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URBACH v. SAYLES

November 19, 1991

SOL URBACH, ON BEHALF OF HIMSELF AND ALL OTHERS SIMILARLY SITUATED, PLAINTIFF,
v.
THOMAS D. SAYLES, JR., ET AL., DEFENDANTS.



The opinion of the court was delivered by: Sarokin, District Judge.

OPINION

Before the court is defendants' motion for certification of appeal.

Background

In this class action, plaintiff charges defendants with a variety of securities violations. Plaintiff Urbach brings this suit as a class action, on behalf of all those who purchased securities of Summit Bancorporation ("Summit"), between December 15, 1988 and July 17, 1990 (the "class period"), including those who acquired securities of Summit by exchanging their securities of Somerset Bancorporation, Inc. ("Somerset"), pursuant to a merger which became effective December 15, 1988.*fn1 A motion for class certification is pending completion of discovery. The suit is brought against Summit and individual defendants who were officers and/or directors of Summit during times material to the claims of the class.

Plaintiff alleges in his complaint that defendants deceived the investing public into purchasing Summit securities at grossly inflated prices. Plaintiff charges defendants with publicizing Summit's supposedly stringent controls, careful underwriting of loans, continuous and scrupulous monitoring of outstanding loans, conservative reserving policies, diverse loan portfolio, and growing earnings and assets. The essence of the complaint is that Summit overstated income and assets by consciously understating its reserves for loan losses.*fn2

Defendants moved this Court to dismiss all plaintiff's claims. On September 4, 1991, this Court issued an opinion and order ("the September Order") denying defendants' motion to dismiss. 1991 WL 236183.

Defendants now move this Court to certify an appeal of the September 4 Opinion and Order to the United States Court of Appeals for the Third Circuit. With the consent of both parties at oral argument, the court also takes this occasion to clarify the September Order and Opinion.

Discussion

28 U.S.C. § 1291 grants courts of appeals jurisdiction of appeals only from final decisions of the district courts. The Interlocutory Appeals Act, codified in 28 U.S.C. § 1292(b), creates a narrowly-tailored exception to the "final decision" requirement:

    When a district judge, in making in a civil
  action an order not otherwise appealable under
  this section, shall be of the opinion that such
  order involves a controlling question of law as
  to which there is substantial ground for
  difference of opinion and that an immediate
  appeal from the order may materially advance the
  ultimate termination of the litigation, he shall
  so state in writing in such order. The Court of
  Appeals may thereupon, in its discretion, permit
  an appeal to be taken from such order,. . . .
  Provided, however, That application for an appeal
  hereunder shall not stay proceedings in the
  district court unless the district judge or the
  Court of Appeals or a judge thereof shall so order.

The statute thus enunciates three criteria which must be met before an interlocutory appeal may be granted: the order from which appeal is taken must (1) "involve a `controlling question of law,'" (2) be of a nature that an immediate appeal would "materially advance the ultimate termination of the litigation," and (3) "offer `substantial ground for difference of opinion' as to its correctness." Katz v. Carte Blanche Corp., 496 F.2d 747, 754 (3d Cir. 1974), cert. denied, 419 U.S. 885, 95 S.Ct. 152, 42 L.Ed.2d 125 (1974) (quoting 28 U.S.C. § 1292(b)).

The Third Circuit has recognized that these requirements should be stringently observed. Milbert v. Bison Laboratories, Inc., 260 F.2d 431, 433 (3d Cir. 1958). In particular, " 28 U.S.C. § 1292(b) is not designed for review of factual matters but addresses itself to a `controlling question of law.'" Link v. Mercedes-Benz of North America, Inc., 550 F.2d 860, 863 (3d Cir. 1977) (en banc), cert. denied, 431 U.S. 933, 97 S.Ct. 2641, 53 L.Ed.2d 250 (1977) (citing Johnson v. Alldredge, 488 F.2d 820 (3d Cir. 1973), cert. denied sub nom. Corrections Officer Cronrath v. Johnson, 419 U.S. 882, 95 S.Ct. 148, 42 L.Ed.2d 122 (1974)).

Plaintiff contends that the issue set forth for certification by defendants — the sufficiency of plaintiff's pleading — should not be certifiable per se because it is fact specific, rather then presenting a "clear-cut question of law against a background of determined and immutable facts," such as is required for certification under 28 U.S.C. § 1292(b). Plaintiff's Opp. at 1 (quoting 9 Moore's Federal Practice ¶ 110.22[2] at 275-76). Plaintiff cites authority for the proposition that questions of law involved in motions to dismiss are seldom controlling questions, insofar as they "relate merely to the form in which a claim . . . should be pleaded and do not affect the ultimate substantive requirements for proof necessary to establish the claim which the plaintiff asserts." Kroch v. Texas Company, 167 F. Supp. 947, 949 (S.D.N.Y. 1958). Further, plaintiff argues that the determinations reached by this Court in its Order denying defendants' motion to dismiss involved only the "application of accepted and settled law to the particular fact pattern set forth in the Complaint." Plaintiff's Opposition at 5.

Defendants reply that the issue of the sufficiency of plaintiff's pleading satisfies all three requirements for certification. Without deciding on the merits of defendants' motion, this court finds that there is no basis for plaintiff's assertion that motions to dismiss should be regarded as per se immune to certification. If this Court's determinations were purely factual, that would indeed bar certification under 28 U.S.C. § 1292(b). However, such a conclusion can only be reached by considering in detail the legal issues raised by defendants and decided by this Court.

In their motion for reconsideration, defendants identify four separate issues which, in their view, satisfy the criteria for certification: whether plaintiff has (1) stated a federal securities claim under Rule 12(b)(6); (2) plead fraud with sufficient particularity to satisfy Rule 9(b); (3) satisfied the relevant statute of limitations; and (4) stated a cause of action under the New Jersey law of negligent misrepresentation. This Court will consider each of these issues in turn to determine which, if any, of them merit certification for appeal.

The 12(b)(6) Claim

In the September Opinion, this Court held that "allegations of misstatements made by defendants in overstating reported net income and assets by consciously under-reserving for problem loans, and misrepresenting material facts concerning the institution's loan quality, underwriting standards, and loan monitoring procedures" stated a claim under 12(b)(6). Order at 10. Defendants contend that this holding embodies a controlling question of law over which there is substantial ground for difference of opinion. In support of this contention, they cite two district court cases in the Third Circuit, Fox v. Equimark Corp., Civ. No. 90-1504, ___ F. Supp. ___ (W.D.Pa. May 22, 1991) and In re UJB Financial Corp. Shareholder Litigation, No. 90-1569 (D.N.J. Jan. 22, 1991), notice of appeal filed (Feb. 25, 1991), which, defendants contend, hold that under-reserving for loan losses represents only mismanagement, not fraud actionable under 12(b)(6). Plaintiff maintains that the distinction between fraud and mismanagement is a factual determination, and that this Court merely came to a different factual conclusion than did the other district courts in their respective cases.

This Court finds plaintiff's characterization of the issue unsatisfactory. There are two possible interpretations of the loan-loss reserve issue which represent distinct legal theories. On the view adopted by this Court in its September Order, a defendant who represents that loss provisions are adequate, and is subsequently proved wrong, may be guilty of either mere mismanagement or actionable fraud. A fraud action will lie where, while representing that loss reserves are adequate, a defendant knows that they are not or lacks any valid basis for her representation. Although there may be many methods for calculating reasonable loss reserves and a wide margin for error based on good faith management decisions, a manager who states that reserves are adequate with the knowledge that they are not should not, in the view of this Court, be immune from an action brought by those she defrauds.

On the other hand, one could maintain as a matter of law that decisions about loss reserves are always business decisions, and hence always insulated from 12(b)(6) liability, even if the corporation and its managers are certain, at the time the reserve amount is determined and disclosed to investors, that the reserves will be inadequate. That interpretation may gain some support from the undoubted fact that providing for future losses involves substantial uncertainty. This Court, however, has rejected the temptation to turn the absence of certainty into a license for unbridled misrepresentation. Although a manager may never "know" with absolute certainty that a reserve against anticipated losses is inadequate, there will be circumstances where she "knows," based on any plausible and acceptable means of calculation, projection, or forecast, that reserves must be increased and yet represents that they need not be.*fn3 The September Order is premised on the view that the latter type of knowledge is sufficient to ground a claim of fraud under 12(b)(6).

Whether the September Order involves a controlling issue of law and whether there is substantial ground for difference of opinion as to its correctness turn on whether the authorities cited by defendants adopt this Court's interpretation of the scope of 12(b)(6) and merely come to different conclusions about its application to particular facts, or embrace the opposing view that misrepresentation of the adequacy of reserves can never rise to the level of actionable fraud.

It is the view of this Court that both the authorities within this Circuit cited by defendants and the weight of legal authority generally adopt the same interpretation of the Securities Acts and employ the same legal principles expressed in the September Order.

It is well accepted in the Third Circuit and other circuits that projections or estimates can ground a fraud claim under the securities laws. See In re Craftmatic Securities Litigation, 890 F.2d 628, 645-46 (3d Cir. 1989) ("[a] projection that is issued without a reasonable basis is an untrue statement and actionable under § 10(b) and Rule 10b-5 if made knowingly or recklessly"); Eisenberg v. Gagnon, 766 F.2d 770, 776 (3d Cir. 1985), cert. denied, 474 U.S. 946, 106 S.Ct. 342, 343, 88 L.Ed.2d 290 (1985) ("[a]n opinion or projection, like any other representation, will be untrue if it has no valid basis") (citation omitted); Cameron v. Outdoor Resorts of Am., Inc., 608 F.2d 187, 194 (5th Cir. 1979), modified, 611 F.2d 105 (5th Cir. 1980) (projections may be actionable); SEC v. Okin, 137 F.2d 862, 864 (2d Cir. 1943); Marx v. Computer Sciences Corp., 507 F.2d 485, 489 (9th Cir. 1974) (forecasts); Myzel v. Fields, 386 F.2d 718, 734 n. 8 (8th Cir. 1967), cert. denied, 390 U.S. 951, 88 S.Ct. 1043, 19 L.Ed.2d 1143 (1968); SEC v. Haffenden-Rimar Int'l, Inc., 362 F. Supp. 323, 327 (E.D.Va. 1973), aff'd, 496 F.2d 1192 (4th Cir. 1974) (projections).

It is also well recognized that loan loss provisions reflect a projection about the risk of a loan portfolio; see, e.g., Blackie v. Barrack, 524 F.2d 891, 90(9th Cir. 1975), cert. denied, 429 U.S. 816, 97 S.Ct. 57, 50 L.Ed.2d 75 (1976). As has been acknowledged by almost every court directly confronted with the question, fraudulent projections about loan loss and risk — like fraudulent projections about other business matters of relevance to an investor — may be a basis for legal liability under the securities laws.*fn4 See, e.g., In re Midlantic Corp. Shareholder Litigation, 758 F. Supp. 226 (D.N.J. 1990); First American Bank and Trust v. Frogel, 726 F. Supp. 1292, 1294 (S.D.Fla. 1989); see also cases collected in Steiner v. Shawmut Nat. Corp., 766 F. Supp. 1236, 1243-46 & n. 19 (D.Conn. 1991); cf. Christidis v. First Pennsylvania Mortgage Trust, 717 F.2d 96, 99 (3d Cir. 1983) (loss reserves may be fraudulent where "property appraisals relied on where either knowingly false, or so facially unreasonable as to be beyond the realm of reasonable reliance for accounting practices").

Many well-reasoned opinions that have granted motions to dismiss in such cases have recognized that intentional or reckless understatement of loan loss reserves may ground a fraud claim, but found that the facts alleged by plaintiff in the particular case amounted to no more than mismanagement. See, e.g., Steiner, 766 F. Supp. at 1243, 1246-47. Although a few cases, not in this circuit, have granted motions to dismiss in such general terms as to give rise to the suggestion that no cause of action for fraud can ever be maintained based on misrepresentations regarding loan loss reserves, see, e.g., Shields v. Amoskeag Bank Shares, Inc., 766 F. Supp. 32 (D.N.H. 1991), this court is satisfied that among courts squarely presented with the question, there is little doubt that misrepresentations concerning the adequacy of loss provisions are in principle actionable under 12(b)(6).

Finally, if there was any doubt about the actionability of fraudulent projections, including loan loss projections, that doubt has been removed by the Supreme Court's recent decision in Virginia Bankshares, Inc. v. Sandberg, ___ U.S. ___, 111 S.Ct. 2749, 115 L.Ed.2d 929 (1991). In Virginia Bankshares, the court held that knowingly false statements of opinion or belief, such as representations that the value that shareholders were to receive for their bank stock was "high" or a deal was "fair," could ground a securities fraud claim. Id. 111 S.Ct. at 2755.

    [Such representations are] reasonably
  understood to rest on a factual basis that
  justifies them as accurate, the absence of which
  renders them misleading. . . . provable facts
  either furnish good reasons to make a conclusory
  commercial judgment, or they count against it,
  and expressions of such judgments can be uttered
  with knowledge of truth or falsity just like
  more ...

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