City of Roseville Employees Retirement System v. Sterling Financial Corporation et al, No. 2:2009cv00368 - Document 135 (E.D. Wash. 2014)

Court Description: ORDER GRANTING DEFENDANTS' MOTION TO DISMISS CONSOLIDATED AMENDED COMPLAINT granting 113 Defendants' Motion to Dismiss for Failure to State a Claim; granting in part and denying in part 119 Defendants' Motion for Judicial Notice; granting in part and denying in part 126 Defendants' Motion for Judicial Notice. Signed by Judge Stanley A Bastian. (VR, Courtroom Deputy)

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City of Roseville Employees Retirement System v. Sterling Financial Corporation et al Doc. 135 1 2 3 4 5 UNITED STATES DISTRICT COURT 6 EASTERN DISTRICT OF WASHINGTON 7 8 CITY OF ROSEVILLE EMPLOYEES’ NO. 2:09-cv-00368-SAB 9 RETIREMENT SYSTEM, Individually 10 and on Behalf of All others Similarly 11 Situated, ORDER GRANTING 12 Plaintiff, DEFENDANTS’ MOTION TO 13 v. DISMISS CONSOLIDATED 14 STERLING FINANCIAL AMENDED COMPLAINT 15 CORPORATION, HAROLD B. GILKEY, 16 and DANIEL G. BYRNE, 17 Defendant. 18 19 Before the Court is Defendants’ Motion to Dismiss Consolidated Amended 20 Complaint for Violation of the Federal Securities Laws, ECF No. 113; 21 Defendants’ Request for Judicial Notice and Notice of Incorporation, ECF No. 22 119; and Defendants’ Supplemental Request for Judicial Notice and Notice of 23 Incorporation by Reference, ECF No. 126. A hearing on the motions was held on 24 August 13, 2014, in Spokane, Washington. Plaintiff was represented by 25 Christopher P. Seefer and Laura J. Black. Defendants were represented by Barry 26 M. Kaplan and Gregory L. Watts. 27 This is the second time around for the parties in arguing the Motion to 28 Dismiss and the first time for this Judge. Previously, Judge Shea entered an Order ORDER GRANTING DEFENDANTS’ MOTION TO DISMISS CONSOLIDATED AMENDED COMPLAINT ~ 1 Dockets.Justia.com 1 granting Defendants’ Motion to Dismiss Consolidated Complaint, but permitting 2 Plaintiff to file an Amended Complaint. Plaintiff did so, and Defendants now 3 move for dismissal on the Amended Consolidated Complaint. In ruling on 4 Defendants’ Motion to Dismiss, the Court does not intend to revisit prior rulings 5 made by Judge Shea. Accordingly, this Order will only address new claims and 1 6 theories that were not presented in Plaintiff’s Consolidated Complaint. 7 A. Legal Standard for Plaintiff’s Claims 8 1. 9 Private federal securities fraud actions are based upon federal securities Section 10(b) Claim 10 statutes and their implementing regulations. Section 10(b) of the Securities 11 Exchange Act of 1934 forbids (1) the “use or employ[ment] . . . of any . . . 12 deceptive device,” (2) “in connection with the purchase or sale of any security,” 13 and (3) “in contravention of” Securities and Exchange Commission “rules and 14 regulations.” 15 U.S.C. § 78j(b). Pursuant to this section, the SEC promulgated 15 Rule 10b-5, which makes it unlawful: (1) to employ any device, scheme, or artifice to defraud; 16 17 18 (2) to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the 19 20 1 The Court adopts Judge Shea’s reasoning in granting, in part, and denying, in part 21 Defendants’ Requests for Judicial Notice and Notice of Incorporation by 22 Reference. See ECF No. 96, at 17-21. Similar to Judge Shea, in resolving 23 Defendants’ Motion, the Court finds it unnecessary to consider the truthfulness of 24 the judicially noticeable documents Defendants have submitted. Rather, to the 25 extent the documents contain out-of-court representations, the Court takes judicial 26 notice of the fact that the representations were made, but does not take judicial 27 notice of the truthfulness of the representation. See Lee v. City of Los Angeles, 250 28 F.3d 668, 690 (9th Cir. 2001). ORDER GRANTING DEFENDANTS’ MOTION TO DISMISS CONSOLIDATED AMENDED COMPLAINT ~ 2 1 light of the circumstances under which they were made, not misleading, or 2 3 (3) to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security. 4 5 6 7 8 9 10 11 12 13 14 17 C.F.R. § 240.10b-5 (2004). Taken together, courts have generally recognized that in order to adequately plead a private securities fraud action, the plaintiff must allege: (1) material misrepresentation or omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation. Police Retirement System of St. Louis v. Intuitive Surgical Inc.,__ F.3d __, 2014 WL 3451566 (July 16, 2014) (citing Halliburton Co. v. Erica P. John Fund, Inc., __ U.S. __, 134 S.Ct. 2398 (2014). 2. 15 16 17 18 19 20 21 22 23 24 25 26 27 28 Section 20(a) Claim In order to prove a prima facie case under Section 20(a) of the Securities Exchange Act of 1934, a plaintiff must prove: (1) a primary violation of federal securities law; and (2) that the defendant exercised actual power or control over the primary violator. No. 84 Employer-Teamster Joint Council Pension Trust Fund v. Am. West. Holding Corp., 320 F.3d 920, 945 (9th Cir. 2003). Section 20(a) claims may be dismissed summarily if a plaintiff fails to adequately plead a primary violation of section 10(b). Zucco Partners, LLC v. Digimarc Corp., 552 F.3d 981, 990 (9th Cir. 2009). B. Pleading Standards The Ninth Circuit has cautioned that plaintiffs in private securities fraud class actions face “formidable pleading requirements to properly state a claim and avoid dismissal under Fed. R. Civ. P. 12(b)(6).” Metzler, Inc. GMBH v. Corinthian Colls., Inc., 540 F.3d 1049, 1055 (9th Cir. 2008). ORDER GRANTING DEFENDANTS’ MOTION TO DISMISS CONSOLIDATED AMENDED COMPLAINT ~ 3 1 1. Fed. R. Civ. P. 12(b)(6) 2 Rule 12(b)(6) of the Federal Rules of Civil Procedure permits a defendant to 3 seek dismissal of a complaint that “fail[s] to state a claim upon which relief can be 4 granted.” Fed. R. Civ. P. 12(b)(6). The Court should not dismiss the complaint if 5 the plaintiff has stated “enough facts to state a claim to relief that is plausible on 6 its face.” Bell Atl. Corp v. Twombly, 550 U.S. 544, 570 (2007). A claim has facial 7 plausibility when the plaintiff pleads factual content that allows the court to draw 8 reasonable inferences that the defendant is liable for the misconduct alleged. 9 Ashcroft v. Iqbal, 556 U.S. 662, 678-79 (2009). The Court accepts all factual 10 allegations in the complaint as true and construes them in the light most favorable 11 to the nonmoving party, except the Court is not required to accept legal 12 conclusions cast in the form of factual allegations if those conclusions cannot be 13 reasonably drawn from the facts alleged. Id. 14 The court must consider the complaint in its entirety, as well as other 15 sources courts ordinarily examine when ruling on a 12(b)(6) motion to dismiss, i.e. 16 documents incorporated into the complaint by reference, and matters of which a 17 court may take judicial notice. Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 18 U.S. 308, 322 (2007). 2. Fed. R. Civ. P. 9(b) and the Private Securities Litigation Reform 19 Act (“PSLRA”) Pleading Requirements 20 Federal R. Civ. P 9(b) and the Private Securities Litigation Reform Act 21 (PSLRA) set forth additional pleading requirements. Reese v. Malone, 747 F.3d 22 557, 568 (9th Cir. 2014). Under Rule 9(b), claims alleging fraud are subject to a 23 heightened pleading requirement, which requires that a party “state with 24 particularity the circumstances constituting fraud or mistake.” Fed. R. Civ. P. 9. 25 Additionally, the PSLRA requires that the complaint plead with particularity both 26 falsity and scienter. 15 U.S.C. § 78u-4(b)(1),(2). 27 a. Pleading Requirements for Falsity and Materiality 28 ORDER GRANTING DEFENDANTS’ MOTION TO DISMISS CONSOLIDATED AMENDED COMPLAINT ~ 4 1 Under Rule 10b-5, the complaint must allege “falsity” by specifying each 2 allegedly misleading statement, why the statement was misleading, and if an 3 allegation is made on information and belief, all facts supporting that belief with 4 particularity. 18 U.S.C. § 78u-4(b)(1); Reese, 747 F.3d at 568. To meet the 5 materiality requirement of Rule 10b-5, the complaint must allege facts sufficient to 6 support the inference that there is “substantial likelihood that the disclosure of the 7 omitted fact would have been viewed by the reasonable investor as having 8 significantly altered the total mix of information made available.” Police 9 Retirement Syst., 2014 WL 3451566 *4. 10 11 b. Pleading Requirements for Scienter Scienter is defined as “a mental state embracing intent to deceive, 12 manipulate, or defraud.” Reese, 747 F.3d at 568. To adequately plead scienter, the 13 complaint must “state with particularity facts giving rise to a strong inference that 14 the defendant acted with the required state of mind.” 15 U.S.C. § 78u-4(b)(2)(A); 15 Reese, 747 F.3d at 568. The inference must be that “the defendant made false or 16 misleading statements either intentionally or with deliberate recklessness.” Id. 17 569. “Deliberate recklessness means that the reckless conduct ‘reflects some 18 degree of intentional or conscious misconduct.’” Id. Thus, mere recklessness or a 19 motive to commit fraud and opportunity to do so is not sufficient to establish a 20 strong inference of deliberate recklessness. Id. To meet the requirements of the 21 PSLRA, the plaintiff must plead “a highly unreasonable omission, involving not 22 merely simple, or even inexcusable negligence, but an extreme departure from the 23 standards of ordinary care, and which presents a danger of misleading buyers or 24 sellers that is either known to the defendant or is so obvious that the actor must 25 have been aware of it.” Zucco Partners, LLC, 552 F.3d at 991. 26 A “strong inference” of scienter exists if, when the allegations are accepted 27 as true, “a reasonable person would deem the inference of scienter cogent and at 28 least as compelling as any opposing inference one could draw from the facts ORDER GRANTING DEFENDANTS’ MOTION TO DISMISS CONSOLIDATED AMENDED COMPLAINT ~ 5 1 alleged.” Tellabs, Inc., 551 U.S. at 324. It must be more than merely plausible or 2 reasonable. Reese, 747 F.3d at 569. Ultimately, the Court must ask: “When the allegations are accepted as true 3 4 and taken collectively, would a reasonable person deem the inference of scienter at 5 least as strong as any opposing inference?” Tellabs, Inc., 551 U.S. at 323. In doing 6 so, “the court must consider all reasonable inferences to be drawn from the 7 allegations, including inferences unfavorable to the plaintiffs.” Metzler, 540 F.3d 8 at 1061 (emphasis in original). Recently, the Ninth Circuit instructed that courts 9 should conduct a holistic review of the allegations to determine whether they 10 combine to create a strong inference of intentional or deliberate recklessness, 11 while also keeping in mind the individual allegations and the inferences drawn 12 from them. In re VeriFone Holdings, Inc. Sec. Litig., 704 F.3d 694, 703 (9th Cir. 13 2012). Stated another way, courts are to examine individual allegations in order to 14 benchmark whether they are actionable, but also consider the allegations 15 collectively to examine the complaint as a whole. Police Retirement System, 2014 16 WL 3451566 at *4. 17 C. Plaintiff’s Consolidated Amended Complaint 18 Plaintiff is bringing a putative class-action lawsuit, alleging securities fraud 19 on behalf of all persons who purchased or otherwise acquired publically-traded 20 securities of Sterling Financial Corporation between July 23, 2008, and October 21 15, 2009 (the “Class Period”). Plaintiff is suing Sterling Financial Corporation and 22 its top officers for violations of the Securities Exchange Act of 1934 and the U.S. 23 Securities and Exchange Commission Rule 10b-5. 24 Defendant Sterling Financial Corporation is a bank holding company 25 operating through its two main banking subsidiaries—Sterling Savings Bank and 26 Golf Savings Bank. During the Class Period, Sterling Savings Bank was the 27 largest commercial bank headquartered in Washington with over $12 billion of 28 assets and one of the largest regional community banks in the western United ORDER GRANTING DEFENDANTS’ MOTION TO DISMISS CONSOLIDATED AMENDED COMPLAINT ~ 6 1 States. 2 Defendant Harold Gilkey co-founded Sterling and was, at all relevant times, 3 President, CEO, Principal Executive Officer, Chairman of the Board at Sterling, 4 and a director of Sterling Savings Bank. He was also Chairman of the Board and 5 CEO of Golf Savings Bank, and director of Intervest-Mortgage Investment 6 Company, a wholly owned subsidiary of Sterling Savings Bank. 7 Defendant Daniel Byrne joined Sterling in 1983. At all relevant times, he 8 was Sterling’s CFO, Executive Vice President of Finance, and Assistant Secretary. 9 He was also Assistant Secretary of Sterling Savings Bank and Golf Savings Bank 10 during the relevant time period. Mr. Byrne is a Certified Public Accountant. 11 According to Plaintiff, Gilkey and Byrne possessed the power and authority 12 to control the contents of Sterling’s communications to the market, including 13 quarterly and yearly SEC filings, press releases, conference call statements and 14 presentations to securities analysts, portfolio managers, and institutional investors. 15 They were provided with copies of the Company’s reports, press releases and 16 communications alleged to have been misleading prior to their issuance and had 17 the power, control, means, ability and opportunity to prevent their issuance or 18 cause them to be not misleading. 19 On December 13, 2006, federal banking agencies issued the Interagency 20 Policy Statement on the Allowance for Loan and Lease Losses (ALLL). This 21 statement revised the 1993 policy statement on the ALLL to ensure consistency 22 with Generally Accepted Accounting Principles (GAAP). Plaintiff alleges that 23 Defendants failed to follow this statement, and as a result, overstated its earnings 24 and capital during the Class Period. 25 Between 2007 and 2009, the levels of adversely classified and 26 nonperforming construction loans held by Sterling Financial Corporation 27 increased as the residential real estate market was in the midst of an unprecedented 28 and rapid decline. During the Class Period, Sterling Financial Corporation filed ORDER GRANTING DEFENDANTS’ MOTION TO DISMISS CONSOLIDATED AMENDED COMPLAINT ~ 7 1 ten quarterly (10-Q) reports with the SEC and also issued press releases that 2 summarized the reports. Notably, during this time, the allowance for credit losses 2 3 increased from $168.7 million in 2Q08 to $355.4 million in 4Q09. Non- 4 performing assets increased from $303.4 million in 2Q08 to $987.4 million in 5 4Q09. Non-performing construction loans increased from $240.9 million in 2Q08 6 to $682.7 million in 4Q09. 7 In October, 2008, the Federal Deposit Insurance Corporation (FDIC) and 8 the Washington Department of Financial Institution (WDFI) conducted a joint 9 safety and soundness exam. According to Plaintiff, during this exam, it was 10 determined that Sterling was improperly including “potential” cash flows from 11 loan guarantors when determining the level of loan losses on collateral-dependent 12 loans. A Report of Examination detailing the findings was mailed to the Sterling 13 Financial Corporation Board on January 28, 2009. Following the completion of 14 the joint field visit in June, 2009, the FDIC and WDFI prepared a Notice of 15 Charges, and issued a joint Report of Visitation. 16 On October 12, 2009, the Sterling Financial Corporation Board fired Gilkey 17 and Heidi Stanley, the CEO of Sterling Savings Bank. According to Plaintiff, they 18 were fired because they had concealed from the Board the numerous unsafe and 19 unsound practices discovered by the regulators. On October 15, 2009, Sterling 20 Financial Corporation consented to the issuance of a Cease & Desist Order, which 21 required the bank to cease and desist from engaging in unsafe and unsound 22 banking practices discovered by the FDIC and WDIC. The Cease & Desist Order 23 required Sterling Financial Corporation to implement numerous corrective actions, 24 25 2 The Court adopts the parties’ methodology for referring to fiscal quarters and 26 years. Thus, fiscal quarters are identified as xQyy, with “x” being the quarter and 27 “yy” being the last two digits of the year. For example, 2Q08 represents the second 28 quarter of 2008 and 4Q09 represents the fourth quarter for 2009. ORDER GRANTING DEFENDANTS’ MOTION TO DISMISS CONSOLIDATED AMENDED COMPLAINT ~ 8 1 including: retain management capable of restoring all aspects of the bank to a 2 safe and sound condition 3 assure effective oversight by the Board of Directors 4 increase capital 5 cease paying dividends 6 review and revise ALLL and ALLL policy 7 plan to reduce nonperforming assets (NFA) 8 adopt and implement policy prohibiting loans to problem borrowers 9 develop and adopt a plan to reduce commercial real estate loans 10 develop a strategic plan to improve profitability and risk.3 11 12 Press releases issued by Sterling Financial Corporation immediately prior to 13 and during the Class Period included the following statements attributed to 14 Gilkey: 15 16 17 18 19 20 21 22 July 22, 2008 Early in this credit cycle, we implemented stringent measures to address softening credit quality. During the last three quarters, our credit team has generally identified, quantified and isolated the distressed assets, which primarily reside in our residential construction portfolio. Our credit department has also intensified its efforts toward credit resolution and we expect that it will take several quarters to resolve the issues related to non-perfoming assets. We are encouraged by the results we are seeing. We, however, remain cautious as parts of the Pacific Northwest continue to see pockets of credit deterioration. 23 24 25 3On September 27, 2010, the FDIC and the WDFI terminated the Cease and Desist 26 Order after Sterling Financial Corporation improved regulator relations, raised 27 additional capital, enhanced governance, transformed the bank’s culture and 28 operations, and complied with the requirements of the Cease and Desist Order. ORDER GRANTING DEFENDANTS’ MOTION TO DISMISS CONSOLIDATED AMENDED COMPLAINT ~ 9 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 October 21, 2008 Sterling’s results reflect some dislocations in the Pacific Northwest economy caused by a variety of factors, including global disruptions to the financial system and the Boeing union strike. These events created a slowdown in the sale of residential product and thereby affected our borrowers and elevated our credit costs. The Pacific Northwest is insulated, but not isolated, from the broader economy. Still, the Pacific Northwest remains relatively strong. Operationally, Sterling’s execution was solid. We slightly reduced the size of our balance sheet while shifting our mix of assets away from residential construction. We grew our deposits. We controlled operating costs. Our liquidity and capital positions remained strong. Our credit administration team proactively managed loan portfolio risk. In sum, we are managing through a difficult credit cycle while maintaining a safe, sound and secure banking practice. January 27, 2009 During the fourth quarter of 2008, we witnessed acceleration in the slowdown of the economy, which caused higher levels of credit stress among our borrowers and an elevation in the level of both our nonperforming and classified assets. We, therefore, modified our approach in determining the fair market value of loans identified as impaired. The weakening economy, the increased charge-offs and declines in real estate appraisal values led to the higher level of credit provisioning in the quarter. 18 19 20 21 22 23 24 25 26 27 28 Additionally, the January 27, 2009 Press release included the following language: Sterling has been proactively addressing credit quality issues within its construction portfolios. During the fourth quarter of 2007, Sterling made a strategic decision to reduce its level of residential construction commitments. During the first quarter of 2008, Sterling activated a Residential Construction Special Project Team to identify, manage and resolve credit quality issues. During the third quarter of 2008, Sterling separated its credit administration team into two dedicated teams: one to fix, repair and manage construction assets; and, the other to focus on generating strategic business and consumer assets. “Throughout the year, Sterling’s bankers have been working in partnership with our borrowers to help avoid credit defaults and protect the bank from losses. Because of our efforts at early ORDER GRANTING DEFENDANTS’ MOTION TO DISMISS CONSOLIDATED AMENDED COMPLAINT ~ 10 1 2 3 4 5 6 7 8 9 10 11 12 13 14 intervention and remediation, we believe our level of classified assets continues to be manageable and will eventually lead to beneficial resolutions,” stated Mr. Gilkey. Sterling modified its methodology in determining the fair value of loans being tested for impairment during the quarter. The fair value is now determined excluding the potential cash flows from certain guarantors. To the extent that these guarantors are able to provide a viable source of repayment, a recovery would be recorded upon receipt. In addition to the higher provisions during the quarter, in many cases, Sterling re-assessed the accounting for real estate loans treated as collateral dependent. As a result, Sterling now considers any impairment on a collateral-dependent loan to be a confirmed loss and charges off the impairment amount when the impairment is identified, rather than establishing a specific allowance on impaired collateraldependent loans that would have been charged off when foreclosure was probable. As a result of this change, the allowance for specific impairment was reduced by approximately $163.9 million and is not reflected as part of net charge-offs. 15 16 17 18 19 20 21 July 23, 2009 . . . “Throughout this credit cycle, Sterling has acted proactively to maintain health capital ratios and a strong liquidity position. Our commitment is to continue maintaining a safe, sound and secure banking practice for the benefit of customers, shareholders and employees, said Mr. Gilkey. Plaintiff obtained pleadings and internal company documents filed by 22 Sterling in borrower bankruptcy proceedings and in numerous lawsuits Sterling 23 filed against delinquent borrowers. According to Plaintiff, these documents 24 establish that Sterling was underreporting the level of nonperforming construction 25 loans and losses in 2Q08 and 3Q08, and that Sterling made loans to borrowers 26 when they had defaulted on other loans. 27 /// /// 28 /// ORDER GRANTING DEFENDANTS’ MOTION TO DISMISS CONSOLIDATED AMENDED COMPLAINT ~ 11 During the Class Period, the price of Defendants’ stock fell 80% from the 1 2 start of the period to the end of the period, and fell 92% from the highest price 3 during the class period. Although Plaintiff’s Amended Consolidated Complaint is 133 pages, 4 5 Plaintiff’s claims can be consolidated into two theories: (1) Defendants made materially false and misleading representations when 6 7 they assured investors that Sterling was maintaining safe, sound and secure 8 banking practices because the evidence demonstrates that it was not doing that; 9 and 10 (2) Defendants made materially false and misleading representations that 11 they were accurately reporting its financial results because the evidence 12 demonstrates that Sterling was not properly classifying assets (identifying them as 13 problem loans), not recording adequate loan loss provisions and charge-offs, and 14 not maintaining an adequate ALLL (Allowance for Loan and Lease Losses). ECF 15 No. 103. 16 The CAC identifies those actions by Defendants that Plaintiff characterizes 4 17 as “unsafe and unsound” banking practices. Plaintiff’s theory is that if Defendants 18 19 4 The CAC identified the following unsafe and unsound practices: (1) including 20 “potential” cash flows from loan guarantors when determining the level of loan 21 losses on collateral-dependent loans; (2) giving unsecured loans to construction 22 loan borrowers so they could make payments on the construction loans; (3) 23 making loans to borrowers when they had defaulted on other loans; (4) failing to 24 maintain an adequate ALLL; and (5) failing to obtain updated appraisals or 25 valuations. It also alleges Defendants falsely represented that Sterling had 26 implemented stringent measures, i.e. had identified problem assets in the 27 construction loan portfolio; made false and misleading statements about the 28 reasons for the unexpected loan loss and goodwill impairment charge; falsely ORDER GRANTING DEFENDANTS’ MOTION TO DISMISS CONSOLIDATED AMENDED COMPLAINT ~ 12 1 promised Sterling was engaging in safe, sound, and secure banking practices and it 2 was not, then Defendants made material misrepresentations to its investors. 3 D. Analysis 4 Securities regulation serves many useful purposes, including: (1) to insure 5 the maintenance of fair and honest markets, 15 U.S.C. § 78b; Basic Inc. v. 6 Levinson, 485 U.S. 224, 230 (1988); (2) to provide investors with full disclosure 7 of material information concerning public offerings of securities in commerce, 8 Ernst & Ernst v. Hochfelder, 425 U.S. 185, 195 (1976); (3) to protect investors 9 against fraud, id.; and (4) to promote ethical standards of honesty and fair dealing, 10 id. However, the Securities Act of 1932 does not serve to provide investors with 11 broad insurance against market losses. Dura Pharm., Inc. v. Broudo, 544 U.S. 336, 12 344 (2005); see also Basic, 485 U.S. at 353 (White, J.) (cautioning against 13 allowing a Rule 10b-5 action to be converted into a scheme of investor’s 14 insurance). That said, the Court is cognizant that it must balance the purposes of 15 the Securities Act against the purpose of the heightened pleading requirements as 16 set out in the Private Securities Litigation Reform Act, which is to protect 17 defendants from the cost of discovery and trial in unmeritorious cases. See Tellabs, 18 Inc., 551 U.S. at 336 (J. Stevens, dissenting) (“The basic purpose of the 19 heightened pleading requirements in the context of securities fraud litigation is to 20 protect defendants from the costs of discovery and trial in unmeritorious cases.”). 21 Also, during the Class Period, the Court notes that the United States, and 22 indeed the world, was experiencing a global recession, rising unemployment, 23 widespread layoffs, bankruptcies, and foreclosures—all significant economic and 24 social circumstances that could contribute to lower stock prices. See Dura, 544 25 U.S. at 343 (“When the purchaser subsequently resells such shares, even at a lower 26 27 represented considerable slowdown in the growth rate of classified assets and 28 falsely represented that the level of classified assets had stabilized. ORDER GRANTING DEFENDANTS’ MOTION TO DISMISS CONSOLIDATED AMENDED COMPLAINT ~ 13 1 price, that lower price may reflect, not the earlier misrepresentations, but changed 2 economic circumstances, changed investor expectations, new industry-specific or 3 firm-specific facts, conditions, or other events, which taken separately or together 4 account for some or all of that lower price.”). 5 These considerations provide the lens through which the Court addresses 6 Defendants’ Motion to Dismiss. 7 1. Scienter 8 Plaintiff’s claims are based upon statements made by Defendants Gilkey and 9 Byrne and in the official filings signed by these individuals. They attempt to 10 satisfy the pleading requirement regarding corporate scienter with evidence Gilkey 11 and Byrne had the necessary mental state. 12 Here, Plaintiff has not met its burden of adequately pleading scienter. 13 Plaintiff faces a high hurdle in attempting to do so in this case in light of the fact 14 that Sterling’s independent auditors consistently provided unqualified opinions 15 regarding Sterling’s financial reports, and the FDIC never required it to restate any 16 of its financials, despite the issuance of the cease and desist order, and the FDIC’s 17 unilateral power to force companies to restate inaccurate financials. See 12 U.S.C. 18 § 1818(b); see also Nolte v. Capital One Fin. Corp., 390 F.3d 311, 316 (4th Cir. 19 2004) (“Had Federal Regulators determined that Capital One’s past practices were 20 deficient, they could have applied corrective measures retroactively and forced the 21 company to restate its earnings to reflect retroactive adjustments.”) 22 Generally, allegations of scienter based on GAAP violations do not create 23 the requisite strong inference of scienter unless Plaintiff’s complaint alleges more. 24 Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1426 (9th Cir. 1994). In the Ninth 25 Circuit, plaintiffs must plead particular facts showing that “the accounting 26 practices were so deficient that the audit amounted to no audit at all, or an 27 egregious refusal to see the obvious, or to investigate the doubtful, or that the 28 accounting judgments which were made were such that no reasonable accountant ORDER GRANTING DEFENDANTS’ MOTION TO DISMISS CONSOLIDATED AMENDED COMPLAINT ~ 14 1 would have made the same decisions if confronted with the same facts.” DSAM 2 Global Value Fund v. Altris Software, Inc., 288 F.3d 385, 390 (9th Cir. 2002) 3 (citation omitted). “[M]ere allegations that an accountant negligently failed to 4 closely review files or follow GAAP cannot raise a strong inference of scienter.” 5 Id. 6 Plaintiff primarily relies on the testimony of Confidential Witness 4 (CW4) 7 to support its allegations of scienter. A complaint relying upon statements from 8 confidential witnesses must pass two hurdles to satisfy the PSLRA pleading 9 requirements. Zucco, 552 F.3d at 995. First, the confidential witnesses must be 10 “described with sufficient particularity to establish their reliability and personal 11 knowledge. Id. Second, the statements themselves must be “indicative of scienter.” 12 Id. 13 CW4 was an executive at Sterling throughout the Class Period until he/she 14 left the company in 2010. CW4’s responsibilities included general financial 15 management, including financial reporting. The CAC attributes the following facts 16 to CW 4: 17 (a) During the 2008 and 2009 field visit, the FDIC determined the bank was 18 not properly classifying loans; 19 (b) During the 2008 examination, the FDIC discovered and directed the 20 bank to discontinue the unsafe and unsound practice of making unsecured loans to 21 construction loan borrowers that were used to make payments on their loans; 22 (c) During the 2008 examination, the regulators informed Sterling that 23 including potential cash flows from construction loan guarantors was contrary to 24 regulatory and accounting guidance; 25 (d) Gilkey insisted on setting the level of loan loss provisions in the 2008 26 budget to 40 million dollars; 27 /// /// 28 /// ORDER GRANTING DEFENDANTS’ MOTION TO DISMISS CONSOLIDATED AMENDED COMPLAINT ~ 15 1 (e) CW4 heard from other bank personnel that the Board of Directors fired 2 Gilkey and Stanley because they were surprised by the Cease and Desist Order and 3 the findings of the regulators during the 2008 examination and 2009 field visit; 4 (f) Gilkey stated that the bank needed to hit certain numbers so it could 5 obtain capital through Troubled Asset Relief Program (“TARP”); 6 (g) Gilkey overruled other bank executives by continuing to originate 7 “higher risk construction loans in 2007,” which contributed to the increase in 8 classification and loan losses in 2008; 9 (h) Sterling made unsecured loans to Patrick McCourt, a real estate 10 developer; 11 (i) regulators downgraded many of the bank’s internal classifications; and 12 (j) Sterling approved loans that exceeded loan-to-value ratios. 13 CW4’s testimony does not meet the Zucco requirements because the 14 testimony fails to establish CW4’s personal knowledge and reliability, and also 15 fails to be indicative of scienter. CW4 does not claim to have communicated 16 directly with Gilkey or Byrne. Many of CW4’s allegations rely on multiple levels 17 of hearsay and speculation. He/she does not identify a single email, date, author, 18 recipient, or specific content of any communication. CW4 does not identify any 19 specific examples of downgrades or loans exceeding ratios. CW4 does not report 20 any statements made by the individual defendants that suggest that they knew 21 Sterling was not operating in a safe and sound manner, or that it was falsely 22 reporting its financials. At most, CW4’s testimony may indicate possible motive 23 and opportunity, but it does not rise to the level of demonstrating intent. See 24 Reese, 747 F.3d at 569 (“Facts showing mere recklessness or a motive to commit 25 fraud and opportunity to do so provide some reasonable inference of intent, but are 26 not independently sufficient.”). Without more, CW4’s testimony is not indicative 27 of scienter. It does not establish that Gilkey or Byrne made false or misleading 28 statements either knowingly, intentionally or with deliberate recklessness. CW4’s ORDER GRANTING DEFENDANTS’ MOTION TO DISMISS CONSOLIDATED AMENDED COMPLAINT ~ 16 1 testimony suggests that a healthy and robust internal debate took place at Sterling. 2 This is expected, particularly during a time of unprecedented economic 3 uncertainty. 4 The facts of the case actually negate any inference of scienter. It is 5 undisputed that Defendants Gilkey or Byrne did not trade a single share of stock to 6 capitalize on the alleged artificial inflation. Defendants held on to their stock at a 7 time when it is alleged they were fraudulently inflating the stock, and as a result, 8 they too experienced a significant loss in their stock value. Similarly, Defendants 9 Gilkey and Byrne received less in compensation during the Class Period than they 10 received before the Class Period. In fact, Gilkey declined a salary increase when it 11 was offered to him. Moreover, Plaintiff has not alleged or identified any 12 contemporaneous information or documents that conflicted with Defendants’ 13 public representations. 14 The Court has reviewed Plaintiff’s allegations holistically, and the 15 allegations do not create an inference of scienter that is nearly as compelling as the 16 far more likely alternative inference, namely that Defendants underestimated the 17 risk in their loan portfolios and failed to timely appreciate the near melt-down of 18 the construction, real estate, and financial markets. Plaintiff’s allegations suggest 19 that Defendants may have exercised poor business judgment, but not that they 20 engaged in fraud. Plaintiff’s allegations, reviewed collectively still do not evince 21 such fraudulent intent or deliberate recklessness as to make the inference of 22 scienter cogent. 23 2. Misrepresentations of Operating in Safe and Sound Manner 24 Plaintiff alleges Defendants falsely represented that Sterling was operating 25 in a safe and sound manner. Plaintiff contends that Defendants were doing the 26 27 28 ORDER GRANTING DEFENDANTS’ MOTION TO DISMISS CONSOLIDATED AMENDED COMPLAINT ~ 17 5 1 opposite, namely operating in an unsafe and unsound manner. 2 Statements of mere corporate puffery, “vague statements of optimism like 3 ‘good,’ ‘well-regarded,’ or other feel good monikers,” are not actionable because 4 “professional investors, and most amateur investors as well, know how to devalue 5 the optimism of corporate executives.” In re Cutera Sec. Litig., 610 F.3d 1103, 6 1111 (9th Cir. 2010); Glen Holly Ent., Inc. v. Tektronix, Inc., 352 F.3d 367, 379 7 (9th Cir. 2003) (finding no liability where the alleged misstatements “were 8 generalized, vague and unspecific assertions, constituting mere puffery upon 9 which a reasonable consumer could not rely.”). Statements that lack a standard 10 against which a reasonable investor could expect them to be pegged are puffery. 11 See In re Wet Seal Inc. Sec. Litig., 518 F.Supp.2d 1148 (C.D. Calif. 2007). 12 Judge Shea found that the term “safe and sound” constitutes immaterial 13 corporate puffery, and was not an actionable term in a securities fraud claim. 14 Judge Shea also found that the statements in the Cease and Desist Order, i.e. that it 15 had reason to believe Sterling was operating in an unsafe and unsound manner, did 16 not provide support for Plaintiff’s claim. The Court adopts Judge Shea’s 17 reasoning. 18 In addition, the Court finds that the term, “safe and sound banking 19 practices” does not have a specific and formal regulatory and definitional 20 21 22 5In its CAC, Plaintiff identifies the following unsafe and unsound practices: (1) 23 improperly including “potential’ cash flows from loan guarantors when 24 determining the level of loan losses on collateral-dependent loans; (2) giving 25 unsecured loans to construction loan borrowers so they could make payments on 26 the construction loans; (3) making loans to borrowers when they had defaulted on 27 other loans; (4) failing to maintain an adequate ALLL; and (5) failing to obtain 28 updated appraisals or valuations. ORDER GRANTING DEFENDANTS’ MOTION TO DISMISS CONSOLIDATED AMENDED COMPLAINT ~ 18 1 meaning, notwithstanding the CAC’s citation to various banking regulations, SEC 2 rules and regulations, and GAAP. Notably, the FDIC Manual states the following: 3 4 5 6 7 8 The concept of unsafe or unsound practices is one of general application which touches upon the entire field of operations of a banking institution. It would, therefore, be virtually impossible to catalog with a single all-inclusive or rigid definition, the broad spectrum of activities which are included by that term. Thus, an activity not necessarily unsafe or unsound in every instance may be so in a particular instance when considered in light of all relevant facts pertaining to that situation. 9 ECF No. 116, Ex. 18 at 269. 10 Further, the Court finds that the term “safe and sound” is too general and 11 would not cause investors to rely upon it. If this generalized statement could 12 provide the basis for a securities fraud claim, the heightened requirements set out 13 in the PSLRA would be meaningless. Additionally, Defendants’ use of the phrase 14 “safe and sound” practices was not unreasonable or reckless. Defendants’ use of 15 the phrase was not an extreme departure from the standards of ordinary care and 16 did not present a danger of misleading buyers or sellers. 17 Moreover, Defendants’ positive statements, such as “Sterling implemented 18 stringent measures to address softening credit quality;” “took a conservative 19 approach towards risk evaluation;” “accelerated loans going into nonperforming 20 status” whenever there were “indications of concern;” and Defendants’ credit 21 administration team was proactively managing portfolio risk” are not more than 22 puffery that does not give rise to any securities fraud violations. See ECA, Local 23 134 IBEW Joint Pension Trust of Chicago v. JP Morgan Chase Co., 553 F.3d 187, 24 205 (2nd Cir. 2009) (holding that the following statements were too general to 25 cause a reasonable investor to rely upon them: statements regarding “highly 26 disciplined risk management” and “standard-setting reputation for integrity.”). The 27 Second Circuit noted that no investor would take such statements seriously in 28 ORDER GRANTING DEFENDANTS’ MOTION TO DISMISS CONSOLIDATED AMENDED COMPLAINT ~ 19 1 assessing a potential investment because almost every investment bank made these 2 statements. Id. (“Finding the JPMC’s statements constitute a material 3 misrepresentation would bring within the sweep of federal securities laws many 4 routine representations made by investment institutions. We decline to broaden the 5 scope of securities laws in that manner.”). Similarly, Defendants’ statements that 6 its credit practices were stringent, conservative, and disciplined are generalizations 7 regarding its business practices, and thus, are not actionable. 8 Consequently, Plaintiff’s reliance on the terms “safe and sound” to anchor 9 its claim that Defendants made materially false and misleading representations 10 fails to meet the materiality requirements of the PSLRA. 3. Misrepresentations about Sterling Financial Corporation’s 11 Financial Results 12 Plaintiff asserts that, during the Class Period, Defendants falsely represented 13 that Sterling was accurately reporting its financial results. Plaintiff contends 14 Defendants failed to accurately classify assets, thereby underreporting the level of 15 nonperforming construction loans and loan losses. 16 A general allegation that the practices at issue resulted in a false report of 17 company earnings is not a sufficiently particular claim of misrepresentation. In re 18 Daou Sys., Inc., 411 F.3d 1006, 1016 (9th Cir. 2005) (quoting Greebel v. FTP 19 Software, Inc., 194 F.3d 185, 203 (1st Cir. 1999)). “To properly state a claim for 20 account fraud, plaintiffs must plead facts sufficient to support a conclusion that 21 defendant prepared the fraudulent financial statements and the alleged financial 22 fraud was material.” Id. When pleading irregularities in revenue recognition, the 23 plaintiffs must plead (1) basic details as the approximate amount by which 24 revenues and earnings were overstated; (2) the products involved in the contingent 25 transaction; (3) the dates of any of the transactions; or (4) the identities of any of 26 the customers or company employees involved in the transactions. Id. Ultimately, 27 the Court must discern whether the alleged violations were minor or technical in 28 ORDER GRANTING DEFENDANTS’ MOTION TO DISMISS CONSOLIDATED AMENDED COMPLAINT ~ 20 1 nature, or whether they constituted widespread and significant inflation of 2 revenue. Id. The plaintiff must show with particularity how the adjustments 3 affected the company’s financial statements and whether they were material in 4 light of the company’s overall financial position. Id. Plaintiff has not met its burden to provide sufficient details of the alleged 5 6 fraudulent financial statements. Moreover, the failure of any agency to require 7 Sterling to restate its financials, the failure of the Cease and Desist Order to 8 specifically address any of the alleged accounting errors/misrepresentations, and 9 the fact that Plaintiff has not alleged that any external auditors counseled against 10 Sterling’s accounting practices weigh against Plaintiff’s allegations of accounting 11 fraud. 12 Plaintiff’s calculations using missed payments to demonstrate the reported 13 amount of underperforming loans was understated does not take into account the 14 fact that the schedule of principal payments changes throughout the course of the 15 year. Thus, its calculations do not provide support for its claim of accounting 16 fraud. Similarly, Plaintiff’s calculations using the bankruptcy pleadings fails to 17 take into consideration what portion of the $170.9 million of nonperforming 18 construction loans became nonperforming in 2Q08 and in 3Q08; fails to 19 distinguish between loans to construction companies and construction loans, fails 20 to plead the maturity dates for some of the loans, and erroneously includes 21 interest, fees, and other charges in the total amount of the loans. Plaintiff’s use of 22 the loan amounts gleaned from the bankruptcy proceedings is speculative. 23 In short, Plaintiff has failed to allege that the statements made by 24 Defendants were misleading. Nothing in the quarterly statements was intended to 25 give a reasonable investor an impression of a state of affairs that differed in a 26 material way from the one that actually existed. See In re Cutera Sec. Litig., 610 27 F.3d at 1108. Plaintiff’s speculative approach in alleging that Defendants falsely 28 ORDER GRANTING DEFENDANTS’ MOTION TO DISMISS CONSOLIDATED AMENDED COMPLAINT ~ 21 1 represented that Sterling’s financial reporting was accurate fails the particularity 2 requirements of the PSLRA. 3 4. Fraud by Hindsight 4 Case law makes clear that a plaintiff may not plead “fraud by hindsight,” i.e. 5 a complaint may not simply contrast a defendant’s past optimism with less 6 favorable actual results. See In re Vantive Corp. Sec. Litig., 283 F.3d 1079, 10847 85 (9th Cir. 2002) abrogated on other grounds by South Ferry LP, No.2 v. 8 Killinger, 542 F.3d 776, 784 (9th Cir. 2008) (“The purpose of this heightened 9 pleading requirement was generally to eliminate abusive securities litigation and 10 particularly to put an end to the practice of pleading “fraud by hindsight.”). 11 Although Plaintiff’s complaint contains additional allegations to 12 demonstrate unsafe and unsound practices and fraudulent financial reporting, such 13 as unwise lending practices, overstatement of goodwill in 2Q08 and 3Q08, false 14 and misleading statements about the reasons for the unexpected loan losses and 15 goodwill impairment, failing to maintain an adequate ALLL, and failing to obtain 16 updated appraisals or valuations, these allegations reflect an in-hindsight 17 assessment of Defendants’ performance and conduct during a time of 18 unprecedented global economic collapse. These allegations do not meet the 19 pleading requirements of the PSLRA. See Novak v. Kasaks, 216 F.3d 300, 309 20 (2nd Cir. 2000) (“[A]llegations that defendants should have anticipated future 21 events and made certain disclosures earlier than they actually did do not suffice to 22 make out a claim of securities fraud.”). Without specific allegations that 23 Defendants either knew or recklessly disregarded the falsity of its own statements 24 at the time the statements were made, the fact that the statements later turned out 25 to be false is irrelevant to a cause of action under the PSLRA. 26 It is worth noting at this point that Defendants’ public statements 27 immediately before and during the Class Period were not exclusively positive or 28 optimistic. Defendants consistently recognized that the economy was in turmoil ORDER GRANTING DEFENDANTS’ MOTION TO DISMISS CONSOLIDATED AMENDED COMPLAINT ~ 22 1 and that Sterling was struggling to identify and properly value troubled assets. 2 Defendants were exercising legitimate business judgment in a transparent manner. 3 The fact that some of these decisions and judgments proved later to be wrong is 4 not actionable. 5 5. Section 20(a) Claim 6 Because Plaintiff has failed to adequately plead a primary violation of 7 section 10(b) of the Securities Exchange Act of 1934, Plaintiff’s section 20(a) 8 claim is summarily dismissed. See Zucco Partners, LLC, 552 F.3d at 990. 6. 9 Leave to Amend Fed. R.Civ. P. 15 instructs the Court to freely give leave to amend 10 11 when justice so requires. However, “where the plaintiff has previously been 12 granted leave to amend and has subsequently failed to add the requisite 13 particularity to its claims, the district court’s discretion to deny leave to 14 amend is particularly broad.” Zucco Partners, LLC, 552 F.3d at 1007. Here, Plaintiff’s underlying premise in its original consolidated complaint 15 16 and its amended consolidated complaint is that Defendants engaged in unsafe and 17 unsound banking practices, and investors were misled when Gilkey reassured 18 them Sterling was practicing safe and sound banking practices. The Court has 19 twice found that the use of the term “safe and sound” by Gilkey cannot support a 20 securities fraud claim. Additionally, the Court has twice found that Plaintiff’s 21 allegations regarding its accounting and financial reporting may reflect poor 22 business judgment, but they do not rise to the level of securities fraud. Plaintiff has 23 essentially re-plead the same legal theories with some additional facts that do not 24 change the outcome of the case. Consequently, the Court finds that granting 25 Plaintiff’s leave to amend would be futile and would result in undue prejudice to 26 Defendants as this litigation has been pending for over five years. Plaintiff’s request for leave to amend is denied. 27 28 /// ORDER GRANTING DEFENDANTS’ MOTION TO DISMISS CONSOLIDATED AMENDED COMPLAINT ~ 23 1 Accordingly, IT IS HEREBY ORDERED: 2 1. Defendants’ Request for Judicial Notice and Notice of Incorporation, 3 ECF No. 119, is GRANTED, in part, and DENIED, in part. 4 2. Defendants’ Supplemental Request for Judicial Notice and Notice of 5 Incorporation by Reference, ECF No. 126, is GRANTED, in part, and DENIED, 6 in part. 7 3. Defendants’ Motion to Dismiss Consolidated Amended Complaint for 8 Violation of the Federal Securities Laws, ECF No. 113, is GRANTED. 9 10 4. The above-captioned case is dismissed, with prejudice. IT IS SO ORDERED. The District Court Executive is hereby directed to 11 file this Order, provide copies to counsel, and close the file. 12 DATED this 17th day of September, 2014. 13 14 15 16 17 18 19 Stanley A. Bastian United States District Judge 20 21 22 23 24 25 26 27 28 ORDER GRANTING DEFENDANTS’ MOTION TO DISMISS CONSOLIDATED AMENDED COMPLAINT ~ 24

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