Judge Andrew Guilford of the United States District Court of the Central District of California has issued a decision that should resonate deeply with the many lenders facing securities fraud claims arising from the current mortgage collapse. Pittleman v. Impac Mortgage Holdings, Inc., 2009 U.S. Dist. LEXIS 18213 (C.D. Cal. March 9, 2009). The decision dismisses with prejudice a securities class action against a mortgage lender and two of its chief executives based on plaintiffs’ failure to adequately plead scienter.
Plaintiffs framed the case as a classic “race-to-the bottom,” where Impac and its CEO and COO allegedly knowingly disregarded basic loan quality and underwriting standards in order to originate more loans. Id. at *10. Impac is a publicly traded mortgage lender that specializes in “Alt-A” loans, which the court described as “more stable than sub-prime loans but . . . not eligible for sale to prime lenders.” 2009 U.S. Dist. LEXIS at *2. Plaintiffs were investors who lost money in the company as it struggled against the current economic downturn. Id.
Plaintiffs brought claims under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. They based their allegations of fraudulent intent or “scienter” entirely on statements supposedly made by five unnamed former employees. Id. at *3-*4, *6. The court rejected these statements as being “too vague to plead a strong inference of scienter” as required under the Private Securities Litigation Reform Act (“PSLRA”), whether the statements were considered individually or in their “totality” as required under the Supreme Court’s decision in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 127 S.Ct. 2499, 2504-05 (2007).
The statements from these anonymous informants included the following:
- A statement that the CEO’s and CFO’s actions were “in violation of standard due diligence procedures,” which the court rejected because it did not identify the specific actions or due diligence procedures. Id. at *7.
- A statement that “when bulk loan pools did not satisfy [Impac]’s guidelines, they were still approved by management on a regular basis,” which the Court rejected because it did not identify the particular loan pools or why they did not satisfy Impac’s guidelines. Id.
- Statements that one of Impac’s divisions “had so many bad loans (loans that did not comply with [Impac] underwriting guidelines) that the division was closed and the loans were securitized and sold to investors,” and that there was “significant pressure” to approve one loan pool, the purchase of another that “did not meet underwriting guidelines,” and that certain companies were “notorious for selling bulk loan pools to Impac.” Id. at *8. The court held all of these statements were “too vague.” Id.
- A statement that one employee “left the Company out of frustration because he said a majority of loans that were being recommended for rejection were regularly approved for sale to investors,” which the court rejected because it did not identify which loans were recommended for rejection, why, or who approved them for sale. Id.
- Statements that another employee had “disagreements regarding the loan approval process on a regular basis” and that he “saw it all the time where we’d deny [a loan] and then say, yeah, we could do this,” which the court rejected because they did not specify the disagreements or loans. Id.
The court characterized all of these statements as “exactly the sorts of vague, conclusory allegations” that “[t]he PLSRA was intended to guard against.” Id. at *11.
The court also rejected the notion that these statements together could give rise to a “core operations inference” of scienter. Plaintiffs argued that they had alleged “facts critical to a business’ core operations or an important transaction [that were] so apparent that their knowledge may be attributed to the company and its key officers.” Id. at *9 (quoting South Ferry LP #2 v. Killinger, 542 F.3d 776, 783 (9th Cir. 2009)). This inference, the court explained, applied only in “exceedingly rare cases,” where the event was so prominent that it would be “absurd” to suggest the company’s key officers lacked knowledge. Id. Plaintiffs’ “vague allegations of violations” did not qualify. Id.
In dismissing the plaintiffs’ third amended complaint with prejudice, the court concluded by offering this simple but elegant reflection on the failings inherent in the complaint:
Plaintiff argues that this case is about “a staggering race-to-the-bottom of loan quality and underwriting standards as part of an effort to originate more loans for sale through secondary market transactions.” The Court disagrees. This case is about a company involved in a volatile industry at the onset of a long, destructive economic downturn.
Id. at *10 (internal citations omitted). This viewpoint should resonate deeply with the many other defendants seeking to strike a similar chord in near-identical securities fraud cases currently pending across the country.