In Re Hertz Global Holdings Inc.

PRECEDENTIAL
UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
_____________
No. 17-2200
_____________
In re: HERTZ GLOBAL HOLDINGS INC
SHEET METAL WORKERS LOCAL UNION 80 PENSION
TRUST FUND;
WESTCHESTER TEAMSTERS PENSION FUND,
Appellants
_____________
On Appeal from the United States District Court
for the District of New Jersey
(D.C. No. 2-13-cv-07050)
District Judge: Hon. Madeline C. Arleo
_______________
Argued
June 12, 2018
Before: AMBRO, JORDAN, and HARDIMAN, Circuit
Judges
(Filed September 20, 2018)
Evan J. Kaufman
Samuel H. Rudman
Robbins Geller Rudman & Dowd
58 S. Service Rd. – Ste. 200
Melville, NY 11747
Douglas S. Wilens [ARGUED]
Robbins Geller Rudman & Dowd
120 E. Palmetto Park Rd. – Ste. 500
Boca Raton, FL 33432
Peter S. Pearlman
Cohn Lifland Pearlman Hermann & Knopf
Park 80 West – Plaza One
250 Pehle Ave. – Ste. 401
Saddle Brook, NJ 07663
Counsel for Appellants Sheet Metal Workers
Local 80 Pension Trust Fund, and Westchester
Teamsters Pension Fund
Ross B. Bricker
Howard S. Suskin
Jenner & Block
353 N. Clark St. – Ste. 4500
Chicago, IL 60654
Adam G. Unikowsky [ARGUED]
Jenner & Block
1099 New York Avenue – Ste. 900
Washington, DC 20001
Counsel for Appellee
Hertz Global Holdings Inc.
2
Kevin H. Marino
John D. Tortorella
Marino, Tortorella & Boyle
437 Southern Blvd.
Chatham, NJ 07928
Counsel for Appellees
Hertz Global Holdings Inc.
and Elyse Douglas
David A. Kotler
Dechert
100 Overlook Center – 2nd Fl.
Princeton, NJ 08540
Andrew J. Levander
Dechert
1095 Avenue of the Americas
New York, NY 10036
Counsel for Appellee
Mark P. Frissora
Elliott Greenfield
Maeve L. O’Connor
Edwin G. Schallert
Debevoise & Plimpton
919 Third Avenue
New York, NY 10022
Counsel for Appellee
Elyse Douglas
3
Gregory A. Markel [ARGUED]
Heather E. Murray
Seyfarth Shaw
620 Eighth Avenue
New York, NY 10018
Counsel for Appellee
Jatindar S. Kapur
_______________
OPINION OF THE COURT
_______________
JORDAN, Circuit Judge.
Sheet Metal Workers Local No. 80 Pension Trust Fund
and Westchester Teamsters Pension Fund (“the Funds”)
brought a putative securities fraud class action against Hertz
Global Holdings, Inc. (“Hertz” or “the Company”) and
several of its current and former executives for violating §§
10(b) and 20(a) of the Securities Exchange Act of 1934, as
amended by the Private Securities Litigation Reform Act of
1995 (“PSLRA”), and Rule 10b-5, 17 C.F.R. § 240.10b-5.
The Funds appeal the District Court’s dismissal of their fourth
amended complaint (“FAC”) for failure to plead a strong
inference of scienter, as required by the PSLRA. We will
affirm.
4
I. Background
A. Allegations in the FAC1
The Funds allege that Hertz, through its former Chief
Executive Officer Mark Frissora, former Chief Financial
Officer Elyse Douglas, and former Senior Vice President of
Finance and Corporate Controller Jatindar Kapur
(collectively, the “Individual Defendants”)2 violated the
securities laws by making materially false and misleading
statements concerning the Company’s financial results,
internal controls, and future earnings projections. The Funds’
securities fraud allegations rely on a financial restatement
Hertz issued with its fiscal year 2014 Form 10-K (“the
Restatement”). In it the Company admitted that “an
inconsistent and sometimes inappropriate tone at the top was
present under the then existing senior management” and that
the tone “resulted in an environment which in some instances
may have led to inappropriate accounting decisions and the
failure to disclose information critical to … effective
review[.]” (App. at 609.)
1
The facts contained in this section come from
allegations in the FAC, documents the FAC referenced or
relied upon, and matters of which we may take judicial
notice. Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S.
308, 322 (2007).
2
The FAC also named as defendants Hertz’s former
interim CFO David Rosenberg and its current CFO Thomas
Kennedy, but the Funds do not appeal the District Court’s
dismissal of the claims against those defendants.
5
The Restatement corrected material errors to Hertz’s
2011, 2012, and 2013 financial statements that, cumulatively,
“[overstated] its pre-tax income ... by $215 million and its net
income … by $132 million.” (App. at 467.) Those errors
stemmed from misstatements relating to fifteen distinct
accounting categories, causing Hertz to make twenty separate
accounting adjustments to its previous financial statements.
Those accounting errors were, in turn, a result of “four
categories of material weaknesses in [Hertz’s] internal control
over financial reporting”: control environment, risk
assessment, information and communication, and monitoring.
(App. at 609.)
As the Individual Defendants were overseeing Hertz’s
accounting department, which was having to deal with the
“inappropriate tone” they set, the Company continued to
report “record” financial results and publish optimistic
anticipated future earnings. That information was
disseminated through press releases; public statements made
by Frissora and Douglas to analysts and investors during
phone calls and industry conferences; and SEC filings.
Moreover, Hertz’s SEC filings included Sarbanes-Oxley Act
(“SOX”) certifications signed by Company executives –
including the Individual Defendants – attesting to the
accuracy of the information contained in the relevant filings
and to the sufficiency of the Company’s internal accounting
controls. Throughout much of 2013 and early 2014, the
defendants relied on Hertz’s financial results from fiscal years
2012 and 2013 to tout the Company’s healthy financial
position and to project a rosy financial outlook for the future.
As the Restatement made clear, however, those financial
results were materially inaccurate; Hertz’s projections of
6
future earnings were misguided; and the Company’s internal
controls throughout the relevant period were deficient.
The accounting problems permeating Hertz’s
accounting department began incrementally coming to public
attention in late 2013, culminating in the Restatement issued
on July 16, 2015. Hertz began revealing its problems in
September 2013, when it walked back its projected earnings
for fiscal year 2013. That announcement came just days after
Hertz abruptly announced Douglas’s resignation for “personal
reasons[.]” (App. at 516.) Next, in March 2014, Hertz
disclosed through an SEC filing that it would have to delay
filing its fiscal year 2013 Form 10-K because “it [had]
identified certain adjustments relating to prior periods which
… require[d] the Company to revise certain of its previously
issued financial statements.” (App. at 550.) Nonetheless,
later that same month, the defendants continued to tout
Hertz’s “record results” and to publish optimistic
anticipations of future earnings. As Hertz continued to
emphasize its “record results,” it also began to disclose that it
had identified tens of millions of dollars in accounting errors
relating to its 2011 and 2012 financial statements. In March
2014, however, Hertz still publicly classified those errors as
non-material misstatements. About one month after revealing
those errors, Hertz announced Kapur’s resignation for
“personal reasons.” (App. at 517.)
By June 2014, Hertz had again delayed required SEC
filings, publicly announced that the Company would have to
restate its financial statements for 2011, and disclosed that it
would also need to correct errors in its 2012 and 2013
financial statements that could potentially result in the need to
issue restatements for those years as well. Hertz also initiated
7
two internal investigations that month, one to review the
Company’s “financial records for fiscal years 2011, 2012, and
2013,” and the other to assess the internal controls the
Company had in place during prior financial reporting
periods. (App. at 608.) Hertz announced Frissora’s
resignation for “personal reasons” several months later, in
September 2014. (App. at 518.)
Hertz slowly revealed the findings of its internal
investigations to the public between August 2014 and July
2015 through periodic SEC filings. Those filings discussed
Hertz’s withdrawal of its previously announced projections
for future earnings and disclosed that the cumulative effect of
the identified accounting errors was material, requiring full
restatements for fiscal years 2011, 2012, and 2013. Each
subsequent SEC filing revised upward the magnitude of the
accounting errors on Hertz’s prior financial statements.
Based on Hertz’s financial disclosures, the Funds allege that
Hertz had overstated its net income and pre-tax income by,
respectively, $28.7 million (17.19%) and $69.3 million
(27.18%) in 2011; $59.1 million (32.12%) and $85.6 million
(23.45%) in 2012; and $44.2 million (14.64%) and $60.1
million (9.97%) in 2013.
In addition to the allegations of financial reporting
fraud, the Funds also allege that during the relevant class
period – February 14, 2013, to July 16, 2015 – Douglas and
Kapur sold large amounts of their Hertz stock holdings, that
those trades were out of line with those individuals’ prior
trading practices, and that those trades resulted in Douglas
and Kapur profiting in an amount in excess of their respective
annual salaries.
8
B. Procedural History
The Funds filed the FAC in March 2016,
approximately seven-and-a-half months after Hertz issued the
Restatement and over twenty-seven months after they first
initiated this lawsuit. The FAC contains numerous
allegations based primarily on the admissions contained in the
Restatement, which the District Court reviewed carefully. In
the end, however, the Court concluded that the FAC failed to
adequately plead a strong inference of scienter. The Court
stated:
Even giving [the Funds] every reasonable
inference, their allegations amount to the
following: Hertz discovered serious accounting
problems, traced those problems back to a
corporate mismanagement (and possibly even
negligent conduct), publicly disclosed those
problems, and updated the public every time it
realized the problem was worse than previously
disclosed. The FAC carefully explains how the
accounting problems were caused by the
Individual Defendants, but it never provides a
cogent and compelling explanation how those
defendants were aware that they caused those
problems before Hertz discovered them. For
those reasons, their claims fail.
(App. at 54.) That conclusion led to the dismissal of the
FAC, and this appeal followed.
9
II. Discussion3
A. Legal Standard for Pleading Securities
Fraud
To adequately allege a § 10(b) securities fraud claim, a
plaintiff must plead “(1) a material misrepresentation or
omission, (2) scienter, (3) a connection between the
misrepresentation or omission and the purchase or sale of a
security, (4) reliance upon the misrepresentation or omission,
(5) economic loss, and (6) loss causation.” City of Edinburgh
Council v. Pfizer, Inc., 754 F.3d 159, 167 (3d Cir. 2014). A
plaintiff must also meet the heightened pleading standards
imposed by the PSLRA. Institutional Inv’rs Grp. v. Avaya,
Inc., 564 F.3d 242, 252 (3d Cir. 2009).
To adequately plead scienter under the PSLRA, a
plaintiff must “state with particularity facts giving rise to a
strong inference that the defendant acted with the required
state of mind,” 15 U.S.C. § 78u-4(b)(2)(A), which we have
described as one “embracing [an] intent to deceive,
manipulate, or defraud,” either knowingly or recklessly.
Avaya, Inc., 564 F.3d at 252 (citation omitted). A complaint
adequately pleads a strong inference of scienter “only if a
reasonable person would deem the inference of scienter
3
The District Court had jurisdiction under 28 U.S.C.
§ 1331 and 15 U.S.C. § 78aa. We have jurisdiction pursuant
to 28 U.S.C. § 1291. We exercise plenary review over a
district court’s dismissal of a complaint for failure to meet the
pleading requirements of the PSLRA and over a district
court’s interpretation of the federal securities laws. Winer
Family Tr. v. Queen, 503 F.3d 319, 325 (3d Cir. 2007).
10
cogent and at least as compelling as any opposing inference
one could draw from the facts alleged.” Tellabs, Inc. v.
Makor Issues & Rights, Ltd., 551 U.S. 308, 324 (2007). But a
plaintiff does not need to come forward with “smoking-gun”
evidence to meet the PSLRA’s pleading requirements. Id.
Rather, in conducting the scienter analysis, courts must
analyze the complaint holistically to determine whether its
allegations, “taken collectively, give rise to a strong inference
of scienter, not whether any individual allegation, scrutinized
in isolation, meets that standard.” Id. at 323.
B. The District Court Applied Tellabs
Appropriately.
The Funds argue that the District Court erred when it
concluded that the FAC’s allegations did not give rise to a
strong inference of scienter. They contend that the Court
failed to adhere to the interpretive framework for assessing
scienter set forth by the Supreme Court in Tellabs, Inc. v.
Makor Issues & Rights, Ltd, and that, when analyzed
appropriately, the FAC’s allegations give an inference of
scienter that is “at least as compelling as any opposing
inference[.]” 551 U.S. at 324. More particularly, the Funds
argue that the Court deviated from the Tellabs framework in
three material ways: by failing to draw inferences favorable to
them, by requiring “smoking-gun” evidence to adequately
plead scienter, and by failing to consider the FAC’s
allegations holistically. Those contentions do not persuade
us.
First, the District Court did not stray from the Tellabs
framework by failing to make inferences only in the Funds’
favor. Rather, it adhered to Tellabs’s explicit instruction to
11
conduct a comparative analysis by considering both
inferences favorable to the Funds as well as “plausible,
nonculpable explanations for the defendant’s conduct[.]” Id.
at 324. That the District Court disagreed with the Funds’
preferred inferences is not a violation of the Tellabs
framework.
Second, the Court did not effectively require the Funds
to submit “smoking-gun” evidence to survive the defendants’
motions to dismiss. It simply emphasized that the FAC
lacked allegations connecting the fact that Hertz had
“accounting problems … caused by the Individual
Defendants” with an inference that “those defendants were
aware that they caused those problems[.]” (App. at 54.) In
other words, the Court only required the Funds to plead
factual allegations supporting a cogent inference that the
Individual Defendants knowingly made material
misstatements, or that they made material misstatements with
reckless disregard for the truth of those statements. That the
Funds could not plead such allegations does not mean that the
District Court effectively required them to submit “smoking-
gun” evidence.
Finally, the District Court conducted the holistic
review of the FAC that Tellabs requires. Although the Court
assessed each category of the Funds’ scienter allegations
independently, it concluded its analysis in a separately headed
sub-section – “Failure to Plead a Strong Inference of
Scienter” – that stated in part:
In sum, [the Funds] have failed to plead a strong
inference [of scienter.]
…
12
The strongest inference of scienter comes from
the Restatement. However, the Restatement is
not enough by itself, so Plaintiffs had to tip the
inferential scale with the four other categories
of allegations. But, as explained, those
categories do not strengthen the inference of
knowledge or recklessness.
(App. at 54.) We have explicitly approved of scienter
analyses that assess individual categories of scienter
allegations individually when it is clear, as it is here, that a
district court ultimately considered the allegations as a whole.
See OFI Asset Mgmt. v. Cooper Tire & Rubber, 834 F.3d 481,
493 (3d Cir. 2016) (concluding that just because a court is
“thorough in explaining why it found scienter lacking as to
each asserted misrepresentation does not suggest that it did
not consider the allegations as a whole”). In fact, we have
adopted that interpretive approach ourselves when conducting
a scienter analysis pursuant to the PSLRA. See Avaya, Inc.,
564 F.3d at 280 (“Although we have discussed each of the
alleged facts bearing on defendants’ scienter one at a time, we
have heeded Tellabs’s command to evaluate [the plaintiffs’]
allegations collectively rather than individually.”).
C. The FAC Does Not Plead a Strong Inference
of Scienter.
The Funds argue that the Restatement’s admission that
Frissora and other Hertz senior management maintained an
“inappropriate tone at the top,” when viewed in conjunction
with the FAC’s scienter allegations, provides an inference of
scienter that is “at least as compelling as any opposing
[nonculpable] inference[.]” Tellabs, 551 U.S. at 324. To
13
make that argument, the Funds depend – as they did in the
District Court – on five categories of scienter allegations: (1)
the size and scope of the Restatement, (2) Hertz’s admission
of material weaknesses in its internal controls, (3) signed
SOX certifications accompanying materially false SEC
filings, (4) Hertz’s replacement of upper management, and (5)
insider trading activity by Douglas and Kapur. Like the
District Court, we will assess each category of allegations
individually before analyzing the FAC’s allegations as a
whole. We ultimately agree with the District Court that the
FAC’s allegations do not give rise to a strong inference of
scienter.
1. Size and Scope of the Restatement
The size and scope of a company’s restatement of prior
financial statements is one factor that courts consider when
conducting a scienter analysis. PR Diamonds, Inc. v.
Chandler, 364 F.3d 671, 685 (6th Cir. 2004); In re BISYS Sec.
Litig., 397 F. Supp. 2d 430, 447 (S.D.N.Y. 2005); In re
Stonepath Grp., Inc. Sec. Litig., 397 F. Supp. 2d 575, 587
(E.D. Pa. 2005). A company’s admission even to significant
accounting errors, however, “is insufficient by itself to give
rise to a strong inference of scienter.” Podraza v. Whiting,
790 F.3d 828, 838 (8th Cir. 2015).
The inferential force of a restatement is lessened when
the plaintiff fails to plead particularized allegations of
fraudulent intent. Id. at 837; see also Dobina v. Weatherford
Int’l Ltd., 909 F. Supp. 2d 228, 251 (S.D.N.Y. 2012)
(explaining that the magnitude of a restatement does not give
rise to a strong inference of scienter if there are no allegations
“that the … defendants had any contemporaneous basis to
14
believe that the information they related was incorrect”). As
the District Court observed, the FAC fails to sufficiently
allege either that the Individual Defendants knowingly caused
Hertz’s accounting personnel to engage in accounting fraud
or that the accounting improprieties were so obvious that the
Individual Defendants must have known about them when
reporting Hertz’s financial results to the public. The Court
logically concluded that, although the Restatement was
substantial, any inference of scienter was “circumscribed by”
the fact that the accounting errors were spread across myriad
accounting categories. (App. at 39.)
Moreover, the size of the Restatement was not
sufficiently drastic to give rise to a strong inference of
scienter absent particularized allegations of fraudulent intent.
The Restatement revealed that Hertz’s financial statements
from 2011 to 2013 cumulatively overstated its net income by
$132 million (20.23%) and its pre-tax income by $215
million (17.58%). When broken down by year, the
Restatement shows that Hertz overstated those income
categories by between 9.97% and 32.12%. Courts that have
looked to the magnitude of a financial restatement to
strengthen the inference of scienter have been faced with
restatements significantly more drastic than what we have
here. See, e.g., Fresno Cty. Empl. Ret. Ass’nv. comScore,
Inc., 268 F. Supp. 3d 526, 553 (S.D.N.Y. 2017) (inferring
scienter when restatement wrote off 100% of an entire
accounting category); In re Atlas Air Worldwide Holdings,
Inc. Sec. Litig., 324 F. Supp. 2d 474, 489 (S.D.N.Y. 2004)
(inferring scienter where restatement “transformed … a
company with retained earnings of approximately $185
million to a company with an accumulated deficit of
approximately $178 million”); In re MicroStrategy, Inc. Sec.
15
Litig., 115 F. Supp. 2d 620, 635-36 (E.D. Va. 2000) (inferring
scienter, in part, because a restatement revealed an issuer had
erroneously been reporting net income instead of net losses);
cf. Webb v. Solarcity Corp., 884 F.3d 844, 858 (9th Cir. 2018)
(explaining that restatement disclosing that net income was
overstated by 15% to 67% per quarter did not give rise to
strong inference of scienter in the absence of other
compelling allegations supporting scienter).
Accordingly, the size and scope of the changes
highlighted in the Restatement provide at most some
inference of scienter but not a strong inference.
2. Hertz’s Admission of Material
Weaknesses in Its Internal Controls
The Funds argue that the District Court erred by
interpreting the Restatement’s admission of an “inappropriate
tone at the top” to be an admission of “mismanagement,” as
opposed to an admission of “misconduct.” (Opening Br. at
28.) We agree with the District Court that the Restatement’s
admissions are more plausibly interpreted as admissions of
mismanagement, not of affirmative misconduct on the part of
the Individual Defendants. We reach that conclusion for two
reasons. First, the Restatement itself explicitly links the
phrase “inappropriate tone at the top” to Frissora’s
management style. For example, after first introducing that
phrase, the Restatement continues, “[i]n particular,
[Frissora’s] management style and temperament created a
pressurized operating environment at the Company, where
challenging targets were set and achieving those targets was a
key performance expectation.” (App. at 609.) Second, the
more plausible inference from the Restatement’s use of the
16
word “tone” is that the Restatement is referring to
management style and not to misconduct. The word “tone,”
after all, means a “style or manner of expression in speaking
or writing[.]” Tone, Merriam-Webster’s Collegiate
Dictionary (10th ed. 2002).4
At most, then, the FAC has pleaded that the Individual
Defendants presided over a poorly managed corporation and
that the mismanagement created an environment in which
improper accounting practices flourished. But we have long
held “that an allegation of mismanagement on the part of a
4
The United States Court of Appeals for the Fourth
Circuit has similarly rejected an argument that an admission
that a defendant company’s “former senior management was
‘incompeten[t]’ and otherwise contributed to [a] deficient
‘tone at the top’” essentially equated to an admission of “an
environment which encourage[d] accounting fraud.” Matrix
Capital Mgmt. Fund, LP v. BearingPoint, Inc., 576 F.3d 172,
183 (4th Cir. 2009). It reasoned that admissions that a
“deficient ‘tone at the top’” existed “fail[ed] to suggest that
defendants intentionally created an environment conducive to
accounting fraud” and explained that the company had
“simply admit[ted] that such an environment existed,” which
“fail[ed] to suggest that defendants acted with scienter[.]” Id.
The Funds attempt to distinguish Matrix Capital by
highlighting that the defendant company there admitted to
“incompetence” whereas Hertz admitted to an “inappropriate
tone.” We do not find that distinction meaningful. Matrix’s
reasoning is sound – an admission that a high-pressure
management style existed in the past is not sufficient to meet
the PSLRA’s scienter requirement without accompanying
allegations of fraudulent intent.
17
defendant will not alone support” a securities fraud claim.
Hayes v. Gross, 982 F.2d 104, 106 (3d Cir. 1992).
Allegations of mismanagement will only support a securities
fraud claim if they are coupled with allegations that the
defendants were aware, or recklessly disregarded, that their
mismanagement created an environment in which fraud was
occurring. See Webb, 884 F.3d at 856 (explaining that
“allegations [that] paint a picture of a mismanaged
organization in need of closer financial oversight” do not give
rise to an inference of scienter absent a compelling inference
that defendants knew they were committing a fraud when
making the material misstatements or omissions); City of
Dearborn Heights Act 345 Police & Fire Ret. Sys. v. Waters
Corp., 632 F.3d 751, 760 (1st Cir. 2011) (“Allegations of
corporate mismanagement are not actionable under Rule 10b–
5.”); Hayes, 982 F.2d at 106 (explaining that allegations of
mismanagement can support an inference of scienter if facts
are alleged “that a defendant was aware that mismanagement
had occurred and” lied about the existence of that
mismanagement). The FAC simply lacks sufficient
allegations to compellingly imply that the Individual
Defendants knew or recklessly disregarded that their actions
were resulting in improper accounting practices.
Accordingly, the Restatement’s admissions of material
weaknesses in Hertz’s internal controls, including its
admission of an “inappropriate tone at the top,” do not weigh
in favor of inferring scienter.
18
3. SOX Certifications Accompanying False
SEC Filings
An allegation that a defendant signed a SOX
certification attesting to the accuracy of an SEC filing that
turned out to be materially false does not add to the scienter
puzzle in the absence of any allegation that the defendant
knew he was signing a false SEC filing or recklessly
disregarded inaccuracies contained in an SEC filing. In re
Zagg, Inc. Sec. Litig., 797 F.3d 1194, 1205 (10th Cir. 2015);
Zucco Partners, LLC v. Digimarc Corp., 552 F.3d 981, 1003-
04 (9th Cir. 2009). As discussed above, the FAC fails to
plead facts that could plausibly lead to such an inference.
4. Replacement of Upper Management
The Funds argue that the Individual Defendants’
resignations show scienter because they each resigned in
close proximity to the public release of “bad news,” the
Restatement blamed the accounting irregularities on an
“inappropriate tone at the top,” and the Restatement explained
that part of Hertz’s remedial measures included hiring a new
senior management team. We agree with the District Court,
however, that the Individual Defendants’ resignations do not
materially add to an inference of scienter because the FAC
lacks allegations that those resignations were a result of the
Individual Defendants’ involvement in a systemic fraud.
The departure of corporate executive defendants is a
factor that can strengthen the inference of scienter. See City
of Dearborn Heights Act 345 Police & Fire Retirement Sys. v.
Align Tech., Inc., 856 F.3d 605, 622 (9th Cir. 2017)
(explaining that, in certain circumstances, “an employee’s
19
resignation supports an inference of scienter”); Brophy v.
Jiangbo Pharm. Inc., 781 F.3d 1296, 1305 (11th Cir. 2015)
(“Various courts have recognized that an executive officer’s
resignation can strengthen an inference of scienter when it
occurs around the same time as an investigation.”). However,
while resignations causally related to a restatement’s issuance
can provide “evidence of the substantial accounting
challenges [a] [c]ompany … faced, [they] do[] not compel an
inference that [the individuals who resigned] were bent on
committing fraud.” Yates v. Mun. Mortg. & Equity, LLC, 744
F.3d 874, 889 (4th Cir. 2014). For a resignation to add to an
inference of scienter, a pleading must set forth allegations
suggesting a compelling inference that the resignation was the
result of something other than “the reasonable assumption
that the resignation occurred as a result of” the release of bad
news. Zucco Partners, 552 F.3d at 1002. In other words, for
corporate departures to strengthen an inference of scienter,
there must be particularized allegations connecting the
departures to the alleged fraud.
Here, Douglas’s resignation was announced just days
before Hertz publicly released bad news stemming from the
Company’s accounting problems, and Frissora’s and Kapur’s
resignations were announced within about two months of
Hertz releasing similar news. Hertz freely acknowledged that
it replaced executive- and management-level employees as a
remedial measure to “change[] and enhance[] leadership in
the business units associated with the restatement matters.”
(App. at 611.) As the District Court noted, the FAC’s
allegations make clear that “the resignations … were causally
related to the bad news” ultimately resulting in the
Restatement. (App. at 47).
20
But pleading scienter requires more than pleading a
link between bad news and an executive’s resignation.
Changes in leadership are only to be expected when
leadership fails. That is not, in itself, a symbol of fraud.
Corporate resignations do not strengthen an inference of
scienter, when, as here, the allegations do not cogently
suggest that the resignations resulted from the relevant
executives’ knowing or reckless involvement in a fraud.
5. Insider Trading Activity
Demonstrating that a defendant had a motive, such as
personal financial gain, to commit a securities fraud violation
is a “relevant consideration” that “may weigh heavily in favor
of a scienter inference[.]” Tellabs, 551 U.S. at 325; see also
Rahman v. Kid Brands, Inc., 736 F.3d 237, 246 (3d Cir. 2013)
(“Though it is not necessary to plead motive to establish that
a defendant acted with scienter, its presence can be persuasive
when concluding a holistic review of the evidence.”).
Alleging insider trading is one way to plead motive. In re
Suprema Specialties, Inc. Sec. Litig., 438 F.3d 256, 277 (3d
Cir. 2006). The mere fact that an insider sold corporate stock,
however, is not enough to give rise to an inference of scienter.
City of Edinburgh, 754 F.3d at 176; In re Suprema, 438 F.3d
at 277.
Insider trading will strengthen an inference of scienter
when the “sales of company stock by insiders … are ‘unusual
in scope or timing[.]’” In re Suprema, 438 F.3d at 277
(citation omitted). We have weighed a number of
considerations when determining whether insider trading
activity was “unusual in scope or timing,” including “the
amount of profit made, the amount of stock traded, the
21
portion of stockholdings sold, … the number of insiders
involved[, and] … whether the profits were substantial
relative to the seller’s ordinary compensation.” Id. (citations
and quotation marks omitted).
Two considerations from the FAC’s insider trading
allegations add to the inference of scienter. First, the FAC
alleges that both Douglas’s and Kapur’s insider trading
activities were unusual when compared to their trading
history. For example, Douglas sold Hertz stock on four
occasions during the class period but had not sold any Hertz
stock in the three years prior to those trades. Similarly, Kapur
sold Hertz stock on five occasions during the class period but
had only traded in Hertz stock one other time in the three
preceding years. Those allegations support an inference of
scienter. Id. at 278. Second, the FAC alleges that Douglas
earned a net profit of approximately $4 million on her insider
trades, which exceeded her 2013 salary of $3 million.
Although the FAC does not identify Kapur’s salary, it alleges
that the approximately $3.1 million in profit he earned from
his trading activities likely exceeded his annual
compensation, given that he was Douglas’s subordinate.
Compare id. (inferring scienter when profits from trading
activities “nearly doubled in one day the total amount of
money” a defendant had earned “over the previous three years
combined”), with Cent. Laborers’ Pension Fund v. Integrated
Elec. Servs. Inc., 497 F.3d 546, 553 (5th Cir. 2007)
(concluding that inference of scienter not strengthened by
allegation that insider stock sale netted a defendant a profit
equivalent to 43% of that defendant’s salary).
Three other considerations, however, lessen the
strength of the scienter inference to be drawn from the FAC’s
22
insider trading allegations. First, the timing of the insider
trades is not particularly suspicious. Douglas and Kapur sold
their shares when Hertz stock was trading between $21.23
and $28.00, with the vast majority of sales occurring at a
price at or below $26.14. The overall class period high, in
contrast, was $31.56 on August 19, 2014. See Greebel v.
FTP Software, Inc., 194 F.3d 185, 206 (1st Cir. 1999)
(finding timing of insider trades to be not “very suspicious”
because the insiders did not sell at “high points of the stock”).
The allegations do not plausibly suggest that Douglas or
Kapur timed their trades to improperly benefit from any
particular disclosure. The lack of any temporally suspicious
trades weighs against inferring scienter from the trading
activity. See Yates, 744 F.3d at 890 (inference that trading
activity was innocent strengthened by fact that “plaintiffs do
not allege that the insiders timed the sales to take advantage
of any particular disclosure”); In re Advanta Corp. Sec. Litig.,
180 F.3d 525, 540 (3d Cir. 1999) (declining to infer scienter
when insider trading took place three months before negative
news publicly announced).
Second, the twenty-nine-month class period alleged by
the Funds cautions against inferring scienter from the alleged
insider trading. “[A]lleging … a lengthy class period makes
it difficult to infer intent from the mere fact of a stock sale, as
it is not unusual for insiders to trade at some point during
their tenure with a company.” Yates, 744 F.3d at 891. Courts
have regularly concluded that an inference of scienter from
insider trading is lessened when, as here, the class period is
well over a year. See id. (concluding that forty-four month
period was “inordinately long” and weighed against inferring
scienter); In re Vantive Corp. Sec. Litig., 283 F.3d 1079, 1092
(9th Cir. 2002) (inference of scienter lessened due to
23
“unusually long class period of sixty-three weeks [fifteen
months]”).
Third, the fact that the FAC named five individuals as
defendants, but alleged insider trading only as to Douglas and
Kapur, decreases the strength of the scienter inference. See In
re Advanta, 180 F.3d at 540 (explaining that a lack of insider
trading allegations against a majority of insider defendants
“rais[es] doubt [about] whether the sales were motivated by
an intent to profit from inflated stock prices”).
A final consideration – the percentage of pre-class
Hertz holdings Douglas and Kapur sold off during the class
period – does not materially move the scienter needle.
Douglas and Kapur sold off, respectively, 24.7% and 62.3%
of their Hertz holdings.5 As a pure percentage of stock
holdings sold, those percentages are supportive of an
inference of scienter. Compare In re Suprema, 438 F.3d at
278 (inferring scienter, in part, because defendants sold off
5
Kapur contests the 62.3% figure by arguing that that
figure includes the exercise of options that he never
technically owned. However, “[i]n calculating the percent of
holdings sold, … it is appropriate to consider not only the
shares of stock that [a defendant] held prior to [his] sales, but
also the shares that [he] could have sold through the exercise
of options[.]” Waters Corp., 632 F.3d at 760; see also In re
Silicon Graphics Inc. Sec. Litig., 183 F.3d 970, 986-87 (9th
Cir. 1999) (“Actual stock shares plus exercisable stock
options represent the owner’s trading potential more
accurately than the stock shares alone.”). Accordingly, we
accept the Funds’ allegation that Kapur sold 62.3% of his
holdings for purposes of this motion to dismiss.
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over 30% of holdings), with Avaya, Inc., 564 F.3d at 279 (not
inferring scienter when defendants sold 17% or less), and In
re Advanta, 180 F.3d at 540-41 (same with regard to selling
off of 5% to 7% of holdings). But the pure percentage of
holdings sold tells only part of the story. Courts have
routinely found that even large percentages of holdings sold
at first blush appearing suspicious are not sufficient to infer
scienter when other factors, such as the timing of the relevant
sales, weigh against that inference. See, e.g., Yates, 744 F.3d
at 890-91 (selling 28% of holdings did not strengthen
inference of scienter when not all defendants sold stock and
the timing of the trades were not suspicious); Ronconi v.
Larkin, 253 F.3d 423, 435 (9th Cir. 2001) (selling 69% of
holdings did not strengthen inference of scienter when there
was no allegation that the trades were timed to take advantage
of alleged non-public information). Here, as described above,
the considerations weighing against inferring scienter limit
the strength of the scienter inference that can be made from
the percentage of pre-class holdings sold by Douglas and
Kapur.
The FAC’s insider-trading allegations thus add only
minimal weight to the inference of scienter.
6. Holistic Review
The Funds urge us to conclude that a holistic review of
the FAC’s allegations leads only to one plausible string of
inferences – that the Individual Defendants recklessly
disregarded that their “tone” would lead lower-level
employees to engage in inappropriate accounting to placate
their demands, then recklessly disregarded that those
irregularities would lead to overstated and inaccurate
25
financial statements, and, consequently, recklessly disclosed
materially false information through SEC filings, press
releases, and public announcements. The problem the Funds
face is that the inferences they propose are simply not as
compelling as the opposing one drawn by the District Court:
that corporate mismanagement resulted in accounting
irregularities and, at most, negligent misstatements.
The FAC and Restatement make clear that the
problems plaguing Hertz and its accounting department were
significant, that Frissora and other members of senior
management created a pressurized environment that
contributed to those problems, and that those problems
resulted in material misstatements regarding the Company’s
financial condition. But the allegations that the Individual
Defendants resigned as Hertz discovered those problems, and
that Douglas and Kapur sold portions of their Hertz stock
holdings while those problems were ongoing, do not
necessarily suggest that Hertz or its senior management were
engaged in a systemic fraud. More plausible is the suggestion
that the Individual Defendants were just bad leaders. The
FAC’s allegations do not give rise to a cogent inference that
the Individual Defendants were aware that their actions were
improper, that they consciously disregarded that their “tone”
was causing employees to engage in erroneous accounting, or
that Hertz’s accounting errors were so obvious that only an
attitude of reckless disregard on the part of the Individual
Defendants can explain what they said and did.6
6
The Funds argue in the alternative that we should
adopt the doctrine of corporate scienter to hold Hertz liable
even if the FAC does not plead a strong inference of scienter
as to any of the Individual Defendants. That doctrine allows
26
III. Conclusion
For the foregoing reasons, we will affirm the District
Court’s dismissal of the FAC.
a plaintiff “to plead an inference of scienter against a
corporate defendant without raising the same inferences
required to attribute scienter to an individual defendant.”
Rahman, 736 F.3d at 246. We have neither accepted nor
rejected that doctrine and decline to do so here because the
FAC’s allegations would not give rise to corporate scienter
under any recognized theory of that doctrine. See In re
Omnicare, Inc. Sec. Litig., 769 F.3d 455, 473-77 (6th Cir.
2014) (discussing different approaches to the doctrine of
corporate scienter).
Furthermore, because we have affirmed the District
Court’s dismissal of the FAC’s Section 10(b) claim, we need
not address the Section 20(a) claim, which is dependent on a
Section 10(b) violation. City of Edinburgh, 754 F.3d at 177.
27