In arguably the most substantive ruling yet in a subprime-related securities class action lawsuit, Judge Ortrie Smith of the United States District Court for the Western District of Missouri, in a June 4 opinion (here) in the NovaStar Financial subprime-related securities class action lawsuit, granted the defendants’ motion to dismiss with prejudice.

The NovaStar lawsuit, which was first filed on February 23, 2007, was one of the first subprime-related securities class action lawsuits to be filed. Background regarding the lawsuit can be found here. The lawsuit alleges that NovaStar, a real estate investment trust, lacked adequate internal controls, as a result of which the company materially misstated its financial results and condition. The lawsuit followed the company’s February 20, 2007 announcement of disappointing results and deteriorating marketplace conditions.

Judge Smith granted the motion to dismiss on the grounds that the complaint does not adequately plead falsity and does not adequately plead scienter.

In addressing the falsity requirements, Judge Smith noted the PSLRA’s specificity requirements, and observed that the complaint, despite its over 100 pages and over 200 paragraphs “presents a very broad picture, and Plaintiff discusses his claims in generalities – precisely what the PSLRA counsels against.” This, Judge Smith said, allowed the Complaint to “create the illusion of detail and insinuate the existence of fraud, which in turn has made it exceedingly difficult for the Court to conduct the analysis required by law.”

After reviewing the complaint’s specific allegations of falsity and finding them each in turn to be inadequate, Judge Smith concluded that “ultimately, Plaintiff fails to identify a single false entry in the Company’s financial statements, nor does he identify the ‘truth’ that should have been disclosed.” Judge Smith goes on to add that the Complaint “reads more like a cautionary tale from a treatise on business management than a charge of knowing misstatements and concealments.” Companies, the court said, “are not expected to be clairvoyant and bad decisions do not constitute fraud.”

With respect to plaintiff’s scienter allegations, the court concludes that the plaintiff “had not presented facts creating an inference of scienter that is at least as strong as an inference that Defendants lacked fraudulent intent.” The court noted that the allegations are “more consistent with a company and executives confronting a deterioration in the business and finding itself unable to prevent it than they are with a company and executives recklessly deceiving the investing community.”

Judge Smith declined to allow the plaintiffs leave to replead, concluding it “would be futile,” since there is “no suggestion that any material was concealed or that any Defendant acted with fraudulent intent, and there is no reason to think further or different pleading will created the necessary inferences.”

The Court’s opinion is pretty much a clean sweep for the defendants, but it is hard to know what the larger significance of the opinion might be. There are few other subprime cases pending in the Western District of Missouri (for which the plaintiffs’ bar is undoubtedly grateful, given the outcome in the NovaStar case), and courts in other jurisdictions may or may attach weight to Judge Smith’s ruling.

One aspect of the opinion that could be significant if it represents the perspective with which other courts will view these cases, and that is the extent to which Judge Smith viewed this case through the screen of the generally deteriorating financial markets and business conditions. Other judges, like Judge Smith, may be similarly disinclined to find anything nefarious in a company’s failure to anticipate declining business conditions – at least in the absence of insider trading or other more compelling factors.

While there may be cases such as the Countrywide derivative lawsuit which courts may be predisposed to allow (about which refer here), there may be others, like the NovaStar case, where courts prove unwilling to infer wrongdoing from business reverses. At a minimum, the NovaStar opinion is a reminder that merely because a company’s fortunes have declined and the plaintiffs have filed a lawsuit does not necessarily mean that the plaintiffs will prevail or make any recovery. There may be more than a few of the cases filed as part of the subprime litigation wave that also fail to survive the initial pleading hurdles.