The Case. A significant decision involving the sufficiency of federal securities fraud claims based on alleged misrepresentations concerning Wachovia Bank’s exposure on variable repayment mortgage practices was handed down in In re Wachovia Equity Securities Litigation, 08 Civ. 6171 (S.D.N.Y. March 31, 2011). In that case, Judge Richard J. Sullivan of the United States District Court for the Southern District of New York dismissed class action claims by purchasers of Wachovia stock.
The Allegations. Plaintiffs’ claims centered on alleged misrepresentations made by Wachovia and its executives concerning the company’s exposure on the Pick-A-Payment mortgage practice employed by Golden West Financial Corporation, a company acquired by Wachovia in October 2006. Pick-A-Payment allowed mortgage borrowers to choose from among multiple payment options each month, including the option of minimum payments that were insufficient to cover the monthly interest assessment, resulting in an increase of loan principal and negative amortization. Plaintiffs contended that defendants misrepresented the risks posed by the Pick-A-Payment practice from 2006 until early 2008, and that when the actual performance of the Pick-A-Payment loan portfolio was disclosed by Wachovia, the price of the company’s stock plummeted to less than $1 per share.
The Court’s Rationale. In holding that the federal securities fraud claims brought by purchasers of Wachovia stock under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 were insufficient to state a claim as a matter of law, Judge Sullivan ruled that plaintiffs had failed to sufficiently plead the element of scienter (intent to defraud) under the enhanced pleading standards adopted in the Private Securities Litigation Reform Act of 1995. The court reasoned that plaintiffs had failed to plead allegations supporting a motive to commit fraud by the defendants, and had failed to specify in their pleading the contrary information allegedly available to defendants at the time of the challenged public statements concerning Pick-A-Payment. Judge Sullivan summarized his holding on the scienter issue as follows:
“After examining the entirety of Plaintiffs’ scienter allegations, the Court finds that Plaintiffs have failed to plead facts giving rise to a strong inference that Defendants acted with the intent ‘to deceive, manipulate, or defraud.’ The more compelling inference, at least based on the facts as they are alleged in the complaints, is that Defendants simply did not anticipate the full extent of the mortgage crisis and the resulting implications for the Pick-A-Pay loan portfolio. Although a colossal blunder with grave consequences for many, such a failure is simply not enough to support a claim for securities fraud. Bad judgment and poor management are not fraud, even when they lead to the demise of a once venerable financial institution.”
Plaintiffs’ Remaining Claims. Despite granting defendants’ motion to dismiss the class action claims brought on behalf of purchasers of Wachovia stock, Judge Sullivan permitted certain securities claims under Sections 11 and 12(2) of the Securities Act by purchasers of Wachovia bonds and notes to proceed against Wachovia and its executives and certain underwriters involved in public offerings of Wachovia securities. Judge Sullivan also denied the motion to dismiss the Section 11 claim against Wachovia’s auditors, KPMG, concerning an audit report included in a Wachovia registration statement.