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IN RE PROVIDIAN FINANCIAL CORPORATION SECURITIES LITIGATION
July 5, 2001
IN RE PROVIDIAN FINANCIAL CORPORATION SECURITIES LITIGATION. IN RE PROVIDIAN FINANCIAL CORPORATION CREDIT CARD TERMS LITIGATION.
The opinion of the court was delivered by: William H. Yohn, Jr., United States District Court Judge.
The plaintiffs in this consolidated class action allege that Providian
Financial Corporation ("Providian"); its Chairman of the Board,
President, and Chief Executive Officer Shalish Mehta ("Mehta"); and its
Executive Vice President and Chief Financial Officer David Petrini
("Petrini") all engaged in securities fraud in violation of § 10(b)
of the Securities Reform Act of 1934 and Rule 10b-5 promulgated
thereunder. The suit began as a series of separate class actions by
customers of the defendants and their shareholders which were launched
after news that various government agencies had begun investigating
Providian's credit card business practices. The investigations ended
after Providian agreed to alter some of its business practices, pay
restitution to certain account holders, and to pay various fines. The
federal suits are still pending but have been consolidated and assigned
to this court. The plaintiffs in this portion of the consolidated action
dealing with the securities litigation purport to represent the class of
persons who purchased Providian common stock on the open market between
January 21, 1999 and June 4, 1999.
Before the court is the defendants' motion to dismiss for failure to
state a claim or, in the alternative, for failure to plead with
particularity. The defendants argue that the Second Amended Consolidated
Class Action Complaint (the "SAC") pleads neither the conduct nor the
scienter necessary to establish securities fraud. However, upon review, I
find that the SAC alleges these basic elements of securities fraud with
The SAC alleges that Providian engaged in a series of illegal or
fraudulent business practices that artificially inflated the company's
financial results and that the statements that reported Providian's
results made no mention of these practices but instead attributed the
results to Providian's "customer-focused approach."
inferences in the plaintiffs' favor, one may reasonably infer that
Providian's statements were misleading or that the statements omitted
information that was necessary to avoid their being misleading. Also, the
SAC makes a number of allegations concerning scienter. First, it is
alleged that Mehta and Petrini received various revenue and sales reports
that notified them of Providian's dramatic performance in core areas of
Providian's business. Second, Mehta and Petrini also received reports of
Providian's extraordinarily high intake of late fee and overlimit fee
revenues. From these reports, plaintiffs allege that Mehta and Petrini,
both senior officers at Providian, knew or should have known about
Providian's illegal or fraudulent business practices. Third, it is
alleged that Mehta and Petrini played a direct role in creating the sales
climate that allegedly led Providian's sales force to mislead customers
and illicitly add products to their accounts without consent. The SAC, in
essence, alleges that Providian's illegal or fraudulent practices
permeated Providian's core business and were so pervasive and obvious that
Mehta and Petrini must have known or at a minimum were reckless in not
knowing. These allegations support a strong inference of knowledge or
recklessness. Furthermore, Mehta and Petrini's knowledge or recklessness
may be attributed to Providian as an entity. Given the sufficiency of
these allegations, the defendants' motion will be denied.
Providian's primary business, credit card lending, generates two types
of revenue: interest and non-interest. Interest revenue comes from
finance fees on outstanding credit card loans. SAC at ¶ 32.
Non-interest revenue comes from a variety of other sources, including
fees for late payments, returned checks, overlimit debits, cash
advances, membership, and add-on services. Id. Providian's add-on
services include programs for healthcare discounts, automobile and travel
discounts, credit protection, and mortgage or rent assistance. Id.
Providian also has various programs to induce consumers to transfer
credit card balances from other creditors. Id. at ¶ 33. Presumably,
the larger the customer pool the lender retains, the larger overall
revenue or at least potentially realizable revenue.
The SAC refers to four of Providian's public statements: (1) the
January 21, 1999 press release; (2) the Form 10-K filed on March 31,
1999; (3) the April 22, 1999 press release; and (4) the Form 10-Q filed
on May 14, 1999. Mehta and Petrini reviewed and approved each of these
statements. Id. at ¶¶ 49, 50, 54, 60. The statements describe
Providian's financial performance, customer-base increases, earnings
projections, or "customer-focused" approach.
(1) The January press release announced that 1998 fourth quarter net
income was $94.9 million, and full year net income was $296.4 million, "a
55% increase over net income of $191.5 million in 1997." "Total managed
revenue for the quarter . . . grew by nearly 82% over fourth quarter
1997, to $757.5 million, while year over year, total managed revenue
increased to $2.4 billion. . . . [Interest revenue] increased over fourth
quarter 1997 to $364.2 million. For all of 1998, [non-interest revenue]
was $1 billion and represented 43% of total managed revenue." Moreover,
"[a]ccount growth climbed at an accelerated pace, with over 1.9 million
new account relationships established during the quarter." By the end of
1998, Providian managed 8 million accounts, a substantial increase over
the number of accounts managed in 1997.
The release quotes Mehta forecasting Providian's future prospects:
"Current trends in each of our businesses give me continued confidence in
Providian's ability to achieve 50% earnings per share growth in 1999 and
to increase our goal for long-term earnings per share growth to at least
25%." Mehta also states that "Providian's performance in the fourth
quarter and results for all of 1998 were outstanding. . . . Our
customer-focused engineering approach to consumer lending and our
unwavering commitment to flawless execution of our business strategy
enable Providian to generate above industry-average returns and to
sustain our high growth rate." Id. at ¶¶ 41-49.
(2) The Form 10-K reports that for 1998, non-interest revenue from
add-on services totaled $165.8 million, compared to $59.3 million the
prior year. For 1998, non-interest revenue from late and overlimit fees
totaled $176.0 million, an increase from the prior year's total of $80.9
million. Other categories of non-interest revenue also rose as a result
of customer volume growth.
The form also describes Providian's customer-focused approach as a
technique that involves the use of Providian's "databases and analytical
techniques" to "develop targeting and credit models to identify
potential customers. . . . After an account is opened, account performance
is monitored and a variety of account management tools are used to build
the customer relationship." Id. at ¶¶ 50-53.
(3) The April press release announced Providian's 1999 first quarter
results. First quarter net income was "$113.5 million, an 102% increase
over the first quarter of 1998." Total managed revenue was $851.1
million, an 88% increase over the first quarter of 1998. Non-interest
revenue "grew by 157% over the first quarter of 1998 to $416.2 million,
and represented 48.9% of total managed revenue[.]" "Growth in all fee
revenue sources was outstanding, including strong add-on product revenue
which was up 223% over the first quarter of 1998." Moreover, "Providian
added over 1 million accounts during the quarter, bringing total customer
relationships to 9 million."
The release again quotes Mehta forecasting Providian's future
prospects: "[Providian's] growth initiatives, along with current trends in
all of our businesses, give me comfort to raise our 1999 earnings
guidance to $3.50 per share, or 72% over 1998, and to increase earnings
guidance for 2000 to 35%, or $4.72 per share, over 1999." Mehta also
states that "[the] customer-focused approach continues to enable
Providian to deliver above average returns." Id. at ¶¶ 50-59.
(4) The Form 10-Q reports that for the first quarter of 1999 "credit
product fee income was $341.8 million[,]" as compared to $96.4 million
during the same period in 1998. "[M]anaged fee-based product revenue
totaled $117 million[,]" as compared to $36.4 million during the same
period in 1998. "Late and overlimit fees totaled $137.7 million[,]" as
compared to $51.7 million for the same period in 1998. For the first
quarter of 1999, Providian also experienced increases in other categories
of non-interest income. The form attributes some of these revenue
increases to customer-base growth. Id. at ¶¶ 60-61.
The SAC describes eight allegedly illegal or fraudulent business
practices, most of which relate primarily to the ...