IN RE BROCADE COMMUNICATIONS SYSTEMS, INC. DERIVATIVE LITIGATION

Filing 377

ORDER by Judge Breyer granting 299 Motion to Dismiss; granting in part and denying in part 303 Motion to Dismiss; granting 304 Motion to Dismiss; granting in part and denying in part 308 Motion to Dismiss; granting 312 Motion to Dismiss; gr anting in part and denying in part 313 Motion to Dismiss; granting 320 Motion to Dismiss; granting 323 Motion to Dismiss; granting in part and denying in part 326 Motion to Dismiss; granting in part and denying in part 329 Motion to Dismiss (crblc2, COURT STAFF) (Filed on 1/6/2009)

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IN THE UNITED STATES DISTRICT COURT FOR THE NORTHERN DISTRICT OF CALIFORNIA

IN RE BROCADE COMMUNICATIONS SYSTEMS, INC. DERIVATIVE 12 LITIGATION
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No. C 05-02233 CRB ORDER ON MOTIONS TO DISMISS

This document relates to ALL ACTIONS /

I.

Introduction This matter began as a shareholders' derivative action brought on behalf of Brocade

Communications Systems, Inc. ("Brocade" or the "Company") against certain of its former officers and directors. Defendants were allegedly involved in a scheme to manipulate stock option grant dates so as to maximize profits to themselves at the expense of the Company. The original shareholder plaintiffs asserted violations of state law, including breaches of fiduciary duties and unjust enrichment. See Verified Derivative Complaint ¶ 1 ("VDC"); Docket Entry ("Dkt.") 1. The Court dismissed the original complaint with leave to amend because no demand was made on the Company. See Dkt. 79. After prolonged negotiations, the Company formed a Special Litigation Committee ("SLC"), which decided to take over litigation and pursue this matter on Brocade's behalf. On August 1, 2008, Brocade filed a Second Amended Complaint ("SAC"). See Dkt. 220. The SAC named as defendants

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individuals who were not previously part of the derivative action and asserted additional claims under federal securities law. Presently before the Court are motions to dismiss filed by all Defendants. The Court conducted a hearing on December 5, 2008. At that hearing the Court assured the parties that it would issue an order the following week. As promised, on December 12, 2008, the Court issued a memorandum order, granting in part and denying in part Defendants' Motions to Dismiss. See Dec. 12, 2008 Order, Dkt. 375. The instant opinion provides the full rationale upon which that order was based.

II.

Background A. Factual Allegations

In the Second Amended Complaint, Brocade alleges the following: 1. The Parties

Plaintiff Brocade was originally incorporated in California in 1995, and later reincorporated in Delaware in 1999. SAC ¶ 10. The Company is a supplier of storage area network equipment and provides data center networking solutions. Id. Defendant Gregory L. Reyes was Brocade's Chief Executive Officer ("CEO") from July 1998 until January 2005, and served on the Board of Directors from July 1998 through April 2005. SAC ¶ 11. Reyes devised a scheme whereby he granted faulted stock options to employees, routinely approving grants as a "committee of one" for Brocade's Board. Id. As a Board member, Reyes was involved in stock-option grants to officers and directors, including himself. Id. Reyes also signed financial statements that later needed to be restated because they incorrectly reported Brocade's compensation-related expenses. Id. Defendant Stephanie Jensen served as Brocade's Vice President of Human Resources ("HR") from October 1999 until February 2004. SAC ¶ 12. Jensen was responsible for Brocade's compensation and benefits programs, including stock options. Jensen knowingly participated in the granting of faulted stock options and altered Brocade's records. Id. Jensen herself received a large number of faulted stock options. Id.
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Defendant Michael J. Byrd was Brocade's Vice President and Chief Financial Officer ("CFO") from May 1999 until May 2001. SAC ¶ 13. Byrd then served as Brocade's Chief Operating Officer ("COO") and President from June 2001 until June 2003. Id. Byrd knowingly participated in the faulted stock-option grant process, signed inaccurate financial statements, and received faulted options. Id. Defendant Antonio Canova was Brocade's Vice President of Finance from November 2000 until November 2004, Vice President of Administration from November 2004 until December 2005, and CFO from May 2001 until December 2005. SAC ¶ 14. Canova was aware of and involved in the granting of faulted stock options. Id. Canova signed inaccurate financial statements and received faulted options. Id. Defendant Neal Dempsey was on Brocade's Board of Directors from December 1996 until April 2007. SAC ¶ 15. Dempsey was a member of the Board's Audit Committee from February 1998 through October 2004, and on the Compensation Committee from February 1998 through February 2007. Id. Defendant Mark Leslie served on Brocade's Board from January 1999 until May 2002. SAC ¶ 16. Leslie was a member of the Audit Committee from June 2001 until May 2002 and a member of the Compensation Committee from March 1999 until August 2001. Id. Defendant Seth D. Neiman was one of Brocade's founders and served on the Board of Directors from August 1995 until April 2006. SAC ¶ 17. Neiman served on the Audit Committee from February 1998 until October 2001, and on the Compensation Committee from August 2001 until October 2004. Id. As members of the Compensation Committee, Defendants Dempsey, Leslie, and Neiman were involved in granting stock options to officers and directors and in ratifying grants to employees. SAC ¶¶ 15-17. All were aware of the improper option-granting practices at Brocade and signed inaccurate financial statements. Id. These Defendants also received faulted options. Id.

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Defendant Paul R. Bonderson, Jr. was one of Brocade's founders. SAC ¶ 18. Bonderson served as Brocade's Vice President of Engineering from August 1995 until November 2001, as Vice President of Strategic Development from November 2001 until January 2003, and as Chief Technology Officer and Chief Engineer from April 2003 until early 2005. Id. Bonderson was involved in the granting and pricing of stock options and was aware of the Company's improper practices. Id. He also received faulted options. Id. Defendant Robert D. Bossi was Brocade's Controller from May 1999 until June 2003. SAC ¶ 19. Bossi participated in administrative and reporting functions in connection with the improper grant of stock options. Id. Bossi received faulted options. Id. Defendant Jack Cuthbert served Brocade as an executive specializing in sales from 1998 until 2004. SAC ¶ 20. Cuthbert was aware of the improper practices at the Company and received faulted options. Id. 2. The Backdating Scheme

Facing an increasingly competitive market for the top technological talent, Brocade used stock options as a form of compensation in order to attract high-caliber employees. SAC ¶ 33. Reyes, in concert with Jensen, routinely provided extra compensation to employees (including themselves) that were backdated to coincide with low closing prices of Brocade's stock. SAC ¶ 58. This practice was contrary to the Company's stock-option plans, which required it to grant stock options with exercise prices based on the stock's fair market value on the actual grant date. SAC ¶ 56. Defendants knew that they were not adhering to the option plans, SAC ¶ 57, and actively manipulated the timing and exercise of stock-option grants, SAC ¶ 58. Defendants falsified the dates of stock-option grants, forged records relating to Board proceedings, and created sham programs to lower the exercise prices of stock-option grants or to change the vesting periods. SAC ¶ 59. Defendants sought to avoid recording the compensation expenses on the Company's financial statements. SAC ¶¶ 54, 57, 58. To implement this scheme, Reyes abused the authority purportedly given to him to grant stock options as a "committee of one." SAC ¶ 60. Reyes granted in-the-money options
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based on falsified documentation suggesting that the options has been granted on an earlier date, when the stock's market price was lower. Id. At the direction of Reyes, Jensen prepared documentation of backdated options. SAC ¶¶ 61-63. Other Defendants knew about and participated in this practice in various ways. SAC ¶ 65. The Compensation Committee purported to have held a meeting approving the issuance of options to eight executives, but such a meeting never occurred. SAC ¶ 67. Byrd implemented a program permitting new hires to select their own grant date for stock options, in contravention of the plans' terms. SAC ¶ 68. Byrd also created a "part-time" program that created artificial start dates for new employees. SAC ¶ 69. In total, the backdating practices led Brocade to issue tens of millions of faulted stock options that were mispriced under the Company's policies. SAC ¶ 70. Defendants' conduct caused the Company to materially misstate its equity option compensation expenses between 2000 and 2004, requiring Brocade twice to restate its public financial statement. SAC ¶ 54. Defendants hid these practices from auditors. SAC ¶ 71. The scheme allowed Brocade to retain key employees while falsely inflating the quality of Brocade's financial performance. SAC ¶ 74. The value of the stock options that Defendants received was enhanced, allowing Defendants to enrich themselves at the expense of the Company. SAC ¶ 75. 3. Discovery of Accounting Problems

In October 2004, Daniel Cudgma, a former employee, sent the Company a draft civil complaint that he intended to file. SAC ¶ 77. Cudgma had received backdated options under Brocade's "part-time" program when he joined the Company. Id. The Board's Audit Committee began an investigation on November 1, 2004 into the alleged improprieties. SAC ¶ 78. On January 6, 2005, Brocade announced that it intended to restate certain of its financial statements to record additional stock-based compensation expenses. SAC ¶ 82. On January 24, 2005, the Company restated its financial statements for 2002 and 2003. SAC ¶ 83. At that point, Reyes stepped down as CEO. SAC ¶ 85. On May 16, 2005, Brocade announced that it would again restate its financial statements for 2002 through 2004 to record
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additional charges for stock-based compensation expenses. SAC ¶ 89. The second restatement occurred on November 14, 2005. SAC ¶ 93. As a result of the Audit Committee investigations, the Board adopted remedial measures changing the strike price on the faulted options. SAC ¶ 96. The backdating scheme led to a panoply of legal proceedings. The United States Department of Justice brought criminal charges against Reyes and Jensen. In 2007, Reyes was convicted of ten counts related to securities fraud, and Jensen was convicted of two criminal counts. The SEC conducted a formal investigation of Brocade, which resulted in a settlement of $7 million. The SEC is also currently pursuing civil enforcement actions against Reyes, Jensen, Canova, and Byrd. A federal securities class action was filed in this Court against Brocade and its former officers on behalf of shareholders. On November 18, 2008, the Court granted preliminary approval of a settlement in that action in the amount of $160 million. A state securities class action is currently pending in California Superior Court. B. Procedural Background

In May 2005, several shareholder derivative actions were filed on behalf of Brocade in California Superior Court, alleging claims for breach of fiduciary duty and state law fraud. Pursuant to the parties' agreement, the state court has stayed proceedings pending the outcome of this litigation. Beginning in June 2005, several additional shareholder derivative actions were filed in this Court, alleging breach of fiduciary duty claims and violation of § 20(a) of the Exchange Act. See, e.g., Dkt. 1. The cases were consolidated into the instant matter. See Dkt. 31. On January 6, 2006, the Court dismissed the derivative action with leave to amend because the plaintiffs failed to demonstrate the futility of a pre-suit demand on Brocade's Board. See Dkt. 79. A formal demand was made on January 13, 2006. SAC ¶ 115. Brocade then entered into settlement discussions with the plaintiffs. SAC ¶ 116. The Court granted preliminary approval of the proposed settlement in February 2007. See Dkt. 126.

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The fairness hearing originally scheduled for April 27, 2007 was subject to multiple continuances as negotiations continued between the parties. See Dkt. 147, 158, 164, 180. On February 22, 2008, after settlement efforts stalled, Brocade's Board appointed the SLC to handle all matters relating to the derivative litigation. SAC ¶ 120. The SLC has full authority to pursue and resolve all claims relating to the backdating scheme. Id. The SLC determined it was independent and not under the influence of the alleged wrongdoers in pursuing this action on behalf of the Company. SAC ¶ 122. The SLC retained separate counsel and undertook its own investigation of these claims. SAC ¶¶ 121, 125-27. On June 18, 2008, the Court instructed the SLC to file its amended complaint. See Dkt. 216. The Second Amended Complaint was filed on August 1, 2008, see Dkt. 220, and on August 27, 2008, the Court realigned Brocade as the sole party-plaintiff in the current action, see Dkt. 251. The Second Amended Complaint asserts thirteen causes of action against the ten Defendants. They are: · (1) violation of the Racketeering Influenced and Corrupt Organizations Act ("RICO") § 1962(c) against Reyes, SAC ¶¶ 1317-30; · (2) violation of § 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5 against Reyes, Jensen, Byrd, Canova, Dempsey, Leslie, and Neiman, SAC ¶¶ 1331-45; · (3) violation of § 304 of the Sarbanes-Oxley Act ("SOX § 304") against Reyes and Canova, SAC ¶¶ 1346-58; · (4) violation of § 13(b) of the Securities Exchange Act of 1934 and SEC Rules 13b2-1 and 13b2-2 against Reyes and Canova, SAC ¶¶ 1359-71; · (5) breach of the fiduciary duty of care against Reyes, Jensen, Byrd, Canova, Dempsey, Leslie, Neiman, and Bossi, SAC ¶¶ 1372-83; · (6) breach of the fiduciary duty of loyalty through self-dealing against Reyes, Jensen, Canova, Dempsey, Neiman, Bonderson, Bossi, and Cuthbert, SAC ¶ 1384-92;
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(7) breach of the fiduciary duty of loyalty through lack of good faith against all Defendants, SAC ¶¶ 1393-1402;

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(8) breach of the fiduciary duty of loyalty through failure of oversight against Reyes, Jensen, Byrd, Canova, Dempsey, Leslie, Neiman, and Bossi, SAC ¶¶ 1403-13;

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(9) violation of §§ 1709 and 1710 of the California Civil Code against Reyes, Jensen, Byrd, Canova, Dempsey, Leslie, and Neiman, SAC ¶¶ 1414-20;

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(10) contribution from Reyes, Byrd, Canova, Dempsey, Leslie, and Neiman, SAC ¶¶ 1421-26;

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(11) unjust enrichment against Reyes, Jensen, Canova, Dempsey, Neiman, Bonderson, Bossi, and Cuthbert, SAC ¶¶ 1427-44;

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(12) breach of an employee's duty of undivided loyalty to his employer against Jensen and Bossi, SAC ¶¶ 1445-52; and

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(13) aiding and abetting a breach of fiduciary duty against Jensen and Bossi, SAC ¶¶ 1453-59.

On October 1, 2008, pursuant to the parties' stipulation, the Court dismissed the claims for self-dealing (sixth cause of action) and unjust enrichment (eleventh cause of action) against Defendants Dempsey and Neiman. Dkt. 284. In the subsequent months, all Defendants filed motions to dismiss, which are subject to the instant order.

III.

Legal Standards A. Rule 12(b)(6)

Pursuant to Federal Rule of Civil Procedure 12(b)(6), a complaint may be dismissed against a defendant for failure to state a claim upon which relief can be granted against that defendant. Dismissal may be based on either "the lack of a cognizable legal theory or the absence of sufficient facts alleged under a cognizable legal theory." Balistreri v. Pacifica Police Dep't, 901 F.2d 696, 699 (9th Cir. 1990). For purposes of evaluating a motion to
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dismiss, the Court "must presume all factual allegations of the complaint to be true and draw all reasonable inferences in favor of the nonmoving party." Usher v. City of Los Angeles, 828 F.2d 556, 561 (9th Cir. 1987). Any existing ambiguities must be resolved in favor of the pleading party. Walling v. Beverly Enters., 476 F.2d 393, 395-96 (9th Cir. 1973). Mere conclusions couched in factual allegations are not sufficient to state a cause of action. Papasan v. Allain, 478 U.S. 265, 286 (1986); see also McGlinchy v. Shell Chem. Co., 845 F.2d 802, 810 (9th Cir. 1988). The complaint must plead "enough facts to state a claim for relief that is plausible on its face." Bell Atl. Corp. v. Twombly, 550 U.S. 544, __, 127 S. Ct. 1955, 1974 (2007). Courts may dismiss a case without leave to amend if the plaintiff is unable to cure the defect by amendment. Lopez v. Smith, 203 F.3d 1122, 1129 (9th Cir. 2000). B. Requirements for Claims Under the Exchange Act

Claims brought under § 10(b) of the Exchange Act and Rule 10b-5 must meet the particularity requirements of Federal Rule of Civil Procedure 9(b), which requires that "[i]n alleging fraud or mistake, a party must state with particularity the circumstances constituting fraud or mistake." Fed. R. Civ. P. 9(b); see also In re Daou Sys., Inc. Sec. Litig., 411 F.3d 1006, 1014 (9th Cir. 2005). Moreover, these claims must also meet the stringent pleading standards of the Private Securities Litigation Reform Act ("PSLRA") of 1995. See 15 U.S.C. § 78u-4. The PSLRA amends the Exchange Act to require that a private securities fraud litigation complaint plead with particularity both falsity and scienter. See id. §§ 78u-4(b)(1)-(2); Daou, 411 F.3d at 1014. Specifically, a complaint alleging securities fraud must "specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed." 15 U.S.C. § 78u-4(b)(1); In re Vantive Corp. Sec. Litig., 283 F.3d 1079, 1084-85 (9th Cir. 2002). The plaintiff must also "state with particularity facts giving rise to a strong inference that the

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defendant acted with the required state of mind." 15 U.S.C. § 78u-4(b)(2); Daou, 411 F.3d at 1014.

IV.

Timeliness of Brocade's Claims The issue of timeliness features prominently in Defendants' motions to dismiss. If the

expiration of the applicable statute of limitations is apparent from the face of the complaint, the defendant may raise a statute of limitations defense in a Rule 12(b)(6) motion to dismiss. Jablon v. Dean Witter & Co., 614 F.2d 677, 682 (9th Cir. 1980). This is true even though expiration of the limitations period is an affirmative defense because Federal Rule of Civil Procedure 9(f) "makes averments of time and place material for the purposes of testing the sufficiency of a complaint." Suckow Borax Mines Consol. v. Borax Consol., 185 F.2d 196, 204 (9th Cir. 1950). The parties set forth various arguments as to why Brocade may not assert certain claims against them due to the expiration of the applicable period of limitations. Many of these arguments have merit; others do not. Brocade's claims fall into three general categories: the federal § 10(b) claim, the California state law claims, and the Delaware state law claims. A. Limitation Period Applicable to § 10(b) Claim

Under the Sarbanes-Oxley Act of 2002, the statute of limitations for a claim brought under § 10(b) is two years from the discovery of facts constituting the violation but no more than five years from the date of the violation. 28 U.S.C. § 1658(b). The five-year outer limitations period in a § 10(b) claim serves as a statute of repose. In re Maxim Integrated Prods., Inc., Deriv. Litig., 574 F. Supp. 2d 1046, 1071 (N.D. Cal. 2008). The two-year statute of limitations period begins to run on one of the following two dates: (1) the date the corporation had actual notice that the representation was false; or (2) the date the corporation, with some form of reasonable diligence, would have been placed on inquiry notice. See Livid Holdings Ltd. v. Salomon Smith Barney, Inc., 416 F.3d 940, 951 (9th Cir. 2005). The five-year statute of repose period may not be tolled and it begins to run on the date of the false representation. Maxim, 574 F. Supp. 2d at 1071. "Each false representation may
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constitute a separate violation of § 10(b); the five-year period begins to run with respect to each violation when it occurs." Id. "There can be no recovery for reliance on representations made prior to the five-year statute of limitations period under a theory of continuing wrong." Id. As a threshold matter, the Court rejects Defendants' contention that accrual on the fraud claims began at the point of their wrongful conduct, on the theory that Defendants' knowledge should be imputed to Brocade. See id. (company could not have discovered fraud from its directors and officers as they were the ones that concealed the wrongdoing). If Defendants' theory were accepted, it would create absurd results in that companies would be limited in their ability to seek relief from the fraudulent misdeeds of their officers and directors, even though others within the company or the shareholders were reasonably unaware of what was occurring. Regardless of the fact that the Company realized some benefit in recruiting and retention of employees from the backdating scheme, Defendants enjoyed ill-gotten gains while injuring the Company's reputation and subjecting it to protracted litigation. As Defendants' individualized knowledge will not be imputed to the Company, the point at which the two-year period of limitations began to run was October 2004, when Brocade had inquiry notice of the conduct giving rise to these claims. The statute of repose applies to limit the federal fraud action to conduct occurring after June 1, 2000, five years before the filing of the original federal complaint. B. Limitation Periods Applicable to California State Law Claims

The statute of limitations for the California statutory claim for fraud and deceit is three years, and it begins to run upon discovery of the facts constituting the fraud. Cal. Code Civ. P. § 338(d). The Company discovered the fraud in October 2004, so Plaintiff had until October 2007 to bring claims under §§ 1709 and 1710. Brocade also asserts claims against Defendants Jensen and Bossi for (1) breach of an employee's duty of loyalty; and (2) aiding and abetting a breach of fiduciary duty. The parties dispute whether these claims are subject to California or Delaware law. Courts in
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California apply the "internal affairs" doctrine, so that the laws of the state of incorporation generally govern causes of action that implicate a company's internal affairs. See In re Verisign, Inc., Deriv. Litig., 531 F. Supp. 2d 1173, 1214-15 (N.D. Cal. 2007); Cal. Corp. Code § 2116 (codifying the internal affairs doctrine for claims brought against "directors"). The Court is not convinced, however, that the internal affairs doctrine mandates that Delaware law apply to tort claims brought against individuals who are not fiduciaries of a plaintiff employer. See, e.g., Solow v. Stone, 994 F. Supp. 173, 177 (S.D.N.Y. 1998) (declining to apply internal affairs doctrine to aiding and abetting fiduciary claim). The Court thus holds that California law governs these claims. See Tucci v. Club Mediterranee, S.A., 89 Cal. App. 4th 180, 189 (2001) (California courts will apply California law unless a party demonstrates a true and material conflict with a foreign law, and the foreign state has a greater interest in having its law applied). The parties dispute whether these claims are subject to a three or four-year limitation period. Under California law, courts must consider the "gravamen" of a claim and the nature of the right sued on to determine the applicable statute of limitations. See Marin Healthcare Dist. v. Sutter Health, 103 Cal. App. 4th 861, 874-75 (2002). Brocade argues that these claims are most analogous to a breach of fiduciary duty claim, and therefore California's four-year statute of limitations for fiduciary duty claims should apply. See Cal. Code Civ. P. § 343. The discovery rule applies to this standard, so that the four-year period "begins to run when plaintiffs discovered, or in the exercise of reasonable diligence could have discovered, that facts had been concealed." Stalberg v. W. Title Ins. Co., 230 Cal. App. 3d 1223, 1230 (1991). Defendants argue that the gravamen of Plaintiff's claims sound in fraud because much of the SAC makes allegations related to Defendants' fraudulent conduct. California applies a three-year statute of limitations for fraud claims. Cal. Code Civ. P. § 338(d). The Court finds that Plaintiff's claims for breach of an employee's duty of loyalty and aiding and abetting a breach of fiduciary duty are most akin to a breach of fiduciary duty claim. California courts have defined the elements of these claims as analogous to a claim
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for breach of fiduciary duty. See Huong Que, Inc. v. Luu, 150 Cal. App. 4th 400, 410 (2007); see also James v. Childtime Childcare, Inc., 2007 WL 1589543, at *3 (E.D. Cal. June 1, 2007) ("The Ninth Circuit has described [an employee's] duty of loyalty as a `fiduciarylike' duty."). The allegations in the SAC do premise these claims on some of the same misconduct asserted to support the fraud claims, but that conduct may also support a finding that Defendants assisted others in breaching their fiduciary duties. The two claims are not mutually exclusive. Accordingly, these claims are timely because California's four-year statute of limitations for breach of fiduciary claims applies. C. Limitation Period Applicable to Delaware State Law Claims

Claims five through eight of the SAC allege breaches of fiduciary duty under Delaware law. Delaware applies a three-year statute of limitations to these claims. 10 Del. Code § 8106(a). Courts have applied that same period to equitable claims by analogy, Ryan v. Gifford, 918 A.2d 341, 359 (Del. Ch. 2007), so the unjust enrichment claim is also governed by a three-year limitations period. The statute "begins to run at the time that the cause of action accrues, which is generally when there has been a harmful act by a defendant." In re Tyson Foods, Inc. Consol. S'holder Litig., 919 A.2d 563, 584 (Del. Ch. 2007). "This is true even if the plaintiff is unaware of the cause of action or the harm." Id. The period may be tolled, however, if the plaintiff alleges fraudulent concealment. Id. at 585; Verisign, 531 F. Supp. 2d at 1215. For tolling to apply, a plaintiff must allege that "the facts were so hidden that a reasonable plaintiff could not have made timely discovery of an injury necessary to file a complaint." Id. (internal quotations marks omitted). Tolling extends until the plaintiff is on inquiry notice of his injury. Id. The period may also be tolled when a plaintiff has reasonably relied on the competence and good faith of a fiduciary. Tyson, 919 A.2d at 585. Here, the cause of action accrued in October 2004, at the point Brocade was on inquiry notice of Defendants' misconduct. Brocade has sufficiently pled that Defendants' collective misdeeds were concealed so that it was not on notice of the alleged fiduciary

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breaches until October 2004. Accordingly, the breach of fiduciary claims based on Delaware law were timely if asserted by October 2007. D. Application of Limitation Periods

The original state court action was filed in May 2005, naming Reyes, Canova, Dempsey, Neiman, Byrd, Leslie, and Bonderson as defendants. Cuthbert and Jensen were added as defendants in the state court action on July 6 and November 13, 2006, respectively. The original derivative complaint in this federal court action was filed on June 1, 2005, naming Reyes, Canova, Dempsey, and Neiman as defendants. Bossi did not appear as a defendant in any action, federal or state, until the SAC was filed on August 1, 2008. Accordingly, six of the ten Defendants (Jensen, Byrd, Leslie, Bonderson, Cuthbert, and Bossi) were not named in this federal action until August 1, 2008, over three years after both Brocade and public shareholders were put on notice of the alleged improprieties. As there are different considerations at play for the original and new federal Defendants, each group is discussed in turn. 1. Four Original Federal Defendants

Defendants Reyes, Canova, Dempsey, and Neiman were among the parties named in the original federal court complaint filed in June 2005, less than a year after Brocade had inquiry notice of Defendants' alleged misconduct. Defendants point out, however, that the original complaint did not include a claim alleging securities fraud. They argue that the fraud claims cannot be sustained because they were filed in August 2008, after § 10(b)'s twoyear statute of limitations and California's three-year statute of limitations had expired. a. Rule 15 Relation Back

Under Federal Rule of Civil Procedure 15(c)(1)(B), an amendment to a pleading relates back to the date of the original pleading when "the amendment asserts a claim or defense that arose out of the conduct, transaction, or occurrence set out ­ or attempted to be set out ­ in the original pleading." A threshold question is whether the SAC is an amendment or an entirely separate filing. Defendants argue that the SAC is a second, separate filing, and therefore cannot
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"relate back" to the first federal complaint. The Ninth Circuit has held that a second, separate complaint cannot "relate back" to the first complaint when the second complaint is not an amendment, but rather a separate filing. O'Donnell v. Vencor Inc., 466 F.3d 1104, 1111 (9th Cir. 2006) (per curiam) (holding second complaint is separate filing after first complaint was dismissed for failure to prosecute). This SAC, however, is not construed as a second filing but rather as a continuation of the original federal court action. On January 6, 2006, the original complaint was dismissed with leave to amend, due to lack of demand. Since then, Brocade decided to take on the action and formed an SLC to investigate the claims. The SAC is a result of its work. The parties have been actively engaged in litigating this matter since the original complaint was filed. If Brocade had decided not to pursue the derivative action, the original plaintiffs certainly would have been able to amend their complaint. There is no reason why, now that Brocade has opted to take on this litigation and has been realigned as the sole party-plaintiff, it should be deprived of the same opportunity. See Telxon Corp. v. Bogomolny, 792 A.2d 964, 973 (Del. Ch. 2001) (holding, under Delaware's analog to Rule 15, that company's amended complaint related back to the original derivative complaint). "It would create an unwarranted interference with the inherent power of boards of directors and lead to anomalous results if this court were to conclude that a timely filed derivative claim was time barred in the hands of a board of directors choosing to realign its interest to assert control of the litigation." Id.; see also In re Zoran Corp. Deriv. Litig., 511 F. Supp. 2d 986, 1011 (N.D. Cal. 2007) ("In a derivative action . . . the true plaintiff is the corporation; the shareholders bringing the action merely stand in the corporation's shoes."). Accordingly, relation back principles apply because the SAC flows from a preserved and timely original derivative complaint.1 Whenever the claim asserted in the amended pleading arose out of the conduct, transaction, or occurrence set forth in the original pleading, the amendment may relate back This same principle does not apply to the state court complaint, however. This complaint cannot "relate back" to the state court action, as it is clearly a separately filed claim from this federal action.
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to the date of the original pleading. Fed. R. Civ. P. 15(c)(1)(B). "[T]he relation back doctrine of Rule 15(c) is to be liberally applied." Clipper Exxpress v. Rocky Mtn. Motor Tariff Bureau, Inc., 690 F.2d 1240, 1260 n.29 (9th Cir. 1982). Here, the transactions that served as the basis for the original claims are the same transactions that are at the heart of the SAC. The original complaint was based on stock option grants made from 1999 through 2004 to new hires, to members of the "part-time" program, and to employees on leaves of absence. See VDC ¶¶ 66, 67, 74. These are the same facts that are at the center of the SAC, even though the SAC focuses on misstatements made in internal documents as opposed to the false and misleading financial statements that were the focus of the original complaint. When a company itself takes over derivative litigation, it is inevitable that it will have access to more information that will enable it to make more specific claims than what could be alleged in a pre-discovery initial pleading. The SAC is more in-depth than the original filing, but the complaints share a common core of operative facts. Because Brocade's claims arise out of the same stock option transactions, Rule 15(c) is satisfied and the claims in the SAC relate back to the original June 2005 filing date. See Martell v. Trilogy Ltd., 872 F.2d 322, 327 (9th Cir. 1989). Thus, there is no statutory time-bar to the claims asserted against Defendants Reyes, Canova, Dempsey, and Neiman. b. Indemnification Agreements

Apart from the issue of a statutory time-bar, Defendants Dempsey and Neiman also argue that Brocade is contractually barred from asserting a fraud claim under their individual indemnification agreements. These agreements provide: No legal action shall be brought and no cause of action shall be asserted by or in the right of the Company against Indemnitee . . . after the expiration of two years from the date of accrual of such cause of action, and any claim or cause of action of the Company shall be extinguished and deemed released unless asserted by the timely filing of a legal action within such two-year period; provided, however, that if any shorter period of limitations is otherwise applicable to any such cause of action, such shorter period shall govern.

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Both Delaware and California courts recognize contractual provisions shortening the relevant statute of limitations as valid and enforceable. See, e.g., Wesselman v. Travelers Indem. Co., 345 A.2d 423, 424 (Del. 1975) (per curiam); Hambrecht & Quist Venture Partners v. Am. Med. Int'l, Inc., 38 Cal. App. 4th 1532, 1548 (1995) (contractual agreement establishing a period of limitations is enforceable "provided it is reasonable."). Here, the indemnification agreement operates to bar the fraud claims newly brought against Dempsey and Neiman.2 Under the contract's plain language, Brocade is foreclosed from asserting "any claim or cause of action" more than two years after such claim or cause of action accrued. As discussed above, the fraud claims accrued in October 2004, at the point when the Company was put on inquiry notice of the backdating scheme. No § 10(b) or California fraud claim was asserted against these Defendants until August 1, 2008, more than four years later.3 Plaintiff argues that under Moreno v. Sanchez, 106 Cal. App. 4th 1415 (2003), the contractual period of limitations should be tolled. Even assuming that California law applies to this matter (an issue contested by the parties), Moreno merely stands for the limited proposition that a cause of action may not accrue in a suit against a home inspector until the injury is discovered. Id. at 1428-29. Applying the discovery rule here means that the § 10(b) claim accrued in October 2004, when the Company was put on inquiry notice of Defendants' conduct. Moreno simply cannot be extended far enough to relieve Brocade of the indemnification it agreed to provide Dempsey and Neiman. Rule 15's "relation back" principle is of no avail to Plaintiff here, as it applies to prevent the running of a statutory period of limitations. Here, Defendants seek protection under a contractual limitation agreement. Although the two complaints share the same core operative facts, Rule 15 was not intended to undermine an agreement between sophisticated

Defendant Reyes had a similar indemnification agreement with Brocade, but it was subject to a tolling agreement that deferred its application for two years. As such, Reyes is not 27 protected by the indemnification provision here.
2

28

Because the breach of fiduciary duty claims were timely filed in the original complaint, the indemnification agreement does not apply to bar those claims here.
3

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parties that defines the contours of their liability. The Company is bound by the contractual agreement it had with these Defendants, and its attempt to escape the agreement through arguments based on tolling is unavailing. Therefore, the claims for fraud under § 10(b) and California Civil Code §§ 1709 and 1710 are barred by the indemnification agreement as to Defendants Dempsey and Neiman.4 These claims are timely as to Defendant Canova as he was not subject to the same indemnification agreement and these claims do relate back to the filing of the original federal complaint. The claims are also timely as to Defendant Reyes as his indemnification agreement had been contractually tolled by the parties.5 2. Six New Federal Defendants

Defendants Jensen, Bossi, Leslie, Cuthbert, Bonderson, and Byrd were not named in the original federal complaint. Different considerations therefore apply as to whether it is appropriate to include them in the suit at this point. a. Rule 15 "Relation Back"

Under Rule 15, a new defendant may be made party to an existing complaint if (1) the claim arose out of the same conduct, transaction, or occurrence; (2) the new defendants received sufficient notice of the original action within 120 days so as not to be prejudiced in defending on the merits; and (3) the new defendants knew or should have known that "but for a mistake concerning the proper party's identity" the complaint would have included them. Fed. R. Civ. P. 15(c)(1)(C); Percy v. San Francisco Gen. Hosp., 841 F.2d 975, 978 (9th Cir. 1988). The main objective is avoiding prejudice to the party to be added. Id. Plaintiff argues that since all (except for Bossi) were party to the timely-filed state court

The Court notes that Defendants Byrd and Leslie also had the same indemnification agreement with Brocade. The analysis on the enforceability of the indemnification agreement applies in equal force to Defendants Byrd and Leslie. Because Byrd 25 and Leslie were not party to the original federal complaint, they are discussed separately. Ultimately, Byrd and Leslie need not rely on the contractual indemnification because Brocade's 26 claims are untimely against through application of the relevant statutes of limitation.
4

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27

The Court hereby clarifies its Memorandum Order issued on December 12, 2008. See Dkt. 375. There, the Court stated that the fraud claims were dismissed as to Defendant 28 Reyes as untimely. The claims are indeed dismissed, but on the ground that Plaintiff failed to state a claim for fraud. The merits of this claim are discussed below.
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action, they were put on notice of the likelihood of this suit and would not suffer prejudice as a result of defending in the federal venue. The first requirement of Rule 15 is met here because Plaintiff's claims arise out of the same transactions and core facts alleged in the original complaint. The second requirement of the relation back doctrine, notice, is also satisfied. "Informal notice is sufficient if it allows the defendant the opportunity to prepare a defense." Abels v. JBC Legal Group, P.C., 229 F.R.D. 152, 158 (N.D. Cal. 2005). As a result of their involvement with the state court action, Defendants had notice of the derivative federal complaint filed less than a month after the state law claim was filed. Defendants will not suffer significant prejudice since they have already been actively involved in defending similar claims, albeit in a different forum. The obstacle preventing amendment here is that the "mistake" prong of Rule 15(c) is not met. If these Defendants were omitted because they were unknown to the plaintiff at the time the complaint was filed, then amendment may be proper. See Kilkenny v. Arco Marine Inc., 800 F.2d 853, 856-58 (9th Cir. 1986). However, if a plaintiff is aware of the potential defendant's identity at the time the original complaint is filed, but is uncertain whether the potential defendant may be found liable, amendment is not allowed to defeat the statute of limitations. Brink v. First Credit Res., 57 F. Supp. 2d 848, 856 (D. Ariz. 1999). Similarly, if the plaintiff learns of the defendant within the limitations period, but seeks to add the defendant only after the period has expired, amendment is not allowed. Id. "In these two situations, the plaintiff's failure to add the defendant(s) before the expiration of the statute of limitations cannot be characterized as a `mistake concerning . . . identity' because the plaintiff was aware of the new party's identity before the statute of limitations had run." Id. "The defendant deserves the protection of the statute of limitations because he or she may believe the plaintiff made a conscious decision not to include him or her." Id.; see also Kilkenny, 800 F.2d at 857-58 ("Rule 15(c) was never intended to assist a plaintiff who ignores or fails to respond in a reasonable fashion to notice of a potential party"). The defendants who were not named in the original federal action are Byrd, Leslie, Bonderson, Cuthbert, Jensen and Bossi. As high-ranking officers and directors, it is hard to
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imagine that these parties were completely unknown to plaintiffs so as to make their omission from the original complaint a "mistake" under Rule 15. As this prong of the "relation back" doctrine is not satisfied, Brocade is not be permitted to escape the statute of limitations by amending the complaint, over three years after it was originally filed, to add these Defendants. Permitting amendment in these circumstances would extend the Rule 15 procedure beyond its intended scope. b. Equitable Tolling

Implicitly acknowledging that it does not meet the requirements of Rule 15 itself, Brocade attempts to rely on equitable tolling principles to bring the new Defendants into this suit. Under California and federal law, a statute of limitations may be tolled where the complaint reveals (1) timely notice to the defendant; (2) lack of prejudice; and (3) good faith and reasonable conduct by the plaintiff in filing the late claim. Daviton v. Columbia/HCA Healthcare Corp., 241 F.3d 1131, 1137-38 (9th Cir. 2001) (applying California law); Oltman v. Holland Am. Line, Inc., 538 F.3d 1271, 1280 (9th Cir. 2008) (federal law). Under Delaware law, tolling is available only until a plaintiff is on inquiry notice of the facts giving rise to the wrong. Weiss v. Swanson, 948 A.2d 433, 451 (Del. Ch. 2008). Equitable tolling simply does not apply under these circumstances. The doctrine is a judicially-created mechanism whereby a court may toll the running of the statute of limitations to avoid manifest injustice. It is usually invoked in circumstances where a plaintiff makes a technical pleading error and the statute of limitations expires before he can cure the defect. See, e.g., Burnett v. New York Cent. R.R., 380 U.S. 424, 429 (1965) (plaintiff injured in railway accident filed claim in wrong court; he "has not slept on his rights but, rather, has been prevented from asserting them" by mistake); Oltman, 538 F.3d at 1280 (couple sickened on cruise; their "timely state court complaint was dismissed for improper forum, they then promptly filed in federal court"). The equitable rationale supporting the tolling of a statute of limitations for diligent but mistaken plaintiffs is simply not present in this case. Tolling is available when "the interests of justice so require." Azer v. Connell, 306 F.3d 930, 936 (9th Cir. 2002). Defendants were
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likely on notice of these claims as a result of the state court action, but justice does not require application of the tolling doctrine in these circumstances. The state court action has not been dismissed, rather it has been stayed pending the outcome of this action. Thus, Plaintiff would not lose all remedies against the state court Defendants if equitable tolling is not permitted here. Furthermore, Plaintiff (through its shareholders) did file a timely complaint in federal court; yet they chose not to pursue a claim against certain Defendants. To apply tolling to this corporate Plaintiff would be an unwarranted extension of the doctrine's underlying principles, particularly where Brocade actively opposed this litigation for nearly two years before changing course. Brocade concedes that Rule 15 alone is insufficient to add these new Defendants, but argues that equitable tolling plus relation back should permit the untimely claims. Plaintiff's argument compounds two separate doctrines and asks this Court to come to an unprecedented conclusion. Neither relation back nor equitable tolling applies here, and looking at the two doctrines in concert does not remedy the problem. Accordingly, the claims asserted in the SAC that have a statute of limitations of less than four years are barred as to Defendants Byrd, Leslie, Bonderson, Cuthbert, Jensen and Bossi. Equitable tolling does not apply, and the requirements for "relation back" under Rule 15 have not been met.

V.

The Merits of the Claims Insofar as the Court finds certain claims are not time-barred, it proceeds to a

discussion of whether Brocade has met its pleading burden on the remaining causes of action. A. Claim One - Civil RICO Liability

Plaintiff alleges a claim under the civil RICO statute against Defendant Reyes. The PSLRA amended RICO to eliminate liability for most securities fraud claims, but such a claim remains viable against any person convicted on criminal charges in connection with the fraud. 18 U.S.C. § 1964(c). Reyes was convicted on ten counts stemming from the conduct alleged in the SAC.
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The federal RICO statute provides that "[a]ny person injured in his business or property by reason of a violation of [18 U.S.C. § 1962]" has a cause of action for which treble damages may be recoverable. 18 U.S.C. § 1964(c). Section 1962 creates substantive civil liability for racketeering activity. See 18 U.S.C. § 1962. The Supreme Court has held that this "by reason of" language requires that RICO plaintiffs show proximate causation, one aspect of which is a "direct relation between the injury asserted and the injurious conduct alleged." Holmes v. Sec. Investor Prot. Corp., 503 U.S. 258, 268 (1992). "Thus, a plaintiff who complains of harm flowing merely from the misfortunes visited upon a third person by the defendant's acts [is] generally said to stand at too remote a distance to recover." Id. at 268-69. The RICO claim is dismissed because the SAC fails to allege that any injuries suffered by Brocade were the "preconceived purpose" or "specifically-intended consequence" of Reyes' acts. See In re American Express Co. S'holder Litig., 39 F.3d 395, 400 (2d Cir. 1994); Meng v. Schwartz, 116 F. Supp. 2d 92, 96 (D.D.C. 2000) (dismissing RICO claim where "[n]owhere in the plaintiffs' pleading is there a claim that [the defendant] sought to harm [the plaintiff] through his actions"). To the contrary, the SAC alleges that Reyes used the backdating program in part to attract and retain talented individuals, to the benefit of the company. See SAC ¶¶ 32, 74, 188. These allegations undermine Brocade's RICO claim. Where conduct was not intended to injure the plaintiff, a RICO claim may not survive, even if the plaintiff eventually suffered harm. See American Express, 39 F.3d at 400; Meng, 119 F. Supp. 2d at 96-97. The Court is not persuaded that Reyes acted in the sole interest of benefitting Brocade, but no facts are alleged showing that Reyes set out specifically to injure the Company. To the contrary, the complaint suggests the injury to the Company was an ancillary consequence of Reyes' misdeeds. See also In re Teledyne Def. Contracting Deriv. Litig., 849 F. Supp. 1369, 1374 (C.D. Cal. 1993). Accordingly, this claim is dismissed with leave to amend. /// ///
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B

Claims Two and Nine - Fraud Under Federal and State Law

The fraud claims are not categorically time-barred only as to Defendants Reyes and Canova. The fraud claims stem from the same core of operative facts as those alleged in the original federal complaint, so relation back is appropriate. Canova was party to the original federal court action and did not have an indemnification agreement with Brocade; Reyes' indemnification agreement had been tolled. 1. Section 10(b) Claim

Liability for violation of § 10(b) of the Exchange Act and Rule 10b-5 lies in connection with either (i) a material misrepresentation or omission or (ii) conduct that constitutes a deceptive act or furtherance of a fraudulent scheme, including any device, scheme, or artifice to defraud. 15 U.S.C. § 78j(b); 17 C.F.R. § 240.10b-5. To state a claim, Plaintiff must plead (1) a misrepresentation or the use or employment of any manipulative or deceptive device or contrivance; (2) scienter; (3) a connection with the purchase or sale of a security; (4) reliance; (5) economic loss; and (6) loss causation. Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, Inc., 128 S. Ct. 761, 768 (2008); Dura Pharm., Inc. v. Broudo, 544 U.S. 336, 341 (2005). Claims brought under this section are subject to the heightened pleading requirements under Fed. R. Civ. P. 9(b) and the PSLRA. Plaintiff must, therefore, plead sufficiently particularized facts to support its allegations concerning false or misleading statements. See Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S. Ct. 2499, 2504 (2007). Plaintiff must "specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed." 15 U.S.C. § 78u-4(b)(1). To survive a motion to dismiss, Plaintiff must allege that a party played a primary role in the faulted option grants; a claim for aiding and abetting in a private action under §10(b) can no longer be maintained. See Stoneridge, 128 S. Ct. at 769. The inquiry is whether a defendant offered "substantial participation" so that he may be considered a "primary
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violator" of the securities laws. Simpson v. AOL Time Warner Inc., 452 F.3d 1040, 1048 (9th Cir. 2006), vacated on other grounds sub nom. Avis Budget Group, Inc. v. Cal. State Teachers' Ret. Sys., 128 S. Ct. 1119 (2008). To be held liable as a primary violator, the defendant "must have engaged in conduct that had the principal purpose and effect of creating a false appearance of fact in furtherance of the scheme." Id. "It is not enough that a transaction in which a defendant was involved had a deceptive purpose and effect; the defendant's own conduct contributing to the transaction or overall scheme must have had a deceptive purpose and effect." Id. A defendant does not actually have to have made the fraudulent statements to be held liable, but a plaintiff must show more than a generalized scheme of misconduct. Id.; Stoneridge, 128 S. Ct. at 769. Brocade's § 10(b) claim is not based on misrepresentations in the company's financial statements. Rather, it challenges statements made in the Company's internal option granting documents. It is undisputed that Defendant Canova was neither the author nor the signatory of those documents. Thus, the Company's § 10(b) theory is that Canova either (a) "substantially participated" in the making of the false statements; or (b) committed "deceptive acts" related to the statements. The allegations against Defendant Canova are as follows: · Canova, Brocade's CFO, was in charge of the Finance Department and therefore responsible for maintaining accurate records of stock-option grants. SAC ¶ 762. · He was involved in creating the financial formula used to determine the number of supplemental options to grant through under the April 20, 2001 "Add-On Program." SAC ¶ 393. He then received supplemental options through the Add-On Program. SAC ¶¶ 394-95. · He received an email from Defendant Bossi stating: "If you recall we had all been jumping through hopes [sic] and bending over backwards for this guy . . . including forging option paperwork and offer letters so he could get better priced options." SAC ¶ 488.

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·

He failed to react to investigate after receiving emails indicating possible manipulation of option grants. SAC ¶¶ 1084-85, 404.

·

He was "involved in" the granting of options to purported "part-time" employees. SAC ¶¶ 184-85.

·

He "understood that new hires were granted stock options with exercise prices based on dates before their full-time employment began [and] understood that those earlier dates were chosen because the stock prices were lower on those dates." SAC ¶ 776.

·

He approved backdating options for an operations director, but stated he "didn't want this happening again." SAC ¶ 1088.

·

He knew that a failure to adhere to Company policies governing stock options could result in a compensation charge. SAC ¶ 1092. Nonetheless, he helped Bonderson select a termination date to give him a longer exercise period for his options. SAC ¶ 1095. He was also aware that another terminated employee had received extended vesting periods. SAC ¶ 1096. None of these factual assertions has the effect of demonstrating that Canova was a

"primary violator" of the securities laws. It is not clear what specific misrepresentations Canova is allegedly responsible for, or that his own conduct had a deceptive purpose. While these allegations may show that Canova was complicit in the backdating scheme, they do not show that his conduct was primarily responsible for any specific material misrepresentation. As for Defendant Reyes, the obstacle is reliance. Brocade's pleading is devoid of allegations that would show reliance in connection with the purchase or sale of a security. In Verisign, this court held that reliance is not proven where a complaint "does not identify a single [company] officer or director who relied on the supposedly false or misleading financial statements in deciding to undertake the stock repurchase on [the company's] behalf." 531 F. Supp. 2d 1173, 1209 (N.D. Cal. 2007). Brocade has not identified any individuals who actually relied on the false grant documentation. Rather, the SAC suggests that knowledge of the improper conduct was widespread amongst the corporate decisionmakers.
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Brocade asks us to reject the holding in Verisign, in accord with In re Countrywide Financial Corp. Derivative Litigation, 554 F. Supp. 2d 1044, 1073 (C.D. Cal. 2008). However, the misrepresentations at issue in Countrywide were public and caused investors to rely on erroneous information. See id. at 1053. Countrywide is inapposite because here, Brocade's claim relies upon alleged misrepresentations made in internal documentation within the Company. Under this theory, Brocade must show reliance by internal decisionmakers rather than simply show general market reliance on public misstatements. In sum, the § 10(b) claim against both Reyes and Canova is dismissed with leave to amend.6 2. State Fraud Claims

Sections 1709 and 1710 of the California Civil Code are codifications of common-law fraud and negligent misrepresentation. See Small v. Fritz Cos., 30 Cal. 4th 167 (2003). To recover for intentional fraud, a plaintiff must allege that (1) a defendant misrepresented a past or existing material fact; (2) the defendant knew the fact was false; (3) the defendant intended to induce a plaintiff's reliance; (4) the plaintiff reasonably relied on the misrepresentation; and (5) damages resulted. Id. at 173. For a negligent misrepresentation claim, the defendant need not have knowledge of the falseness of his representation or the intent to defraud. Id. A claim for fraud under state law must meet the particularity requirements of Fed. R. Civ. P. 9(b). Id. at 184. The federal fraud claim is subject to a more exacting standard than the state law claim. Yet, for the same reasons discussed above as to why Brocade failed to meet its pleading burden on the federal claim, the Court dismisses the California fraud claims against Defendants Reyes and Canova.

Because it is not beyond doubt that Plaintiff could allege some set of facts consistent with its complaint that would entitle it to relief, the Court must dismiss these claims with leave to amend. See Schreiber Dist. v. Serv-Well Furniture Co., 806 F.2d 1393, 1401 (9th 27 Cir. 1986). Yet it is unclear what more could possibly be said. The Court has the impression that Plaintiff has played all of its cards in its 282-page complaint. If Brocade was not able to set 28 forth a fraud claim in that lengthy document, it is hard to imagine what more could be added to plead a fraud claim against Canova or Reyes with the requisite specificity.
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C.

Claims Three and Four - Section 304 of the Sarbanes-Oxley Act and Section 13(b) of the Exchange Act

Every court to address the issue has held that there is no private right of action under Section 304 of the Sarbanes-Oxley Act (SOX § 304). This Court does not hold otherwise. After briefing was completed in this matter, the Ninth Circuit issued an opinion that considered the language and history of this provision and ultimately concluded "that section 304 does not create a private right of action." In re Digimarc Corp. Deriv. Litig., __ F.3d __, 2008 WL 5171347, at *8 (9th Cir. Dec. 11, 2008). Under Digimarc, Plaintiff's arguments on this issue are expressly foreclosed. Claims Three and Four are hereby dismissed. D. Claim Five - Duty of Care

After applying the statue of limitations, a duty of care claim remains as to Defendants Reyes, Canova, Neiman, and Dempsey. Fiduciaries have an obligation to use the "amount of care which ordinarily careful and prudent men would use in similar circumstances" in managing the affairs of a corporation. In re Walt Disney Co. Deriv. Litig., 907 A.2d 693, 746 n.402, 749 (Del. Ch. 2005) (internal quotation marks omitted). To plead a violation of the duty of care, a plaintiff need not allege that a defendant knowingly breached or even consciously disregarded his fiduciary duty to the company; gross negligence is sufficient. See Cinerama, Inc. v. Technicolor, Inc., 663 A.2d 1134, 1148 (Del. Ch. 1994). Defendants make various arguments regarding the sufficiency of Brocade's allegations on this claim. At the very least, Brocade has adequately pled conduct amounting to gross negligence. The SAC alleges Defendants approved, administered, ratified, and/or accepted faulted options grants. This conduct, if true, states a claim for breach of the fiduciary duty of care. The Court is not persuaded that Defendants Neiman and Dempsey are protected by 8 Del. Code § 141(e) as a matter of law. That provision permits directors reasonably to rely on the expertise of management, yet it does not allow directors to completely delegate away their fiduciary responsibilities. As the facts are currently pled, it is not clear that Defendants Neiman and Dempsey are exculpated from their alleged breaches of fiduciary duties because
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they purportedly relied on Reyes' representations. In addition, Brocade alleges that the Compensation Committee Defendants were themselves negligent in signing off on backdated options ­ not simply that they are liable for Reyes' actions. Defendants further argue that Brocade's Certificate of Incorporation relieves them from liability on a duty of care claim. The Charter includes an indemnification provision, but not an exculpatory provision. The two are not the same. The indemnification provision "does not necessarily preclude personal liability for these directors because [indemnification] is not a grant of absolute immunity." Bergstein v. Texas Int'l Co., 453 A.2d 467, 471 (Del. Ch. 1982). The Court also refuses to hold that Brocade is estopped from changing positions with respect to indemnification. Before the SLC was involved in this litigation, Brocade made statements that are contrary to its current position on this issue. Judicial estoppel is a doctrine that precludes a party from gaining an advantage by taking one position, and then seeking a second advantage by taking an incompatible position. Rissetto v. Plumbers & Steamfitters Local 343, 94 F.3d 597, 600 (9th Cir. 1996). A court has discretion in determining whether to invoke this equitable doctrine. Id. at 601. In this instance, the Court refuses to hold that Brocade is barred from taking a position contrary from what it asserted in a letter to the Santa Clara Superior Court. Judicial estoppel will not apply. Finally, there is evidence that an exculpatory provision was intended to be part of Brocade's Charter, but was mistakenly omitted. Brocade was originally a California corporation and had such a provision. In 1999, Brocade was reincorporated as Delaware company. The new Certificate of Incorporation omitted this provision, but had two identical indemnity provisions appearing back to back. This suggests that the exculpation language was inadvertently left out of the new charter. If an error occurred, a company may seek to correct its charter under 8 Del. Code § 103(f) or to reform it under the common law of reformation. A correction is effective "as of the date the original instrument was filed, except as to those persons who are substantially and adversely affected by the correction and as to those persons the instrument as corrected
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