United States District Court, C.D. California
February 13, 2015
TIMOTHY QUINTANILLA, et al
ATTORNEYS FOR PLAINTIFF: Not Present.
ATTORNEYS FOR DEFENDANT: Not Present.
HONORABLE DAVID O. CARTER, JUDGE.
CIVIL MINUTES -- GENERAL
PROCEEDINGS (IN CHAMBERS): ORDER GRANTING IN PART AND DENYING IN PART DEFENDANTS' MOTION TO DISMISS 
Before the Court is Defendants' Motion to Dismiss (Dkt. 65). The Court finds this matter appropriate for resolution without oral argument. See Fed.R.Civ.P. 78; L.R. 7-15. Having considered the papers, the Court GRANTS IN PART and DENIES IN PART Defendants' Motion.
This lawsuit is a putative securities fraud class action brought by Plaintiffs George Zuzulock, William Weakley, and Penny Pace against Defendants Timothy Quintanilla, Henry Mendoza, Bill Torres, James Francis Berger, and Cindy E. Gonzalez. The putative class consists of purchasers of common stock of Electronic Game Card, Inc. (" EGC") between March 26, 2008 and February 19, 2010. First Amended Compl. (" FAC") (Dkt. 64) ¶ 3. The Defendants are all accounts and partners in Mendoza Berger & Co., LLP (" M& B"), a now-defunct firm that once served as EGC's outside auditor. Id. ¶ ¶ 4, 31.
This case is related to another matter currently pending before this Court, Petrie v. Electronic Game Card, Inc., Case No. 8:14-cv-10-0252-DOC (RNBx), a putative securities fraud class action against EGC and its directors and officers. This case is also related to an SEC civil enforcement action currently pending in the Southern District of New York, Case No. 1:12-cv-08167-RJS.
A. Factual Allegations
a. EGC's Troubles
EGC was in the business of designing and manufacturing " scratch off" devices for various casinos, lotteries and other gaming establishments primarily in the United Kingdom and Europe. FAC ¶ 5. Nearly all of EGC's reported revenues were allegedly derived from its UK and European operating subsidiary, Electronic Game Card, Ltd. (" EGCL"). Id. EGC falsely reported incrementally increasing cash balances from March 2008 to September 2009 when, in truth, EGC did not possess any of the millions of dollars it claimed it had in its bank accounts. Id. ¶ 6.
On February 19, 2010, the SEC halted trading in EGC's stock " because of questions that have been raised about the accuracy of assertions by [EGC], and by others, in financial disclosures to investors concerning, among other things, the company's assets." Id. ¶ 8. That same day, EGC announced that its auditor M& B had withdrawn its audit opinions of EGC's financial statements for FY 2006, 2007, and 2008 because M& B had " become aware of irregularities in the audit confirmation of a bank account represented to M& B as having been held by [EGCL], a wholly owned subsidiary of [EGC]..." Id. ¶ 9.
On May 18, 2010, EGC announced that its board of directors had concluded that its financial statements for FY 2006, 2007, and 2008 should no longer be relied upon because of " significant concerns as to the integrity of audited financial statements" for those years. Id. ¶ 12.
Subsequently, EGC's stock was delisted and EGC ultimately filed for Chapter 7 bankruptcy, causing investors to lose their entire investment in EGC. Id. ¶ ¶ 15-16.
On November 8, 2012, the SEC filed a complaint against, among others, Defendant Timothy Quintanilla, in the Southern District of New York. Id. ¶ 17. That complaint alleged that M& B's audit of EGC was so insufficient as to constitute no audit at all. Id.
b. M& B's Misleading Statements
On March 26, 2008, at Defendant Quintanilla's direction, M& B issued an unqualified audit report certifying the accuracy of EGC's financial statements. The audit report was included in EGC's Form 10-KSB filing for FY 2007. The audit report stated that M& B had conducted an audit of EGC's financial statements for that fiscal year in accordance with the standards of the Public Company Accounting Oversight Board (PCAOB) and that, in M& B's opinion, the financial statements " present fairly, in all material respects, the financial position of Electronic Game Card, Inc. as of December 31, 2007 and 2006 and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America." Id. ¶ ¶ 37-38, 42.
On March 24, 2009, also at Defendant Quintanilla's direction, M& B issued an unqualified audit report certifying the accuracy of EGC's financial statements for FY 2008. The audit report was included in EGC's Form 10-K filing for FY 2008. Similar to the previous one, this audit report stated that M& B had conducted an audit of EGC's financial statements for that fiscal year in accordance with the standards of the PCAOB and that, in M& B's opinion, the financial statements " present fairly, in all material respects, the financial position of Electronic Game Card, Inc. as of December 31, 2008 and 2007 and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America." Id. ¶ ¶ 39-40, 42.
Plaintiffs allege that the audit reports were false and misleading because EGC's financial statements actually were not presented in conformity with general accepted accounting principles (GAAP). Id. ¶ 110. Moreover, Defendants did not conduct the audits in accordance with the PCAOB or generally accepted auditing standards (GAAS). Id. ¶ ¶ 41, 43, 66-67. Defendants allegedly failed to routinely review documents collected from EGC to determine if they contained irregularities. When they did note irregularities, Defendants did not investigate further. In addition, Defendants relied on EGC management's representations and materials instead of independently investigating. Id. ¶ ¶ 47-48; see also id. ¶ ¶ 51, 55, 59, 61, 63-65, 68 (describing specific audit process deficiencies alleged by the SEC).
Plaintiffs allege that " Defendants knew that their audits fell well below PCAOB standards, rendering their statements to the contrary in their audit reports in EGC's 10-Ks deliberately false and misleading." Id. ¶ 93.
c. Defendants' Roles
Defendant Timothy Quintanilla began working at M& B in 2006 and brought with him audit clients including Advance Nanotech, Inc., which was one of the companies operated by Lee Cole and Linden Boyne, two executives of EGC. During the relevant times, Quintanilla was the engagement partner for M& B's EGC account. Id. ¶ 26.
Defendant Henry Mendoza was a managing partner at M& B. He had over 27 years of experience in public accounting. His responsibilities at M& B included management of all of the firm's services, including auditing- and accounting-related services, consulting, administration, marketing, recruiting, and management. Id. ¶ 27.
Defendant Bill Torres was a managing partner at M& B and had experience working in consulting, compliance, and tax. He has provided attorneys with tax advice to assist in structuring settlement proposals. Id. ¶ 28.
Defendant James Francis Berger is a senior partner at M& B. His responsibilities included providing auditing and accounting-related services and tax and consulting services; planning and managing engagements including tax preparation, audits, reviews and compilations, and special purpose reports. He previously worked as a forensic accountant. Id. ¶ 29.
Defendant Cindy E. Gonzalez was a partner at M& B responsible for tax matters. She had over 10 years of experience providing compliance services. Id. ¶ 30.
B. Procedural History
Plaintiffs originally filed this lawsuit in the Southern District of New York on January 4, 2013. Compl. (Dkt. 1). The case was transferred to the Central District of California on March 19, 2014 (Dkt. 32). Plaintiffs filed the operative complaint, the First Amended Complaint, on October 14, 2014 (Dkt. 64). The FAC alleges that Defendants violated Section 10(b) and Rule 10b-5 of the Exchange Act. Plaintiffs also allege that Defendants should be held liable as control persons under Section 20(a) of the Exchange Act.
Defendants brought the instant Motion on November 10, 2014 (Dkt. 65). Plaintiffs filed an opposition on December 10, 2014 (Dkt. 67) and Defendants a reply on December 22, 2014 (Dkt. 70).
II. Legal Standard
Under Federal Rule of Civil Procedure 12(b)(6), a complaint must be dismissed when a plaintiff's allegations fail to set forth a set of facts which, if true, would entitle the complainant to relief. Bell A. Corp. v. Twombly, 550 U.S. 544, 555, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007); Ashcroft v. Iqbal, 556 U.S. 662, 679, 129 S.Ct. 1937, 173 L.Ed.2d 868 (2009) (holding that a claim must be facially plausible in order to survive a motion to dismiss). The pleadings must raise the right to relief beyond the speculative level; a plaintiff must provide " more than labels and conclusions, and a formulaic recitation of the elements of a cause of action will not do." Twombly, 550 U.S. at 555 (citing Papasan v. Allain, 478 U.S. 265, 286, 106 S.Ct. 2932, 92 L.Ed.2d 209 (1986)). On a motion to dismiss, this court accepts as true a plaintiff's well-pleaded factual allegations and construes all factual inferences in the light most favorable to the plaintiff. See Manzarek v. St. Paul Fire & Marine Ins. Co., 519 F.3d 1025, 1031 (9th Cir. 2008). The court is not required to accept as true legal conclusions couched as factual allegations. Iqbal, 556 U.S. at 678.
An allegation of " fraud or mistake must state with particularity the circumstances constituting fraud." Fed.R.Civ.P. 9(b). The " circumstances" required by Rule 9(b) are the " who, what, when, where, and how" of the fraudulent activity. Vess v. Ciba-Geigy Corp. USA, 317 F.3d 1097, 1106 (9th Cir. 2003); Neubronner v. Milken, 6 F.3d 666, 672 (9th Cir. 1993) (" [Rule 9(b) requires] the times, dates, places, benefits received, and other details of the alleged fraudulent activity."). In addition, the allegation " must set forth what is false or misleading about a statement, and why it is false." Vess, 317 F.3d at 1106 (quoting In re Glenfed, Inc. Secs. Litig., 42 F.3d 1541, 1548 (9th Cir. 1994)). This heightened pleading standard ensures that " allegations of fraud are specific enough to give defendants notice of the particular misconduct which is alleged to constitute the fraud charged so that they can defend against the charge and not just deny that they have done anything wrong." Semegen v. Weidner, 780 F.2d 727, 731 (9th Cir. 1985).
Under the heightened pleading standards of the Private Securities Litigation Reform Act (" PLSRA"), a securities fraud complaint must identify each alleged misrepresentation, specify the reasons it is misleading, and state with particularity facts giving rise to a strong inference that the defendant who made the misrepresentation acted with fraudulent intent. Tellabs Inc. v. Makor Issues & Rights Ltd., 551 U.S. 308, 321, 127 S.Ct. 2499, 168 L.Ed.2d 179 (2007).
In evaluating a Rule 12(b)(6) motion, review is ordinarily limited to the contents of the complaint and material properly submitted with the complaint. Van Buskirk v. Cable News Network, Inc., 284 F.3d 977, 980 (9th Cir. 2002); Hal Roach Studios, Inc. v. Richard Feiner & Co., Inc., 896 F.2d 1542, 1555 n.19 (9th Cir. 1990). Under the incorporation by reference doctrine, the court may also consider documents " whose contents are alleged in a complaint and whose authenticity no party questions, but which are not physically attached to the pleading." Branch v. Tunnell, 14 F.3d 449, 454 (9th Cir. 1994), overruled on other grounds by 307 F.3d 1119, 1121 (9th Cir. 2002). The court may treat such a document as " part of the complaint, and thus may assume that its contents are true for purposes of a motion to dismiss under Rule 12(b)(6)." United States v. Ritchie, 342 F.3d 903, 908 (9th Cir. 2003).
Additionally, the court may take judicial notice of certain items without converting the motion to dismiss into one for summary judgment. Barron v. Reich, 13 F.3d 1370, 1377 (9th Cir. 1994). For instance, the court may take judicial notice of facts " not subject to reasonable dispute" because they are either: " (1)  generally known within the trial court's territorial jurisdiction; or (2) can be accurately and readily determined from sources whose accuracy cannot reasonably be questioned." Fed.R.Evid. 201; see also Harris v. Cnty. of Orange, 682 F.3d 1126, 1132 (9th Cir. 2012) (noting that the court may take judicial notice of " undisputed matters of public record, " including " documents on file in federal or state courts, " as well as " documents not attached to a complaint . . . if no party questions their authenticity and the complaint relies on those documents").
Dismissal under Rule 12(b)(6) on the basis of an affirmative defense is proper only if the complaint's allegations, with all inferences drawn in Plaintiff's favor, nonetheless show that the affirmative defense " is apparent on the face of the complaint." See Von Saher v. Norton Simon Museum of Art at Pasadena, 592 F.3d 954, 969 (9th Cir. 2009); see also ASARCO, LLC v. Union Pac. R. Co., 765 F.3d 999, 1004 (9th Cir. 2014). " If, from the allegations of the complaint as well as any judicially noticeable materials, an asserted defense raises disputed issues of fact, dismissal under Rule 12(b)(6) is improper." ASARCO, 765 F.3d at 1004 (citing Scott v. Kuhlmann, 746 F.2d 1377, 1378 (9th Cir. 1984) (per curiam)).
Dismissal with leave to amend should be freely given " when justice so requires." Fed.R.Civ.P. 15(a)(2) This policy is applied with " extreme liberality." Morongo Band of Mission Indians v. Rose, 893 F.2d 1074, 1079 (9th Cir. 1990); Lopez v. Smith, 203 F.3d 1122, 1127 (9th Cir. 2000) (holding that dismissal with leave to amend should be granted even if no request to amend was made). Dismissal without leave to amend is appropriate only when the court is satisfied that the deficiencies in the complaint could not possibly be cured by amendment. Jackson v. Carey, 353 F.3d 750, 758 (9th Cir. 2003).
Defendants raise a number of arguments in favor of dismissing the claims against them. The Court addresses each of Defendants' arguments in turn.
A. Statute of Limitations
Defendants argue that Plaintiffs' claims are time-barred because a reasonably diligent investor would have discovered that M& B had potentially violated the securities laws on either (1) February 19, 2010, when the SEC halted trading in EGC's stock and EGC filed a Form 8-K announcing M& B's withdrawal of its audit opinions or, (2) at the latest, May 18, 2010, when EGC filed a Form 8-K announcing that investors should no longer rely on EGC's audited financial statements for FY 2006, 2007, and 2008. Thus, Defendants argue, Plaintiffs should have filed their lawsuit by February or May 2012 and should not have waited until January 4, 2013.
Plaintiffs argue that the clock did not start ticking until they discovered that Defendants had the requisite scienter on November 8, 2012, when the SEC filed a civil enforcement action against Defendant Quintanilla.
Under 28 U.S.C. § 1658(b)(1), a private right of action for securities fraud cannot be brought more than " 2 years after the discovery of the facts constituting the violation."
[T]he limitations period in § 1658(b)(1) begins to run once the plaintiff did discover or a reasonably diligent plaintiff would have " discover[ed] the facts constituting the violation" --whichever comes first. In determining the time at which " discovery" of those " facts" occurred, terms such as " inquiry notice" and " storm warnings" may be useful to the extent that they identify a time when the facts would have prompted a reasonably diligent plaintiff to begin investigating. But the limitations period does not begin to run until the plaintiff thereafter discovers or a reasonably diligent plaintiff would have discovered " the facts constituting the violation, " including scienter--irrespective of whether the actual plaintiff undertook a reasonably diligent investigation.
Merck & Co. v. Reynolds, 559 U.S. 633, 653, 130 S.Ct. 1784, 176 L.Ed.2d 582 (2010).
Here, a reasonably diligent investor would have known by February 19, 2010 that M& B withdrew its audit opinions and that EGC and " others" had potentially violated the securities laws. By May 18, 2010, a reasonably diligent investor would have known that there was a significant problem with the integrity of EGC's audited financial statements for FY 2006, 2007, and 2008. Thus, by May 18, 2010, Plaintiffs had inquiry notice that M& B's auditors had made misrepresentations to them and that M& B's auditors may have done so with scienter.
The question before the Court is whether a reasonably diligent investor would have discovered sometime before January 4, 2011 that M& B auditors' misrepresentations were made intentionally or recklessly rather than negligently. Without a factual record, it is not clear to this Court what a reasonably diligent EGC investor could have or should have done to investigate Defendants' roles and what the investor would have discovered and when. There are no allegations in the complaint or any judicially noticeable facts before the Court showing that a reasonable investor definitively would have discovered Defendants' scienter before January 4, 2011. Accordingly, the Court will not dismiss Plaintiffs' claims on statute of limitations argument at the pleading stage.
B. Statute of Repose
Under 28 U.S.C. § 1658(b)(2), a private right of action for securities fraud cannot be brought more than five years after such violation. Defendants appear to argue that any claims based on M& B's FY 2006 audit opinion are barred by the statute of repose because M& B first issued its FY 2006 audit opinion on April 5, 2007, over 5 years before this lawsuit was filed.
The Court agrees with Plaintiffs that the allegedly misleading statement at issue in this case is the March 26, 2008 audit report in which M& B stated that EGC's financial statements fairly presented EGC's financial position " as of December 31, 2007 and 2006, " FAC ¶ 38, and that the March 26, 2008 statement is actionable as it was made within 5 years prior to the date this lawsuit was filed.
Accordingly, the Court will not grant Defendants' Motion to Dismiss based on Defendants' statute of repose argument.
C. Section 10(b) and Rule 10b-5 Claims
To state a claim under Section 10(b) and Rule 10b-5, a plaintiff must allege facts showing (1) a material misrepresentation, (2) scienter, (3) a connection with the purchase or sale of security, (4) reliance, (5) economic loss, and (6) loss causation. Dura Pharms., Ins. v. Broudo, 544 U.S. 336, 341, 125 S.Ct. 1627, 161 L.Ed.2d 577 (2005). Defendants argue that Plaintiffs have not adequately alleged that M& B made the material misrepresentations and that Defendants had the requisite level of scienter.
a. Whether M& B " Made" the Alleged Misrepresentations
Defendants first argue that M& B cannot be held liable for the alleged misrepresentations because they were not responsible for preparing EGC's financial statements and accounting documents, only for auditing them.
The Court does not find this argument persuasive, as the FAC does not allege that M& B was responsible for preparing those documents. Rather, the FAC alleges that Defendants were responsible for falsely certifying that EGC's financial statements were prepared in accordance with GAAP and for falsely stating that Defendants' audits of those financial statements were conducted in accordance with PCAOB standards. Accordingly, the Court will not grant Defendants' Motion to Dismiss based on this argument.
b. Whether Plaintiffs Can Rely on the SEC's Litigation Filings
Second, Defendants argue that paragraphs 51, 55, 59, 61, 63-65, and 68 of the FAC (" SEC Paragraphs") should be disregarded because they were copied from the SEC's complaint and were not the result of personal investigation by Plaintiffs or Plaintiffs' counsel. Without those paragraphs, much of the detail regarding Defendants' scienter would be stripped from the FAC. The Court first determines whether it can properly consider the contested paragraphs as part of the complaint and then determines whether whatever is left of the complaint adequately alleges scienter.
" Under Rule 11(b), an attorney has a nondelegable responsibility to personally . . . validate the truth and legal reasonableness of the papers filed . . . and to conduct a reasonable factual investigation." In re Connetics Corp. Sec. Litig., 542 F.Supp.2d 996, 1005 (N.D. Cal. 2008) (internal quotation marks and citations omitted). Allegations that are not independently investigated can be stricken from a complaint. See id.; Johns v. Bayer Corp., No. 09CV1935 DMS (JMA), 2010 WL 2573493, at *1 (S.D. Cal. June 24, 2010). An attorney cannot rely solely on another complaint as the sole basis for his or her allegations. However, sources such as newspaper articles and other complaints combined with an attorney's own investigative efforts can be a reasonable source of allegations based on information and belief. In re Connetics, 542 F.Supp.2d at 1005.
Here, Plaintiffs' attorney Jonathan Stern asserts that he verified the accuracy of the SEC's allegations by comparing them to the exhibits attached to the SEC's motion for summary judgment in the Southern District of New York case and to documents in Plaintiffs' possession. Declaration of Jonathan Stern (Dkt. 68) ¶ 2. The Court notes that Plaintiff's counsel obtained subpoena responses from M& B in Petrie before filing the operative complaint in this case. Without more evidence to the contrary, the Court has no reason to believe that Plaintiff's attorneys did not fulfill their Rule 11 obligations.
Accordingly, the Court DENIES Defendants' request to strike the SEC Paragraphs.
c. Whether the FAC Adequately Pleads Scienter
Having established that the Court can consider the SEC Paragraphs, the Court now turns to whether the FAC adequately pleads scienter.
The Private Securities Litigation Reform Act (PSLRA) requires that the complaint " 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) (emphasis added). This scienter requirement means that plaintiffs must plead that the defendants engaged in " knowing" or " intentional" misconduct. South Ferry LP, No. 2 v. Killinger, 542 F.3d 776, 782 (9th Cir. 2008). Under Ninth Circuit precedent, " reckless" conduct may satisfy the scienter requirement when it is " deliberate" and the facts describing the recklessness are set forth in great detail. Id.; see also In re Silicon Graphics, Inc. Sec. Litig., 183 F.3d 970, 977 (9th Cir. 1999) (holding that the recklessness must reflect " some degree of intentional or conscious misconduct" in order to satisfy the scienter requirement), abrogated on other grounds by 542 F.3d 776, 784 (9th Cir. 2008).
In determining whether there is a " strong inference" of scienter, the court must weigh competing inferences. Tellabs, 551 U.S. at 323-24 (" [A] court must consider plausible, nonculpable explanations for the defendant's conduct, as well as inferences favoring the plaintiff."). The inference of scienter must be more than " merely reasonable . . . it must be cogent and compelling, thus strong in light of other explanations." Id. at 324. " Omissions and ambiguities count against inferring scienter, " but the court must " not scrutinize each allegation in isolation." Id. at 326. Instead, the court must view the complaint " holistically." Id.; see also South Ferry, 542 F.3d at 784 (" Vague or ambiguous allegations are now properly considered as a part of a holistic review when considering whether the complaint raises a strong inference of scienter."). Thus, a complaint for securities fraud survives a motion to dismiss when, after considering the totality of the circumstances, " a reasonable person would deem the inference of scienter cogent and at least as compelling as any opposing inference one could draw from the facts alleged." Tellabs, 551 U.S. at 324; South Ferry, 542 F.3d at 784..
Adequately pleading an outside auditor's scienter is typically difficult because " outsider auditors have more limited information than, for example, the company executives who oversee the audit. Further, an auditor exercises 'complex and subjective professional judgments that courts are not ideally positioned to second guess.'" New Mexico State Inv. Council v. Ernst & Young LLP, 641 F.3d 1089, 1097 (9th Cir. 2011) (citing In re Countrywide Fin. Corp. Sec. Litig., 588 F.Supp.2d 1132, 1197 (C.D. Cal. 2008)). In determining whether a strong inference of scienter exists, courts look for potential " red flags, " " including the interaction of auditors with company executives and the breadth and scope of the auditor's deviation from GAAP or GAAS." Id. at 1098. When deviations from GAAP and GAAS are alleged, " the more facts alleged that should cause a reasonable auditor to investigate further before making a representation, the more cogent and compelling a scienter inference becomes." Id.
Alleging that the auditor made minor or technical errors or that the auditor simply misapplied accounting principles is not sufficient to allege a wrongful state of mind. The plaintiff must allege that " the accounting practices were so deficient that the audit amounted to no audit at all, or an egregious refusal to see the obvious, or to investigate the doubtful, or that the accounting judgments which were made were such that no reasonable accountant would have made the same decisions if confronted with the same facts." Id. " The more likely an auditor would have discovered the truth if a reasonable audit had been conducted, the stronger the scienter inference." Id.
Here, Plaintiffs allege, inter alia, that Defendants failed to investigate EGC's representations regarding a Credit Suisse account that supposedly contained between 71% and 91% of EGC's total assets despite " indicia of fraud." FAC ¶ 51. For instance, M& B received a faxed confirmation of the Credit Suisse account balance in April 2007 showing a balance of $2.7 million, which was inconsistent with the $3 million figure reported on M& B's cash lead sheet and general ledger. Id. ¶ 51(c), (e). M& B issued its FY 2007 audit report certifying EGC's 2007 financial statements without receiving any bank statements. Id. ¶ 51(g). Over the years, EGC's ledgers reflected account transfers of tens and hundreds of thousands of dollars from the Credit Suisse account to its Bank of America and Clydesdale accounts. However, bank statements from Bank of America and Clydesdale reflected that those amounts came from accounts held by companies owned by Lee Cole and Linden Boyne, not the Credit Suisse account. Id. ¶ 51(d), (h), (k). Plaintiffs allege that Defendants did not adequately confirm EGC's accounts receivables. Id. ¶ 55. Plaintiffs also allege that Quintanilla issued a clean audit report for FY 2008 two months after finding out that EGC had not filed federal or state tax returns for the past six years. Id. ¶ 59.
The FAC generally makes allegations against " Defendants" as a group. Most of the specific allegations are made against Defendant Quintanilla, the engagement partner for M& B's EGC account. Id. ¶ 26. Quintanilla was allegedly unqualified to conduct the FY 2006, 2007, and 2008 audits. Id. ¶ 63(b). He allegedly backdated and modified and instructed others to backdate and modify audit workpapers in the months after issuing the FY 2008 audit reports in anticipation of an inspection by the PCAOB in September 2009. Id. ¶ 64(b)-(d). The specific allegations about Quintanilla's direct work on and misconduct with regard to the EGC account, combined with the group allegations, are sufficient to plead scienter as to Defendant Quintanilla.
Specific allegations regarding the non-Quintanilla Defendants are much fewer. The FAC describes Torres's and Gonzalez's general roles in the firm, but does not otherwise mention them specifically. Mendoza allegedly endorsed a company-wide practice of modifying and backdating workpapers to conceal deficiencies from the PCAOB. Id. ¶ 64(a). Berger was the concurring partner for the EGC audits, but he allegedly did no substantive work on the EGC audits until after M& B pulled its audit opinions in 2010. Id. ¶ 63(c). Such allegations do not meet the PSLRA's high pleading standard for scienter, as they do not describe with particularity these Defendants' roles in auditing EGC or in making the alleged misrepresentations.
Accordingly, the Court DISMISSES the Section 10(b) and Rule 10b-5 claims against the non-Quintanilla Defendants, but DENIES Defendants' Motion as to Plaintiffs' Section 10(b) and Rule 10b-5 claims against Defendant Quintanilla.
D. Section 20(a) Claims Against Non-Quintanilla Defendants
Defendants argue that the Section 20(a) claims against the non-Quintanilla Defendants should be dismissed for failure to state a claim.
Section 20(a) of the Securities Exchange Act of 1934 provides:
Every person who, directly or indirectly, controls any person liable under any provision of this chapter or of any rule or regulation thereunder shall also be liable jointly and severally with and to the same extent as such controlled person to any person to whom such controlled person is liable . .., unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action.
15 U.S.C. § 78t(a).
To state a claim for control person liability, the plaintiff must allege (1) a primary violation of the federal securities laws, and (2) facts sufficient to show that the defendant had the authority to exercise power or control over the primary violator. Howard v. Everex Sys., Inc., 228 F.3d 1057, 1065 (9th Cir. 2000). " Whether [the defendant] is a controlling person is an intensely factual question, involving scrutiny of the defendant's participation in the day-to-day affairs of the corporation and the defendant's power to control corporate actions." Id. (alteration in original). " [A]n individual's status as an officer or director of the issuing corporation is insufficient, standing alone, to demonstrate the exercise of control." In re Amgen Inc. Sec. Litig., 544 F.Supp.2d 1009, 1037 (C.D. Cal. 2008).
The FAC alleges that the non-Quintanilla Defendants were partners with ownership rights in M& B. FAC ¶ ¶ 27-30, 116. It also alleges that " Defendants had the power to influence and control and did influence and control, directly or indirectly, the decision-making of Defendants including the content and dissemination of the various statements which Plaintiffs contend are false and misleading." Id. ¶ 116. Additionally, " Defendants had direct and supervisory involvement in the day-to-day operations of M& B and, therefore, are presumed to have had the power to control or influence the issuance of the audit reports giving rise to the securities violations as alleged herein, and exercised the same." Id. ¶ 117. Taken together, these allegations are sufficient under the Rule 8 pleading standard to adequately allege that the non-Quintanilla defendants had the authority to exercise control over Quintanilla, the alleged primary violator.
Accordingly, the Court DENIES Defendants' Motion to Dismiss as to the Section 20(a) claims against Defendants Mendoza, Berger, Torres, and Gonzalez.
E. Bankruptcy Stay
Finally, Defendants argue that the claims against Henry Mendoza should be dismissed because the original complaint was filed during Mendoza's bankruptcy proceedings. Pursuant to 11 U.S.C. § 362, the filing of a bankruptcy petition automatically stays, inter alia,
the commencement or continuation, including the issuance or employment of process, of a judicial, administrative, or other action or proceeding against the debtor that was or could have been commenced before the commencement of the case under this title, or to recover a claim against the debtor that arose before the commencement of the case under this title.
Id. § 362(a)(1). " The stay of section 362 is extremely broad in scope and, aside from the limited exception[s] of subsection (b), should apply to almost any type of formal or informal action against the debtor or property of the estate." In re Miller, 397 F.3d 726, 730-31 (9th Cir. 2005). " A party violating the automatic stay . . . must automatically dismiss or stay such proceeding or risk possible sanctions for willful violations pursuant to § 362(h)." Eskanos & Adler, P.C. v. Leetien, 309 F.3d 1210, 1214 (9th Cir. 2002). " [V]iolations of the automatic stay are void, not voidable." In re Schwartz, 954 F.2d 569, 571 (9th Cir. 1992).
Here, the automatic stay was in place between June 8, 2012, when Mendoza filed for Chapter 7 personal bankruptcy protection and April 29, 2013, when he was discharged. See Request for Judicial Notice, Ex. 5 (Dkt. 66). Plaintiffs filed their securities fraud claims against Medoza on January 4, 2013. If the filing constituted an " action . . . that . . . could have been commenced" before June 8, 2012 or the claims " arose" before June 8, 2012, then the filing of the complaint was void as a violation of 11 U.S.C. § 362.
In the Ninth Circuit, a claim generally " arises" under the Bankruptcy Code when the plaintiff " fairly contemplates" a cause of action. In re Zilog, Inc., 450 F.3d 996, 1000 (9th Cir. 2006). That is, " claims" under the Bankruptcy Code include " all future . . . damages cost based on pre-petition conduct that can be fairly contemplated by the parties at the time of [d]ebtors' bankruptcy." In re Jensen, 995 F.2d 925, 930 (9th Cir. 1993) (alteration in original).
Plaintiffs argue that its original complaint was not subject to the automatic stay because they did not " fairly contemplate" their claims against Mendoza, and thus those claims did not " arise, " until Plaintiffs discovered on November 8, 2012, five months after Mendoza filed his bankruptcy petition, that Mendoza might have acted with scienter. Here, as with the statute of limitations, the allegations in the FAC and the judicially noticeable facts before the Court do not definitively establish when Plaintiffs fairly contemplated their claims against Mendoza. Accordingly, the Court cannot dismiss the claims at the pleading stage on the ground that Plaintiffs could have commenced an action against Mendoza or that the claims arose pre-petition.
For the foregoing reasons, the Court GRANTS IN PART and DENIES IN PART Defendants' Motion to Dismiss as follows:
(1) Plaintiffs' Section 10(b) and Rule 10b-5 claims against Defendants Mendoza, Torres, Berger, and Gonzalez are DISMISSED WITH LEAVE TO AMEND;
(2) Defendants' Motion is DENIED as to Plaintiffs' Section 20(a) claims against Defendants Mendoza Torres, Berger, and Gonzalez;
(3) Defendants' Motion is DENIED as to Plaintiffs' claims against Defendant Quintanilla.
The Clerk shall serve this minute order on the parties.