UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF CALIFORNIA
W. DOUGLAS STITT, On Behalf of Himself
and All Others Similarly Situated,
No.
CLASS ACTION
Plaintiff,
vs.
SCIENTIFIC LEARNING CORPORATION,
SHERYLE J. BOLTON, DR. PAULA A.
TALLAL, FRANK M. MATTSON, DR.
MICHAEL M. MERZENICH and DR.
WILLIAM M. JENKINS,
COMPLAINT FOR
VIOLATION OF
THE FEDERAL SECURITIES
LAWS
Defendants.
DEMAND FOR JURY TRIAL
INTRODUCTION AND OVERVIEW
1. This is an action on behalf of those who purchased or otherwise acquired
Scientific Learning Corporation ("Scientific" or the "Company") stock between
5/1/00 and 7/11/00 (the "Class Period") against Scientific and certain of its
executive officers for violation of the federal securities laws.
2. Scientific develops , markets and sells neuroscience -based software and
educational products and services designed to increase human learning and
performance . The Company's Fast ForWord product is an intensive computerbased training program that focuses on improving critical language and reading
skills.
3. Defendants' false and misleading statements concerning the revenues to be
derived from Scientific's sales of its software artificially inflated the price of
Scientific stock to a Class Period high of $23'/4. This upsurge in Scientific's stock
caused by defendants' false and misleading statements enabled defendants to sell
68,300 Scientific shares for proceeds of $1.3 million. On 7/11/00, and days after
defendants had pocketed over $1.3 million in illegal trading proceeds, Scientific
revealed that it was in fact suffering a huge drop in revenues associated with
changes in executive leadership (i.e., superintendent of four separate school
districts). This announcement caused its stock price to drop to as low as $6-3/16 on
record volume on 7/12/00 causing millions of dollars in damages to members of
the Class.
JURISDICTION AND VENUE
4. (a) The claims asserted herein arise under §§10(b) and 20(a) of the Securities
Exchange Act of 1934 ("1934 Act"), 15 U.S.C. §§78j(b) and 78t(a), and Rule lOb5. Jurisdiction is conferred by §27 of the 1934 Act, 15 U.S.C. §78aa. Venue is
proper here pursuant to §27 of the 1934 Act. Acts and transactions giving rise to
the violations of law complained of occurred here.
(b) Assignment of this action to the San Francisco or Oakland Division is
appropriate as a substantial part of the acts or omissions identified herein occurred
in Alameda County.
THE PARTIES
5. Plaintiff W. Douglas Stitt purchased shares of Scientific common stock as
described in the attached certification and was damaged thereby.
6. Defendant Scientific maintains its headquarters at Berkeley , CA. During the
Class Period, Scientific ' s common stock traded in an efficient market on the
NASDAQ National Market System.
7. (a) Defendant Sheryle J. Bolton ("Bolton") was, during the Class Period,
President and Chief Executive Officer of the Company.
(b) Defendant Dr. Paula A. Tallal ("Tallal") was, during the Class Period,
Chairman and Executive Vice President of the Company. Tallal sold 4,600 shares
during the Class Period for proceeds of over $80,000 from her insider trading
activity.
(c) Defendant Frank M. Mattson ("Mattson") was, during the Class Period,
Executive Vice President and Chief Operations Officer of the Company . Mattson
sold 10,000 shares during the Class Period for proceeds of over $170, 000 from his
insider trading activity.
(d) Defendant Dr. Michael M. Merzenich was, during the Class Period, Chief
Scientific Officer and a director of the Company. Merzenich sold 13,500 shares
during the Class Period for proceeds of over $220,000 from his insider trading
activity.
(e) Defendant Dr. William M. Jenkins was, during the Class Period, Vice
President, Product Development, of the Company. Jenkins sold 40,200 shares
during the Class Period for proceeds of $640,000 from his insider trading activity.
8. The individuals named in ¶7(a)-(e) are the "Individual Defendants." They are
liable for the false statements pleaded herein at ¶20, as those statements were each
"group-published" information for which they were collectively responsible. The
Individual Defendants, by reason of their stock ownership and positions with
Scientific, were controlling persons of Scientific. Scientific controlled each of the
Individual Defendants. These controlling persons are liable under §20(a) of the
1934 Act.
SCIENTER AND SCHEME ALLEGATIONS
Scheme
9. Each defendant is liable for making false statements or for failing to disclose
adverse facts and for participating in a fraudulent scheme which operated as a fraud
or deceit on purchasers of Scientific stock.
Knowledge
10. The Individual Defendants are each top executives of Scientific. They ran
Scientific as "hands-on" managers, dealing with important issues facing Scientific's
business, i.e., its relationship with its customers (i.e., the school districts of
Philadelphia, Dallas, Washington, DC and Las Vegas), Scientific's market-share
position, and the growth of the neuroscience education product segment of the
market upon which Scientific's business depended.
11. A key factor in Scientific's competitive position was its ability to offer its
neuroscience-based educational products to school districts. Defendants closely
monitored their relationships with the superintendents of certain school districts,
including Philadelphia, Washington, DC, Dallas and Las Vegas. As a result of the
Individual Defendants' monitoring, each defendant was aware that Scientific would
be unable to achieve the stated Q2 projections. Defendants knew that the demand
for its products in the Philadelphia, Washington D.C., Dallas and Las Vegas school
districts did not exist and as a result (which they knew prior to 5/01/00) its future
earnings estimates would be unattainable.
Motive and Opportunity
12. In addition to having actual knowledge of the falsity of their statements, each
of the defendants had the motive and the opportunity to perpetrate the fraudulent
scheme and course of business described herein. During the Class Period,
defendants were attempting to artificially inflate the price of scientific shares in
order to capitalize on such inflation and sell $1.3 million worth of their Scientific
shares.
FALSE AND MISLEADING STATEMENTS
DURING THE CLASS PERIOD
13. On 5/1/00, Merrill Lynch issued a report on Scientific written by Moe
repeating statements made by Mattson. The report was entitled "Scientific
Learning Comfortable with Revenue and EPS Estimates" and repeated statements
made by Mattson with the intent that they would be relied upon and repeated to
investors. The report reiterated statements made in a 4/28/00 report that Mattson
was comfortable with revenue estimates of $4.9 million for 2ndQ 00 and went on
to state:
We believe Scientific Learning is in a unique position to capture a unique and
growing opportunity. SCIL's neuroscience-based and patented software programs
provide a powerful solution to schools and families with children who are
struggling to read, and the opportunity to expand its solution to reach adolescents,
adults, non-native English speakers, is significant. We have confidence in the
company's high-quality management team to rapidly grow the company's presence
in schools, to capitalize on Internet opportunities and to develop and release new
products.
***
We think Scientific Learning is poised for continued significant growth. 1 Q00
revenues of $3.4 million were up 156% over last year's $1.3 million. Revenues in
1999 were up 98% year over year, hence we have seen an acceleration above the
company's already strong growth rate. SCIL shares currently trade at a P/E of
16.6x on 2001 EPS, and with a long-term projected growth rate of 40%, trade at a
P/E to growth rate of only 42% on 2001 EPS. Additionally, SCIL trades at a price
to sales of only 2.2x our 2001 revenue estimates of $65.5 million, a significant
discount to comparable publicly traded companies. We reiterate our Buy rating and
our price objective of $40.
14. On 5/8/00, Thomas Weisel Partners issued a report on Scientific written by
Gay, repeating Mattson's statements. These statements were made by Mattson with
the intent that they would be relied upon and repeated to investors. The report
forecast second quarter revenue of $4.8 million and reiterated a "strong buy."
15. On 5/9/00, Thomas Weisel Partners issued a report on Scientific written by
Gay, repeating Mattson's statements. These statements were made by Mattson with
the intent that they would be relied upon and repeated to investors. The report
forecast second quarter revenues of $4.8 million.
* We remain comfortable with our Q2 revenue estimate of $4.8 million, and EPS
net loss estimate of $0.47. This is based on the Company's entering Q2 with $2.75
million of deferred revenue, good April billings and management's indication that
the near-terms sales pipeline is strong.
16. On 5/11/00, Thomas Weisel Partners issued a report on Scientific written by
Gay, repeating Mattson's statements. The statements were made by Mattson with
the intent that they would be repeated to investors. The report forecast second
quarter revenues of $4.8 million and stated:
* Evidence of substantial financial benefit is beginning to flow in from customers
using SCIL's revolutionary neuroscience-based products.
* The superintendent of a PA district predicts that the effectiveness of the programs
in returning struggling students to mainstream education will save the district
roughly $35,000 per student over the course of their education.
* We believe today's announcement is significant because it should dispel some
investor concern over the $500-$600 price point of SCIL's programs and provide
the Company's salesforce with an effective "bottom line" angle to approach
districts.
***
Cost Savings Puts Price Point in Perspective: We believe today's announcement is
a significant revelation which should dispel any concern that the price point for
SCIL's program is too high. Considering the level of cost savings that the program
produces, we believe $500-$600 per program is a bargain for these districts. With
the U.S. spending more than $32 billion every year on special education, we
believe SCIL offers an attractive alternative for districts that not only works, but
costs 1/60th as much as current methods.
More Ammunition for the Sales Force: In education today, districts are faced with
enormous pressure to improve student achievement without an increase in funding.
As a result, we believe superintendents are hungry for quality, cost-effective
solutions that provide the greatest "bang for the buck." We believe SCIL offers
such a solution, and this recent announcement should provide the Company's
salesforce with an effective "bottom line" angle to approach districts. We believe
increased awareness of SCIL's opportunity cost savings will drive accelerated sales
to financially constrained districts, a.k.a. all of them.
SCIL remains the best small-cap education technology idea in our universe,
boasting the most effective speech, language and reading program in the market
today. Despite the Company's superior product and highly defensible position,
SCIL trades at a discount to other providers. We reiterate our STRONG BUY
rating on SCIL.
17. On 6/9/00, Pacific Growth Equities issued a report on Scientific written by
Dietz, repeating Mattson's statements. These statements were made by Mattson
with the intent that they be relied upon and repeated to investors. The report
forecasted 2ndQ 00 revenue of $5.1 million and stated:
* Scientific Learning signed its largest contract ever in May. We expect the
contract to be worth in excess of $500,000 to Scientific Learning - an amount that
should go a long way to meeting the Company's Q2:00 revenue estimates (we are
at $5.1 million). This milestone gives us reason to believe the Company is heading
in the right direction, and better times are ahead. We reiterate our Buy rating.
18. On 6/16/00, Pacific Growth Equities issued a report on Scientific written by
Mulcahy, repeating Mattson's statements. These statements were made by Mattson
with the intent that they would be repeated to investors. The report forecast 2ndQ
revenue of $5.1 million, and went on to state:
* In our last note we outlined that Scientific Learning had signed its largest
contract ever with the Chicago Public Schools. We expect similar announcements
over the next several months as the Company has extended its advertising
campaign in an effort to capitalize on its early success in the public school channel.
At this stage we believe these additional expenses are largely one-time in nature
reflecting a targeted campaign during the second quarter. Although we expect the
higher targeted advertising spend will drive revenues going forward, the impact on
this quarter will be additional expenses in our model. Thus, we are adjusting our
Q2:00 EPS estimates to better reflect the Company's expense uptick during the
quarter.
***
We are confident the Company will be able to meet our unchanged revenue
estimate of $ 5.1 million and our new EPS estimate of ($ 0.46) this quarter.
Therefore, we are reiterating our Buy rating on the stock.
19. As Scientific's stock increased in price due to these very positive statements
about Scientific's business detailed at ¶¶13-18, Scientific's insiders Jenkins,
Mattson, Merzenich and Tallal took advantage of this artificial inflation of
Scientific's stock by selling off 40,200, 10,000, 13,500 and 4,600, respectively,
shares of their stock at as high as $18 per share, pocketing $640,000, $170,000,
$229,000, $80,000, respectively, in illegal insider trading proceeds. In total,
between 5/12/00 and 6/16/00, a period ofjust 34 days, the Individual Defendants
unloaded 68,300 shares of their Scientific stock for $1.3 million in illegal insider
trading proceeds.
20. On 7/11/00, Scientific announced revenues of only $3.7 million for its 2ndQ.
The release went on to state:
Scientific Learning Corporation (Nasdaq: SCIL) today announced its revenues for
the second quarter of 2000 are $3.7 million. While lower than expected, this
represents an increase of 80% compared to $2.1 million reported in the second
quarter of 1999, as the Company continues to expand sales of its language and
reading programs to public schools.
***
For the quarter ended June 30, 2000, the Company's net loss was $6.3 million or
$.56 per share compared to a net loss of $4.0 million or $1.35 per share in the
comparable quarter of 1999.
***
Commenting on recent developments in the public school market, Ms. Bolton
noted that "many large districts, such as Philadelphia, Washington, DC, Las
Vegas and Dallas, and a long and growing list of others, have recently changed
their executive leadership as more and more communities demand accelerated
student academic achievement. Some of these changes occurred in the last days of
this quarter and have delayed decision-making in many districts. We remain in
ongoing and serious discussion with many of these districts and expect contracts to
be finalized later this year."
21. Even defendants' explanation for Scientific's disappointing 2ndQ 00 results was
false and misleading. Scientific 's press release stated:
Commenting on recent developments in the public school market, Ms. Bolton
noted that "many large districts, such as Philadelphia, Washington, DC, Las
Vegas and Dallas, and a long and growing list of others, have recently changed
their executive leadership as more and more communities demand accelerated
student academic achievement. Some of these changes occurred in the last days
of this quarter and have delayed decision-making in many districts. We remain in
ongoing and serious discussion with many of these districts and expect contracts to
be finalized later this year."
22. While, there have been changes in the superintendents of these districts, these
changes were not the cause of any unexpected change in Scientific's business. In
fact, the as to the school districts in Washington D.C. and Las Vegas, the
Individual Defendants were aware well before the end of the 2ndQ 00 that the
superintendents were changing. As to the change in Dallas, there had been
indications for months that the superintendent might be dismissed. When he was
dismissed it was after the end of the quarter, i.e., too late to affect any purchasing
decision related to Scientific. The Philadelphia school district's superintendent
resigned well before the end of Scientific's 2ndQ 00. This information is based
upon the following:
• Las Vegas: The superintendent of the Clark County School District, Brian Cram,
was due to retire on 7/31/00. Thus, in early 4/00, the District hired Carlos Garcia to
be superintendent upon Cram's retirement. Cram was with the district for 11 years
and his retirement date had been set for some time. Thus, there was nothing
unexpected about the retirement and the new administration will not take over until
the 3rdQ of Scientific's year and this change would not affect sales by Scientific in
the 2ndQ 00.
• Washington, DC: The current superintendent of the Washington, D.C. school
district, Arlene Ackerman, was offered the same position in San Francisco in mid
5/00. She accepted the position in late 5/00 and was due to leave Washington, D.C.
on 7/17/00. Thus, the Individual Defendants knew by late 5/00 that there would be
a change in that district and the change did not occur until after the 2ndQ 00.
• Dallas: The Dallas Morning News reported on 7/12/00, the following: "The
timing of Superintendent Bill Rojas' dismissal last week was particularly
unfortunate. Although the superintendent and the school board had discussed his
possible departure for some time, the vote last Wednesday [July 5th] came just as
the new school budget was being unveiled." Accordingly, the possibility that Rojas
might be leaving had been discussed for "some time" and was not a surprise to
Scientific. His actual dismissal came after the 2ndQ 00 had ended, too late to affect
Scientific's sales.
• Philadelphia: The Philadelphia Inquirer on 6/6/00 reported that "Philadelphia
School District Superintendent David Hornbeck resigned yesterday, citing a lack of
money for his education agenda and a recognition that the district needs a new
leader to improve relations with Harrisburg." Hornbeck's resignation, "effective
Aug. 15, came at a City Hall news conference at which Mayor (John) Street
embraced Hornbeck, lauded his six-year tenure, and defended his feisty criticism of
state funding." The defendants were therefore aware of the change prior to selling
their shares in 6/00 and prior to telling analysts to slightly reduce 2ndQ 00 earnings
estimates on 6/16/00.
CLASS ACTION ALLEGATIONS
23. This is a class action on behalf of purchasers of Scientific stock between 5/1/00
and 7/11/00, excluding defendants (the "Class"). Excluded from the Class are
officers and directors of the Company, as well as their families and the families of
the defendants. Class members are so numerous that joinder of them is
impracticable.
24. Common questions of law and fact predominate and include whether
defendants: (i) violated the 1934 Act; (ii) omitted and/or misrepresented material
facts; (iii) knew or recklessly disregarded that their statements were false; and (iv)
artificially inflated Scientific's stock price and the extent of and appropriate
measure of damages.
25. Plaintiffs claims are typical of those of the Class. Prosecution of individual
actions would create a risk of inconsistent adjudications. Plaintiff will adequately
protect the interests of the Class. A class action is superior to other available
methods for the fair and efficient adjudication of this controversy.
FIRST CLAIM FOR RELIEF
26. Defendants violated § 10(b) and Rule I Ob-5 by:
(a) Employing devices, schemes and artifices to defraud;
(b) Making untrue statements of material facts and omitting to state material facts
necessary in order to make the statements made, in light of the circumstances under
which they were made, not misleading; and
(c) Engaging in acts, practices and a course of business that operated as a fraud or
deceit upon the Class in connection with their purchases of Scientific stock.
27. Class members were damaged. In reliance on the integrity of the market, they
paid artificially inflated prices for Scientific stock.
SECOND CLAIM FOR RELIEF
For Violation of §20(a) of the 1934 Act
Against All Defendants
28. Plaintiff incorporates ¶¶1-27 by reference.
29. The individual defendants acted as controlling persons of Scientific within the
meaning of §20(a) of the 1934 Act. By reason of their positions as officers and
directors of Scientific, and their ownership of Scientific stock, the individual
defendants had the power and authority to cause Scientific to engage in the
wrongful conduct complained of herein. Scientific controlled each of the Individual
Defendants and all of its employees. By reason of such conduct, the Individual
Defendants and Scientific are liable pursuant to §20(a) of the 1934 Act.
PRAYER
WHEREFORE, plaintiff prays for judgment as follows: declaring this action to be
a proper class action; awarding damages, including interest; and such other
equitable/injunctive relief as the Court may deem proper.
JURY DEMAND
Plaintiff demands a trial by jury.
DATED: August 22, 2000
MILBERG WEISS BERSHAD
HYNES & LERACH LLP
WILLIAM S. LERACH
DARREN J. ROBBINS
WILLIAM S. LERACH
600 West Broadway , Suite 1800
San Diego, CA 92101
Telephone : 619/231-1058
MILBERG WEISS BERSHAD
HYNES & LERACH LLP
PATRICK J. COUGHLIN
100 Pine Street, Suite 2600
San Francisco , CA 94111
Telephone : 415/288-4545
LAW OFFICES OF RICHARD
D. KRANICH
RICHARD D. KRANICH
531 Main Street, Suite 407
New York, NY 10044-0107
Telephone: 212/608-8965
Attorneys for Plaintiff
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