No IN THE UNITED STATES COURT OF APPEALS FOR THE NINTH CIRCUIT

Transcription

1 No N THE UNTED STATES COURT OF APPEALS FOR THE NNTH CRCUT Thomas R. Drelng, a shareholder of NFOSPACE, NC., Plan tff -A ppellan t, VS. FSLED AMERCA ONLNE, NC., a Delaware corporaton, Defendant-Appellee, and JUN CATHY A.cATrERSON, CLERK U.8. COORTOFAPPEALS nfospace, nc., Nomnal Defendant. On Appeal from the Unted States Dstrct Court for the Western Dstrct of Washngton The Honorable James L. Robart, U.S. Dstrct Judge (Seattle, No. C JLR) APPELLANT THOMAS DRELNG'S OPENNG BREF Rchard E. Spoonemore (WSBA #21833) Davd M. Smmonds (WSBA #6994) Stephen J. Srann (WSBA#6957) thdrve N.E. SRANN YOUTZ MEER & SPOONEMORE Redmond, WA Second Avenue, Sute 1100 Telephone: (425) Seattle, WA Facsmle: (425) Telephone: (206) Facsmle: (206) Attorneys for Appellant Drelng

2 . No N THE UNTED STATES COURT OF APPEALS FOR THE NNTH CRCUT Thomas R. Drelng, a shareholder of NFOSPACE, NC., Plafftff-Appellant, VS. AMERCA ONLNE, NC., a Delaware corporaton, Defendant-Appellee, and nfospace, nc., Nomnal Defendant. On Appeal from the Unted States Dstrct Court for the Western Dstrct of Washngton The Honorable James L. Robart, U.S. Dstrct Judge (Seattle, No. C JLR) APPELLANT THOMAS DRELNG'S OPENNG BREF Rchard E. Spoonemore (WSBA #21833) Stephen J. Srann (WSBA#6957) SRANN YOUTZ MEER & SPOONEMORE 719 Second Avenue, Sute 1100 Seattle, WA Telephone: (206) Facsmle: (206) Davd M. Smmonds (WSBA #6994) th Drve N.E. Redmond, WA Attorneys for Appellant Drelng Telephone: (425) Facsmle: (425)

3 TABLE OF CONTENTS NTRODUCTON... 1 JURSDCTONAL STATEMENT... 3 STATEMENT OF THE CASE... 3 STATEMENT OF SSUES... 4 SUMMARY OF FACTS... 6 STATEMENT OF FACTS JAN'S OWNERSHP AND CONTROL OF NFOSPACE THE NTERACTVE WHTE PAGES MARKETNG AGREEMENT A. Jan and AOL Commence Dscusson Over An Agreement B. The Accountng Standards Applcable to the Agreement C Jan Works Wth AOL To Manpulate The Accountng To Create the lluson of a Substantal Penalty D, Due to the Accountng Manpulaton, nfospace Publcly Underreports Over $100 Mllon n Expenses n 1999 and E. Jan Conceals the ntent of the Front-Loaded Payments from nfospace's Audtors JAN AND AOL WORK TOGETHER TO MANPULATE NFOSPACE EARNNGS N Vo AOL AND JAN EACH SELL MASSVE AMOUNTS OF NFOSPACE STOCK BETWEEN JANUARY 31 AND JUNE 13,

4 SUMMARY OF THE ARGUMENT STANDARD OF REVEW ARGUMENT THE PURPOSE OF SECTON 16(B) GENERAL LEGAL STANDARDS RELEVANT TO GROUP STATUS A. Outsde Enttes Can Be Group Members Wth nsders B. Parallelsm s Not Requred C. The Secton 13(d)(3) Test s Dsjunctve D Once Plantff Comes Forward Wth Evdence That A Group Exsted For Any One Of The Three Statutory Purposes, Group Members Are Lable For Short-Swng Trades f They Meet The 10 Percent Collectve Ownershp Test THE DSTRCT COURT ERRONEOUSLY MPOSED CONDTONS ON GROUP STATUS THAT ARE BEYOND THOSE ESTABLSHED BY STATUTE, CASE LAW OR RULE A A Group Exsts Where There s An Agreement To Act Together For The Purpose of Acqurng, Holdhlg or Dsposng of ssuer Securtes; The Dstrct Court Erred n Requrng Evdence Of A Group Purpose To Beneft Members Beyond Those Objectves B. Evdence of Group Conduct May Pre-Date Regstraton Of The ssuers' Securtes C. Evdence of Group Conduct May Pre-Date Ownershp Of ssuers' Securtes... 41

5 H, l. Under the plan language of Rule 13d-5(b)(1), a person may be a member of a group pror to hs or her ownershp of the ssuers' securtes o Even f a person must be a benefcal owner of stock pror to entry nto a group, evdence of group actvty pror to ownershp s relevant to determne group status at the tme of eventual acquston V. SUMMARY JUDGMENT WAS MPROPERLY GRANTED DUE TO THE EXSTENCE OF DSPUTED MATERAL FACTS A. Group Formaton s A Queston of Fact B. A Jury Could Conclude That Jan and AOL Formed a Secton 13(d) Group o Jan and AOL Formed A Group To Allow A Group Member, AOL, To Acqure nfospace Securtes Jan and AOL Formed A Group To Hold And Dspose Of nfospace Securtes C. A Jury Could Conclude that Jan was Motvated by Hs Personal nterest Vo THE DSTRCT COURT ERRED N FALNG TO DRAW FFTH. AMENDMENT NFERENCES AGANST AOL's FORMER EMPLOYEES CONCLUSON... 59

6 , TABLE OF AUTHORTES Cases Anderson v. Lberh/ Lobby, nc. 477 U.S. 242, 106 S. Ct. 2505, 91 L.Ed.2d 202 (1986) Cutter & Buck, nc. v. Geness nsurance Co. 306 F. Supp.2d 988 (W.D. Wa. 2004) Doe ex tel Rudy-Glanzer 232 F.3d 1258 (9 th Cr. 2000) n re Wnstar Commc' ns, nc. 348 B.R Del. 2005) nt'l Banknote Co. v. Muller 713 F. Supp. 612 (S.D.N.Y. 1989) Jezoelcorp nc. v. Pearlman 397 F. Supp. 221 (S.D.N.Y. 1975)... 31, 54 Kay v. Scentex Corp. 719 F.2d 1009 (9 th Cr. 1983) Keystone Land & Dev. Co. v. Xerox Corp. 353 F.3d 1070 (9 t" Cr. 2003) Magma Power Co. v. Dow Chemcal Co. 136 F.3d 316 (2 d Cr. 1998) Morales v. New Valley Corp. 999 F. Supp. 470 (S.D.N.Y. 1998) Morales v. Quntel Entertanment, nc. 249 F.3d 115 (2 d Cr. 2001)... passm Olympc Fsh Prod. v. Lloyd 93 Wash. 2d 596, 611 P.2d 737 (1980) v

7 Roth v. Jennngs 489 F.3d 499 (2 d Cr. 2007)... passm Schaffer v. CC nvest., LDC 153 F. Supp.2d 484 (S.D.N.Y. 2001)... 37, 38 Segen v. Westclff Captal 299 F. Supp.2d 262 (S.D.N.Y. 2004) Strauss v. Amercan Holdngs, nc. 902 F. Supp. 475 (S.D.N.Y. 1995) Warner Commc'ns, nc. v. Murdoch 581 F. Supp (D. Del. 1984)... 31, 53, 54 Statutes 15 U.S.C. 78c(a)(9) U.S.C. 78c(a)(10) U.S.C. 78c(a)(11) U.S.C. 78m(d) U.S.C. 78p... 1, 31, 41 Regulatons 17 C.F.R (b) C.F.R d-5(b)(1)... passm 17 C.F.R a , 31, C.F.R a C.F.R b-6(a) V

8 Other Authortes Ownershp Reports and Tradng by Offcers, Drectors and Prncpal Stockholders, SEC Release No , 53 Fed. Reg , 1988 WL (1988) Ownershp Reports and Tradng by Offcers, Drectors and Prncpal Stockholders, SEC Release No , 56 Fed. Reg , 1991 WL (1991) Schuetze, Walter P., "Speech by SEC Staff : Cooke Jar Reserves," U.S. Securtes and Exchange Commsson. Last Modfed: 5/13/99. Last vsted: 5/28/08. speech/speecharchve/1999/spch276.htm v

9 NTRODUCTON Ths case arses under Secton 16(b) of the Securtes Exchange Act of 1934,1 whch s amed at preventng market manpulaton and nsder tradng by corporate executves and large shareholders. The statute requres corporate nsders to return to ther company any proft realzed from a purchase and sale of the company's equty securtes wthn perods of less than sx months. Unlke other securtes laws, Secton 16(b) does not requre proof that a defendant traded on nsde nformaton or was motvated to obtan a speculatve proft; Congress delberately chose a flat Rule of strct lablty that encompasses all short-swng transactons. nsders subject to Secton 16(b) nclude groups of persons or enttes collectvely holdng more than 10% of the company's securtes. Group status s determned by reference to Secton 13(d) of the Act 2 and SEC Rule 13d-5(b)(1)3-the regulaton desgned to mplement Secton 13(d). Ths regulaton provdes that when "two or more persons agree to act together for the purpose of acqurng, holdng, votng or dsposng of equty securtes of an ssuer," a group s formed. Although many groups under Secton 13(d) are formed for legtmate busness purposes, there s nothng that exempts actors who collectvely 1 15 U.S.C. 78p(b). Relevant portons of the statutes and regulatons cted heren appear n the attached addendum U.S.C. 78m(d) C.F.R d-5(b)(1). 1

10 engage n mproper actons from beng deemed a group. A group formed for a nefarous purpose-such as one formed to manpulate the accountng of a company to artfcally nflate ts share prce- s even more deservng of scrutny under Secton 16(b), gven the legslatve hstory underlyng the statute. Drelng's Secton 16(b) acton aganst Amercan Onlne ("AOL') s based upon AOL's membershp n a group wth nfospace's CEO, Naveen Jan. Jan and AOL worked together to manpulate nfospace's books n order to (1) allow AOL to acqure nfospace warrants, (2) jontly hold nfospace securtes whle the market was artfcally nflated, and (3) ultmately sell ther nfospace stock (to the tune of approxmately $200 mllon each n the frst half of 2000) nto that nflated market. As the dstrct court noted, the facts of ths case support Drelng's allegatons of "concerted actvty... to secretly nfluence the corporate affars of hlfospace by creatng artfcal revenues and earnngs... "4 The dstrct court, however, dsmssed Drelng's acton on summary judgment because t was "not persuaded that two partes actng together to manpulate stock prce by utlzng questonable accountng methods and other smlar actvtes, gves rse to a Secton 13(d) group.'5 Ths was error. A jury could conclude, based on the facts of ths case, that Jan and 4 ER 16, ns ER 20, lns

11 AOL formed a Secton 13(d) group, makng AOL lable to dsgorge the profts t obtaned from ts short-swng transactons n nfospace. JURSDCTONAL STATEMENT The dstrct court had jursdcton pursuant to 15 U.S.C. 78aa. t entered judgment on January 3, Appellant fled a tmely notce of appeal on January 29, Ths Court has jursdcton under 28 U.S.C STATEMENT OF THE CASE Ths case began wth a statutorly requred demand letter ssued by plantff Tom Drelng, an nfospace shareholder, to the Board of Drectors of nfospace, nc.8 Drelng demanded that nfospace prosecute clams aganst AOL for volaton of Secton 16(b) of the 1934 Securtes Exchange Act. 9 nfospace declned. 10 Plantff fled ths sut aganst AOL n August of He alleged that AOL and Jan formed a group under Secton 13(d) of the Securtes Exchange Act of 1934 such that AOL was subject to Secton 16(b) of that Act. n October of 2007, after the close of dscovery, AOL moved for 6 ER ER ER 2, fn. 1. 9d. lo d. 11 ER 915.

12 summary judgment pursuant to FRCP The court granted the moton for summary judgment.13 Ths appeal followed.14 STATEMENT OF SSUES 1. Group Acquston. Under SEC Rule 13d-5(b)(1), a Secton 13(d) group may exst f two or more persons agree to act together for the purpose of acqurhlg, holdng or dsposng of ssuer securtes. The agreement can be nformal. The dstrct court concluded that Drelng proffered suffcent evdence to support hs clam that Jan and AOL engaged n "concerned actvty,.e., to secretly nfluence the corporate affars of nfospace A jury could fnd that ths concerted actvty was desgned to allow AOL to acqure warrants under a manpulated busness deal between nfospace and AOL. A jury could also fnd that the concerted actvty allowed both Jan and AOL to hold ther nfospace shares whle they "create[d] artfcal revenues and earnngs" for nfospace, and then to sell those shares nto the resultng artfcally nflated market.16 Could a jury Jnd that Jan and AOL formed a Secton 13(d) group zohose purpose was to acqure, hold or dspose of lnfospace securtes? 12 ER ER ER ER 16, lns ER 16, lns

13 ,, 2. "Poolng" of Shares. The dstrct court held that Secton 13(d) group status s contngent upon a fndng that group members "pooled" ther shares for a common objectve, such as controllng the ssuer. Secton 13(d) group status, however, s not contngent upon a fndng that group members "pooled" ther shares as part of a control objectve. The agreement under Rule 13d-5(b)(1) need not serve a control purpose, or any other purpose, beyond the purposes lsted n the Rule tself. As a matter of law, s the exstence of a Secton 13(d) group dependent upon proof that the members "pooled" ther shares n order to advance a common purpose beyond those lsted n Rule 13d-5(b)(1),.e., acqurng, holdng, votng or dsposng the securtes n queston? 3. Pre-Regstraton Evdence of Group Actvty. A statutory nsder s only lable under Secton 16(b) f the short-swng trades take place after the ssuer has regstered ts securtes. AOL's short-swng tradng actvty occurred after nfospace had regstered ts securtes. Crtcal evdence of the group actvty between Jan and AOL, however, pre-dates nfospace's regstraton of ts securtes. A jury could fnd that such pre-regstraton group actvty was desgned to allow AOL to acqure nfospace shares after regstraton, and was further desgned to artfcally nflate nfospace's stock prce after regstraton. Can evdence of group actvty that pre-dates regstraton serve as the foundaton of a Secton 13(d) group where that actvty s desgned to take effect after regstraton, and the short-swng trades take place after regstraton? 5

14 l l 1 4. Corporate Capacty verses ntent to Obtan ndvdual Beneft. A jury could fnd that Jan worked wth AOL to artfcally boost nfospace's stock prce by manpulatng ts accountng (wth AOL's assstance) by vrtue of hs poston as CEO of nfospace. Jan, who personally stood to make hundreds of mllons of dollars through the accountng manpulaton orchestrated wth AOL, concealed hs conduct from nfospace's audtors. s Jan a member of a Secton 13(d) group wth AOL f, zvhle cloaked n hs offcal capacty, he secretly conspred wth A OL to manpulate nfospace's accountng h_ order to beneft hmself ndvduauy? 5. Ffth Amendment nferences. Key AOL executves who worked wth Jan to manpulate h_fospace's accountng refused to answer questons on Ffth Amendment grounds. Each of the executves had receved or wrtten documents settng forth the accountng manpulaton, and both had communcated wth Jan on the accountng ssues. Dd the dstrct court err n falng to draw nferences from A OL' s former employees" rejlsal to answer questons surroundng ther nvolvement n AOL" s concerted actvtes wth Jan on Ffth Amendment grounds? SUMMARY OF FACTS n summer 1998, nfospace and AOL negotated an agreement (the "Agreement") that gave nfospace access to AOUs 12 mllon subscrbers. For nfospace and Naveen Jan- the company's founder, CEO, and 66% owner- ths was the catalyst needed to launch nfospace as a publc company. AOL also realzed that there was proft to be made n nfospace's stock. n return for assocatng ts name wth fledglng 6

15 . nfospace, AOL demanded the rght to purchase up to 5% of nfospace, wth a strke prce based upon nfospace's low pre-po (and pre-aol agreement) valuaton. nfospace agreed to (1) pay AOL $2.5 mllon per year, and (2) provde AOL wth warrants to purchase up to 5% of nfospace. The warrants vested quarterly as long as AOL delvered a specfed mnmum amount of web traffc to nfospace. After the partes agreed on the framework for the deal, nfospace's accountants (Delotte & Touche) nformed Jan that (a) AOL's warrants would have to be valued and expensed, and (b) there were two dates as of whch ths could be done- the date of the Agreement wth AOL n md-1998, or the date that each tranche of warrants vested,.e., quarterly over the three- to four-year lfe of the Agreement. Jan expected hffospace's stock prce to ncrease rapdly after the PO. Thus, he knew that to mnmze the warrant-related expenses to be booked, the warrants had to be valued as of the date of the Agreement. f the warrants were valued each quarter as they vested, the quarterly expense would be much hgher, reflectng the antcpated ncrease n nfospace's per-share prce. Jan knew that hgher warrant expenses could mean the dfference between proftablty and non-proftablty, whch, n turn, would be a drag on nfospace stock prce. He testfed that nfospace would not do any deal wth AOL- and AOL would not acqure any warrants-unless nfospace could expense all the warrants as of the pre- PO date of the Agreement. 7

16 Delotte told Jan that accountng rules would permt nfospace to value the warrants before nfospace went publc (.e., as of the date of the Agreement) n only one crcumstance: AOL would have to agree to pay a sgnfcant cash penalty n the event t faled to delver the promsed traffc. Late n the negotatons, Jan explaned the ssue to AOL and asked t to pay just such a penalty. AOL rebuffed hm, callng the penalty provson a "non-starter.'17 Jan convnced AOL to work wth hm to explore "creatve deas to get around" the penalty problem.18 At 4:30 a.m. on August 12, 1998, Jan emaled the head of AOL's Busness Affars Department, Davd Colburn, offerng some "creatve deas" to "monkey around" wth the terms of the Agreement.19 f nfospace front-loaded the cash payments t owed AOL under the Agreement, Jan wrote, AOL could effectvely avod payng any penalty. Jan would have nfospace fund any penalty AOL mght pay. Jan dentfed the major advantage for AOL (and hmself, as the prmary owner of nfospace stock): "beneft from our stock prce" because there would be "no expenses to take for us. "20 AOL agreed to the scheme. n the emals between Jan and AOL that followed, both acknowledged that "[t]he whole dea of accelerated payment was to take care of penalty that [AOL] wll end up payng 17 ER ER ER ER

17 [nfospace] n case [AOL] termnated the contract for any busness reason. "21 As a result, the fnal Agreement purports to mpose a penalty on AOL, whle smultaneously front-loadng the cash payments from nfospace to elmnate or substantally mtgate the effect of the purported "penalty." Delotte was never nformed of ths accountng end-run, and t approved valuhlg the warrants based on a $3.33 per share valuaton on the date of the Agreement, August 24, When AOL's key employees were asked f they had worked wth Jan to manpulate the accountng, and whether they knew that Jan had msled nfospace's audtors, they nvoked the Ffth Amendment. 22 Jan conceded that the front-loadng was desgned to mtgate the penalty clause. 23 One of the fundamental cornerstones of GAAP s that, regardless of form, a transacton must be accounted for based on ts actual substance.24 The AOL/Jan scheme does just the opposte. t creates an lluson of a $2 mllon penalty whle allowng AOL to recoup penalty payments through the front-loadng of cash payments by nfospace. Ths was not a mnor accountng manpulaton. Usng the low 1998 valuaton, hffospace reported a total of $1.65 mllon n AOL warrant expenses for all of 1999 and Had the warrants been properly accounted for, nfospace would have reported warrant expenses of nearly 21 ER ER ; ER ER ER , 2. 9

18 1 $116 mllon durng those two years. n the frst and second quarters of 2000-the quarters n whch AOL sold and hedged ts nfospace stock- nfospace reported only $412,500 n AOL warrant-related expenses. t should have charged over $68 mllon aganst ncome for those two quarters alone. The accountng scheme was not the last tme Jan and AOL worked together to manpulate nfospace's books. n early 2000, nfospace was n danger of falng to meet analyst's earnngs expectatons for the second quarter. Jan decded that nfospace could meet those expectatons by reducng expenses. To do so, Jan contacted Erc Keller at AOL, who agreed to sgn an undated, one-sentence "Amendment 1" to the Agreement retroactvely excusng nfospace's entre revenue share oblgaton to AOL. The Amendment had mnmal or no economc value to AOL. When Keller was asked n deposton whether t had any economc purpose-other than to artfcally assst hffospace n meetng earnngs expectatons -he nvoked the Ffth Amendment. 2s n the frst half of 2000, as nfospace's stock prce reached ts zenth, Jan and AOL each proceeded to dspose of shares worth $200 mllon. Durng these two quarters, n whch nfospace's revenues totaled $43.6 mllon, ts expenses were publcly understated by $68 mllon. l 25 ER

19 STATEMENT OF FACTS. JAN'S OWNERSHP AND CONTROL OF NFOSPACE. Naveen Jan founded nfospace n March He was ts CEO and sole drector. He was elected Charman by an expanded board n Before nfospace went publc on December 15, 1998, Jan (and trusts controlled by hm) owned 66% of the company.27 Afterwards he owned 49.9% of the company. 28 Jan was the "ultmate power at nfospace. "29 n 1998, nfospace provded "yellow pages and whte pages" and the lke for nternet portals.30 t made money by sellng advertsng on Web pages dsplayng ts content.31. THE NTERACTVE WHTE PAGES MARKETNG AGREEMENT. A. Jan and AOL Commence Dscusson Over an Agreement. n 1998, wth some 12 mllon subscrbers, AOL was the largest onlne servce provder n the world.32 n early 1998, nfospace contacted AOL n an effort to develop a relatonshp to "drve more traffc to nfospace.'33 By the md-1998, nfospace and AOL had entered nto 26 ER ER d. 29 ER O ER ER ER ER

20 negotatons. 34 The key players for nfospace were Jan and the company's new Vce Presdent of Busness and Legal Affars, Elya Braden (f/k/a Ellen Alben), who Jan hred n May AOL was represented by Davd Colburn and Erc Keller (the head and second-n-command of AOL's Busness Affars Department) and Jon Zetler (from AOL's legal department).36 Jan, wth "ultmate authorty" for nfospace, was the only nfospace employee who had drect contact wth Colburn and Keller.37 By July 29, 1998, nfospace and AOL had exchanged multple drafts of what would be called the nteractve Whte Pages Marketng Agreement ("Agreement').38 That day, AOL ndcated to Jan that fnal agreement was mannent: Based on the drafts and what heard on the phone today we can fnsh ths up quckly... We should work to get ths all naled down tomorrow. 39 The draft attached to that emal, lke the multple drafts that preceded t, contaned the followng key terms: nfospace would make guaranteed cash payments of $7.5 nxllon to AOL over the three-year orgnal term of 34 ER ER ER ; ER ER ER ; ER ; ER ER

21 the agreement, and an addtonal $2.5 mllon f the Agreement was extended for a fourth year.40 The guaranteed payments would be spread evenly over the lfe of the Agreement,.e., nfospace would pay AOL $2.5 mllon per year over the three- or four-year lfe of the Agreement. 41 AOL would be granted warrants gvng t the rght to purchase 5% of nfospace. The warrants would vest evenly over the term of the Agreement, but were contngent upon AOL delverng a certan number of searches from ts consumers to nfospace. f AOL faled to delver the requste number of searches, t would lose the ablty to vest n some warrants. Ths was the only consequence of falng to meet the search guarantee.42 AOL had the rght to termnate the Agreement for any reason after 18 months. 43 nfospace and AOL would share n the revenue generated by nfospace from the sale of advertsements.44 B. The Accountng Standards Applcable to the Agreement. When a company ssues warrants to another entty n return for goods or servces, t must charge the grant as an expense aganst ncome 40 ER (Secton 6.1); ER 601; ER 631; ER ER (Secton 6.1); ER 601; ER 631; ER 662; ER ER (Secton 6.10); ER (Secton 6.7); ER (Secton 6.9); ER (Secton 6.9). 43 ER 195 (Secton 7.4); ER 604; ; ER ER 192 (Secton 6.2); ER 602; ER 632; ER

22 under GAAP. The amount of expense s a functon of the value assgned to the warrants, whch depends on the valuaton date. For nfospace, the ssue was whether the AOL warrants should be valued (a) when the Agreement was executed on August 24, 1998, or (b) on the dates durng the lfe of the Agreement when the warrants actually vested.45 Ths ssue was momentous for nfospace because ts post-po valuaton (durng the heyday of the dot.com boom) was antcpated to, and dd, dwarf ts pre- PO (date of Agreement) prvate valuaton.46 An accountng standard determnes when warrants must be valued and expensed. Ths standard, known as ETF ssue No , essentally states that warrants must be valued at the tme they vest, unless the warrant grantee's performance commtment makes ts performance probable.47 For performance to be probable, the performng party (the warrant grantee) must be subject to a "substantal penalty" n the event of nonperformance. f the contract contans a substantal penalty, generally defned as a sgnfcant cash penalty, then the warrants may be valued at the date of the agreement.48 Under the terms of the July 29, 1998 draft Agreement, AOL was not subject to any penalty, much less the substantal penalty requred by ssue 45 ER ER ER ER

23 No , for falure to meet ts performance hurdles.49 Shortly thereafter, nfospace asked Delotte to determne what type of penalty would be requred to allow nfospace to expense the warrants on the date of the Agreement. After an evaluaton by ts natonal home offce experts, Delotte concluded that, at mnmum, a cash penalty n excess of 10% of the total value of the Agreement (whch was valued at $13.3 mllon) would be requred.50 Delotte later concluded that "a $2 mllon penalty would be a dsncentve of a magntude suffcent to conclude that performance by A[OL] s probable, based upon the sze of the payment relatve to the current value of the consderaton to be ssued by A[OL].'51 Jan testfed that he understood that a cash penalty n the $1 mllon to $2 mllon range was requred. 52 Because the queston of when nfospace would expense the warrants could have such a huge mpact on nfospace's ncome statement, the ssue was a dealbreaker.53 f the only alternatve were to expense the warrants at future vestng dates, the deal, Jan determned, would be too costly for nfospace ER ER 477; ER ; ER ER ER ER 344, ("We would not have done the deal"). 54 ER 357 ("f the cost s hgher than what you could support from revenue, we wouldn't do a deal"). 15

24 C. Jan Works Wth AOL To Manpulate The Accountng To Create the lluson of a Substantal Penalty. Jan frst floated the dea of a substantal cash penalty wth AOL n late July and early August of AOL mmedately shot t down: got a call from Naveen and hs D&T accountant ths evenng. Ther latest thnkng s that to avod an expense the penalty would have to be a net cash outlay by AOL. n other words, f we faled to meet the hurdle, we would have to return the $2.5M and pay an addtonal $1M. told hm ths was a non-starter Undeterred by AOL's refusal, Jan emaled Davd Colbum, the head of AOUs Busness Affars Dvson, at 4:30 a.m. on August 12 and asked for a "favor."57 Jan explaned that he had been "told by our damn accountant" that AOL's ablty to termnate the Agreement after 18 months could prevent nfospace from expensng the warrants as of the date of the Agreement.58 However, he told Colburn "not to panc" because " do have some creatve deas to get around t The "problem," as Jan dentfed t, was AOL's ablty to termnate the contract after 18 months wthout ncurrng a substantal penalty.60 Jan proposed a "soluton": by "monkey[ng] around wth the numbers," the 55 ER 324; ER ER 217 (talc n orgnal, bold talc suppled). 57 ER d. 59 d. 60 d. 16

25 partes could front-load nfospace's guaranteed yearly $2.5 mllon cash payments to AOL, thereby commttng nfospace to effectvely pre-pay or front any penalty that AOL would be requred to pay f t termnated the contract after 18 months.61 As Jan wrote: nstead of payng you 2.5 mllon per year for the next 4 years n addton to warrant equvalent of 1.25% of outstandng shares, We wll pay you at the followng schedule (we can monkey around wth the numbers but ths wll gve you the dea) 1 st year - 4 Mllon+ warrants 2 nd year - 3 Mllon+ warrants 3 rd year Mllon+ warrants 4 th year Mllon+ warrants AOL pays us penalty of 200K per quarter for the leftover duraton from the 4 years ntal contract, f the contract s termnated any tme (essentally AOL s not meetng the performance hurdles). Please keep readng wth an open mnd Jan took pans to pont out that, under hs proposal, nfospace would be forced to pay AOL more than the prevously-agreed sum of $2.5 mllon per year f the contract was termnated by AOL.63 Jan conceded that "part 61 ER ER Compare ER (Secton 6.1) wth ER 182 ("You gan.., after the penalty s pad...'). 17

26 of the thng s tryng to mtgate" the effect of a penalty n the event of termnaton.64 Jan concluded the emal by pontng out the benefts of the "new plan" -ncludng the fact that AOL would "beneft from our stock prce" f nfospace dd not have to account for the warrant expenses as they vested over tme: Davd, What do you thnk of ths new plan. You get to recognze fle top lne revenue from warrants +earler recognton of addtonal revenue n the frst 2 years+ beneft from our stock prce (no expenses to take for us).65 AOL accepted Jan's proposal, and all future drafts of the Agreement reflected (1) a restructurng of the guaranteed payments to front-load the cash payments, and (2) a new penalty clause.66 (Colburn nvoked the Ffth Amendment when asked the followng queston: "AOL subsequently agreed wth Mr. Jan to front-load the guaranteed cash payments; correct, Mr. Colburn? "67) Jan bluntly acknowledged the purpose of the new accelerated payment schedule n a later emal to AOL: "The whole dea of accelerated payment was to take care of penalty that you zoll end up payng us n case you termnated the contract for any busness reason."68 Other emals 64 ER ER 182 (emphass added). 66 ER 694; ER 698; ER ; ER 731; ER 761; ER ER ER

27 between Jan and AOL further acknowledge that the front-loadng of payments was desgned as a ruse to elmnate or mtgate the penalty clause.69 n the fnal Agreement, nfospace agreed to pay AOL $4 mllon, $3 mllon, $1.5 mllon and $1.5 mllon n years one through four, respectvely.70 The Agreement purported to mpose a $2 mllon "penalty for non-performance" on AOL n the event t termnated the contract before delverng 400 mllon searches. 71 Plantff's expert, forensc accountant George Banks, observed that the accelerated cash payments elmnated or substantally mtgated the purported $2 mllon penalty.72 As a result, Jan and AOL accomplshed exactly what they wanted: a restructurng of the deal to create an lluson of a penalty and satsfy accountng standards, h_ realty, however, the deal left AOL n vrtually the same poston as the penalty-free orgnal deal. As Mr. Banks confrms, the actual or effectve penalty, rangng from nothng to $500,000, dd not come close to satsfyng the penalty prescrbed by Delotte, and requred by ssue No ER 240 ("Even though the payments are now front loaded...'); ER 381 (" [Y]ou are always mllon ahead n payment so t shouldn't hurt you to pay the penalty"); ER 379 (about "makng good on any amounts you've pad us over $2.5M per year"). 7O ER ER ER 903 (chart showng effectve penalty). 73 ER

28 l l D. Due to the Accountng Manpulaton, nfospace Publcly Underreports Over $100 Mllon n Expenses n 1999 and f nfospace had properly accounted for the AOL warrant expenses, t would have ncurred nearly $116 mllon n expenses n years 1999 and nstead, t reported $1.65 mllon, or $206,250 a quarter, over that tme perod.75 To put the expenses n perspectve, nfospace's revenues for all of 1999 totaled $36.8 mllon, and ts revenues for the frst and second quarters of 2000 totaled $43.6 mllon.76 Banks found that Jan and AOL colluded to mproperly create the lluson of a substantal penalty where, n fact, none exsted. He could dscern no legtmate busness purpose behnd the front-loadng of guaranteed payments, whch was done "to crcumvent the requrement of a substantal cash penalty.'77 Ths colluson resulted n nfospace underreportng ts expenses n 1999 and 2000 by $114 mllon. 78 "cornerstone" Put smply, the manpulaton of the accountng volated the 74 ER /d. of GAAP: By desgnng a transacton so that the form was dfferent from ts substance, the partes were volatng the cornerstone of generally accepted accountng prncples (GAAP). GAAP requres that transactons be accounted 76 ER 807; ER 812; ER ER ER 889; ER

29 for based on ther substance, rrespectve of ther form. By Jan and AOL structurng the Agreement to gve the appearance of a substantal economc penalty, nfospace was able to value the warrants ssued to AOL as of the date of ssue, August 24, 1998, and avod reportng charges aganst ts net ncome n the followng perod n excess of $100,000, As Jan wrote to Colbum, the purpose of ths manpulaton was to "beneft from [nfospace's] stock prce" because t would not have to expense the warrants over tme.80 nfospace's stock dd, n fact, skyrocket durng ths perod.81 E. Jan Conceals the Front-Loaded Payments from nfospace's Audtors. Unaware of the front-loadng n the new payment schedule that effectvely elmnated the penalty, Delotte determned that nfospace could account for the warrants as of August 24, The warrants were therefore valued at approxmately $3.26 mllon.83 nfospace expensed ths charge ratably (straghflne) over the lfe of the Agreement, whch resulted n a $206,250 charge aganst ncome h'l each quarter the warrants vested ER ; see also ER ER ER ER ER ER

30 There s no evdence that Delotte was aware that the purpose of front-loadng the guaranteed payments was to elmnate or mtgate the penalty.85 Larry Hle, the Delotte partner n charge of the nfospace account, testfed that he was unaware of any evdence that suggested he or Delotte was: (1) nformed by anyone about the front-loadng of payments; (2) aware that the purpose of acceleratng payments was to elmnate or mtgate any penalty n the event of contract termnaton; or (3) approved, passed on, or even suggested that the front-loadng of guaranteed payments was approprate.86. JAN AND AOL WORK TOGETHER TO MANPULATE NFOSPACE EARNNGS N AOL was prmarly nterested n one goal relatve to nfospace: drvng up ts stock prce. For example, an apparently puzzled AOL employee asked another employee n 2001, " have no context here... why are we fshng for ways to do busness wth nfospace? "87 The response: "[] thought [] explaned before: we have warrants n []nfospace that are pad quarterly. []f ther stock prce rses we get more dough."88 Another AOL emal underscores that AOL's "sole goal" was to affect nfospace's stock prce: 85 ER ; ER ER 468; ER ER d. 22

31 l nfospace popped 20% today... Do you have thoughts on who nternally mght understand best means of affectng stock prce n ths space, snce that's the sole goal-t would facltate decsons on best course. 89 n March 2000, AOL was presented wth an opportunty to affect nfospace's stock prce. Earler, n 1999, Jan had obtaned AOUs agreement to wave nfospace's revenue sharng oblgatons under the Agreement. 90 Jan and AOL kept the agreement nformal. Ths created a type of corporate "cooke jar" that would allow Jan to tap the agreement at a later date when he felt nfospace mght need a boost to ts bottom lne. 91 That day came n March On March 8, nfospace's drector of fnance told Jan the company would have problems meetng analyst's expectatons for second-quarter earnngs.92 The next day, Jan was asked 89 ER 794 (emphass added); see also ER 74 ("Workng wth Moble team to see what, f anythng, s vable for a quck deal to generate analyst/nvestor nterest n nfospace"). 90 ER 388 (confrmng agreement on December 29, 1999); ER The term "cooke jar" or "cooke jar reserves" s explaned by the SEC staff at (last vsted 5/28/08). t s one way to "manage" earnngs, and t s done: (a) to gve the false mpresson of smooth, steady growth; and (b) to artfcally ensure that each quarter's forecasts are met-.e., to "beat the street" each quarter. ER ("... often... the company... was 'managng earnngs' - tryng to meet Wall Street expectatons or those of the boss, tryng also to pretend that the course of busness s smooth and predctable... "); ER ER 391 (" [T]here s real pressure on 2Q00 earnngs... Put another way, beatng analysts by $0.03 wll take approx $7.2m n savngs"). 23

32 to contact hs "frend at AOL" to make AOL revenue sharng expenses "go away."93 Jan proposed an amendment to the Agreement that would serve two goals: (1) t would reduce nfospace's future expenses by elmnatng ts oblgaton to share revenue wth AOL; and (2) t would address the mmedate crss by wpng out a backlog of accrued expenses attrbutable to revenue sharng.94 Jan then contacted Keller at AOL and the one-sentence "Amendment 1" to the Agreement was sgned.95 t was not dated. Delotte, however, was told that t was sgned n the second quarter.96 Ths allowed nfospace to elmnate not only ts second-quarter revenue-sharng expenses, but-all of the prevous revenue sharng expenses that had been accrued on ts books snce 1999, and to record that entre accrued expense reversal n the crtcal second quarter of Plantff conducted an FRCP 30(b)(6) deposton of an AOL representatve on the sole queston of whether "Amendment 1" had any economc value for AOL (other than to prop up hffospace's stock prce). Although tle Amendment requred AOL to gve up sgnfcant cash 93 ER 393; ER ER 393; ER 395; ER ER ER ER ; ER

33 payments, ts representatve could not dentfy even a sngle concrete beneft that AOL receved n exchange for ths concesson.98 AOL's Keller, who sgned Amendment 1, nvoked the Ffth Amendment when asked whether the "sole purpose of Amendment 1 was to assst Mr. Jan n hs efforts to make sure that nfospace could meet or exceed analysts' expectatons for the second quarter of 2000."99 V. AOL AND JAN EACH SELL MASSVE AMOUNTS OF NFOSPACE STOCK BETWEEN JANUARY 31 AND JUNE 13, Between January 31 and June 13, 2000, Jan and AOL each sold or hedged massve amounts of nfospace stock.100 For Jan, hs sales represented half of all the stock he had sold snce lffospace went publc n December For AOL, the sale and hedges represented 100% of ts sales of nfospace stock through at least December The sales took place n two clusters. Jan, who had not sold any hffospace stock n the precedng eght months, sold over $110 mllon of stock on January 31, Nne tradng days later, AOL (whch had prevously sold no shares of nfospace) 98 ER ER ER 518; ER 110; ER ER

34 sold a call for 250,000 shares and purchased a put for 250,000 shares.102 Eght tradng days after that, AOL sold another call for 250,000 shares and purchased another put for 250,000 shares. 103 Another 15 tradng days later, AOL sold 247,746 shares on the open market for proceeds of $47,889, Ths frst cluster of sales -from Jan's sale on January 31 to AOL's sale on March 15- covered 31 tradng days. Nether Jan nor AOL sold any shares over the next 32 tradng days. Then, on May 1, 2000, Jan sold over $15 mllon of nfospace stock. 105 Ths was followed seven tradng days later by AOL's sale of two calls, each of 500,000 shares, and purchase of two puts, each of 500,000 shares. 106 Twenty-two, 23 and 24 tradng days later, Jan sold $6 mllon, $5.6 mllon, and over $55 mllon worth of stock, respectvely.107 Ths cluster of sales-from May to June 13-covered 31 tradng days. Nether Jan nor AOL would make any other sales for the rest of the year, or the followng two years. 102 ER 121; ER 123. A sale of a call and a purchase of a put each consttute separate "sales" of stock for purposes of Secton 16(b). 17 C.F.R b-6(a); Magma Power Co. v. Dow Chemcal Co., 136 F.3d 316, 321 n. 2 (2 d Cr. 1998). These sales can be matched wth the recept of nfospace warrants whch are dervatve securtes and consttute "purchases" when they vest. 17 C.F.R a-1(c). See ER 109 (vestng dates). 103 ER 125; ER ER ER ER 129; ER 131; ER 133; ER ER

35 SUMMARY OF THE ARGUMENT The agreement between Jan and AOL to act together to "secretly nfluence the corporate affars of nfospace" gves rse to a group under Secton 13(d).108 The understandng between Jan and AOL s the type of arrangement that s at the heart of Rule 13d-5(b)(1). A jury could fnd that the understandng was desgned to- and dd - allow AOL to acqure nfospace securtes. A jury could also fnd that f Jan and AOL had not agreed to the accountng scheme, AOL would have never acqured rely nfospace warrants. A jury could fnd that the concerted actvty between Jan and AOL was also desgned to- and dd- allow both Jan and AOL to hold nfospace stock whle they were artfcally nflatng nfospace's stock prce, and then dump shares onto the market. The dstrct court mproperly took ths case from the jury by graftng addtonal nonexstent requrements onto Rule 13d-5(b)(1). t also msframed the ssue of Jan's motvaton and capacty, and faled to draw adverse nferences from the falure of AOUs former hgh-level executves to answer questons about the Jan/AOL scheme at deposton. Frst, the dstrct court erroneously requred evdence that the agreement between Jan and AOL was servng some larger purpose, such as provdng a means for corporate control that could only be acheved by 108 ER 16, ns

36 . "poolng" ther shares.109 Ths requrement, however, appears nowhere n the statute or regulaton, and has been rejected by other courts consderng the same ssue. Second, the dstrct court mproperly restrcted evdence of group coordnaton to events that occurred after nfospace regstered ts shares. Ths restrcton s not mposed by statutes or regulatons, and appears to stem from confuson between substantve law and rules of evdence. Substantvely, a statutory nsder s not lable to dsgorge short-swng profts unless an ssuer has regstered ts shares. There s no rule, however, that prevents a fact fnder from consderng relevant pre-regstraton actvty to determne whether a group exsts n the frst place. f such a group exsts, then ts members wll be precluded by Secton 16(b) from tradng on the short-swng once the ssuer regsters ts shares. Thrd, the dstrct court erroneously treated Jan as "nfospace" because he was workng for nfospace when the accountng scheme was hatched and mplemented. t requred evdence that Jan was actng n hs ndvdual capacty, rather than n a corporate capacty, when the manpulaton occurred. By framng the ssue n terms of the capacty n whch Jan acted, the dstrct court gnored evdence that, regardless of whether he wore hs CEO hat or hs personal hat, Jan's ntent was to personally beneft hmself..corporate fraudsters often explot ther 109 ER 14, lns (no Secton 13(d) group could exst unless the group members were attemptng to "captalze n some way... by agreeng to pool ther shares"). 28

37 poston wthn a company to engage n actvtes desgned to manpulate the company's stock. The relevant queston s not "capacty," as the dstrct court framed t; rather, t s ntent. Here, a fact fnder could conclude that Jan ntended (and dd) to beneft hmself by the manpulaton wth AOL. Fourth, the dstrct court declned to draw any adverse nferences from the nvocaton of the Ffth Amendment by AOL former executves. Gven the magntude of other evdence-such as emals-essentally admttng to manpulaton, an adverse nference should have been drawn. Drelng has proffered more than enough evdence to support hs clam that Jan and AOL were a Secton 13(d) group such that AOL was precluded from tradng nfospace stock on the short-swng. STANDARD OF REVEW The dstrct court's grant of summary judgment to AOL s revewed de novo. Keystone Land & Dev. Co. v. Xerox Corp., 353 F.3d 1070, 1073 (9 th Cr. 2003). A grant of summary judgment wll be affrmed only f "there s no genune ssue as to any materal fact and... the movng party s enttled to a judgment as a matter of law." Fed. R. Cv. P. 56(c). A dspute regardng a materal fact s genune "f the evdence s such that a reasonable jury could return a verdct for the nomnovng party." Anderson v. Lberty Lobby, nc., 477 U.S. 242, 248, 106 S. Ct. 2505, 91 L.Ed.2d 202 (1986). ARGUMENT. THE PURPOSE OF SECTON 16(B). One of a relatve handful of federal statutes amed at nsder tradng, Secton 16(b) s desgned to prevent the "unfar use of nformaton whch 29

38 may have been obtaned by a statutory nsder by reason of hs relatonshp to the ssung corporaton." Kay v. Scentex Corp., 719 F.2d 1009, 1012 (9 th Cr. 1983). Secton 16 s desgned to avod napproprate use of nsder nformaton. More than that, t s also fundamentally concerned wth efforts by nsders to manpulate a company's stock prce for personal gan: h_ some cases, nsders manpulated the market prce of ther stock and caused the company to follow fnancal polces calculated to produce sudden changes n market prces. To combat these abuses, Congress enacted secton 16 to requre reports of securtes transactons by nsders and to provde for the recovery of any short-swng profts. Ozonershp Reports and Tradng by Offcers, Drectors and Prncpal Stockholders, SEC Release No , 53 Fed. Reg at 49998, 1988 WL (1988) (footnotes omtted, emphass added). Secton 16(b) operates by requrng corporate nsders to return to the company any proft realzed by them from a purchase and sale of the company's equty securtes wthn perods of less than sx months. Proof that the defendant traded on nsde nformaton or was motvated to obtan a speculatve proft s not requred; the statute mposes an absolute Rule of strct lablty for purchases and sales occurrng wthn perods of less than sx months. Kay, 719 F.2d at

39 . GENERAL LEGAL STANDARDS RELEVANT TO GROUP STATUS. A. Outsde Enttes Can Be Group Members Wth nsders. Statutory nsders nclude offcers, drectors and owners of 10% or more of the ssuer's securtes. 15 U.S.C. 78p(b) ). n addton, "[t]he Exchange Act also recognzes that the abuses t targets may be accomplshed by persons acthlg not ndvdually but n combnaton wth others." Ro& v. Jennngs, 489 F.3d 499, 507 (2 a Cr. 2007). f a group s formed for "the purpose of acqurng, holdng, or dsposng of securtes of an ssuer," the group "shall be deemed a person" for purposes of Secton 16(b). d. Under SEC Rule 16a-l(a)(1), the queston of whether a Secton 16(b) group exsts s determned by reference to Secton 13(d), whch, n turn, s mplemented by SEC Rule 13d-5(b)(1). 17 C.F.R a-1(a)(1); 17 C.F.R d-5(b)(1); Ro&, 489 F.3d at ; Morales v. Quntel Entertanment, nc., 249 F.3d 115, (2 a Cr. 2001). Under the plan language of Secton 13(d), an outsde party, such as AOL, can form a group wth an nsder, such as Jan- nfospace's CEO. See, e.g., Warner Commc'ns, nc. v. Murdoch, 581 F. Supp (D. Del. 1984); Jewelcorp nc. v. Pearlman, 397 F. Supp. 221, 250 (S.D.N.Y. 1975). B. Parallelsm s Not Requred. Group members need not jontly agree on any specfed terms or condtons. There s no requrement that members "march n lockstep." Morales v. New Valley Corp., 999 F. Supp. 470, (S.D.N.Y. 1998). See also Strauss v. Amercan Holdngs, nc., 902 F. Supp. 475, 480 and fn.5 (S.D.N.Y. 31

40 , 1995) (lack of contemporaneous trades or consstent tradng patterns does not undermne nference of group agreement). As the Second Crcut held: [T]he alleged group members need not be commtted to "acqurng, holdng, votng, or dsposng" of equty securtes on certan specfed terms, but rather they need only have combned to further a common objectve regardng one of the just-rected actvtes. Morales, 249 F.3d at 124 (ctatons omtted, emphass added). Parallelsm can be an ndcator of group exstence, but s not requred. (n any event, there was broad parallelsm between AOL and Jan-as opposed to dentcal behavor-n ther holdng and.dsposng of nfospace stock.) C. The Secton 13(d)(3) Test s Dsjunctve. A group exsts f a common purpose s related to acqurng, holdng or dsposng the securtes: Under 13(d)(3) and Rule 13d-5(b)(1), whch delneate the nsder status of jont actors, f two or more persons act together for the purpose of acqurng, holdng, "or" dsposng of shares of an ssuer, they are deemed a group, and each s deemed the benefcal owner of all the shares benefcally owned by all of the collaborators. Because the statute and the Rule lst those purposes n the dsjunctve, a group s formed as a matter of law f those persons act for any one of the lsted purposes... The dstrct court thus erred n holdng that "for traders to consttute a 'group', the Exchange Act requres that ther coordnated actvty persst durng the tme of purchase and durng the tme of sale of securtes," [ctaton omtted]. That rulng gave a conjunctve readng to provsons that are dsjunctve. Roth, 489 F.3d at

41 D. Once Plantff Comes Forward Wth Evdence That A Group Exsted For Any One Of The Three Statutory Purposes, Group Members Are Lable For Short-Swng Trades f They Meet The 10% Collectve Ownershp Test. f a group acted together to acqure securtes, plantff need not prove that the group actvty contnued whle securtes were held or sold. Roth, 489 F.3d at Smlarly, a group may exst for the purpose of holdng securtes despte a lack of evdence that t exsted to acqure or dspose of securtes. d. Beyond that, all that needs be shown s that the group collectvely owned more than 10% of ssuer stock both before the frst matchng transacton and at the tme of a later matchng transacton. d. n Roth, the Second Crcut was faced wth a dstrct court's concluson that group members were not lable under Secton 16(b) because there was no evdence of group actvty when group members sold ther stock. d. at 513. The dstrct court had reled on the last sentence of Secton 16(b) to support ts concluson, ld. That sentence requres that, to establsh lablty under Secton 16(b) n a purchase-sale sequence, a 10% shareholder benefcally own ssuer securtes both before any short-swng purchase and at the tme of the subsequent short-swng sale. d. Ths provson of Secton 16(b), however, does not defne nsder status; that functon s performed, n the case of groups, by Secton 13(d) and Secton 16(a). d. Under Secton 13(d)(3), a group exsts when two or more persons act together for the purpose of acqurng, holdng, or dsposng of ssuer shares, ld. The Second Crcut therefore rejected the 33

42 dstrct court's concluson that there must be evdence of group actvty at the tme of the sale. d. at 514 (the dstrct court's rulng wrongly "gave a conjunctve readng to provsons that are dsjunctve"). The court went on to summarze the combned effect of Secton 16 and Secton 13(d) regardng the duraton and exstence of a "group": n sum, 16 and 13(d) and the rules thereunder mean that where, as alleged here, two persons acted together for the purpose of acqurng the stock of an ssuer, and collectvely those persons owned more than 10 percent of that stock both before any transacton leadng to a short-swng proft and at the tme of the matchng short-swng transacton, the fnal sentence of 16(b) provdes them no exempton. All of the jont actors n such crcumstances are deemed to be nsders and are presumed to have access to nsder nformaton. d. at 514 (emphass added).. THE DSTRCT COURT ERRONEOUSLY MPOSED CONDTONS ON GROUP STATUS THAT ARE BEYOND THOSE LAW OR RULE. ESTABLSHED BY STATUTE, CASE A. A Group Exsts Where There s An Agreement To Act Together For The Purpose of Acqurng, Holdng or Dsposng of ssuer Securtes; The Dstrct Court Erred n Requrng Evdence Of A Group Purpose To Beneft Members Beyond Those Objectves. To mplement Secton 13(d), the SEC promulgated Rule 13d-5, whch defnes benefcal ownershp by a "group" as follows: When two or more persons agree to act together for the purpose of acqurng, holdng, votng or dsposng of equty securtes of an ssuer, the group 34

43 formed thereby shall be deemed to have acqured benefcal ownershp, for purposes of sectons 13(d) and (g) of the [Exchange] Act, as of the date of such agreement, of all equty securtes of that ssuer benefcally owned by any such persons. 17 C.F.R d-5(b)(1) Under the plan language of Rule 13d-5(b)(1), any common objectve-ether acqurng, holdng or dsposng of securtes- wll suffce: The plan language of 13(d)(3) demands only an agreement "for the purpose of acqurng, holdng, or dsposng of securtes," 15 U.S.C. 78m(d)(3), and Rule 13d-5 s smlarly satsfed by that sort of agreement, 17 C.F.R d-5(b)(1). Nether provson mandates that the narrow object of acqurng, holdng, votng, or dsposng of securtes must tself serve a broader purpose of seekng corporate control or otherwse exertng nfluence over corporate affars. Morales, 249 F.3d at (emphass added). 110 Whle, "[s]olely for purposes of determnng whether a person s a benefcal owner of more than ten percent of any class of equty securtes" under Rule 16a-l(a)(1), each group member s deemed to benefcally own all the securtes owned by other group members, a group member s not subject to dsgorgement under Secton 16(b) wth respect to transactons by other group members nvolvng securtes n whch he or she has no pecunary nterest as defned under Rule 16a-l(a)(2). See Ownershp Reports and Tradng by Offcers, Drectors and Prncpal Stockholders, SEC Release No , 56 Fed. Reg at 7245, 1991 WL (1991); Segen v. WestclffCaptal, 299 F. Supp.2d 262, 272 (S.D.N.Y. 2004). 35

44 The "agreement" among group members may be nothng more than an nformal understandng, whch may be nferred from crcumstantal evdence. See Roth, 489 F.3d at 508; Morales, 249 F.3d at 124. The dstrct court, however, grafted an addtonal requrement nto Rule 13d-5. t requred evdence that an agreement to acqure, hold, or dspose of securtes must ultmately serve some addtonal purpose beyond those lsted objectves: The cases fndng Secton 16(b) lablty, based on group formaton under Secton 13(d), nvolve fact patterns where the defendants attempted to captalze n some way, ether by takng control of the company, preventng ts sale, or otherwse nfluencng stock prce, by agreeng to pool ther shares and votng, dsposng or holdng them to effectuate ther common purpose.ll The dstrct court therefore concluded that a cognzable group must advance a separate and overarchng motve that s dstnct from, but specfcally furthered by, the lsted actvtes.112 By requrng that the lsted actvtes serve as the precse means of advancng some larger purpose, the dstrct court addtonally concluded that a cognzable group also requres 111 ER 14, ns ER 20, ns ("Global ntellcom s a good example of a plantff pleadng suffcently a Secton 13(d) group wheren the underlyng 'common objectve' was to manpulate stock, but also allegng suffcent facts that the defendant acqured, held, voted or sold stock n furtherance of ths common objectve. Absent the latter allegatons there s no Secton 13(d) group") (emphass added). 36

45 t that each group member obtan a dstnct beneft from the poolng of shares wth other members. 113 Nowhere n the plan language of Rule 13d-5(1)(b) s such a requrement present. Under that Rule, an agreement to act together for the purpose of acqurng, holdng or dsposng of ssuer securtes, wthout servng any larger goal, may tself be the end purpose of a cognzable Secton 13(d) group. 114 Morales, 249 F.3d at n contrast to the dstrct court here, the court n Schaffer v. CC nvest., LDC, 153 F. Supp.2d 484, (S.D.N.Y. 2001), whch confronted ths precse ssue, properly artculated the correct legal standard:... Defendants have argued, among other thngs, that n order to consttute a 13(d) group there must exst a common objectve among the defendants to exercse control over the Company or to manpulate ts stock prce... Whle [plantff] concedes that there are no 113 ER 14, lns (Secton 16(b) lablty proper under fact patterns where the group members "captalze n some way.., by agreeng to pool ther shares"); ER 15, ns ("There s no evdence n the record, however, suggestng that Mr. Jan could beneft by beng a 'benefcal' owner of AOL's nfospace stock"). 114 To be sure, there are cases that fnd lablty where two or more group members engaged n actvtes lsted by Rule 13d-5(b)(1) n an effort to acheve some larger goal. See e.g. nt'l Banknote Co. v. Muller, 713 F. Supp. 612, 619 (S.D.N.Y. 1989) (acquston to obtan corporate control). Ths, however, s not a necessary element of proof under Rule 13d-5(b)(1). Roth, 489 F.3d at 508 ("Although a common purpose to acqure control of the ssung company would be an ndcum of collectve acton wthn the meanng of 13(d), t s not essental"). 37

46 allegatons of a common objectve to control the Company specfcally or to manpulate ts stock prce, [plantff] argues that such factors are not determnatve of group formaton. n lght of the Second Crcut's recent decson n Morales... whch was decded subsequent to Schaffer, the Court agrees wth [plantff]. The plan language of 13(d)(3) requres only an agreement "for the purpose of acqurng, holdng, or dsposng of securtes." 15 U.S.C. 78m(d)(3). Ths provson does not mandate that the narrow object of acqurng, holdng, votng, or dsposng of securtes must tself serve a broader purpose of seekng corporate control or otherwse exertng nfluence over corporate affars. Schaffer, 153 F. Supp.2d at go Evdence of Group Conduct May Pre-Date Regstraton of the ssuers' Securtes. The dstrct court noted that Secton 16(b) only apples to securtes regstered pursuant to Secton 12 of the Act. From ths, t concluded that evdence of group actvty pror to regstraton, but s desgned to go nto effect after regstraton, "cannot be the foundaton of [a] group under any 115 The dstrct court, n statng that "[b]y the plan language of the secton, the partes must have agreed, nformally or otherwse, to acqure, hold, vote, or dspose of ther stock," omtted the crtcal phrase "act together." ER 20, lns The agreement contemplated by the Rule s an agreement to "act together" to acheve one of the lsted purposes. The lsted purposes, under the plan language of the Rule, can nclude the end goal of the "agreement to act together" rather than, as the dstrct court requred, the means through whch a further dstnct qualfyng goal s pursued. 38

47 crcumstances... "116 The dstrct court suggested that conduct evdencng an agreement for the purpose of "acqurng, holdng, votng or dsposng of equty securtes of an ssuer" under Rule 13d-5(b)(1) must all take place after regstraton. The dstrct court erroneously created another prerequste to lablty that s not found n the statute or regulatons. The dstrct court reled upon Rule 16a-2 n reachng ts concluson.lt Ths rule, however, does not lmt evdence of preregstraton conduct n determnng whether a group exsts. nstead, t smply provdes that a benefcal owner of more than 10% (whch would nclude a group under Rules 16a-1(a)(1) and 13d-5(b)(1)) becomes subject to Secton 16 once securtes are regstered. The relevant part provdes: Any person who s the benefcal owner, drectly or ndrectly, of more than ten percent of any class of equty securtes ("ten percent benefcal owner") regstered pursuant to secton 12 of the Act... shall be subject to the provsons of secton 16 of the Act (15 U.S.C. 78p). 17 C.F.R a-2. There s no requrement under Rule 16a-2- or, for that matter, any other Rule or statute - that conduct evdencng a Secton 13(d) group must take place after the ssuers' securtes are regstered. Rule 13d-5(b)(1) speaks n terms of an agreement to acqure, hold, vote or dspose of "equty securtes of an ssuer." The defned term "equty securtes" broadly 116 ER 18, fn d., ctng 17 C.F.R a-2. 39

48 ncludes all "stock or smlar securty" of a company, and s not lmted to securtes regstered under Secton U.S.C. 78c(a)(11); see also 15 U.S.C. 78c(a)(10) (defnton of "securty" not lmted to regstered stock); 17 C.F.R a-1(d) (no lmtaton on defnton n rule). Conduct predatng regstraton may determne group status under the plan language of Rule 13d-5(b)(1). Smlarly, a person's pre-regstraton acquston of 10% or more of an ssuer's stock makes hm a statutory nsder subject to Secton 16(b) mmedately upon regstraton, regardless of whether he purchases even a sngle addtonal share of stock post-regstraton. To gnore pre-regstraton group actvty would evscerate the purpose of the statute and create a glarng loophole for shareholder groups. Assume, for example, that as part of a plan to acqure the stock and hype the prce of a newly publc company and sell t at an nflated prce, ten people agree to each acqure securtes of a start-up company as soon as the company regsters ts stock and goes publc. Assume further that as contemplated-when the company regsters ts stock and has ts PO-each begns to purchase stock and hype the company n accordance wth ther earler agreement. Fnally, assume that the group collectvely acqures n excess of 10% of the ssuer's shares. n the dstrct court's vew, the agreement n ths hypothetcal "cannot be the foundaton of the group under any crcumstances" because t was entered nto pror to regstraton.118 Under ths vew, the group 118 ER 18, fn

49 l members would be free to trade on the short-swng wth mpunty throughout the tme that t collectvely owned more than 10% of the ssuer's shares because essental conduct evdencng ther group status took place pror to regstraton. The relevant queston s not whether the conduct evdencng the group took place pror to regstraton, but whether the securtes were regstered at the tme the group engaged n prohbted short-swng transactons. See 15 U.S.C. 78p. The dstrct court erred n concludng that group actvty that predates regstraton "cannot be the foundaton of the group under any crcumstances." 119 C. Evdence of Group Conduct May Pre-Date Ownershp Of ssuers' Securtes. n a smlar ven, the dstrct court noted that a member of a Secton 16(b) group must be a "benefcal owner" of ssuers stock "at the tme of the group's formaton."120 Ths concluson s not supported by the plan language of the governng regulaton. Even were ths an accurate statement of the law, t would not be a bass for gnorng actvty that predates ownershp n order to determne whether a group exsts upon acquston of shares. 119 ER 18, fn ER 10, fn

50 l 1. Under the plan language of Rule 13d-5(b)(1), a person may be a member of a group pror to hs or her ownershp of the ssuers" securtes. Rule 13d-5(b)(1) outlnes the contours of a "group": When two or more persons agree to act together for the purpose of acqurng, holdng, votng or dsposng of equty securtes of an ssuer, the group formed thereby shall be deemed to have acqured benefcal ownershp, for purposes of sectons 13(d) and (g) of the Act, as of the date of such agreement, of all equty securtes of that ssuer benefcally owned by any such persons." The word "persons" as used n Rule 13d-5(b)(1) s defned by the Act. See 17 C.F.R (b) ("Unless otherwse specfcally stated, the terms used n ths part shall have the meanng defned n the act"). The word "person" s also a defned term under the Act: t ncludes a "natural person" and a "company," and s not lmted to persons or enttes who have acqured benefcal ownershp. 15 U.S.C. 78c(a)(9). Thus, "persons" can form a group by engagng n group commmxcatons or actvty wthout frst havng acqured benefcal ownershp of ssuer securtes. Moreover, a Secton 13(d) group can exst for the purpose of "acqurng" securtes. Logcally, the agreement to form a group to acqure securtes must pre-date the acquston of those securtes. f the SEC had ntended otherwse, t would have used the phrase "acqurng more" rather than the word "acqure" n Rule 13d-5(b)(1). Fnally, the plan language of Rule 13d-5(b)(1) certanly covers a group formed between an exstng benefcal owner, such as Jan, and another person or entty who has yet to acqure ndvdual ownershp, such 42

51 l as AOL, when the members have an agreement to "act together" for the lsted purposes. Under the Rule, the members wthout ndvdual ownershp "shall be deemed to have acqured benefcal ownershp" as of the date of the agreement. Jan's ownershp s mputed to AOL under Rule 13d-5(b)(1) and Rule 16a-1(a)(1), whch s n contrast to the actual ownershp requrement set forth n Rule 16a-l(a)(2), a subsecton that requres "drect or ndrect pecunary nterest" by the person or entty to be subject to dsgorgement under Secton 16(b). The SEC knew how to dstngush actual ownershp from mputed ownershp, and dd so explctly n Rule 16a-1(a). f a group can exst before all members have acqured benefcal ownershp, t follows that evdence of group actvty can be consdered before all members have acqured benefcal ownershp. 2. Even f a person must be a benefcal owner of stock pror to entre d nto a group, evdence of group actv_ d pror to ownershp s relevant to determne group status at the tme of even_lal acquston. Many groups- partcularly groups whose common purpose s to acqure stock-wll coordnate wth each other pror to commencng purchases that wll eventually lead to group status. f group members have not acqured ssuer stock pror to such communcaton, there s no legal or polcy reason that the communcaton should be gnored. Courts routnely look to pre-benefcal ownershp actvty for relevant evdence of subsequent Secton 16(b) group status. For example, n Roth, one alleged group member (EMR) purchased ssuer stock on May 21,

52 and loaned $10 mllon to the other alleged group member (Jennngs) so that Jelmngs could purchase ssuer stock on May 29, Roth, 489 F.3d at 512. Before Jennngs purchased ths stock, he owned no ssuer stock whatsoever and therefore could not have been a benefcal owner. d. at 510. Despte Jennngs' lack of benefcal ownershp status before'may 29, the court consdered pre-may 29 conduct (.e., the May 21 purchase and the $10 mllon loan) n concludng that a "ratonal factfnder could.., easly nfer that EMR and Jennngs acted together for the purpose of Jennngs" purchase of shares." d. at 512. Thus, the court n Roth reled upon evdence of group conduct even though one of the alleged group members was not a benefcal owner at the tme of the conduct. See also Morales, 249 F.3d at (court consders sales and employment agreements evdencng group executed two months before defendant made ntal purchase of ssuer stock). Even f benefcal ownershp s a prerequste to membershp n a Secton 13(d) group-a proposton that s nconsstent wth Rule 13d-5- there s no logcal bass to gnore pre-ownershp actvty to determne whether a group "offcally" came nto exstence when securtes were frst acqured. V. SUMMARY JUDGMENT WAS MPROPERLY GRANTED DUE TO THE EXSTENCE OF DSPUTED MATERAL FACTS. A. Group Formaton s a Queston of Fact. Ultmately, because ssues of motve and ntent are mplcated, the queston of whether a group was formed s nherently factual: 44

53 The questons of (a) whether two or more persons "act[ed]" as a group or agreed to act together, and (b) whether ther purpose was the acquston, holdng, or dsposton of an ssuer's equty securtes are questons of fact. Roth, 489 F.3d at 508. See also Morales, 249 F.3d at 124. B. A Jury Could Conclude That Jan and AOL Formed a Secton 13(d) Group. The ultmate queston posed by ths appeal s whether a reasonable jury could conclude that Jan and AOL formed a Secton 13(d) group before or durng the tme AOL made short-swng trades between November 1, 1999 and May 10, The dstrct court correctly recognzed that AOL acqured and was a benefcal owner of nfospace securtes much earlerbegnnng on February 1, f Jan and AOL formed a legally cognzable Secton 16(b) group on or before November 1, 1999, then all subsequent short-swng transactons dentfed by Drelng are subject to Secton 16(b) so long as the Jan/AOL group collectvely contnued to own 10% of nfospace's stock. Roth, 489 F.3d at See also Argument, Secton.D., above. The dstrct court found that "there s evdence to support Mr. Drelng's frst allegaton of concerted actvty,.e., to secretly nfluence the corporate affares of nfospace by creatng artfcal revenues and earnngs... "122 However, t concluded that there was "no probatve 121 ER 10, n ER 16, lns

54 evdence as to Mr. Drelng's second and thrd allegatons of concerned actvty,.e., holdng and sellng ther shares as part of ther concerted actvty.'123 The dstrct court erred. There s plenty of evdence, when vewed n the proper legal framework, for a jury to conclude that Jan and AOL formed a group for fle purpose of acqurng, holdng and dsposng of nfospace securtes, even though only one of these purposes s requred of a Secton 13(d) group. 1. Jan and AOL Formed A Group To Allow A Group Member, AOL, To Acqure nfospace Securtes. n ts Order grantng summary judgment the dstrct court pad scant attenton to Drelng's argument that Jan and AOL formed a group wth respect to the acquston of nfospace securtes. nstead, the dstrct court framed plantff's clam as one based prmarly on holdng and dsposng of shares.124 t mssed the plantff's straghtforward argument on acquston. A reasonable jury could fnd that Jan, n hs August 12, 1998 emal to Colburn, proposed a ruse to avod an accountng Rule (and Delotte's advce) that would have requred nfospace to value AOL's warrants based on the dates of vestng, rather than the low pre-po prce. Ths ruse, a jury could fnd, was specfcally desgned to enable a deal under whch AOL would acqure nfospace securtes. A jury could fnd that AOL agreed to 123 ER 16, lns ER 12, ns ; ER 16, lns

55 ths scheme, and that Jan and AOL modfed the Agreement to create the lluson of a substantal penalty for non-performance. The dstrct court, n fact, appeared to accept that a jury could fnd these facts. 125 The dstrct court, however, concluded that there s "nothng to lnk [the allegaton that purpose of the Agreement was to allow AOL to acqure nfospace securtes ] wth any factual support."126 Nonetheless, as the dstrct court acknowledged, Jan testfed that the Agreement would never have been made f Delotte had refused to sgn off on the pre-po warrant valuaton accountng he wanted.127 Accordngly, a jury could easly conclude that wthout an understandng between Jan and AOL to create the lluson of a substantal penalty through an agreement to use mproper and manpulatve accountng, there would have been no Agreement n the frst place. Ths fact, combned wth the fact that AOL's acquston of nfospace securtes occurred exclusvely through the vestng of warrants under the Agreement, could support a jury fndng that the understandng between Jan and AOL to jontly manpulate nfospace's accountng was desgned to (and dd) allow AOL to acqure nfospace securtes. 128 Put dfferently, "but for" the agreement between Jan and AOL to engage n manpulatve accountng (and to wthhold such manpulaton from 125 ER 16, lns ER 18, ns ER 6, ns ; ER 344; ER ER

56 l nfospace's audtors), AOL would have never acqured any nfospace securtes. The dstrct court may have dscounted ths evdence based on ts vew that a cognzable group's acquston of shares must be the means to some ultmate end beyond the acquston tself.129 Yet, as a legal matter, the group's purpose can be the agreement to acqure the stock. See Argument, Secton.A., above. Moreover, there s no reason why the group's ultmate goal- f some ultmate goal other than acquston, holdng or sellng s requred-cannot be the shared goal of makng money (or bookng revenue). 130 A jury could easly conclude that the ultmate purpose of the agreement was to make money, partcularly gven AOL's objectve of stmulatng nfospace's stock prce so t could "get more dough.'131 The dstrct court may have also erroneously concluded that much of the evdence of group formaton pre-dated nfospace's regstraton of ts securtes, or pre-dated AOL's benefcal ownershp of shares. As noted n Argument, Secton, B and C, above, evdence of an agreement or 129 ER 14, lns The dstrct court's statement that "AOL dd not sell, or otherwse beneft from, ts shares of nfospace stock n 1999" s not accurate. ER 10, ns Throughout 1999 AOL ncreased ts reported revenues and earnngs by bookng the lfflated prce of ts nfospace stock and warrants. ER 237; ER ER 796. See also ER 794 (AOL dscussng "best means of affectng stock prce n ths space, snce that's the sole goal"); ER

57 understandng between Jan and AOL s relevant to determne group status even f t occurred n A jury could fnd that the coordnatng conduct n August of 1998 was specfcally desgned to- and dd- affect events n 1999 and 2000 (.e., AOL's recept of nfospace shares under the Agreement). The understandng and conduct whch led to the Agreement (and ts llusory penalty) set n moton the very mechansm by whch AOL acqured nfospace stock n February of 1999 and beyond. Under the plan language of Rule 13d-5 Jan and AOL "agree[d] to act together for the purpose of acqurng.., equty securtes of an ssuer... " 2. Jan and AOL Formed A Group To Ho d And Dspose Of nfospace Securtes. The Jan/AOL group was also formed for the purpose of holdng and dsposng of nfospace securtes. By workng together to manpulate nfospace's accountng and manage ts earnngs, the group sought to artfcally nflate nfospace's stock prce. As Jan correctly predcted n hs emal to AOL's Colburn, the artfcal reducton of nfospace's expenses would result n a "beneft from our stock prce. "132 Both partes benefted when Jan touted nfospace's ostensble "proftablty" to the street- 132 ER

58 somethng that other dot.com companes were unable to do.133 The dstrct court, however, was msfocused on what t vewed as the lack of precsely coordnated stock sales. TM t appeared to requre an agreement between AOL and Jan to sell on a specfc day, or wthn a specfc very narrow tme frame- as s more typcal when a group of nsders has advance knowledge of the government's award of a major defense contract, for example- than wth the type of systemc revenue and earnngs manpulaton that was nvolved n the Jan/AOL scheme. n analyzng the trades, the dstrct court noted that "AOL's tradng actvtes are more algned wth the theory that AOL sold ts shares when the prce of nfospace stock was at t hghest value... The fact that AOL sold ts shares 133 n the second quarter of 1999, Jan proclamed that nfospace was pro-forma proftable to the tune of $409,000. ER 798. Jan attrbuted ths proftablty to the strength of lffospace's busness model: "Ths demonstrates that growth and proftablty are not mutually exclusve... Achevng proftablty two quarters ahead of Wall Street's expectatons demonstrates the strength of our busness model." d. nfospace reported a pro-forma proft of $3.1 mllon the next quarter. ER 802. Jan wrote: "We had a totally awesome quarter... " d. n the next quarter nfospace reported "Another Record Quarter," wth revenues growng to $14.4 mllon, resultng n pro-forma profts of $5 mllon. ER 807. Then, for the frst quarter of 2000, nfospace reported "Fourth Consecutve Proftable Quarter... wth a pro forma proft of $0.01, beatng Frst Call consensus estmates by $0.07." ER 812. Whle Jan was toutng nfospace's proftablty to the world, Jan and AOL knew the truth- that f AOL's warrants had been properly charged aganst ncome the purported "proftablty" would have been drowned h_ a sea of red nk. 134 ER O

59 around the same tme as Mr. Jan n March of 2000, seems to ndcate only that both partes sold when nfospace stock was hgh."135 The dstrct court, however, gnored the general congruence of massve sales by Jan and AOL. More mportant, t gnored the possblty that $200 mllon n sales by each Jan and AOL "when nfospace stock was hgh" was the successful culmnaton of the Jan/AOL plan objectve to sell nto a market nflated through ther own carefully orchestrated manpulaton. A jury could fnd that the purpose of the Jan/AOL allance was to make nfospace's books, over a four-year perod, vastly understate the expenses t should have charged aganst ncome. t could agree wth Jan when he wrote that hs "creatve dea[]" to "monkey around wth the numbers" would result n a "beneft [to] our stock prce" over that perod of tme.136 t could also fnd that the most sgnfcant mpact on nfospace's reported proftablty occurred n the frst two quarters of 2000-precsely the perod of tme durng whch AOL and Jan each sold massve amounts of nfospace stock. 137 A jury could further fnd that AOL and Jan sold at ths tme, whle they both knew that nfospace was able to meet analysts' expectatons n 135 ER 11, fn ER ER 889; ER 518; ER 110; ER

60 , the second quarter of 2000, only because "Amendment 1" was purportedly executed n that quarter.138 n short, a jury could fnd that Jan and AOL had an understandng, and acted together wthn the context of that understandng, to hold nfospace whle they carred out schemes to prop up the prce of the stock-and then, when the prce reached t zenth due to ther conduct and storm clouds were formng, to sell. Usng the language of the Rule 13d-5, they "agree[d] to act together for the purpose of... holdng... or dsposng of equty securtes." Smply because they dd not sell on the same day does not mean that they dd not share the common objectve to hold and sell nto a market that was unaware of ther coordnated efforts to artfcally nflate nfospace stock. C. A Jury Could Conclude that Jan was Motvated by Hs Personal nterest. The dsb'ct court concluded that the plantff was unable to show that Jan was operatng n hs "personal capacty" whle engneerng the accountng fraud.139 n creatng a dstncton between "personal capacty" and "corporate capacty," the dstrct court mproperly framed the ssue n terms of capacty when the relevant queston s one of ntent. An nsder such as Jan can engage n facally "offcal" conduct that s actually desgned to serve personal or group nterests. As events 138 See Statement of Facts, Secton, above. 139 ER 18, ns

61 surroundng companes such as Enron and WofldCom ndcate, corporate fraud can occur when an nsder uses hs or her poston to engage n actvtes desgned to manpulate the stock of the company the nsder ostensbly serves. t s no defense for an nsder to dsclam personal lablty for fraudulent corporate conduct by clamng t was done n a corporate capacty rather than an ndvdual capacty. t s ndvdual corporate fraudsters, not the companes they manpulate, that go to prson for corporate fraud, even f conducted n ther "corporate capacty." And, where nsders happen to personally sell company stock nto a market they nflated, t s easy to conclude that nsders are attemptng to beneft personally from ther conduct. Properly framed, the ssue s whether a reasonable jury could conclude that Jan-n "secretly" engagng wth AOL n conduct desgned to allow AOL to acqure nfospace stock, and, workng together, nflate nfospace's stock prce so that they could both sell ther consderable holdngs nto an nflated market-ntended to personally beneft from the conduct. See Warner, 581 F. Supp. at (ndvdual corporate nsders can be group members wth an outsde party f the nsders' ntent n engagng n corporate actvty s to beneft themselves); Olympc Fsh Prod. v. Lloyd, 93 Wash. 2d 596, 602, 611 P.2d 737 (1980) (whether a corporate offcer ntended to act on behalf of the corporaton or n hs own nterest n volaton of hs dutes s a queston of fact). n Warner, stock ssuer Warner entered nto an agreement wth an outsde party, Chrs-Craft. The purpose of the agreement, t was alleged, 53

62 was to create a large enough block of Warner's stock to prevent a hostle takeover. The relevant agreements wth Chrs-Craft were made for Warner, by Warner managers actng n ther offcal capactes. d. at The court held that, although Warner tself could not be part of the Secton 13(d) group, Warner's nsde drectors who arranged the agreement together wth Chrs-Craft could be part of a group. "f a management group... engages n a votng or poolng arrangement wth thrd partes, the arrangement should be subject to the dsclosure provsons of 13(d)." d. at Whether the nsde drectors and outsde partes had suffcent ntent to form a group was a fact queston that could be answered based on nferences. d. at Accord, Jezoelcorp, 397 F. Supp. at 250 (drectors, together wth outsde partes, can form a Secton 13(d) group when they act mproperly to soldfy ther own poston; nferences of agreement are permtted). Jan may have engaged n dscussons wth AOL under the cloak of hs offcal ttle at nfospace. Jan, however, abused hs poston to propose, and ultmately mplement wth AOL, a fraud desgned to boost nfospace's stock prce. A reasonable jury could conclude that Jan ntended to beneft hmself by engagng n the accountng scheme, gven evdence that: Jan beleved that the scheme would boost nfospace's stock prce ER 182 (referrng to "beneft from [nfospace's] stock prce"). 54

63 l Jan owned 66% of the outstandng shares of nfospace pror to ts PO n December of 1998, and 49.9% mmedately after the PO.141 Jan personally benefted from an ncrease n nfospace's share prce. He dumped $200 mllon worth of stock nto an nflated market n 1999, and another $200 mllon nto a smlarly nflated market n the frst half of Hs sales n 2000 took place durng two quarters where, because of the scheme wth AOL, nfospace's fnancal statements underreported nfospace's expenses by a whoppng $64 mllon (relatve to total revenues of $44 mllon), and when Jan and AOL knew that storm clouds were on the horzon for nfospace.143 Jan concealed the accountng scheme from nfospace's audtors.144 As a result of an nfospace board of drectors nvestgaton whch revealed that Jan had commtted certan acts n the name of 141 ER Jan, n fact, bragged to AOL about hs personal wealth as a result of nfospace's rse n value, whch also benefted AOL. ER 385 (Jan's emal to Colburn: "n case you ddn't realze recently joned the bg B club (bll's bllonare club). Our stock s up another 20 ponts at 111. You got to love t"). 143 ER 889; ER 812; ER ER ; ER 468; ER ; ER

64 nfospace whch the board felt were not n the company's nterest, Jan voluntarly undertook personal lablty for "any act of fraud... occurrng on or before September 30, "145 Jan sgned pubc flngs and acquesced n other publc pronouncements that msrepresented nfospace's expenses as a result of the scheme, thereby exposng nfospace to sgnfcant lablty. 146 A jury could- and should- conclude that Jan ntended to beneft hmself when- even f cloaked wth corporate authorty - he hatched and mplemented the accountng scheme wth AOL. V. THE DSTRCT COURT ERRED N FALNG TO DRAW FFTH AMENDMENT NFERENCES AGANST AOL's FORMER EMPLOYEES. The dstrct court concluded that t had no dscreton to draw any adverse nferences from the refusal, on Ffth Amendment grounds, of AOL's former executves to answer questons surroundng AOL's coordnaton wth Jan.147 t found that the lack of any addtonal evdence of gult precluded an adverse nference. 148 However, the record contans sgnfcant evdence corroboratng Drelng's clam that these executves had an understandng wth Jan to manpulate the accountng to allow 145 ER ; ER 542. See also ER 416; ER 418; ER ER 798; ER 802; ER 807; ER ER 17, ns ER 17, lns

65 AOL to acqure nfospace securtes, and then to hold and sell those securtes nto a market nflated by the mproper accountng. The two former AOL executves who nvoked the Ffth Amendment, Keller and Colburn, were AOL's prncpal actors n engagng n the group actvtes wth Jan. At ther depostons, they were asked questons drectly related to the ssues nvolved n ths lawsut. They were shown documents produced from AOL's own fles, emals addressed to them, and agreements contanng ther sgnatures.149 Wth these documents n hand, they were asked specfc questons regardng the agreements at ssue.150 For example, at hs deposton Keller was shown emals he was coped on that dscuss front-loadng "to take care of penalty" for termnaton. Keller was then asked, "The goal of ths agreement between Mr. Jan and AOL was to create the appearance of a substantal cash penalty n the agreement when n realty AOL would not be payng a substantal cash penalty n the event AOL dd not meet ts performance hurdles; correct, Mr. Keller?" Keller declned to answer, ctng the Ffth Amendment.151 Gven the emal suggestng the goal and Keller's refusal to answer the drect queston, a jury could nfer that the goal of the agreement was to create a substantal cash penalty n appearance only. 149 ER (Colburn s asked about documents ER , ER , ER 217, ER 219); ER (Keller s asked about documents ER , ER , ER 217, ER 219, ER 237, ER 240, ER 242). 150 d. 151 ER

66 Colburn was the recpent of Jan's late nght "creatve juces" emal proposng a change n the contract to "get around" nfospace's "damn accountant. "152 Colburn's response was a new agreement ncorporatng the "creatve" strategy that Jan proposed. 153 Ths evdence s drectly relevant to whether AOL, through ts employees Keller and Colburn, formed a group wth Jan to manpulate the value of nfospace stock by agreeng to a plan that resulted n under-reportng stock warrant expenses. There s no shortage of corroboratng evdence. The documents these wtnesses had n front of them whle they nvoked the Ffth Amendment are tantamount to the "fngerprnts on the gun" the court hypotheszed n Doe ex rel Rudy-Glanzer, 232 F.3d 1258, 1266, fn.2 (9 th Cr. 2000). They are precsely the type of corroboratng evdence found suffcent n analogous cases to allow a negatve nference from former employees" nvocaton of the Ffth Amendment. See Cutter & Buck, nc. v. Geness nsurance Co., 306 F. Supp.2d 988, 1005 (W.D. Wa. 2004); n re Wnstar Commc'ns, nc., 348 B.R. 234, (D. Del. 2005). The corroboratng evdence here-and AOL's former employee's "fngerprnts" all over that evdence-warrants a proper nference. The dstrct court's concluson that t had no dscreton to draw such an nference was n error. 152 ER ER 694; ER 698; ER ; ER 731; ER 761; ER 765; ER

67 CONCLUSON For the reasons stated above, ths Court should: (1) reverse the dstrct court's grant of summary judgment; and (2) remand for tral. RESPECTFULLY SUBMTTED ths 29 th day of May, SRANN YOUTZ l_lcha'r_. Spoonemore, WSBA #21833 f Stephen J. Srann, WSBA #6957 and Davd M. Smmonds (WSBA #6994) Attorneys for Appellant Drelng / / 59

68 STATEMENT OF RELATED CASES Appellant s unaware of any cases related to ths matter pendng n ths Court. DATED: May 29, "_chard E. Spoonemore

69 ' CERTFCATE OF COMPLANCE PURSUANT TO CRCUT RULE 32-1 certfy that: The bref s: [] Proportonately spaced, has a typeface of 14 ponts or more and contans 13,583 words. 1 or s [--] Monospaced, has 10.5 or fewer characters per nch and contans _ words or _ lnes of text. or s [[] n conformance wth the type specfcatons set forth at Fed. R. App. P. 32(a)(5) and does not exceed pages. DATED: May 29, /'_/Rchard E. Spoonemore

70 CERTFCATE OF SERVCE, Rchard E. Spoonemore, hereby certfy that am a member of the bar of ths Court, and that on May 30, 2008, caused APPELLANT THOMAS DRELNG'S OPENNG BREF and assocated EXCERPT OF RECORD to be served pursuant to Rule 25(b), F.R.A.P., by malng copes of same to the followng counsel: Mchael D Hunsnger THE HUNSNGER LAW FRM 100 S. Kng Street, Sute 400 Seattle, WA Counsel for Amerca Onlne, nc. George A. Borden, J. Andrew Keyes, Amanda MacDonald, Marce R. Zegler, and Dane H. Butswnkas WLLAMS & CONNOLLY, th Street, N.W. LLP Washngton, DC Counsel for Amerca Onlne, nc. [x] By Unted States Mal x] By Emal (bref only) Tel. (206) Fax (206) mke [x] [x] hunsn erlazouers@cahoo.con_ lalzoo.com By Unted States Mal By Emal (bref only) Tel. (202) Fax (202) amacdonald@wc.com, mzegler@wc.com, Douglas W. Greene WLSON SONSN GOODRCH & ROSAT, PC 701 FfthAvenue, Sute5100 Seattle, WA Counsel for lnfospace, nc. [ ] [x] By Unted States Mal By Emal (bref only) Tel. (206) Fax (206) n addton, have caused the orgnal and ffteen copes of the APPELLANT THOMAS DRELNG'S OPENNG BREF and fve copes of the accompanyng EXCERPTS OF RECORD to be forwarded by Federal Express (Prorty Overnght) ths day to the Clerk of the Court addressed as follows: Offce of the Clerk U.S. COURT OF APPEALS, NNTH CRCUT 95 Seventh Street DATED: May 30, 2008, at Seattle San Francsco, CA 94103,,/" _chard E. Spoonemore

71 ADDENDUM P_ A-1 Descrpton Secton 3 of the Securtes Exchange Act of 1934, 15 U.S.C. 78c (Subsectons (a)(9), (10) and (11) only) A-2 Secton 13 of the Securtes Exchange Act of 1934, 15 U.S.C. 78m (Subsecton (d) only) A-5 Secton 16 of the Securtes Exchange Act of 1934, 15 U.S.C. 78p A-9 SEC Rule 0-1, 17 C.F.R A-11 SEC Rule 13d-5, 17 C.F.R d-5 A-13 SEC Rule 16a-1, 17 C.F.R a-1 A-20 SEC Rule 16a-2, 17 C.F.R a-2

72 15 U.S.C.A. 78e Page Secton 3 of the Securtes Exchange Act of 1934, 15 U.S.C. 78c (Subsectons (a)(9), (10) and (11) only) Unted States Code Annotated Currentness Ttle 15. Commerce and Trade _e Chapter 2B. Securtes Exchanges (Refs & Annos) -, 78e. Defntons and applcaton (a) Defntons When used n ths chapter, unless the context otherwse requres-- e "k (9) The term "person" means a natural person, company, government, or poltcal subdvson, agency, or nstrumentalty of a government. 1 1 (10) The term "securty" means any note, stock, treasury stock, securty future, bond, debenture, certfcate of nterest or partcpaton n any proft-sharng agreement or n any ol, gas, or other mneral royalty or lease, any collateraltrust certfcate, preorganzaton certfcate or subscrpton, transferable share, nvestment contract, votng-trust certfcate, certfcate of depost for a securty, any put, call, straddle, opton, or prvlege on any securty, certfcate of depost, or group or ndex of securtes (ncludng any nterest theren or based on the value thereof), or any put, call, straddle, opton, or prvlege entered nto on a natonal securtes exchange relatng to foregn currency, or n general, any nstrument commonly known as a "securty"; or any certfcate of nterest or partcpaton n, temporary or nterm certfcate for, recept for, or warrant or rght to subscrbe to or purchase, any of the foregong; but shall not nclude currency or any note, draft, bll of exchange, or banker's acceptance whch has a maturty at the tme of ssuance of not exceedng nne months, exclusve of days of grace, or any renewal thereof the maturty of whch s lkewse lmted. (11) The term "equty securty" means any stock or smlar securty; or any securty future on any such securty; or any securty convertble, wth or wthout consderaton, nto such a securty, or carryng any warrant or rght to subscrbe to or purchase such a securty; or any such warrant or rght; or any other securty whch the Commsson shall deem to be of smlar nature and consder necessary or approprate, by such rules and regulatons as t may prescrbe n the publc nterest or for the protecton of nvestors, to treat as an equty securty Thomson/West. No Clam to Org. U,S. Govt. Works. A-1

73 15 U.S.C.A. 78m Page 1 Secton 13 of the Securtes Exchange Act of 1934, 15 U.S.C. 78m (Subsecton (d) only) Unted States Code Annotated Currentness Ttle 15. Commerce and Trade Chapter 2B. Securtes Exchanges (R.efs & Annos) -, 78m. Perodcal and other reports (d) Reports by persons acqurng more than fve per centum of certan classes of securtes (1) Any person who, after acqurng drectly or ndrectly the benefcal ownershp of any equty securty of a class whch s regstered pursuant to secton 78l of ths ttle, or any equty securty of an nsurance company whch would have been requred to be so regstered except for the exempton contaned n secton 78l(_(2_(G) of ths rfle, or any equty securty ssued by a closed-end nvestment company regstered under the nvestment Company Act of 1940 [15 U.S.C.A. 80a-1 et seq.] or any equty securty ssued by a Natve Corporaton pursuant to secton 1629c(d)(6) of Ttle 43, s drectly or ndrectly the benefcal owner of more than 5 per centum of such class shall, wthn ten days after such acquston, send to the ssuer of the securty at ts prncpal executve offce, by regstered or certfed mal, send to each exchange where the securty s traded, and fle wth the Commsson, a statement contanng such of the followng nformaton, and such addtonal nformaton, as the Commsson may by rules and regulatons, prescrbe as necessary or approprate n the publc nterest or for the protecton of nvestors-- (A) the background, and dentty, re'sdenee, and ctzenshp of, and the nature of such benefcal ownershp by, such person and all other persons by whom or on whose behalf the purchases have been or are to be effected; (B) the source and amount of the funds or other consderaton used or to be used n makng the purchases, and f any part of the purchase prce s represented or s to be represented by funds or other consderaton borrowed or otherwse obtaned for the purpose of acqurng, holdng, or tradng such securty, a descrpton of the transacton and the names of the partes thereto, except that where a source of funds s a loan made n the ordnary course of busness by a 2008 Thomson/West. No Clam to Org. U.S. Govt. Works. A-2

74 15 U.S.C.A. 78m P.ge 2 bank, as defned n secton 78c(a)('6) of ths ttle, f the person flng such statement so requests, the name of the bank shall not be made avalable to the publc; (C) f the purpose of the purchases or prospectve purchases s to acqure control of the busness of the ssuer of the securtes, any plans or proposals whch such persons may have to lqudate such ssuer, to sell ts assets to or merge t wth any other persons, or to make any other major change n ts busness or corporate structure; (D) the number of shares of such securty whch are benefcally owned, and the number of shares concernng whch there s a rght to acqure, drectly or ndrectly, by () such person, and () by each assocate of such person, gvng the background, dentty, resdence, and ctzenshp of each such assocate; and (E) nformaton as to any contracts, arrangements, or understandngs wth any person wth respect to any securtes of the ssuer, ncludng but not lmted to transfer of any of the securtes, jont ventures, loan or opton arrangements, puts or calls, guarantes of loans, guarantes aganst loss or guarantes of profts, dvson of losses or profts, or the gvng or wthholdng of proxes, namng the persons wth whom such contracts, arrangements, or understandngs have been entered nto, and gvng the detals thereof. (2) f any materal change occurs n the facts set forth n the statements to the ssuer and the exchange, and n the statement fled wth the Commsson, an amendment shall be transmtted to the ssuer and the exchange and shall be fled wth the Commsson, n accordance wth such rules and regulatons as the Commsson may prescrbe as necessary or approprate n the publc nterest or for the protecton of nvestors. (3) When two or more persons act as a partnershp, lmted partnershp, syndcate, or other group for the purpose of acqurng, holdng, or dsposng of securtes of an ssuer, such syndcate or group shall be deemed a "person" for the purposes of ths subsecton. (4) n determnng, for purposes of ths subsecton, any percentage of a class of any securty, such class shall be deemed to consst of the amount of the outstandng 2008 Thomson/West. No Clam to Org. U.S. Govt. Works. A-3

75 15 U.S.C.A. 78m Pagc 3 securtes of such class, exclusve of any securtes of such class held by or for the account of the ssuer or a subsdary of the ssuer. (5) The Commsson, by rule or regulaton or by order, may permt any person to fle n leu of the statement requred by paragraph (1) of ths subsecton or the rules and regulatons thereunder, a notce statng the name of such person, the number of shares of any equty securtes subject to paragraph (1) whch are owned by hm, the date of ther acquston and such other nformaton as the Commsson may specfy, f t appears to the Commsson that such securtes were acqured by such person n the ordnary course of hs busness and were not acqured for the purpose 9f and do not have the effect of changng or nfluencng the control of the ssuer nor n connecton wth or as a partcpant n any transacton havng such purpose or effect. (6) The provsons of ths subsecton shall not apply to-- (A) any acquston or offer to acqure securtes made or proposed to be made by means of a regstraton statement under the Securtes Act of 1933 U.S.C.A. 77a et seq.]; ('B) any acquston of the benefcal ownershp of a securty whch, together wth all other acqustons by the same person of securtes of the same class durng the precedng twelve months, does not exceed 2 per centum of that class; (C) any acquston of an equty securty by the ssuer of such securty; (D) any acquston or proposed acquston of a securty whch the Commsson, by rules or regulatons or by order, shall exempt from the provsons of ths subsecton as not entered nto for the purpose of, and not havng the effect of, changng or nfluencng the control of the ssuer or otherwse as not comprehended wthn the purposes of ths subsecton Thomson/West. No Clam to Org. U.S. Govt. Works. A'_

76 , l 15 U.S.C.A. 78p Page Secton 16 of the Securtes Exchange Act of 1934, 15 U.S.C. 78p Unted States Code Annotated Currentness Ttle 15. Commerce and Trade Chapter 2B. Securtes Exchanges (Refs & Annos) -, 78D. Drectors_ offcers_ and prncpal stockholders (a) Dsclosures requred (1) Drectors, offcers, and prncpal stockholders requred to fle Every person who s drectly or ndrectly the benefcal owner of more than 10 percent of any cass of any equty securty (other than an exempted securty) whch s regstered pursuant to secton 781 of ths ttle, or who s a drector or an offcer of the ssuer of such securty, shall fle the statements requred by ths subsecton wth the Commsson (and, f such securty s regstered on a natonal securtes exchange, also wth the exchange). (2) Tme of flng The statements requred by ths subsecton shall be fled-- (A) at the tme of the regstraton of such securty on a natonal securtes exchange or by the effectve date of a regstraton statement fled pursuant to secton 78l(g) of ths ttle; (B) wthn 10 days after he or she becomes such benefcal owner, drector, or offcer; (C) f there has been a change n such ownershp, or f such person shall have purchased or sold _t securty-based swap agreement (as defned n secton 206Co) of the Grarnm-Leach-Blley Act (15 U.S.C. 78e note)) nvolvng such equty securty, before the end of the second busness day followng the day on whch the subject transacton has been executed, or at such other tme as the Commsson shall establsh, by rule, n any case n whch the Commsson determnes that such 2-day perod s not feasble Thomson/West. No Clam to Org. U.S. Govt. Works. A-5

77 l 1 15 U.S.C.A. 7Sp Pago 2 (3) Contents of statements A statement fled-- (A) under subparagraph (A) or (B) of paragraph (2) shall contan a statement of the amount of all equty securtes of such ssuer of whch the flng person s the benefcal owner; and (B) under subparagraph (C) of such paragraph shall ndcate ownershp by the flng person at the date of flng, any such changes n such ownershp, and such purchases and sales of the securty-based swap agreements as have occurred snce the most recent such flng under such subparagraph. (4) Electronc flng and avalablty Begnnng not later than 1 year after July 30, (A) a statement fled under subparagraph (C) of paragraph (2) shall be fled electroncally; 01) the Commsson shall provde each such statement on a publcly accessble nteract ste not later than the end of the busness day followng that flng; and (C) the ssuer (f the ssuer mantans a corporate webste) shall provde that statement on that corporate webste, not later than the end of the busness day followng that flng. (b) Profts from purchase and sale of securty wthn sx months For the purpose of preventng the unfar use of nformaton whch may have been obtaned by such benefcal owner, drector, or offcer by reason of hs relatonshp to the ssuer, any proft realzed by hm from any purchase and sale, or any sale and purchase, of any equty securty of such ssuer (other than an exempted securty) or a securty-based swap agreement (as defned n secton 206B of the Gramm-Leach-Blley Act) nvolvng any such equty securty wthn any perod of less than sx months, unless such securty or securty-based swap agreement was acqured n good fath n connecton wth a debt prevously contracted, shall nure 2008 Thomson/West. No Clam to Org. U.S. Govt Works. A-6

78 l l 15 U.S.C.A. 78p Page 3 to and be recoverable by the ssuer, rrespectve of any ntenton on the part of such benefcal owner, drector, or offcer n enterng nto such transacton of holdng the securty or securty-based swap agreement purchased or of not repurchasng the securty or securty-based swap agreement sold for a perod exceedng sx months. Sut to recover such proft may be nsttuted at law or n equty n any court of competent jursdcton by the ssuer, or by the owner of any securty of the ssuer n the name and n behalf of the ssuer f the ssuer shall fal or refuse to brng such sut wthn sxty days after request or shall fal dlgently to prosecute the same thereafter; but no such sut shall be brought more than two years after the date such proft was realzed. Ths subsecton shall not be construed to cover any transacton where such benefcal owner was not such both at the tme of the purchase and sale, or the sale and purchase, of the securty or securty-based swap agreement (as defned n secton 206B of the Gramm-Leach-Blley Act) nvolved, or any transacton or transactons whch the Commsson by rules and regulatons may exempt as not comprehended wthn the purpose of ths subsecton. (c) Condtons for sale of securty by benefcal owner, drector, or offcer t shall be unlawful for any such benefcal owner, drector, or offcer, drectly or ndrectly, to sell any equty securty of such ssuer (other than an exempted securty), f the person sellng the securty or hs prncpal (1) does not own the securty sold, or (2) f ownng the securty, does not delver t aganst such sale wthn twenty days thereafter, or does not wthn fve days after such sale depost t n the mals or other usual channels of transportaton; but no person shall be deemed to have volated ths subsecton f he proves that notwthstandng the exercse of good fath he was unable to make such delvery or depost wthn such tme, or that to do so would cause undue nconvenence or expense. (d) Securtes held n nvestment account, transactons n ordnary course of busness, and establshment of prmary or secondary market The provsons of subsecton Co) of ths secton shall not apply to any purchase and sale, or sale and purchase, and the provsons of subsecton (c) of ths secton shall not apply to any sale, of an equty securty not then or theretofore held by hm n an nvestment account, by a dealer n the ordnary course of hs busness and ncdent to the establshment or mantenance by hm of a prmary or secondary market (otherwse than on a natonal securtes exchange or an exchange exempted 2008 Thomson/West. No Clam to Org. U.S. Govt. Works. A-7