BRUCE OWENS, Plaintiff - Appellant v. KENNETH M. JASTROW, II; KENNETH R. DUBUQUE; RONALD D. MURFF; CRAIG E. GIFFORD, Defendants - Appellees
No. 13-10928
United States Court of Appeals for the Fifth Circuit
June 12, 2015
Before JOLLY, OWEN, and HIGGINSON, Circuit Judges.
Appeal from the United States District Court for the Northern District of Texas
This case arises out of one of the largest bank failures in United States history. In August 2009, in the wake of the financial and housing crises, Guaranty Bank’s parent company filed for bankruptcy. Plaintiffs represent a putative class of former Guaranty stockholders whose equity interests were wiped out when Guaranty failed. They bring federal securities law claims against four former Guaranty executives, alleging that the executives made materially false and misleading statements regarding Guaranty’s assets. The district court dismissed the claims. For the following reasons, we AFFIRM.
Temple-Inland, Inc. (“Temple”) was a holding company that operated a packaging and manufacturing business and a financial services business, Guaranty Financial Group Inc., (“GFG”) which, in turn, owned Guaranty Bank (the “Bank”).1 On November 29, 2007, Temple announced that its board of directors had approved a spin-off transaction that would leave GFG as independent owner of the Bank. According to plaintiffs, Temple decided to spin off Guaranty because it was concerned about Guaranty’s solvency, and about various cross-default covenants that would jeopardize Temple’s own solvency if Guaranty became insolvent. Plaintiffs allege that Temple did not provide Guaranty sufficient capital at the time of the spin-off.
Temple’s concerns over Guaranty’s solvency stemmed from the composition of Guaranty’s asset portfolio. Guaranty had purchased investments in residential mortgage-backed securities (“MBS”), which are created by pooling mortgage loans into a trust. Guaranty’s portfolio contained a significant amount of “non-agency” MBS—those issued by private institutions rather than government-sponsored entities. Non-agency MBS are generally understood to have higher returns and higher risks than their government-sponsored counterparts. Plaintiffs allege that Guaranty’s non-agency MBS portfolio always constituted at least 22% of Guaranty’s total assets. Further, plaintiffs allege that a substantial portion of Guaranty’s MBS was collateralized by risky adjustable rate mortgages. On the other hand, none of Guaranty’s MBS contained subprime mortgages. Guaranty also did not invest in the most junior tranches, or levels, of MBS, meaning that losses would not affect Guaranty’s investments until investors in junior tranches lost their
Defendants Kenneth M. Jastrow, Kenneth R. Dubuque, Ronald D. Murff, and Craig E. Gifford were all high-level executives in Guaranty and, in some cases, Temple. Plaintiffs claim that after the spin-off, Guaranty, led by defendants, violated Generally Accepted Accounting Principles (“GAAP”) by systematically overvaluing its MBS portfolio and undervaluing its losses. Defendants allegedly compounded this problem by failing to properly record Guaranty’s losses as “other than temporary impairment” (“OTTI”). Defendants reported these allegedly erroneous accounting figures in public filings. Plaintiffs claim that defendants were motivated by the knowledge that, absent fraud, Guaranty’s regulatory capital would have been inadequate and Guaranty would not have had time to procure capital necessary to continue as a going concern.
For a time, Guaranty was successful in masking its financial difficulties; it attracted capital infusions in 2008. But Guaranty’s health continued to decline. In July 2009, Guaranty announced that, at the direction of the Office of Thrift Supervision (“OTS”), Guaranty had amended its Thrift Financial Report for the period ending March 31, 2009 and recorded a $1.62 billion impairment on its MBS portfolio. Soon after, the OTS closed Guaranty and the Federal Deposit Insurance Corporation (“FDIC”) was appointed as receiver. GFG filed for bankruptcy protection on August 27, 2009.
On August 22, 2011, Guaranty’s bankruptcy trustee, Kenneth L. Tepper, sued Temple and various other defendants, including Jastrow and Dubuque,
Plaintiffs initially filed this putative class action on November 11, 2011. They filed an amended class action complaint on April 19, 2012 on behalf of all purchasers of GFG common stock between December 12, 2007 and August 24, 2009 (the “Class Period”), against Temple and the individual defendants. Temple and the individual defendants moved to dismiss the amended complaint. The district court granted the motions on several grounds, including the failure to adequately allege defendants’ scienter. The district court granted plaintiffs leave to amend, however, and plaintiffs filed the Second Amended Complaint (“SAC”), which alleged claims against the individual defendants alone. The individual defendants again moved to dismiss. The district court found that the SAC did not adequately allege scienter, and granted the motions, dismissing the case with prejudice. Plaintiffs timely appealed.
DISCUSSION
I. Standard of Review
The SAC alleges violations of
We review a district court’s dismissal of federal securities law claims under
Pursuant to
Plaintiffs allege that defendants made an array of materially false and misleading statements in SEC filings and public comments throughout the Class Period. Defendants allegedly violated GAAP and SEC rules by (1) reporting overstated MBS values, and understated losses, stemming from the use of flawed internal asset pricing models; and (2) failing to timely record OTTI in the portfolio.
II. Scienter
The central issue in this case is whether the SAC contains sufficient facts to allege scienter as to each defendant. The district court dismissed the SAC on the ground that it did not.
The PSLRA imposes heightened pleading standards on private plaintiffs bringing actions pursuant to Section 10(b) and Rule 10b-5. See
Severe recklessness is limited to those highly unreasonable omissions or misrepresentations that involve not merely simple or even inexcusable negligence, but an extreme departure from the standard of ordinary care, and that present a danger of misleading buyers or sellers which is either known to the defendant or is so obvious that the defendant must have been aware of it.
To withstand a 12(b)(6) motion to dismiss, the required “strong inference” of severe recklessness must be “more than merely ‘reasonable’ or ‘permissible’—it must be cogent and compelling, thus strong in light of other explanations.” Tellabs, 551 U.S. at 324. A reviewing court therefore must “take into account plausible inferences opposing as well as supporting a strong inference of scienter.” Ind. Elec. Workers’ Pension Trust Fund IBEW v. Shaw Grp., Inc., 537 F.3d 527, 533 (5th Cir. 2008) (citing Tellabs, 551 U.S. at 324). A complaint will survive only if the inference of scienter is “at least as compelling as any opposing inference one could draw from the facts alleged.” Tellabs, 551 U.S. at 324. “[A] tie favors the plaintiff.” Lormand, 565 F.3d at 254 (citing Tellabs, 551 U.S. at 324).
A. Threshold issues
Plaintiffs and defendants each raise one issue that they contend warrants reversal or affirmance, respectively, without requiring consideration of the specific scienter allegations.
i. Holistic review
Plaintiffs contend that the district court’s scienter analysis was flawed because the district court evaluated the scienter allegations individually rather than collectively. When analyzing a complaint for scienter, a court must “assess all the allegations holistically,” not in isolation. Tellabs, 551 U.S. at 326; see also Lormand, 565 F.3d at 251 (“The inquiry is whether all of the facts alleged, taken collectively, give rise to a strong plausible inference of scienter, not whether any individual allegation, scrutinized in isolation, meets that standard.”). The district court methodically analyzed the allegations, determining whether each did or did not contribute to a strong inference of scienter. Then, for each defendant, the district court concluded that the
Plaintiffs raise two points in support of their argument. First, plaintiffs contend that the district court’s two-step method of first assessing the allegations individually, before weighing them collectively, violates Tellabs’s prescription. In support, they cite the Sixth Circuit’s decision in Frank v. Dana Corp., 646 F.3d 954, 961 (6th Cir. 2011). Frank criticized the method the district court employed in this case:
Our former method of reviewing each allegation individually before reviewing them holistically risks losing the forest for the trees. Furthermore, after Tellabs, conducting an individual review of myriad allegations is an unnecessary inefficiency. Consequently, we will address the Plaintiffs’ claims holistically.
Id. Contrary to plaintiffs’ suggestion, Frank does not stand for the proposition that Tellabs forbids the method of first reviewing each allegation individually; rather, Frank advises against such a method because, in the view of that court, it is “an unnecessary inefficiency.” Id. Moreover, this court, after Tellabs, has endorsed the district court’s two-step method. See Central Laborers’ Pension Fund v. Integrated Elec. Servs. Inc., 497 F.3d 546, 552–55 (5th Cir. 2007) (employing two-step method); see also In re VeriFone Holdings, Inc. Sec. Litig., 704 F.3d 694, 703 (9th Cir. 2012) (“[A] dual analysis remains permissible so long as it does not unduly focus on the weakness of individual allegations to the exclusion of the whole picture.”). A district court may best make sense of scienter allegations by first looking to the contribution of each individual allegation to a strong inference of scienter, especially in a complicated case such as this one. Of course, the court must follow this initial step with a holistic look at all the scienter allegations.
ii. Group pleading
Defendants complain that the SAC contains impermissible group pleading. This court has rejected the group pleading doctrine. See Southland, 365 F.3d at 365 (“[T]he PSLRA requires the plaintiffs to distinguish among those they sue and enlighten each defendant as to his or her particular part in the alleged fraud.”) (internal quotation marks omitted). Accordingly, “we do not construe allegations contained in the [SAC] against the ‘defendants’ as a group as properly imputable to any particular defendant unless the connection between the individual defendant and the allegedly fraudulent statement is specifically pleaded.” Id. Defendants contend that the SAC violates these rules by repeatedly using general terms like “Individual Defendants” and
Defendants disagree among themselves about the proper remedy for this deficiency in the SAC. Defendants Jastrow and Dubuque contend that group pleading and the related problem of puzzle pleading—where a court must wade through a complaint and pick out properly pleaded segments—warrants dismissal of the entire SAC. Defendants Murff and Gifford propose disregarding group-pleaded allegations and considering only those that identify each defendant. It is appropriate to disregard the group-pleaded allegations and determine whether the remaining, properly pleaded allegations raise a strong inference of scienter. See id. at 288 (“The district court correctly dismissed the claims relying on group pleading.”); Southland, 365 F.3d at 365 (disregarding the allegations against “defendants” as a group). Although we do not commend plaintiffs’ inclusion of group-pleaded allegations interspersed with defendant-specific allegations, in this case we are able to “separat[e] the wheat from the chaff,” and outright dismissal is unwarranted. See In re Enron Corp. Secs, Derivative & ERISA Litig., 258 F. Supp. 2d 576, 611 (S.D. Tex. 2003). This is not a situation where “[n]o attempt is made to isolate statements and particularize their falsity.” Williams v. WMX Techs., Inc., 112 F.3d 175, 180 (5th Cir. 1997).3 Accordingly, we disregard the group-pleaded allegations and discern whether the remaining allegations state a claim for relief as to each defendant.
We now discuss the allegations that, according to plaintiffs, lead to a strong inference of scienter. First, we look at the various allegations that apply to more than one defendant and discuss the appropriate inference, if any, to be drawn from them.4 Then we proceed, defendant by defendant, adding any allegations unique to that defendant, to comprehensively determine if plaintiffs have alleged facts that give rise to a strong inference of scienter as to any defendant. The SAC contains no direct allegations of fraudulent conduct; rather, plaintiffs rely on circumstantial allegations. See Shaw, 537 F.3d at 535.
i. Knowledge of undercapitalization and motive
One of plaintiffs’ primary allegations is that defendants had knowledge of Guaranty’s undercapitalization5 and, as officers and directors, wanted to raise capital necessary for the continued operation of the business. This, plaintiffs say, created a motive for defendants to overstate the value of Guaranty’s MBS portfolio; if Guaranty appeared to be a healthy company, it could more easily attract much-needed capital.
The SAC pleads with particularity that defendants Jastrow, Dubuque, and Murff—but not Gifford—knew of Guaranty’s undercapitalization. The SAC alleges that Dubuque met with Temple’s management before the spin-off and suggested that Guaranty needed $200 million in additional capital.
The resulting question is whether any inference of scienter should be drawn from defendants’ knowledge of Guaranty’s undercapitalization. The desire to raise capital in the normal course of business does not support a strong inference of scienter because virtually all corporate insiders share this goal. See Abrams, 292 F.3d at 434 (holding that a desire to raise capital, receive incentive compensation, and sell stock at inflated prices did not support a strong inference of scienter). Plaintiffs contend that the inference of scienter here is much greater because capital infusions were not merely desirable, but necessary for the ongoing operation of Guaranty.
“[A]ppropriate allegations of motive and opportunity may meaningfully enhance the strength of the inference of scienter, but . . . allegations of motive and opportunity, without more, will not fulfill the pleading requirements of the PSLRA.” Goldstein v. MCI WorldCom, 340 F.3d 238, 246 (5th Cir. 2003). In
Plaintiffs maintain that this case is similar to Nathenson v. Zonagen Inc., 267 F.3d 400 (5th Cir. 2001). This court, in Nathenson, held that plaintiffs “barely” pled a strong inference of scienter as to a defendant who was President, CEO, and a director of a “one product company” and was alleged to have made misstatements regarding a patent’s applicability to that single product. See id. at 424–25. Nathenson suggested, in dicta, that the rare case might establish a strong inference of scienter solely from motive and opportunity allegations. See id. at 412 (“[I]t would seem to be a rare set of circumstances indeed where [motive and opportunity] allegations alone are both sufficiently persuasive to give rise to a scienter inference of the necessary strength and yet at the same time there is no basis for further allegations also supportive of that inference.”). This is not such a case, even if one could exist after Goldstein’s pronouncement seemingly foreclosing the possibility. Defendants’ alleged misstatement of the MBS portfolio valuation was not as crucial to the continuing operation of Guaranty as were the misstatements regarding the patent’s applicability in Nathenson. Although Guaranty’s non-agency MBS portfolio was undeniably a large and important business asset, it
The motive allegations contribute to a finding of scienter as to Jastrow, Dubuque, and Murff, but must be considered together with other allegations to determine if they rise to a strong inference of scienter.8 See Nathenson, 267 F.3d at 412 (“Appropriate allegations of motive and opportunity may meaningfully enhance the strength of the inference of scienter.”).
ii. Knowledge of red flags regarding MBS valuation
Plaintiffs allege that Guaranty’s MBS valuation and its decision not to recognize losses as “other than temporary” violated GAAP. Because the question of whether the statements actually violated GAAP is fact-dependent, it is not properly addressed on a motion to dismiss. See Barrie v. Intervoice-Brite, Inc., 397 F.3d 249, 257 (5th Cir. 2005). The issue, for the scienter analysis, is whether, assuming the statements violated GAAP, the allegations give rise to a strong inference that individual defendants were severely reckless in valuing the securities.
Plaintiffs contend that several “red flags” included in the SAC should have alerted each defendant that the MBS valuation was materially incorrect. The red flags include (1) a 250% increase in the average delinquency rate on Guaranty’s non-agency MBS portfolio in the nine-month period ending June
The “red flags” add little inference of scienter. Each “red flag” is alleged to have become knowable only in June 2008, whereas many of the alleged misrepresentations occurred before June 2008. Even as to those alleged misstatements that occurred after the “red flags” were apparent, the red flags were disclosed to the public, which negates the inference that defendants acted with scienter. See Fire & Police Pension Ass’n of Colo. v. Simon, 778 F.3d 228, 244 (1st Cir. 2015) (holding that a company’s disclosures of red flags “undercut any inference of scienter”); Ziemba v. Cascade Int’l, Inc., 256 F.3d 1194, 1211 (11th Cir. 2001) (noting that various disclosures of red flags “undermine[d] any hint of fraud”). Plaintiffs dispute whether and to what extent the red flags were disclosed. However, documents referenced in the SAC and attached to defendants’ motion to dismiss confirm that the alleged red flags, or at least the inputs that would allow the public to easily calculate them, were disclosed promptly by Guaranty. See Tellabs, 551 U.S. at 322 (holding that, on a Rule 12(b)(6) motion, a court must consider “documents incorporated into the complaint by reference”).
Additional transparency, not disputed by plaintiffs, further negates the inference of scienter. Defendants disclosed that Guaranty’s MBS valuation was based on internal models, not market prices, and Guaranty disclosed the inputs it used in its models. Guaranty provided investors with additional explanatory and cautionary information from which they could judge the accuracy of the models and Guaranty’s decision not to recognize losses as other than temporary. Guaranty’s filings further disclosed that valuation was “difficult,” and that the valuation estimates involved a “high degree of uncertainty” and might “prove to be materially incorrect.” As the Supreme
We distinguish this case from Spitzberg v. Houston American Energy Corporation, 758 F.3d 676 (5th Cir. 2014). In Spitzberg, an energy company made public statements estimating billions of barrels of oil reserves even though the company had done no geological testing. Id. at 680, 684. We held that defendants were severely reckless because using the term “reserves”—an industry-specific term indicating that production or testing had occurred—would present an obvious danger of misleading investors as to the value of the company’s assets. Id. at 681, 684. Here, in contrast, defendants’ disclosures conveyed to investors that its MBS valuations were far from certain.
Defendants’ disclosure of the “red flags” and candidness about the uncertainty underlying its models neutralize any scienter inference from “red flags.”
iii. Magnitude of alleged misstatements
Plaintiffs contend that the magnitude of the valuation errors contributes to a strong inference of scienter. The significance of a large accounting error depends on the circumstances. In Goldstein, we held that a $685 million write-off did not create a strong inference of scienter because the company was large and frequently took similarly-sized write-offs. 340 F.3d at 251. Here, the magnitude was undoubtedly large; the OTS directed Guaranty to restate its March 31, 2009 Thrift Financial Report and recognize a $1.62 billion OTTI, representing an overvaluation of the MBS portfolio of 100%. But, as we discuss in Section II.C.i, infra, the magnitude’s contribution to an inference of scienter
C. Individual defendants
Having discussed the underpinnings and merits of the common allegations regarding scienter, we proceed to a holistic review, for each defendant, of all scienter allegations applicable to that defendant.
i. Dubuque and Murff10
Dubuque was President, CEO, and a director of Guaranty until his resignation on November 19, 2008. He was also Guaranty’s Chairman from August 26, 2008 until his resignation. Murff was Senior Executive Vice President and Chief Financial Officer of Guaranty until his resignation on July 10, 2009. From October 27, 2008 until his resignation, Murff was also Guaranty’s Principal Accounting Officer. Plaintiffs seek to hold Dubuque and Murff liable for their conduct throughout the Class Period, including statements made in Guaranty’s 2007 10-K, 2008 10-Qs, and several other statements made between February 2008 and November 2008.
As discussed, supra, the SAC alleges that Dubuque and Murff knew of Guaranty’s undercapitalization and had a motive to falsify the MBS valuation to raise additional capital. However, because knowledge and motive alone are insufficient to raise a “strong inference” of scienter, Goldstein, 340 F.3d at 246,
In addition to the knowledge allegations, the SAC alleges that Dubuque and Murff were aware of internal warnings regarding the MBS valuation. These allegations revolve around a confidential witness, designated in the SAC as CW1, who was responsible for purchasing MBS as Guaranty’s Senior Vice President of Investments and Secretary of the Asset Liability Committee (“ALCO”).11 The SAC alleges that, in January 2007, CW1 sent an email to Dubuque and Murff identifying several deficiencies in Guaranty’s internal MBS pricing model, including (1) Guaranty’s use of outdated parameters to value MBS and assess MBS losses; (2) its failure to independently verify the cash flows used in valuing MBS; (3) the elimination of liquidity factors from its valuation; (4) inadequate accounting of interest rate changes on adjustable rate mortgages; and (5) inadequate modeling of credit risk.12 The SAC further alleges that CW1 repeated his or her concerns about the model’s deficiencies at ALCO meetings attended by Dubuque and Murff. The SAC also alleges that CW5, the Chief Lending Officer and Chief Administrative Officer of Guaranty, attended ALCO meetings along with Dubuque and Murff, in which potential MBS write-downs were discussed.13 The SAC alleges that Dubuque and Murff knew or recklessly ignored that the models were flawed, and continued to use
Dubuque’s and Murff’s continued reliance on Guaranty’s internal valuation model and unchanged OTTI determinations, after CW1’s warnings, does not lead to a strong inference of scienter. That the reported figures are alleged to have violated GAAP is not, by itself, actionable. See Shaw, 537 F.3d at 534 (“[A] failure to follow GAAP, without more, does not establish scienter.”); Blackwell, 440 F.3d at 290 (“[F]ailure to follow accounting standards, without more, does not establish scienter.”). Plaintiffs must also plead facts leading to a strong inference that each defendant knew the numbers violated GAAP or was severely reckless in disregarding the concerns. See Abrams, 292 F.3d at 432.14
An inference of severe recklessness is more likely when a statement violates an objective rule than when GAAP permits a range of acceptable outcomes. See In re MicroStrategy, Inc. Sec. Litig., 115 F. Supp. 2d 620, 638 (E.D. Va. 2000) (“[I]f the GAAP rules . . . Defendants are alleged to have violated are relatively simple, it is more likely that the Defendants were aware of the violations and consciously or intentionally implemented or supported them, or were reckless in this regard.”). Applying GAAP often involves subjective determinations. See Fine v. Am. Solar King Corp., 919 F.2d 290, 297 (5th Cir. 1990) (“GAAP tolerates a wide range of acceptable
While recognizing that some GAAP concepts may allow for subjective judgments, plaintiffs argue that defendants’ MBS valuation and decision not to recognize an OTTI were governed by objective standards. Specifically, plaintiffs argue that defendants violated an objective GAAP directive requiring that OTTI be assessed “at the individual security level” by failing to “drill down” and assess OTTI at the individual loan level. Plaintiffs misapprehend this GAAP requirement. In determining whether to recognize an OTTI, GAAP does not require a company to assess the likelihood of repayment of each of thousands of loans in each security.15 Because plaintiffs do not allege that defendants failed to value each security, they have not plausibly alleged a violation of an objective GAAP component.
Even at this early stage of the proceedings—where it is improper to engage in detailed discussion of GAAP rules—it is undeniable that there is some subjectivity present in Guaranty’s decision to continue using its internal models and to delay recognizing impairments as other than temporary. See FASB Staff Position No. EITF 99-20-1, at 1 (permitting “the use of reasonable management judgment of the probability that the holder will be unable to collect all amounts due”); id. at 4 (listing multiple factors that influence an OTTI determination); id. at 6 (“[J]udgment is required in determining whether
Although plaintiffs argue that Dubuque and Murff were “repeatedly” made aware of the deficiencies in Guaranty’s models, the email from CW1 is the only warning alleged to have been conveyed to Dubuque and Murff. CW1’s warnings did not mention GAAP and do not seem to suggest that any issues were so severe that they could lead to a large overvaluation of the MBS portfolio.
Dubuque and Murff relied on outside ratings agencies, which rated all of Guaranty’s MBS AAA until June 2008. We find that reliance on AAA ratings, when CW1 did not caution that reliance on major outside ratings agencies was unwarranted, was not severely reckless. FASB guidance explicitly instructs companies to consider a security’s credit rating when deciding whether to recognize a loss as other than temporary. Moreover, defendants were not alone in relying on AAA ratings in the face of potential red flags. OTS, Guaranty’s regulator, similarly failed to recognize risks associated with Guaranty’s MBS portfolio “primarily because the nonagency MBSs that Guaranty bought were graded AAA by credit rating agencies.” OTS’s report on Guaranty’s demise found that: “From 2004 through 2007, both [Guaranty] and OTS relied on the AAA ratings and considered the risk of purchasing AAA-rated nonagency
We find persuasive the Second Circuit’s discussion of very similar allegations in City of Pontiac Policemen’s and Firemen’s Retirement System v. UBS AG, 752 F.3d 173, 187 (2d Cir. 2014). There, plaintiffs alleged that UBS’s investment bank “disregarded . . . observable market inputs and red flags demonstrating that [its] mortgage-related asset portfolio was materially impaired” when it declined to write down its assets. Id. The Second Circuit held that UBS was not reckless in relying on the assets’ AAA rating in the face of internal and external uncertainty and disagreement about the valuation of mortgage-related assets. See id. The court concluded:
While the collapse in the entire subprime market revealed UBS’s failure to recognize the vulnerability of all its mortgage-related assets to have been poor judgment, poor business judgment—even if attributable to monetary incentives—does not establish an inference of recklessness that is cogent and compelling [and] thus strong in light of other explanations. We do not recognize allegations of fraud by hindsight.
Id. at 187–88 (internal quotation marks and citations omitted). Here, plaintiffs’ allegations similarly combine poor business judgment with financial motive. See Abrams, 292 F.3d at 433 (noting that failure to follow GAAP “can easily arise from negligence, oversight or simple mismanagement, none of which rise to the standard necessary to support a securities fraud action”).17
Considered holistically, plaintiffs’ allegations of knowledge of Guaranty’s undercapitalization, a large misstatement, red flags, and ignorance of internal warnings, do not raise a strong inference of severe recklessness that is equally
ii. Jastrow
Jastrow was the CEO and Chairman of the Board of Directors of Temple until the spin-off, and was Chairman of the Board of Directors of Guaranty until his resignation on August 26, 2008. Plaintiffs seek to hold Jastrow liable for wrongful conduct from the beginning of the Class Period through his resignation. Plaintiffs identify two alleged misstatements made by Jastrow. First, Jastrow signed a cover letter to a Form 8-K filed with the SEC in December 2007, just prior to the spin-off. The Form 8-K contained a statement
The SAC did not allege that Jastrow was ever informed of internal disagreements or warnings regarding Guaranty’s MBS valuation. Plaintiffs do not allege that he received any communications from any of the confidential witnesses. The “red flags” highlighted in the SAC are not alleged to have alerted anyone to problems in the MBS portfolio until June 2008, several months after Jastrow’s last alleged misstatement. As discussed, supra, the SAC’s invocation of the Tepper complaint alleges that Jastrow had knowledge of Guaranty’s undercapitalization during the Class Period. This constitutes a possible motive and creates a slight inference of scienter, but does not rise to the required “strong inference.”
The only additional allegation as to Jastrow does not provide the missing piece. The SAC alleges that, at a Temple board meeting, Jastrow stated that the California real estate markets were deteriorating because adjustable rate mortgages were being reset.19 Plaintiffs contend that this observation contributes to an inference of scienter because the mortgages underlying Guaranty’s MBS portfolio comprised a high concentration of California adjustable rate loans. Together, Jastrow’s knowledge of Guaranty’s undercapitalization and awareness of the decline of the California real estate market do not rise to the level of a “strong inference” of scienter that is at least as likely as the alternative inference that Jastrow was merely negligent in
iii. Gifford
Gifford was Guaranty’s Controller until December 2007 and was Guaranty’s Executive Vice President and Principal Accounting Officer from December 2007 until his resignation on October 27, 2008. Plaintiffs seek to hold Gifford liable for wrongful conduct from the beginning of the Class Period through his resignation. Plaintiffs identify three alleged misstatements made by Gifford. Gifford signed Guaranty’s 2007 10-K and two 10-Qs, filed on April 29, 2008 and August 11, 2008, all of which allegedly included the misrepresentation that the financial statements contained therein complied with GAAP.
The case for Gifford’s scienter is the weakest of any defendant. Gifford was not a party to the Tepper action, nor are there any other allegations that he was aware of Guaranty’s undercapitalization at any point during the Class Period. The SAC does not allege that Gifford was privy to any concerns about deficiencies in Guaranty’s internal valuation models.
Essentially, the SAC alleges only that Gifford held the position of Principal Accounting Officer at the time a large misstatement was made, and that red flags existed. We have already discussed why the magnitude of the misstatement and red flags do not create a strong inference of scienter, and Gifford’s position within Guaranty does not support a strong inference of scienter. “A pleading of scienter may not rest on the inference that defendants must have been aware of the misstatement based on their positions within the company.” Abrams, 292 F.3d at 432; see also Goldstein, 340 F.3d at 251 (concluding that the allegation that defendant was a “hands-on” CEO and therefore must have been aware of accounting error was not specific enough to
III. Other issues
Because of our conclusion that plaintiffs have not raised a strong inference of scienter as to any defendant that is “at least as compelling as any opposing inference of nonfraudulent intent,” Tellabs, 551 U.S. at 314, we need not reach the issue of loss causation. Nor do we decide if Jastrow, as an outside director, was a “maker” of the alleged misstatements, only noting that this court has held that allegations that a corporate officer made statements are sufficient to state a claim that the officer is a “maker” of the statements. Blackwell, 440 F.3d at 287; see also Janus Capital Grp., Inc. v. First Derivative Traders, 131 S. Ct. 2296, 2304–05 (2011) (“[A]ttribution within a statement or implicit from surrounding circumstances is strong evidence that a statement was made by . . . the party to whom it is attributed.”). We also affirm the district court’s dismissal of plaintiffs’ control person claim under
CONCLUSION
Our holistic review of the Second Amended Complaint confirms that plaintiffs have failed to adequately plead facts that raise a strong inference of scienter. Accordingly, we AFFIRM the district court’s dismissal of this action.