UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT
_____________________
No. 92-2519
_____________________
FELIX SHUSHANY, and SHEPARD BARTNOFF,
Plaintiffs-Appellants,
VERSUS
ALLWASTE, INC., and RAYMOND L. NELSON,
Defendants-Appellees.
____________________________________________________
Appeal from the United States District Court
for the Southern District of Texas
_____________________________________________________
(May 21, 1993)
Before WIENER, BARKSDALE, and DeMOSS, Circuit Judges.
BARKSDALE, Circuit Judge:
In issue is the degree of particularity required by Fed. R.
Civ. P. 9(b) to plead fraud, especially securities fraud. Felix
Shushany and Shepard Bartnoff appeal the dismissal with prejudice,
for failure to comply with the rule, of their consolidated action
against Allwaste, Inc., and Raymond L. Nelson. We AFFIRM.
I.
Allwaste is a diversified environmental services company. One
of its subsidiaries, Allwaste Asbestos Abatement, Inc. (AAA),
provides asbestos abatement services. Nelson was chairman of
Allwaste's board. (Allwaste and Nelson are referred to
collectively as "Allwaste".) The complaint alleges that from its
incorporation in 1986 through 1990, Allwaste engaged in an
ambitious acquisition program, almost totally through stock for
stock transactions, and reported phenomenal growth and success,
including in its asbestos abatement division; that in December
1990, however, an Allwaste press release announced its decision "to
restructure its Asbestos Abatement Division to reduce costs and
return the division to profitability pending its ultimate
disposition"; and that, following this adverse disclosure, Allwaste
common stock lost approximately 70 percent of its value.
In May 1991, seeking to represent a class of Allwaste
shareholders, Shushany sued Allwaste under, inter alia, federal
securities laws. He basically alleged that Allwaste had
fraudulently maintained in its public financial reports and
releases the appearance of continued financial growth, when in
fact, its asbestos abatement division had been suffering since
early 1989. In its answer, Allwaste asserted, inter alia, that the
complaint failed to state fraud with particularity as required by
Rule 9(b).
Additionally, Allwaste propounded contention interrogatories,
seeking the factual bases of Shushany's claims. In response,
Shushany essentially referred Allwaste to the complaint, without
providing any further detail. Allwaste then moved to compel more
complete answers, again asserting that the complaint did not
satisfy Rule 9(b). After two extensions of time to respond to the
motion, Shushany submitted amended responses to the interroga-
tories, which still lacked the specificity sought by Allwaste.
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Because Shushany had not purchased Allwaste stock during the
purported class period, he moved to amend the complaint to extend
the period. Prior to a ruling on that motion, however, Shushany's
counsel filed another action for a different plaintiff, Bartnoff,
stating the desired class period, and moved to consolidate the two
cases. (The plaintiffs are referred to collectively as
"Shushany".) Allwaste opposed both motions.
At a hearing on the motions in December 1991, the asserted
Rule 9(b) deficiencies were discussed; and the court informed
Shushany's counsel: "in a case like this the defendant company is
entitled to know which of their documents you feel give you a claim
and what you feel are wrong with them, right up front". Shushany's
counsel responded: "we believe that we can do that, we believe that
we can get out the specific documents that we think
misrepresentations were made, [sic] and we think from those
documents we can set out our complaint within the requisites of
9(b)". With Allwaste's agreement, the court granted the motion to
consolidate, ordering the plaintiffs to "file their Consolidated
Amended Complaint in accordance with Federal Rule 9(b)".
As Shushany concedes, the consolidated complaint, however, was
virtually identical to the prior complaints. Consequently,
Allwaste moved to dismiss for failure to comply with Rule 9(b). At
the hearing in May 1992, Shushany referred to additional
information regarding the fraud, which he had supposedly provided
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in a second set of amended responses to interrogatories.1 Shushany
did not, however, request leave to amend the complaint to include
those details. After extensive argument, the district court
stated: "I do not believe that the Plaintiffs have cured the
problem from their original complaint...." And in its written
opinion, it stated that the consolidated complaint was "virtually
the same" as the prior complaint which "[the court] had previously
found to be insufficient".2 Accordingly, it dismissed the action
with prejudice.3
II.
Shushany contends that the consolidated complaint complied
with the rule.4 A dismissal for failure to state fraud with
1
To the contrary, our review of those amended responses reveals
that many of the details Shushany referred to at the hearing were
not contained in the responses.
2
In light of the district court's prior discussions on the
asserted Rule 9(b) deficiencies, we are at a loss to understand
Shushany's characterization of the district court's holding as "a
judicial broadside". As discussed, the motion to consolidate was
agreed to by Allwaste and granted by the district court only upon
the understanding that Shushany would make good on his promise to
"set out [the] complaint within the requisites of 9(b)".
3
As to the dismissal being with prejudice, see infra note 11.
4
Shushany alternatively contends, as he did in district court,
that Allwaste waived any Rule 9(b) objection by filing an answer to
the original complaint and engaging in discovery. We agree with
the district court that this contention "borders on being
frivolous". From the time of its answer, which, as noted, included
a Rule 9(b) objection, Allwaste repeatedly and consistently
contended that the complaint failed to comply with the rule.
Contrary to Shushany's contention, it is not the law in this
circuit that "[t]he entire concept behind [Rule 9(b)]" is solely to
enable the defendant to prepare a responsive pleading. Further-
more, we see no reason to penalize a defendant who, rather than
initiating time-consuming and costly motions to dismiss a deficient
complaint, chooses to pursue the needed information through
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particularity as required by Rule 9(b) is a dismissal on the
pleadings for failure to state a claim. See Guidry v. Bank of
LaPlace ("Guidry II"), 954 F.2d 278, 281 (5th Cir. 1992); Fed. R.
Civ. P. 12(b)(6). Accordingly, we review the dismissal de novo,
and in so doing, "accept the complaint's well-pleaded factual
allegations as true." Id.
The consolidated complaint had four claims: (1) against both
defendants for violations of § 10(b) of the Securities and Exchange
Act of 1934, 15 U.S.C. § 78(j)(b), and Rule 10b-5 promulgated
thereunder, 17 C.F.R. 240.10b-5; (2) against Nelson, as a
"controlling person" of Allwaste, for violations of § 20(a) of the
discovery. It was only after this avenue of pursuit failed that
Allwaste moved to dismiss.
Moreover, at the first hearing (December 1991) on the Rule
9(b) deficiencies, Shushany's counsel took a quite opposite
position to the present assertion of waiver. When the court asked,
"[h]ave you any serious complaint about the interrogatories
[defendants] propounded that go to that [Rule 9(b)] area?", counsel
stated:
No, your Honor, our only objection is that we
thought the complaint in itself was good enough to
begin with, however, we can respond to the
interrogatories as best we can, and if things don't
work out they can file their ... 9(b) motion, which
we have never seen before. It's always been this
threat that's been hanging out there in the wings
against us, but we've never seen it, we don't
particularly know what they're talking about.
(Emphasis added.)
And, finally, the Rule 9(b) motion addressed the consolidated
complaint, as to which no answer or discovery had been filed.
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Act, 15 U.S.C. § 78t(a); and against both defendants for (3) fraud
and deceit and (4) negligent misrepresentation.5
The elements of a securities fraud claim are "(1) a
misstatement or an omission (2) of material fact (3) made with
scienter (4) on which the plaintiff relied (5) that proximately
caused his injury". Cyrak v. Lemon, 919 F.2d 320, 325 (5th Cir.
1990). A fact is considered material if "there is a substantial
likelihood that a reasonable shareholder would consider it
important ...". TSC Industries, Inc. v. Northway, Inc., 426 U.S.
438, 449 (1976); see also Krim v. BancTexas Group, Inc., No. 92-
1208, slip op. at 4137 (5th Cir. May 12, 1993). Scienter is the
intent to deceive, manipulate, or defraud. Ernst & Ernst v.
Hochfelder, 425 U.S. 185, 193-94 (1976). The scienter element is
satisfied by proof that the defendant acted with severe
recklessness, which is "limited to those highly unreasonable
omissions or misrepresentations that involve not merely simple or
even inexcusable negligence, but an extreme departure from the
standards of ordinary care, and that present a danger of misleading
buyers or sellers which is either known to the defendant or is so
obvious that the defendant must have been aware of it". Broad v.
5
We assume that the same Rule 9(b) concerns apply to the common
law fraud claims as to the securities fraud claims. The complaint
relies on the same allegations for them. In any event, Shushany
made no attempt to distinguish the claims in his brief. See Fed.
R. App. P. 28(a)(5); Zeno v. Great Atlantic & Pacific Tea Co., 803
F.2d 178, 180-81 (5th Cir. 1986) (issues not briefed are waived).
Likewise, because Shushany does not contest in his appellate
brief the district court's dismissal of his negligent mis-
representation claim, we do not address it.
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Rockwell Int'l Corp., 642 F.2d 929, 961-62 (5th Cir.) (en banc),
cert. denied, 454 U.S. 965 (1981).
Rule 9(b) provides: "In all averments of fraud or mistake, the
circumstances constituting fraud or mistake shall be stated with
particularity". Thus, allegations of fraud must meet a higher, or
more strict, standard than the basic notice pleading required by
Rule 8. This standard "stems from the obvious concerns that
general, unsubstantiated charges of fraud can do damage to a
defendant's reputation". Guidry II, 954 F.2d at 288.
Additionally, Rule 9(b) is designed "to preclude litigants from
filing baseless complaints and then attempting to discover unknown
wrongs". Guidry v. Bank of LaPlace ("Guidry I"), 740 F. Supp.
1208, 1216 (E.D. La. 1990), aff'd as modified, 954 F.2d 278 (5th
Cir. 1992); see also O'Brien v. National Property Analysts
Partners, 936 F.2d 674, 676 (2d Cir. 1991) (recognizing threefold
purpose of Rule 9(b) for securities fraud claims -- to provide
defendant with fair notice of claim, to safeguard defendant's
reputation, and to protect defendant against the institution of
strike suits).
"At a minimum, Rule 9(b) requires allegations of the
particulars of time, place, and contents of the false
representations, as well as the identity of the person making the
misrepresentation and what he obtained thereby". Tel-Phonic
Services, Inc. v. TBS Int'l, Inc., 975 F.2d 1134, 1139 (5th Cir.
1992). "What constitutes `particularity' will necessarily differ
with the facts of each case and hence the Fifth Circuit has never
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articulated the requirements of Rule 9(b) in great detail". Guidry
II, 954 F.2d at 288.
Shushany alleged three types of fraudulent statements
contained in various Allwaste public documents and reports:6 (1)
that employees of various AAA divisions were instructed to engage
in improper accounting practices, which resulted in an
overstatement of earnings and income in Allwaste's financial
reports; (2) that statements about increasing demand and
opportunities for growth in the asbestos abatement industry were
false; and (3) that a statement regarding the integrity and
business ethics of Allwaste employees was false. We address each
category separately.
A.
For the period November 22, 1989, through December 21, 1990,
Shushany alleged that "[i]n the face of the worsening business
environment for the asbestos abatement market", Allwaste "embarked
on a plan and scheme to have Allwaste report inflated revenues and
earnings". As examples, Shushany alleged the following:
(a) By no later than the Winter of 1989, the
Defendants or Defendants' agents began a course and
scheme designed to defraud investors by instructing
employees to make arbitrary adjustments for the
accounting of inventory of the asbestos operations
in Houston, Texas;
(b) In January of 1990, the Defendants, or
Defendants' agents, instructed employees, including
Don Higginbotham, an employee of Defendant
Allwaste, to increase bad debt reserves rather
6
Shushany cited various statements from the Allwaste 1989 Form
10-K; its first, second, and third quarter 1990 Forms 10-Q; and an
October 30, 1990, press release by Nelson.
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than, as required, writing off certain accounts
receivable;
(c) In the Spring of 1990, the Defendants'
agents instructed Mr. Higginbotham to arbitrarily
realize an additional $650,000 on one of Allwaste's
largest asbestos contracts for the third quarter of
1990;
(d) Defendants or Defendants' agents were
instructing employees in other Allwaste divisions
to make arbitrary increases to inflate income
during at least the Spring of 1990; and
(e) In the Spring of 1990, the Defendants or
Defendants' agents, instructed their employees to
conceal the securities fraud committed by Allwaste
from the shareholders of Allwaste.
The complaint then cites particular statements from Allwaste's
financial reports, and alleges variously that they were "materially
false and misleading as such amounts were improperly inflated",
were "made without a reasonable basis", and were "inaccurate" due
to the fraudulent accounting procedures.
But, the complaint did not identify who in particular was
instructing the employees to make the arbitrary accounting
adjustments, what particular adjustments were made,7 how those
adjustments were improper in terms of reasonable accounting
practices,8 how those adjustments were incorporated into Allwaste's
7
Cf. Decker v. Massey-Ferguson, 681 F.2d 111, 117 (2d Cir.
1982) (allegations of two instances of a debt placement and a
financing arranged in the "fall of 1977" were insufficient
allegations of the time and place of the fraud); Recchion v.
Westinghouse Elec. Corp., 606 F. Supp. 889, 895 (W.D. Pa. 1985)
(allegations that defendant misstated value of various facilities,
which in turn affected defendant's financial statements, were
insufficient in part because complaint failed to state which
facilities were involved).
8
In fact, surprisingly, the consolidated complaint deleted the
general references to generally accepted accounting principles
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financial statements, and if incorporated, whether those
adjustments were material in light of Allwaste's overall financial
position.9 Although we need not identify which of these
(GAAP) that had been in the prior complaints, replacing allegations
that the defendants violated GAAP with allegations that the facts
reported "were [not] in fact true" and were "inaccurately
reported". Cf. Christidis v. First Pennsylvania Mortg. Trust, 717
F.2d 96, 99 (3d Cir. 1983) (complaint insufficient in absence of
allegation of manner in which defendant's accounting method
departed from reasonable accounting practices and procedures); In
Re Frank B. Hall & Co., Inc., 693 F. Supp. 1460, 1465-66 (S.D.N.Y.
1988) (allegation that accountant arbitrarily valued company $10
million under GAAP, with citation to specific accounting rules
violated, was sufficient); Fox v. Equimark Corp., 782 F. Supp. 295,
301 (W.D. Pa. 1991) (allegations that defendant failed to increase
loan loss reserves when substantial losses were virtually certain
were insufficient, in part because complaint failed to specify
manner in which reserves were improperly established).
9
At oral argument in both the district court and our court,
Shushany argued only that the adjustments must have been material,
or Allwaste would not have made, and attempted to conceal, them.
Obviously, any such inference does not satisfy Rule 9(b)
particularity requirements. Cf. Decker v. Massey-Ferguson, 681
F.2d at 116 (where complaint alleged failure to record value of
certain assets but did not even approximate figures involved, it
failed to demonstrate materiality in light of the overall figures
of the company); Wool v. Tandem Computers, Inc., 818 F.2d 1433,
1440 (9th Cir. 1987) (complaint sufficient where each alleged
misstatement was identified by content, date, and document or
announcement, and complaint stated exact dollar amount of each
alleged overstatement); In Re AM International, Inc., Securities
Litigation, 597 F. Supp. 1117, 1119 & n.3 (S.D.N.Y. 1984)
(allegations that defendant placed intense pressure on accounting
management to overstate income and assets and to withhold adverse
accounting information "prior to 1980" in a "material amount not
yet calculated, but in excess of $5 million" were insufficient with
respect to the 1978 financial reports in part because no factual
basis was provided for the $5 million figure); Recchion v.
Westinghouse Elec. Corp., 606 F. Supp. 889, 895 (W.D. Pa. 1985)
(allegations that defendant misstated production costs for various
facilities, which in turn affected defendant's financial
statements, were insufficient in part because complaint failed to
state extent of the misstatements); In Re Wyse Technology
Securities Litigation, 1990 WL 169149 (N.D. Cal. 1990)
(unpublished) (allegations that improper accounting procedures with
respect to sales and income affected defendant's public financial
statements insufficient where complaint failed to allege
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deficiencies, standing alone, might render the complaint
insufficient under Rule 9(b), we hold that altogether, they do.
Shushany contends that the facts sought lie particularly
within Allwaste's knowledge, and therefore, he is excused from
pleading them, citing, inter alia, Michaels Building Co. v.
Ameritrust Co., N.A., 848 F.2d 674, 680 (6th Cir. 1988); Craftmatic
Securities Litigation v. Kraftsow, 890 F.2d 628, 645 (3d Cir.
1989); and Christidis v. First Pennsylvania Mortgage Trust, 717
F.2d 96, 100 (3d Cir. 1983). Shushany demonstrated at the motion
to dismiss hearing, however, that he had ample access to at least
some of the information sought, through a "whistleblower" AAA
employee, the earlier-referenced Don Higginbotham, who was
assertedly represented by Shushany's counsel in a separate action
against Allwaste.10
As noted, Shushany referred at the hearing to a second set of
amended responses to interrogatories, which purportedly provided
additional facts gleaned from Higginbotham's testimony in the other
case. These included an alleged dispute between Nelson and a Mr.
Stewart over the acquisition of American Environmental, the names
of three individuals who allegedly directed the accounting fraud,
and the date of one such incident. Shushany also represented that
"the securities fraud was directed to be concealed by at least
Wayne Rachlin[, who] directed Don Higginbotham and Olga Guerra to
approximate amount involved to establish materiality).
10
The attorneys made several references to the Higginbotham
action in arguments to the district court, but no evidence of it
appears in the record.
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revise schedules to direct the auditors' attention from the
arbitrary increases to income ... [and] required Mr. Higginbotham
and Ms. Guerra to practice false responses to potential questions
concerning the increases to income". Shushany further represented
to the district court that Higginbotham "will testify that ... he
believes that the same activities were going on not just in Houston
but also at the Argon Asbestos Abatement Division and also in
Birmingham ...". Shushany's counsel then stopped, stating, "I'm
not going to bore the Court by going through all [the] responses".
Although, as also noted, much of this information was not
contained in the amended responses, Shushany demonstrated a greater
knowledge of the factual basis for the fraud claims than appears in
the complaint, yet no effort was made to amend it to include these
details, in spite of the district court's prior admonition and
Allwaste's repeated Rule 9(b) objections.11 Allwaste responded in
part to Shushany's argument by stating, "it's fine to say Mr.
Higginbotham told us this and told us that. In that case, then why
don't they share that with us in an amended complaint that
specifies what it is". Indeed, as Allwaste states in its brief,
11
This notwithstanding, Shushany complains several times in his
appellate briefs -- but does not raise as an issue -- that the
district court dismissed without granting leave to amend.
Additionally, in his reply brief, he states, "[t]o the extent that
Plaintiffs have not so requested Plaintiffs request leave to amend
to address any 9(b) complaint". This untimely request is totally
lacking in merit.
Furthermore, Shushany does not contend that the dismissal
should have been without prejudice. Thus, he has waived any error
in that regard.
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"[i]f there was a claim to be made, few 10b-5 plaintiffs have had
more information with which to make it".12
We find the deficiencies in the complaint particularly
troubling because the alleged fraudulent acts occurred at AAA, an
Allwaste subsidiary.13 Although it is foreseeable that
misstatements in AAA's ledgers could materially skew the accuracy
of Allwaste's financial reports, such an inference standing alone
is obviously insufficient to support a securities fraud claim
against Allwaste and Nelson. The complaint provides only
conclusory allegations to support any connection between the
alleged fraudulent accounting practices at AAA and Allwaste's
financial reports, which do not satisfy the requirements of Rule
9(b).
In sum, Shushany failed to state his allegations regarding
accounting fraud with sufficient particularity to comply with Rule
9(b). As stated, and because this court has recognized that the
degree of particularity required differs with the facts of each
12
Shushany may have been under the impression that because the
same counsel supposedly defended Allwaste in the Higginbotham
action, Allwaste was presumed to have knowledge of Higginbotham's
testimony. Our review, however, as well as the district court's,
is limited to the record established in this case. Therefore, even
if this case turned on Allwaste's actual knowledge, we could not
take note of information not contained in the record.
13
Although Allwaste contends that Higginbotham's employer, AAA
of Houston, was actually a subsidiary of AAA, which would further
attenuate any link between the alleged accounting fraud and
Allwaste's financial reports, we do not find that fact in the
record, and Allwaste provides no record cite to it. See Fed. R.
App. P. 28(a)(4) (the statement of the facts shall contain
"appropriate references to the record").
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case, see Guidry II, 954 F.2d at 288, we base our holding on the
entirety of the complaint rather than on any single defect.
B.
Shushany's allegations about Allwaste's misrepresentations
concerning the demand and opportunity for growth in the asbestos
abatement industry likewise lack sufficient particularity.
Specifically, Shushany quoted the following statements from the
various Allwaste financial reports listed supra, note 6:
1. "Management of the Company believes that
there is a substantial opportunity for growth in
the asbestos abatement business due to the rapidly
increasing demand for these services". (1989 Form
10-K).
2. "Revenues increased at all of the
Company's asbestos abatement operating locations".
(First quarter 1990 Form 10-Q).
3. "Demand for these [asbestos abatement]
services has continued to increase as the Company
has steadily expanded its work force between the
periods, particularly in the Pacific Northwest and
in Houston, Texas". (Second quarter 1990 Form 10-
Q).
4. "Demand for these [asbestos abatement]
services has continued to increase, particularly in
Houston, Texas and along the West Coast". (Third
quarter 1990 Form 10-Q).
5. "Our abatement backlog remains high [in
spite of a decline in fourth quarter results]".
(October 30, 1990, press release).
Shushany variously alleged that these representations were
fraudulent because they were based on the alleged inaccurately
reported financial figures.14
14
Shushany alleged that the various statements "were materially
false and misleading as they included earnings and sales for the
asbestos abatement business of Allwaste which were improperly
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Statements that are predictive in nature are actionable only
if they were false when made. Isquith v. Middle South Utilities,
Inc., 847 F.2d 186, 203 (5th Cir. 1988), cert. denied, 488 U.S. 926
(1988). Furthermore, "projections of future performance not worded
as guarantees are generally not actionable under the federal
securities laws". Krim, slip op. at 4138. To the extent that the
falsity of these statements depends upon Shushany's general
allegations about the "worsening business environment for the
asbestos abatement market", no facts were pleaded to support them.
Nor does Shushany's comparison of Allwaste stock prices before and
after the alleged events support an inference of fraud. As the
Seventh Circuit has explained:
At one time the firm bathes itself in a favorable
light. Later the firm discloses that things are
less rosy. The plaintiff contends that the
difference must be attributable to fraud. "Must
be" is the critical phrase, for the complaint
offers no information other than the differences
inflated, and were made without a reasonable basis"; "were
materially false and misleading because, Allwaste and defendant
Nelson were aware or were reckless in knowing that due to decreased
margins on sales and revenues, the asbestos abatement division was
suffering financially"; "[were] false and misleading because
Allwaste and defendant Nelson were aware that Allwaste was
fraudulently instructing its employees to increase bad debt
reserves, rather than as required writing off certain accounts
receivable, and the financial figures it was reporting were,
therefore, inaccurate"; "[were] false and materially misstated both
the revenues for the Company and the prospects for future revenues
in that Allwaste and Defendant Nelson were aware that Allwaste was
improperly inflating its earnings and was experiencing significant
objections from its employees regarding the manner in which
Allwaste was recognizing income in its asbestos abatement
division"; and "were false and misleading because Allwaste and
Defendant Nelson were fraudulently instructing its employees to
increase its bad debt reserve, rather than making required write
offs, and to make arbitrary increases to inflate the income
recognized by Allwaste".
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between the two statements of the firm's
condition.... Investors must point to some facts
suggesting that the difference is attributable to
fraud.
DiLeo v. Ernst & Young, 901 F.2d 624, 627 (7th Cir. 1990), cert.
denied, 498 U.S. 941 (1990). As noted, the only allegations
suggesting that the statements were false when made are those
concerning the accounting fraud at AAA. Because we have determined
that the accounting fraud allegations were not pleaded with
sufficient particularity, these allegations, which depend upon
them, also must fail.
C.
Finally, regarding the business ethics of Allwaste employees,
Shushany cited the following statement from the annual report
attached to Allwaste's 1989 Form 10-K: "These men and women share
the same fundamental principles upon which your company was founded
-- integrity, hard work, business ethics and fervent commitment to
the highest level of customer service". Again, Shushany's
characterization of this statement as fraudulent depends solely on
the allegations regarding the "unscrupulous and unethical business
practices by the Company", i.e., the alleged accounting fraud. For
the reasons explained above, these allegations also fail to satisfy
Rule 9(b).
III.
Accordingly, the dismissal with prejudice for failure to
comply with Rule 9(b) is
AFFIRMED.
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