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WHITE v. H&R BLOCK

July 27, 2004.

PAUL WHITE, on behalf of himself and all others similarly situated, Plaintiff,
v.
H&R BLOCK, INC., et. al. Defendants.



The opinion of the court was delivered by: MICHAEL MUKASEY, Chief Judge, District

OPINION & ORDER

Plaintiffs represent a class of persons who purchased common stock of defendant H&R Block ("Block") between November 8, 1997 and November 6, 2002 ("the Class Period"). Plaintiffs have sued Block under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 ("Exchange Act"), claiming that Block concealed from investors 20 class action lawsuits relating to Block's Refund Anticipation Loan ("RAL") program. Block has moved to dismiss both claims. As explained below, because plaintiffs were on notice of the facts underlying their claim more than two years before they sued, their claims are time-barred and defendants' motion to dismiss is granted.

  I.

  The court appointed John L. Ross and Robert T. Ross as Lead Plaintiffs on January 21, 2003. They purchased shares of Block common stock during the Class Period. (Consolidated Amended Class Action Complaint ("Compl.") ¶ 16) Plaintiffs Paul White, Richard J. Rodney, Michael F. McCormack and Yuchong Smith also purchased shares of Block common stock during the Class Period. (Id.)

  Defendant Block is a Missouri corporation with its principal offices in Missouri. (Id. at ¶ 17) Defendant Mark A. Ernst has been Chief Executive Officer of Block since January 2001, President since September 1999, and a member of the board of directors since 1999. (Id. at ¶ 18) Ernst was Chief Operating Officer of Block from September 1998 through December 2000 and Executive Vice President from September 1998 until September 1999. (Id. at ¶ 18) Defendant Frank J. Cotroneo joined Block in 2000 and now serves as Block's Senior Vice President and Chief Financial Officer. (Id. at ¶ 19) Defendant Frank L. Salizzoni served as President of Block from June 1996 until September 1999, Chief Executive Officer from June 1996 through December 2000, and Chairman of the Board from September 2000 until September 2002. (Id. at ¶ 20) Defendant Matthew A. Engel is Block's Assistant Vice President and Chief Accounting Officer. (Id. at ¶ 21) Defendant Cheryl L. Givens is Block's Vice President and Corporate Controller. (Id. at ¶ 22) Defendant Ozzie Wenich served as Block's Senior Vice President and Chief Financial Officer from at least the beginning of the Class Period until 2000. (Id. at ¶ 23) Defendant Patrick D. Petrie was Block's Vice President and Corporate Controller from at least the beginning of the Class Period until 1998. (Id. at ¶ 24).

  Plaintiffs' claims arise under Sections 10(b) and 20(a) of the Exchange Act, 15 U.S.C. § 78j(b) and 78t(a), and Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated by the Securities and Exchange Commission ("SEC"). (Id. at ¶ 12) Federal question jurisdiction therefore is present pursuant to 15 U.S.C. § 78aa and 28 U.S.C. § 1331, and venue in this court is proper under 28 U.S.C. § 1391(b) because a substantial part of the events giving rise to the action occurred in this district. (Id. at ¶ 13)

  II.

  The following facts are drawn from plaintiffs' Consolidated Amended Class Action Complaint and related documents. All of the documents reviewed for the purposes of deciding defendants' motion to dismiss are well within the scope of this court's review on a dismissal motion as they were (i) incorporated into the complaint either by reference or through plaintiffs' reliance in making the allegations in the complaint, see Rothman v. Gregor, 220 F.3d 81, 88 (2d Cir. 2000) (the review of documents on a dismissal motion may encompass "any written instrument attached to [the complaint] as an exhibit or any statements or documents incorporated in it by reference . . . and documents that the plaintiffs either possessed or knew about and upon which they relied in bringing the suit") (citations omitted); I. Meyer Pincus & Associates, P.C. v. Oppenheimer & Co., 936 F.2d 759, 762 (2d Cir. 1991) (the review may include a pertinent document where "the complaint contains only `limited quotation' from that document"), or (ii) constitute "matters of which judicial notice may be taken under Fed.R.Evid. 201," Kramer v. Time Warner, Inc., 937 F.2d 767, 773 (2d Cir. 1991). Plaintiffs' well-pleaded allegations have been accepted as true for the purpose of this motion, see Leatherman v. Tarrant County Narcotics Intelligence and Coordination Unit, 507 U.S. 163, 164 (1993), and all reasonable inferences have been drawn in plaintiffs' favor, see Thomas v. City of New York, 143 F.3d 31, 37 (2d Cir. 1998) (internal quotation marks and citation omitted).

  Block's RAL program enabled customers who were owed a refund on their income taxes to take loans in the amount of their expected refunds. (Compl. ¶ 3) RAL customers could then use their anticipated refund sooner than if they had to wait for the refund from the government. (Id.) Some RAL customers began to sue Block beginning around 1992 for failing to disclose that Block had a 50% participation in the interest on these loans and that the bank which made the loans paid Block a fee for each loan. (Id. at ¶¶ 3, 5) These customers claimed that Block misled them into believing that they were receiving their actual refund rather than an interest-bearing loan and that Block's actions constituted Truth-in-Lending Act violations, usury, breach of contract, fraud, unfair and deceptive trade practices, negligent or intentional misrepresentation, R.I.C.O. violations, and breach of fiduciary duty. (Id.) During the Class Period, Block made numerous filings with the SEC, each of which was signed by one or more of defendants, and issued several press releases. (Id. at ¶¶ 35-67) Plaintiffs allege that defendants mentioned the RAL litigation specifically in three of Block's SEC filings and press releases. (Id. at ¶¶ 50, 54) Block discussed the RAL litigation in a press release issued May 2, 2000, stating that it had reserved $5 million for a pending settlement of class action lawsuits involving refund anticipation loans and that Block had not lost any of the lawsuits filed in the RAL litigation. (Id. at ¶ 50) Block again referred to the RAL litigation in its Form 10-K405 filed with the SEC July 28, 2000. (Id. at ¶¶ 51-54) Block reported its year-end financial results as of April 30, 2000 in the Form 10-K405 and incorporated by reference its Annual Report to Shareholders. (Id.) In Block's Annual Report, Block reported that it had "provided for the pending settlement of class action lawsuits involving refund anticipation loans," that there had not been "any final judgments rendered against it" in the RAL litigation, and that it admitted no wrongdoing in the settlement agreement. (Id. at ¶ 54) Finally, Block addressed the RAL litigation in a press release issued September 26, 2000, in which Block announced a nationwide settlement of the RAL litigation. (Id. at ¶ 56) Plaintiffs allege that beginning July 30, 2001, Block added a new section to its Form 10-K405 filing entitled "Legal Proceedings." (Id. at ¶ 60) Although Block did not refer expressly to the RAL litigation, the new section reported that Block was "involved in various litigation and claims as both defendant and plaintiff relating to matters which arise in the normal course of business which management believes will not have a material adverse effect on the Company's consolidated results of operations or financial position." (Id.) This new section appeared again in Block's Form 10-K405 filed July 29, 2002, and again did not expressly reference the RAL litigation. (Id. at ¶¶ 64-66) The language of the "Legal Proceedings" section in the 2002 Form 10-K405 was substantially the same as that in the 2001 Form 10-K405, but the 2002 Form 10-K405 also reported that the amounts claimed in the pending legal proceedings were "substantial in some instances" and that "the ultimate liability" was "difficult to predict." (Id. at ¶ 66)

  On November 1, 2002, Avalon Research Group, Inc. ("Avalon") released a report discussing two class action lawsuits filed against Block in Texas seeking damages of up to $2 billion. (Id. at ¶ 68) Trading on Block's stock was temporarily halted that day, and Block issued a press release in response to "market rumors regarding litigation" in which Block echoed the language of its 2001 and 2002 Forms 10-K405, stating that while the amounts claimed in the litigation were substantial and that ultimate liability was difficult to predict, management did not believe that any amounts that might be paid by Block would be material. (Id. at ¶ 69) Block also reported in that press release that it had not "lost any of the more than 20 class action lawsuits filed against it involving the refund anticipation loan program" and that it had "agreed to a settlement on a nationwide basis." (Id.) Block explained that the settlement involved a $25 million fund, of which Block would pay half, and that the settlement would be reviewed in a fairness hearing two weeks later. (Id.) Block further reported that the settlement was not material. (Id.) After trading in Block's stock resumed, the price of Block's shares dropped 8% by the close of trading on November 1, 2002. (Id. at ¶ 71) Block's stock then dropped 14% on November 7, 2002, the day after a Texas court informed Block that it intended to order Block to repay about $75 million in tax service fees to clients involved in the RAL litigation. (Id. at ¶ 72).

  Plaintiffs claim that Block's press releases and SEC filings during the Class Period were false and misleading because they "concealed the very existence of the RAL litigation." (Id. at ¶ 76) Plaintiffs concede that defendants did make some references to the RAL litigation, but they argue that defendants disclosed only "good news" about those actions. (Id.) Plaintiffs allege several specific facts that defendants failed to disclose during the Class Period: (1) that Block faced over 20 class action lawsuits; (2) the nature of the claims in these lawsuits; (3) Block's purported liability; (4) charges of excessive interest rates on the RAL loans that Block helped arrange; (5) that damages could reach $2 billion; (6) that some of these lawsuits were "successful" in a "number" of state and federal courts; and (7) that the settlement Block announced in its November 1, 2002 press release was "collusive," "that Block was not even a party to that settlement," and that the settlement had been rejected by the Court. (Id. at ¶¶ 76-77).

  Additionally, plaintiffs contend that Block's statements that it had not lost any of the RAL lawsuits and that there had been no final judgments against Block in any of the RAL lawsuits were misleading because Block failed to disclose that "most of those actions were ongoing, or that the plaintiffs in some of those actions had overcome motions to dismiss or that some had obtained class certification." (Id. at ¶ 77) Plaintiffs claim also that Block's financial statements filed during the Class Period failed to comply with Generally Accepted Accounting Principles ("GAAP"), and are therefore "presumptively misleading and inaccurate." (Id. at ¶¶ 78-79) Finally, plaintiffs claim that defendants understated Block's liabilities, thereby misrepresenting its financial stability, during the Class Period, by reserving only $5 million when Block should have reserved at least $1 billion for potential liability from the RAL litigation. (Id. at ¶ 84) According to plaintiffs, each individual defendant, by virtue of his position at Block, knew of all the facts alleged above and exercised power and influence to cause Block to make false and misleading statements during the Class Period. (Id. at ¶¶ 85, 98-100).

  III.

  Plaintiffs have brought two claims against defendants, the first under Section 10(b) of the Exchange Act and Rule 10b-5, and the second under Section 20(a) of the Exchange Act. (Id. at ¶¶ 1, 96, 98, 101) Defendants argue that both claims are time-barred under the limitations provision of the Sarbanes-Oxley Act, 28 U.S.C. § 1658, which states:
[A] private right of action that involves a claim of fraud, deceit, manipulation, or contrivance in contravention of a regulatory requirement concerning the securities laws . . . may be brought not later than the earlier of (1) 2 years after the discovery of the facts constituting the violation; or (2) 5 years after such violation.
Plaintiffs do not dispute that the limitations period set by the Sarbanes-Oxley Act applies to this action. However, they do dispute that their claims are time-barred, arguing that five years is the applicable period and that the Class Period extends five years prior to the date plaintiffs filed the first complaint in this case. Defendants, on the other hand, argue that the two-year limitations applies because plaintiffs should have discovered the facts surrounding the RAL litigation more than two years before filing this action.
  The two-year limitations period begins to run after a plaintiff has "notice of the facts, which in the exercise of reasonable diligence, would have led to actual knowledge." See LC Capital Partners, LP v. Frontier Insurance Group, Inc., 318 F.3d 148, 154 (2d Cir. 2003) (internal quotation marks omitted). This is often called "constructive notice" or "inquiry notice." Id. "Such circumstances are often analogized to `storm warnings.'" Id. (internal quotation marks omitted). The Court of Appeals has explained:
The duty of inquiry results in the imputation of knowledge of a fraud in two different ways, depending on whether the investor undertakes some inquiry. If the investor makes no inquiry once the duty arises, knowledge will be imputed as of the date the duty arose. However, if the investor makes some inquiry once the duty arises, we will impute knowledge of what an investor `in the exercise of reasonable diligence, should have discovered' concerning the fraud, and in such cases the limitations period begins to run from the date such inquiry should have revealed the fraud.
Id. (internal citations ...

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