United States District Court, E.D. Pennsylvania
WEST PALM BEACH POLICE PENSION FUND, on behalf of itself and all others similarly situated, Plaintiffs,
DFC GLOBAL CORP., et al., Defendants.
The payday loan industry allows individuals who do not have ready access to cash to secure loans so that they can pay bills. DFC Global Corp. (“DFC Global”) was a leader in the field. According to the West Palm Beach Police Pension Fund, the Arkansas Teacher Retirement System, the Macomb County Employees’ Retirement System, and the Laborers’ District Council and Contractors’ Pension Fund of Ohio (collectively, “Plaintiffs”), DFC Global misled investors about DFC Global’s lending practices. When the fraud was revealed, the price of the stock plummeted, thereby causing great harm to investors, including Plaintiffs and the purported class they seek to represent. Presently before the Court are two motions to dismiss: one filed by DFC Global and numerous executives and members of the board of directors, and one filed by entities which underwrote a DFC Global stock offering. For the reasons that follow, the motions to dismiss are denied.
I. FACTUAL BACKGROUND
A. The Payday Loan Industry and Regulation
DFC Global provides unsecured short-term consumer loans, often referred to as “payday loans, ” and secured pawn loans, primarily to unbanked and under-banked consumers. (Consol. Class Action Compl. ¶ 20.) “DFC Global maintains the largest market share of all payday lenders in the U.K. and is the largest pawn lender in Europe measured by loan portfolio.” (Id.) DFC Global’s U.K. business operated under various names, including The Money Shop, Dollar Financial, Month End Money, and Payday Express Limited. (Id. ¶ 43.) Jeffrey Weiss was the Chairman and CEO of DFC Global since 1990; Randy Underwood was the CFO since 2004; William Athas was the CAO and senior vice president of finance and corporate controller since 2011. (Id. ¶¶ 23-25.) Defendants David Jessick, Kenneth Schwenke, Clive Kahn, John Gavin, Ronald McLaughlin, and Michael Kooper have all served on DFC Global’s board of directors. (Id. ¶¶ 28-33.) Defendants Credit Suisse and Nomura Securities International, Inc. served as underwriters for DFC’s April 2011 common stock offering and were responsible for ensuring the truthfulness and accuracy of the statements made in the offering materials. (Id. ¶¶ 35-37.)
Payday loans are small loans made to customers experiencing short-term money problems. (Id. ¶ 39.) DFC Global made money from payday loans in three ways: (1) origination fees when the loans were issued; (2) interest rates for loans paid off in their initial term; and (3) interest rates for rolled-over loans. (Id. ¶¶ 40-41.) If a borrower could not repay a loan when it came due, he or she could roll over, or extend, the loan by paying the finance charge to keep the loan current. (Id. ¶ 41.) Payday loans are risky loans because the customer is often “unemployed, underemployed or otherwise income-restrained.” (Id. ¶ 42.) DFC Global’s customers typically fell into two demographics: ALICE (asset limited, income constrained and employed) and ARTI (asset rich, temporarily illiquid). “ALICE customers are generally struggling workers that are forced to hold more than one low-paying job in order to satisfy their monthly bills and living expenses. ARTI customers, on the other hand, often fall within several income and wealth categories, but generally include temporarily unemployed individuals in need of short-term credit.” (Id.)
DFC Global “distinguished itself from its competitors as a conservative lender and manager of risk, ” touting its “‘conservative approach to extending consumer credit, ’” its “‘very effective’ credit analytics function, ” its “ability to underwrite a customer’s ability to repay.” (Id. ¶ 44.) DFC Global held itself out as “‘a leader for responsible behavior in the marketplace.’” (Id.) Investors relied on DFC Global’s conservative approach to help the company withstand additional regulation in the payday loan industry and ensure that the company would appropriately manage risk. (Id. ¶ 45.) DFC Global is a charter member of the Consumer Finance Association (“CFA”), the industry’s leading trade association. (Id.)
Payday lenders in the U.K. must adhere to regulations of the Consumer Credit Act and guidance on lending from the Office of Fair Trading (“OFT”). (Id. ¶ 46.) In 2011, the OFT deemed certain lending practices to be irresponsible, including: (1) failing to establish and implement effective policies and procedures to assess affordability; (2) failing to undertake a reasonable assessment of affordability; and (3) encouraging borrowers to roll over existing debt. (Id. ¶ 47.) The Consumer Credit Act mandated that lenders assess borrower creditworthiness based on sufficient information obtained from the borrower and a credit reference agency, if necessary, to ensure that the borrower could reasonably repay the loan. (Id. ¶ 48.) Payday lenders were also instructed to work with borrowers having trouble repaying their loans, including developing a repayment plan that did not increase the borrower’s indebtedness. (Id. ¶ 49.)
During the class period, scrutiny of payday lenders in the U.K. increased. For example, following an extensive review of fifty payday lenders, including DFC Global, the OFT announced that these lenders faced enforcement actions if they did not improve their lending practices. (Id. ¶¶ 50, 95.)
B. DFC Global’s Lending Practices
The Consolidated Class Action Complaint paints a bleak picture of DFC Global’s business practices. Contrary to public statements, “DFC Global’s underwriting and risk management practices were not ‘conservative’ or ‘responsible.’ The Company also misled investors about critical metrics reported in DFC Global’s financial results, including its loan loss reserves and net income.” (Id. ¶ 54.) DFC Global extended loans to those who could not repay them and repeatedly rolled over loans to borrowers for a fee in order to avoid reporting defaults without any additional credit assessment. (Id. ¶ 54.) To make their case, Plaintiffs relied on a number of confidential witnesses to explain DFC Global’s lending practices. These confidential witnesses, employees of DFC Global, contended that the company made risky loans with little or no oversight or concern about the ability of the borrower to repay the loan. (See id. ¶¶ 58-69.) For example, loans were often approved without verifying a borrower’s income or determining if the borrower could repay the loan. (Id. ¶¶ 58-60.) One confidential witness stated that The Money Shop would target borrowers with bad credit, calling them into the store to offer loans. (Id. ¶ 61.) Indeed, “the Company’s overriding focus was on generating more loans. . . . Management instructed employees to do whatever it took to get a loan.” (Id. ¶ 62.) Management would often override a decision to reject a loan. (Id.) DFC Global also targeted those in desperate need of cash, a practice barred by the OFT and the Consumer Finance Association. (Id. ¶ 63.)
Rollovers were vital to DFC Global, as they generated at least 60% of the company’s total payday lending revenue. (Id. ¶ 80.) The company also had a policy of pressing borrowers to rollover their loans, thereby generating new fees and delaying defaults by deeming as current rolled over loans. (Id. ¶ 69.) These repeated rollovers were often made without any additional assessment as to whether the borrower could repay the loan. (Id. ¶ 70.) This practice was contrary to OFT guidance. (Id. ¶¶ 70-71.) Confidential witnesses stated that there were no limits on the number of times a borrower could roll over a loan, and that employees had rollover quotas. (Id. ¶¶ 73-77.) Indeed, borrowers were encouraged to roll over loans rather than pay them off, even if the borrower did not understand the financial implications of continuous rollovers. (Id. ¶ 73.) DFC Global executives, including Weiss, Underwood, and Athas, regularly discussed loan rollovers and how they affected the bottom line of DFC Global. (Id. ¶ 78.)
“During the Class Period, defendants repeatedly represented that the Company had instituted a credit analytics function that effectively managed risk in its consumer loan activities, and the Executive Defendants certified in quarterly and annual SEC filings that the Company had instituted adequate internal controls.” (Id. ¶¶ 81-82.) However, despite public statements to the contrary, Athas later admitted on behalf of DFC Global that the company could not consistently track loan data on a global basis. (Id. ¶ 83.) In reality, the company “utterly failed to effectively manage its risk by not analyzing rollovers or extensions on a global basis and taking them into account when extending credit or setting the Company’s loan loss reserves.” (Id. ¶ 84.) Confidential witnesses supported this allegation: “There was nothing in place for monitoring the quality of the loans.” (Id.)
Moreover, Plaintiffs charged, DFC Global’s decision to exclude rolled-over loans from its loan loss reserves violated generally accepted accounting principles. (Id. ¶ 85.) “[C]ontrary to the Company’s representations that it complied with GAAP, the Company understated its loan loss reserves in order to inflate its income and to disguise the poorly underwritten and high-risk loans in its loan portfolio.” (Id. ¶ 87.) DFC Global also failed to properly account for rolled over loans by treating them as new, current loans rather than placing them into default. (Id. at 88-91.) “In doing so, the Company effectively wiped out the negative credit history associated with borrowers who had a demonstrated inability to repay their loans.” (Id. ¶ 88.) DFC Global’s policy of treating rolled over loans as new loans with no additional risk came directly from senior management. (Id. ¶ 89.) Following the OFT’s increased regulatory scrutiny, DFC Global had to increase its loan loss reserves as its borrowers increasingly defaulted. (Id. ¶ 92.)
C. The OFT Report
Following its investigation, the OFT reported that the U.K. payday lending industry was rife with irresponsible lending practices, including the failure to properly assess affordability. (Id. ¶ 96.) “The OFT report revealed exactly the types of practices that DFC Global had been engaged in throughout the Class Period. In fact, each of DFC Global’s subsidiaries operating in the U.K. received letters from the OFT identifying deficiencies in operations.” (Id. ¶ 98.) DFC Global was warned that if changes were not implemented within ninety days, DFC Global’s business units that provided payday loans in the U.K. would be shut down. (Id. ¶ 98.)
Despite statements to the contrary from Weiss, the company failed to comply with lending regulations, and “the governing bodies . . . had grave doubts that DFC Global could ever become compliant in light of its business practices.” (Id. ¶¶ 100-01.) For example, a confidential witness stated that the company “never got in compliance with the OFT’s regulations, despite the Company’s purported assurance to the contrary.” (Id. ¶ 101.) The same confidential witness claimed that DFC Global rolled over loans more than three times, even though the company assured others that it was in compliance with the rollover rule that disallowed so many rollovers. (Id. ¶ 102.)
D. False Statements
Plaintiffs alleged that “[t]hroughout the Class Period . . . defendants regularly made statements about DFC Global’s ‘conservative approach’ to underwriting, distinguishing the company from its competitors as a ‘responsible’ lender, and reassured investors that its approach to extending credit was designed to ‘get the money back.’” (Id. ¶ 106.) For instance, during a January 27, 2011 conference call, Weiss stated, “The implementation of what we believe to be industry leading proprietary credit scoring model and our continued conservative approach to extending consumer credit in the midst of a still-weakened economy resulted in a loan loss provision expressed as a percentage of growth consumer lender revenue of 16.6%.” (Id. ¶ 107.) During a June 7, 2011 conference, Weiss stated, “We have, we think, the best analytics, underwriting and collection metrics in the industry.” (Id. ¶ 108.) Underwood stated that DFC Global “undertook a conscious effort to . . . become more selective in the loans we put out, not knowing exactly where the recession was going, probably less money on the table, and we’re pretty certain of that, but we feel a lot better about things having a very conservative approach during the recession until we saw what was going to ultimately happen.” (Id. ¶¶ 108-09.)
During a January 26, 2012 conference call to discuss the company’s second quarter 2012 results, Weiss stated:
Well, first we like to get the money back, not only to give it out. So that’s always our most important consideration. But I think it’s a combination of really many years of investment in credit analytics and the really superior work of our credit analytics group, which encompasses not only underwriting, but the ability to stratify our borrowers and make sure collections are effective. Secondly, our decade of experience in storefront lending has provided us with a base of knowledge and experience that I think is relatively unique in this space.
* * *
We can underwrite to the ninth decimal point a customer’s ability to repay. We’re getting better at underwriting a customer’s willingness to repay.
(Id. ¶ 111.) On January 24, 2013, Weiss praised the company’s ability to keep its second quarter 2013 losses lower than expected:
First we are more selective. Again, repeating what I said, no trick in giving the money out. I think we are more selective particularly in the UK, given the regulatory issues that we have discussed. I think we continue to improve in our ability to figure out how much to lend and to whom and how to collect from people who have difficulty making a full or partial repayment on time. But I think it’s part and parcel of our considered stance to the environment in the UK.
(Id. ¶ 114.) Weiss assured analysts that further regulation of the industry would be helpful to DFC Global:
What we have discovered is regulation is the friend of the responsible. . . . We think that we are on the road to [a] situation in the UK where lots of small lenders who simply lack the infrastructure or inclination to build the appropriate credit analytics and responsible collection apparatus will no longer be able to participate in the marketplace because relevant authorities will simply prevent it.
(Id. ¶ 115.) Plaintiffs contend that these statements were false, as DFC Global was neither conservative nor selective. Rather, it did not adhere to even minimal underwriting standards and instead targeted individuals unlikely to pay back their loans. (Id. ¶ 116.) The failure to disclose DFC Global’s shortcomings meant that “investors were misled about the Company’s true lending practices and the creditworthiness of the Company’s loans.” (Id. ¶ 117.)
DFC Global’s SEC filings contained numerous false and misleading statements regarding its purportedly effective credit analytics, risk management and related financial results. DFC Global’s second quarter 2011 Form 10-Q (repeated in numerous other SEC filings) stated:
The Company has instituted control mechanisms and a credit analytics function that have been very effective in managing risk in its consumer loan activities. Collection activities are also an important aspect of the Company’s operations, particularly with respect to its consumer loan products due to the relatively high incidence of unpaid balances beyond stated terms. The Company operates centralized collection centers to coordinate a consistent approach to customer service and collections in each of its markets. The Company’s risk control mechanisms include, among others, the daily monitoring of initial return rates with respect to payments made on its consumer loan portfolio.
(Id. ¶¶ 118-19.) During an April 30, 2012 conference call discussing the company’s third quarter 2012 fiscal results, Underwood said:
[O]ur vast investment in credit analytics folks, and we have them in several of our business units, as well as corporately, I think certainly has paid off for us many, many times over. And it not only helps out on the front end but it certainly helps out on the back end as we prioritize how to go about collection activities. So, I think we’re happy being what we think is pretty conservative. It very well could be that we’d be leaving money on the table [by lowering underwriting standards] . . . But we think our performance is just fine with being as cautious as we are[.]
(Id. ¶ 125.) In SEC filings, the company also touted its centralized facilities, which “have helped us both to improve our loan servicing significantly and to reduce credit losses on loans originated by us, and significantly enhances our ability to manage the compliance responsibilities related to our consumer lending operations.” (Id. ¶ 126.) In reality, and contrary to these numerous false and misleading statements, DFC Global’s deficient lending and credit assessment practices increased the company’s credit risk and related losses. (Id. ¶ 129.) The company also lied about monitoring loans and “being in the forefront of government and community relations on regulatory issues.” (Id. ¶¶ 130-33.)
Additionally, DFC Global made false statements about the payment status of loan, as well as its loan loss reserves. The company failed to report properly the actual payment status for loans that it rolled over by categorizing such loans as extended or current, when the loans were essentially past due. (Id. ¶¶ 135-36.) “By categorizing rolled over or extended loans as current, the Company avoided classifying them as past due and disclosing the true attendant credit risks and losses.” (Id. ¶ 136.) DFC Global also failed to inform investors that it performed almost no underwriting when the loans were first originated or when they were subsequently rolled over. (Id. ¶ 139.) “The Company’s loss reserve policy . . . and its reported net income, loan loss provision, and loan loss reserve . . . were each false and misleading because when calculating its loan loss reserve, the Company did not take into account the increased credit risk of its loans due to its deficient underwriting; the increased credit risk of continuously rolling over loans without conducting additional underwriting; or the true past due nature of the rolled over loans.” (Id. ¶ 142.) These practices led DFC Global to understate its loan loss reserve and to overstate its net income. (Id. ¶¶ 142-43.)
E. Performance Issues
On April 1, 2013, DFC Global preannounced its third fiscal quarter 2013 results in a press release filed with the SEC and a conference call. (Id. ¶ 151.) The company reported that its consolidated loan loss provision as a percentage of gross consumer lending revenue was expected to spike. (Id.) This spike impacted the company’s reported net income, which declined. (Id.) DFC Global also reported that it was cutting its earnings per share by nearly 30%. (Id. ¶ 152.) On April 1, 2013, DFC Global’s stock price fell from $16.64 to $13.04. (Id.) Despite these performance issues, Weiss and Underwood continued to tout the company as a responsible lender that maintained conservative underwriting practices. (Id. ¶¶ 153-54.) Weiss stated that DFC Global remained confident that it was well positioned for the long term “as irresponsible lenders are eventually targeted by the OFT and removed from the UK market.” (Id. ¶ 153.) When the company announced its third fiscal quarter results on May 1, 2013, its consolidated loan loss provision as a percentage of gross consumer lending spiked more than previously anticipated. (Id. ¶ 156.) DFC Global also confirmed that the company’s three business units in the U.K. that provided payday and single payment loans received “action required” letters from the OFT regarding their improper lending practices in a number of areas. (Id. ¶ 157.) Weiss discounted this news as a “bump in the road” and Underwood “continued to misleadingly describe the Company’s lending practices during the regulatory transition period as responsible.” (Id. ¶ 158.) When DFC Global reported its fiscal year 2013 earnings, it announced that defaulting loans would continue to be a problem through at least the first half of fiscal year 2014. (Id. ¶ 160.) Underwood also announced that DFC Global expected to incur $10-$15 million in expenses every year for regulatory, legal, audit, and compliance-related costs. (Id. ¶ 161.) This news sent the company’s stock down from a close of $15.90 on August 22 to $11.31 on August 23. (Id.)
On October 30, 2013, DFC announced that as a result of higher loan defaults in the United Kingdom, its loan loss provision had increased. (Id. ¶ 163.) Weiss also explained that DFC Global instituted a number of restrictive changes to assure investors that the company maintained a conservative regulatory posture. (Id.) Underwood reported that poor performance was the result of confusion about regulatory requirements; he also stated that he believed the stock was a bargain. (Id. ¶ 164.)
DFC Global’s loan losses caused it to experience liquidity problems. (Id. ¶ 166.) These liquidity problems led the company to announce a private offering of senior notes to institutional investors. (Id.) The company was forced to withdraw the offering just a few days later, however, because “it could not draw sufficient investor interest in its debt.” (Id.) This withdrawal caused a drop in the price of DFC Global stock. (Id.) Moreover, the company’s consolidated loan loss provision continued to increase. (Id. ¶ 167.) The price of the stock continued to decline; on January 31, 2014, the price decreased from $10.57 to $7.52. (Id. ¶ 168.) “Defendants falsely blamed the Company’s poor financial results on the fact that regulatory guidance in the U.K. was not yet definitive and that its competitors were engaging in lending practices that DFC ...