Opinion ID: 778801
Heading Depth: 2
Heading Rank: 1

Heading: Pleading with Particularity — GAAP

Text: 24 Generally Accepted Accounting Principles, or GAAP, are a series of general principles followed by accountants. United States v. Basin Elec. Power Coop., 248 F.3d 781, 786 (8th Cir.2001). More specifically, GAAP are the official standards adopted by the American Institute of Certified Public Accountants (the `AICPA'), a private professional association, through three successor groups it established: the Committee on Accounting Procedure, the Accounting Principles Board (the `APB'), and the Financial Accounting Standards Board (the `FASB'). Ganino v. Citizens Utils. Co., 228 F.3d 154, 160 n. 4 (2d Cir.2000). 25 There are 19 different GAAP sources, any number of which might present conflicting treatments of a particular accounting question. Shalala v. Guernsey Mem'l Hosp., 514 U.S. 87, 101, 115 S.Ct. 1232, 131 L.Ed.2d 106 (1995). The sources for GAAP include official publications consisting of APB opinions, FASB Statements and Accounting Research Bulletins (ARB). Included in GAAP are the Financial Accounting Standards (`FAS') published by the [FASB]. Basin Elec., 248 F.3d at 786. 26 GAAP are far from being a canonical set of rules that will ensure identical accounting treatment of identical transactions. [GAAP], rather, tolerate a range of `reasonable' treatments, leaving the choice among alternatives to management. Thor Power Tool Co. v. C.I.R., 439 U.S. 522, 544, 99 S.Ct. 773, 58 L.Ed.2d 785 (1979) (footnote omitted); see also Guernsey Mem'l, 514 U.S. at 101, 115 S.Ct. 1232 (finding GAAP [f]ar from a single-source accounting rulebook and not [a]lucid or encyclopedic set of pre-existing rules, and GAAP changes and, even at any one point, is often indeterminate). When such conflicts arise, the accountant is directed to consult an elaborate hierarchy of GAAP sources to determine which treatment to follow. Id. In fact, [i]n the event there is no official pronouncement, the consensus of the accounting profession, as manifested in textbooks, for example, determines GAAP. Providence Hosp. of Toppenish v. Shalala, 52 F.3d 213, 218 n. 7 (9th Cir.1995). 27 As our Court recently said: Allegations of GAAP violations are insufficient, standing alone, to raise an inference of scienter. Only where these allegations are coupled with evidence of corresponding fraudulent intent might they be sufficient. In re Navarre Corp., 299 F.3d 735, 2002 WL 1760458, slip op. at 15 (internal citation omitted); see also DSAM Global Value Fund v. Altris Software, Inc., 288 F.3d 385, 390 (9th Cir.2002); City of Philadelphia v. Fleming Cos., Inc., 264 F.3d 1245, 1261 (10th Cir.2001) (Only where such allegations [GAAP violations or accounting irregularities] are coupled with evidence that the violations or irregularities were the result of the defendant's fraudulent intent to mislead investors may they be sufficient to state a claim.); Ziemba v. Cascade Int'l, Inc., 256 F.3d 1194, 1208 (11th Cir.2001) (citing cases) (Allegations of violations of ... GAAP, standing alone, do not satisfy the particularity requirement of Rule 9(b).). Under the Reform Act, the circumstances of the fraud must be stated with particularity, including such matters as the time, place and contents of false representations, as well as, the identity of the person ... and what was obtained or given up thereby.... This means the who, what, when, where, and how. Parnes v. Gateway 2000, Inc., 122 F.3d 539, 549-50 (8th Cir.1997). Conclusory allegations do not satisfy the pleading requirements of the Reform Act. Id. at 549; In re Carter-Wallace, Inc. Sec. Litig., 220 F.3d 36, 39 (2d Cir.2000). 28 In this case, the Class alleged violations of Financial Accounting Standard 121 (FAS 121) and Financial Accounting Standard 5 (FAS 5). Generally, the Class alleged K-tel violated FAS 121 and FAS 5 when it filed the March 10-Q, on May 8, 1998, by representing its net tangible assets were in excess of $4 million. The March 10-Q, signed by individuals Kives, Weiner, and Fischer, stated in relevant part: 29 In 1997, the Company formed an [sic] U.S. media-buying and infomercial-marketing subsidiary, which performed media buying services for third parties and also marketed products through infomercials produced by third parties. As of March 31, 1988[sic], due to accumulated losses to date of $1,300,000 the Company has curtailed most of these media buying operations and will now focus on its existing primary businesses — music distribution and direct response marketing, and its newly launched Internet retailing business. 30 Similarly, the Class alleged K-tel continued the fraudulent scheme through the June 10-K filed on October 13, 1998. The June 10-K made an almost identical statement as did the March 10-Q but included the accumulated losses through June 30, 1998 in the amount of $2.3 million. The June 10-K represented net tangible assets below $4 million and was signed by all of the individual defendants. 31 K-tel counters by arguing the Class is only alleging fraud by hindsight in relying on later write-off amounts in order to argue the write-offs should have been made earlier. Specifically, K-tel points to the complaint which alleged $800,000 was charged to earnings during the quarter ended September 30, 1998, and $698,000 was charged to earnings during the six-month period ended March 31, 1999. These two amounts equal $1,498,000, the amount the Class alleged was the subsidiary's loss known to K-tel in March 1998. 32 Additionally, the complaint alleged $1.8 million in future losses would be incurred due to this subsidiary's contracts; however, the Class fails to specify how it arrived at this figure. The figure does not include $1 million of additional accumulated losses (difference between the March 10-Q and the June 10-K) which the Class breaks into $.3 and $.7 million increments, alleging at least the $.3 million amount should have been disclosed in the March 10-Q as it was incurred by May 8, 1998. 33 [W]e cannot countenance pleading fraud by hindsight.... Green Tree, 270 F.3d at 662. Mere allegations that statements in one report should have been made in earlier reports do not make out a claim of securities fraud. Acito v. IMCERA Group, Inc., 47 F.3d 47, 53 (2d Cir. 1995). Corporate officials need not be clairvoyant; they are only responsible for revealing those material facts reasonably available to them. Novak v. Kasaks, 216 F.3d 300, 309 (2d Cir.2000); see also In re Navarre Corp., 299 F.3d 735, 2002 WL 1760458, slip op. at 12; Acito, 47 F.3d at 53. Under the Reform Act the complaint must allege facts or further particularities that, if true, demonstrate that the defendants had access to, or knowledge of, information contradicting their public statements when they were made. In re Navarre Corp., 299 F.3d 735, 2002 WL 1760458, slip op. at 11. 34 What makes many securities fraud cases more complicated is that often there is no reason to assume that what is true at the moment plaintiff discovers it was also true at the moment of the alleged misrepresentation, and that therefore simply because the alleged misrepresentation conflicts with the current state of facts, the charged statement must have been false.... [A] plaintiff must set forth, as part of the circumstances constituting fraud, an explanation as to why the disputed statement was untrue or misleading when made. 35 City of Philadelphia, 264 F.3d at 1260 (quoting In re GlenFed Sec. Litig., 42 F.3d 1541, 1548-49 (9th Cir.1994) (en banc)). 36
37 FAS 121 relates to the accounting for the impairment and disposal of long-lived assets and certain identifiable intangibles. Specifically, FAS 121: 38 [R]equires that long-lived assets and certain identifiable intangibles to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In performing the review for recoverability, the entity should estimate the future cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the expected future cash flows ... is less than the carrying amount of the asset, an impairment loss is recognized. Otherwise, an impairment loss is not recognized. 39 FAS 121, summary available at http://accounting.rutgers.edu/raw/fasb/map/index.html. 40 The Class alleged the asset subject to FAS 121 review is the Infomercial Subsidiary. No review for the impairment of this asset was reflected in the March 10-Q. The Class alleged K-tel was required by FAS 121 to perform the review because a change in circumstances — namely the curtailing of operations and stated losses — indicated the recoverability of the carrying amount of the subsidiary assets should have been assessed for impairment. The Class further alleged an assessment would have revealed K-tel's obligation pursuant to FAS 121 to write-off the $1,498,000 cost of non-useable infomercials and other media items purchased by the subsidiary. K-tel later charged $800,000 to earnings for the quarter ending September 30, 1998, and $698,000 during the six-month period ending March 31, 1999. 41 K-tel argues the complaint contains no particularized allegation supporting the $1,498,000 figure or the asset or assets subject to FAS 121 assessment. Further, K-tel contends the Class has failed to allege facts implicating a violation of FAS 121. K-tel concludes the Class failed to allege facts showing FAS 121 had been triggered and violated. 42 Although a change in circumstances occurred by the curtailing of operations, which may implicate FAS 121, the complaint failed to allege particular assets subject to FAS 121 assessment. If, however, the assets intended by the Class include the subsidiary itself or unspecified infomercials and other media items, we are unconvinced FAS 121 is implicated. 43 The district court found, and we agree, `long-lived assets' include items such as land, buildings, equipment and furniture. In re K-tel, 107 F.Supp.2d. at 1000 (listing accounting sources). `Identifiable intangibles' include items such as patents, franchises, and trademarks. Id. The assets alleged by the Class are not long-lived assets or identifiable intangibles. Therefore, as a matter of law, the Class has failed to allege facts triggering FAS 121. 44 Rather than argue the district court erred as a matter of law, and submit contrary accounting sources, the Class states, untenably, the district court made its determination as a factual finding. While the allegations contained in the complaint may withstand standard notice pleading, such allegations were not pled with particularity as required by the Reform Act in terms of alleging a basis for implicating FAS 121 and further specifying the assets, the carrying amount and the impairment of such assets. See Greebel v. FTP Software, Inc., 194 F.3d 185, 204 (1st Cir.1999) (plaintiffs presented invoices, purchase orders, and other documentation to substantiate their contentions). 45 Furthermore, the Class has failed to allege any basis or source for why $1,498,000 should have been written off in March 1998 pursuant to FAS 121, rather than in September 1998 and March 1999 pursuant to other accounting rules. Accordingly, the Class allegations related to FAS 121 fail for lack of particularity. 46
47 FAS 5 establishes standards of financial accounting and reporting for loss contingencies. FAS 5: [R]equires accrual by a charge to income (and disclosure) for an estimated loss from a loss contingency if two conditions are met: 48 (a) information available prior to issuance of the financial statements indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements, and 49 (b) the amount of loss can be reasonably estimated. 50 FAS 5, summary available at http://accounting.rutgers.edu/raw/fasb/map/index.html. 51 The Class alleged FAS 5 required K-tel to make a $1.8 million charge to income and disclose the subsidiary's future obligations and likely losses. The Class alleged that the subsidiary: 52 a. Was obligated to perform under one or more contracts which were likely to result in additional future losses of approximately $1.8 million (over and above those which had already been reported) during the twelve month period ended March 31, 1999; and 53 b. Had already sustained no less [than] $.3 million in additional losses (over and above the accumulated losses of $1,300,000 which had been reported) as of the May 8, 1998 date of filing of the March 31, 1998 Form 10-Q, and would suffer an additional $.7 million in losses by June 30, 1998. 54 Again, the Class fails to provide any basis for the allegations or sources for the amounts, other than later financial disclosure made by K-tel. The Class fails to specify any contracts or circumstances that K-tel knew at the time of the March 10-Q or June 10-K would result in the specified losses. Merely stating a particular dollar amount without a corresponding source or basis is insufficient under the Reform Act. See Parnes, 122 F.3d at 550. The complaint does not explain what specific information was available and how any loss could be reasonably estimated for the March 10-Q or the June 10-K. Accordingly, the Class allegations related to FAS 5 also fail for lack of particularity.