In re DVI, Inc. Securities Litigation

Citations: 919 F. Supp. 2d 498; 2013 U.S. Dist. LEXIS 8834; 2013 WL 247149Docket: Civil Action No. 03-5336

Court: District Court, E.D. Pennsylvania; January 22, 2013; Federal District Court

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Plaintiff investors in Diagnostic Ventures, Inc. (DVI) are suing for violations of the Securities Exchange Act, specifically Section 10(b) and Rule 10b-5, as well as for liability under Section 20(a). The case is under federal jurisdiction due to the Exchange Act and federal questions. Defendant Terry Cady, a former executive at DVI Business Credit, Inc., has moved for summary judgment, arguing that there is no evidence that investors relied on his allegedly deceptive actions or statements—an essential element for their claims. Lead Plaintiffs counter that prior case law does not prevent claims against insiders like Cady, and they argue that reliance should be presumed given Cady's high-ranking position at DVI BC and his involvement in the company's financial statements, which reflected his actions.

Cady’s motion further asserts he cannot be held liable under Section 20(a) because there is insufficient evidence he controlled DVI, the entity accused of violating securities laws. The Lead Plaintiffs claim there are factual disputes regarding Cady's control. Ultimately, the court grants Cady’s summary judgment motion, concluding that the evidence does not demonstrate reliance by investors on Cady's conduct or statements and that he lacks the requisite control over DVI.

The Complaint, originally filed in 2003 and amended in 2006, alleges that Cady, along with other DVI executives, engaged in fraudulent schemes to mislead investors about DVI's financial health by concealing accounting irregularities and failing to disclose pertinent information. The Plaintiffs assert a presumption of reliance based on the "fraud-on-the-market" theory and claim Cady is liable under Section 20(a) for his role in DVI's violations of Section 10(b). The Complaint states that investors were unaware of DVI’s true financial status or misleading public filings at the time of their purchases.

The Complaint alleges Rule 10b-5(b) liability but fails to specify that Cady made any public statements or signed documents impacting DVI’s securities market, as previously determined in an earlier ruling. Cady's motion to dismiss the Third Amended Complaint was partially granted due to insufficient pleading regarding his involvement with public statements or company documents. A legal question remained concerning whether signatories to financial statements adopt those documents as statements. The Rule 10b-5(b) claims were allowed to proceed based on this question, provided other elements of the securities fraud claim were sufficiently pled. Subsequently, Lead Plaintiffs sought class certification for DVI investors from August 10, 1999, to August 13, 2003, invoking the presumption of reliance from Affiliated Ute, although this theory was not included in the Complaint. Class certification was granted for all Defendants except Clifford Chance, as the court found no public misstatements by Clifford Chance that affected DVI's securities market. The court ruled that neither the fraud-on-the-market presumption nor the Affiliated Ute presumption applied to Clifford Chance, as it had no duty of disclosure to investors. Consequently, individual issues of reliance predominated, failing the Rule 23(b)(3) predominance requirement for class certification against Clifford Chance. Lead Plaintiffs later petitioned for leave to appeal this denial, arguing for the first time that Clifford Chance was primarily liable for misstatements in the 10-Q based on their deceptive conduct being publicly communicated through DVI’s filings. On March 29, 2011, the Court of Appeals upheld the denial of class certification for Clifford Chance, citing predominance of individual reliance issues.

Plaintiffs were denied the ability to use the fraud-on-the-market presumption of reliance against Clifford Chance, as they did not assert that Clifford Chance's alleged involvement in the fraudulent 10-Q was publicly disclosed. Clifford Chance's summary judgment motion highlighted three key points: (1) Plaintiffs did not claim reliance on Clifford Chance's actions when trading securities; (2) there was no supporting evidence that Plaintiffs relied on Clifford Chance in their trading decisions; and (3) Plaintiffs were unaware of the fraudulent scheme at the time of their securities purchases. On January 4, 2013, summary judgment was granted in favor of Clifford Chance, ruling that the precedents set by Janus Capital Group Inc. v. First Derivative Traders and Stoneridge, along with the Court of Appeals' findings in DVI, determined the outcome. Plaintiffs failed to provide evidence of individualized reliance, precluding liability for Clifford Chance regarding the alleged deceptive scheme or misstatements in public filings. Additional findings noted that DVI, a Delaware corporation with two subsidiaries, engaged in providing credit to healthcare providers, and its financial reports did not specify fund transfers between the subsidiaries used to pay loans. Cady, the CEO of DVI BC, acknowledged that decisions involving fund transfers were occasionally made to maintain operations.

Cady was designated as “Senior Vice President” of DVI in June 2003 but testified that he had no responsibilities over any DVI division except DVI BC. He lacked duties related to DVI's operations, did not serve on DVI’s Board of Directors, and did not sign any financial reports or filings with the SEC. As President of DVI BC, he signed a certification on November 12, 2002, regarding DVI's loss allowances, which he believed reflected an adequate estimate of losses for the company as of August 31, 2002. This certification was part of a series required by DVI’s President due to an audit letter. Although Cady was unaware that the certification would be included in a draft Form 10-Q for review by DVI's auditor, he did not draft or modify the certification and did not discuss it with the auditor or DVI's legal counsel. There is no evidence that the certification was referenced in DVI’s public filings or attributed to Cady. The plaintiffs acknowledged that none of DVI's public filings attributed any statements to Cady, and he did not sign DVI’s consolidated financial statements, thus cannot be held liable for any misstatements in SEC filings. Furthermore, the Complaint did not assert that investors relied on Cady’s statements or that he made any public false or misleading statements regarding DVI’s filings.

Plaintiff investors were unaware of a fraudulent scheme involving Cady at the time they purchased DVI’s securities, nor did they know of any false or misleading statements in DVI’s public filings. There is no evidence that the investors relied on any conduct or statements from Cady regarding their transactions in DVI's securities, nor that Cady made or adopted any false statements in DVI’s filings. Summary judgment is appropriate if there are no genuine disputes of material fact, requiring the opposing party to present specific facts to demonstrate a trial-worthy issue. In this case, reliance—an essential element for claims under Section 10(b) and Rule 10b-5—was not established, as the record indicates that the investors did not know of or rely on any misrepresentations attributed to Cady when they made their purchases. Although the Plaintiffs argue for a fraud-on-the-market presumption of reliance due to Cady's insider status, the court finds that the allegations against him differ from those in Stoneridge, which involved third-party claims. The court concludes that Cady's actions, while reflected in DVI’s public disclosures, did not constitute a causal link to the investors' injuries.

Reliance cannot be assumed in this case. The Court of Appeals determined that plaintiffs cannot use the fraud-on-the-market presumption of reliance under Rule 10b-5(a) and (c) unless the deceptive conduct is publicly disclosed and attributed to the actor. Since plaintiffs do not allege that Clifford Chance's involvement in the fraudulent 10-Q was publicly disclosed, they cannot claim this presumption (DVI, 639 F.3d at 649). A similar ruling applies to Cady, as plaintiffs have failed to demonstrate that the allegedly deceptive conduct was made public and attributed to him. It is inadequate to show public disclosure through other means; the public must be informed of the defendant's actions (DVI, 639 F.3d at 648). The distinction between high-level executives and other third parties is irrelevant, as the lack of public disclosure of the vendors’ actions rendered reliance claims too remote (DVI, 639 F.3d at 647; Stoneridge, 552 U.S. at 161). 

Plaintiffs argue for the Affiliated Ute presumption of reliance, which typically applies when an insider with a duty to disclose material information fails to do so. This presumption is relevant only when material information is withheld by a defendant with an affirmative duty of disclosure (DVI, 639 F.3d at 631 n. 10). However, the proposed duty to disclose is unfounded, as silence without a duty to disclose is not misleading under Rule 10b-5 (Basic, Inc. 485 U.S. at 239 n. 17). An affirmative duty to disclose generally arises only in cases of insider trading, statutory requirements, or misleading disclosures (Winer Family Trust v. Queen, 503 F.3d 319, 329). Clifford Chance had no duty to disclose to DVI’s investors (Stoneridge, 552 U.S. at 159). Additionally, plaintiffs have not provided evidence of individualized reliance on Cady’s actions; each investor must demonstrate reliance on a fraudulent misrepresentation or omission (Newton v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 259 F.3d 154, 174).

To establish liability under Rule 10b-5, plaintiffs must demonstrate that each individual was aware of and misled by a misrepresentation that caused them to engage in the transaction. Plaintiffs claim that Cady “adopted” DVI’s financial statements, asserting that his signature on a certification constituted a false representation to the public. However, evidence shows the certification was directed to DVI executives and possibly Deloitte, without any proof that it was included in DVI's public filings or publicly attributed to Cady. Thus, Cady cannot be considered the maker of any statements in DVI's public filings, as the maker is defined as the entity with ultimate authority over the statement's content and communication. DVI itself is identified as the maker of its financial statements, and it is asserted that Cady's actions did not necessitate DVI's recording of transactions. Even if Cady were deemed a maker, there is no evidence that his certification was made public or attributed to him, precluding a reasonable conclusion that investors relied on his undisclosed actions. 

Under Section 20(a) of the Exchange Act, to impose joint liability for violations of Section 10(b), plaintiffs must show that one person controls another who has committed a primary violation. The allegation is that Cady controlled DVI, which allegedly violated securities laws. However, there is no claim that DVI BC committed any primary violations. Plaintiffs bear the burden to prove Cady's control over DVI, which includes demonstrating that he had actual power or influence over DVI's actions.

The term ‘control’ is defined as the ability to direct the management and policies of a person, which can occur through various means such as ownership or contractual agreements. In the case of Cady's involvement with DVI, there is insufficient evidence to prove he had control over DVI. Despite being presented as an Executive Officer and Senior Vice President, these titles do not equate to actual control or influence over DVI's operations. The record indicates that Cady had no responsibilities related to DVI's management, and his titles and reporting relationships do not demonstrate any actionable power over the parent company. While plaintiffs assert that Cady was involved in fraudulent activities related to loan loss reserves, the evidence presented primarily pertains to his role within DVI BC rather than DVI itself. The record supports that Cady made initial recommendations on loss reserves for DVI BC loans, but these actions do not establish that he directed or influenced DVI’s management or policies. Assertions regarding his participation in various committees and activities are insufficient to demonstrate control over DVI, as they reflect his role at DVI BC.

Cady's involvement in DVI's loan loss reserves is deemed unsupported by evidence, with no indication that he influenced the reserves or concealed liquidity issues. Plaintiffs argue that Cady's signature on a November 12, 2002 certification indicates his control over DVI, suggesting that without his signature, DVI would have had to disclose a material weakness identified by Deloitte, thereby preventing a workaround scheme involving Deloitte and Clifford Chance. However, this argument is characterized as speculative and not substantiated by facts, failing to demonstrate that Cady had the actual power to direct DVI's management or policies. Consequently, Cady cannot be held liable under Section 10(b) or Rule 10b-5 for misstatements in DVI’s public filings, nor under Section 20(a) for being a controlling person. The court granted Cady's Motion for Summary Judgment, ruling in his favor against the plaintiffs and the investor class concerning all claims in the Fifth Amended Complaint. The background of this litigation is referenced in earlier court orders and opinions regarding related motions and certifications. Additionally, the plaintiffs' citation of facts in opposition to Cady's statement did not meet the requirements set by Rule 56, as some facts were not properly cited.

Deloitte advised DVI that federal securities laws, specifically the Sarbanes-Oxley Act of 2002 (SOX), mandated the disclosure of material weaknesses in DVI’s internal controls in their upcoming Form 10-Q. Plaintiffs contended that such disclosure would necessitate significant asset write-downs and reversal of income from impaired loans. DVI initially drafted a 10-Q for the quarter ending September 30, 2002, which included these weaknesses, but John Healy from Clifford Chance allegedly instructed DVI not to release this version. Instead, Healy purportedly created a workaround to avoid disclosure, leading to a final version of the 10-Q that omitted mention of the material weaknesses. Healy’s strategy involved conducting a "special audit" of DVI’s internal controls shortly before the 10-Q filing deadline, intended to demonstrate that no weaknesses existed, thus circumventing SOX disclosure requirements. Additionally, Michael O’Hanlon was identified as having ultimate decision-making authority at DVI, particularly regarding the recognition of losses on delinquent accounts, indicating his dominant influence over the company's financial decisions.