Opinion ID: 1192414
Heading Depth: 1
Heading Rank: 5

Heading: The Earlier Statements

Text: Shareholders have failed to establish a strong inference of scienter with respect to the other statements identified in their Complaint. Each of these statements lacks at least some of the inculpating circumstances surrounding the March discounting statements. The closest case is presented by McGuire's reaffirmation [47] of the earlier financial projections on March 2, the same day as one of his pricing statements. On the one hand, the projection of revenue and margins has a less direct relationship to the crucial alleged discounting than does the pricing statements. But because unusual discounting would be expected to diminish revenues and margins, and because we have already found the Complaint adequately pleads scienter with respect to the pricing statements, one might conclude that the financial-projection allegations must also satisfy the PSLRA's requirements. Unlike the pricing statements, however, the March projections are a classic forward-looking statement under the PSLRA's Safe Harbor provision. See 15 U.S.C. § 78u-5(i)(1)(A) (defining forward-looking statement to include a projection of revenues, income (including income loss), ... or other financial items); see also supra Section III.A. [48] As such, they are not actionable unless Shareholders can prove that the forward-looking statement... was made with actual knowledge ... that the statement was false or misleading. § 78u5(c)(1)(B). Since this provision specifies an actual knowledge standard, the scienter requirement for forward-looking statements is stricter than that for statements of current fact. Whereas liability for the latter requires a showing of either knowing falsity or recklessness, liability for the former attaches only upon proof of knowing falsity. See Miller v. Champion Enters., Inc., 346 F.3d 660, 672 (6th Cir.2003); Greebel v. FTP Software, Inc., 194 F.3d 185, 200-01 (1st Cir.1999); Bryant v. Avado Brands, Inc., 187 F.3d 1271, 1283-84 (11th Cir.1999). This distinction is fatal to Shareholders' allegations regarding the March projections. With the pricing statements, Shareholders' failure to identify the precise means by which McGuire would have learned of the discounting was not determinative. Even if he had not known his denials of unusual discounting were false, the facts alleged gave rise to a strong inference of recklessness. Assuming the truth of those allegations, we concluded the inference that McGuire's denials were knowingly false or reckless was at least as compelling as the possible nonculpable explanations. In the case of the forward-looking statements, however, an inference of recklessness does not avail plaintiffs  that is, it must be placed on the nonculpable-explanation side of the balance when we weigh competing inferences. In light of all the facts alleged, as well as what is not alleged, we find it more likely that the March financial projections were the product of recklessness or other nonculpable ignorance, rather than knowing deception. [49] Shareholders' allegations regarding the January projections fare no better. In Shareholders' view, defendants' assurances that Avaya was on track to meet its financial goals were not forward-looking, as the District Court found, but rather statements of current fact outside of the statutory safe harbor. We have rejected this argument, see supra Section III.A, but even if we agreed, Shareholders have not adequately pleaded scienter. The January forecast is a statement about Avaya's overall financial picture rather than specific pricing levels. Furthermore, it is more distant from the end of the quarter and the release of actual results than were the March statements. Most importantly, the January statement was made on the same day as the release of Avaya's Q1 results, which, as the Complaint itself concedes, were in line with, or better than, analysts' expectations. Compl. ¶ 58. Even if these statements were somehow false (which, as we concluded above, has not been adequately pleaded), the most compelling inference would be that McGuire and Peterson did not yet know this and believed that January had picked up where the first quarter had left off. Shareholders make two arguments in an attempt to avoid this conclusion, but neither is convincing. First, they point to an April statement by McGuire, which they construe as an admission that he was fully aware [of unusual discounting] during the Class Period, even as early as the first quarter. Compl. ¶ 93; Oral Arg. Tr. 6, Mar. 3, 2008. But McGuire's words, as quoted in the Complaint, simply cannot bear this interpretation: Now, I hear that noise that, yes, we were out with a 30% to 40% discount on a program in last quarter.... Compl. ¶ 93. There is no indication that McGuire was informed of the discounting at any particular point in the past. The statement admits only that he was, in April, aware of a discount. Second, Shareholders rely on allegations that Avaya's sales cycle could be quite long. Because of Avaya's 6-18 month cycle for completing sales negotiations with its larger clients, it would have been evident to defendants six months in advance that Avaya was forced into offering huge 30-40% price discounts beginning in October 2004.... Shareholders' Reply Br. 15. The implication is that in order for discounting, or problems with the GTM strategy, to affect Avaya's bottom line in the second quarter, the contracts affected by these issues would have to have been negotiated at least six months in advance, at which point McGuire and Peterson presumably would have known of the problems. This type of allegation might carry some weight if the Complaint provided more specific information about particular contracts, or provided a narrower spectrum of sales-cycle variation. But in light of the fact that the first quarter results met expectations, it is difficult to grant much credit to this allegation. Plaintiffs point to contracts going back as far as October 2003 and tell us only that these contracts had a sales cycle somewhere between six and eighteen months. Plaintiffs then urge us to conclude that somehow these contracts were structured in such a way that the problems lay dormant during the first quarter, not menacing financial results, only to explode and lay waste to revenues and margins during the second quarter. The Complaint's sales-cycle allegations are too vague to support this inference. See Tellabs, 127 S.Ct. at 2511 ([O]missions and ambiguities count against inferring scienter.). Just as the sale-cycle and post-hoc admission allegations cannot give rise to scienter with respect to the January statements, they fail to save the earlier October statements. We have held that Shareholders failed to plead the falsity of the January and October projections adequately. Even if the Complaint were not deficient on that score, it would not sufficiently allege scienter. The satisfactory Q1 results fatally weaken any inference of scienter regarding the statement made in January, the first month of the second quarter, and they a fortiori vitiate any inference of scienter with respect to projection-related statements made at the beginning of the first quarter itself. Nor is the inference of scienter any stronger with respect to the October pricing-pressure statements. Even if we grant these statements were false, as we did above, the Q1 results suggest that any unusual Q1 discounts were not significant  certainly, not significant enough to support the conclusion that Peterson and McGuire were aware of them, or were otherwise reckless, at the time of the October statements. Accordingly, the Complaint does not give rise to a strong inference that these statements were knowingly or recklessly false or misleading.
Shareholders have also attempted to support their scienter pleadings with allegations of defendants' motive and opportunity to commit fraud. In a case decided before Tellabs, we held that plaintiffs may plead scienter by alleging facts establishing a motive and opportunity to commit fraud, or by setting forth facts that constitute circumstantial evidence of either reckless or conscious behavior. Advanta, 180 F.3d at 534-35 (internal quotation marks omitted) (emphasis added). A showing of motive and opportunity, in other words, was an independent means of establishing scienter, one viable even if plaintiffs could not allege facts from which to infer defendants' knowing deceit or recklessness. That had been the law in this circuit before the PSLRA was enacted, and after examining the statutory language and supporting legislative history of the Reform Act, we concluded it did not ... alter the substantive contours of scienter. Id. at 534. This conclusion is no longer tenable in light of Tellabs. [50] Even before the Supreme Court's decision, several of our sister circuits had rebuffed plaintiffs' attempts to establish scienter through proof of motive and opportunity alone. As the Seventh Circuit observed: The Second and Third Circuits take the position that the [PSLRA] adopted the Second Circuit's pre-PSLRA pleading standard for scienter, and thus plaintiffs may continue to state a claim by pleading either motive and opportunity or strong circumstantial evidence of recklessness or conscious misbehavior. The Ninth and Eleventh Circuits disagree, believing that Congress considered, but ultimately rejected the Second Circuit's approach, opting instead for a more onerous burden. The remaining six circuits that have considered this issue take a middle ground, reasoning that Congress chose neither to adopt nor reject particular methods of pleading scienter  such as alleging facts showing motive and opportunity  but instead only required plaintiffs to plead facts that together establish a strong inference of scienter. We find this position persuasive.... The text of the statute states only that the complaint must support a strong inference of scienter. Without more detailed instruction, we conclude that the best approach is for courts to examine all of the allegations in the complaint and then to decide whether collectively they establish such an inference. Motive and opportunity may be useful indicators, but nowhere in the statute does it say that they are either necessary or sufficient. Makor Issues & Rights, Ltd. v. Tellabs, Inc. ( Tellabs I ), 437 F.3d 588, 601 (7th Cir.2006) (internal quotation marks and citations omitted), rev'd on other grounds, 551 U.S. 308, 127 S.Ct. 2499, 168 L.Ed.2d 179 (2007). Although the Supreme Court rejected the Seventh Circuit's interpretation of strong inference, it left its reasoning about motive and opportunity undisturbed. In fact, the Court appeared to endorse this reasoning: While it is true that motive can be a relevant consideration, and personal financial gain may weigh heavily in favor of a scienter inference, we agree with the Seventh Circuit that the absence of a motive allegation is not fatal. As earlier stated, allegations must be considered collectively; the significance that can be ascribed to an allegation of motive, or lack thereof, depends on the entirety of the complaint. Tellabs, 127 S.Ct. at 2511 (internal citations omitted). If the significance of the presence, or absence, of motive allegations can be ascertained only by reference to the complete complaint, then a general rule that motive allegations are sufficient  or necessary  is unsound. We do not rely solely on this one passage of the Court's opinion. Our conclusion that motive and opportunity may no longer serve as an independent route to scienter follows also from Tellabs 's general instruction to weigh culpable and nonculpable inferences. Individuals not infrequently have both strong motive and ample opportunity to commit bad acts  and yet they often forbear, whether from fear of sanction, the dictates of conscience, or some other influence. It cannot be said that, in every conceivable situation in which an individual makes a false or misleading statement and has a strong motive and opportunity to do so, the nonculpable explanations will necessarily not be more compelling than the culpable ones. And if that is true, then allegations of motive and opportunity are not entitled to a special, independent status. Instead, as the Seventh Circuit has said, they are to be considered along with all the other allegations in the complaint. [51] Here, Shareholders' allegations of motive and opportunity do not relate to particular statements but rather purport to bolster a general inference of fraudulent conduct. Shareholders allege that defendants were further motivated to inflate Avaya's stock in order to (1) complete a $549 million repurchase of Liquid Yield Option Notes (LYONs) through common stock in November 2004, and (2) secure a $400 million unsecured revolving credit facility on favorable terms in February 2005. Furthermore, Shareholders allege that McGuire and Peterson were motivated to make the alleged false or misleading statements because they sold Avaya common stock through March 1, 2005, for personal gain. Shareholders contend that their motive allegations are consistent with scienter, even if, standing alone, they do[ ] not establish a strong inference. Shareholders' Br. 40. In other words, the stock sales, the LYONs redemption, and the receipt of a $400 million credit facility are alleged to bolster scienter by providing a coherent reason for fraud. Id. at 43. We agree that these allegations provide a plausible motive for fraud, but the bottom-line question is not whether defendants were likely to have a motive to commit fraud, but whether they were at least as likely as not to have acted on that motive and actually committed fraud. For the reasons that follow, we find the allegations of motive presented here do not strengthen the inference of scienter. On November 18, 2004, Avaya announced it would redeem all of its LYONS due 2021. Pursuant to the terms of these notes, holders had the choice of redeeming the notes with a face value of $1,000 at maturity for a present payment in cash of $545.67, or alternatively the LYONs were convertible into 37.4437 shares of Avaya common stock per $1,000 principal at maturity. [52] LYONs holders were given until December 20, 2004, to choose which method of redemption, cash or stock, they preferred. Prior to December 20, 2004, holders of LYONs with an aggregate principal amount at maturity of $549 million converted their outstanding LYONs into 20,546,199 shares of Avaya common stock. On December 20, 2004, LYONs with an aggregate principal amount at maturity of $61,000, which represented all remaining outstanding LYONs, were redeemed for cash at an aggregate redemption price of $33,000. Shareholders allege defendants were strongly motivated ... to artificially inflate (and maintain) the price of Avaya's common stock to avoid paying cash for the LYONs. On February 24, 2005, Avaya announced it had completed a $400 million five-year unsecured revolving credit facility. The new unsecured credit facility replaced Avaya's existing $250 million secured credit facility, scheduled to expire in September 2005. Shareholders allege defendants were motivated to inflate and maintain the price of Avaya's common stock in order to obtain the increased financing on more favorable terms. According to our pre- Tellabs jurisprudence, [m]otive must be supported by facts stated with particularity, and must give rise to a strong inference of scienter. GSC Partners CDO Fund v. Washington, 368 F.3d 228, 237 (3d Cir.2004) (internal quotation marks omitted). [53] That proposition is no less true after Tellabs, although we no longer make an independent search for scienter on the basis of motive and opportunity allegations alone. [M]otives that are generally possessed by most corporate directors and officers do not suffice; instead, plaintiffs must assert a concrete and personal benefit to the individual defendants resulting from this fraud. Id. (quoting Kalnit v. Eichler, 264 F.3d 131, 139 (2d Cir.2001)); see id. (In every corporate transaction, the corporation and its officers have a desire to complete the transaction, and officers will usually reap financial benefits from a successful transaction. Such allegations alone cannot give rise to a `strong inference' of fraudulent intent.); cf. Tellabs, 127 S.Ct. at 2511 ( [P]ersonal financial gain may weigh heavily in favor of a scienter inference. (emphasis added)). Here, we do not look at motive allegations alone, but the same reasoning undermines any inference of scienter resting upon general motives to aid the company. Corporate officers always have an incentive to improve the lot of their companies, but this is not, absent unusual circumstances, a motive to commit fraud. Certainly, the LYONs redemption and the acquisition of the credit facility fail to contribute meaningfully to a strong inference of scienter here. Both actions reflect merely a general corporate desire to retire debt and raise funds and obtain credit on favorable terms. [54] Cf. Cozzarelli v. Inspire Pharmaceuticals Inc., 549 F.3d 618, 627 (4th Cir.2008) ([T]he motivations to raise capital or increase one's own compensation are common to every company and thus add little to an inference of fraud.). We now turn to the allegations about defendants' stock sales. [W]e will not infer fraudulent intent from the mere fact that some officers sold stock. Advanta, 180 F.3d at 540 (quoting Burlington, 114 F.3d at 1424). But if the stock sales were unusual in scope or timing, they may support an inference of scienter. Id.; see also In re Alpharma Inc. Sec. Litig., 372 F.3d 137, 152 (3d Cir.2004) (reviewing complaint for allegations that stock sales were unusual in scope ( e.g., compared to their total level of compensation or the size of previous sales) or timing ( e.g., compared to the timing of past trades)). As of October 1, 2004, Peterson owned 5,784,834 shares of common stock [55] and McGuire owned 1,418,454 shares of common stock. [56] Avaya Inc., Proxy Statement (Schedule 14A), at 15-16 (Jan. 4, 2005). During the proposed class period, Peterson sold 100,000 shares for proceeds of $1,416,500 and McGuire sold 251,760 shares for proceeds of $3,772,094. As a percentage of total shares owned, Peterson sold 1.7% and McGuire sold 17.7%. All 100,000 shares sold by Peterson during the class period were sold pursuant to the terms of a Rule 10b5-1 plan. During the same period of the previous year, Peterson sold 200,000 shares. Similarly, 140,000 shares sold by McGuire were sold pursuant to the terms of a Rule 10b5-1 plan and the other 111,760 [57] were sold by the LLC controlled by McGuire's spouse. During the same period of the previous year, McGuire sold 236,083 shares. Shareholders' allegations concerning defendants' stock transactions do not significantly enhance the inference of scienter. Defendants' trading practices remained consistent year-over-year and each retained a large percentage of his common stock holdings in Avaya. Accordingly, the sales do not marginally increase the likelihood that defendants made knowingly false or misleading statements out of a desire for personal financial gain.
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 Shareholders' allegations collectively rather than individually. As we have taken up each allegation in turn, we have added it to the picture painted by the previously considered allegations and asked: How does this addition affect the relative strengths of the culpable and non-culpable inferences? Having considered all of the allegations of scienter, we reach the following conclusions. With respect to the March pricing statements, the Complaint successfully state[s] with particularity facts giving rise to a strong inference that the defendants acted consciously or recklessly in making false statements. 15 U.S.C. § 78u-4(b)(2). The Complaint fails to allege scienter adequately, however, with respect to defendants' other statements.
Correctly noting that, where there is no liability for the underlying company [under Section 10(b)], there can be no `controlling person' liability under Section 20(a), the District Court dismissed the claims brought under the latter provision. Charatz, 2006 WL 2806229, at . This conclusion followed ineluctably from the court's finding that Shareholders had not adequately pleaded any violations of Section 10(b). But because, unlike the District Court, we hold that plaintiffs have sufficiently pleaded a Section 10(b) claim with respect to McGuire's March pricing statements, we will vacate the dismissal of the Section 20(a) claims insofar as those statements are concerned. [58] See Suprema, 438 F.3d at 284-86. We will affirm the District Court's dismissal of Shareholders' Section 20(a) claims with respect to the remaining statements.