Introduction: Motion to Dismiss in Securities Class Action Lawsuits

• Scienter:  Refers to the defendant’s intent to deceive, manipulate, or defraud. Under the PSLRA, a plaintiff must plead specific facts giving rise to a “strong inference” of this fraudulent intent, a high bar established to prevent frivolous lawsuits based on mere hindsight. This requires allegations of motive and opportunity, or facts detailing a high degree of recklessness, where the defendant’s actions represent an extreme departure from ordinary care. The standard demands that the inference of scienter must be at least as plausible as any non-culpable explanation for the defendant’s conduct.

• Loss causation:  Requires a plaintiff to demonstrate a direct causal link between the alleged fraudulent misstatement or omission of a material fact and the economic loss suffered by investors. It is not enough to show that a stock price dropped after a corrective disclosure; the plaintiff must prove that the stock’s decline was a direct result of the market learning the truth about the fraud, rather than from unrelated factors such as broader market trends or industry news. This often involves rigorous economic analysis to isolate the harm caused by the fraud from other market factors.

• Materiality determines whether the misstatement or omission was significant enough to influence a reasonable investor’s decision. For a claim to proceed, the information must be considered important when buying or selling stock. In motions to dismiss, defendants often argue that alleged misstatements were either non-actionable “puffery”—vague, optimistic statements that no reasonable investor would rely on—or protected as forward-looking statements under the PSLRA’s “safe harbor” provision, particularly when accompanied by sufficient cautionary language.

Pre-PSLRA and Post-PSLRA Standards

Pleading Standards for Scienter Under the PSLRA

The “strong inference” test from Tellabs

To survive a motion to dismiss under the PSLRA, a plaintiff must satisfy a three-step test for scienter, as established by the Supreme Court in Tellabs: 

1. Accept allegations as true: A court must accept all factual allegations in the complaint as true.
2. Holistic review: A court must consider the complaint in its entirety, evaluating the cumulative effect of all allegations, not just isolated ones.
3. Comparative assessment: The court must weigh the inference of fraudulent intent against any plausible, non-culpable opposing inferences. The strong inference of scienter must be “cogent and at least as compelling as any opposing inference of nonfraudulent intent”. If the competing inferences are equally strong, the plaintiff prevails, but the bar is high. 

Types of evidence that support a strong inference of scienter

Evidence of motive and opportunity

• Suspicious stock sales: Executives selling a large portion of their personal stock holdings immediately before a negative announcement can suggest they were exploiting non-public information. Courts consider the timing, amount, and consistency of the sales.
• Misleading statements tied to compensation: If executives’ compensation or bonuses are tied directly to financial metrics that are allegedly being manipulated, this can demonstrate a powerful financial incentive to commit fraud.

Evidence of recklessness

• Access to contrary information: Allegations that executives or directors had access to internal reports or key company information that contradicted public statements can be compelling evidence. However, plaintiffs typically must plead the contents of those internal documents with particularity, which can be challenging.
• Knowledge of core operations: When a misstatement involves a company’s core, fundamental operational metrics, courts are more willing to find that high-level executives must have been aware of the falsity.

“Red flags” and warnings

• Whistleblower testimony: Firsthand accounts from former employees or confidential witnesses can provide direct evidence that management was aware of problems while publicly projecting a different image.
• Accounting irregularities: Pleading a pattern of specific and significant accounting irregularities or manipulations can suggest deliberate actions rather than innocent mistakes. The magnitude of the misstatement also plays a role in strengthening the strong inference of scienter. 

Implications of the standard for plaintiffs

• Burden of investigation: The PSLRA forces plaintiffs to conduct extensive pre-filing investigations to gather highly specific facts supporting a strong inference of scienter, often without the benefit of formal discovery.
• Early dismissal risk: The heightened standard means a significant number of securities fraud complaints are dismissed at the motion-to-dismiss stage, preventing a case from ever reaching discovery.
• Need for specific allegations: General claims of corporate mismanagement or incompetence are insufficient. The allegations must specifically tie the fraudulent conduct to a particular individual or a small group of senior executives whose mental state can be imputed to the company. 

Common Red Flags in Pleading Scienter

Unrealistic or “too good to be true” promises

• Guaranteed high returns: Any legitimate investment carries some degree of risk. Be skeptical of anyone who guarantees specific returns, particularly if they are high and seem unaffected by market conditions. This was a classic hallmark of Bernie Madoff’s Ponzi scheme.
• “Risk-free” opportunities: No investment is completely free of risk. This is a frequent claim of fraudsters.

Aggressive and high-pressure sales tactics

• Urgency: Promoters create a sense of urgency, pressuring you to “act now” or suggesting the opportunity is “limited” or “exclusive”. This tactic is used to prevent you from doing proper research.
• Unsolicited contact: Fraudsters often initiate contact via unsolicited emails, cold calls, or social media, sometimes feigning familiarity. Legitimate professionals generally do not use these methods.

Lack of documentation and transparency

• Missing documents: A legitimate investment should have a prospectus or other detailed offering documents. If a seller tries to sell you a security with no documentation, it is a major red flag.
• Evasive answers: Fraudsters often give vague or incomplete answers to direct questions. They may avoid giving a straight answer, especially when pressed for details on how the investment works or the risks involved.
• Complex strategies: If a seller uses overly complex language or confusing investment techniques to explain success, they may be trying to obscure a lack of substance.

Financial statement red flags

• Discrepancy between income and cash flow: One of the most significant red flags is a company that reports high profits (net income) but has low or negative operating cash flow. This indicates the earnings may not be backed by actual cash and could be a sign of accounting manipulation.
• Inconsistent revenue growth: Watch for a company with revenue growth that is significantly faster than its competitors or the industry average. Be especially wary if accounts receivable (money owed to the company) is growing disproportionately faster than sales, which could signal channel stuffing or fictitious sales.
• Frequent changes in accounting policies: Companies that frequently change their accounting practices may be attempting to manipulate financial results. This is a common tactic to boost earnings temporarily or hide problems.
• Significant last-minute adjustments: Large, unexplained journal entries made at the end of a reporting period to boost financial results can be a red flag. 

Other behavioral and structural red flags

• Lack of registration: Before investing, verify that both the investment professional and the product are properly registered. Check databases like BrokerCheck (for brokers) and the SEC’s EDGAR system (for public company filings).
• “Insider” information: Be suspicious of claims of exclusive or “insider” tips. Acting on real insider information is illegal, and such promises are often used to build false trust.
• Requests for personal payments: Never wire money or send personal checks directly to an individual for an investment. Legitimate transactions go through a registered firm and are properly documented.
• Unusual asset-holding arrangements: Be cautious if the investment professional insists on holding your assets directly rather than using an independent, third-party custodian. This arrangement makes it easier for fraud to occur. 

How an Event Study Can Strengthen Loss Causation Allegations

An event study is a statistical analysis used to measure the effect of new information on a company’s stock price, making it an essential tool for strengthening loss causation allegations. It helps plaintiffs prove a direct causal link between the alleged misrepresentation and the investors’ economic loss, as required by the Supreme Court’s ruling in Dura Pharmaceuticals v. Broudo (2005).

Here is an elaboration on how an event study can strengthen loss causation allegations:

1. Isolating fraud-related impact

An event study is designed to isolate the impact of specific, company-related news on a stock’s price, separate from broader market or industry movements.

How it works: An economic expert calculates a stock’s “normal” or expected return for a given period by using a statistical model that accounts for overall market and industry trends. The difference between the stock’s actual return and this expected return is the “abnormal” or “residual” return.

• Strengthening the case: By demonstrating a statistically significant abnormal return on the day the corrective disclosure was made, plaintiffs can argue that the price drop was a result of the revealed fraud, not other unrelated factors. For example, if a stock drops 10% on the day of a negative announcement, but the overall market and its industry dropped 5%, the event study can help pinpoint the 5% drop that is attributable to the company-specific information.

2. Identifying corrective disclosures

An event study is used to provide evidence that a company’s stock price reacted specifically to the revelation of previously concealed negative information.

• How it works: A financial expert defines the “event window”—the days immediately surrounding the corrective disclosure—and analyzes the stock price movement during that period. The study helps establish that a specific disclosure, or series of disclosures, “cured” the alleged misrepresentation and caused the stock price to decline.
• Strengthening the case: This analysis provides objective, statistical evidence that plaintiffs can use to link their alleged losses to the defendant’s fraudulent conduct. In cases where there is a “slow leak” of negative information rather than a single event, a series of event studies can be conducted to show that the accumulated negative news systematically eroded the stock price.

3. Measuring the artificial inflation

Event studies are also used to measure the artificial inflation caused by the alleged misrepresentations, which is a component of damages.

• How it works: By identifying the specific price correction associated with a disclosure, experts can calculate the amount of the price drop that can be attributed to the fraud. This price drop represents the deflation of the stock’s value as the market learns the truth.
• Strengthening the case: This allows plaintiffs to quantify their damages and argue that their losses are directly tied to the fraudulent conduct, not broader economic conditions. This is particularly crucial in a fraud-on-the-market theory, where damages are tied to the stock price.

4. Supporting materiality and reliance

Event studies can also help provide economic evidence of materiality (the significance of a misstatement) and reliance (the investor’s presumed reliance on the integrity of the market price).

• How it works: In an efficient market, a statistically significant stock price reaction to a corrective disclosure indicates that the information was material to investors. The magnitude and statistical significance of the price reaction can provide robust evidence that the information, and thus the misrepresentation, was important.
• Strengthening the case: By showing that the the event study provides compelling evidence that the fraudulent statement was material and that the market relied on it.

Conclusion

In short, an event study in securities class actions provides a scientific and statistically rigorous method for establishing loss causation. It allows plaintiffs to move beyond simple allegations and present expert evidence that demonstrates a direct cause-and-effect relationship between the alleged fraud and the investors’ losses. This makes an event study a powerful tool for surviving a motion to dismiss and potentially proving liability and damages.

Identifying Corrective Disclosures

Identifying a corrective disclosure is a crucial step in a securities fraud class action. It is the public event that reveals the truth previously concealed by a defendant’s misrepresentation, causing the stock’s artificial inflation to disappear and triggering investors’ economic loss. A corrective disclosure does not have to be a formal company admission of guilt but must reveal new, previously concealed facts.

Here’s a breakdown of the common types and characteristics of corrective disclosures.

Full vs. partial corrective disclosures

Corrective disclosures can happen in a single event or gradually over time. 

Corrective disclosures can be full, where a single event fully reveals the negative information, often through a formal company announcement, or partial, where the truth is revealed over time through various events. Proving loss causation can be more straightforward with a full disclosure due to a specific date and stock price drop, but more complex with partial disclosures, requiring proof that cumulative disclosures caused a collective decline.

Sources of these disclosures vary and are often more credible if independent of the company. These sources can include formal company admissions, government investigation announcements, and third-party reports like investigative news. Short-seller reports are also utilized but may be viewed critically if based on speculation.

For a corrective disclosure to be considered valid, it must present new information directly related to the alleged fraud, not just speculation. Past examples in securities litigation include revelations in cases involving companies like Theranos, Wells Fargo, and General Electric, often coming from investigative reports or regulatory actions.

Defenses Used to Challenge a Corrective Disclosure in Security Class Actions

Defendants have several strategies to challenge an alleged corrective disclosure, primarily by arguing that it does not satisfy the requirements of loss causation. The goal is to prove that the market decline was caused by something other than the revelation of the alleged fraud, which could lead to a dismissal of the case.

1. Confounding factors defense

This is one of the most common and powerful defenses used to challenge loss causation.

• The argument: The defendant argues that the stock price drop was caused by a “confounding factor”—something other than the alleged corrective disclosure.
• Examples: Confounding factors can include a market-wide downturn, negative news about a competitor, industry-specific trends, or unrelated company news. For example, if a negative product review came out on the same day as the alleged corrective disclosure, the defendant could argue the price drop was due to the review.
• How it works: Defendants and their expert economists use statistical analysis, often critiquing the plaintiffs’ event study, to argue that the stock drop was not statistically significant or was within the normal range of market volatility.

2. “Truth-on-the-market” defense

This defense argues that the truth about the alleged misrepresentation was already available to the market through other public sources before the supposed corrective disclosure.

• The argument: If the information was already public, the market price already reflected it, so the later disclosure could not have been “corrective”.
• Examples: A defendant could show that the information was buried in prior SEC filings, discussed in analyst reports, or widely known within the industry. In such a scenario, the alleged corrective disclosure is merely confirmatory, not revealing new information.
• How it works: This defense directly challenges the premise that the market was misled. If the truth was already out, the defendant can argue there was no artificial inflation for the corrective disclosure to correct.

3. Disclosure was not “new” information

Related to the “truth-on-the-market” defense, defendants can challenge whether the corrective disclosure actually revealed anything novel.

• The argument: The disclosure contained only information that was already known or was based on speculation, not concrete facts.
• Example: As discussed in Sapssov v. Health Mgmt. Assocs., the Eleventh Circuit held that a report summarizing a pre-existing wrongful termination suit was not a corrective disclosure because it only restated publicly available information.
• How it works: Defendants assert that a stock price drop in response to an article or report that simply synthesizes old information or repeats speculation is not sufficient to plead loss causation, especially if the source of the report (e.g., a short-seller) has a financial motive to see the stock price fall.

4. Disclosure is not related to the alleged fraud

Defendants can argue that the corrective disclosure, while negative, was unrelated to the specific fraudulent misrepresentation alleged by the plaintiffs.

• The argument: The alleged fraud was about one aspect of the company (e.g., product safety), but the corrective disclosure was about an entirely different issue (e.g., financial performance or a failed product launch).
• Example: A corrective disclosure about lower-than-expected revenue might not be relevant if the alleged fraud concerned undisclosed product safety issues. The stock drop, in that case, is not linked to the fraud.
• How it works: This defense focuses on the logical connection between the initial fraud and the subsequent stock price decline. If the two are disconnected, loss causation fails.

5. Challenging the source of the disclosure

Defendants may challenge the credibility and nature of the source of the corrective disclosure.

• Short-seller reports: While courts have accepted short-seller reports as corrective disclosures, defendants frequently challenge their validity by claiming they are speculative, based on old information, or motivated by the short-seller’s financial interest.
• Government investigations: The announcement of a government investigation (e.g., by the SEC or DOJ) is not always considered a corrective disclosure on its own. The Eleventh Circuit has held that it reveals only the risk of future negative information, not the truth of the alleged fraud itself.

6. Challenging “partial” disclosures

In cases where plaintiffs allege a series of partial disclosures, defendants can challenge each individual disclosure and its contribution to the stock price drop.

• The argument: The defendant will argue that no single disclosure was significant enough to be considered corrective and that the cumulative effect is insufficient to prove loss causation.
• Example: The defense might argue that a series of smaller disclosures were not material enough to move the stock price, or that the plaintiff’s attempts to connect them are speculative.

Pleading Standards for Materiality

Pleading standards for materiality in securities fraud are governed by the “total mix” standard established by the Supreme Court. A fact is material if there is a “substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available”. 

This standard is a fact-intensive, objective test that evaluates the significance of information from the perspective of a hypothetical “reasonable investor.”

Key case law on materiality

Basic Inc. v. Levinson (1988)

This landmark Supreme Court case solidified the “total mix” standard for materiality under Rule 10b-5.

• Case summary: Involved a company that publicly denied merger discussions while privately negotiating a merger. The plaintiffs, shareholders who sold their stock after the public denials, alleged that the company’s statements were materially misleading.

• Holding: The Court rejected a rigid “bright-line” test for materiality and ruled that materiality must be determined on a case-by-case basis. It also introduced the “probability-magnitude” test for speculative information, balancing the probability of an event’s occurrence against its potential impact.

Matrixx Initiatives, Inc. v. Siracusano (2011)

This Supreme Court decision clarified that statistical significance is not a prerequisite for materiality, particularly in the context of adverse event reports for a pharmaceutical product.

• Case summary: Shareholders sued a company for failing to disclose adverse event reports related to its lead product, even though there was no statistically significant evidence of a link.
• Holding: The Court reaffirmed the “total mix” standard, stating that a reasonable investor could consider non-statistically significant information important, especially when combined with other contextual factors.

Goldman Sachs Group, Inc. v. Arkansas Teacher Retirement System (2021)

This decision clarified how generic statements relate to materiality and price impact.

• Holding: The Supreme Court ruled that the generic nature of an alleged misrepresentation can be considered as evidence of a lack of price impact when determining class certification. This means that if a statement is too general, it may be less likely to have impacted the stock price and thus be found immaterial.

Common challenges to pleading materiality

1. “Puffery” defense

Defendants often argue that a statement is non-actionable “puffery,” which are vague, optimistic statements that a reasonable investor would not rely on.

• How it works: This defense argues that generalized optimism, like a CEO claiming the company is “well-regarded” or poised for “strong growth,” is immaterial as a matter of law. Courts generally distinguish between specific, verifiable facts and general, subjective opinion.

2. “Total mix” already available

A defendant may argue that the omitted information was already available to the market through other channels, meaning its disclosure would not have altered the “total mix” of information.

3. Forward-looking statements

The PSLRA provides a “safe harbor” for certain forward-looking statements. A defendant may argue that a statement is protected if it was accompanied by “meaningful cautionary language” identifying important factors that could cause actual results to differ.

4. Immaterial omission

The failure to disclose a material fact is not, on its own, actionable. A plaintiff must also prove that the omission was necessary to make another statement not misleading. In other words, there must be a duty to disclose that arises from prior statements.

Pleading Standards for Omissions of Material Fact

The Macquariedecision: Pure omissions are not actionable under Rule 10b-5(b)

The pleading standards for omissions in private securities fraud actions were fundamentally reshaped by the unanimous 2024 Supreme Court decision in Macquarie Infrastructure Corp. v. Moab Partners, L.P. This ruling clarified that under Rule 10b-5(b), a private plaintiff cannot sue based on a “pure omission”—the failure to disclose a fact when no affirmative statement was made.

Instead, an omission is only actionable if it renders a prior or concurrent affirmative statement misleading, creating a so-called “half-truth”.

Pleading an actionable omission (half-truth)

To successfully plead an omission of a material fact claim in a Rule 10b-5(b) private action, plaintiffs must allege specific facts that satisfy two key requirements:

1. Identify the misleading “statement made”

Plaintiffs must pinpoint the specific statement (or set of statements) that the omission rendered misleading.

• Context is key: The alleged half-truth must be viewed in the context of the statements that were actually made. For example, a company that touts its strong revenue growth but fails to disclose that a major customer is about to defect has made a half-truth.
• Beyond pure silence: It is no longer enough to argue that the defendant’s silence on a topic that a reasonable investor would find important is fraudulent. The pleading must directly connect the omitted information to an existing affirmative assertion.

2. Establish a duty to correct or update

The omission  of a material fact must violate a duty to disclose, which exists in a few primary circumstances:

• Correcting half-truths: When a company chooses to speak on a topic, it must speak truthfully and completely. An omission of a material fact needed to prevent a statement from being misleading creates a duty to disclose that fact.
• Updating prior statements: A duty to update may arise if a prior statement, though true when made, becomes materially inaccurate due to subsequent events.
• Legal/regulatory duty: While a violation of a separate disclosure obligation (like Item 303 of Regulation S-K) does not automatically create a Rule 10b-5(b) half-truth, it can be a supporting detail. A violation of Item 303 can only support a Rule 10b-5(b) claim if the omission of a material fact makes an affirmative statement misleading.

Omissions under other legal provisions

The Macquarie decision applies only to private actions under Rule 10b-5(b). Other securities laws have different standards.

• SEC enforcement actions: The SEC can still bring enforcement actions for “pure omissions,” including violations of Item 303.
• Section 11 claims: The pleading standard for omissions in claims related to a securities registration statement under Section 11 of the Securities Act is broader. It imposes liability for “pure omissions”—failing to state a material fact required to be stated in the registration statement.

Examples of Omissions That Create a Half-Truth

Following the Supreme Court’s 2024 decision in Macquarie Infrastructure Corp. v. Moab Partners, L.P., a pure omission—simply failing to disclose a fact—is not a basis for private securities fraud claims under Rule 10b-5(b). An omission is only actionable if it makes a prior or concurrent affirmative statement misleading, creating a half-truth.

Example 1: Omitting details that undercut a positive statement

A company makes a positive public statement about a product or its financial performance but withholds critical, negative information that puts the statement into a misleading context.

• Affirmative statement: “In the last quarter, we sold 2 million laptops.”

• Omitted information: The company failed to disclose that half of those laptops were returned due to a serious defect.

• Half-truth created: The statement is technically true but misleads investors into believing the sales were a net positive for the company, when in fact they led to a significant wave of returns that would impact future financial results.

Example 2: Incomplete disclosure about a business condition

A company discloses some information about a business development but omits other known facts that would significantly alter the market’s perception.

• Affirmative statement: A property developer tells potential buyers that a new road might be built near their property, potentially affecting its dimensions.

• Omitted information: The developer fails to mention that a third, larger road is planned that would bisect the entire property and render it useless for the buyer’s intended purpose.

• Half-truth created: The statement about the new roads is literally true, but it misleads the buyer about the overall impact of infrastructure changes on the property’s value.

Example 3: Concealing negative trends

A company touts a positive business metric while concealing a known, negative trend that would be material to investors.

• Affirmative statement: A company reports strong, growing revenue figures in its quarterly report.

• Omitted information: The company fails to disclose that its accounts receivable are growing disproportionately faster than sales, which is an indicator that some of its sales may be fictitious or that it is struggling to collect payments from customers.

• Half-truth created: The reported revenue figures are misleading because they conceal a trend that signals financial distress, not robust growth.

Example 4: Failing to disclose a conflict of interest

When a party speaks about a securities transaction, they must disclose material conflicts of interest that could influence their statements or recommendations.

• Affirmative statement: An investment broker recommends a security to a client, touting its strong prospects.

• Omitted information: The broker fails to disclose that they will receive a significantly higher commission for selling that specific security compared to other investment options.

• Half-truth created: The broker’s recommendation, which appears to be in the client’s best interest, is misleading because it conceals a financial incentive that would likely influence a reasonable investor’s decision.

Example 5: Providing a forward-looking statement without cautionary language

Under the Private Securities Litigation Reform Act (PSLRA), a company can issue forward-looking statements (e.g., earnings forecasts), but they must be accompanied by meaningful cautionary language to be protected by the “safe harbor” provision.

• Affirmative statement: A CEO makes a public forecast, saying the company expects to see “strong earnings growth in the next quarter.”

• Omitted information: The company fails to provide any cautionary language about known risks, such as supply chain issues or a key product recall, that could affect the forecast.

• Half-truth created: The forward-looking statement becomes a misleading half-truth because it presents an optimistic view without acknowledging known, material risks that could make the forecast inaccurate.

Conclusion

In conclusion, a motion to dismiss in securities class action lawsuits plays a critical role in determining the fate of the litigation process. Investors must comprehend the complex nature of such motions to grasp the complexities of securities litigation effectively. A motion to dismiss is typically filed by the defendant, arguing that the plaintiff’s complaint is legally insufficient to warrant further court proceedings.

One of the central arguments in these motions often revolves around the omission of a material fact. Courts scrutinize whether the alleged omission or misrepresentation significantly impacts an investor’s decision-making process. If the court finds that the omission of a material fact is not sufficiently pleaded, it may grant the motion to dismiss, thereby ending the lawsuit before it proceeds to discovery or trial.

Understanding the benchmarks for what constitutes an omission of a material fact is essential for investors involved in securities litigation. Material facts are those that a reasonable investor would consider important in making an investment decision. The courts assess whether these facts, if omitted, mislead investors about the true nature of their investment.

In filing a motion to dismiss, defendants often argue that the purported omissions are either immaterial or adequately disclosed, aiming to demonstrate that there is no actionable misrepresentation.

For investors embroiled in securities litigation, this comprehensive guide underscores the importance of meticulously crafting their complaints to withstand such motions. Detailed allegations, supported by concrete facts, enhance the likelihood of overcoming a motion to dismiss.

By understanding these legal matters, investors can better position themselves to seek justice and potentially recover losses incurred due to misleading statements or omissions by corporations through securities litigation.

Contact Timothy L. Miles Today for a Free Case Evaluation About Securities Class Action Lawsuits

If you need reprentation in securities class action lawsuits, or you have additional questions about a motion to dismiss, call us today for a free case evaluation. 855-846-6529 or [email protected] (24/7/365).

Timothy L. Miles, Esq.
Law Offices of Timothy L. Miles
Tapestry at Brentwood Town Center
300 Centerview Dr. #247
Mailbox #1091
Brentwood,TN 37027
Phone: (855) Tim-MLaw (855-846-6529)
Email: [email protected]
Website: www.classactionlawyertn.com

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