In re Proquest Securities Litigation, 2007 WL 3275109 (E.D.Mich. Nov. 6, 2007) Opinion denying Defendants’ Motions to Dismisss

In re Proquest Securities Litigation, 2007 WL 3275109 (E.D.Mich. Nov. 6, 2007) Opinion denying Defendants’ Motions to Dismisss

November 6, 2007

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United States District Court,E.D. Michigan,Southern Division.
In re PROQUEST SECURITIES LITIGATION.

No. 06-10619.

Nov. 6, 2007.

Background: Investors brought class action against publishing corporation and officers, alleging securities fraud. Defendants moved for dismissal.

Holdings: The District Court, Cohn, J., held that:

(1) investors pleaded scienter and control person liability as to divisional chief financial officer (CFO);

(2) investors pleaded scienter, actionable misrepresentations and control person liability as to chief executive officer (CEO); and

(3) investors pleaded scienter, actionable misrepresentations and control person liability as to corporation and officers.

Motion denied.

[1] Securities Regulation 349B 60.45(1)

349B Securities Regulation
349BI Federal Regulation
349BI(C) Trading and Markets
349BI(C)7 Fraud and Manipulation
349Bk60.43 Grounds of and Defenses to Liability
349Bk60.45 Scienter, Intent, Knowledge, Negligence or Recklessness
349Bk60.45(1) k. In General. Most Cited Cases
Investors who sued publishing corporation and officers alleged that material misstatements or omissions of divisional chief financial officer (CFO) in report were made with scienter, as required to maintain fraud claim under Securities Exchange Act; complaint averred that CFO intentionally manipulated results of business unit by overstating revenues and understating expenses in report to make unit appear more profitable. Securities Exchange Act of 1934, § 10(b), 15 U.S.C.A. § 78j(b); 17 C.F.R. § 240.10b-5.

[2] Securities Regulation 349B 60.40

349B Securities Regulation
349BI Federal Regulation
349BI(C) Trading and Markets
349BI(C)7 Fraud and Manipulation
349Bk60.39 Persons Liable
349Bk60.40 k. In General; Control Persons. Most Cited Cases
Investors who sued publishing corporation and officers alleged that divisional chief financial officer (CFO) had requisite control over corporate activities to be subject to control person liability act under Securities Exchange Act; complaint averred that CFO exercised direct control over accounts in which material misstatements were subsequently disclosed by corporation. Securities Exchange Act of 1934, § 20(a), 15 U.S.C.A. § 78t(a).

[3] Securities Regulation 349B 60.45(1)

349B Securities Regulation
349BI Federal Regulation
349BI(C) Trading and Markets
349BI(C)7 Fraud and Manipulation
349Bk60.43 Grounds of and Defenses to Liability
349Bk60.45 Scienter, Intent, Knowledge, Negligence or Recklessness
349Bk60.45(1) k. In General. Most Cited Cases
Investors who sued publishing corporation and officers alleged that material misstatements or omissions of chief executive officer (CEO) were made with scienter, as required to maintain fraud claim under Securities Exchange Act; complaint averred that CEO had signed certifications ensuring that material information would be made known to corporation during period covered by 10-Q report, and that CEO had personally evaluated effectiveness of procedures. Securities Exchange Act of 1934, § 10(b), 15 U.S.C.A. § 78j(b); 17 C.F.R. § 240.10b-5.

[4] Securities Regulation 349B 60.27(6)

349B Securities Regulation
349BI Federal Regulation
349BI(C) Trading and Markets
349BI(C)7 Fraud and Manipulation
349Bk60.17 Manipulative, Deceptive or Fraudulent Conduct
349Bk60.27 Misrepresentation
349Bk60.27(6) k. Financial or Periodic Reports; Accounting Data and Valuations. Most Cited Cases

Securities Regulation 349B 60.27(7)

349B Securities Regulation
349BI Federal Regulation
349BI(C) Trading and Markets
349BI(C)7 Fraud and Manipulation
349Bk60.17 Manipulative, Deceptive or Fraudulent Conduct
349Bk60.27 Misrepresentation
349Bk60.27(7) k. Statements in the Media, Press Releases and Financial Reporting Services. Most Cited Cases
Investors who sued publishing corporation and officers alleged that chief executive officer (CEO) made actionable misrepresentations of material fact, as required to maintain fraud claim under Securities Exchange Act; complaint averred that CEO and/or other officers had made statements about corporation’s positive financial condition in press releases and form filings that he had signed, as well as oral statements during analyst’s conference call. Securities Exchange Act of 1934, § 10(b), 15 U.S.C.A. § 78j(b); 17 C.F.R. § 240.10b-5.

[5] Securities Regulation 349B 60.40

349B Securities Regulation
349BI Federal Regulation
349BI(C) Trading and Markets
349BI(C)7 Fraud and Manipulation
349Bk60.39 Persons Liable
349Bk60.40 k. In General; Control Persons. Most Cited Cases
Investors who sued publishing corporation and officers alleged that chief executive officer (CEO) had requisite control over corporate activities to be subject to control person liability act under Securities Exchange Act; complaint averred that CEO controlled contents of corporation’s Securities and Exchange Commission (SEC) filings, corporate reports and press releases, and participated in writing or reviewing corporate report, press releases, and filings that were allegedly misleading. Securities Exchange Act of 1934, § 20(a), 15 U.S.C.A. § 78t(a).

[6] Securities Regulation 349B 60.45(1)

349B Securities Regulation
349BI Federal Regulation
349BI(C) Trading and Markets
349BI(C)7 Fraud and Manipulation
349Bk60.43 Grounds of and Defenses to Liability
349Bk60.45 Scienter, Intent, Knowledge, Negligence or Recklessness
349Bk60.45(1) k. In General. Most Cited Cases
Investors who sued publishing corporation and officers alleged that material misstatements or omissions of officers were made with scienter, as required to maintain fraud claim under Securities Exchange Act; complaint averred that expected restatement of earnings was result of intentional fraud at corporation, that divisional chief financial officer (CFO) had actual knowledge of accounting fraud, and that other officers recklessly disregarded fraud. Securities Exchange Act of 1934, § 10(b), 15 U.S.C.A. § 78j(b); 17 C.F.R. § 240.10b-5.

[7] Securities Regulation 349B 60.27(6)

349B Securities Regulation
349BI Federal Regulation
349BI(C) Trading and Markets
349BI(C)7 Fraud and Manipulation
349Bk60.17 Manipulative, Deceptive or Fraudulent Conduct
349Bk60.27 Misrepresentation
349Bk60.27(6) k. Financial or Periodic Reports; Accounting Data and Valuations. Most Cited Cases
Investors who sued publishing corporation and officers alleged that officers made actionable misrepresentations of material fact, as required to maintain fraud claim under Securities Exchange Act; complaint averred that report statements made by officers as to corporation’s annual and quarterly financial results, certifications signed by officers, and statements in officer’s public announcements were false or misleading. Securities Exchange Act of 1934, § 10(b), 15 U.S.C.A. § 78j(b); 17 C.F.R. § 240.10b-5.

[8] Securities Regulation 349B 60.40

349B Securities Regulation
349BI Federal Regulation
349BI(C) Trading and Markets
349BI(C)7 Fraud and Manipulation
349Bk60.39 Persons Liable
349Bk60.40 k. In General; Control Persons. Most Cited Cases
Investors who sued publishing corporation and officers alleged that former chief executive officer (CEO) and chief financial officer (CFO) had requisite control over corporate activities to be subject to control person liability act under Securities Exchange Act; complaint averred that officers controlled contents of corporation’s Securities and Exchange Commission (SEC) filings, corporate reports and press releases, and participated in writing or reviewing corporation’s reports, press releases, and filings alleged to be misleading. Securities Exchange Act of 1934, § 20(a), 15 U.S.C.A. § 78t(a).

David H. Fink, E. Powell Miller, Marc L. Newman, The Miller Law Firm, Rochester, MI, Joel B. Strauss, Kaplan, Fox, New York, NY, Marc A. Topaz, Stuart J. Berman, Schiffrin, Barroway, Radnor, PA, for Industry City Associates Employee Pension Plan Trust, B.V. Brooks, Kathryn Brooks, Sales Marketing Group, Marocchi Group, Betty O’Connell, Arthur W. Wallace and Friedman Venture Partnership.
Michael J. Faris, Latham & Watkins, Chicago, IL, Andrew J. McGuinness, Dykema Gossett, Ann Arbor, MI, Sean M. Walsh, Giarmarco, Mullins, Troy, MI, David F. Dumouchel, George B. Donnini, Sheldon H. Klein, Butzel Long, Detroit, MI, for Proquest Company, Alan W. Aldworth, Kevin G. Gregory, James P. Roemer and Scott Hirth.

MEMORANDUM AND ORDER DENYING DEFENDANTS’ MOTIONS TO DISMISS

AVERN COHN, District Judge.

 

TABLE OF CONTENTS

I.

Introduction.

.—-

.

II.

Background.

.—-

A. General Overview.

.—-

B. The Parties.

.—-

C. Relevant Chronology.

.—-

D. Litigation Procedural History.

.—-

E. The CAC.

.—-

.

III.

Legal Standards.

.—-

A. General Pleading Standards.

.—-

B. Securities Laws/Rules.

.—-

1. Section 10(b) and Rule 10b-5.

.—-

2. Scienter.

.—-

3. Section 20(a).

.—-

C. The Confidential Informants.

.—-

1. The CIs Allegations.

.—-

2. Analysis.

.—-

D. In Sum.

.—-

.

IV.

Hirth’s Motion to Strike or Dismiss.

.—-

A. Motion to Strike.

.—-

B. Motion to Dismiss.

.—-

1. Failure to Plead Scienter.

.—-

2. Failure to Allege Hirth as a Control Person.

.—-

VI.

Roemer’s Motion to Dismiss.

.—-

A. Failure to Plead Scienter.

.—-

B. Failure to Allege an Actionable Misrepresentation.

.—-

C. Failure to Allege Control Person Liability.

.—-

.

VII.

ProQuest, Aldworth, and Gregory’s Motion to Dismiss.

.—-

A. Failure to Plead Scienter.

.—-

B. Failure to Allege an Actionable Misrepresentation.

.—-

C. Failure to Allege Control Person Liability.

.—-

.

VIII.

Conclusion.

.—-

 

I. Introduction

*1 This is a securities fraud case. Lead plaintiffs FN1 B.V. Brooks and Katheryn Brooks, John L. Maracchi, Herbert R. Albert and Sales Marketing Group, MMP (hereinafter “plaintiffs”), on behalf of themselves and all others similarly situated,FN2 are suing defendants ProQuest and certain of its officers, claiming violations of federal securities laws. This is one of several cases before the Court against ProQuest relating to the decline of its stock price following negative corporate news on February 9, 2006 which resulted in an approximate 18% drop in price and continued decline.FN3

Before the Court are motions to dismiss filed by defendants as follows:
Scott Hirth’s Motion to Strike and Dismiss
James Roemer’s Motion to Dismiss
ProQuest, Alan Aldworth and Kevin Gregory’s Motion to Dismiss

For the reasons that follow, the motions are DENIED.

II. BackgroundFN4

A. General Overview

As stated above, this is a securities fraud class action. It has been brought on behalf of all persons who purchased the publicly traded securities of ProQuest between February 20, 2001 and December 14, 2006 (the Class Period) against ProQuest and certain of its present and former officers and executives for violations of the Securities Exchange Act. Plaintiffs overall claim that during the Class Period, defendants represented that ProQuest was a company with consistently growing revenues and earnings. These revenues and earnings, plaintiffs say, however, were materially false and achieve through a variety of improper and fraudulent accounting techniques which resulted in the material overstatement of revenues and material understatement of expenses, thus causing ProQuest’s reported earnings to be materially overstated.

Plaintiffs allege the following:
– defendants falsely represented that ProQuest maintained adequate internal accounting controls.
– After discovering and disclosing “accounting irregularities,” defendants falsely and/or misleadingly reported the extent of the errors as being primarily limited to only one of its units.
– the initial disclosures were motivated by ProQuest’s desire to sell its Business Solutions unit and to arrange a stock offering at a time in which the stock was overpriced.
– ultimately, all of these actions resulted in the stock being artificially inflated during the Class Period.

B. The Parties

ProQuest,FN5 based in Ann Arbor, Michigan is a publisher of information based solutions for the education, automotive and power equipment markets. ProQuest provides services to its customers through two primary business units-ProQuest Information and Learning (PQIL) and ProQuest Business Solutions (PQBS). The PQIL unit formed the majority of ProQuest’s business. During the pendency of this litigation, ProQuest sold its PQBS division to Snap-On, Inc. and sold its PQIL division to Cambridge Information Group, leaving behind a new ProQuest Education division made up of assets formerly in the PQIL business segment.

*2 Defendant Alan W. Aldworth (Aldworth) is currently the Chairman of the Board, President and CEO of ProQuest. During the class period, he was named Chairman in May 2004 and CEO in January 2003. He joined ProQuest in October 2000 as Senior VP and CFO and promoted to President and COO in January 2002. He is a Certified Public Accountant.

Defendant Kevin G. Gregory (Gregory) was CFO from April 2002 until November 11, 2005. On May 6, 2005, ProQuest announced that Gregory would “step down as CO by year-end 2005.”He resigned as of November 11, 2005. He holds a bachelor’s degree in accounting and is also a Certified Public Accountant. He also holds a Juris Doctor and Masters of Law in Taxation degree.

Defendant James P. Roemer (Roemer) is currently a member of the Board of Directors. He previously served as Chairman of the Board until May 2004, when Aldworth took over. He was CEO until January 2003, when Aldworth took over. Prior to the Class Period, Roemer was President from 1995 to 2001.

Defendant Scott Hirth was the VP of Finance and CFO of ProQuest’s PQIL unit. Hirth joined ProQuest in 1994. ProQuest terminated his employment in May 2006 in connection with its internal investigation concerning its accounting practices. He holds a Masters of Business Administration degree.

C. Relevant Chronology

On February 9, 2006, prior to the opening of the market, ProQuest issued a press release entitled “ProQuest Company to Restate Historical Financial Statements.”The press release states in part:
… during a review related to its internal controls assessment required by the Sarbanes-Oxley Act of 2002, the company discovered material irregularities in its accounting. As a result, the company intends to restate certain of its previously issued financial statements.
The accounting irregularities that have been identified primarily affect ProQuest’s Informant and Learning division….
Based upon its initial findings, the company believes that its deferred income and accrued royalty accounts are materially understated in previously issued financial statements. It also believes that its prepaid royalty account is materially overstated … the effect of which will materially reduce earnings from continuing operations for many of the affected periods….
Until the review is complete, the company’s previously issued financial statements for fiscal years 1999 through 2004, quarterly periods in 2005, and the company’s guidance for fiscal 2005, should no longer be relied upon. In additional the company’s review is ongoing and there can be no assurance additional material irregularities or errors will not be identified.

The price of ProQuest’s stock declined 18% on heavy trading volume that day.

On March 8, 2006, ProQuest issued another press release titled “ProQuest 10-K Filing for Fiscal 2005 Will be Delayed; Earnings Release Also Delayed Pending Audited 2005 Financials,” that stated ProQuest would not file is Form 10-K for fiscal year ended December 2005 within the prescribed time period.

*3 On April 28, 2006, prior to market opening, ProQuest issued another press release, stating in part:
Accounting Restatement Update
ProQuest anticipates its accounting review will result in the restatement of previously reported earnings for fiscal years 2000 to 2004 and for the first three quarters of 2005….
Preliminarily, the company expects to restate earnings from continuing operations by reducing previously reported pre-tax earnings by a total of $35 million to $45 million for the first three quarters of 2005 and by $45 million to $55 million for the full year 2004. Based upon information available to date, the company believes it will also restate earnings for fiscal years 2000 through 2003….
Separately, the company and its independent registered public accounting form are reviewing accounting principles with respect to Information and Learning’s revenue recognition for certain one-time sales of published products..

The price of ProQuest’s stock fell another 28% that day. The next trading day, May 1, 2006, the stock price declined another 22%.

On May 2, 2006, ProQuest announced that the SEC had issued a formal order of investigation in connection with its restatement.

On June 30, 2006, ProQuest issued a press release, stating that the Audit Committee would not complete its investigation by the end of June as previously anticipated.

On July 6, 2006, ProQuest disclosed that on June 29, 2006 it received a letter from KPMG, LLC., ProQuest’s auditor, in which KPMG stated that “its opinion on management’s assessment and the effectiveness of the Company’s internal control over financial reporting as of January 1, 2005, should no longer be relief upon.”

On August 1, 2006, during the pendency of this litigation, ProQuest filed an August Form 8-K with the SEC in which it reported the findings of its internal investigation into the accounting improprieties which led to the restatement announcement. The Form 8-K pinned the blame squarely, and almost solely, on Hirth and the PQIL division. It key findings may be summarized as follows:
– [Hirth] bore primarily responsibility for the Company’s for the accounting misstatements
– [Hirth] exercised primary control over the accounts in which significant misstatements were identified and regularly directed (often without providing appropriate support) that manual journal entries, many of which were erroneous, be made in a number of these accounts, especially during month-end and quarter-end closes,
– other than with respect to two employees reporting to and acting under the direction of [Hirth], there is no evidence that any other employee, officer, or director, had any direct knowledge of, or involvement in, the accounting misstatements
– the Company in general and PQIL in particular had certain deficiencies in internal controls that allowed [Hirth] to engage in the misstatements
– no evidence to indicate undue pressure from corporate management to attain certain results
*4 – intentionally manipulated [the Company’s] financial reports in order to inflate PQIL [and, therefore, the Company’s] profit or to create the appearance of profitability and
– the evidence indicated that [Hirth] intentionally manipulated the PQIL financial reports in order to inflate PQIL profits or to create the appearance of profitability and at times made efforts to conceal information from others, including ProQuest’s external auditors

On November 28, 2006, ProQuest disclosed that it had completed the sale of its PQBS division to Snap-on, Inc. for approximately $527 million.

On December 15, 2006, ProQuest issued a press release updating on the restatement process. For the first time, ProQuest indicated that accounting problems may exist in other areas that PQIL. The press release states in part:
the Company has identified additional accounting issues with previously reported results for PQIL and also its ProQuest Education and ProQuest Business Solutions segments which have led to an expansion of the scope of its accounting review.

The press release also reported that ProQuest was selling its PQIL business unit for approximately $222 million. ProQuest’s stock again fell another 27%.

At the time the motions were filed, ProQuest has not issued its restatement. However, on August 31, 2007, ProQuest issued a Form 10-K containing its restatement. As seen from the attached Exhibit A, prepared by counsel for plaintiffs, the results of the restatement show that ProQuest overstated its earnings for the period at issue by more than $400 million.

D. Litigation Procedural History

In total, four securities fraud cases were filed in connection with ProQuest’s activities. Beginning just a day after the February 6, 2006 announcement, the first securities fraud complaint was filed by Industry City Associates Employee Pension Plan Trust Money Purchase U/A 3/10/1986 against ProQuest , Aldworth and Gregory. A similar complaint was filed on February 17, 2006. Yet another complaint was filed on March 16, 2007 and a fourth complaint was filed on April 6, 2006. On May 2, 2006, upon stipulation of the parties, the Court consolidated the four cases, appointed plaintiffs as Lead Plaintiffs, approved plaintiffs’ choice of counsel and liaison counsel.

On July 17, 2006, plaintiffs filed a Consolidated Amended Complaint naming ProQuest, Aldworth, Gregory and Roemer as defendants.

On October 19, 2006, following a status conference, the Court entered an order staying further proceedings pending ProQuest’s restatement. The Court also said that within 30 days of the restatement, plaintiffs should file an Amended Consolidated Class Action Complaint to which defendants may respond.

On January 27, 2007, although no restatement had issued, plaintiffs filed a First Consolidated Class Action Complaint (CAC). Not surprisingly, the CAC names the same defendants as in previous complaints but adds Hirth. This is the governing complaint to which defendants have filed motions to dismiss.

E. The CAC

*5 The CAC, which has been described above, runs 193 paragraphs and 68 pages. It chronicles ProQuest’s financial results and reporting during the Class Period from December 30, 2000 to October 1, 2005, alleging that all of these statements and SEC filings were false and misleading in light of the disclosed accounting problems. It also alleges that defendants knew or should have known of the accounting problems. As to defendant Roemer, it alleges that he sold his ProQuest stock in suspicious amounts at suspicious times during the Class Period. It also alleges defendants failed to have adequate financial controls in place which resulted in creation of an environment where the accounting malfeasance could take place.

The CAC also sets forth allegations from two confidential informants, CI 1 and CI 2.FN6

The CAC makes two claims against all defendants, for violation of 10(b)(5) and violation of 20(a) of the Exchange Act.

III. Legal Standards

A. General Pleading Standards

A motion under Fed.R.Civ.P. 12(b)(6) seeks dismissal for a plaintiff’s failure to state a claim upon which relief can be granted. “The court must construe the complaint in the light most favorable to the plaintiff, accept all the factual allegations as true, and determine whether the plaintiff can prove a set of facts in support of its claims that would entitle it to relief.”Bovee v. Coopers & Lybrand C.P.A., 272 F.3d 356, 360 (6th Cir.2001). To survive a motion to dismiss under Rule 12(b)(6), a “ ‘complaint must contain either direct or inferential allegations respecting all the material elements to sustain a recovery under some viable legal theory.’”Advocacy Org. for Patients & Providers v. Auto Club Ins. Ass’n, 176 F.3d 315, 319 (6th Cir.1999) (quoting Scheid v. Fanny Farmer Candy Shops, Inc., 859 F.2d 434, 436 (6th Cir.1988)).“[W]e do not require heightened fact pleading of specifics, but only enough facts to state a claim to relief that is plausible on its face.”Bell Atl. Corp. v. Twombly, — U.S. —-, —-, 127 S.Ct. 1955, 1974, 167 L.Ed.2d 929 (2007).

Notwithstanding the liberal standard required under Rule 12(b) (6), when fraud is alleged Fed.R.Civ.P. 9(b) requires that the allegations “be stated with particularity.” The particularity requirement of Rule 9(b) serves three purposes:
1) it ensures that allegations are specific enough to inform a defendant of the act of which the plaintiff complains, and to enable him to prepare an effective response and defense; 2) it eliminates those complaints filed as a pretext for the discovery of unknown wrongs-a 9(b) claimant must know what his claim is when he files; and 3) it seeks to protect defendant from unfounded charges of wrongdoing which injure their reputations and goodwill.

Bovee, 272 F.3d 356 at 361-62 (6th Cir.2001) (quoting Vennittilli v. Primerica, Inc., 943 F.Supp. 793, 798 (E.D.Mich.1996)). Consequently, “[c]onclusory allegations that a defendant’s conduct was fraudulent are insufficient.”In re Air Crash Disaster at Detroit Metro. Airport; Valasquez v. Northwest Airlines, Inc., 737 F.Supp. 406, 407 (E.D.Mich.1989); Bovee, 272 F.3d at 361.“Instead, the complaint must describe the conduct that allegedly constitutes the fraud with some specificity.”Id.“Plaintiffs may not simply rely on the proposition that Defendants must have known or should have known of, and participated in, the fraud.”Bovee, 272 F.3d at 361.

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