You're viewing Docket Item 183 from the case Pennsylvania Public School Employees' Retirement System v. Bank of America Corporation et al. View the full docket and case details.

Download this document:




Case 1:11-cv-00733-WHP Document 183 Filed 04/17/13 Page 1 of 13

~USD(:;-sONY ~-~~~-~­
I?OC:;,M~:NT,_,
•ELI:C I
Ie ALL') FILED
IDOC ij : - -..- ­ ..+~~-t.-~-­

UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -X
PENNSYLVANIA PUBLIC SCHOOL
EMPLOYEES' RETIREMENT SYSTEM,
individually and on behalf of all others similarly
situated,

Plaintiff,

-against-

BANK OF AMERICA CORPORATION, et al.,

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -X

Defendants.

WILLIAM H. PAULEY III, District Judge:

11 Civ. 733 (WHP)

MEMORANDUM & ORDER

Lead Plaintiff Pennsylvania Public School Employees' Retirement System

("Plaintiff') brings this putative class action against Bank of America Corporation ("BoA") and

current and past officers and directors of BoA: Kenneth D. Lewis, Joseph Lee Price, II, Brian T.

Moynihan, Neil Cotty, and Charles H. Noski (the "Executive Defendants"). The Executive

Defendants move to dismiss the Amended Consolidated Class Action Complaint. For the

following reasons, the Executive Defendants' motion is denied.

BACKGROUND

This Court's July 11,2012 Memorandum & Order describes the allegations

undergirding this action. See Pa. Pub. Sch. Emps' Ret. Sys. v. Bank of Am. Com., 874 F. Supp.

2d 341, 346 (S.D.N.Y. 2012). In that Memorandum & Order, this Court dismissed all defendants

except BoA from this action, granted Plaintiff leave to re-plead its claims against the Executive

Defendants, and denied the motion to dismiss with respect to the Section 10(b) and Rule IOb-5

claim against BoA. Plaintiff filed its Amended Complaint on August 13,2012.

-1­

Case 1:11-cv-00733-WHP Document 183 Filed 04/17/13 Page 2 of 13

Originally, Plaintiff alleged two claims against the Executive Defendants: (1)

violations of Section 1 O(b) of the Securities Exchange Act of 1934 ("Exchange Act") and Rule

lOb-5, and (2) violations of Section 20(a) of the Exchange Act. This Court dismissed Plaintiffs

first claim because it failed to plead the required strong inference of scienter. Pa. Pub. Sch.

Emps' Ret. Sys., 874 F. Supp. 2d at 359. This Court also dismissed Plaintiffs second claim for

failing to plead the required culpable state of mind. Pa. Pub. Sch. Emps' Ret. Sys., 874 F. Supp.

2d at 368.

In its initial Complaint, Plaintiff alleged that the BoA Defendants: (1) tolerated

robo-signing; (2) failed to disclose BoA's vulnerability to repurchase claims; (3) deliberately

circumvented internal controls in establishing allowances for repurchase claims; (4) kept

reserves for repurchase claims low to forestall additional repurchase claims; (5) fought

repurchase claims to discourage investors from asserting additional ones; (6) resisted investor

attempts to examine loan files; (7) concealed BoA's use of Mortgage Electronic Registration

Systems, Inc. ("MERS"); and (8) failed to notify mortgage-backed securities ("MBS")

purchasers of breaches. Plaintiff also alleged that the magnitude of the fraud created an

additional basis for establishing scienter. This Court found those allegations insufficient and

held that "Plaintiff does not allege that the Executive Defendants knew of specific contradictory

information at the same time they made misleading statements." Pa. Pub. Sch. Emps' Ret. Sys.,

874 F. Supp. 2d at 359.

In its Amended Complaint, Plaintiff alleges that the Executive Defendants made

misleading statements despite knowing that (1) BoA was vulnerable to repurchase claims; (2)

-2­

Case 1:11-cv-00733-WHP Document 183 Filed 04/17/13 Page 3 of 13

BoA had a material weakness in its internal controls; and (3) BoA was failing to comply with

generally accepted accounting principles ("GAAP") and SEC regulations.

First, Plaintiff alleges that a letter dated May 13, 20 I 0 from BoA's outside

counsel to the Financial Crisis Inquiry Commission ("FCIC") establishes Moynihan's scienter.

The letter "summarized the negative effects flowing from BoA's overemphasis on generating

loans for securitization without due regard to prudent lending." Pa. Pub. Sch. Emps' Ret. Sys.,

874 F. Supp. 2d at 364. It was sent in response to a request from FCIC Chairman Green, who

asked Moynihan to expand on prior testimony that he had given to the FCIC. (Amended

Consolidated Class Action Complaint, dated August 13,2012 ("AC") ~~ 86, 301.) The letter

contradicted Moynihan's subsequent representations regarding BoA's vulnerability to repurchase

claims. (AC ~ 302.)

Plaintiff also alleges, more generally, that the other Executive Defendants knew

of repurchase liabilities and did not adequately disclose them. Previously, this Court found that

the Executive Defendants had been "forthright in disclosing losses on repurchase claims." Pa.

Pub. Sch. Emps' Ret. Sys., 874 F. Supp. 2d at 361. Plaintiff now alleges that even if the

Executive Defendants disclosed certain repurchase claims, they failed to disclose repurchase

demands. (AC ~ 302). Repurchase claims refer to lawsuits or other formal proceedings seeking

to compel repurchase; repurchase demands refer to pre-litigation letters requesting repurchase.

Similarly, Plaintiff alleges that scienter can be inferred from the fact that BoA entered into

tolling agreements with Government Sponsored Enterprises ("GSEs") regarding their repurchase

demands. (AC ~ 302(a).) Plaintiff alleges that BoA wrongfully delayed disclosure of these

demands.

-3­

Case 1:11-cv-00733-WHP Document 183 Filed 04/17/13 Page 4 of 13

Second, Plaintiff alleges that the Executive Defendants were knowingly

responsible for material weaknesses in BoA's internal controls. (AC ~ 304.) Specifically, on

January 29, 2010, the SEC sent a letter to BoA regarding BoA's policy of accounting for certain

contingencies. The January letter asked BoA to disclose its public filing information regarding

its repurchase reserve calculation. Cotty and Noski were directly involved in replying to the

letter. On May 3, 2010, the SEC sent another comment letter advising BoA that any "future

filing" would require further disclosures. (AC ~ 304(c).)

Third, Plaintiff alleges that the Executive Defendants failed to disclose

information required by GAAP and SEC regulations. Specifically, Plaintiff alleges that

generally accepted accounting principles require disclosure of potential liabilities. The

Executive Defendants were made aware ofpotential liabilities through their review of various

demand letters and their role in subverting generally accepted accounting principles. (AC ~~

121(e), (k), (1), (n), 303, 304.) By certifying that they were complying with reporting

obligations, they knowingly made materially misleading statements.

DISCUSSION

I. Legal Standard

On a motion to dismiss, a court must accept the material facts alleged in the

complaint as true and construe all reasonable inferences in plaintiffs favor. See Grandon v.

Merrill Lynch & Co., 147 F.3d 184, 188 (2d Cir. 1998). Nonetheless, "factual allegations must

be enough to raise a right of relief above the speculative level, on the assumption that all of the

allegations in the complaint are true." Bell Atl. Corp. v. Twombly, 550 U.S. 544,555 (2007)

(requiring plaintiff to plead "enough fact[s] to raise a reasonable expectation that discovery will

-4­

Case 1:11-cv-00733-WHP Document 183 Filed 04/17/13 Page 5 of 13

reveal evidence of [his claim]"). "To survive a motion to dismiss, a complaint must contain

sufficient factual matter, accepted as true, to 'state a claim to relief that is plausible on its face. '"

Ashcroft v. Iqbal, 556 U.S. 662,678 (2009) (quoting Twombly, 550 U.S. at 570). "The

plausibility standard is not akin to a 'probability requirement,' but it asks for more than a sheer

possibility that a defendant has acted unlawfully." Iqbal, 556 U.S. at 678 (citation omitted). "A

court ruling on such a motion may not properly dismiss a complaint that states a plausible

version of the events merely because the court finds a different version more plausible."

Anderson News, LLC, et al. v Am. Media Inc., 680 F.3d 162, 185 (2d Cir. 2012). "A pleading

that offers 'labels and conclusions' or 'a formulaic recitation of the elements of a cause of action

will not do.' Nor does a complaint suffice if it tenders 'naked assertion[s], devoid of 'further

factual enhancement.'" Iqbal, 556 U.S. at 678 (quoting Twombly, 550 U.S. at 557).

A court's "consideration [on a motion to dismiss] is limited to facts stated on the

face of the complaint, in documents appended to the complaint or incorporated in the complaint

by reference, and to matters of which judicial notice may be taken." Allen v. WestPoint­

Pepperell, Inc., 945 F.2d 40, 44 (2d Cir. 1991). A complaint alleging securities fraud must meet

the heightened pleading standard of Rule 9(b), which requires a plaintiff to "state with

particularity the circumstances constituting fraud." Fed. R. Civ. P. 9(b); see also ATSI

Commc'ns, Inc. v. Shaar Fund, Ltd., 493 F.3d 87, 99 (2d Cir. 2007).

II. Section 10Cb) and Rule IOb-5 Claims

Plaintiff asserts that the Executive Defendants violated Section I O(b) of the

Exchange Act and Rule IOb-5. To state a claim for relief under Section 10(b) and Rule IOb-5,

Plaintiff must allege "(1) a material misrepresentation or omission by the defendant; (2) scienter;

-5­

Case 1:11-cv-00733-WHP Document 183 Filed 04/17/13 Page 6 of 13

(3) a connection between the misrepresentation or omission and the purchase or sale of a

security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss

causation." Pac. Inv. Mgmt. Co. v. Mayer Brown LLP, 603 F.3d 144, 151 (2d Cir. 2010). The

parties dispute whether the Amended Complaint adequately alleges scienter.

The Private Securities Litigation Reform Act of 1995 ("PSLRA") requires that the

plaintiff "plead with particularity facts giving rise to a strong inference that the defendant acted"

with an "intent to deceive, manipulate, or defraud" or acted recklessly. ECA, Local 134 IBEW

Joint Pension Trust of Chi. v. JP Morgan Chase Co., 553 F.3d 187, 198 (2d Cir. 2009) (internal

quotations omitted) (emphasis in original). "Recklessness is defined as at the least, an extreme

departure from the standards of ordinary care to the extent that the danger was either known to

the defendant or so obvious that the defendant must have been aware of it." ECA, 553 F.3d at

198 (internal quotation marks and alternations omitted), "The inquiry ... is whether all of the

facts alleged, taken collectively, give rise to a strong inference of scienter, not whether any

individual allegation, scrutinized in isolation, meets that standard." Tellabs Inc. v. Makor Issues

& Rights. Ltd., 551 U.S. 308, 323 (2007) (emphasis in original).

In assessing whether a plaintiff has stated a claim, "a court must consider

plausible, nonculpable explanations for the defendant's conduct, as well as inferences favoring

the plaintiff." Tellabs, 551 U.S. at 323. "A complaint will survive ... only if a reasonable

person would deem the inference of scienter cogent and at least as compelling as any opposing

inference one could draw from the facts alleged." Tellabs, 551 U.S. at 324. ""[S]cienter can be

established by alleging facts to show either (1) that defendants had the motive and opportunity to

commit fraud, or (2) strong circumstantial evidence of conscious misbehavior or recklessness."

-6­

Case 1:11-cv-00733-WHP Document 183 Filed 04/17/13 Page 7 of 13

ECA, 553 F.3d at 198. "[T]he strength ofthe circumstantial allegations [of conscious

misbehavior or recklessness] must be correspondingly greater if there is no motive." ECA,553

F .3d at 198-99 (internal quotation marks omitted). Here, Plaintiff relies on the second prong.

(Pl.'s Mem. in Opp'n to Mot. to Dismiss ("Opp'n") at 5.)

A. Repurchase Claims

Addressing Moynihan first, Plaintiff now alleges that the May 13 letter establishes

his scienter because Moynihan knew of the information in the letter but nevertheless went on to

make statements contradicting the representations in the letter. (AC, 86.) This Court

previously rejected the argument that the letter established scienter for the Executive Defendants

because there was "no allegation that the Executive Defendants saw the letter or knew of its

contents." Pa. Pub. Sch. Emps.' Ret. Sys., 874 F. Supp. 2d at 359.

In the Amended Complaint, Plaintiff alleges that Moynihan knew of the letter

because it constituted part of his sworn testimony to the FCIC. According to Plaintiff, the letter

responded to a request from FCIC Chairman Green, which was addressed to Moynihan and

asked him to expand on his testimony. While the letter was signed by BoA's outside counsel on

behalf of BoA, Moynihan likely knew its contents because it purported to respond to the FCIC's

demand for Moynihan to supplement his testimony.

BoA argues that, even if Moynihan knew ofthe letter, there is nothing in the letter

that specifically contradicted any of his public statements. But this Court's finding that the letter

"summarized the negative effects flowing from BoA's overemphasis on generating loans for

securitization without due regard to prudent lending" closes the door on that argument at the

pleading stage. Pa. Pub. Sch. Emps.' Ret. Sys., 874 F. Supp. 2d at 364. This Court relied on that

-7­

Case 1:11-cv-00733-WHP Document 183 Filed 04/17/13 Page 8 of 13

fact to find that "Plaintifrs allegations concerning BoA's knowledge of repurchase claims also

raises a strong inference of scienter on BoA's part." Pa. Pub. Sch. Emps.' Ret. Sys., 874 F.

Supp. 2d at 363-64. The May 13 letter establishes that Moynihan had knowledge of the

repurchase claims and renders his subsequent representations misleading. Accordingly, Plaintiff

adequately pleads the required strong inference that Moynihan acted with scienter regarding the

repurchase claims.

Turning to the other Executive Defendants, Plaintiff alleges that their knowledge

of undisclosed repurchase demands render their subsequent certifications misleading. But

immediate disclosure of repurchase demands is not required. See Higginbotham v. Baxter Int'l

Inc., 495 F.3d 753, 760-61 (7th Cir. 2007) ("Prudent managers conduct inquiries rather than

jump the gun with half-formed stories as soon as a problem comes to their attention."); cf. also

Reiss v. Pan Am. World Airways, Inc., 711 F.2d 11, 14 (2d Cir. 1983) (holding that, in the

context of corporate merger negotiations, "[d]isclosure may in fact be more misleading than

secrecy" because such negotiations involve "complex bargaining between two (and often more)

parties which may fail as well as succeed, or may succeed on terms which vary greatly from

those under consideration at the suggested time of disclosure").

Here, the repurchase demands required investigation and not all demands were

meritorious. Plaintiff alleges that, given the size of the demands and the nature of the claims, the

Executive Defendants must have known that the repurchase demands constituted a major

undisclosed liability. But nothing in the Amended Complaint suggests that the Executive

Defendants honestly believed that the existing reserves were inadequate. The Amended

Complaint does not allege that the Executive Defendants conducted a review of each demand

-8­

Case 1:11-cv-00733-WHP Document 183 Filed 04/17/13 Page 9 of 13

and assessed its merit. And regardless, BoA disclosed unresolved repurchase requests in August

2010 to the tune of $11.1 billion. As such, Plaintiff s allegations regarding the Executive

Defendants' response to repurchase claims do not plausibly create a strong inference of scienter.

Nor do Plaintiffs allegations regarding non~disclosure of tolling agreements.

Tolling agreements are entered into for a variety of reasons, and nothing in the Amended

Complaint suggests that the Executive Defendants knew that the claims underlying the tolling

agreements were valid. And BoA disclosed GSE repurchase requests in August 2010.

(Declaration of Scott D. Musoff, dated Jan. 11,2012 ("MusoffDecl.") Ex. D: lO~Q, dated Aug.

6,2010 ("Aug. 2010 lO-Q") at 40.) Accordingly, Plaintiffs allegations establish Moynihan's

scienter but fail to establish scienter against the other Executive Defendants regarding the

statements they made about repurchase claims.

B. Material Weakness in Internal Controls

Plaintiff alleges that the Executive Defendants were knowingly responsible for

undisclosed weaknesses in BoA's internal controls. (AC ~ 302(e).) This Court previously found

that BoA failed to disclose a material weakness in its internal controls but noted that "it does not

make sense that the Executive Defendants would circumvent internal controls to manipulate

allowance levels while being forthright in disclosing losses on repurchase claims." Pa. Pub. Sch.

Emps.' Ret. Sys., 874 F. Supp. 2d at 361. Plaintiff attempts to remedy this deficiency by

alleging that the Executive Defendants did not timely disclose BoA's losses on repurchase

claims and did not disclose repurchase demands. (AC ~~ 302(e), 304(e).)

Specifically, Plaintiff argues that an SEC comment letter indicates that Cotty and

Noski were knowingly responsible for the weakness in internal controls. (AC ~ 304.) In that

-9­

Case 1:11-cv-00733-WHP Document 183 Filed 04/17/13 Page 10 of 13

letter, the SEC inquired as to why BoA had recognized a $3 billion settlement with the GSEs all

at once, rather than accounting for portions of the liability earlier. Plaintiff argues that this letter

demonstrates that the Executive Defendants were aware that it was improper not to disclose

contingent liabilities. But Plaintiff does not plead sufficient facts regarding the Executive

Defendants' judgment regarding the merits of the repurchase demands. Because these demands

were speculative, they do not form the basis of a claim for lack of internal controls.

Plaintiff's additional allegations do not change this analysis. To the extent that the SEC letter is

a criticism of accounting practice, "[a]llegations of accounting irregularities, standing alone, are

insufficient to state a securities fraud claim. Only where such allegations are coupled with

evidence of corresponding fraudulent intent might they be sufficient." In re JP Morgan Chase

Sec. Litig., No. 02 Civ. 1282 (SHS), 2007 WL 950132, at *13 (S.D.N.Y. Mar. 29, 2007)

(internal alterations omitted).

C. GAAP and SEC Regulations

Although the Executive Defendants' failure to disclose potential liability arising

from repurchase demands is not misleading in its own right, it may nevertheless violate GAAP

and SEC regulations. See S.E.C. v. Steadman, 967 F.2d 636, 645 (D.C. Cir. 1992) (noting that

"accounting rules d[ 0] not obligate appellants to attempt to quantify the contingent liability

through rough guesses or speculation," but holding that [generally accepted accounting

principles] require disclosure of "the general nature of the potential liability, as long as there [is]

'a reasonable possibility' that it [will] be realized."). Violating GAAP and SEC regulations may

not amount to a material misrepresentation. But falsely certifying compliance with those same

regulations certainly can. See Steadman, 967 F.2d at 645.

-10­

Case 1:11-cv-00733-WHP Document 183 Filed 04/17/13 Page 11 of 13

The Amended Complaint alleges sufficient specific facts to demonstrate that the

Executive Defendants were aware of the repurchase demands, even if they were not aware of the

merits of each individual demand. And the GAAP precept of Accounting for Contingencies

("F AS 5") requires disclosure of probable losses, even when the losses are not estimable, as long

as there is a "manifestation by a potential claimant of an awareness of a possible claim or

assessment." F AS 5, ~ 10. Under F AS 5, BoA was obligated to disclose the general nature of

the potential liability that it faced. Its failure to do so constituted a violation ofFAS 5. The

Executive Defendants were made aware of these potential liabilities by various demand letters

and by their role in camouflaging those demands. (AC ~~ 121(e), (k), (1), (n).) By certifying that

they were complying with F AS5 when they had failed to disclose such potential liabilities, they

knowingly made materially misleading statements. Accordingly, Plaintiffs allegations

regarding the Executive Defendants' violation of GAAP and SEC regulations give rise to a

strong inference of scienter.

III. Section 20(a) Claims

Plaintiff asserts claims against the Executive Defendants for violations of Section

20(a) of the Exchange Act. To survive a motion to dismiss, plaintiff must allege: (1) "an

underlying primary violation by the controlled person"; (2) "control over the controlled person";

and (3) "particularized facts as to the controlling person's culpable participation in the fraud

perpetrated by the controlled person." In re AOL Time Warner, Inc. Sec. & ERISA Litig., 381

F. Supp. 2d 192,233 (S.D.N.Y. 2004); see also In re Smith Barney Transfer Agent Litig., 884 F.

Supp. 2d 152, 166 (S.D.N.Y. 2012).

-11­

Case 1:11-cv-00733-WHP Document 183 Filed 04/17/13 Page 12 of 13

"While the Second Circuit has not yet addressed the meaning of culpable

participation at length, other than to state that a determination of § 20(a) liability requires an

individualized determination of a defendant's particular culpability, courts have required a

showing of both fraudulent conduct and a culpable state of mind." In re Emex Corp. Sec. Litig.,

No. 01 Civ. 4886 (SWK), 2002 WL 31093612, at *10 (S.D.N.Y. Sept. 18,2002) (internal

quotation marks omitted).

Originally, this Court dismissed Plaintiffs Section 20(a) claim for "failing to

allege particularized facts of the Executive Defendants' culpable participation in the fraud

perpetrated by the controlled person." Pa. Pub. Sch. Emps.' Ret. Sys., 874 F. Supp. 2d at 361

(internal quotations omitted). As explained above, Plaintiffs new allegations plausibly establish

fraudulent conduct and a culpable state of mind as to all Executive Defendants for failing to

comply with GAAP and SEC regulations and against Moynihan for failing to disclose repurchase

liabilities. Accordingly, the Executive Defendants' motion to dismiss Plaintiffs Section 20(a)

claim is denied.

-12­

Case 1:11-cv-00733-WHP Document 183 Filed 04/17/13 Page 13 of 13

CONCLUSION

For the foregoing reasons, the Executive Defendants' motion to dismiss the

Amended Complaint is denied. The Clerk of the Court is directed to terminate the motion

pending at ECF No. 173.

Dated: April 17, 2013

New York, New York

SO ORDERED:

~ be'>. b ~24 'Vou~

WILLIAM H. PAULEY III

U.S.D.J.

Counsel ofRecord:

Mark Robert Rosen
Barrack, Rodos & Bacine
3300 Two Commerce Square, 2001 Market Street
Philadelphia, P A 19103
Lead Counsel for Plaintiff

Jay B. Kasner
Skadden, Arps, Slate, Meagher & Flom LLP (NYC)
Four Times Square
42nd floor
New York, NY 10036
Counsel for Bank ofAmerica and the Executive Defendants

-13­