United States District Court, C.D. California
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 That same day, EGC announced that its auditor M& B had withdrawn its audit opinions of EGC's financial statements for FY 2006, 2007, and 2008 because M& B had " become aware of irregularities in the audit confirmation of a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 ...