Are financial estimates like goodwill and loan loss reserves statements of fact or opinion? The answer is significant, especially for claims brought under Section 11 and Section 12 of the '33 Act based on alleged misrepresentations in a registration statement. If these financial estimates are statements of fact, then a plaintiff is only required to establish that they were objectively false. If these financial estimates are statements of opinion, then a plaintiff must establish that they were objectively false and disbelieved by the defendant at the time they were made. In effect, it converts the cause of action from one based on strict liability (the company) or negligence (the individual defendants), to one based on knowing falsity.
In Fait v. Regions Financing Trust, No. 10-2311-cv (2d Cir. August 23, 2011), the plaintiffs alleged that despite adverse trends in the mortgage and housing markets, particularly in areas where the mortgage loans issued by a company previously acquired by Regions were concentrated, Regions failed to write down goodwill and to sufficiently increase its loan loss reserves. The lower court held that these financial estimates were matters of opinion and dismissed the Section 11 and Section 12 claims brought by purchasers of Region's trust preferred securities.
On appeal, the Second Circuit affirmed the lower court's ruling. Estimating goodwill "depend[s] on management’s determination of the 'fair value' of the assets acquired and liabilities assumed, which are not matters of objective fact." Similarly, loss reserves "reflect management’s opinion or judgment about what, if any, portion of amounts due on the loans ultimately might not be collectible." As a result, plaintiffs were required to plausibly allege that defendants did not believe their statements regarding goodwill and loan loss reserves at the time they made them. In the absence of these allegations, the plaintiffs' claims were subject to dismissal.
Holding: Dismissal affirmed.
There were two major settlements of subprime-related cases this week.
(1) Wachovia Corp. (NYSE:WB), a Charlotte-based financial services company now owned by Wells Fargo & Co., has announced the preliminary settlement of the securities class action pending against the company in the S.D. of New York. The case, originally filed in January 2009 in a California state court, stems from allegations that Wachovia and certain of its officers and directors made materially false statements in registration statements and prospectuses regarding the quality of the company’s loan portfolios. The settlement is for $627 million, of which Wachovia will pay $590 million and KMPG, who audited the company's financial statements, will pay $37 million. Reuters has an article on the settlement.
(2) National City Corp. (NYSE:NCC), a Cleveland-based financial holding company now owned by PNC Financial Services Group Inc., has announced the preliminary settlement of the securities class action pending against the company in the N.D. of Ohio. The case, originally filed in January 2008, stems from allegations that National City and certain of its officers and directors made materially false statements about the company’s mortgage-related exposure. The settlement is for $168 million.
NERA Economic Consulting and Cornerstone Research (in conjunction with the Stanford Securities Class Action Clearinghouse) have released their 2011 midyear reports on securities class action filings. The different methodologies employed by the two organizations have led to different numbers, as usual, although this time that difference also has led to competing conclusions about the overall filing trend.
The findings for the first half of 2011 include:
(1) Filings are either up (NERA) or down (Cornerstone), but both agree that there is a general movement away from Ponzi scheme and credit crisis cases and towards Chinese company and merger & acquisition (M&A) cases. NERA counts 130 filings and Cornerstone counts 94 filings (for some insight on why NERA has a larger total, see footnote 1 of the NERA report, which discusses its counting methodology). The "up" or "down" disparity appears to depend entirely on to which prior period the first half of 2011 is being compared. NERA compares it to the first half of 2010 (71 filings) and concludes that filings are up. Cornerstone compares it to the second half of 2010 (104 filings) and concludes that filings are down. If one looks at the overall trend lines, however, the two reports are reasonably consistent: at the present pace 2011 will be either the biggest (NERA) or second biggest (Cornerstone) year since 2004. An important codicil, however, is that there are only so many listed Chinese companies and M&A cases require continued M&A activity, so past filing performance may not be a good indicator of future filing results.
(2) The lag time between the end of the proposed class period and the filing date continues to decrease. NERA finds that the median lag time was 21 days in the first half of 2011, down from 54 days over the previous four years. Cornerstone finds that the median lag time was 8 days in the first half of 2011, down from 28 days over the previous fourteen years.
(3) NERA also examined the mid-year settlement trends. The average settlement was $23 million, down from the 2010 average settlement of $40 million (excluding settlements over $1 billion). The median settlement was $6.3 million, down sharply from the 2010 all-time high median settlement of $11 million. NERA speculates that the declines may be the result of "defendants' reduced ability to pay," resulting in settlements within insurance limits.
Quote of note (Professor Grundfest - Stanford): "If one focuses exclusively on traditional fraud claims against U.S.-based companies, then 2011 may well be on track to be the quietest litigation year since Congress passed the Private Securities Litigation Reform Act of 1995."