Opinion
Civil No. 02-4893 (PAM/RLE)
June 6, 2004
MEMORANDUM AND ORDER
This matter is before the Court on Defendants' Motions to Dismiss. For the following reasons, the Motions are granted and Plaintiffs' Second Amended Complaint is dismissed with prejudice.
BACKGROUND
The parties and the Court are familiar with the facts. This is a putative class action on behalf of all persons who purchased or otherwise obligated themselves to purchase the publicly traded equity securities of Rural Cellular Corporation ("RCC") between May 7, 2001, and November 12, 2002 ("class period"). Plaintiffs allege violations of §§ 10(b) and 20, and Rule 10b-5, of the Securities and Exchange Act of 1934 ("Exchange Act"), arising from Defendants' issuance of allegedly false financial statements and other allegedly false and misleading statements about RCC's operating performance. In January 2004, the Court dismissed Plaintiffs' Amended Complaint and ordered them to re-plead their allegations of scienter as required by Fed.R.Civ.P. 9(b) and the Private Securities Litigation Reform Act ("PSLRA"). In February 2004, Plaintiffs filed their Second Amended Complaint and these Motions to Dismiss by Defendants subsequently followed. Defendants RCC, the Individual Defendants, and Arthur Andersen, L.L.P. ("Arthur Andersen") again submit that Plaintiffs have failed to sufficiently plead scienter as required by Fed.R.Civ.P. 9(b) and the PSLRA. The Second Amended Complaint contains very few new allegations. Specifically, the Second Amended Complaint contains one paragraph of new allegations against RCC. (2d Am. Compl. ¶ 53.) Plaintiffs claim that four confidential witnesses ("CW") confirm that RCC and the individual defendants knew or recklessly disregarded information that indicated that their statements were false or misleading. (Id.) In particular, CW 1 is a former consumer finance representative, who allegedly learned at an "all hands meeting" that RCC's business was "softening up" and that RCC was forecasting a "lighter year." CW 2 is a former Regional Vice President employed by RCC, who allegedly confirmed that two individual defendants were "firmly in control" of RCC and that they knew every piece of information that passed over their desks. CW 3 is a former high-level marketing executive who allegedly reported that two of the individual defendants participated in a two-day company meeting, where RCC's roaming revenues were discussed. Allegedly, RCC's competitors were "killing" RCC's roaming revenues, which accounted for nearly 40-50% of RCC's total revenues. CW 4 is a former customer service supervisor employed by RCC, who allegedly corroborated CW 3's information, and who allegedly reported that it was RCC's policy to improperly and prematurely recognize revenue when the customer invoices were sent, rather than when payment was received, resulting in an overstatement of RCC revenue. (Id.)
The Second Amended Complaint contains eight new allegations against Arthur Andersen. (Id. ¶¶ 55-58, 62-65, 74-75.) The first of these allegations suggests that Arthur Andersen should be liable because of its recent involvement in the "complete audit failure" at "Enron, Worldcom, Global Crossing, Peregrin, Arizona Baptist Foundation, Waste Management and Sunbeam." (Id. ¶¶ 55-56.) Plaintiffs also assert that Arthur Andersen's dual role as auditor and accounting consultant `Violated GAAS and contravene[d] the spirit of the SEC regarding auditor independence," and that Arthur Andersen was thus financially motivated to ensure RCC's financial success. (Id. ¶¶ 57, 62.) Finally, Plaintiffs allege that Arthur Andersen failed to ask the right questions and obtain the right information within the telecom industry, and but for this failure, Arthur Andersen "would have been aware" that RCC's business faced increased competition. (Id. 74-75.)
DISCUSSION
A. Standard of Review
The PSLRA raised the pleading standards for securities fraud class action claims. In re Navarre Corp. Sec. Litig., 299 F.3d 735, 741 (8th Cir. 2002). At the very least, the PSLRA encompasses the heightened pleading standards of Fed.R.Civ.P. 9(b). Kushner v. Beverly Enter., Inc., 317 F.3d 820, 826 (8th Cir. 2003.) As the Court indicated, Plaintiffs must "set forth specific facts demonstrating what [Defendants] knew or recklessly disregarded in issuing the allegedly false or misleading statements." (January 2004 Order at 13.) These allegations must "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." 15 U.S.C. § 78u-4(b)(2);Navarre, 299 F.3d at 741. Allegations of motive or opportunity alone are insufficient to establish scienter, but coupled with actual knowledge or recklessness, they bolster a plaintiff's showing of scienter. See In re Pemstar Sec. Litig., No. 02-1821, slip op. at 7 (D. Minn. Aug. 15, 2003) (Frank, J.).
B. RCC and Individual Defendants
Plaintiffs include one new paragraph of allegations against RCC and the Individual Defendants, setting forth the information that these defendants allegedly knew or reckless disregarded. (2d Am. Compl. ¶ 53.) Plaintiffs' reliance on four confidential witnesses is permitted, but the Court must look "at all the facts alleged to see if they provide an adequate basis for believing that the defendants' statements were false."In re Cabeltron Sys. Inc., 311 F.3d 11, 29-30 (1st Cir. 2002). The Court must evaluate "the level of detail provided by the confidential sources, the corroborative nature of the other facts alleged (including from other sources), the coherence and plausibility of the allegations, the number of sources, the reliability of the sources, and similar indicia." Id.
Plaintiffs allege that RCC and the Individual Defendants overstated RCC's intangible assets, improperly accounted for certain derivatives or hedge instruments, and improperly calculated the costs of dividends. None of the new allegations in paragraph 53 actually allege what information RCC or the Individual Defendants knew or recklessly disregarded in making the alleged improper accounting or disclosure decisions that are at issue. These allegations are completely unrelated to the alleged wrongful acts committed by RCC and the Individual Defendants. Moreover, allegations that business was "softening" or that competition was increasing do not support an inference of fraudulent wrongdoing. These facts are too attenuated to allow any reasonable inference of scienter by RCC and the Individual Defendants.
Plaintiffs also submit that the magnitude of the financial restatements support an inference of scienter. As RCC and the Individual Defendants point out, the January 2004 Order rejected Plaintiffs' "bald assertion that magnitude alone is sufficient for scienter purposes," because Plaintiffs failed to "put the restatements in perspective to RCC's overall operations and how those restatements impacted RCC's financial results." (January 2004 Order at 10.) Again, Plaintiffs fail to submit facts to indicate any relationship between the overstatement of intangible assets and revenues, operating income, or cash flow. Absent other "red flags," these allegations are insufficient to infer scienter.
Finally, Plaintiffs again contend that RCC and the Individual Defendants were motivated to commit fraud. Plaintiffs contend that RCC and the Individual Defendants were motivated to maintain loan covenant ratios, complete a note offering, and achieve personal financial gain. The Second Amended Complaint lacks allegations to sufficiently connect the allegedly false and misleading statements to these motivating factors. Absent sufficient allegations of what information RCC and the Individual Defendants either knew or recklessly disregarded, motive allegations alone cannot support a strong inference of scienter. Because Plaintiffs' allegations fail to support a strong inference of scienter against RCC or the Individual Defendants, Plaintiffs' against them must be dismissed with prejudice.
The Individual Defendants alternatively contend that the Second Amended Complaint lacks the requisite specificity against each Individual Defendant. In January, the Court declined to discuss the group pleading doctrine, and again declines to discuss it now. Plaintiffs' allegations against RCC are the same as the allegations made against the Individual Defendants. Because Plaintiffs' allegations against RCC fail as a matter of law, the allegations are likewise insufficient against the Individual Defendants.
C. Arthur Andersen
1. Primary Liability
The Court dismissed all allegations seeking to impose primary liability against Arthur Andersen as a secondary actor. Particularly, the Court determined as a matter of law that Arthur Andersen could be liable only for allegedly false statements that it actually made. (January 2004 Order at 13.) This ruling limited Arthur Andersen's liability to its 2001 audit opinion. Plaintiffs now attempt to attribute the May 2002 Prospectus to Arthur Andersen because the Prospectus included the 2001 audit that Arthur Andersen prepared.
The Court rejects Plaintiffs' argument. The 2001 audit opinion relates only to the 2001 financial statements, and in no way relates to the May 2002 Prospectus. Moreover, although Arthur Andersen consented to the inclusion of this audit opinion in the May 2002 Prospectus, Plaintiffs fail to allege what facts Arthur Andersen knew that would have indicated to Arthur Andersen that the May 2002 Prospectus was false and misleading. See Robin v. Arthur Young Co., 915 F.2d 1120, 1127-28 (7th Cir. 1990) (refusing to invoke primary liability because plaintiffs failed to allege facts to show how defendant auditor knew that the basis for its decision to consent to inclusion of report in prospectus was no longer sound); Danis v. USN Communications. Inc., 121 F. Supp.2d 1183, 1192 (N.D. Ill. 2000) (declining to impose auditor liability for inclusion of prior audit report in prospectus because prospectus contained unaudited financial information and auditor did not make statement with respect to that information); see generally Central Bank of Denver, N.A. v. First Interstate of Denver, N.A., 511 U.S. 164 (1994) (rejecting auditor liability and emphasizing that "the making of a material misstatement (or omission) or the commission of a manipulative act" is necessary to invoke auditor liability).
Plaintiffs also propose, for the first time at oral argument, that Arthur Andersen should be primarily liable for the allegedly false and misleading May 2002 Prospectus because of the June 10, 2002 Form 8-K. Plaintiffs submit that the June 10, 2002 Form 8-K, which informed investors that the relationship between Arthur Andersen and RCC had ceased, constitutes some sort of validation by Arthur Andersen of RCC's previous 2002 statements:
During the years ended December 31, 2001 and 2000 and through June 10, 2002, there were no disagreements with Andersen on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which, if not resolved to Andersen's satisfaction, would have caused it to make reference to the subject matter of the disagreements in connection with its report on the Company's consolidated financial statements for such years; and there were no "reportable events," as such term is defined in Item 304(a)(1)(v) of the Regulation S-K.
(RCC Form 8-K at 2.) The Court is unpersuaded. This 8-K statement is not included in the Second Amended Complaint, nor is it mentioned in Plaintiffs' briefs. Moreover, there are no allegations in the Second Amended Complaint to connect the May 2002 Prospectus to the June 10, 2002 Form 8-K, nor are there any allegations to connect Arthur Andersen to either of these statements. This argument is without merit. Arthur Andersen's liability is limited solely to its 2001 audit opinion.
2. Allegations of Scienter
Plaintiffs' Second Amended Complaint contains additional allegations against Arthur Andersen. However, these allegations generally set forth the same arguments as the previous Complaint. Plaintiffs include allegations based on Arthur Andersen's recent involvement in unrelated audit "failures," its dual role as auditor and consultant, and its alleged GAAS and GAAP violations, to support an inference of scienter. "[T]o allege that an independent accountant or auditor acted with scienter, the complaint must identify specific, highly suspicious facts and circumstances available to the auditor at the time of the audit and allege that these facts were ignored, either deliberately or recklessly." PR Diamonds. Inc. v. Chandler, 364 F.3d 671, 694 (6th Cir. 2004) (quoting SmarTalk Teleservs., Inc. Sec. Litig., 124 F. Supp.2d 505, 514 (S.D. Ohio 2000)).
Plaintiffs' allegations against Arthur Andersen fail to support a strong inference of scienter. Although Arthur Andersen performed both auditing and consulting functions for RCC, the alleged facts do not support that Arthur Andersen abandoned its obligation to maintain its independence. Plaintiff rely heavily on In re Global Crossing. Ltd. Secs. Litig., File No. 02-910, slip op. at 21, 2004 WL 763890 (S.D.N.Y. Mar. 23, 2004). In Global Crossing, the court determined that the plaintiffs' allegations against Arthur Andersen for its dual role as auditor and consultant were sufficient to survive a motion to dismiss. In that case, Arthur Andersen received about $12 million in consulting fees, nearly six times what it received as auditor. Id. at 21. In contrast, Arthur Andersen received audit and consulting fees from RCC of $270,000 and $581,000, respectively, in 2001, and $10,000 and $150,000 in 2002. (2d Am. Compl. ¶ 60.) These differences are insignificant compared to Global Crossing. See also In re Complete Mgmt. Inc. Sec. Litig., 153 F. Supp.2d 314, 334 (S.D.N.Y. 2001) (payment of auditor for auditing services and consulting services gave rise to allegation for motive or opportunity, because non-audit compensation was in excess of $1 million for the class period; these inferences coupled with other red flags established scienter). Finally, absent other "red flags," these allegations are insufficient to support an inference of scienter.
Plaintiffs' allegations that Arthur Andersen violated GAAS and GAAP standards are likewise insufficient. Plaintiffs allege that Arthur Andersen had access to internal RCC data and therefore Arthur Andersen knew that RCC's financial statements were false or misleading. These allegations lack any reference whatsoever to any specific or highly suspicious facts that Arthur Andersen knew or recklessly disregarded. The Second Amended Complaint lacks any specified allegation of the extent of Arthur Andersen's access or involvement with such allegedly confidential information at RCC. The mere allegation that Arthur Andersen had "access" to confidential information at RCC is insufficient to support a strong inference of scienter.
Finally, Plaintiffs' assertion that the magnitude of the restatements are sufficient to infer scienter. The $417 million restatement occurred in November 2002, long after the termination of RCC and Arthur Andersen's relationship, and therefore cannot be attributed to Arthur Andersen. As explained above, Plaintiffs also fail to indicate how this restatement of assets related to RCC's financial results. Both parties concede that the restatement did not affect previously reported revenues, operating income, earnings (EBITDA), or any of RCC's debt-related covenants in its credit agreement. "Plaintiffs may not place the square peg of the alleged `asset overstatement' into a round `financial restatement' hole." In re K-tel Int'l, Inc. Sec. Litig., 107 F. Supp.2d 994, 1004 (D. Minn. 2000) (Montgomery, J.). Taken as a whole, Plaintiffs' allegations against Arthur Andersen, at most, indicate mere negligence, not fraud. Failure to identify highly suspicious facts known to Arthur Andersen in 2001 are fatal to Plaintiffs' claims. As a matter of law, Plaintiffs' allegations against Arthur Andersen fail to support a strong inference of scienter, and thus Plaintiffs' claims fail.
D. Section 20(a) Liability
Plaintiffs' claim for control person liability under § 20(a) of the Exchange Act is derivative of their 10(b) claim. Plaintiffs have failed to state a claim under Section 10(b) of the Exchange Act. Therefore, Plaintiffs' claim for control person liability must also be dismissed.K-Tel, 107 F. Supp.2d at 1005.
CONCLUSION
Plaintiffs fail to satisfy the pleading requirements of the PSLRA. Accordingly, based on all the files, records and proceedings herein, IT IS HEREBY ORDERED that:
1. Defendant RCC and the Individual Defendants' Motion to Dismiss (Clerk Doc. No. 40) is GRANTED;
2. Defendant Arthur Andersen's Motion to Dismiss (Clerk Doc. No. 37) is GRANTED; and
3. Plaintiffs' Second Amended Complaint is DISMISSED with prejudice.
LET JUDGMENT BE ENTERED ACCORDINGLY.