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From Securities Regulation Daily, November 13, 2013

MF Global securities class suit goes on

By Mark S. Nelson, J.D.

A class action suit alleging that MF Global Holdings Limited (MF Global) and its officers, independent directors, and two classes of underwriters violated the antifraud provisions of the federal securities laws can move ahead, said the federal court in Manhattan. The defendants had asked the court to dismiss all 14 counts against them (In Re MF Global Holdings Limited Securities Litigation, November 12, 2013, Marrero, V.).

In its 105-page ruling, the court bemoaned the voluminous filings made by both parties, which it said crimped FRCP Rule 1’s admonition that civil suits ought to be pursued with efficiency. The court said this case was a “unique opportunity” for the parties to chart another course, but “…efficiency was not in the cards.” The court also likened MF Global’s collapse to a “massive train wreck” and said the court had invoked the doctrine of res ipsa loquitur (“someone, somewhere, did something wrong”) to try to focus the parties’ on clarifying the record at the suit’s earliest stages.

Ultimately, the court denied the MF Global defendants’ motions to dismiss all claims. The court noted that despite the MF Global defendants’ contrary arguments, the plaintiffs’ allegations met the standards set by the Supreme Court in Iqbal and Twombly, and that to find otherwise may force others’ pleadings to seek “unattainable heights.” Said the court: “[t]o end this prologue on a higher lyrical note, if on this record as pled Plaintiffs cannot make out a plausible claim here, they could not make it anywhere.”

Background. In October 2011, MF Global allegedly collapsed because of shoddy internal controls that led it to place high-risk bets on foreign investments. MF Global also allegedly lost track of over $1.6 billion during its tailspin.

The class plaintiffs are represented by The Virginia Retirement System and Her Majesty The Queen In Right Of Alberta. According to the complaint, which the court viewed as true in ruling on the MF Global defendants’ motions to dismiss, the plaintiffs bought MF Global securities without knowing of the firm’s internal woes, and that MF Global’s officers, independent directors, and underwriters were aware of these problems.

Specifically, the plaintiffs alleged that MF Global: (1) added tax-deferred assets (DTA) to its balance sheet to boost its profits; (2) invested in risky European sovereign debt without telling investors the size of its portfolio; (3) stayed with the sovereign debt plan despite its own reports faulting its internal controls; (4) ousted its chief risk officer in favor of another one who would eventually ask many of the same questions that allegedly got his predecessor fired; and (4) met its liquidity needs via intra-day transfers among the firm’s accounts.

The MF Global defendants include its former chair and CEO, Jon S. Corzine, and two former CFOs, J. Randy MacDonald and Henri J. Steenkamp (followed MacDonald until the class period ended). The independent director defendants include David P. Bolger, Eileen S. Fusco, David Gelber, Martin J. Glynn, Edward L. Goldberg, David I. Schamis, and Robert S. Sloan.

The underwriter defendants fall into two classes, but they collectively are the Securities Act defendants. One group includes: Citigroup Global Markets Inc., Deutsche Bank Securities Inc., Goldman Sachs & Co., J.P. Morgan Securities LLC, Merrill, Lynch, Pierce, Fenner & Smith Incorporated, RBS Securities Inc. The other group includes MF Global’s senior notes underwriters: BMO Capital Markets Corp., Commerz Markets LLC, Jefferies & Company, Inc., Lebenthal & Co., LLC, Natixis Securities North America Inc., Sandler O'Neill & Partners, L.P., and U. S. Bancorp Investments, Inc.

Particularity met. The court found that the plaintiffs’ Exchange Act claims were pleaded with enough particularity. Corzine had argued both that the complaint had too much detail to meet the “short and plain statement” requirement of FRCP Rule 8(a) and yet fell short of the detail required by FRCP Rule 9(b) and the PSLRA. Here, the court said that complicated suits, like this one, are given “some flexibility,” and that the plaintiffs met the particularity requirement.

The court also rejected the independent directors’ arguments that the plaintiffs had to plead Securities Act violations with particularity because they sounded in fraud. First, the court said that the Second Circuit’s 2013 Freidus ruling lets plaintiffs allege that opinions were subjectively disbelieved when made, but still do not sound in fraud. The independent directors had claimed that the plaintiffs’ Securities Act claims sounded in fraud because of a disclaimer added to the complaint in order to satisfy the Second Circuit’s pleading requirements.

Second, the court rejected the independent directors’ argument that the plaintiffs failed to separate their fraud-based Exchange Act claims from their non-fraud-based Securities Act ones. Here, the court determined that regardless of whether the plaintiffs separated these claims, they had met the higher FRCP Rule 9(b) standard.

Materiality. The court first noted the Second Circuit’s Fait decision left open questions about the difference between opinions and facts. Here, the court sided with the underwriter defendants in finding that the plaintiffs’ allegations about MF Global’s DTAs involved opinions, which means the plaintiffs must allege that the DTA statements were false and not honestly believed when made.

The court, however, found that the plaintiffs had adequately pleaded that the underwriters’ statements about MF Global’s DTAs were both objectively and subjectively false. The court also distinguished cases that dismissed complaints, like this one, that alleged untimely DTA valuation allowances because the plaintiffs in those cases failed to allege falsity. Moreover, the court rejected an argument urged by both sets of underwriters that the plaintiffs’ DTA claims are barred by the “bespeaks caution” doctrine, because MF Global’s DTA disclosures were just boilerplate.

Likewise, the court found the complaint sufficient to allege materially false or misleading statements under both the Securities Act and the Exchange Act regarding MF Global’s repurchase-to-maturity (RTM) strategy. The court found that MF Global’s disclosures belied frequent risk limit breaches, lax risk controls, and were further undermined by officers’ characterization of the firm’s risks as “minimal” or “limited.” Corzine himself allegedly said that the RTM plan lessened MF Global’s risks. The court also rejected the defendants’ bespeaks caution and PSLRA safe harbor arguments about the RTM plan.

Scienter. The plaintiffs met their Exchange Act pleading burden concerning the officer defendants’ scienter. Most of the plaintiffs’ claims focused on recklessness. Here, the court noted allegations that MF Global’s officers did not check the firm’s actual trading behavior and failed to grasp its internal controls issues. The court also rejected claims that insider stock purchases countered the plaintiffs’ scienter allegations. Overall, the court found the plaintiffs had met the Supreme Court’s Tellabs standard.

Securities Act defenses. The court decided that the underwriters could not avail themselves of the reasonable reliance defense at this stage of the suit because, even though the complaint did not explicitly plead “red flags,” it still had enough detail to undercut the underwriters’ reliance claims. The court also found that the plaintiffs sufficiently alleged that they bought securities because of the offering documents. As a result, the court left many details regarding the Securities Act claims to be developed via the discovery process.

The case is No. 1:11-cv-07866-VM.

Attorneys: Christopher J. Keller (Labaton Sucharow, LLP) for Virginia Retirement System. Brian C. Kerr (Brower Piven, a Professional Corp.) for Joseph Deangelis. Arthur Harlod Aufses, III, (Kramer Levin Naftalis & Frankel, LLP) for Bradley I. Abelow. Stuart Jay Baskin (Shearman & Sterling LLP) for Sandler O'Neill & Partners, L.P. and U.S. Bancorp Investments, Inc. James J. Capra, Jr. (King & Spalding LLP) for PricewaterhouseCoopers LLP.

Companies: MF Global Holdings Limited; The Virginia Retirement System; Citigroup Global Markets Inc.; Deutsche Bank Securities Inc.; Goldman Sachs & Co.; J.P. Morgan Securities LLC; Merrill, Lynch, Pierce, Fenner & Smith Incorporated; RBS Securities Inc.; BMO Capital Markets Corp.; Commerz Markets LLC; Jefferies & Company, Inc.; Lebenthal & Co., LLC; Natixis Securities North America Inc.; Sandler O’Neill & Partners, L. P.; U.S. Bancorp Investments, Inc.

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