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Phillips v. Triad Guaranty Inc.

United States District Court, M.D. North Carolina

March 30, 2015

JAMES L. PHILLIPS, Individually and on Behalf of All Others Similarly Situated, Plaintiff,
v.
TRIAD GUARANTY INC., MARK K. TONNESEN, and KENNETH W. JONES, Defendants.

MEMORANDUM OPINION AND ORDER

N. CARLTON TILLEY, Jr., Senior District Judge.

The Order and Recommendation of the United States Magistrate Judge (Doc. #87) was filed with the Court in accordance with 28 U.S.C. § 636(b) and, on May 31, 2013, was served on the parties in this action. Counsel for Defendants filed timely objections to the Order and Recommendation. (Doc. #90.) Pursuant to 28 U.S.C. § 636(b)(1), the Court has appropriately reviewed the portions of the Magistrate Judge's Order and Recommendation to which objection was made. The Court has made a determination that the Order was not clearly erroneous or contrary to law. However, the Court has made a de novo[1] determination to reject the Recommendation.

I.

a.

The Magistrate Judge's Order and Recommendation presents a comprehensive procedural history and compilation of the factual background in this case to which this Court directs the parties. (Doc. #87 at 1-8.) After the issuance of the Order and Recommendation, Triad Guaranty, Inc. ("Triad") filed a petition for relief under Chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware. The petition operates as a stay of litigation against Triad. (Doc. #89 (citing 11 U.S.C. § 362(a).) On June 25, 2013, this Court entered an order recognizing that the proceeding against Triad is stayed pending the outcome of the Bankruptcy Court proceedings and ordering the clerk to terminate Triad as a party to the instant action. (Doc. #91.) On October 18, 2013, Plaintiff voluntarily dismissed Triad with prejudice. (Doc. #100.) Thereafter, the parties filed notices of subsequently decided authority. (Docs. # 101-103, 106.)

b.

Defendants Mark K. Tonnesen ("Tonnesen") and Kenneth W. Jones ("Jones") (collectively "Defendants") have objected to (1) the Order granting Plaintiff's Motion to Strike Exhibits 8-11 to the Declaration of Robyn F. Tarnofsky (Docs. #66, 73) and (2) the Recommendation that Defendants' Motion to Dismiss Plaintiff's Second Amended Complaint ("SAC" or "Complaint") be denied (Doc. #63).[2]

In the brief in support of their motion to dismiss and the objections to the Order and Recommendation, Defendants repeatedly refer to and quote from an earlier Recommendation to grant Defendants' Motion to Dismiss the First Amended Complaint. (See, e.g., Doc. #64 at 8-10, 14-15; Doc. #90 at 5-6, 7, 12-13, 16-20.) Defendants go so far as to argue that the "Court should resist revisiting [the earlier] decisions, because under the law of the case' doctrine, in the absence of extraordinary circumstances, when a court decides upon a rule of law, that decision should continue to govern the same issues in subsequent stages in the same case." (Doc. #64 at 12; see also id. at 14, 15 (describing what the Magistrate Judge "held").) The earlier Recommendation was never referred to this Court for adoption, because Plaintiff filed a Second Amended Complaint before any party filed objections to that Recommendation. (See Docs. #56, 59, 60.) Therefore, not only did this Court not review the earlier Recommendation, that Recommendation remained just that - a recommendation to this Court, which became moot upon Plaintiff's filing of the Second Amended Complaint. As much as Defendants preferred the earlier Recommendation to the one before this Court, the Magistrate Judge gave "considered review to [the earlier]... recommendation... [and] addressed the second amended complaint and the motions related thereto on their own merits." (Recommendation p.34 n.6.) This Court has done the same.

II.

Defendants have objected to the Order granting Plaintiff's motion to strike Exhibits 8-11 to the Declaration of Robyn F. Tarnofsky (Doc. #66). Those exhibits are copies of Form 4 filed with the Securities and Exchange Commission ("SEC") showing that Defendants, among others, purchased stock in Triad during the class period. The Order striking those exhibits properly analyzed and applied relevant case law in doing so and was neither clearly erroneous nor contrary to law. See Fed.R.Civ.P. 59(a). Therefore, Defendants' objection to the Order is denied, and the Order stands. Exhibits 8-11 to the Declaration of Robyn F. Tarnofsky (Doc. #66) are stricken.

III.

Next, Defendants have objected to that portion of the Recommendation that Defendants' Motion to Dismiss Plaintiff's Second Amendment Complaint pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure be denied.

"To survive a motion to dismiss, a complaint must contain sufficient factual matter, accepted as true, to state a claim to relief that is plausible on its face.'" Ashcroft v. Iqbal, 556 U.S. 662, 678, 129 S.Ct. 1937, 1949 (2009) (quoting Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570, 127 S.Ct. 1955 (2007)). "Facial plausibility" is "when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged." Id., 129 S.Ct. 1949. The Court accepts as true all well-pleaded allegations and views the complaint in the light most favorable to Plaintiff. See Mylan Labs, Inc. v. Matkari, 7 F.3d 1130, 1134 (4th Cir. 1993).

Plaintiff alleges violations of sections 10(b) and 20(a) of the Securities Exchange Act of 1934. Section 10(b) of the Securities Exchange Act of 1934 makes it unlawful "[t]o use or employ, in connection with the purchase or sale of any security... any manipulative or deceptive device or contrivance in contravention" of Commission rules and regulations. 15 U.S.C. § 78j. Commission Rule 10b-5 makes it unlawful for a person to "employ any device, scheme, or artifice to defraud, " "make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they are made, not misleading, " or "engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person" "in connection with the purchase or sale of any security." 17 C.F.R. § 240.10b-5. Section 20(a) provides, in relevant part, that "[e]very person who, directly or indirectly, controls any person liable under [the Act or related rule or regulation] shall also be liable jointly and severally with and to the same extent as such controlled person...." 15 U.S.C. § 78t.

To prevail in a securities fraud action, a plaintiff must show (1) a material misrepresentation or omission, (2) scienter, (3) a connection with the purchase or sale of a security, (4) reliance, (5) economic loss, and (6) loss causation. Dura Pharm., Inc. v. Broudo, 544 U.S. 336, 341-42, 125 S.Ct. 1627, 1631 (2005). "These substantive elements of a securities fraud claim are demanding." Cozzarelli v. Inspire Pharm. Inc., 549 F.3d 618, 623 (4th Cir. 2008). While Rule 8(a)(2) of the Federal Rules of Civil Procedure requires that a plaintiff include in his complaint only "a short and plain statement of the claim showing that the pleader is entitled to relief, " a plaintiff alleging securities fraud must do more. First, Rule 9(b) of the Federal Rules of Civil Procedure requires a plaintiff alleging fraud to state his claims "with particularity." See Katyle v. Penn Nat'l Gaming, Inc., 637 F.3d 462, 471 (4th Cir. 2011) (reviewing allegations of loss causation for "sufficient specificity, " similar to Rule 9(b)'s requirement of particularity). He must provide the "who, what, when, where, and how" of the alleged fraud. United States ex rel. Willard v. Kellogg Brown & Root, Inc., 525 F.3d 370, 79 (4th Cir. 2008) (internal quotations and citations omitted). In addition, the Private Securities Litigation Reform Act ("PSLRA"), 15 U.S.C. § 78u-4, provides "[e]xacting pleading requirements" in cases, such as this one, where a plaintiff alleges that the defendant made false or misleading statements. Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 313, 127 S.Ct. 2499, 2504 (2007). Under the PSLRA, a plaintiff (1) "shall specify each statement alleged to have been misleading and the reason or reasons why the statement is misleading, "[3] and (2) "shall, with respect to each act or omission... state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." Id. at § 78u-4(b)(1) and (2). In other words, the PSLRA provides heightened pleading requirements beyond Rule 9(b) for the elements of misrepresentation and scienter. Katyle, 637 F.3d at 471 n.5. The PSLRA also states that "the plaintiff shall have the burden of proving that the act or omission of the defendant... caused the loss for which the plaintiff seeks to recover damages." Id. at § 78u-4(b)(4). Defendants argue that Plaintiff fails to plead sufficiently scienter, any false or actionable statements, and loss causation and, therefore, object to the Recommendation's suggestion otherwise.

A.

First, Defendants allege that Plaintiff has not sufficiently pled scienter. Scienter is "a mental state embracing intent to deceive, manipulate, or defraud." Tellabs, Inc., 551 U.S. at 319, 127 S.Ct. at 2507. In the Fourth Circuit, scienter also encompasses "severe recklessness, " Teachers' Ret. Sys. of La. v. Hunter, 477 F.3d 162, 183-84 (4th Cir. 2007), defined in the securities fraud context as "an act so highly unreasonable and such an extreme departure from the standard of ordinary care as to present a danger of misleading the plaintiff to the extent that the danger was either known to the defendant or so obvious that the defendant must have been aware of it, '" Ottmann v. Hanger Orthopedic Grp., Inc., 353 F.3d 338, 343 (4th Cir. 2003) (quoting Phillips v. LCI Int'l, Inc., 190 F.3d 609, 621 (4th Cir. 1999)).

Although the PSLRA requires a plaintiff to "state with particularity facts giving rise to a strong inference" of scienter, "Congress left the key term strong inference' undefined." Tellabs, Inc., 551 U.S. at 314, 127 S.Ct. at 2504. The Supreme Court determined that "[t]o qualify as strong' within the intendment of [the PSLRA], ... an inference of scienter must be more than merely plausible or reasonable - it must be cogent and at least as compelling as any opposing inference of nonfraudulent intent." Id., 127 S.Ct. at 2504; see also id. at 323, 127 S.Ct. 2509 (instructing that when determining whether plaintiff has pled facts that give rise to a strong inference of scienter, "the court must take into account plausible opposing inferences"). "The inquiry... is whether all of the facts alleged, taken collectively, give rise to a strong inference of scienter, not whether any individual allegation, scrutinized in isolation, meets that standard." Id. at 322-23, 127 S.Ct. 2509. "[W]hen the facts as a whole more plausibly suggest that the defendant acted innocently - or even negligently - rather than with intent or severe recklessness, the action must be dismissed." Cozzarelli, 549 F.3d at 624. "In order to establish a strong inference of scienter, plaintiffs must do more than merely demonstrate that defendants should or could have done more." Public Emps.' Ret. Ass'n of Colo. v. Deloitte & Touch LLP, 551 F.3d 305, 314 (4th Cir. 2009). In addition, a plaintiff must allege facts supporting a strong inference that each defendant acted with the requisite scienter. Teachers' Retirement Sys. of La., 477 F.3d at 184.

1.

Defendants argue that "Plaintiff must allege that the misconduct itself is rational" (Doc. #90 at 5), because "allegations of irrational conduct can raise no cogent inference of scienter" (Doc. #64 at 13). In support of this argument, Defendants cite Cozzarelli, 549 F.3d 618 and Atl. Gypsum Co., Inc. v. Lloyds Int'l. Corp., 753 F.Supp. 505 (S.D.N.Y. 1990), but neither case is on point, particularly the latter as it does not involve allegations of securities fraud. Moreover, it would not necessarily be irrational for a reasonable person to infer that Defendants would intentionally price modified pool insurance policies so low that the company was at risk of being unable to cover the claims if the housing market deteriorated, considering the possible net income if the market did not deteriorate. Nevertheless, Plaintiff's scienter allegations do not support a strong inference of intentional or severely reckless conduct.

2.

Nearly all of the facts that Plaintiff alleges in an effort to give rise to a strong inference of scienter are from confidential sources.[4] "When the complaint chooses to rely on facts provided by confidential sources, it must describe the sources with sufficient particularity to support the probability that a person in the position occupied by the source would possess the information alleged or in the alternative provide some other evidence to support their allegations." Teachers' Retirement Sys. of La., 477 F.3d at 174; see also In re Trex Co., Inc. Sec. Litig., 454 F.Supp.2d 560, 573 (W.D. Va. 2006) ("A confidential witness' testimony can be used in pleading under the PSLRA so long as the testimony involves facts of which the witness had personal knowledge."). Plaintiff's allegations fall short of this requirement.

The confidential source identified as the "former Assistant Vice President and Regional Underwriting Manager in Triad's Horsham, PA office was employed with the Company from 2003 through 2008" and "oversaw three underwriters and provided underwriting in the Company's flow' channel."[5] (SAC ¶ 29 n.2.) Plaintiff has attributed its allegations of motive to this confidential source. (See id. ¶ 29.) Even if Plaintiff had described this source with sufficient particularity to support the probability that he[6] would know of Triad's business interests, which it did not, these broad statements attribute no scienter to any defendant. See Ottmann, 353 F.3d at 352 (noting that "courts have repeatedly rejected these types of generalized motives - which are shared by all companies - as insufficient to plead scienter under the PSLRA").

The confidential source identified as the "former Triad Consultant worked for Triad on and off from 1997 through 2007... [and] was responsible for developing the Company's Bid Management Software, which the Company used to bid on Modified Pool insurance." (SAC ¶ 29 n.4.) While Plaintiff has sufficiently pled facts to support the probability that this confidential source would have the requisite knowledge attributed to him (see id. ¶ 29), his statement provides nothing more than the same generalized motive allegations as noted above which are insufficient to attribute scienter.

The confidential source identified as the "former Assistant Vice President of Data Warehousing worked at Triad in a variety of positions from 1998 until 2008, with the witness's last position being Assistant Vice President of Data Warehousing." "[H]e was responsible for providing data for financial and risk management reporting[, ]" initially to Ken Foster and later to Steve Haferman. (Id. ¶ 29 n.5.) Plaintiff does a better job of alleging the responsibilities of the Assistant Vice President of Data Warehousing than it does when describing the other confidential sources. However, this makes little difference, because the facts that this confidential source alleges are either immaterial (id. ¶ 29), admittedly not based on personal knowledge (id. ¶ 48), or not plausibly based on personal knowledge based on the confidential source's job responsibilities (id. ¶ 62). In addition, the confidential source allegedly described the Senior Vice President of Audit as "raising red flags over the process of assessing risk." (Id. ¶ 62.) However, not only does Plaintiff not allege to whom the red flags were raised, but the Senior Vice President of Audit left Triad in 2004 (id. ¶ 29 n.6.).

Plaintiff relies heavily on the confidential source identified as the "former Vice President of Risk Analytics" who "worked for Triad from November 2006 until August 2007." The former employee initially reported to Foster, whose title is not alleged, but who is alleged to have been hired for his expertise in structured pool insurance. Then, the former employee reported to Haferman, who was at some time Senior Vice President of Risk Management. (Id. ¶ 29 n.6.) Plaintiff does not allege the job responsibilities of this confidential source, and the title of Vice President of Risk Analytics is too vague, especially in light of the similarly vague titles of the other confidential sources, to infer those responsibilities. Other than alleging that the former Vice President of Risk Analytics reported to Foster until early 2007, there are no allegations of the interactions between the two during that time, how frequently the confidential source reported to Foster, what or how he reported to Foster, or what interactions, if any, he had with Foster after early 2007. In other words, Plaintiff seems to have assumed that by simply alleging the confidential source's vague title, employment period, and individuals to whom he reported, it would be probable that the confidential source would have personal knowledge of the facts attributed to him throughout Plaintiff's complaint.

Plaintiff's description of this former employee supports the probability that he would know certain facts alleged, (id. ¶¶ 29, 45, 48, 66-72), many of which describe actions that he personally took, (id. ¶¶ 45, 48, 66-72). However, while it is probable that the witness knew of actions he personally took, Plaintiff's allegations surrounding those actions fall short. While Plaintiff alleges that this confidential source "ran the models" (id. ¶ 45), Plaintiff does not allege when he did so, if this was part of his responsibilities, or whether the data used was the actual data available to Triad at the time that it would have been pricing the loans at issue. Although Plaintiff alleges that this confidential source "personally began to raise significant concerns about the prices and bidding... and undocumented adjustments" (id. ¶ 66), Plaintiff does not allege to whom the source raised these concerns.[7] In addition, Plaintiff has not alleged facts to support the probability that this former employee would know the remainder of the information attributed to him. (See id. ¶¶ 35-38, 40-44, 46-49, 58, 75[8].)

The confidential source identified as the "former Senior Vice President of Audit" was a founder of Triad, "had risk management, audit, and underwriting responsibilities[, ]" but left its employment in December 2004. However, "he remained in contact with his former colleagues[.]" (Id. ¶ 48 n.9.) The allegations attributed to him are actions that he took in 2003, 2004, and 2005 - well before the beginning of the class period. (E.g., id. ¶ 57.) At some point in time, he allegedly raised "red flags over the process of assessing risk, " but Plaintiff does not allege to whom or when he did so. (Id. ¶ 62.) He allegedly "raised serious concerns about Foster and the Company's inadequate reserves [and under-reporting of loss ratios on some of its bulk transactions] in an October 2004 meeting with Darryl Thompson, the Company's then-CEO, and General Counsel Earl Wall." (Id. ¶ 63.) Plaintiff does not allege Thompson's or Wall's tenure at Triad, nor that the former Senior Vice President of Audit notified Tonnesen or Jones. The confidential source is alleged to have "again raised his concerns about the reserves" in a January 3, 2005 e-mail with David Whitehurst, a member of Triad's Board of Directors. (Id.) He allegedly discussed the reserves in a conference call in early 2006 "attended by representatives" from Ernst & Young and Whitehurst. (Id.) Plaintiff does not allege that any of this source's concerns were made known to Tonnesen or Jones. Not only does Plaintiff not allege that Tonnesen or Jones were informed of the former Senior Vice President of Audit's concerns about the company's reserves, but the former Senior Vice President of Audit's employment with Triad ended nearly two years before the class period is alleged to have begun. See In re Trex Co., Inc. Sec. Litig., 454 F.Supp.2d at 573 (finding information from witnesses who were not employed during the class period to be unreliable). The source of any of his knowledge thereafter is from "contact[s] with former colleagues." These allegations do not support the probability that the former Senior Vice President of Audit had any personal knowledge of the class period conduct at issue in the Complaint.

The confidential source identified as the "former Vice President of Risk Analytics and Forecasting was employed with the Company from November 2006 through December 2007." (Id. ¶ 51 n.11.) There are no facts alleging the responsibilities of this position, with whom this confidential source worked, or to whom he reported. Nevertheless, it is plausible that the former Vice President of Risk Analytics and Forecasting would know his motivation for evaluating Triad's pricing/risk modeling and the content of his findings that he presented on March 28, 2007 to the Credit Committee. (Id. ¶¶ 67-71.)

The confidential source identified as the "former Senior Vice President/Director of Underwriting worked for Triad from 1993 until January 2007 and reported to Senior Vice President of Operations Shirley Gaddy who, in turn, reported directly to Defendant Tonnesen." (Id. ¶ 59 n.12.) Although this confidential source's title supports the probability that he would have personal knowledge of the only alleged fact attributed to him, "that the Company's Risk Committee was responsible for setting the underwriting guidelines[, ]" it is immaterial to an inference of scienter. (Id. ¶ 59.)

The confidential source identified as the "former Vice President of Product and Strategic Development worked for Triad from approximately August 2006 until August 2007" and "reported directly to Foster." (Id. ¶ 59 n.13.) The confidential source alleges that, as members of the Risk Management Committee, Tonnesen and Jones were provided certain information and "were very well aware'" of Triad's loss rates and claims. (Id. ¶ 59.) He also alleges that Tonnesen and Jones participated in Weekly Operations Committee Meetings. (Id. ¶ 60.) However, the confidential source is not alleged to have been a member of the Risk Management Committee or the Weekly Operations Committee or to have attended any of those meetings. He does not state at which meetings Tonnesen or Jones would have received the referenced information or that he was at those meetings to witness Tonnesen's or Jones' presence. See In re Coventry Healthcare, Inc. Sec. Litig., No. 08:09-CV-2337-AW, 2011 WL 1230998, *5 (D. Md. Mar. 30, 2011) (finding allegation that the witness periodically attended meetings, at which defendants occasionally were present, not of sufficient particularity to support inference that witness could reasonably attribute scienter to defendants because there was no indication of when or how frequently the witness attended the meetings where defendants were alleged to have been present and no indication as ...


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