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LAWRENCE E. JAFFE PENSION PLAN v. HOUSEHOLD INT'L.

March 19, 2004.

LAWRENCE E. JAFFE PENSION PLAN, on Behalf of Itself and All Others Similarly Situated, Plaintiff,
v.
HOUSEHOLD INTERNATIONAL, INC., MERRILL LYNCH, PIERCE, FENNER, & SMITH, INC., GOLDMAN SACHS & CO., INC., ARTHUR ANDERSEN, L.L.P., WILLIAM F. ALDINGER, DAVID A. SCHOENHOLZ, GARY GILMER, J.A. VOZAR, ROBERT J. DARNALL, GARY G. DILLON, JOHN A. EDWARDSON, MARY JOHNSTON EVANS, J. DUDLEY FISHBURN, CYRUS F. FREIDHEIM, LOUIS E. LEVY, GEORGE A. LORCH, JOHN D. NICHOLS, JAMES B. PITBLADO, S. JAY STEWART, and LOUIS W. SULLIVAN, Defendants



The opinion of the court was delivered by: RONALD GUZMAN, District Judge

MEMORANDUM OPINION AND ORDER

Plaintiff Lawrence E. Jaffe Pension Plan, on behalf of itself and all others similarly situated, brought this suit alleging violations of 15 U.S.C. § 78j(b) (" § 10(b)" of the Exchange Act of 1934 ("1934 Act")) and 17 C.F.R. § 240.10b-5 ("Rule 10b-5") against Household, Household Officers, identified as Aldinger, Schoenholz, and Gilmer, and Arthur Andersen ("Andersen") in Count I; violation of 15 U.S.C. § 78t(a) (" § 20(a)" of the 1934 Act) by Household, and Household Officers in Count II; violations of 15 U.S.C. § 77k, 771(a)(2), and 770 ("§§ 11, 12(a)(2), and 15" of the Securities Act of Page 2 1933 ("1933 Act")) by Household, Household Officers, Household Directors, Andersen, Goldman Sachs & Co., Inc. ("Goldman Sachs"), and Merrill Lynch, Pierce, Fenner & Smith, Inc. ("Merrill Lynch") in Count III, and violations of 15 U.S.C. § 77k, 77o (" §§ 11, 15" of the 1933 Act) by Household, Household Directors and Andersen in Count IV. Glickenhaus & Co. has been named lead plaintiff in this case, which is a consolidation of a number of cases.

Household, Officer Defendants, Individual Defendants and Andersen have moved to dismiss Counts I and II under Fed.R.Civ.P. ("Rule") 9(b) and 12(b)(6). Household Officers, Individual Defendants, Andersen, Goldman Sachs and Merrill Lynch have moved to dismiss Counts III and IV under Rule 12(b)(6). In addition, Andersen has moved to strike two paragraphs in the Amended Complaint pursuant to Rule 12(f). For the reasons set forth in this Memorandum Opinion and Order, the Court: (1) denies Household's, Household Officers' and Andersen's motion to dismiss Count I; (2) denies Household's, and Household Officers' motion to dismiss Count II; (3) grants Household's, Household Officers', Household Directors', Andersen's, Goldman Sachs', and Merrill Lynch's motions to dismiss Counts III; (4) denies in part and grants in part Household's, Household Directors' and Andersen's motions to dismiss Count IV; and (4) denies Andersen's motion to strike.

  FACTS

  The complaint at issue relates to violations of Sections 11, 12(a)(2) and 15 of the Securities Act of 1933, Sections 10(b) and 20(a) of the Exchange Act of 1934 and 17 C.F.R. § 240.10b-5. Page 3

  Lead plaintiff Glickenhaus & Company and the other proposed class members purchased shares of Household common stock, preferred stock, bonds, notes, InterNotes(SM) and Trust indentures between October 23, 1997 and October 11, 2002 ("Class Period"). Defendant Household International, Inc. is engaged primarily in consumer lending.

  During the Class Period, Household reported continuous and dramatic growth in income and net earnings. On the basis of quarterly earning statements, meetings, conference calls with analysts and other publication of data, stock analysts from a variety of respected firms issued "buy" reports with respect to Household offerings. Also during this period, Household filed a number of required forms and statements with the Securities and Exchange Commission ("SEC") with the inclusion of reports from various named directors and officers as well as audit reports generated by Andersen and stock analysis reports by Goldman Sachs and Merrill Lynch. On the basis of these statements and assurances, plaintiff purchased Household securities.

  During the Class Period, allegations of predatory lending and improper "reaging" of loans began to surface from a variety of sources. These included allegations in Washington and California that ultimately resulted in the filing of lawsuits during the Class Period. During the Class Period Household entered into a settlement agreement regarding Household's lending practices with the Attorneys General of several states. Also during the Class Period, Washington published the Washington Department of Financial Institutions Expanded Report of Examination of Household Finance Corporation m (April 30, 2002) ("Washington Report"). All of these allegations arose from what plaintiff characterizes as Household's predatory lending practices as outlined Page 4 in what Household had named the "EZ Pay Plan," wherein Household allegedly loaned money to high-risk consumers and home owners, employing a variety of tactics intended to boost the fees and costs associated with the loans. In order to assist in the overall management of Household, during this period Household perfected what it called the "Vision System" that the Officer Defendants publicly praised as making company-wide data available to them and allowing them to engage in proactive management of lending practices at all of the branch offices. In addition, plaintiff alleges Household engaged in "reaging" loans, whereby delinquent loans were reclassified as still current by the addition of the delinquent payments onto the end of the loan term, thereby lengthening the loan term and reducing the appearance of default loans on Household's books.

  Although both Household and Andersen argue that Household's financial statements were prepared in accordance with generally accepted accounting principles ("GAAP") and generally accepted accounting standards ("GAAS"), this was not true according to plaintiff. Under these principles, "reaging" of loans in the manner Household used is strongly recommended against because it fails to indicate whether the accounts may ultimately be collectable. This results in the diminution of the reliability of aging scales and, practically speaking, obscures the risk of delinquency associated with the outstanding loans.

  Throughout most of the Class Period, Household securities generally increased in value, ultimately rising to over $63.25. This began to change, though. On August 14, 2002 Household announced that its new auditors KPMG had recommended a substantial restatement of earnings for a period including the Class Period. The ultimate result was a lowering of net income and equity by $386 million for the period from 1994 to the Page 5 second quarter 2002, Additionally, with the circulation of rumors about a pending California class action legal settlement that would restrict Household's lending practices and result in a multi-million settlement, there was a dramatic fall in stock price to around $28 a share in less than three months.

  Each of the proposed class members purchased Household securities during the Class Period at allegedly artificially inflated prices, relying on the integrity of the market price and market information. Each has been damaged as a result of defendants' misrepresentations.

  Officer Defendants participated directly in the day-to-day operations of Household and were instrumental in the development and execution of the practices and programs plaintiff alleges led to the instant complaint. Each had access to confidential information about the company's business and operations. Each directly and indirectly controlled the conduct of the company's business, the information contained in its filings with the SEC, and public statements about its business and financial results. Officer and Director Defendants were signatories on the Registration Statements that resulted in the issuance of further Household securities. Auditor defendant, Andersen, performed independent audits and provided accounting, management consulting, and tax services for Household during the Class Period. It reviewed financial data used in a variety of SEC filings, e.g., debt registration statements and audit reports included as attachments to various SEC filings. Andersen was intimately involved in Household's confidential corporate financial and business operations. Household Director Defendants were all Household directors during the Class Period. Merrill Lynch and Goldman Sachs both Page 6 provided stock analysis services in connection with the merger between Beneficial and Household.

  DISCUSSION

  Each defendant has moved to dismiss various counts of the Amended Complaint. Household, Officer Defendants, Individual Defendants and Arthur Andersen have moved to dismiss Counts I and H. Household, Officer Defendants, Individual Defendants, Andersen, Goldman Sachs and Merrill Lynch have moved to dismiss Counts III and IV. Additionally, Andersen has moved to strike paragraphs 180 and 181 of the Amended Complaint as prejudicial and irrelevant. The Court addresses each of these arguments in turn.

  A Rule 12(b)(6) motion to dismiss does not test the merits of the case and merely attacks the sufficiency of the complaint. Fishman v. Meinen, No. 02 C 3433, 2003 WL 444223, at *4 (N.D. Ill. Feb. 24, 2003). A court may only dismiss a complaint for failure to state a claim upon which relief may be granted if "it is clear that no relief could be granted under any set of facts that could be proved consistent with the allegations." Hishon v. King & Spalding, 467 U.S. 69, 73 (1984); see Ledford v. Sullivan, 105 F.3d 354, 356 (7th Cir. 1997). A court must accept all well pleaded allegations of the complaint as true, and must view those allegations in the light most favorable to plaintiff. Fishman, 2003 WL 444223, at *4. The Court need not accept as true legal conclusions alleged in the complaint, though a plaintiff may plead conclusions if they "provide the defendant with at least minimal notice of the claim." Jackson v. Marion County, 66 F.3d 151, 154 (7th Cir. 1995). Page 7

  I. Fraud Claims: Section 10(b) and Section 20(a) of the 1934 Act and Rule 10b-5

  Plaintiff seeks relief against Household, Officer Defendants and Andersen for fraud under Section 10(b) of the 1934 Act and Rule 10b-5 in Count I and Section 20(a) in Count n. Defendants contend that plaintiff has insufficiently pleaded according to the standards for fraudulent averments under Rule 9(b), or according to the standards of the Private Securities Litigation Reform Act ("PSLRA"). 15 LJ.S.C. § 78u-4. (Household Mot. Dismiss at 22-24; Andersen Mot. Dismiss at 1-2.)

  It is well settled that "Rule 9(b) [of the Federal Rules of Civil Procedure] governs claims based on fraud and made pursuant to the federal securities laws." Sears v. Likens, 912 F.2d 889, 893 (7th Cir. 1990) (alteration in original, quotations omitted). "Circumstances constituting fraud . . . shall be stated with particularity," which has been interpreted as requiring inclusion of "`the identity of the person making the misrepresentation, the time, place, and content of the misrepresentation, and the method by which the misrepresentation was communicated to the plaintiff" in fraud allegations. Fed.R.Civ.P. 9(b); Uni *Quality, Inc. v. Infotronx, Inc., 974 F.2d 918, 923 (7th Cir. 1992) (quoting Bankers Tr. Co. v. Old Republic Ins. Co., 959 F.2d 677, 683 (7th Cir. 1992)). In essence, the complaint must specify the "who, what, when, where, and how" of the allegedly fraudulent acts. DiLeo v. Ernst & Young, 901 F.2d 624, 627 (7th Cir. 1990). The purpose of this "is to force the plaintiff to do more than the usual investigation before filing his complaint." Ackerman v. Northwestern Mut. Life Ins. Co., 172 F.3d 467, 469 (7th Cir. 1999). The rule serves to (1) protect defendants' reputations from harm, (2) minimize `strike suits' and `fishing expeditions', and (3) provide notice of claims to adverse parties. Fishman, 2003 WL 444223, at *5 (citing Vicom, Inc. v. Page 8 Harbridge Merch. Servs., Inc., 20 F.3d 771, 777 (7th Cir. 1994)).

  In addition, a complaint of securities fraud under the 1934 Act is subject to the PSLRA. 15 U.S.C. § 78u-4(a)(1). Under the PSLRA, a plaintiff must allege a defendant "made an untrue statement of a material fact" or "omitted to state a material fact necessary in order to make the statements made, in the light of the circumstances in which they were made, not misleading." 15 U.S.C. § 78u-4(b)(1). In either case, "the complaint shall specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed." Id. Further, plaintiff must "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." 15 U.S.C. § 78u-4(b)(2). If these requirements are not met, the Court shall dismiss the complaint. 15 U.S.C. § 78u-4(b)(3).

  Together, the overlapping pleading requirements of Rule 9(b) and the PSLRA make it clear that a plaintiff must aver which defendants said what, to whom, and when. Ackerman, 172 F.3d at 471; Fishman, 2003 WL 444223, at *5; see also Sears, 912 F.2d at 893. "Where a plaintiff alleges that a group of individuals is part of a fraudulent scheme, he or she must put each defendant on notice of his or her alleged role." Fishman, 2003 WL 444223, at *5; see Vicom, 20 F.3d at 777-78. In addition, a plaintiff must show a "strong inference" of scienter, whether through a showing of "motive and opportunity to commit fraud" or through a showing of "conscious misbehavior or recklessness." Johnson v. Tellabs, Inc., No. 02 C 4356, 2004 WL 324752, at *18 (N.D. Ill. Feb. 19, 2004). Page 9

  A. § 10(b) and Rule 10b-5

  In pertinent part Section 10(b) and Rule 10b-5 provide that it is unlawful for any person in connection with a securities sale or purchase "[t]o make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or . . . [t]o engage in any act, practice, or course of business which operates or would operate as a, fraud or deceit upon any person, in connection with the purchase or sale of any security." 17 C.F.R. § 240.10b-5(b), (c); see 15 U.S.C. § 78j(b).

  To state a claim for a violation under Section 10(b) or Rule 10b-5, a plaintiff must allege that (1) the defendant made a false statement or omission (2) of material fact (3) with scienter (4) in connection with the purchase or sale of securities (5) upon which the plaintiff justifiably relied (6) and that the false statement proximately caused the plaintiffs damages. Otto v. Variable Annuity Life Ins. Co., 134 F.3d 841, 851 (7th Cir. 1998); Caremark. Inc. v. Coram Healthcare Corp., 113 F.3d 645, 648 (7th Cir. 1997), Plaintiff must establish that defendants had a duty to disclose the omitted information. Basic Inc. v. Levinson, 485 U.S. 224, 239 (1988).

  1. Alleged false and misleading statements

  The first requirement of the PSLRA is to identify each statement alleged to be misleading. For the most part, plaintiff has done this, identifying who made particular statements, when, how they were misleading, and the results of the statements. They point to the following representations as false and misleading. Page 10

  a. Household

  Throughout the Class Period Household published quarterly financial data, usually accompanied by statements from one or more directors. (Am. Compl. at ¶¶ 192, 214, 218, 230, 233, 237, 243, 252, 258, 263, 272, 285, 289, 298, 311, 333.) These statements included net income and earnings per share information, giving both dollar amounts and various comparative statistics with respect to earlier quarters, In each case, the income and earnings per share information increased by double digit percentages over earlier quarters. Plaintiff contends these quarterly statements were untrue and materially misleading statements of Household's financial condition. Plaintiff bases these allegations on the inclusion in the statements of what it alleges were the knowingly inaccurate financial representations, as well as its assertion that Household admitted to violating GAAP through its correction of its financial statements, resulting in part from its "reaging" practices. (Id. at ¶¶ 126, 142, 196, 217, 242, 271, 302, 308, 332, 342.) Plaintiff contends the result of these quarterly releases was the republication of the Household data in a variety of respected analyst reports accompanied by "buy" recommendations and immediately subsequent share price rises based on both Household's and the analysts' reports. (Id. at ¶¶ 193, 198, 205, 210, 222, 224, 230, 234, 238, 240, 244, 253, 259, 265, 273, 274, 287, 290, 291, 326, 335.)

  Further, Household filed Form 10-K SEC filings signed by Aldinger, Schoenholz and Director Defendants that asserted Household was in compliance with SEC Regulations S-X and S-K. (Id. at ¶¶ 200, 225, 246-48, 277, 313.) This was supported by Andersen's audit opinion of the data incorporated by reference in the filing. (Id. at ¶¶ 202, 227, 249, 279, 316.) In the audit opinions Andersen asserted Page 11 "that it had audited Household's financial statements and Schedule 14(d) for [the respective years] in accordance with GAAS and opined that it `fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.'" (Id.) The March 28, 2000 filing contained assertions related to how Household had increased in various indices of operating net income. (Id. at ¶ 246.) It also stated that risk-based pricing and effective collection efforts for its loans resulted in effective management of credit losses. (Id. at ¶ 247.) Household also stated that it had shifted its credit card receivables to its subsidiary HFC, according to plaintiff, for the purpose of avoiding newly enacted federal banking regulations that significantly altered reporting requirements. (Id. at ¶ 250.) The March 28, 2001 filing stated that Household "continue[s] using risk-based pricing and effective collection efforts for each loan. We have a process that gives us a reasonable basis for predicting the asset quality of new accounts." (Id. at ¶ 278.) The March 13, 2002 filing reiterated this language. (Id. at ¶ 315.) It additionally stated in the "Management Report" signed by Aldinger and Schoenholz that "the company will fully comply with laws, rules and regulations of every community in which it operates and adhere to the highest ethical standards." (Id. at ¶ 314.) Plaintiff contends Household through the agency of its officers, directors and auditor based these filings on knowingly false and misleading financial data. (Id. at ¶ 126, 142, 196, 217, 242, 271, 302, 308, 332, 342.) As a result of the successful filings, Household was able to maintain what plaintiff contends was its false financial position which misled analysts and investors. (Id. at ¶¶ 200, 225, 246-48, 277, 313.) Page 12

  b. Aldinger

  In addition to Aldinger's signatures on the above-mentioned SEC filings, plaintiff alleges Aldinger repeatedly made materially misleading statements during the Class Period. Many of these statements were included in Household's quarterly releases of its financial results, (Id. at ¶¶ 192, 197, 209, 214, 218, 229, 233.) Aldinger repeatedly made statements included in these releases concerning Household's financial status and the alleged means used to reach the published results. These statements included ones such as (1) "wider margins, higher average managed receivables, and a continued focus on efficiency []more than offset the impact of higher credit losses"; (2) "[w]e grew revenues 18 percent and kept expenses essentially flat. We absorbed increased chargeoffs consistent with industry-wide trends and further strengthened our credit loss reserves. We also improved our return on managed assets. Our return on equity exceeded 18 percent, even though we significantly increased our capital levels"; (3) "[o]ur tight focus on our core markets, our conservative capital base and our disciplined approach to funding and liquidity management enabled Household to achieve record earnings for the quarter"; (4) "[t]he company's operating results were solid with 6 percent annualized receivable growth, margin expansion and improving efficiency. . . . reserve coverage remains conservative"; (5) reporting net income increases in excess of 70%, resulting in part from "higher yields on unsecured products and lower funding costs, partially offset by the effect of a shift in mix toward secured products"; and (6) "[s]trong loan growth in our consumer finance business, improved efficiency and higher income from our tax refund loan business" as the underlying causes for increases. (Id. at ¶¶ 192, 197, 214, 218, 229.) Page 13

  In response to analyst questions on February 7, 2002 concerning rumors that Household might change its accounting policies, thereby affecting stock value, Aldinger and Schoenholz made various statements indicating that Household would not change its accounting policies. (Id. at ¶ 320.) These included statements such as "Household has had no problems with its commercial paper funding and the costs of that funding has not increased," "Arthur Andersen has always been aggressive with HI. There are no accounting changes being discussed and there are to be no surprises in the 10K. HI's board of ...


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