Dronsejko v. Thornton

• Decision Date: 20 January 2011
• Docket Number: Nos. 09–4222,10–4074.,s. 09–4222
• Citation: 632 F.3d 658
• Parties: Gregory DRONSEJKO; Pedro Garcia; Anthony Mielec, Perla Sierra; Claudio Borghesan; Jerald F. Hassler; Andy Beichert; Jeffrey Bash; Tom Chen; Chris Davidson; Michael Speakman, Plaintiffs–Appellants,v.Grant THORNTON, Defendant–Appellee.
• Court: U.S. Court of Appeals — Tenth Circuit

632 F.3d 658

78 Fed.R.Serv.3d 755

Gregory DRONSEJKO; Pedro Garcia; Anthony Mielec, Perla Sierra; Claudio Borghesan; Jerald F. Hassler; Andy Beichert; Jeffrey Bash; Tom Chen; Chris Davidson; Michael Speakman, Plaintiffs–Appellants,

v.Grant THORNTON, Defendant–Appellee.

Nos. 09–4222

10–4074.

United States Court of Appeals, Tenth Circuit.

Jan. 20, 2011.

Ira M. Press (and Sarah G. Lopez of Kirby, McInerney, L.L.P.; Jonathan Gardner and Carol Villegas of Labaton, Sucharow, L.L.P., New York, NY, Jefferson W. Gross and Richard D. Burbidge of Burbidge, Mitchell & Gross, Salt Lake City, UT, on the brief), New York, NY, for Plaintiffs–Appellants.Gary F. Bendinger (and Christopher B. Sullivan of Howrey, L.L.P., with him on the brief), Salt Lake City, UT, for Defendant–Appellee.Before TACHA, KELLY, and MURPHY, Circuit Judges.PAUL KELLY, JR., Circuit Judge.

This is a securities class action pursuant to Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b–5, brought on behalf of class members who purchased iMergent common stock between October 15, 2002 and October 7, 2005. Aplt.App. 47, 60–63, 105–107. The basis of the claim is improper revenue recognition that materially overstated revenues and earnings and, in August 2005, led to a restatement of iMergent's financial statements for fiscal years 2002, 2003, and 2004. Aplt.App. 70, 91, 106. All claims against iMergent and its directors have settled. Aplt.App. 47. The only remaining defendant is Grant Thornton, iMergent's independent auditor which expressed unqualified or “clean” opinions on iMergent's financial statements for those fiscal years. Aplt.App. 47, 48–49.

Plaintiffs–Appellants contend that Grant Thornton's actions relating to the revenue recognition policy—particularly its expression of unqualified opinions on the financial statements—artificially inflated the market price of iMergent's stock, causing them to suffer damages when the price declined upon news of the revenue recognition problems and restatement of earnings. Aplt.App. 107; Aplt. Br. 4–5.

Two appeals have been consolidated for argument and resolution. No. 09–4222 is Plaintiffs' appeal from the district court's dismissal of the Second Amended Consolidated Complaint for failure to properly plead scienter under the Private Securities Litigation Reform Act of 1995. Aplt.App. 501. No. 10–4074 is Plaintiffs' appeal from the district court's denial of their Rule 60(b) motion, in which Plaintiffs sought the opportunity to file a new amended complaint to incorporate newly discovered evidence. Aplt.App. 663. We have jurisdiction pursuant to 28 U.S.C. § 1291, and we affirm.

Background

For purposes of this appeal, we must take as true all factual allegations in the complaint. See Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 322, 127 S.Ct. 2499, 168 L.Ed.2d 179 (2007). iMergent is an e-services company that, inter alia, sold licenses for software designed to help small businesses engage in e-commerce. Aplt.App. 47, 57. Roughly half of iMergent's revenue during the relevant period came from the sale of licenses on the basis of Extended Payment Term Arrangements (“EPTAs”). Aplt.App. 57; Aplt. Br. 9. Under EPTAs—as opposed to cash or credit card sales—customers paid the purchase price in installments over a twenty-four month period. Aplt.App. 57. iMergent recognized 100% of the revenue from EPTA sales on the date the license was delivered; however, on average iMergent collected only 53% of the total purchase price.¹ Aplt.App. 57, 159, 468. On its 2003 and 2004 10K forms, iMergent disclosed that 47% of its EPTA sales were uncollectible and recognized bad debt expense associated with these sales, which reduced its total income. Aplt.App. 158–59, 162–53, 467–68. Further, iMergent wrote off the uncollectible EPTA accounts against an allowance for doubtful accounts, with the allowance established at the time of sale. Aplt.App. 159, 468.

Companies must adhere to generally accepted accounting principles (“GAAP”) when recognizing revenue in their publicly disclosed financial statements. See Ganino v. Citizens Utils. Co., 228 F.3d 154, 159 n. 4 (2d Cir.2000) (explaining how GAAP are established); 17 C.F.R. § 210.4–01(a)(1) (incorporating GAAP into SEC disclosure requirements). Under the American Institute of Certified Public Accountants (“AICPA”) Statement of Position 97–2 (“SOP 97–2”)—the relevant GAAP for our purposes—companies may immediately recognize revenue from software licenses sold on the basis of extended-term contracts so long as: (1) persuasive evidence of an arrangement exists; (2) delivery of the product has occurred; (3) the fee is fixed and determinable; and (4) collectibility is probable. Aplt.App. 49, 57; Barrie v. Intervoice–Brite, Inc., 397 F.3d 249, 256 (5th Cir.2005) (applying SOP 97–2 as the relevant AICPA and GAAP standard). “Probable” has the same definition as used in FASB Statement No. 5, Accounting for Contingencies. Aplt.App. 71. That statement defines probable as: “The future event or events are likely to occur.” Aplt.App. 71. No GAAP pronouncement establishes a percentage for “probable collectibility” under SOP 97–2.

In 2002, the SEC sent a letter inquiring about iMergent's revenue-recognition practices. Aplt.App. 85. iMergent, after consulting with Grant Thornton, responded that its collection rate for EPTAs was around 70%. Aplt.App. 86. The SEC was satisfied with iMergent's response and took no further action. Aplt.App. 87. The 70% figure, however, reflected the collection rate for executory EPTAs—the collection rate for EPTAs upon completion of the entire two-year term was projected to be 53%. Aplt.App. 86.

In 2005, the SEC again inquired into iMergent's revenue-recognition policy. Aplt.App. 87. In its response, iMergent indicated that collection rates for EPTAs “exceed[ed] 50%” and were therefore “probably collectible” under SOP 97–2. Aplt.App. 89. The SEC responded that in order to qualify as “probable” under SOP 97–2, the collection rate must be “ substantially higher than 50%.” Aplt.App. 89–90. Shortly thereafter Grant Thornton withdrew its audit opinions on iMergent's financial statements, Aplt.App. 90–91, and iMergent was forced to alter its method of recognizing revenue and restate its financial statements for fiscal years 2002, 2003, and 2004. Aplt.App. 67–68, 91–92. The restatements drastically lowered revenues—revenues had been overstated by 372%, 279%, and 301% respectively—and earnings became losses for each of the three years. Aplt.App. 68; Aplt. Br. 18. Not surprisingly, the stock price declined. Aplt.App. 93.

A company's management—not the auditor—is responsible for the information contained in its financial statements and the propriety of its underlying accounting policies, including compliance with GAAP. See Deephaven Private Placement Trading, Ltd. v. Grant Thornton & Co., 454 F.3d 1168, 1174–75 (10th Cir.2006). However, Grant Thornton is responsible for its audit reports, which contained its unqualified opinions on iMergent's financial statements for fiscal years 2002, 2003, and 2004. Aplt.App. 48–49. According to the complaint, Grant Thornton falsely represented that its audits had been conducted in accordance with generally accepted auditing standards (“GAAS”) and wrongfully issued opinions that the financial statements fairly presented iMergent's financial condition and results of operations in conformity with GAAP. Aplt.App. 50, 62, 64, 66–67; Aplt. Br. 3–4. Plaintiffs contend that, contrary to its unqualified opinions, Grant Thornton knew or was reckless in not knowing that iMergent's revenue recognition policy violated GAAP. More specifically, Plaintiffs allege that Grant Thornton knew or was reckless in not knowing that the 53% collection rate on EPTAs did not meet the “probable collectibility” standard under SOP 97–2.² Aplt.App. 67; Aplt. Br. 4.

A. The Second Amended Complaint

In March 2005, Plaintiffs brought suit against Grant Thornton and iMergent. Aplt.App. 26. iMergent promptly settled, and in January 2009 Plaintiffs filed a Second Amended Consolidated Complaint (“SAC” or “complaint”) with Grant Thornton as the lone defendant. Aplt.App. 46. The complaint alleged that Grant Thornton violated Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”) and Rule 10b–5 by recklessly certifying that iMergent's financial statements complied with GAAP and that Grant Thornton's audits complied with Generally Accepted Auditing Standards (“GAAS”). Aplt.App. 47. More particularly, Plaintiffs alleged that Grant Thornton recklessly concluded that iMergent's 53% collection rate on EPTAs satisfied SOP 97–2's “probable collectibility” standard. Aplt.App. 73. Defendants moved to dismiss the complaint with prejudice.

The district court granted Defendant's motion to dismiss, holding that the complaint failed to raise a “strong inference” that Grant Thornton acted with scienter, as is required by the Private Securities Litigation Reform Act of 1995 (“PSLRA”). See In re iMergent Sec. Litig., No. 05–cv–204, 2009 WL 3731965, *7 (D.Utah Nov.2, 2009). Specifically, the court held that Plaintiffs' “allegations fail to raise an inference of fraudulent intent that is cogent and as compelling as the competing non-culpable inference that Grant Thornton was merely negligent.” Id. at *11.

Plaintiffs timely appealed. Aplt.App. 501. They argue that the complaint properly alleged Grant Thornton's reckless conduct, and that the district court erroneously held them to an intentional fraud standard. Aplt. Br. 28, 32. We review this issue de novo. Alvarado v. KOB–TV, LLC, 493 F.3d 1210, 1215 (10th Cir.2007).

B. The Rule 60(b) Motion

After the district court dismissed the complaint, the Public Company Accounting Oversight Board (“PCAOB”)—a private, nonprofit corporation created by the Sarbanes Oxley Act to regulate auditors of publicly traded companies—imposed sanctions on two representatives of Grant Thornton for their role in the...