284 F.

3d 72

Michael ALDRIDGE, individually and on behalf of all others

similarly situated, Plaintiff, Appellant,
v.
A.T. CROSS CORPORATION, Bradford R. Boss, Russell A.
Boss, W. Russell Boss Jr. Trust A, W. Russell Boss Jr. Trust B,
W. Russell Boss Jr. Trust C, John E. Buckley, and John T.
Ruggieri, Defendants, Appellees.
No. 01-1989.

United States Court of Appeals, First Circuit.

Heard February 8, 2002.
Decided March 20, 2002.

COPYRIGHT MATERIAL OMITTED Lawrence Deutsch with whom

Shanon J. Carson, Berger & Montague, P.C., Matthew F. Medeiros, and
Little, Bulman, Medeiros & Whitney, P.C. were on brief for appellant.
John F. Sylvia with whom R. Robert Popeo, Stephen T. Murray, Justin S.
Kudler, and Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C. were on
brief for appellees A.T. Cross Company, Bradford R. Boss, Russell A.
Boss, John E. Buckley, and John T. Ruggieri.
William R. Grimm with whom Charles D. Blackman and Hinckley, Allen
& Snyder LLP were on brief for appellees W. Russell Boss Jr. Trust A, W.
Russell Boss Jr. Trust B, and W. Russell Boss Jr. Trust C.
Before TORRUELLA, Circuit Judge, STAHL, Senior Circuit Judge, and
LYNCH, Circuit Judge.
LYNCH, Circuit Judge.

In early 1998 the A.T. Cross Corporation, a venerable New England maker of
fine pens and pencils, entered the personal electronic devices market by
offering penbased computing products through its Pen Computing Group
(PCG). The stars of its new line were the CrossPad and its later-introduced

smaller cousin, the CrossPad XP. Cross had high hopes for its new product line
and expressed those hopes publicly in September 1997 by saying it expected to
report a minimum of $25 million in profitable sales for PCG in 1998. Indeed,
one of Cross's officers compared its fledgling product to the highly successful
Palm Pilot.
2

Reality did not keep pace with these projections. By late 1999 Cross had
discontinued the product line and suffered losses that year of $24.3 million,
which essentially eliminated profits from the $24.8 million in sales on the PCG
products in 1998.

Michael Aldridge brought this securities action in April 2000 as a putative class
action on behalf of those who purchased Cross common stock between
September 17, 1997 and April 22, 1999 (the class period). An amended
complaint asserts claims against the company, four officers of the company,
and certain trusts which own part of Cross. The complaint alleges violations of
section 10(b) of the Securities and Exchange Act of 1934, 15 U.S.C. 78j(b)
(2000), and Rule 10b-5 under that Act, 17 C.F.R. 240.10b-5 (2001), against
the company, the individual defendants, and the trusts. It also alleges a section
20(a) claim against the individual and trust defendants as "controlling
person[s]."1 15 U.S.C. 78t(a) (2000).

On a Rule 12(b)(6) motion by the defendants, the district court dismissed the
action. Aldridge v. A.T. Cross Corp., No. 00-203ML (D.R.I. June 4, 2001). The
court did not reach the question of whether to certify a class.

We reverse the dismissal of the claims against the individual defendants and
the company. We find that there is sufficient factual support for the allegations
of fraud and a strong inference of scienter to survive a motion to dismiss under
the Private Securities Litigation Reform Act (PSLRA). We affirm the dismissal
of the section 20(a) claim against the trust defendants on different grounds; on
these pleadings, the trust defendants cannot be considered "controlling persons"
for the purpose of section 20(a) liability.

I.
6

Because this is an appeal from a motion to dismiss, we describe the facts in the
case in the light most favorable to Aldridge, the plaintiff and nonmoving party.
Doe v. Walker, 193 F.3d 42, 42 (1st Cir.1999).

Cross is a publicly traded company on the American Stock Exchange. For over

a century, Cross has been producing traditional high-end writing instruments.

By the mid 1990s, sales of these products were dropping off, and the
company's stock price had decreased significantly since 1990. In July 1996,
Cross established a new division it called the Pen Computing Group (PCG) in
an effort to "bridge ... the worlds of traditional and electronic paper," to expand
the company's traditional product base, and "to return Cross to acceptable
margins and earnings."
8

One of these PCG products was the CrossPad, unveiled in November 1997, and
first shipped in March 1998. The CrossPad XP, a smaller model, was
introduced to the market in October 1998. The CrossPads were electronic note
pads with digital pens, with which a user wrote on a note pad atop a battery
powered unit. The pens wrote on the paper in the traditional way and also
recorded the pen strokes for later connection to a computer. Once the
information was stored in a computer, it could be viewed, searched, and
otherwise used.

There was a great deal of optimism about the CrossPads and their positive
impact on Cross as a whole. On September 17, 1997, even before unveiling the
CrossPad, Cross issued a press release announcing that the company expected
at least $25 million in profitable sales from PCG in 1998. On March 23, 1998,
Cross filed a 10-K report with the SEC for the fiscal year 1997, which stated:
"We look at 1998 as a year where ... our Pen Computing Group will provide its
first year of significant sales and earnings." The bulk of PCG's business was the
CrossPad product line. In an April 1998 article in Value Line, an investment
publication, Cross's management said that sales of the CrossPad would drive
PCG's growth, and predicted sales of $200 million in the year 2000. In a June
1998 article in Barron's, another investment publication, management predicted
that CrossPad could triple the size of the company. On June 30, 1998, the Cross
share price peaked for the class period at $14.25.

10

In Cross's 1998 filings with the SEC, the company continued to report
significant sales growth for PCG products. In a business article dated February
4, 1999, the Providence Journal quoted Brian Mullins, the Director of
Marketing for PCG, as saying that PCG's "sales for all of 1998 did meet the
Company's goal of $25 million in sales."

11

Despite the earlier optimism, Cross began to lower the market's expectations
beginning in early 1999. The same February 4 Providence Journal article
discusses Mullins's comments on the recently announced price reductions for
both the CrossPad and the CrossPad XP. He stated that the price cuts were not
related to the sales of the products but were "planned... from the get go" and

were expected by the retailers. The article paraphrases Mullins as saying that
"even with the price cuts, the company will still make a profit." He also said
that more price cuts were expected later in the year. On March 23, 1999, the
company filed its 10-K report with the SEC. The report stated the success of the
CrossPad sales in 1998, but it also acknowledged the price reductions and
"greater marketing support and technical development [than] planned, which
resulted in a loss for Pen Computing operations."
12

On April 22, 1999, Cross announced in a press release that the company's sales
had dropped dramatically from $9 million in the first quarter of 1998 to $1.1
million in the first quarter of 1999. It also expressed its expectation that
revenues from PCG would be a great deal lower in 1999 than they were in
1998.

13

On the same day, Cross's management held a conference call with securities
analysts and investors to discuss the company's results for the first quarter of
1999. During the call, Russell Boss, President and CEO of Cross, explained that
PCG sales had decreased in the first quarter "because of price protections." He
also mentioned "take backs" from customers. Robert Byrnes, President and
CEO of PCG also spoke about "price protection," and said that the price
reductions were part of the company's original sales strategy. John Buckley,
Cross's Executive Vice President and Chief Operating Officer, also
acknowledged the company's price protection practices. Cross did not disclose
any price protection plans or take back agreements in its public financial
disclosures in 1998.

14

Also on April 22, Russell Boss and Bradford Boss announced that they were
stepping down from their positions as CEO and executive Chairman
respectively, and stepping into the positions of non-executive Chairman, and
non-executive Chairman Emeritus. Immediately after the end of the class
period, on April 22, 1999, the share price for Cross fell below $4.

15

PCG sales continued to decline in 1999. On May 13, 1999, the company filed a
10-Q report for the first quarter of the year and revealed for the first time in a
SEC filing a "rebate" program it had with its customers. In a 10-Q report issued
on August 13, 1999, the company reported over $8 million in losses for PCG in
the second quarter of 1999, and an 85% decline in PCG sales compared to the
same quarter the previous year. The company pointed to the excess inventory
its customers had as a reason for the decrease in sales.

16

Finally, the CrossPad product line was discontinued at the end of 1999 because

of poor performance in the market. In a Form 10-K filed on March 23, 2000,
Cross's new President and CEO discussed PCG's decline in 1999. He stated:
17

Early in the year [1999] it became clear that our investment[] in the Pen
Computing Group ... w[as] a significant drain on the Company's financial and
human resources. As a result, in the fourth quarter, the Company discontinued
the CrossPad product line....

18

The company also described a revenue recognition policy not disclosed earlier,
which stated: "Revenue from sales is recognized upon shipment or delivery of
goods. Provision is made at the time the related revenue is recognized for
estimated product returns, term discounts and rebates."

19

Aldridge, the plaintiff, brought a claim under section 10(b) of the Securities
and Exchange Act of 1934, 15 U.S.C. 78j(b) (2000), and Rule 10b-5, 17
C.F.R. 240.10b-5 (2001), for fraud against Cross, members of its top
management team, and three trusts that own a large number of shares in the
company. He argues that the statements made by the company and its
management during the class period were misleading in light of the company's
sales and accounting practices. Specifically, Aldridge says that the company
employed sales strategies, such as price protection, take backs, and channel
stuffing, without disclosing them to the shareholders, or reserving for them in
financial statements, as they were obligated to do. Aldridge also brought a
claim under section 20(a) of the Securities and Exchange Act of 1934, 15
U.S.C. 78t(a) (2000), against the individual defendants and the trust
defendants as "controlling persons" of the corporation. Aldridge argues that the
trust defendants, "[b]y reason of their ownership and ability to select two-thirds
of the Board," and the individual defendants influenced and steered the
company to engage in fraudulent conduct.

20

The district court dismissed the action on a Rule 12(b)(6) motion under the
standards of the Private Securities Litigation Reform Act of 1995 (PSLRA), 15
U.S.C. 78u-4 (2000), finding Aldridge had neither provided sufficient factual
support for the allegations of fraud nor raised a strong inference of scienter.
Aldridge v. A.T. Cross Corp., No. 00-203ML, slip. op. at 10-15 (D.R.I. June 4,
2001). The district court, without reaching the details of the controlling person
issue, also dismissed the section 20(a) claim against the individual defendants
and the trust defendants because it was derivative of the dismissed section
10(b) claim. Id. at 15-16. The court did not reach the question of whether to
certify a class.

II.

21

22

Our review of the allowance of a motion to dismiss is de novo. Serabian v.

Amoskeag Bank Shares, Inc., 24 F.3d 357, 361 (1st Cir.1994). The pleading
standards for violations of section 10(b) and Rule 10b-5 are found in the
PSLRA, 15 U.S.C. 78u-4.2 This circuit's seminal case on the pleading
standards under the PSLRA is Greebel v. FTP Software, Inc., 194 F.3d 185,
193-94 (1st Cir.1999). In Greebel, we held that the PSLRA did not alter this
circuit's rigorous reading of the standards for pleading fraud. The plaintiff in a
securities fraud action must "specify each allegedly misleading statement or
omission" including its time, place and content. Id. at 193. The plaintiff must
provide factual support for the claim that the statements or omissions were
fraudulent, that is, facts that show exactly why the statements or omissions
were misleading. Id. at 193-94. If the plaintiff brings his claims on information
and belief, he must "set forth the source of the information and the reasons for
the belief." Id. at 194 (quoting Romani v. Shearson Lehman Hutton, 929 F.2d
875, 878 (1st Cir.1991)) (internal quotation marks omitted). The plaintiff must
also show that the inferences of scienter "are both reasonable and `strong.'" Id.
at 195-96.
Although the pleading requirements under the PSLRA are strict, id. at 194, they
do not change the standard of review for a motion to dismiss. Even under the
PSLRA, the district court, on a motion to dismiss, must draw all reasonable
inferences from the particular allegations in the plaintiff's favor, while at the
same time requiring the plaintiff to show a strong inference of scienter. Id. at
201; accord Helwig v. Vencor, Inc., 251 F.3d 540, 553 (6th Cir.2001) (en banc),
petition for cert. filed, 70 U.S.L.W. 3269 (Sept. 27, 2001) (No. 01-538).
A. Fraud Allegations

23

The district court correctly found that Aldridge had met the specificity
requirements as to "time, place and content" of the statements said to be
misleading. Aldridge, slip. op. at 10. The district court faulted the complaint,
however, for failing to provide factual support for the allegations of fraud. Id. at
10-11. The district court concluded that even if Cross made false statements or
material omissions, there is no support for the proposition that the defendants
knew these statements or omissions were misleading at the time they were
made. It also relied on the absence of specific figures regarding which
transactions were misstated and by what amounts. It was here that the court
erred. The district court did not "giv[e] plaintiff[] the benefit of all reasonable
inferences" as it should have on a motion to dismiss, Greebel, 194 F.3d at 201,
but appears to have drawn its inferences in the defendants' favor. We take the
plaintiff's allegations to be true and draw inferences in the plaintiff's favor.

24

Aldridge's core claim is that the reported revenues and earnings in A.T. Cross's
financial statements were artificially inflated, and that the statements contained
omissions of material facts. Aldridge alleges that under generally accepted
accounting principles (GAAP), with which Cross purported to comply, Cross
was required to estimate a loss or range of loss and set a reserve with respect to
all contingent sales that were made, including sales for which the buyer had the
right to receive a credit or allowance if the price of the CrossPad declined
before the buyer could resell the product (i.e., price protection). If Cross was
unable to establish a reserve or estimate the loss, it was required to disclose the
practices that gave rise to the contingent revenues and earnings. Aldridge
alleges that the defendants knew that Cross had not sufficiently reserved for the
losses that inevitably would occur when Cross was forced to honor its price
protection commitments, and that their failure to disclose this to the public
violated federal regulations (specifically Item 303 of the SEC's Regulation S-K)
and accounting standards. See 17 C.F.R. 229.303(a) (2001) (requiring that
SEC filings "provide ... information that the registrant believes to be necessary
to an understanding of its financial condition"); Accounting for Contingencies,
Statement of Financial Accounting Standards No. 5, 10 (Financial
Accounting Standards Bd.1975); Revenue Recognition When Right of Return
Exists, Statement of Financial Accounting Standards No. 48, 7 (Financial
Accounting Standards Bd.1981) ("FAS 48"). Cross has not argued that the
information that was not provided in the financial statements was not material.

25

The district court's holding hinged on a key issue: whether, from the statements
made by company officials in 1999, it could be reasonably inferred that Cross
had engaged in undisclosed price protection earlier, in 1998. The district court
thought not. If there was no price protection or similar practice in 1998, the
district court concluded, then the company's financial statements did not
contain misleading omissions. Our view is to the contrary: it is an extremely
reasonable inference, from the defendants' statements in 1999, that the company
had offered its customers price protection guarantees in 1998, likely to induce
them to carry the new CrossPad product lines. From this, it may easily be
inferred that the statements were misleading and that the defendants knew that
they were misleading.

26

There were several statements in 1999 that support the inferences. First, in
February 1999, the prices of the CrossPad products were discounted by up to
30%. A February 4 business article in the Providence Journal reported the price
reductions and cited Mullins, the Director of Marketing, as saying that the
company would make a profit on the CrossPads even with the price cuts.3 The
article also reported (obviously relying on company sources and most likely on
Mullins) that price cuts "had been planned since the products were introduced."

Mullins was quoted as saying that "the price cuts were not related to how well
the units were selling." Mullins said "[w]e actually had planned it from the get
go. We told the retailers to expect it."
27

In this context, "from the get go" is easily read to mean from the introduction
of the new product to the market in 1998. If the price cuts were planned from
early 1998, it is entirely reasonable to think that price protection for the stores
selling the product was also discussed and agreed on at that time, to insulate the
retailers from the inevitable price reductions.

28

The price reductions were also discussed at Cross's April 22, 1999 conference
call with analysts and investors. During that conference call Byrnes, the head of
PCG, said that the price reductions were in line with the company's original
strategy, but were not put into place until February 1999. President Russell
Boss said that "PCG business was down" in the first quarter of 1999 "because
of price protections [Cross] gave retailers." Two other corporate officers,
including Byrnes, mentioned that there was a price protection program.

29

There is a possibility that the Cross officers used the term "price protection" in
some specialized narrow sense for a right to reimbursement offered by the
company to the retailers once the CrossPads had already been on the store
shelves for some months. However, on this record it is just as likely, if not
more likely, that Aldridge's more common definition of price protection is what
was meant: "Price protection is a retailer's or distributor's right to
reimbursement in the event of post-sale price reductions." As Aldridge argues,
"[t]hat price protection is a right implies that it is bargained for at the time the
retailer/distributor contracts to buy product from the manufacturer," not once
the product has been on the shelves for several months.

30

Aldridge also argues that under accounting rules, booking sales subject to price
protection requires adequate accounting reserves at the time of sale to offset the
effects of such price protection. Otherwise, such sales should not be recognized
as revenue. If a reserve is not set up because, for example, the size of the
contingencies was impossible to estimate disclosure should be made. See
Greebel, 194 F.3d at 203 (discussing FAS 48).

31

In dismissing the case, the district court referred to a statement in Greebel that
the absence of specific identifying information as to the amount and nature of
contingent sales transactions was indicative of the generality of the allegations
of violations of GAAP standards such as FAS 48, and thus insufficient by itself
to infer scienter. Aldridge, slip op. at 11 (citing Greebel, 194 F.3d at 203-04).

However, in Greebel, there was no evidence of statements by management

indicating material undisclosed contingencies, while here there was such
evidence. Further, it is reasonable to infer that in this case all customers were
offered price protection as a matter of company policy. Cross itself attributed
losses in early 1999 in part to its price protection program. There was therefore
little need for the type of specificity discussed in Greebel. In Greebel, the
argument that contingent sales were not properly accounted for under FAS 48
was made largely in service of more direct claims of warehousing and whiting
out, claims which, even after discovery, lacked any factual support. Here, in
contrast, there is a reasonable inference of a pattern of price protection. Further,
the evidence that contingent sales were not accounted for as they should have
been under FAS 48 was offered in Greebel as indirect evidence of scienter, and
there was discounted, in the absence of particulars and other evidence of
scienter. Greebel did not hold that a plaintiff, before discovery, must in every
case allege the amount of overstatement of revenues and earnings in order to
state a claim that undisclosed price protection schemes were fraudulent. 194
F.3d at 204 (relying on "complete absence" of particulars but refusing to hold
that such information must appear in a complaint).
32

Aldridge also attempts to support the inference that a price protection program
was entered into in 1998 but not disclosed at the time with allegations of two
corollary practices: take backs and channel stuffing. A "take back" is a promise
to take back goods from customers who have been unable to sell them. In the
April 22, 1999 conference call, Russell Boss specifically used the phrase "take
back." Again, it is reasonable to infer that a take back guarantee for the retailers
of CrossPads was agreed to in 1998, because a take back agreement, just like
price protection, is likely to have been part of the original bargain between
Cross and its customers. No take back agreements were disclosed in the
company's 1998 public statements and filings. The take back allegations
therefore support Aldridge's claim that Cross engaged in undisclosed price
protection.

33

Channel stuffing, in turn, was defined in Greebel:

34

"Channel stuffing" means inducing purchasers to increase substantially their

purchases before they would, in the normal course, otherwise purchase
products from the company. It has the result of shifting earnings into earlier
quarters, quite likely to the detriment of earnings in later quarters.

35

194 F.3d at 202. Aldridge's allegation is that 50% of the store placements for
the CrossPad took place in the last four months of 1998 and that 36% of PCG
sales occurred in the last three months of 1998. These figures might well be

explained by holiday season sales. Beyond that, the second quarter 1999 Form
10-Q report stated that the 85% reduction in sales from the prior year was
attributable to retailers having significantly reduced their purchases as they
reduced their current inventory levels. Also, the company's expenses were
higher as it administered a rebate promotion "to reduce channel inventory at the
retail level." This information may or may not suggest that more inventory was
in the hands of the retailers than commercially warranted. "There is nothing
inherently improper in pressing for sales to be made earlier than in the normal
course," id. at 202, and in this case, the channel stuffing allegations at present
are neutral. After discovery, however, they may play a supporting role in
buttressing the price protection inferences.
36

The company says this is a garden variety "fraud by hindsight" case,

occasioned by the large drop in sales of CrossPad products after 1998. That
characterization is off the mark. Fraud by hindsight occurs when a plaintiff
"simply contrast[s] a defendant's past optimism with less favorable actual
results, and then `contend[s] that the difference must be attributable to fraud.'"
Shaw v. Digital Equip. Corp., 82 F.3d 1194, 1223 (1st Cir.1996) (quoting
DiLeo v. Ernst & Young, 901 F.2d 624, 627 (7th Cir.1990)). In this case, on the
other hand, Aldridge complains that the company failed to disclose certain
known material information as to the contingent nature of the sales, and that
Cross essentially admitted to the 1998 contingencies in 1999.

37

The allegations of fraud in the complaint have sufficient factual support to

survive a motion to dismiss. A closer question is whether the allegations of
scienter are sufficient.
B. Scienter

38

Scienter, which is a requirement for liability under section 10(b) and Rule 10b5, is "a mental state embracing intent to deceive, manipulate, or defraud." Ernst
& Ernst v. Hochfelder, 425 U.S. 185, 193 n. 12, 96 S.Ct. 1375, 47 L.Ed.2d 668
(1976). To win a section 10(b) case, the plaintiff must show either that the
defendants consciously intended to defraud, or that they acted with a high
degree of recklessness. Greebel, 194 F.3d at 198-201.

39

In Greebel, we held that the PSLRA did not mandate a particular test to
determine scienter and that this court would continue to use its case by case
fact-specific approach; "we ... analyze[] the particular facts alleged in each
individual case to determine whether the allegations were sufficient to support
scienter." 194 F.3d at 196; accord City of Philadelphia v. Fleming Cos., 264

F.3d 1245, 1262-63 (10th Cir.2001) (adopting Greebel's fact-specific

approach); Helwig, 251 F.3d at 551 (same). Thus, the plaintiff may combine
various facts and circumstances indicating fraudulent intent to show a strong
inference of scienter. As part of the mix of facts, the plaintiff may allege that
the defendants had the motive ("concrete benefits that could be realized by ...
the false statements and wrongful nondisclosures") and opportunity ("the means
and likely prospect of achieving concrete benefits by the means alleged") to
commit the fraud. Novak v. Kasaks, 216 F.3d 300, 307 (2d Cir.) (quoting
Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1130 (2d Cir.1994)), cert
denied, 531 U.S. 1012, 121 S.Ct. 567, 148 L.Ed.2d 486 (2000). However, as
we stated in Greebel, while mere allegations of motive and opportunity alone
may be insufficient, together with additional factual support, evidence of
motive and opportunity may establish a strong inference of scienter. 194 F.3d at
197.
40

In evaluating whether the inferences of scienter are strong, we agree with the
Sixth Circuit's language that: "Inferences must be reasonable and strong but
not irrefutable.... Plaintiffs need not foreclose all other characterizations of fact,
as the task of weighing contrary accounts is reserved for the fact finder."
Helwig, 251 F.3d at 553. The plaintiff must show that his characterization of
the events and circumstances as showing scienter is highly likely.

41

Taking all the facts and circumstances into consideration, the complaint
survives the requirement that its pleadings raise a strong inference of scienter.
First, strong inferences can be made that the company offered price protection
and take back arrangements in 1998.4 These arrangements, if they existed, were
not disclosed, and that nondisclosure could hardly have been inadvertent. The
company only disclosed the price protection and take back agreements in an
April 1999 conference call with industry analysts and investors. Full public
disclosure of the agreements only occurred in the Form 10-Q report filed on
May 13, 1999. Although the company officials referred to "price protection"
during the conference call, the report used the term "rebates," which may
suggest an attempt to recharacterize the events. Of course, more than mere
proof that the defendants made a particular false or misleading statement is
required to show scienter. Geffon v. Micrion Corp., 249 F.3d 29, 36 (1st
Cir.2001). However, the fact that the defendants published statements when
they knew facts suggesting the statements were inaccurate or misleadingly
incomplete is classic evidence of scienter. Fl. State Bd. of Admin. v. Green Tree
Fin. Corp., 270 F.3d 645, 665 (8th Cir.2001) (collecting cases from various
circuit courts).

42

Second, building on the reasonable inference that either or both the price

protection or take back guarantees were in place in 1998, it may also be

inferred that accounting standards required that a reserve be established or at
least that Cross disclose the sales practices in its financial statements. This is
also evidence of scienter. See Geffon, 249 F.3d at 35 (noting that "accounting
shenanigans" may be evidence of scienter). There is evidence that the
defendants acted with knowledge and intent when they did not account for the
sales practices in the company's reports in 1998. In the Form 10-K filed by the
company on March 23, 2000, after a new company president was installed,
Cross disclosed for the first time after the dramatic PCG losses, a revenue
recognition policy: "Revenue from sales is recognized upon shipment or
delivery of goods. Provision is made at the time the related revenue is
recognized for product returns, term discounts and rebates."
43

The company argues that because it has never restated any of its financials or
otherwise indicated any error in the 1998 financial statements, and because its
financial statements were audited by an independent accounting firm, no
inference of accounting error, and so no inference of scienter, can be drawn. We
disagree. Had the 1998 financials been restated, that might well have been
useful to Aldridge. However, the fact that the financial statements for the year
in question were not restated does not end Aldridge's case when he has
otherwise met the pleading requirements of the PSLRA. To hold otherwise
would shift to accountants the responsibility that belongs to the courts. It would
also allow officers and directors of corporations to exercise an unwarranted
degree of control over whether they are sued, because they must agree to a
restatement of the financial statements.

44

Third, the Cross corporate officers had some particular financial incentives to
load sales and earnings into 1998. Their compensation depended on the
company's earnings; as Cross correctly notes, that fact alone is not and cannot
be enough to establish scienter. Green Tree, 270 F.3d at 661; Fleming Cos., 264
F.3d at 1269-70; Novak, 216 F.3d at 307. What makes this case different are
the inferences that corporate officers understood in 1997 and 1998 that the
success of the new products, and of taking the old line company into a new
world, was important to their own survival and that of the company. Indeed, the
complaint alleges that Russell said, "If I can't turn the company around in one
year, I won't be here." This gave incentive to maximize 1998 earnings in
particular. When financial incentives to exaggerate earnings go far beyond the
usual arrangements of compensation based on the company's earnings, they
may be considered among other facts to show scienter. See, e.g., Green Tree,
270 F.3d at 661 (reversing trial court decision based on lack of scienter where it
was reasonable to infer that defendant officer maximized his compensation by
overstating earnings before his contract ran out).

45

More specifically, the individual defendants were the ones who set the target
sales goal of $25 million, and their jobs were in jeopardy if the goals were not
met. Moreover, the CrossPad product line was very important to Cross. In April
1998 the defendants were quoted as stating that the CrossPad would be the
primary driver of PCG's growth. In a September 30, 1998 press release, Cross
stated that the sales of PCG products made up 34% of the company's total
domestic revenue. That being so, there was incentive to maximize profits in
1998 by various means. See Greebel, 194 F.3d at 196 (stating that "selfinterested motivation of defendants in the form of saving their salaries or jobs"
may be evidence of scienter). As it turned out, the company President, Russell
Boss, and Chairman, Bradford Boss, did resign after the disastrous first quarter
1999 results were made public.

46

Playing lesser but supporting roles in the factual analysis, there were the
additional financial incentives to management to overstate 1998 profits. The
exercise price of the individual defendants' stock options was lowered in 1997,
just before the introduction of the new product line. The exercise price was
lowered again to match the market price in December 1998. There is no
evidence that the defendants exercised their options; Aldridge's point is rather
that the adjustment in price created incentives to "boost A.T. Cross share price."
The adjustments in the exercise price of the defendants' stock options alone are
not enough to create a strong inference of scienter. But this fact is not alone
here. While this case does not involve trading while in possession of material
nonpublic information, which in some circumstances may be taken to support
allegations of motive, see, e.g., Acito v. IMCERA Grp., 47 F.3d 47, 54 (2d
Cir.1995), there were sufficient other sources of financial motive that make the
absence of such evidence less important here.

47

Our conclusion that Aldridge's section 10(b) and Rule 10b-5 claim survives a
motion to dismiss is only that. The defendants may yet prevail once the facts of
the case are further developed.5
C. Section 20(a) Claim

48

The district court's dismissal of the section 20(a) claim was derivative of its
dismissal of the section 10(b) claim. See Suna v. Bailey Corp., 107 F.3d 64, 72
(1st Cir.1997). Because there must be a primary violation for liability under
section 20(a), the district court did not independently evaluate whether the
claim otherwise failed. Nonetheless, we "may affirm a district court's judgment
on any grounds supported by the record." Greenless v. Almond, 277 F.3d 601,
605 (1st Cir.2002).

49

As to the trust defendants only, the matter is plain enough to affirm the
dismissal of the section 20(a) claim against them. Section 20(a) provides:

50

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

51

15 U.S.C. 78t(a) (2000).

52

The trust defendants argue that this court should adopt a three part test for
controlling person liability, under which the plaintiff must allege and prove: (1)
an underlying violation by a controlled person or entity; (2) the defendants
control the violator; and (3) the defendants are in a meaningful sense culpable
participants in the fraud in question. See SEC v. First Jersey Secs. Inc., 101
F.3d 1450, 1472 (2d Cir.1996). They correctly described a split among the
circuits on whether an element of section 20(a) liability is "culpable
participation."6 We do not reach that question, but rest on the "control" element.

53

To meet the control element, the alleged controlling person must not only have
the general power to control the company, but must also actually exercise
control over the company. See Sheinkopf v. Stone, 927 F.2d 1259, 1270 (1st
Cir.1991) ("For [the defendant] to be liable ... there must be `significantly
probative' evidence that the [defendant] exercised, directly or indirectly,
meaningful hegemony over the... venture....") (internal citation omitted); see
also Harrison v. Dean Witter Reynolds, Inc., 974 F.2d 873, 880-881 (7th
Cir.1992) (describing a similar requirement). In this case, the trust defendants
have the power to elect two-thirds of the directors. But they have no direct
control over the management and operations of the company. At most the
evidence pled is that the trust defendants are controlling shareholders. This
indicates some potential ability to control. In the absence of some indicia of the
exercise of control over the entity primarily liable, however, that status alone is
not enough. Although controlling shareholders own the majority of the shares
in a company, they, like any other shareholders, should have the ability to be
passive, leaving the management to the directors and officers. See L. Carson,
The Liability of Controlling Persons Under the Federal Securities Acts, 72
Notre Dame L.Rev. 263, 318-19 (1997). Unless there are facts that indicate that
the controlling shareholders were actively participating in the decisionmaking
processes of the corporation, no controlling person liability can be imposed. In
this case, no facts are pled permitting an inference that the trust defendants

actually exercised control over Cross.

III.
54

The case will be reinstated as to the company and the individual defendants.
The district court may wish to consider limiting discovery initially to key
issues. Nothing in this opinion, of course, predicts any outcome if a
postdiscovery summary judgment motion is filed or the matter goes to trial.
Where there is smoke, there is not always fire.

55

Accordingly, we reverse the dismissal of the section 10(b) claim and the
section 20(a) claim against the company and the individual defendants; we
affirm, on different grounds, the dismissal of the section 20(a) claim against the
trust defendants. No costs are awarded.

Notes:
1

The individual defendants were members of the Cross management team

during the class period: Bradford Boss, Chairman of Cross's board; Russell
Boss, President and CEO of Cross; John Buckley, Executive Vice President and
COO; and John T. Ruggieri, Senior Vice President and CFO. The trust
defendants are: the W. Russell Boss Jr. Trust A; the W. Russell Boss Jr. Trust
B; and the W. Russell Boss Jr. Trust C. For purposes of all but the section 20(a)
analysis, we refer to all of the defendants as the company

The statute provides, in relevant part:

(b) Requirements for securities fraud actions
(1) Misleading statements and omissions In any private action arising under this
chapter in which the plaintiff alleges that the defendant
(A) made an untrue statement of a material fact; or
(B) omitted to state a material fact necessary in order to make the statements
made, in the light of the circumstances in which they were made, not
misleading;
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 on which that belief is formed.
(2) Required state of mind In any private action arising under this chapter 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)(1)-(2).
3

At oral argument Cross argued that Mullins, the Director of Marketing, lacked
authority to make admissionsSee Fed.R.Evid. 801(d)(2). That seems
improbable; but we need not decide it as an evidentiary matter as we take
inferences in the plaintiff's favor, and there is a strong inference that a Director
of Marketing had authority to make such statements.

Aldridge could have buttressed his case by obtaining information, if available

absent discovery, from Cross's customers on the price protection and take back
allegations. In another case the failure to make that effort might prove fatal.
Here it is not

We leave to the district court on remand Aldridge's argument that there is a

sub-class of the 1999 investors

Whether culpable participation is a required element of liability under section

20(a) has generated a great deal of discussionCompare First Jersey Secs., 101
F.3d at 1472-73 (applying such a requirement), with Hollinger v. Titan Capital
Corp., 914 F.2d 1564, 1575 (9th Cir.1990) (en banc) (rejecting such a
requirement); see generally 3C H. Bloomenthal & S. Wolff, Securities and
Federal Corporate Law 14.9 (2d ed.1999) (discussing the culpable
participant requirement).