PSLRA Class Action Defense Cases–In re 2007 Novastar Financial: Missouri Federal Court Grants Defense Motion To Dismiss Securities Class Action For Failure To Plead Fraud With Requisite Specificity

Jul 1, 2008 | By: Michael J. Hassen

Securities Fraud Class Action Complaint, though Extremely Lengthy, Failed to Plead Fraud with Specificity Required by PSLRA (Private Securities Litigation Reform Act) Missouri Federal Court Holds

Plaintiff filed a class action complaint against Novastar Financial and three of its officers alleging securities fraud. In re 2007 Novastar Financial, Inc., Securities Litig., ___ F.Supp.2d ___ (W.D. Mo. June 4, 2008) [Slip Opn., at 1]. Defense attorneys moved to dismiss the class action for failure to comply with the heightened pleadings requirements of the Private Securities Litigation Reform Act (PSLRA), and requested that the district court take judicial notice of certain documents. Id., at 1-2. The district court granted the motion and dismissed the class action, beginning its analysis with an insightful observation and warning as to a court’s consideration of the alleged falsity of a defendants’ statements: “One might be tempted to think that a complaint spanning more than 100 pages and consisting of more than 200 paragraphs could not fail to be specific. The temptation is dangerous and must be resisted.” Id., at 3. Here, the class action merely paints a “broad picture” and consists of “generalities” – which is “precisely what the PSLRA counsels against.” Id. The federal court explained at page 3, “This has allowed Plaintiff to pick isolated threads and snippets from the Complaint to create an illusion of detail and insinuate the existence of fraud, which in turn has made it exceedingly difficult for the Court to conduct the analysis required by law. The Court does not intend to parse out each and every sentence contained in the Complaint because doing so ignores the real problem: what the Complaint does not say is as critical as what it actually says.”

The fact the class action complaint contains more than 50 paragraphs spanning 35 pages does not serve as a talisman to create the requisite specificity. In re 2007 Novastar Financial, at 4. Neither the complaint nor plaintiff’s opposition to the motion to dismiss explained what was false about the challenged statements, id. Federal law does not require a company “to divulge every ‘fact’ known to everyone in a company”; indeed, “the PSLRA’s effort to combat claims of ‘fraud by hindsight’ demonstrates a reluctance to countenance claims that attach heightened importance to facts only when looking back at the aftermath of misfortune. “ Id. Based on the court’s analysis, the challenged statements failed to satisfy the PSLRA’s pleading requirements, id., at 5-6. In the end, the federal court found that the class action “fails to identify a single false entry in the Company’s financial statements, nor does he identify the ‘truth’ that should have been disclosed.” Id., at 6. In the court’s view, the class action complaint “reads more like a cautionary tale from a treatise on business management than a charge of knowing misstatements and concealments.” Id. At worst, the allegations may constitute negligence, breach of fiduciary duty or mismanagement, but not fraud. Id.

With respect to the scienter requirement, the federal court explained that the class action was required to plead “with particularity” facts sufficient to give rise to a “strong inference” of intent to deceive. In re 2007 Novastar Financial, at 6 (citations omitted). Here, however, plaintiff merely “theorizes an intent to defraud can be inferred because Defendants regularly attended meetings during which the adverse effects of policy changes, adverse changes in the Company’s financial position, and ways to improve the Company’s operations were discussed.” Id. The district court held that this was inadequate because it simply described the normal and customary actions of a company and its officers. Id., at 6-7. In the court’s view, “Plaintiff’s allegations are more consistent with a company and executives confronting a deterioration in the business and finding itself unable to prevent it than they are with a company and executives recklessly deceiving the investing community.” Id., at 7.

Finally, the district court considered plaintiff’s request for leave to file an amended class action complaint; the court denied the request, concluding that amendment would be futile. In re 2007 Novastar Financial, at 7-8.

NOTE: The defense request for judicial notice concerned documents filed with the SEC, the Company’s stock price history, and certain developments in the subprime mortgage industry. In re 2007 Novastar Financial, at 1. Plaintiff did not oppose the request to the extent it covered documents filed with the SEC (so long as they were not admitted for the truth of the matters asserted therein), or to the extent it covered the company’s stock price history. Id. Plaintiff opposed consideration of developments in the subprime market, but the district court found that “reversals in this industry are amenable to judicial notice.” Id., at 1-2.

Download PDF file of In re 2007 Novastar Financial

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