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Paskowitz v. Arnall

United States District Court, W.D. North Carolina, Charlotte Division

August 15, 2019




         THIS MATTER is before the Court on “Defendants' Motion to Dismiss Plaintiffs' Amended Class Action Complaint for Violation of the Federal Securities Laws, ” Doc. 56, filed August 14, 2018; “Plaintiffs' Motion to Strike Certain Exhibits to the Declaration of Bethany M. Rezek in Support of Defendants' Motion…, ” Doc. 60, filed September 28, 2018; the Memorandum and Recommendation and Order of the Honorable Magistrate Judge David S. Cayer (“M&R”) entered January 7, 2019, Doc. 67; Defendants' Objection to the M&R, Doc. 68; Plaintiffs' Reply to Defendants' Objection, Doc. 70; and the parties' associated briefs and exhibits that have been considered in accordance with this Order. For the reasons stated below, the Court finds that Plaintiffs' Amended Complaint should be dismissed without prejudice and further finds that the Plaintiffs' Motion to Strike Certain Exhibits to the Declaration of Bethany M. Rezek should be granted in part and denied in part.


         A district court may designate a magistrate judge to “submit to a judge of the court proposed findings of fact and recommendations for the disposition” of dispositive pretrial matters, including motions to dismiss. 28 U.S.C. § 636(b)(1). Any party may object to the magistrate judge's proposed findings and recommendations, and the court “shall make a de novo determination of those portions of the report or specified proposed findings or recommendations to which objection is made.” 28 U.S.C. § 636(b)(1). Objections to the magistrate's proposed findings and recommendations must be made "with sufficient specificity so as reasonably to alert the district court of the true ground for the objection." United States v. Midgette, 478 F.3d 616, 622 (4th Cir.), cert. denied, 551 U.S. 1157 (2007). However, the Court does not perform a de novo review where a party makes only “general and conclusory objections that do not direct the court to a specific error in the magistrate's proposed findings and recommendations.” Orpiano v. Johnson, 687 F.2d 44, 47 (4th Cir. 1982). After reviewing the record, the court may accept, reject, or modify, in whole or in part, the findings or recommendations made by the magistrate judge or recommit the matter with instructions. 28 U.S.C. § 636(b)(1).[1]

         A motion to dismiss under Federal Rule of Civil Procedure 12(b)(6) for “failure to state a claim upon which relief can be granted” tests whether the complaint is legally and factually sufficient. See Fed.R.Civ.P. 12(b)(6); Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009); Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007); Coleman v. Md. Court of Appeals, 626 F.3d 187, 190 (4th Cir. 2010), aff'd, 566 U.S. 30 (2012). A court need not accept a complaint's “legal conclusions, elements of a cause of action, and bare assertions devoid of further factual enhancement.” Nemet Chevrolet, Ltd. v., Inc., 591 F.3d 250, 255 (4th Cir. 2009). The court, however, “accepts all well-pled facts as true and construes these facts in the light most favorable to the plaintiff in weighing the legal sufficiency of the complaint.” Id. Construing the facts in this manner, a complaint must contain “sufficient factual matter, accepted as true, to state a claim to relief that is plausible on its face.” Id.

         Ordinarily, a plaintiff need only make “a short and plain statement of the claim showing that the pleader is entitled to relief.” Fed.R.Civ.P. 8(a)(2). However, Rule 9(b) creates an exception to this liberal pleading standard and requires that “[i]n alleging fraud or mistake, a party must state with particularity the circumstances constituting fraud or mistake.” Fed.R.Civ.P. 9(b). “This heightened pleading requirement serves to protect defendants' reputations from baseless accusations, eliminate meritless suits brought only to extract a settlement, discourage fishing expeditions, and provide defendants with enough information about a plaintiff's allegations to mount a defense.” Maguire Fin., LP v. PowerSecure Int'l, Inc., 876 F.3d 541, 546 (4th Cir. 2017) (citing Pub. Emps.' Ret. Ass'n of Colo. v. Deloitte & Touche LLP, 551 F.3d 305, 311 (4th Cir. 2009)).

         Specifically, allegations of securities fraud claims under federal law are subject to strict pleading standards. Beyond the “heightened” pleading requirements for allegations of fraud, the Private Securities Litigation Reform Act of 1995 (“PSLRA”) imposes additional pleading requirements to prevent Securities Exchange Act claims from being “employed abusively to impose substantial costs on companies and individuals whose conduct conforms to the law.” See Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 313 (2007). Under the PSLRA, a securities fraud complaint must include “each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed.” 15 U.S.C. § 78u-4(b)(1)(B). Where a plaintiff alleges that a defendant's statements omitted material information, the plaintiff must identify an omitted fact and identify how omitting that fact rendered the statements misleading. See Ottmann v. Hanger Orthopedic Grp., Inc., 353 F.3d 338, 342-43(4th Cir. 2003); Longman v. Food Lion, Inc., 197 F.3d 675, 682 (4th Cir. 1999). Further, “the complaint shall ... state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.” Id. § 78u-4(b)(2)(A). If those “demanding” pleading requirements are not satisfied, the complaint must be dismissed. See Cozzarelli, 549 F.3d at 623.


         Defendant Capitala (“Capitala” or the “Company”) is a business development company that invests in lower middle market companies through debt and equity, in a combination of subordinated (“mezzanine”) or more senior “first-lien” type (“unitranche”) positions. See Am. Class Action Compl. for Violation of the Fed. Sec. Laws (Dkt. No. 52) (“AC”) ¶¶ 1, 11; 2016 Form 10-K at 1-2. Capitala's common stock trades under the ticker symbol “CPTA.” AC ¶ 11.[2] Plaintiffs are two purchasers of Capitala's common stock during the period of January 4, 2016 through August 7, 2017 (the putative “Class Period”) who seek to represent a class of purchasers of Capitala's securities during the Class Period who were allegedly damaged by the disclosures made by the Company at the end of the Class Period.

         The Company itself has no employees. ¶22. Rather, Capitala Investment Advisors (the “Investment Advisor”) manages the Company, while Capitala Advisors Corp. provides the administrative services necessary for the Company to operate. ¶22. The Company's executive officers are part of the Investment Advisor's management team. ¶21. Defendant Alala is Capitala's Chairman and Chief Executive Officer and has been in that position throughout the putative Class Period. ¶ 12. Defendant Arnall is Capitala's Chief Financial Officer and has been in that position throughout the Class Period. ¶ 13. During the relevant period, the Investment Advisor's management team was comprised of Alala, Arnall, John F. McGlinn (“McGlinn), the Company's Chief Operating Officer, and Hunt Broyhill (“Broyhill”), a member of the Company's Board of Directors. ¶23. Alala, McGlinn, and Broyhill also served as the Investment Advisor's investment committee. ¶24.

         Capitala makes investments based on the recommendations of the Investment Committee, which is further assisted by a team of “investment professionals.” See 2015 Form 10-K at 2; 2017 Form 10-K at 3. Throughout the Class Period, Capitala identified both the members of the Investment Committee and the key investment professionals assisting the Committee, namely Christopher B. Norton, Michael S. Marr, Richard Wheelahan, Adam Richeson, and Davis Hutchens. See ¶ 34, ¶ 46. The Company also disclosed the number of other investment professionals that assisted the Investment Committee. As reflected in the Company's public filings, none of the members of the Investment Committee or key investment personnel named above left the Investment Advisor during the Class Period. The Amended Complaint does not allege any details (such as name, position or role) regarding the departure of any employees, at any level, from the Company during the putative Class Period.

         Throughout the Class Period, Capitala also disclosed its investment strategy to shareholders, as well as a complete list of its individual investments. The list of individual investments noted which investments had been placed on “non-accrual status, ” and disclosed the cost basis and current fair value of each investment, enabling investors to see which portfolio companies were carried below cost and thus at risk of being placed on “non-accrual status.” In its public filings, the Company explained that if interest and/or principal payments on a loan became 90 days or more past due, or if the Company did not otherwise expect the borrower to be able to service its debt and other obligations, the Company placed the loan on “non-accrual status, ” and generally stopped recognizing interest income on the loan.[3]˒[4]

         Capitala further warned its shareholders that the companies to which Capitala loaned money “may be in a weaker financial position and experience wider variations in their operating results, which may make them more vulnerable to economic downturns.” Moreover, because Capitala did “not hold controlling equity positions in most of [its] portfolio companies, ” Capitala was “not … in a position to exercise control over [its] portfolio companies or … prevent decisions by management of [its] portfolio companies that could decrease the value of [its] investments.”

         In sum, Capitala cautioned that its “investments are very risky and highly speculative, ” and that it “may experience fluctuations in [its] quarterly and annual results.” Capitala also noted that its investments are “typically rated below investment grade” and referred to as “high-yield” or “junk.”

         Capitala paid the Investment Advisor fees for its investment and advisory management services, which included a base management fee, calculated at an annual rate of 1.75% of Capitala's gross assets, and an incentive fee, which was primarily based on Capitala's realized capital gains, if any. On January 4, 2016, Capitala announced that the Investment Advisor had “voluntarily agreed to waive all or such portion of the quarterly incentive fees earned by the Advisor that would otherwise cause Capitala's quarterly NII to be less than the distribution payments declared by Capitala's Board of Directors.” ¶ 32; January 4, 2016 Form 8-K. As Alala then explained, this decision was made in light of “continued pressure on net investment income caused by non-performing investments, ” and due to management's continued focus on “doing the right thing and maintaining proper alignment with shareholders.” ¶ 32.

         Plaintiffs allege that during the Class Period, Defendants touted the experience of the Investment Advisor's “investment professionals” and that “[m]uch of our Investment Advisor's investment team has worked together screening opportunities, underwriting new investments and managing a portfolio of investments in smaller and lower middle-market companies through two recessions, a credit crunch, the dot-com boom and bust and a historic, leverage-fueled asset valuation bubble.” ¶34. Defendants also warned investors that the Company's success “depends on the ability of Capitala Investment Advisors to attract and retain qualified [investment and administrative] personnel in a competitive environment, ” ¶36, as well as on the Investment Advisor's “key personnel, ” consisting of its leadership team and “other senior investment professionals.” ¶37. As of March 2016, Defendants reported that “[T]he Investment Advisor's investment team currently consists of the members of its investment committee, Messrs. Alala, McGlinn and Broyhill, and a team of eighteen additional investment professionals.” ¶38.

         Plaintiffs further allege that during the course of the Class Period, the Investment Advisor was experiencing what Defendants would later refer to as a “significant loss of professionals” in both underwriting and portfolio” management. ¶56. The Investment Advisor's staff shrunk from 18 “investment professionals” in March 2015 to 11 two years later in March 2017 - a reduction of approximately 40 percent ¶¶30, 38, 46.[5] This “drain of talent, ” as Alala later referred to it, “mainly occur[red] in '15 through when we started hiring again last December [2016].” ¶56.

         This litigation followed the second quarter of 2017, when Capitala announced on August 7, 2017 that six of its investments were on non-accrual status. ¶ 1. Also, Plaintiff alleges that Defendants did not disclose the Investment Advisor's so-called “brain drain” and its resulting impact on the Company's investment portfolio to investors until August 8, 2017, when Defendants discussed the departure of employees and the perceived negative impact it had upon the Company during the Company's earnings call. ¶¶55-56. The shares of the Company fell $3.82 per share from August 8 to August 10, 2017, or approximately 30%, to close at $8.99 per share on August 10, 2017.

         As discussed in more detail below, Plaintiffs bring claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”) and SEC Rule 10b-5 alleging that the Company's disclosures related to the waiver of the incentive fee due to Capitala Advisors and certain risk warning disclosures were materially false because they did not include disclosure of the alleged negative effects of the fee waiver and did not discuss the loss of investment employees.


         A. Motion to Dismiss

         Section 10(b) of the Exchange Act, 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 such rules and regulations as the Commission may prescribe.” 15 U.S.C. § 78j(b). Section 10(b) is implemented by Rule 10b-5, which makes it unlawful “[t]o employ any device, scheme or artifice to defraud[;] [t]o make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made ... not misleading, or[;] [t]o engage in any act, practice, or course of business which operates or would ...

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