Opinion
Case Number C-01-21029-JF (RS), [Doc. Nos. 155, 170, 174, 176 and 180].
February 7, 2005
Before the Court are motions to dismiss brought by Defendants Jeremy Lent ("Lent"), John Hashman ("Hashman"), Bruce Rigione ("Rigione"), Yinzi Cai ("Cai"), and Safi Qureshey ("Qureshey"), as well as Lent's motion for leave to use the OCC's 2000 Exam Report in connection with his motion to dismiss. The Court has considered the moving and opposing papers as well as the oral arguments presented at the hearing on October 15, 2004. For the reasons discussed below, the motions to dismiss will be granted with leave to amend and the motion for leave to use the 2000 Exam Report will be denied without prejudice.
I. BACKGROUND
This is a stock-drop securities class action suit originally filed against NextCard, Inc. ("NextCard") and several of its officers and directors. The Court has consolidated a number of actions into this one, and Plaintiffs filed the operative first amended consolidated class action complaint ("FAC") on April 23, 2004, alleging the following:NextCard was an Internet-based provider of consumer credit that offered an online credit approval system for a Visa card through its wholly-owned subsidiary, NextBank. Between April 19, 2000 and October 30, 2001 ("the class period"), NextCard and several of its officers and directors made false or misleading statements to the market indicating that the Internet credit card business was a success and was growing at a dramatic rate. SAC at ¶ 5. In reality, the company was materially overstating earnings, capital and regulatory capital. Id. Specifically, the company: (1) failed to establish sufficient loan loss allowances; (2) improperly capitalized credit card acquisition costs; (3) improperly excluded more than $1 billion of securitized loans from risk weighted assets in violation of federal banking regulations; and (4) improperly classified certain loan loss allowances as "fraud losses," which had the effect of misleading investors about the credit quality of the company's loans. Id. at ¶ 7.
For ease of reference, NextCard and NextBank are referred to collectively as "NextCard" or "the company."
The Office of the Comptroller of the Currency ("OCC") concluded its first annual examination of the company in September 2000. FAC at ¶ 8. The OCC made "adverse examination findings," for example, that the company had failed to identify the extent of its credit quality problems and that its risk management policies and procedures were inadequate. Id. As a result of these adverse findings, the OCC insisted that the company execute a "Capital Assurance Agreement" that required the company to maintain regulatory capital at 12% of risk weighted assets, rather than the 8% required by federal banking regulations. Id. Defendants concealed the OCC's adverse examination findings and the October 2000 Capital Assurance Agreement and continued to make bullish statements about the company's business. Id. at ¶ 9.
The OCC began its second annual examination of the company in May 2001 and discovered that the company had not cured the problems noted in the prior examination. FAC at ¶ 10. The OCC additionally determined that the company was operating in an unsafe and unsound manner and that there was no reasonable prospect for the company to become adequately capitalized without federal assistance. Id. On October 31, 2001, the company announced that it was (1) substantially increasing loan loss allowances; (2) tightening underwriting criteria by limiting new account originations to FICO scores above 680; (3) suspending other lending activities; (4) reclassifying previously recognized fraud losses as credit losses; and (5) increasing risk weighted assets by more than $500 million. Id. at ¶ 11. As a result of these actions, the company could not meet regulatory capitalization requirements and retained Goldman, Sachs Co. to explore a sale of the company. Id.
These disclosures caused NextCard's stock to decline 84% to $.87 per share. FAC at ¶ 12. On February 7, 2002, the OCC closed NextBank and appointed the FDIC as Receiver. Id. at ¶ 13. NextCard declared bankruptcy on November 14, 2002. Id. The OCC, FDIC and SEC initiated separate investigations into the events leading up to the company's demise. Id. at ¶ 15.
Based upon the above allegations, Plaintiffs allege claims against Defendants Lent Hashman, Rigione, Cai and Qureshey pursuant to §§ 10(b) and 20(a) of the Securities Exchange Act of 1934 ("Exchange Act"). Defendants move to dismiss these claims, asserting among other things that Plaintiffs have distorted the contents of the OCC's 2000 Exam Report, which was not in fact adverse.
Plaintiffs do not assert claims against NextCard because of the company's bankruptcy. Plaintiffs have reached settlement with respect to claims against NextCard's outside auditor, Ernst Young, LLP.
Defendant Lent also seeks Court approval to rely upon the 2000 Exam Report in seeking dismissal of the FAC and alternatively moves to strike any references to the Report from the FAC if he is not permitted to rely upon it. Early in the litigation, Defendants moved for leave to use the OCC's 2000 Exam Report in connection with a future motion to dismiss. The Court denied that motion without prejudice in an order issued September 17, 2003, because it was not clear whether the OCC had been afforded an opportunity to make a final agency decision with respect to Defendants' administrative request for access to the 2000 Exam Report. The OCC subsequently issued a final agency decision denying Defendants' request for leave to use the 2000 Exam Report. On May 5, 2004, Defendant Lent filed a renewed motion for leave to use the 2000 Exam Report. On June 25, 2004, the Court issued an order deferring consideration of that motion until after the hearing on the instant motions to dismiss. The Court directed the OCC to provide a copy of the 2000 Exam Report for the Court's in camera review. The OCC provided the report on July 2, 2004. Lent's motion therefore is ripe for decision.
II. DISCUSSION
A. Motion For Leave To Use The OCC's 2000 Exam Report
The Court agrees with Defendant Lent that it would be unfair to permit Plaintiffs to go forward with claims based in part upon allegations that the OCC's 2000 Exam Report was "adverse" while at the same time prohibiting Defendants from referencing the Report in order to support their contention that the Report was not in fact adverse. This conclusion leaves the Court in a somewhat difficult position, given the OCC's refusal to grant permission for Defendants to use the Report and the Court's reluctance to interfere with a regulatory decision of this type. The Court need not resolve the issue at this time, however, because even accepting Plaintiffs' characterization of the Report, the Court concludes that Plaintiffs have failed to state a claim under either § 10(b) or § 20(a). Accordingly, the Court will deny Defendant Lent's motion for leave to use the Exam Report without prejudice to a renewed motion in the event Plaintiffs cure the pleading defects discussed below.
B. Scope Of Section 10(b) And Rule 10b-5
Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act") makes it unlawful for any person, by means of any instrumentality of interstate commerce, the mails, or any facility of any national securities exchange, to use or employ "any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe" in connection with the purchase or sale of any security registered on a national securities exchange. 15 U.S.C. § 78j(b). Rule 10b-5, promulgated by the Securities and Exchange Commission ("SEC") under § 10(b), makes it unlawful to: (a) "employ any device, scheme or artifice to defraud"; (b) "make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading"; or (c) "engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person in connection with the purchase or sale of any security." 17 C.F.R. § 240.10b-5.
As interpreted by the United States Supreme Court, these provisions impose liability on persons who "commit a manipulative or deceptive act in connection with the purchase or sale of securities." Central Bank of Denver v. First Interstate Bank of Denver, N.A., 511 U.S. 164, 166 (1994). While recognizing that the language of Rule 10b-5 could be construed to impose liability for other types of conduct — for example, aiding or abetting a primary violation of § 10(b) — the court held that liability under Rule 10b-5 cannot extend beyond that imposed by § 10(b). Id. at 173. Accordingly, the court concluded that only two types of conduct give rise to liability under § 10(b): (1) the making of a material misstatement or omission or (2) the commission of a manipulative act. Id. at 177.
With respect to the first type of conduct, the making of a material misstatement or omission, the elements of a § 10(b) claim are: (1) a misrepresentation or omission (2) of a material fact (3) made with scienter (4) on which the plaintiff justifiably relied (5) that proximately caused the alleged loss. Binder v. Gillespie, 184 F.3d 1059, 1063 (9th Cir. 1999).
With respect to the second type of conduct, the commission of a manipulative act, the pleading standards are less clear. The Supreme Court has held that a broker's conversion of securities from a customer's investment account gives rise to a § 10(b) claim. See SEC v. Zandford, 535 U.S. 813, 820 (2002). So does insider trading. See United States v. O'Hagan, 521 U.S. 642, 652 (1997) (holding that an insider who trades on material, non-public information in breach of a fiduciary duty to the corporation may be held liable under § 10(b) and Rule 10b-5). While the cases addressing insider trading sometimes refer to a "deceptive device" rather than a "manipulative act," see id., liability under this theory is not based upon the making of a material misstatement or omission but upon the breach of the relationship of trust and confidence existing between a corporation's shareholders and persons who have obtained confidential information by reason of their position within that corporation, id.
In the instant case, Plaintiffs' § 10(b) claim is based upon "fraud on the market." Specifically, Plaintiffs assert that the market was misled by Defendants' misrepresentations regarding the success of the company's Internet credit card business. Under the holding of Central Bank, discussed above, only "primary" actors may be held liable under § 10(b). Central Bank, 511 U.S. at 191. In a misrepresentation case, "primary" actors are those who make or at least substantially contribute to the drafting of the allegedly misleading statements. See In re Homestore.com, Inc. Sec. Litig., 252 F.Supp.2d 1018, 1041 (2003) (holding that § 10(b) extends only to those "connected in some material way to the drafting of the statements made to the investing public"). Accordingly, the Court must look to the statements of each individual defendant in order to determine whether Plaintiffs have stated a claim against that defendant under § 10(b).
Plaintiffs cite No. 84 Employer-Teamster Joint Council Pension Trust Fund v. America West Holding Corp., 320 F.3d 920 (9th Cir. 2003), for the proposition that a defendant may be held liable under § 10(b) even though the defendant did not make any of the alleged misleading statements. In that case, the plaintiffs brought a "fraud on the market" securities class action against America West Airlines and several of its officers, directors and shareholders. Specifically, the plaintiffs alleged that the defendants made misleading statements that artificially inflated the value of America West's stock and engaged in insider trading while the stock was so inflated. Two defendants sought dismissal of the § 10(b) claims against them on the basis that they did not make any of the allegedly misleading statements. The Ninth Circuit rejected this argument, citing O'Hagan, supra, for the proposition that insider trading "qualifies as a `deceptive device' under § 10(b) . . . because a relationship of trust and confidence [exists] between the shareholders of a corporation and those insiders who have obtained confidential information by reason of their position with that corporation." America West, 320 F.3d at 937 (quoting O'Hagan, 521 U.S. at 652). Based upon this authority, the court held that the fact that the two defendants in question did not make any of the allegedly misleading statements did "not shield them from liability." Id.
This reasoning is somewhat confusing, because it does not appear that the plaintiffs in America West were asserting an insider trading claim. To the contrary, it appears that the plaintiffs were asserting only a misrepresentation/omission claim under a "fraud on the market" theory. Accordingly, while the court correctly stated the legal rule that insider trading may give rise to liability under § 10(b), it then appears to have made a logical leap in concluding that as a result a misrepresentation/omission claim may be asserted against a defendant who has not made or contributed to the subject misrepresentation or omission. Another panel of the Ninth Circuit has held that in the context of a misrepresentation/omission claim, "stock sales are helpful only in demonstrating that certain statements were misleading and made with knowledge or deliberate recklessness when those sales are able to be related to the challenged statements." In re Vantive Corp. Sec. Litig., 283 F.3d 1079, 1093 (9th Cir. 2002). The America West decision does not discuss this holding or the holding of Central Bank that only primary actors may be held liable under § 10(b). Because the Supreme Court's decision on this issue is controlling, this Court concludes that § 10(b) misrepresentation/omission claims cannot be maintained against defendants who neither make nor contribute to the drafting of the allegedly misleading statements despite the seemingly contrary holding of America West.
C. Pleading Standards For § 10(b) Claim Based Upon Misrepresentation/Omission
Claims asserted under the Exchange Act as amended by the Private Securities Litigation Reform Act of 1995 ("Reform Act"), Pub.L. No. 104-67 (1995), must meet heightened pleading requirements. For example, a claim based upon a material misrepresentation or omission must "specify each statement alleged to have been misleading" as well as "the reason or reasons why the statement is misleading." 15 U.S.C. § 78u-4(b)(1)(B). If an allegation regarding the statement or omission is made on information and belief, the complaint "shall state with particularity all facts on which that belief is formed." Id. In addition, a claim based upon a material misrepresentation or omission 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). When a claim is based upon a forward-looking statement, the required state of mind generally is "actual knowledge" that the statement is false or misleading. 15 U.S.C. § 78u-5(c)(1)(B). Otherwise, the required state of mind is, at a minimum, "deliberate recklessness." In re Silicon Graphics Inc. Sec. Litig., 183 F.3d 970, 977 (1999).
In order meet the pleading standard for scienter, the plaintiff "must provide, in great detail, all the relevant facts forming the basis of her belief." Silicon Graphics, 183 F.3d at 985. "`[T]he complaint must contain allegations of specific contemporaneous statements or conditions that demonstrate the intentional or deliberately reckless false or misleading nature of the statements when made.'" In re Read-Rite Corp. Sec. Litig., 335 F.3d 843, 846 (9th Cir. 2003) (quoting Ronconi v. Larkin, 253 F.3d 423, 432 (9th Cir. 2001)). It is insufficient that the allegations raise a "reasonable inference" that the defendants acted with the requisite state of mind; the allegations must be sufficiently particularized to raise a "strong inference." Id. at 848-49.
In Silicon Graphics, the plaintiff alleged that the company's internal reports alerted the defendant officers to serious production and sales problems. These allegations were insufficient to meet the heightened pleading standard because the plaintiff failed to allege sufficient corroborating details, such as the sources of her information regarding the reports, how she learned of them, who drafted them, and which officers received them. Silicon Graphics, 183 F.3d at 985. The court held that in the absence of such specifics, it could not determine whether there was any basis for the plaintiff's allegations that the defendants had knowledge of internal problems that would render the subject optimistic statements misleading. Id.
Unusual or suspicious stock sales may constitute circumstantial evidence of scienter. Silicon Graphics, 183 F.3d at 986. However, "insider trading is suspicious only when it is `dramatically out of line with prior trading practices at times calculated to maximize the personal benefit from undisclosed inside information.'" Id. (quoting In re Apple Computer Sec. Litig., 886 F.2d 1109, 1117 (9th Cir. 1989)). A plaintiff relying upon stock sales therefore must allege specific facts regarding the circumstances of the alleged stock sales, such as the amount of shares sold, the percentage of shares sold in comparison to the volume of shares that could have been sold, the timing of the sales and whether the sales were consistent with prior trading history. Id. When determining the percentage of shares sold, stock options must be considered; there is no reason to distinguish vested stock options from shares because the former easily can be converted to shares and sold immediately. Id.
D. Insufficiency Of § 10(b) Claim Asserted In This Case
Plaintiffs' § 10(b) claim fails to meet these heightened pleading requirements. The allegations with respect to each defendant are addressed in turn as follows:
1. Lent
Lent co-founded NextCard with his wife in 1996. He was the Chairman of the Board of Directors from that time through the class period. He also served as NextCard's President from 1996 until March 2000, and its CEO from 1996 until August 2000. In August 2000 he became the company's chief strategy officer. He is alleged to have made the following statements:
(a) April 19, 2000 press release (FAC at ¶ 119): Lent is quoted in the press release as making extremely positive statements about the company's success, including characterizing the quarter as "another outstanding achievement"; stating that NextCard was "continuing to build the foundation of a highly profitable business at a dramatic growth rate"; and stating that the company expected to originate one billion dollars in new loans in 2000.
(b) June 27, 2000 analyst report (FAC at ¶ 122): on June 27, 2000, UBS Warburg analyst Diane B. Glossman issued a report based in part upon a presentation Lent gave the previous day at UBS Warburg's Global Financial Services Conference. Glossman stated that during his presentation Lent represented that NextCard used "data-mining and other technologies to selectively target a strong credit demographic on the Web"; that NextCard's margin was "healthy at 5.9%"; and that NextCard would "break-even in early 2002 . . . without raising additional capital."
(c) July 27, 2000 press release (FAC at ¶ 124): Lent is quoted in the press release as making positive statements, including that the company's "business fundamentals drove another outstanding quarter"; that the strength of the company's business model contributed to its success; and that the company expected to break even in late 2001, a full year earlier than predicted when NextCard went public.
(d) Form 10-Q for Q1 2000 (FAC at ¶ 120): Lent signed the Form 10-Q, stated the company's financial results and that the results were presented in conformity with generally accepted accounting principles ("GAAP").
(e) Form 10-K for Fiscal 2000 (FAC at ¶ 140): Lent signed the Form 10-K, which contained positive statements about the company as well as numerous accounting specifics.
Plaintiffs have failed to allege facts demonstrating that these statements were false or misleading when made, or giving rise to a strong inference that Lent had the requisite scienter. For example, with respect to the April 19, 2000 press release, Plaintiffs allege that Lent's statements were false because "defendants knew" among other things that the company's financials were not prepared in accordance with GAAP, that the company had overstated income as a result of improper classification of certain loan loss allowances as "fraud losses" and that the company was not properly capitalized. FAC at ¶ 121. These allegations of falsity and knowledge are entirely conclusory. Plaintiffs do not reference any particular documents or other sources of information for their conclusory allegations. Moreover, the allegations are phrased in terms of "defendants" collectively and do not allege what Lent knew at the time he made the statements. Id.
Taking another example, with respect to the statements reported in the July 27, 2000 analyst's report, Plaintiffs allege that Lent knew the statements were false and misleading because "Lent knew that NextCard had lowered required FICO scores to increase application approval rates, lower acquisition costs and increase growth." FAC at ¶ 123. Plaintiffs further allege that Lent "knew" that lowering FICO scores targeted a weaker credit demographic and that he "knew that NextCard's ability to attain profitability was dependant on the continuation of defendants' fraud." Id. Plaintiffs do not allege any factual basis for their allegations regarding what Lent "knew," such as reports he may have seen, conversations he may have had, or the like.
The Court notes that toward the beginning of the complaint, Plaintiffs make reference to the OCC's 2000 Exam Report, the 2000 Capital Assurance Agreement, the OCC's 2001 Exam Report, the statements of eight confidential witnesses and various documents, including internal emails, reports and workpapers. See FAC at ¶¶ 44-68. It is possible that Plaintiffs are relying upon these documents and witness statements as a basis for alleging that Lent and the other defendants "knew" certain facts that are alleged conclusorily later in the FAC. However, it is not the Court's responsibility to scour the fact-intensive allegations of these earlier paragraphs in an attempt to determine whether Lent or any of the other defendants is alleged to have seen a particular document or attended a particular meeting. It is Plaintiffs' burden to connect the dots by clearly alleging particularized facts demonstrating why each statement was false or misleading when made and giving rise to a strong inference that the speaker had the requisite scienter. Plaintiffs have not done so here.
As discussed above, allegations of stock sales can give rise to an inference of scienter. Plaintiffs allege that Lent sold 14.55% of his holdings during the class period. FAC at ¶ 115. This is insufficient to raise a strong inference of scienter. See Vantive, 283 F.3d at 1094-95 (sales of 13% and 26% of holdings not suspicious); Ronconi v. Larkin, 253 F.3d 423, 425 (9th Cir. 2001) (sale of 17% of stock not suspicious). Moreover, although Plaintiffs allege that the company's stock price steadily declined over time, Lent is not alleged to have sold any stock until approximately ten months into the class period. Plaintiffs have not alleged that his sales were out of line with his prior selling practices.
2. Hashman
Hashman was NextCard's CFO from August 1999 through August 2000, and its president and CFO from March 2000 through August 2000. In August 2000 he took over from Lent as CEO and held that position through the end of the class period. Hashman is alleged to have made the following statements:
(a) Form 10-Q for Q1 2000 (FAC at ¶ 120): Hashman signed the Form 10-Q, which stated the company's financial results and that the results were presented in conformity with GAAP.
(b) Form 10-Q for Q2 2000 (FAC at ¶ 125): Hashman signed the Form 10-Q, which stated the company's financial results and that the results were presented in conformity with GAAP.
(c) September 11, 2000 press release (FAC at ¶ 127): Hashman is quoted as stating that NextCard's achievement of certain milestones, exceeding $1 billion in loans outstanding and 500,000 customer accounts, was validation that the company's business model for credit card issuance on the Internet was working, and that the company continued to apply "stringent credit and risk management standards" as it closed in on its profitability target for Q4 2001.
(d) September 11, 2000 analyst report (FAC at ¶ 128): Hashman is quoted as stating that "credit quality is well under control."
(e) October 19, 2000 press release (FAC at ¶ 130): Hashman is quoted as stating that the "key economic drivers" of the business were progressing ahead of schedule and that the company was "building the platform for a very profitable business."
(f) October 25, 2000 press release (FAC at ¶ 131): Hashman is quoted as stating once again that the "key economic drivers" of the business were progressing ahead of schedule and that the company was "building the platform for a profitable business."
(g) Form 10-Q for Q3 2000 (FAC at ¶ 132): Hashman signed the Form 10-Q, which made positive statements about the company and stated that the company's financial results were presented in conformity with GAAP.
(h) November 2, 2000 press release (FAC at ¶ 134): Hashman is quoted as stating that NextCard expected to reach profitability by the end of 2001, a full year earlier than originally projected.
(i) December 19, 2000 press release (FAC at ¶ 138): Hashman is quoted as stating that the company's business model "continues to outperform," and that the company's outlook "grows stronger with each quarter."
(j) January 24, 2001 press release (FAC at ¶ 139): Hashman is quoted as stating that the company is consistently ahead of expectations and is "on-track" to achieve profitability by the end of 2001. He also stated that the company's ability to grow rapidly and efficiently was a "testament" to its "leading technology platform and strong execution."
(k) Form 10-K for Fiscal 2000 (FAC at ¶ 140): Hashman signed the Form 10-K, which contained positive statements about the company as well as numerous accounting specifics.
(l) April 25, 2001 press release (FAC at ¶ 142): Hashman is quoted as stating that the company was "on track" to meet its profitability goal by the end of 2001, and attributing the company's rapid and efficient growth to its "industry-leading technology platform" and "strong execution."
(m) June 26, 2001 press release (FAC at ¶ 145): Hashman is quoted as stating that the company was on track to meet its stated goal of break-even by the end of 2001, and that the company's business strategy was allowing it to build the foundation for a large and profitable business.
(n) July 25, 2001 press release (FAC at ¶ 147): Hashman is quoted as stating that the "key drivers" of the business were progressing ahead of expectation, that the company's new version of a proprietary credit scorecard had yielded good delinquency trends, and that the company was on track to meet its goal of profitability by the end of 2001.
The allegations regarding Hashman's statements suffer from the same defects as the allegations regarding Lent's statements. Plaintiffs allege the falsity of each statement in conclusory fashion. For example, with respect to the Form 10-Q for Q1 2000, Plaintiffs allege that "defendants knew" that the company's financials were not prepared in accordance with GAAP. FAC at ¶ 121. Plaintiffs do not allege what portions of the financials were not prepared in accordance with GAAP, what accounting principles were violated or what documents or other evidence demonstrates the GAAP violations. Id. Moreover, most of the scienter allegations address the knowledge of "defendants" collectively. Id. When Plaintiffs do allege that Hashman in particular knew that his statements were false when made, they do so in conclusory fashion.
The Court has reviewed the allegations of falsity and scienter with respect to all of the above statements alleged to have been made by Hashman. Given the number of statements and the length of the FAC, it would be impractical to address every allegation here. However, the Court concludes that all of the allegations of falsity and scienter suffer from the same defects identified with respect to the Form 10-Q for Q1 2000, discussed above.
Plaintiffs allege that Hashman sold 8.6% of his holdings. FAC at ¶ 115. An allegation that an officer sold such a small percentage of his holdings is insufficient to raise a strong inference of scienter, particularly in light of the deficiencies regarding the primary scienter allegations, discussed above.
3. Rigione
Rigione was a director of the company beginning in March 1997. He was a senior vice president of business development from July 1999 through August 2000, and the CFO from August 2000 until the end of the class period. He is alleged to have made the following statements:
(a) Form 10-Q for Q2 2000 (FAC at ¶ 125): Rigione signed the Form 10-Q, which stated the company's financial results and that the results were presented in conformity with GAAP.
(b) September 11, 2000 analyst report (FAC at ¶ 128): Rigione is quoted as stating that "credit quality is well under control."
(c) Form 10-Q for Q3 2000 (FAC at ¶ 132): Rigione signed the Form 10-Q, which made positive statements about the company and stated that the company's financial results were presented in conformity with GAAP.
(d) Form 10-K for Fiscal 2000 (FAC at ¶ 140): Rigione signed the Form 10-K, which contained positive statements about the company as well as numerous accounting specifics.
(e) Form 10-Q for Q2 2001 (FAC at ¶ 148): Rigione signed the Form 10-K, which contained positive statements about the company and represented that the company's financial results were prepared in accordance with GAAP.
Again, Plaintiffs have alleged that these statements were false or misleading when made only in the most conclusory terms. For example, with respect to the September 11, 2000 analyst report, Plaintiffs allege that Rigione's statement that "credit quality is well under control" was directly contradicted by the OCC's adverse examination findings in 2000. FAC at ¶ 129. However, Plaintiffs do not allege that Rigione saw the OCC's 2000 Exam Report prior to making the alleged statement. Id.
Rigione is not alleged to have sold any stock during the class period. FAC at ¶ 115.
4. Cai
Cai was a senior vice president of NextCard beginning in February 1999, the general manager of the credit card business from August 2000 to February 2001 and president and COO from February 2001 through the end of the class period. She is alleged to have made only one statement:
(a) April 25, 2001 press release (FAC at ¶ 142): Cai is quoted as stating that "[w]e have seen positive results from the implementation of our next generation risk scorecard which utilizes more conservative underwriting standards." She further is quoted as stating that "[t]he results from our new scorecard, in conjunction with increased productivity in our collections operations, leads us to believe that delinquencies should increase at a slower rate in the second quarter compared to recent quarters."
Plaintiffs have failed to provide any factual basis for their assertions that these statements were false or that Cai had the requisite scienter. For example, Plaintiffs allege that "Cai's statement that the Company was `utiliz[ing] more conservative underwriting standards' was known to be false. As set forth above, witnesses and the OCC stated that NextCard had considerably loosened underwriting criteria and lowered FICO scores to increase growth." FAC at ¶ 144(e). General statements of this type, without specific reference to documents that Cai may have seen or meetings she attended, are insufficient to meet the heightened pleading requirements of the Reform Act.
Cai is alleged to have sold 14.69% of her holdings. This allegation is insufficient to raise a strong inference of scienter.
5. Qureshey
Qureshey was not an officer of NextCard, but was an outside director and member of the company's compensation and audit committees. He is alleged to have made only one statement:
(a) Form 10-K for Fiscal 2000 (FAC at ¶ 140): Qureshey signed the Form 10-K, which contained positive statements about the company as well as numerous accounting specifics.
These allegations suffer from the same defects as those discussed above. Plaintiffs allege that "defendants knew" that the company's results were not as reported. FAC at ¶ 141. Plaintiffs do not allege any factual basis for this alleged knowledge and do not allege any knowledge on the part of Qureshey in particular. Id. Moreover, even under the more lenient pre-Reform Act pleading standards, several district courts held that an outside director cannot be held liable for the contents of a Form 10-K merely by signing it. See, e.g., Stack v. Lobo, 903 F.Supp. 1361, 1376 (N.D. Cal. 1995); In re Gupta Corp. Sec. Litig., 900 F.Supp. 1217, 1241 (N.D. Cal. 1994).
Qureshey is alleged to have sold 7.67% of his holdings. This is insufficient to raise a strong inference of scienter, particularly in light of the other defects regarding the allegations against Qureshey.
6. Failure To Disclose 2000 Exam Report and Capital Assurance Agreement
It appears that, in addition to claims based upon the allegedly false and misleading statements discussed above, Plaintiffs are asserting a freestanding claim that Defendants violated § 10(b) by failing to disclose to the market the OCC's 2000 Exam Report and 2000 Capital Assurance Agreement. Plaintiffs have failed to allege facts demonstrating that any particular defendant had a duty to disclose the contents of these documents. Moreover, it appears from the record before the Court that Defendants were prohibited by law from disclosing the contents of the OCC's 2000 Exam Report. Plaintiffs have failed to address this fact in their pleading.
7. Leave To Amend
For the reasons discussed above, Plaintiffs have failed to state a § 10(b) claim against any of the defendants. One of the primary defects in the FAC is Plaintiff's failure to match each alleged false statement with facts demonstrating that statement's falsity and facts giving rise to a strong inference that the speaker had the requisite scienter. Plaintiffs may well be able to reorganize their pleading so as to cure this defect by "connecting the dots." Accordingly, the § 10(b) claim will be dismissed with leave to amend as to all defendants.
E. § 20(a) Claim
Section 20(a) of the Exchange Act imposes joint and several liability on any "person who, directly or indirectly, controls any person liable" for securities fraud, "unless the controlling person acted in good faith and did not directly or indirectly induce" the violations. 15 U.S.C. § 78t(a). Because Plaintiffs have failed to allege a viable claim of securities fraud, there is no basis for asserting controlling person liability under § 20(a).
IV. ORDER
(1) Defendant Lent's motion for leave to use the OCC's 2000 Exam Report is DENIED WITHOUT PREJUDICE;(2) Defendants' motions to dismiss the first amended consolidated class action complaint are GRANTED WITH LEAVE TO AMEND; and
(3) Any amended complaint shall be filed and served within sixty days after service of this order.