District Of Kansas Allows Exchange Act Claims Against Financial Services Company To Proceed, Finding That Plaintiffs Adequately Alleged Material Misstatements, Omissions And Scienter

Shearman & Sterling LLP

Shearman & Sterling LLP

On December 3, 2019, Judge John W. Lungstrum of the United States District Court for the District of Kansas denied a motion to dismiss a putative securities class action involving claims brought under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”), and Rule 10b-5 promulgated thereunder, against a financial services company (the “Company”), three of its senior officers and several of its founder directors. Yellowdog Partners, LP and Carpenters Pension Fund of Illinois v. CURO Group Holdings Corp. et al., 18-cv-02662 (D. Kan. Dec. 3, 2019). Plaintiffs alleged that the Company and the three officer defendants made false and materially misleading statements concerning the Company’s business transition away from its most profitable product and its effect on the Company’s financial condition. The Court denied defendants’ motion to dismiss, finding that plaintiffs sufficiently pleaded falsity and scienter.

According to the complaint, the Company “operated as a payday lender” by providing short-term loans to “nonprime, underbanked consumers in need of cash” in the United States, Canada and the United Kingdom. The Company’s most profitable business was its “single-pay” loans in Canada. According to the complaint, in 2016 and 2017, Canada enacted new laws and regulations that imposed restrictions on such loans, which served to decrease the Company’s yield on the single-pay loans in Canada. As a result of the new laws and regulations, the Company decided to transition its Canadian business from “single-pay loans to installment and ‘open-end’ loan products” and began to convert its single-pay customers in Canada to open-end plans. The Complaint alleged that open-ended loans were expected to be less profitable for the Company in the short term “because revenue on such loans takes longer to build and because [the Company] was required to account for increased loan losses” at the time of origination. Plaintiffs further allege that the Company made a number of public assurances with respect to this transition which were misleading, including “assur[ing] investors that the transition . . . would not be immediate[,] that single-pay loans would remain viable[,] and that the negative impact would be minimal . . . [and] confined to the second quarter of 2018” and that the impact had already “been factored into [the Company’s publicly-reported 2018 financial guidance.” Plaintiffs alleged that the Company repeated these assurances in April 2018 and at the end of July 2018—after “a majority of the losses from the transition had already occurred.” In October 2018, the Company significantly reduced its 2018 guidance for income and earnings and announced poor financial results for Q3 2018. Plaintiffs alleged that this rendered materially false the assurances made by the Company because the Company failed to disclose facts about the transition that were necessary to make the Company’s statements not materially misleading in violation of the securities laws.

The Court first addressed defendants’ arguments that the statements that plaintiffs have challenged in the complaint are not actionable as a matter of law. According to defendants, the statements alleged were not actionable or were immaterial because they are opinions and thus not statements of fact, are forward-looking statements protected by the statutory safe harbor or the “bespeaks caution” doctrine, are statements of corporate optimism or puffery and/or are accurate descriptions of historical performance. The Court rejected all these arguments at the motion to dismiss stage, finding that based on “the totality of the allegations in the complaint,” plaintiffs’ claims were not merely based on inaccurate predictions or projections of financial performance, but rather, “at their heart, these claims are based on allegations that defendants failed to disclose specific facts, particularly concerning the strategy and timing of the transition in Canada, which transition was bound to have a substantial undisclosed impact on financial performance.” According to the Court, based on plaintiffs’ theory of the case, those omissions made the challenged statements “materially false or misleading, and thus actionable.”

The Court further addressed defendants’ argument that the statements were “forward-looking statements” protected under the PSLRA’s statutory safe harbor or the “bespeaks caution” doctrine. The Court rejected these arguments, finding that plaintiffs’ claims were based on allegations that the Company failed to disclose specific known facts concerning the strategic timing of the transition and its financial impact, noting that these doctrines are not available for “statements of then-present factual conditions” and they do not “protect statements that imply background factual assumptions that a reasonable investor would regard the speaker as believing to be true.” According to the Court, plaintiffs “alleged that in making any forward-looking statements, defendants failed to disclose that those projections were contradicted by known facts concerning the transition and its inevitable impact” and, therefore, it is ultimately up to “the trier of fact in this case to decide whether defendants’ cautionary statements were sufficient.” The Court similarly rejected defendants’ argument that some of the challenged statements represent “mere opinions.” Citing to Omnicare, Inv. v. Laborers Dist. Council Constr. Indus. Pension Fund, 135 S. Ct. 1318 (2015), the Court found that plaintiffs alleged “that omissions made defendants’ statements, including any statements of opinion, materially misleading,” and that plaintiffs “have not merely made such an allegation conclusory,” but rather, plaintiffs “identified particular facts concerning the timing and strategy of the transition to open-end loans in Ontario, and the financial impact of that decision, that made the challenged statements misleading, and which suggest that the statements were made without a reasonable basis.” Accordingly, the Court found that it “cannot conclude that any particular statements are not actionable because they are statements of opinion.” The Court thus declined “to conclude as a matter of law that particular statements challenged by plaintiffs in their complaint cannot have been materially misleading and thus cannot be actionable.” For the same reasons, the Court found that plaintiffs sufficiently alleged the falsity of the statements with particularity, as required.

The Court next addressed the Company’s alleged failure to disclose facts concerning its transition to open-end loans. The Court noted that defendants’ “concede[d] they had a duty to disclose any facts necessary to make their statements not materially misleading,” but that defendants argued “in fairly summary fashion” that the challenged statements were too vague to trigger a duty to disclose. In rejecting this argument, the Court found that plaintiffs’ complaint is “detailed and contains specific allegations” and identifies “various statements by defendants concerning the transition and [the Company’s] financial performance.” The Court further held that plaintiffs alleged specific facts that should have been disclosed and they have explained how the statements were misleading in light of the omissions. The Court similarly rejected defendants’ argument that their “statements that regulations could affect business and that the transition in Ontario had been accelerated somewhat” fully disclosed all risks associated with the transition, noting that plaintiffs’ claims were “not so limited” and “whether defendants’ statements were misleading in light of omitted facts cannot be decided as a matter of law at this stage.”

The Court next addressed plaintiffs’ claims that defendants violated their duty to disclose under SEC regulation Item 303. The Court rejected defendants’ argument that “the negative performance during part of the third quarter cannot constitute a ‘trend’ that had to be revealed” pursuant to Item 303, finding that plaintiffs “do not merely allege a failure to report third-quarter performance,” but rather allege impact “on the 2018 performance as a whole,” and as such, the Court cannot conclude as a matter of law that there was no “trend” or “uncertainty” here.

Having found actionable misstatements, the Court next considered the issue of scienter. The Court found that plaintiffs’ allegations raised a strong inference of scienter, noting that plaintiffs dedicated nine pages in the complaint to allegations directed specifically to the issue of scienter. Taking each allegation in turn, the Court first considered plaintiffs’ allegation concerning defendants’ post-class-period admissions. Plaintiffs argued that defendants effectively admitted that they did a poor job explaining the near-term negative impact of the transition when they decided to accelerate the transition from “single-pay” to “open-end” loans during the second and third quarters of 2018, causing most of the Company’s losses to occur in July 2018, “prior to the reaffirmance of the 2018 guidance at the end of that month,” and that defendants’ “disclosure controls were not effective.” The Court agreed with plaintiffs that these facts support an inference that “defendants were at least reckless in failing to disclose the decision to accelerate the transition.” Second, the Court considered plaintiffs’ allegation concerning the “importance of the Ontario market” to the Company’s operations. The Court accepted plaintiffs’ argument that because “Ontario was [the Company’s] largest Canadian region . . . the importance of that business creates an inference that defendants would have been closely monitoring that impact and thus would have appreciated the true short-term financial effect of the transition (thus supporting an inference of scienter).” Third, the Court rejected defendants’ argument that plaintiffs’ scienter allegations were grounded in the “‘core operations’ theory,” which defendants claimed the Tenth Circuit rejected—a point that the Court noted was inaccurate—and the Court agreed with plaintiffs that “the importance of this business does support an inference that defendants closely monitored the transition and its effects.” Fourth, turning to plaintiffs’ allegation that “defendants’ experience and their monitoring of the transition in test markets” supports an inference of scienter, the Court found that defendants’ argument that such allegations are “speculative” does not provide any basis to ignore these allegations, which do support plaintiffs’ argument in favor of scienter. Fifth, the Court similarly found persuasive plaintiffs’ allegations that the “timing of the challenged statements made by defendants at the end of July 2018” support an inference of scienter, noting that although the parties “may dispute how strongly these allegations support an inference of scienter . . . they do add to the totality of the facts supporting such an inference.” Sixth, concerning plaintiffs’ allegation that stock sales by certain of the officer defendants during the putative class period support an inference of scienter, the Court rejected defendants’ argument that such inference is lessened because those sales were made pursuant to a 10b-5(1) trading plan, finding that the trading plan cited by defendants was adopted during the putative class period. Finally, the Court agreed with plaintiffs that rather than alleging a mere general motive, the complaint alleges that the Company’s “$690 million offering to raise funds during the class period provided a motive for defendants not to disclose negative financial information.” Based on these findings, the Court held that an inference of scienter “is at least as compelling as opposing inferences.”

Having denied defendants’ motion to dismiss the Section 10(b) claims, the Court addressed the Section 20(a) control person claims against the individual defendants, finding that plaintiffs effectively alleged that the individuals exerted control over the Company’s operations as a result of their positions as controlling stockholders and concomitant power to appoint all board members, their executive positions and the fact that they either personally signed or made the misstatements. Notably, defendants challenged the Section 20(a) claim against the Company’s chief operating officer on the basis that he did not sign the Company’s financial reports and therefore did not control the issuance of the challenged statements. But the Court determined that the claim against this officer could go forward because he “exerted control over the Company’s operations,” he personally made at least two of the alleged misrepresentations, and he was “present and actively participated” in earning calls during which other challenged statements were made. As to the founder defendants, the Court held that the Section 20(a) claims would survive the motion to dismiss because of those defendants’ ability to elect the board of the Company and their relationship with the Company.

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Yellowdog Partners, LP and Carpenters Pension Fund of Illinois v. CURO Group Holdings Corp.

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