United States District Court, S.D. New York
IN RE ITT EDUCATIONAL SERVICES, INC. SECURITIES LITIGATION
[Copyrighted Material Omitted]
For ITT Institutional Investor Group, Lead Plaintiff: Carol V. Gilden, LEAD ATTORNEY, PRO HAC VICE, Cohen Milstein Sellers & Toll PLLC (IL), Chicago, IL; Elizabeth Anne Aniskevich, LEAD ATTORNEY, PRO HAC VICE, Cohen Milstein Sellers & Toll, PLLC, Washinton, DC; Stephen Douglas Bunch, LEAD ATTORNEY, Cohen Milstein Sellers & Toll PLLC (DC), Washington, DC; Kenneth Mark Rehns, Cohen Milstein Sellers & Toll P.L.L.C., New York, NY.
For William Koetsch, individually and on behalf of all others similarly situated, Plaintiff: Carol V. Gilden, LEAD ATTORNEY, PRO HAC VICE, Cohen Milstein Sellers & Toll PLLC (IL), Chicago, IL; Darren J. Robbins, PRO HAC VICE, David C. Walton, Robbins Geller Rudman & Dowd LLP (SANDIEGO), San Diego, CA; Guri Ademi, Ademi & O'Reilly, L.L.P., Cudahy, WI; Samuel Howard Rudman, Robbins Geller Rudman & Dowd LLP(LI), Melville, NY.
For Massachusetts Laborers' Annuity Fund, Consolidated Plaintiff: Carol V. Gilden, LEAD ATTORNEY, PRO HAC VICE, Cohen Milstein Sellers & Toll PLLC (IL), Chicago, IL; Michael Walter Stocker, LEAD ATTORNEY, Labaton & Sucharow LLP (NYC), New York, NY; Christopher J. Keller, Rachel Ann Avan, Labaton Sucharow, LLP, New York, NY.
For Retirement Fund Group, Movant: Michael Walter Stocker, LEAD ATTORNEY, Labaton & Sucharow LLP (NYC), New York, NY.
For ITT Educational Services, Inc., Kevin M. Modany, Daniel M. Fitzpatrick, Defendants: Jennifer Laurie Conn, Gibson, Dunn & Crutcher, LLP (NY), New York, NY.
OPINION AND ORDER
J. PAUL OETKEN, United States District Judge.
Plaintiffs bring this putative class action against Defendants ITT Educational Services, Inc. (ITT); its CEO, Kevin M. Modany; and its CFO and Executive Vice President, Daniel M. Fitzpatrick. Plaintiffs allege violations of § 10(b)(5) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5. They also allege that Defendants Modany and Fitzpatrick were " control persons" within the meaning of § 20(a) of the Securities Exchange Act, 15 U.S.C. § 78t(a). Plaintiffs allege that Defendants misled the investing public about various issues relating to Defendants' student loan programs. Defendants have moved to dismiss the complaint under Rule 12(b)(6) of the Federal Rules of Civil Procedure. For the reasons that follow, the motion is granted in part and denied in part.
ITT is a for-profit college with campuses all over the country. Its business model depends on the availability of student loans. In the years leading up to the putative class period--which runs from April 24, 2008, to February 25, 2013--its students began to default on their loans at a rapidly increasing rate. As a result, many private lenders cut back lending to ITT students.
A. Risk Sharing Agreements
To maintain its students' ongoing access to credit, ITT entered into three risk sharing agreements (RSAs): one with Sallie Mae, and the other two with as-yet unnamed private lenders. Under the RSAs, the lenders would make loans to ITT students for the purpose of paying tuition and expenses, but if the overall default rate on the loans exceeded a threshold percentage, ITT itself would cover all losses above the threshold. Each RSA was a " short-term agreement" with set expiration terms. (¶ 13.) The Sallie Mae RSA had a threshold of 24%. The threshold under the other two RSAs remains unknown, at least to Plaintiffs and the public. Sallie Mae lent ITT students $180 million; the other two lenders lent a combined $487 million.
Throughout the class period, default rates increased. By September 2010, Sallie Mae warned Defendants that defaults were approaching the threshold of 24%. By February 2011, Sallie Mae informed the Defendants that the default rate had exceeded 24%. Beginning in March 2011, Sallie Mae began making regular demands for increasingly large sums of money. Sallie Mae ultimately sued Defendants for payment under its RSA, resulting in a $46 million settlement, announced in January 2013.
Meanwhile, as the expiration date of the RSAs neared, ITT struggled to find new sources of credit for its students. By July 26, 2012, it became clear that ITT would not find new private lenders for its students, so it started lending directly. This required ITT to set aside substantial loan-loss reserves to cover defaults and ultimately resulted in a serious hit to its business.
B. The Alleged False or Misleading Statements
Plaintiffs allege, in essence, three sets of misleading statements or omissions that Defendants made throughout the class period. First, Defendants assured investors that no payments would be due under the Sallie Mae RSA even after Sallie Mae had demanded payment. Second, Defendants repeatedly said that their expected liabilities under the RSAs would be immaterial, and that ITT was adequately reserved for any payments that might come due, even though it was woefully under-reserved according to Generally Accepted Accounting Principles (GAAP), and even though Defendants knew that default rates were increasing rapidly and that this would almost certainly result in substantial liability. Finally, as the RSAs were approaching expiration, Defendants told investors that they were hopeful that they would secure another RSA deal when, in reality, there was no appreciable chance that this would happen.
1. ITT Was Not Expecting to Make Any Payments
After releasing its second quarter 2011 results, ITT hosted a conference call on July 21, 2011, for investment analysts and media representatives. Defendant Modany said that " with regard to the RSA programs of 2007 [made with Sallie Mae] . . . it's hard for us to say if there'll be any cash payments on that. At this point in time we're not projecting any, but again, it's hard to say. The trending is such that we're booking reserves accordingly based on anticipated default rates." (¶ 184.)
Before the conference call, on March 10, 2011 (¶ 183), Sallie Mae had notified ITT that it owed at least $11 million under the RSA.
2. Liabilities Under the RSAs Would be Immaterial
In its first quarter required disclosure statement for 2008 (" 1Q 2008 10-Q" ), ITT
told investors that its " recorded liability related to the  RSA . . . was not material" (¶ 134), and that it was " not able to estimate the undiscounted maximum potential future payments that [it] could be required to make under the 2008 RSA." Id. ITT repeated these two statements in its required quarterly and yearly disclosures through the second quarter of 2011. (¶ 188.)
In the second quarter of 2009, ITT added a statement about its second RSA. In its 2Q 2009 10-Q, ITT said that it " did not record a liability for [its] guarantee obligations under the [second] RSA . . . because [it did] not anticipate that private education loans charged off will exceed the percentage that would require it to make a payment under its guarantee." (¶ 153.) This statement was ...