The opinion of the court was delivered by: Judge Rebecca R. Pallmeyer
MEMORANDUM OPINION AND ORDER
Plaintiffs Thomas G. Ong, Thomas G. Ong IRA, and State Universities Retirement System of Illinois ("SURSI") filed this federal securities class action on behalf of (1) all those who purchased, pursuant to a prospectus, securities issued by Defendant Sears, Roebuck Acceptance Corp. ("SRAC"), a wholly-owned subsidiary of Defendant Sears, Roebuck & Co. ("Sears"), between October 24, 2001 and October 17, 2002 (the "Class Period"), and (2) all those who, during the Class Period, purchased publicly traded securities issued by SRAC before the Class Period and actively traded them through the public markets and over national securities exchanges.
Defendant Sears, one of North America's largest general retailers, provides financing to its customers through private label credit cards and installment plans. Defendant SRAC's principal business is purchasing Sears' short-term notes and account receivable balances, which it finances through public sales of SRAC debt. Plaintiffs have also named, as Defendants, the officers and directors of Sears and SRAC and the financial institutions that served as underwriters to the three SRAC debt securities offerings at issue here.
Plaintiffs allege that Sears manipulated information regarding its credit card operations to make those operations appear "more stable and profitable than they actually were," which artificially inflated the market value of SRAC debt securities. Specifically, Sears misrepresented its reliance on subprime creditors; selectively reported delinquency and charge-off rates; and disguised portfolio losses in order to generate high levels of reported receivables that Sears knew would prove uncollectible. Plaintiffs claim that Defendants all made materially false and misleading statements or omissions in connection with Sears' credit card operations in violation of §§ 11, 12(a)(2), and 15 of the Securities Act of 1933, 15 U.S.C. §§ 77k, 77l(a)(2), and 77o; and §§ 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 promulgated thereunder, 17 C.F.R. § 240.10b-5.
Plaintiffs' Amended Class Action Complaint (the "First Complaint"), filed on October 16, 2003, was the target of four separate motions to dismiss. The court granted those motions in part and denied them in part in September 2004. Ong ex rel. Ong v. Sears, Roebuck & Co., 388 F. Supp. 2d 871 (N.D. Ill. 2004). In a Second Amended Class Action Complaint (the "Second Complaint"), Plaintiffs added SURSI as an additional new Plaintiff, and made additional allegations of scienter. That complaint, too, was the subject of motions to dismiss, which the court granted in part and denied in part in September 2005. Ong ex rel. Ong v. Sears, Roebuck & Co., No. 03 C 4142, 2005 WL 2284285, at *1 (N.D. Ill. Sept. 14, 2005). On October 28, 2005, Plaintiffs filed a Third Amended Class Action Complaint (the "Third Complaint"). Defendants Sears, SRAC, and their officers and directors (collectively, the "Sears Defendants") seek dismissal of Counts VIII and IX of the Third Complaint, in which Plaintiffs allege § 10(b) securities fraud and § 20(a) "control person" liability in light of the Supreme Court's recent decision in Dura Pharmaceuticals, Inc., v. Broudo, 544 U.S. 336 (2005). Defendants contend a third motion to dismiss is warranted because Dura changed the requirements for pleading loss and causation in a securities fraud claim. For the reasons stated here, Defendants' motion is denied.
The extensive procedural and factual background of this case is set forth in this court's two previous opinions in this case. See Ong,2005 WL 2284285, at *2--8; Ong, 388 F. Supp. 2d at 876--88. The court assumes the reader's familiarity with the earlier decisions and attempts to recite only those facts relevant to the Sears Defendants' current motion to dismiss, and those needed for context.
Sears is one of the largest general retailers in North America. As part of its operations, Sears provides financing to customers through private label credit cards and installment plans.*fn1 SRAC, Sears' wholly-owned subsidiary, is primarily in the business of purchasing short-term notes and account receivable balances from Sears. SRAC funds these purchases by issuing debt securities such as commercial paper, medium term notes, and "other borrowings" (collectively, "SRAC Debt Securities") to the public. (Third Am. Compl. ¶¶ 12, 13, 47-48.) SRAC issued three such debt offerings during the Class period, pursuant to Prospectuses dated March 18, 2002 (the "3/18/02 Offering"), May 21, 2002 (the "5/21/02 Offering"), and June 21, 2002 (the "6/21/02 Offering"). (Id. ¶ 2.) Plaintiffs all purchased SRAC Debt Securities during the Class Period.*fn2 (Id. ¶¶ 9-11.)
Defendants Lacy, Liska, Keleghan, Vishwanath, Bergmann, Richter, Trost, Slook, and Raymond were all senior executive officers and/or directors of Sears, SRAC, or both, at some point during the Class Period. (Id. ¶¶ 14--22.) Defendants Credit Suisse First Boston Corporation ("CSFB"), Goldman, Sachs & Co. ("Goldman Sachs"), Morgan Stanley & Co., Inc. ("Morgan Stanley"), Bear, Stearns & Co., Inc. ("Bear Stearns"), Lehman Brothers, Inc. ("Lehman Brothers"), and Merrill Lynch & Co., Inc. ("Merrill Lynch") (collectively, the "Underwriter Defendants") are integrated financial services institutions. (Id. ¶¶ 33-38.) Each of the Underwriter Defendants served as either managing underwriter, lead manager, or book runner for one or more of the three SRAC debt offerings. (Id.)
A. The Relationship between Sears and SRAC
SRAC, Sears' wholly-owned finance subsidiary, has its own board of directors,*fn3 its own SEC filings, and its own independently issued securities. (Id. ¶ 49.) Plaintiffs allege, however, an "intertwining of the finances and operations" of the two companies. (Id. ¶ 57.) According to Plaintiffs, SRAC's operating income is generated primarily from the earnings on its investments in Sears' short-term notes and account receivables. Moreover, Sears requires SRAC to maintain a set ratio of earnings to fixed expenses. As a result, "the yield on SRAC's investment in Sears notes is directly related to SRAC's borrowing costs, i.e., the yield under which SRAC can issue and sell its Debt Securities." It is thus in Sears' financial interest to keep SRAC's borrowing costs as low as possible because the less SRAC pays purchasers of its Debt Securities, the less Sears must pay to borrow from SRAC. (Id. ¶ 49.)
Because of this "inter-relationship" between SRAC and Sears, industry analysts and the financial markets looked to Sears when assessing the investment prospects for SRAC Debt Securities. (Id. ¶ 50.) When analysts viewed Sears favorably, bond rating agencies issued positive ratings on SRAC debt; when Sears issued negative news, those agencies downgraded SRAC's credit rating. (Id.) Plaintiff also alleges a "direct relationship" between the market prices of the two companies' securities. For example, on October 17, 2002, Sears, as will be discussed, disclosed problems with its credit card operations. While the price of Sears stock reacted by falling $10.80 per share (approximately 32%) to close on October 17 at $23.15 on volume twelve times greater than Sears' daily trading average, SRAC Debt Securities from the 6/21/02 Offering fell 8.6% from $24.05 per share to $21.99 per share on six times the daily trading average. (Id. ¶¶ 51, 52.) Similarly, the interest rate on an SRAC proposed bond offering rose dramatically after Sears' October 17 announcement, from 13 to 38 basis points above the one-month London Interbank Offered Rate ("Libor").*fn4 (Id. at 54.) Thus, Plaintiffs assert, it was "reasonable for investors to believe that the ratings and yields on SRAC Debt Securities would correlate with the price of Sears' common stock, and in direct and immediate response to information disclosed to the market as it related to Sears' finances" and operations." (Id. ¶ 56.) The result, according to Plaintiffs, was that an investment in SRAC Debt Securities would "take on the status of a direct investment with Sears itself." (Id. ¶ 57.)
B. Sears' Credit Problems
For many years, Sears was one of the largest credit card issuers in the country. (Id. ¶ 63.) Prior to 1993, Sears stores accepted only Sears' own proprietary credit cards ("Sears Cards"), which could only be used to make purchases at Sears. (Id. ¶¶ 60, 64.) When Sears began accepting general credit cards in 1993, the company saw a drastic decrease in the use of Sears Cards. (Id. ¶ 64.) At the same time, Sears' retail sales were also in decline due to increased competition from discount retailers like Wal-Mart and Kohl's. (Id.) In late 2000, to stimulate sales and help regain income lost from the decline of its proprietary cards, Sears began to issue a Sears MasterCard, a general purpose credit card that could be used wherever MasterCard was accepted and that generated fee income for Sears when used at non-Sears locations. (Id. ¶ 67.) By February 2001, the Sears MasterCard carried $1.4 billion in receivables and Sears, through its subsidiary Sears National Bank, had become one of the top 25 bank card issuers. (Id. ¶ 70.) As Sears' retail business continued to decline, Defendant Lacy, Sears' Chief Executive Officer, identified the Sears MasterCard as a top area for growth and emphasized its importance to the company. (Id. ¶¶ 68, 71, 72.) Before and during the Class Period, Mr. Lacy and other Sears executives touted the success of Sears' credit operations, repeatedly portraying the quality of Sears' credit portfolio as "strong," "stable," and "adequately reserved." (Id. ¶ 73.) Defendant Keleghan, President of Sears Credit, described Sears MasterCard users as "a pristine group," noting "[w]e don't expect significant delinquencies since we're starting out with a low-risk group." (Id. ¶ 70.)
In reality, Sears credit operations suffered from several weaknesses and problems which were hidden from the market. (Id. ¶ 74.) First, contrary to representations that Sears targeted only low-risk consumers for its Sears MasterCard, Sears in fact aggressively marketed the card to borrowers with subprime credit; as a result, the percentage of subprime borrowers in Sears' credit portfolio far exceeded the national average. (Id. ¶¶ 76, 77.) Second, Sears masked the true charge-off and delinquency rates*fn5 of its credit cards by reporting those rates on a portfolio-wide basis rather than separating out the performances of the Sears Card and the Sears MasterCard. When the portfolio was viewed as a whole, the larger size of the Sears Card portfolio and the fast-growing receivables of the new MasterCard combined to give the appearance of stability, when in fact both groups were experiencing "a striking rise in delinquencies and charge-offs every quarter." (Id. ¶¶ 79--81.) Third, Plaintiffs allege (without explanation) that Sears National Bank was not subject to the same rules and regulatory oversight requirements as "ordinary" bank card issuers, thus allowing Sears to adopt more lenient credit policies for customers falling behind in their payments and avoid having to report their accounts as delinquent. (Id. ¶ 83.) Finally, Plaintiffs assert that Sears engaged in fraudulent billing practices by providing such strong incentives for sales of additional services, such as extended warranties, that salespersons were induced to charge customers for these items without the customers' knowledge or consent. As a result, Sears was able to report high receivables it knew to be uncollectible. (Id. ¶ 85.)
C. False and Misleading Statements
Plaintiffs allege that Sears executives issued numerous false and misleading statements to deceive the investing public into believing that Sears' credit operations were "far better, more successful and profitable, than was actually the case." (Id. ¶ 86.) This court in its first of two prior opinions in this case discussed in detail Defendants' alleged false and misleading statements regarding Sears' credit operations. See Ong, 388 F. Supp. 2d 871 at 879--85. The Third Complaint adds no new allegations in this regard. (Third Am. Compl. ¶¶ 86--158.) For purposes of the pending motion to dismiss, there is no dispute that Plaintiffs have sufficiently alleged that the relevant Defendants made false and misleading statements and, thus, the court will not repeat them here. The court notes generally, however, Plaintiffs' allegations that between the third quarter of 2001 and the second quarter of 2002, Defendants issued SEC Form 8-Ks and Form 10-Qs reflecting stable delinquency rates and improving credit portfolio quality. (Id. ¶¶ 96, 97, 99, 100, 109--11, 123--24, 132.) In fact, as noted above, both the Sears Card and Sears MasterCard portfolios were excessively weighted towards the subprime market and, when viewed separately, each reflected rising delinquency and charge-off rates. (Id. ¶¶ 76--81.) Nevertheless, Defendants made statements at analyst meetings, in press releases, and during investor conference calls confirming the stable and even "pristine" quality of the portfolios and projecting significant increases in earnings each year. (Id. ¶¶ 90--93, 98--100, 102, 114, 117--118, 132, 135, 139, 144, 149, 152.)
D. Sears' Disclosures of Problems with its Credit Operations and Market Reaction
Plaintiffs allege that the true state of Sears' credit portfolios finally began to emerge in October 2002. On October 4, 2002, Sears announced that Mr. Liska had replaced Mr. Keleghan as Sears' Executive Vice President and President of Credit and Financial Products. (Id. ¶ 160.) On October 7, 2002, Sears issued a press release reaffirming its July 18, 2002 projection of a 22% increase in earnings per share, but forecasting that earnings from its credit and financial services segment would increase only "in the mid-single digit percent range." This was a significant decrease from "low double digits" increase projected on July 18. (Id. ¶¶ 161--62.) Although Mr. Lacy characterized Mr. Keleghan's departure as unrelated to business performance, analyst W.R. Hambrecht wrote on October 7 that the departure "bodes poorly for Sears Credit operations . . . and creates even greater uncertainty about the quality of earnings at the credit division." (Id. ¶¶ 165, 168.) In response to the negative news, the price of Sears stock fell from a closing price of $37.64 on October 4, 2002, to $32.25 on October 7. (Id. ¶ 166.) Subsequently, the price of SRAC Debt Securities issued pursuant to the 6/21/02 Offering also fell, from an October 8, 2002 close of $24.81 per share to a closing price of $21.91 on October 10, 2002. (Id. ¶ 167.)
On October 17, 2002, Sears issued a press release announcing that it would be increasing its allowance for bad debt by $222 million. The charge against earnings required to cover this increase reduced Sears' earnings for the quarter by 26% as compared to the prior year. Despite having ten days earlier projected a 22% increase in earnings per share that year, Sears now estimated an increase in annual earnings of only 15%. The release also stated that the credit segment was "down 28 percent compared to the prior year." (Id. ¶ 171.)
In an analysts meeting conducted by conference call that day, Mr. Lacy attributed Sears' problems in its credit business to the duplicity of Mr. Keleghan and Mr. Vishwanath, asserting that Mr. Keleghan had not been forthcoming about the issues facing Sears' credit business and had been fired due to Mr. Lacy's "personal loss of confidence in him relative to his personal credibility," and that Mr. Vishwanath had "withheld information" and had been terminated as well. (Id. ¶ 172.) When Mr. Liska took over the conference call, he disclosed that "Middle America" balances made up a large portion of Sears' credit portfolio. Although Mr. Keleghan had, a year earlier, explained that Sears targeted "middle market" consumers as a way of distinguishing that group from the "subprime" market, Mr. Liska now used the term "Middle America" as a euphemism for "subprime": "It is generally recognized that [M]iddle America accounts deteriorate more quickly in a tough economy than prime accounts do." (Id. ¶¶ 173--74.) In contrast to Sears' earlier representations of the quality of its credit card portfolio, Mr. Liska acknowledged that Sears' credit portfolio had been heavily subprime for years: "In 1998 Middle America balances represent[ed] 60% of our portfolio. They represent 48% today. Last year the segment represented 54% of our portfolio." (Id. ¶ 174.)
In response to Sears' October 17, 2002 disclosures, W.R. Hambrecht reported that Sears' "shocking 26% decrease in earnings . . . stunned the Street and all in attendance" at the analysts meeting. "Frankly, it was the realization of our worst-case scenario regarding the state of the company's credit operations, which represent more than 60% of Sears' operating profit." (Id. ¶ 176.) Indeed, as noted above, the price of Sears stock fell $10.80 per share (approximately 32%) to close at $23.15 on October 17, 2002, and there was "extraordinary trading volume" that day of 36 million shares, twelve times greater than Sears' daily trading average of 2.9 million shares during the Class Period. (Id. ¶ 177.) SRAC Debt Securities fell 8.6%, from a close of $24.05 per share on October 16, 2002 to $21.99 on October 17, "on trading of 153,600 Notes, six times the daily trading average of 25,000 shares." (Id. ¶ 178.) A planned new debt offering by SRAC suffered as well. Shortly before the end of the Class Period, SRAC had announced its intention to offer approximately $800 million of three-year SRAC Debt Securities at an interest rate of 13 to 14 basis points above the one-month Libor; after the October 17 disclosures, however, these debt securities were priced at 38 points above Libor. (Id. ¶¶ 54, 179--80.) Plaintiffs assert that "Wall Street analysts attributed this sudden and dramatic increase in interest rates to the recent adverse disclosures not by SRAC, but by its parent, Sears." (Id. ¶ 54.)
On November 12, 2002, Sears filed its Form 10-Q for the third quarter of 2002. In that report, Sears for the first time revealed to investors how the Sears MasterCard and Sears Card portfolios had both been deteriorating during the Class Period. Sears disclosed that delinquency rates were rising in each portfolio when viewed separately; that Sears charged off accounts after 240 days, whereas most bank card issuers charge off at 180 days; that Sears allowed customers to "re-age" delinquent accounts (thus enabling Sears to avoid charging off the balance) once per year simply by making two consecutive monthly payments; and that Sears continued to record credit card fees and finance charges as revenue until an account was charged off. (Id. ¶¶ 182--84.)
Analysts reacted negatively to Sears' third quarter 10-Q filing. An article on The Street.com reported that the new data showed "a big jump in bad loans" that signified "deep deterioration in the MasterCard portfolio," and predicted that, "if this rot continues, the company may have to make loan provisions in 2003 that could wipe out a large part of the earnings analysts currently forecast." (Id. ¶ 186.) On November 20, 2002, Bear Steams described Sears' "aggressive write-off policy" as a "key concern," and expressed "uneas[e]" as to whether Sears had "adequately accounted for the potential level of charge-offs."
On January 16, 2003, Sears issued a press release announcing that it was adding another $150 million to its reserves for uncollectible accounts, in part due to "increases in the net charge-off rate and delinquencies." (Id. ¶ 188.) On February 28, 2003, Sears lost its "A" credit rating when Standard and Poor's downgraded Sears debt. (Id. ¶ 189.) In its 2002 Form 10-K, filed on March 12, 2003, Sears repeated the delinquency and charge-off information contained in the third quarter 2002 SEC filings and acknowledged continuing deterioration in delinquency rates at the end of 2002. (Id. ¶¶ 190-91.) On March 26, 2003, Sears announced that it would seek to ...