Opposition Brief — Scholastic Corp. v. Truncellito

No. 01-397

Ix THI

Supreme Court of the Hnited States

RE < E F EN

SCHOLASTIC CORPORATION and

RAYMOND MARCHUK,

Petitioners,

RICHARD TRUNCELLITO and

THE CITY OF PHILADELPHIA,

Respondents.

On PETITION FOR «4 Writ oF CERTIORARI TO THE

Unirep Srares Court OF APPEALS FOR THE SECOND CIRCUIT

BRIEF IN OPPOSITION

STEPHEN A. WHINSTON JEFFREY A. KLAFTER

Counsel cf Record BerNsTEIN Lirowirz BERGER

Bercer & Monracce, P.C. & GROSSMANN LLP

1622 Locust Street 1285 Avenue of the Americas

Philadelphia, PA 19103 New York, NY LO0O19

(215) 875-3000 (212) 854-1400

Attorneys for Respondents

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TABLE OF CONTENTS

Tatts Of Cited AmtnOrities .. . wc ccc ce econ

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BIB Ie SRE ee Pere

Reasons for Denying the Writ ..................

I.

Certiorari Should Be Denied Because The

Second Circuit’s Application Of The

Standards For Pleading The Circumstances

Of The Fraud Was Consistent With The

PSLRA And With Rulings In Other Circuit

Eg ved eacnweascus <a

The Particularized and Detailed Facts Pled

in the Complaint Regarding Sales and Returns

of Books Satisfy the Statutory Requirements

for Specificity in Pleading the Facts

ek ey Pe eer eT Tee ee

1. Fraud by Hindsight. ................

2. The Purported Rejection of the “All

Facts” Requiem. ©... .<......655.

3. The Purported Rejection of the “Strong

ge a rr

4. Petitioners Failure to Raise any

Challenge to the Second Circuit Standard

in any of the Proceedings Below Weighs

Against Granting Certiorari Because

These Issues Have not Been Fully

Developed by the Parties or Addressed

Oy Che Lower Cowes. «ow. ec cc ceanss

11

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12

13

15

17

19

ll

Contents

Page

Il. Certiorari Should Not Be Granted To Review

The Second Circuit’s Ruling On The

Relevance Of Insider Trading Allegations To

The Pleading Standards For Scienter Since

This Holding Relates Only To Defendant

Marchuk, There Is No Significant Conflict

Among The Circuits Regarding This Issue

And Other Allegations Also Suffice To Plead

SOME oo ica ccciaese eee 21

A. The Circuit Court Only Considered

“Motive and Opportunity” Allegations

as to Defendant Marchuk ........... 21

B. There is no Inter-Circuit Conflict

Concerning Insider Trading Allegations

Ill. Petitioners’ Argument That Circuit And

District Courts Are Confused On PSLRA

Issues Is Not Supported By The Cases Or The

Study Cited, And Is Irrelevant To This

re he aay 27

COMONIINOE. og kn 0h kee eee 29

ae

Appendix — [Corrected] Second Consolidated

Amended Class Action Complaint Dated March

B, TUF ons ckackvuseene eee la

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TABLE OF CITED AUTHORITIES

Page

Cases:

Black yv. Cutter Laboratories, 351 U.S. 292 (1956) .. 20

Bryant v. Avado Brands, Inc., 187 F.3d 1271 (11th

TE ce Vaabaccsssesseenscen 6asutie nes 25

California v. Rooney, 483 U.S. 307 (1987) ....--. 20

Chevron U.S.A. Inc. v. Natural Resources Defense

Council, Inc., 467 U.S. 837 (1984) ........... 20

City of Philadelphia v. Fleming Companies, Inc.,

264 F.3d 1245, 2001 U.S. App. LEXIS 19819

(10th Cir. Sept. 7, 2001) ........... cece eens 19, 24

Cooper v. Pickett, 137 F.3d 616 (9th Cir. 1997) ... 3,14

Denny v. Barber, 576 F.2d 465 (2d Cir. 1978) .... 13

EEOC vy. Fed. Labor Relations Auth., 476 U.S. 19

er rer errr er eee 12

Fecht v. Price Co., 70 F.3d 1078 (9th Cir. 1995), cert.

denied, 517 U.S. 1136 (1996) .............-- 14

Florida State Board of Administration v. Green Tree

Financial Corporation et al., 2001 U.S. App.

LEXIS 22921 (8th Cir. October 25, 2001) ..... 23

Greebel v. FTP Software, Inc., 194 F.3d 185 (1st Cir.

| SPREE Perea reer er rOR TLE 16, 23, 24, 25

Helwig v. Vencor, Inc., 251 F.3d 540 (6th Cir.

RR ee ee ere. 16, 19, 24, 25

iv

Cited Authorities

Page

Howard v. Everex Sys., 228 F.3d 1057 (9th Cir.

BD pic awGkc hae iti cake «ea n4 dee sat 19

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

So PE rer er eee rer eer erry 25

In re Silicon Graphics Inc. Securities Litigation,

183 F.3d 970 (9th Cir. 1999) ......... 13, 16, 17, 24

Johnson v. DeGrandy, 512 U.S. 997 (1994) ...... 20

Kalnit v. Eichler, 2001 U.S. App. LEXIS 19665

(2d Cir. Sept. 5, 2001) ......... 0... eee eee. 28

Nathenson v. Zonagen, Inc., 2001 U.S. App. LEXIS

20902 (Sth Cir. Sept. 25, 2001) ........... 19, 25, 26

Novak v. Kasaks, 216 F.3d 300 (2d Cir. 2000), cert.

denied, __U.S. ___, 121 S. Ct. 567 (2000) ..... 13, 14

Ronconi v. Larkin, 253 F.3d 423 (9th Cir. 2001) ... 14, 24

Rothman v. Gregor, 220 F.3d 81 (2d Cir. 2000) ... 14

Shaw v. Digital Equipment Corp., 82 F.3d 1194

ge re rr Ore ee re rr 14

Texas v. Hopwood, 518 U.S. 1088 (1996) ........ 20

Theoharous v. Fong, 256 F.3d 1219 (11th Cir.

CAL 6e eet de aa ee VE ae ete Cate 19

oe

peor a

y

Cited Authorities

Page

Statutes:

15 U.S.C. § 78j(B) 2... cece cece ee ee cece eens 1

15 UBC. § TOMO) «none ccs c dss essere: ]

15 U.S.C. § 78u-4 ... 1. eee cee eee ees ivanuanae ]

15 U.S.C. § 78u-4(b)(2) oo eee eres 17

Rules:

oe ee eS |) eeerrrrerrr yy er re 16

Fed. R. Civ. P. 12(b)(6) ... 6.6.6. eee eee eee eee: 18, 19

Other Authority:

Joseph A. Grundfest & A.C. Pritchard, “Statutes with

Multiple Personality Disorder: The Value of

Ambiguity in Statutory Design and Interpretation”

(Aug. 23, 2001) 2.2... cece scccereceecces 27

- ¥ ° ne ele NAk ee tied ete et, |. antal oY

l

STATEMENT OF THE CASE

Petitioners/Defendants Scholastic Corporation and

Raymond Marchuk (“Petitioners”) seek Supreme Court review

of aruling by the United States Court of Appeals for the Second

Circuit which concluded that the [Corrected] Second

Consolidated Amended Class Action Complaint (the

“Complaint”) stated a cause of action under Sections 10(b) and

20(a) of the Securities Exchange Act, 15 U.S.C. §§ 78)(b) and

78t(a), as amended by the Private Securities Litigation Reform

Act, 15 U.S.C. § 78u-4.

Scholastic Corporation (“Scholastic” or the “Company’”’)

is a publisher and distributor of children’s books and educational

products. L. 6 (4 13).' At the time in question, the Company’s

most popular product was the “Goosebumps” series of children’s

books by R.L. Stine, which represented about 15% of its gross

revenue for the fiscal year ended May 31, 1996. L. 13 (4 28).

Scholastic distributed books through various retailers and

wholesalers. Its accounting policy permitted it to recognize

revenue on shipment of a book, even though the distributor or

wholesaler had the right of return. This was permissible under

generally accepted accounting rules as long as there was an

adequate reserve for returns. L. 13-14 (4 30). Information

concerning Scholastic’s sales and return rate was therefore

closely watched by security analysts and investors. L. 15, 16,

29, 31 (Ff 34, 36, 56, 60).

To monitor distributor sales and returns, Scholastic

established an extensive system to collect and analyze the

appropriate information in a timely fashion. The form and

frequency of this information for specified distributors

1. Respondents’ have lodged with the Court a copy of the

Complaint. Citations thereto will be in the form of L.___ (4 __), with

“L.” designating the page of the lodging and “4” designating the

paragraph of the Complaint. Although Petitioners ask this Court to

scrutinize the adequacy of the Complaint, they kave not included it in

the materials they have submitted to this Court.

2

representing well over two-thirds of the Goosebumps trade

market is set forth in § 38 of the Complaint, L. 16-17. Scholastic

also had its own internal monitoring system which routinely

collected sales information on a weekly basis in reports to

division heads and transmitted data on returns from its Jefferson

City warehouse to headquarters on a daily basis. L. 17-18

(4 39). Directors received monthly reports. /d.’

Prior to the beginning of the Class Period,’ Scholastic

publicly touted to security analysts and investors that its return

rate of approximately 15-20% was among the lowest in the

industry. L. 15-16 (4 34, 36), that Goosebumps “continued to

sell well in the trade,” id. (4 35), and that “the issue of managing

return exposure [was] one that gets considerable management

attention.” L. 15 (4 34).*

Nevertheless, by September 1996, Plaintiffs allege that

Scholastic had experienced a significant decrease in sales and

increase in returns of Goosebumps books. L. 18-21 (J 41-47).

The Complaint supports these allegations by citing September

1996 sales statistics for Scholastic distributors constituting well

over two-thirds of its trade business which showed a sharp

decline from the previous year.°

2. Given the electronic data systems in place, Scholastic had the

ability to collect and analyze sales and returns data on a more frequent

basis as circumstances warranted.

3. The “Class Period,” December 10, 1996 through February 20,

1997, is the period of time during which Plaintiffs allege that Defendants

made materially false, misleading and omissive statemenis. L. 9 (4 18).

4. The market’s reliance on Scholastic’s internal monitoring of

returns was heightened by the fact that Scholastic disclosed its accounting

for returns only on an annual basis. No statistical or financial information

on returns was included in Scholastic’s quarterly reports. L. 13-14

(¥ 30).

5. According to the Complaint, sales to Ingram, which represented

50% of Scholastic’s trade business, L. 17 (4 38c), had suffered a-

(Cont'd)

3

By December 10, 1996, the beginning of the Class Period,

when Scholastic publicly reported its second quarter

performance, declining sales and increasing returns of

Goosebumps had reached such a level and had gone on for a

sufficient period of time that it could no longer avoid disclosing

these facts to the market without violating Federal securities

laws.°

Specifically, Plaintiffs’ Complaint alleged that several mid-

December 1996 statements made by Petitioners were materially

misleading and omitted material information because they were

completely silent regarding the material decline in sales, the

material increase in returns and the materially reduced outlook

for licensing revenues.’ Sales remained dramatically down from

the previous year. L. 18-19 (4 41-43) (citing results from

distributors representing over two-thirds of the Goosebumps

(Cont'd)

“significant decrease.” L. 18 (4 41). Advanced Marketing Services, which

accounted for 15% of the trade market, had seen its Goosebumps sales

drop from 80,000 books per week in June 1995 to 40,000 books per

week in the fall of 1996. Jd. Fifty percent declines in sales were

also reported by Aramark and Caldor. L. 18-19 (4 42). Year to year

comparisons are appropriate in light of the seasonal nature of Scholastic’s

business (relating to the school year).

6. In addition, by this time, Scholastic knew that it would not be

earning “significant amounts of projected revenues” it anticipated from

Goosebumps merchandise licensing fees. L. 32 (4 66).

7. The statements are identified with particularity in {{] 48, 50 and

54 of the Complaint. L. 21-24, 26. Petitioners argue that the Complaint

seeks to hold Scholastic “responsible for the analysts’ statements.”

Pet. at 8. This is incorrect. Plaintiffs cite these analyst reports only for

the statements in them which were attributed to Scholastic. Nowhere do

Plaintiffs seek to hold Scholastic liable for the analysts’ own views or

opinions. Imposing liability on those who provide materially false

information to the market through securities analysts is a well accepted

principle. See, e.g., Cooper v. Pickett, 137 F.3d 616, 623-624 (9th Cir.

1997).

4

trade market). In addition, the increased returns, which the

Company had sought to forestall by providing extended payment

dates and other unusual incentives, L. 19 (4 44), had now hit

the Company with considerable force. L. 20-21 (4| 46). For

example, returns through Levy Distributors reached

“unprecedented levels” in November and December 1996.

L. 20 (4] 46(c)). Toys R Us returned an “unusually high amount”

of Goosebumps books in December and advised the Company

that this resulted from consumer complaints regarding the scary

nature of the series. /d. (4 46(a)).*

At the same time, a dispute between Scholastic and

Goosebumps author R.L. Stine over negotiations regarding the

renewal of marketing rights for Goosebumps-related products

came to a head. Revenue from these marketing activities was a

“high margin” part of Scholastic’s business and had increased

129% in the previous quarter. L. 31-32 (4 63). Scholastic counted

on the continued receipt of these revenues and factored them

into their assurances to the market regarding third quarter

earnings. L. 32 (4 64). However, unknown to the market, things

were not going well in the negotiations and during the late fall

8. Petitioners claim that the Complaint “did not allege any declining

sales or rising returns during October to December, other than vaguely

noting “unusually high” returns from one retailer in December. Petition

(“Pet.”) at 8. See also Pet. at 10 (“there were no specific allegations

about any additional declines in sales during October to December’’).

This is incorrect both with regard to sales and returns. For example, the

50% drop in AMS weekly sales is alleged to have occurred by “the fall

of 1996 (during the second quarter).” L. 18 (4 41). See also L. 18-19

(4 42) (Aramark sales dropped 50% “between September 1995 and the

fall of 1996”). The fall, of course, includes the months of October and

November and the first twenty-one days of December. Additionally, the

point is not that there were further declines from September to December,

although there were, but that when the drop in sales had not picked up

by December, Petitioners were therefore obligated to disclose that fact,

i.e., ithad become a trend as opposed to a momentary drop. Petitioners’

argument is symptomatic of their narrow reading of the Complaint and

their insistence on not according any inferences in favor of Respondents.

al al

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of 1996, according to Scholastic’s own pleadings in subsequent

litigation, Stine’s company, Parachute Press, engaged in a

“campaign of obstruction and harassment” which “significantly

disrupted” Scholastic’s ability to earn Goosebumps licensing

revenue and caused the Company to lose “significant amounts

of projected revenues.” /d. (4 66).

All of these facts contrast dramatically with Petitioners’

rosy picture of the second quarter results, third quarter

expectations and their complete silence regarding increasing

sales and returns, making the mid-December statements

actionable under the securities laws.”

Scholastic next spoke publicly to the market in mid-January.

L. 27 (4 55). The Complaint lays out additional detailed

information which became available to Scholastic in this period.

In the area of sales, Scholastic’s largest distributor, Ingram,

accounting for over 50% of its trade business, L. 17 (4 38c),

had cut its order in half from 25,000 copies per title to 12,000

copies per title. L. 21 (4] 47(b)). Caldor, whose year-to-year sales

had already declined 50% by September 1996 to a level of 3,000

books per week, L. 18 (4 42), reduced its orders further to 1,800

books per week. L. 21 (4 47(a)).

In the area of returns, year-to-year comparisons showed an

increase of 150% in the overall level of returns in January,

amounting to $4 to $5 million for the month. /d. ({ 46(e)).'°

9. Petitioners find fault with the Complaint for not alleging “what

Scholastic knew on December 10 that should have been disclosed.”

Pet. at 10. However, the Complaint does precisely that in { 49.

L. 22-23.

10. Petitioners claim that the Complaint admits “Scholastic did

not learn about [January] returns until February.” Pet. at 8. This is also

incorrect. While information regarding returns for the entire month of

January was not compiled until early February, L. 30 (4 58), Petitioners

admitted to the close monitoring of returns and the Complaint

(Cont'd)

6

Distributor Levy returned between 50% and 70% of its October

and November “purchases” in January. L. 20 (4 46(c)).""

Incredibly, even at the end of the month, Petitioners

continued to deceive the market. In late January, the Merrill

Lynch analyst responsible for following Scholastic spoke with

Scholastic management to obtain an update on the Company

and subsequently published a report on January 31, 1997 stating

that the Company “suggest|ed] that there has not been a surge

in book returns.” Viewing this an “important” development,

Merrill upgraded its rating on Scholastic from “neutral” to

“accumulate.” L. 29 (4 56) (emphasis added). Based on this

positive report, Scholastic’s stock jumped by $1.50 a share to

$58.75. Id.

As the end of the quarter drew closer, Merrill continued to

inquire of the Company regarding book return rates and the

Company gladly continued to provide misinformation. In early

February, after the returns data for the full month of January

had become available showing a 150% increase over the

previous January, L. 30 (4 58), the Company told Mermill that

returns remained at “normal” levels. L. 31 (4 60).

Finally, with only one week left in the third quarter,

Scholastic began to tell the truth on February 20, 1997. In a

press release, Scholastic now told the market that it anticipated

(Cont'd)

particularizes several sources of sales and return information that were

updated on a weekly or daily basis. L. 16-18 (| 38-39). Petitioners also

fault the Complaint for not specifying “the size of the decline [in sales]

or giv[ing] any date on which Scholastic actually knew about those

declines.” Pet. at 10. Due to the dramatic deterioration of sales and returns

in January and given the detailed daily and weekly sales and return data

available to the Company, L. 17-18 (4 39), the overall January results

could not have come as a shock to Petitioners.

11. See also L. 20-21 (49 46(b),(d)).

7

a loss of $ .70 to $ .80 per share for the quarter. L. 32-33

(4 68).'? Updating its previous repeated statements that returns

were well managed and at “normal” levels, L. 15, 29, 31 (4 34,

56, 60), Scholastic announced that it would take a special pre-

tax charge of $13 million, consisting primarily of a reserve for

additional book returns. L. 32-33 (4 68). Scholastic later revealed

that its trade sales had declined 20% in the quarter. L. 34

(q 75(b)).

Given the sharp divergence of the February 20, 1997

announcement from Scholastic’s previous public comments,

market investors and analysts reacted in shock and dismay.

Scholastic’s stock sunk to a four-year low before closing at

$36.75 per share on February 21, 1997, a one-day drop of $24.75,

or 40% of its previous market value. L. 33 (4 69). Analysts that

followed the stock called the Company a liar in print, id. (4) 70)

(“management’s credibility has been shaken’’); L. 34 (4] 72) (“the

timely dissemination of information remains an unrecognized

problem and as such will likely persist”); id. (4 73)

(“Management credibility has been damaged. The question is

raised: ‘what did you know and when did you know it and why’d

you take so long to tell me?’ ”’)."”

THE DECISION BELOW

The Second Circuit, reversing the decision of the United

States District Court for the Southern District of New York,

held that the Complaint properly stated and pled a cause of

12. Cf. L. 23-24 (4 50) (Company endorses earnings of $ .64 for

the third quarter). The actual reported result was a loss of $ .78 per

share for the quarter. L. 35 (4 75(d)).

13. Declining sales and increasing returns continued, as fourth

quarter losses almost equaled those of the third quarter. L. 35 (Cplt.

4 77). Yet another special charge was taken at the end of the fourth

quarter, this time in the amount of $11 million. /d. (Cplt. § 78). Scholastic

attributed fourth quarter results to “lower irade sales and higher returns

(particularly related to Goosebumps).” Jd. (Cplt. | 77).

Ot

8

action. The Court correctly stated that, pursuant to the

requirements of Section (b)(1) of the PSLRA, Plaintiffs’

Complaint “shall specify each statement alleged to have been

misleading, [and] the reason or reasons why the statement is

misleading.” Further, according to the Second Circuit, the

Complaini must be stated with particularity and “identify the

statements plaintiff asserts where fraudulent and why, in

plaintiff's view, they were fraudulent, specifying who made

them, and where and when they were made.” Pet. App.

8a-9a.

The Second Circuit found that the Complaint set forth

“sufficiently detailed” allegations that Defendants “knew, despite

the fact that their business was cyclical, of a material downward

secular trend.” Pet. App. 18a. See also Pet. App. 17a (“with the

second and third quarters covering months when revenues

should have increased, plaintiffs have alleged enough to permit

proofs that Scholastic should have been alerted, by decreased

sales and increased returns, to negative business results in the

relevant time frame’). The Court properly accepted the

particularized allegations in the Complaint as establishing

Defendants’ knowledge or reckless disregard for the decreasing

sales and increasing returns experienced by Scholastic.

The complaint specifically sets out the distributors

through which Goosebumps books were sold, and

alleges declines in sales as of specific dates, some

in terms of percentage arid other in terms of quantity.

Such information covers over two-thirds of

Scholastic’s trade business in Goosebumps.

Pet. App. 11a. Importantly, the Court recognized that, according

to the Complaint, Defendants not only had access to point-of-

sale data, “but also reviewed it.” Jd.

Similarly, the Second Circuit found allegations concerning

ballooning returns sufficiently particular and in accordance with

the PSLRA’s heightened pleading standards. Pet. App. 13a-14a.

ea

a

7 9

The Second Circuit criticized the District Court for failing

“to take into account the alleged facts that Scholastic reviewed

POS data made available by AMS and Caldor on a daily basis,

by Target on a weekly basis and by Ingram to learn returns would

be on the rise.” Pet. App. 15a. Moreover, the Second Circuit

applied the proper standard in evaluating Plaintiffs’ allegations

as to Company-generated internal reports. In this regard, the

Second Circuit held that “‘a plaintiff needs to specify the internal

reports, who prepared them and when, how firm the numbers

were or which company officers reviewed them.” Pet. App. 15a.

The Second Circuit specifically found that Plaintiffs met this

heightened standard:

Plaintiffs have satisfied this standard by specifying

who prepared internal company reports, how

frequently the reports were prepared and who

reviewed them. We further observe that the

complaint gives additional indications as to the

nature of the reports, because the allegations are

immediately preceded and followed by figures from

retailers to show sales were declining.

Pet. App. 16a.

The Second Circuit found as additional support Plaintiffs’

allegations concerning the Company’s engagement in aggressive

sales practices during the Class Period in order to delay

disclosure of the huge amount of book returns and delay having

to set up an adequate reserve as well as the $13 million pre-tax

special charge taken by the Company in February 1997 for

anticipated book returns. See, e.g., Pet. App. 16a (aggressive

sales practices “would furnish additional support for the

proposition that company officials were aware of declining sales

and increasing returns”); Pet. App. 17a (the $13 million pre-tax

special charge “lends yet more support to the notion that

defendants had knowledge of increasing returns’’).

10

With respect to scienter, the Second Circuit reiterated its

well-established rule that a complaint could survive scrutiny by

(a) pleading facts demonstrating that defendants had both the

motive and an opportunity to commit fraud or (b) otherwise

alleging facts to show strong circumstantial evidence

of defendants’ conscious misbehavior or recklessness.

Pet. App. 19a. With regard to Petitioner Marchuk, the Second

Circuit focused principally on Plaintiffs’ insider trading

allegations, adhering to the Circuit’s long-held view that

‘unusual’ insider sales at the time of the alleged withholding

of negative corporate news may permit an inference of bad faith

and scienter.” Pet. App. 20a. Appiying this standard, the Second

Circuit found that Plaintiffs’ insider trading allegations, along

with other facts in the Complaint, were sufficient to establish

scienter as to Defendant Marchuk. Pet. App. 20a-21a."*

As to Petitioner Scholastic, the Second Circuit found that

the Complaint sufficiently pled allegations concerning

Defendants’ knowing or reckless conduct. Specifically, the

Second Circuit held that:

the second amended complaint contains detailed

allegations as to what defendants knew on a daily,

weekly and monthly basis about the retail trade of

: Goosebumps books, while at the same time making

public statements that painted a different picture.

Defendants publicly represented that returns were

not increasing and failed to adjust revenues despite

14. The Second Circuit also accepted as additional allegations of

Defendant Marchuk’s motive; namely, the fact that he was primarily

responsible for Scholastic’s communications with investors and industry

analysts, was involved in the drafting and/or disseminating false and

misleading statements during the Class Period, had access to internal

corporate documents and reports relating to trade sales and return data,

attended management and committee meetings and prepared the

Directors’ Books. Pet. App. 22a.

1]

their knowledge of rapidly rising returns; these

actions, if proven, are consistent with recklessness.

Pet. App. 24a. As evidence of Defendants’ scienter, the Second

Circuit found particularly compelling allegations in the

Complaint concerming Scholastic’s response to inquiries from

Mermill Lynch in early February 1997.

At this point, even disregarding the information

ostensibly reviewed from computer runs, Scholastic

knew the return rate for January 1997 had increased

150 percent from the year before. Yet by teiling

Merrill Lynch that return rates remained at normal

levels of 20 percent, defendants acted in ways that

could be found to be reckless.

Pet. App. 24a.

REASONS FOR DENYING THE WRIT

I. CERTIORARI SHOULD BE DENIED BECAUSE

THE SECOND CIRCUIT’S APPLICATION OF THE

STANDARDS FOR PLEADING THE CIRCUM-

STANCES OF THE FRAUD WAS CONSISTENT

WITH THE PSLRA AND WITH RULINGS IN

OTHER CIRCUIT COURTS OF APPEALS

A grant of Certiorari would be inappropriate in this case

because the detailed allegations in the Complaint satisfy the

statutory requirements for pleading the circumstances of the

fraud articulated in the PSLRA. The Second Circuit’s application

of that standard here was consistent with rulings of other circuits

which have addressed this issue. This case, therefore, is not an

appropriate vehicle to resolve any purported differences in

pleading standards. In addition, this case is a poor candidate for

review because Petitioners never raised the issue of the proper

pleading standard in any of their arguments below, or, for that

matter, even challenged the application of the Second Circuit’s

12

pleading standard (as they seek to do here).'° Thus, if the Court

were to accept this issue, it would be reviewing general

statements about the law that were never applied to the pleading

at issue in this case.

A. The Particularized and Detailed Facts Pled in the

Complaint Regarding Sales and Returns of Books

Satisfy the Statutory Requirements for Specificity in

Pleading the Facts Constituting Fraud

In this case, the Second Circuit found that the Complaint

satisfied the heightened pleading standards under Sections

21D(b)(1) and (2) of the PSLRA.

The Court based its decision on the well-pled and

particularized allegations in the Complaint which cited reports

of declining sales or increasing returns of Goosebumps from

fifteen different distributors and retailers starting in September

1996 and continuing throughout the Class Period. L. 16-21

({§] 38-47). Additionally, the Complaint alleges that Scholastic

internally monitored trade sales and returns of Goosebumps.

These allegations are not merely boilerplate assertions of internal

controls. Indeed, the Complaint is so particularized that it

identifies the Scholastic employee responsible for compiling

one such report (Leslie Lista), the title of the report (“Director’s

Book’’), the recipients (Scholastic’s Board of Directors), and

the frequency of the report (monthly). L. 17-18 (4 39). Based

on these and other allegations, the Second Circuit concluded,

the Complaint “contains detailed allegations as to what

Petitioners knew on a daily, weekly and monthly basis about

the retail trade of Goosebumps books, while at the same time

making public statements that painted a different picture.”

15. EEOC v. Fed. Labor Relations Auth., 476 USS. 19, 24 (1986)

(“Our usual practice, from which we see no reason to\depart on this

occasion, is to refrain from addressing issues not presented in the Court

of Appeals”’).

13

Pet. App. 24a. This is precisely what is required under (b)(1) of

the PSLRA.

Petitioners’ precise dissatisfaction with the Second Circuit

opinion is not readily apparent. However, Petitioners do raise

three specific areas where, they argue, the Second Circuit differs

from other courts of appeals: the purported endorsement of

“fraud by hindsight,” Pet. at 17-18; the purported rejection of

the statutory requirement to plead “‘all” facts, Pet. at 18-19; and

the purported rejection of the statutory requirement that scienter

allegations result in a “strong inference” of knowing misconduct.

Pet. at 20-21. In each instance, Petitioners misread the opinion

below and grossly exaggerate any differences which may exist

in the language used by the appellate courts.

1. Fraud by Hindsight.

Petitioners argue that the Second Circuit inappropriately

allowed Plaintiffs to plead fraud by hindsight — the use of

subsequent disclosures to conclude that earlier statements were

false. Pet. at 11. Petitioners are correct that the practice of

pleading fraud by hindsight has been unacceptable, even before

the PSLRA. Indeed, it was the Second Circuit that advanced

this position over two decades ago in Denny v. Barber, 576

F.2d 465, 470 (2d Cir. 1978), and has reaffirmed it in numerous

decisions, including most recently in Novak v. Kasaks, 216 F.3d

300, 309 (2d Cir. 2000), cert. denied, US. __, 121 S. Ct.

567 (2000) (“we have refused to allow plaintiffs to proceed with

allegations of ‘fraud by hindsight’ ”’). This principle, moreover,

is consistent with the law in other circuits. See, e.g., Silicon

Graphics, 183 F.3d at 988.

To contend, as Petitioners do here, that the Second Circuit

violated this well-established precept and sub silentio overruled

twenty-five years of precedents is patently absurd. Petitioners

construct this argument from the court’s acknowledgement that

Scholastic’s post-class period announcement of a special charge

for book returns supported the inference of fraud established

14

by other allegations in the Complaint. The Second Circuit did

not base its holding that fraud was sufficiently pled solely on

Petitioners’ subsequent announcements. Rather, as the Court

explained (and Petitioners choose to ignore), Scholastic’s post-

class period announcement represented additional evidence

establishing Petitioners’ state of mind. Pet. App. 17a (the charge

“lends yet more support’). The Second Circuit did not consider

this post Class Period event in a vacuum. The consideration of

this type of allegation as additional evidence of fraud is

consistent with the Second Circuit’s prior holdings (which

Petitioners never challenged below on this point)'® as well as

precedent in other circuits, including the Ninth Circuit.

Indeed, an analysis of case law from other circuits demonstrates

a consistency in the recognition that post-class peniod disclosures

which are inconsistent with recently made statements during

the class period may tend to show that the latter were misleading.

This jurisprudence is particularly well developed in the Ninth

Circuit. Fecht v. Price Co., 70 F.3d 1078, 1083-84 (9th Cir. 1995),

cert. denied, 517 U.S. 1136 (1996) (“shortness of time [between

negative post-class period disclosure and optimistic class period

statements] is circumstantial evidence that the optimistic statements

were false when made’’); Cooper v. Pickett, 137 F.3d 616, 627

(9th Cir. 1997) (short time period between post-class period

disclosure of negative information and positive class period

statements suggests “fraud, rather than business mistake viewed

with the benefit of hindsight”); Ronconi v. Larkin, 253 F.3d

423, 437 (9th Cir. 2001) (“We have allowed the temporal proximity

of an allegedly fraudulent statement or imission and a later

disclosure to bolster a complaint, but we have never allowed the

temporal proximity between the two, without more, to satisfy the

requirements of Rule 9(b). . . . We hold the same in the context of

the PSLRA”) (emph. in original; citations omitted); see also Shaw

v. Digital Equipment Corp., 82 F.3d 1194, 1225 (1st Cir. 1996).

16. See, e.g., Rothman v. Gregor, 220 F.3d 81, 92 (2d Cir. 2000);

Novak v. Kasaks, 216 F.3d at 312-13.

15

2. The Purported Rejection of the “All Facts” Require-

ment.

The powerful facts alleged in the Complaint and found to

be sufficient by the Second Circuit would, without question,

satisfy any circuit court’s articulation of the PSLRA pleading

standard. Petitioners argue that the Second Circuit applied a

more lenient pleading standard than three other circuits because

it did not require Plaintiffs to plead “‘all facts” supporting their

allegations. Pet. 18. Instead, the Second Circuit held that

Plaintiffs “are required only to plead with particularity sufficient

facts to justify those beliefs.” Jd.

The supposedly varying standards between the Circuits are,

at best, nothing more than different judges using different words

to say the same thing. This is demonstrated by examining the

opinion below as a whole, and in the context of Second Circuit

jurisprudence, rather than the single out-of-context sentence

quoted by Petitioners. Thus, the Second Circuit noted that while

a complaint need not include “detailed evidentiary material,” it

cannot simply rely on an “unsupported general claim of the

existence of confidential company sales reports . . . to survive a

motion to dismiss.” Pet. App. 15a. Rather, the court then went

on to state,

a plaintiff needs to specify the internal reports, who

prepared them and when, how firm the numbers were

of which company officers reviewed them. Plaintiffs

have satisfied this standard by specifying who prepared

internal company reports, how frequently the reports

were prepared and who reviewed them. We further

observe that the complaint gives additional indications

as to the nature of the reports, because the allegations

are immediately preceded and followed by figures

from retailers to show sales were declining.

Pet. App. 15a-16a. The Second Circuit specifically held that

the Complaint here met applicable pleading standards, citing

16

First and Seventh Circuit opinions. /d. Indeed, the above-

quoted language is completely consistent with the analysis

in Silicon Graphics, 183 F.3d at 985 (“We would expect that

a proper complaint which purports to rely on the existence

of internal reports would contain at least some specifics from

those reports as well as such facts as may indicate their

reliability”).

The practical application of the pleading standards are

indistinguishable between the various courts. In Silicon

Graphics, plaintiffs alleged in conclusory fashion that

defendants’ knowledge of the fraud was demonstrated by

internal reports that contradicted the positive statements made

to the public. The Ninth Circuit found, however, that the

plaintiff “does not plead facts to corroborate her allegations.”

183 F.3d at 985. Instead, the plaintiff relied solely on a

boilerplate statement about what would be revealed by

discovery. /d. (quoting complaint). This, according to the

Ninth Circuit was “too generic.” Jd."’

Contrary to Petitioners’ argument, the Ninth Circuit did

not require the inclusion of literally all facts in the complaint.

Rather, the court deemed sufficient the pleading of “relevant

facts” with “some specifics” to establish the reliability of

the allegations. /d. This is consistent with the Second

Circuit’s approach here.

Unlike the Complaint Silicon Graphics, the allegations

in this case (as the Second Circuit correctly recognized) are

17. Greebel v. FTP Software, Inc., 194 F.3d 185 (ist Cir. 1999),

and Helwig v. Vencor, Inc., 251 F.3d 540 (6th Cir. 2001), are similarly

inapposite. In Helwig, the Sixth Circuit did not address the application

of the “information and belief” pleading requirements of the PSLRA

other than to quote the statute. 251 F.3d at 550. In Greebel, the First

Circuit did nothing more than reaffirm its prior decisions under Fed. R.

Civ. P. 9(b), which did not require the pleading of every piece of

evidentiary material supporting fraud allegations. 194 F.3d at 194.

17

not based on “generic,” conclusory allegations that could be

asserted against any corporation whose stock price has declined.

Far from a “cookie-cutter” complaint with allegations that have

been recycled from case to case, as in Silicon Graphics, the

Complaint here is painstakingly detailed and is based on a variety

of reliable sources quoted or referred to in the Complaint. The

Complaint is replete with detailed factual allegations concerning

the types of internal reports available and corroborating

information from fifteen different distributors about the contents

of those reports. Such allegations would pass muster under any

standard, including that set forth in Silicon Graphics.

3. The Purported Rejection of the “Strong Inference”

Standard.

Petitioners suggest that the Second Circuit flouted the

PSLRA’s requirement that inferences of scienter be “strong,”

and instead applied a standard that such inferences need only

be “reasonable” (or “not unreasonable”), thus creating a conflict

among the circuits (as well as with the statute itself). Pet. at 20-

22. Petitioners’ position is wrong in all relevant respects.

Petitioners’ contention that the decision below adopts a

“reasonableness” standard for judging inferences of scienter is

contrary to the language of the decision itself. The decision

clearly uses “reasonableness” language only when discussing

inferences involving elements of fraud (such as falsity and

materiality) other than scienter. When the decision discusses

the scienter element, “strong inference” language as used."*

The decision below thus conforms precisely to the PSLRA’s

requirements and to decisions from other circuits on this point.

Petitioners argue that the “Second Circuit accepted any

inferences [of scienter] as long as they were ‘not unreasonable,’ ”

18. The PSLRA’s mandate of pleading facts establishing a “strong

inference” is limited to allegations of scienter. 15 U.S.C. § 78u-4(b)(2).

As to other elements of fraud, the necessary inference may therefore be

reasonable.

18

and specifically that the Second Circuit adopted the

traditional Rule 12(b)(6) principle (that the court must

‘“accept[ | all of the allegations in the complaint as true and

draw{ ] all reasonable inferences in favor of plaintiffs . . . .”)

in assessing the pleading sufficiency of scienter allegations.

Pet. at 9.'° This argument, however, completely misrepresents

the decision below.

The Second Circuit acknowledged inferences which were

“not unreasonable” only in referring to the post class period

announcement of a special charge taken against earnings for

an addition to Schoiastic’s reserves for returned books.

The Court noted that is was “not unreasonable” to infer from

this charge that Goosebumps trade business was in decline

throughout the third quarter. Pet. App. 17a. As this inference

was only considered to be supportive (but not determinative)

of plaintiffs’ allegation that there was a trend of growing

returrs, according to the PSLRA itself, this allegation is not

even subject to the “strong inference of scienter” standard.”°

Petitioners’ description of the supposedly varying

standards among the circuits create a false dichotomy.

According to Petitioners, only the Second Circuit is out of

step, due to its supposed application of general Rule 12(b)(6)

standards for inferences of scienter. But as set forth above,

Petitioners have simply conjured up a pejorative assertion

about Second Circuit law on the strength of scienter

inferences that is simply untrue and is not related in any way

19. While the Second Circuit indeed references the traditional Rule

12(b)(6) standard, it appears at the very beginning of the opinion.

Pet. App. 8a. When the Court turns to a discussion of scienter, it states

clearly that it is governed by the more narrow requirements of the PSLRA.

Pet. App. 18a-19a.

20. Even if deemed to support scienter which is discussed in an

entirely separate section of the opinion, it is one of many circumstances

cited by the Second Circuit which cumulatively reach the “strong

inference” benchmark.

19

to its decision in this case. There is no division among circuits

on this point, and no issue worthy of a grant of certiorari.”

4. Petitioners Failure to Raise any Challenge to the

Second Circuit Standard in any of the Proceedings

Below Weighs Against Granting Certiorari Because

These Issues Have not Been Fully Developed by the

Parties or Addressed by the Lower Courts.

In this case, petitioners focus on abstract statements in the

Court of Appeals’ decision and its routine citation to prior

Second Circuit precedent to which petitioner never objected

below. Petitioners failed to question, let alone to litigate, the

matter of the appropriate pleading standard under the PSLRA

in the Second Circuit. Accordingly, this case would be an

21. Indeed, cases from all circuits continue to include recitations

of the traditional Rule 12(b)(6) standards in their post-PSLRA decisions,

because that standard does continue to apply other than with respect to

inferences of scienter. Howard v. Everex Sys., 228 F.3d 1057, 1060

(9th Cir. 2000) (citations omitted) (“treating the complaint’s allegations

as true and drawing all reasonable inferences in the plaintiff’s favor’);

Nathenson v. Zonagen, Inc., 2001 U.S. App. LEXIS 20902 at *9-10

(Sth Cir. Sept. 25, 2001) (“[W]e will accept the facts alleged in the

complaint as true and construe the allegations in the light most favorable

to the plaintiffs.”); City of Philadelphia v. Fleming Companies,

Inc., 2001 U.S. App. LEXIS 19819 at *22 (10th Cir. Sept. 7, 2001)

(“[{A]ll well-pleaded factual allegations in the . . . complaint are accepted

as true and viewed in the light most favorable to the nonmoving party.”’);

Theoharous v. Fong, 256 F.3d 1219, 1224 (11th Cir. 2001) (“We...

will uphold a dismissal only if it appears beyond doubt that the allegations

in the complaint, when viewed in the light most favorable to the plaintiff,

do not state a claim upon which relief can be granted.”); Helwig v. Vencor,

Inc., 251 F.3d 540, 553 (6th Cir. 2001) (en banc) (“we must construe

the complaint in a light most favorable to the plaintiff, and accept all of

[the] factual allegations as true. . . . Our willingness to draw inferences

in favor of the plaintiff remains unchanged by the PSLRA.”) (internal

quotations and citation omitted); Thus, the Second Circuit’s reiteration

of this black letter law is nothing out of the ordinary.

20

extraordinarily poor vehicle to address the questions presented

as these issues have not been meaningfully reviewed by a lower

court.

As this Court recognized, “this Court reviews judgments,

not opinions.” Chevron U.S.A. Inc. v. Natural Resources Defense

Council, Inc., 467 U.S. 837, 842 (1984); see also California v.

Rooney, 483 U.S. 307, 311 (1987) (per curiam) (dismissing writ

as improvidently granted because “[t]his Court ‘reviews

judgments, not statements in opinions’ ”) (quoting Black v.

Cutter Laboratories, 351 U.S. 292, 297 (1956)). “More

particularly, [this Court] review[s] the judgment that the Court

of Appeals entered in this case, not the judgment that it may

have entered in some other case, or some isolated statement in

its Opinion commenting on the holding in some other case.”

United States v. Doe, 465 U.S. 605, 620 n.1 (1984) (Stevens, J.,

concurring in part and dissenting in part). Accordingly, this Court

will not review “the rationale relied on by the Court of Appeals.”

Texas v. Hopwood, 518 U.S. 1088, 1088 (1996) (statement of

Ginsburg, J., joined by Souter, J., respecting the denial of

certiorari). “Any conflict in these two formulations [in the lower

courts] is of no consequence here.” Johnson v. DeGrandy, 512

U.S. 997, 1003 n.5 (1994).

21

II. CERTIORARI SHOULD NOT BE GRANTED TO

REVIEW THE SECOND CIRCUIT’S RULING ON

THE RELEVANCE OF INSIDER TRADING

ALLEGATIONS TO THE PLEADING STANDARDS

FOR SCIENTER SINCE THIS HOLDING RELATES

ONLY TO DEFENDANT MARCHUK, THERE IS NO

SIGNIFICANT CONFLICT AMONG THE. CIRCUITS

REGARDING THIS ISSUE AND OTHER

ALLEGATIONS ALSO SUFFICE TO PLEAD

~SCIENTER

Certiorari is inappropriate to review the Second Circuit’s

reliance on insider trading allegations to conclude that the

Complaint properly pled scienter. First, this analysis was used

exclusively with regard to Petitioner Marchuk. Thus, any grant

of certiorari on this issue would not impact the principal case

against Scholastic. Second, all the Circuits to reach the issue of

motive and opportunity pleading have concluded that insider

trading allegations such as those asserted against Marchuk may

give rise to a strong inference of scienter. The Complaint

adequately pleads facts supporting a strong inference of

Marchuk’s actual knowledge or reckless disregard of material

misstatements and omissions making the appropriateness of a

motive and opportunity analysis moot.

A. The Circuit Court Only Considered “Motive and

Opportunity” Allegations as to Defendant Marchuk

The Second Circuit’s only reference to “motive and

opportunity” as a means to plead scienter came in connection

with Petitioner Marchuk and his insider trading during the Class

Period. Pet. App. 19a-23a. In discussing the allegations against

Petitioner Scholastic, the Second Circuit held, correctly, that

the Complaint adequately alleged Scholastic’s actual knowledge

or reckless disregard that it was making false statements and

omitting material information from its statements which would

mislead investors. Pet. App. 23a-25a. Since the “motive and

22 .

opportunity” analysis relates only to one defendant, a grant of

certiorari solely on this question would be inappropriate.

B. There is no Inter-Circuit Conflict Concerning Insider

Trading Allegations

Contrary to Petitioners’ argument, there is no conflict among

the Circuits relating to the use of insider trading allegations of

the type alleged here to adequately plead scienter. As the most

recent Circuit Court to consider the issue observed,

Putting aside the Ninth Circuit standard, which gives

the deletion of the Spector amendment a more

pointed reading than it will bear, the split in the other

Circuits is more apparent than real. As we have

discussed . . . , the Second Circuit has dramatically

constricted the types of “motive and opportunity”

that it will recognize as sufficient to plead scienter.

It will not allow plaintiffs to proceed based on widely

held motives such as “(1) the desire to maintain a

high corporate credit rating or otherwise sustain ‘the

appearance of corporate profitability, or of the

success of an investment, [or] (2) the desire to

maintain a high stock price in order to increase

executive compensation or prolong the benefits of

holding office.” Novak, 216 F.3d at 307 (internal

citations omitted). Even complaints based on insider

trading must allege more than that the defendant

benefitted from trading because of a false statement

or omission; the insider trades have to be “unusual,”

either in the amount of the profit made, the amount

of stock traded, the portion of stockholdings sold,

or the number of insiders involved, before they |

will give rise to the required inference of scienter.

See Rothman y. Gregor, 220 F.3d 81, 94 (2d Cir.

2000); Jn re Advanta, 180 F.3d at 540-541; Oran v.

Stafford, 226 F.3d 275, 290 (3d Cir. 2000). This is

23

the same kind of inquiry undertaken by courts that

do not adhere to the motive-and-opportunity

formulation. See Nathenson, 2001 WL 1131511, at

*16; Helwig, 251 F.3d at 552; Greebel, 194 F.3d at

198. The search in the Second Circuit line of cases,

as well as in the other circuits, is for facts that give

a strong reason to believe that there was reckless or

intentional wrongdoing. [citation omitted] Taken as

a whole, the cases do not substantiate the fear that

courts applying the motive-and-opportunity

formulation will permit pleadings to go forward

without facts strongly suggesting wrongdoing.

Florida State Board of Administration v. Green Tree Financial

Corporation et al., 2001 U.S. App. LEXIS 22921 at *37-*38

(8th Cir. October 25, 2001) (emphasis added). A close

examination of the other Circuit decisions confirms that

Petitioners’ contention that there exists a substantive conflict

among the Circuits is unfounded and that even the Ninth

Circuit’s decisions would support the sufficiency of the

allegations against Marchuk.

Petitioners first point to Greebel v. FTP Software, Inc., 194

F.3d 185 (1st Cir. 1999). After observing that “the words of the

Act neither mandate nor prohibit the use of any particular method

to establish an inference of scienter,” id. at 195, the court went

on to specifically reject the “argument that facts showing motive

and opportunity can never be enough to permit the drawing of

a strong inference of scienter,” permitting “use of motive

and opportunity type pleading if it raises a strong inference.”

Id. at 197. The First Circuit concluded that it was in agreement,

not disagreement, with the Second Circuit as well as the Third

and Fifth Circuits on this issue. Jd. (“Three circuits have

interpreted the PSLRA as permitting use of motive and

opportunity type pleading if it raises a strong inference.

See In re Advanta Corp. Sec. Litig., 180 F.3d 525, 534-35 (3d

Cir. 1999); Press v. Chemical Inv. Servs. Corp., 166 F.3d 529,

24

537-38 (2d Cir.1999); Williams v. WMX Techs., Inc., 112 F.3d

175, 178 (Sth Cir. 1997) (dicta)”). Moreover, the First Circuit

went on to recognize that “[u]nusual trading or trading at

suspicious times or in suspicious amounts by corporate insiders

has long been recognized as probative of scienter.” /d. at 197.

Similarly, in Helwig v. Vencor, Inc., 251 F.3d 540 (6th Cir.

2001) (en banc), the Sixth Circuit observed that regardless of

labels, “facts showing [motive and opportunity] may support a

strong inference of recklessness” and therefore “may be of

enough weight to state a claim under the PSLRA.” /d. at 551.

Agreeing with the First Circuit decision in Greebel, the Sixth

Circuit emphasized that determining whether such allegations

will suffice is a “fact-specific approach.” id., and that among

the facts relevant to establishing a strong inference of scienter

is “insider trading at a suspicious time or in an unusual amount.”

Id. at 552. Accord City of Philadelphia v. Fleming Companies,

Inc., 264 F.3d 1245, 1262 (10th Cir. 2001) (“We believe the

most reasonable reading of the PSLRA in regard to motive and

opportunity pleadings is the view adopted by the First Circuit

in Greebel and the Sixth Circuit in Helwig.”). Thus, there is no

conflict among the Circuits.

Petitioners attempt to manufacture such a conflict by

pointing to the Ninth Circuit’s decision in Silicon Graphics,

supra. There, however, after stating the unremarkable

proposition that “plaintiffs proceeding under the PSLRA can

no longer aver intent in general terms of mere ‘motive and

opportunity” or “recklessness,” id. at 979 (emphasis added),

which was the practice in the Ninth Circuit prior to enactment

of the PSLRA, the court went on to specifically reaffirm its

long held view that “unusual” or “‘suspicious” stock sales by

corporate insiders could supply a basis for the requisite strong

inference. Jd. at 985-86. Accord, Ronconi v. Larkin, 253 F.3d at

434-35. Thus, Silicon Graphics presents no disagreement with

the standard employed by the Second Circuit here.

25

Finally, Petitioners erroneously point to Bryant v. Avado

Brands, Inc., 187 F.3d 1271 (11th Cir. 1999), as being in conflict

with the Second Circuit. The Bryant court, however, in stating “that

a showing of mere motive and opportunity is insufficient to plead

scienter’’ was referring to generic motives not at issue here that any

court would deem insufficient to plead scienter. The complaint at

issue alleged such universal motives as the desire to maintain a

high stock price or to reduce bank debt. /d. at 1274.” The Bryant

court did not definitively resolve the impact of insider trading

allegations, leaving that for the district court on remand. Thus,

Bryant does not support a material divergence in the Circuit courts

on the significance of insider trading allegations of the type alleged

against Marchuk here. See also In re Advanta Corp. Sec. Litig.,

180 F.3d 525, 540 (3d Cir. 1999) (“if the stock sales were unusual

in scope or timing, they may support an inference of scienter’’);

Nathenson v. Zonagen, Inc., 2001 U.S. App. LEXIS 20902 at *52

(Sth Cir. 2001) (unusual insider trading would have probative valuc

in analyzing scienter allegations).

Thus, whether phrased in terms of motive and opportunity

or direct evidence knowledge or recklessness, there is no

disagreement among the circuits that unusual and suspicious

insider trading is properly part of the total mix of facts that

must be analyzed to determine whether scienter has been pled

adequately and may suffice to support a strong inference of

scienter.

In the instant case, the Complaint adequately pleads both

unusual and suspicious insider trading by Marchuk. Marchuk

was a Senior corporate officer with access to internal information

about sales and returns and was responsible for the Company’s

22. There is no disagreement that “general” claims of motive and

opportunity are insufficient to allege the requisite state of mind.

See Helwig, 251 F.3d at 551 (“pleading conclusory labels of motive and

opportunity will not suffice.”); Jn re Advanta Corp. Sec. Litig., 180 F.3d

525, 535 (3d Cir. 1999) (rejecting “blanket assertions” and “catch-all

allegations” of motive and opportunity); Greebel, 194 F.3d at 197.

26

contacts with analysts and investors. L. 7 (4 14). As of December

30, 1996, Marchuk owned 24,250 shares of Scholastic stock.

He had sold no such stock since April 11, 1995, some 20 months

earlier. L. 37 (4 81), but between December 31, 1996 and January

7, 1997, Marchuk sold 80% of his holdings, or 19,400 shares,

for proceeds in excess of $1.2 million. /d. Moreover, these sales

took place shortly after he participated in the conference call

with analysts in December during which he assured analysts

that sales were not declining, when in fact they were, that

continued 20% growth was reasonable, when in fact it was not,

and that the Company was “most comfortable” with earnings

projections of around $.64 per share, when in fact the Company

was being hit by materially lower sales and higher returns.

L. 23-26 (4 50, 52, 81).

As these facts confirm, the allegations against Marchuk

were not based solely on motive and opportunity. As one court

has recently noted, that would be an unusual situation.

Appropriate allegations of motive and opportunity

may meaningfully enhance the strength of the

inference of scienter, but it would seem to be a rare

set of circumstances indeed where those allegations

alone are both sufficiently persuasive to give rise to

a scienter inference of the necessary strength and

yet at the same time there is no basis for further

allegations also supportive of that inference.

Nathenson v. Zonagen, 2001 U.S. App. LEXIS 20902 at *52

(Sth Cir. 2001).

Based on these factual allegations, the Second Circuit held

that the Complaint adequately alleged scienter based on a strong

inference emanating from Marchuk’s significant and unusual

insider sales. Pet. App. 19a-22a. The same result would have

been reached in any Circuit.

23. Indeed, the Second Circuit also noted Marchuk’s access to

internal Company data regarding book sales and returns. Pet. App. 22a.

27

Ill. PETITIONERS’ ARGUMENT THAT CIRCUIT AND

DISTRICT COURTS ARE CONFUSED ON PSLRA

ISSUES IS NOT SUPPORTED BY THE CASES OR

THE STUDY CITED, AND IS IRRELEVANT TO

THIS PETITION

Petitioners devote their final two pages of the Petition to

describing asserted confusion among district courts in applying

PSLRA standards, citing a few district court cases (decided

before their circuits issued determinative decisions) and a “work-

in-progress” “discussion paper” (see website cited by

Petitioners) issued by the John M. Olin Center for Law &

Economics just a month before the Petition was filed (Joseph

A. Grundfest & A.C. Pritchard, “Statutes with Multiple

Personality Disorder: The Value of Ambiguity in Statutory

Design and Interpretation” (Aug. 23, 2001) (“Multiple

Personality’).

The paper offers a statistical analysis of circuit and district

court decisions on the PSLRA “motive and opportunity” scienter

pleading issue, but does not address the other PSLRA issues

raised by Petitioners at all. Multiple Personality at 51.

Petitioners’ descriptions of the results of the study are

misleading. Petitioners imply that the paper’s analysis of district

court decisions on motive and opportunity, supporting a “coin-

toss” model of judicial behavior, applies today. Pet. at 27.

The paper, however, makes clear that each district court decision

studied “predates the issuance of [an appellate] decision

addressing the strong inference standard by any panel of the

Court of Appeals for the circuit in which the district court

resides.” Jd. at 61 (emphasis added). In other words, the paper’s

conclusion about district court behavior is largely historical and

inapplicable today, since most circuit courts have now

interpreted the strong inference provision. Jd. at 47-50.

The Petition’s suggestion that the paper found that diverse

district court interpretations represent a current problem is thus

contrary to what the paper studied.

28

With respect to the circuit courts, Petitioners emphasize

the paper’s suggestion that the Second Circuit “motive and

opportunity” pleading standards are too lax, noting reversals of

the last four complaint dismissals to reach the Second Circuit.

As demonstrated above, however, regardless of the labels

employed, there is substantial agreement among the circuits as

to the type of facts which will support a strong inference of

scienter. See Point II, supra. Moreover, the fact that the Second

Circuit reversed (or remanded) four recent dismissals means

nothing as those rulings were justified by the allegations at issue

and not any lax legal standard. Indeed, the Second Circuit

affirmed a dismissal of an inadequate PSLRA pleading in its

most recent decision on the issue, Kalnit v. Eichler, 2001 U.S.

App. LEXIS 19665 (2d Cir. Sept. 5, 2001). There, the Second

Circuit found the motive and opportunity allegations of the

complaint, which were predicated on generic motives such as

the desire to protect existing compensation arrangements and

to avoid personal liability, to be inadequate to plead scienter.

The Court contrasted the facts in Ka/nit with its decision in the

instant case, where the inference of scienter flowed from unusual

insider trading resulting in specific significant and individualized

benefits to the defendant. /d. at *23-*24. The difference between

the two factual scenarios is dramatic as all courts, not just the

Second Circuit, have recognized.

29

CONCLUSION

For the reasons stated herein, Respondents respectfully pray

that the Petition for a Writ of Certiorari be denied.

Respectfully submitted,

STEPHEN A. WHINSTON

Counsel of Record

BERGER & MontacuE, P.C.

1622 Locust Street

Philadelphia, PA 19103

(215) 875-3000

Jerrrey A. KLAFTER

BERNSTEIN LiTow!Tz BERGER

& GROSSMANN LLP

1285 Avenue of the Americas

New York, NY 10019

(212) 554-1400

Attorneys for Respondents

APPENDIX

la

APPENDIX — [CORRECTED] SECOND

CONSOLIDATED AMENDED CLASS ACTION

COMPLAINT DATED MARCH 8, 1999

{Omitted here but submitted

separately as Lodging]