Filed: Mar. 07, 2014
Latest Update: Mar. 02, 2020
Summary: PUBLISHED UNITED STATES COURT OF APPEALS FOR THE FOURTH CIRCUIT No. 12-2496 ROBERT YATES, MJG-08-269; ALAN S. BARRY, MJG-08-269; DAVID YOUNG, MJG-08-269; CARLO HORNSBY; ED FRIEDLANDER, MJG-08-269; PAUL ENGEL, individually and on behalf of all others similarly situated MJG-08-292; WILLIAM D. FELIX; DAVID KREMSER, on behalf of himself and on behalf of Elk Meadow Investments, LLC; CHARLES W. DAMMEYER, on behalf of himself and others similarly situated, Plaintiffs – Appellants, and F. RICHARD MANSON
Summary: PUBLISHED UNITED STATES COURT OF APPEALS FOR THE FOURTH CIRCUIT No. 12-2496 ROBERT YATES, MJG-08-269; ALAN S. BARRY, MJG-08-269; DAVID YOUNG, MJG-08-269; CARLO HORNSBY; ED FRIEDLANDER, MJG-08-269; PAUL ENGEL, individually and on behalf of all others similarly situated MJG-08-292; WILLIAM D. FELIX; DAVID KREMSER, on behalf of himself and on behalf of Elk Meadow Investments, LLC; CHARLES W. DAMMEYER, on behalf of himself and others similarly situated, Plaintiffs – Appellants, and F. RICHARD MANSON,..
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PUBLISHED
UNITED STATES COURT OF APPEALS
FOR THE FOURTH CIRCUIT
No. 12-2496
ROBERT YATES, MJG−08−269; ALAN S. BARRY, MJG−08−269; DAVID
YOUNG, MJG−08−269; CARLO HORNSBY; ED FRIEDLANDER,
MJG−08−269; PAUL ENGEL, individually and on behalf of all
others similarly situated MJG−08−292; WILLIAM D. FELIX;
DAVID KREMSER, on behalf of himself and on behalf of Elk
Meadow Investments, LLC; CHARLES W. DAMMEYER, on behalf of
himself and others similarly situated,
Plaintiffs – Appellants,
and
F. RICHARD MANSON, individually and on behalf of, all
others similarly situated MJG−08−269; GEETA SHAILAM,
individually and on behalf of all others similarly situated
MJG−08−386; MICHAEL J. CIRRITO, individually and on behalf
of all others similarly situated MJG−08−476; JOHN J.
HUFNAGLE, individually and on behalf of all others
similarly situated MJG−08−579; WILLIAM JOHNSTON,
derivatively on behalf of Municipal Mortgage & Equity, LLC
MJG−08−670; ROBERT STAUB, derivatively on behalf of
Municipal Mortgage & Equity, LLC MJG−08−802; THE MARY L.
KIESER TRUST, by Mary L. Kieser and Ralph F. Kieser,
Trustees, derivatively and on behalf of Nominal Defendant,
Municipal Mortgage & Equity LLC MJG−08−805; JUDITH
GREENBERG; JOSEPH S. GELMIS, individually and on behalf of
all others similarly situated MJG−08−2133; ARNOLD J. ROSS,
MJG−08−2133; TROY BROY; JULES ROTHAS, individually and on
behalf of all others similarly situated MJG−08−2134; NAOMI
RAPHAEL; FAFN/SLATER GROUP; KREMSER GROUP, MJG−08−269,
Plaintiffs,
v.
MUNICIPAL MORTGAGE & EQUITY, LLC; MELANIE M. LUNDQUIST;
MICHAEL L. FALCONE; MERRILL LYNCH PIERCE FENNER AND SMITH
INCORPORATED; RBC CAPITAL MARKETS, LLC.; MARK K. JOSEPH;
CHARLES C. BAUM; EDDIE C. BROWN; ROBERT S. HILLMAN; DOUGLAS
A. MCGREGOR; ARTHUR S. MEHLMAN; FRED N. PRATT, JR.; RICHARD
O. BERNDT; WILLIAM S. HARRISON; DAVID KAY; CHARLES M.
PINCKNEY,
Defendants – Appellees,
and
GARY A. MENTESANA; BARBARA B. LUCAS; EARL W. COLE, III;
ANGELA B. BARONE,
Defendants.
Appeal from the United States District Court for the District of
Maryland, at Baltimore. Marvin J. Garbis, Senior District
Judge. (1:08-md-01961-MJG)
Argued: October 30, 2013 Decided: March 7, 2014
Before DIAZ and FLOYD, Circuit Judges, and Joseph F. ANDERSON,
Jr., United States District Judge for the District of South
Carolina, sitting by designation.
Affirmed by published opinion. Judge Diaz wrote the opinion, in
which Judge Floyd and Judge Anderson joined.
ARGUED: David A.P. Brower, BROWER PIVEN, New York, New York, for
Appellants. Mark Holland, New York, New York, William M. Jay,
GOODWIN PROCTER LLP, Washington, D.C.; Jason J. Mendro, GIBSON,
DUNN & CRUTCHER LLP, Washington, D.C., for Appellees. ON BRIEF:
Charles J. Piven, Yelena Trepetin, BROWER PRIVEN, Stevenson,
Maryland; Sherrie R. Savett, Barbara A. Podell, Eric Lechtzin,
BERGER & MONTAGUE, P.C., Philadelphia, Pennsylvania; Kim E.
Miller, KAHN SWICK & FOTI, LLC, New York, New York; Susan K.
Alexander, Andrew S. Love, ROBBINS GELLER RUDMAN & DOWD LLP, San
Francisco, California, for Appellants. Jonathan C. Dickey,
GIBSON, DUNN & CRUTCHER LLP, New York, New York, for Appellees
Merrill Lynch Pierce Fenner and Smith Incorporated, and RBC
Capital Markets, LLC. Mary K. Dulka, GOODWIN PROCTER LLP, New
York, New York; Anthony Candido, CLIFFORD CHANCE LLP, New York,
2
New York; Stephen A. Goldberg, Ward B. Coe III, GALLAGHER
EVELIUS & JONES LLP, Baltimore, Maryland, for Appellees
Municipal Mortgage & Equity, LLC, Mark K. Joseph, William S.
Harrison, Charles M. Pinckney, and David Kay. William M.
Krulak, Jr., MILES & STOCKBRIDGE P.C., Baltimore, Maryland, for
Appellees Charles C. Baum, Richard O. Berndt, Eddie C. Brown,
Robert S. Hillman, Douglas A. McGregor, Arthur S. Mehlman, and
Fred N. Pratt, Jr. Charles O. Monk, II, Geoffrey M. Gamble,
SAUL EWING LLP, Baltimore, Maryland, for Appellee Michael L.
Falcone. David W.T. Daniels, RICHARDS KIBBE & ORBE LLP,
Washington, D.C., for Appellee Melanie Lundquist.
3
DIAZ, Circuit Judge:
This case involves claims that Municipal Mortgage & Equity
(“MuniMae” or the “Company”), and certain of its officers and
directors (collectively, the “MuniMae defendants”), violated
federal securities laws. 1 Plaintiffs, both individually and as
class representatives, contend that the MuniMae defendants
committed securities fraud by (1) falsely representing that the
Company was in full compliance with a new accounting standard
enacted in 2003; and (2) concealing the substantial cost of
correcting the accounting error. Plaintiffs allege that they
relied on the integrity of the market price of the Company’s
stock, and that, as a result of the MuniMae defendants’
fraudulent conduct, investors paid an artificially inflated
price for MuniMae shares during the class period.
The district court dismissed plaintiffs’ claims under
§§ 10(b) and 20(a) of the Securities Exchange Act of 1934,
finding that the amended complaint failed to adequately plead
scienter, or wrongful intent. The court also dismissed claims
under §§ 11, 12(a)(2), and 15 of the Securities Act of 1933
relating to a secondary public offering (“SPO”). The court
1
Plaintiffs also sued Merrill Lynch, Pierce, Fenner &
Smith, Inc. and RBC Capital Markets Corp., who served as lead
underwriters in a secondary public offering conducted by MuniMae
in 2005.
4
found the § 11 claim time-barred by the applicable statute of
repose, and that plaintiffs lacked standing to bring the
§ 12(a)(2) claim. It dismissed the § 15 claim because
plaintiffs failed to adequately plead a primary violation of the
Securities Act. 2
For the reasons that follow, we affirm.
I.
In reviewing the district court's dismissal under Federal
Rule of Civil Procedure 12(b)(6), “we ‘accept all factual
allegations in the complaint as true.’” Matrix Capital Mgmt.
Fund, LP v. BearingPoint, Inc., 576 F.3d 172, 176 (4th Cir.
2009) (quoting Tellabs, Inc. v. Makor Issues & Rights, Ltd.,
551
U.S. 308, 322, (2007)). And as did the district court, we take
judicial notice of the content of relevant SEC filings and other
publicly available documents included in the record. See In re
PEC Solutions, Inc. Sec. Litig.,
418 F.3d 379, 390 & n.10 (4th
Cir. 2005).
2
The district court refused to dismiss three other claims
alleging violations of the Securities Act. After some
procedural skirmishing not relevant to this appeal, the parties
filed a joint motion requesting that the district court certify
the dismissed claims as final pursuant to Federal Rule of Civil
Procedure 54(b). Finding no just reason for delay, the court
granted the motion. We are satisfied that the district court
acted appropriately in certifying its order under Rule 54(b).
See Culosi v. Bullock, 596 F.3d 195, 203 (4th Cir. 2010).
5
A.
The putative class period for this case spans from May 3,
2004, to January 29, 2008. During that period, MuniMae was one
of the nation’s largest syndicators of low-income housing tax
credits (“LIHTCs”). Federal tax law provides LIHTCs to
developers of low-income rental housing. Because most
developers cannot take advantage of these credits, financial
services companies, like MuniMae, organize LIHTC investment
partnerships (“LIHTC Funds”) to pool and sell the credits to
investors.
MuniMae usually acted as the general partner of its LIHTC
Funds during the class period, and it received syndication and
asset management fees for organizing and maintaining them.
Although its ownership share was generally low, ranging from
0.1% to 1.0%, it was typically larger than that of any single
investor. Prior to 2003, MuniMae primarily treated these LIHTC
Funds as off balance sheet entities.
In 2003, the Financial Accounting Standards Board adopted
Financial Accounting Standards Board Interpretation No. 46R
(“FIN 46R”), which addressed the financial reporting
requirements of businesses with respect to off balance sheet
6
activity. 3 FIN 46R defined a new category of entities called
Variable Interest Entities (“VIEs”). Under FIN 46R, a company
must consolidate onto its financial statements the assets and
liabilities of a VIE if the company is its “primary
beneficiary,” that is, if the company absorbs the majority of
the risks and rewards associated with the VIE. Before the
adoption of this revised standard, a company was generally only
required to consolidate financial statements if it had a
majority voting interest in the entity.
The first quarter of 2004 was the first period for which
MuniMae reported compliance with FIN 46R. The Company then
concluded that FIN 46R required it to consolidate some but not
all of its LIHTC Funds, which added a net $1.3 billion in assets
and liabilities to the Company’s financial statements. The
remaining unconsolidated LIHTC Funds had net assets of
approximately $970.3 million and liabilities of approximately
$90.8 million.
Through mid-2006, MuniMae continued to represent its
compliance with FIN 46R in financial reports filed with the SEC.
PricewaterhouseCoopers LLP (“PwC”), MuniMae’s independent public
accountant, certified that those reports had been prepared in
3
The Board initially adopted FIN 46 in January 2003. In
December 2003, it approved various amendments to FIN 46 and
released FIN 46R.
7
accordance with generally accepted accounting principles
(“GAAP”) for fiscal years 2004 and 2005. Between 2004 and 2006,
the Company also made a number of acquisitions and conducted
several offerings, including an SPO in February 2005. At the
end of 2005, Melanie Lundquist replaced William Harrison as the
Company’s CFO.
On March 10, 2006, MuniMae announced that it was restating
its financial statements for the nine-month period ending on
September 30, 2005, as well as fiscal years 2002 through 2004.
The restatement corrected certain financial reporting errors
that were unrelated to FIN 46R. MuniMae issued the restated
financial statements in June 2006.
In August, the Company disclosed that it had identified
“material weaknesses in internal controls over financial
reporting,” and that, as a result, it would be unable to “file
timely its second quarter 2006 Form 10-Q.” J.A. 65. A few
months later, on September 13, 2006, MuniMae announced that it
was again restating its financial statements for fiscal years
2003 through 2005, and for the first quarter of 2006. The
Company initially informed investors that the second restatement
would address three areas: (1) accounting for equity
commitments related to affordable housing projects; (2) the
classification of cash flow from tax credit equity funds; and
(3) accounting for syndication fees. About a month later,
8
however, MuniMae disclosed that it had “not yet reached a
conclusion regarding the extent of the [second] restatement.”
J.A. 1120.
On October 26, 2006, MuniMae announced that it was
replacing PwC as the Company’s independent public accountant.
The Company stated--and PwC agreed--that for fiscal years 2004
and 2005, and through October 2006, “there were no disagreements
with PwC on any matter of accounting principles or practices,
financial statement disclosure or audit scope or procedure which
disagreements if not resolved to the satisfaction of PwC would
have caused them to make reference thereto in their reports on
[MuniMae’s] financial statements.” J.A. 1120.
Three months later, the Company reported its 40th
consecutive increase in its quarterly dividend. In the same
announcement, the Company revealed that the second restatement
would address accounting errors with respect to FIN 46R, and
that the Company would “be required to consolidate substantially
all of the low income housing tax credit equity funds it has
interests in.” J.A. 1373.
On May 4, 2007, MuniMae disclosed that it would not be able
to timely file its 10-K for 2006 “[a]s a result of the
dedication of significant management resources to . . .
restatement efforts.” J.A. 1129. The Company noted that since
September 2006, it had identified additional material weaknesses
9
in its internal controls over financial reporting, including
with respect to its accounting of LIHTC Funds.
On July 10, 2007, MuniMae announced that it had hired
Navigant Consulting to assist its internal auditors in the
restatement. A month later, it disclosed more details about the
scope of the effort, noting that “there are approximately 92
people currently working on the restatement,” including “20
company employees and 72 consultants.” J.A. 1145. Around the
same time, Lundquist resigned and Charles Pinckney replaced her
as CFO.
MuniMae held a teleconference on November 8, 2007 to
further update investors. The Company stated that management
planned to ask the Board to continue the Company’s longstanding
policy of increasing the dividend distribution every quarter,
although it warned that “it is possible that the dividend payout
ratio for the full fiscal year 2007 may exceed 100% of the
Company’s net cash from operations due to the costs being
incurred by the Company from the restatement.” J.A. 1155. The
Company’s officers declined at that point to estimate the cost
of the second restatement, though they acknowledged the costs
were substantial.
On January 28, 2008, MuniMae announced that it was cutting
its quarterly dividend by 37%, from $0.525 to $0.33 per share.
The Company attributed the cut to “the cost of the Company’s
10
ongoing restatement of its financial statements, the decision
. . . to conserve capital . . . given the current volatility in
the credit and capital markets, and the desire to dedicate
additional capital to the high-growth Renewable Energy Finance
business.” J.A. 1171. At the same time, the Company stated
that it did “not believe the results of the restatement w[ould]
materially change the previously recorded cash balances of the
Company and its subsidiaries.” Id. Because the restatement
efforts were still ongoing, the Company also announced that it
anticipated being delisted from the New York Stock Exchange
because it could not meet a NYSE deadline for filing its 2006
Form 10-K. The price of MuniMae shares dropped 46.57%, from
$17.20 per share on January 28, to $9.19 per share on January
29, on unusually heavy trading volume.
MuniMae provided further details to investors regarding the
second restatement during a January 29 conference call. With
respect to FIN 46R, the Company disclosed that it had to
consolidate 230 LIHTC Funds, which required it to review 6,000
separate financial statements. Because the Company had no
automated process in place to review the accounting, this work
had to be done manually. Acknowledging that these developments
were a result of the Company’s “mistakes in the first
instance[,]” CEO Michael Falcone expressed his disappointment
and embarrassment over the “the amount of time and energy and
11
effort[] it’s taking us to fix them.” J.A. 1196. The price of
MuniMae shares dropped an additional 22.416%, to $7.13 per
share, on January 30, again on unusually heavy trading volume.
On April 9, 2008, MuniMae disclosed that it spent $54.1 million
to complete the second restatement.
B.
Shareholders filed multiple lawsuits against MuniMae,
certain of its officers and directors, and the lead underwriters
in the 2005 SPO, alleging violations of federal securities laws.
The actions were consolidated in the District of Maryland for
pretrial proceedings. See In re Mun. Mortg. & Equity, LLC, Sec.
& Derivative Litig., 571 F. Supp. 2d 1373 (J.P.M.L. 2008).
Plaintiffs filed the operative Consolidated Amended Class Action
Complaint on December 5, 2008.
Applying the heightened pleading standards of the Private
Securities Litigation Reform Act (“PSLRA”), 15 U.S.C. § 78u-4,
the district court held that plaintiffs’ Exchange Act claims
failed because the amended complaint did not adequately plead
scienter. See In re Mun. Mortg. & Equity, LLC, Sec. &
Derivative Litig., 876 F. Supp. 2d 616, 647 (D. Md. 2012). The
court also dismissed plaintiffs’ Securities Act claims with
respect to the SPO. It found the § 11 claim time-barred by the
statute of repose in § 13 of the Securities Act. See
id. at
657. It also concluded that Charles Dammeyer, the only named
12
plaintiff asserting Securities Act claims with respect to the
SPO, lacked standing to bring a § 12(a)(2) claim, see id. at
661, and that the amended complaint failed to adequately plead
that the underwriter defendants were immediate sellers, see
id.
at 662.
This appeal followed.
II.
A.
We first consider the district court’s dismissal of
plaintiffs’ claims under § 10(b) of the Securities Exchange Act
of 1934 and SEC Rule 10b-5 for failing to adequately plead
scienter.
The purpose of the Exchange Act and its accompanying
regulations is to ensure that companies disclose the information
necessary for investors to make informed investment decisions.
See Taylor v. First Union Corp. of S.C., 857 F.2d 240, 246 (4th
Cir. 1988). Section 10(b) of the Act prohibits the use of “any
manipulative or deceptive device or contrivance” in connection
with the sale of a security in violation of SEC rules. See 15
U.S.C. § 78j(b). Rule 10b-5 implements § 10(b) by making it
unlawful, in connection with the sale of a security:
(a) To employ any device, scheme, or artifice to
defraud,
13
(b) To make any untrue statement of a material fact 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, or
(c) To engage in any act, practice, or course of
business which operates or would operate as a fraud or
deceit upon any person.
17 C.F.R. § 240.10b-5. The Supreme Court has recognized that
§ 10(b) provides an implied right of action for purchasers or
sellers of securities who have been injured by violations of the
statute. See Stoneridge Inv. Partners v. Scientific-Atlanta,
Inc., 552 U.S. 148, 157 (2008).
In a typical § 10(b) action, a private plaintiff must prove
six elements: “(1) a material misrepresentation or omission by
the defendant; (2) scienter; (3) a connection between the
misrepresentation or omission and the purchase or sale of a
security; (4) reliance upon the misrepresentation or omission;
(5) economic loss; and (6) loss causation.” Id.
To establish scienter, a plaintiff must prove that the
defendant acted with “a mental state embracing intent to
deceive, manipulate, or defraud.”
Tellabs, 551 U.S. at 319
(internal quotation marks omitted). At the pleading stage,
alleging either intentional or severely reckless conduct is
sufficient. See Matrix
Capital, 576 F.3d at 181. In the
§ 10(b) context, a reckless act is one that is “so highly
unreasonable and such an extreme departure from the standard of
14
ordinary care as to present a danger of misleading the plaintiff
to the extent that the danger was either known to the defendant
or so obvious that the defendant must have been aware of it.”
Id. (internal quotation marks omitted).
The PSLRA imposes a heightened pleading standard on fraud
allegations in private securities complaints. See Teachers’
Ret. Sys. of La. v. Hunter, 477 F.3d 162, 171-72 (4th Cir.
2007). The complaint must “state with particularity facts
giving rise to a strong inference that the defendant acted with
the required state of mind” with respect to each act that
allegedly violated the statute. 15 U.S.C. § 78u-4(b)(2). “[T]o
the extent a plaintiff alleges corporate fraud, the plaintiff
must allege facts that support a strong inference of scienter
with respect to at least one authorized agent of the
corporation.” Matrix
Capital, 576 F.3d at 182 (internal
quotation marks omitted). To allege fraud against an individual
defendant, the plaintiff must allege facts supporting a strong
inference of scienter as to that person. See
id.
Evaluating the strength of an inference is necessarily a
comparative inquiry. See
Tellabs, 551 U.S. at 326-27. “[A]n
inference of scienter can only be strong . . . when it is
weighed against the opposing inferences that may be drawn from
the facts in their entirety.” Cozzarelli v. Inspire Pharm.
Inc.,
549 F.3d 618, 624 (4th Cir. 2008). “A court must compare
15
the malicious and innocent inferences cognizable from the facts
pled in the complaint, and only allow the complaint to survive a
motion to dismiss if the malicious inference is at least as
compelling as any opposing innocent inference.” Zucco Partners,
LLC v. Digimarc Corp., 552 F.3d 981, 991 (9th Cir. 2009).
As applied here, “the question is whether the allegations
in the complaint, viewed in their totality and in light of all
the evidence in the record, allow us to draw a strong inference,
at least as compelling as any opposing inference,” that the
MuniMae defendants either knowingly or recklessly defrauded
investors by (1) issuing false financial statements as to the
Company’s compliance with FIN 46R, and (2) concealing the cost
of correctly consolidating LIHTC Funds in accordance with that
standard. See Pub. Emps.’ Ret. Ass’n of Co. v. Deloitte &
Touche LLP, 551 F.3d 305, 313 (4th Cir. 2009). “If we find the
inference that defendants acted innocently, or even negligently,
more compelling than the inference that they acted with the
requisite scienter, we must affirm.”
Id.
B.
1.
We begin by considering whether the facts alleged in the
amended complaint give rise to an inference of scienter and, if
so, the strength of that inference. Although “we ultimately
evaluate plaintiffs’ allegations of scienter holistically, we
16
only afford their allegations the inferential weight warranted
by context and common sense.” Matrix Capital, 576 F.3d at 183.
Plaintiffs rely on four categories of allegations as to
scienter, to which we now turn.
a. Confidential Witness Statements
The amended complaint incorporates information obtained
from three confidential witness (“CW”) statements. “When the
complaint chooses to rely on facts provided by confidential
sources, it must describe the sources with sufficient
particularity to support the probability that a person in the
position occupied by the source would possess the information
alleged or in the alternative provide some other evidence to
support their allegations.” Teachers’ Ret., 477 F.3d at 174
(internal quotation marks omitted). “[O]missions and
ambiguities count against” an inference of scienter because a
complaint’s factual allegations must be stated with
particularity.
Tellabs, 551 U.S. at 326; see also Institutional
Investors Grp. v. Avaya, Inc.,
564 F.3d 242, 263 (3d Cir. 2009)
(noting that courts should steeply discount allegations from
confidential sources that lack sufficient indicia of
reliability). We present the allegations of each of the
confidential witnesses before assessing the strength of the
scienter inferences they support.
17
i. Confidential Witness 3
CW3 served as a staff accountant and later a project
manager in MuniMae’s Internal Accounting Department. CW3
attended accounting meetings with several of the individual
defendants. According to CW3, MuniMae executives considered
restating the Company’s financial statements for months prior to
the announcement of the first restatement, in March 2006. CW3
also asserts that, at some point prior to the first restatement,
a PwC partner advised MuniMae to consolidate the remaining LIHTC
Funds, but certain MuniMae executives disagreed with that
recommendation. Specifically, “CW3’s bosses . . . argued with
PwC about how to classify the tax credit equity funds and how to
determine the percentage of ownership MuniMae held on each one.”
J.A. 84. 4
CW3 also states that the Company was “‘always’” in a state
of “‘some confusion and chaos’” as a result of MuniMae’s rapid
expansion. J.A. 68. As CW3 describes, the Company’s accounting
and legal staff was “bombarded with documentation” as the
Company expanded but lacked sufficient personnel to handle the
paper flow. J.A. 68-69. According to CW3, “the staff was
4
According to CW3, the PwC partner assigned to the MuniMae
account considered the Company’s audits to be “exceedingly
challenging” because MuniMae was a “‘high level, complex
company’ that required a sophisticated external auditing process
in order to comply with FIN 46.” J.A. 84.
18
unprepared professionally for the complex nature of the
accounting needed, particularly compliance with FIN 46R.” J.A.
69.
ii. Confidential Witness 2
CW2 served as an in-house certified public accountant from
late 2005 to April 2007. CW2 reported directly to then-CFO
Lundquist and MuniMae’s Chief Accounting Officer, Greg Thor.
CW2 asserts that by early 2006, Lundquist and Thor had concluded
that there were widespread problems with the accounting done
under former CFO Harrison. The problems led Thor to review,
among other things, the Company’s LIHTC Fund accounting.
According to CW2, by mid-2006 (at the time of the first
restatement), Lundquist knew that the primary beneficiary
determinations for most LIHTC Funds were incorrect and that the
Funds should have been consolidated under FIN 46R. CW2 also
asserts that Lundquist and Falcone were heavily involved in the
restatement effort, with Falcone receiving “updates regarding
the restatement at least on a weekly basis and sometimes on a
daily basis.” J.A. 82.
iii. Confidential Witness 1
Finally, CW1 was the administrative assistant to MuniMae’s
head of Internal Audit, Angela Barone, from June 2004 to June
2007. In that capacity, CW1 attended regular meetings to
discuss progress on ongoing audit work. According to CW1, at
19
some point, frustration with the progress of FIN 46R accounting
became a regular subject of discussion at the meetings, and
Barone communicated that frustration to Lundquist and Falcone. 5
CW1 recounts that Falcone sent a memo to all MuniMae employees
in Fall 2006 emphasizing that the auditing staff would be
focusing all of its energies on the second restatement. The
memo made clear that the related audit work “should be made a
priority and excuses regarding delays providing the Audit
Department with information would not be tolerated.” J.A. 81.
iv. Inferences from the CW Evidence
We conclude that the confidential witness statements permit
an inference that the MuniMae defendants knew, perhaps as early
as mid-2006, that the Company was not in compliance with FIN
46R, despite their representations to the contrary. The
allegations are also consistent with the inference that these
defendants knew--or at least suspected--by Fall 2006 that
consolidating the LIHTC Funds in accordance with FIN 46R would
be a difficult and costly undertaking.
Nonetheless, we agree with the district court that these
allegations do not support a strong inference of wrongful
intent. To begin with, the confidential witnesses do not
5
However, CW1 does not describe the nature of the
accountants’ frustration, nor is it clear precisely when these
discussions took place.
20
expressly assert that the MuniMae defendants intentionally or
recklessly failed to comply with GAAP or their own internal
accounting policies during the class period. The statements are
also generally vague and conclusory as to the MuniMae
defendants’ state of mind.
As even the amended complaint concedes, MuniMae struggled
throughout the class period with what its own former accountant
described as difficult and complex accounting. This complexity
was not helped by an accounting system that was in a constant
state of “‘confusion and chaos,’” J.A. 85, in no small part due
to the Company’s rapid expansion and inadequate staffing. The
MuniMae defendants may well have been negligent in failing to
properly apply FIN 46R to their business in the first instance,
and then by allowing the Company to be overwhelmed by the
resulting accounting tsunami. But plaintiffs’ allegations do
not support a powerful and compelling inference that these
defendants acted with wrongful intent or severe recklessness.
Cf. Zucco Partners, 552 F.3d at 1007 (“Although the allegations
in this case are legion . . . the facts alleged . . . point
towards the conclusion that [the defendant] was simply
overwhelmed with integrating a large new division into its
existing business.”).
That MuniMae’s officers and outside auditor debated how to
account for the LIHTC Funds in light of FIN 46R does not compel
21
an inference of wrongful intent. The more plausible inference
is that there was an honest disagreement over the proper
application of a challenging new accounting standard. That the
MuniMae defendants were ultimately wrong is not enough to
support an inference of scienter. Cf. DSAM Global Value Fund v.
Altris Software, Inc., 288 F.3d 385, 390 (9th Cir. 2002) (“[T]he
mere publication of inaccurate accounting figures, or a failure
to follow GAAP, without more, does not establish scienter.”
(quoting In re Software Toolworks, Inc.,
50 F.3d 615, 627 (9th
Cir. 1994))).
As for CW2’s allegations regarding Lundquist’s knowledge of
the FIN 46R issues, they too fail to support a strong inference
that she--or anyone else--acted with fraudulent purpose. Even
if, as plaintiffs allege, Lundquist began to suspect a problem
with the FIN 46R accounting at the time the first restatement
began in March 2006, we are not persuaded that she then hatched
a plot to defraud the investing public.
To the contrary, we are skeptical that Lundquist would sign
off on the first restatement in June 2006 without addressing FIN
46R issues, thus subjecting herself to SEC sanctions, if she
firmly believed then that the accounting was wrong. A more
logical and compelling inference is that Lundquist and the other
MuniMae defendants were continuing to assess the scope of the
problem before deciding on an appropriate course of action. We
22
also find it significant that it was MuniMae’s management--and
not some outside entity--that ultimately disclosed that the
Company would have to consolidate the remaining LIHTC Funds in
January 2007 (thus conceding the Company’s earlier error). In
our view, this disclosure supports a strong “inference that
defendants were not acting with scienter but rather were
endeavoring in good faith to inform [the investing public].”
Matrix Capital, 576 F.3d at 189.
Finally, we recognize that the Fall 2006 Falcone
memorandum, which noted that that the auditing staff intended to
focus all of its energies on the second restatement, supports an
inference that the MuniMae defendants could have more promptly
anticipated the substantial costs of addressing the Company’s
myriad accounting issues. But that is a far cry from concluding
that Falcone and his fellow defendants resolved then to defraud
plaintiffs by hiding the true costs.
In our view, management’s subsequent disclosures tend to
negate an inference of fraudulent purpose. In July and August
2007, the Company (1) announced the hiring of an independent
consultant to assist with the work of the second restatement,
(2) identified the large number of personnel working on the
accounting issues, and (3) expressed uncertainty as to the costs
of the effort going forward. Although these disclosures were
perhaps not as timely or as fulsome as plaintiffs would have
23
liked, they give rise to a more compelling inference that the
MuniMae defendants were attempting--even if imperfectly--to keep
the investing public informed, while working strenuously to
correct the accounting errors they had discovered.
b. Red Flags
Plaintiffs contend that there were numerous red flags that
should have alerted the MuniMae defendants to the FIN 46R
accounting problems, and that their failure to timely identify
the problems demonstrates a reckless disregard for the accuracy
of the Company’s financial statements. Specifically, they point
to: (1) the need for and magnitude of multiple restatements,
which involved revising several years’ financial statements and
multiple accounting problems; (2) the frequency of accounting
meetings involving FIN 46R issues; (3) the high turnover of CFOs
during the class period; and (4) the firing of PwC.
Additionally, plaintiffs emphasize that the individual
defendants were the Company’s most senior executives, and that
the LIHTC Funds represented a core operation of the Company.
Because these defendants were directly responsible for the
Company’s financial statements--and many were heavily involved
in the second restatement--they must have known, or recklessly
failed to realize, that the Company was not in compliance with
FIN 46R.
24
The presence of “red flags,” coupled with the “breadth and
gravity” of a company’s problems, may provide “substantial
weight” to an inference that high level corporate agents “must
have been aware of the problems.” See Matrix Capital, 576 F.3d
at 183-85. The more significant the error the stronger the
inference it supports. See
id. at 184-85; see also In re Atlas
Worldwide Holdings, Inc. Sec. Litig.,
324 F. Supp. 2d 474, 488-
89 (S.D.N.Y. 2004) (“When a company is forced to restate its
previously issued financial statements, the mere fact that the
company had to make a large correction is some evidence of
scienter.”).
While the red flags alleged in the complaint are not
insubstantial, they do not give rise to a strong inference of
scienter. Fundamentally, the FIN 46R accounting error itself
was not especially obvious, at least with respect to the
Company’s financial bottom-line. In that regard, we note, as
did the district court, that MuniMae’s ownership interest in the
unconsolidated LIHTC Funds was one percent or less. The
cumulative economic impact of all of the restatement
adjustments--including but not limited to the LIHTC Fund
consolidation--was a loss of approximately $44.9 million in
25
shareholders’ equity for fiscal year 2005. 6 For the same year,
MuniMae’s adjusted shareholders’ equity was approximately $723
million. Thus, while the effort to complete the restatement
proved costly, the practical effect of proper consolidation on
the Company’s financial statements was relatively small.
The other potential warning signs also lend themselves to
benign interpretations. We view the frequency of accounting
meetings as a sign of diligence rather than evidence of a
nefarious purpose. Cf. Zucco Partners, 552 F.3d at 1000 (noting
that an allegation that top executives attended several meetings
to discuss the company’s financial affairs was not the kind of
particular evidence required to support a strong inference of
scienter).
A high turnover in CFOs can certainly raise suspicion, but
the facts alleged here mitigate any concern. Harrison left the
Company in late 2005, well before any officer is alleged to have
known about the FIN 46R issues. Lundquist resigned in July
2007, after the Company was required to perform two restatements
under her watch, the second of which entailed numerous delays
and snowballing costs. While Lundquist’s resignation is
6
The loss in shareholders’ equity specifically attributable
to consolidating the LIHTC Funds was $78.3 million, but gains in
other areas as a result of the restatement reduced the overall
impact of consolidation on the Company’s financial bottom-line.
26
evidence of the substantial accounting challenges the Company
then faced, it does not compel an inference that she and the
other individual defendants were bent on committing fraud. See
id. at 1002 (“Where a resignation occurs slightly before or
after the defendant corporation issues a restatement, a
plaintiff must plead facts refuting the reasonable assumption
that the resignation occurred as a result of [the] restatement’s
issuance itself in order for a resignation to be strongly
indicative of scienter.”).
Nor is PwC’s October 2006 departure particularly telling.
The dismissal of an accounting firm around the time of a
restatement is not surprising. Cf. id. (concluding that the
resignation of the defendant’s independent public accountant did
not support a strong inference of scienter because the firm “had
just been partially responsible for the corporation’s failure to
adequately control its accounting procedures”). This is
especially true on these facts, as MuniMae was required to
execute two restatements while PwC was serving as its auditor.
The fact that PwC alerted the Company to one of the many issues
the restatements ultimately addressed does not mean that the
MuniMae defendants were not justifiably dissatisfied with PwC’s
services generally. Any inference of wrongful intent is further
weakened by the fact that PwC made clear in a letter to the SEC
that it had no disagreements with the Company on any matter of
27
accounting principle or practice that it felt obligated to
report. 7
Finally, and in accordance with several of our sister
circuits, we reject plaintiffs’ contention that the individual
defendants must have acted intentionally or recklessly with
respect to the FIN 46R accounting merely because (1) they were
senior executives, and (2) the LIHTC Funds represented a core
business of the Company. See, e.g., In re Suprema Specialties,
Inc. Sec. Litig., 438 F.3d 256, 282 (3d Cir. 2006) (“A pleading
of scienter . . . may not rest on a bare inference that a
defendant must have had knowledge of the facts or must have
known of the fraud given his or her position in the company.”
(internal quotation marks omitted)), abrogated on other grounds
by
Tellabs, 551 U.S. at 322-23; Zucco
Partners, 552 F.3d at 1000
(finding that “bare allegations” that officers must have have
had knowledge of key facts relating to the business’s “core
operations” are rarely enough to support a strong inference of
scienter). To be sure, such allegations are relevant to the
court’s holistic analysis of scienter. But without additional
7
SEC regulations required MuniMae to file a statement
disclosing information about its dismissal of PwC as its
independent public accountant. See 17 C.F.R. § 229.304(a)(1)-
(2). The regulations also required PwC to file a letter stating
whether MuniMae’s disclosures regarding the circumstances of its
dismissal were true. See id. § 229.304(a)(3).
28
detailed allegations establishing the defendants’ actual
exposure to the accounting problem, the complaint falls short of
of the PSLRA’s particularity requirements.
c. Insider Trading
Plaintiffs also say that Company insiders were motivated to
conceal MuniMae’s accounting problems to improperly benefit from
insider trading. Allegations of “personal financial gain may
weigh heavily in favor of a scienter inference.” Tellabs, 551
U.S. at 325. However, the inferential weight that may be
attributed to any claim of motive must be evaluated in context.
See
id. at 324. Insider trading allegations will only support
an inference of scienter “if the timing and amount of a
defendant’s trading were unusual or suspicious.” Teachers’
Ret., 477 F.3d at 184 (internal quotation marks omitted). To
determine whether an insider’s sales were “unusual in scope” we
consider factors such as “the amount of profit made, the amount
of stock traded, the portion of stockholdings sold, or the
number of insiders involved.” In re Suprema
Specialties, 438
F.3d at 277 (internal quotation marks omitted).
In this case, the overall value of MuniMae shares sold
during the class period was higher than in previous years. Six
Company insiders sold 470,210 shares for a total of $12,004,901
in gross proceeds during the class period, as compared to the
sale of 298,002 shares and $7,139,835 in gross proceeds between
29
June 1998 and the beginning of the class period. These numbers
are certainly consistent with an inference that the insiders who
traded during the class period had a motive to commit fraud.
Nonetheless, the inference that the trades were innocent is
stronger. The number of insiders who traded during the class
period is relatively small, and plaintiffs do not allege that
the insiders timed the sales to take advantage of any particular
disclosure. Cf. Teachers’ Ret., 477 F.3d at 184 (finding
deficient a complaint that, among other things, failed to
“allege that defendants timed their sales to profit from any
particular disclosures”).
Nor is the extent of any insiders’ divestiture particularly
alarming. Former CFO Harrison sold 78% of his shares in early
December 2004, but that was well before plaintiffs say that any
officer of the Company knew that the FIN 46R accounting was
flawed. Board Chairman Mark Joseph sold approximately 37% of
his shares between late April 2005 and early June 2006. Some of
these sales coincided with the lead-up to the Company’s
announcement of the first restatement. However, the sales
occurred at fairly regular intervals and amounts compared to
earlier periods. CEO Falcone sold just over 28% of his holdings
during the class period, with the bulk of the sales occurring in
2004 and mid-2005. Falcone sold shares twice in early 2006, but
the volume of the trades was not unusual. In short, none of the
30
defendants’ trading strikes us as suspicious. Cf. id. at 185
(finding insider sales of 92%, 100%, and 82% of defendants’
holdings “unremarkable” in context).
The fact that Falcone and Joseph traded MuniMae shares
under non-discretionary Rule 10b5-1 plans further weakens any
inference of fraudulent purpose. Under Rule 10b5-1, corporate
insiders can set up trading plans to sell company shares at
predetermined times and amounts to avoid accusations of illegal
insider trading. See 17 C.F.R. § 240.10b5-1(c) (stating that it
is an affirmative defense in insider trading cases that the
defendant’s purchases or sales were made pursuant to a “written
plan for trading securities”); see also Cent. Laborers’ Pension
Fund v. Integrated Elec. Servs. Inc., 497 F.3d 546, 554 n.4 (5th
Cir. 2007) (explaining that a 10b5-1 trading plan can give rise
to an inference that the sales were not suspicious); In re
Worlds of Wonder Sec. Litig.,
35 F.3d 1407, 1427-28 (9th Cir.
1994) (same).
Joseph’s Rule 10b5-1 plan does less to shield him from
suspicion because he instituted the plan in March 2005, after
the start of the class period. By contrast, Falcone created his
plan in 2003. Nonetheless, Joseph entered the plan a year
before the complaint alleges that any officer at MuniMae knew
the FIN 46R accounting was wrong, and the amended complaint does
not allege that Joseph traded outside of the plan. Thus,
31
although the Rule 10b5-1 plan does not completely immunize
Joseph from suspicion, it does mitigate any inference of
improper motive surrounding his sales.
An additional problem with the allegations of insider
trading relates to the length of the putative class period. The
plaintiffs have chosen an inordinately long period of 44 months.
See Teachers’ Ret., 477 F.3d at 185 (describing a 46-month class
period as “exceedingly long”); see also In re Vantive Corp. Sec.
Litig.,
283 F.3d 1079, 1092 (9th Cir. 2002) (characterizing a
class period of 15 months as “unusually long”), abrogation on
other grounds recognized by South Ferry LP, No. 2 v. Killinger,
542 F.3d 776, 784 (9th Cir. 2008). In our view, alleging such a
lengthy class period makes it difficult to infer intent from the
mere fact of a stock sale, as it is not unusual for insiders to
trade at some point during their tenure with a company. See
Teachers’
Ret., 477 F.3d at 185.
d. Other Allegations of Motive
Plaintiffs proffer a number of general business motivations
from which they would have us infer fraud. They contend that
MuniMae wanted to artificially inflate the price of its shares
to attract investors, fund corporate acquisitions, avoid a
default on loan covenants, and obtain favorable loan terms. We
decline, however, to infer fraud from financial motivations
common to every company. See Ottmann v. Hanger Orthopedic Grp.,
32
Inc., 353 F.3d 338, 352 (4th Cir. 2003) (“[C]ourts have
repeatedly rejected these types of generalized motives--which
are shared by all companies--as insufficient to plead scienter
under the PSLRA.”).
Although MuniMae conducted numerous offerings and
acquisitions during the class period, very little of this
activity occurred after any officer is alleged to have known
that the FIN 46R accounting was flawed. It is true that the
Company was aware that consolidating LIHTC Funds could affect
its debt covenants, as the initial consolidation in 2004 would
have caused it to default on at least two debt covenants. But
MuniMae disclosed that fact, and it was also able to negotiate
waivers on each covenant to avoid default. In short, nothing
about the specific facts alleged render MuniMae’s general
business motivations particularly suspicious.
e. Class Period Disclosures
For their part, the MuniMae defendants assert that their
class period disclosures rebut any inference of scienter. “It
is appropriate to consider such disclosures, which in some
contexts will indicate that the defendants were acting in good
faith, but in other contexts will indicate that the defendants
had knowledge of operational risks (suggesting a lack of good
faith).” Matrix Capital, 576 F.3d at 185.
33
We believe MuniMae made several relevant disclosures during
the class period. In announcing its first restatement on March
10, 2006, MuniMae also alerted investors to the fact that the
Company suffered from “material weaknesses related to the
financial reporting process.” J.A. 821. Although only a few
material weaknesses were then identified, the Company warned
that management might “identify additional material weaknesses”
as part of the restatement. Id.
Over the next two years, the Company repeatedly disclosed
newly discovered material weaknesses, and reiterated that it
might identify additional problems that would render its
remedial efforts ineffective. The fact that MuniMae continued
to update investors about newly discovered weaknesses tends to
negate an inference that the defendants acted with an intent to
defraud. Cf. Matrix
Capital, 187 F.3d at 187 (“A disclosure
that meaningfully alerts investors to the risk that financial
information is not accurate may suggest that the individuals
responsible for the disclosure did not knowingly (or perhaps not
even recklessly) misstate the underlying financial
information.”).
MuniMae also attempted to update investors regarding the
escalating cost of the second restatement. Although the initial
announcement in September 2006 identified only a few areas for
restatement, the Company announced in October that it had not
34
yet determined its full scope. In May 2007, the Company
disclosed that it was unable to timely file its annual Form 10-K
for fiscal year 2006 because of the “dedication of significant
management resources to these restatement efforts.” J.A. 1129.
On July 10, 2007, the Company announced that it had retained
Navigant Consulting to assist in the restatement efforts. In a
telephone conference with investors the following month, the
Company noted that, given the scope of the restatement, it had
to “bring new and unbudgeted resources online quickly.” J.A.
1145. Finally, at a November 8 teleconference, the Company
informed investors that both the magnitude and cost of the
restatement would be “very significant.” J.A. 1157.
To be sure, the import of some of MuniMae’s disclosures was
moderated by the fact that it occasionally buried the
information in press releases headlined with favorable news.
Nonetheless, MuniMae repeatedly noted the need to restate its
financials, the deficiency in its internal controls, and the
fact that the restatement would require the Company to commit
resources far greater than initially anticipated.
Not only do these disclosures bolster the inference that
the MuniMae defendants acted in good faith, but they also
strengthen the inference that these defendants only realized the
FIN 46R accounting problems--and the cost of fixing them--over
time.
35
2.
After evaluating the inferential weight owed to plaintiffs’
allegations of corporate fraud in light of context and common
sense, we must consider “whether a reasonable person would
regard the inference that defendants knowingly or recklessly
misstated or omitted material information at least as strong as
the inference that [the MuniMae defendants] were merely
negligent with respect to those statements.” Matrix Capital,
576 F.3d at 187. To that end, we must evaluate the complaint
holistically, recognizing that “allegations of scienter that
would not independently create a strong inference of scienter
might compliment [sic] each other to create an inference of
sufficient strength to satisfy the PSLRA.”
Id. at 187-88.
Considered holistically, we conclude that plaintiffs have
not satisfied their burden under the PSLRA. We accept as fact
that management regularly discussed FIN 46R compliance issues,
even before the first restatement, and that by mid-2006, at
least Lundquist had determined that the Company’s LIHTC Fund
accounting was flawed. We know that PwC recommended that the
Company reconsider its LIHTC Fund accounting prior to the first
restatement, but that at least some MuniMae officers disagreed.
We acknowledge that in the fall of 2006, the Company recognized
that correcting various accounting errors would be a management
focus for some time. We accept that the MuniMae defendants had
36
financial motivations--albeit universal ones--to avoid
disclosing the need to consolidate the LIHTC Funds. And we know
that MuniMae suffered from material weaknesses in its internal
controls that, among other things, could have alerted management
to problems with the FIN 46R accounting.
While this mosaic supports an inference of scienter, we
find more compelling the inference that the MuniMae defendants
were, at most, negligent. In 2004, MuniMae was faced with
applying a challenging new accounting standard to its rapidly
expanding business, requiring the Company to determine whether
and how to consolidate a number of LIHTC Funds that previously
were not on the Company’s financial statements. MuniMae's
management mistakenly--and perhaps negligently--failed to have
sufficient accounting controls and processes in place to meet
this challenge, which, together with other accounting errors
over the course of 2004 and 2005, required the Company to twice
restate its financial accounting statements at a substantial
cost. In our view, the facts alleged point more convincingly to
an inference that MuniMae was simply in over its head.
Although some officers may have believed that MuniMae’s
accounting was flawed by mid-2006, the evidence suggests that
others, at least initially, disagreed. This makes it difficult
to infer that the MuniMae defendants intentionally, or even
recklessly, misrepresented the state of the Company’s financial
37
affairs. See Metzler Inv. GMBH v. Corinthian Colls., Inc., 540
F.3d 1049, 1069 (9th Cir. 2008) (finding insufficient
allegations that “point only to disagreement and questioning”
within the Company about a particular accounting practice). And
even if some senior officers had concluded by mid-2006 that the
FIN 46R accounting was wrong, that does not establish that they
acted with fraudulent purpose to conceal the problems until
January 2007.
The strength of the inference with respect to MuniMae’s
knowledge of the costs of the second restatement is even weaker
on the facts alleged. We think it more plausible that the
Company simply had not reached a conclusion with respect to FIN
46R until after it began the second restatement, and that the
MuniMae defendants only gradually became aware of the expense as
it was incurred.
The Company’s successive disclosures suggest that its
officers attempted to keep investors updated about MuniMae’s
internal weaknesses. The pattern of disclosures also suggests
that management only gradually awakened to the magnitude of the
Company’s accounting problems and the cost of fixing them. That
the Company’s accounting department during the early part of the
class period was chronically understaffed and, at least
initially, professionally unprepared for the accounting
challenge before it, strengthens the inference that final
38
decisions regarding the FIN 46R accounting remained unresolved
until late 2006.
On the facts alleged, the inference that the MuniMae
defendants were negligent in discharging their duties may well
be compelling. But that is not enough to survive a motion to
dismiss in this context. See Pub. Emps.’ Ret., 551 F.3d at 313.
We hold that the district court correctly dismissed plaintiffs
claims under the PSLRA for failing to adequately plead scienter. 8
III.
We turn next to plaintiffs’ Securities Act claims. The
“basic purpose” of the Securities Act of 1933 is “to provide
greater protection to purchasers of registered securities.”
Herman & MacLean v. Huddleston, 459 U.S. 375, 383 (1983).
Sections 11 and 12(a)(2) prohibit the use of materially false or
misleading statements or omissions in registration statements
and prospectuses, respectively. See 15 U.S.C. § 77k(a);
77l(a)(2). In contrast to Exchange Act requirements, “scienter
8
The district court also dismissed the plaintiffs’ claims
against the MuniMae officers under § 20(a) of the Exchange Act.
That provision imposes liability on each person who “controls
any person liable under any provision of this chapter or of any
rule or regulation thereunder.” 15 U.S.C. § 78t(a). Section
20(a) liability is derivative of § 10(b). Because the complaint
is legally insufficient with respect to the § 10(b) claim, the
§ 20(a) claim must also fail. See, e.g., Matrix Capital, 576
F.3d at 192.
39
is not an element of a violation” of either section. Newcome v.
Esrey, 862 F.2d 1099, 1106 (4th Cir. 1988) (en banc).
The amended complaint alleges that certain defendants 9
violated §§ 11 and 12(a)(2) because the registration statement
and prospectus for the 2005 SPO incorporated by reference
materially misleading statements and omissions. For example,
the registration statement incorporated by reference the
Company’s quarterly reports from the second and third quarters
of 2004, which represented that MuniMae was in compliance with
FIN 46R. See J.A. 1461. The February 2, 2005, prospectus
supplement expressly represented that MuniMae was in compliance
with FIN 46R. However, it also noted that “[d]ue to the
complexity of FIN 46R . . . we cannot assure you that further
changes in our financial statements will not be required with
respect to the application of FIN 46R.” J.A. 1578.
The district court found the § 11 claim time-barred by the
Securities Act’s statute of repose and dismissed the § 12(a)(2)
claim for lack of standing. We address each issue in turn.
9
The § 11 SPO claim is brought against the MuniMae
defendants and the underwriter defendants. The § 12(a)(2)
claims is alleged against the Company and the underwriter
defendants.
40
A.
1.
Section 13 of the Securities Act contains a three-year
statute of repose. See 15 U.S.C. § 77m. It provides:
In no event shall any such action be brought to
enforce a liability created under [§ 11 or § 12(a)(1)]
of this title more than three years after the security
was bona fide offered to the public . . . .
15 U.S.C. § 77m.
The statute does not define the term “bona fide offered to
the public,” and neither the Supreme Court nor this circuit has
determined the meaning of the phrase. The district court
applied the rule accepted by the majority of courts and found
that the statute of repose began to run on the date the SEC
declared MuniMae’s registration statement effective, i.e.,
January 14, 2005. Because the original complaint in this action
was not filed until February 1, 2008, the court concluded that
the § 11 claim was two-weeks late. See In re Mun. Mortg. &
Equity, 576 F.2d at 655-57.
On appeal, plaintiffs’ arguments are threefold. First,
applying a combination of dictionary and statutory definitions,
they say that a bona fide offering occurs only when securities
are offered “for value” in a manner capable of acceptance, and
in a way that is open and visible. Under this interpretation,
the repose period began to run, at the earliest, on February 2,
41
2005, that is, when MuniMae issued a prospectus supplement
pricing the securities, or on February 3, when the SPO
commenced. Alternatively, plaintiffs suggest the securities
were not bona fide offered until February 8, the last date of
the SPO. Finally, plaintiffs argue that, even if the general
rule is that the statute of repose begins to run on the
effective date of the registration statement, we should not
apply that rule in this case because there was a significant
delay between the effective date and the commencement of the
offering.
Both the MuniMae and underwriter defendants respond that
the effective date of the SPO registration statement constituted
the bona fide offering date because it is the date on which all
barriers to sale were removed. They also emphasize that most
case law defines the effective date of the registration
statement as the bona fide offering.
2.
The meaning of “bona fide offered to the public” in § 13’s
statute of repose is a question of statutory interpretation that
we review de novo. See P. Stolz Family P’ship L.P. v. Daum, 355
F.3d 92, 98 (2d Cir. 2004).
We begin by considering whether the language at issue has a
plain and unambiguous meaning. See United States v. Ashford,
718 F.3d 377, 382 (4th Cir. 2013). At first blush, the
42
plaintiffs’ principal position is appealing. In ordinary usage,
“bona fide” often means (as plaintiffs urge) “genuine.” See
Random House Webster’s Unabridged Dictionary 237 (2d ed. 2001);
see also Black’s Law Dictionary 199 (9th ed. 2009) (“Sincere;
genuine”). But it can also mean “made . . . in good faith” and
“without deception or fraud.” Random House Webster’s Unabridged
Dictionary 237; see also Black’s Law Dictionary 199 (“Made in
good faith; without fraud or deceit”). To the extent other
courts and authorities have considered the meaning of “bona
fide” in context, they have concluded that Congress simply
intended to distinguish a true offering from a “simulated
offering.” See P. Stolz, 355 F.3d at 99; see also 1 Louis Loss,
Joel Seligman & Troy Paredes, Securities Regulation § 2-B-
6(g)(i), at 773 & n.355 (4th ed. 2006) (discussing the dealer
exemption under § 4(3)(A) of the Securities Act, which also uses
the term “bona fide offered to the public”).
The meaning of the word “offer” is no more certain. As
commonly used, “offer” can mean both “to present for acceptance
or rejection” and also to “propose or put forward for
consideration.” See Random House Webster’s Unabridged
Dictionary 1344. Section 2(a)(3) of the Securities Act defines
“offer” to “include every attempt or offer to dispose of, or
solicitation of an offer to buy, a security or interest in a
security, for value.” 15 U.S.C. § 77b(a)(3). But we think it
43
unlikely that Congress intended the meaning of “bona fide
offered” in § 13 to be coterminous with the definition of
“offer” in § 2(a)(3). See Morse v. Peat, Marwick, Mitchell &
Co., 445 F. Supp. 619, 622 (S.D.N.Y 1977) (“The term ‘bona fide
offered to the public’ is a term of art and one not necessarily
synonymous with the full breadth of the statutory term
‘offer.’”).
Because we believe the statutory language is susceptible to
more than one meaning, we look beyond the statute for guidance.
The Second Circuit’s opinion in P. Stolz is the leading
authority on the term “bona fide offered to the public” in § 13.
The question in that case was the meaning of that phrase in the
context of unregistered securities. But the court examined a
number of cases involving registered securities and determined
that “the date of registration has been treated as the date that
starts the running of the repose period.” P. Stolz, 355 F.3d at
99.
A majority of courts have followed the P. Stolz guidance,
see, e.g., Armstrong v. Am. Pallet Leasing Inc., 678 F. Supp. 2d
827, 868 (N.D. Iowa 2009); In re Metro. Sec. Litig.,
2010 WL
537740, at *1 (E.D. Wash. Feb. 8, 2010); In re Countrywide Fin.
Corp. Sec. Litig.,
2009 WL 943271, at *6 (C.D. Cal. Apr. 6,
2009), and we agree that this approach best reflects
congressional purpose. Section 11 is violated when a
44
registration statement containing misleading information becomes
effective. See 15 U.S.C. § 77k(a); 17 J. William Hicks, Civil
Liabilities: Enforcement & Litigation Under the 1933 Act § 4:57
(2013). Using the effective date of the registration statement
as the bona fide offering date logically links a putative
defendant’s liability to the statutory violation. See Fed.
Hous. Fin. Agency v. UBS Ams., Inc., 2012 WL 2400263, at *2
(S.D.N.Y. June 26, 2012) (recognizing that courts have accepted
the effective date as the repose trigger on the ground that “the
registration statement includes the information upon which the
Section 11 claim is predicated--the alleged falsehood”).
Using the effective date is also consistent with the
purpose of statutes of repose generally. Such statutes provide
“a fixed date readily determinable by the defendant . . . rather
than a date determined by the personal circumstances of the
plaintiff.” Caviness v. Derand Res. Corp., 983 F.2d 1295, 1300
n.7 (4th Cir. 1993); see also City of Pontiac Gen. Emps.’ Ret.
Sys. v. MBIA, Inc.,
637 F.3d 169, 176 (2d Cir. 2011)
(contrasting a statute of repose, which “begins to run from the
defendant’s violation,” with a statute of limitations, which
“cannot begin to run until the plaintiff’s claim has accrued”). 10
10
Although we do not rely on the legislative history, we
note that it is not inconsistent with our conclusion. In 1954,
Congress amended numerous provisions of the federal securities
(Continued)
45
Plaintiffs object to this view of the statute, pointing to
§ 4(3) of the Securities Act, which also uses the term “bona
fide offered to the public.” See 15 U.S.C. § 77d(a)(3)(B).
That provision exempts certain dealer transactions from the
prospectus delivery requirement, and it applies “prior to the
expiration of forty days after the effective date of such
registration statement or prior to the expiration of forty days
after the first date upon which the security was bona fide
offered to the public.” See id. (emphasis added). Plaintiffs
say that this language demonstrates that “the date on which a
security is ‘bona fide offered to the public’ can be entirely
distinct from the date on which a registration statement is
declared effective.” Appellants’ Br. at 24.
laws, including the Investment Company Act of 1940. See Act of
August 10, 1954, ch. 667, tit. IV, § 402, 68 Stat. 683, 689
(codified as amended at 15 U.S.C. § 80a-24). Congress amended
the Investment Company Act, 15 U.S.C. § 80a-1 et seq., among
other things, to permit investment companies engaged in
continuous offerings to file amendments to existing registration
statements instead of filing a new one. See S. Rep. No. 83-
1037, at 21 (1954).
Both the House and Senate Reports accompanying the
amendments equate the effective date of the registration
statement with the bona fide offering. See H.R. Rep. No. 83-
1542, at 30 (1954) (“[A] dealer . . . need not use a prospectus
in connection with a transaction in a security after the
expiration of 1 year from the first date on which the security
was bona fide offered to the public, which, in most cases, means
approximately 1 year after the effective date of the
registration statement.”); S. Rep. No. 83-1037, at 20 (same).
46
But the fact that a different section of the statute
provides that the bona fide offer and registration can be
distinct events does not inexorably mean that they always will
be. Cf. In re Lehman Bros. Sec. & ERISA Litig., 903 F. Supp. 2d
152, 171 (S.D.N.Y. 2012) (“To be sure, the phrase bona fide
offered to the public, recognizes that there will be
circumstances in which stock covered by an effective
registration statement has not genuinely been offered to the
public, in which case the commencement of the repose period may
begin later than the effective date of the registration
statement.” (internal quotation marks omitted)).
In “the vast majority of offerings” the bona fide offering
to the public “will be the effective date of the registration
statement.” 17 Hicks, Civil Liabilities § 4:77. The only
exceptions would arise in the context of delayed or continuous
offerings in which information that is fundamental to assessing
the value of a particular offering is not disclosed until after
the registration statement becomes effective. See id.; see also
UBS Ams., Inc., 2012 WL 2400263, at *2. 11
11
At the time of the 2005 SPO, the SEC did not consider the
pricing information MuniMae filed in its prospectus supplement
the kind of fundamental information that would merit exceptional
treatment. See 17 C.F.R. § 229.512(a)(1)(2004); In re Lehman
Bros. Sec. & ERISA Litig., 903 F. Supp. 2d at 171.
47
Plaintiffs argue nonetheless that we should not accept
registration as the triggering event here, even if, as a general
rule, the two coincide. They say that using the effective date
of the registration statement is only appropriate in cases where
there is virtually no delay between registration and the
commencement of the public offering. By contrast, the 2005 SPO
was a shelf offering, and there was a two-week delay between the
effective date and the commencement of the offering. MuniMae
did not file a prospectus supplement announcing that the
registration statement was effective until February 1, and it
only priced the securities on February 2. On these facts,
plaintiffs argue, the securities were not genuinely offered to
the public on January 14.
We disagree. The general rule that the statute of repose
begins to run on the effective date has been repeatedly applied
in the context of delayed offerings. See, e.g., In re Adelphia
Commc'ns Corp. Sec. & Derivative Litig., 2005 WL 1679540, at *6
(S.D.N.Y. July 18, 2005) (“Even where registered securities are
offered pursuant to a less typical delayed offering, the
limitations period runs from the date of either the registration
statement or the [post-effective] amendment . . . .”), adhered
to on reconsideration,
2005 WL 1882281 (S.D.N.Y. Aug. 9, 2005);
see also UBS Ams., Inc.,
2012 WL 2400263, at *2-3 (recognizing
that that the general rule will apply in shelf offerings when
48
the registration statement contains the misleading information
on which the § 11 claim is predicated).
This is not the unusual case in which a post-effective
disclosure--rather than the registration statement--contained
the allegedly false or misleading information. The amended
complaint directly avers that the registration statement
declared effective on January 14 contained or incorporated by
reference the misleading statements to which plaintiffs object. 12
Under these circumstances, we are comfortable concluding that
MuniMae’s exposure began on the effective date.
The two-week gap between the effective date and the
commencement of the SPO does not alter our analysis. The fact
that plaintiffs did not know that the registration statement was
effective as of January 14 is of no consequence for statute of
repose purposes. See Caviness, 983 F.2d at 1300 (“[Section] 13
allows for no qualification emanating from the claimant’s
circumstances.”); see also P.
Stolz, 355 F.3d at 102-03
(explaining that a statute of repose begins to run “even if the
plaintiff has not yet, or could not yet have, discovered that
she has a cause of action”). Moreover, the SEC has sanctioned a
12
By contrast, the prospectus supplement filed on February
2, which priced the securities, contained a rather unambiguous
warning that MuniMae’s FIN 46R accounting might be incorrect.
See J.A. 1578.
49
delay of up to fifteen business days between registration and
the commencement of sale in the context of non-delayed
offerings. See 17 C.F.R. §§ 230.430A(a)(3), 229.512(a). Thus,
the thirteen-day gap here hardly strikes us as abusive.
In sum, we hold that securities will generally be bona fide
offered to the public on the date the SEC declares the
registration statement effective. Applying this holding, we
conclude that MuniMae bona fide offered securities to the public
on January 14, 2005. Plaintiffs’ amended complaint, which
relates back to the original complaint filed on February 1,
2008, is thus time-barred under § 13’s statute of repose.
B.
1.
We turn finally to the amended complaint’s § 12(a)(2) claim
against MuniMae and the underwriter defendants with respect to
the 2005 SPO. Section 12(a)(2) provides that any person who
“offers or sells a security . . . by means of a prospectus or
oral communication” containing a materially false statement or
material omission “shall be liable . . . to the person
purchasing such security from him.” 15 U.S.C. § 77l(a)(2).
The amended complaint alleges that named plaintiff Dammeyer
“purchased MuniMae’s common stock pursuant and/or traceable to
the SPO Registration Statement and Prospectus dated February 2,
2005.” J.A. 89. It incorporates by reference Dammeyer’s
50
confirmation slip for the shares. The slip shows that Dammeyer
purchased 600 shares of MuniMae stock at $26.32 per share on
February 3, 2005, and that he received those shares on February
8, 2005. The slip also bears the logo of RBC Dain Rauscher and
includes the phrase “PROS UNDER SEP COVER.” J.A. 1606.
The district court found the amended complaint and
confirmation slip insufficient to establish Dammeyer’s
standing. It found Dammeyer’s claim that he purchased stock
“pursuant and/or traceable to” the SPO documents conclusory, and
the confirmation slip lacking in “supporting details to make a
plausible claim that Dammeyer purchased directly in the SPO.”
In re Mun. Mortg. & Equity, LLC, 876 F. Supp. 2d at 660.
On appeal, plaintiffs contend that the district court
improperly failed to consider the confirmation slip referenced
in the complaint, and that the slip, when properly considered,
supplies the necessary details to support a plausible allegation
of standing. Defendants respond that Dammeyer would have said
that he purchased his shares directly in the SPO if he actually
did. Moreover, they claim that the details of the confirmation
slip show that Dammeyer purchased his securities on the
secondary market and not in the SPO.
2.
We review the plausibility of the amended complaint’s
standing allegations de novo under the pleading requirements of
51
Rule 8(a). See In re Century Aluminum Co. Sec. Litig., 729 F.3d
1104, 1107-09 (9th Cir. 2013) (reviewing the plausibility of a
complaint’s standing allegations with respect to a § 11 claim).
It is not enough for the amended complaint to allege facts,
which, accepted as true, are merely consistent with the
possibility that Dammeyer purchased shares in the SPO; the
allegations must also render such a conclusion plausible.
Ashcroft v. Iqbal,
556 U.S. 662, 678 (2009).
To establish standing under § 12(a)(2), a plaintiff must
allege that he purchased shares from “[a]ny person” who
“offer[ed] or s[old] a security . . . by means of a prospectus.”
15 U.S.C. § 77l(a)(2). In Gustafson v. Alloyd Co., 513 U.S. 561
(1995), the Supreme Court interpreted the prospectus requirement
of § 12(a)(2), and concluded that, because “prospectus” is a
term of art referring to a specific document in a public
offering, sales made pursuant to private contracts are not made
by means of a prospectus. See
id. at 580-84. Thus, § 12(a)(2)
liability is “limited to public offerings,” and purchasers in
the secondary market may not sue.
Id. at 578; see also In re
CitiGroup Inc. Bond Litig.,
723 F. Supp. 2d 568, 585 (S.D.N.Y.
2010) (“[A] plaintiff seeking redress pursuant to Section
12(a)(2) must establish that it purchased the security directly
from defendants through the public offering at issue.”).
52
A number of district courts have concluded that the
“pursuant and/or traceable to” language employed in the amended
complaint is insufficient to establish standing for § 12(a)(2)
purposes. See, e.g., Pub. Emps.’ Ret. Sys. of Miss. v. Merrill
Lynch & Co., 714 F. Supp. 2d 475, 484 (S.D.N.Y. 2010); In re
Wells Fargo Mortg.-Backed Certificate Litig.,
712 F. Supp. 2d
958, 966 (N.D. Cal. 2010); In re Sterling Foster & Co., Inc.,
Sec. Litig.,
222 F. Supp. 2d 216, 245-46 (E.D.N.Y. 2002). The
general tenor of these opinions is that plaintiffs should plead
that they directly purchased securities in the relevant
offering, and that a failure to do so implies that the
securities were in fact purchased on the secondary market. See,
e.g., In re Sterling
Foster, 222 F. Supp. 2d at 245.
The First Circuit has held that alleging that a plaintiff
purchased securities “pursuant and/or traceable to” a public
offering can be sufficient if coupled with additional supportive
facts. See Plumbers’ Union Local No. 12 Pension Fund v. Nomura
Asset Acceptance Corp., 632 F.3d 762, 776 (1st Cir. 2011)
(finding the terminology sufficient when coupled with
allegations that plaintiffs “‘acquired’” securities “‘from’” the
defendants and that the defendants “‘promoted and sold’” the
securities to the plaintiffs).
We agree that using the “pursuant and/or traceable to”
language--coupled with sufficient supporting facts--can give
53
rise to a plausible inference of standing in certain
circumstances. Here, however, we find the amended complaint and
confirmation slip insufficient to make plaintiffs’ allegations
of standing plausible. Though not dispositive, the plaintiffs’
coy choice of words gives us some pause. And we do not find the
additional supporting facts sufficient to push the claim into
the realm of plausibility.
To be sure, the amended complaint alleges a number of facts
consistent with the possibility that Dammeyer purchased his
shares directly in the SPO. For example, the complaint alleges
that Dammeyer purchased 600 common shares of MuniMae stock on
February 3, 2005, and, according to the amended complaint, the
SPO occurred “[o]n or about February 2, 2005,” J.A. 233.
Although these dates of purchase are close, they do not directly
coincide.
More helpful to plaintiffs, the confirmation slip shows
that the settlement date for Dammeyer’s securities was February
8, see J.A. 1606, which coincides with the date the prospectus
supplement states that SPO shares would be available for
delivery, see J.A. 1557. These supporting facts are not
irrelevant, but they are also not sufficient. Cf. In re Century
Aluminum, 729 F.3d at 1107-08 (finding similar evidence about
pricing and sale dates insufficient in the context of § 11,
where standing requirements are more relaxed).
54
Plaintiffs emphasize the fact that the confirmation slip
bears the notation “PROS UNDER SEP COVER,” which means
prospectus under separate cover. See J.A. 1606; see also
Gustafson, 513 U.S. at 571 (“[T]he liability imposed by
[§ 12(a)(2)] cannot attach unless there is an obligation to
distribute the prospectus . . . .”). However, as defendants
note, RBC is both a registered broker-dealer and an underwriter,
and under SEC regulations, it may have had to deliver a
prospectus to Dammeyer in either capacity. See 15 U.S.C.
§§ 77d(a)(3), 77e(b) (prospectus delivery requirement); 17
C.F.R. § 230.174 (obligations of broker-dealers to comply with
prospectus delivery requirements). Without more, that notation
is merely consistent with the claim that Dammeyer purchased his
shares directly in the SPO. 13
The plausibility of the claim against the underwriter
defendants is even weaker. The confirmation slip provides no
support for the contention that Dammeyer purchased his shares
from Merrill Lynch. With respect to RBC, the allegations are
not much better. The attached confirmation slip bears the logo
13
We also note that the complaint alleges that the SPO
offered shares “priced at $26.51.” J.A. 111. But Dammeyer’s
purchase price was $26.32 per share. J.A. 1606. And, in
contrast to Plumbers’ Union, there are no allegations that
defendants specifically promoted the securities or solicited
Dammeyer’s purchase.
55
of “RBC Dain Rauscher.” However, RBC Capital Markets Corp. was
the designated underwriter for the SPO. See J.A. 1590.
Dammeyer does not allege that these were the same entity as of
2005, or that they should be treated as such for liability
purposes.
At best, the allegations are merely consistent with the
possibility that Dammeyer purchased his securities in the SPO.
The “pursuant and/or traceable to” language of the complaint is
conclusory, and the confirmation slip does not provide
sufficient “factual enhancement” to support a “reasonable
inference that the defendant[s are] liable for the misconduct
alleged.” See Iqbal, 556 U.S. at 678 (internal quotation marks
omitted). In this circumstance, the complaint “stops short of
the line between possibility and plausibility.” See Bell Atl.
Corp. v. Twombly,
550 U.S. 544, 556 (2007). Accordingly, we
agree with the district court that Dammeyer did not adequately
allege standing to bring a § 12(a)(2) claim. 14
14
Dammeyer also brings an SPO-based claim under § 15 of the
Securities Act, which imposes derivative liability on certain
“control persons” for primary violations of the Act. See 15
U.S.C. § 77o. We dismiss the § 15 claim because the complaint
fails to state a claim under the predicate Securities Act
provisions. See Greenhouse v. MCG Capital Corp., 392 F.3d 650,
656 n.7 (4th Cir. 2004).
56
IV.
For the foregoing reasons, we affirm the judgment of the
district court.
AFFIRMED
57
