In re Rent-Way Securities Litigation (209 F. Supp. 2d 493, 2002)

MEMORANDUM OPINION

McLAUGHLIN, District Judge.

This case is a securities fraud class action in which shareholders of Renh-Way, Inc. (“Renir-Way”) seek relief from the company, certain of its current and former officers and directors, and its accounting firm, PricewaterhouseCoopers, LLP (“PwC”). All of the Defendants have filed motions to dismiss the Amended Consolidated Class Action Complaint (“Am. Cmplt.”) that are presently pending in this Court. For the reasons set forth below, we will deny the motions filed by PwC, William E. Morgenstern, Jeffrey A. Conway, Matthew J. Marini and RenL-Way [Doc. Nos. 56, 58, 60, 63, and 69]. We will grant in part and deny in part the motion filed by William A. McDonnell [Doc. No. 62],

I. Background

Rent-Way, a company in the business of renting home furnishings, appliances and other merchandise under full-service rental-purchase agreements, began in 1981 when it opened one store in Erie, Pennsylvania. By 1993, the year of its initial public offering, it had expanded to 19 stores in three states. Thereafter, the company dramatically accelerated the pace of its expansion. In December of 1998, Renb-Way doubled its size and became the second largest company of its kind in the United States when it acquired Home Choice Holdings, Inc. Am. Cmplt. ¶ 33. By the year 2000, Renb-Way owned and operated more than 1100 stores nationwide, compared to a mere 125 stores less than two years earlier. Am. Cmplt. ¶ 48. The class members in this . action purchased Rent-Way stock during the height of the rapid expansion, specifically between December 10, 1998 and October 27, 2000, inclusive. Am. Cmplt. ¶ 1. During the class period, the common stock (symbolized on the New York Stock Exchange by “RWY”), traded for as much as $32 per share. Am. Cmplt. ¶ 4.

On Monday, October 30, 2000, Rent-Way issued a press release announcing that it was “investigating certain accounting matters, including possible accounting irregularities, which if confirmed would result in the need to revise earlier reported unaudited financial results for fiscal year 2000.” Renb-Way also indicated in this release that it expected the same matters to impact its fourth quarter 2000 results. In part, the release provided that:

[biased on its preliminary investigation to date, however, Rent-Way expects . these matters to have a negative, non-cash impact of between $25 million and $35 million pre-tax on fiscal year 2000 earnings. Based on its preliminary investigation to date, Rent-Way expects that no fiscal periods prior to fiscal year 2000 will be affected. Rent-Way had previously announced that it expected to meet consensus analyst estimates for fully diluted earnings per share of $1.83 in fiscal year 2000. Based on its preliminary investigation to date and taking into account the expected impact of these accounting matters, Renb-Way believes it will report fully diluted earnings per share of between $0.88 and $1.14 per share for fiscal year 2000.

Am. Cmplt. ¶ 58. Immediately after this release issued, Renb-Way stock declined more than 80% in the course of one day, plummeting from $23-7/16 per share to close at $5.00 per share. Renb-Way eventually disclosed that the accounting irregularities had a far more substantial impact on its fiscal year 2000 earnings than it originally predicted and that the irregularities also impacted its reported results' for fiscal years 1998 and 1999. Am. Cmplt. ¶¶ 70-72. In its annual Form 10-K report for fiscal year 2000, Renb-Way reported that the total amount of adjustments affecting pre-tax operating income relating to the accounting improprieties was almost $98 million for all three years. Of this amount, $74.3 million applied to fiscal year 2000, $21.0 million applied to fiscal year 1999 and $2.3 million applied to fiscal year 1998. Additional adjustments totaling $24.5 million were made for fiscal year 2000 for other reasons.

Plaintiffs’ 75-page, 161-paragraph Amended Complaint contains numerous allegations that we will more fully set forth in our respective discussions of each Defendant’s motion to dismiss. Briefly, however, Plaintiffs’ claims may be summarized as follows. In Count I, Plaintiffs allege that each Defendant violated Section 10(b) of the Exchange Act of 1934 (“Exchange Act”), 15 U.S.C. § 78j(b), and Rule 10b-5. promulgated thereunder, 17 C.F.R. § 240.10b-5, by disseminating materially false and misleading statements concerning Renb-Way’s earnings, profitability and financial condition during the class period. The Renb-Way statements they allege to have been false and misleading include the originally reported year-end reports for fiscal years 1998 and 1999 and the fiscal quarter-end results for all of the quarters of 1999 and the first three quarters of 2000. Am. Cmplt. ¶¶ 108-135. In its annual report for fiscal year 2000 and on its Form 10-K filed with the SEC, Renb-Way admitted that all of these statements were in fact false. Separate statements made by some of the individual defendants during the class period are also identified. Plaintiffs further assert that PwC falsely represented in its 1998 and 1999 audit opinions that Renb-Way’s financial statements had been prepared in accordance with GAAP and that its audits had been performed in accordance with GAAS, and that it reviewed and approved of Rent-Way’s false quarterly reports. Am. Cmplt. ¶¶ 74, 92. Plaintiffs assert that Renb-Way’s internal accounting structure was severely deficient and that the Rent-Way Defendants knew of and used this fact to manipulate the appearance of the company’s financial condition so that it could continue its acquisition practices. In this regard, Plaintiffs claim that Marini, Renb-Way’s controller, manually altered numerous entries on the company’s ledger prior to the year-end and quarter cuboff dates. They also allege that PwC knew of Renb-Way’s fraudulent practices and of the severe deficiencies in the accounting system but failed to properly fulfill its obligations as auditor because it was not independent from its client. In Count II, Plaintiffs allege that the individual Defendants (Morgenstern, Marini, Conway and McDonnell) are liable under Section 20(a) of the Exchange Act because they were “controlling persons” within the meaning of this provision at all relevant times.

II. Standards of Review

A. Motion to Dismiss

In ruling on a motion to dismiss pursuant to Rule 12(b)(6), the district court must accept as true all well-pleaded allegations, and must view the facts and inferences to be drawn from the pleadings in the light most favorable to the non-moving party. Janney Montgomery Scott, Inc. v. Shepard Niles, Inc., 11 F.3d 399, 406 (3d Cir.1993) (citation omitted). The proper inquiry is “whether relief could be granted ... ‘under any set of facts that could be proved consistent with the allegations.’” Gasoline Sales, Inc. v. Aero Oil Co., 39 F.3d 70, 71 (3d Cir.1994) (quoting National Org. for Women, Inc. v. Schei-dler, 510 U.S. 249, 256, 114 S.Ct. 798, 127 L.Ed.2d 99 (1994)). Judgment will only be granted if it is clearly established that no material issue of fact remains to be resolved and that the movant is entitled to judgment as a matter of law. Regalbuto v. City of Philadelphia, 937 F.Supp. 374, 377 (E.D.Pa.1995) (citing Inst, for Scientific Info., Inc. v. Gordon and Breach, Science Publishers, Inc., 931 F.2d 1002, 1005 (3d Cir.1991), cert. denied, 502 U.S. 909, 112 S.Ct. 302, 116 L.Ed.2d 245 (1991). In deciding motions to dismiss, courts generally consider only the allegations in the complaint, exhibits attached thereto and matters of public record. Pension Benefit Guar. v. White Consolidated Indus., Inc., 998 F.2d 1192, 1196 (3d Cir.1993), cert. denied, 510 U.S. 1042, 114 S.Ct. 687, 126 L.Ed.2d 655 (1994)). A district court may, however, consider the factual allegations within other documents, including those described or identified in the complaint and matters of public record, if the plaintiffs claims are based upon those documents. Id.; In re Westinghouse Sec. Li-tig., 90 F.3d 696, 707 (3d Cir.1996). In these instances, the court is not required to construe the motions to dismiss as motions for summary judgment. In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410,1426 (3d Cir.1997).

B. Section 10(b) and Rule 10b-5

Section 10(b) makes it “unlawful for any person, directly or indirectly ... [t]o use or employ, in connection with the purchase of any security ... any manipulative or deceptive device or contrivance in contravention of [SEC] rules and regulations.” 15 U.S.C. § 788(b). Rule 10b-5 in turn prohibits the “employ[ment of] any device, scheme, or artifice to defraud” and the “mak[ing of] any untrue statement of a material fact or [the omission of] a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading.” 17 C.F.R. § 240.10b-5. To state a securities fraud claim under Section 10(b) and Rule 10b-5, a private plaintiff must plead: (1) that the defendant made a misrepresentation or omission of (2) a material (3) fact; (4) that the defendant acted with knowledge or recklessness and (5) that the plaintiff reasonably relied on the misrepresentation or omission and (6) consequently suffered damage. In re Westinghouse Sec. Litig., 90 F.3d 696, 710 (3d Cir.1996); In re Advanta Corp. Sec. Litig., 180 F.3d 525, 537 (3d Cir.1999).

Section 20(a) imposes liability on “[e]very person who, directly or indirectly, controls any person liable under any provision of this chapter or of any rule or regulation thereunder ...” 15 U.S.C. § 78t(a). The statute requires proof not only that “one person controlled another person, but also that the ‘controlled person’ is liable under the Act. If no controlled person is liable, there can be no controlling person liability.” Shapiro v. UJB Financial Corp., 964 F.2d 272, 279 (3d Cir.1992), cert. denied, 506 U.S. 934, 113 S.Ct. 365, 121 L.Ed.2d 278 (1992) {citing Wool v. Tandem Computers, Inc., 818 F.2d 1433, 1440-41 n. 8 (9th Cir.1987)).

C. Federal Rule of Civil Procedure 9(b) and The Private Litigation Reform Act of 1995 (“PSLRA”)

Because this is a securities fraud case, Plaintiffs’ Amended Complaint must also comply with the special pleading rules set forth in Federal Rule of Civil Procedure 9(b) and the PSLRA. Rule 9(b), applicable to all averments of fraud or mistake, requires that the “circumstances constituting fraud or mistake shall be stated with particularity,” but permits “[m]al-ice, intent, knowledge, and other condition of mind of a person [to] be averred generally.” Fed.R.Civ.P. 9(b). The PSLRA, applicable to securities fraud cases, further heightens the pleading standard germane to Plaintiffs’ claims. Under the PSLRA, the “complaint shall specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed.” 15 U.S.C. § 78u-4(b)(1). Further, the PSLRA mandates that the “complaint shall, with respect to each act or omission alleged to violate this chapter, state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.” 15 U.S.C. § 78u-4(b)(2). Subsequent to the PSLRA’s enactment, the Court of Appeals for the Third Circuit held that it is sufficient for plaintiffs to plead scienter by alleging facts either “establishing a motive and an opportunity to commit fraud” or that “constitute circumstantial evidence of either reckless or conscious behavior.” In re Advanta, 180 F.3d 525, 534-535 (quoting Weiner v. Quaker Oats Co., 129 F.3d 310, 318 n. 8 (3d Cir. 1997)). A reckless statement is one “ ‘involving not merely simple, or even inexcusable negligence, but an extreme departure from the standards of ordinary care, and which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it.’ ” Id. At 535. (quoting McLean v. Alexander, 599 F.2d 1190, 1197 (3d Cir.1979)). Conscious misbehavior may be alleged by “stating with particularity facts giving rise to a strong inference of conscious wrongdoing, such as intentional fraud or other deliberate illegal behavior.” Id.

III. Discussion

I. Section 10(b) and Rule 10b-5

A. PricewaterhouseCoopers (“PwC”)

Plaintiffs allege that PwC falsely reported in its audit opinions for fiscal years 1998 and 1999 that Rent-Way’s financial statements fairly presented its financial condition and results in accordance with Generally Accepted Accounting Principles (“GAAP”). Plaintiffs also contend that PwC improperly reviewed and approved of Renb-Way’s quarterly financial statements for all of the quarters of fiscal 1999 and the first three quarters of fiscal 2000 and thereafter failed to insist that Renb-Way revise these quarterly statements. Am. Cmplt. ¶¶ 19, 74, 86. It is alleged that PwC routinely ignored a number of “red flag” warnings, including a materially weak internal accounting structure, incompatible and nonfunctional accounting systems, reports of declining expense ratios during periods of rapid growth through acquisition, a lack of adequate ledger detail that allegedly prevented PwC from crosschecking Rent-Way’s calculations (%.&., documentation regarding vendor rebates and merchandise depreciation was never generated and provided to PwC), and the fact that Marini, Renb-Way’s controller, manually adjusted and created entries on the company’s ledger in order to make the bottom line numbers balance. Am. Cmplt. ¶¶ 77, 79, 88,100-101.

Specifically, Plaintiffs allege that the Poinb-of-Sale (“POS”) accounting system utilized by Rentr-Way was unable to handle the company’s growth and functioned improperly. Plaintiffs state that one former Rent-Way accountant said that, “[t]he whole place [Rent-Way] was a red flag.” Am. Cmplt. ¶ 35. They also allege that a former Rent-Way employee said the POS system was easy to manipulate because it was “held together by rubber bands.” Am. Cmplt. ¶ 36. Renb-Way’s own financial analysts distrusted the company’s profit/loss statements and knew that they did not reflect the company’s performance. Am. Cmplt. ¶ 38. It is alleged that the POS system accounted for rental merchandise depreciation, the second greatest expense on the company’s ledger, differently among the company’s stores. Am. Cmplt. ¶ 37. Plaintiffs also allege that PwC knew and approved of the fact that Marini made manual adjustments to Rent-Way’s ledger at the ends of fiscal years 1998 and 1999. Am. Cmplt. ¶ 45. It is alleged that PwC knew or recklessly disregarded that Rent-Way intentionally failed to record vendor rebates in order to falsely reduce other unrelated expenses and intentionally overbooked the value of acquired assets for the same reason. Am. Cmplt. ¶¶ 47, 49. Plaintiffs also allege that the PeopleSoft system, which Rent-Way began to install in August, 1999, failed to interface with the POS system and also failed to operate properly; it is asserted that this system failed to properly account for invoices, mis-allocated payroll expenses and failed to record fixed assets for the first six months after it had been installed. Am. Cmplt. ¶¶ 42-44. They allege that a Rent-Way staffer who worked at the company for most of the class period stated that, “[tjhere was never one correct financial statement produced at Renb-Way during the entire time I was there.” Am. Cmplt. ¶44. It is alleged that PwC also was aware that the PeopleSoft system never functioned properly. Am. Cmplt. ¶ 42.

Plaintiffs allege that PwC violated GAAS by failing to insist that Rent-Way revise its interim results for each of the fiscal 1999 quarterly periods and the first three fiscal 2000 quarterly periods. Am. Cmplt. ¶86. They also allege that PwC violated' GAAS by relying on Excel spreadsheets and reconciliation trial balances in the course of its audits instead of obtaining adequate general ledger detail and in failing to expand its audit procedures in light of Renb-Way’s weak internal controls. Am. Cmplt. ¶ 79. Plaintiffs allege that some Renb-Way employees concluded that PwC had simply delegated its audit responsibilities to Marini, Rent-Way’s Controller and Chief Accounting Officer. Am. Cmplt. ¶ 53.

It is further alleged that PwC had motive and opportunity to commit fraud because it desired to retain Renb-Way as a client and to secure more lucrative consulting business from it in the future. Am. Cmplt. ¶ 81. They contend that PwC lacked independénce- from Renb-Way because the engaged partners’ fees were directly tied to the account, and Rick Krause, the partner in charge, was close friends with 'Marini and interviewed for the Chief Financial Officer position at Renb-Way during the class period. Am. Cmplt. ¶ 81. Plaintiffs also assert that during the course of the 1999 year-end audit, Colleen Kipfstuhl, a PwC staff accountant, confronted Morganstern about perceived accounting irregularities and a lack of adequaté documentation, and that PwC subsequently removed her from the account at Marini’s request. Am. Cmplt. ¶ 80.

In its Motion to Dismiss and supporting memorandum, PwC raises three arguments: (1) that its 1998 and 1999 audit opinions are the only misstatements for which it is potentially liable; (2) that Plaintiffs have not alleged facts to support a strong inference that it acted with the requisite state of mind as required by the PSLRA; and (3) that Plaintiffs have not alleged that any misstatements made by PwC caused their loss. We will examine each of these arguments in turn.

1. Potentially Actionable Misstatements

PwC first argues that under Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164, 114 S.Ct. 1439, 128 L.Ed.2d 119 (1994), it may not be held hable for the misstatements in Rent-Way’s 1999 and 2000 unaudited quarterly reports. In Central Bank, the United States Supreme Court put an end to aiding and abetting liability under Section 10(b) and Rule 10b-5:

[b]ecause the text of § 10(b) does not prohibit aiding and abetting, we hold that a private plaintiff may not maintain an aiding and abetting suit under § 10(b). The absence of § 10(b) liability does not mean that secondary actors in the securities markets are always free from liability under the securities Acts. Any person or entity, including a lawyer, accountant, or bank, who employs a manipulative device or makes a material misstatement (or omission) on which a purchaser or seller relies may be liable as a primary violator under 10b-5, assuming all of the requirements for primary liability are met. In any complex securities fraud, moreover, there are likely to be multiple violators ...

Id. at 191, 114 S.Ct. 1439 (internal citation omitted).

Since Central Bank, however, the parameters of primary liability for accountants and other secondary professionals have been anything but clear. See Lewis D. Lowenfels and Alan R. Bromberg, Liabilities of Lawyers arid Accountants Under Rule 10b-5, 53 Bus. Law. 1157, 1158 (1998) (noting that three lines of cases have developed since Central Bank). While there has been no question that accountants’ own misstatements that reach investors provide a basis for liability, there has been disagreement as to whether an auditor’s “substantial participation” (itself a less than well defined concept) in the creation of a misstatement publicly attributable to another is sufficient. The “bright-line” view is well-articulated in Anixter v. Home-Stake Production Co., 77 F.3d 1215 (10th Cir.1996), in which an accountant both assisted in the preparation of his client’s prospectuses and issued his own opinion letters on the company’s financial data and consolidated financial statements. The court noted that much of the evidence could have sustained a finding of primary liability, but not all of it:

[rjeading the language of § 10(b) and 10b-5 through the lens of Central Bank of Denver, we conclude that in order for accountants to “use or employ” a “deception” actionable under the antifraud law, they must themselves make a false or misleading statement (or omission) that they know or should know will reach potential investors ... this rule, though far from a bright line, provides more guidance to litigants than a rule allowing liability to attach to an accountant or other outside professional who provided “significant” or “substantial” assistance to the representations of others.

Id. at 1225, 1226-1227. Numerous other courts, including courts in this circuit, have similarly held that varying levels of participation in another’s misstatement do not give rise to primary liability after Central Bank. See, e.g., Ziemba v. Cascade International, Inc., 256 F.3d 1194, 1205-06 (11th Cir.2001) (fact that law firm played a significant role in drafting, creating, or reviewing fraudulent letters or press releases issued by company insufficient for primary liability); Wright v. Ernst & Young LLP, 152 F.3d 169, 176 (2d Cir. 1998), cert. denied, 525 U.S. 1104,119 S.Ct. 870, 142 L.Ed.2d 772 (1999) (declining to adopt “substantial participation” test but finding that even if it did, it would be “hard-pressed” to find auditor liable for review of press release when release made no mention of auditor and noted that the announced information was unaudited); Danis v. USN Communications, Inc., 121 F.Supp.2d 1183, 1193 (N.D.Ill.2000) (auditor not primarily liable for reviewing company’s unaudited quarterly financial statements; to be liable, auditor was required to have actually made the material misstatements or to have engaged in manipulative behavior); In re Ikon Office Solutions, Inc., 131 F.Supp.2d 680, 685 n. 5 (E.D.Pa.2001), aff'd, 277 F.3d 658 (3d Cir. 2002) (held, citing Wright, that auditor’s approval of press release did not provide a basis for Section 10(b) liability); Copland v. Grumet, 88 F.Supp.2d 326, 332 (D.N.J. 1999) (auditor’s role in formulating, preparing and/or compiling false financial data issued by client not a basis for liability); In re Kendall Square Research Corp. Sec. Litig., 868 F.Supp. 26, 28 (D.Mass.1994) (allegations that auditor reviewed and approved of quarterly financial statements and prospectuses constituted at most aiding, and abetting and was not actionable under Section 10(b)); Vosgerichian v. Commodore International, 862 F.Supp. 1371, 1377-1378 (E.D.Pa.1994) (allegation that auditor gave its guidance and approval to client, and directly and substantially assisted client in misrepresenting the true nature of its transactions not sufficient for primary liability).

The contrary view is represented in In re Software Toolworks, Inc., 50 F.3d 615 (9th Cir.1994), cert. denied, 516 U.S. 907, 116 S.Ct. 274, 133 L.Ed.2d 195 (1995) which reversed a district court opinion granting summary judgment for an accounting firm that had participated in the drafting of two letters sent by Software Toolworks to the SEC. Id. at 628-629. The court found that a reasonable factfin-der could have concluded based upon this participation that the accountants “had access to all information that was available and deliberately chose to conceal the truth.” Id. at 629; see also In re ZZZZ Best Sec. Litig., 864 F.Supp. 960, 970 (C.D.Cal.1994) (evidence of auditor’s involvement in creation of allegedly misleading statements released to the public by Z Best created a question of fact regarding primary liability); Adam v. Silicon Valley Bancshares, 884 F.Supp. 1398, 1401 (N.D.Cal.1995) (plaintiffs could allege primary liability against accountant based upon various statements and reports issued by company); Cashman v. Coopers & Lybrand, 877 F.Supp. 425, 432 (N.D.Ill. 1995) (primary liability may be based on accountant’s “central involvement” in preparation of misstatements); Employers Ins. of Wausau v. Musick, Peeler & Garrett, 871 F.Supp. 381, 389 (S.D.Cal.1994) (sufficient that plaintiffs pled that accountants were architects of prospectus and that the prospectus contained misrepresentations attributable to the accountants).

We find that Central Bank precludes holding PwC liable based on its review and approval -of Rent-Way’s unaudited 1999 and 2000 quarterly reports. Significantly, these statements were prepared and issued solely by Rent-Way, and consequently contained no misrepresentations attributable to PwC upon which investors could have relied. See Central Bank, 511 U.S. at 180, 114 S.Ct. 1439 (“Our reasoning is confirmed by the fact that respondents’ argument would impose 10b-5 aiding and abetting liability when at least one element critical for recovery under 10b-5 is absent: reliance”); Wright, 152 F.3d at 175 ( ... “a secondary actor cannot incur primary liability under the Act for a statement not attributed to that actor at the time of its dissemination. Such a holding would circumvent the reliance requirements of the Act ... ”).

We also find that 17 C.F.R. § 210.10-01(d), effective March 15, 2000 and applicable to Rent-Way’s quarterly financial statements for the second and third quarters of 2000, in no way alters our conclusion on this point. In its entirety, this rule provides:

(d) Interim review by independent public accountant. Prior to filing, interim financial statements included in quarterly reports on Form 10-Q (17 CFR 249.308(a)) must be reviewed by an independent public accountant using professional standards and procedures for conducting such reviews, as established by generally accepted auditing standards, as may be modified or supplemented by the Commission. If, in any filing, the company states that interim financial statements have been reviewed by an independent public accountant, a report of the accountant on the review must be filed with the interim-financial statements.

17 C.F.R. § 210.10-01(d) (emphasis added). This regulation does not mandate that accountants author reports on quarterly financial statements in the absence of an affirmative representation by the reporting company that its interim statement was reviewed, and no such report was authored in this case. As in Wright, the quarterly statements contained a notation that they were unaudited and PwC was not identified in them. Here, Rent-Way was the sole drafter and issuer and the allegation that PwC reviewed and approved the statements remains insufficient to permit an affirmative finding on the element of reliance critical to a Section 10(b) and Rule 10b-5 claim.

Plaintiffs’ argument that PwC had a duty to insist that Rent-Way’s quarterly statements be revised is similarly unavailing. Initially, Rule 10b-5 states that it is unlawful to make a material misstatement or to “omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading.” (emphasis added). As we have already discussed, PwC was not. the maker of the quarterly statements and cannot be responsible for omissions in statements that it itself did not make. See Wafra Leasing Corp. v. Prime Capital Corp., 192 F.Supp.2d 852, 867 (N.D.Ill.2002) (“... a defendant is liable only for those omissions that make its own statements misleading.”). Further regarding omissions, the United States Supreme Court has itself stated that there “can be no fraud absent a duty to speak.” Central Bank, 511 U.S. at 174, 114 S.Ct. 1439. Here, Plaintiffs cite GAAS standard AU §§ 722.20-.22 for the proposition that PwC was obligated to insist that Rent-Way revise its quarterly reports. This standard requires accountants to discuss discovered accounting problems with certain levels of management and, if appropriate, to consider resigning from an engagement in the event of such a' discovery. It does not by its term impose a broadér duty as Plaintiffs suggest. As the Court of Appeals for the Seventh Circuit stated, “[although accountants must exercise care in giving opinions on the accuracy and adequacy of firms’ financial statements, they owe no broader duty to search and sing.” DiLeo v. Ernst & Young, 901 F.2d 624, 629 (7th Cir.1990), cert. denied, 498 U.S. 941, 111 S.Ct. 347, 112 L.Ed.2d 312 (1990); see also Wafra, 192 F.Supp.2d at 868.

Plaintiffs also argue that PwC is liable for RenU-Way’s quarterly financial statements under subsections (a) and (c) of Rule 10b-5 because it employed a “device, scheme or artifice to defraud” and “engaged in acts, practices and a course of business which operated as a fraud and deceit” upon the Plaintiffs. Am. Cmplt. ¶ 147. They contend that it is not necessary to attribute a particular misstatement to PwC under these clauses, and our research on the point has revealed that there is a considerable amount of confusion surrounding this area of the law. Even assuming, however, that a material misstatement or omission is not a requirement for liability under these clauses, we find that Plaintiffs allegations are insufficient to state a claim under them. Fairly read, the Amended Complaint is based upon the misstatements issued by PwC and Rent-Way during the class period. These misstatements are what the Plaintiffs allegedly relied upon to their detriment, and the allegations simply do not permit an inference that Plaintiffs relied upon any “device,” “scheme,” “artifice,” “act,” “practice” or “course of business” employed or engaged in by PwC such that a Rule 10b-5 claim could be established. Essentially, as we understand Plaintiffs’ argument on this point, they seek to impose liability on PwC for aiding Rent-Way’s issuance of the false quarterly statements notwithstanding that Rent-Way itself authored and issued these statements. Such secondary liability has been foreclosed since Central Bank. Additionally on this point, Plaintiffs’ factual allegations fail to specify with any degree of particularity how PwC violated these clauses, and we accordingly also find that Plaintiffs’ allegations in this respect fail to meet the applicable pleading requirements.

In conclusion, we find that Plaintiffs have failed to state a Section 10(b) and Rule -10b-5 claim against PwC based upon the 1999 and 2000 unaudited interim financial statements issued by Rent-Way. Having determined that PwC’s potential liability is limited to its own 1998 and 1999 year-end audit opinions, we will now turn to the firm’s remaining arguments.

2. Scienter

As we have stated previously, it is sufficient for plaintiffs to plead scienter by alleging “facts ‘establishing a motive arid an opportunity to commit fraud, or by setting forth facts that constitute circumstantial evidence of either reckless or conscious behavior.’” In re Advanta, 180 F.3d at 534-535. In this Circuit, allegations of recklessness are sufficient when the reckless acts constitute:

highly unreasonable conduct, involving not merely simple, or even inexcusable negligence, but an extreme departure from the standards of ordinary care, and which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it.

In re Ikon Office Solutions Sec. Litig., 131 F.Supp.2d 680, 691 (E.D.Pa.2001), aff'd 277 F.3d 658 (3d Cir.2002) (citing McLean v. Alexander, 599 F.2d 1190, 1197 (3d Cir. 1979)).

Although the Amended Complaint includes allegations regarding PwC’s scienter based' upon both conscious and reckless behavior, the allegations chiefly run to recklessness and at oral argument Plaintiffs’ counsel confirmed that this is the primary basis upon which they rely. Hearing on Defendants’ Motions to Dismiss held on April 9, 2002 at 50. Initially, we find that their allegation that PwC had a motive and opportunity to commit fraud because it desired to retain Rent-Way’s business is insufficient as a matter of law. Am. Cmplt. ¶ 81. In re SmarTalk Teleservices Inc. Sec. Litig., 124 F.Supp.2d 505, 517-518 (S.D.Ohio 2000) (citing cases and observing that the majority of cases to consider the issue have concluded likewise). Plaintiffs’ other factual allegations relevant to reckless or conscious behavior may be summarized as follows: (1) the magnitude and duration of the fraud was significant; (2) PwC committed serial violations of GAAP and GAAS; (3) PwC knew that RenD-Way’s internal accounting structure and controls were inadequate; and (4) PwC disregarded a number of “red flags,” including reports of declining expense ratios made during periods of substantial growth, a lack of adequate documentation, and Rent-Way personnel’s practice of manually altering entries on the company’s general ledger. En route to evaluating whether these allegations collectively give rise to a strong inference of scienter, we will consider the probative value of each in turn.

A. Magnitude and Duration of the Accounting Improprieties

In and of itself, the magnitude of an erroneous financial statement is insufficient to raise a strong inference that a defendant acted with scienter. In re SCB Computer Technology, Inc. Sec. Litig., 149 F.Supp.2d 334, 357 (W.D.Tenn.2001) (the “magnitude of an erroneous financial statement caused by allegedly fraudulent representations, without more, cannot sustain a finding that an auditor acted with scienter”); see also Reiger v. Price Water House Coopers LLP, 117 F.Supp.2d 1003, 1013 (S.D.Cal.2000), aff'd, 288 F.3d 385 (9th Cir.2002); In re SmarTalk Teleservices, Inc. Sec. Litig., 124 F.Supp.2d 505, 517 (S.D.Ohio 2000). Howevfer, a number of courts have recognized that the magnitude of the fraud, while not determinative of scienter, is probative of it. In re SCB, 149 F.Supp.2d at 358; In re MicroStrategy Inc. Sec. Litig., 115 F.Supp.2d 620, 651 (E.D.Va.2000); In re Baan Co. Sec. Litig., 103 F.Supp.2d 1, 21 (D.D.C.2000); Carley Capital Group v. Deloitte & Touche, L.L.P., 27 F.Supp.2d 1324, 1339 (N.D.Ga. 1998); Rehm v. Eagle Fin. Corp., 954 F.Supp. 1246, 1256 (N.D.Ill.1997); see also P. Schoenfeld Asset Mgmt. LLC v. Cendant Corp., 142 F.Supp.2d 589, 608 (D.N.J. 2001) (aside from a violation of GAAP, other circumstances suggesting fraudulent intent can include the presence of red flags and the magnitude of the alleged fraud).

In this case, Plaintiffs do not rely on the magnitude of the restatements alone to establish scienter, and we accordingly will consider the factual allegation in conjunction with Plaintiffs’ others. In light of our determination that PwC is only potentially liable for the misstatements contained in its fiscal yéar 1998 and fiscal year 1999 audit opinions, we are mindful that the bulk of the total readjustment in this case applied to fiscal year 2000. Notwithstanding this fact, the fiscal year 1998 and 1999 restatements were not insubstantial. For fiscal year 1998, Rent-Way originally reported a $1,838,000 net loss and a $0.09 loss per share. As restated, Rent-Way reported a $5,819,000 net loss and a $0.29 loss per share. For fiscal year 1999 the discrepancy was even more significant. In its original filing, Ren1>-Way reported $14,583,000 in net income, and earnings per share of $0.66. As restated, Rent-Way reported a net loss of $765,000 and earnings per share of $0.04. Rent-Way 10-K Annual Report for Fiscal Year Ended September 30, 2000. We are satisfied that the magnitude of the fraud and the duration of the irregularities (spanning two fiscal years) are such that it is reasonable to find them probative of scienter.

B. GAAP and GAAS Violations

In In re Westinghouse Sec. Litig., 90 F.3d 696, 712 (3d Cir.1996), the Court of Appeals for the Third Circuit affirmed the district court’s conclusion that the plaintiffs failed to state a securities fraud claim based on allegations that Price Water-house violated GAAS and failed to comply with GAAP in the course of performing its 1988 and 1989 audits of Westinghouse. The court observed that although plaintiffs had cited various GAAS standards, they failed to explain “how Price Waterhouse knowingly or recklessly violated those standards in performing its 1988 and 1989 audits.” Id. The court also found that plaintiffs had not alleged facts giving rise to an inference that Price Waterhouse had known or was reckless in failing to know that Westinghouse’s financial statements did not comply with GAAP. Id. The district court had concluded that the only factual allegations relevant to Price Waterhouse pertained to its 1990 audit. In instances where plaintiffs have pled facts explaining how the standards were recklessly or consciously violated, however, courts have found them probative. See, e.g., In re MicroStrategy, 115 F.Supp.2d at 651-652 (allegations that PwC violated simple accounting principles which resulted in significant false reports probative of scien-ter); In re Ikon Office Solutions, Inc. Sec. Litig., 66 F.Supp.2d 622, 629 (E.D.Pa.1999) (numerous, specific violations of GAAP and/or GAAS, when coupled with other red flags, may suffice to plead scienter); In re Sunbeam, 89 F.Supp.2d 1326, 1345-1346 (S.D.Fla.1999) (specific allegations of GAAS violations, including allegations that accountant ignored red flags that should have caused it to obtain additional information, failed to properly plan and supervise its audit, and failed to fully understand its client’s internal control structure, combined with other allegations to demonstrate that the accountant knew or was severely reckless in not knowing that its client was committing accounting improprieties).

Here, we find that Plaintiffs have alleged specific facts explaining how PwC recklessly or consciously disregarded GAAS in the course of its fiscal 1998 and 1999 year-end audits. Central to the allegations in this regard is that PwC conducted its audits without obtaining adequate detail and documentation in violation of GAAS and consequently failed to detect non-standard journal entries made by Rent-Way personnel. Am. Cmplt. ¶ 79. Specifically, Plaintiffs allege that PwC never obtained adequate documentation of Rent-Way’s rental merchandise depreciation expenses (the second largest category of expenses on the ledger) because Rent-Way’s accounting systems did not record it accurately, and that PwC never obtained adequate documentation of Rent-Way’s vendor rebate expenses because the company never recorded these expenses at all. Am. Cmplt. ¶ 79. The court in P. Schoenfeld Asset Mgmt. LLC v. Cendant Corp., 142 F.Supp.2d 589, 606-08 (D.N.J.2001), found similar allegations probative of scienter. (“The complaint asserts that E & Y failed to obtain sufficient competent evidential matter to form a basis for its unqualified reports ... Plaintiffs charge that E & Y failed to obtain direct evidence in connection with CUC’s and CMS’s recording of revenue and elimination or reduction of expenses as a result of write offs of merger reserves. Instead, E & Y relied largely on management’s representations ... when combined with other circumstances suggesting fraudulent intent, allegations of improper accounting may support a strong inference of scienter.”). Plaintiffs also allege that in spite of its knowledge of the specific deficiencies in Rent-Way’s accounting systems, PwC failed to expand its audit procedures in violation of GAAS. Am. Cmplt. ¶¶ 89, 95. These allegations of GAAS violations are distinguishable from the allegations in In re Westinghouse and Zucker v. Sasaki, 963 F.Supp. 301, 307 (S.D.N.Y.1997), also relied on by PwC, because they set forth with particularity how PwC consciously or recklessly violated GAAS in the course of its 1998 and 1999 fiscal year-end audits, and support a strong inference that PwC either knew or was reckless in not knowing that Renb-Way’s financial statements did not comply with GAAP.

C. Knowledge of Weaknesses in Rent-Way’s Internal Accounting Structure

As with the other categories, blanket allegations of weak internal controls do not alone suffice as a basis for inferring scienter. Reiger v. Price Waterhouse Coopers LLP, 117 F.Supp.2d 1003, 1009 n. 5 (S.D.Cal.2000), aff'd, 288 F.3d 385 (9th Cir. 2002) (boilerplate allegation of weak internal controls did not meet the particularity and strong inference requirements of the PSLRA). However, we agree with the court in In re Ikon Office Solutions, Inc. Sec. Litig., 66 F.Supp.2d 622, 630 (E.D.Pa. 1999) that allegations that an accountant’s internal audits “gave it a deep understanding of the existence and significance” of its client’s problems and of facts suggesting the accountant knew that the problems persisted until the time of its unqualified audit opinion are probative.

Plaintiffs make just such allegations in this case. It is alleged, for instance, that PwC knew that Rent-Way’s PoinWof-Sale (“POS”) system, in place until the last month of fiscal year 1999, failed to properly record critical rental merchandise depreciation values. Am. Cmplt. ¶ 37. Plaintiffs also allege that PwC knew that this system was especially ill-equipped to handle Rent-Way’s rapid expansion and was easy to manipulate. Am. Cmplt. ¶ 36. It is alleged that PwC urged Rent-Way to install the PeopleSoft system in August of 1999 and that this system failed to interface with the POS system and permitted entries to be manually altered. Am. Cmplt. ¶ 39. Plaintiffs allege that PwC knew that Marini made manual adjustments to the ledger in order to force the bottom line numbers to balance at the end of fiscal years 1998 and 1999. Am. Cmplt. ¶ 45, 77. We find that these allegations are of the requisite particularity and that they, similar to the allegations in In re Ikon, paint a picture of PwC as knowl-edgéable about the significant problems in its client’s internal control systems and as having reason to know that these problems were occurring when it issued its unqualified audit opinions. Accordingly, we find that Plaintiffs’ claims regarding PwC’s knowledge in this respect are probative of scienter. In re Ikon, 66 F.Supp.2d at 632.

D. Disregard of “Red Flags”

When plaintiffs “allege the existence of specific facts that should put defendants on notice of errors in recognizing revenue or indicate reasons to question management’s representations,” a refusal to react to these “red flags” can support a strong inference of scienter. In re SCB Computer Technology, Inc. Sec. Litig., 149 F.Supp.2d 384, 363 (W.D.Tenn.2001) (citing In re Comshare Inc. Sec. Litig., 183 F.3d 542, 547 (6th Cir.1999)). Here, Plaintiffs allege that the following constitute red flags ignored by PwC: (1) the weak internal accounting controls at Renb-Way; (2) the improperly functioning software systems; (3) the fact that Marini manually adjusted entries on the general ledger; (4) the inadequate ledger detail; and (5) the reports of declining expense ratios during times of rapid growth. Am. Cmplt. ¶¶ 77, 79, 88, 100, 101. Although they do not identify it as a “red flag,” Plaintiffs also allege that Colleen Kipfstuhl, a PwC employee assigned to Rent-Way’s fiscal 1999 year-end audit, confronted Morgenstern about Renb-Way’s “accounting irregularities and lack of adequate accounting documentation” in the course of the audit, and was subsequently removed by Rick Krause, the PwC partner in charge of the audit, at Renb-Way’s request. Am. Cmplt. ¶ 80. Plaintiffs allege that Krause was good friends with Marini and that he interviewed for the position of Chief Financial Officer at Renb-Way while he was in charge of Rent-Way’s audits. Am. Cmplt. ¶ 81.

At the outset, we are satisfied that the Kipfstuhl allegation is more than sufficient to qualify at least as a “red flag” insofar as a theory of recklessness is pursued, (the allegation is also arguably probative of consciousness). See In re SmarTalk Tel-eservices, Inc. Sec. Litig., 124 F.Supp.2d 505, 518-519 (S.D.Ohio 2000) (allegation that auditor informed client that it was reconsidering its position on an already released financial statement but was comfortable with that statement constituted a red flag); In re Ikon Office Solutions, Inc. Sec. Litig., 66 F.Supp.2d 622, 629 (E.D.Pa. 1999) (allegation of a handwritten note in accountant’s file that it had been informed by its client’s management that an employee was cooking the books, if true, would support a claim of reckless behavior); In re Health Mgmt. Inc. Sec. Litig., 970 F.Supp. 192, 203 (E.D.N.Y.1997) (allegation that accountant possessed a letter from an analyst warning that its client had inflated its accounts receivable constituted a red flag). As to the other alleged “red flags,” most concern Rent-Way’s internal controls and have already been discussed and deemed probative.

PwC also argues, relying on In re Party City Sec. Litig., 147 F.Supp.2d 282, 303 (D.N.J.2001), that the Amended Complaint is deficient because Plaintiffs have not alleged the facts on which their allegations made on information and belief are based. PwC makes this argument with respect to a number of Plaintiffs’ allegations, and we address it here only because it is perhaps most strongly advanced with respect to the Kipfstuhl allegation; PwC contends that Plaintiffs are required to disclose its source. We disagree and find that Plaintiffs have complied with the PSLRA in this respect.

The PSLRA requires that “whenever plaintiffs allege, on information and belief, that defendants made material misstatements or omissions, the complaint must ‘state with particularity all facts on which that belief is formed.’ ” Novak v. Kasaks, 216 F.3d 300, 312 (2nd Cir.2000), cert. denied, 531 U.S. 1012, 121 S.Ct. 567, 148 L.Ed.2d 486 (2000) (