The United States District Court for the Southern District of Florida last week dismissed with prejudice a federal securities class action complaint against Merrill Lynch & Co., Inc., (“Merrill Lynch”) and other investment banks due to the plaintiffs’ failure to plead adequately any element of securities fraud. Cordova v. Lehman Brothers, Inc., Case No. 05-21169-CIV-MOORE, --- F.Supp.2d ----, 2007 WL 4287729 (S.D. Fla. Dec. 7, 2007). Sutherland Asbill & Brennan LLP represented Merrill Lynch in this case and in the related case Instituto de Prevision Militar v. Merrill Lynch & Co., Inc., Case No. 05-22721-CIV-MOORE, 2007 WL 2900318 (S.D. Fla. Sept. 28, 2007), which was recently dismissed for similar reasons.1
Plaintiffs’ proposed class consisted of persons and entities, principally residents of Latin America, who invested in allegedly fraudulent retirement trust accounts offered by Pension Fund of America (“PFA”). PFA marketed its products by highlighting the involvement of investment banks as custodians or trustees of investor funds. Plaintiffs sued investment banks that held PFA funds, alleging state law claims that the district court rejected as pre-empted by the federal securities laws. Ultimately, in its third complaint, Plaintiffs contended that the investment banks had violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 of the Rules and Regulations under the 1934 Act. In its recent order, the court dismissed these claims with prejudice, ruling that Plaintiffs had not pleaded adequately the elements of a claim under Section 10(b) and Rule 10b-5—a material misrepresentation or omission, scienter, reliance, and loss causation.
The court rejected Plaintiffs’ allegations of misrepresentations, holding that the alleged activity constituted nothing more than a prohibited aiding and abetting claim under Central Bank of Denver v. First Interstate Bank, 511 U.S. 164 (1994), and the Eleventh Circuit’s subsequent decision in Ziemba v. Cascade International, Inc., 256 F.3d 1194 (11th Cir. 2001). Allegations that the investment banks allowed or permitted PFA to commit fraudulent acts; allowed PFA to use marketing materials or the investment bank’s name or logo; assisted PFA in marketing the retirement trusts; and were aware, had knowledge, or assisted in PFA’s fraudulent activities demonstrated that PFA, not the investment banks, masterminded, perpetrated, and benefited from the frauds. Cordova, Slip op. at 7.
The court rejected Plaintiffs’ argument that the investment banks should be held liable for permitting PFA to use their names and logos in its marketing materials, opining that such a rule would mean that any time one company’s name was listed on another’s solicitation materials, the first company could be held to have vouched for and, therefore, could be held responsible for the business practices of the other company. “Adopting such a rule would too broadly expand liability and would require the court to find misstatements by implication, rather than to analyze the specific wording of statements actually made.” Id. at 8.
The court concluded that allegations that “lump” multiple defendants together, use the passive voice to describe alleged misrepresentations or fraudulent acts in an attempt to broaden responsibility, and do not identify the who, what, when, and where of alleged misrepresentations fail to satisfy the requirement of pleading fraud with particularity set out in Federal Rule of Civil Procedure 9(b). Rejecting undefined allegations that the investment banks “tout[ed] the safety of investing through them,” the court noted that “[g]eneral flowery advertising language … is not generally actionable as a securities fraud.” Id. at 13.
The court similarly rejected Plaintiffs’ omissions claim, because it held that the investment banks did not have a duty to disclose. In so holding, the court noted that Plaintiffs and the investment banks did not have a formal relationship, and thus were not alleged to have the sort of relationship that would give rise to a fiduciary responsibility to disclose. Absent “substantial evidence showing some dependency by one party and some undertaking by the other party to advise, counsel, and protect the weaker party,” there is no fiduciary duty and no duty to disclose. Id. at 20.
The court held that Plaintiffs’ allegations of scienter were deficient and did not show that the investment banks had intentionally or with severe recklessness involved themselves in PFA’s fraud. The court applied the Supreme Court’s recent decision in Tellabs, Inc. v. Makor Issues & Rights, Ltd., holding that Plaintiffs are required to plead facts giving rise to an inference of scienter that is not merely plausible, but “at least as compelling as any opposing inference of nonfraudulent intent.” 127 S. Ct. 2499, 2504-05 (2007). The Cordova court opined that “it would be reasonable to infer that PFA also misled [the investment banks] and that [the investment banks] might have had a business relationship without knowing of PFA’s fraud.” Cordova, Slip op. at 22. In so holding, the court found it notable that the Securities and Exchange Commission concluded, after a thorough investigation, that the investment banks had not intentionally involved themselves in PFA’s fraud.
As an alternative basis for dismissal, the court held that Plaintiffs’ claims are barred by the statute of limitations, which requires that claims be brought within the “earlier of … two years after discovery of the facts constituting the violations; or five years after such violation.” 28 U.S.C. § 1658(b). The court found sufficient basis to conclude that Plaintiffs had received notice of the facts constituting the violations more than two years prior to filing the lawsuit based on the fact that one of the class representatives had filed a lawsuit against PFA and two of the Defendants. Acknowledging that “whether a plaintiff had sufficient facts to place him on inquiry notice of a claim for securities fraud is a question of fact, and as such is often inappropriate for resolution on a motion to dismiss under Rule 12(b)(6),” Cordova, Slip op. at 28, the court held that “where notice can be shown from the pleadings in an earlier case, filed by a class representative, notice is established as a matter of law and no further discovery or fact finding is necessary.” Id. at 29. “[O]nce a party is on notice of a fraudulent scheme, that notice encompasses inquiry into the scope of the scheme and the role of parties whose actions may have contributed to the functioning of the scheme.” Id.