Opinion
NO. CS-O1-0127-EFS
November 19, 2001
ORDER DENYING MOTIONS TO DISMISS
On September 26, 2001 the Court held a hearing in the above-captioned matter. The parties appeared and were represented as set forth in the minutes of that hearing, (Ct. Rec. 127). The Court heard oral argument on Defendants Lincoln Investment Company, Citizens' Realty Company, and RPS II, LLC's Motion to Dismiss under FRCP 9(b) and 12(b)(6), (Ct. Rec. 33), which was joined by RWR Management, (Ct. Rec. 41), Preston, Gates Ellis, (Ct. Rec. 61), prudential Securities, (Ct. Rec. 63), and the Spokane Downtown Foundation, (Ct. Rec. 95). The Court also heard argument on Defendant Foster, Pepper, Shefelman PLLC's Motion to Dismiss, (Ct. Rec. 70), which was joined by the Spokane Downtown Foundation, (Ct. Rec. 95), and RWR Management, (Ct. Rec. 101). The City of Spokane, pursuant to stipulation, did not join any motions to dismiss, but may move for dismissal at a later time, (Ct. Recs. 96, 100). Walker Parking Consultants/Engineers, Inc., and the Spokane Public Parking Development Authority, as well as third-party defendants Roy Koegen, Anne Koegen, and Perkins Cole, LLP, neither moved for dismissal nor joined in any motion to dismiss.
In addition to the motions for dismissal and joinder therein, also noted for hearing were Defendants Lincoln Investment Company, Citizens' Realty Company, and RPS II, LLC's Motion for Stay of Discovery, (Ct. Rec. 31), Defendant City of Spokane's Motion to Strike, (Ct. Rec. 117), and various motions for leave to file overlength memoranda in support of motions, (Ct. Recs. 35, 111, 115).
Having considered the arguments of counsel, the pleadings and memoranda of the parties, and documents referenced in the pleadings, except for papers excluded by the Court, for the reasons stated hereinafter and in Plaintiffs' memorandum in opposition, the Court DENIES Defendants' motions to dismiss.
I. FACTS
Defendants have filed motions to dismiss, under Rules 9 and 12(b) of the Federal Rules of Civil Procedure. For this reason, all facts pled in the Complaint are taken to be true. As a consequence, the facts presented in this section summarize the facts presented in Plaintiff's complaint.
The Court notes that, because the City of Spokane has withdrawn its Motion to Dismiss at this time, the facts presented regarding the City are limited to the facts alleged in the complaint that are relevant to claims against the moving defendants. In addition, the Court declines to consider arguments about the details of the Ordinance, its enforceability, or the role of the ordinance in the underlying transaction. Thus references to the ordinance are summarized for contextual purposes.
The River Park Square ("RPS") Mall, was built in 1974. Since that time, RPS mall has always been owned directly or indirectly by Citizens Realty Company, Lincoln Investment Company of Spokane, RPS Mall, L.L.C., and RPS II, L.L.C., (collectively, "Developers"). A garage of 750 spaces became the dedicated facility for the RPS Mall, and the garage was also owned directly or indirectly by the Developers. Annual revenues for the garage have never exceeded $1 million dollars.
On November 7, 1988, the Spokane Public Parking Development Authority was created, doing business as River Park Square Parking ("Parking Authority"). It is governed by a five member board of directors appointed by the mayor and approved by the city council, and so is subject to the control of the City of Spokane. In the early 1990s, the Developers start to plan redevelopment of the Mall and Garage at a total cost of around $100 million dollars.
In Early 1995, the Developers approached the City with a proposal that the City purchase the renovated and expanded Garage from the Developers. Two years earlier, in 1993, the City's Planning Department had conducted a survey, which indicated a relatively high number of surplus parking spaces in Downtown Spokane. As part of the Developers proposed project, they hired Walker Parking Consultants/Engineers, Inc., to assist the accounting firm of Ernst Young to project the cost of renovating the garage, adding 230 parking spaces, and adding a multiplex cinema to the Mall. In addition to projecting cost, Walker and Ernst Young generated and projected the future financial performance of the renovated and expanded garage.
Walker and Ernst Young produced their report on the financials of renovation in May, 1995 ("1995 Report"). Their projections were based on reasonable, fact-based assumptions, which had been provided by RWR Management, (d/b/a R.W. Robideaux Company), ("Robideaux"). Robideaux is a real property management company, who was the project director for the Developers' proposal to expand and renovate the garage. In addition, Robideaux had managed the day-to-day operations of the garage for a number of years, and therefore had access to data relevant to parking and revenue. The 1995 Report, using reasonable assumptions, set the market value of the renovated and expanded garage at less than $10 million. The revenue projected was $1.75 million in the first year of operation, and $2.28 million in annual revenue after ten years of operation.
In June of 1995, the City and Developers discussed the sale of the existing garage by the Developers to the City for $4.8 million. The City rejected this proposal. Thereafter, the Developers and City began to discuss the issuance of tax-exempt bonds as a means to pay the Developers for an expanded and renovated garage. Based on the 1995 Report, the City, Developers, and Prudential Securities, Inc., calculated that a bond issue of $14 million could fund the purchase of the land and garage, renovation, and 240 space expansion. Revenues projected would be sufficient to support $14 million in bond debt over a twenty-five year term. On June 12, 1995, the City passed a resolution authorizing the development of a proposal to acquire and develop the garage through a bond issue not to exceed $15 million.
In 1996, the Spokane Downtown Foundation ("Foundation") was created by the Developers to issue the bonds, purchase the renovated and expanded garage from the Developers with the bond proceeds, and to lease the ground underneath the garage from the Developers. The Foundation has a board of directors appointed by the Developers and their agents, and is subject to the direct or indirect control of the Developers. The Foundation hired Prudential to underwrite any bonds issued, and retained Preston Gates Ellis as issuer's counsel and as bond counsel. The City hired Walker in April of 1996, to prepare a financial feasibility study of the proposed purchase of the existing garage, with expansion and renovation. When hired, Walker did not disclose any conflict of interest based on prior work for the Developers regarding the same garage.
A few months later, the City and Developers determined that, if the City would supplement the anticipated revenue from the garage by pledging $1.6 million per year from its parking meter revenue fund, that a much larger bond could be supported. With a larger bond issuance in mind, the City and Developers directed Walker to apply a rarely used "investment value" approach. "Investment value" is a method whereby the subjective value of something is assessed based on criteria supplied by the individual investor.
The Developers, acting through Robideaux, supplied Walker with new numbers to use in its financial feasibility study. For example, Walker was directed to assume a $1.50 per hour rate for parking, and an average stay of 3 hours per customer. These numbers did not represent any factual data, but Walker was instructed to assume that the increased figures would be the correct data. The. Developers, City, Walker, and Robideaux all knew that these figures were unrealistic and unreasonable. Nevertheless, the numbers were utilized, and artificially inflated the value of the garage to suggest that it could support a $26 million bond. The new numbers were used to mislead investors to believe that the garage could generate sufficient cash flow to support the increased bond debt.
In June of 1996, Walker's "Financial Feasibility Analysis" was issued, ("Walker Report"), based on the changed factual assumptions. Compared with the 1995 Report, projected revenues have increased by approximately 300%, with an anticipated $4.3 million revenue in the first year of operation, and an estimated $10 million annual revenue after ten years. Around this time, the City Real Estate Manager, Dennis Beringer, advised the City to obtain a market value appraisal of the garage. Mr. Beringer objected to the use of the investment value method, and explained that the investment value approach would unreasonably inflate the value of the garage, causing the City to pay more for the garage than it was worth, and jeopardizing the ability of the Foundation to pay debt service on the bonds. The City then retained Auble and Barrett to perform "investment value" appraisals.
Auble is an MAI certified appraiser, but was not retained to do a standard appraisal. Instead, the City retained Auble to perform an "investment value" appraisal. The Auble Report was issued on July 11, 1996, ("Auble Report"). The Auble Report criticized the investment value approach, and stated that it was not an appropriate valuation method for real estate, and had nothing to do with the fair market value of the garage. The Auble Report did not identify itself as an appraisal, but rather a "consulting assignment," because market value would be so significantly lower than the investment value determined. In addition, Auble found that the Walker Report was not a financial feasibility study, because it ignored issues of competition, and was based on unreasonable assumptions. Auble also observed that the "value" assessed is artificially inflated, compared with the market value, as a result of the City's investment criteria. Similarly, Barrett was another certified MAI Appraiser, who performed a similar assignment for the City in July of 1996, ("Barrett Report"). Like the Auble Report, the Barrett Report disclaimed being an appraisal, and instead identified itself as a consulting assignment. In addition, the Barrett Report criticized the City's investment criteria. Barrett specifically criticized the projections for revenue from cinema patrons.
In November of 1996, the City Council passed a Resolution authorizing the City to prepare ordinances and agreements with the Foundation and the Authority to renovate and expand the parking garage, and to secure the issuance of tax-exempt bonds to acquire the garage. The bonds issued were to have a Moody's rating of BAA or better, or a Standard Poors rating of BBB or better.
Prior to bond issuance, the Sabey Corporation, provided two reports to the City Council, the Developers, and Robideaux, ("Sabey Reports"). The Sabey Reports concluded that the Walker Report was not a legitimate financial feasibility analysis. Factual criticisms of the Walker Report by the Sabey Reports included: (1) the failure to consider the negative impact on usage from raising parking rates 50%; (2) the failure to address claims of the Spokane Downtown Association that 6,000 parking stalls are available; (3) concerns that there was no market in Spokane for a new cinema, and none of the cinema usage projections were based on the Spokane market; (4) concerns that the proposed cinema would double the movie screens in the Spokane market, and that the report assumes that demand would double without any study of demand; and (5) concern that the length of stay assumptions double, when the national average stay is 1.2 hours, and the national trend is a declining stay. More specifically, the Sabey Reports criticized Walker's projections of $4.3 million in first year revenue and $3.2 million in first year profit as flatly unrealistic. On the contrary, actual figures at the time were approximately $725,000 in revenue and $300,000 in profit; so the Walker Report projections increased revenue by 500% and profit by 1,000% in the first year alone. The Sabey Reports warned that "no prudent investor, underwriter, financial institution, or person in a fiduciary position would advance funds on the "investment value' of a real estate asset." Finally, the Sabey Reports warned the City that it should not be involved in the project unless the transaction were based on the market value of the garage.
On January 19, 1997, the City adopted Resolution 97-2 which approved the garage acquisition by the issuance of over $26 million in tax-exempt bonds. The Resolution also ratified all pasts acts taken by agents of the City in furtherance of this goal. On January 27, 1997, the Coopers Lybrand Report was issued to Prudential, the City, the Developers, Preston, Gates Ellis, Robideaux, and Foster Pepper, ("Coopers Lybrand Report"). The Coopers Lybrand Report was commissioned by the City as a market and financial analysis. Coopers Lybrand criticized the Walker Report, finding that the garage was not worth $26 million. Additional criticisms included: (1) the observation that the Cinema was not likely to agree to charging its patrons for parking, given the free parking available at other cinemas; (2) the lack of analysis of whether or not the Cinema operator would cover lost revenues if movie patrons receive validated parking; (3) a complaint that the Walker Report was not a feasibility study, because the numbers used were substantially higher than historic numbers; and (4) that the land allocation value of $8.7 million was overstated, because excess value was attributable to the City's discount rate applied to cash flows, not to the land value. Finally, the Coopers Lybrand Report criticized the failure to address parking validation programs with the Mall and Cinema. The Report observed that, if a program were implemented that was similar to the existing validation program, the garage would need to collect significantly more money from the retailers, owners, or from other sources, and that "[t]o the extent that this does not occur, the financial operations of the RPS garage could be materially overstated."
On January 27, the City passed Ordinance C31823, which pledged parking meter funds connected with the RPS garage transaction. On April 22 and June 29, 1998, the Walker Report was revised and updated. Specifically, Cinema seating was revised upward by 282 seats, and numbers were revised upward again. The Official Statement ("OS") was prepared prior to bond issuance. Prudential was the bond underwriter, and Foster Pepper was retained as underwriter's counsel in connection with the underwriting, issuance, offer, and sale of the bonds. The cover pages of the OS identify Foster Pepper as underwriter's counsel. Foster Pepper was retained to assist Prudential on disclosure issues, to perform due diligence, and to draft and edit the OS.
On September 15, 1998, the Spokane Downtown Foundation issued $31,454,000 in bonds to finance the purchase of the RPS garage from the Developers. On September 24, Foster Pepper issued an opinion in connection with the bond issuance. The same day, Preston Gates Ellis issued a bond opinion to the Foundation and to Prudential, knowing that it would be reasonably relied upon by investors. The City Attorney and Perkins Coie, the City's Special Counsel, also issued opinion letters. These opinion letters stated that the City Ordinance was duly enacted, and had created a legally binding obligation on the City. In addition, the letters stated that certain portions of the OS were accurate, correct, and completely disclosed all material facts regarding the project.
The City knew that the OS was misleading, based on the Auble Report, the Barrett Report, the Sabey Reports, and the Coopers Lybrand Report. However, it proceeded to use the Walker Report as the financial feasibility analysis provided to investors. All Defendants either knew of the critical reports, or recklessly failed to review the Reports, and therefore participated in bond issuance based on false and misleading Official Statements. At all times, even after bond issuance, the value of the RPS garage has been less than $10 million. The Defendants entered a scheme to sell the garage for $26 million in bond funds. At the time the complaint was filed, the bonds had been downgraded below investment grade, and the Foundation has insufficient revenue from the garage to pay any significant amount of debt service on the bonds.
II. MOTIONS TO DISMISS
The Developers filed their @@Motion to Dismiss, (Ct. Rec. 33), for failure to state a claim on which relief may be granted. See Fed.R.Civ.P. 12(b)(6). In a similar motion, Defendant Foster Pepper also seeks dismissal for failure to state a claim, (Ct. Rec. 70). As set forth above, several other defendants have requested joinder in these motions to dismiss. There are no objections to joinder. Consequently, the various motions for joinder, (Ct. Recs. 61, 63, 65), are GRANTED.
Under Section 10(b) of the Securities Exchange Act of 1934, ("§ 10(b)"), and Rule 10b-5 of the Regulations implementing the Act, ("Rule 10b-5"), claims of securities fraud must meet certain pleading standards. See 15 U.S.C. § 78j; 17 C.F.R. § 240.10b-5. Defendants argue that dismissal is appropriate, because Plaintiffs have not satisfied the pleading requirements for their securities laws claims. Defendants further ask the Court to decline jurisdiction of Plaintiffs' pendent state law claims.
Defendants bring their motions under Fed.R.Civ.P. 12(b)(6), arguing that the complaint fails to state legally cognizable claims. Ordinarily, if "matters outside the pleading are presented to and not excluded by the court, the motion shall be treated as one for summary judgment and disposed of as provided in Rule 56." Fed.R.Civ.P. 12(b). However, the Court may consider documents "whose contents are alleged in a complaint and whose authenticity no party questions, but which are not physically attached to the [plaintiffs'] pleading." Branch v. Tunnell, 14 F.3d 449, 453-54 (9th Cir. 1994). Consequently, the Court considers the pleadings, as well as the Official Statement, and the various reports mentioned in the complaint. However, because the City of Spokane has not moved for dismissal, the Court specifically excludes all papers regarding ordinances, resolutions, any history thereof, or other matters regarding records of action taken by the City of Spokane, as irrelevant to the motions actually pending before the Court.
Considering these pleadings, papers, and memoranda submitted in support of Defendants' motions, the Court must determine whether Plaintiffs' complaint should be dismissed. Under Fed.R.Civ.P. 12(b)(6), dismissal is appropriate if (1) the complaint lacks a cognizable legal claim, or (2) it fails to allege facts which could warrant relief under a cognizable legal theory. See, e.g., Robertson v. Dean Witter Reynolds, Inc., 749 F.2d 530, 534 (9th Cir. 1984) (citing 2A J. Moore, Moore's Federal Practice ¶¶ 12.08 at 2271 (2d ed. 1982)). In reviewing Defendants' motions to dismiss, the Court presumes all facts asserted by the Plaintiff to be true. See Johnson v. Knowles, 113 F.3d 1114, 1117 (9th Cir. 1997) (citing Smith v. Jackson, 84 F.3d 1213, 1217 (9th Cir. 1996)). The complaint should only be dismissed if it appears beyond doubt that Plaintiffs can prove no facts which would entitle them to relief. See Everest Jennings v. American Motorist Ins. Co., 23 F.3d 226, 228 (9th Cir. 1994). Applying this standard in the context of the Private Securities Litigation Reform Act, ("PSLRA"), for the reasons stated hereinafter, the Court finds that Plaintiffs' claims are cognizable, that the facts alleged could warrant relief under a cognizable legal theory, and DENIES the motions to dismiss.
III. ANALYSIS
Because of the substantial overlap in arguments of both the Developers and Foster Pepper, both motions to dismiss shall be addressed concurrently. To begin, Defendants argue that Plaintiffs generally fail to state a claim of each element, against each defendant, and fail to plead fraud with particularity. For the elements of a securities fraud claim, defendants attack as insufficient the pleading of misstatement or omissions, and scienter, under the heightened pleading standards of the PSLRA. Next, Defendants argue that Plaintiffs have failed to state claims of materiality and reliance. The Developers also challenge the allegation of controlling persons liability under Section 20(a) of the Securities Exchange Act of 1934. Foster Pepper argues that it was entitled to rely on "expertised" opinions, and that this defense precludes Plaintiffs' claims against them. Finally, the Defendants ask the Court to dismiss state law claims, regardless of whether or not the securities claims are dismissed. The Court addresses each of these issues in turn below, with the response of the Plaintiffs and the Court's ruling on each point.
A. Failure to Meet Pleading Standards
To begin, Defendants argue that Plaintiffs have generally failed to state claims against each Defendant individually. Given the heightened pleading standards of the PSLRA, Defendants assert that Plaintiffs impermissibly rely on a conspiracy theory, rather than stating the elements of each claim against each Defendant. Plaintiffs argue that each Defendant was aware that "investment value" had no factual support in existing revenue data, and to the extent that each Defendant provided the numbers, promoted the numbers, and utilized the numbers in the OS in spite of this knowledge, each Defendant made a material misstatement. To the extent that the statements consist of omitted facts, Plaintiffs also allege a material omission. Finally, the complaint asserts that the use of "investment value" itself was a manipulative device, and that all defendants were aware that this method of "appraisal" materially overstated any reasonably expected revenue.
On review of the Defendants' general arguments of lack of specificity and the failure to adequately plead fraud against each Defendant individually, the Court first examines the standard for violation of § 10(b), and of Rule 10b-5. Next, the applicability of accessorial liability is addressed, as it applies to the Plaintiffs' complaint.
1. Standard for Securities Fraud
Section 10(b) of the Securities Exchange Act of 1934 provides that:
[i]t shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails . . .
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 Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.
U.S.C. § 78j(2)(b) (hereinafter "Section 10(b)" or "§ 10(b)"). Rule 10b-5 of the Securities Exchange Commission Rules is the primary rule implementing this provision:
It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
(a) To employ any device, scheme or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.17 C.F.R. § 240.10b-5 (hereinafter "Rule 10b-5").
To the extent that Plaintiffs' complaint alleges violation of Rule 10b-5(b), by misstatement or omission, Plaintiff must first establish "that the alleged fraud occurred `in connection with the purchase or sale of a security.'" Ambassador Hotel Co., Ltd. v. Wei-Chuan Investment, 189 F.3d 1017, 1025 (9th Cir. 1999).
Once this foundational requirement has been met, the plaintiff must prove five elements:
1. misrepresentation (or omission, where there exists some duty to disclose);
2. materiality;
3. scienter;
4. reliance; and
5. causation.
Id. (citing McGonigle v. Combs, 968 F.2d 810, 817 (9th Cir. 1992)). Thus, Defendants argue that Plaintiffs' complaint in general, does not plead facts which establish each element of a claim against each defendant.
2. Each element against each Defendant
Specifically, Defendants argue that Plaintiffs' complaint impermissibly relies on an "aider and abettor" or a "conspiracy theory" of liability. See Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164, 190 (1994) (holding no Section 10(b) liability for mere aider or abettor); In re GlenFed, Inc. Sec. Litig., 60 F.3d 591, 592 (9th Cir. 1995) (holding no private action for "conspiracy" under Section 10(b)). However, this oversimplifies the Central Bank holding. In Central Bank, the plaintiff did not allege actual violation of federal securities law by Central Bank; instead, the plaintiff alleged that Central Bank was "secondarily liable under § 10(b) for its conduct in aiding and abetting the fraud." Central Bank, 511 U.S. at 191. Thus,
[t]he absence of § 10(b) aiding and abetting liability does not mean that secondary actors in the securities markets are always free from liability under the securities Acts. Any person or entity, including a lawyer, accountant, or bank, who employs a manipulative device or makes a material misstatement (or omission) on which a purchaser or seller of securities relies may be liable as a primary violator under 10b-5, assuming all of the requirements for primary liability under Rule 10b-5 are met."Id. 511 U.S. at 191 (emphasis in original) (citation omitted). Likewise, Defendants argue that the requirement of Rule 9 of the Federal Rules of Civil Procedure, mandates pleading with particularity. See Fed.R.Civ.P. 9(b). As discussed in additional detail herein, the Court finds that Plaintiffs have adequately pled the elements of securities fraud against each of the moving defendants. Plaintiffs have observed that the Defendants ignore the presence of their claims against defendants under Rule 10b-5(a), alleging a "device, scheme, or artifice to defraud," and under Rule 10b-5(c), alleging engagement in any "act, practice, or course of business which operates or would operate as a fraud or deceit upon any person." 17 C.F.R. § 240.10b-5(a), (c).
Thus, to the extent that Plaintiffs allege that the Defendants perpetrated a scheme to (1) overvalue the garage through "investment value" appraisals, (2) issue more bonds than the garage revenue could support, this is not simply a "conspiracy" theory; it is a claim under Rule 10b-5(a). To the extent that Plaintiffs allege that Defendants, by permitting the transaction itself to go forward as structured, and thus engaged in a course of business which operated as a fraud on bond purchasers, it is a claim under Rule 10b-5(c). "In any complex securities fraud, moreover, there are likely to be multiple violators." Central Bank, 511 U.S. at 191. Plaintiffs have pled with specificity the role of each Defendant in the alleged scheme and course of business. For this reason, Plaintiffs' complaint cannot be characterized as relying on accessory liability for any of the moving defendants.
B. Heightened Pleading Standards under PSLRA
In addition to pleading elements of a claim under Section 10(b) and Rule 10b-5, the Private Securities Litigation Reform Act ("PSLRA") imposes heightened pleading requirements for two of the elements of a claim. First, for claims arising under Rule 10b-5(b), involving material misrepresentations or omissions,
the complaint shall specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed.15 U.S.C. § 78u-4(b)(1). Second, for any private action "in which the plaintiff may recover money damages only on proof that the defendant acted with a particular state of mind," the complaint must, "with respect to each act or omission alleged to violate this chapter, state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." 15 U.S.C. § 78u-4(b)(2).
The Ninth Circuit applied this standard to uphold the dismissal of a complaint for insider trading in the Silicon Graphics case. See In re Silicon Graphics Securities Litigation, 183 F.3d 970 (9th Cir. 1999). In that case, the plaintiff alleged that the defendant officers made material misstatements that were contradicted by negative internal reports. See id. at 984. In doing so, the plaintiff alleged that the stock remained artificially inflated, and the officers engaged in prohibited insider trading, to their profit. See id. The Ninth Circuit affirmed the dismissal of the complaint under Fed.R.Civ.P. 12(b)(6), for failure to satisfy the PSLRA's pleading requirements. See Id. Plaintiff "neither state[d] facts with sufficient particularity nor raise[d] a strong inference of deliberate recklessness." Id. Thus, the Silicon Graphics complaint alleged insufficient facts to establish both misrepresentations under 15 U.S.C. § 78u-4(b)(1), and intent under 15 U.S.C. § 78u-4(b)(2). Defendants in this case likewise argue that Plaintiffs complaint is insufficient on both these grounds.
1. Failure to Plead Misrepresentation or Omission
Defendants argue that Plaintiffs have pled insufficient facts to establish that they made misstatements and omissions. However, the complaint in Silicon Graphics was far more cursory than the instant Plaintiffs' complaint. To begin, the Silicon Graphics complaint stated no allegations that the "internal reports" actually existed. Instead, the allegations were based on a "boilerplate" complaint, "that substantial evidentiary support will exist for the allegations after a reasonable opportunity for discovery." Silicon Graphics, 183 F.3d at 985. For the purported reports, the plaintiff did not "include an adequate description of their contents which we believe — if they did exist — would include countless specifics regarding ASIC chip shortages, volume shortages, negative financial projections, and on." Id. Without any detailed pleading showing this type of specific information, the complaint failed to state "facts giving rise to a strong inference of deliberate recklessness or intent." Id.
In this case, by contrast, Plaintiffs allege very specific facts, and have produced specific reports, which gave specific criticisms of the investment value approach. Details of the 1995 Walker Report, the Auble Report, the Barrett Report, the Sabey Reports, and the Walker Report as attached to the OS were set forth in more detail in the Complaint than the facts summarized herein. Plaintiffs have alleged specific numbers and specific warnings in specific reports, indicating that estimates of revenue were not reasonable. Without belaboring these details, Plaintiffs allege among other things that, by use of the "investment value" approach, an expansion of less than 100% was spun into an unrealistic projected annual profit of 1,000%. Plaintiffs then allege that based on unrealistic revenue projections, it was almost certain that revenue would be insufficient to cover the debt service on the bonds.
To give one example; Mr. Barrett's letter summarizing his Report accepts, with reservations, the "investment value" analysis requested by the City of Spokane, (Ct. Rec. 39, Ex. E at 1). Next, it accepts, with reservations, the Walker Report, (Ct. Rec. 39, Ex. E. at 1). After explaining that the City's investment value exceeds market value, Mr. Barrett presents three scenarios, suggesting a total "investment value" of between $25 million on $44 million, (Ct. Rec. 39, Ex. E. at 2). However, Mr. Barrett does not indicate that revenue could support a bond issue equal to the "investment value," (Id.). Instead, "[a]pparently, the difference between the Net Investment Value of the Improvements and the amount of debt which the net income to the improvements will support represents `equity,' or an additional lump sum which the City must produce if the purchase price is to be the full value of the improvements." (Id.). In his summary letter, Mr. Barrett sets the amount of bond debt the income can support at between $15 and $17 million, and finds a shortfall of between $6 and $13 million, (Id.). While this information is in Mr. Barrett's summary, it suggests that the complete report may contain factual data that, even under optimistic revenue projections, a $26 million bond issue was unsupportable.
Plaintiffs' complaint references numerous reports, which do exist, and alleges that all Defendants either reviewed or recklessly failed to review the reports and their contents. Plaintiffs also adequately explain their theory of the case: why the information included in the OS consists of material misrepresentations or "omissions. Applying the standard of 15 U.S.C. § 78u-4(b)(1), and Silicon Graphics, the Court finds that Plaintiffs have pled sufficient facts setting forth alleged misleading statements and reasons why the statements are misleading. To the extent that allegations are made on information and belief, the complaint states sufficient facts on which Plaintiffs' belief is formed.
In addition to the argument that the complaint does not state sufficient facts to establish misrepresentations or omissions under the PSRLA, the Developers argue that Plaintiffs have not established a duty to disclose. To the extent that the complaint alleges omitted facts, Defendants argue that "[s]ilence, absent a duty to disclose, is not misleading under Rule 10b-5." Basic Inc. v. Levinson, 485 U.S. 224, 239 n. 17 (1988). However, Defendants cite this footnote from a case where the factual misstatement alleged was the denial of merger negotiations, when a merger was in fact being negotiated. See id. at 228-29. The court in Basic, then, was more concerned with the issue of at what point the existence of merger discussions become material. In this context, the court observed that the Company was under no duty to say anything regarding merger negotiations, when asked. Thus court's decision involved the materiality of the denial. No one in that case took issue with the proposition that the denial of facts which were true was a misstatement or omission. See id. at 231-41.
In sum, Basic is simply not on point. Further, this statement in context is discernible from the plain language of Rule 10b-5: "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." In other words, to be relevant, Defendants would need to argue that they were silent and had no duty to disclose. This in not the case. Instead, Defendants argue that "they shared [information] with everyone else although it was not ultimately included in the official statement." (Ct. Rec. 34 at 12). This type of conduct is precisely the sort of pattern that comprises an "omission" under Rule 10b-5(b). Further, as Plaintiffs observe, duty is irrelevant to claims of "device, scheme or artifice," under Rule 10b-5(a), and to "practice or course of business which operates or would operate as a fraud or deceit upon any person," under Rule 10b-5(c). As a consequence, the Court finds that Basic, as cited by Defendants, is not legal support for the dismissal of Plaintiffs' complaint.
2. Failure to State a Claim as to Scienter
Defendants also argue that Plaintiffs have failed to meet the heightened pleading requirements of the PSLRA and Silicon Graphics for the requisite state of mind. See 15 U.S.C. § 78u-4(b)(2); Silicon Graphics, 183 F.3d at 985. The standard to plead scienter under the PSLRA is "to state facts giving rise to a strong inference of deliberate recklessness or intent." Silicon Graphics, 183 F.3d at 985. In Silicon Graphics, there were simply insufficient facts in the complaint to establish the required "strong inference:" the complaint relied on allegations of what "internal reports" would show, and simply alleged a downturn after officers sold a noticeable quantity of stock. See id. at 988. Unlike Silicon Graphics, Plaintiffs' complaint does not simply plead "fraud by hindsight." Id. at 988 (citing Medhekar v. United States Dist. Ct., 99 F.3d 325, 328 (9th Cir. 1996)).
To show deliberate recklessness, Plaintiffs allege that, all reports besides the Walker Report called into serious question the "investment value" methodology, assumptions regarding various revenue sources, and assumptions ignoring facts which suggested that revenue might be materially overstated. Given the allegation that Defendants reviewed the Auble Report, Barrett Report, Sabey Reports, and Coopers Lybrand Report, there are numerous allegations of "red flags," which support the inference of deliberate recklessness. See, e.g. In re Health Management, Inc., Sec. Litig., 970 F. Supp. 192, 203 (E.D.N Y 1997) (holding evidence of ignoring "red flags," or documents which warned of inflated accounts receivable were evidence of fraudulent intent); In re Peoplesoft, Inc., Sec. Litig., 2000 WL 1737936 (N.D. Cal. May 25, 2000) at *3 (circumstantial evidence of guilty knowledge includes allegations that conflicting data was ignored).
For example, the Coopers Lybrand Report strongly criticized the failure of the Walker Report to address the impact of mall and cinema validation program on revenue. After making reference to the existing validation program, Coopers Lybrand found that if a similar program were implemented, the garage would need to collect significantly more money from other sources. "To the extent that this does not occur, the financial operations of the RPS garage could be materially overstated." (Ct. Rec. 39, Ex. B, emphasis added). By contrast, the OS states that "the validation program currently in place is revenue neutral," in the portion of the Risks section that purports to address the Coopers Lybrand Report, (Ct. Rec. 39, Ex. A. at 24).
The Developers argue that Plaintiffs' complaint does "not come close" to pleading scienter. However, when facts are critical to an important transaction, there is a presumption that the facts are known to the company and its key officers. See Epstein v. Itron, Inc., 993 F. Supp. 1314, 1325-26 (E.D. Wash. 1998). For the Developers, this was a central transaction in financing the RPS project. As owners of the garage prior to the transfer, the Developers had the most direct knowledge of facts such as the existence and terms of validation programs for mall patrons. Further, the complaint claims that Developers benefitted by receiving the bulk of the profit in the alleged fraudulent scheme.
In a similar manner, RWR Management had the most direct access to accurate information regarding existing garage conditions, because it was responsible for the daily garage operations. Thus, to the extent that Plaintiffs' complaint alleges assumptions provided without any reasonable basis in fact, it raises a strong inference that RWR Management knew that numbers provided to Walker for the Report used in connection with the bond offering were arbitrarily chosen to inflate the price of the garage. The Spokane Downtown Foundation was the entity formed with the specific purpose of issuing the bonds, purchasing the garage from the Developers, and leasing the ground from the Developers. According to the complaint, the Foundation is subject to the direct and indirect control of the Developers because its board of directors was appointed by the Developers.
For Prudential, the underwriter has the obligation to perform due diligence in connection with the bond issuance. For Foster Pepper, as underwriter's counsel, the firm drafted and prepared the OS, was allegedly hired to assist Prudential in their due diligence investigation, and prepared a 10b-5 statement, (Ct. Rec. 1 at 13-14). Similarly, Preston Gates Ellis, as bond counsel and issuer's counsel, issued a 10b-5 statement, that
Based upon our experience as counsel for the issuer and on our review of and participation in the drafting of the Official Statement, and after diligent inquiry, we have no reason to believe that the information regarding the issuer in the official Statement contains any untrue statement of a material fact or omits to state any material fact necessary in order to make the statements made therein, in light of the circumstances under which they were made, not misleading.
(Ct. Rec. 1 at 17-18). Plaintiffs allege that the bonds could not have been issued without these opinions. Further, Plaintiffs claim that the 10b-5 opinions of both counsel were false when made, based on the factual information available in the various critical reports, which did give them reason to believe the OS contained untrue statements of material fact.
Applying the standard for pleading scienter under 15 U.S.C. § 78u-4(b)(2), given the numerous critical reports detailed in the Complaint, and facts alleging that each defendant had actual knowledge of the Reports which warned of possible material misstatement, the Court finds that Plaintiffs' complaint satisfies this requirement for each of the moving defendants. The existence of the Reports, the strong language of the criticisms therein, and the allegation that Defendants had actual knowledge of this information, gives rise to the strong inference that each of the moving defendants acted with at least deliberate recklessness. Accordingly, the Court DENIES the motion to dismiss based on failure to satisfy the pleading requirements of the PSLRA for both material misrepresentations, and scienter.
C. Failure to State Claim of Materiality
The test for materiality of a misstatement or omission is "whether there is a substantial likelihood that a reasonable investor would consider the matter important in making an investment decision. Caravan Mobile Home Sales, Inc. v. Lehman Bros. Kuhn Loeb, Inc., 769 F.2d 561, 565 (9th Cir. 1985) (quoting Vaughn v. Teledyne, Inc., 628 F.2d 1214, 1221 (9th Cir. 1980)). Plaintiffs argue that, the determination of what a "reasonable" investor would consider important is not an appropriate inquiry to make on a motion to dismiss.
Defendants argue that Plaintiffs' complaint, to the extent that it alleges misstatements or omissions, has failed to adequately plead that any alleged misstatement or omission was material. According to the Defendants, Plaintiffs' complaint fails to establish materiality for two reasons. First there is no duty to disclose all projections and forecasts, unless they contain factual data. Second, Defendants argue that under the "bespeaks caution" doctrine, the Court may rule as a matter of law that the OS contained sufficient cautionary language and risk disclosure to insulate the Defendants from claims of securities fraud. The Court examines each of these arguments in turn.
1. Projections and Forecasts Not Actionable
Defendants argue that there is no duty to predict the future, nor do all estimates of future performance necessarily need to be revealed. See, e.g., In re Stac Sec. Litig., 89 F.3d 1399, 1409 (9th Cir. 1996); In re Lyondell Petrochemical Co. Sec. Litig., 984 F.2d 1050, 1053 (9th Cir. 1992). Instead,
[liability for) forecasts attaches under Rule 10b-5 only if at time of publication one of three implied factual assertions is inaccurate: (1) that the statement is genuinely believed, (2) that there is a reasonable basis for that belief, and (3) that the speaker is not aware of any undisclosed facts tending to seriously undermine the accuracy of the statement.In re Verifone Sec. Litig., 11 F.3d 865, 870 (9th Cir. 1993) (citations and internal quotation marks omitted).
On review of the complaint and the Walker Report, in light of the other reports which were not disclosed, the Complaint cannot be dismissed for mere omission of forecasts. Instead, Plaintiffs have pled facts which create a factual issue of whether Defendants genuinely and reasonably believed that the revenue projected in the Walker report was reasonable. Further, several of the reports contain, or imply the existence of, facts and data which were not disclosed in the OS or the Walker report. For example, the Coopers Lybrand Report referred to the existing validation program, and stated that preserving the status quo in validation could result in the projected financial operations being "materially overstated." (Ct Rec. 39, Ex. B at 5). The OS, on the other hand, indicates that the current validation program is "revenue neutral," and that "the impact of any parking validation program between the Authority and the cinema operator is unknown." (Ct. Rec. 39, Ex. A. at 25). This is simply one example of several ways in which Plaintiffs have adequately pled that the undisclosed information was either (1) not reasonably believed, or (2) contained facts and data that seriously undermined the assertions made, or (3) both. As a consequence, the Court declines to find that the alleged omissions were immaterial because they were merely forecasts.
2. "Bespeaks Caution" Defense
In a similar argument, Defendants take refuge in the "bespeaks caution" doctrine: "that economic projections, estimates of future performance, and similar optimistic statements in a prospectus are not actionable when precise cautionary language elsewhere in the document adequately discloses the risks involved." In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1413 (9th Cir. 1994) (quoting district court opinion). The doctrine is applicable in situations where "optimistic projections are coupled with cautionary language — in particular, relevant specific facts or assumptions — affecting the reasonableness of reliance on and the materiality of those projections." Id. at 1414. Bearing this in mind, the doctrine "reflects the unremarkable proposition that statements must be analyzed in context." Id.
The "bespeaks caution" doctrine must be narrowly construed, because
overbroad application of the doctrine would encourage management to conceal deliberate misrepresentations beneath the mantle of broad cautionary language. To prevent this from occurring, the bespeaks caution doctrine applies only to precise cautionary language which directly addresses itself to future projections, estimates or forecasts in a prospectus. By contrast, blanket warnings that securities involve a high degree of risk [are] insufficient to ward against a federal securities fraud claim.Id. at 1414 (citations omitted).
Plaintiffs have alleged that, in essence, Defendants "masked" actual knowledge of the factual data regarding historic revenue of the garage, and red flags involving the "investment value" approach, as risk. "To warn that the untoward may occur when the event is contingent is prudent; to caution that it is only possible for the unfavorable events to happen when they have already occurred is deceit." In re Stac Electronics Sec. Litig. 89 F.3d 1399, 1406 (9th Cir. 1996) (quoting In re Convergent Techonologies Sec. Litig., 948 F.2d 507, 515 (9th Cir. 1991) (quoting Huddleston v. Herman MacLean, 640 F.2d 534, 544 (5th Cir. 1981))). Similarly, "[t]here is a difference between knowing that any product-in-development may run into a few snags, and knowing that a particular product has already developed problems so significant as to require months of delay." In re Apple Computer Sec. Litig., 886 F.2d 1109, 1115 (9th Cir. 1989).
Keeping these standards in mind, the Court reviews each cautionary statement in the "Risks to the Bond Owners" section of the OS, (Ct. Rec. 30, Ex. A at 24-27). For the most part, these sections contain completely generic, and at times tautological, risk disclosure. However, some specific risk disclosure is contained in subparts captioned "Risks Associated With Demand for the Parking Facility," "Risks Associated With Operation of the Parking Facility," and "Limited Remedies Upon Default."
a. Risks Associated With Demand for the Parking Facility
In this section the bulk of disclosures are, again, generic and tautological. This provision does address issues involving competition and success of the RPS mall:
Also, there is no assurance that the number of patrons of the retail stores and cinema complex will be sufficient to generate required revenues. Competition from other regional shopping malls and cinemas and other factors may reduce the number of patrons below the projected numbers.
(Ct. Rec. 39, Ex. A. at 24). Certainly, this statement cautions that, if insufficient patrons utilize the mall and cinema, there will be a negative impact on revenue. However, Plaintiffs allege that several sources raised issues with the existing validation programs, and that given the free parking available at competing malls and cinemas, patrons would expect free parking. To the extent that this cautionary language conceals the negative impact of validation on garage revenue, it is arguably deceptive. This section continues:
Other factors that could adversely impact the demand for the parking Facility include: closure or relocation of any of the nearby public buildings or other retail uses, competition from other parking facilities, or increased use of public transportation.(Id.). The reference to "competition from other parking facilities," is arguably deceptive, in light of allegations that available data demonstrated a surplus of available parking in the downtown area.
b. Risks Associated With Operation of the Parking Facility
The portion of the Risk disclosure titled "Risks Associate With Operation of the Parking Facility," addresses "Management Experience," "Revenues," and "Other Risks." Each of these provisions is problematic, as lacking specific disclosure of facts alleged in the complaint, containing only generic risk disclosure, or expressing disclosure in a manner that is arguably deceptive, accepting Plaintiffs' allegations as true.
Management Experience. The owner of the Parking Facility (the Foundation) is a newly created entity and currently has no full-time staff. Neither the Foundation nor the lessee of the Parking Facility (the Authority) has any operation history or experience owning, operating or maintaining parking facilities.
(Ct. Rec. 30, Ex. A. at 24). Plaintiffs have alleged that Defendants failed to disclose factual data regarding historic garage revenue. This historic data resulted in the reasonable projections of the 1995 Walker Report, which were allegedly altered with the end number in mind, in the final Walker Report. This disclosure arguably is deceptive by suggesting that operational history is unknown, as the new owner and manager have no prior experience with the business of parking facilities.
Revenues. The operating revenues set forth in the Feasibility Analysis are an estimate. Although the operating revenues derived from the Feasibility Analysis are projected to be sufficient to pay debt service on the Bonds, Fixed Ground Rent and Operating Expenses, the Feasibility. Analysis assumes that the Parking Facility will be operated and maintained as a first-class parking facility. Actual revenues generated by the Parking Facility may vary materially from those projected in the Feasibility Analysis.(Id.). Plaintiffs complaint alleges that, given Reports criticizing the Walker Report and its underlying factual assumptions, Defendants' projection that revenue would be sufficient to pay debt service on the Bonds was not reasonable. The only risk disclosed regarding the possibility that revenues might "vary materially" in this section is the assumption that "the Parking Facility will be operated and maintained as a first-class parking facility." This phrase is neither explained nor defined, and it is unclear how the relative classiness of a parking facility is relevant to revenue. Consequently, this risk disclosure is not specific to the factual allegation that Reports read prior to creating the OS undermined the projection that revenue would be sufficient to cover debt service on the Bonds.
Next, the most detailed risk disclosure is presented in a section discussing some of factual criticisms raised in the Coopers Lybrand Report:
Other Risks. A parking facility analysis performed at the request of the City on January 27, 1997, by Coopers Lybrand, L.L.P., described four primary areas of concern in the Feasibility Analysis projections. First, the Feasibility Analysis projects a rate of $1.50 per hour combined with an anticipated stay per transient retail parking customer of 3.0 hours. This represents an increase from the current rate of approximately $1.00 and a current average length of stay of 1.5 hours. If these increased rates and longer anticipated stays are not achieved, revenues generated by the Parking Facility could fall short of projections. Second, the Feasibility Analysis does I not account for the potential impact on revenues of a parking validation program or other negotiated arrangements with tenants of the Commercial Project. The Authority is authorized to participate in a validation program. The validation program currently in place is revenue neutral; however, if any future program were to cost more than the revenue generated by additional parking, revenues generated by the Parking Facility could fall short of projections. Third, the impact of any parking validation program between the Authority and the cinema operator is unknown. Fourth, no independent appraisal of the market value of the land on which the Parking Facility is located has been conducted. To the extent that the market value of the land differs from its negotiated value of $59.94 per square foot, the relative leasehold value of the Parking Facility may be negatively impacted. The analysis acknowledged that Walker is a recognized expert firm in the area of parking garage operations and construction, that Walker's cash flow analysis was developed using the shared parking methodology of the Urban Land Institute, and that a direct comparison of estimated operations in the expanded and renovated Parking Facility to historical operating results is difficult due to the significant changes anticipated in downtown Spokane resulting from the development of the Commercial Project.(Id. at 25). To begin, Plaintiffs takes issue with the statement that the Coopers Lybrand Report only raised four primary areas of concern. Specifically, Plaintiffs argue deception in omitting Coopers Lybrand's criticism that (1) Walker's underlying numbers were unreasonable, and (2) that the Walker Report could not be considered to be a "Feasibility Analysis." (Ct. Rec. 92 at 85-86).
For the first area of concern, the disclosure describes a Walker Report that "projects a rate of $1.50 per hour combined with an anticipated stay per transient retail parking customer of 3.0 hours." While disclosing that this is an increase from historic levels, it also suggests that the increased rates were generated by Walker — not numbers provided to Walker by other Defendants, as alleged by the Plaintiffs. Further, the disclosure ends with references to Walker's expertise in generating parking projections, suggesting that increases had some reasonable factual basis, given Walker's methodology.
Second, the disclosure admits that the Walker Report does not address the impact of a validation program. However, it goes on to describe the existing validation program as "revenue neutral." Plaintiffs argue that this is flatly contradicted by facts available to the Defendants that a validation program similar to the existing validation program could result in financial operations being "materially overstated," unless validation were subsidized from another source than the garage. (Ct. Rec. 30, Ex. B). Similarly, the third area of concern disclosed is that impact of a cinema validation program is "unknown." Plaintiffs argue that Defendants did not reasonably believe that cinema patrons would pay for parking, in light of free parking available at competing cinemas, (Ct. Rec. 92 at 88).
Finally, for the fourth area of concern disclosed in this section, Plaintiffs argue again that the statement is technically true, but misleading. To begin, it does not disclose facts in several reports that the assignment of land value was artificially inflated, and exceeded market value. The reference to "negotiated value," undermines this admission, though, suggesting that the value was arrived at through some disinterested assessment of true value. Given Plaintiffs' allegations, that Defendants were aware that the transactional structure significantly overvalued the land, this disclosure is also arguably deceptive.
c. Limited Remedies Upon Default
The final section of specific risk disclosure in the OS contains the following provision discussing the methodology of the appraisals:
The Owners of the Bonds will be limited to enforcement only of the lien on Parking Facility revenues and enforcement of the covenants in the Indenture and the Lease Agreement. The purchase price of the Parking Facility of $26 million is the result of negotiations involving the Foundation, the City and the b Developer. The purchase price is base primarily on two MAI appraisals commissioned by the City. Those appraisals determine the "Investment Value" rather than the "Market Value" of the Parking Facility. It is not certain that the amount realized upon any sale of the leasehold interest in the Parking Facility would be sufficient to redeem all of the then-outstanding principal amount of the Bonds.(Id. at 25-26). Again, the Plaintiffs have alleged that the reference to "two MAI appraisals," is itself deceptive, given specific warnings against lending money on a real estate asset without a market value appraisal. The use of "Investment Value" is disclosed, but not defined as a value solely based on criteria supplied by the City of Spokane. Finally, the last sentence suggests that market value could be insufficient to pay bond debt, if the garage were sold. Plaintiffs have alleged that Defendants knew that the market value of the garage was less than $10 million, and so must have known that market value would likely be insufficient to pay bond debt. Accordingly, the cautionary statements touch on some areas of concern, but do not provide specific factual detail. In light of Plaintiffs' allegations, the disclosures are arguably deceptive, by implying that further factual information is not available, when it was actually known, and not disclosed.
On review of the specific risks disclosed in the OS and relevant to the instant motions, the Court cannot find dismissal appropriate based on the `bespeaks caution' doctrine. Instead, the disclosures themselves, in light of Plaintiffs' allegations, are arguably deceptive, by concealing alleged facts in language which is merely cautionary, or disclaims knowledge of facts. Further, the Court cannot say that the risks disclosed state "relevant specific facts or assumptions," sufficient to find as a matter of law that either (1) omissions alleged were immaterial, or (2) that reliance thereon was unreasonable. See Worlds of Wonder, 35 F.3d at 1414. Consequently, the Court is not persuaded that Plaintiffs have failed to state a claim that the alleged misstatements and omissions were material.
D. Failure to State a Claim of Reliance
Defendants argue that Plaintiffs' complaint fails as a matter of law, because it does not state facts sufficient to establish reliance on any misstatement or omission. Plaintiffs first counter that the complaint alleges that the Plaintiffs reasonably relied on the unreasonable facts and assumptions used in the Walker Report and in the OS, in purchasing the bonds, (Ct. Rec. 1, ¶ 95). Plaintiffs further observe that the complaint contains an allegation that they did not know the truth of all false and misleading statements, and would not have purchased the bonds had they known of the truth, (Ct. Rec. 1, ¶ 96).
In support of this argument, Defendants cite Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., for the proposition that there can be no aider and abettor liability for a private action under Rule 10b-5, because a plaintiff could not establish reliance. 511 U.S. 164, 180 (1994). This begs the question, though, by assuming that Plaintiffs can only establish aider and abettor-type liability, and therefore cannot establish reliance. Instead, the Central Bank court found a distinction between one who merely aids and abets a violator, and one who "indirectly" violates the statute. See id. at 176. "The problem, of course, is that aiding and abetting liability extends beyond persons who engage, even indirectly, in a proscribed activity; aiding and abetting liability reaches persons who do not engage in the proscribed activities at all, but who give a degree of aid to those who do." Id. Strictly speaking, primary violators who assist one another in their violations may "aid and abet" one another; this does not absolve them. Instead,
The absence of § 10(b) aiding and abetting liability does not mean that secondary actors in the securities markets are always free from liability under the securities Acts. Any person or entity, including a lawyer, accountant, or bank, who employs a manipulative device or makes a material misstatement (or omission) on which a purchaser or seller of securities relies may be liable as a primary violator under 10b-5, assuming all of the requirements for primary liability under Rule 10b-05 are met.Id. at 191 (citation omitted).
As discussed above, Plaintiffs have alleged, inter alia, a manipulative device in the use of "investment value." Further, Plaintiffs allege material misstatements and omissions because inflated figures provided to Walker were contradicted by actual data; Plaintiffs thus allege a scheme in which numbers used to develop the Walker Report had no other rational source than the end sum the developers sought for their garage. Plaintiffs have also alleged that they relied on the Walker Report, and the OS in purchasing the bonds, and that they would not have purchased the bonds had they known the facts of the historic revenue, and the source of the "investment value" appraisal. Whether or not this reliance was reasonable is an issue of fact, properly reserved for trial. Accordingly, the Court finds that Plaintiffs have sufficiently pled reliance to maintain their action.
E. Failure to Establish Controlling Persons Liability under § 20(a)
The Developers move for dismissal of Plaintiffs' claim to the extent that it alleges that the Developers are controlling persons under Section 20(a) of the Securities Exchange Act of 1934. 15 U.S.C. § 78t(a). That section provides
Every person who, directly or indirectly, controls any person liable under any provision of this chapter or of any rule or regulation thereunder 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.Id. "Control" as defined by the SEC involves "the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through ownership of voting securities, by contract, or otherwise." 17 C.F.R. § 230.405.
Plaintiffs assert that Lincoln, Citizens, RPS, and RPS II are controlling persons of the Foundation, "due to their ability to appoint the board of directors of the Foundation." (Ct. Rec. 1 at 74-75). Defendants argue that this allegation is insufficient to sustain a claim of controlling person liability under Section 20(a). "Status alone is ordinarily insufficient to establish control person liability. Similarly, `[m]ere titles are not adequate indicators of control authority.'" In re Gutpa Sec. Litig., 900 F. Supp. 1217, 1243 (N.D. Calif. 1994). In Gutpa, however, that court was concerned with the imposition of control person liability on individual officers of the defendant corporation. In particular, controlling person liability was inappropriate when the person was a minority shareholder with one agent on a board. See e.g., Gutpa, 900 F. Supp. at 1243. This is a very different context than allegations that a group of related corporate entities controlled by one individual, had the power to appoint the entire board of directors of the "controlled" entity.
These Defendants are referred to collectively as the "Developers," in the OS, and in the Complaint. According to the Complaint, Citizens is a wholly owned subsidiary of Cowles Publishing, and Citizens and Lincoln are both controlled by Elizabeth Cowles, who is not named in this action. RPS Mall is a limited liability company comprised of Citizens and Lincoln. RPS II is a wholly owned subsidiary of RPS. Thus, the Developers are referred to collectively by virtue of their common control.
Plaintiffs need not show the actual exercise of power to withstand a motion to dismiss the claim of § 20(a) liability. See Howard v. Everex Systems, Inc., 228 F.3d 1057, 1065 (9th Cir. 2000). Instead, Plaintiffs state a prima facie claim of control by alleging facts that the Developers, had the power to appoint the board of directors of the Foundation. This satisfies the SEC definition of control, because control of the Foundation's board constitutes at least indirect power to "cause the direction of the management and policies of a person, whether through ownership of voting securities, by contract, or otherwise." 17 C.F.R. § 230.405. Where control of an entity is alleged, the putative power to appoint all of the directors of the entity states a claim for control liability under Section 20(a).
The Developers further argue that Plaintiffs have failed to establish control at the time of the Bond issuance. Plaintiffs have, however, alleged that Foundation was formed to participate in the garage transaction as structured by the Developers and the City. In short, the ownership of the garage and bond issuance was the raison d'être of the Foundation. Thus, in context, the argument that the complaint fails to establish control at a relevant time is unpersuasive.
Because Plaintiffs allege that the Developers had power to appoint the entire board of directors of the Foundation, the Court finds that Plaintiffs have stated a prima facie claim of controlling person liability against the Developers under Section 20(a). Whether or not Plaintiffs will ultimately prevail on this aspect of their claim is not before the Court. Consequently, dismissal of the claim of Section 20(a) liability for the Developers as controlling the Foundation is not appropriate on the record before the Court.
F. Expertised Portions
Foster Pepper argues that, in preparing the OS, it was entitled to rely on the reasonableness of assumptions used in the Walker Report, as an "expertised" portion of the Bond offering. Although this is an available defense, it is unclear how the arguments in favor of this defense establish that Plaintiffs have failed to state a claim, in the context of Defendants' Rule 12(b)(6) motions.
An underwriter "need not conduct due diligence into the `expertised' parts of a prospectus, such as certified financial statements." In re Software Toolworks, Inc., Sec. Litig., 50 f.3d 615, 623 (9th Cir. 1994). Instead, an underwriter may raise the defense of reliance on "expertised" material by showing that it "had no reasonable ground to believe, and did not believe . . . that the statements therein were untrue or that there was an omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading." Id. (citing 15 U.S.C. § 77k(b)(3)(C)); see also In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1421 (9th Cir. 1994) (citing 15 U.S.C. § 77k(b)(3)(C)).
As previously discussed, the Court finds that Plaintiffs have stated a claim against the Defendants for material misstatement or omission. To the extent that the Defense raised by Foster Pepper involves a factual inquiry as to whether Foster Pepper reasonably relied on "expertised" portions of the offerings, i.e., the Walker Report, the determination is not discernable on a motion to dismiss.
Further, both cases cited by Foster Pepper relate to a specific statutory defense contained in 15 U.S.C. § 77k(b)(3)(C). This statutory defense applies "as regards any part of the registration statement," of a security. Id. In their brief, Foster Pepper points out that their opinion found that the bonds were exempt from SEC registration, (Ct. Rec. 72 at 7). On the record before the Court, here is no persuasive authority to demonstrate that the statutory defense is available where there is no registration with the SEC. Consequently, the Court declines to address this defense as a basis for dismissal under Rule 12(b)(6).
G. Declination of State Claims
Defendants argue that, assuming the Court dismisses Plaintiffs' claims under Section 10(b) and Rule 10b-5, the Court should decline to exercise pendent jurisdiction of the remaining state law claims. See 28 U.S.C. § 1367. The Developers further argue that the Court should dismiss the state law claims, even if federal claims remain, because "the state claims in this case raise multiple issues of state law; that there is pending litigation in state court; and that the State Supreme Court has already entertained the ordinance at the heart of the case at least twice." (Ct. Rec. 34 at 38). The Court has denied Defendants motions to dismiss, so federal claims remain under Section 10(b) and Rule 10b-5. There is insufficient record for the Court to find "exceptional circumstances," or "other compelling reasons" for declining jurisdiction over the state claims at this time. 28 U.S.C. § 1367(c)(4). Accordingly, the Court declines to remand, and retains jurisdiction of state law claims.
IV. CONCLUSION
For the foregoing reasons, the Court finds that Plaintiffs have stated claims against the moving Defendants under Section 10(b) and Rule 10b-5. Plaintiffs have met the heightened pleading requirements the PSLRA, for both misstatement and scienter. Plaintiffs have generally pled in sufficient detail facts supporting their theory of the case. This includes stating the requisite elements of materiality and reliance. For the Developers, Plaintiffs' pleading states a viable claim for controlling person liability under Section 20(a). For Foster Pepper, it is not clear that the statutory defense of reliance on `expertised' portions of the offering statement is applicable for securities that are exempt from registration. If the defense is available, it involves a factual inquiry that is not discernible from the pleadings and documents referenced in the complaint. Because the Court sustains plaintiff's complaint for federal securities law claims, the Court retains jurisdiction over state law claims. Accordingly,
IT IS HEREBY ORDERED:
1. Defendants Lincoln Investment Company, Citizens' Realty Company, and RPS II, LLC's Motion for Stay of Discovery, (Ct. Rec. 31), is GRANTED. This stay is only effective until the date the Court's Scheduling Order is issued. At that time, discovery shall commence in accordance with the Scheduling Order.
2. Defendants Lincoln Investment Company, Citizens' Realty Company, and RPS II, LLC's Motion to Dismiss under FRCP 9(b) and 12(b)(6), (Ct. Rec. 33), is DENIED.
3. Defendants Lincoln Investment Company, Citizens' Realty Company, and RPS II, LLC's Motion for Leave to File Overlength Brief, (Ct. Rec. 35), is GRANTED.
4. Defendant Preston Gates Ellis, LLP's Motion for Joinder in Motions to Dismiss, (Ct. Rec. 61), is GRANTED.
5. Defendant Prudential Securities, Inc.'s Motion for Joinder in Motions to Dismiss Plaintiffs' Claims, (Ct. Rec. 63), is GRANTED.
6. Defendant Prudential Securities, Inc.'s Motion for Joinder in Motion to Stay, Discovery, (Ct. Rec. 65), is GRANTED.
7. Defendant Foster, Pepper, Shefelman PLLC's Motion to Dismiss, (Ct. Eec. 70), is DENIED.
8. Defendants Lincoln Investment Company, Citizens' Realty Company, and RPS II, LLC's Supplemental Motion for Leave to File Overlength Brief, (Ct. Rec. 111), is DENIED.
9. Pages 25 through 32 of Defendants' Lincoln Investment Company, Citizens' Realty Company, and RPS II, LLC's Overlenth Reply, (Ct. Rec. 114), are STRICKEN. The Supplemental Affidavit of Counsel RE: Motion to Dismiss, and all attachments thereto, (Ct. Rec. 113), are STRICKEN. These papers raise matters outside of the pleadings, inappropriate for consideration on motion to dismiss and are therefore excluded from the record at this time.
10. Defendant City of Spokane's Motion to File Overlength Memorandum in Support of Motion to Strike, (Ct. Rec. 115), is MOOT.
11. Defendant City of Spokane's Motion to Strike, (Ct. Rec. 117), is MOOT.
IT IS SO ORDERED. The District Court Executive is directed to
(A) Enter this Order; and
(B) Provide copies to all counsel.