Opinion ID: 2655931
Heading Depth: 5
Heading Rank: 4

Heading: Inferences from the CW Evidence

Text: We conclude that the confidential witness statements permit an inference that the MuniMae defendants knew, perhaps as early as mid-2006, that the Company was not in compliance with FIN 46R, despite their representations to the contrary. The allegations are also consistent with the inference that these defendants knew--or at least suspected--by Fall 2006 that consolidating the LIHTC Funds in accordance with FIN 46R would be a difficult and costly undertaking. Nonetheless, we agree with the district court that these allegations do not support a strong inference of wrongful intent. To begin with, the confidential witnesses do not 5 However, CW1 does not describe the nature of the accountants’ frustration, nor is it clear precisely when these discussions took place. 20 expressly assert that the MuniMae defendants intentionally or recklessly failed to comply with GAAP or their own internal accounting policies during the class period. The statements are also generally vague and conclusory as to the MuniMae defendants’ state of mind. As even the amended complaint concedes, MuniMae struggled throughout the class period with what its own former accountant described as difficult and complex accounting. This complexity was not helped by an accounting system that was in a constant state of “‘confusion and chaos,’” J.A. 85, in no small part due to the Company’s rapid expansion and inadequate staffing. The MuniMae defendants may well have been negligent in failing to properly apply FIN 46R to their business in the first instance, and then by allowing the Company to be overwhelmed by the resulting accounting tsunami. But plaintiffs’ allegations do not support a powerful and compelling inference that these defendants acted with wrongful intent or severe recklessness. Cf. Zucco Partners, 552 F.3d at 1007 (“Although the allegations in this case are legion . . . the facts alleged . . . point towards the conclusion that [the defendant] was simply overwhelmed with integrating a large new division into its existing business.”). That MuniMae’s officers and outside auditor debated how to account for the LIHTC Funds in light of FIN 46R does not compel 21 an inference of wrongful intent. The more plausible inference is that there was an honest disagreement over the proper application of a challenging new accounting standard. That the MuniMae defendants were ultimately wrong is not enough to support an inference of scienter. Cf. DSAM Global Value Fund v. Altris Software, Inc., 288 F.3d 385, 390 (9th Cir. 2002) (“[T]he mere publication of inaccurate accounting figures, or a failure to follow GAAP, without more, does not establish scienter.” (quoting In re Software Toolworks, Inc., 50 F.3d 615, 627 (9th Cir. 1994))). As for CW2’s allegations regarding Lundquist’s knowledge of the FIN 46R issues, they too fail to support a strong inference that she--or anyone else--acted with fraudulent purpose. Even if, as plaintiffs allege, Lundquist began to suspect a problem with the FIN 46R accounting at the time the first restatement began in March 2006, we are not persuaded that she then hatched a plot to defraud the investing public. To the contrary, we are skeptical that Lundquist would sign off on the first restatement in June 2006 without addressing FIN 46R issues, thus subjecting herself to SEC sanctions, if she firmly believed then that the accounting was wrong. A more logical and compelling inference is that Lundquist and the other MuniMae defendants were continuing to assess the scope of the problem before deciding on an appropriate course of action. We 22 also find it significant that it was MuniMae’s management--and not some outside entity--that ultimately disclosed that the Company would have to consolidate the remaining LIHTC Funds in January 2007 (thus conceding the Company’s earlier error). In our view, this disclosure supports a strong “inference that defendants were not acting with scienter but rather were endeavoring in good faith to inform [the investing public].” Matrix Capital, 576 F.3d at 189. Finally, we recognize that the Fall 2006 Falcone memorandum, which noted that that the auditing staff intended to focus all of its energies on the second restatement, supports an inference that the MuniMae defendants could have more promptly anticipated the substantial costs of addressing the Company’s myriad accounting issues. But that is a far cry from concluding that Falcone and his fellow defendants resolved then to defraud plaintiffs by hiding the true costs. In our view, management’s subsequent disclosures tend to negate an inference of fraudulent purpose. In July and August 2007, the Company (1) announced the hiring of an independent consultant to assist with the work of the second restatement, (2) identified the large number of personnel working on the accounting issues, and (3) expressed uncertainty as to the costs of the effort going forward. Although these disclosures were perhaps not as timely or as fulsome as plaintiffs would have 23 liked, they give rise to a more compelling inference that the MuniMae defendants were attempting--even if imperfectly--to keep the investing public informed, while working strenuously to correct the accounting errors they had discovered.