Eastern District of Washington Reaffirms Strict Securities Fraud Pleading Requirements
In Roseville Employees Retirement System v. Sterling Financial. Corp., 2014 BL 257904 (E.D. Wash. Sept. 17, 2014), the United States District Court for the Eastern District of Washington dismissed a securities fraud complaint filed by the City of Roseville Employees' Retirement System (“Plaintiff”) against Sterling Financial Corporation, CEO Harold Gilkey, and CFO Daniel Byrne, (collectively, the “Defendants”).
According to the complaint, Sterling Financial Corporation was a bank holding company with two subsidiaries, Sterling Savings Bank and Golf Savings Bank (collectively, “Sterling”). From 2008 to 2009, Sterling’s allowance for credit losses increased by $186.7 million, non-performing assets increased by $684 million, and Sterling’s non-performing construction loans increased by $441.8 million.
In October, 2008, the Federal Deposit Insurance Corporation (“FDIC”) and the Washington Department of Financial Institutions (“WDFI”) found that Sterling improperly calculated losses on certain loans. The Board of Sterling received a “Report of Examination” that contained the findings. In June 2009, the FDIC and WDFI “prepared a Notice of Charges, and issued a joint Report of Visitation.” According to the complaint, the Board “fired” the CEO and CFO four months later.
The complaint alleged securities fraud on the theory that Sterling’s financial statements were inaccurate and the Defendants made “materially false and misleading” assurances between 2008 and 2009 describing Sterling as “maintaining safe, sound and secure banking practices.”
The Private Securities Litigation Reform Act (“PSLRA”) “requires that the complaint plead with particularity both falsity and scienter.” Scienter is the intent to deceive and must be pled using specific facts that create a strong inference that the defendant made false statements “intentionally or with deliberate recklessness.” To the extent relying on a confidential witness, the complaint must establish the reliability and personal knowledge of statements “indicative of scienter.” Additionally, scienter based on violations of generally accepted accounting practices must show “the accounting practices were so deficient that the audit amounted to no audit at all.”
The court found that the complaint did not meet the PSLRA’s strict pleading standard required to show scienter. The statements from Sterling describing the bank as “safe and sound” were non-actionable “corporate puffery” because there was no reasonable standard against which to measure them. Plaintiff also did not adequately establish the reliability or personal knowledge of a confidential witness. And finally, the evidence offered in the complaint was not specific enough show how Sterling’s financial statements were inaccurate.
The court also noted that the defendants Gilkey and Byrne held stock in Sterling without selling during the entire period in question and no regulatory agency ever required Sterling to restate its financials.
For the above reasons, the District Court for the Eastern District of Washington granted the Defendant’s motion to dismiss.
The primary materials for this post are available on the DU Corporate Governance website.