In the first appellate court decision related to the subprime and credit crisis litigation wave, the United States Court of Appeals for the Eighth Circuit on September 1, 2009 affirmed the dismissal of the NovaStar Financial subprime related securities class action lawsuit. A copy of the Eighth Circuit’s opinion can be found here. The Eighth Circuit’s action represents a milestone in the evolving litigation wave, but because the decision is focused on pleading deficiencies in the plaintiff’s complaint, the decision’s impact may be somewhat limited.



The NovaStar lawsuit (described in greater detail here), was one of the first subprime-related securities lawsuits to emerge, with the initial complaint filed in February 2007. The lawsuit essentially alleged 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.


As discussed in a prior post (here), on June 4, 2008, Western District of Missouri Judge Ortrie Smith granted the defendants’ motion to dismiss the complaint, with prejudice. A copy of the dismissal opinion can be found here.


Judge Smith Held that the complaint did not satisfy the PSLRA’s pleading requirements, because it did not specify the statements the plaintiff alleged to be misleading, nor did it specify why any such statements are misleading. In addition, Judge Smith held that the complaint did not adequately plead scienter. The plaintiff appealed.


The Eighth Circuit’s Opinion

The Eighth Circuit’s Opinion, written by Judge Raymond Gruender, affirmed the dismissal, but because the Court found that the complaint’s deficiencies alone were sufficient to affirm the district court, the Court did not reach the scienter issue.


The plaintiff had argued that the district court erred in concluding that the complaint failed to specify the allegedly misleading statements, citing a thirty-six page section of the complaint that reproduced numerous public statements, press releases and SEC filings during the class period. The Eighth Circuit noted that "absent from this section (and from any other section of the complaint) however, is any indication as to what specific statements within these communications are alleged to be false and misleading."


In his appellate brief, the plaintiff had attempted to identify specific statements that allegedly were misleading. But the Eighth Circuit said that "identifying specifically false and misleading statements for the first time on appeal, however, doe not excuse a litigant’s failure to comply with the pleading requirements," concluding that the district court did not err in dismissing the complaint for failure to identify which statements were misleading.


The plaintiff also argued that the district court erred in concluding that the complaint failed adequately to allege that the statements were misleading, with respect to which the Eighth Circuit noted "absent an indication of precisely what statements [the plaintiff] alleged to be misleading, it is difficult, if not impossible, to determine whether the complaint adequately specified why each statement was misleading."


The Eighth Circuit went on to note that "even if we were able to identify specific statements that were alleged to be misleading," the complaint "does not provide any link between an alleged misleading statement and specific factual allegations demonstrating the reasons why the statement was false and misleading."


In his appellate brief, the plaintiff reference an omnibus paragraph in the complaint, with respect to which the Eighth Circuit noted "arguably attempts to boil down the complaint’s thirty-four pages of background material … into a generalized one-paragraph summary." The Eighth Circuit found the "broad allegations" in this summary "do not necessarily show that the defendants’ statements were misleading" or "provide the level of particularity required by the PSLRA."


Finally, the Eighth Circuit concluded that the district court did not err in decline to allow plaintiff leave to amend, finding as a procedural matter that the plaintiff had not preserved the right to seek amendment.



Because the Eighth Circuit’s decision in the NovaStar case is the first substantive action by an appellate court in connection with the subprime and credit crisis-related litigation wave, the decision represents a noteworthy development that could hearten defendants in other cases. However, because the decision focuses exclusively on the pleading deficiencies in the plaintiff’s complaint, the decision is likely to be of limited impact in other cases, arguably even in the Eighth Circuit.


Certainly, defendants in other cases will try to show that the complaint in their case is as deficient as the complaint in the NovaStar case. As the Orrick law firm put it in their September 2, 2009 memo about the decision (here), "the court announced stringent standards making clear that plaintiffs cannot rely on a kitchen sink approach to pleading securities fraud that leaves judges to identify what statements were allegedly false and why." But the decision would have been much more valuable to defendants had the Eighth Circuit affirmed on the critical battleground issues of scienter and loss causation.


Moreover, the Eighth Circuit said nothing that would aid other arguments that defendants typically try to make in these cases, such as for example that their companies’ misfortunes were simply the result of the global financial downturn. Indeed, the Eighth Circuit’s opinion seems peculiarly detached in its omission of any detailed discussion of the controversy presented or what it might signify.


Even though the Eighth Circuit’s decision may not represent a breakthrough, it nevertheless is a victory for the defendants and serves as a prominent example of the difficulty plaintiffs continue to face in many of these cases. Though plaintiffs have indeed survived motions to dismiss in a number of subprime and credit crisis-related lawsuits, there is a large and growing number of cases where plaintiffs have not managed to survive the initial pleading motions. The Eighth Circuit’s decision represents a higher profile example of the problems that plaintiffs face.


I have in an event updated my table of subprime and credit crisis-related lawsuit resolutions to reflect the Eighth Circuit’s affirmance in the NovaStar case. The tablecan be accessed here.


Interestingly enough, though Judge Smith granted the defendants’ motion to dismiss in the NovaStar subprime securities lawsuit, a different judge in the same district court denied the motion to dismiss in the companion NovaStar ERISA class action suit, as discussed at greater length here.


More About Outside Director Exposures and D&O Insurance: In a prior post (here), I discussed the massive $55.95 million settlement involving the outside directors of Peregrine Systems and the implications it may have for D&O insurance protection of outside directors. An August 27, 2009 memorandum from the King & Spaulding law firm (here) takes a closer look at the settlement and review the specific D&O insurance issues that should be considered in light of the settlement.