Janice Konkol v. Diebold, Inc.

RECOMMENDED FOR FULL-TEXT PUBLICATION

Pursuant to Sixth Circuit Rule 206

File Name: 09a0433p.06

UNITED STATES COURT OF APPEALS

FOR THE SIXTH CIRCUIT

_________________

X

-

JANICE KONKOL et al.,

-

Plaintiffs-Appellants,

-

-

No. 08-4572

v.

,

>

-

Defendants-Appellees. -

DIEBOLD, INC. et al.,

N

Appeal from the United States District Court

for the Northern District of Ohio at Akron.

No. 05-02873—Peter C. Economus, District Judge.

Argued: October 14, 2009

Decided and Filed: December 22, 2009

*

Before: GILMAN and GIBBONS, Circuit Judges; ANDERSON, District Judge.

_________________

COUNSEL

ARGUED: Geoffrey M. Johnson, SCOTT & SCOTT, LLP, Cleveland Heights, Ohio,

for Appellants. John M. Newman, Jr, JONES DAY, Cleveland, Ohio, for Appellees.

ON BRIEF: Geoffrey M. Johnson, SCOTT & SCOTT, LLP, Cleveland Heights, Ohio,

for Appellants. John M. Newman, Jr, Geoffrey J. Ritts, JONES DAY, Cleveland, Ohio,

John F. McCaffrey, MCLAUGHLIN & MCCAFFREY, Cleveland, Ohio, John D.

Parker, BAKER & HOSTETLER, Cleveland, Ohio, D. Jeffrey Ireland, Martin A. Foos,

FARUKI, IRELAND & COX P.L.L., Dayton, Ohio, Donna M. Donlon, MCKENNA

LONG & ALDRIGE, LLP, Washington, D.C., for Appellees.

*

The Honorable S. Thomas Anderson, United States District Judge for the Western District of

Tennessee, sitting by designation.

1

No. 08-4572 Konkol, et al. v. Diebold, Inc., et al. Page 2

_________________

OPINION

_________________

RONALD LEE GILMAN, Circuit Judge. Janice Konkol and several other

investors filed a class-action securities-fraud lawsuit against Diebold, Inc. (Diebold or

the Company), alleging that between 2003 and 2005 Diebold engaged in a series of

schemes to prematurely recognize revenue in order to inflate the price of its stock.

Holding that the investors’ complaint failed to sufficiently allege scienter, the district

court dismissed the lawsuit for failure to state a claim. The investors appeal that

holding, as well as the district court’s failure to explain its refusal to allow them to file

a second amended complaint. For the reasons set forth below, we AFFIRM the

judgment of the district court.

I. BACKGROUND

A. Factual background

Diebold, a publicly-owned Ohio corporation, manufactures, distributes, and

services electronic voting machines and Automated Teller Machines (ATMs). In

addition to Diebold, the complaint named nine individual defendants, all of whom were

employed by Diebold in senior management positions during the “Class Period” between

October 22, 2003 and September 21, 2005 (these individuals are hereinafter referred to

as the Defendants). All of the investors purchased Diebold stock during the Class

Period. They filed suit in April 2007, alleging that the Defendants manipulated

Diebold’s revenue during the Class Period through three primary schemes:

First, Defendants purposely caused Diebold to improperly recognize

revenue . . . for voting machines sold to California and Ohio counties

even though Defendants knew that the machines were not in compliance

with federal and state “certification” requirements and had not been fully

delivered and accepted by the state and local governments;

Second, Defendants caused Diebold’s service representatives to send out

phony invoices at the end of each financial quarter to artificially inflate

revenue in order to meet the Company’s revenue and earnings targets;

No. 08-4572 Konkol, et al. v. Diebold, Inc., et al. Page 3

Third, Defendants systematically bundled together the Company’s

software products with post-delivery training, maintenance, follow-up

services and rights to software updates, and then prematurely booked

revenue for the portions of the sale that had not yet been earned.

According to the investors, the Defendants “purposely decided to ignore” generally

accepted accounting principles (GAAP) “and booked millions of dollars of revenue

before it was actually earned, choosing to lie to investors and issue false earnings

announcements and financial statements in violation of federal securities laws.”

B. Procedural history

Diebold and the Defendants filed a motion to dismiss the complaint, pursuant to

Rule 12(b)(6) of the Federal Rules of Civil Procedure, in July 2007. Before the district

court ruled on that motion, the investors filed a motion to amend their complaint for a

second time. Without explicitly addressing the investors’ motion to amend, the district

court dismissed the complaint in its entirety in August 2008. The investors have timely

appealed both the dismissal of their lawsuit and the district court’s failure to explain its

refusal to allow them to file a second amended complaint.

II. ANALYSIS

A. Standard of review

The investors allege that Diebold and the Defendants violated Section 10(b) of

the Securities and Exchange Act of 1934 (the Act) and Rule 10b-5 promulgated

thereunder, which prohibit “fraudulent, material misstatements or omissions in

connection with the sale or purchase of a security.” See Morse v. McWhorter, 290 F.3d

795, 798 (6th Cir. 2002). They also allege that the Defendants violated Section 20(a) of

the Act, which imposes control-person liability on “[e]very person who, directly or

indirectly, controls any person liable” under the Act and accompanying rules, unless “the

controlling person acted in good faith and did not directly or indirectly” induce the

illegal acts. See 15 U.S.C. § 78t(a). Such a control-liability claim is contingent upon

the investors’ ability to establish an “underlying” violation of Section 10(b) and Rule

10b-5. PR Diamonds, Inc. v. Chandler, 364 F.3d 671, 696 (6th Cir. 2004).

No. 08-4572 Konkol, et al. v. Diebold, Inc., et al. Page 4

The investors’ lawsuit is thus a securities-fraud action, which falls under the

requirement of Rule 9(b) of the Federal Rules of Civil Procedure that claims of fraud be

plead with particularity. See PR Diamonds, 364 F.3d at 681. Moreover, the Private

Securities Litigation Reform Act of 1995 (PSLRA) “imposes additional and more

‘[e]xacting pleading requirements’ for pleading scienter in a securities fraud case.”

Frank v. Dana Corp., 547 F.3d 564, 570 (6th Cir. 2008) (alterations in original) (quoting

Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 313 (2007)). Securities-fraud

plaintiffs must “state with particularity facts giving rise to a strong inference that the

defendant acted with the required state of mind.” 15 U.S.C. § 78u-4(b)(2). “To qualify

as ‘strong’ . . . , an inference of scienter must be more than merely plausible or

reasonable—it must be cogent and at least as compelling as any opposing inference of

nonfraudulent intent.” Tellabs, 551 U.S. at 314. This “at least as compelling” standard

replaced the old standard used by this court, which provided that “plaintiffs are entitled

only to the most plausible of competing inferences.” See Helwig v. Vencor, Inc., 251

F.3d 540, 553 (6th Cir. 2001) (emphasis added).

Negligence alone on the part of a defendant cannot support a finding of scienter.

Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193, 200-01 (1976). Recklessness, however,

“is a sufficiently culpable state of mind for liability under [section] 10(b) and Rule 10b-

5.” Mansbach v. Prescott, Ball & Turben, 598 F.2d 1017, 1023 (6th Cir. 1979). This

court has long defined recklessness as “highly unreasonable conduct which is an extreme

departure from the standards of ordinary care. While the danger need not be known, it

must at least be so obvious that any reasonable man would have known of it.” Id. at

1025.

The investors allege that the Defendants made fraudulent misstatements in

Diebold’s quarterly and annual press releases and conference calls from the third quarter

of 2003 through the second quarter of 2005. In these press releases and conference calls,

the Defendants touted the strength of Diebold and its record earnings and sales figures.

These statements were allegedly false because the figures were not the result of

No. 08-4572 Konkol, et al. v. Diebold, Inc., et al. Page 5

Diebold’s legitimate business operations, but were instead the result of the Defendants’

scheme to prematurely recognize revenue.

The investors also allege that the Defendants made fraudulent misstatements in

Diebold’s quarterly and annual Securities and Exchange Commission (SEC) filings

during the Class Period. Each of these filings contained a certification that the reported

earnings represented the actual financial condition of Diebold, that Diebold’s internal

disclosure controls were effective, and that Diebold’s revenue-recognition policy and

practice was to account for revenue according to the terms of the relevant contract and

to recognize service revenue when it was actually earned.

We must therefore analyze the investors’ complaint to determine whether the

facts alleged, taken as true, give rise to a strong inference that the Defendants were at

least reckless as to the falsity of these statements and whether that inference is at least

as compelling as any inference of nonfraudulent intent. Our analysis is de novo because

the district court dismissed the investors’ complaint pursuant to Rule 12(b)(6) of the

Federal Rules of Civil Procedure. See Biegas v. Quickway Carriers, Inc., 573 F.3d 365,

377 (6th Cir. 2009).

B. Investors’ request for a remand

As an initial matter, the investors argue that because the district court applied the

now-overruled “most plausible” pleading standard from Helwig, we should remand the

case and instruct the district court to apply the Tellabs standard. See Frank, 547 F.3d

at 571 (remanding a securities-fraud case back to the district court because it erroneously

applied the Helwig standard). Although the earlier portion of the district court’s opinion

in the present case does contain scattered references to the “most plausible” standard that

was overruled in Tellabs, the record reflects that the court ultimately applied the correct

standard. The court, citing Tellabs, specifically acknowledged that it must “ask: ‘would

a reasonable person deem the inference of scienter at least as strong as any opposing

inference?’” Remand is therefore unnecessary.

No. 08-4572 Konkol, et al. v. Diebold, Inc., et al. Page 6

C. Alleged evidence of scienter

The investors’ complaint pleads two sets of facts as evidence that the Defendants

either knew or were reckless as to the falsity of the earnings statements and SEC

certifications. First, the investors allege that scienter can be inferred from the fact that

the Defendants had access to and actually used detailed financial reports and real-time

accounting software, and that they attended weekly high-level accounting meetings.

Second, the investors allege that scienter can be inferred from the suspicious timing of

insider sales of Diebold stock by the Defendants. Both sets of alleged facts are analyzed

below.

1. Defendants’ access to financial information

“[F]raudulent intent cannot be inferred merely from the Individual Defendants’

positions in the Company and alleged access to information.” PR Diamonds, 364 F.3d

at 688 (holding that the defendants’ access to financial reports and control over public

earnings statements were insufficient to support a finding of scienter absent more

particular facts). The investors’ complaint alleges access to information, but it lacks

sufficiently detailed facts regarding the financial reports, how they were used, and their

connection to the Defendants. There are no allegations, for example, as to whether the

reports were used to produce the earnings press releases and SEC reports, whether they

were ever compared to other reports that accurately reflected revenue, or whether the

Defendants were the ones who created the reports.

“In the absence of greater particularity, we have no way of distinguishing the

plaintiffs’ allegations from the countless fishing expeditions which the PSLRA was

designed to deter.” Fischer v. Vantive Corp. (In re Vantive Corp. Secs. Litig.), 283 F.3d

1079, 1087 (9th Cir. 2002) (alterations, citation, and internal quotation marks omitted).

Generalized facts alleging that the Defendants had access to Diebold’s financial

information, in short, do not support a strong inference that the Defendants knew of or

recklessly disregarded the falsity of Diebold’s earnings statements and SEC

certifications. See PR Diamonds, 364 F.3d at 688 (citing In re Peritus Software Servs.,

Inc. Secs. Litig., 52 F. Supp.2d 211, 228 (D. Mass. 1999) (holding that general

No. 08-4572 Konkol, et al. v. Diebold, Inc., et al. Page 7

allegations that a defendant, through his executive position, had access to internal

corporate information and therefore had actual knowledge of misstatements or reckless

disregard for the truth were insufficient to support a strong inference of scienter)). The

standard from Tellabs requires specific facts that those reports were known to

Defendants and reflected the revenue-recognition scheme in such a way that it would

have been obvious that Diebold was improperly inflating its revenue. See In re Peritus

Software Servs., 52 F. Supp. 2d at 228 (rejecting an allegation of scienter because it did

not “achieve the level of specificity” required by the PSLRA).

In their appellate brief, the investors suggest that they cannot compile this more

detailed information because they have not yet engaged in discovery and that the district

court incorrectly “held Plaintiffs to the burden of alleging . . . how these accounting

reports specifically detailed the Company’s revenue recognition schemes.” The district

court, however, was not asking for information that can be obtained only through

discovery. For example, the exact amount of money reflected in the reports is not

relevant at this stage. But what is relevant is the role of these reports in perpetuating the

alleged accounting scheme and the role of these reports in the Defendants’ decision-

making process. Moreover, because the investors had confidential witnesses who

provided generalized statements about the reports, one would reasonably expect those

witnesses to be able to provide more details about the reports and to be able to

specifically connect them to the Defendants.

The Days Sales Outstanding (DSO) reports are the one type of relevant report for

which the investors provided some detail in their complaint. These reports allegedly

reflected the false service-invoice scheme because the accounts receivable would age

and the DSO would therefore increase. The only connection between these reports and

the Defendants, however, is that the Defendants allegedly “monitored” the high DSO.

But this general allegation is not sufficient to support a strong inference of scienter.

Other reports cited in the complaint are even less helpful to the investors in

creating a strong inference of scienter. The complaint, for example, alleges that the

Defendants had access to “Scorecards” in which sales and service employees were

No. 08-4572 Konkol, et al. v. Diebold, Inc., et al. Page 8

ranked based on the amount of revenue they brought in. But ranking employees based

on the amount of revenue they produce is not relevant to whether the Defendants knew

that Diebold was reporting false earnings unless these reports clearly reflected the

revenue-recognition scheme, which is not alleged in the complaint.

The investors also claim that, in addition to the financial reports, Diebold used

real-time data software to track its sales and revenue. Again, however, the complaint

fails to provide key information about this software. It does not, for example, explain

what the software reflected and what would have been obvious to a reasonable person

upon examining the software. Similarly, the complaint fails to connect this software to

eight of the Defendants. As for the ninth Defendant, the complaint simply alleges that

he “used” the software.

The investors raise similar allegations regarding the Defendants’ attendance at

weekly and monthly finance meetings “to discuss . . . the Company’s financial

performance and results.” But attendance at such meetings, without more, does not

support a finding of scienter given that the complaint does not allege that the revenue-

recognition scheme was discussed in the meetings.

Moreover, the investors’ allegations regarding the Defendants’ access to financial

materials and software, and their attendance at meetings, are based solely on two

confidential witnesses (Confidential Witnesses #3 and #11). When confidential sources

are used to support “vague and conclusory” allegations, the allegations are not “accorded

much weight.” Ley v. Visteon Corp., 543 F.3d 801, 811 (6th Cir. 2008) (citing

Higginbotham v. Baxter Int’l Inc., 495 F.3d 753, 757 (7th Cir. 2007) (holding that

allegations of confidential witnesses must be discounted and “[u]sually that discount will

be steep”)). Bare-bones statements, such as the allegation that the Scorecards were “of

huge importance to the decision-making of the Company,” are the type of vague and

conclusory allegations from confidential witnesses that are properly discounted.

Even less weight should be given to the Confidential Witnesses’ allegations due

to the lack of information about them. See Higginbotham, 495 F.3d at 757

(“[A]nonymity conceals information that is essential to the sort of comparative

No. 08-4572 Konkol, et al. v. Diebold, Inc., et al. Page 9

evaluation required by Tellabs. To determine whether a ‘strong’ inference of scienter

has been established, the judiciary must evaluate what the complaint reveals and

disregard what it conceals.”). The complaint does not provide any details about most of

the Confidential Witnesses, such as dates of employment, job description, employment

location or sector, or which Defendants interacted with them. Given the general nature

of the allegations and the absence of critical details, the fact that the Defendants received

financial reports, had access to real-time financial software, and attended financial

meetings is insufficient to support a strong inference that the Defendants had knowledge

of, or a reckless disregard for, the falsity of Diebold’s earnings information.

2. Insider sales of Diebold stock

The Defendants’ “highly lucrative and suspiciously timed insider sales” are the

second set of facts alleged in the complaint in order to establish scienter. Five of the

Defendants sold nearly 40,000 shares on February 11, 2005, two weeks after Diebold

reported earnings that pushed the stock near its all-time high price. These five

Defendants did not make any other sales during the Class Period.

“[I]nsider trading at a suspicious time or in an unusual amount” is one of the nine

factors “usually relevant to scienter” that this court first applied in Helwig v. Vencor,

Inc., 251 F.3d 540, 552 (6th Cir. 2001). The fact that five management-level employees

sold a significant amount of stock on the same day could be probative of the fact that

they knew or at least suspected that Diebold’s earnings reports were misleading. Insider

trading, however, “is suspicious only when it is dramatically out of line with prior

trading practices at times calculated to maximize the personal benefit from undisclosed

inside information.” Zucco Partners, LLC v. Digimarc Corp., 552 F.3d 981, 1005 (9th

Cir. 2009) (citation and internal quotation marks omitted). Thus, “[f]or individual

defendants’ stock sales to raise an inference of scienter, plaintiffs must provide a

meaningful trading history for purposes of comparison to the stock sales within the class

period.” Id. (citation and internal quotation marks omitted).

The investors failed to provide such a history. A “meaningful trading history”

requires information on non-Class Period sales, the amount of stock retained by the

No. 08-4572 Konkol, et al. v. Diebold, Inc., et al. Page 10

Defendants, or, as the Defendants allege, whether the amount of stock owned by the

Defendants actually increased during the Class Period. Absent key background

information confirming their suspicious nature, the stock sales in February 2005 do not

by themselves raise a strong inference of scienter.

D. Investors’ arguments on appeal

In their complaint, the investors primarily relied upon the two sets of facts

discussed above to establish scienter. On appeal, the investors argue that the complaint

alleges at least seven additional facts that support a strong inference of scienter. Each

allegation is addressed in turn below.

1. “The Nature and Pervasiveness of Defendants’ Accounting

Violations”

The first additional fact relied on by the investors is that the alleged accounting

violations were so “basic, pervasive and calculated to mislead investors . . . that they

could not be missed unless the Company’s executives were engaged in knowing or

reckless conduct.” But the “failure to follow GAAP is, by itself, insufficient to state a

securities fraud claim.” Hoffman v. Comshare, Inc. (In re Comshare, Inc. Secs. Litig.),

183 F.3d 542, 553 (6th Cir. 1999). Despite this general rule, “common sense and logic

dictate that the greater the magnitude of a restatement or violation of GAAP, the more

likely it is that such a restatement or violation was made consciously or recklessly.” PR

Diamonds, Inc. v. Chandler, 364 F.3d 671, 685 (6th Cir. 2004) (quoting In re

MicroStrategy, Inc. Secs. Litig., 115 F. Supp. 2d 620, 636 (E.D. Va. 2000)).

One cannot determine from the complaint whether the magnitude of Diebold’s

alleged accounting violations are the type of extreme “in your face facts” that “cry out”

scienter. See id. at 686. The complaint does not specify the total amount of revenue that

Diebold allegedly overstated. Nonetheless, Diebold is a multi-billion-dollar company

and, as such, the amount of improperly recognized revenue would have to be significant

in order to support a finding of scienter. No such significant figures are alleged. The

investors do not contend, for example, that Diebold “reported profits when it should

No. 08-4572 Konkol, et al. v. Diebold, Inc., et al. Page 11

have been reporting losses over several different quarters.” See In re Telxon Corp. Secs.

Litig., 133 F. Supp. 2d 1010, 1031 (N.D. Ohio 2000) (holding that the investors’

complaint adequately plead scienter, based in part on the magnitude of the accounting

errors) (emphasis in original).

Aside from the uncertainty regarding the amount of the purportedly overstated

revenue, the alleged revenue-recognition scheme is not the type of conduct from which

scienter can be strongly inferred by the magnitude of the errors alone. The alleged

scheme involved different product lines, and the revenue came from three very different

sources: uncertified voting-machines sales, software bundling, and false service

invoices. Even if the amount of revenue prematurely recognized was significant, it

would have been spread out among these different sources and therefore would not likely

have served to put the Defendants on notice of the misstated revenue.

2. “The Fact That The Confidential Witnesses Were Able To

Describe The Fraudulent Scheme In Detail”

The second additional fact relied on by the investors to establish a strong

inference of scienter is that “several of the confidential witnesses—who were Diebold

insiders and knew about the inner working of the Company—were able to describe parts

of the fraudulent accounting scheme in detail, and stated that the Individual Defendants

had extensive knowledge about the true financial condition and accounting practices of

the Company.” Nowhere in the complaint, however, are any specific facts alleged that

connect the Defendants to the revenue-recognition scheme. Instead, the investors rely

on general statements from the Confidential Witnesses, such as that “the false invoicing

scheme was perpetrated at a high level within the Company,” “[i]t was very obvious

what they were doing,” and “the false invoicing practice was openly known within the

Company.” These generalized statements cannot substitute for specific facts through

which a factfinder can strongly infer that the Defendants themselves knew of or

recklessly disregarded the falsity of the earnings statements, especially because the

majority of the Confidential Witnesses are not identified as having any contact or

interaction with any of the Defendants. See W. Pa. Elec. Employees Benefits Funds v.

No. 08-4572 Konkol, et al. v. Diebold, Inc., et al. Page 12

Ceridian Corp. (In re Ceridian Corp. Secs. Litig.), 542 F.3d 240, 248 (8th Cir. 2008)

(holding that the plaintiffs failed to meet the PSLRA pleading standard, in part, because

they did not “allege specific facts” giving rise to an inference that the defendants knew

their statements were false).

3. “The Proximity In Time Between The False Statements and the

Disclosure of the Fraud”

The third additional fact relied on by the investors is the proximity in time

between the allegedly false statements by the Defendants and the later corrections. On

August 12, 2005, Diebold stated in an SEC filing that its disclosure controls and

procedures were effective. Three days later, another SEC filing stated that such controls

and procedures were not effective. The investors argue that “[t]he fact that these two

statements were made a mere three days apart strongly suggests that Defendants knew

the first statement was false when it was made.”

“[C]loseness in time of an allegedly fraudulent statement . . . and the later

disclosure of inconsistent information” is one of the nine Helwig factors supporting a

finding of scienter. Helwig v. Vencor, Inc., 251 F.3d 540, 552 (6th Cir. 2001). The

difference of only three days suggests that the Defendants knew or had reason to know

that their certification that the controls were effective was false when it was made.

Proximity alone, however, does not support a strong inference of scienter. Fidel v.

Farley, 392 F.3d 220, 232 (6th Cir. 2004) (holding that the plaintiffs had not adequately

plead scienter despite the temporal proximity of statements “because there is no

indication from the class members’ allegations that [the defendant] knew or recklessly

disregarded information it had before it at the time it issued its” allegedly false

statements). Because the investors in the present case do not allege any specific facts

establishing that the Defendants knew or recklessly disregarded the falsity of their

statements, the proximity of the inconsistent statements is not sufficient to support a

strong inference of scienter.

No. 08-4572 Konkol, et al. v. Diebold, Inc., et al. Page 13

4. “The DOJ and SEC’s Criminal and Civil Investigations”

The fourth additional fact relied on by the investors is the existence of

investigations by the Department of Justice (DOJ) and the SEC into Diebold’s

operations. According to the investors, “as a matter of common sense, the fact that two

government agencies armed with access to the Company’s internal accounting records

have dedicated resources to investigating potential accounting fraud . . . suggests that

more is amiss than technical accounting violations or management negligence.”

The existence of the DOJ investigation was first pled in the investors’ proposed

second amended complaint and is therefore not relevant to whether the investors’

complaint of record gives rise to a strong inference of scienter. Although a government

investigation is not altogether irrelevant to the scienter analysis, a decision by

government agencies to investigate a company is not sufficient to meet the heightened

Tellabs standard on its own, see In re Ceridian Corp., 542 F.3d at 248-49 (holding that

an allegation of an ongoing SEC investigation “[w]ithout more” is not sufficient to

establish scienter), or even in combination with the temporal-proximity factor discussed

above. Government investigations can result from any number of causes, and the

investors have not pointed to any facts suggesting that the SEC investigation was the

result of knowing or reckless behavior by the Defendants. See NECA-IBEW Pension

Fund v. Hutchinson Tech., Inc. (In re Hutchinson Tech., Inc. Secs. Litig.), 536 F.3d 952,

962 (8th Cir. 2008) (“[W]e consider the SEC’s opening and closing an investigation

irrelevant to the issue of [the plaintiff’s] complaint sufficiency. The mere existence of

an SEC investigation does not suggest that any of the allegedly false statements were

actually false . . . [,] nor does it add an inference of scienter.”).

The investors’ related argument is that the investigations should have served as

“red flags” to notify the Defendants of the accounting fraud. See, e.g., In re Health

Mgmt., Inc. Secs. Litig., 970 F. Supp. 192, 203 (E.D.N.Y. 1997) (finding that the SEC’s

investigation into the company’s accounts receivable served as a red flag that “should

have caused [the company] to investigate further”). This argument is without merit,

however, because neither government investigation was initiated until after the close of

No. 08-4572 Konkol, et al. v. Diebold, Inc., et al. Page 14

the Class Period in 2005, so the investigations could not have alerted the Defendants to

the possible falsity of the statements during the Class Period.

5. “Defendants’ Own Class Period Statements”

The fifth additional fact relied on by the investors is that the Defendants’ own

statements during the Class Period “show that [they] were intimately familiar with

Diebold’s accounting and financial reporting practices,” and that by participating in

earnings conference calls and signing SEC certifications about Diebold’s earnings and

policies, the Defendants “held themselves out as extremely knowledgeable about

Diebold’s financial results.” But the Class Period statements detailed in the complaint

are generalized and relate primarily to Diebold’s overall profits and growth. They

therefore do not establish that the Defendants were “intimately familiar” with Diebold’s

revenue-recognition practices.

Moreover, a “Sarbanes-Oxley certification is only probative of scienter if the

person signing the certification was severely reckless in certifying the accuracy of the

financial statements.” Ley v. Visteon Corp., 543 F.3d 801, 812 (6th Cir. 2008) (quoting

Garfield v. NDC Health Corp., 466 F.3d 1255, 1266 (11th Cir. 2006)). The investors

have provided no contemporaneous facts showing that the Defendants knew or should

have been aware that these statements were false. See In re MoneyGram Int’l, Inc. Secs.

Litig., 626 F. Supp. 2d 947, 981 (D. Minn. 2009) (“[F]alse [Sarbanes-Oxley]

certifications are probative of scienter only if they are accompanied by allegations of

particular facts demonstrating how the defendants knew of the scheme at the time they

made their statements of compliance, that they knew the financial statements

overrepresented the company’s true earnings, or that they were aware of a GAAP

violation and disregarded it.” (citation and internal quotation marks omitted)).

Finding scienter based on these allegations would be equivalent to “the classic

fraud by hindsight case where a plaintiff alleges that the fact that something turned out

badly must mean defendant knew earlier that it would turn out badly.” See Miss. Pub.

Employees’ Ret. Sys.v. Boston Scientifc Corp., 523 F.3d 75, 91 (1st Cir. 2008). Without

specific allegations showing that the Defendants either knew of or recklessly disregarded

No. 08-4572 Konkol, et al. v. Diebold, Inc., et al. Page 15

the falsity of their own statements at the time the statements were made, the fact that

their statements later turned out to be false is irrelevant to a cause of action under the

PSLRA.

6. “The Statements Contained in the Internal Jones Day Memos”

The sixth additional fact relied on by the investors is that Jones Day, a law firm

serving as outside counsel to Diebold, prepared two memos in 2003-2004 regarding

whether selling uncertified voting machines to California counties would constitute a

breach of contract and whether voting systems could be modified without California’s

approval. These memos concluded that such sales would likely breach Diebold’s

contract with California and that California’s approval would be needed for system

modifications.

According to the investors, these memos “show that Diebold’s top executives

knew or should have known that the Company could not report revenue from sales of

voting machines that did not comply with state election laws because these voting

machines would result in a breach of contract.” These memos, however, are not

probative of the Defendants’ state of mind because the complaint does not allege that the

Defendants ever read, received, or were informed of the existence of these memos. The

memos, moreover, have nothing to do with whether revenue could be properly

recognized from the voting machine sales. These memos therefore could not have put

the Defendants on notice that revenue from the voting machines would be improperly

recognized.

7. “Defendants’ Inability to Come Up With Any Plausible Non-

Fraud Explanation for the False Financial Statements”

The final additional fact relied on by the investors is that the “Defendants have

provided no alternative non-fraud explanation for their false and misleading statements

during the Class Period.” But this court has never held that a securities-fraud defendant

must proffer a nonfraudulent explanation, and we decline to do so now. The PLSRA and

No. 08-4572 Konkol, et al. v. Diebold, Inc., et al. Page 16

the Supreme Court’s opinion in Tellabs make clear that the burden of proof, at this stage

of the proceedings, rests with the investors.

Moreover, the Defendants have provided nonfraud explanations for several

allegations raised by the investors. To rebut the argument about suspicious insider

trading, for example, the Defendants point out that the February 2005 sales were

explained in public SEC filings as representing “a withholding for taxes incurred when

certain defendants earned common shares of the Company’s stock for the ‘performance

period’ of 2001-2003 under the Company’s Performance Share Program.”

E. Remaining Helwig factors

The investors’ complaint fails to allege any of the seven remaining Helwig

factors. They do not allege, for example, “bribery by a top company official,” “disregard

of the most current factual information,” “disclosure of accounting information in such

a way that its negative implications could only be understood by someone with a high

degree of sophistication,” “personal interest of certain directors in not informing

disinterested directors of an impending sale of stock,” or a “self-interested motivation

of defendants in the form of saving their salaries or jobs.” See Helwig v. Vencor, Inc.,

251 F.3d 540, 552 (6th Cir. 2001).

The investors further fail to allege that the external financial statements published

by Diebold diverged from the internal reports. See id. Indeed, the investors heavily rely

on the fact that the internal reports should have informed the Defendants of the revenue-

recognition scheme, thus suggesting that both the internal reports and the external

reports reflected the alleged premature recognition of revenue. Finally, the complaint

does not allege the “existence of an ancillary lawsuit charging fraud by a company and

the company’s quick settlement of the suit.” See id. The complaint does reference a

false-claims suit by the state of California, but it does not allege that the settlement of

that suit was suspiciously quick or otherwise improper.

Given the absence of any of these other Helwig factors, and the general and

conclusory allegations discussed above, the investors’ complaint does not “state with

No. 08-4572 Konkol, et al. v. Diebold, Inc., et al. Page 17

particularity facts giving rise to a strong inference that the defendant[s] acted with the

required state of mind.” See 15 U.S.C. § 78u-4(b)(2). We therefore conclude that the

district court did not err in holding that the investors’ complaint failed to adequately

allege scienter.

F. Investors’ proposed second amendment to complaint

The investors’ final argument on appeal is that the district court erred in failing

to explain its refusal to permit the investors to file a second amended complaint.

Ordinarily, when a district court “fails to state a basis for its decision to deny a motion

to amend,” it has abused its discretion. Rose v. Hartford Underwriters Ins. Co., 203 F.3d

417, 420 (6th Cir. 2000). If the “proposed amendment would have been futile,”

however, the abuse of discretion amounts to harmless error. Id. A proposed amendment

is futile if the complaint, as amended, would not withstand a Rule 12(b)(6) motion to

dismiss for failure to state a claim. Id.

As amended, the complaint would have contained information about post-Class

Period restatements of earnings, delays in filing financial reports, an investigation by the

DOJ, and Diebold’s decision to withhold compensation from several Defendants “[i]n

light of and in connection with the pending restatements.” But none of these additional

facts would have satisfied the Tellabs standard because they relate primarily to post-

Class Period events. They do not shed any light on whether the Defendants, at the time

the earnings statements and SEC certifications were made, knew of or were reckless

regarding the falsity of those statements or certifications.

The investors’ proposed second amended complaint would also have added a

fourth scheme by which Diebold allegedly recognized revenue prematurely: “Defendants

systematically billed customers, and recognized revenue, for ATM’s that had not been

delivered or installed.” The investors relied heavily upon this alleged “bill and hold”

scheme at oral argument to suggest that the complaint gave rise to a strong inference of

scienter. Specifically, the investors claimed that Diebold had used the bill and hold

accounting method for many years, but failed to mention the use of this method in its

SEC filings and other public reports, therby committing a securities-fraud violation.

No. 08-4572 Konkol, et al. v. Diebold, Inc., et al. Page 18

This allegation, however, does not appear on the face of the proposed second amended

complaint.

Moreover, the allegations in the proposed second amended complaint about the

bill and hold ATM scheme relate primarily to the scope of the alleged scheme, not to the

Defendants’ state of mind. The investors’ proposed amendment would thus have been

futile, and the district court’s failure to justify its refusal to permit the amendment was

harmless.

III. CONCLUSION

In sum, we conclude that neither the complaint nor the proposed second amended

complaint states “with particularity facts giving rise to a strong inference that the

defendant[s] acted with the required state of mind.” 15 U.S.C. § 78u-4(b)(2). Any

inference of scienter is not “cogent” as required by Tellabs, but speculative and

supported only by general and conclusory allegations that fail to connect the Defendants

to the alleged scheme. For all of these reasons, we AFFIRM the judgment of the district

court.