PR Diamonds, Inc. v. Chandler ( 2004 )

RECOMMENDED FOR FULL-TEXT PUBLICATION
Pursuant to Sixth Circuit Rule 206 2 PR Diamonds, et al. v. Chandler, et al. No. 02-3921
ELECTRONIC CITATION: 2004 FED App. 0116P (6th Cir.)
File Name: 04a0116p.06 _________________
COUNSEL
UNITED STATES COURT OF APPEALS
ARGUED: William R. Jacobs, STRAUSS & TROY,
FOR THE SIXTH CIRCUIT Cincinnati, Ohio, for Appellants. Robert A. Pitcairn, Jr.,
_________________ KATZ, TELLER, BRANT & HILD, Cincinnati, Ohio, Robert
N. Hochman, SIDLEY, AUSTIN, BROWN & WOOD,
PR DIAMONDS, INC., et al., X Chicago, Illinois, for Appellees. ON BRIEF: Richard S.
Plaintiffs-Appellants, - Wayne, STRAUSS & TROY, Cincinnati, Ohio, for
- Appellants. Robert A. Pitcairn, Jr., KATZ, TELLER,
- No. 02-3921 BRANT & HILD, Cincinnati, Ohio, Robert N. Hochman,
v. - Jeffrey R. Tone, Jeffrey C. Sharer, SIDLEY, AUSTIN,
> BROWN & WOOD, Chicago, Illinois, for Appellees.
,
JOHN P. CHANDLER, et al., -
Defendants-Appellees. - _________________
N OPINION
Appeal from the United States District Court _________________
for the Southern District of Ohio at Cincinnati.
No. 01-00012—Sandra S. Beckwith, District Judge. GORDON J. QUIST, District Judge. Plaintiffs-appellants
in this securities fraud case are investors in the stock of
Argued: December 12, 2003 Intrenet, Inc. ("Intrenet" and the "Company"). Defendants-
appellees are two Intrenet officers (the "Individual
Decided and Filed: March 3, 2004* Defendants") and Intrenet's outside auditor, Arthur Andersen
LLP ("Andersen"). Plaintiffs' amended consolidated class
Before: COLE and CLAY, Circuit Judges; QUIST, District action complaint (the "Complaint") alleged that the Individual
Judge.** Defendants and Andersen committed securities fraud in
violation of Section 10(b) of the Securities Exchange Act of
1934, 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated by the
Securities and Exchange Commission (the "SEC"), 17 C.F.R.
§ 240.10b-5. In addition, Plaintiffs alleged that the Individual
Defendants were liable as control persons under Section 20(a)
of the Securities Exchange Act of 1934, 15 U.S.C. § 78t(a).
* The district court dismissed the Section 10(b) and Rule 10b-5
This decision was originally issued as an “unpublished decision”
filed on M arch 3 , 2004 . On M arch 29, 2004 , the court designated the claims for lack of specific allegations giving rise to a strong
opinion as one recommend ed for full-text publication. inference of scienter, and later granted judgment on the
**
pleadings on the Section 20(a) claim for failure to state a
The Honorab le Gordon J. Q uist, United States District Judge for the predicate securities fraud claim against the Company.
W estern District of Michigan, sitting by designation.
1
No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 3 4 PR Diamonds, et al. v. Chandler, et al. No. 02-3921
Plaintiffs now appeal the district court's decisions. For the financial statements and press releases over the course of the
reasons set forth below, we affirm. class period. The class period ends with Intrenet's press
release dated October 13, 2000, in which the Company
I. Background announced that it was conducting a review of the accuracy of
its financial statements, focusing on the Advanced
Intrenet was an Indiana corporation with its executive Distribution System ("ADS") subsidiary. The press release
offices and principal place of business in Milford, Ohio. The stated that pending the completion of the review, Intrenet's
Company operated as a holding company for four truckload 1998 and 1999 year-end financial statements should not be
carrier subsidiaries (Roadrunner Trucking, Inc., Roadrunner relied upon, and that the Company expected to reduce its net
Distribution Services, Inc., Eck Miller Transportation Corp., income by approximately $1.3 million. NASDAQ trading in
and Advanced Distribution System, Inc.) and a brokerage Intrenet stock was halted on that same day, never to resume.
logistics operation (INET Logistics, Inc.). Intrenet's On October 18, 2000, Intrenet issued another press release
consolidated financial statements included all five of these indicating that the internal audit showed $1.3 million in
subsidiaries. A publicly-held company, Intrenet was unrecorded expenses at ADS which could result in
registered with the Securities Exchange Commission and its restatements of Intrenet's 1998, 1999, and first and second
stock traded on the NASDAQ National Market System. quarter 2000 financial statements. The press release also
Formed in 1983, Intrenet was once one of the largest public stated that the individual believed to be responsible for the
flatbed carriers in North America. accounting issues was no longer with the Company.
The two Individual Defendants, John P. Chandler and Eric On January 2, 2001, Intrenet announced that effective
C. Jackson, were Intrenet officers and directors. Chandler immediately it and its subsidiary trucking companies would
was President and Chief Executive Officer since June 12, cease operations, lay off most employees, and direct the
2000. Prior to that time, Chandler was, at all relevant times, liquidation of assets. Intrenet said that after a thorough
Executive Vice President and Chief Operating Officer of the review of the Company's business, industry dynamics, and all
Company. Throughout the class period asserted in this available options, it was determined that issues related to fuel
action, Chandler was also a director of Intrenet. Jackson was prices, driver retention, and the unwillingness of many
Chairman of Intrenet's Board of Directors from June 12, customers to accept higher rates would preclude the Company
2000, to December 19, 2000. Prior to his appointment as from achieving operational profitability in the foreseeable
Chairman of the Board, Jackson was President and Chief future. Also, Intrenet noted that it lacked adequate capital to
Executive Officer. Jackson was also a director of the execute its business plan. CEO Chandler further stated that
Company since 1993. Defendant Arthur Andersen LLP the previously announced accounting issues relating to the
served as Intrenet's outside auditor. In that capacity, ADS subsidiary had little impact on the decision to suspend
Andersen audited the Company's financial statements for the operations and liquidate. On January 19, 2001, Intrenet filed
years ending December 31, 1998, and December 31, 1999. for Chapter 11 bankruptcy protection.
The alleged 20-month class period begins with an Intrenet Intrenet stockholder Hirsch Seidman initiated this action in
press release issued on February 19, 1999, reporting the January 2001 in the United States District Court for the
Company's financial results for the fourth quarter and year Southern District of Ohio. Seidman sued both individually
ending December 31, 1998. Intrenet issued additional and on behalf of all other similarly situated public investors
No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 5 6 PR Diamonds, et al. v. Chandler, et al. No. 02-3921
who purchased Intrenet common stock during the class period (c) the financial statements failed to account for
(February 19, 1999, through October 13, 2000) and incurred uncollectible receivables and understated receivable
losses when the stock lost value as a result of the October 13, reserves;
2000, press release and subsequent collapse of the Company.
In June 2001, the district court appointed P.R. Diamonds, Inc. (d) the financial statements failed to record an
as lead plaintiff. Plaintiffs filed an amended consolidated impairment in the value of Intrenet's assets; and
class action complaint (the "Complaint") on August 17, 2001,
to add Andersen as a defendant. Pursuant to this Complaint, (e) the financial statements failed to fully disclose the
Plaintiffs asserted claims under 15 U.S.C. § 78j(b) ("Section significant risks and uncertainties associated with
10(b)") and 17 C.F.R. § 240.10b-5 ("Rule 10b-5") against the deficiencies in the company's internal control and
Individual Defendants and Andersen, as well as claims of accounting system; and
"control person" liability under 15 U.S.C. § 78t(a) ("Section
20(a)") against the Individual Defendants. (3) Intrenet's financial statements, which incorporated the
financial results of its five subsidiaries, artificially
Plaintiffs' Complaint alleges that Intrenet's financial inflated the net income and earnings of its ADS
statements and press releases during the asserted class period subsidiary.
contained material misrepresentations and omissions masking
the Company's true financial condition, making them false In addition to the aforementioned purported omissions and
and misleading. According to Plaintiffs, these fraudulent misrepresentations, the Complaint alleges that Intrenet's
financial statements and press releases inflated the Company's public statements included false and misleading language
financial results and growth, leading to artificial increases in painting an unduly rosy picture of the Company's financial
its stock price. The district court accurately summarized the situation. For example, Intrenet claimed it was making "solid
Complaint's allegations in the following manner: strides" and "positive progress" at the time when Plaintiffs
allege losses were far in excess of those reported. Intrenet
(1) Intrenet's financial results and growth were artificially also announced a plan to increase productivity and eliminate
inflated; expenses and liabilities when Plaintiffs allege it was
artificially inflating its earnings.
(2) Although Intrenet represented that its financial
statements were prepared in compliance with generally With respect to the Individual Defendants, the Complaint
accepted accounting principles ("GAAP"), they were not: asserts that as top-level Intrenet executives and control
persons, they knew of or recklessly disregarded the alleged
(a) the financial statements failed to reconcile inter- misrepresentations and omissions. With respect to Intrenet's
company transactions among Intrenet's five subsidiaries; outside auditor, the Complaint posits that Andersen issued
false and misleading audit reports stating that Intrenet's
(b) the financial statements failed to record day-to-day financial statements fairly represented the Company's
operating expenses; financial condition and complied with GAAP. Plaintiffs also
allege that Andersen failed to conduct its audits in compliance
with generally accepted auditing standards ("GAAS").
No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 7 8 PR Diamonds, et al. v. Chandler, et al. No. 02-3921
On October 10, 2001, the Individual Defendants filed a (2) Whether Plaintiffs' Section 20(a) claims against the
motion to dismiss Plaintiffs' case under Federal Rules of Civil Individual Defendants can proceed despite the absence of
Procedure 9(b) and 12(b)(6). Andersen filed its motion to the Company as a defendant.
dismiss pursuant to Federal Rule of Civil Procedure 12(b)(6)
on October 12, 2001. On November 21, 2001, Plaintiffs filed (3) Whether the district court erred in dismissing
a consolidated memorandum opposing Defendants' motions Plaintiffs' Section 10(b) and Rule 10b-5 claims against
to dismiss and, in the alternative, requesting leave to amend Defendant Arthur Andersen on the basis that Plaintiffs'
their Complaint. The district court issued an order on Complaint does not adequately allege that Andersen
February 26, 2002, dismissing Plaintiffs' claims under Section acted with scienter.
10(b) and Rule 10b-5 against the Individual Defendants and
Andersen for lack of specific allegations giving rise to a (4) Whether the district court erred in dismissing the case
strong inference of scienter as required by the Private without affording Plaintiffs the opportunity to amend
Securities Litigation Reform Act of 1995, as amended, 15 their Complaint.
U.S.C. § 78u-4 (the "PSLRA"). However, the district court
denied the motion to dismiss the Section 20(a) control person II. Standard of Review
claim against the Individual Defendants on the grounds then
asserted. On May 23, 2003, the Individual Defendants filed This Court reviews de novo a district court's dismissal of a
a motion for judgment on the pleadings under Federal Rule of complaint under Fed. R. Civ. P. 12(b)(6). See Valassis
Civil Procedure 12(c) on the remaining Section 20(a) claim. Communications v. Aetna Cas. & Sur. Co., 97 F.3d 870, 873
The district court granted the motion on July 17, 2002, (6th Cir. 1996). The same de novo standard applies to review
concluding that Plaintiffs failed to state an underlying of a district court's judgment on the pleadings under Fed. R.
securities fraud claim against Intrenet as required by Section Civ. P. 12(c). See Ziegler v. IBP Hog Market, Inc., 249 F.3d
20(a), denying as moot Plaintiffs' motion for class 509, 511-12 (6th Cir. 2001). The Court must accept as true
certification, and ordering the action closed. In neither of its "well-pleaded facts" set forth in the complaint. Morgan v.
opinions did the district court discuss granting Plaintiffs leave Church's Fried Chicken, 829 F.2d 10, 12 (6th Cir. 1987).
to amend. On August 4, 2002, Plaintiffs filed a timely notice Construing the complaint in a light most favorable to the
of appeal with this Court. plaintiffs, we must determine whether the plaintiffs
undoubtedly can prove no set of facts in support of their
In this appeal, Plaintiffs present the following issues for claims that would entitle them to relief. Mayer v. Mylod, 988
review: F.2d 635, 637 (6th Cir. 1993). Finally, we review a district
court's denial of leave to amend for abuse of discretion, Miller
(1) Whether the district court erred in dismissing v. Champion Enters., Inc., 346 F.3d 660, 671 (2003), except
Plaintiffs' Section 10(b) and Rule 10b-5 claims against in cases where the district court bases its decision on the legal
the Individual Defendants on the basis that Plaintiffs' conclusion that an amended complaint could not withstand a
Complaint does not adequately allege that the Individual motion to dismiss, where the review is de novo. Monette v.
Defendants acted with scienter. Elec. Data Sys. Corp., 90 F.3d 1173, 1188 (6th Cir. 1996).
No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 9 10 PR Diamonds, et al. v. Chandler, et al. No. 02-3921
III. Discussion 1. Governing Law - Pleading Standards
A. Section 10(b) and Rule 10b-5 Claims Against the Section 10(b)1 of the Exchange Act and Rule 10b-52
Individual Defendants promulgated thereunder prohibit "fraudulent, material
misstatements or omissions in connection with the sale or
Plaintiffs first contend that the district court erred when it purchase of a security." Morse v. McWhorter, 290 F.3d 795,
dismissed the Section 10(b) and Rule 10b-5 claims against the
Individual Defendants on the basis that the Complaint lacked
specific allegations giving rise to a strong inference of 1
scienter, as required under the PSLRA. Plaintiffs challenge Section 10 provides as follows:
the district court's holding, arguing that the allegations of the
It shall be unlawful for any person, directly or indirectly, by the
Complaint, when considered in their totality, do in fact give use of any m eans o r instrumentality of interstate commerce or of
rise to a strong inference that the Individual Defendants had the mails, or of any facility of any national securities exchange -
either actual knowledge of, or at least recklessly disregarded, ....
the alleged material misrepresentations and omissions (b) To use or emp loy, in connection with the purchase
contained in Intrenet's statements to the investing public. As or sale of any security registered on a national
securities exchange or any security not so registered,
we explain in the discussion that follows, we hold that any manipulative or deceptive device or contrivance in
Plaintiffs fail to meet the standards for pleading scienter on contravention of such rules and regulations as the
the part of the Individual Defendants and, therefore, the Commission may prescribe as necessary or appropriate
Section 10(b) and Rule 10b-5 claims against them were in the public interest or for the pro tection of investors.
properly dismissed.
15 U.S.C. §7 8j.
2
Rule 10b-5, prescribed by the SEC under Section 10(b), provides as
follows:
It shall be unlawful for any p erson , directly o r indirectly, by the
use of any means or instrumentality of interstate commerce, or
of the mails or of an y facility of any national securities
exchange,
(a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statem ent of a m aterial fact or to o mit to
state a material fact necessary in order to make the statements
made, in the light of the circumstances under which they were
made, not misleading, or
(c) To engage in any act, practice, or course of business which
operates or would operate as a fraud or deceit upon any person,
in connection with the p urchase or sa le of any se curity.
17 C.F.R. § 240.10b-5.
No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 11 12 PR Diamonds, et al. v. Chandler, et al. No. 02-3921
798 (6th Cir. 2002). In order to state a claim pursuant to Helwig v. Vencor, Inc., 251 F.3d 540, 552 (6th Cir. 2001) (en
Section 10(b) and Rule 10b-5, "a plaintiff must allege, in banc). Recklessness is defined as "highly unreasonable
connection with the purchase or sale of securities, the conduct which is an extreme departure from the standards of
misstatement or omission of a material fact, made with ordinary care. While the danger need not be known, it must
scienter, upon which the plaintiff justifiably relied and which at least be so obvious that any reasonable man would have
proximately caused the plaintiff's injury. Hoffman v. known of it." Mansbach v. Prescott, Ball & Turben, 598 F.2d
Comshare, Inc. (In re Comshare, Inc. Secs. Litig.), 183 F.3d 1017, 1025 (6th Cir. 1979) (quoted in Miller, 346 F.3d at
542, 548 (6th Cir. 1999). Adding to the Federal Rule of Civil 672). Recklessness is "a mental state apart from negligence
Procedure 9(b) requirement that fraud allegations be stated and akin to conscious disregard." Comshare, 183 F.3d at 550.
with particularity, the PSLRA requires that the complaint See also Id. at 550 n.7 ("As we have observed, federal
"specify each statement alleged to have been misleading, the appellate courts have long held the view that, for the purposes
reason or reasons why the statement is misleading, and, if an of securities fraud, 'recklessness' that is far from negligence
allegation regarding the statement or omission is made on and closer to a 'lesser form of intent' constitutes scienter.")
information and belief, the complaint shall state with (quoting Sanders v. John Nuveen & Co., Inc., 554 F.2d 790,
particularity all facts on which that belief is formed." 793 (7th Cir. 1977)).
15 U.S.C. § 78u-4(b)(1).
Next, we examine the special requirements for pleading
The appeal before us centers on whether the Complaint scienter in federal securities fraud cases such as this. As with
adequately pleads the scienter element of a Section 10(b) and all fraud claims, Federal Rule of Civil Procedure 9(b) applies
Rule 10b-5 claim. In reviewing the district court's decision to pleading a defendant's state of mind, allowing that
dismissing the Complaint, we must first examine the meaning "[m]alice, intent, knowledge, and other condition of mind of
of "scienter" in the securities fraud setting. The Supreme a person may be averred generally." However, Congress
Court has defined "scienter" as "a mental state embracing amended the Securities Exchange Act of 1934 through
intent to deceive, manipulate, or defraud." Ernst & Ernst v. passage of the PSLRA, heightening the standard for pleading
Hochfelder, 425 U.S. 185, 193 n.12, 96 S. Ct. 1375, 1381 scienter in a securities fraud case:
n.12 (1976). In securities fraud claims based on statements of
present or historical fact - such as the claims Plaintiffs bring In any private action arising under this title in which the
in this case - scienter consists of knowledge or recklessness.3 plaintiff may recover money damages only on proof that
the defendant acted with a particular state of mind, the
complaint shall, with respect to each act or omission
3
alleged to violate this title, state with particularity facts
Plaintiffs in this case do not allege forward-looking stateme nts, to giving rise to a strong inference that the defendant acted
which the PSL RA applies different scienter requirements pursuant to a with the required state of mind.
safe harbor provision. Forward-looking statements include projections
and estimates of a company's future economic performance, including
statements related to revenues, earnings per share, income , dividends,
capital expenditures, capital structure, and other financial items.
15 U.S.C. § 78u-5(i)(1). As to fo rward -looking statem ents accompanied
by meaningful cautionary language, the P SLR A makes the state of mind
irrelevant. 15 U.S.C. § 78u-5(c)(1)(A). In the case of forward-looking the required state of mind is actual knowledge of the statements' false or
statements that are not accompanied by meaningful cautionary language, misleading nature. 15 U.S.C. § 78 u-5(c)(1)(B).
No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 13 14 PR Diamonds, et al. v. Chandler, et al. No. 02-3921
15 U.S.C. § 78u-4(b)(2) (emphasis added). The PSLRA We have previously stated that the factors enumerated in
provides that if a plaintiff does not meet this requirement, a the following list, while not exhaustive, are probative of
court may, on any defendant's motion, dismiss the complaint. scienter in securities fraud actions:
See 15 U.S.C. § 78u-4(b)(3). "As courts have observed, the
PSLRA did not change the scienter that a plaintiff must prove (1) insider trading at a suspicious time or in an unusual
to prevail in a securities fraud case but instead changed what amount; (2) divergence between internal reports and
a plaintiff must plead in his complaint in order to survive a external statements on the same subject; (3) closeness in
motion to dismiss." Comshare, 183 F.3d at 548-49 (citation time of an allegedly fraudulent statement or omission and
omitted). the later disclosure of inconsistent information;
(4) evidence of bribery by a top company official;
As the foregoing authorities make clear, a plaintiff may (5) existence of an ancillary lawsuit charging fraud by a
survive a motion to dismiss by pleading with particularity company and the company's quick settlement of that suit;
facts giving rise to a strong inference that the defendant acted (6) disregard of the most current factual information
with knowledge or recklessness. In other words, not only before making statements; (7) disclosure of accounting
must the complaint make particular factual allegations, but information in such a way that its negative implications
the inference of scienter which those allegations generate could only be understood by someone with a high degree
must be strong. In Helwig, we provided a definitive of sophistication; (8) the personal interest of certain
explanation of the meaning of a "strong inference": directors in not informing disinterested directors of an
impending sale of stock; and (9) the self-interested
Inferences must be reasonable and strong - but not motivation of defendants in the form of saving their
irrefutable. "Strong inferences" nonetheless involve salaries or jobs.
deductive reasoning; their strength depends on how
closely a conclusion of misconduct follows from a Helwig, 251 F.3d at 552 (citing Greebel v. FTP Software,
plaintiff's proposition of fact. Plaintiffs need not Inc., 194 F.3d 185, 196 (1st Cir. 1999)).
foreclose all other characterizations of fact, as the task of
weighing contrary accounts is reserved for the fact 2. The Complaint Fails to Raise a Strong Inference of
finder. Rather, the "strong inference" requirement means Scienter
that plaintiffs are entitled only to the most plausible of
competing inferences. Plaintiffs contend that the district court erred in concluding
that the Complaint failed to allege facts raising a strong
251 F.3d at 553. The PSLRA does not change the Rule inference of the Individual Defendants' scienter. The gist of
12(b)(6) maxim that when an allegation is capable of more Plaintiffs' argument is that the district court mistakenly
than one inference, it must be construed in the plaintiff's viewed the allegations of the Complaint in a piecemeal
favor. Id. ("Our willingness to draw inferences in favor of the fashion, rather than considering the totality of the
plaintiff remains unchanged by the PSLRA."). However, the circumstances pled. As Plaintiffs correctly point out, this
"strong inference" requirement means that a plaintiff is Court employs a totality of the circumstances analysis
entitled to only the most plausible of competing inferences. whereby the facts argued collectively must give rise to a
Miller, 346 F.3d at 673. strong inference of at least recklessness. See In re Telxon
Corp. Secs. Litig., 133 F. Supp. 2d 1010, 1026 (N.D. Ohio
No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 15 16 PR Diamonds, et al. v. Chandler, et al. No. 02-3921
2000) ("Thus, the Sixth Circuit employs a form of 'totality of of the alleged accounting irregularities at Intrenet, the
the circumstances' analysis; this Court, accordingly, declines Company's financial statements and press releases materially
to examine plaintiffs' allegations in piecemeal fashion and, misrepresented Intrenet's true state of financial affairs. The
will instead, assess them collectively to determine what issue before us is limited to the scienter inquiry: that is,
inferences may be drawn therefrom.") (citing Comshare, 183 whether Plaintiffs have met their burden of pleading specific
F.3d 542 at 549-52). facts which, when viewed together, persuade us that the most
plausible conclusion to draw is that the Individual Defendants
Reading the Complaint in its entirety, Plaintiffs maintain, must or should have known about the problems and
establishes a strong inference that throughout the class period nevertheless knowingly or recklessly made the allegedly
the Individual Defendants knew of serious accounting misleading public statements. While the allegations no doubt
improprieties at Intrenet and the effect such improprieties merit drawing some inference of scienter, that is not enough.
were having on the Company's financial condition, or were The PSLRA requires the Complaint to establish a strong
reckless in not knowing or in disregarding this information. inference - the most plausible of competing inferences - that
Furthermore, Plaintiffs contend that after the outside the Individual Defendants acted at least recklessly, meaning
consultant discovered the accounting improprieties, the that their states of mind were reflected in highly unreasonable
inference of scienter is not merely strong, but virtually conduct constituting an extreme departure from the standards
inescapable. Despite this awareness, Plaintiffs argue, the of ordinary care so obvious that any reasonable person would
Individual Defendants continued to make materially false and have known of it. Here, the Complaint fails.
misleading statements and omissions in Intrenet's financial
statements and press releases. In the following discussion, we consider each allegation
Plaintiffs offer in their effort to plead scienter. As we have
Specifically, Plaintiffs argue that a strong inference of the noted before, "recklessness in securities fraud is an untidy,
Individual Defendants' scienter arises when viewing in case-by-case concept." Helwig, 251 F.3d at 551 (citing
totality the following allegations in the Complaint: the nature Mansbach, 598 F.2d at 1025). "This necessarily involves a
and magnitude of the accounting improprieties at Intrenet; sifting of allegations in the complaint." Id. Accordingly, we
other "red flags" signaling the accounting errors; the sift Plaintiffs' allegations individually and then aggregate the
Individual Defendants' access to Intrenet's financial nuggets of inference they generate, concluding in the end no
information by virtue of their positions at the Company; the strong inference arises.
fact that the accounting improprieties occurred in areas touted
as the Company's key areas of focus; the Individual (a) Accounting Improprieties
Defendants' motives and opportunities to commit fraud; the
hiring of an outside consultant; and the outside consultant's Plaintiffs contend that the Complaint's allegations of
discovery of internal control deficiencies and accounting Intrenet's improper accounting practices and internal control
irregularities. deficiencies comprise circumstantial evidence supporting a
strong inference of the Individual Defendants' scienter.
Our examination of each of these clusters of allegations Plaintiffs suggest that none of these accounting "maneuvers"
shows that, even viewed collectively, they fail to adequately had any facially valid purpose and, therefore, they support the
plead scienter on the part of the Individual Defendants. To inference that the Individual Defendants harbored an intent to
reiterate, we do not in this Opinion address whether, in light artificially inflate the Company's operating results. The
No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 17 18 PR Diamonds, et al. v. Chandler, et al. No. 02-3921
alleged accounting improprieties include: failure to reconcile alleged that accounting violations caused the company to
inter-company transactions; understatement of day-to-day report aggregate "record" net income of $18.9 million over
operating expenses; accounting for uncollectible receivables three years, when in fact the company incurred a net loss for
and understatement of Intrenet's accounts receivable reserve; those years of more than $36 million. Id. at 636. In addition,
failure to record an impairment in the value of assets; failure the company overstated its revenues over the same period by
to disclose significant risks and uncertainties; arbitrarily a total of $66 million. Id. After reiterating the maxim that
applying cash receipts against the oldest outstanding allegations of accounting violations standing alone can never
receivable; and recording journal entries in violation of the lead to a strong inference of scienter, MicroStrategy
Foreign Corrupt Practices Act, without support or backup nevertheless intimated that the nature of the misapplication of
documentation. According to Plaintiffs, the nature and accounting principles - in terms of number, size, timing,
magnitude of the obvious, pervasive accounting problems at frequency, and context - is relevant circumstantial evidence
Intrenet support a strong inference that the Individual of a defendant's state of mind. Id. at 635. Turning to the facts
Defendants knew of or recklessly disregarded these problems before it, the court concluded that the "magnitude,"
when making statements to the investing public. "pervasiveness," and "repetitiveness" of the company's
violations of "simpl[e]" accounting principles "serve[d] to
In Comshare, we held that "[t]he failure to follow GAAP is, amplify the inference of scienter." Id. at 636. The court
by itself, insufficient to state a securities fraud claim." 183 explained:
F.3d at 553 (internal citations omitted). A complaint alleging
accounting irregularities fails to raise a strong inference of Indeed, common sense and logic dictate that the greater
scienter if it "allege[s] no facts to show that Defendants knew the magnitude of a restatement or violation of GAAP, the
or could have known of the errors, or that their regular more likely it is that such a restatement or violation was
procedures should have alerted them to the errors sooner than made consciously or recklessly. This, of course, is a
they actually did." Id. We noted in Comshare that a strong matter of degree, but it cannot be gainsaid that some
inference of scienter cannot be drawn from speculative and violations of GAAP and some restatements of financials
conclusory allegations of GAAP violations. Id. However, as are so significant that they, at the very least, support the
discussed below, some courts have recognized that an inference that conscious fraud or recklessness as to the
inference of knowledge or recklessness may be drawn from danger of misleading the investing public was present.
allegations of accounting violations that are so simple, basic, Cf. In re Oxford Health Plans, Inc. Sec. Litig., 51 F.
and pervasive in nature, and so great in magnitude, that they Supp. 2d 290, 294 (S.D.N.Y. 1999) ("[P]laintiffs allege
should have been obvious to a defendant. 'in your face facts,' that cry out, 'how could [defendants]
not have known that the financial statements were
Courts have described the type and scope of accounting false.'") In this case, the alleged GAAP violations and the
errors that, in combination with other factors, support a strong subsequent restatements are of such a great magnitude –
inference of scienter. For example, Plaintiffs cite In re amounting to a night-and-day difference with regard to
MicroStrategy, Incorporated Securities Litigation, 115 F. MicroStrategy's representations of profitability – as to
Supp. 2d 620 (E.D. Va. 2000) for the proposition that compel an inference that fraud or recklessness was afoot.
violations of simple accounting rules are obvious, and an
inference of scienter becomes more probable as the violations Id. at 636-37 (footnotes omitted).
become more obvious. The complaint in MicroStrategy
No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 19 20 PR Diamonds, et al. v. Chandler, et al. No. 02-3921
Other cases likewise indicate the drastic nature and day-to-day operating expenses as they occurred; (3) $600,000
magnitude necessary for accounting violations to support a in underreported expenses due to failure to adequately reserve
strong inference of scienter. In Telxon, the court for uncollectible accounts receivable resulting in an amplified
distinguished the "far more egregious" facts before it from accounts receivable balance (e.g., during the year ending
those alleged in Comshare, where we held that the alleged December 31, 1999, Intrenet's net accounts receivable
accounting errors did not support a strong inference of increased by approximately $4.4 million, or 14%, but its
scienter. 133 F. Supp. 2d at 1031. "Telxon, allegedly, operating revenues increased by only 8%); and (4) failure to
overstated its revenues for years, did so by over $20 million record an impairment loss in the carrying value of machinery
in a single quarter and reported profits when it should have and equipment assets valued at $340,000 but in reality worth
been reporting losses over several different quarters." Id. nowhere near the recorded amount. The Complaint notes the
(italics in original) In addition, the accounting errors October 18, 2000, press release reporting a possible
appeared to be fortuitously timed, resulting in revenue restatement to the tune of $1.3 million in unrecorded expenses
increases at times when the company foretold that it would at ADS and alleges that improper accounting practices caused
return to profitability, or when the company needed to show Intrenet to report a pre-tax 1999 operating income of
profits to justify rejecting a takeover bid and to win a proxy $750,000 when in fact it should have reported an operating
battle. Id. The Telxon court also noted the defendants' loss of approximately $50,000.
training, background, and access to information. "Thus, the
nature and number of the alleged accounting manipulations, These alleged accounting and reporting problems do not
coupled with the magnitude of the difference between the resemble the pervasive and egregious manipulations found to
originally reported financial disclosures and their support a strong inference of scienter in other cases. Intrenet
restatements, and the fact that the misstatements escalated operated one of the largest trucking fleets in the country, with
dramatically in the face of the [competing offer and proxy over $280 million in revenue and $75 million in total assets
battle]," taken in conjunction with the remaining allegations in 1999. Moreover, the Company did disclose that it lost over
in the complaint, convinced the court that the plaintiffs had $4.8 million in 1999, compared with a gain of $2.8 million in
adequately alleged scienter. Id. 1998, and that its operating income fell from over $6.3
million in 1998 to less than $1 million in 1999 on higher
In contrast to the aforementioned cases, the accounting revenues. Intrenet's press release announced a possible
irregularities Plaintiffs allege in this case are significantly less downward restatement of income of approximately $1.3
egregious in nature and magnitude and thus do not support a million, and Plaintiffs allege that the Company's accounting
strong inference that nondisclosure of the correct numbers irregularities turned the Company's 1999 operating loss of
was the product of a deliberate or reckless effort by the $50,000 into a $750,000 profit. In the face of these figures,
Individual Defendants to defraud investors. Alleged the errors Plaintiffs allege are not especially dramatic.
inaccuracies stemming from GAAP violations at Intrenet Accepting Plaintiffs' allegations as true, Intrenet represented
include: (1) unreconciled and uneliminated inter-company itself as a barely profitable company, when in fact it was a
transactions totaling $600,000 by the end of 1999 that, had barely unprofitable company. It simply cannot be said that
they been properly accounted for, would have reduced Intrenet's accounting improprieties, by virtue of their type and
Intrenet's 1999 pre-tax operating income of $750,000 to size, "should have been obvious," Comshare, 183 F.3d at 554,
$150,000; (2) at least $200,000 in unrecorded expenses to the Individual Defendants. These are not "in your face
resulting from the ADS subsidiary's failure to record normal facts" that "cry out" scienter. Therefore, the alleged GAAP
No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 21 22 PR Diamonds, et al. v. Chandler, et al. No. 02-3921
violations, standing alone, are insufficient to state a securities defendant deliberately chose to ignore multiple red flags that
fraud claim, and when viewed in combination with the other would be "clearly evident" to anyone in the defendant's
allegations only weakly support an inference of scienter, if at position. 871 F. Supp. at 699.
all.
Red flags in this case would be circumstances that would
(b) Red Flags have put the Individual Defendants on notice that Intrenet's
financial statements and press releases contained material
Next, Plaintiffs contend that the Individual Defendants misstatements or omissions, or at least would have given
knowingly or recklessly disregarded "red flags" indicating them reasons to question the veracity of the statements.
Intrenet's improper accounting practices, GAAP violations, Comshare, 183 F.3d at 553. The only purported red flag
and internal control deficiencies. Specific factual allegations Plaintiffs specifically identify in their Complaint is the
that a defendant ignored red flags, or warning signs that allegation that during the year ended December 31, 1999,
would have revealed the accounting errors prior to their Intrenet's net accounts receivable increased by approximately
inclusion in public statements, may support a strong inference $4.4 million, or 14%, but its operating revenues increased by
of scienter. Comshare, 183 F.3d at 553-54. See also Miller only approximately 8%. This supposed red flag, Plaintiffs
v. Material Sciences Corp., 9 F. Supp. 2d 925, 928-29 (N.D. maintain, should have alerted the Individual Defendants to
Ill. 1998) ("Deliberately ignoring 'red flags'...can constitute Intrenet's failure to adequately reserve for uncollectible
the sort of recklessness necessary to support § 10(b) accounts receivable - a failure that resulted in $600,000 of
liability."). On the other hand, ignoring red flags may unreported expenses in 1999. The Court disagrees that these
indicate that a defendant was merely negligent, not reckless. circumstances constitute a red flag sufficiently blatant that
Courts typically look for multiple, obvious red flags before fraudulent intent can be inferred. Perhaps the Individual
drawing an inference that a defendant acted intentionally or Defendants' handling of the alleged accounts receivable
recklessly. See, e.g., In re Health Mgmt., Inc. Secs. Litig., situation suggests negligence on their part, but the
970 F. Supp. 192, 203 (E.D.N.Y. 1997) (citing In re Leslie Complaint's allegations do not resemble in severity or number
Fay Cos., Inc., 871 F. Supp, 686, 699 (S.D.N.Y. 1995)). the sort that courts consider indicative of knowledge or
reckless disregard.
In Health Mgmt., the court inferred an auditor's fraudulent
intent from numerous alleged red flags that should have led (c) Access to Information
the auditor to question its audit opinion, including (i) the
auditor's credulous acceptance of representations from the To buttress the argument that the Individual Defendants
company that fairly obviously failed to reflect reality; (ii) the knew of or recklessly disregarded adverse information about
auditor's failure to follow up on an analyst letter alerting the Intrenet when making representations about the Company to
auditor to artificially inflated accounts receivable levels; and the public, Plaintiffs point to their top-level positions within
(iii) the auditor's failure to exercise heightened scrutiny in Company. During the putative class period, Chandler first
response to the analyst letter and an SEC inquiry on the same served as Intrenet's Executive Vice President and Chief
subject. Id. at 203. The court concluded that the allegations Operating Officer, and after June 12, 2000, was the
implied that the auditor "turned a blind eye" to the Company's President and Chief Executive Officer until the
wrongdoing. Id. Likewise, in Leslie Fay (a pre-PSLRA end of the class period, all this time serving as a director as
case), the court inferred scienter from allegations that the well. Meanwhile, Jackson was Intrenet's President and Chief
No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 23 24 PR Diamonds, et al. v. Chandler, et al. No. 02-3921
Executive Officer from June 1999 to June 12, 2000, when he [the Individual Defendants] knew or could have known of the
became Chairman of the Board of Directors. Jackson also errors, or that their regular procedures should have alerted
served as a director throughout the putative class period. them to the errors sooner than they actually did." 183 F.3d at
Plaintiffs maintain that by virtue of their positions within the 553.
Company, the Individual Defendants had access to all of
Intrenet's financial information and controlled the content of (d) Areas of Focus
all the Company's public statements and SEC filings. The
Individual Defendants' access to Intrenet's financial Plaintiffs seek to draw additional support for a strong
information, Plaintiffs argue, works in favor of drawing a inference of the Individual Defendants' scienter by claiming
strong inference of scienter with respect to the alleged that Intrenet's accounting improprieties occurred in areas of
misrepresentations or omissions in the Company's public the business that the Individual Defendants had specifically
communications. identified as targets of intense focus for the Company and
where they were under pressure to show success. As a basis
Contrary to Plaintiffs' assertions, fraudulent intent cannot for this proposition, Plaintiffs cite Telxon, 133 F. Supp. at
be inferred merely from the Individual Defendants' positions 1029. In that case, the court considered a variety of
in the Company and alleged access to information. As even circumstances relevant to reaching a strong inference of
the authorities which Plaintiffs cite indicate, the Complaint scienter, including allegations of motive and opportunity,
must allege specific facts or circumstances suggestive of their large restatements of the company's financial disclosures, and
knowledge. Without more, Plaintiffs fail to meet the PSLRA accounting manipulations of "substantial magnitude." Id.
requirement to state with particularity facts giving rise to a Another factor the court considered was "the fact that Telxon
strong inference of scienter. See, e.g., In re Peritus Software and its officers were in a very difficult position, facing
Servs., Inc. Secs. Litig., 52 F. Supp. 2d 211, 228 (D. Mass. unusual pressures to perform during the class period, and
1999) (general allegations that a defendant, through his board stood to benefit substantially from a performance record
membership or executive position, had actual knowledge of which matched the healthy ones [a company executive]
false statements or reckless disregard for the truth are continually projected to the public." Id. The pressures to
insufficient to raise strong inference of scienter). While it is make public statements reflecting profitable performance
true that high-level executives can be presumed to be aware stemmed from "the need to stave off [another company's] take
of matters central to their business's operation, In re Complete over efforts and ensuing proxy-battle." Id. at 1028.
Management, Incorporated Securities Litigation, 153 F.
Supp. 2d 314, 325-36 (S.D.N.Y. 2001), in this case it cannot Here, Plaintiffs contend that Intrenet's press releases
be said that the alleged misrepresentations or omissions announcing the Company's financial results touted the
pertained to central, day-to-day operational matters. Instead, Individual Defendants' careful monitoring of the very areas in
they turn largely on accounting issues, predominantly at the which Intrenet committed accounting violations. The press
ADS subsidiary, which the Court has already determined are releases stated that "the Company has implemented a program
relatively arcane in nature and scope. While the Individual to eliminate, where possible, expenses and liabilities that have
Defendants' positions are relevant to the analysis of whether historically been a burden to profitable operations"; "[t]he
they are "control persons" for purposes of Section 20(a), on new management team has been tireless in identifying and
their own they do not bear strongly on the scienter analysis. eliminating unnecessary costs throughout the organization";
Here, as in Comshare, Plaintiffs "allege no facts to show that "[t]he Company has made solid strides and positive progress
No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 25 26 PR Diamonds, et al. v. Chandler, et al. No. 02-3921
during what, otherwise, has been a challenging year"; and that credit agreement. In addition, Plaintiffs allege that the
the Company would be late in filing its 1999 10-K to analyze Individual Defendants had other motives to artificially inflate
the impact of "recent operational trends," primarily Intrenet's stock price, including: (1) to protect themselves and
extraordinary increases in fuel prices, on the Company's their investment in the Company; (2) to protect and enhance
ability to meet financial covenants in its bank loan their executive positions and the substantial compensation
agreements. and prestige obtained thereby; and (3) to allow Jackson to
engage in self-dealing transactions from which he reaped
The Court is not persuaded that the aforementioned profits, wherein Intrenet leased tractor trailers from a leasing
statements in Intrenet's press releases do much to support an company that purchased the trucks from a dealership
inference that the Individual Defendants knew or should have affiliated with Jackson. Also, the Complaint alleges that
known about the specific accounting problems alleged in the Chandler was motivated to disseminate materially false and
Complaint. These are little more than statements of broad misleading financial statements in order to receive a bonus
operational plans or goals - eliminating costs, reducing based on a percentage of net income before taxes, up to a
liabilities, improving profits, etc. These statements do not maximum of $500,000. Finally, the Complaint alleges that
show knowledge or reckless disregard of the discrete and the Individual Defendants had opportunities to participate in
particularized alleged GAAP violations and control fraud due to their positions as the highest ranking officers of
deficiencies concentrated in the ADS subsidiary. Intrenet who controlled the content of the Company's press
releases and public filings.
(e) Motive and Opportunity
"[T]he bare pleading of motive and opportunity does not,
Next, Plaintiffs argue that the Complaint alleges that the standing alone, constitute the pleading of a strong inference
Individual Defendants had motives and opportunities to of scienter." Comshare, 183 F.3d at 551. However, "[w]hile
defraud investors. These allegations, Plaintiffs maintain, it is true that motive and opportunity are not substitutes for a
when considered together with the other allegations in the showing of recklessness, they can be catalysts to fraud and so
Complaint, support a strong inference of knowledge or serve as external markers to the required state of mind."
reckless disregard on the part of the Individual Defendants. Helwig, 251 F.3d at 550. "[F]acts regarding motive and
The Complaint's motive allegations include: (1) the improper opportunity may be relevant to pleading circumstances from
accounting practices helped to mask the Company's which a strong inference of fraudulent scienter may be
deteriorating operating results and forestall its impending inferred, and may, on occasion, rise to the level of creating a
default under certain financial covenants of its bank loan strong inference of reckless or knowing conduct." Comshare,
agreement; (2) the Individual Defendants sought to reduce the 183 F.3d at 551 (internal quotation and citation omitted).
impact of a spike in fuel costs in the first quarter of 2000 by While bare allegations of motive and opportunity, without
reporting consolidated financial statements that incorporated more, are insufficient to establish scienter, the Court must
artificially inflated net income and earnings of the ADS assess whether such allegations, considered in conjunction
subsidiary; (3) the Company was motivated to inflate the with the remainder of Plaintiff's allegations, on the whole
value of its accounts receivable because borrowings under its raise an inference of recklessness or knowing disregard.
$32 million credit facility, which the Company obtained in Telxon, 133 F. Supp. 2d at 1028.
February 2000, were determined by a formula tied to the
Company's eligible accounts receivable as defined in the
No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 27 28 PR Diamonds, et al. v. Chandler, et al. No. 02-3921
Opportunity to commit fraud "entail[s] the means and likely Jackson's alleged self-dealing transactions suggest no more
prospect of achieving concrete benefits by the means alleged." than a general motive for Intrenet's success, not fraud;
In re Criimi Mae, Inc. Secs. Litig., 94 F. Supp. 2d 652, 660 moreover, the allegedly fraudulent SEC filings to which
(D. Md. 2000) (internal quotations and citations omitted). Plaintiffs refer expressly disclosed these transactions.
With respect to the Individual Defendants' opportunities to
engage in fraud, there can be little doubt that they could have, However, the allegations that the Individual Defendants
had they wanted to, committed such acts. See, e.g., San were motivated to engage in fraud in order to forestall
Leandro Emergency Med. Group Profit Sharing Plan v. Intrenet's default of its bank loan agreement and to preserve
Philip Morris Cos., Inc., 75 F.3d 801, 813 (2d Cir. 1996) the Company's ability to borrow pursuant to its credit facility
("There is no doubt that defendants as a group had the warrant closer scrutiny. These more particularized sorts of
opportunity [to manipulate stock prices]....[because they] held motive allegations are more probative of scienter. For
the highest positions of power and authority within the example, as part of the mix of factors contributing to an
company."). inference of scienter, the Ninth Circuit has considered a
defendant's motivation to overstate a company's reported net
The more important question in this case is whether the value so as not to violate loan covenants with its lender and
Complaint alleges motives on the part of the Individual to improve the prospects of increasing its credit line. Howard
Defendants from which the Court could infer a knowing or v. Everex Sys., Inc., 228 F.3d 1057, 1064 (9th Cir. 2000).
reckless state of mind. In order to demonstrate motive, a We view the motive allegations concerning the bank loan and
plaintiff must show concrete benefits that could be realized by credit facility as suggestive of scienter, although standing
one or more of the false statements and wrongful alone they do not establish a strong inference. Accordingly,
nondisclosures alleged. Phillips v. LCI Int'l, Inc., 190 F.3d we will consider these allegations, along with all others, in the
609, 621 (4th Cir. 1999). Our review of the cases cited by the totality of the circumstances analysis. See Helwig, 251 F.3d
parties shows that courts distinguish motives common to at 551 (allegations of motive and opportunity are evaluated in
corporations and executives generally from motives to the same manner as other circumstantial allegations to
commit fraud. All corporate managers share a desire for their determine whether they produce a strong inference that the
companies to appear successful. That desire does not defendant acted at least recklessly).
comprise a motive for fraud. See Chill v. Gen. Elec. Co., 101
F.3d 263, 268 (2d Cir. 1996) ("such a generalized motive, one (f) Absence of Inside Sales
which could be imputed to any publicly-owned, for-profit
endeavor, is not sufficiently concrete for purposes of inferring The Complaint includes no allegations that the Individual
scienter"). Neither does an executive's desire to protect his Defendants ever took advantage of Intrenet's purportedly
position within a company or increase his compensation. See inflated stock prices by selling shares during the class period.
Kalnit v. Eichler, 264 F.3d 131, 140 (2d Cir. 2001) ("an The Individual Defendants point out that the allegations of
allegation that defendants were motivated by a desire to fraudulent motive which courts most often recognize as
maintain or increase executive compensation is insufficient support for a strong inference of scienter are allegations that
because such a desire can be imputed to all corporate insiders sold stock. Indeed, we mentioned in Helwig that
officers"); Criimi Mae, 94 F. Supp. 2d at 660 (allegations that "insider trading at a suspicious time or in an unusual amount"
defendants sought to "protect their executive positions," comprises one of the "fixed constellations of facts that courts
standing alone, are inadequate to plead motive). Finally, have found probative of securities fraud." 251 F.3d at 552.
No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 29 30 PR Diamonds, et al. v. Chandler, et al. No. 02-3921
Conversely, courts have explained that the absence of inside (g) Consultant
sales dulls allegations of fraudulent motive. See, e.g., In re K-
tel Int'l, Inc. Secs. Litig., 300 F.3d 881, 894 (8th Cir. 2002) The Complaint alleges that in early 2000, Intrenet hired an
("evidence that the individual defendants abstained from outside consultant to investigate problems in the Company's
trading may undercut allegations of motive"); In re Northern accounting and internal control systems. The consultant
Telecom Ltd. Secs. Litig., 116 F. Supp. 2d 446, 462 (S.D.N.Y. allegedly discovered improprieties, ultimately leading to the
2000) ("The absence of stock sales by insiders, or any other October 13, 2000, press release that initiated Intrenet's
evidence of pecuniary gain by company insiders at collapse. Plaintiffs maintain that after the consultant was
shareholders' expense, is inconsistent with an intent to hired and discovered the problems, a strong inference that the
defraud shareholders....Even where company insiders sell Individual Defendants knew of or recklessly disregarded the
stock during the class period, scienter is not necessarily problems is inescapable.
inferred.") (citing Kalnit, 99 F. Supp. 2d at 337 and San
Leandro Emergency Med. Group Profit Sharing Plan, 75 First of all, the Court is not willing to infer fraudulent intent
F.3d at 814). from the fact that the Company hired a consultant to examine
its accounting systems. If anything, this fact counters an
However, we have never held that the absence of insider inference that the Individual Defendants were trying to keep
trading defeats an inference of scienter. Cf. Hanon v. the alleged accounting problems hidden from view. Next, the
Dataproducts. Corp., 976 F.2d 597, 507 (9th Cir. 1992) thrust of Plaintiff's argument seems to be that the outside
(scienter can be established even if officers who made consultant "readily discovered" the accounting improprieties
misleading statements did not sell stock during the class in a "short time period," and yet the Individual Defendants
period). What is more, Plaintiffs' motive allegations in this continued to issue materially false and misleading financial
case are not based on a claim that the Individual Defendants statements and press releases, and did not ultimately publicize
sought to personally enrich themselves through sales of their the deficiencies to the investing public until "many months"
own stock. See In re Nuko Info. Sys., Inc. Secs. Litig., 199 later, on October 13, 2000. In the intervening time, Plaintiffs
F.R.D. 338, 344-45 (N.D. Cal. 2000) (when the complaint did maintain, the Individual Defendants must have known or at
not assert claims of insider trading, the absence of defendants' best recklessly disregarded the truths the consultant
selling or trading has little bearing on determining whether unearthed. See Danis v. USN Communications, Inc., 73 F.
plaintiffs have adequately pleaded scienter). We also reject Supp. 2d 923, 939 (N.D. Ill. 1999) ("Problems readily
the Individual Defendants' contention that their purchase of recognized by an outsider can be presumed to be known to a
shares during the class period refutes any inference that they company's management and directors."). Therefore, Plaintiffs
knowingly or recklessly misled the market to increase the urge, a strong inference of scienter is especially warranted
stock's price. Plaintiffs allege, and Intrenet's 1999 10-K after the consultant arrived.
suggests, that the Individual Defendants bought the stock to
infuse cash to the Company as a condition precedent to The allegations regarding the consultant fail to support a
obtaining a new bank agreement. For these reasons, the strong inference of the Individual Defendants' scienter
absence of stock sales by the Individual Defendants works because they wholly lack factual particularity. The Complaint
against but does not conclusively defeat an inference of offers the conclusory assertion that the consultant "swiftly"
scienter. uncovered the accounting irregularities, but nowhere does it
provide any meaningful information regarding when or in
No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 31 32 PR Diamonds, et al. v. Chandler, et al. No. 02-3921
what manner the consultant made his discoveries. The In Helwig, this Court set forth a non-exhaustive list of
relevant issue in determining scienter is not when the "factors usually relevant to scienter." 251 F.3d at 552. Few
accounting improprieties occurred, but rather whether and of these factors emerge in this case. First, there are no
when the Individual Defendants knew about them. There is no allegations of insider trading at a suspicious time or in an
basis in the Complaint's allegations concerning the consultant unusual amount. Second, there are no specific allegations of
from which the Court could conclude that the Individual a divergence between internal reports and external statements
Defendants knew anything about the problems prior to the on the same subject. The allegations regarding the outside
October 13, 2000, press release. Moreover, Plaintiffs fail to consultant lack any detail about when or to whom the
specify what the consultant learned and how he learned it, consultant reported the information he allegedly discovered.
other than offering the conclusory allegation that the Third, there is little temporal proximity between the allegedly
consultant "discovered" Intrenet's alleged accounting fraudulent statements and the later disclosure of inconsistent
improprieties. Claims of securities fraud cannot rest on information in October of 2000. Fourth, there are no
speculation and conclusory allegations. Comshare, 183 F.3d allegations of bribery by a top company official. Fifth, there
at 553-54. is no ancillary lawsuit charging fraud by the Company and the
Company's quick settlement of the suit. Sixth, allegations
(h) Summary of Scienter Allegations Against that the Individual Defendants disregarded the most current
Individual Defendants factual information before making statements lack specific
facts concerning how or when any accounting improprieties
Plaintiffs have accumulated numerous circumstantial became known to them. Once again, the activities of the
allegations from which they ask the Court to draw the strong consultant are so vaguely described as to offer little insight
inference of scienter required for this case to move forward. into what the Individual Defendants knew or when they knew
In the foregoing discussion, we noted that, while some of it. Seventh, the Complaint contains no allegations that
these allegations suggest little about the Individual accounting information was disclosed in such a way that its
Defendants' states of mind, other allegations favor the negative implications could only be understood by someone
implication that they may have known, or were reckless in not with a high degree of sophistication. Eighth, there are no
knowing, of the accounting problems at Intrenet and its true allegations of certain directors holding a personal interest in
financial condition. See MicroStrategy, 115 F. Supp. 2d at not informing disinterested directors of a sale of stock.
649 ("Just as otherwise-unremarkable individual points of Finally, allegations of the Individual Defendants' self-
colored paint in the aggregate become a Seurat painting, so, interested motivation in the form of saving their salaries or
too, do the individual allegations in this case - which, when jobs only mildly suggest scienter.
viewed in isolation may or may not by themselves give rise
to a 'strong inference' of scienter - collectively paint an For all these reasons, the Section 10(b) and Rule 10b-5
equally compelling picture of scienter."). However, "[a] mere claims against the Individual Defendants were properly
reasonable inference is insufficient to survive a motion to dismissed pursuant to Fed. R. Civ. P. 12(b)(6).
dismiss." Greebel v. FTP Software, Inc., 194 F.3d 185, 196
(1st Cir. 1999). Even when added up and viewed in their
entirety, the ultimate inference of scienter the allegations in
this case raise is not strong - that is, the most plausible of
competing inferences.
No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 33 34 PR Diamonds, et al. v. Chandler, et al. No. 02-3921
B. Section 10(b) and Rule 10b-5 Claims Against form of intent (to deceive) than merely a greater degree of
Andersen ordinary negligence") (internal quotations omitted). Scienter
"requires more than a misapplication of accounting principles.
Plaintiffs argue that the district court erred in dismissing the The [plaintiff] must prove that the accounting practices were
Section 10(b) and Rule 10b-5 claims against Andersen on the so deficient that the audit amounted to no audit at all, or an
basis that the Complaint failed to adequately allege that egregious refusal to see the obvious, or to investigate the
Andersen acted with scienter. In Plaintiffs' view, the doubtful, or that the accounting judgments which were made
Complaint alleges facts showing that Andersen was alerted to were such that no reasonable accountant would have made the
Intrenet's internal control deficiencies and accounting errors, same decisions if confronted with the same facts." In re
and thus knew of or recklessly disregarded the falsity of its Worlds of Wonder Secs. Litig., 35 F.3d 1407, 1426 (9th Cir.
certifications that its audit was performed in accordance with 1994) (quoting SEC v. Price Waterhouse, 797 F. Supp. 1217,
GAAS and that Intrenet's 1998 and 1999 financial statements 1240 (S.D.N.Y. 1992)).
were presented in conformity with GAAP. Specifically,
Plaintiffs claim that Intrenet's financial statements were "When the standard of recklessness for an auditor is
admittedly false, the accounting improprieties were obvious overlaid with the pleading requirements of the PSLRA, a
in nature and large in magnitude, numerous red flags arose to simple rule emerges: to allege that an independent accountant
indicate the improprieties, and Andersen had access to or auditor acted with scienter, the complaint must allege
Intrenet's confidential information. Moreover, the outside specific facts showing that the deficiencies in the audit were
consultant allegedly quickly identified the problems once he so severe that they strongly suggest that the auditor must have
came on board. Taken as a whole, Plaintiffs maintain, these been aware of the corporation's fraud." SmarTalk, 124 F.
allegations are sufficient to raise a strong inference of Supp. 2d at 514 (citing Hollinger v. Titan Capital Corp., 914
Andersen's scienter but the district court mistakenly F.2d 1564, 1570 (9th Cir. 1990) and In re Software
scrutinized each allegation in piecemeal fashion to reach its Toolworks, Inc., 50 F.3d 615, 628 (9th Cir. 1994)). "[T]o
erroneous conclusion. allege that an independent accountant or auditor acted with
scienter, the complaint must identify specific, highly
The same PSLRA pleading standards we set forth in our suspicious facts and circumstances available to the auditor at
discussion of the Section 10(b) and Rule 10b-5 allegations the time of the audit and allege that these facts were ignored,
against the Individual Defendants apply to the allegations either deliberately or recklessly." SmarTalk, 124 F. Supp. 2d
against Andersen. However, the meaning of recklessness in at 515.
securities fraud cases is especially stringent when the claim is
brought against an outside auditor. In re SmarTalk Once again, we examine Plaintiffs' allegations collectively
Teleservices, Inc. Secs. Litig., 124 F. Supp. 2d 505, 514 (S.D. to determine whether the totality of the specific facts alleged
Ohio 2000). Recklessness on the part of an independent create a strong inference of scienter. Telxon, 133 F. Supp. 2d
auditor entails a mental state so culpable that it at 1026. The relevant allegations include that Andersen:
"approximate[s] an actual intent to aid in the fraud being (1) was aware of internal control deficiencies at Intrenet;
perpetrated by the audited company." Decker v. Massey- (2) committed numerous GAAP and GAAS violations;
Ferguson, Ltd., 681 F.2d 111, 121 (2d Cir. 1982); Pegasus (3) disregarded certain red flags; and (4) had access to
Fund, Inc. v. Laraneta, 617 F.2d 1335, 1341 (9th Cir. 1980) Intrenet's confidential information. Addressing these
(auditor's recklessness "must come closer to being a lesser allegations in turn and collectively, we conclude that the
No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 35 36 PR Diamonds, et al. v. Chandler, et al. No. 02-3921
Complaint lacks allegations of specific, highly suspicious Plaintiffs point out that under APB No. 20, a restatement is
facts and circumstances that would lead us to reach a strong an admission that financial statements were materially false
inference that Andersen acted with scienter when it certified at the time they were made; therefore, Plaintiffs argue, the
Intrenet's financial statements. alleged accounting errors were material and Andersen's
knowledge or reckless disregard of such errors can be
1. Internal Control Deficiencies inferred. This line of reasoning misapprehends the nature of
the scienter inquiry. To support an inference of fraudulent
Plaintiffs argue that Andersen turned a blind eye to scienter, allegations of GAAP and GAAS violations must
numerous internal control deficiencies at Intrenet, which extend in nature and magnitude beyond merely the materiality
allowed accounting improprieties to continue unchecked. threshold. We reject Plaintiffs' contention that Intrenet's $1.3
Yet, Plaintiffs offer no "specific, highly suspicious facts and million in underreported expenses allegedly resulting from
circumstances" to support an inference that Andersen was Andersen's auditing failures "belies any conclusion that
aware of these deficiencies or recklessly disregarded them, Andersen acted merely negligently." Likewise, the
other than the assertions that Andersen had access to Intrenet's allegations regarding the failure to reserve against accounts
confidential information and that the consultant quickly receivable do not "cry out" scienter. MicroStrategy, 115 F.
discovered the deficiencies. The allegations concerning the Supp. 2d at 636-37. Taking the allegations as true, as we
consultant are insufficiently specific to satisfy the PSLRA's must, Andersen's alleged failures were not so grievous as to
requirements for pleading scienter. Nowhere does the suggest that their work was "no audit at all." Worlds of
Complaint allege facts identifying, for example, the Wonder, 35 F.3d at 1426. These are not the sort of "in your
consultant's level of access to Intrenet's financial records or face" accounting violations that, without additional "specific,
how long the consultant took to reach conclusions. The Court highly suspicious facts and circumstances," support a strong
would be remiss to infer Andersen's scienter based on the inference of scienter. See MicroStrategy, 115 F. Supp. 2d at
conclusory assertion that what the consultant ultimately found 637; SmarTalk, 124 F. Supp. 2d at 515.
out, Andersen must have known or recklessly disregarded.
Once again, Plaintiffs point to the fact that Intrenet hired an
2. GAAP and GAAS Violations outside consultant in early 2000 as proof that Intrenet and its
auditor were aware of the alleged accounting improprieties for
Next, Plaintiffs contend that the Complaint alleges an extended period of time before they revealed them to
violations of GAAS and failure to detect violations of GAAP investors. As we have already stated, the Complaint is largely
of such simple and obvious nature and large magnitude so as devoid of any factual detail regarding how, when, and what
to support a strong inference of Andersen's scienter. It is the consultant discovered. An inference of scienter on this
well-settled that violations of GAAP and GAAS, standing basis would be unwarranted.
alone, do not create an inference of scienter, much less a
strong one. See Comshare, 183 F.3d at 553 (citing cases). 3. Red Flags
However, when the alleged accounting errors are sufficiently
basic and large, their existence, in combination with other Next, Plaintiffs allege that Andersen disregarded numerous
factors, may support the requisite scienter inference. Telxon, red flags that alerted it to the accounting improprieties,
133 F. Supp. 2d at 1031. suggesting Andersen harbored scienter. A red flag creating a
strong inference of scienter consists of "[a]n egregious refusal
No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 37 38 PR Diamonds, et al. v. Chandler, et al. No. 02-3921
to see the obvious, or to investigate the doubtful." Novak v. sufficient..., it might make every auditor liable in cases of
Kasaks, 216 F.3d 300, 308 (2d Cir. 2000) (citation and securities fraud."). However, while the mere fact that an
internal quotation marks omitted). Two of the purported red auditor has access to a company does not necessary mean that
flags simply repeat the alleged GAAP improprieties, namely, it was aware of alleged fraud at the company, the greater the
that Intrenet lacked internal controls (which the outside auditor's "access to and involvement with" the company's
consultant discovered in very little time), and that the operations, the more support an inference of scienter takes on.
accounting problems turned Intrenet's losses into profits. The MicroStrategy, 115 F. Supp. 2d at 653.
only genuine red flag consists of the allegation that during the
year ended December 31, 1999, although Intrenet's net Accordingly, the Court takes into account Andersen's
accounts receivable increased by approximately $4.4 million access to Intrenet's information, but even so doing, no strong
during that year, or approximately 14%,while its operating inference of Andersen's scienter arises. Viewing in totality
revenues increased by only 8%. Plaintiffs contend that these Andersen's access, along with the allegations of internal
circumstances should have put Andersen on notice that control deficiencies, GAAP and GAAS violations, and red
Intrenet's accounts receivable reserve was understated. flags, we do not believe that the most plausible inference to
draw in these circumstances is that Andersen knew of or
This supposed red flag fails to support a strong inference of recklessly disregarded the alleged material misstatements and
scienter because Plaintiffs make no specific allegation that omissions in Intrenet's financial statements. Plaintiffs
Andersen knew that certain accounts were not collectible and repeatedly attempt to bolster their allegations by pointing out
knowingly participated in a scheme to hide that fact from that the outside consultant quickly discovered the accounting
investors. In our judgment, a single year's difference in the irregularities, yet they offer almost no specific factual details
ratio of the increase of receivables to operating revenues does regarding the consultant's work. For these reasons, the
not make it "obvious" to an outside auditor that Intrenet's Section 10(b) and Rule 10b-5 claims against Andersen are
receivables reserve was understated. properly dismissed.
4. Access to Confidential Information C. Section 20(a) Control Person Liability Claims Against
the Individual Defendants
Finally, Plaintiffs allege that Andersen's access to Intrenet's
confidential information supports a strong inference of Plaintiffs contend that the district court erred in granting the
scienter. According to the Complaint, Andersen's personnel Individual Defendants' motion for judgment on the pleadings
were regularly present at Intrenet's corporate headquarters pursuant to Federal Rule of Civil Procedure 12(c) on the
throughout the class period and had continual access to, and Section 20(a) claims. In Plaintiffs' view, the Section 20(a)
knowledge of, Intrenet's confidential financial and business claims should proceed despite the absence of the Company as
information. These allegations, by themselves, are not a defendant. We conclude that the Section 20(a) claims were
enough to raise a strong inference of scienter because such properly adjudicated on the pleadings in the Individual
allegations are insufficiently concrete to support such an Defendants' favor because the Complaint fails to plead a
inference. See, e.g., Kennilworth Partners L.P. v. Cendant required predicate violation of Section 10(b) or Rule 10b-5 by
Corp., 59 F. Supp. 2d 417, 429 (D.N.J. 1999) ("[S]tatement[s the Company, its employees, or the Individual Defendants.
that] could be made in relation to the auditor of every
corporation" are insufficient to plead scienter, for "[i]f it were
No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 39 40 PR Diamonds, et al. v. Chandler, et al. No. 02-3921
Section 20(a) of the Exchange Act creates a cause of action course, is not a named party in this case because it is
for "control person" liability, stating as follows: bankrupt. However, Plaintiffs contend that a company's
controlling persons do not escape liability when the
Every person who, directly or indirectly, controls any company's primary liability cannot be adjudicated due to its
person liable under any provision of this title or of any unavailability. Second, with respect to the control
rule or regulation thereunder shall also be liable jointly requirement, Plaintiffs argue that the Individual Defendants
and severally with and to the same extent as such are controlling persons because by virtue of their top-level
controlled person to any person to whom such controlled positions at Intrenet they had the power to control the
person is liable, unless the controlling person acted in Company's general business affairs and the specific activities
good faith and did not directly or indirectly induce that upon which the alleged primary violations were predicated.
act or acts constituting the violation or cause of action.
As extensively discussed above, we have reviewed the
15 U.S.C. § 78t(a). Section 20(a) thus establishes two Complaint de novo and determined that Plaintiffs have not
requirements for a finding of control person liability. First, stated claims against the Individual Defendants under Section
the "controlled person" must have committed an underlying 10(b) and Rule 10b-5 because the Complaint fails to
violation of the securities laws or the rules and regulations adequately plead scienter. For the same reasons that the
promulgated thereunder. Second, the "controlling person" Section 10(b) and Rule 10b-5 claims against the Individual
defendant in a Section 20(a) claim must have directly or Defendants are properly dismissed as a matter of law, those
indirectly controlled the person liable for the securities law allegations cannot serve as predicates for Section 20(a)
violation. "Control" is defined as "the possession, direct or liability. We therefore need not further examine Plaintiffs'
indirect, of the power to direct or cause the direction of the theory, which would impute the Individual Defendants'
management and policies of a person, whether through the purported violations to the Company in order to establish the
ownership of voting securities, by contract, or otherwise." requisite predicate liability of the controlled person, and then
17 C.F.R. § 230.405. double-back the liability onto the Individual Defendants as
controlling persons under Section 20(a).4
In this case, Plaintiffs' Complaint alleges that the Individual
Defendants are liable under Section 20(a) as controlling
persons of Intrenet. First, with respect to the requirement for 4
an underlying primary violation, Plaintiffs maintain that both W ithout deciding the question, we note that some authority suggests
that a plaintiff may not be ab le simultaneously to asse rt both Section 10(b)
the Individual Defendants and the Company violated Section and Rule 10b-5 claims and Section 20(a) claims against the same
10(b) and Rule 10b-5. As for the Individual Defendants, defendant. "Arguab ly, a § 20 (a) claim canno t be asserted against a
Plaintiffs argue that any Section 10(b) and Rule 10b-5 defendant who is also cha rged with primary violation of § 10(b) and Rule
violations they committed should be imputed to Intrenet, 10b-5; that is, secondary liab ility under § 20(a) is an alternative, not a
thereby establishing a primary violation on the Company's supp lement, to primary liability under § 10(b) and Rule 10b-5." Lemmer
v. Nu-Kote Holding, Inc., No. CIV. A. 398CV0161L, 2001 WL 1112577,
part as a controlled person. In other words, the Individual at *12 (N.D. Tex., Sept. 6, 2001), citing Kalnit v. Eichler, 85 F. Supp. 2d
Defendants' violations are the Company's violations; if the 232, 246 (S.D.N .Y. 1999) (suggesting that plaintiffs could not allege
Individual Defendants are liable, so too is Intrenet. As for the primary liability against the directors of a corporation and at the same
Company, Plaintiffs claim that the Complaint includes time allege con trol person liab ility against the d irectors). See also In re
securities fraud allegations against Intrenet itself. Intrenet, of Capstead Mo rtg. Corp. Secs. Litig., 258 F. Supp. 2d 53 3, 566 (N.D . Tex.
2003) (quoting the aforementioned passage from Lemmer); 183 A.L.R.
No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 41 42 PR Diamonds, et al. v. Chandler, et al. No. 02-3921
Next, the Complaint fails to state a predicate Section 10(b) D. Leave to Amend the Complaint
or Rule 10b-5 claim against Intrenet itself because it fails -
indeed, hardly attempts - to plead scienter on the Company's Finally, Plaintiffs argue that the district court erred in
part. So far as the Court can discern, the Complaint contains dismissing the case without affording them an opportunity to
only a few sparse references to allegations against Intrenet as amend their Complaint. We recognize that when a motion to
a Company or its employees other than the Individual dismiss a complaint is granted, courts typically permit the
Defendants. Paragraph 36 of the Complaint states that losing party leave to amend. However, given the
"Intrenet employees repeatedly recorded journal entries in circumstances of this case, leave to amend should be denied.
violation of FCPA, without support or documentation, which Plaintiffs failed to follow the proper procedure for requesting
the Defendants knew, or recklessly disregarded." This leave to amend, and even had they done so, denial would have
allegation, standing alone, comes nowhere near to making out been appropriate so as to avoid "frustrat[ing] the purposes of
a claim for violation of Section 10(b) or Rule 10b-5 on the the PSLRA." See Miller, 346 F.3d at 690.
part of the unidentified "Intrenet employees." Next, a single
paragraph of the Complaint, paragraph 96, pertains to the Generally, the review of a district court's denial of a motion
Company's knowledge, rather than that of the Individual for leave to amend a complaint is governed by an abuse of
Defendants. That paragraph precisely restates the purported discretion standard. See Crawford v. Roane, 53 F.3d 750, 753
misrepresentations and omissions making Intrenet's press (6th Cir. 1995); United States v. Midwest Suspension &
releases and financial statements materially false and Brake, 49 F.3d 1197, 1202 (6th Cir. 1995). Review, however,
misleading that Plaintiffs allege against the Individual is de novo where the reason for the district court's denial is
Defendants, but this time claims "the Company knew of the because the amended pleading would not withstand a motion
improper accounting practices...[and] knew or reasonably to dismiss. Ziegler, 249 F.3d at 518. In this case, the district
should have known" of the misleading statements. This bare court did not discuss or state why it declined to offer
assertion fails to raise a strong inference of the Company's Plaintiffs an opportunity to amend their Complaint. In fact,
scienter and thus fails to state a claim. as the following discussion explains, there was no "motion"
to deny. Accordingly, we will review the district court's
Because the Complaint fails to state an underlying actions for abuse of discretion.
securities law violation by a controlled person, we need not
address the subsequent question of whether the Individual When a motion to dismiss is granted in a case not involving
Defendants possessed an adequate degree of control to the PSLRA, the usual practice is to grant plaintiffs leave to
support a Section 20(a) claim. The district court correctly amend the complaint. Generally, leave to amend is "freely
granted the Individual Defendants' motion for judgment on given when justice so requires." Morse, 290 F.3d at 799 (6th
the pleadings pursuant to Fed. R. Civ. P. 12(c) on the Section Cir. 2002) (quoting Fed. R. Civ. P. 15(a)). However, the
20(a) claims. Supreme Court has instructed that leave to amend is properly
denied where there is "undue delay, bad faith or dilatory
motive on the part of the movant, repeated failure to cure
deficiencies by amendments previously allowed, undue
Fed. 141 §2[b] (2003) ("It is a freq uent practice to plead in the alternative prejudice to the opposing party by virtue of allowance of the
that a defendant is both a primary violator and a controlling person of amendment, futility of the amendment, etc." Foman v. Davis,
primary violators, although, as som e courts have no ted, one cannot 371 U.S. 178, 182, 83 S. Ct. 227, 230 (1962). And while
simultaneously be both.").
No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 43 44 PR Diamonds, et al. v. Chandler, et al. No. 02-3921
Rule 15 plainly embodies a liberal amendment policy, in the Court would have considered the motions to dismiss in
post-judgment setting we must also take into consideration light of the proposed amendments to the
the competing interest of protecting the finality of judgments complaint....Absent such a motion, however, Defendant
and the expeditious termination of litigation. Morse, 290 was entitled to a review of the complaint as filed
F.3d at 800. "Thus, in the post-judgment context, we must be pursuant to Rule 12(b)(6). Plaintiffs were not entitled to
particularly mindful of not only potential prejudice to the an advisory opinion from the Court informing them of
non-movant, but also the movant's explanation for failing to the deficiencies of the complaint and then an opportunity
seek leave to amend prior to the entry of judgment." Id. to cure those deficiencies.
In this case, Plaintiffs failed to follow the proper procedure 214 F.3d at 784 (emphasis in original).
for requesting leave to amend. They did not actually file a
motion to amend along with an accompanying brief, as The Complaint had already been amended once. The
required by the local rules governing practice before the district court granted in part and denied in part the Individual
district court. Instead, they simply included the following Defendants' and Andersen's motion to dismiss on February
request in their brief opposing the Defendants' motions to 26, 2002. However, final judgment was not entered until
dismiss: "Alternatively, in the event the Court grants any part nearly five months later, when the district court granted the
of the Defendants' motions to dismiss, plaintiffs respectfully Individual Defendants' motion for judgment on the pleadings.
request leave to amend their Complaint." As the D.C. Circuit During the intervening time, Plaintiffs made no attempt to
has found, "a bare request in an opposition to a motion to obtain leave to amend their Complaint. Moreover, Plaintiffs
dismiss – without any indication of the particular grounds on never sought to alter, set aside, or vacate the district court's
which amendment is sought, cf. Federal Rule of Civil judgment pursuant to Fed. R. Civ. P. 59 or 60. See Morse,
Procedure 7(b) – does not constitute a motion within the 290 F.3d at 799 ("Following entry of final judgment, a party
contemplation of Rule 15(a)." Confederate Mem'l Ass'n v. may not seek to amend their complaint without first moving
Hines, 995 F.2d 295, 299 (D.C. Cir. 1993), quoted in D.E.&J. to alter, set aside or vacate judgment pursuant to either Rule
Ltd. P'ship v. Conaway, 284 F. Supp. 2d 719, 751 (E.D. 59 or Rule 60 of the Federal Rules of Civil Procedure."). In
Mich. 2003). This Court's disfavor of such a bare request in light of these procedural failings, the district court was within
lieu of a properly filed motion for leave to amend was made its discretion to withhold granting Plaintiffs an opportunity to
clear in Begala v. PNC Bank, Ohio, N.A., 214 F.3d 776, 784 amend the pleadings.
(6th Cir. 2000): "What plaintiffs may have stated, almost as
an aside to the district court in a memorandum in opposition Our recent decision in Miller set forth a rule that would
to the defendant's motion to dismiss is also not a motion to warrant denying Plaintiffs leave to amend even if they had
amend." As the Begala decision reasoned in affirming the followed the correct procedure. 346 F.3d 660. In that case,
district court's dismissal of the plaintiffs' complaint with we held that "allowing repeated filing of amended complaints
prejudice in that case, would frustrate the purpose of the PSLRA." Id. at 690. We
considered the tension between Rule 15(a) of the Federal
Had plaintiffs filed a motion to amend the complaint Rules of Civil Procedure and the PSLRA, which states that
prior to th[e] Court's consideration of the motions to "[i]n any private action arising under this title, the court shall,
dismiss and accompanied that motion with a on the motion of any defendant, dismiss the complaint if the
memorandum identifying the proposed amendments, the [pleading] requirements...are not met." 15 U.S.C. § 78u-
No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 45
4(b)(3)(A). We resolved the tension in favor of the PSLRA,
concluding that in light of that statute's requirements, "we
think it is correct to interpret the PSLRA as restricting the
ability of plaintiffs to amend their complaint, and thus as
limiting the scope of Rule 15(a) of the Federal Rules of Civil
Procedure." Id. at 692. Moreover, "the purpose of the
PSLRA would be frustrated if district courts were required to
allow repeated amendments to complaints filed under the
PSLRA." Id. The "purpose" of the PSLRA is to screen out
lawsuits having no factual basis, to prevent harassing strike
suits, and to encourage attorneys to use greater care in
drafting their complaints. See In re Champion Enters., Inc.
Secs. Litig., 145 F. Supp. 2d 871, 873-74 (E.D. Mich. 2001),
aff'd 346 F.3d 660 (6th Cir. 2003). Therefore, we affirmed
the district court's decision to dismiss the complaint with
prejudice for failing to meet the pleading requirements.
Champion, 346 F.3d at 690.
In light of our holding in Champion and Plaintiffs'
procedural shortcomings, we hold that Plaintiffs should not be
given yet another opportunity to amend their Complaint, and
we affirm the district court's entry of final judgment against
Plaintiffs.
IV. Conclusion
For the reasons stated above, the district court properly
dismissed Plaintiffs' Section 10(b) and Rule 10b-5 claims
against the Individual Defendants and Andersen. The district
court also properly granted judgment on the pleadings in
favor of the Individual Defendants on Plaintiffs' Section 20(a)
claims. Finally, the district court did not abuse its discretion
in not inviting Plaintiffs to amend their Complaint.
For the foregoing reasons, the judgments of the district
court are AFFIRMED.