Boca Raton Firefighters and Police Pension Fund v. DEVRY, Inc. et al
Filing
110
MEMORANDUM Opinion. Signed by the Honorable John F. Grady on 3/27/2013. Mailed notice(meg, )
10-7031.131-RSK
March 27, 2013
IN THE UNITED STATES DISTRICT COURT
FOR THE NORTHERN DISTRICT OF ILLINOIS
EASTERN DIVISION
BOCA RATON FIREFIGHTERS’ AND
POLICE PENSION FUND and WEST
PALM BEACH FIREFIGHTERS PENSION
FUND, individually and on behalf
of all others similarly situated,
Plaintiffs,
v.
DEVRY INC., DANIEL HAMBURGER, and
RICHARD M. GUNST,
Defendants.
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No. 10 C 7031
MEMORANDUM OPINION
Before the court is the defendants’ combined motion to strike
and to dismiss.
For the reasons explained below, we deny the
defendants’ motion to strike and grant their motion to dismiss.
BACKGROUND
We will assume that the reader is familiar with our earlier
decision dismissing Boca Raton Firefighters’ and Police Pension
Fund’s
(“Boca
Raton”)
amended
complaint.
See
Boca
Raton
Firefighters’ and Police Pension Fund v. Devry, Inc., No. 10 C
7031, 2012 WL 1030474 (N.D. Ill. Mar. 27, 2012).
overview of our decision will be helpful.
complaint
alleged
that
the
defendants
However, a brief
Boca Raton’s previous
—
DeVry,
Inc.,
Daniel
Hamburger (DeVry’s president and CEO), and Richard Gunst (DeVry’s
CFO) — made dozens of public statements that concealed DeVry’s
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“systematically predatory business model.”
Id. at *1.
Boca Raton
described five general categories of alleged wrongdoing: (1) highpressure recruiting tactics; (2) deceptive enrollment practices;
(3)
illegal
employment
recruiter
statistics;
compensation;
and
(5)
(4)
misleading
undisclosed
risks
graduate-
to
DeVry’s
eligibility to receive federal financial aid.
Id. at *3-10.
concluded
allege
that
Boca
Raton
had
failed
to
with
We
the
particularity required by the Private Securities Litigation Act of
1995 ("PSLRA") that the defendants’ statements were false.
see also 15 U.S.C. § 78u-4(b)-1.
Id.;
We observed that its recruiter-
compensation allegations were stronger than the other categories of
alleged wrongdoing, but concluded that those allegations were still
deficient: only one confidential witness (“CW”) supported the
relevant allegations with the detail that the PSLRA requires. See
Boca Raton, 2012 WL 1030474, *7 (“[W]e are reluctant to permit a
securities class action to proceed based on statements from a
single anonymous employee.”).
We also concluded that Boca Raton
had not alleged facts creating a “strong inference” that the
defendants had acted with the necessary state of mind.
*10-12; see also 15 U.S.C. § 78u-4(b)(2)(A).
See id. at
Once again, we
suggested — without deciding — that the inference of scienter was
stronger as it pertained to Boca Raton’s recruiter-compensation
allegations.
See Boca Raton, 2012 WL 1030474, *11 (“[I]f DeVry
paid recruiters ‘variable bonuses’ tied to enrollment, is it likely
- 3 -
that the defendants did not know that when they specifically told
investors otherwise?”) (emphasis in original).
Finally, we held
that Boca Raton had not adequately alleged that the defendants’
fraud had caused its losses.
See id. at *13-18.
According to Boca
Raton, the truth about DeVry’s “predatory business model” had
emerged in a series of partial disclosures during the summer of
2010, causing its stock price to drop.
See id. at *14.
We held
that the purported disclosures, which dealt largely with industrywide (not DeVry-specific) issues, did not reveal the defendants’
alleged fraud.
amend
its
See id. at *14-18.
complaint,
but
expressed
We gave Boca Raton leave to
skepticism
that
it
could
overcome the fundamental problems with its claims: “[g]iven our
conclusions about its loss-causation allegations, the Fund faces an
uphill battle. Indeed, the Fund has not identified any disclosure
even
touching
upon
recruiter
compensation,
the
complaint’s
strongest (although still deficient) allegations.” See id. at *19.
In
response
to
our
opinion,
Boca
Raton
substantially
overhauled the theory underlying its Rule 10b-5 claim.
Instead of
alleging a host of loosely related “predatory practices,” Boca
Raton’s
claims
are
compensation policies.
now
based
solely
on
DeVry’s
recruiter-
(See Second Am. Compl. ¶¶ 54-151.)
also articulated an entirely new loss-causation theory.
It has
It now
alleges that the truth about DeVry’s illegal recruiter-compensation
practices emerged in August 2011 — ten months after Boca Raton
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filed this lawsuit.
(See id. at ¶¶ 360-370.)
The defendants
contend that these changes do not correct the fundamental defects
with Boca Raton’s claims.
But before addressing the defendants’
motion to dismiss, we will briefly address their motion to strike.
In their opening brief, the defendants argued that Boca Raton
lacked standing to sue for public statements that the defendants
made after May 13, 2010, the date that it last purchased DeVry
stock.
(See Def.’s Mem. 19-20); see also Roots Partnership v.
Lands'
End,
Inc.,
965
F.2d
1411,
1420
(7th
Cir.
1992)
(“[P]ost-purchase statements cannot form the basis of Rule 10b-5
liability, because the statements could not have affected the price
at which plaintiff actually purchased.”).
On that basis, the
defendants moved to strike allegations based on those statements as
“immaterial.”
See Fed. R. Civ. P. 12(f).
In response to the
defendants’ motion, Boca Raton moved to amend its complaint to add
an additional plaintiff — West Palm Beach Firefighters’ Pension
Fund (“WPB”).
WPB last purchased DeVry stock on May 11, 2011,
which is the date of the last alleged misrepresentation in the
Second Amended Complaint.
(See Second Am. Compl. ¶ 336.)
The
defendants objected that the amendment was a stall tactic, not that
the proposed amendment would not cure the standing problem.
Defs.’ Opp’n to Pl.’s Mot. to Amend, Dkt. 92.)
(See
We overruled the
defendants’ objection and granted Boca Raton leave to file an
amendment to the complaint adding WPB as a plaintiff.
(See Am. to
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Second Am. Compl., Dkt. 96.)1
WPB clearly has standing to sue for
the defendants’ statements after May 13, 2010.
defendants’ motion to strike is denied.
Therefore, the
We turn now to their
motion to dismiss.
A.
Legal Standard
Count I of the Second Amended Complaint alleges that the
defendants violated Rule 10b-5. In order to prevail on this claim,
the Funds must establish the following: “(1) the defendant made a
false statement or omission (2) of material fact (3) with scienter
(4) in connection with the purchase or sale of securities (5) upon
which the plaintiff justifiably relied and (6) that the false
statement proximately caused the plaintiff damages.”
Makor Issues
& Rights, Ltd. v. Tellabs, Inc., 437 F.3d 588, 595 (7th Cir. 2006)
(rev’d on other grounds by Tellabs, Inc. v. Makor Issues & Rights,
Ltd.,
551
U.S.
308
(2007))
(hereinafter,
“Tellabs
I”).
The
defendants argue that the Funds still have not adequately alleged
facts supporting elements (1), (3), and (6).
(See Defs.’ Mem. at
18-19.) The Funds’ falsity and scienter allegations are subject to
the PSLRA’s “[e]xacting pleading requirements.”
Tellabs, 551 U.S.
at 313; see 15 U.S.C. § 78u-4(a)(1). We discuss those requirements
in greater detail below.
This heightened pleading standard does
1/
For the parties’ convenience and our own, we gave Boca Raton leave to
file a separate amendment to the complaint — rather than an entirely new
complaint — in order to preserve the Second Amended Complaint’s pagination.
References in this opinion to the “Second Amended Complaint” refer to that
complaint as amended to add WPB as a plaintiff. Going forward, we will refer to
the plaintiffs collectively as the “Funds” unless otherwise noted.
- 6 -
not
apply
to
the
Funds’
causation”) allegations.
Roebuck
&
Co.,
459
proximate
cause
(so-called
“loss
See, e.g., Ong ex rel. Ong v. Sears,
F.Supp.2d
729,
742-43
(N.D.
Ill.
2006)
(concluding that loss-causation allegations are governed by Fed. R.
Civ. P. 8(a)(2)) (collecting cases).
When assessing the Funds’
complaint we “must, as with any motion to dismiss for failure to
plead a claim on which relief can be granted, accept all factual
allegations in the complaint as true.”
B.
Tellabs, 551 U.S. at 322.
The Defendants’ Class-Period Statements
The
Funds
continue
to
assert
that
apparently
accurate
statements about DeVry’s enrollment and revenues are false because
they did not reveal the company’s allegedly illegal recruitercompensation practices.
(See Second Am. Compl. ¶¶ 152, 155-56,
162-63, 166-67, 175-76, 180-82, 185, 191-93, 201-02, 204-05, 21014, 216-17, 223, 227, 229, 231, 232, 237, 239, 241-42, 246, 252-53,
256-58, 261, 263, 266-67, 286, 289, 297, 299, 300, 302, 310-11,
314-15, 322-23, 328, and 332-33.)
We previously rejected similar
allegations and the Funds have not attempted to show that our
ruling was incorrect.
See Boca Raton, 2012 WL 1030474, *2; see
also In re Advanta Corp. Securities Litigation, 180 F.3d 525, 538
(3d Cir. 1999) (abrogated on other grounds by Tellabs, 551 U.S. at
325 as recognized in Institutional Investors Group v. Avaya, Inc.,
564 F.3d 242, 277 (3d Cir. 2009)) (“Factual recitations of past
earnings, so long as they are accurate, do not create liability
- 7 -
under Section 10(b).”).
This leaves (1) statements that DeVry
complied with recruiter-compensation regulations (see, e.g., Second
Am. Compl. ¶ 179), (2) statements addressing the impact of new
recruiter-compensation regulations (see, e.g., id. at ¶ 319), and
(3) statements attributing the company’s success to reasons other
than its allegedly illegal conduct (see, e.g., id. at ¶ 157).2
C.
Whether the Funds Have Sufficiently Pled That the Defendants’
Class-Period Statements Were False
The Funds’ complaint must “specify each statement alleged to
have been misleading, the reason or reasons why the statement is
misleading, and, if an allegation regarding the statement or
omission is made on information and belief, the complaint shall
state with particularity all facts on which that belief is formed.”
15 U.S.C. § 78u-4(b)(1).
to
allegations
including
This “particularity” requirement applies
outside
allegations
confidential witnesses.
the
based
plaintiff’s
upon
personal
counsel’s
knowledge,
interviews
with
See Taubenfeld v. Career Educ. Corp., No.
03 C 8884, 2005 WL 350339, *8 (N.D. Ill. Feb. 11, 2005).
Applying
this standard, we ask “whether the facts alleged are sufficient to
support a reasonable belief as to the misleading nature of the
statement or omission.”
Tellabs I, 437 F.3d at 595 (citation and
internal quotation marks omitted).
2/
We assumed in our earlier opinion that statements within this third
category were actionable, despite some disagreement in the case law. See Boca
Raton, 2012 WL 1030474, *2 n.5 (collecting cases). The defendants have not asked
us to revisit that issue, (see Defs.’ Mem. at 22), so we will not do so here.
- 8 -
The Funds have identified 26 confidential witnesses as the
source for their allegations about DeVry’s recruiter-compensation
practices.
(See
Second
Am.
Compl.
¶¶
21-49.)
They
have
sufficiently described where, when, and in what capacity these
witnesses worked while employed by DeVry.
(See id. at ¶¶ 21-49);
see also Tellabs I, 437 F.3d at 596; Boca Raton, 2012 WL 1030474,
*3.
In addition, the Funds have remedied the vagueness and
ambiguity that we identified in the previous complaint about the
sources for particular allegations.
1030474, *3-4.
Cf. Boca Raton, 2012 WL
The thrust of the parties’ dispute is whether the
CW’s statements support a reasonable belief that the defendants’
class-period statements were false.
1.
Higher Education
Regulations
Act
(“HEA”)
Recruiter-Compensation
The HEA prohibits schools from providing “any commission,
bonus, or other incentive payment based directly or indirectly on
success in securing enrollments or financial aid to any persons or
entities engaged in any student recruiting or admission activities
or in making decisions regarding the award of student financial
assistance.”
20 U.S.C.A. § 1094 (20).
In 1992, the Department of
Education (“DOE”) adopted “Safe Harbors” permitting, among other
things:
[t]he payment of fixed compensation, such as a fixed
annual salary or a fixed hourly wage, as long as that
compensation is not adjusted up or down more than twice
during any twelve month period, and any adjustment is not
based solely on the number of students recruited,
admitted, enrolled, or awarded financial aid. For this
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purpose, an increase in fixed compensation resulting from
a cost of living increase that is paid to all or
substantially all full-time employees is not considered
an adjustment.
34 C.F.R. § 668.14(b)(22)(ii)(A) (emphasis added). On May 26, 2009,
the DOE announced its intent to review its incentive compensation
regulations,
among
other
issues.
See
Negotiated
Rulemaking
Committees; Establishment, 74 Fed. Reg. 24,728-01 (May 26, 2009)
(stating that the DOE intended to convene a committee to evaluate
“[i]ncentive
compensation
paid
by
institutions
to
persons
or
entities engaged in student recruiting or admission activities”).
That
same
week,
DOE
Deputy
Undersecretary
Robert
Shireman
participated in a conference call with industry analysts.
Trans.
of
Conf.
Call,
dated
May
29,
2009,
See
available
at
h t t p : / / w w w 2 . e d . g o v / p o l i c y / h i g h e r e d
/reg/hearulemaking/2009/call-analysts.pdf.
During
that
call,
Shireman specified that the DOE was evaluating whether the Safe
Harbors should be revised or eliminated.
See id. at 5.
The DOE
ultimately announced proposed regulations on June 18, 2010 that, if
adopted, would eliminate the Safe Harbors altogether.
See Program
Integrity Issues, 75 Fed. Reg. 34806-01 (proposed June 18, 2010).
In support of the proposed change, the DOE observed that the “fixed
compensation” Safe Harbor had “led institutions to establish, on
paper, other factors that are purportedly used to evaluate student
recruiters other than the sheer numbers of students enrolled.
However, in practice, consideration of these factors has been
minimal at best, or otherwise indiscernible.”
See id. at 34817.
- 10 -
The DOE adopted the proposed amendments on October 29, 2010, which
took effect July 1, 2011, shortly before the end of the class
period.
a. Statements Indicating DeVry’s Compliance with
the pre-July 2011 Regulations
Illegal Bonuses and Other Perks.
In the previous complaint,
a person identified as CW 9 stated that he/she received between 40%
and 60% of his/her compensation in the form of a “variable bonus”
that was based on the number of students he/she enrolled. (See Am.
Compl., Dkt. 27,
¶ 169.)
He/she also received a salary, but “that
could only increase by a few percentage points each year.”
(Id.)
The Safe Harbor only applies to “fixed compensation,” so the
payment of a bonus based upon enrollment would be a clear HEA
violation.
See Boca Raton, 2012 WL 1030474, *7.
Moreover, the
existence of such bonuses would tend to suggest a company-wide
policy violating the HEA.
See id. (“[U]nlike some of the Fund’s
other allegations, we think it is reasonable to extrapolate DeVry’s
compensation policy from the experiences of ‘front line’ employees
.”).
But we were unwilling to find that Boca Raton had established
a false statement based upon statements from one confidential
witness.
See id.3
The Funds still have not identified any CW
corroborating CW 9's (now CW 6's) contention that he/she received
an illegal bonus.
(See Second Am. Compl. ¶ 74.)
CW 16 states that
3/
Other witnesses also discussed DeVry’s recruiter compensation policies,
but they did not do so with the particularity that the PSLRA requires. See Boca
Raton, 2012 WL 1030474, *7.
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he/she received “awards based on enrollment numbers, and that one
of those rewards came with a check for $1,500.”
(See id. at ¶ 92.)
But it is not clear — as it would have been if the Funds had
established the existence of an illegal bonus plan — that CW 16's
“award” indicates a company-wide practice.
CW 1 states that top
recruiters were awarded “trips and prizes” and that those in the
running
for
such
awards
were
identified
in
a
list
that
was
“communicated ‘nationally’ from the top down to all of the 90-plus
DeVry campuses.”
(See id. at ¶ 64.)
CW 16 and CW 1 may be
referring to the same awards program, but there are no allegations
making that connection.
These two uncorroborated statements are
insufficient to impugn the defendants’ class-period statements.4
Illegal Fixed Compensation.
The Funds also allege that DeVry
paid “fixed compensation” to its employees based “solely” on the
number of students that they enrolled.
The Funds’ CW’s indicate
that they received a base salary and a “variable” salary. (See id.
at ¶¶ 62-65, 69-72, 74-75, 77, 82, 85, 87-88, 90, 92-93, 94-95.)
The amount of the “variable” portion of their salary varied
4/
The Funds are on somewhat firmer ground when they allege that the
recruiters who enrolled the most students received a free trip to DeVry's "Pride"
convention and related benefits. (See Second Am. Compl. ¶¶ 64, 67-68.) However,
those stray allegations — barely a paragraph’s worth of material in the Funds’
156-page complaint — form no part of the Funds’ loss-causation theory. As we
discuss supra, the Funds argue that DeVry implicitly disclosed that its
recruiter-compensation practices were illegal when it announced in August 2011
that the new HEA regulations contributed to a decline in enrollments at some
DeVry schools. There is no allegation that DeVry ever stopped paying its top
recruiters’ expenses in connection with the “Pride” convention. So, there is not
even an arguable basis to conclude that the results that DeVry announced in
August 2011 implicitly revealed that DeVry had made such payments.
- 12 -
according to their “level,” with higher level recruiters eligible
to receive larger salaries.
(See id. at ¶¶ 71-72, 93, 100.)
Every
six months the employees were evaluated and if they met or exceeded
their enrollment quotas, they could receive 100% or more of their
“variable” salary.
(See, e.g., id. at ¶¶ 62, 70-71.)
If they
missed their enrollment targets, the “variable” portion of their
salaries decreased.
(See, e.g., id. at ¶¶ 62, 68-69, 79.)
These
adjustments were purportedly based upon a combination of enrollment
success and so-called “TEACH”5 criteria — non-enrollment factors
such as good behavior and timeliness.
id. at ¶ 79.)
(See id. at ¶ 58; see also
The Funds’ CW’s state that the TEACH factors were
pretextual: their variable salaries were based “solely” on the
number of students that they enrolled.
(See id. at ¶¶ 68, 73, 75,
83, 92, 98, 102, and 107.)
The
defendants
argue
that
we
should
disregard
these
allegations because they are not sufficiently “particularized.”
(Defs.’ Mem. at 25.)
We think that the defendants are setting the
PSLRA bar too high.
Several of the Funds’ CW’s provide concrete
details about how the compensation system worked in practice.
For
example, CW 11 states that he/she consistently received high TEACH
ratings when he/she met enrollment expectations.
Compl. ¶ 84.)
(See Second Am.
The one time that he/she missed the enrollment
5/
The Funds allege that “TEACH” stands for “Teamwork, Employee Focus,
Achieving, Continuously Improving, and Helping Students Achieve Their Goals.”
(See Second Am. Compl. ¶ 3 n.1.)
- 13 -
targets, his/her TEACH ratings fell significantly.
(See id.)
His/her TEACH ratings “went ‘right back up’ at the end of the next
session when CW 11 again hit her/his enrollment targets.”
(Id.)
This
other
is
consistent
recruiters.
with
the
experiences
of
several
(See id. at ¶¶ 68, 73, 75, 83, 92, 98, 102, and 107.)
We presume that these employees, some of whom worked for DeVry for
several
years,
have
evaluated and paid.
personal
knowledge
about
how
they
were
In addition, two management-level employees —
CW 24 (Director of Admissions) and CW 25 (Associate Director of
Admissions) — confirm that TEACH ratings were irrelevant. (See id.
at ¶¶ 47-48, 105, 107.)
Two CW’s state that they received TEACH
ratings that were not in line with their enrollment numbers.
CW 2
states that he/she received the “best possible scores” on the TEACH
criteria, but did not meet his/her enrollment targets and was fired
on that account.
(See id. at ¶ 64.)
CW 17 states that his/her
TEACH ratings “weren’t the greatest,” but nevertheless he/she
consistently
received
enrollment targets.
raises
because
(See id. at ¶ 94.)
he/she
met
or
exceeded
These statements suggest
that DeVry’s fixed-compensation practices were not formalized, but
they are consistent with the Funds’ general allegations that TEACH
ratings did not affect compensation.
We conclude that these
allegations are sufficiently clear and particularized to pass
muster under the PSLRA.
- 14 -
The
defendants
also
argue
that
the
allegations
do
not
establish a problem of sufficient magnitude to undermine their
statements about the company as a whole.
(See Defs.’ Mem. at 28.)
This was a significant problem with the previous complaint, which
relied heavily on loosely related anecdotes of misconduct.
Boca Raton, 2012 WL 1030474, *5.
See
However, the Funds’ recruiter-
compensation allegations are more concrete.
The Funds’ CW’s
describe a consistent practice across multiple campuses, and it
stands
to
reason
that
the
company’s
recruiters
—
and
the
individuals evaluating them — would know how DeVry’s recruitercompensation policy worked in practice. This inference is somewhat
weakened by the Funds’ belated attempt to limit their claims to
DeVry University, one of the several schools owned and operated by
DeVry, Inc.
(See Pls.’ Resp. at 3 n.5.)
And it could be, as the
defendants suggest, that the CW’s are mistaking correlation for
causation.
(See Defs.’ Reply at 8.)
But even under the PSLRA, the
Funds are not required to prove their claims at this stage of the
case.
We conclude that the Funds have sufficiently alleged that
the defendants’ class-period statements were false based upon
DeVry’s allegedly illegal fixed-compensation practices.
b. The Defendants’ Statements Regarding the New Incentive
Compensation Regulations
During
statements
the
class
about
the
period,
the
anticipated
defendants
impact
of
made
new
several
incentive-
compensation regulations. (See Second Am. Compl. ¶¶ 221, 303, 306,
- 15 -
318, 319, 330.)
On October 26, 2011 — three days before the DOE
announced that it would, in fact, eliminate the Safe Harbors —
Gunst and Hamburger participated in a conference call with analysts
and investors.
about
whether
(See id. at ¶¶ 303-308.)
enrollment
currently
In response to an inquiry
factored
into
recruiter
compensation, and whether that policy might have to change in
response to new regulations, Hamburger stated:
Well, thanks for asking that because that gives me a
great opportunity to clarify in case anybody thinks that
we pay a bonus or an incentive payment to our admissions
advisors. The answer is no, we don’t. We pay a base
salary. And we expect to continue to pay them a base
salary; I don’t think they’re going to work for free.
So no, we don’t — we do not pay incentives or bonuses.
And that’s one of the things I think is so unfortunate
about some of the reporting that’s out there — again,
based on anecdotes and stories and not based on facts.
The fact is that incentive compensation is already
banned, has been since 1992.
And so, no, we don’t — I mean, well, there could be
changes; we may need to make changes in our evaluation
processes, depending on the rules that are forthcoming,
but it won’t be like we’re going from a situation where
before, you were paying a commission and after, you’re
not, and you have to make this massive adjustment. That’s
not the case.
(Id. at ¶ 306; see also Q1 2011 DeVry Results Conf. Call, dated
October 26, 2010, attached as Ex. F to Saltpeter Decl., at 7.)
analyst then asked for further clarification:
Q: But can you clarify the change in the salary? Is it
all impacted or has been [sic] by success in signing up
students? Is that something that impacts the change in
salary?
The
- 16 -
A: Yes. We do a performance evaluation for admissions
advisors just like we do for any other employee. And just
like we do for any other employee, we look at the
effectiveness of that person in their job. And since a
recruiter’s job is to recruit, we certainly do take into
account, did they recruit any students? And that is a
consideration, which is compliant with the statute and
the regulations.
(Q1 2011 DeVry Results Conf. Call, dated October 26, 2010, at 8;
see also Second Am. Compl. ¶ 307 (emphasis added).)
Hamburger
sounded a similar note during a conference call with investors and
analysts on January 25, 2011, after the DOE had announced that it
was repealing the Safe Harbors effective July 2011:
Q: First question — how did your view for the second half
incorporate any changes that you may be making related to
the regulatory environment?
And can you give us an
update on your thoughts around compensation structures
for enrollment advisors?
A: Well, compensation structures for enrollment advisors
are a base salary. And I want to be very clear that DeVry
-- and when I say DeVry without University, that means
DeVry, all of DeVry -- DeVry pays a base salary. That
means all the schools of DeVry that are covered Title IV
employees . . . .
But DeVry schools, like we’re talking about here, pay a
base salary to enrollment advisors and financial aid
professionals. And so a lot of this talk about incentive
compensation is — there’s a lot of misunderstanding. A
lot of people think that suddenly incentive compensation
is banned, and that’s not the case. It’s been banned
since 1992. And so what the concern that many, many
schools have around the compensation regulations — and of
course, those apply to all schools, public sector,
private sector like DeVry or independent schools, for
that matter — is that it makes it very difficult to
manage and it treats your base salary as though it were
incentive compensation as well. So you can’t do
performance management of somebody even in their annual
performance review, directly or indirectly, based on how
they do their job. And we are very — many schools, all
- 17 -
schools, are concerned about the potential litigation
risk
that
that
could
create
for
colleges
and
universities.
So those are the things we are concerned about in that
area.
Q: So, are you planning for changes to your — recognizing
that you are only paying base salaries, are you planning
changes to the comp structure?
A: Nothing that you would be able to model or see. I
mean, there’s always management changes. There are things
that we’re looking at in our performance management
system. We will certainly do everything we need to do to
ensure that we are compliant, as we always strive to be,
with all rules and laws, but nothing that would be
significant or that would affect your model.
(Q2 2011 DeVry Results Conference Call, dated Jan. 25, 2011,
attached as Ex. H to Saltpeter Decl., at 8 (emphasis added).)
The Funds argue that these statements were misleading in two
respects.
First, as we just discussed, the plaintiffs’ CW’s
describe compensation practices that were not “compliant with the
statute and the regulations.”
dated October 26, 2010, at 8.)
(Q1 2011 DeVry Results Conf. Call,
So, the Funds have sufficiently
alleged that Hamburger made misleading statements about DeVry’s
compliance with the then-current regulations.
Second, the Funds
argue that Hamburger misled investors when he said that DeVry would
not be making “significant” changes to its “performance management
system.”
The
Funds’
CW’s
describe
a
system
of
incentive
compensation that was based “solely” on the number of students
enrolled.
So,
just
on
the
face
of
the
new
regulations,
- 18 -
“significant” changes would be required to make DeVry’s practices
compliant.
On that basis, we conclude that Hamburger’s statement
was misleading.
The Funds go further and allege that DeVry already had reason
to
believe
that
the
changes
would
negatively
impact
student
enrollment. Three CW’s state that DeVry first announced changes to
its compensation policy sometime in 2009, after the DOE announced
that it was reconsidering the Safe Harbors. (See Second Am. Compl.
¶ 111 (CW 1 stating that changes were first announced in June 2009,
to be “rolled out” in June 2010); see also id. at ¶ 112 (CW 4
stating that “at some point in 2009" DeVry “started to move away
from” its old compensation policy); ¶ 113 (CW 5 stating that he/she
“first heard about the possibility of” a new compensation policy
“at
the
end
of
2009").)
CW
5
describes
“pilot”
programs
implementing the changes in or around November 2010 at DeVry
locations in Sherman Oaks, California, Naperville, Illinois, and
Orlando, Florida.
(See id. at ¶ 115.)
He/she states that student
enrollment fell at the test locations, but provides concrete
information only about Orlando.
(See id. (CW 5 stating that under
the new policy enrollments at the Orlando campus fell from 6-7 per
advisor per session to 1-2 per advisor per session); see also id.
at ¶ 123 (CW 16 reporting second hand that “during the pilot
programs for the new compensation plan, enrollments were cut by
‘50%’”); ¶ 129 (CW 20 stating that enrollment decreased by “at
- 19 -
least” 30% during the pilot program).) But the Funds do not allege
that any of these CW’s worked in Orlando, Florida.
(See id. at ¶
28 (alleging that CW 5 worked at DeVry’s Naperville and Sherman
Oaks offices); ¶ 39 (alleging that CW 16 worked for “DeVry Online”
at an unspecified location and later moved to DeVry’s headquarters
in
Illinois);
Arizona).)
¶
43
(alleging
that
CW
20
worked
in
Phoenix,
CW 5 states that the information about Orlando was
“well known throughout DeVry,” (see id. at ¶ 115), but this is
conclusory.
Other witnesses describe declines in enrollment and
attribute them to DeVry’s new policy.
are
vague,6
and
others
describe
Some of these allegations
events
occurring
defendants made the challenged statements.
after
the
(See id. at ¶ 126
(describing events during the two-week session after April 2011),
¶ 128 (describing events after June 2011), ¶ 130 (after July 2011),
¶ 142 (after June 2011).)
Moreover, no CW provides reliable
information about the impact of the pilot programs on DeVry’s
overall
enrollment.7
In
sum,
we
conclude
that
the
Funds’
allegations about DeVry’s “pilot programs” are insufficient under
the PSLRA to demonstrate the falsity of the defendants’ classperiod statements.
6/
(See, e.g., id. at ¶¶ 134-137 (CW 23 describing the impact of the new
changes without identifying any time frame).)
7/
The Funds’ allegations that the new compensation policy caused
recruiters to leave DeVry suffer from the same problem. (See Second Am. Compl.
¶¶ 119, 127, 139, 143.) The CW’s statements are anecdotal and do not provide a
reliable basis for inferring a material, company-wide problem.
- 20 -
3.
Whether the Funds Have Sufficiently Pled Scienter
The PSLRA provides that,
in any private action arising under this chapter in which
the plaintiff may recover money damages only on proof
that the defendant acted with a particular state of mind,
the complaint shall, with respect to each act or omission
alleged to violate this chapter, state with particularity
facts giving rise to a strong inference that the
defendant acted with the required state of mind.
15 U.S.C.A. § 78u-4(b)(2)(A). “That ‘required state of mind’ is an
intent to deceive, demonstrated by knowledge of the statement’s
falsity or reckless disregard of a substantial risk that the
statement is false.”
Higginbotham v. Baxter Intern., Inc., 495
F.3d 753, 756 (7th Cir. 2007).
With respect to forward-looking
statements, the statute requires actual knowledge. See 15 U.S.C.A.
§ 78u-5(c)(1)(B).
The inference of scienter is “strong” if a
reasonable person would deem the inference “cogent” and “at least
as compelling as any opposing inference one could draw from the
facts alleged.”
Tellabs, 551 U.S. at 324.
We concluded in our
earlier opinion that Boca Raton had not satisfied this standard.
There was no evidence tying the individual defendants or any other
senior DeVry executive to the Fund’s “predatory business model”
allegations.
See Boca Raton, 2012 WL 1030474, *10-11.
And the
diffuse nature of the alleged fraud did not lend itself to the
inference that the company’s senior officers must have known what
was going on.
See id.
We suggested, however, that the Fund’s
- 21 -
allegation that DeVry paid illegal bonuses might support such an
inference. See id. (“[I]f DeVry paid recruiters ‘variable bonuses’
tied to enrollment, is it likely that the defendants did not know
that when they specifically told investors otherwise?”) (emphasis
in original).
The Funds still have not alleged facts tying senior DeVry
executives to their recruiter-compensation allegations. See id. at
*11 (“There are no allegations linking Hamburger, Gunst, or any
other senior DeVry executive to facts contradicting the company’s
statements about its recruiter-compensation policies.”).
CW 15
states that he/she participated in monthly conference calls about
“corporate-level and/or system-wide issues” led by David Pauldine,
DeVry’s Executive Vice President.
147.)
(Second Am. Compl. ¶¶ 25 n.3,
CW 15 states that Hamburger “sometimes” participated in
these calls, (id. at ¶ 147), but he/she does not describe what was
discussed. CW 5 states that Hamburger and Pauldine participated in
a meeting announcing the company’s new compensation policy.
id. at ¶ 117.)
(See
But CW 5 did not attend the meeting, and does not
provide even second-hand information about what was discussed.
He/she
merely
states
that
he/she
spoke
with
unidentified
“Directors” “who described how the new compensation policy was
- 22 -
‘supported by corporate.’” (Id.)
These vague allegations add
little to the overall analysis.8
The
primary
thrust
of
the
Funds’
argument
defendants must have known what was going on.
is
that
the
In asking us to draw
this inference, they rely heavily on our previous comments about
their illegal-bonus allegations.
*10-11.
See Boca Raton, 2012 WL 1030474,
As we discussed earlier in this opinion, the Funds have
been unable to adequately support those allegations.
We have held
that the Funds have adequately alleged falsity on other bases, see
supra, but those allegations do not lend themselves to a strong
inference that defendants must have known the truth.
The company
had an ostensibly HEA-compliant policy of “fixed compensation,”
(see, e.g., Second Am. Compl. ¶¶ 58, 68, 79-80), which tends to
support the inference that the defendants believed that their
class-period compliance statements were truthful. See Tellabs, 551
U.S. at 324 (directing courts to weigh competing inferences from
the alleged facts).
The CW’s state that the official policy was a
sham, but it is not clear how the individual defendants and other
senior executives would know that. Even if the defendants reviewed
recruiter evaluations — and there are no allegations that they did
8/
Similarly, we again conclude that the Funds’ motive allegations do
little to bolster the inference of scienter. Most of the relevant allegations
in the Second Amended Complaint are identical to the allegations that we
considered and rejected in our earlier decision.
See Boca Raton, 2012 WL
1030474, *12. With respect to the new alleged facts regarding stock sales by
Gunst, (see Second Am. Compl. ¶¶ 353, 356), the plaintiffs have not meaningfully
responded to the defendants’ arguments that they do not support a strong
inference of scienter. (See Pls.’ Resp. at 35.)
- 23 -
— an HEA violation would not be apparent on their face.
Harbor
gave
institutions
substantial
leeway
to
The Safe
base
fixed
compensation on enrollment success. The Funds’ CW’s emphasize that
the TEACH values were subjective and malleable, (see, e.g., Second
Am. Compl. ¶ 107), but this only underscores the fact that it was
difficult
to
identify
the
line
permissible fixed compensation.
between
permissible
and
non-
See Program Integrity Issues, 75
Fed. Reg. at 34817 (acknowledging this problem and citing it as a
reason for repealing the Safe Harbors).
The inference of scienter
is further undercut by the fact that the Funds’ CW’s do not allege
a uniform practice.
Some witnesses state that TEACH values were
“fixed” to correspond to enrollment success.
(See, e.g., Second
Am. Compl. ¶ 73.) Other witnesses indicate that TEACH ratings were
determined independently, but ignored.
(See id. at ¶¶ 64, 94.)
Institutional Investors Group v. Avaya, Inc., 564 F.3d 242 (3d Cir.
2009)
is
distinguishable.
In
that
case,
the
Third
Circuit
concluded that it was unlikely that the defendant was unaware that
his company had been awarding “massive” price discounts to its
customers when he specifically and repeatedly denied that this was
occurring.
Id. at 269-73.
The existence of “massive” price
discounts directly affecting the company’s bottom line is a readily
verifiable fact; company-wide compliance with a nebulous legal
standard (“not based solely on the number of students recruited”)
is not.
For the same reason, the fact that student enrollment is
- 24 -
important to DeVry’s business supports, at best, a very weak
inference that the defendants knew that the company was paying
illegal recruiter compensation.
See Boca Raton, 2012 WL 1030474,
*11; (cf. Pls.’ Resp. at 28-29).
The inferential leap from the
issue’s significance to the company to the particular fraud alleged
in this case is simply too great.
Arguably, Hamburger’s statements to analysts in connection
with the new regulations were misleading even if he believed that
DeVry was complying with the Safe Harbor.
In October 2010, he
stated that the company did not pay illegal bonuses in response to
a question about whether enrollment was a factor in recruiter
compensation. (See Q1 2011 DeVry Results Conf. Call, dated October
26, 2010, at 7.)
When pressed for clarification, he conceded that
student enrollment was a factor.
say
how
much
conference
quarter,
it
call
contributed
discussing
Hamburger
was
(See id. at 8.)
to
recruiter
DeVry’s
again
results
asked
how
But he did not
pay.
for
the
During
the
the
following
changes
to
recruiter-compensation regulations would affect the company.
the
(See
Q2 2011 DeVry Results Conference Call, dated Jan. 25, 2011, at 8.)
He
stated
that
the
company
was
considering
changes
to
its
recruiter-compensation policy, but that the changes were “nothing
that would be significant or that would affect your [the analyst’s]
model.”
(See id.)
student
enrollment
Hamburger’s comments seem to suggest that
played
only
a
small
role
in
recruiter
- 25 -
compensation, when in fact the Funds’ CW’s state that it played a
significant role even under DeVry’s official policy.
(See Second
Am. Compl. ¶ 68 (“CW 3 stated that the performance evaluation
system was split, with 60% of the performance measured by numbers
(leads, applications, starts) and 40% based on ‘soft skills.’”); ¶
79 (“CW 8 confirmed that performance reviews were based 60% on
achieving quotas and 40% on TEACH values, which included teamwork,
education, attitude, customer service, and willingness to help
students.”).)9
However, there are several factors undermining the
inference of scienter.
First, we have already held that the
plaintiffs’ allegations about DeVry’s unsuccessful “pilot” programs
are deficient.
See In re Career Educ. Corp., No. 03 C 8884, 2007
WL 1029092, *10 (N.D. Ill. Mar. 29, 2007) (insufficiently pled
allegations do not contribute to the inference of scienter).
So,
there are no reliable allegations suggesting that Hamburger knew
(or recklessly disregarded) facts indicating that the changes would
significantly impact DeVry’s bottom line.
Second, Hamburger made
all of the challenged statements months before the new regulations
went into effect in July 2011.
His last challenged statement on
this subject prior to the effective date of the new regulations was
more forthcoming:
9/
The defendants criticize the Funds for failing to provide us with a
“written recruiter compensation policy.”
(Defs.’ Reply at 5.) We would be
surprised, frankly, if the Funds could unearth such a document without the
benefit of discovery. In any event, we believe that the Funds’ CW’s are reliable
sources for the content of DeVry’s official compensation policy. (See infra.)
- 26 -
But we will be making some changes to our performancemanagement systems and processes in the areas that are
covered under the Title IV regulations. And that could
have some distractions for our folks. We do have people
working on changes, so that certainly could be one of the
factors that are included when I say [sic] internal
factors earlier. But to this point, I would [sic] see
that as a major driver, but it’s a factor. And we’ll
just have to see where we go in the future.
(See Q3 2011 DeVry Results Conf. Call, dated April 26, 2011,
attached as Ex. I to Saltpeter Decl., at 8-9.)
conclude
that
the
complaint’s
allegations
Ultimately, we
indicate
only
that
Hamburger’s comments about the new regulations were evasive, and
that is not enough.
See Plumbers and Pipefitters Local Union 719
Pension Fund v. Zimmer Holdings, Inc., 679 F.3d 952, 956 (7th Cir.
2012) (“The worst one could say about Zimmer’s answer is that it
was evasive, which is short of fraudulent.”).
D.
Whether the Funds Have Sufficiently Alleged Loss Causation
At the pleading stage, the plaintiff must “provide a defendant
with some indication of . . . the causal connection” between the
defendant’s misstatement or omission and the plaintiff’s loss.
Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336, 347 (2005). We
previously held that the Fund’s loss-causation allegations were
deficient because Boca Raton failed to adequately allege that the
truth about DeVry’s predatory practices ever emerged.
Raton, 2012 WL 1030474, *13-18.
See Boca
If DeVry’s alleged misconduct was
not revealed, the “truth” could not have caused DeVry’s stock price
to fall in August 2010. See id.; see also Transcontinental Indus.,
- 27 -
Ltd. v. PricewaterhouseCoopers, LLP, 475 F.3d 824, 842 (7th Cir.
2007) (affirming dismissal where the plaintiff did not sufficiently
allege that the market learned what the defendants had allegedly
concealed).
The Funds now allege that the truth about DeVry’s
illegal-compensation practices emerged in August 2011, when DeVry
announced that new undergraduate enrollment fell by 25.6% at DeVry
University.
(See Second Am. Compl. ¶ 338.)10
Among other factors
contributing to the decline, Hamburger cited the need to comply
with the new incentive-compensation regulations. (See Q4 2011 DeVry
Results Conf. Call, attached as Ex. S to Saltpeter Decl., at 2-3.)
Neither DeVry’s 10-K, nor Hamburger’s statements to investors
that same day, disclosed any violation of the HEA’s incentivecompensation rules.11
Instead, the Funds argue that the new
regulations caused DeVry to impose HEA-compliant policies “for the
first time,” (Second Am. Compl. ¶ 5), and therefore the impact of
the new regulations implicitly revealed the illegality of DeVry’s
practices under the old regulations.
In the abstract, we tend to
agree with the Funds that a plaintiff may comply with Dura without
alleging a disclosure explicitly revealing the defendant’s fraud.
(See Pls.’ Resp. at 39-40.)
But their disclosure theory in this
10/
Enrollment at some DeVry schools increased during the same period.
(See Press Release, dated Aug. 11, 2011, attached as Ex. A to Saltpeter Decl.,
at 1.)
11/
The Funds do not cite any other relevant disclosures — e.g., a DOE
investigation directly implicating DeVry — that would have disclosed the alleged
violations.
- 28 -
case is strained and inconsistent with Transcontinental.
The
plaintiffs in Transcontinental alleged that the defendant made
material misrepresentations in a 1997 audit statement that induced
the
plaintiff
to
purchase
stock
Transcontinental, 475 F.3d at 842.
fell
after
it
disclosed
in
Anicom,
Inc.
See
In 2000, Anicom’s stock price
misstatements
financial statements. Id. at 842–43.
in
its
1998
and
1999
Our Court of Appeals held
that Anicom’s revelations concerning its 1998 and 1999 financial
statements did not make the problems with the 1997 audit “generally
known.” Id. This was so despite the plaintiff’s argument that the
disclosed problems were part of the same “on-going scheme to
overrepresent revenue and that the 1998 audit relied in part on
historic information.”
Id. at 842.
The Funds’ theory in this case
— that DeVry’s violations of the old regulations are hidden within
the company’s revelations about the impact of the new regulations
— is substantially similar.
Transcontinental requires a more
direct relationship between the alleged fraud and the disclosure
revealing the fraud to the market. We conclude that the Funds have
not adequately alleged loss causation.
E.
The Fund’s Control Person Claim (Count II)
The Funds’ control-person claim must be dismissed because they
have
failed
violation.
to
adequately
See,
e.g.,
In
allege
re
a
primary
Allscripts,
securities
Inc.
law
Securities
Litigation, No. 00 C 6796, 2001 WL 743411, *12 (N.D. Ill. June 29,
- 29 -
2001) (“If a Complaint does not adequately allege an underlying
violation of the securities laws . . . the district court must
dismiss the section 20(a) claim.”).
F.
Dismissal is With Prejudice
Boca Raton filed this lawsuit before conducting a proper pre-
suit investigation. See Boca Raton, 2012 WL 1030474, *1. With the
defendants’ agreement, (see Joint Scheduling Stipulation, Dkt. 11),
we gave Boca Raton 60 days to file an amended complaint attempting
to comply with the PSLRA.
It “used that time to conduct an
investigation that it should have conducted before filing this
lawsuit.”
See Boca Raton, 2012 WL 1030474, *1.
However, its
amended complaint failed to properly allege any of the elements of
a Rule 10b-5 claim.
See id. at *3-18.
It then scrapped its theory
of the case to emphasize disclosures that the defendants made after
this lawsuit was filed.
The Funds have lost money on their
investments, but the securities laws do not insure against all such
losses.
See Dura, 544 U.S. at 347–48.
The way that the plaintiffs
and their attorneys have conducted this lawsuit — “shoot first, aim
later,” as the defendants aptly put it — indicates that insurance
is what they are seeking.
Under the circumstances, we do not
believe that a fourth opportunity to state a securities-fraud claim
is warranted.
G.
Sanctions
The Funds’ complaint is dismissed with prejudice.
- 30 -
Under the PSLRA, “upon final adjudication of the action, the
court shall include in the record specific findings regarding
compliance by each party and each attorney representing any party
with each requirement of Rule 11(b) of the Federal Rules of Civil
Procedure as to any complaint, responsive pleading, or dispositive
motion.”
15 U.S.C. § 78u-4(c)(1); see also City of Livonia
Employees' Retirement System and Local 295/Local 851 v. Boeing Co.,
— F.3d —, 2013 WL 1197791, *7-8 (7th Cir. Mar. 26, 2013) (slip
op.).
If the court concludes that there has been a Rule 11
violation, then it must impose sanctions on the party or attorney
who violated the rule.
Id. at § 78u-4(c)(2).
The defendants have
asked us to impose sanctions against the plaintiffs.
Mem. at 45-46.)
(See Defs.’
We will give the plaintiffs an opportunity to
address the defendants’ arguments before making our findings under
§ 78u-4(c)(1).
CONCLUSION
The defendants’ motion to dismiss and to strike [83] is
granted in part and denied in part.
denied.
The motion to strike is
The motion to dismiss is granted.
Amended Complaint is dismissed with prejudice.
The Funds’ Second
The Funds shall
file a memorandum addressing the defendants’ request for sanctions
by April 26, 2013. The defendants shall respond to the plaintiffs’
memorandum by May 17, 2013.
under advisement.
The court will then take the matter
- 31 -
DATE:
March 27, 2013
ENTER:
___________________________________________
John F. Grady, United States District Judge
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