In re Pareteum Sec. Litig.
| Decision Date | 11 August 2021 |
| Docket Number | 19 Civ. 9767 (AKH) |
| Parties | IN RE PARETEUM SECURITIES LITIGATION |
| Court | U.S. District Court — Southern District of New York |
Defendants move to dismiss Lead Plaintiffs First Amended Consolidated Complaint ("Complaint") against Pareteum Corporation ("Pareteum," or "Company") Robert H. Turner ("Turner"); Edward O'Donnell ("O'Donnell"); Victor Bozzo ("Bozzo"); Denis McCarthy ("McCarthy," and together with Turner, O'Donnell, and Bozzo, "the Individual Defendants"); Dawson James Securities Inc. ("DJSI"); and Squar Milner (together with DJSI "Underwriter and Auditor Defendants"). The Complaint alleges violations of the Securities Exchange Act of 1934 ("Exchange Act") and the Securities Act of 1933 ("Securities Act"), on behalf of a class of purchasers and/or acquirers of Pareteum securities between December 14, 2017 and October 21, 2019 (the "Class Period").
With respect to the Exchange Act claims, Plaintiff alleges that Pareteum and the Individual Defendants violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, by making materially false and misleading statements concerning Pareteum's (1) reported revenue and realized revenue growth rates; (2) revenue recognition, GAAP compliance internal controls, and financial reporting; (3) backlog value and conversion rates; (4) access to a credit facility; and (5) company growth. The Complaint also asserts control person claims against Turner, O'Donnell, and Bozzo under Section 20(a) of the Exchange Act.
With respect to the Securities Act claims, the Complaint alleges that Pareteum, certain Individual Defendants, and the Underwriter and Auditor Defendants violated Sections 11, 12 and/or 15 of the Securities Act in connection with Pareteum's acquisition of iPass Inc. and a $40 million secondary offering of stocks and warrants ("Secondary Offering"). Plaintiff alleges that Defendants made various false and misleading statements in connection with these transactions and the public filings associated with the same.
The gravamen of the Complaint is that Pareteum, under the direction of the Individual Defendants, fraudulently overstated its reported revenues, realized revenue growth rates, and contractual revenue backlog. When the fraud was revealed and Pareteum announced that it intended to issue a restatement of past financial statements, the Company's share price collapsed. The Complaint further asserts that the Underwriter and Auditor Defendants are liable for the false financial statements incorporated into the public filings associated with the Secondary Offering.
In their motions to dismiss the Exchange Act claims, Defendants argue that the Complaint fails to show (1) that Defendants made actionably false or misleading statements; and (2) that Defendants acted with scienter. With respect to the Securities Act claims, Pareteum and its officers seek to dismiss principally on the same grounds as their Exchange Act arguments (i.e., no actionable false statements). Squar Milner argues principally that its audit opinion is nonactionable and also makes certain standing arguments. DJSI joins the other Defendants' briefs.
I ruled at oral argument that the Complaint adequately alleged that Pareteum, the Individual Defendants, and DJSI made materially false and misleading statements for purposes of applicable claims under the Exchange Act and the Securities Act. Having considered and rejected the remainder of Defendants' arguments, I reserved decision on three issues: (1) whether Plaintiff sufficiently pleads scienter for the Exchange Act claims; (2) whether Plaintiff sufficiently pleads "traceability" with respect to the Section 11 claims under the Securities Act in connection with the Secondary Offering; and (3) whether Plaintiff adequately pleads that Squar Milner made a false statement of material fact sufficient to give rise to liability under Section 11.
For the reasons that follow, the motions to dismiss are denied.
The following facts are taken from the Complaint, see ECF No. 168, and documents incorporated by reference therein.[1] This opinion describes only the facts relevant to the issues discussed below; the parties' familiarity with the entirety of the case is assumed.
Pareteum is a telecommunications software services provider targeting mobile virtual network operators ("MVNOs"), which provide wireless communications to customers, but do not themselves own network infrastructure or create their own software. See Compl. ¶ 6.
Before November 2015, Pareteum was known as Elephant Talk Communications Corporation, "a declining penny stock." Id.¶M. On November 17, 2015, Elephant Talk announced Turner's appointment as Executive Chairman. Id. Following a 12-month restructuring effort, on October 31, 2016, the Company rebranded itself as "Pareteum," and appointed Bozzo as CEO. Id. On January 12, 2017, Pareteum announced the appointment of O'Donnell as CFO, and on February 21, 2018, the Company announced the hiring of McCarthy as Senior Vice President and later President and COO. Id. Bozzo and McCarthy were former colleagues of Turner, the Executive Chairman. Id.
At some point between November 2015 and February 2018, Turner and others in Pareteum's management changed the way the Company reported revenue by focusing analysts and investors on a "36-month Contractual Revenue Backlog" metric, which they described as a "non-GAAP indicative number," a "key performance indicator [that] is directly correlated to our financial and operating results," and "the value of new sales orders intake and the revenue under contract." Id. ¶ 12. As alleged, Pareteum and the Individual Defendants frequently reported the backlog, emphasized its reliability, and represented that it was converting into "incremental monthly revenue" at or above 100%. Id. Plaintiff alleges that the backlog's value was (1) materially and artificially inflated; and (2) not converting to revenue at or above 100%. Id.
During the Class Period, Pareteum and its management reported that the Company's revenues grew from $4, 113 million in 1Q18 to $34.1 million in 2Q19, and that its backlog grew from $200 million in 1Q18 to $1.27 billion in 2Q19. Id. ¶ 13. During this same period, the Company's share price increased from a low of $0.72 per share, as of December 14, 2017, to a high of $5.93 per share, as of March 18, 2019. Id.
In December 2017, Pareteum announced to the market that the Company had undergone a successful "restructuring and repositioning" that "established] a strong outlook for . . . success in 2018 and beyond." Id. ¶ 15. Turner told investors that the Company was focused on a "sales surge" to "deliver maximum value," and Pareteum began touting its sales results by reference to its backlog metric. Id. Following these representations, Pareteum's stock price increased. Id.
Starting in 2018, the Company issued dozens of press releases announcing increasing revenue and sales. On May 7, 2018, Pareteum announced "record" 1Q18 results, reporting revenues of $4, 113 million, "up 47% Year-Over-Year"; that the backlog had reached $200 million; and that backlog revenue conversion had reached 103%. Id. ¶ 17. Based on these results, Pareteum raised its 2018 revenue outlook to at least 60% over 2017. Id.
On May 9, 2018, Pareteum sold 2, 440, 000 shares to raise $6, 100, 000 for "working capital and general corporate purposes." Id. ¶ 18. On June 6, 2018, Turner announced an amendment to his employment agreement to provide for automatic vesting of his restricted stock awards and options immediately upon the Company entering into an agreement to acquire another company. Id. Thereafter, on June 7, 2018, Pareteum announced an agreement to acquire Artilium PLC ("Artilium") for $104.7 million in stock and cash. Id.
On August 6, 2018, Pareteum announced "record" 2Q18 results, reporting "revenues of $6 million, up 85% year-over-year"; an increase in the backlog to $276 million; and backlog revenue conversion of 106%. Id. ¶ 19. The Company raised the 2018 revenue outlook to be greater than 80% over 2017. Id.
Between September and October 2018, Pareteum issued five press releases announcing $134 million in new contracts. Id. ¶ 20. These press releases identified, for the first time, some of the new customers and contracts announced in those releases. Id. Plaintiffs allege that "virtually all" the companies were incapable of generating the $134 million in revenue claimed by Pareteum. Id.
On October 24, 2018, Pareteum announced that it had increased the backlog to $500 million. Id. ¶ 21. On November 7, 2018, Pareteum announced "record" 3Q18 results, reporting revenues of $8 million, "up 129% Year-Over-Year"; an increase in backlog to $403 million; and backlog revenue conversion of 100%. Id. Based on these results, Pareteum raised its 2018 revenue outlook to more than 100% over 2017. Id.
On March 12, 2019, Pareteum announced "record" 4Q18 and FY18 results, reporting year-over-year revenue growth of 139% for FY18 and 256% for 4Q18, and that the Backlog had quadrupled to $615 million, with a 100% conversion rate. Id. ¶ 24. The Company also provided revenue guidance for 2019 in the range of a 225-260% increase year-over-year. Id. During an earnings call on March 24, 2019, Turner and McCarthy told investors that the Company was poised for "dramatic revenue growth . . . fueled by the growth of our [backlog] and its conversion of that backlog into billing customers"; that the backlog was a reliable indicator of revenue; and that the backlog was converting into "incremental monthly...
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