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In re Dynex Capital

February 10, 2006


The opinion of the court was delivered by: Hon. Harold Baer, Jr., District Judge


Lead plaintiff Teamsters Local 445 Freight Divisions Pension Fund ("Local 445") brings this putative class action against defendants Merit Securities Corporation ("Merit"), Dynex Capital, Inc. ("Dynex," collectively the "corporate defendants" or "Dynex"), Thomas H. Potts ("Potts") and Stephen J. Benedetti ("Benedetti") for violations of sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the "Exchange Act") in connection with the sale of asset-backed bonds. Defendants have moved to dismiss the complaint on the grounds that: 1) plaintiff's claims are barred by the statute of limitations; 2) plaintiff fails to plead fraud with the requisite particularity; 3) plaintiff fails to plead scienter; 4) plaintiff fails to plead loss causation; 5) certain of defendant's statements were forward-looking; and 6) plaintiff lacks standing to pursue claims based on classes of bonds that plaintiff itself did not actually purchase. For the following reasons, defendants' motions to dismiss is GRANTED in part and DENIED in part.


Dynex is a financial services corporation principally engaged in "the consummation of public offerings of debt securities using mortgages as collateral." (Compl. ¶ 4). Merit is a wholly owned subsidiary of Dynex. (Compl. ¶ 21). Benedetti was, at all relevant times, the President and CEO of Merit. (Compl. ¶ 27). In addition, Benedetti served on the board of directors of Dynex, and held various senior management positions at Dynex throughout the class period. (Id.) Potts was President and Principal Executive Officer of Dynex from 1997 until June 2002 and served on Dynex's board of directors throughout the class period. (Compl. ¶ 28). In 1999, Merit issued two series of bonds, the "Series 12" bonds and the "Series 13" bonds, collateralized by pools of mobile home installment sales contracts. (Compl. ¶ 54). Local 445 purchased $450,000 par value Series 13 bonds for a total investment of $442,922. (Compl. ¶ 20). Dynex had originated the mobile home loans that served as collateral for the bonds between 1997 and 1999. (Compl. ¶ 55). Plaintiff alleges that, since Dynex "was a relatively 'late comer' to the mobile home loan business[,]" in order to obtain large volumes of loans, Dynex was forced to purchase loans from uncreditworthy borrowers. (Id.) Plaintiff alleges that Dynex engaged in "the undisclosed practice of overtly marketing to mobile home dealers Dynex's willingness to buy 'bad paper' or uncreditworthy loans; purchasing these highly defective and impaired loans" and then using these loans as collateral for the bonds. (Compl. ¶ 5). Plaintiff alleges that the offering documents issued in 1999 in connection with the Series 12 and 13 bonds concealed "the true facts concerning how the collateral was originated." (Compl. ¶ 6). Plaintiff further alleges that, after the initial offering, defendants misrepresented the cause of the bond collateral's poor performance; misrepresented the reasons for restating its loan loss reserves; and concealed the loans' faulty underwriting. (Compl. ¶¶ 7-10). On February 24, 2004, and May 13, 2004, Moody's downgraded the credit rating of the Series 13 and Series 12 bonds, respectively. (Compl. ¶ 13). These downgrades led to steep declines in the price of the bonds. (Compl. ¶ 2). Local 445 brings the instant action on behalf of all open market purchasers of Series 12 and 13 bonds between February 7, 2000 and May 13, 2004. (Compl. ¶ 35).


When ruling on a motion to dismiss pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure, the Court must construe all factual allegations in the complaint in favor of the non-moving party. See Krimstock v. Kelly, 306 F.3d 40, 47 - 48 (2d Cir. 2002). The Court's consideration is normally limited to facts alleged in the complaint, documents appended to the complaint or incorporated in the complaint by reference, and to matters of which judicial notice may be taken. See Allen v. WestPoint-Pepperell, Inc., 945 F.2d 40, 44 (2d Cir. 1991). A motion to dismiss should not be granted "unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Shakur v. Selsky, 391 F.3d 106, 112 (2d Cir. 2004) (quoting Conley v. Gibson, 355 U.S. 41, 45-46 (1957)). When a complaint alleges fraud, "Rule 9(b) requires that allegations of fraud be pleaded with particularity." Harsco Corp. v. Segui, 91 F.3d 337, 347 (2d Cir. 1996). This means that the complaint "must (1) detail the statements (or omissions) that the plaintiff contends are fraudulent, (2) identify the speaker, (3) state where and when the statements (or omissions) were made, and (4) explain why the statements (or omissions) are fraudulent. Id.

"To state a cause of action under section 10(b) [of the Exchange Act] and Rule 10b-5 [of the Securities and Exchange Commission], a plaintiff must plead that the defendant made a false statement or omitted a material fact [in connection with the purchase or sale of securities], with scienter, and that plaintiff's reliance on defendant's action caused plaintiff injury." Kalnit v. Eichler, 264 F.3d 131, 138 (2d Cir. 2000) (internal quotation omitted). "The requisite state of mind, or scienter, in an action under section 10(b) and Rule 10b-5[] that the plaintiff must allege is an intent to deceive, manipulate or defraud." Id. (internal quotation omitted). The Private Securities Litigation Reform Act of 1995 ("PSLRA") imposed heightened pleading requirements for securities fraud actions. Id. The PSLRA provides that:

In any private action . . . in which the plaintiff may recover money damages only on proof that the defendant acted with a particular state of mind, the complaint shall, with respect to each act or omission alleged to violate this chapter, state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.

15 U.S.C. § 78u-4(b)(2).

To establish fraudulent intent, a plaintiff may either allege facts showing "that defendants had both motive and opportunity to commit fraud" or allege "facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness." Kalnit, 264 F.3d at 138 (internal quotation omitted). A plaintiff may establish the requisite strong inference of scienter by alleging that the defendants: "(1) benefited in a concrete and personal way from the purported fraud . . .; (2) engaged in deliberately illegal behavior . . .; (3) knew facts or had access to information suggesting that their public statements were not accurate . . .; or (4) failed to check information they had a duty to monitor." Novak v. Kasaks, 216 F.3d 300, 311 (2d Cir. 2000).

A. Misrepresentations and Omissions

Plaintiff alleges that the prospectuses issued in connection with the offerings of the Series 12 and 13 bonds contained various false and misleading statements. Specifically, plaintiff contends that the offering documents falsely represented the underwriting guidelines employed in originating the loans that served as collateral for the bonds. For example, the prospectuses stated that the underwriting guidelines would encompass the "creditworthiness of the Borrower" and "the Borrower's ability to make Monthly Payments." (Compl. ¶ 67). Further, the offering documents represented that the purpose of the underwriting guidelines was "to evaluate each prospective Borrower's credit standing and repayment ability and the value and adequacy of the related Mortgaged Premises as collateral." (Compl. ¶ 68). The offering documents went on to summarize the types of information utilized to determine a potential borrower's credit-worthiness, including credit history, income and employment status. (Compl. ¶¶ 69-70). Plaintiff alleges that these statements were false because "the creditworthiness of the borrower as well as deficiencies in borrower documentation was systematically disregarded by Dynex regional and corporate officers in order to reach . . . loan volume amounts necessary to consummate" the bond offerings. (Compl. ¶ 71).

Plaintiff alleges that the misrepresentations continued after the offerings were consummated and throughout the class period. A representative sample of those allegations is as follows. In Dynex's 1999 Form 10-K, Dynex stated that it "historically utilized internally generated guidelines to underwrite loans for all product types and . . . performed the servicing function for loans on which the Company has credit exposure." (Compl. ¶ 74). Throughout the class period, in its SEC filings, Dynex represented that it was acting as "master servicer" of the mobile home loans by, inter alia, monitoring the submission of loan payments. (Compl. ¶¶ 80-81). Plaintiff alleges that these representations are misleading because defendants recklessly disregarded underwriting criteria and servicing duties and that this recklessness lead to a material understatement of repossessions made in connection with the loans and the restatement of loan loss reserves. (Compl. ¶¶ 75, 81).

In a letter to shareholders dated April 28, 2000, Potts stated that Dynex had decided to sell its manufactured housing lending business due to an inability to secure funding under reasonable terms. (Compl. ¶ 76). Plaintiff alleges that this statement was misleading because "Dynex failed to disclose that a material factor in the decision to sell the mobile home loan lending business was the poor underwriting and origination practices" that produced a defective loan portfolio. (Compl. ¶ 77). In another letter to shareholders, dated May 4, 2001, Potts stated that "manufactured housing loans are currently experiencing higher loss severities than previously anticipated due to the depressed state of the manufactured housing section." (Compl. ¶ 84).*fn1 In addition, the 2000 Form 10-K filed that same day stated that Dynex had: seen the loss severity on manufactured housing loans increase dramatically . . . as a result of the saturation in the market place with both new and used (repossessed) manufactured housing units. In addition, the Company has seen some increase in overall default rates on its manufactured housing loans. The Company anticipates that market conditions for manufactured housing loans will remain unfavorable through 2001.

(Compl. ¶ 86).*fn2 Plaintiff claims that this statement was misleading because defendants failed to disclose the true reasons for the decline of the mobile home loan portfolio, i.e., reckless loan origination and underwriting. (Compl. ¶ 87).

In its 2002 Form 10-K, Merit revised its loan loss reserves to include "a percentage of all loans with delinquencies greater than 30 days." (Compl. ¶ 100). Merit stated that the "increase in severe loan losses [was] a result of the saturation in the market place with both new and used (repossessed) manufactured housing units" and that "the Company [had] seen some increase in overall default rates. . ." (Id.) Further, in its 2003 Form 10-K, Merit again revised its loan loss estimates to include a portion of "current loans." (Compl. ¶ 110). Merit stated that, "[g]iven . . . "new observable data" including default trends and market conditions, it was advisable to include some amount in its loss reserves to cover current loans. (Compl. ¶ 110).

In addition, on October 28, 2003, Dynex restated the cumulative repossession figures for the Series 13 bonds that it had been reporting monthly on its website. (Compl. ¶ 102-04). Specifically, Dynex reported that the total repossessions through September had been understated by approximately 34%. (Compl. ¶ 104). Finally, in its 2003 Form 10-K, Merit disclosed that it had identified an "internal control deficiency related to the recording of allowance for loan losses in excess of loan obligations" and that Merit was therefore restating its earnings for the first two quarters of 2003. (Compl. ¶ 112). In February, March and May 2004, the Series 12 and 13 bonds suffered severe credit downgrades by credit reporting services which in turn led to a steep drop in market price. (Compl. ¶¶ 107-09, 114).

B. Statute of Limitations

An action "that involves a claim of fraud . . . in contravention of a regulatory requirement concerning the securities laws . . . may be brought no[] later than" two years after "the discovery of the facts constituting the violation" or five years after the violation itself, whichever is earlier. 28 U.S.C. § 1658(b); see also Teamsters Local 445 Freight Division Pension Fund v. Bombardier, Inc., 05 Civ. 1898, 2005 U.S. Dist LEXIS 19506, *15-16 (S.D.N.Y. September 6, 2005).

Plaintiff's complaint was filed on February 7, 2005. Defendants argue that any claims based on statements or omissions contained in the bond offering documents, which were issued in 1999, are barred by the five year statute of repose.*fn3 In addition, defendants argue that the poor performance of the bond collateral, dramatic increases in Dynex and Merit's loss reserves, and news reports regarding risky underwriting practices in the manufactured housing loan ...

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