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Kuriakose v. Federal Home Loan Mortg. Corp.

United States District Court, S.D. New York

September 24, 2012

Jino KURIAKOSE, Individually and on Behalf of All Others Similarly Situated, Plaintiff,
FEDERAL HOME LOAN MORTGAGE CORP., Richard Syron, Patricia L. Cook, and Anthony S. Piszel, Defendants.

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Robbins Geller Rudman & Dowd LLP, by: Paul J. Geller, Esq., David J. George, Esq., Robert T. Robbins, Esq., Samuel H. Rudman, Esq., Darryl J. Alvarado, Esq., for Lead Plaintiff Central States, Southeast and Southwest Areas Pension Fund.

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O'Donoghue & O'Donoghue LLP, by: Louis P. Malone III, Esq., for Plaintiff National Elevator Industry Pension Plan.

Bingham McCutchen LLP, by: Jordan D. Hershman, Esq., Jason D. Frank, Esq., Kenneth I. Schacter, Esq., Federal Home Loan Mortgage Corporation, by: Hyacinth Kucik, Esq., Lance J. Wolf, Esq., Howard Lindenberg, Esq., for Defendants Federal Home Loan Mortgage Corporation.

Murphy & McGonigle, P.C., by: James K. Goldfarb, Esq., Jonathan S. Bashi, Esq., Jerry Isenberg, Esq., William Donnelly, Esq., for Defendant Anthony S. Piszel.


JOHN F. KEENAN, District Judge:

Lead Plaintiff Central States, Southeast and Southwest Areas Pension Fund and Plaintiff National Elevator Industry Pension Plan (collectively, " Plaintiffs" ) bring this putative securities fraud class action suit against the Federal Home Loan Mortgage Corporation (" Freddie Mac" ), former Freddie Mac Chief Executive Officer Richard Syron (" Syron" ), former Freddie Mac Chief Financial Officer Anthony Piszel (" Piszel" ), and former Chief Business Officer Patricia Cook (" Cook" ) (collectively, " Individual Defendants" ). Plaintiffs allege that Freddie Mac and the Individual Defendants violated Section 10(b) of the Securities Exchange Act of 1934 (" '34 Act" ), 15 U.S.C. § 78j(b), and Securities and Exchange Commission Rule 10b-5, 17 C.F.R. § 240.10b-5. Furthermore, Plaintiffs allege that the Individual Defendants are " controlling persons" liable under Section 20(a) of the '34 Act, 15 U.S.C. § 78t, for Freddie Mac's alleged violations of the '34 Act and Rule 10b-5.

Currently before the Court are three motions: (1) Freddie Mac and the Individual Defendants' motion to dismiss with prejudice the Second Amended Complaint under Rules 9(b) and 12(b)(6) of the Federal Rules of Civil Procedure and under Sections 101(b) and 102(b) of the Private Securities Litigation Reform Act of 1995 (" PSLRA" ), 15 U.S.C. §§ 78u-4(b), 78u-5(c); (2) Plaintiffs' motion for leave to file a third amended consolidated complaint; and (3) Plaintiffs' renewed motion to partially lift the PSLRA discovery stay. For the reasons that follow, Defendants' motion to dismiss is granted, Plaintiffs' motion to amend is denied, and Plaintiffs' renewed motion to lift the PSLRA discovery stay is denied as moot.

I. Background

The Court presumes familiarity with the allegations made in Plaintiffs' First Amended Class Action Complaint (" FAC" ) and the procedural history of this litigation prior to the entry of its last Opinion. See Kuriakose v. Federal Home Loan Mortg. Corp., 2011 WL 1158028 (S.D.N.Y. Mar. 30, 2011) (hereinafter " Op." ). Briefly stated, Plaintiffs represent a putative class consisting of all those who purchased Freddie Mac equity securities from November 20, 2007, through September 7, 2008 (" the Class Period" ). Plaintiffs claim that following Freddie Mac's disclosure of a $2 billion loss for the third quarter of 2007 on November 20, 2007, Freddie Mac and the Individual Defendants materially misrepresented Freddie Mac's exposure to risky, or " subprime," mortgage products, the sufficiency of its capital, and the accuracy of its financial reporting. According to Plaintiffs, these misrepresentations resulted in inflated share prices of its common and preferred shares, which declined as " the truth regarding Freddie Mac's true financial circumstances leaked out through a series of partial disclosures, and Defendants' prior misrepresentations and fraudulent

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conduct became apparent to the market." Op. at 3.

A. Dismissal of the FAC

In dismissing the FAC, the Court held that Plaintiffs failed to plead (1) materiality with respect to the extent of Freddie Mac's exposure to non-prime, or subprime, mortgage loans; (2) scienter with respect to the allegation that Freddie Mac misstated its capital adequacy; and (3) loss causation with respect to alleged misrepresentations about Freddie Mac's internal controls and alleged violations of generally accepted accounting principles (" GAAP" ). Since each of these elements is required to withstand a motion to dismiss, the Court dismissed the FAC.

Regarding Freddie Mac's statements about its subprime exposure, the Court found that Plaintiffs failed to establish materiality with respect to their allegations that Defendants misrepresented Freddie Mac's exposure to the subprime market. The Court further held that Plaintiffs did not explain why any of Freddie Mac's alleged misrepresentations were actually false, in light of the amount of information that Freddie Mac disclosed to investors during the Class Period. Specifically, the Court stated that the public was sufficiently made aware of the extent of Freddie Mac's exposure to " non-conforming" mortgages, and without an industry standard definition of the term " subprime," Freddie Mac's statements were not false or misleading. Op. at 26 (" Plaintiffs present no theory at all about why Freddie Mac's disclosures would not be understood by the reasonable investor and thus part of the ‘ total mix’ of information that determined its share price." ). The Court determined that Plaintiffs' allegations did not give rise to the inference that Freddie Mac and its executives made fraudulent accounting decisions in violation of GAAP. Op. at 30.

Next, in holding that Plaintiffs did not adequately plead scienter, the Court found that the alleged misstatements were " forward-looking" and thus not actionable. The Court further noted that the fact that Freddie Mac was placed in a conservatorship does not give rise to an inference of scienter, given the stress placed on Freddie Mac's financial position by the volatility of the financial market during the Class Period. Op. at 27-29 (" Plaintiffs have not adequately pleaded sufficient facts giving rise to a strong inference that Freddie Mac's statements about its capital adequacy or its hope that it would continue to function were made with intent to defraud or without factual basis." ).

The Court's holding with respect to loss causation addressed Plaintiffs' allegations of Freddie Mac's violations of GAAP, as well as statements about the company's internal controls. The Court concluded that Plaintiffs alleged no causal connection between Freddie Mac's alleged misconduct and any loss suffered by purchasers of its equity securities during the Class Period. Op. at 33 (" [N]one of the ‘ partial’ disclosures alleged to have been made between July through September 2008 is alleged to have revealed new information about the failings of Freddie Mac's internal controls or underwriting standards." ).

B. Second Amended Complaint

On July 18, 2011, Plaintiffs filed the Second Amended Class Action Complaint (" SAC" ), which is 136 pages (153 pages shorter than the FAC) and 342 paragraphs (256 paragraphs shorter than the FAC). The SAC asserts new factual allegations, largely based on an internal memorandum from the acting deputy director at Freddie Mac's regulator, the Federal Housing Finance Agency (" FHFA" ) to the Director of the FHFA (the " FHFA Memo" ). In its memorandum opposing Defendants' motion

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to dismiss the SAC (" Pl. SAC Opp." [1]), Plaintiffs herald the FHFA Memo as the " centerpiece of the SAC," because it " provide[s] a damning assessment of the current state of Freddie's business during the Class Period and justified the Agency's need to place Freddie into a conservatorship." Pl. SAC Opp. at 14. According to Plaintiffs, " this document details ‘ pervasive and ongoing problems and deficiencies' caused by Defendants ‘ unsafe and unsound practices.’ " Id. (quoting FHFA Memo at 2, 28).

C. Proposed Third Amended Complaint

Subsequent to filing the SAC, on December 13, 2011, Freddie Mac entered into a Non-Prosecution Agreement with the Securities and Exchange Commission (" SEC" ). Plaintiffs now seek to file a Third Amended Class Action Complaint (" TAC" ), which is 29 pages and 65 paragraphs longer than the SAC. It includes a host of additional allegations based upon the Statement of Facts contained in the Non-Prosecution Agreement. TAC Exh. C (full text of the SEC Non-Prosecution Agreement). Plaintiffs aver that, through the Agreement, " Freddie Mac agreed to a detailed accounting of the events that clearly establish the falsity of Freddie Mac's subprime exposure during the Class Period." Pl. Mot. to Amend at 3.

II. Discussion

A. Legal Standard

To state a claim under Section 10(b) and Rule 10b-5 for fraudulent misrepresentations, plaintiffs must allege that defendants " (1) made misstatements or omissions of material fact; (2) with scienter; (3) in connection with the purchase or sale of securities; (4) upon which plaintiffs relied; and (5) that plaintiffs' reliance was the proximate cause of their injury." Lentell v. Merrill Lynch & Co., Inc., 396 F.3d 161, 172 (2d Cir.), cert. denied, 546 U.S. 935, 126 S.Ct. 421, 163 L.Ed.2d 321 (2005).

As it did in reviewing Defendants' motion to dismiss the FAC, the Court treats all factual allegations in the SAC as true and draws all reasonable inferences in Plaintiffs' favor. See Ganino v. Citizens Util. Co., 228 F.3d 154, 161 (2d Cir.2000); Lee v. Bankers Trust Co., 166 F.3d 540 (2d Cir.1999). " Dismissal is proper ‘ only if it is clear that no relief could be granted under any set of facts that could be proved consistent with the allegations.’ " In re Scholastic Corp. Sec. Litig., 252 F.3d 63, 69 (2d Cir.2001) (quoting Hishon v. King & Spalding, 467 U.S. 69, 73, 104 S.Ct. 2229, 81 L.Ed.2d 59 (1984)). Because the SAC charges securities fraud, Plaintiffs must satisfy the heightened pleading requirements of Federal Rule of Civil Procedure 9(b) and the PSLRA, 15 U.S.C. § 78u-4. See Kalnit v. Eichler, 264 F.3d 131, 138 (2d Cir.2001). Thus, " [t]he complaint must ...

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