Koesterer vs. Washington Mutual, Inc

ORDER granting in part and denying in part (310) Motion to Dismiss; granting in part and denying in part (313) Motion to Dismiss; granting in part and denying in part (316) Motion to Dismiss; granting in part and denying in part (317) Motion to Dismiss; granting in part and denying in part (321) Motion to Dismiss in case 2:08-md-01919-MJP by Judge Marsha J. Pechman.

Western District of Washington, wawd-2:2008-cv-00387

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0 1 2 3 4 UNITED STATES DISTRICT COURT 5 WESTERN DISTRICT OF WASHINGTON AT SEATTLE 6 7 In re Washington Mutual, Inc. Securities, Case No. 2:08-md-1919 MJP 8 Derivative & ERISA Litigation 9 Lead Case No. C08-387 MJP IN RE WASHINGTON MUTUAL, INC. 10 SECURITIES LITIGATION ORDER ON DEFENDANTS' 11 This Document Relates to: ALL CASES MOTIONS TO DISMISS 12 13 14 This matter comes before the Court on five motions to dismiss Plaintiffs' second 15 amended consolidated class action complaint ("Complaint"). (Dkt. No. 293.)1 The motions 16 to dismiss have been filed by: (1) Defendants Goldman, Sachs & Co. ("Goldman Sachs"), 17 Morgan Stanley & Co. Inc. ("Morgan Stanley"), Credit Suisse Securities (USA) LLC ("Credit 18 Suisse"), Deutsche Bank Securities Inc. ("Deutsche Bank"), UBS Securities LLC ("UBS"), 19 Banc of America Securities LLC ("Banc of America"), J.P. Morgan Securities Inc. ("J.P. 20 Morgan"), Barclays Capital Inc. ("Barclays"), Keefe, Bruyette & Woods, Inc. ("Keefe 21 Bruyette"), Cabrera Capital Markets LLC ("Cabrera Capital"), The Williams Capital Group, 22 L.P. ("Williams Capital"), Citigroup Global Markets Inc. ("Citigroup"), Greenwich Markets, 23 Inc. ("Greenwich"), BNY Capital Markets, Inc. ("BNY"), and Samuel A. Ramirez & 24 Company Inc. ("Ramirez & Co.") (collectively, the "Underwriter Defendants") (Dkt. No. 25 1 All citations to entries or filings on the docket refer to case number 2:08-md-1919 MJP. The page numbers refer to the docket number's pagination, not the pagination of the original filing. ORDER ON DEFENDANTS' MOTIONS TO DISMISS - 1 0 1 310); (2) Defendant Deloitte and Touche LLP ("Deloitte") (Dkt. No. 313); (3) Defendants 2 Thomas Casey, Stephen Rotella, Ronald Cathcart, David Schneider, John Woods, and Melissa 3 Ballenger (Dkt. No. 316); (4) Defendants Anne Farrell, Stephen Frank, Thomas Leppert, 4 Charles Lillis, Phillip Matthews, Regina Montoya, Michael Murphy, Margaret Osmer 5 McQuade, Mary Pugh, William Reed, Jr., Orin Smith, James Stever, and Willis Wood, Jr. 6 (collectively, the "Outside Director Defendants") (Dkt. No. 317); and (5) Defendant Kerry 7 Killinger (Dkt. No. 321) (the court refers to Killinger, Casey, Rotella, Cathcart, Schneider, 8 Woods, and Ballenger collectively as the "Officer Defendants"). 9 Having reviewed the motions, Plaintiffs' responses (Dkt. Nos. 332, 333, 334, 335, 10 336), Defendants' reply briefs in support of their motions (Dkt. Nos. 338, 340, 341, 342, 343), 11 and all papers in support thereof, and having heard oral argument from the parties on 12 Tuesday, October 6, 2009 (see Dkt. No. 364), the Court makes the following rulings: (1) the 13 Court DENIES in part and GRANTS in part Defendants' motions to dismiss Counts One, 14 Two, and Three; and (2) the Court GRANTS in part and DENIES in part Defendants' motions 15 to dismiss Counts Four, Five, and Six. The Court's reasoning is set forth below. 16 Procedural History 17 On May 7, 2008, the Court consolidated three related securities class actions as part of 18 a Multi-District Litigation proceeding against Defendants. (Dkt. No. 24.) Defendants filed 19 their first round of motions to dismiss on December 8, 2008, and the Court heard argument on 20 these motions on May 1, 2009. The Court dismissed Counts One, Two, and Three, and 21 granted in part and denied in part Counts Four, Five, and Six. (Dkt. No. 277.) On June 15, 22 2009, Plaintiffs filed their second amended consolidated class action complaint. (Dkt. No. 23 293.) Defendants filed five separate motions to dismiss on July 17, 2009 and the Court heard 24 oral argument on October 6, 2009. 25 ORDER ON DEFENDANTS' MOTIONS TO DISMISS - 2 0 1 Legal Standard and Judicial Notice 2 The standards guiding this court's review of Plaintiffs' Complaint under Rule 12(b)(6) 3 are set forth in the previous Order. (Dkt. No. 277 at 3.) After the Court issued its Order, the 4 Supreme Court decided Ashcroft v. Iqbal, 129 S. Ct. 1937 (2009), which discusses Federal 5 Rule of Civil Procedure ("Rule") 8(a)(2). Iqbal reaffirms the Supreme Court's decision in 6 Bell Atl. Corp. v. Twombly, 550 U.S. 544 (2007) and does not alter the standard the Court 7 previously employed to test those claims in the Complaint subject to Rule 8. As before, "to 8 survive a motion to dismiss, a complaint must contain sufficient factual matter, accepted as 9 true, to 'state a claim to relief that is plausible on its face.'" Iqbal, 129 S. Ct. at 1949 (quoting 10 Twombly, 550 U.S. at 570). 11 Deloitte requests the Court judicially recognize excerpts of Washington Mutual, Inc.'s 12 ("WaMu" or "the Company") amended 2005 Annual Report (Form 10-K/A) and WaMu's 13 2006 Annual Report (Form 10-K), to which Plaintiffs pose no objection. (Dkt. No. 313.) The 14 Court will take notice of these documents and draw no inferences in favor of Defendants from 15 judicially noticed facts. See McGuire v. Dendreon Corp., No. C07-800MJP, 2008 WL 16 1791381, at *4 (W.D. Wash. Apr. 18, 2008). To the extent that Deloitte requests the Court 17 judicially notice the Public Company Accounting Oversight Board's ("PCAOB") Release No. 18 2007-005, the request is denied. This document is not necessary to decide the issues 19 presented in Deloitte's motion. 20 The Officer Defendants request the Court take judicial notice of a number of 21 documents, which largely include SEC filings and conference call transcripts. (Dkt. No. 316.) 22 Plaintiffs object to only one document, a "quasi-editorial Wall Street Journal article criticizing 23 certain accounting rules." (Dkt. No. 333 at 9.) The Court will take no notice of this article 24 (Dkt. No. 319-4 at 43-46), as it is not necessary to decide the issues presented. (See Dkt. No. 25 277 at 4.) The Court will take notice of the other items submitted by the Officer Defendants ORDER ON DEFENDANTS' MOTIONS TO DISMISS - 3 0 1 to which Plaintiffs do not object, and draw no inferences in Defendants' favor. (Dkt. Nos. 2 319-2, 319-3, 319-4 at 1-42.) 3 The Outside Directors ask the Court to take notice of the audit charters of three 4 companies, DTS, Inc., VirnetX Holding Corp., and Morgan Stanley. (Dkt. No. 317 at 13.) 5 Plaintiffs object and argue that these documents are not relevant to deciding the Outside 6 Directors' motion. (Dkt. No. 335 at 7.) These documents are not necessary to decide the 7 issues presented in the motion and the Court declines to afford them judicial notice. 8 Killinger requests the Court take judicial notice of 44 documents, including earnings 9 call transcripts, conference call transcripts, and SEC filings, to which Plaintiffs object. (Dkt. 10 No. 323; Dkt. No. 334 at 3.)2 The Court takes notice of these documents, except Exhibits DD 11 (The New Yorker article), GG (OTS release), HH (FFIEC press release), KK (FDIC 12 quarterly), and MM (abstract related to FASB) of the Davis Declaration, which are not 13 necessary to decide the issues presented in the motion. 14 Discussion 15 Plaintiffs bring this action on behalf of a putative class of individuals who purchased 16 securities issued by WaMu or its subsidiaries from October 19, 2005 to July 23, 2008 (the 17 "Class Period"). Plaintiffs have substantially edited their initial Complaint, which lacked 18 "proper structural organization and coherent pleading." (Dkt. No. 277 at 19.) Plaintiffs' 19 amended Complaint is now 267 pages and 877 paragraphs, in which Plaintiffs present cogent 20 and concise allegations against Defendants. As before, the Complaint asserts claims under 21 §§ 10(b) and 20(a) of the 1934 Securities and Exchange Act (the "Exchange Act") and Rule 22 10b-5 promulgated under § 10(b) of the Exchange Act (Counts One, Two, and Three), and 23 24 2 25 Killinger also provides the Court with documents that summarize and categorize allegations in the Complaint. (See Dkt. Nos. 321-2, 321-2.) The Court has conducted an independent review of the Complaint in its consideration of these motions and does not rely on these summaries and appendices. ORDER ON DEFENDANTS' MOTIONS TO DISMISS - 4 0 1 Claims under §§ 11, 12(a)(2) and 15 of the 1933 Securities Act (the "Securities Act") (Counts 2 Four, Five, and Six). 3 Plaintiffs' allegations focus on WaMu's residential lending practice, which was 4 WaMu's major "business driver and the source of 70% of WaMu's net interest income." 5 (¶ 19.)3 In an effort to increase net income, WaMu allegedly commenced a drive to originate 6 more loans, which were either sold to third parties or kept in WaMu's held-for-investment 7 portfolios. (¶¶ 17, 44.) To meet the demand for more loans, WaMu allegedly engaged in a 8 host of improper activities that it hid from investors, and which caused WaMu's stock and 9 securities to be artificially inflated. (Id.) Specifically, Plaintiffs allege that WaMu and 10 Defendants: (1) deliberately and secretly decreased the efficacy of WaMu's risk management 11 policies; (2) corrupted WaMu's appraisal process; (3) abandoned appropriate underwriting 12 standards; and (4) misrepresented both WaMu's financial results and internal controls. (¶ 1.) 13 The following paragraphs provide a brief summary of Plaintiffs' allegations. 14 Plaintiffs allege that WaMu relegated its risk management group to a "customer 15 service" role to encourage loan volume at the expense of sound credit risk management. 16 (¶ 3.) The Officer Defendants are alleged to have led this drive. (Id.) WaMu also allegedly 17 pressured and hand-picked appraisers willing to abide by WaMu's dictates to inflate appraisal 18 values for homes on which WaMu sold loans. (¶ 4.) This artificially lowered the loan-to- 19 value ("LTV") ratio and created "the illusion of lower credit risk." (Id.) Confidential 20 witnesses ("CWs") from various levels and geographic locations within the Company 21 corroborate WaMu's lax underwriting guidelines, its practice of selling loans to borrowers 22 with extremely low Fair Isaac Credit Organization ("FICO") credit scores, its failure to 23 request documentation or verification of a borrower's stated income, and its habitual 24 underwriting of Option Adjustable Rate Mortgages ("ARMs") to the introductory or "teaser" 25 3 All paragraph citations refer to the Complaint (Dkt. No. 293). ORDER ON DEFENDANTS' MOTIONS TO DISMISS - 5 0 1 rate instead of the fully-indexed rate. (¶ 5.) WaMu also allegedly increased sales of Option 2 ARM loans, which, though classified as "prime," led to high rates of default and negative 3 amortization because they were improperly underwritten. (Id.) WaMu is also alleged to have 4 increased its credit risk by causing the subprime underwriting guidelines to become "nearly 5 nonexistent as underwriters were encouraged to allow exceptions to increasingly permissive 6 standards." (Id.) These actions collectively increased WaMu's credit risk, which was not 7 disclosed to the investing public. 8 Plaintiffs allege that WaMu misstated its financial condition and misled investors as to 9 the condition of its internal controls. (¶ 6.) Generally accepted accounting principles 10 ("GAAP") and SEC regulations required WaMu to "increase the Company's provision for its 11 Allowance in a manner commensurate with the decreasing quality of its home mortgage 12 products." (Id.) Plaintiffs allege that WaMu under-reserved for the increased credit risk it 13 created as described above. (Id.) Plaintiffs allege further that WaMu's Loan Performance 14 Risk Model ("LPRM"), used to determine the Allowance, did not take into account important 15 credit risks, such as the potential for negative amortization from Option ARM loans and the 16 increased credit risk from WaMu's permissive underwriting standards and distorted LTV 17 ratios. (Id.) By under-provisioning its Allowance, WaMu misstated and artificially inflated 18 its net income and earnings per share in each quarter of the Class Period. (Id.) Additionally, 19 WaMu allegedly misrepresented the state of its internal controls, which were weakened in 20 order to facilitate