Opinion ID: 1192414
Heading Depth: 1
Heading Rank: 4

Heading: The March Pricing-Pressure Statements

Text: It is true that Shareholders do not point to any particular document or conversation that would have informed Peterson or McGuire of unusual discounting during the class period. The existence of such a direct link would fortify Shareholders' allegations that defendants' statements about discounting were knowingly or recklessly false. But the Supreme Court has made clear that plaintiffs' allegations of scienter need not be irrefutable, i.e., of the `smoking-gun' genre. Tellabs, 127 S.Ct. at 2510. Instead, our inquiry is whether all of the facts alleged, taken collectively, give rise to a strong inference of scienter. Id. at 2509. Accordingly, as with all totality-of-the-circumstances tests, our analysis will be case specific. It will ultimately rest not on the presence or absence of certain types of allegations but on a practical judgment about whether, accepting the whole factual picture painted by the Complaint, it is at least as likely as not that defendants acted with scienter. See South Ferry LP, # 2 v. Killinger, 542 F.3d 776, 784 (9th Cir.2008) ( Tellabs counsels us to consider the totality of circumstances, rather than to develop separately rules of thumb for each type of scienter allegation.); see also In re Cabletron Sys., Inc., 311 F.3d 11, 32 (1st Cir.2002) (Each securities fraud complaint must be analyzed on its own facts; there is no one-size-fits-all template.). We believe the totality of the facts alleged by Shareholders here establishes a strong inference of scienter with respect to McGuire's March denials of unusual pricing pressure. Contrary to defendants' arguments, Shareholders do not simply allege fraud by hindsight, that is, they do not claim merely that McGuire's statements turned out to be wrong, and therefore must have been fraudulent. Rather, Shareholders' allegations proffer an array of circumstantial evidence giving rise to a strong inference that McGuire's discounting statements were at least reckless, which is enough to survive a motion to dismiss under the PSLRA. Among the facts alleged by Shareholders, the most powerful evidence of scienter is the content and context of McGuire's statements themselves. McGuire did not simply make statements inconsistent with the existence of widespread and unusual discounting; he explicitly denied the existence of such discounting in response to repeated questions about pricing by analysts. During a conference call with analysts on March 2, McGuire was asked for his sense of what the environment is out there right now. McGuire responded that the [p]ricing environment is not significantly different. I mean, there are people that will buy a deal from time to time, but in general, the pricing environment has been fairly stable. During another conference call with analysts on March 7, McGuire was asked whether there had been [a]ny significant changes one way or the other in the pricing environment. McGuire answered, Perhaps not in the last 12 months. I mean, clearly from time to time people will want to buy a deal here or there, but the market itself has been fairly stable with just modest declines over the last 12 months. And during a third conference call for analysts just three days later, on March 10, McGuire was queried yet again on pricing: Now that you say [Cisco] put ... a decent team in place after losing market share last year, what should we expect in terms of the competitive position that is here in the market? What should we expect in terms of pricing? McGuire's answer was consistent with his earlier responses: Pricing has been fairly steady for the last couple of years. I don't anticipate  I don't see any reason that that would change significantly. It is one thing for a plaintiff to claim that a defendant must have known its earnings projections were false because of the existence of unusual price reductions. Earnings are the bottom-line result of many different components, only one of which is pricing. The mere fact that a defendant made a statement about earnings, therefore, does not necessarily imply he would have been aware of particular pricing developments. But it is another thing when a defendant chief financial officer is specifically asked, directly and repeatedly, whether the company's pricing has held steady despite the competitiveness of the market. Although McGuire acknowledged that Avaya inhabited a competitive industry and offered discounts to some customers on some products and services, Shareholders' central allegation is that Avaya engaged in massive discounting on an unusually large scale during the class period, and this McGuire flatly denied in statements evincing certitude. We do not suggest that the specific nature of the analysts' inquiries, by itself, creates a strong inference of a culpable state of mind. But the focused questions do mark an important distinction between this case and those in which defendants win dismissal on a showing that defendants were most likely simply ignorant of the facts that made their statements false. See, e.g., Metzler Inv. GMBH v. Corinthian Colls., Inc., 540 F.3d 1049, 1068 (9th Cir.2008) ([C]orporate management's general awareness of the day-to-day workings of the company's business does not establish scienter  at least absent some additional allegation of specific information conveyed to management and related to the fraud.); ACA Fin. Guar. Corp. v. Advest, Inc., 512 F.3d 46, 62-63 (1st Cir. 2008) (The plaintiffs have not included details about ... whether this information [allegedly belying defendants' statements] was known to the defendants at the relevant time.). Because of the context (specific analyst queries) and content (consistent denials of unusual discounting) of McGuire's statements, the possibility that McGuire was ignorant is not necessarily exculpatory. Even if McGuire were not aware of the full extent of the unusual discounting, or the entirety of the other circumstances alleged by Shareholders, he might be culpable as long as what he knew made obvious the risk that his confident, unhedged denials of unusual discounting would mislead investors. [43] See Advanta, 180 F.3d at 535 (explaining that allowing recklessness to serve as a sufficient basis for liability promotes the policy objective[ ] of discouraging deliberate ignorance); Tellabs II, 513 F.3d at 704 (When the facts known to a person place him on notice of a risk, he cannot ignore the facts and plead ignorance of the risk.). Given the specificity and repetition of the analysts' questions, McGuire's position as Chief Financial Officer, and the alleged state of Avaya's business at the time the questions were asked, there is a strong inference that McGuire's behavior reached this threshold of recklessness. If the alleged discounting were minor or restricted to only a few products or customers, we would be reluctant to infer that McGuire's denials were culpable. In those circumstances, nonculpable ignorance might be the more likely explanation. But as we have discussed, Shareholders' CWs allege widespread discounting involving many different product lines and accounts, including some of Avaya's largest clients. Allegations that the discounting was of a substantial magnitude are supported by analyst reports and by Avaya's disappointing Q2 results. Avaya's Q2 operating margins were particularly weak  4.3%, about 50% lower than the 8.5% to 9% margins predicted for the year, and 44% lower than the first quarter's operating margin of 7.7%. [44] That Avaya's second quarter margins were significantly contracting itself lends support to the inference of scienter. Throughout the class period, one of investors' and analysts' central questions about Avaya was whether it could sustain and expand its margins in the face of a very competitive market. In fact, Avaya's operating margin was viewed as so important to the health of the company (and its attractiveness to investors) that its supposed ability to hold and grow this margin was described as the Avaya story. The perceived importance of margins supports an inference that McGuire, Avaya's Chief Financial Officer, was paying close attention to these numbers. Cf. Dorsey v. Portfolio Equities, Inc., 540 F.3d 333, 342 (5th Cir. 2008) ([T]here can be a number of special circumstances which, taken together with an officer's position, may support a strong inference of scienter. (internal quotation marks omitted)); In re Stone & Webster, Inc., Sec. Litig., 414 F.3d 187, 211 (1st Cir.2005) (The financial strength of the Company was undoubtedly a matter of principal concern to its Chief Executive Officer and Chief Financial Officer.). And because, all else being equal, a change in pricing would directly affect margins, an executive inquiring into a change in margins would be expected to look to pricing for a possible explanation. Accordingly, the steep decline in Avaya's all-important margins in the second quarter of 2005 bolsters the inference that McGuire would have been alerted to the discounting. Just as the magnitude of the alleged discounting and margin contraction strengthens the inference of scienter, so does the temporal proximity of McGuire's March denials to the end of the quarter. The second quarter ended on March 31, and Avaya reported its quarterly results on April 19. CW4 reported that Avaya had been offering discounts to an unusually large number of its customers since January. Taken in their entirety, the allegations suggest that Avaya's Chief Financial Officer was, by early March, aware of Avaya's sharply contracting margins, which were crucial to its story. And as we have said, upon realizing that Avaya's margins were drastically shrinking, it is at least as likely as not that McGuire would have discovered the massive discounting, if he had not already done so. Defendants suggest McGuire would not have been aware of the horrid (as one analyst called them) impending Q2 results in early March because the shortfall was, according to defendants, mostly the product of an unexpected decision by distributors not to reload at the very end of March. Although defendants will, of course, have an opportunity to adduce evidence in support of this explanation at a later stage of the litigation, in light of the alleged facts we may consider (and must assume true) at this stage, we find it more likely that unusual discounting explains the disappointing results. The plausibility of an explanation depends on the plausibility of the alternative explanations. As more and more alternatives to a given explanation are ruled out, the probability of that explanation's being the correct one rises. Tellabs II, 513 F.3d at 711 (internal citations omitted). Here, the centrality of operating margins to the Avaya story, the magnitude and pervasiveness of the alleged discounting, and the proximity of the March statements to the end of the quarter and the release of Avaya's disappointing results, all diminish the plausibility of innocent explanations for McGuire's flat denials of unusual pricing  for example, that developments subsequent to the statements account for the mediocre results, or that the discounting would not have been apparent to McGuire at the time analysts asked about it. As the plausibility of these benign explanations shrinks, the cogency of the culpable explanation  that McGuire either knew his denials of discounting were false or recklessly disregarded the obvious risk of their falsity  correspondingly grows. Having considered the totality of the particularized facts alleged by Shareholders, we find that the culpable explanation of McGuire's March discounting statements is at least as compelling as the nonculpable alternatives. Taken together, the extent of the alleged discounting, the importance to the Avaya story of maintaining margins, the amount by which the second quarter results missed expectations, the proximity of McGuire's statements to the end of the quarter and the release of results, McGuire's position as Chief Financial Officer, and most significantly, the content and context of the statements themselves, give rise to a strong inference that McGuire either knew at the time that his statements were false or was reckless in disregarding the obvious risk of misleading the public. Accordingly, under Tellabs, Shareholders' claims relating to the March discounting statements survive defendants' motion to dismiss. [45] Defendants' primary strategy in resisting this conclusion is to focus on particular types of allegations and argue for the insufficiency of each. For example, in responding to Shareholders' argument that the temporal proximity of the Q2 2005 results to the March statements bolsters the inference of scienter, defendants contend [c]ourts reject inferences premised on such proximity rationales. Defendants' Br. 42 (citing Arazie v. Mullane, 2 F.3d 1456, 1467-68 (7th Cir.1993)); see also id. at 42 n. 16 (citing Ronconi v. Larkin, 253 F.3d 423, 437 (9th Cir.2001), for the proposition that temporal proximity alone is never enough to show scienter (emphasis added)). Whatever the merits of this approach before Tellabs, it is in tension with the prescriptions issued in that case. We are to judge whether all of the facts alleged, taken collectively, give rise to a strong inference of scienter, not whether any individual allegation, scrutinized in isolation, meets that standard. Tellabs, 127 S.Ct. at 2509. Given this instruction, we are hesitant to formulate categorical rules about the sufficiency of different types of allegations in the abstract. Each case will present a different configuration of factual allegations, and it is the composite picture, not the isolated components, that judges must evaluate in the last instance. In assessing the allegations holistically as required by Tellabs, the federal courts certainly need not close their eyes to circumstances that are probative of scienter viewed with a practical and common-sense perspective. South Ferry, 542 F.3d at 784. [46] For this reason, we are unconvinced by defendants' attempt to downplay Shareholders' argumentative focus on the totality of the circumstances alleged. Defendants' Br. 45. The sum of several zeros, defendants state, is still zero. Id. But inference is not arithmetic. The inferential significance of any single allegation can be determined only by reference to all other allegations.