MINER, Circuit Judge:
Plaintiff-appellant Daniel Chill and appellants (collectively, the "plaintiffs") appeal from a judgment entered in the United States District Court for the Southern District of New York (Keenan, J.) dismissing the complaint and denying plaintiffs leave to amend. The district court found that plaintiffs failed to allege facts that supported their claim that defendant-appellee General Electric Company ("GE") committed securities fraud in reporting the false profits generated by a bond trader at its subsidiary, Kidder, Peabody & Co., Inc. ("Kidder"). For the reasons that follow, we affirm the judgment of the district court.
GE is a large and diverse public company with 12 major, separately-managed operating businesses. One of these 12 businesses is GE Capital Services, Inc. ("GE Capital"), which is GE's financial services unit. At the time of the events at issue in this action, GE Capital itself was comprised of 24 separate businesses, one of which was Kidder, a full-service investment bank and securities broker-dealer. Each of these separate businesses reported their quarterly and annual financial results to GE, which reported the results of all its businesses on a consolidated basis.
GE had acquired 80 percent of Kidder for $620 million in 1986. Shortly thereafter, an insider trading scandal was exposed at Kidder, resulting in a $26 million fine paid to the Securities and Exchange Commission ("SEC") and the implementation of a compliance system at Kidder to detect fraudulent trading. Kidder's business declined, with losses of $53 million posted in 1989, and $54 million in 1990. In 1990, GE acquired the remaining 20 percent of Kidder in a $550 million bailout transaction. Following this transaction, Kidder began turning a profit, and did so throughout 1991, 1992 and 1993.
Beginning in late 1991, Orlando Joseph Jett, one of the traders at Kidder's government bond trading desk, allegedly began a scheme to generate false profits in order to increase his year-end, performance-based bonuses. Jett secretly entered thousands of fictitious STRIPs
In April of 1994, Kidder discovered Jett's scheme. Kidder informed GE Capital, and Jett was fired on April 17, 1994. GE announced on April 17, 1994 that it would take a one-time $350 million charge to its first quarter 1994 earnings to adjust for the false profits that had been recorded at Kidder from 1991 through 1994. GE and Kidder also announced that they had retained Gary G. Lynch, a former Director of Enforcement at the SEC, to conduct an internal investigation of Kidder and report on how the Jett scheme remained undetected despite Kidder's internal controls.
Shortly after GE announced its discovery of the scheme, ten class action suits were filed, each on behalf of a class of those who had purchased GE stock during the year prior to the disclosure of the scheme. According to each complaint, the earnings of Kidder, and thus GE, had been overstated as a result of Jett's scheme and thereby had artificially inflated the market price of GE stock. Seven of these actions named GE as a defendant, and the other three actions named as defendants Kidder and several of its officers and directors (the "Kidder defendants").
Pursuant to an order of the district court, all the suits against GE were consolidated into one action, and all the suits against the Kidder defendants were consolidated into a separate action. The order of the district
In October of 1994, the plaintiffs filed an amended complaint against GE. In their amended complaint, the plaintiffs alleged that they had purchased GE stock, or entered into put or call options for GE stock, between April 13, 1993 and April 17, 1994 (the "Class Period"), "based, inter alia, on materially false and misleading press releases and financial statements GE filed with the [SEC]." As stated in the complaint, "GE recorded hundreds of millions of dollars in profits throughout the Class Period it clearly knew or was wholly reckless in not knowing were manufactured out of thin air and that each quarter masked substantial trading losses totalling about $85 million in the aggregate." The plaintiffs alleged that "GE intentionally, knowingly or recklessly turned a blind eye to numerous `red flags' ... alerting [GE] that the `profits' Kidder appeared to be generating throughout the Class Period were fictive," in order "to justify its 1986 acquisition of Kidder." In addition, the plaintiffs alleged that "GE knowingly, intentionally or recklessly issued materially false and misleading statements regarding its financial controls system." Accordingly, the plaintiffs alleged that GE had engaged in securities fraud, in violation of section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and of Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder.
On December 20, 1994, GE moved to dismiss the amended complaint for failure to state a claim. In its Opinion and Order dated October 4, 1995, the district court granted the motion.
The court also found that GE's alleged violations of Generally Accepted Accounting Principles ("GAAP") and SEC accounting regulations did not support a section 10(b) claim, because the plaintiffs failed to successfully allege fraudulent intent. Accordingly, the district court found that the plaintiffs failed to state a section 10(b) claim.
The court declined to grant the plaintiffs leave to replead the complaint. The court stated that it "does not believe that Plaintiffs could ever successfully replead the scienter element of a Section 10(b) claim and for that reason the Court will not permit Plaintiffs to replead their Complaint." This appeal followed.
I. Failure to Allege Scienter on the Part of GE
In order to state a cause of action under section 10(b) and Rule 10b-5, "a plaintiff must plead that in connection with the purchase or sale of securities, the defendant, acting with scienter, made a false material representation or omitted to disclose material information and that plaintiff's reliance on defendant's action caused [plaintiff] injury." Acito v. IMCERA Group, Inc., 47 F.3d 47, 52 (2d Cir.1995) (alteration in original and quotation
We review de novo the district court's dismissal of an action pursuant to Fed. R.Civ.P. 12(b)(6), and accept as true the facts alleged in the complaint. First Nationwide Bank v. Gelt Funding Corp., 27 F.3d 763, 765 (2d Cir.1994), cert. denied, ___ U.S. ___, 115 S.Ct. 728, 130 L.Ed.2d 632 (1995); see Acito, 47 F.3d at 51. "Generally, we will uphold a district court's dismissal of a claim only if it appears that the plaintiff can prove no set of facts upon which relief may be granted." Acito, 47 F.3d at 51 (quotation omitted).
When the complaint contains allegations of fraud, Fed.R.Civ.P. 9(b) requires that "the circumstances constituting fraud ... be stated with particularity. Malice, intent, knowledge, and other condition of mind of a person may be averred generally." (Emphasis added.) Therefore, the actual fraudulent statements or conduct and the fraud alleged must be stated with particularity, see Gold v. Morrison-Knudsen Co., 68 F.3d 1475, 1476-77 (2d Cir.1995), cert. denied, ___ U.S. ___, 116 S.Ct. 1836, 134 L.Ed.2d 939 (1996); Acito, 47 F.3d at 51, whereas the requisite intent of the alleged speaker of the fraud need not be alleged with great specificity, see Cohen v. Koenig, 25 F.3d 1168, 1173 (2d Cir.1994). We apply the more general standard to scienter for the simple reason that "a plaintiff realistically cannot be expected to plead a defendant's actual state of mind." Connecticut Nat'l Bank v. Fluor Corp., 808 F.2d 957, 962 (2d Cir.1987).
Despite Rule 9(b)'s lower standard for scienter, this Court has stated that "we must not mistake the relaxation of Rule 9(b)'s specificity requirement regarding condition of mind for a `license to base claims of fraud on speculation and conclusory allegations.'" Acito, 47 F.3d at 52 (quoting Wexner v. First Manhattan Co., 902 F.2d 169, 172 (2d Cir. 1990)). Plaintiffs still have the "`burden of pleading circumstances that provide at least a minimal factual basis for their conclusory allegations of scienter.'" Cohen, 25 F.3d at 1173 (quoting Fluor, 808 F.2d at 962). Accordingly, we have held that "plaintiffs must allege facts that give rise to a strong inference of fraudulent intent." Acito, 47 F.3d at 52 (emphasis added); see S.Q.K.F.C., Inc. v. Bell Atl. Tricon Leasing Corp., 84 F.3d 629, 634 (2d Cir.1996); In re Time Warner Inc. Sec. Litig., 9 F.3d 259, 268 (2d Cir.1993), cert. denied, ___ U.S. ___, 114 S.Ct. 1397, 128 L.Ed.2d 70 (1994).
A plaintiff can establish a strong inference of fraudulent intent in two ways: "either (a) by alleging facts to show that defendants had both motive and opportunity to commit fraud, or (b) by alleging facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness." Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1128 (2d Cir.1994); see S.Q.K.F.C., 84 F.3d at 634; San Leandro Emergency Med. Group Profit Sharing Plan v. Philip Morris Cos., 75 F.3d 801, 813 (2d Cir.1996); Acito, 47 F.3d at 52. Plaintiffs make allegations under each alternative. We hold that under both approaches, plaintiffs fail to allege facts sufficient for us to infer the requisite scienter.
A. Motive and Opportunity
The first method of pleading scienter is to allege facts that show both motive and opportunity to commit fraud. See Acito, 47 F.3d at 52. It is not disputed that GE had the opportunity to defraud plaintiffs as they allege.
Plaintiffs allege that "GE's interest in justifying to its shareholders its over $1 billion investment in Kidder gave GE a motive to willfully blind itself to facts casting doubt on Kidder's purported profitability." However, GE's motive in justifying its substantial investment in Kidder is not adequate to establish GE's scienter.
In this case, GE obviously would want to justify its investment in Kidder and have that investment appear profitable, but such a generalized motive, one which could be imputed to any publicly-owned, for-profit endeavor, is not sufficiently concrete for purposes of inferring scienter.
The plaintiffs also claim that the district court's determination that they failed to sufficiently allege a motive on the part of GE is inconsistent with the court's finding that the plaintiffs' motive theories were sufficient in their action against the Kidder defendants. However, in In re Kidder Peabody Securities Litigation, the district court simply stated that "Kidder arguably had a motive to either hide Jett's trading scheme or to recklessly disregard the warning signs of that scheme." No. 94 Civ. 3954(JFK), 1995 WL 590624, at *5 (S.D.N.Y. Oct. 4, 1995). In each instance, the district court's determination that the Kidder defendants "arguably" had a motive does not necessarily mean that the parent company, GE, had any motive. Ultimately, whether Kidder defrauded plaintiffs and whether its parent, GE, defrauded plaintiffs are different questions.
Accordingly, we hold that the district court properly determined that the plaintiffs failed to allege facts sufficient to show motive and opportunity to commit fraud.
B. Circumstantial Evidence of Recklessness
A plaintiff in a fraud action may also plead scienter "by alleging facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness." Acito, 47 F.3d at 52 (quotation omitted). The plaintiffs argue that GE's financial reporting was reckless in two respects. First, they contend that GE was reckless in its failure to heed the "red warning flags" coming from Kidder that signaled Kidder's falsification of profits. Second, they argue that GE was reckless in relying on Kidder to monitor its own financial reporting. The district court found plaintiffs' factual allegations insufficient to infer the requisite recklessness.
The facts alleged to support recklessness must be "strong circumstantial evidence" of that recklessness. Acito, 47 F.3d at 52. This showing of recklessness must be such that it gives rise to a "strong inference of fraudulent intent." Shields, 25 F.3d at 1128; see also Decker v. Massey-Ferguson, Ltd., 681 F.2d 111, 121 (2d Cir.1982) (recklessness "must, in fact, approximate an actual intent to aid in the fraud being perpetrated"); In re Leslie Fay Cos. Sec. Litig., 835 F.Supp. 167, 173 (S.D.N.Y.1993) (recklessness must be shown to such an extent that a reasonable finder of fact could actually infer fraudulent intent from it).
Plaintiffs' first and central recklessness claim "is based on GE having made ... false statements recklessly, disregarding obvious indications the supposed earnings and profits were not — and could not have been — the result of the STRIPs trading activities to which they were attributed." Plaintiffs make several allegations designed to support their contention that the district court erred in rejecting their claim that GE was reckless in disregarding "red flags" coming from Kidder.
The plaintiffs argue that they "have identified three distinct sources of specific facts — Kidder financial documents reviewed by GE, the Dammerman memoranda, and the history of GE's investment in its Kidder subsidiary — which together establish compelling circumstantial evidence of GE's recklessness." As regards the Kidder financial documents, the plaintiffs allege that "[d]uring the Class Period GE had before it financial information from Kidder that contained a host of red warning flags about the legitimacy of Kidder's supposed record results." According to the plaintiffs, these red flags included: (1) the huge increase in the dollar volume of trading at Kidder's government bonds trading desk in less than three years; (2) the large increase in reported profits from the first quarter of 1992 to March of 1994; (3) the lack of records of any cash being realized from these trades; and (4) the multi-billion dollar daily fluctuations in Kidder's balance sheet assets.
In addition to these red flags, the plaintiffs contend that GE should have been alerted to possible wrongdoing by monthly memoranda sent from Richard W. O'Donnell, Kidder's Chief Financial Officer, to Dennis D. Dammerman, the Chief Financial Officer at GE (the "Dammerman memoranda"). The plaintiffs argue that GE "disregarded specific information about unprecedented and dramatically increasing profitability of STRIPs trading at Kidder contained in" these memoranda. For instance, it was reported that, by the end of April of 1993, Kidder's government bond trading desk had "already exceeded its 1992 net income of $18.2 [million], with Treasury STRIPs trading being the principal driver of current profitability," and that by the end of December of 1993, net income from STRIPs trading for 1993 had reached $71.8 million, which was 26 percent of the total 1993 annual net income of Kidder's Fixed Income operations.
However, the facts alleged, if true, do not add up to circumstantial evidence of conscious misbehavior or recklessness. The plaintiffs' claim of deliberate blindness is not supported by their allegations. The plaintiffs do not demonstrate how the increased level of activity at Kidder, as reflected in GE's consolidated financial records, would necessarily have indicated to GE that there was misconduct. The fact that GE did not automatically equate record profits with misconduct cannot be said to be reckless. As GE points out, "successfully managed enterprises can earn record (and therefore `extraordinary') profits at any given point in time and a well managed business that is growing should post `record' profits on a regular basis." Furthermore, the fact that financial documents showed larger positions in these market securities would support GE's acceptance of the larger profits. The fact that cash was not realized from these trades is equally ambiguous in import. There is no evidence that GE would normally expect to see more than accounting, or paper, profits from its third-tier subsidiaries. The Dammerman memoranda simply show that the STRIPs trading was very successful. The plaintiffs do not show that the memoranda raised compliance concerns or other potential problems.
Given the significant burden on the plaintiff in stating a fraud claim based on recklessness, the success, even the extraordinary success, of a subsidiary will not suffice in itself to state a claim that the parent was reckless in failing to further investigate. Fraud cannot be inferred simply because GE might have been more curious or concerned about the activity at Kidder. See Shields, 25 F.3d at 1129 (allegations "strongly suggest that the defendants should have been more alert and more skeptical, but nothing alleged indicates that management was promoting a fraud"); see also Serabian v. Amoskeag Bank Shares, Inc., 24 F.3d 357, 362 (1st Cir.1994) ("The fact that the company was in violation of federal law by its ownership of the financial institution stock may reflect poorly on its management, but in no way demonstrates a 10b-5 violation."). In sum, the plaintiffs fail to allege facts to support a finding that GE was faced with sufficient information such that its failure to further investigate Kidder's STRIPs trading practices constituted recklessness.
Plaintiffs also contend that GE acted recklessly in relying on Kidder to monitor the accuracy of its own financial reporting. They refer to GAAP provisions and SEC regulations that required GE to accurately report Kidder's financial information.
In fact, this precise claim was raised in a case where plaintiffs pointed to the fact
In sum, we affirm the district court's finding that the plaintiffs did not allege facts that showed strong circumstantial evidence of recklessness on the part of GE. Accordingly, the district court properly determined that the plaintiffs failed to state a securities fraud claim in connection with the allegedly false financial statements issued by GE.
II. GE's Alleged Misrepresentations of its Financial Controls
The plaintiffs next argue that the district court erred in dismissing their complaint without properly addressing their claim that GE fraudulently misrepresented the efficacy of its financial controls and auditing systems. This contention is without merit.
In claiming that GE misrepresented its financial controls, plaintiffs challenge statements that appeared in GE's 1993 Annual Report. These statements were as follows:
(JA 79). Plaintiffs contend that these statements were fraudulent misstatements because, in fact, "GE's design, implementation and operation of its financial control systems, including its internal auditing process and financial reporting procedures, was inadequate," most notably in that "those systems failed to assure that immediate action was taken in response to the repeated red flags warning of financial irregularities at Kidder."
Regardless of the accuracy of these allegations, in order to state a securities fraud claim, plaintiffs must successfully allege the requisite scienter. See Ernst & Ernst v. Hochfelder, 425 U.S. 185, 201, 96 S.Ct. 1375, 1384, 47 L.Ed.2d 668 (1976). GE has failed to allege the requisite scienter with regard to its claim that GE misrepresented the efficacy of its financial controls. Accordingly, the district court properly dismissed this claim.
III. Denial of Leave to Amend the Complaint
Finally, plaintiffs contend that the district court erred in denying them leave to replead their complaint. We find no merit in this argument.
We review the denial of leave to replead a complaint for abuse of discretion. Philip Morris, 75 F.3d at 815. In general, "[l]eave to amend should be freely granted, especially where dismissal of the complaint was based on Rule 9(b)," and "there must be good reason to deny the motion." Acito, 47 F.3d at 55. In the present case, in denying the plaintiffs leave to amend, the district court stated that it "does not believe that Plaintiffs could ever successfully replead the scienter element of a Section 10(b) claim and for that
Plaintiffs argue that they were denied leave to amend after they had only been permitted "limited document discovery." We disagree. Plaintiffs had ample opportunity to collect the facts concerning Jett's trading scheme in order to attempt to show scienter on the part of GE. They had the Lynch Report to review in drafting their amended complaint. They obtained discovery from Kidder and GE after filing their amended complaint, and used the Dammerman memoranda in responding to GE's motion to dismiss. We agree with the district court that there is no indication that plaintiffs could replead the complaint so as to establish GE's scienter. Therefore, the district court properly exercised its discretion in denying plaintiffs leave to amend.
For the foregoing reasons, the judgment of the district court is affirmed in all respects.