April hasn’t been easy for securities class action defendants seeking second bites at the apple. Twice in the same month a federal judge has “re-denied” a motion to dismiss brought by the defendants in a subprime/credit crisis securities class action.
Los Angeles, April 6: Justice Mariana Pfaelzer (C.D. Cal.) denies the defendants’ motion to reconsider her earlier (Dec. 3, 2008) denial of their motion to dismiss in the Countrywide litigation. (Alison Frankel’s article about this in the AmLaw litigation daily is available here.)
What the plaintiffs got in February
Then New York, April 29: Judge Shirley Wohl Kram (S.D.N.Y.) denies the defendants’ motion to reconsider her earlier (Feb. 18, 2009) denial of their motion to dismiss in the Moody’s litigation. A copy of the February decision is available here and a copy of her honor’s order reconfirming that decision is here.
What the plaintiffs got in April
Moody’s is one of a handful of agencies that assign ratings to securities and other debt instruments including bonds. The other two major rating agencies are Standard & Poor and Fitch. Ratings permit the investing community to assess the riskiness of a bond offering. The complaint alleges that Moody’s assigned unjustifiably high ratings to collateralized debt obligations — bonds — that were in fact quite risky due to their underlying security containing an excessive amount of subprime mortgages. The plaintiffs who had acquired these bonds during the specified class period suffered losses as a result. The claims are that by these misrepresentations, Moody’s and the individual defendants violated § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78(j) and SEC Rule 10b-5, 17 C.F.R. 240.10b-5.
The first event — which is sometimes the main event — in a securities class action is a motion to dismiss under Feb. R. Civ. P. 12(b)(6). This is no ordinary motion to dismiss. The Private Securities Litigation Reform Act of 1995 sets the bar especially high for securities class actions to survive.
- First, plaintiffs have to plead the alleged misleading statements with particularity. 15 U.S.C. § 78u-4(b)(1).
- Second, plaintiffs must show in their pleading that the false statement was made knowingly or recklessly, in other words, that the defendants acted with scienter. 15 U.S.C. § 78u-4(b)(2). Not only that, the Supreme Court ruled that the pleading has to show a “cogent inference” of scienter. Tellabs Inc. v. Makor Issues & Rights, 551 U.S. 308 (2007).
- Third, because the plaintiff must prove causation of its loss by these misrepresentations under 15 U.S.C. 78u-4(b)(4), the complaint must clearly allege loss causation.
Judge Kram decided in February that the plaintiffs fulfilled those requirements. The defendants moved for reconsideration and didn’t get very far; her only concession was to declare that part of one paragraph of her earlier decision was to be removed, characterizing it as a mere clerical error. In her earlier order, the judge included this passage at page 45:
Plaintiffs also cite an instant message conversation as evidence of the Company’s scienter. In that exchange, Moody’s executives commented that their “model def [sic.] does not capture half the risk,” and joke that an issuance could be “structured by cows and [they] would rate it.” (Hume Decl. Ex. H.) The conversation ends with one Committee member saying that he or she “personally doesn’t feel comfortable signing off” on that issuance. (Hume Decl. Ex. H.)
Collateralized Debt Obligations are complex and require teamwork
This is a reference to the “structured-by-cows” passage that was read aloud at a congressional grilling of ratings agency executives on Capitol Hill last October. The New York Times account of that exchange can be read here. By including it in her decision, the judge added color, like the cherry on top of a sundae. The only problem? This was an instant message exchange between two analysts at Standard & Poor, not Moody’s. This may have been the plaintiff’s error, as the judge cites an exhibit filed by the plaintiff as the source. In any event, in her reconsideration decision, the judge treats this passage as not in any way critical to her finding that the plaintiff had sufficiently pleaded that the defendants acted with scienter, and simply declared at page 10 of her April 29 order that it should be removed from her February 18 order:
Rule 60(a) permits the Court to correct a “clerical mistake or mistake arising from oversight or omission whenever one is found in a judgment, order, or other part of the record.” Fed. R. Civ. P. 60(a). Based upon the record, the sentence beginning “Plaintiffs also cite . . . .” at [p.45 of the February order] through the sentence beginning “The conversation ends . . . .” should be deleted from the Court’s Opinion.
The defendants wanted her honor to take the entire sundae away from the plaintiffs. Instead all she did was remove the cherry on top.
As this was already in the plaintiffs’ “win” column in the tally of outcomes on motions to dismiss, nothing on the scorecard has changed. I’ll be analyzing that scorecard and the way it has trended over time in an upcoming post.
I have to comment that I find motions to reconsider one of the more bizarre features of federal practice in the US. You go back to the same judge who made an order you don’t like, asking to overturn it? Another topic for another day, maybe.
