(The article featured below is a selection from Federal Securities Law Reporter, which is available to subscribers of that publication.)

State of Mind Not Relevant to Safe Harbor Determination

A district court (ND Ill) granted in part motions to dismiss three counts in a securities fraud action. Shareholders in a publicly traded real estate investment company alleged that, at the beginning of the credit crisis in late 2008, its officers and directors failed to disclose and materially misrepresented the company's ability to refinance its maturing debt. The shareholders also claimed that the company failed to disclose loans made by the CEO to two officers to help them avoid forced liquidation of their stock. Finally, the shareholders claimed that the company petitioned the SEC to be included on the list of companies protected from short selling and that the officers and directors then engaged in insider trading at artificially inflated prices immediately after implementation of the ban on short selling.

As a threshold issue, the court was asked to determine whether the Private Securities Litigation Reform Act's safe harbor provisions protected forward-looking statements accompanied by meaningful cautionary language but known by the person making those statements to be false at the time they were made. The court declined to follow the lead of other circuits holding that such statements are not protected and concluded that "under the literal language of the safe harbor statute the author of any forward-looking statement—even though a deliberate falsehood—is insulated from liability so long as that statement is accompanied by some meaningful cautionary statement." The court the found that the company's cautionary statements were "meaningful" and protected by the safe harbor provision because they addressed the risk factors and contingencies identified in the complaint. Statements made after it was clear to the company that its efforts to refinance were doomed by the financial climate, however, were not protected. The court went on to consider each statement in turn in order to determine which portions were protected as forward-looking statements and which were not. Those statements that were not protected, such as statements of verifiable fact, survived the motion to dismiss.

The court then found that the concealment of loans made by the CEO to officers violated the company's ethics policy and caused damages to the shareholders because the stock price dropped after the loans were revealed to the market. Regarding scienter, the court held that in a situation such as this one where the company's survival was at stake, it is not impermissible group pleading to assert that corporate officers, by virtue of their positions, knew about the company's serious financial difficulties.

The court then dismissed the second count alleging that the company engaged in insider trading at artificially inflated prices immediately after being listed as protected from short selling. According to the court, the shareholders failed to provide any explanation as to how any of the officers and directors participated in any effort to have the company added to the short-sell ban list and merely asserted that shares were sold after the ban went into effect. Finally, because the shareholders failed to properly plead control, their Section 20(a) controlling person claim was dismissed. The court explained that the complaint improperly offered only a bare assertion that the executives were controlling persons due to their positions without alleging supporting facts other than that status.

Desai v. General Growth Properties, Inc. (ND Ill) is reported at ¶95,348.