Cornwell v. Credit Suisse Group

• Decision Date: 05 October 2009
• Docket Number: No. 08 Civ. 3758(VM).,08 Civ. 3758(VM).
• Citation: 666 F.Supp.2d 381
• Parties: Kevin CORNWELL et al., Plaintiffs, v. CREDIT SUISSE GROUP et al., Defendants.
• Court: U.S. District Court — Southern District of New York

Page 381

666 F.Supp.2d 381

Kevin CORNWELL et al., Plaintiffs, v. CREDIT SUISSE GROUP et al., Defendants.

No. 08 Civ. 3758(VM).

United States District Court, S.D. New York.

October 5, 2009.

COPYRIGHT MATERIAL OMITTED

Bernard M. Gross, The Law Office of Bernard M. Gross, P.C., Philadelphia, PA, Darren J. Robbins, David C. Walton, Coughlin Stoia Geller Rudman & Robbins LLP, San Diego, CA, David Avi Rosenfeld, Samuel Howard Rudman, Coughlin Stoia Geller Rudman & Robbins, LLP, Melville, NY, Deborah R. Gross, Law Offices Bernard M. Gross, P.C., Philadelphia, PA, Beth Ann Kaswan, Scott + Scott, L.L.P., Jonathan Gardner, Labaton Sucharow, LLP, New York, NY, William H. Narwold, Motley Rice LLC, Hartford, CT, for Plaintiffs.

Richard W. Clary, Cravath, Swaine & Moore LLP, New York, NY, for Defendants.

DECISION AND AMENDED ORDER

VICTOR MARRERO, District Judge.

Lead plaintiffs Kevin Cornwell ("Cornwell"), John M. Grady ("Grady"), Erste-Sparinvest Kapitalanlagegesellchaft m.b.H. ("Erste"), and Irish Life and Permanent PLC ("ILP") (collectively, "Lead Plaintiffs") filed a consolidated amended complaint in this action, dated October 20, 2008 (the "Amended Complaint"), naming as defendants Credit Suisse Global ("CSG"), Brady W. Dougan ("Dougan"), Renato Fassbind ("Fassbind"), D. Wilson Ervin ("Ervin"), and Paul Calello ("Calello") (collectively, "Defendants"). Lead Plaintiffs assert claims under § 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act"), 15 U.S.C. § 78j(b) (" § 10(b)"), Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5, and § 20(a) of the Exchange Act, 15 U.S.C. § 78t(a). Lead Plaintiffs bring these claims on behalf of themselves and all other persons or entities, except for Defendants, who purchased CSG securities during the period February 15, 2007 through April 14, 2008 (the "Class Period"). Defendants move to dismiss Lead Plaintiffs' claims pursuant to Federal Rule of Civil Procedure 12(b)(1) ("Rule 12(b)(1)") for lack of subject matter jurisdiction and Federal Rule of Civil Procedure 12(b)(6) ("Rule 12(b)(6)") for failure to state a claim upon which relief can be granted.

By Order dated September 28, 2009 (the "September 28 Order") the Court granted Defendants' motion to dismiss pursuant to Rule 12(b)(1). The Court now sets forth its findings, reasoning, and conclusions in support of the September 28 Order.

I. BACKGROUND¹

During the 1990s and early 2000s, CSG and other investment banks purchased securities backed by high-risk mortgages. The underlying mortgages had been issued to individuals with low credit scores, and thus were referred to as "sub-prime." These mortgages carried risky features such as low introductory rates, no income or asset verification of borrower, high loan-to-value ratios, payment of only the interest on the loan for an initial period, and principal that grew over time. When loans incorporating exotic features such as those described above were issued to borrowers with credit scores that did not qualify as sub-prime, CSG referred to them as "Alternative-A" ("Alt-A") loans. Investment banks bundled high-risk loans into a variety of securities called asset-backed securities. These securities included products such as residential mortgage-backed securities, collateralized debt obligations, and auction rate securities ("ARSs") that are asset-backed. When the housing market began to decline and interest rates increased, mortgage default rates rose and affected securities tied to the underlying high-risk loans.

Despite the faltering housing market and its effects on asset-backed securities, CSG reported strong results for the 2006 fiscal year and the first two quarters of 2007. Although CSG acknowledged the housing crisis, it did not quantify its exposure to sub-prime mortgages. CSG stated that it had fared relatively well when compared with its peer firms, some of which had suffered significant losses from asset-backed securities. CSG attributed its record results and de minimus sub-prime risk exposure to its strong risk management programs and internal controls.

On August 28, 2007, the Securities and Exchange Commission ("SEC") wrote to Fassbind, the Chief Financial Officer of Credit Suisse Group and Credit Suisse Securities, asking for information regarding CSG's sub-prime exposure beyond what had been provided on CSG's 2006 Form 20-F.² Fassbind responded on September 26, 2007 that providing detailed information about all of CSG's sub-prime assets would be burdensome and that such disclosure was not necessary because the risk of a material loss related to these loans was remote. Fassbind pointed to several steps CSG had taken to mitigate any risk associated with these loans, including reducing the number of loans acquired, investing in loans with lower credit risk, and distributing the loans owned by CSG. Fassbind also stated CSG had reduced its sub-prime exposure through hedging. On October 16, 2007, the SEC again encouraged Fassbind to carefully evaluate CSG's sub-prime investments. Fassbind responded by letter dated November 13, 2007, indicating that he would heed the SEC's advice.

For the third and fourth quarters of 2007, CSG announced some asset markdowns, while continuing to emphasize its relative weathering of the mortgage crisis that had severely affected some of its peer banks.

In the third quarter of 2007, CSG announced some markdowns from declines in the values of its ARSs, some of which were in client money market accounts. It was later revealed that two CSG traders had falsified e-mails to clients which purported to confirm that the ARSs in their accounts were backed by safer assets such as student loans, when they were actually backed by sub-prime securities. Civil and criminal suits have been filed against these traders and the defrauded customers have pursued recovery from CSG.

One week after announcing its results for the fourth quarter of 2007, CSG announced an additional $2.8 billion in asset markdowns. CSG stated that the markdowns were necessary because a rogue group of employees in London had mismarked the value of certain structured products. On March 20, 2008, CSG issued revised 2007 results that reflected these mis-markings. The Financial Services Authority ("FSA"), the regulatory body in the United Kingdom, later fined CSG for these mis-markings.

During the Class Period, Cornwell and Grady purchased CSG shares by buying American depository receipts ("ADRs")³ on the New York Stock Exchange ("NYSE"). The Amended Complaint does not state the nationality or place of residence of Cornwell or Grady. Erste and ILP also purchased CSG shares during the Class Period, on the Swiss exchange. Erste is an investment company based in Austria, and ILP is an Irish corporation.

Lead Plaintiffs brought this suit alleging that Defendants had hidden CSG's highrisk exposure to sub-prime and Alt-A loans and had touted CSG's internal controls and risk management programs as having helped CSG avoid the negative effects from the downturn in the housing market. Lead Plaintiffs claim that statements about these controls and CSG's strong financial performance were false and misleading because Defendants knew that CSG did not properly value its assets; failed to disclose the full extent and amount of its exposure to sub-prime risk; improperly transferred high-risk and illiquid securities into client money market accounts in order to shift these securities off CSG's books; and violated Generally Accepted Accounting Principles ("GAAP") as a result of all of the improper activities described above.

Lead Plaintiffs also allege that Defendants were aware that there were flaws in CSG's risk management and internal controls because two criminal schemes were uncovered during the Class Period, one involving mis-marking of assets and the other involving falsified e-mails to clients hiding the illiquid and risky securities being transferred into their money market accounts. Lead Plaintiffs allege that misrepresentations about the schemes caused them to pay inflated prices for CSG shares and ADRs during the Class Period.

II. DISCUSSION

In reviewing the motion to dismiss, the Court will first address grounds that challenge its subject matter jurisdiction because, absent authority to adjudicate, the Court lacks a legal basis to grant any relief, or even consider the action further. See Arar v. Ashcroft, 532 F.3d 157, 168 (2d Cir.2008) ("Determining the existence of subject matter jurisdiction is a threshold inquiry, and a claim is properly dismissed for lack of subject matter jurisdiction under Rule 12(b)(1) when the district court lacks the statutory or constitutional power to adjudicate it." (internal citations and quotation marks omitted)); Can v. United States, 14 F.3d 160, 162 n. 1 (2d Cir.1994) ("[I]n most instances the question whether a court has subject-matter jurisdiction is, conventionally and properly, the first question a court is called on to consider."). Because the Court ultimately finds that it lacks subject matter jurisdiction over the claims of any of the Lead Plaintiffs, it will not address the motion to dismiss pursuant to Rule 12(b)(6).

A. LEGAL STANDARD

The parties direct their arguments toward the question of whether the Court has subject matter jurisdiction over the claims of the foreign Lead Plaintiffs, Erste and ILP, that purchased CSG shares on the Swiss exchange, and the Court will address that question first. The Court will then address the question of subject matter jurisdiction over the claims of Cornwell and Grady, the Lead Plaintiffs who purchased their CSG shares by acquiring ADRs on the NYSE. Although the parties did not directly address this issue in their motion papers, the Court "may examine subject matter jurisdiction, sua sponte, at any stage of the proceeding." Adams v. Suozzi, 433 F.3d 220, 224 (2d Cir.2005).

1. Rule 12(b)(1)

The inquiry on a motion to dismiss for lack of subject matter jurisdiction under Rule 12(b)...