In re Green Tree Financial Corp. Stock Litigation
| Decision Date | 24 August 1999 |
| Docket Number | No. 98-1162(JRT/RLE).,No. 97-2666(JRT/RLE).,No. 97-2679(JRT/RLE).,97-2666(JRT/RLE).,97-2679(JRT/RLE).,98-1162(JRT/RLE). |
| Parties | In re GREEN TREE FINANCIAL CORP. STOCK LITIGATION. In re Green Tree Financial Corp. Options Litigation. Florida State Board of Administration, Plaintiff, v. Green Tree Financial Corp., Lawrence M. Coss, Robert D. Potts, and Edward L. Finn, Defendants. |
| Court | U.S. District Court — District of Minnesota |
Samuel D. Heins, Stacey L. Mills, Daniel C. Hedlund, Heins Mills & Olson, Minneapolis, MN, Jerome Congress, Charles Hellman, Milberg Weiss Bershad Hynes & Lerach, New York, NY, Leonard Barrack, Gerald J. Rodos, Robert A. Hoffman, Barrack Rodos & Bacine, Philadelphia, PA, Jules Brody, Mark Levine, Stull Stull & Brody, New York, NY, for Plaintiffs in the Stock Litigation.
Marshall H. Tanick, Daniel R. Kelly, Mansfield Tanick & Cohen, Minneapolis, MN, Stanley M. Grossman, Mark I. Gross, Patrick V. Dahlstrom, Pomerantz Haudek Block Grossman & Gross, New York, NY, Klari Neuwelt, Law Office, New York, NY, for Plaintiffs in the Options Litigation.
Robert R. Barth, Judith A. Rogosheske, Best & Flanagan, Minneapolis, MN, Michael J. Pucillo, Wendy H. Zoberman, Burt & Pucillo, W. Palm Beach, FL, for Plaintiff Florida State Bd. of Admin.
Gregory P. Joseph, David R. Buchanan, Peter R. Jerdee, Christopher V. Blum, Fried Frank Harris Shriver & Jacobson, New York, NY, Peter S. Hendrixon, Peter W. Carter, Dorsey & Whitney, Minneapolis, MN, for defendants.
Before the Court are three securities fraud actions arising from the same alleged course of conduct brought against defendant Green Tree Financial Corp. ("Green Tree") and several Green Tree officers and directors. Two of the actions are brought on behalf of putative classes (collectively "class plaintiffs"), one consisting of purchasers of Green Tree stock from July 15, 1995 to January 27, 1998, File No. 97-2666 ("purchasers class"), and the other consisting of traders of options on Green Tree stock during the same period, File No. 97-2679 ("options class"). In addition, the Florida State Board of Administration ("FSBA"), which purchased approximately 1.6 million shares of Green Tree common stock between January 30, 1996 to January 27, 1998, has filed its own action, File No. 98-1162.1
Three Green Tree officers and directors (during the relevant period) are named in all of the actions: Lawrence M. Coss, Chief Executive Officer and Chairman of the Board of Directors; Robert D. Potts, President, Chief Operating Officer, and Director; and Edward L. Finn, Executive Vice President and Chief Financial Officer. The purchasers class and options class also have named as defendants Richard G. Evans, an Executive Vice President and Director of Green Tree, and Joel H. Gottesman, the company's General Counsel and Secretary. Finally, the options class asserts claims against Robley D. Evans, Green Tree's Controller and Principal Accounting Officer during the relevant period.
All three complaints allege securities fraud under Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5. They also allege controlling person liability under Section 20(a) of the 1934 Act, 15 U.S.C. § 78t(a). These actions arise out of defendants' alleged fraud in disseminating materially false and misleading public statements that artificially inflated its revenues, net income, and assets during the relevant period. Specifically, the complaints allege that Green Tree's financial statements and other announcements overstated the Company's "gain-on-sale" revenue, which represented the present value of the company's anticipated profit from securitization of loan pools. When Green Tree publicly announced that it had overstated its financial condition by hundreds of millions of dollars, the price of its stock plummeted. The complaints allege millions in dollars in losses resulting from the defendants' alleged fraud.
This matter is before the Court on Green Tree's motions to dismiss the three complaints. Green Tree argues that the complaints fail to meet the pleading standards set forth under the Private Securities Litigation Reform Act of 1995 ("the PSLRA"), 15 U.S.C. §§ 78u-4 and 78u-5, and Fed.R.Civ.P. 9(b) ("Rule 9(b)"), and fail to state a claim on which relief can be granted under Fed.R.Civ.P. 12(b)(6) ("Rule 12(b)(6)").2 For the reasons set forth below, Green Tree's motions are granted.
The factual allegations in the three complaints are similar in virtually all material respects. Indeed, in response to the Court's inquiry regarding whether there are any important differences between the class complaints and the FSBA complaint, defendants' counsel responded that there are not.3
Green Tree is a diversified financial services company that provides financing for manufactured homes, home equity, home improvements, and consumer products, as well as consumer and commercial revolving credit. It was a pioneer in the securitization of asset-backed manufactured housing loans ("MH loans"). Green Tree securitizes a significant portion of its MH loans. For example, during the class period, it securitized ninety-seven percent of these loans. A large percentage of Green Tree's total earnings are derived from financing contracts for these homes.
Green Tree would pool together loans originated or purchased over the course of one to two months, until the total reached approximately $400 million. It then sold the loans to a trust which divided up the pools into tranches to be issued as securities backed by the loans.
Under Generally Accepted Accounting Principles ("GAAP"), Green Tree's revenues and earnings are based on projections of future loan performance. Thus, in connection with each pool of loans, Green Tree computed its revenue using "gain-on-sale" accounting. Specifically, it recorded its revenue gain based on the difference between the present value of the interest to be earned on the underlying loans and the present value of the interest to be paid to investors in the loan-backed securities. This is recorded as revenue on Green Tree's earnings statement and as a balance sheet asset called "Excess Servicing Rights Receivable" ("ESRR" or "Interest Only Securities").4 At all relevant times, gain-on-sale revenue constituted a substantial percentage of Green Tree's reported earnings. For example, in 1996, gain-on-sale receivables constituted 63.8% of the company's net revenue.
Green Tree also sold portions of its Interest Only Securities in the form of NIM certificates. The sale of NIMs are reported as part of the ESRR on the balance sheet. Green Tree bears the risk of any loss on its securitizations and NIM certificates.
Under GAAP, reasonable estimates must be used in calculating gain-on-sale revenue and adjustments (such as additions to reserves). In gain-on-sale accounting, the revenue recorded in connection with the securitization of loan pools is based on complex calculations involving a number of assumptions. The most important assumption is the loan prepayment rate, although other variables such as the likelihood of future defaults, delinquencies, economic conditions, and future interest rates also play a role. Prepayments occur for a variety of reasons, including borrower relocation, default, and refinancing (which is related to interest rate fluctuations). When a loan is prepaid — meaning that some or all of the principal amount is paid back before it is due — the interest the issuer expected to receive over the remaining life of the loan is reduced or terminated. Thus, if the assumed prepayment rates used to compute revenue are lower than actual prepayment experience, revenue and earnings will be overstated.5
Prepayment rates are referred to in the industry as manufactured housing prepayments or "MHP." One hundred MHP assumes a constant prepayment rate of 3.75% per annum of the unpaid principal balance of the contracts in each loan pool in the first month of the life of the contracts and then an additional 0.1% per annum in each month thereafter until the twenty-fourth month. Once the twenty-fourth month is reached, 100 MHP assumes a constant prepayment rate of six percent per annum each month.
During the relevant period, Green Tree did not disclose to the public its prepayment assumptions or other assumptions being used in calculating its gain-on-sale revenue. It stated generally that its assumptions for prepayment and default are based on "assumptions which the Company believes market participants would use." Green Tree also disclosed that the company had an allowance for expected loan losses based on experience and its management's predictions of future credit losses. It stated that the allowance would be reviewed quarterly and adjustments would be made if required by actual experience. Green Tree did have, and allegedly selectively released, information concerning actual prepayment experience in its loan pools.
During the relevant period, the loan pools Green Tree securitized in 1994 and 1995 were prepaying at significantly faster rates than defendants had assumed in calculating the company's gain-on-sale revenue. This began to occur several months after these pools were securitized. Yet Green Tree continued to use a prepayment assumption of 100 MHP for loan pools it securitized throughout 1995. Defendants note that they responded to this phenomenon during the class period by increasing prepayment and loss reserves and increasing prepayment speeds on new securitizations (starting in 1996) from 100 to 150 MHP.
The plaintiff classes also allege that defendants used various techniques to limit loan delinquencies and the amount of charge-offs taken per month. Some of these techniques included setting a cap on the percentage of delinquent loans recognized in a given month, granting unrequested loan...
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