In early January 2011, Judge Paul A. Crotty of the District Court for the Southern District of New York dismissed with prejudice a federal securities class action against Barclays, several of Barclays’ senior officers and a dozen other investment banks. The court rejected plaintiffs’ claims that Barclays had not adequately disclosed and accounted for its exposure to mortgage-backed securities; the court concluded that plaintiffs had erred by failing to plead that Barclays subjectively believed that its valuations of its MBS assets were false. Even though the plaintiffs had not asserted fraud claims, the court’s ruling effectively requires allegations of scienter when plaintiffs premise claims under sections 11 and 12 of the Securities Act on statements of opinion. In re Barclays Bank PLC Securities Litigation, No. 09 Civ. 1989 (S.D.N.Y. Jan. 5, 2011).
The case involved four separate offerings of Barclays American Depositary Shares (ADS) sold between April 2006 and September 2008. Each was accompanied by a prospectus and other offering materials. During this period, Barclays made additional disclosures in November 2007, February 2008 and June 2008 regarding its overall exposure to the US subprime and credit markets and announcing significant writedowns of its mortgage-backed asset holdings.
The lead plaintiffs, purported investors in the ADS, filed suit in March 2009, bringing claims under Sections 11, 12(a)(2) and 15 of the Securities Act of 1933. The central allegation to all of the claims was that the offering materials for the ADS transactions contained materially false and misleading statements. However, in an effort to avoid the strict federal pleading requirements for fraud claims, the complaint “expressly exclude[d] and disclaim[ed] any allegation that could be construed as alleging fraud or intentional or reckless misconduct,” limiting its theories of relief to negligence and strict liability. Plaintiffs specifically charged Barclays with (i) failing to adequately disclose and write down its mortgage-backed asset holdings; (ii) violating applicable accounting and reporting regulations; and (iii) concealing the actual risks of the ADS by overstating the efficacy of its risk-management procedures.
In dismissing plaintiffs’ claims, Judge Crotty relied on the Southern District’s 2010 decision in Fait v. Regions Financial Corporation, in which the court had dismissed Section 11 and 12 claims regarding financial statement valuations of goodwill and loan loss reserves. Finding that such valuations constituted statements of opinion, the Fait court had concluded that under the Supreme Court’s opinion in Virginia Bankshares v. Sandberg, 501 U.S. 1083 (1991), such statements were “actionable under Section 11 or 12 only if the complaint alleges that the speaker did not truly hold the opinion at the time it was issued.” (For more information, see our May 12, 2010 Legal Update, “Subjective Falsity Required For Section 11 and 12 Claims Based On Goodwill and Loan Loss Reserve Valuations.”)
Extending that reasoning, Judge Crotty held that valuations of securities based on financial models, rather than on actual trading prices in an active and efficient market, also constituted subjective opinions that were not actionable under Sections 11 and 12 unless the complaint alleged that Barclays actually believed those valuations were false at the time of the ADS offerings. Because plaintiffs had failed to make such allegations, those claims failed.
Judge Crotty identified numerous additional pleading defects, holding that contrary to the complaint, Sections 11 and 12 did not require Barclays to itemize its mortgage-backed securities holdings into separate categories, that plaintiffs had failed to describe how Barclays had violated any accounting or reporting standards and that Barclays’ description in its offering materials of its risk-management procedures was “precisely the sort of non-actionable statement that is too general for a reasonable investor to rely upon.” Because plaintiffs’ Section 15 claims were dependent on the existence of a Section 11 or 12 violation, the court dismissed those claims as well.
Judge Crotty also concluded that the majority of plaintiffs’ claims were untimely, finding that “a reasonably diligent investor would have noticed the alleged discrepancy in Barclays’ disclosures” following the November 2007 and February 2008 writedowns. As a result, the lead plaintiffs were on “inquiry notice” as of those dates, and the one-year statute of limitations for their claims had expired well before they filed suit. Judge Crotty agreed with defendants that Merck Co. v. Reynolds, 130 S. Ct. 1784 (2010), which held that inquiry notice was not sufficient to start the running of the limitations period on private securities fraud actions under Section 10(b) of the Securities Exchange Act of 1934, did not apply to plaintiffs’ claims. (For more information, see our April 28, 2010 Legal Update, “US Supreme Court Releases Opinion in Merck & Co. v. Reynolds.”)
By requiring an allegation of scienter, the decisions in In re Barclays and Fait pose significant obstacles to plaintiffs seeking to circumvent the heightened pleading standards for Section 10(b) securities fraud claims. In re Barclays also joins a line of decisions out of the Southern District and Second Circuit that impose a strict definition of inquiry notice calling for a high degree of vigilance from investors.