Southland Securities Corp. v. Inspire Insurance Solutions Inc.

United States Court of Appeals
Fifth Circuit
F I L E D
REVISED APRIL 20, 2004
IN THE UNITED STATES COURT OF APPEALS March 31, 2004
FOR THE FIFTH CIRCUIT
Charles R. Fulbruge III
Clerk
No. 02-10558

SOUTHLAND SECURITIES CORPORATION,
on behalf of Itself and All Others
Similarly Situated; ET AL,

Plaintiffs,

JEFFREY A. FIELKOW; RICK TAYLOR;
WILLIAM WARES; RON RUMPLER; WILLIAM WHITE,

Plaintiffs-Appellants,

versus

INSPIRE INSURANCE SOLUTIONS INC, ET Al,

Defendants,

INSPIRE INSURANCE SOLUTIONS INC;
F. GEORGE DUNHAM, III; ROBERT K. AGAZZI;
TERRY G. GAINES; RONALD O. LYNN;
JEFFREY W. ROBINSON; WILLIAM J. SMITH, III;
MILLERS MUTUAL FIRE INSURANCE COMPANY,

Defendants-Appellees.

Appeal from the United States District Court
for the Northern District of Texas

Before GARWOOD, JOLLY, and HIGGINBOTHAM, Circuit Judges.

GARWOOD, Circuit Judge:
 Plaintiffs Southland Securities Corporation, Jeffrey Fielkow,

Rick Taylor, William Wares, Ron Rumpler, and William White

(plaintiffs) appeal the district court's dismissal, pursuant to

Fed. R. Civ. P. 9(b) and the Private Securities Litigation Reform

Act (PSLRA), of their securities fraud complaint. We affirm in

part and reverse in part and remand.1

Background

INSpire Insurance Solutions, Inc. (“INSpire”), the corporate

defendant in this case, provided policy and claims administration

to the property and casualty insurance industry and offered

outsourcing and software services. In this securities-fraud class

action, the defendants are INSpire; Millers Mutual Fire Insurance

1
When this appeal was initially filed one of the appellees
was Millers Insurance Company, formerly known as Millers Mutual
Fire Insurance Company, a defendant below (“Millers”). Liability
against Millers was asserted solely as a “control person” under §
20(a) of the Securities Exchange Act of 1934, 15 U.S.C. § 78t(a).
Millers was represented separately and had filed its own
appellee’s brief in this case. Thereafter, a letter dated March
19, 2003, was received by the court from Millers's counsel,
advising of Millers’s status as an “Impaired Insurer” under Texas
Ins. Code Art. 21.28-C. The 345th Judicial District Court of
Travis County found that Millers was insolvent and appointed the
Texas Commissioner of Insurance as its permanent receiver under
the Texas Insurance Code and issued a permanent injunction. The
receiver discharged Millers’s counsel. The receiver has not
become, or sought to become, a party to this case, and no other
party to this case has sought to make the receiver a party. This
court in a June 27, 2003 order severed the appeal of plaintiffs-
appellants as against Millers from and out of the remainder of
this appeal and stayed the said severed out appeal against
Millers pending further order of this court, and said severance
and stay of said severed appeal remain in effect. This opinion
does not dispose of said severed out appeal as against Millers.

2
Company, allegedly the original parent corporation and largest

shareholder of INSpire (see note 1 above); F. George Dunham

(Dunham), the President, CEO and Chairman of the Board of INSpire

during the class period; Ronald O. Lynn (Lynn), Executive Vice

President and CIO during the class period; Terry G. Gaines

(Gaines), Executive Vice President, CFO, and Treasurer during the

class period; Robert K. Agazzi (Agazzi), Executive Vice President

of Software and Systems during the class period; Jeffrey W.

Robinson (Robinson), Executive Vice President of Outsourcing and

later President and COO during the class period; and William J.

Smith (Smith), President and COO from May 1, 1998 to January 7,

2000, (collectively defendants). INSpire was established in 1995

as a wholly owned subsidiary of Millers, and remained such until

August 1997 when Millers spun it off through an initial public

offering (IPO) of 8.25 million shares, Millers retaining 43.7

percent of INSpire’s outstanding shares. Plaintiffs generally

contend that defendants engaged in a fraudulent scheme to deceive

investors about the company's performance for the purpose of

inflating the price of INSpire stock for their own financial

benefit. The proposed plaintiff class consisted of all those who

acquired INSpire common stock between January 28, 1998, and October

14, 1999.

The plaintiffs' Second Amended Complaint (Complaint), from the

dismissal of which this appeal is taken, alleges that the

3
defendants committed securities fraud by knowingly, or with severe

recklessness, touting INSpire’s software products2 and contracts

despite the software's critical flaws; issuing inaccurate earnings

and revenue estimates; and violating Generally Accepted Accounting

Principles (GAAP) by failing to timely classify receivables as

uncollectible, improperly capitalizing software development costs,

and failing to write down goodwill associated with purchases of

software assets. The plaintiffs allege these misleading statements

were made in forward-looking statements, press releases, and other

corporate documents, and relied upon by analysts in their reports.

The plaintiffs further allege defendants made stock sales based on

insider information, pointing to these sales as evidence of

scienter. The plaintiffs seek to recover damages on behalf of all

persons who acquired Inspire stock between January 28, 1998 and

October 14, 1999.

On December 3, 1999, the plaintiffs, on behalf of themselves

and others similarly situated, filed their original complaint

against the defendants. This case was consolidated with

substantially identical suits subsequently filed by other

2
INSpire's two principal software programs were EmPower and
Windows for Property Casualty (WPC). EmPower is an imaging and
workflow management application designed to allow the user to
create electronic images of insurance applications and forms that
can be routed and traced when used in conjunction with an
electronic policy and claims administration system. INSpire's
first policy and claims administration system was called Policy
and Claims Administration (PCA) and ran on the AS400 platform
while its successor WPC ran on a Windows platform.

4
plaintiffs. On June 7, 2000, the plaintiffs filed their

Consolidated Amended Complaint. On August 10, 2000, the defendants

filed motions to dismiss the plaintiffs’ Consolidated Amended

Complaint, which motions were granted by the Court on March 12,

2001. In that Dismissal Order, the court found that, because the

plaintiffs' Consolidated Amended Complaint had failed to plead

fraud with particularity and improperly relied on the “group

pleading” doctrine in lodging allegations against the defendants

collectively, the plaintiffs did not meet the pleading requirements

established by Fed. R. Civ. P. 9(b) and the Private Securities

Litigation Reform Act (PSLRA). The court held that the plaintiffs

must plead with sufficient particularity wrongdoing and scienter as

to each defendant individually. The court also found the

plaintiffs failed to allege facts supporting an inference that the

forward-looking statements cited in the Consolidated Amended

Complaint were made with actual knowledge that they were false or

misleading.

The court gave the plaintiffs an opportunity to amend their

Complaint. They filed their Second Amended Complaint3 on May 16,

2001. The defendants filed responsive motions to dismiss. The

plaintiffs asserted claims under section 10(b) of the Securities

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

3
Although the plaintiffs title this pleading “First Amended
Complaint” the district court correctly noted the it is actually
the Second Amended Complaint, the first amended pleading being
the Consolidated Amended Complaint filed on June 7, 2001.

5
Commission (SEC), as modified by the PSLRA, codified in relevant

part at 15 U.S.C. §§ 78u-4 and 78u-5, against all of the defendants

except Millers. The plaintiffs also asserted claims under section

20(a) of the Securities Act, 15 U.S.C. § 78t(a), which provides for

control-person liability, against INSpire, Millers, and Dunham.

Discussion

Standard of Review

This court reviews the dismissal of a complaint for failure to

state a claim de novo, accepts “the facts alleged ... as true and

construe[s] the allegations in the light most favorable to the

plaintiff.” Nathenson v. Zonagen Inc., 267 F.3d 400, 406 (5th Cir.

2001). However, we will not "strain to find inferences favorable

to the plaintiffs." Westfall v. Miller, 77 F.3d 868, 870 (5th

Cir. 1996). Nor do we accept conclusory allegations, unwarranted

deductions or legal conclusions. Nathenson, 267 F.3d at 406. A

dismissal for failure to plead fraud with particularity as required

by rule 9(b) is a dismissal on the pleadings for failure to state

a claim. Shushany v. Allwaste, Inc., 992 F.2d 517, 520 (5th Cir.

1993).

Securities Exchange Act and PSLRA

Section 10(b) of the Securities Exchange Act provides in

relevant part:

“It shall be unlawful for any person, directly
or indirectly

6
 . . .

(b) To use or employ, in connection with the
purchase or sale of any security . . . any
manipulative or deceptive device or contrivance in
contravention of such rules and regulations as the
[Securities and Exchange] Commission may prescribe
as necessary or appropriate in the public interest
or for the protection of investors.” 15 U.S.C. §
78j(b) (2000).

Rule 10b-5 provides in relevant part:

“It shall be unlawful for any person, directly
or indirectly

. . .

(b) To make any untrue statement of a material
fact or to omit to state a material fact necessary
in order to make the statements made, in the light
of the circumstances under which they were made,
not misleading . . .

in connection with the purchase or sale of any
security.” 17 C.F.R. § 240.10b-5 (2001).

The PSLRA speaks to the requirements of a securities law class

action complaint as follows:

“(b) Requirements for securities fraud actions

(1) Misleading statements and omissions

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

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

(B) omitted to state a material fact
necessary in order to make the statements
made, in the light of the circumstances in
which they were made, not misleading; the
complaint shall specify each statement alleged
to have been misleading, the reason or reasons

7
 why the statement is misleading, and, if an
allegation regarding the statement or omission
is made on information and belief, the
complaint shall state with particularity all
facts on which that belief is formed.

(2) Required state of mind

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

(3) Motion to dismiss; stay of discovery

(A) Dismissal for failure to meet pleading
requirements

In any private action arising under this
chapter, the court shall, on the motion of any
defendant, dismiss the complaint if the
requirements of paragraphs (1) and (2) are not
met.” 15 U.S.C. § 78u-4(b).

Federal Rule of Civil Procedure 9(b) likewise requires the

plaintiffs in securities fraud causes to plead with particularity

the circumstances constituting the alleged fraud. To satisfy Rule

9(b)'s pleading requirements, the plaintiffs must "specify the

statements contended to be fraudulent, identify the speaker, state

when and where the statements were made, and explain why the

statements were fraudulent." Williams v. WMX Technologies, Inc.,

112 F.3d 175, 177-78 (5th Cir. 1997), cert. denied, 118 S. Ct. 412

(1997). To state a securities-fraud claim under section 10(b), and

Rule 10b-5, plaintiffs must plead (1) a misstatement or omission;

8
(2) of a material fact; (3) made with scienter; (4) on which the

plaintiffs relied; and (5) that proximately caused the plaintiffs'

injuries. Id. at 177. A fact is material if there is “a

substantial likelihood that, under all the circumstances, the

omitted fact would have assumed actual significance in the

deliberations of the reasonable shareholder." Grigsby v. CMI

Corp., 765 F.2d 1369, 1373 (9th Cir. 1985) (quoting TSC Industries,

Inc. v. Northway, Inc., 96 S. Ct. 2126, 2131 (1976)). Materiality

"depends on the significance the reasonable investor would place on

the withheld or misrepresented information." Basic Inc. v.

Levinson, 108 S. Ct. 978, 988 (1988).

"A complaint can be long-winded, even prolix, without pleading

with particularity. Indeed, such a garrulous style is not an

uncommon mask for an absence of detail." Williams, 112 F.3d at

178. This court has noted that "although the requirement for

particularity in pleading fraud does not lend itself to refinement,

and it need not in order to make sense, nevertheless, directly put,

the who, what, when, and where must be laid out before access to

the discovery process is granted." ABC Arbitrage Plaintiffs Group

v. Tchuruk, 291 F.3d 336, 349 (5th Cir. 2002) (quotations

omitted). "In securities fraud suits, this heightened pleading

standard provides defendants with fair notice of the plaintiffs'

claims, protects defendants from harm to their reputation and

goodwill, reduces the number of strike suits, and prevents

9
plaintiffs from filing baseless claims and then attempting to

discover unknown wrongs." Tuchman v. DSC Communications, 14 F.3d

1061, 1067 (5th Cir. 1994).

The PSLRA reinforces the particularity requirements of Rule

9(b), requiring the plaintiffs to state not only the time, place,

the identity of the speaker, and the content of the alleged

misrepresentation, but also to explain why the challenged statement

or omission is false or misleading. Williams, 112 F.3d at 177.4

The PSLRA also requires that the complaint “with respect to each

act or omission alleged” to be false or misleading “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) (emphasis added).

Group Pleading

This court has not heretofore considered whether to recognize

the “group pleading” or “group published” doctrine. This doctrine

“allows plaintiffs to ‘rely on a presumption that statements in

“prospectuses, registration statements, annual reports, press

4
For purposes of the requirement of § 78u-4(b)(1) that “if
an allegation regarding the statement or omission is made on
information or belief, the complaint shall state with
particularity all facts on which that belief is formed,” an
allegation not made on the plaintiff’s personal knowledge is
treated as made on information and belief “although not labeled
as such.” Tchuruk, 291 F.3d at 351. However, the requirement
that “all” facts be plead is not literally applied; sufficient
particular facts is the intent of that requirement. Id. at 352-
53.

10
releases, or other group-published information,” are the collective

work of those individuals with direct involvement in the everyday

business of the company.’” In Re Oxford Health Plans, Inc., 187

F.R.D. 133, 142 (S.D.N.Y. 1999) (quoting In Re Stratosphere Corp.

Securities Litig., 1 F. Supp. 2d 1096, 1108 (D. Nev. 1998)); Danis

v. USN Communications, Inc., 73 F. Supp. 2d 923, 939 n.9 (N.D. Ill.

1999).

Where the misstatements appear in certain types of documents

that plaintiffs believe were written by groups, some courts have

allowed plaintiffs to link certain defendants to alleged

misrepresentations simply by pleading that the defendants were part

of the “group” that likely put the challenged documents together.

In re Solv-Ex Corp. Sec. Litig., 210 F. Supp. 2d 276, 283 (S.D.N.Y.

2000); In re Worlds of Wonder Sec. Litig., 721 F. Supp. 1140, 1143

(N.D. Cal. 1989). Instead of being required to plead that a

defendant actually made, authored or approved an offending

statement in a corporate communication, the “group pleading”

doctrine in its broadest form allows unattributed corporate

statements to be charged to one or more individual defendants based

solely on their corporate titles. Under this doctrine, the

plaintiff need not allege any facts demonstrating an individual

defendant's participation in the particular communication

containing the misstatement or omission where the defendants are

“insiders or affiliates" of the company. In re Solv-Ex Corp. Sec.

11
Litig., 210 F. Supp. 2d at 283. Therefore, the “group pleading”

doctrine as so applied would allow the plaintiff to plead the first

element of a section 10(b) case against an individual defendant

without citing particular facts connecting the defendant to the

alleged fraud.

Congress did not include “group pleading” in any provision of

the Securities Act. See William O. Fisher, Don't Call Me a

Securities Law Groupie: The Rise and Possible Demise of the “Group

Pleading” Protocol in 10b-5 Cases, 56 BUS. LAW. 991 (2001).5 The

Ninth and Second Circuits have largely pioneered this doctrine. In

Wool v. Tandem Computers Inc., 818 F.2d 1433 (9th Cir. 1987), the

Ninth Circuit fashioned the “group pleading” doctrine, holding:

“In cases of corporate fraud where the false
or misleading information is conveyed in
prospectuses, registration statements, annual
reports, press releases, or other 'group-published
information,' it is reasonable to presume that
these are the collective actions of the officers.
Under such circumstances, a plaintiff fulfills the
particularity requirement of Rule 9(b) by pleading
the misrepresentations with particularity and where
possible the roles of the individual defendants in
the misrepresentations.” Id. at 1440 (citation
omitted) (emphasis added).6

5
Fisher discusses the structure of modern corporations,
noting their often varying degrees of compartmentalization and
the fact that an individual's actual role in drafting and
approving particular documents and statements cannot, in many
cases, be reliably deduced from their title.
6
The Wool court added, “The individual defendants are a
narrowly defined group of officers who had direct involvement not
only in the day-to-day affairs of Tandem in general but also in
Tandem's financial statements in particular.” Id. Yet, this

12
 Courts have differed as to whether the “group pleading”

doctrine, assuming its existence prior to the PSLRA, survives that

1995 legislation. The PSLRA requires first, that the complaint

must “specify” “each” statement alleged to have been misleading,

and the reason or reasons why that statement is misleading. 15

U.S.C. § 78u-4(b)(1). Second, as to allegations made upon

information and belief, the complaint must “state with

particularity all facts” on which the belief is formed. Id.

Finally, as to “each” allegedly misleading statement, the complaint

must “state with particularity facts giving rise to a strong

inference that the defendant acted with the required state of

mind.” 15 U.S.C. § 78u-4(b)(2) (emphasis added).

Several courts have held that, largely because the PSLRA does

not explicitly make reference to the “group pleading” doctrine, it

does not abolish it. In re SmarTalk Teleservices, Inc. Sec.

Litig., 124 F. Supp. 2d 527, 545 (S.D. Ohio 2000); In re Baan Co.

Sec. Litig., 103 F. Supp. 2d 1, 17 (D.D.C. 2000); In re Oxford

Health Plans, Inc. Sec. Litig., 187 F.R.D. 133, 142 (S.D.N.Y.

1999); In re Sunbeam Sec. Litig., 89 F. Supp. 2d 1326, 1340-41

(S.D. Fla. 1999); In re BankAmerica Corp. Sec. Litig., 78 F. Supp.

2d 976, 987 (E.D. Mo. 1999); Zuckerman v. Foxmeyer Health Corp., 4

finding appeared unnecessary as a result of the Court's apparent
conclusion that such facts only need to be alleged “where
possible.”

13
F. Supp. 2d 618, 627 n.4 (N.D. Tex. 1998); Robertson v. Strassner,

32 F. Supp. 2d 443, 446 (S.D. Tex. 1998). However, several other

courts have found that the PSLRA effectively abolished the “group

pleading” doctrine. P. Schoenfeld Asset Mgmt. LLC v. Cendant

Corp., 142 F. Supp.2d 589, 618-21 (D.N.J. 2001); Coates v.

Heartland Wireless Communs., Inc., 26 F. Supp.2d 910, 915-16 (N.D.

Tex. 1998); Allison v. Brooktree Corp., 999 F. Supp. 1342, 1350

(S.D. Cal. 1998); Chu v. Sabratek Corp., 100 F. Supp.2d 827, 835-37

(N.D. Ill. 2000).

Significantly, this court has never adopted the “group

pleading” doctrine, even before the PSLRA. While the PSLRA does

not explicitly abolish the doctrine, it was not necessary to do so

because Congress never made this judicial creation law to begin

with. Even prior to the PSLRA, section 10(b) and Rule 10b-5

required plaintiffs to identify the roles of the individual

defendants, and describe their involvement, if any, in preparing

the misleading statements. In re MDC Holdings Sec. Litig., 754 F.

Supp. 785, 795 (S.D. Cal. 1990). Even if this court were to

conclude that the “group pleading” doctrine existed in the absence

of the PSLRA, it cannot withstand the PSLRA's specific requirement

that the untrue statements or omissions be set forth with

particularity as to "the defendant" and that scienter be pleaded

with regard to "each act or omission" sufficient to give "rise to

a strong inference that the defendant acted with the required state

14
of mind." 15 U.S.C. § 78u-4(b). These PSLRA references to “the

defendant” may only reasonably be understood to mean “each

defendant” in multiple defendant cases, as it is inconceivable that

Congress intended liability of any defendants to depend on whether

they were all sued in a single action or were each sued alone in

several separate actions. The court in Allison noted:

“[T]o permit a judicial presumption as to particularity
simply cannot be reconciled with the statutory mandate
that plaintiffs must plead specific facts as to each act
or omission by the defendant. The group published
doctrine permits an inference of wrongdoing not based on
defendant's conduct, but based solely on defendant's
status as an officer or director of a corporation.”
Allison, 999 F. Supp. at 1350.

The “group pleading” doctrine conflicts with the scienter

requirement of the PSLRA because, even if a corporate officer's

position supports a reasonable inference that he likely would be

negligent in not being involved in the preparation of a document or

aware of its contents, the PSLRA state of mind requirement is

severe recklessness or actual knowledge.

Therefore, we agree with the district court that the PSLRA

requires the plaintiffs to “distinguish among those they sue and

enlighten each defendant as to his or her particular part in the

alleged fraud.” As such, corporate officers may not be held

responsible for unattributed corporate statements solely on the

basis of their titles, even if their general level of day-to-day

involvement in the corporation's affairs is pleaded. However,

corporate documents that have no stated author or statements within

15
documents not attributed to any individual may be charged to one or

more corporate officers provided specific factual allegations link

the individual to the statement at issue. Such specific facts

tying a corporate officer to a statement would include a signature

on the document or particular factual allegations explaining the

individual's involvement in the formulation of either the entire

document, or that specific portion of the document, containing the

statement. Various unattributed statements within documents may be

charged to different individuals, and specific facts may tie more

than one individual to the same statement. And, the corporation

itself may be treated as making press releases and public

statements issued by authorized officers on its behalf, and

statements made by its authorized officers to further the interests

of the corporation.

Consistent with our rejection of the “group pleading”

doctrine, we do not construe allegations contained in the Complaint

against the “defendants” as a group as properly imputable to any

particular individual defendant unless the connection between the

individual defendant and the allegedly fraudulent statement is

specifically pleaded. While the plaintiffs aver in paragraph 21 of

the Complaint that the individual defendants “each controlled the

contents of and participated in writing INSpire's SEC filings,

reports and releases,” this conclusory allegation fails to specify

which of these documents is attributable to each individual

16
defendant, let alone which portions or statements within these

documents are assignable to each individual defendant.

Corporate defendant

Respecting the potential section 10(b) liability of INSpire

itself, however, as all of the individual defendants were executive

officers of INSpire whose actions were intended to benefit INSpire,

we will treat as having been made by INSpire the particular

complained of statements in the SEC filings, reports and releases

issued in its name. Statements attributed to individual defendants

are also treated as having been made by INSpire, as all of them

appear from the face of the Complaint to have been made pursuant to

their positions of authority within the company.

Nevertheless, liability under Rule 10(b)(5) requires not only

that the party make a statement which contains an untrue statement

of material fact or omits a material fact necessary in order to

make the statement not misleading, but also that the party have

done so with “not merely simple or even inexcusable negligence” but

rather with “scienter” meaning an “intent to deceive, manipulate,

or defraud” or that “severe recklessness” in which the “danger of

misleading buyers or sellers . . . is either known to the defendant

or is so obvious that the defendant must have been aware of it.”

Broad v. Rockwell Int’l Corp., 642 F.2d 929, 961-62 (5th Cir. 1981)

(en banc). For purposes of determining whether a statement made by

the corporation was made by it with the requisite Rule 10(b)

17
scienter we believe it appropriate to look to the state of mind of

the individual corporate official or officials who make or issue

the statement (or order or approve it or its making or issuance, or

who furnish information or language for inclusion therein, or the

like) rather than generally to the collective knowledge of all the

corporation’s officers and employees acquired in the course of

their employment.7 See, e.g., Nordstrom, Inc. v. Chubb & Son,

Inc., 54 F.3d 1424, 1435 (9th Cir. 1995) (“there is no case law

supporting an independent ‘collective scienter’ theory”); In Re

Apple Computer, Inc. Securities Litigation, 243 F. Supp.2d 1012,

1023 (N.D. Cal. 2002) (“It is not enough to establish fraud on the

part of a corporation that one corporate officer makes a false

statement that another knows to be false. A defendant corporation

is deemed to have the requisite scienter for fraud only if the

individual corporate officer making the statement has the requisite

level of scienter, i.e., knows that the statement is false, or is

at least deliberately reckless as to its falsity, at the time he or

she makes the statement,” citing Nordstrom).8 This is consistent

7
We are, of course, speaking here of § 10(b) liability, not
liability under § 20(a) of the Securities Act, 15 U.S.C. §
78t(a).
8
Cf. In Re Warner Communications Securities Litigation, 618
F. Supp. 735, 752 (S.D.N.Y. 1985), aff’d 798 F.2d 35 (2d Cir.
1986) (“As to Warner, plaintiffs arguably need only show either
that one or more members of top management knew of material
information indicating an earnings decline, but failed to stop
the issuance of misleading statements or to correct prior
statements that had become misleading, or that Warner management

18
with the general common law rule that where, as in fraud, an

essentially subjective state of mind is an element of a cause of

action also involving some sort of conduct, such as a

misrepresentation, the required state of mind must actually exist

in the individual making (or being a cause of the making of) the

misrepresentation, and may not simply be imputed to that individual

on general principles of agency.9 See Restatement (2nd), Agency §

275, comment b; § 268 comment d. See, also, e.g., Woodmont, Inc.

v. Daniels, 274 F.2d 132, 137 (10th Cir. 1959) (“while in some

cases, a corporation may be held constructively responsible for the

composite knowledge of all of its agents, whether acting in unison

or not . . . [citations] we are unwilling to apply the rule to fix

liability where, as here, intent is an essential ingredient of tort

liability as for deceit. See Restatement, Agency 2d, § 275,

comment b”); Gutter v. E.I. DuPont de Nemours, 124 F. Supp. 2d

1291, 1311 (S.D. Fla. 2000) (“The knowledge necessary to form the

requisite fraudulent intent must be possessed by at least one agent

and cannot be inferred and imputed to a corporation based on

disconnected facts known by different agents,” citing, inter alia,

had recklessly failed to set up a procedure that insured the
dissemination of correct information to the marketplace;”
(emphasis added)).
9
Although if the agent, with the requisite actual state of
mind, makes or causes to be made a misrepresentation, the
principal’s vicarious liability will be determined under general
rules of agency. See Paul F. Newton & Co. v. Texas Commerce Bank, 630 F.2d 1111,
1118 (5th Cir. 1980).

19
Woodmont Inc.); First Equity Corp. v. Standard & Poor’s Corp., 690

F. Supp. 256, 260 (S.D.N.Y. 1988), aff’d, 869 F.2d 175 (2d Cir.

1989) (“While . . . a corporation may be charged with the

collective knowledge of its employees, it does not follow that the

corporation may be deemed to have a culpable state of mind when

that state of mind is possessed by no single employee. A

corporation can be held to have a particular state of mind only

when that state of mind is possessed by a single individual”);

United States v. LBS Bank-New York, Inc., 757 F. Supp. 496, 501 n.7

(E.D. Pa. 1990) (“Although . . . a corporate defendant is

considered to have acquired the collective knowledge of its

employees . . . [citations], specific intent cannot be aggregated

similarly,” citing First Equity Corp., and its last above quoted

sentence).

The Complaint does not assert that any particular individual

INSpire director, officer or employee, other than the named

individual defendants, acted with scienter in or respecting the

making or issuing of any of the complained of statements (or in

ordering or approving any of such statements or furnishing

information or language for inclusion therein or omission

therefrom, or the like) or indeed in any other respect.

Accordingly, for purposes of evaluating whether the Complaint

states with particularity facts giving rise to a strong inference

that INSpire had the requisite scienter – namely an intent to

20
deceive, manipulate or defraud or equivalent severe recklessness –

respecting any of the complained of statements, it is only

necessary for us to address the allegations claimed to adequately

show such state of mind on the part of the individual defendants.

Insider Sales

As supportive of their scienter claims, plaintiffs allege

diverse INSpire stock sales by the individual defendants, stating

that together they sold over 1.5 million shares of INSpire stock

during the entire class period for proceeds totaling approximately

$9.6 million.10 Complaint, ¶ 143-145. With respect to the

10
The total is nearly $34 million including some $24.8
million sales by Millers (representing 20.56% of its holdings).
For the first time on appeal, the plaintiffs, relying on
United States v. O'Hagan, 117 S.Ct. 2199, 2206-07 (1997), further
assert that these insider stock sales themselves are actionable
as deceptive devices or acts under the securities laws,
irrespective of whether the defendants made any misleading
statements. This contention presents no ground for reversal. In
an implied private action under § 10(b) and Rule 10(b)(5) the
plaintiff must allege reliance and causation. Nathenson, 267
F.3d at 413-15. See also 15 U.S.C. § 78u-4(b)(4) & § 78u-
4(e)(1). Where, as here, the suit is cast as a class action,
reliance necessarily means fraud on the market. Id. Here the
class is alleged to consist merely of those who acquired INSpire
common stock between January 28, 1998, and October 14, 1999, and
thus necessarily depends on the theory that the complained of
conduct artificially inflated the price of the stock, and indeed
that is what the Complaint pleads, stating “Plaintiffs and the
Class would not have purchased or acquired INSpire stock at the
prices they paid, or at all, if they had been aware that the
market prices had been artificially and falsely inflated by
defendants’ misleading statements.” Complaint, ¶ 155. Yet
plaintiffs do not allege that any of the sales by the individual
defendants were not known to the market or were not timely and
properly publically reported (as, indeed, defendants’ SEC filings
submitted below, which the district court could properly
consider, see, e.g., Lovelace v. Software Spectrum, 78 F.3d 1015,

21
requirement that particular facts be pled which give rise to a

strong inference of scienter, allegations of insider trading are

essentially a form of motive and opportunity allegations. See,

e.g., In Re Comshare Inc. Securities Litigation, 183 F.3d 542, 553

(6th Cir. 1999) (allegations “that the individual Defendants did

profit by selling many of their shares at artificially inflated

prices during the class period. . . . largely tend to illustrate

that Defendants had the motive and opportunity to commit securities

fraud”). And, we have stated that “our court requires more than

allegations of motive and opportunity to withstand dismissal.”

Goldstein v. MCI Worldcom, 340 F.3d 238, 250-51 (5th Cir. 2003).

Nevertheless, we have also recognized that “appropriate allegations

of motive and opportunity may meaningfully enhance the strength of

the inference of scienter.” Nathenson, 267 F.3d at 412. However,

this is true of insider trading “only” when “in suspicious amounts

or at suspicious times.” Abrams v. Baker Hughes, Inc., 292 F.3d

424, 435 (5th Cir. 2002). See also In Re Silicon Graphics Inc.

Securities Litigation, 183 F.2d 970, 987 (9th Cir. 1999) (“insider

trading is suspicious only when dramatically out of line with prior

1018 (5th Cir. 1998), reflect that they were, which plaintiffs
have never disputed). While the Complaint alleges that the
individual defendants’ stock sales were illegal insider trading
because based on an unspecified non-public information, nowhere
does the Complaint ever infer the wholly implausible conclusion
that any of the sales by the individual defendants in fact did,
or would tend to, inflate the market price (nor is it alleged
that any of the class purchased from any individual defendant or
relied on their stock sales).

22
trading practices at times calculated to maximize the personal

benefit from undisclosed inside information,” internal quotation

marks and citation omitted).

Based on their January 1998 holdings, the plaintiffs allege

that during the entire class period Agazzi sold 32.13 percent of

his shares, Dunham 41.14 percent, Gaines 14.87 percent, Lynn 41.70

percent, and Robinson 48.80 percent. Complaint, ¶ 145. The

plaintiffs allege three periods of insider sales: March 26, July

27-August 5, and November 3-9, 1998. Plaintiffs do not expressly

allege in the Complaint that the sales were suspicious in timing or

amount and therefore suggestive of scienter, although they do

allege that the defendants “profit[ed] from the artificial

inflation of INSpire's stock price their violation of law had

created before INSpire's stock price crashed . . . .” Complaint,

¶ 143.11

The March sales occurred during the company's secondary public

offering. On March 26, 1998, INSpire filed its prospectus and

registration statement and made its secondary public offering

covering 1,500,000 shares owned by it and 800,000 shares owned by

then selling shareholders. On March 26, Dunham sold 157,500

11
After listing the defendants' stock sales during the entire
class period, the Complaint notes, “In contrast, from the time of
INSpire's IPO [August 1997] until the beginning of the Class
Period [January 1998], defendants sold no stock.” Complaint, ¶
145. However, the brevity of the period addressed by this
allegation (and the fact that it commences with INSpire’s ceasing
to be a wholly owned Millers’ subsidiary) largely dissipates any
significance it might otherwise have.

23
shares, accounting for 26.40 percent of his January 1998 holdings.

On March 26, Lynn also sold 30,000 shares, representing 26.62

percent of his 1998 holdings, while Robinson sold 37,500 shares,

which amounts to 33.27 percent of his 1998 holdings. While not

insubstantial, these sales do not raise a strong inference of

scienter for several reasons. First, the plaintiffs do not allege

that officer or director sales during a secondary public offering

are unusual. The price of INSpire stock on March 26, 1998, was

$21, significantly less than its eventual high of over $35 reached

in November 1988 (it traded at $30 or above from November 3 through

November 10). Furthermore, following the allegedly misleading

February 24 Sul America contract announcement, INSpire stock rose

from $17.917 (on February 23) to $19.833 (on February 25) (it had

been as high as $19 on February 9; it traded as low as $17.50 in

early March and over $21.00 from March 16 through March 24) but the

defendants sold their stock at approximately this same price after

over a month had passed. Moreover, the stock generally continued

to climb until the revelations of December 11, 1998, suggesting the

timing of the March sales was not unusually prescient. The fact

that defendants Agazzi, Gaines, and Smith did not sell in or around

March 1998 also undermines an inference of scienter (indeed, Smith

did not sell INSpire stock at any time during the entire class

period). The fact that other defendants did not sell their shares

during the relevant class period undermines plaintiffs' claim that

24
defendants delayed notifying the public so that they could sell

their stock at a huge profit. Acito v. IMCERA Group, 47 F.3d 47,

54 (2d Cir. 1995).

The July-August sales are also not inherently suspicious.

First, Agazzi, Lynn, and Smith did not sell at this time.

Combining his sales on July 27 and 28, Dunham sold only 4.27

percent of his shares. Combining his sales on July 30 and August

5, Robinson sold 9.97 percent of his shares. Several weeks later,

on August 18, 19, and 20, Agazzi sold 32.13 percent of his shares.

Additionally, the price of INSpire stock was not unusually volatile

during the July-August interval in which these sales occurred, as

it was $24.375 on July 27 and $26.625 on August 20. The low

between July 27 and August 20 was $22.167 on July 21 while the high

was $26.625 on August 20.

The plaintiffs' strongest argument concerns sales made in

November 1998. Dunham, Gaines, Lynn, and Robinson made sales

between November 3 and November 9. On November 4 and 5, Dunham

sold 69,150 shares, 16.45 percent of his holdings. On November 3,

Gaines sold 10,000 shares, 14.87 percent of his shares. On

November 4, Lynn sold 17,000 shares, 20.55 percent of his holdings.

On November 9, Robinson sold 10,000 shares, 14.77 percent of his

holdings. These sales of INSpire stock at between $30 and $31 were

not perfectly timed, as INSpire stock would hit a high of 35.25 on

November 23, 1998. However, these sales occurred only slightly

25
more than a month before INSpire stock fell precipitously from

$30.813 on December 10, 1998, to $17.625 on December 11, 1998, the

day INSpire issued a release revising downward its 1999 earning

estimates. INSpire stock would never reach 22 again. The November

sales also closely followed INSpire's announcement of its Arrowhead

outsourcing contract on November 1, 1998 and the favorable analyst

reports it spawned on November 2 and 3. INSpire stock rose from

$22.750 on October 27, 1998, to $31.438 on November 5, a 27.64

percent increase in the share price in a span of ten days.12

Alleged misstatements

The plaintiffs' allegations of fraud against the defendants

essentially relate to: 1) misstatements relating to the

functionality and capacity of INSpire's software programs; 2)

misstatements relating to INSpire's past, present, and projected

economic performance; and 3) misstatements in financial reports

consisting of violations of generally accepted accounting

principles (GAAP) pertaining to classification of receivables,

12
The defendants also point to their numerous alleged stock
purchases during the entire class period, but the plaintiffs
compellingly argue that these acquisitions were through options
enabling them to purchase INSpire stock at far below the market
price. For example, the plaintiffs aver that Dunham exercised
100,981 options on December 24, 1998, and March 26, 1999, paying
only 87 cents per option when the open-market price of INSpire
shares was $16 and $17 respectively. In any event, the effect of
such purchases was not addressed in the district court's opinion
and would be more appropriately addressed at trial or on summary
judgment than in a dismissal on the pleadings.

26
software development costs, and goodwill. The plaintiffs

allegations relating to INSpire's software and those relating to

its stated fiscal performance are intertwined to the extent that

much of the Complaint argues that the inadequacies of INSpire's

software caused the company to be unable to deliver on its software

contracts, resulting in subpar performance and INSpire's ultimate

collapse.

The plaintiffs' allegations are divided into five time sub

periods within the overall January 28, 1998, to October 14, 1999,

class period.

January 28, 1998 - April 2, 1998

We first examine the period of January 28, 1998, to April 2,

1998. The Complaint alleges INSpire issued results for the fourth

quarter of 1997 and the year ended 1997, listing Dunham and Gaines

as contact persons. Complaint, ¶ 39. The plaintiffs allege this

statement and all of the statements set forth in the Complaint made

during this sub period were false when issued and that each such

statement failed to disclose information about adverse conditions

in and then impacting INSpire's business, disclosure of which was

required to make the statements made not misleading, and which

information was “then known only to the defendants due to their

access to internal INSpire data.” Complaint, ¶ 57. The plaintiffs

further allege that INSpire's reported revenues and earnings during

this class period were materially overstated due to improper

27
revenue recognition, failure to write off uncollectible

receivables, improper capitalization of software development costs,

and failure to write down goodwill from INSpire's purchase of

Strategic Data Systems (SDS) in violation of GAAP. ¶ 57 (k).

The plaintiffs' allegation that the defendants committed fraud

by reporting the company's results for the fourth quarter of 1997

and year end 1997 fails to meet the pleading requirements outlined

above because the plaintiffs fail to explain how or in what

particulars the reported earnings and revenues figures were

inaccurate, and their conclusory allegation that the defendants

knew the figures were false relies on “group pleading” and fails to

plead facts with the requisite specificity to generate a strong

inference of scienter. An unsupported general claim of the

existence of company reports reflecting contrary information is

insufficient to survive a motion to dismiss. “Such allegations

must have corroborating details regarding the contents of allegedly

contrary reports, their authors and recipients.” Abrams, 292 F.3d

at 432 (emphasis added). See also Goldstein v. MCI Worldcom, 340

F.3d 238, 253 (5th Cir. 2003) (following Abrams and noting that

there the allegations “that the individual defendants (the CEO and

CFO) received daily, weekly, and monthly financial reports that

appraised them of the company’s true financial status” were

insufficient and overly general); Tchuruk, 291 F.3d at 358

(allegations concerning ‘regular reports’ from specified subsidiary

28
to parent and to parent’s CEO and named member of executive

committee insufficient because “any such ‘regular reports’ are

insufficiently identified as to who prepared them and how

frequently they were prepared”); id. at 356 (“a plaintiff needs to

specify the internal reports, who prepared them and when, how firm

the numbers were or which company officers reviewed them;” internal

quotations and citation omitted).

Next, the plaintiffs allege that “INSpire held a telephonic

conference call for” securities analysts, money and portfolio

managers, institutional investors, large shareholders, brokers and

stock traders subsequent to the release of the fourth quarter 1997

results in which they announced seven new contracts, and that

“Dunham and Gaines . . . [d]uring the call – and in follow-up

conversations with participants” – made generally positive

statements about demand for INSpire's products and services,

predicted $46 million in revenues for 1998, and earnings per share

of $.60 and $.86 in 1998 and 1999, respectively. ¶ 40. The

plaintiffs cite a January 30, 1998, Raymond James & Associates

report on INSpire that relied on the new contracts and forecasted

earnings outlined in the conference call and in follow up

conversations “with Dunham and/or Gaines.” ¶ 42.

The defendants argue that these alleged false statements in

paragraph 40 and many others in the Complaint constitute “forward-

looking statements” protected by the PSLRA’s safe harbor

29
provision.13 15 U.S.C. § 78u-5(c)(1)(A). A "forward-looking

statement," which can be either written or oral, is defined under

15 U.S.C. § 77z-2(i)(1) as:

“(A) a statement containing a projection of
revenues, income (including income loss), earnings
(including earnings loss) per share, capital
expenditures, dividends, capital structure or other
financial items'
(B) a statement of the plans and objectives of
management for future operations, including plans
or objectives relating to the products or services
of the issuer;
(C) a statement of future economic performance,
including any statement contained in a discussion
and analysis of financial condition by the
management or in the results of operations included
pursuant to the rules and regulations of the
Commission . . .”

To avoid the safe harbor, plaintiffs must plead facts demonstrating

that the statement was made with actual knowledge of its falsity.

Id. at § 78u-5(c)(1)(B); Nathenson, 267 F.3d at 409. The safe

harbor has two independent prongs: one focusing on the defendant's

cautionary statements and the other on the defendant's state of

mind. 15 U.S.C. §§ 77z-2(c)(1)(A), 78u-5(c)(1)(A) (1996); 15

U.S.C. §§ 77z-2(c)(1)(B), 78u-5(c)(1)(B) (1996). Under the first

prong, there is no liability if, and to the extent that, the

forward-looking statement is: (i) "identified as a forward-looking

statement, and is accompanied by meaningful cautionary statements

identifying important factors that could cause actual results to

13
Defendants refer the court to ¶¶ 40, 42-45, 56, 59, 67, 76-
79, 88, 99, 101-103, and 105.

30
differ materially from those in the forward-looking statement," or

(ii) "immaterial." Id. at §§ 77z-2(c)(1)(A), 78u-5(c)(1)(A).

Under the second prong, there is no liability if the plaintiff

fails to prove that the statement (i) if made by a natural person,

was made with actual knowledge that the statement was false or

misleading, or (ii) if made by a business entity, was made by or

with the approval of an executive officer of that entity with

actual knowledge by that officer that the statement was false or

misleading. Id. at §§ 77z-2(c)(1)(B), 78u-5(c)(1)(B). The

requirement for "meaningful" cautions calls for "substantive"

company-specific warnings based on a realistic description of the

risks applicable to the particular circumstances, not merely a

boilerplate litany of generally applicable risk factors. H.R.

CONF. REP. NO. 369, 104th Cong., 1st Sess. 31, 44 (1995). Oral

statements can qualify for the safe harbor if (i) the statement is

accompanied by a cautionary statement that the "particular" oral

statement is forward-looking and that actual results could differ

materially (essentially a formality as to the form of the

statement); (ii) the statement is accompanied by an oral statement

that additional information that could cause actual results to

differ materially is contained in a readily-available written

document; (iii) the statement identifies the document or portion

thereof containing the additional information; and (iv) the

identified document itself contains appropriate cautionary

31
language. 15 U.S.C. §§ 77z-2(c)(2), 78u-5(c)(2) (1996). Readily

available written documents for this purpose include documents

filed with the SEC or generally disseminated. Id. at §§

77z-2(c)(3), 78u-5(c)(3).

With regard to the five alleged misstatements cited in

paragraph 40, the predictions of future earnings and revenues in

these statements meet the PSLRA’s definition of a forward-looking

statement. 15 U.S.C. § 78u-5(i)(1)(A). However, the defendants

have not shown that these statements were identified as forward-

looking statements. Accordingly, the plaintiffs may properly

allege a claim based on these statements if they were made with

actual knowledge that they were false or misleading. However, the

second and third statements of the five in paragraph 40 are non-

actionable puffery, as they are “of the vague and optimistic type

that cannot support a securities fraud action . . . and contain no

concrete factual or material misrepresentation.” Lain v. Evans,

123 F. Supp. 2d 344, 348 (N.D. Tex. 2000) (citation omitted).

Because analysts "rely on facts in determining the value of a

security," these statements "are certainly not specific enough to

perpetrate a fraud on the market." Raab v. Gen. Physics Corp., 4

F.3d 286, 290 (4th Cir. 1993); Rosenzweig v. Azurix Corp., 332 F.3d

854, 869 (5th Cir. 2003). The generalized, positive statements

about the company's competitive strengths, experienced management,

and future prospects are not actionable because they are

32
immaterial. Rosenzweig, 332 F.3d at 869.

It is arguable whether the plaintiffs adequately allege when

this conference call, and therefore these statements, took place.

Although the Complaint does not date the conference call, it states

that it occurred after INSpire released its December 31, 1997,

results and, because paragraph 41 of the Complaint alleges

INSpire's stock price rose following this call between January 27

and 29, the implication is that the call occurred between January

25 or 26 and January 27, or at least between January 1 and January

27. Although Rule 9(b) does not require that a specific date and

time always be alleged as to each misrepresentation, several courts

have held that simply "outlin[ing] a four-month window during which

all of the misrepresentations occurred . . . does not satisfy the

pleading standard of rule 9(b)." Skylon Corp. v. Guilford Mills,

Inc., No. 93 5581, 1997 U.S. Dist. LEXIS 2104, *6 (S.D.N.Y. Mar. 3,

1997); accord Doehla v. Wathne Ltd., Inc., 1999 U.S. Dist. LEXIS

11787, No. 98 6087 (S.D.N.Y. Aug. 3, 1999) (holding that an

allegation that statements were made over the course of a

four-month period is insufficient for Rule 9(b) purposes). However,

given the context we will assume arguendo that this allegation

provides sufficient notice to the defendants to meet the “when”

requirement under Rule 9(b).

We agree with the district court that the alleged statements

contained in paragraph 40 are not supported by sufficient

33
particular facts to give rise to a strong inference of knowing

falsity. Several of the statements, as noted above, are so general

as to constitute puffing. And, the “Dunham or Gaines” allegations

(¶ 42) insufficiently charge either one. Further, the plaintiffs

fail to provide sufficient facts to raise a strong inference of

scienter as to the falsity of the revenue and earnings projections

when made. The closest the plaintiffs come is in paragraph 57(k)

of the Complaint where they allege “INSpire's reported revenues and

earnings were materially overstated due to improper revenue

recognition, failure to write off uncollectible receivables,

improper capitalization of software development costs and failure

to write down SDS goodwill in violation of Generally Accepted

Accounting Principles.” The plaintiffs, however, fail to plead

facts demonstrating that any of the individual defendants actually

knew ,or were severely reckless in not knowing, of these alleged

infirmities. The plaintiffs' Complaint pleads more facts relating

to scienter as to the flaws in INSpire's software that formed the

basis of the contracts underlying these estimates, but the alleged

shortcomings of INSpire's software do not adequately show scienter

on the part of any particular individual defendant respecting

projected revenues and earnings that assume the terms of INSpire's

contracts will sufficiently be met.

Paragraphs 40 through 42 concern statements made by analysts

and brokers in reports on INSpire. Generally, securities issuers

34
are not liable for statements or forecasts disseminated by

securities analysts or third parties unless they have "sufficiently

entangled [themselves] with the analysts' forecasts [so as] to

render those predictions 'attributable to [the issuers].'" Elkind

v. Liggett & Myers, Inc., 635 F.2d 156, 163 (2d Cir. 1980); In re

Navarre Corp. Sec. Litig., 299 F.3d 735, 743 (8th Cir. 2002). In

order to attribute third-party statements to the defendants, the

investors must demonstrate that the statements were adopted by the

defendants or attributable to the defendants in some way, such as

when officials of a company "have, by their activity, made an

implied representation that the information they have reviewed is

true or at least in accordance with the company's views." Elkind,

635 F.2d at 163; Navarre, 299 F.3d at 743. The investors could

also allege that the defendants used the analysts as a conduit,

making false and misleading statements to securities analysts with

the intent that the analysts communicate those statements to the

market. Cooper v. Pickett, 137 F.3d 616, 624 (9th Cir. 1997);

Navarre, 299 F.3d at 743. The plaintiff must plead with

particularity how these exceptions apply, including who supplied

the information to the analyst, how the analyst received the

information, and how the defendant was entangled with or

manipulated the information and the analyst. Navarre, 299 F.3d at

743; Raab v. General Physics Corp., 4 F.3d 286, 288 (4th Cir.

1993). Since the allegation of entanglement is central to the

35
overall allegation of securities fraud, it must be pleaded with the

required degree of specificity. In re Caere Corporate Sec. Litig.,

837 F. Supp. 1054, 1059 (N.D. Cal. 1993). The pleading should (1)

identify the specific forecasts and name the insider who adopted

them; (2) point to specific interactions between the insider and

the analyst which allegedly gave rise to the entanglement; and (3)

state the dates on which the acts which allegedly gave rise to the

entanglement occurred. Wool v. Tandem Computers, Inc., 818 F.2d

1433, 1439 (9th Cir. 1987). However, analysts' statements that

reflect their own opinions or forecasts may not be charged to the

defendants because the plaintiffs have not sufficiently alleged

entanglement and the adoption of such statements by the defendants.

The analysts' statements in paragraphs 42 through 44 consist

primarily of forward-looking statements for which the plaintiffs do

not allege facts sufficient to create a strong inference of

scienter on the part of defendants and statements of analysts' own

opinions for which the defendants are not liable. Also, the

plaintiffs fail to explain how these statements were false or

misleading due to material omissions when they were made.

The statements in paragraph 45 allegedly made by Dunham to

Investor's Business Daily are mere puffery, with the exception of

his statement that revenue from outsourcing will increase from its

current rate. The plaintiffs do not plead facts sufficient to

raise a strong inference that Dunham had the requisite scienter

36
respecting the falsity of their latter statement.

Paragraph 46 quotes statements from a February 24, 1998

INSpire press release announcing INSpire's contract with Brazilian

insurer Sul America to provide a software system “for all of its

non-auto business that will automate the processing of one-half

billion dollars worth of policies,” that INSpire “will install its

PC-based software system, Windows into Property and Casualty System

(WPC), in 16 Sul America branch locations throughout Brazil over a

12 month period,” that “[t]he majority of the installation process

will be coordinated by INSpire’s branch office in Columbia, S.C.,

and Sul America’s home office in Rio de Janeiro” and that “[t]he

joint installation team will work closely with INSpire’s in-house

software development team.”14

In paragraph 48, the plaintiffs allege that “defendants” (not

otherwise identified) omitted material details about the Sul

America contract from the February 24 press release by failing to

disclose that INSpire was required to purchase a performance bond

in the amount of $3.7 million and that the contract was segregated

into three phases. Which, if any, of the individual defendants

knew of those provisions is not alleged. The plaintiffs also

allege therein that “defendants [not otherwise identified] knew

that the volume at large companies was simply too much for the WPC

14
Because the February 24 press release contains no
identification of statements as forward looking and does not
include any cautionary language, it does not fall within the
first prong of the forward looking statement safe harbor.

37
system to handle;” that unidentified “Senior installers told

defendants that what INSpire was attempting with WPC at Sul America

was an impossibility;” that unidentified INSpire “IT personnel”

told “INSpire management repeatedly that it was, in effect,

installing nothing more than a test product at Sul America;” and

that “defendants thus knew that Sul America would be dissatisfied

and that the completion of all phases of the contract would not

materialize.” These allegations improperly rely on group pleading

and fail to identify any individuals made aware of the software's

purported inadequacies; the allegations likewise fail to identify

any individuals who made the statements about the software or Sul

America, or where, when or on what occasion(s) the statements were

made and whether they were oral or written or both. These

allegations are hence insufficient to give rise to a strong

inference of scienter on the part of any one individual.15

Paragraph 51 reproduces statements from an analyst's report

discussing the analyst's assessment of the insurance claims

administration market and INSpire's general strategy, none of which

contain any alleged misstatements. Paragraphs 52 through 54

address INSpire's March 23, 1998 filing of SEC Form 10-K and its

15
The allegations concerning failure to mention the surety
bond and contract phasing provisions are also deficient in that
the factual allegations of the Complaint do not reflect, and it
does not otherwise appear, that the omission of these details
from the press release rendered it misleading. Moreover, a copy
of the Sul America contract was filed with the SEC in connection
with the March 1998 secondary offering, all without any apparent
adverse effect on the market price of INSpire stock.

38
March 26, 1998 Prospectus/Registration Statement pursuant to its

stock offering. None of the statements in the Prospectus cited by

the plaintiffs are attributed to any of the individual defendants.

The plaintiffs also fail to explain how the general plans outlined

in the Prospectus were false when made. Finally, while the

plaintiffs identify omissions such as the surety bond and the

alleged limitations of INSpire's software, they do not plead facts

that give rise to a strong inference of scienter as to these

omissions, because they do not aver when any individual defendant

either became aware of the software problems or acted with severe

recklessness in being unaware of them. Paragraph 55 cites forward-

looking statements in a broker's report for which the defendants

are not accountable because they represent the analyst's own

opinion as to INSpire's future performance, as indicated by the

fact that they are prefaced with the words “[w]e believe.”

Paragraph 56 quotes comments by Dunham in his letter accompanying

INSpire's Annual Report to Shareholders that consist of factual

statements about INSpire's business strategy and recent

developments, including statements such as an allusion to the Sul

America contract, and puffing, including statements such as “We

enter 1998 with a great deal of momentum.”

Paragraph 57 recites alleged omissions that were necessary to

make the statements cited earlier not misleading and attempts to

plead scienter. The plaintiffs, however, critically fail to plead

with particularity facts that would give rise to a strong inference

39
of scienter on the part of any individual defendant.

In paragraph 57(a), note 3, plaintiffs allege that WPC “was

first developed solely as an administrative system for personal

lines of homeowners auto insurance. . . . Although defendants sold

WPC as a complete solution for the administration of both personal

and commercial lines, WPC only been designed for personal auto

insurance and was not yet capable of processing commercial lines.”16

Plaintiffs also allege the inability of WPC and EmPower to run

simultaneously and interface with each other, that EmPower

originally could not correctly scan typewriting or handwriting,

that it was fixed as to typewriting but INSpire could not fix it

for handwriting, though most applications were handwritten. ¶

57(e). It is also alleged that “Defendants knew EmPower did not

work when INSpire bought it” in May 1997 and that “[t]he original

designer and developer of EmPower, SDS, designed the product for

small networks only. INSpire therefore knew before the purchase of

the EmPower system that EmPower was not designed for high volume

networks.” ¶ 57(f). Plaintiffs also allege that INSpire

programmers, despite ongoing efforts to do so, were never able to

successfully modify these software programs to process the volume

and complexity of policies maintained by Sul America and other

unspecified clients with whom INSpire contracted. They further

allege that “INSpire insiders, including, but not limited to,

16
Paragraph 57 also essentially repeats the allegations of
paragraph 48, herein above discussed and held insufficient.

40
defendants Lynn, Robinson, and Dunham, were repeatedly told by

INSpire programmers and developers that EmPower would never work as

defendants had represented it to work.” ¶ 57(f). This allegation,

however, is insufficient because it fails to state when, where or

on what occasion or occasions this occurred, fails to in any way

identify the INSpire programmers and developers involved, and does

not indicate whether their statements were oral or written or given

any meaningful particulars as to what was stated.

The Complaint alleges that “at least one” INSpire officer

directed the faking of a demonstration, but does not specify which

officer did so, when he did it, or where. Complaint, ¶ 57(d).

Similarly, the Complaint also fails to specify when (other than

“throughout the Class Period”), where, to whom, whether orally or

in writing, in what context or setting, and in reference to what

particular products or aspects thereof, the “smoke and mirrors”

remarks were made by unidentified “employees in the IT department,”

unidentified “managers” and “even Defendant Gaines” to refer to

INSpire's “software products.” Complaint, ¶ 57(b). The plaintiffs

likewise fail to specify when and where defendant Lynn made his

alleged comments that EmPower, one of INSpire's software programs,

“did not work.” Complaint, ¶ 57(f). No date more specific than the

class period is provided for these remarks and “meetings with upper

management” is too vague of an indication of where or to whom the

alleged comment was made. Complaint, ¶ 57(f). Nor is any

indication given as to what particular function of the program Lynn

41
was addressing. The plaintiffs also cite Robinson's alleged

statements to unidentified INSpire IT personnel who questioned the

functionality of the company's software programs to “get with the

program or get out the door.” Complaint, ¶ 57(b). While this

statement may suggest Robinson harbored an intent to deceive, the

plaintiffs fail to identify when and where Robinson made this

statement, or what particular function of what program was being

addressed, and therefore do not meet the particularity requirement

for pleading facts giving rise to a strong inference of scienter on

Robinson's part. The plaintiffs also allege that unidentified

“INSpire engineers regularly read” unidentified INSpire “press

releases” and joked to one another, “I didn't know it could do

that” as to unidentified claims made about the capabilities of

INSpire's software. Complaint, ¶ 57(c). In addition to the fact

that this statement is suggestive of the state of mind of the

engineers rather than of any other individuals, the plaintiffs

again fail to identify the elements of “who, when, and where”

needed to plead scienter with particularity. It is also alleged

that the defendants “knew that EmPower was incapable of interfacing

with other vendors' systems or insurers' proprietary systems” even

while the software was marketed as an integrated, turnkey solution.

Complaint, ¶ 57(g). This allegation fails as to the individual

defendants, however, because it relies on “group pleading” and does

not set forth with particularity how and when any of the individual

defendants became aware of this alleged problem with EmPower. The

42
plaintiffs further allege that INSpire “was manipulating the

amounts charged to Millers to improve INSpire's reported results,”

but they fail to plead when, where, and at who's direction this

occurred. Complaint, ¶ 57(h). The remaining allegations

enumerated in paragraph 57 rely on “group pleading” and fail to

allege with sufficient specificity the “when and where” elements

needed to meet the requirement of pleading facts with particularity

to show scienter.

April 22, 1998 – August 14, 1998

With paragraph 58, the plaintiffs move to the second sub

period, April 22, 1998, to August 14, 1998. Paragraphs 58 through

68 recount statements by INSpire and its executives in corporate

documents and a newspaper article, as well as statements by brokers

and analysts. The statements address earnings and revenue

estimates, the Paragon acquisition, and contracts INSpire entered

into with Sul America, Kemper Insurance, Atlantic Preferred

Insurance Company, Harbor Insurance, Orion Capital Companies, and

Patterson Insurance Company to provide claims administration

software. Many of the statements in these paragraphs are forward-

looking and large portions of the analysts' reports consist of the

opinions and forecasts of the analysts themselves, unaccompanied by

any allegation of entanglement or ratification by any defendant.

Furthermore, many of the statements allegedly made by an identified

defendant in these paragraphs are mere puffery, such as Dunham's

statement that “[t]he first quarter of 1998 was extremely

43
significant for INSpire Insurance Solutions.” ¶ 58. With regard

to each of the statements alleged by the plaintiffs in these

paragraphs, the plaintiffs fail to plead at least one of the

following elements with particularity: when the statements were

made, where they were made, and sufficient allegations for charging

any individual defendant with them. As with the allegations

concerning the first sub period, the plaintiffs do not explain in

connection with or closely following the allegations concerning the

making or issuance of the statements alleged in this section how

the statement was false or misleading, or how and when any

identified individual defendants knew, or was severely reckless in

not knowing, the inaccuracy of the statement. To the extent why a

particular statement is false or misleading is explained and

scienter is pleaded, this occurs in paragraph 69.

Paragraph 69, like paragraph 57, is where the plaintiffs

attempt to plead scienter as to the facts alleged during this sub

period. Paragraph 69 simply repeats many of the allegations

contained in paragraph 57, adding only:

“(n) INSpire had taken an excessive charge for
purchased research and development in connection
with its acquisition of Paragon, writing off $2
million rather than the $400,000 which should have
been recognized. Thus, INSpire was understating
the goodwill amortization charge which should have
been expensed in every quarter after the
acquisition.
(o) As a result of the aforementioned factors, the
defendants actually knew that their forecasts of
40% earnings growth in 1999 to $0.86 where in fact
unreasonable and false.”

44
These allegations fail to plead with particularity facts giving

rise to a strong inference of scienter because they rely on “group

pleading” insofar as they fail to identify which of the individual

defendants knew that the forecasted earnings growth was false. The

above allegations also fail to allege which defendants, if any,

were aware of the specific factors mentioned in ¶ 69(n) that form

the basis of the allegation in ¶ 69(o), which would be merely

conclusory absent scienter as to the facts in (n). Moreover, these

allegations also fail because they do not explain how any defendant

knew, or was severely reckless in not knowing, the proper way to

expense the goodwill amortization charge for the Paragon

acquisition, or that the forward-looking earning statements were

false when made. The remainder of paragraph 68 suffers from the

same fatal “group pleading” and lack of particularity defects

explained above in reference to the essentially identical

allegations set forth in paragraph 57.

September 28, 1998 – November 16, 1998

With paragraph 70, the plaintiffs begin their recitation of

allegations concerning the sub period running from September 28,

1998, to November 16, 1998. Paragraphs 70 through 79 recount

INSpire's September 28 announcement of two software sales

contracts, its October 21 press release addressing its third

quarter 1998 results, and its November 1, 1998 announcement of a

10-year outsourcing agreement with Arrowhead General Insurance

Agency to use INSpire's software and personnel to process their

45
claims. The Complaint also recites INSpire's discussions with

analysts during this time and the subsequent favorable reports

released by these analysts. Complaint, ¶ 76-79. The Complaint

charges that, during this time, Durham and other individual

defendants took advantage of the alleged inflation of INSpire's

stock price, which had increased to $35 3/8 a share, by selling

106,150 shares of their stock for $3.2 million. Complaint, ¶ 80.

INSpire shares had traded between $22 and $25 from October 22

through October 30, 1998. Before October 30, INSpire had traded as

high as $27 on only two days ($27.75 on September 16 and $27.125 on

September 15, 1998). From November 3, 1998, through December 10,

1998, INSpire did not trade below $30 per share, and for several

days traded at or above $33, reaching its high of $35.25 on

November 23, 1998. On December 11, INSpire issued a press release

reducing its estimate of 1999 earnings from $0.90 to $0.84 per

share “due to lower than expected margins” on the Arrowhead

contract “as well as a decrease in anticipated revenues from

another outsourcing contract.” Complaint ¶ 82. The price of

INSpire stock fell from $30.813 on December 10 to $17.625 the next

day. It remained below $20.00 until the latter part of April 1999,

and after December 10, 1998, never traded as high as $22.00.

Many of the complained of statements alleged in these

paragraphs are forward-looking, represent the opinions of analysts

as to which facts are not alleged showing any defendant to bear

liability, or consist of mere puffery. Except as below noted, with

46
regard to each of the statements alleged by the plaintiffs in these

paragraphs, the plaintiffs fail to plead at least one of the

following elements with particularity: when the statements were

made, where they were made, and sufficient allegations for charging

any individual defendant with them. As in the earlier two sub

periods, the plaintiffs largely fail to explain in connection with

or shortly after the allegations concerning the making of the

statements alleged in this period how that statement was false or

misleading, or how and when any individual defendant knew or was

reckless in not knowing the inaccuracy of the statement. Instead,

to the extent the false or misleading nature of a particular

statement is explained and scienter pleaded at all, this is

generally saved for paragraph 81.

Paragraph 81 largely replicates the allegations contained in

paragraphs 51 and 69, adding only the following new averments:

“(o) The Arrowhead deal would require a major
infusion of money to make it profitable and would
not provide earnings to INSpire for at least a
year.
(p) Arrowhead was not servicing enough policies to
generate anywhere close to $35 million in revenue
in year one under the contract. There were
approximately 20,000 policies involved with the
Arrowhead deal and this number of policies could
not possibly generate $35 million in revenue for
INSpire.
(q) INSpire was completely unprepared to handle a
project as large as Arrowhead. INSpire did not
have employees qualified to install a product for a
company such as Arrowhead. Furthermore, the
products sold to Arrowhead were not designed to
service a company of Arrowhead's size.
(r) Ultimately, INSpire was forced to lay off close
to 10% of its workers due to INSpire's need to

47
 discontinue its efforts to develop licensed
software packages. The Company's software services
and licensing business deteriorated until this
layoff became necessary.
(s) As a result of the aforementioned factors, the
defendants actually knew that their forecasts of
40% earnings growth in 1999 to $0.86 and in 2000 to
$1.20+ were in fact unreasonable and false.”

These allegations are plagued by the same defects as those in the

previous class periods. First, the averments in ¶ 81(o) through

(s) rely on “group pleading”, as they fail to identify any

individual. Second, these averments do not themselves allege when,

where, and how any individual knew, or was severely reckless in not

knowing, that INSpire was incapable of performing the Arrowhead

contract. Nor do the plaintiffs explain how or when any individual

actually knew the forward-looking estimate in (s) was false when

made. As such, these allegations by themselves fail to allege with

particularity facts that, absent additional evidence, would give

rise to a strong inference of scienter on the part of any

individual.

Paragraph 76 alleges that “[i]n connection with the [November

1, 1998] release announcing the [Arrowhead] agreement . . . Dunham

and Smith spoke to securities analysis” and “[d]uring these

conversations with analysts, Dunham and Smith directly disseminated

important information into the market, stating: [t]he deal would

add $0.05 per share to 1999 earnings and beyond that so that the

Company would be on track to report EPS of $1.20 in 2000" and

“[t]he cost to INSpire . . . would be $28 million in cash and stock

48
options” and the deal “would generate $35 million in year one

revenues.” While this is a forward looking statement, it cannot be

ascertained from the record whether it was accompanied by

meaningful cautionary language; hence, it is actionable if made

with actual knowledge of its false or misleading character. A

little more than a month after these statements, on December 11,

1998, INSpire revised downward its 1999 earnings forecast, citing

lower than anticipated margins on the Arrowhead contract. Nothing

in the record suggests any knowledge INSpire or Dunham had in this

respect on December 11 that they lacked in early November. The day

following the December 11 announcement, INSpire stock fell by about

42 percent of its value the preceding day. On November 4 and 5,

only a few days after the November 1 Arrowhead announcement and

Dunham’s comments in that respect, Dunham sold 69,150 shares of

INSpire, 16.56% of his holdings, for total proceeds in excess of $2

million. His average price per share was over $30, well above what

the stock had been trading for before November 1, and likewise more

than 30% higher than what it would ever trade at after December 10.

We conclude that these Dunham sales and this sequence of

events, considered in light of all the other facts and

circumstances alleged, including Dunham’s position as CEO, which he

had held ever since INSpire was spun off, his total sales

throughout the class period of over 40 percent of his INSpire

stock, and his personal involvement in promoting the Arrowhead

contract and touting the increased revenues and earnings it would

49
produce, suffice, albeit only barely so, to create a strong

inference of the requisite scienter on Dunham’s part in regard to

his early November statements in connection with the Arrowhead

announcement.17 Because it is alleged that Dunham, with the

requisite scienter, made these statements as INSpire’s CEO and on

its behalf, and in the course of his INSpire employment, INSpire’s

respondent superior liability for those statements is also

adequately alleged. Paul F. Newton & Co. v. Texas Commerce Bank,

630 F.2d 1111, 1118 (5th Cir. 1980).

December 11, 1998 – August 16, 1999

Beginning in paragraph 82, the plaintiffs outline their

allegations relating to the fourth sub period, which runs from

December 11, 1998, to August 16, 1999. In December 1998, INSpire

revealed a decline in earnings growth and disclosed that the

Arrowhead contract would not generate earnings previously forecast,

causing the price of INSpire stock to decline from $30 to $17.

17
It is alleged that Smith also made such statements, but
Smith made no stock sales at any time during the class period.
While Robinson, Gaines and Lynn sold shares in early November
1998 they each sold significantly less than Dunham then sold
(Robinson and Gaines less than one sixth of what Dunham then
sold, Lynn less than a fourth; Robinson and Gaines then sold a
smaller percentage of their shares than did Dunham, Lynn sold a
slightly larger percentage of his), and, more importantly, they
are not identified in connection with any statements between
October 22 and December 12, 1998, or concerning the Arrowhead
contract.
We do not hold that the establishment (on summary judgment
or at trial) of context facts not addressed in the Complaint
could not preclude a finding of actual knowledge against Dunham;
this appeal addresses only the sufficiency of the Complaint.

50
Complaint, ¶ 82. On January 26, 1999, INSpire released its fourth

quarter 1998 and 1998 results, followed by its SEC 10-Q and 10-K

filings on March 24 and 25. Complaint, ¶ 87, 92, 93. On March 29,

INSpire announced a 10-year contract with auto insurer Robert Plan

Corp. to provide claims administration using INSpire's WPC

software. This contract was highlighted in the company's April 21

release of its first quarter 1999 results. Complaint, ¶ 94, 99.

On May 14, INSpire filed its 10-Q for the 1999 first quarter.

Complaint, ¶ 104. On June 17, INSpire announced its 10-year

contract with Island Insurance for claims administration, stating

that it “will produce many positive results." Complaint, ¶ 105.

Many of the statements in these paragraphs are forward-

looking, represent the opinions of analysts as to which defendants

do not bear liability, or consist of mere puffery. Apart from the

SEC filings, plaintiffs fail to plead with particularity when the

statements in these paragraphs were made or where they were made.

As with the previous sub periods, the plaintiffs fail to explain in

connection with or shortly after the allegations concerning the

making of statements alleged in this section how that particular

statement was false or misleading, or how and when any individual

defendant knew, or was severely reckless in not knowing, the

inaccuracy of the statement. To the extent misstatements or

omissions are identified and scienter is pleaded, that is done in

paragraph 109.

51
 Paragraph 109 repeats numerous allegations contained in

paragraphs 51, 69, and 81, adding the following averments relating

primarily to the Robert Plan and Island Insurance contracts:

“(g) When negotiations began with The Robert
Plan Corporation to use the new EmPower program
with their outsourcing, EmPower still was not close
to functioning. The workflow processing
capabilities were not working and many of the
technical problems outlined above remained.
INSpire programmers had many conversations with
defendants Robinson and Lynn, telling them
explicitly that EmPower was not ready to be used
with the Robert Plan contract.
(h) Also, as occurred with Sul America, WPC was not
designed to handle processing for large insurance
companies such as Robert Plan. WPC was designed
for insurance companies that processed
approximately $20-$80 million in policies per year
as opposed to the Robert Plan which processed more
than $100 million in policies per year. Because
WPC was designed for smaller insurance companies,
it had limited processing power and speed. WPC was
designed to run a processing cycle each night.
During that cycle, the system goes through all of
the policies. Because of its design, WPC could
only process a limited number of policies a night.
Because RPC had so many policies, however, WPC did
not have the capability to process all of Robert
Plan's policies every night. Although the contract
between INSpire and Robert Plan called for full
implementation of WPC within a twelve-month period,
defendants knew that this was totally unrealistic.
Defendants knew that it would take a year just to
perform a requirements study and to test the
system.
(i) In a June 2000 meeting, defendant Robinson
told attendees at the InsPIRE Senior Staff Meeting
that INSpire knew when it signed the Robert Plan
contract that it could not meet the implementation
schedule, but that INSpire signed the contract
anyway to “get the business.”
(j) In a January 7, 2001 article in The Fort
Worth Star-Telegram, John Pergande, the new CEO of
INSpire, admitted that in 1999 revenue failed to
materialize and projects lagged ‘largely because
the company didn't have the resources to execute

52
 the contracts it signed.’ In a January 14, 2001
article in the Sheboygan Press, authored by Martha
H. Shad, Pergande discussed the INSpire business
model and Pergande admitted, ‘I believe that in the
past when a customer said they wanted something by
a certain date, it was promised whether it was
feasible or not. We're not going to do that
anymore . . . .”
(k) After all the failures enumerated above,
INSpire then tried to make EmPower work with WPC.
INSpire first tried this with customer Arrowhead
Insurance, then at Island Insurance and Robert
Plan. Although INSpire was promising workflow
solutions to these clients, EmPower was not even
close to functioning with WPC.
(l) Defendants told Island Insurance that WPC
could be used for policy and claims administration
of both their personal and business lines of
insurance. However, WPC was not functional on
administration of business lines of insurance. The
inability of WPC to handle commercial processing is
the reason that Island Insurance terminated their
contract with INSpire. Jim Strickland, Vice
President of Sales and Marketing, at the
instruction of Dunham, told Island Insurance that
WPC could rate commercial properties. This promise
was made even though WPC was not in fact capable of
rating commercial lines and was not designed to
rate commercial lines and Dunham knew it.”

The allegation in (g) that, when negotiations began with

Robert Plan, the EmPower was not close to functioning does not

allege particular facts giving rise to a strong inference of

scienter on the part of any of particular individual. In addition,

the subsequent allegation concerning conversations between

unidentified INSpire programmers and Robinson and Lynn fails to

indicate when or where such conversations occurred. The

allegations set forth in (h) suffer from the “group pleading”

defect, as they fail to delineate among the individual defendants

as to their state of mind with respect to the alleged unsuitability

53
of the WPC software for performing the Robert Plan contract. These

allegations also fail to explain when and how any particular

individual defendant came to know, or was severely reckless in not

knowing, of the asserted mismatch between the capabilities of the

WPC software and the demands of the Robert Plan contract. The

allegation in (i) that Robinson told attendees at “a June 2000

meeting” of INSpire senior staff that “INSpire knew when it signed

the Robert Plan contract [in March 1999] that it could not meet the

implementation schedule,” is insufficient because, in addition to

its overly vague identification of the meeting, it contains no

information suggesting such knowledge on the part of any identified

individual nor any indication of any basis on which (or when)

Robinson reached the general conclusion he allegedly expressed.

The allegations set forth in (j) concerning January 2001 statements

lack particularity because they refer only vaguely to the company's

conduct and state of mind “in the past,” which is overly vague.

The allegation in (k) that after diverse failures “INSpire then

tried to make EmPower work with WPC” for customers Arrowhead,

Island and Robert Plan, but “EmPower was not even close to

functioning with WPC,” does not allege facts giving rise to a

strong inference of scienter as to any individual. In (l) the

allegation that Strickland, at Dunham’s instruction, “told Island

Insurance that WPC could rate commercial lines” even though it

could not “and Dunham knew it,” is likewise insufficient in that no

facts are stated as to how or when that was known by Dunham, nor

54
when, where, how or to what person Strickland so informed Island.

October 15, 1999 – March 31, 2000

On October 15, 1999, INSpire announced large write-offs and

disappointing third quarter 1999 results. Complaint, ¶ 110. After

negative reports by analysts reacting to this news, INSpire's stock

price dropped below $4 per share. ¶¶ 111-113. The Complaint

describes how a number of INSpire's clients terminated contracts

with the company and, in some cases, sued INSpire for breach of

contract. Complaint, ¶ 114-116. In January 2000, INSpire reported

its financial results for the fourth quarter and year ended

December 31, 1999, all of which showed substantial net losses.

Complaint, ¶ 118. The Complaint alleges that, subsequent to

December 31, 1999, INSpire's stock price dropped below $1 per

share. Complaint, ¶ 118. Lastly, the Complaint avers that

INSpire’s then President, Smith, resigned effective January 7,

2000, CFO Kenneth Meister resigned effective March 31, 2000,

executive Eric Yerina resigned, and defendant Robinson was fired

and sued INSpire. Complaint, ¶ 119. The foregoing paragraphs

summarizing INSpire's decline do not identify alleged misstatements

or omissions, nor do they address any individual’s scienter. We

agree with the district court that, because fraud cannot be proved

by hindsight, subsequent lawsuits are unpersuasive of scienter, as

they do not show what any particular individual knew, or was

severely reckless in not knowing, at the time the contracts were

entered into. The subsequent resignations of INSpire executives is

55
similarly unavailing as proof of the commission of fraud by these

or other individuals.

Financial Reporting

The next section of the Complaint concerns INSpire's allegedly

false financial reporting throughout the overall class period. The

plaintiffs allege that the defendants reported inflated revenues

and earnings, improperly recognized revenues, improperly accounted

for goodwill, improperly capitalized software development costs,

and failed to record losses for uncollectible receivables. The

plaintiffs contend that all of these INSpire practices violated

GAAP. This section relies largely on “group pleading” and fails to

plead facts with sufficient particularity to generate a strong

inference of scienter as to any individual. The only reference to

any individual defendant in this section is in paragraph 121 where

plaintiffs allege:

“In fact, during 1998, Dunham once threw a financial
report back at Gaines because Dunham did not like the
numbers reflected in that report. Gaines informed an
employee who had witnessed the incident that when Dunham
did not like the numbers reflected in a financial report,
Dunham would insist that Gaines change those numbers.
Referring to George Dunham, Gaines told one INSpire
employee, “He wants me to write down numbers that don't
exist.” Dunham also instructed financial reporting
managers to back-date contracts in order to inflate
INSpire revenues for specified periods.”

While these allegations bear upon Dunham's general state of

mind, they are not stated with sufficient particularity, as they

fail to state when, other than sometime during 1998, and where

Dunham allegedly acted in this manner, and there is an entire

56
failure to relate or connect the matters set out in the above

quoted allegations to any particular alleged misstatement or

omission in any of INSpire’s financial reports (or, indeed, to any

particular such report).

Conclusion as to primary violations

In conclusion, we hold that the Complaint fails to properly

plead any section 10(b) or Rule 10(b)(5) violations except on the

part of Dunham with respect only to his November 1998 statements

made in connection with the Arrowhead contract announcement, and on

the part of INSpire, with respect to those same Dunham statements,

as having respondeat superior liability for those violations by

Dunham.

Section 20(a) control person liability

The Complaint seeks to also impose control person liability

under section 20(a) of the Securities Exchange Act, 15 U.S.C. §

78t(a), but only as to Dunham and INSpire.18 Control person

liability is secondary only and cannot exist in the absence of a

primary violation. Lovelace v. Software Spectrum Inc., 78 F.3d

1015, 1021 n.8 (5th Cir. 1996). Accordingly, the district court,

having determined that the Complaint alleged no primary violation,

also dismissed the section 20(a) claims. We have concluded that

18
Control person liability was also sought to be imposed on
Millers, but the appeal as to Millers has been severed out into a
separate case (see note 1 above) and we do not consider any
matter as to Millers.

57
the Complaint alleges no primary violations on the part of any

defendant except only as to Dunham respecting only his November

1998 statements in connection with the Arrowhead contract

announcement and as to INSpire, on the basis of respondeat

superior, respecting those same statements by Dunham. Dunham

obviously can have no section 20(a) liability for his own

statements. INSpire can have section 20(a) liability for a primary

violation by its employee Dunham, see Martin v. Shearson Lehman

Hutton, Inc., 986 F.2d 242, 244 (8th Cir. 1993), but INSpire would

in any event have respondeat superior liability for the referenced

primary violations by Dunham. Paul F. Newton & Co., 630 F.2d at

1118.19 Accordingly, our holding renders the section 20(a) claims

against Dunham and INSpire either invalid, as based on no properly

alleged primary violation, or essentially immaterial.

Failure to grant leave to amend

Plaintiffs complain that the district court failed to grant

them leave to amend the Complaint.

At the very end of their lengthy response to defendants’

motion to dismiss the Complaint, plaintiffs stated:

“For the foregoing reasons, plaintiffs respectfully
request that defendants’ motion be denied. If, however,
the Court dismisses the Complaint, plaintiffs request
leave to replead. Federal Rule of Civil Procedure 15(a)
directs that leave to amend ‘shall be freely given when

19
Section 20(a) liability is generally subject to the
affirmative defense of lack of participation and good faith. See
Abbott v. Equity Group, 2 F.3d 613, 619 (5th Cir. 1993).

58
 justice so requires.’”

So far as the record reflects, this is the entirety of what

plaintiffs communicated to the district court concerning amendment

to the Complaint. Plaintiffs never at any time either tendered a

further amended Complaint or advised the district court of how or

in what manner they would amend the Complaint or what allegations

would be added or deleted if allowed to do so.20 Nor have

plaintiffs at any time suggested they have relevant information

they were unaware of when the Complaint was filed (or that the

defendants’ motion to dismiss did not adequately inform them of the

asserted deficiencies in the Complaint).

Moreover, the district court’s prior order of dismissal

specifically found that “Plaintiffs should have one more

opportunity to amend their pleadings in accordance with the

requirements of Rule 9(b) and the PSLRA” (emphasis added) and

granted the plaintiffs until “April 16 [subsequently extended to

May 16], 2001 to file an amended complaint that complies with this

order” (emphasis added). That earlier order specifically noted

that “the PSLRA requires that securities-fraud claimants allege

particular facts demonstrating the required state of mind,” and

that the consolidated complaint failed to meet this standard. The

20
On appeal plaintiffs only inform us that “plaintiffs could
bolster an already compelling case of fraud, by pleading
additional facts corroborating the Complaint’s present
allegations” and “plaintiffs have material that could be added to
an amended complaint (while preserving, of course, their
counsel’s work-product privilege).”

59
earlier order also stated that the consolidated complaint “contains

numerous allegations against the defendants collectively or against

several defendants in the alternative” and was hence defective

“because of its reliance on group pleading,” which was “wholly

inconsistent with the strict-pleading requirement of the PSLRA”

under which plaintiffs “‘must properly plead wrongdoing and

scienter as to each individual defendant.’” Further, that order

noted that contrary to the requirements of the PSLRA, the

consolidated complaint “wholly fails to allege facts supporting an

inference the forward-looking statements to which they refer were

made with actual knowledge that they are false or misleading.”

In its subsequent order dismissing the Second Amended

Complaint and denying further opportunity to amend, the district

court specifically noted these holdings of its prior dismissal

order and that it had allowed plaintiffs “one more opportunity to

amend.” That order goes on to correctly observe that “Plaintiffs

have persisted in their reliance on the group-pleading doctrine

despite this Court’s previous Dismissal Order finding such method

of pleading inadequate,” that “[t]he Second Amended Complaint is

replete with instances of group pleading,” that (except for

jurisdictional and class action/party identification allegations

and quotations from press releases and analyst reports) “virtually

every paragraph in the Second Amended Complaint to some degree

relies on group pleading,” and that these allegations are hence

inadequate. This order likewise notes (correctly) that “Plaintiffs

60
have also continued to rely heavily on forward-looking statements.”

We further note that the district court correctly characterizes the

Second Amended Complaint as “a ‘labyrinth’” which makes “it highly

difficult for the Court to assess” its sufficiency “under Rule 9(b)

and the PSLRA.”

Under these circumstances it is clear that the district court

acted well within its discretion in concluding that plaintiffs

should not be afforded yet another opportunity to replead. See,

e.g., Goldstein, 340 F.3d at 254-55; Tchuruk, 291 F.3d at 362. See

also, e.g., US Ex Rel Doe v. Dow Chemical Co., 343 F.3d 325, 331

(5th Cir. 2003); Rosenzweig, 332 F.3d at 864-65.

Conclusion

We hold that the district court erred in dismissing so much of

the Complaint as charges Dunham with a section 10 and Rule 10(b)

violation in respect to his early November 1998 statements in

connection with the Arrowhead contract announcement and erred in

dismissing so much of the Complaint as charges INSpire with

respondeat superior liability under section 10 and Rule 10(b)

respecting those same statements. We also hold that the district

court did not err in dismissing all other claims of section 10 and

Rule 10(b) primary violations and all section 20(a) control person

liability claims in respect to such properly dismissed primary

violations. Finally, we hold that the district court did not abuse

its discretion in failing to afford plaintiffs the opportunity to

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further amend.

The judgment of the district court is accordingly AFFIRMED in

part; REVERSED in part; and REMANDED for further proceedings not

inconsistent herewith.

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