Opinion ID: 62908
Heading Depth: 3
Heading Rank: 1

Heading: Acquisition Accounting

Text: Plaintiffs allege that Shaw misused the purchase method of accounting for the acquisitions of the assets of two large companies, Stone & Webster and the IT Group, out of their respective bankruptcy proceedings in July 2000 and May 2002. Shaw portrayed the acquisitions as critical to consolidating the company's market position and to its diversification efforts. Shaw fully disclosed its application of the relevant accounting principles. The plaintiffs assert, however, that Shaw artificially inflated the recorded reserves and goodwill associated with the purchase method and thereafter used such accounts to pad Shaw's earnings. Shaw also established reserves for pending contracts acquired from these companies that, according to the plaintiffs, bore no reasonable relationship to the fair market value of the acquired assets, and were used as cookie jar reserves to inflate its reported earnings. Plaintiffs finally allege irregularities in Shaw's accounting for adjustments to the fair value of the acquired assets; its failure to disclose the basis for pre-acquisition contingencies bearing on such adjustments; and its failure to write off impaired goodwill. (Plaintiffs' Consolidated Amended Complaint (Compl.) 98.) All of these allegations are tied to the statements in Shaw's periodic financial reports during the class period, and voluminous citations to accounting rules are included. No direct allegations of fraudulent conduct or intent on the part of Bernhard or Belk are alleged. Instead, plaintiffs rely, as they are permitted to do, on circumstantial allegations. They assert that the individual defendants must have known of the irregularities because of their executive positions in the company, and they emphasize Bernhard's hands-on management style, and the magnitude and extent of the accounting standards violations. None of these assertions withstands analysis. First, this court's caselaw makes clear that pleading[s] of scienter may not rest on the inference that defendants must have been aware of the misstatement based on their positions with the company. Abrams, 292 F.3d at 432. [4] Second, Bernhard's management style, coupled with his alleged boast that there is nothing in this company that I don't know, are insufficient to support a strong inference of scienter. See Goldstein v. MCI WorldCom, 340 F.3d 238, 251 (5th Cir.2003). Such statements lack specificity about what Bernhard may have known or, for that matter, was reckless not to have known, about the details of the company's accounting practices. That these allegations derive from confidential sources further detracts from their weight in the scienter analysis. Following Tellabs, courts must discount allegations from confidential sources. Higginbotham v. Baxter Int'l Inc., 495 F.3d 753, 756-57 (7th Cir. 2007). Such sources afford no basis for drawing the plausible competing inferences required by Tellabs. Id. at 757 ( Tellabs requires judges to weigh the strength of plaintiffs' favored inference in comparison to other possible inferences; anonymity frustrates that process.). At the very least, such sources must be described with sufficient particularity to support the probability that a person in the position occupied by the source ... would possess the information pleaded.... ABC Arbitrage Plaintiffs Group v. Tchuruk, 291 F.3d 336, 353 (5th Cir.2002); see also Central Laborers', 497 F.3d at 552 (same). The final assertion, that Bernhard, Belk and through them, Shaw must have known of the alleged accounting irregularities because they are so massive, disproves itself. This case is quite unlike most securities fraud cases, which are precipitated when the company announces such revelations as a restatement in earnings due to accounting mistakes or the discovery and correction of material errors or misdeeds in a subsidiary. Here, there was no mea culpa from the company in the form of acknowledged wrongdoing or restated financial reports, nor was there any auditor qualification to those aspects of the reports made the basis of this complaint, nor any publicly expressed reservations by the auditors to the financials. There is no single event or fact that the executives can be alleged to have known and concealed from the public. In Central Laborers, by contrast, the company disclosed material weaknesses in its internal controls that eventually required restatement of two and a half fiscal years of financial results. 497 F.3d at 549. This court concluded that the defendant's public statements and subsequent restatement due to GAAP violations provide[d] some basis to infer scienter. Id. at 552. But that is lacking here. Moreover, while plaintiffs strenuously argue that the cookie jar reserves and other devices enabled Shaw to pad its earnings massively, they make no attempt to estimate by how much the earnings were inflated. There is no standard of comparison to what the correct numbers would have been. Valuations of assets, especially contracts and assets acquired from bankrupt companies, as well as the application of sophisticated accounting standards like fair value, leave broad scope for judgment and informed estimation; this is another way of saying that determinations on such matters can differ reasonably and sizably. See Greebel v. FTP Software, Inc., 194 F.3d 185, 205 (1st Cir.1999) (`Generally accepted accounting principles' ... tolerate a range of `reasonable' treatments, leaving the choice among alternatives to management. (quoting Thor Power Tool Co. v. Comm'r of Internal Revenue, 439 U.S. 522, 544, 99 S.Ct. 773, 787, 58 L.Ed.2d 785 (1979))). Plaintiffs cannot transform inherently nuanced conclusions into fraudulent misstatements or omissions simply by saying that there were abuses or misuses of the GAAP rules. See DiLeo v. Ernst & Young, 901 F.2d 624, 627 (7th Cir.1990) (At one time the firm bathes itself in a favorable light. Later the firm discloses that things are less rosy. The plaintiff contends that the difference must be attributable to fraud. `Must be' is the critical phrase, for the complaint offers no information other than the differences between the two statements of the firm's condition.). Likewise, plaintiffs cannot make allegations that strongly support the defendants' guilty knowledge of securities fraud, on the issues of acquisition accounting here raised, by throwing out large numbers with no factual basis for ascertaining what the truth was. See In re Stone & Webster, Inc., Sec. Litig., 414 F.3d 187, 199 (1st Cir.2005) (holding that alleged overstatement of financial results did not contribute to an inference of scienter because complaint gave no indication whatsoever what the size of the alleged overstatement of current profits was). For all these reasons, we cannot derive a strong inference of scienter against Bernhard, Belk and Shaw. Plaintiffs have failed to allege a sufficient basis for defendants' knowledge or severe recklessness as to the accuracy of the accounting standards for the Stone & Webster and IT Group acquisitions.