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SHEPPARD v. TCW/DW TERM TRUST 2000

August 16, 1996

LONNIE SHEPPARD, Plaintiff, against TCW/DW TERM TRUST 2000, TCW/DW TERM TRUST 2003, DEAN WITTER DISTRIBUTORS, INC., DEAN WITTER INTERCAPITAL INC., DEAN WITTER REYNOLDS, INC., TCW FUNDS MANAGEMENT, INC., ROBERT A. DAY, JOHN C. ARGUE, RICHARD M. DeMARTINI, CHARLES A. FIUMEFREDDO, JOHN R. HAIRE, DR. MANUEL H. JOHNSON, PAUL KOLTON, THOMAS E. LARKIN, JR., MICHAEL E. NUGENT and DAVID S. TAPPAN, JR., Defendants. EDMUND MERMELSTEIN, Plaintiff, -against- TCW/DW TERM TRUST 2000, TCW/DW TERM TRUST 2003, DEAN WITTER DISTRIBUTORS, INC., DEAN WITTER INTERCAPITAL INC., DEAN WITTER REYNOLDS, INC., TCW FUNDS MANAGEMENT, INC., ROBERT A. DAY, JOHN C. ARGUE, RICHARD M. DeMARTINI, CHARLES A. FIUMEFREDDO, JOHN R. HAIRE, DR. MANUEL H. JOHNSON, PAUL KOLTON, THOMAS E. LARKIN, JR., MICHAEL E. NUGENT and DAVID S. TAPPAN, JR., Defendants.


The opinion of the court was delivered by: SCHWARTZ

 ALLEN G. SCHWARTZ, DISTRICT JUDGE:

 This is a class action brought by plaintiffs on behalf of all persons, other than defendants and related parties, who purchased shares in TCW/DW Term Trust 2003 ("Trust 2003") during the period from its inception on or about April 22, 1993 to July 19, 1994 and/or shares in TCW/DW Term Trust 2000 ("Trust 2000") during the period from its inception on or about December 22, 1993 to July 19, 1994 (the "Class Period"). On behalf of the purported class, plaintiffs assert violations of Sections 11, 12(2) and 15 of the Securities Act of 1933 (the "1933 Act"), 15 U.S.C. § 77k, 771(2) and 77o, Section 10(b) of the Securities Exchange Act of 1934 (the "1934 Act"), 15 U.S.C. §§ 78j(b), and rule 10b-5 thereunder, 17 C.F.R. § 240.10b-5, and Section 13 of the Investment Company Act of 1940 (the "1940 Act"), 15 U.S.C. § 80a-13.

 This matter is before the Court upon defendants' motion to dismiss the Complaint for failure to state a claim, pursuant to Federal Rule of Civil Procedure 12(b)(6), and for failure to plead fraud with particularity, pursuant to Rule 9(b). For the reasons stated below, defendants' motion is granted.

 BACKGROUND

 The following facts and contentions appear in the Complaint and the documents upon which it is largely based-- specifically, the prospectuses for Trust 2000 and Trust 2003. *fn1"

 Trust 2000 and Trust 2003 are closed-end diversified management investment companies, commonly known as Massachusetts business trusts, and were organized under the laws of the Commonwealth of Massachusetts (collectively, the "Trusts"). Other defendants in this action include the Trusts' investment adviser, TCW Funds Management Inc.; the manager of the Trusts, Dean Witter InterCapital Inc.; the underwriter of the offerings, Dean Witter Distributors, Inc.; the underwriter and manager's parent, Dean Witter Reynolds, Inc.; and various individuals who acted, inter alia, as trustees of the Trusts. Plaintiffs purchased a number of shares in the Trusts, the value of which declined as interest rates rose in 1994.

 Plaintiffs' allegations of wrong-doing fall into three categories: (1) the issuance of false statements in reports filed with the Securities Exchange Commission ("SEC"), including the prospectus in the Registration Statements used to market the offerings, (2) the use of deceptive marketing practices, and (3) deviation from the fundamental policies of the Trusts without a shareholder vote. Plaintiffs claim that, had the defendants accurately disclosed the investment policies of the Trusts and accurately described the investments and the composition of the portfolios of the Trusts and the risks associated therewith, they would not have invested in the Trusts or would not have paid the prices they paid. In addition, plaintiffs assert that, had the defendants adhered to the fundamental policies of the Trusts, plaintiffs would not have suffered the loss of over 20% of their investments.

 The investment objectives of the Trusts, as stated in the prospectus, were to provide a high level of current income and return $ 10 per share, the initial public offering price, to shareholders on the termination date. According to statements in the prospectus, these objectives were to be achieved by investing in high quality fixed-income securities, such as mortgage-backed securities, asset-backed securities, zero coupon securities of municipal issuers, other municipal securities and debt securities of non-U.S issuers, which had a final or expected maturity on or about the termination date of the respective trust. The prospectus stated that, under current market conditions, the Trusts expected that approximately 85% of their total assets would be invested in mortgage-backed securities, such as those issued by the Government National Mortgage Association, the Federal National Mortgage Association, and the Federal Home Loan Mortgage Corporation, private mortgage pass-through securities, collateralized mortgage obligations, including inverse floaters, stripped mortgage-backed securities and asset-backed securities; while approximately 15% of their assets would be invested in zero coupon securities of municipal issuers and other municipal securities. It was further disclosed that the Trusts could invest up to 25-30% (25-40% for Trust 2000) of their assets in inverse floaters. Investors were also informed that the Trusts could borrow or utilize leverage in an amount not to exceed 33.3% of total assets, including the amount borrowed.

 Plaintiffs allege that the Trusts were marketed to investors by emphasizing the credit quality of the securities while obscuring the Trusts' reliance on mortgage-backed derivatives and the magnitude of the interest rate risk of the portfolio, which interest rate risk overwhelmed the safety presented by the credit quality of the portfolio. According to plaintiffs, the prospectus failed to disclose that the initial structures of the Trusts' portfolios were biased toward a declining interest rate scenario and that such bias ensured that the Trusts would suffer severe losses in the event of a rise in interest rates. In addition, plaintiffs claim that, although the Trusts' intent to invest in inverse floaters was disclosed, such disclosure was misleading and the potential volatility of inverse floaters was cloaked in "meaningless corporate terms." Compl. P 31. Plaintiffs further allege that the dollar weighted average maturity of the Trusts' portfolios were 21 and 18 years, respectively, and that this represented a departure from the Trusts' fundamental policies, without the Trusts' having conducted the requisite shareholder vote.

 Defendants move to dismiss the Complaint, pursuant to Federal Rule of Civil Procedure 12(b)(6), on the grounds that (1) plaintiffs have failed to allege any material misrepresentations or omissions, (2) plaintiffs have failed to plead facts suggesting scienter, in violation of Federal Rule of Civil Procedure 9(b), and (3) the Trusts have not violated any fundamental policy.

 DISCUSSION

 In ruling on a motion to dismiss the Complaint for failure to state a claim, plaintiffs' factual allegations must be taken as true, and the Court may only grant the motion where no set of facts could support plaintiffs' claim. International Audiotext Network, Inc. v. American Tel. and Tel. Co., 62 F.3d 69, 71 (2d Cir. 1995). The Court may take into consideration documents upon which the Complaint relies and which are integral to the Complaint, such as the trust prospectuses, without converting the motion to one for summary judgment. See id. at 72.

 I. Plaintiffs' 1933 Act and 1934 Act Claims

 Sections 11 and 12(2) of the 1933 Act, 15 U.S.C. 77k & 771(2), and Section 10(b) of the 1934 Act and Rule 10(b) (5) thereunder, 15 U.S.C. § 78j, 17 C.F.R. § 240.10b-5, all require plaintiffs to identify a false statement of material fact or the omission of a material fact. See I. Meyer Pincus & Assocs. P.C. v. Oppenheimer & Co., Inc., 936 F.2d 759, 761 (2d Cir. 1991). Section 11 of the 1933 Act holds, inter alia, a signer, officer of an issuer, or underwriter liable for a registration statement "containing an untrue statement of a material fact or omitting to state a material fact . . . necessary to make the statements therein not misleading." 15 U.S.C. § 77k(a) Section 12(2) of the 1933 Act prohibits any person from offering or selling a security "by means of a prospectus or oral communication, which includes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements, in light of the circumstances under which they were made, not misleading." 15 U.S.C. § 771(2). *fn2" To state a claim under Section 10(b) of the 1934 Act, plaintiffs must allege that defendants made a false statement or omitted a material fact, with scienter, and that plaintiffs' reliance on defendants' action caused plaintiffs injury. San Leandro Emergency Medical Group Profit Sharing Plan v. Philip Morris Companies, Inc., 75 F.3d 801, 808 (2d Cir. 1996). Because the Court finds that the Trusts truthfully represented and adequately disclosed their investment strategies and the inherent risks therein, plaintiffs' claims under these statutes must be dismissed. See In re Hyperion Secs. Litig., 1995 U.S. Dist. LEXIS 10020, 93 Civ. 7179 (MBM), 1995 WL 422480 *5 (S.D.N.Y. July 14, 1995).

 Plaintiffs allege that the prospectus "obscured the Trust's reliance on mortgage backed derivatives and the magnitude of the interest rate risk of the portfolio . . . ." Compl. P 20. However, the prospectus twice stated that approximately 85% of trust assets would be invested in mortgage-backed securities and specifically warned potential investors of the risk related to an increase in interest rates. For example, the prospectus warned:

 
mortgage-backed and asset-backed securities may decrease in value as a result of increases in interest rates and may benefit less than corporate debt ...

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