In the latest ruling to address the pleading adequacy of a securities suit based on a financial institution’s loan loss reserve disclosures, a federal judge has found that the plaintiffs’ allegations in the SunTrust Trust Preferred Securities lawsuit were not sufficient to state a claim under the securities laws. Northern District of Georgia Judge William Duffey, Jr.’s September 10, 2010 decision (here) , which granted the defendants’ dismissal motions without prejudice, may be particularly noteworthy because it found that the plaintiffs’ allegations were not sufficient even to meet the ’33 Act’s pleading standard.


As discussed at greater length here, the complaint relates to SunTrust’s February 2008 offering of Trust Preferred Securities. The defendants include SunTrust and certain of its directors and officers, as well as the offering underwriters and SunTrust’s outside auditor.



The complaint alleges that the offering documents underestimated SunTrust’s allowance for loan and lease loss reserves (ALLL). The plaintiffs allege that the bank failed to disclose its mortgage-related exposures, and accurately account for losses in those assets and their impact on the bank’s liquidity and capital adequacy. The complaint alleges that as the housing market collapsed, SunTrust failed to increase its ALLL to account for the rise of non-performing loans from the fourth quarter of 2007 to through the end of 2008. The defendants moved to dismiss.



In his September 10 order, Judge Duffey noted that the plaintiff’s allegations depend on their assertion that after the offering, and after the housing market deteriorated further, SunTrust raised its ALLL. The plaintiff, Judge Duffey observed, “thus seeks to assert its Securities Act claims using a backward-looking assessment that interprets, in the context of later events, the statements that Plaintiff has identified” as misleading.



Moreover, whether SunTrust had adequate loan loss reserves “is not a matter of objective fact, but rather a statement of SunTrust’s opinion regarding what portion of its loan portfolio would be uncollectable.” Judge Duffey commented that “Plaintiff only asserts that Sun Trust’s opinion with respect to its loan reserves was ill-founded and proved so by a later course of events.”



Judge Duffey noted that the plaintiff does not allege that the defendants did not hold the opinion it expressed in the financial statements when they were issued, and that “absent an allegation that the Defendants did not believe the statements,” the plaintiff has not stated a claim for misstatements relating to the inadequacy of the loan reserves.



Judge Duffey added that while he would allow the plaintiff to attempt to replead its loan loss reserve allegations, it will have to meet the heightened pleading standards required if the amended complaint alleges that the defendants knowingly or recklessly cause material misstatements to be published. He added that in the current complaint the plaintiff “appears to be attempting to have it both ways, that is, disavowing a claim for fraud to avoid the need to meet the heightened pleading standard, at the same time suggesting that SunTrust’s stated opinion was false because SunTrust knew or should have known that it was undercapitalized.”



Judge Duffey also found that the allegations in the complaint “fails to provide minimal factual content” to meet the requirements of Twombly and Iqbal, noting that the complaint “offers, at most, conclusory assertions, including that SunTrust’s ALLL and loan loss provisions were understated, as evidenced by the fact that SunTrust subsequently raised these figures after the economic downturn.” This “hindsight assessment” does not support an inference that “SunTrust’s financial assessments were false or misleading at the time they were made.” (emphasis in original).



Judge Duffey also granted the underwriter defendants’ and auditor’s motions to dismiss.





Prior decisions granting dismissal motion rulings in loan loss reserve cases have depended on the insufficiency of the complaint’s allegations relating to ’34 Act claims, particularly with respect to scienter. Refer, for example, to my recent post (here) discussing the dismissal of the loan loss reserve disclosure case involving Raymond James Financial.



The SunTrust Trust Preferred Securities case may be noteworthy because the loan loss reserve allegations were found to be insufficient event to satisfy the requirements for a ’33 Act claim, which do not have a scienter requirement. From Judge Duffey’s opinion, and his statement that the plaintiff may have been “trying to have it both ways,” the plaintiffs may have walked too fine of a line in trying avoid having their claims sound in fraud.



Judge Duffey’s firm rejection of what he interpreted as the plaintiff’s hindsight allegations is also interesting. The plaintiffs in many loan loss reserve cases will be fighting similar judicial impressions, especially to the extent that they plaintiffs cannot marshal facts suggesting that the defendants knew the loan loss reserves were insufficient.



Judge Duffey’s rejection of hindsight allegations may also be significant simply because of where his court is located. Georgia has been the leading state for bank failures since January 1, 2008, and many investors have filed actions alleging they were misled regarding the defendant bank’s financial conditions. To the extent Judge Duffey’s rejection of hindsight analysis reflects a larger sense of skepticism about alleged misrepresentations in the context of the subprime meltdown and global financial crisis, many of these investor actions could face an uphill battle.



In that regard, it is worth noting that Judge Duffey’s opinion follows the highly skeptical August 19, 2010 opinion of Judge Tom Thrash in the separate SunTrust subprime securities lawsuit, filed on behalf of SunTrust’s common shareholders. As discussed in a prior post, the opinion was particularly noteworthy for the harshness of the tone Judge Thrash used in dismissing the case. Though Judge Duffey’s opinion lacks the harsh tone, it seems to evince a similar level of skepticism.



Finally, it worth noting that the SunTrust Trust Preferred Securities case is one of numerous lawsuits filed amidst the subprime and credit crisis litigation wave that related to financial institutions’ trust preferred securities offerings, as discussed here. As noted in my prior post, many banks conducted these kinds of offerings in the years leading up to the financial crisis, and investors in these offerings have been active in seeking judicial relief following the meltdown.



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