In a decision that largely turned on detailed confidential witness statements, on June 7, 2011, Northern District of Alabama Judge Inge Prytz Johnson denied the motions to dismiss in the Regions Financial Corporation subprime-related securities lawsuit. This ruling is the latest of a series of decisions involving the company. The June7 ruling can be found here.



As detailed here, this case arose following the company’s January 20, 2009 announcement that it was taking a goodwill impairment of nearly $6 billion related to the company’s November 2006 purchase of AmSouth Bancorporation. As the plaintiffs later alleged, even though Regions acquired AmSouth, with a year former AmSouth executives were running the combined company. The AmSouth loan portfolio was heavily weighted toward Florida real estate.


The plaintiffs allege that the company and its senior officials were well aware of the deteriorating conditions in the Florida real estate market, but they failed to recognize the non-performing loans in the company’s portfolio. As a result, the defendants “repeatedly, yet falsely, claimed that the $6 billion in goodwill associated with the AmSouth acquisition was unimpaired. “


But by January 2009, “the collapsing real estate market proved more devastating than even defendants’ fraud could conceal,” and on January 20, 2009, “defendants were forced to finally announce a huge increase in loan loss reserves , and a colossal $6 billion writedown of goodwill.” The company’s share price declined and litigation ensured. The defendants moved to dismiss.


The June 7 Opinion

Judge Johnson’s June 7 Opinion denying the defendants’ motions to dismiss relied heavily on the statements of confidential witnesses cited in the amended complaint. Her opinion recites this testimony at length. Among other things, one confidential witness reports that senor bank officials changed the status of nonaccrual loans at month or quarter end, but that following the month or quarter end, the numbers would be switched back, the delay done with the purpose of “making the numbers.” Another confidential witness stated  that the company did not properly classify nonperforming loans as nonaccruing assets in a timely manner.


The plaintiffs also relied on confidential witness statements to establish that “defendants were kept aware of this process through both the reporting structure and periodic reports.” The confidential witness cited specific detailed reports senior managers were regularly given.


Another confidential witness statedthat the Federal Reserve has opened an investigation into the company’s classification of loans as “non-accrual,” and that the Company’s Audit Committee is now in the process of conducting its own investigation, and has hired an outside law firm to investigate.


In denying the denying the defendants’ motions to dismiss, Judge Johnson differentiated the plaintiffs’ allegations from those involved in a separate case relating to Regions’ alleged delay in recognizing the impairment of the AmSouth transaction goodwill, in which Southern District of New York Judge Lewis Kaplan had granted the motion of the defendants in that case to dismiss the complaint.


By contrast to the allegations in that case, Judge Johnson said, the plaintiffs in this case have “pled many facts showing that the defendants had information that did not support defendants’ opinions.” Among other things, she cited the statements of the confidential witnesses “showing how defendants improperly handled and classified loans, defendants were aware of the collapsing commercial real estate in Florida yet continued to push for more growth there, and continued to ignore [internal] reports signaling a negative risk-adjusted bottom line.


Judge Johnson concluded that the plaintiffs has sufficiently alleged that the company’s loan loss reserves were false and misleading, citing the testimony of several confidential witnesses that “defendants mishandled loans in order to manipulate their financial reporting numbers.” Because the loan loss reserves impacted the company’s reported income (which was the measure by which the company tested its goodwill), Judge Johnson concluded that the plaintiffs had adequately alleged that the company’s goodwill was “overstate, false and misleading.”


Judge Johnson also relied on the confidential witnesses’ statements in concluding that the plaintiffs had adequately alleged scienter. Taking the fact that the defendants had compensation tied to company performance as one possible motive to be considered, Judge Johnson also noted that the defendants “had access to reports showing the true state of affairs regarding Regions’ loans and the deteriorating markets, particularly in Florida.”


Judge Johnson also found that the defendants’ “significant and sudden increase in loan loss reserves along with its $6 million goodwill write-down, considered collectively with all allegations, supports a strong inference of scienter.”  Judge Johnson added that “coupled with allegations of defendants’ knowledge of the scheme to manipulate classifications of loans, it was apparent to defendants that the financials were inaccurate long before their adjustment in January 2009.”



Securities plaintiffs have been uniformly successful in attempting to rely on confidential witness statements  in order to try to meet the PSLRA’s pleading requirements This case is a notable example where use of confidential witness statements was successful. The success depended on a number of factors. The witnesses’ statements was detailed and specific. More importantly, Judge Johnson found that the witnesses’ statements  showed that the defendants were aware of the information about which the witnesses testified, in particular about alleged differences between the information cited by the witnesses and what the company was saying publicly.


At the same time it seems that the witnesses’ statements  reinforced Judge Johnsons’ predispositions. She clearly found the magnitude of the $6 billion write-down and the January 2009 increase in loan loss reserves to be disturbing, and even suspicious. These factors came together to support her conclusions.


The confidential witness statements were  clearly important and  help explain the difference in outcome between her ruling and that of Judge Kaplan in the separate ’33 Act claim that had been brought on behalf of class of investors who had purchased Regions trust preferred securities in a separate securities offering. As noted above, in that case, Judge Kaplan had granted the motion to dismiss. The difference seems to be the allegations based on the statements  of the confidential witnesses.


There have been a number of other credit crisis-related lawsuits in which the presence of statements from confidential witnesses seemed to have made a difference in enabling plaintiffs’ claims to survive the initial pleading hurdles. Among these cases are: the Sallie Mae case (refer here); and  the Wells Fargo Mortgage-Backed Securities case (refer here). Indeed, in the Credit Suisse case, which later settled for $70 million dollars, the court found that the information in confidential witness statements cited in the amended complaint was sufficient to permit the plaintiffs’ amended complaint to survive the renewed dismissal motions, after the motion to dismiss the initial complaint had been granted, as discussed here.


As I noted in a prior post, here, here have been a number of cases filed against this company in the wake of the AmSouth merger and in light of the problems Regions encountered during the financial crisis. A number of these cases are proceeding, including, as discussed in a prior post, the state court derivative complaint.


These cases are part of the huge number of cases that continue to work their way through the system following the financial crisis. I have in any event added the June 7 ruling to my running tally of credit crisis-related dismissal motion rulings, which can be accessed here.


Special thanks to a loyal reader for sending along a copy of the June 7 order.