Escolar Documentos
Profissional Documentos
Cultura Documentos
FjardeAPFondenv.MorganStanley
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UNITEDSTATESCOURTOFAPPEALS
FORTHESECONDCIRCUIT
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AugustTerm2013
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Argued:December10,2013
Decided:January12,2015
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No.130627cv
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_____________________________________
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JOELSTRATTEMCCLURE,
Plaintiff,
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FJARDEAPFONDEN,
PlaintiffAppellant,
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PLAINTIFFSTATEBOSTONRETIREMENTSYSTEM,
STATEBOSTONRETIREMENTSYSTEM,
MovantAppellant,
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MORGANSTANLEY,aDelawareCorporation,JOHNJ.MACK,
ZOECRUZ,DAVIDSIDWELL,THOMASCOLMKELLEHER,THOMASV.DAULA,
DefendantsAppellees,
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GARYG.LYNCH,
Defendant.
_____________________________________
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Before:
CABRANES,WESLEY,andLIVINGSTON
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AppealfromApril4,2011andJanuary18,2013ordersoftheUnitedStates
District Court for the Southern District of New York (Batts, J.), granting the
Defendantsmotionstodismiss.Forthereasonsstatedhereandinasummaryorder
issued simultaneously with this opinion, we AFFIRM the order granting the
Defendantsmotiontodismiss.
AFFIRMED.
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DEBRAANNLIVINGSTON,CircuitJudge:
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broughtthisputativesecuritiesfraudclassactiononbehalfofthemselvesandother
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similarlysituatedinvestors(Plaintiffs)pursuanttoSections10(b)and20(a),15
U.S.C.78j(b)and78t(a),oftheSecuritiesExchangeActof1934.Theyallegethat
MorganStanleyandsixofitsofficersandformerofficersJohnJ.Mack,ZoeCruz,
DavidSidwell,ThomasColmKelleher,andThomasDaula(collectively,Morgan
StanleyorDefendants)madematerialmisstatementsandomissionsbetween
June20,2007andNovember19,2007(theclassperiod)inanefforttoconceal
MorganStanleysexposuretoandlossesfromthesubprimemortgagemarket.As
a result, Plaintiffs claim, they suffered substantial financial loss when Morgan
Stanleys stock prices dropped following public disclosure of the truth about
MorganStanleyspositionsandlosses.
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TheUnitedStatesDistrictCourtfortheSouthernDistrictofNewYork(Batts,
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J.)dismissedallclaimsonthepleadingsforfailuretostateaclaim,andweaffirm.
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Forthereasonsstatedinthisopinion,weconcludethatthedistrictcourtproperly
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dismissedPlaintiffsclaimthatDefendantsomissionofinformationpurportedly
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229.303(a)(3)(ii) (Item 303), violated Section 10(b). We also affirm its order
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dismissingPlaintiffsotherclaimsinasummaryorderissuedsimultaneouslywith
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thisdecision.
BACKGROUND1
StanleysProprietaryTradingGroupinDecember2006.Thetradeconsistedoftwo
components:a$2billionshortposition(ShortPosition)anda$13.5billionlong
position(LongPosition).IntheShortPosition,MorganStanleypurchasedcredit
(RMBSs).2TheseCDSsoperatedlikeinsurancepoliciesMorganStanleypaid
annualpremiumsfortheassurancethat,ifthehousingmarketworsenedandthe
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mezzanineRMBStranchesbackingitsCDOsdefaultedordeclinedinvalue,itwould
ThefactspresentedherearedrawnfromtheallegationsinPlaintiffssecond
amendedcomplaint,whichweacceptastrueforthepurposesofreviewingthemotion
todismiss.SeeAnschutzCorp.v.MerrillLynch&Co.,690F.3d98,107(2dCir.2012).
Althoughwedecideonlyoneissueinthisopinion,wedescribethePlaintiffs
allegationsingreaterdetailtoprovidecontext.
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Briefly,asdescribedbyPlaintiffs,aRMBSiscreatedbypoolingthousandsof
residentialmortgagesintoatrust.Thetrustthenissuesbonds,whichinvestors
purchase.Themortgagesserveascollateralforthesebonds,andtheinterestonthe
bondsderivesfromthecashflowcreatedbymortgagepayments.RMBSscanbe
aggregatedintoCDOs,whicharesoldintranchesbasedonpriorityofentitlementto
thecashflow.EachtrancheofagivenRMBSisexposedtothesamepoolofmortgages,
butlowertranchessustainlossesbeforehighertranchesintheeventthatmortgagesin
thepooldefaultordonotmeetpaymentdeadlines.CDOsaresimilarlydividedinto
higherandlowertranches.
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receivepayments.IntheLongPosition,MorganStanleysoldCDSs.TheseCDSs,
likethoseitboughtfortheShortPosition,referencedCDOsbackedbymezzanine
tranchesofsubprimeRMBSs.ButtheCDOsreferencedbytheLongPositionwere
superseniortranchesofCDOsthatwerehigherratedandlowerriskthantheCDOs
referenced by the Short Position. Through the Long Position, Morgan Stanley
thereforereceivedpremiumpaymentsfortheguaranteethatitwouldpaytheCDS
purchasersintheeventthattheselowerriskCDOtranchesdefaultedordeclinedin
value.MorganStanleycouldusetheincomefromthosepremiumstofinancethe
ShortPosition,butwouldhavetomakepayoutsiftheCDOtranchesreferencedby
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theLongPositionsuffereddefaultsuptoamaximumof$13.5billionintheevent
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ofa100percentdefaultintheseCDOs.Inessence,thecompanywasbettingthat
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defaultsinthesubprimemortgagemarketswouldbesignificantenoughtoimpair
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thevalueofthehigherriskCDOtranchesreferencedbytheShortPosition,butnot
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significantenoughtoimpairthevalueofthelowerriskCDOtranchesreferencedby
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theLongPosition.
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AccordingtothePlaintiffs,[b]ymid2006,thebiggesthousingbubbleinU.S.
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historyhadpopped.J.A.465.Subprimemortgagesissuedin2005and2006,like
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those backing Morgan Stanleys proprietary trade, rapidly began to suffer from
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delinquenciesanddefaults.OnFebruary12,2007,Morgan[Stanley]economist
RichardBerneracknowledgedthatthese[s]oaringdefaultssignalthatthelong
awaitedmeltdowninsubprimemortgagelendingisnowunderway[.]J.A.469.
AlthoughMorganStanleysProprietaryTradingGrouphadcorrectlypredictedthe
underestimatedthemagnitudeofthecollapse.ThevalueofMorganStanleysswap
positions declined substantially over the course of 2007, and Morgan Stanley
ultimatelylostbillionsofdollarsontheproprietarytrade.
PlaintiffsallegethatDefendantsmadenumerousmaterialmisstatementsand
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omissions from June 20, 2007 through November 19, 2007 to conceal Morgan
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Stanleysexposuretoandlossesfromthissubprimeproprietarytrade.Thesecond
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amendedcomplaintidentifiestwocategoriesofmisrepresentationsandomissions:
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(1)misrepresentationsandomissionsregardingMorganStanleysexposuretocredit
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riskrelatedtotheU.S.subprimemortgagemarketarisingfromitsLongPosition(the
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exposureclaim),and(2)misrepresentationsregardingMorganStanleyslosses
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arisingfromtheLongPosition(thevaluationclaim).Plaintiffsallegethatthese
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misstatementsandomissionsfraudulentlyinflatedMorganStanleysstockprice
during the class period and caused them to suffer financially when the market
learnedthetruthaboutMorganStanleysexposureandlosses.
A.ExposureClaim
PlaintiffsrelyonfourstatementsfromMorganStanleyofficers,andonealleged
omission.First,onaJune20,2007callwithmarketanalystsaboutMorganStanleys
second quarter earnings, Defendant Sidwell stated that concerns early in the
quarter about whether issues in the subprime market were going to spread
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dissipated.J.A.498.Second,onthatsamecall,Sidwellrespondedtoarequestto
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characterizeMorganStanleyspositioninthemortgagemarketandtoexplainthe
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declineinthecompanysfixedincomerevenuesbystatingthatMorganStanley
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reallydidbenefitfromconditionsinthesubprimemarketinthefirstquarterof
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2007,andcertainlydidnotlosemoneyinthisbusinessduringthesecondquarter.
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J.A.498,499.Third,duringanotherearningscallwithmarketanalystsonSeptember
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19,2007,DefendantKelleherstatedthatMorganStanleyremain[ed]exposedtorisk
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exposuresthroughanumberofinstruments[including]CDOs,withoutdescribing
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theextentofthatexposure.J.A.50607.Andfourth,KelleherstatedinanOctober
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24, 2007 interview with CIBC World Markets analyst Meredith Whitney that he
[did]notseefurtherwritedownsto[MorganStanleys]carryingvaluesoverthe
nearterm.J.A.516.Plaintiffsclaimthateachofthesestatementswasmaterially
falseormisleading.
omissions in their 10Q filings by failing to disclose the existence of the Long
Position,thatMorganStanleyhadsustainedlossesonthatpositioninthesecond
andthirdquartersof2007,andthatthecompanywas likelytoincuradditional
significant losses on the position in the future. They argue that Item 303 of
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RegulationSKandrelatedguidancerequirescompaniestodiscloseontheir10Q
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filingsanyknowntrends,oruncertaintiesthathavehad,ormightreasonablybe
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expectedtohave,a[n]...unfavorablematerialeffectonthecompanysrevenue,
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operatingincomeornetincome.J.A.465.Plaintiffsclaimthat[b]yJuly4[,2007,]
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atthelatest,DefendantsknewthattheLongPositionwasreasonablyexpectedto
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haveanunfavorablematerialeffectonrevenue.J.A.482.Itisnotdisputedthat
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MorganStanleydidnotmakethisItem303disclosureonits10Qfilingsin2007.
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B.ValuationClaim
Stanley overstated its earnings in the third quarter of 2007 because it did not
sufficientlywritedownthevalueofitsLongPosition.AccordingtoPlaintiffs,the
LongPositionsvaluewasinherentlylinkedtoanindexofRMBSsknownasthe
ABX.BBB.061Index(theABXIndex).Thus,whentheABXIndexdeclinedby32.8
percentinthethirdquarterof2007,MorganStanleyshouldhavemarkeddownthe
valueoftheLongPositionbythatsamepercentageanddisclosedthelossinits
quarterlystatement.Insteadoftakingthat$4.4billionmarkdown,however,Morgan
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Stanleyrecognizedonlya$1.9billionlossontheLongPositionaftervaluingitusing
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internalmodelsthatdidnotexclusivelyrelyontheABXIndex.Plaintiffsallegethat
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MorganStanleylaterwrotedownthevalueoftheLongPositionbyapercentage
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greaterthanthatdictatedbytheABXIndexinordertomakeupforthemisstatement
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inthethirdquarter.
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C.ProceduralHistory
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Plaintiffs brought suit in the United States District Court for the Central
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DistrictofCalifornia,filinganinitialcomplaintinearly2008andthenanamended
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complaintonNovember24,2008.ThecasewasthentransferredtotheUnitedStates
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DistrictCourtfortheSouthernDistrictofNewYork(Batts,J.),whereDefendants
movedtodismissallclaimspursuanttoRules9(b)and12(b)(6)oftheFederalRules
ofCivilProcedureandSection78u4(b)ofthePrivateSecuritiesLitigationReform
Act.StratteMcClurev.MorganStanley,784F.Supp.2d373,376(S.D.N.Y.2011).The
districtcourtgrantedthemotiontodismissonApril4,2011.Id.at391.Onthe
exposureclaim,thedistrictcourtruledthattheamendedcomplaintdidnotspecify
why Defendants statements about risk and its trading positions were false or
misleadinganddecidedthatDefendantshadnoobligationtodisclosetheLong
Position. See id. at 38586. On the valuation claim, the district court ruled that
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Plaintiffsfailedtopleadlosscausation.Seeid.at39091.ThecourtgrantedPlaintiffs
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leavetoamendtheirpleadingswithregardtotheexposureclaimandlosscausation
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onthevaluationclaim,butotherwisedismissedPlaintiffsclaimswithprejudice.
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Seeid.at391.
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OnJune9,2011,PlaintiffsfiledasecondamendedcomplaintandDefendants
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movedtodismisssoonthereafter.Onceagain,thedistrictcourtdismissedallofthe
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(S.D.N.Y. Jan. 18, 2013). The district court found no reason to alter its earlier
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decisionthatPlaintiffsfailedtopleadlosscausationforthevaluationclaim.Seeid.
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at*12*13.Withregardtotheaffirmativestatementsconsideredinconnectionwith
theexposureclaim,thedistrictcourtfoundnoreasontoalteritsearlierdecisionthat
Plaintiffsdidnotsufficientlypleadfalsity.Seeid.at*4*5.Butthistime,thecourt
ruled that Morgan Stanley did have a duty under Item 303 to disclose the Long
Positioninits2007Form10Qfilings.Seeid.at*7.Thedistrictcourtjustifiedthe
PartnersInc.v.IkanosCommunications,Inc.,681F.3d114(2dCir.2012),andLitwinv.
BlackstoneGroup,L.P.,634F.3d706(2dCir.2011),whichheldthatItem303may
provide a basis for disclosure obligations under Sections 11 and 12(a)(2) of the
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Securities Act of 1933. 2013 WL 297954, at *5. The district court nevertheless
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dismissedtheexposureclaimafterdecidingthatthesecondamendedcomplaint
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failedtopleadastronginferenceofscienterwithrespecttoDefendantsfailureto
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disclose the Long Position. Id. at *9. Plaintiffs now appeal both district court
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decisions.
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DISCUSSION
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WereviewdenovothedistrictcourtsjudgmentgrantingDefendantsmotion
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todismiss.AbsoluteActivistValueMasterFundLtd.v.Ficeto,677F.3d60,65(2dCir.
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2012).Tosurviveamotiontodismiss,acomplaintmustcontainsufficientfactual
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matter, accepted as true, to state a claim for relief that is plausible on its face.
Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009) (internal quotation marks omitted). In
makingthisdetermination,weconsideranywritteninstrumentattachedto[the
reference,aswellaspublicdisclosuredocumentsrequiredbylawtobe,andthat
havebeen,filedwiththeSEC,anddocumentsthattheplaintiffseitherpossessedor
knewaboutanduponwhichtheyreliedinbringingthesuit.Rothmanv.Gregor,220
F.3d81,88(2dCir.2000)(citationsomitted).
Section10(b)oftheSecuritiesExchangeActof1934makesitunlawfultouse
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manipulativeordeceptivedeviceorcontrivanceincontraventionof[the]rulesand
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regulationsthattheSECprescribes.15U.S.C.78j.Inturn,Rule10b5,which
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implementsSection10(b),provides:
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Itshallbeunlawfulforanyperson,directlyorindirectly...:
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(a)Toemployanydevice,scheme,orartificetodefraud,
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(b)Tomakeanyuntruestatementofamaterialfactortoomitto
stateamaterialfactnecessaryinordertomakethestatements
made,inthelightofthecircumstancesunderwhichtheywere
made,notmisleading,or
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(c)Toengageinanyact,practice,orcourseofbusinesswhich
operatesorwouldoperateasafraudordeceituponanyperson,
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inconnectionwiththepurchaseorsaleofanysecurity.
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17C.F.R.240.10b5.Tostateaclaimforsecuritiesfraudundertheseprovisionsa
plaintiffmustallegethateachdefendant(1)mademisstatementsoromissionsof
material fact, (2) with scienter, (3) in connection with the purchase or sale of
securities,(4)uponwhichtheplaintiffrelied,and(5)thattheplaintiffsreliancewas
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theproximatecauseofitsinjury.ATSICommcns,Inc.v.ShaarFund,Ltd.,493F.3d
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87,105(2dCir.2007).
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This opinion addresses the district courts decision that Morgan Stanleys
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failuretodisclosetheLongPositioninitsJulyandOctober10Qfilings,inalleged
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disregardofItem303ofRegulationSK,constitutedanactionableomissionunder
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Section10(b)andRule10b5.3Weconclude,asamatteroffirstimpressioninthis
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Court,thatafailuretomakearequiredItem303disclosureina10Qfilingisindeed
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anomissionthatcanserveasthebasisforaSection10(b)securitiesfraudclaim.
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requirementsoutlinedinBasicInc.v.Levinson,485U.S.224(1988),andifallofthe
Asalreadynoted,Plaintiffsremainingclaimsareaddressedinthesummary
orderfiledsimultaneouslywiththisopinion.
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otherrequirementstosustainanactionunderSection10(b)arefulfilled.Here,the
districtcourtproperlydismissedPlaintiffsexposureclaimpredicatedonMorgan
StanleysfailuretodiscloseunderItem303becausethesecondamendedcomplaint
didnotsufficientlypleadscienter.
I.
TheSupremeCourthasinstructedthat[s]ilence,absentadutytodisclose,
isnotmisleadingunderRule10b5.Basic,485U.S.at239n.17;seealsoChiarellav.
UnitedStates,445U.S.222,230(1980).Asaresult,wehaveconsistentlyheldthatan
omissionisactionableunderthesecuritieslawsonlywhenthecorporationissubject
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toadutytodisclosetheomittedfacts.InreTimeWarnerInc.Sec.Litig.,9F.3d259,
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267(2dCir.1993);seeGlazerv.FormicaCorp.,964F.2d149,157(2dCir.1992).Such
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information,astatuteorregulationrequiringdisclosure,oracorporatestatement
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thatwouldotherwisebeinaccurate,incomplete,ormisleading.Glazer,964F.2d
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at157(quotingBackmanv.PolaroidCorp.,910F.2d10,12(1stCir.1990)(enbanc));
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accordOranv.Stafford,226F.3d275,28586(3dCir.2000).
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AsPlaintiffscorrectlyargue,Item303ofRegulationSKimposesdisclosure
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requirementsoncompaniesfilingSECmandatedreports,includingquarterlyForm
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10Qreports.SeeLouisLoss&JoelSeligman,FundamentalsofSecuritiesRegulation
512&n.14(5thed.2004).Thoserequirementsincludetheobligationto[d]escribe
anyknowntrendsoruncertainties...thattheregistrantreasonablyexpectswill
haveamaterial...unfavorableimpacton...revenuesorincomefromcontinuing
operations.17C.F.R.229.303(a)(3)(ii).TheSEChasprovidedguidanceonItem
303,clarifyingthatdisclosureisnecessarywhereatrend,demand,commitment,
eventoruncertaintyisbothpresentlyknowntomanagementandreasonablylikely
operations.ManagementsDiscussionandAnalysisofFinancialConditionand
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ResultsofOperations,ExchangeActReleaseNo.6835,43S.E.C.Docket1330,1989
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WL1092885,at*4(May18,1989)[hereinafterExchangeActReleaseNo.6835].
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Item303saffirmativedutytodiscloseinForm10Qscanserveasthebasisfor
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asecuritiesfraudclaimunderSection10(b).Wehavealreadyheldthatfailingto
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complywithItem303byomittingknowntrendsoruncertaintiesfromaregistration
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statementorprospectusisactionableunderSections11and12(a)(2)oftheSecurities
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Actof1933.4SeePantherPartners,681F.3dat120;Litwin,634F.3dat716;accordJ&R
Wehavealsoheldthatdefendantsfailuretomakerequireddisclosuresunder
Item303contributedtoanadequatelypledsecuritiesfraudclaimunderSection10(b)in
InreScholasticCorp.SecuritiesLitigation,252F.3d63,7074(2dCir.2001).Whilethat
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Mktg. v. Gen. Motors Corp., 549 F.3d 384, 392 (6th Cir. 2008); Silverstrand Invs. v.
AMAGPharm.,Inc.,707F.3d95,10203,107(1stCir.2013).LikeSection12(a)(2),
Rule10b5requiresdisclosureofmaterialfact[s]necessaryinordertomake...
statementsmade...notmisleading.ThisCourtandoursistercircuitshavelong
recognizedthatadutytodiscloseunderSection10(b)canderivefromstatutesor
regulationsthatobligateapartytospeak.See,e.g.,Glazer,964F.2dat149;Backman,
910F.2dat20;Oran,226F.3dat28586;Gallagherv.AbbottLabs.,269F.3d806,808
(7th Cir. 2001). And this conclusion stands to reason for omitting an item
casealsoinvolvedaffirmativelymisleadingstatements,weciteddefendantsalleged
failuretodisclosetrendsinitsForm10Q,despiteadutyunderItem303todisclose
thosetrends,asevidencethatplaintiffsadequatelyallegedaSection10(b)violation,
implyingthatItem303saffirmativedutytodiscloseinForm10Qscanserveasthe
basisforasecuritiesfraudclaimunderSection10(b).Seeid.Nevertheless,perhaps
becauseInreScholasticdidnotsquarelyaddresswhetherItem303cangiverisetoa
dutytodiscloseunder10b5,districtcourtsinthisCircuithavecontinuedtoexpress
confusionontheissue.See,e.g.,Abuhamdanv.Blyth,Inc.,9F.Supp.3d175,206n.25(D.
Conn.2014)([I]tisfarfromcertainthattherequirementthattherebeadutytodisclose
underRule10b5maybesatisfiedbyimportingthedisclosuredutiesfromSK303....
(internalquotationmarksomitted));InreNevsunRes.Ltd.,No.12cv1845,2013WL
6017402,at*11n.4(S.D.N.Y.Sept.27,2013)(PlaintiffscannotbasetheirSection10(b)
claimonatheorythatDefendantsviolatedItem303.);cf.InreCorning,Inc.Sec.Litig.,
349F.Supp.2d698,716(S.D.N.Y.2004)([T]heSecondCircuit...reversedadistrict
courtsdismissalofaRule10b5claimthatwasbasedonadefendantsfailuretomake
disclosuresallegedlyrequiredunderSK303.Itwouldappearthatthe[District]Court
mustconsiderItem303inconnectionwithplaintiffsclaimunderRule10b5.(citingIn
reScholastic,252F.3dat74)).
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requiredtobedisclosedona10Qcanrenderthatfinancialstatementmisleading.
Likeregistrationstatementsandprospectuses,Form10Qsaremandatoryfilings
thatspeak...totheentiremarket.Shawv.DigitalEquip.Corp.,82F.3d1194,1222
(1stCir.1996)(abrogatedbystatuteonothergrounds).Asrequiredelementsof
those filings, Item 303 disclosures give investors an opportunity to look at the
prospectiveanalysisoftheregistrantsfinancialconditionandresultsofoperations.
ExchangeActReleaseNo.6835,1989WL1092885,at*17.Duetotheobligatory
natureoftheseregulations,areasonableinvestorwouldinterprettheabsenceofan
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Item303disclosuretoimplythenonexistenceofknowntrendsoruncertainties.
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..thattheregistrantreasonablyexpectswillhaveamaterial...unfavorableimpact
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on...revenuesorincomefromcontinuingoperations.17C.F.R.229.303(a)(3)(ii);
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seealsoDonaldC.Langevoort&G.MituGulati,TheMuddledDutytoDiscloseUnder
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Rule10b5,57Vand.L.Rev.1639,1680(2004).ItfollowsthatItem303imposesthe
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type of duty to speak that can, in appropriate cases, give rise to liability under
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Section10(b).5
BecauseSection10(b)prohibitsmanipulativeordeceptivedevice[s]...in
contraventionof[theSECs]rulesandregulations,15U.S.C.78j,allowinga10b5
causeofactiontoarisefromafailuretodiscloseunderItem303doesnotexceedwhat
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ThefailuretomakearequireddisclosureunderItem303,however,isnotby
itselfsufficienttostateaclaimforsecuritiesfraudunderSection10(b).Significantly,
Rule10b5makesonlymaterialomissionsactionable.17C.F.R.240.10b5(b).
InBasicInc.v.Levinson,theSupremeCourtconcludedthat,insecuritiesfraudcases
underSection10(b)andRule10b5,thematerialityofanallegedlyrequiredforward
lookingdisclosureisdeterminedbyabalancingofboththeindicatedprobabilitythat
theeventwilloccurandtheanticipatedmagnitudeoftheeventinlightofthetotality
ofthecompanyactivity.485U.S.at238(quotingSECv.TexasGulfSulfurCo.,401
F.2d833,849(2dCir.1968)(enbanc))(emphasisadded).TheSECstestforaduty
Congressauthorize[d]whenitfirstenactedthe[SecuritiesExchangeAct].Janus
CapitalGrp.,Inc.v.FirstDerivativeTraders,131S.Ct.2296,2302(2011)(internalquotation
marksomitted);seealsoCent.BankofDenver,N.A.v.FirstInterstateBankofDenver,N.A.,
511U.S.164,173(1994)([A]privateplaintiffmaynotbringa10b5suitagainsta
defendantforactsnotprohibitedbythetextof10(b).).OurconclusionthatItem303
mayprovidethebasisfora10b5violationissupportedbyanSECCeaseandDesist
Order,inwhichtheCommissionheldthatacompanyviolatedSection10(b)andRule
10b5byfailingtoincludeinForm10Qsinformationitwasobligatedtodiscloseunder
Item303.InreValleySys.,Inc.,FileNo.38811,1995WL547801,at*4(S.E.C.Sept.14,
1995).OurdecisionisalsoconsistentwithanopinionintheFirstCircuit.SeeShaw,82
F.3dat1222&n.37([I]nthecontextofapublicoffering,plaintiffswho(throughthe
market)relyuponthecompletenessofaregistrationstatementorprospectusmaysue
underSection10(b)andRule10b5fornondisclosuresofmaterialfactsomittedfrom
thosedocumentsinviolationoftheapplicableSECrulesandregulations.).
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toreportunderItem303,ontheotherhand,involvesatwopart(anddifferent)
inquiry.Onceatrendbecomesknown,managementmustmaketwoassessments:
(1)Istheknowntrend...likelytocometofruition?Ifmanagement
determines that it is not reasonably likely to occur, no disclosure is
required.
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(2)Ifmanagementcannotmakethatdetermination,itmustevaluate
objectivelytheconsequencesoftheknowntrend...ontheassumption
that it will come to fruition. Disclosure is then required unless
management determines that a material effect on the registrants
financialconditionorresultsofoperationsisnotreasonablylikelyto
occur.
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ExchangeActReleaseNo.6835,1989WL1092885,at*6.AccordingtotheSEC,this
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disclosurestandardisuniquetoItem303,and[t]heprobability/magnitudetestfor
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materialityapprovedbytheSupremeCourtin[Basic]isinapposite.Id.at*6n.27;
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seealsoOran,226F.3dat288(notingthatItem303sdisclosureobligationsextend
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considerablybeyondthoserequiredbyRule10b5).
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SincetheSupremeCourtsinterpretationofmaterialinRule10b5dictates
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whetheraprivateplaintiffhasproperlystatedaclaim,weconcludethataviolation
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ofItem303sdisclosurerequirementscanonlysustainaclaimunderSection10(b)
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and Rule 10b5 if the allegedly omitted information satisfies Basics test for
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materiality.Thatis,aplaintiffmustfirstallegethatthedefendantfailedtocomply
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with Item 303 in a 10Q or other filing. Such a showing establishes that the
defendant had a duty to disclose. A plaintiff must then allege that the omitted
informationwasmaterialunderBasicsprobability/magnitudetest,because10b5
onlymakesunlawfulanomissionofmaterialinformationthatisnecessaryto
make...statementsmade,inthiscasetheForm10Qs,notmisleading.Matrixx
Initiatives, Inc. v. Siracusano, 131 S. Ct. 1309, 132122 (2011) (quoting 17 C.F.R.
240.10b5(b))(internalquotationmarksomitted).Ofcourse,aswithanySection
10(b)claim,aplaintiffmustalsosufficientlypleadscienter,aconnectionbetween
the...omissionandthepurchaseorsaleofasecurity,relianceontheomission,
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andaneconomiclosscausedbythatreliance.Levittv.J.P.MorganSec.,Inc.,710F.3d
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454,465(2dCir.2013).
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WenotethatourconclusionisatoddswiththeNinthCircuitsrecentopinion
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inInreNVIDIACorp.SecuritiesLitigation,768F.3d1046(9thCir.2014).Thatcase
14
heldthatItem303sdisclosuredutyisnotactionableunderSection10(b)andRule
15
10b5,relyingonaThirdCircuitopinionbythenJudgeAlito,Oranv.Stafford,226
16
F.3dat275.ButOransimplydeterminedthat,[b]ecausethematerialitystandards
17
forRule10b5and[Item303]differsignificantly,aviolationofItem303doesnot
18
automaticallygiverisetoamaterialomissionunderRule10b5.Id.at288(emphasis
20
added).Havingalreadydecidedthattheomissionsinthatcasewerenotmaterial
underBasic,theThirdCircuitconcludedthatItem303couldnotprovideabasisfor
liability. Id. Contrary to the Ninth Circuits implication that Oran compels a
conclusionthatItem303violationsareneveractionableunder10b5,Oranactually
suggested,withoutdeciding,thatincertaininstancesaviolationofItem303could
giverisetoamaterial10b5omission.Ataminimum,Oranisconsistentwithour
decisionthatfailuretocomplywithItem303inaForm10Qcangiverisetoliability
under Rule 10b5 so long as the omission is material under Basic, and the other
elementsofRule10b5havebeenestablished.
10
TheNinthCircuitsopinioninNVIDIAalsomisconstruestherelationship
11
betweenRule10b5andSection12(a)(2)oftheSecuritiesAct.InLitwinandPanther
12
Partners,weestablishedthatItem303createsadutytodiscloseforthepurposesof
13
liabilityunderSection12(a)(2).Litwin,634F.3dat716;PantherPartners,681F.3dat
14
120.TheNinthCircuithadalsoadoptedthatposition.SeeSteckmanv.HartBrewing,
15
Inc.,143F.3d1293,1296(9thCir.1998).InNVIDIA,apaneloftheNinthCircuit
16
found these decisions irrelevant to its interpretation of Rule 10b5. But Section
17
12(a)(2)sprohibitiononomissionsistextuallyidenticaltothatofRule10b5:both
18
makeunlawfulomissionofmaterialfact[s].. .necessaryinordertomake...
21
statements, in light of the circumstances under which they were made, not
misleading.15U.S.C.77l;seealso17C.F.R.240.10b5.SECregulations,likeItem
303,dictatethecontentsofmandatorydisclosuresbetheyForm10Qsinthecase
ofRule10b5orprospectusesinthecaseofSection12(a)(2)andarethereforean
essentialpartofthecircumstancesunderwhichsuchdisclosuresaremade.Litwin
andPantherPartnersrecognizedthatissuingfinancialstatementsthatomitelements
requiredbyItem303canmisleadinvestors.Thosedecisionsprovidefirmfooting
forourdecisioninthiscase.
II.
10
Applying the standards set forth above, we conclude that Plaintiffs have
11
adequatelyallegedthatDefendantsbreachedtheirItem303dutytodisclosethat
12
MorganStanleyfacedadeterioratingsubprimemortgagemarketthat,inlightofthe
13
companysexposuretothemarket,waslikelytocausetradinglossesthatwould
14
materiallyaffectthecompanysfinancialcondition.Weassume,arguendo,thatthis
15
omission was material under Basic. We nonetheless affirm the district courts
16
dismissaloftheclaim,concludingthatPlaintiffsfailedadequatelytopleadscienter.
17
Plaintiffshaveplausiblyallegedthat,bythesecondandthirdquartersof2007,there
18
wasasignificantdownwardtrendinthesubprimeresidentialmortgagemarketthat
22
couldnegativelyaffectMorganStanleysoverallfinancialposition.Tobeginwith,
Plaintiffsallegethatmarketwatchers,includingMorganStanleyanalysts,reported
adownwardtrendintherealestateandsubprimemortgagemarketsasearlyas
2006.ByFebruary27,2007,aMorganStanleyeconomisthadwrittenthat[s]oaring
defaultssignalthatthelongawaitedmeltdowninsubprimemortgagelendingis
nowunderway,andthecompanysownCDOanalystsreportedsignificantrisks
toCDOsbackedbyassetbackedsecurities,includingRMBSs.J.A.469.Thattrend
continuedintothesummer,whenMorganStanleyanalystsallegedlyreportedthat
[r]atingsdowngradesin[assetbacked]CDOtranchesareinevitableandmaterial,
10
thatthoseCDOswereexpectedtoremainunderseverepressure,andthatlong
11
term value assessment metrics would continue to decline. J.A. 473 (emphasis
12
omitted).
13
Plaintiffs have also plausibly alleged that Morgan Stanley had significant
14
exposuretoasharpdownturninthesubprimemarketthroughitsLongPosition.
15
Atthebeginningoftheclassperiod,DefendantshadalreadywrittendowntheLong
16
Positionby$300millionasaresultoftheweakeningmarket.Whilethatwritedown
17
didnotexceedgainsfromtheShortPosition,itdidcatchtheDefendantsattention,
18
andMorganStanleyorderedstresstestsontheLongPositionandtheninitiateda
23
task force to find strategies to sell off its assets that were placed at risk by the
collapseofthesubprimemarket.Atthemotiontodismissstage,theseallegations
are sufficient to support a claim that Morgan Stanley was faced with a known
trend[]...that[was]reasonablyexpectedtohavematerialeffectsonthecompanys
financialposition.ExchangeActReleaseNo.6835,1989WL1092885at*4(emphasis
omitted)(describingreductionintheregistrantsproductprices;erosioninthe
registrantsmarketshare;changesininsurancecoverage;orthelikelynonrenewal
ofamaterialcontractasexamplesofcurrentlyknowntrends).
Defendants argue that they satisfied their obligations under Item 303 by
10
disclosing the deterioration of the real estate, credit, and subprime mortgage
11
markets,anditspotentialnegativelytoaffectMorganStanley.ButMorganStanleys
12
disclosures about market trends were generic, spread out over several different
13
filings,andoftenunconnectedtothecompanysfinancialposition.Suchgeneric
14
cautionarylanguagedoesnotsatisfyItem303.SeePantherPartners,681F.3dat122.
15
TheSEChasemphasizedthatItem303requiresnotonlyadiscussionbutalsoan
16
17
18
ResultsofOperations,ReleaseNos.338350,3448960,68Fed.Reg.75056,75061
(Dec.29,2003)[hereinafterReleaseNo.3448960].Plaintiffshaveadequatelyalleged
thatMorganStanleyspatchworkcommentaryontherelevantmarkettrendsdidnot
liveuptothatobligation.
Thatisnottosay,however,thatMorganStanleysdisclosureobligationswere
asextensiveasthedistrictcourtdecided.Aswehaveemphasized,Item303requires
disclosureofaknowntrendandthemannerinwhichitmightreasonablybe
expectedtomateriallyimpactacompanysoverallfinancialposition.Litwin,634
10
F.3dat71819.6TheSEChascautionedthatthisobligationrequiresquantitative
11
12
information for investors. Release No. 3448960, 68 Fed. Reg. at 75062, 75065.
13
Contrarytothedistrictcourtsview,theCommissionhasnevergonesofarasto
14
requireacompanytoannounceitsinternalbusinessstrategiesortoidentifythe
TheSECdistinguishesrequireddisclosuresaboutcurrentlyknowntrends...
thatarereasonablyexpectedtohavematerialeffectsandoptionalforwardlooking
disclosure[s]thatinvolve[]anticipatingafuturetrend...oranticipatingaless
predictableimpactofaknownevent,trendoruncertainty.ExchangeActReleaseNo.
336835,1989WL1092885,at*4.Anyforwardlookinginformationsuppliedis
expresslycoveredbythesafeharborruleforprojections.17C.F.R.229.303(a),
Instruction7.
25
particularsofitstradingpositionssuchastheLongPosition.Thisisinlinewiththis
companiestogivecompetitorsnoticeofproprietarystrategiesandinformation.See
SanLeandroEmergencyMed.Grp.ProfitSharingPlanv.PhilipMorrisCos.,75F.3d801,
809(2dCir.1996).Therefore,insteadofbeingrequiredtodisclosethedetailsofthe
LongPosition,underItem303,MorganStanleyneededtodiscloseonlythatitfaced
deteriorating real estate, credit, and subprime mortgage markets, that it had
significantexposuretothosemarkets,andthatifthetrendscametofruition,the
companyfacedtradinglossesthatcouldmateriallyaffectitsfinancialcondition.7
10
ThePlaintiffs,moreover,whileadequatelyallegingthatDefendantsbreached
11
theirItem303dutytodisclose,didnotadequatelypleadaclaimunderSection10(b).
12
ForDefendantsbreachoftheirItem303dutytobeactionableunderSection10(b),
13
Plaintiffswererequiredadequatelytopleadeachelementofa10b5securitiesfraud
14
claim.Thesecondamendedcomplaintdoesnotaccomplishthatgoal.Weassume,
15
withoutdeciding,thatMorganStanleysfailuretodisclosepursuanttoItem303met
16
Asdiscussedsupra,however,MorganStanleywasrequiredtoconnectthe
trendstoitsfinancialpositionandtooffermorethangenericcautionarylanguage.
PantherPartners,681F.3dat122.
26
nonethelessfailsbecausethesecondamendedcomplaintdoesnotgiverisetoa
stronginferenceofscienter.
ThePrivateSecuritiesLitigationReformAct,15U.S.C.78u4(b),subjects
scienter, the statute requires that plaintiffs allege facts giving rise to a strong
inference that the defendant acted with the required state of mind. Id. 78u
4(b)(2)(A).Thisrequirementcanbesatisfiedbyallegingfacts(1)showingthatthe
defendantshadbothmotiveandopportunitytocommitthefraudor(2)constituting
strongcircumstantialevidenceofconsciousmisbehaviororrecklessness.ATSI
10
Commcns,493F.3dat99.Here,PlaintiffsrelysolelyontheDefendantsalleged
11
12
recklessnessi.e.,astateofmindapproximatingactualintent,andnotmerelya
13
heightenedformofnegligence.S.CherrySt.,LLCv.HennesseeGrp.LLC,573F.3d
14
98, 109 (2d Cir. 2009) (quoting Novak v. Kasaks, 216 F.3d 300, 312 (2d Cir. 2000))
15
(emphasisomitted).Weconsiderthecomplaintinitsentiretyandtakeintoaccount
16
plausibleopposinginferences.Tellabs,Inc.v.MakorIssues&Rights,Ltd.,551U.S.
17
308, 323 (2007). The inference of scienter must be . . . cogent and at least as
18
compellingasanyopposinginferenceonecoulddrawfromthefactsalleged.Id.
27
at324;seeTeamstersLocal445FreightDiv.PensionFundv.DynexCapitalInc.,531F.3d
190,195(2dCir.2008).
Thedistrictcourtcorrectlyruledthatthesecondamendedcomplaintdoesnot
includesufficientfactstogiverisetoastronginferenceofscienterastothematter
omittedfromthe10Qfilings.Tomeetthatrequirement,Plaintiffsmustallegethat
Defendants wereatleastconsciouslyrecklessregardingwhethertheirfailureto
provideadequateItem303disclosuresduringthesecondandthirdquartersof2007
would mislead investors about material facts. See ECA & Local 134 IBEW Joint
Pension Trust of Chicago v. JP Morgan Chase Co., 553 F.3d 187, 202 (2d Cir. 2009)
10
(concludingthat,toadequatelypleadscienter,plaintiffsmustpleadfactsshowing
11
thatdefendantsknewanomissionwasmaterial).Here,Plaintiffsmakeallegations
12
aboutdevelopmentsinthesubprimemarket,internalconcernaboutcapitalcallsand
13
writedownsontheLongPosition,andthecreationofataskforcetoinvestigate
14
sellingoffsomeofMorganStanleyssubprimepositions.Butthesefactsdonot
15
16
disclosures.SouthCherrySt.,573F.3dat109(emphasisomitted).Specifically,while
17
thecomplaintmakesoutthatMorganStanleywasintheprocessofassessingthe
18
risktoitsproprietarytradeduringthesecondandthirdquartersof2007,itissilent
28
aboutwhenemployeesrealizedthatthemorepessimisticassessmentsofthemarket
werelikelytocometofruitionandthattheywouldbeunabletoreducetheLong
Position. To the contrary, the complaint shows that Cruz ordered Daula and
anotherMorganStanleyemployee,NealShear,tocuttheLongPositionregardless
ofthelikelihoodthatthepessimisticassumptionsofthestresstestwouldcometo
pass. See J.A. 477 (I dont care what your view of probability [sic] is. Cut the
position.).Themeetingsabouttheproprietarytradeshowsimilarcaution:Morgan
Stanleys task force discussed strategies to reduce the Long Position while also
developingabettersenseoftherangeoflossesthecompanycouldface.J.A.485.
10
GiventherigidityofForm10Qfilingdeadlines,wefindnobasistoinferanything
11
more than a heightened form of negligence (if that) about whether Morgan
12
13
especiallyaftertakingintoaccountthatMorganStanleywasalsoprofitingfromthe
14
decliningmarketthroughitsShortPosition.SeeSouthCherrySt.,573F.3dat109;see
15
alsoKalnitv.Eichler,264F.3d131,144(2dCir.2001)(holdingthatwhereacomplaint
16
does not present facts indicating a clear duty to disclose it does not establish
17
strongevidenceofconsciousmisbehaviororrecklessness).
29
Moreover,aswedecideinthesummaryorderissuedintandemwiththis
opinion,MorganStanleysaffirmativestatementsaboutitsexposuretothemortgage
securitiesmarketduringtherelevanttimeperiodwerenotmisleading.Cf.Matrixx,
131 S. Ct. at 1324 (finding it most significant[] for scienter that the defendant
issuedapressreleasethataffirmativelymisrepresentedfacts).Andthecompany
didfullyreportitsexposuretomortgagesecuritiesbackedbysubprimeloansin
November2007lessthanamonthafteritsthirdquarterfilingandamonthin
advanceofthenextquarterlyreport.SeeRombachv.Chang,355F.3d164,176(2dCir.
2004) (noting that disclosure of facts prior to a filing deadline weaken[s] the
10
inferencethatdefendantsactedrecklessly);Novak,216F.3dat30809(explainingthat
11
scientershouldnotbefoundwheredefendantsmerelyshouldhaveanticipated
12
futureeventsandmadecertaindisclosuresearlierthantheyactuallydid).The
13
mostcogentinferencefromtheseallegations,intandemwithassertionsabout
14
MorganStanleysinternaldeliberations,isthat[thecompany]delayedreleasing
15
informationonitsForm10Qsinthesecondandthirdquartersof2007tocarefully
16
reviewalloftherelevantevidenceandwasatworstnegligentastotheeffectofthe
17
delay on investors. Matrixx, 131 S. Ct. at 1324 n.15 (internal quotation marks
18
omitted).BecauseareasonablepersonwouldnotdeemtheinferencethatMorgan
30
Stanleywasconsciouslyrecklessaboutwhetheritsmandatedfilingswouldmislead
investorsatleastascompellingasthisopposinginference,weconcludethatthe
Plaintiffshavenotadequatelypledscienter.Tellabs,551U.S.at324.
CONCLUSION
4
5
Tosummarize:
(1)Weconcludethat,asamatteroffirstimpressioninthisCourt,a
failuretomakearequireddisclosureunderItem303ofRegulationSK,
17 C.F.R. 229.303(a)(3)(ii), in a 10Q filing is an omission that can
serve as the basis for a Section 10(b) securities fraud claim, if the
omission satisfies the materiality requirements outlined in Basic v.
Levinson,485U.S.at224,andifalloftheotherrequirementstosustain
anactionunderSection10(b)arefulfilled.
7
8
9
10
11
12
13
14
15
16
17
18
(2)PlaintiffshaveadequatelyallegedthatDefendantsbreachedtheir
Item303dutytodisclosethatMorganStanleyfacedadeteriorating
subprimemortgagemarketthat,inlightofthecompanysexposureto
themarket,waslikelytocausetradinglossesthatwouldmaterially
affectthecompanysfinancialcondition.
19
20
21
22
23
24
25
(3)Weassumewithoutdecidingthatthisomissionmetthemateriality
thresholdestablishedbyBasic.However,wedonotagreewiththe
district court regarding the extent of Morgan Stanleys disclosure
obligations.Specifically,theCommissionhasnevergonesofarasto
requireacompanytoannounceitsinternalbusinessstrategiesorto
identifytheparticularsofitstradingpositions.
26
27
28
29
30
Fortheforegoingreasons,andforthereasonsstatedinthesummaryorderissued
simultaneously with this opinion, the judgment of the district court is hereby
AFFIRMED.
32