In a July 1, 2009 opinion (here), Northern District of California Judge Susan Illston denied in part and granted in part the defendants’ motion to dismiss the plaintiffs’ consolidated complaint in the subprime-related securities class action lawsuit pending against the The PMI Group and certain of its directors and officers. Among other things, Judge Illston specifically found that insider trades pursuant to a Rule 10b5-1 trading plan cannot serve as the basis of a finding of scienter. Background regarding the case can be found here.


Judge Illston denied the defendants’ motion in part, finding that the plaintiffs’ consolidated complaint had sufficiently alleged material misrepresentations with respect to the adequacy of PMI’s risk management practices and its reporting of its loss reserves. She also found that the complaint adequately alleged loss causation. However, she nevertheless granted the defendants’ motion to dismiss with leave to amend on the grounds that the consolidated complaint did not adequately allege scienter.


With respect to scienter, Judge Illston found that the complaint "falls short of showing that the defendants were aware that the statements were false or misleading when made."


Judge Illston specifically found that the confidential witness testimony on which the plaintiffs sought to rely was insufficient. Judge Illston noted with respect to the internal reports that one confidential witness referenced that "the complaint does not describe these reports in any detail, and thus there is no information in the complaint as to whether the reports should have alerted the defendants" as to the falsity of the disclosures.


With respect to the other confidential witnesses’ testimony, she said that the complaint does not disclose how the witnesses would have had "personal knowledge" of the items they reference or that that the individual defendants were aware of this information.


Judge Illston also rejected as insufficient the plaintiffs’ attempt to satisfy the scienter requirements by arguing that the individual defendants are company officers who may be presumed to have knowledge of the company’s "core operations." She found that the "plaintiffs have not shown that this case fits within the unusual circumstances" to which the "core operations" theory might apply, noting that in addition to alleging the defendants’ corporate positions, the complaint must detail the defendants’ actual exposure to information. She noted that the plaintiffs can attempt to amend their complaint if they can to show that the defendants "actually had information showing the problems."


In addition, Judge Illston rejected as insufficient the plaintiffs’ attempt to rely on the existence of a bonus plan and of insider trading to establish scienter. She noted that "the simple fact that PMI had a bonus compensation plan, without more does not support scienter."


She rejected the alleged insider trading allegations as insufficient both because the complaint does not contain any allegations regarding the defendants’ prior trading histories and because she found that three of the defendants had actually increased their holdings during the class period, "which is inconsistent with the intent to defraud."


Finally, Judge Illston noted on the issue of scienter that 98% of on individual defendant’s sales were pursuant to Rule 10b5-1 trading plans, with respect to which she further noted that "sales according to pre-determined plans may rebut an inference of scienter." (Refer here for discussion of another recent case where trades pursuant to a Rule 10b5-1 plan were also found sufficient to rebut the inference of scienter.)


Because she concluded that plaintiffs had not adequately alleged scienter she granted defendants’ motion to dismiss with leave to amend. The plaintiffs have until July 24, 2009 to file their amended complaint.


I have in any event added Judge Illston’s opinion to my running register of subprime and credit crisis-related securities lawsuit dismissal motion rulings, which can be accessed here.


Special thanks to Adam Savett of the Securities Litigation Watch for providing a copy of Judge Illston’s opinion.


Bloomberg Podcast on Directors’ Accountability Now Available: On June 24, 2009, I participated in a Bloomberg-sponsored roundtable discussion on the topic of "Corporate Directors’ Accountability During and After the Economic Crisis." Also participating on the panel were Professor Charles Elson, Director of the John L. Weinberg Center for Corporate Governance at the University of Delaware, Michael Barry of Grant & Eisenhofer, and Michael Forman of Dorsey & Whitney. The hour-long panel discussion can now be accessed or downloaded from Bloomberg’s website, here.


The Latest Stanford Financial Group Lawsuit: According to a July 13, 2009 Bloomberg article (here), Stanford Group investors have filed a class actoin lawsuit in the Southern District of Texas against The Commonwealth of Antigua and Barbuda, alleging that the Caribbean nation helped the financier engineer a massive fraud. The complaint (here) , purports to be filed on behalf of all individuals and investors who were customers of Stanford International Bank as of February 16, 2009, alleges violations of and seeks to recover damages under RICO.


I have added this latest lawsuit to my running register of all Stanford Group-related litigation, which can be accessed here.