Eca, Local 134 Ibew Joint v. Jp Morgan Chase

• Decision Date: 21 January 2009
• Docket Number: No. 07-1786-cv.,07-1786-cv.
• Citation: 553 F.3d 187
• Parties: ECA and LOCAL 134 IBEW JOINT PENSION TRUST OF CHICAGO, Penn Security Bank & Trust Co., Empire Life Insurance Co. and Brian Barry, on behalf of the Barry Family LP, individually, and on behalf of all others similarly situated, Plaintiffs-Appellants, v. JP MORGAN CHASE CO., Defendant-Appellee.
• Court: U.S. Court of Appeals — Second Circuit

553 F.3d 187

ECA and LOCAL 134 IBEW JOINT PENSION TRUST OF CHICAGO, Penn Security Bank & Trust Co., Empire Life Insurance Co. and Brian Barry, on behalf of the Barry Family LP, individually, and on behalf of all others similarly situated, Plaintiffs-Appellants, v. JP MORGAN CHASE CO., Defendant-Appellee.

No. 07-1786-cv.

United States Court of Appeals, Second Circuit.

Heard: October 20, 2008.

Decided: January 21, 2009.

Craig Spiegel (Steve W. Berman, Erin K. Flory, Hagens, Berman, Sobol, Shapiro, L.L.P, Seattle, WA, Joseph H. Weiss, David C. Katz, Richard Acocelli, Weiss & Lurie, New York City, on the briefs), for Plaintiffs-Appellants.

Bruce D. Angiolillo (Thomas C. Rice, George S. Wang, Simpson, Thacher, & Bartlett, L.L.P., New York City, on the brief), for Defendant-Appellee.

Before KEARSE, SACK, and KELLY,^* Circuit Judges.

PAUL J. KELLY, JR., Circuit Judge.

Plaintiffs, shareholders of JP Morgan Chase & Co. (JPMC), appeal from a judgment of the United States District Court for the Southern District of New York, Sidney H. Stein, District Judge, granting JPMC's Fed.R.Civ.P. 12(b)(6) motion to dismiss for failure to state a claim. The basis of Plaintiffs' claim, in essence, was that they were defrauded by JPMC's complicity in Enron Corporation's financial scandals. In March 2005, the district court dismissed without prejudice Plaintiffs' First Amended Complaint (FAC) for failure to sufficiently allege scienter for all but the allegations involving JPMC's improper characterization of certain transactions (the "Mahonia transactions") as trades, and for failure to plead materiality adequately with regard to that allegation. See In re JP Morgan Chase Sec. Litig., 363 F.Supp.2d 595, 619-34 (S.D.N.Y.2005) ("JP Morgan Chase I"). Plaintiffs then filed a Second Amended Complaint (SAC). Again, however, the district court concluded that Plaintiffs had only sufficiently pleaded scienter with respect to JPMC's characterization of the Mahonia transactions, but that these transactions were not material. Accordingly, the district court dismissed the second amended complaint for failure to state a claim, this time with prejudice. In re JP Morgan Chase Sec. Litig., No. 02 Civ. 1282, 2007 WL 950132, at *15 (S.D.N.Y. Mar. 29, 2007) ("JP Morgan Chase II"). Plaintiffs now appeal the district court's dismissal. Our jurisdiction arises under 28 U.S.C. § 1291, and we affirm.

Background

The facts preceding this appeal, including the precise nature of the allegations contained in the first and second amended complaints, have been exhaustively set forth in the district court's opinions below. See JP Morgan Chase I, 363 F.Supp.2d at 602-14; JP Morgan Chase II, 2007 WL 950132, at *1-10. Therefore, we will set forth only a brief recitation of the factual background to this appeal. Because this case presents an appeal from a Fed. R.Civ.P. 12(b)(6) dismissal, the factual allegations in the complaint must be accepted as true. In re Carter-Wallace, Inc., Sec. Litig., 220 F.3d 36, 38 (2d Cir.2000).

A. The First Amended Complaint

In their FAC, Plaintiffs alleged that JPMC¹ and two of its officers, William Harrison, Jr., and Marc J. Shapiro, defrauded JPMC shareholders by making deliberate misrepresentations that artificially inflated the price of JPMC stock and ultimately led to a collapse of JPMC's share price. JP Morgan Chase I, 363 F.Supp.2d at 601-03. Plaintiffs alleged that JPMC created disguised loans for Enron and concealed the nature of these transactions by making false statements or omissions of material fact in its accounting and Securities and Exchange Commission (SEC) filings. Id. According to the complaint, JPMC created "Special Purpose Entities," among them an entity called Mahonia Ltd., to facilitate disguised loan transactions with Enron Corporation. Id. at 602-04; FAC ¶¶ 42, 58-61. Allegedly, the creation of Mahonia enabled Enron to conceal its debt from investors because Enron could report the cash flow from JPMC through Mahonia to Enron as revenue from prepaid commodity trades rather than as loan proceeds. JP Morgan Chase I, 363 F.Supp.2d at 604; FAC ¶¶ 61, 67-69.

Essentially, Mahonia borrowed money from JPM Chase and used that money to buy gas from Enron; Mahonia would then satisfy its debt to JPM Chase by providing the gas to JPM Chase, which would resell the gas at a fixed future price back to Enron. In reality ... neither the physical commodity nor title to it were ever intended to be transferred.

JP Morgan Chase I, 363 F.Supp.2d at 604; see also FAC ¶¶ 71-74. According to the complaint, the commodity transactions lacked economic substance; while a financially settled commodity swap would eliminate any price risk, the economic reality is that the transactions were loans. FAC ¶¶ 73-74. Furthermore, JPMC cooperated with Enron in these deceptive practices by mischaracterizing the transactions on its financial statements as trading assets rather than as loans. JP Morgan Chase I, 363 F.Supp.2d at 604-05; FAC ¶¶ 77-80. In return, JPMC earned exorbitant fees. JP Morgan Chase I, 363 F.Supp.2d at 602; FAC ¶¶ 49-50, 55. Moreover, the complaint alleged that JPMC repeatedly assured investors that it maintained high standards of integrity and credit-risk management throughout the period during which it engaged in transactions with Enron. JP Morgan Chase I, 363 F.Supp.2d at 608-09, 612; FAC ¶¶ 153-57, 161-62, 168-73. Following the collapse of Enron, however, the Senate investigated JPMC's role in Enron's fraudulent practices and concluded that JPMC had knowingly engaged in and actively assisted Enron in its sham transactions; the resulting disclosures caused JPMC's stock to suffer significant losses. JP Morgan Chase I, 363 F.Supp.2d at 608, 613-14; FAC ¶¶ 22, 357-72.

In sum, the FAC alleged that JPMC defrauded its shareholders by, inter alia, downplaying its Enron-related exposure, failing to disclose alleged violations of law in connection with the Mahonia and other transactions, falsely portraying itself as a low-risk company with a reputation for fiscal discipline and integrity, and improperly accounting for the Mahonia prepays as viable trades rather than as impaired loans on its financial statements (thereby failing to disclose the credit risk). See JP Morgan Chase II, 2007 WL 950132, at *2.

The district court evaluated the allegations in light of the heightened pleading standard under Fed.R.Civ.P. 9(b) and the Private Securities Litigation Reform Act (PSLRA) and found that the FAC failed to plead with the requisite particularity that JPMC made a materially false statement or omitted a material fact, with scienter. JP Morgan Chase I, 363 F.Supp.2d at 619-34. First, the court found that Plaintiffs had failed to allege scienter with any of the allegations, except the alleged improper accounting of the Mahonia transactions as trades rather than loans.² Id.; see JP Morgan Chase II, 2007 WL 950132, at *3-5. However, the court found that the allegedly improper accounting of the Mahonia transactions as trades rather than loans was not material. JP Morgan Chase I, 363 F.Supp.2d at 630-31; see JP Morgan Chase II, 2007 WL 950132, at *5. Accordingly, the court held that the FAC failed to state a claim pursuant to section 10(b) of the Securities and Exchange Act of 1934 (Exchange Act), 15 U.S.C. § 78j. JP Morgan Chase I, 363 F.Supp.2d at 634. The court also dismissed Plaintiffs' other claims for relief, which included claims under section 15 of the Securities Act of 1933 (Securities Act), 15 U.S.C. § 77o; section 11 of the Securities Act, 15 U.S.C. § 77k; and section 14(a) of the Exchange Act, 15 U.S.C. § 78n(a). Id. at 635-36. Because the district court dismissed the claims without prejudice, Plaintiffs were permitted to file the SAC.

B. The Second Amended Complaint

As the district court noted in JP Morgan Chase II, the SAC consisted mostly of the same allegations present in the FAC, with three general exceptions. The SAC made new allegations relating to (1) JPMC's alleged downplaying of its Enron-related exposure, (2) JPMC's alleged misrepresentation of its integrity and risk management, and (3) the allegedly faulty reporting of the Mahonia transactions. JP Morgan Chase II, 2007 WL 950132, at *6. The latter two are of the most importance here.

The SAC included new material on Plaintiffs' allegation that JPMC had misrepresented its integrity. The SAC pointed to charges in the SEC's civil lawsuit against JPMC accusing JPMC of aiding and abetting Enron, to Senate hearings where JPMC was accused of "actively assist[ing] Enron," and to JPMC's underwriting of securities issued by WorldCom, see generally In re WorldCom, Inc., Sec. Litig., 294 F.Supp.2d 392, 399-400, 403-404 (S.D.N.Y.2003), to show that JPMC, in fact, lacked integrity and did not conduct adequate due diligence as claimed in its statements on sound risk management. Id. at *7; SAC ¶¶ 636-39, 587-604, 188-240. The district court again dismissed Plaintiffs' allegations regarding JPMC's statements on its integrity and risk management strategy as mere "puffery." JP Morgan Chase II, 2007 WL 950132, at *12. The district court noted that even if these statements were not puffery, they would not be material. Id. Finally, the district court added that the SAC's new focus on the SEC investigation, the Senate testimony, and the WorldCom evidence was misguided because those statements pertained to misleading Enron and WorldCom shareholders, not JPMC shareholders. Id.

The SAC also included new allegations relating to Plaintiffs' contention that JPMC made material misstatements in reporting its transactions with Mahonia as viable trading assets. Id. at **8-9. Of particular importance here, the SAC alleged that not only were the Mahonia transactions wrongfully stated as viable trades rather than impaired loans, but they also should have been reported as "related-party transactions" in order to comply with Statement of Financial Accounting Standards No. 57 (SFAS 57). Id.; SAC...