SAM SPARKS, District Judge.
BE IT REMEMBERED on the 22nd of June 2016, the Court held a hearing in the abovestyled cause, and the parties appeared by and through counsel. Before the Court are Defendants EZCorp, Inc. and Mark Kuchenrither (Defendants)'s Motion to Dismiss [#32], Co-Lead Plaintiffs Wu Winfred Huang and John Rooney's Response [#33] in opposition, and Defendants' Reply [#37] in support. Having reviewed the documents, the arguments of the parties at the hearing, the governing law, and the file as a whole, the Court now enters the following opinion and orders.
This is a securities fraud class action brought on behalf of all persons who purchased Class A common stock
Defendants have moved to dismiss Plaintiffs' complaint, arguing Plaintiffs have failed to adequately plead scienter. Because the Court agrees with Defendants, their motion to dismiss is GRANTED.
EZCORP offers its customers multiple ways to access instant cash, including pawn
On January 12, 2012, EZCORP announced it was acquiring a 60% ownership interest in Grupo Finmart, a Mexican company which issues small consumer loans to Mexican governmental employees. Id. ¶ 3. According to EZCORP,
Id. ¶ 102. EZCORP has described Grupo Finmart's role in Mexico's payroll lending industry:
Id. ¶ 36 (quoting 2014 Form 10-K).
On June 30, 2014, EZCORP acquired an additional 16% of Grupo Finmart. Id. ¶ 34. On September 1, 2015, EZCORP purchased another 18% of Grupo Finmart, making it a 94% owner in Grupo Finmart. Id. ¶ 34. EZCORP now consists of three segments: (1) the United States and Canada segment, (2) the Latin America segment, and (3) the Other International segment.
Plaintiffs allege that throughout the Class Periods, Defendants' internal controls over financial reporting gave rise to two primary accounting errors: (1) the failure to adequately track non-performing loans (Non-Performing Loans), and (2) the failure to properly account for the structured asset sales (Loan Sales). Plaintiffs claim Kuchenrither "knew" of these accounting control issues, but nevertheless materially overstated EZCORP's financial results by misrepresenting the amount of non-performing loans in Grupo Finmart's loan portfolio and improperly recording gains from the sale of certain Grupo Finmart loans. Id. ¶¶ 6, 37, 105.
Plaintiffs allege Defendants failed to properly identify and record non-performing loans and improperly continued to accrue interest revenue on the non-performing loans. Nonperforming loans are "loans that were being carried as active loans but with respect to which Grupo Finmart was not currently receiving payments." Id. ¶ 105. Out-of-payroll loans are outstanding loans from customers who are no longer employed. Id. Pursuant to "Grupo Finmart's historic accounting policy," "[i]f one payment of an out-of-payroll loan is delinquent, that one payment is considered in default; if two or more payments are delinquent at any time, the entire loan is considered in default." Id. Upon default of an out-of-payroll loan, EZCORP ceased accruing future interest revenue. Id. However, "[d]ue to the likelihood of ultimately receiving payment if the customer remains employed, [Grupo Finmart] continue[d] to accrue interest on all in-payroll loans, even though Grupo Finmart may not be currently receiving payments." Id.
In its corrective disclosures, EZCORP determined Grupo Finmart's non-performing loans included a number of out-of-payroll loans that had not been properly classified as such. Id. This error resulted in an understatement of bad debt expense and an overstatement of accrued interest revenue in prior periods. Id. EZCORP further determined that many of the non-performing loans, while still in-payroll, had been in non-performing status for "some time." Id. Despite the loans' non-performing status, Grupo Finmart continued to accrue interest income on in-payroll loans over the stated life of the loans, such that "the period over which the interest income is actually received is longer than the stated loan term." Id. However, EZCORP later concluded "it is more appropriate to accrue and recognize interest income over the period that payments are actually received rather than over the stated term of the loan." Id.
Plaintiffs allege EZCORP sent its internal auditors to Mexico to conduct a pre-acquisition due diligence report of Grupo Finmart in early 2012. At the close of the investigation, EZCORP's internal audit team allegedly recommended against the purchase of Grupo Finmart in a series of written reports to senior management. Id. ¶ 4. The internal audit team purportedly believed Grupo Finmart's internal controls were "in such disarray that the internal audit team could not assess the value of the loan portfolio." Id. ¶ 44. Plaintiffs point to two specific examples of Grupo Finmart's poor internal accounting controls: (1) while investigating Grupo Finmart, the audit team never saw an accounts payable aging report—an account report which shows non-paying loans and the period of time during which they are non-paying—thereby making it impossible to accurately assess whether Grupo Finmart's customers were timely repaying their loans; and (2) the audit team allegedly found Grupo Finmart's collections system and recordkeeping so flawed that it took Grupo Finmart up to two years to realize its debtors had stopping making payments. Id. ¶¶ 4, 44, 58, 118, 119, 142.
Despite the internal audit reports supposedly notifying Kuchenrither of "significant red flags as to Grupo Finmart's operational and internal controls during the Class Period," Kuchenrither nevertheless certified EZCORP's internal controls were adequate throughout the Class Period. Id. ¶¶ 5, 42, 91, 120, 143-144.
According to Plaintiffs, in response to "the loan losses piling up at Grupo Finmart due to non-performing loans," Kuchenrither devised a plan to package and sell Grupo Finmart's loans to third-party investors in order to remove non-performing loans from EZCORP's books and allow EZCORP to record revenue and income from the sales. See Resp. [#33] at 9; Am. Compl. [#29] ¶¶ 6, 120. However, one confidential source, EZCORP's former Vice President of Internal Audit (CW1), claims to have told Kuchenrither that under the terms of the loan sale documents, the third-party investors retained a right to return non-performing loans to EZCORP. Id. Thus, if any of the sold loans defaulted, the third parties had the right to make EZCORP repurchase the loans. According to Plaintiffs, CW1 told Kuchenrither generally accepted accounting principles (GAAP) prohibited EZCORP from recognizing any revenue from the loan sales. Id. Despite Kuchenrither's apparent knowledge, EZCORP executed five separate sales of Grupo Finmart's loans in the 2014 fiscal year, recognizing $33 million in gains on these sales. Id. ¶¶ 7, 98. In the first quarter of 2015, EZCORP executed another loan sale, recognizing $6.6 million in income on this sale. Id. ¶¶ 7, 123. Plaintiffs claim the improper accounting for the sale of the loans had the effect of artificially boosting EZCORP's reported income in the 2014 fiscal year by 45% and its reported income during the first quarter of 2015 by 32%. Id. ¶7.
The statements Plaintiffs identify as misleading are taken from EZCORP's press releases, conference calls, and SEC forms disclosing EZCORP's financial results during the Class Period. These statements deal with EZCORP's financial results during the fourth quarter of 2012 (4Q12), the 2013 fiscal year (FY2013), the 2014 fiscal year (FY2014) and the first quarter of 2015 (1Q15). The alleged misstatements and omissions fall into two general categories: (1) reports which overstated EZCORP's financial results because EZCORP failed to track its non-performing loans, and (2) statements which misrepresented the nature of the loan sales by recording them as gains. A few examples of both categories will suffice.
First, Plaintiffs contend EZCORP's financial reports during the Class Period falsely misrepresented EZCORP's financial results, including its net income and earnings per share.
Second, Plaintiffs maintain Defendants misrepresented the loan sales by recording them as gains. For example, in a press release issued on January 28, 2014, EZCORP stated "[c]ash and cash equivalents, including restricted case, were $45 million at quarter-end, with debt of $252 million, including $106 million of Grupo Finmart third-party debt, which is non-recourse to EZCORP." Id. ¶ 62 (emphasis added); see also id. ¶ 69 ("Cash and cash equivalents . . . were $63 million at quarter-end, with debt of $228 million, including $145 million of Grupo Finmart fhird-party debt, which is non-recourse to EZCORP") (emphasis added); id. ¶ 72 (similar). Moreover, during an earnings conference call held on July 29, 2014, Kuchenrither described the loan sales as "true loan sales," expressly stating "it's a true profit" because "the risk associated with the loans passed to the buyer of the loans." Id. 75. He further stated the loan sales were not securitizations, but instead "truly an asset sale. I just want to make that distinction, because [it's] very important." Id. 76. According to Plaintiffs, the "asset sales" identified by Kuchenrither were not true asset sales and were improperly recorded as revenue by EZCORP in violation of GAAP. Id. ¶ 77.
On December 11, 2014, EZCORP hosted its 2014 Investor Day. Jodie Maccarrone, EZCORP's President of Global Financial Services, touted Grupo Finmart as EZCORP's growth center, specifically stating:
Id. ¶90. Plaintiffs contend these representations were misleading because EZCORP and Kuchenrither were aware of Grupo Finmart's significant operational and control issues. Id. ¶¶ 91.45, 51, 68, 72, 74.
Finally, throughout the Class Period, EZCORP filed its quarterly and annual reports with the SEC. Each of these forms (Forms 10-Q and 10-K) reaffirmed EZCORP's financial results previously announced in its press releases. Kuchenrither certified the reports did not contain any false statements of material fact or omit any material facts. See, e.g., id. ¶¶ 43, 47, 64.
Plaintiffs allege Defendants' corrective disclosures began on April 30, 2015, when EZCORP announced the release of its 2Q15 financial results would be delayed "due to an ongoing review of certain elements of its Grupo Finmart loan portfolio, which is not yet completed." Id. ¶99. Following this announcement, EZCORP's stock fell $0.79 per share to close at $8.41 per share on May 1, 2015. Id. ¶100.
On May 20, 2015, EZCORP filed its Form 8-K with the SEC, stating "we believe that it is likely that management and the Audit Committee will conclude that we have a material weakness in internal control over financial reporting and deficiencies in our disclosure controls and procedures." Id. ¶102. EZCORP further stated, "[w]e believe that failure to identify out-ofpayroll loans and failure to adequately track the aging of non-performing loans are control deficiencies that likely constitute a material weakness in our internal control over financial reporting." Id. Following this announcement, EZCORP's stock declined $0.66 per share to close at $8.33 per share on May 21, 2015. Id. ¶103.
On July 17, 2015, EZCORP issued a press release, which stated "[fjollowing a comprehensive review of the terms and conditions of each of the structured asset sales, management has determined that the asset sales should not have been accounted for as sales, principally due to certain control rights that Grupo Finmart retained as servicer of the loans." Id. ¶ 104. EZCORP further "identified a number of out-of-payroll loans that had not been properly classified and accounted for as such, causing an understatement of bad debt expense and an overstatement of accrued interest revenue in prior periods." Id. That same day, EZCORP filed its Form 8-K with the SEC, announcing it would restate its financial statements for FY2014, 1Q15, and possibly for periods prior to FY2014. Id. ¶ 105. Following this announcement, EZCORP's stock declined $0.26 per share to close at $6.48 per share on July 17, 2015. Id. ¶106.
On October 20, 2015, EZCORP issued a press release confirming it would restate its previously issued financial statements for FY2012 and FY2013. Id. ¶107. The restatement would correct errors relating to the accrued interest revenue associated with non-performing loans. Id. Following this announcement, EZCORP's stock declined $0.29 per share to close at $6.32 per share on October 20, 2015. Id. ¶ 108.
On November 9, 2015, EZCORP filed its restated financials from 2Q12 through 1Q15. Id. ¶ 110. The restatement dealt primarily with the two discrete issues identified above: (1) the non-performing loans and (2) the loans sales. Id. ¶137. In regards to Grupo Finmart's nonperforming loans, EZCORP explained "[management did not recognize the extent of the Grupo Finmart non-performing loans[,]" because:
Id. As to the improper accounting of the loan sales, EZCORP explained "[management reached incorrect conclusions with respect to proper accounting of the Asset Sales," because:
Id.
According to Plaintiffs, the restatement revealed EZCORP had:
Id. ¶ 198.
Following the restatement and correction of the accounting errors, EZCORP's stock declined $0.29 per share to close at $6.51 per share on November 9, 2015. Id. ¶ 166.
According to Plaintiffs, Kuchenrither knew or recklessly disregarded the possibility that the statements describing EZCORP's financial results were materially false and misleading when they were made. Plaintiffs rely on the following allegations to support a finding of Kuchenrither's scienter: (1) the size of the restatement, (2) statements from confidential witnesses, (3) Kuchenrither's Sarbanes-Oxley certifications, and (4) Kuchenrither's incentivebased bonus.
First, Plaintiffs contend the sheer magnitude of the restatement was highly suggestive of fraud. Id. ¶¶ 109, 112-14. Second, Plaintiffs rely on statements from three former employees in EZCORP's internal audit department (CW1, CW2, and CW3),
CW2, who was part of the internal audit team that visited Grupo Finmart every quarter to test its Sarbanes-Oxley compliance, stated the internal audit team was forced to resort to "black box testing" for loan balances in order to conclude Grupo Finmart was technically in Sarbanes-Oxley compliance. Id. ¶ 59. According to CW2, "black box testing" consists of simply verifying the reported numbers and ignoring the potentially questionable methods used to calculate those numbers. Id. Plaintiff also rely on statements from CW3, who alleges Kuchenrither knew Grupo Finmart's internal controls "were a mess" when he signed the Sarbanes-Oxley certifications. Id. ¶ 58. According to CW3, Kuchenrither was aware Grupo Finmart had no aging report to track bad debt, and there was no acceptable accounting methodology to determine whether Grupo Finmart was properly recording losses from non-performing loans. Id. ¶ 44. CW3 further stated "Grupo Finmart's records were in such disarray the team could not assess the value of the portfolio [,] and [] there were basic questions that Grupo Finmart employees could not answer that they should have been able to answer." Id. Based on CW2 and CW3's statements, Plaintiffs contend Kuchenrither had no reasonable basis to sign the Sarbanes-Oxley certifications. Id. ¶¶ 61, 143.
Finally, Plaintiffs contend it was Kuchenrither himself who fashioned a plan to package and sell Grupo Finmart's non-performing loans to third-party investors, which purportedly allowed EZCORP to remove the non-performing loans from its books and to record revenue and income from the sales, which in turn artificially boosted its reported earnings. Id. ¶6. Plaintiffs maintain Kuchenrither was motivated to inflate EZCORP's financials, because he received a bonus for developing this plan. Id. ¶ 149.
Federal Rule of Civil Procedure 8(a)(2) requires a complaint to contain "a short and plain statement of the claim showing that the pleader is entitled to relief." FED. R. Civ. P. 8(a)(2). A motion under Federal Rule of Civil Procedure 12(b)(6) asks a court to dismiss a complaint for "failure to state a claim upon which relief can be granted." FED. R. Civ. P. 12(b)(6). The plaintiff must plead sufficient facts to state a claim for relief that is facially plausible. Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009); Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007). "A claim has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged." Iqbal, 566 U.S. at 678. Although a plaintiffs factual allegations need not establish that the defendant is probably liable, they must establish more than a "sheer possibility" that a defendant has acted unlawfully. Id. Determining plausibility is a "context-specific task," and must be performed in light of a court's "judicial experience and common sense." Id. at 679.
In deciding a motion to dismiss under Rule 12(b)(6), a court generally accepts as true all factual allegations contained within the complaint. Leatherman v. Tarrant Cty. Narcotics Intelligence & Coordination Unit, 507 U.S. 163, 164 (1993). However, a court is not bound to accept legal conclusions couched as factual allegations. Papasan v. Allain, 478 U.S. 265, 286 (1986). Although all reasonable inferences will be resolved in favor of the plaintiff, the plaintiff must plead "specific facts, not mere conclusory allegations." Tuchman, 14 F.3d at 1067. In deciding a motion to dismiss, courts may consider the complaint, as well as other sources such as documents incorporated into the complaint by reference, and matters of which a court may take judicial notice. Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 322 (2007).
Section 10(b) of the Securities Exchange Act of 1934 empowers the SEC to promulgate rules to prevent manipulative or deceptive practices in the sale or purchase of securities. 15 U.S.C. § 78j(b). Under this grant of authority, the SEC issued Rule 10b-5, which makes it unlawful:
17C.F.R. §240.10b-5.
The Fifth Circuit has held the elements of a claim under § 10(b) are: (1) a misrepresentation or omission; (2) of a material fact; (3) in connection with the purchase or sale of a security; (4) scienter by the defendant; (5) justifiable reliance by the plaintiff; (6) damages; and (7) proximate cause. Rosenzweig v. Azurix Corp., 332 F.3d 854, 865 (5th Cir. 2003). To establish scienter, a plaintiff must show the defendant intended to deceive, defraud, or manipulate, or that the defendant acted with severe recklessness. Lormand v. US Unwired, Inc., 565 F.3d 228, 251 (5th Cir. 2009). Severe recklessness is limited to "highly unreasonable omissions or misrepresentations" involving an "extreme departure from the standards of ordinary care." Nathenson v. Zonagen, Inc., 267 F.3d 400, 408 (5th Cir. 2001).
Both Federal Rule of Civil Procedure 9(b) and the Private Securities Litigation Reform Act (PSLRA) impose a heightened pleading requirement on § 10(b) claims. FED. R. CIV. P. 9(b); 15 U.S.C. § 78u-4(b). Rule 9(b) requires plaintiffs alleging fraud or mistake to "state with particularity the circumstances constituting fraud or mistake." FED. R. CIV. P. 9(b). In order to avoid dismissal under Rule 9(b) for lack of particularity, the Fifth Circuit has held a plaintiff must:
Rosenzweig, 332 F.3d at 866.
The PSLRA dictates a more rigorous pleading standard for private securities fraud actions in two ways. First, in any such action alleging the defendant made an untrue statement of material fact or a misleading omission:
Id. (emphasis added). Based on the elements of a § 10(b) claim described above, it is clear that § 10(b) claims are subject to both of these requirements of the PSLRA.
In their motion to dismiss, Defendants contend Plaintiffs' 94-page amended complaint falls short of meeting the PSLRA's heightened pleading requirements, because the complaint fails to plead facts giving rise to a strong inference of scienter. Because the Court agrees with Defendants that Plaintiffs have failed to plead facts giving rise to a strong inference of scienter, Plaintiffs' complaint must be dismissed.
The United States Supreme Court has outlined a framework for courts to use in analyzing motions to dismiss § 10(b) complaints for failing to establish a "strong inference" of scienter. First, as in any other motion to dismiss, the court accepts all factual allegations in the complaint as true. Second, the court considers the entire complaint, other sources typically examined in a 12(b)(6) motion, sources incorporated by reference into the complaint, and matters of which a court may take judicial notice. Third, in determining whether the pleaded facts give rise to a "strong" inference of scienter, as required by the PSLRA, a court should consider all of the facts alleged, taken collectively, and should also take into account plausible opposing inferences. Tellabs, 551 U.S. at 322-23. The inference need not be irrefutable, nor even the most compelling of all competing inferences, but must be strong in light of other inferences. Id. at 324. Ultimately, a complaint will only survive if "a reasonable person would deem the inference of scienter cogent and at least as compelling as any opposing inference one could draw from the facts alleged." Id.
Plaintiffs assert the following allegations to support a strong inference of scienter: (1) the post-Class Period financial restatements themselves, (2) the confidential witnesses' allegations, (3) Kuchenrither's inaccurate Sarbanes-Oxley certifications, and (4) Kuchenrither's incentivebased bonus. The Court addresses each allegation in turn.
GAAP violations are insufficient in and of themselves to establish scienter, but can contribute significant weight to the analysis based on their "number, size, timing, nature, frequency, and context[.]" In re ArthroCare Corp. Sec. Litig., 726 F.Supp.2d 696, 721 (W.D. Tex. 2010) (citation omitted); see also Cent. Laborers' Pension Fund v. IntegratedElec. Serv. Inc., 497 F.3d 546, 552 (5th Cir. 2007) (finding a detailed description of GAAP violations and subsequent restatement "provide some basis to infer scienter"). Indeed "[m]any courts have held significant overstatements of revenue or income tend to support the conclusion that defendants acted with scienter." ArthroCare, 726 F. Supp. 2d at 721-22. "[C]ommon sense and logic dictate that the greater the magnitude of a restatement or violation of GAAP, the more likely it is that such a restatement or violation was made consciously or recklessly." In re MicroStrategy, Inc. Sec. Litig., 115 F.Supp.2d 620, 636 (E.D. Va. 2000)
In this case, Plaintiffs contend the sheer magnitude of the restatement warrants a departure from the general rule that the existence of a restatement does not support a strong inference of scienter. As alleged in the amended complaint, EZCORP overstated its net income by 52.9% in fiscal year 2013, 29.4% in fiscal year 2014, and 31% in the first quarter of 2015. Am. Compl. [#29] ¶ 12.
Plaintiffs insist EZCORP's overstatements to net income are much higher than the overstatements in City ofPontiac, where this Court found overstatements of 7.8% in 3Q13, 41% in 1Q14, and 8.3% in 2Q14 provided "some basis from which to infer scienter," and are comparable to ArthroCare, where this Court found overstatements of 98.9% in 2007, 12.6% in 2006, and 19% in 2005 "significantly contribute[d] to a finding of scienter." City ofPontiac Gen. Emps.' Ret. Sys. v. Asar et. al, No. A-14-CA-1026-SS, slip op. at 25 (W.D. Tex. April 1, 2016); ArthroCare, 726 F. Supp. 2d at 722. The Court finds the present case lies somewhere between City of Pontiac and Arthrocare, and therefore concludes the overstated income and revenues figure provide some basis from which to infer scienter. See, e.g., MicroStrategy, Inc., 115 F. Supp. 2d at 637 (concluding some inference of scienter was warranted where company overstated revenue by $66 million over a three-year period, had actually been operating at a loss, and overstatement occurred because revenue was recognized on company's three largest unexecuted contracts).
As noted above, the restatement addressed two discrete issues: (1) non-performing loans and (2) the loan sales. To support an inference of scienter regarding these discrete issues, Plaintiffs rely on CW1 and CW3's allegations.
"Following Tellabs, courts must discount allegations from confidential sources." Ind. Elec. Workers' Pension Trust Fun IBEWv. Shaw Grp., Inc., 537 F.3d 527, 535 (5th Cir. 2008). To be given any weight, confidential sources must be described "with sufficient particularity to support the probability that a person in the position occupied by the source . . . would possess the information pleaded." ABC Arbitrage Plaintiffs Grp. v. Tchuruk, 291 F.3d 336, 353 (5th Cir. 2002). The complaint should give details such as the person's job description, individual responsibilities, and specific employment dates. Cent. Laborers' Pension Fund, 497 F.3d at 552. Furthermore, plaintiffs must allege with particularity when a comment was made to a confidential source, or, if the source alleges a conversation took place, when and where the conversation occurred. Ind. Elec, 537 F.3d at 538; Southland Sees. Corp. v. INSpire Ins. Sols., Inc., 365 F.3d 353, 382 (5th Cir. 2004).
In light of the Fifth Circuit's clear directive to view confidential witnesses with some level of skepticism, the Court finds CW3's allegations insufficient to support an inference of scienter. Plaintiffs claim Kuchenrither knew Grupo Finmart incorrectly accounted for certain non-performing loans, because CW3 states "a series of written reports sent to senior management" indicated Grupo Finmart's accounting controls were "a mess" and recommended against EZCORP's acquisition of Grupo Finmart. Am. Compl. [#29] ¶4. These written reports resulted from an internal audit which occurred sometime between one and three months before the Grupo Finmart transaction closed on January 30, 2012. Id. ¶¶ 3, 4, 34. Notably, however, Plaintiffs have failed to show CW3 possessed personal knowledge regarding the internal audit or the reports it generated, because according to Plaintiffs, CW3 did not even work in EZCORP's internal audit department until October 2012, several months after the Grupo Finmart transaction closed and the audit reports were allegedly sent to senior management. Id. ¶32. Without personal knowledge of the events CW3 describes, the Court finds CW3's statements unreliable. See, e.g., Partners, LLC v. Digimarc Corp., 552 F.3d 981, 995 (9th Cir. 2009) (concluding only those statements which are reported by confidential witnesses with "sufficient reliability and personal knowledge" support an inference of scienter); In re Vertex Pharm. Inc. Sec. Litig., 357 F.Supp.2d 343, 353 (D. Mass. 2005) (concluding the plaintiffs' allegations did not establish a strong inference of scienter, where "none of the [confidential witnesses] claims to have personal knowledge of the most important facts they allege").
Moreover, Plaintiffs have failed to specify the contents of the reports beyond a vague allegation that they described Grupo Finmart's accounting controls "as a mess." Am. Compl. [#29] ¶ 4. Such vague allegations are insufficient to support an inference of scienter. See Abrams v. Baker Hughes Inc., 292 F.3d 424, 433 (5th Cir. 2002) (allegations regarding non-specific internal reports "must have corroborating details regarding the contents of [the] reports"). CW3 goes on to claim Grupo Finmart's records "were in such disarray that the team could not assess the value of its loan portfolio," and "Grupo Finmart had no aging report for its loans . . . to track bad debt, making it impossible to determine whether and when loans were in default." Am. Compl. [#29] ¶4. Notably absent from CW3's statements, however, is any allegation that these alleged deficiencies were included in the reports.
Furthermore, even assuming the report contained the requisite level of detail, Plaintiffs have failed to specifically allege Kuchenrither actually saw the report. Instead, CW3 simply states the report was "sent to senior management," but does not provide any information as to whether "senior management" included Kuchenrither, who did not assume the position of CFO until October 2012 and was not even promoted to Executive Vice President until May 2012. Am. Compl. [#29] ¶¶ 4, 28. Accordingly, CW3's statements are too vague to permit an inference of scienter. See Abrams, 292 F.3d at 432 (concluding the plaintiffs' allegations failed to "reach the required standard" for scienter where the plaintiffs "point[ed] to no allegations that the defendants knew about the internal control problems, only that they should have known").
Likewise, the Court finds CWl's allegations insufficient to support an inference of scienter. Plaintiffs claim Kuchenrither knew or should have known the loans could not be accounted as "true asset" sales because CWl supposedly told Kuchenrither doing so was a violation of ASC 860-10-40-5. According to CWl, this conversation occurred "in October or November 2013." Am. Compl. [#29] ¶ 6. However, CWl's statements lack sufficient indicia of reliability to give rise to a strong inference of scienter, because neither CWl nor Plaintiffs provide the Court with any further specifics as to "when and where the conversation occurred."
Based on the foregoing, the Court concludes the confidential witness statements are either not indicative of scienter or so vague and unreliable as to be unpersuasive.
Kuchenrither's Sarbanes-Oxley certifications provide little, if any, additional support for an inference of scienter. An officer's Sarbanes-Oxley certification on an SEC financial report is not, standing alone, indicative of scienter, but may provide support for such an inference where the officer had reason to know or suspect the financial statements contained material inaccuracies "due to the presence of glaring accounting irregularities or other `red flags[.]'" See Cent. Laborers' Pension Fund, 497 F.3d at 554-55.
In an attempt to demonstrate it has pled such "red flags," Plaintiffs point to CW2's statement that the audit team had to resort to "black box" testing in order to find Grupo Finmart Sarbanes-Oxley-certified.
Without any specific allegations Kuchenrither knew about the "black box testing"—even assuming this constitutes an accounting violation—the pleadings are too vague to permit an inference of scienter. See, e.g., In re Dell Inc., Sees. Litig., 591 F.Supp.2d 877, 894 (W.D. Tex. 2008) (concluding the plaintiffs failed to plead a strong inference of scienter where the "Individual Defendants oversaw accounting functions, had unfettered access to information, and approved high-level decisions, but [the plaintiffs] allege[d] nothing specific about what the Individual Defendants knew or intended"),
Plaintiffs attempt to show a strong inference of scienter based on CWl's assertion that Kuchenrither was motivated to inflate Grupo Finmart's financials because Kuchenrither's compensation was partially tied to EZCORP's performance. According to Plaintiffs, Kuchenrither received a $350,000 bonus in 2014 for developing a plan "to address [EZCORP's] challenges over the next several quarters" by selling a portion of Grupo Finmart's loans to thirdparty investors. Am. Compl. [#29] ¶ 149.
As an initial matter, CW1 is the sole source of this information, and Plaintiffs have provided no basis why CW1—a former Vice President of Internal Audit—would be privy to Board of Directors' discussions regarding executive compensation and bonuses. Moreover, standing alone, the alleged desire to increase compensation does not support a strong interference of scienter. Indeed, as the Fifth Circuit has noted,
Tuchman, 14 F.3d at 1068-69 (quoting lower court's holding in Tuchman v. DSC Commc'ns Corp., 818 F.Supp. 971, 976 (N.D. Tex. 1993)). While "[incentive compensation packages may be considered in conjunction with other scienter allegations, [] only in an extraordinary case is it probative." Ind. Elec, 537 F.3d at 544 (internal citations omitted). Kuchenrither's $350,000 bonus is by no means sparing, but neither is it extraordinary. "[A]s a motivation to fraud," it is minor. See id.
Finally, because Plaintiffs have filed to state a claim for any predicate securities fraud violation under § 10(b), Plaintiffs have necessarily failed to state a claim against Defendants for "controlling person" liability under § 20(a). The Court therefore dismisses Plaintiffs' § 20(a) claims. See ABC Arbitrage, 291 F.3d at 362 n. 123.
Because Plaintiffs failed to properly allege a violation of the federal securities law, Plaintiffs' claims against EZCORP and Kuchenrither are properly dismissed.
Accordingly,
