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Huang v. Ezcorp, Inc.

United States District Court, W.D. Texas, Austin Division

May 5, 2017

WU WINFRED HUANG and JOHN ROONEY, Individually and on Behalf of All Others Similarly Situated, Plaintiffs,
v.
EZCORP, INC. and MARK E. KUCHENRITHER, Defendants.

          ORDER

          SAM SPARKS UNITED STATES DISTRICT JUDGE.

         BE IT 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.

         Factual Background[1]

         As 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[2] of Defendant EZCORP, Inc., a company which provides "instant cash" services like payday loans and pawn loans, between November 7, 2013, [3] 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, [4]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.

         Defendants 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.

         I. EZCORP's Acquisition of Grupo Finmart

         EZCORP 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. Id.

         On 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).

         On June 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.

         II. EZCORP's Alleged Accounting Deficiencies

         Plaintiffs 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.

         Plaintiffs 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.

         III. The Allegedly False and Misleading Statements

         The 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.

         First, 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.

         Moreover, 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.

         Second, 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.

         IV. The Alleged Corrective Disclosures

         Plaintiffs 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. ¶ 97.

         On May 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 secured borrowings.

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.

         On July 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 accounting purposes.

Id. ¶ 101.

         As to 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. ΒΆ 102. Following this announcement, EZCORP's stock declined $0.26 per share to ...


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