Hurley v. Federal Deposit Ins. Corp., Civ. A. No. 88-1940-T

• Decision Date: 08 August 1989
• Docket Number: Civ. A. No. 88-1940-T,88-1969-T.
• Citation: 719 F. Supp. 27
• Parties: Mary HURLEY, Sumner Woodrow, and Ronald E. Crosthwaite, Plaintiffs, v. FEDERAL DEPOSIT INSURANCE CORPORATION, C. William Wester, Robert F. Fredo, Jr., Francis W. A'Hearn, Thomas J. Bagley, Walter E. Bennett, Ernest N. Daulton, Jr., Robert C. Keogh, Ralph Lolli, Jr., J. Parker Rice, Jr., Lester H. Rome, Eugene L. Sorbo, Defendants.
• Court: U.S. District Court — District of Massachusetts

719 F. Supp. 27

Mary HURLEY, Sumner Woodrow, and Ronald E. Crosthwaite, Plaintiffs, v. FEDERAL DEPOSIT INSURANCE CORPORATION, C. William Wester, Robert F. Fredo, Jr., Francis W. A'Hearn, Thomas J. Bagley, Walter E. Bennett, Ernest N. Daulton, Jr., Robert C. Keogh, Ralph Lolli, Jr., J. Parker Rice, Jr., Lester H. Rome, Eugene L. Sorbo, Defendants.

Civ. A. Nos. 88-1940-T, 88-1969-T.

United States District Court, D. Massachusetts.

August 8, 1989.

Glen DeValerio, Norman Berman, Berman, DeValerio & Pease, Boston, Mass., for Mary Hurley.

Stanley M. Grossman, Pomerantz Levy Haudek Block & Grossman, New York City, for Sumner Woodrow.

William J. Patton, Robert J. Stillman, David Martland, Ropes & Gray, Boston, Mass., and Rae Schupack Nathan, Regional Counsel, F.D.I.C., New York City, for F.D. I.C.

Stephen R. Delinsky, Evan Slavitt, Fine & Ambrogne, John G. Fabiano, Peter A. Spaeth, Hale & Dorr, Boston, Mass., Sherrie R. Savett, Gary E. Cantor, Lawrence Deutsch, Berger & Montague, Philadelphia, Pa., for C. William Wester.

Thomas Dwyer, Dwyer & Collora, Boston, Mass., for Robert F. Fredo, Jr.

Laura Steinberg, Sullivan & Worcester, Boston, Mass., for Francis A'Hearn.

John H. Henn, Brandon F. White, Foley, Hoag & Eliot, John G. Fabiano, Peter A. Spaeth, Hale & Dorr, Boston, Mass., for Service Bank For Savings.

MEMORANDUM

TAURO, District Judge.

This lawsuit is one of a series of cases filed in federal and state court following the disclosure by bank examiners of financial irregularities at the First Service Bank for Savings.¹ The plaintiffs are representatives of a putative class of the bank's shareholders who purchased stock in the over the counter ("OTC") market between December 5, 1986 and August 15, 1988. The defendants fit into five categories: 1) the Federal Deposit Insurance Corporation;² 2) C. William Wester, the bank's former President, Chief Executive Officer and Chairman of the bank's board of directors; 3) Robert F. Fredo, Jr., the bank's former Senior Vice President and Senior Lending Officer; 4) Francis W. A'Hearn, the bank's current Senior Vice President, Chief Financial Officer and Treasurer; and 5) members of the bank's board of directors who, as members of the bank's executive or audit committees, signed various disclosure statements.

The complaint alleges that the defendants misrepresented the financial health of the bank by filing quarterly and annual reports with the FDIC that contained misrepresentations and omissions of material facts. Count I of the complaint claims that all the defendants violated § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) and Rule 10b-5, 17 C.F.R. § 240.10b-5. Count II claims that the defendants' conduct constitutes common law fraud. Count III claims that the defendants' actions constitute negligent misrepresentation. All the defendants have filed motions to dismiss.

I.

According to the complaint,³ the bank made numerous loans which involved bad banking practices. These practices included loans made without sufficient collateral, loans secured by unappraised property or unperfected security interests, extending or renewing loans without reviewing their creditworthiness, rolling loans over instead of placing them on a delinquency status or declaring them in default, and lending money to borrowers for the sole purpose of paying interest due on previous loans. Additionally, the complaint details several loans that were made to Wester and Fredo's business partners, as well as loans made to a real estate trust in which Wester and Fredo had an undisclosed beneficial interest.

During the period of time when the alleged bad lending practices were taking place, the bank issued numerous press releases and filed periodic reports with the FDIC. These reports included such data as the bank's capital to asset ratio, reserve for possible loan losses, amount of delinquent loans, and the bank's procedure for making loans and handling delinquent loans. Plaintiffs claim the financial data contained in these reports was false, because they did not take into account the numerous problem loans that plaintiffs' complaint details. Moreover, the reports failed to disclose the existence of these problem loans and the manner in which the loans had been made and supervised. These misrepresentations and omissions allegedly overestimated the financial value of the bank and underestimated the magnitude of the bank's delinquent loans by millions of dollars.

Defendants make four arguments in support of their motions to dismiss. First, they argue that plaintiffs lack standing, because any injury which has occurred is a claim that belongs to the bank itself, not to the individual shareholders. Second, defendants claim that counts I and II should be dismissed for failure to plead fraud with particularity. Third, defendants claim that reliance has not been adequately plead to support counts I and II. Finally, defendants claim that count III fails to state a claim for negligent misrepresentations. Each of these arguments are addressed seriatim.

II.

General principles of corporate law provide that a shareholder may not sue either the corporation or some other wrongdoer if the only injury alleged is a diminution of the corporation's net worth. In such circumstances the corporation is the injured party, and it alone may sue the wrongdoer for the damage caused. See 12B W. Fletcher, Cyclopedia of the Law of Private Corporations § 5907 et seq. (1984) ("Fletcher"). Corporate mismanagement, or even fraud perpetrated on the corporation, resulting in lower stock prices cannot form the basis for an individual shareholder lawsuit against the wrongdoer or against the corporation. See id. See also Sante Fe Industries, Inc. v. Green, 430 U.S. 462, 477-80, 97 S.Ct. 1292, 1302-05, 51 L.Ed.2d 480 (1977) (Rule 10b-5 is not violated by simple corporate mismanagement).

Only where the shareholders themselves have been defrauded, may they sue the wrongdoer. See 12B Fletcher § 5923.2 ("defrauded purchasers or seller of stock or securities may maintain an action under Rule 10b-5 ... either individually or as a class action"). That is true even if all the shareholders are victims of the fraud. Id.

Plaintiffs' complaint alleges more than mere corporate mismanagement. It alleges that the defendants made false statements in the bank's periodic disclosure reports and failed to disclose other material information. These material misrepresentations and omissions are alleged to have caused plaintiffs to buy and sell securities at deceptive prices. The prohibition on individual shareholders bringing a 10b-5 claim based on corporate mismanagement is inapplicable where, as here, there are allegations of material misrepresentations and omissions. See Green, 430 U.S. at 474, 97 S.Ct. at 1301 ("As we have indicated, the case comes to us on the premise that the complaint failed to allege a material misrepresentation or a material failure to disclose."). Plaintiffs, therefore, have standing to maintain the instant action.

III.

Defendants contend that the securities fraud and common law fraud claims should be dismissed for failure to plead their individual involvement in the fraud with particularity. The Federal Rules of Civil Procedure mandate that "the circumstances constituting fraud ... shall be stated with particularity ... but malice, intent, knowledge, and other condition of mind of a person may be averred generally." Fed. R.Civ.P. 9(b). This requirement is especially important in securities fraud cases where the strike suit value of a complaint is high. See Wayne Investment Inc. v. Gulf Oil Co., 739 F.2d 11, 13-14 (1st Cir. 1984).

To satisfy Rule 9(b) a pleading must "specify ... the time, place and content of an alleged false representation, but not the circumstances or evidence from which fraudulent intent could be inferred." McGinty v. Beranger Volkswagen, Inc., 633 F.2d 226, 229 (1st Cir.1980). "This interpretation of Rule 9 ... harmonizes the rule with Rule 8, which requires that averments in pleadings be concise and direct, and at the same time ... gives adequate notice of plaintiff's claim of fraud." Id. Where multiple defendants are involved, each defendant's role in the fraud must be particularized. See Margaret Hall Foundation v. Atlantic Financial Management, Inc., 572 F.Supp. 1475, 1481 (D.Mass.1983) (Tauro, J.). This requirement serves to place each defendant on notice of what role he is alleged to have played in the fraud. Id.

The complaint specifies precisely which of the bank's quarterly and annual reports and FDIC disclosure forms are alleged to have contained material misrepresentations and omissions. Specifically, the complaint alleges, inter alia, that the bank's 1986 and 1987 annual reports to the FDIC along with quarterly reports for all four quarters of 1987 and the first quarter of 1988 misrepresented the bank's financial condition. See First Amended Complaint ¶ 20-24, 26-31. The complaint quotes the figures reported in each instance for the amount of delinquent loans, the bank's delinquency rates, the bank's net worth and its reserves for potential loan losses. Next the complaint details numerous loans which are alleged to have been made in violation of good banking practices, as well as loans that were rolled over to avoid having to report them as delinquent on the books of the bank. See id at ¶¶ 36-52. Then, the complaint explains what the true figures would have been on each of the bank's various periodic reports if the bad loans had been accounted for properly. See id. at ¶¶ 22, 24, 29, 30 and 31. Finally, the complaint details which of the defendants allegedly signed each of the periodic reports, and avers that each defendant knew of the falsity of the reports, or acted with reckless disregard as to the truth of the contents of those reports. Id. at ¶¶ 6 and 67.

Consequently, the complaint adequately pleads the "time, place and content of ... each alleged false...