Opinion

Phelps v. Stomber

883 F. Supp. 2d 233
2012 U.S. Dist. LEXIS 113181
2012 WL 3276975

Court: District Court, District of Columbia
Filed: Aug 13, 2012
Status: Published
Author: Jackson
On the bench: Judge Amy Berman Jackson
Nature of suit: Civil
Cited by: 3 cases
Authority: More cited than 53.8%

The opinion

UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF COLUMBIA

____________________________________

)

E. L. PHELPS, et al., )

)

Plaintiffs, )

)

v. ) Civil Action No. 11-1142 (ABJ)

)

JOHN CRUMPTON STOMBER, et al., )

)

Defendants. )

____________________________________)

MEMORANDUM OPINION

“We may employ leverage without limit, which may result in the market value of

our investments being highly volatile, limit our range of possible investments, and

adversely affect our return on investments and the cash available for

distributions.”

***

“An investment . . . is suitable only for investors who are experienced in analyzing

and bearing the risks associated with investments having a very high degree of

leverage.”

***

“We cannot assure you that that the Liquidity Cushion will be sufficient to satisfy

margin calls on our financed securities that may arise in connection with highly

unusual adverse market conditions.”

***

“While borrowing and leverage present opportunities for increasing total return,

they have the effect of potentially increasing losses as well . . . . [A]ny event which

adversely affects the value of our investments would be magnified to the extent

leverage is employed.”

Carlyle Capital Corporation (“CCC”) Offering Memorandum [Dkt. # 52-3] at 13–14.

This case involves highly leveraged, highly speculative investment products. It raises the

question of whether plaintiffs were defrauded under the following circumstances: they bought

shares in a company whose sole business consisted of buying residential mortgage-backed

securities on margin; the shares were made available only to a restricted group of sophisticated,

wealthy investors; the shares were marketed with ominous warnings such as the ones above; and

the very risks that were disclosed materialized when conditions in the real estate market and

global economy deteriorated in 2008.

The consolidated complaint alleges claims of securities fraud under sections 10(b) and

20(a) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78j(b), 78t(a), and SEC Rule 10b-5,

17 C.F.R. § 240.10b-5. The complaint includes common law fraud and negligent

misrepresentation allegations, as well as claims under the laws of the United Kingdom and the

Netherlands. As plaintiffs have explained it, the gravamen of the complaint is that the CCC

Offering Memorandum was materially false and misleading because while it disclosed that

liquidity issues that would threaten the company could occur, it omitted information that would

have alerted investors to the fact that those events were already occurring. Plaintiffs also

contend that after the Offering, defendants continued to conceal the worsening financial

condition of the company until CCC collapsed in March of 2008.

Defendants have moved to dismiss the consolidated complaint pursuant to Federal Rules

of Civil Procedure 9(b) and 12(b)(6) and the Private Securities Litigation Reform Act of 1995

(“PSLRA”), 15 U.S.C. § 78u–4, for failure to state a claim upon which relief can be granted.

[Dkt. # 51 and # 52]. For the reasons set forth in more detail below, the Court will grant the

motions to dismiss.

Essentially, this complaint is an attack on how CCC was managed, and ultimately, it

questions the wisdom behind the adoption of its business model in the first place. But chiding

CCC with the benefit of hindsight for its failure to resist the stampede to purchase mortgage-

backed securities is not the same thing as alleging fraud, particularly given the stringent

standards of the PSLRA.

With respect to the counts related to the Offering, the complaint does not plausibly allege

a securities fraud claim grounded on omissions because the Offering documents – in particular,

the Supplemental Memorandum issued after the initial Offering was postponed – specifically

placed buyers on notice of what CCC was doing and the fact that it had recently experienced the

very reversals that plaintiffs claim should have been disclosed. So, this action lacks the defining

element of fraud: a falsehood. The federal claims also fall short of supporting the necessary

allegation that the alleged fraud caused the plaintiffs’ losses. The common law claims related to

the Offering suffer from the same flaws, and in addition, they fail to set forth facts that would

support the element of actual reliance.

As for the claims based on sales of securities in the aftermarket, the federal claims are

barred since the shares were purchased on a foreign exchange and not in the United States. And,

if the Court were to go on to consider the common law aftermarket claims, it would find those

allegations to be devoid of the necessary allegations of reliance as well.

I. BACKGROUND

A. The Parties

1. Plaintiffs

Plaintiffs bring this action pursuant to Federal Rules of Civil Procedure 23(a) and (b)(3)

on behalf of two proposed classes. The first proposed class is the “Offering Class,” which the

complaint defines as “all persons who purchased or otherwise acquired Class B Shares or

Restricted Depository Shares (“RDS”) of CCC in its Offering and were damaged thereby” and a

“U.S. Offering” subclass of U.S. residents. Compl. ¶ 30. The second proposed class is the

“Aftermarket Class,” which the complaint defines as “all persons who purchased or otherwise

acquired Class B Shares of CCC in market purchases from July 4, 2007 through March 17, 2008

. . . and were damaged thereby,” and includes a “U.S. Aftermarket Subclass” of U.S. residents.

Id. Plaintiffs estimate that there are at least 500 members of the Class. See id. ¶ 31.

The named plaintiffs in this action are:

Plaintiff E.L. Phelps, a resident of Virginia who purchased (1) 15,789 RDSs in the

Offering and (2) 15,000 Class B Shares listed for trading on the Euronext exchange in

the aftermarket. Id. ¶ 4;

Plaintiff M.J. McLister, a resident of Virginia who purchased (1) 26,316 RDSs in the

Offering, and (2) 54,225 Class B Shares listed for trading on the Euronext exchange

in the aftermarket. Id. ¶ 5;

Plaintiff D.J. Wu, a resident of Washington, D.C. who purchased (1) 26,316 RDSs in

the Offering, and (2) 25,000 Class B Shares listed for trading on the Euronext

exchange in the aftermarket. Id. ¶ 6;

Plaintiff S.M. Liss, a resident of Maryland who purchased 15,789 RDSs in the

Offering. Id. ¶ 7;

Plaintiff W.F. Schaefer, a resident of Maryland who purchased 7,895 RDSs in the

Offering. Id. ¶ 8;

Plaintiff Jonathan Glaubach who purchased 500 shares of CCC securities in the

Offering. Glaubach Decl. ¶ 4 to Mot. for App’t as Lead Pl. [Dkt. # 4-3];

2. Defendants

The consolidated complaint names the following institutional defendants:

Defendant Carlyle Investment Management, LLC (“CIM”), a Delaware limited

liability company with its principal place of business in Washington, D.C. Compl.

¶ 9. Under an investment management agreement with CCC, CIM served as the

investment manager of CCC and “had full discretionary investment authority.” Id.

According to the Offering Memorandum, CIM was responsible for “the day-to-day

management and operations of [CCC’s] business.” CCC Offering Memorandum

(“Off. Mem.”) [Dkt. # 52-3] at 62–63;

Defendant T.C. Group, LLC (“TCG”), a Delaware limited liability company with its

principal place of business in Washington, D.C. Compl. ¶ 10. According to the

complaint, TCG owned 75 percent of CIM. Id.;

Defendant TC Group Holdings, LLC (“TCG Holdings”), a Delaware limited liability

company with its principal place of business in Washington, DC. TCG Holdings was

the holding company and managing member of TCG. Id. ¶ 11;

Defendant CCC, a Guernsey limited company that is currently in liquidation.

Id. ¶ 22. 1

The complaint also names two groups of individual defendants. The first group of

defendants, who are referred to as the “Carlyle Defendants,” is:

Defendant William Elias Conway, Jr., a resident of Virginia who served as managing

director of CIM, a director of CCC, and the Chief Investment Officer of TCG.

Id. ¶ 14;

Defendant John Crumpton Stomber, a resident of Connecticut who served as the

Chief Executive Offer, Chief Investment Officer and President, and a director of

CCC, as well as Managing Director of CIM and TCG. Id. ¶ 15;

Defendant James H. Hance, a resident of North Carolina who served as a Director of

CCC from September 14, 2006 and at all relevant times thereafter. Id. ¶ 16. He also

served as Chairman of the Board until March 2007 and was a senior adviser to CIM.

Id.;

Defendant Michael J. Zupon, a resident of New York who served as a Director of

CCC from September 14, 2006 and at all relevant times thereafter. Id. ¶ 17.

According to the complaint, Zupon was a founding member, Chief Investment

Officer, and Managing Director and Head of Carlyle’s U.S. Leveraged Finance Group

and a Partner and Managing Director of Carlyle. Id.

The second group of individual defendants, who are referred to as the “Outside Directors,” is:

Defendant Robert Barclay Allardice, III, a resident of New York who served as a

Director of CCC from September 14, 2006 and at all relevant times thereafter.

Id. ¶ 19;

Defendant Henry Jay Sarles, a resident of Massachusetts who was a Director of CCC

from September 14, 2006 and at all relevant times thereafter. Id. ¶ 20;

1 On February 10, 2012, defendant CCC asked the Court for leave to file a responsive

pleading thirty days after the Court rules on the motions to dismiss. CCC’s Mot. to Extend Time

to Respond to Consol. Am. Compl. [Dkt. # 55] at 1–2. They submitted that “[f]orcing the

insolvent estate to litigate these claims as, in effect, an ancillary defendant is duplicative and

wasteful of both the insolvent estate’s assets and the Court’s resources, as well as being futile.”

Id. The Court granted the motion. Minute Order, Feb. 10, 2012.

Defendant John Leonard Loveridge, a resident of Guernsey who was a Director of

CCC from September 14, 2006 and at all relevant times thereafter. Id. ¶ 21.

B. Factual Background

1. CCC’s business model

As the complaint sets forth, CCC was a closed-end investment fund that was formed as a

limited company under the laws of Guernsey on August 29, 2006. Compl. ¶ 40. 2 Although CCC

was technically a separate business entity, the complaint alleges that CCC was “an investment

product created and managed at all times by [defendants].” Id. ¶ 23. CCC’s business model

involved using highly leveraged financing in the form of repurchase loan agreements (“repos”)

to invest in residential mortgage-backed securities (“RMBS”). Id. ¶ 41; Off. Mem. at 45.

CCC shares were initially sold to investors through a private placement of Class B shares,

which was completed by December 31, 2006 and raised over $260 million. Compl. ¶ 50. A

second private placement was completed by February 28, 2007, raising over $336 million.

Id. ¶ 52. The total amount of capital raised through the private placements was approximately

$600 million. Id.

2. The Offering and Offering Memoranda

a. Types of securities sold in the Offering

The Offering (“Offering”) was initially scheduled to take place in early July 2007. Off.

Mem. at cover. There were two types of securities to be sold: Class B Shares and Restricted

Depository Shares (“RDSs”). Class B shares were issued from CCC and were sold only outside

the United States to foreign investors. Off. Mem. at cover. RDSs were issued by the Bank of

New York and sold to investors in the United States, as well as foreign investors. Id. The

2 All citations to “Compl.” refer to the Consolidated Complaint filed on December 5, 2011.

[Dkt. # 42].

securities sold in the Offering were not widely available – only certain types of investors and

investors in certain locations were permitted to purchase the securities. In the United States,

only qualified institutional buyers (“QIBs”) and accredited investors were permitted to purchase

RDSs. 3 Similarly, in order to purchase either type of security, an investor was required to be a

“qualified purchaser,” meaning a QIB with at least $25 million in qualifying investments or an

individual with at least $5 million in qualifying investments. Id. at A-2. Both types of securities

were subject to transfer restrictions. See, e.g., id. at 136, 138.

b. The period preceding the issuance of the Offering Memorandum

In the months leading up to the Offering, the CCC Board of Directors (“the Board”)

reviewed drafts of the Offering Memorandum and took action on several issues related to the

Offering. See, e.g., id. ¶¶ 53, 54, 56. The Memorandum was ultimately issued on June 19, 2007.

Id. ¶ 74.

According to the Offering Memorandum, CCC had an investment guideline stating that

the fund would maintain a “liquidity cushion” of 20 percent, meaning that “unrestricted cash and

cash equivalents . . . [would be] equal to no less than 20% of [CCC’s] [a]djusted [c]apital.” Off.

Mem. at 7. The liquidity cushion was set at 20% based on “extensive statistical testing of

[CCC’s] expected portfolio, including testing during periods of significant financial market

volatility and stress . . . .” Id. at 50. The purpose of the liquidity cushion was to enable CCC “to

meet reasonably foreseeable margin calls on [its] financed securities.” Id. at 50. But CCC also

informed potential investors that it could change its investment guidelines without a shareholder

3 The Offering Memorandum defined QIBs as “institutional investors that own or invest on

a discretionary basis at least $100 million of securities.” Off. Mem. at 145. Similarly, accredited

investors were defined as “qualified purchasers . . . which generally include most institutions,

certain of [CCC’s] management officials and individuals meeting specified net worth income

tests.” Id.

vote at any time with approval of a majority of directors. Id. at 7. In fact, the Offering

Memorandum disclosed that it had already deviated from the guidelines in the past and “may do

so again in the future.” Id.

In its critique of the Offering, the complaint focuses on events that were occurring during

the same time period. It alleges that at some point in April 2007, the Board approved a request

made by defendant Stomber to use the liquidity cushion to buy certain RMBSs prior to the

Offering, which resulted in a reduction of the liquidity cushion to 15 percent. Id. ¶ 58. Also,

during this period, CCC entered into a term loan agreement with CitiGroup Global Markets, Inc.,

which was one of the brokerage firms that agreed to market the Offering to U.S. investors.

Id. ¶ 60. CCC thus secured a bridge loan in the amount of $191 million, which was “obtained in

contemplation of the Offering and was required to be repaid from the proceeds of the Offering.”

Id.

The complaint also alleges that on June 7, 2007, defendant Stomber informed the Board

in an email that CCC had recently sustained substantial losses. Id. ¶ 63. It states:

Stomber told the Board that as a consequence of a change in the “5 years

swap rate,” a $25 million unrealized gain had become an $8 million unrealized

loss on CCC’s mortgage backed securities and that CCC’s New Asset Value had

declined as a result. Stomber stated that “[t]oday was a wild day” in the market

“where rates went up materially” and that CCC could sustain further significant

losses . . . . Most importantly, Stomber was aware and informed the Board that

those events had negatively impacted CCC’s Liquidity Cushion: “ . . . . The Liq

Cushion stands at 23 percent but could be called down close to 20 percent – that is

why we have it.”

Id.

On June 13, 2007, Stomber announced to the Board that the Offering would be postponed

because of “volatile market conditions” and the uncertainty of the valuation of CCC’s balance

sheet. Compl. ¶ 64. According to the complaint, he reported that “CCC’s IFRS net income ‘was

on target for a 14.5% 2nd quarter, but he also noted that CCC’s ‘Fair Value Reserve was down

$63.9MM from inception and $76.2MM for the year,’ meaning that CCC had suffered unrealized

losses in those amounts under IFRS.” Id. 4 Stomber went on:

We are having a major liquidity event so I invoked “emergency powers”

on the balance sheet. The liquidity cushion is currently at $148MM,

which is technically above 20% of our current MTM equity position. But

please take no comfort in that, we could be margin called for up to another

$70MM and therefore bring the cushion down to about 11%. Therefore,

we need independent Board Member approval to go under 20% – that is

the purpose of the liquidity cushion – to be there so we don[’t] not have to

sell securities at depressed prices during a margin call. Therefore, I ask

you for your formal approval.

Id. (alteration in original). The complaint alleges that on June 14, 2007, the Board approved a

resolution to give Stomber the authority he requested to reduce CCC’s minimum liquidity

cushion. Compl. ¶ 66. 5

Shortly thereafter, on June 19, 2007, CCC issued the original Offering Memorandum.

Id. ¶ 74; Off. Mem. at cover. The Offering Memorandum contained detailed information about

the Offering, including explanations of the types of securities that were to be sold, CCC’s

business model and its associated risks, and the fund’s financial status.

c. The description of CCC’s business model and associated risks in the Offering

Memorandum

The Offering Memorandum set forth CCC’s business model in detail, particularly its use

of leverage and the risks associated with such an approach. The first page of the Memorandum

4 “IFRS” stands for “International Financial Reporting Standards,” which are the

accounting standards issued by the International Accounting Standards Board. Compl. ¶ 64 n.1.

IFRS, which differs from the Generally Accepted Accounting Principles (GAAP) used in the

United States, is the standard under which CCC prepared its financial statements and quarterly

reports.

5 There is no allegation, though, that at this time, the cushion actually dropped below 20

percent.

summarized CCC’s investment strategy in the following way:

Our objective is to achieve attractive risk-adjusted returns for shareholders

through current income and, to a lesser extent, capital appreciation. We

seek to achieve this objective by investing in a diversified portfolio of

fixed income assets consisting of mortgage products and leveraged finance

assets. Our income is generated primarily from the difference between the

interest income earned on our assets and the costs of financing those assets

as well as from capital gains generated when we dispose of our assets.

We use leverage to increase the potential return on shareholders’ equity.

The actual amount of leverage that we will utilize, although not limited by

our investment guidelines, will depend on a variety of factors, including

type and maturity of assets, cost of financing, credit profile of the

underlying assets and general economic and market conditions.

Id. at 1. The Offering Memorandum emphasized that CCC would “utilize leverage extensively”

and “without limit.” Id. at 5. It noted that the fund’s leverage ratio, which was defined as “debt

directly incurred to finance investment assets to total equity,” had already exceeded 26:1 by

March 31, 2007, and that it was expected to exceed 29:1 after the Offering. Id.

The Offering Memorandum also discussed the risk factors associated with CCC’s

business model, explaining:

“We may change our investment strategy or investment guidelines at any times

without the consent of shareholders, which could result in us acquiring assets that are

different from, and possibly riskier than, the investment guidelines described in the

offering memorandum.” Id. at 10.

“We may change our investment strategy and/or capital allocation guidelines without

a vote of our shareholders, provided that any change to our investment guidelines

must be approved by a majority of our independent directors. In the past, we have

deviated from these guidelines with the approval of a majority of our independent

directors and we may do so again in the future.” Id. at 7.

“We cannot assure you that the Liquidity Cushion will be sufficient to satisfy

margin calls.

Despite extensive statistical testing of relevant data, the Liquidity Cushion is not

designed to protect us under all possible adverse market scenarios. Therefore, we

cannot assure you that that the Liquidity Cushion will be sufficient to satisfy margin

calls on our financed securities that may arise in connection with highly unusual

adverse market conditions.” Id. at 14 (emphasis in original).

“Our organizational, ownership and investment structure may create significant

conflicts of interest that may be resolved in a manner which is not always in our best

interests or those of our shareholders.” Id. at 10.

“The price of Class B shares and the RDSs may fluctuate significantly and you could

lose all or part of your investment.” Id. at 11.

With respect to the use of leverage, the Offering Memorandum warned:

“We may employ leverage without limit, which may result in the market value of our

investments being highly volatile, limit our range of possible investments, and

adversely affect our return on investments and the cash available for distributions.

An investment in the Class B shares or RDSs is suitable only for investors who are

experienced in analyzing and bearing the risks associated with investments having a

very high degree of leverage.” Id. at 13.

“Most leveraged transactions require the posting of collateral. The amount of

collateral required to be posted may increase rapidly in the context of changes in

market value of the assets to which we have leveraged exposure[.]” Id.

“While borrowing and leverage present opportunities for increasing total return, they

have the effect of potentially increasing losses as well . . . [A]ny event which

adversely affects the value of our investments would be magnified to the extent

leverage is employed. Increased leverage also increases the risk that we will not be

able to meet our debt service obligations, and consequently increases the risk that we

will lose some or all of our assets to foreclosure or sale.” Id.

Finally, because CCC’s business model depended heavily on RMBS assets and financing with

repo agreements, the Offering Memorandum outlined the risks related to those circumstances:

“If residential and/or commercial real estate property values decrease materially . . .

we may realize material losses related to foreclosures or to the restructuring of our

mortgage loans and the mortgage loans that back the mortgage-backed securities in

our investment portfolio.” Id. at 12.

“The adverse effect of a decline in the market value of our assets may be exacerbated

in instances where we have borrowed money based on the market value of those

assets. If the market value of those assets declines, the lender may require us to post

additional collateral to support the loan. If we were unable to post the additional

collateral, we would have to sell the assets at a time when we might not otherwise

choose to do so.” Id. at 15.

d. The description of CCC’s financial status in the Offering Memorandum

The Offering Memorandum provided information regarding CCC’s financial status as of

March 31, 2007, which was the end of the latest financial reporting period. Id. ¶ 77; Off. Mem.

at 8. But in a section entitled “Recent Developments,” the document also supplied updated

financial information that was current as of June 13, 2007. In particular, this section disclosed

that prior to the Offering, CCC’s fair value reserves had declined by $28.9 million between April

and June 2007:

As a result of changes in interest rates, we estimate that from April 1, 2007

to June 13, 2007, our fair value reserved declined by approximately $28.9

million (unaudited), from approximately $24.0 million (unaudited) as of

March 31, 2007 to an estimated $(4.9) million (unaudited) as of June 13,

2007.

Off. Mem. at 8.

Ultimately, the Offering did not take place as scheduled.

e. Postponement of the Offering and the Supplemental Offering Memorandum

On June 28, 2007, CCC announced that it had postponed the Offering and that it would

issue a Supplemental Offering Memorandum (“the Supplement”) setting forth a revised

timetable and changing the terms of the Offering. Compl. ¶ 83. The next day, CCC issued the

Supplement, which stated that it was “supplemental to, forms part of and must be read in

conjunction with the Offering Memorandum” and that it “amends and updates” any information

in the Offering Memorandum. Compl. ¶ 84; Supplemental Offering Memorandum (“Supp. Off.

Mem.”) [Dkt. # 52-6] at 1. The Supplement specifically notified investors that where it

contained information inconsistent with Offering Memorandum, the Supplement superseded the

earlier document. Supp. Off. Mem. at 1. 6

The Supplement stated that the number of Class B shares available in the Offering would

be reduced from 19,047,620 to 15,962,673 and that the price of the shares would be reduced to

$19, from the price range of $20–$22 stated in the Offering Memorandum. Supp. Off. Mem. at

5. In a section entitled “Recent Developments,” the Supplement also disclosed:

[F]rom April 1, 2007 to June 26, 2007, our fair value reserves declined by

approximately $84.2 million (unaudited), from approximately $24.0

million (unaudited) as of March 31, 2007 to an estimated ($60.2) million

(unaudited) as of June 26, 2007.

Supp. Off. Mem. at 8–9.

The Offering was completed on July 11, 2007. Supp. Off. Mem. at 9. More than 18

million Class B Shares and RDSs were sold in the Offering, raising over $345 million in

proceeds for CCC. Compl. ¶ 85.

f. The subsequent financial crisis and collapse of CCC

In the months following the Offering, CCC experienced a decline in the value of its

investments. The complaint alleges that, in August 2007, several of CCC’s repo counterparties

made substantial margin calls and sought “haircuts,”7 which required CCC to provide more

collateral for the loans used to finance the RMBS assets. Id. ¶ 116. These demands negatively

affected CCC’s liquidity cushion. Id. ¶ 117. Around August 7, 2007, Stomber sought and

received permission from the Board to reduce the liquidity cushion to 15 percent for a period of

ninety days. Id. On August 23, 2007, the Board held an emergency meeting, at which defendant

6 Because the Supplement is not paginated, the Court assigned the page numbers

referenced in the citations by beginning to count on the cover page.

7 A “haircut” is the “difference between the amount of a loan and the market value of the

collateral securing the loan.” Black’s Law Dictionary 781 (9th ed. 2009).

Hance informed Board members that the recent market events had “diminished [CCC’s] liquidity

cushion below zero.” Id. ¶ 119. Stomber allegedly told the Board at the meeting that

“[m]anagement believes it would be prudent to wind down the Company to its core level at this

time.” Id.

On August 27, 2007, Stomber informed shareholders in a letter that the recent market

volatility had resulted in increased margin calls and that “CCC’s liquidity cushion has not been

sufficient to meet recent margin calls.” Id. ¶ 122. On September 11, 2007, the Carlyle Investor

Conference took place in Washington, DC, at which Stomber said that “fundamental revisions to

CCC’s business model were required and would be implemented.” Id. ¶ 126. He acknowledged

that “CCC’s business model needed to be thoroughly restructured to reduce leverage and

increase minimum liquidity cushion to at least 40%.” Id. According to the complaint,

defendants made a commitment to (1) “employ less leverage”; (2) “have more diversified asset

classes”; and (3) “improv[e] and stabiliz[e] sources.” Id. But plaintiffs allege that despite these

promises, defendants did not take any steps to maintain or increase the liquidity cushion, which

had been reduced to 3 percent of CCC’s adjusted capital by November 13, 2007. Id. ¶ 130.

At a meeting on November 13, 2007, the Board approved amendments to the definition

of the term “liquidity cushion” to include undrawn debt from Carlyle as liquid assets. Id. ¶ 131.

Plaintiffs allege that this revision made “CCC’s position appear more favorable than it was”

because “the Board did not take any steps to actually address CCC’s precarious liquidity

problems and over-accumulation of RMBS-based assets.” Id. The Board met again on February

27, 2008, and voted to suspend the 20 percent liquidity cushion until September 2008. Id. ¶ 137.

The same day, CCC issued its annual report for the year ending December 31, 2007, which

reported that “[d]uring the fourth quarter our portfolio stabilized and we were able to generate

returns consistent with our near term targets.” Id. ¶ 138; see also Ex. 3 to CD Mem. at 4

[Dkt. # 52-5].

But on March 5, 2008, CCC issued a press release announcing that “since filing its

annual report on February 28, 2008, the Company ha[d] been subject to margin calls and

additional collateral requirements totaling more than $60 million.” Id. ¶ 140; Ex. 9 to CD Mem.

at 1. The press release went on to say:

Until March 5, the Company had met all of the margin requirements

imposed by its repo counterparties. However, on March 5, the Company

received additional margin calls from seven of its [thirteen] repo

counterparties totaling more than $37 million. The Company has met

margin calls from three of these financing counterparties that have

indicated a willingness to work with the Company during these

tumultuous times, but did not meet the margin requirements of the four

other repo financing counterparties. From this group of four

counterparties, one notice of default has been received by the Company

and management expects to receive at least one additional default notice.

Id. One week later, on March 12, 2008, CCC issued another press release announcing:

[A]lthough it has been working diligently with its lenders, the Company

has not been able to reach a mutually beneficial agreement to stabilize its

financing. The Company expects that its lenders will promptly take

possession of substantially all of the Company’s remaining assets.

The only assets held in the Company’s portfolio as of today are the U.S.

government agency AAA-rated residential mortgage-backed securities

(RMBS). During the last seven business days, the Company received

margin calls in excess of $40 million. As the Company was unable to pay

these margin calls, its lenders proceeded to foreclose on the RMBS

collateral. In total, through March 12, the Company has defaulted on

approximately $16.6 billion of its indebtedness. The remaining

indebtedness is expected soon to go into default.

Ex. 10 to CD Mem. at 1; see also Compl. ¶ 141.

On March 17, 2008, CCC entered liquidation, and the Royal Court of Guernsey

appointed liquidators “to wind down the affairs of, and liquidate, the enterprise.” Id. ¶ 142.

CCC’s liquidators filed suit in Delaware Chancery Court against the Carlyle entities and CCC’s

former directors, alleging breach of fiduciary duty claims under Delaware and Guernsey law.

Carlyle Capital Corp. v. Conway, et al., No. 10-5625 (Del. Ch. July 7, 2010).

C. The Cases Before the Court

1. The consolidated cases

There are currently four related cases pending before the Court:

Phelps v. Stomber, et al., 11-cv-1142. Plaintiffs filed this action on June 21, 2011,

alleging violations of federal securities law;

Phelps v. Carlyle Capital Corp., 11-cv-1143. Plaintiffs filed this action on June 21,

2011, alleging the same violations of federal securities law as Phelps v. Stomber;

Glaubach v. Carlyle Capital Corporation Limited, 11-cv-1523. Plaintiff Jonathan

Glaubach filed this related case on August 24, 2011, asserting one claim under the

laws of the United Kingdom;

Wu v. Stomber, 11-cv-2287. Plaintiff Wu and four other plaintiffs filed this action in

New York state court, asserting claims for common law fraud, negligent

misrepresentation, and violations of Dutch statutory laws. The case was removed to

federal court and transferred to this Court on December 27, 2011.

On October 7, 2011, the Court granted plaintiffs’ motion to consolidate both of the

Phelps actions, 11-cv-1142 and 11-cv-1143, and the Glaubach action, 11-cv-1523. Order, Oct.

7, 2012 [Dkt. # 22]. At the time of the consolidation, the Wu action had not yet been transferred

to this Court, so it was not consolidated with the others. Defendants have also filed a pending

motion to dismiss [Dkt. # 26] in the Wu case. The Court considers the motion to dismiss in the

Wu case here, and an identical memorandum opinion will be filed in both the Phelps and Wu

cases.

2. Lead plaintiff

Immediately after filing the complaint in the Phelps action, a group of plaintiffs referred

to as the “McLister Group,” filed a motion for appointment as lead plaintiff [Dkt. # 3] under

Section 21(d)(a)(3)(B) of the Exchange Act, 15 U.S.C. § 78u-4(a)(3)(B), as amended by Section

101(a) of the Private Securities Litigation Reform Act of 1995. Soon thereafter, plaintiff

Glaubach filed a competing motion for appointment as lead plaintiff. [Dkt. # 4]. Because the

Court found that the McLister Group best satisfied the requirements and purpose of the lead

plaintiff procedure in the PSLRA, it granted their motion and denied Glaubach’s motion.

[Dkt. # 37]. Glaubach subsequently filed a motion for reconsideration [Dkt. # 40], which was

denied. [Dkt. # 64].

3. The consolidated complaint

Plaintiffs filed a consolidated complaint on December 5, 2011. [Dkt. # 42]. The

complaint includes eleven counts: the first six address the Offering and the remaining five

address the subsequent sale of CCC shares on the aftermarket.

Count I alleges a violation of Section 10(b) of the Exchange Act and Rule 10b-5 on

behalf of the U.S. Offering Subclass against defendants Stomber, CCC, CIM and

TCG. Compl. ¶¶ 156–71;

Count II alleges a violation of Section 20(a) of the Exchange Act on behalf of the

U.S. Offering Subclass against all defendants. Id. ¶¶ 172–74;

Count III alleges a common law fraud claim on behalf of the Offering Class against

all defendants. Id. ¶¶ 175–77;

Count IV alleges a common law negligent misrepresentation claim on behalf of the

Offering Class against all defendants. Id. ¶¶ 178–80;

Count V alleges a violation of Dutch prospectus liability and tort law on behalf of the

Offering Class against all defendants. Id. ¶¶ 181–86;

Count VI alleges a violation of Section 90 of the Financial Services and Markets Act

(“FSMA”) of 2000, a law of the United Kingdom, on behalf of the Offering Class

against all defendants. Id. ¶¶ 187–91; 8

8 Lead plaintiffs took the position that Count VI should be withdrawn. Tr. of Mot. Hr’g,

Afternoon Session (“PM Tr.”), at 42–43 (May 23, 2012). Therefore, the Court permitted

plaintiff Glaubach to file an opposition to defendants’ motion to dismiss that claim, [Dkt. # 70],

which he had originally advanced.

Count VII alleges a violation of Section 10(b) of the Exchange Act and Rule 10b-5 on

behalf of the U.S. Aftermarket Subclass against all defendants. Id. ¶¶ 192–206;

Count VIII alleges a violation of Section 20(a) of the Exchange Act on behalf of the

U.S. Aftermarket Class against all defendants. Id. ¶¶ 207–08;

Count IX alleges a violation a common law fraud claim on behalf of Aftermarket

Class on behalf of the Aftermarket Class against all defendants. Id. ¶¶ 209–10;

Count X alleges a common law negligent misrepresentation claim on behalf of the

Aftermarket Class against all defendants. Id. ¶¶ 211–12;

Count XI alleges a violation of Dutch prospectus liability and tort law on behalf of

the Aftermarket Class against all defendants. Id. ¶¶ 213–227.

4. Motions to dismiss

On January 17, 2012, defendants TCG, TCG Holdings, CIM, Stomber, Conway, Hance,

and Zupon (“the Carlyle Defendants”) moved to dismiss all of the claims against them under

Federal Rule of Civil Procedure 12(b)(6) and the PSLRA for failure to state a claim upon which

relief can be granted. Carlyle Defendants’ Mot. to Dismiss and Mem. in Supp. (“CD Mem.”)

[Dkt. # 52]. The same day, defendants Allardice, Sarles, and Loveridge (the “Outside

Directors”) moved to dismiss the nine claims filed against them under Rules 12(b)(6) and 9(b).

[Dkt. # 51]. The Outside Directors were not named in Counts I and VII (the section 10(b)

claims) – they argued that the claims filed against them under section 20(a) of the Exchange Act

were insufficient to state a plausible claim. With respect to the common law and foreign law

claims, the Outside Directors joined the arguments advanced by the Carlyle Defendants in their

motion. The Court held a motions hearing on the motions to dismiss on May 23, 2012.

II. STANDARD OF REVIEW

“To survive a [Rule 12(b)(6)] 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 (2009) (internal quotation marks omitted); accord Bell Atl. Corp. v.

Twombly, 550 U.S. 544, 570 (2007). In Iqbal, the Supreme Court reiterated the two principles

underlying its decision in Twombly: “First, the tenet that a court must accept as true all of the

allegations contained in a complaint is inapplicable to legal conclusions.” 556 U.S. at 678. And

“[s]econd, only a complaint that states a plausible claim for relief survives a motion to dismiss.”

Id. at 679.

A claim is facially plausible when the pleaded factual content “allows the court to draw

the reasonable inference that the defendant is liable for the misconduct alleged.” Id. at 678.

“The plausibility standard is not akin to a ‘probability requirement,’ but it asks for more than a

sheer possibility that a defendant has acted unlawfully.” Id. A pleading must offer more than

“labels and conclusions” or a “formulaic recitation of the elements of a cause of action,” id.,

quoting Twombly, 550 U.S. at 555, and “[t]hreadbare recitals of the elements of a cause of

action, supported by mere conclusory statements, do not suffice.” Id.

When considering a motion to dismiss under Rule 12(b)(6), the complaint is construed

liberally in plaintiff’s favor, and the Court should grant plaintiff “the benefit of all inferences that

can be derived from the facts alleged.” Kowal v. MCI Commc’ns Corp., 16 F.3d 1271, 1276

(D.C. Cir. 1994). Nevertheless, the Court need not accept inferences drawn by plaintiff if those

inferences are unsupported by facts alleged in the complaint, nor must the Court accept

plaintiff’s legal conclusions. See Browning v. Clinton, 292 F.3d 235, 242 (D.C. Cir. 2002);

Kowal, 16 F.3d at 1276. In ruling upon a motion to dismiss for failure to state a claim, a court

may ordinarily consider only “the facts alleged in the complaint, documents attached as exhibits

or incorporated by reference in the complaint, and matters about which the Court may take

judicial notice.” Gustave-Schmidt v. Chao, 226 F. Supp. 2d 191, 196 (D.D.C. 2002) (citations

omitted).

For claims alleging fraud, Federal Rule of Civil Procedure 9(b) requires a plaintiff to

“state with particularity the circumstances constituting fraud or mistake.” Fed. R. Civ. P. 9(b).

And securities fraud claims are governed by the heightened pleading standard set forth in the

PSLRA, which exceeds even the standard set forth in Rule 9(b). In its effort to curb potentially

abusive lawsuits, the PSLRA requires plaintiffs to “specify each statement alleged to have been

misleading [and] the reasons why the statement is misleading” and to “state with particularity

facts giving rise to a strong inference that the defendant acted with the requisite state of mind.”

15 U.S.C. § 78u–4(b)(1)–(2); see also Plumbers Local No. 200 Pension Fund v. Wash. Post Co.,

831 F. Supp. 2d 291, 294 (D.D.C. 2011).

In order to assure itself that it had distilled all of the fraud allegations from plaintiffs’

sixty-five page, 227 paragraph consolidated complaint, so that it could properly assess them

under these standards, the Court ordered plaintiffs to prepare a supplemental memorandum after

the hearing on the motions. Plaintiffs were ordered to create a chart that listed every statement in

the Offering documents that they alleged was false as well as every omission that they alleged

was actionable because it rendered the Offering documents to be false. PM Tr. 63–68.

Defendants were then permitted to complete a second column pointing out when and where they

contended the allegedly omitted facts had actually been disclosed and responding to the alleged

affirmative misrepresentations as well. Id.

III. ANALYSIS

Plaintiffs’ claims can be divided into four categories, which the Court will discuss in

turn: (1) federal securities claims pertaining to the Offering; (2) federal securities claims

pertaining to the aftermarket; (3) common law claims pertaining to the Offering; and (4)

common law claims pertaining to the aftermarket. For the reasons set forth below, these claims

will be resolved as follows:

Federal Offering Claims: dismissed for failure to allege a materially misleading

statement or omission and failure to allege loss causation;

Federal Aftermarket Claims: dismissed under Morrison v. National Australia

Bank, 130 S. Ct. 2869 (2010).

Common Law Offering Claims: dismissed on the same grounds and for failure to

plead reliance;

Common Law Aftermarket Claims: in the absence of federal claims, the Court

declines to exercise jurisdiction, but it notes a failure to plead reliance in any

event.

A. Federal Offering Claims

1. Morrison v. National Australia Bank

Counts I and II allege claims under federal securities law related to the Offering. Counts

VII and VIII allege claims under federal securities law pertaining to the aftermarket. Defendants

seek dismissal of all of these claims under the Supreme Court’s decision in Morrison v. National

Australia Bank, 130 S. Ct. 2869, 2883 (2010). Since the analysis of Morrison’s application to

the Offering claims and the aftermarket claims is intertwined, the Court will discuss both sets of

claims in this section, but only the aftermarket claims will be dismissed on these grounds.

In Morrison, the Supreme Court held that Section 10(b) does not apply extraterritorially

to foreign securities transactions. Id. at 2877–78, 2883. Rejecting what had become known as

the “conduct and effects” test, the Court set forth a bright-line “transactional” test for

determining whether a securities purchase is within the scope of section 10(b). The Court held

that section 10(b) covers: (1) “the purchase or sale of a security listed on an American stock

exchange,” or (2) “the purchase or sale of any other security in the United States.” Id. at 2888.

The Court reasoned:

[W]e think the focus of the Exchange Act is not upon the place where the

deception originated, but upon purchases and sales of securities in the

United States. Section 10(b) does not punish deceptive conduct, but only

deceptive conduct “in connection with the purchase or sale of any security

registered on a national securities exchange or any security not so

registered.”

Id. at 2884, citing 15 U.S.C. § 78j(b).

With respect to the first part of the Morrison test, the parties agree that neither the RDSs

nor the Class B shares was listed on an American stock exchange. Mem. of Points and

Authorities in Opp. to Motions to Dismiss (“Pls.’ Opp.”) [Dkt. # 56] at 40; CD Mem. at 25; see

also Compl. ¶ 93; Off. Mem. at 33, 145. Rather, plaintiffs contend that they meet the second

part of the Morrison test because both the RDSs and Class B shares were “bought or sold in the

United States.” Id.

a. No Class B shares were purchased in the Offering, and the Class B shares

sold in the aftermarket were purchased on a foreign exchange.

Taking the Class B shares first, there is no allegation in the complaint that any plaintiff

purchased Class B shares in the Offering in the United States. Indeed, the Offering

Memorandum specifically states that “the Class B shares [could] not be offered or sold within

the United States or to U.S. persons.” Off. Mem. at cover. Plaintiffs do not dispute this. See

PM Tr. at 17 (stating at oral argument that no plaintiff bought any Class B shares at the time of

the Offering).

With respect to the Class B shares purchased in the aftermarket, the complaint alleges

that Class B shares were only listed on the foreign exchange, Euronext. Compl. ¶¶ 32, 109. But

plaintiffs argue that the fact that the shares were sold on a foreign exchange is not dispositive

under Morrison. Their position is that Morrison addressed what they describe as a “foreign

cubed transaction,” involving “foreign plaintiffs, a foreign issuer, and a foreign exchange.” Pls.’

Opp. at 44. Plaintiffs contend that by contrast, this case involves a “U.S. purchaser, a U.S.

issuer, and a foreign stock exchange.” Id. They argue that CCC was actually a U.S. company,

even though it was incorporated under the laws of Guernsey, and that Euronext was actually a

U.S. exchange because while it is located in the Netherlands, it was owned by a Delaware

company. Id. at 44–45. Although plaintiffs acknowledge that other courts have extended

Morrison’s holding to “foreign-squared transactions (those involving a U.S. purchaser, foreign

issuer, and foreign stock exchange), they state that “no court has yet extended Morrison to a fact

pattern involving a U.S. purchaser, a U.S. issuer, and a foreign stock exchange.” Id. at 44.

But plaintiffs’ effort to label everything “Made in America” to get around Morrison

requires the Court to ignore allegations in the complaint and information contained in the

Offering documents referenced in the complaint. According to plaintiffs’ own allegations, CCC

is not a U.S. company – it was incorporated under the laws of Guernsey. Compl. ¶ 40. And

Euronext is not a U.S. exchange. The exchange is located in the Netherlands. Off. Mem. at

cover (stating that Euronext is the “regulated market of Euronext Amsterdam . . . .”). Plaintiff

points to no authority that would suggest that there is any significance to the fact that a foreign

exchange was owned by a U.S. entity. To the contrary, Morrison specifically directed courts to

focus on the geographic location of the transaction, 130 S. Ct. at 2884, and here, the aftermarket

purchase of Class B shares occurred on a foreign exchange. The Court notes that other courts

that have considered similar questions after Morrison have treated Euronext as a foreign

exchange. Carlyle Defendants’ Reply Brief in Supp. of Mot. to Dismiss (“CD Reply”)

[Dkt. # 63] at 7, citing In re Vivendi Universal, S.A. Sec. Litig., No. 02 Civ. 5571 (RJH) et al., ---

F. Supp. 2d ---, 2012 WL 280252, at *1 (S.D.N.Y. Jan. 27, 2012); In re Société Générale Sec.

Litig., No. 08 Civ. 2495 (RMB), 2010 WL 3910286, at *5 (S.D.N.Y. Sept. 29, 2010). 9 So, the

aftermarket securities claims do not survive the motion to dismiss under Morrison.

b. No RDSs were purchased in the aftermarket, and the RDSs sold in the

Offering were “bought or sold” in the United States.

The complaint does not allege that plaintiffs purchased RDSs in the aftermarket, so the

Court is only concerned with RDSs that were purchased in the Offering. See, e.g., Compl. ¶¶ 4,

5, 6, 7, 8 (alleging that each plaintiff purchased RDSs in the Offering). Plaintiffs point to the

following allegations in the complaint as support for the conclusion that the RDSs were

purchased in the United States for Morrison purposes:

The RDSs were sold to U.S. investors in the Offering under Regulation D, 17 C.F.R.

§§ 230.501–230.508, and Rule 144A, 17 C.F.R. § 230.144A, which are the two

registration exemptions applicable to securities sold in the United States. Id. ¶ 85.

The RDSs were issued by the Bank of New York, which described them as “U.S.

securities” on their website. Id. ¶ 90.

The subscription documents were transmitted to Citigroup Global Markets, a U.S.

brokerage-dealer in New York. Id. ¶ 94, 104.

CCC hired six New York-based broker-dealers for “solicitation of purchasers”

throughout the United States. Id. ¶ 101.

U.S. investors were only permitted to purchase RDSs in the Offering because they

were not eligible to buy Class B shares. Id. ¶¶ 92, 93.

In addition, the complaint alleges that the plaintiffs were residents of the United

States and that their participation in the Offering was solicited by their stockbrokers,

who were registered U.S. broker-dealers. Id. ¶¶ 4–8.

9 In addition, the fact that plaintiffs insist that Dutch law should apply to the common law

claims pertaining to the aftermarket because the Netherlands is the jurisdiction with the most

significant relationship to aftermarket claims, see Pls.’ Opp. at 57–58, undercuts their argument

here that Euronext is actually an American exchange.

Taking these allegations together, there is no question that the RDSs were “bought and

sold in the United States,” and defendants do not appear to challenge that conclusion seriously.

Rather, their primary contention is that the RDSs sold here were “tethered” to the Class B shares

sold only on the foreign exchange. CD Mem. at 27.

What we really have here is we have a[n] actual security that has to be

traded on the foreign exchange. So the loop is not completed. If I buy an

RDS, it’s not over. There has to be a corresponding purchase of a Class B

share.

Tr. of Mot. Hr’g, Morning Session (“AM Tr.”), at 54 (May 23, 2012). Under those

circumstances, defendants urge the Court to look at the “economic reality” underlying the

transaction and to conclude that purchasing an RDS was “a transaction that has a necessary

foreign connection” for Morrison purposes. Id. at 50.

In support of this argument, defendants point to several post-Morrison cases from courts

in other districts. CD Mem. at 27–28, citing Société Générale, 2010 WL 3910286, at *6–7 and

Elliott Associates v. Porsche Automobil Holdings SE, 759 F. Supp. 2d 469, 477 (S.D.N.Y. 2010).

In Société Générale, the plaintiffs had purchased securities known as American Depository

Receipts (“ADRs”) in the United States, which are similar to RDSs in that they represent the

shareholder’s ownership of a foreign security traded on a foreign exchange. 2010 WL 3910286,

at *1. The court determined that because “trade in ADRs is considered to be a predominately

foreign securities transaction,” section 10(b) did not apply. Id., at *4 (internal quotation marks

omitted). Elliot concerned the purchase of securities-based swap agreements that referenced the

share price of a foreign stock. 759 F. Supp. 2d at 470. The district court observed that the swap

agreements at issue were “the functional equivalent of trading the underlying [company’s] shares

on [a foreign] exchange” and therefore the “economic reality” is that such agreements are

“essentially ‘transactions conducted upon foreign exchanges and markets,’ and not ‘domestic

transactions’ that merit the protection of [section] 10(b).” Id. at 476, citing Morrison, 130 S. Ct.

at 2882, 2884. The court therefore dismissed the section 10(b) claims on those grounds.

Relying on these cases, defendants suggest that the Court employ an “economic reality”

or “functional equivalent” test to determine whether the claims are barred under Morrison. AM

Tr. at 50. But, in the Court’s view, the “functional equivalent” gloss that the Elliot and Société

Général courts have developed is inconsistent with the bright line test set forth by the Supreme

Court in Morrison, which focuses specifically and exclusively on where the plaintiff’s purchase

occurred. The Supreme Court was clear in its holding that “the focus of the Exchange Act is not

upon the place where the deception originated, but upon purchases and sales of securities in the

United States.” Morrison, 130 S. Ct. at 2884. While defendants’ contention that an investor

could not purchase an RDS in the United States without a corresponding overseas transaction

may be true, it does not change the fact that a purchase in the United States still took place. 10

In sum, the Court concludes the following with respect to Morrison:

The federal securities claims with respect to the Offering are not barred by Morrison

because plaintiffs’ purchases of RDSs constituted a “purchase or sale of [a] security

in the United States.” Id. at 2993.

The federal securities claims with respect to the aftermarket are barred by Morrison

because the Class B shares were purchased on a foreign exchange and therefore were

not bought or sold in the United States. Accordingly, Counts VII and VIII are

dismissed with prejudice.

10 The Elliott case relied upon by defendants is also distinguishable on other grounds. In

Elliott, because the issuer sponsored the sale in the United States, the court emphasized that it

was “loathe to create a rule that would make foreign issuers with little relationship to the U.S.

subject to suits here simply because a private party in this country entered into a derivatives

contract that references the foreign issuer’s stocks.” 759 F. Supp. 2d at 476. Those factual

circumstances are not present here, where CCC’s RDS program was purposefully sponsored by

the issuer to make shares available for purchase in the United States. See Off. Mem. at 113.

2. Statute of limitations

Defendants next contend that the federal securities claims pertaining to the Offering are

time-barred. 11 This is a close question, which the Court need not resolve in this case.

Federal securities claims are governed by a two year statute of limitations which begins

to run “[two] years after the discovery of the facts constituting the violation[.]”

28 U.S.C. § 1658; see also Merck & Co. v. Reynolds, 130 S. Ct. 1784, 1790 (2010). The

Supreme Court has explained that “discovery of the facts constituting the violation ‘encompasses

not only those facts that the plaintiff actually knew, but also those facts a reasonably diligent

plaintiff would have known.’” Merck, 130 S. Ct. at 1796. And, in Merck, the Court made it

clear that “the facts constituting the violation” to be known or discovered include facts showing

scienter. Id. Accordingly, the question the Court must resolve is when the limitations period

began to run in this case.

The complaint was filed on June 21, 2011. [Dkt. # 1]. Defendants argue that the latest

possible date that a reasonably diligent plaintiff would have discovered the facts underlying the

alleged violation is February 27, 2008 – the date that CCC issued its 2007 annual report for the

year ending December 31, 2007. CD Mem. at 17; AM Tr. at 13–14. 12 Plaintiffs do not dispute

that the annual report contained significant financial information about the company, but they

maintain that they did not discover, and could not have discovered, “the facts constituting the

violation” until the liquidators’ complaint was filed, because that document provided them with

the internal Board communications that support the necessary scienter allegations. Pls.’ Opp. at

11 This analysis also applies to the federal aftermarket claims (Counts VII and VIII).

12 Indeed, defendants contend that most of the relevant facts were publicly available by the

Fall of 2007. CD Mem. at 17.

79–83, 85–86. The gist of the complaint is that defendants fraudulently concealed the true

financial nature of the company by misrepresenting and omitting material information, and

plaintiffs point to the internal communications as the critical evidence allegedly revealing the

difference between what CCC officials knew and what they stated publicly. See id. Under

plaintiffs’ theory, the operative date when the limitations period began running was July 7, 2010,

when the liquidators filed their complaint. 13

But the Merck test is not simply what these plaintiffs know – it asks what a reasonably

diligent plaintiff could have known. Are plaintiffs’ claims time-barred as defendants claim

because there is no allegation that they even attempted to undertake an investigation – that is,

there were no reasonably diligent efforts made to obtain the information at all? Or, can the Court

presume, as plaintiffs ask it to do, that no diligent investigation could have unearthed the internal

emails because that is not the sort of information that is typically available to investors in

advance of litigation? Plaintiffs may well be correct that it is unlikely that the Board would have

handed over its internal communications absent the compulsion of a lawsuit. But it strikes the

Court that adopting the plaintiffs’ approach would mean that the statute of limitations would be

13 Plaintiff’s claim that the statute of limitations did not begin to run until the liquidators’

complaint was filed is somewhat inconsistent with the allegation in paragraph 220 of the

complaint that “as truth about the extent and severity of the deterioration of the financial and

operating condition, and inadequacy of internal controls, of CCC started to be released and

became apparent in the market, the prices of CCC securities plummeted. All or a significant

portion of the decrease in the market prices of CCC stock was due to the disclosure, revelation,

and/or leakage of information inconsistent with [d]efendants’ prior disclosures and other public

filings and releases.” Compl. ¶ 220 (emphasis added); see also id. ¶ 145 (“The collapse of CCC

and the failure of its business model became public knowledge in March 2008 . . . .”); id. ¶ 165

(“the truth started to become apparent in March of 2008”). If, according to plaintiffs, it was the

disclosure of information inconsistent with prior public statements that caused the stock prices to

drop in March of 2008, then the alleged difference between the true financial picture and the

company’s public pronouncements was known to potential plaintiffs at that time. But plaintiffs

submit that the limitations clock did not start ticking because in order to sue, they needed more

than that: they needed specific facts that would satisfy the PSLRA’s high threshold for scienter.

held in abeyance in just about every securities fraud case, and that would be inconsistent with

Merck.

The Supreme Court did provide some guidance in Merck, as it instructed courts to apply

an objective test, not a test that turns on what a particular plaintiff actually did:

We conclude that the limitations period in [28 U.S.C. § 1658] begins to

run once the plaintiff did discover or a reasonably diligent plaintiff would

have “discover[ed] the facts constituting the violation” – whichever comes

first. In determining the time at which “discovery” of those “facts”

occurred, terms such as “inquiry notice” and “storm warnings” may be

useful to the extent that they identify a time when the facts would have

prompted a reasonably diligent plaintiff to begin investigating. But the

limitations period does not being to run until the plaintiff thereafter

discovers or a reasonably diligent plaintiff would have discovered “the

facts constituting the violation,” including scienter – irrespective of

whether the actual plaintiff undertook a reasonably diligent investigation.

Merck, 130 S. Ct. at 1798 (emphasis added). While this language weighs in favor of plaintiffs on

the statute of limitations question, the Court need not resolve the issue because it finds that the

complaint fails to plead adequately a securities fraud claim.

3. Whether the complaint adequately pleads a materially misleading

statement or omission

Defendants seek dismissal of plaintiffs’ securities fraud claims under sections 10(b) and

20(a) of the Exchange Act on the grounds that the complaint fails to allege that defendants made

the necessary false statements or material omissions. Because the viability of plaintiffs’ section

20(a) claim depends on whether they have adequately alleged an underlying section 10(b) claim,

the Court addresses section 10(b) first.

Section 10(b) makes it unlawful for any person to “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 or regulations as the Commission may prescribe as necessary or

appropriate in the public interest or for the protection of investors.” 15 U.S.C. § 78j(b). Rule

10b–5 implements this section by making it unlawful “[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, in

light of the circumstances under which they were made, not misleading[.]”

17 C.F.R. § 240.10b–5(b).

To state a claim under section 10(b), a complaint must include six elements: (1) a material

misstatement or omission; (2) scienter – an intent to deceive or defraud; (3) in connection with

the purchase or sale of a security; (4) through the use of interstate commerce or a national

securities exchange; (5) upon which plaintiffs relied; and (6) which caused injury to plaintiffs. In

re XM Satellite Radio Holdings Sec. Litig., 479 F. Supp. 2d 165, 175 (D.D.C. 2007), citing In re

Baan Co. Sec. Litig., 103 F. Supp. 2d 1, 11 (D.D.C. 2000).

Under the PSLRA, a complaint must “specify each statement alleged to have been

misleading [and] the reason or reasons why the statement is misleading” and must “state with

particularity facts giving rise to a strong inference that the defendant acted with the required state

of mind.” 15 U.S.C. § 78u–4(b)(1), (2). With respect to omissions, a company must disclose

information “‘when silence would make other statements misleading or false.’” XM Satellite,

479 F. Supp. 2d at 178, quoting Taylor v. First Union Corp., 857 F.2d 240, 243–44 (4th Cir.

1999) and In re Time Warner Inc. Sec. Litig., 9 F.3d 259, 268 (2d Cir. 1993) (“A duty to disclose

arises whenever secret information renders prior public statements materially misleading[.]”); In

re NAHC, Inc. Sec. Litig., 306 F.3d 1314, 1330 (3d Cir. 2002) (“To be actionable, a statement or

omission must have been misleading at the time it was made; liability cannot be imposed on the

basis of subsequent events.”).

In addition, the misstatement or omission must be material. “A statement or omission is

material if a reasonable investor would consider it important in deciding whether to buy or sell a

stock.” XM Satellite, 479 F. Supp. 2d at 176, citing TSC Indus., Inc. v. Northway, Inc., 426 U.S.

438, 449 (1976). “‘The touchstone of the [materiality] inquiry is . . . whether defendants’

representations or omissions, considered together and in context, would affect the total mix of

information and thereby mislead a reasonable investor regarding the nature of the securities

offered.’” Id. at 178, quoting Halperin v. eBanker USA.com, Inc., 296 F.3d 352, 357 (2d Cir.

2002).

In this case, the complaint expresses a series of general concerns about how CCC was

structured and managed, and it takes issue with the overall wisdom of the company’s chosen

business model. But the theory underlying the fraud claims in particular emerged more clearly at

the motions hearing. Counsel for plaintiffs told the Court:

The offering claim, in its essence, is a claim that CCC failed to disclose

that it was experiencing a liquidity crisis in June of 2007, just days before

the offering memorandum was published. We’re not talking about generic

liquidity problems; we’re talking about a very specific liquidity crisis that

was happening days before the [O]ffering.

AM Tr. at 20. Counsel went on:

That’s the gravamen of the complaint, is that the company was

experiencing a liquidity crisis certainly by the June 7th to June 14th time

frame, as revealed by internal e-mail correspondence that only became

public upon filing of a complaint by the liquidator of Carlyle Capital,

which was filed in July of 2010.

Id.

Plaintiffs submit that the omitted information about the financial condition of CCC at the

time of the Offering was “sufficiently material to affect the ‘total mix’ of information available

to prospective investors, who, if given full disclosure” may have been dissuaded from investing.

Pls.’ Opp. at 11. Specifically, plaintiffs place emphasis on an e-mail sent by defendant Stomber

to CCC’s directors just days before the Offering on June 13, 2007, which stated: