PR Diamonds, Inc. v. Chandler

• Court: Court of Appeals for the Sixth Circuit
• Decided: March 3, 2004
• Docket: 02-3921
• Status: Published

Opinion

RECOMMENDED FOR FULL-TEXT PUBLICATION Pursuant to Sixth Circuit Rule 206 2 PR Diamonds, et al. v. Chandler, et al. No. 02-3921 ELECTRONIC CITATION: 2004 FED App. 0116P (6th Cir.) File Name: 04a0116p.06 _________________ COUNSEL UNITED STATES COURT OF APPEALS ARGUED: William R. Jacobs, STRAUSS & TROY, FOR THE SIXTH CIRCUIT Cincinnati, Ohio, for Appellants. Robert A. Pitcairn, Jr., _________________ KATZ, TELLER, BRANT & HILD, Cincinnati, Ohio, Robert N. Hochman, SIDLEY, AUSTIN, BROWN & WOOD, PR DIAMONDS, INC., et al., X Chicago, Illinois, for Appellees. ON BRIEF: Richard S. Plaintiffs-Appellants, - Wayne, STRAUSS & TROY, Cincinnati, Ohio, for - Appellants. Robert A. Pitcairn, Jr., KATZ, TELLER, - No. 02-3921 BRANT & HILD, Cincinnati, Ohio, Robert N. Hochman, v. - Jeffrey R. Tone, Jeffrey C. Sharer, SIDLEY, AUSTIN, > BROWN & WOOD, Chicago, Illinois, for Appellees. , JOHN P. CHANDLER, et al., - Defendants-Appellees. - _________________ N OPINION Appeal from the United States District Court _________________ for the Southern District of Ohio at Cincinnati. No. 01-00012—Sandra S. Beckwith, District Judge. GORDON J. QUIST, District Judge. Plaintiffs-appellants in this securities fraud case are investors in the stock of Argued: December 12, 2003 Intrenet, Inc. ("Intrenet" and the "Company"). Defendants- appellees are two Intrenet officers (the "Individual Decided and Filed: March 3, 2004* Defendants") and Intrenet's outside auditor, Arthur Andersen LLP ("Andersen"). Plaintiffs' amended consolidated class Before: COLE and CLAY, Circuit Judges; QUIST, District action complaint (the "Complaint") alleged that the Individual Judge.** Defendants and Andersen committed securities fraud in violation of Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated by the Securities and Exchange Commission (the "SEC"), 17 C.F.R. § 240.10b-5. In addition, Plaintiffs alleged that the Individual Defendants were liable as control persons under Section 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. § 78t(a). * The district court dismissed the Section 10(b) and Rule 10b-5 This decision was originally issued as an “unpublished decision” filed on M arch 3 , 2004 . On M arch 29, 2004 , the court designated the claims for lack of specific allegations giving rise to a strong opinion as one recommend ed for full-text publication. inference of scienter, and later granted judgment on the ** pleadings on the Section 20(a) claim for failure to state a The Honorab le Gordon J. Q uist, United States District Judge for the predicate securities fraud claim against the Company. W estern District of Michigan, sitting by designation.

1 No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 3 4 PR Diamonds, et al. v. Chandler, et al. No. 02-3921

Plaintiffs now appeal the district court's decisions. For the financial statements and press releases over the course of the reasons set forth below, we affirm. class period. The class period ends with Intrenet's press release dated October 13, 2000, in which the Company I. Background announced that it was conducting a review of the accuracy of its financial statements, focusing on the Advanced Intrenet was an Indiana corporation with its executive Distribution System ("ADS") subsidiary. The press release offices and principal place of business in Milford, Ohio. The stated that pending the completion of the review, Intrenet's Company operated as a holding company for four truckload 1998 and 1999 year-end financial statements should not be carrier subsidiaries (Roadrunner Trucking, Inc., Roadrunner relied upon, and that the Company expected to reduce its net Distribution Services, Inc., Eck Miller Transportation Corp., income by approximately $1.3 million. NASDAQ trading in and Advanced Distribution System, Inc.) and a brokerage Intrenet stock was halted on that same day, never to resume. logistics operation (INET Logistics, Inc.). Intrenet's On October 18, 2000, Intrenet issued another press release consolidated financial statements included all five of these indicating that the internal audit showed $1.3 million in subsidiaries. A publicly-held company, Intrenet was unrecorded expenses at ADS which could result in registered with the Securities Exchange Commission and its restatements of Intrenet's 1998, 1999, and first and second stock traded on the NASDAQ National Market System. quarter 2000 financial statements. The press release also Formed in 1983, Intrenet was once one of the largest public stated that the individual believed to be responsible for the flatbed carriers in North America. accounting issues was no longer with the Company. The two Individual Defendants, John P. Chandler and Eric On January 2, 2001, Intrenet announced that effective C. Jackson, were Intrenet officers and directors. Chandler immediately it and its subsidiary trucking companies would was President and Chief Executive Officer since June 12, cease operations, lay off most employees, and direct the 2000. Prior to that time, Chandler was, at all relevant times, liquidation of assets. Intrenet said that after a thorough Executive Vice President and Chief Operating Officer of the review of the Company's business, industry dynamics, and all Company. Throughout the class period asserted in this available options, it was determined that issues related to fuel action, Chandler was also a director of Intrenet. Jackson was prices, driver retention, and the unwillingness of many Chairman of Intrenet's Board of Directors from June 12, customers to accept higher rates would preclude the Company 2000, to December 19, 2000. Prior to his appointment as from achieving operational profitability in the foreseeable Chairman of the Board, Jackson was President and Chief future. Also, Intrenet noted that it lacked adequate capital to Executive Officer. Jackson was also a director of the execute its business plan. CEO Chandler further stated that Company since 1993. Defendant Arthur Andersen LLP the previously announced accounting issues relating to the served as Intrenet's outside auditor. In that capacity, ADS subsidiary had little impact on the decision to suspend Andersen audited the Company's financial statements for the operations and liquidate. On January 19, 2001, Intrenet filed years ending December 31, 1998, and December 31, 1999. for Chapter 11 bankruptcy protection. The alleged 20-month class period begins with an Intrenet Intrenet stockholder Hirsch Seidman initiated this action in press release issued on February 19, 1999, reporting the January 2001 in the United States District Court for the Company's financial results for the fourth quarter and year Southern District of Ohio. Seidman sued both individually ending December 31, 1998. Intrenet issued additional and on behalf of all other similarly situated public investors No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 5 6 PR Diamonds, et al. v. Chandler, et al. No. 02-3921

who purchased Intrenet common stock during the class period (c) the financial statements failed to account for (February 19, 1999, through October 13, 2000) and incurred uncollectible receivables and understated receivable losses when the stock lost value as a result of the October 13, reserves; 2000, press release and subsequent collapse of the Company. In June 2001, the district court appointed P.R. Diamonds, Inc. (d) the financial statements failed to record an as lead plaintiff. Plaintiffs filed an amended consolidated impairment in the value of Intrenet's assets; and class action complaint (the "Complaint") on August 17, 2001, to add Andersen as a defendant. Pursuant to this Complaint, (e) the financial statements failed to fully disclose the Plaintiffs asserted claims under 15 U.S.C. § 78j(b) ("Section significant risks and uncertainties associated with 10(b)") and 17 C.F.R. § 240.10b-5 ("Rule 10b-5") against the deficiencies in the company's internal control and Individual Defendants and Andersen, as well as claims of accounting system; and "control person" liability under 15 U.S.C. § 78t(a) ("Section 20(a)") against the Individual Defendants. (3) Intrenet's financial statements, which incorporated the financial results of its five subsidiaries, artificially Plaintiffs' Complaint alleges that Intrenet's financial inflated the net income and earnings of its ADS statements and press releases during the asserted class period subsidiary. contained material misrepresentations and omissions masking the Company's true financial condition, making them false In addition to the aforementioned purported omissions and and misleading. According to Plaintiffs, these fraudulent misrepresentations, the Complaint alleges that Intrenet's financial statements and press releases inflated the Company's public statements included false and misleading language financial results and growth, leading to artificial increases in painting an unduly rosy picture of the Company's financial its stock price. The district court accurately summarized the situation. For example, Intrenet claimed it was making "solid Complaint's allegations in the following manner: strides" and "positive progress" at the time when Plaintiffs allege losses were far in excess of those reported. Intrenet (1) Intrenet's financial results and growth were artificially also announced a plan to increase productivity and eliminate inflated; expenses and liabilities when Plaintiffs allege it was artificially inflating its earnings. (2) Although Intrenet represented that its financial statements were prepared in compliance with generally With respect to the Individual Defendants, the Complaint accepted accounting principles ("GAAP"), they were not: asserts that as top-level Intrenet executives and control persons, they knew of or recklessly disregarded the alleged (a) the financial statements failed to reconcile inter- misrepresentations and omissions. With respect to Intrenet's company transactions among Intrenet's five subsidiaries; outside auditor, the Complaint posits that Andersen issued false and misleading audit reports stating that Intrenet's (b) the financial statements failed to record day-to-day financial statements fairly represented the Company's operating expenses; financial condition and complied with GAAP. Plaintiffs also allege that Andersen failed to conduct its audits in compliance with generally accepted auditing standards ("GAAS"). No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 7 8 PR Diamonds, et al. v. Chandler, et al. No. 02-3921

On October 10, 2001, the Individual Defendants filed a (2) Whether Plaintiffs' Section 20(a) claims against the motion to dismiss Plaintiffs' case under Federal Rules of Civil Individual Defendants can proceed despite the absence of Procedure 9(b) and 12(b)(6). Andersen filed its motion to the Company as a defendant. dismiss pursuant to Federal Rule of Civil Procedure 12(b)(6) on October 12, 2001. On November 21, 2001, Plaintiffs filed (3) Whether the district court erred in dismissing a consolidated memorandum opposing Defendants' motions Plaintiffs' Section 10(b) and Rule 10b-5 claims against to dismiss and, in the alternative, requesting leave to amend Defendant Arthur Andersen on the basis that Plaintiffs' their Complaint. The district court issued an order on Complaint does not adequately allege that Andersen February 26, 2002, dismissing Plaintiffs' claims under Section acted with scienter. 10(b) and Rule 10b-5 against the Individual Defendants and Andersen for lack of specific allegations giving rise to a (4) Whether the district court erred in dismissing the case strong inference of scienter as required by the Private without affording Plaintiffs the opportunity to amend Securities Litigation Reform Act of 1995, as amended, 15 their Complaint. U.S.C. § 78u-4 (the "PSLRA"). However, the district court denied the motion to dismiss the Section 20(a) control person II. Standard of Review claim against the Individual Defendants on the grounds then asserted. On May 23, 2003, the Individual Defendants filed This Court reviews de novo a district court's dismissal of a a motion for judgment on the pleadings under Federal Rule of complaint under Fed. R. Civ. P. 12(b)(6). See Valassis Civil Procedure 12(c) on the remaining Section 20(a) claim. Communications v. Aetna Cas. & Sur. Co., 97 F.3d 870, 873 The district court granted the motion on July 17, 2002, (6th Cir. 1996). The same de novo standard applies to review concluding that Plaintiffs failed to state an underlying of a district court's judgment on the pleadings under Fed. R. securities fraud claim against Intrenet as required by Section Civ. P. 12(c). See Ziegler v. IBP Hog Market, Inc., 249 F.3d 20(a), denying as moot Plaintiffs' motion for class 509, 511-12 (6th Cir. 2001). The Court must accept as true certification, and ordering the action closed. In neither of its "well-pleaded facts" set forth in the complaint. Morgan v. opinions did the district court discuss granting Plaintiffs leave Church's Fried Chicken, 829 F.2d 10, 12 (6th Cir. 1987). to amend. On August 4, 2002, Plaintiffs filed a timely notice Construing the complaint in a light most favorable to the of appeal with this Court. plaintiffs, we must determine whether the plaintiffs undoubtedly can prove no set of facts in support of their In this appeal, Plaintiffs present the following issues for claims that would entitle them to relief. Mayer v. Mylod, 988 review: F.2d 635, 637 (6th Cir. 1993). Finally, we review a district court's denial of leave to amend for abuse of discretion, Miller (1) Whether the district court erred in dismissing v. Champion Enters., Inc., 346 F.3d 660, 671 (2003), except Plaintiffs' Section 10(b) and Rule 10b-5 claims against in cases where the district court bases its decision on the legal the Individual Defendants on the basis that Plaintiffs' conclusion that an amended complaint could not withstand a Complaint does not adequately allege that the Individual motion to dismiss, where the review is de novo. Monette v. Defendants acted with scienter. Elec. Data Sys. Corp., 90 F.3d 1173, 1188 (6th Cir. 1996). No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 9 10 PR Diamonds, et al. v. Chandler, et al. No. 02-3921

III. Discussion 1. Governing Law - Pleading Standards A. Section 10(b) and Rule 10b-5 Claims Against the Section 10(b)1 of the Exchange Act and Rule 10b-52 Individual Defendants promulgated thereunder prohibit "fraudulent, material misstatements or omissions in connection with the sale or Plaintiffs first contend that the district court erred when it purchase of a security." Morse v. McWhorter, 290 F.3d 795, dismissed the Section 10(b) and Rule 10b-5 claims against the Individual Defendants on the basis that the Complaint lacked specific allegations giving rise to a strong inference of 1 scienter, as required under the PSLRA. Plaintiffs challenge Section 10 provides as follows: the district court's holding, arguing that the allegations of the It shall be unlawful for any person, directly or indirectly, by the Complaint, when considered in their totality, do in fact give use of any m eans o r instrumentality of interstate commerce or of rise to a strong inference that the Individual Defendants had the mails, or of any facility of any national securities exchange - either actual knowledge of, or at least recklessly disregarded, .... the alleged material misrepresentations and omissions (b) To use or emp loy, in connection with the purchase contained in Intrenet's statements to the investing public. As or sale of any security registered on a national securities exchange or any security not so registered, we explain in the discussion that follows, we hold that any manipulative or deceptive device or contrivance in Plaintiffs fail to meet the standards for pleading scienter on contravention of such rules and regulations as the the part of the Individual Defendants and, therefore, the Commission may prescribe as necessary or appropriate Section 10(b) and Rule 10b-5 claims against them were in the public interest or for the pro tection of investors. properly dismissed. 15 U.S.C. §7 8j.

2 Rule 10b-5, prescribed by the SEC under Section 10(b), provides as follows:

It shall be unlawful for any p erson , directly o r indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of an y facility of any national securities exchange,

(a) To employ any device, scheme, or artifice to defraud,

(b) To make any untrue statem ent of a m aterial fact or to o mit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or

(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the p urchase or sa le of any se curity.

17 C.F.R. § 240.10b-5. No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 11 12 PR Diamonds, et al. v. Chandler, et al. No. 02-3921

798 (6th Cir. 2002). In order to state a claim pursuant to Helwig v. Vencor, Inc., 251 F.3d 540, 552 (6th Cir. 2001) (en Section 10(b) and Rule 10b-5, "a plaintiff must allege, in banc). Recklessness is defined as "highly unreasonable connection with the purchase or sale of securities, the conduct which is an extreme departure from the standards of misstatement or omission of a material fact, made with ordinary care. While the danger need not be known, it must scienter, upon which the plaintiff justifiably relied and which at least be so obvious that any reasonable man would have proximately caused the plaintiff's injury. Hoffman v. known of it." Mansbach v. Prescott, Ball & Turben, 598 F.2d Comshare, Inc. (In re Comshare, Inc. Secs. Litig.), 183 F.3d 1017, 1025 (6th Cir. 1979) (quoted in Miller, 346 F.3d at 542, 548 (6th Cir. 1999). Adding to the Federal Rule of Civil 672). Recklessness is "a mental state apart from negligence Procedure 9(b) requirement that fraud allegations be stated and akin to conscious disregard." Comshare, 183 F.3d at 550. with particularity, the PSLRA requires that the complaint See also Id. at 550 n.7 ("As we have observed, federal "specify each statement alleged to have been misleading, the appellate courts have long held the view that, for the purposes reason or reasons why the statement is misleading, and, if an of securities fraud, 'recklessness' that is far from negligence allegation regarding the statement or omission is made on and closer to a 'lesser form of intent' constitutes scienter.") information and belief, the complaint shall state with (quoting Sanders v. John Nuveen & Co., Inc., 554 F.2d 790, particularity all facts on which that belief is formed." 793 (7th Cir. 1977)). 15 U.S.C. § 78u-4(b)(1). Next, we examine the special requirements for pleading The appeal before us centers on whether the Complaint scienter in federal securities fraud cases such as this. As with adequately pleads the scienter element of a Section 10(b) and all fraud claims, Federal Rule of Civil Procedure 9(b) applies Rule 10b-5 claim. In reviewing the district court's decision to pleading a defendant's state of mind, allowing that dismissing the Complaint, we must first examine the meaning "[m]alice, intent, knowledge, and other condition of mind of of "scienter" in the securities fraud setting. The Supreme a person may be averred generally." However, Congress Court has defined "scienter" as "a mental state embracing amended the Securities Exchange Act of 1934 through intent to deceive, manipulate, or defraud." Ernst & Ernst v. passage of the PSLRA, heightening the standard for pleading Hochfelder, 425 U.S. 185, 193 n.12, 96 S. Ct. 1375, 1381 scienter in a securities fraud case: n.12 (1976). In securities fraud claims based on statements of present or historical fact - such as the claims Plaintiffs bring In any private action arising under this title in which the in this case - scienter consists of knowledge or recklessness.3 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 3 alleged to violate this title, state with particularity facts Plaintiffs in this case do not allege forward-looking stateme nts, to giving rise to a strong inference that the defendant acted which the PSL RA applies different scienter requirements pursuant to a with the required state of mind. safe harbor provision. Forward-looking statements include projections and estimates of a company's future economic performance, including statements related to revenues, earnings per share, income , dividends, capital expenditures, capital structure, and other financial items. 15 U.S.C. § 78u-5(i)(1). As to fo rward -looking statem ents accompanied by meaningful cautionary language, the P SLR A makes the state of mind irrelevant. 15 U.S.C. § 78u-5(c)(1)(A). In the case of forward-looking the required state of mind is actual knowledge of the statements' false or statements that are not accompanied by meaningful cautionary language, misleading nature. 15 U.S.C. § 78 u-5(c)(1)(B). No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 13 14 PR Diamonds, et al. v. Chandler, et al. No. 02-3921

15 U.S.C. § 78u-4(b)(2) (emphasis added). The PSLRA We have previously stated that the factors enumerated in provides that if a plaintiff does not meet this requirement, a the following list, while not exhaustive, are probative of court may, on any defendant's motion, dismiss the complaint. scienter in securities fraud actions: See 15 U.S.C. § 78u-4(b)(3). "As courts have observed, the PSLRA did not change the scienter that a plaintiff must prove (1) insider trading at a suspicious time or in an unusual to prevail in a securities fraud case but instead changed what amount; (2) divergence between internal reports and a plaintiff must plead in his complaint in order to survive a external statements on the same subject; (3) closeness in motion to dismiss." Comshare, 183 F.3d at 548-49 (citation time of an allegedly fraudulent statement or omission and omitted). the later disclosure of inconsistent information; (4) evidence of bribery by a top company official; As the foregoing authorities make clear, a plaintiff may (5) existence of an ancillary lawsuit charging fraud by a survive a motion to dismiss by pleading with particularity company and the company's quick settlement of that suit; facts giving rise to a strong inference that the defendant acted (6) disregard of the most current factual information with knowledge or recklessness. In other words, not only before making statements; (7) disclosure of accounting must the complaint make particular factual allegations, but information in such a way that its negative implications the inference of scienter which those allegations generate could only be understood by someone with a high degree must be strong. In Helwig, we provided a definitive of sophistication; (8) the personal interest of certain explanation of the meaning of a "strong inference": directors in not informing disinterested directors of an impending sale of stock; and (9) the self-interested Inferences must be reasonable and strong - but not motivation of defendants in the form of saving their irrefutable. "Strong inferences" nonetheless involve salaries or jobs. deductive reasoning; their strength depends on how closely a conclusion of misconduct follows from a Helwig, 251 F.3d at 552 (citing Greebel v. FTP Software, plaintiff's proposition of fact. Plaintiffs need not Inc., 194 F.3d 185, 196 (1st Cir. 1999)). foreclose all other characterizations of fact, as the task of weighing contrary accounts is reserved for the fact 2. The Complaint Fails to Raise a Strong Inference of finder. Rather, the "strong inference" requirement means Scienter that plaintiffs are entitled only to the most plausible of competing inferences. Plaintiffs contend that the district court erred in concluding that the Complaint failed to allege facts raising a strong 251 F.3d at 553. The PSLRA does not change the Rule inference of the Individual Defendants' scienter. The gist of 12(b)(6) maxim that when an allegation is capable of more Plaintiffs' argument is that the district court mistakenly than one inference, it must be construed in the plaintiff's viewed the allegations of the Complaint in a piecemeal favor. Id. ("Our willingness to draw inferences in favor of the fashion, rather than considering the totality of the plaintiff remains unchanged by the PSLRA."). However, the circumstances pled. As Plaintiffs correctly point out, this "strong inference" requirement means that a plaintiff is Court employs a totality of the circumstances analysis entitled to only the most plausible of competing inferences. whereby the facts argued collectively must give rise to a Miller, 346 F.3d at 673. strong inference of at least recklessness. See In re Telxon Corp. Secs. Litig., 133 F. Supp. 2d 1010, 1026 (N.D. Ohio No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 15 16 PR Diamonds, et al. v. Chandler, et al. No. 02-3921

2000) ("Thus, the Sixth Circuit employs a form of 'totality of of the alleged accounting irregularities at Intrenet, the the circumstances' analysis; this Court, accordingly, declines Company's financial statements and press releases materially to examine plaintiffs' allegations in piecemeal fashion and, misrepresented Intrenet's true state of financial affairs. The will instead, assess them collectively to determine what issue before us is limited to the scienter inquiry: that is, inferences may be drawn therefrom.") (citing Comshare, 183 whether Plaintiffs have met their burden of pleading specific F.3d 542 at 549-52). facts which, when viewed together, persuade us that the most plausible conclusion to draw is that the Individual Defendants Reading the Complaint in its entirety, Plaintiffs maintain, must or should have known about the problems and establishes a strong inference that throughout the class period nevertheless knowingly or recklessly made the allegedly the Individual Defendants knew of serious accounting misleading public statements. While the allegations no doubt improprieties at Intrenet and the effect such improprieties merit drawing some inference of scienter, that is not enough. were having on the Company's financial condition, or were The PSLRA requires the Complaint to establish a strong reckless in not knowing or in disregarding this information. inference - the most plausible of competing inferences - that Furthermore, Plaintiffs contend that after the outside the Individual Defendants acted at least recklessly, meaning consultant discovered the accounting improprieties, the that their states of mind were reflected in highly unreasonable inference of scienter is not merely strong, but virtually conduct constituting an extreme departure from the standards inescapable. Despite this awareness, Plaintiffs argue, the of ordinary care so obvious that any reasonable person would Individual Defendants continued to make materially false and have known of it. Here, the Complaint fails. misleading statements and omissions in Intrenet's financial statements and press releases. In the following discussion, we consider each allegation Plaintiffs offer in their effort to plead scienter. As we have Specifically, Plaintiffs argue that a strong inference of the noted before, "recklessness in securities fraud is an untidy, Individual Defendants' scienter arises when viewing in case-by-case concept." Helwig, 251 F.3d at 551 (citing totality the following allegations in the Complaint: the nature Mansbach, 598 F.2d at 1025). "This necessarily involves a and magnitude of the accounting improprieties at Intrenet; sifting of allegations in the complaint." Id. Accordingly, we other "red flags" signaling the accounting errors; the sift Plaintiffs' allegations individually and then aggregate the Individual Defendants' access to Intrenet's financial nuggets of inference they generate, concluding in the end no information by virtue of their positions at the Company; the strong inference arises. fact that the accounting improprieties occurred in areas touted as the Company's key areas of focus; the Individual (a) Accounting Improprieties Defendants' motives and opportunities to commit fraud; the hiring of an outside consultant; and the outside consultant's Plaintiffs contend that the Complaint's allegations of discovery of internal control deficiencies and accounting Intrenet's improper accounting practices and internal control irregularities. deficiencies comprise circumstantial evidence supporting a strong inference of the Individual Defendants' scienter. Our examination of each of these clusters of allegations Plaintiffs suggest that none of these accounting "maneuvers" shows that, even viewed collectively, they fail to adequately had any facially valid purpose and, therefore, they support the plead scienter on the part of the Individual Defendants. To inference that the Individual Defendants harbored an intent to reiterate, we do not in this Opinion address whether, in light artificially inflate the Company's operating results. The No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 17 18 PR Diamonds, et al. v. Chandler, et al. No. 02-3921

alleged accounting improprieties include: failure to reconcile alleged that accounting violations caused the company to inter-company transactions; understatement of day-to-day report aggregate "record" net income of $18.9 million over operating expenses; accounting for uncollectible receivables three years, when in fact the company incurred a net loss for and understatement of Intrenet's accounts receivable reserve; those years of more than $36 million. Id. at 636. In addition, failure to record an impairment in the value of assets; failure the company overstated its revenues over the same period by to disclose significant risks and uncertainties; arbitrarily a total of $66 million. Id. After reiterating the maxim that applying cash receipts against the oldest outstanding allegations of accounting violations standing alone can never receivable; and recording journal entries in violation of the lead to a strong inference of scienter, MicroStrategy Foreign Corrupt Practices Act, without support or backup nevertheless intimated that the nature of the misapplication of documentation. According to Plaintiffs, the nature and accounting principles - in terms of number, size, timing, magnitude of the obvious, pervasive accounting problems at frequency, and context - is relevant circumstantial evidence Intrenet support a strong inference that the Individual of a defendant's state of mind. Id. at 635. Turning to the facts Defendants knew of or recklessly disregarded these problems before it, the court concluded that the "magnitude," when making statements to the investing public. "pervasiveness," and "repetitiveness" of the company's violations of "simpl[e]" accounting principles "serve[d] to In Comshare, we held that "[t]he failure to follow GAAP is, amplify the inference of scienter." Id. at 636. The court by itself, insufficient to state a securities fraud claim." 183 explained: F.3d at 553 (internal citations omitted). A complaint alleging accounting irregularities fails to raise a strong inference of Indeed, common sense and logic dictate that the greater scienter if it "allege[s] no facts to show that Defendants knew the magnitude of a restatement or violation of GAAP, the or could have known of the errors, or that their regular more likely it is that such a restatement or violation was procedures should have alerted them to the errors sooner than made consciously or recklessly. This, of course, is a they actually did." Id. We noted in Comshare that a strong matter of degree, but it cannot be gainsaid that some inference of scienter cannot be drawn from speculative and violations of GAAP and some restatements of financials conclusory allegations of GAAP violations. Id. However, as are so significant that they, at the very least, support the discussed below, some courts have recognized that an inference that conscious fraud or recklessness as to the inference of knowledge or recklessness may be drawn from danger of misleading the investing public was present. allegations of accounting violations that are so simple, basic, Cf. In re Oxford Health Plans, Inc. Sec. Litig., 51 F. and pervasive in nature, and so great in magnitude, that they Supp. 2d 290, 294 (S.D.N.Y. 1999) ("[P]laintiffs allege should have been obvious to a defendant. 'in your face facts,' that cry out, 'how could [defendants] not have known that the financial statements were Courts have described the type and scope of accounting false.'") In this case, the alleged GAAP violations and the errors that, in combination with other factors, support a strong subsequent restatements are of such a great magnitude – inference of scienter. For example, Plaintiffs cite In re amounting to a night-and-day difference with regard to MicroStrategy, Incorporated Securities Litigation, 115 F. MicroStrategy's representations of profitability – as to Supp. 2d 620 (E.D. Va. 2000) for the proposition that compel an inference that fraud or recklessness was afoot. violations of simple accounting rules are obvious, and an inference of scienter becomes more probable as the violations Id. at 636-37 (footnotes omitted). become more obvious. The complaint in MicroStrategy No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 19 20 PR Diamonds, et al. v. Chandler, et al. No. 02-3921

Other cases likewise indicate the drastic nature and day-to-day operating expenses as they occurred; (3) $600,000 magnitude necessary for accounting violations to support a in underreported expenses due to failure to adequately reserve strong inference of scienter. In Telxon, the court for uncollectible accounts receivable resulting in an amplified distinguished the "far more egregious" facts before it from accounts receivable balance (e.g., during the year ending those alleged in Comshare, where we held that the alleged December 31, 1999, Intrenet's net accounts receivable accounting errors did not support a strong inference of increased by approximately $4.4 million, or 14%, but its scienter. 133 F. Supp. 2d at 1031. "Telxon, allegedly, operating revenues increased by only 8%); and (4) failure to overstated its revenues for years, did so by over $20 million record an impairment loss in the carrying value of machinery in a single quarter and reported profits when it should have and equipment assets valued at $340,000 but in reality worth been reporting losses over several different quarters." Id. nowhere near the recorded amount. The Complaint notes the (italics in original) In addition, the accounting errors October 18, 2000, press release reporting a possible appeared to be fortuitously timed, resulting in revenue restatement to the tune of $1.3 million in unrecorded expenses increases at times when the company foretold that it would at ADS and alleges that improper accounting practices caused return to profitability, or when the company needed to show Intrenet to report a pre-tax 1999 operating income of profits to justify rejecting a takeover bid and to win a proxy $750,000 when in fact it should have reported an operating battle. Id. The Telxon court also noted the defendants' loss of approximately $50,000. training, background, and access to information. "Thus, the nature and number of the alleged accounting manipulations, These alleged accounting and reporting problems do not coupled with the magnitude of the difference between the resemble the pervasive and egregious manipulations found to originally reported financial disclosures and their support a strong inference of scienter in other cases. Intrenet restatements, and the fact that the misstatements escalated operated one of the largest trucking fleets in the country, with dramatically in the face of the [competing offer and proxy over $280 million in revenue and $75 million in total assets battle]," taken in conjunction with the remaining allegations in 1999. Moreover, the Company did disclose that it lost over in the complaint, convinced the court that the plaintiffs had $4.8 million in 1999, compared with a gain of $2.8 million in adequately alleged scienter. Id. 1998, and that its operating income fell from over $6.3 million in 1998 to less than $1 million in 1999 on higher In contrast to the aforementioned cases, the accounting revenues. Intrenet's press release announced a possible irregularities Plaintiffs allege in this case are significantly less downward restatement of income of approximately $1.3 egregious in nature and magnitude and thus do not support a million, and Plaintiffs allege that the Company's accounting strong inference that nondisclosure of the correct numbers irregularities turned the Company's 1999 operating loss of was the product of a deliberate or reckless effort by the $50,000 into a $750,000 profit. In the face of these figures, Individual Defendants to defraud investors. Alleged the errors Plaintiffs allege are not especially dramatic. inaccuracies stemming from GAAP violations at Intrenet Accepting Plaintiffs' allegations as true, Intrenet represented include: (1) unreconciled and uneliminated inter-company itself as a barely profitable company, when in fact it was a transactions totaling $600,000 by the end of 1999 that, had barely unprofitable company. It simply cannot be said that they been properly accounted for, would have reduced Intrenet's accounting improprieties, by virtue of their type and Intrenet's 1999 pre-tax operating income of $750,000 to size, "should have been obvious," Comshare, 183 F.3d at 554, $150,000; (2) at least $200,000 in unrecorded expenses to the Individual Defendants. These are not "in your face resulting from the ADS subsidiary's failure to record normal facts" that "cry out" scienter. Therefore, the alleged GAAP No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 21 22 PR Diamonds, et al. v. Chandler, et al. No. 02-3921

violations, standing alone, are insufficient to state a securities defendant deliberately chose to ignore multiple red flags that fraud claim, and when viewed in combination with the other would be "clearly evident" to anyone in the defendant's allegations only weakly support an inference of scienter, if at position. 871 F. Supp. at 699. all. Red flags in this case would be circumstances that would (b) Red Flags have put the Individual Defendants on notice that Intrenet's financial statements and press releases contained material Next, Plaintiffs contend that the Individual Defendants misstatements or omissions, or at least would have given knowingly or recklessly disregarded "red flags" indicating them reasons to question the veracity of the statements. Intrenet's improper accounting practices, GAAP violations, Comshare, 183 F.3d at 553. The only purported red flag and internal control deficiencies. Specific factual allegations Plaintiffs specifically identify in their Complaint is the that a defendant ignored red flags, or warning signs that allegation that during the year ended December 31, 1999, would have revealed the accounting errors prior to their Intrenet's net accounts receivable increased by approximately inclusion in public statements, may support a strong inference $4.4 million, or 14%, but its operating revenues increased by of scienter. Comshare, 183 F.3d at 553-54. See also Miller only approximately 8%. This supposed red flag, Plaintiffs v. Material Sciences Corp., 9 F. Supp. 2d 925, 928-29 (N.D. maintain, should have alerted the Individual Defendants to Ill. 1998) ("Deliberately ignoring 'red flags'...can constitute Intrenet's failure to adequately reserve for uncollectible the sort of recklessness necessary to support § 10(b) accounts receivable - a failure that resulted in $600,000 of liability."). On the other hand, ignoring red flags may unreported expenses in 1999. The Court disagrees that these indicate that a defendant was merely negligent, not reckless. circumstances constitute a red flag sufficiently blatant that Courts typically look for multiple, obvious red flags before fraudulent intent can be inferred. Perhaps the Individual drawing an inference that a defendant acted intentionally or Defendants' handling of the alleged accounts receivable recklessly. See, e.g., In re Health Mgmt., Inc. Secs. Litig., situation suggests negligence on their part, but the 970 F. Supp. 192, 203 (E.D.N.Y. 1997) (citing In re Leslie Complaint's allegations do not resemble in severity or number Fay Cos., Inc., 871 F. Supp, 686, 699 (S.D.N.Y. 1995)). the sort that courts consider indicative of knowledge or reckless disregard. In Health Mgmt., the court inferred an auditor's fraudulent intent from numerous alleged red flags that should have led (c) Access to Information the auditor to question its audit opinion, including (i) the auditor's credulous acceptance of representations from the To buttress the argument that the Individual Defendants company that fairly obviously failed to reflect reality; (ii) the knew of or recklessly disregarded adverse information about auditor's failure to follow up on an analyst letter alerting the Intrenet when making representations about the Company to auditor to artificially inflated accounts receivable levels; and the public, Plaintiffs point to their top-level positions within (iii) the auditor's failure to exercise heightened scrutiny in Company. During the putative class period, Chandler first response to the analyst letter and an SEC inquiry on the same served as Intrenet's Executive Vice President and Chief subject. Id. at 203. The court concluded that the allegations Operating Officer, and after June 12, 2000, was the implied that the auditor "turned a blind eye" to the Company's President and Chief Executive Officer until the wrongdoing. Id. Likewise, in Leslie Fay (a pre-PSLRA end of the class period, all this time serving as a director as case), the court inferred scienter from allegations that the well. Meanwhile, Jackson was Intrenet's President and Chief No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 23 24 PR Diamonds, et al. v. Chandler, et al. No. 02-3921

Executive Officer from June 1999 to June 12, 2000, when he [the Individual Defendants] knew or could have known of the became Chairman of the Board of Directors. Jackson also errors, or that their regular procedures should have alerted served as a director throughout the putative class period. them to the errors sooner than they actually did." 183 F.3d at Plaintiffs maintain that by virtue of their positions within the 553. Company, the Individual Defendants had access to all of Intrenet's financial information and controlled the content of (d) Areas of Focus all the Company's public statements and SEC filings. The Individual Defendants' access to Intrenet's financial Plaintiffs seek to draw additional support for a strong information, Plaintiffs argue, works in favor of drawing a inference of the Individual Defendants' scienter by claiming strong inference of scienter with respect to the alleged that Intrenet's accounting improprieties occurred in areas of misrepresentations or omissions in the Company's public the business that the Individual Defendants had specifically communications. identified as targets of intense focus for the Company and where they were under pressure to show success. As a basis Contrary to Plaintiffs' assertions, fraudulent intent cannot for this proposition, Plaintiffs cite Telxon, 133 F. Supp. at be inferred merely from the Individual Defendants' positions 1029. In that case, the court considered a variety of in the Company and alleged access to information. As even circumstances relevant to reaching a strong inference of the authorities which Plaintiffs cite indicate, the Complaint scienter, including allegations of motive and opportunity, must allege specific facts or circumstances suggestive of their large restatements of the company's financial disclosures, and knowledge. Without more, Plaintiffs fail to meet the PSLRA accounting manipulations of "substantial magnitude." Id. requirement to state with particularity facts giving rise to a Another factor the court considered was "the fact that Telxon strong inference of scienter. See, e.g., In re Peritus Software and its officers were in a very difficult position, facing Servs., Inc. Secs. Litig., 52 F. Supp. 2d 211, 228 (D. Mass. unusual pressures to perform during the class period, and 1999) (general allegations that a defendant, through his board stood to benefit substantially from a performance record membership or executive position, had actual knowledge of which matched the healthy ones [a company executive] false statements or reckless disregard for the truth are continually projected to the public." Id. The pressures to insufficient to raise strong inference of scienter). While it is make public statements reflecting profitable performance true that high-level executives can be presumed to be aware stemmed from "the need to stave off [another company's] take of matters central to their business's operation, In re Complete over efforts and ensuing proxy-battle." Id. at 1028. Management, Incorporated Securities Litigation, 153 F. Supp. 2d 314, 325-36 (S.D.N.Y. 2001), in this case it cannot Here, Plaintiffs contend that Intrenet's press releases be said that the alleged misrepresentations or omissions announcing the Company's financial results touted the pertained to central, day-to-day operational matters. Instead, Individual Defendants' careful monitoring of the very areas in they turn largely on accounting issues, predominantly at the which Intrenet committed accounting violations. The press ADS subsidiary, which the Court has already determined are releases stated that "the Company has implemented a program relatively arcane in nature and scope. While the Individual to eliminate, where possible, expenses and liabilities that have Defendants' positions are relevant to the analysis of whether historically been a burden to profitable operations"; "[t]he they are "control persons" for purposes of Section 20(a), on new management team has been tireless in identifying and their own they do not bear strongly on the scienter analysis. eliminating unnecessary costs throughout the organization"; Here, as in Comshare, Plaintiffs "allege no facts to show that "[t]he Company has made solid strides and positive progress No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 25 26 PR Diamonds, et al. v. Chandler, et al. No. 02-3921

during what, otherwise, has been a challenging year"; and that credit agreement. In addition, Plaintiffs allege that the the Company would be late in filing its 1999 10-K to analyze Individual Defendants had other motives to artificially inflate the impact of "recent operational trends," primarily Intrenet's stock price, including: (1) to protect themselves and extraordinary increases in fuel prices, on the Company's their investment in the Company; (2) to protect and enhance ability to meet financial covenants in its bank loan their executive positions and the substantial compensation agreements. and prestige obtained thereby; and (3) to allow Jackson to engage in self-dealing transactions from which he reaped The Court is not persuaded that the aforementioned profits, wherein Intrenet leased tractor trailers from a leasing statements in Intrenet's press releases do much to support an company that purchased the trucks from a dealership inference that the Individual Defendants knew or should have affiliated with Jackson. Also, the Complaint alleges that known about the specific accounting problems alleged in the Chandler was motivated to disseminate materially false and Complaint. These are little more than statements of broad misleading financial statements in order to receive a bonus operational plans or goals - eliminating costs, reducing based on a percentage of net income before taxes, up to a liabilities, improving profits, etc. These statements do not maximum of $500,000. Finally, the Complaint alleges that show knowledge or reckless disregard of the discrete and the Individual Defendants had opportunities to participate in particularized alleged GAAP violations and control fraud due to their positions as the highest ranking officers of deficiencies concentrated in the ADS subsidiary. Intrenet who controlled the content of the Company's press releases and public filings. (e) Motive and Opportunity "[T]he bare pleading of motive and opportunity does not, Next, Plaintiffs argue that the Complaint alleges that the standing alone, constitute the pleading of a strong inference Individual Defendants had motives and opportunities to of scienter." Comshare, 183 F.3d at 551. However, "[w]hile defraud investors. These allegations, Plaintiffs maintain, it is true that motive and opportunity are not substitutes for a when considered together with the other allegations in the showing of recklessness, they can be catalysts to fraud and so Complaint, support a strong inference of knowledge or serve as external markers to the required state of mind." reckless disregard on the part of the Individual Defendants. Helwig, 251 F.3d at 550. "[F]acts regarding motive and The Complaint's motive allegations include: (1) the improper opportunity may be relevant to pleading circumstances from accounting practices helped to mask the Company's which a strong inference of fraudulent scienter may be deteriorating operating results and forestall its impending inferred, and may, on occasion, rise to the level of creating a default under certain financial covenants of its bank loan strong inference of reckless or knowing conduct." Comshare, agreement; (2) the Individual Defendants sought to reduce the 183 F.3d at 551 (internal quotation and citation omitted). impact of a spike in fuel costs in the first quarter of 2000 by While bare allegations of motive and opportunity, without reporting consolidated financial statements that incorporated more, are insufficient to establish scienter, the Court must artificially inflated net income and earnings of the ADS assess whether such allegations, considered in conjunction subsidiary; (3) the Company was motivated to inflate the with the remainder of Plaintiff's allegations, on the whole value of its accounts receivable because borrowings under its raise an inference of recklessness or knowing disregard. $32 million credit facility, which the Company obtained in Telxon, 133 F. Supp. 2d at 1028. February 2000, were determined by a formula tied to the Company's eligible accounts receivable as defined in the No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 27 28 PR Diamonds, et al. v. Chandler, et al. No. 02-3921

Opportunity to commit fraud "entail[s] the means and likely Jackson's alleged self-dealing transactions suggest no more prospect of achieving concrete benefits by the means alleged." than a general motive for Intrenet's success, not fraud; In re Criimi Mae, Inc. Secs. Litig., 94 F. Supp. 2d 652, 660 moreover, the allegedly fraudulent SEC filings to which (D. Md. 2000) (internal quotations and citations omitted). Plaintiffs refer expressly disclosed these transactions. With respect to the Individual Defendants' opportunities to engage in fraud, there can be little doubt that they could have, However, the allegations that the Individual Defendants had they wanted to, committed such acts. See, e.g., San were motivated to engage in fraud in order to forestall Leandro Emergency Med. Group Profit Sharing Plan v. Intrenet's default of its bank loan agreement and to preserve Philip Morris Cos., Inc., 75 F.3d 801, 813 (2d Cir. 1996) the Company's ability to borrow pursuant to its credit facility ("There is no doubt that defendants as a group had the warrant closer scrutiny. These more particularized sorts of opportunity [to manipulate stock prices]....[because they] held motive allegations are more probative of scienter. For the highest positions of power and authority within the example, as part of the mix of factors contributing to an company."). inference of scienter, the Ninth Circuit has considered a defendant's motivation to overstate a company's reported net The more important question in this case is whether the value so as not to violate loan covenants with its lender and Complaint alleges motives on the part of the Individual to improve the prospects of increasing its credit line. Howard Defendants from which the Court could infer a knowing or v. Everex Sys., Inc., 228 F.3d 1057, 1064 (9th Cir. 2000). reckless state of mind. In order to demonstrate motive, a We view the motive allegations concerning the bank loan and plaintiff must show concrete benefits that could be realized by credit facility as suggestive of scienter, although standing one or more of the false statements and wrongful alone they do not establish a strong inference. Accordingly, nondisclosures alleged. Phillips v. LCI Int'l, Inc., 190 F.3d we will consider these allegations, along with all others, in the 609, 621 (4th Cir. 1999). Our review of the cases cited by the totality of the circumstances analysis. See Helwig, 251 F.3d parties shows that courts distinguish motives common to at 551 (allegations of motive and opportunity are evaluated in corporations and executives generally from motives to the same manner as other circumstantial allegations to commit fraud. All corporate managers share a desire for their determine whether they produce a strong inference that the companies to appear successful. That desire does not defendant acted at least recklessly). comprise a motive for fraud. See Chill v. Gen. Elec. Co., 101 F.3d 263, 268 (2d Cir. 1996) ("such a generalized motive, one (f) Absence of Inside Sales which could be imputed to any publicly-owned, for-profit endeavor, is not sufficiently concrete for purposes of inferring The Complaint includes no allegations that the Individual scienter"). Neither does an executive's desire to protect his Defendants ever took advantage of Intrenet's purportedly position within a company or increase his compensation. See inflated stock prices by selling shares during the class period. Kalnit v. Eichler, 264 F.3d 131, 140 (2d Cir. 2001) ("an The Individual Defendants point out that the allegations of allegation that defendants were motivated by a desire to fraudulent motive which courts most often recognize as maintain or increase executive compensation is insufficient support for a strong inference of scienter are allegations that because such a desire can be imputed to all corporate insiders sold stock. Indeed, we mentioned in Helwig that officers"); Criimi Mae, 94 F. Supp. 2d at 660 (allegations that "insider trading at a suspicious time or in an unusual amount" defendants sought to "protect their executive positions," comprises one of the "fixed constellations of facts that courts standing alone, are inadequate to plead motive). Finally, have found probative of securities fraud." 251 F.3d at 552. No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 29 30 PR Diamonds, et al. v. Chandler, et al. No. 02-3921

Conversely, courts have explained that the absence of inside (g) Consultant sales dulls allegations of fraudulent motive. See, e.g., In re K- tel Int'l, Inc. Secs. Litig., 300 F.3d 881, 894 (8th Cir. 2002) The Complaint alleges that in early 2000, Intrenet hired an ("evidence that the individual defendants abstained from outside consultant to investigate problems in the Company's trading may undercut allegations of motive"); In re Northern accounting and internal control systems. The consultant Telecom Ltd. Secs. Litig., 116 F. Supp. 2d 446, 462 (S.D.N.Y. allegedly discovered improprieties, ultimately leading to the 2000) ("The absence of stock sales by insiders, or any other October 13, 2000, press release that initiated Intrenet's evidence of pecuniary gain by company insiders at collapse. Plaintiffs maintain that after the consultant was shareholders' expense, is inconsistent with an intent to hired and discovered the problems, a strong inference that the defraud shareholders....Even where company insiders sell Individual Defendants knew of or recklessly disregarded the stock during the class period, scienter is not necessarily problems is inescapable. inferred.") (citing Kalnit, 99 F. Supp. 2d at 337 and San Leandro Emergency Med. Group Profit Sharing Plan, 75 First of all, the Court is not willing to infer fraudulent intent F.3d at 814). from the fact that the Company hired a consultant to examine its accounting systems. If anything, this fact counters an However, we have never held that the absence of insider inference that the Individual Defendants were trying to keep trading defeats an inference of scienter. Cf. Hanon v. the alleged accounting problems hidden from view. Next, the Dataproducts. Corp., 976 F.2d 597, 507 (9th Cir. 1992) thrust of Plaintiff's argument seems to be that the outside (scienter can be established even if officers who made consultant "readily discovered" the accounting improprieties misleading statements did not sell stock during the class in a "short time period," and yet the Individual Defendants period). What is more, Plaintiffs' motive allegations in this continued to issue materially false and misleading financial case are not based on a claim that the Individual Defendants statements and press releases, and did not ultimately publicize sought to personally enrich themselves through sales of their the deficiencies to the investing public until "many months" own stock. See In re Nuko Info. Sys., Inc. Secs. Litig., 199 later, on October 13, 2000. In the intervening time, Plaintiffs F.R.D. 338, 344-45 (N.D. Cal. 2000) (when the complaint did maintain, the Individual Defendants must have known or at not assert claims of insider trading, the absence of defendants' best recklessly disregarded the truths the consultant selling or trading has little bearing on determining whether unearthed. See Danis v. USN Communications, Inc., 73 F. plaintiffs have adequately pleaded scienter). We also reject Supp. 2d 923, 939 (N.D. Ill. 1999) ("Problems readily the Individual Defendants' contention that their purchase of recognized by an outsider can be presumed to be known to a shares during the class period refutes any inference that they company's management and directors."). Therefore, Plaintiffs knowingly or recklessly misled the market to increase the urge, a strong inference of scienter is especially warranted stock's price. Plaintiffs allege, and Intrenet's 1999 10-K after the consultant arrived. suggests, that the Individual Defendants bought the stock to infuse cash to the Company as a condition precedent to The allegations regarding the consultant fail to support a obtaining a new bank agreement. For these reasons, the strong inference of the Individual Defendants' scienter absence of stock sales by the Individual Defendants works because they wholly lack factual particularity. The Complaint against but does not conclusively defeat an inference of offers the conclusory assertion that the consultant "swiftly" scienter. uncovered the accounting irregularities, but nowhere does it provide any meaningful information regarding when or in No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 31 32 PR Diamonds, et al. v. Chandler, et al. No. 02-3921

what manner the consultant made his discoveries. The In Helwig, this Court set forth a non-exhaustive list of relevant issue in determining scienter is not when the "factors usually relevant to scienter." 251 F.3d at 552. Few accounting improprieties occurred, but rather whether and of these factors emerge in this case. First, there are no when the Individual Defendants knew about them. There is no allegations of insider trading at a suspicious time or in an basis in the Complaint's allegations concerning the consultant unusual amount. Second, there are no specific allegations of from which the Court could conclude that the Individual a divergence between internal reports and external statements Defendants knew anything about the problems prior to the on the same subject. The allegations regarding the outside October 13, 2000, press release. Moreover, Plaintiffs fail to consultant lack any detail about when or to whom the specify what the consultant learned and how he learned it, consultant reported the information he allegedly discovered. other than offering the conclusory allegation that the Third, there is little temporal proximity between the allegedly consultant "discovered" Intrenet's alleged accounting fraudulent statements and the later disclosure of inconsistent improprieties. Claims of securities fraud cannot rest on information in October of 2000. Fourth, there are no speculation and conclusory allegations. Comshare, 183 F.3d allegations of bribery by a top company official. Fifth, there at 553-54. is no ancillary lawsuit charging fraud by the Company and the Company's quick settlement of the suit. Sixth, allegations (h) Summary of Scienter Allegations Against that the Individual Defendants disregarded the most current Individual Defendants factual information before making statements lack specific facts concerning how or when any accounting improprieties Plaintiffs have accumulated numerous circumstantial became known to them. Once again, the activities of the allegations from which they ask the Court to draw the strong consultant are so vaguely described as to offer little insight inference of scienter required for this case to move forward. into what the Individual Defendants knew or when they knew In the foregoing discussion, we noted that, while some of it. Seventh, the Complaint contains no allegations that these allegations suggest little about the Individual accounting information was disclosed in such a way that its Defendants' states of mind, other allegations favor the negative implications could only be understood by someone implication that they may have known, or were reckless in not with a high degree of sophistication. Eighth, there are no knowing, of the accounting problems at Intrenet and its true allegations of certain directors holding a personal interest in financial condition. See MicroStrategy, 115 F. Supp. 2d at not informing disinterested directors of a sale of stock. 649 ("Just as otherwise-unremarkable individual points of Finally, allegations of the Individual Defendants' self- colored paint in the aggregate become a Seurat painting, so, interested motivation in the form of saving their salaries or too, do the individual allegations in this case - which, when jobs only mildly suggest scienter. viewed in isolation may or may not by themselves give rise to a 'strong inference' of scienter - collectively paint an For all these reasons, the Section 10(b) and Rule 10b-5 equally compelling picture of scienter."). However, "[a] mere claims against the Individual Defendants were properly reasonable inference is insufficient to survive a motion to dismissed pursuant to Fed. R. Civ. P. 12(b)(6). dismiss." Greebel v. FTP Software, Inc., 194 F.3d 185, 196 (1st Cir. 1999). Even when added up and viewed in their entirety, the ultimate inference of scienter the allegations in this case raise is not strong - that is, the most plausible of competing inferences. No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 33 34 PR Diamonds, et al. v. Chandler, et al. No. 02-3921

B. Section 10(b) and Rule 10b-5 Claims Against form of intent (to deceive) than merely a greater degree of Andersen ordinary negligence") (internal quotations omitted). Scienter "requires more than a misapplication of accounting principles. Plaintiffs argue that the district court erred in dismissing the The [plaintiff] must prove that the accounting practices were Section 10(b) and Rule 10b-5 claims against Andersen on the so deficient that the audit amounted to no audit at all, or an basis that the Complaint failed to adequately allege that egregious refusal to see the obvious, or to investigate the Andersen acted with scienter. In Plaintiffs' view, the doubtful, or that the accounting judgments which were made Complaint alleges facts showing that Andersen was alerted to were such that no reasonable accountant would have made the Intrenet's internal control deficiencies and accounting errors, same decisions if confronted with the same facts." In re and thus knew of or recklessly disregarded the falsity of its Worlds of Wonder Secs. Litig., 35 F.3d 1407, 1426 (9th Cir. certifications that its audit was performed in accordance with 1994) (quoting SEC v. Price Waterhouse, 797 F. Supp. 1217, GAAS and that Intrenet's 1998 and 1999 financial statements 1240 (S.D.N.Y. 1992)). were presented in conformity with GAAP. Specifically, Plaintiffs claim that Intrenet's financial statements were "When the standard of recklessness for an auditor is admittedly false, the accounting improprieties were obvious overlaid with the pleading requirements of the PSLRA, a in nature and large in magnitude, numerous red flags arose to simple rule emerges: to allege that an independent accountant indicate the improprieties, and Andersen had access to or auditor acted with scienter, the complaint must allege Intrenet's confidential information. Moreover, the outside specific facts showing that the deficiencies in the audit were consultant allegedly quickly identified the problems once he so severe that they strongly suggest that the auditor must have came on board. Taken as a whole, Plaintiffs maintain, these been aware of the corporation's fraud." SmarTalk, 124 F. allegations are sufficient to raise a strong inference of Supp. 2d at 514 (citing Hollinger v. Titan Capital Corp., 914 Andersen's scienter but the district court mistakenly F.2d 1564, 1570 (9th Cir. 1990) and In re Software scrutinized each allegation in piecemeal fashion to reach its Toolworks, Inc., 50 F.3d 615, 628 (9th Cir. 1994)). "[T]o erroneous conclusion. allege that an independent accountant or auditor acted with scienter, the complaint must identify specific, highly The same PSLRA pleading standards we set forth in our suspicious facts and circumstances available to the auditor at discussion of the Section 10(b) and Rule 10b-5 allegations the time of the audit and allege that these facts were ignored, against the Individual Defendants apply to the allegations either deliberately or recklessly." SmarTalk, 124 F. Supp. 2d against Andersen. However, the meaning of recklessness in at 515. securities fraud cases is especially stringent when the claim is brought against an outside auditor. In re SmarTalk Once again, we examine Plaintiffs' allegations collectively Teleservices, Inc. Secs. Litig., 124 F. Supp. 2d 505, 514 (S.D. to determine whether the totality of the specific facts alleged Ohio 2000). Recklessness on the part of an independent create a strong inference of scienter. Telxon, 133 F. Supp. 2d auditor entails a mental state so culpable that it at 1026. The relevant allegations include that Andersen: "approximate[s] an actual intent to aid in the fraud being (1) was aware of internal control deficiencies at Intrenet; perpetrated by the audited company." Decker v. Massey- (2) committed numerous GAAP and GAAS violations; Ferguson, Ltd., 681 F.2d 111, 121 (2d Cir. 1982); Pegasus (3) disregarded certain red flags; and (4) had access to Fund, Inc. v. Laraneta, 617 F.2d 1335, 1341 (9th Cir. 1980) Intrenet's confidential information. Addressing these (auditor's recklessness "must come closer to being a lesser allegations in turn and collectively, we conclude that the No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 35 36 PR Diamonds, et al. v. Chandler, et al. No. 02-3921

Complaint lacks allegations of specific, highly suspicious Plaintiffs point out that under APB No. 20, a restatement is facts and circumstances that would lead us to reach a strong an admission that financial statements were materially false inference that Andersen acted with scienter when it certified at the time they were made; therefore, Plaintiffs argue, the Intrenet's financial statements. alleged accounting errors were material and Andersen's knowledge or reckless disregard of such errors can be 1. Internal Control Deficiencies inferred. This line of reasoning misapprehends the nature of the scienter inquiry. To support an inference of fraudulent Plaintiffs argue that Andersen turned a blind eye to scienter, allegations of GAAP and GAAS violations must numerous internal control deficiencies at Intrenet, which extend in nature and magnitude beyond merely the materiality allowed accounting improprieties to continue unchecked. threshold. We reject Plaintiffs' contention that Intrenet's $1.3 Yet, Plaintiffs offer no "specific, highly suspicious facts and million in underreported expenses allegedly resulting from circumstances" to support an inference that Andersen was Andersen's auditing failures "belies any conclusion that aware of these deficiencies or recklessly disregarded them, Andersen acted merely negligently." Likewise, the other than the assertions that Andersen had access to Intrenet's allegations regarding the failure to reserve against accounts confidential information and that the consultant quickly receivable do not "cry out" scienter. MicroStrategy, 115 F. discovered the deficiencies. The allegations concerning the Supp. 2d at 636-37. Taking the allegations as true, as we consultant are insufficiently specific to satisfy the PSLRA's must, Andersen's alleged failures were not so grievous as to requirements for pleading scienter. Nowhere does the suggest that their work was "no audit at all." Worlds of Complaint allege facts identifying, for example, the Wonder, 35 F.3d at 1426. These are not the sort of "in your consultant's level of access to Intrenet's financial records or face" accounting violations that, without additional "specific, how long the consultant took to reach conclusions. The Court highly suspicious facts and circumstances," support a strong would be remiss to infer Andersen's scienter based on the inference of scienter. See MicroStrategy, 115 F. Supp. 2d at conclusory assertion that what the consultant ultimately found 637; SmarTalk, 124 F. Supp. 2d at 515. out, Andersen must have known or recklessly disregarded. Once again, Plaintiffs point to the fact that Intrenet hired an 2. GAAP and GAAS Violations outside consultant in early 2000 as proof that Intrenet and its auditor were aware of the alleged accounting improprieties for Next, Plaintiffs contend that the Complaint alleges an extended period of time before they revealed them to violations of GAAS and failure to detect violations of GAAP investors. As we have already stated, the Complaint is largely of such simple and obvious nature and large magnitude so as devoid of any factual detail regarding how, when, and what to support a strong inference of Andersen's scienter. It is the consultant discovered. An inference of scienter on this well-settled that violations of GAAP and GAAS, standing basis would be unwarranted. alone, do not create an inference of scienter, much less a strong one. See Comshare, 183 F.3d at 553 (citing cases). 3. Red Flags However, when the alleged accounting errors are sufficiently basic and large, their existence, in combination with other Next, Plaintiffs allege that Andersen disregarded numerous factors, may support the requisite scienter inference. Telxon, red flags that alerted it to the accounting improprieties, 133 F. Supp. 2d at 1031. suggesting Andersen harbored scienter. A red flag creating a strong inference of scienter consists of "[a]n egregious refusal No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 37 38 PR Diamonds, et al. v. Chandler, et al. No. 02-3921

to see the obvious, or to investigate the doubtful." Novak v. sufficient..., it might make every auditor liable in cases of Kasaks, 216 F.3d 300, 308 (2d Cir. 2000) (citation and securities fraud."). However, while the mere fact that an internal quotation marks omitted). Two of the purported red auditor has access to a company does not necessary mean that flags simply repeat the alleged GAAP improprieties, namely, it was aware of alleged fraud at the company, the greater the that Intrenet lacked internal controls (which the outside auditor's "access to and involvement with" the company's consultant discovered in very little time), and that the operations, the more support an inference of scienter takes on. accounting problems turned Intrenet's losses into profits. The MicroStrategy, 115 F. Supp. 2d at 653. only genuine red flag consists of the allegation that during the year ended December 31, 1999, although Intrenet's net Accordingly, the Court takes into account Andersen's accounts receivable increased by approximately $4.4 million access to Intrenet's information, but even so doing, no strong during that year, or approximately 14%,while its operating inference of Andersen's scienter arises. Viewing in totality revenues increased by only 8%. Plaintiffs contend that these Andersen's access, along with the allegations of internal circumstances should have put Andersen on notice that control deficiencies, GAAP and GAAS violations, and red Intrenet's accounts receivable reserve was understated. flags, we do not believe that the most plausible inference to draw in these circumstances is that Andersen knew of or This supposed red flag fails to support a strong inference of recklessly disregarded the alleged material misstatements and scienter because Plaintiffs make no specific allegation that omissions in Intrenet's financial statements. Plaintiffs Andersen knew that certain accounts were not collectible and repeatedly attempt to bolster their allegations by pointing out knowingly participated in a scheme to hide that fact from that the outside consultant quickly discovered the accounting investors. In our judgment, a single year's difference in the irregularities, yet they offer almost no specific factual details ratio of the increase of receivables to operating revenues does regarding the consultant's work. For these reasons, the not make it "obvious" to an outside auditor that Intrenet's Section 10(b) and Rule 10b-5 claims against Andersen are receivables reserve was understated. properly dismissed. 4. Access to Confidential Information C. Section 20(a) Control Person Liability Claims Against the Individual Defendants Finally, Plaintiffs allege that Andersen's access to Intrenet's confidential information supports a strong inference of Plaintiffs contend that the district court erred in granting the scienter. According to the Complaint, Andersen's personnel Individual Defendants' motion for judgment on the pleadings were regularly present at Intrenet's corporate headquarters pursuant to Federal Rule of Civil Procedure 12(c) on the throughout the class period and had continual access to, and Section 20(a) claims. In Plaintiffs' view, the Section 20(a) knowledge of, Intrenet's confidential financial and business claims should proceed despite the absence of the Company as information. These allegations, by themselves, are not a defendant. We conclude that the Section 20(a) claims were enough to raise a strong inference of scienter because such properly adjudicated on the pleadings in the Individual allegations are insufficiently concrete to support such an Defendants' favor because the Complaint fails to plead a inference. See, e.g., Kennilworth Partners L.P. v. Cendant required predicate violation of Section 10(b) or Rule 10b-5 by Corp., 59 F. Supp. 2d 417, 429 (D.N.J. 1999) ("[S]tatement[s the Company, its employees, or the Individual Defendants. that] could be made in relation to the auditor of every corporation" are insufficient to plead scienter, for "[i]f it were No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 39 40 PR Diamonds, et al. v. Chandler, et al. No. 02-3921

Section 20(a) of the Exchange Act creates a cause of action course, is not a named party in this case because it is for "control person" liability, stating as follows: bankrupt. However, Plaintiffs contend that a company's controlling persons do not escape liability when the Every person who, directly or indirectly, controls any company's primary liability cannot be adjudicated due to its person liable under any provision of this title or of any unavailability. Second, with respect to the control rule or regulation thereunder shall also be liable jointly requirement, Plaintiffs argue that the Individual Defendants and severally with and to the same extent as such are controlling persons because by virtue of their top-level controlled person to any person to whom such controlled positions at Intrenet they had the power to control the person is liable, unless the controlling person acted in Company's general business affairs and the specific activities good faith and did not directly or indirectly induce that upon which the alleged primary violations were predicated. act or acts constituting the violation or cause of action. As extensively discussed above, we have reviewed the 15 U.S.C. § 78t(a). Section 20(a) thus establishes two Complaint de novo and determined that Plaintiffs have not requirements for a finding of control person liability. First, stated claims against the Individual Defendants under Section the "controlled person" must have committed an underlying 10(b) and Rule 10b-5 because the Complaint fails to violation of the securities laws or the rules and regulations adequately plead scienter. For the same reasons that the promulgated thereunder. Second, the "controlling person" Section 10(b) and Rule 10b-5 claims against the Individual defendant in a Section 20(a) claim must have directly or Defendants are properly dismissed as a matter of law, those indirectly controlled the person liable for the securities law allegations cannot serve as predicates for Section 20(a) violation. "Control" is defined as "the possession, direct or liability. We therefore need not further examine Plaintiffs' indirect, of the power to direct or cause the direction of the theory, which would impute the Individual Defendants' management and policies of a person, whether through the purported violations to the Company in order to establish the ownership of voting securities, by contract, or otherwise." requisite predicate liability of the controlled person, and then 17 C.F.R. § 230.405. double-back the liability onto the Individual Defendants as controlling persons under Section 20(a).4 In this case, Plaintiffs' Complaint alleges that the Individual Defendants are liable under Section 20(a) as controlling persons of Intrenet. First, with respect to the requirement for 4 an underlying primary violation, Plaintiffs maintain that both W ithout deciding the question, we note that some authority suggests that a plaintiff may not be ab le simultaneously to asse rt both Section 10(b) the Individual Defendants and the Company violated Section and Rule 10b-5 claims and Section 20(a) claims against the same 10(b) and Rule 10b-5. As for the Individual Defendants, defendant. "Arguab ly, a § 20 (a) claim canno t be asserted against a Plaintiffs argue that any Section 10(b) and Rule 10b-5 defendant who is also cha rged with primary violation of § 10(b) and Rule violations they committed should be imputed to Intrenet, 10b-5; that is, secondary liab ility under § 20(a) is an alternative, not a thereby establishing a primary violation on the Company's supp lement, to primary liability under § 10(b) and Rule 10b-5." Lemmer v. Nu-Kote Holding, Inc., No. CIV. A. 398CV0161L, 2001 WL 1112577, part as a controlled person. In other words, the Individual at *12 (N.D. Tex., Sept. 6, 2001), citing Kalnit v. Eichler, 85 F. Supp. 2d Defendants' violations are the Company's violations; if the 232, 246 (S.D.N .Y. 1999) (suggesting that plaintiffs could not allege Individual Defendants are liable, so too is Intrenet. As for the primary liability against the directors of a corporation and at the same Company, Plaintiffs claim that the Complaint includes time allege con trol person liab ility against the d irectors). See also In re securities fraud allegations against Intrenet itself. Intrenet, of Capstead Mo rtg. Corp. Secs. Litig., 258 F. Supp. 2d 53 3, 566 (N.D . Tex. 2003) (quoting the aforementioned passage from Lemmer); 183 A.L.R. No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 41 42 PR Diamonds, et al. v. Chandler, et al. No. 02-3921

Next, the Complaint fails to state a predicate Section 10(b) D. Leave to Amend the Complaint or Rule 10b-5 claim against Intrenet itself because it fails - indeed, hardly attempts - to plead scienter on the Company's Finally, Plaintiffs argue that the district court erred in part. So far as the Court can discern, the Complaint contains dismissing the case without affording them an opportunity to only a few sparse references to allegations against Intrenet as amend their Complaint. We recognize that when a motion to a Company or its employees other than the Individual dismiss a complaint is granted, courts typically permit the Defendants. Paragraph 36 of the Complaint states that losing party leave to amend. However, given the "Intrenet employees repeatedly recorded journal entries in circumstances of this case, leave to amend should be denied. violation of FCPA, without support or documentation, which Plaintiffs failed to follow the proper procedure for requesting the Defendants knew, or recklessly disregarded." This leave to amend, and even had they done so, denial would have allegation, standing alone, comes nowhere near to making out been appropriate so as to avoid "frustrat[ing] the purposes of a claim for violation of Section 10(b) or Rule 10b-5 on the the PSLRA." See Miller, 346 F.3d at 690. part of the unidentified "Intrenet employees." Next, a single paragraph of the Complaint, paragraph 96, pertains to the Generally, the review of a district court's denial of a motion Company's knowledge, rather than that of the Individual for leave to amend a complaint is governed by an abuse of Defendants. That paragraph precisely restates the purported discretion standard. See Crawford v. Roane, 53 F.3d 750, 753 misrepresentations and omissions making Intrenet's press (6th Cir. 1995); United States v. Midwest Suspension & releases and financial statements materially false and Brake, 49 F.3d 1197, 1202 (6th Cir. 1995). Review, however, misleading that Plaintiffs allege against the Individual is de novo where the reason for the district court's denial is Defendants, but this time claims "the Company knew of the because the amended pleading would not withstand a motion improper accounting practices...[and] knew or reasonably to dismiss. Ziegler, 249 F.3d at 518. In this case, the district should have known" of the misleading statements. This bare court did not discuss or state why it declined to offer assertion fails to raise a strong inference of the Company's Plaintiffs an opportunity to amend their Complaint. In fact, scienter and thus fails to state a claim. as the following discussion explains, there was no "motion" to deny. Accordingly, we will review the district court's Because the Complaint fails to state an underlying actions for abuse of discretion. securities law violation by a controlled person, we need not address the subsequent question of whether the Individual When a motion to dismiss is granted in a case not involving Defendants possessed an adequate degree of control to the PSLRA, the usual practice is to grant plaintiffs leave to support a Section 20(a) claim. The district court correctly amend the complaint. Generally, leave to amend is "freely granted the Individual Defendants' motion for judgment on given when justice so requires." Morse, 290 F.3d at 799 (6th the pleadings pursuant to Fed. R. Civ. P. 12(c) on the Section Cir. 2002) (quoting Fed. R. Civ. P. 15(a)). However, the 20(a) claims. Supreme Court has instructed that leave to amend is properly denied where there is "undue delay, bad faith or dilatory motive on the part of the movant, repeated failure to cure deficiencies by amendments previously allowed, undue Fed. 141 §2[b] (2003) ("It is a freq uent practice to plead in the alternative prejudice to the opposing party by virtue of allowance of the that a defendant is both a primary violator and a controlling person of amendment, futility of the amendment, etc." Foman v. Davis, primary violators, although, as som e courts have no ted, one cannot 371 U.S. 178, 182, 83 S. Ct. 227, 230 (1962). And while simultaneously be both."). No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 43 44 PR Diamonds, et al. v. Chandler, et al. No. 02-3921

Rule 15 plainly embodies a liberal amendment policy, in the Court would have considered the motions to dismiss in post-judgment setting we must also take into consideration light of the proposed amendments to the the competing interest of protecting the finality of judgments complaint....Absent such a motion, however, Defendant and the expeditious termination of litigation. Morse, 290 was entitled to a review of the complaint as filed F.3d at 800. "Thus, in the post-judgment context, we must be pursuant to Rule 12(b)(6). Plaintiffs were not entitled to particularly mindful of not only potential prejudice to the an advisory opinion from the Court informing them of non-movant, but also the movant's explanation for failing to the deficiencies of the complaint and then an opportunity seek leave to amend prior to the entry of judgment." Id. to cure those deficiencies. In this case, Plaintiffs failed to follow the proper procedure 214 F.3d at 784 (emphasis in original). for requesting leave to amend. They did not actually file a motion to amend along with an accompanying brief, as The Complaint had already been amended once. The required by the local rules governing practice before the district court granted in part and denied in part the Individual district court. Instead, they simply included the following Defendants' and Andersen's motion to dismiss on February request in their brief opposing the Defendants' motions to 26, 2002. However, final judgment was not entered until dismiss: "Alternatively, in the event the Court grants any part nearly five months later, when the district court granted the of the Defendants' motions to dismiss, plaintiffs respectfully Individual Defendants' motion for judgment on the pleadings. request leave to amend their Complaint." As the D.C. Circuit During the intervening time, Plaintiffs made no attempt to has found, "a bare request in an opposition to a motion to obtain leave to amend their Complaint. Moreover, Plaintiffs dismiss – without any indication of the particular grounds on never sought to alter, set aside, or vacate the district court's which amendment is sought, cf. Federal Rule of Civil judgment pursuant to Fed. R. Civ. P. 59 or 60. See Morse, Procedure 7(b) – does not constitute a motion within the 290 F.3d at 799 ("Following entry of final judgment, a party contemplation of Rule 15(a)." Confederate Mem'l Ass'n v. may not seek to amend their complaint without first moving Hines, 995 F.2d 295, 299 (D.C. Cir. 1993), quoted in D.E.&J. to alter, set aside or vacate judgment pursuant to either Rule Ltd. P'ship v. Conaway, 284 F. Supp. 2d 719, 751 (E.D. 59 or Rule 60 of the Federal Rules of Civil Procedure."). In Mich. 2003). This Court's disfavor of such a bare request in light of these procedural failings, the district court was within lieu of a properly filed motion for leave to amend was made its discretion to withhold granting Plaintiffs an opportunity to clear in Begala v. PNC Bank, Ohio, N.A., 214 F.3d 776, 784 amend the pleadings. (6th Cir. 2000): "What plaintiffs may have stated, almost as an aside to the district court in a memorandum in opposition Our recent decision in Miller set forth a rule that would to the defendant's motion to dismiss is also not a motion to warrant denying Plaintiffs leave to amend even if they had amend." As the Begala decision reasoned in affirming the followed the correct procedure. 346 F.3d 660. In that case, district court's dismissal of the plaintiffs' complaint with we held that "allowing repeated filing of amended complaints prejudice in that case, would frustrate the purpose of the PSLRA." Id. at 690. We considered the tension between Rule 15(a) of the Federal Had plaintiffs filed a motion to amend the complaint Rules of Civil Procedure and the PSLRA, which states that prior to th[e] Court's consideration of the motions to "[i]n any private action arising under this title, the court shall, dismiss and accompanied that motion with a on the motion of any defendant, dismiss the complaint if the memorandum identifying the proposed amendments, the [pleading] requirements...are not met." 15 U.S.C. § 78u- No. 02-3921 PR Diamonds, et al. v. Chandler, et al. 45

4(b)(3)(A). We resolved the tension in favor of the PSLRA, concluding that in light of that statute's requirements, "we think it is correct to interpret the PSLRA as restricting the ability of plaintiffs to amend their complaint, and thus as limiting the scope of Rule 15(a) of the Federal Rules of Civil Procedure." Id. at 692. Moreover, "the purpose of the PSLRA would be frustrated if district courts were required to allow repeated amendments to complaints filed under the PSLRA." Id. The "purpose" of the PSLRA is to screen out lawsuits having no factual basis, to prevent harassing strike suits, and to encourage attorneys to use greater care in drafting their complaints. See In re Champion Enters., Inc. Secs. Litig., 145 F. Supp. 2d 871, 873-74 (E.D. Mich. 2001), aff'd 346 F.3d 660 (6th Cir. 2003). Therefore, we affirmed the district court's decision to dismiss the complaint with prejudice for failing to meet the pleading requirements. Champion, 346 F.3d at 690. In light of our holding in Champion and Plaintiffs' procedural shortcomings, we hold that Plaintiffs should not be given yet another opportunity to amend their Complaint, and we affirm the district court's entry of final judgment against Plaintiffs. IV. Conclusion For the reasons stated above, the district court properly dismissed Plaintiffs' Section 10(b) and Rule 10b-5 claims against the Individual Defendants and Andersen. The district court also properly granted judgment on the pleadings in favor of the Individual Defendants on Plaintiffs' Section 20(a) claims. Finally, the district court did not abuse its discretion in not inviting Plaintiffs to amend their Complaint. For the foregoing reasons, the judgments of the district court are AFFIRMED.