Inst Inv Grp v. Avaya Inc

Opinions of the United

2009 Decisions States Court of Appeals

for the Third Circuit

4-30-2009

Inst Inv Grp v. Avaya Inc

Precedential or Non-Precedential: Precedential

Docket No. 06-4595

Follow this and additional works at: http://digitalcommons.law.villanova.edu/thirdcircuit_2009

Recommended Citation

"Inst Inv Grp v. Avaya Inc" (2009). 2009 Decisions. Paper 1418.

http://digitalcommons.law.villanova.edu/thirdcircuit_2009/1418

This decision is brought to you for free and open access by the Opinions of the United States Court of Appeals for the Third Circuit at Villanova

University School of Law Digital Repository. It has been accepted for inclusion in 2009 Decisions by an authorized administrator of Villanova

University School of Law Digital Repository. For more information, please contact Benjamin.Carlson@law.villanova.edu.

PRECEDENTIAL

UNITED STATES COURT OF APPEALS

FOR THE THIRD CIRCUIT

No. 06-4595

INSTITUTIONAL INVESTORS GROUP, Lead Plaintiff;

HOWARD CHARATZ, individually and on

behalf of all others similarly situated,

Appellants

v.

AVAYA, INC.;

DONALD K. PETERSON; GARRY K. McGUIRE, SR.

On Appeal from the United States District Court

for the District of New Jersey

D.C. Civil Action No. 05-cv-2319

(Honorable Mary L. Cooper)

Argued March 3, 2008

Before: SCIRICA, Chief Judge,

FISHER and ROTH, Circuit Judges.

(FiledL: April 30, 2009)

SANFORD SVETCOV, ESQUIRE (ARGUED)

Coughlin Stoia Geller Rudman & Robbins

100 Pine Street, Suite 2600

San Francisco, California 94111

Attorney for Appellants

STEVEN M. SCHATZ, ESQUIRE (ARGUED)

Wilson Sonsini Goodrich & Rosati

650 Page Mill Road

Palo Alto, California 94304

KERRI E. CHEWNING, ESQUIRE

Archer & Greiner

One Centennial Square

P.O. Box 3000

Haddonfield, New Jersey 08033

Attorneys for Appellees

OPINION OF THE COURT

2

SCIRICA, Chief Judge.

This is a shareholders securities action, putatively a class

action, alleging defendants made false or misleading statements

about earnings growth potential and pricing pressure in violation

of the Securities and Exchange Act of 1934. Shareholders’

central theory is that investors and analysts viewed the key to

Avaya’s success to be its ability to increase sales revenues

without cutting prices. The District Court granted defendants’

motion to dismiss for failure to meet the pleading requirements

of the Private Securities Litigation Reform Act of 1995

(PSLRA). We will affirm in part and reverse in part and remand

for proceedings consistent with this opinion.

I.

Defendant Avaya Inc. sells communications products and

services.1 Shareholders allege Avaya, through its Chairman and

CEO, defendant Peterson, and its CFO, defendant McGuire, (1)

affirmatively denied unusual price competition was occurring

during the class period, despite knowing there was price

1

During the relevant period, its Chairman and Chief

Executive Officer was Donald Peterson, and its Chief Financial

Officer and Senior Vice President of Corporate Development

was Garry McGuire. The allegations in this case all involve the

2005 fiscal year; Shareholders propose a class period running

from October 26, 2004, to April 19, 2005 (the company’s fiscal

year ends on September 30).

3

competition that was hurting profit margins; and (2) issued

baseless financial projections and positive portrayals to the

market despite knowing the projections and portrayals were

impossible to fulfill in light of intense price competition and

problems with the company’s “go-to-market” (GTM) strategy.2

Shareholders support their claims through a variety of

circumstantial allegations of falsity and knowledge, including

the accounts of confidential witnesses (CWs), analyst reports,

and alleged “admissions” by Peterson and McGuire.

Statements during three separate portions of the class

period form the basis of Shareholders’ claims: (1) in late

October 2004, after the start of Avaya’s 2005 fiscal year

2

For purposes of background explanation, we note that,

according to Avaya’s SEC filing, the GTM strategy “realign[ed]

our sales and marketing efforts by expanding direct sales

coverage of key accounts; by enlarging the number of strategic

accounts; by identifying a second tier of named accounts served

by a combination of our direct sales team and our channel

partners; and by servicing our medium and small business

customers primarily through our channel partners. This had the

result, among other things, of reassigning accounts among

different channels and sales teams.” Avaya Inc., Quarterly

Report for the Period Ended March 31, 2005 (Form 10-Q), at 35

( M a y 1 0 , 2 0 0 5 ) , a v a i l a b l e a t

http://idea.sec.gov/Archives/edgar/data/1116521/0001104659

05021893/a05-8780_110q.htm.

4

(FY2005), Avaya, through Peterson and McGuire, announced

results for FY2004 and made projections for FY2005; (2) in late

January 2005, Avaya announced results for the first quarter of

FY2005 and made positive portrayals; (3) in the first two weeks

of March 2005, McGuire allegedly increased his revenue

projections for FY2005 and made false or misleading comments

about the state of Avaya’s business. All of the statements fall

into one of two general categories. First, there are “pricing-

pressure statements,” in which McGuire and Peterson are

alleged to have falsely denied Avaya was offering unusual

discounts and facing significant pricing pressure from market

rivals. Second, there are “forecast-related statements,” in which

defendants projected financial results (such as operating margin

and revenue growth) and made positive portrayals, notably the

statement that Avaya was “on track” to achieve its goals or

projections.

The Complaint alleges the following facts.3

A.

On October 26, 2004, Avaya released financial results for

FY2004 and the fourth quarter of 2004 (Q4 FY2004), which had

ended September 30, 2004. A press release stated in part: “We

3

Where the Complaint refers to other documents, we draw on

information in those documents beyond what is directly quoted

in the Complaint. See infra Section II.C (citing Tellabs, Inc. v.

Makor Issues & Rights, Ltd., 127 S. Ct. 2499, 2509 (2007)).

5

have entered the new year well positioned to translate our

ongoing success in the marketplace into enhanced shareholder

value.” In a conference call for analysts and investors, Peterson

elaborated: “Clearly we are enjoying significant momentum in

the marketplace, and we are converting that momentum into

increased profitability and financial strength. Underlying this

momentum are our Company’s strategic advantages.” Peterson

added that “[t]he end result is that today we are a stronger more

competitive organization that enjoyed [sic] significant potential

. . . to further build shareholder value.” When asked about

prospects for operating margins, McGuire said he expected

continued improvement in FY2005. Peterson commented on

pricing: “I’d say pricing as a general comment is not different

than what it has been. There continues to be . . . pressure in the

market, it’s a very competitive marketplace but I wouldn’t say

there’s anything particularly noteworthy in the trend line one

way or the other.” 4

4

The Complaint alleges analysts reported optimistically on

the results and management’s statements, focusing especially on

the strong expected gross and operating margins for FY2005.

A JP Morgan analyst stated “management indicated that not only

are the margins likely sustainable but, in fact, there is room for

additional expansion,” and “[p]ricing pressure remains under

control.” “Management noted that no unusual pricing pressure

in the quarter affected margins, and while they expect pricing to

continually decline, the shift towards products such as higher-

margin IP software would benefit Avaya’s gross margin.” A

6

On October 29, Avaya issued a set of financial

projections. For FY2005, the company projected an operating

margin 5 of 8.5% to 9% and revenue growth of 25% to 27%. For

FY2006, it projected an operating margin of 10% to 12%.

McGuire and Peterson spoke at a conference and made positive

portrayals, focusing particularly on the 8.5% to 9% estimate for

operating margin.

On January 25, 2005, defendants announced Avaya’s

financial and operational results for Q1 FY2005. The results

were “in line with, or better than, analysts’ expectations.” First

quarter operating income grew 70% year-over-year and the

Prudential analyst reported the statements by McGuire,

characterizing them as follows: “While competitors have cut

prices and may have sacrificed margins on some individual

deals, [Avaya] remains committed to growing its share

profitably, and it is not seeing any widespread change in the

telephone pricing environment.” The analyst added that Avaya

“believes these margins are sustainable.”

5

Operating margin is determined by dividing operating

income by total revenue. Operating margin measures the

proportion of a company’s revenue left over after paying for

variable costs (e.g., wages, raw materials, etc.). It gives

investors and analysts an indication of how much a company

makes on each dollar of sales (before interest and taxes).

7

gross margin percentage 6 was 47.3%. Total revenues grew 18%

compared with Q1 FY2004.7 Notably, defendants stated: “Our

first quarter results position us to meet our goals for the year”;

and “we are on track to meet our goals for the year, even though

there were some aspects of our performance that are below our

expectations and that we are working on to improve.” 8

During a conference call with analysts, Peterson

reiterated Avaya’s FY2005 expectations:

Growing revenue 25 to 27 percent. Increasing

operating income by 40 percent. Increasing our

annualized margin to the 8.5 to 9 percent range,

6

Gross margin percentage equals: Revenue minus Cost of

Goods Sold, divided by Revenue. The gross margin represents

the percent of total sales revenue the company retains after

incurring the direct costs associated with producing the goods

and services sold by the company.

7

Excluding the impact of two business acquisitions—Tenovis

and Spectel—revenues grew 5% compared to Q1 FY2004.

8

See also Statement of Don Peterson, Chairman and CEO,

Avaya, Q1 2005 Avaya Earnings Conference Call (Jan. 25,

2005) (“While our results put us in line to achieve our goals for

the year, there are some elements to our performance that we are

focused on improving. Product sales in the U.S. were not up to

our expectations.”).

8

which would put us on the trajectory to go beyond

that in 2006. All those things are on track. We

do have a business that is somewhat more

seasonal in its pattern than some of our data

industry brethren, and this is a fall-over or

holdover of the telecom business even though

these things are merging in IP telephony. But we

think that we had a solid quarter that is

positioning us well to go on through the rest of

the year and achieve those goals.

We will obviously report to you as we make that

progress at the very least in our quarterly results.

And if there is something particularly important,

we will come to you before that, but otherwise

assume that we are on track and going to make

that—going to deliver on those promises as the

year goes on.

On March 2, 2005, McGuire adjusted Avaya’s projected

annual revenue growth to 28% 9 and noted that “we are building

on the momentum that we’ve got in the market relative to the

technology lead, our applications, . . . and our global services.”

In response to analyst inquiries about the effect of pricing

9

The increase in projected revenue growth was due to the

earlier-than-predicted completion of the acquisition of Tenovis.

The acquisition allowed Avaya to recognize an additional 3% of

revenues in 2005 for that “stub” period.

9

pressure from Cisco, McGuire stated that Cisco is “a good

competitor . . . to have relative to the pricing environment. . . .

[I]f they start a price war in IP telephony, they’re only going to

further exacerbate the pressure they’ve got on gross margins. So

in that regard, I kind of view them as a nice competitor to have

because that’s a problem they’ve got to live with.” Similarly, on

several occasions in March, McGuire said there were no

significant changes to the pricing environment. See Statement

of Garry McGuire, CFO, Avaya, Fourth Annual JMP Securities

Research Conference (Mar. 2, 2005) (“Pricing environment is

not significantly different. I mean, there are people that will buy

a deal from time to time, but in general, the pricing environment

is—has been fairly stable.”); Statement of Garry McGuire, CFO,

Avaya, Morgan Stanley Semiconductor and Systems Conference

(Mar. 7, 2005) (“[C]learly from time to time people will want to

buy a deal here or there, but the market itself has been fairly

stable with just modest declines over the last 12 months.”);

Statement of Garry McGuire, CFO, Avaya, Deutsche Bank

Securities Inc. IT Hardware Conference (Mar. 10, 2005)

(“Pricing has been fairly steady for the last couple of years. . . .

I don’t see any reason that that would change significantly. I

think that in the last year or so, it has really been a 2-horse race

with us and Cisco in the IP telephony area.”).

Also in March, analyst reports identified potential

obstacles faced by Avaya. On March 4, 2005, members of the

Buckingham Research Group performed a sales channel check

and concluded that Avaya was experiencing “weak” spending

10

for its products and had fired sales staff in order to cut costs.

The analysts predicted Avaya’s actions would “negatively effect

[sic] growth.” In addition, a March 21, 2005, Equity Research

Update by Lehman Brothers analysts reported that Avaya

resellers had indicated that the company was “offering

aggressive [30–40%] discounts for its mid-range products

(150–400 lines) since [the] beg[inning] of March [2005].” 10

Lehman Brothers characterized the discounts as “quite unusual”

and warned that if the promotion were highly successful,

“Avaya’s product margins would be somewhat impacted.”

On April 19, 2005,11 Avaya announced that it would be

unable to meet its previously stated goals for growing revenues,

operating income, and operating margin in FY2005. Avaya’s

Q2 FY2005 revenues increased 21% compared to the revenue

in Q2 FY2004. The revenue growth “reflected the impact of

Avaya’s recent acquisitions and revenue growth internationally.”

But “U.S. product and services revenues declined year-over-

year.” On April 20, 2005, Avaya’s stock price dropped

10

The report indicated that “[w]hile accurate industry data is

hard to obtain, we estimate sales of 150–400 line systems

constitute a significant portion of the enterprise telephony

industry sales.”

11

As noted, Q2 FY2005 ended on March 31, 2005.

11

approximately 25%—from $10.69 to $8.01.12

Peterson blamed internal problems, especially the GTM

strategy, for the missed benchmarks. See Statement of Don

Peterson, Chairman and CEO, Avaya, Q2 2005 Avaya Earnings

Conference Call (Apr. 19, 2005) (“[W]ell over a majority of this

shortfall I would attribute more to issues related to us than issues

related to the market. . . . I think most of this [sic] are things

that if I have to get to and fix and therefore they’re within our

control and we will fix them and get back on track.”); id. (“The

implementation of our new go-to-market strategy . . . is taking

longer and has been somewhat more disruptive than we had

envisioned. While we still believe it is the right strategy and it

will ultimately strengthen our presence in the marketplace it has

in the short-term negatively affected our direct sales in the

U.S.”).

McGuire noted that during the first two months of the

second quarter, Avaya was “tracking slightly at or just a little bit

below the quarter before” and was “track[ing] well for March

closure both on the indirect and the direct side.” According to

McGuire, “all of the indicators that we had gave us comfort that

that would come through.” But Avaya was “caught . . . by

surprise in the last week” of the quarter when distributors

decided not to “reload” at the rates they had done in the past and

when Avaya was unable to close several deals during the

12

On April 20, 2005, the S&P 500 dropped 1.3% and the

Dow Jones Industrial Average dropped 1.1%.

12

quarter.

Also, in response to questions about discounting,

McGuire stated: “There is no new specific discounting policy

we put in place. I can tell you that our discounts were relatively

black or improved in most parts of the world, except for

international direct where they were up slightly.” During a

conference call with Merrill Lynch on April 28, 2005,13

McGuire was asked about “some reports published recently

saying that Avaya gave a 30% to 40% discount in the first

quarter.” McGuire responded: “Now, I hear the noise that, yes,

we were out with a 30% to 40% discount on a program in last

quarter. . . . [I]t’s not unusual . . . . And quite frankly, a 30% to

40% discount is not out of the norm for any of these programs.”

B.

Based on the following “true facts,” Shareholders allege

a “two-pronged fraud scheme to increase Avaya’s stock price.”

13

Although Shareholders’ proposed class period ran from

October 26, 2004, to April 19, 2005, the April 28 statements

may be relevant. See In re Merck & Co. Sec. Litig., 432 F.3d

261, 272 (3d Cir. 2005) (“[B]oth post-class-period data and pre-

class data could be used to ‘confirm what a defendant should

have known during the class period’” because “‘[a]ny

information that sheds light on whether class period statements

were false or materially misleading is relevant.’” (quoting In re

Scholastic Corp. Sec. Litig., 252 F.3d 63, 72 (2d Cir. 2001))).

13

Shareholders’ Br. 5. First, Shareholders allege that, beginning

in October 2004, and continuing throughout the class period,

defendants denied that Avaya was offering unusual price

discounts and that its profit margins were being impaired.

Shareholders contend the “true facts” show Avaya was in fact

encountering serious pricing pressures and was forced to grant

unusually large discounts in negotiations with clients, which

would manifest themselves in less-profitable contracts booked

in subsequent quarters (since the negotiation process “regularly

lasted months”), eviscerating margins. Second, Shareholders

allege the financial projections Avaya released on October 29,

2004, and reaffirmed in January and March 2005, were false or

misleading. According to Shareholders, defendants knew the

projections could not be achieved because of unusual pricing

discounts and declining sales due to Avaya’s sales force

realignment under the GTM strategy, which impaired both

earnings and revenues.

CW3 is a confidential witness and former Global

Contract Manager who worked at Avaya “for many years prior

to leaving in November 2004” and who “participated in the

negotiation of contracts with many of Avaya’s biggest clients,”

including work on the top forty accounts in the U.S. According

to CW3, “Avaya’s operational model had essentially broken

down” in the months prior to his November 2004 departure,

“resulting in Avaya’s inability to compete with the business

models of rivals in the industry such as Cisco and AT&T

Solutions.” CW3 asserts it was “well-recognized within Avaya

14

that its business model faced significant problems” and that its

inability to compete with an “outsourcing” product offered by

AT&T Solutions allowed numerous large clients, such as Merrill

Lynch and Citigroup, to pressure Avaya “as a means of winning

substantial price concessions.” Citigroup allegedly forced

Avaya to accept a 20% price reduction with no change in

services because Avaya feared losing Citigroup to AT&T

Solutions’s “outsourcing” product. In the months leading up to

the beginning of the class period, CW3 contends “defendants

realized Avaya’s margins on business with relatively small

accounts . . . had substantially declined,” so that it had become

unprofitable to negotiate such contracts. Avaya shifted to a

policy of non-negotiation on those accounts, leading to a decline

in business as Avaya lost those accounts to competitors.

CW4 is a former Avaya employee “who was at the

Company prior to and throughout the Class Period and who was

responsible for evaluating the profitability of special bids in the

Services organization,” which allegedly provided half of

Avaya’s revenues. See Shareholders’ Br. 11. According to

CW4, “Avaya gave substantial discounts to win business in the

period leading up to the beginning of the Class Period through

May 2005.” The customers receiving such discounts were

among Avaya’s largest. CW4 provided the names of four of the

customers. CW4 stated that, historically, Avaya gave 20%

discounts to 20% of its special bid customers. But between

January and May 2005, at the request of the sales force, Avaya

management gave 20% discounts to 80% of its special bid

15

customers. In 2004 and 2005, “Avaya was facing substantial

competition from newer companies that were aggressively

pursuing Avaya’s customers by competing on price.” 14 “[I]n

many instances Avaya was granting price concessions in excess

of 30%–40% in order to win business . . . .” 15 Finally, CW4

contends, Avaya inherited a number of low-margin contracts

from its acquisition of a company called Expanets in October

2003. This problem allegedly continued throughout the class

period, and by March 2005, Avaya was “happy to merely break

even on such contracts.”

CW5, a former Senior Client Executive at Avaya from

2001 until March 2004, said Avaya’s GTM strategy had begun

in October 2003 and involved reassigning Client Executives

from larger “enterprise” accounts to “mid-market” accounts.

14

According to CW4, one such company, United Assets

Coverage, specifically targeted customers who received Avaya’s

Maintenance Software Permission product. In October 2004,

“defendants learned about United Assets Coverage’s tactic to

target Avaya customers.”

15

CW6, an independent Avaya sales manager who sold

Avaya products but was not employed by the company,

confirmed that in March 2005, Avaya was cutting prices on

some of its mid-range systems. According to CW6, “Cisco was

attacking Avaya on price and hurting Avaya in the small and

midsized business markets.”

16

CW5 realized in October 2003 that the GTM strategy would

cause “a substantial loss of business already in the pipeline.”

The effect of the GTM strategy was that “many customers lost

confidence and trust in Avaya and certain large sales were lost.”

For example, CW5 allegedly lost $7 million in sales through

2004, “including lucrative contracts with ACS in Utica, New

York for $1.5 million and a $750,000 deal with Alcoa.”

According to CW5, these and other similar FY2004 losses

attributable to the GTM strategy “were to have a substantial

impact on Avaya’s financial results during the Class Period”

because Avaya’s “sales cycle” for enterprise accounts ranged

from six months to a year and a half.

Two CWs (a former Director of Operations for Global

Solutions Sales and Support and a former Senior Client

Executive) claimed McGuire established the financial

projections on a “top-down basis,” meaning he did not solicit

input from salespeople. The resulting forecast was allegedly

“dictated” from the top and was not realistically attainable.

Finally, according to CW3, Avaya fired employees in September

2004 “specifically because the Company’s business was not

doing well,” demonstrating that despite the “positive spin”

Peterson and McGuire issued in October 2004, internally they

were “taking drastic steps to reduce costs” in order to meet the

projections.

II.

The District Court granted defendants’ motion to dismiss

17

under the Private Securities Litigation Reform Act (PSLRA) for

three reasons: (1) some statements defendants allegedly made

were “forward-looking” and protected under the PSLRA’s Safe

Harbor provision; (2) other alleged statements were not

actionably false or misleading; and (3) with respect to remaining

statements that may have been actionable, Shareholders failed

to plead facts giving rise to a strong inference of scienter as the

PSLRA requires. See Charatz v. Avaya, Inc., No. 05-2319

(MLC), 2006 WL 2806229, at *12–20 (D.N.J. Sept. 28, 2006).

Shareholders timely appealed.16

We exercise plenary review over the District Court’s

dismissal of the Complaint for failure to meet the pleading

requirements of the PSLRA and over the District Court’s

interpretation of the federal securities laws. Winer Family Trust

v. Queen, 503 F.3d 319, 325 (3d Cir. 2007).

A. Section 10(b) and Rule 10b-5

Section 10(b) of the Securities Exchange Act of 1934

prohibits the “use or employ[ment], in connection with the

purchase or sale of any security . . . , [of] any manipulative or

deceptive device or contrivance in contravention of such rules

and regulations as the Commission may prescribe.” 15 U.S.C.

16

The District Court had jurisdiction over Shareholders’

federal securities fraud claims under 28 U.S.C. § 1331 and 15

U.S.C. § 78aa. We have jurisdiction over this appeal from the

District Court’s final order of dismissal under 28 U.S.C. § 1291.

18

§ 78j(b). Rule 10b-5, promulgated by the Securities and

Exchange Commission, makes it unlawful

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

defraud,

(b) To make any untrue statement of a material

fact or to omit to state a material fact necessary in

order to make the statements made, in the light of

the circumstances under which they were made,

not misleading, or

(c) To engage in any act, practice, or course of

business which operates or would operate as a

fraud or deceit upon any person, in connection

with the purchase or sale of any security.

17 C.F.R. § 240.10b-5.

To state a claim for securities fraud under Rule 10b-5,

plaintiffs must “allege defendants made a misstatement or an

omission of material fact with scienter in connection with the

purchase or the sale of a security upon which plaintiffs

reasonably relied and plaintiff’s [sic] reliance was the proximate

cause of their injury.” Winer Family Trust, 503 F.3d at 326.

Although Shareholders’ Complaint focuses on the statements of

McGuire and Peterson, liability for these statements, if they

were fraudulent, can also be imputed to Avaya because “[a]

corporation is liable for statements by employees who have

apparent authority to make them.” Makor Issues & Rights, Ltd.

v. Tellabs Inc. (Tellabs II), 513 F.3d 702, 708 (7th Cir. 2008)

19

(citing Am. Soc’y of Mech. Eng’rs, Inc. v. Hydrolevel Corp., 456

U.S. 556, 568 (1982); In re Atlantic Fin. Mgmt., Inc., 784 F.2d

29, 31–32 (1st Cir. 1986)).

Avaya does not dispute that the following elements of the

cause of action are properly pleaded: materiality, reliance, loss

causation, and damages. Falsity and scienter are disputed. With

respect to falsity, Shareholders must specify each allegedly

misleading statement and the reasons why the statement is

misleading. Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S.

Ct. 2499, 2508 (2007). Scienter is a “mental state embracing

intent to deceive, manipulate, or defraud,” Ernst & Ernst v.

Hochfelder, 425 U.S. 185, 194 n.12 (1976), and requires a

knowing or reckless state of mind, In re Advanta Corp. Sec.

Litig., 180 F.3d 525, 534–35 (3d Cir. 1999).

B. Section 20(a)

Section 20(a) of the Securities Exchange Act of 1934

creates a cause of action against individuals who exercise

control over a “controlled person,” including a corporation, that

has committed a violation of Section 10(b). 15 U.S.C. § 78t(a);

In re Suprema Specialties, Inc. Sec. Litig., 438 F.3d 256, 284

(3d Cir. 2006). Accordingly, liability under Section 20(a) is

derivative of an underlying violation of Section 10(b) by the

controlled person. In re Alpharma Inc. Sec. Litig., 372 F.3d

137, 153 (3d Cir. 2004) (“[P]laintiffs must prove not only that

one person controlled another person, but also that the

‘controlled person’ is liable under the Act.” (internal quotation

20

marks omitted)). Shareholders allege the individual defendants

are liable under Section 20(a) for the allegedly fraudulent

statements made by Avaya, a “controlled person,” during the

class period.

C. Heightened Pleading Rules

“[F]aced with a Rule 12(b)(6) motion to dismiss a § 10(b)

action, courts must, as with any motion to dismiss for failure to

plead a claim on which relief can be granted, accept all factual

allegations in the complaint as true.” Tellabs, 127 S. Ct. at

2509. As is also true generally, “courts must consider the

complaint in its entirety, as well as . . . documents incorporated

into the complaint by reference, and matters of which a court

may take judicial notice.” Id. Because this is a securities fraud

case, however, we do not merely ask, as we normally would

under Rule 12(b)(6), “whether, under any reasonable reading of

the complaint, the plaintiff may be entitled to relief.” Phillips

v. County of Allegheny, 515 F.3d 224, 233 (3d Cir. 2008)

(internal quotation marks omitted) (applying standard set forth

in Bell Atl. Corp. v. Twombly, 550 U.S. 544 (2007)). Instead,

Shareholders must satisfy the heightened pleading rules codified

in the PSLRA.

The PSLRA provides two distinct pleading requirements,

both of which must be met in order for a complaint to survive a

motion to dismiss. First, under 15 U.S.C. § 78u-4(b)(1), the

21

complaint must “specify each allegedly misleading statement,17

why the statement was misleading, and, if an allegation is made

on information and belief, all facts supporting that belief with

particularity.” Winer Family Trust, 503 F.3d at 326 (footnote

added) (construing 15 U.S.C. § 78u-4(b)(1)). Second, the

complaint must, “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)(2).

Significantly, both provisions require facts to be pleaded

“with particularity.” As we have explained, “[t]his

[‘particularity’] language echoes precisely Fed. R. Civ. P. 9(b).”

Advanta, 180 F.3d at 534; see Fed. R. Civ. P. 9(b) (“[A] party

must state with particularity the circumstances constituting fraud

or mistake.”). Indeed, although the PSLRA replaced Rule 9(b)

as the pleading standard governing private securities class

actions, see Tellabs, 127 S. Ct. at 2507–08, Rule 9(b)’s

particularity requirement “is comparable to and effectively

subsumed by the requirements of [§ 78u-4(b)(1) of] the

PSLRA.” Miss. Pub. Employees’ Ret. Sys. v. Boston Scientific

Corp., 523 F.3d 75, 85 n.5 (1st Cir. 2008); see Rubke v. Capitol

Bancorp Ltd., 551 F.3d 1156, 1165 (9th Cir. 2009) (“[T]he

17

Here, the District Court found Shareholders adequately

identified defendants’ allegedly misleading statements with the

requisite particularity. Charatz, 2006 WL 2806229, at *9.

Defendants do not dispute this finding on appeal.

22

inquiry into whether plaintiffs have pled falsity with the

requisite particularity under the PSLRA is nearly identical to

that under Federal Rule of Civil Procedure 9(b) . . . .”); Cent.

Laborers’ Pension Fund v. Integrated Elec. Servs. Inc., 497 F.3d

546, 550 (5th Cir. 2007) (Section 78u-4(b)(1) “appears to

comport with this Court’s relatively strict interpretation of Rule

9(b), which requires a plaintiff to specify the statements

contended to be fraudulent, identify the speaker, state when and

where the statements were made, and explain why the

statements were fraudulent.” (internal quotation marks

omitted)). This standard “requires plaintiffs to plead the who,

what, when, where and how: the first paragraph of any

newspaper story.” Advanta, 180 F.3d at 534 (internal quotation

marks omitted). Section 78u-4(b)(1) adds an additional

requirement where “an allegation regarding [a defendant’s]

statement or omission is made on information and belief.” 15

U.S.C. § 78u-4(b)(1). In those circumstances, plaintiffs must

also “state with particularity all facts on which that belief is

formed.” Id.; see ABC Arbitrage Plaintiffs Group v. Tchuruk,

291 F.3d 336, 350 (5th Cir. 2002). That is, when allegations are

made on information and belief, the complaint must not only

state the allegations with factual particularity, but must also

describe the sources of information with particularity, providing

the who, what, when, where and how of the sources, as well as

the who, what, when, where and how of the information those

sources convey.

The PSLRA’s requirement for pleading scienter, on the

23

other hand, marks a sharp break with Rule 9(b). Under § 78u-

4(b)(2), “a plaintiff can no longer plead the requisite scienter

element generally, as he previously could under Rule 9(b).”

Mizzaro v. Home Depot, Inc., 544 F.3d 1230, 1238 (11th Cir.

2008); see Fed. R. Civ. P. 9(b) (“Malice, intent, knowledge, and

other conditions of a person’s mind may be alleged generally.”).

Instead, under the PSLRA’s “[e]xacting” pleading standard for

scienter, “any private securities complaint alleging that the

defendant made a false or misleading statement must . . . state

with particularity facts giving rise to a strong inference that the

defendant acted with the required state of mind.” Tellabs, 127

S. Ct. at 2504, 2508 (internal quotation marks omitted).

D. Safe Harbor

Plaintiffs must satisfy these pleading requirements

whether the alleged fraudulent statement at issue is an assertion

of current fact or a prediction of the future. The PSLRA

imposes additional burdens, however, with respect to allegations

involving predictions. The Safe Harbor provision, 15 U.S.C. §

78u-5(c), immunizes from liability any forward-looking

statement, provided that: the statement is identified as such and

accompanied by meaningful cautionary language; or is

immaterial; or the plaintiff fails to show the statement was made

with actual knowledge of its falsehood.18 The District Court

18

The Safe Harbor provides:

[A] person . . . shall not be liable with respect to

any forward-looking statement, whether written or

24

found that many of the allegedly misleading statements

identified in the Complaint were protected by the Safe Harbor

provision. Charatz, 2006 WL 2806229, at *18–19. It

concluded that defendants’ statements were “forward-looking

predictions of future economic performance” indicating

“management’s plans and objectives,” id. at *18, and were

oral, if and to the extent that—

(A) the forward-looking statement is—

(i) identified as a forward-looking statement,

and is accompanied by meaningful cautionary

statements identifying important factors that

could cause actual results to differ materially

from those in the forward-looking statement;

or

(ii) immaterial; or

(B) the plaintiff fails to prove that the

forward-looking statement—

(i) if made by a natural person, was made with

actual knowledge by that person that the

statement was false or misleading; or

(ii) if made by a business entity; was—

(I) made by or with the approval of an

executive officer of that entity; and

(II) made or approved by such officer with

actual knowledge by that officer that the

statement was false or misleading.

15 U.S.C. § 78u-5(c)(1).

25

accompanied by meaningful cautionary language.

III.

A. Applicability of the Safe Harbor

Shareholders contend the District Court erred in applying

the Safe Harbor to immunize certain statements. First, they

argue the court improperly held the “on track” statements were

forward-looking. Second, as for the other forecast-related

statements, they contend the Safe Harbor should not be applied

on the pleadings because jurors could reasonably disagree over

the meaningfulness of Avaya’s cautionary language.

Shareholders argue Avaya’s cautionary statements were

“diluted” by the later “assurances” that it was “on track” to meet

its projections and was not impairing profits with price

concessions. Finally, Shareholders contend the Safe Harbor

does not apply here because they have sufficiently alleged

defendants had actual knowledge of the false or misleading

nature of the forecast-related statements.

On January 25, 2005, defendants announced Avaya’s

financial and operational results for Q1 FY2005. Notably,

defendants stated: “Our first quarter results position us to meet

our goals for the year”; and “we are on track to meet our goals

for the year, even though there were some aspects to our

performance that are below our expectations and that we are

26

working on to improve.”19 Defendants assert that these

statements are forward-looking because their accuracy can only

be discerned at a future date. Furthermore, they contend these

statements are inactionable puffery and that, in any case, “a

statement that a company is ‘on track’—even if to meet a

specific goal—is simply too vague and general to be

actionable.” Defendants’ Br. 37. Shareholders contend these

“on track” recitals are positive statements of current fact and,

accordingly, are not forward-looking.

The term “forward-looking statement” is broadly defined

in the statute to include statements “containing a projection of

revenues, income (including income loss), earnings (including

earnings loss) per share, capital expenditures, dividends, capital

structure, or other financial items”; statements of “the plans and

objectives of management for future operations, including plans

or objectives relating to the products or services of the issuer”;

or statements of “future economic performance, including any

such statement contained in a discussion and analysis of

19

See also Statement of Don Peterson, CEO, Q1 2005 Avaya

Earnings Conference Call, Jan. 25, 2005 (“I would just . . . take

a moment and reiterate again what we have said we plan to do

for the year. Growing revenue 25 to 27 percent. Increasing

operating income by 40 percent. Increasing our annualized

margin to the 8.5 to 9 percent range, which would put us on the

trajectory to go beyond that in 2006. All those things are on

track.”).

27

financial condition by the management or in the results of

operations included pursuant to the rules and regulations of the

Commission.” 15 U.S.C. § 78u-5(i)(1)(A)–(C). Further,

forward-looking statements include “any statement of the

assumptions underlying or relating to any statement described”

in the definition. § 78u-5(i)(1)(D).

“[A] mixed present/future statement is not entitled to the

safe harbor with respect to the part of the statement that refers

to the present.” Tellabs II, 513 F.3d at 705; accord In re Stone

& Webster, Inc., Sec. Litig., 414 F.3d 187, 213 (1st Cir. 2005)

(“The mere fact that a statement contains some reference to a

projection of future events cannot sensibly bring the statement

within the safe harbor if the allegation of falsehood relates to

non-forward-looking aspects of the statement.”). In Tellabs II,

defendants stated that sales of their product were “still going

strong.” 513 F.3d at 705. The Seventh Circuit interpreted the

communication as “saying both that current sales were strong

and that they would continue to be so, at least for a time, since

the statement would be misleading if Tellabs knew that its sales

were about to collapse.” Id. Accordingly, defendants were not

entitled to “a safe harbor with regard to the statement’s

representation concerning current sales.” Id. In Stone &

Webster, defendants had asserted that the company “has on hand

and has access to sufficient sources of funds to meet its

anticipated . . . needs.” 414 F.3d at 207. Even though “the

statement includes a reference to anticipated future needs for

funds,” the First Circuit found a portion of defendants’ assertion

28

to be a statement of present fact ineligible for the Safe Harbor

provision. Id. at 212. “[T]he alleged falsehood was in the fact

that the statement claimed that the Company had access to

ample cash at a time when the Company was suffering a dire

cash shortage. The claim was not that the Company was

understating its future cash needs.” Id. at 213.

Unlike the language in Tellabs II and Stone & Webster,

the “on track” and “position us” portions of the January 25,

2005 statements, when read in context, cannot meaningfully be

distinguished from the future projection of which they are a part.

Shareholders argue that these phrases make claims of current

fact. Here, however, the assertions of current fact are too vague

to be actionable. These statements do not justify the financial

projections in terms of any particular aspect of the company’s

current situation; they say only that, whatever that situation is,

it makes the future projection attainable. Such an assertion is

necessarily implicit in every future projection. At issue in

Tellabs II, by contrast, was a specific assertion about the current

state of sales that could be distinguished from the future

projections: it could be true, for example, both that current sales

are weak, and that future sales will be strong.

Similarly, defendants in Stone & Webster made a claim

about the company’s current level of funding. Insofar as that

present situation was related to future projections, the Stone &

Webster language bears a superficial resemblance to the

language here. But the claim in Stone & Webster was not

merely that the company would hit a certain target in the future,

29

but rather that the company had, at the present moment, enough

funding to meet anticipated future liabilities. As the First

Circuit explained, the question was not whether “the Company

was understating its future cash needs,” but whether it “had

access to ample cash” at the time the statement was made. Id.

The “on track” and “position us” language here, however, does

not advert to a particular current fact such as cash on hand, but

expresses only defendants’ continuing comfort with the earlier,

October annual projection, which they were then reiterating; that

is, it amounts in essence to a reaffirmation of that projection.20

It does not transform the statements, or any part of them, into

non-forward-looking assertions outside of the Safe Harbor.21

Shareholders also contend that their allegations based on

defendants’ forward-looking statements throughout the class

period were improperly dismissed because reasonable jurors

could disagree on the meaningfulness of the cautionary language

associated with the forecasts. Specifically, Shareholders assert

that defendants “diluted” cautionary language associated with

the forecasts by later assuring investors that Avaya was “on

track” to meet projections, by increasing the revenue growth

20

See also infra note 48.

21

Even if parts of the January statements do not enjoy Safe

Harbor protection, Shareholders have not adequately pled either

the falsity of the statements, or defendants’ scienter. See infra

Section III.B–C.

30

forecast in March, and by indicating that Avaya was not offering

unusual and increased discounts.

Forward-looking statements are protected under § 78u-

5(c) if they are identified as forward-looking 22 and are

“accompanied by meaningful cautionary statements identifying

important factors that could cause actual results to differ

materially from those in the forward-looking statement.” 15

U.S.C. § 78u-5(c)(1)(A)(i). “Cautionary language must be

‘extensive and specific.’” GSC Partners CDO Fund v.

Washington, 368 F.3d 228, 243 n.3 (3d Cir. 2004) (quoting

Semerenko v. Cendant Corp., 223 F.3d 165, 182 (3d Cir. 2000)).

“[A] vague or blanket (boilerplate) disclaimer which merely

warns the reader that the investment has risks will ordinarily be

inadequate to prevent misinformation. To suffice, the

cautionary statements must be substantive and tailored to the

specific future projections, estimates or opinions in the

prospectus which the plaintiffs challenge.” Id. (quoting

Semerenko, 223 F.3d at 182).23

22

Defendants noted in each of their conference calls, press

releases, and presentations that forward-looking statements were

contained therein. Shareholders do not contest this point.

23

Shareholders suggest the very fact that Avaya’s share price

dropped precipitously upon the announcement of its Q2 results

is proof that the cautionary language provided insufficient

warning. But the case on which Shareholders rely, Asher v.

31

Defendants’ cautionary language here was extensive and

specific. Avaya’s SEC filings contain a detailed list of specific

factors and uncertainties that could affect its future economic

performance. See, e.g., Avaya Inc., Quarterly Report for the

Period Ended December 31, 2004 (Form 10-Q), at 44–45 (Feb.

8, 2005). These documents explicitly warned that Avaya’s

forward-looking statements “may turn out to be wrong” because

“[t]hey can be affected by inaccurate assumptions we might

make or by known or unknown risks and uncertainties.” Id. at

44. Avaya included in a list of these “risks and uncertainties”

the very “price and product competition” Shareholders assert

was responsible for Avaya’s missing its projections. Id.; see

Baxter International Inc., 377 F.3d 727 (7th Cir. 2004), rejected

that argument. The Asher court acknowledged the intuitive

appeal of Shareholders’ position, noting that “one can complain

that the cautionary statement must have been inadequate”

whenever “the firm’s disclosures (including the accompanying

cautionary statements) are false or misleadingly incomplete.”

Id. at 729. But such a view would divest the Safe Harbor of any

function, since there is no potential liability—and thus no need

for Safe Harbor protection—where there is nothing false or

misleading about a firm’s statements. In other words, if the Safe

Harbor were automatically inapplicable whenever a firm’s

disclosures actually misled investors, then the Safe Harbor

would be superfluous. “Yet it would be unsound to read the

statute so that the safe harbor never works; then one might as

well treat . . . § 78u-5 as defunct.” Id.

32

also id. at 47–48 (“We face intense competition from our current

competitors and . . . may face increased competition from

companies that do not currently complete [sic] directly against

us. . . . Competitors with greater resources also may be able to

offer lower prices . . . .”). Avaya also warned about

uncertainties related to its marketing strategy, stating that “if we

do not successfully execute our strategy to expand our sales in

market segments with higher growth rates, our revenue and

operating results may continue to be adversely affected.” Id. at

46. In each conference call24 and press release,25 defendants also

24

For example, Avaya’s Vice President of Investor Relations,

Matt Booher, began the January 25, 2005 conference call with

analysts with the following admonition:

These remarks may contain forward-looking

statements regarding the Company’s outlook.

This outlook is based on current expectations,

forecasts and assumptions that involve risks and

uncertainties that could cause actual outcomes

and results to differ. Additional information

regarding these risks and uncertainties may be

found in our filings with the Securities and

Exchange Commission and in particular our fiscal

2004 Form 10-K and in our 10-Q filings.

25

For example, Avaya’s January 25, 2005 Press Release

stated:

This news release contains forward-looking

33

statements regarding the company’s outlook for

operating results based on current expectations,

forecasts and assumptions that involve risks and

uncertainties that could cause actual outcomes

and results to differ materially. These risks and

uncertainties include, but are not limited to,

general industry market conditions and growth

rates and general domestic and international

economic conditions including interest rate and

currency exchange rate fluctuations and the

economic, political, and other risks associated

with international sales and operations, U.S. and

foreign government regulation, price and product

competition [emphasis added], rapid technological

development, dependence on new product

development, the successful introduction of new

products, the mix of our products and services,

customer demand for our products and services,

the ability to successfully integrate acquired

companies, control of costs and expenses, the

ability to implement in a timely manner our

restructuring plans, and the ability to form and

implement alliances.

For a further list and description of such

risks and uncertainties, see the reports filed by

Avaya with the Securities and Exchange

34

explained that the forward-looking statements involved risks and

uncertainties that could cause actual outcomes and results to

differ materially from projections and specifically directed

readers to Avaya’s SEC filings. We agree with the District

Court’s assessment that “[t]hese cautionary statements are not

vague or blanket disclaimers, but instead are substantive,

extensive, and tailored to the future-looking statements they

reference.” Charatz, 2006 WL 2806229, at *19.

Shareholders assert defendants’ “on track” statements,

March forecast increase, and assurances regarding price stability

“diluted” the impact and meaningfulness of the cautionary

language. Shareholders rely on EP MedSystems, Inc. v.

EchoCath, Inc., 235 F.3d 865 (3d Cir. 2000), suggesting that

“repeat assurances may preclude invocation of the safe harbor

defense as a matter of law, because reasonable jurors could

differ about whether the warning was meaningful.”

Shareholders’ Br. 46. But EP MedSystems is distinguishable.

In EP MedSystems, plaintiffs brought a Section 10(b) suit

alleging EchoCath enticed them into investing $1.4 million by

assuring them that contracts with four prominent companies to

market EchoCath products were imminent. Id. at 867. Several

of EchoCath’s Annual and Quarterly reports cautioned investors

that there could be no assurance that the company would ever

successfully commercialize any of its products or complete any

of the expected license agreements or strategic alliances on

Commission.

35

acceptable terms. Id. at 877. But when negotiating with EP

MedSystems, EchoCath’s CEO made repeated assurances that

license agreements with four companies were imminent. Id. at

876–77. These representations were not accompanied by any

cautionary language. Id. at 877. We concluded that whether the

cautionary language found elsewhere was “sufficient to

neutralize” EchoCath’s initial representations and repeated

assurances could not be decided as a matter of law. Id. In

contrast to the statements made by EchoCath, Avaya’s alleged

assurances were, as noted, accompanied by cautionary

language.26 Accordingly, the cautionary language issue was

26

EP MedSystems may be distinguishable for another reason.

The court acknowledged that the case “is more akin to a contract

action than a securities action”:

[T]here are important distinctions between this

case and the usual securities actions for which

these principles were developed. Although

EchoCath . . . sought to sell its securities in the

market . . . MedSystems does not base its claim on

public misrepresentations or omissions that

affected the price of the stock it purchased.

Instead, it contends that it was induced to make

the substantial $1.4 million investment as a result

of personal representations directly made to its

executives by EchoCath’s executives and that

those representations were false and misleading.

Id. at 871.

36

properly decided as a matter of law.27

Finally, Shareholders contend that the Safe Harbor

provision does not apply because they have sufficiently alleged

defendants had actual knowledge of the falsehood of the

forecast-related statements. The parties dispute whether

statements made with actual knowledge of falsity can

nonetheless be immunized by cautionary language under the

Safe Harbor. Defendants note the Safe Harbor is written

disjunctively and thus argue that the cautionary-language prong

provides a separate, independent “inlet” of protection even

where plaintiffs can show (or, for purposes of Rule 12(b)(6),

adequately allege) defendants’ knowledge of a statement’s

falsity. Shareholders, by contrast, contend that cautionary

27

Shareholders also cite Asher v. Baxter International Inc.,

377 F.3d 727 (7th Cir. 2004), for support. Asher is

distinguishable. In Asher, the plaintiffs contended defendant’s

cautionary language was not meaningful because it did not

identify the major risks Baxter International faced during the

relevant period. Id. at 734. In contrast, the major risks that

allegedly were realized here—failure of the GTM strategy,

intense competition, and pricing pressure—were identified and

disclosed by Avaya throughout the relevant period.

We also reject any implication that the mere repetition of

the projections by defendants somehow “serve[d] to neutralize

the cautions.” Shareholders’ Br. 46. Each statement was

accompanied by the appropriate cautionary language.

37

language cannot be “meaningful,” see 15 U.S.C. § 78u-

5(c)(1)(A)(i), when it identifies possible risks that defendants

know have already eventuated. Compare In re SeeBeyond

Techs. Corp. Sec. Litig., 266 F. Supp. 2d 1150, 1165–67 (C.D.

Cal. 2003) (supporting Shareholders’ position),28 with Miller v.

Champion Enters., Inc., 346 F.3d 660, 672 (6th Cir. 2003)

(supporting defendants’ position), Southland Sec. Corp. v.

INSpire Ins. Solutions, Inc., 365 F.3d 353, 371–72 (5th Cir.

2004) (same), Greebel v. FTP Software, Inc., 194 F.3d 185, 201

(1st Cir. 1999) (same), and Harris v. Ivax Corp., 182 F.3d 799,

803–04 (11th Cir. 1999) (same).

Shareholders do not deny, however, that defendants’

forward-looking statements come within the Safe Harbor as long

as the Complaint’s allegations fail to give rise to a strong

inference that defendants actually knew of the statements’

falsity. See 15 U.S.C. § 78u-5(c)(1). This point is dispositive

here, since we conclude below, see infra Section III.C, that

Shareholders have not sufficiently pleaded a strong inference

that defendants acted with actual knowledge that their

28

Shareholders also seek support from our opinion in In re

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

Because there was no cautionary language to consider in that

case, however, we did not address whether cautionary language

could immunize a statement made with actual knowledge of its

falsity.

38

projections were false or misleading.29 This scienter conclusion

provides a ground for dismissing Shareholders’ claims relating

to the forward-looking statements, one that would apply even

assuming defendants’ cautionary language was inadequate.

B. Falsity

Under Rule 10b-5, it is unlawful to “make any untrue

statement of a material fact or to omit to state a material fact

necessary in order to make the statements made, in the light of

the circumstances under which they were made, not misleading

. . . in connection with the purchase or sale of any security.” 17

C.F.R. § 240.10b-5(b)–(c). The first requirement under the

PSLRA obliges a plaintiff to specify each allegedly misleading

statement, the reason or reasons why the statement is

misleading, and, if an allegation is made on information and

belief, all facts supporting that belief with particularity. 15

U.S.C. § 78u-4(b)(1);30 Tellabs, 127 S. Ct. at 2508; Winer

29

As explained below, this is a more demanding standard of

scienter than applies to statements of current fact.

30

Section 78u-4(b)(1) states, in its entirety:

(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

39

Family Trust, 503 F.3d at 326. Defendants contend

Shareholders’ allegations are insufficient because they fail to

demonstrate with sufficient particularity that defendants’

statements were false or misleading when made—i.e., “the

reason or reasons why the statement[s are] misleading.”

1. Pricing-Pressure Statements

First, defendants challenge the sufficiency of the

Shareholders’ pricing-pressure allegations. As noted, Peterson

and McGuire repeatedly assured analysts and investors that,

although there was pressure in the market, there were no

significant changes to the pricing environment. Shareholders

challenge several of defendants’ statements denying the

existence of significant pricing pressure from competitors,

contending that defendants knew of or recklessly disregarded

the fact that competition was forcing 20% to 40% price

discounts that impaired profit margins. Shareholders attempt to

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.

40

show falsity by alleging various sources for the “true facts”

known or recklessly disregarded by defendants.

Defendants contend the CW statements and Lehman

Brothers report provide, at most, anecdotal evidence of

discounts. They note that the CWs and the Lehman Brothers

analysts only had access to information on a product level and

did not have access to national data. Furthermore, defendants

assert that the discounts were not unusual during the class period

compared to prior years.31 Defendants assert any price

31

As evidence, defendants compare the gross margin

percentage during the class period (46%) to the same period

during the prior fiscal year (46%). See supra note 6 (defining

gross margin percentage). Although the gross margin

percentage did not differ from the same period in the previous

year, many different factors in addition to discounting can affect

this figure. For example, Avaya’s second quarter 10-Q report

indicated several factors affecting its gross margin percentage:

increased volume, cost reduction initiatives, product mix, and

the acquisition of Tenovis. Avaya Inc., Quarterly Report for the

Period Ended March 31, 2005 (Form 10-Q), at 32 (May 10,

2005). Because the gross margin percentage is not conclusive

as to the existence of unusual discounting, defendants’ reliance

on similar gross margin percentage numbers to “demonstrat[e]

that any supposed price concessions were in line with prior

practice,” Defendants’ Br. 34, is misplaced.

Insofar as Avaya’s gross margin percentage and other

41

concessions were in line with prior practice.

Shareholders’ allegations primarily rely on the

representations of confidential witnesses. As noted, CW3 is a

confidential witness and former Global Contract Manager who

worked at Avaya until November 2004. CW3 worked on the top

forty accounts in the United States. According to CW3, Avaya’s

business model had “essentially broken down” prior to his

departure. Due to Avaya’s “inability to compete” with Cisco

reported financial results are in tension with the reports of the

CWs and analysts, a jury could decide to discredit the latter. But

in reviewing a district court’s dismissal under Rule 12(b)(6), we

do not resolve factual disputes—even in cases governed by the

PSLRA. Rather, we “must, as with any motion to dismiss for

failure to plead a claim on which relief can be granted, accept all

factual allegations in the complaint as true.” Tellabs, 127 S. Ct.

at 2509; see Cent. Laborers’ Pension Fund v. Integrated Elec.

Servs. Inc., 497 F.3d 546, 551 (5th Cir. 2007) (“[T]he strong-

inference pleading standard does not license us to resolve

disputed facts at this stage of the case.” (internal quotation

marks omitted)). We then test these allegations to see whether

they are adequately particularized and whether they satisfy the

pleading requirements for falsity and scienter. When we

consider allegations of scienter under 15 U.S.C. § 78u-4(b)(2),

Tellabs instructs us to consider competing inferences from the

allegations, but we nonetheless assume the truth of the specific

facts alleged. See Integrated Elec. Servs., 497 F.3d at 551.

42

and AT&T Solutions, numerous large clients, such as Merrill

Lynch and Citigroup, were able to pressure Avaya into large

price concessions. For example, Citigroup allegedly forced

Avaya to accept a 20% price reduction with no change in

services because Avaya feared losing Citigroup to AT&T

Solutions’s “outsourcing” product.

CW4 is a former Avaya employee who was employed

throughout the class period and was responsible for evaluating

the profitability of special bids in the Services organization.

According to CW4, Avaya was facing substantial pricing

pressure 32 and was forced to give substantial discounts to win

business throughout the class period. “In many instances Avaya

was granting price concessions in excess of 30%–40% in order

to w in business.” Several of Avaya’s largest

customers—American Express, Hilton Hotels, Dell and Wynn

Resorts—received discounts in 2004 and 2005. Furthermore,

CW4 stated that, historically, Avaya gave 20% discounts to 20%

of its special bid customers. But between January and May

2005, at the request of the sales force, Avaya management gave

20% discounts to 80% of its special bid customers.

CW6, an independent Avaya sales manager who sold

Avaya product but was not employed by the company, noted

32

For example, several companies specifically targeted Avaya

customers. According to CW4, in October 2004, Avaya learned

of United Assets Coverage’s tactic to target Avaya customers.

43

that, in March 2005, Avaya was cutting prices on some of its

mid-range systems. According to CW6, “Cisco was attacking

Avaya on price and hurting Avaya in the small and midsized

business markets.”

In a case decided before Tellabs, we stated:

[W]here plaintiffs rely on confidential personal

sources but also on other facts, they need not

name their sources as long as the latter facts

provide an adequate basis for believing that the

defendants’ statements were false. Moreover,

even if personal sources must be identified, there

is no requirement that they be named, provided

they are described in the complaint with sufficient

particularity to support the probability that a

person in the position occupied by the source

would possess the information alleged.

Cal. Pub. Employees’ Ret. Sys. v. Chubb Corp., 394 F.3d 126,

146 (3d Cir. 2004) (quoting Novak v. Kasaks, 216 F.3d 300, 314

(2d Cir. 2000)). In other words, “a complaint can meet the

pleading requirement [of the PSLRA] by providing sufficient

documentary evidence and/or a sufficient description of the

personal sources of the plaintiff’s beliefs.” Id. at 147. We

consider the “detail provided by the confidential sources, the

sources’ basis of knowledge, the reliability of the sources, the

corroborative nature of other facts alleged, including from other

sources, the coherence and plausibility of the allegations, and

44

similar indicia.” Id. Where, as here, plaintiffs lack documentary

evidence such as internal memoranda, “reliance on confidential

sources to supply the requisite particularity for their fraud claims

. . . assumes a heightened importance.” Id. at 148.

We must determine whether this jurisprudence remains

good law after Tellabs. As one court of appeals has observed,

“Tellabs did not [specifically] address . . . how courts should go

about evaluating allegations based on statements made by

unidentified, confidential witnesses.” Mizzaro v. Home Depot,

Inc., 544 F.3d 1230, 1239 (11th Cir. 2008). Nonetheless,

several of our sister circuits have considered where anonymous

witnesses stand in the wake of the Supreme Court’s decision.

An early Seventh Circuit opinion concluded that Tellabs

required it to “discount allegations that the complaint [at bar]

attributes to five ‘confidential witnesses.’” Higginbotham v.

Baxter Int’l Inc., 495 F.3d 753, 756 (7th Cir. 2007). “Tellabs

requires judges to weigh the strength of plaintiffs’ favored

inference in comparison to other possible inferences,” but in

Higginbotham’s view, “anonymity frustrates that process”

because it “conceals information that is essential to th[is] sort of

comparative evaluation.” Id. at 757. The Higginbotham court

nonetheless acknowledged that anonymous sources can

sometimes “corroborate or disambiguate” other evidence, and

that the precise weight to be given to confidential witness

allegations can be determined only in the context of all the other

allegations presented in a specific case. Id. For these reasons,

the court concluded that information alleged by confidential

45

sources “must be ‘discounted’ rather than ignored.” Id. But it

emphasized that “[u]sually that discount will be steep.” Id.

Other courts, however, have qualified Higginbotham’s

strong skepticism of confidential sources. The Seventh Circuit

itself distinguished Higginbotham in Tellabs II. As the latter

case observed, not only were the sources in the Higginbotham

complaint anonymous, but they were also “described merely as

three ex-employees of [the defendant company] and two

consultants.” Tellabs II, 513 F.3d at 712. The confidential

sources listed in the Tellabs II complaint, on the other hand, “are

numerous and consist of persons who from the description of

their jobs were in a position to know at first hand the facts to

which they are prepared to testify . . . . The information that the

confidential informants are reported to have obtained is set forth

in convincing detail, with some of the information, moreover,

corroborated by multiple sources.” Id. The Tellabs II court

conceded that, all else being equal, a complaint with named

sources “would be better” than one with confidential witnesses,

but “the absence of proper names does not invalidate the

drawing of a strong inference from informants’ assertions.” Id.

Tellabs II apparently circumscribes Higginbotham’s broad

pronouncement that confidential witness allegations will

“usually” be steeply discounted, clarifying that the weight

accorded to anonymous sources will depend in large part on the

level of detail with which they are described. In Tellabs II, then,

the Seventh Circuit appears to have reached essentially the same

conclusion we set forth earlier in Chubb. Tellabs II cites that

46

case approvingly. See id.

Other circuits have staked out similar positions. See, e.g.,

Zucco Partners, LLC v. Digimarc Corp., 552 F.3d 981, 995 (9th

Cir. 2009) (evaluating “whether a complaint has provided

sufficient detail about a confidential witness’ position within the

defendant company to provide a basis for attributing the facts

reported by that witness to the witness’ personal knowledge”);

Mizzaro, 544 F.3d at 1240 (Although there are “reasons why

courts may be skeptical of confidential sources cited in

securities fraud complaints . . . [,] [c]onfidentiality . . . should

not eviscerate the weight given [to these sources] if the

complaint otherwise fully describes the foundation or basis of

the confidential witness’s knowledge, including the position(s)

held, the proximity to the offending conduct, and the relevant

time frame.”); see also Ley v. Visteon Corp., 543 F.3d 801, 811

(6th Cir. 2008) (endorsing Higginbotham’s steep discount where

plaintiffs not only withheld the names of employees who knew

of defendant’s “alleged accounting improprieties,” but also

failed to allege “what, when, where, and how” the employees

knew of that information).

In our view, the case law interpreting the Supreme

Court’s Tellabs opinion confirms the position we took in Chubb.

The PSLRA imposes a particularity requirement on all

allegations, whether they are offered in support of a statement’s

falsity or of a defendant’s scienter. 15 U.S.C. § 78u-4(b)(1),

(b)(2). In the case of confidential witness allegations, we apply

that requirement by evaluating the “detail provided by the

47

confidential sources, the sources’ basis of knowledge, the

reliability of the sources, the corroborative nature of other facts

alleged, including from other sources, the coherence and

plausibility of the allegations, and similar indicia.” Chubb, 394

F.3d at 147. If anonymous source allegations are found wanting

with respect to these criteria, then we must discount them

steeply. This is consistent with Tellabs’s teaching that

“omissions and ambiguities count against inferring scienter”

under the PSLRA’s particularity requirements. Tellabs, 127 S.

Ct. at 2511. If, on the other hand, a complaint’s confidential

witness allegations are adequately particularized, we will not

dismiss them simply on account of their anonymity.33 In short,

33

Of course, confidential witness allegations may score

highly on the Chubb test yet fail either to establish the falsity of

a statement, or to give rise to a strong inference of scienter.

Nonetheless, for analytical purposes, it is important to

distinguish deficiencies relating to the content of allegations

from those relating to their form. The Chubb test addresses only

the latter issue. See, e.g., Metzler Inv. GMBH v. Corinthian

Colls., Inc., 540 F.3d 1049, 1069 n.13 (9th Cir. 2008) (The

confidential witnesses’ “identity and knowledge . . . are

described with sufficient specificity to meet the PSLRA’s

standards generally. The problem for [plaintiff] is not that the

confidential witnesses are inadequately identified—the problem

is that these witnesses do not convey information sufficient to

support the strong inference of scienter that the PSLRA

requires.” (internal citation omitted)).

48

Chubb remains good law.

Referring to the Chubb factors, the District Court here

concluded that “[p]laintiffs have appropriately described the

positions formerly held by each of [the confidential] sources as

well as the basis of the sources’ personal knowledge.” Charatz,

2006 WL 2806229, at *10. We agree. Shareholders have

adequately described the duration of each CW’s employment,

the time period during which the CWs acquired the relevant

information, and how each CW had access to such information.

See Chubb, 394 F.3d at 150.

In addition to the CW statements, Shareholders cite the

March 2005 Lehman Brothers report, which was based upon

discussions with Avaya resellers. The report indicated that

Avaya offered “aggressive” and “unusually attractive” 30% to

40% discounts on its mid-range products (150–400 lines)

beginning in March 2005.34 Lehman Brothers estimated that

sales of the mid-range systems “constitute a significant portion

of the enterprise telephony industry sales” and warned that if the

promotion were highly successful, “Avaya’s product margins

would be somewhat impacted.” According to Shareholders, this

report corroborates CW3’s, CW4’s, and CW6’s allegations and

directly contradicts McGuire’s assurances that pricing remained

34

The report stated: “According to some resellers, the

aggressive 30–40% discount Avaya has been offering on its

mid-range (150–400 lines) systems since the beginning of

March is quite unusual.”

49

normal.

Furthermore, Shareholders allege that after denying the

existence of unusual discounting and pricing pressure, McGuire

admitted that Avaya was in fact providing discounts. On April

19, 2005,35 in response to questions about discounting, McGuire

stated: “There is no new specific discounting policy we put in

place. I can tell you that our discounts were relatively black or

improved in most parts of the world, except for international

direct where they were up slightly.” On April 28, 2005,

McGuire was asked about “some reports published recently

saying that Avaya gave a 30% to 40% discount in the first

quarter.” As noted, McGuire responded: “Now, I hear the noise

that, yes, we were out with a 30% to 40% discount on a program

in last quarter.36 . . . [I]t’s not unusual . . . . And quite frankly,

35

As noted, Q2 FY2005 ended on March 31, 2005.

36

Shareholders interpret “last quarter” to mean Q1 FY2005

(October 2004 to December 2004). Defendants disagree,

contending that since the statement was made in Q3 FY2005,

McGuire was referring to the discount reported by Lehman

Brothers in Q2 FY2005. Because the quarter referred to by

McGuire remains unclear, we will assume for purposes of this

appeal that Shareholders’ interpretation is correct. See supra

note 31; Phillips v. County of Allegheny, 515 F.3d 224, 233 (3d

Cir. 2008) (accepting “all factual allegations as true” and

construing “the complaint in the light most favorable to the

50

a 30% to 40% discount is not out of the norm for any of these

programs.”

The CW statements allege a series of unusual and

substantial discounts across several business lines—both sales

of products and services. The Complaint alleges that Avaya

provided significant and unusual discounts to some of its biggest

customers in order to retain their business. Furthermore, the

Complaint lists several of the large customers awarded

discounts. The Lehman Brothers report and McGuire’s April

28, 2005 statement reinforce the CWs’ account that a 30% to

40% discount was in place on the mid-range products.

Furthermore, the Lehman Brothers report, based on

conversations with resellers, characterized the discount as “quite

unusual” and “aggressive.”

In Chubb, plaintiffs alleged that defendants issued false

or misleading statements representing that a rate initiative was

ameliorating the problems in their business and was doing so

more quickly than anticipated. To substantiate these allegations,

plaintiffs proffered confidential witness statements identifying

specific customers that Chubb lost as a result of their rate

initiative. Nonetheless, we concluded that the “anecdotal

examples of profitable customers lost or policies renewed at flat

or slightly raised rates does not demonstrate that the rate

initiative was failing, especially in light of defendants’ Class

Period disclosures.” Id. at 156. But here, the CW statements

plaintiff” (internal quotation marks omitted)).

51

identifying deep and unusual discounting, although anecdotal,

represent the range of Avaya’s U.S. businesses—including both

products and services. Furthermore, the statements directly

conflict with McGuire’s repeated assurances throughout the

class period that pricing remained “fairly steady.” Accordingly,

Shareholders have pled unusual price discounting with the

particularity required by the PSLRA. While we find that

Shareholders have sufficiently pled falsity with respect to all of

the discounting statements, it is worth noting that the allegations

of discounting are significantly stronger—that is, broader, more

detailed, and more interlocking—for Q2 (January to March

2005) than for Q1 (October to December 2004).

2. Forecast-Related Statements

Shareholders also challenge defendants’ revenue and

operating margin growth forecasts made throughout the class

period, alleging that defendants’ January 2005 “on track”

statements were materially false or misleading because Avaya

was not “on track” and had no basis for claiming Avaya would

do better in the United States as the year progressed. They

assert that “defendants knew at the time of making their

statements that Avaya was experiencing substantial disruption

in its sales channels as a result of the [GTM] program.” 37 On

37

According to a former Avaya Director of Operations,

Global Solutions Sales and Support and a former Avaya Senior

Client Executive, McGuire established financial projections on

a “top down” basis; he did not solicit any input from the sales

52

several occasions during FY2005, defendants represented they

were “on track” to meet their projected goals. Furthermore, in

March 2005, approximately a month and a half before the April

19, 2005 announcement, McGuire expressed confidence in the

forecast.

Defendants contend Shareholders’ reliance on the CWs

in the Complaint is insufficient to meet the particularity

requirements of the PSLRA because none of the CWs worked

in positions which would provide them with insight or visibility

into Avaya’s corporate-wide forecasts. According to

defendants, Shareholders point to relatively low-level former

employees (or non-employees)—none of the CWs are officers,

none worked at headquarters, and none claimed to participate in

the forecasting process.38 Defendants assert that, at most, the

CWs’ statements consist of random anecdotes that, when

juxtaposed against defendants’ statements, do not meet the

representatives. Shareholders allege that “McGuire’s quotas

were based upon the unreasonable financial projections

McGuire made to investors, as opposed to reasonable

assessments as to what was realistically attainable.”

38

As stated above, CW3 was a Global Contract Manager,

CW4 evaluated the profitability of special bids in the Services

organization, CW5 was a Senior Client Executive who left the

company in March 2004, and CW6 was an independent sales

manager who was not employed by the company.

53

standard for pleading falsity.

As noted, in October 2004, Avaya set its operating

margin goal for FY2005 between 8.5% and 9% and its expected

revenue growth rate between 25% and 27%. At the end of the

first quarter, defendants said “we are on track to meet our goals

for the year, even though there were some aspects of our

performance that are below our expectations and that we are

working on to improve.” During a January conference call with

analysts, Peterson reiterated the October 2004 forecast and

explained that even though Avaya’s business is “somewhat . . .

seasonal” and that U.S. product sales were “not up to our

expectations,” “we think that we had a solid quarter that is

positioning us well to go on through the rest of the year and

achieve those goals.”

On March 2, 2005, McGuire adjusted Avaya’s projected

revenue growth to 28%,39 expressed comfort with the October

2004 forecast, and noted that “we are building on the

momentum that we’ve got in the market relative to the

technology lead, our applications, . . . and our global services.”

On April 19, 2005, Avaya announced that it would be

unable to meet its previously stated goals for growing revenues,

operating income, and operating margin in FY2005. Peterson

blamed internal problems, especially the GTM strategy, for the

missed benchmarks. McGuire claimed that during January and

39

See supra note 9.

54

February 2005, Avaya was “tracking slightly at or just a little bit

below the quarter before” and was “track[ing] well for March

closure both on the indirect and the direct side.” According to

McGuire, the internal indicators provided “comfort” that Avaya

would remain on track to achieve the year-end goals. But Avaya

was caught by “surprise” in the last week of March when

distributors did not repurchase at rates consistent with prior

practice and when Avaya failed to close several deals.

Shareholders allege various sources and “true facts,” in

addition to those described above, to show that defendants’

forecast-related statements were materially false or misleading.

In addition to the facts alleged by CW3 and CW4—Avaya was

faced with and succumbed to significant pricing

pressure—CW5, a former Senior Client Executive with Avaya

from 2001 to March 2004, alleged that it became apparent in

October 2003 that Avaya’s sales strategy40 would cause a

“substantial loss of business.” He noted many customers lost

confidence and trust in Avaya when Client Executives were

reassigned to mid-market accounts. CW5 averred that he

personally lost approximately $7 million in sales, including

contracts with ACS in Utica, New York and Alcoa. According

to CW5, due to the long sales cycle—between six months and

one-and-a-half years—losses experienced in October 2003

40

According to CW5, the GTM strategy began in October

2003. In contrast, defendants state that the GTM strategy was

launched in October 2004. See supra note 31.

55

would have a “substantial impact” on Avaya’s financial results

in FY2005.

Shareholders also assert defendants’ March forecasting

statements were false or misleading when made. As evidence,

Shareholders cite a March 4, 2005 report by members of the

Buckingham Research Group who performed a sales channel

check. The report concluded that Avaya was experiencing

“weak” spending for its products and had fired sales staff in

order to cut costs. The analysts predicted Avaya’s actions would

“negatively effect [sic] growth.”

As noted, a plaintiff must explain “how or why” their

confidential source would have the knowledge alleged. Chubb,

394 F.3d at 149. Shareholders have adequately alleged when

their sources were employed by Avaya, when they obtained the

information they allegedly possess, and whether their supposed

knowledge is first or second hand. See id. at 150. Shareholders

contend that defendants’ forecast-related statements were

materially false or misleading at the time they were made based

on the collection of information before us.

This information sufficiently pleads the falsity of the

March projections, for many of the same reasons it adequately

pleaded the falsity of the March pricing statements. If we

assume the allegations of significant Q2 discounting are true, it

is reasonable to infer that the reaffirmed projections of revenue

and margins were, by March, no longer sound (and were thus

misleading). The anecdotal allegations, however, are less

56

persuasive with regard to the earlier statements. To begin with,

they are both less focused chronologically and less mutually

reinforcing than the allegations of Q2 discounts. An even larger

stumbling block for plaintiffs, however, is that Avaya exceeded

expectations for Q1 FY2005—October 2004 to December

2004.41 Defendants contend that, at the time of the forecast-

related statements (first issued in October and reiterated in

January), the projections were possible to achieve. The facts

alleged in the Complaint, when viewed against the backdrop of

the successful Q1 results, do not belie this conclusion. We

therefore agree with defendants that Shareholders have failed to

plead with the requisite particularity the allegation that the

October and January forecasts were false or misleading when

made. See In re NAHC, Inc. Sec. Litig., 306 F.3d 1314, 1330

(3d Cir. 2002) (“To be actionable, a statement or omission must

have been misleading at the time it was made; liability cannot be

imposed on the basis of subsequent events.”).

3. Falsity Conclusion

Shareholders have adequately specified the reasons why

defendants’ pricing-pressure statements and March projections

were false or misleading when made. In contrast, we find

insufficient the allegations that defendants’ January and October

41

See Compl. ¶ 58 (“Avaya’s first quarter results were in line

with, or better than, analysts’ expectations. For instance, Avaya

reported Earnings Per Share (“EPS”) of 20 cents, beating

consensus estimates of 18 cents.”).

57

forecast-related statements were false or misleading when made.

C. Scienter

As discussed above, the PSLRA’s first pleading

requirement is that a plaintiff must “specify each allegedly

misleading statement, why the statement was misleading, and,

if an allegation is made on information and belief, all facts

supporting that belief with particularity.” Winer Family Trust,

503 F.3d at 326 (construing 15 U.S.C. § 78u-4(b)(1)). As noted,

only Shareholders’ pricing-pressure and March-projection

allegations satisfy this requirement. Under the PSLRA’s second

pleading requirement, a plaintiff must “state with particularity

facts giving rise to a strong inference that the defendant acted

with the required state of mind.” 15 U.S.C. § 78u-4(b)(2). This

scienter standard requires plaintiffs to allege facts giving rise to

a “strong inference” of “either reckless 42 or conscious behavior.”

42

“A reckless statement is one 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 that the actor must have been aware

of it.” Advanta, 180 F.3d at 535 (internal quotation marks

omitted). “[C]laims essentially grounded on corporate

mismanagement” do not adequately plead recklessness. Id. at

540 (internal quotation marks omitted).

In Tellabs, the Supreme Court continued to reserve

judgment on “whether reckless behavior is sufficient for civil

58

Advanta, 180 F.3d at 534–35 (footnote added). Two cases

clarifying the PSLRA standard for pleading scienter were

decided after the District Court issued its order in this case:

Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S. Ct. 2499

(2007), and Winer Family Trust v. Queen, 503 F.3d 319 (3d Cir.

2007).

As interpreted by Tellabs, the second requirement of the

PSLRA—that the plaintiff plead with particularity facts giving

rise to a “strong inference” of scienter—obliges courts to weigh

the “plausible nonculpable explanations for the defendant’s

conduct” against the “inferences favoring the plaintiff.” 127 S.

Ct. at 2510. A “strong inference” of scienter is one that is

“cogent and at least as compelling as any opposing inference of

nonfraudulent intent.” Id. at 2504–05; see also id. at 2510 (“The

inference that the defendant acted with scienter need not be

irrefutable, i.e., of the ‘smoking-gun’ genre, or even the most

plausible of competing inferences.” (internal quotation marks

omitted)). The pertinent question is “whether all of the facts

alleged, taken collectively, give rise to a strong inference of

scienter, not whether any individual allegation, scrutinized in

isolation, meets that standard.” Id. at 2509; see also id. at 2511

liability under § 10(b) and Rule 10b-5,” but it noted that

“[e]very Court of Appeals that has considered the issue has held

that a plaintiff may meet the scienter requirement by showing

that the defendant acted intentionally or recklessly.” 127 S. Ct.

at 2507 n.3.

59

(“[T]he court’s job is not to scrutinize each allegation in

isolation but to assess all the allegations holistically.”).

Omissions and ambiguities “count against inferring scienter.”

Id. at 2511.

The District Court concluded that Shareholders failed to

plead scienter sufficiently. Shareholders assert error, contending

the District Court did not consider the combination of specific

facts from various sources “collectively.” They maintain that,

when considered collectively, the pleaded facts “meet and

exceed” the strong-inference pleading standard. Specifically,

they argue that “[t]aken together, plaintiffs’ witness reports,

analyst and reseller information, and defendants’ own

admissions, bolstered by the core business inference, the

magnitude of the missed forecasts in April 2005, and their

temporal proximity to defendants’ ‘on track’ assurances and

increased forecast in March 2005, support a strong inference of

scienter.” Shareholders’ Br. 40. Further, they assert their

“motive allegations are consistent with scienter, even if,”

standing alone, they “do[] not establish a strong inference.” Id.

Defendants contend the pleaded facts, including Shareholders’

confidential witness accounts, do not show defendants’

knowledge (or reckless disregard of the risk) that their

statements were false or misleading when made. Furthermore,

defendants assert that Shareholders’ motive allegations are not

indicative of fraud.

1. Conscious or Reckless Behavior

60

Peterson and McGuire repeatedly assured analysts and

investors that, although there was pressure in the market, there

were no significant changes to the pricing environment.

Shareholders allege that defendants knew of or recklessly

disregarded the fact that competition was forcing unusually

large 20% to 40% price discounts that were hurting profit

margins. In addition to the CWs’ statements, the Lehman

Report, and defendants’ alleged admissions (described above),

Shareholders assert that since competition, pricing policies, and

pricing concessions are “core matters” of central importance to

Avaya and its principal executives, a “core operations inference”

supports scienter. Shareholders contend that “[i]t strains reason

to suggest” that Peterson and McGuire did not know about the

discounts impairing Avaya’s profit margin. Shareholders’ Reply

Br. 18. Furthermore, Shareholders assert that the magnitude of

the missed forecasts in April 2005, and their temporal proximity

to defendants’ assurances, also support a strong inference of

scienter. According to Shareholders, the core operations

inference, the magnitude of the miss, and its temporal proximity

do not stand alone, but instead “bolster” the “true facts”

alleged—the confidential witness reports, the Lehman Brother’s

report, and McGuire’s alleged admissions. In response,

defendants contend none of the CWs claimed to have had any

connection to or communication with Peterson or McGuire, or

knowledge about the information or records to which Peterson

or McGuire had access. According to defendants, the CWs offer

no factual basis to show that Peterson or McGuire knew, or were

reckless regarding the risk that, their statements were false or

61

misleading when made.

The March Pricing-Pressure Statements

It is true that Shareholders do not point to any particular

document or conversation that would have informed Peterson or

McGuire of unusual discounting during the class period. The

existence of such a direct link would fortify Shareholders’

allegations that defendants’ statements about discounting were

knowingly or recklessly false. But the Supreme Court has made

clear that plaintiffs’ allegations of scienter “need not be

irrefutable, i.e., of the ‘smoking-gun’ genre.” Tellabs, 127 S.

Ct. at 2510. Instead, our inquiry is “whether all of the facts

alleged, taken collectively, give rise to a strong inference of

scienter.” Id. at 2509. Accordingly, as with all totality-of-the-

circumstances tests, our analysis will be case specific. It will

ultimately rest not on the presence or absence of certain types of

allegations but on a practical judgment about whether, accepting

the whole factual picture painted by the Complaint, it is at least

as likely as not that defendants acted with scienter. See South

Ferry LP, #2 v. Killinger, 542 F.3d 776, 784 (9th Cir. 2008)

(“Tellabs counsels us to consider the totality of circumstances,

rather than to develop separately rules of thumb for each type of

scienter allegation.”); see also In re Cabletron Sys., Inc., 311

F.3d 11, 32 (1st Cir. 2002) (“Each securities fraud complaint

must be analyzed on its own facts; there is no one-size-fits-all

template.”).

We believe the totality of the facts alleged by

62

Shareholders here establishes a strong inference of scienter with

respect to McGuire’s March denials of unusual pricing pressure.

Contrary to defendants’ arguments, Shareholders do not simply

allege “fraud by hindsight,” that is, they do not claim merely that

McGuire’s statements turned out to be wrong, and therefore

must have been fraudulent. Rather, Shareholders’ allegations

proffer an array of circumstantial evidence giving rise to a

strong inference that McGuire’s discounting statements were at

least reckless, which is enough to survive a motion to dismiss

under the PSLRA.

Among the facts alleged by Shareholders, the most

powerful evidence of scienter is the content and context of

McGuire’s statements themselves. McGuire did not simply

make statements inconsistent with the existence of widespread

and unusual discounting; he explicitly denied the existence of

such discounting in response to repeated questions about pricing

by analysts. During a conference call with analysts on March 2,

McGuire was asked for his “sense of what the environment is

out there right now.” McGuire responded that the “[p]ricing

environnment is not significantly different. I mean, there are

people that will buy a deal from time to time, but in general, the

pricing environment has been fairly stable.” During another

conference call with analysts on March 7, McGuire was asked

whether there had been “[a]ny significant changes one way or

the other in the pricing environment.” McGuire answered,

“Perhaps not in the last 12 months. I mean, clearly from time to

time people will want to buy a deal here or there, but the market

63

itself has been fairly stable with just modest declines over the

last 12 months.” And during a third conference call for analysts

just three days later, on March 10, McGuire was queried yet

again on pricing: “Now that you say [Cisco] put . . . a decent

team in place after losing market share last year, what should we

expect in terms of the competitive position that is here in the

market? What should we expect in terms of pricing?”

McGuire’s answer was consistent with his earlier responses:

“Pricing has been fairly steady for the last couple of years. I

don’t anticipate—I don’t see any reason that that would change

significantly.”

It is one thing for a plaintiff to claim that a defendant

must have known its earnings projections were false because of

the existence of unusual price reductions. Earnings are the

bottom-line result of many different components, only one of

which is pricing. The mere fact that a defendant made a

statement about earnings, therefore, does not necessarily imply

he would have been aware of particular pricing developments.

But it is another thing when a defendant chief financial officer

is specifically asked, directly and repeatedly, whether the

company’s pricing has held steady despite the competitiveness

of the market. Although McGuire acknowledged that Avaya

inhabited a competitive industry and offered discounts to some

customers on some products and services, Shareholders’ central

allegation is that Avaya engaged in massive discounting on an

unusually large scale during the class period, and this McGuire

flatly denied in statements evincing certitude.

64

We do not suggest that the specific nature of the analysts’

inquiries, by itself, creates a strong inference of a culpable state

of mind. But the focused questions do mark an important

distinction between this case and those in which defendants win

dismissal on a showing that defendants were most likely simply

ignorant of the facts that made their statements false. See, e.g.,

Metzler Inv. GMBH v. Corinthian Colls., Inc., 540 F.3d 1049,

1068 (9th Cir. 2008) (“[C]orporate management’s general

awareness of the day-to-day workings of the company’s

business does not establish scienter—at least absent some

additional allegation of specific information conveyed to

management and related to the fraud.”); ACA Fin. Guar. Corp.

v. Advest, Inc., 512 F.3d 46, 62–63 (1st Cir. 2008) (“The

plaintiffs have not included details about . . . whether this

information [allegedly belying defendants’ statements] was

known to the defendants at the relevant time.”). Because of the

context (specific analyst queries) and content (consistent denials

of unusual discounting) of McGuire’s statements, the possibility

that McGuire was ignorant is not necessarily exculpatory. Even

if McGuire were not aware of the full extent of the unusual

discounting, or the entirety of the other circumstances alleged by

Shareholders, he might be culpable as long as what he knew

made obvious the risk that his confident, unhedged denials of

unusual discounting would mislead investors.43 See Advanta,

43

Of course, if McGuire simply had no idea whether there

was unusual discounting, and nonetheless confidently denied its

existence, this would also have presented an obvious risk of

65

180 F.3d at 535 (explaining that allowing recklessness to serve

as a sufficient basis for liability “promotes the policy objective[]

of discouraging deliberate ignorance”); Tellabs II, 513 F.3d at

704 (“When the facts known to a person place him on notice of

a risk, he cannot ignore the facts and plead ignorance of the

risk.”). Given the specificity and repetition of the analysts’

questions, McGuire’s position as Chief Financial Officer, and

the alleged state of Avaya’s business at the time the questions

were asked, there is a strong inference that McGuire’s behavior

reached this threshold of recklessness.

If the alleged discounting were minor or restricted to only

a few products or customers, we would be reluctant to infer that

McGuire’s denials were culpable. In those circumstances,

nonculpable ignorance might be the more likely explanation.

But as we have discussed, Shareholders’ CWs allege widespread

discounting involving many different product lines and

accounts, including some of Avaya’s largest clients. Allegations

that the discounting was of a substantial magnitude are

supported by analyst reports and by Avaya’s disappointing Q2

results. Avaya’s Q2 operating margins were particularly

weak—4.3%, about 50% lower than the 8.5% to 9% margins

predicted for the year, and 44% lower than the first quarter’s

misleading investors.

66

operating margin of 7.7%.44 That Avaya’s second quarter

margins were significantly contracting itself lends support to the

inference of scienter. Throughout the class period, one of

investors’ and analysts’ central questions about Avaya was

whether it could sustain and expand its margins in the face of a

very competitive market. In fact, Avaya’s operating margin was

viewed as so important to the health of the company (and its

attractiveness to investors) that its supposed ability to hold and

grow this margin was described as the “Avaya story.” The

perceived importance of margins supports an inference that

McGuire, Avaya’s Chief Financial Officer, was paying close

attention to these numbers. Cf. Dorsey v. Portfolio Equities,

Inc., 540 F.3d 333, 342 (5th Cir. 2008) (“[T]here can be a

number of special circumstances which, taken together with an

officer’s position, may support a strong inference of scienter.”

44

Defendants attempt to minimize the significance of the Q2

results, emphasizing that the financial projections at issue

concerned expected results for the entirety of the 2005 fiscal

year, not for individual quarters. Defendants’ Br. 42–43. This

point would be relevant if it suggested that Q2 results, while less

impressive than the Q1 figures, were nonetheless satisfactory

and consistent with the annual projections. Not only, however,

did the April figures disappoint the market and analysts, but

these results also prompted Avaya itself to announce that its

previous annual projections were no longer realizable. Id. at

12–13. Defendants’ insistence that Avaya did not “‘miss’ the

quarter,” see id. at 43 n.17, is mere wordplay.

67

(internal quotation marks omitted)); In re Stone & Webster, Inc.,

Sec. Litig., 414 F.3d 187, 211 (1st Cir. 2005) (“The financial

strength of the Company was undoubtedly a matter of principal

concern to its Chief Executive Officer and Chief Financial

Officer.”). And because, all else being equal, a change in

pricing would directly affect margins, an executive inquiring

into a change in margins would be expected to look to pricing

for a possible explanation. Accordingly, the steep decline in

Avaya’s all-important margins in the second quarter of 2005

bolsters the inference that McGuire would have been alerted to

the discounting.

Just as the magnitude of the alleged discounting and

margin contraction strengthens the inference of scienter, so does

the temporal proximity of McGuire’s March denials to the end

of the quarter. The second quarter ended on March 31, and

Avaya reported its quarterly results on April 19. CW4 reported

that Avaya had been offering discounts to an unusually large

number of its customers since January. Taken in their entirety,

the allegations suggest that Avaya’s Chief Financial Officer

was, by early March, aware of Avaya’s sharply contracting

margins, which were crucial to its “story.” And as we have said,

upon realizing that Avaya’s margins were drastically shrinking,

it is at least as likely as not that McGuire would have discovered

the massive discounting, if he had not already done so.

Defendants suggest McGuire would not have been aware

of the “horrid” (as one analyst called them) impending Q2

results in early March because the shortfall was, according to

68

defendants, mostly the product of an unexpected decision by

distributors not to “reload” at the very end of March. Although

defendants will, of course, have an opportunity to adduce

evidence in support of this explanation at a later stage of the

litigation, in light of the alleged facts we may consider (and

must assume true) at this stage, we find it more likely that

unusual discounting explains the disappointing results. “The

plausibility of an explanation depends on the plausibility of the

alternative explanations. As more and more alternatives to a

given explanation are ruled out, the probability of that

explanation’s being the correct one rises.” Tellabs II, 513 F.3d

at 711 (internal citations omitted). Here, the centrality of

operating margins to the “Avaya story,” the magnitude and

pervasiveness of the alleged discounting, and the proximity of

the March statements to the end of the quarter and the release of

Avaya’s disappointing results, all diminish the plausibility of

innocent explanations for McGuire’s flat denials of unusual

pricing—for example, that developments subsequent to the

statements account for the mediocre results, or that the

discounting would not have been apparent to McGuire at the

time analysts asked about it. As the plausibility of these benign

explanations shrinks, the cogency of the culpable

explanation—that McGuire either knew his denials of

discounting were false or recklessly disregarded the obvious risk

of their falsity—correspondingly grows.

Having considered the totality of the particularized facts

alleged by Shareholders, we find that the culpable explanation

69

of McGuire’s March discounting statements is at least as

compelling as the nonculpable alternatives. Taken together, the

extent of the alleged discounting, the importance to the “Avaya

story” of maintaining margins, the amount by which the second

quarter results missed expectations, the proximity of McGuire’s

statements to the end of the quarter and the release of results,

McGuire’s position as Chief Financial Officer, and most

significantly, the content and context of the statements

themselves, give rise to a strong inference that McGuire either

knew at the time that his statements were false or was reckless

in disregarding the obvious risk of misleading the public.

Accordingly, under Tellabs, Shareholders’ claims relating to the

March discounting statements survive defendants’ motion to

dismiss.45

Defendants’ primary strategy in resisting this conclusion

is to focus on particular types of allegations and argue for the

insufficiency of each. For example, in responding to

Shareholders’ argument that the temporal proximity of the Q2

45

Of course, these conclusions assume the truth of plaintiffs’

allegations and are based only on the limited information we

may consider on a motion to dismiss. “Our ruling does not

mean that plaintiffs’ claims have any merit. It means only that

the claims are not to be dismissed at this very early stage.

Nothing has been proven yet.” Miss. Pub. Employees’ Ret. Sys.

v. Boston Scientific Corp., 523 F.3d 75, 79 (1st Cir. 2008)

(internal quotation marks omitted).

70

2005 results to the March statements bolsters the inference of

scienter, defendants contend “[c]ourts reject inferences premised

on such proximity rationales.” Defendants’ Br. 42 (citing Arazie

v. Mullane, 2 F.3d 1456, 1467–68 (7th Cir. 1993)); see also id.

at 42 n.16 (citing Ronconi v. Larkin, 253 F.3d 423, 437 (9th Cir.

2001), for the proposition that “temporal proximity alone is

never enough to show scienter” (emphasis added)). Whatever

the merits of this approach before Tellabs, it is in tension with

the prescriptions issued in that case. We are to judge “whether

all of the facts alleged, taken collectively, give rise to a strong

inference of scienter, not whether any individual allegation,

scrutinized in isolation, meets that standard.” Tellabs, 127 S. Ct.

at 2509. Given this instruction, we are hesitant to formulate

categorical rules about the sufficiency of different types of

allegations in the abstract. Each case will present a different

configuration of factual allegations, and it is the composite

picture, not the isolated components, that judges must evaluate

in the last instance. “In assessing the allegations holistically as

required by Tellabs, the federal courts certainly need not close

their eyes to circumstances that are probative of scienter viewed

with a practical and common-sense perspective.” South Ferry,

542 F.3d at 784.46

46

For the same reasons that we approve of South Ferry’s

holistic approach to inference, we decline to follow two recent

Ninth Circuit opinions calling on courts to undertake two

separate scienter inquiries. According to this proposed

analytical framework, courts will first “determine whether any

71

of the plaintiff’s allegations, standing alone, are sufficient to

create a strong inference of scienter; second, if no individual

allegations are sufficient, we will conduct a ‘holistic’ review of

the same allegations to determine whether the insufficient

allegations combine to create a strong inference of intentional

conduct or deliberate recklessness.” Zucco Partners, LLC v.

Digimarc Corp., 552 F.3d 981, 992 (9th Cir. 2009); accord

Rubke v. Capitol Bancorp Ltd., 551 F.3d 1156, 1165 (9th Cir.

2009). Perhaps we misunderstand this new standard, but it

appears to graft Tellabs’s holistic analysis onto the Ninth

Circuit’s earlier jurisprudence as an extra layer. If this is true,

the result, in our view, misinterprets the Supreme Court’s

decision, which calls only for “consider[ing] the complaint in its

entirety” and explicitly warns against “scrutiniz[ing]”

allegations “in isolation.” Tellabs, 127 S. Ct. at 2509; see also

id. at 2511 (“In sum, the reviewing court must ask: When the

allegations are accepted as true and taken collectively, would a

reasonable person deem the inference of scienter at least as

strong as any opposing inference?”). As an earlier Ninth Circuit

opinion had recognized, “the Tellabs Court’s directive that a

complaint must be read in its entirety cuts both ways. Although

a defendant cannot gain dismissal by de-contextualizing every

statement in a complaint that goes to scienter, a plaintiff cannot

avoid dismissal by reliance on an isolated statement . . . .”

Metzler Inv. GMBH, 540 F.3d at 1069. Just as facts innocent in

themselves may appear more suspicious in the company of other

72

For this reason, we are unconvinced by defendants’

attempt to downplay Shareholders’ argumentative focus on the

“totality of the circumstances alleged.” Defendants’ Br. 45.

“The sum of several zeros,” defendants state, “is still zero.” Id.

But inference is not arithmetic. The inferential significance of

any single allegation can be determined only by reference to all

other allegations.

The Earlier Statements

Shareholders have failed to establish a strong inference

of scienter with respect to the other statements identified in their

Complaint. Each of these statements lacks at least some of the

inculpating circumstances surrounding the March discounting

statements. The closest case is presented by McGuire’s

reaffirmation 47 of the earlier financial projections on March 2,

facts, so too can a fact that seems damning when presented

alone sometimes be explained away by reference to other

circumstances.

47

The parties dispute whether the March statement, which

adjusted Avaya’s projected revenue growth to 28% due to the

earlier-than-predicted close of the acquisition of Tenovis, see

supra note 9, “increased” revenue estimates. Since the

“increase” was solely a result of the early close of the

acquisition, which had occurred before the statement, the

predictive portion of the guidance essentially reaffirmed the

earlier estimates.

73

the same day as one of his pricing statements. On the one hand,

the projection of revenue and margins has a less direct

relationship to the crucial alleged discounting than does the

pricing statements. But because unusual discounting would be

expected to diminish revenues and margins, and because we

have already found the Complaint adequately pleads scienter

with respect to the pricing statements, one might conclude that

the financial-projection allegations must also satisfy the

PSLRA’s requirements.

Unlike the pricing statements, however, the March

projections are a classic forward-looking statement under the

PSLRA’s Safe Harbor provision. See 15 U.S.C. § 78u-

5(i)(1)(A) (defining “forward-looking statement” to include “a

projection of revenues, income (including income loss), . . . or

other financial items”); see also supra Section III.A.48 As such,

48

In oral argument, counsel for Shareholders implied the

March financial projections were assertions of current fact

insofar as McGuire explicitly expressed “comfort” with them.

Oral Arg. Tr. 12–13, Mar. 3, 2008 (contending this court has

held “that when a company expresses comfort with a projection

that that endorses it and it’s actionable”) (citing Burlington, 114

F.3d 1410). We disagree. McGuire’s “comfort” about the

projection is, of course, a current fact, but the statement about

corporate finances remains forward-looking. Burlington stands

only for the proposition that a corporate officer’s expression of

“comfort” with an analyst’s projections makes those projections

74

they are not actionable unless Shareholders can “prove that the

forward-looking statement . . . was made with actual knowledge

. . . that the statement was false or misleading.” § 78u-

5(c)(1)(B). Since this provision specifies an “actual knowledge”

standard, the scienter requirement for forward-looking

statements is stricter than that for statements of current fact.

Whereas liability for the latter requires a showing of either

knowing falsity or recklessness, liability for the former attaches

only upon proof of knowing falsity. See Miller v. Champion

Enters., Inc., 346 F.3d 660, 672 (6th Cir. 2003); Greebel v. FTP

Software, Inc., 194 F.3d 185, 200–01 (1st Cir. 1999); Bryant v.

Avado Brands, Inc., 187 F.3d 1271, 1283–84 (11th Cir. 1999).

This distinction is fatal to Shareholders’ allegations

regarding the March projections. With the pricing statements,

Shareholders’ failure to identify the precise means by which

McGuire would have learned of the discounting was not

determinative. Even if he had not known his denials of unusual

discounting were false, the facts alleged gave rise to a strong

inference of recklessness. Assuming the truth of those

allegations, we concluded the inference that McGuire’s denials

attributable to the officer. It says nothing to suggest an

expression of comfort somehow renders the statement itself

ineligible for Safe Harbor protection. To the contrary,

Burlington consistently describes the statement at issue as

“forward-looking,” a “prediction,” and a “projection.”

Burlington, 114 F.3d at 1428–29.

75

were knowingly false or reckless was at least as compelling as

the possible nonculpable explanations. In the case of the

forward-looking statements, however, an inference of

recklessness does not avail plaintiffs—that is, it must be placed

on the nonculpable-explanation side of the balance when we

weigh competing inferences. In light of all the facts alleged, as

well as what is not alleged, we find it more likely that the March

financial projections were the product of recklessness or other

nonculpable ignorance, rather than knowing deception.49

Shareholders’ allegations regarding the January

projections fare no better. In Shareholders’ view, defendants’

assurances that Avaya was “on track” to meet its financial goals

were not forward-looking, as the District Court found, but rather

statements of current fact outside of the statutory safe harbor.

We have rejected this argument, see supra Section III.A, but

even if we agreed, Shareholders have not adequately pleaded

scienter. The January forecast is a statement about Avaya’s

overall financial picture rather than specific pricing levels.

Furthermore, it is more distant from the end of the quarter and

the release of actual results than were the March statements.

Most importantly, the January statement was made on the same

49

Our decision to dismiss the allegations concerning the

March 2 financial projections is unlikely to be of any practical

consequence. Because we have found a discounting statement

made on the same day to be well pleaded, the projection

statement would not extend the class period.

76

day as the release of Avaya’s Q1 results, which, as the

Complaint itself concedes, were “in line with, or better than,

analysts’ expectations.” Compl. ¶ 58. Even if these statements

were somehow false (which, as we concluded above, has not

been adequately pleaded), the most compelling inference would

be that McGuire and Peterson did not yet know this and believed

that January had picked up where the first quarter had left off.

Shareholders make two arguments in an attempt to avoid

this conclusion, but neither is convincing. First, they point to an

April statement by McGuire, which they construe as an

“admission” that “he was fully aware [of unusual discounting]

during the Class Period,” even as early as the first quarter.

Compl. ¶ 93; Oral Arg. Tr. 6, Mar. 3, 2008. But McGuire’s

words, as quoted in the Complaint, simply cannot bear this

interpretation: “Now, I hear that noise that, yes, we were out

with a 30% to 40% discount on a program in last quarter . . . .”

Compl. ¶ 93. There is no indication that McGuire was informed

of the discounting at any particular point in the past. The

statement “admits” only that he was, in April, aware of a

discount.

Second, Shareholders rely on allegations that Avaya’s

sales cycle could be quite long. “Because of Avaya’s 6–18

month cycle for completing sales negotiations with its larger

clients, it would have been evident to defendants six months in

advance that Avaya was forced into offering huge 30–40% price

discounts beginning in October 2004 . . . .” Shareholders’ Reply

Br. 15. The implication is that in order for discounting, or

77

problems with the GTM strategy, to affect Avaya’s bottom line

in the second quarter, the contracts affected by these issues

would have to have been negotiated at least six months in

advance, at which point McGuire and Peterson presumably

would have known of the problems. This type of allegation

might carry some weight if the Complaint provided more

specific information about particular contracts, or provided a

narrower spectrum of sales-cycle variation. But in light of the

fact that the first quarter results met expectations, it is difficult

to grant much credit to this allegation. Plaintiffs point to

contracts going back as far as October 2003 and tell us only that

these contracts had a sales cycle somewhere between six and

eighteen months. Plaintiffs then urge us to conclude that

somehow these contracts were structured in such a way that the

problems lay dormant during the first quarter, not menacing

financial results, only to explode and lay waste to revenues and

margins during the second quarter. The Complaint’s sales-cycle

allegations are too vague to support this inference. See Tellabs,

127 S. Ct. at 2511 (“[O]missions and ambiguities count against

inferring scienter.”).

Just as the sale-cycle and post-hoc admission allegations

cannot give rise to scienter with respect to the January

statements, they fail to save the earlier October statements. We

have held that Shareholders failed to plead the falsity of the

January and October projections adequately. Even if the

Complaint were not deficient on that score, it would not

sufficiently allege scienter. The satisfactory Q1 results fatally

78

weaken any inference of scienter regarding the statement made

in January, the first month of the second quarter, and they a

fortiori vitiate any inference of scienter with respect to

projection-related statements made at the beginning of the first

quarter itself.

Nor is the inference of scienter any stronger with respect

to the October pricing-pressure statements. Even if we grant

these statements were false, as we did above, the Q1 results

suggest that any unusual Q1 discounts were not

significant—certainly, not significant enough to support the

conclusion that Peterson and McGuire were aware of them, or

were otherwise reckless, at the time of the October statements.

Accordingly, the Complaint does not give rise to a strong

inference that these statements were knowingly or recklessly

false or misleading.

2. Motive and Opportunity

Shareholders have also attempted to support their scienter

pleadings with allegations of defendants’ motive and

opportunity to commit fraud. In a case decided before Tellabs,

we held that plaintiffs may plead scienter “by alleging facts

establishing a motive and opportunity to commit fraud, or by

setting forth facts that constitute circumstantial evidence of

either reckless or conscious behavior.” Advanta, 180 F.3d at

534–35 (internal quotation marks omitted) (emphasis added). A

showing of motive and opportunity, in other words, was an

independent means of establishing scienter, one viable even if

79

plaintiffs could not allege facts from which to infer defendants’

knowing deceit or recklessness. That had been the law in this

circuit before the PSLRA was enacted, and after examining “the

statutory language and supporting legislative history” of the

Reform Act, we concluded “it did not . . . alter the substantive

contours of scienter.” Id. at 534.

This conclusion is no longer tenable in light of Tellabs.50

Even before the Supreme Court’s decision, several of our sister

circuits had rebuffed plaintiffs’ attempts to establish scienter

through proof of motive and opportunity alone. As the Seventh

Circuit observed:

The Second and Third Circuits take the position

that the [PSLRA] adopted the Second Circuit’s

pre-PSLRA pleading standard for scienter, and

thus plaintiffs may continue to state a claim by

pleading either motive and opportunity or strong

50

“Although a panel of this court is bound by, and lacks

authority to overrule, a published opinion of a prior panel, a

panel may reevaluate a precedent in light of intervening

authority . . . .” Reich v. D.M. Sabia Co., 90 F.3d 854, 858 (3d

Cir. 1996); see also Williams v. Ashland Eng’g Co., 45 F.3d

588, 592 (1st Cir. 1995) (“An existing panel decision may be

undermined by controlling authority, subsequently announced,

such as an opinion of the Supreme Court . . . .”), overruled on

other grounds by Carpenters Local Union No. 26 v. U.S. Fid. &

Guar. Co., 215 F.3d 136 (1st Cir. 2000).

80

circumstantial evidence of recklessness or

conscious misbehavior. The Ninth and Eleventh

Circuits disagree, believing that Congress

considered, but ultimately rejected the Second

Circuit’s approach, opting instead for a more

onerous burden.

The remaining six circuits that have

considered this issue take a middle ground,

reasoning that Congress chose neither to adopt

nor reject particular methods of pleading

scienter—such as alleging facts showing motive

and opportunity—but instead only required

plaintiffs to plead facts that together establish a

strong inference of scienter. We find this position

persuasive. . . . The text of the statute states only

that the complaint must support “a strong

inference” of scienter. Without more detailed

instruction, we conclude that the best approach is

for courts to examine all of the allegations in the

complaint and then to decide whether collectively

they establish such an inference. Motive and

opportunity may be useful indicators, but nowhere

in the statute does it say that they are either

necessary or sufficient.

Makor Issues & Rights, Ltd. v. Tellabs, Inc. (Tellabs I), 437 F.3d

588, 601 (7th Cir. 2006) (internal quotation marks and citations

omitted), rev’d on other grounds, 127 S. Ct. 2499 (2007).

81

Although the Supreme Court rejected the Seventh

Circuit’s interpretation of “strong inference,” it left its reasoning

about “motive and opportunity” undisturbed. In fact, the Court

appeared to endorse this reasoning:

While it is true that motive can be a relevant

consideration, and personal financial gain may

weigh heavily in favor of a scienter inference, we

agree with the Seventh Circuit that the absence of

a motive allegation is not fatal. As earlier stated,

allegations must be considered collectively; the

significance that can be ascribed to an allegation

of motive, or lack thereof, depends on the entirety

of the complaint.

Tellabs, 127 S. Ct. at 2511 (internal citations omitted). If the

significance of the presence, or absence, of motive allegations

can be ascertained only by reference to the complete complaint,

then a general rule that motive allegations are sufficient—or

necessary—is unsound.

We do not rely solely on this one passage of the Court’s

opinion. Our conclusion that “motive and opportunity” may no

longer serve as an independent route to scienter follows also

from Tellabs’s general instruction to weigh culpable and

nonculpable inferences. Individuals not infrequently have both

strong motive and ample opportunity to commit bad acts—and

yet they often forbear, whether from fear of sanction, the

dictates of conscience, or some other influence. It cannot be

82

said that, in every conceivable situation in which an individual

makes a false or misleading statement and has a strong motive

and opportunity to do so, the nonculpable explanations will

necessarily not be more compelling than the culpable ones. And

if that is true, then allegations of motive and opportunity are not

entitled to a special, independent status. Instead, as the Seventh

Circuit has said, they are to be considered along with all the

other allegations in the complaint.51

Here, Shareholders’ allegations of motive and

opportunity do not relate to particular statements but rather

purport to bolster a general inference of fraudulent conduct.

Shareholders allege that defendants were “further motivated” to

inflate Avaya’s stock in order to (1) complete a $549 million

repurchase of Liquid Yield Option Notes (LYONs) through

common stock in November 2004, and (2) secure a $400 million

unsecured revolving credit facility on favorable terms in

February 2005. Furthermore, Shareholders allege that McGuire

51

The Second Circuit has continued to treat motive and

opportunity allegations as a separate category, but it does not

appear to have explicitly examined whether that practice is

consistent with Tellabs. See ECA & Local 134 IBEW Joint

Pension Trust of Chi. v. JP Morgan Chase Co., 553 F.3d 187,

198–99 (2d Cir. 2009); Teamsters Local 445 Freight Div.

Pension Fund v. Dynex Capital Inc., 531 F.3d 190, 195 (2d Cir.

2008); ATSI Commc’ns, Inc. v. Shaar Fund, Ltd., 493 F.3d 87,

99 (2d Cir. 2007).

83

and Peterson were motivated to make the alleged false or

misleading statements because they sold Avaya common stock

through March 1, 2005, for personal gain.

Shareholders contend that their “motive allegations are

consistent with scienter, even if,” standing alone, they “do[] not

establish a strong inference.” Shareholders’ Br. 40. In other

words, the stock sales, the LYONs redemption, and the receipt

of a $400 million credit facility are alleged to “bolster scienter

by providing a coherent reason for fraud.” Id. at 43. We agree

that these allegations provide a plausible motive for fraud, but

the bottom-line question is not whether defendants were likely

to have a motive to commit fraud, but whether they were at least

as likely as not to have acted on that motive and actually

committed fraud. For the reasons that follow, we find the

allegations of motive presented here do not strengthen the

inference of scienter.

On November 18, 2004, Avaya announced it would

redeem all of its LYONS due 2021. Pursuant to the terms of

these notes, holders had the choice of redeeming the notes with

a face value of $1,000 at maturity for a present payment in cash

of $545.67, or alternatively the LYONs were convertible into

37.4437 shares of Avaya common stock per $1,000 principal at

maturity.52 LYONs holders were given until December 20,

52

37.4437 shares of Avaya stock at $14.58 a share equals

$545.93. On November 18, 2004, Avaya’s stock closed at

$16.45. On that date, a LYON redemption would have been

84

2004, to choose which method of redemption, cash or stock,

they preferred. Prior to December 20, 2004, holders of LYONs

with an aggregate principal amount at maturity of $549 million

converted their outstanding LYONs into 20,546,199 shares of

Avaya common stock. On December 20, 2004, LYONs with an

aggregate principal amount at maturity of $61,000, which

represented all remaining outstanding LYONs, were redeemed

for cash at an aggregate redemption price of $33,000.

Shareholders allege defendants were “strongly motivated . . . to

artificially inflate (and maintain) the price of Avaya’s common

stock” to avoid paying cash for the LYONs.

On February 24, 2005, Avaya announced it had

completed a $400 million five-year unsecured revolving credit

facility. The new unsecured credit facility replaced Avaya’s

existing $250 million secured credit facility, scheduled to expire

in September 2005. Shareholders allege defendants were

motivated to inflate and maintain the price of Avaya’s common

stock in order to obtain the increased financing on more

favorable terms.

According to our pre-Tellabs jurisprudence, “[m]otive

must be supported by facts stated with particularity, and must

worth $615.95. On December 20, 2004, Avaya’s stock closed

at $17.16. A LYON redemption would have been worth

$642.53. During the period between November 18 and

December 20, the closing price of Avaya’s stock ranged from

$15.82 to $17.73.

85

give rise to a strong inference of scienter.” GSC Partners CDO

Fund v. Washington, 368 F.3d 228, 237 (3d Cir. 2004) (internal

quotation marks omitted).53 That proposition is no less true after

Tellabs, although we no longer make an independent search for

scienter on the basis of motive and opportunity allegations

alone. “[M]otives that are generally possessed by most

corporate directors and officers do not suffice; instead, plaintiffs

must assert a concrete and personal benefit to the individual

defendants resulting from this fraud.” Id. (quoting Kalnit v.

Eichler, 264 F.3d 131, 139 (2d Cir. 2001)); see id. (“In every

corporate transaction, the corporation and its officers have a

desire to complete the transaction, and officers will usually reap

financial benefits from a successful transaction. Such

allegations alone cannot give rise to a ‘strong inference’ of

fraudulent intent.”); cf. Tellabs, 127 S. Ct. at 2511 (“[P]ersonal

financial gain may weigh heavily in favor of a scienter

inference.” (emphasis added)). Here, we do not look at motive

allegations alone, but the same reasoning undermines any

inference of scienter resting upon general motives to aid the

company. Corporate officers always have an incentive to

improve the lot of their companies, but this is not, absent

unusual circumstances, a motive to commit fraud. Certainly, the

53

In GSC Partners, plaintiffs alleged that they purchased

notes from Washington Group International, Inc. due to false or

misleading statements contained in Washington’s circular.

Washington used the money raised from selling the notes to

purchase another company.

86

LYONs redemption and the acquisition of the credit facility fail

to contribute meaningfully to a “strong inference” of scienter

here. Both actions reflect merely a general corporate desire to

retire debt and raise funds and obtain credit on favorable

terms.54 Cf. Cozzarelli v. Inspire Pharmaceuticals Inc., 549

F.3d 618, 627 (4th Cir. 2008) (“[T]he motivations to raise

capital or increase one’s own compensation are common to

every company and thus add little to an inference of fraud.”).

We now turn to the allegations about defendants’ stock

sales. “[W]e will not infer fraudulent intent from the mere fact

that some officers sold stock.” Advanta, 180 F.3d at 540

(quoting Burlington, 114 F.3d at 1424). “But if the stock sales

were unusual in scope or timing, they may support an inference

of scienter.” Id.; see also In re Alpharma Inc. Sec. Litig., 372

F.3d 137, 152 (3d Cir. 2004) (reviewing complaint for

allegations that stock sales were “unusual in scope (e.g.,

compared to their total level of compensation or the size of

previous sales) or timing (e.g., compared to the timing of past

trades)”).

As of October 1, 2004, Peterson owned 5,784,834 shares

54

Furthermore, the LYONs redemption was announced and

occurred in November and December 2004—before most of the

challenged statements alleged in the Complaint.

87

of common stock 55 and McGuire owned 1,418,454 shares of

common stock.56 Avaya Inc., Proxy Statement (Schedule 14A),

at 15–16 (Jan. 4, 2005). During the proposed class period,

Peterson sold 100,000 shares for proceeds of $1,416,500 and

McGuire sold 251,760 shares for proceeds of $3,772,094. As a

percentage of total shares owned, Peterson sold 1.7% and

McGuire sold 17.7%. All 100,000 shares sold by Peterson

during the class period were sold pursuant to the terms of a Rule

10b5-1 plan. During the same period of the previous year,

Peterson sold 200,000 shares. Similarly, 140,000 shares sold by

McGuire were sold pursuant to the terms of a Rule 10b5-1 plan

55

This total includes 4,694,660 stock options, 358,280 shares

to be received upon termination of employment with Avaya,

722,934 shares under a deferred compensation plan, and 8,960

shares held in a deferred account. Avaya Inc., Proxy Statement

(Schedule 14A), at 15–16 (Jan. 4, 2005).

56

This total includes 1,300,832 stock options and 111,761

shares owned by a limited liability company in which McGuire’s

spouse owned the controlling interest and had voting control.

McGuire disclaimed any beneficial ownership in those 111,761

shares, except to the extent of his pecuniary interests therein.

Avaya Inc., Proxy Statement (Schedule 14A), at 15–16 (Jan. 4,

2005).

88

and the other 111,760 57 were sold by the LLC controlled by

McGuire’s spouse. During the same period of the previous year,

McGuire sold 236,083 shares.

Shareholders’ allegations concerning defendants’ stock

transactions do not significantly enhance the inference of

scienter. Defendants’ trading practices remained consistent

year-over-year and each retained a large percentage of his

common stock holdings in Avaya. Accordingly, the sales do not

marginally increase the likelihood that defendants made

knowingly false or misleading statements out of a desire for

personal financial gain.

3. Scienter Conclusion

Although we have discussed each of the alleged facts

bearing on defendants’ scienter one at a time, we have heeded

Tellabs’s command to evaluate Shareholders’ allegations

collectively rather than individually. As we have taken up each

allegation in turn, we have added it to the picture painted by the

previously considered allegations and asked: How does this

addition affect the relative strengths of the culpable and non-

culpable inferences?

Having considered all of the allegations of scienter, we

reach the following conclusions. With respect to the March

pricing statements, the Complaint successfully “state[s] with

57

Garry McGuire, Avaya Inc., Statement of Changes in

Beneficial Ownership (Form 4) (Nov. 3, 2004).

89

particularity facts giving rise to a strong inference” that the

defendants acted consciously or recklessly in making false

statements. 15 U.S.C. § 78u-4(b)(2). The Complaint fails to

allege scienter adequately, however, with respect to defendants’

other statements.

D. Section 20(a) Conclusion

Correctly noting that, where there is “no liability for the

underlying company [under Section 10(b)], there can be no

‘controlling person’ liability under Section 20(a),” the District

Court dismissed the claims brought under the latter provision.

Charatz, 2006 WL 2806229, at *20. This conclusion followed

ineluctably from the court’s finding that Shareholders had not

adequately pleaded any violations of Section 10(b). But

because, unlike the District Court, we hold that plaintiffs have

sufficiently pleaded a Section 10(b) claim with respect to

McGuire’s March pricing statements, we will vacate the

dismissal of the Section 20(a) claims insofar as those statements

are concerned.58 See Suprema, 438 F.3d at 284–86. We will

affirm the District Court’s dismissal of Shareholders’ Section

58

Since none of the March pricing statements were made by

Peterson, all Section 10(b) claims against him are dismissed.

Accordingly, he may be liable only, if at all, as a “controlling

person” under Section 20(a). Because the parties have not

briefed the issue of whether the Complaint properly pleads a

Section 20(a) claim, we leave this issue to the District Court.

90

20(a) claims with respect to the remaining statements.

IV.

For the foregoing reasons, we will reverse the District

Court’s judgment with respect to Shareholders’ claims relating

to the March pricing statements, affirm it with respect to claims

relating to the remaining statements, and remand for further

proceedings consistent with this opinion. Our disposition entails

a shorter class period than Shareholders propose. Because the

Complaint has not adequately pleaded fraud for any statements

made before March 2, 2005, the class period can begin to run no

earlier than that date.

91