or its insiders.” (A6). Thus the

Ninth Circuit separately analyzed each of the claimed

misstatements to determine whether Plaintiffs met that

burden. (A7; A14-A28).

In Virginia Bankshares v. Sandberg, 501 U.S. 1083

(1991), this Court noted the importance of considering a

claimed misstatement in context. There, this Court

observed that “publishing accurate facts . . . can render a

misleading proposition too unimportant to ground lia-

bility.” Id. at 1097. In analyzing the claimed material

misstatements and omissions in the Prospectus at issue

here, the Ninth Circuit similarly held “ ‘that economic

projections, estimates of future performance, and similar

optimistic statements in a prospectus are not actionable

when precise cautionary language elsewhere in the docu-

ment adequately discloses the risks involved.’ ” (A7). The

Ninth Circuit approved the district court’s use of the

“rubric of the ‘bespeaks caution’ doctrine” to describe the

above holding (A7), noting that “bespeaks caution” is

simply shorthand for the “unremarkable proposition that

a statement must be analyzed in context.” (A11); see also

In re Donald J. Trump Casino Sec. Litig., 7 F.3d 357, 371-73

(3d Cir. 1993), cert. denied, 114 S. Ct. 1219 (1994); Rubin-

stein v. Collins, 20 F.3d 160, 166-68 (5th Cir. 1994).

Plaintiffs do not challenge the bespeaks caution doc-

trine, conceding that it is “ ‘merely new nomenclature

rather than [a] substantive change in the law.’ ” Pet. at 24

(citing Trump, 7 F.3d at 364). Rather, plaintiffs assert that

the Ninth Circuit erred in 1) determining that risk dis-

closure “per se” precludes liability; and 2) holding that

risk disclosure “immunizes” material misstatements of

existing fact. Pet. at 24, 26. These assertions mischaracter-

ize the Ninth Circuit’s opinion.

The Ninth Circuit did not hold, as Plaintiffs assert,

that “the mere fact that the Prospectus addressed a particu-

lar subject foreclosed any claim that the Prospectus was

misleading with respect to that subject.” Pet. at 26

(emphasis in original). The Ninth Circuit emphasized the

need for “precise cautionary language” that was directly

addressed to the allegedly misleading misstatement, and

specifically held that “blanket warnings” that the securi-

ties were risky would be insufficient to avoid liability.

(A12). The Ninth Circuit’s thorough analysis of the speci-

ficity and accuracy of the risk disclosures in light of the

evidence also demonstrates that the panel did not apply a

“per se” rule. (A14-A28).4

Plaintiffs also assert that the Ninth Circuit improp-

erly held that risk disclosure “immunizes material mis-

representations and omissions of existing facts.” Pet. at 25

(emphasis in original). However, Plaintiffs’ interpretation

of the WOW decision is belied by WOW itself and was

explicitly rejected by the Ninth Circuit’s subsequent deci-

sion in Kaplan v. Rose, 49 F.3d 1363 (9th Cir. 1994), petition

for cert. filed, 63 U.S.L.W. 3849 (U.S. May 10, 1995) (No.

94-1895). In Kaplan, the Ninth Circuit observed that its

recent adoption of the “bespeaks caution” doctrine in

WOW “holds that if ‘precise cautionary lan-

guage . . . directly addresses itself to future projections,

estimates, or forecasts in a prospectus,’ ‘the projections

will not give rise to a claim of securities fraud.’ ” 49 F.3d

4 Plaintiffs’ references to the Ninth Circuit’s analysis of the

Prospectus do not support their assertion that the court applied

the bespeaks caution doctrine as a per se rule. See Sections

III(A)(1)(a)-(b), infra, and n.3, supra.

10

at 1373. The court in Kaplan, however, concluded that the

WOW decision did not eliminate liability for misrepresen-

tations of existing facts or conditions. Id. at 1374; see also

In re Valence Technology Sec. Litig., No. C94-1542-SC, 1995

WL 274343 at *14, 16 (N.D. Cal. May 8, 1995) (refusing to

apply the bespeaks caution doctrine because plaintiffs’

allegations “concern existing misrepresentations”); Whirl-

pool Fin. Corp. v. GN Holdings, 873 F. Supp. 111, 124 n.19

(N.D. Ill. 1995); In re Browning-Ferris Indus. Sec. Litig., 876

F. Supp. 870, 879 (S.D. Tex. 1995).

Further, the Ninth Circuit held that Plaintiffs had not

presented sufficient evidence showing that the textual

disclosure in the Prospectus materially misrepresented

WOW’s business and financial condition — not that the

risk disclosure somehow “immunized” material misstate-

ments of existing fact. The only two examples cited by

Plaintiffs, relating to WOW’s sales and internal controls,

do not support their arguments to the contrary.5

5 Plaintiffs’ argument also references pages 17-19 of their

petition, Pet. at 26, which address the alleged evidence regard-

ing WOW’s liquidity and WOW’s sales practices. In that earlier

discussion, Plaintiffs claim that the Ninth Circuit somehow

“ignored” their evidence. Pet. at 18. However, the Ninth Circuit

thoroughly addressed the evidence presented by Plaintiffs and

determined that Plaintiffs’ arguments were not supported by

the facts.

The Ninth Circuit held that the Prospectus “clearly bespoke

caution on the serious risks WOW’s liquidity crisis posed to

investors.” (A15). Making the identical argument that was

rejected below, Plaintiffs assert that the Prospectus did not dis-

close that WOW would supposedly run out of cash “imme-

diately after” the offering. Pet. at 18. However, Plaintiffs relied

on only two documents, both of which are dated after the offer-

ing: 1) a memorandum from WOW’s lender indicating that

11

The Ninth Circuit conducted a thorough de novo

review of all the evidence submitted by Plaintiffs in sup-

port of those allegations, and determined that the evi-

dence did not support their claims. (A17-A19; A22-A26).

Plaintiffs’ argument is thus nothing more than a com-

plaint that the Ninth Circuit got the facts wrong. How-

ever, that is not an appropriate basis for review by this

Court.

WOW had drawn-down on its line of credit; and 2) a memoran-

dum by Mr. Stein speculating that WOW might encounter a cash

shortfall in late 1987. (A15-A16). The Ninth Circuit specifically

considered both documents, and determined that the docu-

ments did not show that WOW was out of cash at the time of the

offering. (Id.)

Plaintiffs also challenge the Ninth Circuit’s factual findings

regarding WOW’s sales practices. However, as noted by the

Ninth Circuit, Plaintiffs themselves “concede[d] that price pro-

tection is a common practice in the toy industry,” and “the

undisputed evidence also indicates that stock balancing is com-

monplace in the industry.” (A20). Accordingly, WOW had no

duty under the securities laws to disclose its observance of

those practices. (Id.) The court also considered Plaintiffs’ evi-

dence of supposed guaranteed sales, and reached the factual

determination that such evidence was “speculative, nebulous

and nowhere purported to quantify the degree to which WOW

engaged in this ‘normal business’ practice.” (A29). The Ninth

Circuit noted that WOW’s auditors had examined WOW’s sales

practices and concluded that any guaranteed sales “were mini-

mal in number and did not have a material impact on WOW’s

financial statements taken as a whole.” (Id.)

12

a. Sales and demand

Plaintiffs assert that the Prospectus failed to disclose

that sales and demand for WOW’s products were “col-

lapsing” at the time of the debenture offering. However,

the Ninth Circuit carefully examined the specific risk

disclosures in the Prospectus and determined that the fact

Plaintiffs claim was omitted — that sales for WOW’s prod-

ucts had declined — actually was disclosed. As the Ninth

Circuit observed, the Prospectus “fully disclosed” 1) a

significant decline in both net sales and net income for

the first three months of calendar 1987; 2) that WOW

expected that sales for the quarter ended June 30, 1987

would be below sales for the prior three quarters; and 3)

that the loss for the quarter would be “disproportionally

greater” than the year-earlier quarter. (A22-A23). Thus,

the Prospectus clearly and specifically disclosed a down-

ward trend in sales and earnings, and the panel did not,

as Plaintiffs assert, provide immunity on the basis that

the Prospectus merely “addressed” a subject. Pet. at 26.

More importantly, Plaintiffs’ evidence did not sup-

port their claim that WOW failed to disclose an existing

“collapse” in sales and product demand at the time of the

offering. Plaintiffs argued that because WOW’s sales (pri-

marily for Lazer Tag) in April and May 1987 were below

WOW’’s internal plan for the fiscal year ended March 31,

1988, the Officers should have disclosed that sales were

“dead” at the time of the offering. (A24-A25). However,

the evidence considered by the Ninth Circuit showed that

WOW’s Officers, the investment bankers, and retailers all

expected that WOW’s products would sell well over the

coming fiscal year; that WOW’s sales performance in

13

April and May 1987 was “relatively inconsequential,”

since WOW’s internal financial plan projected that sales

for those months would account for only four percent of

total anticipated revenue for fiscal year 1988 (most toy

sales occur at Christmas); and that WOW had com-

menced a production schedule implementing the corpo-

ration’s business plan projecting $542 million in sales.

(A25). The Ninth Circuit determined that Plaintiffs’ evi-

dence did not support their contention that there was a

sales crisis at the time of the offering, and indeed, that

such a contention was contradicted by the evidence.

(A24-A26). Plaintiffs’ disagreement with that factual

determination provides no basis for this Court to grant a

writ of certiorari.

b. Internal controls

Plaintiffs’ argument concerning WOW’s disclosure of

internal controls, (Pet. at 11-12), is particularly ironic

given the panel’s finding that, if anything, WOW “erred

on the side of over disclosure.” (A19). In attacking the

decision, Plaintiffs misrepresent the Ninth Circuit’s hold-

ing and again rely on documents and arguments that

were thoroughly examined by the courts below.

First, the Ninth Circuit did not hold, as Plaintiffs

assert, that omissions regarding existing problems with

WOW’s internal controls were rendered immaterial by

the disclosure of future risks. Pet. at 25. Indeed, the Ninth

Circuit expressly noted the Prospectus’ disclosure that

WOW’s internal controls had “lagged behind” the Com-

pany’s growth, and that there was no assurance that

efforts to improve internal controls would be successful.

14

(A17-A18). Similarly, the court noted that the Prospectus

“did not state or imply that WOW’s internal control prob-

lems ‘were in the past’ and not ongoing.” (A18). Thus the

Prospectus did disclose internal control deficiencies.

Second, Plaintiffs’ evidence regarding internal con-

trol deficiencies demonstrated that those deficiencies, to

the extent they existed at the time of the offering, were

immaterial. Plaintiffs relied entirely on Deloitte’s man-

agement letter that was prepared 2 1/2 months after the

offering. The Ninth Circuit, however, noted that the man-

agement letter concluded that WOW’s internal controls

“had no material weaknesses.” (A18).

2. The Ninth Circuit’s Determination that the

Prospectus Contained no Material Misrep-

resentations or Omissions is Consistent

with Supreme Court Precedent and the

Decisions of Other Circuits.

Plaintiffs argue that the Ninth Circuit’s determina-

tions regarding materiality and the adequacy of the dis-

closures in the Prospectus conflict with Supreme Court

precedent and the decisions of the other Circuits. How-

ever, Plaintiffs’ argument is premised on their erroneous

contention that the Ninth Circuit held that risk disclosure

“per se” precludes liability, which it did not. See Section

Ill (A), supra.

As the Ninth Circuit noted, its context-specific

approach to analyzing the alleged misstatements was

entirely consistent with Virginia Bankshares v. Sandberg,

501 U.S. 1083, 1097 (1991), which held that “while a

misleading statement will not always lose its deceptive

15

edge simply by joinder with others that are true, the true

statements may discredit the other one so obviously that

the risk of real deception drops to nil.” (A12); see also In re

Donald J. Trump Casino Sec. Litig., 7 F.3d 357, 369, 373 (3d

Cir. 1993) (“Virginia Bankshares just restates . . . that mate-

riality involves a context-specific analysis such that warn-

ings and cautionary language will sometimes suffice to

render the allegedly misleading misrepresentations or

omissions immaterial as a matter of law”), cert. denied, 114

S. Ct. 1219 (1994). In Trump, the Third Circuit noted that

its context-specific adoption of the “bespeaks caution”

doctrine also was consistent with this Court’s decision in

TSC Industries v. Northway, Inc., 426 U.S. 438 (1976), and

stated that “ ‘bespeaks caution’ is essentially shorthand

for the well-established principle that a statement or

omission must be considered in context, so that accom-

panying statements may render it immaterial as a matter

of law.” Trump, 7 F.3d at 364.

Similarly, there is no Circuit split on this issue. The

Ninth Circuit noted that its definition of the “bespeaks

caution” doctrine was supported by “a wealth of author-

ity” from other Circuits and district courts. (A10). Indeed,

the Ninth Circuit closely followed the Third Circuit’s

decision in Trump, which is considered the leading deci-

sion on the bespeaks caution doctrine. The Ninth Circuit

also cited to cases in the First, Second, Fifth, Sixth, and

Eighth Circuits adopting the doctrine. (A9-A10); see

Rubinstein v. Collins, 20 F.3d 160, 166-68 (5th Cir. 1994);

Moorhead v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 949

F.2d 243, 245-46 (8th Cir. 1991); Sinay v. Lamson & Sessions

Co., 948 F.2d 1037, 1040 (6th Cir. 1991); I. Meyer Pincus &

Assoc., P.C. v. Oppenheimer & Co., 936 F.2d 759, 763 (2d Cir.

16

1991); Romani v. Shearson Lehman Hutton, 929 F.2d 875, 879

(1st Cir. 1991). Since the Ninth Circuit’s decision in WOW,

the bespeaks caution doctrine also has been adopted by

the Eleventh Circuit in Saltzberg v. TM Sterling/Austin

Assocs., 45 F.3d 399 (11th Cir. 1995).

None of the courts citing the Ninth Circuit’s adoption

of the “bespeaks caution” doctrine in WOW has held that

WOW’s approach to the “bespeaks caution” doctrine was

inconsistent in any material manner from decisions of the

other Circuits. See Kaplan v. Rose, 49 F.3d 1363, 1373 (9th

Cir. 1994); In re Valence Technology Sec. Litig., 1995 WL

274343 at *14, 16; Whirlpool Financial, 873 F. Supp. at 124

n.19; Browning-Ferris, 876 F. Supp. at 879, 882.

The cases cited by Plaintiffs are not to the contrary.

Plaintiffs’ suggestion that the Ninth Circuit’s decision is

inconsistent with Rubinstein again is based on their erro-

neous contention that the Ninth Circuit held that risk

disclosure “per se” immunizes misstatements or omis-

sions. The Fifth Circuit in Rubinstein did not reject a

context-specific approach to analyzing risk disclosure,

but held only that the district court erred in applying a

per se rule that economic forecasts and predictions may

never form the basis for securities fraud when couched in

cautionary language. 20 F.3d at 167. The Fifth Circuit did

not reject more fact-specific applications of the bespeaks

caution doctrine, such as that applied by the Ninth Cir-

cuit. Id. Indeed, the Ninth Circuit cited Rubinstein as

providing an explanation of the doctrine. (A10-A11).

Similarly, in Mayer v. Mylod, 988 F.2d 635, 639 (6th

Cir. 1993), which was decided on a motion to dismiss, the

Sixth Circuit held only that risk disclosure does not per se

17

cure the misleading nature of alleged misstatements. In

Mayer, the Sixth Circuit clarified and narrowed its earlier

decision in Sinay v. Lamson & Sessions Co., which the

Mayer court feared could have been interpreted as hold-

ing that economic projections coupled with cautionary

statements were per se non-actionable. Mayer held, at the

pleading stage, that it was necessary to “weigh” the

evidence against the risk disclosure. In WOW, however,

the Ninth Circuit, after extensive discovery, held that the

disclosure in the Prospectus was not misleading in light

of all the evidence. WOW is entirely consistent with

Mayer, given that the Ninth Circuit, like the Sixth Circuit,

refused to establish a sweeping rule that cautionary state-

ments will always render misrepresentations or omis-

sions immaterial as a matter of law. See also Trump, 7 F.3d

at 373 n.16 (discussing Mayer).

Pommer v. Medtest Corp., 961 F.2d 620 (7th Cir. 1992),

is similarly inapplicable. Pommer held merely that “boil-

erplate” and “generic” warnings that did not address the

subject matter of the alleged false statements would be

insufficient to avoid liability. Id. at 624-25. The Ninth

Circuit similarly noted that “blanket warnings” are insuf-

ficient, citing Kline v. First Western Government Securities,

24 F.3d 480, 489 (3d Cir.) (“application of the ‘bespeaks

caution’ doctrine . . . requires that the language bespeak-

ing caution relate directly to that by which plaintiffs

claim to have been misled”), cert. denied, 115 S. Ct. 613

(1994). (A12).

Plaintiffs’ argument that the Ninth Circuit’s decision

is inconsistent with the decisions of this Court and the

other Circuits is clearly wrong. That argument is based

solely on Plaintiffs’ misstatement of the bases for the

18

Ninth Circuit’s opinion, a misstatement that is readily

apparent from the text of the opinion. The Ninth Circuit

expressly rejected the application of the bespeaks caution

doctrine that Plaintiffs contend it adopted; the Ninth

Circuit instead adopted a “context-specific approach,”

which “applies only to precise cautionary language which

directly addresses itself to future projections, estimates or

forecasts.” This approach is wholly consistent with the

decisions of other Circuits.

B. Tue NintnH Circurt’s Hoipinc On Screnter Was

Basep ON Tue Speciric Facrs In Tuis Case.

To withstand summary judgment on the issue of

scienter, plaintiffs must present sufficient probative evi-

dence of a “mental state embracing an intent to deceive.”

See Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n.12, reh’g

denied, 425 U.S. 986 (1976). Thus, in analyzing the WOW

defendants’ motions for summary judgment on the issue

of scienter, the Ninth Circuit looked at the facts presented

by Plaintiffs to determine whether they met that evidenti-

ary burden. The Ninth Circuit found that the Plaintiffs

failed to present any direct evidence of scienter, and that

the inferences that they sought based on circumstantial

evidence were unreasonable. The Ninth Circuit thus con-

cluded, based on the facts in this case, that Plaintiffs had

not made the required evidentiary showing. Plaintiffs’

contention that the Ninth Circuit’s holding dictates that

summary judgment on the issue of scienter be granted

19

regardless of the strength of the evidence submitted by

plaintiffs is erroneous. Pet. at 3, 20.°

Plaintiffs make conclusory allegations that the Offi-

cers “knowingly made false public statements”; “sold

massive quantities of WOW stock”; “failed to disclose

material adverse facts known to them”; and “were aware

of bogus financial transactions.” Pet. at 27. However,

those identical allegations were fully considered and

rejected by the Ninth Circuit and the district court after a

careful review of the evidence. (A38-A39). The Ninth

6 Plaintiffs also challenge the Ninth Circuit’s holding

regarding the auditors’ alleged scienter, claiming that the court

held that “a § 10(b) plaintiff can never get to the jury on the

scienter issue, no matter how strong his evidence of fraudulent

intent, knowledge or recklessness, as long as the auditor prof-

fers expert testimony that its accounting determinations were

valid.” Pet. at 3. However, the court held nothing of the kind.

The court held that Plaintiffs had presented no probative evi-

dence of fraudulent intent or recklessness, not that such evi-

dence was outweighed by the opinion of the auditor’s expert.

Indeed, the court barely mentioned the declaration of the audi-

tor’s expert, focusing instead on the absence of any evidence

presented by Plaintiffs. In so holding, the court fully considered

all of the evidence presented by Plaintiffs, carefully reviewed

the declaration of Plaintiffs’ expert, accepted as true the exis-

tence of disputed issues as to whether WOW’s audited financial

statements failed to comply with generally accepted accounting

principles, and correctly held that merely questioning account-

ing judgments was not sufficient to establish scienter. (A42-

A44); see also In re Software Toolworks Sec. Litig., 50 F.3d 615, 627

(9th Cir. 1994), petition for cert. filed, 63 U.S.L.W. 3892 (U.S. June

12, 1995) (No. 94-2027); Melder v. Morris, 27 F.3d 1097, 1103 (5th

Cir. 1994); Malone v. Microdyne Corp., 26 F.3d 471, 479 (4th Cir.

1994); Stamatio v. Hurco Cos., Inc., No. IP 94308C, 1995 WL

431916, at *2 (S.D. Ind. July 18, 1995); In re In-Store Advertising

Sec. Litig., 878 F. Supp. 645, 648-49 (S.D.N.Y. 1995).

20

Circuit’s fact-based application of settled law is not an

appropriate issue for Supreme Court review.

Plaintiffs also assert that the Ninth Circuit erro-

neously held that “persons [such as officers, directors,

underwriters and controlling persons] can ‘conclusively’

rebut scienter” merely by submitting certain evidence.

Pet. at 4, 37. First, regardless of whether there was evi-

dence “rebutting” scienter (which there was), defendants

are not required to prove the absence of scienter; rather

plaintiffs must present sufficient probative evidence of

scienter. See Matsushita Elec. Indus. Co. v. Zenith Radio,

Corp., 475 U.S. 574, 587, 596-97 (1986). Here, the Ninth

Circuit held that Plaintiffs “produced no direct evidence

of any scienter.” (A39). To the extent Plaintiffs contend

that the Ninth Circuit’s holding applies to cases in which

plaintiffs actually meet their evidentiary burden with

regard to scienter, they are wrong. The Ninth Circuit was

not presented with such a case, and its opinion does not

address that hypothetical situation.

Plaintiffs also argue that the Ninth Circuit’s holding

in this case conflicts with the holdings of other Circuits.

However, that argument hinges on Plaintiffs’ obviously

erroneous (and unsupported) assertion that the Ninth

Circuit held that “a corporate insider can trade with

impunity as long as he retains most of his stock.” Pet. at

27. Here, Plaintiffs presented no evidence of insider trad-

ing. Instead, Plaintiffs attempted to infer scienter for all

of the Officers based on Mr. Kingsborough’s sale of a

fraction of his stockholding in late July 1987. The Ninth

Circuit rejected such an inference, because 1) Mr. Kings-

borough’s sales occurred after the disclosure of disap-

pointing results for the June 30, 1987 quarter and well

iii iii |

21

before WOW’s problems in late 1987; 2) the other Offi-

cers, Messrs. Pezzani and Stein, sold no stock prior to

WOW’s collapse; and 3) Mr. Kingsborough retained the

vast bulk of his stockholdings. The Ninth Circuit properly

held that this evidence negated the “inference of scienter”

urged by Plaintiffs on the basis of Mr. Kingsborough’s

sales. (A40 (citing In re Apple Computer Sec. Litig., 886 F.2d

1109, 1117 (9th Cir. 1989), cert. denied, 496 U.S. 943 (1990)

(“credible and wholly innocent explanations for the stock

sales . . . are sufficient to defeat any inference of bad

faith”))). Accord Acito v. IMCERA Group, 47 F.3d 47, 54 (2d

Cir. 1995); Thornton v. Micrografx, 878 F. Supp. 931, 938

(N.D. Tex. 1995).

Plaintiffs similarly mischaracterize the Ninth Cir-

cuit’s holding regarding the other evidence negating any

inference of scienter, which included the Officers’ post-

offering efforts to continue WOW’s expansion and the

detailed risk disclosure in the Prospectus. Contrary to

Plaintiffs’ arguments, the Ninth Circuit did not hold that

this evidence provided an absolute bar to liability. Rather,

the court held that the overall conduct of the Officers

rebutted the “speculative inferences” of scienter sought

by Plaintiffs. (A39). Again, the Ninth Circuit’s holding

was based on the specific facts in this case.

The Ninth Circuit’s holding on scienter is entirely

consistent with Supreme Court authority and the hold-

ings of the Ninth Circuit and the other Circuits. As this

Court stated in Matsushita:

[To survive summary judgment], the nonmoving

party must come forward with ‘specific facts

showing that there is a genuine issue for

trial.’ . . . Where the record taken as a whole

22

could not lead a rational trier of fact to find for

the non-moving party, there is no ‘genuine issue

for trial.’ . . . It follows from these settled princi-

ples that if the factual context renders [the non-

movants’] claim implausible — if the claim is one

that simply makes no economic sense — [the

non-movants}] must come forward with more

persuasive evidence to support their claim than

would otherwise be necessary.

475 U.S. at 587 (citations omitted). Thus, where, as here,

speculative inferences based on circumstantial evidence

of wrongdoing are contradicted by defendants’ overall

pattern of conduct, summary judgment is appropriate.

See id. at 596-97 (where defendants have no motive to

engage in wrongdoing and their “conduct is consistent

with other equally plausible explanations, the conduct

does not give rise to an inference of [wrongdoing]”);

Apple, 886 F.2d at 1117 (same).

C. THe Ninty Circurr Appurep THe Correcr Sum-

MARY JUDGMENT STANDARDS.

Plaintiffs’ argument that the Ninth Circuit applied

controlling summary judgment standards improperly to

the facts of the case is not appropriate for review by this

Court. Indeed, Plaintiffs do not even muster an argument

that this Court’s review of this issue will affect parties

other than those involved in this case. The Ninth Circuit

established no new law in this area, relying on well-

settled summary judgment principles set forth by the

Ninth Circuit in Hanon v. Dataproducts Corp., 976 F.2d 497,

500 (9th Cir. 1992), which were based on this Court’s

decisions in Anderson v. Liberty Lobby, Inc., 477 U.S. 242,

23

247-48 (1986) and Matsushita Electric Industry Co. v. Zenith

Radio Corp., 475 U.S. 574, 587 (1986).

Plaintiffs misapprehend controlling authority by

asserting that the Ninth Circuit “disregarded” the con-

trolling principles set out in those cases. See Pet. at 29

(court found the Class’ evidence “not very probative”).

Supreme Court and Ninth Circuit precedent require that

summary judgment be granted when plaintiffs fail to

provide “significant probative evidence” to allow a rea-

sonable jury to find in their favor.”? Thus, the Ninth Cir-

cuit was obligated to analyze the evidence to determine

whether it was probative of Plaintiffs’ allegations.

What Plaintiffs are really asserting is that the panel

should have indulged their speculative inferences based

on circumstantial evidence. This Court has emphasized,

however, that summary judgment may not be defeated by

such inferences.® In short, the Ninth Circuit applied the

appropriate standards for summary judgment.

7 See Anderson, 477 U.S. at 252-54; In re Apple Computer Sec.

Litig., 886 F.2d 1109, 1113 (9th Cir. 1989), cert. denied, 496 U.S. 943

(1990); Smolen v. Deloitte, Haskens & Sells, 921 F.2d 959, 963 (9th

Cir. 1990).

® Matsushita, 475 U.S. at 587; see also Hanon, 976 F.2d at 500;

In re Coordinated Pretrial Proceedings in Petroleum Prods. Antitrust

Litig., 906 F.2d 432, 441 (9th Cir. 1990), cert. denied, 500 U.S. 959

(1991).

iii

24

IV. CONCLUSION

For the foregoing reasons, the Officer Respondents

respectfully request that the Court deny Plaintiffs’ Peti-

tion for a Writ of Certiorari.

Respectfully submitted,

James A. DiBolse

Counsel of Record

WILSON, SONSINI, GOODRICH &

ROsATI

Professional Corporation

650 Page Mill Road

Palo Alto, CA 94304-1050

(415) 493-9300

August 28, 1995