Appeal from the March 30, 2007, judgment of the United States District Court for the Southern District of New York (Sidney H. Stein, District Judge), dismissing the Plaintiffs' Second Amended Complaint for failure to state a claim for relief pursuant to Fed. R. Civ. P. 12(b)(6) and for failure to comply with the heightened pleading standard required by Fed. R. Civ. P. 9(b) and the Private Securities Litigation Reform Act, 15 U.S.C. § 78u-4. Plaintiffs contend that they adequately pled materiality and scienter in order to state a claim for securities fraud.
The opinion of the court was delivered by: Paul J. Kelly, Jr., Circuit Judge.
Before: KEARSE, SACK, and KELLY,*fn1 Circuit Judges.
Plaintiffs, shareholders of JP Morgan Chase & Co. (JPMC), appeal from a judgment of the United States District Court for the Southern District of New York, Sidney H. Stein, District Judge, granting JPM C's Fed. R. Civ. P. 12(b)(6) motion to dismiss for failure to state a claim. The basis of Plaintiffs' claim, in essence, was that they were defrauded by JPM C's complicity in Enron Corporation's financial scandals. In March 2005, the district court dismissed without prejudice Plaintiffs' First Amended Complaint (FAC) for failure to sufficiently allege scienter for all but the allegations involving JPM C's improper characterization of certain transactions (the "M ahonia transactions") as trades, and for failure to plead materiality adequately with regard to that allegation. See In re JP M organ Chase Sec. Litig., 363 F. Supp. 2d 595, 619-34 (S.D.N.Y. 2005) ("JP M organ Chase I"). Plaintiffs then filed a Second Amended Complaint (SAC). Again, however, the district court concluded that Plaintiffs had only sufficiently pleaded scienter with respect to JPM C's characterization of the Mahonia transactions, but that these transactions were not material. Accordingly, the district court dismissed the second amended complaint for failure to state a claim, this time with prejudice. In re JP M organ Chase Sec. Litig., No. 02 Civ. 1282, 2007 WL 950132, at *15 (S.D.N.Y. Mar. 29, 2007) ("JP Morgan Chase II"). Plaintiffs now appeal the district court's dismissal. Our jurisdiction arises under 28 U.S.C. § 1291, and we affirm.
The facts preceding this appeal, including the precise nature of the allegations contained in the first and second amended complaints, have been exhaustively set forth in the district court's opinions below. See JP M organ Chase I, 363 F. Supp. 2d at 602-14; JP M organ Chase II, 2007 WL 950132, at *1-10. Therefore, we will set forth only a brief recitation of the factual background to this appeal. Because this case presents an appeal from a Fed. R. Civ. P. 12(b)(6) dismissal, the factual allegations in the complaint must be accepted as true. In re Carter-Wallace, Inc., Sec. Litig., 220 F.3d 36, 38 (2d Cir. 2000).
A. The First Amended Complaint
In their FAC, Plaintiffs alleged that JPMC*fn2 and two of its officers, William Harrison, Jr., and Marc J. Shapiro, defrauded JPM C shareholders by making deliberate misrepresentations that artificially inflated the price of JPM C stock and ultimately led to a collapse of JPMC's share price. JP Morgan Chase I, 363 F. Supp. 2d at 601-03. Plaintiffs alleged that JPM C created disguised loans for Enron and concealed the nature of these transactions by making false statements or omissions of material fact in its accounting and Securities and Exchange Commission (SEC) filings. Id. According to the complaint, JPM C created "Special Purpose Entities," among them an entity called Mahonia Ltd., to facilitate disguised loan transactions with Enron Corporation. Id. at 602-04; FAC ¶¶ 42, 58-61. Allegedly, the creation of Mahonia enabled Enron to conceal its debt from investors because Enron could report the cash flow from JPM C through Mahonia to Enron as revenue from prepaid commodity trades rather than as loan proceeds. JP Morgan Chase I, 363 F. Supp. 2d at 604; FAC ¶¶ 61, 67-69.
Essentially, Mahonia borrowed money from JPM Chase and used that money to buy gas from Enron; Mahonia would then satisfy its debt to JPM Chase by providing the gas to JPM Chase, which would resell the gas at a fixed future price back to Enron. In reality . . . neither the physical commodity nor title to it were ever intended to be transferred.
JP Morgan Chase I, 363 F. Supp. 2d at 604; see also FAC ¶¶ 71-74. According to the complaint, the commodity transactions lacked economic substance; while a financially settled commodity swap would eliminate any price risk, the economic reality is that the transactions were loans. FAC ¶¶ 73-74. Furthermore, JPMC cooperated with Enron in these deceptive practices by mischaracterizing the transactions on its financial statements as trading assets rather than as loans. JP Morgan Chase I, 363 F. Supp. 2d at 604-05; FAC ¶¶ 77-80. In return, JPMC earned exorbitant fees. JP M organ Chase I, 363 F. Supp. 2d at 602; FAC ¶¶ 49-50, 55. Moreover, the complaint alleged that JPMC repeatedly assured investors that it maintained high standards of integrity and credit-risk management throughout the period during which it engaged in transactions with Enron. JP Morgan Chase I, 363 F. Supp. 2d at 608-09, 612; FAC ¶¶ 153-57, 161-62, 168-73. Following the collapse of Enron, however, the Senate investigated JPMC's role in Enron's fraudulent practices and concluded that JPMC had knowingly engaged in and actively assisted Enron in its sham transactions; the resulting disclosures caused JPMC's stock to suffer significant losses. JP Morgan Chase I, 363 F. Supp. 2d at 608, 613-14; FAC ¶¶ 22, 357-72.
In sum, the FAC alleged that JPM C defrauded its shareholders by, inter alia, downplaying its Enron-related exposure, failing to disclose alleged violations of law in connection with the Mahonia and other transactions, falsely portraying itself as a low-risk company with a reputation for fiscal discipline and integrity, and improperly accounting for the Mahonia prepays as viable trades rather than as impaired loans on its financial statements (thereby failing to disclose the credit risk). See JP M organ Chase II, 2007 WL 950132, at *2.
The district court evaluated the allegations in light of the heightened pleading standard under Fed. R. Civ. P. 9(b) and the Private Securities Litigation Reform Act (PSLRA) and found that the FAC failed to plead with the requisite particularity that JPM C made a materially false statement or omitted a material fact, with scienter. JP M organ Chase I, 363 F. Supp. 2d at 619-34. First, the court found that Plaintiffs had failed to allege scienter with any of the allegations, except the alleged improper accounting of the Mahonia transactions as trades rather than loans.*fn3 Id.; see JP Morgan Chase II, 2007 WL 950132, at *3-5.
However, the court found that the allegedly improper accounting of the Mahonia transactions as trades rather than loans was not material. JP M organ Chase I, 363 F. Supp. 2d at 630-31; see JP Morgan Chase II, 2007 WL 950132, at *5. Accordingly, the court held that the FAC failed to state a claim pursuant to section 10(b) of the Securities and Exchange Act of 1934 (Exchange Act), 15 U.S.C. § 78j. JP M organ Chase I, 363 F. Supp. 2d at 634. The court also dismissed Plaintiffs' other claims for relief, which included claims under section 15 of the Securities Act of 1933 (Securities Act), 15 U.S.C. § 77o; section 11 of the Securities Act, 15 U.S.C. § 77k; and section 14(a) of the Exchange Act, 15 U.S.C. § 78n(a). Id. at 635-36. Because the district court dismissed the claims without prejudice, Plaintiffs were permitted to file the SAC.
B. The Second Amended Complaint
As the district court noted in JP M organ Chase II, the SAC consisted mostly of the same allegations present in the FAC, with three general exceptions. The SAC made new allegations relating to (1) JPMC's alleged downplaying of its Enron-related exposure, (2) JPM C's alleged misrepresentation of its integrity and risk management, and (3) the allegedly faulty reporting of the Mahonia transactions. JP M organ Chase II, 2007 WL 950132, at *6. The latter two are of the most importance here.
The SAC included new material on Plaintiffs' allegation that JPM C had misrepresented its integrity. The SAC pointed to charges in the SEC's civil lawsuit against JPMC accusing JPMC of aiding and abetting Enron, to Senate hearings where JPMC was accused of "actively assist[ing] Enron," and to JPMC's underwriting of securities issued by WorldCom, see generally In re WorldCom, Inc., Sec. Litig., 294 F. Supp. 2d 392, 399-400, 403-404 (S.D.N.Y. 2003), to show that JPM C, in fact, lacked integrity and did not conduct adequate due diligence as claimed in its statements on sound risk management. Id. at *7; SAC ¶¶ 636-39, 587-604, 188-240. The district court again dismissed Plaintiffs' allegations regarding JPM C's statements on its integrity and risk management strategy as mere "puffery." JP Morgan Chase II, 2007 WL 950132, at *12. The district court noted that even if these statements were not puffery, they would not be material.
Id. Finally, the district court added that the SAC's new focus on the SEC investigation, the Senate testimony, and the WorldCom evidence was misguided because those statements pertained to misleading Enron ...