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DANIS v. USN COMMUNICATIONS
November 7, 2000
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
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
[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.
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,
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