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Hall v. Rent-A-Center, Inc.

United States District Court, E.D. Texas, Sherman Division

December 14, 2017

ALAN HALL and JAMES DEPALMA, individually and on behalf of all others similarly situated, Plaintiffs



         Came on for consideration the amended report of the United States Magistrate Judge in this action, this matter having been referred to the United States Magistrate Judge pursuant to 28 U.S.C. § 636. On October 19, 2017, the Magistrate Judge issued an Amended Report and Recommendation (“R&R”), [1] recommending Defendants' Motion to Dismiss Plaintiffs' Consolidated Class Action Complaint (Dkt. #44) be denied. Defendants filed objections to the R&R, Plaintiffs filed a response to the objections, and Defendants filed a reply. The Court conducts a de novo review of the Magistrate Judge's findings and conclusions.


         This is a federal securities class action brought pursuant to Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”) and SEC Rule 10b-5 promulgated thereunder (17 C.F.R. § 240.10b-5) against Rent-A-Center, Inc. (“RAC” or the “Company”); its former Chief Executive Officer (“CEO”) Robert D. Davis (“Davis”); and its former Executive Vice President of Finance, Chief Financial Officer (“CFO”), and Treasurer Guy J. Constant (“Constant”) (collectively “Defendants”)[2] on behalf of all persons and entities that purchased or otherwise acquired RAC publicly traded common stock during the period from February 2, 2015 through October 11, 2016, inclusive (the “Class Period”) and who were damaged thereby. The action involves Defendants' alleged collective failure to inform the market that the “pivotal initiative the Company undertook during the Class Period and had been promising Wall Street - the rollout of its proprietary point-of-sale (‘POS') management information system, which had been in development for more than five years and cost the Company at least $175 million - was an abject failure fraught with stability and functionality problems that directly affected the Company's ability to complete sales and collect rental income during the Class Period.” Dkt. #45 at 1.

         The Court provides the following facts, as outlined in the Amended Report and Recommendation. RAC is one of the largest rent-to-own operators in North America. Compl., ¶ 2. At RAC's stores, customers can rent-to-own electronics, appliances, furniture, and other durable items. During the Class Period, RAC generated revenue from four operating segments: (1) Core U.S., (2) Acceptance Now, (3) Mexico, and (4) Franchising. Id. at ¶ 3. Core U.S. was RAC's largest segment, operating between 2, 400 to 2, 800 company-owned stores in the United States, Canada, and Puerto Rico. The Core U.S. segment comprised approximately 72% of the Company's consolidated net revenues during the Class Period. The Company disclosed in its SEC filings, including its Form 10-K for the year ended December 31, 2014, that RAC is “highly dependent on the financial performance of the Core U.S. segment” and that any “significant decrease in the financial performance of the Core U.S. segment may also have a material adverse impact on our ability to implement our growth strategies.” Id.

         Approximately 85% of RAC's Core U.S. rent-to-own agreements were on weekly terms. Id. at ¶ 4. Pursuant to such terms, RAC's customers were required to make payments either electronically (over the phone or in person) or by cash or credit in one of RAC's stores. Because RAC's key customer demographic was “unbanked” and without credit, most of its customers paid by cash in the store each week. If a customer could not or did not elect to continue their rent-to-own agreement, the customer would be able to return the merchandise at any time subject to certain conditions. The Company estimates that approximately 75% of rent-to-own items were returned and re-rented, with only 25% reaching full term such that the customer took ownership of the product. Id.

         The financial status of RAC's customer demographic also required RAC to devote significant resources to collection efforts. RAC regularly monitored customer accounts for missed payments and employed a variety of tactics to timely collect on past due accounts. The Company's primary and most time-intensive collection method involved staff from each store using the in-store computer system to identify past due accounts and to access contact information for each account. Id.

         Beginning in the fourth quarter of 2014, the Company began rolling out “SIMS, ” its proprietary point-of-sale management information system (“POS” or “SIMS”), which had been in development since at least 2009. Id. at ¶ 5. This new POS system was purportedly designed to centralize and manage sales, inventory, collections, customer relationship management, and payment tracking on a Company-wide basis, and provided RAC headquarters with real-time access to each store's sales and collection data.[3] Prior to the rollout of the new POS system, each store was required to download and transmit to RAC headquarters all store data at least twice daily. Id.

         At the beginning of the Class Period, on February 2, 2015, RAC announced the new POS system was “fully operational” at its first store “following the system-wide implementation of the back office solution.” Id. at ¶ 6. Otherwise, RAC provided little other information about the new system, including challenges it was facing with developing and implementing the system and the system's importance to the Company's revenues and strategic growth initiatives. Specifically, Defendants knew, but failed to inform investors, the POS system had a long history of stability and functionality problems which had not been remediated at the time of the rollout and which jeopardized many of the strategic initiatives that RAC was promising, including improvements to RAC's inventory management and account collection functions, and new flexible pricing and e-commerce projects, all which relied on the successful implementation of the system. Id.

         Throughout 2015, the Company rolled out the POS system to an increasing number of stores, and by December 31, 2015, the system was deployed in 385 stores. Id. at ¶ 7. However, despite being in possession of test results including Root Cause Analysis Reports, Incident Reports, and other information that should have caused Defendants to either halt the Company-wide rollout of the system or at least undertake a system-wide revamp before proceeding with a full rollout, Defendants steadfastly refused to do either. Id. at ¶ 8. Defendants also failed to inform investors of the ongoing problems, despite knowing internally that these issues would likely result in financial losses. Instead, Defendants repeatedly assured the market that the system was “fully operational and ready to go.” Id.

         “Defendants rushed out a full rollout of the POS system Company-wide in the first half of 2016, going from 385 stores on December 31, 2015 to 887 on March 31, 2016, and then completing the rollout to all 2, 478 Core U.S. stores by June 30, 2016.” Id. at ¶ 9. According to Plaintiffs, the truth about the severity of the problems with the POS implementation came to light through a series of partial disclosures that began on February 1, 2016, when the Company announced its results for the year ended December 31, 2015 after the market closed that day. Id. at ¶ 10. The next day, during the Company's earnings call, Defendants acknowledged problems with implementation of the POS system and disclosed that for the first quarter of 2016 (ended March 31, 2016) RAC expected a decrease in year-over-year earnings in the critical Core U.S. segment due to “a pretty short-term impact. . . associated with putting in new point-of-sale system in the stores” and the impact of training RAC workers on the new POS system. Id.

         According to Plaintiffs, Defendants falsely assured investors the “little bit of impact to revenue” would “go away then in the back half of the year.” Id. Defendants also falsely assured the market that RAC had “a very good knowledge of what we see in terms of the impact on the stores.” Despite these assurances, RAC's stock price dropped approximately 25% on February 2, 2016 on high trading volume. Id.

         Additional information about problems with the POS system's implementation was revealed on April 27, 2016. Id. at ¶ 11. The next day, during the Company's earnings call, Defendants disclosed that the implementation of the POS system had been delayed so the Company could address a “greater-than-expected impact on sales.” Id. However, according to Defendants, the problems had been fully remediated by then and the POS rollout had been restarted with “approximately one-third of our core stores [] operating this new POS system.” Id. Defendants also assured investors the Company was “constantly monitoring the results to make sure [the POS system] is landing well in our stores, ” that the overall impact to Core revenues was not going to be “any more significant” than originally disclosed, and that overall guidance for the year remained on track. In reaction to these revelations, RAC's common stock price fell approximately 12.8% from its close on April 27, 2016 of $15.71 per share to a close of $13.70 per share on April 28, 2016 on high trading volume. However, Plaintiffs allege the price of RAC's stock remained artificially inflated as the Company emphasized its measured approach to the POS rollout and that it had addressed all system issues. Id.

         The negative effects of the POS implementation on Core revenues were further revealed on July 27, 2016. Id. at ¶ 12. Despite revealing decreased sales because of the impacts and acceleration of the POS system rollout, Defendants represented “the distraction of a major system roll-out is now behind us.” Id. As a result of these disclosures, on July 28, 2016, RAC's common stock price fell approximately 17.6% from a close on July 27, 2016 of $13.26 per share to a close on July 28, 2016 of $10.92 per share on high trading volume. Id. The full truth was finally revealed on October 11, 2016, when Defendants issued a press release announcing preliminary results for the third quarter ended September 30, 2016. Id. at ¶ 13.

         According to the release, Core U.S. same-store sales were estimated to be down approximately 12% in the quarter due to performance issues with the POS system and peak-time Company-wide outages that “resulted in a larger than expected negative impact on Core sales.” Id. “In reaction to this disclosure of the full extent of the problems with the POS implementation, RAC's common stock price fell by $3.70 per share, or over 28% on abnormally high trading volume.” Id. (emphasis in original).

         On October 27, 2016, during the third quarter earnings call, Defendant Davis explained that the Company had begun experiencing “capacity-related system slowness and outages” at the time the POS went fully live in all Core stores in the second quarter of 2016 and that these issues persisted throughout the third quarter with the frequency of the outages not subsiding until the end of the quarter. Id. at ¶ 14. On December 2, 2016, the Company announced the termination of Defendant Constant effective immediately. Id. at ¶ 15. On January 9, 2017, the Company announced the “resignation” of Defendant Davis, a 24-year Company veteran and RAC Board member, also effective immediately. Id.

         According to Plaintiffs, the statements of former RAC employees (“confidential witnesses” or “CWs”) “with personal knowledge of SIMS' development and implementation confirm that internally known, entrenched, and systemic issues existed at the time RAC initially implemented the POS system in late 2014, and that these problems were not sufficiently remediated during the Company-wide rollout of the POS system when additional scalability and functionality problems surfaced.” Dkt. #45 at 1. According to the Complaint, the statements of former RAC employees with knowledge of SIMS' development and implementation confirm that “internally known, entrenched, and systemic issues seriously threatened the implementation of the POS system when it was initially rolled out in early 2015.” Compl., ¶ 16.

         For example, a former Senior Systems Engineering Manager employed by RAC at its headquarters from November 2013 until June 2016 who managed a team of systems engineers responsible for implementing SIMS, and who initially reported to the Director of IT Systems and Operations and then to the Senior Director of Technical Operations (both of whom reported to CTO Christi Liebe) (“CW-1"), “stated Defendants were aware that the operating system SIMS ran on was outdated prior to and during its initial rollout.” Id. According to CW-1, this severely limited its functionality, prevented enhancements and other necessary fixes, and caused SIMS to clash with current applications that RAC needed to keep the system operational. “Notwithstanding, CW-1 said that the Company moved forward in an effort to avoid a write-down or write-off on the POS system, a capitalized asset which had been in development for approximately five years.” Id.

         The Complaint also relies on “CW-2, ” who was employed by RAC for nineteen years from 1997 until June 2016. Id. at ¶ 17. “From March 2007 to June 2016, CW-2 held the title of Senior Director of Information Security and IT Service Management and reported directly to Chief Information Officer . . . who was Herman Nell from December 2013 to April 2016, and then Angela Yochem starting in May 2016 when Nell retired.” Id. “CW-2 was responsible for the information security of all RAC business units, including the Core U.S. segment, as well as litigation support, e-Discovery, and he was the custodian of all records at the Core store level.” Id. CW-2 was also a member of the project team that evaluated risks related to the SIMS rollout. CW-2 attended a “Go No-Go” meeting each time RAC rolled SIMS out to additional stores, and CW-2 corroborated information provided by CW-1 about persistent problems with SIMS, including intermittent outages and other functional issues well before the system was fully implemented in the second quarter of 2016. Id.


         On June 5, 2017, Defendants filed their current Motion to Dismiss Plaintiffs' Consolidated Amended Class Action Complaint pursuant to Federal Rules of Civil Procedure 9(b) and 12(b)(6) and the PSLRA. Dkt. #44. Defendants assert the Complaint fails to plead either (1) falsity or (2) the requisite strong inference of scienter with particularity as to any of the alleged misrepresentations.

         On October 19, 2017, the Magistrate Judge issued a sixty-nine page Amended Report and Recommendation (“R&R”), recommending Defendants' motion to dismiss be denied. In considering whether the complaint pleads with particularity any false or misleading representation, the Magistrate Judge first set forth approximately sixteen pages of allegations before determining Defendants' statements are not entitled to protection under the PSLRA's Safe Harbor provision (R&R at 39) and the “statements identified by Defendants are not inactionable statements of puffery.” R&R at 40. Relying in part on the confidential witness allegations, the Magistrate Judge concluded a reasonable person may draw the plausible inferences from the allegations that Defendants made material misrepresentations or omissions. R&R at 50.

         Regarding Defendants' arguments with regard to scienter, the Magistrate Judge first noted allegations of “motive and opportunity standing alone” are not enough to establish scienter but that such circumstantial evidence may “meaningfully enhance the strength of the inference of scienter.” R&R at 54 (citation omitted). The Magistrate Judge considered the following categories of scienter allegations (confidential witness allegations, motive, core operations, and terminations/resignations of Davis and Constant) and then viewed the scienter allegations holistically. According to the Magistrate Judge, viewed holistically, “Plaintiffs' allegations give rise to a strong inference of scienter and satisfy Plaintiffs' burden under the PSLRA.” R&R at 67. The Magistrate Judge stated even if “Defendants' interpretation of the event does support a strong inference as to a lack of scienter, “15 U.S.C. § 78u-4(b)(2) is nonetheless satisfied in the present case because the competing inference of severe recklessness is at least as cogent and compelling.” Id. (quoting Spitzberg v. Houston Am. Energy Corp., 758 F.3d 676, 686 (5th Cir. 2014).

         Finally, the Magistrate Judge noted that Defendants contest Plaintiffs' § 20(a) claims only on the basis that the underlying § 10(b) claim should be dismissed. Finding those arguments fail, the Magistrate Judge concluded Defendants' assertions regarding Plaintiffs' claims under § 20(a) of the Exchange Act are also without merit. R&R at 68.


         Defendants filed objections to the Report and Recommendation. Defendants first assert the Magistrate Judge erred in stating and applying the law regarding allegations by confidential witnesses. According to Defendants, the R&R credits allegations by two departed employees who never had communications with the individual defendants. Defendants contend the R&R does not examine whether the “supposedly non-disclosed information would render misleading what a reasonable person would infer from the Company's statements” and does not rely on “any particularized facts possessed by either of the Individual Defendants demonstrating why either of them knew (or recklessly disregarded) that their statements were false or misleading.” Dkt. #57 at 2. Defendants assert the allegations attributed to confidential witnesses must be discounted for scienter purposes.

         Defendants next assert the R&R improperly credits allegations of motive in finding the scienter allegations sufficient. Finally, Defendants assert the R&R improperly finds two executive resignations add to the inference of scienter.

         DE ...

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