IN THE UNITED STATES DISTRICT COURT FOR THE EASTERN DISTRICT OF PENNSYLVANIA
September 9, 2011
WILLIAM E. UNDERLAND AND MARK SCHALLER, ON BEHALF OF THEMSELVES AND ALL OTHERS SIMILARLY SITUATED, PLAINTIFFS,
DENNIS ALTER, WILLIAM ROSOFF, PHILIP BROWNE, DAVID WEINSTOCK, ROBERT BLANK, MAX BOTEL, THOMAS COSTELLO, DANA BECKER DUNN, RONALD LUBNER, OLAF OLAFSSON, MICHAEL STOPLER, AND KPMG LLP; DEFENDANTS.
The opinion of the court was delivered by: Rufe, J.
MEMORANDUM OPINION & ORDER
In this action, Plaintiffs assert claims against the directors and officers of Advanta Corporation ("the Advanta Defendants") and their outside auditor, KPMG LLP, under the Securities Exchange Act of 1933. *fn1 Plaintiffs allege that the Advanta Defendants sold $500 million worth of notes using registration statements containing material misstatements and omissions in violation of the Act. They further allege that KPMG LLP certified the misstated financial records.
The Advanta Defendants and KPMG each move under Federal Rule of Civil Procedure 12(b)(6) to dismiss all counts of the Plaintiffs' Amended Complaint for failure to state a claim. After oral argument on this matter on August 15, 2011, and upon consideration of the Parties' papers, KPMG's motion is granted and the Advanta Defendants' motion is granted in part.
I. B ACKGROUND*fn2
Named Plaintiffs bring this action on behalf of a putative class
of individuals who purchased Advanta securities between June 24, 2007
and November 28, 2009. The Advanta Defendants *fn3
are directors and senior officers of Advanta who signed
the allegedly untrue registration statement used to sell the
securities. *fn4 Defendant KPMG LLP is an
international accounting and auditing firm that reviewed the accuracy
of and certified Advanta's financial statement. *fn5
Advanta Corporation is not a defendant in this
A. A DVANTA' S B USINESS M ODEL AND C OLLAPSE
Prior to its collapse, Advanta was one of the largest issuers of
credit cards to businesses in the United States. *fn6
It operated its business primarily through its
wholly-owned subsidiary, Advanta
Bank Corporation. *fn7 Advanta was a
"monoline" (specialized) credit-card bank: it focused primarily on
small business credit-card customers, and it did not have any other
significant banking operations. *fn8 Its
business strategy was considered "risky" because the loans it made
were unsecured, revolving lines of credit, with credit lines greater
than those for consumer credit cards. *fn9
Consequently, Advanta's credit rating was "below investment grade."
Advanta's primary source of funding was derived from the securitization *fn10 of its credit card receivables. Credit card securitization allows banks and other issuers of credit cards to convert their receivables into cash. To securitize its receivables, Advanta sold them to a wholly-owned special-purpose trust ("the Trust"). The Trust pooled the receivables together, packaged them, and sold them as RediReserve variable rate certificates and investment notes ("RediReserve Notes").
On August 18, 2006, Advanta filed a shelf registration statement *fn11 and prospectus with the Securities and Exchange Commission ("SEC"), which indicated its intent to offer $500 million worth of RediReserve notes. By the terms of the shelf registration, and pursuant to federal law, each of Advanta's subsequent annual reports amended the Registration Statement. *fn12
Advanta issued $350 million worth of notes on August 18, 2006; on
February 9, 2009, it issued another $150 million of notes.
*fn13 Advanta capped investment in the notes at
$500,000. *fn14 The notes were not sold in
traditional debt markets, but instead were marketed directly to
investors through newspaper advertisements. *fn15
The notes paid varying rates depending on the amount of
the initial investment and the duration of the note. *fn16
Advanta received cash upon the sale of the receivables to
the Trust, but retained an interest in the receivables.
*fn17 Advanta relied on the proceeds from the
receivables' securitization as its primary source of funding. The
RediReserve notes gave investors the right to a certain return on
their investment; as customers paid their Advanta credit card
payments, the Trust would make payouts to noteholders. Thus,
noteholders were dependent upon Advanta's revenues for periodic
interest payments and the eventual repayment of principal
upon their note's maturity. *fn18
The RediReserve Notes were not insured or guaranteed by the
FDIC, *fn19 and Advanta did not establish a
"sinking fund" *fn20 as a precaution in the
event that Advanta was unable to repay noteholders. *fn21
To protect investors, however, the RediReserve Notes
contained an "early amortization clause," *fn22
which, once triggered, *fn23
required Advanta to immediately repay noteholders' principal. The
RediReserve notes were designed to amortize early if the monthly
excess spread fell to zero or below for three consecutive months.
Beginning in August 2007, due to serious economic disruptions, securitization market activity virtually halted, and the market for small issuers-like Advanta-collapsed. *fn24
Consequently, Advanta's securities sales significantly decreased. *fn25 Then, in March 2008, credit-card delinquencies and charge-offs began to rapidly increase. As more of Advanta's credit-card customers defaulted, profits generated by its securitized receivables dropped dramatically.
In June 2009, after the excess spread dropped to below zero for three consecutive months, the early amortization clause was triggered. Because the early amortization required Advanta to direct all funds from the securitization pool to repay principle due to noteholders, Advanta was obligated to fund its credit card customers from a different source. But since the securitization fund was the only source of funding for its primary business, once the early amortization occurred, Advanta was no longer able to fund its credit card customers. *fn26 Unable to fund its credit cards, and in the face of still-rising loan losses, Advanta cancelled all charging privileges for its cardholders. *fn27
A few months later, in November 2009, Advanta filed for Chapter 11 bankruptcy.
B. T HE P ENDING L INSTIGATION
On June 24, 2010, Plaintiffs commenced this action in the Court of
Common Pleas of Montgomery County, Pennsylvania. *fn28
Defendants timely removed the action to this Court;
Plaintiffs did not move to remand. After the Court granted Plaintiffs'
motion to appoint class counsel and lead plaintiffs, *fn29
Plaintiffs filed the pending amended complaint.
Plaintiffs claims arise from the 2006 Shelf Registration Statement and its Amendments. *fn31
According to Plaintiffs, those documents misrepresented Advanta as a "prudent company with a 'very strong' financial condition," when in fact Advanta was engaging in "unsafe and unsound banking practices" that ultimately led to its collapse. *fn32
Plaintiffs pinpoint three documents issued by the FDIC as proof that the registration statement and its amendments included material misstatements and omissions. *fn33 The first, a 2010 Material Loss Review, allegedly "makes clear that Advanta was engaged in numerous unsound and illegal activities that were misrepresented and not adequately disclosed in the Registration Statement." *fn34 The two other documents, FDIC cease and desist orders, allegedly corroborate the Material Loss Review. *fn35
In its Material Loss Review, the FDIC reviewed Advanta's business
practices between December 2004 and December 2009 in order to
determine, among other things, the cause of Advanta's failure. Based
on the audit, the FDIC concluded that "Advanta failed due to
insolvency brought on by the Board of Directors' and management's
failure to implement risk management practices commensurate with the
risks associated with its business model." *fn36
In particular, the FDIC faulted Advanta's board and management for failing to develop
adequate contingency plans for responding to an early amortization
event, and its failure to incorporate those plans into its capital
adequacy model. *fn37
The FDIC also concluded that although a rapid increase in customer
defaults was partially caused by economic conditions, they were also
attributable to an "aggressive repricing campaign" that Advanta began
in late 2007. During that campaign, Advanta repriced 68 percent of its
credit card loan portfolio by increasing customer finance charges and
raising interest rates. *fn38 The price hikes
resulted in higher minimum payments for customers, and made it
difficult for struggling customers to cure any delinquencies. The FDIC
found that Advanta's aggressive repricing practices were illegal:
*fn39 Advanta imposed the rate hikes on customers
without disclosing the basis and reasons for the increase, the amount
of the increase, or the customers' right to opt-out. *fn40
Nor did it notify its customers of the specific reasons
for the adverse actions.
On June 30, 2009, two FDIC cease-and-desist orders took effect against Advanta, and were disclosed by Advanta in an 8-K filing with the SEC. *fn41 In the first order, the FDIC directed Advanta to cease and desist certain "unsafe and unsound" banking practices, including: "The Bank's Board of Directors and Management operating the Bank in a manner that causes the Bank's significant deterioration;" "operating with inadequate capital for the Bank's risk profile;" and "[o]perating in a manner that does not sustain satisfactory earnings performance to maintain sufficient capital in relation to the Bank's risk profile." *fn42 In the second cease and desist order, the FDIC alleged that Advanta had raised the interest rates on certain customer accounts and marketed its Cash Back Rewards program in violation of consumer protection laws. Based on those findings, the FDIC ordered Advanta to pay restitution to customers "substantially injured" by those practices.
Plaintiffs' amended complaint includes three counts: Count One alleges violations of § 11 of the 1933 Securities Act *fn43 against the Advanta Defendants and KPMG; and Counts Two and Three allege that the Advanta Defendants violated §§ 12(a)(2) and 15 of the 1933 Act.
II. S TANDARD OF R REVIEW
In reviewing a Rule 12(b)(6) motion to dismiss for failure to
state a claim upon which relief may be granted, the Court must accept
a plaintiff's factual allegations as true and construe the complaint
in the light most favorable to the plaintiff. *fn44
Courts are not, however, bound to accept as true legal
conclusions couched as factual allegations, *fn45
or "accept as true unsupported conclusions and
unwarranted inferences." *fn46 The Complaint
must set forth "direct or inferential allegations [for]
all the material elements necessary to sustain recovery under some
viable legal theory." *fn47 And it must
allege "enough facts to state a claim to relief that is plausible on
its face." *fn48 "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."
A. S ECURITIES A CT OF 1933
Sections 11, 12 and 15 of the Securities Act of 1933, on which Plaintiffs' claims are founded, protect investors by imposing liability on certain participants in a registered security offering when the publicly filed documents used during the offering contain material misstatements or omissions. *fn50 Sections 11 *fn51 and 12(a)(2) *fn52 allow purchasers to sue certain parties in a registered offering when materially false or misleading statements are included in registration statements and prospectuses. *fn53 Section 15, a form of derivative liability, imposes liability on one who "controls any person liable" under sections 11 or 12.
"Section 11 and 12(a)(2) are 'Securities Act siblings' with 'roughly parallel elements.'" *fn54 A
section 11 action can only be brought against the issuer, its
directors or partners, and accountants who are named as having
prepared or certified the registration statement. *fn55
For those parties, "[l]iability . . . is virtually
absolute, even for innocent misstatements." *fn56
Thus, to state a prima facie case under section 11,
Plaintiffs need only allege that they purchased securities pursuant to
a registration statement that contained a material misstatement or
omission. *fn57 Similarly, to state a claim
under section 12(a)(2), plaintiffs need only allege that they
purchased securities pursuant to a
materially false or misleading "prospectus or oral
communication." *fn58 Alternatively,
plaintiffs may establish a prima facie violation of sections 11 or
12(a)(2) by alleging that "an omitted material fact was required to be
included by the securities laws or that its absence rendered
statements in the prospectus misleading." *fn59
Here, Plaintiffs properly alleged that they acquired securities pursuant to a registration statement, and that the Advanta Defendants and KPMG are among those liable under the Securities Act of 1933. *fn60 As such, the only issue presented by the pending motions to dismiss is whether plaintiffs have sufficiently alleged that the challenged registration statement, as amended, contained material misstatements or omissions.
B. M ATERIALITY
A misstatement or omission is material "if there is a substantial likelihood that a reasonable shareholder would consider it important" in making an investment decision. *fn61 Thus, for a misrepresentation or omission to be material, "there must be a substantial likelihood that the disclosure of the omitted fact [or misrepresentation] would have been viewed by the reasonable investor as having significantly altered the 'total mix' of information made available." *fn62 "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." *fn63
"Materiality is ordinarily an issue left to the factfinder and is therefore not typically a matter for Rule 12(b)(6) dismissal." *fn64 However, certain categories of "soft information" are "so obviously unimportant to an investor that reasonable minds cannot differ on the question of materiality," *fn65 and
"it is appropriate for the district court to rule that the
allegations are inactionable as a matter of law." *fn66
Soft information includes "statements of subjective
analysis or extrapolation, such as
opinions, motives, and intentions . . . forward-looking
statements, such as projections, estimates, and forecasts,"
*fn67 or "general statements of optimism [which]
constitute no more than 'puffery' and are understood by reasonable
investors as such." *fn68 The courts have
adopted various doctrines to evaluate the materiality of misstated or
omitted soft information, two of which are relevant to the Court's
Generally, an alleged misrepresentation or omission must concern an objective fact. *fn69 Under Virginia Bankshares v. Sandberg, *fn70 statements of reasons, opinions, or beliefs may be "factual" if they are "a statement of the psychological fact of the speaker's belief in what he says." *fn71 In Virginia Bankshares, the Court explained that opinions contain two components: the opinion itself and the factual basis for the opinion. Assuming that the undergirding facts are neither false nor misleading, a statement of belief might be objectionable "solely as a misstatement of the psychological fact of the speaker's belief in what he says." *fn72 Thus, to allege a material misstatement of reason, opinion or belief, plaintiffs must allege either that the defendant did not actually believe her stated opinion or that she had no reasonable basis for her belief. "Defendants are not liable under the securities laws when their opinions, or those they reported, were honestly held when formed but simply turn out later to be inaccurate; nor are they liable only because they could have formed 'better' opinions." *fn73
A second doctrine useful to this Court's analysis is the "bespeaks
caution" doctrine, under which cautionary language in a offering
statement may negate the materiality of an otherwise misleading
forward-looking statement. *fn74 The bespeaks
caution doctrine is subject to limitations: First, not just any
cautionary language will render accompanying forward-looking
statements immaterial; to suffice, the language "must be substantive
and tailored to the specific future projections, estimates or
opinions" in the challenged communication. *fn75
Second, a blanket warning that an investment is risky is
likely to be insufficient to ward off a securities fraud claim.
*fn76 And finally, the bespeaks caution doctrine
does not apply to facts: "[f]raud is still fraud, and all the
cautionary language in the world will not replace a true material
omission or misstatement of a fact which would matter to a reasonable
C. T HE A LLEGED M ISSTATEMENTS AND O MISSIONS
As to the Advanta Defendants, Plaintiffs attack six categories of alleged misstatements and omissions contained in Registration Statement and its subsequent amendments: (1) Advanta's predictions about the likelihood of an early amortization event; (2) its representations about the calculation and adequacy of its loan loss reserves; (3) its espoused belief that it was in compliance with capital adequacy requirements; (4) its assessment of its capital levels as "strong;" (5) alleged misstatements and omissions about Advanta's commitment to maintaining and strengthening customer relationships; and, (6) descriptions of Advanta's methodology for accessing and monitoring customer creditworthiness.
Plaintiffs sole claim against Defendant KPMG is brought under Section 11 of the 1933 Act. KPMG allegedly certified that certain financial statements fairly presented Advanta's financial position and conformed to Generally Accepted Accounting Principals ("GAAP"). *fn78 Plaintiffs contend that KPMG is liable for misstatements contained in those financial statements, namely the overstating of Advanta's financial position due to its failure to maintain and calculate an adequate allowance for loan and lease losses.
1. Statements about the prospect and potential impact of early amortization Advanta addressed the prospect and potential impact of early amortization in three 2009 filings: a January 11, 2009 8-K filing; *fn79 the February 2009 Amendment (which incorporated the 8- K); and the March 2009 Amendment. *fn80 In the January 8-K, Advanta stated, "in response to recent media," that:
[E]arly amortization for our business credit card master trust is avoidable and the Company does not expect it to occur. The Company has repricing conditions and other structuring alternatives available to it . . . .
The financial condition of the Company is very strong, and our cash and short-term investment position has been increased in the fourth quarter from the $1.8 billion we reported as of September 30, 2008. *fn81
Later, in the March 2009 Amendment, Advanta addressed the prospect of an early amortization again:
[W]e are under no obligation to fund new receivables on our balance sheet whether or not there is an early amortization. We can do so for the accounts we choose and to the degree we choose. Therefore, we do not expect an early amortization to cause a serious reduction of our strong levels of liquidity. Our expectation is that we would use our tools to prevent an early amortization unless we conclude that it is to our advantage not to do so. *fn82
Pointing to the FDIC Material Loss Review, which partially attributed Advanta's collapse to its failure to develop an adequate contingency plan for dealing with an early amortization event, *fn83
Plaintiffs attack the statements about early amortization for containing both material misstatements and omissions.
Sections 11(a) and 12(a)(2) "impose upon defendants the duty to
disclose any material facts that are necessary to make disclosed
material statements, whether mandatory or volunteered, not
misleading." *fn84 When defendants
"voluntarily disclose information, they have a duty to disclose
additional material facts only to the extent that the volunteered
disclosure was misleading as to a material fact." *fn85
An omitted fact is material if there is a "substantial
likelihood that, under all the circumstances, the omitted fact would
have assumed actual significance in the deliberations of the
reasonable shareholder." *fn86 As noted
above, "[o]nly when the disclosures or omissions are so clearly
unimportant that reasonable minds could not differ should the ultimate
issue of materiality be decided as a matter of law." *fn87
Plaintiffs argue that by raising the issue of amortization, Advanta put the adequacy of its contingency plan "in play." Thus, Plaintiffs reason, Advanta omitted a material fact by failing to disclose that it did not have an adequate contingency plan in place for an early amortization event. *fn88
Defendants argue that the challenged statements did not put the adequacy of Advanta's contingency plan "in play" because the statements "deal with Advanta's plans and expectations for avoiding early amortization, while any plan for dealing with early amortization once it had occurred simply is an entirely separate issue." *fn89 The Court agrees. There is a fundamental mismatch between the challenged statements and the topic they allegedly put in play. Far from characterizing a contingency plan, the statements do not even indicate that such a plan existed.
Because Advanta did not put the adequacy of its contingency plan
"in play," it had no duty to disclose that its plan for an early
amortization was inadequate. It is well established that neither
allegations of mismanagement nor failure to disclose mismanagement are
material, and accordingly are not actionable under federal laws.
*fn90 Thus, the securities laws do not obligate
defendants to reveal the "culpability of their activities," "impure
motives for entering a transaction," or a "breach of fiduciary duty."
Here, Advanta's failure to provide an adequate contingency plan
reflects, at bottom, mismanagement and ineptitude. *fn91
In In re Craftmatic Securities Litigation,
*fn92 the Third Circuit dismissed similar
allegations as stating claims for "mere mismanagement." There,
Plaintiffs claimed that defendant Craftmatic's failure to characterize
its new product research as "meaningless," or its information systems
as "wholly inadequate" implicated the Securities Act. The alleged
omission here is indistinguishable from those dismissed by the Third
Circuit in Craftmatic. Thus, Plaintiffs have not sufficiently alleged
the existence of a material omission.
Plaintiffs also allege that Advanta's statements about early amortization contained two material misstatements. First, Plaintiffs challenge Advanta's opinion that its economic condition was "very strong." Plaintiffs generally aver that the company was "nearing collapse by early 2009;" but they do not allege that at the time this statement was published-January 11, 2009-the speakers either did not believe that their financial position was strong or that they had no reasonable basis for believing that to be true. Indeed, the Material Loss Review, upon which Plaintiffs heavily rely, shows that the precipitous drop in profits that ultimately led to the early amortization (the direct cause of Advanta's collapse) did not begin until March 2009. *fn93 Although in hindsight Advanta was certainly teetering on the edge of financial ruin in early 2009, Defendants cannot be liable for statements that simply failed to foresee the future. *fn94
For similar reasons, Plaintiffs second challenge, to Advanta's statement that it "did not expect an early amortization to cause a serious reduction of our strong levels of liquidity," also fails. Under Virginia Bankshares v. Sandberg, for "misrepresentations in an opinion or [statement of ] belief to be actionable, Plaintiffs must show that the statement was issued without a genuine belief or reasonable basis." Plaintiffs allege neither.
2. Statements about Loan Loss Reserves The next category of challenged misstatements pertain to the Advanta Defendants' calculation of loan loss reserves. A "loan loss" reserve is a current reserve against likely credit losses in a company's portfolio. "As losses occur, they are charged against this reserve. That is, the loan account is credited and the reserve account is debited. The reserve is established by a debit to an expense account called the loan loss provision, with a corresponding credit to the loan loss reserve." *fn95
The gravamen of Plaintiffs' claims is that the Advanta Defendants did not conform to their disclosed methodology for calculating loan loss and consequently overstated their net income, and that KPMG violated securities laws by certifying the false loan loss and net income statements.
a. The Advanta Defendants
Plaintiffs allege that Advanta made two categories of misstatements about the loan loss reserves: First, Plaintiffs allege that although Advanta disclosed a methodology by which it claimed loan loss reserves were calculated, it did not conform to that method, and consequently, understated its loan loss reserves. Second, Plaintiffs allege that by understating its loan loss reserves-which are subtracted from gross income-Advanta misrepresented its net income.
In response, the Advanta Defendants argue that loan loss reserves
are forward-looking statements because they are predictions or
estimates of future financial liabilities. *fn96
As such, loan reserves are statements of "opinion" that
require an allegation of subjective knowledge to be actionable. Thus,
Defendants contend that Plaintiffs' complaint is deficient because it
fails to allege
that the Advanta Defendants knew the loan loss reserves were misstated. The 2008 and March 2009 Amendments (which are duplicative in all material respects) represented Advanta's methodology for calculating loan loss reserves and included cautionary language that the loan loss allowance was inherently subjective and susceptible to changing economic conditions:
Receivables on the consolidated balance sheets are presented net
of the allowance for receivable losses. The allowance for receivable
losses represents management's estimate of probable losses inherent in
the on-balance sheet receivable portfolio. We establish the allowance
for receivable losses through provisions charged to earnings. We
report provisions for credit losses, representing the portion of
receivable losses attributable to principal, separately on the
consolidated income statements. We record provisions for interest and
fee receivable losses as direct reductions to interest and fee income.
The allowance for receivable losses is evaluated on a
regular basis by management and is based upon management's review of
the collectability of receivables in light of historical experience by
receivable type, the nature and volume of the receivable portfolio,
adverse situations that may affect the borrowers' ability to repay and
prevailing economic conditions. Since our business credit
card receivable portfolio is comprised of smaller balance homogeneous
receivables, we generally evaluate the receivables collectively for
impairment through the use of a migration analysis as well as the
consideration of other factors that may indicate increased risk of
loss, such as bankrupt accounts, overlimit accounts or accounts that
have been re-aged or entered a workout program. A migration analysis
is a technique used to estimate the likelihood that a receivable or
pool of receivables will progress through various delinquency stages
and charge off. The allowance evaluation is inherently subjective as
it requires estimates that are susceptible to significant revision as
more information becomes available. Changes in economic conditions,
the composition and risk characteristics of the receivables portfolio,
bankruptcy laws or regulatory policies could impact our credit
Defendants contend that in Shapiro v. UJB, *fn98
the Third Circuit held that loan reserves are always
forward-looking statements of "opinion," only actionable as material
misstatements upon a showing of the speaker's subjective
knowledge. *fn99 But neither Shapiro nor any
other case Defendants
rely upon stands for the broad proposition that all
statements pertaining to loan loss reserves are opinions.
*fn100 To the contrary, Shapiro made clear that
"[t]here is nothing unique about representations and omissions
regarding loan loss reserves that removes them from the purview . . .
of the federal securities laws."
In Shapiro, the court held that "general labels" such as "strong," "very strong," and "maintained at adequate levels" might be actionable material misstatements under Virginia Bankshares, but concluded that plaintiff's claims were not sufficient because they did not allege the defendant knew the "general labels" were false. Instead, the plaintiffs' allegations simply "charge[d] defendants with essentially failing to predict the future."
In contrast to Shapiro, the Advanta Defendants did not describe the quality of the loan loss reserves using a "general label." Instead, they disclosed a method by which they claimed loan loss reserves were calculated. And Plaintiffs allege that, as evidenced by the Material Loss Review, Advanta did not adhere to that methodology. This allegation does not allege Advanta Defendants failed to protect the future, but instead alleges that Advanta refused to incorporate, among other things, current losses into its calculations: Advanta claimed that its loan loss calculations were based, inter alia , on "historical experience by receivable type," "adverse situations that may affect the borrower's ability to repay," "prevailing economic conditions," and "factors that may indicate increased risk of loss." *fn101 But that claim is contradicted by the FDIC Material Loss review, *fn102 which concluded that "Advanta . . . failed to incorporate into its allowance for loan and lease methodology . . . anticipated and actual changes in portfolio behavior." *fn103 If Advanta did not, as the FDIC concluded, incorporate anticipated and actual changes into its methodology, it is reasonable to infer that Advanta was not considering "historical experience," "adverse situations," or "factors that may indicate increased risk of loss." *fn104 The FDIC's findings also support Plaintiffs' contentions that "Advanta ignored the adverse credit effects caused by its aggressive repricing campaign and the economic downturn and, consequently, took an inadequate allowance for loan losses." *fn105 Because Plaintiffs have sufficiently alleged that Defendants departed from their claimed methodology to calculate the loan loss reserve, they have sufficiently alleged that Advanta's net income and loan loss reserves were misstated. *fn106 Unlike a subjective evaluation that a loan reserve is adequate or not, nonconformance to a stated methodology to arrive at a loan loss reserve amount is a measurable objective fact. *fn107 If, as Plaintiffs allege, Advanta omitted factors from its calculation, the sum of that calculation is necessarily misstated.
To the extent that Defendants challenge the materiality of the
statements about the loan loss reserves, they rely on the "bespeaks
caution" doctrine, under which "an offering statement [or other
disclosure document], such as a prospectus, accompanies statements of
future forecasts, projections and expectations with adequate
cautionary language, those statements are not actionable as securities
fraud." *fn108 In their statements, the
Defendants noted that the calculation of loan loss reserves was
"inherently subjective." But the bespeaks caution doctrine does not
apply to facts, *fn109 and, as Plaintiffs
have challenged a statement of fact, not opinion, Advanta's cautionary
language does not cure the misstatement. *fn110
Accordingly, the Court cannot conclude that the alleged
would have been so obviously unimportant to an investor that
reasonable minds cannot differ on the question of materiality.
b. Loan Loss Reserves and KPMG Plaintiff s allege that KPMG violated securities laws by certifying false financial statements in the Registration statement. *fn112 Under 15 U.S.C. § 77k(a)(4), accountants are only liable for the parts of a registration statement that they have prepared or certified. *fn113 Thus, while "liability against the issuer of a security is virtually absolute, even for innocent misstatements," accountant liability under Section 11 is limited to "those matters which purport to have been prepared or certified by them." *fn114
Plaintiffs allege that KPMG certified Advanta's loan loss provision and net income as correct by stating, in both the 2008 and 2009 report, that:
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on criteria established in the Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 21, 2007 and 2006, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2007, in conformity with U.S. generally accepted accounting principles. *fn115
By their terms, the challenged statements are only "false" if Advanta's financial statements did not, as KPMG stated, conform to GAAP. Thus, Plaintiffs' vague allegation that KPMG's statements "were not correct for the reasons set forth in the various FDIC orders and reports" is insufficient. The FDIC reports do not conclude that Advanta's financial results were not prepared in conformity with GAAP or that its internal controls did not adhere to the criteria established in the Internal Control Integrated Framework. Plaintiffs have neither alleged what GAAP standards KPMG violated nor how the statements in the audit report were false or misleading at the time they were made. *fn116 Indeed, Plaintiffs have not even alleged that the statements did not conform to GAAP. *fn117 In sum, Plaintiffs' allegations are entirely conclusory and do not contain factual matter sufficient to support a plausible claim for relief.
3. Statements about Advanta's Compliance with Capital Adequacy Requirements The 2008 Amendment stated that "[m]anagement believes that at December 31, 2007,
Advanta Bank Corp. was in compliance with the capital adequacy requirements to which it was subject." *fn118 Plaintiffs allege that the 2008 statement was false because the FDIC found in its material loss review that Advanta was "in need of capital." *fn119 In addition, Plaintiffs highlight the first FDIC Cease and Desist Report, which found that Advanta was operating with insufficient capital. Further, Plaintiffs argue that because Advanta was overstating its financial position by maintaining inadequate loan and lease losses, the capital levels reported in the 2008 report were overstated. The 2008 Amendment explains that Advanta was subject to capital adequacy guidelines issued by the Federal Financial Institutions Examination Council (the "FFIEC"):
Under the rules and regulations of the FFIEC, at least half of a bank's total capital is required to be "Tier I capital," comprised of common equity, retained earnings and a limited amount of non-cumulative perpetual preferred stock. The remaining capital, "Tier II capital," may consist of other preferred stock, a limited amount of term subordinated debt or a limited amount of the reserve for possible credit losses.
Plaintiffs allegations about compliance with capital adequacy requirements sufficiently state a claim. Defendants attempt to characterize this statement as "forward-looking" is unpersuasive. Whether or not Advanta was in compliance with its capital adequacy reserves as of December 31, 2007 is a historical fact, verifiable by discovery. A statement is not mere "puffery" when it provides specific facts that may be relied on. *fn120
4. Statements Characterizing Advanta's Capital Reserves In the March 2009 Amendment, Advanta stated that "We believe we have helped position ourselves for the current challenging economic environment by increasing our levels of cash and liquid assets throughout 2008 and maintaining strong capital levels." Plaintiffs do not challenge the statement on the basis that Advanta did not raise its capital levels throughout 2008, nor do they identify Advanta's actual capital levels. *fn121 Thus, the sole inquiry here is whether Advanta's statement that it had "strong" capital levels was a material misstatement.
Advanta's description of its capital levels is a statement of opinion that is couched as Advanta's "belief." Thus, to be actionable, Plaintiffs must allege that the Advanta Defendants either knew the capital levels were not strong, or that they had no reasonable basis for their opinion. Because they have alleged neither, this allegation fails.
5. Statements about Evaluating Customer Creditworthiness In the 2007, 2008, and 2009 Amendments, Advanta explained that it had developed models
for assessing the creditworthiness of applicants:
Using a proprietary credit scoring system, we evaluate common applicant characteristics and their correlation to credit risk. We regularly validate and update our scoring models to maintain and enhance their predictive power. *fn122
According to Plaintiffs, these statements were false because "Advanta was being operated in an unsafe and unsound manner, was not updating its credit portfolios to account for changes in portfolio behavior associated with the economic downturn, and was using an aggressive re-pricing strategy." In addition, Plaintiffs note that the FDIC failed to incorporate anticipated and actual changes in portfolio behavior into its loan loss methodology.
Defendants contend that these allegations fail because the plaintiffs do not contend that the methodology was actually misstated. Defendants also note that "plaintiffs do not even attempt to allege a connection between the Company's creditworthiness methodology and the Company's loan loss methodology."
Plaintiffs' allegations are deficient and do not state a claim. Plaintiffs do not connect their allegations that Advanta was operated in an "unsafe and unsound manner," or that it "failed to incorporate anticipated and actual changes in portfolio behavior" to Advanta's creditworthiness scoring model. At best, Plaintiffs' allegations might raise an inference that because Advanta failed to incorporate anticipated and actual changes into its loan loss calculations, it also failed to account for those changes in its creditworthiness models. Or perhaps the Court might infer that because Advanta was not updating its credit portfolio, it was also not "regularly validat[ing] and updat[ing] its scoring models." But speculating about potential claims is not the Court's task; it is the Plaintiff's responsibility to set forth "direct or inferential allegations for all the material elements necessary to sustain recovery." Plaintiffs have failed to do so here; their allegations do not explain why the statements about creditworthiness were false or misleading.
6. Statements about Maintaining Strong Relationships with Customers Plaintiffs also challenge Advanta's statements regarding its relationships with customers. In
the 2008 and 2009 Amendments, Advanta stated that it sought to
strengthen and improve its relationships with customers and maximize
long-term profits by attracting and retaining high-credit quality
customers and deepening customer relationships. *fn123
In reality, Plaintiffs allege, Advanta was
damaging its relationships by: (1) beginning in at least June
2007, engaging in "an aggressive" repricing campaign that "according
to the FDIC, violated Section 5 of the Federal Trade Commission Act"
and "substantial[ly] injure[ed]" its customers; (2) failing to send
sufficient notice letters providing customers with explanations for
the adverse actions, in violation of Regulation B; and (3) imposing
severe price increases on customers that, according to the FDIC, made
it "very difficult for customers already struggling to make their
minimum payments to cure any outstanding delinquency."
These alleged misrepresentations are vague statements of "opinion or expectation" that courts have uniformly held not actionable. The statement claiming that Advanta intended to strengthen relationships with customers is not the type of information the ordinary investor would be likely to find important to his or her investment decision. *fn125 This type of puffery cannot serve as the basis for liability under Federal securities laws. *fn126
V. C ONCLUSION
For the foregoing reasons, the Court will grant KPMG's Motion to Dismiss and grant in part the Advanta Defendants' Motion to Dismiss. An appropriate order follows.
IN THE UNITED STATES DISTRICT COURT FOR THE EASTERN DISTRICT OF PENNSYLVANIA
CIVIL ACTIONNO. 10-3621
WILLIAM E. UNDERLAND and MARK SCHALLER, on behalf of : themselves and all others similarly situated, Plaintiffs, v. DENNIS ALTER, WILLIAM ROSOFF, PHILIP BROWNE, DAVID WEINSTOCK, ROBERT BLANK, MAX BOTEL, THOMAS COSTELLO, DANA BECKER DUNN, RONALD : LUBNER, OLAF OLAFSSON, MICHAEL STOPLER, and KPMG LLP; Defendants.
ORDER AND NOW, this 9th day of September 2011, in accordance with the foregoing reasons, it is hereby ORDERED that:
1) The Advanta Defendants' Motion to Dismiss is GRANTED IN PART . For the reasons set forth in the accompanying opinion, Plaintiffs have not sufficiently alleged that the following misstatements are actionable: (1) Advanta's predictions about the likelihood of an early amortization event; (2) its assessment of its capital levels as "strong;" (3) alleged misstatements and omissions about Advanta's commitment to maintaining and strengthening customer relationships, and; (4) descriptions of Advanta's methodology for accessing and monitoring customer creditworthiness; and,
2) KPMG LLP's Motion to Dismiss is GRANTED ; and,
3) Plaintiffs are granted leave to amend their Complaint on or before October 9, 2011.
It is so ORDERED.
BY THE COURT:
HON. CYNTHIA M. RUFE