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From Securities Regulation Daily, March 28, 2013

Fraud Case Against Deutsche Bank, Three of Four Executives Goes On

By Mark S. Nelson, J.D.

The federal court in Manhattan has ruled that a complaint alleging a fraudulent scheme and misstatements or omissions by Deutsche Bank and three of its executives may proceed. The case arose from Deutsche Bank’s alleged scheme to inflate the bank’s share price in the run-up to the recent financial crisis by originating and repackaging residential mortgages into RMBS and CDO portfolios whose interests could be sold to investors while simultaneously taking a short position betting against these portfolios. The fraud claims, including controlling person claims, may proceed against Deutsche Bank and its executives Josef Ackermann (CEO), Anthony Di Iorio (CFO), and Hugo Banziger (CRO), but not Clemens Borsig (IBEW Local 90 Pension Fund. v. Deutsche Bank AG, March 27, 2013, Forrest, K.).

Claims against bank. The court found that the complaint adequately alleged fraudulent scheme liability against Deutsche Bank. The court said the complaint contained specific allegations that Deutsche Bank used the RMBS/CDO offerings to inflate its stock price. The court also noted that the alleged scheme involved material bank operations.

The court also found that the plaintiffs adequately alleged scienter. The court said the complaint alleged many instances where top bank executives knew the true risk profile of assets underlying the RMBS/CDO instruments. Specifically, the plaintiffs alleged that bank executives queried internal experts about the underlying assets and received presentations about portfolio risk. These exchanges contradicted the bank’s public statements about its allegedly conservative risk profile.

Said the court, "At the very least, the fact that information existed and was presented disproving the validity of the public statements made by Deutsche Bank supports plausible allegations of recklessness."

The court, however, rejected the bank’s claim that its alleged misstatements and omissions were non-actionable opinion. Here, the court said that the bank publicly stated that it had a conservative risk profile at the inception of the recent financial crisis. But these public statements differ from the bank’s internal understanding of the risk inherent in its RMBS/CDO portfolios. In distinguishing the Second Circuit’s opinions in City of Omaha and Fait, the court said the complaint adequately alleged objective and subjective falsity.

Executives. The court examined the allegations against each defendant separately and found the complaint adequately pleaded fraud against three of four named Deutsche Bank executives. The court first found that Mr. Ackermann, Mr. Di Iorio, and Mr. Banziger were alleged to have made statements about the risk profile of Deutsche Bank’s RMBS/CDO portfolio. However, Mr. Borsig made no statements.

The court next found that misstatements by Mr. Ackermann, Mr. Di Iorio, and Mr. Banziger sufficiently alleged fraudulent scheme liability against them. All three executives allegedly sat on Deutsche Bank’s management board and on the bank’s group executive committee. The complaint also alleged that the person responsible for executing the short position sought approval for the strategy in meetings with group executive committee members.

But the court said scheme liability would not apply to Mr. Borsig, who made no actionable statements, because the complaint’s scheme allegations against him were not specific enough. The court similarly rejected the plaintiff’s effort to hold Borsig liable for generic statements made by the bank’s supervisory board (Borsig was chairman) that appeared in the bank’s Form 20-F.

The complaint also sufficiently alleged scienter against Mr. Ackermann, Mr. Di Iorio, and Mr. Banziger, but not Mr. Borsig. The court said the plaintiffs’ allegations sufficiently showed that the three remaining executives were privy to internal information, some of it from those executing the short position, that the underlying mortgages were riskier than had been publicly disclosed. The court said these executives’ statements demonstrated a strong inference of scienter because they were objectively false. The court also said the statements were subjectively false because they had been made with knowledge or recklessness as to their truth.

Lastly, the court found that the plaintiffs adequately alleged causation. Here, the court noted statements in the complaint citing Deutsche Bank’s 2008 annual report’s explanation of RMBS mark-downs. The complaint also alleged that $4.5 billion in Deutsche Bank RMBS losses in 2007 and 2008 pushed the bank’s stock price down 86 percent. The court said these allegations sufficiently notified the executives of the causal connection between their alleged fraud and the plaintiffs’ economic loss.

Controlling persons. The court found that controlling person claims under Exchange Act Section 20(a) may proceed against Mr. Ackermann, Mr. Di Iorio, and Mr. Banziger, but not Mr. Borsig. In addition to allegations that support primary liability, these executives held key positions at Deutsche Bank, and many specific allegations detailed their direct participation in the alleged scheme and misstatements as well as their participation in management groups alleged to have also participated in the scheme.

The case is No. 11 Civ. 4209 (KBF).

Attorneys: Samuel Howard Rudman (Robbins Geller Rudman & Dowd, LLC) for IBEW Local 90 Pension Fund, Building Trades United Pension Trust Fund, and Steward Global Equity Income Fund and the Steward International Enhanced Index Fund. Charles Alan Gilman (Cahill Gordon & Reindel LLP) for Deutsche Bank AG, Josef Ackermann, Hugo Banziger, Anthony Di Iorio and Clemens Borsig

Companies: IBEW Local 90 Pension Fund, Building Trades United Pension Trust Fund; Steward Global Equity Income Fund and the Steward International Enhanced Index Fund; Deutsche Bank AG

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