improper accounting may support a strong inference of scienter."
First Merchants, 1998 WL 781118, at *10; see also In re
Digi Int'l; Inc. Securities Litig., 6 F. Supp.2d at 1098 (D.Minn. 1998)
(plaintiffs adequately pled scienter under the PSLRA by alleging
accounting violations and "other related omissions of material facts" in
public statements regarding the defendant's acquisition of a developmental
company); Rehm, 954 F. Supp. at 1255-56.
Some of these other circumstances constituting fraudulent intent "can
include the presence of "red flags' or warning signs that the financial
reports are fraudulent." First Merchants, 1998 WL 781118, at *11.
Plaintiffs sufficiently allege the existence of and Deloitte's awareness
of these "red flags." In addition to Deloitte's improper auditing,
plaintiffs contend that Deloitte had sufficient contact with USN to become
aware of the fraudulent abuses and pervasive and fundamental internal
control problems at USN — the improper, inaccurate, or non-existent
practices concerning USN's recording of revenue, sales, accounts,
billing, and provisioning. Plaintiffs support this claim by citing USN's
retention of Deloitte as an information technology consultant hired to
create a billing system for USN prior to the public offering. According
to plaintiffs, for thirteen months prior to the public offering, as many
as thirteen Deloitte employees consulted USN on its financial
recordkeeping infrastructure and the development of a functional billing
system. In the course of this consultation, Deloitte prepared an
extensive report — the "Summary of Findings and Recommendations
Report" — detailing USN's lack of technological infrastructure.
These are not simply allegations of "access to information." Rather,
Deloitte is claimed to have been brought on specifically to evaluate
USN's internal accounting and billing controls and to design a system for
their improvement. Deloitte's knowledge or reckless disregard of USN's
problems may be inferred.
Finally, plaintiffs' claim that USN's lack of internal controls was
readily apparent to outsiders such as AT & T and GTE buttresses a strong
inference of Deloitte's recklessness; conditions readily discoverable by
a third party suggests that an auditor and consultant was likely aware of
those conditions. See First Merchants, 1998 WL 781118, at *11 (fact that
company's chief financial officer "almost immediately discovered the
discrepancies in the financial statements" supported Deloitte's
recklessness). In totality, plaintiffs allege sufficient facts to support
an inference of Deloitte's recklessness.*fn11
III. LOSS CAUSATION
Finally, defendants argue that the complaint fails in the entirety
because plaintiffs cannot show "loss causation."*fn12 To state a
securities fraud claim, a plaintiff must allege loss causation —
"that it was in fact injured by the misstatement or omission of which it
Inc. v. Coram Healthcare Corp., 113 F.3d 645, 649
(7th Cir. 1997); see also Bastian v. Petren Resources Corp., 892 F.2d 680,
683 (7th Cir. 1990) (loss causation occurs where "but for the
circumstances that the fraud concealed, the investment would not have
lost its value"). The requirement is not a difficult one, and it "ought
not place unrealistic burdens on the plaintiff at the initial pleading
stage." Caremark, 113 F.3d at 649. Plaintiffs must allege facts
supporting an inference that their loss resulted from defendants'
misconduct. See Retsky Family Limited Partnership v. Price Waterhouse
LLP, 1998 WL 774678, at *14 (N.D. Ill. Oct. 21, 1998).
In the typical loss causation situation, the plaintiff alleges
inflation of the stock price due to defendants' painting the company in a
favorable, albeit untruthful, light, disclosure of the true state of the
company at some later point, and an immediate decline in the stock price
as a result of market reaction to the belated disclosure. See Retsky,
1998 WL 774678, at *13. Defendants try to cast plaintiffs' claims in this
mold, characterizing plaintiffs' loss as a drop in USN's stock price
after the disclosure in November 1998 of certain "true" facts about the
dire state at USN. Defendants argue the November 1998 disclosure could
not cause the loss because USN's stock prices declined steadily during
the class period. According to defendants, the stock price dropped
throughout the class period due to the various warnings in the prospectus
and the subsequent disclosures during the class period that USN had not
generated positive cash flow and that it required additional financing.
Defendants contend that it is specious for plaintiffs to argue that the
drop resulted from the November 1998 disclosures because those
disclosures simply did not reveal any new material information. The stock
price had almost completely bottomed out by that point.
Defendants' argument is unpersuasive. Plaintiffs do not contend that it
was disclosure of USN's true financial state in November 1998 that caused
the stock price to decline and thereby cause their loss. Rather,
plaintiffs allege that their losses resulted from paying an inflated price
for USN stock because of the misrepresentations and omissions occurring
prior to and throughout the class "period. Compl. ¶¶ 237,240,244. As
plaintiffs note, simply because the price of USN stock had dropped below
$1.00 per share by the time of the November 1998 disclosures does not
mean that defendants' misstatements did not cause the loss. See Wool v.
Tandem Computers, Inc., 818 F.2d 1433, 1437 (9th Cir. 1987) (explaining
that a loss may be caused by a misrepresentation before a corrective
disclosure "as a result of market forces operating on the
misrepresentations"); Retsky, 1998 WL 774678, at *13 (same).*fn13 To the
contrary, it is permissible to infer that had the investing public known
of USN's true state of affairs at the outset, USN would not have gone
public, at least not at the price of $16.00 per share. According to
plaintiffs, the market responded to and "corrected" the price of USN stock
over the better part of a year as bits and pieces of negative information
became available and it became apparent that USN was not capable of
performing as originally represented. Plaintiffs' allegations of an
inflated purchase price suffice to meet their burden of pleading loss
The motions to dismiss are granted in part and denied in part. Count II
is dismissed as to the individual defendants.
The motions are denied in all other respects.