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Decided: March 7, 2014

The Fourth Circuit held that the United States District Court for the District of Maryland properly dismissed the plaintiff shareholders’ claims against Municipal Mortgage & Equity (MuniMae) and certain directors and officers of MuniMae (collectively, the MuniMae defendants) under the Private Securities Litigation Reform Act (PSLRA), 15 U.S.C. § 78u-4, as the plaintiffs did not adequately plead scienter in their action under § 10(b) of the Securities Exchange Act of 1934 (Exchange Act), 15 U.S.C. § 78j(b); that the plaintiffs’ claim under § 11 of the Securities Act of 1933 (Securities Act), 15 U.S.C. § 77k(a), was time-barred by the three-year statute of repose in § 13 of the Securities Act, 15 U.S.C. § 77m; and that named plaintiff Charles W. Dammeyer (Dammeyer) did not sufficiently allege standing to bring a claim under § 12(a)(2) of the Securities Act, 15 U.S.C. § 77l(a)(2).  The Fourth Circuit therefore affirmed the judgment of the district court.

During the putative class period—spanning from May 3, 2004, to January 29, 2008—MuniMae “was one of the nation’s largest syndicators of low-income housing tax credits” (LIHTCs).  MuniMae organized certain LIHTC investment partnerships (LIHTC Funds) to pool LIHTCs and sell them to investors.  During the putative class period, MuniMae typically served as the general partner of these LIHTC Funds.  MuniMae mainly considered its LIHTC Funds to be off balance sheet entities before 2003.  In 2003, “the Financial Accounting Standards Board adopted Financial Accounting Standards Board Interpretation No. 46R” (FIN 46R), addressing the reporting requirements for off balance sheet entities therein.  FIN 46R created a new category of off balance sheet entity, the Variable Interest Entity (VIE); pursuant to FIN 46R, a company that is the “primary beneficiary” of a VIE must consolidate the VIE’s assets and liabilities onto its financial statements.  MuniMae first reported compliance with FIN 46R in the first quarter of 2004 and continued to assert compliance in its financial filings with the Securities and Exchange Commission through mid-2006.  MuniMae also conducted a secondary public offering (SPO) in February 2005.  In March 2006, MuniMae revealed that it was restating certain financial statements that involved financial reporting errors unrelated to FIN 46R.  In September 2006, MuniMae announced another restatement (the second restatement).  While MuniMae initially did not tell investors that the second restatement would deal with FIN 46R compliance issues, it later revealed that it had yet to “reach[] a conclusion regarding the extent of the [second] restatement.”  In January 2007, MuniMae disclosed that the second restatement would deal with accounting errors involving FIN 46R; MuniMae stated that it would “be required to consolidate substantially all of the [LIHTC] equity funds it has interests in.”  In a November 2007 teleconference with investors, MuniMae officers declined to estimate the second restatement’s cost—though they admitted that the cost would be substantial.  In January 2008, MuniMae announced cuts to its quarterly dividend, attributing the cuts to, inter alia, the cost of the second restatement.  However, MuniMae also asserted that it did “not believe the results of the restatement w[ould] materially change the previously recorded cash balances of the Company and its subsidiaries.”  MuniMae’s share price dropped precipitously in late January.  In a conference call on January 29, MuniMae gave investors more details about the second restatement—including details about the second restatement’s massive scope.  In April 2008, MuniMae revealed that it had spent over $54 million on the second restatement.

After shareholders brought multiple lawsuits against the MuniMae defendants and the 2005 SPO’s lead underwriters, their suits were consolidated for pretrial proceedings; the shareholders then filed a class action complaint.  They brought claims under the Exchange Act and the Securities Act, alleging that the MuniMae defendants committed securities fraud through false representations of MuniMae’s compliance with FIN 46R and concealment of the second restatement’s cost.  With regard to the plaintiffs’ claims under § 10(b) of the Exchange Act, the district court held that—under the PSLRA’s heightened pleading standards—the plaintiffs’ amended complaint did not sufficiently plead scienter.  The district court also found the plaintiffs’ claim under § 11 of the Securities Act time-barred by the Act’s statute of repose; furthermore, the district court found that Dammeyer—“the only named plaintiff asserting Securities Act claims with respect to the SPO”—did not have standing to bring a claim under § 12(a)(2) of the Securities Act.  The district court therefore dismissed these claims, and the plaintiffs appealed.

With regard to the plaintiffs’ claims under § 10(b) of the Exchange Act, the Fourth Circuit concluded that, under the PSLRA’s heightened pleading standards, the inference that the MuniMae defendants acted with intent or severe recklessness—which the plaintiffs aimed to establish through the statements of three confidential witnesses, the presence of certain red flags, allegations of insider trading, and general business motivations for committing fraud—was not at least as compelling as the opposing inference that the MuniMae defendants acted innocently or negligently.  The Fourth Circuit also considered the disclosures made by the MuniMae defendants during the class period when making this comparative inquiry.  With regard to the plaintiffs’ claims under § 11 of the Securities Act, the Fourth Circuit found that the date upon which the securities in the SPO were “bona fide offered to the public” was the effective date of MuniMae’s registration statement—January 14, 2005.  Because the plaintiffs brought their § 11 action more than three years after this date, the Fourth Circuit found their claim time-barred by the statute of repose.  Lastly, with regard to the claim under § 12(a)(2) of the Securities Act, the Fourth Circuit found that the “pursuant and/or traceable to” language in the amended complaint to be conclusory; furthermore, the Fourth Circuit found that this language was not accompanied with sufficient supportive facts to support a plausible inference of standing.

Full Opinion

– Stephen Sutherland