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One quarter of the nearly 200 securities class actions brought in 2000 were filed against companies that have gone public in the past three years. Both the general characteristics and the specific allegations of these cases reflect patterns that distinguish them from actions filed against more established issuers. In general, the actions filed in 2000 against newer companies tend to cover shorter class periods, sometimes as brief as two or three months. [FOOTNOTE 1]The financial projections that form the basis for the suits are often exponential figures, such as revenue growth from 300 percent to 600 percent. The decline in new issuers’ stock prices tends to be more dramatic than for established companies — for example, a decline from $125 to $10 per share. Ninety percent of the issuers sued for securities fraud in 2000 trade on Nasdaq rather than the New York Stock Exchange. Beyond these general characteristics, there are several other observable trends in the specific allegations against newer issuers in 2000, particularly against high-technology and other emerging growth companies. A comparison of suits against 20 of these “new economy” issuers with suits against 20 established issuers provides clear evidence of a few of these patterns. [FOOTNOTE 2] One common feature of the securities class actions filed against emerging growth companies in 2000 is the allegation of bootstrapping. Plaintiffs allege not only a decline in a particular issuer’s stock, but an overall decline in the market for emerging growth companies’ stocks, which, they contend, has adversely impacted a given issuer’s stock. For example, in the Copper Mountaincase, the plaintiffs allege that the “dramatic decline in Internet related stocks … had an immediate and dramatic adverse impact” on the company’s high-tech customers and, by extension, on the company itself. [FOOTNOTE 3] In another action against an emerging growth issuer, it is alleged that “many of [its] Internet related customers were already starting to show signs of cash distress … such that defendants had no reasonable basis to claim that near term revenue and earnings growth would likely continue” and that because of “market conditions,” the defendant’s reserves were inadequate. [FOOTNOTE 4]In another action, the plaintiffs allege that demand for the issuer’s initial public offering was “fanned” by the “dot-com frenzy.” [FOOTNOTE 5] The efficacy of these allegations is open to question. Typically, information alleged to have been withheld from the marketplace is internal, rather than public. The volatility of the stock prices for technology issuers throughout 2000, by contrast, was clearly headline news. Thus, whether these types of allegations will sustain claims for nondisclosure or misrepresentation is unclear. SMALL SIZE, SMALL WORLD Another trend among the sample of actions against emerging growth issuers is the attempt to exploit their small size. Interactions with only one or a handful of key customers often form the basis for the complaint’s allegations, and it is then argued that because of a company’s size, directors and officers must have been aware of dealings with that customer. [FOOTNOTE 6]Alternately, an issuer’s cash “burn rate” or operation “on borrowed time” may be alleged as evidence of knowledge of failing operations. [FOOTNOTE 7]Assuming, however, that issuers disclose the relatively small number of customers on which they depend or their limited cash flow, it can be argued that investors knowingly undertook the risks stemming from these situations. An emerging growth issuer’s difficulty in competing because of its smaller size may also form the basis for scienter allegations. For example, the need to complete an acquisition to “compete head-to-head with the dominant companies in the industry” has been alleged to provide motive to inflate the company’s stock price. [FOOTNOTE 8]Generally, the motive of completing acquisitions using artificially inflated stock as a basis for scienter has been rejected by most courts, with a few exceptions. [FOOTNOTE 9]How the additional wrinkle — that the acquisitions were themselves motivated to establish competitive viability — will affect the acceptance of these allegations remains to be seen. Somewhat related to these issuers’ smaller size is how prominently revenue recognition issues figure in the actions against emerging growth companies brought in 2000. Because the timing of the receipt of revenues from key customers can determine whether quarterly estimates are met, revenue recognition becomes a significant area of potential exposure. Among the first 20 cases sampled, revenue recognition improprieties are alleged in half. By contrast, revenue recognition allegations appear in only three of the sample of 20 actions against established issuers. Another trend among actions against emerging growth companies in 2000 is the impact of novel legal questions involving the issuers’ businesses. For example, in Ivanoff v. MP3.com, the defendants are alleged to have known that their business model was based on an impermissible use of copyrighted materials. A judgment to that effect during the class period, followed by a stock price drop, provided the road map for the plaintiffs’ allegations. Another example is Rosenfeld v. Musicmaker.com, in which the issuer is alleged to have known that an agreement governing use of electronic music files would not provide the type of Internet content projected because of legal complications arising from necessary licenses and anti-coupling provisions. Like allegations relating to general market decline, these claims may be subject to challenge to the extent that they derive from public, rather than internal, information. D�J� VU ALL OVER AGAIN Despite these differences, other allegations of scienter among the cases filed in 2000, whether against newer or more established issuers, are strikingly similar. Allegations of insider stock sales or of internal reports inconsistent with public disclosures constitute the mainstay of plaintiffs’ scienter claims in nearly every action. In nine of the 20 emerging growth company actions sampled, insider sales or executive compensation is alleged to demonstrate scienter; similarly, for more established companies, sales or executive compensation is alleged in 10 of the actions. Likewise, 10 of the emerging growth company actions feature internal reports, as do nine of the 20 actions against established issuers. Based on the actions filed in 2000, emerging growth companies are just as likely as their more established counterparts to be sued for securities fraud. Nevertheless, when emerging growth issuers are the target of such actions, there is a degree of predictability as to the types of allegations that will be lodged against them. An awareness of which of these particular claims succeed beyond the pleading stage is critical to a successful risk-avoidance strategy for management. Mr. Williamson is a litigation partner in the Irvine and Newport Beach, Calif., offices, and Ms. Longo is a litigation associate in the Newport Beach office of O’Melveny & Myers. Both specialize in representing high-technology companies in corporate securities, intellectual property and general business and commercial matters. The firm represents an individual defendant (not the issuer) in Alves v. Quintus, one of the cases discussed in this article. Aleta Benjamin, librarian in the firm’s Newport Beach office, and Mitzi Haggerty, a legal assistant at the firm, contributed to the preparation of this article, as did Bernadette St. John, manager of the Stanford Law School Securities Class Action Clearinghouse. ::::FOOTNOTES:::: FN1The class period temporally defines the universe of potential plaintiffs in a securities class action because only people who bought or sold stock within that timeframe are eligible to be members of the plaintiff class. Typically, class periods run anywhere from 18 to 36 months. FN2The 20 cases that comprise the sample for “new economy” issuers are: Troxell v. Copper Mountain Networks Inc., No. 00-CV-3944 (N.D. Cal. filed Oct. 25, 2000); Weiss v. Covad Communications Group Inc., No. C-00-4293-BZ (N.D. Cal. filed Nov. 16, 2000); Margonelli v. Crossroads Systems Inc.,No. 1:00-CV-505 (W.D. Texas filed Oct. 13, 2000); Frankel v. Entrust Technologies Inc., No. 2:00-CV-119 (E.D. Texas filed July 6, 2000); Campbell v. Firstworld Communications Inc., No. 1:00-CV-1398 (D. Colo. filed July 10, 2000); Caudle v. Hastings Entertainment Inc., No. 3:00-CV-598 (N.D. Texas filed March 17, 2000); Ivanoff v. MP3.com Inc., No. 3:00-CV-1873 (S.D. Cal. filed Sept. 19, 2000); Stitt v. Scientific Learning Corp., No. 3:00-CV-3014 (N.D. Cal. filed Aug. 22, 2000); Rappaport v. Smith-Gardner & Associates Inc., No. 9:00-CV-8547 (S.D. Fla. filed June 20, 2000); Barton v. Tenfold Corp., No. 2:00-CV-669 (D. Utah filed Aug. 21, 2000); Wilson v. Netsolve Inc., No. 1:00-CV-591 (W.D. Texas filed Sept. 11, 2000); Rosenfeld v. Musicmaker.com Inc., No. 2:00-CV-02018 (C.D. Cal. filed Feb. 25, 2000); Vegoe v. Interspeed Inc., No. 00-CV-12090 (D. Mass. filed Oct. 10, 2000); Alves v. Quintus Corp., No. C-00-4308 (N.D. Cal. filed Nov. 17, 2000); Simon v. Ramp Networks Inc.,No. CV-00-3645 (N.D. Cal. filed Oct. 2, 2000); Fidel v. OfficeMax Inc., No. 00-CV-2432 (N.D. Ohio filed Sept. 22, 2000); Wein v. UniCapital Corp., No. 00-2054 (S.D. Fla. filed June 8, 2000); Steiner v. Aurora Foods Inc.,No. 4:00-CV-602 (N.D. Cal. filed Feb. 25, 2000 ); Gibson v. Dr.koop.com Inc., No. 00-CV-439 (W.D. Texas filed July 20, 2000); Castaldo v. Microstrategy Inc., No. 1:00-CV-473 (E.D. Va. filed March 20, 2000). The 20 cases that comprise the sample for “established” issuers are: The Ezra Charitable Trust v. Frontier Insurance Group Inc., No. 00CV5361 (S.D.N.Y. filed July 19, 2000); Anderson v. First Security Corp., No. 2:00 CV-0418K (D. Utah filed May 22, 2000); CalPERS v. The Chubb Corp., No. 00-4285 (D.N.J. filed Aug. 31, 2000); Greiner v. Conseco Inc., No. IP00-C-0639-Y/S (S.D. Ind. filed Apr. 17, 2000); Silverstein v. Snell, No. 00-72682 (E.D. Mich. filed June 14, 2000); Kushner v. Reliance Group Holdings Inc., No. 00CIV4653 (S.D.N.Y. filed June 22, 2000); Dubois v. Stone & Webster Inc., No. 00-CV-10883 (D. Mass. filed May 9, 2000); Market Street Securities v. Racing Champions Corp., No. 00C3267 (N.D. Ill. filed May 25, 2000); Albert v. Century Business Services Inc., No. 00-CV-565 (D. Md. filed Feb. 28, 2000); In re Bank One Shareholders Class Actions, No. 00-C-880 (N.D. Ill. filed Feb. 25, 2000); Paradise Wire & Cable Defined Profit Sharing Plan v. PE Corp., No. 3:00-CV-881 (D. Conn. filed May 15, 2000); Mandelbaum v. Columbia Laboratories Inc., No. 00-2112 (S.D. Fla. filed June 12, 2000); Nelson v. Flooring America Inc., No. 1:2000 CV 1506 (N.D. Ga. filed June 15, 2000); Charles v. Profit Recovery Group, No. 1:2000 CV 01529 (N.D. Ga. filed June 16, 2000); Wilner v. Steve Madden Ltd., No. CV-00-3676 (E.D.N.Y. filed June 21, 2000); Gunter v. U.S. Franchise Systems Inc., No. 1:00-CV-1244 (N.D. Ga. filed May 17, 2000); D’Elia v. Lee, No. 00-CIV-4117 (S.D.N.Y. filed June 1, 2000); Graf v. Cyber-Care Inc., No.00-8404 (S.D. Fla., filed May 19, 2000); Felgoise v. Open Market Inc., No. 00-CV-11162NG (D. Mass. filed June 14, 2000); Winick v. Pacific Gateway Exchange Inc., No. C-00-1121-WHA (N.D. Cal., filed Apr. 7, 2000). The cases were selected based on a variety of factors, including the availability of the complaints and other information pertaining to each case, the depth and specificity of the factual allegations in the complaints, the geographical and industry diversity of the issuers and the degree to which the complaints reflect issues that are likely to be faced by a significant number of issuers. FN3Copper Mountain Compl., � 15. FN4Rappaport Compl. � 24. FN5Rosenfeld Compl. �� 15. FN6See, e.g., Copper Mountain Compl., � 1. FN7E.g., Covad Communications Compl. � 13. FN8E.g., Covad Communications Compl. � 12. FN9E.g., In re Galileo Corp. Shareholders Litig., 2001 WL 66304, at *19 (D. Mass. Jan. 21, 2001).

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