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holding that the disclaimer sufficiently prevented the allegations from sounding in fraud
Summary of this case from Lenartz v. Am. Superconductor Corp.Opinion
Civil No. 05-2148 (GAG).
November 6, 2006
OPINION AND ORDER
Lead plaintiffs Robert Fox, Marquita McLaughlin, and Plumbers and Pipefitters Local 51 Pension Fund brought this action individually and on behalf of all others similarly situated against First BanCorp, Angel Alvarez-Perez ("Alvarez"), Annie Astor-Carbonell ("Astor"), Laura Villarino-Tur ("Villarino"), and UBS Financial Services, Inc. of Puerto Rico ("UBS") alleging violations of federal securities laws. Plaintiffs' claims arise out of Sections 11, 12(a)(2), and 15 of the Securities Act of 1933 ("Securities Act"), 15 U.S.C. §§ 77k, 77l(a)(2), and 77o, and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 ("Exchange Act"), U.S.C. §§ 78j(b), and 78t(a). Defendants move to dismiss the plaintiffs' amended class action complaint pursuant to Fed.R.Civ.P. 12(b)(6) and 9(b) and the Private Securities Litigation Reform Act of 1995 ("PSLRA"), 15 U.S.C. § 78u-4(b). After reviewing the pleadings, the court denies the motion to dismiss as to the Section 11 claims against all of the defendants; the court grants the motion to dismiss as to the Section 12(a)(2) claims against defendants First BanCorp, Alvarez, Astor, and Villarino; the court denies the motion to dismiss as to the Section 12(a)(2) claims against defendant UBS; the court denies the motion to dismiss as to the Section 15 claims against defendants Alvarez, Astor, and Villarino; the court denies the motion to dismiss as to the Section 10(b) and Rule 10b-5 claims against defendants First BanCorp, Alvarez, Astor, and Villarino; and the court denies the motion to dismiss as to the Section 20(a) claims against defendants Alvarez, Astor, and Villarino.
I. Relevant Factual Background As Alleged in the Complaint
A. Parties
The lead plaintiffs in this consolidated class action suit purchased First BanCorp common stock between April 16, 2001 and December 13, 2005 (the "class period"). See Docket No. 14 at ¶ 23. First BanCorp is a Puerto Rico corporation that operates as the holding company for First Bank, which provides various financial services in Puerto Rico, the U.S. Virgin Islands, and British Virgin Islands. Id. at ¶ 24. During the class period, defendant Alvarez was the Chief Executive Officer and Chairman of the Board of Directors of First BanCorp; defendant Astor was Senior Executive Vice President and Chief Financial Officer of First BanCorp; defendant Villarino was Senior Vice President and Comptroller of First BanCorp until her retirement in May 2005; and defendant UBS was the lead underwriter of First BanCorp' Series E Preferred Stock Offering.Id. at ¶¶ 25-27, 29. Plaintiffs' claims center around First BanCorp's accounting treatment of certain mortgage transactions and interest-rate swaps.
All citations to the Complaint refer to the First Amended Consolidated Class Action Complaint filed on February 13, 2006.
B. Mortgage Transactions
During fiscal years 2001 through 2005, First BanCorp improperly classified mortgage transactions with Doral Financial Corp. ("Doral") and R G Financial Corp. ("R G) as sales from Doral and R G to First BanCorp rather than commercial loans secured by the mortgages from First BanCorp to Doral and R G. Id. at ¶¶ 3, 58. This accounting error violated the Generally Accepted Accounting Principles ("GAAP"). Id. at ¶¶ 3, 40, 58. By classifying the mortgage transactions as sales rather than loans, FirstBank was able to meet or exceed the capital requirements of a well-capitalized bank. Id. at ¶¶ 6, 50, 251. Achieving a well-capitalized status enabled First BanCorp to pledge the purchased mortgages as security to borrow money at a low cost from the Federal Home Loan Bank ("FHLB") and increase First BanCorp's business of brokering CDs. Id. at ¶¶ 4-7, 40, 45, 46, 50, 58, 219-221, 251, 256. To conceal the true nature of the mortgage transactions, First BanCorp received full recourse rights through side deals and oral agreements. Id. at ¶¶ 3, 40, 188, 201, 202.
During the class period, First BanCorp filed with the SEC annual and quarterly reports, which overstated First BanCorp's mortgage portfolio. Id. at ¶¶ 56, 61, 65, 70, 75, 79, 83, 87, 92, 96, 104, 111, 118, 122, 127, 134, 149, 228. Defendants Alvarez, Astor, and Villarino (the "individual defendants") signed these reports. Id. They also signed certifications attesting to the integrity of First BanCorp's financial statements. Id. at ¶¶ 87, 112, 142, 229. At all relevant times, the individual defendants had access to information regarding the improper accounting methods used by First BanCorp. Id. at ¶¶ 31, 244. They were part of Investment Committee for First BanCorp. Id. at ¶ 254. This committee monitored First BanCorp's investment portfolio. Id. It met on a weekly basis during the six years that First BanCorp had side deals and oral agreements with Doral and R G. Id. The meetings' focus included "reviews of liquidity, unrealized gains and losses in securities, recent or proposed changes to the investment portfolio, alternative funding sources and their costs, hedging and the possible purchase of derivatives such as swaps and caps, and any tax or regulatory issues which may be pertinent to these areas." Id.
The individual defendants were motivated by the prospect of receiving substantial incentive compensation that was tied directly to First BanCorp's reported net income. Id. at ¶¶ 256, 258. During the class period, Alvarez received discretionary cash bonuses totaling $3.1 million and options to purchase 555,000 shares of First BanCorp stock. Id. at ¶ 258. Astor received cash bonuses totaling $1,100,000 and options to purchase 111,000 shares of First BanCorp. Id. According to the Company's 2004 Proxy Statement, filed with the SEC on or about March 24, 2005, the awards to Alvarez were based, in part, on "the continued significant increases in First BanCorp's earnings . . . and the achievement of goals that are geared to ensure the Corporation's continued trend of earnings growth." Id.
Aside from this profit-based compensation, the individual defendants also benefitted financially during the class period by selling stock: Alvarez sold 400,000 shares for approximately $11.4 million; Astor sold 20,000 shares for approximately $640,000; and Villarino sold $30,000 shares for approximately $940,000. Id. at ¶ 257.
C. Interest-Rate Swaps
First BanCorp improperly used the short-cut method to account for interest-rate swaps. Id. at ¶ 211. This accounting error violated GAAP. Id. at ¶ 257. By using the short-cut method, First BanCorp inflated its net income by approximately $175 million.Id. at ¶¶ 8, 58, 214, 225. To reflect this unrealized loss, BanCorp will have to restate its fiscal-year 2001 to first-quarter 2005 financial statements. Id. at ¶ 214.
D. Public Offerings
During the time that First BanCorp reported improving financial results, it made three public offerings, which raised more than $350 million for the company. Id. at ¶¶ 60, 68, 100. Of particular importance to this case is the Series E Preferred Stock Offering. On September 26, 2003, First BanCorp filed with the SEC a Prospectus and Registration statement, dated September 25, 2003, in connection with a public offering of Series E stock.Id. at ¶ 99. This statement incorporated by reference previous filings with the SEC, including several Form 10-Q Reports, which overstated the value of First BanCorp's mortgage portfolio. Id.
E. Economic Loss
The prices of First BanCorp securities fell when the truth concerning the company's false and misleading statements was finally disclosed to the market. Id. at ¶ 232. From August 11, 2005, when First BanCorp announced that it was examining its mortgage transactions with Doral and R G, to December 13, 2005, the day First BanCorp announced its restatement, the company's stock dropped from $22.73 to $12.24, a decline of 46%. Id. at ¶ 239. Similarly, from October 25, 2005, the day that First BanCorp announced that it may have to restate its financial results, through November 9, 2005, the Series E, D, C Preferred Shares declined by approximately 18%, 15%, and 15%, respectively. This decline in stock prices damaged plaintiffs, who had purchased or acquired First BanCorp shares relying upon the integrity of the market price of First BanCorp securities and market information relating to First BanCorp. Id. at ¶ 240.
II. Standard of Review
When ruling on a motion to dismiss grounded on Rule 12(b)(6), the court will take the facts affirmatively alleged by plaintiff as true and construe the disputed facts in the light most favorable to the plaintiff without crediting conclusory allegations. See Berezin v. Regency Savings Bank, 234 F.3d 68, 70 (1st Cir. 2000);Ticketmaster-New York, Inc. v. Alioto, 26 F.3d 201, 203 (1st Cir. 1994). The court may grant dismissal only "if it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Roeder v. Alpha Indus, Inc., 814 F.2d 22, 25 (1st Cir. 1987) (quoting Conley v. Gibson, 355 U.S. 41, 45-46 (1957).
Because count five of plaintiffs' amended complaint has been brought under Section 10(b) and Rule 10b-5 of the Exchange Act, it is subject to the heightened pleading standards of Rule 9(b) and the PSLRA. Rule 9(b) provides that [i]n all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity." Fed.R.Civ.P. 9(b). In the securities context, Rule 9(b) is applied strictly. Serabian v. Amoskeag Bank Shares, Inc., 24 F.3d 357, 361 (1st Cir. 1994) (citing New England Data Services v. Becher, 829 F.2d 286, 288 (1st Cir. 1987). It requires a plaintiff in a securities fraud case to specify the time, place, and content of an alleged false representation. Romano v. Shearson Lehman Hutton, 929 F.2d 875, 878 (1st Cir. 1991) (citing Wayne Investment v. Gulf Oil Corp., 739 F.2d 11, 13 (1st Cir. 1984).
The plaintiffs' amended complaint does not contain a count one.
Relevant to this case, the PSLRA requires that a complaint "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." 15 U.S.C. § 78u-4(b)(2). To determine whether a complaint satisfies the PSLRA, the court must perform "an individualized assessment that sweeps before it the totality of the facts in a given case.In re Credit Suisse First Boston Corp., 431 F.3d 36, 46 (1st Cir. 2005). The PSLRA's pleading standard is "congruent and consistent" with the First Circuit's pre-existing Rule 9(b) pleading standards. In re Stone Webster, Inc., Sec. Litig., 414 F.3d 187, 195 (1st Cir. 2005). Although these standards are rigorous, they do not change the standard of review for a motion to dismiss. Aldridge v. A.T. Cross Corp., 284 F.3d 72, 78 (1st Cir. 2002).
III. Legal Analysis
A. Claim under Section 11 of the Securities Act
Section 11 of the Securities Act imposes liability on signers of a registration statement and on underwriters, among others, if the registration statement, at the time it became effective, "contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading." 15 U.S.C. § 77k(a). Plaintiff Marquita McLaughlin, the only lead plaintiff bringing a Section 11 claim, alleged that defendants violated Section 11 because the Series E Registration Statement/Prospectus contained untrue statements or omitted material facts. See Docket No. 14 at ¶ 270. Defendants have moved to dismiss this claim on three grounds.
1. Rule 9(b)
Defendants First BanCorp, Alvarez, Astor, and Villarino (the "First Bancorp defendants") moved to dismiss the Section 11 claim on the ground that plaintiffs failed to plead with the particularity required by Fed.R.Civ.P. 9(b). Fraud is not an element of a Section 11 claim. See Shaw v. Digital, 82 F.3d 1194, 1223 (1st Cir. 1996). However, a complaint asserting a Section 11 violation may sound in fraud. See Haft v. Eastland Financial Corp., 755 F.Supp 1123, 1126 (D.R.I. 1991). Such complaints trigger the particularity requirements of Rule 9(b). See Shaw, 82 F.3d at 1223.
The plaintiffs' complaint expressly disclaimed any allegations that sound in fraud concerning the claims under the Securities Act. See Docket No. 14 at ¶¶ 268, 278. This disclaimer prevents the complaint from sounding in fraud and the application of Rule 9(b). See In re Number Nine Visual Tech. Corp. Sec. Litig., 51 F.Supp.2d 1, 12 (D. Mass. 1999) (holding that the "disclaimer of fraud-type allegations" was effective "to prevent the Securities Act claims from sounding in fraud").
2. Materiality
Defendant Alvarez moved to dismiss the Section 11 claim on the ground that the alleged misrepresentations about the mortgage-related transactions are not material. In the securities law context, information is material if "there is a reasonable likelihood that a reasonable investor would consider it important." Glassman v. Computervision Corp., 90 F.3d 617, 632 (1st Cir. 1996); see also Shaw, 82 F.3d at 1219 (citing Basic Inc. v. Levinson, 485 U.S. 224, 231-32 (1988)). The materiality of a particular statement is a question of fact that ordinarily is inappropriate for decision on a motion to dismiss and should instead be resolved by a jury. In re Cabletron Sys., Inc., 311 F.3d 11, 34 (1st Cir. 2002).
Plaintiffs alleged in their complaint that on September 26, 2003, First BanCorp filed with the SEC a Prospectus and Registration statement, dated September 25, 2003, in connection with a public offering of Series E stock. See Docket No. 14 at ¶ 99. This statement incorporated by reference previous filings with the SEC, including several Form 10-Q Reports. Plaintiffs claim that these reports overstated the value of First BanCorp's mortgage portfolio. Id. at ¶ 58. Reasonable investors could very well find information regarding First BanCorp's mortgage portfolio important in deciding whether to buy the Series E stock. First BanCorp's ability to use the mortgages as collateral to secure funding from the FHLB can affect the company's bottom line, and in turn change the expected return on an investment. Indeed, the negative reaction of the stock market to the eventual disclosure of the accounting error in the mortgage transactions is itself an indicia of materiality. See SEC v. MacDonald, 699 F.2d 47, 49-50 (1st Cir. 1983) (en banc). Thus, the Court cannot conclude as a matter of law that reasonable investors would not have considered the value of the company's mortgage portfolio material information.
3. Reliance
Defendant UBS moved to dismiss the Section 11 claim on the ground that plaintiffs did not allege reliance on the registration statement. Section 11 requires proof of reliance for investors who acquire securities "after the issuer has made generally available . . . an earning statement covering a period of at least twelve months beginning after the effective date of the registration statement." 15 U.S.C. § 77k(a).
The plaintiffs' complaint incorporated by reference a certification filed by plaintiff Marquita McLaughlin. See Docket No. 14. In this certification, plaintiff McLaughlin stated that she purchased 72,000 of Series E shares on September 25, 2003. In its motion to dismiss, UBS introduced documentary evidence showing that Marquita McLaughlin acquired her shares from Tita Corporation on August 31, 2005. UBS argued that because plaintiff McLaughlin acquired her shares almost two years after the stock offering, she cannot allege that she relied on the registration statement. In this case, a factual dispute exists as to when plaintiff McLaughlin purchased her Series E shares. Because this is a motion to dismiss, the Court construes this disputed fact in the light most favorable to plaintiff. Accordingly, plaintiffs were not required to plead reliance in their Section 11 claim. Because discovery has been stayed in this case pursuant to Section 21D(b)(3)(B) of the Exchange Act, as amended by the PSLRA, 15 U.S.C. § 78u 4(b)(3)(B), the court declines defendant UBS's invitation to convert this motion to dismiss into a motion for summary judgment.
B. Claim under Section 12(a)(2) of the Securities Act
Section 12(a)(2) of the Securities Act imposes liability on sellers of a security who have imparted material misstatements or failed to disclose material facts concerning the security by means of a prospectus or oral communication. See 15 U.S.C. § 77l(a)(2). Plaintiff Marquita McLaughlin, the only lead plaintiff bringing a Section 12(a)(2) claim, alleged that defendants violated Section 12(a)(2) because the Series E Registration Statement/Prospectus contained untrue statements or omitted material facts. See Docket No. 14 at ¶ 281. Defendants have moved to dismiss this claim on three grounds.
1. Standing
The First BanCorp defendants moved to dismiss the Section 12(a)(2) claim on the ground that plaintiffs purchased the Series E stock not from First BanCorp, but rather from an underwriter. A plaintiff has standing to bring a Section 12(a)(2) claim only against the person or entity from whom he directly purchased the security. See Shaw, 82 F.3d at 1215. In a firm commitment offering, "the issuer of the securities sells all the shares to be offered to one or more underwriters, at some discount from the offering price." Id. When title passes in this way, "[the company] and its officers cannot be held liable as seller under Section 12(2) unless they actively `solicited' the plaintiffs' purchase of securities to further their own financial motives, in the manner of a broker or vendor's agent."In re Sonus Networks, Inc. Sec. Litig., 2006 WL 1308165 at *10 (D. Mass. 2006) (quoting Shaw, 82 F.3d at 1215).
Prior to the PSLRA, Section 12(a)(2) of the Securities Act was Section 12(2).
Plaintiffs' complaint states that [u]nder the terms and conditions of the underwriting agreement, First BanCorp was obligated to sell, and the Underwriters were obligated to purchase, all 6.6 million shares of the Series E Preferred Stock." See Docket No. 14 at ¶ 100. The sale of Series E shares pursuant to an underwriting agreement means that First BanCorp was not a statutory seller. See Shaw, 82 F.3d at 1215. Nevertheless, the First BanCorp defendants can still be liable under Section 12(a)(2) if they actively solicited plaintiffs to purchase the Series E shares. Plaintiffs argue that the First BanCorp defendants engaged in active solicitation because they prepared the registration statement and prospectus that were provided to purchasers in the Series E offering and because they stood to derive financial benefits from the Series E offering. However, "neither involvement in preparation of a registration statement or prospectus nor participation in `activities' relating to the sale of securities, standing alone, demonstrates the kind of relationship between defendant and plaintiff that could establish statutory seller status. Id. at 1216 (emphasis in original) (citing Pinter v. Dahl, 486 U.S. 622, 650-51 (1988)). Similarly, plaintiffs' general and conclusory allegations that the defendants stood to gain financially from the Series E offering are insufficient to state a viable claim against defendants under section 12(a)(2). Lalor v. Omtool, Ltd., 2000 WL 1843247 at *8 (D.N.H. 2000).
Defendant UBS argues that plaintiffs' Section 12(a)(2) claim should be dismissed because plaintiff McLaughlin did not acquire her Series E shares from UBS in the public offering in September of 2003. Instead, UBS contends, plaintiff McLaughling acquired her Series E shares from Tita Corporation on August 31, 2005. As metioned previously, plaintiff McLaughlin stated in a certification incorporated in plaintiffs' complaint that she purchased 72,000 of Series E shares on September 25, 2003. See Docket No. 14. Construing this disputed fact in the light most favorable to plaintiff, as the court is required to in a motion to dismiss, the court concludes that plaintiffs have standing to bring a Section 12(a)(2) claim against UBS.
2. Rule 9(b)
The First BanCorp defendants moved to dismiss the Section 12(a)(2) claim on the ground that plaintiffs failed to plead with the particularity required by Fed.R.Civ.P. 9(b). Complaints asserting Section 12(a)(2) violations that sound in fraud trigger the particularity requirements of Rule 9(b). See Shaw, 82 F.3d at 1223. Because plaintiffs' complaint does not sound in fraud (see section III. A. 1.), the complaint is not subject to the heightened pleading standards of Rule 9(b).3. Materiality
Defendants Alvarez and Villarino moved to dismiss the Section 12(a)(2) claim on the ground that the alleged misrepresentations about the mortgage-related transactions are not material. Because a reasonable investor could find information regarding First BanCorp's mortgage portfolio important in deciding whether to buy the Series E stock (see section III. A. 2. supra), the court cannot conclude that the alleged misrepresentations in the registration statement and prospectus are not material.
C. Claim under Section 15 of the Securities Act
Section 15 of the Securities Act imposes derivative liability upon persons who control those liable under Sections 11 and 12.See 15 U.S.C. § 77o. The elements of control person liability under Section 15 are: (i) an underlying violation of Section 11 or 12 and (ii) control of the primary violator by the defendant.See In re Stone, 414 F.3d at 194; Cooperman v. Individual Inc., 171 F.3d 43, 52 (1st Cir. 1999). Plaintiffs alleged that the individual defendants violated Section 15 because they controlled First BanCorp and caused it to engage in acts that violated Section 11 and 12. See Docket No. 14 at ¶¶ 287-88. The individual defendants have moved to dismiss this claim on three grounds.
1. Primary violation
The individual defendants moved to dismiss the Section 15 claim on the ground that plaintiffs have not pled a primary violation of Section 11 or 12 of the Securities Act. Having found that plaintiffs pled a viable Section 11 violation (see section III. A. supra), the Court finds that plaintiffs have pled a primary violation for Section 15 purposes.
2. Control of primary violator
The individual defendants' second ground for dismissing the Section 15 claim is that plaintiffs have failed to allege sufficient facts from which it can be inferred that defendants controlled First BanCorp. The control prong requires a showing that defendants had the general power to control the company and actually exercised control over the company. Aldridge, 284 F.3d at 85; Sheinkopf v. Stone, 927 F.2d 1259, 1270 (1st Cir. 1991). Control is question of fact "that will not ordinarily be resolved summarily at the pleading stage. The issue raises a number of complexities that should not be resolved on such an underdeveloped record." Cabletron 311 F.3d at 41 (quoting 2 T.L. Hazen, Treatise on the Law of Securities Regulation § 12.24(1) (4th ed. 2002)).
Plaintiffs' allegations regarding defendants' control over First BanCorp are sufficient to meet the pleading requirements of Section 15's control prong. Plaintiffs alleged in their complaint that the individual defendants at all relevant times:(i) had the power to control First BanCorp by virtue of their management positions; (ii) had access to internal company documents; (iii) signed annual and quarterly reports filed with the SEC; (iv) owned First BanCorp stock; and (v) signed certifications attesting to the integrity of First BanCorp's financial statements and internal controls. Taken together, these allegations sufficiently plead facts from which it can be inferred that the individual defendants had the general power to control First BanCorp and actually exercised control over First BanCorp. See Quaak v. Dexia, S.A., 445 F. Supp.2d 130, 148-49 (D. Mass. 2006) (denying defendant's motion to dismiss control person liability claim because plaintiffs alleged that defendant had almost complete control over company's day-to-day operations); In re Stocker Yale, 2006 WL 2772581 at *15 (D.N.H. 2006, September 27, 2006) (denying defendant's motion to dismiss control person liability claim because plaintiffs alleged that defendants were officers of the company, were responsible for the day-to-day management of the company, possessed power and authority to control the content of allegedly misleading press releases, and had seen allegedly misleading press releases before they were issued).
Although Quaak and Yale were decided under Section 20(a) of the Exchange Act instead of under Section 15 of the Securities Act, control person liability is given identical interpretations under both federal statutes. Durham v. Kelly, 810 F.2d 1500, 1503 (9th Cir. 1987).
3. Culpable Participation
Defendant Alvarez moved to dismiss the Section 15 claim on the ground that plaintiffs did not plead that defendants were culpable participants in the alleged fraud. Some courts have indicated that plaintiffs must prove culpable participation on the part of the controlling person to sustain a control person liability claim. See SEC v. First Jersey Sec., Inc., 101 F.3d 1450, 1472 (2d Cir. 1996); Rochez Bros., Inc. v. Rhoades, 527 F.2d 880, 890 (3d Cir. 1975). Other circuits have expressly rejected the element. See Hollinger v. Titan Capital Corp., 914 F.2d 1564 (9th Cir. 1990); Harrison v. Dean Witter Reynolds, Inc., 79 F.3d 609, 614 (7th Cir. 1996). To date, the First Circuit has yet to rule on whether culpable participation is an element necessary to sustain a claim under Section 15 of the Securities Act and Section 20(a) of the Exchange Act. See In re Stone, 414 F.3d at 194 n. 4; Aldridge, 284 F.3d.at 85.It is not necessary at this time to decide whether culpable participation is a required element of a control person liability claim because even if such requirement existed, plaintiffs sufficiently pled it. The complaint alleged that defendants signed annual and quarterly reports filed with the SEC which contained untrue statements and signed certifications attesting to the integrity of First BanCorp's financial statements and internal controls even though such controls suffered from material weaknesses. These facts support an inference that defendants were culpable participants in the alleged fraud. See In re Stone Webster, Inc., Sec. Litig., 253 F. Supp.2d 102, 135 (D. Mass. 2003) (finding that if culpable participation is a required element of a control person liability claim, plaintiffs sufficiently pled it by alleging that defendants reviewed account payable reports which contained material misrepresentations) (affirmed in part, vacated in part (on other grounds), 414 F.3d 187 (1st Cir. 2005)).
D. Claim under Section 10(b) and Rule 10b-5 of the Exchange Act
Section 10(b) and Rule 10b-5 of the Exchange Act provide that it is unlawful for any person to commit fraud in connection with the purchase or sale of securities. See 15 U.S.C. § 78j(b); 17 C.F.R. § 240.10b-5. The elements of a claim under Section 10(b) and Rule 10b-5 are: (i) a material misrepresentation [or omission]; (ii) made with scienter, (3) in connection with the purchase or sale of a security; (iv) reliance; (v) economic loss; and (6) loss causation. In re Stone, 414 F.3d at 193 (citing Dura Pharm., Inc. v. Broudo, 544 U.S. 336, 341-42 (2005). Plaintiffs alleged that the First BanCorp defendants violated Section 10(b) and Rule 10b-5 because they issued materially false statements about First BanCorp's mortgage portfolio and financial conditions. These mistatements artificially inflated the price of First BanCorp securities. Plaintiffs bought First BanCorp shares relying on the First BanCorp defendants' mistatements and the integrity of the market and suffered damages when the truth of the mistatements was exposed. See Docket No. 14 at ¶¶ 3-18. The First BanCorp defendants have moved to dismiss this claim on two grounds.
1. Rule 9(b) and PSLRA
The First BanCorp defendants moved to dismiss the Section 10(b) and Rule 10b-5 claim on the ground that plaintiffs failed to plead scienter under the heightened pleading standards of Rule 9(b) and the PSLRA. Scienter is "a mental state embracing the intent to deceive, manipulate or defraud." Ernst Ernst v. Hochfelder, 425 U.S. 185, 193-94 n. 12 (1976). Plaintiffs may meet the scienter requirement by allegations of knowing or reckless conduct. Cabletron, 311 F.3d at 38-40. In evaluating such allegations, the "scienter must be reasonable and strong, but need not be irrefutable." Id. at 38. To show a strong inference of scienter, as required by the PSLRA, "the plaintiff may combine various facts and circumstances indicating fraudulent intent," including those demonstrating motive and opportunity.Aldridge, 284 F.3d at 82.
Plaintiffs' allegations regarding First BanCorp's scienter are sufficient to meet the heightened pleading standards of Rule 9(b) and the PSLRA. Plaintiffs alleged in their complaint that: (i) First BanCorp repeatedly violated GAAP by improperly classifying the mortgage transactions with Doral and R G as purchases rather than loans; (ii) First BanCorp was motivated by a desire to achieve a well-capitalized status, borrow money at a low cost from FHLB, and increase its business of brokering CDs; (iii) First BanCorp concealed the true nature of the mortgage transactions through side deals and oral agreements; (iv) First BanCorp filed with the SEC annual and quarterly reports, which overstated First BanCorp's mortgage portfolio; (v) First BanCorp violated GAAP through the use of improper hedge accounting for interest-rate swaps; (vi) this accounting error in the treatment of interest-rate swaps enabled First BanCorp to inflate its net income by approximately $175 million, and (vii) during the time that First BanCorp reported improving financial results, it made three public offerings, which raised more than $350 million for the company. Taken together, these allegations raise a strong inference that First BanCorp acted with scienter. See Aldridge, 284 F.3d at 82 (motive and opportunity may be used to show a strong inference of scienter); Greebel, 194 F.3d at 203 (significant GAAP violations may provide evidence of scienter); In re Raytheon Sec. Litig., 157 F.Supp.2d 131, 147-48 (D. Mass 2001) (GAAP violations combined with large accounting overstatements may provide strong inference of scienter).
Similarly, plaintiffs' allegations regarding the individual defendants' scienter are sufficient to meet the heightened pleading standards of Rule 9(b) and the PSLRA. Plaintiffs alleged in their complaint that: (i) the individual defendants had access to information regarding the improper accounting methods used by First BanCorp due to their executive and managerial positions; (ii) having access to this information, the individual defendants signed annual and quarterly reports filed with the SEC that contained untrue statements and signed certifications attesting to the integrity of First BanCorp's financial statements and internal controls even though the controls suffered material weaknesses; (iii) the individual defendants were motivated by the prospect of receiving substantial incentive compensation that was tied directly to First BanCorp's reported net income; and (iv) the individual defendants engaged in insider trading. Taken together, these allegations support a strong inference that defendants acted with scienter. See Cabletron, 311 F.3d at 41 (holding that plaintiffs sufficiently pled scienter by alleging that defendant officers had access to information contrary to the company's public statements, participated in a number of statements, including signing several reports filed with the SEC, and made significant stock sales).
2. Materiality
Defendants Alvarez and Astor moved to dismiss the Section 10(b) and Rule 10b-5 claim on the ground that the alleged mistatements about the mortgage transactions are not material. Because a reasonable investor could find information regarding First BanCorp's mortgage portfolio important in deciding whether to buy First BanCorp stock (see section III. A. 2. supra), the court cannot conclude that the alleged mistatements about the mortgage transactions are not material.
E. Claim under Section 20(a) of the Exchange Act
Section 20(a) of the Exchange Act imposes derivative liability upon persons who control those liable under a provision of the Exchange Act. See 15 U.S.C. § 78t(a). The elements of control person liability under Section 20(a) are: (i) an underlying violation of the same chapter of the securities laws and (ii) control of the primary violator by the defendant. See In re Stone, 414 F.3d at 194. Plaintiffs alleged that the individual defendants violated Section 20(a) because they controlled First BanCorp and caused it to engage in acts that violated Section 10(b) and Rule 10b-5 of the Exchange Act.
The individual defendants have moved to dismiss this claim on the ground that plaintiffs have not pled a primary violation, control of the primary violator, and culpable participation. Having found that plaintiffs pled a viable Section 10(b) and Rule 10b-5 claim (see Section III. D. supra), the court finds that plaintiffs have pled a primary violation for Section 20(a) purposes. Similarly, given that plaintiffs sufficiently pled control and culpable participation (if culpable participation is an element of control person liability) under Section 15, the court finds that plaintiffs adequately pled control and culpable participation under Section 20(a). This is appropriate because control person liability is given identical interpretations under Section 15 of the Securities Act and Section 20 of the Exchange Act. See Durham, 810 F.2d at 1503.
IV. Conclusion
For the foregoing reasons, defendants' motion to dismiss as to the Section 11 claims against all of the defendants is denied (Docket Nos. 41, 42, 44, 47, 102); the motion to dismiss as to the Section 12(a)(2) claims against defendants First BanCorp, Alvarez, Astor, and Villarino is granted (Docket Nos. 41, 42, 44, 102); the motion to dismiss as to the Section 12(a)(2) claims against defendant UBS is denied (Docket No. 47); the motion to dismiss as to the Section 15 claims against defendants Alvarez, Astor, and Villarino is denied (Docket Nos. 41, 44, 102); the motion to dismiss as to the Section 10(b) and Rule 10b-5 claims against defendants First BanCorp, Alvarez, Astor, and Villarino is denied (Docket Nos. 41, 42, 44, 102); and the motion to dismiss as to the Section 20(a) claims against defendants Alvarez, Astor, and Villarino is denied (Docket Nos. 41, 44, 102).