We are now well into the second year of the current subprime litigation wave, but the rulings on preliminary dismissal motions are still just trickling in. In the latest of the early returns, involving one of the earliest subprime securities lawsuits, Judge James T. Giles of the Eastern District of Pennsylvania in an opinion dated August 29, 2008 denied defendants’ motion to dismiss the securities lawsuit pending against home builder Toll Brothers and nine of its directors and officers.


A copy of the August 29 opinion can be found here. Background regarding the case can be found here.


According to the Amended Complaint (here), between December 9, 2004 and November 8, 2005, the defendants made several misrepresentations relating to the company’s "ability to open new active selling communities at the rate necessary to support its financial projections, traffic in its existing communities, demand for Toll Brothers homes, and the ability to continue its historically strong earnings growth." The Amended Complaint further alleges that despite "adverse developments" the company raised its earning projections, which allegedly inflated the company’s share price, facilitating the defendants’ sale of 14 million of company shares for proceeds of over $617 million.


The Amended Complaint also alleges that "within days" of the completion of the insider sales, defendants "shocked investors" in a series of disclosures between August and November 2005 revealing that traffic and sales were declining, as a result of which the company’s share price declined 43% from its class period high.


Judge Giles’s August 29 opinion is relatively brief and largely represents a statement of his conclusions rather than an explanation of his reasoning. Thus, he simply states that plaintiffs have adequately alleged material misrepresentations and omissions, and have adequately alleged that defendants’ forward-looking misrepresentations were "knowingly unreasonable" at the time made. He also states that plaintiffs have adequately alleged that the company’s forward-looking statements were not accompanied by sufficient cautionary language and were mixed with representations of current condition.


The Judge’s rulings with respect to the issues of scienter and loss causation are slightly more detailed and are also more interesting.


With respect to the issue of scienter, Judge Giles noted that "Plaintiffs have alleged that Defendants’ stock sales were unusual in scope and timing, and the court finds these insider allegations are pled with the particularity required by the PSLRA." As a purported "plausible opposing inference," the defendants contended that the purpose of their stock sales "was diversification of their investments." The court concluded that "a reasonable person would find that the inference of scienter is at least as strong as the opposing inference."


With respect to the issue of loss causation, the plaintiffs alleged that the defendants made four statements between August and November 2005 that revealed the truth about the company. The defendants contended that plaintiffs "inappropriately grouped" the alleged "revelations" together in an attempt to establish loss causation.


Judge Giles rejected the defendants’ argument, and found that the plaintiffs made two allegations with respect to loss causation that the court found to be sufficient: first, the plaintiffs alleged that each of the four revelations and subsequent stock price drops were actionable; and second the plaintiffs allege that "through these four revelations" defendants "gradually revealed the truth regarding their prior misrepresentations."


Because the bases of Judge Giles’s rulings are not detailed, his opinion is unlikely to be influential in other subprime-related securities cases, particularly since the magnitude and timing of the alleged insider trading clearly seems to have been an important factor. Judge Giles’s willingness to accept the plaintiffs’ allegations that the truth was "gradually" revealed as sufficient to satisfy loss causation pleading requirements could be more significant, as plaintiffs in cases in which there was no abrupt stock price drop often attempt to make similar "gradual revelation" arguments.


In any event, Judge Giles’s ruling joins the small collection of subprime-related securities lawsuit dismissal motion determinations, a list of which may be accessed here. Although among the small group of rulings dismissal motions have been both granted and denied, the motion denial in the Toll Brothers case comes after the two most recent rulings in the Standard Pacific (refer here) and NovaStar (refer here) cases, in which the dismissal motions were granted.


There are many more cases in which the dismissal motions are yet to be heard, but Judge Giles’s opinion in the Toll Brothers case is a reminder that even with the substantial arguments that defendants can make in reliance on Tellabs and Dura Pharmaceuticals, some cases will nevertheless survive motions to dismiss. At least based on the Toll Brothers ruling, the presence of significant insider sales may be a significant factor in producing that result.