Auditor Can’t Escape ANR Action

KPMG Bermuda has lost it’s bid to be dismissed from the ANR securities class action.Senior Judge Ellen Bree Burns (D. Conn.) (pictured left) evaluated the audit firm’s alleged knowledge and intent, holding that “repeated restatements can… raise an inference of scienter.”

The other prong of her opinion addressed materiality, with Judge Burns finding that KPMG Bermuda’s audit opinions, which said that “ANR’s financial statements fairly represented its financial position and were created in accordance with GAAP,” “were relied upon by investors making their investment decisions,” and “thus, plaintiffs have adequately pled the existence of material misrepresentations made by KPMG Bermuda.”

You can read Schnall v. ANR, issued August 30, 2006 at 2006 U.S. Dist. LEXIS 61898

Nugget: “While allegations of GAAP and GAAS violations alone are generally not sufficient to create a strong inference, of reckless behavior, where plaintiffs have alleged facts showing that there were numerous red flags that KPMG must have been aware of, if it were conducting any kind of audit, reckless conduct can be, and has been, inferred.”

Tenth Circuit Speaks in Pre-Paid

It seems like it’s been a while since we had a Court of Appeals PSLRA decision, but the Tenth Circuit has put an end to that dry spell in the Pre-Paid Legal Services action, with colorful language (in places) that definitely reminds me of an Easterbrook opinion. Judge Terrence L. O’Brien (George W. Class of ’02), writing for the Panel, said that “this case may be a close call, but it is difficult to tell because the complaint is so rich in sweeping, generalized and sometimes conclusory allegations. Pleading precision could have better informed the debate and aided the critical analysis necessary to resolve a motion to dismiss.”

So “in the face of a somewhat chaotic complaint the district court understandably cut to the chase. Although the district court listed the numerous alleged GAAP violations, it appears the court distilled the Consolidated Complaint to the single GAAP violation concerning the recording of unearned commission advances as assets. When so limited, the Consolidated Complaint fails to adequately allege scienter because there is no evidence that this alleged GAAP violation was the result of Pre-Paid Defendants’ fraudulent intent to mislead investors. The district court noted Pre-Paid’s SEC filings disclosed it recorded unearned commission advances as assets on its balance sheets and warned it might not be able to recoup unearned commission advances.”

Wrapping it up, the Panel concluded that “if Pre-Paid Defendants intended to deceive investors, it makes little sense for them to overtly disclose their scheme to the SEC and public. But, charitably regarded, the complaint alleges more subtle means and purposes.”

You can read McNamara v. Pre-Paid, issued July 14, 2006, here or at 2006 U.S. App. LEXIS 17902.

Nugget: “Based on the above, we conclude Plaintiffs’ Consolidated Complaint insufficiently pleads scienter. However, unlike the district court, we do not believe Plaintiffs’ fraud theory is “patently absurd.” The Consolidated Complaint raises some serious “red flags” concerning Pre-Paid Defendants’ long term recording of unrecoverable unearned commission advances as assets and the credibility of their pre-2001 SEC disclosures. Nevertheless, it is lacking in allegations demonstrating Pre-Paid Defendants’ alleged fraud was economically logical in light of Pre-Paid’s repurchase of its own stock at allegedly inflated prices. It also fails to adequately allege Pre-Paid’s GAAP violation was the result of an intent to mislead investors. Therefore, dismissal was appropriate.”

Molex Misdeeds

Judge Ruben Castillo (N.D. Ill.) describes it as “a complex securities case involving numerous allegations of corporate misdeeds amid suspicious factual circumstances, including the resignation of Molex‘s independent auditor, several undisclosed accounting errors, and multiple short-term changes in accounting methods.” And it seems those alleged suspicious misdeeds were more than enough for Defendants to lose their motions to dismiss.

Judge Castillo touched on lots of issues, but said that “although the magnitude of the accounting errors in the instant case were a relatively small percentage of Molex’s total income,” “Plaintiffs have detailed each of Defendants’ prior notice of the various errors and manipulative accounting methods, as well as their alleged conscious decision not to reveal the errors to the public or to their independent auditor.” So “although general allegations of GAAP violations are insufficient, ‘[t]he critical facts alleged by the plaintiffs in this case are the identification of the specific transactions alleged to have violated GAAP and the amount of detail provided in explaining those transactions.’”

You can read Takara Trust v. Molex, issued April 28, 2006, at 2006 U.S. Dist. LEXIS 29655.

Nugget: “While SAB No. 99 does not carry the force of law, SEC staff accounting bulletins constitute a body of experience and informed judgment, and SAB No. 99 is thoroughly reasoned and consistent with existing law.”

Thanks. Oh, and Goodbye.

Judge Stewart R. Dalzell (E.D. Pa.) was “most grateful” to Plaintiffs for their “professional courtesy” in providing a “red-lined version of the 132-page second amended complaint,” as it “greatly simplified” the “task.” What “task” might that be you ask? How about granting Defendants’ motions to dismiss — again.

You see, Judge Dalzell held that “Plaintiffs have again failed to allege particularized facts that create a strong inference that defendants acted with the scienter that the law requires,” because they have not pled “facts showing that the Individual Defendants were presented with suspicious earnings figures or information that would call into question otherwise reasonable earnings reports.”

In sum, “the relevant jurisprudence prevents us from reflexively imputing to the Individual Defendants knowledge of a subsidiary’s under-reporting of transportation costs. We cannot do so absent strong indications that those defendants had sufficient reason to know of, or be suspicious about, the defective accounting system.”

You can read In re Stonepath, issued April 3, 2006, at 2006 U.S. Dist. LEXIS 15808.

Nugget: “We cannot impute knowledge to those defendants of the deficiencies of an accounting program used by a subsidiary, albeit an important one.”

Back to the Drawing Board

Judge Neil Vincent Wake (D. Ariz.) has given Plaintiffs 30 days to try again in the Hypercom securities class action. In tossing the amended complaint, Judge Wake found that “Plaintiffs allege little more than the fact that Hypercom issued a financial restatement because of GAAP violations. The amount of the restatement is not overly probative. Plaintiffs have failed to allege with particularity how the GAAP violations were so obvious that Smolak and Alexander must have known about the misclassification. The culpability statement only provides that there were internal control deficiencies, which caused the accounting error. Such a culpability statement does not establish a strong inference that Defendants misrepresented Hypercom’s financial figures with knowledge or deliberate recklessness.”

“Furthermore, the allegations of one confidential witness in this case fail to raise the level of the inference to ‘strong.’ While Plaintiffs may have alleged facts establishing a reasonable inference of scienter, the standard is a strong inference, which Plaintiffs have not raised. Therefore, Plaintiffs’ claim that Defendants violated Section 10(b) of the Securities Exchange Act of 1934 is dismissed without prejudice.”

You can read In re Hypercom, issued January 26, 2005, at 2006 U.S. Dist. LEXIS 2669.

Nugget: “Plaintiffs need to plead particularized facts establishing a strong inference that Defendants acted with scienter, not mere negligence.”

Inquiring Minds Want to Know

Plaintiffs have taken no prisoners in the Liquidmetal securities class action, having achieved complete victory over Defendants’ motions to dismiss their ’33 and ’34 Act claims. Judge Steven D. Merryday (M.D. Fl.) “carefully considered the ninety-eight page consolidated amended class action complaint, the parties’ exhaustive legal memoranda, and the pertinent legal authorities,” and concluded that “any reasonable investor contemplating investing during a company’s IPO would want to know whether the company was overstating its financial earnings in violation of GAAP. Likewise, any reasonable investor would appreciate learning of an officer’s preexisting obligation to violate the very lock-up agreement touted to investors in the IPO.”

You can read Primavera v. Liquidmetal, issued December 2, 2005, at 2005 U.S. Dist. LEXIS 30418.

Nugget: “Although the amended complaint contains allegations based on ‘forward-looking’ statements, including projections of revenue, business objectives, and future economic performance, the plaintiffs sufficiently allege that no reasonable basis existed for the forward-looking statements issued during the class period.”

Sarbanes 304 Finally Addressed

In what appears to be the first time in a reported securities class action decision, a court has addressed the issue of whether private investors can seek to disgorge personal profits from the CEO and CFO under Section 304 of Sarbanes-Oxley. In the Qwest action, Judge Robert E. Blackburn (D. Colo.) took a look at the provision, which could force the two execs to pay back “any bonus or other incentive-based or equity-based compensation” earned “during the 12-month period following the first public issuance” of a “accounting restatement” made “as a result of misconduct.”

Qwest’s CFO, Robin Szeliga, argued that Plaintiff “does not have standing to assert a claim under § 304 because the statute provides only for reimbursement to the issuer which, in this case, is Qwest.” Judge Blackburn agreed, holding that Plaintiff “is not entitled to the reimbursement required by the statute” because he “is not asserting derivative claims on behalf of Qwest.” Therefore, Plaintiff “does not have standing to assert a claim against” the CFO under § 304 and it “should be dismissed.”

Plaintiffs probably shouldn’t feel too bad though. First, they just negotiated a $400 million partial settlement. And second, the other two reported decisions on Sarbanes 304 are both derivative actions, and both courts ruled that Plaintiffs had no authority to bring 304 claims as the statute does not provide them with a private right of action. Guess the SEC is going to have to enforce 304. Remains to be seen if they are ever going to get serious about it though.

You can read In re Qwest, issued September 12, 2005, at 387 F. Supp. 2d 1130.

Nugget: “Qwest restated its GAAP revenues for this period from $ 40.674 billion to 37.8 billion, an overstatement of $ 2.874 billion, and its losses from $ 4.802 billion to $ 30.290 billion, an understatement of $ 25.488 billion.”

Excuses, Excuses

Your car salesman did it to you and betcha you didn’t get a penny. Puffery is a bad thing he says? OK smart guy, how in the world am I supposed to sell these Chryslers then? And don’t even talk to me about moving these Kia’s. Yes, of course they are all highway miles. Well, he might be able to get away with it on the lot, but when it comes to running a public company, it’s a different story. No exaggeration.

You see, the executives in the Uniroyal Technology securities class action basically tried to say we didn’t lie, we just “puffed” up the truth. At the worst your Honor. But his Honor, Judge James D. Whittemore (M.D. Fla.), didn’t go for it, holding that “while aspects of the alleged misstatements contain elements of corporate optimism, this Court cannot conclude, at this stage of the litigation, that Defendants’ assurances regarding Uniroyal’s progress in developing and producing [certain] products were clearly immaterial to investors. When the comments Defendants contend are mere puffery are read in context and in conjunction with Plaintiffs’ other allegations, the Court cannot conclude that the alleged misstatements are merely general predictions and not material as a matter of law.”

Judge Whittemore also rejected Defendants’ argument that they forewarned investors of the trouble ahead, finding that “Defendants fail to sufficiently identify the cautionary language they rely on and fail to sufficiently link a cautionary statement to the projection about which Plaintiffs complain.” Finally, the Court also found that the GAAP violations were adequate, because “by failing to write down the inventory to the lower of cost or market value through a charge to earnings during the Class Period, Uniroyal’s financial statements reflected grossly overstated assets, income, and net worth.”

Guess these execs’ excuses are their own.

You can read Bellocco v. Curd, issued October 20, 2005, at 2005 U.S. Dist. LEXIS 24251.

Nugget: “The Court cannot conclude that these statements are so vague, exaggerated or unspecific that a reasonable investor would not rely on them.”

Tripos Plaintiffs Largely Victorious

Rush Limbaugh’s uncle (it’s true, really), Judge Stephen N. Limbaugh, Sr. (E.D. Mo.), has issued two decisions in the Tripos securities class action. In them, he denies the Company’s (including its CEO and CFO) motion to dismiss, although in the other he decides to kick Ernst and Young out of all the fun. Basically, Plaintiffs alleged that Defendants knew of “a lost software contract and improper accounting methods, which when eventually disclosed, caused a significant drop in the stock value.” However, in spite of this, they continued “to forecast extremely positive revenues.”

Perhaps part of the problem for Defendants, as Judge Limbaugh put it, was that they “spend considerable time, not addressing the pleading standards but rather defending themselves against the allegations.” Oops, guess that didn’t work. At any rate, “the bottom line is that the plaintiffs have pleaded that during the Class Period, the defendants had in their possession (or could have easily obtained) facts which rendered their financial results materially false when first stated to the investing public, and given these facts, intentionally delayed recognition of these ‘facts’ in violation of GAAP, then intentionally delayed recognition of the GAAP violations in order to induce plaintiffs to continue investing in a ‘profitable’ enterprise.”

Oh, as for E&Y, the Judge found that even “assuming GAAP and GAAS violation did occur, at best, all the plaintiffs have alleged is negligence.”

You can read the In re Tripos decisions, issued on September 30, 2005, at 2005 U.S. Dist. LEXIS 22752 and 2005 U.S. Dist. LEXIS 22753.

Nugget: “Without a doubt the ‘merits’ of the allegations as presented can be argued fervently; however such a debate involves questions of fact that cannot render the complaint inadequate, lest the heightened pleading requirements of the Reform Act replace the function of a trial.”

CFO Answers Complaint, Takes Fifth

What’s that, answer a PSLRA complaint? No motion to dismiss? Yes, it’s true, and you can read all about it in one of two separate opinions issued by Judge William S. Duffey, Jr. (N.D. Ga.) in the securities class action and the consolidated derivative action in the Friedman’s litigation. There’s a lot to go over in the securities opinion, with the court evaluating “eleven motions to dismiss” the 1933 and 1934 claims filed by executives, outside directors, underwriters, control entities, and Ernst & Young. “Essentially, Plaintiffs contend Defendants engaged in significant accounting fraud, resulting in the overstatement of the Company’s reported earnings.” And yep, the former CFO (Victor M. Suglia) “did not file a motion to dismiss,” opting instead to answer by “asserting his Fifth Amendment rights in response to many of Plaintiffs’ allegations.” As for everyone else, the Court largely denied their motions to dismiss, finding that Plaintiffs “assert a systemic practice by which the Company inflated revenue by booking sales for which they knew payment was improbable,” and “have identified and pleaded with sufficient particularity five categories of alleged misconduct that resulted in the Company’s issuance of allegedly false and misleading financial statements during the class period.”

As for the derivative action, which Judge Duffey noted consists of “similar allegations,” it didn’t fare so well. “The Court concludes that Plaintiffs have failed to allege particularized facts, either in isolation or in their totality, creating reasonable doubt as to a majority of the directors’ independence or disinterestedness to excuse the requirement that Plaintiffs make demand on the Board.” Case dismissed.

You can read In re Friedman’s Securities Litigation at 2005 U.S. Dist. LEXIS 19503, and In re Friedman’s Derivative Litigation, at 2005 U.S. Dist. LEXIS 20094. Both were issued on September 7, 2005.

Nugget: “In light of the complexity of the allegations and Plaintiffs’ obligation to plead its claims with particularity — a separate ground on which Defendant urges Plaintiffs’ Complaint be dismissed — the Court finds Plaintiffs’ Complaint is not a “shotgun pleading” which should be dismissed.”