ITT Educational Services Wins Dismissal of Shareholder Suit

A few months after federal investigators ended their inquiry into ITT Educational Services' operations without filing charges, an Indianapolis federal court has dismissed the shareholder suits against the post-secondary educational provider.

The consolidated suits followed a raid on ITT headquarters and 10 local offices conducted by federal investigators in February 2004. The investigators sought documents related to student placement, retention, grades, attendance and other data crucial for the school to qualify for federal educational loan and grant programs.

ITT emphasizes technology-oriented programs and offers associate's, bachelor's and master's degree programs at 77 institutes throughout the United States.

When ITT revealed the execution of the search warrants and related grand jury subpoenas, its stock fell by one-third from $57.40 to $38.50 per share. Within two days, several securities fraud suits were filed against the educational provider in the U.S. District Court for the Southern District of Indiana.

A few weeks later ITT announced that it was also being investigated by the Securities and Exchange Commission and had been under scrutiny by the California attorney general since October 2002. Its stock price then dropped another 12 percent to close at $28.29.

The lead plaintiff, the City of Austin Police Retirement System, asserted in its complaint that ITT made material misrepresentations regarding its operations between Oct. 17, 2002, and March 8, 2004, that caused shareholders' losses.

The suit charged the educational institute with falsifying records that were used as indicators of its success. The school and various officials named as defendants had inflated enrollment figures, counted students as enrolled who never attended the school, double-counted enrollees, changed grades, and misrepresented attendance and placement records, the shareholder said.

These allegations were based on the statements of numerous former employees and instructors.

The plaintiff also asserted that ITT failed to disclose the existence of the California investigation and that its accounting failed to comply with generally accepted accounting principles in violation of Section 10(b) of the Securities Exchange Act.

ITT maintained from the start that it was highly regulated by the U.S. Department of Education and the litany of supposed operational irregularities would not have gone unnoticed. It also asserted that many of the witnesses were not in positions that would have given them access to the information provided.

ITT moved to dismiss for failure to plead with the required particularity under Federal Rule of Civil Procedure 9(b) and the heightened pleading standards of the Private Securities Litigation Reform Act.

ITT also filed supplemental briefing with the District Court this summer pointing out that federal investigators from the U.S. Attorney's Office in the Southern District of Texas and the SEC had respectively terminated their criminal and civil investigations.

Although the closing of these investigations did not amount to an exoneration, U.S. District Judge David F. Hamilton pointed out that plaintiff "attempted to use the existence of the investigations to support its allegations that ITT and its senior officials were engaged in a widespread and systematic scheme to defraud."

The judge said the lack of charges effectively negated the adverse inference the plaintiff was trying to draw.

Turning to the testimony of the confidential witnesses, the judge found that plaintiff had failed to establish that the witnesses were employed during the class period or had personal knowledge of the facts they described.

For instance, the allegation by a former ITT marketing representative/recruiter that students' grades were inflated did not contain any details regarding how a marketing rep would be in a position to know about grade inflation, the judge said.

"These failings are especially problematic because plaintiff relies on statements by former employees who worked in local ITT institutes," Judge Hamilton wrote. "Plaintiff's burden is to raise an inference of fraud concerning ITT's business on a national scale."

The judge also said the existence of the California investigation alone did not establish systematic misconduct throughout ITT or any inference of an intent to deceive by its top officials.

The judge dismissed the suit without prejudice, and the plaintiffs have until Oct. 14 to file an amended complaint.