Class Action Defense Cases-Quaak v. Dexia: Massachusetts Federal Court Denies Defense Motion To Dismiss Securities Class Action Against Banker Because Of Alleged Involvement In Scheme To Inflate Stock Price

Nov 7, 2006 | By: Michael J. Hassen

Defense Motion to Dismiss Class Action Complaint Denied Because Plaintiff Adequately Alleged Securities Laws Violations by Company’s Chief Commercial Banker

Plaintiff filed a securities fraud class action against Dexia Bank Belgium as successor to Artesia Banking Corp., “the former chief commercial banker for Lernout & Hauspie Speech Products N.V.,” alleging “that L&H could not have committed its wide ranging fraud without the intimate involvement of Defendant … as architect of the fraudulent scheme” and that Defendant “made numerous fraudulent loans to L&H in an effort to bolster L&H’s stock price.” Quaak v. Dexia, S.A., 445 F.Supp.2d 130, 134 (D. Mass. 2006). The district court denied a defense motion to dismiss the class action complaint, but certified several questions to the First Circuit because “the legal issues involved, particularly the question of scheme liability under the securities laws, were … quite cutting edge,” and the First Circuit accepted the appeal. Id. Before the Circuit Court heard oral argument, plaintiff sought and received leave from the district court to amend the class action complaint; the Circuit Court therefore vacated the appeal, and defense attorneys filed a new motion to dismiss. Id.

The district court explained that the amended complaint added “significant factual allegations” based on newly discovered documents that purportedly evidenced Defendant made millions in profits from the sale of L&H stock and that it “exercised absolute control over the operations of a wholly-owned subsidiary” and caused the issuance of reports that promoted the purchase of L&H stock based on false financial data. Quaak, at 135. According to the complaint, the scheme inflated the value of the stock or artificially caused it to retain its inflated value, but the stock plummeted once the company’s true financial condition was learned. Id. Based on the new allegations, the complaint alleged Defendant was a “controlling person” and therefore liable within the meaning of Section 20(a) of the Exchange Act, 15 U.S.C. § 78t(a), and liable under Section 10(b) for the issuance of false and misleading reports. Id.

In denying the motion to dismiss, the federal court noted that “‘even under the PSLRA [Private Securities Litigation Reform Act], the district court, on a motion to dismiss, must draw all reasonable inferences in the plaintiff’s favor.’” Quaak, at 136 (citation omitted). The court first addressed the statute of limitations ground for the motion to dismiss, id., at 136-39, concluding that “while it is a close question” the new allegations relate back to the filing of the original complaint and therefore are not time-barred, id., at 139.

With respect to the Section 10(b) violation, defense attorneys argued that Defendant was not liable for any false or misleading reports issued by the subsidiary under theories of “agency, entanglement, and control person liability.” Quaak, at 139. The district court concluded that each of the necessary elements had been alleged. Id., at 139-43.

With respect to the Section 20(a) claim, plaintiff alleged that the subsidiary was Defendant’s agent, that Defendant “entangled itself” with its subsidiary in the issuance of the reports, and that Defendant was a “control person” of the subsidiary. Quaak, at 143. In essence, the class action complaint alleged that Defendant orchestrated the scheme “from the top down” and acted with scienter. Id. After a detailed analysis, the district court concluded that the complaint adequately alleged the necessary elements to support the Section 20(a) violation. Id., at 143-49.

Finally, the district court determined that the complaint adequately alleged insider trading, Quaak, at 149-51, because as alleged Defendant “was more than just an arms-length lender to L&H, but rather acted more as a consultant in developing the method to finance the entities at the heart of this alleged scheme,” id., at 151.

NOTE: The district court denied a request by defense attorneys to recertify the questions to the First Circuit. Quaak, at 151.

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