In re Midlantic Corp. Shareholder Litigation

• Decision Date: 11 October 1990
• Docket Number: Civ. No. 90-1275 (DRD).
• Citation: 758 F. Supp. 226
• Parties: In re MIDLANTIC CORPORATION SHAREHOLDER LITIGATION.
• Court: U.S. District Court — District of New Jersey

758 F. Supp. 226

In re MIDLANTIC CORPORATION SHAREHOLDER LITIGATION.

Civ. No. 90-1275 (DRD).

United States District Court, D. New Jersey.

October 11, 1990.

COPYRIGHT MATERIAL OMITTED

Barrack, Rodos & Bacine, Leonard Barrack, Anthony J. Bolognese, Cherry Hill, N.J., for plaintiffs Cheryl Cohen, Custodian for Jason Mark Cohen, Rose B. Rosenbaum, and Barry F. Schwartzman, Co-lead Counsel for Class.

Greenfield & Chimicles, Richard D. Greenfield, Mark C. Rifkin, Haverford, Pa., for plaintiff Gerry Banmiller and Co-lead Counsel for Class.

Gross & Metzer, Debra R. Gross, Anne D. White, Philadelphia, Pa., for plaintiff Labov and Counsel in the Derivative Claims.

Pitney, Hardin, Kipp & Szuch, Clyde A. Szuch, Dennis R. LaFiura, Morristown, N.J. (Skadden, Arps, Slate, Meagher & Flom, Jeremy Berman, New York City, of counsel), for defendants.

OPINION

DEBEVOISE, District Judge.

Pursuant to Federal Rule of Civil Procedure 12(b)(6) defendant Midlantic Corporation and individual defendants Van Buren, Peraino, Rishel, McDonald, Fox, Holman, Hough, and Lewis move to dismiss plaintiffs' complaint for failure to state a claim on which relief can be granted. Specifically, defendants claim that the causes of action alleged in plaintiffs' Consolidated Amended and Derivative Complaint (hereafter "Complaint") sounding in fraud under Section 10(b) of the Exchange Act, 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5, have been pled with insufficient particularity under Federal Rule of Civil Procedure 9(b). Defendants also claim that several Counts allege failures to disclose mismanagement and to make financial predictions and are thus not actionable under Section 10(b) and Rule 10b-5. Furthermore, defendants move for dismissal of plaintiffs' claims under Sections 14(a) and 20(a) of the Exchange Act, 15 U.S.C. §§ 78n(a), 78t(a), and plaintiffs' shareholder derivative action under Federal Rule of Civil Procedure 23.1 for failure to plead facts sufficient to support actionable claims. Likewise, the legal sufficiency of plaintiffs' pendent state law claim alleging negligent misrepresentation under New Jersey law is challenged for failure to plead adequate facts to sustain a cause of action.

Plaintiffs have voluntarily dismissed Count II of the Complaint. Thus plaintiffs do not oppose defendants' motion to dismiss as to Count II of the Complaint asserting claims under Sections 11, 12 and 15 of the Securities Act, 15 U.S.C. §§ 77k, 77l (2), 77o. Accordingly, this opinion will not address the issues raised by defendants with respect to these claims.

FACTS

Midlantic Corporation hereafter "Midlantic"¹ is an interstate bank holding company with assets of approximately $23.7 billion dollars and operations primarily serving the mid-Atlantic region but with offices scattered throughout Pennsylvania, New Jersey, Florida, Delaware, Maryland, London, Hong Kong, and the Cayman Islands. Complaint ¶ 6. Midlantic was formed in January 1987 by the reorganization of CBI and Midlantic Banks, Inc. Complaint ¶ 16. Dubbing itself "the Hungry Bankers", Midlantic then engaged in an aggressive expansion campaign which allegedly entailed making increasingly risky loans and investments concentrated in real estate, construction and leveraged buy-outs (LBOs). Complaint ¶¶ 17-19, 30(a).

Plaintiffs allege that this expansion program required Midlantic to maximize reported earnings to paint a glowing picture of financial health that veiled the enormous risks assumed by its recent investments and the concentration of its capital committed to such high-risk ventures. As a consequence of this alleged need to boost the profits on the books and conceal the risks entailed by defendants' strategy for expansion, plaintiffs allege that the pressures to continue Midlantic's fast-paced growth led defendants to "under-reserve for potential loan losses and to avoid acknowledgment of the risks inherent in the loans and investments" made by the corporation. Complaint ¶ 19. In other words, Midlantic failed to set aside sufficient funds to cover the amount of loans and investments likely to become non-performing and thus posing a likelihood of vast losses. Plaintiffs further allege that these pressures, inherent in Midlantic's expansion drive, also led defendants to make material misstatements of fact and material omissions of fact in public announcements and publications that perpetuated the illusory image of a financially untroubled corporation experiencing rapid growth of assets and profits which was a safe investment opportunity. The gravamen of plaintiffs' Complaint is their allegation that these material misstatements and omissions were designed to and did in fact induce prospective investors to purchase Midlantic securities at artificially high prices to raise badly needed capital during a period from March 27, 1987 and April 5, 1990 hereafter "the class period". See Complaint ¶¶ 7(f), 22-23, 29-39.

On December 20, 1989, Midlantic added $75 million dollars to its loan loss reserves. Plaintiffs allege this increase was accompanied by false and misleading statements to "downplay and conceal the material extent to which the Midlantic's earnings, assets, and shareholders' equity had been overstated, and possible loan losses had been understated." Complaint ¶ 26. Midlantic's loan loss reserves were again increased on April 6, 1990, this time by $110 million. Complaint ¶ 27. Plaintiffs claim that defendants again responded with materially false public statements. Id. The speculative bubble Midlantic had allegedly become apparently burst at or about this time. April 5, 1990 marks the end of the class period, during which plaintiffs claim they and other investors in Midlantic securities were misled by defendants' statements and purchased securities at inflated prices.

Midlantic's securities, traded on the NASDAQ exchange, tumbled in price following the announcement that loan loss reserves were to be dramatically increased. Consequently, Midlantic's shareholders absorbed the loss from this fall in the value of their Midlantic securities. A number of these shareholders brought class actions and one derivative action was brought on behalf of Midlantic against the individual defendants for damages incurred as the true financial state of Midlantic came to be appreciated by the financial markets. All actions were consolidated by Pre-Trial Order No. 1 on May 25, 1990.

Plaintiffs' first complaint was filed with the Clerk of this Court on March 28, 1990 and a Consolidated Amended Class and Derivative Complaint on May 25, 1990. A second Consolidated Amended Class and Derivative Complaint was filed June 5, 1990. They claim, inter alia, that Midlantic, its senior officers, and its directors made a practice of issuing misleading statements and engaging in suspect accounting and managerial practices to conceal risks lying at the very foundation of its loan and investment portfolios and in this manner induced members of the public to invest in Midlantic without the benefit of material information which would have led them to invest elsewhere.

Defendants filed this motion July 31, 1990 to dismiss for failure to state a claim upon which relief can be granted, pursuant to Federal Rule of Civil Procedure 12(b)(6), failure to plead fraud with particularity as required by Federal Rule of Civil Procedure 9(b), for lack of actionable subject matter as to the state law Counts III and V, and for insufficiency of service of process as to individual defendants Fox, Holman, Hough and Lewis.

Defendants' motion to stay merits discovery was denied by Order dated August 17, 1990 which set a schedule for discovery and production of specified classes of documents. Plaintiffs were to receive the first "wave" of discovery materials, nine categories of documents, on September 4, 1990. A hearing on class certification has been postponed until the disposition of this motion to dismiss.

DISCUSSION

Defendants bring a Motion to dismiss under Federal Rule of Civil Procedure 12(b)(6). Pursuant to Rule 12(b)(6), plaintiffs' complaints must be dismissed for failure to state a claim if defendants demonstrate "beyond a doubt that plaintiffs can prove no set of facts in support of their claim which would entitle them to relief." Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 102, 2 L.Ed.2d 80 (1957); see Johnsrud v. Carter, 620 F.2d 29, 33 (3d Cir.1980). All allegations set forth in the complaint must be accepted as true, see Cruz v. Beto, 405 U.S. 319, 322, 92 S.Ct. 1079, 1081, 31 L.Ed.2d 263 (1972); Walck v. American Stock Exchange, Inc., 687 F.2d 778, 780 (3d Cir.1982), and all reasonable inferences must be drawn in plaintiff's favor, see McKnight v. Southeastern Pennsylvania Transportation Authority, 583 F.2d 1229, 1235-36 (3d Cir.1978). To withstand the motion, it "is not necessary to plead facts upon which the claim is based." Bogosian v. Gulf Oil Corp., 561 F.2d 434, 446 (3d Cir.1977).

PLEADING REQUIREMENTS FOR FRAUD CLAIMS UNDER RULE 9(b)

The majority of defendants' arguments in favor of this motion to dismiss involves the sufficiency of plaintiffs' pleading fraud with particularity under Federal Rule of Civil Procedure 9(b). Thus the standard for pleading fraud under the Rule as construed by the Court of Appeals for the Third Circuit is the logical starting point in considering this motion. Rule 9(b) states

In all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity. Malice, intent, knowledge, and other condition of the mind of a person may be averred generally.

Fed.R.Civ.P. 9(b). The simplicity of this Rule, evident from the text, requires judicial interpretation to properly apply it to complex factual contexts. However, any interpretation given the Rule must be informed by an awareness that "focusing exclusively on the particularity requirement is `too narrow an approach and fails to take account of the general simplicity...