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IN RE QUINTEL ENTERTAINMENT INC. SECURITIES LITIG.

October 25, 1999

IN RE QUINTEL ENTERTAINMENT INC. SECURITIES LITIGATION


The opinion of the court was delivered by: William C. Conner, Senior District Judge.

    This class action lawsuit is brought by plaintiffs on behalf of all persons or entities who purchased common stock of Quintel Entertainment ("Quintel") during the period July 15, 1997 through October 15, 1997 (the "Class Period"). The Consolidated and Amended Class Action Complaint ("Complaint") alleges violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. The Complaint also alleges that numerous individual defendants are liable pursuant to Section 20(a) of the Exchange Act. The action is currently before the Court on defendants' Motion to Dismiss pursuant to Rules 12(b)(6) and 9 (b) of the Federal Rules of Civil Procedure and the Private Securities Litigation Reform Act of 1995 (the "PSLRA").

BACKGROUND

These facts are drawn from plaintiffs' Complaint and are accepted as true for the purposes of the motion to dismiss. See In re AES Corp. Sec. Litig., 825 F. Supp. 578, 583 (S.D.N.Y. 1993).

Defendant Quintel is a corporation that, during the Class Period, was in the business of developing and marketing telephone entertainment services, consisting primarily of live conversation and pre-recorded horoscopes, tarot card readings and live psychic consultations. See Compl. ¶ 12. Quintel also provided voice mail services. ("VM Product").

Defendant Jeffrey L. Schwartz ("Schwartz") was Quintel's Chairman, Chief Executive Officer, and Secretary/Treasurer during the Class Period. Defendant Daniel Harvey ("Harvey") joined Quintel in September 1996 and became its Chief Financial Officer in January 1997. Defendant Jay Greenwald ("Greenwald") was President, Chief Operating Officer, and a director of Quintel during the Class Period. Defendant Claudia Newman Hirsch ("Hirsch") was Executive Vice President and a director of Quintel during the Class Period. Defendant Andrew Stollman ("Stollman") was Senior Vice President, Secretary and a director of Quintel during the Class Period. Defendants Greenwald, Hirsch, and Stollman received compensation based, in part, on Quintel's reported financial performance. Defendants Mark Gutterman ("Gutterman") and Michael G. Miller ("Miller") were directors of Quintel during the Class Period. Finally, Defendant Steven L. Feder ("Feder") was both a director and employee of Quintel during the Class Period. See Compl. ¶¶ 13-20. Defendants Schwartz, Harvey, Greenwald, Hirsch, Stollman, Gutterman, Feder and Miller are referred to herein as the "individual defendants."

Quintel's entertainment services, accessed by dialing "900" telephone numbers, allowed callers to receive live psychic or tarot card readings. These live services were billed at $3.99 to $4.99 per minute, with the first two to five minutes free to the customer. Quintel's live conversation "900" services accounted for about 76% and 67% of Quintel's net revenues for the fiscal years ending November 30, 1996 and 1997 respectively. See Compl. ¶ 37. Quintel billed and collected for the "900" number calls through the use of service bureaus and local and long distance companies. Quintel recognized the revenues from these calls at the time a customer made a billable call. These recognized revenues were net a provision for customer "chargebacks," which included refunds, credits and uncollectible amounts. The reserve for chargebacks was estimated based on chargeback history updated on a monthly basis. See Compl. ¶ 39.

Quintel entered into a marketing agreement with AT & T in 1996 (the "AT & T partnership"), whereby Quintel offered psychic products and subscription services as an incentive for customers to switch their long distance service to AT & T. See Compl. ¶ 44.

Three months prior to the Class Period, defendants issued a series of public statements regarding the growth and financial strength of Quintel. On April 14, 1997, Quintel, through Schwartz, reported first quarter fiscal 1997 revenues of $44,059,812, an increase of 175% over net revenues for the first quarter in 1996. Schwartz also reported net income of $5,435,397, or $0.29 per share, an increase of 26% over the comparable period in 1996. Schwartz attributed the increase in revenues to Quintel's diversification into the marketing of telecommunications products and services. These financial results were incorporated into Quintel's Form 10-Q filed on April 14, 1997 and signed by Schwartz and Harvey. See Compl. ¶¶ 45-9.

The April 14, 1997 Form 10-Q also stated that the provision for chargebacks as a percentage of gross revenues was reduced from 38% for the three months ended February 29, 1996 to about 25% for the three months ended February 28, 1997. This reduction was due to the decrease in chargebacks relating to the "900" entertainment services resulting from customer service modifications instituted by one of Quintel's service providers. See Form 10-Q, April 14, 1997.*fn1

During a meeting with analysts on April 21, 1997, Schwartz commented that Quintel's ability to convert a customer from an inquiry to a paid caller had improved as the result of improved technology in their billing system. Schwartz and Harvey also explained that the chargeback rate had been reduced because of the formation of two customer service centers dedicated to the 900 business. Schwartz also noted that Quintel's partnership with AT & T was "unique" and "the most exciting partnership that [AT & T] has entered into since they began their strategic marketing program." See Compl. ¶¶ 51-4.

Several business publications also quoted defendants as making optimistic statements about Quintel's growing success. See Compl. ¶¶ 56-9.

Immediately prior to the Class Period, Quintel's common stock was trading at an all time high of $14.625 per share on July 14, 1997. See Compl. ¶ 59.

Only July 15, 1997, Quintel's financial results for the second quarter of fiscal 1997 were set forth in its Form 10-Q, signed by defendants" Schwartz and Harvey, and in a press release on that same day. The Form 10-Q stated Quintel's partnership with AT & T accounted for 24% of the increase in the prior year's net revenues. See Compl. ¶ 61. Also, the provision for chargebacks as a percentage of gross revenues was down from 43% in the prior year's second quarter to 28% for the second quarter of fiscal 1997. See id.

Soon after the announcement of Quintel's favorable financial results, the individual defendants sold over 730,000 shares of the Quintel stock that they owned for a collective profit of about $10 million. See Compl. ¶¶ 13, 15-20, 64-5. Defendant Schwartz sold 165,000 shares during the Class Period and realized aggregate proceeds of over $2.3 million. Defendant Greenwald sold 135,000 shares of Quintel common stock and realized $1,890,000. Defendant Hirsch sold 90,000 shares during the Class Period for proceeds of $1,260,000. Defendant Stollman sold 50,000 shares of Quintel common stock and realized $700,000. Defendant Gutterman sold 10,000 shares of Quintel common stock during the Class Period, realizing $138,880. Defendant Miller sold 112,500 shares of Quintel common stock for proceeds of $1,576,210. Defendant Feder sold 54,500 shares and realized $758,020. These sales accounted for approximately 48.8% of Quintel's trading volume during the seven trading days from July 18, 1997 through July 28, 1997. The total of 730,000 shares sold by the individual defendants during the Class Period represented a 156% increase over the total insider sales for the 14-month period prior to the start of the Class Period.

On August 24, 1997, the Miami Herald published a news article stating that customers were being wrongfully induced to call Quintel's "900" numbers by false representations of free psychic readings. See Compl. ¶¶ 66-73. Complaints to state attorneys general were "pouring in" from all over the country.

In an October 7, 1997 press release, Quintel announced that its earnings for the third quarter of fiscal year 1997 would decline from both the second quarter of that year and the third quarter of fiscal year 1996. The decline in earnings was attributed to a higher incidence of customer chargebacks for its telecommunications entertainment programs. See Compl. ¶ 74. On October 8, 1997, Quintel shares fell 1 7/16 to 8 15/16. See Compl. ¶ 75.

On October 15, 1997, Quintel announced in a press release and its Form 10-Q the third quarter results for fiscal year 1997. Net income was $0.01 per share, as compared to $0.20 per share for the comparable period in 1996. Net revenues were $44,688,568, compared to $17,493, 179 in the third quarter of fiscal year 1996. Schwartz commented that: "During and subsequent to the third quarter we received information from our providers indicating a substantial increase in the rate of chargebacks, resulting in an under-reserve for prior periods and causing an increased chargeback rate for the current period." Compl. ¶ 76.

The October 15, 1997 press release also indicated that AT & T modified its contract with Quintel during the quarter ended August 31, 1997. AT & T's limitation of Quintel's marketing efforts led to reductions in revenue for the quarter.

Quintel filed its Form 10-Q for the third quarter of fiscal year 1997 with the Securities and Exchange Commission ("SEC") on October 16, 1997. The provision for chargebacks increased from 35% in the third fiscal quarter of 1996 to 44% in the comparable period of 1997. The third quarter Form 10-Q attributed the increase of the provision for chargebacks to information Quintel received during the quarter ending August 31, 1997 about a significant increase in the rate of "900" service chargebacks. See Compl. ¶ 79.

The third quarter Form 10-Q also commented upon AT & T's modification of its contract with Quintel, stating that the adjustment was "commenced in late July 1997."

On October 15, 1997, Quintel common stock was trading at $7.75 per share, or less than half of its Class Period high of $15.625 per share.

According to its Form 10-K for fiscal year ended November 30, 1997, Quintel used several companies to provide billing and collection services in connection with its telephone entertainment services and "900" numbers. One of these companies, West TeleServices Corporation ("West"), provided Quintel with reports that included the amount of money received for "900" calls in each month and the chargeback initially charged for each month. Quintel would then use this information to project eventual chargebacks within a given financial period. As of July ...


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