In re Interbank Funding Corp. Securities Lit.

Decision Date09 August 2004
Docket NumberNo. CIV.A. 02-1490(JDB).,CIV.A. 02-1490(JDB).
Citation329 F.Supp.2d 84
CourtU.S. District Court — District of Columbia

Theodore Sonde, Michael Martinez, Crowell & Moring, LLP, Washington.

Adam S. Fels, David M. Brodsky, Jeff G. Hammel, DeMaurice F. Smith, Julia M. McLaren, Latham & Watkins, Washington.


BATES, District Judge.

This is an as-yet uncertified class action in which plaintiffs Monica Belizan and Dr William Prather ("Belizan" and "Prather," or "plaintiffs") assert a variety of securities law claims relating to their investments in Interbank Funding Corporation ("IBF"). Between 1997 and 2002, IBF and its subsidiaries issued debt securities in several investment funds totaling $195 million. Plaintiffs claim that the funds amounted to a Ponzi scheme: proceeds from later fund offerings were allegedly used to make interest payments to earlier investors.

The case comes before the Court on motions to dismiss by defendants CIBC World Markets Corp. ("CIBC"), a brokerage firm that sold some IBF securities, and Radin, Glass & Co., LLP ("Radin"), IBF's auditor. Plaintiffs contend that CIBC and Radin violated Section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act"), 15 U.S.C. § 78j(b) ("Section 10(b)"), and Exchange Act Rule 10b-5, 17 C.F.R. § 240.10b-5, by willingly participating in the promulgation of misleading disclosures regarding the funds. Additionally, plaintiffs contend that Radin's conduct violated Section 11 of the Securities Act of 1933 (the "Securities Act"), 15 U.S.C. § 77k ("Section 11"). A purported subclass of the plaintiffs asserts that CIBC violated sections 12(a)(1) and (2) of the Securities Act, 15 U.S.C. § § 77l(a)(1) & (2) ("Section 12(a)(1)" and "Section 12(a)(2)"). The Court concludes that none of these claims can proceed in the face of the demanding pleading standards applicable in securities cases, and accordingly grants the motions to dismiss.


IBF was organized in 1996 by Simon A. Hershon1 as a distressed loan outfit. See Consol. Am. Compl. ("Compl.") ¶ 20. Its business plan was ostensibly to pool capital into funds that would invest in under-performing loans and, after restructuring or otherwise rehabilitating the loans, sell them at a profit. The funds also invested in IBF-affiliated hotel development and industry consolidation ventures. In all, IBF organized seven funds between 1996 and 1999 (referred to herein as "Fund I," etc.).2 Funds I through IV and Fund VII offered notes under various private placement memoranda. Compl. ¶ 15.3 Each of these funds issued five-year notes bearing interest at rates between 8 and 12 percent annually, plus an additional variable interest payment tied to the respective fund's gross profits. Id. Both IBF and CIBC allegedly made private placement memoranda available to interested investors. Compl. ¶ 28. On September 20, 2000, and March 26, 2001, Prather allegedly purchased IBF securities through CIBC after being solicited by a CIBC broker. CIBC Mot. to Dismiss, App. 1. Belizan claims to have purchased IBF securities sometime between July 26, 1999, and June 7, 2002, the purported Class Period. See Compl. ¶¶ 1, 6.

During that time, allege plaintiffs, IBF routinely repaid investors by shuffling money between its various funds. Compl. ¶ 35. To do this, it transferred loan assets between funds at par value, "meaning that the acquiring fund paid the selling fund all principal, interest and fees outstanding, without regard to the value and performance status of the underling loans." Id. As an example, plaintiffs allege that sometime "in 2000" IBF caused Fund VII to acquire about forty percent of Fund I's portfolio for cash to allow Fund I to pay its noteholders. Compl. ¶ 37. Generally accepted accounting principles ("GAAP") obliged IBF to disclose such material related-party transactions. Nonetheless, "other than generic disclosures saying that, from time to time, the IBF Funds acquire loans from one another," this and other inter-fund transfers were not properly reported in IBF's private placement memoranda.4 See Compl. ¶ 38.

CIBC allegedly informed potential and actual purchasers of IBF securities, including Prather, that it had conducted extensive due diligence investigations into IBF's business practices. Compl. ¶ 96; see also Compl. ¶ 90 ("Prior to signing the selling agreement [with IBF], CIBC Oppenheimer conducted due diligence for approximately two-years [sic]. This due diligence including [sic] a review of financial statements; meetings with IBF Securities management including all of the top executives and senior management in the District of Columbia and New York; and reviews of loan files."). Plaintiffs' claim is that, if CIBC did in fact perform a thorough due diligence investigation, it "must have obtained knowledge" of IBF's inter-fund transfers and noticed their omission from the Offering Materials. Compl. ¶ 97.. CIBC was allegedly motivated to withhold what it knew from its clients because it was to receive nine percent of the gross sale price of each unit of IBF securities it sold, plus a pro-rata share of IBF's gross annual profits. Compl. ¶ 32. Thus, say plaintiffs, CIBC became a willing participant in the promulgation of misleading disclosures. CIBC supplied its clients with IBF materials and management presentations that it must have known were false or misleading as to the Funds' cash flow, ability to pay interest, and loan losses.

Meanwhile, Radin allegedly overlooked IBF's malfeasances and rendered unqualified audit reports during the relevant period. See Compl. ¶¶ 61-63. According to former IBF insiders interviewed by plaintiffs, Radin personnel spent up to four weeks annually at IBF's Washington, D.C. offices performing audits and reviews for the opinions published in IBF's financial statements and offering materials. Compl. ¶ 66. Plaintiffs charge Radin with knowing, or recklessly failing to know, that IBF's failure to disclose its purchases of bad loans were materially misleading. See Compl. ¶ 71. According to plaintiffs, Radin's reports, which did not expose IBF's inter-fund transfers, were included in at least eleven SEC filings between 1999 and 2002. Compl. ¶ 64. The impact of these omissions was allegedly material because the omissions obscured significant fund losses. Radin was paid audit fees ranging from $10,000 to $15,000 per fund and ultimately $50,000 to $100,000 per year in aggregate fees. Compl. ¶ 67.

Aside from their allegations about IBF's inter-fund transfers, plaintiffs charge in general that IBF's offering memoranda contained materially false and misleading maturity statistics. These gave the misimpression that the loans in at least one of IBF's portfolios turned over more frequently than they actually did. See Compl. ¶¶ 81-83. A stock of short-term loans would suggest a more stable investment than the stagnant pool of poor performers that the IBF funds allegedly contained. The Complaint also asserts that IBF failed to disclose the methodology it used to estimate the value of the collateral for its loans. As an example, plaintiffs cite a Fund VII report dated September 30, 2001, that supplied a 146-percent collateral coverage statistic for the Fund. Plaintiffs allege that Radin knew or was reckless in not knowing that the failure to disclose the lack of methodology was materially misleading given the apparent precision of that statistic. Compl. ¶ 87.

Throughout 2001, the SEC conducted an inquiry into allegations that IBF operated as a Ponzi scheme. The inquiry led to a private order of investigation and, on December 17, 2001, the SEC requested that all new offering proceeds from IBF Funds be deposited in an escrow account. Compl. ¶ 25. Incoming monies were thus not available for new investments or to service the debt from prior offerings. Sometime in January 2002, an IBF executive allegedly informed CIBC that IBF was the subject of an SEC investigation. Compl. ¶ 31. Radin also purportedly became aware of the SEC investigation some time in January 2002. Compl. ¶ 72 IBF ceased offering securities on January 31, 2002, and filed for bankruptcy that June. On July 23, 2002, the SEC filed a complaint against IBF, Funds VI and VII, and Hershon in the United States District Court for the Southern District of New York. See SEC v. IBF Collateralized Finance Corp., 2002 WL 32081630, 2002 U.S. LEXIS (S.D.N.Y. Dec. 6, 2002) (order under granting partial summary judgment in favor of the SEC and appointing a trustee pursuant to the Investment Company Act, 15 U.S.C. § 80a-41(d)); In re InterBank Funding Corp., 310 B.R. 238 (Bankr.S.D.N.Y.2004).

A. Applicable Legal Standard

A motion to dismiss pursuant to FED.R.CIV.P. 12(b)(6) will not be granted unless "it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 2 L.Ed.2d 80 (1957); see also Haynesworth v. Miller, 820 F.2d 1245, 1254 (D.C.Cir.1987). Generally speaking, all that the Federal Rules of Civil Procedure require of a complaint is that it contain "`a short and plain statement of the claim' that will give the defendant fair notice of what the plaintiff's claim is and the grounds upon which it rests." Conley, 355 U.S. at 47, 78 S.Ct. 99. However, where fraud is alleged, the circumstances constituting fraud must be stated with particularity. FED. R. CIV. P. 9(b).

The Private Litigation Reform Act of 1995, 15 U.S.C. § 78u-4 ("PSLRA"), imposes additional pleading requirements on plaintiffs is securities cases. First, the statute requires that,

in any private action arising under this chapter in which the plaintiff may recover money damages only on proof that the defendant acted with a particular state of mind, the complaint shall, with...

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