PainCare Holdings, Inc.’s common stock purchasers brought a securities fraud class action, alleging that the company’s reported financial results violated GAAP by materially understating reported expenses and materially overstating reported net income. Plaintiffs contended that these erroneously favorable figures enabled the company to engage in acquisitions and other transactions by using artificially inflated common stock. The company’s stock price declined substantially immediately after it disclosed the violations and its need to restate earnings for a two year period. Defendants prevailed on their move to dismiss the lawsuit on the grounds that the complaint failed to satisfy the enhanced pleading requirements of the Private Securities Litigation Reform Act (PSLRA) and Rule 9(b) of the Federal Rules of Civil Procedure.

The court found that the “essence” of plaintiff’s allegations of defendants’ fraudulent misrepresentations was simply that the Company’s financial statements, Securities and Exchange Commission filings and press releases about its financial performance during the two year period preceding the restatement announcement were incorrect. The court ruled that these allegations did not satisfy either the “who, what, when, where, and how” requirement of Rule 9(b) or the pleading threshold to establish scienter. While recognizing that scienter may be satisfied by showing that defendants “acted with a severely reckless state of mind,” the court noted the absence of any allegations indicating such a state of mind. To the contrary, the court noted that the company at all relevant times consistently used the same disclosed method of accounting in its financial statements and that all such statements had been certified by independent auditors. The court also ruled that the massive restatement of earnings was not an indicium of fraud, noting the complete absence of any allegations that the defendants were aware of the GAAP violations at the time the alleged misrepresentations were made. (In re PainCare Holdings Securities Litigation, No. 6:06-cv-362-Orl-28DAB, 2007 WL 1229701 (M.D. Fla. April 25, 2007))

Corporation Adequately Pleaded Securities Fraud Against Chairman

A corporation engaged in oil and gas producing activities brought a securities fraud action against individual defendants, including its former chairman and several unlicensed brokers, to recover damages allegedly incurred as a result of a fraudulent scheme pursuant to which the defendants sold the company’s securities in order to artificially inflate the stock price and generate illegal commissions. The company alleged, among other things, that the chairman (i) in order to build a “ponzi” scheme and attract future investors, arranged for each investor to be paid a “profit” that exactly matched pre-investment projections, regardless of the company’s actual performance; (ii) knew that many of the individuals purchasing stock were “unaccredited investors;” (iii) entered into commission agreements with the defendant brokers whose existence was deliberately concealed from the Board through which more than $7 million in commissions were paid, which payments were often falsely described as being for “consulting,” “legal,” or “acquisition” fees; and (iv) caused false reports to be filed with the Securities and Exchange Commission. The company claimed that, as a result of these actions, its financial well-being and the market for its securities had been damaged by, among other things, demands by victimized investors for rescission, a publicly disclosed SEC investigation and the company’s incurring related legal and professional expenses.

The court denied the chairman’s motion to dismiss the securities fraud claims. The court rejected the chairman’s argument that any damages allegedly sustained were speculative or consequential, ruling that that the damages alleged – for rescission, for paying millions of dollars in improper commissions, and incurring legal and professional expenses relating to the SEC investigation – were neither remote from the consequences of the chairman’s alleged wrongdoing nor speculative.

The court also ruled that the company adequately pleaded reliance by alleging that the chairman repeatedly withheld material information from the Board in order to prevent the Board from uncovering the illegal scheme. Finally, the court ruled that the complaint satisfied the pleading requirements of Rule 9(b) and the PSLRA because the company alleged with specificity omissions that the chairman made to the Board, misstatements included in specifically identified SEC filings signed by the chairman, and details of the chairman’s role in creating the scheme. (Energytec, Inc. v. Proctor, No. 3:06-CV-871-L, 3:06-CV-933-L, 2007 WL 1266051 (N.D. Tex. April 30, 2007))