United States Court of Appeals

For the First Circuit

____________________

No. 01-1989

MICHAEL ALDRIDGE, individually and on behalf of 

all others similarly situated,

Plaintiff, Appellant,

v.

A.T. CROSS CORPORATION, BRADFORD R. BOSS, RUSSELL A. BOSS, W.

RUSSELL BOSS JR. TRUST A, W. RUSSELL BOSS JR. TRUST B, W. RUSSELL

BOSS JR. TRUST C, JOHN E. BUCKLEY, and JOHN T. RUGGIERI,

Defendants, Appellees.

____________________

APPEAL FROM THE UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF RHODE ISLAND

[Hon. Mary M. Lisi, U.S. District Judge]

____________________

Before

Torruella, Circuit Judge,

Stahl, Senior Circuit Judge,

and Lynch, Circuit Judge. 

____________________

Lawrence Deutsch with whom Shanon J. Carson, Berger &

Montague, P.C., Matthew F. Medeiros, and Little, Bulman, Medeiros

& Whitney, P.C. were on brief for appellant.

John F. Sylvia with whom R. Robert Popeo, Stephen T. Murray,

Justin S. Kudler, and Mintz, Levin, Cohn, Ferris, Glovsky and

Popeo, P.C. were on brief for appellees A.T. Cross Company,

Bradford R. Boss, Russell A. Boss, John E. Buckley, and John T.

Ruggieri.

William R. Grimm with whom Charles D. Blackman and Hinckley,

Allen & Snyder LLP were on brief for appellees W. Russell Boss Jr.
Trust A, W. Russell Boss Jr. Trust B, and W. Russell Boss Jr. Trust

C. 

____________________

March 20, 2002

____________________
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LYNCH, Circuit Judge. In early 1998 the A.T. Cross

Corporation, a venerable New England maker of fine pens and

pencils, entered the personal electronic devices market by offering

pen-based computing products through its Pen Computing Group (PCG).

The stars of its new line were the CrossPad and its laterintroduced smaller cousin, the CrossPad XP. Cross had high hopes

for its new product line and expressed those hopes publicly in

September 1997 by saying it expected to report a minimum of $25

million in profitable sales for PCG in 1998. Indeed, one of

Cross's officers compared its fledgling product to the highly

successful Palm Pilot.

Reality did not keep pace with these projections. By

late 1999 Cross had discontinued the product line and suffered

losses that year of $24.3 million, which essentially eliminated

profits from the $24.8 million in sales on the PCG products in

1998.

Michael Aldridge brought this securities action in April

2000 as a putative class action on behalf of those who purchased

Cross common stock between September 17, 1997 and April 22, 1999

(the class period). An amended complaint asserts claims against

the company, four officers of the company, and certain trusts which

own part of Cross. The complaint alleges violations of section

10(b) of the Securities and Exchange Act of 1934, 15 U.S.C. §

78j(b) (2000), and Rule 10b-5 under that Act, 17 C.F.R. § 240.10b-5

(2001), against the company, the individual defendants, and the

trusts. It also alleges a section 20(a) claim against the
1 The individual defendants were members of the Cross

management team during the class period: Bradford Boss, Chairman of

Cross's board; Russell Boss, President and CEO of Cross; John

Buckley, Executive Vice President and COO; and John T. Ruggieri,

Senior Vice President and CFO. The trust defendants are: the W.

Russell Boss Jr. Trust A; the W. Russell Boss Jr. Trust B; and the

W. Russell Boss Jr. Trust C. For purposes of all but the section

20(a) analysis, we refer to all of the defendants as the company.

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individual and trust defendants as "controlling person[s]."

1 15

U.S.C. § 78t(a) (2000). 

On a Rule 12(b)(6) motion by the defendants, the district

court dismissed the action. Aldridge v. A.T. Cross Corp., No. 00-

203ML (D.R.I. June 4, 2001). The court did not reach the question

of whether to certify a class.

We reverse the dismissal of the claims against the

individual defendants and the company. We find that there is

sufficient factual support for the allegations of fraud and a

strong inference of scienter to survive a motion to dismiss under

the Private Securities Litigation Reform Act (PSLRA). We affirm

the dismissal of the section 20(a) claim against the trust

defendants on different grounds; on these pleadings, the trust

defendants cannot be considered "controlling persons" for the

purpose of section 20(a) liability.

I.

Because this is an appeal from a motion to dismiss, we

describe the facts in the case in the light most favorable to

Aldridge, the plaintiff and nonmoving party. Doe v. Walker, 193

F.3d 42, 42 (1st Cir. 1999).
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Cross is a publicly traded company on the American Stock

Exchange. For over a century, Cross has been producing traditional

high-end writing instruments. By the mid 1990s, sales of these

products were dropping off, and the company's stock price had

decreased significantly since 1990. In July 1996, Cross

established a new division it called the Pen Computing Group (PCG)

in an effort to "bridge . . . the worlds of traditional and

electronic paper," to expand the company's traditional product

base, and "to return Cross to acceptable margins and earnings."

One of these PCG products was the CrossPad, unveiled in

November 1997, and first shipped in March 1998. The CrossPad XP,

a smaller model, was introduced to the market in October 1998. The

CrossPads were electronic note pads with digital pens, with which

a user wrote on a note pad atop a battery powered unit. The pens

wrote on the paper in the traditional way and also recorded the pen

strokes for later connection to a computer. Once the information

was stored in a computer, it could be viewed, searched, and

otherwise used.

There was a great deal of optimism about the CrossPads

and their positive impact on Cross as a whole. On September 17,

1997, even before unveiling the CrossPad, Cross issued a press

release announcing that the company expected at least $25 million

in profitable sales from PCG in 1998. On March 23, 1998, Cross

filed a 10-K report with the SEC for the fiscal year 1997, which

stated: "We look at 1998 as a year where . . . our Pen Computing

Group will provide its first year of significant sales and
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earnings." The bulk of PCG's business was the CrossPad product

line. In an April 1998 article in Value Line, an investment

publication, Cross's management said that sales of the CrossPad

would drive PCG's growth, and predicted sales of $200 million in

the year 2000. In a June 1998 article in Barron's, another

investment publication, management predicted that CrossPad could

triple the size of the company. On June 30, 1998, the Cross share

price peaked for the class period at $14.25. 

In Cross's 1998 filings with the SEC, the company

continued to report significant sales growth for PCG products. In

a business article dated February 4, 1999, the Providence Journal

quoted Brian Mullins, the Director of Marketing for PCG, as saying

that PCG's "sales for all of 1998 did meet the Company's goal of

$25 million in sales." 

Despite the earlier optimism, Cross began to lower the

market's expectations beginning in early 1999. The same February

4 Providence Journal article discusses Mullins's comments on the

recently announced price reductions for both the CrossPad and the

CrossPad XP. He stated that the price cuts were not related to the

sales of the products but were "planned . . . from the get go" and

were expected by the retailers. The article paraphrases Mullins as

saying that "even with the price cuts, the company will still make

a profit." He also said that more price cuts were expected later

in the year. On March 23, 1999, the company filed its 10-K report

with the SEC. The report stated the success of the CrossPad sales

in 1998, but it also acknowledged the price reductions and "greater
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marketing support and technical development [than] planned, which

resulted in a loss for Pen Computing operations." 

On April 22, 1999, Cross announced in a press release

that the company's sales had dropped dramatically from $9 million

in the first quarter of 1998 to $1.1 million in the first quarter

of 1999. It also expressed its expectation that revenues from PCG

would be a great deal lower in 1999 than they were in 1998. 

On the same day, Cross's management held a conference

call with securities analysts and investors to discuss the

company's results for the first quarter of 1999. During the call,

Russell Boss, President and CEO of Cross, explained that PCG sales

had decreased in the first quarter "because of price protections."

He also mentioned "take backs" from customers. Robert Byrnes,

President and CEO of PCG also spoke about "price protection," and

said that the price reductions were part of the company's original

sales strategy. John Buckley, Cross's Executive Vice President and

Chief Operating Officer, also acknowledged the company's price

protection practices. Cross did not disclose any price protection

plans or take back agreements in its public financial disclosures

in 1998.

Also on April 22, Russell Boss and Bradford Boss

announced that they were stepping down from their positions as CEO

and executive Chairman respectively, and stepping into the

positions of non-executive Chairman, and non-executive Chairman

Emeritus. Immediately after the end of the class period, on April

22, 1999, the share price for Cross fell below $4.
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PCG sales continued to decline in 1999. On May 13, 1999,

the company filed a 10-Q report for the first quarter of the year,

and revealed for the first time in a SEC filing a "rebate" program

it had with its customers. In a 10-Q report issued on August 13,

1999, the company reported over $8 million in losses for PCG in the

second quarter of 1999, and an 85% decline in PCG sales compared to

the same quarter the previous year. The company pointed to the

excess inventory its customers had as a reason for the decrease in

sales.

Finally, the CrossPad product line was discontinued at

the end of 1999 because of poor performance in the market. In a

Form 10-K filed on March 23, 2000, Cross's new President and CEO

discussed PCG's decline in 1999. He stated: 

Early in the year [1999] it became clear that our

investment[] in the Pen Computing Group . . . w[as] a

significant drain on the Company's financial and human

resources. As a result, in the fourth quarter, the

Company discontinued the CrossPad product line . . . . 

The company also described a revenue recognition policy not

disclosed earlier, which stated: "Revenue from sales is recognized

upon shipment or delivery of goods. Provision is made at the time

the related revenue is recognized for estimated product returns,

term discounts and rebates." 

Aldridge, the plaintiff, brought a claim under section

10(b) of the Securities and Exchange Act of 1934, 15 U.S.C. §

78j(b) (2000), and Rule 10b-5, 17 C.F.R. § 240.10b-5 (2001), for

fraud against Cross, members of its top management team, and three

trusts that own a large number of shares in the company. He argues
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that the statements made by the company and its management during

the class period were misleading in light of the company's sales

and accounting practices. Specifically, Aldridge says that the

company employed sales strategies, such as price protection, take

backs, and channel stuffing, without disclosing them to the

shareholders, or reserving for them in financial statements, as

they were obligated to do. Aldridge also brought a claim under

section 20(a) of the Securities and Exchange Act of 1934, 15 U.S.C.

§ 78t(a) (2000), against the individual defendants and the trust

defendants as "controlling persons" of the corporation. Aldridge

argues that the trust defendants, "[b]y reason of their ownership

and ability to select two-thirds of the Board," and the individual

defendants influenced and steered the company to engage in

fraudulent conduct. 

The district court dismissed the action on a Rule

12(b)(6) motion under the standards of the Private Securities

Litigation Reform Act of 1995 (PSLRA), 15 U.S.C. § 78u-4 (2000),

finding Aldridge had neither provided sufficient factual support

for the allegations of fraud nor raised a strong inference of

scienter. Aldridge v. A.T. Cross Corp., No. 00-203ML, slip. op. at

10-15 (D.R.I. June 4, 2001). The district court, without reaching

the details of the controlling person issue, also dismissed the

section 20(a) claim against the individual defendants and the trust

defendants because it was derivative of the dismissed section 10(b)

claim. Id. at 15-16. The court did not reach the question of

whether to certify a class.
2 The statute provides, in relevant part:

(b) Requirements for securities fraud actions

(1) Misleading statements and omissions

In any private action arising under this chapter in

which the plaintiff alleges that the defendant -- 

(A) made an untrue statement of a material

fact; or 

(B) omitted to state a material fact necessary

in order to make the statements made, in the

light of the circumstances in which they

were made, not misleading; 

the complaint shall specify each statement alleged

to have been misleading, the reason or reasons why

the statement is misleading, and, if an allegation

regarding the statement or omission is made on

information and belief, the complaint shall state

with particularity all facts on which that belief

is formed.

(2) Required state of mind 

In any private action arising under this chapter in

which the 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 alleged to violate this

chapter, 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)(1)-(2). 

-10-

II.

Our review of the allowance of a motion to dismiss is de

novo. Serabian v. Amoskeag Bank Shares, Inc., 24 F.3d 357, 361

(1st Cir. 1994). The pleading standards for violations of section

10(b) and Rule 10b-5 are found in the PSLRA, 15 U.S.C. §78u-4.2 

This circuit's seminal case on the pleading standards under the

PSLRA is Greebel v. FTP Software, Inc., 194 F.3d 185, 193-94 (1st

Cir. 1999). In Greebel, we held that the PSLRA did not alter this

circuit's rigorous reading of the standards for pleading fraud.

The plaintiff in a securities fraud action must "specify each
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allegedly misleading statement or omission" including its time,

place and content. Id. at 193. The plaintiff must provide factual

support for the claim that the statements or omissions were

fraudulent, that is, facts that show exactly why the statements or

omissions were misleading. Id. at 193-94. If the plaintiff brings

his claims on information and belief, he must "set forth the source

of the information and the reasons for the belief." Id. at 194

(quoting Romani v. Shearson Lehman Hutton, 929 F.2d 875, 878 (1st

Cir. 1991)) (internal quotation marks omitted). The plaintiff must

also show that the inferences of scienter "are both reasonable and

'strong.'" Id. at 195-96. 

Although the pleading requirements under the PSLRA are

strict, id. at 194, they do not change the standard of review for

a motion to dismiss. Even under the PSLRA, the district court, on

a motion to dismiss, must draw all reasonable inferences from the

particular allegations in the plaintiff’s favor, while at the same

time requiring the plaintiff to show a strong inference of

scienter. Id. at 201; accord Helwig v. Vencor, Inc., 251 F.3d 540,

553 (6th Cir. 2001) (en banc), petition for cert. filed, 70

U.S.L.W. 3269 (Sept. 27, 2001) (No. 01-538).

A. Fraud Allegations

The district court correctly found that Aldridge had met

the specificity requirements as to "time, place and content" of the

statements said to be misleading. Aldridge, slip. op. at 10. The

district court faulted the complaint, however, for failing to

provide factual support for the allegations of fraud. Id. at 10-
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11. The district court concluded that even if Cross made false

statements or material omissions, there is no support for the

proposition that the defendants knew these statements or omissions

were misleading at the time they were made. It also relied on the

absence of specific figures regarding which transactions were

misstated and by what amounts. It was here that the court erred.

The district court did not "giv[e] plaintiff[] the benefit of all

reasonable inferences" as it should have on a motion to dismiss,

Greebel, 194 F.3d at 201, but appears to have drawn its inferences

in the defendants' favor. We take the plaintiff’s allegations to

be true and draw inferences in the plaintiff’s favor.

Aldridge's core claim is that the reported revenues and

earnings in A.T. Cross’s financial statements were artificially

inflated, and that the statements contained omissions of material

facts. Aldridge alleges that under generally accepted accounting

principles (GAAP), with which Cross purported to comply, Cross was

required to estimate a loss or range of loss and set a reserve with

respect to all contingent sales that were made, including sales for

which the buyer had the right to receive a credit or allowance if

the price of the CrossPad declined before the buyer could resell

the product (i.e., price protection). If Cross was unable to

establish a reserve or estimate the loss, it was required to

disclose the practices that gave rise to the contingent revenues

and earnings. Aldridge alleges that the defendants knew that Cross

had not sufficiently reserved for the losses that inevitably would

occur when Cross was forced to honor its price protection
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commitments, and that their failure to disclose this to the public

violated federal regulations (specifically Item 303 of the SEC's

Regulation S-K) and accounting standards. See 17 C.F.R. §

229.303(a) (2001) (requiring that SEC filings "provide . . .

information that the registrant believes to be necessary to an

understanding of its financial condition"); Accounting for

Contingencies, Statement of Financial Accounting Standards No. 5,

¶ 10 (Financial Accounting Standards Bd. 1975); Revenue Recognition

When Right of Return Exists, Statement of Financial Accounting

Standards No. 48, ¶ 7 (Financial Accounting Standards Bd. 1981)

("FAS 48"). Cross has not argued that the information that was not

provided in the financial statements was not material.

The district court’s holding hinged on a key issue:

whether, from the statements made by company officials in 1999, it

could be reasonably inferred that Cross had engaged in undisclosed

price protection earlier, in 1998. The district court thought not.

If there was no price protection or similar practice in 1998, the

district court concluded, then the company's financial statements

did not contain misleading omissions. Our view is to the contrary:

it is an extremely reasonable inference, from the defendants'

statements in 1999, that the company had offered its customers

price protection guarantees in 1998, likely to induce them to carry

the new CrossPad product lines. From this, it may easily be

inferred that the statements were misleading and that the

defendants knew that they were misleading.
3 At oral argument Cross argued that Mullins, the Director

of Marketing, lacked authority to make admissions. See Fed. R.

Evid. 801(d)(2). That seems improbable; but we need not decide it

as an evidentiary matter as we take inferences in the plaintiff’s

favor, and there is a strong inference that a Director of Marketing

had authority to make such statements.

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There were several statements in 1999 that support the

inferences. First, in February 1999, the prices of the CrossPad

products were discounted by up to 30%. A February 4 business

article in the Providence Journal reported the price reductions and

cited Mullins, the Director of Marketing, as saying that the

company would make a profit on the CrossPads even with the price

cuts.3 The article also reported (obviously relying on company

sources and most likely on Mullins) that price cuts "had been

planned since the products were introduced." Mullins was quoted as

saying that "the price cuts were not related to how well the units

were selling." Mullins said "[w]e actually had planned it from the

get go. We told the retailers to expect it." 

In this context, "from the get go" is easily read to mean

from the introduction of the new product to the market in 1998. If

the price cuts were planned from early 1998, it is entirely

reasonable to think that price protection for the stores selling

the product was also discussed and agreed on at that time, to

insulate the retailers from the inevitable price reductions.

The price reductions were also discussed at Cross's April

22, 1999 conference call with analysts and investors. During that

conference call Byrnes, the head of PCG, said that the price

reductions were in line with the company’s original strategy, but
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were not put into place until February 1999. President Russell

Boss said that "PCG business was down" in the first quarter of 1999

"because of price protections [Cross] gave retailers." Two other

corporate officers, including Byrnes, mentioned that there was a

price protection program. 

There is a possibility that the Cross officers used the

term "price protection" in some specialized narrow sense for a

right to reimbursement offered by the company to the retailers once

the CrossPads had already been on the store shelves for some

months. However, on this record it is just as likely, if not more

likely, that Aldridge's more common definition of price protection

is what was meant: "Price protection is a retailer’s or

distributor’s right to reimbursement in the event of post-sale

price reductions." As Aldridge argues, "[t]hat price protection is

a right implies that it is bargained for at the time the

retailer/distributor contracts to buy product from the

manufacturer," not once the product has been on the shelves for

several months. 

Aldridge also argues that under accounting rules, booking

sales subject to price protection requires adequate accounting

reserves at the time of sale to offset the effects of such price

protection. Otherwise, such sales should not be recognized as

revenue. If a reserve is not set up -- because, for example, the

size of the contingencies was impossible to estimate -- disclosure

should be made. See Greebel, 194 F.3d at 203 (discussing FAS 48).
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In dismissing the case, the district court referred to a

statement in Greebel that the absence of specific identifying

information as to the amount and nature of contingent sales

transactions was indicative of the generality of the allegations of

violations of GAAP standards such as FAS 48, and thus insufficient

by itself to infer scienter. Aldridge, slip op. at 11 (citing

Greebel, 194 F.3d at 203-04). However, in Greebel, there was no

evidence of statements by management indicating material

undisclosed contingencies, while here there was such evidence.

Further, it is reasonable to infer that in this case all customers

were offered price protection as a matter of company policy. Cross

itself attributed losses in early 1999 in part to its price

protection program. There was therefore little need for the type

of specificity discussed in Greebel. In Greebel, the argument that

contingent sales were not properly accounted for under FAS 48 was

made largely in service of more direct claims of warehousing and

whiting out, claims which, even after discovery, lacked any factual

support. Here, in contrast, there is a reasonable inference of a

pattern of price protection. Further, the evidence that contingent

sales were not accounted for as they should have been under FAS 48

was offered in Greebel as indirect evidence of scienter, and there

was discounted, in the absence of particulars and other evidence of

scienter. Greebel did not hold that a plaintiff, before discovery,

must in every case allege the amount of overstatement of revenues

and earnings in order to state a claim that undisclosed price

protection schemes were fraudulent. 194 F.3d at 204 (relying on
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"complete absence" of particulars but refusing to hold that such

information must appear in a complaint).

Aldridge also attempts to support the inference that a

price protection program was entered into in 1998 but not disclosed

at the time with allegations of two corollary practices: take

backs and channel stuffing. A "take back" is a promise to take

back goods from customers who have been unable to sell them. In

the April 22, 1999 conference call, Russell Boss specifically used

the phrase "take back." Again, it is reasonable to infer that a

take back guarantee for the retailers of CrossPads was agreed to in

1998, because a take back agreement, just like price protection, is

likely to have been part of the original bargain between Cross and

its customers. No take back agreements were disclosed in the

company’s 1998 public statements and filings. The take back

allegations therefore support Aldridge's claim that Cross engaged

in undisclosed price protection.

Channel stuffing, in turn, was defined in Greebel:

"Channel stuffing" means inducing purchasers to increase

substantially their purchases before they would, in the

normal course, otherwise purchase products from the

company. It has the result of shifting earnings into

earlier quarters, quite likely to the detriment of

earnings in later quarters.

194 F.3d at 202. Aldridge's allegation is that 50% of the store

placements for the CrossPad took place in the last four months of

1998 and that 36% of PCG sales occurred in the last three months of

1998. These figures might well be explained by holiday season

sales. Beyond that, the second quarter 1999 Form 10-Q report

stated that the 85% reduction in sales from the prior year was
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attributable to retailers having significantly reduced their

purchases as they reduced their current inventory levels. Also,

the company’s expenses were higher as it administered a rebate

promotion "to reduce channel inventory at the retail level." This

information may or may not suggest that more inventory was in the

hands of the retailers than commercially warranted. "There is

nothing inherently improper in pressing for sales to be made

earlier than in the normal course," id. at 202, and in this case,

the channel stuffing allegations at present are neutral. After

discovery, however, they may play a supporting role in buttressing

the price protection inferences.

The company says this is a garden variety "fraud by

hindsight" case, occasioned by the large drop in sales of CrossPad

products after 1998. That characterization is off the mark. Fraud

by hindsight occurs when a plaintiff "simply contrast[s] a

defendant's past optimism with less favorable actual results, and

then 'contend[s] that the difference must be attributable to

fraud.'" Shaw v. Digital Equip. Corp., 82 F.3d 1194, 1223 (1st

Cir. 1996) (quoting DiLeo v. Ernst & Young, 901 F.2d 624, 627 (7th

Cir. 1990)). In this case, on the other hand, Aldridge complains

that the company failed to disclose certain known material

information as to the contingent nature of the sales, and that

Cross essentially admitted to the 1998 contingencies in 1999. 

The allegations of fraud in the complaint have sufficient

factual support to survive a motion to dismiss. A closer question

is whether the allegations of scienter are sufficient.
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B. Scienter

Scienter, which is a requirement for liability under

section 10(b) and Rule 10b-5, is "a mental state embracing intent

to deceive, manipulate, or defraud." Ernst & Ernst v. Hochfelder,

425 U.S. 185, 193 n.12 (1976). To win a section 10(b) case, the

plaintiff must show either that the defendants consciously intended

to defraud, or that they acted with a high degree of recklessness.

Greebel, 194 F.3d at 198-201. 

In Greebel, we held that the PSLRA did not mandate a

particular test to determine scienter and that this court would

continue to use its case by case fact-specific approach; "we . . .

analyze[] the particular facts alleged in each individual case to

determine whether the allegations were sufficient to support

scienter." 194 F.3d at 196; accord City of Philadelphia v. Fleming

Cos., 264 F.3d 1245, 1262-63 (10th Cir. 2001) (adopting Greebel's

fact-specific approach); Helwig, 251 F.3d at 551 (same). Thus, the

plaintiff may combine various facts and circumstances indicating

fraudulent intent to show a strong inference of scienter. As part

of the mix of facts, the plaintiff may allege that the defendants

had the motive ("concrete benefits that could be realized by . . .

the false statements and wrongful nondisclosures") and opportunity

("the means and likely prospect of achieving concrete benefits by

the means alleged") to commit the fraud. Novak v. Kasaks, 216 F.3d

300, 307 (2d Cir.) (quoting Shields v. Citytrust Bancorp, Inc., 25

F.3d 1124, 1130 (2d Cir. 1994)), cert denied, 531 U.S. 1012 (2000).

However, as we stated in Greebel, while mere allegations of motive
4 Aldridge could have buttressed his case by obtaining

information, if available absent discovery, from Cross's customers

on the price protection and take back allegations. In another case

the failure to make that effort might prove fatal. Here it is not.

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and opportunity alone may be insufficient, together with additional

factual support, evidence of motive and opportunity may establish

a strong inference of scienter. 194 F.3d at 197.

In evaluating whether the inferences of scienter are

strong, we agree with the Sixth Circuit’s language that:

"Inferences must be reasonable and strong -- but not irrefutable.

. . . Plaintiffs need not foreclose all other characterizations of

fact, as the task of weighing contrary accounts is reserved for the

fact finder." Helwig, 251 F.3d at 553. The plaintiff must show

that his characterization of the events and circumstances as

showing scienter is highly likely. 

Taking all the facts and circumstances into

consideration, the complaint survives the requirement that its

pleadings raise a strong inference of scienter. First, strong

inferences can be made that the company offered price protection

and take back arrangements in 1998.4 These arrangements, if they

existed, were not disclosed, and that nondisclosure could hardly

have been inadvertent. The company only disclosed the price

protection and take back agreements in an April 1999 conference

call with industry analysts and investors. Full public disclosure

of the agreements only occurred in the Form 10-Q report filed on

May 13, 1999. Although the company officials referred to "price

protection" during the conference call, the report used the term
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"rebates," which may suggest an attempt to recharacterize the

events. Of course, more than mere proof that the defendants made

a particular false or misleading statement is required to show

scienter. Geffon v. Micrion Corp., 249 F.3d 29, 36 (1st Cir.

2001). However, the fact that the defendants published statements

when they knew facts suggesting the statements were inaccurate or

misleadingly incomplete is classic evidence of scienter. Fl. State

Bd. of Admin. v. Green Tree Fin. Corp., 270 F.3d 645, 665 (8th Cir.

2001) (collecting cases from various circuit courts).

Second, building on the reasonable inference that either

or both the price protection or take back guarantees were in place

in 1998, it may also be inferred that accounting standards required

that a reserve be established or at least that Cross disclose the

sales practices in its financial statements. This is also evidence

of scienter. See Geffon, 249 F.3d at 35 (noting that "accounting

shenanigans" may be evidence of scienter). There is evidence that

the defendants acted with knowledge and intent when they did not

account for the sales practices in the company's reports in 1998.

In the Form 10-K filed by the company on March 23, 2000, after a

new company president was installed, Cross disclosed for the first

time after the dramatic PCG losses, a revenue recognition policy:

"Revenue from sales is recognized upon shipment or delivery of

goods. Provision is made at the time the related revenue is

recognized for product returns, term discounts and rebates."

The company argues that because it has never restated any

of its financials or otherwise indicated any error in the 1998
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financial statements, and because its financial statements were

audited by an independent accounting firm, no inference of

accounting error, and so no inference of scienter, can be drawn. 

We disagree. Had the 1998 financials been restated, that might

well have been useful to Aldridge. However, the fact that the

financial statements for the year in question were not restated

does not end Aldridge's case when he has otherwise met the pleading

requirements of the PSLRA. To hold otherwise would shift to

accountants the responsibility that belongs to the courts. It

would also allow officers and directors of corporations to exercise

an unwarranted degree of control over whether they are sued,

because they must agree to a restatement of the financial

statements. 

Third, the Cross corporate officers had some particular

financial incentives to load sales and earnings into 1998. Their

compensation depended on the company’s earnings; as Cross correctly

notes, that fact alone is not and cannot be enough to establish

scienter. Green Tree, 270 F.3d at 661; Fleming Cos., 264 F.3d at

1269-70; Novak, 216 F.3d at 307. What makes this case different

are the inferences that corporate officers understood in 1997 and

1998 that the success of the new products, and of taking the old

line company into a new world, was important to their own survival

and that of the company. Indeed, the complaint alleges that

Russell said, "If I can’t turn the company around in one year, I

won’t be here." This gave incentive to maximize 1998 earnings in

particular. When financial incentives to exaggerate earnings go
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far beyond the usual arrangements of compensation based on the

company's earnings, they may be considered among other facts to

show scienter. See, e.g., Green Tree, 270 F.3d at 661 (reversing

trial court decision based on lack of scienter where it was

reasonable to infer that defendant officer maximized his

compensation by overstating earnings before his contract ran out).

More specifically, the individual defendants were the

ones who set the target sales goal of $25 million, and their jobs

were in jeopardy if the goals were not met. Moreover, the CrossPad

product line was very important to Cross. In April 1998 the

defendants were quoted as stating that the CrossPad would be the

primary driver of PCG’s growth. In a September 30, 1998 press

release, Cross stated that the sales of PCG products made up 34% of

the company’s total domestic revenue. That being so, there was

incentive to maximize profits in 1998 by various means. See

Greebel, 194 F.3d at 196 (stating that "self-interested motivation

of defendants in the form of saving their salaries or jobs" may be

evidence of scienter). As it turned out, the company President,

Russell Boss, and Chairman, Bradford Boss, did resign after the

disastrous first quarter 1999 results were made public. 

Playing lesser but supporting roles in the factual

analysis, there were the additional financial incentives to

management to overstate 1998 profits. The exercise price of the

individual defendants' stock options was lowered in 1997, just

before the introduction of the new product line. The exercise

price was lowered again to match the market price in December 1998.
5 We leave to the district court on remand Aldridge’s

argument that there is a sub-class of the 1999 investors.

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There is no evidence that the defendants exercised their options;

Aldridge's point is rather that the adjustment in price created

incentives to "boost A.T. Cross share price." The adjustments in

the exercise price of the defendants' stock options alone are not

enough to create a strong inference of scienter. But this fact is

not alone here. While this case does not involve trading while in

possession of material nonpublic information, which in some

circumstances may be taken to support allegations of motive, see,

e.g., Acito v. IMCERA Grp., 47 F.3d 47, 54 (2d Cir. 1995), there

were sufficient other sources of financial motive that make the

absence of such evidence less important here.

Our conclusion that Aldridge's section 10(b) and Rule

10b-5 claim survives a motion to dismiss is only that. The

defendants may yet prevail once the facts of the case are further

developed.5

C. Section 20(a) Claim

The district court’s dismissal of the section 20(a) claim

was derivative of its dismissal of the section 10(b) claim. See

Suna v. Bailey Corp., 107 F.3d 64, 72 (1st Cir. 1997). Because

there must be a primary violation for liability under section

20(a), the district court did not independently evaluate whether

the claim otherwise failed. Nonetheless, we "may affirm a district

court's judgment on any grounds supported by the record."

Greenless v. Almond, 277 F.3d 601, 605 (1st Cir. 2002).
6 Whether culpable participation is a required element of

liability under section 20(a) has generated a great deal of

discussion. Compare First Jersey Secs., 101 F.3d at 1472-73

(applying such a requirement), with Hollinger v. Titan Capital

Corp., 914 F.2d 1564, 1575 (9th Cir. 1990) (en banc) (rejecting

such a requirement); see generally 3C H. Bloomenthal & S. Wolff,

Securities and Federal Corporate Law § 14.9 (2d ed. 1999)

(discussing the culpable participant requirement).

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As to the trust defendants only, the matter is plain

enough to affirm the dismissal of the section 20(a) claim against

them. Section 20(a) provides: 

Every person who, directly or indirectly, controls

any person liable under any provision of this chapter or

of any rule or regulation thereunder shall also be liable

jointly and severally with and to the same extent as

such controlled person . . . unless the controlling

person acted in good faith and did not directly or

indirectly induce the act or acts constituting the

violation or cause of action. 

15 U.S.C. § 78t(a) (2000). 

The trust defendants argue that this court should adopt

a three part test for controlling person liability, under which the

plaintiff must allege and prove: (1) an underlying violation by a

controlled person or entity; (2) the defendants control the

violator; and (3) the defendants are in a meaningful sense culpable

participants in the fraud in question. See SEC v. First Jersey

Secs. Inc., 101 F.3d 1450, 1472 (2d Cir. 1996). They correctly

described a split among the circuits on whether an element of

section 20(a) liability is "culpable participation."6 We do not

reach that question, but rest on the "control" element.

To meet the control element, the alleged controlling

person must not only have the general power to control the company,

but must also actually exercise control over the company. See
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Sheinkopf v. Stone, 927 F.2d 1259, 1270 (1st Cir. 1991) ("For [the

defendant] to be liable . . . there must be 'significantly

probative' evidence that the [defendant] exercised, directly or

indirectly, meaningful hegemony over the . . . venture . . . .")

(internal citation omitted); see also Harrison v. Dean Witter

Reynolds, Inc., 974 F.2d 873, 880-881 (7th Cir. 1992) (describing

a similar requirement). In this case, the trust defendants have

the power to elect two-thirds of the directors. But they have no

direct control over the management and operations of the company.

At most the evidence pled is that the trust defendants are

controlling shareholders. This indicates some potential ability to

control. In the absence of some indicia of the exercise of control

over the entity primarily liable, however, that status alone is not

enough. Although controlling shareholders own the majority of the

shares in a company, they, like any other shareholders, should have

the ability to be passive, leaving the management to the directors

and officers. See L. Carson, The Liability of Controlling Persons

Under the Federal Securities Acts, 72 Notre Dame L. Rev. 263, 318-

19 (1997). Unless there are facts that indicate that the

controlling shareholders were actively participating in the

decisionmaking processes of the corporation, no controlling person

liability can be imposed. In this case, no facts are pled

permitting an inference that the trust defendants actually

exercised control over Cross.

III.
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The case will be reinstated as to the company and the

individual defendants. The district court may wish to consider

limiting discovery initially to key issues. Nothing in this

opinion, of course, predicts any outcome if a postdiscovery summary

judgment motion is filed or the matter goes to trial. Where there

is smoke, there is not always fire.

Accordingly, we reverse the dismissal of the section

10(b) claim and the section 20(a) claim against the company and the

individual defendants; we affirm, on different grounds, the

dismissal of the section 20(a) claim against the trust defendants.

No costs are awarded.