Ellington v. Paragon 28, Inc. et al

IN THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF COLORADO
Judge Philip A. Brimmer
_____________________________________________________________________
Civil Action No. 24-cv-02712-PAB-TPO
(Consolidated with Civil Case No. 24-cv-02898-PAB-TPO)
_____________________________________________________________________
Civil Case No. 24-cv-02712-PAB-TPO
JOHN K. ELLINGTON, individually and on behalf of all others similarly situated,
Plaintiff,
v.
PARAGON 28, INC.,
ALBERT DACOSTA,
STEPHEN M. DEITSCH, and
KRISTINA WRIGHT, 1
Defendants.
_____________________________________________________________________
Civil Case No. 24-cv-02898-PAB-TPO
NICHOLAS TIEDT, individually and on behalf of all other similarly situated,
Plaintiff,
v.
PARAGON 28, INC.,
ALBERT DACOSTA,
STEPHEN M. DEITSCH,
KRISTINA WRIGHT, and
ERIK MICKELSON, 2
1 Ms. Wright was a party to this action in the original complaint. Docket No. 1 at
3, ¶ 11. However, the operative complaint, Docket No. 32, brings no claims against Ms.
Wright and lists her as a relevant non-party Paragon 28 executive. Id. at 24, ¶ 34.
Thus, although the parties list her in the case caption, she is no longer a party.
2 Mr. Mickelson was a party to this action in the original complaint filed in Tiedt v.
Paragon 28, Inc., et. al., 24-cv-02898-PAB-TPO, which was consolidated with Ellington
v. Paragon 28, Inc., et. al., 24-cv-02712. 24-cv-02898-PAB-TPO, Docket No. 1 at 7,
¶ 23. However, the operative complaint, Docket No. 32, brings no claims against Mr.
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Defendants.
ORDER
This matter comes before the Court on Defendants’ Motion to Dismiss the
Amended Consolidated Class Action Complaint (DKT. 32) [Docket No. 40] and
defendants’ Request for Judicial Notice in Support of Defendants’ Motion to Dismiss
Amended Consolidated Class Action Complaint (Dkt. 32) [Docket No. 41]. Plaintiff filed
responses, Docket Nos. 42 and 43, and defendants filed replies. Docket Nos. 44 and
45.
I. BACKGROUND 3
Paragon 28 (“Paragon”) is a medical device company which develops and sells a
wide range of implants, instruments, and surgical systems designed to treat various foot
and ankle conditions. 4 Docket No. 32 at 10, 28, ¶¶ 2, 51. In the consolidated class
action complaint, lead plaintiff Nicholas Tiedt brings suit against defendant Albert
DaCosta, Paragon’s Chief Executive Officer (“CEO”) during the class period, 5 defendant
Stephen M. Deitsch, Paragon’s Chief Financial Officer (“CFO”) until April 3, 2024, and
Paragon itself. Id. at 21-24, ¶¶ 29-33. Plaintiff brings claims for securities fraud,
Mickelson and lists him as a relevant non-party Paragon 28 executive. Id. at 24, ¶ 35.
Thus, although the parties list him in the case caption, he is no longer a party.
3 The facts below are taken from plaintiffs’ amended consolidated class action
complaint (“the complaint”), Docket No. 32, and are presumed to be true, unless
otherwise noted, for purposes of ruling on defendants’ motion to dismiss.
4 On April 21, 2025, Paragon was acquired by Zimmer Biomet Holdings, Inc.
Docket No. 32 at 20, ¶ 27. Upon the acquisition, Paragon became a wholly-owned
subsidiary of Zimmer Biomet and was delisted from the New York Stock Exchange. Id.
5 The class period starts on May 5, 2023 and ends on September 20, 2024.
Docket No. 32 at 9.
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alleging violations of Section 10(b) of the Securities Exchange Act, 15 U.S.C. § 78j(b),
and Rule 10b-5 promulgated thereunder, and violations of Section 20(a) of the
Securities Exchange Act. Id. at 151-54, ¶¶ 356-370.
A. Importance of Inventory Management
Medical device companies like Paragon face competing inventory demands: they
must maintain sufficient stock to meet the immediate needs of surgeons and hospitals,
while minimizing excess stock that can quickly become obsolete, damaged, or expired
due to regulatory changes or product advancements. Id. at 10, ¶ 3. Paragon needed to
have an accurate understanding of its inventory in order to gauge important financial
metrics. Id. at 29, 32-34, 39-41, ¶¶ 53-54, 63-67, 69, 80-87. Inventory related data
impacts how Paragon calculated its Adjusted Earnings Before Interest, Taxes,
Depreciation, and Amortization (“Adjusted EBITDA”) and gross margin, which are
financial metrics that are material to investors and analysts. Id. at 39, ¶ 81.
The initial inventory data is multiple steps removed from the ultimate calculation
of Adjusted EBITDA and gross margin. Id. at 39-41, ¶¶ 80-87. Paragon must have an
accurate count of its existing inventory in order to determine the carrying value of its
inventory. Id. at 32, ¶ 63. Paragon’s estimates of its excess and obsolete inventory are
also based in part on current inventory levels. Id. at 32-33, ¶¶ 65-66. Estimates of
excess and obsolete inventory also relied on historical sales, and are adjusted to reflect
usage patterns and life cycles of Paragon’s implant systems. Id., ¶¶ 64-65. Paragon’s
auditor, Deloitte & Touche LLP (“Deloitte”), identified estimates of excess and obsolete
inventory as a critical audit matter (“CAM”), noting that it related to accounts or
disclosures which are material to financial statements, but that there is a high degree of
subjectivity involved in its calculation. Id. at 33, ¶ 66. Deloitte also noted that Paragon’s
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estimates involved sensitivity related to changes in key assumptions, including length of
product life cycles. Id. Data related to excess and obsolete inventory is utilized when
calculating costs of goods sold. Id. at 39-40, ¶¶ 82-83. Costs of goods sold refers to
costs which are attributable to manufacturing or selling the inventory of a business. Id.
at 39, ¶ 82. Moreover, in regard to the implants Paragon sells, the cost of goods sold is
not recognized until the implant is used in surgery. Id. at 39-40, ¶ 83. As a result, being
able to account for the status of implants is important for determining costs of goods
sold. Id. Costs of goods sold is an important input when calculating gross profit and
gross margin. Id. at 40, ¶ 84. Paragon calculated gross profit as net revenue less cost
of goods sold, and gross margin as gross profit divided by net revenue. Id. As a result,
any increase in the costs of goods sold—including through charges due to the amount
of excess and obsolete inventory or use of implants in surgery—would lead to a
decrease in Paragon’s gross profit and gross profit margin. Id. A decrease in
Paragon’s gross profit would negatively impact Paragon’s Adjusted EBITDA. Id., ¶ 85.
The inverse is true as well, understating the cost of goods sold would result in an
overstatement of gross margin and Adjusted EBITDA. Id., ¶ 86. In sum, the accurate
calculation of gross margin and Adjusted EBITDA depends on properly accounting for
the existence and valuation of inventory. Id. at 40-41, ¶ 87.
B. Paragon’s Improper Inventory Control
Paragon lacked sufficient inventory controls and could not track and accurately
value its inventory. Id. at 42, ¶ 93. Five former employees (“FEs”) support that Paragon
had inventory management problems. Id. at 42-51, 54-65, ¶¶ 94, 96-97, 100-119, 126-
32. For example, FE-1 was a product manager at Paragon who was responsible for
reporting and forecasting estimates of inventory availability. Id. at 25, ¶ 37. FE-1 said
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that Paragon did not pause business operations when changing its inventory tracking
system, leading to billing and tracking issues. Id. at 42-43, ¶ 94. Moreover, FE-1 stated
that higher-volume Stock Keeping Units (“SKUs”) were not tracked by lot numbers,
which purportedly made it impossible to determine how much product was on hand or
shipped to distributers. Id. at 43-44, ¶ 97. FE-1 stated there were no standard
operating procedures in place for inventory tracking. Id. at 49, ¶ 114. FE-4—a senior
financial analyst—stated that Paragon utilized an “SAP system.” Id. at 26-27, 45, ¶ 45,
101. This system could ostensibly be used to track inventory. Id. at 45, ¶ 102.
However, in practice, Paragon employees did not rely on any cohesive system to track
inventory. Id., ¶ 103.
For example, FE-4 stated that there was no system in place to know what was in
stock and what was needed. Id. at 45-46, ¶ 104. FE-4 claimed that each department
seemed to have a different method to track inventory, with many using Excel
spreadsheets. Id. FE-1 said that many Paragon employees used Excel spreadsheets
to track inventory. Id. at 46-47, ¶ 107. FE-3—a sales representative—stated that sales
representatives similarly struggled to track inventory. Id. at 47-48, ¶ 109. FE-3 said
that, when FE-3 did receive direction from Paragon on how to track inventory, the
system Paragon provided failed to track when products expired. Id., ¶¶ 109-110. FE-
2—a senior design quality engineer—noted that some parts were not tracked once they
were shipped out. Id. at 25 58, ¶¶ 40, 140. FE-5—a distribution supervisor responsible
for inventory—said that Paragon’s “bin accuracy” was poor for industry standards. Id. at
27, 48-49, ¶¶ 47-49, 112. Bin accuracy is a term which describes whether a physical
bin contains its documented components. Id. at 48-49, ¶ 112. FE-5 stated that, when
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FE-5 began working at Paragon in October 2022, the bin accuracy was approximately
53%, but was up to 81% in January 2025. Id. According to FE-4 and FE-5, audits
showed that Paragon’s reported inventory figures did not align with the actual inventory
counts. Id. at 54-55, ¶¶ 126-130. FE-5 said that Deloitte personnel expressed concern
to FE-5 about the accuracy of the audits. Id. at 55, ¶ 131. Exacerbating the inventory
problems further, FE-5 stated that FE-5 was often told to stop receiving inventory. Id. at
56, ¶ 133. FE-5 stated that Paragon’s supply chain director and Paragon’s supply chain
manager told FE-5 that this was because they did not want the inventory recorded on
the books. Id.
There were also inventory issues stemming from Paragon’s inventory
management of “Hindfoot” products. Id. at 49-50, ¶¶ 115-116. Hindfoot was Paragon’s
largest product line and consisted of various nails, plates, and screws. Id., ¶ 115. FE-1
stated that a product manager, Mark Traina, knew that there were glaring problems
involving the inventory levels of Hindfoot products. Id. at 50, ¶ 116. However, in spite
of this knowledge, FE-1 said that Paragon executives informed employees that the
inventory levels for Hindfoot products were satisfactory. Id. Thus, the Paragon
salesforce would promote Hindfoot products when there was not sufficient inventory to
sell them. Id.
C. Paragon Executive’s Knowledge of Inventory Issues
Mr. DaCosta and Mr. Deitsch had varying levels of involvement with the
purported ongoing inventory management issues. FE-1 said that Mr. DaCosta attended
weekly calls dedicated to fixing tracking and inventory issues. Id. at 52, ¶ 121. Mr.
DaCosta “gave guidance” during these meetings. Id. at 43, ¶ 95. Spreadsheets entitled
“stockout reports” were prepared for the weekly calls and were emailed to various
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recipients, including Mr. DaCosta and Mr. Deitsch. Id. at 52, ¶ 122. The stockout
reports detailed current levels of inventory. Id. According to FE-1, the stockout reports
were used during the calls to show discrepancies between what procurement said was
available in Paragon’s inventory and what was actually available in inventory. Id. at 52-
53, ¶ 123. Furthermore, “[a]ccording to FE-1, DaCosta was totally informed of [the]
inventory issues affecting the Hindfoot products.” Id. at 50, ¶ 116. “[I]nventory controls
fell under the Company’s overall internal control for financial reporting.” Id. at 41, ¶ 89.
Mr. DaCosta and Mr. Deitsch certified that they were responsible for establishing and
maintaining internal controls, that they evaluated internal controls, and that they
reported on their effectiveness. Id. at 42, ¶ 92.
Other Paragon executives besides Mr. DaCosta and Mr. Deitsch were informed
about the inventory issues. For instance, FE-4 formed a monthly meeting dedicated to
establishing a new process for determining what Paragon has in stock. Id. at 53-54,
¶ 125. Multiple senior employees participated in these meetings. Id. FE-5 sent emails
regarding inventory tracking issues to multiple Paragon executives. Id. at 49, ¶ 113.
Similarly, FE-1 discussed inventory issues in-person with Paragon executives. Id. at 51,
¶ 119.
D. Defendants’ Misstatements 6
Plaintiff alleges that defendants artificially inflated or maintained Paragon’s stock
price by falsely reporting key financial results, including Paragon’s Adjusted EBITDA
6 Plaintiff pleads 57 separate paragraphs detailing defendants’ allegedly false
and misleading statements, with some of these paragraphs consisting of multiple
statements. Docket No. 32 at 87-93, 100-106, 109-113, 115-120, 124-126, ¶¶ 211-222,
234-247, 254-262, 267-279, 286-294. While the Court has analyzed the details of each
statement, it will only provide an overview of the allegedly false and misleading
statements here.
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and gross margin, affirming Paragon’s internal controls, and misrepresenting the state
of Paragon’s inventory. Id. at 60, ¶ 145. Specifically, plaintiff alleges that defendants
falsely stated Paragon’s financial metrics, including Paragon’s gross margin and
Adjusted EBITDA, in all quarters of 2023 and the first quarter of 2024. Id. at 87-90, 92-
106, 109-113, 115-120, ¶¶ 211-217, 234-247, 254-262, 267-279.
On July 30, 2024, Paragon filed a restatement announcement with the Securities
Exchange Commission (“SEC”) which disclosed that its past financial statements should
no longer be relied upon. Id. at 66, ¶ 157. The restatement announcement stated that
Paragon “identified errors in the accounting for inventory including the calculation of its
excess and obsolete inventory reserve.” Id., ¶ 158. These errors resulted in the
overstatement of inventory in all quarters of 2023 and the first quarter of 2024, and an
understatement in the costs of goods sold for the same period. Id. The restatement
announcement also stated that, as a result of the accounting errors, Paragon “identified
one or more material weaknesses in its internal control over financial reporting” and that
its internal control was not effective. Id. at 67, ¶ 160. On August 8, 2024, Paragon filed
its amended financial statements on Form 10-K/A and on Form 10-Q/A. Id. at 68,
¶ 165. In its Form 10-K/A, Paragon claimed that the restatements would correct not
only the identified errors in the calculation of excess and obsolete inventory, but also
errors in Paragon’s accounting for inventory variances. Id. at 68-69, ¶ 166. It was
these errors which impacted the valuation of inventory, resulting in an overstatement of
“Inventories, net” and “a net understatement in Cost of goods sold.” Id. Paragon
reiterated that, “during the second quarter of fiscal year 2024, errors were identified with
respect to our accounting for the valuation of inventory, including the calculation of the
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excess and obsolescence reserve and capitalization of purchase price variances
[(“PPVs”)].” Id. at 78-79, ¶ 185.
On August 8, 2024, in addition to filing its Form 10-K/A, Paragon filed restated
financial statements. Id. at 69, ¶ 167. Paragon determined that its Q1 2023 7 gross
margin was inflated by 3.1% and its Adjusted EBITDA loss was understated by 93.4%.
Id. at 70, ¶ 170. Paragon’s Q2 2023 gross margin was inflated by 6.4% and its
Adjusted EBITDA loss was understated by 104.3%. Id. at 72, ¶ 173. Paragon’s Q3
2023 gross margin was inflated by 3.6% and its Adjusted EBITDA loss was understated
by 122.3%. Id. at 74, ¶ 176. Paragon’s Q4 2023 gross margin was inflated by 6.2%
and its Adjusted EBITDA loss was understated by 62.5%. Id. at 76, ¶ 180. For the
entire 2023 fiscal year, Paragon’s gross margin was inflated by 4.9% and its Adjusted
EBITDA loss was understated by 86%. Id. Finally, Paragon’s Q1 2024 gross margins
were inflated by 3.3% and its Adjusted EBITDA was understated by 40.6%. Id. at 78,
¶ 183. For Q2 and Q3 of 2023 and for Q1 of 2024, the gross margins reported prior to
the restatement were over 80%, but were under 80% after the restatement was issued.
Id. at 72, 74, 78, ¶¶ 173, 176, 183. Mr. Deitsch had previously represented to investors
that Paragon was working towards Adjusted EBITDA profitability and that Paragon
expected to maintain an 80% gross margin. Id. at 91, 104, 119, ¶¶ 219, 243, 275-76.
Mr. Deitsch resigned from Paragon shortly after the end of Q1 2024, claiming he
was pursuing an opportunity with another medical device company. Id. at 65, ¶ 154.
Additionally, on September 20, 2024, less than two months after the restatement was
issued, Paragon’s Chief Accounting Officer, Erik Mickelson, resigned. Id. at 83, ¶ 195.
7 Q1 2023 refers to the first quarter of 2023.
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Paragon’s stock price dropped shortly after announcing each of these resignations. Id.
at 65, 83, ¶¶ 154-56, 195-96.
Mr. DaCosta and Mr. Deitsch attached Sarbanes-Oxley certifications 8 (“SOX
certifications”) to various financial reports. Id. at 89-91, 102, 112, 118-119, ¶¶ 216-17,
8 Section 302 of the Sarbanes-Oxley Act of 2002, PL 107-204, 116 Stat 747
requires certain officers of public companies to certify all annual and quarterly reports
filed with the SEC. Sarbanes-Oxley § 302 certification, 1 Sec. Law Handbook § 12:41;
15 U.S.C. § 7241(a). Specifically, the officers certify that:
(1) the signing officer has reviewed the report;
(2) based on the officer's knowledge, the report does not contain any untrue
statement of a material fact or omit to state a material fact necessary in order to make
the statements made, in light of the circumstances under which such statements were
made, not misleading;
(3) based on such officer's knowledge, the financial statements, and other
financial information included in the report, fairly present in all material respects the
financial condition and results of operations of the issuer as of, and for, the periods
presented in the report;
(4) the signing officers--
(A) are responsible for establishing and maintaining internal controls;
(B) have designed such internal controls to ensure that material information
relating to the issuer and its consolidated subsidiaries is made known to such
officers by others within those entities, particularly during the period in which the
periodic reports are being prepared;
(C) have evaluated the effectiveness of the issuer's internal controls as of a date
within 90 days prior to the report; and
(D) have presented in the report their conclusions about the effectiveness of their
internal controls based on their evaluation as of that date;
(5) the signing officers have disclosed to the issuer's auditors and the audit
committee of the board of directors (or persons fulfilling the equivalent function)--
(A) all significant deficiencies in the design or operation of internal controls which
could adversely affect the issuer's ability to record, process, summarize, and report
financial data and have identified for the issuer's auditors any material weaknesses in
internal controls; and
(B) any fraud, whether or not material, that involves management or other
employees who have a significant role in the issuer's internal controls; and
(6) the signing officers have indicated in the report whether or not there were
significant changes in internal controls or in other factors that could significantly affect
internal controls subsequent to the date of their evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses. 15 U.S.C.
§ 7241(a)(1)-(6).
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239, 260, 274, 292. These certifications attested to the effectiveness of Paragon’s
internal controls. Id. Mr. Deitsch misrepresented the state of Paragon’s inventory by,
among other things, creating an impression that Paragon was able to accurately track
its inventory. Id. at 103-04, 106, 120, ¶¶ 241, 243, 247, 278-79. During the Class
Period, Paragon’s stock lost hundreds of millions of dollars in market capitalization,
down more than 65% from its Class Period high. Id. at 19, ¶ 20. Plaintiff alleges that
the inaccurate financial metrics, the SOX certifications regarding Paragon’s internal
controls, and the misrepresentations about inventory artificially impacted Paragon’s
stock price. Id. at 60, ¶ 145.
II. LEGAL STANDARD
“Section 10(b) of the Securities Exchange Act and Rule 10b–5 promulgated
thereunder ‘prohibit making any material misstatement or omission in connection with
the purchase or sale of any security.’” Smallen v. The W. Union Co., 950 F.3d 1297,
1304 (10th Cir. 2020) (quoting Halliburton Co. v. Erica P. John Fund, Inc., 573 U.S. 258,
267 (2014)); see also 15 U.S.C. § 78j(b); 17 C.F.R. § 240.10b-5. To prevail on a
Section 10(b) and Rule 10b-5 claim, a plaintiff must prove that:
(1) the defendant made an untrue or misleading statement of material fact,
or failed to state a material fact necessary to make statements not
misleading; (2) the statement complained of was made in connection with
the purchase or sale of securities; (3) the defendant acted with scienter,
that is, with intent to defraud or recklessness; (4) the plaintiff relied on the
misleading statements; and (5) the plaintiff suffered damages as a result
of his reliance.
Smallen, 950 F.3d at 1304 (citation omitted). In this case, the third element—scienter—
is at issue.
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When “faced with a Rule 12(b)(6) motion to dismiss a § 10(b) action, courts must,
as with any motion to dismiss for failure to plead a claim on which relief can be granted,
accept all factual allegations in the complaint as true.” Tellabs, Inc. v. Makor Issues &
Rts., Ltd., 551 U.S. 308, 322 (2007). 9 In most civil actions, a complaint need only
contain “a short and plain statement of the claim showing that the pleader is entitled to
relief.” Fed. R. Civ. P. 8(a)(2). However, “federal law creates a heavy burden on
claimants alleging securities fraud.” Meitav Dash Provident Funds & Pension Ltd. v.
Spirit AeroSystems Holdings, Inc., 79 F.4th 1209, 1216 (10th Cir. 2023). In an effort to
decrease abusive securities fraud actions by private parties, “Congress enacted the
Private Securities Litigation Reform Act of 1995 (PSLRA), 109 Stat. 737.” Tellabs, 551
U.S. at 313. The PSLRA “imposed heightened pleading standards that ‘require[ ]
plaintiffs to state with particularity both the facts constituting the alleged violation, and
the facts evidencing scienter.” In re Zagg, Inc. Sec. Litig., 797 F.3d 1194, 1201 (10th
Cir. 2015) (quoting Tellabs, 551 U.S. at 313).
In the context of securities fraud, “[s]cienter is a mental state embracing [1] intent
to deceive, manipulate, or defraud, or [2] recklessness.” Smallen, 950 F.3d at 1304
(citation and internal quotations omitted). “[R]ecklessness under section 10(b) is a
9 Moreover, “courts must consider the complaint in its entirety, as well as other
sources courts ordinarily examine when ruling on Rule 12(b)(6) motions to dismiss, in
particular, documents incorporated into the complaint by reference, and matters of
which a court may take judicial notice.” Tellabs, 551 U.S. at 322. Defendants have filed
a motion for the Court to take judicial notice of multiple SEC filings and transcripts from
earnings calls. Docket No. 41. The motion is opposed. Docket No. 43. However, the
complaint fails to state a claim on its face, thus obviating the need to refer to the
substance of the documents filed by defendants. Thus, the Court will deny the motion
as moot.
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particularly high standard.” Dronsejko v. Thornton, 632 F.3d 658, 668 (10th Cir. 2011)
(citation omitted); see also In re Zagg, 797 F.3d at 1201 (“Recklessness in the context
of securities fraud is a high bar.”). “It is defined as conduct that is 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 Zagg, 797 F.3d at 1201 (citation and internal quotations
omitted). In other words, “recklessness is akin to conscious disregard—allegations of
negligence or even gross negligence fall ‘below the high threshold for liability under
Section 10(b) of the Exchange Act.’” Smallen, 950 F.3d at 1305 (quoting Dronsejko,
632 F.3d at 668).
In order to properly plead scienter under the PLSRA, the complaint must, “with
respect to each act or omission . . ., 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)(A) (emphasis added). In Tellabs, 551 U.S. at 314, the Supreme Court analyzed
the term “strong inference,” holding that “an inference of scienter must be more than
merely plausible or reasonable—it must be cogent and at least as compelling as any
opposing inference of nonfraudulent intent.” Id. Thus, the analysis is “inherently
comparative: How likely is it that one conclusion, as compared to others, follows from
the underlying facts.” Id at 323. In making this determination, “a court must consider
plausible, nonculpable explanations for the defendant’s conduct, as well as inferences
favoring the plaintiff.” Id. at 324. The Supreme Court further specified that “[t]he inquiry
. . . is whether all of the facts alleged, taken collectively, give rise to a strong inference
of scienter, not whether any individual allegation, scrutinized in isolation, meets that
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standard.” Id. at 322-23 (emphasis in original). Therefore, courts must “assess all the
allegations holistically.” Id. at 326.
III. ANALYSIS
In their motion to dismiss, defendants argue that plaintiff has failed to plead
particularized facts creating a strong inference of scienter. Docket No. 40 at 9. The
Court agrees. 10 The Court begins its analysis by examining the parties’ competing
inferences of defendants’ scienter.
A. Competing Scienter Theories
Defendants claim that defendants made an accounting error, which they argue
creates a compelling inference that defendants acted without fraudulent intent. Id. at
21-22. Specifically, defendants argue that Paragon has complex inventory
requirements which require it to calculate excess and obsolete inventory reserves. Id.
at 22. The calculation of excess and obsolete inventory reserves is complicated and
requires subjective judgment with respect to multiple variables. Id. In 2024, Paragon
discovered an error in its calculation, which impacted its financial metrics. Id. Upon
discovery of this error, Paragon immediately disclosed its mistake, issued a
restatement, and took steps to correct the error. Id.
Conversely, plaintiff posits a theory of the case which he claims creates a
compelling inference that defendants did act with fraudulent intent. Docket No. 42 at
10 Defendants also argue that plaintiff challenges certain statements which are
not actionable because they are either not false or because they are “mere puffery.”
Docket No. 40 at 22-24. Additionally, defendants claim that plaintiff has failed to
establish loss causation in regard to press releases announcing the departures of Mr.
Deitsch and Mr. Mickelson. Id. at 24-25. Because the Court will grant the motion to
dismiss on defendants’ scienter argument, it need not consider defendants’ other
arguments.
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22-23. Plaintiff argues that Paragon’s ability to accurately track inventory was deeply
flawed. Id. at 22. Defendants were aware of Paragon’s inventory management issues,
and knew they would skew material financial metrics—specifically, Adjusted EBITDA
and gross margin. Id. Defendants were motivated to avoid disrupting Paragon’s key
financial goals and to conceal Paragon’s issues with its inventory management. Id. at
23. In order to accomplish this, defendants stated false financial metrics. Id. When the
falsity could no longer be maintained, the restatements and resignations occurred. Id.
Plaintiff alternatively argues that the complaint alleges scienter based on recklessness.
Id. at 22.
Plaintiff’s theory is premised on the notion that the misstated financial metrics
leading to the restatement were due to Paragon’s issues with managing its inventory.
Defendants argue that this is a fatal flaw in plaintiff’s theory of scienter because “[t]he
Complaint itself alleges that the Restatement was the result of errors in accounting
calculations—in P28’s calculation of its E&O inventory reserve and its capitalization of
PPVs—and not due to issues with physical inventory inputs into those calculations.”
Docket No. 44 at 4. In this regard, defendants are correct. According to the complaint,
the restatement announcement stated that Paragon “identified errors in the accounting
for inventory including the calculation of its excess and obsolete inventory reserve” and
that these errors resulted in the overstatement of inventory and an understatement in
costs of goods sold. Docket No. 32 at 66, ¶ 158 (emphasis added). Moreover, the
restatement announcement indicated that Paragon “identified one or more weaknesses
in its internal control over financial reporting” as a result of the accounting errors. Id. at
67, ¶ 160. The Form 10-K/A reiterates that “errors were identified with respect to our
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accounting for the valuation of inventory, including the calculation of the excess and
obsolesce reserve and capitalization of purchase price variances.” Id. at 78-79, ¶ 185.
The Form 10-K/A further noted that the restatements would correct these accounting
errors, but does not mention that Paragon would change any inventory management
practices. Id. at 68-69, ¶ 166. Thus, the complaint alleges that the misstated financial
metrics were due to accounting errors, not due to issues managing inventory.
Plaintiff, however, argues that “[i]nventory levels are an input for calculating
Paragon’s ‘cost of goods sold,’ which is an important figure used to determine Adjusted
EBITDA and gross margin.” Docket No. 42 at 4. Plaintiff is correct that inventory data
was an important input in Paragon’s calculations for determining Adjusted EBITDA and
gross margin. Paragon’s estimates of its excess and obsolete inventory were based in
part on its current inventory levels. Docket No. 32 at 32-33, ¶¶ 65-66. In fact,
defendants themselves note that certain data, including quantities of inventory on hand,
was used by management “in making their estimates and assumptions related to
excess and obsolete inventories.” Docket No. 40 at 6 (citation omitted). Data related to
excess and obsolete inventory was used to calculate the costs of goods sold, which is
an important input when calculating gross margin and Adjusted EBITDA. Docket No. 32
at 39-41, ¶¶ 82-84, 87. But where plaintiff’s argument fails is that the complaint does
not allege that inaccurate inputs were the cause of the misstated financial metrics.
Rather, the complaint indicates that errors in accounting for excess and obsolete
inventory and capitalization of PPVs 11 were what led to the restatement. Id. at 78-79,
11 Plaintiff does not argue that Paragon’s inventory management problems led to
errors in accounting for capitalization of PPVs. See generally Docket No. 42.
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¶ 185. In other words, the problem was not with the data input into the equation, but
with the equation itself.
The Court will therefore analyze whether there is a strong inference that
defendants acted with scienter when stating the financial metrics that were affected by
the accounting error. For defendants to have done so, they must have either known of
the accounting error or must have acted in reckless disregard of its existence.
Moreover, even though the complaint does not allege that inventory issues led to the
misstated financial metrics, plaintiff is correct that there is a necessary link between
inventory data and the calculation of Adjusted EBITDA and gross margin. And not all
allegations of fraud in the complaint are based on the misstated financial metrics; some
arise from alleged misstatements Mr. DaCosta and Mr. Deitsch made about Paragon’s
inventory. Id. at 103-04, 106, 120, ¶¶ 241, 243, 247, 278-79. Additionally, it is possible
that the financial metrics were inaccurate due to inventory management issues even
though defendants claimed in the restatement that an accounting error was to blame.
Thus, the Court will also analyze whether Paragon’s inventory issues create a
compelling inference of scienter.
1. 	Knowledge of Accounting Error
The only allegations that plaintiff points to which could support an inference that
defendants had knowledge of the accounting error relate to the restatement. 12 Docket
No. 42 at 21-22. “But the mere existence of an error warranting restatement does not
necessarily reflect on the scienter behind that error.” In re Molson Coors, 2020 WL
13499995, at *4. Rather, “[w]hether the Restatement and the underlying [ ]accounting
12 Plaintiff, however, notes that he “does not rely on Paragon’s restatements as
primary support for scienter.” Docket No. 42 at 21.
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error imply scienter depends on what exactly the error entailed.” Id. An error that is
simple or obvious is more likely to support an inference of scienter. Id. Moreover, “[t]he
magnitude of an alleged falsity can strengthen a scienter inference.” Id. at *5.
Here, the accounting error is not simple. Although the complaint does not allege
how Paragon accounted for the capitalization of PPVs, see generally Docket No. 32, it
does allege facts which support a finding that calculating estimates of excess and
obsolete inventory was a complicated task. Id. at 32-33, ¶¶ 64-66. Specifically, the
complaint alleges that Deloitte identified the estimates of excess and obsolete inventory
as a CAM. 13 Id. at 33, ¶ 66. Deloitte identified the estimate of excess and obsolete
inventory as a CAM “because of the high degree of subjectivity involved in developing
the estimates and sensitivity related to changes in key assumptions including length of
product life cycles.” 14 Id. Thus, according to Deloitte, calculating estimates of obsolete
and excess inventory involved subjective judgment calls and required sensitive
assumptions to be made. Yet, despite Deloitte’s awareness of these potential issues in
calculating estimates of obsolete and excess inventory, plaintiff does not allege that
Deloitte was aware of the accounting error or that defendants concealed the accounting
13 “A CAM is any matter arising from the audit of the financial statements that
was communicated or required to be communicated to the audit committee, and that 1)
relates to accounts or disclosures that are material to the financial statements; and 2)
involved especially challenging, subjective, or complex auditor judgment.” Robert G.
Eccles, A Critical Audit Matter: It’s Time for Auditors To Come Clean On Climate
Change, Forbes (Mar. 10, 2021, at 13:04 ET),
https://www.forbes.com/sites/bobeccles/2021/03/10/a-critical-audit-matter-its-time-for-
auditors-to-come-clean-on-climate-change/.
14 In his response, plaintiff asserts that Deloitte “flagged the importance of
properly tracking inventory as a critical audit matter.” Docket No. 42 at 21. However,
for support, plaintiff cites Docket No. 32 at 33, ¶ 66, which states that Deloitte “identified
management’s estimate of excess and obsolete inventories as a critical audit matter.”
Docket No. 32 at 33, ¶ 66.
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error from Deloitte. These allegations lead to an inference that the accounting error was
complicated. See Molson Coors, 2020 WL 13499995 (finding the fact that “Plaintiffs
bring no claim against [their auditor] and do not allege that Defendants concealed the
fraud from [their auditor] or that [their auditor] was aware of the accounting error or
participated in the alleged fraud” to be indicative that the auditor failed to identify the
error, and thus to be indicative that the error was not “simple” or “obvious.”).
Moreover, cases have acknowledged that “[a]ccounting for the financial results of
a large publicly-traded company is a highly complicated task,” and plaintiff points to no
allegations indicating that the accounting here would be an exception. U.S. S.E.C. v.
Dunn, 587 F. Supp. 2d 486, 504 (S.D.N.Y. 2008); see also McGrane v. Reader's Dig.
Ass’n, Inc., 822 F. Supp. 1044, 1046 (S.D.N.Y. 1993) (“For better or worse, in most
large corporate entities financial structures and their associated accounting, reporting
and recordkeeping aspects are highly complex.”). Finally, plaintiff alleges that the error
is not complex because “it is obvious to a CEO and CFO that the inability to track its
large inventory undercut the financial statements.” Docket No. 42 at 21. This misses
the point. As discussed above, according to the complaint, the financial statements
were inaccurate not because of an inability to track inventory, but because of an
accounting error. In any event, as will be discussed below, the Court finds that it would
not be obvious to Mr. DaCosta and Mr. Deitsch that Paragon’s inventory management
issues would lead to misstated financial metrics. Thus, the complexity of the error
weighs against an inference that defendants must have known about the error.
The magnitude of the restatement also weighs against an inference that
defendants knew about the error. The complaint indicates Paragon’s gross profit was
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not severely impacted by the restatement. Docket No. 32 at 70, 72, 74, 76, 78, ¶¶ 170,
173, 176, 180, 183. For example, Paragon only restated five quarters worth of financial
metrics. Id. Paragon initially reported that its gross profit for the 2023 fiscal year—
consisting of four of the quarters restated—was $172,791,000 15 whereas its restated
gross profit for the 2023 fiscal year was $164,435,000. Id. at 76, ¶ 180. Paragon
initially reported that its gross profit for Q1 2024 was $48,896,000, whereas its restated
gross profit for Q1 2024 was $47,240,000. Id. at 78, ¶ 183. Thus, the difference
between Paragon’s initially reported gross profit and its restated gross profit is
$10,012,000. Conversely, in In re Qwest Commc’ns Int’l, Inc. Sec. Litig., 387 F. Supp.
2d 1130, 1147 (D. Colo. 2005), the plaintiff alleged a “sustained pattern of repeated
manipulations and misrepresentations over a period of more than two and one-half
years . . . of a substantial magnitude amounting to hundreds of millions of dollars.”
There, the court found that the “magnitude of these alleged manipulations and
misrepresentations is large enough to provide substantial support for a strong inference
of scienter.” Id. In this case, an error causing a difference of $10,012,000 dollars in
quarterly gross profit over the course of five quarters, while not insignificant, is not
substantial enough to indicate that defendants must have known of the error.
The Court will now analyze whether Paragon’s inventory management issues
give rise to a strong inference of scienter.
15 The chart in the complaint indicates that the amount is $172,791. Docket No.
32 at 76, ¶ 80. The Court presumes that the amount is actually $172,791,000, and the
chart uses $172,791 as a shorthand for formatting purposes. This is the case for all the
subsequent mentions of gross profit in this paragraph.
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B. Inventory Management
Plaintiff has pled sufficient allegations with particularity to indicate that Paragon
failed to effectively manage its inventory. See, e.g., Docket No. 32 at 25, ¶ 37
(Paragon’s transition to a new inventory tracking system); id. at 45, ¶¶ 102-03
(disjointed methods for tracking inventory across departments); id. at 25, 58, ¶¶ 40, 140
(a failure to track inventory once it was shipped); id. at 43-44, ¶ 97 (a failure to track
higher-volume SKUs by lot numbers). Moreover, plaintiff alleged that audits and bin
accuracy statistics confirmed that Paragon did not have an accurate count of its
inventory. Id. at 48-49, 54-55, ¶¶ 112, 126-131.
C. Knowledge of Inventory Management Issues
Plaintiff’s allegations about Mr. DaCosta and Mr. Deitsch’s knowledge of the
inventory management issues are less compelling. Plaintiff attempts to establish
defendants’ knowledge through the statements of FEs. 16 First, plaintiff relies on
allegations from FE-1 that Mr. DaCosta knew about the inventory management issues
due to his participation in a weekly call. Docket No. 42 at 12. The complaint alleges
that “FE-1 said that CEO DaCosta . . . sat in on numerous calls discussing the
[inventory management] issues and gave guidance to get people moving in the right
direction.” Docket No. 32 at 43, ¶ 95. Moreover, according to FE-1, “there was a
dedicated call that took place once per week to try to fix tracking and inventory issues.
FE-1 attended these calls, and said that DaCosta would be on the calls discussing
16 When analyzing the statements of the former employees, the court “accept[s]
the truth of the witness’s accounts as pleaded in the complaint and do[es] not assess
the witnesses’ credibility.” Anderson v. Spirit Aerosystems Holdings, Inc., 827 F.3d,
1229, 1239 (10th Cir. 2016) (citations omitted).
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these issues.” Id. at 52, ¶ 121. While plaintiff alleges that inventory management
issues were discussed in the call, plaintiff does not allege any details of what Mr.
DaCosta was told or if he was informed of the full extent of Paragon’s inventory tracking
issues. Furthermore, while plaintiff alleges Mr. DaCosta discussed the issues and gave
guidance, plaintiff does not allege what Mr. DaCosta’s statements concerned or what
guidance he gave. Thus, the Court cannot determine from these allegations what
specific knowledge Mr. DaCosta had regarding the inventory issues.
Moreover, the Tenth Circuit has stated that “mere attendance at meetings does
not contribute to an inference of scienter.” Anderson, 827 F.3d at 1246 (citing MHC
Mut. Conversion Fund, L.P. v. Sandler O'Neill & Partners, L.P., 761 F.3d 1109, 1122
(10th Cir. 2014)); see also In re Level 3 Commc’ns, Inc. Sec. Litig., 667 F.3d 1331, 1344
(10th Cir. 2012). The Tenth Circuit analyzed the effect of defendants’ regular
attendance at meetings in In re Level 3 Commc’ns, 667 F.3d at 1344. There, the
defendants’ alleged misstatements revolved around the integration of an acquired
company into the parent company. Id. The plaintiff alleged that defendants monitored
the integration process through regular meetings and reports. Id. The court held that,
while the defendants’ monitoring of the situation could plausibly lead to an inference of
scienter, it was not as compelling as a competing inference. Id. at 1344-45. In order to
make this determination, the court analyzed the content of the meetings and reports. Id.
Here, plaintiff has not alleged the details of the meetings’ content with particularity, so
the Court cannot properly analyze competing inferences regarding whether the calls
imparted Mr. DaCosta with knowledge about the extent of Paragon’s inventory issues.
And while Mr. DaCosta might have had some knowledge of the inventory management
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issues through these calls, there is no indication that he had knowledge that these
inventory issues were pervasive and severe. See Smallen, 950 F.3d at 1307 (“We fail
to see how . . . discussions about the need for improving Western Union’s compliance
controls equates to knowledge of ongoing, unaddressed compliance violations.”). The
allegation that Mr. DaCosta gave guidance during the calls suggests that Mr. DaCosta
did more than merely passively attend the meetings, but, as noted earlier, the allegation
about guidance does not explain what guidance Mr. DaCosta gave or how it related to
his knowledge of Paragon’s inventory issues.
Plaintiff’s reliance on FEs for inferring the scienter of defendants is limited by the
FEs’ access to the defendants. The Tenth Circuit has found evidence from former
employees less compelling when they were not in a reporting relationship with
defendants. See Anderson, 827 F.3d at 1243-44; Meitav Dash, 79 F.4th at 1220-21.
FE-1 did not report to Mr. DaCosta directly. Docket No. 32 at 25, ¶ 38. Plaintiff has not
alleged that anybody FE-1 reported to was in a reporting relationship with Mr. DaCosta.
Docket No. 32 at 25, ¶ 38. FE-1 reported to the VP of Marketing and Product
Management, who reported to the Chief Commercial Officer. Id. There is no allegation
that the Chief Commercial Officer reported to Mr. DaCosta. Thus, plaintiff’s allegations
regarding Mr. DaCosta’s participation in the weekly calls does not create a compelling
inference that Mr. DaCosta was aware of the severity of Paragon’s inventory
management issues.
Plaintiff’s other allegations on this subject have similar deficiencies. For
example, plaintiff alleges that “FE-1 sent weekly emails for months with spreadsheets
and guidance updating the finance and forecasting departments and advising them of
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massive discrepancies in inventories. FE-1’s forecasting reports – which included
estimates of inventory availability – were also sent to DaCosta. FE-1 said their
guidance was continuously ignored.” Docket No. 32 at 44, ¶ 98. This allegation
provides no inference that Mr. Deitsch knew of the inventory management issues.
While Mr. Deitsch, as CFO, would presumably be in the finance department, there is no
particularized allegation that Mr. Deitsch received the email. See Anderson, 827 F.3d at
1240 (finding that reports which allegedly undercut a defendant’s statements did not
contribute to a cogent or compelling inference of scienter because, among other
reasons, there were no allegations that the reports were sent to the defendant).
These emails do not create a compelling inference of scienter regarding Mr.
DaCosta either. While plaintiff alleges that Mr. DaCosta was sent the emails, the
allegation does not explain what guidance was sent or how severe the discrepancies
were. See id. at 1240-41 (finding that reports which allegedly undercut a defendant’s
statements did not contribute to a cogent or compelling inference of scienter because,
among other reasons, there were not sufficient allegations as to the content of the
reports).
Plaintiff alleges, based on FE-1’s statements, that Paragon executives, including
Mr. DaCosta and Mr. Deitsch, were regularly sent “stockout reports.” Docket No. 32 at
52, ¶ 122. The stockout reports listed current levels of inventory and, according to FE-
1, were used in the weekly calls to show discrepancies between what procurement
believed was available and what was actually in Paragon’s inventory. Id. at 52-53,
¶ 123. This allegation has the same deficiencies as the allegations above. For one,
there are no particularized allegations regarding the discrepancies identified in the
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stockout reports or how they were discussed during the weekly meetings. Second,
there is no allegation that Mr. Deitsch was on the weekly calls. Accordingly, the
stockout reports fail to establish a compelling inference of scienter.
Plaintiff points to the allegation that Mr. DaCosta was “totally informed of
inventory issues affecting the Hindfoot products” as evidence that Mr. DaCosta knew
about Paragon’s inventory management issues. Docket No. 42 at 9. The general claim
that Mr. DaCosta was “totally informed” is not stated with particularity, as it does not
explain how he became informed. Thus, it fails to satisfy the heightened pleading
standards of the PSLRA and does not contribute to a compelling inference of scienter.
Plaintiff argues that the “core operations doctrine lends further support to a
strong scienter inference.” Id. at 13-14. “Core-operations refer to instances where the
nature of the relevant facts allegedly known and not disclosed by defendants was ‘of
such prominence that it would be “absurd” to suggest that management was without
knowledge of the matter.’” In re Molycorp, Inc. Sec. Litig., 157 F. Supp. 3d 987, 1011
(D. Colo. 2016) (citation omitted). The Tenth Circuit has held that courts “cannot infer
scienter based only on a defendant’s position in a company or involvement with a
particular project.” Anderson, 827 F.3d at 1245; see also Meitav Dash, 79 F.4th at
1222; City of Philadelphia v. Fleming Companies, Inc., 264 F.3d 1245, 1264 (10th Cir.
2001). “However, an allegation that an individual defendant knew certain information
based on that individual’s position in a company, combined with other relevant
allegations concerning knowledge or motive, can be sufficient to support a strong
inference of scienter under the PSLRA.” In re Qwest, 396 F. Supp. 2d at 1206 (D. Colo.
2004) (citing Adams v. Kinder-Morgan, Inc., 340 F.3d 1083, 1105-06 (10th Cir. 2003));
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see also In re Molycorp., 157 F. Supp. 3d at 1010-11. Thus, the mere fact that Mr.
DaCosta was CEO and Mr. Deitsch was CFO cannot establish scienter, but it can help
support a strong inference of scienter in conjunction with other allegations.
As CEO, Mr. DaCosta would likely have a general understanding of large-scale
issues impacting Paragon, like the inventory management issues, particularly
considering his involvement in the weekly calls. However, just as the allegations about
the weekly calls did not establish that Mr. DaCosta had an in-depth knowledge of the
extent of the inventory management issues, there is no reason to believe Mr. DaCosta
would know the full extent of the inventory management issues by nature of being CEO.
Moreover, “an executive’s position in the company doesn’t show knowledge of specific
facts.” Meitav Dash, 79 F.4th at 1217 (citations omitted).
As for Mr. Deitsch, plaintiff has not provided sufficient allegations establishing
that he had any knowledge of the inventory management issues. Thus, because there
are no relevant allegations regarding Mr. Deitch’s knowledge, no inference of scienter
can be established solely by reference to his position. In any event, it is not clear why it
would be “absurd,” In re Molycorp., 157 F. Supp. 3d at 1011, to suggest that Mr.
Deitsch, as CFO, did not have knowledge of Paragon’s inventory management issues.
Finally, the complaint contained allegations that other Paragon executives were
informed about the inventory management issues. Docket No. 32 at 49, 51, 53-54,
¶¶ 113, 119, 125. While these allegations help establish that Paragon did in fact have
issues managing its inventory, they do nothing to establish that Mr. DaCosta or Mr.
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Deitsch had knowledge of those issues. 17 Accordingly, while plaintiff arguably
establishes that Mr. DaCosta had some knowledge of the inventory management
issues, plaintiff does not establish that Mr. DaCosta knew those issues were ongoing,
pervasive, and severe. Moreover, plaintiff does not establish that Mr. Deitsch had any
knowledge of the inventory issues whatsoever.
D. Inventory Issues’ Impact on Financial Metrics
As discussed above, Paragon’s inventory management issues are unrelated to
Paragon’s misstated financial metrics. This is because the complaint alleges that the
financial metrics were misstated due to accounting errors related to the calculation of
excess and obsolete inventory and capitalization of purchase price variants, not due to
issues with inventory. Docket No. 32 at 78-79, ¶ 185. The fact that inventory data is an
input in calculating excess and obsolete inventory does not change this; the issue is
with the calculation itself, not the underlying data. Thus, issues with inventory
management cannot give rise to an inference of scienter as to the financial statements.
However, as explained below, even if Paragon’s inventory management issues did
impact the misstated financial metrics, they would still not give rise to a strong inference
of scienter.
17 Plaintiff argues that the allegation which claims FE-5 was told to stop receiving
inventory further supports scienter. Docket No. 42 at 20-21. However, the allegation
states that “FE-5 received these directions from Omar Romo . . . and Jesus Regosa.”
Docket No. 32 at 56, ¶ 133. Nevertheless, plaintiff argues that “such a scheme of
operational scope and material impact would likely require the direct knowledge or
approval of DaCosta and Deitsch, who are ultimately responsible for the accuracy of
reported financials.” Docket No. 42 at 20. The complaint contains no allegations that
Mr. DaCosta or Mr. Deitsch knew of the alleged direction to stop receiving inventory, nor
does the Court find that such an action would invariably be approved by a company’s
CEO or CFO. Thus, this allegation does not support an inference of scienter.
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E. Knowledge of Inventory Issues’ Impact on Financial Metrics
If Mr. DaCosta and Mr. Deitsch did not know that the inventory management
issues would materially impact Paragon’s financial metrics, then there can be no
inference of scienter arising from misstating the financial metrics. Plaintiff notes that
Paragon’s 2024 annual report detailed how Paragon’s inventory levels affected
Adjusted EBITDA and gross margin. Docket No. 42 at 14. Plaintiff also claims that the
financial statements in Paragon’s quarterly and annual reports reference inventories as
part of the earnings, expense, and income calculations. Id. Plaintiff argues that Mr.
DaCosta and Mr. Deitsch were aware that Paragon’s inventory management issues
would affect Adjusted EBITDA and gross margin because they certified the annual
reports. Id. at 15.
Defendants point to In re Gold Res. Corp. Sec. Litig., 776 F.3d 1103, 1116 (10th
Cir. 2015), as support for the proposition that “[t]he ‘bare allegation’ that defendants lied
when they certified [their] financial statements pursuant to SOX adds ‘nothing
substantial to the scienter calculus.’” Docket No. 44 at 12. But, in this context, plaintiff
is not attempting to establish scienter by stating that defendants lied when certifying the
annual reports. 18 Docket No. 42 at 15-16. Rather, plaintiff is arguing that the SOX
certifications show that defendants had knowledge of the annual reports, and thus had
knowledge that inventory levels would impact financial metrics. Id. SOX certifications
can be indicative of a defendant’s knowledge. See Croker v. Carrier Access Corp., No.
05-cv-01011-LTB-OES, 2006 WL 2035366, at *11 (D. Colo. July 18, 2006) (noting that
SOX certifications are “one factor among many that courts may consider, in the totality
18 Plaintiff does make this argument in the context of SOX certifications regarding
Paragon’s internal controls, which will be discussed below. Docket No. 42 at 13.
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of the circumstances, to evaluate scienter” and that SOX certifications can be indicative
of a defendant’s knowledge.).
Plaintiff also argues that Mr. DaCosta and Mr. Deitsch demonstrated their
knowledge of how inventory affects Adjusted EBITDA and gross margins in earnings
calls. Docket No. 42 at 16. A defendant’s statements to analysts and investors can
support a finding of scienter. Indiana Pub. Ret. Sys. v. Pluralsight, Inc., 45 F.4th 1236,
1263-64 (10th Cir. 2022). Mr. Deitsch made comments about how excess and obsolete
inventory costs impacted gross profit margin. Docket No. 32 at 90-91, ¶ 218. Mr.
Deitsch also noted how inventory stockpiling relates to write-downs, which in turn
reduces gross profit margins. Id. at 119, ¶ 276.
Finally, plaintiff argues that Mr. DaCosta and Mr. Deitsch would know that an
inability to track physical inventory would impact key financial metrics due to their
respective positions as CEO and CFO. Docket No. 42 at 16. As mentioned above, Mr.
DaCosta and Mr. Deitsch’s position can only support an inference of scienter in
conjunction with other allegations. The Court finds it reasonable that a CFO would have
the financial literacy to understand that physical inventory would affect the calculation of
Adjusted EBITDA and gross margin. This is particularly true here, where Mr. Deitsch
certified the annual reports and made statements regarding how inventory impacted
gross profit margins. 19 It is less clear that a CEO would necessarily have this
knowledge. Nevertheless, the Court finds that defendant provided enough allegations
to establish at least a weak inference that Mr. DaCosta might have known that issues
19 As noted earlier, plaintiff has not sufficiently alleged that Mr. Deitsch was
aware that Paragon was experiencing issues managing its inventory.
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with inventory management could affect financial metrics. This does not, however,
establish that Mr. DaCosta knew that Paragon’s inventory issues were pervasive or
severe enough to materially affect its Adjusted EBITDA and gross margin calculations.
F. Motive
Merely arguing that a defendant had access to information which contradicted
the defendant’s statements is not sufficient to draw a strong inference of scienter.
Meitav Dash, 79 F.4th at 1217. Rather, “[a] plaintiff must . . . allege facts with
particularity showing not only the executive’s access to contradictory information but
also the executive’s fraudulent intent or reckless disregard of accessible information.”
Id. Plaintiff attempts to allege facts showing Mr. DaCosta and Mr. Deitsch’s fraudulent
intent by arguing that they had a motive to represent to investors that Paragon reached
its financial goals of maintaining an 80% gross margin level and of working towards
EBITDA profitability. Docket No. 42 at 18-19. Plaintiff argues that the fact that the
inaccurate financial metrics “directly caused Paragon to reach these touted metrics
strongly suggests an inference of motive.” Id. at 19. Plaintiff also argues that Mr.
DaCosta and Mr. Deitsch “had a personal motive to conceal the inventory problems to
avoid being seen as incapable of managing Paragon or being caught misrepresenting
facts” and that “Defendants . . . hoped to obtain additional time to create a successful
image.” Id.
Allegations of motive are relevant to the scienter analysis, but the absence of a
motive allegation is not fatal. Tellabs, 551 U.S. at 325. “Motive allegations must show
that the defendant benefitted from the alleged fraud in some concrete and personal
way.” Molson Coors, 2020 WL 13499995, at *7 (citation and internal quotations
omitted). For instance, “personal financial gain may weigh heavily in favor of a scienter
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inference.” Tellabs, 551 U.S. at 325; see also MHC Mut. Conversion Fund, L.P., 761
F.3d at 1122 (finding that allegations of motive did not establish scienter because the
complaint did not allege that the defendants stood to personally benefit). “But general
motives for management to further the interests of a corporation fail to raise an
inference of scienter. Corporate officers always have an incentive to improve the lot of
their companies, but this is not, absent unusual circumstances, a motive to commit
fraud.” In re Level 3 Commc’ns, 667 F.3d at 1346 (citation and internal quotations
omitted).
Here, plaintiff’s motive allegations are those of general motive and are insufficient
to establish scienter. Every corporate officer would desire to represent to investors that
a company has reached its financial goals by achieving its aspired Adjusted EBITDA
and gross margin. Thus, such an allegation fails to show that defendants would benefit
from the alleged fraud in a concrete and personal way. This is particularly true when
there are no allegations that defendants had any unique stake in Paragon reaching its
financial goals. Moreover, the inaccurate gross margins were not always over 80%.
For instance, the originally reported gross margin for Q4 2023 was 74.5%, but was
restated as 69.9%. Docket No. 32 at 76, ¶ 180. Additionally, the gross margin for fiscal
year 2023 was originally reported as being 79.9%, but was restated as 76%. Id. Thus,
the alleged motive of keeping gross margins at or above 80% was not consistently
achieved. And even when the gross margins were originally reported as being over
80%, but were later restated as being below 80%, the discrepancy was relatively minor.
For instance, the originally reported gross margin for Q3 2023 was 80.3%, but was
restated as 77.4%. Id. at 74, ¶ 176. This weakens the allegations of motive because
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there is less of a reason to defraud investors when Paragon’s accurate financial metrics
were not significantly lower than its aspired to metrics. 20
Plaintiff’s argument that Mr. DaCosta and Mr. Deitsch had a personal motive to
conceal the inventory problems to avoid being seen as incapable also fails to establish
scienter. For one, there are no allegations in the complaint that Mr. DaCosta or Mr.
Deitsch had any specific duty to oversee Paragon’s inventory or that they were uniquely
responsible for the inventory issues. There are no specific allegations in the complaint
that Mr. DaCosta or Mr. Deitsch had a compelling reason to cover up Paragon’s
inventory issues. Thus, this does not show that Mr. DaCosta or Mr. Deitsch would
benefit from the alleged fraud in a concrete and personal manner. The argument that
Mr. DaCosta and Mr. Deitsch hoped to obtain additional time to create a successful
image fails for the same reason; it is a general corporate motive that is not specific to
defendants. See Anderson, 827 F.3d at 1238-39 (stating that a motive to mislead in
order to buy time in the hope that a difficult financial situation would right itself was
insufficient to establish scienter because it suggests a “generalized corporate motive.”).
There are also logical flaws present in plaintiff’s motive argument. As explained
above, the allegations in the complaint relating to Paragon’s inventory issues show that
Paragon was unable to accurately track its inventory. There are no allegations,
20 Plaintiff argues that, even if the originally reported gross margins and Adjusted
EBITDAs were not significantly different than the restated metrics, the restatement still
had a substantial effect, “as Paragon’s share price dropped 13.7% and 20% on July 31
and August 9, 2024, respectively, after investors learned of the restatements.” Docket
No. 42 at 21 (citing Docket No. 32 at 144, ¶¶ 327, 329). It is possible the drop in stock
price was because Paragon’s gross margins were no longer consistently at 80% and
because Paragon was no longer on the road to EBITDA profitability. However, it is a
more compelling inference that the drop in stock price was because Paragon had to
issue a restatement to begin with, which disconcerted investors.
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however, that Mr. DaCosta or Mr. Deitsch intentionally falsified inventory data in order to
increase Adjusted EBITDA and gross margin, or that Mr. DaCosta or Mr. Deitsch knew
the inaccurate inventory data would lead to a higher Adjusted EBITDA and gross
margin. Thus, even if Mr. DaCosta and Mr. Deitsch knew that Paragon had severe and
pervasive inventory issues and knew that those inventory issues would impact its
financial metrics, there is no indication that Mr. DaCosta or Mr. Deitsch knew those
inaccurate financial metrics would be inflated. More importantly, the restatement
indicated that the initially reported financial metrics were inaccurate due to an
accounting error, not because of issues managing inventory. As discussed above,
there are no allegations supporting an inference that Mr. DaCosta or Mr. Deitsch knew
about the accounting error. Without knowledge of the accounting error, there is no
plausible inference that they used improper accounting or inventory management
practices to manipulate the financial statements. This significantly undercuts plaintiff’s
argument that Mr. DaCosta and Mr. Deitsch were acting with the intent to defraud
investors.
G. Recklessness
Even if Mr. DaCosta and Mr. Deitsch did not act with fraudulent intent when
stating Paragon’s inaccurate financial metrics, plaintiff argues, in the alternative, they
acted recklessly. Docket No. 42 at 22. Plaintiff states that, “[a]t a minimum, Defendants
acted with recklessness, as they were well aware that their inventory tracking and
accounting system was ineffective and . . . they consciously disregarded the impact the
inventory tracking uses has on their public representations.” Id.
As noted above, “recklessness under section 10(b) is a particularly high
standard.” Dronsejko, 632 F.3d at 668 (citation omitted). In fact, “recklessness in this
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context is . . . something closer to a state of mind approximating actual intent.” In re
Zagg, 797 F.3d at 1206 (citations and internal quotations omitted). Plaintiff has failed to
meet this high standard.
As discussed above, the complaint indicates that the accounting error was
complicated. There are no allegations that defendants knew of the error but did nothing
about it. Moreover, failing to catch such a complicated error does not represent an
extreme departure from the standards of ordinary care, especially for non-accountants.
Thus, the Court finds that the complaint fails to allege that defendants were reckless as
to the accounting error.
Furthermore, Mr. DaCosta and Mr. Deitsch were not reckless as to Paragon’s
inventory management issues either. As explained above, the allegations in the
complaint fail to plausibly allege that Mr. Deitsch had knowledge of Paragon’s inventory
management issues, and only establish a weak inference that Mr. DaCosta had
knowledge of the inventory management issues. However, the allegations of the
complaint do not sufficiently allege that the inventory management issues would impact
the financial metrics which would need to be restated, as the restatement was issued
due to the accounting error. But even if financial metrics did need to be restated
because of inventory issues, there would still not be a compelling inference of scienter
based on recklessness. While the complaint alleges that Mr. Deitsch was aware that
inventory management issues would impact financial metrics, this is not relevant to
scienter because the complaint does not plausibly allege that Mr. Deitsch knew Paragon
was experiencing inventory management issues. The complaint only makes a weak
showing that Mr. DaCosta knew that inventory management issues would impact
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financial metrics, which is further undercut by the fact that the complaint does not
sufficiently allege that Mr. DaCosta had particularized knowledge of how severe or
pervasive Paragon’s inventory management problems were. Thus, plaintiff has not
strongly established that Mr. DaCosta or Mr. Deitsch knew Paragon’s originally stated
financial metrics were inaccurate, and thus has not strongly established that Mr.
DaCosta or Mr. Deitsch knew the originally stated financial metrics would present a
danger of misleading investors.
However, even if plaintiff made a stronger showing that Mr. DaCosta and Mr.
Deitsch had knowledge of the inventory management issues and the possibility that
those issues could impact financial metrics, there would still not be an extreme
departure from the standards of ordinary care. The fact that Paragon experienced
inventory management issues is akin to a “red flag” that could have put Mr. DaCosta
and Mr. Deitsch on alert that there might be issues with accurately calculating
Paragon’s Adjusted EBITDA and gross margin. 21 The Tenth Circuit has been reluctant
to find that defendants are reckless for failing to properly account for red flags, instead
finding it to be negligent. See Smallen, 950 F.3d at 1312 (finding that a failure to give
adequate weight to red flags established an inference of, “at most, . . . negligence or
possibly even gross negligence.”); Anderson, 827 F.3d at 1238 (finding that a failure to
give adequate weight to financial red flags likely was indicative of benign optimism
rather than malevolence); In re Level 3 Commc’ns, 667 F.3d at 1345 (holding that
21 No red flags arise from the accounting error, however, because the accounting
error was complicated and did not substantially impact Paragon’s financial metrics.
Thus, there was nothing that should have reasonably put defendants on notice that
such an error existed.
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allegations based on an inconsistency between the defendants’ progress reports and
internal reports were inadequate to establish scienter because “the strongest inference
we can draw is that defendants were negligent in failing to put together the pieces.”).
Plaintiff’s complaint arguably establishes a weak inference that Mr. DaCosta and Mr.
Deitsch did not properly account for Paragon’s inventory management issues when
stating Paragon’s Adjusted EBITDA and gross margin; however, that inference is not
helpful to plaintiff on scienter because the complaint does not indicate that the inventory
management issues caused the Adjusted EBITDA and gross margin to be restated.
And even if inventory management did impact the financial metrics, such an oversight
would be at worst negligent. Allegations that amount to negligence or even gross
negligence do not suffice to establish recklessness. In re Zagg, 797 F.3d at 1201.
Accordingly, the complaint fails to create a strong inference that Mr. DaCosta or Mr.
Deitsch were reckless.
H. Other Alleged Misstatements
Beyond allegations that defendants disclosed inaccurate financial metrics,
plaintiff’s claims are also based on statements regarding Paragon’s internal controls
over financial accounting and the state of Paragon’s inventory. Docket No. 42 at 9.
Plaintiff fails to establish that these alleged statements were made with scienter.
1. 	Internal Controls
Plaintiff notes that “DaCosta and Deitsch certified their responsibility for
establishing and maintaining internal controls and evaluating their effectiveness.” Id. at
13. These certifications affirmed the effectiveness of Paragon’s internal controls. Id.
Plaintiff argues that “[t]he stark contradiction between their repeated attestations of the
effectiveness of internal controls and the subsequent acknowledgement of severe
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deficiencies . . . supports scienter.” Id. However, for SOX certifications to establish
scienter, the question is not whether they were false when made, “but whether
defendants made them knowing that they were false.” In re Molson Coors, 2020 WL
13499995, at *10. “Absent particularized facts suggesting that Defendants knew of the
certifications’ falsity, the certifications’ mere existence is ‘unpersuasive’ to prove
scienter and at most supports an inference of negligence.” Id. (citing In re Zagg, 797
F.3d at 1205). An argument that statements regarding effective internal controls were
false when made because the defendant later admitted the controls were inadequate
“says nothing about whether Defendants made them with scienter.” Id. at *6. In fact,
“the material weakness in [defendants’] internal controls over financial reporting may
well favor Defendants by explaining why the accounting problem was missed, without
implying anything about Defendants’ scienter.” Id. Accordingly, Mr. DaCosta and Mr.
Deitsch’s SOX certifications do not create an inference of scienter because there is no
indication that they knew the certifications were false at the time they were made.
2. 	State of Paragon’s Inventory
Plaintiff claims that defendants misrepresented the state of Paragon’s inventory,
citing various allegations in the complaint for support. Docket No. 42 at 9 (citing Docket
No. 32 at 103-04, 106, 116-17, 120, ¶¶ 241, 243, 247, 269-70, 278-79). Plaintiff does
not provide any argument to establish scienter relating to these allegations. See
generally id. The Court does not find that any of the allegations establish a strong
inference of scienter.
Notably, the allegations in paragraphs 241, 242, 247, 278, and 279 involve
statements made by Mr. Deitsch about Paragon’s inventory. Docket No. 32 at 103-04,
106, 120, ¶¶ 241-42, 247, 278-279. These statements do not establish a strong
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inference of scienter because, as discussed above, plaintiff has not shown that Mr.
Deitsch had knowledge of Paragon’s inventory management issues. For example,
paragraphs 241, 242, and 247 state that Mr. Deitsch misleadingly represented that
Paragon’s inventory levels were increasing. Id. at 103-04, 106, ¶¶ 241-42, 247. The
complaint alleges that these statements were misleading because Paragon did not have
the ability to track and value its inventory. Id. However, Mr. Deitsch could not have
made these allegations with fraudulent intent because there are no allegations
establishing that he knew Paragon did not have the ability to track and value its
inventory. Thus, the allegations related to Mr. Deitsch do not establish an inference of
scienter.
Paragraph 269 alleges that defendants made statements which “gave the false
impression that the Company’s significant inventory write-off of $4 million was a one-
time event ‘[r]elated to the recent inventory stockpiling’ and not, in reality, ongoing
issues affecting the Company’s ability to track and value its inventory.” 22 Id. at 116-17,
¶ 269. However, this allegation is conclusory, as plaintiff provides no particularized
facts showing how defendants gave this false impression. Paragraph 270 expands on
this allegation, stating that, in an investor presentation, defendants showed a slide
which noted that Paragon’s EBITDA was “negatively impacted by $4.0M of inventory
write-downs recorded in the fourth quarter.” Id. at 117, ¶ 270. According to the
complaint, this “misrepresented that the $4.0 million inventory write-off was a one-off
event.” Id. The Court does not find that this language gives the impression that the
22 Plaintiff does not allege which defendants made these statements, claiming
that they came from a press release from the February 2024 8-k. Docket No. 32 at 116,
¶ 269.
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write-off was a one-off event. Moreover, even if it did give that impression, plaintiff does
not provide argument that defendants did not honestly believe that the $4.0 million
dollar write-off was a one-off event. Thus, these allegations fail to establish an
inference of scienter.
I. 	Additional Allegations of Scienter
Plaintiff points to additional allegations which he claims support scienter. Docket
No. 42 at 19-22. These include allegations relating to Mr. Deitsch and Mr. Mickelson
resigning from Paragon and allegations relating to Paragon violating Generally
Accepted Accounting Principles (“GAAP”). Id.
1. 	Executive Departures
Plaintiff argues that Mr. Deitsch’s and Mr. Mickelson’s departures from Paragon
support an inference of scienter. Id. at 19-20. Specifically, plaintiff points out that
“Deitsch departed Paragon in April 2024, just months before Defendants disclosed the
restatements and internal control material weaknesses.” Id. at 19. Plaintiff argues that
timing of this resignation is suspicious and supports a finding of scienter. Id.
Additionally, plaintiff notes that Mr. Deitsch’s replacement—interim CFO Kristina
Wright—quickly discovered the inventory error, suggesting that it was obvious. Id. at
20. Plaintiff argues that Mr. Mickelson—the Chief Accounting Officer—also departed
Paragon under suspicious circumstances. Id. Plaintiff points to Mickelson’s unilateral
release of claims, arguing that it suggests a potential dispute regarding the role he had
in overseeing the accounting and internal control issues. Id. Plaintiff also finds it
suspicious that Paragon did not announce a replacement for Mr. Mickelson. Id.
An executive’s resignation does not give rise to a strong inference of scienter
merely because it occurs close in time to a restatement; instead, there must be
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particularized allegations connecting the resignation to the alleged fraud. See Bouzaglo
v. Inspirato Inc., No. 23-cv-00438-RMR-SBP, 2024 WL 3738813, at * 5 (D. Colo. July
16, 2024), report and recommendation adopted sub nom. Koch v. Inspirato Inc., 2024
WL 4591328 (D. Colo. Sept. 23, 2024); In re Molson Coors, 2020 WL 13499995, at *11
(“Plaintiffs fail to explain why this retirement was suspicious, pointing only to its temporal
proximity to the Restatement. Absent factual allegations connecting Hunter’s retirement
to the alleged fraud, his departure at best gives rise to only a weak inference of
scienter.”). Thus, the argument that Mr. Deitsch’s resignation is suspicious because it
occurred months before the restatements were disclosed does not create a strong
inference of scienter. Moreover, the complaint alleges that Mr. Deitsch claimed he
resigned to pursue an opportunity with a different medical device company. Docket No.
32 at 65, ¶ 154. See Bouzaglo, 2024 WL 3738813, at *5 (“there are any number of
reasons that an executive might resign, most of which are not related to fraud”) (citation
omitted).
Plaintiff’s argument that Ms. Wright’s quick discovery of the inventory error shows
that the error was obvious similarly fails to create a strong inference of scienter.
Arguably, Ms. Wright’s quick discovery of the error creates a weak inference that Mr.
Deitsch was negligent, but negligence is insufficient to establish scienter. In re Zagg,
797 F.3d at 1201.
Furthermore, Mr. Mickelson’s resignation is irrelevant to defendants’ scienter.
When an executive is a non-party and when there are no allegations connecting them to
the alleged fraud, courts do not give their resignations any weight. See In re Molson
Coors, 2020 WL 13499995, at *11 (“None of these executives are named as defendants
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and there are no allegations connecting them to the alleged fraud. The Court gives
these departures no weight.”). Here, there are no allegations explaining why Mr.
Mickelson’s release of claims or Paragon’s failure to announce a replacement relates to
defendants’ mental state. Thus, the Court finds it does not contribute to an inference of
scienter.
2. 	GAAP Violations
Plaintiff argues that Paragon’s GAAP violations support scienter. Docket No. 42
at 22. GAAP “are the conventions, rules, and procedures that define accepted
accounting practices.” United States v. Arthur Young & Co., 465 U.S. 805, 811 n.7
(1984) (citations omitted). Financial statements filed with the SEC that are not prepared
in compliance with GAAP are presumed to be inaccurate or misleading. 17 C.F.R.
§ 210.4-01(a)(1); Docket No. 32 at 30, ¶ 57. Defendants represented that Paragon’s
financial statements were prepared and issued in conformity with GAAP. Id. Plaintiff
alleges that Paragon’s inability to track its inventory constituted a GAAP violation. Id. at
34, ¶ 68.
“[A]llegations of GAAP violations or accounting irregularities, standing alone, are
insufficient to state a securities fraud claim.” In re Gold, 776 F.3d at 1113 (citation
omitted). “Only where such allegations are coupled with evidence that the violations or
irregularities were the result of the defendant’s fraudulent intent to mislead investors
may they be sufficient to state a claim.” Fleming, 264 F.3d at 1261. As discussed when
the Court analyzed motive, defendants did not have fraudulent intent to mislead
investors. Accordingly, defendants’ alleged GAAP violations do not support scienter.
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J. 	Holistic Analysis
Once a court has addressed plaintiff’s scienter-related allegations, it must
“assess all the allegations holistically.” Tellabs, 551 U.S. at 326 (citation omitted). In
doing so, the court “must ask: When the allegations are accepted as true and taken
collectively, would a reasonable person deem the inference of scienter at least as
strong as any opposing inference.” Id. Here, the answer is no. The Court will first
address allegations related to Mr. DaCosta and then address allegations related to Mr.
Deitsch.
Under plaintiff’s theory of the case, Paragon had severe and pervasive issues
managing its inventory. Mr. DaCosta became aware of these issues through
participating in a weekly call (the exact details of which are not alleged), receiving
various reports and emails (the exact details of which are not alleged), and through his
role as CEO. Mr. DaCosta knew the inventory management issues would impact
Paragon’s ability to accurately calculate its Adjusted EBITDA and gross margin, as
evidenced through his certification of annual reports which contained this information,
through a statement he made after Paragon had already disclosed its error, and through
his role as CEO. Using this knowledge, Mr. DaCosta risked engaging in fraud to inflate
Paragon’s Adjusted EBITDA and gross margins to reach Paragon’s financial goals,
while not inflating gross margins enough to consistently achieve those goals. Mr.
DaCosta did this despite not knowing whether the accurate inventory data would cause
Paragon’s Adjusted EBITDA and gross margin to be higher or lower than what was
reported. Mr. DaCosta then decided to issue a restatement which falsely claimed that
the financial metrics were misstated due to an accounting error, when the real cause
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was because of issues with managing inventory. Mr. DaCosta issued this restatement
despite the risk that a restatement could lead to a drop in stock price.
As for Mr. Deitsch, the complaint alleges that he became fully apprised of
Paragon’s inventory management issues through his role as CFO and through receiving
stockout reports which detailed current levels of inventory, without having participated in
the weekly calls discussing the stockout reports to understand their context. Mr.
Deitsch had the financial knowledge to understand that these inventory issues would
impact Paragon’s financial metrics. Not knowing whether the accurate Adjusted
EBITDA and gross margin would be higher or lower than what was calculated, Mr.
Deitsch nevertheless stated inaccurate financial metrics in the hopes of defrauding
investors. Afterwards, Mr. Deitsch resigned in disgrace.
This theory of the case does not create a compelling inference of scienter.
Plaintiff’s additional allegations related to GAAP violations, Mr. Mickelson’s departure,
inventory controls, and what other Paragon executives knew do little to bolster them.
The simpler, more compelling explanation is that Paragon’s inventory issues were not
the cause of the misstated financial metrics at all. Rather, as indicated in the
restatement, Paragon’s financial metrics were skewed due to a complex accounting
error. Mr. DaCosta and Mr. Deitsch did not know about this error, and once they
discovered it, Paragon issued a restatement explaining the mistake. As for the
misstatements regarding Paragon’s inventory, the most compelling explanation is that
Mr. DaCosta and Mr. Deitsch did not fully understand Paragon’s inventory issues,
leading them to state some mistakenly inaccurate comments. This opposing
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explanation suggests no inference of scienter. Thus, plaintiff has failed to establish
scienter, and his Section 10(b) claim and Rule 10b-5 claim will be dismissed. 23
K. Control Person Liability
Plaintiff also brings a claim for “control-person” liability under Section 20(a) of the
Securities Exchange Act, 15 U.S.C. § 78t(a). Docket No. 32 at 153-56, ¶¶ 366-70.
“[T]o state a prima facie case of control person liability, the plaintiff must establish (1) a
primary violation of the securities laws and (2) ‘control’ over the primary violator by the
alleged controlling person.” Adams, 340 F.3d at 1107 (citing Fleming, 264 F.3d at
1270-71). Plaintiff has failed to establish a primary violation of the securities laws.
Thus, the Court will dismiss plaintiff’s Section 20(a) claim. See Smallen, 950 F.3d at
1315 (dismissing Section 20(a) claims after the plaintiff failed to establish scienter, and
thus failed to allege a primary violation of the securities fraud).
L. Dismissal With Prejudice
At the end of his response to defendants’ motion, plaintiff notes that, “[i]f the
Court grants any part of the motion, Lead Plaintiff believes any defects can be resolved
and requests that dismissal be without prejudice as to have the opportunity to amend
based on the Court’s order.” Docket No. 42 at 25. Plaintiff, however, has not filed a
motion to amend the complaint.
23 “The scienter of the senior controlling officers of a corporation may be
attributed to the corporation itself to establish liability as a primary violator of § 10(b) and
Rule 10b-5 when those senior officials were acting within the scope of their apparent
authority.” Adams, 340 F.3d at 1006. The Court found that Mr. DaCosta and Mr.
Deitsch did not act with scienter. Thus, no scienter may be attributed to Paragon from
their actions. Plaintiff makes no other argument regarding Paragon’s scienter. See
generally Docket No. 42. Thus, plaintiff has failed to establish that Paragon acted with
scienter and dismissal against all parties is appropriate.
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“It is normally improper to request leave to amend a complaint in response to a
motion to dismiss.” Nardy v. Chipotle Mexican Grill, Inc., No. 17-cv-01760-WYD-STV,
2019 WL 3297467, at *18 (D. Colo. Mar. 29, 2019) (citing Calderon v. Kansas Dep’t of
Soc. & Rehab. Servs., 181 F.3d 1180, 1187 (10th Cir. 1999)). The Local Rules of this
District state that “a motion shall not be included in a response or reply to the original
motion,” D.C.COLO.LCivR 7.1(d), and the Federal Rules of Civil Procedure require that
a “request for a court order must be made by motion.” Fed. R. Civ. P. 7(b)(1). Thus,
plaintiff has inadequately presented his request to amend the complaint.
Moreover, plaintiff’s request is merely a single sentence and does not explain
how plaintiff would amend his complaint. “[A] request for leave to amend must give
adequate notice to the district court and to the opposing party of the basis of the
proposed amendment before the court is required to recognize that a motion for leave to
amend is before it.” In re Gold, 776 F.3d at 1118 (quoting Calderon, 181 F.3d at 1186-
87). Plaintiff’s single sentence fails to provide any such notice here. “Absent any stated
basis for the proposed amendment, ‘a district court need not independently determine
whether grounds justifying an amendment exist.’” In re Molson Coors, 2020 WL
13499995, at *13 (quoting Sanchez v. Crocs, Inc., 667 F. App’x 710, 725 (10th Cir.
2016) (unpublished)). Plaintiff has already filed a detailed, 156-page amended
complaint, and has not explained how he plans to amend it to remedy its deficiencies.
Accordingly, the Court will deny plaintiff’s request for leave to amend and will dismiss
plaintiff’s Amended Consolidated Class Action Complaint for Violations of the Federal
Securities Laws, Docket No. 32, with prejudice.
IV. CONCLUSION
Therefore, it is
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ORDERED that Defendants’ Motion to Dismiss the Amended Consolidated Class
Action Complaint (Dkt. 32) [Docket No. 40] is GRANTED. It is further
ORDERED that the Request for Judicial Notice in Support of Defendants’ Motion
to Dismiss Amended Consolidated Class Action Complaint (Dkt. 32) [Docket No. 41] is
DENIED as moot. It is further
ORDERED that plaintiff’s Amended Consolidated Class Action Complaint for
Violations of the Federal Securities Laws [Docket No. 32] is DISMISSED with
prejudice. It is further
ORDERED that this case is closed.
DATED March 24, 2026.
BY THE COURT:
___________________________
PHILIP A. BRIMMER
United States District Judge
__________________	_ _______
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