Gearren v. McGraw-Hill Companies, Inc.

• Decision Date: 10 February 2010
• Docket Number: 09 Civ. 5450(RJS).,No. 08 Civ. 7890(RJS),08 Civ. 7890(RJS)
• Citation: 690 F. Supp.2d 254
• Parties: Patrick L. GEARREN and Jan Deperry, on Behalf of themselves and all others similarly situated, Plaintiffs, v. The McGRAW-HILL COMPANIES, INC., et al., Defendants. Harvey Sullivan, Mary Sullivan, and Cynthia Davis, On Behalf of Themselves and All Others Similarly Situated, Plaintiffs, v. The McGraw-Hill Companies, Inc., et al., Defendants.
• Court: U.S. District Court — Southern District of New York

690 F.Supp.2d 254

Patrick L. GEARREN and Jan Deperry, on Behalf of themselves and all others similarly situated, Plaintiffs, v. The McGRAW-HILL COMPANIES, INC., et al., Defendants.

Harvey Sullivan, Mary Sullivan, and Cynthia Davis, On Behalf of Themselves and All Others Similarly Situated, Plaintiffs, v. The McGraw-Hill Companies, Inc., et al., Defendants.

Nos. 08 Civ. 7890(RJS), 09 Civ. 5450(RJS).

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

February 10, 2010.

Edwin J. Mills and Michael Jason Klein of Stull, Stull & Brody, New York, NY, and Major Khan of Major Khan LLC, Street, Weehawken, NJ, for the Sullivan Plaintiffs.

Frank James Johnson, Albert Yong Chang, and Derek J. Wilson of Johnson Bottini, LLP, San Diego, CA, and Francis A. Bottini of Johnson & Silie, LLP, Second Floor, Bronx, NY, for the Gearren Plaintiffs.

Myron D. Rumeld and Russell Laurence Hischhom of Proskauer Rose LLP, New York, NY, Harold Shapiro of Proskauer Rose LLP, New Orleans, LA, and Floyd Abrams, Susan Buckley, and Tammy Lynn Roy of Cahill Gordon & Reindell LLP, New York, NY, for Defendants.

OPINION AND ORDER

RICHARD J. SULLIVAN, District Judge:

Before the Court are two substantially identical cases that have been consolidated for resolution, with the parties' consent. Both are purported class actions brought by current and former employees of the McGraw-Hill Companies, Inc. ("McGraw-Hill" or "the company"), alleging that the company and some of its committees, directors, and employees violated the fiduciary duties imposed by the Employee Retirement Income Security Act of 1974.

Plaintiffs allege that Defendants knew or should have known that McGraw-Hill stock was likely to decline sharply in value once it was revealed that its Financial Services division, Standard & Poors ("S & P"), had given improperly high credit ratings to complex financial instruments like residential mortgage-backed securities and collateralized debt obligations. As a result of this purported knowledge, Defendants allegedly violated their fiduciary duties in two ways. First, they continued to offer the McGraw-Hill Stock Fund, which invested almost entirely in McGraw-Hill common stock, as an investment option under the retirement plans after it became imprudent to do so. Second, they failed to disclose to plan participants the information they knew about company stock. Plaintiffs also allege that some of the Defendants violated their duty of loyalty and their duty to properly appoint, monitor, and inform other Defendants, thereby making them secondarily liable for their co-Defendants' alleged breaches.

For the reasons that follow, the Court concludes that Plaintiffs have failed to state a claim upon which relief can be granted and therefore grants Defendants' motions to dismiss these cases pursuant to Federal Rule of Civil Procedure 12(b)(6).

I. BACKGROUND

The following facts, unless otherwise noted, are taken from the Complaint;¹ from documents attached thereto, incorporated therein by reference, or otherwise integral to Plaintiffs' claims, even if not explicitly incorporated by reference; and from publicly available documents of which the Court may take judicial notice. See Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 322, 127 S.Ct. 2499, 168 L.Ed.2d 179 (2007); ATSI Commc'ns, Inc. v. Shaar Fund, Ltd., 493 F.3d 87, 98 (2d Cir.2007); Police and Fire Ret. Sys. of Detroit v. Safenet, Inc., 645 F.Supp.2d 210, 224 (S.D.N.Y.2009).

A. Facts

McGraw-Hill provides information to the financial services, education, and business information markets. (Compl. ¶ 10.) The company is divided into four operating divisions: Corporate, Education, Information & Media, and Financial Services. Its Financial Services division is known as Standard & Poors. (Id. ¶ 51.) S & P— through its Credit Market Services group—provides independent credit ratings for corporate and government entities, infrastructure projects, and (most relevantly) structured financial instruments, including residential mortgage-backed securities and collateralized debt obligations.² S & P typically gave these residential mortgage-backed securities and collateralized debt obligations high, investment-grade ratings, indicating that they were safe investment vehicles. (Id. ¶ 57.) As it turned out, many of them were much riskier than S & P's credit ratings had suggested, and their eventual defaults drastically exacerbated the financial crisis of the last few years. (See id. ¶ 66 ("`The mortgage crisis currently facing this nation was caused in part by misrepresentations and misunderstanding of the true value of mortgage securities. The tremendous reach of this crisis cannot be understated sic—our entire economy continues to feel aftershocks from the collapse of the mortgage industry.'" (quoting a press release of the Attorney General of New York) (additional quotations omitted)); id. ¶ 72 ("The high credit ratings, particularly for structured financial products, were widely viewed as contributing to the credit crunch that has helped spark the financial crisis" (quotations omitted).)

According to Plaintiffs, this was not a simple case of a good-faith attempt to evaluate complex financial instruments that went awry. Rather, Plaintiffs allege that S & P rated these securities in a manner that was either deeply careless or improperly biased by a desire to win business from the investment banks that were issuing the securities being rated. (Id. ¶ 45.) Furthermore, flaws in the ratings were apparent to at least some S & P employees, even from the outset. (Id. ¶ 70.) In 2001, one employee, when asked to rate a collateralized debt obligation, requested the underlying "collateral tapes" in order to evaluate their riskiness. (Id.) When told by S & P's managing director that his request was "totally unreasonable" and that he "must produce a credit estimate" and must "devise some method for doing so" in the absence of the underlying data, the analyst responded, "This is the most amazing memo I have ever received in my business career." (Id. (capitalization and punctuation altered).) In another email, "an analytical manager in the collateralized debt obligations group at S & P told a senior analytical manager ... that `rating agencies continue to create' an `even bigger monster—the collateralized debt obligations market. Let's hope we are all wealthy and retired by the time this house of cards falters.'" (Id. ¶ 69 (quoting a Wall St. Journal article disclosing company emails) (emoticon omitted).)

Even when the true riskiness of these financial instruments began to become clear, S & P did not adjust its ratings. (Id. ¶ 57 ("`Some subprime-mortgage bonds that were assigned investment-grade ratings as recently as 2006 are even trading at prices that imply they could be as risky as junk bonds. Yet most of their ratings haven't changed.'") (quoting a Wall Street Journal article).) Nor did S & P promptly acknowledge its mistakes or the likely effects they would have on its business. (Id. ¶¶ 58-59.) To the contrary, the company continued to tout S & P's growth prospects, predicting double-digit growth in 2007. (Id. ¶¶ 59, 63, 64.) Finally, in March 2008, the company withdrew its earnings guidance, pushing the stock price down to roughly $38 per share. (Id. ¶ 65.) A few months later, after investigations by the European Union, the Securities and Exchange Commission, and several states' attorneys general, the company entered into a settlement agreement that required it "to change its fee structures, to obtain due diligence information for the first time, and to create due diligence and lender standards for residential mortgage-backed securities." (Id. ¶ 66.)

* * *

Against this backdrop, McGraw-Hill offered two 401(k) savings plans to its employees —one for McGraw-Hill employees generally and one for S & P employees specifically.³ (Id. ¶¶ 30, 32.) The plans allowed employees to divert a portion of their income into individual retirement savings accounts, with McGraw-Hill providing a partial matching contribution in cash. (Id.) Employees were then presented with an array of investment options, which were selected by the plans' administrators. (Id.) While most of these investment options were diversified mutual funds, one of them was always the McGraw-Hill Stock Fund, which invested almost entirely in McGraw-Hill common stock. (Hirschhorn Decl. Exs. C, D.)⁴ Each participant could choose to invest his retirement money in any one of the funds, or parcel the money out between some or all of them. (Id.) Each participant was also free to alter the allocation of his money at any time. (Id.)

At the end of 2007, roughly $190 million of the plans' assets, or nearly 9.5% of the total, was invested in McGraw-Hill common stock. (Compl. ¶¶ 31, 33.) During the class period—December 31, 2006 through December 5, 2008 (Id. ¶ 2)—the price of McGraw-Hill common stock declined from $68.02 per share at the outset to $24.23 per share at the end, a decrease of 64.4%. (Id. ¶ 73.) As a result, Plaintiffs lost much of their retirement savings. (Id.)

Plaintiffs now seek to recover those losses under ERISA's liability provisions. Their theory of the case can be summarized as follows: Defendants knew or should have known that the investment-grade ratings that S & P was giving to residential mortgage-backed securities and collateralized debt obligations were wildly off-base. As a result, Defendants should have known that McGraw-Hill's stock price was inflated, in that it would surely decline once the market (and regulators) discovered that its ratings were flawed and once the mortgage bubble that it helped inflate burst. Because the stock was inflated, it was imprudent for the fiduciaries of the retirement plans to present the Stock Fund as an investment option and to invest the Fund's assets in McGraw-Hill common stock. And because the company knew that its stock price would suffer as soon as its poor ratings methodology was...