NECA-IBEW Pension Fund, The Decatur Plan v. Northern Trust Corporation et al

Filing 76

Opinion and Order Signed by the Honorable Joan H. Lefkow on 3/28/2013:Mailed notice(mad, )

IN THE UNITED STATES DISTRICT COURT
FOR THE NORTHERN DISTRICT OF ILLINOIS
EASTERN DIVISION

NECA-IBEW PENSION FUND (THE
DECATUR PLAN) and CITY OF WESTLAND
POLICE & FIRE RETIREMENT SYSTEM,
individually and on behalf of all others
similarly-situated,
Plaintiff,
v.
NORTHERN TRUST CORPORATION, et al.
Defendants.

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No. 10-cv-5339
Judge Joan H. Lefkow

OPINION AND ORDER
Lead plaintiff City of Westland Police and Fire Retirement System and named plaintiff
United Wire Metal and Machine Pension Fund (the “plaintiffs”) are two pension funds that
purchased shares of defendant Northern Trust Corporation. They allege a series of fraudulent
statements or omissions through which Northern Trust artificially inflated the price of its stock.
The funds, on behalf of the certified class, filed an amended complaint in which they allege
violations of federal securities laws against Northern Trust and three executives (the
“defendants”). (See Am. Compl. (Dkt. 28).) The defendants move to dismiss, arguing that the
complaint fails the heightened pleading requirements for allegations of securities fraud. Also
before the court is the plaintiffs’ motion to strike some of the exhibits to the defendants’ motion
to dismiss. For the reasons that follow, the motion to dismiss is granted, while the motion to
strike is denied as unnecessary.

BACKGROUND
The following facts are taken from the complaint and accepted as true for purposes of
ruling on the motion to dismiss. Northern Trust is a publicly-traded bank holding company in
Chicago. Through subsidiaries, it offers banking and wealth management services to businesses
and high net-worth individuals. During the relevant time period, defendant William Osborn
served as Northern Trust’s chief executive officer through December 2007, and chairman of the
board. Defendant Frederick Waddell served as Northern Trust’s president and, since January
2008, as chief executive officer. Defendant Steve Fradkin served as Northern Trust’s chief
financial officer through September 2009 and as president of its Corporate and Institutional
Business Unit since September 2009.
As a publicly-held company, Northern Trust releases financial statements on a quarterly
basis. The plaintiffs’ claims involve the statements or omissions made by the defendants about
the quarterly financial statements released during the class period, October 17, 2007 through
October 20, 2009. At the time, the mortgage market was unraveling, which reverberated
throughout the general financial markets and led to the collapse of many financial institutions.
Northern Trust’s allegedly false or misleading statements concerned two components of its
business: its loan portfolio and its securities lending services.
I.

LOAN PORTFOLIO
The plaintiffs allege that statements made by Northern Trust in conjunction with the

release of its quarterly financial statements misled investors into believing that its loan loss
reserves were adequate. Generally accepted accounting principles require a lender to set funds
aside in reserve to cover anticipated losses from nonperforming loans. Northern Trust set aside a

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loan loss provision each quarter to add to its total loan loss reserve, and announced the amount of
the provision and the total reserve in each quarterly financial statement. The plaintiffs contend
that during the class period, Northern Trust failed to set aside adequate reserves. At the
beginning of the class period, Northern Trust recorded a quarterly loan loss provision of just $6
million and total reserves of $143 million, or .57% of its total loans. (Am. Compl. ¶ 122.) But
by the end of the class period, Northern Trust’s quarterly loan loss provision had grown to $60
million and its total reserve had grown to $333 million, or 1.09% of its total loans. (Id. ¶¶ 67,
122.)
The plaintiffs allege that Northern Trust should have built up a bigger reserve by setting
aside reserves in the amount of 1.09% of its total loans throughout the class period, not just at the
end. According to the plaintiffs, a bigger reserve was required because (1) the real estate market
was collapsing, including in Florida, Illinois, and Arizona where most of Northern Trust’s loans
were concentrated, and (2) Northern Trust had “sacrificed loan quality by originating riskier
loans, such as adjustable-rate or second-home mortgages.” (Id. ¶¶ 64, 67.) The plaintiffs allege
that Northern Trust misled investors about the need for higher loan loss reserves by repeatedly
misrepresenting the quality of its loan portfolio. Specifically, they allege that with the release of
each quarterly financial statement then-chief financial officer Steven Fradkin described the
quality of Northern Trust’s loan portfolio in overly rosy terms, such as:
•

“pristine credit quality remains a hallmark of Northern
Trust,” referring to “longstanding consistent and prudent
strategies” (Id. ¶ 74) (November 8, 2007, remarks to
analysts and the media);

•

“loan portfolio for us has been extremely clean” (Id. ¶ 78)
(January 16, 2008, remarks to analysts, the media and
investors);
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•

“[c]redit quality remained exceptionally strong” (Id. ¶ 81)
(April 15, 2008, remarks to analysts);

•

“our conservative practices and policies have not wavered”
(Id. ¶ 83) (May 28, 2008, remarks to analysts, the media
and investors);

•

“[c]redit quality remains strong” and “our credit metrics
remain outstanding” (Id. ¶ 95) (October 22, 2008, remarks
to analysts, the media, and investors); and

•

“our portfolio it is quite different from many other
banks. . . . The quality of the portfolio continues to be very
sound” (Id. ¶ 115) (July 22, 2009, remarks to analysts, the
media, and investors).

The plaintiffs allege that president and CEO Frederick Waddell also made overly positive
statements about Northern Trust’s loan portfolio.
•

•

II.

referring to the “high quality of our loan and investment
portfolios” (Id. ¶ 94) (October 22, 2008 remarks in press
release); and
“[o]ur outstanding credit quality is noticeably better than
our peers’” (Id. ¶ 102) (January 28, 2009, remarks to
analysts and the media).

SECURITIES LENDING SERVICES
Another financial service that Northern Trust provides to its clients is securities lending.

Northern Trust acts as an agent on behalf of the owners of securities who are seeking to lend the
securities to borrowers. As part of the transaction, the borrower must post collateral with the
lender, typically cash worth about 102-105% of the value of the securities. While the securities
are on loan, Northern Trust invests the collateral in fixed-income securities, earning interest.
When the loan terminates, the collateral is returned to the borrower along with a rebate as

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compensation for use of the collateral. Northern Trust splits the interest generated by investing
the collateral with the lender, less the rebate paid to the borrower who put up the collateral.
The plaintiffs allege that while Northern Trust should have been prudently investing the
collateral in “conservative, low-risk” securities, it opted for “longer-duration and riskier
investments, such as asset- and mortgage-backed securities” to increase the interest generated,
which in turn increased the revenue Northern Trust generated. (Id. ¶¶ 25, 40.) The plaintiffs
allege that Northern Trust continued to hold on to mortgage-backed and similarly risky
securities, including its interests in Sigma Finance Corporation, Theta Finance Corporation, and
Lehman Brothers Holdings, Inc., despite signs that mortgage-related markets were unraveling.
On September 15, 2008, one of those holdings, Lehman Brothers, petitioned for
bankruptcy. On September 17, 2008, Northern Trust issued an SEC Form 8-K report publicly
acknowledging that its collateral pools held Lehman Brothers securities, that Lehman Brothers
had borrowed securities from Northern Trust’s securities lending program, and that the Lehman
Brothers securities were now impaired. On September 21, 2008, Northern Trust announced that
holdings in Lehman, Sigma and Theta were permanently impaired resulting in a collateral
deficiency, meaning the value of the collateral posted by borrowers now fell short of the value of
the securities lent. On September 22, 2008, Northern Trust issued a press release quantifying the
exposure caused by the Lehman Brothers bankruptcy at $821 million. On September 29, 2008,
Northern Trust announced that it would take a pre-tax charge of approximately $525 million to
“support various funds and to buy back illiquid auction rate securities,” and would also incur a
pre-tax charge of approximately $150 million “to provide support for securities lending clients
whose cash collateral [was] negatively impacted by recent market events.” (Id. ¶ 58.)

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III.

STOCK PRICE DROPS
The plaintiffs allege that Northern Trust’s fraudulent statements or omissions about its

loan portfolio and securities lending services artificially inflated the value of its shares. At the
beginning of the class period, the release of its results for the third quarter of 2007 saw the price
of its shares rise from $69.26 per share to more than $74.00 per share. (Id. ¶ 71.) A year later
they traded at more than $80 per share. (Id. ¶ 88.) But upon its September 29, 2008
announcement that, in the wake of the bankruptcy filing of Lehman Brothers, it was taking pretax charges of $150 million to support its securities lending clients, the price of Northern Trust’s
stock fell 18.81% to $64.88 per share. (Id. ¶ 59.) On April 21, 2009, the price fell $1.98 a share
to $56.17, when Northern Trust disclosed its results for the first quarter of 2009, including that
its quarterly loan loss provision had risen to $55 million and total reserve had risen to $286.2
million. (Id. ¶ 106.) By the end of the class period on October 21, 2009, the announcement that
Northern Trust’s credit loss provision for the third quarter was $60 million and its total reserve
was $333 million saw the price of its stock drop $3.29 per share to $54.16. (Id. ¶¶ 118, 119.)
The plaintiffs’ complaint consists of two counts. In Count I, the plaintiffs allege that
Northern Trust and each of the individual defendants violated Section 10(b) of the Securities
Exchange Act of 1934, as well as Securities and Exchange Commission Rule 10b-5, by
deceiving investors about known threats to its loan portfolio and securities lending services. See
15 U.S.C. § 78j(b); 17 C.F.R. § 240.10b-5. In Count II, the plaintiffs allege control person
liability under Section 20(a) of the Securities Exchange Act of 1934. See 15 U.S.C. § 78t(a).
ANALYSIS
I.

MOTION TO DISMISS (Dkt. 34)

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A motion to dismiss under Rule 12(b)(6) challenges a complaint for failure to state a
claim upon which relief may be granted. Fed. R. Civ. P. 12(b)(6). To state such a claim, the
complaint need only contain a “short and plain statement of the claim showing that the pleader is
entitled to relief.” Fed. R. Civ. P. 8(a)(2). To survive a Rule 12(b)(6) motion, the complaint
must not only provide the defendant with fair notice of a claim's basis, but must also establish
that the requested relief is plausible on its face. See Ashcroft v. Iqbal, 556 U.S. 662, 678, 129 S.
Ct. 1937, 173 L. Ed. 2d 868 (2009). “A claim has facial plausibility when the plaintiff pleads
factual content that allows the court to draw the reasonable inference that the defendant is liable
for the misconduct alleged.” Id. at 678. In ruling on a 12(b)(6) motion, the court accepts as true
all well-pleaded facts in the plaintiffs’ complaint and draws all reasonable inferences from those
facts in the plaintiff's favor. Dixon v. Page, 291 F.3d 485, 486 (7th Cir. 2002).
Allegations of fraud are subject to the heightened pleading standard of Rule 9(b), which
requires a plaintiff to “state with particularity the circumstances constituting fraud or mistake.”
Fed. R. Civ. P. 9(b). This requirement is met by pleading the “who, what, when, where, and
how: the first paragraph of any newspaper story.” DiLeo v. Ernst & Young, 901 F.2d 624, 627
(7th Cir. 1990). In addition, private securities actions such as this one must also satisfy the
requirements of the Private Securities Litigation Reform Act of 1995 (“PSLRA”), under which a
complaint must “‘with respect to each act or omission . . . state with particularity the facts giving
rise to a strong inference that the defendant acted with the required state of mind.’” Pugh v.
Tribune Co., 521 F.3d 686, 693 (7th Cir. 2008) (quoting 15 U.S.C. § 78u-4(b)(2)). Allegations
that are based on information and belief must set forth “with particularity all facts on which that
belief is formed.” 15 U.S.C. § 78u-4(b)(1).

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A.

Count I: Violation of § 10(b) and Rule 10b-5

Section 10(b) of the Securities Exchange Act of 1934 makes it unlawful to “use or
employ, in connection with the purchase or sale of any security registered on a national securities
exchange or any security not so registered . . . any manipulative or deceptive device or
contrivance in contravention of such rules and regulations as the [Securities and Exchange]
Commission may prescribe . . .” 15 U.S.C. § 78j(b). Section 10b-5 is implemented by Securities
and Exchange Commission Rule 10b-5, which makes it unlawful to, among other things, “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.” 17 C.F.R. § 240.10b-5. To show a violation of § 10(b) and Rule 10b-5, the
plaintiffs must establish that the defendants (1) made a false statement or omission (2) of
material fact (3) with scienter (4) in connection with the purchase or sale of securities (5) on
which the plaintiffs justifiably relied and (6) that the false statement proximately caused the
plaintiffs’ damages. See Caremark, Inc. v. Coram Healthcare Corp., 113 F.3d 645, 648 (7th Cir.
1997) (citations omitted). The plaintiffs allege that the defendants violated § 10(b) and Rule
10b-5 by making false or misleading statements or omissions (1) as to whether Northern Trust’s
loan loss reserves were adequate in light of the condition of its loan portfolio and (2) failing to
reveal risky investment strategies used by Northern Trust’s securities lending business.

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1.

Loan Loss Reserves
a.

False Statement or Omission

The plaintiffs allege that the defendants violated § 10(b) and Rule 10b-5 by falsely
portraying that Northern Trust’s loan portfolio was “pristine” and “strong” when, in fact, it failed
to maintain an adequate loan loss reserve and relaxed its standards in order to make increasingly
risky loans. Defendants argue that the portion of Count I involving statements about its loan
portfolio should be dismissed because the facts alleged do not plausibly suggest that Northern
Trust failed to set aside adequate reserves or relaxed its lending standards. Therefore, the
defendants contend, the plaintiffs have not plausibly suggested that their statements were false.
In response, the plaintiffs rely on their allegation that Northern Trust should have
maintained reserves at 1.09% of total loans throughout the class period, the level at which
reserves stood at the end of the class period and have stood ever since. (Am. Compl. ¶ 154.)
The allegation evokes the “fraud by hindsight” theory under which a plaintiff attempts to show
that because huge reserves were required at the end of the class period, the defendant must have
known that its reserves were inadequate all along. However, the Seventh Circuit has rejected
attempts to plead fraud by hindsight. In DiLeo v. Ernest & Young, it explained that “plaintiffs
may not proffer the different financial statements and rest” but, rather, must “point to some facts
suggesting that the difference is attributable to fraud.” DiLeo, 901 F.2d at 627.
The plaintiffs dispute that they rely on the fraud by hindsight theory. Rather, they
contend that they have “allege[d] specific, concrete reasons” that Northern Trust’s reserves were
inadequate: (1) the deteriorating mortgage market generally, and (2) the deteriorating condition
of Northern Trust’s existing loan portfolio. (Response (Dkt. 37) at 8.) The plaintiffs allege that

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the collapse of the real estate market generally and the resulting failure of numerous financial
institutions should have alerted Northern Trust that its reserves were inadequate. But the
plaintiffs have alleged no facts to show that Northern Trust ignored the conditions or that it
failed to increase its loan loss provisions each quarter to account for those conditions. To the
contrary, according to the plaintiffs’ allegations, Northern Trust repeatedly increased the
quarterly loan loss provisions as the mortgage market continued to deteriorate over the class
period, from $6 million for the quarter beginning the class period to $60 million for the quarter
ending the class period. (Am. Compl. ¶ 122.) Thus, the plaintiffs have alleged no facts to show
that the defendants’ descriptions of the conditions of Northern Trust’s portfolio, or its loan loss
reserves, were inaccurate when made.
Moreover, while the defendants described Northern Trust’s portfolio as “pristine” and
“strong,” an examination of the full context of their statements reveals that the characterizations
were made along with warnings that market conditions were deteriorating, which could impact
Northern Trust. While discussing Northern Trust’s financial statement for the third quarter of
2007 with analysts at the beginning of the class period, chief financial officer Steve Fradkin
warned that the “cycle of credit quality has been very, very good for quite some time, and it can
only get so good. So is our antenna up? Yes, every quarter we talk about the quality of our loan
portfolio, and it is outstanding, but it won’t stay there forever.” (Am. Compl. ¶ 74). Fradkin
also acknowledged that the market “is changing, and I think you’re seeing that in the results that
most banks are putting up and we’re not above that.” (Id.)
Fradkin’s warnings continued throughout the class period. While addressing results from
the second quarter of 2008, he again warned that “it is a very difficult environment and we are

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not immune to that environment.” (Am. Compl. ¶ 86.) He specifically addressed “a
disproportionate amount of stress in the west coast of Florida. . . . I guess if I had to pick a place,
I’d pick the west coast of Florida, as the one we have to keep the closest eye on.” (Id.) Later,
while addressing third quarter 2008 results, he again acknowledged the deteriorating market
conditions and its effect on Northern Trust’s reserves: “So we believe that we are appropriately
reserved for the environment that we’ve got. Our coverage has gone up as the environment has
deteriorated . . .” (Am. Compl. ¶ 99.) Given that context, the plaintiffs have failed to plausibly
allege that the defendants ignored market conditions generally or the possibility that those
conditions could negatively impact Northern Trust’s portfolio.
In addition to general market conditions, the plaintiffs allege facts specific to Northern
Trust’s portfolio they contend also should have alerted Northern Trust to the need for greater
loan loss provisions. For instance, they cite (1) the growth in nonperforming assets within the
loan portfolio, from $29.3 million at the beginning of the class period to $301.5 million at the
end of the class period, (2) the growth in net charge-offs (loans that will never be paid), from
$8.8 million at the beginning of the class period to $125.8 million at the end, and (3) the fact that
Northern Trust had assigned its riskiest classification to loans totaling $700 million. (Am.
Compl. ¶ 131.) But, again, the plaintiffs have alleged no facts that Northern Trust ignored those
developments or failed to account for them. In fact, Northern Trust reported those developments
in its quarterly financial statements. In addition, it repeatedly increased its quarterly loan loss
provisions in tandem with the increase in nonperforming assets, net charge-offs, and the growth
in the number of loans classified as risky.

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The plaintiffs’ allegations stand in sharp contrast to those in Jones v. Corus Bankshares,
Inc., 701 F. Supp. 2d 1014, 1020 (N.D. Ill. 2010), where the plaintiff specified unfavorable
information about the condition of the defendant’s loan portfolio that the defendant had
withheld, and that contradicted the defendant’s public statements about the portfolio. For
instance, the plaintiffs alleged that, according to confidential sources including a former vicepresident and senior construction manager, construction on condominiums financed by the
defendant had fallen behind schedule, construction costs had skyrocketed, developers were
unable to obtain additional financing needed to complete the condominiums, buyers who had
placed down payments on units were walking away from their purchase commitments, and the
defendant’s creation of Special Purpose Entities to hide its distressed properties, all of which was
withheld from investors. See Corus Bankshares, No. 09 CV 1538, Dkt. 66 ¶ 56 (N.D. Ill.). The
court held that the allegations of information that was withheld and that contradicted public
statements plausibly suggested that the defendant had misled investors about the adequacy of its
reserves. See Corus Bankshares, Inc., 701 F. Supp. 2d at 1020.
The only information the plaintiffs in the instant case allege was withheld was that
Northern Trust had begun to “sacrifice[] loan quality by originating riskier loans, such as
adjustable-rate or second-home mortgages to maintain its client base,” and had “concentrated
[its] loan portfolio in real estate markets that were already showing signs of overheating, such as
in Illinois, Florida and Arizona.” (Am. Compl. ¶ 64.) But the plaintiffs have not identified the
source of those alleged facts. In order to satisfy the heightened pleading requirements of the
PSLRA, a plaintiff must specify the reasons why a statement is misleading. See 15 U.S.C.
§ 78u-4(b)(1). Allegations that cannot be attributed to a source with knowledge are insufficient.

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See Plumbers & Pipefitters Local Union No. 630 Pension-Annuity Trust Fund v. AllscriptsMisys Healthcare Solutions, Inc., 707 F. Supp. 2d 774, 783 (N.D. Ill. 2010) (where a plaintiff
does not purport to have firsthand knowledge of its allegations, it must describe its source in
detail in order to satisfy the requirements of the PSLRA). Thus, when a plaintiff relies on an
insider or other confidential source for the facts alleged, the plaintiff must specify the source’s
relationship to the company in order to establish that the source has a basis for the knowledge it
provided. See Makor Issues & Rights, Ltd. v. Tellabs, Inc., 513 F.3d 702, 712 (7th Cir. 2008).
The plaintiffs here have failed to identify any specific source for their purported knowledge other
than to state generally that their allegations are based on a review of publicly-available
information. The plaintiffs’ failure to specify the source of their allegations run afoul of the
requirements of the PSLRA. See Allscripts-Misys, 707 F. Supp. 2d at 783.
Because the plaintiffs have not identified facts supporting their allegations that reserves
were inadequate or that Northern Trust had relaxed its lending standards, they have failed to
plausibly suggest that Northern Trust’s statements about the condition of its loan portfolio were
false.
b.

Scienter

In addition to failing to plead a false statement or omission, the plaintiffs have also failed
to plead scienter. To establish scienter in the securities fraud context, the plaintiff must show
that “the defendants either knew that the representations they made to investors were false or
were reckless in disregarding a substantial risk that they were false.” Securities & Exchange
Commission v. Lyttle, 538 F.3d 601, 603 (7th Cir. 2008). In assessing whether a plaintiff has
sufficiently pleaded scienter, a court must “consider the complaint in its entirety” to determine

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“whether all of the facts alleged, taken collectively, give rise to a strong inference of scienter.”
Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 322-23, 127 S. Ct. 2499, 168 L. Ed.
2d 179 (2007) (emphasis in original). “[I]n determining whether the pleaded facts give rise to a
‘strong’ inference of scienter, the court must take into account plausible opposing inferences.”
Id.
The plaintiffs argue that they have raised a strong inference of scienter by alleging that
the defendants knew or had access to information that Northern Trust had relaxed its lending
standards and that its loan portfolio was deteriorating. According to the plaintiffs, by alleging
that the defendants knew about the deteriorating condition of Northern Trust’s loan portfolio,
they have created a strong inference that the defendants also knew that their statements that the
portfolio was “pristine” and “clean” were false or made in reckless disregard of the truth.
However, as described above, in fact the defendants repeatedly acknowledged the deteriorating
conditions generally, and that they were affecting Northern Trust’s portfolio. Indeed, in
statements made about results from the fourth quarter of 2008, Fradkin acknowledged that while
the quality of the loan portfolio was still “high,” it was no longer “pristine,” and had
“deteriorated clearly consistent with the environment.” (Am. Compl. ¶ 101.)
The only information that the plaintiff have specifically alleged was withheld by the
defendants was Northern Trust’s purported relaxation of its lending standards. But as discussed
above, this allegation is inadequate because the plaintiffs have not identified its source. In any
event, allegations that “a defendant was aware of the allegedly undisclosed information” without
more is insufficient to create an inference of scienter. New Orleans v. Privatebancorp, Inc., No.
10 C 6826, 2011 WL 5374095, at *4 (N.D. Ill. Nov. 3, 2011).

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Alternatively, the plaintiffs attempt to create an inference of scienter with allegations that
the individual defendants reaped millions of dollars by selling shares of Northern Trust while
prices were artificially inflated. Specifically, they allege that former chairman of the board and
chief executive officer William Osborn sold shares worth $19.8 million during the class period,
while president and current chairman of the board Frederick Waddell sold shares worth $2.3
million, and former chief financial officer and current president of the corporate and institutional
business unit Steven Fradkin sold shares worth $330,305. The plaintiffs also allege that the
individual defendants were incentivized to portray Northern Trust’s loan portfolio as strong
because they received additional compensation for achieving performance goals.
“Without more, an executive’s sale of stock does not lead to the conclusion that he
engaged in fraud.” Davis v. SPSS, Inc., 385 F. Supp. 2d 697, 713 (N.D. Ill. 2005). The “sale
must be suspicious in scope or timing to support an inference of scienter.” Id. The plaintiffs
have alleged no facts that would show the sales to be suspicious, such as facts showing that the
sales were out of line from the defendants’ trading histories. Without such context, the plaintiffs
have not alleged scienter. Silverman v. Motorola, Inc., No. 07 C 4507, 2008 WL 4360648, at
*13 (N.D. Ill. Sept. 23, 2008) (plaintiffs failed to allege scienter because they did not show that
sales of stock were out of the ordinary). Likewise, allegations that an executive’s bonuses were
tied to his corporation’s performance do not support an inference of scienter. Boca Raton
Firefighters’ & Police Pension Fund v. DeVry, Inc., No. 10 C 7031, 2012 WL 1030474, at *12
(N.D. Ill. Mar. 27, 2012) (executive bonuses tied to performance are too commonplace to
support an inference of scienter).

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In short, the plaintiffs have simply failed to allege facts showing that the defendants acted
to mislead investors about the strength of Northern Trust’s portfolio or the adequacy of its loan
loss reserves. As a result, their allegations stand in sharp contrast to those in cases such as Corus
Bankshares, where the plaintiffs plausibly suggested scienter by alleging facts showing that the
defendants secretly created Special Purpose Entities to hide distressed properties from investors.
See Corus Bankshares, 701 F. Supp. 2d at 1022.
In the absence of factual allegations supporting an inference that the defendants intended
to mislead investors about their loan portfolio and loan loss reserves, the plaintiffs have failed to
allege scienter with the particularity required under Rule 9(b) and the PLSRA. Accordingly, the
motion to dismiss the portion of Count I regarding Northern Trust’s loan loss reserves is granted.
2.

Securities Lending

Next, the plaintiffs allege a violation of § 10(b) and Rule 10b-5 based on the following
statements or omissions about Northern Trust’s securities lending services:
•

repeated assurances during the class period that even
though the value of collateral had dropped in one of
Northern Trust’s collateral pools, known as the STEP
holdings, the collateral would mature at par value;

•

Northern Trust’s failure to disclose that it had shifted to an
investment strategy that sought higher returns on the
securities held by its collateral pools, but which also made
the pools’ portfolios longer-term, riskier, and increasingly
illiquid;

•

Northern Trust’s failure to disclose unrealized losses in the
collateral pools, instead encouraging investors to continue
their participation in the pools; and

•

Northern Trust’s failure to disclose that it had not properly
“mitigate[d] increasingly significant investment exposures.

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(Resp. (Dkt. 37) at 24.)
a.

Forward-Looking Statement

The only false statements that the plaintiffs contend constitute a violation of § 10(b) and
Rule 10b-5 are statements made by Fradkin that Northern Trust “continue[s] to expect that the
[STEP] fund’s holdings will mature at par.” (Am. Compl. ¶¶ 83, 86.) Fradkin made the
statements while addressing the fact that although the value of securities held in the STEP fund
had dropped, the securities had not yet been sold, no loss had been realized, and Fradkin
expected the securities to regain the lost value before they matured. (Am. Compl. ¶¶ 83, 86.)
Because Fradkin’s statements about his expectations for the STEP fund are forwardlooking, the required level of scienter is “actual knowledge.” 15 U.S.C. § 78u-5(c)(1)(B)(i);
Matrixx Initiatives, Inc. v. Siracusano, 131 S. Ct. 1309, 1324 n.14, 179 L. Ed. 2d 398 (2011).
The plaintiffs have not pleaded with particularity facts to show that Fradkin had actual
knowledge that the collateral would not mature at par. Instead, they argue that Fradkin must
have known the collateral holdings would not mature at par because he assessed the pool’s
holdings daily and, therefore, should have known that the securities it held were at risk.
(Response (Dkt. 37) at 34.) However, the plaintiffs’ argument fails to take into account the
heightened level of scienter required for forward-looking statements, which is based not on what
a defendant should have known but, rather, “actual knowledge.” 15 U.S.C. § 78u-5(c)(1)(B)(i).
Because the plaintiffs have not alleged actual knowledge, they have not plausibly suggested that
Fradkin’s forward-looking statements violated § 10(b) or Rule 10b-5.

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b.

Omissions

The remainder of the plaintiffs’ claim involves alleged omissions. Specifically, the
plaintiffs contend that they have established a violation of § 10(b) and Rule 10b-5 by alleging the
defendants failed to disclose: (1) collateral was being invested in high-earning but risky and
illiquid securities; (2) the value of those securities had dropped; and (3) Northern Trust had not
properly mitigated the risk presented by these securities. The Supreme Court has addressed
attempts to plausibly suggest violations of Section 10(b) and Rule 10b-5 by alleging omissions:
Moreover, it bears emphasis that § 10(b) and Rule 10b-5(b) do not
create an affirmative duty to disclose any and all material
information. Disclosure is required under these provisions only
when necessary “to make . . . statements made, in the light of the
circumstances under which they were made, not misleading.”
17 CFR § 240.10b-5(b); see also Basic, 485 U.S., at 239, n.17,
108 S. Ct. 978 (“Silence, absent a duty to disclose, is not
misleading under Rule 10b-5”). Even with respect to information
that a reasonable investor might consider material, companies can
control what they have to disclose under these provisions by
controlling what they say to the market.
Matrixx Initiatives, 131 S. Ct. at 1321-22. Therefore, to plausibly suggest securities fraud based
on an omission, a plaintiff must allege not only information that was withheld, but also
information whose disclosure was necessary to prevent information that was disclosed from
being misleading. Id.
Plaintiffs have not specified any statements made by the defendants that were misleading
because of the alleged omission. Rather than identifying any specific statements, they refer only
generally to the defendants “[h]aving repeatedly spoken about the securities-lending program’s
operating status.” (Resp. (Dkt. 37) at 25.) By failing to identify specific statements made by the

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defendants, the plaintiffs have left the court unable to assess whether the plaintiffs have plausibly
alleged omissions that were necessary to avoid making the defendants’ statements misleading.
Although the plaintiffs have not identified specific statements made misleading by the
defendants’ alleged omissions, they have alleged statements in which the defendants
acknowledge the adverse impact of market conditions on the collateral pools. For example, at
the beginning of the class period during a conference call for analysts to discuss third quarter
2007 results, Fradkin stated that the “credit market environment in this year’s third quarter had a
negative impact on securities lending results that we’re reporting today.” (Am. Compl. ¶ 70.) In
statements the plaintiffs omitted from their excerpts of the conference call, Fradkin went on to
note that Northern Trust’s “securities lending results in the third quarter were adversely impacted
by this summer’s disruption in the credit environment, which began with concerns in the
subprime mortgage market and spread to the fixed income arena more broadly.” (Transcript of
October 17, 2007 Earnings Call (attached as Exhibit L1 to Defendants’ Exhibits to the Motion to
Dismiss(35-1) at 6.) In remarks made to analysts regarding fourth quarter 2007 results, Fradkin
again acknowledged that “[p]ricing pressure on fixed-income securities continued.” (Transcript
of January 16, 2008 Earnings Call (attached as Exhibit M2 to Defendants’ Exhibits to the Motion
to Dismiss (Dkt. 35-1) at 5.)
1

Exhibit L [Dkt. 35-1] is not the subject of the plaintiffs’ Motion to Strike. It is the full transcript
of a conference call with analysts excerpted by the plaintiffs in their amended complaint. Because the
conference call is mentioned in the complaint and statements made during the call are central to the
plaintiffs’ claims, the court can consider the transcript in ruling on the motion to dismiss. See Sullivan v.
Alcatel-Lucent USA, Inc., No. 12 CV 7528, 2013 WL 228244, at *2 (N.D. Ill. Jan. 22, 2013).
2

As with Exhibit L discussed in the previous footnote, Exhibit M (Dkt. 35-1) is the
transcript of a conference call with analysts that is mentioned in the complaint and central to the
plaintiffs’ claims. The court can therefore consider the transcript in ruling on the motion to
dismiss. See Sullivan, 2013 WL 228244, at *2.
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The plaintiffs contend that Fradkin’s statements applied only to a single collateral
pool—the STEP fund—and were misleading in that they did not acknowledge similar problems
across all of Northern Trust’s collateral pools. However, the full transcripts of Fradkin’s
statements do not support the plaintiffs’ assertion. Fradkin’s October 17, 2007, statement that
securities lending results were adversely impacted by the subprime mortgage were made during
background information he gave to explain Northern Trust’s securities lending services and
appear to concern the services generally. Only then did he proceed to focus specifically on the
negative impact on the STEP fund, explaining that the impact on it was more profound because it
was a mark-to-market fund whose assets were revalued daily, even though the assets were not
being sold and thus not realizing losses. (Transcript of October 17, 2007 Earnings Call (attached
as Exhibit L to Defendants’ Exhibits to the Motion to Dismiss (Dkt. 35-1) at 6.)
In light of these disclosures by the defendants, and the plaintiffs’ failure to identify
statements made misleading by the omissions alleged, the plaintiffs have not plausibly alleged
omissions that violated § 10(b) or Rule 10b-5. Accordingly, the motion to dismiss the portion of
Count I involving Northern Trust’s securities lending services is also granted.

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B.

Count II: Control Person Liability under § 20(a)

In Count II, the plaintiffs seek to hold the individual defendants liable for violations of
§ 10(b) and Rule 10b-5 by virtue of their positions as control persons of Northern Trust. Section
20(a) of the Securities Exchange Act provides that “[e]very person who, directly or indirectly,
controls any person liable under any provision of this chapter . . . shall also be liable jointly and
severally with and to the same extent as such controlled person to any person to whom such
controlled person is liable . . . unless the controlling person acted in good faith and did not
directly or indirectly induce the act or acts constituting the violation or cause of action.”
15 U.S.C. § 78t(a). To state a claim under § 20(a) claim, a plaintiff must allege each of the
following: (1) a primary securities violation; (2) general control over the operations of the
wrongdoer; and (3) “the power or ability to control the specific transaction or activity upon
which the primary violation was predicated, whether or not that power was exercised.” Harrison
v. Dean Witter Reynolds, Inc., 974 F.2d 873, 881 (7th Cir. 1992).
The defendants seek to dismiss the control person claim on the ground that the plaintiffs
have failed to allege a primary securities fraud violation. Because the plaintiffs failed to plead a
primary securities violation in Count I, Count II is also dismissed. See City of Livonia
Employees’ Retirement Sys. v. Boeing Co., No. 09 C 7143, 2010 WL 2169491, at *7 (N.D. Ill.
May 26, 2010).
II.

MOTION TO STRIKE DEFENDANTS’ EXHIBITS (Dkt. 39)
The plaintiffs seek to strike certain exhibits offered by the defendants in support of their

motion to dismiss. The exhibits are: A, G through K (Dkt. 35-1), and SEC Forms 1 through 3
(Dkt. 36). The plaintiffs contend that the exhibits are not mentioned in the complaint or subject

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to judicial notice, and therefore cannot be considered by the court on a motion to dismiss. See
Sullivan v. Alcatel-Lucent USA, Inc., No. 12 C 7528, 2013 WL 228244, at *2 (N.D. Ill. Jan. 22,
2013) (court cannot consider matters outside the pleadings on a motion to dismiss except for
matters attached to the complaint, central to its claims, or subject to judicial notice).
The court’s consideration of the motion to dismiss did not rely on any of the exhibits
subject to the motion to strike. Accordingly, the motion to strike is denied as unnecessary.
CONCLUSION
For the foregoing reasons, the motion to strike (Dkt. 39) is denied as unnecessary and the
motion to dismiss (Dkt. 34) is granted without prejudice. The plaintiffs are granted leave to file
a second amended complaint by May 8, 2013. If no amended complaint is filed by that date, the
dismissal will be with prejudice and the court will enter judgment in favor of the defendants.

ENTER:

Date: March 28, 2013

__________________________________________
Joan Humphrey Lefkow
UNITED STATES DISTRICT COURT

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