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LITE DEPALMA GREENBERG & RIVAS, LLC
Joseph J. DePalma
Katrina Carroll
Two Gateway Center, 12th Floor
Newark, NJ 07102-5003
Telephone: (973) 623-3000
Facsimile: (973) 623-0858
jdepalma@ldgrlaw.com
Liaison Counsel for Lead Plaintiff
UNITED STATES DISTRICT COURT
DISTRICT OF NEW JERSEY
____________________________________
KAREN M. BAUER, Individually and on ) Civil Action No. 09-1120-JLL
Behalf of All Others Similarly Situated, )
)
Plaintiff, )
vs. )
)
PRUDENTIAL FINANCIAL, INC., et al. )
)
Defendants. )
____________________________________)
NOAH HADDOCK, Individually and on )
Behalf of all Others Similarly Situated, ) Civil Action No. 09-1771-JLL
)
Plaintiff, )
vs. )
)
PRUDENTIAL FINANCIAL, INC., et al. )
)
Defendants. )
____________________________________)
PLAINTIFF’S MEMORANDUM OF LAW IN OPPOSITION TO THE
PRUDENTIAL DEFENDANTS’ AND THE UNDERWRITER DEFENDANTS’
MOTIONS TO DISMISS THE CONSOLIDATED
AMENDED CLASS ACTION COMPLAINT
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TABLE OF CONTENTS
TABLE OF AUTHORITIES ...................................................................... iii
I. INTRODUCTION..................................................................................1
II. THE OFFERING ...................................................................................3
III. STANDARD OF REVIEW ON A MOTION TO DISMISS ..................5
IV. ARGUMENT ........................................................................................6
A. The Elements Of A Section 11 Claim..............................................7
1. Liability Under Section 11 Is “Virtually Absolute” ....................7
2. Liability For Omission of Material Facts Pursuant
To Item 303..............................................................................10
B. Defendants Misrepresented The Existence Of Material
Litigation Concerning The Auction Rate Securities Market ..........11
1. Plaintiffs’ Allegations Concerning Defendants’ Material
Misrepresentations and Omissions Concerning the Joint
Venture Litigation State A Claim ..............................................11
2. Defendants’ Arguments Are Without Merit...............................16
C. Defendants Misrepresented The Amount of Money Required
To Pay For Prudential’s Annuity Obligations And Deferred
Policy Acquisition Costs ...............................................................24
1. Plaintiff Alleges Material Misrepresentations and Omissions
Concerning the Cost of Funding Prudential’s Annuity and
Deferred Acquisition Costs ......................................................24
2. Defendants’ Arguments Are Without Merit..............................26
D. Plaintiff’s Impairment Allegations State a Claim ..........................30
1. Plaintiff’s Allegations Concerning Other-Than Temporary
Impairments of Prudential’s Assets State A Claim ...................30
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2. Defendants’ Arguments Are Without Merit..............................32
E. Plaintiff Has Properly Pled Compensable Loss ..............................36
F. The Complaint States A Claim Against The Individual
Defendants And The Underwriter Defendants...............................38
G. The Complaint States A Control Person Claim Against The
Individual Defendants ...................................................................39
V. CONCLUSION.....................................................................................40
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TABLE OF AUTHORITIES
Cases
Angres v. Smallworldwide PLC,
94 F. Supp. 2d 1167 (D. Colo. 2000).................................................................... 33
Ashcroft v. Iqbal,
__ U.S. __, 129 S. Ct. 1937 (2009)......................................................................... 6
Basic v. Levinson,
485 U.S. 224 (1988).............................................................................................. 21
Berson v. Applied Signal Tech., Inc.,
527 F.3d 982 (9th Cir. 2008)................................................................................. 23
Cafaro v. HMC Intern., LLC,
No 07-2793, 2009 WL 1622825 (D.N.J. June 10, 2009) ......................................... 5
Caviness v. Derand Resources Corp.,
983 F.2d 1295 (4th Cir. 1993) ............................................................................... 14
Foman v. Davis,
371 U.S. 178 (1962).............................................................................................. 40
Ganino v. Citizens Utilities Co.,
228 F.3d 154 (2d Cir. 2000) ................................................................. 17, 19, 21, 31
Gustafson v. Alloyd Co.,
513 U.S. 561 (1995).............................................................................................2, 7
Herman & MacLean v. Huddleston,
459 U.S. 375 (1983)........................................................................................passim
Huddleston v. Herman & MacLean,
640 F.2d 534 (5th Cir. 1981) ...........................................................................35, 36
Hutchinson v. CBRE Realty Finance, Inc.,
638 F. Supp. 2d 265 (D. Conn. 2009)...................................................................... 9
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In re Adams Golf, Inc. Sec. Litig.,
176 F. Supp. 2d 216 (D. Del. 2001)..................................................................28, 29
In re Adams Golf, Inc. Sec. Litig.,
381 F.3d 267 (3d Cir. 2004) ...................................................................8, 21, 28, 29
In re Adams Golf, Inc. Sec. Litig.,
618 F. Supp. 2d 343 (D. Del. 2009)...................................................................... 10
In re Arbinet-thexchange, Inc. Sec. Litig.,
No. 05-4404, 2006 WL 3831396 (D.N.J. Dec. 28, 2006) ...................................8, 10
In re Burlington Coat Factory Sec. Litig.,
114 F.3d 1410 (3d Cir. 1997) ................................................................................ 26
In re Cigna Corp. Sec. Litig.,
459 F. Supp. 2d 338 (E.D. Pa. 2006)..................................................................... 28
In re Constar Int’l, Inc. Sec. Litig.,
585 F.3d 774 (3d Cir. 2009) ............................................................................passim
In re Countrywide Fin. Corp. Sec. Litig.,
588 F. Supp. 2d 1132 (C.D. Cal. 2008) ................................................................. 39
In re Par Pharmaceutical Sec. Litig.,
733 F. Supp. 668 (S.D.N.Y. 1990) ........................................................................ 33
In re PMA Capital Corp. Sec. Litig.,
No. 03-6121, 2005 WL 1806503 (E.D. Pa. July 27, 2005) .................................... 39
In re Suprema Specialties, Inc. Sec. Litig.,
438 F.3d 256 (3d Cir. 2006) .........................................................................8, 16, 38
In re ValueVision Intern., Inc. Sec. Litig.,
896 F. Supp. 434 (E.D. Pa. 1995).......................................................................... 33
In re Vonage Initial Public Offering Sec. Litig,
No. 07-177, 2009 WL 936872 (D.N.J. April 6, 2009) ........................................9, 13
Kusner v. First Pennsylvania Corp.,
531 F.2d 1234 (3d Cir. 1976) ................................................................................ 22
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Lormand v. US Unwired, Inc.,
565 F.3d 228 (5th Cir. 2009)................................................................................. 35
Luminent Mortg. Captial, Inc. v. Merrill Lynch & Co.,
No. 07-5423, 2009 WL 2590087 (E.D. Pa. Aug. 20, 2009) ................................... 37
Makor Issues & Rights, Ltd. v. Tellabs Inc.,
437 F.3d 588 (7th Cir. 2006)................................................................................. 35
No. 84 Employer-Teamster Joint Council Pension Trust Fund
v. Am. West Holding Corp.,
320 F.3d 920 (9th Cir. 2003)................................................................................. 23
Ottmann v. Hanger Orthopedic Group, Inc.,
353 F.3d 338 (4th Cir. 2003)................................................................................. 28
Oxford Asset Management, Ltd. v. Jaharis,
297 F.3d 1182 (11th Cir. 2002) ............................................................................... 6
Rubenstein v. Collins,
20 F.3d 160 (5th Cir. 1994)................................................................................... 36
Shapiro v. UJB Fin. Corp.,
964 F.2d 272 (3d Cir. 1992) .................................................................................. 20
Siracusano v. Matrixx Initiatives, Inc.,
585 F.3d 1167 (9th Cir. 2009) ............................................................................... 13
TSC Industries v. Northway, Inc.,
426 U.S. 438 (1976).............................................................................................. 20
Zell v. InterCapital Income Sec., Inc.,
675 F.2d 1041 (9th Cir. 1982) ............................................................................... 14
Statutes
15 U.S.C. § 77k(a) ................................................................................................7, 38
15 U.S.C. §§ 77k and 77o .......................................................................................... 2
15 U.S.C. §77k(b).............................................................................................8, 9, 38
15 U.S.C. §77k(e) .................................................................................................... 36
15 U.S.C. §77o ........................................................................................................ 39
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Rules
Fed. R. Civ. P. 12(b)(6)...........................................................................................5, 9
Fed. R. Civ. P. 15(a) ................................................................................................ 40
Fed. R. Civ. P. 9......................................................................................................... 6
Regulations
17 C.F.R. §229.303(a)(3)(ii) .................................................................................... 10
17 C.F.R. 229.103.................................................................................................... 19
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Lead Plaintiff Paul J. Perry, Trustee of the Paul J. Perry Revocable Trust
(“Plaintiff”), on behalf of himself and all others similarly situated, respectfully
submits this Memorandum of Law in Opposition to the Motions to Dismiss the
Consolidated Amended Class Action Complaint (the “Complaint”) filed by (i) the
Prudential Defendants [Doc. #57-1] (“Prud. Mem.”)1 and (ii) the Underwriter
Defendants [Doc. #58-1] (“Und. Mem.”) (collectively, the “Motions”).2
I. INTRODUCTION
On June 24, 2008 – just four business days before the end of the second quarter
ended June 30, 2008 – Defendants obtained over $920 million dollars from Class
Members in an initial public offering (the “Offering”) of 9% Junior Subordinated
Notes (the “Notes”) offered at $25 per Note through a registration statement and
prospectus (the “Registration Statement”). The Registration Statement contained
several material misrepresentations and omissions. First, the Registration Statement
misrepresented and concealed the existence of material litigation against a Prudential
1 The Prudential Defendants are Arthur F. Ryan, Richard J. Carbone, Peter B. Sayre,
Dennis G. Sullivan, Frederic K. Becker, Gordon M. Bethune, Gaston Caperton,
Gilbert F. Casellas, James G. Cullen, William H Gray III, Jon F. Hanson, Constance
J. Horner, Karl J. Krapek, and James A. Unruh (the “Individual Defendants”) (¶¶ 10-
23), together with Prudential Financial, Inc. (“Prudential”).
2 The Underwriter Defendants are Citigroup Global Markets Inc.; Merrill Lynch,
Pierce, Fenner & Smith Inc.; Morgan Stanley & Co. Inc.; UBS Securities LLC;
Wachovia Capital Markets LLC; Banc of America Securities LLC; RBC Capital
Markets Corp,; and J.P Morgan Securities Inc. (¶¶25-32).
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joint venture arising out of Prudential’s involvement in the collapse of the Auction
Rate Securities (“ARS”) market. Only after the Offering did Defendants disclose the
litigation which Prudential has paid $235 million to date to resolve in part. Second,
the Registration Statement understated the amount of Prudential’s liability in
connection with its annuity obligations and deferred acquisition costs by up to $380
million by misrepresenting the amount of money necessary to fund those obligations.
Finally, the Registration Statement materially understated by approximately $205
million the amount of Prudential’s assets that had declined in value by more than
50% in the period preceding the Offering. In total, the Registration Statement
overstated Prudential’s reported pre-tax income by approximately $820 million; as a
result, instead of the $69 million in net income reported, Defendants should have
reported a net loss of approximately $454 million.
Plaintiff is entitled to relief under the liberal liability provisions for initial
public offerings under §§ 11 and 15 of the Securities Act of 1933 (the “Securities
Act”), 15 U.S.C. §§ 77k and 77o. Plaintiff need not prove “either fraud or reliance on
those whose moral responsibility to the public is particularly heavy – the originators
of securities.” Gustafson v. Alloyd Co., 513 U.S. 561, 582 (1995) (internal citations
omitted). Consequently, a Defendant need not have acted with knowledge or
scienter, nor must Plaintiff prove causation. Herman & MacLean v. Huddleston, 459
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U.S. 375, 381-82 (1983). Moreover, the amount of liability is clear. On the day this
litigation was filed on March 4, 2009, the Notes had decreased in value from $25 per
Note to only $13.04 per Note, a decrease of almost 48%.
Defendants seek to dismiss Plaintiff’s claims based upon fact-bound arguments
that are contrary to the express allegations in the Complaint and, at most, raise
disputed issues of fact. In addition to challenging the materiality of the
misrepresentations in the Registration Statement (which courts routinely hold is
uniquely inappropriate for resolution on a motion to dismiss), Defendants repeatedly
challenge whether the alleged misrepresentations in the Registration Statement were
false when made by ignoring the factual allegations in the Complaint. Consequently,
Defendants’ factual arguments should be rejected and their motions to dismiss
denied.
II. THE OFFERING
On June 24, 2008, Defendants conducted an initial public offering (the “IPO”
or the “Offering”). ¶¶3, 41.3 In the Offering, Prudential sold 36.8 million 9% Junior
Subordinated notes (the “Notes” or “Securities”) at $25 per Note. ¶1, 3. Prudential
raised over $920 million. ¶3. Curiously, Prudential scheduled the Offering for only
3 All references to “¶_” herein are to Plaintiff’s Complaint.
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four business days before the end of Prudential’s second fiscal quarter on June 30,
2008. ¶41.4
On June 24, 2008, Prudential filed a prospectus supplement for the Offering
(the “Prospectus Supplement”). ¶41. The Prospectus Supplement expressly
incorporated by reference, inter alia, Prudential’s quarterly report for the quarter
ended March 31, 2008 filed on Form 10-Q with the SEC (the “Form 10-Q”) and
Prudential’s annual report for the year ended December 31, 2007 filed on form 10-K
with the SEC (the “Form 10-K”). Id. The Form S-3, Prospectus Supplement, Form
10-K and Form 10-Q (together with other documents incorporated by reference into
the Prospectus Supplement) jointly formed the registration statement for the Offering
(the “Registration Statement”). The Registration Statement was signed by every
Individual Defendant (¶¶10-23), and every Underwriter Defendant underwrote the
Offering (¶¶25-32).
By March 12, 2009 – the date of the initiation of this litigation – the price per
Note had declined by approximately 48% from the Offering price of $25.00 to only
$13.04 per Note.5
4 Prudential and Defendants conducted the Offering pursuant to a “shelf
registration” (or continuous offering) process. ¶40. On or about March 16, 2006,
Prudential filed a form S-3 Registration Statement and Prospectus with the SEC (the
“Form S-3”). Id. Under the “shelf registration” process, Prudential was then allowed
to sell securities through prospectus supplements in future offerings. Id..
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III. STANDARD OF REVIEW ON A MOTION TO DISMISS
A Court evaluating a motion to dismiss under Fed. R. Civ. P. 12(b)(6) “must
accept all well-pleaded factual allegations in the complaint as true and draw all
reasonable inferences in favour of the non-moving party.” Cafaro v. HMC Intern.,
LLC, No 07-2793, 2009 WL 1622825, at *2 (D.N.J. June 10, 2009) (Linares, J.). A
complaint should not be dismissed so long as it “contain[s] sufficient factual matter,
accepted as true, to state a claim to relief that is plausible on its face.” Id.
Plaintiff’s claims arise exclusively under §§ 11 and 15 of the Securities Act.
The standard for alleging a claim under the Securities Act is not difficult. “A prima
facie case under § 11 is straightforward, requiring only a showing of a material
misrepresentation or omission from a defendant’s registration statement.” In re
Constar Int’l, Inc. Sec. Litig., 585 F.3d 774, 782-83 (3d Cir. 2009). Accordingly, the
standard for Plaintiff to “nudge[]” his claim “across the line from conceivable to
5 The first complaint in this Litigation was filed on March 12, 2009 [Doc. #1], on
behalf of all persons who purchased the Notes pursuant to and/or traceable to the
false and misleading Registration Statement. On May 22, 2009, this Court appointed
Plaintiff as Lead Plaintiff in this Litigation to represent the Class [Doc. #29], and
Plaintiff filed the operative consolidated amended Complaint on July 21, 2009 [Doc.
#43].
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plausible” to defeat a motion to dismiss (see Ashcroft v. Iqbal, __ U.S. __, 129 S. Ct.
1937, 1951 (2009) (internal citations omitted)) is easily met.6
IV. ARGUMENT
The Securities Act imposes liability upon defendants that sell securities in
public offerings through material misstatements or omissions, even if those
misrepresentations were innocent, and without proof of reliance or causation (see Part
IV.A. below). Defendants’ Motions should be denied because Plaintiff has
specifically alleged materially false representations and/or omissions in the
Registration Statement in connection with three different subjects (see Parts IV.B, C
and D below).
6 Plaintiff’s claims all arise under the Securities Act and do not involve (and, indeed,
the Complaint expressly disclaims) any allegation of fraud. ¶¶69, 80. Accordingly,
the heightened pleading standards under Fed. R. Civ. P. 9 and the Private Securities
Litigation Reform Act (“PSLRA”) do not apply in this case. See In re Suprema
Specialties, Inc. Sec. Litig, 438 F.3d 256, 269 (3d Cir. 2006) (“Section 11 . . . does
not require plaintiffs to allege that defendants possessed any scienter”) (internal
citations omitted). Contrary to Defendants’ argument (Prud. Mem. 8, n.3), Plaintiff’s
allegation that Defendants failed to disclose material information in the Registration
Statement in violation of Item 303 does not mean that the Complaint “sounds in
fraud.” A Securities Act claim for liability arising out of the failure to disclose
known trends or uncertainties under Item 303 arises through negligent conduct. See
Oxford Asset Management, Ltd. v. Jaharis, 297 F.3d 1182, 1191 (11th Cir. 2002)
(liability under the Securities Act for violation of Item 303 only requires showing of
negligence). Accordingly, nothing in Item 303 requires that a complaint allege
fraudulent intent in order to state a claim under the Securities Act.
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A. The Elements Of A Section 11 Claim
1. Liability Under Section 11 Is “Virtually Absolute”
Under Section 11 of the Securities Act, if an issuer of new securities is taking
investors’ money, the issuer, not the investors, is liable for any material
misrepresentation made in connection with that new offering. Indeed, section 11
imposes liability on all who are involved in the securities offering, including absolute
liability on the issuer (here, Prudential) and prima facie liability on all directors,
signatories to the registration statement and underwriters, where the registration
statement (1) contained an untrue statement of a material fact; (2) omitted to state a
required material fact; or (3) omitted to state a material fact necessary to make the
statements therein not misleading. See 15 U.S.C. § 77k(a) (imposing liability where
“any part of the registration statement, when such part 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”).
Section 11 imposes liability “without proof of either fraud or reliance on ‘those
whose moral responsibility to the public is particularly heavy’ – the ‘originators of
securities.’” Gustafson, 513 U.S. at 582 (quoting legislative history of the Securities
Act). Section 11 of the Securities Act:
was designed to assure compliance with the disclosure provisions of
the Act by imposing a stringent standard of liability on the parties who
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play a direct role in a registered offering. If a plaintiff purchased a
security issued pursuant to a registration statement, he need only show
a material misstatement or omission to establish his prima facie case.
Liability against the issuer of a security is virtually absolute, even for
innocent misrepresentations. Other defendants bear the burden of
demonstrating due diligence. See 15 U.S.C. §77k(b). Although
limited in scope, Section 11 places a relatively minimal burden on a
plaintiff.
Herman & MacLean, 459 U.S. at 381-82 (1983) (footnotes omitted) (emphasis
added); In re Suprema Specialties, Inc., 438 F.3d at 269 (quoting Huddleston and
noting that that “Section 11 is a virtually absolute liability provision”) (citation
omitted); see Constar, 585 F.3d at 782 (holding that “[a] prima face case under § 11
is straightforward”); In re Adams Golf, Inc. Sec. Litig., 381 F.3d 267, 273 (3d Cir.
2004) (holding that § 11 “impose[s] civil liability for the making of materially false
or misleading statements in registration statements”); see In re Arbinet-thexchange,
Inc. Sec. Litig., No. 05-4404, 2006 WL 3831396, at *3-4 (D.N.J. Dec. 28, 2006)
(Linares, J.) (noting that § 11 imposes liability “upon persons who signed the
registration statement, current and in certain instances future directors of the
company, and the offering underwriters”).
Under § 11 of the Securities Act, liability is “strict;” that is, liability for a
material misrepresentation or omission is imposed upon the issuer regardless of
whether that defendant actually knew or should have known the misrepresented or
omitted facts. See Herman & MacLean, 459 U.S. at 381-82; 15 U.S.C. § 77k(b);
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Hutchinson v. CBRE Realty Finance, Inc., 638 F. Supp. 2d 265, 274 (D. Conn. 2009)
(“[S]ecurities issuers [are] subject to strict liability with regard to material
misstatements and omissions, regardless of whether the material omitted facts were
known or knowable or not. . . . [I]nnocent misstatements, even when the issuer was
duly diligent in preparing the securities offering at question, are subject to a strict
liability standard”) (emphasis added) (citing Herman & MacLean); In re Vonage
Initial Public Offering Sec. Litig, No. 07-177, 2009 WL 936872, at *11, n.11 (D.N.J.
April 6, 2009) (where Plaintiff alleged that Registration Statement was misleading for
failure to disclose initiation of litigation against issuer before initial public offering,
but which was not served on issuer until after offering, defendant’s argument that
“they had no knowledge of the filing of the []litigation prior to the IPO issuing” is
“irrelevant for a Rule 12(b)(6) analysis” of a Securities Act claim). Defendants other
than Prudential may escape ultimate liability on summary judgment or at trial by
affirmatively “demonstrating due diligence.” Herman & MacLean, 459 U.S. at 381-
82; see 15 U.S.C. § 77k(b). However, the availability of this affirmative defense to
non-issuer defendants does not change the standard for properly alleging a prima
facie case under § 11. See Herman & MacLean, 459 U.S. at 381-82.
Accordingly, the only pertinent question at this stage of the litigation is
whether the statements and omissions were objectively false or misleading at the time
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of the Offering (i.e., were false when made). Defendants’ factual arguments that they
did not know, or could not have known, of the adverse facts (see., e.g., Prud. Mem. at
8, 9, 31-33) are therefore not only contrary to the factual allegations in the Complaint,
but irrelevant on a motion to dismiss.7
2. Liability For Omission of Material Facts
Pursuant To Item 303
Section 11 not only imposes liability for false or misleading statements, but
expressly imposes liability for the omission of facts that are “required to be stated” in
a registration statement. See Constar, 585 F.3d at 783. Among the types of
information “required to be stated” are:
any known trends or uncertainties that have had or that the
registrant reasonably expects will have a material favorable or
unfavorable impact on net sales or revenues or income from
continuing operations . . .
Regulation S-K, Item 303; 17 C.F.R. §229.303(a)(3)(ii) (“Item 303”); In re Adams
Golf, Inc. Sec. Litig., 618 F. Supp. 2d 343, 348-49 (D. Del. 2009) (denying motion for
summary judgment where “a jury could reasonably conclude that [the allegedly
7 In In re Arbinet-theexchange, Inc. Sec. Litig., No. 05-4404, 2006 WL 3831396
(D.N.J. Dec. 28, 2006), this Court stated in dicta that a “plaintiff must plead facts to
demonstrate that the allegedly omitted facts existed and were either known or
knowable at the time of the offering.” See Prud. Mem. at 9. Plaintiff’s counsel
respectfully submits that the fact that omitted facts existed at the time of the Offering
is sufficient to state a prima facie case under § 11. In any event, as discussed below,
the allegedly omitted facts were “known or knowable” by Defendants at the time of
the Offering.
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undisclosed] risk was, in fact, a known trend or uncertainty [that] rendered the
statements the [] defendants made in their IPO registration materials false and
misleading”). Therefore, regardless of whether any of the statements in the
Prospectus are false or misleading, Defendants were expressly obligated to disclose
any material known trends or uncertainties.
B. Defendants Misrepresented The Existence Of Material Litigation
Concerning The Auction Rate Securities Market
1. Plaintiffs’ Allegations Concerning Defendants’ Material
Misrepresentations and Omissions Concerning the Joint
Venture Litigation State A Claim
The Registration Statement contained material misrepresentations of present
fact concerning Prudential’s involvement in and liability from litigation arising out of
the February 2008 collapse of the market for auction rate securities (“Auction Rate
Securities” or “ARS”). Auction Rate Securities are municipal bonds, corporate bonds
and preferred stock with interest rate or dividend yields that are re-set through
periodic actions. ¶43. Since 2003, Prudential had been a 38% owner in a two-partner
joint venture (with Wachovia Securities Financial Holdings LLC) that underwrote,
sold and participated in ARS auctions (the “Joint Venture”). ¶43. According to
Prudential’s Form 10-Q for the quarter ended March 31, 2008, the Joint Venture
produced $51 million in pre-tax income for Prudential for that quarter (constituting a
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substantial portion of the $69 million in net income that Prudential reported for that
quarter).
The ARS market collapsed on February 14, 2008 (i.e., over four months before
the Offering). ¶44. Immediately following this collapse, various lawsuits and
investigations were initiated against the Joint Venture. For example, a class action
complaint (the “Joint Venture Class Action”) was filed on or about March 19, 2008
(over three months before the Offering). Also, prior to the Offering, the SEC and
other regulatory agencies commenced an investigation into the Joint Venture’s
alleged misconduct (the “Joint Venture Regulatory Investigations,” and, together with
the Joint Venture Class Action, the “Joint Venture Litigation”). ¶45.
Even though the Registration Statement contained sections entitled “Litigation
and Regulatory Matters” and “Legal Proceedings” that purported to describe all of the
material lawsuits and regulatory matters concerning Prudential (¶48), it did not even
mention the Joint Venture Litigation. The affirmative representations of present fact
concerning existing lawsuits were false because they concealed the existence of the
Joint Venture Litigation. ¶48.
On July 31, 2008 – approximately one month after raising $920 million in the
Offering – Prudential disclosed the existence of the Joint Venture Litigation in its
quarterly report for the quarter ended June 30, 2008. ¶46. On October 29, 2008,
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Prudential disclosed it was taking a pre-tax charge of $235 million to resolve the
Joint Venture Regulatory Investigations (¶46); to date, the Joint Venture Class Action
is unresolved, and it is likely that Prudential will have to pay substantially more
money to resolve the remaining Joint Venture Litigation.
Plaintiff has alleged a prima facie claim concerning the material
misrepresentations and nondisclosures of present fact concerning Prudential’s
involvement in, and liability arising out of, the Joint Venture Litigation. First, the
Registration Statement misrepresented Prudential’s material lawsuits and regulatory
matters because the sections entitled “Litigation and Regulatory Matters” and “Legal
Proceedings,” which purported to list all material lawsuits and regulatory matters
concerning Prudential, ignored the Joint Venture Litigation. These statements
constituted representations of present fact to a reasonable investor that, as of the
Offering, there were no other material lawsuits or regulatory matters. These
representations were materially false or misleading due to their failure to disclose the
existence of, and Prudential’s potential liability as a result of, the Joint Venture
Litigation. See, e.g., In re Vonage, 2009 WL 936872, at *12-13 (failure to disclose
litigation in registration statement would be actionable under § 11 if litigation had
already commenced or was substantially certain to occur); Siracusano v. Matrixx
Initiatives, Inc.¸ 585 F.3d 1167, 1172, 1179-1080 (9th Cir. 2009) (statements in Form
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10-Q warning that product liability claims and litigation could have a material
adverse impact on the company were materially false and misleading where 10-Q
failed to disclose that litigation had already been initiated); Caviness v. Derand
Resources Corp., 983 F.2d 1295, 1304 (4th Cir. 1993) (complaint alleged violation
where securities offering documents and financial statements failed to disclose
pending litigation); see also Zell v. InterCapital Income Sec., Inc., 675 F.2d 1041,
1045-46 (9th Cir. 1982) (reversing grant of summary judgment to defendant on claim
that defendant had failed to disclose lawsuits because “[i]t cannot be inferred from
the present record that the litigation omitted from the statements would have no
substantial significance to a reasonable stockholder”).
Second, even if Defendants had not purported to disclose all material litigation
in the Registration Statement, their failure to disclose the existence of the Joint
Venture Litigation rendered Prudential’s financial statements materially misleading in
violation of generally accepted accounting principles (“GAAP”). Prudential was
required under GAAP to disclose “loss contingencies” resulting from “pending or
threatened litigation” in its financial statements. ¶¶50-51. Companies are required to
make this disclosure even if the reporting entity believes that an “unfavourable
outcome” is “not probable” or “the amount of loss cannot be reasonably estimated” at
the time of filing. ¶51 (quoting paras. 4(b) and 37 of Financial Accounting Standards
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Board Statement No. 5 (“FASB 5”)). The first Joint Venture Litigation was initiated
prior to the Offering, and as early as March 19, 2008. ¶45. Consequently, the
financial statements in the Registration Statement were false and misleading because
they failed to disclose the existence of the pending Joint Venture Litigation.
Third, the Registration Statement materially overstated financial results by
failing to disclose the amount of Prudential’s contingent liabilities in connection with
the Joint Venture Litigation. GAAP expressly requires that financial statements
accrue a charge for a contingent loss where the “[i]nformation available prior to the
issuance of the financial statements indicates that it is probable that an asset has been
impaired or a liability has been incurred.” ¶50 (quoting FASB 5). Here, in violation
of GAAP, the financial statements made no accrual for the Company’s contingent
liability from the Joint Venture Litigation.
Fourth, Defendants’ failure to disclose the existence of, and Prudential’s
potential liability from, the Joint Venture Litigation violated of Item 303. ¶52. The
Joint Venture Litigation begun by March 19, 2008 at the latest – which resulted in a
$235 million reduction in Prudential’s income – constituted “known trends or
uncertainties” within the meaning of Item 303. The concealment of these “known
trends or uncertainties” was material to Prudential’s financial results, as the $235
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million loss to Prudential was almost four times the size of the $69 million reported
as income for the quarter ended March 31, 2008.
2. Defendants’ Arguments Are Without Merit
Significantly, Defendants do not (and cannot) dispute that (i) the Joint Venture
Litigation began months before the Offering; and (ii) the Registration Statement
completely failed to disclose or account for the existence of the Joint Venture
Litigation. See Herman & MacLean, 459 U.S. at 381-82 (plaintiff “need only show a
material statement or omission to establish his prima facie case”); In re Suprema
Specialties, Inc., 438 F.3d at 269 (same, quoting Herman & MacLean).
Defendants’ attempts to avoid liability for their concealment of the Joint
Venture Litigation fail. First, Defendants’ argument that the Joint Venture Litigation
did not “concern” Prudential (Prud. Mem. At 26-27, 30-31) borders on the frivolous,
and is contrary to the factual allegations in the Complaint. Prudential was a co-owner
of the Joint Venture with only one other partner. Both Prudential’s 2007 Form 10-K
and its Form 8-K filed on August 12, 2008 expressly state that Prudential “has a 38%
ownership interest in the [J]oint [V]enture.” See, e.g., Prudential Ex. 15.8
8 Although Prudential argues that it only had a 25% ownership interest based on
certain after-the-fact accounting “lookback” options Prudential subsequently decided
to implement (Prud. Mem. at 27), Prudential’s post hoc accounting does not change
the fact that Prudential owned 38% of the Joint Venture at the time of the Offering.
In any event, even an ownership level of 25% established that the Joint Venture
Litigation “concerned” prudential under GAAP.
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Consequently, and as Defendants admit, Prudential used “equity accounting” to
account for its investment in the Joint Venture in that Prudential owned over 20% of
the Joint Venture. See Prud. Mem. at 27, 35. “Ownership of 20% or more of the
voting stock of an investee should lead to a presumption that . . . an investor has the
ability to exercise significant influence over the investee” and that “the investing
company is required to report its percentage share of the investee’s income or loss on
its own financial statement.” Ganino v. Citizens Utilities Co., 228 F.3d 154, 164 n.7
(2d Cir. 2000) (citing Accounting Principles Board Opinion No. 18 (“APB Opinion
No. 18”), attached to the Prudential Motion as Exhibit 24); see also FASB Statement
No. 57 (use of equity accounting is an admission of “significant influence”).
Consequently, these admissions are themselves enough under GAAP to establish that
the Joint Venture’s affairs “concern” Prudential.
Prudential essentially admitted that the Joint Venture Litigation concerned
Prudential in its Form 10-Q for the quarter ended June 30, 2008 – the period of the
Offering – where it (belatedly) disclosed the existence of the Joint Venture Litigation
for the first time. Prudential explained that the Company’s earnings included
“[e]arnings of the [J]oint [V]enture,” and thus that Prudential’s earnings were
themselves “subject to certain risks of the [J]oint [V]enture operations, including . . .
legal actions, including a putative class action, and investigations by securities
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regulators and agencies relating to [the Joint Venture’s] role in the underwriting, sale,
and auction of auction rate securities.” See ¶46. Not surprisingly, Defendants fail to
mention this admission in their briefs.
That the Joint Venture Litigation “concerned” Prudential is further confirmed
by the hundreds of millions of dollars that Prudential has already paid to resolve a
portion of the Joint Venture Litigation. Defendants admit that to date Prudential has
taken $235 million in pre-tax charges arising from its ownership interest in the Joint
Venture to resolve its liability. ¶46. These charges, if reflected in the Registration
Statement, would have eliminated Prudential’s reported net income for the quarter
ended March 31, 2008.
Defendants’ argument that their failure to disclose the Joint Venture Litigation
did not render those statements false and misleading because the Joint Venture had
not finished negotiating the $235 million settlement as of the June 24, 2008 Offering
(Prud. Mem. at 31-33) mischaracterizes the claims in the Complaint in that Plaintiff
does not contend that the failure to disclose settlement negotiations was improper.
Rather, the Complaint alleges that the concealment of (i) the existence of the Joint
Venture Litigation; and (ii) the amount of the potential liabilities from the Joint
Venture Litigation rendered the Registration Statement materially misleading.
Because the existence of and potential liability from litigation must be disclosed long
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before the commencement of settlement negotiations near the end of a case,
Defendants’ argument is wrong.9
Defendants’ argument that Prudential was not required under GAAP to
disclose the Joint Venture Litigation because the Prudential did not have direct
liability for the Joint Venture’s litigation exposure likewise fails. As discussed
above, Prudential’s undisputed use of “equity accounting” (see Prud. Mem. at 35)
establishes that Prudential was liable under GAAP for the Joint Venture Litigation.
Ganino, 228 F.3d at 164 n.7. Incredibly, Defendants ignore the allegation that
Prudential has to date taken $235 million in pre-tax charges to resolve the Joint
Venture Litigation (¶46). Given these undisputed facts, there can be no question that
Prudential was liable for the Joint Venture’s conduct.10
9 Defendants’ bizarre argument that they were not required to disclose the Joint
Venture Litigation because disclosure was not required by an SEC rule not alleged by
Plaintiff (Item 103 of SEC Reg. S-K, 17 C.F.R. 229.103) (Prud. Mem. at 28-29), is
without merit. Item 103 only requires disclosure of litigation where a registrant is a
named party in a lawsuit. Because Plaintiff does not allege that Prudential was
named as a defendant in the Joint Venture Litigation, Plaintiff did not allege that
Prudential was required to disclose the Joint Venture Litigation under Item 103.
However, nothing in Item 103 immunizes a joint venture partner like Prudential from
liability for failure to disclose material facts required under other statutory, regulatory
or GAAP provisions. Nor does Prudential cite to any authority that reads Item 103 to
grant such immunity, as no authority exists for such a nonsensical proposition.
10 Defendants’ argument that Prudential was not required to disclose or account for
the Joint Venture Litigation under GAAP because Prudential was only a “minority
investor” in the Joint Venture (Prud. Mem. at 35-36) is equally without merit. GAAP
requires that any material loss contingency impacting the Joint Venture’s net income
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Defendants’ argument that Defendants’ misrepresentations and omissions were
immaterial as a matter of law (Prud. Mem. at 36-37) is also contrary to the factual
allegations in the Complaint and without merit. Materiality is a question of fact that
is uniquely inappropriate for resolution on a motion to dismiss because the
determination “requires delicate assessments of the inferences a ‘reasonable
[prospective purchaser]’ would draw from a given set of facts and the significance of
those inferences to him, and these assessments are peculiarly ones for the trier of
fact.” TSC Industries v. Northway, Inc., 426 U.S. 438, 450 (1976) (footnotes
omitted); Shapiro v. UJB Fin. Corp., 964 F.2d 272, 280-81 & n.11 (3d Cir. 1992) (an
omitted fact is material so long as there is “a substantial likelihood that the disclosure
of the omitted fact would have been viewed by the reasonable investor as having
significantly altered the ‘total mix’ of information available”) (quoting TSC Indus.,
426 U.S. at 449). “Only if the alleged misrepresentations or omissions are so
(such as the pendency of the Joint Venture Litigation) be reported or disclosed as part
of Prudential’s statement of net income, regardless of whether Prudential is only a
“minority investor.” APB Opinion No. 18 (GAAP requires an investor using the
equity method of accounting to “adjust[] the carrying amount of the investment to
recognize the investor’s share of the earnings or losses of the investee” and that that
adjustment must be “included in the determination of net income by the investor”)
(emphasis added). Defendants’ related argument that “like any stakeholder in a
corporation, Prudential was not responsible for potential legal liability Wachovia
Securities faced, except as otherwise agreed” (Prud, Mem. at 35-36) is puzzling.
Given that Prudential has paid $235 million to date, it is clear that Prudential is not
just another “stakeholder in a corporation,” but rather “agreed” to substantial
financial responsibility for the Joint Venture.
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obviously unimportant to an investor that reasonable minds cannot differ on the
question of materiality is it appropriate for the district court to rule that the allegations
are inactionable as a matter of law.” In re Adams Golf, Inc. Sec. Litig., 381 F.3d 267,
274-75 (3d Cir. 2004) (dismissal proper only if alleged misrepresentations “were
plainly unimportant to a reasonable investor”) (emphasis in original; citations
omitted). Materiality is not amenable to numerical formulas or cutoffs. Basic v.
Levinson, 485 U.S. 224, 233, 236 n.14 (1988) (rejecting any “bright-line rule” for
evaluating materiality because “[t]he materiality concept is judgmental in nature and
it is not possible to translate this into a numerical formula”); Ganino v. Citizens
Utilities Co., 228 F.3d 154, 162-63 (2d Cir. 2000) (citing Basic and rejecting
“formulaic approach” or numerical benchmarks to establish materiality). Given the
hundreds of millions of dollars in liability – enough to completely wipe out
Prudential’s reported net income in the Registration Statement – at the very least
there is a question of fact as to whether the concealment of the Joint Venture
Litigation was a material fact to investors who purchased Notes (and it certainly
cannot be said to be “obviously unimportant” as a matter of law).
Similarly unavailing is Defendants’ argument that the existence of the Joint
Venture Litigation was “immaterial” because it purportedly did not affect
“Prudential’s ability to repay the Notes or make interest payments” (Prud. Mem. at
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36-37). The fact that Prudential’s liability for the Joint Venture Litigation (to date) is
hundreds of millions of dollars, enough to completely eliminate Prudential’s reported
net income in the Registration Statement, cannot be said to be “obviously
unimportant” to Note investors (or to not affect Prudential’s ability to repay the Notes
or make interest payments as a matter of law). The prices and interest rates for bonds
fluctuate based on the perceived risk of repayment and credit ratings. For example,
United States treasury bonds have the lowest interest rates because there is no
repayment risk. Junk bonds have the highest interest rates and trade like stocks. The
prices and interest rates of corporate bonds fall across a wide spectrum between the
two, and these prices fluctuate dramatically based on the financial condition of the
issuer. The bonds of a highly profitable company are worth more than the bonds of a
company that loses money. Consequently, whether Prudential made or lost money
would be material. Moreover, this argument raises questions of fact beyond the
allegations of the Complaint and the mattes at issue here before the Court.11
11 Defendants’ reliance on Kusner v. First Pennsylvania Corp., 531 F.2d 1234, 1237
(3d Cir. 1976) is without merit. The Kusner court merely examined in dicta the types
of misrepresentations that might be of interest to holders of various types of securities
(including convertible and non-convertible bonds), before holding that “a
misrepresentation in the prospectus that would be material do a stock purchaser
would be material to a convertible bond purchaser.” Id. at 1237. The Kusner court
did not address the present situation – where the misrepresentations alleged in a
Registration Statement would completely wipe out the issuer’s quarterly earnings –
and certainly did not hold that such misrepresentations would be “immaterial” to
bond holders.
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Finally, Defendants’ argument that it had no duty to disclose under Item 303
because it did not know about the Joint Venture Litigation (Prud. Mem. at 33-34) is
without merit. It strains credibility to believe that Prudential was simply unaware of
lawsuits (including government investigations) concerning a Joint Venture in which it
held a 38% ownership interest and which produced $51 million in pre-tax income for
Prudential in the quarter ended March 31, 2008 (which, even after accounting for
taxes, would comprise a substantial portion of the $69 million in net income that
Prudential reported for that quarter).12
12 Although Plaintiff is not required to allege facts giving rise to a “strong inference”
that Defendants knew about the Joint Venture Litigation prior to the Offering to state
a claim under the Securities Act (as opposed to claims to the Securities Exchange Act
of 1934), the facts concerning the Joint Venture Litigation would easily satisfy a
scienter pleading standard given the significance of the Joint Venture to Prudential.
See, e.g., Berson v. Applied Signal Tech., Inc., 527 F.3d 982, 987-88 (9th Cir. 2008)
(defendant officers’ high level position in company infers scienter of their knowledge
of financial issue with “devastating effect on the corporation’s revenue”); No. 84
Employer-Teamster Joint Council Pension Trust Fund v. Am. West Holding Corp.,
320 F.3d 920, 942-43 (9th Cir. 2003) (reversing district court’s dismissal on ground
that complaint failed to allege strong inference that defendants knew of airline’s
undisclosed maintenance and operational problems because assertions even by
outside director defendants that they did not know of alleged significant problems
affecting important aspects of a company’s business and operations are “patently
incredible” and “absurd”).
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C. Defendants Misrepresented The Amount of Money Required To Pay
For Prudential’s Annuity Obligations And Deferred Policy
Acquisition Costs
1. Plaintiff Alleges Material Misrepresentations and Omissions
Concerning the Cost Of Funding Prudential’s Annuity And
Deferred Acquisition Costs
Plaintiff has alleged a prima facie § 11 claim concerning the material
misrepresentations of present fact concerning the actual costs of funding Prudential’s
annuity and deferred acquisition costs. The Registration Statement represented that
Prudential earned approximately $54 million in pre-tax income for the quarter ended
March 31, 2008. ¶55. This $54 million had been calculated after establishing a
reserve to pay for Prudential’s annuity obligations (i.e., the amount of money
required to pay for Prudential’s obligations under the annuity contracts it sold to
customers) and its deferred policy acquisition costs (i.e., the amount of money
required to pay for Prudential’s commissions to sales agents, underwriting costs, and
other costs incurred in connection with the sale of annuities) (the “Reserves”). ¶56.
The Registration Statement further represented that the amount of the Reserves was
calculated using statistically generated hypothetical “future rate of return
assumptions” about the performance of the Company’s investments contained in the
Reserves, and that Prudential would have had to set aside an additional $30 million if
the actual performance of Prudential’s investments to date had been used to calculate
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the needed reserves (instead of just the hypothetical “future rate of return
assumptions”). ¶¶56-57.
The representations that the actual performance of Prudential’s investments to
date required Prudential to set aside only an additional $30 million were false because
the actual performance of Prudential’s investments as of the Offering required up to
an additional $380 million, up to twelve times more. Had this $380 million amount
been added to the Reserves at the time of the Offering, the charge would have
completely eliminated the Company’s reported net income of $69 million and in fact
would have resulted in a significant, material loss. ¶59.
Not only was Defendants’ statement that, based on actual performance, an
additional $30 million would be needed to pay Prudential’s annuity and deferred
policy acquisition costs false because it should have been up to $380 million, it was
also false because Prudential had not even done a legitimate analysis of its actual
performance. Defendants admit that when they reported Prudential’s reserves in
connection with the June 24, 2008 Offering, Prudential had not updated the financial
data and assumptions since the third quarter of 2007. Prud. Mem. at 13. Moreover,
Defendant Carbone (Prudential’s Chief Financial Officer) admitted during a
conference call on October 30, 2008 that the Company’s investments had been
steadily deteriorating since well before the Offering. See ¶58 (Prudential’s
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investments had been deteriorating “over the past year,” i.e., since eight months
before the Offering). Consequently, the $30 million figure was not based upon the
actual performance of the Company’s investments at the time of the Offering because
it did not take into account the admitted deterioration of the Company’s investments
in the eight months since October 2007.13
2. Defendants’ Arguments Are Without Merit
Defendants make the remarkable argument that Prudential’s affirmative
statement that use of actual investment performance required only a $30 million
increase to the Reserves somehow “alerted investors” that the Company would need
to increase reserves by up to $350 million more “if investment performance did not
improve.” Prud. Mem. at 10-11. To the contrary, a reasonable investor would have
13 During the October 30, 2008 conference call, Mark Grier (Prudential’s Vice
Chairman) admitted that prior to the close of the third financial quarter ended
September 30, 2008, Prudential had calculated its Reserves based upon overly
optimistic future rate of return assumptions and stated that in the future Prudential
would (i) cap assumed future investment returns at 10.5%; (ii) change future cost
assumptions to reflect the fact “that future performance will average out with
historical performance;” and (iii) “give effect to market performance each quarter”
because previously “we have held out [i.e., ignored] the impact of market
performance until the annual review in the third quarter.” Although Grier’s statement
is not specifically alleged in the Complaint, it is contained in the same October 30
Conference Call discussed in the Complaint (see ¶58). As Defendants acknowledge
(Prud. Mem. at 12, n. 6), a court may consider the full text of documents referred to
or relied on in the complaint. See, e.g., In re Burlington Coat Factory Sec. Litig., 114
F.3d 1410, 1426 (3d Cir. 1997). Moreover, Plaintiff could file an amended complaint
with the additional allegation in the event that the Court believes that doing so is
necessary.
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understood Prudential’s representation to mean what it said: that investment returns
were such that only $30 million in additional Reserves would be necessary if actual
investment performance were used, not that the actual performance of the Company’s
investments would require Prudential to pay more than ten times greater than that $30
million amount. Moreover, because GAAP requires future rate of return
assumptions to be evaluated regularly (see FASB Statement No. 97, par. 25), a
reasonable investor also would have assumed that the Company had already adjusted
downward its “future return assumptions” to account for the deteriorating investment
returns it was actually experiencing. A reasonable investor would not know from the
Registration Statement that Prudential would need to increase reserves by up to $350
million more (i.e., over ten times more) to pay for the Company’s annuity and
deferred acquisition costs.14
14 Defendants’ argument that “Prudential’s 2007 annual report on Form 10-K put
investors . . . on notice of this annual review process” (Prud. Mem. at 13, citing
Prudential Ex. 2 (PRU 2007 10-K at 82-83)) is without merit. The Registration
Statement specifically stated that an additional $30 million would be necessary to pay
for Prudential’s annuity and deferred policy acquisition costs as of the quarter ended
March 31, 2008, if actual performance of Prudential’s investments were used. From
this misrepresentation, a reasonable investor would necessarily infer that Prudential
had conducted an analysis as of the March 31, 2008, quarter. Moreover, although the
Form 10-K discusses (in the notes to the financial statements) an “annual review” in
connection with Prudential’s annuity obligations, it does not inform investors that
interim reviews did not also occur each quarter (or specify that the annual review had
not occurred since the third quarter of 2007).
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Second, Defendants are incorrect that there are no facts that “support any
inference that consideration of actual performance in the first quarter would have
required increasing reserves . . . by $380 million at that time” (Prud. Mem. at 11; see
Prud. Mem. at 11-14).15 The Complaint specifically alleges that Defendant Carbone
admitted during the October 30, 2008 conference call that the decline in the actual
performance of the Company’s investments necessitating the additional $380 million
was the result of declines in the actual performance of the Company’s investments
since October 2007, eight months before the Offering. ¶ 58.16 In addition, Prudential
15 As an initial matter, Plaintiff does not allege that the full $380 million charge
eventually taken in the third quarter should necessarily have been taken at the time of
the Offering. Plaintiff alleges that, based on Prudential’s own admission in October
2008 that performance had been deteriorating “over the past year,” an amount “as
much as $380 million” should have been charged in the Offering. ¶¶ 58, 60
(emphasis added). The precise charge that Prudential should have taken at the time
of the Offering will necessarily be the subject of discovery and expert analysis. See,
e.g., Ottmann v. Hanger Orthopedic Group, Inc., 353 F.3d 338, 350 n. 8 (4th Cir.
2003) (holding that “[i]t is inappropriate at the pleading state, before discovery” to
require plaintiff to provide precise detail of alleged improper financial results); In re
Cigna Corp. Sec. Litig., 459 F. Supp. 2d 338, 356-57 (E.D. Pa. 2006) (due to
“complexity” of determining precise financial impact of alleged misrepresentation
and need for expert testimony, “the task of determining the precise measure of
economic loss and damages here is best assigned to the factfinder at trial”)
16 Contrary to Defendants’ arguments (Prud. Mem. at 14), nothing in In re Adams
Golf, Inc. Sec. Litig., 176 F. Supp. 2d 216, 221 (D. Del. 2001), aff’d in part by 381
F.3d 267 (3d Cir. 2004), prevents the Court from considering Prudential’s admission
that the decline in the actual performance of the Company’s investments had occurred
“over the past year.” The Court of Appeals found that there was “nothing contrary or
inconsistent” between the defendant’s statement that an oversupply of inventory at
the retail level “has weakened club sales industry-wide over the last 12 months [and]
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admitted (as discussed above) that, as of the Offering, Prudential had not even
calculated the impact of actual market performance in almost a year (since October
2007). Consequently, Prudential effectively admitted that the $30 million reserve
figure did not account for the deteriorating actual performance between October,
2007 and June, 2008. For these reasons, Defendants’ argument that the need to come
up with up to an additional $350 million did not exist at the time of the Offering (but
was solely due to a “market-related decline” that “worsened precipitously in late
September 2008)” (Prud. Mem. at 14) is directly contrary to the facts and, at best, is a
question of fact that is uniquely inappropriate for resolution on a motion to dismiss.17
resulted in substantial reductions in retailer purchases” (see 176 F. Supp. 2d at 221)
and the earlier representations in the registration statement that “[t]he Company
believes its prompt delivery of products enables its retail accounts to maintain smaller
quantities of inventory than may be required with other golf equipment
manufacturers” and “general forward-looking statements concerning the trends
‘likely to increase the demand’ for [defendant’s] products.” 381 F.3d at 279. By
contrast, there is an inherent contradiction in this litigation between Defendants’
representation in the Registration Statement that only an additional $30 million would
be necessary if actual investment performance to date were used, and its admission
four months later that, due to performance problems “over the past year,” an
additional $380 million were necessary.
17 Defendants’ argument that it “warned investors that reserves . . . would increase if
market conditions did not improve” (Prud. Mem. at 14 & n. 9) is without merit. As
discussed further below, Prudential’s warning about what could occur in the future
does not relieve it of liability for misrepresentations concerning losses that had
already occurred as of the date of the Offering. See Part IV.D.2 below; Huddleston
v. Herman & MacLean, 640 F.2d 534, 544 (5th Cir. 1981) (“To warn that the
untoward may occur when the event is contingent is prudent; to caution that it is only
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Finally, as discussed above (see Part IV.B.2), Defendants argument that these
misstatements were immaterial as a matter of law (Prud. Mem. at 16-17) is wrong.
Defendants’ misrepresentations and omissions understated Prudential’s liability by up
to $380 million, which would be enough to completely wipe out Prudential’s net
income. As discussed above, this information would be tremendously important to
investors who purchased Notes in the Offering (and certainly cannot be said to be
“obviously unimportant”). At best, Defendants’ materiality argument should be
rejected as it requires the resolution of disputed fact questions, which is inappropriate
on a motion to dismiss.
D. Plaintiff’s Impairment Allegations State A Claim
1. Plaintiff’s Allegations Concerning Other-Than Temporary
Impairments of Prudential’s Assets State A Claim
Plaintiff has alleged a prima facie Section 11 claim concerning the material
misrepresentations in the Registration Statement arising out of the understatement of
the amount of “other than temporary impairments” of Prudential’s assets. As
discussed above, the Registration Statement represented that Prudential had net
income of $69 million for the quarter ended March 31, 2008. ¶3. These financial
results had been calculated after accounting for $539 million in “other-than-
possible for the unfavorable events to happen when they have already occurred is
deceit.”), aff’d in part, rev’d in part on other grounds, 459 U.S. 375 (1983).
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temporary impairment” losses on “fixed maturity securities” for the quarter ended
March 31, 2008. ¶63. Prudential recognized “other-than-temporary impairments” on
its asset-backed fixed maturity securities when the value of those securities had
decreased in amount (i) by 20% or more for six months or (ii) by 50%. Id.
On July 31, 2008, Prudential conducted a conference call with analysts
discussing the results of Prudential’s quarter ended June 30, 2008 (the “July 31
Conference Call”). ¶64. During the July 31 Conference Call, Defendant Carbone
(Prudential’s CFO) reported that Prudential was recognizing an additional “$452
million of fixed maturity impairments” in the quarter ended June 30, 2008. ¶65.
Carbone then admitted that $205 million of this $452 million was due to impairments
to asset-backed fixed maturity securities that “came primarily from declines of 50%
or more that were in the zero to three month category at March 31[, 2008].” Id.
Because they declined by more than 50% prior to March 31, 2008, they should have
been recorded as “other-than-temporary” impairment losses as of March 31, 2008.
Had this additional impairment of $205 million been accounted for in the Registration
Statement, the loss would have wiped out the net income of $69 million reported for
the quarter ended March 31, 2008.
Carbone’s statement that the $205 million consisted of asset-backed fixed
maturity securities that were already impaired by more than 50% in the quarter ended
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March 31, 2008 rendered the Registration Statement materially false and misleading
for failing to account for this (already extant) $205 million in “other-than-temporary”
losses. ¶64. In the alternative, even assuming (as Defendants strenuously argue; see
Part IV.D.2 below) that the $205 million at issue only became impaired by 50%
during the quarter ended June 30, 2008 (rather than during the quarter ended March
30, 2008), Defendants are liable under Item 303 because the Registration Statement
failed to disclose this clearly known trend that would have a materially unfavorable
impact on income from continuing operations. ¶66. As noted above, the effective
date of the Offering was June 24, 2008 – only four business days before the end of
Prudential’s June 30, 2008 quarter. ¶41. Accordingly, even assuming that the
additional $205 million of asset-backed fixed maturity securities had not become
impaired by 50% by March 31, 2008, there is no dispute that they were impaired by
50% or more by the June 24, 2008 effective date of the Offering.18
2. Defendants’ Arguments Are Without Merit
Defendants’ arguments that they are not liable for their misrepresentations and
omissions concerning the amount of “other than temporary impairments” of the
Company’s assets are unavailing. Indeed, Defendants’ primary argument – that the
$205 million in assets were not impaired by 50% as of March 31, 2008, but only
18 There is absolutely no factual basis to infer that the assets magically became
impaired by 50% in the four business days between June 25, 2008 and June 30, 2008.
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became impaired by 50% during the quarter ended June 30, 2008 – is effectively an
admission that Defendants were required to disclose this negative “trend” in the
Registration Statement under Item 303.
Although Defendants devote several pages of their brief contesting Plaintiff’s
allegation that Carbone’s statements during the July 31 Conference Call constituted
an admission that the $205 million of assets were impaired by 50% as of March 31,
2008 (see Prud. Mem. at 18-23), a plain reading of Carbone’s statement – that the
$205 million represented impairments to asset-backed fixed maturity securities that
“came primarily from declines of 50% or more that were in the zero to three month
category at March 31[, 2008]” – clearly confirms the allegations. Even if there is a
dispute about how investors would have understood disputed language, which
Plaintiff denies, that is a question of fact not amenable to resolution on a motion to
dismiss. See, e.g., In re ValueVision Intern., Inc. Sec. Litig., 896 F. Supp. 434, 443
(E.D. Pa. 1995) (holding that, where dispute over how reasonable investors would
interpret statements in defendants’ press releases, the court “cannot resolve this
factual dispute on a motion to dismiss”).19
19 See Angres v. Smallworldwide PLC, 94 F. Supp. 2d 1167, 1174 (D. Colo.
2000) (denying motion to dismiss where the parties disputed the meaning of the term
“release” used by a software developer because “[a] dispute over how reasonable
investors understand a term contained within defendants’ statements is a factual
inquiry which cannot be determined on a motion to dismiss”); In re Par
Pharmaceutical Sec. Litig., 733 F. Supp. 668, 677 (S.D.N.Y. 1990) (“A statement is
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However, even assuming, arguendo, that Defendants’ arguments concerning
Carbone’s statements during the July 31 Conference Call were true, Defendants’ own
argument confirms that Defendants are liable under Item 303. Defendants argue at
length that “what drove the additional $205 million in impairment charges was
precipitous decline” during the June 30, 2008 quarter (rather than the March 31,
2008 quarter). Prud. Mem. at 23. Significantly, Defendants do not dispute that,
although Defendants conducted the Offering on June 24, 2008 (just four business
days before the end of the quarter), Defendants did not disclose this “precipitous
decline” in the Prospectus Supplement filed on that date or anywhere else in the
Registration Statement. This is precisely the type of material, adverse trend for
which Item 303 compels disclosure.
Defendants are also incorrect that the Registration Statement somehow
purportedly warned investors that $205 million in impairments of Prudential’s asset-
backed fixed maturity securities had occurred. See Prud. Mem. at 23-24. As
discussed above, even Defendants admit that the additional $205 million of assets had
already become impaired by 50% by the June 30, 2008 quarter. One of the purported
misleading if a reasonable investor, in the exercise of due care, would have received a
false impression from the statement. Because this determination requires delicate
assessments of the inferences a ‘reasonable shareholder’ would draw from a given set
of facts, it is generally a question of fact for the jury”; motion to dismiss denied)
(citations and quotation marks omitted).
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warnings cited by Defendants – that “Prudential had already recorded $539 million in
other-than-temporary impairment charges” as of March 31, 2008 – is simply a
statement of past fact that did not even remotely warn that additional impairments
had already occurred during the June quarter. Likewise, the remaining two warnings
cited by Defendants only generically state the obvious – that impairment losses “can
be expected to increase when economic conditions worsen” and that additional
impairments could occur “if the market did not improve;” they do not disclose that,
by the time of the Offering, $205 million in additional impairments (enough to
eliminate Prudential’s reported income in the Registration Statement) had already
occurred. Purported cautionary language that warns of adverse events that could
conceivably occur in the future does not immunize defendants from liability for
failing to disclose adverse events that have already in fact occurred. See Makor
Issues & Rights, Ltd. v. Tellabs Inc., 437 F.3d 588, 598-500 (7th Cir. 2006) (when
defendants knew that product demand was already drying up and production was far
behind schedule, warnings that an industry downturn could affect forecasts or that
there were risks associated with introducing new products were inadequate);
Huddleston, 640 F.2d at 544 (“To warn that the untoward may occur when the event
is contingent is prudent; to caution that it is only possible for the unfavorable events
to happen when they have already occurred is deceit.”).20
20 See Lormand v. US Unwired, Inc., 565 F.3d 228, 249 (5th Cir. 2009) (purported
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Finally, Defendants’ argument that the additional $205 million in impairments
as of the Offering – enough to eliminate Prudential’s income as reported in the
Registration Statement – somehow was not “material” as a matter of law (Prud. Mem.
at 25-26) is without merit. As discussed above, materiality is a question of fact and,
in any event, it would not have been “obviously unimportant” for investors to know
that Prudential was overstating its income and that, if the overstatement were
properly removed, Prudential would have a net loss. See Part IV.B.2 above.
E. Plaintiff Has Properly Pled Compensable Loss
Plaintiff has easily satisfied the minimal burden for pleading damages in a §
11 claim. “Under § 11(e), the measure of damages is set as the difference between
the price paid for a security purchased pursuant to the registration statement, and the
price at the time suit was filed or the security was sold. . . . Any decline in value is
presumed to be cause by the misrepresentation in the registration statement.” In re
Constar, 585 F.3d at 782-83 (citations omitted); see 15 U.S.C. §77k(e). Here,
Plaintiff alleged that he purchased Notes pursuant to or traceable to the Registration
Statement (¶8) and that suit was filed on March 4, 2009, by which point the Notes
risk warnings were misleading because the “defendants continually skewed the mix
of information by omitting the known severe risks associated with these business
actions even as they recognized signs that those risks had already materialized”),
citing Rubenstein v. Collins, 20 F.3d 160, 171 (5th Cir. 1994) (“the inclusion of
general cautionary language regarding a prediction would not excuse the alleged
failure to reveal known material, adverse facts”) and Huddleston, 640 F.2d at 544.
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were trading at only $13.04 per Note, approximately 48% below the $25 per Note
offering price (¶78).
Defendants’ argument that Plaintiff suffered no loss because “[t]he Notes are
currently trading above the offering price” and Plaintiff did not sell his Notes at a loss
(Prud. Mem. at 37) ignores the plain language of §11(e) (and the Third Circuit’s
express holding in Constar), which specifically provides that Plaintiff’s damages are
measured by the (undisputed) difference between the $25 per Note Offering price and
$13.04 per Note price on March 4, 2009, when this litigation was first filed.21
Defendants further argue (Prud. Mem. at 37-38) that Plaintiff has not properly alleged
that the misrepresentations alleged in the complaint “caused” Plaintiff’s damages. To
the contrary, however, “[i]n a §11 case, plaintiffs do not have the burden of proving
causation.” In re Constar, 585 F.3d at 782-83 (emphasis added). Rather, “defendants
may assert, as an affirmative defense, that a lower share value did not result from
any nondisclosure or false statement.” Id. (emphasis added).
21 Defendants are incorrect that Luminent Mortg. Captial, Inc. v. Merrill Lynch &
Co., No. 07-5423, 2009 WL 2590087 (E.D. Pa. Aug. 20, 2009) requires that a
plaintiff in a § 11 case actually have sold his securities at a price lower than the
offering price in order to allege damages. In Luminent, the plaintiff only alleged that
he suffered damages from an investment in mortgage-backed securities because the
investment paid a lower “income stream” than had been represented in the offering
documents. Id. at *13. Whatever the merits of plaintiff’s unusual and non-statutory
damages claim in Luminent, they do not impact the adequacy of Plaintiff’s damages
allegations here, which conform directly to § 11(e) and the Third Circuit’s holding in
Constar.
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F. The Complaint States A Claim Against The Individual Defendants
And The Underwriter Defendants
Plaintiff has adequately alleged the primary liability of the Individual
Defendants and the Underwriter Defendants under § 11.22 As discussed above (see
Part IV.A.1), in order “to establish his prima face case” under §11, Plaintiff “need
only show a material misstatement or omission” in the Registration Statement.
Herman & MacLean, 459 U.S. at 381-82; In re Suprema Specialties, Inc., 438 F.3d at
269; see 15 U.S.C. § 77k(a). The Individual Defendants each signed the Registration
Statement (¶¶10-23), and the Underwriter Defendants each underwrote the Offering
(¶¶25-32). Accordingly, Plaintiff has met his pleading burden. Each of these
Defendants now “bear the burden of demonstrating due diligence” as an affirmative
defense in order to escape liability. Herman & MacLean, 459 U.S. at 381-82; see 15
U.S.C. §77k(b). Contrary to Defendants’ argument (Prud. Mem. at 39; Und. Mem. at
2), Plaintiff has no obligation to allege facts rebutting this potential affirmative
defense as part of Plaintiff’s own Complaint.23
22 The Underwriter Defendants’ motion to dismiss makes no additional argument
beyond incorporating by reference the arguments in the Prudential Defendants’
motion to dismiss (see Und. Mem. at 1). Accordingly, the Underwriter Defendants’
motion to dismiss should similarly be denied for all of the reasons set forth in this
brief.
23 Defendants’ argument that, contrary to the fundamental nature of an affirmative
defense, Plaintiff has the burden of pleading that Defendants’ affirmative defense
does not apply (Prud. Mem. at 39) is plainly wrong. In the sole authority cited by
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G. The Complaint States A Control Person Claim Against The
Individual Defendants
Plaintiff also has alleged the control person liability of each Individual
Defendant under §15 of the Securities Act, 15 U.S.C. §77o. “In order to plead
control person liability [under §15], a plaintiff must allege facts that show that the
defendant had the power or potential power to influence and control the activities
during the relevant period or that the defendant had actual control over the
transaction in question.” In re PMA Capital Corp. Sec. Litig., No. 03-6121, 2005 WL
1806503, at *20 (E.D. Pa. July 27, 2005) (emphasis added). Defendants’ argument
that plaintiffs must “allege that each individual defendant had control over or
involvement in the specific statements of the issuer being challenged” (Prud. Mem. at
39) improperly focuses only on the second component of the control person test.
Here, the fact that each Individual Defendant signed the Registration Statement
demonstrates that he or she had the “potential power to influence” whether it was
filed or not (and thus whether the Offering occurred or not). This is enough to satisfy
the standard for pleading a §15 violation. See id. (denying individual defendant’s
Defendants for this tenuous proposition, the court held that the plaintiff had the
burden to plead facts rebutting the application of an affirmative defense specifically
“[b]ecause the[] due diligence defense appear[ed] on the face of the” complaint. In
re Countrywide Fin. Corp. Sec. Litig., 588 F. Supp. 2d 1132, 1181-82 (C.D. Cal.
2008). By contrast, Defendant does not (and cannot) allege a single fact “on the face
of” Plaintiff’s Complaint that purportedly demonstrates that the Individual or
Underwriter Defendants used “due diligence.”
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motion to dismiss §15 claim because “plaintiffs plead that McDonnell, as CFO,
signed PMA’s financial statements [and t]herefore, under the plain meaning of §15,
McDonnell can be liable because his acts influenced the setting of loss reserves and
the reporting of PMA’s financial status”).
V. CONCLUSION
For the foregoing reasons, Plaintiff has met all applicable pleading burdens and
the Prudential and Underwriter Defendants’ Motions to Dismiss should be denied. If
this Court determines that any part of the Complaint should be dismissed, Plaintiff
respectfully requests leave to amend pursuant to Fed. R. Civ. P. 15(a) to address any
pleading deficiencies identified by the Court. Leave to amend should be “freely
given.” Fed. R. Civ. P. 15(a); see Foman v. Davis, 371 U.S. 178, 182 (1962).
Dated: December 8, 2009 LITE DEPALMA GREENBERG
& RIVAS, LLC
By: /s/ Joseph J. DePalma
Joseph J. DePalma
Katrina Carroll
Two Gateway Center, 12th Floor
Newark, NJ 07102-5003
Telephone: (973) 623-3000
Facsimile: (973) 623-0858
jdepalma@ldgrlaw.com
Liaison Counsel for Plaintiff
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Jeffrey S. Nobel
Nancy A. Kulesa
IZARD NOBEL LLP
29 South Main Street, Suite 215
West Hartford, CT 06107
Telephone: (860) 493-6292
Facsimile: (860) 493-6290
jnobel@izardnobel.com
Lead Counsel for Plaintiff
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