On August 19, 2010, District Court Judge Thomas Thrash of the Northern District of Georgia dismissed a putative class action filed against SunTrust and certain of its officers and directors based on the plaintiff’s failure to plead multiple required elements of a securities fraud claim. Waterford Township Gen. Employees Ret. Sys. v. SunTrust, Inc., No. 1:09-CV-617-TWT, 2010 WL 3368922 (N.D. Ga. Aug. 19, 2010). Plaintiff’s central theory in the amended complaint was that SunTrust misled investors by classifying many of its nonperforming loans as “in process” loans during the second and third quarters of 2008 in order to make the company’s financial results look more attractive. Id. at *1. According to the plaintiff, SunTrust’s stock price declined significantly when SunTrust was forced to re-classify those loans in the fourth quarter of 2008 and report a sharp increase in the number of nonperforming loans. Id. Judge Thrash, in a strongly worded and well-reasoned opinion, rejected plaintiff’s claims on several fronts, which will be addressed in turn.
Pleading Material Misrepresentations:
The court first held that the plaintiff failed to plead an actionable misrepresentation. The amended complaint described two types of alleged misrepresentations. First, plaintiff alleged that the defendants deliberately hid “half a billion dollars of nonperforming loans.” Id. at *2. This allegation, however, lacked any factual support. According to the court, the half-a-billion-dollar figure “seem[ed] to be plucked out of thin air.” Id. The court observed that any suggestion of intentional conduct was also belied by the fact that SunTrust’s average balance for nonperforming loans continually increased from the beginning of each quarter to the end of the quarter over the course of the class period. This increasing balance each quarter was “entirely consistent with the continuing deterioration of SunTrust’s loan portfolio over the course of the financial crisis.” Id. On the other hand, this continued deterioration was “entirely inconsistent with Plaintiff’s theory of large scale misclassification of nonperforming loans at the end of each quarter.” Id.
The second type of alleged misrepresentation involved alleged GAAP violations stemming from supposedly inadequate reserves for nonperforming loans. The court held, however, that the mere fact that SunTrust ultimately had to increase its reserves for nonperforming loans was not indicative of fraud. Indeed, SunTrust had not been required to restate its financial reports from the first three quarters in 2008. For these reasons, the court concluded that “[l]ife is too short to say more about this."
Plaintiff attempted to demonstrate a strong inference of scienter in several ways. First, it contended that the individual defendants intentionally directed others to misclassify loans. As support for this theory, the plaintiff offered testimony from a confidential witness. The court, however, rejected this testimony on the basis that the amended complaint failed to provide “any basis for the witness’ knowledge about SunTrust’s 2008 loan classification practices.” Id. at *3.
The court also rejected plaintiff’s attempt to plead that defendants recklessly overlooked internal reports demonstrating the improper classification of nonperforming loans. Id. The court held that the mere “access to information, even when accompanied by a duty to monitor the information, is not enough to create a strong inference of scienter.” Id. The court further rejected plaintiff’s allegations that defendants were motivated to improperly classify non-performing loans because, for example, there were no allegations of personal profit-taking in the form of insider stock sales. Id. at *4.
Pleading Loss Causation:
The court’s loss causation analysis is particularly interesting given its potential application to suits against other companies similarly hurt by the recent financial crisis. The court rejected plaintiff’s loss causation argument, holding that the loss at issue was likely caused by the “financial crisis that hit the financial services industry particularly hard.” Id. at *5. This conclusion was based on two factors. First, SunTrust’s stock had already lost most of its value prior to the first alleged corrective disclosure on June 21, 2009. Id. Second, the court found it persuasive that “other banks suffered similar losses on January 22, 2009.” Id. Because the plaintiff could not plead facts sufficient to indicate that SunTrust’s misstatements – rather than general market conditions – caused its loss, the amended complaint failed to plead loss causation.