UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK
------x In re: : CIT GROUP INC. SECURITIES LITIGATION : : MASTER FILE : 08 CV 6613 (BSJ) This Document Applies to: ALL ACTIONS. : : ECF CASE ------x
MEMORANDUM OF LAW IN SUPPORT OF DEFENDANTS’ MOTION TO DISMISS THE CONSOLIDATED AMENDED COMPLAINT
Douglas H. Flaum Israel David Catherine Meza Adam M. Harris Alfred L. Fatale III FRIED, FRANK, HARRIS, SHRIVER & JACOBSON LLP One New York Plaza New York, New York 10004-1980 (212) 859-8000 [email protected]
Attorneys for Defendants CIT Group Inc., Jeffrey M. Peek, Joseph M. Leone, William J. Taylor, Thomas B. Hallman, Gary C. Butler, William M. Freeman, Susan Lyne, Marianne Miller Parrs, Timothy M. Ring, John Ryan, Seymour Sternberg, Peter J. Tobin, and Lois M. Van Deusen
TABLE OF CONTENTS
Preliminary Statement ...... 1
Factual Background ...... 6
Argument ...... 11
I. COUNTS I AND II SHOULD BE DISMISSED BECAUSE THE COMPLAINT FAILS TO ADEQUATELY ALLEGE SCIENTER ...... 11
A. Plaintiffs’ Motive and Opportunity Allegations Fail ...... 13
1. The Individual Defendants’ Stock Transactions Do Not Support an Inference of Scienter ...... 13
2. The Other Motive Allegations Do Not Support an Inference Of Scienter ...... 20
B. Plaintiffs’ “Circumstantial Evidence” Allegations Fail ...... 23
1. The Confidential Sources Do Not Support Any Inference of Scienter ...... 23
2. The Vaguely Described Internal Meetings and Reports Do Not Support an Inference of Scienter ...... 31
II. COUNTS I AND II SHOULD ALSO BE DISMISSED BECAUSE PLAINTIFFS FAIL TO IDENTIFY ANY FALSE STATEMENTS ...... 32
A. Plaintiffs Fail to Plead That Defendants Made Any False Statement or Ommission Regarding CIT’s Home Lending Portfolio ...... 33
1. CIT Fully Disclosed the Subprime Nature and Credit Profile of Its Home Lending Portfolio ...... 33
2. CIT Repeatedly Warned Investors of a Downturn in the Housing Market and Increasing Loan Delinquencies ...... 34
3. Plaintiffs Fail to Plead Falsity With Respect to CIT’s Timing of a Write Down of Its Home Loans ...... 37
4. Plaintiffs Have Pled No Facts to Suggest that CIT Made Any False or Misleading Statements or Omissions About Supposedly “Reduced” Underwriting Standards ...... 40
i 5. Expressions of Optimism and Other Puffery Are Not Actionable ...... 43
6. Defendants’ Forwarding-Looking Statements Are Not Actionable ...... 44
B. The Complaint Fails to Allege That CIT Made Any False Statement or Omission Regarding Its Student Loans ...... 44
1. The Volume of Silver State Loans Was Immaterial ...... 46
2. Plaintiffs Allege No Particularized Facts Suggesting that CIT Should Have Written Off — Or Made Any Affirmative Disclosures Regarding — Its Silver State Loans Prior to February 2008 ...... 47
C. Plaintiffs’ GAAP Allegations Fail to State a Claim ...... 54
D. Count II Should Be Dismissed Because Plaintiffs Fail to Plead Control Person Liability ...... 56
III. COUNTS III, IV & V SHOULD BE DISMISSED BECAUSE THE COMPLAINT FAILS TO STATE A CLAIM UNDER THE SECURITIES ACT ...... 56
A. Plaintiffs’ Claims Under Sections 11, 12(a)(2) and 15 Sound in Fraud and Are Subject to the Heightened Pleading Requirements of Rule 9(b) ...... 57
B. The Complaint Fails to Allege Any Untrue Statement or Actionable Omission ...... 58
C. Plaintiffs’ Control Person Claim Fails ...... 58
D. The Section 12(a)(2) Claim (Count IV) Should Also Be Dismissed For Lack of Standing ...... 59
Conclusion ...... 59
ii TABLE OF AUTHORITIES CASES
ACA Fin. Guar. Corp. v Advest, Inc., 512 F.3d 46 (1st Cir. 2008)...... 49
Acito v. IMCERA Group, Inc., 47 F.3d 47 (2d Cir. 1995) ...... 14
Ashcroft v. Iqbal, 129 S. Ct. 1937 (2009) ...... 12 n. 10, 30
ATSI Commc’ns Inc. v. Shaar Fund, Ltd., 493 F.3d 87 (2d Cir. 2007) ...... 6 n. 3
Avon Pension Fund v. GlaxoSmithKline PLC, 2009 U.S. App. LEXIS 18969 (2d Cir. Aug. 24, 2009) ...... 15
Caiafa v. Sea Containers Ltd., 525 F. Supp. 2d 398 (S.D.N.Y. 2007) ...... 51, 59 n. 35
California Pub. Employees Ret. Sys. v. Chubb Corp., 394 F.3d 126 (3d Cir. 2004) ...... 25
Campo v. Sears Holdings Corp., 2009 U.S. Dist. LEXIS 62068 (S.D.N.Y. Jul. 21, 2009) ...... 23 n. 21
Chiarella v. United States, 445 U.S. 222 (1980) ...... 1 n. 1
Chill v. General Elec. Co., 101 F.3d 263 (2d Cir. 1996) ...... 13
Coronel v. Quanta Cap. Holdings Ltd., 2009 U.S. Dist. LEXIS 6633 (S.D.N.Y. Jan. 26, 2009) ...... 55
DiLeo v. Ernst & Young, 901 F.2d 624 (7th Cir. 1990) ...... 37
ECA v. JP Morgan Chase Co., 553 F.3d 187 (2d Cir. 2009) ...... passim
Fadem v. Ford Motor Co., 352 F. Supp. 2d 501 (S.D.N.Y. 2005) ...... 46
Ferber v. Travelers Corp., 785 F. Supp. 1101 (D. Conn. 1991) ...... 21
iii Fishbaum v. Liz Claiborne, Inc., 1999 U.S. App. LEXIS 18155 (2d Cir. July 27, 1999) ...... 16
Garber v. Legg Mason, Inc., 537 F. Supp. 2d 597 (S.D.N.Y. 2008) ...... 45
Glickman v. Alexander & Alexander Servs., 1996 U.S. Dist. LEXIS 2325 (S.D.N.Y. Feb. 29, 1996) ...... 22
Goplen v. 51Job, Inc., 453 F. Supp. 2d 759 (S.D.N.Y. 2006) ...... 32, 42
Grandon v. Merrill Lynch & Co., 147 F.3d 184 (2d Cir. 1998) ...... 39
Grossman v. Texas Commerce Bancshares, 1995 U.S. Dist. LEXIS 13501 (S.D.N.Y. Sept. 12, 1995) ...... 21
Gustafson v. Alloyd Co., 513 U.S. 561 (1995) ...... 59
Hall v. Children's Place Retail Stores, Inc., 580 F. Supp. 2d 212 (S.D.N.Y. 2008) ...... 23 n. 21
Higginbotham v. Baxter Int’l, Inc., 495 F.3d 753 (7th Cir. 2007) ...... 25 n. 22
Hinerfeld v. United Auto Group, 1998 U.S. Dist. LEXIS 10601 (S.D.N.Y. Jul. 15, 1998) ...... 45
In re 2007 Novastar Fin. Inc. Sec. Litig., 2008 U.S. Dist. LEXIS 44166 (W.D. Mo. June 4, 2008) ...... 38, 55
In re Advanta Corp. Sec. Litig., 180 F.3d 525 (3d Cir. 1999) ...... 17, 20
In re Allied Capital Corp. Sec. Litig., 2003 U.S. Dist. LEXIS 6962 (S.D.N.Y. Apr. 25, 2003) ...... 38, 47
In re Am. Express Co. Sec. Litig., 2008 U.S. Dist. LEXIS 74372 (S.D.N.Y. Sept. 26, 2008) ...... 24, 26
In re Apple Computer Sec. Litig., 88 F.3d 1109 (9th Cir. 1989) ...... 15
In re AstraZeneca Sec. Litig., 559 F. Supp. 2d 453 (S.D.N.Y. 2008) ...... 15, 21
iv In re AXIS Capital Hold. Ltd. Sec. Litig., 456 F. Supp. 2d 576 (S.D.N.Y. 2006) ...... 57 n.34
In re Bausch & Lomb, Inc. Sec. Litig., 592 F. Supp. 2d 323 (W.D.N.Y. 2008) ...... 16, 24, 29
In re Bristol-Myers Sec. Litig., 312 F. Supp. 2d 549 (S.D.N.Y 2004) ...... 16 n. 13, 19
In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410 (3rd Cir. 1997) ...... 16
In re CIT Group, Inc., 349 F. Supp. 2d 685 (S.D.N.Y. 2004) ...... 40, 46, 54 n. 32
In re Cosi, Inc. Sec. Litig., 379 F. Supp. 2d 580 (S.D.N.Y. 2005) ...... 59 n. 35
In re Downey Sec. Litig., 2009 WL 2767670 (C.D. Cal. Aug. 21, 2009) ...... 26, 32, 38, 45
In re Elan Corp. Sec. Litig., 543 F. Supp. 2d 187 (S.D.N.Y. 2008) ...... 28
In re eSpeed, Inc. Sec. Litig., 457 F. Supp. 2d 266 (S.D.N.Y. 2006) ...... 14, 20, 23 n. 20
In re Ferro Corp. Sec. Litig., 2007 U.S. Dist. LEXIS 42191 (N.D. Ohio June 11, 2007) ...... 27
In re Gildan Activewear, Inc. Sec. Litig., 2009 U.S. Dist. LEXIS 55984 (S.D.N.Y. July 1, 2009) ...... 19 n. 16
In re Glenayre Techs. Inc. Sec. Litig., 1998 U.S. Dist. LEXIS 20344 (S.D.N.Y. Dec. 30, 1998) ...... 18
In re Health Mgmt. Sys., Inc. Sec. Litig., 1998 U.S. Dist. LEXIS 8061 (S.D.N.Y. May 27, 1998) ...... 15
In re Hutchinson Technology, Inc. Sec. Litig., 536 F.3d 952 (8th Cir. 2008) ...... 23 n. 20
In re IAC/InterActiveCorp Sec. Litig., 478 F. Supp. 2d 574 (S.D.N.Y. 2007) ...... 25, 57, 58
In re Intelligroup Sec. Litig., 527 F. Supp. 2d 262 (S.D.N.Y. 2007) ...... 21
v In re Keyspan Corp. Sec. Litig., 383 F. Supp. 2d 358 (E.D.N.Y. 2003) ...... 20
In re N.Y. Cmty. Bancorp, Inc. Sec. Litig., 448 F. Supp. 2d 466 (E.D.N.Y. 2006) ...... 43
In re Network Assocs. Sec. Litig., 2003 U.S. Dist. LEXIS 14442 (N.D. Cal. Mar. 25, 2003) ...... 23
In re Northern Telecom Ltd. Sec. Litig., 1994 U.S. Dist. LEXIS 11730 (S.D.N.Y. Aug. 19, 1994) ...... 53
In re PXRE Group Ltd., Secs. Litig., 600 F. Supp. 2d 510 (S.D.N.Y. 2009) ...... 20, 29 n. 25, 30
In re Radian Sec. Litig., 612 F. Supp. 2d 594 (E.D. Pa. 2009) ...... 16 n. 13
In re Scholastic Corp. Sec. Litig., 252 F.3d 63 (2d Cir. 2001) ...... 48
In re Sierra Wireless, Inc. Sec. Litig., 482 F. Supp. 2d 365 (S.D.N.Y. 2007) ...... 26
In re Sina Corp. Sec. Litig., 2006 U.S. Dist. LEXIS 71089 (S.D.N.Y. Sept. 25, 2006) ...... 18, 19
In re Sterling Foster & Co. Sec. Litig., 222 F. Supp. 2d 216 (E.D.N.Y. 2002) ...... 59 n. 35
In re VEECO Instruments, Inc. Sec. Litig., 235 F.R.D. 220 (S.D.N.Y. 2006) ...... 44
In re Watchguard Sec. Litig., 2006 U.S. Dist. LEXIS 74269 (W.D. Wash. Oct. 12, 2006) ...... 25
In re Yukos Oil Co. Sec. Litig., 2006 U.S. Dist. LEXIS 78067 (S.D.N.Y. Oct. 25, 2006) ...... 22
Ind. Elec. Workers’ Pension Trust Fund IBEW v. Shaw Group, Inc., 537 F.3d 527 (5th Cir. 2008) ...... 25 n. 22
Institutional Investors Group v. Avaya, Inc., 564 F.3d 242 (3rd Cir. 2009) ...... 23 n. 21
Johnson v. NYFIX, Inc., 399 F. Supp. 2d 105 (D. Conn. 2005) ...... 57 n. 34
vi Kalnit v. Eichler, 264 F.3d 131 (2d Cir. 2001) ...... 20
Malin v. XL Capital Ltd., 499 F. Supp. 2d 117 (D. Conn. 2007) ...... 17, 43, 50, 55
Merrill Lynch, Pierce, Fenner & Smith v. Dabit, 547 U.S. 71 (2006) ...... 12
Miller v. Lazard, Ltd., 473 F. Supp. 2d 571 (S.D.N.Y. 2007) ...... 57, 58
Novak v. Kasaks, 216 F.3d 300 (2d Cir. 2000) ...... 25, 43, 48
Parnes v. Gateway 2000, 122 F.3d 539 (8th Cir. 1997) ...... 47, 59
Raab v. Gen. Physics Corp., 4 F.3d 286 (4th Cir. 1993) ...... 5
Ressler v. Liz Claiborne, Inc., 75 F. Supp. 2d 43 (E.D.N.Y. 1998) ...... 19
Rombach v. Chang, 355 F. 3d 164 (2d Cir. 2004) ...... 44, 57
Rothman v. Gregor, 220 F.3d 81 (2d Cir. 2000) ...... 19 n. 17
San Leandro Emergency Med. Group Profit Sharing Plan v. Philip Morris Cos., 75 F.3d 801 (2d Cir. 1996) ...... passim
Starr v. Georgeson S’holder, Inc., 412 F.3d 103 (2d Cir. 2005) ...... 35
Steinberg v. Ericsson LM Tel. Co., 2008 U.S. Dist. LEXIS 99727 (S.D.N.Y. Dec. 10, 2008) ...... 24
Tabor v. Bodisen Biotech, Inc., 579 F. Supp. 2d 438 (S.D.N.Y. 2008) ...... 55
Teamsters Local 445 Freight Div. Pension Fund v. Dynex Capital Inc., 531 F.3d 190 (2d Cir. 2008) ...... 41, 49
Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S. Ct. 2499 (2007) ...... passim
vii Vladimir v. Bioenvision, Inc., 606 F. Supp. 2d 473 (S.D.N.Y. 2009) ...... 27 n. 23
White v. H&R Block, Inc., 2004 U.S. Dist. LEXIS 14522 (S.D.N.Y. July 28, 2004) ...... 35
Yung v. Lee, 432 F.3d 142 (2d Cir. 2005) ...... 59
STATUTES, RULES AND REGULATIONS
Fed. R. Civ. P. 9(b) ...... 57, 58, 60
Fed. R. Civ. P. 12(b)(6)...... 60
Securities Act § 11, 15 U.S.C. § 77k ...... 58
Securities Act § 11, 15 U.S.C. § 78u-4(b)(1)-(2) ...... 12
Securities Act § 11, 15 U.S.C. § 78u-5(c)(1)(B), (C) ...... 44
Wendell H. Ford Aviation Investment and Reform Act for the 21st Century § 715, 49 U.S.C. § 44703(c) ...... 50 n. 28
OTHER AUTHORITIES
The Financial Crisis and The Role of Federal Regulators: Hearing Before the House Committee on Oversight and Government Reform, 110th Cong. (2008) ...... 8
Outlook of the U. S. Economy, Hearing Before the Joint Economic Comm., 109th Cong. (2006) (statement of Chairman Ben S. Bernanke) ...... 8
Student Pilot Guide (FAA-H-8083-27A), U.S. Department Of Transportation, Federal Aviation Administration (March 8, 2006) ...... 53
S&P 500 Financial Sector Market Cap Continues to Sink, Jan. 14, 2009 ...... 8
viii
TABLE OF ABBREVIATIONS FOR SEC FILINGS AND INVESTOR CONFERENCE CALLS
ABBREVIATION DESCRIPTION EXHIBIT1
CIT Exchange Act Filings
3/30/05 8-K CIT Group Inc. Current Report filed with the SEC on Form 2 8-K on March 30, 2005
12/22/05 8-K CIT Group Inc. Current Report filed with the SEC on Form 3 8-K on December 22, 2005
2005 10-K CIT Group Inc. Annual Report on Form 10-K for the year 4 ending December 31, 2005, filed with the SEC on March 6, 2006
5/8/06 10-Q CIT Group Inc. Quarterly Report on Form 10-Q for the 5 quarter ending March 31, 2006, filed with the SEC on May 8, 2006
8/3/06 8-K CIT Group Inc. Current Report filed with the SEC on Form 6 8-K on August 3, 2006
11/6/06 10-Q CIT Group Inc. Quarterly Report on Form 10-Q for the 7 quarter ending September 30, 2006 filed with the SEC on November 6, 2006
12/21/06 8-K CIT Group Inc. Current Report filed with the SEC on Form 8 8-K on December 21, 2006
1/17/07 8-K CIT Group Inc. Press Release filed with the SEC on Form 9 8-K on January 17, 2007
2006 10-K CIT Group Inc. Annual Report on Form 10-K for the year 10 ending December 31, 2006, filed with the SEC on March 1, 2007
4/18/07 8-K CIT Group Inc. Press Release filed with the SEC on Form 11 8-K on April 18, 2007
5/8/07 10-Q CIT Group Inc. Quarterly Report on Form 10-Q for the 12 quarter ending March 31, 2007 filed with the SEC on May 8, 2007
1 The documents listed herein are attached to the accompanying Declaration of Adam M. Harris, dated September 11, 2009 and filed herewith.
ix
7/18/07 8-K CIT Group Inc. Press Release filed with the SEC on Form 13 8-K on July 18, 2007
8/7/07 10-Q CIT Group Inc. Quarterly Report on Form 10-Q for the 14 quarter ending June 30, 2007 filed with the SEC on August 7, 2007
10/17/07 8-K CIT Group Inc. Press Release filed with the SEC on Form 15 8-K on October 17, 2007
11/6/07 10-Q/A CIT Group Inc. Amended Quarterly Report on Form 10- 16 Q/A for the quarter ending September 30, 2007 filed with the SEC on November 6, 2007
2007 10-K CIT Group Inc. Annual Report on Form 10-K for the year 17 ending December 31, 2007, filed with the SEC on February 29, 2008
8/11/08 10-Q CIT Group Inc. Quarterly Report on Form 10-Q for the 18 quarter ending June 30, 2008 filed with the SEC on August 11, 2008
8/17/09 10-Q CIT Group Inc. Quarterly Report on Form 10-Q for the 19 quarter ending June 30, 2009 filed with the SEC on August 17, 2009
Conference Call & Investor Presentation Transcripts
12/12/06 Investor Transcript of Goldman Sachs Financial Services CEO 20 Presentation Conference, December 12, 2006
1/17/07 Conf. Call Transcript of CIT Group Inc. Fourth Quarter 2006 Earnings 21 Conference Call, January 17, 2007
4/18/07 Conf. Call Transcript of CIT Group Inc. First Quarter 2007 Earnings 22 Conference Call, April 18, 2007
5/08/07 Investor Transcript of CIT Group Inc. 2007 Annual Stockholders 23 Presentation Meeting, May 8, 2007
5/14/07 Investor Transcript of UBS Financial Services Conference, May 14, 24 Presentation 2007
5/15/07 Investor Transcript of AFSA 17th Finance Industry Conference for 25 Presentation Fixed-Income Investors, May 15, 2007
x
Forms 4 and 5
Peek Forms 4 & 5 Jeffrey M. Peek Forms 4 and Forms 5 26
Leone Forms 4 & 5 Joseph M. Leone Forms 4 and Forms 5 27
Taylor Forms 4 & 5 William J. Taylor Forms 4 and Form 5 28
Hallman Forms 4 & 5 Thomas B. Hallman Forms 4 and Form 5 29
xi
“Section 10(b) is aptly described as a catchall provision, but what it catches must be fraud.”1
PRELIMINARY STATEMENT
In February 2008, a helicopter pilot training school headquartered in Nevada (“Silver
State”) declared bankruptcy, ceased operating and was widely reported to have been a sham.
Silver State left many innocent victims in its wake. Perhaps its largest victim, though, was CIT
Group Inc. (including its subsidiaries “CIT” or the “Company”), which is in the business of
providing loans and other financing products to clients worldwide. As of Silver State’s closure,
CIT held approximately $196 million of private (i.e., non-government guaranteed) loans to
students of Silver State. CIT wrote down the value of these loans as a result of Silver State’s
collapse. There is no dispute that CIT promptly disclosed the adverse impact of this event.
This purported securities fraud class action by CIT shareholders thus stems — in classic
strike suit fashion — from plaintiffs’ reckless speculation that, along with this financial setback
to CIT, there must have been (somewhere, somehow) an accompanying securities fraud by CIT.
Thus, the amended complaint (the “Complaint”) claims that CIT and four of its senior-most
officers (the “Individual Defendants”) knew but failed to disclose that Silver State was a sham
and that the loans CIT made to Silver State’s students would not be paid back.
Nothing could be further from the truth. Nowhere in the 120-page Complaint is a single
fact alleged remotely suggesting that the Individual Defendants were aware that Silver State was
a sham, much less that these individuals committed securities fraud. Plaintiffs do not cite a
single document or statement (contemporaneous or otherwise) that suggests any of the Individual
Defendants’ statements were false or that they made any material omissions. Instead, the
Complaint relies exclusively on the adverse events that ultimately materialized and then argues
1 Chiarella v. United States, 445 U.S. 222, 234-35 (1980).
1 backwards that CIT must have been aware of risks that it failed to disclose. Congress passed the
Private Securities Litigation Reform Act of 1995 (“PSLRA”) for the express purpose of barring
hindsight-driven attacks like this one.
To describe this claim is to show how far-fetched it is. CIT’s $196 million in loans to
Silver State students represented a miniscule less than one-quarter of 1% of CIT’s approximately
$80 billion in outstanding loans at the time. Only now, after Silver State’s bankruptcy, do
plaintiffs cobble together irrelevant and conclusory tidbits — for example, claiming that Silver
State’s training equipment was substandard — and self-righteously proclaim (with the benefit of
20/20 hindsight) that it must have been clear to everyone that Silver State was not a legitimate school. This claim defies common sense, and pointedly ignores the fact that numerous other individuals and entities were duped by Silver State. Hundreds, if not thousands, of students invested their tuition and precious time training for a career at a school which plaintiffs’ counsel now glibly claims was obviously a charade. Likewise, Citibank made millions of dollars in loans to Silver State students at the same time (indeed, even after the time) that CIT was making loans to Silver State students. Under plaintiffs’ theory that it was so clear that Silver State was a sham, why did all of these individuals and entities invest so heavily in Silver State? The answer is simple: They (like CIT) were not aware that Silver State was a sham.
As the Court is aware, the three original purported securities class actions which the
Court consolidated into this action — and which were the sole basis upon which the Court designated these plaintiffs as lead plaintiff — all revolved exclusively around plaintiffs’ Silver
State claims. Yet, to deflect attention from the emptiness of their Silver State claims, plaintiffs
have now added “subprime” home lending claims, which are wholly unrelated to the Silver State
claims. In particular, in July 2007, CIT announced that it would be exiting its subprime home
2 lending business and that it would take a pre-tax charge of $765 million on its $10.6 billion
portfolio of home loans, and in October 2007 disclosed that it would record a further $465
million charge with respect to its home loan receivables. Now, for the very first time — a full
two years after CIT first announced it was exiting the subprime business and taking sizable
losses in that regard — plaintiffs allege that CIT and the Individual Defendants somehow committed securities fraud by failing to disclose earlier the risks inherent in its subprime
portfolio, as if the mere incantation of the term “subprime” is a ticket past a motion to dismiss.
Plaintiffs again could not be more wrong. Plain and simple, CIT’s home lending business
(which during the class period amounted to approximately 13% of CIT’s business) operated
squarely and openly within the subprime portion of the home lending industry. CIT publicly
disclosed this fact on numerous occasions in its SEC filings and in publicly-available conference
calls with investors both before and throughout the class period. The Complaint does not cite a
single material fact that CIT failed to disclose in connection with its subprime home lending
business, and certainly does not allege any facts suggesting that any such alleged omissions (to
be absolutely clear, there were none) were made with an intent to defraud.
The obvious reality — which plaintiffs ignore, without so much as a nod to the critical
context — is that the United States is in the throes of a crushing meltdown in its financial,
housing and credit markets, the likes of which have not been seen since the Great Depression.
The toll has been staggering. Many millions of jobs have evaporated. The largest bank failures
in United States history have occurred, and previously-iconic institutions have now been
relegated to the dustbin of history. Not surprisingly, CIT’s subprime business suffered
significant losses. The unfortunate irony here is that CIT recognized the disintegrating home
lending market and exited the business relatively early in the cycle as compared to a great many
3 financial institutions which suffered far greater losses on their subprime exposure — which
explains why no one (except these plaintiffs, in their zeal to manufacture a claim out of whole
cloth) ever alleged securities fraud in connection with CIT’s subprime home lending business in
the two full years since those losses were publicly disclosed.
Ultimately, the crux of any securities fraud claim is the intent to defraud, commonly
referred to as scienter. The Supreme Court — in the recent, and seminal, Tellabs decision —
held that in evaluating whether plaintiffs have pled factual allegations “giving rise to a strong
inference of scienter” (as the PSLRA requires), the Court must weigh competing inferences
arising from the facts alleged and matters subject to judicial notice and may permit the case to go
forward only if the inference that the defendants acted with scienter is both “cogent and at least
as compelling as any opposing inference of nonfraudulent intent.” Tellabs, Inc. v. Makor Issues
& Rights, Ltd., 127 S. Ct. 2499, 2505 (2007).
Here, despite plaintiffs’ claim that scienter can be inferred from “insider sales,” plaintiffs conspicuously ignore that the Individual Defendants’ behavior is irreconcilable with any intent to
defraud. Most tellingly, CIT’s CEO, Mr. Jeffrey Peek, did not sell a single share of CIT stock
during the 15-month class period. Indeed, Mr. Peek purchased over $1.4 million of CIT stock on
the open market during the heart of the class period: i.e., if plaintiffs’ theory is to be credited,
CIT’s top executive bought shares at precisely the same time that he was orchestrating a scheme
to artificially inflate the price of those shares. These transactions alone eviscerate any suggestion
of scienter — in fact, they affirmatively establish the absence of scienter. Moreover, the
publicly-available trading data, of which this Court must take notice, tells a clear and compelling
story: each of the Individual Defendants owned more CIT stock at the end of the class period
than they did at the beginning. Further, all of the so-called “sales” misleadingly cited by
4 plaintiffs were (as confirmed by the public documents plaintiffs rely upon) actually stock-option
exercise transactions in which the Individual Defendants acquired shares of CIT stock through
the exercise of options and then contemporaneously sold those shares. This is hardly the picture
of stock-dumping that plaintiffs seek to portray.
Beyond its specious allegations of insider sales, the Complaint does not plead a single
fact suggesting that any of the Individual Defendants acted with scienter. None of the obligatory
confidential witnesses whom plaintiffs parade through the Complaint is alleged to have ever
communicated with any of, or even been in the presence of, the Individual Defendants. Plaintiffs identify no document — whether or not communicated to or by the Individual Defendants — that contradicts any of their public statements.
* * *
In the end, the Complaint asserts nothing more than a classic “fraud-by-hindsight” claim.
According to plaintiffs, the mere fact that CIT suffered losses on its subprime mortgage portfolio
and on loans to Silver State students somehow provides an inference of scienter and a way for
shareholders to escape the risk they knowingly assumed. Unfortunately for plaintiffs, it does not:
“The market has risks; the securities laws do not serve as investment insurance.” Raab v. Gen.
Physics Corp., 4 F.3d 286, 291 (4th Cir. 1993).
It is not hard to state with specificity factual allegations to support a claim for securities
fraud when there actually is a basis to do so. Here — precisely because there was none —
plaintiffs come woefully short of alleging any inference of fraud, much less the “strong
inference” required by the PSLRA, and certainly far less than an inference which, as required by
Tellabs, is both “cogent and at least as compelling as any opposing inference of nonfraudulent
intent.” 127 S. Ct. at 2505. Plaintiffs’ claims should be dismissed.
5 FACTUAL BACKGROUND2
CIT and Its Business.3 Defendant CIT Group Inc. (“CIT” or the “Company”) is a leading commercial and consumer finance company, providing clients with financing and leasing
products and advisory services worldwide. ¶10. As of December 31, 2007, CIT had total managed assets of $83.2 billion, comprised of an owned loan and lease portfolio of $76.9 billion and a securitized portfolio of $6.3 billion. 2007 10-K at 2. CIT employed approximately 6,700 individuals as of December 31, 2007. Id. at 6. As of the end of 2007, CIT served clients in its portfolio across six business segments (Id. at 3):
Segment Market and Services Assets Corporate Lending and leasing to healthcare, communications, media and $24.1 billion Finance energy companies Vendor Financing and leasing solutions for manufacturers, distributors $16.1 billion Finance and customers worldwide Transportation Large ticket equipment leases and other secured financing to $13.6 billion Finance transportation and defense companies Consumer Student loans through Student Loan Xpress; other consumer $12.3 billion loans through CIT Bank Home Lending Home loans to individual homeowners $9.8 billion Trade Finance Financial services to companies in the retail supply chain $7.3 billion
The Individual Defendants. Jeffrey M. Peek is, and was during the class period, CIT’s
Chairman and CEO. ¶11. Joseph M. Leone is, and was during the class period, the Company’s
Vice Chairman and Chief Financial Officer. ¶12. Thomas B. Hallman, who retired from CIT in
2 Unless otherwise noted, emphasis is added and internal citations are omitted throughout. Copies of cited documents are attached to the accompanying declaration of Adam M. Harris, dated September 11, 2009. Citations to paragraphs (“¶”) are to paragraphs of the Complaint.
3 For purposes of this motion only, all of the factual — as opposed to conclusory — allegations of the Complaint are assumed to be true. However, in addition to the allegations in the Complaint, the Court “must consider … sources courts ordinarily examine when ruling on Rule 12(b)(6) motions to dismiss, in particular, documents incorporated into the complaint by reference, and matters of which a court may take judicial notice.” Tellabs, 127 S. Ct. at 2509. This Factual Background, therefore, is drawn from (i) the Complaint, (ii) documents referenced in the Complaint, (iii) SEC filings, and (iv) other published, historical information. See, e.g., ATSI Commc’ns Inc. v. Shaar Fund, Ltd., 493 F.3d 87, 98 (2d Cir. 2007) (court may consider “legally required public disclosure documents filed with the SEC, and documents possessed by or known to the plaintiff and upon which it relied in bringing the suit”).
6 December 2007, served as the Company’s Vice Chairman for Specialty Finance, which included
the Vendor Finance, Consumer, Home, and Small Business lending segments of CIT’s business.
¶13; 2006 10-K at 3. Prior to his retirement from CIT in December 2008, William J. Taylor was
CIT’s Executive Vice President & Controller. ¶14.
Gary C. Butler, William M. Freeman, Susan Lyne, Marianne Miller Parrs, Timothy M.
Ring, John Ryan, Seymour Sternberg, Peter J. Tobin, and Lois M. Van Deusen were Directors of
CIT at the time of the Company’s October 17, 2007 offering of CIT-Z securities. ¶¶20-28.
The Home Lending Business. CIT’s home lending unit primarily originated, purchased
and serviced loans secured by first liens on detached, single-family, residential properties. 2006
10-K at 5. CIT originated home loans through brokers and correspondents, and also bought and
sold individual loans and portfolios of loans from and to banks, thrifts and other originators of
consumer loans. 2006 10-K at 5.
CIT consistently disclosed the fact that it held “subprime” home loans.4 Indeed, in its
disclosures made prior to and throughout the class period, CIT explicitly informed investors of
exactly what types of home loans it held in its portfolio, providing data on: (i) the average FICO score of loan recipients; (ii) the average loan-to-value ratio of home loans in the portfolio; (iii) the percentage of loans that had adjustable rather than fixed interest rates; (iv) geographic
concentration of the loans; and (v) average loan size. 2005 10-K at 38; 11/6/06 10-Q at 43; 2006
10-K at 41; 5/8/07 10-Q at 37; 8/7/07 10-Q at 24.
The Credit Crisis. The United States recently suffered a crushing meltdown in its
financial, housing and credit markets. Numerous governmental entities and regulators, as well as
the vast majority of major financial institutions around the globe, all failed to predict the
unprecedented collapse of the housing market and the resulting trillion-dollar losses in the
4 1/17/07 Conf. Call at 10; 4/18/07 Conf. Call at 3; 5/08/07 Investor Presentation at 8.
7 financial industry. Indeed, Federal Reserve Chairman Ben Bernanke notoriously opined in April
2006 testimony before Congress that “[a]t this point, the available data on the housing market, together with ongoing support for housing demand from factors such as strong job creation and still-low mortgage rates, suggest that this sector will most likely experience a gradual cooling rather than a sharp slowdown.”5
The complete fallout from the now well-publicized credit and housing crises that arose in
2007 remains unknown. What is known, however, is that the financial sector has not suffered
comparable losses at any time since the Great Depression. As Alan Greenspan famously
testified, “We are in the midst of a once in a century credit tsunami.”6 And not surprisingly,
those companies with more significant exposure to the mortgage industry have experienced the
most spectacular losses of all. Fannie Mae and Freddie Mac, the two government-sponsored
entities charged with creating a secondary market for mortgages, were effectively nationalized
after they could not cover losses on their mortgage portfolios. The country’s largest savings and
loan, Washington Mutual, suffered a stock-price decline of 99% before being seized by the
government and placed into receivership. Other examples are myriad and include Lehman
Brothers, the then-largest bankruptcy in U.S. history, and GE, Bank of America, and Citigroup,
which are among companies that received massive government bailouts. In total, a staggering $2
trillion in market capitalization vanished from the financial sector alone.7 CIT and its
shareholders, of course, were not insulated from this financial catastrophe.
5 Outlook of the U. S. Economy, Hearing Before the Joint Economic Comm., 109th Cong. (2006) (statement of Chairman Ben S. Bernanke).
6 The Financial Crisis and The Role of Federal Regulators: Hearing Before the House Committee on Oversight and Government Reform, 110th Cong. (2008).
7 See S&P 500 Financial Sector Market Cap Continues to Sink, Jan. 14, 2009, http://seekingalpha.com/ article/114820-s-p-500-financial-sector-market-cap-continues-to-sink.
8 CIT’s Disclosures Regarding the Housing Market Downturn. As the nation’s housing
market began to experience a downturn, CIT disclosed the downturn’s negative effect on the
Company. Indeed, on the first day of the class period, Mr. Peek warned investors at a conference
that “We do expect losses to increase, particularly in the home lending environment.” 12/12/06
Investor Presentation at 6. As the period continued, CIT’s public disclosures regarding the
downturn in the market and its effects on the Company continued:
• In January 2007, Mr. Peek noted that home lending delinquencies had risen to 4.75% (from 3.77%). 1/17/07 Conf. Call at 5. This represented an over 25% increase from the previous quarter. 11/6/06 10-Q at 43.
• In April 2007, CIT disclosed that home lending charge-offs experienced a 73% increase from the year prior, and a 37% increase from the previous quarter. 4/18/07 8-K, Ex. 99.1 at 15.
• In May 2007, CIT disclosed that the dollar amount of home loans in delinquency status rose 22.5% in just 3 months. 5/8/07 10-Q at 24. The delinquency rate increased 76% on a year-over-year basis. 5/8/06 10-Q at 38.
Against this backdrop, on July 18, 2007, CIT announced that it would exit the home
lending business. 7/18/07 8-K, Ex. 99.1 at 1. This decision was based on management’s projection of decreased residential mortgage origination activity and weakened residential property values, and management’s view that the residential mortgage business could be weak
for an extended period of time. 8/7/07 10-Q at 22. In July 2007, CIT took a write down of
$681.8 million (6.2%) to the home loan portfolio due to accelerated market deterioration and on
October 17, 2007, CIT disclosed that it had recorded a further $465.5 million charge with respect
to its home lending receivables. Id.; 10/17/07 8-K, Ex. 99.1 at 1.
The Student Lending Business. During the class period, CIT was also engaged in the
student lending business through a subsidiary, Student Loan Xpress, Inc. (“SLX”), which CIT
acquired in February 2005. 2007 10-K at 43. CIT’s student loans were originated and acquired
9 through direct consumer marketing, school channel referrals, as well as periodic purchases of
loan portfolios. Id. at 5. The vast majority of CIT’s student loans were government-guaranteed.
Id. at 43. CIT also offered private student loans, which carried no government guarantee, until
the Company ceased originating such loans in 2007. Id. at 5. In each of its financial reports,
CIT specified for investors the proportion of its student loans that were private and warned that
these loans were not guaranteed by the government. 2006 10-K at 42; 5/8/07 10-Q at 38; 8/7/07
10-Q at 40; 11/6/07 10-Q/A at 43; 2007 10-K at 43. Over the class period, CIT fully disclosed the composition of its student loan portfolio (in millions of dollars):
Date Consolidation Other U.S. Private (Non- Total Private Loans Loans Government Guaranteed) Student As A Portion Guaranteed Loans and Other Loans of Student Loans Loan Portfolio 12/31/06 7,399.8 1,064.1 308.8 8,772.7 3.52% 3/31/07 8,182.3 1,336.2 358.4 9,876.9 3.62% 6/30/07 8,522.0 1,398.7 364.6 10,285.3 3.54% 9/30/07 9,281.3 1,784.3 486.3 11,551.9 4.20% 12/31/07 9,050.4 1,935.3 599.3 11,585.0 5.17%
As indicated, non-guaranteed private student loans made up a small fraction of CIT’s
overall student lending portfolio. As a proportion of CIT’s consolidated $83 billion portfolio of
managed assets (as of December 31, 2007), private student loans constituted a mere 0.72%.
2007 10-K at 2, 43. In late 2007, CIT ceased originating private student loans after an evaluation
of the return and risk associated with such loans. 2007 10-K at 118.
Silver State. Through SLX, its subsidiary, CIT made private student loans to Silver State students. ¶81.8 As of December 31, 2007, Silver State students (including some who had already graduated) had outstanding loans to CIT totaling approximately $196 million. 2007 10-
8 Although not relevant to the issues in this case, we note as a strictly technical matter that CIT acquired the Silver State loans from a third-party that had initially funded these loans. However, for the sake of brevity, we refer throughout this Memorandum to the loans as having been made by CIT.
10 K at 118. These loans represented approximately 1.69% of CIT’s student lending portfolio, and
a miniscule 0.235% of CIT’s total managed assets. As of the end of 2007, a mere $2 million of
CIT’s Silver State loans in “repayment” status were past due 60 days or more. Id.
On January 31, 2008, Citibank, another lender to students at Silver State, announced that it would cease originating loans at the school.9 Silver State closed its doors the following day,
February 1, 2008, and filed for Chapter 7 bankruptcy on February 3, 2008. ¶119. Following
Silver State’s bankruptcy, in CIT’s annual report filed in February 2008, the Company disclosed
that it was evaluating the collectability of its Silver State loans as well as projected cash flows
related to those loans, and warned that reserves may be required in connection with the loans,
given the uncertainties regarding their collection. 2007 10-K at 118. Subsequently, CIT
increased its reserves for credit losses by approximately $126 million as a result of Silver State’s
bankruptcy. 8/11/08 10-Q at 10. After Silver State filed for bankruptcy, CIT voluntarily placed
those students who were in school at the time of the closure in “grace” status, such that pending
further notice no payments under their loans are required to be made and no interest on their
loans is accruing. 8/17/09 10-Q at 30.
ARGUMENT
I. COUNTS I AND II SHOULD BE DISMISSED BECAUSE THE COMPLAINT FAILS TO ADEQUATELY ALLEGE SCIENTER
To state a claim under Section 10(b) of the Securities Exchange Act of 1934 and Rule
10b-5 promulgated thereunder, the plaintiff “must establish that ‘the defendant, in connection
with the purchase or sale of securities, made a materially false statement or omitted a material
9 Lead Counsel acknowledged Citibank’s role as lender to Silver State students in its earlier complaint filed in this action (Plumbers, Pipefitters, et al. v. CIT Group Inc. et al. (08-cv-6613) (BSJ) (filed July 2, 2008)), ¶30 (“On January 31, 2008, Citibank refused to provide any further loans to Silver State….”)
11 fact, with scienter, and that the plaintiff’s reliance on the defendant’s action caused injury to the plaintiff.’” ECA v. JP Morgan Chase Co., 553 F.3d 187, 197 (2d Cir. 2009).
The PSLRA “insists that securities fraud complaints ‘specify’ each misleading statement,
that they set forth the facts ‘on which [a] belief’ that a statement is misleading was ‘formed’; and
that they ‘state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.’” Merrill Lynch, Pierce, Fenner & Smith v. Dabit, 547 U.S. 71,
81-82 (2006); see also 15 U.S.C. § 78u-4(b)(1)-(2). Thus, although courts “‘normally draw reasonable inferences in the non-movant’s favor on a motion to dismiss,’ the PSLRA ‘establishes a more stringent rule for inferences involving scienter’ because the PSLRA requires particular allegations giving rise to a strong inference of scienter.” ECA, 553 F.3d at 196.10
It is long settled that the “required state of mind” in any securities fraud case is scienter
— “a mental state embracing intent to deceive, manipulate, or defraud.” Tellabs, 127 S. Ct. at
2507. Under Tellabs, a securities fraud “complaint will survive … only if a reasonable person
would deem the inference of scienter cogent and at least as compelling as any opposing inference
one could draw from the facts alleged.” Id. at 2510. Stated differently, “an inference of scienter
[must be] at least as likely as any plausible opposing inference.” Id. at 2503 (emphasis in original). In determining whether a plaintiff has met its statutory burden of pleading a “‘strong
inference’ of scienter, a court must consider plausible nonculpable explanations for the
defendant’s conduct, as well as inferences favoring the plaintiff.” Id. at 2510.
Plaintiffs in the Second Circuit can meet this high burden only by pleading particularized
facts showing “either (1) that defendants had the motive and opportunity to commit fraud, or
10 The Supreme Court recently reiterated in Ashcroft v. Iqbal that a plaintiff must plead “factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct.” 129 S. Ct. 1937, 1949 (2009). A plaintiff must thus show “more than a sheer possibility that a defendant has acted unlawfully.” Id.
12 (2) strong circumstantial evidence of conscious misbehavior or recklessness.” ECA, 553 F.3d at
198. In Tellabs, the Supreme Court held that “motive” allegations may not be considered in
isolation and instructed that “the significance that can be ascribed to an allegation of motive, or
lack thereof, depends on the entirety of the complaint.” 127 S. Ct. at 2511. Further, the Second
Circuit has made clear that recklessness in this context means “highly unreasonable” conduct that “represents an extreme departure from the standards of ordinary care to the extent that the danger was either known to the defendant or so obvious that the defendant must have been aware of it.” ECA, 553 F.3d at 203. Thus, recklessness “must, in fact, approximate actual intent to aid in the fraud.” Chill v. General Elec. Co., 101 F.3d 263, 269 (2d Cir. 1996). Regardless of the pleading method used (i.e., “motive and opportunity” or “circumstantial evidence”), scienter allegations must now satisfy the Tellabs test: they must be cogent and at least as compelling as any opposing inference one could draw from the facts alleged. 127 S. Ct. at 2510.
A. Plaintiffs’ Motive and Opportunity Allegations Fail
1. The Individual Defendants’ Stock Transactions Do Not Support an Inference of Scienter
Plaintiffs’ barebones allegations of “insider trading” are completely undermined by
judicially-noticeable facts in the Individual Defendants’ SEC filings, including:
• Mr. Peek did not sell any CIT stock during the class period. In fact, Mr. Peek made significant open market purchases of CIT stock at the very time plaintiffs claim that CIT and its management knew (but failed to disclose) that CIT’s subprime home loan and student loan portfolios were impaired.
• The Complaint fails to demonstrate that the Individual Defendants’ routine and predetermined sale of shares acquired through the exercise of options, pursuant to 10b5-1 safe-harbor trading plans, were unusual or suspicious.
• The Individual Defendants actually increased their holdings of CIT stock by over 48% during the class period.
13 When these judicially-noticeable facts are considered, the bottom line becomes clear: a
finding of scienter is not legally permissible here.
Mr. Peek Made Open Market Purchases — and No Sales. Mr. Peek, Chairman and
CEO of CIT, did not sell a single share of CIT stock during the class period. The Second Circuit has repeatedly held that where, as here, multiple defendants are named, the other defendants’
abstention from selling their stock undermines a plaintiff’s theory that negative information was
withheld by any defendant to obtain a higher sales price. This is especially so here, where the
non-selling defendant was the CEO and is alleged to have made more of the challenged
statements than any of the other defendants. See San Leandro Emergency Med. Group Profit
Sharing Plan v. Philip Morris Cos., 75 F.3d 801, 814 (2d Cir. 1996) (finding that where one company executive sells stock “the fact that the other defendants did not … sufficiently undermines plaintiffs’ claim regarding motive”); Acito v. IMCERA Group, Inc., 47 F.3d 47, 54
(2d Cir. 1995) (“The fact that the other defendants did not sell their shares during the class period undermines plaintiffs’ claim that defendants delayed notifying the public ‘so that they could sell their stock at a huge profit’”); In re eSpeed, Inc. Sec. Litig., 457 F. Supp. 2d 266, 289 (S.D.N.Y.
2006) (fact that there were no stock sales by Chairman/CEO, who, “if anyone, was surely well- positioned to reap profits from insider knowledge” weighed against inference of scienter based on insider sales).
Further, during the class period, Mr. Peek made substantial open market purchases, which affirmatively negate any inference of scienter. In August, October and November of 2007 — precisely when he is alleged to have possessed undisclosed negative information — Mr. Peek purchased for himself and various family trusts 45,300 shares on the open market at a cost of
14 over $1.4 million.11 These purchases obliterate any inference of scienter. See Avon Pension
Fund v. GlaxoSmithKline PLC, 2009 U.S. App. LEXIS 18969, at *6 (2d Cir. Aug. 24, 2009)
(finding no inference of scienter where “defendants’ purchases of even more [company] stock
during the relevant period signals only confidence in the future of the company”); In re Health
Mgmt. Sys., Inc. Sec. Litig., 1998 U.S. Dist. LEXIS 8061, at *18 (S.D.N.Y. May 27, 1998)
(scienter insufficiently pled where defendant sold no shares and bought shares during the class period).
The Individual Defendants’ So-Called Sales Were Not “Unusual.” Allegations of
insider stock sales can satisfy the PSLRA’s scienter requirement only where particularized
factual allegations also establish that such sales were “unusual.” Acito, 47 F.3d at 54 (citing In
re Apple Computer Sec. Litig., 88 F.3d 1109, 1117 (9th Cir. 1989)); see also In re AstraZeneca
Sec. Litig., 559 F. Supp. 2d 453, 468 (S.D.N.Y. 2008) (same). Here, the Complaint seeks to
conjure illusions of “unusual” trading by pointing to sales that — in light of the judicially-
noticeable facts — bear none of the indicia of stock transactions that could give rise to a finding
of scienter.
First, all of Messrs. Hallman’s, Leone’s and Taylor’s sales were made pursuant to Rule
10b5-1 safe-harbor trading plans (the “Trading Plans”). CIT fully disclosed that the Trading
Plans allowed certain percentages of Messrs. Hallman’s, Leone’s and Taylor’s respective
employee stock options to be exercised and an equal amount of CIT stock to be sold. 12/21/06
12 8-K. Thus, any inference is undercut by the existence of the Trading Plans themselves because
11 Peek Forms 4 dated 8/9/07, 8/22/07, 10/19/07, 11/2/07, 11/21/07, 11/26/07. 12 In particular, the Trading Plans provided that the brokerage firm could exercise options representing up to 166,728 shares for Mr. Hallman (23.1% of outstanding options), 207,390 shares for Mr. Leone (24.4% of outstanding options), and 34,710 shares for Mr. Taylor (23.8% of outstanding options) between February 1, 2007 and January 31, 2008. 12/21/06 8-K.
15 pre-ordained, regular trading plans undermine allegations of suspicious insider trading. See In re
Bausch & Lomb, Inc. Sec. Litig., 592 F. Supp. 2d 323, 344 (W.D.N.Y. 2008) (sales not unusual
where they “adhere to a pattern and were made at regular intervals as part of preset trading plans
under Rule 10b5-1”); Fishbaum v. Liz Claiborne, Inc., 1999 U.S. App. LEXIS 18155, at *13 (2d
Cir. July 27, 1999) (insider trades were “not suspicious, as [defendants’] stock sales appeared to
be part of a periodic divestment plan”).
Second, and even more fundamental, every single so-called sale at issue occurred
contemporaneously with Messrs. Hallman, Leone, or Taylor exercising options in the same exact
amount, on the same exact day.13 For example, on February 1, 2007, the Trading Plans exercised
55,576 options for Mr. Hallman, 69,130 options for Mr. Leone and 11,570 options for Mr.
Taylor, and on the same day sold a corresponding 55,576, 69,130, and 11,570 CIT shares for
Messrs. Hallman, Leone and Taylor, respectively.14 Thus, the net effect of these transactions was
a zero percent change in the amount of stock the defendants held. See In re Burlington Coat
Factory Sec. Litig., 114 F.3d 1410, 1424 (3rd Cir. 1997) (“A large number of today’s corporate
executives are compensated in terms of stock and stock options. It follows then that these
individuals will trade those securities in the normal course of events”).
13 For unexplained reasons, plaintiffs’ calculations of class period transactions are inaccurate and do not even cite all of the sales executed during the trading windows on which the Complaint focuses. The calculations herein reflect all transactions executed during the class period, and still show substantial increases in holdings. Further, in addition to the sales pursuant to the Trading Plans, the calculations include three acquisition-related sales undertaken to pay tax liabilities directly associated with the vesting of restricted CIT stock. See Hallman Form 4 dated 2/6/07; Leone Form 4 dated 2/6/07; Taylor Form 4 dated 2/6/07. These “sales” weigh against an inference of scienter. See In re Bristol-Myers Squibb Sec. Litig., 312 F. Supp. 2d 549, 561 (S.D.N.Y. 2004) (sales “undertaken primarily to make payments required for the exercise of stock options or to pay taxes” not indicative of fraud); see also In re Radian Sec. Litig., 612 F. Supp. 2d 594, 611 (E.D. Pa. 2009) (same).
14 The other class period sales at issue are as follows: On May 3, 2007, the Trading Plans exercised 55,576, 69,130, and 9,183 options, and then sold the same amount of CIT stock, for Messrs. Hallman, Leone and Taylor, respectively. On August 1 and 2, 2007, Mr. Leone’s Trading Plan exercised 34,500 options and sold the same amount of CIT stock.
16 Third, all of Messrs. Hallman’s, Leone’s and Taylor’s sales were part of the planned (and publicly disclosed) divestment of stock options they received as compensation. As fully disclosed by CIT, Messrs. Hallman, Leone and Taylor received a “substantial portion of their compensation in the form of equity awards” and the Trading Plans were “established as part of
[their] individual long-term strateg[ies] for asset diversification and liquidity.” 12/21/06 8-K.
Given that Messrs. Hallman, Leone and Taylor received stock options as a “substantial portion of their compensation,” the fact that they executed the options and collected the proceeds cannot give rise to any inference of scienter. In re Advanta Corp. Sec. Litig., 180 F.3d 525, 541 (3d Cir.
1999) (holding that an inference of scienter is not permitted where the challenged “proceeds were the result of accumulated stock options [that] were an intended part of [the defendants’] overall compensation package”); see also Malin v. XL Capital Ltd., 499 F. Supp. 2d 117, 156 (D.
Conn. 2007).
Accordingly, the facts alleged in the Complaint with respect to Messrs. Hallman’s,
Leone’s and Taylor’s so-called sales fall far short of creating any inference of scienter.
The Timing of the Trading Plans Was Not Suspicious. Recognizing that the stock trades of Messrs. Leone, Hallman and Taylor were not suspicious because, among other reasons, they were made in accordance with pre-determined Trading Plans, plaintiffs resort to challenging the timing of the implementation of the Trading Plans themselves. ¶194. Plaintiffs misleadingly charge that Messrs. Hallman, Leone and Taylor implemented Trading Plans at the beginning of the class period in December 2006, so as to allegedly take advantage of “material nonpublic information about CIT’s subprime home lending portfolio.” Id. Plaintiffs allege that the
Individual Defendants were in possession of material nonpublic information about only the subprime home lending portfolio at the time the Trading Plans were implemented. Id. Thus, this
17 allegation relates only to plaintiffs’ subprime home lending claims, and does not concern the student lending claims.
As noted, allegations of insider stock transactions support no inference of scienter unless plaintiffs establish that such transactions were “unusual.” Acito, 47 F.3d at 54. Critically, plaintiffs omit from the Complaint any mention of the fact that Messrs. Hallman, Leone and
Taylor had adopted 10b5-1 Trading Plans far in advance of the start of the class period.15 The fact that these Individual Defendants employed such plans long before plaintiffs allege they should have become aware of supposed impairments in CIT’s home lending portfolio undermines any inference that the Trading Plans were implemented in order to take advantage of material nonpublic information in December 2006. See In re Sina Corp. Sec. Litig., 2006 U.S.
Dist. LEXIS 71089, at *37 (S.D.N.Y. Sept. 25, 2006) (“Defendants’ trading activity during the
Class Period was not at all unusual when compared with their prior activity”). Plaintiffs allege
no facts to support their claim that the implementation of the trading plans was “dramatically out
of line with prior trading practices” of the Individual Defendants or suspicious in any other way.
In re Glenayre Techs. Inc. Sec. Litig., 1998 U.S. Dist. LEXIS 20344, at *11-12 (S.D.N.Y. Dec.
30, 1998).
The Individual Defendants Increased Their Holdings. Each of the Individual
Defendants acquired substantial additional amounts of CIT stock during the class period,
15 Messrs. Hallman and Leone adopted 10b5-1 plans in March 2005, over a year and half before the start of the class period. 3/30/05 8-K. Mr. Taylor adopted a 10b5-1 plan in March 2006, nearly a year before the start of the class period. Taylor Forms 4 dated 5/4/06, 9/15/06, 11/6/06. The March 2005 10b5-1 plan entered into by Messrs. Hallman and Leone had an expiration date of January 31, 2006. 3/30/05 8-K. Messrs. Hallman and Leone entered into new 10b5-1 plans in December of 2005, which were set to expire in January 2007. 12/22/05 8-K. On July 31, 2007 Messrs. Hallman and Leone terminated their December 2005 plans. 8/3/06 8-K. Pursuant to CIT’s publicly disclosed security trading policy, after canceling that plan, Messrs. Hallman and Leone were unable to enter into new trade plans that were effective prior to 2007. Id. Thus, in December 2006, Messrs. Hallman and Leone entered into the 10b5-1 plans that were applicable at the time of the trades at issue here. There was nothing unique about the December 2006 plan as opposed to the earlier plans, and plaintiffs — who do not even acknowledge the existence of the earlier plans — make no allegations otherwise.
18 collectively increasing their holdings by over 170,000 shares, or nearly 50%. Courts in this
District have repeatedly held that the increase by defendants of their total stock holdings during a
class period is “a fact wholly inconsistent with fraudulent intent.” In re Bristol-Myers Squibb
Sec. Litig., 312 F. Supp. 2d at 561; In re Sina Corp. Sec. Litig., 2006 U.S. Dist. LEXIS 71089, at
*37 (inference of scienter negated because “Individual Defendants collectively held 31,532 more
shares of [company] stock” after class period) (emphasis in original); Ressler v. Liz Claiborne,
Inc., 75 F. Supp. 2d 43, 60 (E.D.N.Y. 1998) (same).
Holdings at the Start Holdings at the End Defendant16 Percentage Increase of Class Period17 of Class Period Mr. Peek18 196,836 315,345 60.02% Mr. Hallman 67,280 91,422 35.88% Mr. Taylor 17,016 22,464 32.01% Mr. Leone 72,329 96,724 33.72% Total 353,461 525,955 48.80%
Included in these figures — but omitted from the Complaint — is the fact that the
Individual Defendants’ holdings grew throughout the class period with open market purchases by
Mr. Peek, awards of performance shares, the exercise of stock options, and reinvestment of dividends on vested restricted stock and shares purchased through the CIT Group Inc. Employee
Stock Purchase Plan. The only inference that can be drawn from the Individual Defendants’
substantial, growing CIT holdings — including the substantial additional shares Mr. Peek
16 Peek Forms 4 & 5 dated 2/6/07 through 2/13/08; Hallman Forms 4 & 5 dated 2/5/07 through 5/7/07; Taylor Forms 4 & 5 dated 2/5/07 through 5/7/07; Leone Forms 4 & 5 dated 2/5/07 through 2/13/08.
17 Holdings represent the Individual Defendants’ direct ownership of CIT vested and unvested stock. See In re Gildan Activewear, Inc. Sec. Litig., 2009 U.S. Dist. LEXIS 55984, at *21-22 n.5 (S.D.N.Y. July 1, 2009) (finding that plaintiffs’ alleged sales figures were inflated if the court took “into account the Individual Defendants’ total beneficial ownership in the Company … includ[ing] restricted stock and exercisable and unexercisable options”); see also Rothman v. Gregor, 220 F.3d 81, 94 (2d Cir. 2000) (considering percentage of shares sold out of the total number of shares beneficially owned).
18 Mr. Peek’s holdings do not include the 27,300 shares of CIT stock, which Mr. Peek purchased during the class period for two grantor retained annuity trusts and three trusts in his children’s names. If these purchases were included, the Individual Defendants’ holdings at the end of the class period would show an even greater increase.
19 purchased on the open market — is that they believed CIT had a positive future. Executives
engaged in a fraud do not increase their holdings and retain a significant stake in the company
before disclosing the “true” facts about their company, as plaintiffs claim the Individual
Defendants did beginning in late 2006. See In re KeySpan Corp. Sec. Litig., 383 F. Supp. 2d
358, 383 (E.D.N.Y. 2003) (finding that the “acquisition of shares cuts against the notion that
defendants sought to unload their holdings of … stock before their likely diminution in value
following the disclosure of negative insider information”); San Leandro, 75 F.3d at 814 (finding
no scienter where the only defendant who sold stock in the company retained a large investment
and acquired more shares during the relevant time period); In re eSpeed, Inc. Sec. Litig., 457 F.
Supp. 2d at 290 n. 182 (noting “dozens of cases” dismissing complaints where “motive allegations were undermined by increases in total holdings”). Far from having any motive to
defraud investors, therefore, the Individual Defendants were heavily invested in CIT throughout the class period and had “every incentive” to ensure the Company’s long-term financial success.
Advanta, 180 F.3d at 540-41.
2. The Other Motive Allegations Do Not Support an Inference of Scienter
Plaintiffs alternatively allege that defendants were “motivated” to commit fraud in order
to inflate CIT’s stock price, so that they could: (i) collect performance-based bonuses; (ii)
preserve CIT’s credit and debt ratings; (iii) raise funds through the CIT-Z offering; (iv) avoid
triggering dividend restrictions; and (v) facilitate attempts to sell the Silver State loan portfolio.
¶¶178-193. As the Southern District has recognized, “to plead motive a securities plaintiff must
plead a ‘concrete and personal’ benefit to be realized from the allegedly improper behavior.” In re PXRE Group Ltd., Sec. Litig., 600 F. Supp. 2d 510, 533 (S.D.N.Y. 2009); see also Kalnit v.
Eichler, 264 F.3d 131, 139 (2d Cir. 2001) (“motives that are generally possessed by most
20 corporate directors and officers do not suffice”). Thus, under long-settled law, these throw-away allegations cannot establish any inference of scienter because if they could, “virtually every company in the United States that experiences a downturn in stock price could be forced to defend securities fraud actions.” Acito, 47 F.3d at 54.
• Performance-Based Bonuses. The generic allegation that the Individual Defendants were motivated to commit fraud in order to inflate CIT’s stock price so that they could earn greater amounts of performance-based compensation (¶¶179-80) is common to all corporate executives, and “can hardly be the basis on which an allegation of fraud is predicated.” Acito, 47 F.3d at 54; see also Ferber v. Travelers Corp., 785 F. Supp. 1101, 1107 (D. Conn. 1991) (“It does not logically follow that because executives have components of their compensation keyed to performance, one can infer fraudulent intent”).
• Credit Rating. Plaintiffs’ allegation that the Individual Defendants were motivated to inflate CIT’s stock price in order to maintain the Company’s credit and debt ratings (¶¶181-186) likewise fails, since “every company’s executives likely wish to report positive financial health so that the company can reap the varied benefits that flow from an image of financial stability.” Grossman v. Texas Commerce Bancshares, 1995 U.S. Dist. LEXIS 13501, at *38 (S.D.N.Y. Sept. 12, 1995). Accordingly, a desire to maintain a high credit or debt rating does not give rise to an inference of scienter. See In re Intelligroup Sec. Litig., 527 F. Supp. 2d 262, 342 (S.D.N.Y. 2007) (“the law treats the desire of corporate officials to assure good credit of their companies no differently [than] any other business goal”); San Leandro, 75 F.3d at 813- 14 (“a company’s desire to maintain a high bond or credit rating” is an insufficient motive for fraud because “such motive could be imputed to any company”).
• CIT-Z Offering. Likewise, allegations that defendants were motivated to commit fraud in order to raise funds through a stock or debt offering (here, the CIT-Z securities; ¶¶191-192) have been roundly rejected by the courts, because “any potential motive to keep the share price high in order to have a more successful placement is just an example of a generalized motive that any officer or director who desires to operate a successful company will have.” In re AstraZeneca, 559 F. Supp. 2d at 469 (desire to conduct $1 billion stock offering “when the stock was near its class period high” not indicative of scienter because “it is very common for companies to have secondary placements, and any officer or director would wish the stock price to be as high as possible during such a placement”); San Leandro, 75 F.3d at 813 (allegation that defendants committed fraud to maximize the marketability of $700 million in debt securities did not give rise to inference of scienter);
21 Glickman v. Alexander & Alexander Servs., 1996 U.S. Dist. LEXIS 2325, at *34-35 (S.D.N.Y. Feb. 27, 1996) (same).
• Dividend Restrictions. Plaintiffs claim that the Individual Defendants were motivated to inflate CIT’s stock price in order to avoid triggering restrictions on dividend payments, which they allege would have impacted CIT’s ability to raise capital and affected the Individual Defendants (and every other CIT shareholder) financially. ¶¶187-190. Because “this incentive is common to all shareholders, it lacks the requisite ‘concrete and personal’ nexus to the individual alleged to have made the misstatement or omission.” In re Yukos Oil Co. Sec. Litig., 2006 U.S. Dist. LEXIS 78067, at *58 (S.D.N.Y. Oct. 25, 2006) (allegation that defendants were motivated to inflate share price in order to personally obtain over $1 billion in dividends “fails to plead facts to support a strong inference that individual defendants had the motive to commit securities fraud”).19
Sale of the Silver State Portfolio. Finally, plaintiffs allege that an inference of
scienter can be drawn because the Individual Defendants were motivated by their desire
to “dump” the allegedly impaired Silver State loan portfolio in 2007. ¶193. This circular
allegation supports no inference of scienter. First, plaintiffs do not allege that CIT sought
to hide information on the performance of the Silver State portfolio from any potential
suitors, who presumably would have learned of all relevant facts during the due diligence
process. Second, without first assuming and presupposing the very inference plaintiffs
are attempting to draw (i.e., that the Individual Defendants committed fraud because they
knew of impairments in the Silver State portfolio), the fact that CIT desired to profit from
the sale of a portion of CIT’s portfolio adds nothing. The desire to profit from a sale of
assets is a general motivation common to all companies, let alone one in the financing business. See, e.g., ECA, 553 F.3d at 201 (generalized desire to profit from being acquired “fail[s] to establish the requisite scienter because the desire to achieve the most
19 Ironically, but indicative of the weakness of this assertion, plaintiffs inconsistently allege that the Individual Defendants were motivated to mislead investors in order to profit from the benefits of CIT stock ownership while at the same time seeking to divest themselves of those same holdings.
22 lucrative acquisition proposal can be attributed to virtually every company seeking to be acquired”).
B. Plaintiffs’ “Circumstantial Evidence” Allegations Fail20
1. The Confidential Sources Do Not Support Any Inference of Scienter
Plaintiffs’ confidential source allegations, sprinkled throughout the Complaint, fall far
short of providing an inference of scienter that is cogent and at least as compelling as any
opposing inference one could draw from the facts alleged. Tellabs, 127 S. Ct. at 2510.
Incomprehensible Pleading Method. In an attempt to make their confidential sources appear more numerous and to obscure the absence of any relevant information provided by these sources, plaintiffs fail to identify how many such sources exist, and do “not distinguish between and among confidential witnesses (i.e., confidential witness 1, confidential witness 2, etc.), so that the Court can determine which confidential witness is alleging which facts.” In re Network
Assocs. Sec. Litig., 2003 U.S. Dist. LEXIS 14442, at *36 (N.D. Cal. Mar. 25, 2003). This
inherently suspect pleading method, which stands in sharp contrast to that employed in other
securities actions relying on anonymous source allegations — including numerous actions filed
by Lead Counsel in cases in this District and throughout the country21 — does not suffice to
plead scienter. See id. (“In sum, the ambiguous nature with which the confidential witnesses and
the basis of their knowledge are described does not comport with the heightened pleading
standards under the Reform Act … even assuming the actual assertion[s] made by the
20 Where, as here, plaintiffs fail to allege any motive for the supposedly fraudulent scheme, “the strength of the circumstantial allegations must be correspondingly greater.” ECA, 553 F.3d at 199.
21 See, e.g., Campo v. Sears Holdings Corp., 2009 U.S. Dist. LEXIS 62068, at *14 (S.D.N.Y. Jul. 21, 2009); Hall v. Children's Place Retail Stores, Inc., 580 F. Supp. 2d 212, 220-22 (S.D.N.Y. 2008); In re eSpeed, Inc. Sec. Litig., 457 F. Supp. 2d at 272-74; Institutional Investors Group v. Avaya, Inc., 564 F.3d 242, 249- 51 (3rd Cir. 2009); In re Hutchinson Technology, Inc. Sec. Litig., 536 F.3d 952, 957-59 (8th Cir. 2008).
23 confidential witnesses are pled with sufficient particularity, the Court would still be required to grant the motion to dismiss…”).
No Contact With The Individual Defendants. Tellingly, plaintiffs do not allege that any of the confidential sources ever (either directly or indirectly) communicated with, provided any reports to, received instructions from, or met with the Individual Defendants. These witnesses are therefore not able to provide — and are not seriously alleged to have — any insight as to what CIT’s senior management (including the Individual Defendants) knew or should have known during the class period. Allegations of scienter in such circumstances are routinely rejected. See, e.g., Steinberg v. Ericsson LM Tel. Co., 2008 U.S. Dist. LEXIS 99727, at *38-39
(S.D.N.Y. Dec. 10, 2008) (scienter not alleged where plaintiff’s three confidential sources were mid-level managers who had no contact with any of the defendants); In re Bausch & Lomb, Inc.
Sec. Litig., 592 F. Supp. 2d at 342 (scienter not alleged where neither of the two confidential sources “had any contact with the Individual Defendants or would have knowledge of what they knew or should have known during the Class Period”); In re Am. Express Co. Sec. Litig., 2008
U.S. Dist. LEXIS 74372, at *21-22 (S.D.N.Y. Sept. 26, 2008) (rejecting allegations based on confidential sources where those sources had no contact with the individual defendants).
Unable to produce any source with relevant (indeed, any) knowledge regarding the
Individual Defendants, plaintiffs fall back on several vaguely described sources who offer nothing more than the most general, unparticularized allegations, the substance of which in no way supports any inference (strong or otherwise) that the Individual Defendants committed securities fraud. Critically, Second Circuit law requires that plaintiffs meet a high standard if they expect to rely on any confidential sources. To survive a motion to dismiss and contribute meaningfully towards a strong inference of scienter, confidential source allegations must be
24 accompanied by enough particularized facts “to support the probability that a person in the position occupied by the source would possess the information alleged.” Novak v. Kasaks, 216
F.3d 300, 314 (2d Cir. 2000). Applying the Second Circuit’s Novak standard “necessarily entails an examination of the detail provided by the confidential sources, the sources’ basis of knowledge, the reliability of the sources, the corroborative nature of other facts alleged … the coherence and plausibility of the allegations, and similar indicia.” California Pub. Employees
Ret. Sys. v. Chubb Corp., 394 F.3d 126, 147 (3d Cir. 2004) (applying Novak); see also In re
IAC/InterActiveCorp Sec. Litig., 478 F. Supp. 2d 574, 592 (S.D.N.Y. 2007) (same).22
Home Lending. Plaintiffs identify no source who alleges any facts that would lead to any inference of scienter with respect to the allegations involving home lending.
Senior Vice President. The only source regarding home lending purportedly occupying anything other than a very low-level position within CIT’s corporate structure, is a “former
Consumer Finance Senior Vice President at CIT who had responsibility for home lending during
2006 and at the start of the Class Period.” ¶170. Yet, the only allegations plaintiffs make based on this source (who appears to have been in his or her position for about one month of the class period) is that he or she “described Hallman’s dictatorial control over the business and asserted that Hallman was responsible for decisions on the composition of the subprime home loan portfolios and what loans were to be bought and sold by CIT.” Id. Plaintiffs offer no explanation as to how these allegations, even if true, render any challenged statement made by
CIT false, much less knowingly false. See In re Watchguard Sec. Litig., 2006 U.S. Dist. LEXIS
22 Indeed, several Circuit courts have held that, in light of Tellabs, anonymous source allegations must be viewed with the utmost skepticism. See Higginbotham v. Baxter Int’l, Inc., 495 F.3d 753, 756-57 (7th Cir. 2007) (following Tellabs, “[i]t is hard to see how information from anonymous sources could be deemed ‘compelling’ or how we could take account of plausible opposing inferences”); Ind. Elec. Workers’ Pension Trust Fund IBEW v. Shaw Group, Inc., 537 F.3d 527, 535 (5th Cir. 2008) (“Following Tellabs, courts must discount allegations from confidential sources [because] [s]uch sources afford no basis for drawing the plausible competing inferences required by Tellabs”).
25 74269, at *9 (W.D. Wash. Oct. 12, 2006) (“Although [the confidential source] describes [the
defendant] as ‘very controlling’ [the source] does not allege a single act of [the defendant] that
would illuminate [how] his controlling nature [is of] relevance [to the issues presented in] this
lawsuit”); In re Am. Express, 2008 U.S. Dist. LEXIS 74372, at *21 (confidential source’s
assertion that an individual defendant “‘sanctioned and engineered [the company’s] investments
strategy’ does not establish that [the individual defendant] was aware of any information
contradicting the Company’s statements”).
Area Manager. Plaintiffs next cite a “former CIT Area Manager,” who offers rank
speculation that “Company-wide decisions” on loan standards “could only have been made at the
level of Peek, Leone and Hallman.” ¶170. Plaintiffs then build on this speculative foundation of
straw with the vague allegation that Mr. Peek supposedly “passed down” (whatever that means)
underwriting guidelines, which plaintiffs (not the source) surmise “would include the reduced
underwriting standards in 2006.” ¶¶170-71. This allegation provides no support for the
conclusion that Mr. Peek or any other Individual Defendant was aware (or should have been
aware) that any of CIT’s home loans were impaired prior to the time that CIT wrote down their
value. This type of “could have/would have” rank speculation is “routinely rejected by courts as not evidencing scienter.” In re Ferro Corp. Sec. Litig., 2007 U.S. Dist. LEXIS 42191, at *34-35
(N.D. Ohio June 11, 2007). As another court recently held in dismissing a “subprime” case much like this one: confidential witness allegations are “disregarded if … based on hearsay,
rumor, or speculation;” a confidential witness’ claim that senior management and board “‘would
have known that the market and its loans were going to implode’ because [they] studied ‘trends’
lacks specificity and is nothing more than sheer speculation.” In Re Downey Sec. Litig., 2009
WL 2767670, at *10 (C.D. Cal. Aug. 21, 2009); see also In re Sierra Wireless, Inc. Sec. Litig.,
26 482 F. Supp. 2d 365, 376 (S.D.N.Y. 2007) (dismissing plaintiffs’ claim supported by general statement by confidential witness that “merely parrots the conclusory allegations contained in the complaint”).23
No Support for Student Lending Claims. The Complaint cites several vaguely described purported former employees of SLX, CIT’s student lending subsidiary, none of whom is even alleged to have worked at CIT’s headquarters, much less to have said anything to any Individual
Defendant or to have heard anything said by any Individual Defendant. See California Pub.
Employees, 394 F.3d at 148 (rejecting allegations by confidential sources where plaintiffs
“heavily rely on former employees who worked in [company’s] local branch offices for information concerning [company’s] business on a national scale”).
Executive Vice President at SLX. Plaintiffs cite a purported “former Executive Vice
President at SLX” who claims that “SLX’s new business development was highly scrutinized by senior executives at CIT, including Hallman and Chesler” and who “recalls growing concern at
CIT that the portfolio of private loans, including the Silver State loans, had become disproportionately large and risky.” ¶174. There is no indication of what this “scrutiny” of SLX consisted of (assuming, of course, that “scrutiny” is a bad thing), when it allegedly occurred,
23 In allegations that are beyond vague, plaintiffs also charge that “numerous Account Executives and Branch Managers” allegedly “confirmed” that a supposed reduction in home lending credit standards was at the direction of CIT’s “senior executives” (¶170) and that according to “numerous former employees in CIT’s subprime home origination business,” the Company’s bonus and incentive programs “would have been set and approved by Peek and CIT’s senior executives.” ¶ 172. Even putting aside the glaring omission of any attempt to specify any details about the alleged “reduction” in credit standards, the Complaint makes no attempt to identify or describe who these “numerous” purported sources are, where they worked, what their job responsibilities were, or that they have any basis to speak to the conclusory allegations they make. It is difficult (if not impossible) to imagine a more unspecified confidential source allegation. Accordingly, these sources absolutely cannot give rise to any inference of scienter whatsoever. See Vladimir v. Bioenvision, Inc., 606 F. Supp. 2d 473, 485 (S.D.N.Y. 2009) (“Plaintiffs have not alleged anything at all about [the] alleged anonymous source, let alone describing him with any particularity whatsoever, and the Court is wholly unable to determine whether this source was in a position to know [the relevant facts], or, in fact, whether or not this alleged anonymous source even exists”); In re Sierra Wireless, 482 F. Supp. 2d at 376 (allegations by confidential source with “unspecified role” during class period did not satisfy PSLRA’s pleading requirements).
27 what it revealed, or that it had anything to do with SLX’s Silver State loans. Indeed, even by its
own vague terms, the allegation reflects an alleged concern regarding private loans generally, not
any concern regarding Silver State. Nor is there any allegation regarding: who at CIT was
supposedly concerned about the Silver State loans, why they were concerned, how the source
was in a position to know what anyone at CIT believed, and what, if anything, the source actually observed, and when these events took place. In sum, this source provides no facts suggesting that a particular person — whether an Individual Defendant or otherwise — had knowledge or a reason to believe that the Silver State loans should have been written off earlier than they were. See In re Elan Corp. Sec. Litig., 543 F. Supp. 2d 187, 220 (S.D.N.Y. 2008)
(rejecting confidential source allegations without facts indicating that sources would have reason to know what was communicated to senior management).
Former Vice Presidents at SLX. Plaintiffs cite several other vaguely described “Vice
Presidents” at SLX, who offer only vacuous generalizations. In particular, the Complaint cites a
“former Vice President at SLX” who claims that it was “recognized within CIT” that Silver
State’s “lack of FAA Part 141 approval and the substandard conditions at Silver State rendered
the few graduates of Silver State unemployable.” ¶84.24 This individual also claims that another
helicopter school had “identified for the Company that Silver State was a scam.” Id. Critically, this source never identifies who within CIT allegedly “recognized” that graduates were supposedly unemployable due to Silver State’s FAA status and purported “substandard conditions;” how anyone supposedly recognized that; who at CIT supposedly received
information about Silver State from the other helicopter school; what that information actually
consisted of; when any of these events occurred; how they occurred; and what, if any, basis the
24 As explained below (p. 53) the fact that Silver State was an FAA Part 61, rather than an FAA Part 141, certified school could not possibly indicate that Silver State was a “ponzi scheme.”
28 witness has to speak to such facts. It is indeed telling that this unidentified Vice President never claims that he or she ever told any of the Individual Defendants (or any other senior executive of
CIT) about these alleged concerns and discussions. 25
Either this same or another “former Vice President at SLX” (plaintiffs again make it
impossible to tell) alleges that “CIT’s management was … very stressed about getting the Silver
State loan portfolio sold in 2007 and the sale was motivated by the known problems with Silver
State and the recognition that those problems meant that there was very little chance that CIT would be able to collect on the loans.” ¶91. This allegation is hopelessly vague; it offers no explanation as to what is meant by “known problems” or “very stressed,” or when in 2007 these events allegedly occurred. Most fundamentally, there is no allegation as to who at CIT was
“very stressed” due to these wholly unspecified problems. See Bausch & Lomb, 592 F. Supp. 2d
at 342 (“absent from [the confidential sources’] story are allegations that any of the Individual
Defendants were personally involved in or had knowledge of any of the [improper accounting
practices] … or that any of the accounting issues were ‘ever passed up the chain of command’ to
the Individual Defendants themselves”).
Finally, the Complaint refers to “two other former Vice Presidents at SLX” who claim
that Randy Chesler, a CIT executive who is not a party to this case, held a sales meeting in
September 2007 during which Mr. Chesler stated that “CIT’s expansion into private student
25 In another paragraph of the Complaint, plaintiffs allege that a “former SLX officer who worked on the Silver State account during the Class Period recounted that [an individual from another helicopter school] had told [the purported source] that Silver State had a very poor reputation and warned that CIT’s involvement with Silver State was a ‘really bad idea.’” ¶177(g). Plaintiffs do not make clear whether this “officer” is the same purported “former Vice President” referenced in paragraph 84 of the Complaint. What is clear is that that this additional conclusory allegation provides no inference of scienter. The source (whose actual job title and duties are never described) does not allege what was allegedly said to him, when, or why. Moreover, there is no allegation that even if this source did possess relevant facts (which the Complaint’s lack of factual detail makes extremely doubtful) that any of these concerns were ever communicated to any Individual Defendant. See PXRE Group, 600 F. Supp. 2d at 537 (finding scienter not pled where there was no allegation that an employee’s concerns, expressed to a confidential witness, “were ever brought to the attention of the individual Defendants, or anyone else at [the company]”).
29 loans had been a mistake and that there was a substantial problem with Silver State that was going to cost CIT a lot of money on the loans to students of the school.” ¶175. There is no allegation that any Individual Defendant attended this meeting or that any of Mr. Chesler’s concerns were otherwise communicated to them. See PXRE Group, 600 F. Supp. at 540
(rejecting allegations of scienter based on an employee’s expression of “concern” about loss estimation figures, finding no scienter “[a]bsent allegations that the individual defendants disregarded an employee’s specific and direct communication about the alleged flaws in the loss estimation process”). Moreover, there is no allegation as to what this “problem” was or that it was not being addressed. Indeed, the most plausible inference to be drawn from the allegation that the Silver State loans were being discussed generally at an employee meeting is that CIT was taking steps to deal with its private loans, and had nothing to hide. See Iqbal, 129 S. Ct. at
1949. 26
In short, plaintiffs’ confidential sources detail no facts that give rise to any inference that the Individual Defendants acted with an intent to defraud (i.e., scienter) that is in any way remotely cogent and compelling, as required by Tellabs. Indeed, the fact that experienced plaintiffs’ counsel would feel compelled to offer such astonishingly weak and ill-defined
“confidential witness” allegations speaks volumes about the absence of any scienter in this case.
26 The Complaint further alleges that, according to the same or another purported “former SLX Vice President,” the “decision to cease lending ‘pulled the rug out’ from under the Silver State ponzi scheme.” ¶177(k). This is a red herring. This vaguely described individual is not alleged to have realized (or suspected) that Silver State was a “ponzi scheme” at any point during the class period, let alone that he or she ever communicated such an allegation to any Individual Defendant or other CIT senior executive at any time. Rather, viewed charitably, this statement appears to be nothing more than a conclusory charge made from hindsight regarding what this individual now thinks was the effect of CIT’s decision to cease lending to Silver State students.
30 2. The Vaguely Described Internal Meetings and Reports Do Not Support an Inference of Scienter
The Complaint also employs the repeatedly rejected stratagem of purporting to allege
scienter by making vague allegations that the Individual Defendants received various “reports” concerning CIT’s lending practices and loan performance. See ¶¶13, 171, 173. Plaintiffs do not attach copies of these unnamed reports to their Complaint, do not date the reports, and — most tellingly — do not describe with any particularity the contents of the reports. These allegations thus do nothing to support an inference of scienter here.
Student Lending. The Complaint contains the wholly unremarkable allegation that Mr.
Hallman (who headed Specialty Finance) participated in monthly conference calls with SLX executives, to “review the student loan portfolio, including private student loans, and monthly financial results.” ¶13(b). The Complaint alleges that “together with these calls,” Mr. Hallman would be provided with a report regarding CIT’s student lending portfolio, which purportedly
included: (i) sections detailing CIT’s portfolio of private student loans (including delinquency
rates); (ii) a breakdown of the total loans outstanding to students of certain schools, including
Silver State; and (iii) “punchlist updates” that supposedly included information on CIT’s efforts
to sell the Silver State loan portfolio. Id.; ¶173. Thus, this allegation merely asserts in the most
conclusory terms that an undated, untitled report allegedly provided to Mr. Hallman regarding a
$10 billion portfolio of student loans included details regarding the alleged efforts to sell the
Silver State loan portfolio. As detailed below (p. 51) the allegation that CIT sought to sell its
Silver State loans does not support any inference that CIT was aware of any problems at Silver
State. See San Leandro, 75 F.3d at 812 (dismissing securities complaint for failure to allege scienter where complaint provided an “unsupported general claim of the existence of confidential
company sales reports that revealed [a] larger decline in sales”).
31 Home Lending. The Complaint also alleges that “based on memoranda that were
provided to him, the former Area Manager ascertained that summaries of … lending pipeline
reports, which would have identified CIT’s reduced lending standards in 2006, were provided to
Mr. Peek and were available to CIT’s senior executives.” ¶171. The Complaint further alleges
that, according to a “former Account Executive” the individual reports underlying these
“summaries” (which the source never alleges any Individual Defendant saw or had access to)
would identify the “increasing numbers of stated income loans, high loan-to-value loans, 2/28
and 3/37 ARMs and reduced credit scores.” Id. It is evident that neither of these sources cited has any inkling what any Individual Defendant knew via these “reports” or otherwise. The
“Area Manager” does not even purport to know what was in the “summaries” to which he refers.
Rather, he “ascertained” from vaguely described “memoranda that were provided to him” what the summaries “would have” shown. See Downey, 2009 WL 2767670, at *10 (rejecting speculation by confidential witness as to what company’s board “would have known”).
Likewise, the “former Account Executive” does not allege that any Individual Defendant received or even had access to any document, let alone whether it contained any information that would bear on the truth or falsity of any statement made by CIT. See Goplen v. 51Job, Inc., 453
F. Supp. 2d 759, 773 (S.D.N.Y. 2006) (allegations based on “bare assertions” that “defendants, due to their high-level positions in the Company, had access to adverse undisclosed financial information” are routinely rejected).
II. COUNTS I AND II SHOULD ALSO BE DISMISSED BECAUSE PLAINTIFFS FAIL TO IDENTIFY ANY FALSE STATEMENTS
Beyond their fatal failure to plead any facts giving rise to a strong inference of scienter, plaintiffs do not meet the most fundamental requirement in any securities fraud action — to set
32 forth factual allegations demonstrating that the defendants made an actionable false or misleading statement or omission.
A. Plaintiffs Fail to Plead That Defendants Made Any False Statement or Omission Regarding CIT’s Home Lending Portfolio
Plaintiffs claim that during the class period CIT issued misleading statements and failed to disclose the “true facts” regarding the risks inherent in the Company’s subprime home lending portfolio, and that the Company failed to appropriately reserve for its loan loss exposure. ¶¶53-
54, 66-67, 131-33. Notwithstanding the Complaint’s rhetoric, it does not allege any misstatements or omissions by CIT.
1. CIT Fully Disclosed the Subprime Nature and Credit Profile of Its Home Lending Portfolio
CIT Consistently Disclosed It Held “Subprime” Loans. Throughout the class period,
CIT fully disclosed the “subprime” nature of its home lending portfolio, and repeatedly and consistently emphasized the risks inherent in subprime lending. For example:
• Mr. Leone discussed strategies for managing CIT’s subprime home loan portfolio on an earnings conference call held at the beginning of the class period in January 2007. 1/17/07 Conf. Call at 10.
• Mr. Peek described certain of CIT’s home loans as “subprime” on a conference call held in April 2007. 4/18/07 Conf. Call at 3.
• On that same call in April 2007, Mr. Leone described the interest rate structure of CIT’s subprime portfolio. Id. at 18.
• At CIT’s Annual Stockholders’ Meeting in May 2007, Mr. Peek explained how the Company went about reserving for losses with respect to the Company’s subprime home loan portfolio. 5/8/07 Investor Presentation at 8.
• Mr. Leone described how the securitization markets were impacting the Company’s subprime home loans at an industry conference held in May 2007. 5/15/07 Investor Presentation at 10.
33 CIT Disclosed Detailed Data On Its Home Loans. Plaintiffs’ hollow allegations that
CIT failed to disclose the risk in its home loan portfolio are belied by the fact that CIT
consistently provided investors with detailed disclosures on exactly the type of loans it held in its
home lending portfolio, even prior to the start of the class period. Specifically — in numerous
SEC filings both before and during the class period — CIT informed investors of the average
FICO score for CIT’s home loan borrowers, average loan-to-value information, indicating how
much equity CIT’s borrowers had in the underlying properties, the proportion of CIT’s home
loans that had adjustable interest rates, the average loan size of CIT’s home loans, and
information on the geographic concentration of the loans by state. This information was
repeated in every form 10-Q and 10-K filed by CIT during the class period. 2006 10-K at 41;
5/8/07 10-Q at 37; 8/7/07 10-Q at 24. Plaintiffs do not challenge the accuracy of these detailed disclosures providing investors with the underlying credit profile of the Company’s home loans.
2. CIT Repeatedly Warned Investors of a Downturn in the Housing Market and Increasing Loan Delinquencies
The fact that the housing market began to dramatically decline in early 2007 has hardly
been a secret. In fact, CIT itself repeatedly disclosed this fact. See 12/12/06 Investor
Presentation at 6, 10; 2006 10-K at 42; 5/8/07 10-Q at 37. Moreover, housing prices are a matter
of public record, and plaintiffs cannot base a claim on allegations that CIT failed to disclose a
fact known to all. See Starr v. Georgeson S’holder, Inc., 412 F.3d 103, 109-10 (2d Cir. 2005)
(no material misrepresentation where allegedly concealed information was already “reasonably
available” in the market); White v. H&R Block, Inc., 2004 U.S. Dist. LEXIS 14522, at *36
(S.D.N.Y. July 28, 2004) (no material misrepresentation where allegedly concealed information
was “all over the market” in press coverage, public court and SEC filings, and press releases).
34 Nor did CIT ever assert or suggest that its home loans somehow were immune from the
housing crisis. To the contrary, throughout the class period the Company issued profuse on-
point warnings about the challenges and difficulties it was experiencing in the mortgage market.
As home lending delinquencies began to rise in late 2006, CIT repeatedly informed investors of
this fact. Indeed, in the month before the start of the class period, CIT announced that as of
September 30, 2006, home loan delinquencies were 25% higher than a year prior. 11/6/06 10-Q
at 29, 43. As the class period began, this message was repeated over and over. Tellingly, on the
first day of the class period, December 12, 2006, Mr. Peek warned investors at a conference that
“We do expect losses to increase, particularly in the home lending environment” and that “we
know we are going to see some increased losses … in our home lending portfolio.” 12/12/06
Investor Presentation at 6, 10.
In January 2007, CIT released its fourth quarter 2006 earnings, in which the Company
disclosed that non-performing assets were increasing, and that the increase was driven largely by
home lending. 1/17/07 8-K, Ex. 99.1 at 6. At that time, Mr. Peek participated in an earnings
conference call, during which he stated multiple times that home lending delinquencies had begun to rise. 1/17/07 Conf. Call at 3 (“delinquencies in home lending [were] higher”); 5 (“In
home lending … delinquencies did increase to about 4 3/4% …) [representing a 25% increase
from the previous quarter]. Moreover, Mr. Peek warned that “As we look forward to 2007 we
expect continued high delinquencies and charge-offs…”). Id. at 5.
In March 2007, CIT issued its annual report for 2006. This report again plainly told
investors that delinquencies and net charge-offs of home loans had increased in 2006, and that
management expected the trend to continue into 2007 “due to softening in the home lending
sector” as well as CIT’s decision to slow growth in its home loan portfolio. 2006 10-K at 42; 23
35 (same). These disclosures increased in frequency and volume over the coming months as the national housing crisis deepened.
For example, in April 2007, CIT issued its first quarter earnings. At that time, the
Company disclosed home lending charge-offs had increased to 1.20%, a 73% increase from the year prior, and a 37% increase from the previous quarter. 4/18/07 8-K, Ex. 99.1 at 6, 15.
Moreover investors were informed that “increases in home lending delinquencies … and non- performing accounts … reflected the negative influences of economic conditions in this sector.”
Id. at 6. On a conference call to discuss these results Mr. Peek:
• Referred to the “near doubling of home loan losses” in the Company’s portfolio;
• Stated that “the subprime home lending industry has obviously been under pressure;” and
• Reiterated that “our delinquencies and losses in home lending have trended higher….”
4/18/07 Conf. Call at 2, 3.
May 2007 brought even more disclosures. In that month, CIT released its quarterly report, and disclosed numerous times that home lending delinquencies were continuing to increase. 5/8/07 10-Q at 23, 24, 25, 26. In fact, the data disclosed to investors indicated that the dollar amount of home loans in delinquency status had risen 22.5% in just 3 months. Id. at 24.
That same month at an industry conference, CIT continued to warn of a deteriorating housing market:
• “No question about it. It’s a softer market. There’s a lot of shake out in [the home lending market].”
• “We also said we wouldn’t be insulated from the downturn and we’re not.”
• “We’ve [seen] softening in the housing market. You typically have more softening on the higher end, rising delinquencies…”
36
5/14/07 Investor Presentation at 4.
As these and numerous similar disclosures make apparent, CIT did not hide from
investors information regarding the makeup and performance of its home loan portfolio.
To the contrary, CIT consistently disclosed such data in detail and in real-time.
3. Plaintiffs Fail to Plead Falsity With Respect to CIT’s Timing of a Write Down of Its Home Loans
Plaintiffs also claim that from December 2006 through May 2007, CIT failed to properly
reserve for loan losses with respect to its subprime home loans thereby overstating net income.
¶¶66-67, 132-134. The essence of plaintiffs’ claim is that the write downs taken by CIT in July
and October of 2007 should have been taken earlier. However, there are no specific allegations
of fact suggesting that CIT was required to take this write down earlier. As the Second Circuit
has held, “[m]ere allegations that statements in one report should have been made in earlier
reports do not make out a claim of securities fraud.” Acito, 47 F.3d at 53; DiLeo v. Ernst &
Young, 901 F.2d 624, 627 (7th Cir. 1990) (“if all that is involved is a dispute about the timing of
the writeoff, based on estimates of the probability that a particular debtor will pay, we do not
have fraud; we may not even have negligence”).
According to plaintiffs, CIT should have taken a write down “in the form of loss
reserves” for its home loan portfolio by December 2006, based on “the already known risks and
impairments to the loan portfolio.” ¶132. Plaintiffs claim that CIT was required to write down
the value of its home loans earlier due to the (fully disclosed) risk profile of those loans and the fact that (as detailed repeatedly in its public statements) CIT was experiencing rising delinquencies. ¶133. Plaintiffs then recite a tired litany of items they classify as “red flags” that they claim CIT ignored. These items are not even specific to CIT or its home loans, but rather
37 detail industry trends and financial results for other companies — information in the public
domain. Id.
Rather than pleading specific facts to support their claims, plaintiffs simply juxtapose the fully disclosed nature of CIT’s home loan portfolios (i.e., FICO scores of recipients, the adjustable nature of interest rates on some of the loans, and rising delinquency rates) and a litany of news clippings about the housing industry in 2007 with the fact that the Company ultimately
took write downs on its home loans, and on this basis allege that the failure to take a write down
earlier was fraudulent. This manner of “hindsight” pleading does not state a claim for fraud. See
Downey, 2009 WL 2767670, at *5 (subprime lending claims dismissed with prejudice where
plaintiffs “simply assume that [the company] ignored the financial metrics in setting its reserves
without alleging any particularized facts that [the company] did, in fact, ignore its own publicly-
disclosed information”); In re 2007 Novastar Fin. Inc. Sec. Litig., 2008 U.S. Dist. LEXIS 44166,
at *13 (W.D. Mo. June 4, 2008) (claims of falsity as to loss reserves of mortgage lender
insufficient where plaintiff failed to identify the “truth” that should have been disclosed).
Ultimately, plaintiffs’ claim relating to the timing of CIT’s home lending write downs
“establishes nothing more than that the plaintiffs disagree with some of [defendant’s] investment
valuations….” In re Allied Capital Corp. Sec. Litig., 2003 U.S. Dist. LEXIS 6962, at *13
(S.D.N.Y. Apr. 21, 2003). This, of course, is not the basis of a valid securities law claim. See
Grandon v. Merrill Lynch & Co., 147 F.3d 184, 193-94 (2d Cir. 1998) (“A plaintiff’s conclusory allegation that markups are excessive is similar to a barroom generality; it is insufficient to state a securities fraud claim”).
CIT Repeatedly Warned That Its Credit Reserves May Prove Inadequate. Plaintiffs’ claim that CIT made false and misleading statements by failing to take earlier reserves for credit
38 losses also fails to plead falsity because CIT repeatedly warned investors that worsening
conditions might mean its credit reserves would prove inadequate. As described above, CIT continuously provided the investing public with detailed data on the credit performance of its home loans. CIT also explained to investors how it went about reserving for potential losses:
We maintain a consolidated reserve for credit losses on finance receivables that reflects management’s judgment of losses inherent in the portfolio. We periodically review our consolidated reserve for adequacy considering economic conditions and trends, collateral values and credit quality indicators, including past charge-off experience and levels of past due loans and non- performing assets.
2006 10-K at 10. Moreover, the Company disclosed the underlying data that informed managements’ decisions regarding reserve levels. See, e.g., 2006 10-K at 25.
With regard to this process of reserving for losses, CIT consistently warned investors the reserve process was based on subjective judgments and that it was possible those reserves could prove inadequate. Specifically, investors were cautioned:
• “We cannot be certain that our consolidated reserve for credit losses will be adequate over time to cover credit losses in our portfolio because of unanticipated adverse changes in the economy or events adversely affecting specific customers, industries or markets.” 2006 10-K at 10.
• “The reserve for credit losses is intended to provide for losses inherent in the portfolio, which requires the application of estimates and significant judgment as to the ultimate outcome of collection efforts and realization of collateral values, among other things. Therefore, changes in economic conditions or credit metrics, including past due and non-performing accounts, or other events affecting specific obligors or industries may necessitate additions or reductions to the reserve for credit losses.... The process involves the use of estimates and a high degree of management judgment.” 2006 10-K at 52.
Moreover, with respect to home lending, CIT specifically warned that:
“We continue to believe the losses in [the home lending] portfolio will approximate 120 basis points for the year, though we now project higher portfolio balances than previously. These expectations, which could deteriorate if industry conditions persist or worsen, are based on historical data and our assessment of economic and industry trends.”
39
5/8/07 10-Q at 37; see also 8/7/2007 10-Q at 22.
The stark lack of any supporting factual allegations suggesting that CIT was required to
take a write down earlier, combined with explicit warnings that despite its rigorous (and
disclosed) process of reserving for credit losses, there was a possibility that those reserves could
prove inadequate, demonstrates that plaintiffs have failed to sufficiently plead falsity here. See
In re CIT Group, Inc., 349 F. Supp. 2d 685, 691 (S.D.N.Y. 2004) (“defendants stated that they believed that loan loss reserves … were adequate, but they also acknowledged a ‘substantial decline’ in the industry and indicated an understanding that ‘continued deterioration in the sector could result in losses beyond current reserve levels.’ Given the absence of any facts to show that defendants did not believe, or have a reasonable basis to believe, that the reserves were inadequate, this Court cannot simply draw an inference based upon mere speculation that this was the case.”).
4. Plaintiffs Have Pled No Facts to Suggest that CIT Made Any False or Misleading Statements or Omissions About Supposedly “Reduced” Underwriting Standards
Plaintiffs claim that CIT misrepresented the quality of its “credit metrics,” which they
claim had “been weakened as defendants reduced credit standards to boost loan originations.”
¶53(d). This allegation likewise finds no well-pled factual support in the Complaint.
“Reduced” FICO Score Requirements. Plaintiffs cite “form [sic] CIT home lending
Account Executives at CIT offices throughout the country,” who purportedly claim that “by the
end of 2006 CIT had substantially reduced the … minimum FICO score, for subprime loan
approval.” ¶53(d). Even setting aside the confidential source deficiencies inherent in this allegation (see above p. 23), it is insufficient to support a claim that CIT made any false or
misleading statements or omissions during the class period. As an initial matter, this allegation
40 is impermissibly vague as it offers zero details regarding the supposed (non-existent)
“reduction,” i.e., what the required FICO score was previously, what it supposedly was changed to, and when.
Moreover, the claim that CIT misrepresented or failed to disclose material facts about the
FICO scores required for its home loans is completely belied by the fact that CIT consistently disclosed the average FICO score of its home loans prior to and throughout the class period.
2005 10-K at 38; 2006 10-K at 41; 5/8/07 10-Q at 37; 8/7/07 10-Q at 24. This data shows that, contrary to plaintiffs’ unsupported allegations, the average FICO score of CIT home borrowers increased by 3 points between the end of 2005 and the end of 2006 (to 636), and remained constant through the time that CIT announced it would exit the home lending business. Id.
Plaintiffs not only fail to challenge the accuracy of these disclosures, they actually cite them in the Complaint in support of their claim that the home loans were impaired. ¶133 (citing 636
FICO score average). Plaintiffs also cite other data in the Complaint — disclosed by the
Company in August 2007 — showing that 27% of borrowers had sub-600 FICO scores. ¶133.
However, plaintiffs plead no facts showing that this publicly disclosed data represented any sort of reduction in credit standards, and the fact that (as plaintiffs acknowledge) there was no reduction in the average FICO score in CIT’s home loan portfolio over the class period indicates that any claim to the contrary finds no factual support in the Complaint. See Teamsters Local
445 Freight Div. Pension Fund v. Dynex Capital Inc., 531 F.3d 190, 196-97 (2d Cir. 2008)
(finding plaintiffs “fail to allege the existence of information that would demonstrate that the statements made to investors were misleading”).
“Stated Income Loans.” In support of their allegation that CIT was “reducing credit standards” in 2006, plaintiffs also plead, without attribution to any source, that “in an effort to
41 drive up originations and assets under management, CIT was making increasingly risky home
loans, including no documentation, stated income loans – also known as ‘liar loans.’” ¶53(d).
As an initial matter, as plaintiffs acknowledge, CIT publicly disclosed that its portfolio included
stated income loans. ¶49 (quoting 1/17/07 Conf. Call at 10). Moreover, plaintiffs plead no facts
to support any allegation that CIT was “increasingly” making stated income loans, and cite no
data, confidential source or other particularized factual basis for such an allegation.27 More fundamentally, once again plaintiffs offer no details regarding the supposed “increase” in these
loans. See Goplen, 453 F. Supp 2d at 769 (dismissing claim that company failed to disclose in
press release that it was experiencing downturn in advertising revenue where plaintiffs failed to
demonstrate that such a downturn actually existed and presented no documents, meetings, or
reports showing that defendants knew or should have known about the alleged downturn at time
of press release). Moreover, there are no facts alleged in the Complaint that identify what
information CIT obtained and documented (for example, whether asset checks were performed)
that may have obviated the need to verify borrower income on these loans. Nor do these
allegations address whether there were other factors — such as the loan-to-value of the loan, the
borrower’s assets, employment and the borrower’s detailed credit history — that mitigated the use of stated income loans.
Adjustable Interest Rates. Plaintiffs also cite vaguely-defined “former Account
Executives” who allege that “CIT was increasingly using 2/28 and 3/27 adjustable rate
mortgages … to drive loan originations.” ¶53(d). As noted, CIT consistently disclosed the
27 Plaintiffs allege that the “form [sic] CIT home lending Account Executives at CIT offices throughout the country” claim that “by the end of 2006 CIT had substantially reduced the amount of documentation necessary … for subprime loan approval.” ¶53(d). However, in addition to failing to particularize that this vaguely described “group” of confidential witnesses has some reliable basis to speak to the knowledge or intent of anyone at CIT, this allegation is far too vague and conclusory to support a charge of falsity because (i) the “sources” do not even purport to describe what documentation CIT required for home loans, and (ii) there are no facts alleged as to how the documentation requirement was in any way “reduced.”
42 features of its home loan portfolio, including the exact percentage of loans that had adjustable
rates. 2005 10-K at 38; 2006 10-K at 41; 5/8/07 10-Q at 37; 8/7/07 10-Q at 24. This data, the
accuracy of which plaintiffs do not challenge, reveal that, contrary to plaintiffs’ conclusory
assertions, the percentage of mortgages with adjustable rates remained constant between the end
of 2005 and the end of 2006. Id. Plaintiffs plead no facts or sources to support their conclusory
allegation that CIT was “increasingly” originating adjustable rate mortgages (whether classified
as 2/28, 3/27 or otherwise). See Malin, 499 F. Supp. 2d at 148 (claim based on allegation that
defendants failed to disclose that company had set up a particular trust dismissed where plaintiffs
failed to allege with particularity that such a trust had been established at the relevant time).
5. Expressions of Optimism and Other Puffery Are Not Actionable
The Complaint also alleges that the adjectives and phrases used to describe the credit
profile of CIT’s subprime home loans were false and misleading because CIT failed to disclose
the risk associated with such loans. In particular, plaintiffs point to statements that CIT’s
subprime home lending credit quality was “solid,” “stable” or “conservative” and that credit
metrics remained “strong.” ¶¶ 46-50, 53, 55-57, 59, 63, 65-66. The Second Circuit has just this
year confirmed that the use of such descriptive words is mere “puffery” not actionable under the
securities laws. ECA, 553 F.3d at 187 (statements regarding “highly disciplined” risk
management and “standard-setting reputation for integrity” were non-actionable puffery); Novak,
216 F.3d at 315 (“statements containing simple economic projections, expressions of optimism, and other puffery are insufficient” to form the basis of a claim of securities fraud); In re N.Y.
Cmty. Bancorp, Inc. Sec. Litig., 448 F. Supp. 2d 466, 471-72, 478-79 (E.D.N.Y. 2006)
(statements that rising interest rates would not affect company because it originated
43 “conservatively written multi-family loans” and that company’s “greatest asset” was its “risk
averse” approach to decision-making amounted “to no more than inactionable puffery”).
6. Defendants’ Forwarding-Looking Statements Are Not Actionable
Plaintiffs challenge several of defendants’ statements regarding CIT’s home lending portfolio that constitute projections for the future. ¶46 (projection that charge-offs “are not going to be that much higher”), ¶49 (projection that charge-offs “could go up to the 120 basis point area”), ¶58 (projection that “in terms of the loss number…about [the] 120 basis point area is still the number we’re looking at and forecasting”), ¶64 (projection that “the outcome” with respect to aspects of the housing market “will be predictable, measurable and within the context of what we’ve been talking about”). None of these statements gives rise to an actionable misrepresentation, because under the PSLRA, “statements are non-actionable where (1) they are identified as forward-looking and are accompanied by meaningful cautionary statements or are immaterial; or (2) plaintiffs fail to prove that they were made with actual knowledge that the
statements were false or misleading.” In re VEECO Instruments, Inc. Sec. Litig., 235 F.R.D.
220, 235 (S.D.N.Y. 2006); see 15 U.S.C. § 78u-5(c)(1)(B), (C). Because the challenged forward-looking statements were accompanied by incessant warnings regarding the very risks that ultimately materialized (see above p. 38), they could not “mislead a reasonable investor regarding the nature of the securities at issue.” Rombach v. Chang, 355 F. 3d 164, 175-76 (2d
Cir. 2004). Likewise, because the forward-looking statements were not made with any — much less actual — knowledge of falsity, these claims must be dismissed.
B. The Complaint Fails to Allege That CIT Made Any False Statement or Omission Regarding Its Student Loans
Plaintiffs acknowledge that CIT made no public statements regarding Silver State, or
CIT’s Silver State student loans, at any time prior to Silver State’s bankruptcy in February 2008.
44 Rather, the essence of plaintiffs’ claim of falsity with regard to CIT’s student loans is that CIT should have taken a reserve for the loans made to students of Silver State prior to Silver State’s bankruptcy in February 2008. ¶95(a) (“Defendants … failed to appropriately reserve for the
Company’s loan loss exposure”); ¶104(a) (same). Based on this theory, plaintiffs challenge nearly every statement that CIT made regarding its student lending business during the class
period. Thus, the Complaint claims that CIT “concealed adverse material information” about its
student lending business (¶207) and affirmatively made false and misleading statements about
the performance of its student loans. See ¶94 (statement at conference that the student loan
business was “performing well”); ¶101 (statement in financial report that non-performing assets
were insignificant); ¶103 (statement that student loan business had strongest operating quarter).
However, “the failure to anticipate the extent of necessary reserves, even if it amounts to
mismanagement, is not actionable under federal securities laws.” Hinerfeld v. United Auto
Group, 1998 U.S. Dist. LEXIS 10601, at *21-22 (S.D.N.Y. Jul. 15, 1998); see above p. 37.
Accordingly, plaintiffs must allege with particularity the facts supporting their belief that the
challenged omissions and statements were false or misleading at the time they were made. See
Downey, 2009 WL 2767670, at *5 (“Merely alleging that bad debt reserves were inadequate is insufficient because even reasonable predictions turn out to be wrong. Instead, plaintiffs must allege with particularity facts that show the initial prediction was a falsehood”); Garber v. Legg
Mason, Inc., 537 F. Supp. 2d 597, 613 (S.D.N.Y. 2008) (allegations that defendants withheld information regarding increasing customer withdrawals and increasing expenses dismissed where plaintiff cited no reports or data supporting the existence of either of these alleged trends at the time). Plaintiffs plead no particularized facts that meet this standard.
45 Rather, now that Silver State appears to have been a ponzi scheme — of which CIT was
one of the largest victims by far — plaintiffs simply cobble together a patchwork of isolated data
points (with no indication that these points are actually accurate, much less that CIT was aware
of them) and assert in classic hindsight fashion that these issues would have made it clear to
plaintiffs’ counsel, with the benefit of 20/20 hindsight, that Silver State was a ponzi scheme.
Unfortunately for plaintiffs, the PSLRA requires that they do a lot more, including the
fundamental obligation to allege particularized facts from which it should be inferred that the
statements were false at the time they were made. See Fadem v. Ford Motor Co., 352 F. Supp.
2d 501, 519 (S.D.N.Y. 2005) (“corporate officials need not be clairvoyant; they are only
responsible for revealing those material facts readily available to them”); CIT Group, 349 F.
Supp. 2d at 691 (dismissing Section 11 and 12 claims where plaintiffs failed “to plead any facts
from which it could be inferred that defendants’ belief in the adequacy of the [loan loss] reserves
was beyond the pale of reason”).
1. The Volume of Silver State Loans Was Immaterial
As a threshold matter, plaintiffs’ claims should be dismissed because the amount of loans
to Silver State students held by CIT was immaterial as a matter of law. Throughout the
Complaint, plaintiffs go to great lengths to aggrandize the volume of Silver State loans held by
CIT, so as to make it appear that the loans made up a material portion of CIT’s total loan portfolio or even its total student loan portfolio. Thus, rather than describe the Silver State loans
as a proportion of CIT’s total loans (0.235%), its consumer and home loans (0.88%), or its
student loans (1.69%), plaintiffs misleadingly invent their own denominator (“at-risk loans”) to
make the $196 million in Silver State loans held by CIT appear to constitute a far greater
proportion of CIT’s then $83.2 billion loan portfolio, and ask the Court to view CIT’s Silver
46 State loans in hindsight as a percentage of these “at-risk” loans. ¶¶77, 81, 95, 104, 113. Were
plaintiffs’ methodology to prevail, materiality would always exist, because plaintiffs could
always gerrymander some self-serving subset of the total pool being considered to make the
proportion appear inflated.
The reason for plaintiffs’ attempted subterfuge is clear: by any reasonable measure, CIT’s
Silver State loans, which represented less than 2% of CIT’s student loans, less than 1% of its
portfolio of consumer and home loans, and less than a quarter of 1% of its total loan portfolio,
were immaterial as a matter of law. See ECA, 553 F.3d at 204 (confirming that a “five percent
numerical threshold is a good starting place for assessing the materiality” of an alleged
omission); CIT Group, 349 F.Supp. 2d at 691 (dismissing claim where $240 million charge to
loan loss reserves in a company with over $27 billion in receivables found immaterial); In re
Allied Capital, 2003 U.S. Dist. LEXIS 6962, at *16 (finding that no reasonable investor would
have found misstatements in estimates that overvalued holdings in $237 million worth of assets
material in a company that had $2.3 billion in assets); Parnes v. Gateway 2000, 122 F.3d 539,
547 (8th Cir. 1997) (defendants’ alleged overstatement of assets by $6.8 million was immaterial
as a matter of law where it represented only 2% of company’s total assets). It is only in
hindsight — after the majority of those loans were written off in the wake of the Silver State
bankruptcy — that these loans came into sharp focus.
2. Plaintiffs Allege No Particularized Facts Suggesting that CIT Should Have Written Off — Or Made Any Affirmative Disclosures Regarding — Its Silver State Loans Prior to February 2008
Graduation and Delinquency Rates. Plaintiffs claim that during the class period, no more than 10% of all Silver State students whose loans were held by CIT had graduated, that the school had a 20% gradation rate generally, and that these supposed graduation rates should have
47 prompted CIT to write down its loans earlier. ¶¶95(f), 104(e), 113(e), 155, 177(j). However, the
Complaint provides no particularized allegations of fact to support a cause of action.
Most fundamentally, the Complaint contains no allegation of fact underlying plaintiffs’
supposed graduation data, such as when the data was derived, how, by whom, how firm it was,
or which company officers reviewed it. In fact, after failing to plead the specific basis for the
alleged graduation data, plaintiffs simply repeat the vague figure over and over — as if they had
already pled a factual basis for the allegation — claiming it applied at several points throughout
2007. ¶95(f) (“less than 10%” as of March 31, 2007); ¶177(j) (“less than 10%” “by April
2007”); ¶104(e) (“less than 10%” as of June 30, 2007); ¶113(e) (“less than 10%” as of
September 30, 2007). “Where plaintiffs contend defendants had access to contrary facts, they must specifically identify the reports or statements containing this information.” Novak, 216
F.3d. at 309. “To survive a motion to dismiss, plaintiffs “need to specify the internal reports,
who prepared them and when, how firm the numbers were or which company officers reviewed
them.” Garber, 537 F. Supp. 2d at 615 (quoting In re Scholastic Corp. Sec. Litig., 252 F.3d 63,
72 (2d Cir. 2001)).
Moreover, plaintiffs’ purported 10% graduation rate for the loans held by CIT — vague as it is — also lacks critical context, without which it is meaningless. Plaintiffs allege that CIT made loans to Silver State students between mid-2005 and mid-2007, and that the course took 18 months to complete. ¶¶76, 82. Plaintiffs then allege (without any particularized basis) what the
“graduation rate” was throughout 2007, without regard to how long students had actually been in the program or whether and when they were even yet due to graduate. ¶¶95(f), 104(e), 113(e),
177(j). Indeed, the Complaint itself alleges that as of “the end of 2005 CIT had only made $17.6 million in private student loans.” ¶76. Accordingly, since most Silver State students whose
48 loans were held by CIT, by plaintiffs’ own allegations, would have begun their 18 month
program sometime during 2006 or 2007, plaintiffs’ allegations as to what the “graduation rate”
was throughout 2007 (by which date very few students would have been scheduled to complete the course) supports no allegation of falsity (even if CIT were properly alleged to have known that information). See Dynex, 531 F.3d at 196-97 (finding plaintiffs “fail to allege the existence of information that would demonstrate that the statements made to investors were misleading”).
Elsewhere, plaintiffs allege — again without any factual predicate at all — that Silver
State had a 20% graduation rate. ¶113(e). This unsupported figure cannot suffice to plead falsity under the securities laws. See, e.g., ACA Fin. Guar. Corp. v Advest, Inc., 512 F.3d 46, 62-63
(1st Cir. 2008) (upholding dismissal of claim that student enrollment projections were unreasonable based on allegation that school experienced a 20% decline in student deposits because “plaintiffs have not included details about how they were able to identify the 20% figure, much less whether this information was known to the defendants at the relevant time”).28
Plaintiffs also claim that “by March 2007, Doug Henkel, SLX’s Vice President of
Business Development, was privately meeting with Silver State executives to discuss the school’s lack of graduates.” ¶84. Critically, plaintiffs do not allege: (i) any facts upon which they base this assertion, (ii) what specifically prompted the meetings, (iii) what actually occurred
28 Plaintiffs also allege that “even a cursory review of the FAA’s publicly available database … would have revealed that only a small fraction of Silver State students” received pilot certifications. ¶154. Yet despite the alleged ease with which plaintiffs allege such data supposedly could have been obtained, plaintiffs do not allege what this data would have actually revealed nor whether it would have provided any relevant details, such as how many people had attempted to become pilots after attending Silver State but had not, and when those who had not yet completed the Silver State program were actually due to graduate. Indeed, a review of the FAA’s website reveals that its database: 1) does not include any data on the flight school attended by the licensed pilots listed, but rather lists only names, addresses, and certification information, and 2) it is not even an exhaustive list, since it expressly “does not include … the records of those airmen who do not want their addresses released.” See http://www.faa.gov/licenses_certificates/ airmen_certification/releasable_airmen_download; see also Wendell H. Ford Aviation Investment and Reform Act for the 21st Century § 715, 49 U.S.C. § 44703(c) (requiring FAA to release only names, addresses, and ratings information for all licensed pilots and requiring that the pilots be given an opportunity to opt out of the database). Accordingly, plaintiffs’ allegation regarding this irrelevant data cannot support any claim that CIT knew or “should have” known that Silver State was a ponzi scheme.
49 and what was said at the meetings, or (iv) why these meetings should have indicated to anyone at
CIT that the Silver State student loans — which were an independent obligation from each student to CIT — should have been written down before February 2008. See Malin, 499 F.
Supp. 2d at 140 (“Generic and conclusory allegations based upon rumor or conjecture are indisputably insufficient to satisfy the heightened pleading standard of [the PSLRA]”).
Plaintiffs also cite supposed data on the number of Silver State students with CIT loans in repayment status (defined in CIT’s disclosures as students who had graduated or were otherwise required to start paying back their loans) that were delinquent in making payments on their loans
(defined as late for 60 days or more). ¶¶90, 113(f). Here, too, while claiming that CIT was in possession of data contradicting its disclosures, plaintiffs fail to specifically identify the reports or statements containing this purported information, who supposedly prepared them and when, and which company officers reviewed them. See San Leandro, 75 F.3d at 812 (“unsupported general claim of the existence of confidential company sales reports that revealed [unfavorable figures] is insufficient to survive a motion to dismiss”). Moreover, plaintiffs themselves acknowledge the very limited value of their own purported delinquency data; by plaintiffs’ own theory, few Silver State students with CIT loans had been at the school long enough to complete the program and graduate, and thus there were few students in repayment status. ¶90.
Lastly, plaintiffs’ unsupported allegations as to the delinquency rate of CIT’s Silver State loans are inconsistent with the Company’s February 29, 2008 statements disclosing the Silver
State bankruptcy and the existence of the Company’s Silver State loans, the accuracy of which plaintiffs have not challenged. CIT’s February 29, 2008 disclosure that it held $196 million in
Silver State loans stated that $17 million of the total loans were in repayment status. 2007 10-K at 118. It further disclosed that the amount of such loans in repayment status that were
50 delinquent was approximately $2.0 million. Id. This represents a delinquency rate of 11.76%,
which stands in sharp contrast to plaintiffs’ purported numbers. See, e.g., ¶113(f) (claiming rate was 35.65% in late 2007). Plaintiffs make no attempt to reconcile their allegations with this contradictory data.29
Suspension of New Loans to Silver State and Efforts to Sell the Loans. Plaintiffs allege
that CIT suspended making new loans to Silver State students and attempted to sell its Silver
State loan portfolio in May 2007 due to “known risks at the school.” ¶113(g). However, this conclusory allegation adds nothing to plaintiffs’ claims that CIT acted to mislead.
CIT’s purported attempts to sell its Silver State loans, which plaintiffs conspicuously
ignore were obligations to CIT by individual students who chose to attend Silver State, not loans
to Silver State itself, support no allegation of falsity. As a global financing company, it was
routine for CIT to sell loan receivables in the ordinary course of business; indeed, as expressly
disclosed to investors in the very first few pages of CIT’s annual reports, part of CIT’s business
model was to “sell finance receivables on a whole-loan basis.” 2006 10-K at 4, 36 (describing
increased revenue “reflecting higher gains on sales of…student lending receivables”); 5/8/07 10-
Q at 34 (same). Nothing about CIT’s alleged decision to attempt to sell the Silver State loans
gives rise to any inference that CIT was aware that Silver State was a ponzi scheme, given the
stark lack of facts alleged as to why CIT supposedly made efforts to sell its Silver State portfolio or that the Company actually had any reason to believe that its Silver State loans were impaired.
See Caiafa v. Sea Containers Ltd., 525 F. Supp. 2d 398, 413 (S.D.N.Y. 2007) (“plaintiffs have failed to plead with particularity… ‘how the statements were false or misleading’”). Indeed, the
29 Even if plaintiffs’ 35.65% loan delinquency figure were credited, this would mean that CIT had at most $6 million of delinquent loans to Silver State students.
51 only logical inference was that CIT was merely continuing its long-standing and fully disclosed practice of selling student lending receivables.
Similarly, plaintiffs work backwards from the fact that CIT disclosed following Silver
State’s bankruptcy that it had ceased originating loans to Silver State students in mid-2007, and assert, without factual support, that CIT must have done so because management was aware at that time that CIT’s loans to Silver State students were impaired. Yet again, plaintiffs’ logic requires the Court to assume that which plaintiffs are attempting to infer: that CIT knew that
Silver State was a ponzi scheme. See Rombach, 355 F.3d at 174 (“To succeed on [their securities fraud] claim, plaintiffs must do more than say that the statements in the press releases were false and misleading; they must demonstrate with specificity why and how that is so”).
Moreover, plaintiffs ignore the fact that — as publicly disclosed — CIT ceased originating all private student loans during 2007. 2007 10-K at 5. When that fact is considered, the most compelling inference is that the decision to stop making loans to Silver State students was made in connection with CIT’s overall decision to cease originating private student loans entirely. See
Tellabs, 127 S. Ct. at 2510.
Other Alleged Problems at Silver State. Plaintiffs assert that CIT should have been aware its Silver State student loans were impaired because KeyBank, a lender to Silver State students prior to CIT, by March 2004 “had concerns about Silver State and acknowledged internally that ‘it could be the next big one to go under.’” ¶87. Not only do plaintiffs fail to allege with particularity any facts as to the source of this information that was purportedly internal to KeyBank, or any supporting facts as to why anyone at KeyBank was ostensibly concerned, but even more fundamentally, there is no allegation whatsoever that CIT was ever aware of KeyBank’s purported concerns. Moreover, plaintiffs’ implicit allegation that purported
52 internal information from KeyBank should somehow be imputed to CIT makes no sense in light
of the fact that (as plaintiffs acknowledge) Citibank, one of the largest banks in the United States,
continued to make loans to students at Silver State following CIT’s decision to cease originating
new loans, and that Citibank continued to make Silver State loans until January 31, 2008. It was
this decision by Citibank in early 2008 that led to Silver State’s bankruptcy.30 It obviously defies common sense to suggest that CIT and Citibank both simultaneously knowingly engaged in a scheme (unknown to each other) to make loans to students of a school that was a ponzi scheme.
Plaintiffs repeatedly trumpet the publicly available fact that Silver State was not an “FAA
Part 141” approved school. ¶¶84, 154, 177. Regrettably, plaintiffs omit from the Complaint any mention of the fact that according to the FAA itself there exist two kinds of flight schools and that the FAA advises prospective students that “many excellent flight schools find it impractical
to qualify for the FAA part 141 certificate and are referred to as part 61 schools.”31 Thus,
according to the very governmental agency whose certification process plaintiffs seek to invoke,
there was nothing inherent in Silver State’s FAA status that should have tipped off anyone at CIT
that Silver State may not be a bona fide operation. See In re Northern Telecom Ltd. Sec. Litig.,
1994 U.S. Dist. LEXIS 11730, at *19 (S.D.N.Y. Aug. 19, 1994) (“Because the complaint does not contain information that would support an inference that any of the facts mentioned … were false, plaintiffs may not base a claim on this statement”).
Plaintiffs also assert that CIT had notice the Silver State loans were impaired because of
Silver State’s purported “promise” to hire its graduates, which plaintiffs claim indicated that
30 See above p. 11 n. 9.
31 See Student Pilot Guide (FAA-H-8083-27A), U.S. Department Of Transportation, Federal Aviation Administration (March 8, 2006), http://www.faa.gov/library/manuals/aviation/media/faa-h-8083-27a.pdf.
53 Silver State was a ponzi scheme. ¶¶82, 154, 177. This claim borders on being silly. There is no
allegation that anyone at CIT was aware of any such “promise” if in fact it was made. Moreover,
it would be ridiculous to assume that CIT was aware of each of the statements of “promises”
made by the many schools its student borrowers chose to attend. Nor is there any allegation that this “promise” was anything more than an assurance that all students would find a job, as opposed to a policy to hire all students as instructors for future students (requiring a supply of new recruits to be trained by old ones). ¶82.
Finally, plaintiffs repeatedly allege that CIT should have known that Silver State was a
ponzi scheme due to the school’s “substandard training and equipment,” its supposedly “highly
unusual” tuition and refund policies, the “demographic” markup of its students, and similar
irrelevant tidbits. ¶¶83, 84, 86, 88, 154, 177.32 Again, there are no particularized allegations in
the Complaint suggesting that these purported issues were known to anyone at CIT. See Dynex,
531 F.3d at 196-97 (plaintiffs must sufficiently plead that defendants “knew facts or had access
to information suggesting that their public statements were not accurate”).
C. Plaintiffs’ GAAP Allegations Fail to State a Claim
The 17-page “GAAP” section of the Complaint, ¶¶ 135-164, adds nothing of substance;
it is completely dependent upon the preceding deficient paragraphs. Plaintiffs simply dress-up
CIT’s supposed failure to disclose risks associated with its subprime home loans and loans to
students of Silver State and to take write downs of those loans earlier as GAAP violations. See
Tabor v. Bodisen Biotech, Inc., 579 F. Supp. 2d 438, 452-53 (S.D.N.Y. 2008) (dismissing claims
32 Plaintiffs also allege that CIT was aware or should have been aware that Silver State was ponzi scheme because certain former students had brought class action lawsuits against the school alleging that Silver State did not have sufficient resources. ¶154. Plaintiffs do not allege than anyone at CIT was actually aware of these lawsuits. As the Court is aware, anyone can make allegations in a lawsuit, and the making of allegations does not make them true or even probable. Indeed, plaintiffs’ counsel in this action brought a class action lawsuit against CIT in 2003, which Judge Sprizzo dismissed with prejudice. See CIT Group Inc., 349 F. Supp. 2d at 685. Thus, CIT was well aware of how little it means in some cases to have been sued in a class action lawsuit.
54 of inadequate internal controls and GAAP violations when those claims were premised on
underlying statements that were not found to be fraudulent).
These bootstrapped allegations also fail because conclusory, after-the-fact
allegations of GAAP violations do not show a false or misleading statement where, as here, the
GAAP provisions in question concern highly subjective assessments and no one — not the
Company, not the Company’s auditor (PricewaterhouseCoopers), and not the SEC — has stated
that the Company’s financials should be restated due to supposed GAAP violations. Under these circumstances, plaintiffs must do far more than point to a series of judgmental items such as disclosures concerning credit risk concentration and allowances for loan losses and cry fraud.
See In re 2007 Novastar Fin., 2008 U.S. Dist. LEXIS 44166, at *3 (rejecting claim that defendants violated GAAP where “nobody — the SEC, Novastar’s auditors, or anyone else — has suggested Novastar should or must restate its financial reports”); Malin, 499 F. Supp. 2d at
148 (rejecting claim that defendants misreported financial data where “there is no allegation here
[that] there has been any restatement of any financial statement or that any auditor has qualified
or withdrawn its opinion”).
At bottom, all plaintiffs do is offer their naked, self-serving opinion that CIT’s financial statements violated GAAP; plaintiffs do not come close to satisfying their burden of actually pleading underlying facts that demonstrate the falsity of any particular accounting entry.
• Home Loan Reserves. Plaintiffs’ attempt to demonstrate the inadequacy of CIT’s loan-loss reserves by pointing to later losses is baseless. See, e.g., Coronel v. Quanta Cap. Holdings Ltd., 2009 U.S. Dist. LEXIS 6633, at *81 (S.D.N.Y. Jan. 26, 2009) (“The Complaint alleges nothing to show that the reserves did not have a reasonable basis at the time they were made”). Plaintiffs plead no facts to support their charge that there were any “changes” in CIT’s loan origination standards, nor that any of the (fully disclosed) features of certain of CIT’s home loans made any statement by the Company false or misleading or otherwise demonstrates that the Company was required to take loan loss reserves earlier. See above p. 32.
55
• Collateral Values. Plaintiffs further claim that “defendants were required to consider the declining value of the collateral backing its home loans.” ¶145. Critically, there is no claim, much less particularized allegations of fact, that CIT actually failed to consider declining collateral values in setting its loan loss reserves.
• Silver State Loan Reserves and Disclosures. Plaintiffs claim that defendants violated GAAP by failing to take a reserve for its Silver State loans earlier. ¶156. They further tack on a claim alleging that CIT violated GAAP by not disclosing the “the concentration and risks” of its loans to Silver State students. ¶¶158-164. However, as noted, plaintiffs plead no specific facts to support the allegation that CIT was or should have been aware that Silver State was a sham prior to February 2008. See above p. 44; ¶¶153-54.
• CIT’s Financial Statements. Finally, plaintiffs claim that the failure of CIT to take loan loss reserves earlier in purported violation of GAAP inflated the Company’s pre-tax income and earnings per share from 4Q 2006 through 3Q 2007. ¶¶147, 157. However, because there are no particularized factual allegations supporting the conclusion that CIT was required to take such reserves earlier (see above pp. 37, 47) the bootstrapped allegation that the Company’s financial statements were false is unsupported by the Complaint.
D. Count II Should Be Dismissed Because Plaintiffs Fail to Plead Control Person Liability
Plaintiffs’ “control person” claim under Section 20(a) of the Exchange Act (Count II) fails because, as detailed above, plaintiffs have not alleged a primary violation of the Exchange
Act. See ECA, 553 F.3d at 207.
III. COUNTS III, IV & V SHOULD BE DISMISSED BECAUSE THE COMPLAINT FAILS TO STATE A CLAIM UNDER THE SECURITIES ACT
Plaintiffs’ claims under Sections 11, 12 and 15 of the Securities Act (Counts III, IV, and
V) relate only to the CIT-Z registration statement and prospectus issued October 17, 2007.
¶¶220, 228, 236. Because CIT had fully disclosed its write-downs of the value of the subprime home loan portfolio by that time (¶¶68, 72), these claims concern only the student lending related allegations. All of these claims should be dismissed as a matter of law.
56 A. Plaintiffs’ Claims Under Sections 11, 12(a)(2) and 15 Sound in Fraud and Are Subject to the Heightened Pleading Requirements of Rule 9(b)
Claims brought under Sections 11, 12(a)(2) and 15 of the Securities Act that “sound in fraud” must comply with the heightened pleading standard of Rule 9(b). See Rombach, 355 F.3d
at 171. The applicable test under Rombach is whether a complaint includes “wording and imputations ... classically associated with fraud.” Id. at 172. Here, as in Rombach, the
Complaint is replete with allegations of statements that are “materially false and misleading” and
are “untrue statements of material facts,” including, significantly, their allegations under the
Securities Act.33 See id. (allegations that registration statement contained “untrue statements of material facts,” contained “materially false and misleading written statements,” and were
“inaccurate and misleading” sounded in fraud); see also IAC/InterActiveCorp, 478 F. Supp. 2d at
596 (finding allegations based on registration statements that contained “allegedly false and
misleading statement[s]” “plainly sound in fraud”); Miller v. Lazard, Ltd., 473 F. Supp. 2d 571,
585-86 (S.D.N.Y. 2007) (same).
Plaintiffs cannot avoid Rule 9(b) by disclaiming “any allegations of fraud,” (¶¶ 220, 236),
nor can they simply disavow any reliance on “knowing or reckless misconduct” (¶¶220, 336).34
Plaintiffs’ theory of why CIT’s SEC filings were purportedly false and misleading for the
purposes of their Securities Act claims is based on the same course of conduct as their fraud
claims — i.e., the same purported misrepresentations underlie the Securities Act and Exchange
Act Claims. The alleged failure to disclose information about the subprime home loan portfolio,
33 ¶206 (“untrue statements of material fact”), ¶208 (“untrue statements of material fact”), ¶209 (materially false and misleading”), ¶212 (“false and misleading information”).
34 In re AXIS Cap. Holdings Ltd. Sec. Litig., 456 F. Supp. 2d 576, 598 (S.D.N.Y. 2006) (applying rule 9(b), noting “[c]ourts have repeatedly noted that the insertion of a simple disclaimer of fraud is insufficient”); Johnson v. NYFIX, Inc., 399 F. Supp. 2d 105, 121-22 (D. Conn. 2005) (holding plaintiffs’ Section 11 claim sounds in fraud despite having “gone to great lengths ... to disavow fraud as a basis for the Section 11 claim, and assert[ing] that it is a strict liability cause of action”).
57 the alleged failure to disclose information about the Company’s Silver State loans, and the
alleged GAAP violations were all alleged to have been made with scienter for the purposes of
plaintiffs’ Exchange Act claims. Having alleged that the defendants engaged in a scheme to defraud, plaintiffs “cannot so facilely put the fraud genie back in the bottle.” Miller, 473 F. Supp.
2d at 585-86 (“alluding to fraud throughout the Complaint in order to allege wrongdoing, only to avoid the pleading consequences of so doing in the end, cannot succeed”).
Given the plaintiffs’ failure to allege falsity in their Section 10(b) claims relating to the same purported misstatements, their stripped-down Securities Act claims must similarly fail (i.e.,
Counts III-V). See IAC/InterActiveCorp, 478 F. Supp. 2d at 596 (holding that “because the
Court has already found in connection with the Section 10(b) claim, that those underlying allegations are not sufficiently pleaded to satisfy Rule 9(b) and the PSLRA, the Court likewise finds here that plaintiff’s Section 11 claim is not sufficiently pled”).
B. The Complaint Fails to Allege Any Untrue Statement or Actionable Omission
Even if Rule 9(b) does not apply to plaintiffs’ Securities Act claims, those claims still
must be dismissed because plaintiffs do not plead any materially false statements or omissions in
the CIT-Z registration statement. 15 U.S.C. § 77k. As noted, plaintiffs’ Securities Act claims
and Section 10(b) claims are premised on the same allegedly misleading disclosures from the
same class-period filings. Because plaintiffs fail in their Securities Act claims to identify any
new facts demonstrating that any of the defendants made any false or misleading statements or
omissions, their Section 11 and 12(a)(2) claims must be dismissed for all of the reasons
articulated in Part II, above pp. 35, 44 (no falsity for purposes of Section 10(b)).
C. Plaintiffs’ Control Person Claim Fails
Plaintiffs’ “control person” claim under Section 15 of the Securities Act (Count V) should be dismissed because plaintiffs fail to allege a primary violation of the Securities Act.
58 ECA, 553 F.3d at 207; Rombach, 355 F.3d at 177-78.
D. The Section 12(a)(2) Claim (Count IV) Should Also Be Dismissed For Lack of Standing
Only those who purchased in an offering of securities have standing to bring a Section
12(a)(2) claim. Yung v. Lee, 432 F.3d 142, 149 (2d Cir. 2005); Gustafson v. Alloyd Co., 513
U.S. 561, 584 (1995). Here, Count IV of the Complaint purports to be a claim for an alleged violation of Section 12(a)(2) based on the October 17, 2007 offering of CIT-Z securities. Yet, as
Exhibits A and B to the Complaint make crystal clear, neither of the two named plaintiffs in this action (PH&C and Mr. Pizzuti) purchased any CIT-Z securities in the offering. Indeed, Mr.
Pizzuti — who is the only named plaintiff alleged to have ever purchased any CIT-Z securities
— purchased those securities in the secondary market in 2008 (well after the offering), and not in the offering itself. See Exhibit B to the Complaint at Schedule A (demonstrating that all of Mr.
Pizzuti’s purchases occurred in 2008). Thus, Mr. Pizzuti lacks standing to maintain any claim under Section 12(a)(2).35 As a result, and because no other named plaintiff purchased in the
October 17, 2007 offering, plaintiffs’ Section 12(a)(2) claim must be dismissed as a matter of law.
CONCLUSION
As the Eighth Circuit observed in Parnes v. Gateway 2000, Inc., 122 F.3d 539, 551 (8th
Cir. 1997): “While it is unfortunate that the Plaintiffs … lost money in their investments, their misfortune alone does not create a viable cause of action.” For all of the reasons stated above, the Complaint should be dismissed in its entirety pursuant to Rules 9(b) and 12(b)(6) of the
Federal Rules of Civil Procedure, and the PSLRA.
35 See In re Sterling Foster & Co. Sec. Litig., 222 F. Supp. 2d 216, 246 (E.D.N.Y. 2002) (dismissing § 12(a)(2) claims because plaintiffs failed to “specify at the pleading stage whether they made these purchases in the offering or in the secondary market”); Caiafa, 525 F. Supp. 2d at 407-08; In re Cosi, Inc. Sec. Litig., 379 F. Supp. 2d 580, 588-89 (S.D.N.Y. 2005).
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Dated: September 11, 2009
FRIED, FRANK, HARRIS, SHRIVER & JACOBSON LLP By: /s/ Douglas H. Flaum
Douglas H. Flaum ([email protected]) Israel David
One New York Plaza New York, New York 10004-1980 Telephone: (212) 859-8000
Attorneys for Defendants CIT Group Inc., Jeffrey M. Peek, Joseph M. Leone, William J. Taylor, Thomas B. Hallman, Gary C. Butler, William M. Freeman, Susan Lyne, Marianne Miller Parrs, Timothy M. Ring, John Ryan, Seymour Sternberg, Peter J. Tobin, and Lois M. Van Deusen
60