Steiner v. Shawmut Nat. Corp., Civ. No. H-90-253 (AHN).

• Decision Date: 10 June 1991
• Docket Number: Civ. No. H-90-253 (AHN).
• Citation: 766 F. Supp. 1236
• Parties: Gary STEINER, Kenneth Steiner, Norman Mermelstein, John Heller, Lepow Equities, Inc., Steven G. Cooperman, Jeanne Schaefer and Leonard Shapiro v. SHAWMUT NATIONAL CORP., Joel B. Alvord, John P. Hamill, and Gunnar S. Overstrom, Jr.
• Court: U.S. District Court — District of Connecticut

766 F. Supp. 1236

Gary STEINER, Kenneth Steiner, Norman Mermelstein, John Heller, Lepow Equities, Inc., Steven G. Cooperman, Jeanne Schaefer and Leonard Shapiro v. SHAWMUT NATIONAL CORP., Joel B. Alvord, John P. Hamill, and Gunnar S. Overstrom, Jr.

Civ. No. H-90-253 (AHN).

United States District Court, D. Connecticut.

June 10, 1991.

Susan Peck, Hartford, Conn., Stephen Oestreich, Wolf, Popper, Ross, Wolf & Jones, Stephen R. Steinberg, Milberg, Weiss, Bershad, Specthrie & Lerach, New York City, for plaintiffs.

Donn A. Randall, Hartford, Conn., Douglas M. Kraus, Skadden, Arps, Slate, Meagher & Flom, New York City, Thomas J. Groark and James Sicilian, Day, Berry and Howard, Hartford, Conn., for defendants.

RULING ON MOTION TO DISMISS

NEVAS, District Judge.

In this four-count class and derivative action¹ brought against the defendants Shawmut National Corp. ("Shawmut"), Joel B. Alvord ("Alvord"),² John P. Hamill ("Hamill"),³ and Gunnar S. Overstrom ("Overstrom")⁴ for violations of the federal securities and common law, the plaintiffs allege that, in reports disseminated to the public between December 8, 1988 and March 21, 1990 ("the Class Period"), the defendants understated Shawmut's loan loss reserves, overstated its earnings, misrepresented the quality of its loan portfolio, and overestimated its future prospects. In count one, the class action plaintiffs⁵ sue the defendants for securities fraud, alleging the violation of Sections 10(b) and 20 of the Securities Exchange Act of 1934 ("1934 Act"), 15 U.S.C. §§ 78j(b) and 78t(a), and Rule 10b-5, 17 C.F.R. Section 240.10b-5, promulgated thereunder. In count two, the class action plaintiffs bring a pendent state law claim of negligent misrepresentation. In counts three and four, based on diversity⁶ jurisdiction, the derivative plaintiff, Leonard Shapiro ("Shapiro"),⁷ sues derivatively, on behalf of Shawmut, defendants Alvord and Overstrom, alleging in count three a state law claim of waste and mismanagement and in count four a state law claim of indemnification. Now pending is defendants' motion to dismiss (filing 41) counts one, two and four of the amended complaint for failure to state a claim, pursuant to Rule 12(b)(6), Fed.R.Civ.P., and to dismiss counts two, three⁸ and four for lack of subject matter jurisdiction, pursuant to Fed.R.Civ.P. 12(b)(1). For the reasons that follow, the defendants' motion to dismiss is denied in part and granted in part.

I.

A.

The Complaint sketches the following narrative. In February 1988, Shawmut Corporation ("SC") and Hartford National Corporation ("Hartford") merged to form Shawmut National Corporation.⁹ In their introductory Letter to the Shareholders in Shawmut's 1988 Annual Report, the directors referred to 1988 as a year of "transition" in which the corporation refined its "focused business strategy, made progress toward established financial goals, and integrated certain businesses and operations ... and established a strong foundation, which will enable the Corporation to enter the 1990s with quality assets, strong capital and earnings momentum." Defendants' Reply Memorandum of Law in Further Support of Their Motion To Dismiss (filing 64) ("Defendants' Reply Memorandum"), Ex. A; Amended Complaint ("Am.Comp.") ¶ 27.

In the first three quarterly financial reports for 1989, Shawmut's reported earnings rose in comparison to the prior year's result. However, in a public announcement on January 23, 1990, earnings for the fourth quarter of 1989 were reported as down from $66.1 million reported in 1988 to $3.9 million, due to an increase in nonperforming loans of $146.3 million that led to a $139.4 million addition to the loan loss reserves. (Am.Comp. ¶ 42). Investors were told that the net results nevertheless amounted to a profit, with earnings for 1989 of $201.7 million. Alvord stated that Shawmut was confident of its ability to compete because of its "strong capital position, well-diversified loan portfolio, and tight control of expenses." (Am.Comp. ¶ 42). In an interview on January 25, 1990, Alvord commented that "New England is not Texas, and it's not going to be Texas." (Am.Comp. ¶ 43).

In February and March, 1990, 180 federal bank regulators (Am.Comp. ¶ 45) examined Shawmut's books.¹⁰ Thereafter, on March 21, 1990, Shawmut acknowledged that greater portions of its loans were nonperforming than previously reported. The previously reported figure for nonperforming loans for 1989 was $535.6 million. After the federal examiners came, the figure for nonperforming loans rose by nearly 100% to $1.05 billion. The provision for loan loss reserves reported in the fourth quarter of 1989 as $139.4 million rose to $572.3 million, thus bringing the total loan loss reserve to $705 million, almost 45% higher than the figure reported in January, 1990. Whereas Shawmut had reported earnings for 1989 of $201.7 million, after the bank examination a loss was reported for 1989 of $128.9 million. Am.Comp. ¶ 46; Plaintiffs' Memorandum in Opposition to Defendants' Motion to Dismiss (filing 60) ("Plaintiff's Memorandum"), at 11.

B.

The plaintiffs allege that when SC and Hartford merged to form Shawmut in February, 1988, the new bank holding corporation adopted an aggressive lending policy, particularly in the high risk area of real estate development. At a time when the New England economy, and especially the real estate sector, had begun to deteriorate, the defendants allegedly misclassified loans in Shawmut's portfolio as performing and consequently underreserved for possible losses relating to those loans. (Am. Comp. ¶ 54). The plaintiffs allege that since additions to the loan loss reserves are charged against earnings, Shawmut's practice of underreserving for possible losses produced inflated financial results which, in turn, artificially boosted the price of the stock. Thus, the defendants "knowingly or recklessly" (Am.Comp. ¶¶ 49, 54, 56, 59, 60) deferred recognition of the extent of Shawmut's problem loans and failed to establish loan loss reserves which would have shown up in the financial statements as lower earnings. (Am.Comp. ¶ 49). In so doing, the defendants allegedly embarked on a "scheme" (Am.Comp. ¶¶ 24, 51) designed to "conceal" from investors "the true financial and operating condition of Shawmut." (Am.Comp. ¶¶ 53, 54). The plaintiffs allege that the defendants "ignored, hid, or disregarded" the impact the problem loans would have on Shawmut's financial condition (Am.Comp. ¶ 54) in order "to bolster" the reported earnings and net worth and "to enhance" the market price of the stock. (Am.Comp. ¶ 24).

The heart of the plaintiff's claims is contained in paragraph 52 of the Amended Complaint. There, the plaintiffs allege that the public information and reports¹¹ issued during the class period contained materially false and misleading information in that the defendants overstated the value of Shawmut's real estate and commercial loan portfolio (Am.Comp. ¶ 52(a)); that the allowance for nonperforming loans and investments was not maintained at an adequate level (Am.Comp. ¶ 52(b)); that management was inadequate to supervise and control properly the lending activities of the bank (Am.Comp. ¶ 52(c)); that the defendants understated nonperforming loans and failed to provide adequate loan loss reserves and instead granted extensions to problem loan customers (Am. Comp. ¶ 52(d)); that materially false and misleading projections were made about Shawmut's future profitability and successful performance (Am.Comp. ¶ 52(e)); that Shawmut's system of internal financial and accounting controls was materially deficient (Am.Comp. ¶ 52(f)); and that Shawmut's income, assets and net worth were materially and deceptively overstated (Am. Comp. ¶ 52(g)).

The plaintiffs thus allege that the defendants intentionally made the following misrepresentations: 1) that Shawmut managed its "highly-diversified" (Am.Comp. ¶¶ 28, 42) high quality loan portfolio "conservatively" (Am.Comp. ¶ 55(a)) and maintained "tight expense control" (Am.Comp. ¶ 55(c)); 2) that Shawmut's loan loss reserves were "adequate" (Am.Comp. ¶¶ 52(b)); 3) that Shawmut would continue to grow and be profitable (Am.Comp. ¶¶ 52(e), 53). The plaintiffs allege that the defendants' statements were materially false and misleading when made (Am.Comp. ¶ 49) "because the defendants materially understated Shawmut's requirements for loan loss reserves and consequently overstated Shawmut's reported earnings, assets and net worth." (Am.Comp. ¶ 49). Thus, the defendants allegedly knew that the statements were false at the time that they were made.

C.

The defendants contend that these allegations, couched in the language of state law corporate mismanagement claims—the understatement of loan loss reserves, the inadequacy of supervision, the improper postponement of additions to the loan loss reserves, the rosy projections—are "all simply different sides of the same valuation coin," Defendants' Reply Memorandum, at 9-10, manifestations of mismanagement, perhaps, but not of fraud. They maintain that allowance for loan loss reserves is a matter of business judgment.¹² Memorandum of Law in Support of Defendants' Motion to Dismiss Plaintiffs' Amended Class Action and Shareholders' Derivative Complaint (filing 42) ("Defendants' Memorandum"), at 18. They argue that there were no intentional misstatements or omissions of material objective facts, and that if, in hindsight, the valuations made were too high and the picture painted was too rosy, the defendants were merely guilty of puffing. Naye v. Boyd, 1986-87 Transfer Binder Fed.Sec.L.Rep. (CCH) ¶ 92,979, 1986 WL 198 (W.D.Wash.), aff'd, 804 F.2d 146 (9th Cir.1986) (optimistic prognoses amounting to "obvious puffing" not actionable under federal securities laws); see also Vt. Investors v. R & D Funding Corp., 733 F.Supp. 823, 837-38 (D.N.J. 1990) (prediction that investors would realize cash flow in excess of $60,000 per month "can only be...