Abrams v. Baker Hughes Inc.

UNITED STATES COURT OF APPEALS
For the Fifth Circuit

No. 01-20514

DAVID ABRAMS, etc.; et al,
Plaintiffs,

YMCA RETIREMENT FUND; HOWARD UNIVERSITY; FEDERATED NATIONAL
INSURANCE COMPANY; HEADWATERS CAPITAL LLC; FRANK D. TIMMONS,
Plaintiffs - Appellants,

VERSUS

BAKER HUGHES INC.; MAX L. LUKENS; GEORGE STEPHEN FINLEY;
ANDREW SZESCILA,
Defendants -Appellees,

E. L. MATTSON,
Appellee.

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

May 21, 2002

Before ALDISERT1, DAVIS, and PARKER, Circuit Judges.

W. EUGENE DAVIS, Circuit Judge:

The plaintiffs appeal from a dismissal under F.R.C.P. 12(b)(6) of their securities fraud class

action under §§10(b) and 20(a) of the Exchange Act. The district court dismissed the case based on

its conclusion that the plaintiffs failed to adequately allege part icularized facts to establish the

necessary element of scienter. Finding no error, we affirm.

1
Circuit Judge, U.S. Court of Appeals for the Third Circuit, sitting by designation.
 I.

This securities fraud class action is brought on behalf of all investors who purchased common

stock of Baker Hughes from February 1, 1999 through December 8, 1999 (the “Class Period”). Baker

Hughes is a diversified oil and gas services company headquartered in Houston, Texas, whose stock

trades on the New York Stock Exchange under the symbol “BHI.” Defendant Lukens was Baker

Hughes’ president, chairman and chief operating officer. Defendant George Finley was its chief

financial officer. The plaintiffs contend generally that the defendants’ Class Period press releases and

SEC filings contained false and misleading statements and omissions. Specifically, the plaintiffs allege

that the defendants deceived the investing public regarding the adequacy of Baker Hughes’ internal

financial controls, the fiscal discipline with which the company operated and the company’s financial

condition. They contend that these misstatements artificially inflated the price of the company’s

common stock during the Class Period. Thus, they allege that they were harmed when they purchased

Baker Hughes stock at artificially high prices.

The Complaint

The complaint contains the following chronology of events and allegations regarding scienter.

The complaint alleges that in 1998, Baker Hughes’ revenues and earnings were suffering. Years of

growth through mergers and acquisitions had left Baker Hughes’ accounting systems in disarray, with

no unified accounting system and a lack of proper internal controls. The primary problems were in

the INTEQ division, located in Venezuela which produced approximately 20% of company revenues.

During 1999, Baker Hughes initiated Project Renaissance. The purpose of the project was to cut costs

and streamline internal control systems. The project was built around a new information system called

SAP which was designed to unify all accounting and data management systems at the company.

2
 Problems were encountered in the implementation of the new system which the defendants

allegedly kept quiet so as not to jeopardize their incentive compensation or the success of a scheduled

$200 million debt offering. During the Class Period internal controls were inadequate and unreliable

but the defendants repeatedly touted the adequacy of the company’s internal controls. The lack of

internal controls caused Baker Hughes to issue false and misleading financial reports throughout the

Class Period. Based on the company’s reported financial results and the apparent success of the

implementation of SAP, the price of Baker Hughes’ stock increased throughout the Class Period and

analysts upgraded their ratings of the stock.

For example, in March 1999, the company filed its 1998 Form 10-K with the SEC. The report

included a letter from the defendants that indicated that the company had in place an extensive system

of internal controls to prevent material errors or irregularities in the reports. In May 1999, Baker

Hughes announced favorable first quarter results and the stock price rose from $29.785 per share on

April 30, 1998 to $31.83 per share on May 3, 1999. Also in May, Schroder & Co., Inc. issued a

report raising its rating for Baker Hughes in reliance on a conversation with Baker Hughes

management that SAP was on track to produce significantly improved returns. The next day,

defendant Finley sold 21,574 shares of Baker Hughes stock at $30.88 per share. Finley was largely

responsible for the implementation of SAP. Two weeks later, Finley was appointed chief financial

officer and senior vice president of finance and administration.

On May 21, 1999, t he former senior vice president and chief financial officer as well as the

controller resigned. Baker Hughes stated that these officials left “to pursue other interests.” Platt’s

Oilgram News reported that the CFO left because of cost overruns and operations glitches associated

with the SAP conversion. The resignations raised concerns in the investment community. On the

3
same day Merrill Lynch issued a favorable report on Baker Hughes based on conversations with

management. The report noted the resignations but assured that there are “no accounting issues” at

the company. Baker Hughes stock price rose to $31.125 per share. In June 1999, Schoder & Co.

issued another favorable report after meetings with defendant Lukens. Baker Hughes price rose $1

per share to $34.5625. On September 27, 1999, Baker filed a shelf registration for the future issuance

of debt and equity securities totaling one billion dollars. The plaintiffs claim that it was critical for

Baker to raise capital to cover fixed charges that could not be covered by earnings.

The alleged deceptions were brought to light beginning in December, 1999. On December 1,

1999, Baker Hughes announced that results for the 4th quarter would be poor and the company would

record a $130 million pre-tax charge to dispose of assets and equipment due to adverse market

conditions. On December 8, 1999, the company announced the existence of accounting irregularities

at INTEQ, one of its major subsidiaries, that would adversely affect the company’s financial statements

by $40 to $50 million pre tax. The company canceled the previously announced note offering. On

December 9, 1999, Baker Hughes stock closed at $19.25 per share. During the Class Period the stock

traded as high as $36.125 per share.

On December 16, 1999, t he president of INTEQ resigned. On January 24, 2000, the

company’s general counsel resigned. On January 31, 2000, Baker Hughes announced that it had fired

defendant Lukens from his position as Chairman and Chief executive officer. Also on that day, the

company announced that the head of the company’s Western Geophysical, Baker Atlas and INTEQ

divisions resigned.

On February 17, 2000, the company announced that it would restate previously filed financial

reports for periods dating back to December 31, 1997. The restatement reduced profit by $31 million,

4
$24.2 million of which was related to INTEQ. The writeoffs related to uncollectible accounts

receivable, inventory write downs and unrecorded employee compensation. More details regarding

the writeoffs were disclosed on March 16, 2000 when Baker Hughes filed its 1999 10-K. The report

noted t hat the misstatements “were primarily the result of noncompliance with the Company’s

accounting and operating procedures and that such noncompliance was isolated primarily to INTEQ’s

operations in Venezuela.” On April 10, 2000, Baker Hughes filed amended quarterly reports for 1999.

The District Court’s Decision

The defendants filed a motion to dismiss the case on the grounds that the plaintiffs failed to

adequately allege particularized facts as to defendants’ scienter and that the plaintiffs failed to show

that the alleged misleading public statements were material. Without the benefit of the Zonagen

decision, discussed later in this opinion, the district court analyzed case law from this and other circuits

and concluded, properly that a strong inference of scienter is not raised where a plaintiff merely alleges

facts of a defendants’ motive and opportunity to commit fraud. Rather, the plaintiffs must plead

specific facts constituting strong circumstantial evidence of conscious misbehavior or recklessness and

motive and opportunity may be considered as a factor in determining whether a strong inference has

been raised.

The district court proceeded to analyze the three claims raised by the plaintiffs: (1) the

defendants had the motive and opportunity to commit fraud based on the need to raise capital,

incentive compensation contingent on the successful implementation of SAP and Finley’s insider stock

sales; (2) the defendants engaged in conscious misbehavior or were reckless as to their public

representations because Lukens and Finley were intimately familiar with the company’s inadequate

5
internal controls, and (3) the defendants violated generally accepted accounting principles. The district

court concluded that the “totality of the Plaintiffs’ facts has failed t o raise a strong inference of

scienter.” The court went on to say that although the facts were insufficient in the aggregate, it was

not error for the court to compartmentalize the allegations and “wipe the slate clean after considering

each component.” The district court accordingly dismissed t he plaintiffs 10(b) and 10b-5 claims.

Because the plaintiffs failed to raise a strong inference of scienter, it declined to reach the issue of

materiality. Although not sought by the parties, the district court further held that dismissal of the

10(b) and 10b-5 claims required dismissal of the 20(a) claim.

The plaintiffs appeal.

II.

This Court reviews a district court's dismissal under Rule 12(b)(6) de novo. In doing so, we

will accept the facts alleged in t he complaint as true and construe the allegations in the light most

favorable to the plaintiffs.2

To state a claim under §10(b) of the Exchange Act, a plaintiff must show: “(1) a misstatement

or omission (2) of a material fact (3) made with scienter (4) on which the plaintiff relied (5) that

proximately caused his injury.”3 The scienter, or state of mind element of a § 10(b) claim is a “mental

state embracing intent to deceive, manipulate, or defraud.”4 A §10b-5 claim is subject to both Federal

Rule of Civil Procedure 9(b)’s requirement that fraud be pled “with particularity” and the requirements

2
Nathenson v. Zonagen Inc. , 267 F.3d. 400 (5th Cir. 2001).
3
Shushany v. Allwaste, Inc., 992 F.2d 517, 520-21 (5th Cir. 1993) (quoting Cyrak v. Lemon,
919 F.2d 320, 325 (5th Cir. 1990).
4
Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193, n.12 (1976).

6
of the requirements of the Private Securities Litigation Reform Act (the “PSLRA”). Under the

PSLRA, to allege scienter:

the complaint shall, with respect to 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.5

In addition,

the complaint shall specify each statement alleged to have been misleading, the reason
or reasons why the statement is misleading, and, if an allegation regarding the
statement or omission is made on information and belief, the complaint shall state with
particularity all facts upon which that belief is formed.6

This court’s recent decision in Nathenson v. Zonagen Inc. sets the standard of pleading

required after the enactment of the PSLRA.7 That case, which first applied the PSLRA in this circuit,

held that “in order to survive a motion to dismiss, a plaintiff alleging a section 10(b)/Rule 10b-5 claim

must now plead specific facts giving rise to a ‘strong inference’ of scienter.”8 As it did before the

enactment of the PSLRA, severe recklessness can supply the scienter required to prove securities

fraud.9 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

standard of ordinary care, and that present a danger of misleading buyers or sellers which is either

5
15 U.S.C. § 78u-4(b)(2)(Supp.V. 1999).
6
Id.
7
267 F.3d 400 (5th Cir. 2001).
8
Id. at 407.
9
Id. at 408-409.

7
known to the defendant or is so obvious that the defendant must have been aware of it.”10 Allegations

of motive and opportunity, standing alone, are no longer sufficient to plead a strong inference of

scienter, although appropriate allegations of motive and opportunity may enhance other allegations

of scienter.11 Circumstantial evidence can support a strong inference of scienter.12 Zonagen also

establishes that the effect of the PSLRA “at a minimum, incorporates the standard for pleading fraud

under Fed. R. Civ. P. 9(b).”13 This circuit interprets Rule 9(b) strictly, requiring the plaintiff "to

specify the statements contended to be fraudulent, identify the speaker, state when and where the

statements were made, and explain why the statements were fraudulent."14

Finally, Zonagen suggests that the allegations should not be read in isolation, but taken

together as a whole to see if they raise the necessary strong inference of scienter. In analyzing whether

the complaint adequately alleged scienter, the court in Zonagen react ed negatively to the district

court’s consideration of certain statements in isolation.15 The appropriate analysis, under Zonagen is

to consider whether all facts and circumstances “taken together” are sufficient to support the necessary

strong inference of scienter on the part of the plaintiffs.16

10
Id. at 408, citing Broad v. Rockwell International Corp., 642 F.2d 929, 961-62 (5th Cir.
1981)(en banc).
11
Id. at 410-12.
12
Id. at 410.
13
Id. at 412.
14
Id.
15
Id. at 424.
16
Id. at 425.

8
 III.

Plaintiffs complain first that the district court erred by failing to analyze their scienter

allegations based on the totality of the circumstances alleged as required by Zonagen. The district

court stated in its opinion that it was not error for the court to compartmentalize the allegations and

“wipe the slate clean aft er considering each component,” citing Coates v. Heartland Wireless

Communications, Inc., 55 F.Supp.2d 628 (N.D. Tex. 1999)(“Coates II”). However, in its conclusion,

the district court also stated that the facts in the complaint were insufficient when viewed in the

aggregate. The district court concluded that the “totality of the Plaintiffs’ facts has failed to raise a

strong inference of scienter.” The district court’s clear statement that it considered the allegations

insufficient in the aggregate, although without analysis, is difficult for us to contradict. We need not

do so as we conclude, based on our independent review, that the complaint taken as a whole fails to

sufficiently plead scienter and agree with the result reached by the district court.

IV.

We turn now to our analysis of the plaintiffs’ complaint. The false and misleading statements

alleged in the complaint relate to Baker Hughes’ internal accounting and financial controls.

Specifically, during the Class Period, the plaintiffs allege that the defendants issued positive

representations to the investing community that the disclosures in the company’s financial reports were

sufficient to make them reasonably accurate. Plaintiffs focus on statements defendants made in the

wake of the resignation of two top financial officers, that there were “no accounting issues” at the

company. The plaintiffs contend that these statements were false when made as revealed by statements

issued by the company beginning in December 1999. They further contend that the defendants knew

the statements were false or were severely reckless in making them based on the following

9
circumstantial evidence. First, the individual defendants were senior level executives of Baker Hughes

who were intimately familiar with the inner workings of the company, including the inadequacies of

its internal controls. Both allegedly received unidentified daily, weekly and monthly financial reports

that apprized them of the company’s true financial status and had the power and influence to cause

Baker Hughes to issue the false statements. The defendants knew that the SAP program was being

implemented because the company lacked a single uniform accounting system and thus knew that the

company’s internal controls lacked cohesiveness. Accounting irregularities discovered mainly at

INTEQ necessitated restatement of several previously issued reports. The restatement announced in

2000 was stated to be the result of noncompliance with the company’s accounting and operating

procedures. Second, the defendants’ violations of generally accepted accounting principles (“GAAP”)

in combination with other allegations raise a strong inference of scienter. Third, the allegations of the

defendants’ motive and opportunity to commit fraud enhance the strong inference of scienter. The

allegat ions of motive include the need to raise additional capital, a desire to protect their incentive

compensation, and insider stock sales.

Based on case law in this and other circuits, these allegations fail to reach the required

standard. Plaintiffs point to no allegations that the defendants knew about the internal control

problems, only that they should have known or that their lack of knowledge based on the their

corporate positions demonstrates recklessness. A pleading of scienter may not rest on the inference

that defendants must have been aware of the misstatement based on their positions within the

company.17

The plaintiffs’ allegations regarding non-specific internal reports are also inadequate. An

17
In re Advanta Corp. Sec. Litig., 180 F. 3d 525, 539 (3d Cir. 1999).

10
unsupported general claim about the existence of confidential corporate reports that reveal information

contrary to reported accounts is insufficient to survive a motion to dismiss.18 Such allegations must

have co rroborating details regarding the contents of allegedly contrary reports, their authors and

recipients.19 Also, the mere publication of inaccurate accounting figures or failure to follow GAAP,

without more, does not establish scienter. The party must know that it is publishing materially false

information, or must be severely reckless in publishing such information.20 The plaintiffs point to no

specific internal or external report available at the time of the alleged misstatements that would

contradict them.

As an example of the type of allegations that survive a motion to dismiss, see Novak v.

Kasaks.21 In that case the complaint alleged that the defendants knew that the company had serious

inventory problems that they sought to disguise by adopting a cover up scheme. The defendants acted

intentionally and deliberately to artificially inflate the company’s financial results in ways that violated

the company’s internal policies. The complaint in Novak alleged that the defendants “discussed the

need to mark down inventory but refused to do so because that would damage the Company’s

financial prospects.”22 Further the Novak defendants approved an inventory management practice

18
San Leandro Emergency Medical Group Profit Sharing Plan v. Philip Morris Cos., 75 F.3d
801, 812 (2d Cir. N.Y. 1996).
19
Janas v. McCracken (In re Silicon Graphics Sec. Litig.), 183 F.3d 970, 985 (9th Cir. 1999).
20
Fine v. American Solar King Corp., 919 F.2d 290 (5th Cir. 1990).
21
216 F.3d 300 (2d Cir. 2000).
22
216 F.3d at 311.

11
that violated the company’s own markdown policy as it was stated in the company’s public filings.23

Also, despite their knowledge that the inventory practice they adopted in violation of stated company

policy was the reason for growth in inventory, the defendants in Novak gave false explanations for its

growth.24 We have no such allegations of actual knowledge or intentional or deliberate behavior in

this case. Rather the nature of the accounting problems at Baker Hughes that lead to the restatement,

i.e. uncollectible accounts receivable, inventory write downs and unrecorded employee compensation,

can easily arise from negligence, oversight or simple mismanagement, none of which rise to the

standard necessary to support a securities fraud action.

This case is more like Melder v. Morris.25 In Melder, the complaint alleged that “the true

adverse facts about URCARCO’s financial condition . . . were known to or recklessly disregarded by

defendants” and “[b]ecause of their board membership and/or their executive and managerial positions

with URCARCO, defendants . . . knew or had access to information concerning the adverse non-public

information about URCARCO’s adverse financial outlook.”26 In that case this court concluded that

the plaintiffs failed to plead scienter adequately.

In our case, the plaintiffs have not pointed to any particular reports or information–available

to defendants before the announced financial restatements–that are contrary to the restatements. The

fact that Baker Hughes was overhauling its accounting system via Project Renaissance and the SAP

program does not command an inference that company officials should have anticipated finding a

23
Id.
24
Id. at 311-312.
25
27 F.3d 1097 (5th Cir. 1994).
26
Id. at 1103.

12
problem or assumed that financial data reported under old system was inaccurate. We can just as easily

infer that the implementation of SAP was driven by a need to better coordinate the accounting systems

in place in various companies Baker Hughes had merged with over the years. A planned improvement

or upgrade does not mean that the prior system was necessarily producing bad data. A perfectly

reasonable explanation for implementing Project Renaissance was to improve efficiency and lower

costs. In discussing the standard for reckless conduct, the court in Novak noted that company officials

should not be held responsible for failure to foresee future events. Also, as long as public statements

are reasonably consistent with reasonably available data, corporate officials need not present an overly

gloomy or cautious picture of the company’s current performance.27 The cases relied on by the

plaintiffs in this regard involve actual knowledge of the falsity of the published reports, which is not

alleged in this case. See Meadows v. SEC, 119 F.3d 1219, 1226 (5th Cir. 1997)(Meadows told

investors that certain companies were low-risk investments that were virtually certain to yield a high

return without disclosing that he was an officer and director of one of the companies, had been

temporarily denied after-hours access to the Companies' books; he had never conducted a background

investigation into the principals, any of their assertions, or the Companies' purported successes and

that therefore, he had no basis for recommending the investments. Further Meadows was aware one

principal of the company had recently been accused of misappropriation; he was aware that a

recommendation that they maintain separate bank accounts for each drilling program was not being

followed; and he had been forced out of the Companies by certain principals, who also paid him to be

silent about the Companies' financial situation.); Serabian v. Amoskeag Bank Shares, 24 F.3d 357,

365 (1st Cir. 1994)(General statement that bank’s existing loan review function was not operating

27
Novak, 216 F.3d at 309.

13
timely and of other failures to follow internal policy does not support conclusion that defendants knew

loans were deteriorating in creditworthiness. However, bank’s statement that loss reserves were

adequate, conservative and cautious directly contrary to identified internal reports was sufficient to

state a claim.).

Plaintiffs imply that the resignation of key accounting officials from the company in May 1999

should have served as a warning that problems existed within that department and that the defendants

were reckless for failing to investigate, especially given their statement that there were “no accounting

issues” at the company. However, nothing in the complaint points to any information that would

indicate that either the resigning officials, their replacements or other defendants knew of any

accounting irregularities or that such irregularities were the reason for their resignations. According

to the complaint, Baker Hughes reported that these officials resigned to “pursue other interests.”

Platt’s Oilgram News reported that the CFO resigned because of cost overruns and operational

glitches associated with the implementation of SAP. Neither reason has any scienter implications.28

V.

In addition, although we acknowledge that allegations of motive and opportunity to commit

fraud may enhance an inference of scienter, the motives alleged in the complaint are not the types of

motive that support a strong inference of scienter. The plaintiffs allege that the defendants were

motivated to commit fraud by the need to raise capital, the desire for enhanced incentive compensation

and t he desire to sell stock at inflated prices. This court has held that similar allegations were

28
Branca v. Paymentech, Inc. [2000 Transfer Binder] Fed.Sec. L. Rep. (CCH) ¶ 90,911, at
93,855-56 (N.D. Tex. Feb. 8 2000) (Scienter may not be inferred from resignation of company
officials “for personal reasons.”)

14
insufficient to support an inference of scienter. In Melder v. URCARCO, the plaintiffs claimed that

the defendants engaged in a conspiracy to commit securities fraud in order to inflate the price of the

company’s stock to allow for successful stock offerings, to protect their executive positions and to

enhance the value o f their personal stock holdings in the company.29 Absent an allegation that the

defendants profited from the inflated stock value or the offerings, such allegations fail. Similar claims

were rejected in Tuchman v. DSC Communications Corp.30 In Tuchman, this court stated:

Incentive compensation can hardly be the basis on which an allegation of fraud is
predicated. On a practical level, were the opposite true, the executives of virtually
every corporation in the United States would be subject to fraud allegations. It does
not follow that because executives have components of their compensation keyed to
performance, one can infer fraudulent intent.31

As to the alleged insider stock sales, only one defendant sold only a portion of his shares in the

company. Finley exercised and sold 21,574 of 92,405 stock options and sold none of his other 34,980

shares. Only insider trading in suspicious amounts or at suspicious times is probative of scienter.32

Plaintiffs make no allegations that these sales are out of line with prior trading practices or at times

calculated to maximize personal profit.33 Further, even unusual sales by one insider do not give rise

to a strong inference of scienter when other defendants do not sell some or all of their shares during

the Class Period.34

29
27 F.3d 1097, 1102, (5th Cir. 1994).
30
14 F.3d 1061, 1068 (5th Cir. 1994).
31
Id. at 1068-69.
32
In re Silicon Graphics, 183 F.3d at 987.
33
Id.
34
San Leandro, 75 F.3d 801, 814 (2d Cir. 1996).

15
 VI.

In summary, based on our complete review of the plaintiffs’ complaint, we conclude that it fails

to adequately plead facts that raise a strong inference of scienter. Accordingly, the district court

correctly dismissed plaintiffs’ action. AFFIRMED.

16
ROBERT M. PARKER, Circuit Judge, concurring:

In general terms, Plaintiffs allege that Defendants fraudulently misrepresented the effectiveness

of Baker Hughes’s internal acco unting controls, and that Plaintiffs, having relied on these

representations, were damaged when the company later revealed the true state of its financial affairs.

They contend that as Baker Hughes merged or acquired other entities the accuracy of company-wide

accounting practices det eriorated. Methods for reporting asset values and earnings, for example,

differed fro m one business unit to the next. Plaintiffs allege that the lack of a single, coherent

accounting practice caused Baker Hughes to issue numbers that did not fairly represent the company’s

disparate divisions. The consequences of Baker Hughes’s growth, from an accounting standpoint, was

understood by Defendants, Plaintiffs argue. That they continued to represent the company’s financials

as accurate anyway evidences severe recklessness.

Allegations like the foregoing, if properly detailed, are sufficient to state a cause of action for

securities fraud. A company’s public filings are the medium through which stockholders monitor the

performance of directors and management. When that conduit is wrongfully obscured owners lose

the only reliable means they have for protecting hard-earned capital. History reminds us of the

consequences when the financial statements of publically-held companies do not accord with reality.

Indeed, it was to protect against them that our nation’s securities laws were enacted.

At the same time, we must pay heed to a different set of consequences--those brought about

by the overzealous prosecution of specious securities fraud actions. Congress, in passing the Private

Securities Litigation Reform Act of 1995, took pains to deter such strike suits. Its findings and

17
legislative history suggest that the cost of protecting against fraud was unduly impairing the efficient

operation of lawful businesses. Today, when applying the PSLRA, courts must keep this policy

consideration foremost in mind. But we must also recognize that Congress left unaffected

shareholders’ right to sue for recompense when they are made the victims of self-dealing and deceit.

The PSLRA is a mechanism for winnowing out suits that lack a requisite level of specificity. It was

not meant to let business and management run amuck to the detriment of shareholders.

With respect to the case at hand, I view it as being very close. Ultimately, however, I like the

majority conclude that Plaintiffs’ complaint does not pass muster under the stringent standards of the

PSLRA.

I.

The PSLRA did not change the substantive state-of-mind requirement for securities fraud, as

we recognized in Nathenson v. Zonagen, Inc., 267 F.3d 400, 408 (5th Cir. 2001). As before, severe

recklessness will satisfy the scienter element. See id. What did change was the pleading standard.

Now, when alleging scienter, a plaintiff must state particular facts giving rise to a strong inference of

severe recklessness. See 15 U.S.C. § 78u-4(b)(2). Only one circuit has reached a different conclusion.

The Ninth Circuit has concluded that under the PSLRA a plaintiff must prove that the defendant was

at least deliberately reckless. See In re Silicon Graphics, Inc. Sec. Litig., 183 F.3d 970, 975-77 (9th

Cir. 1999). Thus, by extension, to survive a motion to dismiss, a plaintiff in that circuit must state

facts that give rise to a strong inference of knowing misconduct. See Lipton v. Pathogenesis Corp.,

284 F.3d 1027, 1035-36 (9th Cir. 2002). In Nathenson, we expressly declined to follow the Ninth

Circuit’s articulation of scienter. 267 F.3d at 409. In so doing, we noted that elsewhere in the PSLRA

Congress pointedly limited liability to only those misstatements that were made knowingly. Id. (citing

-18-
15 U.S.C. § 78u-5(c)(forward-looking statements) and id. § 78u-4(f)(joint-and-several liability)).

With respect to one of these limitations, Congress was careful to state that “nothing in this subsection

shall be construed to create, affect, or in any manner modify, the standard for liability associated with

any action arising under the securities laws.” 15 U.S.C. § 78u-4(f)(1). And in Nathenson, we

concluded that Congress’s specifying a heightened scienter requirement for those special provisions

suggested that it meant to leave alone “the reckless state of mind[] uniformly held sufficient by the

federal courts.” 267 F.3d at 409 (internal quotations omitted). Thus, there is little room for doubt

that in most circuits, and certainly in this one, an allegation of actual knowledge is not required to

withstand a motion to dismiss.

Novak v. Kasaks, 216 F.3d 300 (2d Cir. 2000), cited by the majority here, was a case involving

allegations of conscious, intentional fraud. There, defendants supposedly categorized certain out-of-

date inventory as “Box and Hold,” meaning the company was able to avoid having to write down its

value. The inventory, fashionable ladies’ attire, depreciated with the times and was likely to sell for

only a small fraction of its originally-marked price. In the complaint, defendants were alleged to have

led investors and analysts to believe that the company’s method of accounting accorded inventory its

fair market value. The complaint also alleged that particular (but unnamed) company employees urged

defendants to terminate the “Box and Hold” policy; that the defendants in express words refused to

comply because of the effect discontinuance would have on the company’s stock price; and that

defendants effectively maintained two sets of books, thereby hiding from public view the company’s

inventory practices. The Second Circuit, in reversing dismissal by the district court, concluded, “There

is no doubt that this pleading satisfies . . . the requirement of the PSLRA that plaintiffs state facts with

particularity that give rise to a strong inference of the required state of mind.” Id. at 312.

-19-
 I do not read the majority as citing Novak to suggest that it marks a floor for pleading scienter

or even necessarily that it is representative of cases that have withstood a motion to dismiss since the

PSLRA was enacted. Nevertheless, lest there be any confusion, our conclusion in this case does not

rest on Plaintiffs’ having failed to set out “allegations of actual knowledge or intentional or deliberate

behavior.” Maj. Op. at 12. Pleading severe recklessness does not require such contentions.

II.

I agree that the complaint in this case fails to give rise to a st rong inference of scienter,

although it is a close question. Taking Plaintiffs’ allegations as true, as we are required to do even

under the PSLRA, see Nathenson, 267 F.3d at 406, the complaint lacks the requisite detail to support

a strong inference. For example, Plaintiffs allege that Project Renaissance was initiated “after a decade

of merger and acquisition activity[] left the Company’s accounting in disarray.” Compl. ¶ 41. But

little or no facts are offered to support this bald contention. The complaint only specifically mentions

one company with which Baker Hughes merged, Western Atlas. Even as to that company, there is

no detail about how its and Baker Hughes’s accounting practices differed. Companies are required

to disclose their methods of accounting. Presumably, comparing Baker Hughes’s and Western Atlas’s

respective reports and filings would have enabled Plaintiffs to explain how the respective accounting

practices of each were incompatible, thus resulting in the claimed-of disarray. Plaintiffs could then

have proceeded in this fashion with respect to each entity Baker Hughes had acquired over the years.

As it stands, however, there is no basis for inferring that Project Renaissance was intended to remedy

disparate accounting practices, let alone that such practices were generating faulty numbers. Without

facts in this regard, we cannot infer that Defendants were severely reckless in claiming that Baker

Hughes’s financials were accurate as reported.

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 Clearly, the closest issue in the case is raised by Plaintiffs’ claim that Defendants’ statements

to certain investment analysts that Baker Hughes had no “accounting issues” or “numbers issues” were

fraudulent.35 These statements were reported the day Baker Hughes’s chief financial officer and its

comptroller, Eric Mattson and James Harris, both suddenly resigned. The complaint shows that

analysts were concerned when Mattson and Harris unexpectedly left. Baker Hughes’s nebulous

explanation for their leaving--that they wanted “to pursue other interests”--likely did little to mollify

the situation. But Plaintiffs have failed explain how these events st nding alone support a strong
a

inference that the discovery of accounting irregularities precipitated Mattson’s and Harris’s leaving.

Several months later, a report in Platt’s Oilgram News attributed the departures to cost overruns in

the implementation of Project Renaissance. No facts have been alleged that would undermine this

explanation. Moreover, assuming for the moment that faulty accounting practices were the reason

Mattson and Harris left, Plaintiffs have failed to make particular allegations about how evidence of the

problem had made its way to Defendants. Plaintiffs argue that “Individual Defendants each received

daily, weekly[,] and monthly financial reports to apprise them of the true financial status of Baker

Hughes.” Compl. ¶ 95. No back-up support is given for this contention, however. It would be easier

to infer that they had received such reports if, for example, we were given information about who

generated the reports, when they were reviewed, how Defendants responded to them, etc. See, e.g.,

In re Scholastic Corp. Sec. Litig., 252 F.3d 63, 70-72 (2d Cir. 2001). Not having this information

35
Not before us is the question whether statements to third-
party analysts are actionable. See, e.g., Novak, 216 F.3d at 314-
15. Also not before us is whether allegedly false statements
reported by analysts but not attributed to a particular person are
actionable. See, e.g., Florida St. Bd. of Admin. v. Green Tree
Financial Corp., 270 F.3d 645, 667-69 (8th Cir. 2001).

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makes it difficult to say whether Defendants were reckless in misrepresenting Baker Hughes’s

accounting controls.

As we concluded in Nathenson, allegations of motive and opportunity on the part of a

defendant may in some cases contribute to a strong showing of scienter. 267 F.3d at 412. In reaching

this conclusion, we suggested that the usefulness of such allegations depends on the facts of the case

at hand. Id. at 411-12. Along these lines, we refused to adopt any hard-and-fast rule regarding the

circumstances in which a strong inference of scienter can be drawn from the existence of motive and

opportunity. In this case, I agree with my colleagues that Defendant Finley’s exercising 23% of the

stock options he owned at the time does not in a material way contribute to reaching the strong-

inference standard. In Florida State Board of Administration v. Green Tree Financial Corp., the

Eighth Circuit determined that an “unusual or heightened motive will often form an important part of

a complaint that meets the Reform Act standard.” 270 F.3d at 660. Here, Finley’s trading activity

was not “unusual or heightened.” But I believe that it is not necessary to flatly state, as the majority

does, that “[o]nly insider trading in suspicious amounts or at suspicious times is probative of scienter.”

Maj. Op. at 15. A case-specific evaluation of each complaint is better than absolute rules. I likewise

think the majority goes too far in stating, “Further, even unusual sales by one insider do not give rise

to a strong inference of scienter when other defendants do not sell some or all of their shares during

the Class Period.” Id. at 15-16. Again, determining in advance which situations support an inference

of scienter is getting away from the precepts of Nathenson. Moreover, such an inference against one

defendant ought not turn on a finding that his co-defendant likewise profited from illegal insider

trading. See, e.g, Green Tree, 270 F.3d at 664-65.

Two other areas bear mention. In Nathenson, we concluded that the size and organization of

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the defendant company, together with the position of the individual defendant within it, supported an

inference o f scienter. There, we noted that the defendant was the chief executive of what “was

essentially a one product company.” 267 F.3d. at 424-25. Given that the company’s fortunes would

rise or fall based on the success of that single product, we deduced that that misstatements concerning

it were more likely to have been made with scienter. In this case, Plaintiffs note that Baker Hughes’s

INTEQ division, which was allegedly the source of the accounting irregularities in this case, accounted

for 20% of the company’s revenues. That is not an insignificant fraction. At the same time, as the

complaint notes, Baker Hughes has eight other divisions with operations worldwide. Defendants’

understanding of the INTEQ situation therefore cannot be so easily inferred. Second, the size of the

accounting restatement was relatively modest when compared to Baker Hughes’s revenues and profits

generally. As such, inferring recklessness by Defendants is more difficult. Cf. Green Tree, 270 F.3d

at 666 (“[T]he sheer size of the $390 million write-down adds to the inference that the defendants

must have been aware the problem was brewing.”)

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