Mizzaro v. Home Depot, Inc.

                                                                [PUBLISH]

              IN THE UNITED STATES COURT OF APPEALS

                        FOR THE ELEVENTH CIRCUIT
                         ________________________
                                                               FILED
                                 No. 07-13810        U.S. COURT OF APPEALS
                                                        ELEVENTH CIRCUIT
                         ________________________          October 8, 2008
                                                         THOMAS K. KAHN
                   D.   C. Docket No. 06-01151-CV-ODE-1       CLERK

JOHN MIZZARO, on behalf of himself and all others
similarly situated,
BUCKS COUNTY RETIREMENT BOARD, Lead Plaintiff,


                                                      Plaintiffs-Appellants,

                                   versus

HOME DEPOT, INC.,
ROBERT L. NARDELLI, et. al.,


                                                      Defendants-Appellees.

                         ________________________

                               No. 07-13811
                         ________________________

                   D. C. Docket No. 06-01197-CV-ODE-1

M. BRAD BICKERSTAFF, Individually and on behalf of all others
similarly situated,
BUCKS COUNTY RETIREMENT BOARD, Lead Plaintiff,
                                                       Plaintiffs-Appellants,

                                  versus

HOME DEPOT, INC.,
ROBERT L. NARDELLI, et. al.,

                                                      Defendants-Appellees.

                        ________________________

                              No. 07-13812
                        ________________________

                   D. C. Docket No. 06-01349-CV-ODE-1

BRUCE B. BELODOFF, Individually and on behalf of all others
similarly situated,
BUCKS COUNTY RETIREMENT BOARD, Lead Plaintiff,


                                                       Plaintiffs-Appellants,

                                  versus

HOME DEPOT, INC.,
ROBERT L. NARDELLI, et. al.,


                                                      Defendants-Appellees.

                        ________________________

                              No. 07-13813
                        ________________________

                   D. C. Docket No. 06-01617-CV-ODE-1

                                     2
ROBERT D. JAFFEE, As trustee of the Robert D. Jaffee Revocable Trust,
on behalf of plaintiff and all others similarly situated,
BUCKS COUNTY RETIREMENT BOARD, Lead Plaintiff,


                                                           Plaintiffs-Appellants,

                                     versus

HOME DEPOT, INC.,
ROBERT L. NARDELLI, et. al.,


                                                           Defendants-Appellees.

                         ________________________

                               No. 07-13859
                         ________________________

                     D. C. Docket No. 06-01616-CV-ODE-1

PAUL COBLE, On behalf of plaintiff and all others similarly situated,
BUCKS COUNTY RETIREMENT BOARD, Lead Plaintiff,


                                                           Plaintiffs-Appellants,

                                     versus

HOME DEPOT, INC.,
ROBERT L. NARDELLI, et. al.,


                                                           Defendants-Appellees.




                                        3
                             ________________________

                    Appeals from the United States District Court
                        for the Northern District of Georgia
                          _________________________
                                 (October 8, 2008)

Before CARNES and MARCUS, Circuit Judges, and BUCKLEW,* District Judge.

MARCUS, Circuit Judge:

       To survive a motion to dismiss under the Private Securities Litigation

Reform Act of 1995, the factual allegations contained in a private securities fraud

class action complaint must raise a “strong inference,” one that is “cogent and

compelling,” that the named defendants acted with the requisite scienter. The

question presented in this appeal is whether lead plaintiff Bucks County

Retirement Board’s (“Bucks County’s”) Amended Class Action Complaint

(“ACAC” or “amended complaint”) against Home Depot, Inc. and six of its

officers and directors has met this demanding standard. The district court said

“no,” dismissed the complaint for failure to state a claim, and denied as futile a

motion for leave to amend. After thorough review, we affirm.

                                             I.




       *
          Honorable Susan C. Bucklew, United States District Judge for the Middle District of
Florida, sitting by designation.

                                             4
         This case began on May 12, 2006, when John Mizzaro, an individual

investor in Home Depot stock, filed a securities fraud class action complaint

against Home Depot, Inc. and several of its officers and directors in the United

States District Court for the Northern District of Georgia. In short order, four

more individual investors filed essentially identical complaints. The district court

consolidated the cases “for the purposes of discovery and case management only,”

Doc. 30 at 2, and appointed Bucks County, a major investor in Home Depot stock,

as the sole lead plaintiff, see 15 U.S.C. § 78u-4(a)(3)(B)(i) (requiring the district

court to appoint as lead plaintiff “the member or members of the purported

plaintiff class that the court determines to be most capable of adequately

representing the interests of class members”). The defendants then moved to

dismiss each of the five pending cases. Rather than defend the existing complaints

(which it presumably had no part in drafting), Bucks County filed a 150-page

Amended Class Action Complaint, which became the operative pleading in all five

cases.

         The amended complaint is a putative class action on behalf of every

shareholder who purchased Home Depot stock between May 29, 2001 and

February 22, 2005 (the “class period”). In a nutshell, the amended complaint

alleges that (1) Home Depot obtained excessive rebates from its vendors, and (2)

                                           5
violated the securities laws by not informing investors that the financial results it

reported for fiscal years 2001-2004 were inflated by these excessive rebates. In

addition to Home Depot, Inc., the amended complaint names six high-ranking

Home Depot officials as defendants -- senior executives Robert Nardelli, the

President, Chief Executive Officer, and Chairman of the Board; Carol Tomeì, an

Executive Vice President and the Chief Financial Officer; and Larry Mercer, the

Executive Vice President of Store Operations; and board members Kenneth

Langone, Berry Cox, and John Clendenin -- and claims that their failure to

disclose the alleged earnings inflation violated § 10(b) of the Exchange Act of

1934, 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. §

240.10b-5. The amended complaint also asserts that the individual defendants are

liable for the § 10(b) and Rule 10b-5 violations by Home Depot, Inc., because they

qualify as “control persons” under § 20(a) of the Exchange Act, 15 U.S.C. §

78t(a).

      Rather than answer Bucks County’s lengthy pleading, all of the defendants

moved to dismiss the amended complaint, arguing, among other things, that it

failed to create a “strong inference” that they acted with the requisite scienter. 15

U.S.C. § 78u-4(b)(2). While the motion to dismiss was pending, Bucks County

moved for leave to amend if the district court concluded that the amended

                                          6
complaint failed to state a claim. The district court granted the defendants’ motion

to dismiss in a lengthy order and denied leave to amend, concluding that, under

controlling law, the amended complaint had failed to adequately plead scienter,

and that granting leave would be futile because the additional facts presented in

the motion for leave would not change that result.

                                        II.

      We review de novo an order granting a motion to dismiss for failure to meet

the heightened pleading standards embodied in the PSLRA. Garfield v. NDC

Health Corp., 466 F.3d 1255, 1261 (11th Cir. 2006). Moreover, because denial of

leave to amend based on futility is a legal conclusion, we review the denial de

novo as well. St. Charles Foods, Inc. v. America’s Favorite Chicken Co., 198 F.3d

815, 822 (11th Cir. 1999).

      An understanding of the nature of the legal claims asserted by Bucks

County and the special pleading rules that apply to them is essential to deciding

this case. Bucks County’s primary claim is that Home Depot and the six

individual defendants violated § 10(b) of the Exchange Act and Rule 10b-5

promulgated thereunder by making material misrepresentations or omissions in

press releases and in the company’s financial statements. Section 10(b) makes it

unlawful to

                                         7
      use or employ, in connection with the purchase or sale of any security
      registered on a national securities exchange . . . , any manipulative or
      deceptive device or contrivance in contravention of such rules and
      regulations as the Commission may prescribe as necessary or
      appropriate in the public interest or for the protection of investors.

15 U.S.C. § 78j(b). Rule 10b-5, in turn, forbids

      any person, directly or indirectly, . . .

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

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

      (c) To engage in any act, practice, or course of business which
      operates or would operate as a fraud or deceit upon any person, in
      connection with the purchase or sale of any security.

17 C.F.R. § 240.10b-5.

      Under these provisions, a securities fraud claim based on failure to reveal

information to investors, as Bucks County has alleged here, has six elements: (1) a

material misrepresentation or omission; (2) made with scienter; (3) a connection

with the purchase or sale of a security; (4) reliance on the missstatement or

omission; (5) economic loss; and (6) a causal connection between the material

misrepresentation or omission and the loss, commonly called “loss causation.”

Dura Pharms., Inc. v. Broudo, 544 U.S. 336, 341-42 (2005).



                                            8
      Bucks County also claims that the six individual defendants are liable as

“control persons” under § 20(a) of the Exchange Act. Section 20(a) provides:

      Every person who, directly or indirectly, controls any person liable
      under any provision of this chapter or of any rule or regulation
      thereunder shall also be liable jointly and severally with and to the
      same extent as such controlled person to any person to whom such
      controlled person is liable, unless the controlling person acted in good
      faith and did not directly or indirectly induce the act or acts
      constituting the violation or cause of action.

15 U.S.C. § 78t(a). This statute “imposes derivative liability on persons that

control primary violators of the Act.” Laperriere v. Vesta Ins. Group, Inc., 526

F.3d 715, 721 (11th Cir. 2008) (per curiam). To state a claim under § 20(a), Bucks

County must allege three elements: (1) that Home Depot, Inc. committed a primary

violation of the securities laws; (2) that the individual defendants had the power to

control the general business affairs of Home Depot; and (3) that the individual

defendants “had the requisite power to directly or indirectly control or influence

the specific corporate policy which resulted in primary liability.” Theoharous v.

Fong, 256 F.3d 1219, 1227 (11th Cir. 2001) (quotation marks omitted); accord

Brown v. Enstar Group, Inc., 84 F.3d 393, 396-97 (11th Cir. 1996). Because a

primary violation of the securities laws is an essential element of a § 20(a)

derivative claim, we have held that a plaintiff adequately pleads a § 20(a) claim

only if the primary violation is adequately pleaded. See, e.g., Garfield, 466 F.3d at

                                          9
1261; Theoharous, 256 F.3d at 1227. Therefore, the pivotal issue in this case

remains whether Bucks County adequately pleaded a violation of § 10(b) and Rule

10b-5.

      Ordinarily, a complaint is adequate if it meets Fed. R. Civ. P. 8(a)(2)’s

requirement of “a short and plain statement of the claim showing that the pleader

is entitled to relief.” But securities fraud claims, like other types of fraud claims,

have always been subject to Fed. R. Civ. P. 9(b)’s heightened pleading

requirements, which require a complaint “to state with particularity the

circumstances constituting fraud.” As we have previously observed,

      Rule 9(b) is satisfied if the complaint sets forth “(1) precisely what
      statements were made in what documents or oral representations or
      what omissions were made, and (2) the time and place of each such
      statement and the person responsible for making (or, in the case of
      omissions, not making) same, and (3) the content of such statements
      and the manner in which they misled the plaintiff, and (4) what the
      defendants obtained as a consequence of the fraud.”

Tello v. Dean Witter Reynolds, Inc., 494 F.3d 956, 972 (11th Cir. 2007) (quoting

Ziemba v. Cascade Int’l, Inc., 256 F.3d 1194, 1202 (11th Cir. 2001)). Notably,

Rule 9(b) does not require a plaintiff to allege specific facts related to the

defendant’s state of mind when the allegedly fraudulent statements were made.

Instead, as Rule 9(b) itself states, “[m]alice, intent, knowledge, and other

conditions of a person’s mind may be alleged generally.” Thus, under Rule 9(b), it

                                          10
is sufficient to plead the who, what, when, where, and how of the allegedly false

statements and then allege generally that those statements were made with the

requisite intent.

      But in 1995, “[a]s a check against abusive litigation by private parties,”

Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S. Ct. 2499, 2504 (2007),

Congress passed the Private Securities Litigation Reform Act (“PSLRA”), Pub. L.

No. 104-67, 109 Stat. 737 (1995), which made two notable changes to the

pleading requirements for securities fraud class actions. First, the PSLRA slightly

altered Rule 9(b)’s particularity requirement by mandating that a securities fraud

class action complaint

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

15 U.S.C. § 78u-4(b)(1)(B).

      Second, and more importantly, the PSLRA raised the standard for pleading

scienter. Specifically, in any securities fraud class action

      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.

                                          11
15 U.S.C. § 78u-4(b)(2) (emphasis added). Thus, in a securities fraud class action,

a plaintiff can no longer plead the requisite scienter element generally, as he

previously could under Rule 9(b). Moreover, the complaint must allege facts

supporting a strong inference of scienter “for each defendant with respect to each

violation.” Phillips v. Scientific-Atlanta, Inc., 374 F.3d 1015, 1016 (11th Cir.

2004).

      Although the PSLRA substantially raised the pleading standard for scienter,

it did not change any substantive intent requirements. Bryant v. Avado Brands,

Inc., 187 F.3d 1271, 1284 (11th Cir. 1999). In this Circuit it is by now well-

established that § 10(b) and Rule 10b-5 require a showing of either an “intent to

deceive, manipulate, or defraud,” or “severe recklessness.” Id. at 1282 (quotation

marks omitted). We have described “severe recklessness” this way:

      Severe recklessness 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.

Id. at 1282 n.18 (quotation marks omitted). Putting the PSLRA and our

substantive scienter case law together yields the following stringent standard: to

survive a motion to dismiss in this case, Bucks County must (in addition to

                                         12
pleading all of the other elements of a § 10(b) claim) plead “with particularity

facts giving rise to a strong inference” that the defendants either intended to

defraud investors or were severely reckless when they made the allegedly

materially false or incomplete statements.

      Any discussion of what constitutes a “strong inference” of scienter must

begin with the Supreme Court’s recent decision in Tellabs. In that case, the Court

held that a “strong inference” of scienter means an inference that is “cogent and at

least as compelling as any opposing inference one could draw from the facts

alleged.” Tellabs, 127 S. Ct. at 2510. Because the strong-inference inquiry asks

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

of scienter, not whether any individual allegation, scrutinized in isolation, meets

that standard,” “courts must consider the complaint in its entirety,” and “omissions

and ambiguities count against inferring scienter.” Id. at 2509, 2511. Moreover, the

inquiry is “inherently comparative” because courts “must take into account

plausible opposing inferences.” Id. at 2510, 2509. Tellabs explained how to

balance opposing inferences this way:

      To determine whether the plaintiff has alleged facts that give rise to
      the requisite “strong inference” of scienter, a court must consider
      plausible nonculpable explanations for the defendant’s conduct, as
      well as inferences favoring the plaintiff. The inference that the
      defendant acted with scienter need not be irrefutable, i.e., of the

                                          13
      “smoking-gun” genre, or even the “most plausible of competing
      inferences.” . . . Yet the inference of scienter must be more than
      merely “reasonable” or “permissible” -- it must be cogent and
      compelling, thus strong in light of other explanations.

Id. at 2510. “In sum, the reviewing court must ask: When the allegations are

accepted as true and taken collectively, would a reasonable person deem the

inference of scienter at least as strong as any opposing inference?” Id. at 2511.

      Notably, this test is not the same as the standard we employ for summary

judgment under Fed. R. Civ. P. 56, because it asks what a reasonable person would

think, not what a reasonable person could think. Compare Tellabs, 127 S. Ct. at

2510 (“A complaint will survive, we hold, only if a reasonable person would deem

the inference of scienter cogent and at least as compelling as any opposing

inference one could draw from the facts alleged.”) (emphasis added) with

Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 252 (1986) (“The judge’s inquiry

[at the summary judgment stage] . . . asks whether reasonable jurors could find by

a preponderance of the evidence that the plaintiff is entitled to a verdict[.]”)

(emphasis added).

      One topic Tellabs did not address is how courts should go about evaluating

allegations based on statements made by unidentified, confidential witnesses. The

issue is important here because statements by confidential witnesses form one of



                                          14
the main building blocks of the amended complaint. The defendants argue that

allegations based on statements by confidential witnesses should be “heavily

discounted” in all cases. Not surprisingly, Bucks County says the amended

complaint’s confidential-witness allegations are entitled to great weight and

should not be discounted simply because the names of the witnesses have been

withheld. Although a whisteblower who demands confidentiality may be less

credible than one who is willing to put his name behind his accusations, we do not

put as much weight on that inference as the defendants suggest.

      Courts are often called upon to evaluate confidential sources to determine

whether an affidavit establishes probable cause to issue a search warrant. In that

area of the law, it is well-settled that a confidential, indeed even an anonymous

source may support a finding of probable cause where the tipster provides the

specific basis for his knowledge. See Illinois v. Gates, 462 U.S. 213, 230 (1983)

(describing an anonymous informant’s “basis of knowledge” as “highly relevant in

determining the value of his report”); United States v. Brundidge, 170 F.3d 1350,

1353 (11th Cir. 1999) (per curiam) (refusing to suppress evidence seized pursuant

to a search warrant because of, among other things, the “good” “basis of

knowledge” of the informant relied on by the warrant-application affiant).

Applying the same logic here, we see no reason to adopt a per se rule that always

                                         15
requires a securities-fraud complaint to name the confidential source, so long as

the complaint unambiguously provides in a cognizable and detailed way the basis

of the whistleblower’s knowledge. Accord In re Cabletron Sys., Inc., 311 F.3d 11,

21 (1st Cir. 2002); Novak v. Kasaks, 216 F.3d 300, 313-14 (2d Cir. 2000);

CALPERS v. Chubb Corp., 394 F.3d 126, 147 (3d Cir. 2004); Teacher’s Ret. Sys.

v. Hunter, 477 F.3d 162, 174 (4th Cir. 2007); ABC Arbitrage Plaintiffs Group v.

Tchuruk, 291 F.3d 336, 353-54 (5th Cir. 2002); Makor Issues & Rights, Ltd. v.

Tellabs, Inc., 513 F.3d 702, 712 (7th Cir. 2008); In re Daou Sys., Inc., 411 F.3d

1006, 1015-16 (9th Cir. 2005); Adams v. Kinder-Morgan, Inc., 340 F.3d 1083,

1101-02 (10th Cir. 2003).

      We are, however, careful not to carry the search-warrant analogy too far.

For one thing, the probable-cause standard for issuing search warrants is less

stringent than the “cogent and compelling” standard imposed on plaintiffs under

the PSLRA. For another, lying to the police or to law enforcement in general will

likely lead to much harsher consequences than lying to a plaintiff’s attorney, so

statements by confidential police informants may be more reliable than

conversations between plaintiffs’ attorneys and whistleblowers. These are just

two reasons why courts may be skeptical of confidential sources cited in securities

fraud complaints; there are likely others. We conclude that the weight to be

                                         16
afforded to allegations based on statements proffered by a confidential source

depends on the particularity of the allegations made in each case, and

confidentiality is one factor that courts may consider. Confidentiality, however,

should not eviscerate the weight given if the complaint otherwise fully describes

the foundation or basis of the confidential witness’s knowledge, including the

position(s) held, the proximity to the offending conduct, and the relevant time

frame.

                                         III.

         We turn to the factual allegations in the amended complaint, which we

accept as true for the purposes of this appeal. Tellabs, 127 S. Ct. at 2509. As our

discussion of the applicable law makes clear, a court examining a motion to

dismiss under the PSLRA must carefully examine the complaint to determine

whether the allegations, taken as a whole, create a cogent and compelling

inference that the named defendants acted with the requisite scienter.

Accordingly, we begin our review with the amended complaint’s description of

the fraud.

                                          A.

         As any would-be home improver knows, Home Depot sells “a wide

assortment of building materials, home improvement and lawn and garden

                                          17
products, and offer[s] a variety of installation services,” through over 2000 stores

nationwide. ACAC ¶ 14. Home Depot obtains its merchandise from third-party

vendors. By contract, these vendors grant Home Depot a credit, commonly known

as a “return-to-vender” or “RTV” chargeback for defective merchandise. Id. ¶ 45.

Some of Home Depot’s vendor contracts allow the company to “process an RTV

chargeback for defective merchandise and then dispose of the merchandise (rather

than return it to the vendor)[.]” Id. ¶ 46. (Colloquially, this practice is called

“destroy-in-field.” Id.) In general, vendor contracts with such provisions contain

“an ‘allowance’ or ‘ceiling’ under which Home Depot could process the RTV and

dispose of predetermined amounts of the supposedly defective merchandise

without the vendor’s inspection of the goods.” Id. According to the amended

complaint, “[t]he accounting treatment for a legitmate RTV is straightforward”:

“When an RTV chargeback is processed, the Company makes an adjustment to

‘cost of goods sold’ in an amount that offsets or negates the original cost.” Id. ¶

48. Thus, “[l]egitimate RTV chargebacks have no impact on a company’s

financial results.” Id.

      “[I]llegitimate RTV chargeback[s],” on the other hand, may “artificially

inflate[] a company’s earnings and profit margins.” Id. Earnings inflation can

occur in two ways. First, illegitimate RTVs can be used to reduce “shrink,” which

                                           18
is retail-industry lingo for inventory that is lost or damaged due to shoplifting,

employee theft, store use, or damage by store employees. The amended complaint

says that “[t]he proper accounting treatment for shrink is to write-down the

missing product to zero, which cuts directly into a company’s earnings and

operating margin[.]” Id. ¶ 52. A company may fraudulently reduce shrink by

classifying missing inventory as defective and receiving an RTV chargeback for

that amount under a destroy-in-field provision. Second, a company can

fraudulently claim an item is defective and receive an RTV chargeback under a

destroy-in-field provision, and then sell the product to a customer. According to

the amended complaint, this specie of fraud produces “100% pure profit (because

the fraudulent RTV offset[s] the cost of the merchandise)[.]” Id. ¶ 53.

      The amended complaint alleges that Home Depot stores routinely processed

fraudulent RTV chargebacks as part of a “companywide scheme” to boost profits.

Id. The amended complaint relies on five kinds of evidence to demonstrate the

scope and duration of the scheme: (1) confidential employee witnesses; (2)

newspaper articles; (3) internal Home Depot documents; (4) one whistleblower

complaint; and (5) commentary on the SEC’s inquiry into Home Depot’s practices.




                                          19
                             1. Confidential Witnesses

      Six confidential witnesses are cited in the amended complaint. The most

important is “CW1,” who was the Director of Home Depot’s Northwest Division

from 1997 through 2003. His “job responsibilities included oversight of 300

stores in 12 states and supervision of at least 26 district managers.” Id. ¶ 54.

CW1 stated that “fraudulent misconduct” -- meaning both methods described

above for using fraudulent RTV chargebacks to inflate revenue and profits -- was

“‘common place’ at Home Depot throughout the course of his/her employment.”

Id.

      CW1 also said that in 2001 Home Depot published a Strategic Operating

Plan that forecast a reduction in the Northwest Division’s shrink from 2.04% in

2001 to 1.29% in 2004. Id. ¶ 84. According to CW1, the Plan set forth a “Shrink

Benefit Summary” that included numerous initiatives to reduce shrink, such as

increased physical security. Among the initiatives was a “Refunds/Returns/RTVs

line item” that forecast benefits increasing from $4.32 million in 2002 to $15.3

million in 2004. Id. ¶ 85. Although it alleges that “the Plan contemplated using

RTV chargebacks to reduce shrink,” id., the amended complaint does not explain

why the Plan’s projected rise in RTV benefits could not have come from increased

processing of legitimate chargebacks.

                                          20
      The Plan also described the gross margins for the Northwest Division and

included a line item for “Vendor Income (Rebates).” Id. ¶ 86. The Plan forecast

an increase in this line item from 4.5% in 2001 to 5.2% in 2004. According to

CW1, “‘Vendor Income (Rebates)’ was initially referred to as vender income, but

it was then changed and a word was added to not draw any attention to it, the

change was called Vender Income (Rebates).” Id. ¶ 87 (alteration omitted). CW1

explained that Home Depot did not “do a lot of rebates . . . so it’s easy to see what

they were doing.” Id. “[T]he implication,” the amended complaint suggests, is

“that the Company accounted for the illicit RTVs as ‘Vender Income (Rebates)’ so

that the actual artificially inflated earnings and operating margins would

correspond with budgeted amounts.” Id.

      Notably, the amended complaint does not cite the Plan itself; instead, it

relies entirely on CW1’s recollection of the Plan. Moreover, other than the vague

statement that the “Company published” the Plan “in or around 2001,” id. ¶ 84, the

amended complaint does not explain who wrote it, how it was distributed to

employees, or who received it.

      The other five confidential witnesses, whom the complaint labels CW2

through CW6, were former store-level employees who worked at various Home




                                         21
Depot stores throughout the country. The amended complaint’s allegations

regarding their statements include the following:

   • CW2 worked as an RTV clerk “directly responsible for processing RTV
     chargebacks” at three Home Depot stores in New York State from August
     1999 to May 2001. Id. ¶ 60. According to CW2, RTV chargebacks were
     “constantly inflated,” id. ¶ 61, and he estimated that 30% - 40% of the
     chargebacks were fraudulent. Based on this estimate, the amended
     complaint alleges that the fraud generated “nearly $1 million annually in
     pure profit” from “just . . . two stores.” Id. ¶ 63.

   • CW3 worked as a receiving associate and then as an RTV clerk at one
     Home Depot store in Colorado from May 2002 through June 2004. CW3
     stated that “phony RTV chargebacks occurred throughout his/her
     employment,” id. ¶ 64.

   • CW4 worked as an RTV clerk at three Home Depot stores in Connecticut
     from 1993 to 1996. According to CW4, “management . . . instituted a quota
     which mandated that RTV clerks charge a certain dollar value of RTVs. . . .
     [T]o fufill the quota Home Depot stores processed fraudulent RTVs
     throughout the period of his employment.” Id. ¶ 67.

   • CW5 worked at seven different Home Depot stores in California from 1986
     to 2002 as, among other things, a department manager and a store manager.
     CW5 stated that “RTVs were fraudulently processed to artificially inflate
     the Company’s financial results.” Id. ¶ 71. According to CW5, “Home
     Depot policy” required store managers to keep shrink to 1.5% or less on
     pain of termination. Id. ¶ 73. To meet this low figure, “stores recaptured
     shrink by processing fraudulent RTV chargebacks.” Id. Moreover, the
     stores where CW5 worked would distribute lists of what each vendor would
     and would not inspect, and “the Company’s goal was to reach (but not
     exceed) the limit of the vendors’ allotted RTVs.” Id. ¶ 74. “[T]o reach this
     quota the Company stuffed the RTVs with merchandise that was not
     defective but instead was missing as a result of shrink.” Id.




                                        22
   • Finally, CW6 worked as an assistant RTV clerk at a Home Depot store in
     Massachusetts from November 2003 through August 2005 and “recounted
     similar fraudulent misconduct.” Id. ¶ 75. CW6 estimated that “10 to 20
     percent” of the “hundreds of thousands of dollars in chargebacks per
     month” were “questionable.” Id. ¶ 79. Both CW6 and the main RTV clerk
     at CW6’s store quit because they were concerned about “abusive RTV
     chargebacks.” Id. ¶ 76.

                               2. Newspaper Articles

             The amended complaint also cites a number of articles published in

the New York Post in 2005 and 2006. Two published in August 2005 and a series

published in the fall of 2006 are worth mentioning. First, an article published

August 4, 2005 describes an RTV-chargeback related memo sent to store

managers by defendant Larry Mercer. According to the article, this so-called

“Mercer Memo,” dated April 19, 2002, “discussed ‘missed RTV dollars’ and

pinpointed specific categories . . . that had the greatest opportunity to boost

chargebacks.” Id. ¶ 81 (emphasis omitted). The memo estimated that

companywide Home Depot could boost chargebacks by $59 million.

      Notably, the amended complaint does not cite or quote from the memo

itself. Instead, it relies on the New York Post article and CW5, the only

confidential witness who is alleged to have seen it. According to CW5, after his

store received the Mercer Memo, “every department manager spent an hour each

week assisting the RTV clerk with processing RTV chargebacks.” Id. ¶ 82.

                                          23
CW5’s store manager at the time told his subordinates that “‘here’s a great

opportunity to capture the loss,’ which CW5 understood meant to increase RTV

chargebacks, regardless of whether they were legitimate or not[.]” Id. CW5 also

stated that in the five months following the Mercer Memo, “RTV chargebacks

increased by approximately 25%” at his store. Id. ¶ 83. Although CW5 claimed to

have a “vivid recollection” of the memo, id. ¶ 82, he did not explain what the

memo said, and he did not say that the memo itself directed store managers to

process fraudulent RTV chargebacks. Thus, as to the content of the memo, the

amended complaint relies entirely on a very brief summary contained in the New

York Post article.

      Second, an August 15, 2005 newspaper article reported that “[a] senior

Home Depot official” acknowledged that “management” had been aware of the

allegedly fraudulent chargeback schemes “for at least 19 months, when a memo

dated February 12, 2004, was circulated by the corporate office that outlined

procedures for collecting chargebacks from suppliers.” Id. ¶ 88. Notably, the

“senior official” is not named, his position is not provided, and no indication is

given about his proximity to the offending conduct. Indeed, based on the

allegations in the amended complaint, the article says nothing at all about the basis




                                         24
of the unidentified “senior official’s” knowledge, nor does it state that he was even

employed by Home Depot when the memo was distributed.

       Third, a series of newspaper articles published in 2006 detailed the

investigation and termination of various Home Depot managers responsible for

inventory management. A New York Post article published on September 7, 2006

claims that “[a]uditors descended on stores in Washington, D.C., Virginia,

Maryland, Pennsylvania and New York this summer. . . . A focal point was

whether employees had been given a weekly percentage target for RTV claims.”

Id. ¶ 115. According to the amended complaint, the story names two district

managers who were fired and two store managers who were placed on

administrative leave as “part of an ongoing internal investigation into allegations

of improper vendor chargebacks[.]” Id. The only source cited for these statements

is Natasha Williams, one of the store managers placed on administrative leave,

who by that time had filed a discrimination lawsuit against Home Depot. Id. ¶¶

115-16. The article does not explain how Williams (or any other unnamed source)

learned of the extent of the investigation or of the purported reasons behind the

firings.

       A follow-up newspaper article published on October 16, 2006 discusses the

termination of four store managers and a district manager in Pennsylvania,

                                         25
Maryland, and Washington, D.C., and observed that “the recent blood-letting

doubles to 10 the number of Home Depot employees who have lost their job as a

result of the [RTV-chargeback] inquiry.” Id. ¶ 117. The article says that “all but

one of the employees . . . were let go as a result of the on-going probe,” id., but, at

least according to the allegations in the amended complaint, it provides no basis

whatsoever for this statement.1

                           3. Internal Home Depot Documents

       In addition to the memos referred to in the New York Post newspaper

stories, the amended complaint cites several documents describing the “Back-End

Automation & Re-Engineering” (“BEAR” for short) system, a new system Home

Depot developed to process RTV chargebacks. See id. at ¶¶ 90-95. Among other

things, the memos identify the RTV process as “a critical focus area for 2004 and

2005,” and promised “more comprehensive policies” and “consistent, accurate

RTV policy execution in stores.” Id. ¶¶ 92, 93 (emphasis omitted). Moreover,

under the new system, “the Home Depot RTV Associate and Supplier



       1
          The remaining New York Post articles say: (1) at least three Home Depot employees claim
to have been retaliated against for refusing to process fraudulent chargebacks; (2) Raymond
Hammond, a “former Home Depot subcontractor,” ACAC ¶ 110, stated that RTV abuse happened
routinely at all five upstate New York Home Depot stores he worked at from 1999 to 2001; and (3)
“a West Coast member of a[n] RTV team” said that “the questionable practices took place in stores
in his region as well,” id. ¶ 118 (quotation marks omitted).

                                               26
Representative will no longer be able to override negotiated policies.” Id. ¶ 93

(emphasis and brackets omitted).

                           4. Whistleblower Complaint

      On June 30, 2005, Michael Davis, a former Home Depot employee, filed a

Sarbanes-Oxley whistleblower complaint with the Department of Labor. See 18

U.S.C. § 1514A. Davis worked as, among other things, a loss prevention officer

and an RTV clerk at one Home Depot store in Maryland from October 1997 until

he was fired in March 2005. Davis’s complaint alleged that beginning in 2000

store management instructed RTV clerks to process RTV chargebacks for

merchandise that was “never defective, damaged, or returned to the store.” Id. ¶

103. Moreover, Davis’s complaint claimed that “[c]ompany management would

circulate memos telling personnel to use RTVs instead of markdowns. . . . These

memos came from another store, the Atlanta home office, and the Paramus, New

Jersey office in some cases setting dollar value store goals, dollar value regional

goals and a companywide goal of $59 million.” Id. (emphasis omitted). And in

2004, Davis “was given a package from District Loss Prevention Manager Alan

Wells explaining, on a company-wide basis, that RTV clerks could generate

dollars for the store, the region, and companywide.” Id. (emphasis and brackets

omitted).

                                         27
       Still another New York Post article published on January 20, 2006, says that

during a deposition in Davis’s whistleblower case, one of Davis’s former co-

workers, Donald Moyer, testified that a physical count of the inventory at a Home

Depot store in Maryland produced a number that exceeded the inventory on its

records by $1 million. Id. ¶ 107. The amended complaint does not cite Moyer’s

testimony itself, relying instead on the New York Post’s account of it. According

to the newspaper, Moyer said that Home Depot’s corporate office sent a team to

investigate the discrepancy, and “[t]hey determined that the extra inventory was

the result of inflated RTV dollars.” Id. A second New York Post article,

published on April 14, 2006, reports that Davis said that RTVs might rise to

$35,000 per week around the busy Christmas season, but would soar to $80,000

per week “[i]n the weeks leading up to the stores’ bi-annual inventory audit.” Id. ¶

109.

                                  5. SEC Inquiry

       Finally, the amended complaint alleges that the Securities and Exchange

Commission opened an “informal inquiry” into Home Depot’s RTV chargeback

practices. Id. ¶ 119. In addition, a reporter for CNBC discussing the SEC inquiry

observed that Michael Davis -- the whistleblower complainant -- claimed that his

store processed $25,000 of improper charges per week. According to the

                                        28
commentator, “[t]hat is about $1.3 million. Extending that out to all the stores in

the Home Depot empire and you are talking more than $1 billion . . . .” Id. ¶ 120

(emphasis omitted). Notably, however, the amended complaint does not explain

what prompted the investigation, the scope of the investigation, who the SEC

talked to, or, most importantly, the results of the inquiry. Simply put, the only fact

of substance alleged in the amended complaint is that at some point the SEC

looked into Home Depot’s RTV chargeback practices.

                                          B.

      Bucks County, as lead plaintiff for a putative class of investors who

purchased Home Depot common stock between May 29, 2001 and February 22,

2005 (the day Home Depot released its results for the fourth quarter of 2004),

alleges that Home Depot’s failure to disclose the RTV chargeback scheme in its

financial statements and press releases from 2001 through February 2005

amounted to securities fraud under Section 10(b) of the Exchange Act of 1934, 15

U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, 17 U.S.C. § 240.10b-5.

In other words, investors looked at the company’s financial statements and press

releases and reasonably believed the numbers reflected legitimate transactions,

rather than results inflated by theft from vendors. After describing at length the

press releases and financial reports containing the alleged misrepresentations and

                                         29
omissions, see ACAC ¶¶ 123-218; see also 15 U.S.C. § 78u-4(b)(1)(B) (requiring

a securities fraud class action complaint to “specify each statement alleged to have

been misleading [and] the reason or reasons why the statement is misleading”);

Fed. R. Civ. P. 9(b) (requiring allegations of fraud to be pleaded with

particularity), the amended complaint alleges that all of these public statements

were

       false or misleading when made because they misrepresented or
       omitted the following material adverse facts that the Defendants knew
       at the time the statements were made:

                   a. That during [the relevant fiscal year], Home Depot
             was engaged in a scheme to inflate the Company’s earnings
             through fraudulent RTV practices;

                   b. That during [the relevant fiscal year], Home Depot
             derived a material portion of its revenues and profits from
             fraudulent RTV practices;

                   c. That the Company had failing and deficient internal
             controls and procedures and lacked any meaningful ability to
             accurately report its financial results;

                    d. That the Company’s improper RTV practices were in
             direct violation of its own code of conduct; and

                   e. That the Company’s illicit scheme vis-a-vis fraudulent
             RTV practices potentially subjected Home Depot to substantial
             regulatory fines, penalties and other legal action, thereby
             compromising the Company’s overall financial condition and
             prospects.



                                            30
ACAC ¶¶ 142, 170, 198, 219. The amended complaint also alleges that the

misrepresentations in Home Depot’s SEC filings violated various Generally

Accepted Accounting Principles. See id. ¶ 224.

      According to the amended complaint, Home Depot’s stock price was

artificially inflated “as a direct result of the fraudulent scheme.” Id. ¶ 261. But

Home Depot is said to have stopped the scheme in the fourth quarter of 2004. As

a result, the company met (but failed to exceed) analysts’ expectations for that

quarter. Following the fourth quarter earnings announcement, Home Depot’s

stock price fell. Bucks County says this share-price drop was “a direct and

forseeable consequence of Defendants’ failure to disclose and their concealment

of, inter alia, the true state of the business operations and financial condition of

Home Depot.” Id. ¶ 276.

                                          C.

      In addition to naming Home Depot, Inc. as a corporate defendant, Bucks

County attempts to pin responsibility for the alleged fraud on six high-ranking

Home Depot officials whom it also names as defendants: Robert Nardelli, Carol

Tomeì, Larry Mercer, Kenneth Langone, Berry Cox, and John Clendenin. The

amended complaint summarizes their positions within Home Depot this way:




                                          31
• Robert Nardelli became the President and Chief Executive Officer of Home
  Depot in December 2000 and Chairman of the Board of Directors in January
  2002. He retained those positions throughout the class period.

• Carol Tomeì became Home Depot’s Chief Financial Officer and an
  Executive Vice President of the company in May 2001 and held those
  positions throughout the class period. Previously, she was a Senior Vice
  President of Finance from February 2000 to May 2001 and Vice President
  and Treasurer from 1995 to 2000.

• Larry Mercer was Home Depot’s Executive Vice President of Store
  Operations from the beginning of the class period until he retired in August
  2002. Following his retirement, Mercer served as an advisor to Nardelli
  until February 2004.

• Kenneth Langone is one of the co-founders of Home Depot and has served
  on its Board of Directors since 1978. During the class period, Langone
  served as Home Depot’s “Lead Director,” a position that required him to
  “act[] as a liaison between non-management directors . . . and Company
  management . . . , chair[] executive sessions of non-management directors,”
  and consult with the Chairman of the Board (Nardelli) on various matters.
  ACAC ¶ 23. Throughout the class period, Langone was also a member of
  the Board’s Executive Committee and its Nominating and Corporate
  Governance Committee, which “is responsible for, inter alia, overseeing the
  Company’s corporate governance practices and procedures.” Id. ¶ 24.
  Finally, Langone served on the Board’s Audit Committee for the 2004 fiscal
  year.

• Berry Cox was a member of Home Depot’s Board from 1978 to June 2005.
  He was Chairman of the Board’s Audit Committee from the beginning of
  the class period until August 2002.

• John Clendenin joined the Home Depot Board in 1996. In 2002, he took
  over Cox’s position as Chairman of the Audit Committee and held that
  position throughout the remainder of the class period.




                                    32
                                             IV.

       With this background, we turn to the critical question: whether the amended

complaint, taken as a whole, creates a “strong inference” -- one that is “cogent and

compelling” -- that the individual defendants acted with the required scienter. We

hold that it does not.

       To begin with, we agree with the district court’s observation that the

amended complaint’s allegations, if accepted as true, establish that Home Depot

stores processed improper RTV chargebacks. Thus, for example, the confidential

witnesses describe RTV-chargeback fraud occurring at Home Depot stores

throughout the Northwest and at particular stores in California, Colorado, New

York, Connecticut, and Massachusetts. Although we do not know the names of

these witnesses, the similarity of the fraudulent schemes they describe supports the

claim. Moreover, five of the witnesses were either RTV clerks or store managers,

positions that might have exposed them to their stores’ RTV-chargeback practices

on a regular basis.2 Thus, the amended complaint provides an adequate foundation


       2
         The only confidential witness who was not a store-level employee is CW1, who managed
the 300 stores of Home Depot’s Northwest Division from 1997 to 2003. Although the amended
complaint alleges that CW1 said RTV fraud was “‘common place’ at Home Depot throughout the
course of his/her employment,” ACAC ¶ 54, it does not explain the basis of his knowledge. The
amended complaint does not allege, for example, whether CW1 based his opinion on personal
observations he made during trips to Home Depot stores, or instead just repeated scuttlebutt he
overheard around the office.

                                              33
for their statements. Moreover, the allegations in the amended complaint also

support the suggestion that the fraud may have lasted several years. Specifically,

CW1, CW2, CW3, CW5, CW6, and Raymond Hammond, a Home Depot

subcontractor, all reported fraud occurring at various times between 2001 and the

fourth quarter of 2004.

      But simply alleging that a widespread fraud may have occurred is not

enough. Because scienter is an essential element of a securities fraud claim,

Bucks County’s allegations must create a strong inference -- again, one that is

“cogent and compelling” -- that the individual defendants knew about the alleged

fraud (or were severely reckless in not knowing about it) when they made the

purportedly false or misleading statements. In other words, to state a claim against

the individual defendants, Bucks County also must allege facts from which a

reasonable person would infer that it is at least as likely as not that the individual

high-ranking defendants either orchestrated the alleged fraud (and thus always

knew about it), or learned about the alleged fraud sometime before the fourth

quarter of 2004, or were otherwise severely reckless in not learning of the claimed

fraud during that period. Like the district court, we are convinced that the

amended complaint falls short.




                                          34
                                           A.

      At the outset, we note that the amended complaint relies exclusively on the

widespread nature of the fraud, and the purported amount of the fraud, to draw a

strong inference that the individual defendants (all high-ranking officials) acted

with the requisite scienter. Thus, there are no claimed e-mails or letters from any

of the individual defendants expressly ordering or even suggesting that Home

Depot employees process fraudulent RTV chargebacks; nor do any of the

confidential witnesses say that any one of the individual defendants ever discussed

the alleged fraud or even knew about it. Indeed, none of the confidential

witnesses even claims to know or have so much as ever met any of the six

individual defendants. Although Bucks County views the so-called Mercer Memo

and the 2001 Strategic Operating Plan referred to by CW1 as direct evidence of

fraudulent intent, we are not persuaded.

      Taking the Mercer Memo first, it is important to point out that the amended

complaint does not quote the memo itself. Rather, it relies entirely on what the

New York Post said about it. And according to the amended complaint, the

newspaper did not say much, because the article is alleged to have reported only

that the memo “discussed ‘missed RTV dollars,’” “pinpointed specific categories

. . . that had the greatest opportunity to ‘boost chargebacks,’” and “estimate[d]

                                           35
that, on a companywide scale, Home Depot could boost RTV chargebacks by

more than $59 million[.]” ACAC ¶ 81 (emphases omitted). Notably, the amended

complaint is careful never to say that the memo itself orders employees to engage

in RTV fraud. Indeed, based on the descriptions of it in the amended complaint,

nothing in the memo indicates fraud. Instead, the newspaper article’s recitation of

the memo appears to instruct store managers to look closely at RTVs to ensure that

employees maximize legitimate chargebacks. There is nothing sinister about

management highlighting areas where employees can legitimately save the

company money.

      Moreover, to assign a fraudulent intent to the memo, the amended complaint

relies on how a single employee (CW5) interpreted his store manager’s comment

about it:

      According to CW5, the store manager . . . told the assistant and
      department managers that “here’s a great opportunity to capture the
      loss,” which CW5 understood meant to increase RTV chargebacks,
      regardless of whether they were legitimate or not, in order to reduce
      shrink.

ACAC ¶ 82. A single employee’s interpretation of his manager’s facially

innocuous comment about a document says precious little, if anything, about the

knowledge or intent of the drafter of the memo (Mercer), not to mention the rest of

the individual defendants, who are referenced in no way by CW5, or by anyone

                                        36
else. In our view, the Mercer Memo does not amount to direct evidence that the

individual defendants orchestrated or even knew about the alleged fraud and did

nothing.

      Bucks County’s strained inferences from the 2001 Strategic Operating Plan

are similarly unconvincing. Once again, Bucks County does not quote the Plan

itself. Rather, the amended complaint relies on CW1's brief summary of it. From

CW1's thumbnail sketch, Bucks County focuses on two aspects of the Plan that

allegedly raise suspicion. First, Bucks County notes ominously that the Plan

“contemplated using RTV chargebacks to reduce shrink.” ACAC ¶ 85. But there

is nothing wrong with using legitimate RTV chargebacks to reduce shrink, so this

aspect of the Plan does not amount to anything suspicious at all. Second, the Plan

set actual and targeted financial goals for the Northwest Division. Among these

goals was an amount for “Vender Income (Rebates).” According to CW1,

“‘Vendor Income (Rebates)’ was initially ‘referred to as vendor income, but it was

then changed and a word was added to not draw any attention to it, the change was

called Vendor Income (Rebates).’ . . . ‘[W]e don’t do a lot of rebates at Home

Depot, so it’s easy to see what they were doing.’” ACAC ¶ 87. From this muddled

explanation, Bucks County infers that Home Depot somehow “accounted for the




                                        37
illicit RTVs as ‘Vendor Income (Rebates)’ so that the actual artificially inflated

earnings and operating margins would correspond with budgeted amounts.” Id.

      First off, there is no information about who wrote the Plan or who received

it. More importantly, CW1’s description of it is so vague that the allegations

about it are not particularized as required by the PSLRA. Specifically, we cannot

tell what “rebates” in this context means, nor do we know what in CW1’s view

constitutes “a lot” of them. All of these gaps in the amended complaint’s

description of the Plan undermine any inference of scienter that Bucks County

hopes to draw from it. See Garfield, 466 F.3d at 1265 (concluding that allegations

about what was said at a meeting involving senior executives was insufficiently

particularized where the complaint “failed to allege what was said at the meeting,

to whom it was said, or in what context”). Moreover, nothing in the amended

complaint’s description of the document suggests that the “rebates” referred to in

the Plan were anything other than legitimate rebates. Instead, the amended

complaint relies entirely on CW1’s inference from a single change in terminology.

But CW1 does not explain how he knows the name was even changed, and, more

importantly, we do not see how so much can be read only into the label placed on

a column heading. In short, we do not think the 2001 Strategic Operating Plan




                                         38
does very much to establish scienter either, let alone afford a cogent and

compelling inference of scienter.

      Of course, the lack of direct evidence connecting the defendants to the

alleged fraud is not fatal, because plaintiffs may create a “strong inference” of

scienter by circumstantial evidence alone. See Tellabs, 127 S. Ct. at 2510

(explaining that the plaintiff need not provide allegations “of the ‘smoking-gun’

genre”). Thus, the question before us boils down to whether a reasonable person

would infer that there was at least a fifty-fifty chance that the individual

defendants knew about the alleged fraud (or were severely reckless in not knowing

about it) based on its nature, duration, or amount. The district court said “no,” and

so do we.

                                          B.

      We begin by rejecting Bucks County’s assertion that the widespread nature

or duration of the fraud leads to a strong inference that it was “orchestrated at

corporate headquarters.” ACAC ¶ 239. Bucks County relies on the common-

sense notion that large numbers of people do not often think of the same idea at

roughly the same time without talking to each other. Thus, if some Home Depot

stores in varying parts of the country engaged in the same kind of fraud during

overlapping time frames, then, the argument goes, it is likely that someone

                                          39
overseeing the entire company, such as senior management like Nardelli, Tomeì,

and Mercer, devised the fraud and ordered lower-level employees to execute it.

Although this argument has some surface appeal, we see three reasons why it

breaks down here.

      First, the alleged fraud appears to have been a simple one, and, if it

occurred, plainly did not require the participation of upper management, let alone

the CEO or the CFO of the company. The more complex an idea, the less likely it

is that many people will stumble onto it simultaneously. So if the fraud alleged

here were complex, then it would be more likely that it originated from one or a

few persons at the top of Home Depot, as opposed to a number of store managers

devising the scheme themselves. Likewise, certain types of fraud, such as

sophisticated, Enron-style accounting frauds, undeniably require the participation

of senior management -- these frauds simply cannot be carried out by low-level

employees acting on their own. But the fraud alleged here was very simple: store

employees simply told vendors that perfectly good merchandise was damaged.

Because vendors with destroy-in-field provisions in their contracts did not check

these claims, the alleged fraud required no elaborate cover-up or fancy accounting

tricks. The purportedly damaged items were simply thrown out or left on the

shelves to be sold. The simplicity of the fraud and the fact that it could be

                                         40
completed without the involvement of any upper management officials tend to

undermine the inference that it must have originated with senior Home Depot

officials, rather than with store-level employees.

      Second, if Nardelli, Tomeì, and Mercer -- three of the most senior officials at

Home Depot -- orchestrated the fraud, presumably they would have communicated

their instructions either through regional managers, such as CW1, or store

managers, such as CW5. But neither CW1 nor CW5 so much as mentions any

conversation or directive coming from the individual defendants (or from anyone

else for that matter) ordering them to commit RTV fraud or instructing them on

how to do it. The allegations based on statements by CW1 are particularly striking

in this regard. Although the amended complaint devotes several pages to

recounting his statements, see ACAC ¶¶ 54-58, 84-87, CW1 never once says that

anyone above him on the corporate ladder discussed RTV fraud with him or

demanded that he order his stores to engage in it. Simply put, if Nardelli, Tomeì,

Mercer, and other officials at “corporate headquarters” orchestrated the fraud,

CW1 would have known this and said so explicitly, but he never said that. Indeed,

the amended complaint fails to cite even one communication of any kind from the

individual defendants (or any other high-ranking Home Depot official) that could

reasonably be interpreted as ordering or even encouraging RTV fraud. The

                                         41
absence of these types of allegations weighs strongly against the inference that the

named defendants or other very senior Home Depot officials orchestrated the

fraud.

         Third, the amended complaint’s allegations suggest that some store

managers orchestrated the fraud in order to meet aggressive company targets for

reducing shrink. In particular, CW5, who managed a Home Depot store in

California, said that “Home Depot policy” required store managers to keep shrink

to 1.5% or less on pain of termination. Id. ¶ 73. To meet this standard, CW5

stated, “stores recaptured shrink by processing fraudulent RTV chargebacks.” Id.

These allegations may suggest that a store manager may have orchestrated RTV

fraud, rather than senior management. The most plausible inference to draw from

the amended complaint’s allegations, taken together, is that the RTV fraud began

at the store level in response to pressure on store managers to reduce shrink.

         That conclusion does not end our inquiry, however, because even if the

named defendants did not orchestrate the fraud, it is possible they could have

learned about it sometime before the fourth quarter of 2004. And that knowledge,

Bucks County suggests, would make their public statements not only false, but

fraudulent as well. But once again, Bucks County cites no documentation,

communication, or conversation suggesting that the high-ranking defendants knew

                                          42
anything about the alleged fraud. Rather, Bucks County argues only that, based on

the breadth and amount of the fraud and Home Depot’s decision to overhaul its

RTV processing system in 2004, the individual defendants must have known about

it.

         To begin with, we indulge at least some skepticism about allegations that

hinge entirely on a theory that senior management “must have known” everything

that was happening in a company as large as Home Depot, which operates over

2000 stores. ACAC ¶ 14. The amended complaint, therefore, must at least allege

some facts showing how knowledge of the fraud would or should have percolated

up to senior management. The amended complaint does not come close to

accomplishing that task. In particular, Bucks County’s “must have known” theory

fails because the alleged amount of the fraud is wholly speculative, the type of

fraud alleged would be very difficult for senior management to detect, Bucks

County alleges no suspicious stock sales by management, and Home Depot’s 2004

overhaul of its RTV processing system does not suggest knowledge of widespread

fraud.

         1. The amount of the fraud is speculative. First, Bucks County asks us to

infer that the fraud approached $1 billion per year, a figure that Bucks County

contends is so large that any senior executive either knew about it or was severely

                                          43
reckless in not discovering it. There are two problems with this argument. For

one thing, although surely a significant sum, $1 billion represents less than 2% of

Home Depot’s annual sales, which amounted to $53.6 billion in fiscal year 2001

and rose to $64.8 billion in fiscal year 2003. ACAC ¶¶ 139, 194. This is not a

case where allegedly fraudulent transactions amounted to an overwhelming

percentage of the corporation’s business. Compare In re Suprema Specialties, Inc.

Secs. Litig., 438 F.3d 256, 278-79 (3d Cir. 2006) (concluding that a strong

inference of scienter existed where, among other things, the complaint alleged that

“fictitious transactions . . . constituted more than two-thirds of the company’s

revenue”) (quotation marks omitted, emphasis added) with In re Alpharma Inc.

Secs. Litig., 372 F.3d 137, 151 (3d Cir. 2004) (concluding that no strong inference

of scienter existed where the complaint, which relied on fraud occurring at a

subsidiary, was “devoid of any allegations which would establish that [the

subsidiary] was so central to Alpharma’s business that its increased revenue

figures should have received particular attention from company executives”).

      Far more importantly, the PSLRA requires plaintiffs to plead with

particularity the facts supporting a “strong inference” of scienter, but the amended

complaint contains precious little of substance about the total amount of the

alleged fraud. Indeed, Bucks County appears to rely entirely on the estimate of

                                         44
only one store employee (CW2), an RTV clerk, who allegedly observed fraud

occurring at only two stores and estimated that the fraud at these two stores

together amounted to $1 million annually. See ACAC ¶ 63. CW2’s statements

tell us absolutely nothing about the amount of fraud at other stores, yet Bucks

County apparently calculates its $1 billion figure simply by multiplying CW2’s

per-store number ($500,000) by the total number of Home Depot stores

(approximately 2,000). Likewise, the CNBC commentator cited in the amended

complaint relied entirely on whistleblower Michael Davis’s estimate of $25,000

per week at one store to make a quick, back-of-the-envelope guess of more than $1

billion for the entire company. See id. ¶ 120. Simply put, estimates of fraud

occurring at one or a few stores, like the estimates provided by CW2 and Davis,

are far too shaky a foundation on which to make any reasonable calculus of the

total amount of the fraud. Thus, even assuming the fraud was widespread, we

have no reliable way of estimating its total amount, let alone inferring from the

dollar amount the knowledge of senior management.

      2. The type of fraud alleged would be difficult for senior management to

detect. The fraud in this case involved some Home Depot employees lying to

some vendors to obtain excessive rebates. As we have already explained, the

fraud was simple and did not require employees to make phantom entries on Home

                                         45
Depot’s books or engage in other kinds of sophisticated accounting cover-ups.

Rather, the rebates from vendors really were flowing into Home Depot’s coffers,

so there was no lack of actual cash flow that would have raised a red flag among

company executives or auditors. See Garfield, 466 F.3d at 1266-67 (concluding

that the complaint failed to create a strong inference of scienter because, among

other things, it contained “no allegations . . . that indicate the presence of . . . ‘red

flags’ in the company’s financial statements”). Likewise, the amended complaint

does not allege that Home Depot’s RTV rate was extremely high compared with

other companies. On the basis of what is contained in the amended complaint,

there appears to be no accounting red flag that would have tipped off the

individual defendants to their subordinates’ allegedly fraudulent activity.

      The lack of accounting red flags also undermines Bucks County’s argument

that scienter can be inferred from the fact that the individual defendants were

required to certify Home Depot’s financial statements under the Sarbanes-Oxley

Act. In Garfield, we held that “a Sarbanes-Oxley certification is only probative of

scienter if the person signing the certification was severely reckless in certifying

the accuracy of the financial statements.” 466 F.3d at 1266. A certifier would be

severely reckless, Garfield held, only if he “had reason to know, or should have

suspected, due to the presence of glaring accounting irregularities or other ‘red

                                            46
flags,’ that the financial statements contained material misstatements or

omissions.” Id. Because no such glaring “accounting irregularities” or “red flags”

are present here, the Sarbanes-Oxley certifications by the individual defendants do

not support an inference of scienter.

      Even though an examination of Home Depot’s financial statements would

not have revealed the alleged RTV fraud, it conceivably might have been detected

by inventory checks that counted more merchandise on a store’s shelves than on

its books. Ordinarily, shrink causes a store’s actual inventory to be lower than the

inventory recorded on its books. But if an inventory revealed that a store’s book

figure was lower than its actual inventory, then the auditors would be on notice

that something was wrong. The amended complaint alleges that each of Home

Depot’s 2000 stores was inventoried twice per year, see ACAC ¶¶ 107, 109, yet

only one time was such a discrepancy discovered. One problematic inventory

would not put upper management on notice of widespread and pervasive fraud.

      Moreover, the amended complaint is unclear about when this troubling audit

occurred. Citing only a New York Post article, which in turn quotes statements

made by an employee at a Maryland Home Depot store, the amended complaint

states that a “2004 audit” of one store revealed $1 million in excess inventory. Id.

¶ 107. But the article was published in 2006 and goes on to say that the auditors

                                         47
discovered the discrepancy “[l]ast year.” Id. At best, this newspaper account

supports the inference that one inventory produced an anomalous result one time

at the very end of the class period. As the same paragraph in the amended

complaint states, it was only after the discrepancy was discovered that “the

corporate office sent a team to investigate.” Id. According to an employee quoted

in the New York Post article, that team (presumably at some later date)

“determined that the extra inventory was the result of inflated RTV dollars.” Id.

This allegation does nothing to bolster the claim that the defendants knew about

the fraud during the class period, because the audit almost certainly did not reach

its conclusions about RTV fraud until after Home Depot released its results for the

fourth quarter of 2004. Indeed, the lack of evidence about similar discrepancies in

earlier inventories supports the more likely inference that management was not

aware of the problem.

      Still another way senior managers could have learned of the fraud would be

through the complaints of whistleblowers. Although the amended complaint

discusses complaints by three whistleblowers, it makes no claim that any of the

senior-management defendants learned of these complaints before Home Depot

released its fourth quarter financial information in February 2005. For example,

Michael Davis, a former Home Depot employee, did not file his Sarbanes-Oxley

                                         48
whistleblower complaint until June 2005. See ACAC ¶ 101. Quite simply, the

amended complaint affords no basis for inferring that the individual defendants

would have heard about these whistleblower complaints during the class period.

Moreover, nothing in the vague stories published by the New York Post provides a

sufficiently cognizable and detailed basis for inferring that internal complaints by

employees alerted senior management to the alleged fraud.

      Finally, senior managers perhaps could have learned of the alleged fraud

from unhappy vendors who contacted Home Depot to complain about excessive

RTV chargebacks. But once again, the amended complaint makes no mention of

even a single vendor who complained to anyone at Home Depot, let alone

complained to senior management.

      The alleged RTV fraud produced no accounting red flags, and the amended

complaint strongly suggests that management would not have learned about it

from inventory checks, whistleblower complaints, or vendors. Simply put, the

evidence recited in the allegations is far from yielding a “strong inference” of

scienter.

      3. No suspicious stock sales occurred. Moreover, as many courts have

held, the timing of stock trades by insiders also may be relevant to inferring

scienter. Stock sales or purchases timed to maximize returns on nonpublic

                                         49
information weigh in favor of inferring scienter; the lack of similar sales weighs

against inferring scienter. Compare In re Navarre Corp. Secs. Litig., 299 F.3d

735, 747 (8th Cir. 2002) (explaining that stock sales are suspicious when “the

level of trading is dramatically out of line with prior trading practices at times

calculated to maximize the personal benefit from undisclosed inside information”)

(quotation marks omitted) with Pugh v. Tribune Co., 521 F.3d 686, 695 (7th Cir.

2008) (“Tellabs instructs us to consider all potential inferences, and the fact that

the defendants are not alleged to have sold the stock at the inflated prices meant

that they stood to lose a lot of money if the value of Tribune’s stock fell.”). In this

case, the amended complaint says nothing about suspicious stock transactions by

any of the individual defendants, an omission that weighs against inferring

scienter.3

       4. Home Depot’s 2004 overhaul of its RTV processing system does not

suggest fraud. In 2004, Home Depot implemented a new automated system -- the

BEAR system -- for handling RTV chargebacks. According to Bucks County,

Home Depot never would have designed and implemented BEAR unless it knew

that a large, on-going fraud was occurring and wanted to stop it. Thus, Bucks


       3
          We emphasize that suspicious stock sales are not necessary to create a strong inference of
scienter. See Tellabs, 127 S. Ct. at 2511. Instead, the presence or absence of such allegations must
be assessed in light of all of the allegations found in the complaint.

                                                50
County says, senior executives at Home Depot must have known about the fraud

at least as early as 2003, when they began work on BEAR, and their failure to

disclose that knowledge amounts to a violation of the securities laws. We remain

unpersuaded.

      Large corporations like Home Depot make incremental improvements to

their business operations all the time, and, from the amended complaint, BEAR

appears to be nothing more than that. The Home Depot documents quoted in the

amended complaint, which were written in 2003 and 2004, say that implementing

BEAR would result in “more comprehensive policies” and “consistent, accurate

RTV policy execution,” and that store employees “will no longer be able to

override negotiated policies.” ACAC ¶ 93. Moreover, “[t]he enhanced integral

reporting and metrics will help Home Depot to reinforce desired behaviors and

allow performance tracking to drive future improvements.” Id. ¶ 95. Cutting

through the jargon, these statements appear to say nothing more than that Home

Depot is trying to create a more centralized system for handling RTV chargebacks.

We do not believe that reasonable people would infer very much from the design

and implementation of a system that appears to do little more than increase

management’s control and improve management’s access to information.




                                        51
      In short, the amended complaint contains no allegations directly linking the

named defendants to the RTV fraud, and the allegations about the geographic

scope, duration, and amount of the alleged fraud are insufficient to create a “strong

inference” (meaning a “cogent and compelling” one) that the individual

defendants orchestrated the fraud, knew about it, or were severely reckless in not

knowing about it. Accordingly, the district court was right to dismiss the § 10(b)

and Rule 10b.5 claim against the individual defendants under the heightened

pleading standards unambiguously imposed by Congress in the PSLRA.

      Even though it failed to plead scienter adequately for any of the individual

defendants, the amended complaint could, in theory, still create a strong inference

that the corporate defendant, Home Depot, Inc., acted with the requisite state of

mind. Corporations, of course, have no state of mind of their own. Instead, the

scienter of their agents must be imputed to them. See, e.g., Teamsters Local 445

Freight Div. Pension Fund v. Dynex Capital Inc., 531 F.3d 190, 195-96 (2d Cir.

2008); Tellabs, 513 F.3d at 708-10; Southland Secs. Corp. v. INSpire Ins.

Solutions, Inc., 365 F.3d 353, 366 (5th Cir. 2004). Because the allegations in this

case relate to allegedly fraudulent public statements, we “look to the state of mind

of the individual corporate official or officials who make or issue the statement (or




                                         52
order or approve it or its making or issuance, or who furnish information or

language for inclusion therein, or the like)[.]” Southland Secs., 365 F.3d at 366.

      Here, however, Bucks County does not argue that any Home Depot officials

were responsible for the company’s financial statements other than the named

individual defendants. In other words, Bucks County does not argue that, even if

the amended complaint fails to raise a strong inference of scienter as to any of the

individually named defendants, it does raise a strong inference that somebody

responsible for the allegedly misleading statements must have known about the

fraud. For that reason alone we need not pursue this issue further. See Greenbriar,

Ltd. v. City of Alabaster, 881 F.2d 1570, 1573 n.6 (11th Cir. 1989) (arguments not

made are waived). But in any event, the amended complaint does not create any

inference, let alone a strong one, that unnamed Home Depot officials were both

responsible for issuing the allegedly false public statements and were aware of the

alleged fraud. Accordingly, we are constrained to affirm the dismissal of the

§ 10(b) and Rule 10b-5 claim against Home Depot, Inc.

      Because Bucks County failed to adequately plead a violation of § 10(b) and

Rule 10b-5 by Home Depot, Inc., its § 20(a) control-person claims against the

individual defendants necessarily fail as well. See Garfield, 466 F.3d at 1261;




                                         53
Theoharous, 256 F.3d at 1227. Thus, we affirm the district court’s dismissal of the

amended complaint in its entirety.

                                                 V.

       The only remaining question is whether the district court properly denied

Bucks County leave to amend. Although Bucks County did not submit a proposed

amended complaint, its motion for leave cited three newly discovered facts that

purportedly bolster the inference of scienter: (1) President and CEO Nardelli

resigned less than six weeks after Bucks County filed the amended complaint; (2)

in late 2006, Home Depot admitted that its executives had backdated options prior

to December 2000; and (3) a July 2004 internal Home Depot report encouraged

RTV fraud. The district court concluded that the additional facts, even when

viewed in concert with those alleged in the amended complaint, did not create a

strong inference of scienter, and, therefore, denied as futile the motion for leave to

amend. We agree.4




       4
          The district court also noted that Bucks County “failed to attach a proposed amended
complaint to their motion to amend, contrary to customary practice in this court.” Doc. 80 at 22.
Although submitting a proposed amended complaint is good practice and we highly recommend it,
our case law makes clear that failing to do so is not a basis for denying leave to amend. A motion
for leave is sufficient if the motion itself “set[s] forth the substance of the proposed amendment[.]”
Long v. Satz, 181 F.3d 1275, 1279 (11th Cir. 1999). Nevertheless, we affirm the denial of leave in
this case because the district court plainly rested its holding on futility, rather than on Bucks
County’s failure to attach a proposed amended complaint.

                                                 54
      Under Fed. R. Civ. P. 15(a)(2), the court “should freely give leave when

justice so requires.” Because justice does not require district courts to waste their

time on hopeless cases, leave may be denied if a proposed amendment fails to

correct the deficiencies in the original complaint or otherwise fails to state a claim.

See Foman v. Davis, 371 U.S. 178, 182 (1962) (describing “futility” as a basis for

denying leave). Since “[t]he text of the [PSLRA] neither purports to affect Rule

15(a), nor . . . require[s] that all dismissals be with prejudice,” the normal Rule

15(a) standards apply here. ACA Fin. Guar. Corp. v. Advest, Inc., 512 F.3d 46, 56

(1st Cir. 2008); accord Belizan v. Hershon, 434 F.3d 579, 583-84 (D.C. Cir. 2006).

      We find nothing in the three purportedly new facts proffered by Bucks

County that would create a strong inference of scienter where none existed before.

To begin with, allegations about options backdating that occurred prior to 2001

are simply irrelevant. As far as we can tell, Bucks County included these

allegations because some of the backdated options vested during the class period,

which, in Bucks County’s view, created a motive for Home Depot’s senior

executives to artificially inflate the company’s stock price. But every optionholder

(or stockholder for that matter) has an incentive to inflate the company’s stock

price, irrespective of whether the options in question were backdated. Thus, these

allegations simply boil down to the claim that Home Depot executives had a

                                          55
motive to inflate the company’s stock price because they held options on Home

Depot stock. And as we have already explained, the motive created by stock or

option ownership is insufficient to create a strong inference of scienter. Instead,

stock or option ownership can create a strong inference of scienter only when

combined with suspicious stock sales or purchases. See Part IV(B)(3), supra.

Nothing in Bucks County’s motion for leave suggests that any of the named

defendants (or for that matter anyone else at Home Depot) engaged in suspicious

sales or purchases. The backdating allegations add nothing to the amended

complaint on the issue of scienter.

      Nardelli’s resignation is similarly unhelpful to Bucks County. The motion

for leave to amend says that Nardelli left the company on January 3, 2007, six

weeks after Bucks County filed the amended complaint. Home Depot called

Nardelli’s departure a resignation, but the motion suggests he was fired. Either

way, Bucks County argues that the timing of the termination supports an inference

that Nardelli was aware of the RTV scheme. This argument is without merit.

      Although the amended complaint was filed just six week prior to Nardelli’s

departure, the original complaints raising these allegations were filed in May

2006, eight months earlier. Moreover, the motion acknowledges that on December

6, 2006, less than a month before Nardelli’s departure, Home Depot publicly

                                         56
disclosed the full extent of the options backdating that occurred from 1981

through November 2000. Based on the timing of these events, the much more

plausible inference is that if Nardelli’s firing was caused by unlawful conduct, it

was the options backdating scandal that did him in, not the alleged RTV fraud

underlying this lawsuit. This allegation too, even when viewed collectively with

the allegations in the amended complaint, does not create a strong inference of

scienter.

      Finally, we come to the July 2004 internal Home Depot report. According

to the motion for leave, “the Report reveals RTVs exceeded more than 10% of

total sales in 11 of 29 stores covered by the Report.” Doc. 69 at 6-7. Indeed,

“[o]ne store reported that RTVs amounted to more than 29% of that store’s

sales[.]” Id. at 7. Eighteen of the stores, the report continued, were below the

division’s average RTV rate. If they had met the average rate, those 18 stores

could have processed “an additional $691,000 year-to-date or $1,658,400

annualized.” Id. Finally, “[t]he Report also established an overall ‘RTV target’ of

at least 8.8% per store, a rate that significantly exceeded industry standards and

bears no relation to the true amount of defective products that a store received

from its vendors.” Id.




                                         57
       Unfortunately for Bucks County, this document does not say what Bucks

County claims it says. The “report” is actually a lengthy PowerPoint presentation

apparently given to store managers as part of a workshop on how to reduce shrink.

The presentation focuses on the 29 worst performing stores in the eastern region

and details numerous ways in which those stores can reduce shrink. Better

processing of RTV credits is only one of the measures discussed, and only three

presentation slides out of thirty are devoted to it. Moreover, contrary to Bucks

County’s claims in the motion for leave, none of the slides talks about RTVs as a

percentage of total sales. Instead, one slide contains a chart breaking down four

product categories -- annuals, shrubs/landscaping, mouldings, and magazines --

and compares the stores’ shrink percentages across only these four categories.5

Although the motion suggests that the rates across these specific categories


       5
           A close inspection of the PowerPoint presentation shows that the figures represent RTVs
for just these four product categories, not total store sales. The critical slide has five main columns
labeled “Annuals,” “Shrubs/Landsca[ping],” “Mouldings,” “Magazines,” and “Total.” Doc. 70, Ex.
A. Within each of these columns are three more columns: “Store,” “RTV $,” and “%.” Thus, for
each of the 29 stores profiled, the slide presents the amount of RTVs per product category in dollar
and percentage terms, and then adds all four categories together in the “Total” column. Indeed, there
can be no doubt that the “Total” column represents the totals for just these four product categories,
and not total store sales, because adding up the “RTV $” entries in the four product columns for a
given store yields the entry for “RTV $” in the “Total” column for that store. Store 1221, for
example, has the following four entries for “RTV $”: 1,584 (annuals), 10,585 (shrubs/landscaping),
185,210 (mouldings), and 27,409 (magazines). Adding these four numbers together yields 224,788,
the same number found in the “Total” column for Store 1221.



                                                 58
“significantly exceed industry standards,” it utterly fails to provide any support for

that claim.

       Moreover, nothing in the slides even hints at processing fraudulent RTVs.

Rather, the presentation focuses entirely on legitimate ways to reduce shrink,

which undoubtedly is a problem in any retail industry. At most, the presentation

merely shows that Home Depot’s management was aware of the shrink rates at its

stores and worked to reduce it. That is good management; it is not fraud. Because

Bucks County’s motion for leave presented nothing that would bolster the

allegations of scienter in the amended complaint, the district court correctly denied

it as futile.

                                         VI.

       In sum, the amended complaint fails to surmount the pleading hurdles that

Congress has imposed on private securities fraud class actions. Fearing that these

types of lawsuits were “injur[ing] the entire U.S. economy” by rewarding

“nuisance filings, targeting of deep-pocket defendants, vexatious discovery

requests, and manipulation by class action lawyers of the clients whom they

purportedly represent,” Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Dabit, 547

U.S. 71, 81 (2006) (quotation marks omitted), Congress decided to open the

courthouse doors only to those plaintiffs whose complaints raised a “strong

                                         59
inference” that the defendants they sought to hold responsible for their losses

acted with the required bad intent. And the Supreme Court has unambiguously

explained to us that the “strong inference” requirement, though not

insurmountable, is difficult to meet -- the inference must be cogent and at least as

compelling as any opposing inference. We are constrained to conclude that the

allegations in the amended complaint do not pass Congress’s stringent test.

      AFFIRMED.




                                         60