The opinion of the court was delivered by: JOHN BATES, District Judge
This is an as-yet uncertified class action in which plaintiffs
Monica Belizan and Dr. William Prather ("Belizan" and "Prather,"
or "plaintiffs") assert a variety of securities law claims
relating to their investments in Interbank Funding Corporation
("IBF"). Between 1997 and 2002, IBF and its subsidiaries issued
debt securities in several investment funds totaling $195
million. Plaintiffs claim that the funds amounted to a Ponzi
scheme: proceeds from later fund offerings were allegedly used to
make interest payments to earlier investors.
The case comes before the Court on motions to dismiss by
defendants CIBC World Markets Corp. ("CIBC"), a brokerage firm
that sold some IBF securities, and Radin, Glass & Co., LLP
("Radin"), IBF's auditor. Plaintiffs contend that CIBC and Radin
violated Section 10(b) of the Securities Exchange Act of 1934
(the "Exchange Act"), 15 U.S.C. § 78j(b) ("Section 10(b)"), and
Exchange Act Rule 10b-5, 17 C.F.R. § 240.10b-5, by willingly
participating in the promulgation of misleading disclosures
regarding the funds. Additionally, plaintiffs contend that
Radin's conduct violated Section 11 of the Securities Act of 1933
(the "Securities Act"), 15 U.S.C. § 77k ("Section 11"). A
purported subclass of the plaintiffs asserts that CIBC violated
sections 12(a)(1) and (2) of the Securities Act,
15 U.S.C. § 771(a)(1) & (2) ("Section 12(a)(1)" and "Section 12(a)(2)"). The Court concludes that none of these
claims can proceed in the face of the demanding pleading
standards applicable in securities cases, and accordingly grants
the motions to dismiss.
IBF was organized in 1996 by Simon A. Hershon*fn1 as a
distressed loan outfit. See Consol. Am. Compl. ("Compl.") ¶ 20.
Its business plan was ostensibly to pool capital into funds that
would invest in under-performing loans and, after restructuring
or otherwise rehabilitating the loans, sell them at a profit. The
funds also invested in IBF-affiliated hotel development and
industry consolidation ventures. In all, IBF organized seven
funds between 1996 and 1999 (referred to herein as "Fund I,"
etc.).*fn2 Funds I through IV and Fund VII offered notes
under various private placement memoranda. Compl. ¶ 15.*fn3
Each of these funds issued five-year notes bearing interest at
rates between 8 and 12 percent annually, plus an additional
variable interest payment tied to the respective fund's gross
profits. Id. Both IBF and CIBC allegedly made private placement memoranda available to interested investors.
Compl. ¶ 28. On September 20, 2000, and March 26, 2001, Prather
allegedly purchased IBF securities through CIBC after being
solicited by a CIBC broker. CIBC Mot. to Dismiss, App. 1. Belizan
claims to have purchased IBF securities sometime between July 26,
1999, and June 7, 2002, the purported Class Period. See Compl.
¶¶ 1, 6.
During that time, allege plaintiffs, IBF routinely repaid
investors by shuffling money between its various funds. Compl. ¶
35. To do this, it transferred loan assets between funds at par
value, "meaning that the acquiring fund paid the selling fund all
principal, interest and fees outstanding, without regard to the
value and performance status of the underling loans." Id. As an
example, plaintiffs allege that sometime "in 2000" IBF caused
Fund VII to acquire about forty percent of Fund I's portfolio for
cash to allow Fund I to pay its noteholders. Compl. ¶ 37.
Generally accepted accounting principles ("GAAP") obliged IBF to
disclose such material related-party transactions. Nonetheless,
"other than generic disclosures saying that, from time to time,
the IBF Funds acquire loans from one another," this and other
inter-fund transfers were not properly reported in IBF's private
placement memoranda.*fn4 See Compl. ¶ 38. CIBC allegedly informed potential and actual purchasers of IBF
securities, including Prather, that it had conducted extensive
due diligence investigations into IBF's business practices.
Compl. ¶ 96; see also Compl. ¶ 90 ("Prior to signing the
selling agreement [with IBF], CIBC Oppenheimer conducted due
diligence for approximately two-years [sic]. This due diligence
including [sic] a review of financial statements; meetings with
IBF Securities management including all of the top executives and
senior management in the District of Columbia and New York; and
reviews of loan files."). Plaintiffs' claim is that, if CIBC did
in fact perform a thorough due diligence investigation, it "must
have obtained knowledge" of IBF's inter-fund transfers and
noticed their omission from the Offering Materials. Compl. ¶ 97.
CIBC was allegedly motivated to withhold what it knew from its
clients because it was to receive nine percent of the gross sale
price of each unit of IBF securities it sold, plus a pro-rata
share of IBF's gross annual profits. Compl. ¶ 32. Thus, say
plaintiffs, CIBC became a willing participant in the promulgation
of misleading disclosures. CIBC supplied its clients with IBF
materials and management presentations that it must have known
were false or misleading as to the Funds' cash flow, ability to
pay interest, and loan losses.
Meanwhile, Radin allegedly overlooked IBF's malfeasances and
rendered unqualified audit reports during the relevant period.
See Compl. ¶¶ 61-63. According to former IBF insiders
interviewed by plaintiffs, Radin personnel spent up to four weeks
annually at IBF's Washington, D.C. offices performing audits and
reviews for the opinions published in IBF's financial statements
and offering materials. Compl. ¶ 66. Plaintiffs charge Radin with
knowing, or recklessly failing to know, that IBF's failure to
disclose its purchases of bad loans were materially misleading.
See Compl. ¶ 71. According to plaintiffs, Radin's reports,
which did not expose IBF's inter-fund transfers, were included in at least eleven SEC
filings between 1999 and 2002. Compl. ¶ 64. The impact of these
omissions was allegedly material because the omissions obscured
significant fund losses. Radin was paid audit fees ranging from
$10,000 to $15,000 per fund and ultimately $50,000 to $100,000
per year in aggregate fees. Compl. ¶ 67.
Aside from their allegations about IBF's inter-fund transfers,
plaintiffs charge in general that IBF's offering memoranda
contained materially false and misleading maturity statistics.
These gave the misimpression that the loans in at least one of
IBF's portfolios turned over more frequently than they actually
did. See Compl. ¶¶ 81-83. A stock of short-term loans would
suggest a more stable investment than the stagnant pool of poor
performers that the IBF funds allegedly contained. The Complaint
also asserts that IBF failed to disclose the methodology it used
to estimate the value of the collateral for its loans. As an
example, plaintiffs cite a Fund VII report dated September 30,
2001, that supplied a 146-percent collateral coverage statistic
for the Fund. Plaintiffs allege that Radin knew or was reckless
in not knowing that the failure to disclose the lack of
methodology was materially misleading given the apparent
precision of that statistic. Compl. ¶ 87.
Throughout 2001, the SEC conducted an inquiry into allegations
that IBF operated as a Ponzi scheme. The inquiry led to a private
order of investigation and, on December 17, 2001, the SEC
requested that all new offering proceeds from IBF Funds be
deposited in an escrow account. Compl. ¶ 25. Incoming monies were
thus not available for new investments or to service the debt
from prior offerings. Sometime in January 2002, an IBF executive
allegedly informed CIBC that IBF was the subject of an SEC
investigation. Compl. ¶ 31. Radin also purportedly became aware
of the SEC investigation some time in January 2002. Compl. ¶ 72
IBF ceased offering securities on January 31, 2002, and filed for bankruptcy that
June. On July 23, 2002, the SEC filed a complaint against IBF,
Funds VI and VII, and Hershon in the United States District Court
for the Southern District of New York. See SEC v. IBF
Collateralized Finance Corp., 2002 U.S. LEXIS (S.D.N.Y. Dec. 6,
2002) (order under granting partial summary judgment in favor of
the SEC and appointing a trustee pursuant to the Investment
Company Act, 15 U.S.C. § 80a-41(d)); In re InterBank Funding
Corp., 310 B.R. 238 (Bankr. S.D.N.Y. 2004).
A. Applicable Legal Standard
A motion to dismiss pursuant to FED.R.CIV.P. 12(b)(6) will not
be granted unless "it appears beyond doubt that the plaintiff can
prove no set of facts in support of his claim which would entitle
him to relief." Conley v. Gibson, 355 U.S. 41, 45-46 (1957);
see also Haynesworth v. Miller, 820 F.2d 1245, 1254 (D.C.
Cir. 1987). Generally speaking, all that the Federal Rules of
Civil Procedure require of a complaint is that it contain "`a
short and plain statement of the claim' that will give the
defendant fair notice of what the plaintiff's claim is and the
grounds upon which it rests." Conley, 355 U.S. at 47. However,
where fraud is alleged, the circumstances constituting fraud must
be stated with particularity. FED. R. CIV. P. 9(b).
The Private Litigation Reform Act of 1995, 15 U.S.C. § 78u-4
("PSLRA"), imposes additional pleading requirements on plaintiffs
is securities cases. First, the statute requires that,
in any private action arising under this chapter in
which the plaintiff may recover money damages only on
proof that the defendant acted with a particular
state of mind, the complaint shall, with respect to
each act or omission alleged to violate this chapter,
state with particularity facts giving rise to a
strong inference that the defendant acted with the
required state of mind.
15 U.S.C. § 78u-4(b)(2); see also In re Digital Island Sec.
Litig., 357 F.3d 322
, 328 (3d Cir. 2004) ("In requiring a `strong inference of scienter, the PSLRA
alters the normal operation of inferences under FED.R.CIV.P.
12(b)(6)."). Second, the PSLRA requires that where a plaintiff
alleges that a defendant made an untrue statement of material
fact or omitted to state a material fact necessary to make the
statements, in light of their circumstances, not misleading:
the complaint shall specify each statement alleged to
have been ...