CROWELL v. IONICS

343 F.Supp.2d 1 (2004) | Cited 8 times | D. Massachusetts | November 3, 2004

MEMORANDUM

This case involves a federal securities law class action onbehalf of all individuals who purchased or acquired the commonstock of Ionics, Inc. ("Ionics") between October 25, 2001, andMarch 14, 2003 (inclusively, the "Class Period"), and weredamaged by allegedly materially false or misleading statementsthat Ionics made regarding its financial situation andoperations. Am. Compl. ¶ 9 [Doc. No. 12]. The lead plaintiff,John L. Crowell1 ("Crowell"), seeks certification of theclass and, ultimately, damages. Ionics, along with the defendants Arthur L. Goldstein ("Goldstein") and Daniel M. Kuzmak ("Kuzmak")(collectively, "Ionics Defendants"), move to dismiss underFederal Rule of Civil Procedure 12(b)(6), partly on standinggrounds, but primarily attacking the legal sufficiency ofCrowell's complaint, particularly in light of the heightenedpleading requirements under the federal securities laws and underFederal Rule of Civil Procedure 9(b). After a hearing on February24, 2004, the Court denied the Ionics Defendants' Motion ToDismiss from the bench. This memorandum explains the reasonsbehind the Court's decision.

I. INTRODUCTION

A. Facts

The Court takes the facts alleged in Crowell's Complaint astrue in considering the Ionics Defendants' Motion to Dismiss.Crowell has attributed the facts alleged to witness or documentsources, as this Court has required. Given the heightenedpleading requirements in securities fraud cases, the facts mustbe described in some detail.

1. The Parties

Crowell allegedly purchased Ionics common stock during theClass Period at artificially inflated prices, and was damagedthereby. Am. Compl. ¶ 6. Ionics is a Massachusetts corporationwith its principal place of business in Watertown, Massachusetts.Id. ¶ 7. Goldstein was at all relevant times Ionics' Chairmanand Chief Executive Officer. Id. ¶ 8(a). Kuzmak was at all relevanttimes Ionics' Chief Financial Officer and Vice President. Id. ¶8(b). Crowell has adequately alleged facts suggesting that theclass action is an appropriate form for this litigation.

2. Ionics and its Operations

Ionics develops and manufactures systems and provides relatedservices for water treatment, and also produces desalination,water, and wastewater treatment systems and instruments. Id. ¶7. Most of its revenues come from long-term sales andconstruction-type contracts. Id. ¶ 15. According to Crowell,"[t]hese transactions are highly complex and require a highlyeffective system of internal controls and procedures, among otherthings, in order to properly recognize contract revenues andcosts in the Company's financial statements." Id.

Ionics manages its operations through four business groupsegments: the equipment business group ("EBG"), the ultrapurewater group ("UWG"), the consumer water group ("CWG"), and theinstrument business group ("IBG"). Id. ¶ 16. Within thesebusiness segments, Ionics has identified certain core product andmarket sectors, including water desalination/purificationequipment and facilities serving general industries andmunicipalities, and ultrapure water processing systems servicingprimarily the microelectronics and power industries. Id. In 2001, the EBG and the UWG accounted for roughly 67 percentof Ionics' revenues, and that percentage grew to approximately 80percent near the beginning of the Class Period, due to theDecember 2001 sale of the company's Aqua Cool Pure Bottled WaterOperations in the United States, the United Kingdom, and France("Aqua Cool"). Id. ¶ 17.2 In other words, the Aqua Coolassets accounted for over 16 percent of the company's 2001revenues, and comprised the major portion of Ionics' consumersegment revenues and assets both in the United States and abroad.Id. ¶ 18. "At all relevant times, therefore, the [Ionics]defendants were highly motivated to make it appear that EWG andUWG segments were operating profitably." Id.

In recent years, Ionics has increasingly implemented a "build,own, and operate" ("build-own-operate") strategy whereby thecompany constructs, owns, operates, and maintains waterdesalination and purification facilities, among other activities.Id. ¶ 19. During the Class Period, Ionics maintained orinitiated investments in at least seven foreign "affiliated"companies under the build-own-operate strategy, including GrupoEmpresarial de Mejoramiento Ambiental, S. de R.L. de C.V. —Mexico (the "EDF project") and Desalination Company of Trinidadand Tobago, Ltd. ("Desalcott" or the "Trinidad project"). Id.Ionics has a minority interest in each of the seven known foreign affiliates (50 percent or less), and so does not includeaffiliate financial statements in its consolidated financialstatements. Id.

Ionics conducts a substantial amount of its EBG businessthrough sales of equipment and construction services to companiesoutside the United States. Id. ¶ 20. In 2001, revenues of over$20 million resulted from such sales, but that number declined to$12 million in 2002.3 Id. Ionics primarily attributedthe decline to the completion of the Desalcott constructionproject in Trinidad. Id. Purportedly, where Ionics has a 20percent to 50 percent ownership interest in an affiliate, it usesequity basis accounting and makes certain profit eliminations ordeferrals on its sales to those affiliates. Id.

3. Ionics Reports Allegedly Artificially Inflated FinancialResults by Failing to Record Losses on Long-Term Contracts in thePeriod During Which They Were Incurred

On November 5, 2002, Ionics issued a press release announcingthat it was restating its financial results for the first twoquarters of fiscal year 2002. Id. ¶ 21. The announcement"stunned" the market. Id. Ionics reduced previously reportedincome by roughly $1,300,000, or over 31 percent, for the sixmonths ending June 30, 2002. Id. The company attributed the restatement to "intercompany transactionsbetween the Company and its French subsidiary that wereerroneously recorded at the subsidiary level." Id. (quotingIonics' press release).

The "intercompany transactions" were in fact unrecorded"project cost overruns," among other things, that Ionics incurredon the EDF project (in Mexico) prior to and during the first twoquarters of 2002, but failed to report in its consolidatedoperating results. Id. ¶ 22. At least $600,000 of the restatedcosts and expenses related to the EDF project. Id. ¶ 23. Formeremployees of Ionics France, a French subsidiary that was losingmoney at the time, state that when Ionics was closing the booksfor the first quarter of 2002, during April 2002, a dispute arosebetween Ionics' corporate controller, Anthony DiPaola, andcertain officers of Ionics France over the recording of$2,000,000 in EDF cost overruns, which Ionics (through Goldsteinand others) directed Ionics France to record. Id. ¶ 23-24.These and other losses (probably from Kuwait) that Ionics soughtto shift onto its European subsidiaries totaled an estimated$5,000,000 to $6,000,000. Id. ¶ 26. The Ionics France employeesrefused to place the costs on Ionics France's books, because thecosts related to Ionics' losses from its business segments inMexico and the United States; in other words those losses werenot attributable to Ionics France. Id. ¶ 23. Ionics France'sVice President was fired in April 2002 for refusing to follow Goldstein's orders, and the decision was allegedly made byGoldstein and Ed Cichon ("Cichon"), Ionics' Vice President andhead of the BEG. Id. ¶ 25.

Essentially, Ionics was seeking to shift losses from its ownbooks to those of a subsidiary. A former Ionics France employeehas stated that the motive for this was to reduce Ionics' taxliabilities arising from a $19,000,000 gain related to theDecember 2001 sale of Aqua Cool's France operations. Id. ¶ 26.Another former Ionics France employee stated that during thesecond quarter of 2002, Ionics attempted to falsify tax documentsprepared in connection with the Aqua Cool sale, stating theproceeds as a long-term profit rather than a short-term profitafter three years. Id.

Thus, as of at least April 2002, the Ionics Defendants knewthat Ionics France did not record the costs and expensesassociated with the EDF project cost overruns, among others,which the Ionics Defendants had ordered the French subsidiary'scontroller to record during 2002's first two quarters. Id. ¶27. According to Crowell, "Ionics has now restated its financialstatements for the first and second quarter of 2002, therebyadmitting that those financial statements were materially falseand misleading when issued." Id. ¶ 28.4 4. Ionics Allegedly Improperly Accounts for Long-Term ContractRevenues, Thereby Overstating its Financial Results

The aforementioned accounting improprieties were not the onlyones in which Ionics is alleged to have engaged. Crowell allegesthat during the Class Period, Ionics overstated revenues andprofits by millions of dollars by improperly accounting for costsand expenses associated with its long-term equipment andconstruction contracts. Id. ¶ 29. Ionics shifted "costoverruns" on certain long-term equipment sales contracts andconstruction projects from unprofitable projects where they wereactually incurred to other unrelated projects that could absorbthe costs and mask the losses. Id. ¶ 30. This action allowedIonics to continue to accrue contract revenues under thepercentage of completion accounting method using falsified costestimates (i.e., the estimates excluded the cost overruns). Id.

Under the "percentage of completion accounting method," Ionicsrecognizes revenues on its equipment sales contracts usingperiodic estimates of the ratio of costs incurred to date and the total estimated costs to complete the contract. Id. ¶ 31.Former Ionics employees state that the Ionics Defendantsroutinely approved falsification of cost estimates. Id. ¶ 32.All of Crowell's examples, however, come from before the ClassPeriod began.

For example, Kuzmak and other Ionics executives orderedcontract cost estimates falsified at Ionics' Bridgeville,Pennsylvania manufacturing facility, which allowed Ionics toaccrue sales revenues and profits on certain commercial andUnited States Navy nuclear programs that were actuallyunprofitable. Id. ¶ 32. At a January 2001 meeting to discuss"some accounting principles" at Ionics' Pittsburgh division(which owned the Bridgeville facility), Kuzmak stated "I want togo on the record stating it's not proper accounting — but it'snice to make money." Id. ¶ 33.

Similar practices occurred at Desalcott, which was building awater treatment facility. See id. ¶ 34. A former employee ofIonics' European operations stated that in the third quarter of2001, Ionics recognized revenues prematurely to "compensate"Ionics for losses it was incurring during the construction phaseof the Trinidad project. Id. Accounting rules only permittedIonics to record future revenues for cubic meters of water thathad been sold, but revenues were recorded before construction ofthe water treatment plant was even completed. Id. Ionics lacked the internal controls necessary properly toutilize percentage of completion accounting, and had no dedicatedinternal audit function. Id. ¶ 35. Rather, divisionalcontrollers performed "desk audits" to review cost estimates andother information developed by operations personnel, and thensent results to the corporate office. Id. Price WaterhouseCoopers, Ionics' independent auditor, relied on these reportswhen it conducted its periodic examination. Id.

Operational personnel had incentive to recognize revenueimproperly, as their performance ratings were based on the unit'sfinancial results. Id. A former controller in Ionics' Asiandivision, employed by Ionics between February 2001 and March2003, stated that whereas other companies he had worked forclosely examined estimates used to recognize revenue everyquarter, most of the time at Ionics the operations personnel'snumbers were not examined at all. Id. ¶ 35(a). A formercontroller of Ionics' Pittsburgh division stated that he knewthat Ionics overstated equipment contract revenues by $2,200,000in 1999, and that he told Di Paola and Bob Halliday, Ionics' vicepresident of finance, about it, but that neither executive evercorrected the misstatement. Id. ¶ 35(b).

5. Ionics Allegedly Misstates the 2001 Operating Results ofits Bottled Water Operations

On December 3, 2001, the second month of the Class Period,Ionics announced that it had entered into an agreement to sell Aqua Cool to Perrier-Vittel, S.A., a subsidiary of Nestle,S.A. (collectively "Nestle"). Id. ¶ 36. The agreement includedthe sale of operations in the United States, the United Kingdom,and France to Aqua Cool for $220,000,000, subject to certainprice adjustments. Id. The price of Ionics common stockappreciated over 12 percent after the announcement, closing at$30.99 on December 7, 2001, after several days of heavy trading.Id. ¶ 37.

Ionics allegedly had schemed to inflate Aqua Cool's productsales and customer base artificially in the period immediatelypreceding the Nestle acquisition in order to facilitate the saleand to meet or exceed certain financial performance criteria setout in the sales agreement with Nestle. Id. ¶ 38. Inparticular, the Ionics Defendants ordered Aqua Cool's sales forceto deliver hundreds of thousands of unordered and unwantedbottled water products to Aqua Cool's retail customers, one extrabottle per customer. Id. ¶ 39. If the customer complained, theywere told the extra bottle was free; otherwise, the customer wascharged the ordinary price. Id. ¶ 39(b). Drivers were paid $1per extra bottle delivered, as drivers ordinarily would notdeliver merchandise not listed on the invoice. Id. Revenueswere inflated by millions of dollars, and the number of "active"Aqua Cool customers was significantly overstated. Id. ¶ 40.

In December 2001, Ionics reported "a $112,000,000 gain from theAqua Cool sale, . . . less certain reserves for possible price adjustments as per the sales agreement with Nestle." Id.In the fourth quarter of 2002, Ionics announced a settlement ofthe price adjustments with Nestle that reduced the Aqua Cool saleprice to $207,000,000, $13,000,000 less than the initiallyreported price. Id. The artificial inflation of revenues andsales probably explains most of the discrepancy. See id. ¶41.

6. Ionics Allegedly Fails to Disclose Deficiencies in itsSystem of Internal Controls

Throughout the Class Period, Ionics represented that its"critical accounting policies" were being administered through afunctioning system of internal controls. Id. ¶ 42. In its 200110-K form, filed with the SEC, Ionics stated: The Company closely monitors compliance and consistency of application of its critical accounting policies related to contract accounting. In addition, reviews of the status of contracts are performed through periodic contract status and performance reviews. In all cases, changes to total estimated costs and anticipated losses, if any, are recognized in the period in which determined.Id. Ionics' internal controls were in fact materiallydeficient. Id. ¶ 43. In a press release issued on March 14,2003, and shortly thereafter in a 10-K Form released on March 31,2003, the Ionics Defendants admitted that in connection with theaudit of its 2002 financial statements, Ionics' independentauditor informed the Company "that certain of its internalcontrols had deficiencies and material weaknesses." Id.(quoting Ionics' 2002 10-K Form).5 The release and the 10-K Form also revealedthat Ionics had been taking numerous steps to correct knownweaknesses in the accounting system throughout 2002. See id.¶ 44 (providing an extensive quotation from Ionics' 2002 10-KForm).

7. Ionics' Allegedly False and Misleading Statements IssuedDuring the Class Period

In general, Crowell describes period press releases and publicfilings (particularly 10-K and 10-Q Forms) that he alleges makematerially false and misleading statements. Each of the 10-Qforms contains representations that "[i]n the opinion of themanagement of the Company, all adjustments have been made thatare necessary for a fair statement of the consolidated financialposition of the Company, the consolidated results of itsoperations and the consolidated cash flows for each periodpresented." See, e.g., id. ¶ 56.

On October 25, 2001, the beginning of the Class Period, Ionicsannounced its financial results for the third quarter and ninemonths ended September 30, 2001. Id. ¶ 45. In its pressrelease, Ionics reported revenues of $118,300,000, net income of$4,200,000, and earnings per share of $0.24, as compared to$124,900,000, $2,900,000 and $0.18, respectively, from the thirdquarter in 2000. Id. For the first nine months of 2001,revenues were stated as $354,900,000, net income as $11,400,000, and earnings per share as $0.66, whereas the figures for thefirst nine months of 2000 were $330,500,000, $10,700,000, and$0.65, respectively. Id. In the press release, Goldstein statedthat "our water supply and service businesses have continued toremain stable and predictable and provided a substantial portionof the profits generated by the Company in the third quarter."Id.

On November 13, 2001, Ionics filed its quarterly report on Form10-Q for the third quarter and nine months ended September 30,2001, signed by Goldstein and Kuzmak. Id. ¶ 46. The 10-Qincorporated Ionics' previously issued financial results, andstated that the substantial revenue growth since the previousyear was attributable "to continued growth in both the bottledwater business, primarily in the United Kingdom, and home waterbusiness." Id. (quoting Ionics' November 13, 2001 10-Q Form).

In the December 3, 2001 press release regarding the sale ofAqua Cool to Nestle, Goldstein stated that Aqua Cool was"currently generating revenues of over $70 million per year."Id. ¶ 47 (quoting the press release). Heavy trading in Ionicscommon stock followed, leading to a 12 percent appreciation byDecember 7, 2001, and closing at $30.99 on that day. Id. ¶ 48.

On January 15, 2002, Ionics filed with the SEC on Form 8-K the"Master Agreement" governing the sale of Aqua Cool to Nestle.Id. ¶ 49. Under the agreement, the sales price of the Aqua Cooloperations was subject to adjustment based on, inter alia, the number of active customer accounts at the date of transfer. Id.Within 180 days after closing, Nestle and Ionics would each makean independent determination as to which equipment customersqualified as "active customers," and Ionics would then have 90days to accept Nestle's determination or to describe in detailany disagreement that might justify an adjustment of Nestle'sestimate. See id. (providing an extensive quotation from theMaster Agreement). Any unresolvable disputes would be submittedto an international accounting firm for resolution. Id.

In a March 7, 2002 press release, Ionics announced financialresults for the fourth quarter and fiscal year ending December31, 2001. Id. ¶ 50. Ionics reported $111,800,000 in revenues,$33,300,000 in net income, and $1.90 in earnings per share forthe fourth quarter, as compared to $144,100,000, negative$12,600,000, and negative $0.77 per share, respectively, in theprevious year's fourth quarter. Id. It also reported resultsfor the year: revenues of $466,700,000 (including Aqua Coolrevenues of roughly $76,200,000), net income of $44,700,000, and$2.59 in earnings per share, as compared to negative $1,900,000,and negative $0.12, respectively, for the previous year. Id.The release stated that "[n]et income for the fourth quarterincludes a one-time, non-operating gain of $3.57 per share on the[Aqua Cool sale], as well as one-time and unusual costs whichreduced operating income by $1.68 per share." Id. (quoting therelease). Further, the "one-time and unusual costs" included "losses in the Consumer Water Group which occurred primarily inconjunction with the Aqua Cool business being readied for sale."Id. (quoting the release).

Goldstein stated in the release that "corporate bookings wereat a near record level in the fourth quarter and that backlogreached $258.9 million, an increase of $38.9 million during thequarter." Id. (quoting the release). He further stated thatIonics' portion of a facility to be built in Kuwait inconjunction with the award of a large water reuse concessioncontract was not yet included in bookings of the year-endbacklog. Id.

On March 29, 2002, Ionics filed its Annual Report on Form 10-Kfor the fiscal year ended December 31, 2001, signed by Goldsteinand Kuzmak, which confirmed the announcements in the March 7,2002 press release. Id. ¶ 51. It related that Ionics had soldAqua Cool for $220,000,000, of which $10,000,000 was being heldin escrow pursuant to the terms of the divestiture agreement, andthat Aqua Cool had had sales of $76,200,000 in 2001. Id.

According to Crowell, each of the statements described abovewas materially false and misleading, because each misrepresentedor failed to disclose the following facts: (1) that Aqua Cool'sreported $76,200,000 in sales was overstated by tens of millionsof dollars as a result of Ionics' improper sales practices; (2)that Ionics' revenues accrued under the "percentage of completion accounting method" were materially overstated because of thefalsification of contract cost estimates; (3) that this in turnrendered Ionics' reported financial results materiallyoverstated; (4) that Ionics' financial statements were notprepared in accordance with Generally Accepted AccountingPrinciples ("GAAP"), and were therefore materially false andmisleading; and (5) that Ionics' system of internal controls wasmaterially deficient, resulting in an inability of Ionics toascertain its true operating results and financial condition.Id. ¶ 52.

On May 6, 2002, Ionics issued a press release announcingfinancial results for the first quarter of 2002, which endedMarch 31, 2002. Id. ¶ 53. Revenues were stated as $80,300,000,net income as $1,900,000, and earnings per share as $0.11, ascompared to $123,000,000, $3,000,000, and $0.18 per share,respectively, in the previous year's first quarter. Id.Goldstein stated that the results reflected continuing costs fromIonics' Malaysian business, the planned divestiture of which wassupposed to take place during the second quarter, and fromcertain continuing restructuring costs associated with the AquaCool sale. Id.

On May 15, 2002, Ionics filed its Form 10-Q for the firstquarter of 2002, signed by Goldstein and Kuzmak, which confirmedthe results in the press release. Id. ¶ 54. It stated thatEBG's revenues had decreased by 14.9 percent as compared to the first quarter of the previous year ($38,300,000 as compared to$45,000,000), and said that "[t]his decrease was primarilyattributable to lower capital equipment revenues, reflecting thewind-down of the construction phase of the Trinidad desalinationproject." Id. (quoting Ionics' May 15, 2002 Form 10-Q).

On August 1, 2002, Ionics issued a press release, followed by aForm 10-Q on August 14, 2002 (signed by Goldstein and Kuzmak),stating financial results for the second quarter of 2002, theperiod ending June 30, 2002. Id. ¶¶ 55-56. Revenues were statedas $79,300,000, net income as $2,100,000, and earnings per shareas $0.12, as compared to $113,700,000, $4,200,000, and $0.24 pershare, respectively, in the second quarter of the previous year.Id. ¶ 55. The Form 10-Q made statements about the revenues ofEBG and UWG, Ionics' two largest operating segments. Id. ¶ 56.It stated that EBG's revenues during the second quarter of 2002($38,600,000) had fallen 16.3% from the $46,200,000 figure forthe second quarter of 2001, and that the $76,900,000 in revenuessince the beginning of 2002 represented a 15.6% decline from the$91,100,000 figure for the first six months of 2001. Id. UWGrevenues for the second quarter of 2002 ($25,200,000) decreasedby $5,600,000, or 18.3%, from the previous year's second quarter,and the $50,200,000 in revenues for the first six months of 2002constituted a decrease of $21,400,000, or 29.9%, from the figurefor the first six months of 2001. Id. The fall in UWG revenueswas attributed to "continued softness in the microelectronics industry,particularly with respect to domestic capital equipment sales."Id. (quoting Ionics' August 14, 2002 10-Q Form).

Crowell argues that the statements described from May 6, 2002onward were materially false and misleading, for the reasonsdiscussed above. Id. ¶ 57. To the unreported or distorted factsallegedly rendering Ionics' statements materially false andmisleading, Crowell adds the following: (1) that Ionics'operating results were materially overstated, given Ionics'failure to reflect project cost overruns related to the EDFproject in the company's consolidated financial results, and (2)that Ionics' financial statements for the first two quarters of2002 were not prepared in accordance with GAAP and were thusmaterially false and misleading. Id.

On November 5, 2002, Ionics "shocked the market" (Crowell'swords) by announcing in a press release that it would berestating its financial results for the first two quarters of2002, "primarily as a result of intercompany transactions betweenthe Company and its French subsidiary that were erroneouslyrecorded at the subsidiary level." Id. ¶ 58 (quoting theNovember 5, 2002 press release). Revenues for the first andsecond quarters were revised from $80,300,000 and $79,300,000,respectively, to $80,000,000 and $79,700,000, respectively. Id.Net income for the first and second quarters was revised from $1,900,000 and $2,100,000, respectively, to $1,500,000 and$1,200,000, respectively (a total restatement of $1,300,000, asdescribed above). Id. Earnings per share for the first andsecond quarters was revised from $0.11 and $0.12, respectively,to $0.08 and $0.07, respectively. Id.

Ionics also reported its financial results for the thirdquarter of 2002, including a large loss associated with itsoperations in France. Id. As a result of these losses, Ionicsannounced that it would "downsize, discontinue and consolidatevarious operations of its French subsidiary." Id. (quoting theNovember 5, 2002 press release). Goldstein stated that: [W]hile Ionics' management was disappointed by the need to adjust Q1 and Q2 2002 results primarily due to the issues relating to its French subsidiary, and the need to take unexpected downsizing and cost reduction actions at that subsidiary, management was encouraged by the record backlog which was achieved during an uncertain and difficult economic period worldwide.Id. (quoting the press release).

Immediately following the issuance of the third quarterresults, Goldstein, Kuzmak, and other Ionics officials held aconference call with analysts to review those results. Id. ¶59. Goldstein stated that "the issues in France that we'retalking about were discovered less than two weeks ago." Id.(quoting a transcript of the call, published by the FairDisclosure Wire). Later, he said that "[w]hat we discoveredourselves and what we communicated to our outside auditors — theydidn't discover this, we did — were two improper, inaccuraterecordings of what essentially was a single inter-company [transaction] which wasdone by the Controller at our French subsidiary." Id. (quotingthe transcript). In addition he stated that "to a significantdegree, the problem we had in France before we recognized theinter-company transactions issue masked the operating problemthat we had there and pushed the resolution of staffing andoverhead reduction issues . . . from the end of Q2, when weshould have discovered it, to the end of Q3." Id. (quoting thetranscript).

Following the November 5, 2002 announcement, shares of Ionicsfell $5.01 per share, on volume of over 1,700,000 shares traded,almost thirty times the average daily volume. Id. ¶ 61.

8. Statements at the End of the Class Period, and LaterDevelopments

On March 14, 2003, at the end of the Class Period, Ionicsissued a press release announcing financial results for thefourth quarter of 2002 and for the twelve months ending onDecember 31, 2002. Id. ¶ 62. Ionics reported a $0.11 per shareloss for the fourth quarter, excluding final price-adjustmentgains on the Aqua Cool sale of $0.21 per share. Id. Ionics'operating loss for the fourth quarter reflected an increase of$2,400,000, or $0.06 per share, in Ionics' reserve for doubtfulaccounts and "higher than normal legal and accounting" costs of$0.04 per share. Id. Shortly after the announcement, the priceof Ionics common stock fell roughly five percent to close at $16.70 on March 14, 2003, in heavy trading of 1,200,000 shares(similar in order of magnitude to the 1,700,000 shares traded onNovember 5, 2002). Id. ¶ 63.

On March 31, 2003, Ionics filed its annual report on Form 10-Kfor the fiscal year ended December 31, 2002. Id. ¶ 64. Again,this 10-K Report revealed that Ionics' independent auditor hadadvised it "that certain of its internal controls haddeficiencies and material weaknesses." Id. (quoting the March31, 2003 10-K Form). One of the steps Ionics said it was takingwas "to evaluate and strengthen its financial and accountingstaff and their knowledge and understanding of key policies underU.S. generally accepted accounting principles and of theirresponsibilities." Id. (quoting the 10-K Form). The 10-K Formfor the first time described the nature of the transactions thatcaused Ionics to restate financial results from the first twoquarters of fiscal 2002. Id. ¶ 65. The transactions hadpreviously been described as "inter-company transactions thatwere erroneously recorded at the [French] subsidiary level," andit was now revealed that the transactions related to "projectcost overruns." Id. (alteration in original). With regard tothis, the Form 10-K stated that: These adjustments primarily affected accounting entries related to revenues from sales of spare parts and expenses related to project cost overruns, sales support cost and severance costs. These adjustments, which increased the historical pre-tax loss at the French subsidiary in the quarters ended March 31, 2002 and June 30, 2002 and the forecast of the French subsidiary's pre-tax losses for the year ended December 31, 2002.Id. (quoting the 10-K Form).

The 10-K Form also revealed that the final purchase priceadjustment settled between Ionics and Nestle reduced the sellingprice of Aqua Cool by roughly $13,000,000. Id. ¶ 66.

The parties agreed at oral argument that the pertinentinformation from the 10-K Form had been in the March 14, 2003press release as well, which was issued on the last day of theClass Period.

II. DISCUSSION

A. Jurisdiction and Venue

The Court has jurisdiction under 28 U.S.C. §§ 1331 and 1337,and under Section 27 of the Securities and Exchange Act of 1934("Exchange Act"), codified at 15 U.S.C. § 78aa, as the claims inthis action arise under and pursuant to Sections 10(b) and 20(a)of the Exchange Act, codified at 15 U.S.C. §§ 78j(b) and 78t(a),respectively, and Rule 10b-5, promulgated thereunder by theSecurities and Exchange Commission ("SEC"),17 C.F.R. § 240.10b-5. Crowell has adequately alleged that Ionics made use ofthe means and instrumentalities of interstate commerce incommitting the acts of which he complains. Venue is proper under15 U.S.C. § 78aa and under 28 U.S.C. § 1391(b).

B. Standard of Review In passing on a motion to dismiss under Rule 12(b)(6), theCourt must accept as true all well-pleaded allegations in thenonmovant's complaint, except in deciding certain jurisdictionalquestions not relevant here, and must draw all inferences infavor of the nonmovant. See, e.g., Cooperman v. Individual,Inc., 171 F.3d 43, 46 (1st Cir. 1999). Dismissal "is onlyappropriate if the complaint, so viewed, presents no set of factsjustifying recovery." Id. As the Court will explain, however,the heightened pleading standard that Federal Rule of CivilProcedure 9(b) applies to fraud allegations, in combination withthe strict requirements of the Private Securities LitigationReform Act of 1995 ("PSLRA"), Pub.L. No. 104-67, codified at15 U.S.C. § 78u-4, make it significantly more difficult forsecurities fraud plaintiffs to survive a motion to dismiss thanfor ordinary plaintiffs.

C. Relevant Legal Standards, Role of Rule 9(b)

To state a claim under Rule 10b-5, "a plaintiff must allegethat: (1) in connection with the purchase or sale of securities,(2) the defendant made a false statement or omitted a materialfact, (3) with the requisite scienter, and that (4) plaintiffrelied on the statement or omission, (5) with resultant injury."In re Boston Tech., Inc. Sec. Litig., 8 F. Supp. 2d 43, 52 (D.Mass. 1998) (Lasker, J.) (citing Gross v. Summa Four, Inc.,93 F.3d 987, 992 (1st Cir. 1996), and Shaw v. Digital Equip.Corp., 82 F.3d 1194, 1216-17 (1st Cir. 1996)). A misrepresentation oromission is material only if a reasonable investor would haveviewed it as "having significantly altered the total mix ofinformation made available." Basic, Inc. v. Levinson,485 U.S. 224, 231-32 (1988). As for scienter, the plaintiff mustplead "a mental state embracing [an] intent to deceive,manipulate, or defraud." Ernst & Ernst v. Hochfelder,425 U.S. 185, 193 n. 12 (1976).

Federal Rule of Civil Procedure 9(b) provides that "[i]n allaverments of fraud . . ., the circumstances constituting thefraud . . . shall be stated with particularity." The FirstCircuit is "especially strict in demanding adherence to Rule 9(b)in the securities context." Gross, 93 F.3d at 991.6Thus, "the complaint must set forth specific facts that make itreasonable to believe that the defendant knew a statement wasmaterially false or misleading. The rule requires that theparticular times, dates, places, or other details of the allegedfraudulent involvement of the actors be alleged." Id. As thisCourt has put it: "To survive a motion to dismiss, a complaintalleging fraud must specify: (1) the statements that theplaintiff contends were fraudulent; (2) the identity of thespeaker; (3) where and when the statements were made; (4) why thestatements were fraudulent." Fitzer v. Sec. Dynamics Tech., Inc.,119 F. Supp. 2d 12, 18 (D. Mass. 2000).

Allegations based on information and belief "must set forth thesource of the information and the reasons for the belief."Romani v. Shearson Lehman Hutton, 929 F.2d 875, 878 (1st Cir.1991). The allegations must create a "strong" inference offraudulent intent. Greebel v. FTP Software, Inc.,194 F.3d 185, 196-97 (1st Cir. 1999) (holding that the PSLRA requires a"strong" inference, rather than merely a "reasonable" one)."[E]xaggerated, vague, or loosely optimistic statements about acompany are not actionable under Rule 10b-5." In re BostonTech., 8 F. Supp. 2d at 54 (citing Gross, 93 F.3d at 995).

Scienter can be proved by showing either knowledge thatstatements in issue were materially false or misleading, orrecklessness in that regard, and the complaint must so plead.See Geffon v. Micrion Corp., 249 F.3d 29, 35 (1st Cir.2001); Greebel, 194 F.3d at 198-201. Mere negligence does notmeet the "recklessness" standard. Geffon, 249 F.3d at 35-36.Rather, what is required is "a highly unreasonable omission [orstatement], involving . . . an extreme departure from thestandards of ordinary care, and which presents a danger ofmisleading buyers or sellers that is either known to thedefendant or is so obvious the actor must have been aware of it."Greebel, 194 F.3d at 198 (quoting Sundstrand Corp. v. SunChem. Corp., 553 F.2d 1033, 1045 (7th Cir. 1977)). In making thescienter determination, courts consider the totality of thecircumstances, rather than examining each alleged omission ormisstatement in isolation. See In re Cabletron Sys., Inc.,311 F.3d 11, 40 (1st Cir. 2002); Friedberg v. Discreet LogicInc., 959 F. Supp. 42, 50-52 (D. Mass. 1997) (Harrington, J.)(superseded by statute on other grounds).

Should Crowell successfully make out a primary violation ofRule 10b-5, the parties do not dispute that he can make outcontrol person liability against Goldstein and Kuzmak underSection 20(a) of the Exchange Act. See, e.g., Gelfer v.Pegasystems, Inc., 96 F. Supp. 2d 10, 18 (D. Mass. 2000)(Tauro, J.).

D. The Merits of the Ionics Defendants' Arguments

1. Crowell Does Not Lack Standing

The Ionics Defendants note that the only transaction thatCrowell made with regard to Ionics common stock during the classperiod was a purchase on May 7, 2002. Defs.' Mem. at 19 [Doc. No.14]. They argue that he therefore lacks standing to challenge anyalleged misstatements made after that date, because any laterstatements "could not possibly have inflated" his purchase price.Id. (quoting Gross, 93 F.3d at 993) (internal quotation marksomitted); see also Shaw, 82 F.3d at 1222; Roots P'ship v.Land's End, Inc., 965 F.2d 1411, 1420 (7th Cir. 1992). It is true that one "cannot maintain an action on behalf ofclass members to redress an injury for which [one] has nostanding in [one's] own right. Gross, 93 F.3d at 993 (citingRoots, 965 F.2d at 1420 n. 6, and Britt v. McKenney,529 F.2d 44, 45 (1st Cir. 1976), cert. denied, 429 U.S. 854(1976)). Gross, however, involved a plaintiff who purchased hisstock before any allegedly false or misleading statements weremade, and is therefore distinguishable. See 93 F.3d at 993."Numerous courts have stated that class representatives do havestanding to assert claims under § 10(b) which arise fromstatements made after the class representative purchased sharesas long as the statements allegedly were made in furtherance of acommon scheme to defraud." Upton v. McKerrow,887 F. Supp. 1573, 1577 (N.D. Ga. 1995) (collecting cases); cf. Priest v.Zayre Corp., 118 F.R.D. 552, 557 (D. Mass. 1988) (Zobel, J.)(holding that differing purchase dates does not bar classcertification, if all purchases occurred during the course of acommon, fraudulent scheme); Kirby v. Cullinet Software, Inc.,116 F.R.D. 303, 311-12 (D. Mass. 1987) (Wolf, J.) (same).Otherwise, "only someone who bought on the last day of the ClassPeriod would be able to bring an action based on allegations suchas those in the complaint, either on her own behalf or on behalfof the entire class." Nicholas v. Poughkeepsie Sav. Bank/FSB,1990 U.S. Dist. LEXIS 12677, at *15 (S.D.N.Y. Sept. 17, 1990)(citing cases). Here, Crowell alleges a common scheme to defraud,which involved numerous alleged wrongful actions and statements that took place before hispurchase.

This Court has previously suggested that it might not join withthe courts that grant a lead plaintiff standing to representclaimants injured by statements that took place after hispurchase, when those misstatements are part of a common,fraudulent scheme that began before the plaintiff's transactionsoccurred. See Abato v. Marcam Corp., 162 F.R.D. 8, 10-11(D. Mass. 1995). The Court correctly stated that cases dealingwith whether plaintiffs like Crowell meet, say, the typicalityrequirement for class certification, are not necessarily on pointfor standing determinations. The Court is, however, persuadedthat cases like Upton, which apply a "common course of conduct"analysis to standing questions, are better reasoned than casesthat require the lead plaintiff to have purchased on the last dayof the class period.

In many ways, a "common course of conduct" test is moreappropriate in the standing inquiry than in the certificationinquiry. The certification inquiry and the standing inquiry havesome overlap, insofar as they seek to ensure that issues will bepresented effectively to the court, and in that zone, theargument for a "common course" approach is equally strong foreach inquiry. The certification inquiry adds to this commonground an element of concern for the rights of all classmembers who may be bound by a class action judgment (although this isperhaps present to a lesser degree in the standing inquiry), andthis element weighs against using "common course" analysis,although not enough to prevent courts from adopting it. Standing,on the other hand, adds a concern about separation of powers, anidea that courts should not reach out and decide cases notproperly before them. See 1 Laurence H. Tribe, AmericanConstitutional Law § 3-14, at 387-91 (3d ed. 2000) (summarizingand critiquing Supreme Court case law that evinces an increasingemphasis on separation of powers concepts in deciding standingquestions). That concern is obviated if there is any oneplaintiff before the court raising the claim in question; onceone plaintiff in a case has standing, courts typically do notinquire whether other plaintiffs do. E.g., Clinton v. Cityof New York, 524 U.S. 417, 431 n. 19 (1998) (citing Bowsher v.Synar, 478 U.S. 714, 721 (1986). To obviate the specialconcerns raised in the certification inquiry, one would have tobring all the later purchasers before the court. To obviate thespecial concerns raised in the standing inquiry, one would onlyhave to bring one such purchaser before the court. It thereforeseems that, as long as there is some indication that laterpurchasers in fact exist, as there invariably will be, a "commoncourse" analysis is entirely appropriate in the standing context.

2. Crowell Has Adequately Alleged Scienter As discussed above, the First Circuit applies a strict standardfor plaintiffs pleading scienter. Contrary to the IonicsDefendants' claim, however, Crowell has met that standard.

a. The Absence of Insider Trading Does Not Preclude anInference of Scienter

The Ionics Defendants correctly point out that Crowell nowherealleges that Goldstein, Kuzmak, or any other Ionics official soldany stock during the Class Period. Defs.' Mem. at 4. The absenceof insider trading does weaken a case for scienter. See In reSunterra Sec. Litig., 199 F. Supp. 2d 1308, 1326 (M.D. Fla.2002); In re N. Telecom Ltd. Sec. Litig., 116 F. Supp. 2d 446,462 (S.D.N.Y. 2000); In re Segue Software Sec., Inc. Litig.,106 F. Supp. 2d 161, 171 & n. 23 (D. Mass. 2000) (Stearns, J.);Kalnit v. Eichler, 99 F. Supp. 2d 327, 337 (S.D.N.Y. 2000).

Further, the Ionics Defendants argue that SEC filings show thatGoldstein's holding of Ionics stock actually lost almost$2,200,000 in value during the class period. Defs.' Mem. at 4(referencing the SEC filings). If true, this would make the casefor scienter even more difficult, at least under a "knowledge"theory. See Coates v. Heartland Wireless Communications,Inc., 26 F. Supp. 2d 910, 920 (N.D. Tex. 1998) ("[T]he notionthat [the defendant] would engage in fraud and then wait for thestock price to plummet before selling his securities withoutbenefitting from the fraud is a `non-sensical premise.'"); see also Maldonado v. Dominguez, 137 F.3d 1, 12 n. 9 (1st Cir.1998); In re PetSmart, Inc. Sec. Litig., 61 F. Supp. 2d 982,1000 (D. Ariz. 1999). The submitted filings do not, however,conclusively establish that Goldstein engaged in no stock tradingduring the Class Period.7 Thus, the best the IonicsDefendants can say at the motion to dismiss stage is that thereis no allegation that any of them profited from stock tradingduring the Class Period.

Even if none of the Ionics Defendants profited from stocktrades during the Class Period, that does not establish that theylacked any motive to mislead the investing public, and arecklessness argument by definition would not require a motive inany event. First, the absence of stock trading profit does not establish the absence of a scheme to profit through insidertrading. It only establishes the absence of a successful scheme.The Ionics Defendants could have commenced a fraudulent scheme,in hopes of profiting from insider trading, but simply havewaited too long to sell, such that by the time it became apparentthat full disclosure would be necessary, massive trades wouldexpose them to potential criminal liability.

Second, the alleged fraudulent scheme could well producenumerous benefits for each of the Ionics Defendants. Each elementof the scheme potentially increases Ionics' profits, stock price,or both. Anything that benefits Ionics in turn benefits Goldsteinand Kuzmak; presumably their continued employment, and probablyto some extent their compensation, is largely tied to thecompany's performance, as measured by profits, stock price, andother indicia. The artificial inflation of Aqua Cool's sales andcustomer base would benefit Ionics by potentially giving it ahigher sales price for the Aqua Cool unit. Similarly, shiftinglosses to Ionics' France operations benefitted Ionics byartificially inflating the profitability of its North Americanoperations, and by decreasing the tax liability of Ionics France,Ionics' subsidiary. Fraudulent accounting would similarlyartificially inflate the profitability of Ionics' operations, andfailure to maintain adequate internal controls would make iteasier to maintain the fraud and would increase profits bycutting costs that ought not be cut. Of course, none of the benefits of these actions could berealized unless the Ionics Defendants repeatedly made materialmisrepresentations and omissions to the investing public.

Crowell does not appear to allege any profit by the IonicsDefendants from stock trading during the Class Period, but headequately alleges that they had pecuniary motives for each ofthe wrongful actions alleged.8

b. Crowell Alleges Sufficient Facts To Support an Inferencethat the Ionics Defendants Knew the Alleged Misstatements WereMaterially False When Made9

The Ionics Defendants challenge each class of allegedmisstatements individually. Crowell successfully parries everythrust, and could survive the motion to dismiss, even if theCourt only examined each allegation in isolation from the others.Crowell provides evidence in the form of particularizedallegations by knowledgeable former employees, which "add to the inference of scienter." See, e.g., In re Lernout & HauspieSec. Litig., 208 F. Supp. 2d 74, 87 (D. Mass. 2002) (Saris, J.)(citing cases).

Crowell's case becomes even stronger, however, when theallegations are considered together. The way in which theallegedly fraudulent acts fit together and reinforce one anotherstrongly suggests a conscious course of conduct. Fraudulentcontract accounting, failure to maintain adequate internalcontrols, and shifting of Ionics' costs between differententities (or failing to report such costs at all) all combine toinflate Ionics' profits artificially. Such artificial inflationwould make the artificial inflation of Aqua Cool's sales andcustomer base more believable to Nestle. The tax impact ofprofits from this inflated sale price is then dampened by theshifting of the EDF Project's costs onto Ionics France. Thisshift in turn further inflates Ionics' appearance of financialstrength. None of the allegedly fraudulent acts could beeffective without repeated misstatements to the investing public.

(1) France/Restatement Allegations

The Ionics Defendants correctly note that standing alone, thefact that Ionics restated its results does not support a stronginference of scienter. See In re Peritus Software Servs.,Inc., 52 F. Supp. 2d 211, 224 (D. Mass. 1999); accord Chillv. Gen. Elec. Co., 101 F.3d 263, 270-71 (2d Cir. 1996)."Instead, the Court must ask whether the GAAP violations, combined withother circumstances indicative of fraudulent intent, raise astrong inference that defendants knowingly or recklessly misledinvestors." In re Peritus, 52 F. Supp. 2d at 224. Thus, thoughby no means conclusive, violations of GAAP and of a corporation'sown corporate revenue recognition policies are obviouslyprobative of scienter. See, e.g., Aldridge v. A.T. CrossCorp., 284 F.3d 72, 83 (1st Cir. 2002); Geffon, 249 F.3d at 36(noting that "accounting shenanigans" are probative of scienter);In re Raytheon Sec. Litig., 157 F. Supp. 2d 131, 148 (D. Mass.2001) (Saris, J.) (similar); Chalverus v. Pegasystems, Inc.,59 F. Supp. 2d 226, 235 (D. Mass. 1999) (noting that GAAPviolations combined with other circumstances, including company'sviolation of own revenue recognition policy, may raise a stronginference of scienter); Van de Velde v. Coopers & Lybrand,899 F. Supp. 731, 735-37 (D. Mass. 1995) (Saris, J.) (holdingthat an auditor's knowledge that a company violated its owninternal policies is sufficient to plead scienter).

The Ionics Defendants characterize what happened as a disputeabout "where within the Ionics corporate structure amounts wouldbe recorded." Defs.' Mem. at 5. According to the IonicsDefendants, Ionics directed its French subsidiary to recordcertain losses, and there is no evidence that the IonicsDefendants knew of any failure by the French subsidiary to do so. Id. at 6.10 They note that Ionics publishes itsfinancial statements on a consolidated basis, and argue thatwhichever subsidiary absorbed the losses, those losses wouldstill appear on the financial statement. See id. at 5-6. AsCrowell explained at oral argument, however, differentallocations of losses among entities on a consolidated financialstatement do not necessarily produce identical results when usingpercentage of completion accounting. This is true even assumingthat different allocations do not affect tax liability.

In any case, Crowell's complaint adequately alleges thatsomething sinister was going on. It is improper to place losseson a subsidiary's books that clearly belong either to the parentor to another entity; Crowell thus alleges something more than agood-faith dispute. Moreover, Crowell alleges not merely thatIonics reported cost overruns in the wrong place, but that itultimately did not report them at all. Pl.'s Mem. at 12 [Doc. No.17]. Even were this not so, Crowell's allegations about the taxconsequences of misallocating cost overruns render specious theIonics Defendants' argument that "it was all consolidated anyway"; because a later reallocation of those overruns wouldpresumably increase Ionics France's tax liability for thatearlier year, Ionics' original accounting choices overstatedconsolidated profits, possibly by a significant amount. As forknowledge, Crowell adequately alleges that Goldstein ordered theaccounting manipulations, and as Crowell correctly points out,the Court can infer that Kuzmak, as Ionics' CFO, and Goldstein,as Ionics' CEO, knew or should have known of Ionics' practices inthis regard, because their positions gave them unfettered accessto internal undisclosed adverse information. See MarksmanPartners, L.P. v. Chantal Pharm. Corp., 927 F. Supp. 1297,1313-14 (C.D. Cal. 1996); see also Cosmas v. Hassett,886 F.2d 8, 13 (2d Cir. 1989).

The Ionics Defendants next argue that certain facts are"incompatible with scienter." Defs.' Mem. at 7. The first fact isthe "minuscule amounts of revenues and expenses moved from onequarter to another as a result of the restatement." Id. Inparticular, according to the Ionics Defendants, "[t]he revenuesaffected by the restatement ($160,000) constituted less than0.01% of [Ionics'] annual revenues for fiscal 2002 (over $335million)," and "[t]he expenses affected ($1.1 million)constituted only about 0.3% of [Ionics'] 2002 annual expenses(about $338 million)." Defs.' Mem. at 1.

The focus on revenue, an old chestnut that securities frauddefendants frequently try on judges and juries, is entirely specious. What matters most to investors is income, not revenues,and the restatement led to a downward revision of income for thefirst two quarters of that year from a total of $4,000,000 to atotal of $2,700,000.11 See Defs.' App. Ex. 7 (copy ofthe November 5, 2002 press release). This constitutes a 32.5percent downward revision, hardly "minuscule."

To bolster their argument that the restatement was a minorevent, the Ionics Defendants argue that the stock price declinedonly "modestly" on the day the restatement was announced, andthat it "rebounded immediately and within less than a week wastrading at its pre-restatement level." Defs.' Mem. at 1; Defs.'App. Ex. 1. Assuming arguendo that the Court can take judicialnotice of the stock price chart that Ionics provides, the $5 dropthat the common stock price experienced on that day (from $24.47to $19.46) represented 20 percent of the stock's value, hardly"modest." See Defs.' App. Ex. 1. The Ionics Defendants' graphof Ionics' common stock price between June 2001 and June 2003shows that the November 5 drop was the most precipitous one-daydrop in that entire period. See id. Moreover, based on thestock price chart, the stock price did not "rebound immediately,"and certainly did not do so "within less than a week." Rather,although the stock price did recover, there was only one day between the restatement announcement and June 12, 2003 (the lastdate on the stock chart) where the stock price closed at or aboveits pre-restatement price: December 16, 2002. Id. Admittedly,the November 4, 2002 closing price was itself a local peak,perhaps in anticipation of the November 5, 2002 announcement.Still, for the two or three weeks prior to the announcement, thestock price was consistently closing at over $22, and the stockprice did not close at that level again after the announcementuntil November 25, 2002 — three weeks later, not "less than aweek." Id.

The Ionics Defendants also claim that Crowell credits Ionics'statement that Ionics itself had discovered the erroneousintercompany entries made by the French controller, and haditself brought these entries to its outside auditors' attention.Defs.' Mem. at 7. If Crowell accepted such a statement, it mightbe inconsistent with scienter, but Crowell does no such thing.

(2) Aqua Cool Allegations

The Ionics Defendants argue that Crowell at most alleges thatIonics' manipulations regarding Aqua Cool only sought to deceiveNestle, not the investing public. Defs.' Mem. at 8. Crowell'sresponse refutes this allegation. Figures based on the allegedartificial inflation of Aqua Cool's sales, which allegedlyviolated GAAP and Ionics' internal accounting policies, werereported to the investing public, who then purchased Ionics stock at an artificially inflated price. Pl.'s Mem. at 14. Whileit is possible that artificial inflation of Ionics' stock pricewas merely an unintended consequence of deceiving Nestle, it isequally plausible that such inflation, which would increaseIonics' market capital and access to capital and maintain anappearance that Goldstein and Kuzmak were performing better thanthey actually were, was an intended consequence.

The Ionics Defendants further argue that Crowell's sources, aformer "customer service and accounts receivable clerk at [the]Baltimore D.C. Aqua Cool division from April 1999 to December2001 and a former operations manager at the Boston office of AquaCool from July 2001 to February 2002," were not in a position toknow how Ionics financial management calculated the revenues thatit reported from the Aqua Cool sale or from customer sales ofbottled water. Defs.' Mem. at 9 (internal quotes omitted).Moreover, neither was still employed by Aqua Cool on March 7,2002, when Ionics reported bottled water sale revenue for thefourth quarter of 2001. Id. Neither is alleged to havecommunicated with Goldstein or Kuzmak, or any other senior Ionicsexecutive. Id.

Again, Crowell successfully parries by arguing that thesewitnesses were employees in different markets, with personalknowledge of Aqua Cool's sales practices, describing the precisemeans through which a fraud was perpetrated. Pl.'s Mem. at 15 &n. 7. One of the employees received an email indicating that the fraudulent sales practice was company-wide, ordered by an AquaCool Vice President. Id. at 15. That is sufficient to allegethat the scheme was taking place. As to the allegation that theIonics Defendants knowingly or recklessly failed to reveal thisfraudulent scheme in disclosures to the investing public, it canbe inferred that top executives at Ionics were aware of a schemeinvolving systemically fraudulent sales practices, given theimportance of the Aqua Cool sale to Ionics' business that year.See In re Tel-Save Sec. Litig., 1999 U.S. Dist. Lexis 16800,at *14 (E.D. Pa. Oct. 19, 1999); Epstein v. Itron, Inc.,993 F. Supp. 1314, 1326 (E.D. Wash. 1998) (citing Cosmas,886 F.2d 8, 10 (2d Cir. 1989)) ("[F]acts critical to a business's coreoperations or an important transaction generally are so apparentthat their knowledge may be attributed to the company and itsofficers.").

Here, moreover, the Ionics Defendants had a clear motive toinflate Ionics' stock price artificially by engaging in afraudulent scheme to inflate Aqua Cool's sales and customer baseartificially. They wanted to maximize Aqua Cool's sale price.Deliberate overstatement of revenues to consummate a major saleor acquisition of stock or assets is sufficient to support astrong inference of scienter. See In re Livent, Inc.Noteholders Sec. Litig., 174 F. Supp. 2d 144, 152 (S.D.N.Y.2001); In re Nanophase Tech. Corp. Sec. Litig., 2000 U.S. Dist.LEXIS 11744, at *18-19 (N.D. Ill. Aug. 14, 2000); In re Nuko Info. Sys. Sec.Litig., 199 F.R.D. 338, 344-45 (N.D. Cal. 2000).

(3) Internal Controls Allegations

If the allegations regarding Ionics' failure to maintainadequate internal controls were the only ones in the Complaint,the Court would almost certainly have to dismiss the case.Internal controls allegations are frequently dismissed, even whena corporation's executives knew that internal controls wereinadequate.12 Such allegations are probative of scienter,however, and can add to the strength of a case based on otherallegations. See, e.g., Svezzese v. Duratek, Inc., No.01-CV-1830, 2002 WL 1012967, at *6 (D. Md. Apr. 30, 2002),aff'd, 2003 WL 21357313(4th Cir. June 12, 2003).

Facts alleged in Crowell's complaint suggest that Ionics'failure to develop internal controls was egregious. Almostcomplete reliance for contract revenue figures was placed on estimates made by operations personnel whose compensation wastied directly to contract revenues. A better formula forsystematic revenue misstatement would be difficult to imagine.Although it is likely true that standing alone, even this levelof mismanagement does not constitute scienter, when considered incontext with the other, stronger allegations, it at leaststrengthens Crowell's case. In particular, Crowell has adequatelyalleged that Ionics was knowingly (or perhaps recklessly) engagedin multiple courses of conduct to inflate revenues artificially,and the desire to hide such fraudulent conduct would provide anobvious motive to maintain minimal internal controls. Thissuggests that the failure to maintain internal controls wasintentional, rather than negligent. Likewise, the fact thatIonics chose not to implement adequate internal controlsreinforces the inference that it was intentionally engaged in thefraudulent courses of conduct described above.

(4) Contract Accounting Allegations

The Ionics Defendants first refute the contract accountingcharges by arguing that all of the alleged conduct supportingthem occurred prior to the beginning of the Class Period, andthere is no evidence that such practices occurred during theClass Period. Defs.' Mem. at 11. Second, the Ionics Defendants argue that there is no evidence that any of them knowinglyaccounted for contract revenue improperly. Id.

Crowell does not refute these arguments in his brief, which wasover-length in any case. His complaint does adequately allegeconduct of this sort during the quarter right before the classperiod began, however, and that quarter ended only 25 days beforethe commencement of the Class Period. This latter example is atleast modestly probative of the approach Ionics was taking to itsaccounting practices, although it obviously could not make out asecurities fraud case standing alone. In other words, the factthat some evidence has been found, pre-discovery, that over aspan of several years Ionics at least sometimes, perhapsfrequently, engaged in improper contract accounting bolstersCrowell's other, more substantial allegations.

3. Crowell Has Adequately Alleged Falsity and Materiality

The Ionics Defendants generally argue that Crowell fails toallege specific facts that explain why any particular one of thedisclosures made was materially false when made. Defs.' Mem. at13. This simply is not true.

a. Aqua Cool Allegations

With regard specifically to these allegations, the IonicsDefendants first argue that they are not pled with sufficientparticularity. Defs.' Mem. at 13. Relying heavily on this Court'sdecision in Fitzer, they argue that Crowell must allege who the customers that received excess water bottles were, aswell as the time, terms, and amount of the specific transactions.Id. (citing Fitzer, 119 F. Supp. 2d at 35-36).

Crowell in turn relies on Cabletron, which makes clear thatthe question whether a complaint satisfies the PSLRA isfact-specific, and that not every question regarding relevanttransactions must be answered at the pleading stage. See311 F.3d at 32. More to the point, "the rigorous standards forpleading securities fraud do not require a plaintiff to pleadevidence." Id. at 33.

The complaint in this case is closer to the one in Cabletronthan to the one in Fitzer. Crowell has alleged a specific typeof scheme, taking place over a specified time period, for aspecified reason, with specified results, based on testimony ofmultiple witnesses with personal knowledge, and on reasonableinferences from the later downward adjustment in Aqua Cool'ssales price. Crowell has, without the benefit of any discovery,made a reasonable estimate of the magnitude of the artificialinflation of Aqua Cool's revenues, based on the fact that AquaCool's price was ultimately revised downward by $13,000,000,presumably based primarily on Nestle's "audit" regarding thenumber and nature of Aqua Cool's active customers. Requiring moreof Crowell would be requiring him to "plead evidence."

Despite the Ionics Defendants' protestations to the contrary,Crowell has adequately alleged that statements Ionics made about its financial condition after the fraudulent Aqua Coolscheme began were false. He has demonstrated that before the AquaCool sale, a scheme existed whose likely result would be toinflate Ionics' revenues artificially, and that after thestatements were made, Nestle's examination of the facts led it todevalue Aqua Cool by $13,000,000. This likely occurred primarilybecause Nestle found that Aqua Cool had lower sales and a smallercustomer base than appeared at the time of the sale. It isdifficult to see how Crowell could allege more without "pleadingevidence."

The Ionics Defendants next make a specious argument thatIonics' statements regarding Aqua Cool were neither false normaterial, because Ionics originally had set aside large cashreserves at the time of the Aqua Cool sale, was able to releasesome of those reserves after the final adjustment, and wastherefore able to realize an additional pre-tax gain of$8,200,000. Defs.' Mem. at 15. The relevant question is notwhether there was ultimately a release of reserves, but ratherwhether Ionics' failure to disclose its artificial inflation ofAqua Cool's sales and customer base would have led a reasonableinvestor to overestimate the likely amount of that release.

There can thus be little doubt that the omission was material.Assuming, as it is reasonable to do at this stage, that most ofthe $13,000,000 readjustment was due to the artificial inflationof Aqua Cool's sales and customer base, Aqua Cool's omission would have led a reasonable investor tooverestimate the release by roughly $13,000,000. Ionics'originally reported income for 2001 was $33,300,000, and thisCourt can safely say that a 39 percent discrepancy is material,or more accurately, that the question ought go to a jury. SeeCabletron, 311 F.3d at 34. The 12 percent rise in Ionics'common stock value at the time of the Aqua Cool sale announcementstrengthens this conclusion, as Crowell adequately alleges thatthere was an efficient market for Ionics common stock, and theIonics Defendants do not dispute that contention. See Ganinov. Citizens Utils. Co., 228 F.3d 154, 166 (2d Cir. 2000);Oran v. Stafford, 226 F.3d 275, 282 (3d Cir. 2000).

b. Contract Accounting Allegations

The Ionics Defendants' arguments in this regard are similar tothose in the scienter discussion above, and again, Crowell hasnot responded to them directly. These allegations thus onlycurrently have significance insofar as they lend plausibility tothe Aqua Cool and France/Restatement allegations.

4. Crowell Adequately Alleges Loss Causation

A securities plaintiff must plead and ultimately prove twokinds of causation: transaction causation (what induced thepurchase) and loss causation (what caused the stock to decline invalue and produce a loss). E.g., In re Polaroid Corp. Sec.Litig., 134 F. Supp. 2d 176, 188 (D. Mass. 2001) (Saris, J.) (citing AUSA Life Ins. Co. v. Ernst & Young, 206 F.3d 202,209 (2d Cir. 2000)). Loss causation thus resembles the concept ofproximate cause in tort law. Id. The pleading burden for thiselement is only a "minimal burden," much less than the "stronginference" requirement for scienter, and can be satisfied byalleging that the Ionics Defendants' misstatements artificiallyinflated the price of Ionics common stock during the classperiod.13

There can be little doubt that Crowell meets this minimalstandard. Even under heightened pleading standards, Crowell hasalleged that heavy trading and serious devaluation of Ionicscommon stock occurred in the wake of the November 5, 2002announcement of restatement (allegedly based on the misallocationof losses at Ionics' French subsidiary), and of the March 14,2003 announcement.14 Similarly, Crowell would meet therequirement even if he could only allege that the IonicsDefendants' misrepresentations had induced him to acquire Ionicscommon stock and that they had "induced a disparity between the transaction price and the true `investment quality' of thesecurities at the time of the transaction." Suez EquityInvestors, L.P. v. Toronto-Dominion Bank, 250 F.3d 87, 97-98(2d Cir. 2001).

5. Crowell's "Contingent Liabilities" and "SignificantUncertainties" Meet Pleading Requirements

The Ionics Defendants argue that two more allegations fail tomeet pleading standards. The first is an allegation that GAAPrequired Ionics to disclose its ongoing payment disputes withDesalcott in financial statements released during the ClassPeriod. See Defs.' Mem. at 17; Am. Compl. ¶ 100. Ionicsrecorded millions of dollars in receivables with Desalcott. Am.Compl. ¶ 100. Ionics revealed in its June 30, 2003 10-Q Form thatit had "resolved the outstanding payment matters that were indispute with Desalcott relating to the construction of the[desalination plant] facility." Id. (alteration in original).During an investor conference call on August 1, 2003, DouglasBrown, Ionics President and CEO, stated that the resolution ofthe dispute hurt Ionics' earnings during the second quarter of2003 (the last quarter of the Class Period). Id.

The Ionics Defendants are certainly correct that standingalone, this allegation could not make out a securities fraudcase, and the allegation currently has limited probative value.Given that Crowell has now survived the motion to dismiss stage, however, there is no reason to forbid him from exploring thisissue further in discovery.

Crowell's second allegation stands on firmer ground. Based onthe testimony of a former Ionics Vice President of EuropeanOperations, Crowell alleges that Ionics formed five to tenspecial purpose entities ("SPEs") to disguise payments made toLibya, where Ionics had transacted business for years, and thatduring the fourth quarter of 2001, Ionics wrote off about$1,000,000 in bad debt that it had accumulated over time forbribes and unpaid equipment delivered to Libya. Id. ¶ 101.Similarly, the former Vice President alleged that Ionics' officein Italy was "hiding payments under the table to Iraq." Id.Crowell urges that failing to disclose these contingentliabilities and significant risks violated GAAP.

These allegations, standing alone, would probably not sustain asecurities fraud complaint. They are more specific than theaccounts receivable dispute allegation, however, and the Courtgives some consideration to the difficulty of pleading matterslike this with greater particularity without the benefit ofdiscovery. SPEs are typically "off the books," and there is noindication that the alleged SPEs are under any obligation to fileinformation publicly. Indeed, the purpose of SPEs often is toevade public scrutiny of certain transactions, and to provideparticipants in those transactions with protections that the lawwould not afford them were the transactions done in the traditional manner. The secrecy that typically surrounds SPEs andthe dubious legality of many of them suggest that Crowell shouldbe permitted to pursue this line of inquiry in discovery. It ishard to imagine how he could plead with more particularity herewithout "pleading evidence."

III. CONCLUSION

For the reasons stated above, the Ionics Defendants' Motion ToDismiss [Docket No. 13] was DENIED, although the Court emphasizedto Crowell that it would scrutinize discovery requests with somecare to ensure that discovery did not become a fishingexpedition.

1. On June 9, 2003, this Court allowed Mr. Crowell's motion tobe appointed lead plaintiff, thereby replacing Jerome Deckler asthe named plaintiff in this matter.

2. After selling Aqua Cool, Ionics retained certain Aqua Cooloperations in the Middle East and the Carribean. Id. ¶ 18.

3. In 2002, without explanation, Ionics restated its 2001"Revenue — unaffiliated customers," reducing it by $21 millionfrom $466 million to $445 million. Am. Compl. ¶ 20 n. 1.

4. It is unclear from the parties' filings to what extent theforeign affiliates' results were reported in Ionics' consolidatedfinancial statements, the way subsidiaries' results werereported. Answers to questions at oral argument provided littleillumination on the subject. Thus, it is unclear whether theCourt is confronting a situation where a company violatesGenerally Accepted Accounting Principles ("GAAP") by failing toconsolidate results from an entity over which the companyexercises sufficient control to require such consolidation. Itmay be that EDF costs would ordinarily be reported on Ionics'consolidated financial statement. The Ionics Defendants seemimplicitly to assume in their arguments that whether the EDFlosses were recorded at Ionics France or at their true source,they would appear on the consolidated balance sheet all thesame.

5. Although this is not clear from the Complaint, the partiesagreed at oral argument that the pertinent information in the10-K Form was also in the press release.

6. Gross has been partially superceded on other grounds bythe Private Securities Litigation Reform Act of 1995 ("PSLRA"),which is codified at 15 U.S.C. § 78u-4. Greebel v. FTPSoftware, Inc., 194 F.3d 185, 191 (1st Cir. 1999).

7. The Ionics Defendants provide a copy of Goldstein's August3, 2001 Form 4 filing, which shows that he possessed 282,555shares of Ionics common stock at that time. Defs.' App. Ex. 3[Doc. No. 15]. They also provide a Proxy Statement, dated April9, 2003, which lists Goldstein as having 802,112 shares as ofMarch 21, 2003, which includes 7,557 shares in a 401(k) plan and512,000 shares that Goldstein had a right to acquire pursuant toexercise of certain stock options. Id. Subtracting the 512,000and the 7,557 from 802,112 produces exactly 282,555 shares. TheIonics Defendants also correctly state that this Court may takejudicial notice of the Form 4, without converting their motion todismiss into a motion for summary judgment. See Defs.' Mem. at4 n. 1 (citing Oran v. Stafford, 226 F.3d 275, 289 (3d Cir.2000), and In re Stone & Webster, Inc. Sec. Litig.,253 F. Supp. 2d 102, 128 & n. 11 (D. Mass. 2003) (Lindsay, J.)); seealso Fed.R. Evid. 201(b)(2). The Ionics Defendants have not,however, provided any SEC filings to demonstrate that Goldsteinhad the same holdings as of October 25, 2001, the beginning ofthe Class Period, much less on March 14, 2003, the end of theClass Period. The SEC filings submitted would obviously beprobative at trial — they suggest that Goldstein did not sell anyshares during the class period — but they are scarcelyconclusive, particularly at the motion to dismiss stage.

8. This second theory of motive is sufficient to get the caseto discovery, where it is entirely possible that Crowell couldlearn that at least one of the Ionics Defendants did in factprofit from stock trading. It is by no means unheard of for anexecutive to file a Form 4 late, or not at all.

9. The Ionics Defendants argue that Crowell's complaint isstructured and expressed in a misleading manner. There is littleto their allegation that Crowell's "modus operandi is to state abroad proposition followed by supposed support . . . attributedto an unnamed source . . . [and] typically only loosely related(and at times unrelated) to the preceding proposition." Defs.'Mem. at 7. They stand on firmer ground when they accuse Crowellof "block quoting" in a misleading way, but the complaint stilladequately alleges what it must to survive this motion todismiss. Id. at 8.

10. The Ionics Defendants deny that there was any disputebetween Ionics and its French subsidiary, or that any suchdispute was the reason for the misstatement, although theyrecognize that this is irrelevant to disposition of the Motion toDismiss. Defs.' Mem. at 6 n. 4. Ionics points to Goldstein'sstatements in Ionics' 2002 10-K filing to refute Crowell's claimsregarding the reasons for the restatement, id. at 6 n. 5, butthe Ionics Defendants' self-serving statements cannot be creditedat the motion to dismiss stage.

11. More accurately, it is the prospect for future earningsgrowth that matters, but present income is obviously relevant inevaluating likely future performance.

12. See Abrams v. Baker Hughes Inc., 292 F.3d 424, 433(5th Cir. 2002) (holding that accounting failures due to"negligence, oversight, or simple mismanagement" were notactionable); In re Westinghouse Sec. Litig., 90 F.3d 696,711-12 (3d Cir. 1996); Svezzese v. Duratek, Inc., No.01-CV-1830, 2002 WL 1012967, at *6 (D. Md. Apr. 30, 2002),aff'd, 2003 WL 21357313 (4th Cir. June 12, 2003); In reSunterra Corp. Sec. Litig., 199 F. Supp. 2d 1308, 1326 (M.D.Fla. 2002) (holding that under the circumstances, failure tomaintain adequate controls at most constituted negligence, notactionable scienter); see also Shaw, 82 F.3d at 1206 (1stCir.) (noting that mere mismanagement is not actionable under thesecurities laws); Glickman v. Alexander & Alexander Servs.,Inc., 1996 WL 88570, at *15 (S.D.N.Y. Feb. 29, 1996)("Intentional misconduct or recklessness cannot be presumed froma parent's reliance on its subsidiary's internal controls").

13. See, e.g., Picard Chem. Profit Sharing Plan v.Perrigo Co., 940 F. Supp. 1101, 1126 (W.D. Mich. 1996); In reAllaire, 224 F. Supp. 2d at 339; see also In re Xcelera.comSec. Litig., No. 00-CV-11649-RWZ, 2002 U.S. DIST. LEXIS 7400, at*14 (D. Mass. Mar. 8, 2002) (Zobel, J.) (holding that thepleading requirement was met where the complaint "continuouslyallege[d] that this misrepresentation was the proximate cause of[the shareholders'] losing investment").

14. The parties agreed at oral argument that the Aqua Coolprice revision was revealed at this time.

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