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DANIS v. USN COMMUNICATIONS

November 7, 2000

DANIS, PLAINTIFF,
V.
USN COMMUNICATIONS, INC., ET AL., DEFENDANTS.



The opinion of the court was delivered by: Conlon, District Judge.

    MEMORANDUM OPINION AND ORDER

Plaintiffs bring this class action on behalf of all persons and entities who (1) purchased USN Communications, Inc. ("USN") common stock in the open market pursuant to the registration statement and prospectus or purchased stock during the period February 4, 1998 through November 20 1998 ("class period"), and (2) were damaged by defendants' violations of the federal securities laws. Consolidated Class Action Complaint ("Cmplt.") ¶ 1. Plaintiffs name Deloitte & Touche LLP ("Deloitte") as one of the defendants.*fn1 Plaintiffs allege that Deloitte violated Section 11 of the Securities Act of 1933 ("§ 11") by certifying materially false statements in USN's prospectus (Count I). Plaintiffs further allege that Deloitte violated Section 10(b) and Rule 10(b)(5) of the Securities Exchange Act of 1934 ("Rule 10(b)(5)") by intentionally or recklessly deceiving stock investors and artificially inflating the price of USN stock (Count III).*fn2

BACKGROUND

I. USN

All facts are undisputed unless otherwise noted. USN was a reseller of telecommunication services. Def.App. Ex. 28 at 4.*fn3 The company purchased various local and long distance telecommunication services from Regional Bell Operating Companies ("RBOCs"), such as Ameritech, bundled the services, and sold the package. Id. USN employees contacted RBOC customers and offered them lower rates for switching to USN's services. Id. If the solicitation was successful, USN provisioned the former RBOC customer over to USN. Id.

In February 1998, USN offered its stock to the public ("the IPO"). Id. at 1. The prospectus issued in connection with the IPO contained a 1996 audit report. Pl. 56.1(b)(3)(A) at ¶ 65.*fn4 The prospectus included September 30, 1997 interim financial statements. Id. at ¶ 74. These interim statements were prepared by USN management and were marked as unaudited in the prospectus. Id. at ¶¶ 75-76.

USN's rapid growth prior to the IPO caused functional problems with the company's billing system. Def.App. Ex. 28 at 34. The system did not correctly account for all customer charges. Id. As a result, accurate billing of USN clients was delayed. Id. USN's prospectus disclosed warnings about USN's operations and financial standing, many of which were found in a 10-page section of risk factors. These warnings include:

The accurate and prompt billing of the Company's customers is essential to the Company's operations and future profitability . . . Indeed, the company had already experienced substantial delays in accurately and timely billing its customers. Id. at 13, 34.
[USN] has modified and will continue to modify its billing and customer care systems . . . [h]owever, there can be no assurance that such systems will be adequate to manage the Company's anticipated expansion . . . the failure by the Company to implement other alternatives . . . or implement adequate revenue assurance programs could have a material adverse effect on the Company's financial condition and results of operations. Id. at 13, 19.
The Company expects to realize additional operating losses on a consolidated basis while it continues to expand and develop its service offerings and its customer base. There can be no assurance that the Company will be able to develop or expand its customer base or that it will achieve profitability in future years . . . There can be no assurance that the Company will be able to achieve or sustain positive cash flow from operating activities or to implement its growth strategy. Id. at 12.
No assurance can be given that the Company will be able to manage its expanding operations and, if the Company's management is unable to manage growth effectively, the Company's financial condition and results of operations could be materially adversely affected. Id. at 19.
USN's stock price may be affected due to "delays by the Company in achieving its expansion goals, fluctuations in the Company's operating results, . . . changes in earnings estimates of securities analysts . . ." Id. at 20.

Ten months after USN offered its stock to the public, its value declined from the IPO price of $16 per share to under $.50 per share. Id. at 47, 67-68. On February 18, 1999, USN filed for bankruptcy under Chapter 11. Id. at 69.

II. Deloitte

Deloitte conducted audits of USN's financial statements from 1994 through 1997. Deloitte 56.1(a)(3) at 10-11. Deloitte consented to the 1996 audit report's inclusion in USN's prospectus. Id. at 49-50. Jerry Cohen was the partner in charge of USN's audits. Id. at 11. In addition to leading the audits, he reviewed USN's quarterly financial statements, issued the consents in regard to USN's prospectus, and performed consulting services and revenue assurance work for the company. Id. As a result of the work Deloitte performed for USN, Deloitte knew about USN's customer billing problems and its problems with internal controls. Id. at 22. After performing its audits, Deloitte accurately assured plaintiffs that USN would remain in business at least until December 31, 1998. Id. at 43.

III. Claims against Deloitte

Plaintiffs' claims against Deloitte are all based on the same set of allegations. Plaintiffs contend that USN's 1996, 1997 and 1998 financial statements contain material misrepresentations. Specifically, they contend that (1) USN's practice of billing former customers for monthly recurring charges caused USN's revenue, accounts receivable, and assets to be over-stated, and (2) USN's untimely, inaccurate billing system caused many bills to be uncollectible, and thus contributed to material overstatement of the company's accounts receivable. Pl. 56.1(b)(3)(B) at ¶¶ 29, 55.*fn5

DISCUSSION

I Summary judgment ...


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