
USCA1 Opinion

	




             September 18, 1992                            UNITED STATES COURT OF APPEALS                                FOR THE FIRST CIRCUIT                                 ____________________        No. 91-2241        No. 92-1026                  AMY GREENSTONE, AND ALL OTHERS SIMILARLY SITUATED,                               Plaintiffs, Appellants,                                          v.                             CAMBEX CORPORATION, ET AL.,                                Defendants, Appellees.                                 ____________________                    APPEALS FROM THE UNITED STATES DISTRICT COURT                          FOR THE DISTRICT OF MASSACHUSETTS                   [Hon. Edward F. Harrington, U.S. District Judge]                                               ___________________                                 ____________________                                        Before                                 Breyer, Chief Judge,                                         ___________                        O'Scannlain,* and Cyr, Circuit Judges.                                               ______________                                 ____________________            Roger  W. Kirby  with whom  Jeffrey H. Squire,  Kaufman, Malchman,            _______________             _________________   __________________        Kaufmann  & Kirby, Thomas G.  Shapiro, Gretchen Van  Ness, and Shapiro        _________________  __________________  __________________      _______        Grace & Haber were on brief for appellants.        _____________            John D. Donovan, Jr.  with whom Andrew C. Pickett and Ropes & Gray            ____________________            _________________     ____________        were on brief for appellees.                                 ____________________                                 ____________________                                         -1-                                          1        _____________________        *Of the Ninth Circuit, sitting by designation.                       BREYER, Chief Judge.   The question on this appeal                               ___________             is  whether the  appellant's  complaint states  a claim  for             fraud under the federal securities laws, 15 U.S.C.   78j(b),             a claim that she  must plead "with particularity."   Fed. R.             Civ. P.  9(b).  The district court held that it did not, and             it dismissed the complaint.  We affirm that decision.                                          I                                   The Allegations                                   _______________                       The  plaintiff  (and  appellant), Amy  Greenstone,             filed a  securities fraud  claim against  Cambex Corporation             and several  of its  officers.  Her  complaint, in  essence,             says (1) that Cambex would sell its Cambex memory boards for             use  in IBM computers; (2)  that it would  accept IBM memory             boards as  "trade-ins;" (3) that  a lessor of  IBM computers             claimed that Cambex's business was unlawful, sued Cambex and             won; and (4) that Cambex should have disclosed the threat of             such a  lawsuit in advance. Her  complaint more specifically             alleged:                       l.  Cambex  Corporation  makes   various  computer                       products, including memory boards.                         2. In 1989  and 1990 Cambex sold memory boards for                       use in  IBM computers.  The  Cambex customer would                       replace the  IBM memory board in  his IBM computer                       with a Cambex memory  board.  Cambex would accept,                       as  a  trade-in in  part  payment  for its  memory                       board, the IBM memory  board that the Cambex board                       had replaced.  Cambex then would either resell the                                         -3-                                          3                       IBM memory board or lease the IBM memory board, to                       others, thereby obtaining additional revenue.                         3. If the Cambex customer had an IBM computer that                       he had  leased, rather  than bought,  Cambex would                               ______                       sometimes return the IBM board to the IBM computer                       before the  customer returned the IBM  computer to                       the IBM computer lessor.                       4. In  1989 and 1990 Cambex's financial statements                       showed significant revenues  from this "IBM memory                       board replacement"  activity.   During  this  time                       Cambex issued other public statements, which said,                       for   example,   that   its   sale   of   Cambex's                       "substantially better" memory boards,  and resale,                       or  lease,  of less  desirable  IBM  memory boards                       taken as trade-ins, made a "steady contribution to                       revenues   and   profits,"   helped  bring   about                       "steadily improving results,"  helped account  for                       Cambex's  "sound  performance,"  and, in  general,                       helped Cambex maintain profits.                       5.  On Friday,  February  1, 1991,  IBM Credit  (a                       subsidiary of  IBM and a lessor  of IBM computers)                       filed  a  lawsuit  against  Cambex.    IBM  Credit                       claimed in  essence that  the terms of  its leases                       prohibited its lessees (and Cambex)  from removing                       IBM's memory boards and  selling, or leasing, them                       to others without IBM Credit's approval.                       6. About  one month  later, Cambex and  IBM Credit                       settled  the lawsuit.   Cambex  agreed to  pay IBM                       about $6 million and  "to comply with IBM Credit's                       terms and conditions of its subleases."                       7.   Throughout 1989  and  1990 Cambex  executives                       knew that Cambex did  not have the legal  right to                       take,  and  to resell  or  lease,  the IBM  memory                       boards.                       8. On January 22, 1991, just before IBM's lawsuit,                       she bought 500 shares of  Cambex stock at a  price                       of $14 5/8 per share.  About two weeks later, just                       after the IBM lawsuit  became public, she sold the                       shares at $12 7/8  per share, a loss of  $1.75 per                       share, or 12% of the purchase price.  During those                                         -4-                                          4                       two  weeks, Cambex  stock had suddenly  climbed to                       $18  per share, from which height  it fell, on the                       day the lawsuit was  announced, to 11 3/4, closing                       the day at $13 1/4 per share.                       The complaint goes on  to claim, in general terms,             that the facts set  forth show that Cambex and  its officers             violated the securities law  -- law that forbids  any person             "in  connection with the purchase or sale" of securities, to             make an                       untrue statement of  a material fact  or                       to  omit   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 . . . .                       ____________________             17  C.F.R.    240.10b-5(b)(emphasis  added).   The complaint             argues  that Cambex's financial statements, though literally             true, were "misleading" in "light of the circumstances under             which they were made,"  for they failed to disclose Cambex's             potential legal liability to IBM lessors.                           The  district court  concluded that  the complaint             did  not state an actionable claim because it failed to meet             the requirement of Fed. R. Civ. P. 9(b), which says:                        In  all averments  of  fraud .  . .  the                       circumstances constituting fraud  . .  .                       shall be stated with particularity.               The   complaint  did   not  set  forth   "the  circumstances             constituting  fraud  .  . .  with  particularity." (Emphasis                                          ____  _____________                                         -5-                                          5             added).  For this  reason, it dismissed the complaint.   The             court  also  refused to  permit  the  plaintiff  to file  an             amended complaint.  She now appeals.                       After  examining  both   the  complaint  and   the             proposed amended complaint,  we conclude  that neither  sets             forth  a   claim   of  securities   fraud  with   sufficient             particularity.  In explaining our conclusion, we shall focus             on  the  proposed  amended  complaint,  which,  essentially,             reiterates  the initial  complaint  with additional  detail.             (Our conclusions apply to the initial complaint a fortiori).                                                             __________                                          II                               The Financial Statements                               ________________________                       The  complaint lists  specific statements  that it             says mislead by omission.   Many of these statements consist             of  figures, e.g.  revenue,  income and  profit figures,  on             Cambex's 1989 and 1990 income statements and balance sheets,             filed  with  the SEC  in those  years.   The  statements are             accurate   and  could   not   mislead   unless,  given   the                                                     ______             circumstances, an investor  would normally have expected  to             find some kind of qualification of the figures, disclosing a             significant   potential   liability.     Generally  Accepted             Accounting  Principles,  with   which  the  SEC   ordinarily                                         -6-                                          6             requires  compliance,  set  forth  rules  that  govern  such             disclosures.  The kindof potential liability at issuehere is                       a   loss    contingency   involving   an                       unasserted  claim   or  assessment  when                       there  has  been no  manifestation  by a                       potential claimant of  an awareness of a                       possible claim or assessment. . . .               Financial Accounting Standards Board  Statement No. 5,   10.             The rules  say that  financial statements need  not disclose                                                             ___             this kind of potential liability unless:                                              ______                       it is  considered probable that  a claim                       will   be  asserted   and  there   is  a                       reasonable possibility  that the outcome                       will be unfavorable.              Id.; see  Loss  &  Seligman,  Securities  Regulation  652-57             ___  ___                      ______________________             (1989) (discussing  application of  FASB Statement No.  5 to             the   disclosure  of   unasserted   legal  claims);   S.E.C.             Accounting   Release   (Dec.   20,   1973)   ("[P]rinciples,             standards,  and practices  promulgated  by the  FASB in  its             Statements and  Interpretations  will be  considered by  the             Commission  as having substantial authoritative support, and             those contrary to such FASB promulgations will be considered             to have  no such  support." (footnotes omitted));  S.E.C. v.                                                                ______             Steadman, Nos. 91-5090, 91-5130, 1992 WL142065, 7 (D.C. Cir.             ________             June  26, 1992) (considering FASB No. 5 in SEC suit alleging             that  company  failed  to  disclose  contingent  liability).             Given  the  kinds  of  qualifications  that investors  would                                         -7-                                          7             necessarily expect financial  statements to disclose,  we do             not see how these financial statements could have materially             misled  unless,  at  the  time Cambex  filed  its  financial             statements, Cambex  (and its officers) knew  that the future             IBM Credit suit was "probable."  The question is whether the             complaint alleges specific facts sufficient to  support that             claim.                       Conclusory Allegations.    The complaint  says, in                       _______________________             conclusory fashion, (1) that Cambex "knew" that IBM Credit's             leases forbade  Cambex's memory  trade-ins and (2)  that the             defendants  "knowingly  or recklessly"  published misleading             financial statements.   Appellant  argues that at  least the             first of these assertions satisfies Rule 9(b), for that rule             permits averments of "knowledge" in "general[]" terms.  Rule             9(b),  however, also  requires the  plaintiff to  plead "the             circumstances constituting  fraud . . . with particularity."             Fed. R.  Civ. P.  9(b).   And, one  cannot avoid the  latter             requirement   simply  through   a   general  averment   that             defendants "knew" earlier what later turned out badly.                         Case law  requires a  plaintiff to do  more.   The             courts have uniformly held inadequate a complaint's  general             averment of the defendant's "knowledge" of material falsity,             unless  the complaint  also sets  forth specific  facts that                                    ____                                         -8-                                          8             make it reasonable  to believe  that defendant  knew that  a             statement was  materially false  or misleading.   See, e.g.,             Wexner  v. First Manhattan Co.,  902 F.2d 169,  172 (2d Cir.             ______    ____________________             1990)  ("Although scienter  need not  be alleged  with great             specificity,  plaintiffs  are still  required  to  plead the             factual basis  which gives rise  to a 'strong  inference' of             fraudulent intent."  (citation omitted)); DiLeo  v. Ernst  &                                                       _____     ________             Young,  901 F.2d 624,  629 (7th  Cir.) ("Although  Rule 9(b)             _____             does  not   require  'particularity'  with  respect  to  the             defendants' mental state, the  complaint still must afford a             basis for believing that plaintiffs could prove scienter."),             cert.  denied, 111  S. Ct.  347 (1990);  Romani v.  Shearson             _____  ______                            ______     ________             Lehman Hutton, 929 F.2d 875, 878 (1st Cir. 1991)  ("Although             _____________             a plaintiff  need not specify the  circumstances or evidence             from  which  fraudulent   intent  could  be   inferred,  the             complaint  must  provide  some   factual  support  for   the             allegations of fraud.  The requirement that supporting facts             be pleaded  applies even when  the fraud relates  to matters             peculiarly  within  the knowledge  of  the  opposing party."             (citations omitted));  Wayne Inv.,  Inc. v. Gulf  Oil Corp.,                                    _________________    _______________             739 F.2d 11, 14  (1st Cir. 1984) (same); Luce  v. Edelstein,                                                      ____     _________             802  F.2d 49, 54 n. 1 (2d  Cir. 1986) ("To satisfy Rule 9(b)             [with  respect  to  matters peculiarly  within  the opposing                                         -9-                                          9             party's knowledge], the allegations must be accompanied by a             statement  of the facts upon which the belief is founded.");             Craftmatic Sec.  Litig. v. Kraftsow,  890 F.2d 628,  645 (3d             _______________________    ________             Cir. 1989)  ("[E]ven under a non-restrictive  application of             [Rule  9(b)],  pleaders  must  allege   that  the  necessary             information  lies  within  defendants'  control,  and  their             allegations must be  accompanied by a statement of the facts             upon which the allegations are based.").                       Were the  law otherwise,  a complaint could  evade             too easily  the "particularity"  requirement in  Rule 9(b)'s             first  sentence.   Suppose,  for  example,  that  in 1991  a             corporation  projects substantial  revenues in  the upcoming             year.   Suppose the corporation's actual 1992  sales are 50%             less than predicted.  To permit a securities fraud complaint             to  state, without  more, that the  corporation's executives             "knew"  in 1991 about the likely decline in 1992 sales would             sanction what  Judge Friendly  called "fraud  by hindsight,"             Denny  v.  Barber,  576 F.2d  465,  470  (2d  Cir. 1978),  a             _____      ______             practice that courts  have not allowed.   To understand  the             type of  "particularity" that this Circuit  has required, we             have examined Romani.  In that case, this Circuit considered                           ______             a  complaint that  charged that  a company's  rosy financial             predictions made in mid-1986 were  misleading.  See 929 F.2d                                                             ___                                         -10-                                          10             at  877-79.  The complaint conceded that early 1986 had been             profitable but, to show knowledge of falsity, it pointed (1)             to the company's later, actual poor financial performance in             1987-1989, see id.  at 877,  and (2) to  a company  document                        ___ ___             that  said the  company had  begun to  experience cash  flow             problems in late 1986 or early 1987, only a few months after                                                                    _____             it had predicted a bright future.  See id. at  878-79.  This                                                ___ ___             court found that these  allegations were not specific enough             to meet the Rule 9(b) threshold.  See id. at 880.                                                 ___ ___                       The   "hindsight"  at  issue  in  Romani  involved                                                         ______             inferring,  from later  poor performance,  earlier knowledge             that such later performance was  likely.  The "hindsight" at             issue here involves inferring, from a later lawsuit, earlier             knowledge  that  such  a  lawsuit was  likely.    A  general             averment of such knowledge,  without more, will not do.   We             must  decide  whether  the  specific facts  alleged  in  the             complaint before us are different enough from those at issue             in Romani to warrant a different legal result.                ______                       Specific Factual Allegations.  As appellant points                       _____________________________             out, her complaint  does more than make a  simple conclusory             assertion   of  "knowledge"   of  falsity   (or  "misleading             incompleteness").  It also alleges four specific facts that,             appellant claims, offer adequate support for the proposition                                         -11-                                          11             that  the  defendants, in  1989 or  1990,  knew that  an IBM             Credit lawsuit (or the like) was probable.                         First, the  complaint points  out that  IBM Credit             did, in fact,  bring a  lawsuit in  early 1991,  only a  few             months after Cambex filed a financial statement that omitted             to mention this potential future liability.  The bringing of             the  lawsuit tends to show its earlier likelihood.  And, the             existence  of   that  likelihood   helps   support  (in   an             evidentiary sense) an inference  that defendants knew  about             that likelihood.                         We can  understand how sometimes a  later lawsuit,             say a  lawsuit charging bribery  by a top  company official,             might   constitute   fairly  strong   evidence   of  earlier             knowledge,  say that the top  official knew (a  few weeks or             months before)  of the liability-causing,  underlying facts.             But, sometimes  the later  lawsuit would not  readily permit             such an inference.  All  depends upon the lawsuit's  subject             matter and  the underlying circumstances.  In this case, the             appellant's  complaint is  not specific.   It  describes IBM             Credit's allegations in general terms; it does not set forth             the IBM Credit lease language; nor does it offer any factual             reason to believe that Cambex feared a lawsuit based on that             language.  To  the contrary, the complaint  makes clear that                                         -12-                                          12             Cambex publicized its IBM  memory "trade-in" practice with a             candor that  seems inconsistent with knowledge of illegality             or fear of a lawsuit.  See S.E.C. v. Steadman, Nos. 91-5090,                                    ___ ______    ________             91-5130, 1992 WL142065, 4  (D.C. Cir. June 26, 1992).   Once             we look past the complaint's conclusory characterizations to             the facts  that it characterizes,  we cannot find,  in those             facts, a lawsuit  based upon the kind of egregiously illegal             practice  the illegality of which Cambex officials, earlier,             would  have had  to have  known.   Cf. Barker  v. Henderson,                                                ___ ______     __________             Franklin,  Starnes & Holt, 797 F.2d 490, 497 (7th Cir. 1986)             _________________________             (case  against, say,  conspirator "may  not  rest on  a bare             inference that  the defendant  'must have had'  knowledge of             the facts.").                       Second, the  complaint says that  a Cambex officer             sold stock  in Cambex before  IBM Credit filed  its lawsuit.             Insider  trading in  suspicious  amounts  or  at  suspicious             times, of course, could help the appellant.  See In Re Apple                                                          ___ ___________             Computer Sec. Litig., 886  F.2d 1109, 1117 (9th Cir.  1989),             ____________________             cert. denied, 496 U.S.  943 (1990).  But the  complaint does             _____ ______             not tell  us when the Cambex  officer sold the stock.   And,             the complaint indicates that the  insider sold his shares at             an  average price under $14, only about 75 cents higher than             the  $13  1/4 price  at which  Cambex  stock sold  after IBM                                                                _____                                         -13-                                          13             Credit announced its suit.   The stock sale  allegation does             not help the plaintiff.                       Third,  the complaint  says  that the  defendants'             "knowledge  is shown by the fact that Cambex agreed with its             customers  to 'restore' IBM memory  units at the  end of the             customer's lease term with IBM credit."   This fact tends to             show  that Cambex  believed it  was supposed  to  return IBM             memory  boards in  leased computers  to IBM.   But,  it also             shows that Cambex did  so.  It shows nothing  about Cambex's             knowledge  of the  likely legality  or illegality  of Cambex             accepting IBM  memory boards and re-leasing  them during the             period of the IBM computer's lease from IBM Credit.  One can             as easily argue that Cambex thought returning the boards  to             the  IBM machine  would  satisfy IBM  Credit,  as argue  the             contrary.                       Fourth,  the complaint alleges that Cambex quickly             settled the lawsuit for  a large amount of money  (more than             $5  million).    We agree  that  this  allegation  helps the             appellant.    She  can reasonably  argue  that  it helps  to             support a chain of  inferences: 1) that the suit  was valid,             2) that  its underlying assertion (that  IBM Credit's leases             gave IBM Credit  the right  to control Cambex's  use of  IBM             memories)  was true,  3) that  Cambex must  have known  this                                         -14-                                          14             earlier,  and  4)  that  Cambex therefore  must  have  known             earlier that a lawsuit (or the equivalent) was probable.  In             our  view, however,  this  single, factual  keystone --  the             settled  lawsuit -- is not  strong enough to  bear the great             overarching weight of factual inference the plaintiff wishes             it to support.                         Our  conclusion, in  part,  reflects logic.    The             inferential links are weak.  Does the  quick settlement, for             example, suggest pre-lawsuit  knowledge and recalcitrance or             post-lawsuit surprise?  And, how does the fact of settlement             circumvent the  vagueness  of pre-lawsuit  circumstances  we             have discussed above?                         Our conclusion, in part, reflects precedent.   The             complaint before us resembles  too closely the complaints in             Romani  and other  "fraud  by hindsight"  cases to  permit a             ______             different result here.   See e.g., Romani, 929 F.2d  at 880;                                      ___ ____  ______             Bryson v. Royal Business  Group, 763 F.2d 491, 494  n.7 (1st             ______    _____________________             Cir. 1985); Sinay v.  Lamson & Sessions Co., 948  F.2d 1037,                         _____     _____________________             1042 (6th Cir. 1991); Dileo, 901 F.2d at 628 (citing Denny);                                   _____                          _____             Berliner v. Lotus Dev. Corp., 783 F. Supp. 708, 710 (D. Mass             ________    _______________             1992);  Urbach v.  Sayles,  779 F.  Supp.  351, 358  (D.N.J.                     ______     ______             1991).    Finally,  our  conclusion, to  a  degree, reflects             policy.  Given  the costs  of lawsuits to  the parties,  the                                         -15-                                          15             public problems associated  with overcrowded court  dockets,             and  the   correlative  public   and  private  benefits   of             settlements, we  fear a  rule of  law that  would discourage             settlements  by  permitting securities  fraud  plaintiffs to             make their claims by  pointing to later-settled lawsuits and             nothing more.                         For  these  reasons,  we  believe  that  Rule 9(b)             forbids  a  plaintiff  to  assert a  fraud  claim  simply by             pointing to a later-settled  lawsuit the factual relation of             which  to earlier fraud is as uncertain as that described in             the complaint before us.                                         III                                   Other Arguments                                   _______________                       We   consider   two   additional  arguments   that             appellant might  make in response  to our analysis.   First,             appellant's complaint,  as she has written  it, focuses less             upon  the  IBM  Credit  lawsuit than  our  opinion  implies.             Rather, the  complaint frequently refers to  the defendants'             knowledge, not of the lawsuit, but of certain critical facts             underlying  the lawsuit, such  as the fact  that IBM Credit,             not  Cambex, owned  the  IBM memories  that  Cambex took  in             trade.   The  problem with these  allegations (and  with any             argument  based  on  them)  is that  the  complaint  nowhere                                         -16-                                          16             explains  how these  facts  (facts about  rights to  control             memories)  are material,  except  insofar as  they formed  a                                       ______             basis for  IBM Credit's legal  claim, which claim,  in turn,             led to a significant  Cambex financial loss.  As far  as the             complaint is concerned, Cambex's financial  statements could             have misled through omission only insofar as they omitted to             disclose  the  likelihood  of  that  potential  loss-causing             lawsuit.   And, for reasons stated in Part II, the complaint             does not  set forth sufficient  specific facts to  justify a             belief  that  the  defendants  knew  that  the  loss-causing             lawsuit was likely.                       Second, the complaint sets  forth a host of Cambex             statements, other than income statements and balance sheets,             related  to Cambex's  IBM memory  trade-in activity  and its             profitability.    It  says  that  Cambex,  in  making  these             (literally accurate) statements, materially misled investors             by failing to qualify them by noting the likelihood that the             activity would  create considerable Cambex liability  to IBM             Credit.  And, these statements may be subject to a different             potential liability-disclosing standard  than formal  income             statements  or  balance  sheets.     See,  e.g.,  17  C.F.R.                                                  ___   ____              229.303(a)(3)(ii) (requiring description  of "known  trends             or uncertainties that have had or that registrant reasonably                                         -17-                                          17             expects  will  have  a  material  favorable  or  unfavorable             impact.  . . ."); S.E.C. Rel. Nos 33-6835, 34-26831 (May 18,             1989)  (under  229.303,  "A disclosure  duty exists  where a             trend,  demand, commitment,  event  or  uncertainty is  both             presently known to management  and reasonably likely to have             material effects on the registrant's financial  condition or             results of operation.")                         We need not investigate  the merits of this claim,             however, nor need we decide whether the appropriate standard             is knowledge (1) that  an IBM Credit lawsuit  was "probable"             or   (2)  that  the  lawsuit  (or  some  similar  loss)  was             "reasonably likely".   Whether  the standard  is one  or the             other  or   yet  some   third  similar  standard   (such  as             "reasonably expects"), we should reach the same result.  The             complaint,  for the  reasons  set forth  in  Part II,  fails             adequately to specify facts that would meet any of them.  We             cannot find  specific factual  allegations in  the complaint             that set forth a basis for the conclusion that Cambex or its             officers knew  of a significant possibility  of loss flowing             from  the IBM  Credit leases  prior to  the time  IBM Credit             filed its lawsuit.                        For  these reasons,  the judgment of  the district             court is                                         -18-                                          18                       Affirmed.                       _________                                         -19-                                          19
