Dees et al v. Colonial BancGroup, Inc. et al (LEAD)

Filing 530

MEMORANDUM OPINION. Signed by The Honorable R. David Proctor on 3/27/14. (scn, )

IN THE UNITED STATES DISTRICT COURT
FOR THE MIDDLE DISTRICT OF ALABAMA
NORTHERN DIVISION

In re COLONIAL BANCGROUP,
INC. SECURITIES LITIGATION

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Case No.: 2:09-CV-00104-RDP-WC

MEMORANDUM OPINION
This matter is before the court on the remaining portion of PwC’s Motion to Dismiss
Plaintiffs’ First Amended Consolidated Class Action Complaint (“FAC”) (Doc. # 436), and deals
with a claim asserted against PwC not addressed in the court’s prior Order. (Doc. # 522). That
particular claim arises under Section 10(b) of the Securities Exchange Act of 1934 (the “Act”),
which forbids:
[A]ny person, directly or indirectly ... [from] ... us[ing] or employ[ing], in connection
with the purchase or sale of any security registered on a national securities exchange
... any manipulative or deceptive device or contrivance in contravention of such rules
and 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, issued by the Securities Exchange Commission under Section 10(b)
of the Act, makes it unlawful:
(a) To employ any device, scheme, or artifice to defraud,
(b) To 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 were made, not misleading, or
(c) To 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.

I.

Applicable Law
Pursuant to Section 10(b) and Rule 10b-5, a securities fraud claim based on failure to reveal

information to investors has six required elements: “(1) a material misrepresentation or omission;
(2) made with scienter; (3) a connection with the purchase or sale of a security; (4) reliance on the
misstatement or omission; (5) economic loss; and (6) a causal connection between the material
misrepresentation or omission and the loss, commonly called ‘loss causation.’” Mizzaro v. Home
Depot, Inc., 544 F.3d 1230, 1236-37 (11th Cir. 2008) (quoting Dura Pharms., Inc. v. Broudo, 544
U.S. 336, 341-42 (2005)).
Securities fraud claims, like general fraud claims, must meet the heightened pleading
standard of Federal Rule of Civil Procedure 9(b), which requires that such claims be pled with
“particularity.” Fed.R.Civ.P. 9(b). The requirements of Rule 9(b) are designed to notify defendants
of the “precise misconduct with which they are charged.” Ziemba v. Cascade Intern., Inc., 256 F.3d
1194, 1202 (11th Cir. 2001) (quoting Durham v. Bus. Mgmt. Assocs., 847 F.2d 1505, 1511 (11th Cir.
1988) but internal quotations omitted). In Ziemba, the Eleventh Circuit found that Rule 9(b) was
satisfied when the complaint states “(1) precisely what statements were made in what documents or
oral representations or what omissions were made, and (2) the time and place of each such statement
and the person responsible for making (or, in the case of omissions, not making) same, and (3) the
content of such statements and the manner in which they misled the plaintiff, and (4) what the
defendants obtained as a consequence of the fraud.” Id. (quoting Brooks v. Blue Cross and Blue
Shield of Florida, Inc., 116 F.3d 1364, 1371 (11th Cir. 1997)). Under Rule 9(b), “[m]alice, intent,
knowledge, and other conditions of a person’s mind may be alleged generally.” Fed. R. C iv. P. 9(b).

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In 1995, Congress passed the Private Securities Litigation Reform Act (“PSLRA”), which
was intended to be “a check against abusive litigation by private parties.” Tellabs, Inc. v. Makor
Issues & Rights, Ltd., 551 U.S. 308, 313 (2007). Upon its passage, the PSLRA was intended to
impose stringent pleading requirements on securities fraud plaintiffs and made two important
changes in the area of securities fraud class action pleading. First, a securities fraud class action
complaint must “specify 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). Second, the PSLRA requires a securities fraud plaintiff to
offer heightened pleading of scienter:
in any private action arising under this chapter in which the plaintiff may recover
money damages only on proof that the defendant acted with a particular state of
mind, the complaint shall, with respect to each act or omission alleged to violate this
chapter, 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)(2). The Supreme Court has held that this “strong inference” of scienter is met
when the inference is “more than merely plausible or reasonable – it must be cogent and at least as
compelling as any opposing inference of nonfraudulent intent.” Tellabs, 551 U.S. at 314 (emphasis
added). This inquiry should focus on 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 323.
The Eleventh Circuit has also addressed claims under Section 10(b) and Rule 10b-5 and has
found that those provisions “require a showing of either an ‘intent to deceive, manipulate, or

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defraud’ or ‘severe recklessness.’” Mizzaro, 544 F.3d at 1238 (quoting Bryant v. Avado Brands, Inc.,
187 F.3d 1271, 1282 (11th Cir. 1999)).
Severe recklessness is limited to those highly unreasonable omissions or
misrepresentations that involve not merely simple or even inexcusable negligence,
but an extreme departure from the standards of ordinary care, and that present a
danger of misleading buyers or sellers which is either known to the defendant or is
so obvious that the defendant must have been aware of it.
Id. Our court of appeals has explicitly rejected “the notion that allegations of motive and opportunity
to commit fraud, standing alone, are sufficient to establish scienter in this Circuit.” Bryant, 187 F.3d
at 1285-86.
To be sure, section 10(b) and Rule 10b-5 do not protect investors against negligence or
corporate mismanagement. Indiana Elec. Workers’ Pension Trust Fund IBEW v. Shaw Group, Inc.,
537 F.3d 527, 539 (5th Cir. 2008). Furthermore, “[w]hile the consequences of [] fraud are dire
indeed, the PSLRA limits the extent to which outside auditors—only indirectly involved with any
wrongdoing—may be held accountable for investors’ losses.” Iowa Public Employee’s Retirement
System v. Deloitte & Touche LLP, 919 F.Supp.2d 321, 326 (S.D.N.Y. 2013).
II.

The Alleged Misstatements
Although the FAC alleges a number of alleged misstatements, Plaintiffs seek to hold PwC

liable only for certain of its opinions related to Colonial’s financials. In particular, in their most
recent pleading, Plaintiffs allege that PwC made three false and misleading statements in its audit
reports issued in connection with Colonial’s 2007 and 2008 year end consolidated financial
statements:
(1)

That Colonial’s 2007 and 2008 financials were accurate and complied with GAAP;

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(2)

PwC conducted its 2007 and 2008 audits of Colonial’s financials in accordance with
GAAS; and

(3)

Colonial maintained, in all material respects, effective internal control over financial
reporting as of December 31 in 2007 and 2008.

(Doc. # 424 at ¶¶ 701-02).
III.

Discussion
PwC argues that Plaintiffs’ claims against it fail at the threshold for at least three reasons.

First, PwC contends that Plaintiffs have failed to allege material misrepresentations. Second, PwC
asserts that Plaintiffs have failed to adequately plead scienter. Finally, PwC argues that Plaintiffs
have not plead loss causation. These contentions are addressed in turn below.
A.

Plaintiffs Have Failed to Allege Material Misstatements

A review of Plaintiffs’ pleadings makes clear that the alleged misstatements reflect PwC’s
opinions as to Colonial’s financial reports. See Buttonwood Tree Value Partners, LP v. Sweeney,
2012 WL 2086607, at *2 (C.D. Cal. 2012) (“An auditor’s report is a statement of professional
opinion, not fact.” (citing In re Lehman Bros. Sec & ERISA Litig., 799 F.Supp.2d 258, 300-03
(S.D.N.Y. 2011) (holding that statements regarding compliance with GAAS and GAAP are
inherently statements of opinion)); see also Belmont Holdings Corp. v. SunTrust Banks, Inc., 896
F.Supp.2d 1210, 1228 n.17 (N.D. Ga. 2012) (“audit opinions are statements of opinion or belief
about [a company’s] financial results, the effectiveness of a company’s internal controls, and
compliance with accounting standards.”).
“To state a § 10(b) claim against an issuer’s accountant, a plaintiff must allege a
misstatement that is attributed to the accountant ‘at the time of its dissemination,’ and cannot rely
on the accountant’s alleged assistance in the drafting or compilation of a filing.” Lattanzio v.
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Deloitte & Touche LLP, 476 F.3d 147, 153 (2d Cir. 2007) (quoting Wright v. Ernst & Young LLP,
152 F.3d 169, 174 (2d Cir. 1998)). “If the statement is an opinion, it is actionable only if ‘the
complaint alleges that the speaker did not truly have the opinion at the time it was issued.’” Perry
v. Duoyuan Printing, Inc., 2013 WL 4505199, at *5 (S.D.N.Y. 2013) (quoting In re Lehman Bros.
Sec. & ERISA Litig., 684 F.Supp.2d 485, 494 (S.D.N.Y. 2010) and citing Shields v. Citytrust
Bancorp., 25 F.3d 1124, 1131 (2d Cir. 1994)). Alternatively, a complaint must allege facts that, if
true, would permit a conclusion that the auditors knew that they had no reasonable basis for their
opinion. In re China Valves Technology Securities Litigation, 2013 WL 5708570, at *10 (S.D.N.Y.
2013) (quoting In re Lehman Bros. Sec. & Erisa Litig., 799 F.Supp.2d 258, 293-94 (S.D.N.Y.
2011)).
In Garfield, the Eleventh Circuit provided us a common sense model to evaluate whether a
securities plaintiff’s allegations are sufficiently particularized. There, the court noted that Rule 9(b)
requires a plaintiff to plead “the who, what, when, where and how [of the alleged fraud]: the first
paragraph of any newspaper story.” 466 F.3d at 1262. Plaintiffs’ pleadings fall far short of
Garfield’s requirements.
In large measure, Plaintiffs rely on reports issued or events occurring after the fact to allege
that PwC had no reasonable basis for its 2007 and 2008 clear audit opinions. In the section of the
FAC addressing “Material Misstatements by PwC,” paragraph 701 alleges that PwC’s statements
in the 2007 and 2008 audit reports were “untrue for the reasons set forth in Section VII.FF above.”
(Doc. # 424 at ¶ 701). Section VII.FF of the FAC is entitled “False and Misleading Statements
Approved by PwC.” (Doc. # 424 at ¶¶ 584-85). The allegations contained within that section are
found in paragraphs 585 through 661. Nowhere in those paragraphs do Plaintiffs allege that PwC
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“did not truly have the [stated] opinion at the time it was issued.’” Perry, 2013 WL 4505199, at *5.
(Doc. # 424 at ¶¶ 584-661). Rather, Plaintiffs merely repeat allegations to the effect that
“Defendants knew or were reckless in not knowing that Colonial’s accounting practices [or
underwriting standards] and controls were weak and resulted in inaccurate” measurements. (See,
e.g., Doc. # 424 at ¶¶ 597, 604, 608, 610, 612, 616, 621, 635, 646, 650, and 653) (emphasis added)).
In addition, these paragraphs fail to allege that PwC had no reasonable basis for its opinion.
This is “the classic fraud by hindsight case where a plaintiff alleges that the fact that
something turned out badly must mean defendant knew earlier that it would turn out badly.”
Louisiana School Employees’ Retirement System v. Ernst & Young, LLP, 622 F.3d 471, 484 (6th Cir.
2010) (quoting Konkol v. Diebold, Inc., 590 F.3d 390, 403 (6th Cir. 2009)). To be sure, the financial
failure of Colonial occurred during a historic recession. But even in circumstances not involving
such a recession, when an audited entity’s financials turn out to be false, courts routinely have
rejected this type of fraud-by-hindsight pleading directed at the auditor. See, e.g., Novak v. Kasaks,
216 F.3d 300, 309 (2d Cir. 2000) (“[A]llegations that defendants should have anticipated future
events and made certain disclosures earlier than they actually did do not suffice to make out a claim
of securities fraud.”). Hindsight allegations simply do not suggest fraud. Without specific
allegations that PwC either knew or recklessly disregarded the falsity of its own statements at the
time the statements were made, the fact that the statements later turned out to be false is irrelevant
to a cause of action under the PSLRA. Plaintiffs have failed to allege facts sufficient to show that
PwC either did not in fact hold the opinions stated in the audit reports, or that there was no

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reasonable basis for those opinions.1 That is, Plaintiffs’ allegations do not address whether
Colonial’s 2007 financial statements were misstated when they were issued. See, e.g., In re Fannie
Mae, 742 F.Supp.2d at 411 (finding that post-conservatorship write-down of securities did not
support allegations that impairment existed at the time the financial statements were issued).
Therefore, they have failed to adequately allege particularized facts that, if proven, would show that
PwC made any material misstatements of fact.
B.

Plaintiffs Have Failed to Adequately Plead Scienter

Some rules of law have developed in the securities area when a securities plaintiff’s case
targets an outside accounting firm performing an audit. “An outside auditor will typically not have
an apparent motive to commit fraud, and its duty to monitor an audited company for fraud is less

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By way of example, Plaintiffs’ allegations relating to goodwill are fairly typical of the FAC’s fraud-by-hindsight approach. Likewise, the
FAC follows this same formula in challenging matters related to Colonial’s allowance for loan losses and its valuation of its mortgage-backed securities.
But, for reasons explained in Defendants’ briefing (see Doc. # 437 at 35-37), Plaintiffs cannot sustain those claims on such theories.
GAAP sets forth a fact-intensive, two-part test for determining whether goodwill has been impaired (i.e., worth less than the amount
recorded). By its very nature, this test requires a company to make subjective estimates, including projections related to its future cash flow and the
future value of its assets and liabilities. (See Doc. # 424 at ¶ 241; Doc. # 437-6 at 21-22). Colonial tested its goodwill for impairment in the third quarter
of 2007, at the end of 2007, and throughout 2008. On each of those occasions, it was determined that it did not need to reduce the recorded value of
that asset. (Note: The court acknowledges Plaintiffs’ assertion that Colonial did not test for goodwill impairment between the third quarters of 2007
and 2008 (Compl. ¶ 251) is not only flat wrong, it is also inconsistent with other allegations in the FAC. Colonial’s public filings show that the Company
tested for goodwill impairment during that period. See Doc. # 424 at ¶ 494 (quoting Colonial’s SEC filings)). In the fourth quarter of 2008, as the
economic crisis reached a crescendo, the bank recorded a $575 million reduction to goodwill. (Id. at ¶ 10).
Rather than alleging particularized facts showing that the GAAP criteria for goodwill impairment required Colonial to reduce goodwill in
its year-end 2007 financial statements, Plaintiffs allege merely that Colonial should have reduced its goodwill earlier because it eventually was required
to take a large impairment charge at the end of 2008. (Doc. # 424 at ¶ 254). But these type of allegations could be leveled against nearly any company
following the credit crisis of last decade. As one court explained in dismissing similar allegations:
Instead of explaining why optimism [about goodwill] was unwarranted at each step of the way . . ., the
amended complaint simply cites disappointing figures from the future as though these are evidence of
fraud in the past. If that were true, of course, we would have to conclude that almost every company in
the fall of 2008 was run by fraudsters because their predictions would have been knocked down by the
dramatic recession . . . . It should go without saying that one could be mistaken in a prediction about the
future without committing fraud.
Iron Workers Local No. 25 Pension Fund v. OshKosh Corp., 2010 WL 1287058, at *17 (E.D. Wis. Mar. 30, 2010); see also City of Sterling Heights
Police & Fire Ret. Sys. v. Vodafone Group Public, Ltd., 655 F.Supp.2d 262, 272 (S.D.N.Y. 2009)(“That Vodafone ultimately would take an impairment
charge in 2006 does not in itself provide an actionable basis to claim that the failure to do so earlier was fraudulent.”). Further, that Colonial tested
goodwill throughout 2007 and 2008 to determine whether an impairment existed disaffirms any notion of fraud, see OshKosh, 2010 WL 1287058, at
*14-17, particularly when it is an auditor’s actions that are at issue here. When an auditor is the target of a Section 10(b) claim, “the plaintiff must plead
that the market reacted negatively to some disclosure correcting the falsity in the . . . auditor’s statements (not simply the underlying fraud).” Amoroso
v. Ernst & Young LLP, 682 F.Supp.2d 351, 363 (S.D.N.Y. 2010). It is not enough for a plaintiff to allege that the market somehow learned that the
auditor’s client committed fraud—the disclosure must reveal that the auditor’s opinion was false. Id.

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demanding than the company’s duty not to commit fraud. Thus, the failure of a non-fiduciary
accounting firm to identify problems with a company’s internal controls and accounting practices
does not constitute recklessness.” In re Longtop Financial Technologies Ltd. Securities Litigation,
939 F.Supp.2d 360, 377 (S.D.N.Y. 2013), citing Stephenson v. PricewaterhouseCoopers, LLP, 482
Fed.Appx. 618, 623 (2d Cir. 2012), in turn citing Novak v. Kasaks, 216 F.3d 300, 309 (2d Cir. 2000)
(internal quotations and alterations omitted). “In a common formulation, such recklessness must
approximate an actual intent to aid in the fraud being perpetrated by the audited company.” In re
Longtop Financial Technologies Ltd. Securities Litigation, 939 F.Supp.2d at 377 (internal quotations
omitted but quoting Meridian Horizon Fund, LP v. KPMG (Cayman), 487 Fed.Appx. 636, 639-40
(2d Cir. 2012) and in turn quoting Rothman v. Gregor, 220 F.3d 81, 90 (2d Cir. 2000)); accord Iowa
Public Employee’s Retirement System, 919 F.Supp.2d at 344. It is simply not sufficient to allege that
a defendant should have performed a better or more thorough investigation of the financials at issue
or that the auditor had access to the information by which it could have discovered the fraud. In re
Longtop Financial Technologies Ltd. Securities Litigation, 939 F.Supp.2d at 378. A plaintiff’s
section 10(b) claim may only survive “if no reasonable auditor, with access to the type of
information present in [Colonial’s] books and records, would have made the decision to issue a clean
audit report.” Iowa Public Employee’s Retirement System, 919 F.Supp.2d at 336 (citing In re
Scottish Re Group Sec. Litig., 524 F.Supp.2d 370, 385 (S.D.N.Y. 2007)).
Mere allegations of GAAP and GAAS violations are “insufficient to plead scienter against
an outside auditor for the purposes of Section 10(b).” In re Longtop Financial Technologies Ltd.
Securities Litigation, 910 F.Supp.2d 561, 576 (S.D.N.Y. 2012). However, in combination with
allegations that an auditor ignored certain “red flags,” a combination of such violations may
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sufficiently state the requisite state of mind. Iowa Public Employee’s Retirement System, 919
F.Supp.2d at 336 (emphasis added) (citing In re Scottish Re Group Sec. Litig., 524 F.Supp.2d at
385).
In the Eleventh Circuit, “[r]ed flags are ‘those facts which come to the attention of an auditor
which would place a reasonable auditor on notice that the audited company was engaged in
wrongdoing to the detriment of its investors.’ ... ‘It is established, however, that the purported red
flags cannot simply “re-hash” the alleged GAAP violations.’” Garfield v. NDC Health Corp., 466
F.3d 1255, 1268 (11th Cir. 2006) (emphasis added and internal citations omitted). A plaintiff
pleading scienter based on an “ignoring [a] red flag” theory must plead red flags that are more than
simply the “boilerplate ‘red flags,’ present in almost every securities fraud action, [such as] that the
audited company had weak internal accounting controls.” Reiger v. Price Waterhouse Coopers, LLP,
117 F.Supp.2d 1003, 1009 n.5 (S.D. Cal. 2000) (citing Novak, 216 F.3d 300, 309 (2d Cir. 2000)).
Moreover, a securities fraud plaintiff must do more than allege that the auditor had access to
information which would have revealed to it the purported red flags:
Notably, if an auditor is “not aware of facts indicating that a transaction was
suspicious, or part of a fraud, the auditor’s failure to investigate the
transaction—even if negligent—does not provide a basis for a fraud claim.” In re
CBI Holding Co., Inc., 419 B.R. 553, 566-67 (S.D.N.Y. 2009). In the context of red
flags, courts have also noted that an auditor’s access “to the information by which it
could have discovered the fraud is not sufficient” to establish recklessness. In other
words, auditor access is not tantamount to auditor awareness. In re Tremont Sec.
Law, State Law & Ins. Litig., 703 F.Supp.2d 362, 371 (S.D.N.Y. 2010) (citing In re
aaiPharma, Inc., Securities Litig., 521 F.Supp.2d 507, 513-14 (E.D.N.C. 2007) (“For
example, merely because a person has broad access to every book in a library does
not mean that the person has read and chosen to ignore facts contained in a particular
book in the library. Merely alleging that [the auditor] had broad access to [the
client’s] operations at best supports an inference that [the auditor] was negligent, and
more likely supports nothing at all.”)).

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Iowa Public Employee’s Retirement System, 919 F.Supp.2d at 332.
The heart of the court’s scienter analysis focuses on Plaintiffs’ “red flag” allegations in the
FAC since the scienter analysis turns on this issue. Rather than setting forth all of those allegations
here—allegations which span twenty-six pages of the FAC—the court incorporates by reference
those sections of Plaintiffs’ FAC which set forth the “red flag” allegations and will address select
items. (Doc. # 424 at ¶¶ 709-90).
The court has closely reviewed the “red flag” allegations in the FAC and finds the following
deficiencies. The vast majority of the “red flag” section of the FAC recites auditing standards and
regulatory investigations of Colonial. (Doc. # 424 at ¶¶ 709-90). This section also allege that “had
PwC conducted its audits of Colonial in accordance with GAAS, PwC would have been alerted” to
various alleged facts. In many instances, Plaintiffs cite evidence which only came to light after the
fact – including certain regulatory reports and testimony in a criminal trial in 2011 – as evidence of
PwC’s scienter in 2007 and 2008. (Doc. # 424 at ¶¶ 782-87).
Many of the paragraphs in the “red flag” section of the FAC merely set forth GAAS and
GAAP requirements. (Doc. # 424 at ¶¶ 712, 714, 717-23, 765, 781). Those allegations which cite
to auditing standards are just repackaged versions of Plaintiffs’ allegations that PwC violated GAAS
and GAAP and do not support an inference of scienter. See Garfield, 466 F.3d at 1268 (“the
purported red flags cannot simply re-hash the alleged GAAP violations”) (internal quotation marks
omitted).
As to other alleged “red flags,” Plaintiffs merely allege that PwC was “bound to know,”
“bound to review,” or “knew or was reckless in not knowing” information contained in certain
regulatory materials. (Doc. # 424 at ¶¶ 715, 726, 727, 729, 730, 733-35, 738, 740, 742, 746, 748,
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749, 752, 753). However, allegations that an auditor had access to information which would have
revealed to it the purported red flags is insufficient to establish scienter. “[A]uditor access is not
tantamount to auditor awareness.” Iowa Public Employee’s Retirement System, 919 F.Supp.2d at
332, citing In re Tremont Sec. Law, State Law & Ins. Litig., 703 F.Supp.2d 362, 371 (S.D.N.Y.
2010), and in turn citing In re aaiPharma, Inc., Securities Litig., 521 F.Supp.2d 507, 513-14
(E.D.N.C. 2007). Red flags are facts which actually come to the attention of an auditor. Garfield,
466 F.3d at 1268. Plaintiffs have failed to allege that these investigatory materials actually came to
PwC’s attention during its audits.
Moreover, only some of the regulatory materials Plaintiffs allege “were bound to” have come
to PwC’s attention during its 2007 and 2008 audits were even created before PwC issued the relevant
audit reports. The OIG Report heavily relied upon by Plaintiffs (Doc. # 424 at ¶¶ 711, 724, 729,
734(a)-(j), 738 (a)-(e), 739, 743 (a)-(g), 744, 745, 749-51, 755, 773, 779, 780) was issued in 2010.
The FDIC June 2008 Examination Report also relied upon by Plaintiffs was issued in May 2009.
(Doc. # 437-5 at 4-5). Moreover, notably, nowhere do Plaintiffs allege when any other such reports
came to PwC’s attention, or even that they actually did so. These allegations amount to nothing
more than an allegation that PwC had access to documents which should have alerted them to the
fraud, which is insufficient to support a finding of the requisite scienter. See, e.g., Garfield, 466
F.3d at 1268; Iowa Public Employee’s Retirement System, 919 F.Supp.2d at 332. Certainly, these
allegations fail to give rise to a “strong inference” of scienter which is at least as compelling as the
opposing inference of non-fraudulent intent. See Tellabs, 551 U.S. at 314.
Furthermore, the after-the-fact 2010 OIG Report in no way criticizes (or even assesses) the
quality of PwC’s 2007 and 2008 audit opinions, let alone concludes that PwC committed fraud. (See
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generally Doc. # 437-5 - OIG Report). Indeed, even the regulatory reports that Plaintiffs allege were
“bound to have” been noticed by PwC before it issued one or both of its audit opinions would not
have alerted PwC to any fraud. Those reports do not suggest that the regulators suspected fraud.
(See, e.g., Doc. # 437 at 15, 20, 29). To be sure, the regulators whose reports Plaintiffs allege
should have put PwC on notice of fraud did not take any action with regard to Colonial’s finances
until they entered into a December 15, 2008 Memorandum of Understanding, and at that stage the
actions taken were designed to “tak[e] steps which [were] expected to improve [Colonial’s] asset
quality and capital ... .” (Doc. # 437-4 at 7). They did not indicate any suspicion of fraud.
Plaintiffs’ FAC is replete with allegations that PwC would have learned the truth as to
Colonial’s fraud if PwC had performed the due diligence it promised. But these allegations are
simply not sufficient to allege scienter. Dobina v. Weatherford Int’l Ltd., 909 F.Supp.2d 228, 256
(S.D.N.Y. 2012). Judge Scheindlin’s words in In re Longtop Financial Technologies Ltd. Securities
Litigation ring true here:
At bottom, the Complaint alleges fraud by hindsight, a claim that is accorded the
same respect in this Circuit today as it was when Judge Friendly gave it a name.
Fraud is always obvious in retrospect, but it is not reckless to lack clairvoyance.
Apart from its exhaustive recitation of auditing standards and purported red flags, the
Complaint does little more than allege that, had [PwC] performed a better audit,
[Colonial’s] fraud would have been uncovered sooner. Considering the allegations
in the Complaint as a whole, the strongest inference is that [PwC] was duped by
[Colonial and TBW], not that it recklessly enabled them. Accordingly, the Complaint
fails to adequately plead scienter.
910 F.Supp.2d at 579.
Additionally, Plaintiffs have brought to the court’s attention two Complaints filed against
PwC related to its dealings with Colonial and argue that those Complaints support the conclusion
that PwC acted with the requisite scienter. (Docs. # 461-1 and 488-1). However, neither of those
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Complaints alleges that PwC engaged in fraudulent conduct. At worst, they allege claims of
negligence and breach of contract against PwC. (Docs. # 461-1 and 488-1). Moreover, they each
emphasize the fact that the fraud committed here was committed by Colonial’s largest mortgage
banking customer, Taylor Bean & Whitaker Mortgage Corp (“TBW”), not PwC. (Docs. # 461-1 and
488-1). The FDIC’s 2012 Complaint alleges that TBW “committed a massive, multi-year fraud
against Colonial ... .” (Doc. # 488-1 at 1). The allegations against PwC assert that it fell short in its
duties by failing to uncover fraud, not that PwC participated in any such fraud. (Docs. # 461-1 and
488-1). Therefore, these related Complaints have no bearing on the court’s scienter analysis.
After careful analysis, the court finds that Plaintiffs’ allegations of scienter are not as cogent
or as compelling as the opposing inference of nonfraudulent intent. The court finds that all of the
facts alleged, taken collectively, do not give rise to the required strong inference of scienter. Tellabs,
551 U.S. at 314, 323.
C.

Plaintiffs Have Failed to Plead Loss Causation

Pursuant to the PSLRA, Plaintiffs must also shoulder the burden of proving that each alleged
misrepresentation or omission caused the loss for which Plaintiffs seek to recover damages. See 15
U.S.C. § 78u-4(b)(4). That is, Plaintiffs must plead “a causal connection between the material
misrepresentation or omission and the loss, commonly called ‘loss causation.’” Mizzaro, 544 F.3d
at 1236-37 (quoting Dura Pharms., Inc., 544 U.S. at 341-42). The loss causation element requires
that a defendant’s fraud be both the “but-for” and proximate cause of a plaintiff’s later losses.
FindWhat Investor Group v. FindWhat.com, 658 F.3d 1282, 1300 (11th Cir. 2012). “[L]oss
causation describes the link between the defendant’s misconduct and the plaintiff’s economic loss.”
Robbins v. Koger Properties, Inc., 116 F.3d 1441, 1447 (11th Cir. 1997). However, where the
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allegations of a complaint establish that plaintiffs sold all of their stock prior to a corrective
disclosure, those allegations fail to adequately allege loss causation. See Dura Pharms., Inc., 544
U.S. at 342-43 (if the purchaser sells his stock before the relevant truth begins to leak out, the
misrepresentation will not have caused his loss).
“[Al]though § 10(b) is designed to protect against fraud, it is not a prophylaxis against the
normal risks attendant to speculation and investment in the financial markets, and loss causation
therefore ensures that private securities actions remain a scalpel for defending against the former,
while not becoming a meat axe exploited to achieve the latter.” Meyer v. Greene, 710 F.3d 1189,
1196 (11th Cir. 2013). “A plaintiff may demonstrate loss causation circumstantially, by:
(1) identifying a “corrective disclosure” (a release of information that reveals to the
market the pertinent truth that was previously concealed or obscured by the
company’s fraud); (2) showing that the stock price dropped soon after the corrective
disclosure; and (3) eliminating other possible explanations for this price drop, so that
the factfinder can infer that it is more probable than not that it was the corrective
disclosure—as opposed to other possible depressive factors—that caused at least a
“substantial” amount of the price drop.
Meyer, 710 F.3d at 1196 (quoting FindWhat Investor Grp. v. FindWhat.com, 658 F.3d 1282, 1311-12
(11th Cir. 2011). “‘To be corrective, [a] disclosure need not precisely mirror the earlier
misrepresentation, but it must at least relate back to the misrepresentation and not to some other
negative information about the company.’” Meyer, 710 F.3d at 1196 (quoting In re Williams Sec.
Litig.—WCG Subclass, 558 F.3d 1130, 1140 (10th Cir. 2009)). In other words, “‘did the relevant
truth eventually come out and thereby cause the plaintiffs to suffer losses?’” Meyer, 710 F.3d at 1197
(quoting FindWhat, 658 F.3d at 1312). “[A] corrective disclosure must ‘reveal[ ] to the market the
falsity of [a] prior misstatement [ ].’” Meyer, 710 F.3d at 1200 (quoting FindWhat, 658 F.3d at 1311
n. 28).
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Plaintiffs’ FAC identifies five purportedly corrective disclosures that Plaintiffs say revealed
the “truth” about PwC’s alleged misrepresentations. The court addresses them in turn.
The first alleged partial disclosure was an October 22, 2008 Form 8-K issued by Colonial
(Doc. # 424 at ¶ 840) which came after PwC’s 2007 audit, but before its 2008 audit. The October
22, 2008 Form 8-K reported that Colonial’s non-performing assets, net charge offs, and nonperforming loans had increased significantly. Of course, this information is not corrective as to the
2007 audit report because it reported subsequent financial data occurring in 2008, after the 2007
audit report was issued. Nor was it corrective as to the 2008 audit report because it predated that
report which was issued on March 2, 2009. Finally, it was not corrective as to any alleged
misstatements by PwC; it merely reported negative financial results which were worse than
estimated. Therefore, it could not have been a corrective disclosure as to PwC’s audit reports. These
results “may reflect, not the earlier misrepresentation, but changed economic circumstances, changed
investor expectations, new industry-specific or firm-specific facts, conditions, or other events, which
taken separately or together account for some or all of that lower price.” Dura Pharms., Inc., 544
U.S. at 343.
The second alleged partial disclosure was a January 27, 2009 announcement by Colonial of
its fourth quarter 2008 and fiscal year 2008 results. In this announcement, Colonial communicated
a net loss of $825 million for fourth quarter 2008 and $880 million for the year ended December 31,
2008, including $575 million attributable to impairment of goodwill. (Doc. # 424 at ¶ 841). This
is not corrective as to PwC’s 2007 audit report because it reported subsequent financial results
occurring in 2008, after the 2007 audit report was issued. Nor was it corrective as to the 2008 audit

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report because it predated that report which was issued on March 2, 2009. Therefore, it could not
have been a corrective disclosure as to PwC’s audit reports.
The remaining three alleged corrective disclosures are the only ones post-dating PwC’s 2008
audit, and those occurred on June 9, 2009, July 31, 2009, and August 7, 2009 respectively. (Doc.
# 424 at ¶¶ 842-44). None of the named Lead Plaintiffs owned their stock at the time of these
remaining alleged corrective disclosures. (Doc. # 437 at 10, 11, 12, 13). Therefore, these Plaintiffs
cannot establish loss causation. Moreover, the Moyer Trust is not a Section 10(b) Plaintiff; rather,
it is only an additional named Plaintiff with regarding to the Section 11, 12, and 15 claims. (Doc.
# 424 at ¶¶ 19-23, 871). Finally, the Moyer Trust only held Colonial notes to which the Section
10(b) claims do not apply. (Doc. # 424 at ¶¶ 840-44, 871). Therefore, none of the Section 10(b)
Plaintiffs have adequately alleged loss causation.
III.

Conclusion
Plaintiffs have failed to adequately plead three essential elements of their Section 10(b)

claim: a material misstatement, scienter, and loss causation. Even a single failure to allege one of
these elements is fatal to a securities plaintiff’s fraud claim. But here, there is even a greater failure.
Plaintiffs have failed to adequately allege all three. Therefore, Plaintiffs’ Section 10(b) claim
against PwC is due to be dismissed for failure to state a claim. A separate order will be entered.
DONE and ORDERED this

27th

day of March, 2014.

___________________________________
R. DAVID PROCTOR
UNITED STATES DISTRICT JUDGE

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