PUBLISHED
UNITED STATES COURT OF APPEALS
FOR THE FOURTH CIRCUIT
PUBLIC EMPLOYEES’ RETIREMENT
ASSOCIATION OF COLORADO; GENERIC
TRADING OF PHILADELPHIA, L.L.C.,
Plaintiffs-Appellants,
v. No. 07-1704
DELOITTE & TOUCHE LLP;
DELOITTE & TOUCHE ACCOUNTANTS,
Defendants-Appellees.
Appeal from the United States District Court
for the District of Maryland, at Baltimore.
Catherine C. Blake, District Judge.
(1:03-md-01539-CCB; 1:03-cv-01825-CCB)
Argued: October 28, 2008
Decided: January 5, 2009
Before WILKINSON and AGEE, Circuit Judges, and
John T. COPENHAVER, JR., United States District Judge
for the Southern District of West Virginia,
sitting by designation.
Affirmed by published opinion. Judge Wilkinson wrote the
opinion, in which Judge Agee and Judge Copenhaver joined.
COUNSEL
ARGUED: Andrew John Entwistle, ENTWISTLE & CAP-
PUCCI, L.L.P., New York, New York, for Appellants. Daniel
2 PUBLIC EMPLOYEES’ RETIREMENT v. DELOITTE & TOUCHE
F. Kolb, DAVIS, POLK & WARDWELL, New York, New
York; John T. Behrendt, GIBSON, DUNN & CRUTCHER,
L.L.P., New York, New York, for Appellees. ON BRIEF:
Johnston de F. Whitman, Jr., Richard W. Gonnello, Jordan A.
Cortez, ENTWISTLE & CAPPUCCI, L.L.P., New York,
New York; ADELBERG, RUDOW, DORF & HENDLER,
L.L.C., Baltimore, Maryland, for Appellants. Marshall R.
King, Lee G. Dunst, LaShann M. DeArcy, GIBSON, DUNN
& CRUTCHER, L.L.P., New York, New York, Daniel F.
Goldstein, BROWN, GOLDSTEIN & LEVY, L.L.P., Balti-
more, Maryland, for Appellee Deloitte & Touche Accoun-
tants; Sharon Katz, Jane Alexandra Small, Joshua D. Liston,
DAVIS, POLK & WARDWELL, New York, New York, Max
H. Lauten, KRAMON & GRAHAM, P.A., Baltimore, Mary-
land, for Appellee Deloitte & Touche LLP.
OPINION
WILKINSON, Circuit Judge:
This class action securities fraud lawsuit arises out of
improper accounting by Royal Ahold, N.V., a Dutch corpora-
tion, and U.S. Foodservice, Inc. ("USF"), a Maryland-based
Ahold subsidiary. The misconduct of Ahold and USF is not
disputed in this appeal; at issue is the liability of Ahold’s
accountants, Deloitte & Touche LLP ("Deloitte U.S.") and
Deloitte & Touche Accountants ("Deloitte Netherlands"), for
their alleged role in the fraud perpetrated by Ahold and USF.
Under the Private Securities Litigation Reform Act
("PSLRA"), Pub. L. No. 104-67, 109 Stat. 737, plaintiffs must
plead facts alleging a "strong inference" that the defendants
acted with the required scienter. As recently explained by the
Supreme Court in Tellabs, Inc. v. Makor Issues & Rights,
Ltd., 127 S. Ct. 2499 (2007), a strong inference "must be
more than merely plausible or reasonable — it must be cogent
and at least as compelling as any opposing inference of non-
PUBLIC EMPLOYEES’ RETIREMENT v. DELOITTE & TOUCHE 3
fraudulent intent." Id. at 2504-05. Because we find the infer-
ence that the Deloitte defendants lacked the necessary scienter
more compelling than any competing inference that they
knowingly or recklessly perpetrated a fraud on Ahold’s inves-
tors, we affirm the district court’s judgment that plaintiffs’
motion for leave to file a second proposed amended complaint
was futile.
I.
Ahold owns and operates grocery stores and food service
companies in the United States and other countries. Deloitte
U.S. is an American accounting firm that audited Ahold’s
American subsidiaries and acted as a filing reviewer for
Ahold’s filings with the Securities and Exchange Commission
("SEC"). Deloitte Netherlands is a Dutch accounting firm that
served as Ahold’s outside auditor. Although they work
closely together, the two Deloittes are legally distinct entities.
Beginning in the 1990s, and continuing until 2003, Ahold
perpetrated two frauds that led it to significantly overstate its
earnings on financial reports. First, Ahold improperly "con-
solidated" the revenue from a number of joint ventures with
supermarket operators in Europe and Latin America ("the JV
fraud"). That is, for accounting purposes Ahold treated these
joint ventures as if it fully controlled them — and thus treated
all revenue from the ventures as revenue to Ahold — when
in fact Ahold did not have a controlling stake. Under Dutch
and U.S. generally accepted accounting principles (GAAP),
Ahold should only have consolidated the revenue proportion-
ally to Ahold’s stake in the ventures.
Second, USF falsely reported its income from promotional
allowances ("the PA fraud"). Also known as vendor rebates,
promotional allowances ("PAs") are payments or discounts
that manufacturers and vendors provide to retailers like USF
in order to encourage the retailers to promote the manufactur-
ers’ products. In order to increase its stated income, USF pre-
4 PUBLIC EMPLOYEES’ RETIREMENT v. DELOITTE & TOUCHE
maturely recognized income from PAs and inflated its
reported PA income beyond amounts actually received.
On February 24, 2003, Ahold announced that its earnings
for fiscal years 2001 and 2002 had been overstated by at least
$500 million as a result of the fraudulent accounting for pro-
motional allowances at USF and that Ahold would be restat-
ing revenues because it would cease treating the joint ventures
as fully consolidated. After this announcement, Ahold com-
mon stock trading on the Euronext stock exchange and Ahold
American Depository Receipts trading on the New York
Stock Exchange lost more than 60% of their value. Subse-
quent to the February 2003 announcement, Ahold made fur-
ther restatements to its earnings totaling $24.8 billion in
revenues and approximately $1.1 billion in net income.
As a result of the frauds, the SEC filed civil enforcement
actions against Ahold and several individual defendants. Sep-
arately, twenty-one private class action securities and ERISA
actions were filed against Ahold, both Deloittes, and other
defendants. On June 18, 2003, the Judicial Panel on Multidis-
trict Litigation transferred them to the U.S. District Court for
the District of Maryland. In re Royal Ahold N.V. Securities &
"ERISA" Litig., 269 F. Supp. 2d 1362 (J.P.M.L. 2003). Subse-
quently, several more related actions were also transferred to
the District of Maryland.
On November 4, 2003, the district court consolidated all
the actions and designated plaintiffs Public Employees’
Retirement Association of Colorado and Generic Trading of
Philadelphia, LLC as Lead Plaintiffs. In re Royal Ahold N.V.
Securities and ERISA Litig., 219 F.R.D. 343 (D. Md. 2003).
On February 18, 2004, the Lead Plaintiffs filed a Consoli-
dated Amended Securities Class Action Complaint ("CAC")
against Ahold, several Ahold subsidiaries, both Deloittes, and
some of Ahold’s underwriters, officers, and directors. The
CAC charged Ahold, its subsidiaries, the Deloittes, and the
individual defendants with violations of § 10(b) of the Securi-
PUBLIC EMPLOYEES’ RETIREMENT v. DELOITTE & TOUCHE 5
ties Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-
5(b), as well as 10b-5(a) and (c), 17 C.F.R. § 240.10b, pro-
mulgated thereunder, and also charged some defendants with
other violations of the securities laws not relevant here.
Both Deloittes moved to dismiss the CAC on several
grounds. The district court on December 21, 2004, dismissed
all of the claims against both Deloitte defendants for failure
to state a claim, and held that with respect to the § 10(b)
claims the complaint did not plead facts alleging a strong
inference of scienter as required by the PSLRA. In re Royal
Ahold N.V. Securities & ERISA Litig., 351 F. Supp. 2d 334,
385-96 (D. Md. 2004). The district court also dismissed some
but not all of the claims against the other defendants on vari-
ous grounds.1 See id. at 411. The plaintiffs continued the liti-
gation on the remaining claims and proceeded with discovery.
On November 28, 2005, Ahold and the Lead Plaintiffs
announced a $1.1 billion settlement resolving the Class’s
claims against all the defendants other than Deloitte U.S. and
Deloitte Netherlands.
On March 6, 2006, the Lead Plaintiffs filed a motion to
amend the original complaint accompanied by a proposed
Second Consolidated Amended Securities Class Action Com-
plaint ("SAC"). The SAC alleged two causes of action: one
under Rule 10b-5(b), and one under both 10b-5(a) and (c).
After briefing and oral argument, the district court denied the
motion on the basis of futility, for it determined that the
amended motion still did not meet the PSLRA’s requirement
that it allege a strong inference of scienter against the Deloit-
tes. Plaintiffs timely appealed.
1
The district court also dismissed all allegations regarding conduct
before July 30, 1999 as time-barred. In re Royal Ahold, 351 F. Supp. 2d
at 364-68. Thus, the Class Period at issue in this litigation runs from July
30, 1999 to February 23, 2003.
6 PUBLIC EMPLOYEES’ RETIREMENT v. DELOITTE & TOUCHE
II.
This appeal turns on Ahold’s accountants’ alleged role in
the JV and PA frauds. Accordingly, we shall review the
frauds and the Deloittes’ roles in them as indicated by the
record. Although Ahold began consolidating its joint ventures
in 1992, the purported class period did not begin until July 30,
1999. Our discussion of events before that date serves only to
provide background for later events.
A.
With respect to the JV fraud, both Deloittes advised Ahold
on the consolidation of the joint ventures. Five joint ventures
are at issue in this litigation: JMR, formed in August 1992;
Bompreço, formed in November 1996; DAIH, formed in Jan-
uary 1998; Paiz-Ahold, formed in December 1999; and ICA,
formed in February 2000. Ahold had a 49% stake in JMR and
a 50% share of each of the other ventures at their respective
times of formation.
Prior to Ahold’s entering into the first joint venture,
Deloitte Netherlands and Deloitte U.S. gave Ahold advice
about revenue consolidation under Dutch and U.S. GAAP.
For example, several months before the first joint venture was
formed, Deloitte U.S. partner David Herskovits sent Ahold
Senior Vice President Cor Sterk a memorandum providing
details on the consolidation of joint venture revenue. It
explained that control of a joint venture is required for consol-
idation of the venture’s revenue and discussed what situations
are sufficient to demonstrate control. The memo indicated that
control could be shown by a majority voting interest, a large
minority voting interest under certain circumstances, or by a
contractual arrangement.
Ahold began consolidating the joint ventures as they were
formed. The various Joint Venture Agreements ("JVAs") did
not indicate that Ahold controlled the ventures. For example,
PUBLIC EMPLOYEES’ RETIREMENT v. DELOITTE & TOUCHE 7
the JMR joint venture agreement specified that decisions
would be made by a board of directors, "deciding unani-
mously," and that the board would consist of three members
appointed by Ahold and four members appointed by JMH,
Ahold’s partner in the venture.
However, Ahold represented to Deloitte Netherlands that it
nonetheless possessed the control requisite for consolidation.
Deloitte Netherlands initially accepted these representations
for the consolidation of JMR and Bompreço. But as consoli-
dation continued, the Deloittes became concerned that Ahold
lacked the control necessary to consolidate these first two
joint ventures. On August 24, 1998, Deloitte Netherlands
partner John van den Dries sent a letter to Michiel Meurs,
Ahold’s CFO, advising him that Ahold’s representations of
control would no longer suffice, that Ahold would need to
produce more evidence of control in order to justify continu-
ing consolidation of joint venture revenue under U.S. GAAP,
and that without such evidence a financial restatement would
be required.
In response to Deloitte Netherlands’ requests, Ahold
drafted a "control letter" addressed to BompreçoPar S.A., its
partner in the Bompreço joint venture. The letter stated that
the parties agreed that if they were unable to reach a consen-
sus decision on a particular issue, "Ahold’s proposal to solve
that issue will in the end be decisive." After reviewing the
draft letter, Deloitte Netherlands advised Ahold that if coun-
tersigned by the joint venture partner the letter would be suffi-
cient evidence to consolidate the venture. The letter was
signed by Ahold and BompreçoPar in May 1999. By late
2000, Ahold had obtained similar countersigned control let-
ters for the ICA, DAIH, and Paiz-Ahold joint ventures. Based
on these letters and other evidence, Deloitte Netherlands con-
cluded that consolidation was appropriate.
However, in October 2002 the Deloittes learned of a "side
letter" sent to Ahold in May 2000 by one of Ahold’s ICA
8 PUBLIC EMPLOYEES’ RETIREMENT v. DELOITTE & TOUCHE
joint venture partners, Canica. The letter stated that Canica
did not agree with the interpretation of the shareholder agree-
ment stated in the ICA control letter. At this point, Deloitte
Netherlands and Deloitte U.S. began trying to get Ahold to
obtain an amendment to the shareholder agreement in order to
justify ongoing consolidation. At a February 14, 2003 meet-
ing, Deloitte Netherlands and Deloitte U.S. told Ahold that
Ahold lacked the necessary control for consolidation.
On February 22, 2003, Ahold revealed to Deloitte Nether-
lands side letters contradicting the Bompreço, DAIH, and
Paiz-Ahold control letters. Two days later, Ahold announced
that it had improperly consolidated its joint ventures and
would be restating its revenues.
B.
Now we turn to the PA fraud. Ahold acquired USF in early
2000. Prior to the acquisition, Deloitte U.S. participated in
Ahold’s due diligence on USF. In a February 2000 memo,
Deloitte U.S. noted that USF’s internal system for recording
promotional allowances received was weak because it heavily
relied on vendors’ figures, and that the system could "easily
result in losses and in frauds." Deloitte U.S. also noted in the
memo that USF’s use of value added service providers, spe-
cial purpose entities that bought products from vendors and
then resold them to USF for a higher price, needed to be eval-
uated for their "tax and legal implications and associated busi-
ness risks."
After Ahold’s acquisition of USF was finalized, Deloitte
U.S. became USF’s external auditor. When performing an
Opening Balance Sheet audit of USF, Deloitte U.S. discov-
ered that a USF division in Buffalo, New York had been
fraudulently accounting for PA income. This fraud required a
restatement of $11 million of PA income. USF also down-
wardly adjusted its income by $90 million as a result of
PUBLIC EMPLOYEES’ RETIREMENT v. DELOITTE & TOUCHE 9
Deloitte U.S.’s advice that it be less aggressive in its method
for recognizing PA income.
USF used at interim periods a method known as the "PA
recognition rate" to estimate promotional allowance income,
in which PAs were estimated as a percentage of USF’s total
sales. The rate used by USF was 4.58 percent at the time of
Ahold’s acquisition of USF, but rose as high as 8.51 percent
in 2002. When USF booked final numbers, Deloitte U.S. in its
audits tested USF’s recognition of PAs by requesting written
confirmation of PA amounts from vendors and by performing
cash receipt tests. Using this confirmation process, Deloitte
U.S. was able to test between 65 and 73 percent of PA receiv-
ables in its audits for 2000 and 2001.
Because USF lacked an internal auditing department, in
April 2000 Ahold USA, Inc. (Ahold’s American holding com-
pany) hired Deloitte U.S. to perform internal auditing services
at USF. The internal auditors did not report to the Deloitte
U.S. external auditors.2 Instead, they reported initially to
Ahold USA’s internal audit director and, later, to USF’s inter-
nal audit director after he was hired. The audit was managed
by Jennifer van Cleave under the supervision of Patricia Gru-
bel, a Deloitte U.S. Partner.
One of the internal audit’s objectives was to determine
whether USF’s tracking of PAs was adequate. In van Cleave’s
attempt to verify USF’s PA numbers, she requested a number
of documents from USF management, including vendor con-
tracts. Management refused to produce a number of the
requested documents. Several members of management also
refused to meet with van Cleave when she asked to conduct
exit meetings. Van Cleave was thus unable to complete all of
the audit’s objectives.
2
Under the professional standards then in effect, an auditing firm could
provide both internal and external auditing services to the same client. See
The American Institute of Certified Public Accountants, Principles of Pro-
fessional Conduct, § 101.15 (2000). (J.A. 4502-04.)
10 PUBLIC EMPLOYEES’ RETIREMENT v. DELOITTE & TOUCHE
In a February 5, 2001 draft report, van Cleave described
how management’s failure to produce requested documents
resulted in her inability to complete some of the goals of the
audit. Grubel instructed van Cleave to soften the report’s lan-
guage, and the version submitted to Michael Resnick, Direc-
tor of USF’s Internal Audit Department, simply stated that
Deloitte U.S. "was unable to obtain supporting documentation
for some of the promotional allowance sample items" without
more specifically detailing management’s failures.
In its February 2003 external audit for 2002, Deloitte U.S.
discovered through the PA confirmation process that USF had
been inflating its recorded PA income. An investigation
ensued. Ultimately, USF’s former Chief Marketing Officer
("CMO"), Mark Kaiser, was convicted on all counts of a fed-
eral indictment that alleged that he had induced USF’s ven-
dors to falsely report PA income amounts and receivable
balances to Deloitte U.S. and that he had concealed the exis-
tence of written contracts with USF vendors from Deloitte
U.S.
Two other USF executives pled guilty to federal securities
fraud charges; in their plea colloquies, they admitted that USF
lied to and deceived Deloitte U.S., and that they induced ven-
dors to sign false audit confirmation letters that falsely over-
stated PA payments. In addition, seventeen individuals
associated with USF vendors pled guilty to various charges,
and admitted that they signed false audit confirmation letters
in order to conceal the PA fraud from Deloitte U.S.
III.
A.
In passing the PSLRA in 1995, Congress imposed height-
ened pleading requirements for private securities fraud
actions. As a general matter, heightened pleading is not the
norm in federal civil procedure. The drafters of the original
PUBLIC EMPLOYEES’ RETIREMENT v. DELOITTE & TOUCHE 11
Federal Rules of Civil Procedure rejected technical pleading
requirements and instead sought to ensure "that pleadings
[would] be construed liberally so as to do substantial justice."
5 Charles Alan Wright & Arthur R. Miller, Federal Practice
and Procedure § 1202, at 87 (3d ed. 2004). Embodying this
goal, Federal Rule of Civil Procedure 8 requires merely "a
short and plain statement of the claim showing that the
pleader is entitled to relief." Fed. R. Civ. P. 8(a)(2).
However, for several reasons it has long been believed that
heightened pleading requirements are necessary for allega-
tions of fraud. Frequently stated reasons include protecting
defendants’ reputations from baseless accusations, eliminating
unmeritorious suits that are brought only for their nuisance
value, discouraging fishing expeditions brought in the dim
hope of discovering a fraud, and providing defendants with
detailed information in order to enable them to effectively
defend against a claim. See 5A Wright & Miller § 1296, at 31-
39. Thus Rule 9(b) of the Federal Rules creates an exception
to Rule 8’s relaxed standard. When "alleging fraud or mis-
take," plaintiffs "must state with particularity the circum-
stances constituting fraud or mistake." Fed. R. Civ. P. 9(b).
Under § 10(b) of the Securities Exchange Act, it is unlaw-
ful "[t]o use or employ, in connection with the purchase or
sale of any security . . . any manipulative or deceptive device
or contrivance in contravention of such rules and regulations
as the [SEC] may prescribe . . . ." 15 U.S.C § 78(j)(b). Pursu-
ant to § 10(b), the SEC has promulgated Rule 10b-5, which
forbids employing "any device, scheme, or artifice to defraud,
. . . mak[ing] any untrue statement of a material fact or omit[-
ting] to state a material fact . . . or . . . engag[ing] in any act,
practice, or course of business which operates or would oper-
ate as a fraud or deceit upon any person." 17 C.F.R.
§ 240.10b-5. Section 10(b) creates a private right of action for
purchasers or sellers of securities who have been injured by
the statute’s violation. See, e.g., Superintendent of Ins. of
12 PUBLIC EMPLOYEES’ RETIREMENT v. DELOITTE & TOUCHE
State of N.Y. v. Bankers Life & Casualty Co., 404 U.S. 6, 13
n.9 (1971).
As § 10(b) prohibits fraud, claims brought under it prior to
the PSLRA were governed by Federal Rule of Civil Proce-
dure 9(b), not Rule 8. Tellabs, 127 S. Ct. at 2507. However,
circuits split on the question of how much factual specificity
Rule 9(b) required of complaints alleging claims under
§ 10(b). See William C. Baskin III, Note, Using Rule 9(b) to
Reduce Nuisance Securities Litigation, 99 Yale L.J. 1591,
1593-94 (1990). Thus, Congress passed the PSLRA to estab-
lish a uniform pleading standard that would reduce frivolous
securities fraud suits. "As the Committee of Conference that
reported the PSLRA noted, ‘[Rule 9(b)] has not prevented
abuse of the securities laws by private litigants. Moreover, the
courts of appeals have interpreted Rule 9(b)’s requirement in
conflicting ways, creating distinctly different standards
among the circuits.’" Teachers’ Retirement Sys. of La. v.
Hunter, 477 F.3d 162, 171 (4th Cir. 2007) (quoting H.R. Rep.
No. 104-369, at 41 (1995) (Conf. Rep.), reprinted in 1995
U.S.C.C.A.N. 730, 740).
The PSLRA imposed a number of requirements designed to
discourage private securities actions lacking merit. Among
them is the requirement that in a private securities 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." 15 U.S.C § 78u-4(b)(2). Com-
plaints that do not adequately plead scienter are to be dis-
missed. Id. § 78u-4(b)(3)(A).
Because the PSLRA did not define "a strong inference," the
courts of appeals again disagreed on how much factual speci-
ficity plaintiffs must plead in private securities actions. See
Makor Issues & Rights, Ltd. v. Tellabs, Inc., 437 F.3d 588,
PUBLIC EMPLOYEES’ RETIREMENT v. DELOITTE & TOUCHE 13
601 (7th Cir. 2006) (listing approaches of different circuits),
vacated and remanded, 127 S. Ct. 2499. The Supreme Court
recently resolved that issue in Tellabs, in which the Court pre-
scribed the following analysis for Rule 12(b)(6) motions to
dismiss § 10(b) actions:
First, . . . courts must, as with any motion to dis-
miss for failure to plead a claim on which relief can
be granted, accept all factual allegations in the com-
plaint as true . . . .
Second, courts must consider the complaint in its
entirety, as well as other sources courts ordinarily
examine when ruling on Rule 12(b)(6) motions to
dismiss . . . . The inquiry, as several Courts of
Appeals have recognized, is whether all of the facts
alleged, taken collectively, give rise to a strong infer-
ence of scienter, not whether any individual allega-
tion, scrutinized in isolation, meets that standard.
Third, in determining whether the pleaded facts
give rise to a "strong" inference of scienter, the court
must take into account plausible opposing inferences
. . . . The strength of an inference cannot be decided
in a vacuum. The inquiry is inherently comparative:
How likely is it that one conclusion, as compared to
others, follows from the underlying facts? . . . . [T]he
inference of scienter must be more than merely "rea-
sonable" or "permissible" — it must be cogent and
compelling, thus strong in light of other explana-
tions. 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.
127 S. Ct. at 2509-10 (citations and footnote omitted).
14 PUBLIC EMPLOYEES’ RETIREMENT v. DELOITTE & TOUCHE
To be sure, by no means did the PSLRA or the Supreme
Court eliminate the private right of action in § 10(b), which
remains "an essential supplement to criminal prosecutions and
civil enforcement actions brought, respectively, by the
Department of Justice and the [SEC]." Tellabs, 127 S. Ct. at
2504. The "strong inference" requirement is not meant to pre-
vent litigants with meritorious claims from continuing to
uncover fraud and ensure confidence in the securities markets.
Rather, the requirement aims to weed out meritless claims at
the pleading stage, without forcing defendants to go through
a potentially costly discovery process.
Thus, as directed by Tellabs, we must analyze the factual
allegations raised by the plaintiffs, as well as other evidence
in the record, and determine what plausible inferences we can
draw from them. Having drawn all plausible inferences, we
may reverse the district court only if we find the inference
that Deloitte Netherlands and Deloitte U.S. acted with scienter
"at least as compelling" as the inference that the defendants
lacked the required mental state. In this endeavor, we "must
consider plausible nonculpable explanations for the defen-
dant’s conduct, as well as inferences favoring the plaintiff."
Tellabs, 127 S. Ct. at 2510. It is to this comparative analysis
that we now turn.
B.
The "strong inference" requirement and the comparative
analysis of inferences still leave unanswered the question of
exactly what state of mind satisfies the scienter requirement
of a 10b-5 action. In Ernst & Ernst v. Hochfelder, 425 U.S.
185 (1976), the Supreme Court held that a plaintiff must show
that the defendant possessed the "intent to deceive, manipu-
late, or defraud" in an action brought under § 10(b) and Rule
10b-5. Id. at 193. However, the Court has never made clear
what mental state suffices to meet this requirement. See id. at
193-94 n.12 ("We need not address here the question whether,
in some circumstances, reckless behavior is sufficient for civil
PUBLIC EMPLOYEES’ RETIREMENT v. DELOITTE & TOUCHE 15
liability under s 10(b) and Rule 10b-5."); Tellabs, 127 S. Ct.
at 2507 n.3 ("The question whether and when recklessness
satisfies the scienter requirement is not presented in this
case.").
This court has held that "a securities fraud plaintiff may
allege scienter by pleading not only intentional misconduct,
but also recklessness." Ottman v. Hanger Orthopedic Group,
Inc., 353 F.3d 338, 344 (4th Cir. 2003). We have defined a
reckless act in the § 10(b) context as one "‘so highly unrea-
sonable and such an extreme departure from the standard of
ordinary care as to present a danger of misleading the plaintiff
to the extent that the danger was either known to the defen-
dant or so obvious that the defendant must have been aware
of it.’" Id. at 343 (quoting Phillips v. LCI Int’l, Inc., 190 F.3d
609, 621 (4th Cir. 1999)). A showing of mere negligence,
however, will not suffice to support a § 10(b) claim. See Ernst
& Ernst, 425 U.S. at 199.
Thus, the question is whether the allegations in the com-
plaint, viewed in their totality and in light of all the evidence
in the record, allow us to draw a strong inference, at least as
compelling as any opposing inference, that the Deloitte defen-
dants either knowingly or recklessly defrauded investors by
issuing false audit opinions in violation of Rule 10b-5(b) or
10b-5(a) and (c). If we find the inference that defendants
acted innocently, or even negligently, more compelling than
the inference that they acted with the requisite scienter, we
must affirm.3 Plaintiffs must show that defendants actually
made a misrepresentation or omission in their audit opinions
on which investors relied; parties who merely assist another
3
We review a district court’s denial of a motion for leave to amend a
complaint for abuse of discretion. Nourison Rug Corp. v. Parvizian, 535
F.3d 295, 298 (4th Cir. 2008). However, because the district court denied
leave to amend because it determined that the amended complaint would
not survive a motion to dismiss, we review that legal conclusion de novo.
See HCMF Corp. v. Allen, 238 F.3d 273, 277 n.2 (4th Cir. 2001).
16 PUBLIC EMPLOYEES’ RETIREMENT v. DELOITTE & TOUCHE
in violating § 10(b) are not liable under § 10(b).4 See
Stoneridge Investment Partners, LLC v. Scientific-Atlanta,
Inc., 128 S. Ct. 761 (2008).
IV.
A.
In light of the foregoing standards, we consider first the JV
fraud. Plaintiffs allege that Deloitte U.S. and Deloitte Nether-
lands allowed Ahold to consolidate the joint ventures despite
knowing, or being reckless with regard to the risk, that Ahold
lacked the control required for consolidation. The thrust of
plaintiffs’ argument is that the control letters and Ahold’s oral
representations were insufficient evidence of control under
Dutch and U.S. GAAP. Thus, they argue, the defendants were
complicit in the fraud. According to plaintiffs, the secret side
letters, in which the joint venture partners contradicted
Ahold’s interpretations of the joint venture agreements in the
control letters, are irrelevant because the control letters them-
selves did not amend the joint venture agreements.
Plaintiffs’ arguments do not provide a basis for a strong
inference that either Deloitte U.S. or Deloitte Netherlands
acted knowingly or recklessly in relation to the JV fraud. The
most plausible inference that one can draw from the fact that
Ahold concealed the side letters from its accountants is that
the accountants were uninvolved in the fraud. Ahold produced
letters attesting to Ahold’s control countersigned by Ahold’s
4
The SAC recounts a number of alleged misrepresentations by Deloitte
Netherlands, including audit opinions issued in conjunction with Ahold’s
1999 SEC Form 20-F, 2000 Form 20-F, 2001 Form 20-F, and Ahold’s
September 2001 Prospectus Supplement. Defendants contend in their brief
that Deloitte U.S. did not issue any audit opinions on Ahold’s or USF’s
financial statements. Brief of Appellees at 1-2. Because this case was
briefed and argued purely as a scienter case, and because defendants make
no argument that Stoneridge precludes liability, we do not consider the
applicability of that case.
PUBLIC EMPLOYEES’ RETIREMENT v. DELOITTE & TOUCHE 17
partners for the ICA, Bompreço, DAIH, and Paiz-Ahold joint
ventures at the Deloitte defendants’ request, all the while con-
cealing the side letters from those same defendants. These
facts lead to a strong inference that the Deloitte defendants
were attempting to ensure that Ahold had sufficient control
over the joint ventures for consolidation and that Ahold was
determined to prevent them from discovering otherwise.
With perfect hindsight, one might posit that defendants
should have required stronger evidence of control from
Ahold. Indeed, as the district court noted, it may have been
negligent for defendants to accept as the only evidence of
control Ahold’s repeated representations that it controlled
JMR, the one joint venture for which Ahold never produced
a control letter. See In re Royal Ahold, 351 F. Supp. 2d at
395-96.5 Nonetheless, the evidence as a whole leads to the
strong inference that defendants were deceived by their clients
into approving the consolidation. Ahold would not have
needed to go out of its way to produce false evidence of con-
trol had the Deloittes been complicit in the fraud, or had they
been so reckless in their duties that their audit "amounted to
no audit at all," as the Southern District of New York has
described the standard. S.E.C. v. Price Waterhouse, 797 F.
Supp. 1217, 1240 (S.D.N.Y. 1992) (citing McLean v. Alexan-
der, 599 F.2d 1190, 1198 (3d Cir. 1979)).
In order to establish a strong inference of scienter, plaintiffs
must do more than merely demonstrate that defendants should
or could have done more. They must demonstrate that the
Deloittes were either knowingly complicit in the fraud, or so
reckless in their duties as to be oblivious to malfeasance that
was readily apparent. The inference we find most compelling
based on the evidence in the record is not that the defendants
were knowingly complicit or reckless, but that they were
5
Because JMR comprised a relatively small portion of Ahold’s financial
results, the district court found that any financial misstatement resulting
from its consolidation was immaterial. 351 F. Supp. 2d at 395-96.
18 PUBLIC EMPLOYEES’ RETIREMENT v. DELOITTE & TOUCHE
deceived by their client’s repeated lies and artifices. Perhaps
their failure to demand more evidence of consolidation was
improper under accounting guidelines, but that is not the stan-
dard, which "requires more than a misapplication of account-
ing principles." Price Waterhouse, 797 F. Supp. at 740.
B.
Next we examine the PA fraud. Plaintiffs argue that
Deloitte U.S. was knowingly complicit in the fraud when it
ignored several "red flags," including: USF’s lack of internal
controls to track PA income; USF management’s obstruction
of the internal audit; and the facts and the circumstances of
USF Chief Financial Officer Ernie Smith’s resignation.6
With respect to USF’s problems with tracking income with
PAs, it is not the case that Deloitte U.S. simply ignored the
weak internal controls, as plaintiffs allege. Rather, Deloitte
U.S. raised this issue numerous times with Ahold and USF
management. Deloitte U.S. designed a confirmation process
to verify USF’s reported PA income in which it contacted
third-party vendors and received letters from them confirming
PA amounts.
In the SAC plaintiffs describe the confirmation process as
one that "confirmed nothing." Yet instead of merely relying
on USF CMO Mark Kaiser’s representations, as plaintiffs
assert, Deloitte U.S. obtained corroboration from vendors for
the figures provided by USF. Deloitte U.S. would not have
attempted to verify USF’s figures with third parties if it were
complicit in the scheme; nor can it be said that it was anything
but proper to attempt to check the accuracy of representations
made by USF management.
6
Plaintiffs do not distinguish Deloitte U.S. and Deloitte Netherlands in
their complaint, but they have failed to challenge the district court’s con-
clusion that the two firms are separate legal entities.
PUBLIC EMPLOYEES’ RETIREMENT v. DELOITTE & TOUCHE 19
Plaintiffs attempt to suggest that the confirmation process
was unsound because, for example, Deloitte U.S. accepted
confirmation letters via fax and the letters were sent to bro-
kers or sale executives instead of financial officers. But even
if the confirmation process was somewhat flawed — which
defendants contest — the larger fact remains that the PA fraud
went undetected initially only because USF and its vendors
conspired to lie to Deloitte U.S. and to conceal important doc-
uments. Indeed, it was Deloitte U.S.’s confirmation process
itself that ultimately revealed the fraud. In the course of the
2002 audit, Deloitte U.S. learned in early 2003 from a vendor
from which it had requested PA confirmations that employees
had signed inaccurate confirmation letters. Shortly thereafter,
Ahold authorized an internal investigation that revealed the
extent of the fraud. No doubt it would have been better had
the fraud been discovered earlier, but the strongest inference
one can draw from the evidence is that the fraud initially went
undetected because of USF’s collusion with the vendors, not
because of wrongdoing by Deloitte U.S.
As to the internal audit, the internal auditors reported not
to the Deloitte U.S. external auditors but to USF, as was con-
sistent with professional standards. See Standards for the Pro-
fessional Practice of Internal Auditing, Statements on Internal
Auditing Standards Nos. 1-18, § 230. Plaintiffs suggest that
Grubel’s editing of the language in van Cleave’s initial report
indicates scienter. They argue that Grubel’s edits suggest that
Deloitte U.S. was trying to cover up the fact that management
had obstructed the internal audit. But as the district court
noted, "while [the] language in the initial draft of the internal
audit report was softened, the revised language continued to
state the essential point, that the internal auditors had been
unable to obtain certain documents related to promotional
allowances and unable to achieve specific testing objectives."
J.A. 6122.
The rest of the supposed "red flags" pointed to by plaintiffs
also fail to create a strong inference of scienter. With respect
20 PUBLIC EMPLOYEES’ RETIREMENT v. DELOITTE & TOUCHE
to plaintiffs’ allegations that Smith told Deloitte U.S. about
the vendor rebate fraud, the district court twice concluded that
this claim had no support in the record, and we see no reason
to disagree with its conclusion. Plaintiffs allege that facts like
the high CFO turnover at USF and USF’s rapid growth should
have alerted Deloitte U.S. that there was fraud afoot, but they
do not explain why this was the only conclusion Deloitte U.S.
could have drawn without being reckless. There are many
possible reasons other than fraud for high personnel turnover
— personality conflicts, lack of opportunities for advance-
ment, salary and compensation disputes, to name a few.
Seeing the forest as well as the trees is essential. With
respect to both frauds, plaintiffs point to ways that defendants
could have been more careful and perhaps discovered the
frauds earlier. But plaintiffs cannot escape the fact that Ahold
and USF went to considerable lengths to conceal the frauds
from the accountants and that it was the defendants that ulti-
mately uncovered the frauds. The strong inference to be
drawn from this fact is that Deloitte U.S. and Deloitte Nether-
lands lacked the requisite scienter and instead were deceived
by Ahold and USF. That inference is significantly more plau-
sible than the competing inference that defendants somehow
knew that Ahold and USF were defrauding their investors.
It is not an accountant’s fault if its client actively conspires
with others in order to deprive the accountant of accurate
information about the client’s finances. It would be wrong and
counter to the purposes of the PSLRA to find an accountant
liable in such an instance. Because we find no version of the
facts creates a strong inference that the Deloitte defendants
had the scienter required for a cause of action under § 10(b),
the district court rightly denied the plaintiffs’ motion for leave
to amend their complaint.
V.
We establish no blanket immunity for accountants for oth-
erwise actionable statements with a strong inference of
PUBLIC EMPLOYEES’ RETIREMENT v. DELOITTE & TOUCHE 21
scienter. But in this case, the stronger and more plausible
inference is that the Deloittes were, like the plaintiffs, victims
of Ahold’s fraud rather than its enablers. Plaintiffs’ action is
the paradigm situation to which the PSLRA and Tellabs were
meant to apply. Accordingly, the judgment below is
AFFIRMED.