Tenth Circuit Speaks in Pre-Paid

It seems like it’s been a while since we had a Court of Appeals PSLRA decision, but the Tenth Circuit has put an end to that dry spell in the Pre-Paid Legal Services action, with colorful language (in places) that definitely reminds me of an Easterbrook opinion. Judge Terrence L. O'Brien (George W. Class of ’02), writing for the Panel, said that “this case may be a close call, but it is difficult to tell because the complaint is so rich in sweeping, generalized and sometimes conclusory allegations. Pleading precision could have better informed the debate and aided the critical analysis necessary to resolve a motion to dismiss.”

So “in the face of a somewhat chaotic complaint the district court understandably cut to the chase. Although the district court listed the numerous alleged GAAP violations, it appears the court distilled the Consolidated Complaint to the single GAAP violation concerning the recording of unearned commission advances as assets. When so limited, the Consolidated Complaint fails to adequately allege scienter because there is no evidence that this alleged GAAP violation was the result of Pre-Paid Defendants' fraudulent intent to mislead investors. The district court noted Pre-Paid's SEC filings disclosed it recorded unearned commission advances as assets on its balance sheets and warned it might not be able to recoup unearned commission advances.”

Wrapping it up, the Panel concluded that “if Pre-Paid Defendants intended to deceive investors, it makes little sense for them to overtly disclose their scheme to the SEC and public. But, charitably regarded, the complaint alleges more subtle means and purposes.”

You can read McNamara v. Pre-Paid, issued July 14, 2006, here or at 2006 U.S. App. LEXIS 17902.

Nugget: “Based on the above, we conclude Plaintiffs' Consolidated Complaint insufficiently pleads scienter. However, unlike the district court, we do not believe Plaintiffs' fraud theory is "patently absurd." The Consolidated Complaint raises some serious "red flags" concerning Pre-Paid Defendants' long term recording of unrecoverable unearned commission advances as assets and the credibility of their pre-2001 SEC disclosures. Nevertheless, it is lacking in allegations demonstrating Pre-Paid Defendants' alleged fraud was economically logical in light of Pre-Paid's repurchase of its own stock at allegedly inflated prices. It also fails to adequately allege Pre-Paid's GAAP violation was the result of an intent to mislead investors. Therefore, dismissal was appropriate.”