[See 8/4/99 Amended Opinion]
FOR PUBLICATION
UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT
In re SILICON GRAPHICS INC.
SECURITIES LITIGATION.
EDMUND J. JANAS,
Plaintiff-Appellant,
No. 97-16204
v.
D.C. No.
EDWARD R. McCRACKEN; MICHAEL
CV-96-0393-FMS
RAMSAY; ROBERT K. BURGESS;
THOMAS J. OSWALD; TERUYASU
SEKIMOTO; FOREST BASKETT;
STEPHEN GOGGIANO; WILLIAM M.
KELLY; LUCILLE SHAPIRO; SILICON
GRAPHICS, INC.,
Defendants-Appellees.
9695
DEANNA BRODY; ANDREA S.
DONALD; ISRAEL BUCK; RUTH BUCK;
DENISE STRUTHERS; THOMAS G. DI
CICCO IRA; STEVEN B. EWALL;
ROSALYN GOLAINE; JERRY KRIM;
MARY ANNE BEKE; HERMAN
97-16240
GROSSMAN; SAMUEL J. REINER;
D.C. No.
DENNIS LUCAS,
CV-96-0393-FMS
Plaintiffs-Appellants,
AMENDED
v.
CONCURRING
EDWARD R. McCRACKEN; MICHAEL
AND DISSENTING
RAMSAY; ROBERT K. BURGESS;
OPINION
THOMAS J. OSWALD; TERUYASU
SEKIMOTO; FOREST BASKETT;
STEPHEN GOGGIANO; WILLIAM M.
KELLY; LUCILLE SHAPIRO; SILICON
GRAPHICS, INC.,
Defendants-Appellees.
Amended Concurring and Dissenting Opinion
Filed August 25, 1999
Before: James R. Browning and Joseph T. Sneed,
Circuit Judges, and John S. Rhoades,1 District Judge.
_________________________________________________________________
1 The Honorable John S. Rhoades, United States District Judge for the
Southern District of California, sitting by designation.
9696
BROWNING, Circuit Judge, concurring in part and dissent-
ing in part:
I respectfully dissent from the majority's holding that (1)
the Private Securities Litigation Reform Act (the "Reform
Act") eliminated recklessness and motive and opportunity to
commit fraud as bases for establishing scienter under S 10(b)
and Rule 10b-5, and (2) the allegations of scienter in Brody's
complaint were insufficient to survive a motion to dismiss.2
Congress plainly intended the Reform Act to raise the plead-
ing standard by requiring plaintiffs to allege facts raising a
"strong inference" of scienter, rather than permitting plaintiffs
(as this circuit did) to plead scienter "simply by saying that
scienter existed," In re Glenfed, Inc. Sec. Litig., 42 F.3d 1541,
1547 (9th Cir. 1994) (en banc), but did not intend to restrict
the evidentiary bases from which the inference of scienter
might be drawn. By holding to the contrary, the majority
raises the pleading bar higher than that envisioned by Con-
gress, and places the Ninth Circuit at odds with both the Sec-
ond and Third Circuits.
I.
The Reform Act
The Reform Act requires plaintiffs to "state with particular-
ity facts giving rise to a strong inference" of scienter. 15
U.S.C. S 78u-4(b)(2). Although the majority concedes that
"[t]he plain text of the [Reform Act] leaves it open for us to
consider circumstantial evidence of recklessness and motive
and opportunity as evidence of [scienter], " ante, at 8884, it
concludes that the legislative history of the Act establishes
that allegations either of recklessness (a term the majority
refers to as "mere recklessness" or "simple recklessness,"
_________________________________________________________________
2 I concur in two parts of the majority opinion: section IV(A)(4) (affirm-
ing summary judgment in favor of Baskett, Burgess, Ramsay, and Seki-
moto) and section IV(B) (affirming the dismissal of Janas' complaint).
9697
ante at 8877) or of motive and opportunity to commit fraud
are no longer sufficient to avoid dismissal, see ante, at 8888-
89.
Some courts addressing the issue have also reached a simi-
lar conclusion.3 Other courts have held allegations of motive
and opportunity to defraud are not sufficient to support the
required inference of scienter, but have stopped short of elimi-
nating allegations of recklessness as a basis for such an
inference.4 A third line of cases, led by the Second Circuit in
which the "strong inference" standard originated, have held
that allegations of recklessness or motive and opportunity are
sufficient to satisfy the "strong inference" standard. See In re
Advanta Corp. Sec. Litig., _______ F.3d _______, No. 98-1846, 1999
WL 395997, at *8 (3d Cir. June 17, 1999); Press v. Chemical
Inv. Servs. Corp., 166 F.3d 529, 537-38 (2d Cir. 1999).5
The latter approach begins and ends with the plain text of
the statute. The statute nowhere mentions proof of motive and
opportunity to commit fraud or any other specific means of
establishing scienter, but simply requires that plaintiffs "state
with particularity facts giving rise to a strong inference that
the defendant acted with the required state of mind. " 15
U.S.C. S 78u-4(b)(2). There is no support in the text for con-
cluding that proof of recklessness6 or motive and opportunity
_________________________________________________________________
3 See, e.g., Norwood Venture Corp. v. Converse Inc., 959 F. Supp. 205,
208 (S.D.N.Y. 1997); Friedberg v. Discreet Logic Inc., 959 F. Supp. 42,
49-50 (D. Mass. 1997).
4 See, e.g., In re: Comshare, Inc. Sec. Litig., _______ F.3d _______, No. 97-2098,
1999 WL 460917, at *5 (6th Cir. July 8, 1999); Malin v. IVAX Corp., 17
F. Supp. 2d 1345, 1356-57 (S.D. Fla. 1998).
5 See also, e.g., In re Health Management, Inc. Sec. Litig., 970 F.Supp.
192, 201 (E.D.N.Y 1997); Fugman v. Aprogenex, Inc., 961 F. Supp. 1190,
1195 (N.D. Ill. 1997).
6 "Recklessness" involves "a highly unreasonable omission, involving
not merely simple, or even inexcusable negligence, but an extreme depar-
ture from the standards of ordinary care, and which presents a danger of
misleading buyers or sellers that is either known to the defendant or is so
obvious that the actor must have been aware of it." Hollinger v. Titan
Capital Corp., 914 F.2d 1564, 1569 (9th Cir. 1990) (quoting Sundstrand
Corp. v. Sun Chem. Corp., 553 F.2d 1033, 1045 (7th Cir. 1977)).
9698
to commit fraud7 are not sufficient to meet the "strong
inference" standard.
The majority concedes as much, but nonetheless resorts to
legislative history because the language of the statute "does
not indicate whether [allegations of recklessness or motive
and opportunity] alone are enough to establish a`strong infer-
ence' of [scienter]." Ante, at 8884. In effect, the majority
holds that the breadth and flexibility of the Reform Act's
unambiguous pleading standard are sufficient to justify depar-
ture from the statute's plain text. Respectfully, that thesis is
not supportable. As the Court stated in Barnhill v. Johnson,
503 U.S. 393, 401 (1992), "[A]ppeals to statutory history are
well taken only to resolve `statutory ambiguity.' " See also
Pennsylvania Dept. of Corrections v. Yeskey, 118 S. Ct. 1952,
1956 (1998) ("[T]he fact that a statute can be applied in situa-
tions not expressly anticipated by Congress does not demon-
strate ambiguity. It demonstrates breadth." (internal
quotations omitted)).8
Even if it were appropriate to reach beyond the plain text,
the Reform Act's legislative history does not support the
majority's interpretation. Although Congress clearly intended
to adopt the Second Circuit's "strong inference " standard, the
legislative history taken as a whole does not suggest that Con-
_________________________________________________________________
7 The Second Circuit defines "motive and opportunity" as follows:
"Motive would entail concrete benefits that could be realized by one or
more of the false statements and wrongful nondisclosures alleged. Oppor-
tunity would entail the means and likely prospect of achieving concrete
benefits by the means alleged." Shields v. Citytrust Bancorp, Inc., 25 F.3d
1124, 1130 (2d Cir. 1994).
8 See also In re Catapult Enter., Inc., 165 F.3d 747, 753 (9th Cir. 1999)
("[B]ecause we discern no ambiguity in the plain statutory language, we
need not resort to legislative history."); United States v. Phelps, 895 F.2d
1281, 1283 (9th Cir. 1990) (Kozinski, J., dissenting from order denying
petition for rehearing en banc) ("In deciding whether it is appropriate to
go beyond statutory language, the touchstone is not breadth but
ambiguity[.]").
9699
gress intended to reject the Second Circuit's holdings that
allegations of recklessness or of motive and opportunity to
defraud could satisfy that standard.
The majority contends that the Conference Committee
"implicitly rejected" motive, opportunity, and recklessness as
bases for a "strong inference" of fraud by eliminating lan-
guage incorporated in the bill in the Senate by the Specter
Amendment, which purported to codify all aspects of the Sec-
ond Circuit's case law applying the "strong inference" stan-
dard. Ante, at 8886. The legislative history suggests, however,
that the Committee rejected language added by the Specter
Amendment because it was "an incomplete and inaccurate
codification" of Second Circuit case law,9 not because the
Committee intended to restrict the ways in which a "strong
inference" of scienter might be shown. Indeed, supporters of
the defeated Specter Amendment were assured that while the
Reform Act did not expressly provide that plaintiffs could
plead scienter based on recklessness or motive and opportu-
nity to defraud, "the guidance [provided by Second Circuit
case law] is still going to be there." 141 Cong. Rec. S19071
(daily ed. Dec. 21, 1995) (statement of Sen. Dodd). 10
_________________________________________________________________
9 141 Cong. Rec. S19067 (daily ed. Dec. 21, 1995) (Sen. Dodd quoting
from memorandum of Prof. Grundfest); see also 141 Cong. Rec. S17960
(daily ed. Dec. 5, 1995) (statement of Sen. Dodd) ("The Senator's amend-
ment adopted the guidance of the [S]econd[C]ircuit, but the amendment
. . . completely omits a critical qualification in the case law. The courts
have held that `where motive is not apparent, a plaintiff may plead scienter
by identifying circumstances' indicating wrongful behavior, but `the
strength of the circumstantial allegations must be correspondingly greater'
from the number of cases."); 141 Cong. Rec. S19068 (daily ed. Dec. 21,
1995) (statement of Sen. Dodd) ("The Specter amendment . . . did not
really follow the guidance of the [S]econd[C]ircuit. So that is the reason
that amendment was taken out . . . . But the suggestion that the standard
and--the guidance, rather, was included in the Specter amendment, omits
--omits that where a motive is not apparent, the strength of circumstantial
allegations must be correspondingly greater. That was omitted.").
10 Accord 141 Cong. Rec. S19068 (daily ed. Dec. 21, 1995) (statement
of Sen. Dodd) ("We have left out the guidance. That does not mean you
9700
Moreover, the Specter Amendment's codification of a spe-
cific test for pleading scienter would have been inconsistent
with the provisions of the Reform Act requiring a different
state of mind for different statements. Under the Reform Act's
"safe harbor" provisions, plaintiffs must prove that "forward-
looking" statements were made with "actual knowledge" that
they were false or misleading. 15 U.S.C. SS 78u-5(c)(1)(B),
77z-2(c)(1)(B). A recklessness standard for pleading that
would apply to all statements, such as that proposed in the
Specter Amendment, would have been inconsistent with the
safe harbor's requirement of "actual knowledge " for forward-
looking statements.
The majority relies on a statement in the Conference Report
that "[b]ecause the Conference Committee intends to
strengthen existing pleading requirements, it does not intend
to codify the Second Circuit's case law interpreting this
pleading standard . . . . For this reason, the Conference Report
chose not to include in the pleading standard certain language
relating to motive, opportunity, or recklessness. " H.R. Conf.
Rep. 104-369, at 41 & n.23 (1995), reprinted in 1995
U.S.C.C.A.N. 730, 740, 747 n.23. The majority infers from
this comment that Congress intended to impose a "more
stringent" standard than that of the Second Circuit by reject-
ing the sufficiency of allegations of motive and opportunity
and circumstantial evidence of recklessness to establish a
"strong inference" of scienter. Ante, at 8886. The more plausi-
ble and direct explanation is that Congress chose not to
include language relating to these specific modes of proving
the required intent to defraud because it was concerned only
with adopting the Second Circuit's pleading standard, not
_________________________________________________________________
disregard it."); see also H.R. Conf. Rep. 104-369, at 41 (1995), reprinted
in 1995 U.S.C.C.A.N. 730, 740 ("The Conference Committee language is
based in part on the pleading standard of the Second Circuit."); S. Rep.
104-98, at 15 (1995), reprinted in 1995 U.S.C.C.A.N. 679, 694 ("The
Committee does not intend to codify the Second Circuit's caselaw inter-
preting this pleading standard, although courts may find this body of law
instructive.").
9701
with adopting (or rejecting) particular factual patterns that
might satisfy that standard. That task was left to the courts.
See Advanta, 1999 WL 395997, at *16 n.8 ("[I]f Congress
had desired to eliminate motive and opportunity or reckless-
ness as a basis for scienter, it could have done so expressly
in the text of the Reform Act. In our view, the fact that Con-
gress considered inserting language directly addressing this
line of cases, but ultimately chose not to, suggests that it
intended to leave the matter to judicial interpretation.").11
Congress also declined to include in the Reform Act lan-
guage relating to a variation of the second method of meeting
the Second Circuit's standard (by alleging and proving
"circumstantial evidence of conscious misbehavior"12), but the
majority does not suggest that because of this omission con-
scious misbehavior no longer provides an appropriate basis
for inferring scienter. Indeed, the majority's own "deliberate
or conscious recklessness" test focuses on conscious misbe-
havior. See ante, at 8888-89.
The majority relies heavily upon the fact that in announcing
his reasons for vetoing the Reform Act, the President
expressed his concern that the legislation would elevate the
pleading standard above that previously adopted in the Sec-
_________________________________________________________________
11 See also, e.g., 141 Cong. Rec. S17960 (daily ed. Dec. 5, 1995) (state-
ment of Sen. Dodd) ("[I]nstead of trying to take each case that came under
the [S]econd [C]ircuit, we are trying to get to the point where we would
have well-pleaded complaints. We are using the standards in the [S]econd
[C]ircuit in that regard, then letting the courts--as these matters will--test.
They can then refer to specific cases, the [S]econd [C]ircuit, otherwise, to
determine if these standards are based on facts and circumstances in a par-
ticular case.").
12 Press, 166 F.3d at 538 ("As a pleading requirement, a plaintiff must
either (a) allege facts to show that `defendants had both motive and oppor-
tunity to commit fraud' or (b) allege facts that`constitute strong circum-
stantial evidence of conscious misbehavior or recklessness.' " (emphasis
added) (quoting Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1128 (2d
Cir. 1994))).
9702
ond Circuit. The majority argues that by overriding the Presi-
dent's veto, "Congress provided powerful evidence of its
intent to elevate the pleading standard to a level beyond that
in the Second Circuit." Ante, at 8888. This argument rests on
the assumption that Congress, in overriding the President's
veto, agreed with the President that the Reform Act, as passed
by Congress, adopted a pleading standard more demanding
than the Second Circuit's standard. During Senate debate on
overriding the President's veto, however, the sponsors of the
bill explicitly disagreed with the President's interpretation and
reaffirmed their own view that, contrary to the President's
belief, the Reform Act's pleading standard was "faithful to the
Second Circuit's test." 141 Cong. Rec. S19067 (daily ed. Dec.
21, 1995) (Sen. Dodd quoting from memorandum of Prof.
Grundfest).13
Other provisions of the Reform Act undermine the majori-
ty's holding, particularly the majority's across-the-board
elimination of "mere" recklessness as a basis of liability.
Before the Reform Act was adopted, every court of appeal
addressing the issue, including this one, had concluded that
recklessness14 satisfied section 10(b)'s scienter requirement.
_________________________________________________________________
13 Accord 141 Cong. Rec. S19150 (daily ed. Dec. 22, 1995) (statement
of Sen. Domenici) ("The President objected to the pleading standard. Yet
it is the Second Circuit's pleading standard."); 141 Cong. Rec. S19,068
(daily ed. Dec. 21, 1995) (statement of Sen. Dodd) (the Reform Act "met
the [S]econd [C]ircuit standard"); see also 141 Cong. Rec. H15219 (daily
ed. Dec. 20, 1995) (statement of Rep. Lofgren) ("The President says he
supports the [S]econd [C]ircuit standard for pleading. So do I. That is what
is included in this bill."); 141 Cong. Rec. H15218 (daily ed. Dec. 20,
1995) (statement of Rep. Moran) ("We know we are going to have the
Second Circuit standard applied, and that in fact when legislation is at
variance with legislative history or report language, that it is the bill itself
that prevails.").
14 In Hollinger, this court adopted the Seventh Circuit's widely-accepted
definition of recklessness: " `[R]eckless conduct may be defined as a
highly unreasonable omission, involving not merely simple, or even inex-
cusable negligence, but an extreme departure from the standards of ordi-
9703
See Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1568-69
& n.6 (9th Cir. 1990).15 When Congress intended to proscribe
liability for recklessness in the Reform Act, it did so explic-
itly. As noted, the standard of liability for "forward-looking"
fraudulent statements in the Reform Act's "safe harbor" pro-
visions requires plaintiffs to allege that such statements were
made with "actual knowledge" of falsity. See 15 U.S.C.
SS 78u-5(c)(1)(B), 77z-2(c)(1)(B). Similarly, the provisions
governing proportionate liability provide that joint and several
liability is to be imposed only if the plaintiff has shown that
the defendant "knowingly committed a violation of the securi-
ties laws," 15 U.S.C. S 78u-4(g)(2)(A), a term which Con-
gress expressly defined to exclude "reckless conduct," 15
U.S.C. S 78u-4(g)(10)(B). These provisions suggest that if
Congress had intended to proscribe liability for recklessness
in other circumstances it would have done so directly.16
_________________________________________________________________
nary care, and which presents a danger of misleading buyers or sellers that
is either known to the defendant or is so obvious that the actor must have
been aware of it.' " Hollinger, 914 F.2d at 1569 (quoting Sundstrand
Corp. v. Sun Chem. Corp., 553 F.2d 1033, 1045 (7th Cir. 1977)). By
adopting a definition of recklessness accepted by a majority of circuits, the
en banc court intended "to bring greater uniformity to the law of the vari-
ous circuits." Id. at 1569 n.7. The majority departs from Hollinger's hold-
ing by displacing our pre-Reform Act definition of recklessness (a term
the majority refers to as "simple recklessness " or "mere recklessness,"
ante at 8877) with a new and untested "deliberate recklessness" standard.
Ante at 8884. This holding undermines Hollinger's attempt to establish a
uniform definition of recklessness, and places the Ninth Circuit squarely
at odds with the Third and Sixth Circuits, both of which have held that the
Reform Act did not eliminate liability for recklessness and did not alter the
definition of that term. See Comshare, 1999 WL 460917, at *6 & *10 n.8;
Advanta, 1999 WL 395997, at *8; see also Press, 166 F.3d at 538.
15 See also Nelson v. Serwold, 576 F.2d 1332, 1337 (9th Cir. 1978) (per
curiam) ("Although the Supreme Court left undecided the question
whether recklessness is sufficient to support liability under Rule 10b-5,
distinguished jurists have long considered it so.").
16 See Advanta, 1999 WL 395997, at *16 n.8 ("[I]f Congress had desired
to eliminate motive and opportunity or recklessness as a basis for scienter,
it could have done so expressly in the text of the Reform Act.").
9704
The Securities and Exchange Commission is uniquely qual-
ified to assess "the proper balance between the need to insure
adequate disclosure and the need to avoid the adverse conse-
quences of setting too low a threshold for civil liability[.]"
TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 n.10
(1976) (giving deference to the SEC's interpretation of Rule
14a-9). The Commission "often relies on the recklessness
standard in its own law enforcement cases,"17 and argues
forcefully that the Reform Act did not eliminate recklessness
as a basis for liability generally. In the Commission's view,
liability for recklessness is "essential to the effective function-
ing of Section 10(b)," and "necessary to protect investors and
the integrity of the disclosure process."18 The Commission's
amicus brief states:
Construing the Reform Act's pleading standard pro-
vision as eliminating recklessness would convert
what was intended to be a procedural provision into
a substantive change in the definition of scienter. It
would, in effect, eliminate recklessness (in private
actions) from the uniformly accepted definition of
scienter. Because the substantive law allows liability
for recklessness, it follows that plaintiffs must be
allowed to plead that the defendants acted recklessly.
If plaintiffs can state with particularity facts giving
rise to a strong inference that defendants acted reck-
lessly, their complaint is sufficient under the Reform
Act.
Brief of Amicus SEC at 18-19 (emphases in original). 19 The
_________________________________________________________________
17 Brief of Amicus SEC at 21.
18 Brief of Amicus SEC at 17, 20.
19 See also Richard H. Walker & J. Gordon Seymour, Recent Judicial
and Legislative Developments Affecting the Private Securities Fraud Class
Action, 40 Ariz. L. Rev. 1003, 1027-28 (1998) ("[N]either the Reform Act
nor its legislative history reflects any intention to eliminate recklessness
as a basis of liability. The recklessness standard has long been recognized
by the federal courts and is essential to investor protection.").
9705
Commission's rationale is shared by the Third Circuit, which
recently stated: "Retaining recklessness not only is consistent
with the Reform Act's expressly procedural language, but
also promotes the policy objectives of discouraging deliberate
ignorance and preventing defendants from escaping liability
solely because of the difficulty of proving conscious intent to
commit fraud." Advanta, 1999 WL 395997, at *8.
The Senate Report stated that "[t]he Committee does not
adopt a new and untested pleading standard that would gener-
ate additional litigation."20 The pleading standard proposed by
the majority, however, would require plaintiffs to plead
"deliberate or conscious recklessness," a formulation not
found in the text of the statute, in the legislative history, or in
any case heretofore litigated, and rejected by the responsible
administrative agency; it would eliminate recklessness as a
basis for liability, and treat allegations of motive and opportu-
nity to commit fraud as insufficient to allege scienter. It is
"new," "untested," and certain to "generate additional
litigation."
II.
Brody's Complaint
The Reform Act, properly interpreted, permits plaintiffs to
plead a strong inference of scienter by alleging with particu-
larity facts that constitute circumstantial evidence of reckless
or conscious misbehavior, or a motive and opportunity to
defraud. Brody's complaint satisfies this standard by setting
forth, in adequate detail, the factual basis for a strong infer-
ence that Silicon Graphics, Inc. ("SGI" or "the Company")
and its officers knowingly or recklessly misrepresented the
state of the Company's affairs and, as evidenced by the indi-
_________________________________________________________________
20 S. Rep. 104-98, at 15 (1995) (Report of Senate Committee on Bank-
ing, Housing and Urban Affairs), reprinted in 1995 U.S.C.C.A.N. 679,
694.
9706
vidual defendants' insider stock sales, had the motive and
opportunity to defraud. Dismissal is not warranted because it
does not "appear[ ] beyond doubt that plaintiff can prove no
set of facts in support of [her] claim which would entitle [her]
to relief," Neubronner v. Milken, 6 F.3d 666, 669 (9th Cir.
1993) (emphasis added, internal quotations omitted), even
under the majority's "deliberate recklessness " standard.
1.
Particularity
Before considering whether they support a "strong
inference" of fraud, the court must assess the particularity of
Brody's allegations. Federal Rule of Civil Procedure 9(b) pro-
vides that "the circumstances constituting fraud or mistake
shall be stated with particularity." Fed. R. Civ. P. 9(b). The
Reform Act modifies this requirement, providing that a secur-
ities fraud complaint shall identify: (1) each statement alleged
to have been misleading; (2) the reason or reasons why the
statement is misleading; and (3) all facts on which that belief
is formed. See 15 U.S.C. S 78u-4(b)(1). Brody satisfies each
requirement.
Brody alleged that during the class period--September 13,
1995 to December 29, 1995--SGI and the individual defen-
dants made material misrepresentations regarding the condi-
tion of the Company in order to inflate the price of its stock
and facilitate profitable insider trading. Brody challenged
eleven allegedly misleading statements made by officers of
SGI,21 described the content of each, and either named the
_________________________________________________________________
21 (1) September 13, 1995: SGI CEO Edward McCracken told Morgan
Stanley that there were "no supply constraints " on the production of an
improved line of graphic design computers called the "Indigo2 Impact
Workstation" ("Indigo2"); (2) September 21, 1995: McCracken
announced at a computer conference that sales growth was "accelerating";
(3) September 22, 1995: McCracken told Morgan Stanley there was "no
9707
individuals who made the statements, or identified them with
enough specificity to permit SGI to determine the source.
Thus, Brody has given the defendants adequate notice of the
specific instances of alleged fraud grounding her complaint to
permit them to respond. See 5 Charles Alan Wright & Arthur
R. Miller, Federal Practice and ProcedureS 1298 (2d ed.
1990) ("Perhaps the most basic consideration in making a
_________________________________________________________________
problem with [the Indigo2], nor is there an engineering halt"; (4) Septem-
ber 26, 1995: SGI announced "volume shipments " of the Indigo2; (5)
October 19, 1995: SGI issued a press release announcing 33% revenue
growth, and reporting that the Indigo2 was shipping in volume; (6) Octo-
ber 19, 1995: SGI held a conference call during which McCracken and
other executives told securities analysts and institutional investors SGI had
not met its goal of 40% revenue growth during the first quarter of fiscal
year 1996. SGI executives explained that the reorganization of its sales
force temporarily hurt sales, but the reorganization had been successful.
The executives also attributed the shortcoming to a drop in North Ameri-
can and European orders. SGI assured investors that (a) there were no
manufacturing problems with or supply constraints on the Indigo2; (b)
demand was strong for the workstation, and it was being shipped in vol-
ume; and (c) the revenue target of 40% for Fiscal Year 96 would be
achieved; (7) October 19, 1995: McCracken stated in an interview that
SGI's first quarter growth was "probably less " than the growth the Com-
pany would see during Fiscal Year 1996; (8) November 2, 1995: SGI
executives held a press conference for securities analysts and investors,
stating that (a) SGI would still achieve its goal of 40% revenue growth,
and its second quarter performance should better its first quarter perfor-
mance; (b) the failure to meet growth expectations for the first quarter
resulted from temporary sales force reorganization problems and a tempo-
rary drop in sales; and (c) Indigo2 sales were beating expectations, and the
product was now shipping in volume after some initial problems with the
supply of a key chip component; (9) Early November, 1995: SGI's first
quarter report to shareholders included a letter from McCracken stating
that the Indigo2 "began shipping in volume in September"; (10) December
15, 1995: McCracken and another SGI executive told Dean Witter that (a)
SGI had a strong November; (b) sales force productivity was improving;
(c) European and North American sales were likely to improve; and (d)
the Company would meet its goal of 40% growth for the second quarter;
(11) Mid-December, 1995: McCracken and another SGI executive told
Smith Barney that SGI would meet its goal of 40% growth, notwithstand-
ing sluggish sales in some areas.
9708
judgment as to the sufficiency of a pleading is the determina-
tion of how much detail is necessary to give adequate notice
to an adverse party and enable him to prepare a responsive
pleading.").
Brody also adequately pled facts showing why these eleven
statements were false when made, alleging "specific problems
undermining a defendant's optimistic claims[.]" Fecht v.
Price Co., 70 F.3d 1078, 1083 (9th Cir. 1995). The statements
challenged by Brody can be grouped into three categories: (1)
statements assuring investors that there were no problems
with the production and distribution of SGI's improved line
of graphic design computers called the "Indigo2 Impact
Workstation" ("Indigo2"); (2) statements acknowledging
sluggish sales in North America and Europe, but downplaying
their significance; and (3) statements predicting SGI would
meet its goal of 40% growth for Fiscal Year 1996. Brody's
complaint pleads facts that conflict with each of these catego-
ries of statements, alleging that confidential SGI reports
informed officers as early as September 1995 that: (1) SGI
was encountering difficulty securing enough components to
produce Indigo2 workstations in volume; (2) SGI continued
to experience sluggish sales in North America and Europe;
and (3) these problems made it impossible for SGI to meet its
annual or quarterly growth targets for Fiscal Year 1996.
Because Brody's allegations are based on information and
belief,22 she was required to "state with particularity all facts
_________________________________________________________________
22 Brody contends the pleading requirements applicable to allegations
made on information and belief do not apply to her because her allegations
are based on the investigations of her counsel, and therefore on informa-
tion known personally to her. Brody's complaint includes a paragraph
entitled "Basis of Allegations," which states that "Plaintiffs have alleged
the foregoing based upon the investigation of their counsel, which
included a review of SGI's SEC filings, securities analysts reports and
advisories about the Company and discussions with consultants, and
believe that substantial evidentiary support will exist for the allegations
. . . after a reasonable opportunity for discovery. " Brody relies on these
sources precisely because she does not have direct personal knowledge of
the defendants' alleged misconduct. Her complaint is therefore pled on
information and belief.
9709
on which that belief is formed." 15 U.S.C. S 78u-4(b)(1). She
must therefore allege facts reflecting "the who, what, when,
where, and how" with respect to the facts underlying her
claim. Advanta, 1999 WL 395887, at *7 (internal quotations
omitted).23 The facts alleged by Brody are of two kinds: (1)
internal SGI reports indicating that the defendants were aware
of problems that made their favorable statements false and
misleading; and (2) allegations of "suspicious " insider trading
by the defendants. There is no dispute that the allegations in
the second category were sufficiently particularized, but the
majority concludes that the allegations in the first category are
"too generic" to meet the Reform Act's pleading require-
ments. Ante, at 8906.
Brody's complaint identified three types of internal status
reports allegedly containing information contrary to the
defendants' public statements: (1) daily reports; (2) monthly
financial reports; and (3) "Stop Ship" reports. The daily and
monthly reports included manufacturing, sales, and financial
data. Monthly reports were broken down into "Flash
Reports," brief reports distributed at the end of the month, and
"Monthly Financial Statements/Packages," more detailed
reports distributed within ten days of the close of the month.
Brody alleged that daily and monthly reports: (1) were pre-
pared by "SGI's financial department" (who ); (2) informed
"SGI's top managers, such as [the individual defendants]" of
production problems with the Indigo2, as well as sluggish
sales in North America and Europe which resulted in SGI's
inability to meet its financial goals (what); (3) were distrib-
uted at specific times during the class period24 (when); (4)
_________________________________________________________________
23 See also Stevelman v. Alias Research Inc., _______ F.3d _______, No. 97-9544,
1999 WL 187646, at *4 (2d Cir. Apr. 5, 1999) ("To state a claim with the
required particularity, a complaint must: (1) specify the statements that the
plaintiff contends were fraudulent, (2) identify the speaker, (3) state where
and when the statements were made, and (4) explain why the statements
were fraudulent." (citations and internal quotations omitted)).
24 Brody alleged that the individual defendants received monthly finan-
cial reports "and/or" Flash Reports "on or about" October 3-4, and 10,
1995, "no later than Nov. 3 or 6 and 10, 1995, " and "no later than Dec.
4 or 5 and 10, 1995."
9710
were presented in the form of daily reports, "Flash Reports,"
and "Monthly Financial Statements/Packages" (where); and
(5) were suppressed by the named defendants in an alleged
cover-up, leading to false statements about the Indigo2, North
American and European sales, and the Company's ability to
meet its financial goals (how).
The "Stop Ship" report: (1) was prepared by "the market-
ing, engineering and manufacturing managers" in conjunction
with Indigo2's "Program Director" (who); (2) informed the
named defendants of "serious quality and performance
problems" with Indigo2 due to defects in the computer chip
(what); (3) was distributed to the officers in "mid-Sept. 1995"
(when); (4) was presented in report form (where); and (5) was
suppressed by the named defendants in an alleged cover-up,
leading to false statements about the production and shipping
of Indigo2 (how).
Admittedly, Brody's allegations are not as detailed as they
could have been. The complaint did not identify the specific
person who drafted the reports, nor did it state with exacting
detail the content of the reports; it did not include specific
information about component shortages, volume shortages, or
negative financial news in the internal reports, for example.25
_________________________________________________________________
25 The majority faults Brody for "fail[ing] to state facts relating to the
internal reports, including their contents, who prepared them, which offi-
cers reviewed them and from whom she obtained the information." Ante,
at 8898. This criticism is not justified. As noted, the complaint described
the content of the reports, identified the officers who reviewed them (e.g.,
the named defendants), and who prepared them, albeit by department or
job title (e.g., "SGI's financial department" and "the marketing, engineer-
ing and manufacturing managers" in conjunction with Indigo2's "Program
Director"). Greater detail was not required. See, e.g., Stevelman, 1999 WL
187646, at *6 (strong inference of scienter found despite plaintiff's
"fail[ure] to allege in his Amended Complaint what percentage of their
[stock] holdings the other officers, besides[CEO] Bingham, liquidated in
the period at issue, or how many shares they retained; he also fails to
allege whether all [company] officers sold at the inflated prices, or only
some of them").
9711
Such precise detail, however, is neither expected nor required
at the pleading stage of the proceedings:
[W]e cannot hold plaintiffs to a standard that would
effectively require them, pre-discovery, to plead evi-
dence. Rule 9(b) proscribes the pleading of "fraud by
hindsight," but neither can plaintiffs be expected to
plead fraud with complete insight.
Shaw v. Digital Equip. Corp., 82 F.3d 1194, 1225 (1st Cir.
1996) (citation omitted).26
Because Brody's complaint sets forth, in adequate detail,
the factual basis for her belief that SGI and its officers com-
mitted fraud, the majority erroneously concludes that the
complaint failed to satisfy the Reform Act's particularity
requirements.
_________________________________________________________________
The Reform Act neither explicitly nor implicitly mandates disclosure in
the complaint itself of the sources of the facts alleged. The majority cites
no authority to the contrary. Although disclosure will be required during
discovery, see Fed. R. Civ. P. 26(a)(1)(A), at that time the district court
can enter an appropriate order to protect informants, etc., see Fed. R. Civ.
P. 26(c); Seattle Times Co. v. Rhinehart, 467 U.S. 20, 34-35 & n.21
(1984). Considering "the possible retaliation that frequently results when
a whistleblower is identified," Management Info. Techs., Inc. v. Alyeska
Pipeline Serv. Co., 151 F.R.D. 478, 481 (D.D.C. 1993), the majority's crit-
icism of Brody's complaint on this ground is unjustified.
26 See also Press, 166 F.3d at 538 (refusing to interpret the Reform Act's
pleading standard in a manner that "would make virtually impossible a
plaintiff's ability to plead scienter in a financial transaction involving a
corporation, institution, bank or the like that did not involve specifically
greedy comments from an authorized corporate individual").
9712
2.
"Strong Inference" of Fraud
Brody's complaint alleges two factual bases for inferring
scienter: (1) internal SGI reports indicating the defendants
were aware of problems that made their favorable statements
false and misleading; and (2) "massive" insider sales of SGI
stock by the defendants during a period when the Company's
stock price was peaking.
a.
Internal Reports
Brody alleged that numerous internal reports generated by
SGI revealed financial and production problems not fully dis-
closed to the public until months later. The majority con-
cludes that Brody's allegations are "too generic " to raise a
strong inference of scienter. Ante, at 8906. The internal
reports referred to in Brody's complaint were described in
sufficient detail as to the source, relevant content, and distri-
bution to form the basis for a strong inference that SGI's offi-
cers knew the representations they were making to the public
were false when made. Brody alleged that "SGI's top manag-
ers, such as [the individual defendants]" received "Flash
Reports" and "Monthly Financial Statements/Packages" pre-
pared by "SGI's financial department." These reports, which
were distributed in October, November, and December of
1995,27 allegedly described production problems with the
Indigo2, as well as sluggish sales in North America and
Europe which were inhibiting the Company's ability to meet
its financial goals.28 The complaint alleged that although these
_________________________________________________________________
27 See supra note 24.
28 Paragraph 36 of the complaint is representative:
36. As a result of the problems with the ASIC chips for use
in the Indigo2 IMPACT Workstation, as well as weak sales in
9713
reports disclosed "weak" sales and "net income and earnings
per share well below forecasted and budgeted levels, " SGI
repeatedly assured investors that it would meet revenue and
growth goals.
Brody also alleged the defendants received a "Stop Ship"
report prepared in "mid-Sept. 1995" by "the marketing, engi-
neering and manufacturing managers" in conjunction with the
Indigo2's "Program Director," which informed the named
defendants of "serious quality and performance problems with
the Indigo2 IMPACT Workstations due to the ASIC chip per-
formance problems as it attempted to assemble and ship the
Indigo2 IMPACT Workstations in volume in Sept. 1995."
The complaint alleged that despite this information,
McCracken told Morgan Stanley on September 13, 1995 that
"there were no supply constraints" with respect to Indigo2,
and on September 22, 1995 confirmed that "there is no prob-
lem with the product, nor is there an engineering halt."
Allegations similar to Brody's have been held sufficient to
preclude dismissal under the "strong inference " standard. In
Serabian v. Amoskeag Bank Shares, Inc., 24 F.3d 357 (1st
Cir. 1994), the plaintiffs claimed officers and directors of a
bank holding company artificially inflated stock prices by
misrepresenting the bank's true financial condition. See id. at
360. The complaint alleged that while the company's public
statements characterized its loan review capabilities as
"strong" and its approach to loan reserves as "conservative,"
internal reports warned directors of problems in the loan
review department and "serious deficiencies" in the bank's
_________________________________________________________________
North America due to problems with SGI's North American
direct sales force, weak OEM sales and weaker than expected
sales in Europe, SGI's results for the month and quarter ended
Sept. 30, 1995 were significantly below forecasted or budgeted
levels. Each of the individual defendants received this informa-
tion by way of the Sept. "Flash" report on or about Oct. 3-4,
1995, and/or the Sept. Monthly Financial Statement/Package on
or about Oct. 10, 1995.
9714
loan reserves. Id. at 363-64. The allegations were held suffi-
cient:
[P]laintiffs do more than simply identify manage-
ment problems or point to statements that put a posi-
tive spin on the company's circumstances, without
indicating how or why defendants should have
known the descriptions were inaccurate. Rather,
these paragraphs present a contrast between what
company officials were hearing internally about their
loan review effectiveness and the adequacy of their
[loan reserves], and what the company was telling
the public at the same time.
Id. at 365 (emphasis in original).29 Similarly, Brody's com-
plaint alleges how and why SGI should have known its public
statements about sales growth and Indigo2 production were
false and misleading, and provided the basis for a strong
inference of fraud by contrasting what Company officials
were hearing internally and what they were telling investors
at the same time. See also, e.g., Cosmas v. Hassett, 886 F.2d
8, 12-13 (2d Cir. 1989) (strong inference test met where direc-
tors allegedly knew of import restrictions on Chinese trade
but still predicted a significant part of the company's revenue
would come from exports to China).
_________________________________________________________________
29 The First Circuit, like the Second Circuit, applied a "strong inference"
standard with respect to scienter prior to the Reform Act. See Maldonado
v. Dominguez, 137 F.3d 1, 9 & n.5 (1st Cir. 1998) (citing Greenstone v.
Cambex Corp., 975 F.2d 22, 25 (1st Cir. 1992)). As the First Circuit
recently observed, albeit in dicta, the Reform Act's heightened pleading
requirements do not differ from that circuit's historical standard. See id.
at 9 n.5.
9715
b.
Insider Stock Sales
Brody alleged that the six individual defendants engaged in
"massive" insider trading, collectively selling 388,188 shares
of stock and realizing aggregate proceeds of $13,821,053 dur-
ing the fifteen-week class period. The majority determines
that sales by two of the individual defendants "appear some-
what suspicious," ante, at 8905, but holds that the allegations
fail to raise a strong inference of scienter.
"Suspicious" stock sales by corporate insiders are circum-
stantial evidence of intent to defraud. In re Apple Computer
Sec. Litig, 886 F.2d 1109, 1117 (9th Cir. 1989). Insider trad-
ing is suspicious when "dramatically out of line with prior
trading practices at times calculated to maximize personal
benefit from undisclosed inside information." Id. As the
majority indicates, sales during the class period by three
defendants with significant trading histories--McCracken,
Baskett, and Ramsay--did not deviate dramatically from their
prior sales. McCracken sold 60,000 shares during the class
period, but routinely sold comparable blocks of SGI stock in
previous quarters. Baskett and Ramsay sold 30,000 and
20,000 shares respectively during the class period, but both
previously sold larger quantities of SGI stock. If vested stock
options are considered, four of the individual defendants sold
relatively modest portions of the shares they could have sold:
McCracken sold 2.6% of his holdings and options; Baskett
7.7%; Ramsay 4.1%; and Sekimoto 6.9%. These facts weigh
against Brody's claim. See Acito v. IMCERA Group, Inc., 47
F.3d 47, 54 (2d Cir. 1995) (sale by retired director of "less
than 11% of his holdings"); In re Worlds of Wonder Sec.
Litig., 35 F.3d 1407, 1427-28 (9th Cir. 1994) (sale of "only
a minuscule fraction" of stock holdings); Apple Computer,
886 F.2d at 1117 (collective sale of 8% of stock holdings).
9716
However, Senior Vice Presidents Kelly and Burgess sold
significant percentages (43.6% and 75.3% respectively) of the
shares they could have sold, if vested options are included. If
vested options are excluded, Kelly and Burgess sold 95% and
99.8% of their holdings respectively. Viewed in the light most
favorable to Brody, either set of data provides support for an
inference of fraud sufficient to preclude dismissal, see
Stevelman v. Alias Research Inc., _______ F.3d _______, No. 97-9544,
1999 WL 187646, at *1, *5-7 (2d Cir. Apr. 5, 1999) (strong
inference of fraud where complaint alleged sale of 40% of
shares by CEO, and "thousands" of shares by two vice presi-
dents); Shaw, 82 F.3d at 1224 (sales of 68% and 20% by two
directors militates against motion to dismiss), 30 especially
considering the allegation that all of the named defendants
sold some stock during the class period, see Friedberg v. Dis-
creet Logic Inc., 959 F. Supp. 42, 51-52 (D. Mass. 1997)
(refusing to dismiss complaint brought under the Reform Act
where two officers sold 33% and 50% of their respective
stock holdings, and each of the named defendants sold some
stock).31
_________________________________________________________________
30 Cf. Advanta, 1999 WL 395997, at *14-15 (upholding dismissal of
complaint where not all defendants sold stock, and those who did sold
"only small percentages of their holdings").
31 Cf. Advanta, 1999 WL 395997, at *14 ("Here, three of the individual
defendants sold no stock at all during the class period, raising doubt
whether the sales were motivated by an intent to profit from inflated stock
prices before the upcoming losses were reported."); Stevelman, 1999 WL
187646, at *6 ("[W]e have suggested that scienter may not be inferred
`strongly' when the alleged fraud is alleged to have benefitted only a sin-
gle defendant in a corporate entity."); San Leandro Emergency Med.
Group Profit Sharing Plan v. Philip Morris Cos., Inc., 75 F.3d 801, 814
(2d Cir. 1996) ("In the context of this case, we conclude that the sale of
stock by one company executive does not give rise to a strong inference
of the company's fraudulent intent; the fact that other defendants did not
sell their shares during the relevant class period sufficiently undermines
plaintiffs' claim regarding motive."); Acito , 47 F.3d at 54 ("The fact that
the other defendants did not sell their shares during the relevant class
period undermines plaintiffs' claim that defendants delayed notifying the
public so that they could sell their stock at a huge profit." (citation and
quotations omitted)).
9717
The majority concedes that the sales by Burgess of more
than a quarter-million shares valued at $8 million appear
"extremely significant for purposes of Brody's class action,"
ante, at 8905, but nonetheless concludes that the allegations
were insufficient:
Brody overlooks crucial facts pertaining to Burgess's
sales. Brody states that "Burgess had never before
sold any of his SGI stock"; however, she omits men-
tion of the fact that SGI acquired his Toronto com-
pany, Alias, Inc., in June 1995, and that he was
legally forbidden to trade his new SGI stock until the
second quarter of 1995, which embraced the period
in which his sales occurred. Nor does Brody mention
that Burgess remained in Toronto, in charge of Alias,
Inc., without any day-to-day contact with SGI's offi-
cers or involvement in its operations. Moreover,
Burgess -- unlike Kelly -- did not make any of the
allegedly misleading statements. Under these cir-
cumstances, Burgess's stock sales do not give rise to
a strong inference of fraudulent intent.
Ante, at 8905-06. While benign explanations for insider stock
sales, if unrebutted,32 are properly considered on a motion for
summary judgment, see, e.g., Provenz v. Miller, 102 F.3d
_________________________________________________________________
32 The "crucial facts" upon which the majority relies conflict with the
allegations in the complaint. For example, the majority claims that Bur-
gess was "without any day-to-day contact with SGI's officers or involve-
ment in its operations," ante, at 8905, but the complaint alleges that
Burgess was "a Senior Vice President of the Company in charge of soft-
ware development including the software used in the Indigo2 IMPACT
workstation gate arrays. Because of defendant Burgess' position with the
Company, he knew of the adverse non-public information about its busi-
ness, finances, products, markets and present and future business prospects
via access to internal corporate documents (including the Company's
operating plans, budgets and forecasts and reports of actual operations
compared thereto), conversations and connections with other corporate
officers and employees, attendance at management meetings and via
reports and other information provided to him in connection therewith."
9718
1478, 1491 (9th Cir. 1996), review under Rule 12(b)(6) is
confined to the allegations of the complaint, which must be
accepted as true, see, e.g., Rubinstein v. Collins, 20 F.3d 160,
169 n.38 (5th Cir. 1994) (refusing to look beyond the four
corners of the complaint when reviewing a motion to dismiss
even though defendants claimed that the alleged insider stock
sales "were innocuous because they were made in response to
tax considerations").33
Considering the allegations regarding insider sales and the
allegations regarding internal corporate memoranda together,
Brody successfully surmounted the Reform Act's pleading
hurdle. As the Supreme Court has noted, "[I]ndividual pieces
of evidence, insufficient in themselves to prove a point, may
in cumulation prove it. The sum of an evidentiary presentation
may well be greater than its constituent parts." Bourjaily v.
United States, 483 U.S. 171, 179-80 (1987) (examining the
"simple facts of evidentiary life"). The allegations regarding
the internal reports, if true, tend to show that the defendants
knowingly misrepresented SGI's ability to meet its growth
targets, and knowingly or recklessly misrepresented the Com-
pany's internal affairs, particularly with respect to the produc-
tion and distribution of Indigo2 workstations. Coupled with
the allegations of suspicious stock sales by Burgess and Kelly
and across-the-board stock sales by all the individual defen-
dants, plaintiffs' allegations are sufficient to raise a "strong
inference" of fraud. Because it does not "appear[ ] beyond
doubt that plaintiff can prove no set of facts in support of
[her] claim which would entitle [her] to relief," Neubronner,
6 F.3d at 669 (emphasis added, internal quotations omitted),
dismissal was unwarranted.
_________________________________________________________________
33 The majority also relies on the fact that the defendants "[c]ollectively"
retained a large percentage of their stock holdings. Ante, at 8904. How-
ever, "an insider may not always trade all his shares in the company for
which he possesses the inside information; the trader may hold on to a
portion of his shares to hedge against the unforeseen or to obscure the
insider trading from the SEC." Worlds of Wonder, 35 F.3d at 1427.
9719
Source: www.ce9.uscourts.gov website