Suit Over Accounting Woes At Diet Concern Medifast Inc. Tossed

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The U.S. District Court for the District of Maryland March 28 dismissed an investor securities suit over accounting problems at diet concern Medifast Inc.(MED) during a period of rapid growth (Proter v. Medifast Inc., D. Md., Civil Action No. GLR-720, 3/28/13).

Judge George Russell III dismissed the litigation in its entirety, determining that, when viewed collectively, the lead plaintiffs’ allegations “fail, at their inception, to raise a strong inference of scienter.”

Period of Growth
The court explained that the company’s stock has been listed on the New York Stock Exchange since 2006, and analysts consistently praised Medifast for sales and profits. By 2010, the court recounted, Medifast’s net income had grown to nearly $20 million.

During this period of growth, the court wrote, Medifast allegedly discovered errors in its accounting practices. “In sum, Medifast proffers a benign, non-fraudulent explanation for the Company’s series of misstatements beginning on March 4, 2010: the Company’s rapid growth, coupled with the transition between outside accountants, resulted in insufficient outside financial guidance and necessitated restatements of the Company’s financials.”

However, the court said, the lead plaintiffs “posit a veritable decathlon of allegations, the sum total of which, they believe, give rise to a cogent and compelling inference that Medifast and the Individual Defendants misled the market intentionally or with severe recklessness.”

'Cogent Narrative'
After reviewing the complaint, the court said that the allegations “support a single, cogent narrative: the Company experienced exponential growth, and in that time of transition, accounting errors resulted.” For example, the court said that while Medifast’s “restatements of net income were material, they are not of the nature that would give rise to a strong inference that they resulted from fraud.”

The court also rejected the lead plaintiffs' “attempt to characterize the duration of the accounting errors as indicative of scienter. It is established law in this Circuit that there can be no inference of scienter based solely on [generally accepted accounting principles] or other accounting errors, even when such errors occur routinely.”

Moreover, the court said, the lead plaintiffs’ assertion that two individual Medifast defendants’ Sarbanes-Oxley certifications support a strong inference of scienter “is misguided.” The Sarbanes-Oxley allegation fails, the court exlained, “because Lead Plaintiffs do not plead facts indicating that defendants intentionally misstated a material fact or acted recklessly. Without that, there is no inference, much less a strong inference, that Defendants acted with the required scienter.”

The court rejected other attempts by the lead plaintiffs to satisfy the scienter element--including a “final salvo” based on the alleged insider trading of the individual defendants. None of the individual defendants sold stock in amounts that “were unusual or suspicious in comparison to their prior trading histories or to case law,” the court said.

The court also remarked that it “strains credulity to allege” that the defendants “were engaging in a nefarious scheme to inflate the price of Company stock for their own benefit while simultaneously making a public disclosure of their intention to sell shares far in advance.”

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