The opinion of the court was delivered by: Jack D. Shanstrom Senior United States District Judge
MEMORANDUM OPINION AND ORDER
Presently before the Court is Defendants' Motion to Dismiss Plaintiffs' First Amended Complaint. Defendants argue the Complaint ought to be dismissed under Federal Rules of Civil Procedure 12(b)(6) and 9(b) on the following four grounds: (1) Plaintiffs fail to plead particularized facts to show that any defendant misstated or omitted a material fact; (2) even assuming a material misstatement or omission had been pled, Plaintiffs have not satisfied their burden under the Private Securities Litigation Reform Act (PSLRA) 15 U.S.C. § 78u-4(b)(1) to plead particularized facts that defendants acted with scienter, or an intent to deceive; (3) Plaintiffs fail to show real economic damages or loss causation; and (4) Plaintiffs cannot establish secondary liability because they have not pled that any individual defendant was either a "control person" or a "culpable participant" in a securities fraud context.
On April 24, 2009, the Court held a hearing on the matter and is prepared to rule on Defendants' Motion.
This case presents a class action lawsuit on behalf of purchasers of the common stock of Allied Capital Corporation (Allied) between November 7, 2005 and January 22, 2007, inclusive (the "Class Period"). Plaintiffs request remedies under the Securities Exchange Act of 1934 (the "SEA") within the scope of the PSLRA.
Allied is a business development corporation with headquarters located in Washington, D.C. Amended Class Action Complaint (Complt.) ¶ 2. Defendants William L. Walton, Penni F. Roll and Joan M. Sweeney are or were officers and/or directors of Allied. Complt ¶ 17. Allied manages and participates in the operation of certain "portfolio companies" which include unconsolidated subsidiaries. Id. at 2. Allied finances the portfolio companies through debt financing in the form of senior loans, second lien debt, and subordinated debt. Id.
One such portfolio company is Business Loan Express ("BLX"), which deals in small business loans guaranteed under the U.S. Small Business Administration's (SBA) Section 7(a) Guaranteed Loan Program. Id. at ¶ 3. BLX and its predecessors were largely owned by Allied since on or about the year 2000. Id. Patrick J. Harrington ("Harrington") was the Executive Vice President of BLX's Troy, Michigan branch office from January 1, 2000 until September 8, 2006. On January 9, 2007, an indictment against Harrington was unsealed in Federal District Court in Detroit, Michigan (the "Harrington Indictment"). Id. ¶ 10. The Harrington Indictment concerned at least 76 fraudulently originated SBA guaranteed loans with a value of approximately $76,869,200. Id. ¶ 11. On January 11, 2007, Allied issued a press release concerning the Harrington Indictment. Consequently, Plaintiffs allege, the Company's stock price fell closing at $29.40, falling more than $2.00 per share from its previous day's close of $31.58 per share. Id. ¶ 13. The stock was traded more than 5 million shares, ten times its average daily trading volume of approximately 500,000 shares. Id.
Plaintiffs allege that throughout the Class Period, Defendants knowingly or recklessly failed to disclose that Allied's financial condition was inflated, because a substantial amount of the income reported by BLX was from fraudulently procured SBA backed Section 7(a) loans. Id. at ¶ 4. Further, Plaintiffs claim that Defendants misrepresented the nature and scope of the government investigations of both Allied and BLX, byfailing to disclose U.S. Attorney's and SBA Office of Inspector General's ("SBA-OIG") investigations in the Eastern District of Michigan concerning the lending activities of BLX's Troy, Michigan office.
Essentially, Plaintiffs allege that Defendants knew of, or were reckless in not knowing, the fraudulent loan origination practices at BLX through the following: (1) discovery demands made by the U.S. Attorney's Office not later than December, 2004; (2) letters provided to Allied's board not later than March 11, 2005 by an investment firm; (3) government interviews and testimony provided by Allied and BLX employees, including grand jury testimony by a BLX principal in October of 2005; and (4) Defendants' managerial involvement in BLX. Id. ¶ 5. Plaintiffs argue that Allied set forth optimistic and inflated projections (misstatements) despite the fact that they were the result of fraudulent loan practices at BLX.
Subsequent to filing Defendants' Motion to Dismiss, Harrington pled guilty in U.S. District Court for the Eastern District of Michigan to a two count superceding indictment for conspiracy to defraud the United States and making false declarations to a grand jury. See Defendants' Notice of Supplemental Authority p.2 [Doc. No. 35], United States v. Harrington, 06-cr-20662 (E.D. Mich. 2008). In a sentencing memorandum, Harrington's attorney represents that the Government sought to implicate the senior managers at BLX, by way of Harrington, suggesting a possible significant reduction in his sentence. Id. (Exhibit 2). However, Harrington could provide no assistance to the Government. In support, Harrington provided a privately administered polygraph examination which indicated he was telling the truth that no one above him at BLX knew or was involved in his fraudulent activities. Id. Ultimately, Harrington was sentenced to 120 months in prison and ordered to pay $30 million in restitution to BLX. Id. (Exhibit 3, Court's Sentencing Memorandum).
Rule 12(b)(6) of the Federal Rules of Civil Procedure allows dismissal of a complaint if plaintiffs fail "to state a claim upon which relief can be granted." Fed.R.Civ.P. 12(b)(6). In Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007), the Supreme Court clarified the standard of pleading that plaintiffs must meet in order to survive a motion to dismiss under Rule 12(b)(6). The Court noted that "Federal Rule of Civil Procedure 8(a)(2) requires only 'a short and plain statement of the claim showing that the pleader is entitled to relief,' in order to 'give the defendant fair notice of what the ... claim is and the grounds upon which it rests[.]' " Id. at 555 (quoting Conley v. Gibson, 355 U.S. 41, 47 (1957)); see also Aktieselskabet AF 21 v. Fame Jeans Inc., 525 F.3d 8, 15 (D.C.Cir.2008). Although "detailed factual allegations" are not necessary to withstand a Rule 12(b)(6) motion to dismiss, to provide the "grounds" of "entitle[ment] to relief," plaintiffs must furnish "more than labels and conclusions" or "a formulaic recitation of the elements of a cause of action." Bell Atlantic Corp. v. Twombly, 550 U.S. at 555; see also Papasan v. Allain, 478 U.S. 265, 286 (1986). The Court stated that there was no "probability requirement at the pleading stage," Bell Atlantic Corp. v. Twombly, 550 U.S. at 556, but "something beyond ... mere possibility ... must be alleged[ .]" Id. at 557-58. The facts alleged in the complaint "must be enough to raise a right to relief above the speculative level," id. at 555, or must be sufficient "to state a claim for relief that is plausible on its face." Id. at 570. The Court referred to this newly clarified standard as "the plausibility standard." Id. at 560 (abandoning the "no set of facts" language from Conley v. Gibson). According to the D.C. Circuit, Twombly "leaves the long-standing fundamentals of notice pleading intact." Aktieselskabet AF 21 v. Fame Jeans Inc., 525 F.3d at 15.
Nevertheless, the Court need not accept inferences drawn by plaintiffs if those inferences are unsupported by facts alleged in the complaint; nor must the Court accept plaintiffs' legal conclusions. See Browning v. Clinton, 292 F.3d 235, 242 (D.C.Cir.2002).
Heightened Pleading Requirements under the PLSA.
Historically, "[t]o state a claim for securities fraud under Rule 10b-5, a plaintiff must allege that the defendant knowingly or recklessly made a false or misleading statement of material fact in connection with the purchase or sale of a security, upon which plaintiff reasonably relied, ... proximately causing his injury." Kowal v. MCI Communications Corp., 16 F.3d 1271, 1276 (D.C. Cir 1994). Congress enacted the Private Securities Litigation Reform Act of 1995 (PSLRA), as a check against abusive litigation by private parties. Under the PSLRA, Congress requires exacting heightened standards of pleading for security fraud cases. The PLSRA requires plaintiffs to state with particularity both the facts constituting the alleged violation, and the facts evidencing scienter, i.e., the defendant's intention "to deceive, manipulate, or defraud." Ernst & Ernst v. Hochfelder, 425 U.S. 185, 194, and n. 12, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976); see 15 U.S.C. § 78u-4(b)(1),(2). The PSLRA's heightened pleading instructions require that any private securities complaint alleging that the defendant made a false or misleading statement: (1) "specify each statement alleged to have been misleading [and] the reason or reasons why the statement is misleading," 15 U.S.C. § 78u-4(b)(1); and (2) "state with particularity facts giving rise to a strong ...