United States District Court, W.D. Texas, Austin Division
WU WINFRED HUANG and JOHN ROONEY, Individually and on Behalf of All Others Similarly Situated, Plaintiffs,
EZCORP, INC. and MARK E. KUCHENRITHER, Defendants.
SPARKS UNITED STATES DISTRICT JUDGE.
REMEMBERED on this day the Court reviewed the file in the
above-styled cause, and specifically Defendants EZCORP, Inc.
and Mark Kuchenrither (Defendants)' Motion to Dismiss
[#50], Co-Lead Plaintiffs Wu Winfred Huang and John
Rooney's Response [#52] in opposition, and
Defendants' Reply [#53] in support. Having reviewed the
documents, the arguments of the parties at the hearing, the
governing law, and the file as a whole, the Court now enters
the following opinion and order.
recounted in the Court's October 18, 2016 Order, this is
a securities fraud class action brought on behalf of all
persons who purchased Class A common stock of Defendant
EZCORP, Inc., a company which provides "instant
cash" services like payday loans and pawn loans, between
November 7, 2013,  to October 20, 2015 (the Class Period).
Co-Lead Plaintiffs Wu Winfred Huang and John Rooney, on
behalf of the plaintiff class, allege that during the Class
Period, Defendant Mark Kuchenrither, EZCorp's CFO, CEO,
and the only individual defendant, made material
misrepresentations to shareholders in violation of
§§ 10(b) and 20(a) of the Securities Exchange Act
of 1934 and SEC Rule 10b-5.
have moved to dismiss the SAC, arguing Plaintiffs have failed
to plead facts giving rise to a strong inference of scienter.
The Court agrees with Defendants in part and therefore grants
Defendants' motion to dismiss in part.
EZCORP's Acquisition of Grupo Finmart
provides customers with multiple ways to access instant cash
through pawn and consumer loans in the United States, Mexico,
and Canada, as well as through fee-based credit services. SAC
[#47] ¶ 2. In addition, at its pawn stores and online,
EZCORP sells collateral forfeited from pawn lending
operations and used merchandise purchased from customers.
January 12, 2012, EZCORP announced it was acquiring a 60%
ownership interest in Grupo Finmart, a Mexican company which
issues small consumer loans to Mexican governmental
employees. Id. ¶ 4. According to EZCORP,
Grupo Finmart enters into payroll withholding agreements
("convenios") with Mexican employers, primarily
federal, state and local governments and agencies, and
provides unsecured, multiple-payment consumer loans to
employees of those various employers. Interest and principal
payments are collected by the employers through payroll
deductions and remitted to Grupo Finmart.
Id. ¶ 99 (quoting May 20, 2015 Form 8-K).
EZCORP has described Grupo Finmart's role in Mexico's
payroll lending industry:
The unsecured payroll lending industry in Mexico is less
developed than other Latin American countries. Payroll
lending in Mexico is generally marketed to public sector
employees, who on average earn more and rotate less
frequently than their private sector peers. Additionally,
government entities tend to be more stable and on average
have more employees than private companies. It is estimated
that less than 15% of the market potential is being serviced.
Grupo Finmart is the fifth largest vertically integrated
payroll lender in Mexico with 53 branch offices located in 24
of the 32 states in the country.
Id. ¶ 43 (quoting 2014 Form 10-K).
30, 2014, EZCORP acquired an additional 16% of Grupo
Finmart's ordinary shares. Id. ¶ 4. On
September 1, 2015, EZCORP increased its ownership position in
Grupo Finmart by 18%, thereby making it a 94% owner of Grupo
Finmart. Id. EZCORP now consists of three segments:
(1) the United States and Canada segment, (2) the Latin
America segment, and (3) the Other International segment.
Id. ¶ 42.
EZCORP's Alleged Accounting Deficiencies
allege that throughout the Class Period, EZCORP's lack of
internal controls over its financial reporting gave rise to
two primary accounting errors: (1) the failure to properly
account for the sale of certain non-performing loans to third
parties (Loan Sales), and (2) the failure to properly account
for Grupo Finmart's non-performing payroll loans
(Non-Performing Loans). As alleged in the SAC, Non-Performing
Loans are "loans that were being carried as active loans
but with respect to which Grupo Finmart was not currently
receiving payments." Id. ¶ 99.
Out-of-payroll loans are outstanding loans from customers who
are no longer employed. Id. "Under Grupo
Finmart's historic accounting policy, " "[i]f
one payment of an out-of-payroll loan is delinquent, that one
payment is considered in default; if two or more payments are
delinquent at any time, the entire loan is considered in
default." Id. Upon default of an out-of-payroll
loan, EZCORP ceased accruing future interest revenue.
Id. However, "[d]ue to the likelihood of
ultimately receiving payment if the customer remains
employed, [Grupo Finmart] continue[d] to accrue interest on
all in-payroll loans, even though Grupo Finmart may not be
currently receiving payments." Id. In its
corrective disclosures, EZCORP determined Grupo Finmart's
non-performing loans included a number of out-of-payroll
loans that had not been properly classified as such, and some
in-payroll loans that had been in non-performing status for
some time. Id. By failing to properly account for
the Non-Performing Loans, Plaintiffs argue, EZCORP was able
"to artificially maintain its ratio of bad debt expense
to consumer loan fees and interest - a measure of health of
the underlying loan portfolio." Id. ¶ 108.
further contend EZCORP failed to properly account for the
sale of these Non-Performing Loans. According to Plaintiffs,
a confidential witness informed Kuchenrither that under the
terms of the loan sale documents, the third-party purchasers
retained a right to return non-performing loans to EZCORP,
and generally accepted accounting principles (GAAP)
prohibited EZCORP from recognizing any revenue from these
loan sales. Id. ¶ 7. Despite the confidential
witness's warning, EZCORP executed five separate sales of
Grupo Finmart's loans in the 2014 fiscal year,
recognizing $33 million in gains on these sales. Id.
¶ 9. In the first quarter of 2015, EZCORP executed
another loan sale, recognizing $6.6 million in
income on this sale. Id. Plaintiffs claim the
improper accounting for the sale of the loans had the effect
of artificially boosting EZCORP's reported income in the
2014 fiscal year by 45% and its reported income during the
first quarter of 2015 by 32%. Id.
The Allegedly False and Misleading
statements Plaintiffs identify as misleading are taken from
EZCORP's press releases, conference calls, and SEC forms
disclosing EZCORP's financial results during the Class
Period. These statements deal with EZCORP's financial
results during the fourth quarter of 2013 (4Q13), the 2014
fiscal year (FY2014), and the first quarter of 2015 (1Q15).
Plaintiffs' SAC quotes extensively from Defendants'
various public statements made throughout the Class Period,
but the allegedly false and misleading statements and
omissions fall into two general categories: (1) statements
relating to the overstatement of EZCORP's financial
results, as a result of EZCORP's failure to properly
account for the Loan Sales and Non-Performing Loans, and (2)
statements relating to the nature of the Loan Sales.
Plaintiffs contend EZCORP's financial reports
misrepresented its financial results, including its net
income and earnings per share. For instance, in its 3Q14
press release, EZCORP reported $11.3 million in net income
from continuing operations and earnings per share of $0.21.
Id. ¶ 70. According to Plaintiffs, the
reporting of $11.3 million of net income from continuing
operations was false because EZCORP improperly recorded $14.3
million in income from the sale of Grupo Finmart debt to
third parties. Id. ¶ 71. Similarly, in its 4Q14
press release, EZCORP reported $47 million of net income from
continuing operations for the 2014 fiscal year, but according
to Plaintiffs, this amount was overstated by $31.956 million.
Id. ¶ 79.
throughout the Class Period, EZCORP filed its quarterly and
annual reports with the SEC. Each of these forms (Forms 10-Q
and 10-K) reaffirmed EZCORP's financial results
previously announced in its press releases. Kuchenrither
certified the reports did not contain any false statements of
material fact or omit any material facts. See, e.g.,
Id. ¶¶ 62, 68, 76, 91.
Plaintiffs maintain Defendants misrepresented the nature of
the Loans Sales. For example, in a January 28, 2014 press
release, EZCORP stated "[c]ash and cash equivalents,
including restricted case, were $45 million at quarter-end,
with debt of $252 million, including $106 million of Grupo
Finmart third-party debt, which is non-recourse to
EZCORP." Id. ¶ 61 (emphasis added); see
also Id. ¶ 66 ("Cash and cash equivalents .. .
were $63 million at quarter-end, with debt of $228 million,
including $145 million of Grupo Finmart third-party debt,
which is non-recourse to EZCORP") (emphasis
added). Moreover, during an earnings conference call held on
July 29, 2014, Kuchenrither described the Loan Sales as
"true loan sales, " explaining "it's a
true profit" because "the risk associated with the
loans passed to the buyer of the loans." Id.
¶ 73. He further stated the Loan Sales were not
securitizations, but instead "truly an asset sale. I
just want to make that distinction, because [it's] very
important." Id. ¶ 74. According to
Plaintiffs, the "asset sales" identified by
Kuchenrither were not true asset sales and were improperly
recorded as revenue by EZCORP in violation of GAAP.
Id. ¶ 75.
The Alleged Corrective Disclosures
allege Defendants' corrective disclosures began on April
30, 2015, and ended on November 9, 2015. On April 30, 2015,
EZCORP announced the release of its 2Q15 financial results
would be delayed "due to an ongoing review of certain
elements of its Grupo Finmart loan portfolio, which is not
yet completed." Id. ¶ 96. In that same
press release, EZCORP further stated it "did not
undertake any asset sales in Grupo Finmart this quarter"
and "noted some differences in the performance of parts
of our Grupo Finmart loan portfolio that prompted a more
thorough review and analysis of our loan
reserves[.]"Id. ¶ 96. Following this
announcement, EZCORP's stock fell $0.79 per share to
close at $8.41 per share on May 1, 2015. Id. ¶
20, 2015, EZCORP filed its Form 8-K with the SEC, stating
We have identified certain errors in a portion of our Grupo
Finmart loan portfolio that may impact current and historical
amounts of loan reserves and interest income. . . . We are
also reviewing whether certain structured asset sales from
Grupo Finmart met the criteria required for sale accounting
treatment or whether they should have been accounted for as
Id. ¶ 99. EZCORP further stated "we
believe that it is likely that management and the Audit
Committee will conclude that we have a material weakness in
internal control over financial reporting and deficiencies in
our disclosure controls and procedures." Id.
Following this announcement, EZCORP's stock declined
$0.66 per share to close at $8.33 per share on May 21, 2015.
Id. ¶ 100.
17, 2015, EZCORP issued a press release, which corrected
previous representations regarding the Loan Sales and the
Non-Performing Loans. As to the Loan Sales, EZCORP stated,
Following a comprehensive review of the terms and conditions
of each of the structured asset sales, management has
determined that the asset sales should not have been
accounted for as sales, principally due to certain control
rights that Grupo Finmart retained as servicer of the loans.
Because of these control rights, the trusts to which the
loans were sold should be accounted for as "variable
interest entities" and consolidated pursuant to ASC
810-10 (Consolidation and the Variable Interest Model), and
therefore, the sales should not have been recognized for
Id. ¶ 101.
the Non-Performing Loans, EZCORP stated,
The company has identified a number of out-of-payroll loans
that had not been properly classified and accounted for as
such, causing an understatement of bad debt expense and an
overstatement of accrued interest revenue in prior periods.
In addition, after reviewing the aging characteristics of the
non-performing loans, the company . . . has determined that
it is more appropriate to accrue and recognize interest
income over the period that payments are actually received
rather than over the stated term of the loans[.]
Id. That same day, EZCORP filed its Form 8-K with
the SEC, announcing it would restate its financial statements
for FY2014, 1Q15, and possibly for periods prior to FY2014.
Id. ¶ 102. Following this announcement,
EZCORP's stock declined $0.26 per share to ...