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In re World Acceptance Corp. Derivative Litigation

United States District Court, D. South Carolina, Greenville Division

February 28, 2017

IN RE WORLD ACCEPTANCE CORPORATION DERIVATIVE LITIGATION This Document Relates To: ALL ACTIONS.

          MEMORANDUM OPINION AND ORDER GRANTING DEFENDANTS' MOTIONS TO DISMISS THE VERIFIED AMENDED CONSOLIDATED DERIVATIVE COMPLAINT

          MARY GEIGER LEWIS UNITED STATES DISTRICT JUDGE.

         I. INTRODUCTION

         Plaintiffs filed this case as a shareholder derivative action. The Court has jurisdiction over the matter under 28 U.S.C. §§ 1331 and 1367(a), as well as Section 26 of the Exchange Act, 15 U.S.C. § 78aa.

         Pending before the Court is Defendants James R. Gilreath, Charles D. Way, Ken R. Bramlett, Jr., Scott J. Vassalluzzo, and Darrell E. Whitaker's (Outside Director Defendants) Motion to Dismiss Plaintiffs' Verified Amended Consolidated Derivative Complaint (Amended Complaint) for failure to satisfy the heightened pleading requirements of Rule 23.1 of the Federal Rules of Civil Procedure. ECF No. 60. Defendants A. Alexander McLean III, John L. Calmes, Jr., Kelly M. Malson, Mark C. Roland (Individually Named Defendants, collectively, Defendants), and Nominal Defendant World Acceptance (World Acceptance or the Company) have filed a motion to dismiss in which they join Outside Director Defendants' Motion to Dismiss. ECF No. 61. Having carefully considered the motions, the response, the replies, the record, and the relevant law, it is the judgment of the Court Defendants' Motions to Dismiss will be granted.

         II. FACTUAL AND PROCEDRUAL HISTORY

         The following facts are taken from Plaintiffs' Amended Complaint, the documents incorporated by reference therein, and public filings of which the Court may take judicial notice. World Acceptance is a small-loan consumer finance business that specializes in sub-subprime lending, offering short-term installment loans to “consumers who have no other place to turn for financial help.” ECF No. 55 at 8. The Company's customers “by and large are low-income consumers with bad credit, little educational background, and very limited financial resources.” Id. at 25. The typical installment loan World Acceptance offers is between $300 and $4, 000 in value, and is payable in fully amortizing monthly installments with terms ranging from four to forty-two months. Id. at 124. World Acceptance has rapidly expanded over the past decade, and by the end of the 2014 fiscal year, the Company had a loan portfolio in excess of 956, 000 loans valued at more than $1.1 billion. Id.

         Although World Acceptance provides financing that is otherwise unavailable to these borrowers, Plaintiffs assert the financing “amounts to little more than a form of perpetual debt” as a result of exorbitant interest rates, unnecessary credit insurance products frequently forced on the consumer, and the Company's practice of encouraging customers to refinance, or “renew, ” existing loans. Id. at 8-9. Plaintiffs allege World Acceptance aggressively pushed customers to refinance their loans only two or three months into an existing loan, which created the perception the Company was experiencing rapid growth in loans and loan revenue and helped avoid delinquencies. Id. at 32. These “small-dollar loan renewals” occurred whenever a customer took out a “new” loan by refinancing a preexisting loan, at which point the Company marked the old loan as paid in full. Id. at 11. Plaintiffs avow Defendants made this calculated perception their “number one priority”; small-dollar loan renewals comprised as much as 75% of the Company's loan portfolio from January 30, 2013-July 15, 2015 (Relevant Period). Id. July 15, 2015, is the date Plaintiffs brought this lawsuit. ECF No. 1.

         The Company later admitted it had improperly accounted for such loan renewals in direct violation of Generally Accepted Accounting Principles (GAAP). ECF No. 55 at 11. GAAP allows an existing loan to be recapitalized into a “new” loan only if the borrower has repaid at least 10% of the principal. In those instances, the old loan may be recorded as extinguished and a new loan may be recorded in the lender's books. Id. In contrast, if a borrower has repaid less than 10% of the principal, the “new” loan must be accounted for as a “modification” of an existing loan-not as a “new” loan. Id. The crux of Plaintiffs' allegations are Defendants “failed to disclose, or recklessly disregarded, ” these faulty accounting practices, which “artificially inflated loan volume and growth during the Relevant Period.” Id. at 45.

         On January 30, 2013, Defendants announced the Company's 2013 third quarter financial results by filing a Form 8-K and a Form 10-Q with the SEC. Id. at 45, 48. The press release attached to the filing emphasized the Company's forty-eighth consecutive year-over-year quarterly increase in diluted earnings per share, which the Company attributed primarily to “the increase in average net loans and the associated growth in interest and fees.” Id. Total revenue increased by 10.1%: from $136 million during the third quarter of the prior year to $149.6 million in the third quarter of 2013, due to loan growth. Id. at 46. In a follow-up conference call, Defendant McLean, in responding to a question by a securities analyst, concluded, “I certainly don't believe the outlook for this Company is anything but positive.” Id. at 47.

         According to Plaintiffs' Amended Complaint, certain Defendants assured “the Company's accounting and reporting policies are in accordance with U.S. GAAP and conform to general practices within the finance company industry.” Id. at 49. Further, the Summary of Quarterly Results also noted:

An evaluation was carried out under the supervision and with the participation of the Company's management, including its CEO and CFO, of the effectiveness of the Company's disclosure controls and procedures as of December 31, 2012. Based on that evaluation, the Company's management, including the CEO and CFO, has concluded that the Company's disclosure controls and procedures are effective as of December 31, 2012.

Id. (internal quotation marks omitted). Defendants McLean and Malson signed certifications required by the Sarbanes-Oxley Act of 2002 (SOX) stating they had reviewed the Form 10-Q and it did “not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made in light of the circumstances under which such statements were made, not misleading with respect to the period covered by that report.” Id. (internal quotation marks omitted). The market reacted favorably to this report, and the stock price for World Acceptance rose from $75.31 to $77.55 the next day, and eventually up to $78.20 per share on February 8, 2013. Id. at 50.

         Following the release of the Form 8-K on January 30, 2013, certain Defendants began selling some of their World Acceptance stock over the course of the next two months. Id. Defendant Roland sold 7, 500 shares at $77.76 per share for total proceeds of $583, 193; Defendant Whitaker sold 1, 000 shares at $77.76 per share for total proceeds of $77, 370; Defendant Vassalluzzo sold or caused to be sold 34, 477 shares at $78.77 per share for total proceeds of $2, 715, 792; and Defendant and CEO McLean sold 25, 000 shares at prices ranging from $79.01 to $79.55 per share for total proceeds of $1, 978, 499. Id.

         On April 25, 2013, World Acceptance announced its fourth quarter and fiscal year 2013 financial results, which closely resembled the prior announcement, including continued growth in total revenue, average net loans, and loan volume. Id. at 52. During a conference call that same day, several analysts asked questions regarding the effects of state and federal regulation on the Company's refinancings. Id. When asked what percentage of new loans written were refinancings of prior outstanding loans, Defendant McLean responded, “If you base it on loan volume, 77% of our loan volume represents renewals of existing loans.” Id. at 54.

         Following the announcement on April 25, 2013, Defendants Roland and Vassalluzzo sold more stock. Id. at 55. On May 6 and May 8, 2013, Defendant Vassalluzzo sold 214, 218 shares of Company stock at prices ranging from $91.08 to $92.93 per share for total proceeds of $19, 863, 245; on May 22, 2013, Defendant Roland sold 1, 758 shares at $88.76 per share for total proceeds of $156, 044. Id.

         The Company released its fourth quarter and fiscal year 2013 financial results in its 2013 Form 10-K, initially filed with SEC on June 14, 2013, and amended July 19, 2013. Id. In its Form 10-K, World Acceptance claimed to adhere to stringent underwriting practices for its installment loans, and the Company admitted to “actively” marketing the opportunity for qualifying customers to refinance existing loans prior to maturity. Id. The Form 10-K reiterated the Company's adherence to GAAP and contained similar SOX certifications. Id. at 58. Both the fiscal 2013 Form 10-K and the 2013 amended Form 10-K were signed by, among others, Defendants McLean, Whitaker, Vassalluzzo, Way, Bramlett, and Gilreath. Id. at 59.

         Plaintiffs advance the truth about the Company's allegedly illicit lending practices began to emerge when World Acceptance filed Form NT 10-K/A with the SEC on July 3, 2013, disclosing “the Company was unable to file a completed Form 10-K for the fiscal year ended March 31, 2013, ‘because of unexpected delays' relating to the need for an ‘additional review and analysis' of the Company's allowance for loan losses.” Id. at 12. The Company disclosed it was “possible that the Company's amended Form 10-K [would] report a material weakness in its internal control over financial reporting relating to its process for determining its allowance for loan losses.” Id. (emphasis omitted). After these announcements, the Company's stock price fell more than 12% the next trading day. Id.

         On July 25, 2013, Defendant McLean, on behalf of World Acceptance, explained the Public Company Accounting Oversight Board (PCAOB), during an audit of the Company's independent auditor KPMG, discovered a “material weakness” in World Acceptance's accounting treatment of small-dollar loan renewals as a result of loans improperly being recorded as “renewals” instead of “modifications.” Id. at 64. Specifically, “it was determined that the Company did not have a control to assess less than 10% renewals and had difficulty proving that they did not materially affect the allowance.” Id. at 61. As Defendant McLean later admitted during an April 29, 2014, conference call, the Company “was not properly accounting for those loans with proceeds of less than 10%.” Id. at 35.

         Despite the amended 10-K and admitted material weakness, Defendant McLean, during his conference call with analysts, said, “I do not believe that it will represent a material impact on our operations or results.” Id. at 62. Defendant McLean confirmed to analysts the Company already possessed the data necessary for proper accounting, and provided further assurances “this situation is well under control.” Id. at 64.

         Although the Company's share price fell 4.3%, Plaintiffs claim the drop would have been much greater had Defendants not (a) downplayed numerous analysts' inquiries, (b) falsely reassured shareholders the “material weakness” would not have a significant impact on the overall operations of the Company moving forward, and (c) not simultaneously disclosed generally positive news regarding the Company's “record financial results” for the first quarter of fiscal year 2014. Id. at 70.

         On August 14, 2013, after the stock price had begun to recover from the Company's announcement regarding its internal accounting controls, Defendant Way sold 6, 000 shares of World Acceptance stock at $86.54 per share for total proceeds of $519, 240; on August 20, 2013, Defendant Bramlett sold 3, 000 shares at $88.41 per share for total proceeds of $265, 230. Id. at 68. On September 10, 2013, the Company announced its Chief Financial Officer and Senior Vice President, Defendant Malson, would retire. Id. at 19. On November 4, 2013, the Company announced its Chief Operating Officer and President, Defendant Roland, was resigning for “personal reasons.” Id. According to Plaintiffs, this pattern of reporting loan and revenue growth, continuing inflation of the Company's stock price, and subsequent selling of stock by Defendants continued through the second and third quarters of fiscal year 2014. Id. at 68-75.

         On March 12, 2014, the Consumer Financial Protection Bureau (CFPB) served World Acceptance with a Civil Investigative Demand (CID) related to the Company's lending practices. Id. at 43. The Company publicly disclosed this event by filing a Form 8-K with the SEC. Id. According to the Form 8-K, the CID stated the CFPB was investigating:

(i) to determine whether finance companies or other unnamed persons have been or are engaging in unlawful acts or practices in connection with marketing, offering, or extension of credit in violation of Sections 1031 and 1036 of the Consumer Financial Protection Act, 12 U.S.C. §§ 5531, 5536, the Truth in Lending Act, 15 U.S.C. §§ 1601. et seq., Regulation Z, 12 C.F.R. pt. 1026, or any other Federal consumer financial law and (ii) to determine whether Bureau action to obtain legal or equitable relief would be in the public interest.

Id. Following this disclosure, the Company's stock fell almost 20%. Id.

         On April 29, 2014, Plaintiffs aver Defendants caused the Company to issue World Acceptance's fourth quarter 2014 financial results, which were filed with the SEC in Form 8-K. Id. at 76, 79. World Acceptance announced in the Form 8-K it had made some “system changes that ensured customers were not encouraged to refinance existing loans where the proceeds from the transaction were less than 10% of the loan being refinanced.” Id. at 77. The Company acknowledged “this resulted in a decrease in our loan volume and had an impact on our balances outstanding and our overall yields.” Id. Following the announcement of the “system changes, ” the Company experienced its lowest quarterly growth in nine years. Id. at 78.

         Defendants incorporated the Company's fourth quarter and full year financial results into its fiscal 2014 Form 10-K, which was filed with the SEC on June 12, 2014. Id. at 79. The 2014 Form 10-K contained “substantially similar statements as those in the Company's fiscal 2013 Form 10-K, ” including similar SOX certifications and an emphasis on adhering to GAAP. Id. The “system changes” had a significant, negative impact on the Company's shareholders. When an analyst inquired as to the percent of originations that came from sub-10% renewals before and after the changes were implemented, Defendant McLean responded, “It's dropped down to the 7% or 8% range from the 20% range that we announced last year. So it's dropped down dramatically.” Id. Regarding the ongoing CFPB investigation, the Company stated in the Form 10-K,

While the Company believes its marketing and lending practices are lawful, there can be no assurance that CFPB's ongoing investigation or future exercise of its enforcement, regulatory, discretionary, or other powers will not result in findings or alleged violations of federal consumer financial protection laws that could lead to enforcement actions, proceedings, or litigation and the imposition of damages, fines, penalties, restitution, other monetary liabilities, sanctions, settlements, or changes to the Company's business practices or operations that could have a material adverse effect on the Company's business, financial condition or results of ...

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