Shields v. Citytrust Bancorp, Inc.

Decision Date02 June 1994
Docket NumberD,No. 802,802
PartiesFed. Sec. L. Rep. P 98,239, 29 Fed.R.Serv.3d 239 Sarah B. SHIELDS, Individually and as representative of all others similarly situated, Plaintiff-Appellant, v. CITYTRUST BANCORP, INC., George F. Taylor and Irwin Engelman, Defendants-Appellees. ocket 93-7738.
CourtU.S. Court of Appeals — Second Circuit

Mark C. Rifkin, Haverford, PA (Greenfield & Rifkin, Haverford, PA, Goodkind Labaton Rudoff & Sucharow, New York City, Gordon & Hiller, Bridgeport, CT, of counsel) for plaintiff-appellant.

Philip L. Graham, Jr., New York City (Theodore W. Rosen, Sullivan & Cromwell, New York City, of counsel) for defendants-appellees.

Before: NEWMAN, Chief Judge, WINTER and JACOBS, Circuit Judges.

JACOBS, Circuit Judge:

As the aggrieved holder of somewhat less than one share of stock in Citytrust Bancorp, Inc. ("Citytrust"), Sarah B. Shields brought this class action claiming that Citytrust and two of its senior executives concealed and misrepresented Citytrust's financial condition--in particular, facts concerning its loan portfolio and loan loss reserves--in violation of Section 10(b) of the Securities Exchange Act of 1934 (the "1934 Act"), 15 U.S.C. Sec. 78j(b); Rule 10b-5 promulgated thereunder, 17 C.F.R. Sec. 240.10b-5; and New York law on negligent misrepresentation. The senior executives named in the complaint, George F. Taylor and Irwin Engelman, were also sued as "controlling persons" under Section 20 of the 1934 Act. 15 U.S.C. Sec. 78t(a). Defendants signed a stipulation, so ordered by the district court, certifying the class and designating Shields as class representative. Thereafter, Citytrust and co-defendants Taylor and Engelman moved to dismiss the Complaint pursuant to Fed.R.Civ.P. 12(b)(6) for failure to state a claim upon which relief can be granted, or, alternatively, pursuant to Fed.R.Civ.P. 9(b) for failure to plead fraud with particularity. On June 18, 1993, the United States District Court for the District of Connecticut (Eginton, J.) found that the Complaint failed to satisfy the pleading requirements of Rule 9(b) and dismissed. We affirm.

A. Shields's Allegations

We must accept as true all facts alleged in the Second Amended Complaint dismissed by the district court. See Luce v. Edelstein, 802 F.2d 49, 52 (2d Cir.1986). At all relevant times, Citytrust was a bank holding company organized under the laws of Connecticut. Citytrust's principal asset was Citytrust Bank, Connecticut's third largest commercial bank on the basis of total assets. Taylor was Between 1984 and 1988, Citytrust's reported assets rose from $1.5 billion to $2.6 billion, and its reported net income increased sixty percent. In July 1988, Citytrust announced that it expected to realize record earnings for the eleventh consecutive year, and voted a twenty cent quarterly dividend. Shields alleges that Taylor, at that time, falsely and unjustifiably stated that Citytrust's loan portfolio was "extremely healthy, as evidenced by net charge-offs of approximately 1/4 of 1 percent of loans over the past four years," a rate "well below the average for our industry." In October 1988, Citytrust reported a 10% increase in earnings and voted another twenty cent quarterly dividend. In January 1989, Citytrust reported that it had achieved its eleventh consecutive year of record net income as expected, which Taylor called "a solid performance," and had voted yet another twenty cent dividend for the quarter.

chairman of the board and chief executive officer of Citytrust and the Bank. Engelman was a director, president and chief operating officer of Citytrust and the Bank.

Shields alleged that Citytrust's financial health was deteriorating throughout this period largely because, in respect of a number of loans in its portfolio, Citytrust had accepted a right to share in equity appreciation in lieu of its usual collateral. As a result of such "shared appreciation loans," Citytrust was critically vulnerable to any drop in real estate values. Shields alleged that this risk was intentionally concealed by the defendants. In April 1989, Citytrust announced another increase in net income and Taylor stated that "prospects appear bright for further gains in earnings and returns on assets and equity. Our plan calls for 1989 to be our 12th consecutive year of record earnings."

Two months later, however, on June 15, 1989, Citytrust announced that, following an "intensive review" of its loan portfolios, it was necessary to take a $40 million charge against earnings in order to increase its loan loss reserves. Citytrust also stated that this charge would result in its reporting a loss in the second quarter of 1989, as well as for the entire 1989 fiscal year. Furthermore, Citytrust projected non-performing loans of up to $130 million for the second quarter of 1989 (up from $96 million in the first quarter) and noted that the amount could further increase in the second half of 1989.

The day after the June 15 announcement, Citytrust's stock dropped from $40- 5/8 per share to $34- 7/8, despite Taylor's declaration "that the second half of 1989 will be profitable for Citytrust because of a strong performance from the rest of our businesses and the continued underlying strength of the Company's earnings." Although Citytrust reported a net loss for the second quarter of 1989, Taylor allegedly continued his effort to mislead the investing public by stating: "While we are concerned with the extent of our loan problems, it is important to note that the underlying earnings of the bank remain strong." He also made the alleged misrepresentation that "[t]he addition to reserves is a prudent and conservative action in view of current negative real estate market conditions. We have assessed the underlying value of the bank's real estate related assets and provided for both the current exposure and potential for further decline in value."

The first of the two plaintiff sub-classes certified by the district court is composed of purchasers of Citytrust common stock in the period between March 31, 1989 and June 16, 1989 during which the events just described took place. The second plaintiff sub-class is composed of such purchasers in the period between June 17, 1989 and December 20, 1989, the date on which Citytrust announced further unnerving developments, including the elimination of its dividend for 1990. We recount the highlights of the second sub-class period, as alleged by Shields, in the following paragraphs.

Citytrust issued a news release on August 9, 1989, in which it claimed to be "moving aggressively" to overcome its problems, in part by making a "forceful drive to expand market share." Taylor again asserted that "the underlying earnings of the bank remain firm" and claimed that Citytrust was "committed to delivering solid earnings in the third and fourth quarters despite the pressure from our non-performing loans." On August 10, 1989, Citytrust filed a Form 10-Q that stated "management believes the current Two months later, on December 20, 1989, Citytrust announced a significant addition to its loan loss reserves, reflecting an increase in non-performing loans, which would cause it to report a considerable loss for the fourth quarter. Citytrust also announced the elimination of its dividend for 1990. During the second sub-class period, the price of Citytrust stock declined from $33 on June 16, 1989 to $11 on December 20, 1989.

                level of the allowance is adequate to provide for both the current loss exposure and the potential for a further decline in value."   On October 18, 1989, Citytrust declared a quarterly dividend of twenty-eight cents per share, allegedly to create an illusion of renewed financial health
B. Procedural History

Shields filed her class action on June 16, 1989, the day after Citytrust's first announcement that it would take a charge against earnings in order to increase its loan loss reserves. Defendants filed their answer on July 11, 1989, pleading as defenses failure to state a claim and failure to plead fraud with the requisite particularity.

In the months that followed, Citytrust permitted Shields to review certain documents relating to her allegations and to interview one of its executives. Shields moved to amend her complaint on February 5, 1990, in the wake of Citytrust's December 20, 1989 announcement of additional loan loss reserves and a resulting substantial quarterly loss. That motion and other issues were the subject of a "Revised Stipulation and Pretrial Order No. 1," entered into by the parties on September 27, 1990, and so ordered by the district court on October 23, 1990. The stipulation and order provided that the case would proceed as a class action, with two sub-classes, both represented by Shields; allowed Shields to serve and file an amended complaint; arranged for the organization of class counsel; and implemented certain housekeeping arrangements.

Shields filed the present Complaint on December 13, 1990, which included allegations relating to Citytrust's December 20 announcement and extended the class period accordingly. On February 15, 1991, Defendants moved to dismiss the Complaint and ten days later filed a motion to stay discovery pending a decision on the motion to dismiss. The district court granted the motion to stay discovery on June 21, 1991.

In August 1991, federal banking regulators declared Citytrust Bank insolvent and appointed the Federal Deposit Insurance Company as receiver. Citytrust succeeded in converting the bankruptcy into a Chapter 11 proceeding in September 1991, and an amended plan of reorganization was confirmed by the bankruptcy court on March 27, 1992. The amended plan had the effect of dissolving the automatic stay imposed by 11 U.S.C. Sec. 362 with respect to the present lawsuit.

On June 18, 1993, the district court ruled that Shields's allegations "do not satisfy the specificity...

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