Greebel v. FTP Software, Inc.

United States Court of Appeals

For the First Circuit

No. 98-2194

LAWRENCE M. GREEBEL, RICHARD CRANE,

BRIAN D. ROBINSON, and JOHN and ANN SOMERS

on behalf of themselves and

all others similarly situated,

Appellants,

v.

FTP SOFTWARE, INC.; ROBERT W. GOODNOW, Jr.;

PENNY C. LEAVY; DOUGLAS F. FLOOD; JONATHAN RODIN;

CHARLOTTE H. EVANS; and DAVID H. ZIRKLE,

Appellees.

APPEAL FROM THE UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF MASSACHUSETTS

[Hon. Joseph L. Tauro, U.S. District Judge]

Before

Torruella, Chief Judge,

Noonan and Lynch, Circuit Judges.

Stephen Moulton, with whom Nancy Freeman Gans and Moulton &

Gans, LLP, and Sanford P. Dumain, with whom Samuel H. Rudman and

Milberg Weiss Bershad Hynes & Lerach LLP, were on brief, for

appellants.

Bruce G. Vanyo, with whom Jerome F. Birn, Jr., Rebecca A.

Mitchells, and Wilson Sonsini Goodrich & Rosati, were on brief for

appellee FTP Software, Inc.

Jeffrey B. Rudman, with whom Peter J. Macdonald and Hale and

Dorr LLP, were on brief, for individual appellees.

Harvey J. Goldschmid, General Counsel, Jacob H. Stillman,

Solicitor, Eric Summergrad, Deputy Solicitor, and Luis de la Torre,

Attorney, on brief for amicus curiae Securities and Exchange

Commission.

October 8, 1999

LYNCH, Circuit Judge. This case requires us for the

first time to interpret the provisions of the Private Securities

Litigation Reform Act of 1995, 15 U.S.C. 78u-4. Plaintiffs,

purchasers of FTP Software stock from July 14, 1995 to January 3,

1996, brought suit under sections 10(b) and 20(a) of the Securities

Exchange Act of 1934, 15 U.S.C. 78j(b), 78t(a). During the

period of plaintiffs' purchases, the stock reached a high of

$38.875 per share. On January 4, 1996, the company announced that

sales growth had declined and that it would have lower earnings.

That same day, the stock price fell 52% on heavy trading, from

$25.25 to $11.875 per share. By August 9, 1996, the stock price

was $8 per share. Plaintiffs' suit was filed on March 3, 1996. It

was dismissed on September 24, 1998. See Greebel v. FTP Software,

Inc., 182 F.R.D. 370, 376 (D. Mass. 1998).

We affirm the dismissal of the complaint under the

standards we now adopt:

1. The PSLRA imposes requirements for pleading with particularity

that are consistent with this circuit's prior rigorous requirements

for pleading fraud with particularity under Fed. R. Civ. P. 9(b).

2. The PSLRA mandates neither the adoption nor the rejection of

particular patterns of evidence to prove fraud and scienter, and

thus does not alter this circuit's prior law on these points.

3. The PSLRA does, significantly, impose a requirement that

pleadings raise a "strong" inference of scienter rather than a

merely "reasonable" inference of scienter.

4. The PSLRA does not alter the previous definition of scienter,

one that in this circuit includes a narrowly defined concept of

recklessness which does not include ordinary negligence, but is

closer to being a lesser form of intent.

I

The district court denied defendants' first motion to

dismiss largely on the basis of the complaint's allegations that

defendants had routinely "whited out" the contingency terms

inserted by customers into purchase orders; this was allegedly done

in furtherance of a scheme to inflate revenues by improperly

booking contingent transactions as final sales. After limited

discovery, the district court concluded that plaintiffs could not

prove the white-out claims and entered judgment on those claims.

The defendants renewed their motion to dismiss the complaint, and

the plaintiffs, in response, sought to make their allegations of

fraud more specific by referring to discovered documents, but did

not formally move to amend. The district court dismissed the

complaint with prejudice, thus effectively denying the plaintiffs

an opportunity to amend their complaint. The court did so without

deciding whether, in light of the new evidence and allegations, the

complaint was adequate to survive.

Plaintiffs appeal saying that summary judgment on the

white-out allegations was inappropriate; that they are given refuge

by Rule 56(f); that the dismissal of the remaining allegations was

improper; and that they were entitled to amend their complaint.

II

The complaint alleges the following. FTP Software, Inc.

develops, markets, and supports Internet and Intranet software for

personal computers and networks. By the beginning of the Class

Period (from July 14, 1995 to January 3, 1996), the demand for

FTP's software was diminishing because many of FTP's clients were

either developing the technology themselves or acquiring competing

systems from other manufacturers, such as Microsoft and Netscape.

Microsoft, for example, was incorporating networking capabilities

into its new Windows 95 software, free of additional charge. In

addition, FTP was struggling to keep pace with "revolutionary"

technological developments that threatened to render its software

obsolete. In response, FTP and several of its directors and

officers through fraudulent schemes inflated FTP's stock price and

then made various false statements and material omissions.

Plaintiffs allege that FTP failed to disclose the threats

to its continued success, as well as several "questionable" sales

practices. These included the making of "warehouse shipments" --

that is, booking a fictitious sale of a product to a non-existent

buyer, shipping that product to a warehouse for storage, and then

eventually returning it to FTP. According to plaintiffs, one FTP

employee who complained about these shipments, and who refused (in

at least one instance) to sign for the product return, was

dismissed as a result of his protest, all before the Class Period.

Other objectionable sales practices included excessively discounted

sales (as high as 90%) and "channel stuffing" activity that

compressed sales and orders into the final weeks of a fiscal

quarter, with the intention of "cosmetically" improving the

reported results for that quarter. Finally, plaintiffs say that

FTP failed to disclose its practice of inducing distributors to

purchase more product than they needed by promising that the

distributors could return the unsold product. Distributors would

send their orders to FTP with a notation that they were entitled to

return any unsold product. FTP then booked these sales as revenue,

but because FTP understood that recognizing such sales as revenue

was improper (because of a right of return existed), it allegedly

instructed the sales force to white-out these right-of-return

notations on the distributors' order forms.

FTP also made several statements that the plaintiffs

characterize as false or materially misleading. On July 14, 1995,

the first day of the Class Period, David Zirkle, FTP's President

and Chief Executive Officer, reported FTP's financial performance

results for the second fiscal quarter of 1995. Zirkle declared:

"We are pleased with our performance for the second quarter. Sales

continue to be strong in both our U.S. and international channels."

Zirkle also touted the release of several new products, stating

that "[t]hese products should help us achieve our revenue objective

for the second half of 1995." Plaintiffs argue that these comments

"falsely convey[ed] the impression that sales were, and would

continue to be, healthy and strong" and that this false impression

was deliberately aided by FTP's failure to disclose that in or

around January 1995, the French Post Office canceled its planned

purchase of $10 million of FTP products "due to the impending

release of 'Windows '95.'"

On the same day, Zirkle discussed FTP's impending

corporate "reconfiguration" into two business units. He predicted

that "FTP Software [would] lead the market in providing

applications and support that make it possible to share information

and access resources across workgroups, LAN's, enterprise networks

and the global Internet." After this announcement, FTP's stock

fell from $31.75 to $28.25. Zirkle dismissed this decline as

merely "a 'knee-jerk' reaction to the short-term impact of the

restructuring on earnings," and on the next trading day, the stock

recovered, closing at $30.875. Plaintiffs argue that these

comments were misleading because Zirkle did not disclose that FTP's

costly investments in its reorganization would have to be continued

over the long term.

FTP's management team next met with "the investment

community and with securities analysts" to promote the company's

products and stock. One securities firm rated FTP as a "long-term

buy." Plaintiffs assert that this report "and the estimates

contained therein were based upon communications with the

management of FTP and were of a nature that could only have been

provided (or be based on specific information provided) by [FTP]

and its management."

Meanwhile, several of the individual defendants sold some

of their FTP stock. In total, the six individual defendants sold

over $23 million in stock during the Class Period.

Zirkle made another false statement, plaintiffs say, on

October 25, 1995, when he reported FTP's financial results for the

third quarter of fiscal year 1995:

This was another excellent quarter for FTP. Sales

continue to grow both in our U.S. and international

channels . . . . Our new ventures are also off to a good

start with revenues of $2.7 million. . . . These new

products have been well received by our channel partners

and customers and will help us in our efforts to achieve

fourth quarter revenue objectives.

Plaintiffs assert that the "new ventures" Zirkle referred to were

failing to generate the expected new business.

On November 15, 1995, FTP filed its Form 10-Q report for

the third quarter of 1995 with the SEC. The report revealed a

dramatic increase in accounts receivable for the fiscal year ending

on December 31, 1994. FTP explained that:

Such an increase is primarily attributable to increased

unit sales and a relative increase, during the third

quarter of 1995, in the number of units shipped during

the last month of such quarter compared to prior

quarters. The Company believes that it may continue to

experience such a relative increase as it continues to

grow, as is typical in the software industry.

Plaintiffs claim that the 10-Q report, and these statements, were

false and misleading because the increased unit sales were subject

to the purchasers' right to return unsold merchandise and were not

the result of FTP's growth.

FTP continued the "drumbeat" of misleading positive

statements, according to plaintiffs, when Zirkle, speaking in an

interview published in the November 27 - December 3, 1995 issue of

Mass High Tech, said that "[t]he networking business (TCP/IP) is a

cash cow that is feeding the development of other businesses, which

are feeding back new technology that makes the core business even

better." In December 1995, two other securities firms issued

positive reports on FTP; after these statements, FTP's stock rose.

Finally, the complaint alleges, the "truth [began] to

emerge" on January 4, 1996, when FTP announced that its earnings

for the fourth fiscal quarter of 1995 would be less than the same

period in 1994. FTP stated that this decline reflected, in part,

the company's investment in its New Ventures Business Unit, but,

nonetheless, the company's stock fell $13.375 per share to close at

$11.875 per share (a one-day decline of 52%). Plaintiffs emphasize

that this decline represented a $27 drop in market value (an

approximately 70% decrease) from a Class Period high of $38.875 per

share.

III

On March 3, 1996, plaintiffs brought suit against FTP and

the individual defendants for violations of sections 10(b) and

20(a) of the Securities Exchange Act of 1934. The defendants moved

to dismiss. The procedural history was recited above. The

district court ultimately granted summary judgment on the white-out

allegations because plaintiffs' only witness, Ms. Trudy Nichols,

was unavailable and her testimony was potentially inadmissible (as

hearsay). Furthermore, the plaintiffs did not establish that the

defendants had ordered the alteration of any documents.

The district court also granted the defendants' renewed

motion to dismiss. The court found that the complaint failed to

plead the circumstances of fraud with specificity, and could not

even meet the pleading standards required to establish scienter

under Fed. R. Civ. P. 9(b).

IV

Interpretation of the PSLRA

The enactment of the PSLRA in 1995 marked a bipartisan

effort to curb abuse in private securities lawsuits, particularly

the filing of strike suits. See H.R. Conf. Rep. No. 104-369, at

32 (1995), reprinted in 1995 U.S.C.C.A.N. 730, 731.

The PSLRA restated the requirements for securities fraud

actions at subsections 21D(b)(1) and (2), codified at 15 U.S.C.

78u-4(b)(1)-(2). Those provisions, involved here, read as follows:

(b) Requirements for securities fraud actions

(1) Misleading statements and omissions

In any private action arising under this chapter in

which the plaintiff alleges that the defendant -

(A) made an untrue statement of a material fact; or

(B) omitted to state a material fact necessary in

order to make the statements made, in the light of

the circumstances in which they were made, not

misleading;

the complaint shall specify each statement alleged to

have been misleading, the reason or reasons why the

statement is misleading, and, if an allegation regarding

the statement or omission is made on information and

belief, the complaint shall state with particularity all

facts on which that belief is formed.

(2) Required state of mind

In any private action arising under this chapter in

which the 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 alleged to violate this chapter, 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)(1)-(2).

The parties and the SEC as amicus have framed different

possible interpretations of these provisions. Essentially, these

questions are raised:

First, did the PSLRA alter the standards for pleading fraud with

particularity previously adhered to by this circuit?

Second, did the PSLRA restrict the characteristic patterns of facts

that may be pleaded in order to establish a "strong inference" of

scienter? Specifically, are the two methods of showing scienter

endorsed earlier by the Second Circuit -- motive and opportunity or

circumstantial evidence of reckless or conscious behavior

sufficient to raise a "'strong inference' of fraudulent intent,"

see, e.g., In re Time Warner Inc. Sec. Litig., 9 F.3d 259, 268-69

(2d Cir. 1993) (quoting O'Brien v. National Property Analysts

Partners, 936 F.2d 674, 676 (2d Cir. 1991) (internal quotation

marks omitted)) -- now available?

Third, did the PSLRA alter the scienter requirement for actions

under section 10(b) and Rule 10b-5, 17 C.F.R. 240.10b-5?

Specifically, is some form of recklessness sufficient to satisfy

the scienter requirement?

The parties and amicus all rely heavily on competing

excerpts from the congressional history of the Act and on the pre-

Act case law from the Second Circuit.

The words of the statute are the first guide to any

interpretation of the meaning of the statute. The usual maxim is

that courts do not go beyond the text of the statute if the meaning

is plain. See United Food & Commercial Workers Union, Local 328 v.

Almac's Inc., 90 F.3d 1, 5 (1st Cir. 1996). But that maxim has

inherent flexibility. Even seemingly straightforward text should

be informed by the purpose and context of the statute. See

Stafford v. Briggs, 444 U.S. 527, 535 (1980); Puerto Rico Tel. Co.

v. Telecommunications Regulatory Bd., No. 98-2228, 1999 WL 618061,

at *6 (1st Cir. Aug. 19, 1999). Both this court and the Supreme

Court have checked a sense of a statute's plain meaning against

undisputed legislative history as a guard against judicial error.

See, e.g., Bob Jones Univ. v. United States, 461 U.S. 574, 586

(1983) ("It is a well-established canon of statutory construction

that a court should go beyond the literal language of a statute if

reliance on that language would defeat the plain purpose of the

statute . . . ."); Cablevision of Boston v. Public Improvement

Comm'n, 184 F.3d 88, 101 (1st Cir. 1999). If the meaning is not

plain from the words of the statute, then resort to legislative

history is required. See Akins v. Penobscot Nation, 130 F.3d 482,

488 (1st Cir. 1997).

On some of the points neither text nor history is

indisputably clear. The legislative history is irretrievably

conflicted as to the second issue -- which characteristic patterns

of facts may be pleaded in order to establish a "strong inference"

of scienter -- with all sides finding some support for their

positions. About all that can be said with confidence on that

issue is that Congress agreed on the need to curb abuses, that it

attempted to do so in the guise of what are articulated as

procedural requirements, and that there was agreement on the words

of the statute and on little else. And so we return to the text of

the statute and its purpose.

A. Pleading Standards for Fraud Allegations

The text of the Act requires now that any complaint

alleging that a statement or omission is misleading must:

1. specify each statement alleged to have been

misleading,

2. [specify] the reason or reasons why the statement

is misleading,

3. and, if an allegation regarding the statement or

omission is made on information and belief, . . .

state with particularity all facts on which that

belief is formed.

15 U.S.C. 78u-4(b)(1). The effect of this is to embody in the

Act itself at least the standards of Rule 9(b), Fed. R. Civ. P.

Before the PSLRA, a securities fraud claim had to meet

the standards set by Rule 9(b). See Simcox v. San Juan Shipyard,

Inc., 754 F.2d 430, 439 (1st Cir. 1985). Rule 9(b) provides that

"[i]n all averments of fraud or mistake, the circumstances

constituting fraud or mistake shall be stated with particularity.

Malice, intent, knowledge, and other condition of mind of a person

may be averred generally." Fed. R. Civ. P. 9(b). This circuit has

interpreted Rule 9(b) to require "specification of the time, place,

and content of an alleged false representation." McGinty v.

Beranger Volkswagen, Inc., 633 F.2d 226, 228 (1st Cir. 1980).

"Even where allegations are based on information and belief,

supporting facts on which the belief is founded must be set forth

in the complaint. And this holds true even when the fraud relates

to matters peculiarly within the knowledge of the opposing party."

Hayduk v. Lanna, 775 F.2d 441, 444 (1st Cir. 1985) (internal

quotation marks and citations omitted).

The PSLRA's pleading standard is congruent and consistent

with the pre-existing standards of this circuit. This circuit has

been notably strict and rigorous in applying the Rule 9(b) standard

in securities fraud actions. See Maldonado v. Domnguez, 137 F.3d

1, 9 (1st Cir. 1998) ("This court has been especially rigorous in

applying Rule 9(b) in securities fraud actions . . . .") (quotation

marks omitted); Shaw v. Digital Equip. Corp., 82 F.3d 1194, 1223

(1st Cir. 1996) (similar); Romani v. Shearson Lehman Hutton, 929

F.2d 875, 878 (1st Cir. 1991) ("We have been especially rigorous in

demanding . . . factual support in the securities context . . .

.").

The requirements of the PSLRA's new pleading standard in

78u-4(b)(1) were largely imposed under First Circuit law,

although this court has not used the same precise terminology.

First, this court had already required a fraud plaintiff to specify

each allegedly misleading statement or omission. See, e.g.,

Romani, 929 F.2d at 878 (plaintiffs' isolation of the offering

materials as the source of the alleged fraud was "sufficient to

identify the time and place of the alleged misrepresentations");

New England Data Servs., 829 F.2d at 292 (rejecting plaintiffs'

claims as merely "conclusory allegations of mail and wire fraud .

. . with no description of any time, place or content of the

communication").

Second, this court has required a securities fraud

plaintiff to explain why the challenged statement or omission is

misleading by requiring that "the complaint . . . provide some

factual support for the allegations of fraud." Romani, 929 F.2d at

878 (citation omitted). This means that the plaintiff must not

only allege the time, place, and content of the alleged

misrepresentations with specificity, but also the "factual

allegations that would support a reasonable inference that adverse

circumstances existed at the time of the offering, and were known

and deliberately or recklessly disregarded by defendants." Id.

Finally, this court has required plaintiffs who bring

their claims on information and belief to "set forth the source of

the information and the reasons for the belief." Romani, 929 F.2d

at 878; see also New England Data Servs., 829 F.2d at 288; Hayduk,

775 F.2d at 444-45; Wayne Inv., Inc. v. Gulf Oil Corp., 739 F.2d

11, 13 (1st Cir. 1984).

Our previous strict pleading requirements under Rule 9(b)

are, in our view, consistent with the PSLRA. See Maldonado, 137

F.3d at 10 n.6.

B. Pleading Required State of Mind: Characteristic Fact Patterns

Where a plaintiff can recover money damages on proof that

a defendant acted with a particular state of mind, the PSLRA now

requires a complaint to "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). The "required state of

mind" for liability under section 10(b) and Rule 10b-5 is referred

to as scienter, which the Supreme Court has defined as "a mental

state embracing intent to deceive, manipulate, or defraud." Ernst

& Ernst v. Hochfelder, 425 U.S. 185, 193 n.12 (1976).

The debate between the plaintiffs and the defendants is

largely over whether Congress intended to embody, as the SEC says,

the prior Second Circuit methods for proving scienter (i.e., by

showing motive and opportunity or evidence of reckless or conscious

behavior sufficient to raise a strong inference) or, as the

defendants say, to prohibit use of at least the motive and

opportunity method. This focus of the parties is not surprising,

as there was much debate in Congress on these points.

The plaintiffs and the SEC argue that the PSLRA does not

prohibit use of the Second Circuit's methods for proving scienter.

They refer to the bill reported out of the Senate Committee on

Banking, Housing, and Urban Affairs, see S. 240, 104th Cong.

104(b) (1995), reprinted in 141 Cong. Rec. S9222 (daily ed. June

28, 1995), and to the Senate Report, which states, in part, that:

The Committee does not adopt a new and untested pleading

standard that would generate additional litigation.

Instead, the Committee chose a uniform standard modeled

upon the pleading standard of the Second Circuit. . . .

[T]he Second Circuit requires that the plaintiff plead

facts that give rise to a "strong inference" of

defendant's fraudulent intent. The Committee does not

intend to codify the Second Circuit's caselaw

interpreting this pleading standard, although courts may

find this body of law instructive.

S. Res. 98, 104th Cong., at 15 (1995), reprinted in 1995

U.S.C.C.A.N. 679, 694 (footnotes omitted). They also rely on the

comments of Senator Dodd, co-sponsor of the PSLRA, explaining that

Congress intended to codify the Second Circuit's "pleading

standards." 141 Cong. Rec. S17960 (daily ed. Dec. 5, 1995).

Finally, they argue that their position is bolstered by the

Statement of Managers of the Securities Litigation Uniform

Standards Act of 1998, Pub. L. No. 105-353, 112 Stat. 3227, which

declared that "the managers again emphasize that the clear intent

in 1995 and our continuing intent in this legislation is that

neither the Reform Act nor [the Standards Act] in any way alters

the scienter standard in Federal securities fraud suits." Joint

Explanatory Statement of the Committee of Conference, Conference

Report to Accompany S. 1260, H.R. Conf. Rep. No. 105-803 ("1998

Conf. Rep."), at 15 (1998).

The defendants argue that allegations of the existence of

motive and opportunity to commit fraud (or simple recklessness) do

not satisfy the scienter requirement. To support their view, they

note Congress' statement that "[t]he Conference Committee language

is based in part on the pleading standard of the Second Circuit,"

(emphasis added) and that "[b]ecause the Conference Committee

intends to strengthen existing pleading requirements, it does not

intend to codify the Second Circuit's case law interpreting this

pleading standard." H.R. Conf. Rep. 104-369, at 41 (1995),

reprinted in 1995 U.S.C.C.A.N. 730, 740. Defendants also rely

heavily on the footnote associated with this sentence, which

states: "For this reason, the Conference Report chose not to

include in the pleading standard certain language relating to

motive, opportunity, or recklessness." Id. at 41 n.23, reprinted

in 1995 U.S.C.C.A.N. at 747. Further, the defendants emphasize

that although the Senate Bill (S. 240) included an amendment that

would codify Second Circuit law, the Conference Committee

eliminated that amendment. See Amend. 1485, S. 240, 104th Cong.,

1st Sess. (1995), 141 Cong. Rec. S9170 (daily ed. June 27, 1995).

Finally, the defendants place considerable weight on

Congress' decision to override President Clinton's veto, in light

of the President's statement that in the Act Congress "intended to

'strengthen' the existing pleading requirements of the Second

Circuit . . . [and] to erect a higher barrier to bringing suit than

any now existing[.]" H.R. Doc. No. 104-150, 104th Cong., 1st Sess.

(1995), 141 Cong. Rec. H15214 (Dec. 20, 1995). Counsel for

defendant FTP candidly admitted before the district court that the

legislative history standing alone could be read either way, but

argued that the President's veto -- based on his reading of the Act

as overruling the Second Circuit motive and opportunity test --

administered the coup de grace. While the President's view of what

Congress meant has some informational value, we give that view

little weight: the real issue is what the intent was of the

Congress, not the President.

The legislative history is inconclusive on whether the

Act was meant to either embody or to reject the Second Circuit's

pleading standards. As the Third Circuit has noted, "[t]he Reform

Act's legislative history on this point is ambiguous and even

contradictory." In re Advanta Corp. Sec. Litig., 180 F.3d 525, 531

(3d Cir. 1999). The history and text show no agreement to restrict

the types of evidence which may be used to show a strong inference

of scienter. Indeed, it would be unusual for Congress to legislate

on what fact patterns could or could not prove fraud or scienter.

At best, there appears to have been an agreement to disagree on the

issue of Second Circuit standards (other than the strong inference

standard), and perhaps, as is common, to leave such matters for

courts to resolve. See, e.g., Burlington Indus., Inc. v. Ellerth,

118 S. Ct. 2257, 2264 (1998).

From the words of the Act, certain conclusions can be

drawn. First, Congress plainly contemplated that scienter could be

proven by inference, thus acknowledging the role of indirect and

circumstantial evidence. See 15 U.S.C. 78u-4(b)(2) (requiring

that "the complaint . . . state with particularity facts giving

rise to a strong inference that the defendant acted with the

required state of mind") (emphasis added). Second, the words of

the Act neither mandate nor prohibit the use of any particular

method to establish an inference of scienter. Third, Congress has

effectively mandated a special standard for measuring whether

allegations of scienter survive a motion to dismiss. While under

Rule 12(b)(6) all inferences must be drawn in plaintiffs' favor,

inferences of scienter do not survive if they are merely

reasonable, as is true when pleadings for other causes of action

are tested by motion to dismiss under Rule 12(b)(6). See Conley v.

Gibson, 355 U.S. 41, 45-46 (1957). Rather, inferences of scienter

survive a motion to dismiss only if they are both reasonable and

"strong" inferences.

Indeed, the debate about adoption or rejection of prior

Second Circuit standards strikes us as somewhat beside the point.

The categorization of patterns of facts as acceptable or

unacceptable to prove scienter or to prove fraud has never been the

approach this circuit has taken to securities fraud. As stated in

Maldonado, 137 F.3d at 10 n.6, this court has never adopted the

Second Circuit test. Instead we have analyzed the particular facts

alleged in each individual case to determine whether the

allegations were sufficient to support scienter. See, e.g., Shaw

v. Digital Equip. Corp., 82 F.3d 1194, 1209 (1st Cir. 1996). In

this, the approach of this circuit has been like that taken by the

Supreme Court as to the issue of materiality in Basic Inc. v.

Levinson, 485 U.S. 224 (1988).

This court has considered many different types of

evidence as relevant to show scienter. Examples include: insider

trading (discussed below); divergence between internal reports and

external statements on the same subject (see Serabian v. Amoskeag

Bank Shares, Inc., 24 F.3d 357, 361 (1st Cir. 1994)); closeness in

time of an allegedly fraudulent statement or omission and the later

disclosure of inconsistent information (see Shaw, 82 F.3d at 1224-

25); evidence of bribery by a top company official (see Greenstone

v. Cambex Corp., 975 F.2d 22, 26 (1st Cir. 1992)); existence of an

ancillary lawsuit charging fraud by a company and the company's

quick settlement of that suit (see id.); disregard of the most

current factual information before making statements (see Glassman

v. Computervision Corp., 90 F.3d 617, 627 (1st Cir. 1996));

disclosure of accrual basis information in a way which could only

be understood by a sophisticated person with a high degree of

accounting skill (see Holmes v. Bateson, 583 F.2d 542, 552 (1st

Cir. 1978)); the personal interest of certain directors in not

informing disinterested directors of impending sale of stock (see

Estate of Soler v. Rodrguez, 63 F.3d 45, 54 (1st Cir. 1995)); and

the self-interested motivation of defendants in the form of saving

their salaries or jobs (see Serabian, 24 F.3d at 368). While a

number of these cases could be thought of as falling into motive

and opportunity patterns, this court continues to prefer a more

fact-specific inquiry. See, e.g., Glassman, 90 F.3d at 624 (fact

that lead underwriter may have had incentive to inflate the

offering price was significant, but overall, complaint failed to

state a claim on which relief could be granted).

The most salient feature of the PSLRA is that whatever

the characteristic pattern of the facts alleged, those facts must

now present a strong inference of scienter. A mere reasonable

inference is insufficient to survive a motion to dismiss. Our pre-

Act case law had used both the language of "strong" inference and

of "reasonable" inference in various contexts. For example,

"strong inference" is used in Maldonado, 137 F.3d at 9 and Suna v.

Bailey Corp., 107 F.3d 64, 68 (1st Cir. 1997). "Reasonable

inference" language was used in Gross v. Summa Four Inc., 93 F.3d

987, 996 (1st Cir. 1996); Shaw, 82 F.3d at 1224; Serabian, 24 F.3d

at 368; Greenstone, 975 F.2d at 25; and Romani, 929 F.2d at 878.

It is clear that scienter allegations now must be judged under the

"strong inference" standard at the motion to dismiss stage.

Our view of the Act is thus close to that articulated by

the Sixth Circuit. That court held that a plaintiff could survive

a motion to dismiss by "pleading facts that give rise to a strong

inference of [scienter]." In re Comshare, Inc. Sec. Litig., 183

F.3d 542, 550 (6th Cir. 1999) (internal quotation marks omitted).

The Sixth Circuit found that evidence of motive and opportunity to

commit fraud did not, of itself, constitute scienter for purposes

of section 10(b) and Rule 10b-5. See id. at 551. "Indeed, those

courts addressing motive and opportunity in Securities Act cases

have held only that facts showing a motive and opportunity may

adequately allege scienter, not that the existence of motive and

opportunity may support, as scienter itself, liability under 10b

or Rule 10b-5." Id. The court held that evidence of motive and

opportunity was "relevant" to pleading facts that could establish

scienter, and, on occasion, could "rise to the level of creating a

strong inference of reckless or knowing conduct." Id.

Nevertheless, such evidence, standing alone, could not "constitute

the pleading of a strong inference of scienter." Id.; accord

Bryant v. Avado Brands, Inc., No. 98-9253, 1999 WL 688050, at *8

(11th Cir. Sept. 3, 1999).

Without adopting any pleading litany of motive and

opportunity, we reject defendants' argument that facts showing

motive and opportunity can never be enough to permit the drawing of

a strong inference of scienter. But, as we cautioned in Maldonado,

137 F.3d at 10 n.6, merely pleading motive and opportunity,

regardless of the strength of the inferences to be drawn of

scienter, is not enough. Three circuits have interpreted the PSLRA

as permitting use of motive and opportunity type pleading if it

raises a strong inference. See In re Advanta Corp. Sec. Litig.,

180 F.3d 525, 534-35 (3d Cir. 1999); Press v. Chemical Inv. Servs.

Corp., 166 F.3d 529, 537-38 (2d Cir. 1999); Williams v. WMX Techs.,

Inc., 112 F.3d 175, 178 (5th Cir. 1997) (dicta). Like the Third

Circuit, we caution that "catch-all allegations that defendants

stood to benefit from wrongdoing and had the opportunity to

implement a fraudulent scheme are [not] sufficient." In re Advanta

Corp., 180 F.3d at 535.

Similarly, the PSLRA neither prohibits nor endorses the

pleading of insider trading as evidence of scienter, but requires

that the evidence meet the "strong inference" standard. Unusual

trading or trading at suspicious times or in suspicious amounts by

corporate insiders has long been recognized as probative of

scienter. See Shaw, 82 F.3d at 1204; Rubinstein v. Collins, 20

F.3d 160, 169-70 (5th Cir. 1994); Greenstone, 975 F.2d at 26. The

vitality of the inference to be drawn depends on the facts, and can

range from marginal, see Shaw, 82 F.3d at 1204, to strong, see

Rubinstein, 20 F.3d at 169-70. This continues to be true in

litigation after the effective date of the PSLRA. Indeed, in

Greenstone we noted, and still think today, that allegations of

unusual insider trading by a defendant with access to material non-

public information can support a strong inference of scienter. See

Greenstone, 975 F.2d at 26. We similarly caution that mere

pleading of insider trading, without regard to either context or

the strength of the inferences to be drawn, is not enough. See

Maldonado, 137 F.3d at 9-10. At a minimum, the trading must be in

a context where defendants have incentives to withhold material,

non-public information, and it must be unusual, well beyond the

normal patterns of trading by those defendants.

C. Substantive Scienter Standards

The parties disagree about the effect, if any, of the

PSLRA on the substantive standard for proving scienter. We start

with the state of the law in this circuit before the enactment of

the PSLRA.

The Supreme Court has defined scienter as "a mental state

embracing intent to deceive, manipulate, or defraud." Ernst &

Ernst v. Hochfelder, 425 U.S. 185, 193 n.12 (1976). The Court

explicitly reserved the issue of whether recklessness sufficed,

saying "[i]n certain areas of the law recklessness is considered to

be a form of intentional conduct for purposes of imposing liability

for some act." Id. Before enactment of the PSLRA, most circuits

had held that scienter in civil securities fraud actions could be

shown by showing recklessness. It is accepted that recklessness

may establish intent to defraud in criminal prosecutions under

17(a)(1) of the Exchange Act and under the mail and wire fraud

statutes. See 8 L. Loss and J. Seligman, Securities Regulation

3656-57 (3d ed. 1991). The question became whether the standard

for criminal liability should also apply to civil liability. That,

in turn, raised the question of what was meant by recklessness.

We have used a definition of recklessness articulated by

the Seventh Circuit:

[R]eckless conduct may be defined as a highly

unreasonable omission, involving not merely simple, or

even inexcusable, negligence, but an extreme departure

from the standards of ordinary care, and which presents

a danger of misleading buyers or sellers that is either

known to the defendant or is so obvious the actor must

have been aware of it.

Sundstrand Corp. v. Sun Chem. Corp., 553 F.2d 1033, 1045 (7th Cir.

1977) (quoting Franke v. Midwestern Okla. Dev. Auth., 428 F. Supp.

719, 725 (W.D. Okla. 1976)). Without at first explicitly adopting

that standard, this court assumed that it applied and cited it with

approval in Cook v. Avien, Inc., 573 F.2d 685, 692 (1st Cir. 1978).

In Hoffman v. Estabrook & Co., 587 F.2d 509, 515-16 (1st Cir.

1978), this court again assumed that recklessness could ground a

Rule 10b-5 action and, again, quoted with approval a Seventh

Circuit definition:

In view of the Supreme Court's analysis in

Hochfelder of the statutory scheme of implied private

remedies and express remedies, the definition of

"reckless behavior" should not be a liberal one lest any

discernible distinction between "scienter" and

"negligence" be obliterated for these purposes. We

believe "reckless" in these circumstances comes closer to

being a lesser form of intent than merely a greater

degree of ordinary negligence. We perceive it to be not

just a difference in degree, but also in kind.

Sanders v. John Nuveen & Co., 554 F.2d 790, 793 (7th Cir. 1977).

This court explicitly rejected a formulation of recklessness as

mere negligence, finding it had to come closer to being a lesser

form of intent than merely a greater degree of ordinary negligence.

See Hoffman, 587 F.2d at 516 & n.10.

In Serabian this court held that it was error to dismiss

a securities fraud complaint that alleged sufficient facts to draw

"an inference that the [defendant] knew, or should have known, that

its public statements were inconsistent with the actual conditions

then being reported to [it]." Serabian, 24 F.3d at 365 (emphasis

added and original emphasis omitted). We understand Serabian to

have used "should have known" in the reckless disregard sense used

in Cook and Hoffman. This court has explicitly tested factual

allegations to see whether they supported an inference that

defendants acted with reckless disregard. See Romani, 929 F.2d at

878. Since then, there have been encapsulated references to this

rule in dicta in other cases. See, e.g., Maldonado, 137 F.3d at 9

n.4. The rule in this circuit has been to accept recklessness, as

narrowly defined in the two Seventh Circuit cases (Sundstrand and

Sanders), as a method of proving scienter. See Serabian, 24 F.3d

at 365. That definition of recklessness does not encompass

ordinary negligence and is closer to a lesser form of intent.

The effect of the PSLRA on the standard for scienter has

been much disputed. The Act itself is silent on the general

scienter requirements for 10b-5 actions, referring only to scienter

as "the required state of mind." 15 U.S.C. 78u-4(b)(2).

Plaintiffs and the SEC maintain that the PSLRA did not intend or

purport to change whatever the preexisting standard was, and that

standard included some form of recklessness. The defendants say

that only the most heightened recklessness standard should be used,

and that the SEC's views are not entitled to any weight.

The circuit courts have reached different results. A

panel in the Ninth Circuit has held that the PSLRA elevated the

standard to one of "deliberate recklessness," In re Silicon

Graphics Inc. Sec. Litig., 183 F.3d 970, 974 (9th Cir. 1999). One

district court within this circuit has concluded that recklessness

is insufficient and that only conscious conduct would suffice under

the Act. See Friedberg v. Discreet Logic Inc., 959 F. Supp. 42, 48

(D. Mass. 1997).

In contrast, the Sixth Circuit has concluded that the

PSLRA did not alter the state of mind requirement and thus a

complaint pleading facts that give rise to a "'strong inference of

recklessness' of the kind required for securities fraud liability"

suffices. In re Comshare, Inc. Sec. Litig., 183 F.3d 542, 552-53

(6th Cir. 1999). The Sixth Circuit had previously adopted, as had

this circuit, the Sundstrand definition of recklessness, see id. at

550, and concluded that same standard applied after the PSLRA was

enacted. The Eleventh Circuit has expressed its "basic agreement"

with the Sixth Circuit, Bryant v. Avado Brands, Inc., No. 98-9253,

1999 WL 688050, at *8 (11th Cir. Sept. 3, 1999), holding that the

PSLRA did not "substantively change the actionable level of

scienter," id. at *10. The Third Circuit has concluded that

"[a]lthough the Reform Act established a uniform pleading standard,

it did not purport to alter the substantive contours of scienter,"

In re Advanta Corp. Sec. Litig., 180 F.3d 525, 534 (3d Cir. 1999),

and reiterated its prior law that recklessness, as defined in

Sundstrand, suffices, see id. Without much discussion of the

issue, the Second Circuit has adhered to its previous acceptance of

recklessness. See Press v. Chemical Inv. Servs. Corp., 166 F.3d

529, 537-38 (2d Cir. 1999). The Fourth Circuit has also concluded

that the PSLRA did not change the pre-existing scienter standard.

See Phillips v. LCI Int'l, Inc., No. 98-2572, 1999 WL 717253, at

*11 (4th Cir. Sept. 15, 1999) ("[T]o establish scienter, a

plaintiff must still prove that the defendant acted intentionally,

which may perhaps be shown by recklessness."). Two district courts

in this circuit have reached the conclusion that some form of

recklessness is available. See In re PLC Sys., Inc. Sec. Litig.,

41 F.Supp.2d 106, 115 (D. Mass 1999); Lirette v. Shiva Corp., 27

F.Supp.2d 268, 282 (D. Mass. 1998).

We agree with those courts that hold that the PSLRA did

not address the substantive definition of scienter. The

legislative history shows no such intent and the language of the

Act itself does not address the topic. See generally Dunn, Note,

Pleading Scienter After the Private Securities Litigation Reform

Act, 84 Cornell L. Rev. 193 (1998). The opinions of the Sixth and

Third Circuits discuss these points ably and there is no reason to

repeat the discussion here.

We add additional reasons that buttress this conclusion.

The PSLRA does in fact discuss the role of "knowing" violations,

and thus an aspect of scienter, in two different respects. The

first concerns contribution; the second, "safe harbors" for

defendants. As to contribution, the Act, through a new 21D(g),

added a section "to preserve joint and several liability for

persons who knowingly commit securities fraud, but otherwise to

proportionately limit liability to the 'portion of the judgment

that corresponds to the percentage of responsibility of that

covered person.'" 10 Loss & Seligman, at 4687 (quoting 15 U.S.C.

78u-4(f)(2)(B)(i)). The PSLRA specifies that:

[a]ny covered person against whom a final judgment is

entered in a private action shall be liable for damages

jointly and severally only if the trier of fact

specifically determines that such covered person

knowingly committed a violation of the securities laws.

15 U.S.C. 78u-4(f)(2)(A). In turn "knowingly commits a violation

of the securities laws" is defined (for 10b-5 purposes) as

requiring "actual knowledge" that a representation is false or an

omission renders a representation false. Id. 78u-4(f)(10)(A).

The definition specifically excludes "reckless conduct" as a basis

for construing a knowing commission of a violation. Id. 78-

u(f)(10)(B).

These special contribution provisions lead to several

conclusions. Congress, having explicitly eliminated recklessness

as a basis for imposing joint and several liability, should not be

taken as implicitly having eliminated recklessness as a basis for

any liability. See In re Silicon Graphics, 183 F.3d at 995

(Browning, J., concurring in part and dissenting in part). Because

joint and several liability is more onerous than individual

liability, the exclusion of recklessness as the basis for imposing

joint and several liability constitutes a recognition that some

form of recklessness may suffice for individual liability.

Furthermore, Congress took great care to insure that the actual

knowledge requirement was restricted to the joint and several

liability provisions of the Act. Section 78u-4(f)(1) provides that

"nothing in this subsection shall be construed to create, affect,

or in any manner modify, the standard for liability associated with

any action arising under the securities laws." 15 U.S.C. 78-

u(f)(1). Including this language would not make sense if Congress

had altered the general scienter requirement to restrict it to

actual knowledge.

The "safe harbor" provisions of the Act similarly

buttress the conclusion that the Act did not alter pre-existing law

defining scienter. The PSLRA adopted a statutory "safe harbor" by

adding a new section 27A to the 1933 Act, 15 U.S.C. 77z-2, and a

new section 21E to the 1934 Act, 15 U.S.C. 78u-5. The safe

harbor has two alternative inlets: the first shelters forward-

looking statements that are accompanied by meaningful cautionary

statements. See 15 U.S.C. 78u-5(c)(1)(A)(i). The second inlet

is of importance here. It focuses on the state of mind of the

defendant and precludes liability for a forward-looking statement

unless the maker of the statement had actual knowledge it was false

or misleading. See 78u-5(c)(1)(B); H.R. Conf. Rep. No. 104-369

(1995), reprinted in 1995 U.S.C.C.A.N. 730, 743. Again, this new

section 21E to the 1934 Act is explicit, in contrast with the lack

of such language in the definition of scienter in 21D(b)(2). See

Bryant, 1999 WL 688050, at *10; In re Silicon Graphics, 183 F.3d at

995 (Browning, J., concurring in part and dissenting in part).

Concluding that the Act does not alter the pre-existing

definition of scienter adopted by this circuit, we accordingly test

the complaint against that definition.

V

Application of Standards to Plaintiffs' Complaint

We review the dismissal of plaintiffs' complaint de novo,

giving plaintiffs the benefit of all reasonable inferences, but

holding plaintiffs to the standard of showing a strong inference of

scienter. See Gross v. Summa Four, Inc., 93 F.3d 987, 991 (1st

Cir. 1996). We think the claims are either insufficiently

particularized or, where particularized, do not permit a strong

inference of scienter.

At the heart of plaintiffs' case is the allegation that

defendants consistently overstated the earnings of the company by

improperly booking as revenue (and inadequately reserving) "sales"

that were actually contingent transactions. This was improper,

plaintiffs say, under generally accepted accounting principles

("GAAP"), specifically Statement of Financial Accounting Standards

No. 48 ("FAS 48"). Plaintiffs claim that the sales were contingent

because there were unlimited return rights. Plaintiffs say that

they have evidence both tending directly to show conscious

wrongdoing on the part of defendants and circumstantial evidence

from which such wrongdoing may be inferred, including that the

defendants had both motive and opportunity.

A. Direct Evidence of Scienter

Two types of allegations tend to show conscious

wrongdoing: the "white-out" and the warehousing allegations.

1. The "White-Out" Allegations and the Rule 56(f) Motion

The "white-out" allegations claimed that FTP personnel

"whited out" (in a manner undetectable to company auditors) the

customers' additions to standard purchase orders; those additions

made orders contingent on the customers' unlimited right to return

the goods to FTP. The white-out allegations were powerful, as the

district court recognized in initially denying the motion to

dismiss. If adequately supported, claims that management

deliberately altered company records to hide material information

from company auditors could well create strong inferences of

scienter. But, as the district court correctly ruled on summary

judgment, plaintiffs could not produce admissible evidence to

support the white-out allegations, and so we disregard these

allegations.

2. The Warehousing Allegations

The warehousing allegations remain. In essence, the

complaint asserts that at some time before the Class Period, the

company made a phony sale or sales and caused to be booked as goods

sold certain product that was shipped to a warehouse and not to

customers; the company then recognized the revenue from such phony

sales. After a period, the product was sent back from the

warehouse as "returned" goods. The allegations state that Robert

Casa, an employee who refused to sign for the "returned" product

and complained about the practice, was fired. If true, such

practices by a company are very serious. See United States v.

Bradstreet, 135 F.3d 46, 48 (1st Cir. 1998) (affirming a criminal

conviction for, inter alia, "knowingly falsifying [a company's]

books and records in an attempt to conceal [securities] fraud").

The complaint is deficient in not identifying when this

took place. The complaint is specific only in saying this occurred

before the Class Period. The complaint alleges, on information and

belief, that the practice continued into the Class Period but

provides no specifics about why the practice is thought to have

occurred during the Class Period or why it caused harm to

plaintiffs. The defendants say the temporal lag means the

allegations are irrelevant and should be disregarded. The

allegations are not irrelevant -- evidence of past practice may

indeed be probative of present practice. But there is scant else

from which to infer that this was the company's practice at any

pertinent time, and the allegations are not enough to support a

strong inference of scienter. See Lefkowitz v. Smith Barney,

Harris Upham & Co., 804 F.2d 154, 155-56 (1st Cir. 1986).

B. Indirect Evidence of Scienter

There is also indirect evidence from which plaintiffs say

scienter can be inferred. Defendants, or so the complaint alleges,

knew the company was in trouble because they knew that Microsoft

would have, as an integral part of its Windows 95 package, a

product that would compete with FTP's wares. Purchasers of Windows

95 would therefore have no reason to purchase FTP's product. Before

and during the Class Period (July 14, 1995, to January 3, 1996),

FTP engineers repeatedly warned management of this competitive

threat. Indeed, certain large orders, such as a $10 million order

by the French Post Office, were cancelled. Plaintiffs allege that

FTP's management responded through two strategies, "channel

stuffing" and contingent sales, which artificially inflated the

company's revenues.

1. Channel Stuffing

"Channel stuffing" means inducing purchasers to increase

substantially their purchases before they would, in the normal

course, otherwise purchase products from the company. It has the

result of shifting earnings into earlier quarters, quite likely to

the detriment of earnings in later quarters. There is nothing

inherently improper in pressing for sales to be made earlier than

in the normal course, and we do not understand plaintiffs'

complaint to make any such claim. Plaintiffs make use of the

channel stuffing allegations in a different way. They say evidence

of channel stuffing supports their contention that management knew

that revenues during the Class Period would be low and attempted to

hide that fact by shifting income through channel stuffing (which

remained undisclosed) and by artificially inflating income through

improper revenue recognition. In this context, the channel

stuffing evidence has some probative value. But that value is

weak. Unlike altering company documents, there may be any number

of legitimate reasons for attempting to achieve sales earlier.

Thus, it does not support a strong inference of scienter.

2. Contingent Sales

Plaintiffs allege that the financial statements included

in FTP's Form 10-Q report for the third quarter of 1995 were

prepared in violation of GAAP and contained improperly inflated

revenues and earnings. Specifically, plaintiffs claim that FTP

recognized revenues from sales that included a right of return,

which did not meet the requirements for revenue recognition set

forth in FAS 48. When a buyer has the right to return a product,

FAS 48 prohibits the seller from recognizing income from the sale

unless six conditions are met. See Statement of Financial

Accounting Standards No. 48, 6 (Fin. Accounting Standards Bd.,

June 1981).

Plaintiffs focus on three of the six FAS 48 conditions:

that the buyer's obligation to pay the seller is not contingent on

resale of the product; that the seller does not have significant

obligations for future performance directly to bring about resale

of the product by the buyer; and that the amount of future returns

can be reasonably estimated. See id. If any of the conditions are

not met at the time of the sale, sales revenue cannot be

immediately recognized. See id.

Plaintiffs allege that during the Class Period FTP

recorded as "sales" transactions including a right of return that

violated all three of the above conditions. Plaintiffs claim FTP

"induc[ed] distributors to purchase more product than they needed

with the promise that they could return the product if it were

unsold . . . . [S]ubsequently, a material portion of these 'sales'

were either returned in the fourth fiscal quarter of 1995 or

remained with distributors, but were unpaid for." Plaintiffs

contend that "[u]nder certain circumstances, the distributor could

defer payment until FTP's or its own sales force had booked a sale

to an ultimate customer for the products. FTP, however, would not

receive payment until the distributor was in a position to book the

sale and ship the product and receive payment from the end user .

. . ." Furthermore, "due to the constantly changing competitive

environment and the release of Microsoft's 'Windows '95', FTP had

no way to reasonably estimate returns." Finally, even if all the

conditions for immediate revenue recognition are met, FAS 48

requires that the seller reduce sales revenue and cost of sales

reported in the income statement to reflect estimated returns. See

id. 7. Plaintiffs allege that FTP violated this by failing to

adequately reserve for returns.

Violations of GAAP standards such as FAS 48 could provide

evidence of scienter. See Malone v. Microdyne Corp., 26 F.3d 471,

478-79 (4th Cir. 1994). To support even a reasonable inference of

scienter, however, the complaint must describe the violations with

sufficient particularity; "a general allegation that the practices

at issue resulted in a false report of company earnings is not a

sufficiently particular claim of misrepresentation." Gross v.

Summa Four, Inc., 93 F.3d 987, 996 (1st Cir. 1996) (quoting

Serabian v. Amoskeag Bank Shares, Inc., 24 F.3d 357, 362 n.5 (1st

Cir. 1994)). Here, as the district court correctly concluded, the

complaint clearly falls short. The allegations in the complaint

do not include such basic details as the approximate amount by

which revenues and earnings were overstated, see Gross, 93 F.3d at

996; the products involved in the contingent transactions, cf.

Malone, 26 F.3d at 476-77 (products that were "sold" with rights of

return specifically identified); the dates of any of the

transactions; or the identities of any of the customers or FTP

employees involved in the transactions. We do not say that each of

these particulars must appear in a complaint, but their complete

absence in this case is indicative of the excessive generality of

these allegations.

As part of their opposition to defendants' renewed motion

to dismiss, plaintiffs attempted to introduce evidence of four

alleged contingent transactions drawn from defendants' automatic

disclosure. The district court, however, refused to take this new

evidence into consideration in its ruling. The court reasoned that

there would have been no disclosure but for the white-out

allegations, because the complaint would have been dismissed at the

outset; the white-out allegations proved insubstantial, even with

the benefit of disclosure; and therefore the remainder of the

complaint should be judged without the additional evidence obtained

through disclosure. We need not decide whether the district

court's refusal to consider the additional evidence was correct,

because we believe that plaintiffs' additional evidence would not

have sufficed to prevent dismissal.

Plaintiffs identify four sets of transactions from the

third quarter of 1995 that allegedly involve improperly booked

revenue. Plaintiffs present invoices, purchase orders, and other

documentation that show, they contend: (a) a set of transactions

totaling $678,000 with a distributor, Merisel, in which Merisel was

not obliged to pay for the product; (b) a $705,250 transaction with

reseller CC-OPS in which CC-OPS was given an unlimited right to

return the product; (c) a $1.14 million transaction with reseller

Afina Sistemas that involved the "sale" of an FTP product that did

not yet exist; and (d) a $416,325 transaction with reseller Force

3 that was contingent upon Force 3 receiving a government contract.

a. The Merisel Transactions

The Merisel allegations involve one $130,078 transaction

in August 1995 and two transactions in late September 1995 totaling

$548,192. Plaintiffs claim that the August transaction, for which

FTP issued an invoice, was not a true sale but a "stock rotation,"

in which FTP replaced outdated products in Merisel's inventory at

no charge. Plaintiffs point to a credit issued to Merisel by FTP

in mid-October for the full amount. Less detail is provided

concerning the September transactions. To support their contention

that those transactions were improperly booked contingent sales,

plaintiffs proffer three items: the $548,192 posted to accounts

receivable on September 29; the fact that $494,872 remained unpaid

as of December 31; and the agreement between Merisel and FTP, which

states that Merisel will pay FTP for all copies of FTP's products

sub-licensed by Merisel and its dealers.

A possible -- though far from necessary -- conclusion is

that the August transaction was an exchange of new products for old

improperly booked as a sale, as the original Merisel purchase order

contains the notation "[o]ffsetting order f. stockrotation" (sic).

The September transactions, on the other hand, are described in

insufficient detail to support plaintiffs' allegations. The mere

existence of an overdue receivable does not support an inference

that the original transaction was booked as a sale in violation of

GAAP.

b. The CC-OPS Transaction

The CC-OPS allegation concerns a September 29 order for

$705,250 of FTP products, which FTP immediately booked as a sale.

A letter from FTP's sales director for the Americas apparently

accompanied the invoice. The letter stated that it was FTP's

"policy" to "allow[] large or frequent customers to return product

without contingency within 60 days of receipt of order." Large

customers were defined as those generating over $100,000 per year.

A copy of the original letter is not present in the invoice file.

On November 27, CC-OPS faxed a copy of the letter back to FTP, and

FTP extended the right of return from 60 to 90 days. This revised

letter is present in the file. Shortly after the return period was

lengthened, FTP issued a credit for the full amount of the invoice

and authorized the return of the product. On the original invoice

is written: "Credit per Jack Geraghty. Not recognizable revenue."

Plaintiffs charge that the initial booking of revenue

from this transaction violated GAAP; that the letter indicates that

FTP had a policy of granting unlimited return rights to its

customers; and that the absence of the original September 29 letter

from the file indicates that FTP was attempting to conceal the

existence of return rights. However, FAS 48 permits sellers to

recognize sales that include a right of return, so long as the

required conditions are met and the seller establishes a reasonable

reserve for returns. The granting of a right of return in a

particular transaction, or even a general policy of granting return

rights, does not per se mean that revenue cannot be recognized at

the time of sale. Plaintiffs merely make an allegation that FTP

failed to adequately reserve and materially overstated FTP's

revenues. Without any information on FTP's experience with past

return rates, the size of its reserve for returns, or how the

reserve changed over time, it is difficult to infer that FTP's

revenue recognition decisions were unreasonable enough to violate

GAAP, or that they give rise to a strong inference of scienter.

"'Generally accepted accounting principles,' . . . tolerate a range

of 'reasonable' treatments, leaving the choice among alternatives

to management." Thor Power Tool Co. v. Commissioner of Internal

Revenue, 439 U.S. 522, 544 (1979).

c. The Afina Sistemas Transaction

The Afina Sistemas ("Afina") allegation involves two

purchase orders totaling $1.14 million issued on September 28. The

orders were for 200,000 copies of FTP's Internet browser, custom

made for an Afina client. FTP booked the entire amount as revenue

on September 29 and carried the amount as an account receivable

throughout the fourth quarter. Plaintiffs claim that this revenue

was improperly booked because the version of the browser ordered by

Afina was then still under development. An internal FTP document

indicates that the test version of the Spanish edition of the

browser was not scheduled to be completed until late October.

Plaintiffs also point to notations reading "DO NOT SHIP PRODUCTS"

on documents attached to each invoice.

This transaction is difficult to classify. This appears

to be one part of a larger undertaking (the "Telefonica project"

referred to on the Afina purchase order) about which plaintiffs

present only fragmentary information. It is not clear that the

custom version of FTP's browser referred to in Afina's purchase

order is the same as the Spanish version listed on FTP's

development schedule. Furthermore, marking "DO NOT SHIP"

prominently on documents seems an odd way to conceal an improperly

booked sale from auditors. Finally, the fact that an overseas

customer with 90 days to pay has not paid after 94 days is not

highly suspicious. It is possible to infer, however -- at least

tentatively -- that this transaction should not have been booked as

a sale in September. It is a leap from there to a strong inference

of scienter.

d. The Force 3 Transaction

The Force 3 allegations concern a purchase order for

$416,325 issued on September 30, which stated on its face that it

was contingent on Force 3's receipt of a government contract. FTP

nonetheless immediately recorded the entire amount as an account

receivable. On December 29, FTP issued Force 3 a credit for the

full amount. The same day, Force 3 sent FTP a new purchase order

for the same products it ordered on September 30, but this purchase

order did not refer to any contingency. FTP issued a new invoice

and again booked the amount as a sale. The original booking of

this sale in September appears to have violated the requirement in

FAS 48 that the buyer's obligation to pay the seller is not

contingent on resale of the product.

At best, plaintiffs' additional evidence supports an

inference that FTP improperly recognized from $416,000 to $1.55

million in revenue in the third quarter of 1995. Because FTP

reported overall revenue during the quarter of $37.1 million, these

transactions do not support a strong inference of scienter. It

is equally possible to conclude that FTP made some incorrect

accounting decisions regarding a limited number of transactions.

Seeing fraud, however, requires too great of an inferential leap.

In short, even when viewed in combination with plaintiffs' other

allegations, plaintiffs' additional evidence does not support a

strong inference of scienter, and thus the district court's

decision not to consider the evidence could not have affected the

outcome of the motion to dismiss.

3. Insider Trading

The allegations of insider trading do not, either alone

or together with the other allegations, suffice. The individual

defendants sold FTP common stock during the Class Period. For

example, Zirkle sold 40,000 shares on July 21, 1995 at a price of

$26.27 per share, for total proceeds of $1,050,800. Goodnow sold

40,000 shares on July 27 at a price of $29.00 per share, for a

total price of $1,160,000. Last, on August 2, 1995, Charlotte

Evans sold 200 shares at $28.50 per share, for a total of $57,000.

All three defendants sold stock later in the Class Period as well.

We first look at context. The timing does not appear

very suspicious. None of these three key players sold at the high

points of the stock price. Each waited to sell until after FTP

announced a corporate reorganization on July 14, an announcement

which caused the price of the stock to fall. Each sold some stock

before an allegedly manipulated analyst's report from Brookehill

Equities recommended FTP stock as a long-term buy on August 3,

1995, and before a favorable Cowen & Co. report on December 1,

1995.

The total sum of sales involved -- over $23 million

during a six month period -- could be suspicious, but a closer look

provides ready explanations. Goodnow, as plaintiffs allege,

retired on October 26, 1995, from his position as vice president,

CFO, and treasurer. His sale of stock in July occurred not long

before he left the company. He also sold a considerable number of

shares after he left the company -- 690,000 shares accounting for

$19 million out of his total of almost $20.2 million in sales

during the Class Period. The vast majority of the $23 million in

sales by the individual defendants, more than $20 million worth,

were by one individual who was leaving the company, and more than

$19 million was after that individual had left the company. It is

not unusual for individuals leaving a company, like Goodnow, to

sell shares. Indeed, they often have a limited period of time to

exercise their company stock options. As to the others, the sales

do not reflect either unusual sales or sales made before a big

"event" unknown to the public. Selling after delivering news that

causes a company's stock price to go down is not suggestive of

withholding information. But that is what happened here.

Plaintiffs provided no information on sales by corporate insiders

at times outside the Class Period, so there is no comparison point.

Although the total sum involved was large, the district

court correctly concluded that plaintiffs produced no evidence that

the trading was out of the ordinary or suspicious. Absent

additional evidence, it is not possible to draw a strong inference

of scienter based on improper trading on material, non-public

information.

C. Other Alleged False Statements and Material Omissions

1. Zirkle's Statements

Zirkle's upbeat statements of optimism and puffing about

the company's prospects, described earlier, have each been reviewed

and we conclude that they are not actionable. See Glassman, 90

F.3d at 635-36; Shaw, 82 F.3d at 1217-19.

2. Form 10-Q Report for Third Quarter 1995

The 10-Q Report stated there was an increase in accounts

receivable and attributed it to increased sales. Plaintiffs do not

say this statement was false; only that it was misleading because

it did not say the increased sales were subject to return rights.

As an independent ground, this is too slight; as a ground in

service of the contingent sales/improper booking argument, it fails

for the same reasons that argument fails.

D. Individual Defendants

Because the dismissal of the complaint is upheld, we do

not reach the arguments of the individual defendants that the facts

alleged do not make out a claim against them.

E. Section 20(a) Claim

Plaintiffs also assert claims against the individual

defendants under Section 20(a) of the Exchange Act, which provides

for derivative liability of persons who "control" others found to

be primarily liable under the Exchange Act. See 15 U.S.C.

78t(a). Because plaintiffs' complaint does not adequately allege

an underlying violation of the securities laws, the district court

was correct to dismiss the Section 20(a) claim. See Suna v. Bailey

Corp., 107 F.3d 64, 72 (1st Cir. 1997).

VI

The district court correctly refused to dismiss the

complaint originally and was well within its discretion in limiting

the discovery it afforded. The difficult and different balance the

Act now requires -- testing allegations before little or no

discovery, but holding plaintiffs to a strong inference of scienter

standard -- has been honored in this case. Plaintiffs did not have

enough weight on their side of the balance to meet the requirements

of the Act, and so we affirm the dismissal. Costs to appellants.