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July 13, 2005.

In re PARMALAT SECURITIES LITIGATION. This document relates to: 04 Civ. 0030.

The opinion of the court was delivered by: LEWIS KAPLAN, District Judge


The plaintiffs in these consolidated class actions were investors in the securities of the international dairy conglomerate Parmalat Finanziaria S.p.A. and subsidiaries and affiliates (collectively "Parmalat"). They allege that Parmalat's officers, directors, accountants, lawyers, and banks made representations and structured transactions that operated to defraud Parmalat's investors in violation of Sections 10(b)*fn1 and 20(a)*fn2 of the Securities Exchange Act of 1934 and Rule 10b-5*fn3 thereunder.

  This opinion addresses the motions of the defendant banks to dismiss the actions as to them pursuant to Rules 12(b) and 9(b) of the Federal Rules of Civil Procedure. They require consideration of, among other issues, the contours of subsections (a) and (c) of Rule 10b-5, which prohibit "any device, scheme, or artifice to defraud" and "any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person" in connection with the purchase or sale of any security.

  I. The Complaint and the Motions to Dismiss

  As described in an earlier opinion,*fn4 the plaintiffs purport to represent classes of persons who purchased Parmalat securities from January 5, 1999 to December 18, 2003 (the "Class Period.").*fn5 The 368-page amended consolidated complaint details various fraudulent acts allegedly perpetrated by Parmalat and the defendants.

  A. Citigroup

  1. Factual Allegations

  Citigroup Inc. and Citibank, N.A. ("Citibank"), and their subsidiaries and affiliates (collectively "Citigroup"), are alleged "knowingly and actively [to have] participated in the fraudulent scheme" and to have had "intimate knowledge" of Parmalat's finances through its "close relationship with its important client" and its "direct participation in the fraudulent activities."*fn6 The complaint describes three specific arrangements involving Citigroup.

  a. Securitization of Invoices

  The first involved Citigroup's purchase and securitization of allegedly worthless invoices.*fn7 Under agreements entered into in 1995, 1999, 2000, and 2001, invoices for goods sold by various Parmalat subsidiaries were purchased by defendant Eureka Securitisation plc ("Eureka"), a Citigroup affiliate, as well as by Eureka's wholly-owned Italian subsidiary, Archimede Securitization S.r.1. ("Archimede"). Archimede and Eureka then sold commercial paper secured by the invoices.*fn8 This securitization alone would appear to have been neither unusual nor deceptive.

  The deception allegedly stemmed from Parmalat's billing system, under which many of the invoices were in effect duplicates that did not represent anything actually due. Parmalat supplied supermarkets and other retailers through a network of wholesale dealers. These dealers were invoiced for each delivery and typically paid Parmalat the full amount of the invoices. The dealers sometimes sold to retailers on their own account and sometimes distributed Parmalat's products to supermarkets on Parmalat's behalf. In the latter case, the dealer would furnish to Parmalat proof of delivery to the supermarket. Parmalat then would issue a second invoice, this one directly to the supermarket, and undertake to reimburse the dealer for the goods it distributed to the supermarket. In other words, when a dealer acted purely as Parmalat's distributor, amounts that the dealer owed Parmalat for goods distributed for Parmalat were offset by Parmalat's corresponding obligation to reimburse the dealer.*fn9 Like the securitization of receivables, there appears to have been nothing remarkable or deceptive about this billing system — which the complaint implies had been used for forty years*fn10 — standing alone. The problem was that Parmalat assigned to Archimedes and Eureka, and they then securitized, both the supermarket invoices, which represented receivables, and the corresponding dealer invoices for the same goods. The latter did not represent a real revenue stream for Parmalat because Parmalat was obligated to reimburse the dealers the same amounts that the dealers owed Parmalat.*fn11 In other words:
"Citibank sold investors the supermarket invoices and the dealer invoices, even though . . . Parmalat was entitled to receive money from just one set of invoices. Citibank therefore double counted the invoices. . . ."*fn12
The arrangement generated approximately $348 million during the Class Period.*fn13

  The complaint alleges that Citigroup structured the program, performed due diligence, and had detailed knowledge as early as 1995 of Parmalat's invoicing system, including the duplicate invoices.*fn14 Citibank installed proprietary software on Parmalat's computer network that allowed Citibank "to determine which receivables were eligible for the securitization program and to regularly audit Parmalat's sales."*fn15 Citibank thus "knew that the securitization program Citibank designed would create a false impression about Parmalat's cash flow from its operations, and therefore mislead the market about Parmalat's real financial condition."*fn16 Citigroup allegedly received $35 million in fees for its role in the securitization program.*fn17

  The complaint alleges as well a separate aspect to the scheme. The applicable regulations governing securitization permitted only independent financial institutions, not the entities generating the receivables, to collect on them. Eureka and Archimede, however, allegedly assigned back to Parmalat the right to collect payment on the invoices. Parmalat's characterization on its balance sheets of the arrangement with Eureka and Archimede as a securitization rather than as debt therefore allegedly was misleading.*fn18

  b. The Geslat/Buconero Arrangement

  The complaint asserts also that Citibank structured transactions in which several of its subsidiaries made loans to Parmalat that were disguised as equity investments.*fn19 The alleged reason for the scheme was that Parmalat was performing poorly, but it did not want to damage its credit rating by issuing debt through the bond markets. Citibank allegedly knew that Parmalat would use the arrangement to mask its debt on its financial statements.*fn20

  The arrangement began in 1995, when Parmalat entered into an agreement with Citibank styled as a joint venture. In connection with the agreement, Parmalat set up a Swiss branch of its subsidiary, Gestione Centrale Latte S.r.l. ("Geslat"), to which Citibank contributed funds. The Swiss branch of Geslat was to make loans to other companies in the Parmalat group, with Citibank receiving a proportional share of the profits from those loans. At the same time, Parmalat gave Citibank a put option that allowed Citibank to sell its interest in Geslat back to Parmalat at a price that guaranteed that Citibank would receive a return on its investment.*fn21

  On December 9, 1999, Citibank altered the arrangement so that the funds would be provided by two Citibank subsidiaries, defendants Buconero LLC ("Buconero") and Vialattea LLC ("Vialattea"), both Delaware limited liability companies.*fn22 As the plaintiffs unflaggingly point out, "Buconero" means "black hole" in Italian.*fn23 Geslat guaranteed that Citibank would receive at least a certain fixed rate of return.*fn24 Buconero would be responsible for Geslat's losses if they exceeded a certain threshold, but Citibank could avoid that condition entirely because it had the right to dismantle the relationship with Geslat and require the repayment of its contribution if Geslat's performance or Parmalat's creditworthiness declined.*fn25 From 1999 to 2001, Buconero and Vialattea contributed as much as $120 million to Geslat.*fn26 Parmalat recorded these funds as equity on its balance sheets. The funds, however, were in reality loans at favorable interest rates and therefore should have been recorded as debt.*fn27 The result was to understate Parmalat's liabilities by $137 million, permitting the conglomerate to conceal its troubles in South America and elsewhere.*fn28 Following Parmalat's collapse, Citibank publicly characterized the investments as debt and stated that "today we would only do this type of transaction if a client agreed to provide greater disclosure."*fn29

  A Parmalat press release dated November 21, 2003 and "approved"*fn30 by Citigroup made the following disclosures:*fn31

"Parmalat Finanziaria details of participation agreement
* * *
"On December 16, 1999, Geslat Srl, a consolidated subsidiary, acting as lead firm via its branch office in Lugano (Switzerland), entered into a participation agreement with a third party, Buconero LLC, a Citicorp group company, acting as partner. . . .
"The partner, whose contribution amounts to a total of 117 million euros, receives a return determined each year on the basis of the company's net profit before appropriation of net profit attributable to the partner, as is common practice in relation to participation agreements.
"Geslat Srl uses the partner's contribution and the capital of the company and of the Parmalat Group to grant loans to consolidated companies in the accounts of the Parmalat Group. As of December 31, 2002 such loans amounted to 458 million euros.
"The transaction enables a leading international group to participate in and contribute to the development of the Parmalat Group's businesses through its role as a partner. In December 1999, the parties signed a five-year business plan governing the activities of the company and its Lugano branch office. Geslat Srl gave the partner, Buconero, an undertaking to comply with certain restrictions. The company thus undertook to maintain the branch office in Lugano, to use the partner's contribution and the company's capital for the purposes defined in the company's articles of association . . . [and] to not raise further funds or carry out capital increases unless provided for by specific legislation. . . . The participation agreement will automatically terminate on expiry of the business plan, unless a new business plan is agreed by the parties.
* * *
"In the notes to Parmalat Finanziaria Spa's consolidated financial statements, the note to `Shareholders' equity attributable to minority interests' specifies that minority interests in the share capital and reserves include financial contributions deriving from a participation agreement drawn up by a consolidated company, in partnership with a third-party financier acting as partner."*fn32
  Citibank, which regarded the Geslat transactions as a financing arrangement rather than as equity investments,*fn33 received annual returns from them of approximately $5 to $6 million as well as approximately $7 million in fees for structuring the transactions. Citibank derived tax benefits as well.*fn34

  c. Parmalat Canada Arrangement

  The final set of allegations against Citigroup also involves the alleged classification of debt as equity.*fn35

  In 1997 and 1998, Parmalat purchased three Canadian food and dairy companies (collectively "Parmalat Canada"). Citibank helped finance the purchase with capital contributions of C$171.9 million. The agreement between Parmalat and Citibank provided that Parmalat Canada either would be publicly listed or that Citibank could put its interest back to Parmalat for a specified amount.*fn36 Parmalat recorded Citibank's investments as equity on its financial statements when they should have been recorded as high-interest loans because the put option meant that Citibank bore no risk.*fn37 Furthermore, Parmalat's financial statements allegedly failed to disclose the put option after 1999.*fn38 A senior Citibank executive allegedly misrepresented the nature of Citibank's involvement in Parmalat Canada in statements to the press in 1997 and 1998.*fn39

  The complaint asserts that "Citibank designed the financing transactions to enable Parmalat to characterize them as equity and thereby maintain the false appearance of a lower debt-to-equity ratio."*fn40 The bank received C$1.3 million in subscription fees and C$5.6 million in financial advisory fees as well as a net tax-free gain of C$47.82 million upon the exercise of the put option. According to the complaint, "[t]his abnormally high return can only be explained by the illegal nature of the activity."*fn41

  2. Causes of Action, Grounds for Motion to Dismiss

  The complaint asserts causes of action against the Citigroup defendants for violation of Rules 10b-5(a) and (c) and 10b-5(b). It asserts also claims against Citigroup Inc. and Citibank under Section 20(a) for alleged primary violations of Section 10(b) and Rule 10b-5 by Citibank, Buconero, Vialattea, and Eureka.

  Citigroup argues that it was not a primary violator, the allegations are deficient as to scienter, causation, and reliance, and the complaint fails to state a claim for controlling person liability under Section 20(a). B. Bank of America

  1. Factual Allegations

  The complaint describes two arrangements involving defendants Bank of America Corporation ("BoA Corp."), Bank of America, N.A. ("BANA"), and Banc of America Securities Limited ("BASL"), and their subsidiaries and affiliates (collectively "BoA").*fn42 The plaintiffs allege that BoA "was aware of the true value of Parmalat's assets and liabilities"*fn43 but was "motivated to participate" in fraud because it wanted to maintain and capitalize on its lucrative relationship with Parmalat.*fn44

  a. The Parmalat Administracao Private Placement

  The first set of allegations against BoA involves loans to private investors disguised as an equity investment in a Brazilian Parmalat subsidiary that the plaintiffs call "Parmalat Empreendimentos e Administracao" ("Parmalat Administracao").

  In 1999, BoA proposed and arranged what appeared to be the sale of an 18.18 percent interest in Parmalat Administracao to a group of investors led by BoA for $300 million. In reality, however, the investors purchased four-year notes issued by two special purpose Cayman Islands entities and guaranteed by Parmalat. Furthermore, as with Citibank's Parmalat Canada arrangement, the investors had the right to put their investments back to Parmalat if Parmalat Administracao did not become publicly listed.*fn45 BoA and Parmalat allegedly knew that such a listing was economically impractical and therefore would not occur.*fn46

  BoA*fn47 and Parmalat co-wrote a Parmalat press release issued December 18, 1999 in which they stated in pertinent part:*fn48

  "New shareholders for Parmalat in Brazil

"Parmalat Administracao Ltda . . . has increased its share capital in favour of a Group of North American investors lead [sic] by Bank of America. The transaction, completed yesterday, will generate for Parmalat Administracao a cash inflow of USD 150 million. Then, there is an option for the transaction to be increased, up to the end of this month, by a further USD 150 million. Should this option be exercised the new shareholders will own slightly over 18% of the company's share capital.
"The total implied value attributed to Parmalat Administracao amounts to some USD 1[.]35 billion. . . .
"The objective of the transaction is to further strengthen the Group presence in Brazil . . . and also to lay the ground for the floatation of the Brazilian company within the next four years. "Should the Brazilian company not be listed within the next four years, Parmalat Administracao's new shareholders will have the option to sell the shares acquired in the capital increase back to the Parmalat Group. In this event, the cost to Parmalat would be equal to the original price paid by the North American investors increased by a spread consistent with the most recent financial transactions undertaken by the Group on the international capital markets."*fn49
This press release allegedly "made it appear as though [Parmalat] was issuing new equity for cash to finance Parmalat's expansion."*fn50 In its 1999 Annual Report, Parmalat included similar language,*fn51 which allegedly was false and "concealed the fact that instead of being an equity transaction . . ., the deal was really a $300 million private debt placement partly secured by the Brazilian stake."*fn52 Furthermore, the funds were assigned to a Uruguayan subsidiary rather than used for the Brazilian operations.*fn53

  The complaint alleges additional, related transactions. BoA entered into an agreement with Parmalat pursuant to which BoA fronted to the Cayman Islands companies the funds needed to make interest payments on the four-year notes. When it became clear that Parmalat could not raise the money to redeem the notes, BoA assumed some of the exposure and attempted to offer another private placement to cover it.*fn54

  BoA and an Italian bank received as much as $38.5 million in fees and commissions for their role in the Parmalat Administracao private placement.*fn55

  b. Loans Backed by Funds Raised Through Private Placements

  The complaint alleges as well that BoA extended loans to Parmalat subsidiaries and required that the loans be secured with funds raised from private placements of debt issued by Parmalat and underwritten by BoA. In essence, BoA transferred the risk of default on these loans from itself to purchasers of Parmalat's debt. The complaint includes three examples of such loans: an $80 million loan in 1998 to Parmalat subsidiaries in Venezuela, a $100 million loan to a Brazilian subsidiary in September 1998, and an $80 million loan to Parmalat Capital Finance in December 2001.*fn56

  With full disclosure, of course, there would have been nothing deceptive about these transactions. The complaint, however, alleges that: (a) "[n]either Bank of America nor Parmalat disclosed [that a 1998 $80 million offering] was related to the Venezuelan loan, or that the $80 million loan was done to pay off a 1997 Bank of America loan in the same amount to Parmalat Venezuela that lacked the same security for Bank of America,"*fn57 (b) "[i]n each instance, Bank of America publicly announced it had made a conventional loan in the stated amount to Parmalat. The reality of these transactions, however, was much different,"*fn58 and (c) "side letter agreements . . . that required Parmalat to pay additional interest on its loans" were not disclosed.*fn59

  BoA allegedly earned over $30 million in fees and interest from these transactions.*fn60

  2. Causes of Action, Grounds for Motions to Dismiss

  The complaint includes causes of action against the BoA defendants for violations of Rules 10b-5(a) and (c) and 10b-5(b), as well as causes of action under Section 20(a) against each of BoA Corp., BANA, and BASL for alleged primary violations of Section 10(b) and Rule 10b-5 by various BoA subsidiaries, agents, and employees.

  BoA*fn61 argues that the Rule 10b-5(b) claims fail because BoA made no misstatements or actionable omissions, any alleged misstatements or omissions and scienter are not pled with the required specificity, and the allegations regarding causation are deficient. Furthermore, argues BoA, the Rule 10b-5(a) and (c) claims fail because the plaintiffs have not alleged any manipulation or deception and because the allegations regarding reliance and scienter are deficient. Finally, BoA contends that the plaintiffs fail to state claims for controlling person liability under Section 20(a).

  C. Banca Nazionale del Lavoro

  1. Factual Allegations*fn62

  The core allegation against Banca Nazionale del Lavoro S.p.A. ("BNL") is that its factoring arm and 99.6 percent-owned subsidiary, Ifitalia S.p.A. ("Ifitalia"), along with other institutions, repeatedly paid Parmalat cash in exchange for assignment of invoices that both parties knew were bad.*fn63 Although the complaint is not completely clear, it implies that Parmalat booked the cash as an asset.

  This was quite misleading. In a normal factoring transaction, one party purchases, at a discount, receivables from the party that issued them and then attempts to collect the face amount of the invoices. Here, however, Parmalat had guaranteed to BNL or Ifitalia,*fn64 and the other banks, payment of the full face value of the invoices.*fn65 Moreover, Parmalat invariably made good on that guarantee, at least while the arrangement was in place.*fn66 The receivables thus played no economic role in the transaction; they were simply a device or excuse that permitted Parmalat to record the revenue and to conceal the liability on the guarantees. The complaint suggests, in other words, that the scheme in substance involved loans by BNL to Parmalat rather than factoring of receivables.

  The complaint alleges that Parmalat used old invoices for this arrangement and that each time payment on the invoices came due, Parmalat would pay BNL and the other banks the full amount for the previous set. The complaint suggests that, at the same time, Parmalat would assign to the banks, in exchange for another payment, a new set of invoices that were the same as the previous ones except that a single digit on each one had been changed to avoid detection and exclusion by BNL's computers.*fn67 If Parmalat's payment to the banks of the full amount on the previous set of invoices occurred at the same time as the banks' payment to Parmalat for assignment of the next set — a point on which the complaint is not entirely clear — then presumably the two payments would have been offset such that Parmalat in effect paid interest on a loan.

  This arrangement began in December 1999 and was renewed every six months. It allegedly resulted in Parmalat overstating its assets and receivables and understating its debt by 103 million each year during the Class Period.*fn68

  BNL allegedly benefitted by receiving returns from this scheme that were "far greater than returns earned in typical factoring transactions" and from bearing Parmalat's credit risk rather than that of third parties owing payment on invoices. Furthermore, BNL was co-managing underwriter for two large bond offerings by Parmalat during the Class Period. The profits from the factoring scheme and the underwriting fees were the alleged "payoffs" for BNL's participation in the fraud.*fn69

  The plaintiffs allege that BNL had "intimate knowledge of the fraud" because BNL and Parmalat shared two directors, one of whom was the president of Ifitalia.*fn70 Furthermore, "BNL's knowledge of the fraud was also apparent in its acceptance of numerous invoices which were identical except for a change in one digit — a change made so that the invoices would be accepted by BNL's processing software which was ...

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