Teachers' Retirement System v. Cree Inc.

PUBLISHED

UNITED STATES COURT OF APPEALS
FOR THE FOURTH CIRCUIT

TEACHERS’ RETIREMENT SYSTEM OF 
LOUISIANA,
Plaintiff-Appellant,
and
BARRY SCHOENFELD, Individually and
on behalf of all others similarly
situated; SCHOENFELD GROUP;
BERNARDINELLI GROUP, Carmine
Bernardanelli, Joseph M. Hansen
and Frances C. Hunt being referred
to as Bernardinelli Group; GARY
SANDLER; ROCHELLE SANDLER; JUDY
A. SMITH; WILLIAM H. DAIL;  No. 05-1988
LOUISIANA SCHOOL EMPLOYEE
RETIREMENT SYSTEM,
Plaintiffs,
v.
FRED NEAL HUNTER; CYNTHIA B.
MERRELL; DOLPH W. VON ARX;
CHARLES SWOBODA; WALTER ROBB;
JOHN W. PALMOUR; CREE,
INCORPORATED; CALVIN H. CARTER,
JR.; JAMES E. DYKES,
Defendants-Appellees.

Appeal from the United States District Court
for the Middle District of North Carolina, at Durham.
Frank W. Bullock, Jr., District Judge;
Wallace W. Dixon, Magistrate Judge.
(CA-03-549-1)
2 TEACHERS’ RETIREMENT SYSTEM v. HUNTER
Argued: September 20, 2006

Decided: February 20, 2007

Before WILKINSON, NIEMEYER, and SHEDD, Circuit Judges.

Affirmed by published opinion. Judge Niemeyer wrote the majority
opinion, in which Judge Wilkinson joined. Judge Shedd wrote a dis-
senting opinion.

COUNSEL

ARGUED: Richard Ara Harpootlian, Columbia, South Carolina, for
Appellant. Bruce C. Vanyo, KATTEN, MUCHIN & ROSENMAN,
L.L.P., Los Angeles, California, for Appellees. ON BRIEF: Jay W.
Eisenhofer, John C. Kairis, Sidney S. Liebesman, GRANT & EISEN-
HOFER, P.A., Wilmington, Delaware, for Appellant. Carl N. Patter-
son, Jr., Donald H. Tucker, Jr., SMITH, ANDERSON, BLOUNT,
DORSETT, MITCHELL & JERNIGAN, L.L.P., Raleigh, North Car-
olina; Lyle Roberts, Paul Chalmers, Nicholas I. Porritt, Ilana Kramer,
WILSON, SONSINI, GOODRICH & ROSATI, Reston, Virginia, for
Appellees.

OPINION

NIEMEYER, Circuit Judge:

The district court dismissed plaintiffs’ 168-page securities-fraud
class-action complaint brought against Cree, Inc., a high-technology
business in Durham, North Carolina,1 which purported to allege
1
Founded in 1987, Cree is a major innovator and manufacturer of sili-
con carbide-based products, including semiconductors, transistors, and
light-emitting diodes, which are used in a variety of products such as dig-
ital cameras and wireless telephones.
 TEACHERS’ RETIREMENT SYSTEM v. HUNTER 3
claims under § 10(b) of the Securities Exchange Act of 1934 and Rule
10b-5 thereunder. The complaint claims that Cree made misleading
statements about its business transactions with six companies over a
period of almost four years, which were discovered when a former
officer sued the company in June 2003. Relying on Federal Rule of
Civil Procedure 12(b)(6) and the Private Securities Litigation Reform
Act of 1995, the district court held that the complaint failed to allege
facts sufficient to support the plaintiffs’ claims that Cree’s statements
were misleading. The court also concluded that the plaintiffs did not
sufficiently allege that the statements were made with the requisite
scienter or that plaintiffs’ losses were caused by the misrepresenta-
tions and omissions of which they complained.

Applying the Private Securities Litigation Reform Act and Federal
Rules of Civil Procedure 8(a), 9(b), and 12(b)(6) to plaintiffs’ com-
plaint de novo, we affirm, concluding that plaintiffs are complaining
only about market risks, not particularized securities fraud.

I

On June 12, 2003, Eric Hunter, co-founder and CEO of Cree, Inc.,
from 1987 to 1994, and his wife filed suit against Cree, F. Neal
Hunter (Eric Hunter’s brother and co-founder of Cree, as well as its
CEO from 1994 to 2001 and chairman of the board thereafter), and
other officers, alleging violations of state and federal securities laws,
defamation, and intentional infliction of emotional distress. Eric
Hunter also sought a preliminary injunction against Cree and Neal
Hunter to prevent alleged personal harassment that appeared to have
attended an ongoing family fight. News of the lawsuit caused the
price of Cree’s stock to fall the next day from $22.21 to $18.10.

Although Eric Hunter promptly settled his suit in August 2003, the
allegations in his complaint quickly spawned numerous class actions
by purchasers of Cree stock who alleged securities fraud during a
period beginning on August 12, 1999, when Cree filed an annual
report on SEC Form 10-K, and ending on June 13, 2003, the day after
Eric Hunter filed his suit, purportedly revealing the truth of Cree’s
fraud during the previous years. The cases were consolidated in the
Middle District of North Carolina, and Teachers’ Retirement System
of Louisiana was named the lead plaintiff. In a consolidated class
4 TEACHERS’ RETIREMENT SYSTEM v. HUNTER
action complaint, Teachers’ Retirement System and the other plain-
tiffs (collectively, "plaintiffs") sought certification of a class of all
purchasers of Cree’s common stock during the period from August
12, 1999 to June 13, 2003. The consolidated class action complaint
named Cree, as well as six of the corporation’s officers and directors,
F. Neal Hunter, Cynthia B. Merrell, Dolph W. Von Arx, Charles
Swoboda, Walter L. Robb, and John W. Palmour, as defendants
(often hereafter referred to collectively as "Cree").

Count I of the consolidated class action complaint alleged that Cree
violated § 10(b) of the Securities Exchange Act ("the Exchange Act"),
15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5, which
prohibits making false or misleading statements in connection with
the sale of securities. Count II claimed that the individual defendants
violated § 20(a) of the Exchange Act, 15 U.S.C. § 78t(a), which
assigns joint and several liability to a person who controls another
who violates a securities regulation. The district court granted the
defendants’ motion to dismiss that complaint for failing both to plead
fraud with particularity and to plead facts supporting a strong infer-
ence that Cree acted with scienter. See In re Cree, Inc. Sec. Litig., 333
F. Supp. 2d 461, 474-75 (M.D.N.C. 2004).

In response, the plaintiffs filed the first amended consolidated class
action complaint (hereafter, "the complaint"), at issue in this appeal.
The complaint bolstered the allegations made in the original consoli-
dated class action complaint and named two more Cree directors as
defendants, Calvin H. Carter and James E. Dykes. Additionally, the
complaint added Counts III, IV, and V. Count III alleged that the indi-
vidual defendants engaged in insider trading, in violation of § 20A of
the Exchange Act, 15 U.S.C. § 78t-1(a). Count IV claimed that the
individual defendants are personally liable under § 18 of the
Exchange Act, 15 U.S.C. § 78r(a), for making misleading statements.
Count V claimed that Neal Hunter, Swoboda, and Merrell violated
§ 304 of the Sarbanes-Oxley Act, 15 U.S.C. § 7243, which requires
CEOs and CFOs to reimburse their corporations for bonuses and other
compensation if the corporation is required to prepare an accounting
restatement due to misconduct.

Each of the counts relies on allegations that Cree misrepresented
a series of its transactions with six other companies over a period of
 TEACHERS’ RETIREMENT SYSTEM v. HUNTER 5
46 months in an effort to artificially inflate the price of its stock. The
complaint alleges that Cree engaged in a "channel-stuffing" scheme
with Charles & Colvard ("C&C"), by which Cree forced C&C to pur-
chase silicon carbide crystals far in excess of C&C’s need and then
booked the unqualified revenue from the sales of these crystals even
though C&C held an undisclosed right to return the crystals later on.
It also alleges that Cree improperly booked revenue from a research
and development agreement with C&C and a sale of equipment to
C&C, because these transactions were a sham.

The complaint further alleges that Cree engaged in "round-trip"
transactions with five other companies, Microvision, Inc., Spectrian,
Inc., World Theatre, Inc., Xemod, Inc., and Lighthouse, Inc. "Round-
tripping" typically refers to reciprocal agreements, involving the same
products or services, that lack economic substance but permit the par-
ties to book revenue to improve their financial statements. The puta-
tive pattern of these deals as alleged in the complaint was that Cree
would intentionally overpay for an investment in the stock of the
other company in exchange for the other company’s agreement to
purchase bogus R&D services from Cree.

Although Cree disclosed aspects of these transactions in its public
filings, the plaintiffs’ complaint alleges that the true nature of the
transactions became known only when Eric Hunter filed his action
against Cree, his brother, and other officers of Cree in June 2003. The
complaint alleges that what was learned in June 2003 differed from
what Cree had disclosed publicly and that the public disclosures were
materially misleading.

Cree filed a motion to dismiss plaintiffs’ amended class-action
complaint pursuant to Federal Rule of Civil Procedure 12(b)(6), and
the district court granted the motion in its entirety, finding that the
complaint’s impressive length did not portend similarly impressive
substance. The court concluded first that "plaintiffs adequately iden-
tif[ied] the statements [of Cree] they believe[d] to be false and the
reasons why they believe[d] them to be false, but fail[ed] to state with
particularity facts supporting a strong inference of fraud." Second, the
district court concluded that plaintiffs did not adequately plead that
the defendants acted with the requisite scienter because the complaint
neither identified misleading statements or omissions nor alleged suf-
6 TEACHERS’ RETIREMENT SYSTEM v. HUNTER
ficient circumstantial evidence of scienter. Finally, the court found
that "plaintiffs . . . failed to demonstrate a direct relationship between
their losses and the alleged misrepresentations and have failed, there-
fore, to establish the required element of loss causation."

Having dismissed the first count alleging a claim under § 10(b) and
Rule 10b-5, the court also dismissed plaintiffs’ claims under §§ 20(a)
and 20A of the Exchange Act because these claims depended upon
the liability alleged in the first count. Similarly, the court dismissed
plaintiffs’ claim pursuant to § 18 of the Exchange Act because plain-
tiffs failed to plead facts showing that Cree made false statements.
Finally, the court dismissed plaintiffs’ claim under § 304 of the
Sarbanes-Oxley Act because plaintiffs did not allege that Cree was
required to issue any restatement of its financial reports.

From the district court’s final order dismissing the complaint with
prejudice, the plaintiffs filed this appeal, challenging each of the dis-
trict court’s grounds for dismissal and seeking either the reinstatement
of their complaint or leave to amend it. Cree urges us to affirm the
district court’s order or, in the alternative, to find that the complaint
was barred by the applicable statute of limitations. Cree argues that
in a securities fraud case such as this, the limitations period began to
run when a reasonable investor would have "inquiry notice" of poten-
tial fraud, citing Brumbaugh v. Princeton Partners, 985 F.2d 157, 162
(4th Cir. 1993).

II

The district court dismissed the plaintiffs’ class-action complaint
under Federal Rule of Civil Procedure 12(b)(6) and the Private Secur-
ities Litigation Reform Act of 1995, Pub. L. No. 104-67, 109 Stat.
737 (the "PSLRA"). Because the district court’s order ruled on the
legal sufficiency of the complaint, we review that order de novo. See
Jordan v. Alternative Res. Corp., 458 F.3d 332, 338 (4th Cir. 2006).

Ordinarily, the legal sufficiency of a complaint under Rule 12(b)(6)
is determined by whether the complaint states a claim upon which
relief can be granted in light of the pleading requirements of Rules 8
and 9, as well as the larger design of the Federal Rules. This design
provides for simplicity in pleading that intends to give little more than
 TEACHERS’ RETIREMENT SYSTEM v. HUNTER 7
notice to the defendant of the plaintiff’s claims and that defers until
after discovery any challenge to those claims insofar as they rely on
facts. Of course, the issue of whether the plaintiff is pursuing a claim
upon which relief can be granted is a purely legal question that can
be determined at virtually any stage of the federal process — in the
beginning, under Rule 12(b)(6); after the pleadings have been filed,
under Rule 12(c); after discovery, under Rule 56; or after the plaintiff
has presented his case at trial, under Rules 50(a) or 52. When the
issue of whether a complaint states a claim upon which relief can be
granted is raised by a Rule 12(b)(6) motion and is dependent on the
development of facts, however, the jurisprudence of Rule 12(b)(6)
requires postponement of any final determination of the issue.

More precisely, under this scheme of notice pleading and broad
discovery, consideration of a motion to dismiss must account for the
possibility that a noticed claim could become legally sufficient if the
necessary facts were to be developed during discovery. As the
Supreme Court has characterized this approach to Rule 12(b)(6)
motions:

Given the Federal Rules’ simplified standard for pleading,
a court may dismiss a complaint only if it is clear that no
relief could be granted under any set of facts that could be
proved consistent with the allegations.

Swierkiewicz v. Sorema N.A., 534 U.S. 506, 514 (2002) (internal quo-
tation marks and citation omitted) (emphasis added). Of course, when
the matters alleged in the complaint are taken as true and the com-
plaint still fails to state a claim upon which relief can be granted, it
will be dismissed at the outset, under Rule 12(b)(6). See Jordan, 458
F.3d at 338.

Some have criticized this design of federal procedure as encourag-
ing the filing of frivolous suits that have little hope of success and are
designed to harass the defendant. The Supreme Court in Swierkiewicz
considered the defendant’s similar argument that "allowing lawsuits
based on conclusory allegations of discrimination to go forward will
burden the courts and encourage disgruntled employees to bring
unsubstantiated suits." 534 U.S. at 514. The Supreme Court
responded:
8 TEACHERS’ RETIREMENT SYSTEM v. HUNTER
Whatever the practical merits of this argument, the Federal
Rules do not contain a heightened pleading standard for
employment discrimination suits. A requirement of greater
specificity for particular claims is a result that must be
obtained by the process of amending the Federal Rules, and
not by judicial interpretation. Furthermore, Rule 8(a) estab-
lishes a pleading standard without regard to whether a claim
will succeed on the merits. Indeed, it may appear on the face
of the pleadings that a recovery is very remote and unlikely
but that is not the test.

Id. at 514-15 (internal quotation marks and citations omitted).

To address just the type of argument that the defendant advanced
in Swierkiewicz, the Federal Rules of Civil Procedure require particu-
larized pleadings in specific types of cases, including those alleging
fraud. Rule 9(b) provides:

In all averments of fraud or mistake, the circumstances con-
stituting fraud or mistake shall be stated with particularity.
Malice, intent, knowledge, and other condition of mind of
a person may be averred generally.

The reasons that have been given for applying this heightened plead-
ing standard in fraud cases are numerous and continue to be debated.
See generally 5A Charles Alan Wright & Arthur M. Miller, Federal
Practice and Procedure § 1296 (3d ed. 2004). But one repeatedly
given reason is summarized as follows:

[S]ome federal courts have expressed the view that allega-
tions of fraud or mistake frequently are advanced only for
their nuisance or settlement value and with little hope that
they will be successful on the merits; indeed, there actually
may be little or no incentive to secure the adjudication of the
claim in some instances. Thus, unfounded fraud claims
should be identified and disposed of early.

Id. at 37. Professors Wright and Miller also note, with particular rele-
vance to the case before us, that this justification for Rule 9(b) encap-
 TEACHERS’ RETIREMENT SYSTEM v. HUNTER 9
sulates the goal of sorting out at an early stage "strike suits" in the
securities field. Id. at 45-47.

Yet, the inconsistent application and interpretation of Rule 9(b) and
other abuses in securities cases prompted Congress to enact the
PSLRA. As the Committee of Conference that reported the PSLRA
noted, "[Rule 9(b)] has not prevented abuse of the securities laws by
private litigants. Moreover, the courts of appeals have interpreted
Rule 9(b)’s requirement in conflicting ways, creating distinctly differ-
ent standards among the circuits." H.R. Rep. No. 104-369, at 41
(1995) (Conf. Rep.), reprinted in 1995 U.S.C.C.A.N. 730, 740. The
Committee of Conference stated that it was reacting to testimony on
the need to establish "uniform and more stringent pleading require-
ments to curtail the filing of meritless lawsuits," and therefore
intended "to strengthen existing pleading requirements." Id. Thus, the
PSLRA was enacted in response to evidence presented to the Com-
mittee that

abusive practices committed in private securities litigation
include . . . the routine filing of lawsuits against issuers of
securities and others whenever there is a significant change
in an issuer’s stock price, without regard to any underlying
culpability of the issuer, and with only faint hope that the
discovery process might lead eventually to some plausible
cause of action.

***

This legislation implements needed procedural protections
to discourage frivolous litigation.

Id. at 730-31.

The PSLRA provides that in pleading a material misrepresentation
or omission, in violation of § 10(b) of the Exchange Act and Rule
10b-5, and the scienter necessary to such a misrepresentation or omis-
sion, the plaintiff must plead facts. Cf. Fed. R. Civ. P. 8(a)(2) (provid-
ing that a pleading generally need only contain "a short and plain
statement of the claim showing that the pleader is entitled to relief"
10 TEACHERS’ RETIREMENT SYSTEM v. HUNTER
(emphasis added)). Thus, in alleging misrepresentations or omissions
under the PSLRA, a complaint must include "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 par-
ticularity all facts on which that belief is formed." 15 U.S.C. § 78u-
4(b)(1) (emphasis added). And in alleging scienter, the plaintiff 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." Id. § 78u-4(b)(2)
(emphasis added). The PSLRA also directs that any complaint not
meeting the pleading requirements be dismissed, id. § 78u-4(b)(3)(A),
and that during the pendency of any motion to dismiss, discovery be
stayed, subject to exceptions, id. § 78u-4(b)(3)(B).

Thus, while the Federal Rules generally allow a court, in ruling on
a motion to dismiss under Rule 12(b)(6), to take into account any set
of facts that could be proved consistent with the allegations of the
complaint, even though such facts have not been alleged in the com-
plaint, the PSLRA modifies this scheme (1) by requiring a plaintiff
to plead facts to state a claim and (2) by authorizing the court to
assume that the plaintiff has indeed stated all of the facts upon which
he bases his allegation of a misrepresentation or omission. 15 U.S.C.
§ 78u-4(b)(1). The Act also requires a plaintiff to plead sufficient
facts to raise a strong inference of scienter. Id. § 78u-4(b)(2). Of
course, the other elements of a securities fraud claim would be ana-
lyzed under the traditional pleading scheme of Rules 8 and 9, since
Congress only addressed misrepresentations and scienter in § 78u-
4(b).

In purporting to allege claims under § 10(b) and Rule 10b-5, the
plaintiffs were required to allege that "(1) the defendant made a false
statement or omission of material fact (2) with scienter (3) upon
which the plaintiff justifiably relied (4) that proximately caused the
plaintiff’s damages."2 Hillson Partners Ltd. P’ship v. Adage, Inc., 42
2
Breaking down these elements further, the Supreme Court recently
stated:
In cases involving publicly traded securities and purchases or
sales in public securities markets, the action’s basic elements
include:
 TEACHERS’ RETIREMENT SYSTEM v. HUNTER 11
F.3d 204, 208 (4th Cir. 1994). In dismissing the plaintiffs’ complaint,
the district court held the complaint to be wanting as to elements (1)
(misrepresentation or omission), (2) (scienter), and (4) (loss causa-
tion). Thus, with respect to elements (1) and (2), we will apply the
pleading standard created by the PSLRA, and with respect to element
(4) — that the misrepresentation caused the plaintiffs’ loss — we will
apply the general pleading standards of Rules 8 and 9, as applicable
to any fraud claim.

III

In dismissing the plaintiffs’ complaint, the district court concluded
first that the complaint failed to satisfy § 78u-4(b)(1)’s heightened
requirements for pleading misrepresentations or omissions. While it
found that the complaint adequately specified the allegedly mislead-
ing statements and the reasons why they were misleading, it con-
cluded that, with respect to every single statement, the complaint fell
short of alleging facts sufficient to support the plaintiffs’ information
and belief that the statements were misleading, as required by § 78u-
4(b)(1).

(1) a material misrepresentation (or omission);
(2) scienter, i.e., a wrongful state of mind;
(3) a connection with the purchase or sale of a security;
(4) reliance, often referred to in cases involving public secur-
ities markets (fraud-on-the-market cases) as "transaction
causation," see Basic [Inc. v. Levinson, 485 U.S. 224, 248-49
(1988)] (nonconclusively presuming that the price of a pub-
licly traded share reflects a material misrepresentation and
that plaintiffs have relied upon that misrepresentation as long
as they would not have bought the share in the absence);
(5) economic loss; and
(6) "loss causation," i.e., a causal connection between the
material misrepresentation and the loss.
Dura Pharm., Inc. v. Broudo, 544 U.S. 336, 341-42 (2005) (citations
omitted).
12 TEACHERS’ RETIREMENT SYSTEM v. HUNTER
Section 78u-4(b)(1) provides:

In any private action arising under this chapter in which the
plaintiff alleges that the defendant —

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

(B) omitted to state a material fact necessary in
order to make the statements made, in the light of
the circumstances in which they were made, not
misleading;

the complaint shall specify each statement alleged to have
been misleading, the reason or reasons why the statement is
misleading, and, if an allegation regarding the statement or
omission is made on information and belief, the complaint
shall state with particularity all facts on which that belief is
formed.

15 U.S.C. § 78u-4(b)(1) (emphasis added). Thus, plaintiffs must
allege: (1) each misleading statement; (2) the reasons each statement
was misleading; and (3) when an allegation regarding such a state-
ment is based on information and belief, "with particularity all facts
on which that belief is formed."

The "all facts" requirement is imposed for several reasons. First
and most obviously, it is included to determine the legal sufficiency
of the complaint under Rule 12(b)(6). Under Rule 12(b)(6), a com-
plaint is legally sufficient if it "state[s] a claim upon which relief can
be granted." As explained above, under the generally applicable
notice pleading rules, this standard requires the court to ask whether
any conceivable set of facts could be proved consistent with the com-
plaint’s allegations that would permit relief to be granted. See Swier-
kiewicz, 534 U.S. at 514. The PSLRA’s "all facts" standard, however,
changes the relevant set of facts for alleging misrepresentations and
omissions to those alleged in the complaint. Under the PSLRA, there-
fore, our inquiry becomes whether, if those facts alleged in the com-
plaint are true, relief could be granted on the plaintiffs’ claim. Stated
another way, we must ascertain whether the complaint states sufficient
 TEACHERS’ RETIREMENT SYSTEM v. HUNTER 13
facts to permit a reasonable person to find that the plaintiff satisfied
this element of his claim — that the defendant made a false or mis-
leading statement.

If the plaintiff fails to allege all facts but does allege sufficient facts
to support a reasonable belief in the allegation that the defendant’s
statement was misleading, the court should deny the Rule 12(b)(6)
motion as to this "misrepresentation" element. See, e.g., Novak v.
Kasaks, 216 F.3d 300, 313-14 (2d Cir. 2000); see also Makor Issues
& Rights, Ltd. v. Tellabs, Inc., 437 F.3d 588, 595 (7th Cir. 2006)
(endorsing Novak’s standard); California Pub. Employees’ Retirement
Sys. v. Chubb Corp., 394 F.3d 126, 146 (3d Cir. 2004) (same); Adams
v. Kinder-Morgan, Inc., 340 F.3d 1083, 1099 (10th Cir. 2003) (same).
This construction of § 78u-4(b)(1) logically follows from the inquiry
required by Rule 12(b)(6), which tests only the legal sufficiency of the
complaint.

In interpreting § 78u-4(b)(1)’s "all facts" standard in the context of
a Rule 12(b)(6) motion to require a pleading of "sufficient facts," we
do not read the "all facts" standard out of the statute. It remains rele-
vant to other aspects of the court’s supervision of securities fraud
class action litigation. For example, the court must be able to deter-
mine whether some discovery will be permitted, despite the general
bar against discovery pending motions to dismiss. See 15 U.S.C.
§ 78u-4(b)(3)(B). Having the assurance that all facts upon which the
plaintiffs’ belief is based could be relevant in making this decision.
The court might be similarly assisted in supervising the preservation
of evidence "relevant to the allegations" under § 78u-4(b)(3)(C). And
of course, at the conclusion of every lawsuit covered by the PSLRA,
the court must make specific findings as to the parties’ compliance
with Federal Rule of Civil Procedure 11(b) as it applies to "any com-
plaint, responsive pleading, or dispositive motion." See id. § 78u-
4(c)(2) (emphasis added).

Reading § 78u-4(b)(1) to require the pleading of all facts which
support a plaintiff’s belief on the sanction of dismissal authorized by
§ 78u-4(b)(3)(A) could theoretically lead to some harsh results in the
management of discovery and PSLRA litigation in general. See
Novak, 216 F.3d at 314 (discussing these possibilities). But since Rule
12(b)(6) focuses on whether the complaint states a claim upon which
14 TEACHERS’ RETIREMENT SYSTEM v. HUNTER
relief "can be granted," we need only determine in the circumstances
before us whether plaintiffs’ complaint alleges sufficient facts upon
which a reasonable belief can be formed that Cree’s representations
or omissions were misleading.

Determining whether the complaint satisfies this standard necessar-
ily entails a case-by-case assessment of the complaint as a whole. We
will consider the number and level of detail of the facts; the plausibil-
ity and coherence of the facts; whether sources of the facts are dis-
closed and the apparent reliability of those sources; and any other
criteria that inform how well the facts support the plaintiff’s allega-
tion that defendant’s statements or omissions were misleading. See
Adams, 340 F.3d at 1102-03; Chubb Corp., 394 F.3d at 147-55. When
the complaint chooses to rely on facts provided by confidential
sources, it must describe the sources "with sufficient particularity ‘to
support the probability that a person in the position occupied by the
source would possess the information alleged’ or in the alternative
provide other evidence to support their allegations." Tellabs, Inc., 437
F.3d at 596 (quoting Novak, 216 F.3d at 314).

The complaint at issue here adequately specifies the statements
alleged to have been misleading and the reasons why they were mis-
leading. Indeed, it identifies no less than 48 statements publicly made
over nearly four years regarding Cree’s transactions. But after each
misleading statement, the complaint simply repeats a formulaic set of
allegations why, upon "information and belief," the statement was
misleading. The facts alleged in support of these formulaic reasons
fail to support a reasonable belief that the statements were in fact mis-
leading, and therefore we conclude that the complaint fails to satisfy
the PSLRA and Rule 12(b)(6)’s requirement that the complaint shall
state with particularity sufficient facts on which a reasonable belief
can be formed. This becomes clear when we consider the facts sup-
porting the allegations about each transaction.

A. C&C Crystal Supply Agreement, R&D Agreement, and
Equipment Sale

In multiple public filings from 1997 to 2002, Cree disclosed two
agreements entered into with Charles & Colvard ("C&C"), a company
founded in 1995 by Eric Hunter and then managed by his brother, Jeff
 TEACHERS’ RETIREMENT SYSTEM v. HUNTER 15
Hunter. One agreement was a long-term supply agreement, dated June
6, 1997, in which C&C agreed to purchase half of its requirements for
silicon carbide crystals from Cree during each calendar quarter. Cree,
in turn, agreed to supply specific quantities and colors of crystals
exclusively to C&C. The agreement also provided that if C&C would
order more crystals than Cree had a capacity to produce, C&C would
have the right either to reduce the quantity of its order or to purchase
crystal-growing equipment from Cree. If C&C opted to purchase
equipment, Cree would construct the equipment on its premises to
produce the additional crystals for C&C, and C&C would become
obligated to purchase at least six months’ output from the new equip-
ment. After the equipment was fully depreciated, C&C would be
required to transfer title to the equipment to Cree.

Under the second agreement, entered into at the same time as the
crystal supply agreement, C&C agreed to pay Cree for research and
development of colorless silicon carbide crystals. As amended in
1998, this agreement required C&C to pay Cree for R&D efforts at
a level totaling $2.88 million annually for four years. In an amend-
ment in May 1999, however, the parties lowered the level of R&D to
$1.44 million annually.

For fiscal year 1999, Cree reported booking $11.4 million in reve-
nue from the agreements, and in fiscal year 2000, $16.2 million.
These sales were boosted by C&C’s exercise of its option to purchase
equipment in May 1999 for Cree’s production of more silicon carbide
crystals. As disclosed that month, this decision triggered C&C’s con-
tractual obligation to purchase the output of the new equipment over
the next two years. C&C’s payments during these years constituted
a substantial portion of Cree’s revenue for the relevant periods. For
instance, sales of silicon carbide crystal materials to C&C for the sec-
ond half of the calendar year 1999 represented 35% of Cree’s revenue
for the period.

In late 1999, C&C’s fortunes began to take a downward turn, and
C&C’s need for silicon carbide crystals thereafter steadily declined.
Cree disclosed in its January 3, 2000 SEC registration statement that
C&C’s sales were slow and inventory had grown, and Cree acknowl-
edged that "a substantial portion of [its] revenue has come from large
purchases by a small number of customers," of which C&C was one.
16 TEACHERS’ RETIREMENT SYSTEM v. HUNTER
Cree reported that it "anticipate[d] that sales to [C&C] will decrease
in calendar 2000" and that Cree "agreed that [C&C] could reschedule
approximately one-half of its purchase commitments from the first
half of calendar 2000 to the second half of the year." In April 2000,
Cree disclosed in its quarterly report that, due to C&C’s anemic sales
and high inventory, "We anticipate that overall sales to [C&C] will
decrease to less than 10 percent of our revenue for the fourth quarter
of fiscal 2000, and will continue to decline as a percentage of revenue
through the first half of 2001." Likewise, in February 2001, Cree’s
quarterly report stated, "We anticipate little or no revenue from the
gemstone business over the next several quarters as [C&C] balance[s]
their inventory levels. C&C sales made up approximately 5% of total
revenue during the second quarter of fiscal 2001." By May 2001, Cree
reported that it had made no sales to C&C in the third quarter of 2001
and expected "little to no revenue" from C&C in the several upcom-
ing quarters. Because C&C’s weakening sales hindered its ability to
pay for Cree’s crystals, Cree repurchased the crystal-growing equip-
ment that it had constructed and sold to C&C, financing the purchase
by giving C&C a $5 million credit against C&C’s future crystal pur-
chases. C&C disclosed this equipment sale in its own April 2000
quarterly report.

Plaintiffs’ complaint alleges that Cree’s disclosures were false or
misleading because Cree’s arrangement with C&C was a "channel-
stuffing" scheme, by which Cree "exerted actual control over C&C"
in their business dealings and caused "C&C to purchase SiC [silicon
carbide] materials in excess of its demand for such materials, know-
ing that such purchases were leading to excessive inventory buildup"
and which signaled "growth in recurring business that did not exist."
The complaint also alleges that Cree overstated its revenues by book-
ing "payments by C&C for SiC material which C&C had a right to
reject and return." The complaint alleges that Cree overstated its reve-
nues by "book[ing] payments from C&C for Cree’s R&D work as
revenue when Cree never conducted such R&D work." Finally, the
complaint alleges that Cree fraudulently "booked revenues from the
sale of equipment to C&C, and booked that transaction as a sale to
C&C followed by Cree’s repurchase of the equipment when no such
sale and repurchase had occurred."

The complaint, however, completely fails to include facts sufficient
to permit a reasonable belief that Cree exercised any control over
 TEACHERS’ RETIREMENT SYSTEM v. HUNTER 17
C&C and caused C&C to purchase unneeded crystals in a "channel
stuffing" scheme. Far from impeaching the truth of Cree’s public dis-
closures, the facts alleged in the complaint are consistent with the per-
formance of the publicly disclosed supply contract, which obligated
C&C to purchase certain outputs of crystals. The complaint alleges
testimony of a former Cree process engineer who observed Cree sell-
ing consistent quantities of silicon carbide crystals to C&C during
2000 — precisely what the publicly disclosed supply contract called
for. It also includes the statement of a confidential source, an undis-
closed former C&C director of technology, who stated that "C&C
spent money like ‘drunken sailors’ by regularly writing checks to
Cree for $200,000-$300,000." This, too, is indicative of C&C’s actual
payments to Cree pursuant to the contract. To the extent that the com-
plaint alleges that Cree somehow forced C&C to enter the supply con-
tract, the facts are even more wanting. The complaint’s only support
of this claim is that managing officers from the two companies were
related and met periodically to negotiate and supervise the agree-
ments. It is impossible to infer from this that the publicly disclosed
agreements were fraudulent.

To plead facts sufficient to permit a reasonable belief that Cree
improperly booked sales of silicon carbide crystals to C&C, the com-
plaint depends on the existence of a right of C&C to return the crys-
tals. The complaint works under the assumption that Cree would not
have been entitled to book the sales if C&C had purchased the crys-
tals on the condition that they could be rejected and returned. Even
if this assumption were correct, the complaint fails to provide facts
from which a reasonable person could conclude that C&C held any
such right of return. Moreover, the complaint fails to suggest that
Cree ever had to adjust its revenues due to any returns of crystals
from C&C. If such a right of return had existed and the purchases
were a sham, one would expect that C&C would have exercised the
right of return, requiring Cree to adjust its books. Yet, no such sce-
nario is even suggested in the complaint.

Instead, the complaint relies on two personal sources who alleged
that Cree concealed C&C’s right of return — Eric Hunter and an
unidentified former Cree process engineer. First, Eric Hunter’s state-
ment cannot reasonably be taken to support such an agreement
because his service as a Cree officer ended in 1994 — three years
18 TEACHERS’ RETIREMENT SYSTEM v. HUNTER
before the class period began — and the complaint provides no basis
for his assertions about the Cree-C&C agreements. While Eric Hunter
was under contract as a Cree employee during the class period, the
complaint states that Eric Hunter never actually performed work
under the contract. Nor does the bare fact that Eric Hunter is the
brother of Neal Hunter help because the complaint does not allege
that Neal Hunter ever communicated with Eric Hunter regarding
Cree’s operations. To the contrary, Eric Hunter’s personal complaint
filed against Cree in June 2003, which the plaintiffs incorporated in
their complaint, alleged that Neal Hunter and other Cree officials
harassed, threatened, intimidated, and defamed Eric Hunter and his
family. The complaint’s allegations based on Eric Hunter’s statement
do not, in short, support a reasonable belief that Cree afforded C&C
a secret right to return silicon carbide crystals.

The complaint’s second source alleging a secret right of return is
a "former Cree process engineer who worked as the lead engineer on
and manager of the C&C product line" from mid-2000 to mid-2001.
This source stated that in his last few months of his employment (i.e.,
early 2001), C&C began rejecting large quantities of crystals. He
claimed that "the rejected products were kept in C&C’s facilities to
create justification as to why Cree was not required to create a reserve
or take a charge for the purportedly rejected and nonconforming
goods." But these facts are not meaningful in light of the settled, pub-
licly disclosed history. By early 2001, Cree’s sales to C&C had
slowed to a trickle; Cree reported booking no revenue from sales to
C&C in January to March 2001 and expected "little to no revenue"
in the subsequent quarters. Thus, even if this source correctly recalls
C&C rejecting large shipments of silicon carbide crystals from Cree,
he is simply wrong regarding Cree’s revenue recognition methods.
Cree booked no sales to C&C during this time.

Finally, this leaves the complaint’s allegations that Cree improp-
erly booked revenue for R&D that it never performed and that Cree
improperly accounted for the crystal-growing equipment transaction.
Again, these allegations rest entirely upon Eric Hunter’s assertions.
As discussed above, the complaint advances insufficient facts to show
how Eric Hunter could have had any access to this information and
therefore fails to satisfy PSLRA’s stringent requirements for pleading
misleading statements or omissions.
 TEACHERS’ RETIREMENT SYSTEM v. HUNTER 19
B. Microvision Investment and R&D Agreement

In its 1999 annual report, Cree reported that in May 1999, it pur-
chased $4.5 million of the stock of Microvision, Inc., a Washington
corporation. At the same time, Microvision agreed to pay Cree $2.6
million for research and development on light-emitting diodes.

In its quarterly report of April 2000, Cree reported that on March
17, 2000, it purchased an additional 250,000 shares of Microvision,
when Microvision stock was trading at $63.75. The stock purchase
agreement contemplated a closing on April 13, 2000, and provided for
a revision of the purchase price to $50 per share if Microvision’s
share price dropped substantially by that date. Because Microvision’s
shares in fact traded at $36.88 at the closing date, Cree paid Microvi-
sion $50 per share ($12.5 million), in accordance with the agreement.
Microvision’s quarterly report of March 30, 2000, discloses that, at
that time, Microvision also entered into an identical stock purchase
agreement with General Electric.

In its April 2000 quarterly report, Cree also disclosed that Cree and
Microvision had amended their prior R&D contract, bringing its total
value to $12.6 million over two years. In its 2000 annual report, Cree
stated that it would apply this funding from Microvision to reduce
Cree’s R&D expenses over fiscal years 2000, 2001, and 2002.

Also in its 2000 annual report, Cree disclosed that in June 2000,
it sold 162,200 of its Microvision shares, realizing a $3.6 million
gain. Microvision’s shares, however, steadily declined in value there-
after, and Cree ultimately sold the remainder of the stock in Decem-
ber 2002 for $1.8 million.

Plaintiffs’ complaint alleges that Cree misrepresented what, in real-
ity, were meaningless "round-trip" transactions with Microvision,
entered into only for purposes of creating "sham" income. The com-
plaint alleges that Cree intentionally overpaid in making its $12.5 mil-
lion investment in Microvision, paying $50 per share when
Microvision’s shares traded at $36.88. The complaint alleges that
Cree made this overpayment in exchange for Microvision’s return of
the money in payments for "sham" R&D work, which neither com-
pany intended Cree to actually perform. The complaint further alleges
20 TEACHERS’ RETIREMENT SYSTEM v. HUNTER
that rather than using the payments for R&D to perform research ben-
eficial to Microvision, "Cree simply continued doing the very same
research it had been doing in the ordinary course of business." The
alleged goal of the Microvision deal was to reduce Cree’s R&D costs
and thereby overstate its net income.

A typical "round-tripping" scheme involves parties entering into
reciprocal contracts to exchange similar amounts of money for similar
services. See, e.g., In re Homestore.com, Inc. Sec. Litig., 252 F. Supp.
2d 1018, 1024-25 (C.D. Cal. 2003) (describing the bartering of like
services to artificially inflate revenues). Such transactions can be
improper because the parties book revenues even though the transac-
tions "wash out" without any economic substance. But the basis for
alleging "round-tripping" does not exist when either of the transac-
tions have economic substance because those transactions would not
wash out. The mere existence of reciprocal dealing does not suggest
"round-tripping." Indeed, it is a common, legitimate, and perhaps use-
ful business practice for one company to invest in the stock of a sec-
ond company with which it is entering into a major contract for
products or services.

The plaintiffs do not allege the usual "round-tripping" exchange of
like services. Instead, their theory is that Cree paid an extra amount
of money for Microvision’s stock beyond its market value, and that
Microvision returned that excess amount in the disguise of a payment
for R&D work that Cree did not actually perform. This allegation of
round-tripping is plausible, however, only if both transactions involve
this same excess amount of payment and otherwise lack economic
substance. If either transaction has economic substance, the transac-
tions cannot be a wash, and there would be no artificial inflation of
revenue. Thus, the complaint must allege facts sufficient to support
a reasonable belief that both legs of the round-tripping were a sham,
washing each other out. See Matsushita Elec. Indus. Co. v. Zenith
Radio Corp., 475 U.S. 574, 587 (1986) ("[I]f the claim is one that
simply makes no economic sense — [the plaintiff] must come for-
ward with more persuasive evidence to support their claim than would
otherwise be necessary").

The complaint fails adequately to allege facts supporting the con-
clusion that either leg of Cree’s "round-trip" transactions with
 TEACHERS’ RETIREMENT SYSTEM v. HUNTER 21
Microvision lacked economic substance. As to Cree’s intentional
overpayment, plaintiffs rely solely on the fact that Cree paid $50.00
per share when Microvision’s shares were trading at $36.88 on the
deal’s closing date. The public filings about this transaction show,
however, that Cree’s agreement to invest in Microvision was signed
when Microvision’s shares were trading at $63.75. Moreover, the
agreement provided a neutral formula that established a purchase
price of $50.00 if Microvision’s share price dropped substantially by
the closing date. Because Microvision’s share price in fact dropped,
the agreement operated to fix the price at $50.00 per share. It is note-
worthy that Microvision’s quarterly report of March 30, 2000, shows
that Microvision also entered into an identical stock-sale agreement
with General Electric. These facts do not support a reasonable belief
that Cree intentionally overpaid for its investment in Microvision.

As for the second leg of this alleged "round-trip" — that Cree pro-
vided no R&D for Microvision’s payments — the complaint relies on
statements from two confidential sources besides Eric Hunter. An
unnamed former Microvision project manager who purportedly had
"personal knowledge of the contract between Cree and Microvision"
stated that the R&D contract "made no mention of the development
of improvements in blue and green laser devices for mobile handsets"
and that "the contract did not contain any milestones or deadlines for
the development of any products." But the actual contract belies these
statements, providing that "Cree will undertake . . . the development
of blue and green LEDs and LDs useful in scanned beam display sys-
tems." Additionally, the contract lays out specific program goals and
deadlines. Given this source’s evident lack of familiarity with the
R&D contract, the facts he stated cannot support the complaint’s
assertion that Cree performed no R&D work.

Plaintiffs’ second basis for impugning the R&D contract was state-
ments from a confidential former Microvision R&D director, who
stated that his position gave him knowledge of Microvision’s "inter-
nal and external research projects." But the complaint also states that
Microvision and Cree officials denied that director access to informa-
tion about the R&D agreement. Thus, this source’s only firsthand tes-
timony is that he did not know whether Cree performed R&D work.
Yet, plaintiffs argue that these allegations support the belief that Cree
22 TEACHERS’ RETIREMENT SYSTEM v. HUNTER
in fact performed no other R&D work for Microvision. Fraud is not
a reasonable inference to be drawn from the statements of this source.

C. UltraRF Acquisition and Spectrian R&D Agreement

The complaint also alleged a "round-tripping" arrangement with
Spectrian. In a January 2001 SEC filing, Cree disclosed that in
December 2000, it had acquired UltraRF, a division of Spectrian
located in Sunnyvale, California, for $100 million. UltraRF was
engaged in the design and manufacturing of transistors and laterally
diffused metal oxide semiconductors ("LDMOS"). At the same time,
Cree also announced that Spectrian agreed to pay Cree $2.4 million
for the further development of LDMOS devices for Spectrian and to
purchase from Cree $58 million of UltraRF/Cree products over a
period of two years. In March 2001, Cree amended its January filing,
reporting that it had allocated $81.6 million of its purchase price for
UltraRF to goodwill.

As it turned out, UltraRF/Cree reported better-than-expected reve-
nues in fiscal 2001 of $19.2 million, of which about 90% came from
its sales to Spectrian. Cree’s May 2001 quarterly report spoke of
UltraRF with cautious optimism: "In the long term, UltraRF’s success
will depend on the rate at which we diversify our Spectrian-
concentrated business. . . . We believe that LDMOS product line will
enable growth of our products to customers other than Spectrian."
During the first quarter of fiscal 2002, Cree announced that the high
level of sales from its UltraRF operations continued, reporting another
$9.6 million in revenue.

Cree, however, began to have trouble developing a newer LDMOS
device, dubbed "LDMOS-8," which Spectrian required. In its Febru-
ary 2002 quarterly report, Cree announced that the companies had
modified the supply agreement in October 2001 to push back Spectri-
an’s purchases to the two subsequent quarters and give Spectrian a
$2.1 million credit if UltraRF/Cree did not meet specified develop-
ment goals. In a March 12, 2002 press release, Cree announced that
it expected to complete the LDMOS-8 development and to deliver it
during the fourth quarter of fiscal 2002. But it also stated that the
delays prompted Cree to consider writing down UltraRF’s goodwill
in a one-time charge of $60 to $77 million. Cree’s May 2002 quar-
 TEACHERS’ RETIREMENT SYSTEM v. HUNTER 23
terly report disclosed that the companies again modified the supply
agreement to extend it by six months and reduce Spectrian’s total pur-
chase commitment to $54.8 million, subject to further reduction if
Cree did not complete the development of the LDMOS-8 technology.
The quarterly report also disclosed that Cree wrote down the entirety
of UltraRF’s goodwill in March 2002, having determined that its
value was fully impaired.

During the course of a July 30, 2002 conference call, the defen-
dants Merrell and Swoboda stated that Cree had achieved important
development milestones in the LDMOS devices and expected testing
to be completed by September 2002. But Cree’s annual statement,
filed August 19, 2002, was less optimistic and simply stated, "If we
are unable to complete the full product qualification process and ramp
up production of our recently released LDMOS-8 products ade-
quately, Spectrian may reduce the amount it purchases during the
applicable quarter under the agreement."

The next quarterly report dated October 29, 2002, disclosed that
UltraRF/Cree’s sales to Spectrian in that quarter totaled only
$190,000. It also disclosed that the amended supply agreement "per-
mits Spectrian to significantly reduce its purchase obligations if we
were not able to complete our qualification of our LDMOS-8 products
prior to the end of the first quarter of fiscal 2003 and for each subse-
quent month until those parts are qualified."

Finally, in Cree’s January 31, 2003 quarterly report, Cree disclosed
that the LDMOS-8 development delays caused Spectrian to cancel the
supply agreement with a final $5 million payment in late 2002, as the
agreement allowed.

Plaintiffs’ complaint alleges that the truth of the matter was that
Cree engaged in "round-tripping" with Spectrian and that Cree "inten-
tionally overpaid for UltraRF with the understanding that the over-
payment would be returned to Cree as revenues under the Supply
Agreement." The complaint further alleges that Cree’s disclosures
were misleading because they failed to disclose that "prior to the
acquisition, Cree knew it did not have the ability to perform the R&D
contemplated in Cree’s agreements" and that "Cree never performed
the R&D work required under its agreements with Spectrian."
24 TEACHERS’ RETIREMENT SYSTEM v. HUNTER
The fact that Cree ultimately had to write down the value of
UltraRF’s goodwill or was unable to develop the LDMOS-8 technol-
ogy in a timely fashion does not mean that Cree fraudulently overpaid
for UltraRF or neglected to conduct LDMOS-8 research and develop-
ment. These facts are just as consistent with Cree having taken a risk
in the hope of securing profits, and it is well known that the risks are
great in high-technology industries, such as Cree’s. A failed venture,
standing alone, does not permit a reasonable inference of fraud.

The complaint’s primary basis for this allegation is the fact that the
purchase price exceeded UltraRF’s book value by about five times,
forcing Cree to allocate approximately $81.6 million of the acquisi-
tion price to goodwill. While this fact, standing alone, might signal
that Cree made an investment that carried great risk, and indeed
potential for reward, it does not suggest an excessive price, much less
a fraudulent price. A "fair" acquisition price depends on a wide vari-
ety of factors, including market value, dividends, earning prospects,
the nature of the enterprise, and "any other facts . . . which throw any
light on future prospects." See Viacom Int’l, Inc. v. Icahn, 946 F.2d
998, 1000-01 (2d Cir. 1991).

Most telling is the fact that the complaint is devoid of particular
facts that speak to a fraudulent valuation of UltraRF at the time it was
acquired. It relies on conclusory and hardly probative statements by
four confidential sources besides Eric Hunter. For example, a Cree
technician asserted that "it was well-known within Cree that they had
overpaid for a company with dim prospects," but the complaint does
not tie this "well-known" sentiment to any particular date or persons.
In hindsight, Cree employees likely regretted the UltraRF acquisition,
but this does not mean Cree knew ex ante that the investment would
sour. Also, a former employee in Cree’s IT department asserted that
Cree was "‘very aggressive’ in cutting deals for Cree" and "would
‘move the line’ when necessary." This vague statement also provides
no particularized fact that supports the belief that Cree intentionally
overpaid for UltraRF. A former assistant to the president of Spectri-
an’s UltraRF division asserted that UltraRF had no "saleable" prod-
ucts and that "the division would be worth its total value in facilities
and infrastructure or between $5 million and $10 million." The com-
plaint does not say, however, how this person would know this infor-
mation or would have expertise in valuing a business. Moreover, his
 TEACHERS’ RETIREMENT SYSTEM v. HUNTER 25
assessment appears to be contradicted in the complaint by the fact that
UltraRF, after being acquired by Cree, did sell approximately $30
million of products to Spectrian. Whether Spectrian found the prod-
ucts useful is immaterial; for Cree’s purposes, these were bona fide
sales because "real products were shipped to [a] real customer[ ] who
then paid with real money." In re Bristol-Myers Squibb Sec. Litig.,
312 F. Supp. 2d 549, 566 (S.D.N.Y. 2004).

The complaint also fails to support the allegations of the second leg
of the alleged round-trip with Spectrian — the "sham" product sales
and R&D agreement. The complaint’s basic problem is that the facts
it alleges do not contradict Cree’s public disclosures. Cree and Spec-
trian disclosed that Spectrian committed to purchase certain levels of
UltraRF products, which is precisely what happened. The complaint
assigns a sinister motive to the deal, in light of UltraRF’s ultimate
failure, but, as we noted above, there are no facts to support this claim
or belief. To be sure, reciprocal contracts without more are not per se
fraudulent.

In an attempt to cure their deficient pleading, plaintiffs’ complaint
alleges that Cree concealed what it knew upon entering the agree-
ments with Spectrian in December 2000 — that UltraRF/Cree would
be able neither to develop the LDMOS technology nor to attempt to
develop it. The complaint proffers just one confidential source to sup-
port this allegation, a Spectrian vice president of operations who
stated baldly, "Cree never performed any real R&D for Spectrian,"
and who called Cree’s R&D work "smoke and mirrors." The com-
plaint does not allege facts to support how this source would know
that UltraRF/Cree performed no "real" R&D work for Spectrian.
Moreover, even this source’s observations, if they were in fact obser-
vations, do not support the conclusory allegation that Cree knew,
when it entered into the R&D agreement, that it could not perform it.

In short, the complaint fails to plead with particularity facts that
Cree made any misleading disclosures with respect to the Spectrian
transactions.

D. WTI, Xemod, and Lighthouse Investments and R&D
Agreements

Plaintiffs’ complaint also alleges, in far less detail, that Cree
entered into undisclosed "round-tripping" arrangements with three
26 TEACHERS’ RETIREMENT SYSTEM v. HUNTER
other technology firms — World Theatre, Inc. ("WTI"), Xemod, Inc.,
and Lighthouse, Inc. The pattern alleged was that Cree overpaid for
investments in those firms in exchange for the firm’s promises to pay
Cree for R&D services with the knowledge that Cree would not actu-
ally perform the services.

With respect to the WTI arrangement, Cree filed a preliminary
proxy on SEC Form PRE 14A in September 2000, which disclosed
that in April 2000, Cree had invested $5 million in WTI. In the defini-
tive proxy statement filed three weeks later, Cree disclosed that in late
2000, WTI entered into a four-year development agreement with Cree
and that WTI had exercised its option to terminate that agreement in
March 2001. In Cree’s 2003 annual statement, filed in September
2003, Cree disclosed that it had taken several write-downs of its WTI
investment, recognizing its value to be impaired. These write-downs
occurred in the fourth quarter of fiscal 2001 in the amount of
$750,000, in the second quarter of fiscal 2002 in the amount of $2.1
million, and in the fourth quarter of fiscal 2002 in the amount of $2.1
million.

Plaintiffs’ complaint alleges that Cree knowingly overpaid for its
investment in WTI and hid this fact by failing to disclose the write-
downs until September 2003, over a year later. The complaint does
not, however, make any allegations regarding the legitimacy of the
development agreement that existed briefly between the companies.

With respect to Xemod, Cree announced in a press release on Sep-
tember 20, 2000, that it had invested $11.3 million in Xemod, a
privately-held developer and maker of amplifier components for wire-
less communications. At some point, Cree also invested in an affiliate
of Lighthouse, Inc., though the record contains no specific disclosure
by Cree of the Lighthouse investment. Cree’s 2003 annual statement,
however, filed in September 2003, disclosed a series of write-downs
that Cree took on its investments in Xemod and Lighthouse. In the
fourth quarter of 2001, Cree took a write-down of $2.4 million on
Xemod and $1.4 million on Lighthouse; in the second quarter of fiscal
2002, Cree took an $8.4 million write-down on Xemod and $1.8 mil-
lion on Lighthouse; and in the fourth quarter of 2002, it took a $3.4
million write-down on Lighthouse. Cree’s 2003 annual statement fur-
ther disclosed that Cree had completed R&D agreements with Xemod
 TEACHERS’ RETIREMENT SYSTEM v. HUNTER 27
and Lighthouse in the recent past. Under these agreements, the two
companies paid Cree $500,000 in 2001, $3.5 million in 2002, and
$5.2 million in 2003.

Plaintiffs’ complaint alleges that Cree intentionally overpaid for its
investments in Xemod and Lighthouse in exchange for those compa-
nies returning the funds to Cree for "sham" R&D work. The com-
plaint also alleges misrepresentations in that Cree did not disclose the
existence of the investments or the development agreements until
September 2003, even though some were executed as early as 2000.
The record shows, however, that Cree did in fact disclose the write-
downs on investments and developments with WTI, Xemod, and
Lighthouse before 2003. Cree’s annual reports in 2001 and 2002
described its write-downs on privately-held investments and R&D
revenues in the aggregate. Cree’s 2001 annual report disclosed that it
took a $4.6 million write-down in the fourth quarter of fiscal 2001 "to
establish a reserve for investments made in private companies that
was considered to be other than temporary impairment to value."
Cree’s 2002 annual report discloses that it recorded a $20.4 million
write-down on its privately held investments due to their impaired
value. Cree explains that these disclosures related to the transactions
about which the plaintiffs complain in their complaint.

The complaint alleges no documentary or personal source to sup-
port the allegation that Cree intentionally overpaid for these invest-
ments or failed to perform R&D pursuant to the agreements. It simply
engages in pleading fraud by hindsight, noting that Cree had to write
down these investments in fiscal years 2000, 2001, and 2002, and that
Cree did not report these write-downs until it filed its 2003 annual
report. Previous public filings of Cree, however, did report the write-
downs, albeit in the aggregate, without breaking down which invest-
ments were overvalued and by what amounts. Even if Cree’s choice
of reporting method was improper accounting, which the complaint
does not specifically allege, this method of reporting is not probative
of plaintiffs’ allegation of "round-tripping."

In sum, we affirm the district court’s dismissal of the complaint on
the ground that it fails to state with sufficient particularity facts
needed to support the allegations that Cree made misleading state-
ments.
28 TEACHERS’ RETIREMENT SYSTEM v. HUNTER
IV

For the second element of a securities fraud claim under § 10b of
the Exchange Act and Rule 10b-5 thereunder, a plaintiff must allege
that the defendant made the misleading statement or omission inten-
tionally or with "severe recklessness" regarding the danger of deceiv-
ing the plaintiff. Ottmann v. Hanger Orthopedic Group, Inc., 353
F.3d 338, 343-44 (4th Cir. 2003). A showing of mere negligence will
not suffice. Id.

The PSLRA significantly strengthens the requirement for pleading
this scienter. Whereas Federal Rule of Civil Procedure 9(b) allowed
a person’s state of mind to "be averred generally," the PSLRA pro-
vides:

In any private action arising under this chapter in which the
plaintiff may recover money damages only on proof that the
defendant acted with a particular state of mind, the com-
plaint shall, with respect to each act or omission alleged to
violate this chapter, state with particularity facts giving rise
to a strong inference that the defendant acted with the
required state of mind.

15 U.S.C. § 78u-4(b)(2). Thus, to allege a securities fraud claim
against individual defendants, a plaintiff must allege facts that support
a "strong inference" that each defendant acted with at least reckless-
ness in making the false statement. See Tellabs, Inc., 437 F.3d at 602-
03; Southland Sec. Corp. v. INSpire Ins. Solutions, Inc., 365 F.3d 353,
363-67 (5th Cir. 2004). And if the defendant is a corporation, the
plaintiff must allege facts that support a strong inference of scienter
with respect to at least one authorized agent of the corporation, since
corporate liability derives from the actions of its agents. See Tellabs,
Inc., 437 F.3d at 602-03; Southland Sec. Corp., 365 F.3d at 363-67.

The district court held that if the plaintiffs’ allegations were true,
the complaint may have sufficiently alleged scienter through a series
of attenuated inferences based on the positions that individuals held
in Cree. But it concluded that any more probing scienter inquiry was
rendered moot by its conclusion that the complaint failed to plead that
the defendants made any misleading statement or omission. Because
 TEACHERS’ RETIREMENT SYSTEM v. HUNTER 29
no misleading statement or omission was sufficiently alleged, the
defendants could not have made misrepresentations or omissions
intentionally or with sufficient recklessness.

We agree with this conclusion. While the complaint does allege
facts that demonstrate that at least defendants Neal Hunter, Merrell,
and Swoboda had fairly intimate knowledge of the various relevant
transactions, any inferences that could be drawn from the facts are
immaterial because the statements or omissions about those transac-
tions were not misleading.

In addition, other facts stated in the complaint are too circumstan-
tial to give rise to a "strong inference" that the defendants acted with
scienter. The complaint suggests that the defendants artificially
inflated Cree’s share price in order to profit from personal sales of
Cree stock. But insider trading can imply scienter only if the timing
and amount of a defendant’s trading were "unusual or suspicious."
See, e.g., In re PEC Solutions, Inc. Sec. Litig., 418 F.3d at 390; Ron-
coni v. Larkin, 253 F.3d 423, 435 (9th Cir. 2001). The complaint falls
far short of showing that the trades were made at a time consistent
with knowing or reckless fraud. The complaint does not allege that
defendants timed their sales to profit from any particular disclosures,
and defendants’ sales generally occurred at prices that were not espe-
cially high for the class period. See Ronconi, 253 F.3d at 435 (finding
defendants’ sales did not suggest "knowing falsehood" when sales
were made at prices well below the stock’s high point). Thus, for
example, while Cree’s shares reached a high of $198 per share during
the class period, over 75% of Neal Hunter’s trades within the class
period occurred when Cree’s shares traded below $30 per share.
Additionally, the complaint does not provide defendants’ trading pat-
terns outside the class period to permit comparison with their trades
within the class period. See id. at 436 (faulting plaintiff for stating
defendants’ trading history for only seven months before class
period).

The complaint does emphasize the number of shares that the defen-
dants traded within the class period in relation to their total holdings
of Cree stock. Specifically, the complaint alleges that Neal Hunter,
Merrell, and Swoboda sold 92%, 100%, and 82%, respectively, of
their Cree stock during the class period. But this allegation is unre-
30 TEACHERS’ RETIREMENT SYSTEM v. HUNTER
markable without taking into account the defendants’ vested stock
options. Cree argues, for example, that because Merrell held some
369,200 vested stock options at the end of the class period, her trading
within the class period would have to appear much less significant.
In any event, the complaint does not provide the facts sufficient to
generate the required "strong inference."

In addition, plaintiffs’ allegations about trading relate to an exceed-
ingly long putative class period. The allegedly fraudulent scheme
lasted some 46 months (from August 12, 1999, to June 12, 2003). By
way of comparison, the Ninth Circuit has considered a class period
of just 15 months "unusually long." See In re The Vantive Corp. Sec.
Litig., 283 F.3d 1079, 1092-93 (9th Cir. 2002). Alleging such a
lengthy class period weakens any inference of scienter that could be
drawn from the timing of defendants’ trades. Indeed, the lengthy
period strengthens a competing inference that the plaintiffs filed their
complaint simply to embark on a fishing expedition with the hope of
catching a valid claim.

V

Finally, the district court relied on plaintiffs’ failure adequately to
allege loss causation, the fourth element of a securities fraud claim
under § 10b and Rule 10b-5. As we have held, a plaintiff must allege
and prove that the defendant’s misrepresentations proximately caused
the plaintiff’s economic loss — in this case, the diminution of the
value of their shares. See Hillson, 42 F.3d at 208.

Loss causation is not one of the elements with respect to which the
PSLRA imposes a more stringent pleading requirement. But the Act
does explicitly state that a plaintiff must prove loss causation in that
the defendants’ material misrepresentations or omissions caused the
drop in the stock’s value. As the PSLRA provides:

In any private action arising under this chapter, the plaintiff
shall have the burden of proving that the act or omission of
the defendant alleged to violate this chapter caused the loss
for which the plaintiff seeks to recover damages.
 TEACHERS’ RETIREMENT SYSTEM v. HUNTER 31
15 U.S.C. § 78u-4(b)(4). Because the PSLRA explicitly requires that
the plaintiff prove loss causation, the general rules of pleading require
that the plaintiff also plead it in his complaint. See Dura Pharm., Inc.
v. Broudo, 544 U.S. 336, 346 (2005) ("our holding about plaintiffs’
need to prove proximate causation in economic loss leads us also to
conclude that the plaintiffs’ complaint here failed adequately to allege
these requirements").

Neither the PSLRA nor the Supreme Court has established whether
loss causation is a sufficient part of an "averment of fraud" to fall
within the requirements of Federal Rule of Civil Procedure 9(b). A
strong case can be made that because loss causation is among the "cir-
cumstances constituting fraud for which Rule 9(b) demands particu-
larity, loss causation should be pleaded with particularity." See Dura
Pharm., 544 U.S. at 343-44 (comparing § 78u-4(b)(4) to a common
law action for deceit which requires that a plaintiff "show not only
that he had known the truth he would not have acted but also that he
suffered actual economic loss"); Miller v. Asensio & Co., Inc., 364
F.3d 223, 231-32 (4th Cir. 2004) (explaining loss causation to require
a showing that "defendant’s misrepresentation was a substantial cause
of the loss by showing ‘a direct or proximate relationship between the
loss and the misrepresentation.’" (quoting Gasner v. Bd. of Supervi-
sors, 103 F.3d 351, 360 (4th Cir. 1996))). Moreover, the Supreme
Court has not ruled out a holding that Rule 9(b) governs a pleading
of loss causation. See Dura Pharm., 544 U.S. at 346.

Even in the absence of an explicit holding, the Dura Pharmaceuti-
cals Court concluded that a plaintiff does not state a claim upon
which relief can be granted — even under the relaxed pleading
requirements of Rule 8(a) — by simply alleging that the plaintiff pur-
chased defendant’s stock at an "artificially inflated purchase price"
and thereby sustained damages. Id. at 347. The Court required some-
thing more, stating:

We concede that ordinary pleading rules are not meant to
impose a great burden upon a plaintiff. But it should not
prove burdensome for a plaintiff who has suffered an eco-
nomic loss to provide a defendant with some indication of
the loss and the causal connection that the plaintiff has in
mind. At the same time, allowing a plaintiff to forgo giving
32 TEACHERS’ RETIREMENT SYSTEM v. HUNTER
any indication of the economic loss and proximate cause
that the plaintiff has in mind would bring about the harm of
the very sort that the [PSLRA] seek[s] to avoid.

Id. at 347 (citations omitted). A failure to recognize that loss causa-
tion be specifically alleged and demonstrated by the allegations of the
complaint would

permit a plaintiff with a largely groundless claim to simply
take up the time of a number of other people, with the right
to do so representing an in terrorem increment of the settle-
ment value, rather than a reasonably founded hope that the
discovery process will reveal relevant evidence. Such a rule
would tend to transform a private securities action into a
partial downside insurance policy.

Id. at 347-48 (internal quotation marks and citations omitted).

Accordingly, we conclude that a plaintiff purporting to allege a
securities fraud claim must not only prove loss causation — that the
material misrepresentations or omissions alleged actually caused the
loss for which the plaintiff seeks damages — but he must also plead
it with sufficient specificity to enable the court to evaluate whether
the necessary causal link exists. See Lentell v. Merrill Lynch & Co.,
396 F.3d 161, 172 (2d Cir. 2005).

The complaint in this case outlines a theory of loss causation, iden-
tifying the plaintiffs’ loss as the $4.11 drop in the price of Cree’s
stock that followed publicity of Eric Hunter’s lawsuit against Cree in
June 2003. According to plaintiffs, Hunter’s complaint finally
revealed the "true facts" of Cree’s fraudulent schemes over the years,
causing the market to reduce its valuation of Cree’s shares. But this
theory must fail for various reasons. First, Eric Hunter’s 2003 com-
plaint contained no allegations relating to the "round-trip" transac-
tions with Microvision, Spectrian, WTI, Xemod, or Lighthouse, about
which he now complains. Because Hunter’s 2003 complaint did not
reveal the "true facts" of these transactions, the 2003 revelations could
not have caused the plaintiffs’ loss. While plaintiffs respond that "the
market would have construed Hunter’s allegations [in his 2003 com-
plaint] broadly since Cree had previously denied it engaged in round
 TEACHERS’ RETIREMENT SYSTEM v. HUNTER 33
tripping," the problem remains that Hunter’s 2003 complaint is
devoid even of general allegations of round-tripping. We thus agree
with the district court’s dismissal for lack of pleading loss causation
with respect to Cree’s dealings with Microvision, Spectrian, WTI,
Xemod, and Lighthouse.

Second, with respect to Cree’s dealings with C&C, plaintiffs’ the-
ory of loss causation suffers from a different but no less fatal flaw.
Eric Hunter’s 2003 complaint did contain allegations relating to C&C,
accusing Cree and Neal Hunter of:

(d) Entering into an undisclosed and long-term requirements
contract with Jeff Hunter, Chairman of [C&C] Corporation
. . . which required [C&C] to accept shipments of silicon
carbide crystals . . . far in excess of market demand, in order
to artificially increase the operating and income of Cree by
approximately forty percent or more, and artificially
increased the per share value of Cree stock.

(e) Misleading investors and the [SEC] by purchasing in
excess of $4.0 million worth of equipment from [C&C] in
which Cree already held a beneficial interest, with the
understanding that [C&C]’s Chairman would restrict use
and allocation of the proceeds to payments under the long-
term requirements contract, thereby disguising [C&C]’s
severe cashflow deficit and forced inventory surplus of sili-
con carbide crystals.

The problem with plaintiffs’ theory on the C&C transactions is that
these facts had already been disclosed in public filings, so their reve-
lation in Hunter’s 2003 complaint could not have caused Cree’s stock
price to decline. Cree’s May 1999 quarterly filing with the SEC
included a copy of its supply contract with C&C, which obligated
C&C to purchase set amounts of silicon carbide crystals. Likewise,
C&C’s April 2000 quarterly report and Cree’s 2000 annual report dis-
closed that Cree agreed to repurchase crystal-growing equipment for
$5 million and apply that amount as a credit to C&C for future crystal
purchases. Disclosure of these facts by Eric Hunter in his 2003 com-
plaint could not therefore have caused Cree’s stock price to decline.
As the district court explained, "Eric Hunter’s complaint discloses
34 TEACHERS’ RETIREMENT SYSTEM v. HUNTER
nothing new, but merely attributes an improper purpose to the previ-
ously disclosed facts."

To allege loss causation in this case, plaintiffs would have to allege
that the market reacted to new facts disclosed in June 2003 that
revealed Cree’s previous representations to have been fraudulent.3
Because no such facts were disclosed, the drop in Cree’s share price
on June 13, 2003, more logically occurred because the market feared
that a lawsuit launched by a founder and former CEO of the corpora-
tion portended a period of instability and discord that could disrupt
the corporation’s operations. That loss, however, is not one for which
the plaintiffs in this case are entitled to compensation.

The plaintiffs argue in the alternative that they should at least be
granted leave to amend their complaint in light of the Supreme
Court’s decision in Dura Pharmaceuticals, 544 U.S. 336 (2005). The
Supreme Court decided Dura Pharmaceuticals in April 2005, after
plaintiffs had filed their complaint and before the district court
granted Cree’s motion to dismiss. As noted above, however, we do
not understand Dura Pharmaceuticals to have changed the standard
for pleading loss causation. Even before Congress enacted PSLRA,
plaintiffs were required to allege that the defendant’s misrepresenta-
tion caused him actual loss. See Harnett v. Billman, 800 F.2d 1308,
1315-16 (4th Cir. 1986). And our discussion in Miller v. Asensio &
Co., 364 F.3d at 232-33, decided months before plaintiffs filed their
complaint, aligns well with the Supreme Court’s decision in Dura
Pharmaceuticals, requiring a plaintiff to show a causal link between
the defendant’s misrepresentation and the decline in the stock value.
3
We acknowledge the possibility that a plaintiff could successfully
allege loss causation by pleading that a previously concealed risk materi-
alized, causing the plaintiff’s loss. In such a case, the plaintiffs would not
need to identify a public disclosure that corrected the previous, mislead-
ing disclosure because the news of the materialized risk would itself be
the revelation of fraud that caused plaintiffs’ loss. See, e.g., In re Par-
malat Sec. Litig., 375 F. Supp. 2d 278, 305-07 (S.D.N.Y. 2005) (accept-
ing plaintiffs’ allegations of loss causation where news that Parmalat
could not service its debt revealed that previous disclosures concealed
the company’s true position and caused the share price to tumble). But
the plaintiffs have not alleged that any previously concealed risk materi-
alized in June 2003, causing their loss.
 TEACHERS’ RETIREMENT SYSTEM v. HUNTER 35
We can find no basis for concluding that Dura Pharmaceuticals
provides plaintiffs with a cure for the deficient allegations of loss cau-
sation in their complaint. The information that Eric Hunter’s com-
plaint revealed to the world on June 12, 2003, were historical facts
that plaintiffs could not change. The plaintiffs have, therefore, demon-
strated no reason why we should permit them leave to amend their
complaint.

For all of these reasons, we affirm the district court’s order dis-
missing plaintiffs’ claim under § 10(b) of the Exchange Act and Rule
10b-5 for failure to state a claim for which relief can be granted.

VI

The district court dismissed plaintiffs’ four other causes of action
as essentially dependent upon plaintiffs’ success in alleging a claim
under § 10(b) of the Exchange Act and Rule 10b-5. Count II alleges
a claim under § 20(a) of the Exchange Act, which imposes liability
on each person who "controls any person liable under any provision
of this chapter." 15 U.S.C. § 78t(a). Count III is based on § 20A of
the Exchange Act, which provides a private right of action against one
who engaged in insider trading. Id. § 78t-1(a). Count IV brings a
claim under § 18 of the Exchange Act which holds a person, who
makes a misleading statement in an SEC filing, liable to one who det-
rimentally relied on that misstatement. Id. § 78r(a). Each of these
counts requires a predicate allegation of a violation of law. Because,
as we explained above, the complaint fails to allege that Cree made
any misleading statement or omission in violation of § 10(b) and Rule
10b-5, we affirm the district court’s dismissal of these claims.

Plaintiffs’ final claim arises under § 304 of the Sarbanes-Oxley
Act, which mandates that corporate officers forfeit bonuses and prof-
its if the corporation is "required to prepare an accounting restate-
ment" due to the issuer’s "misconduct." 15 U.S.C. § 7243. While Cree
has not, to date, issued any accounting restatement that could provide
a basis for this claim, plaintiffs argue that § 304 is not dependent upon
a restatement having actually been issued, but upon one being "re-
quired." They note that the complaint alleges numerous GAAP viola-
tions which "require" Cree to issue restatements.
36 TEACHERS’ RETIREMENT SYSTEM v. HUNTER
Even if this were the case, for the reasons we rejected the com-
plaint’s § 10(b) and Rule 10b-5 claim, we conclude that the complaint
does not adequately allege that any restatement is required.

In addition, plaintiffs have not presented a convincing analysis that
§ 304 provides private litigants with a cause of action, although we
do not now reach that issue. See Ormet Corp. v. Ohio Power Co., 98
F.3d 799, 805 (4th Cir. 1996) (noting this court’s "presumption that
if a statute does not expressly create a private cause of action, one
does not exist").

VII

Because we uphold the district court’s dismissal of plaintiffs’ com-
plaint in its entirety, we have no cause to pass upon Cree’s argument
that plaintiffs’ claim is barred by the applicable statute of limitations.

VIII

This case boils down to the continuing fallout from an intra-
Hunter-family dispute. In June 2003, Eric Hunter, a former officer of
Cree, sued his brother Neal Hunter, an officer of Cree, purportedly
over dissatisfaction in the way Cree was being operated. With Eric
Hunter’s filing of that action, the price of Cree shares dropped over
$4 per share. For this temporary drop in the price of Cree’s stock, the
plaintiffs in this case filed their complaint, attributing the drop to the
way Cree was run during the four years prior to June 2003. While
plaintiffs point to some reciprocal business dealings and high risk
investments with six different companies during that period, the trans-
actions were disclosed in public filings over the years, and the plain-
tiffs have not been able to point to facts supporting a reasonable belief
that the disclosures were misleading.

The district court properly dismissed this case as one of the type
that Congress sought to eliminate by enacting the PSLRA. The
PSLRA’s requirements that were applied in this case are not technical
pleading rules by which unwary plaintiffs can be trapped; they go to
the heart of separating claims based simply on market risks from
claims based on actual fraud. The district court correctly concluded
that this case fell into the former class of claims.
 TEACHERS’ RETIREMENT SYSTEM v. HUNTER 37
As an epilogue, it appears that the market reached the same conclu-
sion regarding plaintiffs’ allegations. The record shows that although
Cree’s share price dropped from $22.21 to $18.10 the day after Eric
Hunter filed his complaint on June 12, 2003, and then dropped to a
low of $11.84 in August 2003, the price recovered quickly, trading
above $18.00 by the end of 2003, and at $22.00 or higher for most
of 2004.

We affirm the judgment of the district court.

AFFIRMED

SHEDD, Circuit Judge, dissenting:

The district court dismissed the 170-page First Amended Consoli-
dated Class Action Complaint ("Complaint") of Teachers’ Retirement
System of Louisiana ("TRSL"), which named as defendants Cree, Inc.
and several of its managers (collectively, "Cree") in a complicated
securities fraud action, holding that the Complaint failed to plead
facts sufficient to support a cause of action under § 10(b) of the
Securities Exchange Act of 1934 and Rule 10b-5. In reaching its con-
clusion, the district court interpreted and applied the Private Securities
Litigation Reform Act of 1995 ("PSLRA"), Pub. L. No. 104-67, 109
Stat. 737. In my view, the factual allegations in the Complaint satisfy
the heightened pleading requirements of the PSLRA as well as the
ordinary pleading requirements that apply to any action for fraud, as
provided in Rules 8 and 9 of the Federal Rules of Civil Procedure.
Accordingly, I would reverse the decision of the district court and
remand this case for further proceedings consistent with this opinion.

I

We review de novo the decision of the district court to grant a
motion to dismiss pursuant to Fed. R. Civ. P. 12(b)(6). Kloth v.
Microsoft Corp., 444 F.3d 312, 319 (4th Cir. 2006). A court should
grant a Rule 12(b)(6) motion only if "after accepting all well-pleaded
allegations in the plaintiff’s complaint as true and drawing all reason-
able factual inferences from those facts in the plaintiff’s favor, it
appears certain that the plaintiff cannot prove any set of facts in sup-
38 TEACHERS’ RETIREMENT SYSTEM v. HUNTER
port of his claim entitling him to relief." Edwards v. City of Golds-
boro, 178 F.3d 231, 244 (4th Cir. 1999).1

Generally speaking, the majority opinion correctly summarizes the
law of securities fraud. To plead a prima facie case, one must allege:
(1) a false statement or omission of material fact by the defendant, (2)
scienter, (3) reasonable reliance by the plaintiff, and (4) loss causa-
tion. Hillson Partners L.P. v. Adage, Inc., 42 F.3d 204, 208 (4th Cir.
1994). However, in contrast to an ordinary action for fraud, a securi-
ties fraud action must meet the heightened standards imposed by the
PSLRA when pleading the first two of these four elements. 15 U.S.C.
§ 78u-4(a)(1). When pleading the final two elements of securities
fraud, a plaintiff must simply satisfy the generally applicable require-
ments of Rules 8 and 9 of the Federal Rules of Civil Procedure.

As the majority notes, the district court dismissed the Complaint
for three reasons: (1) failure to plead with particularity all facts giving
rise to the belief that a false statement or omission of material fact
occurred, (2) failure to plead with particularity facts giving rise to a
strong inference of scienter, and (3) failure to adequately plead loss
causation.2 The majority approach to testing the adequacy of the
Complaint examines in isolation each individual suspect transaction
in order to ascertain whether the elements of securities fraud have
been adequately pled with respect to each one.3 However, this
approach ignores the fact that this case revolves around a single
securities fraud action against a single company, Cree.
1
With the exception of requiring a strong inference of scienter, the
PSLRA does not change our normal standard of review for a 12(b)(6)
motion. For the most part, the PSLRA simply modifies the quantum of
information that must be included in a complaint. Accordingly, for pur-
poses of my analysis, I assume the truth of all well-pleaded allegations
in the Complaint, and I draw all reasonable factual inferences in favor of
TRSL.
2
This is a fraud-on-the-market case; thus, investor reliance upon publi-
cized market prices is presumed. Basic, Inc. v. Levinson, 485 U.S. 224,
246-47 (1988).
3
This approach is substantially the same as the one employed by the
district court, which, like the majority, divided its opinion into sections
titled according to the companies that Cree dealt with: i.e., C&C,
Microvision, Spectrian, WTI, Xemod, and Lighthouse.
 TEACHERS’ RETIREMENT SYSTEM v. HUNTER 39
Therefore, the Complaint does not — and need not — allege an
action for securities fraud with respect to all six companies with
which Cree dealt. Instead, the Complaint alleges a single cause of
action for securities fraud, as evidenced by many transactions with
multiple companies. If even one of these transactions is pled ade-
quately enough to meet the pleading requirements under the PSLRA
and Rules 8 and 9, the cause of action must survive the motion to dis-
miss. Moreover, if the totality of Cree’s actions reveals a larger pic-
ture of fraud sufficient to meet the necessary pleading requirements,
this case must advance beyond the current stage of the proceedings.
In my opinion, the C&C transactions alone, especially when viewed
in conjunction with the numerous other transactions as a whole, per-
mit a reasonable inference of fraud that requires denial of Cree’s
motion to dismiss.

II

A.

To plead a material misrepresentation or omission of material fact
under the PSLRA, a complaint must "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 par-
ticularity all facts on which that belief is formed." 15 U.S.C. § 78u-
4(b)(1). TRSL has alleged a multitude of misleading statements by
Cree. The Complaint plainly specifies each of these statements under
the heading, "Defendants’ False and Misleading Statements During
the Class Period." J.A. 1007. The statements include 23 SEC filings,
22 press releases, two conference calls, and one news article. There-
fore, the Complaint clearly meets the first prong of this element by
specifying each statement believed to be misleading.

Further, the Complaint gives adequate reasons why each of the
statements is misleading. TRSL has alleged that Cree was involved
in numerous activities to inflate its revenue artificially. These fraudu-
lent schemes, known as "channel stuffing" and "round-tripping,"
involved a series of sham deals in which Cree, in collusion with insid-
ers at other companies, would exchange goods or services subject to
either secret rights of return or secret agreements that excused Cree’s
40 TEACHERS’ RETIREMENT SYSTEM v. HUNTER
non-performance.4 Cree included or referenced the favorable portions
of these agreements in its SEC filings, press releases, conference
calls, and the news article. However, the secret portions of the agree-
ments, which rendered the agreements futile, were, of course, omitted.
Thus, Cree’s public representations about these agreements were mis-
leading because they made material omissions — i.e., the secret
"handshake" deals that vitiated any substance the contracts otherwise
appeared to retain.5

Finally, it is important to note that all of TRSL’s allegations
regarding Cree and its transactions are made on information and
belief; thus, I agree with the majority that the Complaint must state
at least "sufficient facts to support a reasonable belief in the allega-
tion" that the material omissions were misleading. Maj. Op. 13. TRSL
has alleged sufficient facts to support such a reasonable belief by bas-
ing many of its allegations on information obtained from a lawsuit
filed by Eric Hunter, one of Cree’s co-founders. The day before the
class period closed, Eric Hunter filed suit against Cree, alleging, inter
alia, securities fraud. In his complaint, Eric Hunter alleged that Cree
had engaged "in a series of undisclosed corporate activities, including
but not limited to" the following: (1) Cree’s public filings omitted
material facts in connection with stock offerings and (2) Cree entered
into an undisclosed requirements contract with C&C that amounted
4
An example is Cree’s alleged channel stuffing agreement with C&C.
C&C would "purchase" silicon carbide crystals from Cree, subject to a
secret right of return. C&C would then exercise its secret right of return
and "reject" shipments of crystals. However, instead of actually returning
the crystals to Cree, C&C would store the crystals at its facilities, thereby
allowing Cree to avoid accounting for reserves or charges for its returned
products. Thus, this agreement allowed Cree to create the appearance of
permanent sales and profits that were, in fact, illusory. Cree allegedly
entered into similarly illusory "exchanges" with Microvision, Spectrian,
and others.
5
Both the district court and the majority seem to miss the crux of
TRSL’s argument on this point. Simply because a contract is publicly
disclosed and appears to be legitimate does not prevent it from being
materially misleading. The secret agreements between Cree and the other
companies caused the publicly disclosed contracts to appear to be some-
thing that they were not. These omissions are what rendered the public
statements materially misleading.
 TEACHERS’ RETIREMENT SYSTEM v. HUNTER 41
6
to channel stuffing and round-tripping. J.A. 672. Eric Hunter is the
brother of Neal Hunter, Cree’s chairman during the class period. Eric
Hunter is also the brother of Jeff Hunter, C&C’s chairman during the
class period. In addition to being a co-founder of Cree, Eric Hunter
was Cree’s CEO until 1994, and during the class period, he was a
paid consultant for Cree.7 Eric Hunter’s statements and his close pro-
fessional and familial relationship to the allegedly fraudulent actors
certainly support a reasonable belief that the omissions in Cree’s pub-
lic statements were misleading.

Though Eric Hunter’s allegations alone would likely suffice to sat-
isfy the particularity requirements that the PSLRA imposes on allega-
tions made under information and belief, TRSL identifies numerous
other sources who attest to the fraudulent, secret agreements between
Cree and other companies. The majority refers to these individuals as
"confidential sources." Maj. Op. 14.8 In addressing these confidential
6
Though Eric Hunter’s complaint never used the words "channel stuff-
ing" or "round-tripping," it alleged facts sufficient to reasonably infer
such schemes.
7
The fact that Eric Hunter performed no work in his capacity as a con-
sultant only underscores the continuation of his "insider" status with
Cree, despite the fact that he was no longer an executive in the company.
Only someone with close personal ties to a corporation would receive a
salary in exchange for no substantial work.
8
I question if the characterization as "confidential" is particularly use-
ful in this context, where the sources are readily discernable by Cree.
These sources are confidential only in that they are not specifically
named; however, TRSL identified them by title and the years they were
employed by various companies. Though their names do not appear in
the Complaint, a modest inquiry by Cree would likely establish who they
are. These so-called confidential sources cited by TRSL are numerous,
and they certainly provide sufficient facts to form a reasonable belief that
Cree’s public statements were misleading.
For example, TRSL identifies a former Cree process engineer
employed during the class period; this source learned from a top manager
at Cree that a secret deal existed between Cree and C&C, which required
C&C to accept shipments of crystals far in excess of its needs. TRSL
also reveals a former C&C director and vice president of marketing, who
claimed that C&C was simply "feeding Cree" and spending money like
"drunken sailors" because of the close familial relationship between the
directors of Cree and C&C. Many more examples of such unnamed
sources are presented in the Complaint.
42 TEACHERS’ RETIREMENT SYSTEM v. HUNTER
sources, the majority adopts the analysis of the Seventh Circuit in
Makor Issues & Rights, Ltd. v. Tellabs, Inc., 437 F.3d 588, 595 (7th
Cir. 2006). The Tellabs court held that a complaint which relies on
confidential sources must allege facts sufficient "‘to support the prob-
ability that a person in the position occupied by the source would pos-
sess the information alleged.’" Id. at 596 (quoting Novak v. Kasaks,
216 F.3d 300, 314 (2d Cir. 2000)).

I would resolve the issues surrounding unnamed sources differently
because the approach adopted by the majority does not inhere in the
plain language of the PSLRA. The plain language of the PSLRA does
not subject unnamed sources to higher scrutiny than other averments
made upon information and belief. Accordingly, in my view, a com-
plaint must simply identify unnamed sources "with particularity," as
required by the plain language of the PSLRA, which might include
the source’s job title and years of employment, or possibly, other facts
sufficient to support a reasonable belief that the plaintiff did not
merely invent sources. The purpose of the PSLRA’s particularity
requirement is to prevent the fabrication of information, not to weigh
its reliability or credibility.9 For example, a personal aide or adminis-
trative assistant to the CEO could plausibly overhear a pertinent piece
of information that may later form the basis for a securities fraud
action, notwithstanding his job title. Accordingly, I believe that both
Eric Hunter and the numerous unnamed sources listed in the Com-
plaint provide sufficient particularity to form a reasonable basis for
believing that the disclosed contracts made materially misleading
omissions.

B.

To plead adequately the scienter element of a securities fraud
action, a complaint must allege "with particularity facts giving rise to
9
Like the district court, the majority weighs the credibility of various
unnamed sources and discredits them because their recollections conflict
with publicly available information. However, assessing a 12(b)(6)
motion requires that we refrain from weighing evidence and assume all
facts in favor of the plaintiff. This is particularly relevant in the current
case, where the crux of TRSL’s claim is that Cree falsified publicly
available information.
 TEACHERS’ RETIREMENT SYSTEM v. HUNTER 43
a strong inference that the defendant acted with" scienter. 15 U.S.C.
§ 78u-4(b)(2). We have noted that scienter may be pled by allegations
that amount to severe recklessness. Ottmann v. Hanger Orthopedic
Group, Inc., 353 F.3d 338, 344 (4th Cir. 2003). In Ottman, we
rejected a categorical approach that would require a pleading to allege
motive and opportunity in order to satisfy the heightened scienter
pleading standards under the PSLRA. Id. at 345. Instead, we adopted
a case-specific approach, which requires courts to "examine all of the
allegations in each case to determine whether they collectively estab-
lish a strong inference of scienter." Id.

Based on a reading of the Complaint as a whole, I believe it ade-
quately pleads scienter. Assuming the truth of the material misrepre-
sentation allegations, the individuals named as defendants certainly
would have known about the secret agreements between Cree and
various other companies. Aside from the personal wealth that Cree
management allegedly gained from the channel stuffing and round-
tripping agreements,10 the mere fact that individual executives and
directors were the people actively entering into fraudulent agreements
to inflate Cree’s revenues supports a strong inference of scienter. The
material omissions from Cree’s public statements could not have
occurred without the agents of the company knowingly facilitating the
fraudulent transactions. Accordingly, a strong inference of scienter is
supported under the facts alleged in the Complaint as a whole.

C.

Finally, the Complaint must adequately allege loss causation,
which is not subject to any heightened pleading requirement under the
PSLRA. I agree with the majority that the Supreme Court in Dura
Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005), expressly
refused to decide whether loss causation must meet the ordinary
pleading requirements of Rule 8 or the heightened pleading require-
ments for fraud under Rule 9. Instead, the Court "assume[d], at least
for argument’s sake," that the ordinary requirements of Rule 8
10
I do not rely on the timing or substance of stock trades in finding a
strong inference of scienter. Rather, scienter may be directly shown by
the nature of the fraudulent acts at issue here — intentionally omitting
salient details from otherwise publicly disclosed contracts.
44 TEACHERS’ RETIREMENT SYSTEM v. HUNTER
applied. Id. at 346. Following the example of the Court in Broudo, I
analyze the allegations of loss causation in the Complaint under the
ordinary Rule 8 "short and plain statement" requirement.

The Complaint alleges loss causation by referencing the precipitous
decline in stock value upon the filing of Eric Hunter’s lawsuit against
Cree. Though Eric Hunter’s complaint specifically referenced only
the secret agreements with C&C, it clearly stated that Cree had
engaged in a "series of undisclosed . . . violation[s] of the federal
securities . . . laws, including but not limited to" the agreements with
C&C. J.A. 672. Eric Hunter’s complaint contradicted, or at least cal-
led into question, Cree’s prior denials of round-tripping. When the
information in Eric Hunter’s complaint became public knowledge,
Cree’s stock price dropped by nearly 20%. Under the normal pleading
standards of Rule 8, a reasonable inference of loss causation plainly
exists under these facts. I simply cannot envision a more direct and
proximate causal link than an insider’s disclosure of fraud that causes
a sudden and severe drop in stock price.11 These facts, which are
assumed to be true for purposes of my review, plainly give rise to a
reasonable inference of loss causation.

III

Accordingly, I would reverse the district court and remand for fur-
ther proceedings.12
11
I note that this case is distinguishable from Dura because the correc-
tive disclosure in Dura was much more tenuously connected to the alle-
gations made in Broudo’s complaint. The corrective disclosure in Dura
— a company press release — simply stated that earnings would be
diminished because of reduced drug sales. Id. at 339. However, the pri-
mary misrepresentations that Broudo allegedly relied upon related to the
pending approval of an asthmatic spray device by the Federal Drug
Administration. To the contrary, in the case before us, the corrective dis-
closure was a lawsuit filed by an insider that revealed secret fraudulent
agreements; the misrepresentations that TRSL relied upon were public
disclosures that failed to mention these secret agreements. Thus, com-
pared to Dura, this case has a much closer nexus between the corrective
disclosure and the misrepresentations relied upon by TRSL.
12
Because the district court disposed of TRSL’s other claims based on
its dismissal of the securities fraud claim, I would remand for further
proceedings on these claims as well.