Opinion

Alison Frankel

Fait accompli: the securities defense bar’s favorite new weapon

By Alison Frankel
August 13, 2012

On Friday, U.S. District Judge Deborah Batts dismissed a securities class action against Deutsche Bank and its underwriters on a $5.6 billion offering of preferred securities. The judge ruled on a defense motion for reconsideration that under the 2nd Circuit Court of Appeals’ 2011 ruling in Fait v. Regions Financial, the defendants’ valuation of Deutsche Bank’s exposure to subprime mortgages was an opinion, and the plaintiffs couldn’t show that the defendants didn’t believe that opinion when offering materials were published. Batts’s ruling was a big win for Deutsche Bank’s lawyers at Cahill Gordon & Reindel and the underwriting syndicate’s counsel at Skadden, Arps, Slate, Meagher & Flom.

It’s also the latest indication that as Fait approaches its one-year anniversary on Aug. 23, it’s shaping up to be one of the most powerful tool for securities defendants since Morrison v. National Australia Bank. In Fait, 2nd Circuit judges Rosemary Pooler, Barrington Parker and Raymond Lohier held that statements in offering materials about an issuer’s goodwill and loan loss reserves are not matters of objective fact, but opinions. And as opinions, they can’t be the basis of liability under the Securities Act unless investors can show that defendants didn’t actually believe what they were saying when they said it. “When a plaintiff asserts a claim under Section 11 or 12 [of the Securities Act] based upon a belief or opinion alleged to have been communicated by a defendant,” Parker wrote for the panel, “liability lies only to the extent that the statement was both objectively false and disbelieved by the defendant at the time it was expressed.”

That language raised the bar for investors, and some cases haven’t been able to clear it. You want examples? In July, U.S. District judges Denise Cote and William Pauley both cited Fait in opinions dismissing investor claims, Pauley in a partial dismissal of a case claiming Bank of America misrepresented its liability for breaches of representations on mortgage-backed securities and Cote in refusing to permit investors to file a new complaint against General Electric in connection with $12 billion in stock offerings. In February, U.S. Magistrate Judge Henry Pitman of Manhattan cited Fait in recommending the dismissal of another class action against BofA, this one involving alleged misrepresentations in three 2008 stock offerings. According to a Westlaw search, Fait has been cited in more than 50 trial and appellate court briefs in securities cases since last August, so we should be seeing more decisions based on Fait in coming months.

The ruling isn’t a free pass for defendants facing claims under the Securities Act of 1933. In the Federal Housing Finance Agency’s case against UBS, for instance, Cote refused in May to dismiss allegations that the bank misled mortgage-backed securities investors about the quality of underlying loans, rejecting Fait arguments by UBS’s lawyers at Skadden. “There is dictum in Fait that superficially supports defendants’ claims,” she wrote, noting “confusion” about the 2nd Circuit’s holding. ” upon closer examination of that decision and its reasoning,” Cote continued, “the court is convinced that [the FHFA] has the better of the argument.” Similarly, in June U.S. District Judge Shira Scheindlin denied the credit rating agencies’ Fait-based motion to reconsider her refusal to dismiss a special purpose vehicle investor’s negligent misrepresentation claims.

But the 2nd Circuit believes so strongly in the decision that in May, in a per curiam ruling, the appellate court extended its reasoning in Fait from claims under the Securities Act to fraud claims under the Exchange Act of 1934. “Even if the [plaintiffs'] second amended complaint did plausibly plead that defendants were aware of facts that should have led them to [revise accounting], such pleading alone would not suffice to state a securities fraud claim after Fait,” the 2nd Circuit said in City of Omaha v. CBS. “Plaintiffs’ second amended complaint is devoid even of conclusory allegations that defendants did not believe in their statements of opinion regarding CBS’s goodwill at the time they made them.”

The Securities Act, as you know, is notable for imposing no burden on plaintiffs to prove scienter, the defendants’ wrongful intent. (That’s in contrast to fraud claims under the Exchange Act.) The 2nd Circuit noted in a footnote in Fait that its new standard does not amount to a requirement of scienter in Securities Act cases. “We do not view a requirement that a plaintiff plausibly allege that defendant misstated his truly held belief and an allegation that defendant did so with fraudulent intent as one and the same,” Parker wrote.

Securities Act plaintiffs, as we’ve explained, usually avoid alleging anything close to outright fraud because complaints that “sound in fraud” have to meet a higher pleading standard to withstand dismissal motions. Alleging a deliberate misstatement to satisfy Fait without crossing the line into fraud doesn’t leave a whole lot of room. That’s the fascinating issue the 2nd Circuit will hear next month in a case called In re Barclays, in which plaintiffs’ lawyers at Robbins Geller Rudman & Dowd are actually arguing in their appellate brief that Fait compels them to argue that Barclays and its underwriters knowingly deceived investors — but those assertions don’t mean they’re pleading fraud.

Fait has generally not been kind to Robbins Geller, which argued and lost the ruling at the 2nd Circuit last year and also lost the Deutsche Bank reconsideration. Partners Darren Robbins and Samuel Rudman didn’t respond to my requests for comment.

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