On Behalf Of All Others Similarly Situated v. Young

• Citation: 622 F.3d 471
• Decision Date: 22 September 2010
• Docket Number: No. 08-6194.,08-6194.
• Parties: LOUISIANA SCHOOL EMPLOYEES' RETIREMENT SYSTEM; Debra Swiman, individually and on Behalf of All Others Similarly Situated, Plaintiffs-Appellants, v. ERNST & YOUNG, LLP, Defendant-Appellee.
• Court: U.S. Court of Appeals — Sixth Circuit

622 F.3d 471

LOUISIANA SCHOOL EMPLOYEES' RETIREMENT SYSTEM; Debra Swiman, individually and on Behalf of All Others Similarly Situated, Plaintiffs-Appellants,

v.ERNST & YOUNG, LLP, Defendant-Appellee.

No. 08-6194.

United States Court of Appeals,Sixth Circuit.

Argued: Oct. 15, 2009.

Decided and Filed: Sept. 22, 2010.

COPYRIGHT MATERIAL OMITTED.

ARGUED: Joseph D. Daley, Coughlin Stoia Geller Rudman & Robbins LLP, San Diego, California, for Appellants. L. Joseph Loveland, King & Spalding LLP, Atlanta, Georgia, for Appellee. ON BRIEF: Joseph D. Daley, Mark Solomon, Coughlin Stoia Geller Rudman & Robbins LLP, San Diego, California, for Appellants. L. Joseph Loveland, John P. Brumbaugh, Tracy C. Braintwain, Shelby S. Guilbert, Jr., King & Spalding LLP, Atlanta, Georgia, Paul D. Clement, King & Spalding LLP, Washington, D.C., for Appellee.

Before: BOGGS, MOORE, and GIBSON, Circuit Judges. ^*

OPINION

JOHN R. GIBSON, Circuit Judge.

This appeal is from a dismissal on the pleadings of a securities fraud class action pursuant to Federal Rules of Civil Procedure 9(b) and 12(b)(6) and the pleading requirements of the Private Securities Litigation Reform Act of 1995 (“PSLRA”). This lawsuit against public accounting firm Ernst & Young is brought on behalf of all persons who and entities which purchased the publicly traded securities of Accredo Health, Inc. (“Accredo”) between June 16, 2002 and April 7, 2003 (the “Class Period”). Accredo is a pharmaceutical distribution company.

The class contends that the district court misinterpreted and misapplied the Supreme Court's scienter-pleading standard from Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 127 S.Ct. 2499, 168 L.Ed.2d 179 (2007), and instead used the higher pre- Tellabs pleading standard set forth in Helwig v. Vencor, Inc., 251 F.3d 540 (6th Cir.2001) (en banc). Plaintiffs further allege that the district court erred when it rejected facts that, when considered collectively, raise a strong inference of defendant's scienter. Finally, the class asserts that the district court abused its discretion by ignoring plaintiffs' request to be allowed to move for amendment should the court dismiss any part of the complaint.

For the reasons set forth below, we AFFIRM the judgment of the district court.

I. Background

The Louisiana School Employees' Retirement System and Debra Swiman (the “Lead Plaintiffs”), individually and on behalf of all others similarly situated, filed a complaint against Defendant Ernst & Young for alleged violations of federal securities laws. Each member of the Plaintiff Class purchased or otherwise acquired Accredo securities during the Class Period. Ernst & Young provided services to Accredo during the Class Period until Accredo terminated Ernst & Young as its auditor because of alleged professional malpractice.

Ernst & Young's involvement began well before the Class Period. Gentiva Health Services Inc. (“Gentiva”), a company Accredo was interested in acquiring, retained Cap Gemini/Ernst & Young (Ernst & Young's consulting arm) between May and September 2000. Gentiva needed assistance in the collection of hundreds of millions of dollars of outstanding receivables owed to one of its divisions, the Speciality Pharmaceutical Services division (“Gentiva Division”). In September 2000, Cap Gemini/Ernst & Young recommended that Gentiva write off a substantial portion of its accounts receivable and redirect its focus on more current accounts receivable. As a result of Cap Gemini/Ernst & Young's audits of Gentiva's financials, in 2000 Gentiva wrote off approximately $92 million in uncollectible accounts receivable attributable to the Gentiva Division.

In the summer of 2001, Accredo sought to expand its business through acquiring from Gentiva substantially all of the assets of the Gentiva Division, which was composed of two kinds of pharmacies: the “acute” and “chronic” health care products and services segments. In September 2001, Accredo's senior officers and Ernst & Young began conducting due diligence in connection with the potential acquisition. Plaintiffs allege that between September 2001 and June 2002, during its audit of the Gentiva Division, Ernst & Young learned that nearly $58.5 million of acute segment receivables were uncollectible. They further allege that Ernst & Young recognized that the Gentiva Division's allowance for doubtful accounts was understated, causing Accredo's net income and earnings per share to be materially overstated during the Class Period. Despite Ernst & Young's knowledge of the uncollectible accounts on Accredo's balance sheet, Ernst & Young issued an unqualified audit opinion on Accredo's 2002 fiscal year financial results and approved the quarterly reports in Accredo's 10-Qs for the first and second quarters of fiscal year 2003. On January 2, 2002, Gentiva and Accredo entered into an Asset Purchase Agreement. Accredo then acquired the Gentiva Division on June 13, 2002.

Plaintiffs further allege that following its June 2002 acquisition of the Gentiva Division, Accredo tried to sell the acute segment of the Gentiva Division but was not able to do so because of the uncollectible receivables. Accredo was forced to write off $58.5 million in uncollectible receivables.

Plaintiffs aver that Ernst & Young was involved in the alleged accounting fraud from the beginning of the due diligence preceding the acquisition of the Gentiva Division and that Ernst & Young knew of the uncollectible receivables as early as 2001. Plaintiffs allege that Accredo's acquisition of the Gentiva Division depended on Ernst & Young's issuance of unqualified audit opinions on the Gentiva Division's financial statements, that Accredo retained Ernst & Young to analyze the adequacy of the allowance for the Gentiva Division's doubtful accounts, and that accounts receivable comprised seventy-five percent of the $415 million purchase price. Ernst & Young's unqualified audit opinions were incorporated into the 2002 proxy statement filed with the Securities & Exchange Commission (“SEC”).

Gentiva was intent on selling both the acute and chronic segments of the Gentiva Division to Accredo; Accredo needed the chronic segment to enable Accredo to become the billion-dollar company it aspired to be. Plaintiffs allege that Accredo and Ernst & Young hid the acute segment's accounts receivable problems from investors so that Accredo could proceed with the transaction. Accredo intended to rid itself of the acute segment soon after the transaction was completed. The 2002 proxy statement stated that Accredo would sell the acute segment by December 31, 2002.

On April 7, 2003, William Drummond, an Ernst & Young partner and the lead auditor during the Class Period, admitted to Joel Kimbrough, Accredo's Senior Vice President and CFO, that “there was a problem.” A day later, an Accredo press release disclosed that, due to the understated allowance for doubtful accounts, the Gentiva Division's receivables had been overstated. This announcement caused a one-day forty-four percent drop in Accredo's stock price.

On May 2, 2003, Accredo consulted with Ernst & Young about its intention to present information about the write-off in an upcoming press release. Three days later, Accredo issued a press release, stating that it had taken a current period charge to earnings to write off $58.5 million of acute accounts receivable that it had acquired from Gentiva. On May 5, 2003, Accredo issued its fiscal year 2003 third quarter Form 10-Q, which included a note to the consolidated financial statements that if the collection rates had been evaluated based on data as of January 1, 2003, a $58.5 million charge would have been recorded as of that date. Plaintiffs allege that this change in the language was made to avoid having to restate Accredo's Class Period financial statements. That same day, Accredo terminated Ernst & Young as its auditor and filed a civil suit against Ernst & Young charging professional malpractice. (Cir.Ct.Tenn. No. CT-002556-03). ¹

On September 15, 2004, plaintiffs filed a consolidated complaint against Accredo and two of its executives in a related class action (the “Accredo Action”), which settled four years later. In re ACCREDO HEALTH, INC. Sec. Litig., Civ. No. 03-2216-BBD, 2006 WL 6035851 (W.D.Tenn.). Lead Plaintiffs were also appointed as lead plaintiffs in the Accredo Action. On April 13, 2006, plaintiffs filed this separate single-count lawsuit against Ernst & Young, and in June 2006, Ernst & Young moved to dismiss the complaint pursuant to Federal Rules of Civil Procedure 9(b) and 12(b)(6) and the pleading requirements of the PSLRA. The motion to dismiss the complaint was pending when the Supreme Court decided Tellabs, resolving a circuit split regarding the relevance of competing inferences in evaluating whether a complaint satisfies the “strong inference” of scienter requirement of the PSLRA.

On August 14, 2008, the district court entered its order granting Ernst & Young's motion to dismiss. The district court held that Ernst & Young is not liable under Rule 10b-5 for statements that it did not make. With respect to Ernst & Young's audit report on Accredo's 2002 financial statements, which was included in Accredo's fiscal year form filed with the SEC, the district court held that “[a] review of the complaint as a whole shows that plaintiffs have failed to meet the PSLRA's requirement of pleading with particularity facts that give rise to a strong inference of scienter.” The district court thus dismissed the complaint. In its discussion of scienter, the district court correctly paraphrased the Tellabs standard but also repeated this Court's pre- Tellabs holding, which articulates a higher pleading standard:

[P]laintiffs are only entitled to the most plausible of competing inferences. Helwig, 251 F.3d at 553. The “strong inference” requirement means that a plaintiff is entitled only to the most plausible of competing potential...