In re New Century
| Decision Date | 03 December 2008 |
| Docket Number | No. CV 07-00931 DDP (JTLx).,CV 07-00931 DDP (JTLx). |
| Citation | 588 F.Supp.2d 1206 |
| Parties | In re NEW CENTURY. |
| Court | U.S. District Court — Central District of California |
This is a securities class action that arises in the wake of the sub-prime mortgage lending crisis and the collapse of one of the industry's formerly largest subprime mortgage lenders, New Century Financial Corporation ("New Century"). Lead Plaintiff New York State Teachers Retirement System ("NYSTRS") brings this action on behalf of all persons and entities, other than Defendants, who purchased or acquired New Century common stock, New Century Series A Cumulative Redeemable Preferred Stock ("Series A Stock"), New Century Series B Cumulative Redeemable Preferred Stock ("Series B Stock"), and/or New Century call options, or who sold New Century put options, between May 5, 2005 and March 13, 2007 (the "Class Period"). (Compl.¶ 1.) Defendants are New Century officers ("Officer Defendants"), its directors ("Director Defendants"), its auditor KPMG ("KPMG"), and the underwriters of the stock offering ("Underwriter Defendants").
Sub-prime lending involves originating and purchasing loans for borrowers considered high-risk by traditional credit and underwriting standards. (Compl.¶ 2.) The recent sub-prime mortgage lending crisis has caused many mortgage lending companies—and the value of their stocks—to collapse. New Century became one of the nation's largest mortgage finance companies by focusing on sub-prime lending. (Compl.¶ 2.) In 1996, when New Century was formed, it had $357 million in total loan originations and purchases. For the year-ended December 31, 2005, New Century reported $56.1 billion in total loan originations and purchases. (Compl.¶¶ 55-60.) Sub-prime loans accounted for $32.8 billion, or 62.2% of total loans financed or sold. (Compl.¶ 65.)
In June 2005 and August 2006, New Century made offerings of the Series A stock and Series B stock respectively. On February 7, 2007, a day before 2006 fourth-quarter and year-end results were scheduled to be released, New Century issued a press release that disclosed a restatement of earnings for the previous three quarters of 2006. New Century stated that material weaknesses in internal controls over financial reporting caused the reporting errors. (Compl.¶ 457.) Upon this announcement, New Century stock plummeted by 36% the following day. (Id. at ¶ 459) In the period subsequent to these and additional disclosures, (Id. at ¶¶ 464, 468-476), New Century stock further declined. On March 14, 2007, New Century stock closed at $ 0.67 per share, a 97% decline from the over $30 per share prior to the disclosures. (Id. at ¶ 9) The Series A and Series B stock likewise fell by 75% during this period. (Id. at ¶¶ 9, 478.)
Plaintiffs filed this lawsuit alleging securities violations in connection with New Century's Series A and Series B stock. Plaintiffs maintain that these declines were foreseeable, and that Defendants made numerous material misstatements regarding New Century's financial situation and business operations. In summary, Plaintiffs allege that Defendants, during the Class Period, misrepresented New Century's ability to repurchase defaulted loans; overvalued its residual interests in securitizations; falsely certified the adequacy of its internal controls, loan origination standards, and the quality of its loans; and failed to identify these problems in public statements, registration documents, audits, or elsewhere. They claim that Defendants' material misrepresentations and omissions violated Section 11 of the Securities Act of 1933, 15 U.S.C. § 77k. They further claim that the New Century Officer Defendants and KPMG violated sections 10(b) and 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. § 78u-4(b), and Rule 10b-5 of the regulations promulgated by the Securities and Exchange Commission ("SEC").
On April 30, 2008, Plaintiffs filed their second amended consolidated class action complaint.1 There are currently five motions to dismiss and one motion to strike before the Court. The Officer Defendants move to dismiss the securities fraud claims under section 10(b) and Rule 10b-5, as well as the derivative control person liability claims. Officer Defendant Robert Cole files his own motion to dismiss the same claims. The Director Defendants and Underwriter Defendants move to dismiss claims alleging violations of section 11 of the Securities Act of 1933, 15 U.S.C. § 77k, in connection with the Series A and Series B stock. Those motions are joined by the Officer Defendants against whom Plaintiffs also allege violations of section 11 of the Securities Act. Defendant KPMG moves to dismiss the claim against it alleging violations of section 11 of the Securities Act in connection with Series B stock, and the securities fraud claim against it under section 10(b) and Rule 10b-5. Defendant KPMG also moves to strike all references in the Complaint to the Bankruptcy Report.
After reviewing the extensive briefing, hearing oral argument, and considering the arguments raised by all parties, the Court denies Defendants' motions to dismiss and denies Defendant KPMG's motion to strike.
The Court's review on a motion to dismiss is generally limited to the allegations in the Complaint, taken as true and construed in the light most favorable to the non-moving party. Resnick v. Hayes, 213 F.3d 443, 447 (9th Cir.2000). The following background is derived from Plaintiffs' second amended complaint ("Complaint").
Lead Plaintiff New York State Teachers Retirement System ("NYSTRS") has over 400,000 active members, retirees, and beneficiaries.2 NYSTRS provides retirement, disability, and death benefits to eligible public school teachers in New York State. NYSTRS purchased New Century common stock during the Class Period and claims to have suffered damages due to the alleged wrongful conduct. (Compl.¶ 19.) Plaintiff Carl Larson acquired New Century Series A and B Preferred Stock during the Class Period and claims to have suffered damages due to the alleged wrongful conduct. (Id. at ¶ 20.) Plaintiff Charles Hooten sold New Century put options during the Class Period and claims to have suffered damages due to the alleged wrongful conduct. (Id. at ¶¶ 21.)
On April 2, 2007, New Century filed for Chapter 11 bankruptcy protection. For this reason, the action against New Century has been stayed. (Compl.¶ 22.) Plaintiffs assert claims against several other Defendants in this action. To be consistent, the Court follows the categorization from the Complaint: New Century Officer Defendants, New Century Director Defendants, KPMG, and New Century Underwriters.
The Officer Defendants were corporate officers of New Century during the Class Period.3 (Compl.¶¶ 23-26.) The officers' duties included disseminating prompt, accurate information about the Company's business, operations, financial statements and internal controls, and correcting any previously issued statements that had become materially untrue. They were involved in drafting, producing, reviewing, and/or disseminating the alleged material misstatements at issue in this case. (Id. at ¶¶ 27-29.)
The Director Defendants served as directors of New Century during the Class Period.4 (Compl.¶¶ 30-38.) Each of the Director Defendants either signed the registration statements for Series A and. Series B stock, or were directors when the stock was offered to the public. (Id.)
Defendant KPMG served as New Century's outside auditor during the Class Period. (Compl.¶ 39.) The Underwriter Defendants are the investment banks that acted as underwriters to the public offerings of New Century stock in June 2005.5 (Id. at ¶¶ 40-47.)
New Century primarily originated subprime mortgage loans. Sub-prime lending refers to providing loans with typically high interest rates to high-risk borrowers, who may have poor credit histories, the lack of income documentation, or debt. The sub-prime mortgage lending industry collapsed, in part, because high-risk adjustable-rate interest-only loans, and "stated income" loans resulted in increased default rates among borrowers. (Compl.¶ 4.)
New Century's business was not limited to originating loans. New Century, like many sub-prime lenders, sought to sell its loans in a secondary market and recognize a "gain on sale" of those loans. New Century either made (1) whole loan sales; (2) securitizations structured as sales; or (3) securitizations structured as "financings." (Compl.¶ 61.) In whole loan sales, New Century realized gains upon sale of a pool of loans to third-parties. In securitizations structured as sales, New Century realized gains by selling a pool of loans to a trust, and receiving cash flows from its residual interests in the securitized pool of loans. In securitizations structured as financings, New Century did not record a gain on sale when it sold a pool of loans, but rather, received interest income as payments on the mortgages were made. (Compl.¶¶ 61-64.)
In June 2005, New Century sold its Series A preferred stock, for net proceeds of approximately $109 million. The Underwriter Defendants, excluding Morgan Stanley and Jefferies & Co., provided underwriting for the offering. The Series A stock was sold pursuant to a Form S-3 registration statement and prospectus. These documents are collectively referred to as "Series A Registration Statement."6 (Compl.¶¶ 236-238.) The Series A Registration Statement incorporated by reference the following documents: New Century's quarterly report (Form 10-Q) for the quarter ended March 31, 2005 and current report (Form 8-K) filed on or around May 5, 2005. (Id. at ¶ 238....
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