Discovery Stay Error Won’t Tank Class Action

(CN) - Reviving fraud claims against a defunct company that sold credit-card-size electronic games, the 9th Circuit found that investors did not violate a discovery stay.

Dalton Petrie is the lead plaintiff in the 2010 class action filed after the bankruptcy of Electronic Game Card Inc. Filed in Santa Ana, Calif., the investors claimed that executives Lee Cole and Linden Boyne had misrepresented the company's earnings and assets and hid a subsidiary agreement, among other things.

The Securities and Exchange Commission filed similar claims against the executives in 2012 for "repeatedly lying to investors about the operations and financial condition" of the company.

A second amended complaint in Petrie's case in 2011 led Cole to give notice that he would seek judgment on the pleadings. Cole later claimed that such notice should have triggered a stay of discovery under the Private Securities Litigation Reform Act (PSLRA).

The plaintiffs nevertheless filed a third amended complaint (TAC) with more detailed allegations of concealment shortly thereafter.

"The TAC also alleges the company was able to report millions of dollars in cash and cash equivalents at the end of fiscal years 2006, 2007, and 2008 because its financial statements were wrongfully consolidated with its subsidiary's," the 9th Circuit explained on July 30. "Allegedly, much of this cash was represented to the auditor as being held in a bank account with Credit Suisse in Gibraltar, Spain that was controlled by the company and its subsidiary."

Another allegation of the TAC was that "the multi-million dollar Gibraltar account never existed," according to the 9th Circuit's ruling.

Cole moved to strike these so-called "auditor discovery materials" from the amended complaint, arguing that they had been obtained in violation of the stay of discovery.

U.S. District Judge David Carter agreed with Cole and struck portions of the complaint, finding that the investors should have ceased all discovery after Cole had announced plans to file his motion.

The court later dismissed the amended complaint altogether and ruled for the defendants. Without the new allegations, Judge Carter found, the investors could not show falsity or knowledge of wrongdoing.

A three-judge panel with the 9th Circuit reversed and sent the case back to the lower court on July 30, saying key portions of the amended complaint had been struck improperly.

"The complaint at issue in this appeal, the Third Amended Complaint, was based in large part on discovery materials subpoenaed before the company's former CEO gave notice of his intent to file a motion for judgment on the pleadings," Judge Morgan Christen wrote for the court in Pasadena. "These materials were not received until after the CEO gave such notice."

Auditor discovery materials can remain in the amended complaint because they were not obtained or used in violation of the PSLRA, according to the ruling. With the inclusion of such materials, the amended complaint "adequately pleads both falsity and scienter as to defendants Cole and Boyne," Christen wrote.

Attorney Jeffrey Greenbaum represents Cole, and Michael Cypers represents Boyne. Neither returned a request for comment.

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