Demonstrating Scienter Requirement in Subprime Securities Lawsuits

Demonstrating Scienter Requirement in Subprime Securities Lawsuits

A recent ruling by U.S. Judge George H. Wu of the Central District of California indicates that shareholders may have difficulty in demonstrating the scienter requirement in subprime securities lawsuits.
 
On Dec. 4, Judge Wu dismissed the second amended complaint filed by IndyMac Bancorp Inc. shareholders against the company, its chief executive officer, chief financial officer and executive vice president of specialty mortgage lending. The shareholders alleged that the defendants violated the Securities Exchange Act of 1934 by issuing a series of false and misleading statements and SEC proxy reports falsely portraying the company’s financial stability despite an industrywide downturn in the subprime mortgage lending industry.
 
Judge Wu concluded that the shareholders’ use of confidential witnesses and their reliance on a press release, earning conference call and financial statements reflecting chargeoffs were not sufficient to give rise to a “strong inference” of scienter. Rather, the judge found that the evidence raised “an even stronger inference” that the defendants “were simply unable to shield themselves as effectively as they anticipated from the drastic change in the housing and mortgage markets and, once that inability became evident, IndyMac’s financials were changed accordingly.”
 
In addition, the shareholders could not rely on violations of Generally Accepted Accounting Principles to provide evidence of scienter because IndyMac’s financials were audited without restatement.
 
The plaintiffs have until Jan. 18 to file an amended complaint.
 
A full report on the case appeared in the December issue of Mealey’s Litigation Report: Mortgage Lending. The Report will continue to follow the litigation in this case.