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REHM v. EAGLE FIN. CORP.

January 27, 1997

ALFRED REHM, on behalf of himself and all other similarly situated, Plaintiff,
v.
EAGLE FINANCE CORP., CHARLES F. WONDERLIC, RONALD B. CLONTS, and ROBERT J. BRAASCH, Defendants.



The opinion of the court was delivered by: MORAN

 Plaintiff Alfred Rehm (Rehm), on behalf of all persons who purchased or acquired the common stock of Eagle Finance Corporation (Eagle) during the period from May 12, 1995 to April 15, 1996 (class period), brought this class action suit alleging that defendant Eagle and its executive officers materially misrepresented Eagle's known credit losses and net income for the fiscal year 1995 in violation of § 10(b) and § 20(a) of the Securities Exchange Act of 1934 (SEA), 15 U.S.C. § 78j(b) and § 78t(a), and Rule 10b-5, 17 C.F.R. § 240.10b-5 (1996). Defendants now move to dismiss the complaint pursuant to Fed. R. Civ. P. 12(b)(6), arguing that plaintiffs have failed to allege facts sufficient to show a strong inference of scienter as required by the Private Securities Litigation and Reform Act of 1995 (PSLRA). 15 U.S.C. § 78u-4(b)(2). For the reasons set forth below, defendants' motion is denied.

 BACKGROUND

 In considering a motion to dismiss under Rule 12(b)(6) for failure to state a claim, we accept all well pled factual allegations in the complaint as true and draw all reasonable inferences from these facts in favor of the plaintiff. Travel All Over the World, Inc. v. The Kingdom of Saudi Arabia, 73 F.3d 1423, 1429 (7th Cir. 1996). Read in this light, the facts are as follows.

 Eagle is a Delaware corporation headquartered in Gurnee, Illinois which operates as a specialized financial services company engaged primarily in the acquisition and service of automobile and retail installment sales contracts by "sub-prime" consumers. At all relevant times, Charles F. Wonderlic (Wonderlic) was Chairman of the Board and Chief Executive Officer of Eagle. Robert J. Braasch (Braasch) was Eagle's Chief Financial Officer, Senior Vice President, and Treasurer. Ronald B. Clonts (Clonts) was President and a Director of Eagle.

 The first press release was issued May 12, 1995. First quarter net income was reported at $ 1.240 million or $ .30 per share. On approximately May 15, 1996, Eagle filed Form 10-Q for the first quarter which reiterated the financial information disclosed in the May 12 report. The May 15 10-Q was signed by defendant Braasch. It stated that Eagle's provision for credit losses during the first quarter was $ 13,000. In May 1995, Eagle's stock traded at approximately $ 14 - $ 15 per share. In June 1995, the stock traded at approximately $ 17 - $ 18 per share.

 On August 7, 1995, Eagle issued its second press release. Reported net income for the second quarter and first six months of fiscal year 1995 was stated at $ 1.315 million and $ 2.555 million, respectively, which represented earnings of $ .31 and $ .61 per share, respectively. Eagle reported that as of June 30, Eagle's allowance for credit losses and nonrefundable acquisition discount totaled $ 16.892 million, or 13.3% of net receivables. On approximately August 14, 1995, defendants filed Form 10-Q for the second quarter which reiterated the financial information disclosed in its press release. The second quarter 10-Q was signed by Braasch. It stated that Eagle's provision for credit losses during the second quarter was $ 46,000. In August and September of 1995, Eagle's stock traded in the price range of $ 20 - $ 24 per share.

 In August of 1995, at the time when Eagle stock traded near the highest price in its history, defendant Clonts sold 35,000 shares on the open market, for which he received over $ 720,000 in proceeds. These sales by Clonts were the only public sales of Eagle stock he ever made.

 On November 6, 1995 Eagle issued its third quarter press release which reported third quarter net income at $ 1.429 million or $ .33 per share. Net income for the nine month period was reported at $ 3.983 million or $ .93 per share. Eagle's total allowance for credit losses was reported at $ 17.029 million, or 12.5% of its net receivables. The press release indicated that as of September 30, 1995, 8.8% of accounts were delinquent. In the press release, defendant Wonderlic stated that although delinquency rates had been unacceptable in the previous two quarters due to an inadequate collection staff, that trend had been reversed and delinquency was declining. (Compl. at 10 - 11.) Wonderlic described Eagle's first half credit loss experience as an "interim 'hiccup.'" (Compl. at 11.) Wonderlic conceded that Eagle could not at that time state with specificity what the appropriate level of credit loss allowance would be required at the year's end to cover the outstanding delinquencies. Id. However, he stated "with some confidence" that Eagle would be profitable in the fourth quarter and would show record earnings growth. Id.

 The information in the November 6 press release was restated in Eagle's third quarter Form 10-Q which was filed on approximately November 15, 1995 and signed by Braasch. During the third quarter, Eagle made no provision for credit losses. Eagle's stock traded throughout November in the range of approximately $ 14 3/4 to $ 16 1/8 per share.

 Eagle issued its fourth quarter press release on March 13, 1996. A net loss of $ 348,000 or $ .08 per share was reported for the quarter. Full-year results were stated at $ 3.530 million or $ .82 per share. Total loss reserves were increased to $ 22.639 million, representing 14.8% of Eagle's net receivables. Installment contract delinquency was reported at 8.2%.

 Eagle's fourth quarter provision for credit losses was reported at $ 2,194,000, a sharp increase over previously reported levels. Total credit losses for fiscal year 1995 were reported at $ 2,253,000. In the March 13 press release, Wonderlic explained the fourth quarter increase in loss reserves as follows:

 
The fourth quarter charge was based on a stringent, comprehensive review of the credit performance of each loan pool, economic uncertainty and changes in evaluating the reserve adequacy of discounted loan purchases. We have conservatively built our reserves to stay ahead of the loss curve and the standard we applied in the process exacted the cost of eliminating fourth quarter profitability and a record profitability for 1995 as a whole.

 (Compl. at 15.) Wonderlic reassured the public that the reserve adjustments were a one-time revision to cover unexpected losses and that the company looked forward to resuming its long-term growth. (Compl. at 15.)

 Following the March 13 press release, several market analysts lowered their ratings of Eagle's stock due to its inadequate reserve accounting. On March 18, 1995, Eagle issued another press release in which Braasch stated that "the analysts' viewpoint isn't educated by what we believe are the relevant facts of the matter. . .As to the level of reserves, it is our considered judgment, which is supported by our independent outside auditors, that the level of reserves taken against this portfolio is adequate." (Compl. at 16.)

 However, on April 2, 1996, Eagle announced that it had been "unexpectedly" advised by its accountants, KPMG Peat Marwick LLP, that in connection with their year-end audit, the accountants would require the company to make a substantial addition to its allowance for credit losses as of December 31, 1995, resulting in a drastic reduction of previously ...


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