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In re EVCI Colleges Holding Corp. Securities Litigation

December 13, 2006

IN RE EVCI COLLEGES HOLDING CORP. SECURITIES LITIGATION


The opinion of the court was delivered by: McMahon, J.

DECISION AND ORDER DENYING MOTION TO DISMISS CONSOLIDATED AMENDED CLASS ACTION COMPLAINT

The passage of the Private Securities Litigation Reform Act ("PSLRA"), 15 U.S.C.§ 78u-4(b) -- a statute designed to eliminate proven abuses of the securities class action process -- has led to some tension between that Act and the ordinary rules applicable to motions to dismiss federal complaints. The PSLRA imposes heightened pleading standards on plaintiffs in securities class action suits. If read too literally, the statute would appear to impose on a securities plaintiff the almost insuperable burden of having to file a complaint that is as comprehensive as his closing argument after trial.

This tension is front and center in the instant motion to dismiss plaintiffs' amended complaint. The defendants -- EVCI Colleges Holding Corp. and three of its former officers/employees -- contend that plaintiffs have failed to meet the heightened pleading requirements of Fed. R. Civ. P. 9(b) and the PSLRA, despite filing a 203 paragraph amended complaint that lays out extensive information about (1) a scathing New York State Education Department ("SED") report, which revealed highly questionable admissions practices at EVCI; and (2) the results of counsel's private investigation, using confidential informants who, by virtue of their positions with EVCI, had reason to be able to confirm the abuses identified by the SED. Defendants also argue that plaintiffs have not sufficiently pled the scienter required to make out a securities fraud violation by the individual defendants.

Plaintiffs counter that they have more than met their burden at the pleading stage on both counts.

The PSLRA's effort to weed out strike suits was well-intentioned. Unfortunately, the statute does not protect courts from the defense equivalent -- a "strike" motion to dismiss that is utterly lacking in merit. If ever a complaint was well-pleaded under the PSLRA, this one is; if ever a motion to dismiss was utterly lacking in merit, it is this one.

The motion is denied.

Standard for Determining the Motion

Even under the PSLRA, the usual rules for determining motions to dismiss pertain: the well-pleaded allegations of the complaint are deemed true and all inferences are drawn in favor of the pleader. The court is not to weigh the merits of the case on a motion to dismiss or to engage in fact-finding. "While Congress has acted to discourage the filing of strike suits, nothing Congress has done suggests that the general principles of a motion to dismiss are no longer applicable in securities fraud cases." In re Independent Energy Holdings PLC Securities Litigation, 154 F. Supp. 2d 741, 747-48 (S.D.N.Y. 2001)(abrogated on other grounds by In re Initial Public Offering Sec. Litig., 241 F. Supp. 2d 281 (S.D.N.Y. 2003). "Even under the enhanced pleading standards for Rule 10(b) claims set forth by the PSLRA, the standard for granting a motion to dismiss . . . for lack of a claim upon which relief may be granted is still high." Babaev v. Grossman, 312 F. Supp. 2d 407, 410 (E.D.N.Y. 2004).

The gloss imposed by the PSLRA involves what allegations can be deemed "well pleaded." In addition to the long-standing requirements of Fed. R. Civ. P. 9(b) which requires the plaintiffs to state "the circumstances constituting fraud.....with particularity," the PSLRA requires them to "state with particularity all facts on which [information and belief that defendants have violated Rule 10(b)(5)] is formed." 15 U.S.C. § 78u-4(b)(1). The Second Circuit has ruled that the word "all" as used in the PSLRA means that plaintiffs must plead "sufficient" facts to support a reasonable belief as to the misleading nature of defendants' statements or omissions. Novak v. Kasaks, 216 F. 3d 300 (2d Cir. 2000).

The Allegations of the Amended Complaint

The issue raised on this motion is whether plaintiffs have pleaded "sufficient" facts to support their asserted belief that there was pervasive fraud in the admissions process at EVCI's Interboro College -- the institution that generated nearly all of EVCI's revenue during the asserted class period (August 2003 through December 2005). Defendants, parsing each individual allegation, urges the court to find that none of them, taken individually, is sufficiently supported by a factual underpinning. Plaintiffs, viewing the complaint as a whole, argue that the big picture includes sufficient factual allegations to warrant denial of the motion at the pre-discovery stage.

Here, in a nutshell, is what the amended complaint pleads:

EVCI is a holding company. Organized in 1997 and public since 1999, EVCI provides on-campus career two year college education through three subsidiaries: Interboro, Technical Career Institutes, Inc., and Pennsylvania School of Business, Inc. Its principal asset is Interboro, which generates the bulk of EVCI's revenue. That revenue has grown substantially, from $8.6 million in 2000 to $50.4 million in 2005.

Dr. Arol Buntzman was a founder of EVCI and has chaired its Board of Directors since the school's inception. He served as EVCI's Chief Executive Officer from March 1998 until December 2002.

Dr. John McGrath, another founder of EVCI, has served as President of the corporation since its inception and since January 1, 2003 has been its Chief Executive Officer. He sits on the corporation's Board.

Richard Goldenberg is a director of EVCI and served as its Chief Financial Officer between March 1997 and October 2005.

Interboro is a two year college. It was conditionally accredited by the New York State Board of Regents on June 9, 2003. EVCI purchased Interboro on January 14, 2000. Interboro's students are primarily minority students from economically disadvantaged backgrounds; 85% or more lack a high school diploma or GED. They are able to attend a college only by passing a federally approved ability-to-benefit ("ATB") examination, and by obtaining financial assistance through federal and state grants: Pell grants and New York State Tuition Assistance Program ("TAP") grants. Interboro's student body consists of a higher percentage of ATB students than almost all other colleges or universities whose students receive Pell and TAP grants, and Interboro does not charge tuition in excess of the amount received from those grants. In other words, Interboro's revenues derive in substantial part -- 94%, to be precise -- from publicly funded education grants awarded to students who are both poor and poorly prepared for higher education. And EVCI, in turn, derives nearly all its revenue from Interboro.

As a commercial college that admits nearly all its students through ATB entry tests, Interboro is subject to strict regulation and intense scrutiny from state and federal regulators. In particular, accreditation is a prerequisite for participation in the Pell and TAP grant programs that give EVCI the bulk of its revenue. Throughout the Class Period, Interboro's accreditation was "conditional," and was dependent on, among other things, Interboro's ability to (1) increase its ability to retain students, not just enroll them; (2) attain a graduation rate of at least 25% for classes entering in the fall of 2001, and increasing thereafter; (3) address issues surrounding teaching load and class size; and (4) provide appropriate print collection at the library facilities at all Interboro locations. Interboro was required to provide an updated and revised "institutional effectiveness plan" by January 30, 2004, and to submit a mid-point accreditation self-study in the spring of 2006. Interboro also had to comply with standard minimum level of quality required by the State to obtain and maintain institutional accreditation. And the ATB testing process was highly regulated; federal regulations required that the tests be administered by professionally-trained independent test administrators who are not students or former students. Test procedures also had to be secure so that test results would not be compromised.

Interboro also needed state approval to open sites as extension centers (satellite sites enrolling 35 students or more). Without extension centers, enrollment possibilities were limited. Since Interboro's (and by extension EVCI's) income was directly proportional to the amount the school received from the Pell and TAP programs, more students meant more money. Interboro had extension sites approved in Flushing (2001) and Washington Heights (2003).

Defendants were aware, throughout the class period, that Interboro's failure to comply with the state and federal regulations governing Interboro's operations would subject EVCI to adverse consequences, including limits on growth and a denial of re-accreditation. EVCI disclosed as much in its Form 10-KSB for March 23, 2005.

Throughout the class period, EVCI reported to the investing public that Interboro's enrollments were increasing at a significant rate and that the company's revenues were increasing dramatically as well. As reported by EVCI, enrollments and revenues increased between 15 and 85 percent every quarter compared to the previous year's corresponding quarter. Defendants attributed this growth to "carefully developed strategies....designed to meet the unique needs of economically disadvantaged students" and to Interboro's "greater retention of existing students." (Cplt. ¶ 41)

As a condition for obtaining approval for the Washington Heights extension site, Interboro agreed to implement additional screening mechanisms for applicants that were specifically designed to enhance quality control and lead to a lower percentage of admitted students. Interboro acknowledges that this would have "significant budgeting, planning, scheduling and revenue implications for the college."(¶ 59). Although the agreement referred to a lower "percentage" of admitted students, the State's emphasis on quality control necessarily meant that this new screening mechanism would lead to a lower "number" of students -- an expectation driven home by the SED's insistence that, "We expect this reduction in admitted students to continue until the Institution's graduation rate reaches 25 percent and remains at that percentage for two years or higher. (¶ 58).

In September 2004, Interboro applied for extension center status for its Yonkers location. The SED responded by noting that Interboro had been operating Yonkers as an extension center before the application was submitted, in violation of state law and contrary to Interboro's representations -- a defalcation to which Interboro quickly admitted. (¶ 63). The SED also questioned certain discrepancies and deficiencies in Interboro's submissions regarding enrollments, retention and performance data. In a letter dated December 6, 2004, the SED notified Interboro's President, Stephen Adolphus, that the state would not approve Yonkers as an extension center if it concluded that Interboro did not have the capacity to expand.

In an initial assessment of Interboro's facilities dated June 15, 2005, the SED concluded that Interboro did not have the capacity to expand, the SED found inadequate library facilities at Yonkers, Washington Heights and the main campus in Manhattan, and generally inadequate facilities in Washington Heights. The SED also noted that Interboro's "persistence" (i.e., student retention) "is not improving, but is getting worse." The SED concluded its letter evaluation with the following words: "Given the current deficiencies, the State Education Department will not approve Yonkers as an extension center . . . the Institute is overextended in its ability to effectively serve the students it enrolls. However, the Department will be open to entering into conversations with the Institute with respect to agreeing upon an appropriate number of students that the Institute can serve given the educational needs of the students and the state of the facilities and services currently available." (¶ 65). However, the SED did not take immediate steps to close down the illegally-opened and inadequately-maintained extension center.

EVCI did not disclose that, based on the SED's December 2004 threat and its adverse findings, Yonkers had not been approved as an extension site. Instead, EVCI represented that the SED "may" withhold approval of Yonkers.

The following month, on October 7, 2005, Interboro received a Draft Report from the SED. The Report chronicled fraudulent practices with respect to Interboro's admissions and financial aid processes. Using undercover operatives posing as potential applicants, the State found that one apparent applicant was encouraged to lie about his income in order to qualify for financial aid; at least three investigators who had purposely failed the ATB test, were told that they had passed and that Interboro had changed their ...


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