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Southeastern Pennsylvania Transportation Auth. v. Orrstown Financial Services, Inc.

United States District Court, M.D. Pennsylvania

June 22, 2015







A. Factual Allegations

1. Expansion and March 2010 Offering

2. Post-March 2010 Offering

3. Defendant Auditor Smith Elliott Kearns

B. Legal Standard Applicable to Plaintiff’s Claims

1. Securities Act

2. Exchange Act

3. Principles Governing Materiality Under the Acts

a. Statements of Opinion or Belief

b. Forward-Looking Statements

c. Puffery

C. Analysis

1. Securities Act Claims

a. Applicable Pleading Standard

b. Count I: Defendants Orrstown and the Bank

i. Statements related to “underwriting standards, credit review policies, and internal controls”

ii. Statements related to loan loss reserves

iii. Statements regarding credit practices during Road Show PowerPoint Presentation

iv. Post-March 2010 Offering Statements related to credit procedures

v. Statements related to the effectiveness of management

c. Count II: Individual Defendants, Defendant Smith Elliott Kearns, and Defendants Sandler O’Neil and Janney Scott

i. Individual Securities Defendants and Underwriter Defendants

ii. Auditor Defendant Smith Elliott Kearns

d. Count III: Orrstown, the Bank, Individual Securities Act Defendants, Defendant Jeffrey Embly, and the Underwriter Defendants

e. Counr IV: Section 15, Individual Securities Act Defendants

2. Exchange Act Claims

a. Count V: Section 10(b) and Rule 10b-5, Orrstown Exchange Act Defendants

i. Statements in the 2009 Annual Report

ii. Statements at the May 4, 2010 shareholder meeting and in the May 5, 2010 Form 8-K

iii. Statements regarding risk assets and loan loss reserves

iv. Statements from the second quarter 2010 through first quarter 2011

v. Statements from the second quarter 2011

vi. Statements from the third quarter 2011 through end of class period

vii. Financial reporting

b. Count VI: Section 10(b) and Rule 10b-5, Auditor Defendant

c. Count VII: Section 20(a), Orrstown Exchange Act Defendants Quinn, Everly, and Embly



Before the Court is a motion to dismiss filed on behalf of Defendants Orrstown Financial Services, Orrstown Bank, Anthony Ceddia, Jeffrey Coy, Mark Keller, Andrea Pugh, Thomas Quinn, Jr., Gregory Rosenberry, Kenneth Shoemaker, Glenn Snoke, John Ward, Bradley Every, Joel Zullinger, and Jeffrey Embly (Doc. No. 53); a motion to dismiss on behalf of Defendant Smith Elliott Kearns & Company LLC (Doc. No. 56); and a motion to dismiss on behalf of Defendants Sandler O’Neill & Partners, L.P. and Janney Montgomery Scott, LLC (Doc. No. 58). For the reasons that follow, the Defendants’ motions will be granted.


Defendant Orrstown Bank, (the “Bank”), a wholly-owned subsidiary of Defendant Orrstown Financial Services, LLC, (“Orrstown”), was founded in 1919 and provides community banking and bank related services in the South Central Pennsylvania region. (Doc. No. 40 ¶¶ 26-27.) The Bank has twenty-one branches, concentrated in Cumberland, Franklin, and Perry Counties, as well as one branch in Hagerstown, Maryland. (Id. ¶ 27.) Approximately seventy-five percent of the Bank’s loan portfolio is concentrated in commercial loans. (Id.)

In early 2010, Defendants Orrstown and the Bank raised almost $40 million from investors through the public offering of approximately 1.4 million shares of Orrstown common stock at $27.00 per share. (Id. ¶ 1.) However, following a series of revelations concerning the Bank’s financial condition, on January 26, 2012, Defendant Orrstown reported losses of twenty-three million for the fourth quarter of 2011. (Id. ¶ 9.) On March 15, 2012, Defendant Orrstown disclosed that it had failed to “maintain effective internal control over the process to prepare and report information related to loan ratings and its impact on the allowance of loan losses.” (Id. ¶ 11.) On March 23, 2012, Defendants Orrstown and the Bank, and their shared Board of Directors, revealed that they had entered into an agreement with the Federal Reserve Bank of Philadelphia and a consent order with the Commonwealth of Pennsylvania, Department of Banking, Bureau of Commercial Institutions. (Id. ¶ 12.) As part of the agreement and consent order, Defendants Orrstown and the Bank were required, among other things, to revise their loan underwriting and credit administration policies and strengthen their credit risk management practices. (Id.) On March 30, 2012, Orrstown mailed additional proxy materials to shareholders, informing them that it had faced significant challenges in 2011 and had been operating under the guidance of regulators to make structural changes. On April 5, 2012, Orrstown stock closed at $8.20 per share. (Id. ¶ 13.)

On May 5, 2012, Lead Plaintiff Southeastern Pennsylvania Transportation Authority (“SEPTA”), on behalf of two classes, filed this class action pursuant to Federal Rule of Civil Procedure 23(a) and (b)(3) against Defendants Orrstown, the Bank, certain of Orrstown’s officers and directors, Smith Elliott Kearns & Company, LLC, Sandler O’Neill & Partners L.P. and Janney Montgomery Scott, LLC, alleging that Defendants issued materially untrue and/or misleading statements and omissions in violation of the federal securities laws. (Id. ¶ 16.) Plaintiff asserts claims on behalf of two classes: (1) the “Securities Act Class, ” which consists of all persons and/or entities who purchased Orrstown common stock pursuant to, or traceable to, Orrstown’s February 8, 2010 registration statement and March 23, 2010 prospectus supplement issued in connection with Orrstown’s secondary stock offering in March 2010 and were damaged thereby; and (2) the “Exchange Act Class, ” which consists of all persons or entities who purchased Orrstown common stock on the open market between March 15, 2010 and April 5, 2012 (the “class period”) and were damaged thereby. (Id. ¶¶ 17-18.) Plaintiff SEPTA acquired Orrstown stock pursuant to the offering documents for the March 2010 offering, and also purchased Orrstown common stock on the open market during the class period. (Id. ¶ 25.)

On March 4, 2013, Plaintiff filed an amended complaint. (Doc. No. 40.) On May 28, 2013, Defendants Orrstown, the Bank, and the Orrstown individual defendants (the “Orrstown Defendants”) moved the Court to dismiss Plaintiff’s amended complaint pursuant to Federal Rule of Civil Procedure 12(b)(6). (Doc. No. 53.) On that same day, Defendant Smith Elliott Kearns & Company, LLC (the “Auditor Defendant”) also moved the Court to dismiss Plaintiff’s amended complaint for failure to state a claim (Doc. No. 56), as did Defendants Sandler O’Neill & Partners and Janney Montgomery Scott, LLC (the “Underwriter Defendants”) (Doc. No. 58.). The Orrstown Defendants, the Auditor Defendant and the Underwriter Defendants filed briefs in support of their motions to dismiss. (Doc. Nos. 57, 59, 60.) On July 22, 2013, Plaintiff filed an omnibus brief in opposition to the motions to dismiss. (Doc. No. 66.) Each group of defendants submitted a reply brief in response. (Doc. Nos. 68, 71, 72.) The Court heard oral argument on the collective motions to dismiss on April 29, 2014. (Doc. No. 84.)

On March 25, 2015, the Court issued an Order requiring the parties to file briefs addressing the impact of the United States Supreme Court’s March 24, 2015 decision in Omnicare, Inc. v. Laborers Dist. Council Constr. Indus. Pension Fund, No. 13-435 (U.S. Mar. 24, 2015), on the pending motions to dismiss. (Doc. No. 87.) Those briefs were filed on April 10, 2015. (Doc. Nos. 90, 91.) The matter is now ripe for disposition.


A motion filed under Federal Rule of Civil Procedure 12(b)(6) tests the sufficiency of a complaint’s factual allegations. Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009). A complaint must contain “a short and plain statement of the claim showing that the pleader is entitled to relief, ” in order to “give the defendant fair notice of what the ... claim is and the grounds upon which it rests.” Bell Atl. Corp. v. Twombly, 550 U.S. 544, 555 (2007) (internal quotation marks omitted) (interpreting Fed.R.Civ.P. 8(a)). Generally, a court considering a motion to dismiss pursuant to Federal Rule of Civil Procedure 12(b)(6) must determine whether the complaint contains sufficient factual matter, accepted as true, to “state a claim to relief that is plausible on its face.” Iqbal, 556 U.S. at 678.

Consistent with the Supreme Court’s rulings in Twombly and Iqbal, the Third Circuit requires district courts to engage in a two-part analysis when reviewing a Rule 12(b)(6) motion: (1) first, a court should separate the factual and legal elements of a claim, accepting well-pleaded factual matter and disregarding legal conclusions; (2) second, a court should determine whether the remaining well-pled facts sufficiently demonstrate that a plaintiff has a “plausible claim for relief.” Fowler v. UPMC Shadyside, 578 F.3d 203, 210-11 (3d Cir. 2009) (quoting Iqbal, 556 U.S. at 679). Facial plausibility exists when the plaintiff pleads factual content “that allows the court to draw a reasonable inference that the defendant is liable for the misconduct alleged.” Iqbal, 556 U.S. at 678 (internal citations omitted).

In conducting its analysis, a court must accept all well-pleaded factual allegations in the complaint as true for purposes of determining whether the complaint states a plausible claim for relief, and must view the factual allegations in the light most favorable to the plaintiff. Phillips v. Cnty. of Allegheny, 515 F.3d 224, 231 (3d Cir. 2008). In this regard, a court may also consider “documents incorporated into the complaint by reference, and matters of which a court may take judicial notice.” Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 322 (2007).

The court’s determination on a Rule 12(b)(6) review is not whether the non-moving party “will ultimately prevail, ” but whether that party is “entitled to offer evidence to support the claims.” United States ex rel. Wilkins v. United Health Grp., Inc., 659 F.3d 295, 302 (3d Cir. 2011) (internal citations omitted). The court’s analysis is a context-specific task requiring the court “to draw on its judicial experience and common sense.” Iqbal, 556 U.S. at 663-64.


A. Factual allegations

1. Expansion and March 2010 offering

Plaintiff’s complaint begins with Defendant Orrstown’s expansion into the commercial loan market in Hagerstown, Maryland in early 2005, during which Plaintiff alleges that Orrstown Bank Senior Vice President of Business Development Terry Reiber “aggressively developed lending relationships” in the Hagerstown, Maryland market. (Doc. No. 40 ¶¶ 73, 75.) Plaintiff’s complaint relies in part on information obtained from six confidential witnesses, all of whom had various relationships to Defendant Orrstown. (Id. ¶¶ 56-61.) Plaintiff alleges that Mr. Reiber influenced the Bank’s credit review and approval process in order to extend “large commercial loans to risky borrowers, ” many of whom ultimately defaulted. (Id. ¶ 76.) Plaintiff also alleges that the Bank’s credit and loan procedures in place at the time were flawed, in that the loan review officer did not have any formal training, and the credit analysts were often working with incomplete packets of information. (Id. ¶¶ 82-83.) Plaintiff singles out Mr. Reiber’s role in approving risky loans, alleging that he modified or independently prepared loan review packets. (Id. ¶ 84.) Relying on Confidential Witnesses #1 and #3, Plaintiff further alleges that the Bank’s Loan Review Committee “routinely” approved loans that failed to satisfy their purported credit standards. (Id. ¶ 87.) For example, according to Plaintiff, Confidential Witness #3 recalled that the Loan Review Committee would approve commercial loans that Terry Reiber generated based upon “frivolous exceptions” (id. ¶ 90), and that the Loan Review Committee lowered the debt service ratio in order to approve “very risky loans in the Hagerstown and Chambersburg markets” (id. ¶ 92). Citing the Bank’s commercial lending relationships with the Azadi and Shaool families, as well as its lending relationships with the Chambersburg Developers and Yorktown Funding, Plaintiff contends that the Bank was not acting in a prudent manner by virtue of lending money to these borrowers, who eventually defaulted on their loans. (Id. ¶¶ 109-33.)

Later, in November 2009, the Bank initiated an Internal Review in order to identify any potential weaknesses and deterioration in its loan portfolio. (Id. ¶ 99.) Plaintiff alleges that this internal review was “intended to portray to investors a false sense of assurance about the Bank’s internal controls and quality of the loan portfolio.” (Id. ¶ 101.) In support of this allegation, Plaintiff relies on information obtained from Confidential Witness #2, who stated that none of the members on the Internal Review team were “credit minded, ” meaning that the Internal Review suffered from structural bias. (Id. ¶¶ 102-05.)

Plaintiff alleges that despite these ongoing internal problems, Defendants nevertheless attempted to paint a picture of a “well-run, disciplined Company on the move” in the Offering Documents[2] related to the March 24, 2010 stock offering.[3] Plaintiff avers that the Bank made false and misleading statements relating to underwriting standards, credit review policies, internal controls, and loan loss reserves.[4] (Id. ¶¶ 165-67.)

Plaintiff additionally alleges that Defendants Quinn, Everly, and Embly made further false and misleading statements concerning the Bank’s credit practices during their “Road Show PowerPoint Presentation, ” which Defendants used to market the March 2010 Offering directly to investment managers and other financial advisors, as well as the investing public. (Id. ¶¶ 168-69.) Finally, Plaintiff alleges that the Offering Documents contained false and misleading statements regarding the quality of Defendant Orrstown and the Bank’s management.

2. Post-March 2010 offering

After the March 2010 Offering closed, Plaintiff alleges that the Bank “continued to issue false statements about the Company’s stringent credit procedures and misled investors about the reasons for the increase in provision for loan losses.” (Id. ¶ 170) According to Plaintiff, Defendant Orrstown made additional false and misleading statements at its annual shareholder meeting held on May 4, 2010, during which a slide show presentation was made. (Id. ¶ 239.) The meeting transcript and slide presentation were filed with the SEC as exhibits to a May 5, 2010 Form 8-K issued by Defendant Orrstown. (Id.) Plaintiff’s complaint highlights five statements made during that presentation (id. ¶¶ 239-42), which the Court will discuss later in this memorandum.

Plaintiff also alleges that Defendant Orrstown issued a false statement in a Form 8-K Press Release announcing its first quarter 2010 Operating Results. (Id. ¶ 244.) Those Operating Results indicated a $21 million increase in Risk Assets but only a $1.4 million increase in loan loss reserves from the end of the prior year. (Id.) According to Plaintiff, Defendants Orrstown and the Bank did not want to keep the additional $21 million of Risk Assets on Orrstown’s book for long, as doing so would unseat them from their purported position as a bank that was superior to their peers in comparable financial and banking metrics, in particular with respect to the percentage of non-performing assets to its total assets, in contrast to their statements to investors. (Id. ¶ 246.) Plaintiff alleges that Defendants Orrstown and the Bank formulated and implemented a scheme to defraud investors about the health and financial condition of Orrstown and to conceal and materially lower Orrstown’s Risk Assets, adopting a new eight point internal risk rating system, which gave the Bank discretion to use several different rating levels until it would ultimately have to move a troubled loan into the nonperforming category. (Id. ¶ 247.) Plaintiff alleges that as a consequence of this change, Defendant Orrstown no longer identified as “impaired” its “performing substandard loans.” (Id.) Plaintiff asserts that this change in policy was not disclosed until Orrstown filed its 2010 Form 10-K in March 2011, and was implemented to facilitate the Defendants’ concealment of, and their misleading investors about, the magnitude of impaired loans, in particular the Hagerstown-based and Azadi loans. (Id.)

Plaintiff next alleges that the Defendants’ filings for the second and third quarters of 2010 demonstrate significant decreases in Risk Assets and only slight increases in loan loss reserves upon implementation of this new risk rating system. (Id. ¶ 248.) Consequently, Plaintiff alleges that statements in Orrstown’s Form 8-K Press Releases for 2Q 2010 and 3Q 2010 were false and misleading (id. ¶¶ 249-50), which the Court will discuss in detail later in this memorandum.

Plaintiff alleges that Defendant Quinn continued to mislead investors about the true state of Orrstown’s financial condition when in November 2010 he spoke at the “2010 East Coast Financial Services Conference” hosted by Underwriter Defendant Sandler O’Neill & Partners L.P. (Id. ¶ 251.) Plaintiff also alleges that Defendant Quinn continued to make false and misleading statements when he spoke at two different investment conferences for investment managers and financial services providers in February and March 2011. (Id. ¶ 253.) Plaintiff further alleges that Defendant Quinn continued to falsely and misleadingly tout Orrstown’s success in a Press Release dated February 10, 2011. (Id. ¶ 254.) Orrstown’s false and misleading statements allegedly continued in its Form 10-K for the Year Ended 12/31/10, filed with the SEC on March 11, 2011. (Id. ¶ 255.)

Plaintiff alleges that by late 2010, the Loan Committee had approved in total over $21 million in loans to the Chambersburg Developers’ related entities from 2008 through late 2010. (Id. ¶ 256.) Plaintiff alleges that, according to Confidential Witness #3, Defendants Orrstown and the Bank realized that they may have gone over the Bank’s legal lending limit, and that in any event, the extension of credit to the Chambersburg Developers did not constitute “conservative lending” and represented an “unusual concentration[ ] of credit” in one group of borrowers. (Id.)

Further, Plaintiff alleges that, according to Confidential Witnesses #1, #2, and #3, at the time, Orrstown was restructuring many of its larger troubled loan relationships as part of its effort to obfuscate the true level of Risk Assets and needed provisions for loan loss reserves. (Id. ¶ 257.) Plaintiff alleges that in late 2010, Confidential Witness #4 entered into a series of “Change in Terms Agreements” on $1.6 million of prior loans, all of which had been originally brokered by Terry Reiber in 2007, 2008 and 2009. (Id.)

Plaintiff alleges that Orrstown’s reports of “significant growth” in 2010 – for example, growth touted by Quinn in a February 2011 press release (id. ¶ 254) – was accompanied by the increase over the year prior of Risk Assets, reaching a high-water mark in first quarter 2010 but declining in subsequent 2010 quarters when the Company applied the eight point internal risk rating system. (Id. ¶ 258.) Plaintiff avers that this “artificial” decline in Risk Assets and alleged “understatement” of loan loss reserves provided investors with financial data reassurance that the Bank was competently managing the credit risks in its portfolio, and failed to inform investors that the level of Risk Assets was due to the failure of the Bank’s internal controls and loan review process. (Id.)

Plaintiff alleges that unbeknownst to the Class, as early as July 2010, the Bank’s primary regulators -- the Federal Reserve Bank and the Commonwealth of Pennsylvania Department of Banking -- had put the Bank on notice that its management and banking practices raised material concerns. (Id. ¶ 260.) According to Plaintiff, the regulators commenced a Joint Examination of the Bank on March 31, 2011, to scrutinize the Bank’s management and internal controls. (Id.) Plaintiff alleges that subsequent to the initiation of the Joint Examination, the Bank’s Form 8-K announcing Operating Results for 2Q2011, followed by the Form 10-Q for 2Q2011, contained false or misleading statements. (Id. ¶ 262-63.)

Plaintiff alleges that after the market closed on October 26, 2011, Defendant Orrstown reported that the Federal Reserve Bank had refused to approve its declaration of a cash quarterly dividend for third quarter 2011. (Id. ¶¶ 266-67.) Plaintiff alleges that the Federal Reserve Bank only denies approval of a dividend if payment of the dividend represents an unsafe or unsound practice. (Id. ¶ 267.) Plaintiff alleges that Defendant Orrstown also filed a Form 8-K 3Q2011 Operating Results on that date, wherein it reported a “decrease[] in asset quality ratios, including elevated levels of nonaccrual loans, restructured loans and delinquencies.” (Id. ¶ 191.) Plaintiff alleges that on October 27, 2011, Defendant Orrstown filed another Form 8-K containing a letter from Defendant Quinn to Orrstown shareholders, in which he falsely and misleadingly stated that Orrstown remained “safe and sound.” (Id. ¶ 268.) Plaintiff alleges that the market “reacted swiftly to these two filings, and the share prices dropped to close at $9.20 per share.” (Id.)

Plaintiff further alleges that on January 26, 2012, the Bank issued a Press Release on 4Q2011 Operating Results, filed with the SEC on Form 8-K, indicating a quarterly net income loss and one-time non-cash goodwill impairment charge off of $19.4 million, as well as the continued suspension of the payment of a dividend. (Id. ¶ 271.) According to Plaintiff, Defendant Quinn falsely stated that the Bank had effective internal controls to address the “asset quality issues.” (Id.) Plaintiff alleges that the market reacted to the reported news of continued losses and ongoing suspension of a quarterly dividend, with Orrstown stock closing at $7.94 on January 26, 2012, representing a 14.5% drop from the closing price on October 27, 2011. (Id. ¶ 273.)

On March 15, 2012, the Bank filed its 2011 Annual Report, Form 10-K with the SEC, in which it allegedly conceded material weaknesses in its internal controls. (Id. ¶ 275.) Also included in the 2011 Annual Report was the “Report of Independent Registered Public Accounting Firm” by Defendant Smith Elliott Kearns & Company LLC (“SEK”) in which, for the first time, Defendant SEK recognized publicly that Orrstown’s internal controls were flawed. (Id.) Plaintiff alleges that despite the significant disclosures made in the 2011 Annual Report, the Bank continued to blame its level of Risk Assets solely on external factors, such as softness in the real estate market. (Id. ¶ 276.)

Plaintiff alleges that on or around Friday, March 30, 2012, Orrstown mailed to its shareholders and filed with the SEC additional proxy materials in which Orrstown admitted that the Bank faced “significant challenges in 2011" and the Bank’s systemic problems required Orrstown to “heed[ ] the advice and guidance of the governmental agencies that regulate” the Bank, and to “have begun the process of stress testing many aspects of the organization.” (Id. ¶ 280.) Plaintiff alleges that this statement was in direct contrast to the information Orrstown disclosed to the Exchange Act Class during the class period. (Id.) By April 5, 2012, Orrstown stock closed at $8.20. (Id.) As a result of the drop in Orrstown stock price, Plaintiff alleges that it suffered significant losses and damages. (Id. ¶ 281.)

Plaintiff alleges that following its Internal Review in late 2009, by early 2010 management could not ignore the new credit data gathered by the Internal Review for the Bank’s larger commercial lending relationships and the communications from large borrowers like the Azadis and Yorktown Funding of financial difficulties. (Id. ¶ 288.) However, Plaintiff alleges that the Defendants did not want to sabotage the planned March 2010 Offering by issuing financial statements revealing a weakened loan portfolio with sharply increasing Risk Assets and provisions for loan loss reserves. (Id.) Accordingly, Plaintiff alleges that the Defendants reached a compromise position in that they reclassified some of the impaired loans and made some of the requisite allocations for loan loss reserves in 4Q2009, but forestalled accounting for the other impaired loans until after the March 2010 Offering closed. (Id.) Plaintiff alleges that after the March 2010 Offering closed, the Defendants employed the eight point internal risk rating system to further forestall classifying loans as Risk Assets and making loan loss reserve allocations that would have negatively impacted Orrstown’s net income. (Id.) Plaintiff alleges that the regulators’ Joint Examination forced Orrstown to admit in its 2011 Annual Report that its internal controls were flawed. (Id. ¶ 290.)

3. Defendant Auditor Smith Elliott Kearns

Plaintiff also challenges Defendant SEK’s statements in connection with its role as auditor of Orrstown’s financial statements. Plaintiff alleges that during the class period, SEK issued unqualified or “clean” audit reports for the years ending December 31, 2009 and 2010 that incorrectly certified Orrstown and the Bank’s class period financial statements as being free of material misstatements and opined that the Company’s internal controls were effective and without any material weaknesses. (Id. ¶ 294.)

Plaintiff alleges that SEK affirmatively stated that it had conducted its 2009 and 2010 audits in accordance with Public Company Account Oversight Board (“PCAOB”) standards. (Id. ¶¶ 296, 301.) Accordingly, Plaintiff alleges that it was SEK’s responsibility to apply PCAOB standard AU Section 342[5] in evaluating the reasonableness of Orrstown’s loan loss reserves, which required SEK to “review and test the process used by management to develop the estimate, ” develop its own “independent expectation of the estimate” to cross-check management’s estimate, and “review subsequent events” that would have impacted the credit relationships for which loan loss reserves were being allocated. (Id.) Further, Plaintiff alleges that AU Section 342, as well as Financial Accounting Standards Board (“FASB”) Statement No. 5[6] and Auditing Standard No. 5 (“AS No. 5”)[7] required SEK to delve into the recent and historic credit data for each of the Bank’s loan relationships and integrate all relevant information coming from the Bank and regulators to thoroughly test management’s estimates. (Id.)

Plaintiff further alleges that if SEK performed its audit of Orrstown’s 2009 and 2010 10-K Annual Reports in accordance with PCAOB auditing standards, as it stated it did, it is implausible that SEK did not have actual knowledge that Orrstown and the Bank’s financial statements contained material understatements with respect to the classification of impaired loans and allocation of loan loss reserves, especially in light of the updated credit data gathered by the 2009 Internal Review. (Id. ¶¶ 298, 303.) Accordingly, Plaintiff alleges that SEK’s unqualified audit reports for the years 2009 and 2010 were materially false and misleading because SEK failed to apply the standards of the PCAOB. (Id. ¶¶ 299, 304.) Plaintiff alleges that under the PCAOB standards, a reasonable auditor would have exercised professional skepticism and discovered that the financial statements contained material understatements of Risk Assets and that there was a material weakness in Orrstown’s internal controls over the financial reporting of Risk Assets and loan loss reserve allocations such that the financial statements were not prepared in accordance with GAAP. (Id.)

With regard to Orrstown’s 201110-K Annual Report, Plaintiff alleges that SEK, while certifying compliance with GAAP, expressed an adverse opinion about Orrstown’s internal controls. (Id. ¶ 305.) As with the 2009 and 2010 annual reports, Plaintiff alleges that had SEK conducted its audit in accordance with the applicable standards, it must have been aware of Orrstown’s material understatements of its Risk Assets. (Id. ¶¶ 306-308.) Plaintiff alleges that the 2011 audit report was false and misleading. (Id. ¶ 309.)

Plaintiff alleges that as detailed previously, the Exchange Act Defendants made false and misleading statements and engaged in a course of conduct to deceive that artificially inflated the price of Orrstown stock, and operated as a fraud or deceit on the Exchange Act class by misrepresenting, throughout the class period, the quality of the Bank’s lending practices, loan portfolio and financial condition. (Id. ¶ 311.) Plaintiff further alleges that when these misrepresentations were revealed to the market, the price of Orrstown’s common stock fell precipitously as a result of the revelations (id.), and as a result, Plaintiff and the members of the Exchange Act class suffered damages. (Id. ¶ 312.)

Plaintiff alleges that during the class period, the Exchange Act Defendants had both the motive and opportunity to commit fraud (id. ¶ 313), and had actual knowledge of the misleading nature of the statements they made, or acted with reckless disregard for the true information known to them at that time. (Id. ¶ 314.) Plaintiff alleges that the Exchange Act Defendants benefitted from perpetuating the fraud of selling a “safe and sound” financial institution. (Id. ¶ 315.) Plaintiff alleges that Orrstown paid SEK fees for professional auditing services which SEK risked losing if it challenged management about its accounting irregularities. (Id.) Plaintiff further alleges that the Exchange Act Defendants financially benefitted by hiding the deteriorating condition of the Bank, as they received significant income and benefits in 2009 and 2010. (Id.) Specifically, Plaintiff alleges that once the regulators had imposed their supervision, Defendants Quinn, Everly and Embly were no longer able to receive bonuses, resulting in a drastic decrease in compensation for 2011. (Id. ¶ 316.) Plaintiff alleges that following the regulators’ intervention and requirement that the Bank “adopt and implement a plan, acceptable to the [regulators], to strengthen oversight of management and operations[, ]” and engage an independent consultant to evaluate the competency and effectiveness of management, with a report to be submitted to the regulators within 120 days of the execution of the enforcement actions taken on March 23, 2012, Defendants Embly and Everly resigned as employees and executives at Orrstown. (Id. ¶ 317.)

Plaintiff also alleges that Exchange Act Defendants Zullinger, Shoemaker, Snoke and Coy, directors of the Company who also sat at various times on the Loan Committee, Enterprise Risk Management Committee and possibly the Credit Administration Committee, also benefitted from misleading and deceiving the investing public about the true financial condition of Orrstown, through the receipt of compensation. (Id. ¶ 318.)

Plaintiff alleges that at all relevant times, the market for Orrstown stock was an efficient ...

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