# Opposition Brief — Miller v. Pezzani

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## Record

- **Collection:** Supreme Court brief
- **Document type:** Opposition Brief
- **Published:** January 1, 1995
- **Citation:** 516 U.S. 868

## Text

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BEST AVAILABLE COPY.

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—

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..

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

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40386012_2414%3A3. Public record. Not legal advice.