Investors’ securities fraud action against an education provider and two of its officers for questionable revenue recognition was dismissed without prejudice for failing to adequately plead scienter (Zamir v. Bridgepoint Education, Inc., April 5, 2017, Sammartino, J.L.).
As a for-profit provider of higher education, Bridgepoint’s main source of revenue is tuition received through federal financial aid. During a 2012 upgrade of its student management system, technical issues delayed students’ qualification for financial aid. Consequently, many students had to pay outstanding balances on their own.
In March 2012, Bridgepoint reported an increase in bad debt expense, blaming the technical delays. The bad debt expenses continued into 2013 and in late 2013, the SEC contacted Bridgepoint’s CFO to inquire about the company’s declining enrollment and increased revenue.
After Bridgepoint announced that it would be restating its 2013 financial statements, the SEC requested that it restate 2011 and 2012 financials. The SEC subsequently sent a subpoena requesting information on the company’s accounting practices, including revenue recognition.
Investors sued, alleging causes of action against the company, Andrew Clark (Bridgepoint’s co-founder and CEO) and Daniel Devine (Bridgepoint’s CFO) for violating Exchange Act Section 10(b) and Rule 10b-5. In addition, Clark and Devine allegedly violated Exchange Act Section 20(a).
An amended complaint was dismissed with leave to amend, and a Second Amended Complaint (SAC) was filed. This opinion addressed a motion to dismiss under FRCP 12(b)(6) for failing to adequately plead two required elements of Rule 10b-5: scienter and loss causation.
Deliberate GAAP violations do not support inference of scienter. The investors asserted that Devine and Clark were aware of GAAP and SEC guidance that revenue cannot be recognized until collectibility is reasonably assured. They claimed that Bridgepoint’s assessment of revenue collectibility failed to consider students’ ability to pay. But even if Clark and Devine had been put "on notice" when the SEC raised the issue, mere awareness of the issue was insufficient to establish the requisite scienter, the court ruled. The SAC failed to plausibly allege that Clark "had any knowledge of, or involvement with, the accounting for the independent paying students," much less that he, a non-accountant, "would have an informed opinion as to whether treating the independent paying students as presenting a revenue recognition issue, versus a bad debt issue, was the only correct decision under GAAP." GAAP violations, without more, do not establish scienter, even if those GAAP violations were deliberate, the court stated.
Government investigations. The investors asserted that SEC, DOJ and DOE regulatory investigations into the company, after it announced that it would restate its financials, supported an inference of scienter. But even when reviewed holistically, these allegations failed to give rise to a strong inference of scienter at least as compelling as an inference of nonfraudulent conduct. This time, the holistic analysis was made without allegations of insider trading (withdrawn from the SAC). As such, the scienter element was inadequately pleaded and again dismissed without prejudice.
Loss causation claim still viable. The court had previously concluded that allegations pointing to partial corrective disclosures revealing the fraud to the market could plausibly establish loss causation. Nothing had changed in the SAC and the court therefore denied the motion to dismiss on this alternative ground.
The case is No. 3:15-cv-408.
Attorneys: Casey Edwards Sadler (Glancy Prongay & Murray LLP) for Nelda Zamir. Daniel John Tyukody, Jr. (Greenberg Traurig, LLP) for Bridgepoint Education, Inc.
Companies: Bridgepoint Education, Inc.
MainStory: TopStory AccountingAuditing DirectorsOfficers FraudManipulation PublicCompanyReportingDisclosure CaliforniaNews
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