Court Holds Allegations in Securities Class Action Fail to Meet Heightened Pleadings Requirements Mandated by FRCP Rule 9(b) and the PSLRA (Private Securities Litigation Reform Act of 1995), and Denies Plaintiffs Request To Rule on its Year-Old Remand Motion as Untimely
Plaintiff investors filed separate putative class actions against New York Community Bancorp (NYCB) and several of its officers alleging violations of federal securities laws by making materially false and misleading statements to investors. In re New York Community Bancorp, Inc., Securities Litig., 448 F.Supp.2d 466, 469 (E.D.N.Y. 2006). The federal court eventually consolidated 11 such class action lawsuits, and appointed lead plaintiff and lead counsel. Following the filing of a Consolidated and Amended Class Action Complaint, defense attorneys filed a motion to dismiss and certain plaintiffs filed a motion for reconsideration of the consolidation order. Id. The district court denied the motion for reconsideration and granted the defense motion to dismiss.
The amended class action complaint alleged violations of the Securities and Exchange Act of 1934 (“Exchange Act”) and the Securities Act of 1933 (“Securities Act”) on behalf of NYCB shareholders. In re New York Comm. Bancorp, at 469. NYCB went through a period of substantial earnings growth and acquired several financial institutions, building “a unique and profitable core lending business comprised of multi-family mortgage loans.” Id., at 470. Over time, however, market conditions changed and NYCB expanded into a ” risky, but common, leveraging strategy involving mortgage-backed securities known as the ‘carry trade.'” Id. The complaint alleged that NYCB diverted increasingly large sums away from conservative investments and to carry trade investments, but continually held itself out as a risk-adverse, conservative community bank. Id., at 471. The court summarized the material allegations of the complaint as follows: “In particular, the Plaintiffs allege that the Defendants: (1) falsely represented that NYCB was uniquely able to thrive in an environment of rising interest rates and that its business prospects remained strong; (2) highlighted a false strategy of deleveraging following the acquisition of Roslyn; and (3) failed to adequately disclose the extent of the risks of the carry trade activity.” Id.
The court first addressed the motion for reconsideration, which additionally sought to reinstate a motion that the plaintiffs had filed more than a year earlier to remand to state court one of the class action lawsuits. In re New York Comm. Bancorp, at 474. Plaintiffs had filed their class action in state court, and the defense removed the lawsuit to federal court. Plaintiffs filed a motion to remand arguing that the Securities Litigation Uniform Standards Act of 1998 (SLUSA) prohibits removal of cases based exclusively on the Securities Act. When the federal court consolidated the 11 securities class actions, it did not specifically address the remand motion but the practical effect of the court’s ruling was to deny the motion. Id., at 475. In evaluating the plaintiffs’ motion, the district court concluded that even though claim of improper removal appears to have merit, id., the fact remained that plaintiffs’ motion was too late, id., at 475-76.
With respect to the defense motion to dismiss, the court assiduously applied the requirements of FRCP Rule 9(b), requiring that fraud be pleaded with specificity, and the scienter requirements imposed by the Private Securities Litigation Reform Act of 1995 (PSLRA). In re New York Comm. Bancorp, at 476. The court then concluded that the allegedly misleading statements concerning its risk-adverse, conservative investments were not material facts but rather “generalizations regarding integrity, fiscal discipline, and risk management, that amount to no more than inactionable puffery.” Id., at 478-79 (citations omitted). At bottom, “‘An investor may not justifiably rely on a misrepresentation if, through minimal diligence, the investor should have discovered the truth.'” Id., at 479 (citations omitted). Here, NYCB’s quarterly reports clearly disclosed the level of its investments in mortgage-backed securities. Id., at 479-81. Similarly, the court agreed with defense attorneys that NYCB’s disclosures concerning its deleveraging strategy were consistent with its actual investment conduct, id., at 481-83. “‘Plaintiffs cannot now claim they were unaware of the “real” investment plan when that plan was based on disclosed facts.'” Id., at 482 (citation omitted). And finally, the court agreed with the defense that statements concerning the financial performance of customer deposits were not misstatements because NYCB’s public disclosures accurately revealed, “in precise detail,” the performance of those deposits. Id., at 483. Because plaintiffs had not met the heightened burdens under Rule 9(b) and the PSLRA for pleadings violations of the federal securities laws, the court granted the defense motion to dismiss. Id., at 484.
NOTE: For those unfamiliar with the banking industry, the federal court explained the “carry trade” and the risks associated with it at pages 470 and 471 as follows:
The carry trade involves financing or “carrying” the purchase of mortgage-backed securities with funds borrowed through repurchase agreements from the money market. This strategy attempts to take advantage of the differences between the rates of repurchase agreements, which have lower short-term interest rates, and the mortgage-backed securities, which have higher long-term interest rates. A comparison of the differences between the rates is called the “yield curve.” Relying on this mismatch of interest rates can produce significant gains when the yield curve is steep, that is, when the spread between long-term and short-term interest rates is wide. This investment strategy was, according to the Complaint, allegedly utilized by NYCB to offset the undisclosed limited growth in its core lending business.
However, the carry trade has its risks. If the yield curve flattens because short-term interest rates increase and long-term rates do not increase at a similar pace, the investment is exposed in two ways. First, the spread between the interest rates is reduced such that net income from the spread decreases, an event known as a “margin squeeze.” Second, under applicable accounting rules, mortgage-backed securities are classified as “available-for sale,” instead of “held to maturity,” and thus the investor must immediately realize any loss on the decline in value of the securities. Accordingly, the more money NYCB borrowed to purchase mortgage-backed securities, the more vulnerable it was to increases in short-term interest rates, which would both decrease the net interest income and force the Company to immediately recognize losses.