USCA1 Opinion
UNITED STATES COURT OF APPEALS
FOR THE FIRST CIRCUIT
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No. 93-2070
NISHAN SERABIAN, ET AL.,
Plaintiffs, Appellants,
v.
AMOSKEAG BANK SHARES, INC., ET AL.,
Defendants, Appellees.
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APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF NEW HAMPSHIRE
[Hon. Shane Devine, Senior U.S. District Judge]
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Before
Torruella, Circuit Judge,
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Coffin, Senior Circuit Judge,
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and Boudin, Circuit Judge.
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James R. Malone, Jr., with whom C. Oliver Burt, III, Michael D.
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Gottsch, Pamela Bond and Peter A. Pease were on brief appellants.
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Robert Upton, II, with whom Charles W. Grau was on brief for
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Amoskeag Bank Shares, Inc.
Ovide M. Lamontagne with whom E. Donald Dufresne was on brief for
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Allen, Machinist, Bushnell, Yakovakis, Woolson, Allman and Keegan.
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May 27, 1994
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COFFIN, Senior Circuit Judge. The question on this appeal
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is whether appellants' Third Amended Complaint states a claim for
fraud under federal securities law, see 15 U.S.C. 78j(b) (
___
10(b) of the Securities Exchange Act of 1934); SEC Rule 10b-5 (17
C.F.R. 240.10b-5), a claim that must be plead "with
particularity." Fed. R. Civ. P. 9(b). The district court held
that it did not, and dismissed the complaint with prejudice.
After carefully studying the 86-page, 107-paragraph complaint, we
have concluded that portions of it are entitled to survive. We
therefore vacate the dismissal in part, and remand for further
proceedings limited to the actionable allegations.
I. Background
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During the period relevant to this litigation, defendant
Amoskeag Bank Shares ("Bank Shares" or "the bank" or "the
company") was a New Hampshire bank holding corporation with four
wholly owned subsidiaries: Amoskeag Bank, New Hampshire's largest
bank; Nashua Trust Company; Bank Meridian, N.A.; and Souhegan
National Bank of Milford.1 The seven individual defendants are
certain of Bank Shares' former officers and/or directors.
Plaintiffs are the purchasers of Bank Shares' common stock.
In this lawsuit, filed as a class action but still uncertified,
they claim that the defendants issued various documents, reports,
and statements that misrepresented and failed to disclose
material facts concerning Bank Shares' true financial condition,
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1 Bank Shares was taken over by the FDIC in October 1991.
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thereby artificially inflating the market price of the company's
stock at the time they purchased it.2
The complaint depicts an increasingly familiar saga of a
bank that boomed with the real estate market of the early 1980s,
but suffered in the recession and deteriorating market that
followed. See, e.g., In Re Wells Fargo Securities Litigation, 12
___ ____ _______________________________________
F.3d 922 (9th Cir. 1993); In Re Glenfed, Inc. Securities
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Litigation, 11 F.3d 843 (9th Cir. 1993), reh'ng en banc, granted,
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11 F.3d 843 (9th Cir. Feb. 25, 1994); Shapiro v. UJB Financial
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Corp., 964 F.2d 272 (3d Cir. 1992); DiLeo v. Ernst & Young, 901
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F.2d 624 (7th Cir. 1990). The primary thrust of the allegations
is that defendants knew that their loan portfolio contained many
high-risk loans, that the reserves for such loans were
inadequate,3 and that poor internal controls exacerbated the
difficulties, but that they nevertheless continued to paint a
rosy picture of the bank's financial circumstances.
The district court, having given plaintiffs the opportunity
to amend a previous version of the complaint, concluded that,
"[a]t most, the [Third Amended] [C]omplaint demonstrates dubious
business judgment or mismanagement." The court felt that the
pleading, reduced to its essence, alleged that the defendants
throughout the relevant period knowingly reserved too little in
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2 Rule 10b-5, promulgated by the SEC under the authority
provided by 10(b) of the Securities Exchange Act, makes it
unlawful to misrepresent or omit material information in
connection with the purchase or sale of securities.
3 The amount put aside as a protection against loan defaults
is known as the ALL -- the "allowance for loan losses."
-3-
anticipation of loan losses. In the court's view, however, the
complaint lacked a basis for inferring the defendants' knowledge
of the deficiency and, moreover, failed to identify any specific
loans whose reserves were inadequate. These deficiencies,
despite ample opportunity for discovery and "considerable
ingenuity in pleading," prompted the court to dismiss the
complaint with prejudice.
Plaintiffs argue on appeal that the complaint more than
adequately set forth the bases for their allegations of fraud by
detailing numerous specific instances in which the defendants had
knowledge of the "true facts," yet made substantially different
representations to the investing public. They claim that the
district court impermissibly drew inferences in favor of the
defendants, contrary to its obligation to indulge every
reasonable inference helpful to their case. See, e.g., Garita
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Hotel Ltd. Partnership v. Ponce Federal Bank, 958 F.2d 15, 17
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(1st Cir. 1992).
We review the district court's determination de novo,
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applying the same criteria employed by the district court. Id.
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If the allegations would permit recovery under any viable theory,
the dismissal must be reversed. Id.
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II. Applicable Standards
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We preface our discussion with a brief survey of the general
principles that must guide our review of plaintiffs' complaint.
First, the securities laws "do not guarantee sound business
practices and do not protect investors against reverses," DiLeo,
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-4-
901 F.2d at 627. In stating an actionable claim for
misrepresentation, therefore, plaintiffs must plead more than
that defendants acted irresponsibly and unwisely, but that they
were aware that "mismanagement had occurred and made a material
public statement about the state of corporate affairs
inconsistent with the existence of the mismanagement," Hayes v.
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Gross, 982 F.2d 104, 106 (3d Cir. 1992). See also Shapiro, 964
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F.2d at 283 ("[I]t is not a violation of the securities laws to
simply fail to provide adequate loan loss reserves; properly
collaterize or secure a loan portfolio; or provide sufficient
internal controls or loan management practices.").
Second, defendants may not be held liable under the
securities laws for accurate reports of past successes, even if
present circumstances are less rosy, see Capri Optics Profit
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Sharing v. Digital Equipment, 950 F.2d 5, 7-8 (1st Cir. 1991),4
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and optimistic predictions about the future that prove to be off
the mark likewise are immunized unless plaintiffs meet their
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4 In Capri Optics, we described our earlier decision,
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Backman v. Polaroid, 910 F.2d 10 (1st Cir. 1990) (en banc), as
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holding that
there was no duty to disclose to market buyers
information simply because it was material, or to
amplify what was said, unless the omitted matter caused
what was said to be misleading . . . . As an
illustration, if defendant reported, correctly, without
more, "This is our eighth consecutive quarter in which
our gross has increased," there was no duty to add, for
the benefit of market buyers, "We are concerned about
the next one."
We recognized, of course, that "if defendant's apprehension was
of a disaster the rule might be different . . . ."
-5-
burden of demonstrating intentional deception, see Greenstone v.
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Cambex Corp., 975 F.2d 22, 25-26 (1st Cir. 1992) (there is no
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"`fraud by hindsight'"); DiLeo, 901 F.2d at 627 (same). See also
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Shapiro, 964 F.2d at 283-84 n.12 (quarterly report stating that
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the company "looks to the future with great optimism . . . is
clearly inactionable puffing").
Third, and finally, general averments of the defendants'
knowledge of material falsity will not suffice. Greenstone, 975
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F.2d at 25. Consistent with Fed. R. Civ. P. 9(b), the complaint
must set forth "specific facts that make it reasonable to believe
that defendant[s] knew that a statement was materially false or
misleading." Id. The rule requires that the particular "`times,
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dates, places or other details of [the] alleged fraudulent
involvement'" of the actors be alleged. In re Glenfed, 11 F.3d
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at 847-48 (citation omitted). See also Romani v. Shearson Lehman
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Hutton, 929 F.2d 875, 878 (1st Cir. 1991); New England Data
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Services v. Becher, 829 F.2d 286, 288 (1st Cir. 1987) ("[I]n the
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securities context, and in general, this circuit has strictly
applied Rule 9(b).").
With this framework in mind, we begin our scrutiny of
plaintiffs' allegations.
III.
The Third Amended Complaint contains 63 paragraphs ( 23-
86) describing the misstatements and omissions allegedly made by
defendants during the class period from June 17, 1987 through
October 23, 1989. We have read the paragraphs line-by-line, and
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agree with the district court that much of complaint fails to
establish an actionable 10b-5 claim. Many of the challenged
statements either were undisputedly true representations of the
company's circumstances, or are unaccompanied in the complaint by
specifics tending to show knowing falsity. Other portions of the
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complaint are inadequate because they allege improper conduct in
wholly conclusory terms.
The complaint is more successful in stating a claim
concerning statements made during late 1988 and 1989, when
plaintiffs contend that the bank was experiencing accelerated
loan deterioration. Public announcements during that time
suggested that the bank's loan business was under control while
plaintiffs allege that the bank recognized that its problems were
severe, particularly that its ALL was inadequate and its internal
procedures for identifying problem loans deficient.
In the following sections, we explain our conclusions by
considering in detail various portions of the complaint. We do
not examine separately each allegation contained in this
voluminous pleading, but believe our discussion is sufficiently
complete and illustrative to enable the district court to
distinguish the actionable from the inactionable in the remaining
paragraphs. Sales of stock and mortgage-backed securities,
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23-25. These paragraphs describe Bank Shares' substantial
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losses in June and July 1987 when it sold certain mortgage backed
securities, as well as stock that it unlawfully held in eight
banking companies. Plaintiffs allege that, with the approval or
-7-
acquiescence of "Bank Shares['] purportedly independent
auditors," the company knowingly allocated these losses to the
improper fiscal quarters of 1987. As a result, plaintiffs
allege, Amoskeag's announced earnings for the quarter ended June
30, 1987 were artificially inflated. The complaint also
criticizes the defendants' failure to recognize loss on the
company's equity securities portfolio until the end of the year.
We fail to find a basis for actionable securities fraud in
these paragraphs. Plaintiffs allege no representations
inconsistent with the bank's state of affairs.5 The fact that
the company was in violation of federal law by its ownership of
the financial institution stock may reflect poorly on its
management, but in no way demonstrates a 10b-5 violation.
Nothing in the complaint suggests that the decision of Bank
Shares to delay its equity security loss until the end of the
year was fraudulent, even if, as the complaint alleges, it was a
violation of Generally Accepted Accounting Principles (GAAP).
Indeed, the complaint acknowledges that Ernst & Whinney, Bank
Shares' accounting firm, approved the method by which the company
recognized its losses, arguably casting doubt on the existence of
any impropriety.6
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5 A general allegation that the practices at issue resulted
in a false report of company earnings is not a sufficiently
particular claim of misrepresentation.
6 As a result of our conclusion that these paragraphs, as
well as 26-42, were dismissed properly for lack of actionable
allegations, we need not address defendants' contention that they
should be stricken as time-barred.
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Reversal of $275,000 in 1987 loan loss provision, 26-30.
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These paragraphs allege that, at the end of the second
quarter of 1987, defendants reversed an allocation of $275,000
that had been made earlier in the year to its loan loss provision
"for no reason other than arbitrary manipulation" designed "to
offset the impact of other losses." Plaintiffs claim that
defendants falsely represented in their Form 10-Q for the quarter
that the decrease was attributable to the credit quality of the
bank's loan portfolio.
This conclusory allegation of falsity is unsupported by any
specific facts. Plaintiffs offer no basis for inferring that the
defendants knew that the bank's loan portfolio was, at that time,
improperly characterized as "excellent." They provide no
information about the general health of the company's loan
portfolio, and fail to cite any specific loans that were in
trouble. Defendants' 10-Q states that the decision to reduce the
loan loss provision was attributable to, inter alia, the sale of
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$48 million in loans and the low level of non-performing loans.
The figures and statistics contained in the document are not
alleged to be inaccurate. We consequently find no actionable,
particularized allegation of fraud in this portion of the
complaint.
Economic outlook and internal review, 1987 Annual Report,
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33-43.7
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7 Paragraph 32 quotes at length from the company's 1987
annual report and suggests that its "decidedly upbeat" tone was
fraudulent. Plaintiffs acknowledge, however, that the bank
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This portion of the complaint describes a growing awareness
by the Company of the slowdown in the real estate market, and
recognition of the need to quantify possible losses inherent in
its loan portfolio. The complaint alleges:
[C]ontrary to public representations, by February 1988,
the defendants had determined that the existing loan
review function was unable to keep up with timely
reviews of the Company's loan portfolios (which were
known by defendants to be deteriorating in
creditworthiness due to changes in the economy) and the
Company lacked sufficient loan credit file
documentation to properly analyze the ALL. Thus, the
Company hired a retired career banker, J. Howard "Mac"
McGloon, on a consulting basis to review lending
practices and ostensibly to assist the Loan Review
department in its function.
34.
Nothing in the following paragraphs, which describe various
"public representations" contained in the company's 1987 annual
report, supports the assertion that officials knowingly
misrepresented the bank's ability to manage its loan portfolio.
That a consultant was hired to assist with loan review is not
inconsistent with the company's statement, cited in 37, that
"[m]anagement closely monitors the quality of the loan and lease
financing portfolio." Getting the help needed to stay on top of
the situation, or to improve it, is one aspect of close
monitoring.8
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disclosed the substantial drop in net income from the prior year
and the substantial loss in equity securities. No facts suggest
knowing falsity in any of the company's optimistic statements
about its future prospects.
8 Similarly, plaintiffs fail to demonstrate any basis for
inferring knowing falsity in the defendants' statement, also
quoted in 37 of the complaint, that "the Company's basic
-10-
Although 40-42 allege that, during early 1988, defendants
failed to follow internal policy for recognizing earnings on
commercial real estate loans and to allocate the appropriate ALL
amount for such loans, the complaint does not demonstrate how
these flaws in procedure add up to a securities violation. As
noted earlier, "mere failure to provide adequate reserves (or to
perform competently other management tasks) does not implicate
the concerns of the federal securities laws and is not normally
actionable," Shapiro, 964 F.2d at 281.
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Plaintiffs additionally complain about the tone of a press
release issued by the company on July 14, and the company's
quarterly report filed with the SEC on August 12. These reports
were misleadingly positive, plaintiffs allege, because they
stated that earnings were down in part because of an increase in
loan reserves designed as a "safeguard against an extended
slowdown in real estate and condominium markets." See 43.
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There is nothing actionable in these statements, which simply
report the company's reduced earnings and one of the reasons for
it.
Chaston finds "serious deficiencies"; internal concerns;
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"conservative" approach, 46-69.
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This portion of the complaint primarily describes events and
information relating to the bank's handling of its ALL in late
1988 and early 1989, as well as corresponding public statements
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banking business is strong as indicated by the excellent quality
of the loan and lease financing portfolio."
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made by the defendants about those matters. In our view, it is
the only section of the complaint that contains allegations
sufficiently particular and pertinent to survive defendants'
motion to dismiss.
The scenario depicted by these allegations can be summarized
as follows: at least by August 1988, the company had become aware
that the quality of its commercial loans had deteriorated
significantly, and that the loan review department was having
difficulty staying on top of problem loans, particularly in
commercial real estate. See 47.9 This prompted the hiring of
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a consulting firm, Chaston Associates, that began work in mid-
October. Chaston reported within two weeks that there were
"serious deficiencies" in the ALL at Amoskeag, and this finding
was partly responsible for a $6 million increase in loan loss
reserves at the end of the third quarter, September 30, 1988.
See 46. Meanwhile, internal reviews also had revealed
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deficiencies in the ALL at both Nashua Trust Company (NTC) and
Amoskeag, and the auditor concluded that "additional injections
to the reserve [at Amoskeag] are required as soon as financially
feasible." 50 (a), (b).
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9 This paragraph alleges that, on August 10, 1988, Bank
Shares' vice president and loan review officer Worden informed an
Ernst & Whinney auditor that
the quality of commercial loans had deteriorated since
E&W's last audit review as of December 31, 1987, and
that Worden did not believe that his department was
devoting an adequate amount of time to the monitoring
of the appropriateness of credit quality ratings
assigned by Amoskeag's loan officers, particularly in
the area of CRE [commercial real estate] loans.
-12-
Plaintiffs juxtapose these allegations showing internal
awareness of review problems and inadequate loan loss reserves
with the company's public statements characterizing its loan
review capabilities as "strong" and its ALL approach as
"conservative." In 52 of the complaint, for example,
plaintiffs cite a press release issued on October 24, 1988,
announcing third quarter earnings that were substantially reduced
from the same period a year earlier. The paragraph continues:
Defendants Machinist and Allen made the following false
and misleading statements in the press release with
respect to the increase in loan loss provision:
. . .
[W]e have experienced a build-up of non-performing
loans to $47 million, or 2.7 percent of total loans,
from $35 million at June 20, 1988, the majority of
which relates to commercial real estate. Our loan
Our loan
review capabilities are strong and we have directed
review capabilities are strong and we have directed
specific resources to each of those loans.
specific resources to each of those loans
The decision to make a substantial addition to the
loan reserve is consistent with past practice of the
consistent with past practice of the
company to address issues in a timely and conservative
company to address issues in a timely and conservative
manner. We strongly believe this action will ensure
manner
the integrity of our financial statements and solidify
the foundation for future earnings gains.
52 (some emphasis added, other omitted).
Plaintiffs quote similar remarks by defendant Allen at a
combined meeting of New York and New England stock analysts on
October 28, 1988, and by defendants Machinist and Allen in a
press release issued on January 30, 1989:
We at Amoskeag are risk-averse bankers. If
risk-averse
the banking business involves the fundamental
choice between eating well and sleeping well,
we'll cut back a little on the calories for
more peace of mind. We have excellent people
We have excellent people
-13-
in loan review. They oversee a comprehensive
in loan review. They oversee a comprehensive
reporting and monitoring system
reporting and monitoring system
***
When we allocated $6 million to the loan loss
reserve in the third quarter, we worked from
we worked from
very conservative assumptions. We considered
very conservative assumptions
all the factors and assumed less-than-
favorable economic conditions. Higher short-
term rates. Low overall economic growth.
Further potential softening in real estate
markets.
We made this decision without prompting from
We made this decision without prompting from
regulators or accountants.
regulators or accountants
56 (emphasis added).
While non-accrual loans rose in the
fourth quarter, from $26.6 million to $35.8
million, the rate of increase in problem
loans has moderated. We are managing those
We are managing those
loans intensively and with success.
loans intensively and with success
The real estate market is turning around
slowly and further reductions of excess
inventory have been realized. Our policy of
Our policy of
reserving conservatively in advance of need
reserving conservatively in advance of need
is being validated. We remain well secured
is being validated We remain well secured
and confident of the values underlying our
and confident of the values underlying our
loans.
loans
62 (some emphasis added, other omitted).
Plaintiffs also allege that, despite company awareness that
"additional injections to the reserve" were required, see
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50(b), 59, 60, a management statement contained in Bank Shares'
1988 Annual Report, filed with the SEC in late March 1989,
observed that "[i]t is management's judgment that the allowance
for loan and lease losses at year-end 1988 is sufficient to
absorb losses inherent in the existing portfolio," 68. See
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also 64 (defendants stated in annual report that amount of
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increase in the ALL from year-end 1987 to year-end 1988 is "a
prudent and proper course for today"); 69(d).10
In this series of allegations, plaintiffs do more than
simply identify management problems or point to statements that
put a positive spin on the company's circumstances, without
indicating how or why defendants should have known the
descriptions were inaccurate. Rather, these paragraphs present a
contrast between what company officials were hearing internally
about their loan review effectiveness and the adequacy of their
ALL, and what the company was telling the public at the same
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time. Cf. Romani, 929 F.2d at 878-80 (complaint contains no
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factual allegations supporting a reasonable inference that
adverse circumstances were known and deliberately or recklessly
disregarded by defendants); Hayes, 982 F.2d at 106 ("[P]laintiff
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alleges more than mismanagement. He alleges that defendants made
affirmative representations inconsistent with the state of
corporate affairs they knew to exist."). When defendants
"affirmatively characterize[] management practices as `adequate,'
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10 In 69(d), plaintiffs allege that on about February 21,
1989, the company's audit committee was told by its accounting
firm, Ernst & Whinney, that a Chaston report
"presented management and E&W with a problem" since
Chaston had concluded the allowances for loan loss at
both Amoskeag and NTC were inadequate by a combined
total of $9.4 million. E&W further told the Audit
Committee it had been required to expend "significant
effort in reviewing [a] large number of individual
loans to support adequacy of a reserve less than
Chaston felt was needed."
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`conservative,' `cautious,' and the like, the subject is `in
play.'" Shapiro, 964 F.2d at 282.
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For example, if a defendant represents that its lending
practices are "conservative" and that its
collateralization is "adequate," the securities laws
are clearly implicated if it nevertheless intentionally
or recklessly omits certain facts contradicting these
representations. Likewise, if a defendant
characterizes loan loss reserves as "adequate" or
"solid" even though it knows they are inadequate or
unstable, it exposes itself to possible liability for
securities fraud. By addressing the quality of a
particular management practice, a defendant declares
the subject of its representation to be material to the
reasonable shareholder, and thus is bound to speak
truthfully.
Id. See also In Re Wells Fargo, 12 F.3d at 930; Hayes, 982 F.2d
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at 106-07.
These allegations also are sufficiently particular to meet
the requirements of Rule 9(b). In the paragraphs at issue,
plaintiffs specifically identify the internal reports and the
public statements underlying their claims, providing names and
dates. Although this section of the complaint would be
strengthened if it contained specific examples of problem loans
requiring a higher ALL, see In Re Wells Fargo, 12 F.3d at 926-28,
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the summaries of the auditors' and consultants' reviews serve the
same purpose. Both permit an inference that the bank knew, or
should have known, that its public statements were inconsistent
with the actual conditions then being reported to them. The
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complaint does not simply rely on poor performance in the
aftermath of positive reports.11
Despite our conclusion that certain allegations survive
threshold consideration, we note that plaintiffs remain a great
distance from actually proving securities fraud. Their ability
to demonstrate that defendants acted with fraudulent intent in
making the various representations about Bank Shares'
conservative ALL approach may depend, inter alia, on whether
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company officials in good faith believed their allocations were
adequate, and considered the increases recommended by the
consultants to be "ultra" conservative, and thus excessive. See
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In Re Wells Fargo, 12 F.3d at 927 ("[T]he setting of loan loss
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reserves is, by all accounts, an `art and not a science' . . . .
"). The precise timing of certain statements in relation to the
bank's ALL activity also is crucial.12
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11 The complaint does not entirely lack reference to
specific loans. For example, in paragraphs 48 and 49, plaintiffs
aver that, in meetings held on August 16, 1988, an Ernst &
Whinney representative was told by the head of Amoskeag's
commercial real estate (CRE) division that certain CRE loans
"were now `maturing' and some were beginning to evidence signs of
deterioration not previously evident." 48. The Amoskeag
officer, Stephen Bradbury, noted in particular residential
condominiums, for which the bank had 18 or 19 outstanding loans.
Additionally, plaintiffs allege that E&W learned from the head of
Amoskeag's private banking division of a number of large,
unsecured problem loans, three of which are specifically
identified. 49. The complaint does not allege a connection,
however, between these specific loans and the asserted problems
with internal monitoring and inadequate ALL.
12 While a generous reading of the allegations in this
section would permit the inference that Bank Shares was
representing its ALL as adequate and "conservative" at the same
time that it was receiving multiple reports that it was not, it
also is possible that some of the disputed statements occurred
-17-
Similarly, the contested statements regarding the quality of
Bank Shares' loan management capabilities may turn out to be
neither material nor misleading if, for example, hiring
consultants is a typical strategy of aggressive bank managers to
prevent more serious problems. In other words, defendants may
show that, in the banking context, "effective" loan monitoring
often includes adding hired experts to the company's own internal
procedures.
We note, as an additional caveat to the court and the
parties, that not every paragraph in this section of the
complaint contains actionable allegations,13 and even those
paragraphs that cannot be dismissed in their entirety as a matter
of law may contain allegations and wholly conclusory statements
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only in the aftermath of corrective action -- in particular, the
$6 million allocation as of September 30, 1988 -- and that bank
officials thus reasonably believed that their reports were
accurate. For example, the review of Amoskeag's ALL performed by
the company's Internal Audit Department "[a]s of September 30,
1988" indicated the need for "additional injections" to the ALL,
but it is not clear whether this assessment was based on the
amount of reserves before or after the $6 million was allocated
retroactively to the third quarter. See 50(b). Indeed, it is
___
necessary to determine whether Bank Shares in October 1988 viewed
the $6 million as a complete solution to the identified problems,
or knew that it was only a partial response to Chaston's initial
findings, in order to evaluate its public statements. See, e.g.,
___ ____
46, 54, 55, 57, 62.
13 For example, 61 states that defendants Allen, Yakovakis
and Machinist were "not surprise[d]" by Chaston's conclusion that
the Amoskeag and NTC ALLS were inadequate by a total of $12.1
million. The paragraph fails to identify with the required
particularity the conversations on which it is based, giving no
information about when and where these conversations supposedly
took place. Similarly, nothing in 58, which addresses "below
market rate" loans given to condominium purchasers, gives rise to
an inference of fraud, as distinguished from simple
mismanagement.
-18-
that warrant no further attention.14 Although we leave to the
district court's discretion how it chooses to proceed upon
remand, we suspect that it may wish to direct plaintiffs to
submit a revised, limited complaint consistent with this decision
before conducting further proceedings. Cf. Shapiro, 964 F.2d at
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284 (directing plaintiffs to reorganize complaint on remand to
facilitate evaluation).15
Continuing loan deterioration, declining earnings,
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increasing ALL, 70-86.
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These allegations detail developments beginning in mid-1989
with Bank Shares' acknowledging a substantial problem with non-
performing loans, prompting dramatic increases in its ALL
(including a $31.5 million addition to the previously announced
$6.1 million allocation for the first quarter), and ultimately
resulting in a reported net loss of $50.7 million for fiscal year
1989. Presumably, plaintiffs seek to establish in this section
of the complaint that the precipitous drop in Bank Shares'
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14 In 53, for example, plaintiffs allege that "defendants
knew that the provision for loan losses in prior periods had been
arbitrarily understated without regard to the requirement of the
ALL, for the purposes of manipulating and artificially increasing
the Company's reported earnings." This language re-introduces
the allegations surrounding the 1987 decrease in the ALL, but it
is no more supportable at this point than it was earlier. See
___
supra at 8-9.
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15 Although we have focused on the section of the complaint
labeled "Class Period Misstatements and Omissions," we note that
significant portions of paragraphs 87 to 106, describing
plaintiffs' cause of action, also could be substantially reduced
if the district court chooses to order plaintiffs to amend their
complaint before taking further action.
-19-
financial condition was not really so precipitous, and thus
reflects the company's earlier concealment of its poor situation.
This approach, however, is simply an impermissible effort to
establish fraud through hindsight. It is well established that
plaintiffs in a securities action have not alleged actionable
fraud if their claim rests on the assumption that the defendants
must have known of the severity of their problems earlier because
conditions became so bad later on. See Kowal v. MCI
___ _____ ___
Communications Corp., 16 F.3d 1271, 1278 (D.C. Cir. 1994);
_____________________
Greenstone, 975 F.2d at 25 (Rule 9(b) not satisfied by general
__________
averment that "defendants `knew' earlier what later turned out
badly"). See also supra at 5-6. Unlike the earlier section of
___ ____ _____
the complaint, detailing the basis for the alleged inconsistency
between defendants' knowledge and their public statements, there
are no facts stated here with any particularity from which an
inference of fraud reasonably can be drawn.
The complaint instead states that bank examiners in May
reported the need for an increased ALL, see 73, that Bank
___
Shares at approximately that time obtained an extension for
filing its first quarter report for 1989 so that it could
readdress the adequacy of its ALL, see 75, and that it shortly
___
thereafter made a substantial increase, see 76. From all that
___
appears, Bank Shares acted properly in doing what it was advised
-20-
to do, while reporting accurately that it was taking these steps
because of "real estate related loan problems," see 79.16
___
The concluding paragraphs in this section of the complaint
describe various Chaston reports on Bank Shares' loan management
procedures and its ALL, as well as the company's reports of its
losses in the third and fourth quarters of 1989. See 81-86.
___
None of them provides a basis for a securities fraud claim.
IV.
In addition to its claim against Bank Shares as a
corporation, plaintiffs allege liability against seven individual
former officers and directors of the company. The district court
did not address the sufficiency of these allegations in the Third
Amended Complaint, but did reject the claims as insufficiently
particular when it reviewed an earlier version. See Shields v.
___ _______
Amoskeag Bank Shares, 766 F. Supp. 32, 40-41 (D.N.H. 1991).
____________________
We conclude that, with respect to five of the seven
defendants, the complaint alleges a sufficiently specific
connection to certain of the challenged statements that dismissal
____________________
16 Plaintiffs point to a statement in Bank Shares' 10-Q for
the second quarter of 1989, filed with the SEC on about August 1,
explaining that the increase in the provision for loan and lease
losses "was the result of management's assessment of the adequacy
of the allowance for loan and lease losses in light of [the]
judgment that there has been significant deterioration in the
condition of problem loans since year-end," 79. Nothing in the
complaint suggests that this was other than an accurate depiction
of what occurred. That "management's assessment" may have been
affected by the views of examiners or consultants does not make
the statement a fraudulent misrepresentation. In asserting in
80 that this statement was knowingly false and misleading,
plaintiffs provide only conclusory support lacking in
particularity.
-21-
of plaintiffs' claims as a matter of law is inappropriate. With
the exception of Bushnell and Woolson, all of the defendants are
alleged to have signed the 1988 Annual Report in which Bank
Shares' loan loss reserves were depicted as "sufficient" and
"prudent," see supra at 14; Complaint, at 64,17 and also are
___ _____
alleged to have received copies of the internal auditor's report
concluding that additions to the reserves were required as soon
as possible, Complaint, at 50-51, as well as Chaston's report
in December 1988 stating that the ALL was inadequate, id. at
___
59-61. The acceptance of responsibility for the contents of the
Annual Report, demonstrated by defendants' signatures, combined
with specific allegations that they knew of conflicting
conditions, establishes a sufficient link between the defendants
and the alleged fraud to satisfy Rule 9(b)'s particularity
requirement. Cf. Romani, 929 F.2d at 880 n.4; Wool v. Tandem
___ ______ ____ ______
Computers Inc., 818 F.2d 1433, 1440 (9th Cir. 1987) ("In cases of
______________
corporate fraud where the false or misleading information is
conveyed in . . . annual reports . . . or other `group-published
____________________
17 The complaint alleges that Bushnell was chairman and
chief executive officer of Bank Shares until his resignation in
early 1988, and he therefore was no longer with the company when
the 1988 Annual Report was written and released. Indeed, because
all of the actionable allegations concern the time period after
his departure, we affirm his dismissal from the case.
Woolson is the only defendant not alleged to have been a
director of Bank Shares, and thus not a signatory of the holding
company's Annual Report.
-22-
information,' it is reasonable to presume that these are the
collective actions of the officers.").18
Defendants Machinist and Allen are identified as the authors
or speakers of the other statements contained in the paragraphs
that survive dismissal, and those allegations also remain live
against them. As to those statements, the other defendants are
alleged only to have authorized or acquiesced in them (the press
releases), or they are attributed no role at all in the
dissemination of the statements (remarks by Allen and Machinist
at analysts meeting). See 52, 56. This is insufficient to
___
meet the requirements of Rule 9(b).19
Defendants assert that the complaint fails in any respect to
state an actionable claim against the individual defendants
because there are no allegations from which scienter reasonably
may be inferred, such as that they sold their personal stock in
Bank Shares during the class period. They argue that it is
insufficient to base a claim of fraudulent intent on allegations
that defendants sought to protect their compensation and
prestige. See Complaint at 105. See also Tuchman v. DSC
___ ___ ____ _______ ___
Communications Corp., 14 F.3d 1061, 1068-69 (5th Cir. 1994).20
____________________
____________________
18 We see no need to distinguish at this juncture between
plaintiffs' primary and secondary liability theories.
19 Because these are the only relevant allegations relating
to Woolson, he, like Bushnell, is entitled to dismissal.
20 The Fifth Circuit in Tuchman endorsed language from the
_______
district court's opinion in that case rejecting the pursuit of
increased compensation as a sufficient basis for inferring fraud:
-23-
We agree that allegations that defendants committed fraud to
save their salaries or jobs ordinarily will not be enough to
support a reasonable inference of scienter if the complaint lacks
any other basis for inferring fraudulent intent. In this case,
however, plaintiffs have done more than simply aver generally
that defendants knowingly misrepresented Bank Shares'
circumstances, while relying on a job-preservation motive to
establish the element of scienter. As described above,
plaintiffs specifically cited reports and documents presented to
defendants at relevant times that were inconsistent with the
defendants' public statements. This satisfies the necessary
pleading requirements. See In Re Wells Fargo, 12 F.3d at 931
___ __________________
("While `allegation[s] of unusual insider trading by defendants
immediately preceding the disclosure of negative news' may be . .
. a characteristic of a `typical securities fraud class action,'
they are not required.").21
____________________
On a practical level, were the opposite true, the
executives of virtually every corporation in the United
States would be subject to fraud allegations. It does
not follow that because executives have components of
their compensation keyed to performance, one can infer
fraudulent intent.
14 F.3d at 1068-69 (quoting 818 F. Supp. 971, 976 (N.D. Tex.
1993)).
21 Nothing in Tuchman, a case emphasized by defendants at
_______
oral argument, is to the contrary. In that case, the Ninth
Circuit observed that "[w]here a defendant's motive is not
apparent, a plaintiff may adequately plead scienter by
identifying circumstances that indicate conscious behavior on the
part of the defendant, though the strength of the circumstantial
allegations must be correspondingly greater." 14 F.3d at 1068.
After rejecting the desire to preserve incentive compensation and
similar "perquisites and emoluments of office" as a sufficient
-24-
V.
We conclude that the plaintiffs have stated a claim against
Bank Shares and five of the individual defendants based on
certain of the allegations contained in paragraphs 46 to 69, with
such limitations and exclusions as previously described. To that
extent, the dismissal of the Third Amended Complaint is reversed.
The district court may choose to require a Fourth Amended
Complaint, consistent with this decision, before conducting
further proceedings. In all other respects, the district court's
decision is affirmed.22
Affirmed in part, reversed in part, and remanded. No costs.
________________________________________________ _________
____________________
basis for an inference of scienter, the court looked to whether
plaintiffs otherwise had established fraudulent intent. It found
that they had not, observing that the complaint failed to assert
"any fact that makes it reasonable to believe that the defendants
knew that any of their statements were materially false or
misleading when made." Id. at 1069. This case is
___
distinguishable because, as we have discussed, plaintiffs here
have alleged facts from which an inference of knowledge
reasonably may be drawn.
22 We note that the complaint indicates that only one of the
three named plaintiffs, Nishan Serabian, purchased shares during
the time period giving rise to the actionable allegations, and it
therefore appears that plaintiffs Horvei and Lo Priore no longer
are proper parties. The district court will need to address this
matter on remand.
-25-
