Rosenberg v. Gould

• Decision Date: 09 January 2009
• Docket Number: No. 08-12392.,08-12392.
• Citation: 554 F.3d 962
• Parties: Ruth ROSENBERG, Individually and on behalf of all others similarly situated, Plaintiff, Witness Systems Investor Group, Plaintiff-Appellant, v. David B. GOULD, Nicholas Discombe, William Evans, Joel G. Katz, Thomas J. Crotty, et al., Defendants-Appellees.
• Court: U.S. Court of Appeals — Eleventh Circuit

554 F.3d 962

Ruth ROSENBERG, Individually and on behalf of all others similarly situated, Plaintiff Witness Systems Investor Group, Plaintiff-Appellant, v. David B. GOULD, Nicholas Discombe, William Evans, Joel G. Katz, Thomas J. Crotty, et al., Defendants-Appellees.

No. 08-12392.

United States Court of Appeals, Eleventh Circuit.

January 9, 2009.

David A. Bain, Atlanta, GA, Gregg S. Levin, Lance V. Oliver, Motley Rice LLC, Mt. Pleasant, SC, William H. Narwold, Motley Rice, LLC, Hartford, CT, for Appellant.

Ross A. Albert, Morris, Manning & Martin, LLP, Atlanta, GA, Dawn N. Wilson, Peter J. Macdonald, Wilmer Cutler Pickering Hale & Dorr-NY, New York City, for Appellee.

Appeal from the United States District Court for the Northern District of Georgia.

Before BIRCH and PRYOR, Circuit

Judges, and STROM,^* District Judge.

PRYOR, Circuit Judge:

This appeal presents the issue whether a complaint satisfies the heightened standard for pleading scienter, under section 10(b) of the Securities Exchange Act, 15 U.S.C. § 78j(b), when the complaint alleges that a chief executive officer who had granted backdated options in 2000 and 2001 later signed security filings and made other statements that minimally overstated earnings between 2004 and 2006. Shareholders who purchased stock of Witness Systems, Inc. between April 23, 2004, and August 11, 2006, filed a putative class action against Witness and its former chief executive, David B. Gould, for securities fraud in violation of section 10(b) of the Securities Exchange Act and Rule 10b-5 and against Gould for violation of section 20(a), 15 U.S.C. § 78t(a). The amended complaint alleged fraudulent reporting that caused the putative class economic harm when they bought shares at an inflated price. The district court dismissed the complaint with prejudice for failure to satisfy the heightened standard for pleading scienter and loss causation and denied a request by the class for leave to amend the complaint sub silentio. Because we conclude that the complaint fails to satisfy the standard for pleading scienter, we affirm.

I. BACKGROUND

From 2001 until the end of 2006, Gould was the chairman of the board of directors and chief executive officer of Witness. Before July 2001, Gould was the sole person responsible for granting stock options to non-officers who were employees below the rank of senior vice president. Gould allegedly granted and received thousands of backdated options. When Gould granted and received backdated options in 2000 and 2001, he signed filings for the Securities and Exchange Commission that represented that the options were granted at fair market value and did not need to be recorded as a compensation expense. During the class period, Gould allegedly misrepresented that revenue and earnings per share exceeded expectations and signed financial statements of Witness. Gould sold 38.9 percent of his stock during the class period for more than nine million dollars.

On May 17, 2006, Deutsche Bank publicly questioned the historical options grants of Witness. By May 19, Witness stock had fallen by $1.14 per share. Witness voluntarily investigated its historical practices but did not announce this investigation until July 27, 2006. Witness explained that the investigation would possibly result in adjustments to the financial statements of earlier periods. The next day, the share price dropped from $18.19 to $15.75.

On August 9, 2006, Witness announced that a special committee of its board had found discrepancies in the recorded grant dates of historical options and that it would record additional non-cash expenses in periods before 2005 for a total of approximately ten million dollars. On August 9, the share price dropped from $14.93 to $13.48. On February 8, 2007, six months after the end of the class period, the company issued a restatement that admitted that "substantially all grants issued prior to 2002" had inaccurate measurement dates and that it would record an additional 9.7 million dollars in stock-based compensation expenses.

Ruth Rosenberg, a shareholder of Witness, and the Witness Systems Investor Group filed, and later amended, a complaint against Witness, ten officers and directors, and an accounting firm. The defendants moved to dismiss the complaint for failure to satisfy the standard for pleading scienter and loss causation. The district court dismissed the complaint with prejudice. The shareholders appeal the dismissal of their complaint against only Witness and Gould.

II. STANDARDS OF REVIEW

Two standards of review govern this appeal. We review de novo the dismissal of a complaint for failure to state a claim. Stephens v. Dep't of Health & Human Servs., 901 F.2d 1571, 1573 (11th Cir.1990). We review the decision of the district court to grant or deny a request for leave to amend for abuse of discretion. Long v. Satz, 181 F.3d 1275, 1278 (11th Cir.1999).

III. DISCUSSION

Our discussion is divided in three parts. First, we address whether the shareholders' complaint satisfies the standard for pleading scienter. Because we hold that the complaint fails to satisfy that standard, we do not reach the question whether the complaint satisfies the standard for pleading loss causation. Second, we address whether the complaint states a claim of secondary liability under section 20(a). Third, we address whether the district court abused its discretion when it did not allow the shareholders to amend their complaint.

A. The Complaint Fails To Satisfy the Standard for Pleading Scienter.

The Private Securities Litigation Reform Act of 1995 imposes a heightened standard for pleading scienter. Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 127 S.Ct. 2499, 2504, 168 L.Ed.2d 179 (2007). A plaintiff must "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." 15 U.S.C. § 78u-4(b)(2). "An inference of scienter must be more than merely plausible or reasonable—it must be cogent and at least as compelling as any opposing inference of nonfraudulent intent." Tellabs, 127 S.Ct. at 2504-05. Three guidelines govern our review: (1) "courts must ... accept all factual allegations as true"; (2) "courts must consider the complaint in its entirety" and determine whether "all of the facts alleged, taken collectively, give rise to a strong inference of scienter, not whether any individual allegation, scrutinized in isolation, meets that standard"; and (3) "court[s] must take into account plausible opposing inferences." Id. at 2509. An allegation of "severe recklessness" must satisfy an exacting standard:

"Severe recklessness is limited to those highly unreasonable omissions or misrepresentations that involve not merely simple or even inexcusable negligence, but an extreme departure from the standards of ordinary care, and that present a danger of misleading buyers or sellers which is either known to the defendant or is so obvious that the defendant must have been aware of it."

Garfield v. NDC Health Corp., 466 F.3d 1255, 1264 (11th Cir.2006) (quoting Bryant v. Avado Brands, Inc., 187 F.3d 1271, 1282 n. 18 (11th Cir.1999)).

The complaint alleges that, because Gould granted and received backdated stock options in 2000 and 2001, he possessed fraudulent intent during the class period when he signed filings for the Securities and Exchange Commission and overstated earnings in announcements of quarterly results. The shareholders' complaint alleges the following facts as supporting a reasonable inference of Gould's scienter: (1) "[P]rior to July of 2001, Defendant Gould ... had the sole responsibility and authority to grant non-officer stock options"; (2) "`Inaccurate measurement dates were found to have been used for substantially all grants prior to 2002,'" and non-officers received backdated options prior to 2002; (3) "`Of the total $9.7 million additional stock-based compensation expense ... approximately $5.5 million relate[d] to non-officer grants'"; (4) "[I]n July of 2001, the Board of Directors created the Options Committee to which Gould ... [was] appointed ... [and options granted by the committee] `resulted in additional stock-based compensation expense of approximately $0.5 million'"; (5) "Gould was granted 1,196,000 options ... much of which was either backdated or springloaded"; and (6) Gould "made materially false and misleading statements during the Class Period." The shareholders also allege that the following facts provide circumstantial evidence of scienter: (1) Gould sold approximately 39 percent of his shares during the class period; (2) Defendants took "advantage of the artificial inflation in the price of Company shares" to acquire another company and raise additional capital through a secondary offering; and (3) "Gould resigned his positions on...